Initial Feasibility Study Mortgage Securitization Project In The United Arab Emirates (UAE)

Transcription

1 Initial Feasibility Study Mortgage Securitization Project In The United Arab Emirates (UAE)

2 MANAGEMENT SUMMARY Dubai International Financial Centre (DIFC) and Absalon Project (Absalon), performed in February 2010 an Initial Feasibility Study in the United Arab Emirates (UAE) with the purpose to investigate whether it is a viable business idea to establish a mortgage solution in the UAE, based on the principles behind the Danish Mortgage Model. Based on the findings and draft report some further clarifications were done in November 2010 and a new draft was issued and sent out for comments. Most comments are in line with our findings and conclusions and are not mentioned specifically while a few others are commented briefly in the report. The Danish Mortgage Model has caught international interest during the latest financial crises. The model eliminates market risk and significantly reduces credit risk for banks. The mortgages are financed though an ongoing issuances of covered bonds with same characteristics as the mortgages. On top of the payments to investors the borrowers pay an administration fee. This makes the solution completely transparent. Investors have access to low risk and liquid bond series and borrowers have transparent, affordable and flexible mortgages. The strict origination procedures in the model will comply to the suggested Basel 3 rules with minor changes. Absalon has in 2007 made an implementation of a Mortgage Model based on the Danish Model in Mexico and are now offering implementations in other countries. The objectives for the study are to investigate whether the prerequisites for introducing the Danish Mortgage Model in the UAE are available and to identify the benefits of the introduction of Danish style mortgages in the UAE. During the analysis we have found that: The project idea is well received by all parties visited, which has included commercial banks, mortgage banks, construction companies and developers, regulators, investors and Stock Exchanges. Most visits have been made to companies and institutions in Dubai, but also several visits have been made to federal offices in Abu Dhabi including the Securities and Commodities Authority and the Central Bank of the UAE. Major gaps between the prerequisites for the Danish Mortgage Model to work and the current legal and practical infrastructure in the UAE have been identified. Especially issues in the following areas needs to be solved or clarified before a decision to start implementation could be made: - Lack of federal mortgage law - Lack of federal bankruptcy law - Lack of full implemented strata law - Expatriates limited rights to stay in the UAE (work permits, tourist visa, retirement) - Unclear legal framework for expatriates It has been recommended that the study should cover the whole of the UAE and with the aim to expand the model to cover the GCC region at a later stage. At this stage the implementation focus should be the UAE. The model can be implemented to issue traditional mortgages, ljara mortgages or both types dependant on the feedback from the market. The main objectives is to create as large and liquid bond series as possible. Also the lack of a capital market in the UAE is considered a major issue for the introduction the mortgage model in the UAE. On the other hand there are initiatives on their way to create such a market, and federal government bonds are expected to be issued in late 2011 or early The need for mortgage financing has been estimated in Dubai at the current market conditions, and those findings indicate that there will be a viable business case for introducing the Danish Mortgage Model in Dubai. It is the impression that also Abu Dhabi would benefit from joining the model but we have had no direct contact with current suppliers of mortgages in Abu Dhabi like Abu Dhabi Finance. Based on these findings it is our recommendation to establish a project with joint ownership on a UAE level, at least with participants from Dubai and Abu Dhabi to: Analyse the prerequisites for a stepwise implementation plan: Dubai first, then Abu Dhabi and finally on a UAE level when prerequisites are available. 2 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

3 Propose a more detailed implementation plan in accordance with the overall strategy along with a project budget: Identify the need for changes in legal and/or practical aspects in the mortgage industry in the UAE for the introduction of the Danish Mortgage Model. Address the issues and gaps raised in this report and give practical solutions to overcome the issues. Address the impact to the UAE on a macroeconomic level of the introduction the Danish Mortgage Model To bring the project forward a project team should be established to prepare a plan according to the recommendations above. A project team could be staffed with: Representatives from Absalon Project Legal advisor from the UAE with knowledge of the housing market and the mortgage area Finance expert in the investment area from the UAE Mortgage expert from the UAE Economist from the UAE for macro economic analysis. Absalon and DIFC have financed this initial step. The project to create the proposed plan is estimated to cost around USD. A project sponsor is needed to finance the work of the project team to make the detailed plan. So the immediate next steps are: Identify sponsor to finance the next steps. Identify members of the project team Identify governance of the project including budget and timetables 3

4 Table of Contents 1. PROJECT BACKGROUND AND OBJECTIVES Introduction Objectives for the study Development of the project idea 2 2. INTRODUCTION TO THE DANISH MORTGAGE MODEL Basic Principles of the Danish Mortgage Model Participants roles and responsibilities 4 3. PRODUCTS AND MARKETING Product definition Borrowers of the mortgages Investors for the mortgage bonds Pricing analysis Competitors COMPANY STRUCTURE AND IMPLEMENTATION Mortgage Service Provider Implementation alternative 1: Government Related Entity Implementation alternative 2: Market Owned Entity FINANCIAL OUTLOOK DEVELOPMENTAL PERSPECTIVES SWOT ANALYSIS AND ISSUES SWOT analysis Issues and gaps CONCLUSION AND NEXT STEPS Conclusions Recommendations Next Steps 21 APPENDICES 23 Appendix 1: Organizations that participated in the Initial Feasibility Study 24 Appendix 2: Mortgage Model in Denmark 25 Appendix 3: Implementation of the Danish Mortgage Model in Mexico 26 Appendix 4: Mortgage Model in Singapore and Hong Kong 36 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

