Announcements Research

Structured Finance Outlook for South African Transactions in Light of the COVID-19 Disaster

Overview

  • GCR anticipates a particularly challenging 2020, particularly due to the COVID-19 disaster.
  • We expect an increase in credit risk within the next three months being more prevalent in Asset Backed Securities (‘ABS’) transactions. Auto and Equipment Lease ABS transactions tend to have a sizable exposure to vulnerable sectors and debtors.
  • Residential Mortgage Backed Securities (‘RMBS’) transactions are expected to maintain robust performance with one exception.
  • Credit Linked Notes (‘CLN’) & Asset Backed Commercial Paper (‘ABCP’) transactions are expected to experience some degree of credit weakening albeit highly rated assets.
  • None of the rated Structured Finance transactions rated by GCR have covenants that relate directly to the participants and sectors deemed most at risk highlighted above. Covenant headroom for certain transaction are constrained especially given the expected increase of arrears and defaults. Structured Finance transactions have various structural protection mechanisms to insulate against credit risks.

2020 is shaping up to be an even more challenging year than 2019 and, of course, the exact local and global impact of the COVID-19 pandemic is currently unknown. However, to date, GCR have assumed a severe stress environment will extend through the period laid down by the timelines of the National Disaster, i.e. up to 15th June 2020. The type of stress is based on the reduction of economic activity reflecting a fall in consumer spending and negative business sentiment caused by travel restrictions, large scale self-isolations, quarantines and social distancing measures in effect in South Africa and globally. Specifically, we are assuming that South African corporates and individuals exposed to hospitality, tourism and discretionary retail will be hit hardest (economically) and it will exacerbate already significant weaknesses in the economy. GCR believes that the significant 100bps interest rate cut will provide little impetus for growth in Q2’20 but it should further help debt serviceability of the private sector and could provide more stimulus in the 2nd half of 2020. See the “GCR Lowers its Corporate Sector Risk Scores for South African Hospitality, Gaming and Discretionary Retail in Light of the COVID-19 Crisis.” and “Sustained Economic Headwinds compounded by COVID-19 Risks Will Pressure South African Banks Earnings & Asset Quality in 2020” publications for more details.

This research piece deals with Structured Finance transactions rated by GCR.

Equipment Lease ABS issuers are second-tier banks and Non-Bank Financial Institutions that originate assets and seek opportunity in underserviced and overlooked sectors and clients (often small and medium enterprises). Originations are often a result of product/supplier financing relations. While, the client base is somewhat price-sensitive, product/equipment preference tends to be of more importance. Secondary leases tend to be erratic and of short duration, albeit they generate generous excess spread. In light of the above, GCR expects these transactions to act as a bellwether for economic strain. GCR will continue to monitor the performance of these issuers.

Auto Loan ABS issuers are first-tier bank originated assets (instalment sale agreements) that have a highly competitive product offering for retail consumers (employed, self-employed and businesses). Originations are typically through the vehicle dealer networks. There has been a longstanding shift from new to used vehicle registrations might display similar to higher default rates. Given the section, vulnerability of many consumers and weakening of performance is expected. However, the January and March 2020 interest rate reductions, and further anticipated reductions, would offer some reprieve. GCR will continue to monitor the performance of the issuers in this sector.

RMBS originators are first-tier banks and challenger Non-Banking Financial Institutions. Both continue to be meaningful market participants and recurring debt issuers. GCR’s public ratings in this asset class are restricted to Investec Bank Limited, whose client base consists of high-net-worth individuals and professionals that should display a high degree of resilience to economic headwinds, which is assisted by the competitive interest rates offered on Investec’s mortgage products. These transactions have abnormally high prepayment rates and their sequential payment structures lead to quarterly increases in credit enhancement.

