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Japan Structured Finance Outlook: Coexisting With COVID

As Japan enters year three of the COVID-19 pandemic, the nation's securitization market remains generally equipped to cope with its consequences. Still, risks will linger until the global crisis subsides.

In S&P Global Ratings' view, assets backing owner-occupied housing loan receivables and condominium investment loan receivables will likely perform stably in 2022. The same goes for consumer receivables asset-backed securities (ABS) and corporate receivables ABS. However, we expect somewhat negative performances for apartment loan residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS).

We consider the assets underlying RMBS, ABS, and CMBS to be representative asset classes of Japan's securitization market. In this report, we discuss our views on the performance outlooks for Japanese RMBS, ABS, and CMBS deals in 2022.

S&P Global Ratings believes the omicron variant is a stark reminder that the COVID-19 pandemic is far from over. Uncertainty still surrounds its transmissibility, severity, and the effectiveness of existing vaccines against it. Early evidence points toward faster transmissibility, which has led many countries to reimpose social distancing measures and international travel restrictions. Over coming weeks, we expect additional evidence and testing will show the extent of the danger it poses to enable us to make a more informed assessment of the risks to credit. In our view, the emergence of the omicron variant shows once again that more coordinated and decisive efforts are needed to vaccinate the world's population to prevent the emergence of new, more dangerous variants.

Table 1

Outlooks By Asset Class
Underlying asset class Performance outlook for asset class Expected rating trend
Owner-occupied housing loan receivables; condominium investment loan receivables Stable Stable
Apartment loan receivables Somewhat negative Somewhat negative
Consumer receivables (auto loan receivables, shopping credit receivables, credit card shopping and cashing receivables, consumer loan receivables) Stable Stable
Corporate receivables (equipment lease receivables, auto lease receivables) Stable --*
Commercial mortgage loan receivables Somewhat negative --*
*No rated transactions. Source: S&P Global Ratings.

Japan Macroeconomic Scenario

We expect the Japanese economy to register positive growth in 2022 in line with a moderate recovery in economic activity. In 2021, as the COVID-19 pandemic continued, the government declared nationwide states of emergency. Precautionary measures were also in place for much of the year. This limited economic activity, weakening consumer spending. Moreover, the pandemic and a semiconductor shortage disrupted supply chains.

Japan's real GDP contracted year on year on an annualized basis in the first quarter (January to March) and the third quarter (July to September) of 2021 (see chart 1). However, consumer spending has been recovering since October 2021, when the government lifted the nationwide state of the emergency. We assume real GDP growth in Japan of 1.9% in 2021.

Chart 1


We assume real GDP growth in Japan of 2.3% in 2022. From 2023 onward, we expect growth of about 1.0% (see table 2).

Table 2

Real GDP Growth Rates In Japan
(%) 2020a 2021f 2022f 2023f 2024f
Real GDP growth (4.7) 1.9 2.3 1.2 1.0
a--Actual. f--Forecast. Source: S&P Global Ratings, taken from "Asia-Pacific: Ghosts Of COVID Past Hover Over 2022," published Nov. 29, 2021.

We assume a Japan unemployment rate of 2.5% in 2022 (see table 3). Although the rate rose the previous year, it will likely ease back to the pre-pandemic level in 2022.

We watch employment indicators closely, to help forecast the performance of loans extended to individuals, which underlie assets of RMBS and ABS. According to the Ministry of Internal Affairs and Communications, Japan's unemployment rate has remained below 3.0% since June 2021. Special measures, such as employment adjustment subsidies, have kept employment conditions from deteriorating to a degree (see chart 2). As of January 2022, special measures for employment adjustment subsidies are set to be extended until March 31, 2022. For this reason, we believe the government support is likely to continue to temper any deterioration in employment conditions.

Generally, the active jobs-to-applicants ratio is regarded as a coincident indicator because labor supply and demand are generally tied economic performance. The number of new job offers is regarded as a leading indicator because companies increase job offers during phases of economic recovery. The active jobs-to-applicants ratio remains low; it has declined during the states of emergency. Meanwhile, the number of new job offers is recovering after a 2020 plummet. We project a moderate recovery for employment conditions in 2022, in tandem with a gentle increase in economic activity.