5 1. PROJECT BACKGROUND AND OBJECTIVES 1.1 Introduction Dubai International Financial Centre (DIFC) and Absalon Project (Absalon), a joint venture between affiliates of VP SECURITIES A/S and Soros Fund Management, performed in February 2010 an Initial Feasibility Study in the United Arab Emirates (UAE) with the purpose to investigate whether it is a viable business idea to establish a mortgage solution in the UAE based on the principles behind the Danish Mortgage Model. Based on the findings and draft report some further clarifications were done in November The Danish Mortgage Model 1 has existed for more than 200 years and has undergone only few minor changes throughout the years. The model is still a viable, strong solution to provide funds for housing through continuous issuance of mortgage bonds in the same quantity and nature as the underlying mortgages. During the 200 years of existence no single investor has ever had a loss due to default of the mortgages, and the model has survived several crises though the years, including the current one, which started in autumn Absalon has in 2007 made an implementation of a Mortgage Model based on the Danish Model in Mexico 2 and are currently investigating other countries for possibilities of implementation. For more information please visit During the initial study, the mortgage models used in models in Singapore and Hong Kong 3 has been briefly examined. The immediate conclusion is that the models from these areas are not likely to be useful as inspiration for UAE. The project in UAE is hereafter referred to as the UAE Mortgage Securitization Project. This initial study is financed by the partners respectively. 1.2 Objectives for the study The objectives for the study are to investigate whether the prerequisites for introducing the Danish Mortgage Model in the UAE are available and to identify the benefits to the UAE of the introduction of Danish style mortgages in the UAE. The findings are expected to be presented to future key members of such a solution, governmental representatives and/or other possible founders of a mortgage project in the UAE with the purpose to: Identify changes in legislative and operative procedures to close the gaps that have been identified for the Danish Mortgage Model to work in the UAE Suggest alternative structures and ownership of a Mortgage Service Provider (MSP) utility in the UAE Estimate an initial budget for the project development Be the foundation for raising commitment and capital - to carry the project through an actual more indepth analysis - to form the basis for an actual decision to implement the project and to bring the project into daily operations The implementation of the project is expected to be in the form of a centralized Shared Service Facility named a Mortgage Service Provider (MSP), that will administer all services and regulations for the mortgage model to work, and provide the needed interfaces to the distributors of the mortgages, the Mortgage Credit Intermediaries (MCI) and connections to other partners in the model such as regulators, Stock Exchange and Central Securities Depository (CSD). 1 Appendix 2 2 Appendix 3 3 Appendix 4 1

6 1.3 Development of the project idea DIFC and VP got introduced to each other in autumn 2009, as DIFC had learned about the Danish Mortgage Model and a Mortgage Securitization Project VP had undertaken in Mexico, in a company named Absalon, a partnership between affiliates of VP and Soros Fund Management. VP was invited to participate in a Housing Finance Seminar in November 2009 at the DIFC, organised by Dr. Nasser Saidi from DIFC. DIFC and VP (on behalf of Absalon Project) then agreed to pursue the business idea to introduce the Danish Mortgage Model to finance private dwellings in the UAE. To meet these objectives, a series of meetings was organized by DIFC in February and November 2010 with representatives from possible future participants in the model from Dubai, Abu Dhabi and representatives from federal UAE level. During these meetings, the gap that exists between the current situation in the UAE and the prerequisites for the Danish Mortgage Model to operate successfully in the UAE were identified. A draft report dated December 20, 2010 was then issued and sent to key stake holders for their response to the findings and conclusions. Some comments were received until end of February and has been taken into account in this final version. Besides the remarks already in the SWOT analysis and issues list the comments generally was concentrated around the following areas: A suggestion to let a law firm identify the gaps and issues for the Mortgage Model to work in UAE Lack of clear description of functions and roles of key stake holders if the model is implemented Concerns regarding domestic liquidity to invest in the mortgage bonds and/or a doubt whether the bonds will attract foreign capital to the UAE. And finally if the model is open for all banks to become part of the project or it was limited to local bank 2 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

7 2. INTRODUCTION TO THE DANISH MORTGAGE MODEL 2.1 Basic Principles of the Danish Mortgage Model The model will offer mortgages to owners of private homes residential mortgages. The mortgages are characterized by the following main principles known in the Danish Mortgage Model: Principle of Balance The mortgages are financed through the issuance of mortgages bonds directly into the secondary market. The amount of mortgages and the amount of bonds in circulation used to fund those mortgages should always match each other. This means that bonds are only issued when they are needed to securitize a mortgage (tap issuance on a daily basis), and bonds are redeemed by calling at par, whenever the borrowers make principal payments or prepayments. Pooling of mortgages with similar characteristics To ensure large and liquid mortgage bond series, mortgages with same characteristics regarding maturity, interest rate, amortisation profile and risk profile are pooled together, and securitized by issuance of mortgage bonds with characteristics corresponding to the mortgages. Series are open for issuance in 3 years. Mortgages are serviced by the issuer of the mortgages The Mortgage Credit Intermediaries (MCI) which originated the mortgage will also service the mortgage throughout the lifetime of the mortgage until maturity. In the situation that a mortgage defaults, the MCI guarantees to the investors that bonds corresponding to defaulted mortgages will be taken out of circulation. So the MCI is encouraged to perform a proper credit scoring of the borrower and appraisal of the property to ensure only to grant mortgages to borrowers who they believe are likely to be able to pay the obligations of the mortgage. Borrower has two prepayment options The borrower is at any time entitled to make a full or partial prepayment of the mortgage by the cheaper of two options: Buying the bonds corresponding to the mortgage in the market at market price and delivering them to the MCI, who will then cancel both the bonds and the mortgage. Prepaying the mortgage at par value. The MCI will call the bonds at par to maintain the Principle of Balance. The prepayment options protect the borrower s ability to sell the property and prepay the mortgage both in case of increasing and decreasing interest level. Separation of credit risk and interest risk An important consequence of using these principles is a complete separation of credit risk and interest risk. Credit risk is maintained within the MCI, and an important part of implementation of the model is setting up rules and procedures for the MCI to ensure high quality of the mortgages and sufficient capitalization of the issuer to stand up against losses on the mortgages. It is very important for the model that the investors can have complete confidence that the mortgage bonds do not contain any credit risk. On the other hand, all interest risk is transferred to the investors, so the MCI has no risk in this area. Normally a Danish Mortgage is denominated in local currency to avoid any currency risk. The model though can handle all currencies. Loan types The basic idea is to offer the borrowers long term mortgages. In Denmark mortgages are normally with 30 years maturity and in the UAE probably years or longer. However currently it is not likely that investors in the UAE will accept bonds with that 3

