This record is a partial extract of the original cable. The full text of the original cable is not available.

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... 
----------------------- 
 
¶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. 
 
-------------------------------- 
...but still room for expansion 
-------------------------------- 
 
¶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. 
 
------------------------ 
A Loss-leader for Banks 
------------------------ 
 
¶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. 
 
-------------------- 
A Regulatory Vacuum 
-------------------- 
 
¶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