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A Primer On China's Auto Loan Asset-Backed Securities


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A Primer On China's Auto Loan Asset-Backed Securities

The growth in auto loan ABS in China will continue over the next two to three years at least. Despite the COVID-19 pandemic, issuance went up by 16% year-on-year (YoY) in the first half (1H) of 2021, following only a mild decline of 1.3% in 2020.

S&P Global Ratings believes the potential increase in auto sales, the need for diversifying funding channels, and steady penetration rate in China will continue to fuel the growth in auto loan ABS. However, we believe the growth rate will be mild following an increasing use of revolving structure.

China's auto loan ABS segment will particularly benefit from the country's dominant position in the global automobile market. We see good potential for auto sales volumes in China to expand at a pace that few other markets in the world can match. As of end-2020, China remained the world's largest new-car sales market with annual sales of 25.3 million units. According to China Association of Automobile Manufacturers, automobile sales (by unit) increased 169.4% from 2008 to 2020, representing a compounded annual growth rate (CAGR) of approximately 8.6% (see chart 1).

Chart 1


Table Of Contents


1.Dynamics Of The Auto Loan And Auto Loan Market In China

1.1. Positive developments in China's auto market

In our view, China's economic recovery and favorable government policies will continue to support the momentum. Some of the stimulative policies include encouraging automobile sales in rural areas, subsidies for the disposal of automobiles, and sales tax waiver for more fuel-efficient vehicles like new energy vehicles (NEV).

The future is increasingly electric  

NEV sales will continue to ramp up. In 2020, about 1.4 million NEV were sold in China, representing about 5% of the country's passenger car market and approximately 41% of all global NEV sales. The Chinese government aims to achieve carbon emission peak before 2030 and carbon neutrality by 2060. To achieve this goal, the government has been promoting the transition to a green and sustainable society. It targets to increase the proportion of NEV sales to 20% of total auto sales by 2025, from 5.4% in 2020. This implies a CAGR of 30%-40% during 2021-2025.

In our view, the government's ambitious growth plan is supported by strengthening battery technology, wider product offerings, novel purchase modes, and growing infrastructure support for NEV.

Such positive industry developments have caused the NEV penetration rate to surge to 9.4% in 1H 2021, and 12.7% in June 2021, from 5.4% in 2010. In our view, NEV sales growth will continue to outpace that of internal combustion engine (ICE) vehicles in China as these vehicles receive wider consumer acceptance.

Supportive government policies boost used vehicle sales  

Car buyers in China had preferred to buy new vehicles due to the relatively low acquisition cost, less transparent second-hand car prices and vehicle conditions, and complications related to moving vehicles between provinces.

However, the used car market has grown rapidly in recent years. Used cars' turnover in China increased to over 14 million units in 2020, from 9.2 million units in 2014, representing a CAGR of approximately 9.3% (see chart 2). The surge in used car sales was mainly driven by the rapid development of e-commerce platforms and announcement of favorable policies such as tax reduction and simplification of used vehicle registration and trading. The used car to new car sales ratio went up to 0.65x in 1H 2021, from 0.39x in 2014.

Chart 2


We see room for substantial growth when compared to the U.S. and the U.K. where the ratio was more than 2x and 4x, respectively. We anticipate used car sales will grow at a slightly faster pace than that in the past few years, but are less likely to surge in the next two years despite the room for growth.

China's commercial vehicles sales outshine the world's  

Global sales of commercial vehicles declined 8.7% to 24.4 million in 2020, from 26.7 million in 2019. The decline was attributable to the slowdown in business activities during the pandemic. Meanwhile, China was the only one in the top 10 markets that recorded sales growth, with a surge of 18.7% in 2020 (see chart 3).

Chart 3


We believe China's remarkable auto sales growth amid the pandemic was partially driven by the rising demand for light commercial vehicles (LCV), given more infrastructure projects have commenced in China. It was also partly fueled by the nationwide implementation of China's stage six emission standards for light duty vehicles, effective from Jan. 1, 2021. Under this standard, light duty vehicle production after this date must follow the China's stage six emission standards, and vehicles that only meet the country's stage three emission standards or below will be gradually eliminated.

