Tapping into the huge and underserved housing market is the next challenge for Brazilian banks. John Rumsey reports on the growth of mortgages and the consequent development of the securitisation market.

Brazil’s mortgage market is tiny. Mortgages represent just 2% of gross domestic product (GDP) compared with 16% in Chile and 65% in the US. Banco Itaú, one of the three major private banks in the country, which has 100bn reais ($52bn) in outstanding loans, has a piffling 3bn reais outstanding mortgage lending. Still, the market may be microscopic today, but bankers like to think that just means there is more scope for growth. Their successes in profiting from consumer lending has them fired up about the potential for mortgages.

“In the past, we were willing to provide lending for real estate only to the letter of the law because there was an opportunity cost from cutting lending in other areas. Now, we view mortgages as being as attractive as other lending,” says Demósthenes Madureira de Pinho Neto, head of wholesale business at Unibanco, another of the top three private institutions.

Top three rival Banco Bradesco made 2bn reais in real estate loans last year and expects that to increase to 3bn reais this year, according to its president, Márcio Cypriano. “If we see more demand, we could increase that figure,” he says, adding that the market is big enough to accommodate all the banks.

Roberto Setúbal, president and CEO of Itaú, expects the bank to lend 1.5bn reais this year, increasing its outstanding portfolio by 50%.

Bradesco, which is leading the pack in lending among the private sector banks in this area, is starting to lend at fixed rates for 20 years. “You can hardly believe that Brazil has come to this, splitting payments into 240 segments,” says Mr Cypriano. The bank is also funding companies that are buying land for building, he says. He estimates that Basel II, which will allow banks usually to reduce the risk weighting counted towards reserves when they lend for mortgages, will have a significant impact on galvanising the market. A recent change in the law that facilitates repossession in the event of default is giving banks more confidence that they will recoup properties, too, he says.

Further decreases in interest rates are essential. “With very long-term lending of 15 to 20 years, each point drop makes a big difference,” says Mr Setúbal. “When we can offer mortgages in the single digits, then this market will really take off.”

The other obstacle is access to the kind of long-term funding that is essential to underpin mortgages. For now, Brazilian banks are unable to issue certificates of deposit at long tenors and if they lend in the longer term, this creates a mismatch in their asset-liability profile, which creates risk with which they need to be comfortable, says Mr Madureira de Pinho Neto. Banks are weighing up how much risk they are willing to take on their balance sheet from this mismatched asset-liability profile. Unibanco is cautious about this risk, he says. “It’s very easy to get hurt in lending to individuals.”

Securitisation success

One way around balance sheet constraints is the development of the securitisation market. Shorter term receivables are already being sold successfully in Brazil.

Peter Geraghty, managing director at Dredsner Kleinwort in New York, says demand is outstripping supply in this sector. Local structures are already rated, typically AAA or AA. “Originators are finding it easy to sell every piece of paper,” he says. That is in spite of the 15% withholding tax that issuers absorb and interest rates that are still high.

This success has spurred banks to scour the market, looking at securitising a wider range of receivables than those offered at present, which are typically based on payroll deductions, auto loans and credit card borrowing. This is resulting in the emergence of more complex, multi-asset structures. As yields are tumbling fast, junior tranches are being more readily accepted by the market, says Mr Geraghty.

Last year, about $5.5bn in flows was securitised in Brazil, says Maria Muller, senior vice-president, Latin America structured financing, at Moody’s in New York. Still, Cities Readiness Initiative funds, based on real estate, accounted for just 8%.

For now, the mortgage market is mostly carried out through government-directed lending programmes, particularly payroll tax funds. Market-based funding has only accounted for a fraction of mortgages, notes John Tonelli, managing director at Bear Stearns. Local players dominate the market but there are signs of change. The move in May by government-owned Caixa Econômica Federal (CEF) to securitise 2bn reais of its extensive mortgage portfolio is a positive development, says Mr Tonelli.

CEF, which is dominant in the mortgage sector with one million contracts, has used capital markets sparingly in the past and there has been a lack of initiative from the government, but Mr Tonelli says this is a first major step in building out a mortgage-backed market. It is likely to come initially through local issuance and this should form the backbone of the mortgage market with smaller deals, placed over a relatively long period time, perhaps in the range of 300m reais per deal, he says.

Market promotion

Other initiatives are helping to promote mortgage securitisation. The creation of association Cibrasec is the first attempt to systematise the market, says Mr Cypriano.

Mr Madureira de Pinho Neto agrees. “Securitisation will be an important instrument,” he says. He points out that for now large public sector pension funds are overinvested in real estate because of government-directed funding. A change in legislation to enable them to exclude securitised real estate from this definition would open up their resources.

Other impediments will be harder to remove. The central bank requires a percentage of banks’ savings accounts to be directed to real estate lending. As securitisation takes mortgages off balance sheet and these investments cannot be counted towards the requirement, banks are reluctant to securitise portfolios, says Ms Muller.

Mr Setúbal says he thinks the old model of compulsion to reserve savings for directed mortgages is not going to be the future. “The funding need is much greater than the savings that we can offer. We need market-oriented regulations,” he says. The equivalent of a Fannie Mae or Freddie Mac will also be needed, he adds.

Technical problems

There are technical problems that further complicate structuring of mortgages in Brazil. “You think that the structure of the product relieves capital but to some extent it doesn’t,” says Lourenço Miranda, vice-president of risk management at ABN AMRO in Săo Paulo. Many banks that act as originator are obliged to keep the junior tranche of the deal in their portfolios, partly to show that they believe in the underlying assets, he says. By holding subordinated tranches, banks do not get the capital relief that comes from securitisation. “The industry is not well aware of this,” he cautions.

Although new laws to ease repossession have been passed, there are few cases to indicate how easy it is in practice to evict sitting tenants and auction properties. Although it is getting easier, the process is still expensive, says Mr Miranda. There is also basis risk as securitised instruments have fixed-income assets and floating liabilities. That risk is mitigated through swaps, but the market has not been tested, he says. “If liquidity drops, it would be chaotic.” Despite the legislative and market risk obstacles, Mr Miranda says he believes that there will be rapid growth in the mortgage market.

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