Credit FAQ:

How The United Arab Emirates' Caps On Mortgage Loans Will Affect Banks And Property Developers
Primary Credit Analysts: Timucin Engin, Dubai (971) 4-372-7150; timucin.engin@standardandpoors.com Tommy J Trask, Dubai (971) 4-372-7151; tommy.trask@standardandpoors.com Secondary Contact: Emmanuel F Volland, Paris (33) 1-4420-6696; emmanuel.volland@standardandpoors.com

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Frequently Asked Questions Related Research

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Credit FAQ:

How The United Arab Emirates' Caps On Mortgage Loans Will Affect Banks And Property Developers
New residential mortgage regulations issued by the United Arab Emirates (UAE) Central Bank could support the credit risk profiles of domestic banks and property developers over the longer term, in Standard & Poor's Ratings Services view. The regulations for the first time place various limits on the amount that home buyers may borrow in relation to the value of a property. We expect that these loan-to-value (LTV) mortgage caps will be neutral for the ratings on the four banks and the four property companies with exposure to the UAE's residential real estate sector that we rate: National Bank of Abu Dhabi (AA-/Stable/A-1+); Abu Dhabi Commercial Bank (A/Stable/A-1); Mashreqbank (BBB+/Stable/A-2); Sharjah Islamic Bank (BBB+/Stable/A-2); Emaar Properties PJSC (BB+/Stable/--); Aldar Properties PJSC (BB/Stable/B); Tourism Development and Investment Co. P.J.S.C. (TDIC; AA/Stable/A-1+); and Dubai Investments Park Development Company LLC (Dubai Investments Park; BB/Stable/--).

Nevertheless, we believe that the regulations will force banks to adopt more conservative lending practices in the future, which in our view would support their risk profiles over the longer term. For rated UAE property developers, while another property market boom could provide very significant short-term benefits, a more gradual and sustainable recovery would be far better for the long-term credit standing of these entities, in our view. We believe the mortgage caps could help reduce market volatility and ultimately loan losses, and prevent another boom-and-bust cycle that was witnessed in the UAE property markets over the past decade. Here, we address some frequent questions we have received from investors regarding the regulations, which the Central Bank published on Oct. 28, 2013.

Frequently Asked Questions

What specific loan-to-value caps does the regulation impose?
These caps are the most important aspect of the regulations, in our view. They differ according to whether the borrower is a UAE national or non-national, whether he is a first-time buyer, and whether the property will be owner-occupied or an investment purchase. They also depend on the price of the property as well as the sale structure. For the UAE nationals, the LTV ratio cap is 80% for the first property purchased if it is to be owner-occupied and if the purchase value of the property is below UAE dirham (AED) 5 million ($1.36 million). The cap declines to 70% of the loan value for property costing above AED5 million. For any subsequent purchases (investment units), the LTV cap for UAE nationals is 65%, regardless of the property value. For non-nationals, the LTV cap is 75% for the first property if

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Credit FAQ: How The United Arab Emirates' Caps On Mortgage Loans Will Affect Banks And Property Developers

the property value is below AED5 million, and 65% for the purchases above this amount. For any subsequent purchases the LTV cap for non-UAE nationals is 60%, regardless of the property value. All mortgages for off-plan properties (that is properties bought before they are constructed, based on the developer's plan) will be capped at 50%, regardless of the buyer's nationality or the value of the property. In addition, the Central Bank regulations set the maximum tenor for mortgage loans at 25 years. The monthly mortgage and interest repayments remain limited to a maximum of 50% of a customer's monthly income. The total loan is limited to no more than seven years' annual income for expatriates and eight years for nationals.

What will be the credit impact of the mortgage regulation on financial institutions?
We believe that these first explicit regulations on mortgage lending in the UAE will support the credit profile of the banks over the longer term by forcing them to adopt more conservative lending practices in residential real estate lending. The strong emphasis on loan-to-value caps replicates practices in some Asia Pacific countries.

What is the rationale behind different lending rules for locals versus expatriates?
We believe the Central Bank considers non-national property buyers to have a higher risk profile than UAE nationals. In the UAE, similar to other markets in the Gulf, non-nationals or expatriates constitute the dominant portion of the resident population and labor force. They are also active investors in the country's real estate market. During the last crisis, some commercial banks observed higher loan delinquencies in certain retail lending exposures to expatriates in comparison with nationals. A UAE national arguably has a greater long-term incentive to service his debt in a large negative equity position, whereas, arguably, a foreign national might have a greater incentive to default on a loan and leave the country. Additionally, given the country's employment structure, the loss of jobs in a downcycle is significantly more pronounced among foreign workers and expatriates than among UAE nationals. This also places pressure on debt service capacity and highlights a difference in the risk profile of UAE nationals versus non-nationals, in our view.

Why are investment units subject to tighter lending regulations than owner-occupied properties?
Traditionally, investment units exhibit higher risk than owner-occupied units. We believe this is more prevalent in the UAE than in many other countries. This is because rental prices--and therefore cash flow generation ability--are volatile as they're driven largely by expatriate demand. The group can fluctuate significantly between business cycles, owing to sharp changes in employment conditions. Added to this, currently historically low interest rates are creating investor demand for investment units for their rental yield. Meanwhile, low mortgage rates are allowing investors to take leveraged positions in this asset class. We therefore consider that the Central Bank is adopting a cautious stance against a speculative bubble among investment purchases.

