Since S&P Global Ratings assigned its first rating to a China-based residential mortgage backed security (RMBS) transaction in 2018, this sector has been attracting increasing attention from offshore investors. We believe one draw is the longer weighted-average tenor offered by RMBS relative to other securitization assets in China.

In our view, it's imperative that market participants in RMBS, particularly offshore investors, gain a holistic view of China's housing market, mortgage market, and RMBS sector. We provide an overall of all three in this report.

Table Of Contents

1. China Housing Market Overview

1.1. Property type and ownership

Property types: Urban high-rises predominate in China's residential markets 

China's urban development model relies heavily on high-rise residences for land-use and environmental purposes. Hence most mortgage loans are for units in apartments or high-rises complexes. Stand-alone houses and developments also exist but constitute a much smaller part of the market.

Due to years of almost continual price appreciation, regulators have long layered the market with restrictions to keep housing within affordable range, especially for first-time homebuyers. Size is used as a gauge when setting such housing restrictions and associated regulations. In China, developers often rely on pre-sales to obtain cash to complete construction of development projects. For this reason, stage-of-development is important to watch in this RMBS market.

Property types include: 

Ordinary and non-ordinary housing.   A major distinction between the two is floor size. In general, the first type is defined by regulators as floor size no greater than 144 square meters, among other criteria, while the second type is floor size greater than 144 square meters. This distinction is worth noting because different compliance rules and tax rates may be applied for non-ordinary housing.

New (including forward-delivery) and existing homes.  For new homes, registered contracts of sale are an important source for mortgage originators to decide the loan-to-value (LTV) ratio. For existing homes, banks usually consider the lower of sale price and property appraisal by a third party when determining the LTV ratio.

Completed houses and forward delivery houses.   A completed house is one with certificates of house ownership and land use rights. It is ready for delivery. A forward delivery house is clearly defined in the context of mortgage loan origination. The definition is that when a building is topped out (i.e. its roof is sealed), a bank can apply for an advance registration notice of mortgage and disburse a mortgage loan based upon such notice. The time taken to complete construction for delivery is typically a few months to two years. When the house is completed and associated certificates become available, the bank has the priority right to register a typical mortgage on the house. In our view, mortgage loans extended against forward delivery houses are exposed to construction risk.

In China, we do not rate RMBS whose underlying pools include mortgage loans on forward-delivery houses. Hence our rated RMBS are not exposed to construction risk of the underlying properties.

Ownership: China has a leasehold system 

Homeowners in China are entitled to the property ownership and the land-use rights granted through leases. The two together constitute the property rights. The ownership of the residential land belongs to the state. There is no private land ownership under Chinese law.

The lease term for much of China's residential land is 70 years. In other rare cases, the lease term may range from 20 years to 50 years. According to the regulators, the 70-year leases will be automatically renewed when expire.

Property rights in China is governed by the Property Law of the People's Republic of China.

1.2 Housing price trend

Restrictive policies set to maintain price stability 

Housing prices have been cooling off since 2017, when regulators implemented stricter rules to curb fast growing property prices and speculation in the property market. Fighting bubbles has been a long-time priority for regulators.

In China's major (or tier-one) cities, prices have stagnated since 2018, with nearly flat year-on-year (yoy) growth price moves. Initially some momentum shifted to tier-two and tier-three cities, however growth rates have gradually slowed down there as well. In the past twelve months, growth rates of average property price in tier-two and tier three cities remained at or below 5% (see chart 1).

Chart 1

1.3. Property location

Property markets are sharply differentiated by region 

Like in most Asian countries, China's properties located in city centers and downtown areas are usually prime and in high demand. Unlike markets with suburban housing sprawl, such as in the United States and Australia, the key residential markets are urban in China.

Due to large wealth gaps within China, regional property markets vary greatly depending on factors such as local population trends, income, and economic growth. Housing supply and demand, and consequently average selling prices, vary from city to city too. For example, average selling price (ASP) increased about 80% in China's four tier-one cities over 2012-2016. In the same period, ASP also grew by about 25% in tier-two cities, but with exceptions. The ASP in Wenzhou, a trade-oriented city on the coast of Zhejiang province with a lively private sector, dropped 30% due to a localized financial crisis.

