Document of The World Bank FOR OFFICIAL USE ONLY Report No: RESTRUCTURING PAPER ON A PROPOSED PROJECT RESTRUCTURING OF TANZANIA - HOUSING FINANCE PROJECT PROJECT LOAN MARCH 9, 2010 TO THE UNITED REPUBLIC OF TANZANIA FEBRUARY 4, 2013 AFTFE This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. ABBREVIATIONS AND ACRONYMS BOT Bank of Tanzania CBA Commercial Bank of Africa CEMAC Economic and Monetary Community of Central Africa FA Financing Agreement HFP Housing Finance Project IBRD International Bank for Reconstruction and Development IDA International Development Association IFC International Finance Corporation MOF Ministry of Finance M&E Monitoring and Evaluation PA Project Agreement PDO Project Development Objective PML Participating Mortgage Lender PMU Project Management Unit UEMOA West African Economic and Monetary Union USD United State Dollars TMRC Tanzania Mortgage Refinancing Corporation TTL Task Team Leader TZS Tanzania Shillings WB World Bank Regional Vice President: Makhtar Diop Country Director: Philippe Dongier Sector Manager: Irina Astrakhan Task Team Leader: Nozomi Mizuno 2 TANZANIA TANZANIA - HOUSING FINANCE PROJECT CONTENTS Page A. SUMMARY ........................................................................................................................... 4 B. PROJECT STATUS .............................................................................................................. 4 C. PROPOSED CHANGES ...................................................................................................... 5 D. APPRAISAL SUMMARY.................................................................................................... 6 ANNEX 1: RESULTS FRAMEWORK AND MONITORING ................................................. 6 ANNEX 2: MONITORING AND MECHANISM NOTE .......................................................... 8 3 TANZANIA – Housing Finance Project RESTRUCTING PAPER A. SUMMARY 1. During implementation of the Housing Finance Project (HFP) the team found that the lack of long term funding combined with a very conservative banking sector was preventing the mortgage market from getting off the ground. Banks were reluctant to take on maturity mismatches even for limited periods. It had been anticipated that the creation of a long term funding vehicle, the Tanzania Mortgage Refinancing Company (TMRC)1 would help alleviate this, and encourage banks to start originating loans. However, because banks have to hold the loans on their books for a minimum of six month and they also need to build up a portfolio large enough to refinance through a single transaction, the banks still face some maturity risk which they are reluctant to take. Waiting for the market to grow organically could take years, so the option proposed below is to ‘kick start’ the market by providing some prefinancing to help build mortgage portfolios which can then be refinanced allowing banks to obtain further long term funds and continue building their portfolios. A prolonged delay in growing the mortgage market threatens the sustainability of TMRC as volumes needed to generate revenue sufficient to cover the operating cost will take time to be achieved. 2. In view of this, the government requested an amendment in Agreements of the project to allow TMRC to pre-finance as well as refinance mortgage portfolios from Primary Mortgage Lenders (PML). The need for pre-financing is to allow for an initial 'kick start' period to generate mortgage assets onto the balance sheets of the banks which can then be used as eligible assets for refinancing purposes. The funds provided under the refinancing can then be used to originate more loans and the cycle will be under way. This will require amendment to the Financing Agreement and the Project Agreement, as well as revising indicators in Monitoring & Evaluation (M&E) framework. B. PROJECT STATUS 3. The HFP Financing Agreement and Project Agreement were signed on March 31, 2010, and the project became effective on January 21, 2011. 1 TMRC is a legal limited liability company involved in the development and promotion of the mortgage finance market through the provision of liquidity to mortgage lenders and development of the local bond market. 4 4. The Project Development Objectives (PDO) of the HFP is to develop the housing mortgage finance market through the provision of medium and long-term liquidity to mortgage lenders. The HFP covers the following components; (i) Development of the Mortgage Market (ii) Development of Housing Microfinance (iii)Expansion of Affordable Housing Supply 5. The main element of the HFP is the provision of long term funds to the mortgage market through a mortgage liquidity facility. The TMRC was set up for this purpose with a USD 30 million line of credit from the World Bank. TMRC functions by providing long term loans to banks which are collateralized using high quality mortgage loans. However unlike securitization if the mortgage loans go into default they should be replaced with performing loans or other assets. TMRC currently has eleven2 share holder banks and refinanced USD 2.6 million. 