Volkswagen Beetle

As more and more Chinese gain the financial access to buy a car with a loan, lenders will look increasingly to securitization to keep origination going.

That’s the consensus among players in the country, although, as with any emerging industry, there are teething issues, among them difficulties with vehicular repossession and the lack of back-up servicing.

This past May, Ford Automotive Finance (China) became the first entirely foreign-owned subsidiary in China to issue a deal backed by auto loans.

While GMAC-SAIC — a foreign-local joint venture — issued the first deal in this asset class during 2008, auto loan securitization from captive finance companies had been basically dead until Ford’s transaction, according to sources.

The sector has been following the rhythm of the broader securitization market in China, which is determined by the China Banking Regulatory Commission (CBRC), the People’s Bank of China (PBOC) and the China Securities Regulatory Commission.

In the bank and non-bank financial sector, the CBRC and PBOC authorize securitization through a program that they started in 2005 and then shut down in late 2008 in the midst of the U.S. subprime crisis.

Regulators revived the program in 2012 but it was only this year that Ford was authorized to issue its transaction for CNY800 million ($129 million). This was followed by identically-sized deals from Toyota Motor Finance (China) Co., BMW Automotive Finance (China) Co., and Volkswagen Finance (China) Co. Dongfeng Nissan Auto Finance Co. also completed a deal but the press office did not provide requested information as of press time.

Securitization outside of auto loans in China is growing fast as well, with issuance volume of collateralized loan obligations already past CNY69 billion so far this year, from about CNY15.8 billion in all of 2013.

“There will be potential for more auto loan ABS from both auto captive finance companies and banks,” said Jerome Cheng, a Hong Kong-based senior vice president at Moody’s Investors Service.

It is easy to see why. As Standard & Poor’s managing director Vera Chaplin pointed out, rising per capital income is lifting swathes of the population into the upper tiers of the middle class, opening up the possibility for them to own a car for the first time.

Auto sales in China continue to rise.

Total units sold last year was a hair shy of 22 million. The figure for the U.S. was 15.6 million.
Sales for the first five months of this year in China hit 9.8 million, up 9% year over year. The subcategory of passenger cars reached a touch over eight million, up 11.2% in the same period. The highest growth segments were SUVs and MPVs, each growing more then an annual 30% during the Jan-May timeframe in China.

The volume of sales that involve financing is not as clear but it is certainly nowhere near the level in developed countries.

Somewhere between 5% and 20% of auto sales are financed with loans from auto finance companies. “This contrasts with levels much higher in other markets,” McCarthy said.

In the U.S. the volume of auto loans was about $892 billion at the end of the first quarter, according to data at the Federal Reserve. At last count, Moody’s alone rated about $126 billion of outstanding auto loan securitization.

While auto finance in general does not appear to be growing as fast as sales — using debt to buy cars is not a traditional practice in China — it is clear that the sheer scale of the auto market translates to great potential for loan growth, according to Fitch Ratings’ head of APAC structured finance Ben McCarthy, based in Sydney.

Ford’s Soaring Growth
Saying that Ford would “anticipate more transactions in the future,” company spokeswoman Margaret Mellott pointed to its heady expansion in China.

“Ford Automotive Finance (China) is growing — receivables were up almost 90% in the first quarter 2014 compared with first quarter 2013,” she said. “FAFC provides wholesale financing to more than 400 dealers in China and retail financing to nearly 300 cities.” The recent loan growth comes on top of an increase of nearly 60% in origination between 2012 and 2013.

The company sold a record 935,813 wholesale vehicles in China in 2013, a 49% jump from the 626,616 vehicles sold in 2012.

Mellott said the figure is forecast to surpass one million this year. Last year Ford’s passenger car joint venture, Changan Ford Automobile, hawked a record 678,951 vehicles, a 62% leap from 2012.

Issued in May, Ford’s deal, Fuyuan 2014-1 Retail Auto Mortgage Loan Securitization Trust, consisted of two tranches. A CNY680 million piece with an expected maturity of November 2015 priced to yield 5.5%. A CNY72 million piece priced at 9%. The deal was only rated by local agencies. There was also an unrated equity tranche for CNY47.8 million.

China Cheng Xin International (CCXI) — a joint venture with Moody’s — and China Credit Rating Co. (CCRC) both gave senior piece triple-A ratings and the B piece single-A plus.

Ford retained the equity piece — equal to 6% of the deal — going a step beyond the 5% retention that local regulators require for each securitization.

China International Capital Corp. was the lead underwriter, and was helped by a number of co-managers, Mellott said.

Given the choice of lead and the fact that the deal didn’t carry ratings from the international agencies, it would appear the originator was not as focused on foreign investors.

Mellott declined to give details on the foreign/domestic split of the investor book. She did, however, say that the Ford was “pleased with the level of investor interest and diversity of investors” in Fuyuan 2014-1.

Toyota followed suit with its own deal. A CNY698-million A tranche with a weighted average maturity of 0.77 years priced at a spread of 220 basis points over the one-year PBOC deposit rate (currently around 3%), while a CNY40-million B tranche with a weighted average maturity yielded 520 basis points over.

The deal also included an unrated, CNY61.6-million equity piece. CCXI and CCRC both rated Toyotay’s senior tranche triple A, but they differed on the B piece, with CCXI giving it a single A and CCRC a double A plus.

BMW came next with a deal that closed June 17. A CNY672 million A piece priced to yield 180 basis points over the one-year PBOC deposit rate, while a B piece for CNY88 million earned a spread of 509 basis points over.

