China's central bank, the People's Bank of China, recently announced that it has given permission to the China Construction Bank to start offering mortgage-backed securities. The move caused a flurry of publicity in international newspapers and capital markets publications, with the Financial Times quoting Li Zibin, the mayor of Shenzhen, one of the two cities chosen to pilot the securities, saying that a deal would be launched "very soon or, at the latest, by the end of the year."
The deal in question is linked to a project between CCB and Macquarie Bank, an Australian mortgage bank with significant securitization expertise, which has seen Macquarie advising CCB on originating mortgages with a view to securitization some time in the future. The project has been running for the best part of two years.
Andrew Bruce, managing director of Macquarie in Hong Kong, declined to comment on the reports, but other securitization pros, with knowledge of the project and experience of working in China, warned that any deal is likely to be some way off - if it ever sees the light of day.
While the CCB has been advancing mortgages for some time, with some sources in China estimating that the bank has lent around Rmb100 billion ($12 billion), it is not clear how many of these mortgages securitizable.
One expert with knowledge of the project between Macquarie and CCB, said it was along way from a mortgage-backed deal. "They are still at phase one, which is actually getting the origination process fully up and running and creating something that could actually be securitized," he said.
Pros also pointed to the many significant problems that stand in the way of any securitization in China. International deals are effectively ruled out by the partial convertibility of the renminbi, particularly given the terrible history of internationally placed project financings backed by renminbi toll road revenues, most if not all of which are worth considerably less than their launch price.
Even for domestic MBS, appetite for which is at best uncertain, there are many problems that could scupper a deal, starting with the difficulty of creating a security interest in a mortgage and being certain that the courts will enforce it in the event of a default.
There is also the near impossibility of creating a genuinely independent onshore bankruptcy remote vehicle to hold the mortgages, the security interest in the underlying property and issue the bonds. "We went through this recently with lawyers in the PRC in some depth and it is impossible to create any kind of bankruptcy remote entity," said Neil Campbell, a securitization partner at U.S. law firm Brown & Wood's Hong Kong office. "In other words, an entity where the mortgages could be held and where the risk of insolvency is extremely remote, as you can elsewhere by having it owned by a trust, for example."
Campbell suggested that the nearest thing to an independent SPV that is possible in Chinese law may be one owned by a central government-sponsored body; a solution that may work for domestic transactions, but is far from ideal.
Lawyers and securitization pros added that a domestic mortgage deal will only become possible if new legislation is introduced to deal with these and other problems. Other lawyers went so far as to suggest that normal enabling legislation would not be enough and that the Chinese legal system would have to be completely overhauled to make possible deals with anything like the safeguards and certainties required in normal securitizations elsewhere.
Of course, all of this doesn't mean that a deal won't at some stage be possible, even if it a transaction may at best be a quasi-securitization, pros added. China's big banks (all of which are state-owned) are riddled with non-performing loans made to badly performing state-owned industries on the orders of the government. However, the government has also instructed the banks to start mortgage lending in order to make possible the government's desire to increase private housing and get away from state-provided housing and accommodation provided by state-owned companies.
Consequently, experts said, the banks will sooner or later face a liquidity crunch and unless they can raise finance from the mortgages they have already lent cash may simply dry up. Combine this with the fact that the government is obviously keen to gain the benefits of securitization and it is possible that some kind of deal will eventually emerge.
"What announcements like this demonstrate is that the government is keen to use securitization. And what the Chinese government wants, it usually gets. Whether a deal will really be a securitization, or even a quasi-securitization, is another question," said a banker in Hong Kong.
"You have to remember that many financial decisions in China are not rational economic ones, but come from policy objectives," said another lawyer at a U.S. firm. "That is not the kind of deal that Macquarie will be involved in, but it is certainly possible that that is how the Chinese government will view mortgage securitizations.
"To take an example, without referring to this project specifically: in normal circumstances a deal will be a success if there are investors who are impressed with it and want to buy it; but that may not apply in China, as it is conceivable that a deal will be issued and the government will simply order state-owned insurance and pension companies to buy it. You may think that that is simply reshuffling the pack, as all these institutions are state-owned, but that hasn't stopped them before."