Real Estate Exposure Class
| No: 44047144 | Date(g): 27/12/2022 | Date(h): 4/6/1444 | Status: In-Force |
| 7.61 | Real estate is immovable property that is land, including agricultural land and forest, or anything treated as attached to land, in particular buildings, in contrast to being treated as movable/personal property. The real estate exposure asset class consists of: | |
| 1. | Exposures secured by real estate that are classified as “regulatory real estate” exposures. | |
| 2. | Exposures secured by real estate that are classified as “other real estate” exposures. | |
| 3. | Exposures that are classified as “land acquisition, development and construction” (ADC) exposures. | |
| 7.62 | “Regulatory real estate” exposures consist of: | |
| 1. | “Regulatory residential real estate” exposures that are not “materially dependent on cash flows generated by the property”. | |
| 2. | “Regulatory residential real estate” exposures that are “materially dependent on cash flows generated by the property”. | |
| 3. | “Regulatory commercial real estate” exposures that are not “materially dependent on cash flows generated by the property”. | |
| 4. | “Regulatory commercial real estate” exposures that are “materially dependent on cash flows generated by the property”. | |
| Regulatory real estate exposures | ||
| 7.63 | For an exposure secured by real estate to be classified as a “regulatory real estate” exposure, the loan must meet the following requirements: | |
| 1. | Finished property: | |
| The exposure must be secured by a fully completed immovable property. This requirement does not apply to forest, desert and agricultural land. This criteria can be met by loans to individuals that are secured by residential property under construction or land upon which residential property would be constructed, provided that: (i) the property is a one-to-four family residential housing unit that will be the primary residence of the borrower and the lending to the individual is not, in effect, indirectly financing land acquisition, development and construction exposures described in paragraph 7.82; or (ii) sovereign or PSEs involved have the legal powers and ability to ensure that the property under construction will be finished. | ||
| 2. | Legal enforceability: | |
| Any claim on the property taken must be legally enforceable in all relevant jurisdictions. The collateral agreement and the legal process underpinning it must be such that they provide for the bank to realize the value of the property within a reasonable time frame. | ||
| 3. | Claims over the property: | |
| The loan is a claim over the property where the lender bank holds a first lien over the property, or a single bank holds the first lien and any sequentially lower ranking lien(s) (i.e. there is no intermediate lien from another bank) over the same property. However, where junior liens20 provide the holder with a claim for collateral that is legally enforceable and constitute an effective credit risk mitigant, junior liens held by a different bank than the one holding the senior lien mayalso be recognized.21 In order to meet the above requirements, the national frameworks governing liens should ensure the following: (i) each bank holding a lien on a property can initiate the sale of the property independently from other entities holding a lien on the property; and (ii) where the sale of the property is not carried out by means of a public auction, entities holding a senior lien take reasonable steps to obtain a fair market value or the best price that may be obtained in the circumstances when exercising any power of sale on their own (i.e. it is not possible for the entity holding the senior lien to sell the property on its own at a discounted value in detriment of the junior lien). | ||
| 4. | Ability of the borrower to repay: | |
| The borrower must meet the requirements set according to paragraph 7.65. | ||
| 5. | Prudent value of property: | |
| The property must be valued according to the criteria in paragraphs 7.66 to 7.68 for determining the value in the loan-to- value ratio (LTV). Moreover, the value of the property must not depend materially on the performance of the borrower. | ||
| 6. | Required documentation: | |
| All the information required at loan origination and for monitoring purposes must be properly documented, including information on the ability of the borrower to repay and on the valuation of the property. | ||
| 7.64 | SAMA may require banks to increase the risk weights in the corresponding risk weight tables as appropriate if they are determined to be too low for real estate exposures based on default experience and other factors such as market price stability. Banks will be informed accordingly. | |
| 7.65 | Banks should put in place underwriting policies with respect to the granting of mortgage loans that include the assessment of the ability of the borrower to repay. Underwriting policies must define a metric(s) (such as the loan’s debt service coverage ratio) and specify its (their) corresponding relevant level(s) to conduct such assessment22. Underwriting policies must also be appropriate when the repayment of the mortgage loan depends materially on the cash flows generated by the property, including relevant metrics (such as an occupancy rate of the property). | |
| 7.66 | The LTV is the amount of the loan divided by the value of the property. When calculating the LTV, the loan amount will be reduced as the loan amortizes. The value of the property will be maintained at the value measured at origination, with the following exceptions: | |
