Clare Nuttall in Almaty -

Russian banks continue to fuel the growth of the country's mortgage market even after real estate has fallen out of favour internationally. A report from Alfa Bank warns that this rapid growth is unsustainable and forecasts a slowdown in 2009.

Alfa's report, "Mortgage Growth: Following Real Estate Prices?," says that as interest rates rise, banks might turn their focus from mortgages to shorter-term loans. Meanwhile, the anticipated decline in Russian real estate prices could increase the number of non-performing loans (NPLs) and force banks to tighten their lending requirements.

This follows six months of stellar growth in Russia's mortgage market. In the first half of 2008, it saw growth of $14bn, or 45%. Mortgages accounted for 42% of total retail growth in January to June, which pushed up their share of overall retail lending to 28% (see graph 1). A similar trend had been seen in 2006 and 2007, when mortgages also grew faster than the overall retail market.

This increase hasn't been uniform across the banking sector. State banks Sberbank and VTB raised their share of the corporate lending market, but their share of the mortgage market was up only slightly between mid-2007 to mid-2008 (from 49.2% to 51.4%). Meanwhile, the combined share of international banks dropped from 10.7% in 2007 to 10.1% in the first half of this year, with Raiffeisen and City Mortgage Bank reducing their shares (see table 2).

Overall, Alfa attributes the strong growth of Russia's mortgage market to a combination of interest rate stability, access to foreign debt markets and the continuing rise in real estate prices in Russia's largest cities. "We believe that since the mortgage market equals only 3% of Russia's current GDP, banks continued to fund its growth despite the worldwide souring of attitudes toward the housing market. Another important point is that in the first half, Russian banks were able to borrow on international markets. They did so actively in May-June 2008," the report says. "Now, neither of the above factors is true: at $45bn, the market is already big enough, and international financial markets will not open up any time soon. Therefore, mortgage market growth is likely to slow significantly in the coming months."

The slowdown won't be immediate, however. Alfa reckons the market is set to grow by a further $10bn in the second half of 2008. However, the outlook for 2009 "is gloomier despite the low penetration of mortgages in the economy."

Alfa identifies increased interest rates as the single most important factor influencing mortgage market growth in the coming months. With low global interest rates, and therefore cheap capital, for several years, mortgage lending penetrated numerous emerging markets (see graph 3). "Now, the trend has reversed," Alfa says. "Russian banks expecting a rise in rates may reduce their exposure to mortgages and concentrate on markets with shorter maturities."

Refinancing standards are also tightening. In Russia, most regional entities refinance their mortgages through the state AIGK or VTB-24 programmes. Recently, AIGK increased its interest rates by 200-300 basis points in response to the increase in bad loans in its portfolio, while VTB-24 has decided to stop buying mortgage loan portfolios.

The Russian mortgage market was previously seen as attractive due to its very low level of non-performing loans, due mainly to the continuing increase in real estate prices. In future, Alfa forecasts, NPLs will pose a major problem. "If real estate prices drop, Russian mortgage players are likely to see their NPLs increase significantly, since a number of clients may refuse to pay back loans, preferring instead to leave the banks with their collateral," its report cautions. "This risk is leading banks to tighten their requirements for potential, clients, which is contributing to the slowdown in market growth."

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