Top 10 players dominate the fragmented automobile market  

About 100 brands compete for sales in China's auto market, but the top 10 passenger car manufacturers accounted for about 89.8% of aggregate unit sales in 2020. Shanghai Volkswagen, FAW-Volkswagen, and Dongfeng Motor Corp. were the three largest passenger car manufacturers in China last year (see chart 4). Since July 2020, Chinese brands have gained shares in the passenger vehicle market, which is likely the result of the "going to the countryside" campaign, which encourages some of the more price-sensitive consumers in lower-tier cities to purchase cars (see chart 5). In our view, such policies will continue to support this trend in 2021. For premium brands, we believe consumption upgrades and the launch of more compact models will support continued market share expansion (see chart 6).

Chart 4


Chart 5


Chart 6


1.2. Major trends that matter to auto loan ABS

NEV will remain in the spotlight over the medium term 

NEV started to gain ground only in recent years. Therefore, loans backed by NEV currently account for a very insignificant portion of the loans books of most auto finance companies (AFCs) in China. Demand and supply of NEV will grow in the coming years for the country to achieve long-term carbon neutrality. We anticipate that the government's stimulus and favorable policies will be spawn more innovative financial products to finance the purchase of NEV. In consideration of the growing demand for flexibility in car ownership and customers' concerns on the usage life and battery lifespan of NEV, some AFCs are offering operating lease products and balloon lease products with return options.

To date, auto loan ABS backed by NEV exclusively is rare in China. However, green securitization has slowly emerged in the last couple of years with the debut auto ABS transaction securitized by 100% NEV loans issued by China Merchants Bank in 2019. In June 2021, Shanghai Automotive Group Finance Co. issued the first green auto ABS in China' interbank bond market. The green auto ABS is backed by auto loans for purchasing NEV and certified by a third-party evaluator as contributing to carbon dioxide reductions. The green auto ABS has to meet a list of criteria set by the regulator, including the usage of issuance proceeds with a system to track usage afterwards.

NEV will remain a target growth area over the medium term. However, we do not anticipate NEV-backed auto loans to account for a meaningful portion of the securitized pool across transactions during this period. Having said that, with more NEV models to be launched in the years to come, we expect a gradual increase in the proportion of loans backed by NEV to be securitized.

Used car loans will increase modestly  

Although the majority of retail auto loan products in China are for new car purchases, used car loans are growing fast due to the increasing participation of AFCs, finance lease companies, and used-car e-commerce platform. Used car loans currently account for a low single digit percentage of most AFCs' loan books, and in some cases a small proportion (typically less than 5%) of the initial pool balance are securitized.

In our view, used car loans tend to underperform relative to loans backed by new cars, as borrowers' willingness to repay tends to decrease when the pre-owned cars become obsolete with a lower residual value relative to the new vehicles. Besides, used car loans in China are prone to fraud risk as the borrower segment is different from typical prime borrowers.

Having said that, some AFCs have reacted promptly with fraud prevention processes and implemented measures to mitigate potential fraud risk when such risk emerged in 2018 and 2019 in the auto finance industry in China. They have also tightened financing terms, such as shorter loan tenors and higher down payments, to mitigate credit risk. That said, idiosyncratic risk cannot be underestimated as some AFCs are new to used vehicle financing. Also, it is plausible that new types of fraud might not be detected throughout the loan underwriting process.

With an increase in the trading of used cars and demand for financing, we believe used car loans will increase but will not form a significant portion in pools backing auto ABS in the next two years. However, should there be a notable surge in the underwriting of used cars loans, we will need to take a further deep dive into major aspects of used car loans when conducting credit analysis.

More LCV could be securitized, underpinned by the sales growth and stable asset performance 

Certain AFCs, especially those that finance a wide array of vehicle brands relative to industry peers, have started to securitize loans backed by LCV. Based on limited historical data available to us, we consider loans backed by LCV tend to perform better and exhibit higher prepayment rates than the aggregate portfolio of the AFCs that finance various brands.