CCXI and CCRC alike gave the deal a rating of triple-A for the senior tranche and single-A for the junior one. The senior piece has an expected maturity of a year and the subordinated piece 1.5 years. Both have a legal final maturity of 4.5 years.

A spokesman for BMW did not answer requests for additional information as of press time.

Volkswagen ABS Secures Global Ratings
The last of this recent wave of deals was Driver China One from Volkswagen. Unlike the transactions from Ford, BMW or Toyota, this one carries international ratings, from Fitch and Moody’s.
Driver China One is divvied up into A notes amounting to CNY699 million, B notes worth a total CNY44 million, and an unrated tranche of subordinated notes for CNY52.7 million. Fitch rated the A notes ‘AAsf’ and the B notes ‘A-sf’. Moody’s corresponding grades were ‘Aa3(sf)’ and ‘Baa2(sf).’

The A tranche, with a weighted average life of 0.58 years, priced to yield a fixed-rate of 4.8% and the B tranche, with a WAL of 1.37 years, priced at 8.08%. In a press release, the company said that it expected to post double-digit sales growth in China, with the goal of delivering more than 3.5 million vehicles for the first time. Loan growth is moving even faster, with a 52% rise in financing contracts between Chinese customers and Volkswagen Financial Services during 2013.

Given that the VW deal marked the first time a Chinese auto loan deal obtained international ratings, the approaches and concerns of Moody’s and Fith with regards to Driver China One sheds a good deal of light on how players in general are likely to see the sector during this nascent stage of its development.

As with other deals backed by existing assets in an emerging-market jurisdiction, a cap imposed by the Chinese sovereign limits how high Driver China One can go.

“Our rating is above the sovereign ceiling of China and the sovereign ceiling is a significant input,” said Fitch’s McCarthy. “If the sovereign rating moved downward there is a good chance the rating of the transaction will follow. [But] the reverse — [a deal upgrade following a sovereign upgrade] — is not necessarily true.”

Cheng said Moody’s ‘Aa3’ rating on the deal is the same as China’s country ceiling. ”The Aa3 (sf) rating of the notes is the same as China’s country ceiling. The notes’ rating could be higher if there is an upgrade of the local currency country ceiling of China and a significant better-than-expected performance of the pool, together with an increase in the credit enhancement of the notes.” he added.

All the collateral in the securitizations issued so far are denominated in renminbi — no one contacted for this article had heard of auto loans in other currencies in China.

Playing It Safe
Even with the recent crop of deals, there are still plenty of auto loan finance companies in China that have yet to securitize their collateral (see table below for full list of approved auto finance companies).

The loans backing deals so far are considered quite strong. In the case of VW’s deal, Fitch expects a lifetime default rate of 2.1%. The pool has a weighted average loan-to-value ratio of 64.9%; only about 1.4% of the loans face refinancing risk when balloon payments are due; and more than 99% of the vehicles are new.

“We’ve noticed from public information that auto loan performance [in China] has been quite stable in the last few years,” said S&P’s Chaplin. 

In a report, Moody’s said it expects the conservative credit characteristics of ABS pools — such as strong borrower credit and high down payment requirements — to continue.

One thing that helps is the Credit Reference Center (CRC) of the PBOC, a centralized bureau that had records on 837 million individuals — or about 61% of the country’s population — as of November 30, 2013, according to a late June report by Moody’s. But not much more than a third of those listed in the CRC, about 48% of the total, had any kind of loan history. Of the population at large, 77% had no loan history at all.

Banks are obligated to provide information to the CRC, while other financial institutions and companies report data as well. Lenders have access to this information with the consent of borrowers, but other organizations, such as credit rating agencies, do not. And there is no equivalent of credit score such as FICO that is widely accessible.

Risks from Inexperience
What CRC data cannot do is tell lenders what consumers might do in a credit crisis or recession — the Chinese economy has not experienced that degree of economic distress since the CRC began 10 years ago, Moody’s said.

Similarly, a short track record in the auto loan sector also shows up in an undeveloped servicing market. Back up servicing in particular has note been tested, making it a source of risk, sources said.

Helen Wong, head of non-Japan Asia structured finance at Fitch, said that if VW goes bankrupt the agency assumed that one of the commercial banks would step in. She added that the servicing fee assumption is slightly above the current market price.

Moody’s Hu said that servicing was an area of concern. “There hasn’t been any real backup servicing,” he said, adding that the expansive geography of the country is a barrier as well. “As the market develops, these third party servicers will develop…how fast we don’t know.”

Both Wong and Hu said potential support from the VW parent helps mitigate risk from the lack of a backup servicer.

Repossession is also tricky in China. To repossess a vehicle, a lender needs a court judgment, a process that can take months. “The process is quite complicated,” said Hu. “A lot of the [value of] the recovery may not be from the sale of the repossessed [vehicle].”

Lenders could reach out to others connected to the obligor such as guarantors or family members. This obviously reflects on recovery values.

McCarthy said that in assessing Driver China One, Fitch received data from VW for early recoveries but none for recoveries through a workout process.

The agency uses a base case recovery value of 15% for the deal, which is then cut by 50% for the ‘AA’ rating. “’So [it’s] fair to say [there’s] not much by way of recoveries,” he added.

These limitations have not stood in the way of deals and players said the regulatory approval of the first batch this year shows that the authorities see securitization as a way for lenders to obtain more financing.

This holds especially for the financing arm of auto manufacturers. “For banks, it’s about funding; it’s mainly for them to off load receivables from the balance sheet and allow more room for further lending,” said Wong. “For nonbank companies, they need it as a funding tool and to diversify their current funding sources which are by majority bank loans.”

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