Chart 2


Table 3

Japan's Unemployment Rate
(%) 2020a 2021f 2022f 2023f 2024f
Unemployment rate 2.8 2.8 2.5 2.4 2.3
a--Actual. F—forecast. Source: S&P Global Ratings, taken from "Asia-Pacific: Ghosts Of COVID Past Hover Over 2022," published Nov. 29, 2021.

We expect Japan's inflation rate to be 0.9% in 2022 (see table 4). Individuals generally repay loans extended to them with disposable income, which we consider to be household income minus nonliving expenditures (including taxes and social insurance premiums). Such loans underlie RMBS and ABS. Therefore, changes in disposable income can greatly sway the performance of loans extended to individuals.

Salaries of the Japan's private-sector corporations have long been flat. And raising such salaries has, time and again, proved no easy task. The previous administration, of Prime Minister Yoshihide Suga, promoted an increase in the minimum wage. The administration of his successor, Fumio Kishida, launched in October 2021 has drawn up an plan to double incomes during the Reiwa era.

A sharp rise in the inflation rate could weigh on household income. However, we anticipate a rate in Japan of less than 1.0% over the next three years. Based on this, we do not view inflation as a negative factor for the performance of RMBS and ABS.

Table 4

Japan's Inflation Rate
(%) 2020a 2021f 2022f 2023f 2024f
Inflation rate 0.0 (0.2) 0.9 0.6 0.7
a--Actual. F—forecast. Source: S&P Global Ratings, taken from "Asia-Pacific: Ghosts Of COVID Past Hover Over 2022," published Nov. 29, 2021.

Owner-Occupied RMBS And Condominium Investment RMBS

Performance outlook for underlying assets is stable

The outlook is stable in 2022 for assets underlying RMBS transactions backed by loans for purchasing owner-occupied houses (owner-occupied RMBS) and RMBS transactions backed by loans for investments in condominiums (condominium investment RMBS).

Since the spring of 2020, the Japanese government has intermittently imposed limits on economic activity to attempt to prevent the spread of the coronavirus. These limits had some negative effect on the performance of loans backing owner-occupied RMBS and condominium investment RMBS.

The first state of emergency, declared in April 2020, requested nationwide suspensions of business across sectors, leading to strict limits on economic activity. This led to repurchases of receivables, as repayment conditions were eased, and loan delinquencies and defaults increased temporarily.

Meanwhile, the states of emergency declared in 2021 were limited to certain areas, and looser in terms of restrictions on economic activity. Consequently, the impact on the performance of loans backing owner-occupied RMBS and condominium investment RMBS was limited. Delinquency and default rates are at pre-pandemic levels after a temporary rise.

We believe the performance on housing loans is highly correlated with the unemployment rate. In November 2021, we forecast Japan's annual average unemployment rate would be 2.8% in 2021, as it was in 2020. We assume the unemployment rate is likely to recover moderately in tandem with mild but steady recovery in the economy, standing at 2.5% in 2022, 2.4% in 2023 and 2.3% in 2024. After factoring in the effects of measures taken by the government and our expected unemployment rate, we forecast a limited impact from COVID-19 on the performance of underlying assets in 2022.

Vaccination rates are up in Japan. But a new variant is on the loose. If it triggers a resurgence in the pandemic, again limiting economic activity and hampering recovery, the performance of assets underlying RMBS transactions could suffer.

Rating trend will likely be stable

We expect rating trends for owner-occupied RMBS and condominium investment RMBS for 2022 to be stable.

The pace of the economic recovery has been slower than we originally assumed. For example, the semiconductor shortage led to production cuts at automakers. In our November 2021 forecasts, however, we assume Japan will return to moderate growth from 2022. We also assume unemployment will remain stable at 2%-3% until 2024. We therefore forecast the performance of assets backing owner-occupied RMBS and condominium investment RMBS will highly likely remain largely at current levels and our ratings on these securities will be stable.

Most housing loans in Japan have either floating or convertible interest rates. Accordingly, a rise in interest rates directly results in an increase in repayment amounts for borrowers, and therefore would be a risk factor for the performance of housing loans and ratings on RMBS. However, higher interest rates would not be a major risk factor for owner-occupied RMBS and condominium investment RMBS that we rate, because more than 90% of underlying loans backing these securities have fixed interest rates. We also view the risk of a rate hike to be extremely limited in the medium term even for RMBS transactions backed by loans with floating interest rates or convertible interest rates. This is based on our November 2021 assumption that Japan's policy rate will remain at -0.10% until 2024.

