30 Jan The Hidden Risk In The World’s SecondLargest Auto ABS Market
In 1985, only 60 people in Beijing owned private cars. Less than 25 years later, in 2009, China became the world’s largest passenger car market.
Perhaps this statistic is not so surprising given that China is also the world’s most populous nation. But at the time, only a fraction of the purchases were on credit. Startlingly, while China’s rate of penetration of auto financing still lags the U.S., Germany and even India, its market for securities backed by auto loans (“auto ABS”) is poised to become the largest in the world.
Last year China’s new issue market for auto ABS was $88 billion (587.19 billion yen), just one deal shy of matching the U.S., at $90 billion. Three factors are driving this market’s phenomenal growth:
1. China is pushing to develop the ABS market
2. The country’s domestic banks need to manage their capital efficiently by selling financial products
3. Foreign auto manufacturers need to raise RMB financing to sell their cars Ford, General Motors, Nissan, BMW, Volkswagen and other global manufacturers in China are lining up alongside Chinese banks to vie for the same “melting pot” of cash. Because of the crosscultural influence, Chinese auto ABS are of special interest to hedge funds and deal junkies as a harbinger of how China ABS will evolve.
Are Chinese auto ABS deals like U.S. auto ABS deals?
Optically yes. They follow the basic pattern whereby an issuer, a bankruptcyremote Special Purpose Vehicle, buys a pool of loans using proceeds from the sale of securities. Security holders are entitled to receive cash collected on the loans and paid through the hierarchy of claims, or capital structure. Typically more than one class is issued, to attract investors at the top of the hierarchy seeking principal safety as well as those towards the bottom, seeking yield.
All Chinese auto ABS capital structures have 13 tranches, which is not so different from the simplest, 4tranche U.S. deals. On the other hand, some Chinese auto ABS incorporate U.S.style triggers designed to allocate cash more efficiently between the classes. These are scarcely found in other Chinese ABS deals.
But in the fine print of Chinese auto ABS prospectuses lurks another significant feature that isn’t in U.S. deals: title risk.
Car owners prove their ownership by holding the title. When an individual buys a car on credit, the lender attaches a lien and perfects its security interest in the car. In case of default, the lender has the right to sell the car to recover principal, accrued interest and the costs of foreclosure.
Auto ABS should work by the same principle so ABS investors (the new, de facto lenders) are entitled to receive recovery cash flows. If the car is not attached to the loan, the ABS investors’ claim on these cash flows is uncertain. Uncertainty lowers the value of the ABS.
Title risk is off the radar screen of U.S. investors because it is thoroughly addressed in U.S. commercial law. But what about title risk in Chinese auto ABS?
Where is it found in Chinese auto ABS?
According to Cynthia Chen, an independent ABS analyst, title risk disclosures may be found in the Risk Factors sections of certain prospectuses. It is alluded to in other prospectuses where Chinese law is discussed. Otherwise, very little context or analysis on the financial impact of title risk on Chinese auto ABS can be found online in English or Chinese, Chen says.
For example, General Motors (GM), China Merchants Bank (CMB) and Pingan Bank (PAB) all disclose existence of title risk in their prospectus Risk Factors sections. CMB and PAB repurchase loans with title risk and publish their repurchase amounts in the firstmonth servicer reports; GM does not disclose repurchases. For the CMB 20152 and PAB 20151 deals, these were 0.71% and 0.5% of the pool, respectively.
BMW, Nissan, and Ford prospectuses do not mention title risk in the Risk Factors section, but they allude to it in the Chinese Law section. There, the reader can find a lengthy discussion about judicial proceedings in a default under China’s property law and the potential impact on investors’ ability to recover cash flows from a mortgaged asset. The discussion is not concrete enough to enable investors to anticipate and price for deal risk, however.
The servicer reports for BMW, Nissan and Ford deals do not have a buyback data field. The latest servicer reports from BMW 20151, Nissan 20151 and Ford 20151 were 0.27%, 0.31% and 0.58%, respectively. But the collateral performance data are not sufficiently rich for an analyst to reasonably decide how much of the loss is attributable to a titling problem.
The possible risk impact
The impact of 0.5% losses due to title risk on an averagesized deal would be $2 million and $50 million if issuance in 2017 reaches the $100 billion mark. That’s not chump change. But it also isn’t the key point.
The real issue for China’s auto ABS market is that losses net of recoveries are part of the standard ABS credit analysis whereas title risk is outside the analysis. Chen says most of the available information about title risk in Chinese auto ABS is from the perspective of legal mechanics, not from the credit analyst’s perspective: “We know there’s title risk. What we can’t know is whether and how it factors into security ratings and prices.”
The lack of precision may be a cost of the market’s lighteningspeed growth.
-Ann Rutledge, CSC