6. The proposed restructuring was first discussed during the implementation support mission that took place in January 2012. The WB received a restructuring request letter from the Government in September 2012, and was discussed in detail during the last implementation support mission that took place between October 5-12, 2012. 7. This will be the first restructuring of the project. 8. The task team is aware of slow disbursement of the project and the fact that many targets are yet to be achieved. However, there are some extremely good reasons why the project has not been disbursing, why it has not yet achieved the targets and why the restructuring will help turn this around. 9. The project had six project effectiveness conditions to meet before the project can become effective, and after achieving effectiveness, it required a year of capacity building and training to make the first Mortgage Liquidity Facility in Sub-Saharan Africa a fully operational entity. This is because the HFP is ground-breaking as the first such project in Sub-Saharan Africa and is a model for other initiatives currently being discussed or actively in preparation in Nigeria, UEMOA, CEMAC, Kenya, Uganda and Rwanda. In addition, the restructuring has taken a great deal of time to process with many delays on the Tanzanian side. The process was begun 18 months ago, if it had been approved right away the project would most likely be close to fully disbursed by now. There is a pipeline of business awaiting this restructuring to be approved and once it is, disbursement should accelerate markedly. 10. Although the M&E framework will not reflect this (because they are designed to measure the final outcome), some valuable amount of work has been achieved in past 2 years. Several detailed studies have been conducted laying the ground for 2 CRDB Bank, AZANIA Bank, Tanzania Investment Bank, EXIM Bank, National Microfinance Bank, DCB Commercial Bank, National Insurance Corporation, ABC Bank, National Bank of Commerce, People’s Bank of Zanzibar, and Bank of Africa. 5 expansion of affordable housing supply and component 2 on housing microfinance. A hugely successful conference was organized in September 2012 by the Housing Finance Project PMU, and results on the ground were demonstrated to the 300+ participants by a site visit to new affordable housing priced at around $10,000 a unit. This is a direct consequence of the project and the restructuring of the National Housing Corporation which the project advocated and supported. Much more housing is being planned, financed through private sector mortgages. 11. The main blockage which the project is addressing is access to long term funds among lenders in Tanzania. This was always the main issue which the project aimed to tackle. Lenders in Tanzania tend to be very conservative and are unwilling to be exposed to a maturity mismatch by funding long term mortgage loans using short term deposits. The situation was more extreme than expected with lenders unwilling to fully commit to developing mortgage loan portfolios without receiving funding first to ensure they do not run into mismatch issues. Incidentally the new Basel III international framework on global regulatory standards for capital adequacy imposes much stricter norms on such maturity mismatches. Clearly Tanzania is some way off Basel III standards nevertheless, this project does provide an important tool towards better managing risks in the financial system and moving towards international best practice. 12. The proposed solution contained in this restructuring proposal is to provide ‘pre- financing’ as a kick-start measure for the mortgage market, enabling lenders to develop portfolio and build up the stock of mortgages to then be used as collateral in refinancing transactions. This would be supported by a strong program of capacity building and technical assistance which is planned during course of 2013. The task team, supported by AFTFE, strongly believes that the project restructuring will significantly improve the project implementation. Cancelling the operation at this stage would send a much wider signal to the continent as a whole about the World Bank’s willingness to support housing finance in Africa, and its willingness to take some risks and innovate with new structures. C. PROPOSED CHANGES 13. Proposal - To allow TMRC to pre-finance as well as refinance mortgage portfolios from Primary Mortgage Lenders (PMLs). This will be achieved by allowing TMRC to engage in providing loans collateralized by Treasury Bonds. The proposal will allow TMRC to carry out its business and provide the long term funds needed to get the mortgage market off the ground. As mortgage portfolios grow, it is expected that these will then be used as collateral in refinancing operations as originally intended. 14. Results/indicators - A proposed revised M&E Framework with new indicators and updated target figures are included in Annex 1. 15. Amendment of Financing Agreement and Project Agreement - The proposed restructure will involve amendment of following documents to allow use of the 6 proceeds of the credit is not limited to refinancing, and that to allow Treasury bonds as eligible collateral in refinancing operations disbursing IDA funds:  Financing Agreement; and  Project Agreement. 