China offers early test of consumer loan-backed bonds

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China’s booming mortgage and auto-backed bond market is facing its first major test.

The number of delinquent loans backed by such bonds has reached record levels, according to global rating companies, as the coronavirus pandemic puts pressure on Chinese consumers.

While delinquent loan rates are not at alarming levels, the early deterioration bodes ill for other markets, including the United States. American consumers tend to borrow more relative to their assets or income than Chinese consumers, who tend to have more savings to fall back on. This could potentially lead to increased stress in the United States on similar deals.

“Data from China suggests that lockdowns will have a substantial impact on the performance of structured finance products and may provide early signals of how similar closures in other markets might affect these products,” said Tracy Wan. , structured finance analyst at fitch Valuations.

In China, she added, “We expect payment delays to increase further over the next few months and snowball into more defaults. She said the number of defaults turning into defaults depends on China’s recovery and the ability of borrowers who have lost income to quickly regain their footing.

Bondholders could ultimately suffer losses if Chinese borrowers eventually default. Most of the investors in these securities are local, although China has opened up various channels for foreigners to buy onshore debt.

Two commonly observed indicators are the proportion of loans overdue by up to 30 days and those overdue by 30 to 60 days, indicating more serious financial stress.

For auto loan securities tracked by Fitch Ratings in China, 2.2% of loans were up to 30 days late, while 0.4% were 30 to 60 days overdue, the two highest rates since that Fitch began recording such data in December 2014. In the bond market, 0.54% of loans were up to 30 days overdue. It’s also the highest proportion since Fitch started tracking this data in late 2014.

Another sign of household financial difficulties is that fewer borrowers are repaying their car loans earlier than usual.

Smaller and more export-dependent Chinese companies may struggle to recover, and staff who lose their jobs or experience wage cuts may be less able or less willing to repay debts, said Ms. Wan of Fitch. . Urban unemployment stood at 5.9% in March, close to its all-time high, according to official survey data, and economy shrank 6.8% year-on-year in the first quarter.

An Audi dealership in Wuhan, Hubei province. Fewer borrowers are paying off car loans earlier than usual.


Photo:

Stringer / Bloomberg News

For a bond deal issued last year by Mercedes-Benz Financial Services, controlled by the German automaker

Daimler AG

, the proportion of loans past due up to 30 days jumped to 3.2% in February, from 0.63% at the end of the year. The company said it was working with customers to defer payments or restructure contracts.

Bonds like these are a form of structured finance, in which a pool of future payments is sliced ​​to create securities with varying levels of risk and return. Any loss is initially the responsibility of the holders of the riskiest and most productive securities.

China first experimented with such securitizations in 2006. It did not let the market take off seriously in 2014.

Since 2016, China has been the largest market outside of the United States in terms of annual volume of new dollar transactions, according to S&P Global Ratings. There are now about 3.6 trillion yuan ($ 508 billion) of asset-backed securities outstanding, including 1,000 billion yuan of mortgage-backed securities, and about 165 billion yuan of mortgage-backed bonds. auto loans, according to financial data provider Wind.

Still, analysts point to the strengths of the Chinese market.

The deal structures are fairly conservative, as a relatively large share of total debt, typically 12-17%, is held by junior bondholders, said Jerry Fang, credit analyst at S&P Global Ratings. This makes transactions safer from the perspective of most bondholders, who are primarily institutional investors holding senior debt. This is because investors who rank lower in the payment order should absorb losses due to defaults before senior bondholders are affected.

Fang added that Chinese borrowers are often financially strong: they save a lot, enjoy financial support from family members, and undergo rigorous credit checks for auto loans.

Fitch has a stable outlook for its ratings on auto loans and residential mortgage-backed securities, which it says partly reflects bond structures and because its analysis takes into account “periodic credit stresses.”

Lu Yan, an analyst for auto consulting firm Gasgoo in Shanghai, said regulations require a minimum down payment of 20% for auto loans, which can only last for five years. This helped control the risk of default, he said.

Zheng Yuanshun, a 26-year-old salesman, is an example of a Chinese borrower facing difficulties, but also avoiding a default. He sold his Hyundai sedan at the end of March, after falling behind on his car loan. He bought the new car for around 110,000 yuan ($ 15,532) in 2018, borrowing more than 60,000 yuan from an auto finance arm of the South Korean automaker.

Mr. Zheng resigned from his job in the southern city of Guangzhou at the end of last year. He had planned to find a new role after the Lunar New Year. Instead, he found himself locked up in his hometown of Qianjiang, a small town in central Hubei Province, with no income and with loan repayments owed on his car and other loans.

Hubei, where the coronavirus pandemic first appeared in the capital of Wuhan, eased restrictions on March 25. After the lockdown ended, Mr. Zheng said, “The first thing I did after I returned to Guangzhou was to sell the car and clean the car. ready. It made me not sleep at night. He sold the vehicle to a junk dealer for about 72,000 yuan and paid off the loan balance.

President Trump sets out guidelines to reopen the economy in three phases, China records its first-ever quarterly GDP contraction, and Gilead Sciences shares are skyrocketing on hopes of a potential Covid-19 drug. Shelby Holliday of the WSJ has the latest pandemic news. Photo: John Moore / Getty Images

Write to Xie Yu at [email protected]

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