8 long maturity, so the solution will probably be long term loans with refinancing every 5 or 10 years. This need to be further analyzed with the market during the implementation of the model. It is important to notice that this will differentiate the implemented model from the traditional Danish Mortgage Model. The normal products in the Danish Mortgage Model are bond loans with level payments or interest only payments. A solution with initially very small principal payments, which will be increased exponentially over time (L-factor loan) is also a possibility (this loan type was developed for the Mexican market). 2.2 Participants roles and responsibilities The customers of the Mortgage Service Provider (MSP) will be financial institutions which want to offer competitive home financing to their clients by joining the MSP and become a MCI according to the model described. When entering this co-operation, the MCI will sign a contract with the Mortgage Service Provider, defining the conditions of the partnership. It is not analyzed in details yet how the legal structure of the MSP and the MCIs should be in the UAE. In the following, a model close to the model implemented in Mexico is assumed, but the legal framework for the UAE could make it necessary for this to change, when the legislation and regulation are analyzed more into depth. The model described involves a number of different participants: MCI 1st layer trusts 2nd layer trusts Mortgage Service Provider CSD (Centralized Securities Depository) Stock Exchange Market Maker(s) Underwriter Trustee The tasks of these participants are described below: MCI The MCI will be the sales channel of the mortgages with the following responsibilities: Marketing (supported by the Mortgage Service Provider) Counselling of the borrowers Handling of loan applications (supported by IT systems provided by the Mortgage Service Provider) Appraisal of the properties Collection of all necessary documentation Credit score of the borrowers (supported by IT systems provided by the Mortgage Service Provider) Registration of property deeds and mortgage deeds Further on the MCI will take on responsibility for defaulted mortgages, meaning that if a mortgage is overdue, and the borrower is not expected to be able to fulfil his obligations, the MCI is committed to move the mortgage to its own books by prepaying the mortgage and removing the bonds from circulation. Potential MCIs are specialized mortgage banks like Tamweel and Amlak but also commercial banks in the UAE, which want to enter into or expand their participation in the mortgage market. 1 st layer trust In order to separate the risk of the issuer of the mortgages and bonds from other risks of the MCI, the MCI will have to create a trust (capital centre), which has the mortgages as asset with the property as collateral. Procedures in the trust will be established to ensure that sufficient capital is available in the trust to ensure that the mortgage bonds always are rated by international 4 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

9 rating agencies to the same level as sovereign debt. The model can be illustrated by the figure 1. below. The trust should be capitalized by the MCI, which will put in sufficient equity to ensure the rating of the bonds. It should be considered to allow that some of the capital is provided by issuing mezzanine- or junior bonds, which the MCI can sell at the market to diminish the capital requirements from the MCI. Instalments from the borrowers are paid to the trust, which pays interest and redemption to investors and also a spread which pays other obligations in connection with the issuance of the bonds. Part of the spread paid by the borrower will be given to the MCI as payment for the work performed and the risk involved for the MCI. However, the MCI will only receive this payment when all other obligations to the trust are fulfilled, including possible need for additional capital. If new bond series needs to be opened because of changed coupons, different maturity or other changes in characteristics of the bond are needed, the MCI will have to establish a new sub trust to maintain only one set of characteristics in all bonds issued by each sub trust. However, these sub trusts will have joint liability towards all claims, and the MCI will only receive their spread, if all obligations in all sub trusts for which MCI is beneficiary are met. This can be illustrated by the figure 2. on page 6. In the figure it is assumed that sub trust 1B has many defaulting mortgages, so this sub trust needs to receive liquidity from the other sub trusts for which MCI1 is beneficiary. Figure 1. Separation of credit and interest risk 5

10 Figure 2. Separation of credit and interest risk Figure 3. 2 Layer Trust structure to ensure large bond pools 6 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

11 2 nd layer trust We expect that the MCIs, which will be joining the model, will require separation of the credit risk from the mortgages of other MCIs. So in principle, all MCIs joining the model should have their own bond series. On the other hand, it is essential for the model to have great liquidity in the bonds, so to ensure big bond series, the bonds issued to fund the mortgages of one MCI are not sent to the market as public bonds. Instead the bonds are issued as private bonds, which are sent to a new trust. This 2 nd layer trust will then issue the public bonds in a one to one proportion, and these public bonds are then sold in the market. This can be illustrated in fig 3.2 on page 6. The model ensures that the quality of the mortgages and the capitalization of all the 1 st layer trust are such that all credit risk will be maintained within the 1 st layer trust, and the private bonds issued by all 1 st layer trusts are locally AAA rated by international rating agencies. All private bonds transferred to the 2 nd layer trust will all have same coupon, maturity and other characteristics, and the same characteristics will apply for the public bonds. This means that the 2 nd layer trust will be able to issue AAA rated public bonds without any capital. If several coupons or maturities are needed, new 2 nd layer trusts will be created to handle these. Mortgage Service Provider The Mortgage Service Provider will perform the following tasks: Clarify all legal aspects of establishing the model, including clarifications with the Ministry of Finance, the Central Bank of UAE, the Securities & Commodities Authority, and other authorities Enter all agreements with participating parties: - MCIs - Trustees - Market Makers - Stock Exchange - Securities Depository Prepare prospectuses and get approvals for the bonds Support the MCIs with marketing activities Support the MCIs with IT systems (counselling and handling of loan applications) Administer the trusts on behalf of the trustee, among other things with - Final approval of mortgages - Issuance of bonds to fund mortgages - Payment collection from borrowers - Assisting borrowers with prepayments - Solvency calculation -Distribution of payments (waterfall process) - Accounting The Mortgage Service Provider will receive its income from three different types of fees: 1. Access fee from MCIs: One time payments for entering the model plus an annual fee 2. Securitization fee: A percentage of the amount securitized 3. Administration fee: A percentage of the outstanding mortgage debt (part of the spread paid by the borrowers) The size of these fees will be decided during the establishment of the company after further analysis of the size of the market. The MSP is a new entity in UAE and is expected to be established as a shared service facility, owned by market participants and possibly also with participation from government. The MSP should be the project owner. CSD (Centralized Securities Depository) It is important that an efficient CSD exists in the market. The Danish model requires special features which not necessarily are present in all units taking care of registration of ownership, clearing and settlement of securities in the UAE today: Possibility for tap issuance on a regularly basis, either on a daily basis directly to the secondary market or to the primary market through frequent auctions Possibility to cancel bonds which have been delivered to the MCI for prepayments 7

