Compliance reviews on mortgage balance asset securitization

Mortgage balance asset securitization refers to the asset-backed securities (ABS) of a business in which cash flow generated by accounts receivable on mortgage balance assets serve as the backing for repayment. As of the end of March 2018, more than 20 mortgage balance ABS products had been successfully offered on the market, amounting to approximately RMB30 billion. This column summarizes the key points of the compliance reviews of the application for such projects by the two major national stock exchanges (the Exchanges).

Scrutinization of loan agreements for real estate projects. Oversight of payment under a loan agreement for real estate projects and the monitoring of cash flow under payment accounts are key concerns that the Exchanges pay attention to. As the bank extends a loan to real estate developers, it will usually specify in the loan agreement the way in which the real estate purchase of sales payments are to take place and will also place restrictions on the liquidity of the funds in the payment account. The Exchanges will usually require project legal counsels to disclose any particulars in the loan agreement executed by the original beneficial owner and its subsidiaries. Furthermore, it will require project legal counsels to express a clear opinion on whether the loan agreement places restrictions on the original beneficial owner and its subsidiaries when using real estate purchase of sales payments for financing purposes. The authors would recommend that the project legal counsel collate all of the loan agreement documentation that relates to the underlying assets and, presenting the data in a table or other formats, list all of the terms under the various agreements that relate to any financing restrictions; and in light of the actual circumstances of the various projects, demonstrate that such terms do not constitute as material impact on the project sales payments. Additionally, the authors would recommend that the original beneficial owner be required to provide a thorough undertaking on financing restrictions.

Scrutinization of down payment loans. As to whether the underlying assets are in the pool involved with down payment loans, this is a concerning issue to which the Exchanges pay special attention. Pursuant to the Notice on Regulating Housing Purchase Financing and Strengthening Anti-Money Laundering Work, the provisions strictly prohibit buyers using down payment financing by real estate developers, real estate intermediary firms, etc. Accordingly, for ABS businesses whereupon final payment of house-purchasing takes place, if the average down payment percentage relating to the underlying assets in the pool is relatively high, the Exchange may require the project legal counsel to scrutinize whether the down payments under the housing purchase contracts correspond to the underlying assets involved in the down payment loans. The authors would recommend that the project legal counsel requires the original beneficial owner to provide all the documents evidencing the sources of the buyers’ funds and request the original beneficial owner to give an undertaking specifically to the effect that they did not provide down payment loans to buyers in any manner whatsoever.

Compliance and scrutinization of revolving purchases. In the Guidelines for Confirming the Conditions for Asset-Backed Securities upon receivable assets, issued at the end of 2017, the Exchanges set forth clearer requirements for the transaction structure for revolving purchases. Compared with the preceding version of the document on the rules for ABS businesses, the Guidelines require the intermediary firms to carry out full due diligence on the assets in the pool that are subject to revolving purchases and require the plan manager to carry out scrutinization and dynamic testing of the operating status on the pool of assets and the cash flow situation on a regular and irregular basis. When the value of qualified assets are insufficient, they require a prompt disclosure of information as well as any undertaking of risk mitigation measures. The authors would recommend that, pursuant to the foregoing requirements, due diligence matters relating to the underlying assets subject to revolving purchases and matters relating to monitoring of the relevant assets be set forth in detail in transaction documents such as the Standard Terms, Asset Sale and Purchase Agreement and Asset Service Agreement.

Dedicated scrutinization of real estate businesses. As specified in the Trials of Classified Supervision for Companies from Real Estate Industry and Industries with Excess Capacities, the project legal counsel is required to carry out a dedicated scrutinization of the real estate business and its real estate enterprise that proposes to offer the mortgage balance ABS, and the scope of such scrutinization should include whether a condition of idle land applies to the original beneficial owner; and whether it has been involved in illegal acts such as land speculation, property hoarding, housing resource hoarding, boosting housing prices, etc. The authors would recommend that the project legal counsel conduct a comprehensive scrutinization of the original beneficial owner’s real estate business during the said reporting period in accordance with the Exchange’s requirements, with such methods to include but not limited to the examining of the original beneficial owner’s financial statements and performing random examination of the necessary qualification documents secured during the stages of development and sales of relevant projects, the searching of the official website of the relevant land and resources authority, etc, and placing an emphasis on checking whether any online media have exposed violations of laws or regulations such as those mentioned above that may have been committed by the original beneficial owner. If they have done so, the project legal counsel should check whether such acts constitute to a material impact and therefore hinders the asset securitization of the mortgage balances and they must clearly express legal opinions thereon.

In one of the projects handled by the authors, a real estate developer was dubbed the “land king” by the media for its high bids at auctions, and the Exchanges required the project legal counsel to examine the matter and express a clear legal opinion thereon. In such a case, the authors would recommend that an effort must be made to determine whether the original beneficial owner had also tried to bid for the same land, by referring to similar cases and conducting an analysis of the total transaction price, the land premium rate and details of the location of the lot.

In addition to the key main review points, the Exchanges will announce compliance review opinions corresponding to the specific features of each project.