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Credit FAQ: What's Behind Our First 'AAA (sf)' Rating Assigned To Chinese Exchange ABS?

On May 8, 2024, S&P Global Ratings assigned its 'AAA (sf)' rating to the class A notes and 'A (sf)' rating to the class B notes of Tianfeng-Fenqile Phase 1 Asset-Backed Specific Plan (Fenqile Phase 1). This marked the first time we rated asset-backed securities (ABS) that were issued under the securitization scheme of the China Securities Regulatory Commission (CSRC), as well as the first 'AAA (sf)' rating that we assigned to ABS issued under the CSRC scheme. The issued notes are backed by a pool of unsecured consumer loans co-originated by TTCO Trust Corp. Ltd. and Shenzhen Fenqile Network Technology Co., Ltd. (Fenqile).

This report addresses questions from investors looking into the CSRC's securitization scheme (also known as exchange ABS), as well as our rating methodology.

Frequently Asked Questions

What are the key developments and features of China's exchange ABS?

The CSRC securitization scheme was set up in 2006 and managed in accordance with regulatory guidelines following an announcement in 2014 (hereinafter referred to as "the guidelines"). Since then, ABS issuance under the CSRC scheme has rapidly gained ground and outpaced other issuance platforms.

Chart 1

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The CSRC scheme is open to any entity in China's securitization market, including financial institutions and nonbank financial institutions (NBFIs). It leverages the existing asset management platforms in securities firms and fund companies in China. The basic laws and government regulations relied on for the scheme include the Securities Law, the Securities Fund Management Law, the Provisional Rules on the Supervision and Administration of Securities Companies, the Contract Law, and the Minutes of the National Court Work Conference for Civil and Commercial Trials 2019 (Ninth Conference Minutes) issued by the Supreme People's Court (the highest court of China).

Issuers under this scheme have some unique features not seen in typical special-purpose entity structures in other markets or in China's special-purpose trust structure in the interbank bond market. These include the use of a special asset management program (SAMP) to purchase the underlying assets and issue notes, and the appointment of a SAMP manager to oversee the underlying assets.

What are the key characteristics of the rated transaction?

Certain key characteristics are as follows (see "Tianfeng-Fenqile Phase 1 Asset-Backed Specific Plan" published on May 8, 2024).

Regulatory regime:  The transaction is constructed as per China's CSRC securitization scheme, set up and managed in accordance with the guidelines.

Dual underwriting process:  The initial securitized pool is co-originated by TTCO (acting as the originator, seller and servicer 1) and Fenqile (acting as servicer 2 and shortfall payment provider). The underlying loans are solely extended and funded by TTCO via a trust agreement, around two months before deal closing. The borrowers apply for unsecured consumer loans via Fenqile's online platform or mobile application. Fenqile reviews the applications, and subsequently refers approved loan applications to TTCO based on certain eligibility criteria. TTCO independently conducts its credit review and ultimately extends the loans to its approved retail borrowers.

At deal close:  TTCO sold a pool of Fenqile consumer loan receivables to a SAMP, established and managed by TF Securities Asset Management Co. Ltd., which acts as the program manager (i.e., SAMP manager) for this transaction. To fund such receivables purchase, the SAMP issued class A, class B, and subordinated notes. We rated the class A notes 'AAA (sf)' and the class B notes 'A (sf)'. We do not rate the subordinated notes.

Securitized pool:  The collateralized assets are consumer loans extended to retail borrowers. The borrowers draw personal lines of credit to purchase goods and services, and pay later through monthly instalments. As of the initial cut-off date, the pool consisted of more than 57,000 contracts, with a weighted-average loan balance of about Chinese renminbi (RMB) 6,130, weighted-average interest rate of 21.35%, and weighted-average remaining tenor of six months.

Revolving period:  The asset pool will be revolving for 12 months. During the revolving period, the SAMP manager, acting on behalf of the SAMP for the beneficiary of the noteholders, will purchase additional loans from TTCO on a daily basis via the securitization servicing account.

Sequential pay:  Briefly speaking, the transaction adopts a sequential pay arrangement after entering into the amortization period. The expected amortization period is six months.

Cash liquidity reserve:  A cash liquidity reserve equivalent to 0.5% of the initial notes balance provides liquidity support to the transaction. During the transaction's life, the liquidity reserve will be maintained at a required amount of 0.5% of the outstanding notes balance.

