Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

China's love affair with asset-backed securities, the kind of financial product that helped spur the 2008 global credit crisis, has the intensity of a new passion. But for all the concerns about the speed at which things are moving, the market is only just getting started.

After going from zero to $61.5 billion in just two years, total sales of ABS slowed last year, according to data compiled by ChinaBond. Don't expect that to continue, though.

Structured notes backed by receivables, which form part of the ABS market, jumped 130 percent to 455.2 billion yuan ($66 billion) in 2016, according to official data released last week that captures a lot more issuance than Chinabond. Those sorts of notes accounted for 54 percent of all ABS issued in China, up from 33 percent in 2015, that data show.

Warp Speed
Asset-backed security issuance in China slowed last year. But that was before new rules that enable corporations to issue in the main bond market venue were rolled out
Source: ChinaBond

The key is trust. ABS investors like to be sure that no matter what happens to the company that originally lent the money, they'll be able to get their cash back. That's done by putting loans into a company, or more often a trust, created to manage the assets and funnel proceeds to investors.

It's partly thanks to this kind of structure that actual losses for mortgage-backed securities from the 2008 crisis weren't that big. A study published last year by Juan Ospina and Harald Uhlig from the University of Chicago found that losses on the AAA-rated portion of 2,824 such bonds sold in the U.S. between 2006 and 2012 came to only 6 percent of the total value, in spite of a spike in delinquencies. Debentures backed by subprime loans, particularly those early-vintage ones issued before the crisis, performed even better.

That wouldn't have been the case if those bonds weren't legally separated from the firms that lent the money originally. Until August, Chinese companies weren't allowed to use such structures when selling ABS in the interbank market, the nation's main debt arena. As a result, pools of bank loans dominated, which, as the official data show, is no longer the case.

And you can expect the numbers to balloon if the U.S. is any gauge. In 2015, total ABS issued in China represented 0.56 percent of gross domestic product, compared with 1.4 percent in North America. By that measure, things peaked in 2006 when U.S. companies sold ABS equivalent to 4.9 percent of the economy.

The Real Thing
In spite of the financial crisis, asset-backed security issuance in the U.S. hasn't dipped below $100 billion a year since 1995. And 2016 saw $207.5 billion of sales, much higher than in China
Source: Securities Industry and Financial Markets Association (SIFMA)

Whether the growth of this market in China could backfire depends on what kind of oversight local authorities impose on the loans being packaged into bonds. It would be a good time to bring in the expertise of global rating companies. After the flack they copped in 2008, they've learned a thing or two about evaluating pools of loans and perhaps that's why Beijing is looking at doing just that.

It would also be a welcome new stream of revenue for Fitch Ratings Ltd., S&P Global Ratings and Moody's Investors Service Inc. But whether they're involved or not, the reality is there's no stopping this juggernaut: China's relationship with structured finance is about to get serious.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net