the world bank setting priorities for housing finance in armenia britt gwinner may 29, 2005

The World The World BankBank

Setting Priorities for Housing Financein Armenia

Britt Gwinner

May 29, 2005

Armenia Housing Finance2


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



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



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



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



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



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)




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)




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



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



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



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



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.

the world bank setting priorities for housing finance in armenia britt gwinner may 29, 2005

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