According to certain originators, this is because the LCV in such loans are used as a tool for business like logistics or delivery services. There is a higher incentive for the borrowers to repay timely so that they can continue using the vehicle for business. The replacement cycle also supports the better asset performance given borrowers of LCV tend to sell the vehicles in two to three years to buy new vehicles and repay the loans as soon as they receive a lump sum of earnings. In contrast, borrowers of passenger vehicles have lower incentive to prepay loans for the purchase of new cars.

Some AFCs have securitized a portion of LCV in the asset pool, with an aim to securitize better assets to lower funding costs and achieve higher ratings. We expect an increase in the number of transactions issued by local AFCs that are backed by a certain portion of LCV loans, particularly if the AFCs have shifted to originate more LCV loans and such loans exhibit better performance than the aggregate loan book.

2. Characteristics Of The Auto Loan Market In China

2.1. Type of auto financing

Auto finance in China can be in the form of loans or leases provided by commercial banks, AFCs, and other financing companies, which are extended to retail and institutional buyers and auto dealers for new or used car purchase. The development of auto finance in China goes hand in hand with the expansion of China's automobile market. An increasing number of AFCs have set up leasing arms to develop finance lease and operating lease business in recent years to meet customers' demand and enhance market penetration.

China's auto financing business started in the late 1990s. Commercial banks provided most of the auto loans at the early stage, before AFCs entered the market in 2004. To date, almost every major commercial bank and about 25 specialized auto finance companies are providing auto finance in China. Most AFCs are manufacturer-captive finance companies.

2.2. Type of auto loan originators

AFCs and commercial banks are two major licensed players in China's auto loan market. Other auto financiers, such as leasing companies, consumer finance companies, internet finance companies and micro-loan providers, only represent a small portion of the industry.

2.3. Loan size industry-wide

Average loan size in the past few years ranged from Chinese renminbi (RMB) 50,000 to RMB 80,000. In the first half of 2021, the average loan size increased to RMB63,539 from RMB58,478 as of end-2020 (see chart 7). The average loan size in a typical issuance size of RMB 3 billion - RMB5 billion contributes to the granularity and good diversification of the securitized pools.

Chart 7


2.4. Typical auto loan products and recent trends

Typical auto loan products include the following:

  • Fully-amortizing loans. A vast majority of the auto loans in China are fully-amortizing loans with equal monthly principal and interest instalment, or equal principal repayment.
  • Balloon/Interest-only loans. In China, the share of balloon loans that have a big portion of repayment due at maturity is rising but remains at a single-digit percentage for most financiers. For such loans, the loan tenors are shorter (usually three years or less) and the down-payment ratio tends to be higher for the financiers to mitigate credit risk. During the pandemic in 2020, many AFCs introduced interest-only balloon loans as a promotional campaign. Such loans typically have a shorter loan tenor of one to two years, and require high down-payment of 50%, with a balloon payment upon maturity.
  • Subvented loans. Zero interest or low interest rate loans are often offered by the manufacturers to subsidize their captive finance companies for sales stimulation purpose. Subvented loans are also offered to cash buyers to boost sales and penetration rate. The effective interest rate could settle at around 10%, depending on lenders' marketing strategies and subvention from manufacturers.
  • Add-on products. Increasingly more AFCs have been offering add-on loans to finance the purchase tax amount, GPS devices, decoration and insurance premium for extension warranties, etc. on top of the financed vehicle. The financing amount is generally limited to certain percentage of vehicle price and capped at a certain amount, based upon the underwriting criteria of the AFC per se.

Recent trends that we have observed include the following:

