Boom in Chinese securitization sparks concern

A variety of institutions have led the spree, including large government-owned banks and local lenders unloading loans from their books and packaging them into products such as collateralized loan obligations, which make up the bulk of such asset-backed securities in China.

Captive financing units of car makers from Ford Motor to Volkswagen have sold debt instruments composed of bundled auto loans.

Asset securitization currently provides businesses with an additional channel of credit as banks have become increasingly selective about lending and are looking to clean up their balance sheets.

Goldman Sachs economist MK Tang said: “Securitization can in theory help banks vacate existing loans from their balance sheets, making room to lend to the underserviced sector in the economy.”

Some analysts and investors, though, are concerned about the potential risks from these structured securities. The products were heavily criticized during the 2008 global financial crisis when low-quality mortgage loans that US banks packaged and sold to investors ran into trouble, as homeowners defaulted on their mortgages amid a housing-market collapse.

In China, concerns centre on whether borrowers of the underlying securities will fully pay back the loans on time. In the case of auto-loan asset-backed securities, it is car buyers who pay in instalments; for collateralized loan obligations, it is companies.

“China’s economy has been expanding so quickly in the last 30 years, and borrowers’ repayment ability in times of stress remains untested,” said Hilary Tan, structured products director at Fitch Ratings.

China began allowing asset securitization on an experimental basis in 2005, but put the pilot program on hold in 2009 when bonds backed by subprime mortgages were among the biggest losers during the global financial crisis. Beijing revived the program in 2012 and China’s cabinet, the State Council, said last year that it would expand the trial ABS program to boost credit and economic growth.

Risks in the financial system

Jerome Cheng, senior vice president at Moody’s Investors Service explained: “Although securitization is aimed at moving credit risks away from banks — already under stress because of mounting nonperforming assets — the majority of buyers are other lenders, so the risks remain in the financial system.

“It’s highly likely that more securitized bonds will be issued for the rest of this year and next year amid regulators’ push and market demand.”

A lack of Chinese bankruptcies, however, means that global money managers are unsure of how they can get back their money or assets in times of financial stress.

“Overseas investors need more clarity, for instance, on how to reclaim underlying assets should there be a case of default, as the legal procedures to foreclose the assets could be complicated and less tested in China,” said Aaron Lei, structured finance director at Standard & Poor’s Ratings Services.

Lesi Zuo, Standard Chartered PLC’s head of capital markets solutions in Greater China and Northeast Asia added: “Some international investors, though, are starting to get involved in auto-loan asset-backed deals. Volkswagen’s auto-loan ABS issued this year was the first such debt instrument in China to receive international credit ratings, a move meant to reassure overseas bond buyers.”

For now, each deal needs to be approved by Beijing, and issuers have to provide underlying debtors’ credit records to the People’s Bank of China, the central bank.

Among the largest transactions was policy lender China Development Bank’s packaging in February of six billion yuan (US$977 million) of railway loans into a trust, which was then sold to bond investors.

Volkswagen’s financing company in August issued bonds backed by 800 million yuan of its car-buyer loans, as auto sales have boomed in China. Postal Savings Bank of China, the nation’s seventh-largest lender by assets, in July issued China’s first mortgage-backed securities in seven years, raising $1.1 billion.