Beijing, Shanghai, Guangzhou, and Shenzhen are classified as tier-one cities. They are four of 70 cities tracked by the government on residential-property indicators including ASP and sales volume. Cities are classified as tiers one, two, and three for mortgage-disclosure and other purposes. However, market participants devise their own categorizations as well; so other than for tier-one cities, the tiers and ranking can vary among private rankings.

Regional markets will get more leeway in setting locally relevant policies 

Under the umbrella of strict national rules set by the Chinese central government, the regional regulatory authorities are urged to develop local rules and policies that are adaptable to individual markets. Trials of the "one city, one strategy" property control policy have started in 2019, first among a dozen of provincial cities such as Changsha and Hangzhou. For example, Hangzhou, like many provincial cities in the pilot, eased residency requirements for non-local talents to purchase homes and offered the group numerous housing purchase subsidies to attract them to settle down and work in the city. The market expects the "one city, one strategy" policy to be further rolled out in a greater range of cities following the push from the government. The goal is to stabilize the housing market in each region based on its own needs and market conditions.

2. Mortgage Market

2.1. Mortgage originators

Two types of financers provide mortgage loans in China, namely banks and house provident funds (HPF). Six banks dominate the market.

China's top six banks account for around 75% of bank-financed residential mortgages 

Aggregate measures of China's five large state-owned commercial banks are good indicators for the bank-financed mortgage loan segment, in light of the banks' aggregate market share and nationwide branch network. Postal Savings Bank of China Co. Ltd. (PSBC), the sixth-largest commercial bank in China by total assets, plays a unique position in the county and rural banking market.

HPF serves qualified obligors with cheaper funding 

The mandate of HPF is to help low- to middle-income households by extending cheaper home loans. Employees are required to contribute a proportion of their monthly salaries to the fund, with employers contributing certain amounts. Contributors to the fund can apply for preferential-rate mortgage loans, withdraw funds to pay for housing repairs and maintenance costs, and pay for rent if certain conditions are met. The People's Bank Of China (PBOC) occasionally adjusts the preferential benchmark rate. The rate is currently 3.25% for loans over five years, compared with 4.75% base rate for ordinary mortgage lending at around the same tenor.

2.2. Size

The outstanding balance of bank-originated mortgage loans reached RMB30 trillion by the end of 2019 (see chart 2). The size of the bank's mortgage loan portfolio has increased by more than four times in less than a decade.

The market expanded rapidly from 2015 to 2017, with the growth rate of the outstanding mortgage loans exceeding 35% in early 2017, the fastest ever. Regulators responded by implementing much stricter controls over the property market and mortgage market to curb speculation. Criteria for both housing purchases and mortgage lending were greatly tightened. The growth rate for mortgage loans immediately slowed (see chart 2).

Chart 2

2.3. Product types and related features

By lenders.   Home loans, depending on the originators, are classified into bank loans, HPF loans, and "combo" loans. A combo loan refers to homebuyers borrowing via both HPF and a bank. This is common because despite the low cost, HPF loans are usually subject to strict rules for maximum limits and may not fully meet the funding needs of borrowers.

In most Chinese RMBS transactions, the securitized assets are bank loans.

Principal repayment method.  Principal is repaid in equal monthly instalments or equal principal repayments. In most Chinese RMBS transactions we rate, the weighting of equal monthly instalments versus equal principal repayments is around 80% to 20%.

Mortgage rates.  Loan Prime Rate is the new base rate. The Chinese central bank implemented a new loan pricing regime in 2019, replacing the PBOC lending rates with loan prime rates (LPR) as the new base rate for mortgage loans. The effective mortgage rate is calculated as the LPR plus or minus a fixed spread. The regime was initially rolled out in 2019 to new mortgage loans only. The conversion of the existing mortgage loans to the LPR rate will take effect from March to August 2020. The five-year LPR is used for mortgage loans. The rate is reset each month by PBOC based on quotes from a panel of participating banks. The latest quote of the five-year LPR was 4.65% as of May 2020.

PBOC lending rates were the previous reference.   Prior to LPR conversion, the PBOC five plus year lending rate was the most commonly used base rate for mortgage loans. If a loan's tenor is not longer than five years, PBOC's one to five year lending rate would be the base rate. Under the PBOC pricing regime, the mortgage rate was calculated as the PBOC lending rate adjusted by a fixed multiplier. The PBOC five plus year lending rate is 4.9%. PBOC one to five year lending rate is 4.75%.

