Rising rates, fiscal uncertainty threaten mortgage growth in Chile

The recent uptick in mortgage rates in Chile could pose a threat to housing credit demand, Banco Central de Chile warned, as inflation heats up and a rising benchmark rate buoys interest on loans to their highest levels in more than two years.

Financial rates in the economy are rising as uncertainty stemming from the constitutional reform process begins to impact long-term expectations for the country's economy. In addition, a pickup in inflation has led the central bank to double its benchmark rate, putting pressure on other rates in the economy, including banking loans.

Housing loans have been a major engine for loan growth during the COVID-19 pandemic, but this momentum could lose steam given these recent developments.

Another cause for concern has been the approval by the lower house of a fourth withdrawal of private pension fund savings, a measure seen by several economists as damaging to long-term expectations. The senate has yet to ratify the initiative.

Credit default swaps in the economy spiked in September, with insurance against default rising to 88.3 basis points on Sept. 30, up 41.2% from 62.5 basis points at the beginning of the month. Year to date, the CDS price also rose 29.6% from 68.2 basis points.

Interest rates on mortgages have moved in tandem with other rates in the economy. The average mortgage rate rose from 2.3% in March to 3.1% in August, the highest level in the last 30 months, according to central bank data.

In its monthly report, the central bank warned that prospects of the new pension fund withdrawals — together with an uncertain fiscal outlook — are rippling through the mortgage market, and added that this new reality could have an "incipient impact (…) on demand for these loans."

According to a private report, the deceleration in housing loans has already begun. The peak in loan preapprovals, a gauge of the outlook for loan demand, was reached in June, according to Chilean real estate firm Enlace Inmobiliario.

A rise in financial costs should lead to "a slower pace of new loans and at higher rates," according to Institución Financiera Cooperativa Coopeuch, a local financial firm.

"That is precisely what is happening on the margin with mortgage credit," Felipe Ramirez, chief economist at the institution, told S&P Global Market Intelligence.

Rising rates could slow down housing loans

Retail real estate loans have been one of the fastest growing segments for banks in Chile during the pandemic. With very low delinquency rates, Chilean banks have been able to expand their loan book in real terms while suffering setbacks in other lines such as consumer credit.

In the 12 months leading up to July 2021, the Chilean financial system saw its mortgage book grow by 6.2% in real terms, whereas commercial and consumer credit fell by as much as 3.2% and 9.4%, respectively, according to data from the national banking association.

"Housing loans have been one of the pillars of [loan] growth," Ivana Recalde, a bank director with S&P Global Ratings, said in an interview. "The drop in consumer loans was more or less compensated with mortgages, which had a strong dynamic of its own."

Chilean banks saw momentum in mortgage lending continue well into 2021. Housing portfolios at Scotiabank Chile SA, Banco del Estado de Chile, Banco de Credito e Inversiones and Banco Santander Chile all grew during the first half of 2021 on a year over year basis, according to data compiled by Market Intelligence. Retail real estate loans weight in the portfolio typically stand at around a third of the book, ranging from 22% to 41% in the case of the selected banks.

But although 2021 looks promising to analysts in terms of economic growth, the rise in mortgage rates could affect future loan generation and could lead to an uptick in non-performing loan ratios.

"2021 is more or less a done year," Recalde said, arguing that the inertia from home purchases and mortgages has already been strong. S&P Global Ratings expects mortgage lending to grow between 8% and 10% this year, in nominal terms. However, she warned that the risks of higher rates would come over the medium term, when "it is probable that [mortgage loans] will decelerate" if a scenario of higher rates and inflation persists.

Another round of pension fund withdrawals

Ahead of the November presidential elections, Chile's Congress is discussing a fourth withdrawal of pension funds, for which the lower house has already granted preliminary approval. Building social pressure has led Congress to approve several early savings withdrawals.

Members of government have advised strongly against such a move. Finance Minister Rodrigo Cerda warned that it would have effects on the economy that could lead to "higher inflation" and "more expensive loans." Central Bank Governor Mario Marcel said that the withdrawal poses the "greatest threat" to economic recovery in Chile.

Chile's GDP is expected to grow this year by between 10.5% and 11.5%, one of the strongest rebounds in Latin America from the COVID-19 crisis. But the effects of the pandemic and resulted in a looser fiscal grip by the government, which has posed challenges for the regulator.

Earlier this year, the central bank made a sharp revision of its inflation estimates, up to 5.7% from 4.4% before. This has ushered a faster normalization of its benchmark rate, which it raised by 75 basis points on Aug. 31, the greatest hike by the bank in nearly 23 years in a bid to tame inflationary pressures.

"It would not be a surprise that inflation edges closer to 6% by the end of the year should the fourth withdrawal take place," Ramirez, chief economist with Coopeuch, told Market Intelligence. "As in previous withdrawals, this would be a renewed stimulus to aggregate demand and generate new pricing pressures on basic goods."

But the fourth withdrawal has not been approved yet, however. In a recent report, Credicorp analysts argued that a base case scenario is one of non-approval. But political pressure is likely to build up in the run up to presidential elections on Nov. 21.

"Imbalances are the main source of concern," Credicorp's report read. "Higher risks over the medium term that arise from pressure on both inflation and fiscal accounts," the analysts warned.