China: Hey, Wanna Buy Some Used Mortgages?
What does an urban Chinese worker want after a mobile phone and a digital video player? A home. The days of free, or subsidized, housing are ending in China. Surprisingly, residential developments, even in go-go cities like Shanghai, aren't prohibitively expensive. And if buyers don't want to hand over cash, they can now obtain 30-year mortgage loans at reasonable rates of 5.58%.
But what's been good for Chinese consumers has created a dilemma for China's big banks. They've now got billions of dollars worth of long-term mortgages weighing them down, while most of their deposits are short-term. So several are hoping to issue mortgage-backed securities, a sophisticated financial instrument that should boost banks' liquidity. The banks get the loans off their books by packaging large numbers of them and reselling them to investors, using the money they receive to make yet more loans. "MBS is perfect for China because it can turn long-term loans into cash almost overnight," says Xu Xiaonian, research director at China International Capital Corp. If the securities take off--a decided "if"--they could help heal China's sick banks and give local investors an added, and better-paying, home for their savings.
China Construction Bank (CCB), one of the four largest state-owned commercial banks, will be the first to launch such a program. CCB received approval from the central bank in April and may begin selling as much as $1 billion worth of MBS in Shanghai and other major cities later this year. CCB accounts for some 50% of the country's home loans. At the end of April, its mortgage portfolio stood at $12 billion, a quarter of it at the bank's Shanghai branch. A separate institution will bundle MBSs for sale. Bank officials have been working with Australia's Macquarie Securitization to create the program. The International Financial Corporation and ratings agency Standard and Poor's Corp. also are advising CCB, though the securities will initially only be available to domestic investors.
Securitized mortgages could help clean up banks' balance sheets. China's lenders are saddled with an estimated $250 billion in bad loans, mostly made at Beijing's behest, to loss-making state-owned enterprises. By contrast, Chinese home-buyers are a good bet, defaulting only about 2% of the time. "Securitization is a bridge from the banks to the capital markets," says Gu Haozhong, who runs the mortgage division at CCB's Shanghai branch. At the same time, Gu adds, MBS would make lenders' credit operations more transparent, since the banks would have to report to investors.
DRAWBACKS. China's insurance companies are likely to be eager buyers of the new securities. Currently, insurers are limited to investing in such instruments as bank deposits, treasury bonds, and securities funds. Eventually, brokers will target ordinary Chinese, who have some $725 billion in savings and earn meager returns of about 2.5% on bank deposits. CCB also hopes to sell MBS to international investors one day, though that may be years away.
For any investor, mortgage-backed securities carry some risk, of course. First, banks' credit assessment and administration are sometimes poor. That would be less worrisome if the country's financial rating industry were fully developed. But it isn't, and international debt-rating agencies won't be evaluating China's MBS. And the nation's financial regulatory structure is not really in place yet either.
To compensate for these drawbacks, the banks may first have to guarantee the securities themselves, says Diane Lam, S&P's director of structured finance ratings in Hong Kong. It won't be purely market finance, that's for sure. But it might be close enough for Chinese investors.