"MORTGAGE" MARKET STEAMS FORWARD EVEN AS NEW LAW

UNCLAS SECTION 01 OF 03 ISTANBUL 000798

SIPDIS

SENSITIVE

STATE FOR EUR/SE AND EB/IFD
TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER

E.O. 12958: N/A
TAGS: EFIN ECON TU
SUBJECT: "MORTGAGE" MARKET STEAMS FORWARD EVEN AS NEW LAW
LAGS

REF: ISTANBUL 392

Sensitive but unclassified. Not for internet distribution.
This message was coordinated with Embassy Ankara.


1. (SBU) Summary: Turkey's newfound macroeconomic stability
and failing interest rates have brought a boom in consumer
lending, including especially a dramatic increase in
"mortgage" financing for home purchases. Housing loans grew
four fold over the course of 2005, from $1.8 billion to $7.5
billion, and registered a more tempered though still healthy
growth rate of 36 percent through the first quarter of 2006,
as Turkish banks have aggressively sought to expand their
market share. The rapid loan growth has fueled a boom in
Turkey's construction sector, but has preceded long-awaited
reform legislation, as the country's draft mortgage law has
not yet been approved by parliament. Experts at the Capital
Markets Board in Ankara predict passage before parliament's
summer recess, though they concede that a number of important
issues, including a tax deduction for mortgage interest,
remain unresolved. The explosive growth in home loans raises
the question of how well banks will manage the risks. On the
other hand, the sharp increase in home loans is another sign
of the normalization of the Turkish economy and of the
deepening of its stunted financial markets. End Summary.

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Housing Finance Boom...
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2. (U) Recent figures highlight continued, albeit more
tempered, growth in Turkey's fast growing market for home
finance. (Note: experts stress that until the draft
mortgage law passes parliament (see below),such finance
cannot technically be considered "mortgages" though it
operates on the same principles. End Note.) After
increasing four-fold over 2005 from $1.8 billion to $7.5
billion, mortgage loans increased a further 36 percent in the
first quarter of 2006. Capital Markets Board Chairman Dogan
Cansizlar recently predicted total housing loans could reach
$19 billion by the end of 2006. Low interest rates
(generally around 1.1 - 1.2 percent per month) and the
availability of long-term loans (up to 25 years by some
banks) have encouraged high demand for real estate,
especially in major metropolitan areas like Istanbul, Ankara
and Izmir. Despite the availability of long maturities,
however, most Turks have preferred to limit their horizon:
Central Bank data shows the preferred loan term is 5-10 years
(some 45 percent of the total),with an additional 28 percent
of loans for only a 3-5 year term. The expanded availability
of credit has fueled a construction boom: the sector led the
economy in 2005 with 19.7 percent growth. 1.362 million
housing units were sold in that year, and licenses were
obtained for an additional 511,000, up 55 percent from 2004.
Total investment in real estate units reached $26.6 billion.


3. (U) Experts differ on whether there is a housing deficit
in Turkey. While the Association of Real Estate Investment
Companies (GYODER) argues that nationally there is no such
deficit, the head of Turkey's public housing authority last
year cited a shortfall of 2.5 million housing units. Even
GYODER sees large growth opportunities for the construction
sector, however, based on the fact that 38 percent of
Turkey's existing 13.6 million houses were built without a
building license. In Istanbul, that percentage is even
higher at 52%. With mortgages, experts believe, will come
the opportunity to satisfy demand for housing that is up to
code.

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...but still room for expansion
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4. (SBU) Our banking contacts note that though it has come
a long way, Turkey has far to go before it approaches
mortgage levels typical of developing countries, much less
developed Western European markets. They note that mortgage
debt in most developing countries averages 10-15 percent of
GDP, which for Turkey would translate into a $40-50 billion
market. In the 25 EU countries, housing loans are 40 percent
of GDP. Turkey's current level translates to 2.5 - 3 percent
of GDP. They also note that at current interest rates, only
the top 10 percent of the population is able to afford home
finance. One senior banker at Kocbank/Yapi Kredi explained
to us that to date the mortgage market extends only to the
affluent "A" part of the population, which has an income of
above $25,000. Rates will have to drop significantly, he
estimated, before the more marginal "B" (above $12,500) and
"C-plus" (above $7,500) segments of the population enter the
market. Experts at the Capital Markets Board agreed, arguing
that interest deductibility could play an important role in
making home finance available to a larger proportion of the
population. With deductibility and long term finance, they
argued, the "middle class" of civil servants and middle
management would be able to afford property.

