Mortgage-Backed Securities: an Option for Financing Housing and Urban Development

MORTGAGE-BACKED SECURITIES: AN OPTION FOR FINANCING HOUSING AND URBAN DEVELOPMENT

Prof. Bob Osaze, Ph.D

INTRODUCTION

The Capital Market is unarguably the most robust set of institutions in any economy for mobilizing the necessary funds for financing productive assets and generally economic growth and development. Hence, any nation that desires to grow and develop its economy must have a vibrant capital market or at the very least have unfettered access to one. This is because the capital market is the only institution known to economic man that has the ability to pool vast long- term financial resources together from fund suppliers and distributing, same to continuously competing uses and users of such resources. But more importantly, the capital market has the mechanism for sourcing funds and allocating them to highly disciplined, self-regenerative and acceptable return-yielding investments.

In the process of doing so, it protects investors and fund suppliers while guaranteeing good returns. But it also assures fund users of probably the cheapest and least-costly finance for their projects and programmes.

Thus, the capital market is a complex of institutions and mechanisms through which intermediate and long-term finance is pooled and made available to business, government and individuals and instruments already outstanding are transferred from savers to users and other investors. The capital market is the prime motor that drives any economy on its path to growth and development because it is responsible for long-term growth capital formation.

II. FINANCING OPTIONS AND VEHICLES IN NIGERIA

Inspite of the pivotal role of the capital market in the development process, the Nigerian market is yet to appreciably perform its natural function in terms of financial transformation through gross fixed capital formation for funding productive investments.

One of the major indicators of capital market development is the proportion of long-term fixed capital that is raised in relation to the Gross Domestic Product. Unfortunately between 1980 and 2003, capital formation in terms of long-term funds raised from the market through new issues to the GDP has averaged less than 1%. The capital market has not been as popular a source of finance as it should be for several reasons:

1 i. the instability of the economy; ii. the low yields to investors in capital market instruments; iii. government overbearing presence in economic matters; iv. deepening of the Treasury Bills market through discount houses which has complicated the overriding dominance of the short-term money market over the long-term growth-inducing capital market. This negative term transformation tempts financial intermediaries to encourage investors to switch from long-term to shorter term investments where the return is better and relatively assured. Furthermore, the sale of Treasury Bills in Nigeria is usually to captive markets – insurance companies, pension funds and banks seeking safe outlets for funds which they are not lending; and v. paucity of good quality and attractive investment instruments.

Generally speaking, apart from the traditional investment instruments – equities, preference stock, corporate debenture stocks, government bonds and recently sector-focused investment funds like the Energy Sector Fund, Nigeria International Debt Fund, IBTC Equity Fund and the Discovery Fund – there has been very little added to the portfolio of instruments in the capital market. The Options, Futures and Derivative markets are still on the drawing boards of our capital market operators and financial intermediaries. Even governments at the Federal, State and Local Council levels which are expected to be prime movers of the capital market, through their fund raising activities prefer to finance development programmes using the traditional allocatory means from their generated revenues thereby putting unnecessary pressure on this scarce source. As a result, the Nigerian Capital Market even though deepening appreciably in the last five years still lacks breath, that is the size and scope of the market in terms of the variety of securities that are available as investment choices. Hence, the need for greater creativity and proactivity on the part of all capital market operators, SROs, Regulatory bodies and the government in encouraging the introduction, deployment and active promotion of new financing and investment instruments in the capital market to further leverage its robustness. One of such new instruments which is being actively promoted by the SEC for financing housing and urban development in Nigeria is the MORTGAGE-BACKED SECURITY.

2 III. FINANCING HOUSING AND URBAN DEVELOPMENT IN NIGERIA

Over the years, housing and urban development/renewal has always been financed in Nigeria through one or a combination of several ways:

a. Direct statutory allocation by the Federal Government to the relevant ministerial departments; b. State statutory allocations to the relevant ministerial departments; c. Foreign grants-in-aid

However, with dwindling revenues and greater demand for development financing alternative financing methods had to be created. In 1978, the defunct Bendel State blazed the trail in sourcing capital market funds for housing development when it floated its First Revenue Bond 7%, N20 million 1988.

In 1989, the Kaduna State Government also raised N30 million through a 10-year Revenue Bond to finance urban renewal and market development.

In 1992, the First Lagos Island Local Government Floating Rate Revenue Bond N100 million was floated to finance the Sura Shopping Complex.

The year 2000 saw both the Edo and Delta State Governments accessing the capital market to raise N1 billion and N5 billion respectively to finance housing projects/modern markets.

Similarly, in 2002 Yobe State came to the market to raise a N2.5 billion 1 3 /2-year floating rate bond to finance urban roads, improve drainages, develop houses and embark on an industrial estate.

