Structured Credit in the PRC and Hong Kong
Structured finance is a financial instrument whereby an asset, such as a bond, or a pool of assets, such as residential mortgages, credit card repayments or corporate loans, are repackaged into notes and sold to investors. The cashflow generated from these underlying assets will be used to repay the notes issued to investors. Swap instruments may also be used to customise bespoke interest rates, currency and repayment dates based on the investors’ requirements.
securitisation in the prc
The structured finance market in the region continues to be relatively new in comparison to the European market and certainly in comparison to the North American market. Nevertheless over the last few years, there has been a marked upward trend in the region, particularly in the PRC. With the tightening of liquidity and credit controls in the PRC, banks and financial institutions are looking for ways to reduce its existing credit exposure by moving any existing loans off their balance sheet. Similarly, the combination of a historically borrower friendly credit market resulting in a fall fees and margins for banks and financial institutions, together with the deterioration of the credit market has resulted in a rise in restructuring, refinancing and non-performing loan transactions. In such an environment, we expect companies and investors alike to be considering alternative methods to capitalise on existing assets, driving up the demand for securitised finance products for varying complexity.
The PRC domestic securitisation market has, over the years, seen strong growth under the robust securitisation schemes supervised by the China Securities Regulatory Commission and the China Banking Regulatory Commission respectively (the “PRC Securitisation Schemes”).
Asset performance has, over the last few years, been stable in Chinese securitisation transactions, except for very limited stress cases of servicer transition, originator failures, and missed interest payments. Retail securitisations continued to demonstrate strong performance: The cumulated asset default rate in auto loan asset-backed security vintages kept improving, and mortgage default rates in most resident mortgage backed securities transactions remained below 0.5%. Stable employment, rising household income, shorter loan tenors and the full-amortisation nature of most loans support the debt serviceability for these sectors.
THE RISE OF CROSS BORDER SECURITISATION and repackages
In the midst of a boom in the domestic securitisation market, in recent years, there has also been a growing demand for the securitisation of offshore assets, such as a pool of corporate loans issued to the offshore subsidiaries of PRC companies, and the repackaging of onshore assets, for example, bonds issued by a PRC corporation or pre-IPO shares in a PRC company, in the form of notes to be sold to overseas investors.
The introduction of Bond Connect in 2017 has certainly helped drive this trend forward. Bond Connect is a mutual market access scheme that allows investors from Mainland China and overseas to trade in each other’s bond markets through a connection between the related Mainland China and Hong Kong financial infrastructure institutions. Bond Connect has been successful in providing a gateway for foreign investors to tap into the PRC securitisation market and will continue to be instrumental in this market.
Due to the cross border element of these transactions, such securitisation transactions will usually be facilitated through a Cayman orphan SPV structure, more commonly seen in the North America securitisation market, as opposed to a PRC trust company under the PRC Securitisation Schemes, which is used solely in the PRC domestic securitisation market.
Hong Kong continues to be an important hub for such cross border structured finance transactions, as it offers geographical proximity to the onshore market, as well as being home to a number of intermediaries and service providers such as securities houses, trustees, rating agents and law firms who are able to originate and execute such transactions in a way that is acceptable to both Chinese and foreign investors alike.
securitisation in the region GOING FORWARD
In light of the Coronavirus pandemic, it remains to be seen how the structured finance market will develop this year. The impact of pro-longed social distancing is already affecting businesses, particularly in retail and tourism, which puts pressure on repayment obligations, particularly in commercial mortgage backed securities. Similarly, growing unemployment and generally reduced expenditure may have an adverse impact on securities backed by small corporate loans and residential mortgages, as companies struggle to repay underlying loans.
That said, now more than ever, there is a demand for credit. With the PRC announcing that it is keeping its benchmark lending rate the same earlier last month, businesses will be looking for alternative funding opportunities. Whilst securitisation of debt may see a decline, we hope to see new and creative assets being repackaged on the market as companies seek new and different ways to monetise existing assets to raise capital.
