Saudi Arabia and its banks are exploring issuance of residential mortgage-backed securities (RMBS) as a means of attracting foreign capital into the kingdom and freeing up liquidity to help fund the country’s Vision 2030 economic strategy.

The country's banking sector has rapidly expanded its presence in international bond markets in recent years, leaning heavily on credit investors to raise funding and shore up capital ratios. Saudi financial institutions have issued US$6.05bn of senior and subordinated bonds and sukuk in 2024, more than three times the previous year’s supply.

Establishing a functioning RMBS market would be the next frontier, allowing local banks to free up some of the US$170bn of their balance sheets that is currently taken up with residential mortgages.

“Given the scale of Vision 2030 and the associated financing needs, we think that banks need to attract alternative funding sources,” said Mohamed Damak, global head of Islamic finance at S&P.

“They have already been tapping international capital markets through bonds and sukuk in order to fund the growth of their balance sheets. The other alternative is selling a portion of their existing assets in the form of residential mortgage-backed securities.”

Saudi Arabia needs to pull every lever it can to bring cash into the kingdom and unlock local liquidity. Vision 2030 – the government programme intended to diversify the economy away from oil – requires enormous amounts of investment.

Total government spending for 2025 is estimated to reach SR1.285trn (US$340bn), while total revenues are projected to come in at around SR1.184trn, leaving a roughly SR101bn fiscal deficit equating to around 2.3% of gross domestic product.

RMBS would allow banks to reallocate funds to corporate lending and support projects linked to Vision 2030.

But real estate finance is still in its infancy in Saudi Arabia. The legislation enabling the creation of mortgages was only put in place in 2012. Home financing was possible before that but the obligor would have to transfer the title to a special purpose vehicle created by the bank providing the financing.

Mortgage growth only really picked up in 2019 after the Saudi Central Bank issued the standard documents for sharia-compliant ijara and murabaha mortgages in 2018. The vast majority of mortgages originated in Saudi Arabia are Islamic.

Laying the foundations

In August, the Saudi Real Estate Refinancing Company (SRC), an entity established and owned by the Public Investment Fund to inject life into the Saudi housing finance market, signed a memorandum of understanding with BlackRock to work towards that aim while expanding the participation of institutional investors in the sector.

The development of a Saudi RMBS market is one of the SRC’s publicly stated goals. Although local banks may look to issue RMBS directly, the SRC also has the potential to be the market’s key issuing vehicle, along the lines of the government-sponsored enterprises Fannie Mae and Freddie Mac in the US.

The SRC's mandate directs it to buy mortgages from banks and other financial institutions to help create space for new lending. So far, it has funded its activities through the issuance of riyal-denominated government-guaranteed sukuk, but funding could also be raised in future by packaging up and selling its mortgage holdings.

At almost SR28bn at the end of June, the SRC's mortgage portfolio accounts for just over 4% of the overall SR639.5bn national mortgage market.

The youth of the Saudi mortgage market helps to explain why local lenders have so far only sold a small proportion of their mortgages, since they were all originated during an era of ultra-low interest rates.

“Then rates went up,” said S&P's Damak. “IFRS tells you that whenever you want to remove an asset from your balance sheet to sell it you have to fair-value it. And, given that the vast majority of these mortgages are fixed rate, with the increase in interest rates, if you revalue them you end up crystallising losses.”

Buyers, foreclosures and currencies

In order to create a market that would allow Saudi Arabia’s banks or the SRC to securitise large parts of their mortgage portfolios, a number of obstacles would have to be overcome.

The big question is: who would buy Saudi RMBS? There is no existing investor base for asset-backed securities in the Middle East, while ABS investors in the West are not familiar with Saudi Arabia’s banks or their lending practices.

“The starting point is understanding the jurisdiction, which I have no understanding of, and the history of the mortgage market,” said one Europe-based RMBS investor. “What kind of data can they provide? And then it will also come down to secondary market liquidity. You would need a huge premium to be getting involved in anything like that.”

RMBS investors taking a closer look into the Saudi mortgage market may find more reasons to be wary. While they are used to mortgage lenders being able to foreclose on a home and sell it into a functioning housing market if the borrower defaults, it is still not entirely clear that they could rely on this remedy in Saudi Arabia.

“The Saudi banks say that the legal environment allows them to take possession of properties, but the question is, from a reputational perspective, can you foreclose on an asset because the borrower has trouble repaying?” said Damak. “In reality, they try to work out solutions so that they don’t put people on the street.”

For potential investors, that is a problem.

“We’re at a point in the [European] market where all the nuts and bolts are sorted and we can focus on the actual credit risk associated with the assets,” said a second Europe-based RMBS investor. “I’ve not got a huge amount of interest in going back to a place where we don’t understand how the structures might actually work.”

Currency could also pose a barrier to international investment, in particular from European funds. US investors may find the going easier because of the peg between the riyal and the dollar. Saudi banks have always picked US dollars when issuing bonds internationally and RMBS would likely follow suit.

The first investor suggested that while traditional ABS investors might struggle, specialist funds and private credit investors, in the broadest sense, would be a reasonable target investor base.

“My intuition is it would go to private credit, fast money, and it wouldn’t necessarily see the light of the day in normal public markets,” the investor said.

Additional reporting by Giulia Lasagni