| 1. | SAMA may require banks to revise the property value downward. If the value has been adjusted downwards, a subsequent upwards adjustment can be made but not to a higher value than the value at origination. | |
| 2. | The value must be adjusted if an extraordinary, idiosyncratic event occurs resulting in a permanent reduction of the property value. | |
| 3. | Modifications made to the property that unequivocally increase its value could also be considered in the LTV. | |
| 7.67 | The LTV must be prudently calculated in accordance with the following requirements: | |
| 1. | Amount of the loan: | |
| Includes the outstanding loan amount and any undrawn committed amount of the mortgage loan23. The loan amount must be calculated gross of any provisions and other risk mitigants, except for pledged deposits accounts with the lending bank that meet all requirements for on-balance sheet netting and have been unconditionally and irrevocably pledged for the sole purposes of redemption of the mortgage loan.24 | ||
| 2. | Value of the property: | |
| The valuation must be appraised independently25 using prudently conservative valuation criteria. To ensure that the value of the property is appraised in a prudently conservative manner, the valuation must exclude expectations on price increases and must be adjusted to take into account the potential for the current market price to be significantly above the value that would be sustainable over the life of the loan.26 | ||
| 7.68 | A guarantee or financial collateral may be recognized as a credit risk mitigant in relation to exposures secured by real estate if it qualifies as eligible collateral under the credit risk mitigation framework (chapter 9). This may include mortgage insurance27 if it meets the operational requirements of the credit risk mitigation framework for a guarantee. Banks may recognize these risk mitigants in calculating the exposure amount; however, the LTV bucket and risk weight to be applied to the exposure amount must be determined before the application of the appropriate credit risk mitigation technique. | |
| Definition of “regulatory residential real estate” exposures | ||||
| 7.69 | A “regulatory residential real estate” exposure is a regulatory real estate exposure that is secured by a property that has the nature of a dwelling and satisfies all applicable laws and regulations enabling the property to be occupied for housing purposes (i.e. residential property).28 | |||
| Definition of “regulatory commercial real estate” exposures | |||||||||||||||||||||||
| 7.70 | A “regulatory commercial real estate” exposure is regulatory real estate exposure that is not a regulatory residential real estate exposure. | ||||||||||||||||||||||
| Definition of exposures that are “materially dependent on cash flows generated by the property” | |||||||||||||||||||||||
| 7.71 | Regulatory real estate exposures (both residential and commercial) are classified as exposures that are “materially dependent on cash flows generated by the property” when the prospects for servicing the loan materially depend on the cash flows generated by the property securing the loan rather than on the underlying capacity of the borrower to service the debt from other sources. The primary source of these cash flows would generally be lease or rental payments, or the sale of the property. The distinguishing characteristic of these exposures compared to other regulatory real estate exposures is that both the servicing of the loan and the prospects for recovery in the event of default depend materially on the cash flows generated by the property securing the exposure. | ||||||||||||||||||||||
| 7.72 | It is expected that the material dependence condition, set out in paragraph 7.71 above, would predominantly apply to loans to corporates, MSMEs or SPVs, but is not restricted to those borrower types. As an example, a loan may be considered materially dependent if more than 50% of the income from the borrower used in the bank's assessment of its ability to service the loan is from cash flows generated by the residential property. | ||||||||||||||||||||||
| 7.73 | As exceptions to the definition contained in paragraph 7.71 above, the following types of regulatory real estate exposures are not classified as exposures that are materially dependent on cash flows generated by the property: | ||||||||||||||||||||||
| 1. | An exposure secured by a property that is the borrower’s primary residence; | ||||||||||||||||||||||
| 2. | An exposure secured by an income-producing residential housing unit, to an individual who has mortgaged less than two properties or housing units; | ||||||||||||||||||||||
| 3. | An exposure secured by residential real estate property to associations or cooperatives of individuals that are regulated under national law and exist with the only purpose of granting its members the use of a primary residence in the property securing the loans; and | ||||||||||||||||||||||
| 4. | An exposure secured by residential real estate property to public housing companies and not-for-profit associations regulated under national law that exist to serve social purposes and to offer tenants long-term housing. | ||||||||||||||||||||||
| Risk weights for regulatory residential real estate exposures that are not materially dependent on cash flows generated by the property | |||||||||||||||||||||||
