Banks' worries about borrowers defaulting on their debt and a continuing liquidity squeeze means that mortgage rates in the UAE remain much higher.
Costly UAE mortgages repel buyers
Mortgage finance in the UAE is barely as old as the six-year property boom that it helped sustain. Now it may also play a crucial role in ensuring the return of confidence to an industry that has been battered by almost a year of price declines, investor defaults and stalled projects. Despite falling interbank borrowing rates, the cost of mortgages remains stubbornly high. That will need to change before a recovery can take place, analysts say. "The mortgage market revival is important for the property market to bounce back. Better and cheaper access to mortgages is surely key here," says Philippe Dauba-Pantanacce, a senior economist for Middle East and North Africa global markets at Standard Chartered Bank in Dubai. The availability of affordable home loans is now being seen as a vital requirement for a recovery in the residential property market, where prices have fallen by as much as half from their peak last year. Mortgage rates have dropped worldwide as regulators have introduced stimulus measures to encourage consumer spending by cutting the cost of lending. Average 15-year mortgage rates in the US have dipped to 4.54 per cent, Freddie Mac (the Federal Home Loan Mortgage Corporation) said last week. Mortgage costs have tumbled even further in the UK, where last week HSBC announced its lowest ever rate of 1.99 per cent. But the cheapest rate now available from HSBC Middle East for a UAE mortgage is 7.45 per cent. Speculators helped fuel the escalation of property prices in the UAE, often placing multiple deposits on off-plan properties with the intention of selling them on for short-term gains, a practice that became known as "flipping". Off-plan sales helped to fund a six-year property boom, but the large-scale participation of speculators made it difficult to assess real demand for finished properties from end-users intending to occupy them. "We are currently in the half-time break between the knockout of the speculators and the resurgence of the end-users. If we want to shorten that break, mortgage rates have to come down substantially," says Roy Cherry, a vice president of research at Shuaa Capital in Dubai. Banks say that despite falling interbank borrowing rates, they remain under pressure to meet strict government capital adequacy targets, while a continuing liquidity squeeze makes it more difficult for them to offer more competitive loans. "Banks are stuck between a rock and a hard place. They are exposed to developers, in terms of project finance, and to individuals on home financing. To say the least, they are in trouble and hence extra-cautious," a senior Dubai based analyst says. According to a research note from Credit Suisse earlier this year, banks could lose as much as Dh24 billion (US$6.5bn), or almost half of their Dh60bn exposure to the mortgage market, based on an assumption that properties would lose half their value on average and that banks would recover only 50 per cent of their collateral as three out of four mortgage holders default. Other estimates come in much lower, with EFG-Hermes estimating bad mortgage loans in the UAE at about Dh6bn. This scenario assumes that one in five home buyers will default, with banks expected to recover half of the mortgage value. Unlike western markets, large-scale foreclosures are yet to materialise and there are no official data to indicate how much lenders have already lost on their mortgage portfolios. Liquidity is expected to improve as the banking system benefits from moves by the Government to pump Dh120bn into the financial system while also guaranteeing bank deposits. More significantly, the benchmark Emirates interbank offered rate (Eibor) has fallen sharply in recent weeks. The three-month Eibor has slipped from a peak of 4.8 per cent in November to about 2 per cent today. The Central Bank wants to see it fall further to stimulate cheaper lending. Last month, the regulator said it would change the mechanism of calculating Eibor to give it a more direct role in the process. However, the drop in the UAE's interbank borrowing benchmark rate has as yet done little to spur mortgage financing by bringing down the rates that banks charge their customers for home loans. Local mortgages are usually offered on variable interest rates, where banks earn a certain percentage over Eibor. The UAE's largest mortgage lenders are Tamweel and Amlak, followed by Emirates NBD, Abu Dhabi Commercial Bank, HSBC and Standard Chartered. Tamweel and Amlak both stopped selling new home loans last November, when the Government announced the pair would be restructured before a possible merger. HSBC Middle East currently offers loans of 5 per cent over the July 1 three-month Eibor rate of 2.456 per cent. But that increases to 6 per cent over Eibor for loans that require lending equivalent to 75 per cent of the property value. Standard Chartered offers mortgages of between 6.5 per cent and 7 per cent, while Abu Dhabi Commercial Bank currently offers mortgages as high as 4.75 per cent over its own base rate of 5 per cent, pushing the total interest rate to 9.75 per cent per annum. These rates are much higher than in many other international markets, but local bankers say they are taking on a greater level of risk, which also means they are unable to offer fixed-rate deals. "We can't afford to offer fixed rates. Policies in this market change in a day and banks are not willing to tie up long-term investments for a fixed premium," says a senior mortgage adviser at Standard Chartered. Analysts say the high variable rates currently on offer are dissuading many investors from entering the market, despite the increased affordability of some properties, which have seen substantial declines in value. "Mortgage rates in Dubai are already among the highest in the world. The fact that they are variable means they could be lower today, but there is no guarantee they will remain the same in the next quarterly review," says Saud Masud, the head of research and lead property analyst at UBS Bank in Dubai. "The lender can go to any lengths to cover its risk, which makes investors uneasy in uncertain times such as these." The lack of a local credit checking regime during the boom years has been blamed for the rising bad debts currently being accumulated by UAE banks. "In a normal economic environment, a cheaper refinancing rate, in this case Eibor, can be passed on to the consumer," Mr Dauba-Pantanacce says. "But in the present economic situation, the rise of risk aversion has meant that this link of passing on the cheaper refinancing rate to the consumer has been somehow broken, not only in this country but all over the world. Access to credit is simply more difficult because lenders are becoming extra cautious." This reluctance to increase lending suggests banks may need another injection of liquidity before they can think about exposing their limited funds at hand to the mortgage market. Bank lending fell 0.2 per cent in July to Dh1.007 trillion, from Dh1.009tn the previous month. Although lending has grown by about 1.3 per cent since the start of the year, it is still far below the levels seen last year, which indicates banks are merely rolling over their current exposure and replacing existing loans that run out with new ones. "Banks are to be blamed to some extent for the situation they are in now. Giving out 90 to 95 per cent loan-to-value ratios at the peak of the market meant they were stretching themselves to the limits," Mr Masud says. "Bank financing makes up about 15 per cent of the total housing market of the country, while the rest is still cash-based. Of the Dh110bn estimated mortgages written in 2008, the majority were for Dubai projects and 60 per cent of them have been issued by Amlak and Tamweel." Most analysts agree that the mortgage market is unlikely to recover for some time to the levels of activity seen last year. "It would be a staggering achievement if the market this year could reach 75 per cent of mortgage issuance of 2008. I doubt if it is achievable," Mr Masud says. Dubai is the only emirate with a specific mortgage law, which was introduced last year. The absence of a long-standing regulatory regime may also be contributing to the higher cost of mortgage financing as lenders add a greater risk premium to the market. "The problem with the mortgage market is not entirely the offered rates," says Miles Payne, the head of the Dubai branch of the British property consultancy Strutt and Parker. "The regulation surrounding the market needs more stability as well. For example, there is no regulation which protects both parties in case of a default. We know this is a young market, but the natural progression demands solidifying of the regulations." Until that happens, homeowners across the Emirates are likely to remain shackled to expensive mortgage finance. * additional reporting by Tom Arnold firstname.lastname@example.org