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A Loss-leader for Banks
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5. (SBU) Though still expensive for most Turks, home
finance rates have declined dramatically over the past year,
as banks have engaged in a contest for market share that has
brought returns down to near and in some cases even below the
bank's cost of financing. Market leaders Isbank and Akbank,
for instance, are currently offering mortgages at 14 percent
per year, while they pay large depositors up to 18 percent on
their Turkish lira deposits. Our contacts agree that the
current situation is not sustainable, though they note it is
cushioned by the fact that mortgages are not financed by such
deposits but via syndicated loans. They predict that as
interest rates continue to decline, the banks' positions will
become more sustainable. For now, banks are counting on the
fact that once they have a mortgage customer, that customer
typically also takes on other more profitable product lines,
including credit cards and auto loans.


6. (SBU) Industry contacts also note that the fact that the
relatively short maturity of Turkish housing loans also
limits the banks' exposure, though even with the short 5-7
year term there is a maturity mismatch with the syndicated
loans and other assets (particularly savings deposits--which
have an average maturity of only two months) with which
mortgages are financed. That risk will increase as mortgage
maturities lengthen, they note, and will require increasing
attention to risk management by Turkish banks, particularly
as they reach down into segments of the population that
hitherto were not considered "bankable." Experts also see
some exchange rate risk, given the dependence on financing
via syndicated loans. Banking Regulators should pay close
attention to this issue, one industry expert told us, while
banks need to become more sophisticated in using hedging
strategies to limit their exposure.


7. (SBU) Even with the recent market expansion, bankers
note that defaults have not been an issue, with the NPL ratio
for mortgages hovering at an anemic .02 percent, far below
the 6 percent rate for credit cards. (Privately, some
speculate the increase in mortgage lending may explain some
part of the recent rise in credit card defaults.)
Culturally, they note, like others Turks will forego any
other expenditure in order to pay their mortgage, as the
title to their property is the last thing they want to give
up. Shorter terms and focus on top echelons of society have
also limited defaults.

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A Regulatory Vacuum
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8. (SBU) The rapid expansion of housing loans has preceded
the adoption by the Turkish parliament of changes in the law
that the industry considers essential for creation of a
stable and sustainable mortgage market. Among the changes
the law would introduce are the possibility of offering
variable rate mortgages (banned since the 1994 crisis),the
ability to charge a fee for early payment, and in the case of
default, the ability for lenders to go directly after the
underlying property, without first seeking a bankruptcy
judgment against the borrower. The new law is also expected
to play an important role in helping Turkey deepen its still
shallow capital markets, by enabling the securitization and
resale of mortgagees via either covered bonds or
mortgage-backed securities, and by creating rules governing
secondary market institutions. Creation of such a market is
critical, our SPK contacts tell us, because Turkish capital
alone is insufficient to finance the sector. International
capital is needed as well. Recent conferences, including
this month's "Summit on Turkish Real Estate," show that
international investors are ready to move, provided the legal
framework is completed.


9. (SBU) In recent meetings in Ankara, SPK experts, who
wrote the draft mortgage law, told Emboffs that it had
reached the Parliament's Plan and Budget Commission in late
April, and that they expected its passage before Parliament's
summer recess. A number of issues remain unresolved,
however, including particularly whether or not mortgage
interest will be tax deductible. The SPK originally proposed
such a deduction, but the government, fearing a loss of tax
revenue (and with the IMF's encouragement),removed the
provision. Parliament has since reintroduced it. Our SPK
experts argue that the deduction would be tax neutral, since
it would encourage more accurate reporting of sale values and
thereby bring home sales out of the "shadow economy." Some
Istanbul economists are skeptical of this claim, however,
noting that they deduction is likely to be capped at some
level, and thus will not bring accurate reporting of home
sales and their values. The IMF Resrep told Emboffs that the
IMF is generally opposed to the tax-deductibility of mortgage
interest as not in keeping with international best practice.
In Turkey's specific case, the Fund believes this provision
would reduce collections by providing an offset to existing
taxable income.


10. (SBU) Another issue relates to Turkey's withholding tax,
which has caused concern in some financial circles, even
though until recently its larger market has been minimal
(reftel). The SPK is pressing for exclusion of
mortgage-backed securities from the tax, fearing that
otherwise the desired foreign investment will not
materialize, or at the very least investors will demand
higher returns to compensate for the 15 percent tax. In its
view, this would be at cross purposes with the law's overall
goal of encouraging more affordable housing finance.
Industry experts agree. Former SPK Deputy Department Head
Bahadir Teker, now an Istanbul consultant, told the May 2006
Istanbul Real Estate Summit that this issue is "critical," in
that if it remains on the books, there will "not be enough
liquidity" in the secondary market.

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Comment:
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11. (SBU) The emergence of mortgage lending is yet another
sign of the increasing "normalization" of the Turkish
economy. Its continued spread will play an important role,
together with still developing private pension schemes, in
the deepening and widening of the country's hithertoo quite
shallow financial markets. It will also allow development of
a dramatically wider housing market and renewal of the
country's often inadequate housing stock. End Comment
JONES