12 Frequent redemption by calling bonds at par proportionally between all investors A model with single investor accounts at the CSD is preferable. This will make the redemption to the individual investors most efficient. In the UAE the CSD functionality is managed by the Stock Exchanges. Stock Exchange The bonds should be listed and traded at the stock exchange at UAE level. At the moment, two stock exchanges exist in the UAE, ADX (Abu Dhabi Securities Exchange) in Abu Dhabi, and DFM (Dubai Financial Market) in Dubai. These are supervised by ESM (Emirates Securities Market), which is part of SCA (Securities & Commodity Authorities). A third stock exchange exists in DIFC, NASDAQ Dubai, which operates under surveillance of DFSA (Dubai Financial Service Authorities). Market Maker A prerequisite for the model to work is a liquid market where it is always possible to sell the bonds issued at a price which reflects the interest level of the market, and where it is possible to buy bonds to be used for prepayments at a fair price. Further on, it should be possible for the borrower to hedge himself against fluctuations in the price of the bonds by making a fixed price agreement. When signing the loan agreement, the borrower will know the future payments to be paid, but he does not know the exact amount he will receive until the bonds are actually issued and sold in the market, unless he makes a fixed price agreement with somebody who guarantees to buy the bonds at a certain price. somebody will guarantee to sell the required amount of bonds at a certain price on the date where the prepayment will take place. To perform these tasks, a Market Maker will be needed. The Market Maker is a financial institution which always has a certain stock of the relevant bond series. The Market Maker will quote a price on a daily basis on the stock exchange, and he always accepts to buy at this price minus a certain margin, and to sell at this price plus the same margin. Underwriter The task of the Underwriter is normally to sign the prospectus and to organize and guarantee the sale of the securities at a predefined minimum price. As the bonds according the Danish Mortgage Model are issued at the same rate as the loans are appropriated and therefore sold using tap issuance (sold a little by little), the fact that the borrower will need to accept that bonds are sold at market price, and finally as a Market Maker is obligated to provide a realistic market price, the role of the Underwriter is less important than in a traditional securitizing model (and should as a consequence be substantial cheaper). The role of the Underwriter will be handled by a broker, typically a bank. Trustee The role of the trustee depends on local legislation, but his primary role is guaranteeing the investors that the issuing trust is acting in accordance with regulations and takes care of their interests. The role as trustee is typically handled by a bank. Accordingly, a borrower who wants to prepay his mortgage does not know the cost of doing so until he actually buys the bonds in the market, unless 8 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

13 3. PRODUCTS AND MARKETING 3.1 Product definition The model will offer mortgages to owners of private homes residential mortgages. The mortgages are characterized by main principles known in the Danish Mortgage Model, which is described in section 2.1. It should be considered to offer the mortgages in a way which is Sharia compliant, either as the only product type or as an alternative product for Islamic clients to offer in addition to traditional mortgages. Sharia compliance can be obtained by issuing the mortgage as a ljara based financing. The main principles for a ljara are: The property is bought by the mortgagee, not the mortgagor. The mortgagor makes an agreement with the mortgagee to buy the property after a certain period (e.g. 20 or 30 years) at the same price as the mortgagee paid. During the period, the mortgagor will pay the price of the property according to a pre-defined schedule. During the period, the mortgagor will have access to the property. He will pay a pre-agreed rent during the period. The rent can be set as a percentage of the part of the purchase price, which has not been paid yet. If the property is sold with a profit before it has been handed over to the final owner, the profit will be given to the final owner, as he already has an agreement to buy the property at a given price. The funding of a ljara mortgage is done in sukuks, i.e. Sharia compliant bonds. An investor in a sukuk is entitled to a payment, which represents a lease rental on the underlying mortgages. After having consulted a manager of the Sharia compliant origination in Standard Chartered Bank in Dubai, it is evaluated that the Danish Mortgage Model will qualify to offer Sharia compliant lending, with some minor adjustments. Procedures around forced sale of the property, if the mortgagor defaults, should be defined. 3.2 Borrowers of the mortgages The mortgage market in Dubai today is dominated by Amlak and Tamweel, who holds about 50-60% of the issued mortgages. A mortgage is for the moment needed in about 30% of the sales of properties in Dubai. In the remaining sales, the price is paid in cash. We assume that similar conditions exist in the rest of UAE. The proportion of people needing a mortgage is expected to increase in the future, as focus in development projects will change from high end and upper middle class to middle class. It is also expected that some of the speculators, who bought projects in cash to make a fast resell will need a mortgage, as they might not want to sell the property under the current market conditions. The present mortgage market in Dubai alone is estimated to 250 million USD new mortgages per month, which is about 25% of the size before the crisis started 4. We have no consolidated figures for the whole of the UAE at the moment. We have not met with representatives from Abu Dhabi Finance, the leading mortgage provider in Abu Dhabi, but anticipate that most of the conditions for mortgages in Abu Dhabi are similar to those in Dubai, even though the financial situation is different in the two emirates. However, there are a number of issues regarding the borrowers in the UAE: The value of a property, especially in Dubai, is difficult to settle at the moment 80-85% of the inhabitants of the UAE are expatriates, who can be forced to leave the country with short notice Many of the local people from the UAE will build their property on a piece of land given to him for free (granted land). However, a property on granted land can t be sold, and for that reason, can t be used as collateral for a mortgage. 4 According to information from Tamweel and Amlak 9