Part of the 2002 N4 billion 4-year Ekiti State floating rate bond was for housing and urban renewal.

In essence, the capital market has played only a small role in the financing of housing and urban development in Nigeria. So far, only the states and local governments have accessed the market for this purpose. The Federal Government, on its part has preferred to finance housing and urban development through the window of the Federal Mortgage Bank. The Federal Mortgage Bank and the Primary Mortgage Institutions which it functions through are essentially operating as savings and loans

3 associations where potential homeowners make periodic savings toward homeownership and are thereby qualified for a mortgage loan from the Federal Mortgage Bank and PMIS to make up the balance for buying or building a house. The impact of this method of financing in Nigeria has also been minimal as most homeowners have had to either save to build their own homes or raise the funds expensively from the money market.

What is yet to be introduced into the capital market in Nigeria as an alternative source of financing housing and urban development is the MORTGAGE-BACKED SECURITY.

IV. THE RESIDENTIAL MORTGAGE MARKET

One of the most important dreams of Nigerians is to own their own home. Government is also aware of this fact and has always attempted to increase the housing stock by building new homes through the Federal Housing Authority to be sold to Nigerians. Subsequently, Home ownership has tremendous financial, economic and psychological values to those who are able to achieve their goals.

Apart from their rising market values, which outpace the inflation rate, they also serve as valuable collateralisable assets for loans. This is beside the pscychic and immeasurable value home ownership confers on Nigerians.

However, building and owning a home in Nigeria has become increasingly difficult over the years as a result of the credit restraint posture of the banks and the limited availability of loanable funds even from the Federal Mortgage Bank and the Primary Mortgage Institutions. It is estimated by the Federal Mortgage Bank of Nigeria (FMBN), the apex mortgage institution in the country, that about N12 trillion is required to meet the shortfall in Nigeria’s housing needs which it put at about 12 million units. The Federal Mortgage Bank of Nigeria also reveals that “barely N200 million comes in as monthly contributions into the National Housing Fund, the current size of which has been put at N2.4 billion” (Guardian, Monday, November 1, 2004:35). The Chief Executive Officer of the Federal Mortgage Bank of Nigeria, Tanimu Yakubu, also rightly argues that “the major challenge facing the housing financing system is how to provide mortgage facilities to Nigerians. As things stand, a mismatch exists between the housing finance demand and supply in the country” (2004:35)

4 Similarly, the Central Bank of Nigeria (CBN) puts the amount of investible funds available to the existing 81 Primary Mortgage Institutions (PMI) at a mere N36.7 billion. But even that is not enough cheering news as only N22 billion or 60% of the amount has a reasonable chance of being available for mortgage loans origination (CBN, 2003).

Unfortunately, the capital market has not yet been able to play a major role in alleviating fund availability for housing and urban development in Nigeria. According to Yakubu (2004:37) “the challenge, therefore, is to render a housing financing system that will be able to deliver a robust housing finance system”. Hence the desire to link the housing sector to the capital market by converting or securitizing mortgage loans that are traded in by loan originators through the secondary mortgage market thus creating Mortgage-Backed Securities (MBS). The FMBN hopes to sell these MBS to such institutional investors as insurance companies and pension funds for on-lending to the housing sector. This way, more funds are created and more potential homeowners will be able to access funds to build or buy their own homes. Furthermore, pressure will be lifted off the banking sector in terms of the myriad of investments and businesses it may have to finance.

V. MOTGAGE-BACKED SECURITIES AND THE MORTGAGE MARKET

Mortgage-backed securities derive from mortgages which are conventional corporate debentures floated by corporate entities to raise funds. Hence, a mortgage is really a debenture that is secured by the collateral of some identified real estate property or physical asset. However, in the housing and housing development market, a mortgage is also a loan or debenture but this time collateralized by real estate property only. In essence the piece of real estate property is mortgaged by a borrower (mortgagor) for a loan from the lender (Mortgagee).

These mortgage loans can then be securitized and used as a means for raising funds in the market.

Two types of real estate property can be mortgaged. These are:

 Residential property; and  Non-Residential property – office complexes, commercial buildings , hotels, shopping malls and farm properties.

The market where mortgaged funds can be raised is called the mortgage market which like any capital market is made up of both a primary market and the secondary end. Where the actual loan is advanced by the lender

5 to the borrower is the primary market. “The Secondary market channels liquidity into the primary market by way of purchasing packages of loans from lenders. Hence provide more loanable funds to lenders who in turn are able to make more loans to home buyers” (Bhattacharya, Fabozzi and Chang, 2001:3). Mortgages can also be pooled by private channels and securities issued.

