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Credit FAQ: What's Behind Our First Rating On Credit Card ABS In China

On Nov. 30, 2021, S&P Global Ratings assigned its preliminary ratings to the senior notes of Zhaoyin Hezhi 2021 Phase I Personal Consumer Loan Asset-backed Securities (Hezhi 2021-1). This is the first China credit card asset-backed securities (ABS) transaction rated by an international agency. The notes to be issued are backed by a pool of credit card receivables originated by China Merchants Bank.

Here we answer frequently asked questions from investors on China's credit card sector and our rating process and methodology.

Frequently Asked Questions

What are the prospects for China's credit card industry?

China's credit card industry should continue to grow at a moderate rate. The country's outstanding unsecured consumer lending has expanded significantly over the past decade. The number of issued credit cards increased to 790 million as of June 30, 2021, from 331 million as of end-2012. Bank card outstanding balances rose to Chinese renminbi (RMB) 8.18 trillion from RMB1.1 trillion over the same period.

The growth rate has however been slowing down since 2017, following regulatory tightening on cash loans, person-to-person lending (P2P), and internet finance (see chart 1). The drop in the annual growth rate over the three years to 4% in 2020 reflects the tightened financial flexibility of credit card holders as a result of the crackdown on many P2P and internet finance lending companies. In addition, banks also reduced their cash advance business in response to the regulatory changes.

Chart 1

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Besides the tightened regulations, the evolving payment system in China also poses new challenges to the credit card industry. Currently, most of the non-cash transactions are made through the two major digital payment platforms, Alipay and WeChat Pay, which inevitably reduced the share of credit card payment. While tight regulations on unsecured consumer finance lending will continue to restrain the cash advance business, it will however not lower credit card usage.

We also expect the performance of credit card receivables to continue its recent stabilizing trend under the backdrop of moderate growth rate and tightened regulations. The China credit card nonperforming loan (NPL) rate (defined as loans overdue more than three months) is crawling close to 1% of total loans in recent years. The outbreak of COVID-19 caused some performance volatility, yet the impact was insignificant. Since the second half of 2020, the NPL rate has gradually returned to pre-pandemic level (see chart 2).

Chart 2

image

What are some key characteristics of major originators of credit card ABS in China ?

China's credit-card segment is mainly transaction-based (i.e., used to make purchases) with regulated banks being the dominant players. Those large national banks and some mid-size joint-stock commercial banks are also major originators of credit card ABS in the country.

In the credit card origination process, it's common for Chinese bank card issuers to partner with internet-retail stores and utilize fintech to expand and screen customers. Typical receivable types generated by credit cards include purchase-led receivables (lump sum or revolving), instalments, and cash advance. Card holders can choose to make the lump-sum payment on the purchase amount or make partial payment (subject to banks' required minimum payment) and keep the remaining balance revolving. They can also convert the payable amount into instalments ranging from a few months to two to three years. The cash advance product provides relatively flexible funding to borrowers but is not actively promoted.

To date, purchase-led receivables dominate banks' credit card portfolio and are also the major product type in securitized portfolios. Interest rates vary across different product types, but commonly fall in the 10%-18% range, with close monitoring by China's regulators.

In the underwriting and receivable management process, bank originators generally employ credit and behavior scorecards to evaluate customers. The credit scorecard, in particular, incorporates personal credit data from People's Bank of China's credit bureau and third-party databases, in addition to other parameters assessing borrowers' payment capacity. Through a scorecard evaluation, customers are classified and extended credit lines either through an automatic or a manual approval process.

Borrowers' credit card payments are made through a wide range of options, including auto-debit, mobile phone application, internet banking, automated teller machines, telephone banking and bank branches. Banks generally manage late payments (arrears) by a staged approach. Depending on the arrears aging bucket, different collection approaches, from auto-dial call-out and SMS messages to intensive recourse through third party or legal action, will be taken.

What are key rating factors for credit card ABS?

In analyzing credit card ABS transactions, we apply our global consumer receivables criteria (see "Global Methodology And Assumptions For Assessing The Credit Quality Of Securitized Consumer Receivables," published Oct. 9, 2014).

We review an originator's management experience, consistency of underwriting, account management, and servicing standards. We also consider historical asset performances, macroeconomic conditions and industry trends to establish our base-case assumptions of the following performance variables:

  • Charge-off/loss rate: The weighted average losses on principal receivables for the collection period as a percentage of eligible principal receivables (annualized).
  • Portfolio yield: The weighted average total trust income for the collection period as a percentage of eligible principal receivables (annualized).
  • Payment rate: The weighted average total monthly collections (obligor principal and finance charge payments) as a percentage of the total outstanding amounts.
  • Dilution rate: The weighted average monthly non-cash reductions to the receivables balance (including merchandise returns, rebates, refunds, and fraud) as a percentage of the total outstanding amounts.
  • Purchase rate: The rate at which new receivables are created as cardholders use their credit cards to make purchases or cash advances.