Do off-plan sales present a similar risk?

In the years following the real estate price correction, nonpayment was notably higher in the off-plan sales market. One reason for this was higher speculative purchases in the off-plan market, particularly in 2007 and 2008. What's more, construction risks, such as non-delivery or late delivery of units, also created cash flow problems for borrowers. We believe that the UAE regulator is trying to curb potential speculative purchases in this segment by implementing

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Credit FAQ: How The United Arab Emirates' Caps On Mortgage Loans Will Affect Banks And Property Developers

more conservative caps.

Are the UAE's mortgage caps similar to macro prudential tools adopted by other regulators globally?
The use of explicit LTV limits is common in certain Asian countries, such as China, India, Thailand, Singapore, and Hong Kong. In Hong Kong, the regulator differentiates between the value of projects and applies a lower LTV cap for properties valued above a certain level. However, regulators in different jurisdictions across the world focus on different macro prudential instruments or use a combination of various measures, depending on the structure of the banking system they regulate. An explicit LTV limit is neither the only tool used, nor it is commonly used in all countries. For example, to influence bank lending behavior and disincentivize riskier lending in certain countries, regulators might impose a tiered capital requirement over and above the usual 35% standardized risk weight under Basel II. In Norway, for example, the practice is to apply a 35% risk weighting for loans with an LTV of below 80%, while applying higher risk weights for exposures with higher LTVs. Some countries cap real estate exposure as a portion of a balance-sheet metric. Regulators also emphasize debt service coverage, maximum payment tenors, or differentiate between owner-occupied versus investment units. The absence of an established credit bureau in the UAE makes it hard to monitor borrowers' debt-service requirements.

Do you believe the new mortgage regulations will affect credit growth in UAE?
UAE banks have limited direct exposure to residential mortgages. The latest published data on residential real estate exposures, published in the UAE Central Bank's Financial Stability Review in September 2012, put UAE banks' direct residential mortgage exposure at AED37 billion ($10.1 billion) for nationals and AED37.6 billion ($10.2 billion) for expatriates as of year-end 2011. The total represented less than 7% of the UAE banks' net loans and advances at the time. Although we believe this exposure will likely have increased since then--in line with the increased volume of real estate transactions in 2012 and 2013--we would still expect that residential mortgages constitute less than 10% of the UAE banks' lending books. We consequently expect the direct impact from the regulation on the aggregate lending to be rather limited.

What is the potential impact on property markets?

The regulation is aimed at the residential real estate markets, so should not affect commercial real estate transactions, unless they have a residential component. Unlike markets with a more developed mortgage industry, we understand that the great majority of real estate transactions in the UAE are financed through means other than mortgage loans. That said, mortgages do play a role, and more restrictive mortgage lending criteria are likely to prevent some potential buyers from pursuing a property purchase. Taken in combination with the recent hike in the property transfer fee in Dubai (to 4% from 2%), this is likely to have a dampening effect on volume and price growth in a market otherwise generally characterized by strong optimism.

Could more conservative LTV caps affect the ratings on UAE property developers?
We believe that the purpose of the mortgage caps is to reduce market volatility and ultimately loan losses. The aim is to prevent another boom-and-bust cycle that was witnessed in the UAE property markets over the past decade. With Dubai property prices edging close to the 2008 peak in certain high-end developments, we believe the Central Bank is concerned that prices may yet again head toward unsustainable levels. In our view, the mortgage regulation could make a positive difference.

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Credit FAQ: How The United Arab Emirates' Caps On Mortgage Loans Will Affect Banks And Property Developers

Standard & Poor's considers a stable evolution of the UAE property markets as positive for the credit profiles of the rated UAE property developers such as Emaar, Aldar, Dubai Investment Park, and TDIC. Although another property market boom could provide very significant short-term benefits to these issuers, a more gradual and sustainable recovery would be far better for the long-term credit standing of these entities. The mortgage regulation is also likely to reduce the risk of borrowers being unable to service their mortgages, which in turn is likely to reduce defaults on off-plan property purchases. Nevertheless, the cap on off-plan lending is an element of the regulation that could be considered negative for property developers. Off-plan sales are an effective risk-mitigation technique for the developers, and the regulation may have some impact on the demand for off-plan developments going forward.

Related Research
Stronger Corporate Governance Could Unlock Capital Market Access for Gulf Companies, Nov. 5, 2013 Credit FAQ: How Project Bonds Could Plug The Potential Gap In GCC Infrastructure Financing, Oct. 30, 2013 Gulf Islamic Banks Continue To Grow Faster Than Their Conventional Peers, But Profitability Rates Are Converging, Oct. 2, 2013 A Growing Economy And Strong Capitalization Keep Gulf Banks On A Path To Recovery, March 20, 2013 Low Interest Rates Should Keep Gulf Banks' Debt Issuance Levels Strong In 2013, March 4, 2013 Credit FAQ: How Will Saudi Arabia's New Mortgage Law Affect Domestic Banks?, Feb. 22, 2013 Exit European Banks, Enter Gulf Banks As Major Acquirers In The Region's Emerging Markets, Feb. 1, 2013

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