The Existence of a Secondary Mortgage Market in Saudi Arabia:
After you read the research paper in 550 words write a word document containing a literature review and a methodology and the results of the research paper. At the end of the second paragraph of the research paper you will find (Therefore, can the secondary mortgage market be existent and helpful for the sake of the economy?) Change this question into a statement.
Alfaisal University:
The Existence of a Secondary Mortgage Market in Saudi Arabia
Financial Markets and Institutions
Dr. Declan Mccrohan
Prepared By:
Ahmed Hatem Abou El Ela
Nasser AlHatlani
Meshal fawaz Altimyat
During the last few months, Saudi Arabia has been reviewing draft regulations that could originate the creation of a real estate refinancing company similar to U.S. firm Fannie Mae and Freddy Mac. The regulations are part of long-awaited government efforts to develop a housing mortgage sector in the kingdom of Saudi Arabia where the restrictions of Islamic sharia law have made it difficult to secure lending against property. The world’s top oil exporter faces a housing shortage, particularly among lower and middle-income individuals, as land prices appreciate rapidly. This year the government has passed laws regarding the regulation of mortgage and lease lending.
The establishment of a mortgage liquidity center is a critical milestone for developing a stable and effective mortgage market. The key stages of mortgage industry development, is the examining of the role that mortgage liquidity centers have played in other emerging markets, and the outlining of the best solutions for the Saudi Arabian Mortgage Market. As the first stage of mortgage industry development the foundation needs to be set by establishing a minimum set of legal, regulatory and primary market infrastructure provisions. In order to incentivize lending and growing of the sector, a mortgage liquidity center should be created through government sponsorship as primary lenders require a source of long term liquidity. As the mortgage industry matures, deeper secondary market access is created through direct access to capital markets and mortgage lenders which in turn move beyond relying solely on centralized liquidity centers. Therefore, can the secondary mortgage market be existent and helpful for the sake of the economy?
Saudi Arabia places the primary roots for the foundation of the Islamic secondary mortgage market, and this market is an enormous step where only professionals in the field of financial instruments can know what really is going on. And this step could revive the dead secondary market of Sukuk and the creation of another financial instrument which in this case is Securitization. Considerations have been made for the creation of a local company that is concerned with refinancing of mortgages, and this is an important step in the creation of the secondary mortgage market. Currently, the government is going to be holding the majority stake in that company (refinancing mortgage company). Expectations roughly say that 19% is going to be the stake that is offered publicly. And 51% will be the stake of the public investment fund which is belongs to the ministry of finance, and lastly, 30% goes to Private mortgage financing companies and this is settled with a market capital of 2 billion riyals. (AlKhnaifer)
Let us now talk more about the technical details of how to create the securities mortgages which will be traded in the secondary Market. In the beginning, the client approaches the mortgage finance companies for the purpose of acquiring a new house; the contract is then signed between the two parties for twenty years. The client is required to pay monthly payments agreed upon in the contract, and that is for the purpose of reaching a total payment of for example 1 million riyals. And of course, the company will have an insurance saying that the client will be able of paying the full amount looking at the client’s inflows. In addition, (the Saudi Fannie Mae) agrees with the private mortgage finance company that it is ready to buy those financial rights with a discount only which is about for example 970,000 riyals.
Consequently, (the Saudi Fannie Mae) is going to buy those financial rights for re-selling to investors. SAMA quoted that “It will treat the Mortgage contract rights as cash flows, mortgages, guarantees, and other rights”. (SAMA)
And the “Moving of the financial rights” means that the financial right will be transferred till the debt matures, or any other right from the Mortgage finance company to the (Saudi Fannie Mae) which in turn sells it to another party/investor. Regulations say: “it has to be mentioned in the Mortgage Financing Contract, that the right of the mortgage finance company is to transfer all of its financial rights through others in the secondary markets without the approval of the client. (SAMA)
The Saudi Fannie Mae aims to facilitate the flow of funds in order to provide liquidity to the secondary market and to provide a better way for mortgage companies to fund beneficiaries to own residential property. One of the operations made by the Saudi Fannie Mae is the issuance of Sukuk and other financial instruments or securities to finance itself. This includes real estate securities, and asset-backed Sukuk.
(The Saudi Fannie Mae) may ensure payments resulting from the assets backing those securities (timing insurance) which is to ensure that the payments are made on time and here comes the role of Rent system launched by the Ministry of Housing, such a system could work as a guarantee of the payments and especially the payments that are incurred shall be deducted monthly the way rental-backed securities work.
To fully complete the system and success is fully achieved there must be an assessment upon which the returns of these assets reflects the true and fair value, in order to achieve confidence of investors in the quality of their returns. This system which is a door for many who want to invest in real estate and who are unable to handle large costs for the establishment of these unit mortgages, then they can buy those backed securities and take advantage of its revenues also the level of liquidity.
