China's prospective non-performing loan (NPL) securitizations transactions will be challenging for investors and potentially banks themselves due to hard-to-predict cash flows and an uncertain judicial process, says Fitch Ratings.
The credit rating agency believes that these factors make it difficult to rate these products at an investment grade level on an international rating scale.
China has reignited initiatives to securitize banks' NPLs in an attempt to clean up banks' balance sheets.
At the end of 2015, Chinese commercial banks reported RMB1.27 trillion (US$195 billion) in NPLs, or 1.67% of their outstanding balances, according to official numbers.
Chinese regulators have set RMB50 billion (US$7.7 billion) as the initial quota for the six-largest banks to test NPL securitizations.
Cash-flow uncertainty and opaque information are the biggest challenge for NPL secularization, says Fitch.
In addition, NPL securitizations may be unable to achieve its objective of taking these bad debt off banks' balance sheet if banks end up buying and holding most of the NPL securitization products.
Banks currently hold most asset-based securities in China due to the nascent nature of the Chinese investor market.
Furthermore, if banks have not already taken significant loan write-downs, the NPL securitization process is likely to crystallize losses and potentially require additional capital injections to maintain financial metrics.
Previously, four NPL securitization transactions were issued by China Cinda Asset Management Co., Ltd., China Orient Asset Management Corporation and China Construction Bank Corporation between 2006 and 2008.
Actual performance varied among transactions, but for the four deals, all senior bonds were able to pay in full.
Take the example of Xinyuan 2008-1, the expected total collections were RMB5.1 billion, to be recovered over four years, with RMB3.1 billion forecast to be realized in the first 18 months.
When the trust was liquidated in September 2010, or 20 months later, it had collected RMB2.2 billion, sufficient to pay off senior notes in full but far below initial expectations.
It is difficult to tell if the subordinated bonds would be paid in full by the maturity date, as the trust was terminated three years earlier than its legal final maturity date, says Fitch.