CONCRETE JUNGLE: High-rise buildings stand in Beijing's central business district, where investors and buyers take stock of the changing securities market (CFP)
In hopes of bolstering a gloomy real estate market, China's central bank at the end of September announced its decision to encourage banks and financial institutions to free up home loans by issuing mortgage-based securities (MBS).
MBS, a type of asset-backed securities secured by a mortgage, or more commonly, a collection of mortgages, are nothing new. As early as the 1960s, the United States had established Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp.) to expand the secondary mortgage market by securitizing mortgages in the form of mortgage-backed securities.
In 2005, the China Development Bank and China Construction Bank were approved to carry out asset-backed securities and MBS pilot projects. After that, the China Construction Bank unveiled two terms of residential MBS in 2005 and 2007. However, there was no further promotion after the subprime mortgage crisis descended on the United States in 2007.
"MBS can liberate an untapped resource for home mortgages and boost the funding liquidity of the property market by diversifying the sources of home loans," said Chen Qing, deputy head of the Financial Research Center of Chongqing University.
According to statistics from the People's Bank of China, the central bank, by the end of September, the real estate loan balance in the nation had amounted to 16.74 trillion yuan ($2.74 trillion), with individual housing loans totaling 11.12 trillion yuan ($1.82 trillion).
"The huge volume of deposited assets has severely restrained commercial banks' capacity to issue home loans, aggravated the risk of defaults, and jacked up the cost of home loans," said Chen.
So what does MBS mean for banks? If mortgage loans are packaged into MBS products and sold to investors at a certain interest rate, banks can take back the money they lend to home buyers, earn fixed interest rate differentials, and transfer the risks to the securities market.
Merits and demerits
Although the securitization of credit assets was ceased in 2008, issuing bodies have constantly pursued expansion and the underlying assets have been remarkably diversified since the practice was resumed in 2011, said Zeng Gang, a research fellow from the Institute of Finance and Banking at the Chinese Academy of Social Sciences.
Zou Hengchao, an analyst from Minsheng Securities, believed both home buyers and investors will benefit from the promotion of MBS. Traditionally, banks have been reluctant to engage in mortgage loans because their comprehensive cost is high. With the large-scale issuance of MBS and special financial bonds, banks will be motivated to release more home loans and their interest rates, to some extent, will fall.
Beyond that, in the process of interest rate liberalization, the cost of attracting bank deposits will rise. As opposed to that, the pricing of home loans, given the fact that their repayment may span several years, lacks elasticity and flexibility. "By releasing MBS products, banks can move home mortgage lending out of their balance sheet, which will effectively alleviate the mismatch risk and optimize the financial structure," said Zeng.
On the other side, these MBS products may turn out to be less appealing to investors. "Since there is little past data on default rates and down payment rates that can be referred to by the issuers, it will be difficult for them to decide the prices of MBS products," said Cao Yang, a macroeconomic analyst from the Finance and Market Department of the Shanghai Pudong Development Bank, noting that there are no lack of alternative assets carrying a lower degree of risk and higher yields in the market.
In addition, if MBS products can only be traded in the interbank market, banks may reach tacit agreements on the reciprocal purchase of such products, in order to move loan assets out of their balance sheets and avoid credit supervision, said financial commentator Yu Fenghui.