16. In addition to the above mentioned documents (para.9), the proposed restructuring will involve amendment of the following documents: Sub-financing agreement between the Bank of Tanzania (BOT) and TMRC; Operations Manual adopted by the BOT; Model Participation Agreement between the TMRC and Participating Mortgage Lenders (PMLs). 17. This restructuring will not involve any change in PDO, institutional arrangement, safeguards, reallocation of funds, cancellations of funds, financial management, procurement, closing date, and implementation schedule. 18. This will be the first restructuring of the project. 19. Rationale for the Proposed Restructuring – During implementation of the HFP the team found that the lack of long term funding combined with a very conservative banking sector was preventing the mortgage market from getting off the ground. Banks were reluctant to take on maturity mismatches even for limited periods. It had been anticipated that the creation of a long term funding vehicle, the TMRC, would help alleviate this, and encourage banks to start originating loans. However, because banks have to hold the loans on their books for a minimum of six month and they also need to build up a portfolio large enough to refinance through a single transaction, the banks still face some maturity risk which they are reluctant to take. Waiting for the market to grow organically could take years, so the option proposed in this restructuring paper is to ‘kick start’ the market by providing some prefinancing to help build mortgage portfolios which can then be refinanced allowing banks to obtain further long term funds and continue building their portfolios. A prolonged delay in growing the mortgage market threatens the sustainability of TMRC as volumes needed to generate revenue sufficient to cover the operating cost will take time to be achieved. Aside from the natural conservatism, there are two further constraints on banks originating mortgages and taking on the maturity mismatch:  a minimum 6 month seasoning period is required before loans qualify as eligible collateral for refinancing purposes. The first six months of a loan are often the riskiest, as this is when the loan to value is at its highest and when it becomes clear if loan underwriting has been done correctly and the borrower is able to manage the monthly repayments. This would also be the period during which it would become apparent when any fraud may have been committed. So the 6 month seasoning period is essential in terms of protecting the refinanced loans by ensuring the high quality of the collateral. 7  a minimum portfolio size is required before a refinance transaction can be entered into. Typically banks would be able to access 'warehouse' financing to enable them to build up a loan portfolio and meet the seasoning requirements. Given that the refinancing takes place on a deal by deal basis, a minimum portfolio of probably at least 100 loans is required to make the transaction economically viable. This will lengthen the period during which a mismatch has to be carried. In developed financial systems, specialist financing is available during this period and banks are able to run Commercial Paper programs, in Tanzania the banks will be much more reliant on their own very limited capital resources. 20. The combination of the factors above have meant that despite demand for mortgage finance, the market has not started up as expected, as banks are unable or unwilling to take the maturity mismatch risks between origination and refinancing. It has also been realized if TMRC waits for the creation of mortgage portfolio; it will significantly delay the development of mortgage market in Tanzania. The delay also threatens the sustainability of TMRC as volumes needed to generate revenue sufficient to cover the operating cost will take time to be achieved3 . This market issue has become a bottleneck in achieving the project’s objectives within the time frame. 21. Other Options considered - Several Other options have been considered towards ensuring the sustainability of TMRC and some of these will be followed alongside this proposal. One of the key ways of achieving this, is raising sufficient capital to generate returns which can cover its running costs and stop capital depletion. These include:  Recruiting more banks as shareholders in TMRC – There are currently 10 shareholders and all of the large banks are included. The one missing member who is also the mortgage market leader is the Commercial Bank of Africa (CBA). It is hoped that they will be able to join soon.  Raising further funds from existing shareholders – This is being considered and may be possible. It would however not resolve problem of slow growth in the mortgage market.  External Shareholders – Organizations such as IFC or Shelter Afrique may be able to join as shareholders of TMRC. This is under consideration, but is clearly a decision which is independent of the project.  