Money to be made on Saudi mortgages? How KSA's new law is planned to boost markets
As the largest domestic banking sector in the GCC, Saudi Arabia continues to perform well with both assets and profitability rising. Saudi banks’ performance in 2013 has been positively impacted by the growing economy, the increasing ability to supply housing finance, and by the increased capital spending included in the budget. After a three-year downward trend, margins have risen slightly. A continuation of confidence should provide further growth in the local equities market, with resultant improvement in banks’ fee and commission income.
Overall, banks’ loan books, which have experienced greater rates of increase since the decline in 2009, should continue to rise by rates in the mid- teens, further expanding net profit. The banks’ capital and liquidity situations, which are very solid, should enable such growth without significant negative effects on their balance sheets.
Saudi banks continue to be challenged by the gradual disappearance from the market of Saudi Government Development Bonds. Originally issued to finance the deficits of the 1990s, their existence has been a casualty of the continuing budget surpluses. For banks they represent sound, profitable and liquid assets which serve to meet internal liquidity requirements, as well as regulatory ratios. With interest rates at record lows, banks are suffering from the effects of replacing these high-yielding assets with much less profitable ones.
Saudi banks have used several different avenues to replace this diminishing asset, including short-term Saudi treasury bills, which are being issued on a weekly basis, but at lower rates. Fully Shar’ia-compliant banks have made arrangements to conduct mutajara activity with SAMA as alternatives to reverse repos and treasury bills. Other alternatives used have included US Treasuries or other G-10 or GCC obligations.
In March 2013 the long-awaited mortgage banking law was promulgated, and it covered several (but not all) of the aspects of the issue. The mortgage law provides, among other things, a procedure for banks and others to become licensed to provide mortgage finance, and a maximum loan-to-value ratio of 70 per cent. Among the issues either to be decided or to be tested in practice are those of foreclosure and liquidity. Most banks appear to be moving cautiously until the first few cases of foreclosure arise, and to make strategic decisions based on how such cases are decided.
Liquidity will most likely be made available to mortgage providers through purchase or discount facilities provided by the Public Investment Fund (PIF). Such a mechanism would not only assist in resolving the housing and housing finance problems in the kingdom, but would also provide banks with sound assets as replacements for their SGDBs.
The Saudi economy is largely dependent on petroleum – global supply, global demand, price, and production within the kingdom. This remains the case despite some increases over the past decade in the relative importance of the non-oil sector in the economy. These factors affect the kingdom’s external and internal finances, and both continue to be robust. In the short and medium-terms, this should remain the case, as global demand is expected to remain flat, affecting growth rates even in such erstwhile rapidly growing economies as China and India. In the medium-term, prices will also be affected by increasing production from North America, which may exceed OPEC production sometime between 2015 and 2020. However, all of the medium and long-term projections could be moot in the short-term because of potential supply disruptions in some major oil- producing countries, notably Iran.
In 2012, the Saudi economy enjoyed record revenues as prices remained firm and production rose to close to 10 million barrels per day. The net positive inflow provided the country with a current account surplus of some $175 billion, or more than 20 per cent of GDP, in 2012. The Saudi government’s practice is to not monetise much of the US dollar income from petroleum products, in order to minimise the rate of price inflation and to set aside large amounts for leaner times. The kingdom has built up well over $500 billion in foreign-exchange reserves for that eventuality.
The 2013 budget calls for increases on both the revenue and the expenditure sides – 18 per cent and 19per cent respectively. Accordingly, the planned surplus is reduced from SAR12 billion to SAR9 billion. The planned spending increase in 2013 is fairly evenly divided – in absolute terms – between current spending and capital spending. While numerous infrastructure projects were in the planning stage in 2012, the initiation of many high-profile projects was delayed for a variety of reasons. 2013 is expected to be the high-water mark, as many projects in the fields of housing, health and education experience large spending increases, with capital spending expected to slow gradually in 2014 and beyond.
Arab National Bank is in a good position to capitalise on the expanding mortgage market in Saudi through its 40 per cent ownership of Saudi Home Loan Company. The affiliate provides home and real estate financing on a Shari’a-compliant basis. The synergy here is that ANB acts as sales outlet for the company’s services for which it is compensated separately.
In 2012, Riyad Bank continued to expand its retail business, with positive effects on its funding mix as well as on the concentration in its loan book. Net profit, rose modestly in 2012 and also in the first half 2013, the result of a strong jump in operating profit but dampened by the increased need for loan-loss provisions. NPLs increased in absolute terms last year, and the rise in the NPL ratio ran contrary to the trend in the peer group. The bank will continue to grow its retail business, as the results of recent branch expansion begin to bear fruit. With the bulk of the costs related to that expansion now behind it, costs are not likely to be an impediment to operating profitability.
One of the key products on offer, which Riyad Bank is continually developing and improving, is mortgage finance – a product in great demand in Saudi Arabia. Other products include personal loans, auto leasing and credit and debit cards. Personal loans, virtually all of which are secured by salary assignments, continue to grow and increase market share; moreover, pricing discipline has served to increase margins on the product.
The two major restraints on Al Rajhi Bank’s success in 2012 were the same that have dampened earnings in 2013: new non-performing Islamic finance facilities and weakness in financing income. The latter is not typical for Al Rajhi, but can be blamed at least partly on the low level of interest rates. If asset quality does not deteriorate, income should post a stronger increase in 2013 than it did in 2012. Profitability and asset quality both hinge on the trend in loan asset quality this year. The past two years have seen large accretions in non performing financing, while the rest of the sector reported significantly lower accretion rates.
Retail banking was the driving force behind Al Rajhi’s initial growth. Although retail lost some of its predominance in the balance sheet temporarily as the corporate book expanded, it has now returned to its former status. It continues to grow and the bank currently claims a leading market share in the consumer segment.
Saudi banks are expected to record good results in 2013 and 2014 should be no different.