Saudi Arabia's new mortgage law

The effect of recently introduced mortgage legislation has become one of the more salient industry concerns in 2015. First promulgated in March 2013, many market observers thought the law a long overdue formalisation of a rapidly growing segment. Real estate lending had been steadily rising as a percentage of the consumer credit total for some years, increasing from SR70bn ($18.7bn) in 2013 to SR94bn ($25.1bn) in 2014, according to data from the Saudi Arabian Monetary Agency (SAMA).

The IMF, in its 2013 Article IV Consultation with Saudi Arabia, took note of the situation, recording that real estate finance from banks to individuals has risen by more than 25% per year since early 2011. With growth rates such as these, a more comprehensive regulatory framework for home loan activity was called for, and the new law – actually a set of five separate pieces of legislation collectively known as the Real Estate Mortgage and Financing Laws – promised to do just that.

Between them they cover a broad sweep of activity and concepts, such as creation and registration of a mortgage, the rights and obligations of mortgagors and mortgagees, regulatory oversight (which falls to SAMA), finance lease contracts (and, importantly, the rules and processes of recovering an asset when a borrower defaults), the establishment and operation of finance companies, and matters related to enforcement. Their implementation by SAMA promises to radically overhaul the manner in which home finance is offered to Saudi Arabia’s population. Abdulmohsen Al Fares, CEO of Alinma Bank, told OBG, “SAMA is one of the strongest central banks in the world, enforcing tough regulations, which are regularly updated to maintain global best practices.”

MARKET EFFECT: The immediate effect of the legislation, however, has been counter to what many expected. During the lengthy prologue to the introduction of the law, concerns arose that the real estate crashes which shook regional and global economies following the 2008 financial crisis might be repeated in Saudi Arabia if the route to home finance was made easier for large numbers of the population. By addressing the need for more straightforward access to housing credit in this way, it was argued, the legislation heightened systemic risk.

However, events in 2014 and early 2015 proved these fears to be unfounded. By the fourth quarter of 2014 real estate companies were reporting a decline in appetite in home purchases as the effect of the new legislation began to be felt in the market. Global real estate firm James Lang LaSalle’s “Real Estate Overview,” which focused on the last three months of the year, showed that sale prices fell for the period as potential purchasers opted for rental properties instead – and cited the mortgage law as the principal cause of this shift.

LOOKING AT THE NUMBERS: Unpacking the statistics that underlie this trend is problematic. Aggregate data for the banking sector shows that real estate lending continued to grow over 2014. According to figures from SAMA, retail real estate loans by banks totalled SR343.8bn ($91.6bn) for the year, a 33% increase on the SR258.2bn ($68.8bn) in 2013.

However, the effect of the recently implemented legislation is not yet fully reflected in the data due to the fact that in 2014 banks were not required to apply the new lending criteria on mortgages that were already in the pipeline. The interpretation of this concession varied from lender to lender, with some banks including early-stage applicants in the pipeline and others only excusing those who had already signed contracts from the new criteria.

Moreover, OBG learned from discussions with the finance houses serving the real estate credit arena that in February 2015 decreases in lending of up to 50% were seen across the sector. Over the course of 2015 the statistical picture will undoubtedly become clearer, but it is already apparent that the legislation has not provided the real estate lending market with the boost that was widely anticipated before its implementation.

CONSERVATIVE STANCE: The explanation for this constriction of credit to the real estate sector lies in the lending criteria applied on mortgage facilities by SAMA. Mindful of the risk of easy credit fuelling an unsustainable housing market boom, the regulator has adopted a conservative stance under the new legislation. The loan-to-value (LTV) ratio of 70% is certainly at the lower end of the range when benchmarked globally, with developing economies such as India allowing 80%, European markets such as Finland regulating for 90%, and LTVs in the highly developed UK market typically running at 90-95%.

However, from the perspective of a regulator intent on protecting the market from overheating, establishing a low LTV ratio at the outset is prudent. “The LTV will stop aggressive, speculative lending and therefore create a healthier, more sustainable sector,” Naif Al Baz, CEO of Deutsche Gulf Finance, told OBG. “It is better for the economy, as it will prevent the creation of a bubble, which will help us avoid situations such as what occurred in the US.”

The LTV limit is the most commonly deployed macro-prudential measure across international housing markets, and is widely considered to have been effective in mitigating housing and credit cycles elsewhere. Should the housing market cool significantly over the coming year, the regulator has the option of recalibrating its position.

In the meantime, however, many potential borrowers will face a challenge in raising the 30% deposit made necessary by the current lending criteria: according to proprietary research carried out by Morgan Stanley in 2010, the average down payment in Saudi Arabia was in the region of 10%.

LOOKING AHEAD: From the perspective of the Kingdom’s banks, the mortgage market, in the longer term, remains one of potential, with considerable scope for future growth in the area. According to the IMF, real estate finance from banks to individuals – despite its growth over recent years – still accounts for less than 5% of total bank credit.

This fact has not escaped the notice of international finance companies, which, thanks to the new legislation, are able to extend credit to the housing segment. Deutsche Gulf Finance, which has partnered with Al Rajhi bank to offer credit to homebuyers, is one of the early entrants to the arena, and the arrival of similar global home loan institutions may herald a long-term alteration of market structure that will see finance companies rather than banks playing the leading role, as is the case in more advanced real estate markets elsewhere.

Banks, however, will continue to play an important part in the process. Under the originate-to-sell model popular in other markets and already developing in the Kingdom, dedicated real estate finance institutions originate transactions, park them temporarily on their balance sheets, and then sell them on to investors – of which banks will be the obvious choice. The 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 speed with which international finance companies enter Saudi Arabia will depend on market conditions over the coming months and years, and with real estate companies reporting muted interest in purchases in early 2015 there is unlikely to be a rush into the Kingdom.

However, OBG understands from discussions with the market regulator that 17 international finance companies have applied to the Saudi Arabian General Investment Authority for licences to operate in the country, which as foreign companies they must do before seeking a licence from SAMA.

MORE LONG-TERM BENEFITS: The anticipated increase in competition is likely to bring a number of benefits in the form of primary mortgage products. In the UAE and Kuwait, for example, a rise in market participants is credited with introducing more features such as penalty-free refinancing, second mortgages on favourable terms and fixed interest rate mortgage products. These innovations tend to have positive effects on the wider financial sector. For example, the ability to borrow against accumulated home equity allows homebuyers to access their housing wealth directly, as well as to borrow more when house prices increase.

While the new mortgage legislation will not result in a surge in home-lending activity in the short term, its passage represents a significant advance in the long-term goal of opening up housing finance to a larger segment of the population. Market conditions and the regulator’s use of its principal control lever, the LTV ratio, will determine the segment’s expansion rate. The Kingdom’s well-capitalised banks stand to benefit from this long-awaited legislative change. Despite initial concerns over the new law, it is a long overdue piece of legislation that will provide further support for a rapidly growing segment.