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Sun 10 Feb 2008 04:00 AM

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Raising the roof

Mortgage securitisation may make you think of Citigroup's Chuck Prince's US$23.2bn misjudgement.

Mortgage securitisation may make you think of Citigroup's Chuck Prince's US$23.2bn misjudgement.

Mortgage providers like Tamweel are utilising securitisation to make better use of their capital and free up cash for expansion. Daniel Stanton looks into the details of the first GCC transactions.

Think of mortgage securitisation and you probably think of Citigroup's Chuck Prince clearing his desk after a US$23.2 bn misjudgement.

It would be a shame if the US sub-prime meltdown, which occurred due to a failure to judge risk accurately, rather than a problem with the financial techniques involved, deters Middle East finance houses from opening up to securitisation, a process that could allow them to release funds for more effective investment.

In Saudi Arabia, even up to today there is no mortgage law.

The mortgage market is booming in the Gulf - high demand from a growing population, and the development of laws to make it easier for expatriates to buy property are combining to create a golden opportunity for home finance providers.

Despite the favourable market conditions for mortgage providers, some are realising that they could do even better by managing their capital more effectively. Securitisation, in which finance providers free up capital by selling the rights to future earnings, can allow institutions to raise funds for expansion now, rather than in a few years' time.

Unicorn Investment Bank (UIB) undertook the first mortgage-backed securitisation (MBS) in Saudi Arabia in July 2006 on behalf of Kingdom Installment Company (KIC) - a transaction that was also the first true-sale securitisation in the GCC. UIB acted as lead manager, Shariah advisor and joint bookrunner, with Standard Bank the other joint bookrunner.

The sukuk transaction was backed by US$23m of ijara and istisna contracts, with banks making up the majority of the investor base. The sukuk was priced at a fixed rate of 6.55%, maturing in 2020, although KIC is committed to repurchase the assets at month 36, backed by a guarantee from Dar Al Arkan.

In addition, the International Finance Corporation (IFC), the private sector financing arm of the World Bank, provided a mezzanine credit enhancement in the form of a standby murabaha facility.

Ikbal Daredia, managing director, head of capital markets and institutional banking, UIB, says there were challenges involved with the transaction.

"In Saudi Arabia, even up to today there is no mortgage law," says Daredia. "They are developing it and they have licensed mortgage providers, but the mortgage law in itself is not there yet."

This can create difficulties should a mortgagee default on their payments, since Saudi courts are often reluctant to evict tenants.

Daredia adds: "The other issue that one may face, especially in Saudi Arabia, is that these mortgages are for long term periods, like 25 to 30 years, and with the lack of a proper swap market, the tendency is to do a fixed rate MBS rather than a floating rate MBS.

"Given the interest rates where they are, we are probably at the bottom of the interest rate cycle, so institutions which are lending against these may find that it could be a loss making transaction.

The relatively recent development of the mortgage market in the Gulf also means that there are fewer mortgages to use as underlying assets for a securitisation.

"To do an MBS you need the volume as well," points out Daredia. "If you look at the UAE market, the market has picked up in the last few years quite well in terms of mortgages etc, but still you don't have the mass volume like you have in the West. That in itself slightly restricts the volume that you can do on MBSs.

Tamweel, an Islamic mortgage provider in the UAE, has market-leading positions in market share, net profits and return on equity. It has attempted to strengthen this position through the use of securitisation to enable further investment.

Adel Al-Shirawi, CEO of Tamweel, says that the way mortgage providers use their capital will decide which ones succeed.

"How good is their product know-how, do they create products that could be underwritten, securitised, structured, and could be sold off outside?" he asks. "Or they could structure silly products that cannot go beyond their balance sheet, that will be always capped to their internal balance sheet and they cannot take it off.

In line with this belief, Tamweel has completed two Shariah compliant securitisations so far, totalling $560m. "We did the first securitisation in 2005, but that was cash-collateralised," says Al-Shirawi.

The second one we did recently was $210m, rated Aa2 by Moody's, AA by Fitch, and 85% of the securitisation was senior debt." In July last year, the Irish Stock Exchange listed Tamweel Residential ABS CL 1, based on residential properties in the UAE.

It securitised lease payments from Shariah compliant, long term real estate lease agreements.

This marked the first-ever issuance of various tranches of notes in an Islamic transaction and the first perfected sale structures in a securitisation transaction from the UAE.

Tamweel securitised its book of 736 ijara contracts worth $210m, with the issuance divided into notes of four classes with a legal maturity in 2037. Of these classes, A, B and C were rated Aa2 by Moody's Investors Service and AA by Fitch Ratings Limited, while the unrated class was retained by originator.
It was a pioneering deal for the GCC, explains Sandeep Chaudhry, CEO of the Emirates National Securitisation Corporation (Ensec), the boutique which structured the transaction.

"There was a lot of scepticism in this market as to whether you could really get the ratings, you could get the scale, the investor acceptance, whether you could really get a true sale - all the elements you need to get these deals done," he says.

"I think the Tamweel transaction was a very bold transaction to show all the naysayers and sceptics that a world class, world equivalent transaction was well and truly possible in this market.

There were question marks about how Shariah interplays with commercial law, question marks about foreclosure ability, question marks about land registration, title ownership and title transfer. All of these got answered in the Tamweel deal.

In fact, the Islamic finance element of the mortgages may have made securitisation easier in some respects: since the housing finance provider already owns the properties in question, tenants lease it back until they reach the end of their agreement and ownership is transferred to them.

This means that it should be easier to evict tenants in the event that they default on their mortgage payments, so the foreclosure process is simplified - it is more akin to an eviction. This also aided legal and rating analysis.

