As Brazil's economy slowly climbs out of its deep recession, the country is turning its attention to jump-starting recovery in its real estate market. On Aug. 19, 2019, the National Monetary Council (CMN), one of Brazil's financial regulatory bodies, approved Resolução Nº 4.739 (Resolution No. 4.739), which is intended to widen the pool of funds available to finance purchases of homes in the country. The resolution removed restrictions on the use of market indices-adjusted interest rates on residential mortgages under the scope of the housing finance mechanism, Sistema Financeiro Habitacional (SFH), which represents most of the mortgages in the country. In practice, the new resolution will allow residential mortgages to be linked to Brazil's Consumer Price Index (IPCA), which will attract significantly more investors to Brazil's incipient residential mortgage-backed securities (RMBS) via Certificados de Recebíveis Imobiliários (CRIs) and covered bonds via Letras Imobiliárias Garantidas (LIGs).
S&P Global Ratings believes Resolution No. 4.739 will likely boost mortgage lending growth in Brazil over the next two to three years because issuance of CRIs and LIGs could significantly expand the credit available for home purchases. Currently, most mortgage loans are funded with savings deposits and retiree funds (FGTS), which may become insufficient to fund the demand for residential mortgages once the economy rebounds. Nevertheless, we also believe that indexing mortgages to IPCA comes with risks that must be monitored. The high volatility of Brazil's economy increase the risk of a sudden rise in inflation, which could result in a higher debt burden to homeowners, increased delinquencies, and weaker credit quality of securitized mortgages.
Regulatory Changes Make Brazilian RMBS And Covered Bond Issuance More Viable
Resolution No. 4.739 is a complementary initiative to the July 31, 2018, CMN-approved Resolution No. 4.676, which established a series of measures that lessened restrictions on home financing and have been supporting the gradual recovery of Brazil's real estate market. Resolution No. 4.739 provides lenders with the ability to adjust mortgage interest rates under SFH to IPCA rather than the referential rate, Taxa Referencial (TR), which is a daily indexer based on a daily average of 30-day deposit plus a reducing factor defined by the Central Bank of Brazil. The new resolution will likely allow the development of IPCA-linked RMBS and covered bond markets in Brazil, given that investors have a stronger appetite for inflation-linked investments, and increased demand may turn those instruments into key funding alternatives for domestic financial institutions.
Following the new regulation, the state-owned bank Caixa Economica Federal, which has an approximately 70% share of the home financing market, launched a mortgage product linked to IPCA. The new product line will have a minimum interest rate of IPCA + 2.95%, which is lower than the rates for products linked to TR, considering current inflation levels. These mortgages will have a maximum term of 360 months and a maximum loan to value (LTV) ratio of 80%. We believe that other large banks, fintech companies, and other lenders will likely follow the same path, increasing competition in the segment.
What Are The Risks For Inflation-Linked Mortgages?
IPCA-indexed real estate financing can be riskier for borrowers because wage inflation doesn't always mirror IPCA, and Brazil's inflation rate has experienced high volatility over long periods of time. Brazil's residential mortgages usually last between 15 and 30 years. During the past 20 years, IPCA has had a much higher volatility than the central bank-established TR (see chart below). Although inflation in Brazil has been below the target set by the central bank over the past three years, the index has not always behaved as expected, such as in 2015 when the IPCA surpassed 10%. It is difficult to predict how inflation will behave during the life of a residential mortgage, especially in a country with fluid political dynamics such as Brazil.
In addition, a sharp increase in inflation levels during an economic crisis could increase debt service as GDP declines. In this scenario, higher unemployment and inflation levels could lower borrowers' payment capacity while the market value of properties drops significantly, leading to a sharp increase in mortgage LTVs and higher credit risk. Thus, when S&P Global Ratings evaluates inflation-linked mortgages, we typically increase our foreclosure frequency expectation for the asset pool.
The risk of a sudden rise in LTV is particularly relevant for markets such as Brazil, where domestic lenders have limited recourse on most residential mortgages (i.e., the borrowers have no obligation to pay the balance of any debt if a shortfall occurs after the sale of the collateral). In limited recourse markets, a borrower may have an incentive to hand in the keys if little to no equity exists in the mortgaged property or if the borrower has negative equity due to adverse property price fluctuations. For example, during the Great Recession, some borrowers in the U.S., which operates mainly under limited recourse, simply handed in their keys after the equity in their homes turned negative. This caused sharp increases in foreclosures and led to a widespread drop in property values, further weakening U.S. RMBS credit quality.
Could Inflation-Linked Mortgages Lead To Loan Modifications?
The social importance of residential mortgages increases the risk of mortgage modifications as inflation increase in an economic stress scenario. For example, in Argentina, President Mauricio Macri announced that the government will freeze readjustments of mortgages denominated in UVA (a value unit linked to inflation) for four months through December 2019, following the significant depreciation of the peso and a spike in interest rates after the primary elections on Aug. 11, 2019. Although it is still unclear how this measure would be implemented, it could reduce the expected cash flow for the securitizations.
LTV And Borrower Indebtedness Are Key For IPCA-Linked Mortgage Credit Quality
Although indexing mortgages to IPCA will likely make Brazil's RMBS and covered bonds markets more viable and expand the credit available to purchase homes, we also believe a rapid growth of inflation-linked mortgages could pose risks to Brazil's real estate market, given the high volatility of the country's economic and political environment and mortgage lenders' limited recourse. On the other hand, if the origination of inflation-linked mortgages is combined with lower LTV and debt-to-income ratios, those risks can be mitigated. As such, we believe prudent originators and investors will account for those risks when defining their appetite for Brazilian floating-rate RMBS in their portfolios, and we will monitor the RMBS transactions we rate accordingly.
This report does not constitute a rating action.
|Primary Credit Analyst:||Pedro Breviglieri, Sao Paulo +55 (11) 3039-9725;|
|Secondary Contacts:||Leandro C Albuquerque, Sao Paulo +55 (11) 3039-9729;|
|Marcus Fernandes, Sao Paulo (55) 11-3039-9743;|
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: firstname.lastname@example.org.