Base rate resetting.   Under the LPR regime, the rate resetting period shall not be shorter than one year. Based on common market practices, we believe rates will likely be reset at the beginning of the next year or on the anniversary of the last reset.

The conversation to the new rate-setting regime is still in transition. In the context of PBOC lending rate, four types of resetting frequencies have predominated: a new rate may become effective in the month, the quarter, beginning of next year, or an anniversary, following the rate change.

Loan tenor.  Initial term to maturity can go up to 30 years. In practice, most tenors are not this long, due to restrictions; e.g., the maximum total of the loan tenor and the age of the borrower cannot exceed 65 years. For existing homes, more thresholds such as test of property age may apply, further limiting the loan tenor.

In our observation, initial loan tenor commonly range between 20 to 30 years. And initial loan tenor of less than five years is rare. Average initial loan term according to PBOC's announcement in July 2017 was 269 months (around 22.4 years) for newly originated loans. The governmental policies on mortgage loan tenor have not much changed in the recent years.

Notable features.  The mortgage loans offered in China are straightforward and homogenous. Notable features associated with mortgage loans are:

• Home insurance is not common.
• Interest-only periods, teaser periods, and mortgage insurance are rare.
• Mortgage refinance or balance transfer is rare, partly due to regulatory restrictions. In addition, mortgage rates among banks in the same region are usually not much different and hence provide no incentive for borrowers to refinance through another bank to lower mortgage rates. The regional banking association sets minimum lending rates as reference for banks in each regional market.
• Redraw facility is not allowed.

2.4. Regulatory dynamics

Regulators.   The PBOC and China Banking and Insurance Regulatory Commission (CBIRC) are the main regulators.

The Ministry of Housing and Urban-Rural Development is in charge of property-related matters. It has from time to time released rulings and guidance jointly with the PBOC and CBIRC regarding the housing and mortgage market.

Key regulations in relation to mortgage lending  

Debt-to-income test.   Mortgage borrowers have to meet criteria for income as a proportion of debt, according to the "Commercial Bank Real Estate Lending Risk Management Guidance," issued in 2004, by the forerunner of the CBIRC. The key measures of debt-to-income assessment are:

• Monthly mortgage payment over monthly income is equal to or less than 50% and
• Monthly debt payment over monthly income is equal or less than 55%.

Loan-to-value ratio.  Chinese homeowners have to put down a lot of cash to get a mortgage loan. According to the PBOC's regulatory requirement, the loan-to-value ratio to apply in mortgage lending needs to observe the following rules:

• For first-home purchases, the general rule of the maximum LTV ratio is 80%. If the purchase is subject to purchase restrictions, the maximum LTV ratio drops to 70%. For example, in Beijing, mortgage loans for first-home purchases with floor size over 90 square meters needs to put down at least 30% in cash.
• For second-home purchases the maximum LTV ratio cannot exceed 60%. If the second home is a non-ordinary housing (for example, housing size exceeding 144 square meters), the maximum LTV ratio is at most 20%.

2.5. Underwriting criteria

PBOC Credit Bureau check and score card.   The PBOC administrated Credit Bureau provides personal and entity credit records that can be accessed by banks for credit checks. A nationwide credit system was first implemented in 2006, and covered about 1 billion people by 2019. With an upgrade beginning in 2020, the second generation of the system is said to have enhanced on key functions including information quality, usefulness and security. In addition to PBOC credit checks, banks also use their in-house score card systems to facilitate credit underwriting. With pre-embedded underwriting criteria, the score card system can automatically score a loan application and classify it into a relevant risk level. Based on the outcome, the system can either automatically approve/reject an application, or assign it to a credit officer for manual review.

Debt-to-income ratio.   Banks in China adopt the debt-to-income test as the affordability measure in underwriting mortgage loans. This is in compliance with the regulatory requirement specified in section 2.4 above.

In calculating monthly debt payments, banks usually refer to the PBOC's credit bureau records and HPF sponsored-mortgage loans. The PBOC's credit records normally include debt with financial institutions such as banks and auto finance companies. Banks usually don't calculate in debt obligations related to fintech companies such as unsecured consumer instalment receivables or loans. However, we believe some banks may be seeking to incorporate scores developed by fintech companies, as information is becoming more transparent in line with financial technologies.