  • Fixed-rate loans dominate. Prior to the conversion of the loan prime rate (LPR) in China in August 2020, an auto loan could be priced either at fixed rate, variable rate (with the rate to be reset at the lender's discretion), or floating rate (based on the lending rate of People's Bank of China [PBOC]). Following the LPR conversion, all AFCs have converted nearly all variable rate and floating rate loans to fixed rate loans, and the new loans originated since the beginning of 2020 are priced at fixed rate. Floating rate loans, if present, would be very rare.
  • Shift to longer tenor. While two- and three-year loans are still the majority, more longer tenor loans (four- and five-year) have been originated in the past year. A shift to longer tenor was mainly driven by market demand, seasonal promotions offered by the manufacturers, the need to match assets and liabilities, as well as to enhance the overall portfolio yield.
  • Growing and changing demand of younger customers. The younger generation has become the target customer segment of most AFCs, as the market generally expects generations born after 2000s (Generation Z) will emerge as an important buying group for automobiles in China in the long term. According to a report released by the China Automotive New Consumption Forum in 2020, Generation Z consumers' spending in China accounts for 15% of the household expenditures, compared to 5% in France and 4% in the U.S. This relatively young consumer group is more willing to spend on cars and more eager to take on financing than the older generations. Increasingly more AFCs have started to offer long tenor loans (up to five years) in the past few years to meet the increasing demand from the young customers who have lower income in general, since a longer tenor can allow them to repay at a lower monthly instalment.
  • Changing preference for ownership. Another trend we have observed is that the younger generations are embracing the idea of paying for using vehicles and trading-in for newer models later, so the traditional preference for ownership may gradually change. More and more vehicle manufacturers in China now have affiliated lease companies to address these demands, in addition to the traditional auto loan businesses.
  • Penetration to lower-tier cities. Slowing auto sales in major cities in China has encouraged the penetration of both vehicles and auto financing to the lower-tier cities in the past few years, especially for the economy brands focusing on the mass market. For some AFCs, lower-tier cities could be less familiar for them and therefore a test in areas such as borrower credit assessment and loan underwriting.
2.5. Regulatory dynamics

The PBOC and China Banking and Insurance Regulatory Commission (CBIRC) are the main regulators.

China's auto loan market has relatively stringent regulatory oversight.   Auto loan underwriting standards are regulated in China. The "Auto Loans Management Guideline" promulgated by the PBOC and CBIRC constitutes the following basic loan underwriting requirements that all AFCs and commercial banks must follow in their auto loan business:

  • Credit history. The borrowers need to have good credit history, with demonstration of stable income or other property to support the down payment and continued debt servicing.
  • Loan tenor. The terms of the loan financing a new vehicle should not be longer than five years, and the terms for preowned-vehicle loan should not be longer than three years.
  • Loan-to-value ratio. The highest loan-to-value (LTV) ratio on retail loans is 80% for new passenger vehicles, 70% for traditional commercial vehicles, 85% for NEV, 75% for NEV commercial vehicles and 70% for preowned vehicles. The value of the vehicles for the calculation of LTV ratio should be the lower of the manufacturers' suggested vehicle price and the amount actually paid by the purchasers (for new vehicles). The LTV ratio for a typical auto loan in China is currently in the range of 60% to 65%.

There is greater flexibility over mortgage requirement. Regulations state that borrowers with good credit quality and debt serviceability may have loans without mortgages on the vehicles financed. We have seen some AFCs offer loans without mortgage registration to customers with high creditworthiness in some selected cities such as Beijing and Shanghai, where the process for mortgage registration is relatively time consuming.

2.6. Underwriting criteria

In addition to complying with the loan underwriting requirements set forth by the Chinese regulators, auto financiers have put more efforts into risk management and prudent underwriting in the last couple of years, with more proficient use of nationwide obligor credit information database and identity-check systems for fraud prevention, and continued enhancement in credit-scoring system.

PBOC credit bureau check  

The PBOC administrated Credit Bureau provides personal and entity credit records that can be assessed by auto financiers for credit checks. A nationwide credit system was first implemented in 2006 and covered about 1 billion people by 2019. With an upgrade beginning in 2020, the second generation of the system is said to have enhanced key functions including information quality, usefulness, and security. This said, it will still take a bit of time before AFCs can take advantage of the second generation to further enhance credit models or scorecards.

Other government data and external source  

In addition to PBOC credit report, AFCs also perform check against internal policy rules, and conduct the customer's identity verification check from the National Citizen Identity Information Center, the CBIRC's blacklist and internal blacklist. Besides, external data sources are usually used for cross checking to identify multiple borrowing behavior and fraud prevention. A common source of credit check is the use of Baihang Credit, which is the first licensed personal credit agency in China and operates under the supervision and guidance of the PBOC.

Sophisticated score card  

Most of the AFCs have developed a quantitative credit-scoring system for credit assessment. The applicant's employment stability, residential stability, income and assets level will be considered.

