Banks hoard Fed cuts

Regional mortgage lenders are refusing to pass falling US interest rates on to customers in the emirates.
Banks hoard Fed cuts
By Claire Ferris-Lay and Sara Hamdan
Thu 29 May 2008 04:00 AM

The US Federal Reserve has lowered its interest rates seven times since September 18, 2007, bringing down the cost of borrowing to just 2%.

The successive rate cuts should have sent mortgage rates tumbling in the UAE as banks benefited from cheaper funding costs. Instead banks including HSBC, Lloyds TSB and Barclays have resisted lowering their rates to below the range of 7.1% to 8.5%.

At his office in Dubai Media City, business analyst Nasir Aijaz produces a binder full of correspondence with HSBC Bank Middle East, a unit of Europe's biggest bank by market value.

His emails relate to why the bank has failed to pass on successive Fed rate cuts on the variable rate mortgage he took out - even as its own borrowing costs have been slashed.

"When I took out my mortgage, one of the best rates available was with HSBC, which was offering 7.25% if I made a down payment of 25%.

My understanding was that if the Fed rate dropped in the future, I would get a better interest rate," he says, citing the terms and conditions of the mortgage published on HSBC's own website.

It states that the bank may change its mortgage rate "based on movements in the USA Fed Funds Rate".

Despite all of his letters to the bank Aijaz has failed to get his interest rate lowered. He has attempted to contact both the UAE Central Bank and the Ministry of Economy's consumer protection unit with his grievances, but has yet to receive a response.

International banks have been attracted to the UAE mortgage market since 2002 when the introduction of foreign ownership rights in Dubai triggered a six-year property boom.

Demand for new properties could top 500,000 units by 2012 with a total transaction value of more than US$190bn, according to research from EFG-Hermes.

The US has been slashing interest rates in a bid to stave off recession in the wake of the subprime mortgage crisis which has led to credit losses and write-downs totaling about US$383bn since last year among the world's largest banks.

Gulf economies including the UAE and Qatar have been forced to cut their benchmark interest rates as the Fed has lowered its own rates, in order to maintain their currency pegs with the ailing US dollar.

Most international banks offering mortgages in the UAE advertise rates of between 7.1% and 8.5% but often require substantial deposits of up to 25% for customers to benefit from the lowest rates available.

This compares to mortgage rates averaging around 5.5% in the US, 2.4% in Japan, and 2.5% in Hong Kong according to financial website the US Fed raised its interest rate by a quarter of a percent in June 2006, HSBC Bank Middle East followed suit, increasing its mortgage lending rate by the same measure.

Since then the Fed has cut its rate seven times in succession bringing rates down by 3.25%. The HSBC Middle East rate has remained unchanged.

The bank's refusal to lower its lending rates has provoked fury from customers who have been waiting for a reduction in their repayments since the Fed started cutting last September.

While HSBC has been hit hard by subprime losses in the US, its Middle East business is booming. The bank set aside US$3.2bn to cover bad loans in the US when it published its first-quarter earnings on May 12. It has also cut some 2000 jobs in response to declining US earnings.

That contrasts starkly with its performance in the Middle East where profits increased "across all of our customer groups and global businesses," according to its latest earnings statement.

HSBC's subprime woe started when it paid about US$15.5bn for Household International Inc in 2003, one of the largest subprime lenders.

In the UAE, the bank is coming under pressure from customers to drop its rates in line with its published conditions.

Aijaz cites last month's AED2.35bn (US$612m) bond sale by HSBC Holdings, the largest conventional dirham bond sale to be sold by any bank, as evidence of how the company is making handsome profits from the difference between how much it pays for its own funds, and how much it charges its customers for home loans.

The five-year HSBC bonds were priced at 70 basis points above the six-month Emirates Interbank Offered Rate known as ‘EIBOR' - the interest rate charged by banks in the UAE for transactions between themselves.

"HSBC has just borrowed US$612m at 70 basis points above EIBOR so the current cost of funds for HSBC in the UAE is approximately 2.7% - keeping a spread of 4.5% to 5.5% is very unjustified," he says.

Darryl Tarr, a pilot who bought his villa in Dubai's Arabian Ranches development is another of the bank's customers who is critical of their refusal to lower rates.

"I'm disappointed they are exploiting the market here," says Tarr, who bought his villa in Dubai three years ago. "They need to wake up."

Tarr says he chose the mortgage because the contract said that the rate was flexible. "Now they seem to have moved the goalposts and they are profiting from this," he says.

James Howard, another Dubai-based homeowner, took out a mortgage with HSBC in 2006 after previously being with Amlak, and has complained repeatedly to the bank over its refusal to lower rates in recent months.

"I think they are rebuilding their balance sheet from the subprime fallout," says Howard, who is considering referring his own case to the Jersey Financial Services Commission, the Channel Islands-based regulator of HSBC Middle East. "There is no way they would get away with this sort of nonsense in the UK."HSBC regional home finance head Gul Khan said that the company's mortgages were based on long-term dirham interest rates and were not influenced by the US Federal Funds Rate.

"The US Federal Funds Rate is the dollar short-term interest rate while mortgages are based on dirham long-term interest rates," he said in an e-mailed statement.

This statement contradicts the information carried on the bank's website which refers specifically to the USA Fed Funds Rate. Khan added that the bank's rates would be "revised" on July 1, 2008.

"Although the EIBOR rate has come down, the banks haven't followed suit," says Antony Anderton, head of mortgages for Dubai-based Smith & Ken Mortgage Services. "It boils down to the fact that they have a captive market here."

Local banks are using ‘risk' as a justification for charging higher interest rates in the UAE than in other markets with a comparable underlying cost of finance, according to Jean Luc Desbois, managing director of Home Matters, a Dubai-based mortgage consultancy firm.

"They are saying the market is not like it is in the UK or the US and it is still a bit unknown. So the banks are justifying themselves by saying they are building in a risk premium - they are putting in margins of 3 to 4% above EIBOR which is too much really."

Desbois also says that the high interest rates being charged could amplify the impact of any downturn in the market where prices dropped.

"The justification for anyone paying 7 to 8% on their mortgage is that you believe you will be making double-digit returns," he says.

"The crunch will come when the market starts levelling out. As soon as that growth stops then that could jeopardise the market," he warns.

Lloyds TSB Middle East consumer banking director Richard Musty said the bank's dirham-denominated mortgage rate was 7.99% - after being reduced by 0.51% in April.

"Our mortgage rate is not directly linked to the Federal Reserve rate. It is managed through a dynamic pricing process, taking into account the local market circumstances, the composition of our product range and the rates of our competitors," said Musty.

Barclays spokeswoman Umayma Abubakar refused to answer any questions relating to recent Fed rate cuts and would only confirm the bank's current interest rates which range between 7.25% and 8.55%, having been cut by 0.57% in December 2007.

The UAE operations of both Lloyds TSB and Barclays are regulated by the UK-based Financial Services Authority (FSA).

However, FSA spokesman Robin Gordon-Walker said variable rate mortgages were not covered by the FSA's remit. "That is not an area we regulate," he said.

The UAE's Ministry of Economy's consumer protection department did not respond to faxed questions.

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