The Washington Post once remarked that Alphonso Jackson would be remembered as the cabinet secretary so committed to President Bush’s homeownership goals that his policies contributed to much of the mortgage crisis that gripped the United States eight years ago. But fewer people may recall that in July 2007 – several months before Jackson’s removal as head of the US Department of Housing and Urban Planning – he flew to Beijing in a last-ditch attempt to salvage his legacy.
Amid a surge of homeowner defaults, Jackson tried to cajole the Chinese into buying more of America’s securitised debts. It was a tough sell because China Investment Corp was only two months away from launching – its mission to diversify China’s sovereign wealth funds away from US assets. Moreover the Chinese financial system was already sitting on massive exposure to American mortgage-backed securities (MBS). The China Banking Regulatory Commission (CBRC) found in June 2008 that 14 of the nation’s banks held $31 billion of the securities, all backed by US housing giants Fannie Mae and Freddie Mac (these figures excluded off-balance sheet exposures).
Of course, as the financial crisis took hold these positions soon soured, leading to losses. This was a setback for China’s financial sector reformers, who had been pushing for more liberalisation. Trials to pilot a local securitisation market – transforming illiquid assets such as mortgages, bad loans and other recurring cashflows into marketable securities – were called off. But with cracks now emerging in China’s own real estate sector, policymakers seem to be having a rethink. It looks like regulators might see securitisation as a more viable option than before. The alphabet soup of MBS, ABS (asset-backed securities) and even CLO (collateralised loan obligations) are back on the table, and there’s even speculation that Beijing may opt to create its own version of Fannie Mae.
What is the latest securitisation push?
On September 30 the People’s Bank of China and the CBRC issued a joint statement easing mortgage lending restrictions for the first time since 2008. People applying for a mortgage to buy a second home are now required to stump up a 30% downpayment, provided they have fully repaid their existing mortgage loans. That’s the same as for first-time home buyers (60% downpayment was required prior to the policy change, as a minimum).
Initially the concession was interpreted as another effort to revive a flagging sector. Home sales in the first three quarters of this year have fallen 10.8% to Rmb4 trillion ($660 billion), according to the National Bureau of Statistics. The slowdown has left a slew of property developers with liquidity troubles (see WiC256 for more on Agile’s woes).
But analysts then started finding juicier meat in the reform package. Media soon noted that the regulators were also encouraging the country’s banks to raise funds for new home loans by selling “MBS and special financial bonds” with longer maturities. “It represents the first time the two regulators have come out in favour of a bigger mortgage-based securities market after a six-year hiatus,” the South China Morning Post observed.
Subsequent reports have suggested another major change, with Xinhua proclaiming that the imminent launch of “the Chinese version of the ‘Two Fangs”. (Fang means “house” in Chinese. “Two Fangs” is Chinese slang for Fannie Mae and Freddie Mac.)
According to data from the PBoC, property loans in the banking sector stood at Rmb1.6 trillion in June, of which 66% are mortgages. “This massive sedimentary asset has hampered the banks’ lending capacity, pushing up mortgage costs along the way,” Xinhua suggests. “Once MBS issuance is allowed, it will unleash a Rmb1 trillion of illiquid assets back into financing channels.”
MBS to the rescue?
Mortgage-backed assets aren’t entirely new to China. Regulators first allowed pilot programmes in 2005, when China Construction Bank sold Rmb3 billion of MBS, following up with another issuance two years later. Regulators resumed the pilot plan in 2012, with Postal Savings Bank of China raising Rmb6.8 billion by selling residential mortgage-backed securities.
The Economic Observer reports that Bank of Communications could be the latest to join the experiment and has been studying a Rmb7 billion MBS sale since March. The proposal may now be accelerated following the latest regulatory encouragement.
But given the limited scale of MBS issuance, the market is still relatively untested. Earlier trials have been stop-start too. “There has been no policy continuity for the establishment of a healthy (MBS) market,” Economic Observer suggests. “Trading in the secondary market is thin which means not many investors are interested.”
As such, ratings agency Moody’s has warned that the banks themselves contributed the majority of buying demand for the early securitisation transactions. This defeats the purpose of the programme because it does nothing to diversify credit risk away from the banking system.
Price is also an issue. “There is no shortage of high-yield products in the financial market. If the MBS products are priced too high the risk is too big, if they are priced too cheaply issuers won’t be interested,” National Business Daily warns.
“Full interest rate liberalisation is the prerequisite for a mature MBS market.”
