Is Kenya ready for secondary mortgages?

In a country where the number of primary mortgage holders is still small, the idea of a higher-tier home loans market where lenders resell mortgages to external investors using the value of mortgage loans as collateral may sound far-fetched. But proponents of a secondary mortgage market argue that is what Kenya needs to ensure long-term funding as well as realise single-digit lending rates, writes FRANCIS AYIEKO.

Mugo Kibati, the man charged with steering the country to a newly industrialising, middle-income status by 2030, has a new vision. The Vision 2030 Secretariat Director-General has lately been thinking about real estate and believes he has an idea that could make housing affordable to the majority of Kenyans.

“I know Reits (Real Estate Investment Trusts) regulations were recently gazetted. I hope we will also have a secondary mortgage market in the near future,” Kibati said on July 15 during the listing of Home Afrika on the Nairobi Securities Exchange.

With the country’s primary mortgage market still under-developed, the idea of a secondary mortgage market may sound far-fetched. The question thus is: Is Kenya ready for a secondary mortgage market as Kibati suggested? How could a secondary mortgage market make home ownership affordable to the masses? And what is a secondary mortgage market?

Simply put, a secondary mortgage market is a housing financing arrangement in which financial institutions resell mortgages to external investors using the value of mortgage loans as collateral.

Primary Mortgages

Under this form of housing finance, the mortgage lender, which may be commercial banks or specialised firms, group together many loans and sell the grouped loans as securities to “bigger” investors.

Currently, Kenya has only primary mortgage lenders, which comprise all the major commercial banks and one specialised lender, Housing Finance. Each of these institutions operates within lending limits set by their own exposure policy and prudential guidelines from the banking regulatory authority.  But under a secondary mortgage market, banks can ‘bundle’ and securitise mortgages and resell them on the open market. The investor that purchases the bundle will then be the one to receive the steady stream of mortgage repayments from the primary lenders, not the original lender.

Here is how a secondary mortgage market works: Once your lender gives you and others home loans, a third party entity known as a Special Purpose Vehicle (SPV) purchases the mortgages from the primary (your) lender who then uses the proceeds from the sale to offer new loans.

The SPV will purchase mortgages that share similar characteristics, such as repayment terms and interest rates.

Sometimes, the mortgages may have varying characteristics — some mortgages may carry a greater credit risk than others, based on the type of property or the credit history of the borrower.

These mortgages are then pooled into large groups and packaged into securities that represent claims on the principal and interest payments made by borrowers on the loan in the pool.

The securities are then sold to investors in the secondary mortgage market (instead of holding the mortgages until the home buyers have repaid the entire loan) that would include large-scale institutional investors such as pension funds, insurance companies and mutual funds.

This way, the secondary mortgage market helps primary lenders like commercial banks and mortgage firms free up money to make another loan to another consumer.

This ultimately brings down the cost of mortgage financing and allows the volumes (many people can now borrow) that sustain the mortgage firms on a day-to-day basis and still provide a solid capital base for long-term growth.

The purchasers or investors buy the mortgages at a lower interest rate than what the primary lenders had negotiated with the borrowers and the difference in the two rates is the pool’s profit.

Is the Kenyan mortgage market ready for this?

There has been push for the introduction of a secondary mortgage market for the last few years. In 2007, for instance, former chair of the Kenya Private Developers Association, Dr Laila Macharia, argued in a newspaper article that a secondary mortgage market in Eastern Africa (where there exists none currently) would have an instant effect on the volume of mortgages that housing finance institutions could issue.

“By allowing reselling, these institutions could offload old debt for new, which would invigorate their portfolios,” said Dr Macharia. “This would in turn dramatically increase the pool of financing available for home buyers and spur growth in the real estate sector and the economy at large.”

If established, a secondary mortgage market would solve the problem of lack of long-term funds, which is often cited by mortgage lenders as a major hindrance to the growth of the country’s mortgage market.

Short-Term Funds

Most mortgage lenders depend on short-term funds, such as customer deposits, to raise finances to lend to homebuyers.

Short-term funds, however, are not usually a good option because the cost depends heavily on the prevailing monetary policies, explaining why banks prefer variable rate mortgages to fixed rate mortgages as the former changes with the prevailing economic circumstances.

