Securitization is the process whereby an originator structures and issues securities with illiquid assets that can generate steady cash flow as underlying assets. It is a type of structured financing backed by credit of the underlying assets. The term “real estate securitization” is used in this article to refer to a process where a property developer structures and issues asset-backed securities (ABSs) secured by all of its qualified assets.
Data from the Asset Management Association of China (AMAC) show that since the filing system was implemented in late 2014, the combined issue size of ABS programmes had been rising drastically to RMB1.61 trillion (US$251 billion) as of the end of 2017, growing by 133.56% on a year-on-year basis. Apart from robust growth, securitization products backed by real estate assets are increasingly diversifying to include quasi-real estate investment trusts (REITs), commercial mortgage-backed securities (CMBS), as well as ABSs with property management fee, long-term rental income from apartments, etc., as underlying assets.
The prevailing regulatory policies for the real estate industry and the regulatory environment for the financial industry are forcing real estate companies to take immediate action to adapt to the new market environment and policies. These involve shifting their focus from extensive expansion to lean management, and considering the use of securitization to achieve objectives that range from gaining access to external capital, improving debt structure, and reducing leverages to revitalizing existing assets and transforming their business models.
The tightening regulation over financing activities combined with increasingly steady control measures for the housing market in recent years is presenting a wealth of opportunities for asset securitization, as real estate companies find it more and more difficult to gain access to capital.
Securitization will help effective implementation of the policy encouraging both housing purchases and renting. As President Xi Jinping’s report to the 19th CPC National Congress noted: “We must not forget that housing is for living in, not for speculation. With this in mind, we will move faster to put in place a housing system that ensures supply through multiple sources, provides housing support through multiple channels, and encourages both housing purchases and renting, thereby ensuring that all our people will have a proper place to live in.” Securitization is expected to drive effective implementation of this policy, providing rental home suppliers with a new financing channel and an alternative to exit investments. It will help companies develop the business cycle including the steps of investment and construction, holding and operations, exiting and cashing in, and finally reinvestment – so they will be able to shift their focus to specialization, branding and scale building.
Following the footsteps of Xinpai Apartments, which obtained approval in October 2017 for its ABS programme based on long-term rental income from apartments, the first of its kind modelled on quasi-REITs, several rental home operators such as MoFang Apartment and Ziroom also launched their securitization programmes. In May 2018, the joint ABS programme of Shenzhen Capital Group and Shenzhen Talents Housing Group, based on rental homes for people of good ability – on which the authors advised – was successfully approved by Shenzhen Stock Exchange. It was the first quasi-REIT in China based on public rental homes for people of good ability.
In April 2018, the China Securities Regulatory Commission (CSRC) and the Ministry of Housing and Urban-Rural Development issued the Notice on Promoting Work Relating to Securitization of Rental Homes, providing guidelines for professionals involved in securitization of rental homes.
REITs will help real estate companies to decrease their financial leverages. As financial products that pool investors’ capital to invest in mature properties, REITs are allowed to invest in real estate projects ranging from commercial properties and office buildings to hotels and infrastructure. Their sources of income include property operations and property appreciation.
REITs play a positive role in assisting real estate companies to revitalize their existing assets, move assets and liabilities off balance sheets, and adjust their debt structures. As noted in the Opinions on Actively and Safely Lowering Leverages of Companies, support will be provided to real estate companies so that they can shift to asset-light models through development of REITs.
Of the quasi-REITs that have been issued, most are structured with reference to mature REITs and in accordance with the existing guidelines on securitization. Typical examples include CITIC Qihang Specific Asset Management Plan and the ABS programme jointly created by Bank of China, China Merchants Bank and Beijing Kaiheng Building.
According to China Securities Journal, guidelines for publicly traded REITs are expected to be released later in 2018. It is likely that infrastructure assets, public service assets and operational properties will become the first underlying assets for these REITs.
Regulators have started strengthening risk control over securitization programmes given negative news, including without limitation insufficient disclosure, improper regulation over funds, and redemption failure upon maturity.
Strengthened credit risk management during the term of products. In May 2018, Shanghai Stock Exchange and Shenzhen Stock Exchange issued the Guidelines for the Management of Credit Risks during the Term of Asset-backed Securities and the Guidelines for the Content and Format of Periodic Reports for Asset-backed Securities. Defining credit risk management responsibilities of market players, these guidelines aim at improving the risk management system for securitization transactions, strengthening credit risk management during the term of products, and protecting the legitimate rights and interests of investors.
Strengthened review and supervision over originators. China Securities Journal reports that CSRC and AMAC are formulating guidelines on originator review with focus on originators’ securitization experience and qualification, as well as use of fund under securitization programmes. The purpose is to keep business risks under control at sources and bring the fundamental role of securitization transactions (i.e., helping to revitalize existing assets and supporting the real economy) back into play.
Opportunities never come without risks. Given the current regulatory environment, lawyers do not only need to study business guidelines to ensure a holistic approach to their practice, but also have to attend to details such as due diligence and selection of underlying assets, product structuring, and design of credit enhancement arrangements.
Jia Yong and Ma Huijun are partners at Zhong Lun Law Firm