Rating Action: Moody's assigns first time ratings to Saudi Real Estate Refinance CompanyGlobal Credit Research - 19 Apr 2021Limassol, April 19, 2021 -- Moody's Investors Service ("Moody's") has today assigned first time issuer ratings to Saudi Real Estate Refinance Company (SRC) of A2/P-1. At the same time, the rating agency assigned Aa2.sa/SA-1 national scale issuer ratings for SRC. The outlook assigned to SRC is negative, in line with the negative outlook assigned to the government of Saudi Arabia's issuer rating (A1 negative), the support provider.The Saudi Real Estate Refinance Company was established in 2017 to develop the Saudi housing finance market by enabling originators to offer home buyers long-term and short-term financing solutions. SRC is solely owned by the Saudi government through the Public Investment Fund (PIF, Saudi sovereign wealth fund) and is licensed to operate in the secondary real estate market by the Saudi Central Bank, formerly known as Saudi Arabian Monetary Authority (SAMA).Moody's regards SRC as a government-related issuer (GRI) and applies the Government-Related Issuers Methodology to arrive at the company's issuer ratings and the Finance Companies Methodology to arrive at SRC's standalone BCA.The A2 long-term issuer ratings assigned to SRC are four notches above its baa3 Baseline Credit Assessment (BCA), reflecting Moody's expectation of high probability of government support based on SRC's 100% government ownership and its important policy mandate of increasing home ownership among Saudi nationals. The credit support mechanism the company has from the government which guarantees certain sukuk issuances, is also a key factor in Moody's expectation of high probability of support as it signifies the importance of SRC and the role it plays for the Saudi government. SRC's baa3 BCA reflects the company's solid asset quality and strong capitalisation which are moderated by a still evolving profitability profile, high reliance on wholesale funding, concentrated exposure to the relatively new mortgage market in Saudi Arabia and low levels of liquidity.A list of affected ratings can be found at the end of this press release.RATINGS RATIONALERATIONALE FOR BCASOLID ASSET QUALITY MODERATED BY RAPID GROWTH AND PRODUCT CONCENTRATIONMoody's expects SRC to maintain solid asset quality, supported by the resilient performance of the mortgage market in Saudi. The company's non-performing financing remains low at 0.3% as at September 2020. SRC acquires home finance contracts (mortgages) from finance companies and banks in Saudi Arabia through its purchase without recourse (PWOR) mechanism. Through this mechanism, SRC assumes the credit risk of the borrower with the property contract assigned to SRC. The bank or the finance company acts as the servicing agent for SRC and continues to automatically deduct the monthly instalments from clients' accounts. Most of the home finance borrowers in Saudi Arabia are government employees where job stability is fairly high and hence the agency expects the performance of the market to be resilient despite the impact of the pandemic on the operating environment.SRC's other credit exposure comes from its short-term funding facilities extended to finance companies. These facilities enable finance companies to originate new home finance contracts which can also be acquired by SRC following the conclusion of a minimum seasoning period. The company has set concentration limits for these facilities linked to the finance companies' risk classification.SRC's solid asset quality is moderated by the company's product concentration and rapid growth which exceeded 60% annually on average since its inception in 2017. The company's activity is largely reliant on the performance of a single product, this being mortgages. In addition, given it is a relatively new company starting from a low base, Moody's expects the growth in assets going forward to remain very high which may put the company's operational and risk capacity under pressure.STRONG ALBEIT MODERATING CAPITALISATIONSRC's capitalisation is strong with a tangible common equity / tangible managed assets ratio of 24% as at September 2020. The company has secure access to capital through the public investment fund (PIF, sole shareholder and sovereign wealth fund of Saudi) which has plans to increase the company's capitalisation more than threefold from its current SAR 1.5 billion paid up capital. However, despite the current strong capitalisation and the plan to increase paid up capital, Moody's expects that the company's aggressive asset growth plans will moderate capitalisation as it builds up its portfolio. Nonetheless, the agency still expects the company's capitalisation to remain strong and further supported by a strong shareholder in case of a need.PROFITABILITY STILL WEAK BUT SET TO IMPROVESRC moved into profitability in the first nine months of 2020, as measured by its net income / average managed assets of 0.4%, compared to a loss of 1.0% as at December 2019. The company's financial performance benefited from the significant increase in its financing portfolio which jumped to about SAR 6 billion as at September 2020 up from SAR 2.2 billion in December 2019. Whilst the company's weak profitability largely reflects its new franchise, Moody's expect SRC's earning power to improve and stabilise as it increases its leverage.SRC has an efficient cost structure since they do not require branches to conduct business and their single line of business requires less operational investment. Despite the agency's expectation of continued increase in operating expenses resulting from SRC's ongoing franchise build up, Moody's anticipates that the improvement in earning power will lead to further improvement in the company's cost to income ratio, which stood at 77% as at September 2020 compared to 168% in December 2019.SRC's current healthy profit margin of 3.3% (analogous to the net interest margin) as at September 2020 is largely due to the company's low leverage and the utilisation of short-term banking facilities and capital to fund its asset acquisition. Moody's however expects this margin to come under severe pressure as the company increases its leverage and start matching the asset duration through long-term funding.FUNDING AND LIQUIDITY RISKS PRESSURE SRC'S FINANCIAL PROFILEAs a non-depository institution, SRC relies solely on confidence-sensitive sukuk and short-term facilities for funding. The company also maintains low liquidity, as the proportion of liquid assets to total assets was only 1% as of September 2020. The risk of SRC's current funding and liquidity profile is further exacerbated by the lack of track record of adequate management of