Revised rules bolster car loans but with influx of lower quality borrowers

The asset quality of auto finance companies will be tested.

China’s revised auto loan rules will support car sales in 2024, but also raises the risks of defaults.

Revisions include the removal of the regulatory minimum downpayment requirement, which brings in lower quality borrowers to auto finance companies (AFCs) and banks, noted Fitch Ratings. 

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

“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,” the ratings agency said.

It added that lending structures may need to be altered to accommodate for the additional risk. AFCs are expected to adjust credit models to accommodate riskier loans.

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Enhanced regulations can mitigate the impact of AFCs’ credit profiles.

“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,” Fitch noted.

Overall, Fitch exepcts that the 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. This is, however, common in mature global auto markets. 

“We expect 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,” Fitch said.

The annualised default rates for Chinese auto-ABS transactions have been hovering around 0.5% since 2016, comparable with the performance of prime auto loans in the US and Europe.

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Banks are estimated to underwrite about half of the new Chinese auto loans. 

The new rules could even incentivise banks to increase their risk appetite for auto loans amidst tepid demand for other consumer loans. This, in turn, can boost banks’ retail growth, although overall impact will be modest and auto loan exposure will likely stay in low single digits.