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Brazil builds up to a mortgage boom

Local banks have finally started to take the mortgage market seriously. After decades of high interest rates that made residential lending impossible, they are slowly branching out into what could be an enormous market. Chloe Hayward reports on the challenges.

Low income moves centre stage


For years the Brazilian mortgage sector has been neglected. In a context of uncontrolled inflation and high interest rates, the sector has received no long-term investment for two decades. In 2006, the Brazilian mortgage market was worth R$9.34 billion ($5.36 billion), only 2.2% of GDP. In August 2007 alone, however, R$1.8 billion-worth of mortgages were originated. But compared with other Latin American countries such as Chile, where residential mortgages account for 15% of GDP, or Mexico at 11%, it is clear Brazil has a long way to go.

Now that Brazil’s economy has enjoyed a period of stability and interest rates have dropped into the low double digits, the residential mortgage market has taken some big steps forward. This year the first-ever Brazilian mortgage-backed securitization by a bank using its own assets as collateral has been issued, and local banking players are devoting more resources to developing their mortgage businesses.

There are significant barriers hindering Brazil’s burgeoning mortgage market, including a need for regulatory changes, further macroeconomic improvements and fiscal reforms. Nevertheless, several private sector players are gearing up to compete in residential mortgage origination, which some market observers believe could be worth about 25% of GDP in the course of 2008.

Banco Bradesco and Banco Itaú have already stepped up their residential mortgage origination activities. At the moment the largest player in the market is the state-owned Caixa Econômica Federal (CEF), which has a 59% market share. Its private sector competitors, however, are for the first time reporting substantial increases in their market shares – for example, Itaú posted a 30% increase in mortgage business (albeit from a low base) in the first quarter of 2007 over the same period in 2006.

Bradesco, one of the biggest privately owned banks in Brazil, is involved with all stages of real estate development from financing construction to mortgage lending. The bank has also opened 14 specialized real estate centres focused solely on growing its mortgage operation and to complement its branch network, which already offers mortgages. Bradesco had originated nearly R$3 billion of residential mortgage loans in 2007 by October, compared with R$700 million in 2005. Its target for 2008 is R$4 billion. Itaú, another of the top three players, has a residential mortgage portfolio of R$2.4 billion and expects similar growth rates.

Although investors and bankers agree that mortgage lending is on the rise, there is serious disagreement on statistics. Gafisa, a Brazilian residential property developer, predicts mortgage volumes will jump to R$31 billion for 2007, from the R$6.7 billion in 2003 – a 436% increase. Optimists see the market reaching 25% of GDP by 2008. Others are more conservative. Ademir Cossiello, executive director at Bradesco, thinks it will be 10 years before 25% of GDP is reached, because he doubts individual wealth in the country will grow at the speed necessary to achieve that level.

In the past two years there has been a dramatic change in circumstances for the Brazilian economy and its financial institutions. In macroeconomic terms, Brazil has experienced sustained economic growth, which has been much less volatile than in the past, as well as a steady fall in real interest rates. Interest rates have fallen from 25% in 2005 to 12% this year and could fall to single digits in 2008. Inflation is stable at roughly 3.1%. There has also been a substantial increase in formal employment and real income. The Fiscal Responsibility Act, which came into effect in May 2000, added to economic stability by imposing spending restrictions on state and municipal governments.

As Luiz França, managing director of Itaú, says: "It is the economic facts, together with the economic stability of the country, which has led us to believe a sharp increase in the demand for mortgage loans in Brazil is finally coming."

At the same time, there have been several developments aimed at making credit more widely available to a larger proportion of the population. Part of this progress is thanks to advancements in credit risk management and the introduction of new mortgage products, such as payroll-linked mortgages to reduce the chance of repayment delinquency. Legal changes and government initiatives have also helped to jump-start the mortgage market.

One reason mortgage lending had not been widely promoted in Brazil was the problem of dealing with defaults. If a mortgage fell into delinquency, it could take more than six years for the bank to foreclose on a property. In 2004, a new law gave the banks a greater hold over the asset until repayments had been completed, reducing the repossession time to less than a year, making mortgage origination less risky for lenders.

Accelerating growth

Other moves from the government to encourage the real estate market include the PAC programme – Programme for Accelerating Growth – which will provide basic infrastructure to more remote regions as well as encouraging new investment in home building. Under PAC, in 2006 the Brazilian president outlined a five-pillar programme that aims to increase economic growth in Brazil by 0.5% a year. Of the R$504 billion set aside for the programme, R$171 billion will go into social infrastructure, including housing.

Already salaries have increased and credit is becoming more accessible to a much larger proportion of Brazilian society than ever before – including lower-income individuals. So banks see mortgages as an opportunity waiting to be taken. Already competition is heating up, resulting in increased product development and innovation.

Some innovations have been relatively straightforward. Recently, tenors on mortgages have doubled to 20 years. Also, some homebuyers now need only put down 20% deposits, whereas previously they had to lay out 35%.

Bradesco fixes its interest rate for Brazilians buying their first property at 12.5% annualized for 20 years as long as the property value does not exceed R$350,000. In 2005, 12-year floating-rate loans had interest rates of at least 15%. Bradesco also stretched mortgage maturities to 25 years from 20 in July this year. Itaú followed suit, offering its first 25-year mortgage in August.

