AMID THE CRISIS

The mortgage crisis, which has shaken the US economy and brought a number of European banks to the brink of bankruptcy, continues. Statistical data on the US economy continue to indicate its weakness. For example, the residential construction sector in the United States in January was only slightly above a 16-year low.

Analysts interviewed by the Bloomberg agency say that this is a signal that the most profound recession of the last quarter of a century will continue to adversely affect the US economy in 2008. The number of new development projects last month is estimated to have increased by 0.4% - up to 1.01 million, if extrapolated for the entire year. The number of construction permits, which is an indicator of the number of future projects, has fallen by 2.2% to 1.045 million, which is another 16-year low. These factors will probably force the Federal Reserve System to extend the series of successive interest rate cuts because the risk of a further weakening of the economy exceeds inflation-related risks.

The US mortgage crisis has been blown to European shores by the Atlantic winds. Many banks specializing in these types of loans are either already bankrupt or are being nationalized to avert total disaster. Neighbouring Russia is worried about the international mortgage market too, although it is not expected to have a big effect on the domestic market. So does this affect Azerbaijan, where the mortgage sector is only in the initial stages of development?

Will it happen?

Despite the suspension by the Azerbaijani Mortgage Fund (AMF) of mortgage loans from the national budget, interest in this sector is as keen as ever. Of course, the criteria set by local banks are much tighter than the AMF used to have, but they have their customers. It could not be any other way. Residential real estate prices are rising steadily in Azerbaijan, and so is average personal income (in January 2008 alone, it was 32.9% higher than in January 2007, reaching a total of AZN 1,218.7 million).

This explains the growth in stock prices in this sector. Last year 1,743 issues of mortgage stocks, worth AZN 69 million, were registered in Azerbaijan. This is 18 times higher than 2006, when only 193 issues, totalling AZN 5 million, were registered. The issuing of housing certificates is also on the increase: seven construction companies issued 4,219 certificates for 469,000 square metres of residential space, whereas in 2006 1,174 certificates were issued for 117,000 square metres.

At the same time, income per person (AZN 143.2) and average monthly salary per person (AZN 230) are still far below a level which would enable the population to buy an apartment within one year. This is why a mortgage is the only affordable option for families wishing to acquire real estate today.

However, as mentioned above, Azerbaijani banks offer quite steep terms for mortgage loans. First and foremost, interest rates are very high, standing at 15-20% per year. The repayment period is shorter than that offered by the AMF - from 5 to 20 years - so these loans are not always affordable for the so-called "middle class." Young families and employees of national budget-funded organizations are particularly vulnerable. They are waiting with great impatience for the resumption of AFM funding. But will it be resumed?

National bank changes the mortgage model

As early as last year, National Bank Board Chairman, Elman Rustamov, said that mortgage procedures would be changed. In particular, the state was to stop financing commercial mortgage loans. "The state should only be concerned with social mortgage loans. Commercial loans should be regulated by the market, as is the case elsewhere in the world," said Rustamov. In his opinion, the Azerbaijani banking market is quite capable of dealing with commercial mortgage loans: "The fact that AZN 220 million worth of loans were issued on top of state-funded mortgage loans shows that there is a demand and need for mortgage loans in the country. As for the interest rate on social mortgage loans, there will be no change."

It has emerged just recently that the National Bank has proposed a change in the form of the mortgage system in Azerbaijan. It elaborated on the law, "On building the banks of Azerbaijan" and sent it to the Government for discussion.

According to Deputy National Bank Board Chairman, Rufat Aslanli, the provisions of the new law are different from the existing mortgage model in that a special savings bank will be created in which customers will accumulate funds for a period of time and then, by adding a loan to that sum, will buy real estate. The purchased property will remain the property of the bank as a form of security until the expiry of the credit term.

"This model was used in Germany after World War II, which is why it is called the German model," Aslanli said. He also noted that some European banks issue mortgage loans under the model, which envisages secured mortgage bonds.

The National Bank executive said that the German Commerzbank had expressed an interest in funding mortgage transactions in Azerbaijan. "During talks with Commerzbank management in Baku, we told them about the draft law and they showed an interest. Our guests said that they have subsidiary banks which operate to the same model and, if the law is passed, we will discuss details of cooperation in the future," Aslanli concluded.

Periodically, various initiative groups propose amendments to the law, "On mortgage."  They mainly target the socially vulnerable strata, whose average monthly income precludes any possibility of owning real estate. For example, a group of young Milli Meclis members recently proposed the introduction of favourable mortgage terms for employees of the education and health care sectors.

Fuad Muradov, a member of the group, said that there are international precedents. "The relevant ministries could create this mechanism by holding talks with the Government. We want to improve the law," he said.

And the banks are still faring well…

At the same time, foreign experts say that the extent of residential construction in Azerbaijan does not correspond to the total amount of mortgage loans. For example, in the opinion of Santiago Ruiz-Morales, Central Asia Mortgage Project Manager of the International Finance Corporation (a World Bank subsidiary), the residential construction sector is developing at an accelerated pace in the country, but the mortgage sector plays a minor role in its development, due to limited resources. "To meet the growing market demand for residential construction, the ratio should be brought closer to the international norm, although I am certain that the country is moving in the right direction," he said.

In the meantime, to avoid the problems which haunt international financial markets following the mortgage crisis in the United States, Azerbaijani banks have set a limit of 20% of assets for long-term loans. This limit is necessary because external funding sources are usually used for shorter-term loans, rather than for the usually long-term mortgage loans (10-30 years). Only if this condition is met can short-term deposits be considered stable, whereas the remaining 80% can be used to insure against the risks of long-term loans. In addition the banks, whose mechanisms are different in different countries, need refinancing.

Further, Morales drew attention to the increased risks associated with long-term mortgage loans in dollars, the most common lending currency in Azerbaijan. "If the borrower has no dollar assets, the risk becomes significant, due to variations in the exchange rate," said the consultant.

In the mean time, Azerbaijani banks are not particularly worried by the world crisis; on the contrary, they are implementing their own mortgage projects and, professedly, quite successfully too.  However, as the head of one of the leading local banks admitted, attracting foreign credit resources to this loan sector has become difficult, but it is still possible. The country's 10 leading banks are already implementing their own mortgage projects and one of them has even opened a separate subsidiary to specialize in this sector.

So it may be said that the mortgage loan sector has gained a foothold in Azerbaijan and established a customer base. This means that the business will continue to develop despite the negative international trends.