China was the first country to suffer a COVID-19 health emergency, and the economic fallout from virus containment measures. Economic data released so far has led S&P Global Ratings to revise down its full-year GDP growth forecasts 2.9%, from 5.7% pre-outbreak. In terms of the country's still-nascent securitized assets market, the first round of data is now available--its shows volatility has increased, though not dramatically. However, risks remain tilted to the downside.
In this article, we address investor's questions about the performance of our rated China auto-loan asset-backed securities (ABS) and residential mortgage-backed securities (RMBS) amid the economic fallout from the domestic and global health emergency. The asset performances in February are especially critical as they reveal COVID-19 impact on securitized portfolios for the full month, as well as the effects of financial relief measures provided to obligors who have applied and been accepted for loan extensions.
Some policy measures should alleviate borrowers' financial stress, at least temporarily. However, forbearance on timely loan payments has the potential to stall cash flows to securitized portfolios. While delinquencies for both auto ABS and RMBS are up only slightly from a low base, we anticipate the impact could nonetheless be lagged. Hence we stress-test for scenarios including a jump in late loan payments.
S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Frequently Asked Questions
What broad measures has the China government adopted in response to the economic fallout of the health emergency?
At this stage, the relief is focused on stabilizing financial conditions. The People's Bank of China has injected liquidity to smooth volatility in markets. Authorities have also guided financial institutions to ease financial burdens on households, small and midsize enterprises, and affected manufacturers. For example, announcements since late January have guided financial institutions to consider flexibility on loan repayment from individual borrowers who are infected with COVID-19, quarantined, medical staff, or temporarily unemployed due to the outbreak.
In our view, these announcements provide high-level guidance but do not specify execution details. Hence, actual financial relief measures offered by financial institutions vary slightly.
Will forbearance offered by financial institutions extend to obligations underlying auto loan ABS and RMBS?
Theoretically, yes, but so far the impact has been limited. The main financial relief measures offered by financial institutions (transaction servicers in the securitization context) include a grace period for one monthly payment and a waiver of late-payment fees. For example, if a monthly instalment fell into a defined period from a certain date in January to a certain date in February, affected borrowers could apply for a grace period, which could be a period such as two weeks, 20 days, or a month (or longer for borrowers in Hubei province). Details vary from servicer by servicer. Penalties on the overdue amount can be waived if payment is made within the grace period.
As part of our regular and ad hoc surveillance process, we learned from the servicers that only a limited number of loan payments have been granted extensions under the financial relief measures. This is supported by asset performance, which has only modestly deteriorated (see below). Moreover, most of the servicers have a process in place to request proof of burden and check historical payment records before granting financial relief.
How did China auto loan ABS and RMBS rated by S&P Global Ratings perform in February?
The delinquency rate increased from a low base. In absolute terms, arrears rose modestly in in January and February.
Our key observations are as follows:
- In terms of the 11 China auto ABS we rate, the weighted average 1-30 days past due (dpd) ratio rose to 1.5% in February, from 1.1% in January--higher than 0.9% over the Lunar New Year (LNY) break in 2019, which fell in February 2019. The weighted-averaged 31-60 dpd ratio increased to 0.13% in February from 0.04% in January, compared with rates that went no higher than 0.03% throughout 2019.
- With respect to the five China RMBS we rate, the weighted-average 1-30 dpd ratio rose to 0.8% in February, from 0.3% in January--and also 0.3% over the LNY break in 2019. The weighted-average 31-60 dpd ratio increased to 0.14% in February from 0.04% in January--the range it averaged throughout 2019.
Is January and February performance data useful--or is too early to tell?
We believe the latest collateral performance reports improved the visibility of future performance. The data for February are especially critical as they reveal a full month's impact from COVID-19 on securitized portfolios, as well as the effects of financial relief measures provided to obligors who have applied and been accepted.
Nonetheless, we expect asset quality of the auto ABS and RMBS we rate to remain under pressure over the next three to six months. Some industries are not immune to overseas market turmoil, and the disruptions to global supply chains. Continued fallout could lead to job or pay cuts for workers due to reduced demand.
This said, our channel checks indicate that business operators and people's daily lives are gradually returning to normal. This is based on information from industry sources, as well as on-the-ground observations. In addition, we expect transaction servicers to fully resume their operation over the next few weeks.
What is the trend on asset principal collections?
The monthly principal collections are decreasing mainly due to a declining prepayment rate.
Our observations are as follows:
- For the 11 China auto ABS we rate, the weighted-average monthly prepayment rate dropped to 0.1% in February from around 0.3% during most of 2019.
- For our five rated China RMBS, the weighted-average monthly prepayment rate fell to 0.2% in February.