Servicers:  There are three servicers for this transaction: TTCO, Fenqile, and WeShare Technology Servicers (Shenzhen) Ltd. While TTCO acts as the initial servicer to collect borrowers' payments, Fenqile is the key servicer for loan servicing and arrears management.

Back-up servicer:  WeShare, named as servicer 3, is also the initial contractual back-up servicer upon transaction close, and provides services including technical support. If a servicer termination event occurs in relation to TTCO or Fenqile, then WeShare will take over the servicer role promptly in accordance with the transaction documents.

The underlying pool exhibits similar characteristics to other Chinese consumer loan ABS that we rate, including a relatively short remaining tenor, high interest rate, and small average loan size.

How do you rate Chinese consumer finance ABS transaction?

We apply our relevant criteria to analyze a transaction using five main risk perspectives: credit, cash flow, operational, counterparty, and legal. Ratings above the sovereign are an additional consideration in our analysis. Please see "Credit FAQ: What's Behind The First 'AAA (sf)' Rating Assigned To Chinese Consumer Finance ABS," published Aug. 24, 2023, for the related risk analyses and the following questions specific to Fenqile Phase 1 exchange ABS.

How did you analyze credit risk in this transaction?

We applied our "Global Consumer ABS Methodology And Assumptions" criteria, published March 31, 2022, to analyze credit risk in this transaction.

In our credit risk analysis, we assumed all loans that have been delinquent for more than 90 days would default, and used this classification to determine the base-case default frequency for the securitized pool. This assumption is supported by the low historical cure rates--returning from delinquency to current--of loans overdue for more than 90 days.

Our base-case lifetime default assumption for the collateral pool is 1.5%, based on the stable and strong historical performance observed in the static pool data, securitized pool characteristics, peer comparison with other China consumer loan ABS that we rate, and our observation of underwriting and servicing capabilities of Fenqile and TTCO.

Our base-case default rate assumptions also factor in our view on economic conditions, such as the unemployment trend in China, the recent trend observed in dynamic delinquency ratios, and the potential fluctuation of asset performance.

We applied stress multiples to the base-case default percentage in the 'AAA' and 'A' rating categories for the class A and class B notes.

The magnitude of the stress multiples that we applied reflect the respective rating levels for the notes, and the underlying pool's revolving nature that could render a portfolio profile different from the initial pool. We also factored in the relatively short development history of consumer loan securitization in China and the market's limited experience of macroeconomic stress during the past decade.

Furthermore, we have considered the data opacity in compliance with regulatory requirements by applying higher rating multiples within the criteria ranges, compared with other consumer loan ABS that we rate.

We have taken into account the relatively short remaining terms of initial loans from the securitized pool and the cap on the remaining tenor of the additional purchased loans during the 12-month revolving period per the eligibility criteria. We believe these factors make the risk exposure period of the transaction, or weighted-average term of the notes, short relative to other asset types. Due to the unsecured nature of the loans in the portfolio, we assumed zero recovery.

How did you analyze cash flow in this transaction?

We analyzed the capacity of the transaction's cash flows to support the rated notes--i.e., timely interest payments and repayment of principal by the legal maturity date--by running several different scenarios correlated with a 'AAA' rating level for the class A notes and the 'A' rating level for the class B notes. Our cash flow analysis included various scenarios that reflect different combinations of the following factors, such as default level, default timing, prepayment, fees and expenses, servicing commingling delay, and our expectation on minimum pool yield.

How did you analyze operational risk in this transaction?

There are three servicers for this transaction: TTCO, Fenqile, and WeShare. Also, TF Securities acts as the SAMP manager. We view Fenqile as the performance key transaction party (KTP) and TTCO and the SAMP manager as administrative KTPs. In our view, administrative KTPs pose less event risk and do not constrain the maximum potential rating on a transaction if they are replaceable per transaction documents.

The servicers  We assess reliance of the assets' performance on the performance of the servicers, the ease of finding a replacement, if needed, and the servicers' financial and operating conditions. Based on the transaction arrangement, we believe it does not pose any major risks in relation to the continuation of loan servicing that could constrain our rating on the transaction.

In our rating analyses, we do not consider further uplift to the rating cap due to the existence of the back-up servicer because there is no rating cap on the transaction from our operational risk analyses. However, we view WeShare as a "hot" back-up servicer, which provides back-up servicing support to a standard in accordance with our "Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities" criteria, published on Oct. 9, 2014 (operational risk criteria). In our view, such an arrangement can largely mitigate potential servicer transition risk, and we have considered it in the requirement of a liquidity reserve for this transaction.