14 There is not a well proven practice for forced sale if mortgages default. The first forced sales have though been performed in Dubai. There is no culture for making credit scoring of borrowers in the UAE. In the following these obstacles are discussed in relation to the proposed model. Appraisal of the property It is essential for the model that the property can be appraised at a realistic price. If the appraisal is not realistic and there is not a correct value of the property, the collateral might be worth less than expected to cover for the mortgage. Dubai Land Department has a unit that appraises property for taxation and other issues and that unit is expected to be able to evaluate the property at realistic prices. However in Dubai there is a current supply of property of 350,000 units that not has been sold to the market yet, a figure which is expected to increase with 50,000 units this year 5. In contrast in Abu Dhabi there is still a need for construction of new dwellings, as demand exceeds supply. For this reason, it is very difficult to set a price on a house or an apartment at the moment. In certain areas, prices have dropped up to 70% since the crisis started in 2008, while in other areas the prices have only gone down with 5-10%. During the visit in November we got the information from both Tamweel and Amlak that the housing market was moving again and that Tamweel had started up issueing mortgages again. The real prices on property are where buyers and sellers can meet and agree on transactions. Registration of ownership It is essential that the registration of the ownership to land and the associated house or apartment is done in a transparent and indisputable manner so there is no doubt about the ownership. For the suggested model to work it is furthermore essential that the mortgage is registered on the property as it works as collateral for the mortgage. There is no federal mortgage law in place. In Dubai there is 3 different legal status of land: Freehold, Leasehold and Granted land. In Freehold land it s possible for all to buy the land and build on it and register all rights to that land. On Leasehold Land it s possible for all to build a property and have all rights to that building, but the land is only leased (from government). On Grated Land only Emiratis can build, and they only get the right to use the building, they can t sell it. As a very important prerequisite in the Danish Mortgage Model is that the house serves as collateral if the loan defaults. For that reason houses on Granted land can t qualify for Danish Style Mortgages without some specific arrangement is put in place to replace the house as collateral. For the Freehold and Leasehold Land the model works. During the visit in November we met with representatives from Dubai Land Department to learn about their services. It seems like in Dubai it is possible to get an official evaluation of the property and to register ownership to that property in the Land Department. We were told that in Abu Dhabi this service was offered by the developers, and were not implemented as a centralized, governmental service. Afterwards we have learned that there are initiatives on their way to implement a federal solution.to organize ownership and registration of real estate across the country 6. 5 According to information from Emirates NBD 6 Article in Gulf News March 7, Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

15 Property rights for expatriates in the UAE and visa rules 80-85% of all inhabitants in the UAE are expatriates, many of them working in the UAE according to a residence visa or permit. Normally such visa is granted for 3 years, and should be sponsored by an employer. When the visa expires or is cancelled (e.g. if the person looses his job), and if it is not renewed, the expatriate only has 30 days to leave the country (this period is considered being increased to 90 days, but that has not been changed yet). Also it is not possible to get a visa to retire to the UAE neither if you have worked in the UAE up to retirement nor if you for some reason would like to retire in UAE. Both the short notice by which your visa can be terminated and the lack of possibility to be a resident in the UAE upon retirement makes it a very uncertain decision to own a property in the UAE. It also seems like most developments have been sold to professional investors and therefore many apartments and houses have not yet been sold to the secondary market (to an owner that actually occupies the property). Another problem in relation to mortgages and expatriates is evaluation of the value of the house compared to the mortgage. In case the expatriate loses his job and/or visa, and the value of the house is evaluated to be less that the mortgage, the expatriate has no incentive to keep the loan current, as he is about to leave the country. Generally it takes much longer time to sell a property and finalize all the paper work, and this very limited period expatriates are given to get out of the country is estimated to have a negative impact on expatriates willingness to buy a house. Property on Granted land Emiratis are often given a piece of land to build a house (Granted Land). Often they are also given a loan, in which case they don t need a mortgage. But if this is not the case, the person might need a mortgage. However, properties on Granted Land cannot be sold, but should be delivered back to the government, so it is not possible to use the property as collateral for a mortgage. Another problem is that no expropriation legislation exists for Granted Land in the UAE. Practice is to compensate the owner of the property, but he has no legal right to compensation. If the model should work on Granted Land there should be a kind of sovereign guarantee that the mortgage will always be kept current. Forced sale In the UAE no mortgage legislation exists at federal level. In Dubai a mortgage law has been passed but only a few forced sales have been carried through. To minimize loss for the MCI, it is important that defaulting mortgages can be terminated in a fast and efficient way. Special consideration will need to be taken, if the mortgages should be ljara based to make the lending arrangement Sharia compliant. Credit scoring of the borrower There is no income tax in the UAE, so no authority requires information and documentation about income. For this reason there is no culture for preparing a household budget, and credit scoring of the borrower can be a problem. There has recently been established a company in Dubai that delivers credit scoring of individuals. 3.3 Investors for the mortgage bonds The UAE has at the moment no federal government bond market, as the federal government until now has not needed liquidity. A consequence of that is that no reference interest (yield curve) exists in the market. So pricing of other types of bonds will be difficult. 11

16 However, a Public Debt Management Unit has recently been established under the Ministry of Finance and the Central Bank of UAE 7, and the first federal government bond issuance is expected by end of 2010 or beginning of It seems like this issuance has been postponed 1 year so it will not happen until earliest end We believe that a federal government bond market will be a prerequisite for a liquid mortgage bond market, but in the absence of a federal government bond market, the pricing of the bonds will have to be decided in comparison to the individual emirates government bond markets. There is at the present no huge demand for mortgage bonds in the UAE. There are, besides the lack of a government bond market, several reasons for that: There are only a few and small institutional investors (insurance companies and pension savings funds). Private investors have up till now had a preference for short term investment with a high profit. There is in the UAE a tradition for negotiating terms of investments. Danish Style Mortgage Bonds have fixed and non negotiable terms. Further on, the present real estate crisis in Dubai has made international investors very cautious. We have though experience some interest among some of the banks of investing in these kinds of long term investments. It is crucial for the model that a liquid market exits. The Danish Model is dependent on the ability to sell bonds in the market whenever a tap issuance is made to fund a mortgage, and on the ability for the borrower to be able to buy bonds in the market to make a prepayment. Both transactions should be at fair prices reflecting the current interest level in the market. Potential investors in the mortgage bonds could be: Institutional investors (though few and small) Family owned enterprises Private people in the UAE Foreign investors Governmental institutions To attract foreign investors it is critical that the current policy of having a close link between AED and USD is maintained, so that the investors will regard currency risk to be minor. 3.4 Pricing analysis The model ensures a very transparent pricing for the borrowers. The interest to be paid by the borrowers will consist of two elements: Cost of funding, i.e. the coupon paid to investors. Spread, which consists of: - Insurance premiums (if relevant) - Fee to MCI, covering origination cost, guarantee fee and profit - Administration fee to the Mortgage Service Provider Note that the bonds normally will be sold at a discount, giving a real interest rate a little higher than the coupon rate plus spread. The costs will, apart from the discount on the bond price, be known in advance, so the borrower will know the payments to be paid in the future. The spread is expected to be lower than the current, due to efficient procedures, higher volume and more competition. (In Denmark the total spread on mortgages to private dwellings is around %. In the UAE it is expected to be higher than that due to lower volume, at least in the beginning). 7 Press release from UAE Ministry of Finance referenced in article in Thaindian News September 7, Article in The National January 24, Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