Itaú can now offer credit reports within 24 hours and contract loans for up to 25 years. Itaú is also using innovative funding sources, and in September signed the first contract of its kind with Inter-American Investment Corporation, a group that works to promote and support the development of the private sector and the capital markets in Latin America. The group will provide Itaú with R$200 million, which is to be converted into loans of up to R$100,000 for consumers.

As well as offering tenor of up to 300 months with fixed and floating rates, several banks are looking at forming partnerships with real estate companies, builders and developers. One idea is to make mortgages with flexible payment options available during the construction phase. For example, end customers can pay less if they start paying for the property before it is finished or if they lodge deposits before moving in.

Established players CEF and Santander continue to lead the way in market share. Both offer 30-year mortgages and boast an established middle to lower income client-base, which comprises the bulk of potential new clients looking at mortgages in Brazil.

Luiz França, Itaú

"A mortgage loan generates a long-term relationship between bank and customer, which is an excellent source for cross-selling" Luiz França, Itaú

One thing is clear. Mortgages are good for banks’ business as they foster long-term relationships with clients. "A mortgage loan generates a long-term relationship between bank and customer, which is an excellent source for cross-selling," says Itaú’s França. Banks are eager to gain a greater share of their clients’ wallets now that Brazilians are bringing home bigger incomes. "Mortgages are also an excellent way of strengthening client loyalty in the long term as the payback period can last up to 20 or 30 years," says Bradesco’s Cossiello.

Despite impressive market growth, there are still serious obstacles to significant development. Bankers point to the continued lack of government sponsorship. Unlike Mexico, which has Sociedad Hipotecaria Federal driving its mortgage market development, Brazil does not have a government entity in charge of developing primary and secondary mortgage markets through the issuance of credit and guarantees. Bankers argue that the government needs to step in to promote mortgage lending as well as bolster the fledgling MBS market.

"The current Brazilian model which regulates how resources are raised has to be changed and a free credit market established," says Cossiello. "Banks should be allowed to use these credit assets on the securitization market."

In 1998 the government realized that there was a growing housing shortage and so attempted to ease the problem and encourage a housing finance market by introducing a new housing trust law that enabled any assets that were related to real estate to be securitized through certificado de recebíveis imobiliários (CRI) funds, which also carried tax exemptions and other financial and efficiency incentives. But there has been little interest in mortgage-backed securities in Brazil, despite these incentives.

Bankers looking at the mortgage-backed securities market have hit two limitations – a thin secondary market and a need for banks to direct 65% of their savings deposits into the housing market in order to fund housing loans. This savings requirement is finally being reconsidered and there are plans afoot to change the deposit regulations. However, several politicians are against radical change. They argue that Brazil is in a transition period and so changes should be small and occur without a huge shake-up from the top. The government has also has been working to develop a fixed-income yield curve. Until this is in place, any secondary MBS market, and growth in the mortgage-linked securitization market, will be stalled.

"We are always evaluating the securitization of our mortgage assets," says Itaú’s França. "However we do have to meet the government requirements that make it difficult to securitize our assets."

Urgent need for MBS

Cossiello at Bradesco points out that the need for the mortgage market to grow is increasing by the day. "The securitization market is very important because, although the resources from savings accounts are growing, they are starting to become saturated which means that measures will be needed to allow free credit to be made available for home purchases," he says. "At this point the banks will generate operations, which will be transferred to the securitization market. This would be the ideal funding for operations like this since it is expected that the mortgage sector in terms of GDP could rise to 12% by 2014."

Ademir Cossiello, Bradesco

"Banks should be allowed to use these credit assets on the securitization market"
Ademir Cossiello, Bradesco

But a rush into equity funding by real estate companies, which coincided with debt financing becoming expensive, has further hindered the mortgage securitization market in Brazil. With several developers being involved in releasing house finance loans, several could have securitized their assets, but only a few did. Since September 2005, 20 real estate companies have completed IPOs and secondary deals worth $7.59 billion. However, this tide could be changing as debt financing is starting to make a come back. As it becomes gradually cheaper, so certain companies are turning their attention towards bond issues and securitization, rather than just focusing on equity fund raising. Brazilian real estate developer PDG Realty is planning to offer R$300 million of seven-year debentures this year. Gafisa has seen its borrowing costs fall by more than 20% since 2005. Gafisa is planning to buy back its R$240 million debentures due in 2011 and sell new debt in the second half at a longer duration and lower coupon. As the developers turn back towards the debt market so the investment banks are also assessing their options in the RMBS market. Credit Suisse completed a small deal last year with assets that were bought from local retail banks. And last August, ABN Amro’s Sudameris bank issued a RMBS deal, understood to be both the country’s largest to date and the first securitizing its own mortgage assets. State-owned bank CEF is reported to be working on a similar deal that it hopes will come to the market soon. Issuance from CEF could lead the way for other lenders to securitize by adding some much needed liquidity to the market.

Bankers stress that even with the excitement surrounding Brazil’s mortgage market and increased activity, it is still very early days. That doesn’t mean there is a lack of ambition on the part of private and public sector players. Both see the massive potential for a market that has the potential to cater to Brazil’s nearly 50 million households.

"We trust that the mortgage boom is just starting in Brazil and the conditions for sustainable growth are in place," says Renato Steiner, head of personal financial services at HSBC. "The expectation is that the market will continue to grow and reach maturity in 20 years’ time."

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