| 7.74 | For regulatory residential real estate exposures that are not materially dependent on cash flow generated by the property, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV ratio in Table 9 below. The use of the risk weights in Table 9 is referred to as the “whole loan” approach. | ||||||||||||||||||||||
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| 7.75 | As an alternative to the whole loan approach for regulatory residential real estate exposures that are not materially dependent on cash flows generated by the property, banks may apply the “loan splitting” approach. Under the loan splitting approach, the risk weight of 20% is applied to the part of the exposure up to 55% of the property value and the risk weight of the counterparty (as prescribed in paragraph Error! Reference source not found.) is applied to the residual exposure29. Where there are liens on the property that are not held by the bank, the treatment is as follows: | ||||||||||||||||||||||
| 1. | Where a bank holds the junior lien and there are senior liens not held by the bank, to determine the part of the bank’s exposure that is eligible for the 20% risk weight, the amount of 55% of the property value should be reduced by the amount of the senior liens not held by the bank. For example, for a loan of SAR 70,000 to an individual secured on a property valued at SAR 100,000, where there is also a senior ranking lien of SAR 10,000 held by another institution, the bank will apply a risk weight of 20% to SAR 45,000 (=max (SAR 55,000 – SAR 10,000, 0)) of the exposure and, according to paragraph Error! Reference source not found. a risk weight of 75% to the residual exposure of SAR 25,000. (this does not take into account the other loan taken by the borrower from the senior lien holder). | ||||||||||||||||||||||
| 2. | Where liens not held by the bank rank pari passu with the bank’s lien, to determine the part of the bank’s exposure that is eligible for the 20% risk weight, the amount of 55% of the property value, reduced by the amount of more senior liens not held by the bank (if any), should be reduced by the product of: | ||||||||||||||||||||||
| (i) | 55% of the property value, reduced by the amount of any senior liens (if any, both held by the bank and held by other institutions); and | ||||||||||||||||||||||
| (ii) | The amount of liens not held by the bank that rank pari passu with the bank’s lien divided by the sum of all pari passu liens. For example, for a loan of SAR 70,000 to an individual secured on a property valued at SAR 100,000, where there is also a pari passu ranking lien of SAR 10,000 held by another institution, the bank will apply a risk weight of 20% to SAR 48,125 (=SAR 55,000 – SAR 55,000 * SAR 10,000/SAR 80,000) of the exposure and, according to CRE20.89(1), a risk weight of 75% to the residual exposure of SAR 21,875. If both the loan and the bank’s lien is only SAR 30,000 and there is additionally a more senior lien of SAR 10,000 not held by the bank, the property value remaining available is SAR 33,750 (= (SAR 55,000 – SAR 10,000) - ((SAR 55,000 – SAR 10,000) * SAR 10,000/(SAR 10,000+ SAR 30,000)), and the bank will apply a risk weight of 20% to SAR 30,000. | ||||||||||||||||||||||
| Risk weights for regulatory residential real estate exposures that are materially dependent on cash flows generated by the property | |||||||||||||||||||||
| 7.76 | For regulatory residential real estate exposures that are materially dependent on cash flows generated by the property, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV ratio in Table10 below. | ||||||||||||||||||||
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| Risk weights for regulatory commercial real estate exposures that are not materially dependent on cash flows generated by the property | |||||||||||||||||||||
| 7.77 | For regulatory commercial real estate exposures that are not materially dependent on cash flow generated by the property, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV in Table 11 below (which sets out a whole loan approach). The risk weight of the counterparty for the purposes of Table 11 below and 7.78 below is prescribed in paragraph Error! Reference source not found.. | ||||||||||||||||||||
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| 7.78 | Banks may apply the “loan splitting” approach, as an alternative to the whole loan approach, for regulatory commercial real estate exposures that are not materially dependent on cash flows generated by the property. Under the loan splitting approach, the risk weight of 60% or the risk weight of the counterparty, whichever is lower, is applied to the part of the exposure up to 55% of the property value30, and the risk weight of the counterparty is applied to the residual exposure | ||||||||||||||||||||
| Risk weights for regulatory commercial real estate exposures that are materially dependent on cash flows generated by the property | |||||||||||||
| 7.79 | For regulatory commercial real estate exposures that are materially dependent on cash flows generated by the property, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV in Table 12 below. | ||||||||||||
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| Definition of “other real estate” exposures and applicable risk weights | |||||||||||||
| 7.80 | An “other real estate” exposure is an exposure within the real estate asset class that is not a regulatory real estate exposure (as defined in paragraph 7.63 above) and is not a land ADC exposure (as defined in paragraph 7.82 below). | ||||||||||||
| 7.81 | Other real estate exposures are risk weighted as follows: | ||||||||||||
