After over a year of preparation, China's first cross-border commercial mortgage-backed securitization launched recently. Citigroup is sole bookrunner on the $145 million issue - called Dynasty Assets - which it jointly arranged with Macquarie Bank.

Roadshows were held in Singapore and Hong Kong last week, with pricing due on Sept. 25. Moody's Investors Service and Fitch Ratings rated the single tranche deal - which has an expected maturity of 2.75-years and legal final of 5.75-years - at the sovereign ceiling of A2'/'A-'.

Although a few Chinese companies issued cross-border transactions in the mid-90s, they involved offshore-generated revenues. The Dynasty issue - secured over nine retail properties located in nine cities in Eastern China - is the first to feature onshore assets.

As a first of its kind, market watchers will look closely at the pricing. "It will be a big benchmark and could open the way for further cross-border activity from China," said one head of Asian ABS. "A China deal has novelty value so there could be lots of demand and, one assumes, competitive spreads."

Through a complicated ownership structure, Macquarie Wanda Real Estate Fund (MWREF), a joint venture between Macquarie and local property developer Dalian Wanda, ultimately controls the properties.

The borrower in the transaction is Dynasty Property Investment (DPIL), a Bermuda-registered special purpose company that will shortly become 100% owned by MWREF. DPIL has 100% interests in the nine property holding companies (PHCs) that technically own the properties. The PHCs were established in Mauritius due to that country having a treaty with China to avoid double taxation.

Under the terms of the deal, the Cayman-Islands SPV (Dynasty Assets) will purchase a term loan facility extended by Citigroup and Macquarie to DPIL.

The nine properties - independently valued at $475 million - feature lease agreements with 40 tenants, including international names such as Wal-Mart, B&Q, KFC and Pizza Hut. The weighted average remaining lease term is 11 years, while the assets have a combined average LTV of 49.1% and debt service coverage ratio of 2.3 times.

One impressive aspect of the transaction is high occupancy. The average occupancy rate in June of the portfolio was 98%, with seven properties boasting 100% takeup.

Despite this, any transaction involving Chinese assets is subject to concerns over the legal and tax environment. Consequently, several safeguards were structured into the deal to ensure investors are properly protected. These include a $13.2 million liquidity facility provided by the arrangers; a reserve trapping mechanism that is triggered once the DSCR falls below two times and a $5 million revolving credit facility.

According to Li Ma, senior analyst in Moody's Asian structured finance group, the transaction presented several challenges.

"Given the differences in the legal and administrative procedures between various regions in China, it was a challenge to analyze each region or even city separately," Ma said. "In addition, it is complicated to fully understand the legal framework, land usage, property ownership complexities and relevant tax regimes - especially given that China's legal framework is constantly evolving."

Ma added that the availability of relevant data is limited: in this case the agency had to gather data from various sources and analyze them. "There were also delays to getting important data - some statistical information we gathered from government sources may be a couple of years old," he said.

While it is tempting to believe the transaction sets a replicable template for cross-border issuance of Chinese assets, a recent legal development concerning the ownership of property in China could put the brakes on similar activity.

Until recently, the government recognized three types of holding structures. The first involves 100% ownership by an onshore entity; while the second sees assets owned by an overseas entity with no operational presence in China. The third is a two-tier structure, where properties are owned by an onshore entity such as a Wholly-Owned Foreign Enterprise, which is 100% controlled by an offshore entity.

Now, however, the 100% offshore property holding structure used in the Dynasty deal may no longer be feasible. The government has stipulated companies must have a Chinese presence to own property in the country. Although this does not impact offshore PHC's existing portfolios, it prohibits them from acquiring new assets.

"The 100% offshore property holding structure may not be sustainable, although we may see a few more deals done in this way," Ma said. "For future cross-border activity, work needs to be done to explore the two-tier structure and how to securitize assets held by such entities. This definitely has potential, but it is hard to say when it might materialize as certain issues need to be addressed.

For example, the 50% share capital requirement embedded in a two-tier property holding structure needs to be rectified. If the mortgaged amount is capped at 50% of the property value, additional safeguards may need to be incorporated if a CMBS has an issuance LTV of over 50%, Ma stated.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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