A long-awaited mortgage law is about to come into force in Saudi Arabia, but it will be several years before its full impact becomes clear. Published in Euromoney, October 2012
There have been plenty of false dawns before, but Saudi Arabia is at last about to get a mortgage law, after almost 10 years of discussion. In early July, the Council of Ministers announced that the draft law had been approved, starting a process that should bring it into force by October.
For the country’s banks it opens up a large new area of business. There is certainly substantial pent-up demand for housing finance in Saudi Arabia, but the willingness of banks to lend to consumers has yet to be properly tested, as has the interest of developers in turning away from luxury developments and towards more affordable housing.
The cautious nature of banks and regulators in Saudi Arabia, and the conservative nature of the country as a whole, means that a slow evolution of the market seems more likely than rapid transformation. Even so, some industry figures think the new law could have a big impact.
"This is a major and potentially transformative piece of legislation," says Jarmo Kotilaine, chief economist at National Commercial Bank. "It creates the potential to offer mortgages to a far broader range of clients. It will create the incentive for developers to provide housing for the middle-income segment, and that will begin to transform the housing market in Saudi Arabia."
There is little doubt that change is needed. James Reeve, a senior economist at Samba Financial Group, estimates that there is a deficit of about a million housing units in the Saudi market, and the figure is growing by 200,000 units a year.
"The ultimate sticking point at the moment is affordability," he says. "The average income in Saudi Arabia is around $30,000 a year, which, by most metrics, means you can’t afford to buy much more than an apartment. It seems that most Saudis aspire to own a villa and, until expectations are adjusted, there’s going to be a lot of unfilled demand."
How quickly the new mortgage law might change the housing market hinges on its precise wording, which has yet to be published. What is known is that the law is a collection of five different regulations, which together create a comprehensive regulatory framework. The measures include a codification of the rights and obligations of lenders and borrowers, including new rules dealing with the repossession of property. The registry of titles is also to be made more systematic, which will give greater confidence about legal ownership of a property. The law will also allow for the operation of stand-alone real estate leasing companies and securitization.
Perhaps the most important element, in terms of encouraging the development of mortgage finance, is the right for finance firms to repossess a property if a borrower defaults. It will take a few cases to work their way through the system before banks will be able to have total confidence in the enforcement system.
"Real strides will be made once the mortgage law, its regulations and the judicial process with respect to foreclosure and repossession have been tested and challenged. This will take at least two to three years," says Naveed Siddiqui, chief executive of Capitas Group International, a local Shariah-compliant real estate consultant.
It is likely to be several years before some other elements of the mortgage law start to play an important role too, including the provision for securitization. The ample liquidity in the Saudi banking system means that this option is unlikely to be used by banks soon. Once the market reaches its full potential that could change, however.
"As and when the market grows there will be opportunities for securitization and moving the debts off the banks’ books," says Kotilaine. "This law creates the mechanism for that, but there is no immediate need for it. Banks are flush with cash and can still fund mortgages from deposits, so it could be two or three years before securitization happens."
In anticipation of the new law, some banks have already begun to dip their toes in the water. Their current inability to repossess properties has meant that they have been willing to lend only to those with the best possible credit ratings, but it is a start nonetheless. Bank lending for home purchases is running at around 1% to 2% of GDP, according to Capitas. That compares with around 30% in Malaysia and 50% or more in many European markets.
"All the big banks are providing mortgages," adds Shahid Kazi, general manager of JAJ Consultants, a Dubai-based real estate advisory firm. "Financial institutions have taken the view that they’re willing to take risks because the level of default in the economy is so low. The only big thing was that if somebody defaulted, they wouldn’t be able to repossess the property, which limited their ability to finance beyond a certain level."
The government has also been providing some home financing, through the Real Estate Development Fund, which offers subsidized loans to people wanting to build homes. So far this year it has approved three tranches of loans, in January, April and June. Together they cover almost 35,000 loans to build 42,000 housing units and were worth a total of SR17.3 billion ($4.6 billion).
Once the new law comes into force the key question will be how quickly banks will be willing to ramp up their lending. For the moment, they are keeping their plans to themselves. Ibrahim Abomouti, a spokesman for local bank SABB, describes the mortgage law as "very significant" but declines to say how his bank might react. "Naturally, SABB will look closely at such details before we consider any changes to our product offering," he says.
Most observers expect only a gradual rise in loans. In a note issued in July, Fitch Ratings suggested that the mortgage law would improve housing supply and social stability, as well as provide diversification for the banking sector, but the gains will not be instant.
"Most banks are likely to be cautious in their approach to mortgages because it is unclear exactly how the foreclosure process will work," the ratings agency said. "Furthermore, they are funded through short-term deposits, which limit the amount of long-term lending they will want to undertake. The funding mismatch is not an immediate problem because short-term deposits tend to stay at banks for long periods. But banks are likely to search out longer-term funding before building up large mortgage portfolios."
