OREANDA-NEWS. Revolving structures emerged in the second half of 2015 in a number of consumer ABS transactions in the Chinese Credit Asset Securitization market and Fitch Ratings expects this to become a more widely used structure for short-tenor collateral. However, the use of revolving periods, which allow issuers to invest repaid receivables in purchasing new receivables, introduces a number of risks for investors that are not present in a transaction that does not have a revolving period (static transaction).

For a revolving transaction to achieve a rating comparable to a static one with similar collateral, these additional risks need to be either mitigated by structural features within the transactions or addressed in the rating analysis.

Revolving features emerged in securitisations of consumer assets during the second half of 2015, as Fitch forecast in its commentary "Fitch: Revolving Structures Are a Necessary Development for ABS in China", dated 18 May 2015. Revolving periods provide benefits to issuers and investors by lengthening the term of the financing and investment, respectively. In the past six months Fitch is aware of four transactions that contain revolving periods under the Credit Asset Securitization Scheme: two consumer credit ABS transactions sponsored by Bank of Ningbo, and two auto loan ABS sponsored by China Merchants Bank and SAIC-GMAC Automotive Finance Co., Ltd respectively. All the transactions have the substitution of repaid cash for new receivables in common, but have different parameters around the substitution and the protection afforded to investors.

Among the additional risks that investors in a revolving transaction face is that the transaction would have greater exposure to economic cycles and a longer transaction life implies that it is more likely to have bonds outstanding during a downturn. Revolving transactions are also exposed to the risk of deteriorating portfolio credit quality due to declining origination standards or due to changes in the types of assets included in the pool. Additionally, there may be incremental losses from new loans that are added, which may need additional credit enhancement to cover. Transactions could also be exposed to negative carry when insufficient new receivables are available for purchase and cash does not generate enough yield to cover expenses and coupons, although this risk is at least partly offset by the cash not being subject to default risk.

The rating process may include a higher loss assumption based on the maturity of the underlying assets and the length of the revolving period to address the greater exposure to economic cycles. To address the potential for deterioration in collateral quality and incremental loss, revolving transactions usually feature certain portfolio covenants and performance-based stop-revolving triggers. Portfolio covenants include individual loan and portfolio level eligibility criteria. Fitch will normally assume the portfolio will migrate to the worst practically possible combination based on the set parameters. Stop-revolving triggers will halt the revolving if the transaction or the assets are not performing as expected; the most frequently used types are cumulative defaults or portfolio delinquency levels. To avoid adverse selection, Chinese revolving transactions also require originators to offer 20%-100% more eligible assets than available cash for trusts to select. In the example of the Hexin auto loan ABS transaction, the originator China Merchants Bank is required to offer eligible collateral at 200% available cash balance for the trust to pick on each purchase date.

In the example of the YongDong consumer credit transactions sponsored by Bank of Ningbo, the revolving feature will be terminated when cumulative defaults reach 5%. In evaluating revolving structures, Fitch assesses the effectiveness of those triggers in preventing the build-up of additional loss and their impact on the credit enhancement needed to support the assigned rating. In mitigating negative carry, transactions use stop-revolving triggers when there are insufficient new receivables for purchase. In the example of the Hexin auto loan ABS transaction, the one-year revolving period will stop if cash as percentage of outstanding principal balance reaches 10%.

Fitch believes that while revolving transactions provide efficiencies to originators involved in certain types of short-tenor collateral, the additional risks warrant closer scrutiny on their structures and associated mitigants. Revolving structures also require additional disclosure in regular reporting. Updated pool information, including updated pool cuts, is needed on a regular basis during revolving periods to allow market participants to assess how the pool is evolving over time and whether portfolio migration is positive or not.

Furthermore, revolving transactions are exposed to the risk of changes in origination standards during the revolving period. As such, Fitch will request updates to information regarding origination procedures and controls, as well as product profiles and limits.