Apartment Loan RMBS

Performance outlook for underlying assets is somewhat negative

We expect the performance outlook of assets underlying RMBS transactions typically backed by loans to landowners who build rental apartment buildings (apartment loan RMBS) to be somewhat negative in 2022.

The performance of assets underlying apartment loan RMBS transactions that we rate was favorable in 2021; delinquencies and defaults remained low. This is mainly because developers of the collateral apartment buildings have entered long-term master lease contracts with the borrowers of the underlying loans. These contracts allow the borrowers to receive stable master lease rent, regardless of vacancy rates or apartment rent levels. Although underlying apartment loans have floating interest rates, the borrowers received sufficient rental income to pay principal and interest in 2021. This is attributable to unchanged loan repayment costs in the persistently low interest rate environment and the continued execution of master lease contracts.

On the other hand, Leopalace21 Corp., a major apartment builder in Japan, has not totally resolved issues related to defects detected in 2018 at some apartment buildings it constructed. The company is still examining all its buildings and conducting repairs. In general, rent under master lease contract is reviewed on a regular basis. Some borrowers have suffered a decline in master lease rent when contracts come up for revision, mainly because of rises in vacancy rates of their apartment buildings.

COVID-19 remains a risk factor for apartment loans in the short term. Single-occupancy studio apartments account for a large portion of underlying assets. Rent from such apartments could further decline and vacancy rates rise, if the economy takes longer to recover than we assume, because of factors such as omicron-induced ennui. Specifically, a pandemic resurgence could and reduce demand for studio apartments among factory workers whose employment contracts are terminated or students studying online rather than in classrooms.

In the medium- to long-term, demographic decline looms. Fewer people may mean less demand for residential rental houses and apartments, which would be a stressor for apartment loans.

Meanwhile, land deemed "productive green areas"--agricultural land in urban setting that benefits from tax breaks--is set to lose its designation in 2022. Sales and effective use of such lands should therefore become more likely. Real estate developers could purchase this green land and concrete it over with rental buildings. Or owners of such land could choose to use it to build apartment blocks. This would worsen the performance of existing apartments in surrounding areas amid fiercer competition.

We expect the environment surrounding the apartment loans to remain slightly negative, despite our expectations of overall moderate economic growth.

Rating trend will likely be somewhat negative

We expect the overall rating trend of apartment loan RMBS for 2022 to be somewhat negative. This reflects the factors driving our outlook for Japan's residential rental housing market. First, we think the needs for rental housing will decline in line with a decrease in Japan's population. Second, the competitiveness of existing apartment buildings will weaken as newly build competitors reach the market. In addition, there is the possibility of an increase in apartment loan defaults and delinquencies caused by declines in master lease rent. Rent from master lease contracts could drop for certain properties if vacancy rates rise or rent levels decline due to persistent problems with defects at Leopalace21's apartment buildings and other factors.

Meanwhile, some Japanese RMBS use LIBOR as a reference rate. And transitions to replacement rates is incomplete for some transactions, mainly apartment loan RMBS, as of the end of 2021. Events in this space from now could negatively impact our ratings on some deals.

ABS Backed By Consumer Receivables

Performance outlook for consumer receivables is stable

We expect the performance of consumer receivables--auto loan receivables, shopping credit receivables, credit card receivables (shopping and cashing receivables), and consumer loan receivables--backing ABS transactions to be stable in 2022.

We think the performance of consumer receivables is highly correlated with the unemployment rate. We assume Japan's unemployment rate will slightly decline to 2.5% in 2022 from the previous year. A decrease in obligors' income because of job losses could cause delinquencies and defaults of consumer loans. Nevertheless, we believe the performance of consumer receivables is likely to remain stable as employment conditions are unlikely to change considerably.

The performance of auto loans backing consumer ABS transactions that we rate did not change materially even during the ongoing coronavirus crisis. This is partly because ABS transactions that we rate are backed by the collateral pools consisting of obligors with high credit quality, compared with ordinary auto loans.

