Saudi Arabia: Preparing for mortgages

New legislation paving the way for Saudi Arabia’s banks to provide mortgages to clients should see the loan portfolios − and earnings − of the majority of the Kingdom’s lenders expand substantially. However, market conditions and the sector’s own inherent caution could limit the number of mortgages granted, at least until the market becomes more developed and is tested.

In early July, the Saudi cabinet approved legislation that will allow banks to provide mortgage products to clients. While there is already a mortgage system operated by many Saudi banks, it is based on loans being advanced to clients, with repayments deducted from the homebuyer’s salary. Previously, banks were not able to use the property as collateral for the loan; with the new system, banks will be able to reclaim the property if a borrower defaults on the loan.

Under the new scheme, the potential for local banks is immense. Some estimates put the value of the mortgage market at around $32bn per year, a level that could be sustained for a decade or more as the government seeks to achieve its goal of increasing home ownership to around 80% of the population, up from the present 30%, local media has reported.

According to ratings agency Fitch, current mortgage lending amounts to just 2% of GDP, compared to around 70% in some Western countries, such as the US or the UK. At present, it is estimated that only 3.5% of housing purchases in Saudi Arabia are made through mortgages, though mortgage lending by local banks amounted to $7.8bn in 2011, a 27% increase on the previous year’s total.

Although the new legislation will be welcomed by lenders, it is unlikely that the full potential of the market will be reached in the short term, and not just as a result of those issuing credit wanting to test the law – prospective buyers are contending with a significant shortage of housing. And while the government is aiming to provide 500,000 units for lower-income families, even this will still leave a large gap between supply and demand.

According to a report prepared by Jeddah-based National Commercial Bank, average Saudis cannot afford a housing unit beyond $160,000. Current prices for apartments and small villas currently sit below this figure but a surge of new buyers into the market could push prices up.

“With the arrival of the mortgage law in the Kingdom, regulators and banks must remain prudent,” Ziad Aba Al Khail, the managing director and CEO of Aljazira Capital, told OBG. “The one key difference [between the Kingdom and the US] is here mortgage loans are based on salary transfer and are primarily for end users, so there is a greater level of control on who can qualify for a loan.”

Indeed, the historically conservative approach of local lenders has served the banking sector well in the past and it would not be unreasonable to assume that this new line of business will be treated any differently. According to Sheetal Kothari, a research analyst at Frost & Sullivan, an international consultancy, Saudi Arabia’s banks operate from a sound fiscal position, which should allow them to deal with the changing business environment.

“The banks in the Kingdom have a good track record of maintaining strong asset quality and adapting adequate lending practices and underwriting standards,” Kothari said on August 26 in a report issued by financial magazine Gulf Business.

The Saudi Arabian Monetary Agency – the Kingdom’s central bank – is currently finalising its regulations covering mortgage financing, after which the law will go into effect and allow local institutions to ready themselves for what many are seeing as a new era in the country’s economic development.