The household net income is used in calculating DTI, with income taxes excluded. For salaried borrowers, stamped income letters and bank statements are mostly used as proof of income. For private-enterprise employees or self-employed borrowers, additional documents such as business licenses may be required. The banks may conduct phone inquiries or online checks to verify the employment authenticity. For rental or investment incomes, documents such as rental contracts, investment certificates need to be provided.

Loan-to-value ratio.   Banks in China strictly follow the PBOC's guidance on the LTV ratios. As detailed above (see section 2.4), the maximum LTV in China is 80%, and available only for first-home purchases in general. For second home purchases or properties located in markets subject to purchase restrictions, more conservative LTV ratios are applied. The definition of second-home purchase includes scenarios of both second mortgage and first mortgage for a second home when the borrower's first home remains on hand. The current policy restricts selling of third homes.

According to data reported by sample banks in China, the LTV ratios of first-home purchase and second-home purchase have both declined since 2017. The tightening was in correspondence with stronger regulatory restrictions on property and mortgage markets. For first-home mortgage loans, 70% LTV has replaced 80% LTV as dominant market trend. For second-home mortgage loans, 60% LTV was losing steam while 50% and 40% LTV were rising quickly.

Property appraisal.   The property value for a new home is based upon "registered" contract of sale. If banks believe the registered contract of sale to be higher than the market level, they could apply a lower property value. A contract of sale and sale price needs to be registered and therefore can be found online via websites managed by China's real estate-related government agency.

For an existing home, a third-party property appraisal report is required. The selection of appraisal vendors and procurement of appraisal services are usually centralized.

2.6. Mortgages

In China, the most common form of security granted over real estate is a mortgage. A bank mortgage lender must execute in writing through either the signing of a separate mortgage agreement by the mortgagor (the borrower) and the mortgagee (the bank), or co-signing of the mortgage loan agreement incorporating terms of the mortgage by the mortgagor.

In addition, the mortgage lender must register the mortgage with the real estate-related government agency to create a valid mortgage right over the associated residential property. This is why typically a mortgage lender would check if a mortgage registration is made before the lender disburses the loan backing a residential property with title certificate.

2.7. Servicing

Borrowers are required to set up auto-debit bank accounts for monthly repayment before loan disbursement. This is an industry practice.

Besides collection, the servicing scope also includes ongoing monitoring of the loan book's performance conducted by dedicated servicing teams set up by banks in their headquarters and branch offices. Risk models and behavior scorecards are the most frequently adopted approaches to identify risks before potential delinquencies. Based on the early alerts generated by the monitoring system, the branch servicing team will follow up with borrowers.

Property reappraisal is often required one year after loan disbursement, mostly as part of banks' internal risk-monitoring activity. After the first-time reappraisal, banks can decide the future re-appraisal frequency.

2.8. Arrear management

Based on our observation, bank mortgage lenders take notification action prompted by the number of days overdue and risk level. They tend to first send out text messages, followed by automatic voice-system calls in the first few days after a loan becomes delinquent.

If a loan remains in early delinquency, which usually means less than 90 days past due, banks might phone, send out warning notices, or visit delinquent borrowers in person.

If a loan becomes more than 90 days overdue, or exhibits higher risk to recovery in the bank's view, the mortgage lender would take legal action via court process.

Chinese bank mortgage lenders also use third-party collection agencies to conduct outbound calls or contact delinquent borrowers in person. In our view, in-person approach appears to be susceptible to the measures such as social distancing or lockdown amidst recent COVID-19 pandemic.

2.9. Foreclosure process

Mortgage lenders can work out defaulted loans through the courts or directly.

In a non-court process, borrowers may cure the default by repaying the arrears with money from other sources or settle the debt with proceeds from selling their homes. If a dispute is brought to court, the legal proceeding will run through litigation, ruling, enforcement, and liquidation through auction. The foreclosure costs typically are borne by the defaulted borrowers in accordance with typical loan agreements.

The non-court process to recover defaulted loans seems more common, in our observation. This route is cheaper and faster. Experiences by China's major banks indicate that defaulted loan can be worked in less than one year through a non-court process, and one to three years or even longer if through court process.

