China's new auto loan rules set to drive sales, Fitch predicts

April 15, 2024 (MLN): China’s revised auto loan rules are likely to support car sales this year, especially for lower-priced, new energy vehicle (NEV) models, says Fitch Ratings.

The removal of the regulatory minimum downpayment requirement is likely to introduce some lower-quality borrowers to auto finance companies (AFCs) and banks, but brings the regime more into line with most other developed auto-financing markets.

Underlying default rates for auto loan asset-backed securities (ABS) could ultimately edge higher if more loans with higher loan-to-value (LTV) ratios and longer terms are added to the securitization pools. Their structures may also need to be altered to accommodate the additional risk.

The new rules published by China’s central bank and the National Financial Regulatory Administration (NAFR) in early April ease the requirements on consumer auto loans by granting lenders greater discretion in underwriting standards, and, in turn, allow them to target a broader customer base.

The minimum downpayment requirement for consumer purchases of new vehicles had previously been 20% for traditional vehicles and 15% for NEVs.

AFCs, facing intense competition, have increasingly explored riskier market segments by offering loans with higher LTV ratios and extended terms.

Some captive finance arms of automakers have broadened their scope to include lease products with less strict downpayment requirement and non-proprietary brands.

Our analysis of underlying assets of auto-loan ABS in China identifies LTV as a key predictor for auto-loan defaults, indicating that higher LTVs correlate with increased default risks.

The latest policy relaxation could test the risk management of AFCs as they adjust credit models to accommodate riskier loans.

The impact on AFCs’ credit profiles could, however, be mitigated by the enhanced regulations. The revised management guidelines for AFCs, which took effect in August 2023, mandate higher support from main shareholders and require them to inject capital and liquidity when necessary.

The supervision measures released by the NAFR in February 2024 implement a regulatory rating scale for AFCs, with lower-rated companies facing business restrictions.

Default rates underlying auto-loan ABS are likely to edge higher, as originators expand portfolios to include higher LTV loans that reach or exceed 100% LTV as is common in mature global auto markets.

Fitch expects any deterioration to be gradual, as it will take time to originate loans under the new parameters, and only some new loans would test the limits of the allowable new underwriting regime.

The annualized default rates for Chinese auto-ABS transactions have been hovering around 0.50% since 2016, comparable with the performance of prime auto loans in the US and Europe.

The entity estimates banks underwrite around half of Chinese auto loans.

The new rules could also incentivize banks to increase their risk appetite for auto loans, especially as demand for other consumer loans - such as residential mortgages remains tepid.

This could boost banks’ retail loan growth rates moderately but also raises asset-quality risks.

However, Fitch expects the impact to be modest, with the banks’ average exposures to auto loans likely to stay in the low-single digits.

The relaxed downpayment requirements may help reduce customer-price sensitivity and ease explicit price competition among auto manufacturers.

Yet, there is a risk that automakers may subsidise finance companies or offer lender incentives, potentially raising selling costs especially for those with a large inventory of traditional vehicles.

Expansion at captive finance companies may also strain their parent automakers’ finances by raising working-capital needs and hastening cash depletion.

For the agency’s rated auto dealers, the policy change could benefit their sales and commission income modestly, especially from sales of used cars and lower-end models, as auto-financing penetration is lower in the former segment and buyers are more price-sensitive.

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