Mortgage-Backed Securities:

Mortgage-Backed Securities (MBS) are created when mortgages are pooled together and undivided interest or participation in the pool are sold. The initiator of the MBS continues to service the original mortgages in the pool, collecting payments and sending across (passing-through) the principal and interest, less the servicing, guarantee and other fees to the security holders who share these cashflows on a pro-rata basis. Part of the outstanding principal is paid monthly according to the amortization schedule of the individual mortgages. However, the principal can be prepaid without cost wholly or partially at any time before the maturity date of the security.

The usual initiators or originators of MBS are commercial banks, savings and loans companies, finance houses and primary mortgaged institutions.

The MBS originated may be unconventional which is backed by government or government guarantee or conventional which is not federally guaranteed or sponsored by any of its agencies.

In the US, MBS have become the main vehicles for securitizing all the different types of mortgage instruments which are available to home buyers. The federally guaranteed loans are guaranteed by the Government National Mortgage Association (GNMA) established in 1970. The mortgage pools deriving from the GNMA consist of Federal Housing Authority – insured loans and bear the full faith and credit of the US government. In other words, whether the mortgage payment is made or not, the security holder is guaranteed full and timely payment of principal and interest. The second major issuer of MBS is the Federal National Mortgage Association (FNMA) which was established in 1981 as a quasi- private corporation without government subsidy or subventions. Apart from holding loans which were purchased from the originations in its portfolio, it also securitises and sells mortgages. It pools mortgages from its purchases and issues MBS to initiators in exchange for pooled mortgages. Both the GNMA and FNMA guarantee the timely payment of principal and interest on all the securitizes that they issue.

6 With GNMA and FNMA, the US government has succeeded in expanding the volume of funds available for housing and urban development in America. This has resulted from its very active involvement and participation in the secondary market for mortgages.

VI. MORTGAGE-BACKED SECURITIES AND HOUSING FINANCE IN NIGERIA

Given the limited pool of funds available for housing finance and urban development in Nigeria, can MBS as financing vehicles come to the rescue? What role can government and housing finance associations play in expanding the pool of loanable funds for housing development in Nigeria.

Mortgage-backed securities as alternative housing finance options have proved to be very effective vehicles for expanding housing funding in other countries, especially in the US. It can and will work here in Nigeria. It would appear that too many Nigerians believe in acquiring property rather than creating assets. A property is not as useful as an asset in the sense that the latter is securitisable and expandable while the former is not. What needs to be done is to change the attitude of Nigerians to the value of assets through securitization. This is where the MBS proves its mettle. With the packaging and repackaging of housing loans, securitizing them and selling them as assets, the pool of funds is expandable several folds. The N36.7 billion investible funds available to the PMIS will increase dramatically and the gap between the demand for housing loans and its supply will narrow.

The FMBN can begin to actualize its new mandate of linking the housing sector to the capital market by taking the next step in creating government-backed or in its case government agency-sponsored GNMA mortgage-backed securities.

It can also facilitate the efforts of the Real Estate Development of Nigeria or similar, private sector organizations in originating FNMA-type mortgage- backed securities. All these are easily registrable with the regulatory authorities, including SEC if well organized and promoted.

This is not to say that there aren’t obstacles on the way. For one the primary and secondary mortgage markets remain relatively underdeveloped in Nigeria. Secondly, the capacity of our PMIS to absorb large funds and initiate large loans remains small due to their low capitalization. Thirdly, the regulatory environment for MBS is still unclear and must be addressed by the CBN and SEC.

7 Finally, the pricing of the MBS must be correctly done to attract investors and borrowers alike. These are not insurmountable problems. With the will and determination to succeed, the market for MBS will flourish in Nigeria. All it takes is a little daring and proactivity as economic development itself is an adventurous process.

8 REFERENCES

1. Bhattacharya, A.K, Frank J. Fabozzi and Esther Chang (2001) “Overview of the Mortgage Market” in The Handbook of Mortgage-Backed Securities; Frank J. Fabozzi (et) McGraw-Hill Book Company: NY. Pp 3-24

2. Central Bank of Nigeria (2003) Annual Report and Statement of accounts

3. Fabozzi, Frank J (2001) The Handbook of Mortgage-Backed Securities Ny: McGraw-Hill Book Company

4. Lowell, l (2001) “Mortgage Pass-Through Securities” in The Handbook of Mortgage-Backed Securities; NY: McGraw-Hill Book Company Pp 25-50

5. Rose, Peter S. (1983) Money and Capital Markets; Plano, Texas: Business Publications Inc.

6. Yakubu, Tanimu (2004) “N12 trillion needed to house Nigerians, mortgage review imperative” in The Guardian Monday November 1, Pp 35-37