The scoring models typically assess the obligor's creditworthiness and assign each obligor with a credit score, based on statistical parameters including the development of historical performance of the loan asset portfolio, customer's characteristics and demographic data, credit history, loan products, market conditions and financed vehicles information.

The scoring model of some sophisticated AFCs (especially those with a highly integrated risk-management and technology platform with their parent group) generates a risk score that predicts each applicant's probability of default. Based on the credit score and internal policy rules, the credit-scoring system will make automatic approval, rejection or refer the case for manual approval.

2.7. Servicing practices

Mandatory direct debit  

Borrowers are required to set up auto-debit bank accounts with major national banks for monthly repayment before loan disbursement. This is an industry practice. In some cases, payments can be concentrated on particular days of the month.

Heavy use of information technology  

Most AFCs employ a comprehensive information technology system to support loan operations and mitigate operational risk. The information technology system can flag loans and track payments, thereby assisting the collections team to monitor the loan book's performance on an ongoing basis.

Frequent use of risk models and behavior scorecard  

Risk models and behavior scorecards are the most frequently adopted approaches to identify risks before potential delinquencies. Based on the early alerts generated by the monitoring system, the collections team will follow up with borrowers. Some well-established AFCs have developed a collection scorecard for delinquent customers to analyze customer payment behavior, manage the collection process, as well as to deploy effective collection and recovery strategies in early stage.

2.8. Arrear management practices

Staged approach  

Most AFCs take a staged approach in their collection process based upon the number of days overdue and risk level. When a contract falls into arrear, the collection process typically begins with automatic text messaging and phone notification within the first 30 days delinquency. The collection team will contact customers through phone calls, send out text messages and official letters when the payment has been overdue for more than 31 days.

When payment has been overdue for more than 45 to 60 days, AFCs usually start on-site collections and engagement of collection agencies for outsourced debt recovery and vehicles repossession. If a loan has become more than 90 to 120 days overdue, the AFCs may take legal action via court process. AFCs would generally charge off loans that have been delinquent for more than 120 days or 180 days, depending on their internal charge-off policies, which take into consideration relevant regulatory policies.

Different AFCs may deploy different collection and recovery methods at different stage, based upon their arrear management practices, nature of the loan products and customer's risk level. However, AFCs in general do not rely on car repossession for loan recovery due to the enforcement process in China. Should there be any remaining amount owed to the originator after a vehicle is sold, including costs and expenses incurred during the collection process, the originator has the right to continue pursuing the obligor, due to the full-recourse nature of the loan contract.

Risk-based approach  

Some AFCs adopt a risk-based approach to arrears management. They manage loans that require additional servicing or collection efforts through internal customer follow-up system, supported by risk-classification queuing and call-monitoring software. All loans in the customer follow-up system are automatically reviewed and assigned a risk classification code, based on customer characteristics, loan terms, customer payment history, and payment patterns. The classification code will determine the priority and collection strategy of the delinquent loan based on its risk classification.

3. Auto Loan Securitization In China Has Been Expanding

3.1. Issuance size

Since the normalization of securitization in 2013, the auto loan ABS issuance surged for seven years (see chart 8). The annual securitization volume increased to RMB194 billion (US$29.9 billion) in 2020, from RMB42.4 billion (US$5.4 billion) in 2015, a CAGR of approximately 35.5%.

Chart 8


Although the outbreak of COVID-19 temporarily curbed vehicle sales in China in 1H 2020, the market environment strengthened significantly from the second half of 2020 through 1H of 2021. New auto loan ABS issuance volume reached RMB121.5 billion (US$19 billion) in 1H2021, an increase of 16% YoY. The rapid growth is partly due to the low base in the 1H 2020, as well as the favorable issuance atmosphere. Many frequent originators made repeated issuance, in order to tap offshore investors and capture benefit from the current low interest rate environment.

We believe economic recovery and favorable government policies will continue to support the ongoing growth in new issuance in the coming year.