PBoC Governor Zhou Xiaochuan said in March that fuller interest rate liberalisation could occur within two years. And if this can be achieved, there is only one major roadblock to overcome: a government-backed entity that guarantees investors against MBS defaults. But this should not prove too much of an impediment for the central government. After all, Beijing has never been shy when it comes to sharing its creditworthiness with its state giants, especially when they are involved in projects that it regards as strategic (Cinda, the asset management firm, and some of the companies reporting to the now defunct railways ministry, have had their bonds backstopped with government guarantees, for instance.)
The state media seems to agree. “It’s time for the central government to establish a Chinese version of the US mortgage finance giants Fannie Mae and Freddie Mac to prevent a property bust,” the Global Times argued in September, just a week before the PBoC and CBRC made their statement on the creation of a MBS market.
Another broad hint was included in the communiqué issued after the Party’s Third Plenum last November, when it addressed the need for “policy-oriented financial institute on the residential market”. With control of more than Rmb1 trillion of mortgage assets at stake, the idea has piqued the interest of various government ministries. In February, Century Weekly reported that the housing ministry had proposed establishing a “special bank” to finance more homes for grass-roots families. Creating such a policy bank, the magazine suggested, would bridge funding gaps at many of the country’s numerous affordable housing projects (see WiC251). The lender could be run at lower cost if the central government waived taxes normally levied on commercial lenders, it also thought.
China Development Bank (CDB) has already volunteered to do the job too. The lending powerhouse has been competing for business with commercial banks since 2008 (for more on its unique background, see our Talking Point in issue 189). But with interest margins squeezed by more market-oriented monetary policy, it might be plotting a return to some of its policy-banking roots. Some sources are now convinced it is the prime candidate to become the housing policy bank. This was hinted in July when it received Rmb1 trillion from the central bank for a relending programme to support shantytown urban renovation projects.
If CDB is to become a state-sponsored specialist with a mission to promote the MBS market, it may not need to worry about who is going to buy its securitised wares. According to the Xinhua-run China Securities Journal, the State Council will encourage it to raise capital by selling “designated financial securities” to China’s social security funds (these are longer term investors holding large pools of often-idle capital). The newspaper doesn’t mention if CDB’s potential new role would make it an issuer or as a guarantor, or a mixture of both. However, it stresses that a new housing financier will guard against systematic risks and “avoid repeating the same mistakes committed by Fannie Mae and Freddie Mac”.
Is another policy U-turn possible?
Asset-backed issuance has been making a comeback globally. According to The Economist, issuance of paper backed by non-residential mortgages was up from just $4 billion in 2009 to more than $100 billion last year.
In China too the data speaks for itself. Data tracker Dealogic believes that securitisation deals so far this year have already outnumbered the total business completed over the previous eight years. Sales of asset-back bonds jumped to nearly $20 billion in the first three quarters of 2014, up from $3 billion last year.
Car loans have been one of the big drivers in the securitisation spree, following a CBRC initiative in February that allowed non-bank financial institutions to issue auto loan securitisations. Since then foreign-owned auto lenders including Volkswagen, Toyota and Ford have all tapped China’s new ABS market.
But there are also signs of caution about securities-backed activity. In a notable example that illustrated the state’s sometimes less-than-ideal policy coordination, a Rmb2.6 billion CLO issuance by Ping An Bank (backed by small consumer loans with an average maturity of about two years) was caught in the crossfire between the securities and banking watchdogs. The central bank halted the CLO sale in June, a day after Ping An announced that the securities would debut on the Shanghai bourse. The question here was whether structured products should be made available to the general public. But the intervention drew criticism from the investment community and the PBoC backtracked. Ping An’s CLO became the first of its kind to trade on a Chinese exchange.
Regulators have adopted a more cohesive approach since then. The PBoC’s deputy governor Hu Xiaolian even told the International Conference of Banking Supervisors last month that the central bank sees merits in allowing new avenues for shadow banking – by which she means any effort to move away from conventional bank lending.
“The fast development of shadow banking is in many cases driven by regulatory arbitrage,” Hu said. “But we shouldn’t simply adopt a negative attitude because of such regulatory arbitrage activities.”
With inflation easing to a five-year low (the consumer price index rose only 1.6% last month from a year ago), analysts generally agree that there is room for monetary loosening. As part of this, the emergence of a more expansive MBS market could stabilise the housing market and even become “the Chinese version of quantitative easing”, the Economic Observer argues.
But what about those memories from the 2008 meltdown in the US? On this score, confidence seems high that China won’t fall into the same trap as the US and other major markets. “The evolution of finance is, in fact, a history of turning financial tools from weapons of mass destruction into conventional arms. The very same principle also applies to securitisation,” the Economic Information Daily ventured breezily this week.
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