| 1. | The risk weight of the counterparty is used for other real estate exposures that are not materially dependent on the cash flows generated by the property. For exposures to individuals the risk weight applied will be 75%. For exposures to SMEs, the risk weight applied will be 85%. For exposures to other counterparties, the risk weight applied is the risk weight that would be assigned to an unsecured exposure to that counterparty. | ||||||||||||
| 2. | The risk weight of 150% is used for other real estate exposures that are materially dependent on the cash flows generated by the property. | ||||||||||||
| Definition of land acquisition, development and construction exposures and applicable risk weights | |||||||||||||
| 7.82 | Land ADC exposures31 refers to loans to companies or SPVs financing any of the land acquisition for development and construction purposes, or development and construction of any residential or commercial property. ADC exposures will be risk-weighted at 150%, unless they meet the criteria in paragraph 7.83. | ||||||||||||
| 7.83 | ADC exposures to residential real estate may be risk weighted at 100%, provided that the following criteria are met: | ||||||||||||
| 1. | prudential underwriting standards meet the requirements in paragraph 7.63 (i.e. the requirements that are used to classify regulatory real estate exposures) where applicable; | ||||||||||||
| 2. | Pre-sale or pre-lease contracts amount to a significant portion of total contracts or substantial equity at risk. Pre-sale or pre-lease contracts must be legally binding written contracts and the purchaser/renter must have made a substantial cash deposit which is subject to forfeiture if the contract is terminated. Equity at risk should be determined as an appropriate amount of borrower-contributed equity to the real estate’s appraised as-completed value. | ||||||||||||
20 Please refer to Art 24, the ‘Registered Real Estate Mortgage’s Law issued via Royal Decree No. M/49 dated 03/07/2012.
21 Likewise, this would apply to junior liens held by the same bank that holds the senior lien in case there is an intermediate lien from another bank (i.e. the senior and junior liens held by the bank are not in sequential ranking order
22 Metrics and levels for measuring the ability to repay should mirror the Financial Stability Board (FSB) Principles for sound residential mortgage underwriting practices (April 2012).
23 If a bank grants different loans secured by the same property and they are sequential in ranking order (i.e. there is no intermediate lien from another bank), the different loans should be considered as a single exposure for risk-weighting purposes, and the amount of the loans should be added to calculate the LTV
24 The loan amount of the junior liens must include all other loans secured with liens of equal or higher ranking than the bank’s lien securing the loan for purposes of defining the LTV bucket and risk weight for the junior lien. If there is insufficient information for ascertaining the ranking of the other liens, the bank should assume that these liens rank pari passu with the junior lien held by the bank. This treatment does not apply to exposures that are risk weighted according to the loan splitting approach (paragraphs 7.75 and 7.78), where the junior lien would be taken into account in the calculation of the value of the property. The bank will first determine the “base” risk weight based on Tables 9, 10, 11 or 12 as applicable and adjust the “base” risk weight by a multiplier of 1.25, for application to the loan amount of the junior lien. If the “base” risk weight corresponds to the lowest LTV bucket, the multiplier will not be applied. The resulting risk weight of multiplying the “base” risk weight by 1.25 will be capped at the risk weight applied to the exposure when the requirements in paragraph 7.63 are not met.
25 The valuation must be done independently from the bank’s mortgage acquisition, loan processing and loan decision process.
26 In the case where the mortgage loan is financing the purchase of the property, the value of the property for LTV purposes will not be higher than the effective purchase price.
27 A bank’s use of mortgage insurance should mirror the FSB Principles for sound residential mortgage underwriting (April 2012).
28 For residential property under construction described in paragraph 7.63(1), this means there should be an expectation that the property will satisfy all applicable laws and regulations enabling the property to be occupied for housing purposes.
29 For example, for a loan of SAR 70,000 to an individual secured on a property valued at SAR 100,000, the bank will apply a risk weight of 20% to SAR 55,000 of the exposure and, according to paragraph 7.82(1), a risk weight of 75% to the residual exposure of SAR 15,000. This gives total risk weighted assets for the exposure of SAR 22,250 = (0.20 * SAR 55,000) + (0.75 * SAR 15,000).
30 Where there are liens on the property that are not held by the bank, the part of the exposure up to 55% of the property value should be reduced by the amount of the senior liens not held by the bank and by a pro-rata percentage of any liens pari passu with the bank’s lien but not held by the bank. See paragraph 7.75 for examples of how this methodology applies in the case of residential retail exposures.
31 ADC exposures do not include the acquisition of forest or desert or agricultural land, where there is no planning consent or intention to apply for planning consent.