One of the more interesting developments in Saudi Arabia’s financial sector in 2015-16 is the attention being paid by the regulator to the Kingdom’s nascent mortgage industry. As with many economies in the region, mortgages have traditionally played only a small part in the financial workings of the housing market, due largely to the precepts of sharia which prohibit the giving or receiving of interest.
However, population growth and an expanding middle class have placed considerable strain on housing markets across the MENA region, and banking practices have evolved to cater to a growing need for new homes. Modern mortgage issuance industries have thus sprung up around the Gulf with remarkable speed. “Long-term residential growth will be bigger than, for example, the short-term boom in hotels, so this is the area to focus on,” Naif Al Baz, CEO of Deutsche Gulf Finance, told OBG.
In the Kingdom’s case, the industry began to grow in earnest around the turn of the century, and within a decade it had evolved to such an extent that providers were offering mortgages with a 0% down payment – mortgage lenders in Saudi Arabia pioneered this practice. This presented a number of questions regarding financial stability, all of which were given fresh urgency when the financial crisis of 2008 burst housing bubbles in the developed markets of the US and Europe.
Throughout this period, real estate lending in Saudi Arabia continued to increase as a percentage of total consumer credit, more than doubling in size between 2008 to 2013 – from SR14.9bn ($4bn) to SR38.4bn ($10.2bn) – according to data from the sector’s regulator, the Saudi Arabian Monetary Agency (SAMA). As well as emerging as a regulatory concern, the issue began to attract attention from the international financial community, most notably in the IMF’s observation in its 2013 Article IV Consultation that the level of real estate finance from banks to individuals had risen by more than 25% per year since early 2011.
In November 2014 SAMA rolled out the Real Estate Mortgage and Financing Laws – a set of five pieces of legislation – to cover a broad sweep of activity and concepts, such as the creation and registration of mortgages, the rights and obligations of mortgage lenders and mortgagees, regulatory oversight (which falls to SAMA), finance lease contracts and the rules and processes for recovering an asset when a borrower defaults, the establishment and operation of finance companies, and other matters related to enforcement.
In practical terms, the most important innovation ushered in by the legislation was a new loan-to-value (LTV) limit of 70%. As industry observers noted at the time, this would have a significant effect on a market where 100% LTV ratios were commonplace in mortgage instruments, and raised the risk of denying potential purchasers access to finance. The 70% rate is certainly at the conservative end of the range when benchmarked globally, with developing economies such as India allowing 80%. European markets such as Finland regulate for 90%, with LTVs in the highly developed UK market typically running at 95%.
Nevertheless, the rationale for this new stricture was clear: preventing a residential bubble that has the potential to undermine economic stability. Negotiating the narrow line between the popular demand for housing and safeguarding the stability of the national economy is a balancing act that jurisdictions around the world have had to perform in recent years, and in each case the approach has varied according to the particularities of the local economy. The first full year of implementation of the new framework was therefore of significant interest, in that it allows both regulators and industry participants to judge the effect of the changes.
The results that began to filter in during early 2016 revealed that, as expected, the increased stability being provided by the new regulations came with a cost to the housing market. According to commercial real estate services firm Jones Lang LaSalle, the number of residential transactions carried out in the Kingdom declined by 5% in the year to November 2015. Given the protected nature of mortgage applications, this figure may understate the true scale of the effect: mortgage originations decreased by 70% from 2014 to 2015, according to housing finance providers. Many potential homebuyers chose to rent instead, resulting in an increase in average apartment rents of 13% in Jeddah and 9% in Riyadh. The central issue, according to industry observers, was simple: the steady rise in house prices over several years had made a 30% down payment on a home purchase unaffordable for a large portion of the population.
Specialised home finance companies were particularly hard hit in the LTV environment brought in by the 2014 laws. Many of these firms had been waiting for the introduction of mortgage legislation to enter the market, but now found themselves facing significant challenges.
The six housing finance firms currently competing with banks to service the mortgage market face two main competitive disadvantages: more expensive terms than their banking equivalents and the inability to cross-sell mortgages with other products through large branch networks. For this reason, the changes made by SAMA to its mortgage regulations in 2016 were especially welcomed by the nation’s housing finance companies.
Recognising the need to level the playing field on which banks and specialist financing houses compete, in February 2016 SAMA altered its framework to allow housing finance firms to provide financing for 85% of a property’s value. Commercial banks will continue to use the 70% LTV limit, with the exception of mortgages provided to the approximately 450,000 nationals on a Ministry of Housing waiting list; these clients will receive 70% financing from their bank under normal terms, and a further 15% to be guaranteed by the ministry, for a total of 85%.
These changes appear to be a successful move on the regulator’s part. The new LTV levels mean that the deposit requirement has been reduced from 30% to 15% for the clients of housing finance companies and the large number of bank customers on the Ministry of Housing’s waiting list, thereby easing access to finance. The more favourable terms offered to finance companies, meanwhile, will help them to overcome the disadvantages they suffer vis-à-vis the commercial banks. This is important for the long-term health of the nascent housing finance market that, if it is to mature into a developed industry, will require a broader ecosystem than the banks alone can provide.
In many markets, various types of mortgage providers work together to provide financing to clients. For example, under the originate-to-sell model already developing in the Kingdom, specialised real estate finance institutions originate transactions and hold them temporarily on their balance sheets before selling them on to investors – of which banks are the obvious choice. The Kingdom’s banks therefore act as providers of liquidity and bookers of assets, a role that they are likely to happily accept given the potential returns on offer.
The increasing interaction, and competition, between banks and housing finance firms is also important in terms of product innovation. Other emerging mortgage markets in the region have seen the introduction of facilities such as penalty-free refinancing, second mortgages on favourable terms and fixed-interest-rate mortgage products. These innovations tend to have positive ramifications for the wider financial sector: for example, the ability to borrow against accumulated home equity allows homebuyers to access their housing wealth directly and to borrow larger amounts when house prices increase.
The loosening of SAMA’s new mortgage regulations is a boon to both homebuyers and financial institutions, and is likely to underpin growth in lending levels and product development over the coming years. Meanwhile, another industry change looks set to further shake up the market. In 2015 it was announced that the state-owned Real Estate Development Fund (REDF), which provides housing loans of up to SR500,000 ($133,000), will be turned into a bank with a mandate to cooperate with the private sector to address the housing shortage in Saudi Arabia. The new dispensation will allow the REDF to offer mortgages for existing homes in addition to providing mortgages for the development of new homes and, while its effect on the market is yet to be seen, it is likely to further deepen the pool of finance that is available to homebuyers.
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