The performance of auto loans backing consumer ABS transactions is also susceptible to conditions in the used car market, in our view. Gas-powered vehicles typically account for most of the collateral pools of auto loan-backed ABS transactions. From now, however, the percentage of electric vehicles (EV) and fuel cell electric vehicles (FCEV) in the pools will likely increase, in our view. Furthermore, to forecast the developments in the used car market, we should incorporate the impact of prevalence of EV and FCEV on lowering prices of gas-powered vehicles. According to the Japan Automobile Dealers Association, the unit sales of EV, FCEV, and plug-in hybrid electric vehicles (PHEV) accounted for about 2% of total sales in October 2021, which suggests the full-scale prevalence of EV is still more to come. Taking into account the average remaining years of auto loans backing consumer ABS transactions, we think the impact of price decline in gas-powered vehicles in the used car market is likely to be limited. Meanwhile, if new policies and fuel regulations are introduced, we will closely observe the impact of them on prices of used gas-powered vehicles.

Rating trend will likely be stable

We expect our ratings on ABS transactions backed by consumer receivables to remain stable in 2022. We believe the following factors support the ratings. First, the performance of underlying auto loans is stable. Second, credit enhancement has accumulated due to the repayment of the rated securities that we rate. And third, the underlying auto loans carry fixed interest rates and therefore would be protected from any rise in interest rates.

ABS Backed By Corporate Receivables

Performance outlook for corporate receivables is stable

We expect the performance of corporate receivables backing ABS transactions to be stable in 2022.

In the case of ABS transactions backed by corporate receivables, the main underlying assets are lease receivables (including auto lease receivables) and trade receivables. Lease receivables have been decreasing since the first half of fiscal 2020 (April 1 to Sept. 30, 2020) when the COVID-19 pandemic started. According to the Japan Leasing Association, lease transactions decreased 8.5% year on year to ¥1,976.7 billion in the first half of fiscal 2021. Corporate intentions on capital investment have become more bearish due to the pandemic, which has negatively affected lease transaction volume, in our view.

The default rates of pools of corporate receivables generally trend in line with corporate bankruptcies in Japan. According to Teikoku Databank Ltd., the number of corporate bankruptcies totaled 2,938 in the first half of fiscal 2021. It was below 3,000 for the first time since fiscal 1966. Although the operating environment continued to be severe due to the pandemic, as seen mainly for restaurant and accommodation industries, we believe corporations were supported by government subsidies and consultations for corporations by financial institutions that have led to agreements in areas such as moratoriums on repayments.

Details published on an additional economic package from the government detail the provision of a business revival support fund and a continuation in 2022 of extensions of interest-free loans and unsecured loans from financial institutions, as happened in 2021.

The continuation of measures for supporting corporations' financing in 2022 makes a material increase in the number of corporate bankruptcies unlikely. On the other hand, the operating environment has not returned to pre-pandemic conditions, and therefore financial challenges, particularly for small and midsize enterprises, endure. Accordingly, we continue to closely observe the developments of the number of corporate bankruptcies.

In addition, we consider surging gas prices since May 2021 a possible risk to ABS transactions whose underlying assets are composed of auto lease receivables. Many obligors of auto lease receivables are land transportation operators. Higher gas prices push up their transportation costs. While the trajectory of gas prices remains uncertain, if they stay high, this is bad news for the transportation industry.


Outlook for the performance of office buildings is somewhat negative

We expect the value of properties backing Japanese commercial real estate CMBS to either slightly decline or remain unchanged in 2022. By asset class, we expect the value of office buildings will somewhat decline from the previous year. The value of rental apartment buildings will remain nearly unchanged or decline slightly and that of distribution and warehouse facilities will be almost flat.

Office buildings

We expect the value of office buildings to remain slightly weak in 2022. This is because demand for rental offices will moderately weaken as more people work remotely and companies review their office spaces. In addition, the capitalization rates for office buildings appear to have almost peaked to market players, and property prices also look high.

The average vacancy rate of office buildings in Tokyo's business districts as of the end of November 2021 was 6.35%, up 2.02 percentage points from a year earlier, according to data from Miki Shoji Co. Ltd. The ratio greatly rose in a short period of time, after bottoming at 1.49% in February 2020. Meanwhile, average rents have dropped in tandem with the rise in vacancy rates. After hitting a peak in July 2020, average rents started to decline. As of the end of November 2021, they had decreased 6.9% year on year. Although trends vary, a moderate decline in the leasing market for new and existing buildings suggests overall weakening.

