In view of the steady increase in investor inquiries regarding Hong Kong's consumer finance asset-backed securities (ABS) market, S&P Global Ratings is providing a market overview to address some common queries.
1. Overview Of Hong Kong's Personal Loan Market
1.1. Originators of unsecured personal loans
Unsecured personal loans in Hong Kong are mainly originated by licensed money lenders registered at the Companies Registry and authorized institutions regulated by the Hong Kong Monetary Authority, including banks, restricted-license banks, and deposit-taking companies (see chart 1). By the end of March 2022, the market size of unsecured personal loans was around HK$102 billion, while that of unsecured revolving loans was HK$17.9 billion. This commentary will place greater emphasis on unsecured amortizing personal loans in the money lending sector, where our rated transactions are originated.
1.2. Typical features of loans originated by money lenders
Fast and simple application process
Money lenders often promote fast and easy applications via mobile apps or websites, without the need to show up in person in branches. They also offer a highly flexible approval and drawdown process, such as loan approval seven days a week and instant cash delivery.
Certain product types only require minimal information, such as a Hong Kong identity card, phone number, and bank account information. When the loan amount exceeds a certain threshold, income proof may be required, and borrowers' credit scores will be checked with TransUnion. Such scores range from AA to JJ, with AA being the highest. TransUnion is currently the only accredited credit reference agency in Hong Kong that issues personal credit reports for financial institutions to conduct credit checks.
Borrowers and loan products
Money lenders often focus on higher-risk borrowers than banks, and act as an alternative funding source to those facing difficulties in obtaining bank funding, mostly due to a weaker credit profile or lack of income proof. According to TransUnion's five-tier risk definition--which categorizes borrowers into super prime, prime plus, prime, near prime, and subprime--money lenders' exposure to below-prime consumers was 95% in the fourth quarter of 2021, much higher than banks' exposure of 45% in the same period.
For local borrowers, typical personal loans include amortizing loans and revolving loans. Money lenders offer various product types to meet a borrower's loan purpose, including generic personal loans, tax loans, home renovation loans, and debt consolidation loans.
Apart from local borrowers, some money lenders also target certain nonlocal borrowers working in Hong Kong, such as domestic helpers.
Loan tenor varies by product
The tenor of local loans mostly ranges from three to 84 months, while that of domestic helper loans is much shorter, at 24 months or fewer, in consideration of the fixed term of their work contract and visa validity.
Interest rates are generally higher than banks
Money lenders typically charge higher interest rates than banks. This considers money lenders' lower underwriting requirement, higher risk profile of borrowers, higher cost of funds, highly flexible application and drawdown process, and the constraint from Money Lenders Ordinance (MLO) (Cap. 163) that prohibits money lenders from charging costs or expenses relating to the negotiations or granting of loans.
In April 2021, the government proposed to lower the statutory limits of effective interest rates stipulated in MLO. The interest rate cap under section 24(1) will be lowered to 48% per annum from 60%, while the presumed definition of extortionate rate under section 25(3) will be lowered to 36% per annum from 48%. These revised limits will come into effect on Dec. 30, 2022, if they are approved by the Legislative Council.
1.3. Performance trend
Origination trend remains dependent on socio-economic conditions
The origination growth of personal loans narrowed from the second half of 2019 to the beginning of 2021, when Hong Kong experienced an economic downturn due to social unrest and COVID-19. This may also have been a result of lenders' more prudent underwriting policy amid uncertainty over economic prospects and consumers' restrained spending and borrowing during an economic slowdown.
Origination grew markedly in 2021. Such a shift in dynamics may be driven by a low-base effect, given a significant drop in origination volume in the previous year. Another contributing factor could be the revival of local consumption in 2021, when the pandemic subsided temporarily, social distancing restrictions were relaxed, and stimulus measures, such as the government's consumption voucher scheme and tax concessions, were rolled out. Consumer spending and credit demand rebounded, while the resumption of lenders' willingness to advance loans led to increased risk appetite, as indicated by a higher distribution in money lenders' share of originations to below-prime consumers, to 95% in the fourth quarter of 2021 from 82% in the same period a year earlier, according to TransUnion data.