Last November of the year 2013, Moody’s Investors Service gave a rating to the government bond of Saudi Arabia an Aa3 government bond rating, and mentioned that the government has a stable economy and a considerable government financial strength and that is why they rated its bonds that way. In recent years windfall oil revenues have generated large fiscal surpluses, allowing the government to build a sizeable asset cushion and sharply reduce its debt ratios, to levels much lower than its peers. Moody noted that this rating isn’t a real rating though but it is more or less an update given for the market to be aware of. Moody’s noted that Saudi Arabia’s economy has performed well since the 2008 global financial crisis. Its Real GDP growth averaged 6.3 percent between 2008 and 2012, making Saudi Arabia one of the fastest growing economies globally. SAMA (Saudi Arabian Monetary Authority) proved very effective through the financial crisis and the years that followed. Saudi Arabia’s oil price is around $100 per barrel. This piece of datum, gives the foreigner and local investors the confidence for investing in the Saudi Arabian Market. (NEWS, 2013)
In order to answer the question mentioned above we would like to mention some of the issues that faced the sukuk market. First of all, the face value is way overvalued which is about 500,000 Riyals per bond, where a lot of investors cannot really buy it at this overvalued price. Another problem was that when companies issue sukuk they will pay millions in operational costs to SAMA. Which they refer to be financed by banks which is way cheaper for them and faster in operational steps because it takes a lot of time to go through the rules and regulations. The supply of issued sukuk is too low, and the whole operation can only be done (over counter). And of course the Sukuk is a new terminology to the Saudi Arabian individuals. And they aren’t very used to the concept of debt where they believe that debt has something to do with non shariah compliance which isn’t really the case here.
Now we are going to talk about the benefits of the Secondary markets, secondary markets reduce mortgage interest rates in several ways. First, they increase competition by encouraging the development of a new industry of loan originators. Second, absence of the secondary markets, since the only institutions originating mortgage loans are those with the capacity to hold them permanently, termed “portfolio lenders.” In small communities especially, borrowers may be at the mercy of one or a few local banks or savings and loan associations. The entry of mortgage companies that can sell into the secondary market breaks up these local businesses, much to the benefit of borrowers. Third, Secondary markets increase efficiency by encouraging a specialization of lending functions that reduces costs. Portfolio lenders typically do everything connected to originating and servicing loans, even though they may do some things quite inefficiently. Secondary markets, in contrast, create pressures to break functions apart and price them separately, and this imposes a discipline on mortgage companies to concentrate on what they do best.
Secondary markets have also vastly expanded the size of the borrower pool. Portfolio lenders generally restrict their loans to “A-quality” borrowers, in large part because of regulatory concerns about their safety and soundness. Secondary markets, in contrast, can access investors who are prepared to hold risky loans. If the price is right, the result has been the emergence of the so called “sub-prime market” and a new category of borrowers—borrowers who previously had recourse only to family, friends, and home sellers.
Local financial firm Arqaam Capital has said “the introduction of a legal framework for mortgages will see the amount of lending to purchase housing in Saudi Arabia eventually double to 12 percent of gross domestic product. The country’s GDP is about $650 billion”. However, the full framework is some way from being established.
Implementing regulations on how defaults will be handled, a big concern for lenders who fear sharia courts and Saudi police will not evict people who fail to pay loans, have not yet been published. Some lenders already offer mortgage-like products, but the lack of a clear legal framework has restricted the market to comparatively wealthy Saudis in high-paying jobs, whose payments can be deducted by the bank from their salaries. The secondary market can exist and will exist but regulators have to overcome some issues as the ones mentioned above so that there would be more investors in that field. And for other fields to also exist in the future, knowing that it is very hard for a market to exist from scratch in any country in the world, in addition that the government of Saudi Arabia is very serious in implementing such a market through the creation of a two billion riyals company to organize and accelerate the implementation of the process. We forecast that the full secondary market will be fully implemented in the next 3-6 years.
In Conclusion, The real estate market will not mature unless there exists companies such (the Saudi Fannie Mae) and other Private Mortgage Finance Companies) that have not established yet. Furthermore, the number of mortgage companies that is available now with local banks and lending portfolios are not sufficient to cover the requirements of large real estate market. Of course this requires banks to urge to set up independent massive real estate finance companies with local and foreign investors and offer it to the public. Especially since the capital requirements of incorporation is relatively small in the range of about 200 million riyals, which must be re-considered or to activate the secondary market so that it can rotate money mortgage through them. Regulators believe that leaving the financier assess the efficiency of the client and the financial value of the asset to determine the percentage of lending, which is thought that it should go beyond the 70% specified by the regulations.
References:
AlKhnaifer, M. (n.d.). A look at the Secondary Mortgage Market. Retrieved January 6, 2014, from www.al-jazirah.com: https://www.al-jazirah.com/2012/20121211/bf3.htm
NEWS, S. A. (2013, November 15). Moody’s: Saudi economy performed well since 2008. Retrieved January 5, 2014, from www.arabnews.com:
https://www.arabnews.com/news/477551
SAMA. (n.d.). Rules and regulations concerning the creation of the secondary market. Retrieved 1 5, 2014, from www.sama.gov.sa:
https://www.sama.gov.sa/Finance/DocLib1/L_AR_ImplementingRegulationsOfTheRealEstateFinanceLaw.pdf