17 3.5 Competitors The mortgage market today is relatively small. The two main players in the current market in Dubai are Amlak and Tamweel. Those two have both expressed interest in joining the model because they experience now difficulties in providing sufficient funding. Also the big commercial banks are active in the market, and the ones we have met also express interest in joining the model. In general the Mortgage Service Provider will act as a centralized utility that delivers a standardized funding mechanism for mortgage loans and a set of IT administrative functions that are available to all parties that comply with the standards and participant policies for the company. Competition will be outside the Mortgage Service Provider between the different participants, and based on factors like marketing efforts and access to possible customers, pricing of spread and service offerings in accordance with the mortgage loan. 13

18 4. COMPANY STRUCTURE AND IMPLEMENTATION It is the intention to establish a Mortgage Service Provider company to handle all centralized IT procedures as well as business processes in relation to the implementation of the UAE Mortgage Securitization Project. As the prerequisites for the model to work is not currently present at a federal level, it is suggested to implement the model so that it in any case will work at a UAE level, but the ability to issue mortgages in an emirate will be implemented in a one-by-one order in the sequence that an emirate have the prerequisites in place. The individual credit scoring will make it possible to issue mortgages in the same trusts across different emirates, to ensure large mortgage bond pools to support a liquid market. So the suggested step-by-step implementation will just stimulate the emirates to get the prerequisites in place to join the model and get started, rather than the project needs to wait until all emirates are ready, or a joint federal legislation is in place. 4.1 Mortgage Service Provider The MSP will as such operate as a Shared Service Facility with the objective to make the services needed to administer the IT- and business procedures to support the UAE Mortgage Model available to the MCI s as efficient and cost effective as possible 9. All legal and most practical aspects in relation to the implementation of the UAE Mortgage Model will be handled by the MSP, and terms and conditions related to those areas will be allocated to the MCI s in the relevant Participation Agreements. This structure will ensure that all generic procedures are managed in a centralized manner at the MSP level and that all interaction with the borrowers and individual services to the borrowers will be handled in a decentralized manner by the participating MCIs. With this structure there is no need to introduce more MSPs in the UAE, as the services that the suggested MSP will deliver are neutral in their nature to the participating MCI s, and the competition to attract customers for the Figure 4. Roles in the suggested UAE Mortgage Model 9 See chapter 2.2 for roles and responsibilities for key stake holders 14 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

19 individual MCIs are related to their ability to market their services to the customers compared to other MCIs. The basic price of funding and products offered are the same, but different service offerings could be developed by the individual MCIs. It is important to notice that it will be the IT- and business procedures of the MSP that will be rated by the international rating agencies. Therefore by definition the mortgage bonds that will be issued by the MSP as a consequence of an approved loan application will be rated as sovereign debt locally, which is the current objective for the rating. The handling of mortgage bonds from issuance to maturity inclusive payment of instalments to investors and giving market information to investors and regulators will be done by the MSP. All companies that comply with the terms and conditions to act as a MCI can be a member of the MSP and utilize the services of the MSP. The MCIs can join the model without the need to modify their systems. In a later stage they could chose to make system-tosystem connections between their own IT systems and parts of the functionality from the MSP systems. The Mortgage Service Provider will receive its income from three different types of fees: 1. Membership fee from MCIs: One time payment plus an annual fee 2. Securitization fee: A percentage of the amount securitized 3. Administration fee: A percentage of the outstanding mortgage debt (part of the spread paid by the borrowers) The size of these fees will decided during the establishment of the company after further analysis of the size of the market and the cost of establishing and operating the MSP. 4.2 Implementation alternative 1: Government Related Entity If the MSP is established as a Government Related Entity (GRE), this will kick start the introduction of the Mortgage Model in the UAE, as it is then assumed that the funding and governance of the MSP is given and also that the needed changes in business practices and/ or legal matters more easily can be done. This alternative will ensure that there is no doubt about who is the project owner and therefore many decisions in relation to the foundation of the company and the implementation of all the systems and procedures can be done very efficient in this model. Also it is the impression that many companies in the UAE has this ownership structure, so it s a commonly used approach to enforce activities that government would like to introduce to the community. 4.3 Implementation alternative 2: Market Owned Entity The MSP could also be established as a market owned utility, where local financial institutions jointly could own the Shared Service Facility. Financing of the MSP is not regarded as a problem, but foreign investors could be considered as founding members to bring knowledge regarding mortgage financing to the board of the company. Also relevant government related entities on the UAE level could have an ownership in the MSP without having a dominant position. In this alternative there is an initial phase where the project has to be presented to interested parties and the founding of the company needs to take place before the funding of the project can be committed. This approach introduces some financial and governance issues to overcome before the company actually can be founded. A project owner needs to be identified to finance and manage the needed activities listed below: 1. A more in-depth analysis needs to be performed regarding the introduction of the project in the UAE to prepare a business case to present for possible investors. 2. Identify possible founding members of the MSP and develop investment plans and shareholder agreements to them 15