TMRC to issue bonds – If TMRC were to raise its own funds it would not be subject to the requirements of the Financing Agreement for those funds. It could therefore provide loans secured by Treasury bonds fully in accordance with Bank of Tanzania regulations. However, to issue bonds it needs to be fully operational and already have a portfolio of refinancing activities. It is a realistic option in years 2 or 3 of TMRC but at present it is reliant on World Bank debt. 3 The resultant losses will continue eroding TMRC's capital which is currently TZS 8.9 billion. 8 D. APPRAISAL SUMMARY Economic Analysis: 22. The proposed restructuring will have a noticeable impact in terms of speeding up the growth of mortgage market and have a far reaching impact on the financial services sector as a whole. It will also have a catalytic effect on other related sectors of the economy such as construction industry, furniture, appliances, etc. The expansion mortgage market translates into the expansion of housing construction. Housing construction has a direct impact on the overall economy as it creates employment and generates more tax revenues for the government. 23. Although it is not easy to quantify the economic impact specifically for these types of initiatives, a simple economic analysis can assist in illustrating the potential benefit. This analysis measures the impact of pre-financing to the Gross Domestic Product (GDP). The table 1 below illustrates the anticipated increase in GDP in 2013 due to the additional USD 15 million (TZS 24 billion) mortgage debt outstanding as a result of pre-financing: Table 1 2012 2013 Mortgage Debt to GDP ratio* 0.28% 0.34% *Based on mortgage and GDP data reported to Bank of Tanzania Financial Analysis: 24. TMRC has eleven members and only one has a portfolio of mortgages qualifying for refinancing. Given the size of that bank and its portfolio, TMRC has very limited business to conduct in the first few years of its operation, as it takes time for member banks to develop mortgage products and grow sufficient portfolios for refinancing; Using refinancing, only USD 2.6 million (TZS 4.2 billion) has been utilized by the same bank (Azania Bank). 25. With pre-financing, more member banks will borrow from TMRC. Pre-financing arrangement should also attract more banks to join TMRC and therefore increase TMRC capital. Using TMRC pre-financing projections for 2013, the table 2 below shows the anticipated financial impact in terms of number of mortgage loans and amounts: Table 2 9 Refinance Pre-finance (2012 (2013 Actual) Projection) Amount (TZS) 4.2 Billion 24 Billion Number of loans 95 542 Average loan size (TZS) 44,210,526 44,210,526 Market Risk and Mitigation measures: 26. The key underlying risk with pre-financing is the potential for banks using the funds for other purposes rather than mortgage lending. This risk is mitigated by the well thought out proposed monitoring mechanism that has been developed specifically for the pre-financing window4. The monitoring mechanism also provide for specific penalties for any failure to comply. It also provides for specific expectations on the rate of security conversion from Treasury bond to mortgage loans. In addition to the pre-financing monitoring mechanism, there are monthly reporting requirements as well as periodic on-site visits that are part of the risk management structure that is already in place at TMRC. 4 Monitoring mechanism note is attached as Annex 2. 10 ANNEX 1: Results Framework and Monitoring Project Development Objective (PDO): To develop the housing mortgage finance market through the provision of medium and long-term liquidity to mortgage lenders. Revised Project Development Objective: No Change D=Dropped Cumulative Target Values** C=Continue N= New Core PDO Level Results R=Revised Unit of Baseline YR 1 YR 2 YR 3 YR4 Data Source/ Responsibility for Frequency Indicators* Measure March 2010 March March March March Methodology Data Collection 2011 2012 2013 2014 Indicator One: C # of 0 100 130 200 600 Monthly TMRC BOT A1. Total number of housing loans finance loans provided5 - Refinanced Housing Mortgage Loans A2. Total number of housing N # of 0 0 0 100 250 Monthly TMRC BOT loans provided - Pre-financed loans Housing Mortgage Loans A3. Total number of housing C # of 462 1000 1200 1800 2000 Monthly BOT BOT loans provided – Housing loans Microfinance Loans Indicator Two: C % 0.45% 0.47% 0.30% 0.40% 0.45% Bi-annual BOT BOT B. Mortgage debt 5 Mortgage Loans which benefited from pre-financing and were then subsequently refinanced should only be counted once. Double counting shall be avoided by way of method/formula to be set forth in the Operational Manual. outstanding/GDP Indicator Three: C % 18-21% Up to 18% Up to18% Up to 16% Up to15% Bi-annual BOT BOT C. Mortgage interest rate (%) INTERMEDIATE RESULTS Intermediate Result (Component One): To improve access to long-term housing mortgage finance, progressively mobilized through the domestic capital market Revised Intermediate Result (Component One): No Change Intermediate Result indicator C # of FIs 0 0 2 3 7 Bi-annual TMRC BOT One: Number of financial institutions refinanced by TMRC Intermediate Result indicator N # of FIs 0 0 0 3 6 Bi-annual