the company's asset and liability mismatch due to its fairly short history.Reliance on wholesale funding and low liquidity levels are risks common to the majority of the mortgages refinance companies and are not specific to SRC. To partially mitigate the risk, the company has adequate committed liquidity facilities in place from highly rated banks which it mostly uses to bridge the financing gap between the time it facilitates the acquisition of a portfolio and the time its matches the funding duration through the long term sukuk issuances. SRC has also credit support mechanism from the government whereby the latter will provide an unconditional and irrevocable guarantee for specific issuances by SRC which will reduce funding costs and ease market access.RATIONALE FOR LONG-TERM ISSUER RATINGSRC's A2 long-term issuer rating incorporates four notches of uplift from its baa3 BCA. This is based on Moody's assessment of a high probability of support from the government in case of need, which reflects (1) the government's strong capacity to support, (2) SRC's important policy role of increasing home ownership among Saudi nationals, (3) SRC's 100% government ownership through PIF (4) past evidence of systemic support in the system, and (5) the credit support mechanism from the government also signifies the importance of SRC for the Saudi government and is a key factor in assigning high probability of support.OPERATING ENVIRONMENTMoody's assigns a Baa2 Operating Environment score to SRC, which incorporates a Macro-Level Indicator score of A3 and an Industry Risk score of Baa. The Macro-Level Indicator score of A3 reflects Saudi's large size economy, high per-capita income and large hydrocarbon endowment. The score also reflects the country's strong policy credibility and improved performance in government effectiveness and control of corruption. Persistent regional geopolitical tensions moderate Saudi's Macro-Level Indicator score. The Industry Risk score of Baa reflects the stability of the mortgage market, which is underpinned by steady employment levels, effective regulatory oversight by the central bank and the prudent underwriting standards among banks and finance companies, as well as the high barriers to entry. Ongoing initiatives by the government to boost homeownership will also help drive long-term growth in the mortgage market.ENVIRONMENTAL SOCIAL AND GOVERNANCE CONSIDERATIONSThe global finance companies sector has been classified as "Low" risk in our E heatmap . In line with our general view for finance companies, SRC has a low exposure to environmental risks. However, given the sizeable contribution of the hydrocarbon industry to the economy, SRC's indirect exposure to the hydrocarbon sector may increase its vulnerability to environmental risks. The finance companies sector has been classified as "Moderate" risk in our S heatmap . The most relevant social risks for finance companies arise from the way they interact with their customers. Social risks are particularly high in the area of data security and customer privacy which is partly mitigated by sizeable technology investments and long track record of handling sensitive client data. Governance is highly relevant for SRC, as it is to all participants in the finance industry. Corporate governance weaknesses can lead to a deterioration in a company's credit quality, while governance strengths can benefit its credit profile.RATIONALE FOR NATIONAL SCALE RATINGSRC's Aa2.sa/SA-1 national scale issuer ratings are underpinned by the company's global scale long-term issuer rating of A2, which in turn reflects a standalone BCA of baa3 and four notches of government support uplift. The Aa2.sa is the higher of two NSR categories corresponding to SRC's global scale issuer rating.NEGATIVE OUTLOOKThe negative outlook on SRC mirrors the negative outlook on the Saudi Government's issuer rating, the support provider.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSGiven the Negative outlook, there is no upward pressure on SRC's issuer ratings. Moody's may stabilise the issuer ratings if the outlook on the support provider was changed to stable from negative, and the company's financial profile remains robust.Downward pressure on the SRC's issuer ratings could materialise if (1) Moody's downgrades the Saudi government's sovereign rating; (2) severe losses on SRC's mortgage portfolio erode a significant portion of its capital; and/or (3) the company could not adequately manage its asset and liability mismatch leading to heightened liquidity and market risks.LIST OF AFFECTED RATINGS..Issuer: Saudi Real Estate Refinance CompanyAssignments:....Long-term Issuer Ratings, Assigned A2....Short-term Issuer Ratings, Assigned P-1....NSR Short-term Issuer Ratings, Assigned SA-1.... NSR Long-term Issuer Ratings, Assigned Aa2.saOutlook Actions:....Outlook, Assigned NegativePRINCIPAL METHODOLOGYThe methodologies used in these ratings were Government-Related Issuers Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1186207, and Finance Companies Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187099. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.Moody's National Scale Credit Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale credit ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".za" for South Africa. For further information on Moody's approach to national scale credit ratings, please refer to Moody's Credit rating Methodology published in May 2016 entitled "Mapping National Scale Ratings from Global Scale Ratings". While NSRs have no inherent absolute meaning in terms of default risk or expected loss, a historical probability of default consistent with a given NSR can be inferred from the GSR to which it maps back at that particular point in time. For information on the historical default rates associated with different global scale rating categories over different investment horizons, please see https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1216309.The local market analyst for this rating is Ashraf Madani, +971 (423) 795-42.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.REFERENCES/CITATIONS https://www.moodys.com/research/-PBC_1135665 https://www.moodys.com/research/-PBC_1132742Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Christos Theofilou, CFA Vice President - Senior Analyst Financial Institutions Group Moody's Investors Service Cyprus Ltd. Porto Bello Building 1, Siafi Street, 3042 Limassol PO Box 53205 Limassol CY 3301 Cyprus JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Sean Marion MD - Financial Institutions Financial Institutions Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Cyprus Ltd. 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