It was a natural choice to target European markets with the Tamweel sukuk, Chaudhry says.

The way that we had looked at securitisation here initially was that we would look to originate assets here, originate deals here, and then sell them into the markets where you have the most cost-effective pricing, which traditionally have been the European and US investor markets," he says.

So the idea was originate in Dubai, the UAE, and the GCC and look for investors to buy highly rated paper. The reason we used that strategy is because the European investors are typically the pricemakers.

Investors in those markets are also likely to be more specialised than those in the Middle East. "For instance, if you were doing a multi-tranche deal with a AA rating, A rating and a non-investment grade rating like a BB rating, you would have specialised investors who would have interest in each of those different tranches of paper," explains Chaudhry.

"Whereas in the Middle East today you have more name-based investing or lending - if it's X or Y company then it's 100 basis points. The fact that you say it's X or Y company with a structured deal and therefore rated higher than that company doesn't really matter.

The timing of Tamweel's transaction was good; within a few weeks, the US sub-prime mortgage lending crisis had broken, and the credit markets subsequently tightened dramatically.

"With the credit crunch, pricing in the European and US markets has widened," says Chaudhry.

"It's more than just pricing, the appetite for doing deals has been curtailed. This means if you were issuing a bond in August or September, it almost didn't matter what the price was, the answer was almost certainly going to be ‘no'. That meant it was an incredibly disjointed market.

This meant that some of Ensec's issues had to be put on hold.

"For the Middle Eastern originators to go out and chase that money would have been a dangerous exercise, so we deliberately backed off on the execution side somewhat and slowed down the execution of some of our deals to ensure that we weren't going into a very choppy fourth quarter," says Chaudhry.

It's our anticipation that the markets will start to improve and hopefully the improvements will accelerate over the next few months, and so we'll have a return to some levels of normalcy.

Although they have faced some knock-on effects from the credit crisis, Middle East mortgage issuers are unlikely to face their own sub-prime problems, at least in the near future. The GCC in particular has a stratified society in which many people on low incomes do not qualify for current accounts, let alone mortgages.

"The bar is raised to such a high level here that you really are inhibiting the ability to generate huge sub-prime portfolios by not lending to that part of the population," says Chaudhry.

You'll see the bar getting lowered gradually over time with competitive pressures, as that economic echelon starts to cross over to the echelon above it, but it's going to be really marginal, I think.

I don't see the GCC in the medium term being a big source for that kind of lending, whether it be consumer or credit card or mortgages. It's a very conservative place from a credit perspective.
Part of the tough lending restrictions in the UAE may come from the lack of a credit bureau there, although Emcredit is developing one. This means that housing finance providers have had to make their own assessments of the credit risk posed by mortgagees.

Tamweel in particular has made efforts to assess its borrowers' credit risk accurately, thanks to its implementation of a system from Fair Isaac.

The system has been running at Tamweel for a year, but Al-Shirawi says that since it needs to be tested with real life examples and there are fewer mortgages issued than, for example, credit cards, the programme has been running internally for a year so far.

"We issue the most of everyone, but with quality - and we reject the most," says Al-Shirawi. "We know the product criteria and product pricing and securitisation parameters and hence we issue based on the philosophy that as soon as we underwrite it, we securitise it.

"We don't issue it to keep it on the book, we issue it to sell it off the book. Our criteria are very stringent.

Other mortgage providers are likely to sharpen their internal practices, if they have not already, as they come around to the benefits of securitisation.

The legal and regulatory framework to support securitisation already exists in many Middle East jurisdictions, but one local regulatory body is known to be working on measures to support and encourage the process.

The main driver, however, may simply be that securitisation reduces some of the uncertainty for issuers and allows them to make investments sooner, rather than later.

"If you're looking for a way to finance your house finance or mortgage pool in a cost effective manner and a treasury effective way which has factors like asset/liability matching management qualities, has tenor, has rating, has competitive pricing and has effective capital treatment, then securitisation is the way to go," says Chaudhry.

If you're in a growing economy or a growing business, securitisation allows you to tap into liquidity in a capital efficient manner such that you don't have to constantly go out there to the market and tap into equity and dilute your existing shareholders' interests.

With securitisations so far from the likes of the UAE's Tecom, on commercial mortgages; Bahrain's Reef Real Estate Finance Company and Eskan Bank, both on residential mortgages; and Dubai Electricity and Water Authority (DEWA) on utilities, more are bound to follow.

Al-Shirawi hints that Tamweel could be about to issue its third securitisation now that European credit markets have regained some stability.

Macro-economic mortgagesRogue researcher Edward Ingram advocates a mortgage model in which all assets and cash flows are tied to average earnings growth (AEG), and taxation, revenue and spending flows are harmonised.

This, he says, would avoid situations where borrowers find themselves unable to meet their interest payments, and would mean that all sectors of the economy grew and slowed down at the same rate.

If this system were to be implemented, "relative values of all financial assets and the relative volumes of all cash flows would respond to monetary policy in a uniform manner without any one sector such as housing being singled out as the regulator of the economy," he claims.

The proposed system would benefit lenders as well as borrowers, Ingram says.

"The new design and the new lending and savings system results in returns on savings that can compete with other investments without increasing the gross rate of interest above the current norms," he writes.

"Gross interest rate, even for housing finance already averages more than the rate of Average Earnings Growth (AEG), before tax. With this problem removed, lenders will be able to offer secure defined benefit pensions as well as business loans that can more often compete in safety and accessibility with equity finance.

By taking on this additional business, lenders could double their size and more than double their profits as lending risk falls away.

For more information on the scheme's proposals and opportunities for involvement, see the Ingram Foundation's website at

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