This years World Cup has brought its usual economic shot-in-the-arm to Brazil. An estimated 2.9 million TV sets were bought between April and June in the run-up to the matches, a big jump compared to 1.5 million over the last three months before the last games which kicked off in 2002. One major reason that Brazilians were able to splash out on sets is down to the growth of the credit market, a sea-change that has enabled millions to borrow for the first time. Perhaps they now wish they hadn´t bothered: Brazils lacklustre team under Cafu flunked out to France in the quarter finals.
The use of credit to buy TVs is a neat illustration of the burgeoning lending markets in the country and whats happened to date is likely to be just a foretaste of whats to come. Consumer credit is going to become of far longer tenor, will spread into new markets, especially mortgages, and become far more diffuse throughout the economy. It will be one of the most significant drivers for economic growth over the next few years. The only question is: how fast will it happen?
The consumer credit market is already growing at a very healthy annual clip of 20-25%, albeit from a very low base and with a very short track record. Brazils credit markets are just 30% of the size of GDP which is typical of Latin America but low on an international basis, says Celina Vansetti, senior analyst at Moodys in New York. In Chile, the figure is 60% and in some Asian countries, it is over 100%, she points out. Until several years ago, Brazilian credit markets were moribund. Hyper-inflation struck down the retail market and government regulation kept it bed-ridden despite the economic stability of the last few years. Even when it started back up, it was only the largest corporates that were able to borrow.
The governments diagnosis of the sectors ills dates back to 1999 when it instigated a system for classifying loans (from double A through A to H). That helped banks map creditworthiness of borrowers. The government followed this up with a key piece of legislation with its 2003 microcredit programme. As a social aim, the government wanted to encourage banks to serve under- or non-banked, lower income employees. To do this, it enabled simplified access to credit by allowing banks to lend and be repaid directly through pay roll.
This pay roll deduction loan system has been a success beyond the governments wildest dreams. It has had a significant effect on the ability of Brazilians to borrow and some 50% of consumer lending is now carried out through the payroll deduction system. Furthermore, it has proved highly lucrative for banks and its primarily this market that has been taking off in the last three years. Banks love the payroll system because it offers very low risk (the money is deducted from payroll and so jumps the queue of any other debt held by the borrower) and they have spotted a particularly good niche: lending to retirees who receive their pension from the government, a truly gilt-edged investment.
There are signs that although this payroll deduction market will continue to grow, the rate of that growth will slow and profits stagnate over the longer term. Its not hard to see why: payroll deductions are limited to 30% of total salary and the banks have already picked off the easiest targets: high earners in the large urban areas. Furthermore, spreads are already coming down because of strong competition in a low risk product and some government intervention. Banks such as Bradesco and Itaú are increasingly looking at rural areas and poorer customers to boost their customer base and maintain profitability at a time when margins are being squeezed, notes Daniel Araújo, Director, Corporate Government Services and Credit Market Services at Standard & Poors in São Paulo.
Banks are also looking at other ways to boost their credit book and thats where the picture becomes a little more murky. Increasingly, they are giving the nod to consumer loans on a less secure (and therefore higher spread) basis. The side effect is already clear. The rate of non-performing loans (NPLs) is increasing substantially. NPLs have moved from 2.9% in June of 2005 to 3.5% now and look set to increase to 4%. And these figures are even worse than they initially appear as they include all those very safe payroll loans.
The numbers suggest that credit quality on loans outside the payroll deductions is deteriorating swiftly, says Vansetti. The most likely hypothesis is that banks are lending to a raft of new customers with little or no credit history. Furthermore, it is likely that we have not seen the end of the deterioration in these NPL numbers. This kind of lending is new and with tenors of one to two years, we have not worked through the first raft of these loans, she cautions. Nevertheless, new laws are helping banks feel more secure in recovering delinquent debt, points out Araújo. The auto market has developed rapidly as the law governing collection here is the most transparent and enforceable.
Banco Itaú, just to take one example, has seen a dramatic increase in its provision for doubtful loans. In the first quarter of this year, it saw such provisioning increase by 18.6% quarter-over-quarter to BRL1.4 billion. The bank blamed loans to individual customers for the majority of the deterioration in the quality of its portfolio. The nonperforming loans ratio showed an unexpected rise in the quarter, reaching 4.0%, compared to the ratio of 3.5% in the previous quarter. This increase arises from our strategy of channeling funds into transactions capable of generating greater financial margins, which simultaneously means taking on greater risks. That came in its financial statement of March this year.
The statement also discussed its conservative stance in provisioning against bad loans, indicating one of the major pitfalls of lending on a non-secured basis in Brazil. Despite the governments classification system from 1999, theres a worrying paucity of data because lending didnt really take off until 2003. That means there are only three of four years of reliable data while economists generally like to see 10 years of data to build reliable models, notes Vansetti. The large banks that will need to adapt to Basel II regulations will be analyzing credit data but the smaller banks that do not need to comply with Basel are unlikely to be as rigorous in tracing default levels.
To capture the credit business, the large domestic banks have been pursuing different growth strategies. Unibanco sold its 30% stake in Credicard and, although it has retained its own brand and private label credit card, it has been most active in partnering with large chains in offering store cards, says Vansetti. Bradesco has pursued the opposite strategy by increasing its credit card business. It paid $490m for parts of the operations of American Express in Brazil, primarily the Centurion credit card business. The large retail banks have in some cases teamed up with smaller regional banks to enlarge their customer base: they offer the funding and the local banks supply the clients. This has proved a big business for some, such as the specialist Banco BMG in Belo Horizonte, notes Araújo. This flurry of deals shows just how far the retail lending market has come.
The greatest prize is yet to come. Kick-starting the mortgage market would transform credit and the economy. For now, a true market sees some way off. After all, the tenor of most consumer debt remains stalled at one- or two-years with a duration of three-years proving still relatively rare.
There are a number of reasons for the slow growth of the mortgage market. There is a very limited secondary and securitization market. Government borrowing continues to disable capital markets-based solutions to the development of any market. And government assistance to boost the market is unlikely. When the government tried to promote mortgages market before, it backfired spectacularly. It offered borrowers some protection against inflation, a promise that it was unable to honour as hyper-inflation surpassed predictions.
This means the solution to providing mortgages is going to come from the market. And a market is emerging in Brazil. According to data from ABECIP, the Portuguese acronym for the Brazilian Association of Credit and Savings Entities, the mortgage market is already growing fast. This May saw a tripling in the volume of financing contracts compared to the same month last year and in the year to May 2006, real estate financing reached BRL6.4 billion financing the construction of 80,000 housing units.
Another sign of optimism is the number of property developers that have raised money on the São Paulo stock exchange, Bovespa, commanding high multiples. In eight months up to early 2006, Gafisa, Cyrela Brazil Realty, Rossi Residencial and Company SA raised money from primary and secondary share offerings. Gafisa, which went public in February of this year, jumped 37% on its first day of trading.
For now, however, mortgage lending remains small beer. It is the next stage of growth that will be so enticing. That depends on the government paying down debt, keeping interest rates falling, and passing suitable legislation. If that happens, as seems likely, the market will really take off in the next two to three years with all the benefits for economic growth that implies.