Caution ahead of final rollout for Saudi Arabia's mortgage law

As Saudi Arabia gets ready to launch its long-awaited mortgage law, banks are keeping a close eye on a crucial part of the legislation that involves repossession if the borrower defaults. Published in MEED, 3 July 2013

A mortgage law is edging closer to reality in Saudi Arabia after more than a decade in the planning. The law was finally approved in July last year by the Council of Ministers and three of the five sets of regulations have now been published. The remaining two are expected to follow before long.

But putting a legal system in place is only one of the prerequisites before the home loans market can really take off. A number of other issues have to be tested before it can be considered a success, including how those laws are interpreted by the courts. As a result, the prevailing mood among bankers and other industry professionals in the country appears to be one of caution for now.

Enforcement key

The three laws in the public domain cover real estate financing, financial leasing and the supervision of financial companies, all of which were published by the central bank, the Saudi Arabian Monetary Agency (Sama), in late February. The country’s commercial banks appear to be largely happy with the regulations so far, but the details of the remaining two pieces of legislation, covering mortgage registrations and the enforcement of foreclosures, will be critical in ensuring that a workable system is being put in place.

In particular, the issue of repossession is a make-or-break one for the sector and the regulations on that point will be studied very closely by banks once they are released. “The mortgage law is a very positive development, but it is hard to tell what impact it will have. Enforcement will be the litmus test,” says a senior executive at one local bank.

It is the concerns that banks have had around the security of their loans and their ability to regain control of a property if the borrower defaults that have prevented the mortgage market in Saudi Arabia from developing properly before now. Without the certainty that they could repossess a property if necessary, banks have tended to be very wary about how much they lend and to whom. That historic caution is matched by the scepticism that many have about how effective any new measures on foreclosure will prove to be and whether the courts will side with banks or with late-paying customers.

Some think that no matter what the law says, the courts will simply not be willing to turn people out onto the streets just because they have failed to keep up with their repayment plan. “The courts wouldn’t like the idea of foreclosure at all, so you’re not meant to fail to pay,” says one local lawyer.

It will probably require at least one test case going through the courts and finding in favour of a bank before lenders feel able to really commit themselves to the market.

“In emerging markets, the key trigger for a mortgage market explosion tends to come in the form of a successful foreclosure,” says one banking analyst in Riyadh. “If the banks become comfortable that the regulations have been tested and upheld it will be a big confidence booster for them. But until that time, a large number of banks will remain very selective about whom they will lend to on the mortgage side.”

Even if the courts do prove amenable to the banks on this point, some lenders in Riyadh say they simply will not build up a mortgage business based around a need for repossessions. “Banks are in the business of taking risk and any market will have corporate and retail credit issues from time to time,” says another executive. “It is not possible to have a banking model without credit risk. However, as long as risk management procedures are robust, such losses are manageable.”

Mortgage funding

A second big issue that needs to be overcome is the funding of the mortgages. Saudi banks are generally well capitalised and have an ample and cheap source of funding in the shape of customer deposits on which they often pay no interest. But they will need to find a way to bridge the gap between the short-term nature of those deposits on the one hand and the long-term nature of mortgage lending on the other.

One solution is to develop a securitisation market. This would allow banks to sell their loan books on to other investors, thus enabling them to make more loans to more home-buyers. A securitisation system is covered by the new mortgage law and investment banks in Riyadh are looking closely at the opportunities in this area, seeing it as one of the main areas of potential in the coming years. Even so, it will take time for a system to get up and running.

“If banks can originate home loans, package them into a security and sell them to investors to free up their balance sheet for more home loans, that will be a very valuable proposition for the development of the capital markets and home loan finance,” says David Dew, chief executive of Sabb, the local affiliate of HSBC.

There are also longer-term issues that could give some banks pause for thought. At the moment, interest rates are very low in the Saudi market, which makes borrowing to buy a home an attractive proposition. However, those rates will inevitably start to go up at some point in the future, which could cause problems for some borrowers who will then find themselves overstretched.

“At some point, interest rates will rise and the monthly bill for the customers will rise,” says Dew. “We have seen problems in many markets in the West, where customers couldn’t afford the increase and ran into delinquency problems. Until the market can develop more effective funding mechanisms or hedging mechanisms for long-term interest rate risk that is always going to be a constraint.”

Housing programme

Any pick-up in lending activity by the country’s financial institutions will also have to be matched by the construction industry as there is an acute housing shortage in the kingdom that needs to be addressed.

In 2011, King Abdullah pledged that the government would spend SR250bn ($66.7bn) to build 500,000 new homes under the auspices of the General Commission for Housing. But government-financed homes have been slow in materialising and, in any case, will only partly solve the problem.

The local Capitas Group International, a sharia-compliant housing finance company, has estimated there is a shortfall of some 1 million housing units and that around 150,000 new homes are needed every year if supply is to match demand. Others suggest the figure is closer to 200,000 units a year.

One problem is that private sector developers tend to concentrate on the upper end of the market. That is partly because profit margins are fatter for luxury developments, but also because an inability to access financing means less well-off Saudis cannot afford to buy a property at all.

The government has also boosted the amount of housing finance available through the Real Estate Development Fund (REDF), but it remains under-resourced compared with demand. There are some 537,000 Saudis on the waiting list to receive home loans from the REDF and a further 1.7 million applications have yet to be reviewed, according to NCB Capital, a local investment bank.

There is one other potential fly in the ointment. In May this year, local media reports suggested that Sama was considering bringing in regulations to unify the mortgage rates that banks could charge their customers, citing comments by Mohammed al-Shaya, general manager of the control finance companies division of the central bank. The apparent aim is to control mortgage lending so that it keeps pace with overall money supply in the banking system.

Under such a system, mortgage rates would have to closely follow key policy rates with a profit margin added on top, the level of which could perhaps vary to take account of the condition of the housing market.

Since then, there have been no official pronouncements on the subject, but it would not be a huge surprise if such measures were introduced. Sama is a well regarded regulator and is not afraid of being seen as interventionist. There has, for example, also been some speculation that Sama is looking at standardising fee structures for other retail banking products and services, such as account maintenance fees and the cost of sending remittances overseas. As one property industry professional in Riyadh points out: “This is a very centrally planned economy with a veneer of capitalism.”

Controlling rates

However, any such controls of mortgage rates could also limit the growth of the mortgage market which, after years as a tiny niche within the banking sector, is finally on the verge of becoming a substantial line of business for the country’s banks.

If the ability of banks to make a profit from home loans is constrained too much, they may look for opportunities elsewhere. Having said that, banks may be willing to accept some limits, as they are keen to diversify lending. Saudi banks tend to be heavily concentrated on their domestic market and there is only a limited range of lending opportunities to be shared between the 12 main commercial banks.

“The banks are happy with the law,” says one investment banker in Riyadh. “It will help individuals to own houses and it will help banks to mange their liquidity and to have another channel for investment and better returns. It will also potentially develop the capital markets.”

Just do not expect any of that to happen too quickly. “The impact is not likely to be seen in the short term,” he adds. “Banks will experiment with loans to see how things go and how the courts act.”