Some, however, suggest that the banks will be far more active.
"Banks that have been on the sidelines are going to come in aggressively. There’s going to be a race to number one," predicts Shahid Umerani, chief executive officer of JAJ Consultants. "The banks have the appetite. Some banks have already been providing mortgages on an ad hoc basis. They’ve been building up their mortgage books. They have the clientele."
Whether the market booms or merely grows gradually, the country’s leading retail banks, such as Al Rahji Bank, Samba and SABB, are expected to dominate, at least in the short term. However, there should be some opportunities for others too.
Insurance and real estate agents should also benefit, and specialist mortgage finance companies might flourish. Some are already active in the market, such as Amlak International, which has offices in Riyadh, Jeddah and Dammam. Others are sizing up the opportunity. Local investment bank Sidra Capital, for example, has said that it plans to set up a housing finance company with SR1 billion in capital.
"We expect all the kingdom’s banks to remain active after the law is enacted," says Siddiqui. "In the mid to long term, however, we expect that banks will play more of a liquidity role and focus their activity on secondary market transactions, allowing specialized mortgage financing companies to lead origination and manage the long-term client relationships."
Another, bigger question is whether or not the mortgage law has a wider significance for the country, and if it is part of a concerted effort by the authorities in Riyadh to modernize the economy. There have been contradictory signs around this, with the plans to open the Saudi stock exchange (Tadawul) to international investors losing momentum this year, for example.
Given those conflicting trends, it is perhaps more revealing to view the mortgage law in a political rather than an economic context and as part of the government’s attempts to address the economic pressures of local Saudis, lest they decide to follow the lead of their peers in countries such as Egypt or Bahrain.
There have been persistent protests in the Shia-dominated eastern province of Saudi Arabia over recent years, where locals have been voicing their discontent at their position in a country dominated by the Sunni majority. In other parts of the country, protests have been far less common, but the fear of them might be influencing the policy decisions.
The death of Crown Prince Nayef in June has given some hope to those in favour of reform that the process can continue and perhaps accelerate. However, his replacement, the 76-year-old Prince Salman, is from the same generation and it is not clear how much appetite there is for greater reforms among the ruling elite, either within King Abdullah’s inner circle or beyond.
"I don’t think the going away of one crown prince or another has too much influence on these things because there is a whole set-up of people who run things behind the scenes," says one observer.
For all the political motivations and the potential long-term gains in addressing the country’s misfiring housing market, there are short-term risks to the mortgage law too. The influx of buyers is liable to push prices up even higher and even if developers quickly alter their habits there will inevitably be a time lag before new, more affordable properties reach the market.
"At the moment most of the development that is going on is at the higher end of the market," says Reeve. "There isn’t sufficient incentive for developers to come in at the middle and lower end of the market because, effectively, there isn’t any demand there as people are unable to get mortgages. So until you release demand you’re not going to get supply. It’s too early to say if it will prompt developers to change their approach, but it should do."
The government itself has been attempting to boost the supply of housing to the lower ends of the market. The most eye-catching announcement came in March 2011 as part of a series of decrees issued by King Abdullah at a time when governments around the region were scrambling to deal with the consequences of the Arab Spring.
Along with pay rises and bonuses to government employees, King Abdullah pledged that the government would spend SR250 billion on building 500,000 residential units across the country in an initiative to be managed by the General Commission for Housing. He also raised the maximum amount of interest-free loans issued by the Real Estate Development Fund from SR300,000 to SR500,000 a person.
Such measures will no doubt help the construction sector in Saudi Arabia and might help to deal with the housing shortage. However, they will not solve the housing problem entirely, nor will the mortgage law itself.
One issue that will continue to cause problems is the level of unemployment. Labour force participation was just 36% in 2009, according to the IMF, but the figure is lower among young men and for women of all ages. Given that mortgage contracts are likely to involve a direct payment from a borrower’s salary, it will mean that a large proportion of the Saudi population will be excluded from the mortgage market.
There are also tight restrictions on the percentage of a salary that anyone can borrow. Saudi Arabia has the most stringent regime in the Gulf in this respect, allowing just 33% of net monthly salary for personal loans and credit cards. Any personal loan has a maximum tenor of five years.
Other countries in the Gulf set the borrowing limit higher. In Kuwait it is 40% of net salary, for example, while in the UAE and Bahrain it is 50% of gross salary. The Saudi authorities are expected to set a higher limit for housing loans as part of their mortgage law reforms, but it is not clear how much they will be willing to relax them. Such issues mean that, while the mortgage law is being widely welcomed, it is by no means a complete solution.
"Mortgages can increase access to housing, but they can never bring universal access to housing," says Kotilaine.