20 5. FINANCIAL OUTLOOK This Initial Feasibility Study has not been focused on preparing a financial analysis of the costs of introducing the Danish Mortgage Model in the UAE, but rather focused on the prerequisites for the model to work and the benefits to the UAE of introducing the model. The development of the housing market in the UAE and the outlook for further development indicates that there will be a good opportunity to introduce the model in the UAE. The amount that is currently being mortgaged in Dubai during the current situation is worth 250 million USD monthly 10 (30% of all sales in Dubai) and this amount is estimated to be 25% of the level before the crises started. Based on the experiences from Mexico and under the prerequisite that the model can be implemented as described in this study including the sharia compliance, it is expected that the implementation costs for the project including the setup of the MSP and the finance of the initial operational losses will be in the area of million USD. A more in-depth analysis as part of the suggested project to create an implementation plan will prepare a better projection of the costs to establish the project as well as the income. The project to create a detailed implementation plan is expected to cost maximum USD. We need to further analyse the demand for mortgages in Abu Dhabi and the other emirates in the UAE as a total. 10 According to information from Tamweel and Amlak 16 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

21 6. DEVELOPMENTAL PERSPECTIVES The UAE is not unfamiliar with the development of mortgage products and services. During the last 5-10 years the mortgage business has developed and both commercial banks and more specialized mortgage banks have provided mortgages. Tamweel and Amlak in Dubai and Abu Dhabi Finance in Abu Dhabi are examples of such specialized mortgage banks. The problem that has arisen as a consequence of the current crises is that the mortgages are financed through the balance sheets of the involved banks, which are now stressed due to the crises. The study has assumed that that a model following the principles in the Danish Mortgage Model should be implemented in the UAE but other alternatives could be considered. As part of the study the mortgage models in Singapore and Hong Kong 11 have been briefly examined. It is our opinion that these solutions will not bring the same benefits to the UAE as the Danish Mortgage Model. The Singapore model is based primarily on subsidies from government and the Hong Kong model is equivalent to the US model, where the problems in that model recently have been disclosed by the so called subprime crise within the real estate market in the US. The mortgage market will become more competitive, loan terms will be more flexible for the borrowers, the cost structure will be transparent and the loans are expected to be cheaper which will open the doors to more people to take on mortgages and own their own houses. Further on the introduction of the model would ease the current situation where access to funds is limited. Therefore many investors in housing today are stuck with their investments and are unable to sell due to the fact that potential buyers have no access to affordable mortgage financing. It is though necessary that government supports the model and is willing to invest in the mortgage bonds, at least in an initial phase, to launch the model and assist in creating a liquid mortgage bond market in the UAE. The Danish Mortgage Model 12 will introduce a mortgage model where the mortgages are financed through the capital market by issuing mortgage bonds directly into the market. The Danish Mortgage Model is developed during more than 200 years of operation. The model has successfully been exported to Mexico, where the first Danish Style Mortgages were issued before Christmas in Based on the experiences from Mexico the securitization project in the UAE is meant to leverage on this experience and stimulate the economy in the UAE. 11 Appendix 4 12 Appendix 2 17

22 7. SWOT ANALYSIS AND ISSUES As a concluding part of the study, the projected MSP has been subject to an analysis of strengths, weaknesses, opportunities and threats (SWOT). 7.1 SWOT analysis Strengths Introduce a mortgage model that is financed through the capital market The UAE real estate market will be less dependant on access to bank liquidity Cheaper funding for borrowers of private houses More flexible funding for borrowers with transparent prepayment options at par and at market price Banks can free some capital by issuing Danish Style Mortgages which allows for other business opportunities with the same amount of equity Opportunities There is a need for mortgage financing now and in the future According to several sources independently the level of need for mortgage financing is around 25-30% of all sales of new units. Future need for mortgages is expected to be higher due to more focus on middle class and also due to a growing secondary housing market The current (low) level of mortgages amounts to around 250 million USD per month according to two sources The study has indicated that it will be possible to use the Danish Model as basis for Sharia compliant lending. There are plans in place both in Dubai and Abu Dhabi to continue the construction of private homes to drive growth Weaknesses No debt capital market established in the UAE, meaning there is no yield curve for government bonds to set the guideline principles for pricing of the mortgage bonds No federal mortgage law supports taking over the house as a collateral if the borrower defaults Low demand for long term investments in bonds due to current limited need for savings in pension funds and insurance companies Strata legislation is not fully implemented Land Department functionality is not fully implemented Threats High number of expatriates compared to Emiratis (85/15%) Expatriates has to leave the UAE with short notice if they loose the job/work permit Expatriates can only acquire a house/apartment in Freehold and Leasehold Land Emiratis get land (Granted land) from government to build their house which can not be transferred to others (not possible to take as collateral if financed through the mortgage model) 18 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

23 7.2 Issues and gaps The study has identified some major issues and gaps that need to be addressed for the project to succeed in the UAE. Capital Market There needs to be established a capital market in the UAE, where government will issue government bonds to act as benchmark for the mortgage bonds. A government bond market is a prerequisite for the model to work properly. Initiatives are on their way in the UAE. First issuances expected in late 2010 or early New status on November 2010 is that the issuance is 1 year delayed. Stock Exchange Central Securities Depository (CSD) There needs to be a market place for the trading of the mortgage bonds. As the mortgage bonds are suggested to be issued in the local currency (AED), and the majority of investors in the bonds are expected to be domestic, it should be investigated further how the bonds could be listed at an UAE level, either at DFM and/or ADX. There will be a need for a function at the UAE level for the registration of ownership to the Government Bonds and the clearing and settlement after trading. It is preferable that the mortgage bonds also are registered at this CSD to make tight connections to the central bank for clearing purposes. If a federal solution will not be in place from the beginning of the project, the CSD functionality should be utilized at local emirate level. Registration of ownership The Danish Mortgage Model is built on the prerequisite that the house/apartment is registered as collateral for the mortgage until the mortgage is fully redeemed. To ensure the integrity of the mortgage model there shall be no question regarding ownership to the property. This is essential for the markets evaluation of the quality of the collateral. No federal function exists today. Dubai Land Department manages this in Dubai. In Abu Dhabi this functionality is managed by the developers. Mortgage law The Danish Mortgage Model is built on the prerequisite that the house/apartment is registered as collateral for the mortgage until the mortgage is fully redeemed and that the mortgage can be financed by issuance of mortgage bonds. If the borrower is not able to fulfil the commitments to the mortgage, the MCI can through legal steps get access to the house and sell it in a forced sale to cover for the defaulted mortgage. It should be possible to take the collateral into possession and make a forced sale. No mortgage law exists on a federal level. A mortgage law is passed in Dubai. Sharia compliance Many local investors will only invest in financial products that are Sharia compliant. Adjustments to the model should be made to ensure Sharia compliance to stimulate domestic investors. Solutions around bankruptcy and forced sales should be developed to cope with sharia compliance. 19