3.2. Key issuers are affiliates of global majors

China auto-loan ABS leverages global securitization experience  

Many AFCs in China are affiliates of global operators such as BMW, Ford, General Motors, Nissan, Toyota, and Volkswagen. These global financiers have engaged in securitization transactions in recent years in the U.S., Europe, Japan, and Australia, and now leverage their experience in China. We believe most of the underwriting standards and deal structures in China are similar to those in other markets. An exception is product composition, which tends to be more conservative in China.

In our view, linking the local offerings with originators' global issuance practices has hastened the learning process in deal origination and structuring, making quick offerings possible. Investors also might have greater confidence over the performance of China auto-loan securitization because similar structures have already been tested in other markets. International investors meanwhile find it easier to analyze Chinese transactions because they are already familiar with the global peers.

In recent years, an increasing number of local AFCs have made their debut in the securitization market. Auto ABS issuance provides an important funding source for local AFCs. Since 2018, we have seen frequent and regular issuance backed by leading domestic auto manufacturers such as BYD Co. Ltd., Chery Automobile Co. Ltd., and Anhui Jianghuai Automobile Group Co. Ltd. (see chart 9). Despite the relatively small issue size, local AFCs are actively tapping ABS market with different structures and underlying securities (such as auto lease ABS, and ABS backed by NEV). Currently, most of their issuances are supported by domestic investors. However, more local AFCs are exploring the feasibility of tapping offshore investors.

Chart 9


3.3. Asset characteristics

Prime and diversified borrowers  

China's auto loan ABS issues to date are backed only by borrowers classified as prime. In addition, the loan pools in China are with diversified borrowers and geographic distribution.

Mostly backed by new vehicles 

China's auto ABS deals are nearly all backed by new vehicles. In the U.S. and Europe, the deals generally contain a mix of new and used vehicle loans.

NEV backed issuance may gain momentum  

Frequent originators have included a small amount of loans backed by NEV in the securitized pool. Considering the evolving ESG landscape in China, China has set the goal to increase the proportion of NEV to 20% of total car sales by 2025. Besides, major cities have also adopted license plate control for conventional ICE to lower carbon emissions. The control measure drives up sales of NEV and NEV financings accordingly.

LTV ratios will remain low  

Auto loan pools securitized in China usually have original LTV ratios of 70%-80%, with the weighted average remaining LTV ratio ranging from 60% to 65%. This is relatively low compared with auto loan pools securitized in the developed markets, which are usually 80%-100%, or even more for subprime.

Most loans are fully amortizing loans 

Most auto loan receivables securitized in China are fully amortized, with level payment every month. Balloon or bullet contracts exist in some of the transactions, but with only a small percentage of the receivables amount.

The majority of tenors are two to three years 

We observed the average loan tenors are increasing in China's auto ABS transactions. Frequent originators are offering longer tenor loans with maturities in the following three to five years, compared to 1.5 years to 3 years a few years ago, so as to utilize capital more efficiently. Nonetheless, the loan tenors are capped at five years per regulatory requirement and are generally shorter compared with the transactions in other major markets which are up to seven to eight years.

Full-recourse loans 

All contractual payments under the auto loan receivables are full-recourse obligations of the borrowers under the Chinese law. As a result, a trust is less exposed to any market-value risk associated with the sale of motor vehicles (on performing receivables). This is a risk that could be associated with other products, such as operating leases. The full-recourse nature will not only reduce a borrower's intention to default, but also increase the recovery of defaulted loans because the special purpose trust (the issuer) can go after the borrower's other assets for debt repayment.

Loans are relatively seasoned  

The average seasoning is eight to nine months, with small variation across originators. Experienced issuers tend to securitize loans that are less seasoned, while local originators with limited securitization track record are generally more conservative and offering more seasoned assets. Our observations in other markets suggest these features tend to support consistent and stronger performance.

Mortgage registration 

The current guidelines provide more flexibility over mortgage requirement if the lenders believe the borrowers have good credit quality and debt serviceability. Per Article 403 of China's Civil Code, a mortgage on movable property shall be created at the time when the mortgage contract enters into effect; without registration, such a mortgage may not be claimed against a bona fide third party. Having said that, all the auto loan ABS transactions rated by us are secured by mortgages over the financed vehicles, and most of such mortgages have been registered with the relevant registration authorities in China, with the originator registered as the first priority mortgagee. Typically, according to certain originators, only borrowers with high creditworthiness may be exempted from mortgage registration.