We estimate court-process potential costs to be 10% to 12% of the loan principal amount. Our estimated costs include expenditures such as court-related fees (3%-4%), attorney fees (3%-7%), and stamp duties (0.05%) borne by seller. Our estimate is based on the official processing fees schedule, as well as actual costs incurred in a sample of past legal cases.

While banks can foreclose on a property the court might not allow the bank to seize the property. According to the Supreme People's Court, a property in foreclosure may not be auctioned if that property is necessary for the associated borrower and family for living. This may lengthen the foreclosure period. However, in an updated supreme court ruling in 2015, liquidation may be granted if the bank promises to use some of the proceeds to provide the defaulted borrower with 5-8 years of rent for public rental housing. This updates give mortgage lenders more flexibility to resolve a default loan.

3. China's RMBS sector

3.1. Issuance size

China's RMBS issuance surged in the past two years. After a few years of rapid initial development, the Chinese RMBS market came to a full blossom in 2018. In this year, annual issuance of bank-originated RMBS reached a record high of RMB584.3 billion (chart 3), 2.4x higher than the year before. The number of transactions offered grew by 1.8x, amounting to 54.

Chart 3

Government support and strong needs from bank originators have fueled such high growth. For banks, RMBS issuance can free up their balance sheets to increase lending when market demand for mortgage loans is rising, without breaching regulatory requirements. That, anyway, was a major explanation for 2018. In 2019, after a year of an unprecedented issuance growth, and amid weakening demand from mortgage market, repeat issuance from large banks dropped. However, the number of first-time transactions from small and midsize banks rose in this year, making RMBS a more widely used tool for balance-sheet management among the banking participants.

3.2. RMBS as a funding source for mortgage loans

RMBS in China has not yet had a meaningful impact on the mortgage market. The utilization rate of RMBS, as measured by outstanding RMBS divided by total outstanding bank-sponsored mortgage loans, has continued to rise year over year; however, the ratio remains less than 5%.

We believe the RMBS market in China still has strong growth potential. First and foremost, regulators are highly supportive of the market development of RMBS. In addition, demand from banks to utilize RMBS to manage their balance sheets may rise from time to time, depending on the loan demand.

3.3. Key issuers

The RMBS market is dominated by two large commercial banks, namely China Construction Bank and Industrial and Commercial Bank of China. Their combined total issuance accounted for roughly 72% of issuance volume in 2017, 76% in 2018, and 53% in 2019. Their market share decreased last year, in our view, due to their lower balance-sheet management needs as a result of cooling mortgage loan demand. In addition, activity was relatively solid for first-time issuers and repeated issuance from other banks.

Banks that have issued five RMBS transactions or more (as of end-2019) include Bank of China, China CITIC Bank, Industrial Bank, China Merchant Bank and Bank of Communications.

3.4. How do investors acquire a legal interest in the collateral?

RMBS issuers in China transfer the assets by true sale to a trust company, which issues beneficiary certificates to investors.

The legal structure of the trust is established as a special-purpose trust (SPT) under China's Trust law, and is in full compliance with the PBOC's credit assets securitization (CAS) scheme and CBIRC's governance. The legal structure of the SPT meets our criteria for asset true sale and insolvency remoteness.

3.5. Key legal risks and mitigants In Chinese RMBS from a rating perspective

Loan transferability.  According to article 79 of China's Contract Law, a loan can be transferred to a third party unless restricted by contract. In our rated RMBS transactions, we observed that the loan agreements used for the securitized mortgage loans do not prohibit those loans from being transferred. This is typically covered by legal due diligence and confirmed by the legal due diligence finding.

Notification to borrowers of the mortgage pool.   The originator must announce the establishment of the SPT and asset transfer in nationwide media in accordance with article 12 of the Administrative Measures for the Securitization of Credit Assets. However, individual borrowers are not notified at trust settlement. As a result, the transfer of the loans are legally effective between the originator and the trustee; it however does not extend to the borrowers. This leaves a legal loophole, should the originator/servicer become insolvent and borrowers continue to make payments to the originator acting as the servicer. Typically a transaction is structured to mitigate such risk by requiring a minimum rating on the originating bank/initial servicer, and if the rating on the bank falls below the minimum requirement then notifications will be sent to individual borrowers for redirecting payment to the trust account directly.