Delinquency rate remains sensitive to market conditions
The 60-plus-day delinquency ratio has been levelling off since the second quarter of 2020, trending back to the level before the period of social unrest in Hong Kong and COVID-19.
However, some social distancing restrictions have been reintroduced in the first half of the year with the onset of the fifth wave of COVID-19 in early 2022. The latest macro data show that GDP shrank 1.3% in the second quarter of 2022 after a 3.9% contraction in the prior quarter--meaning that Hong Kong has technically slipped into an economic recession. Delinquencies may edge up in the coming one to two quarters due to reporting lag.
Under debt consolidation or refinancing programs, new loans are extended to borrowers, such that they may use part of the proceeds to repay existing loans. Depending on where borrowers' existing loans originated, such practices may result in a higher prepayment rate in not only the money lender's portfolio, but potentially the bank's portfolio as well.
1.4. Key drivers to loan performance
Considering the highly fragmented market and divergent underwriting practices, individual lenders' loan performance varies greatly. Nonetheless, some macro factors, including individual bankruptcy petitions and the unemployment rate, generally have been able to explain past loan performance and may serve as indicators for future performance.
Bankruptcy petition and personal loan delinquency have been correlating positively in the past three years--with Hong Kong experiencing a stressed period of social unrest and COVID-19 (see chart 4). Under Hong Kong's bankruptcy regime, no proceedings can be taken against or continued without the court's approval once a bankruptcy petition is filed or when the court makes a bankruptcy order. This infers that borrowers' payment obligations will be paused once a bankruptcy petition is filed. As such, bankruptcy petition figures are generally correlated with the state of debt serviceability.
The unemployment rate and bankruptcy petitions also exhibit some correlation, as reflected throughout macro cycles in the past two decades, including the 2002-2003 recession, 2008-2009 recession, and recent turbulence since mid-2019 (see chart 5).
We believe that the unemployment rate could also be a contributing factor in loan performance since employment status can affect a borrower's income level and repayment ability. Before the stressed period of social unrest and COVID-19, Hong Kong's unemployment rate had been lower than 3% throughout 2018. The figure began rising after mid-2019, until it more than doubled to 6.7% in the first quarter of 2021. During this period, personal loans' 60-plus-day delinquency ratio also hit a three-year peak of 0.63% in the second quarter of 2020 compared with 0.37% at the beginning of 2019.
2. Hong Kong Consumer Finance ABS Sector
2.1. Stable issuance trend at a low level
The transactions we rate are originated by a major money lender in Hong Kong. The number of outstanding rated transactions has been stable at one to two annually since 2017, while issuance or committed amount per transaction averaged at HK$1 billion-HK$2 billion. We would not be surprised to see more originators tapping into this market during the next two to three years.
2.2. Typical deal structure of rated transactions
We compare the two latest rated transactions in table 1.
|Rated transactions||River Funding No. 4||Ocean Funding 2019-1|
|Issued/initially committed amount for senior notes||HK$1,512 million||US$200 million|
|Credit support for senior notes||26.0%||37.7%|
|Rating on senior notes||AA- (sf)||AAA (sf)|
|Benchmark index||One-month HIBOR||One-month LIBOR|
Our rated transactions are typically structured with two to four classes of notes issued, comprising senior notes, subordinated notes, and occasionally mezzanine notes. We only assign ratings to the senior notes, which carry floating-rate coupons. The subordinated notes are held by the originator, which also takes up the roles of servicer and transaction administrator.
Apart from the subordination of mezzanine notes and subordinated notes, credit support for the senior notes typically consists of a certain amount of excess spread due to the asset nature of high interest rates.
The transactions we rate often adopt a revolving structure. This is mainly driven by funding efficiency, and in consideration of the shorter tenor of some loans, such as domestic helper loans.
During the reinvestment period, which usually lasts for at least two years, receivables are purchased and added to the securitized pool. The newly acquired receivables must meet the documented asset eligibility criteria and portfolio parameters. These include, but are not limited to, the maximum exposure to different loan products, distribution of internally assessed credit scores, and average loan size. Failure to maintain these preset portfolio parameters will lead to transaction amortization.
