Chile Fund Returns 10% With Loans Big Banks Won’t Touch

Publicado en Bloomerg | 06 Noviembre, 2014
Chilean asset manager Larrain Vial Activos has produced returns that trounce those of the country’s stock market with a novel strategy: making small home loans that big banks won’t touch..

The asset management firm, a unit of Larrain Vial SA, which oversees about $18 billion in assets and owns Chile’s largest stock broker, started the fund in 2010 to provide mortgages to borrowers who receive government housing subsidies. The fund has delivered gains of 9.8 percent to investors over the past 12 months through Nov. 4, according to data compiled by Bloomberg.

Larrain Vial expanded into mortgages in Chile after President Michelle Bachelet decreed in 2009 that the government would fully guarantee loans to borrowers who received subsidies. The program, designed to remedy a shortage of affordable housing, has provided hundreds of thousands of payments to Chileans who didn’t own property to buy homes. Larrain Vial Activos managers have seized the opportunity by giving $83 million in guaranteed loans to these first-time buyers in Chile.

“Chile has been very successful in reducing its housing deficit,” said Slaven Razmilic, an economist at Santiago-based Centro de Estudios Publicos, who researches residential real estate. “The state has been particularly active in promoting the participation and addition of private lenders in the industry.”

Managers from the U.S. to South Korea run closed-end funds, such as Larrain Vial Deuda con Subsidio Habitacional, that focus on mortgages. Most of these funds, which have a fixed number of shares, invest in mortgage-backed securities while Santiago-based Larrain Vial Activos holds the loans.

20% Returns

The $269 million Pasadena, California-based Western Asset Mortgage Defined Opportunity Fund (DMO), which has more than half of its holdings in subprime or alt-A residential mortgage-backed securities, returned 19 percent over the last 12 months ending in Nov. 4. It’s the top performer among 17 closed-end mortgage-focused funds, according to Bloomberg data. Larrain Vial’s fund ranked No. 2 over the last year and has returned 8 percent annually over a three-year span. The $389 million New York-based Brookfield Mortgage Opportunity Income Fund (BOI), which has about half of its assets in floating-rate residential mortgage-backed securities, gained 8.7 percent, making it No. 3.

The Larrain Vial fund also outperformed the stock and fixed-income markets in Chile. The IPSA index, Chile’s main stock benchmark, fell 0.3 percent over the past year. The yield on Chile’s inflation-indexed 10-year bond has fallen to 1.6 percent from 2.2 percent in the same period.

Extremely Conservative

Larrain Vial Activos works in partnership with MYV Mutuos Hipotecarios, a private lender that screens potential borrowers, originates loans and sells them to the fund. MYV requires that borrowers earn at least four times their mortgage payments, and their total monthly financial obligations can’t be more than half of their income.

The loans carry an interest rate of about 5.9 percent plus inflation, which reached 4.9 percent in the last 12 months. Larrain Vial Activos had 4,165 loans in its fund in August.

MYV Mutuos Hipotecarios allows borrowers to buy units anywhere in Chile developed by its approved construction companies. The units bought through MYV Mutuos Hipotecarios cost between $33,000 and $62,000. Larger lenders, such as Banco Santander Chile and Banco de Chile, provide lending for more expensive houses.

“We’ve wanted to be extremely conservative with this fund,” said Gabriel Mena, 48, who has nine years of experience at Larrain Vial and co-manages the mortgage fund. “If we were to fund more expensive unsubsidized houses, we would start to compete with local banks and they have lower funding costs, and that would push us to lend to riskier debtors.”

Government Subsidy

Ignacio Montane, 36, who is Mena’s partner, said the fund’s requirement that the borrowers have a subsidy offers additional protection against a default.

“A debtor with a government subsidy is very aware that the property is by far his or her most valuable asset,” Montane, who has worked as an engineer, said. “You can only get the government subsidy once in your life, and that increases willingness to pay.”

