China Encourages Mortgage Securities to Boost Real Estate Market

On September 30th, China’s central bank issued a round of measures aimed at stimulating demand for housing in China, the most important of which may have been overlooked.

While the decision by the People’s Bank of China to broaden the pool of homebuyers getting better deals on mortgages and expanding access to mortgage financing was widely reported, many observers overlooked the PBOC’s encouragement of mortgage-back securities (MBS).

In its September 30th statement, the PBOC gave banks the green light to issue more MBS, as a way to expand the pool of mortgage credit available for potential borrowers. The move could help rekindle demand for housing, but also raises the risks to China’s banking sector if the mortgages being backed with these securities are not carefully scrutinized.

Enabling Banks to Issue More Mortgages

In July this year, the state-owned Postal Savings Bank of China began marketing RMB 6.8 billion ($1.1 billion) of mortgage-backed notes, the first time that at Chinese financial institution had been allowed to issue securities of this type since they were banned in 2007.

By encouraging banks to securitise mortgage loans and sell along the securities to investors, the government hopes to free up more capital for further mortgages. The movement back toward MBS came as China continues to struggle with a year-long housing slump which saw average home prices in September decline nationwide for a fifth straight month.

The inability of individual buyers to obtain mortgage financing had been a major drag on the housing market in 2014, as China last year largely did away with preferential mortgage rates for first time buyers, and many banks became reluctant to provide mortgages amidst a declining market.

Mortgage-Backed Securities Seen as Major Culprit in US Housing Collapse

While propping up the housing market seems like a good thing in a country where 20 percent of GDP is estimated to come from property investment, encouraging the return of MBS in China is likely to bring along its own set of risks.

The government originally banned MBS after “toxic-derivatives” made up of repackaged sub-prime mortgages were seen as a catalyst of the US housing bubble and its subsequent collapse. Just last month HSBC paid US$550 million in a settlement to resolve claims regarding risky mortgage securities it sold before the US housing market collapsed in 2007.

While China’s situation should theoretically carry less risk than the US’ because of the relatively high minimum downpayment percentage of 30 percent, some financial institutions are now offering loans that allow home buyers to borrow the cost of their downpayments, and there is widespread speculation that further downward movement in the housing market could lead to a reduction in downpayment levels.

Facilitating Speculation

In response to the central bank’s encouragement of MBS sales, Fitch Ratings said last week that the move will “facilitate speculation, because banks offering the mortgages would have difficulty in differentiating end-users from speculators.”

The ratings service warned that, “If this develops into another cycle of excessive investment and speculation, it may slow down the homebuilding sector’s restructuring and hurt the industry’s development in the long term.”

The extent of the potential threat that MBS could create for China’s banks depends on to what degree the banks embrace them, as well as on the policing of the quality of mortgages used to create the securities.