- As in prior months, scheduled principal repayment rates on the initial pool balance show a general trend of stable decline in January and February as underlying loans gradually matured, which is common for pools containing equal-installment loans. For portfolios containing balloon loans, the principal repayment ratios used to be more volatile, depending on the timing and portion of balloon payments. The ratios are also more sensitive to seasonal effect and macro environment changes, and this is why there has been some volatility in recent months despite the generally declining trend.
In our view, February's decline in prepayments may extend the expected maturity of notes for the transactions adopting a soft amortization schedule; this is given the slowing prepayments could prolong investors' holding of notes beyond the original schedule.
As part of our surveillance process, we also closely monitor the correlation between the principal repayment trend and reported delinquencies. This is because we consider principal collections as a potential indicator of delinquency reporting action.
How does S&P Global Ratings address the potential risks arising from payment delays due to forbearance?
In China auto-loan ABS and RMBS transactions, pass-through is the most common payment structure. Therefore delayed payments of underlying loans would decrease notes' pay-down speed. They could also increase the chance of negative carry because a special purpose trust issuer still needs to pay regular costs to keep a transaction running.
Data for the first two months indicate that asset performance has not dramatically deteriorated, given that only a small portion of loans were granted special coronavirus-related grace periods. Nonetheless, we conducted several stress tests to see how well structures would hold up in the event of rising late payments or other types of market disruption.
We test for a scenario of low asset collections to assess the effect of negative carry. Our low prepayment assumptions, which range from 0.5% per annum (p.a.) to 2.0% p.a. for ABS and 3.0% p.a. for RMBS, have captured reduced asset collections to an extent covering current circumstances.
We also applied additional payment-delay stress to further test cash flow adequacy of rated transactions. We found that China auto loan ABS and RMBS have sufficient cash flows to absorb the impact of payment delays in 30%-40% of monthly collections over six months. This is largely because of their adequate credit enhancements and structural support from principal draws and liquidity reserves. These structural features allow issuers to bridge timing mismatches between available collections and payment obligations, and therefore mitigate the risk of temporary cash flow disruptions.
How does the COVID-19 pandemic affect securitizations in China from an operational perspective?
Financial-sector business operations have been delayed or suspended since the start of LNY in late January. Most automotive finance companies and banks did not start to resume normal business operations until mid-February to early March. Such disruptions make it harder to manage and grow auto ABS and RMBS. Of the three key fronts--namely regular collections, arrear management, and loan origination--we believe arrear management is most vulnerable to fallout from the health emergency.
Regular collections: The hit is minimal and short-term because almost all borrowers in China are required to set up direct-debit to repay their auto loans and mortgage loans. Mobile-phone applications are getting popular too as a supporting payment method.
Arrears management: This part of the business is more labor-intensive and thus more disrupted by suspended activities related to COVID-19. Typically transaction servicers utilize both automated processes, such as automatic outbound SMS and calling, as well as manual approaches such as reaching out at debtors through call centers at early delinquency stages, or for low-risk overdue accounts. As overdue accounts approach the late delinquency stage or high-risk category, transaction servicers tend to engage third-party collection agencies or law firms to intensify collection efforts. Social distancing in China in the past few weeks would have made labor-intensive measures extremely challenging, if at all possible. We expect such disruptions will temporarily increase carryover rates on severe delinquencies, and reduce recovery after default, before servicers can fully resume their operations over the next few weeks. As a result, carryover rates are likely to get back on track and recovery rates to bottom out over the next two to three months.
Origination: The stall in loan origination will likely be temporary and have a negligible impact on the auto ABS with revolving structure. This is based on our expectation that loan origination was low in February but should gradually recovery over the next few months. Respective originators in revolving transactions can maintain loan transfer due to their relatively large loan books. Auto ABS generally accounts for 10% or less of auto finance companies' loan books.
Overall, we believe originators/ servicers of our rated transactions have presented competent business continuity practices in response to COVID-19 impact, demonstrating, for example, system capability and data backup efficiency in the face of disruptions. It helps that most ABS operations are not labor intensive, and regular collections can be done by direct debit. Servicers were also able to execute alternative arrangements, such as working remotely or splitting workforce among different locations.
- Asia-Pacific Economic Forecasts: The Cost Of Coronavirus Is Now US$620 Billion, March 22, 2020.
- COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure, March 17, 2020
- COVID-19 Macroeconomic Update: The Global Recession Is Here And Now, March 17, 2020
- How S&P Global Ratings Factors In The Potential Effects Of The COVID-19 Outbreak When Analyzing China Auto ABS And RMBS, March 4, 2020
- China Auto ABS And RMBS Must Brace For Coronavirus Impact, Feb. 3, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||Andrea Lin, Hong Kong (852) 2532-8072;|
|Secondary Contacts:||Jerry Fang, Hong Kong (852) 2533-3518;|
|KY Stephanie Wong, Hong Kong 85225333529;|
|Carol Hu, Hong Kong + 852-2912-3066;|
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