The SAMP manager  In our view, the SAMP manager's insolvency would not have a significant impact on the transaction's operation because there is a replacement mechanism in place should a termination event occur.

How did you assess the back-up servicer from a rating perspective?

We have applied our operational risk criteria to assess the back-up servicer in this transaction.

Scope of the back-up servicer  WeShare acts as a contractual back-up servicer at transaction close. It provides services including upfront data mapping and testing on its back-up system, daily update in data storage, verification on monthly repayment of the underlying loans, surveillance of asset performance, and technical support.

Assessment on the back-up servicer per our criteria  We assess the back-up servicer's experience (in view of the asset class and role), its readiness to assume the servicer's responsibilities, and related provisions in the transaction documents.

WeShare has been the back-up servicer for about 20 issuances, some of which were consumer finance related. In our view, the insolvency risk of the servicers and back-up servicer is not highly correlated. WeShare has sufficient capacity to take on the back-up servicer's obligations, and the likelihood of a material disruption in the back-up servicing is low.

In our view, the transaction is supported by a hot back-up servicer, which includes provisions in the transaction documents calling for parallel systems and real-time data reporting to a standard in accordance with our operational risk criteria. Upon the occurrence of a servicer termination event, WeShare can immediately assume the servicer responsibility. The transaction documents also include provisions for the replacement of back-up servicer.

The benefit of a back-up servicer from rating perspective  Per our criteria, a structured finance transaction can potentially have a maximum four to six notches of rating cap uplift if it is supported by a hot back-up servicer.

In our rating analyses, we do not consider further rating uplift due to the existence of the back-up servicer because there is no rating cap on the transaction, based on our operational risk analyses.

That said, we do view WeShare as a hot back-up servicer, which can largely mitigate potential servicer transition risk. We have considered it in the requirement of a liquidity reserve for this transaction, in which the reserve amount will only cover one month worth of tax, senior fees/expenses, and rated notes' interest, compared with two months coverage typically in other ABS transactions that we rate in China.

How did you analyze counterparty risk in this transaction?

We analyzed the potential counterparty risks by looking at the bank account provider, servicer commingling, and set off.

Bank account provider  Issuer accounts for Fenqile Phase 1 are held with Industrial and Commercial Bank of China Ltd., pursuant to the account bank agreement. Among other transaction arrangements, the bank will be replaced within 90 calendar days if the rating on it is lower than 'A'. This arrangement meets our counterparty criteria to support a 'AAA' rated transaction, considering the transaction's cash flow arrangement.

Servicer commingling risk  Our counterparty criteria consider a transaction's commingling risk through the rating on the servicer, the amount of funds likely to be held in a servicer account at any given time, and the potential impact of a delay in receipt of those funds on the supported securities. In our view, the commingling risk is largely addressed by the absence of concentrations in borrower payment dates and the maximum two days of collections the servicers can hold before it remits the collections to the issuer account.

For this transaction, we considered the amount of funds likely to be held in the trust account and the securitization servicing account in the name of servicer 1--TTCO--in different scenarios.

We modeled a one-year delay for the 1% collections of the notes issuance amount in our cash flow analysis. This addresses the potential commingling delay risk associated with servicer 1 for the maximum amount of funds that may accumulate in the account for more than two days. The assumption of a one-year delay is based upon legal opinion and our observations on comparable court precedents.

Set-off risk  We believe the chance of monetary loss due to borrowers' set-off right against Fenqile or TTCO is remote in this transaction. TTCO is not a deposit-taking institution that allows the borrowers to set off their debt, while Fenqile is not a lender of the trust loans.

How did you analyze legal risk in this transaction?

The key considerations in our assessment of legal risk include asset transferability, asset true sale, and asset segregation from the originator and the SAMP manager, as well as the issuer's bankruptcy remoteness. Based on the guidelines and applicable laws and regulations, as well as the transaction's legal opinion, we believe the asset's true sale and issuer's bankruptcy remoteness in this transaction meet our legal criteria.

In this FAQ, we focus on explaining the unique legal aspects associated with the CSRC scheme. For comprehensive legal analysis, please refer to our rating report.

