ABS series (3): a new breakthrough for securitisation, and the practical points of REITs

1. Background

Regulators have recently tightened the rules on leverage across the financial system, and many financing channels are at risk of drying up. How to widen a company's financing options while taking debt off the balance sheet, and so pave the way for future financing needs, has become the first question for many companies.

On 21 June the first shelf-registered equity quasi-REIT for long-term rented apartments in China, the Gaohe Chenxi – CITIC Securities – Lingyu No. 1 asset-backed special plan, was successfully issued. REIT asset-backed securities have drawn the attention of the industry. REITs stands for real estate investment trust, and the vehicle raises funds from investors, in equity or in debt form, out of the returns on real estate, including rises in value and rental income. What regulators in China favour more is asset-backed securities for rented housing.

Earlier still, the Shenzhen Stock Exchange began providing transfer services on its comprehensive agreement trading platform for the Zhonglian Qianhai Kaiyuan – Country Garden Rental Housing No. 1 (first tranche) asset-backed special plan, with a product size of 10 billion yuan, senior securities maturing on 27 April 2036, and repayment by periodic interest payments with principal repaid in one sum at maturity.

2. The relevant rules

These products derive from the Notice on Advancing the Securitisation of Rental Housing Assets published jointly by the China Securities Regulatory Commission and the Ministry of Housing and Urban-Rural Development on 24 April this year, which sets out clearly the conditions for securitising rental housing and the policy support for it.

An issue of rental housing asset-backed securities shall meet the following basic conditions:

1. the property has been completed and title to it is clear, the quality of construction and the safety standards meet the relevant requirements, and the registration and filing formalities for letting have been completed as required;

2. the property is operating normally and generates continuous and stable cash flow;

3. the originator, that is the original beneficiary, has sound corporate governance and the capacity for continued operation and strong operational management, and has committed no major breach of law or regulation in the last two years.

The notice also sets out directions of support: priority for large and medium-sized cities, the Xiongan New Area and other regions the state particularly supports; emphasis on supporting rental housing enterprises to issue equity securitisation products with the immovable property they hold as the underlying asset; and the establishment of a green channel for filing such products.

Because the rental yield in first-tier cities is at present low, however, whether ABS products for rented housing can offer a spread investors will accept and be redeemed on time is a matter to watch.

Highly indebted developers still have an incentive to raise funds by securitisation, particularly to obtain money without increasing their debt ratio. Compared with rental housing securitisation, which is heavily policy-driven, securitisation of property mortgage loans and of property management fees has a longer history and a more mature issuance record.

Securitisation of property mortgage loans usually means ABS on outstanding home purchase payments: on 14 June 2018, for instance, the Huaxi – Yunku Hui – Shouchuang Zhiye home purchase receivables asset-backed special plan, with a size of 1.42 billion yuan, was successfully issued on the Shanghai Stock Exchange at an interest rate of 5.70 per cent.

Qualifying home purchase receivables arise mainly from bank loans and housing provident fund loans, and the purchase contract must have been registered online so that the receivables may be pooled as underlying assets. A developer usually sets up a project company to develop a particular project, and a well-known developer often has several such companies; setting up an asset-backed special plan or product with each project company as originator is cumbersome, so the better course is for the project companies to assign their home purchase receivables to the originator, which then assigns them to the special plan or product, so unifying the arrangement.

Securitisation of property management fees, by contrast, is now relatively mature. Property management companies are graded first, second and third class, and the class determines the area of property they may manage, so the first object of due diligence is to confirm that the company's grade matches the area it manages and that the grade will last for the whole term of the special plan.

Property service contracts fall into different types: pre-development contracts, property service contracts, sales-office contracts and car park management contracts. Residential fees are generally low but stable, while commercial fees are high but unstable, so the two are best handled separately. Where the term of the property contract and the term of the special plan do not match, the practice used to be to pledge the fees and grant an entrusted or trust loan, but Article 10 of the Measures for the Administration of Entrusted Loans by Commercial Banks, issued at the beginning of this year, has closed off the entrusted loan route; whether a trust loan is workable depends on the guidance currently given.

3. The filing procedure

How is an asset-backed security filed? The most convenient way is a letter of no objection from the Shanghai or Shenzhen Stock Exchange, since a first transaction in the interbank market requires an application for the relevant business qualification.

The main transaction documents in an exchange market issue include the asset purchase agreement, the asset servicing agreement, the custody agreement, the supervision agreement, the guarantee agreement or letter, the shortfall undertaking agreement, and the subscription agreement and risk disclosure statement for the asset-backed securities. The intermediary documents include the plan description or standard terms, the legal opinion and the credit rating report.

The other intermediary reports include three years and one period of audited financial statements of the particular originator, one year and one period of financial statements of the guarantor and of the person undertaking to make up any shortfall, an appraisal report on the assignment of the underlying assets or a cash flow forecast, and a due diligence report on the special plan. There are besides various undertakings and explanations, such as the resolution of the competent body to carry out the securitisation, a special explanation and undertaking as to the funds raised, and a statement that the issuer is not on the negative list, which need not be set out here.

The specific process is as follows.

Preliminary preparation: analysis of the feasibility of the project and discussion with the exchange, selection of intermediaries and determination of the underlying assets

Note: this stage takes about half a month to a month.

Formal preparation: interviews and due diligence on site, further due diligence and feedback, drafting and finalising the various documents, completing the application materials and submitting them to the exchange, and responding to the exchange's comments until the letter of no objection is obtained

Note: this stage takes about a month and a half.

It should be noted that the Negative List for Asset Securitisation published by the Asset Management Association of China imposes corresponding limits on REITs: rent receivables over immovable property that cannot generate stable cash flow because it is vacant, and immovable property or rights to income from immovable property, such as infrastructure, commercial property and residential housing, that is awaiting development or under construction to a proportion of more than 10 per cent, are to be excluded.

Asset securitisation began with REITs, and although it has since extended into many other fields, its practice in the field of immovable property continues to innovate and deserves attention.