In Chile, with a population of 17 million, the boom in copper exports in the last decade has brought wealth to parts of Santiago, where 700 square-meter (about 7,500 square feet) luxury apartments in the Las Condes and Vitacura districts sell for up to $3 million, according to Portalinmobiliario.com, a real estate Web site. About 30,000 Chilean families remain in 682 shanty towns, including those scattered on the banks of Santiago’s Mapocho river or illegally set up on the periphery of the capital, according to non-governmental organization Techo Chile.

President Bachelet

President Bachelet, 63, expanded the housing program that began in the 1970s with more incentives for private lenders. She boosted the size of the subsidy to make sure that the mortgage only had to cover about 50 percent of the value of the house. And she increased the government guarantee to cover 100 percent of the difference between the loan amount and the value of a foreclosed home sold at auction.

“This is a variation on a common theme of trying to find longer term funding for mortgages,” said Alex Pollock, resident fellow at the American Enterprise Institute who focuses on mortgage policy, about the Larrain Vial fund. “But the success of replicating this housing fund all depends on the credit performance.”

The government handed out subsidies for about 224,000 houses from 2011 to 2013, according to data on the Housing Ministry’s website. The partnership between the government and private lenders cut the housing shortage to 495,000 units in 2011 from 780,000 homes in 1992, said Razmilic, the economist.

Slowing Economy

Jocelyn Sanchez, 27, a single mother of two whose boyfriend works in construction, said she was approved for a subsidy of $17,000 for a new two-story home costing $33,000 in the district of Puente Alto, south of Santiago.

“Nothing is free,” Sanchez said outside the housing ministry offices in Santiago. “There aren’t other options if you want to have your own house.”

Mena and Montane’s fund, which competes with state-owned Banco del Estado de Chile and insurers, faces the challenge of a slowing economy and the threat of foreclosures. As the price of copper, Chile’s biggest export, has fallen 7.1 percent in the last 12 months, economists have been cutting their forecasts for growth in Chile to 2 percent in 2014, the lowest since 2009, from 4.2 percent at the end of last year, according to Bloomberg data.

Late Payments

As unemployment rose to 6.6 percent in September from 5.7 percent in December, the number of late payments on loans in the fund also jumped. In August, 983 borrowers were one month late in making payments, and 85 borrowers were delinquent on six or more monthly installments, according to a report on the fund’s website. That compares with 61 borrowers in April who were at least six months behind on payments, which can trigger a foreclosure.

“While there has been an increase in late payments, it’s not much of a concern for the fund’s investors as they have the guarantee that the loan will be fully repaid after an auction of the house,” Fernando Villa, a credit analyst at ICR Chile, said by e-mail.

The fund managers are also grappling with rising house prices that limit the locations of properties available to their borrowers. In Santiago, prices have doubled over the past two decades as the capital city runs out of space to build and labor costs have increased, said Esteban Gonzalez, a partner at real estate consultants AGS Negocios. Values rose 9.9 percent in the second quarter from the previous year after discounting for inflation, according to data from Chile’s Construction Chamber.

Peru, Colombia

Mena and Montane must now search outside of Santiago for affordable housing developments that fit within their borrowers’ price range. And a mining boom in northern Chile has made it harder for the managers to find housing in cities such as Iquique, Antofagasta or Copiapo.

“Whatever we were financing four years ago when we started the fund, we can’t fund anymore because now it’s out of our target range,” Montane said. “Areas in the south of Chile have filled the gap, especially with the reconstruction efforts after the 2010 earthquake.”

President Bachelet, who began her second term in March, said in a Sept. 1 statement that the government will provide funding for an additional 16,000 subsidies before the end of the year.

Mena and Montane have seen an increase in demand from investors to participate in their fund, which convinced them to launch the second one and explore options outside of Chile.

“This successful funding system has convinced us that we can replicate this in Peru and Colombia,” Montane said. “We’ve started the first contacts in those countries to learn more about policies that promote private investment in affordable housing.”



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