Shifts in the way we work are also negative for the office building leasing market in 2022. Demand for office spaces will likely weaken gradually because of a decrease in workers going to the office, changes in corporate strategies on office space, and the growth of shared office space. Conversely, some factors support the market, such as possible recovery for some aspects of the economy and below-average annual supply of new office space. Consequently, even if the office building leasing market remains weak across the board, we are unlikely to see big shifts in conditions.

The Japan Real Estate Institute's (JREI) survey on real estate investors shows that the capitalization rates of office buildings in central Tokyo is about 4%. The rates are basically flat at low levels, with some slight declines. For this reason, we believe the demand for property investments is stable currently. On the other hand, the value of Japan's commercial real estate may come under pressure over the medium term, in our view. The supply of new office spaces in 2023 and thereafter will likely exceed previous overall averages, negatively impacting values and capitalization rates.

Rental apartment buildings

We expect the value of rental apartment buildings to basically remain nearly flat or decline slightly in 2022. Our view bases on positive factors, such as the stability of the leasing market and capitalization rates. These factors, however, are counterbalanced by the negative reaction to sentiment in the market that prices are already high.

Rents in Tokyo remain stable at high levels. Data related to condominium rents in Tokyo's 23 wards from Tokyo Kantei Co. Ltd. shows rents currently remain almost unchanged from the previous year, after hitting a peak in March 2021. Capitalization rates have slightly declined in certain areas. In summary, the value of rental apartment buildings basically remains almost flat at low levels, as it does for office buildings. This leads us to believe the demand for such buildings remains solid.

Regarding the market for condominiums for sale and existing condominiums, according to the Real Estate Information Network for East Japan, closing numbers for sales of existing condominiums in the greater Tokyo area have been recording a year-on-year decrease since the summer of 2021. Conversely, contracted prices per square meter for condominiums have been moderately increasing from the previous year. We attribute this to continued willingness to buy as a reaction to restrained buying during the state of emergency, as well as low supply of condominiums, as indicated by 10%-20% year-on-year declines in condominiums available every month. In addition, the supply of new condominiums has been decreasing, which may have resulted in a shift in demand for existing condominiums. On the other hand, the average price per new condominium unit in the greater Tokyo area is at its highest since the bubble years, overheating market sentiment.

Compared with condominiums for sale and existing condominiums, the value of rental apartment buildings is less liquid and there are fewer of them in the market. However, the value of rental apartment buildings could be affected by high price sentiment. Accordingly, we forecast value will likely weaken in some areas.

Distribution and warehouse facilities

We expect the value of distribution and warehouse facilities to remain stable in 2022 based on the following:

  • Rental revenue from them is likely to be stable thanks to robust demand,
  • The survey on real estate investors indicates capitalization rates have slightly improved from the previous year in all areas, and
  • The demand for investments in distribution and warehouse facilities from domestic and overseas investors continues to be strong.

The distribution and warehouse facilities leasing market is susceptible to the business standing of e-commerce, one of the main lessees. Although a large supply is likely in some parts of the distribution leasing market in 2022, overall, it should remain largely unchanged. This is because of demand from e-commerce and distribution companies. Generally, e-commerce business has been expanding in a stable manner. Also, demand from consumers stuck at home during the pandemic has boosted such business.

Vacancy rates in the third quarter of 2021 for distribution and warehouse facilities remain relatively low, despite slight differences by region. The rate stood at 2.6% in the greater Tokyo area and 1.6% in the Kinki (greater Osaka and nearby prefectures) region, according to CBRE Inc. Rents largely remain stable reflecting stable demand. They are mostly unchanged, though some have increased moderately. Although the market will likely see stable demand from e-commerce business, distribution, retail, and manufacturing industries, supply looks high for 2021 and 2022. Based on this, we predict a part of the distribution and warehouse facilities leasing market will likely weaken temporarily, and at the same time, tenants will likely be more selective about properties.

Related Criteria

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Hiroshi Sonoda, Tokyo (81) 3-4550-8474;
Secondary Contacts:Yuji Hashimoto, Tokyo + 81 3 4550 8275;
Toshiaki Shimizu, Tokyo + 81 3 4550 8302;

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