24 Market Maker Credit Scoring The model requires some financial institutions to act as Market Makers to ensure having a liquid bond market with actual and fair buying and selling prices. Some of the major players in the financial market should be urged to act as market makers. We have received positive feedback from many banks and the following banks were mentioned to us as potential market makers: Emirates NBD Abu Dhabi Commercial bank National Bank of Abu Dhabi First Gulf Bank Mashreq Bank Dubai Islamic bank Abu Dhabi Islamic Bank The model requires a realistic evaluation of the borrowers financial ability to fulfil the obligations towards the mortgage. Giving that more and more transactions need to be financed through mortgages in the future, the need for the introduction of a viable model for credit scoring of the individual borrowers increases. The process is furthermore complicated by the fact that expatriates can be asked to leave the UAE with a short notice if they loose their job or by other ways loose their work permit. Appraisal of property The properties need to be appraised by strict procedures to determine a realistic value, as the mortgages are backed by the value of the collateral (the property). In an economy where the housing sector is driven by development plans for growth in the area there is a tendency that the natural demand for housing is less than the supply. When a crises occur this turns into a problem, as there is too little domestic demand and there is a huge oversupply of housing. How can a realistic evaluation process be established in the UAE? Investors Mortgage bonds are long term, stable investments. We learned that short term investments were the preferred investment form in the UAE currently. There is not a tradition for long term investments in the UAE in debt instruments. Basically this might be due to the fact that there is only limited demand for pension funds, life insurances and similar kinds of services that requires long term investments. Investors should be trained in this new investment possibility as well as government though different institutions should be urged to invest in the mortgage bonds. Maybe the mortgage bonds should have shorter maturity than what is the normal 30 years fixed rate mortgage bond in Denmark. Training of the investors should make them realize that a very liquid market makes long term bonds suitable also for shorter term investments. 20 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

25 8. CONCLUSION AND NEXT STEPS 8.1 Conclusions During the analysis results we have found that: The project idea is well received by all parties visited, which has included commercial banks, mortgage banks, construction companies and developers, regulators, investors and Stock Exchanges. Most visits have been made to companies and institutions in Dubai, but also several visits have been made to federal offices in Abu Dhabi including the Securities and Commodities Authority and the Central Bank of the UAE. Major gaps between the prerequisites for the Danish Mortgage Model to work and the current legal and practical infrastructure in the UAE have been identified. Especially issues in the following areas needs to be solved or clarified before a decision to start implementation could be made: - Lack of federal mortgage law - Lack of federal bankruptcy law - Lack of full implemented strata law - Expatriates limited rights to stay in the UAE (work permits, tourist visa, retirement) - Unclear legal framework for expatriates It has been recommended that the study should cover the whole of the UAE and with the aim to expand the model to cover the GCC region at a later stage. At this stage the implementation focus should be the UAE. The model can be implemented to issue traditional mortgages, ljara mortgages or a both types dependant on the feedback from the market. The main objectives is to create as large and liquid bond series as possible. Also the lack of a capital market in the UAE is considered a major issue for the introduction the mortgage model in the UAE. On the other hand there are initiatives on their way to create such a market, and federal government bonds are expected to be issued in late 2010 or early The need for mortgage financing has been estimated in Dubai at the current market conditions, and those findings indicate that there will be a viable business case for introducing the Danish Mortgage Model in the UAE. It is the impression that also Abu Dhabi would benefit from joining the model but we have had no direct contact with current suppliers of mortgages in Abu Dhabi like Abu Dhabi Finance. 8.2 Recommendations Based on these findings it is our recommendation to: Establish the project with joint ownership on a UAE level, at least with participants from Dubai and Abu Dhabi. Decide on a stepwise implementation plan: Dubai first then Abu Dhabi and then on a UAE level. Prepare a more detailed implementation plan in accordance with the overall strategy along with a project budget: Identify the need for changes in legal and/or practical aspects in the mortgage industry in the UAE for the introduction of the Danish Mortgage Model. Address the issues and gaps raised in this report and give practical solutions to overcome the issues. Address the impact to the UAE on a macro economic level of the introduction the Danish Mortgage Model 8.3 Next Steps To bring the project forward a project team should be established to deliver a detailed implementation plan according to the recommendations above: A project team could be staffed with: Wagn Erik Norgaard, Absalon CTO Henrik Hogsaa, Absalon Product Manager Legal advisor from the UAE with knowledge of the housing market and the mortgage area Finance expert in the investment area from the UAE Mortgage expert from the UAE Economist from the UAE for macro economic analysis. 21

26 Absalon and DIFC have financed this initial step. The project to create an implementation plan is estimated to cost around USD. A project sponsor is needed to finance the work of the project team to make the detailed implementation plan. So the immediate next steps are: Identify sponsor to finance the next steps Identify members of the project team Identify governance of the project including budget and timetables 22 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)

27 APPENDICES Appendix 1: Organizations and companies that participated in the Initial feasibility Study Appendix 2: Mortgage Model in Denmark Appendix 3: Implementation of the Danish Mortgage Model in Mexico Appendix 4: Mortgage Model in Singapore and Hong Kong 23

28 Appendix 1: Organizations that participated in the Initial Feasibility Study 24 Initial Feasibility Study: Mortgage Securitization Project In The United Arab Emirates (UAE)