GCR rates TUHF Urban Finance (RF) Ltd using components of it RMBS criteria. The issuer’s assets consist of a pool of mortgages offered to inner-city property entrepreneurs usually taking the legal form of a small business. The issuer is in its scheduled amortisation phase with the first capital repayment scheduled for 30 April 2020, which could not have come at a more appropriate time given recent economic events. This transaction has a high degree of concentration given mortgage sizes and its lower income tenants that are its ultimate source of repayment and are amongst the most vulnerable to an economic downturn, notwithstanding the diverse economic sector distribution and the market shortage of affordable housing.

GCR will continue to monitor the performance of these issuers.

CLN & ABCP issuers are first tier-banks that originate assets offered to large enterprises across all economic sectors. The said assets usually offer a degree of credit protection in the form of loan covenants (positive and negative). Notes issued under these transactions seek to exploit the assets versus notes margin differential to cover for senior costs and that may result in positive excess spread. The underlying obligors are usually highly-rated counterparties that might, in some cases, see a deterioration in their underlying credit metrics. GCR will continue to monitor the performance of the transactions. It is important to mention that ratings migrations are possible, based on possible ratings changes to the reference entities for these transactions.

Surveillance and Monitoring

GCR continuously monitors and publishes Monitoring Dashboards on its website.

Analytical contacts

Primary analyst Corné Els Senior Structured Finance & Securitisation Analyst
Johannesburg, ZA CorneE@GCRratings.com +27 11 784 1771
Secondary analyst Gary Nyoni Structured Finance & Securitisation Analyst
Johannesburg, ZA GaryN@GCRratings.com +27 11 784 1771
Sector Head Yohan Assous Sector head: Structured Finance & Securitisation
Johannesburg, ZA Yohan@GCRratings.com +27 11 784 1771

Related criteria and research

Criteria for Rating Structured Finance Transactions – Sep ’18
Criteria for Rating Consumer Asset Backed Securities – Sep ’18
Criteria for Rating Residential Mortgage Backed Securities – Nov ’18
Criteria for Rating Asset Backed Commercial Paper – Nov ’18
Criteria for Rating Credit Linked Notes and Repackaging Vehicles – Nov ’18

