Onerous settlement clauses and long periods of fixed rates prevent borrowers from refinancing mortgages in the United Arab Emirates and Saudi Arabia, respectively, helping to alleviate the impact of historic low interest rates on banks’ increasingly declining margins.
Mortgages have been the main drivers of earnings for creditors on the Gulf Cooperation Council. In the United Arab Emirates, bank profits were driven by higher interest rates in early 2020, and Saudi Arabian banks have enjoyed a mortgage lending boom due to the government’s goals of increasing home ownership as part of its Vision 2030 development program.
Growth in residential credit
The mortgage portfolio of First Abu Dhabi Bank P.JSC, the largest asset bank in the United Arab Emirates, grew 18.2% last year to 22.2 billion UAE dirhams, representing 5.5% of its total loans, while the country’s benchmark EIBOR in one and three months interest rates fell by 173 and 170 bps in 2020, according to rival Emirates NBD Bank PJSC.
“The home loan portfolio has been an area of growth,” said Jaap Meijer, director of research at Arqaam Capital in Dubai, noting that the UAE’s long-depressed housing market started showing signs of recovery in mid-2020.
New home loans are available at variable rates as low as 2.25%, while five-year fixed mortgages start at around 2.75%.
“Because of the early settlement penalty clauses – usually 1% – and existing mortgages already at floating rates, we have not seen many borrowers do business elsewhere, while UAE banks have been able to accommodate requests from borrowers to reduce the spread. EIBOR, although not with the same spread of new customers “, said Meijer.
Still, the FAB’s net interest margin dropped to 1.47% in 2020, from 1.78% in 2019 and 2.00% in 2018, according to standardized data from S&P Global Market Intelligence. An accumulated cut of 225 basis points in interest rates since 2019 has cost the FAB 2 billion dirhams in revenue, according to the bank.
The Emirates NBD’s NIM also dropped to 2.66% in 2020, from 2.93% in 2019, as “a reduction in loan yields more than offset the lower financing costs after base rate cuts”. Expects a further decline in 2021.
“The sharp cut in the benchmark interest rate impacts banks ‘NIM, which is having a huge impact on banks’ profitability,” said Chiro Ghosh, vice president for financial institutions at Banco SICO in Bahrain.
Net interest income in 2021 is likely to be below last year’s, Ghosh predicts, with rate cuts not fully accounted for in bank profits until mid-2020.
“Banks like fixed-rate mortgage loans because the fall in interest rates does not affect them,” said Ghosh.
Abu Dhabi Commercial Bank PJSC’s NIM fell to 2.57% in 2020, from 2.69% in 2019. The lender allowed customers to postpone mortgage payments of 24.6 million dirhams in 2020 on mortgages totaling 998 , 4 million dirhams.
“Banks are willing to lend and have no capacity restrictions, which makes it a competitive mortgage market,” said Shabbir Malik, banking analyst at EFG Hermes in Dubai. “The margins on mortgage products have narrowed, but are still better than those on corporate loans, where margins have been further compressed.”
The asset quality of UAE banks will deteriorate, while their cost of risk will increase this year, S&P Global Ratings predicts, as leniency measures to help distressed borrowers are removed. This will likely leave banks’ profitability reduced and some may experience losses. S&P expects non-performing loans to reach 7% in 2021.
Borrowers are less likely to default on mortgages than SMEs and personal loans, Malik said.
Saudi banks receive money
Saudi Arabian banks have expanded their mortgage portfolios by capitalizing on government plans to increase home ownership to 60% by 2020 and 70% by 2030, from 50% previously.
“The mortgage markets in the United Arab Emirates and Saudi Arabia are very different,” said Ghosh, of SICO. “In Saudi Arabia, banks are doing everything they can to increase their mortgage lending, while banks in the UAE are much more skeptical.”
This caution is due to a sustained fall in house prices since mid-2014, with many mortgage borrowers now having negative equity. This left banks vulnerable to debtors – whose collateral was removed – default on repayments.
Meanwhile, with Saudi ownership of around 63%, some in the industry believe the government will cut back on support measures for potential buyers, although this is not a view shared by Ghosh.
“I see the target of 70% minimum, not maximum,” he said, predicting that Saudi banks’ total mortgage lending will increase by 15% to 17% this year.
Dynamic mortgage lending has allowed Saudi banks to exceed profit expectations last year, although S&P warns that the market will gradually saturate. The banks’ combined mortgage portfolio will expand by more than 100 billion Saudi Arabian rials in 2021, S&P Ratings predicts, slightly below last year’s increase in rial terms.
Among Saudi banks, the annual NIM of the Samba Financial Group fell to 2.08% in 2020, from 2.74% in 2019, according to standardized numbers from S&P Global Market Intelligence. The National Commercial Bank, Saudi Arabia’s largest bank by assets and in the middle of acquiring Samba, reported an annual increase of 99% in its mortgage portfolio to 74 billion riyals on December 31.
Mortgage loans from Riyad Bank increased 25% over the previous year in 2020, to 39 billion riyals, although its NIM fell to 2.86% in 2020.
Normally, mortgages in Saudi Arabia have a fixed rate for the entire term – usually 25 years. Borrowers can refinance after a certain period, but there is little incentive to do so, even if rates have dropped because the government pays up to 100% of the interest portion of the mortgage repayment, Malik said.
“This helps make it a very profitable segment for Saudi banks – although the rates are fixed, the margins are high enough to remain attractive to creditors,” he added. “Credit risk is also mitigated by generous government subsidies, while capital requirements for mortgages are low, so for every loan that banks make, they need to reserve relatively little capital.”
On April 7, $ 1 was 3.67 UAE dirhams and 3.75 Saudi rials.