3.4. Typical deal structure

Simple capital structure 

In China's auto ABS market, most deals are offered at RMB3 billion–RMB5 billion, with some exceptions. Most of the auto loan ABS transactions have adopted simple payment hierarchies, with two or three classes of notes issued. The capital structure is generally made up of one of the following:

  • Class A-1 and class A-2 notes are issued as senior notes, ranking in pari passu, supported by the subordination of the subordinated notes.
  • Class A (or class A-1 and A-2) notes are issued as senior notes, supported by a mezzanine tranche (if any) and a subordinated tranche.

The ratings are usually assigned to the senior notes and the mezzanine notes. Subordinated notes are usually held by the originators.

Single waterfall as well as separate interest and principal waterfalls are both common  

It is common to see that the ABS transactions adopt either a single waterfall or separate interest and principal waterfalls. Principal draw is allowed to cover liquidity shortfalls when needed. Principal collections available after covering liquidity shortfall will be used to pay down notes either in accordance with soft amortization schedules or in a pass-through manner.

Sequential payment is mostly used  

The senior and mezzanine notes will receive interest payments on a regular basis. The allocation of the available interest will first be paid to the senior notes coupons and then the mezzanine notes coupons. Among the notes ranked in pari passu, their interest payments will be paid on a pro-rata basis. The principal payment will also follow the sequential pay, in which the senior notes will receive the payment first, followed by the mezzanine notes if the senior notes have been fully repaid, and at last the subordinated notes when the mezzanines notes are redeemed in full. Excess spread, if any, can be applied for turbo principal repayment of the senior notes. Pro-rata pay mechanisms between senior and junior notes have been used, but are not common.

Soft amortization schedule and acceleration event triggers  

Some of our rated ABS transactions adopt soft amortization schedules for the class A-1 notes. For the class A-2 notes, a pass-through is used. When an acceleration event is triggered, such as a rise of cumulative default rate over a certain threshold, the payment among the class A notes may switch to pro-rata, depending on the priority of payments stipulated in the transaction documents.

Credit enhancement  

Primary credit enhancement used in Chinese auto loan ABS is provided in the form of notes subordination, overcollateralization and excess spread when it exists. Overcollateralization may also be found in deals that have negative carry risk. In addition, our rated ABS transactions also have liquidity reserves and principal draw feature to meet short-term liquidity risks.

Revolving structure  

We have seen increasing adoption of revolving structure since 2020, partly driven by funding efficiency and bank investors' needs. Receivables are purchased and added to the securitized pool during the reinvestment period, typically one month to 12 months. The transaction will stop reinvestment and start amortization upon the occurrence of an early amortization event trigger, which typically includes a performance-based trigger such as the cumulative default rate exceeding certain threshold, as well as the occurrence of an enforcement event or a servicer termination event. Certain documented triggers including the minimum weighted average yield, maximum remaining tenor, geographic concentration limit and proportion of balloon loans (if any) are typically set in the asset eligibility criteria or portfolio parameters to constrain the worsening of pool composition during the revolving period. A yield supplementary reserve is sometimes provided in revolving structure as an additional credit support to cover credit losses and negative carry incurred during the revolving period.

4. Asset Performance Will Likely Stay Stable

The cumulative default rates were largely stable in the past few years and overall stayed low. Asset performance has been resilient during COVID-19, with cumulative default rates increased only marginally by 3 bps–5bps for the 2019 and 2020 vintages at the end of 2Q 2021 (see chart 10). This is mainly attributable to the short-lived impact of the business shutdown in 1Q 2020 and broadly stable collateral performance.

Chart 10


We expect the economic recovery and favorable pool attributes, such as low loan-to-value ratios and higher seasoning relative to the initial loan tenor to underpin the steady performance of auto loan ABS.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Iris Suen, Hong Kong +852 2532 8092;
Secondary Contacts:Jerry Fang, Hong Kong + 852 2533 3518;
Patrick Chan, Hong Kong + 852 2533 3528;
Yilin Lou, Hong Kong +852 2533 3524;

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