TMRC BOT Two: Number of financial institutions pre-financed by TMRC Intermediate Result indicator C TZS 0 16 billion 17 billion 20 billion 25 billion Bi-annual TMRC BOT Three: Outstanding volume of loans refinanced6 by the TMRC (TZS) Intermediate Result indicator N TZS 0 0 0 10 billion 15 billion Bi-annual TMRC BOT Four: Outstanding volume of loans pre-financed by the TMRC (TZS) Intermediate Result (Component Two): To develop access to medium-term affordable housing microfinance Revised Intermediate Result (Component Two): No Change 6 Mortgage Loans which benefited from pre-financing and were then subsequently refinanced should only be counted once 12 Intermediate Result indicator C # FIs 4 4 4 6 8 Bi-annual BOT BOT One: Number of credit institution providing housing microfinance loans Intermediate Result indicator C TZS 354 million 700 million 730 million 1.0 billion 1.5 billion Bi-annual BOT BOT Two: Volume of housing microfinance loans outstanding (TZS) Intermediate Result indicator C # of loans 0 0 0 0 1000 Bi-annual BOT BOT Three: Number of housing microfinance loans extended by HMFF Intermediate Result (Component One): To Revised Intermediate Result (Component One): No Change Intermediate Result indicator C # of units 3000 3000 3000 4000 5500 Bi-annual MLHSD BOT One: Number of new housing units approved for construction7 7 This includes the number of permits issued in the following major urban centers: Mwanza, Tanga, Arusha, Dodoma, Morogoro and Dar es Salaam. The baseline figure of 3000 is based on data collected for 2008 and 2009: in 2008, the number of units approved was 3463, and in 2009, it was 2201 for the period January-August. 13 ANNEX 2: Monitoring Mechanism Note _______________________________________________________________________ Proposed short term lending on Secured Basis to allow for Inception of Mortgages: Procedure to be followed in sanctioning and monitoring loans issued to member banks on a pre-financing basis to enable banks accessing TMRC loans in originating mortgage loans. 1. Eligibility: a) All member banks, who have committed to exclusively use funds to originate new mortgages through loan application letter. Expected mortgage conversion ratei is 33% year 1, 66% by the end of year 2, and full amount of loan by the end of year 3. b) Evidence of mortgage lending business strategy including projected mortgage book, product policy, and operational policy. 2. Loan Amount: A maximum of 50% of PML’s approved credit limit, provided that total TMRC portfolio originated on such a “pre-financing� arrangement does not exceed an equivalent of USD 15 million (fifteen million) 3. Loan Term: a) Short-term basis to maximum term of three years with option of rollover into medium to long term upon PML replacing collateral with mortgage portfolio. b) In the event that, the PML fails to issue sufficient loans or issue loans which are not qualified for refinancing, Expired Loan will not be rolled over and the PML shall be required to repay back forthwith. In any event the full amount advanced shall be required to be converted into refinancing line at the end of three year period. 4. Primary Collateral: 95% of Government Securities (Treasury bonds) with remaining maturities of more than 3 years. 5. Collateral replacement: PMLs may submit portfolios meeting conditions for normal refinancing for credit review and sanction, on an annual basis, or whenever the member bank consider to have qualifying mortgage portfolio. TMRC shall release Treasury Bonds relative to the size of accepted portfolio and replace them with submitted mortgage portfolio accordingly. 6. Affirmation: a) PMLs shall provide TMRC and BoT on quarterly basis with the report on the number and amount of loans outstanding. TMRC shall monitor the rate of conversion compared to the commitment signed prior to borrowing funds from TMRC. 7. On site monitoring: TMRC shall conduct quarterly site visits to borrowing PMLs and a report shall be filed with BoT/PMU. PMU shall reserve the right to do a full review if they so decide. No additional loan shall be extended to any bank lagging behind pre agreed conversion rate. 8. Penalties: a) PMLs failing to convert at least 33% at the expiration of the first year or 66% at the expiration of the second year or any amount at the expiration of the third year shall be given notice of re-calling the loan. b) A penalty of 2% over and above the PMLs weighted average interbank borrowing rate over three years shall be levied on the amount called back as penalty. Amount un 3 yrs PML’s applied to 2% Penalty = X( average + mortgage loans Premium) interbank rate at loan maturity c) Failure to pay the penalty will be regarded as default and the member bank shall be locked out from participating in borrowing until such time when the default is corrected. TMRC shall notify BOT of the default by the member bank. 15 All sections of the credit policy will be applicable for loans being replaced with Treasury Bonds onward until the loan’s expiration. i Percentage of loan that must be converted into refinancing loans, thereby replacing collateral of Treasury’s Bonds with usual mortgage portfolio. 16