Setting Priorities for Housing Finance in Armenia

1
Setting Priorities for Housing Financein Armenia

• Britt Gwinner
• May 29, 2005

2
Overview

• The Armenian housing finance market holds
  promise, banks are lending to upper income
  households
• Issues include depreciated housing stock and
  deferred maintenance, legal framework, lender
  capacity, short maturities, varying contract
  terms, lack of market data, market weakness
  outside of Yerevan
• Capital markets are useless if primary markets
  are weak - the focus for reforms should be the
  primary market
• A liquidity facility could lead to longer
  maturities, greater affordability, and provide
  incentives to improve risk management

3
Robust housing finance createsjobs and growth

• Countries with strong financial systems grow
  faster than countries without them
• Strong housing finance systems generate savings
  and improved living conditions for moderate and
  low income households, local employment (building
  materials, skilled labor, financial
  professionals) and growth
• In the U.S., employment in housing and
  housing-related industries is estimated to have
  accounted for 43 of the rise in private-sector
  payrolls since late 2001

4
Mortgage lending in Armenia is limited, short
term, lacks risk-based pricing

• Mortgage lending small but growing
• Accounted for about 4 of total bank assets end
  March, 2005 versus 1.5 at end 2003
• Macro conditions are good low inflation, 12
  annual GDP growth 01-04, important remittance
  flows
• Most mortgages are to upper-income households in
  and around Yerevan, for short terms (3 5
  years), at high rates of interest (13 to 19),
  in USD
• Non-standard contract and financial terms
• Mortgage lenders do not currently calculate the
  cost of risk, or price on a risk-adjusted basis

5
Lending should extend beyond purchase money
mortgages

• Renovation loans for windows, kitchens, floors,
  should be a big business for moderate and low
  income households, given the privatization of
  apartments
• Only 12 percent of lending was for renovations at
  end 2004
• Renovation loans may be extended for shorter
  terms without a lien
• Obstacle maintenance, responsibility for common
  spaces and structures (roofs, stairwells)
• Eventually, should lend to condominium
  associations for capital improvements

6
Construction finance should be developed

• Construction currently funded by developer equity
  and buyer down payments
• Limits the market to upper income buyers
• Much of the risk is borne by would-be buyers, who
  have limited means to protect themselves
• Many emerging markets have established legal
  means to enable cheaper and more stable
  construction finance
• Partly constructed buildings are given standing
  in law as assets and so may serve as collateral
• Trusts, escrow accounts, enforced reporting
  requirements
• Securitization of construction loans

7
Primary market recommendations (1)

• Improve the policy, legal, and regulatory
  framework (educate the judiciary, clarify and
  strengthen foreclosure auctions and eviction
  processes)
• Training programs and regulatory incentives could
  address lender shortcomings
• Limited lender experience in underwriting and
  managing the risks of long term mortgage credit
• How to interact with borrowers to mitigate
  default risk when payments are late (e.g.,
  counseling, loan workouts, deed in lieu)

8
Primary market recommendations (2)

• Improve transparency and liquidity
• Government, banks, realtors, and appraisers
  should systematically gather and publish data on
  housing and land prices and transactions
• Banks should disclose data on mortgage lending as
  part of their periodic public disclosures (e.g.,
  volume, weighted average maturity, weighted
  average yield)
• The government should promulgate consumer
  disclosure regulations on loan terms and risks,
  especially for non-dram loans
• Government and industry can cooperate to promote
  standards and professional training for
  appraisers, realtors, mortgage finance
  professionals (already started with realtors,
  work could be done on appraisal standards)

9
Primary market recommendations (3)

• Address maintenance shortfalls work with
  municipalities, collect fees adequate to cover
  all costs, privatize maintenance companies
• Government, banks, realtors should pursue a
  public education program for condominium
  associations and improved maintenance
• Find a means to address mixed income populations
  within buildings
• Financial aid for lower income residents

10
Securitization not currently feasible

• Long-lived contracts - requires substantial trust
  in professional standards for and transparency of
  financial institutions and intermediaries
  (trustees, appraisers, rating agencies, audit,
  accounting, etc.)
• Requires public data on loan performance,
  property values
• Requires institutional investors
• Insurers all reinsure internationally, so
  reserves are minimal
• State pension system lacks reserves, absence of
  private pension
• Eventually needs credit ratings, a yield curve,
  reference rates
• Needs a steady monthly production of new mortgage
  originations to maintain deal flow, cover
  issuance costs

11
The Role of a Liquidity Facility

• Limit credit risk should provide long term
  funding with full recourse to primary lenders
  upon default
• Provide incentives for banks to manage credit
  risk, standardize mortgage terms
• Provide long term funding for loans that meet
  financial, underwriting, and contractual
  standards
• Government-sponsored facility should be separate
  from the bank regulator
• Conflicts of interest can arise from the
  regulator owning a lending institution, e.g., the
  U.S. Federal Home Loan Bank Board during the
  1980s Savings and Loan crisis...
• Governance, ownership structure should include
  private sector participants

12
Mortgage bonds could be a medium term goal

• A useful step after the liquidity facility and
  deposit insurance for banks as they build
  financial strength, earnings, and credibility
• Would serve as an investment vehicle for
  insurers, banks
• Less demanding than securitization
• Legislation is required for a sustainable
  mortgage bond market
• Establish the protection of collateral pool in
  case of failure of the issuing bank
• Requirements for the quality of the collateral
  pool, any permitted alternative collateral
• No need for specialized lending institutions

13
Conclusions

• Bankers are interested in mortgage markets,
  originations are rising provide training,
  market and regulatory incentives for them to
  start manage risk effectively now
• Successful focus on the primary market will lead
  the way for the development of the secondary
  market
• Restrict the government role to 1) creating the
  legal and regulatory framework 2) facilitating
  technical assistance and professional norms and
  3) providing long term liquidity to extend
  maturities and so make lending affordable to
  lower and moderate income households.