Asset segregation from the SAMP manager and issuer's bankruptcy remoteness under the CSRC scheme  Under the guidelines, a SAMP will issue the notes based on the assets transferred from the originator. However, the SAMP is not a legal entity or trust, in legal terms, and the SAMP relies on a securities company or a subsidiary of a funds company to manage the SAMP's activities.

In respect of asset segregation from the SAMP manager, it could be deemed as the owner of the receivables, and its operations and legal rights should not be affected by the failure of the SAMP manager. This is because the SAMP is specifically set up for this transaction and for the acquisition of an identifiable pool of assets. The assets and accounts in this transaction are arranged in a way to ensure the clear separation and non-commingling of SAMP assets with the SAMP manager's own assets. The transaction documents also have relevant provisions that meet our special-purpose entity criteria.

Besides, the guidelines support the issuer's bankruptcy remoteness in a number of ways. They clearly intend for the SAMP issuer to have special-purpose entity status (clause 4), and confirm the segregation of the assets from the SAMP manager's assets, and that the assets will not be consolidated into the bankruptcy estate of the SAMP manager (clause 5). The guidelines also prohibit the setoff of the collections from the assets (clause 7).

We recognize the risk that the guidelines may be subject to court challenges to the extent that they conflict with laws or other regulations. This is because the guidelines are department-level regulations rather than national legislation, and there is no official securitization legislation in China for asset segregation and issuer bankruptcy remoteness.

However, based on the legal opinion of the transaction, such uncertainty is largely mitigated by clause 88 of the Ninth Conference Minutes, which clearly states that the asset management business conducted by a financial institution acting as a trustee constitutes a trust relationship. For any related disputes, the provisions in the Trust Law shall apply. This implies that the SAMP can be viewed as an extension of the trust concept, with the SAMP manager being viewed as the trust manager. Hence, asset segregation from the SAMP manager is supported by the Trust Law.

Another distinctive feature in this transaction is that Fenqile and Shenzhen Lexin Software Technology Co. Ltd. both undertake that they will make-whole the senior payments and stated notes payments to class A and class B noteholders in the event of a shortfall from the SAMP's distributions. The general risk on this arrangement is that such an undertaking may be read as guaranteeing the asset performance ultimately, and thus fundamentally challenge the validity of true sale.

According to Fenqile Phase 1's legal counsel, the asset segregation is protected by clause 5 of the guidelines, which confirms the segregation of the assets from any third parties and that the assets will not be consolidated into the bankruptcy estate of the third parties. Besides, asset true sale is achieved by the transfer of assets at fair value between the SAMP manager and TTCO.

Is sovereign risk a rating constraint for this transaction?

No, there is no cap on our rating from a sovereign risk perspective.

Our rating on the class A notes is higher than our sovereign rating on China. We applied our "Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions" criteria, published Jan. 30, 2019, and determined that the highest rating that can be considered for this transaction is 'AAA'.

To address sovereign default tail risk, our criteria employ a notching framework that caps the maximum achievable rating. The maximum differential of the number of notches above the sovereign rating for Fenqile Phase 1 is driven by our view of the sensitivity of the transaction's assets and structure to a sovereign default, our sovereign credit rating on China (A+/Stable/A-1), and our assessment that the rated notes can withstand sovereign default stress. We use asset-class-specific assumptions from our typical 'A' rating stress scenario for cash flow analysis to replicate the impact of a sovereign default scenario, as per our criteria.

What is your view on the originator and servicers? How do you consider their credit profile when assigning a rating to ABS?

Please refer to the "Originator/Servicer Overview" section of our rating report (see "Tianfeng-Fenqile Phase 1 Asset-Backed Specific Plan," published May 8, 2024). The section summarizes what we learned from in-depth operational review meetings with the originator and the servicers, as well as other data available to S&P Global Ratings.

We analyzed the risks associated with the originator and servicers from an ABS transaction perspective, such as operational risk and servicer commingling risk, based upon the information and transaction documents, as per our relevant criteria. Our rating committee is of the opinion that the ABS can be assigned a 'AAA (sf)' rating, delinked from the risk exposed to the originator and servicers. This is because either the risks are remote from a rating perspective, or they have mitigants compatible with our applicable criteria.

Related Criteria And Research

Related Criteria

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Iris Suen, Hong Kong +852 2532 8092;
iris.suen@spglobal.com
Secondary Contact:Jerry Fang, Hong Kong + 852 2533 3518;
jerry.fang@spglobal.com

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