By any standards, Brazilian consumer debt is exploding. The balance of credit cards, payroll-deductible loans, unsecured loans and auto loans totaled R$264 billion ($1.57 billion) at the end of 2007, up 29% from a year earlier.
With blazing growth like this, and given the liquidity crisis abroad, you might expect a significant slowdown. But experts say that's not in the cards.
Fevered competition among the small-to-medium banks that lend payroll-deductible personal loans and the expansion of all kinds of credit to poorer segments of the population are fanning the spread of consumer lending.
In the race for quantity, where's quality headed?
Fitch Ratings rang a warning bell two months ago to investors in ABS backed by payroll-deductible loans, pointing out the hazards in a business where origination is robust. The industry, which targets individuals who work for public entities or receive social security payments, pulled in R$1.1 billion in 2007 by securitizing deductible loans. That was a drop from R$1.7 billion in 2006, with M&A activity and a boom in IPOs eroding the need for funding via ABS.
But the loan machines are still keyed up. "Origination probably won't drop because [the banks] haven't used the resources from the IPOs in 2007," said Bernardo Costa, associate director at Fitch.
Heightened competition among lenders has encouraged questionable practices in origination and in refinancing assets in securitization deals, players said. When a qualified borrower seeks a payroll-deductible loan, a broker, known locally as a pastinha, will typically request a loan from more than one bank. Sometimes, more than one bank will disburse the loan, but only the first to get all the paperwork signed can actually deduct from the borrower's paycheck. The other ends up having either an unsecured loan with the borrower or is forced to renegotiate the terms in order for the total in deducted loans to stay within a pre-set cap, expressed as a percentage of a borrower's monthly income.
Pensioners being paid through the local social security system are limited to 20% of their income, but for those borrowing through other payment systems, it could be higher.
On the ABS front, the prepayment and refinancing of collateralized payroll-deductible loans could whittle down credit enhancement, Standard & Poor's said in a recent report. And it's not only falling interest rates and brisker competition among lenders that has led to prepayments. It also includes repurchases of "problematic loans," the agency added.
One of the main issues is that there simply isn't good data on renegotiated loans and prepayment rates, said Patricia Bentes, a managing partner at consultancy Hampton Solfise.
With originating banks treating these securitizations as virtual credit lines, repurchasing is part of their funding strategy - but what happens if they decide it's no longer worth it?
So far, while delinquencies have risen in ABS backed by payroll-deductible loans, enhancements are still strong enough to avoid S&P downgrades.
Overall, defaults in the consumer sector are still low. Luciano Araujo, another managing partner at Hampton Solfise, pointed out that 90-plus-day delinquencies for all personal loans were 5% in February, down from 6.5% in 2004. And this during a time when tenors doubled.
The aggregate overall consumer indebtedness in Brazil remains a fraction of the U.S. figure, but with scant data on individual borrowers, it's not known how this leverage is spread. This could spell trouble down the road.
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