We assume a combination of these key variables under rating-specific stress scenarios and consider the transaction structure, including asset eligibility criteria, portfolio parameters, payment allocation provisions, term of the revolving period, and amortization events in our rating analysis. These variables interact with each other and can sometimes have an offsetting impact on a transaction's cash flows. For example, a higher payment rate results in shorter receivable life and lower exposure of the pool to losses over the transaction life. A higher portfolio yield may also contribute to more excess income, which can be used for coverage of asset losses if allowed by the transaction structure.

How do loss rates of auto loan ABS compare with credit card ABS?

Prime credit card ABS generally has a higher loss rate on the initial portfolio balance than prime auto loan ABS. This mainly reflects the unsecured nature of credit cards and their relatively weaker arrears performance.

In auto and credit card ABS with revolving-pool structures, performance triggers related to asset defaults or losses are commonly seen in early amortization events. This is done to mitigate risks of deteriorating asset performance and reduction of credit enhancement. In China's credit card ABS transactions, performance triggers associated with asset yields or excess spread are also quite common given credit cards' relatively higher asset yield, which can provide additional structural support when used for coverage of losses.

When stressing losses in rating-specific scenarios, we will take into consideration portfolio parameters as well as these structural arrangements.

What are typical arrangements for mitigating servicer commingling and set-off risks?

In securitization transactions, investors may be exposed to loss or delay in receiving funds if remittances from the underlying assets are collected into a servicer account and the servicer becomes the subject of insolvency proceedings (i.e. servicer commingling risk). They may also be subject to set-off risk when underlying obligors exercise set-off right on debt payments against the originator.

Structural mechanisms that we believe may reduce or eliminate the issuer's exposure to servicer commingling risk include: (1) obligor payments made directly to a trust account or a lockbox account to which the servicer has limited access; (2) the servicer's commitment to deposit all collections to the trust account within two business days of receipt; and (3) the provision of a cash reserve, additional credit enhancement, or a liquidity facility to cover potential delay.

In our rated China credit card ABS (Hezhi 2021-1), the transaction's servicer will remit asset collections within two business days upon receipt. There are also arrangements of right perfection notice upon originator's (initial servicer) insolvency and subsequent redirection of underlying payments to trust account. Given such structural mitigation, we do not include commingling loss in our cash flow analysis.

There exist common arrangements for mitigating set-off risk as well. These include: (1) the originator's undertaking to remit set-off amount upon occurrence; (2) eligibility criteria to exclude assets of potential set-off risk associated with the originator's employees from being securitized; and (3) provisions of a reserve to cover set-off potential exposure or additional credit enhancement. While analyzing China credit card ABS, we also consider the government-sponsored deposit issuance scheme, which largely mitigates the set-off exposure. Our rated transaction Hezhi 2021-1 also has sufficient credit enhancement level to cover potential unmitigated losses, if any.

Is the sovereign risk a rating constraint?

No, there is no rating cap from a sovereign risk perspective. We apply our criteria "Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions," along with its associated guidance, for consideration of sovereign risk in rating securitization transactions.

Credit card ABS is typically a plain vanilla structured finance instrument, and the criteria allows a maximum differential of four notches above the sovereign rating for securitization of this kind. Given that the long-term sovereign rating on China is 'A+', the highest rating that can be assigned to a credit card ABS transaction in China is 'AAA (sf)'.

How do ESG credit factors feed in to the rating analysis?

In general, the credit card ABS sector has below average exposure to environmental credit factors, above average social credit factors, and average governance credit factors. Our credit ratings incorporate environmental, social, and governance (ESG) credit factors when, in our opinion, they could affect the likelihood of timely payment of interest or ultimate repayment of principal by the legal final maturity date of the securities. In the rated Chinese credit card ABS transaction, exposure to ESG credit factors is indirect or mitigated by structural features, such as a diversified portfolio, regulatory supervision, and documented restrictions on counterparty activities.

Our "ESG Industry Report Card: Credit Card Asset-Backed Securities" published March 31, 2021, discusses how ESG credit factors could influence the credit quality of credit card ABS and provides a benchmark for typical ESG considerations in the sector.

What are key high-level structural differences between China's credit card ABS and those issued in mature markets?

In mature markets, many credit card ABS adopt the master trust structure. Besides, they usually issue both seller/transferor certificates and investor certificates. The former usually is issued to, and retained by, the originator, while the latter is usually is tranched into senior and subordinated structure. The senior investor certificates are rated and placed with investors.

In China, credit card ABS don't adopt the master trust structure because there are legal issues to overcome. Moreover, transactions are structured like any other ABS without issuing seller certificates or the concept of transferor's percentage.

Related Criteria And Research

Related Criteria
Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Andrea Lin, Hong Kong + 852 2532 8072;
andrea.lin@spglobal.com
Secondary Contact:Jerry Fang, Hong Kong + 852 2533 3518;
jerry.fang@spglobal.com

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