No mortgage reregistration at closing.   When the mortgage pool is transferred to the trust, the mortgage in relation to the loans will not be reregistered. The originator is still the registered first-ranking beneficiary. Without mortgage reregistration at deal close, the trustee on behalf of the trust still has mortgage rights. This is according to article 192 of the Property Law and article 81 of the Contract Law, the associated rights can't be separated from the debts attached by those rights.

3.6. Asset performance

Chinese RMBS transactions exhibited healthy and stable performance. The cumulative default rates of Chinese RMBS transactions by annual vintages remained mostly below 0.5% (see chart 4) as of the end-2019. The relatively lower default of 2014 and higher default of 2015 were mostly due to small samples. The cumulative defaults of annual vintages since 2016 have shown less variance.

Favorable pool attributes underpin the sound performance of RMBS. The diversified nature of the underlying pools in the RMBS transactions and favorable pool attributes, such as a low weighted average current loan-to-value ratio and long weighted average loan seasoning, are key pillars of stable performance in our rated RMBS transactions in China.

Chart 4

The prepayment rate is trending below 10% in recent years. The weighted average prepayment rate (CPR rate) of bank-originated RMBS transactions has recently shifted below 10%, compared to mid-teens a few years ago (see chart 5). Borrowers' prepayment behavior varies widely among transactions. In the majority of the transactions, the CPR rate falls between 5% and 15%, based on publicly available monthly RMBS trustee reports.

Chart 5

3.7. Capital structure

The capital structure used in Chinese RMBS is not complex.   In Chinese RMBS transactions the senior tranche usually have three to four classes of notes ranking equally, namely class A-1, class A-2, class A-3 and class A-4. Following those, there may or may not be a mezzanine tranche and then a subordinated tranche. The ratings are usually assigned to the senior notes and the mezzanine notes.

Separate interest and principal waterfalls.   RMBS transactions in China commonly adopt separate interest and principal waterfalls. A principal draw is allowed to cover liquidity shortfalls when needed. Principal collections available after covering liquidity shortfalls will be used to pay down notes either in accordance with soft amortization schedules or in a pass-through manner.

Sequential payment is mostly used.   The senior and mezzanine notes will receive interest payments on a regular basis. The available interest-collections will first pay to the senior notes coupons and then the mezzanine notes coupons. Among the notes ranked equally, their interest payments will be paid on a pro-rata basis. The principal payments will also follow the sequential pay, in which the senior notes will receive the payment first, followed by the mezzanine notes if the senior notes have been fully repaid, and at last the subordinated notes when the mezzanines notes are redeemed in full.

Soft amortization schedule and acceleration event triggers.   Our rated RMBS transactions usually adopt soft amortization schedules for the class A-1 and class A-2 notes. For the class A-3 and class A-4 notes, a pass-through is used. When an acceleration event is triggered, such as a rise of cumulative default rate over a certain threshold, the payments among the class A notes will switch to pro-rata.

Credit enhancement.   Primary credit enhancements come in the forms of note subordination, and excess spread when it exists. In addition, our rated RMBS transactions also have liquidity reserves and principal-draw feature to meet short-term liquidity risks.

Related Research

• China Securitization Performance Watch 1Q 2020: COVID Pain Still To Come, May 18, 2020
• What Do The First Performance Reports Reveal About COVID-19's Effects On China Auto ABS And RMBS?, March 26, 2020
• China Structured Finance Outlook 2020: Performance To Diverge Amid Flat-To-Modest Issuance Growth, Feb. 6, 2020
• New Loan Pricing Framework Increases Basis Risk For China RMBS, Dec. 30, 2019

China RMBS Rated By S&P Global Ratings

• New Issue: Jianyuan 2020-2 Residential Mortgage Backed Securities, June 24, 2020
• New Issue: Jianyuan 2019-10 Residential Mortgage Backed Securities, Nov. 28, 2019
• New Issue: Jianyuan 2019-7 Residential Mortgage Backed Securities , Aug. 9, 2019
• New Issue: Jianyuan 2019-2 Residential Mortgage Backed Securities, April 16, 2019
• New Issue: Jianyuan 2018-21 Residential Mortgage Backed Securities, Dec. 13, 2018
• New Issue: Jianyuan 2018-11 Residential Mortgage Backed Securities, July 7, 2018