Securing the foundations
As the real estate market in Latin America’s top five economies continues to expand, concerns are growing that expansion of mortgage credit could undermine the strong growth in the financial sector.
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The International Monetary Fund has reiterated its concerns about the rapid expansion of mortgage credit in Latin America and how this could lead to a steep rise in non-performing loans if an economic deterioration takes place.
Between the end of 2002 and the end of last year, mortgage credit expanded on average by 14.3% a year in five of Latin America’s main economies – known as the LA5 – according to the IMF. The LA5 consists of Brazil, Chile, Colombia, Mexico, and Peru. During the period, Brazil witnessed the fastest expansion at 19.4% a year and Peru saw the second most rapid growth at 17.4% a year. During 2010 and last year, expansion in Brazil shot up to 40% annually.
In 2011, total mortgage credit against GDP averaged 7.5% in the LA5 against 5.6% in 2003. The equivalent figures today for the US and Asia are 65% and 20%, respectively.
“Mortgage credit has been expanding at a very fast pace,” said Luis Cubeddu, the deputy chief of the studies division for Latin America at the IMF. “In terms of mortgage deepening or penetration, Latin America remains low compared to the developed world and Asia. Currently, we do not think the situation presents a systemic risk; however, if this pace of increase persists for a while longer, it could create some vulnerabilities in the banking system. If the economic situation worsens, non-performing loans could rise very quickly.”
Shoring up statistics
The IMF is calling upon national governments within the region to shore up their national statistics offices to ensure that they are thoroughly monitoring developments in the housing and mortgage markets. It also says that the countries’ banking superintendencies need to keep a close eye on the situation to make sure that no banks become vulnerable if there is a pick-up in NPLs.
“National supervisors and international agencies should always be vigilant in times of expansion to ensure that growth is sustainable and not artificially fuelled by pro-cyclical monetary or fiscal policies,” said Carlos Rey, director of business development in the Americas division at Santander. “However, in the case of Latin America, we see several fundamental factors underpinning growth in mortgages.”
The development of the middle class in the region over the last 10 years has boosted growth in the real estate market, which should lead to an increase in mortgages as families begin to be able to acquire homes. In 2000, there were 210m people considered middle-class but that number had risen to 318m people by 2010, according to Santander. Recent forecasts estimate an additional increase of around 50m people by 2015 and of 100m by the end of the decade.
Santander believes recent price trends in the real estate markets are in line with the historical average, with no huge price hikes. For example, in Chile, Colombia and Mexico average price increases over the last two years have been below 5% in real terms.
Furthermore, during the past few years, the deep impact of the real estate crisis in developed countries has caused central banks and financial supervisors in Latin America to monitor closely real estate prices and their valuation relative to their economies and interest rates.
“Under this perspective, real estate prices are moving in line with the dynamism of the economy and the level of interest rates, with no signs of significant price increases,” added Rey. “Generally, real estate bubbles tend to generate in periods of very low interest rates, which is currently not the case in Latin America. Mortgages have to increase in order to satisfy demand from growing middle classes, but in a sustainable manner and in line with economic fundamentals.”
Within the LA5, total mortgages against GDP are highest in Chile at around 19.2%. In Brazil, the equivalent figure is 4.4% and in Peru 3.9%.
However, the IMF says Chile has one of the most developed capital markets in the region and the total level of mortgages against GDP in the country has been high for a long time. It says that mortgage credit expansion in Chile has not been as fast as other countries. The amount of mortgage debt outstanding has increased by an average of 11.1% per year, in real terms, over the past five years, according to Standard & Poor’s.
One of the IMF’s main concerns has been the rise in household debt against disposable income. For example, in 2010 in Brazil total household debt against disposable income stood at 36% against 21.7% in 2005.
“For many individuals in several countries, the authorities have no records of someone’s credit history,” said Cubeddu. “That means that loans are being given to people with no credit history and that is a concern if it is not monitored properly.”
Sub-prime debt does not exist in Latin America and until now most financial institutions have funded mortgages from their deposits. Most Latin American countries have a very limited level of securitisation; it is not common for mortgages to be bundled and sold on.
However, the wholesale funding of mortgages is growing in Brazil and this could become a concern if household debt against disposable income continues to rise at a fast pace. BNDES, the country’s development bank, also offers mortgages at subsidised rates and the state’s finances could deteriorate if there is a pick-up in NPLs.
In 2008 mortgage NPLs as a percentage of total mortgage credit stood at 1.8% in Brazil and 0.9% in Peru. However, one of the IMF’s main concerns has been the real growth of NPLs between 2009 and last year: up 22% annually in Brazil and 32.8% a year in Peru.
“The Brazilian mortgage market has been one of the most dynamic business lines for banks, with an average real growth rate of 40% per year for the past five years, though these loans account for a moderate 13% approximately of the banking system’s total loans,“ said Jose Perez-Gorozpe, primary credit analyst at S&P. “Asset quality remains manageable, with a 1.6% NPL ratio according to our estimates.”
S&P says Brazil’s loan-to-value ratio remains at a conservative average of 62.7%. If growth rates in this sector remain steady over the next five years at 15% a year, however, mortgage loans could represent around 35% of the banking system’s total portfolio. Perez-Gorozpe said this would warrant additional scrutiny if origination standards relax, for example if there were higher LTVs, longer mortgages than the current average of 25.8 years, and house prices continued to rise at last year’s rate of 26.3%.
“For now, we believe that conservative LTV ratios and the relatively small share of mortgages in the system’s portfolio help offset the risks associated with a potential asset price bubble in the real estate market,” said Perez-Gorozpe.
Mexico’s story during the past few years highlights how matters can go wrong when mortgage lenders become too dependent on wholesale funding. Mortgages represent 38.7% of the Mexican banking system’s total portfolio and equal 9.7% of GDP, according to S&P.
The role of two government agencies, Infonavit and Fovissste, has been vital in developing the mortgage loan market: on June 30 this year, the two together held 66.7% of all mortgages in the country.
However, the main problem during the 2009 crisis in Mexico involved non-bank mortgage underwriters, which relied heavily on wholesale funding. When debt markets dried up and non-bank mortgage underwriters could not roll over their borrowings, Sociedad Hipotecaria Federal, a government development bank, came to their rescue.
Nonetheless, the mortgage underwriters’ asset quality deteriorated severely because of weak origination policies – including high loan to value ratios, high debt and payment to income ratios, poor initial property valuations, inflation-linked loans, and risky lending to the informal sector – and very few survived the crisis.
Luckily, these companies held only 8% of the mortgage market and most mortgages – those granted by government agencies and banks – managed to perform fairly adequately. The current NPLs to total loans ratio is around 6% (weighted system-wide average), down from 7.3% in December 2009, according to S&P. The ratings agency expects it to remain stable over the next two years.
“Mortgage market growth in Mexico has been gradually recovering over the past two years, averaging 5% per year in real terms, but is still subdued compared to the pre-crisis years when it grew at a double-digit pace,” said Perez-Gorozpe.
“We expect that mortgage lending will expand by around 8% in 2012, although a continued economic slowdown may yield lower growth for 2013. House prices have been very stable through the cycle, averaging a 1% increase per year in real terms, and we are expecting this trend to continue over the next two years. Therefore, we believe that there is little if any risk of an asset price bubble in this market.”
Brazil does not yet face a real estate bubble or a mortgage crisis but the country’s authorities need to ensure that the rise in household debt against disposable income does not become unsustainable.