In its annual bank supervision report for 2012, the Central Bank of Kenya identified lack of access to long-term funds as the topmost constraint to the growth of the mortgage sector. It was followed by high interest rates. By December 2012, Kenya’s total mortgage value stood at Sh122.2 billion, up from Sh90.4 billion by December 2011. This represented 19,177 mortgage accounts.

This situation, according to The Mortgage Company, could be reversed through long-term funding to primary lenders. Releasing the mortgage report for the first quarter of this year in April, The Mortgage Company Managing Director Caroline Kariuki said that today, the funding of mortgages is done primarily through bank deposits, making the industry vulnerable to shifts in short-term market liquidity.

“The impact of this cannot be underestimated with the interest rates in the market moving in October 2011 from an average of 14 per cent to 24 per cent, leaving many mortgage takers in distress after their mortgage payments doubled,” she said, adding: “Although this position has improved slightly, we require a long-term and sustainable solution to funding of mortgages to give a lasting solution to this challenge.”

She said cheap long-term funds directed towards mortgage financing was needed to enable the country to move towards single digit interest rates and radically change the affordability of mortgages like in the United States. Here, mortgage rates are about 3.5 per cent because the majority of residential mortgage loans are funded through the secondary mortgage market.

“To encourage the flow of long-term funding, we need to seriously look at the possibility of developing a well organised securitisation programme where financiers can obtain funding from the capital markets,” she said.

Kariuki added: “While Reits will be great for developers and long-term investors in commercial properties, we need to address the more important aspect of allowing the flow of pension funds, Saccos and insurance funds to the mortgage market.”

In her 2007 article, Dr Macharia said one of the things urgently required to achieve a secondary mortgage market in East Africa in general, and Kenya in particular, was mortgage securitisation, which refers to the conversion of cash flows into marketable securities or bonds, which are then sold to third party investors in the capital markets.

“For a mortgage to be easily resold, all housing finance institutions must standardise their approvals and administration process so that a third party can compare apples to apples,” said Dr Macharia.

According to a World Bank report on Kenya’s mortgage market released in 2011, Kenya could be ripe for a secondary mortgage market, but is yet to put in place the basic requisites for the existence of such a market.

Titled, Developing Kenya’s Mortgage Market, the report says the country has a large investor base made up of individual investors, pension funds, insurance companies, banks, the National Social Security Fund (NSSF) — all of which are potential investors in a secondary mortgage market. This is boosted by the existence of a strong regulatory framework, says the report.

“The Capital Markets Authority publishes regular data on investment holdings by type of asset and by investor, which provides a useful profile of the potential investors in a secondary mortgage market,” says the report.

Competent Regulator

As well as the presence of an investor community, another supporting factor for the development of a secondary mortgage market is the advanced level of market infrastructure in Kenya, notes the report: “The market benefits from a strong and competent regulator, and a secondary bond market exists with trading growing rapidly.”

However, technicalities involved in securitisation, a major requirement in setting up a secondary mortgage market, are putting a damper on such efforts.

It says securitisation can involve significant costs and is complex to set up and administer. Furthermore, the fact that there is risk transfer also raises a number of issues related to the ability of banks to manage their risks and investors to take on credit risk, interest rate risk and pre-payment risk.

Securitisation

(The key difference between securitisation and funding from an institutional investor is that banks effectively sell rights of the mortgage to a securitisation entity who then sells bonds to investors who are now directly exposed to the risk of default.)

“Securitisation has some potential in Kenya given the size of the mortgage market and the number of institutional investors. However, there are some key obstacles to the successful use of securitisation at present,” says the World Bank report, which outlines some of the obstacles as high issuance costs, lack of detailed portfolio data, potentially negative impact of competition, risk management issues, prudential risks, and lack of “feed stock”.

Then comes the depressing clincher: “There are many drawbacks to doing securitisation, especially in an emerging market such as Kenya. The risk premium which would be charged together with the issuance costs would outweigh many of the benefits of tapping the capital markets.”

Yet, key stakeholders like Caroline Kariuki of The Mortgage Company and Mugo Kibati’s Vision 2030 are still optimistic and hopeful.

“I think Kenya is ready for a secondary mortgage market,” Kariuki told journalists in April.

Kibati, on his part, is convinced that a secondary mortgage market would be a game-changer for home ownership in the country: “Prices go down when commodities can easily be traded on the stock exchange. The easier it is to trade and offload assets on the stock market, the cheaper it will be for ordinary citizens to buy.”

When will we get there?