Glossary of Terms/Acronyms

Amortisation From a liability perspective, the paying off of debt in a series of instalments over a period of time. From an asset perspective, the spreading of capital expenses for intangible assets over a specific period of time (usually over the asset’s useful life).
Arrears An overdue debt, liability or obligation. An account is said to be ‘in arrears’ if one or more payments have been missed in transactions where regular payments are contractually required.
Asset Backed Securities Securitisation: debt securities issued that are backed or covered by a pool of assets or receivables (Auto loans and leases, consumer loans, commercial assets, credit cards, mortgage loans).
Asset Quality Refers primarily to the credit quality of a bank’s earning assets, the bulk of which comprises its loan portfolio, but will also include its investment portfolio as well as off balance sheet items. Quality in this context means the degree to which the loans that the bank has extended are performing (ie, being paid back in accordance with their terms) and the likelihood that they will continue to perform.
Asset A resource with economic value that a company owns or controls with the expectation that it will provide future benefit.
Assets A resource with economic value that a company owns or controls with the expectation that it will provide future benefit.
Concentrations A high degree of positive correlation between factors or excessive exposure to a single factor that share similar demographics or financial instrument or specific sector or specific industry or specific markets.
Covenant A provision that is indicative of performance. Covenants are either positive or negative. Positive covenants are activities that the borrower commits to, typically in its normal course of business. Negative covenants are certain limits and restrictions on the borrowers’ activities.
Credit Enhancement Limited protection to a transaction against losses arising from the assets. The credit enhancement can be either internal or external. Internal credit enhancement may include: Subordination; over-collateralisation; excess spread; security package; arrears reserve; reserve fund and hedging. External credit enhancement may include: Guarantees; Letters of Credit and hedging.
Credit Rating An opinion regarding the creditworthiness of an entity, a security or financial instrument, or an issuer of securities or financial instruments, using an established and defined ranking system of rating categories.
Credit Risk The possibility that a bond issuer or any other borrowers (including debtors/creditors) will default and fail to pay the principal and interest when due.
Debt An obligation to repay a sum of money. More specifically, it is funds passed from a creditor to a debtor in exchange for interest and a commitment to repay the principal in full on a specified date or over a specified period.
Default A default occurs when: 1.) The Borrower is unable to repay its debt obligations in full; 2.) A credit-loss event such as charge-off, specific provision or distressed restructuring involving the forgiveness or postponement of obligations; 3.) The borrower is past due more than X days on any debt obligations as defined in the transaction documents; 4.) The obligor has filed for bankruptcy or similar protection from creditors.
Excess Spread The net weighted average interest rate receivable on a pool of assets being greater than the weighted average interest rate payable for the debt securities.
Experience A term used to describe the relationship, usually expressed as a percent or ratio, of premiums to claims for a plan, coverage, or benefits for a stated time period.
Exposure Exposure is the amount of risk the holder of an asset or security is faced with as a consequence of holding the security or asset. For a company, its exposure may relate to a particular product class or customer grouping. Exposure may also arise from an overreliance on one source of funding. In insurance, it refers to an individual or company’s vulnerability to various risks
Financial Institution An entity that focuses on dealing with financial transactions, such as investments, loans and deposits.
Interest Rate The charge or the return on an asset or debt expressed as a percentage of the price or size of the asset or debt. It is usually expressed on an annual basis.
Interest Scheduled payments made to a creditor in return for the use of borrowed money. The size of the payments will be determined by the interest rate, the amount borrowed or principal and the duration of the loan.
Issuer The party indebted or the person making repayments for its borrowings.
Lease Conveyance of land, buildings, equipment or other assets from one person (lessor) to another (lessee) for a specific period of time for monetary or other consideration, usually in the form of rent.
Loan A sum of money borrowed by a debtor that is expected to be paid back with interest to the creditor. A debt instrument where immovable property is the collateral for the loan. A mortgage gives the lender a right to take possession of the property if the borrower fails to repay the loan. Registration is a prerequisite for the existence of any mortgage loan. A mortgage can be registered over either a corporeal or incorporeal property, even if it does not belong to the mortgagee. Also called a Mortgage bond.
Margin A term whose meaning depends on the context. In the widest sense, it means the difference between two values.
Market An assessment of the property value, with the value being compared to similar properties in the area.
Obligor The party indebted or the person making repayments for its borrowings.
Origination A process of creating assets.
Pool An organisation of insurers or reinsurers through which particular types of risk are underwritten and premiums, losses and expenses are shared in agreed-upon amounts.
Prepayment Rate The rate of prepayment in relation to the pool of obligations. Also called prepayment speed.
Prepayment Any unscheduled or early repayment of the principal of a mortgage/loan.
Property Movable or immovable asset.
Recovery The action or process of regaining possession or control of something lost. To recoup losses.
Risk The chance of future uncertainty (i.e. deviation from expected earnings or an expected outcome) that will have an impact on objectives.
Securities Various instruments used in the capital market to raise funds.
Securitisation A process of repackaging portfolios of cash-flow producing financial instruments into securities for sale to third parties.
Senior A security that has a higher repayment priority than junior securities.
Short Term Current; ordinarily less than one year.
Spread The interest rate that is paid in addition to the reference rate for debt securities.
Structured Finance A method of raising funds in the capital markets. A Structured Finance transaction is established to accomplish certain funding objectives whist reducing risk.
Surveillance Process of monitoring a transaction according to triggers, covenants and key performance indicators.
Transaction A transaction that enables an Issuer to issue debt securities in the capital markets. A debt issuance programme that allows an Issuer the continued and flexible issuance of several types of securities in accordance with the programme terms and conditions.
Weighted Average An average resulting from the multiplication of each component by a factor reflecting its importance or, relative size to a pool of assets or liabilities.
Weighted The weight that a single obligation has in relation to the aggregated pool of obligations. For example, a single mortgage principal balance divided by the aggregated mortgage pool principal balance.
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