As margins fall, mortgage refinancing dynamics favor UAE, Saudi banks

Onerous early settlement clauses and long fixed-rate periods deter borrowers from refinancing mortgages in the United Arab Emirates and Saudi Arabia, respectively, helping ease the impact of historic low interest rates on banks' dwindling margins.

Mortgages have been key earnings drivers for lenders in the Gulf Cooperation Council. In the UAE, bank profits were buoyed by higher interest rates in early 2020, and Saudi Arabia's banks have enjoyed a mortgage lending boom due to government targets to increase home ownership as part of its Vision 2030 development program.

Growth in residential loans

The mortgage book of First Abu Dhabi Bank PJSC, the UAE's top bank by assets, expanded 18.2% last year to 22.2 billion UAE dirhams to represent 5.5% of its overall lending, while the country's benchmark Emirates interbank offered rate, or EIBOR, one-month and three-month interest rates fell 173 basis points and 170 bps in 2020, respectively, according to rival lender Emirates NBD Bank PJSC.

"The residential loan book has been a growth area," said Jaap Meijer, managing director of research at Dubai's Arqaam Capital, noting the UAE's long-depressed housing market began to show 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 penalty clauses on early settlement — typically 1% — and existing mortgages already at floating rates, we haven't seen many borrowers taking their business elsewhere, while the UAE banks have been able to accommodate requests by borrowers to reduce the spread over EIBOR, though not at the same spread as new customers," said Meijer.

Nonetheless, FAB's net interest margin fell to 1.47% in 2020, from 1.78% in 2019 and 2.00% in 2018, according to S&P Global Market Intelligence standardized figures. A cumulative 225-basis-point cut to interest rates since 2019 has cost FAB 2 billion dirhams in revenue, according to the bank.

Emirates NBD's NIM also fell, to 2.66% in 2020 from 2.93% in 2019 as "a reduction in loan yields more than offset lower funding costs following base rate cuts." It expects a further decline in 2021.

"The sharp cut in benchmark interest rate impacts banks' NIM, which is having a massive impact on banks' profitability," said Chiro Ghosh, vice president for financial institutions at Bahrain's SICO Bank.

Net interest income in 2021 will likely be below that of last year, Ghosh predicts, with rate cuts not fully factored into banks' earnings until mid-to-late 2020.

"Banks like fixed-rate mortgage lending because the decline in interest rates doesn't impact them," Ghosh said.

Abu Dhabi Commercial Bank PJSC's NIM fell to 2.57% in 2020, from 2.69% in 2019. The lender allowed customers to defer mortgage repayments of 24.6 million dirhams in 2020 on mortgages totaling 998.4 million dirhams.

"Banks are willing to lend and don't have capacity constraints, so that makes it a competitive mortgage market," said Shabbir Malik, a bank analyst at EFG Hermes in Dubai. "Margins on mortgage products have tightened but are still better than on corporate lending where margins have been even more squeezed."

Sign up to receive email alerts for our new, improved Middle East & Africa Monitor, a weekly roundup of essential financials news from the MEA region. Follow this link or use the "Create Alert" button on any edition of the Middle East & Africa Monitor on the MI platform or in your profile settings.

UAE banks' asset quality will deteriorate while their cost of risk will rise this year, S&P Global Ratings forecasts, as forbearance measures to help struggling borrowers are removed. This will likely leave banks' profitability subdued and some may report losses. Ratings expects nonperforming loans to top 7% in 2021.

Borrowers are less likely to default on mortgages than on small and medium-sized enterprise and personal loans, Malik said.

Saudi banks cash in

Saudi Arabia's banks have expanded their mortgage books by capitalizing on government plans to boost home ownership to 60% by 2020 and 70% by 2030, from 50% previously.

"The UAE and Saudi mortgage markets are very different," said SICO's Ghosh. "In Saudi, banks are going all out to increase their mortgage lending, whereas UAE banks are a lot more skeptical."

This wariness is due to a sustained slump prices in house prices since mid-2014, with many mortgage borrowers now in negative equity. That has left banks vulnerable should borrowers — whose collateral has been wiped out — default on repayments.

Meanwhile, with Saudi home ownership now around 63%, some in the industry believe the government will reduce support measures for would-be buyers, although that is not a view shared by Ghosh.

"I see the 70% target as a minimum, not the maximum," he said, forecasting Saudi banks' total mortgage lending will increase 15% to 17% this year.

Buoyant mortgage lending enabled Saudi banks to beat earnings expectations last year, although S&P Global Ratings warns the market will gradually saturate. Banks' combined mortgage book will expand by more than 100 billion Saudi Arabian riyals in 2021, Ratings forecasts, slightly below last year's increase in riyal terms.

Among Saudi banks, Samba Financial Group's full-year NIM fell to 2.08% in 2020, from 2.74% in 2019, according to S&P Global Market Intelligence's standardized figures. The National Commercial Bank, Saudi Arabia's largest bank by assets which is in the midst of acquiring Samba, reported a 99% annual increase in its mortgage book to 74 billion riyals as of Dec. 31, 2020.

Riyad Bank's mortgage lending expanded 25% year-over-year in 2020 to 39 billion riyals, although its NIM fell to 2.86%.

Typically, mortgages in Saudi Arabia are at 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 declined because the government pays up to 100% of the interest portion of the mortgage repayment, said Malik.

"This helps make it a very lucrative segment for Saudi banks — although rates are fixed, the margins are high enough for it to remain compelling for lenders," he added. "The credit risk is also mitigated by the generous government subsidy, while capital requirements for mortgages are low so for every loan that banks write they have to set aside relatively little capital."

As of April 7, US$1 was equivalent to 3.67 UAE dirhams and 3.75 Saudi Arabian riyals.