The transaction will also stop reinvesting in new receivables and enter an amortization period by the end of the revolving period or when any early amortization event occurs. This includes the failure of key third parties, such as the servicer, in carrying out their obligations, breach of preset loan performance measures, including delinquency and default rates, as well as a failure to maintain a minimum excess spread or a set of loan tenor-loan interest combinations.
The transactions we rate are backed by local loans and domestic helper loans. We observe that the latter often have lower cumulative deemed default rates in the historical static pool data. This is due to the higher income stability that is secured by fixed-period contracts and faster amortization resulting from their shorter loan tenors.
The secured assets are all amortizing loans. The tenor of domestic helper loans is generally much shorter. For instance, in Ocean Funding 2019-1, the maximum tenor for such loans is two years, in contrast with local loans' limit of eight years.
The current maximum interest rate allowable under MLO is 60% per annum. The proposed change to interest rate cap in MLO may affect the yield of some high-risk personal loans. However, we expect there to be only a limited effect on securitized transactions because eligibility criteria often filter out defaulted or seriously delinquent loans and place certain requirements on a borrower's credit score. This means that the proportion of high-risk loans--priced with the maximum or near-maximum interest rate allowed by law--are minimal.
Other factors at play include market players' pricing strategies and risk appetite after the change in MLO becomes effective.
2.3. Asset performance
Rated portfolios generally remained resilient
Against the backdrop of social unrest and COVID-19, there had been some upticks in delinquencies and defaults in the pool backing our rated consumer finance ABS transactions in 2019-2020. Other asset classes have seen similar volatility in the past two years, and our rated portfolio of consumer finance ABS has already seen an improving trend in recent quarters. The originator of the portfolio of transactions we rate is a key player in the money-lending market, which traditionally targets borrowers with weaker creditworthiness than those served by banks. Nonetheless, the cumulative deemed default rates of quarterly vintages--observed in the historical static pool data of our rated portfolio's mother pool--generally remain within single-digit percentages, demonstrating resilience in overall performance and in line with our base case assumptions. The transactions' high excess spreads, stringent portfolio parameters, and early amortization triggers also help ensure that credit losses are fully covered and credit enhancements are maintained during the revolving period.
High prepayment rates
The transactions we rate have seen higher prepayment rates than other asset classes. This is because borrowers are incentivized by the underlying loans' high interest rate to repay sooner, while additional proceeds offered by some lenders under debt consolidation or refinancing programs made early repayment feasible. Such high prepayment rates tend to affect the excess spread available to the transactions. We've taken into account such factors in our cash flow modeling.
3. Challenges Remain While Issuance Trend Will Be Largely Stable
Headwinds remain for the personal loans sector, although some improvements have been seen compared with early 2022. Potential areas of concern include the evolution of the pandemic, the government's economic support measures, the extent of interest rate hikes, and the likelihood of further mobility restrictions. These factors could affect money lenders' branch operations as well as borrowers' income levels, debt repayment capacity, and ability to make in-person repayment arrangements.
In terms of issuance, we do not expect to see dramatic changes in Hong Kong's consumer finance ABS in the coming few years. Meanwhile, we believe that the securitization market in Hong Kong may see more diversified asset types in next two to three years.
- China Securitization Performance Watch 2Q 2022: Tough Economic Conditions Weigh On Issuance And Asset Performance, Aug. 11, 2022
- Credit Conditions Asia-Pacific Q3 2022: Costs Heighten, China Growth Tightens, June 28, 2022
- Economic Outlook Asia-Pacific Q3 2022: Overcoming Obstacles, June 27, 2022
- China Structured Finance Midyear Outlook 2022: New Issuance Set For Historic Fall, June 19, 2022
- China's COVID Policy To Further Weigh On Economy, Credit, May 16, 2022
This report does not constitute a rating action.
|Primary Credit Analyst:||Melanie Tsui, Hong Kong +852 2532 8087;|
|Secondary Contacts:||Jerry Fang, Hong Kong + 852 2533 3518;|
|Iris Suen, Hong Kong +852 2532 8092;|
|Patrick Chan, Hong Kong + 852 2533 3528;|
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