Brazil Covered Bonds Boosting Housing Key to Election: Mortgages

Brazil President Dilma Rousseff, who has championed affordable housing since taking office in 2010, is turning to the international bond market for real-estate funds in the final weeks of her re-election campaign.

Finance Minister Guido Mantega said last month that Brazilian banks will be allowed to sell covered bonds -- financing pioneered in Europe to fund home loans. Banks can borrow more cheaply using the securities because mortgages provide additional collateral, giving homebuyers lower rates.

Rousseff, 66, frequently touts her signature program, My House, My Life, in a presidential race in which she lags behind her opponent in polls. As the program adds to the budget deficit, now at a seven-year high, the bonds will provide another financing source for banks, which rely on deposits and government loans to provide mortgages.

“It is necessary to create alternative sources of funding for the housing sector and it makes sense for this government to do it while it still is in office,” said Octavio de Lazari Jr., a deputy director at Sao Paulo-based Banco Bradesco SA and president of Abecip, an association of real-estate lenders.

Banks could issue a total of almost 200 billion reais ($89.6 billion) in a decade, according to Alexandre Assolini Mota, a partner at PMKA Advogados in Sao Paulo who specializes in real estate law. The securities probably would draw interest from Brazilian institutional investors such as pension funds, he said.

18th-century Prussia

Covered bonds originated in 18th-century Prussia, when King Frederick let aristocrats, churches and monasteries raise money by pledging their estates as collateral. The market now spans 29 countries from Canada to Finland and New Zealand.

“This is a security that is spreading around the world at the moment,” said Leandro Albuquerque, senior director at Standard & Poor’s in Sao Paulo.

Last year, Europe’s covered bond market shrank for the first time in at least a decade. The continent’s lenders trimmed balance sheets to meet stricter capital regulations while central banks flooded the financial system with cheap funds. Issuance in Europe was 429.1 billion euros ($555.5 billion) in 2013, the lowest for a single year since 2004, according to the European Covered Bond Council.

“It is appealing for investors to look at new countries, especially if they are paid a premium for the fact that those markets are less well-established,” Henrik Stille, a money manager at Nordea Investment Management, which oversees 160 billion euros, said in a telephone interview from Copenhagen.

Bond Risk

The risk with covered bonds is that they reduce the amount of assets that could be liquidated to pay depositors in the event of a bank failure, according to a study by specialists including James Chapman, an assistant chief in the Financial Stability Department at the Bank of Canada. The study said banks could be forced to inject assets into a covered bond to ensure that it’s properly collateralized, exacerbating a liquidity crisis.

When Rousseff was a minister under former President Luis Inacio Lula da Silva, she helped create My House, My Life in 2009. The program’s mortgage subsidy reduces rates by half for Brazilians making less than 5,000 reais a month.

After she was elected in 2010, Rousseff, who belongs to the Workers Party, boosted the program’s funding. As of Aug. 15, it has subsidized the purchase of 3.56 million homes throughout Brazil, totaling 222.8 billion reais in funding, according to data from the Ministry of Cities.

Rousseff’s Flag

“The program has been one of the major flags for Rousseff in the past few years, and she has been exploiting that as much as she can during the campaign now,” said Camila Abdelmalack, an economist at CM Capital Markets in Sao Paulo. “At the end it has an impact on the budget.”

Brazil’s Treasury has lent more than 440 billion reais to state banks since 2008, helping fund their balance sheets. State-owned Caixa Economica Federal, the biggest mortgage lender with about 70 percent of the market, gave a total 49 billion reais in housing subsidies and mortgages in 2013, more than triple the amount released in 2009, according to the firm.

The loans and subsidies from state banks that fuel the housing market are driving up Brazil’s deficit and the debt needed to finance it. The budget gap will expand to 3.9 percent of gross domestic product this year, according to a survey of forecasters by Bloomberg in August.

Credit Rating

Moody’s Investors Service cut Brazil’s Baa2 credit rating outlook to negative from stable yesterday, citing meager economic growth for the year and worsening debt metrics.

Demand for mortgages has slowed this year as the economy has shrunk for two straight quarters. To control inflation, Brazilian policy makers have raised their key rate by 3.75 percentage points to 11 percent since April 2013. That’s pushed the average subsidized rate on a new residential real-estate loan to 9.68 percent as of July from 7.97 percent in August 2012, according to the central bank.

When demand for mortgages rebounds, banks will need financing from covered bonds. The funding coming from savings accounts will lose pace with the growth in mortgages by 2016, according to Fitch Ratings.

“Savings accounts are the main funding for real-estate financing but we cannot rely on them forever,” said Carlos Ratto, commercial and products director at securities clearinghouse Cetip SA Mercados Organizados. “There still is a demand for housing and real-estate all over the country. It is necessary to create new tools for funding that will allow growth in the future.”

Clear Rules

Regulators of covered bonds need to develop clear rules laying out how the collateral is segregated from other bank assets to protect investors in case the firm is liquidated, said Mota of PMKA Advogados. Regulators also should specify what entity will be responsible for auditing and supervising the assets, he said.

Matheus Cavallari, the Finance Ministry’s deputy secretary for microeconomic policy, declined to say when the regulations will be published. Lenders have been discussing the implementation of covered bonds with the government for three years, said Lazari of Abecip.

Rousseff is trailing challenger Marina Silva of the Brazilian Socialist Party in the polls prior to the first round of voting on Oct. 5. While the recession has hurt Rousseff’s popularity, she plugs her expansion of homeownership in her blog, TV ads and at campaign stops.

Presidential Campaign

At a July event in Espirito Santo, a state in southeast Brazil, the president handed house keys to a family benefiting from My House, My Life.

“To me, that is something extremely important, it is a right to achieve a dream,” Rousseff said at the event.

Covered bonds, by making mortgages less expensive, hold the possibility of advancing Rousseff’s agenda -- even if she’s defeated.

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