OPINION – Undetermined judicial policy raises seven issues for RMBS among floods of mortgage boycott

By Qi Lyu

Reports on recent Chinese mortgage boycott has been overoptimistic on risk contagion between RMBS (Residential Mortgage Backed Security) and Chinese housing market.

Qi Lyu, expert in financial law, founder of Beijing Finlegal Corp.
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They listed at least two grounds. First, the RMBS market, with the volume of ¥1200 billion occupies only 3 per cent share of total residential mortgage loans stock market.

And more important, the overall default rate remains rather low.However, this opinion deserves more considering, when facing such violating disputes over the liability distribution among the defaulted developers, the financing banks and the furious mortgagees.

The judicial position, especially the approach performed by the six circuit court, Supreme People’s Court in the now prominent leading case is doomed to have material influence to the RMBS business.

Seven issues are related.

1. Would the emerging RMBS be forced to make structure adjustment 

In 2021,the incremental residential mortgage assets has amounted to ¥1400 billion with newly issued RMBS expanding to¥499.3billion, which means almost 1/3 volume of housing mortgage was transferred off the banks’ book through RMBS. That is the strongest surge in ABS section by 17% increase in RMBS. If the final loss rate in RMBS turn out to be unpredictable, unmeasurable and uncertain, questions may be raised as whether this channel still workable for banks’ balance-sheet management and the securitization products still marketable. This most powerful part in ABS market may have to restricted its business to the finished project mortgage assets with proper security perfection.

However, as the data shows the rate of pre-mortgage registration in existing RMBS is no more than 30%, the surplus 70% may not be qualified for the RMBS any longer until perfection of the security interests in the estate, which may postpone four years to remove from banks’ book on average.

2. Would the three basic principles for mortgage rating accordingly change

RMBS has long been recognized as good assets for satisfying three rating rationales: debtors dispersed, low default rate and security interest over real property, which, however, could all be overturned once the developer defaults. The present circumstance has proved it not only a theoretical possibility: the boycott of the mortgage repayment, instead of resistance individually, the lack of willingness to repay, rather than the capability, the unfinished property unready for mortgage perfection, are all in breach of the original assumed rating logistics for RMBS. The remedies against the real estate developer is meaningless.

3. Would any legal liability come out against the intermediary services providers

Issuing RMBS requires law firm’s legal opinion, as well as that of accountants. However, before the present mortgage event, it is never heard of any of them supplying with qualified opinion and specific due diligence on the delayed property projects. Had a RMBS project actually trapped by such defaulted mortgages and eventually are only entitled to recover from the developer with the borrowers released, would the intermediary firms be liable for their professional services? The case of Wuyang Bond still reminds the industry of the tragedy of law firm and accounting firm being both thrown out of the boat.

4. Could the share reserved by the originator stop the risks splashing out

Regulatory requirement for RMBS originator is to reserve at least 5 percentage of total risky assets. Some study thinks the current buffet cushion is sufficiently safe as of nearly 10% on average. But, there are 2 misunderstandings: first, the risks to each project is determined individually with nothing to do with average risks. And second, the statutory buffet cushion for issuer is only 5%. Unless a higher rate is held by the originate bank itself at his discretion, other subordinate holders are also investors.

5. What do the final RMBS investors look like

Restricted by the low liquidity in Chinese market, RMBS is mainly invested by two parts, banks and banks wealth management products on investors’ behalf. The consumers of bank WMP are typically of low risks perception and preference, who may actually burden the risks of loss which intended to place on deep-pocket banks. Imbalance may arise between the protection for consumers of residential apartments and that for financial products consumers.

6. How could bank trustee measure the related product net value

It becomes a disturbing issue for WMP (wealth management product) to measure net value when RMBS contained. Without an efficient secondary market, the related regulatory requirements allow the trustee bank to value MBS by its historic cost and to adjust timely when finding circumstances changed. What matters is when to adjust is professional and reasonable, at the time of finding package covered delayed projects, or being served with final judgment against only the defaulted developers while exempting borrowers? It appears solely discretional but tested seriously with diligence duty for bank trustees.

7. How to make information disclosure on the related WMP

When valuating risks, a product largely invested to RMBS is generally categorized as fixed-proceed labelling low risks. However, what if the product, subjects to the strict judicial policy, distributed to the perspective investors who consequently suffer loss? Will the trustee bank be decided negligent for not- knowing his own product?

Further, in the course of standardized disclosure, is the trustee bank liable to share the precise data of those affected products to make up leeway for investors. Any potential claims against the bank asserting its malpractice?