NEW YORK--(BUSINESS WIRE)--Brazilian banks could face modestly higher asset quality risk within payroll loan portfolios under a proposal by banking regulators to raise the maximum permissible payroll loan amount to 40%, from 30% of gross pretax income, says Fitch Ratings. This proposal is in addition to another change to rules governing payroll loans approved last October, whereby regulators extended the maximum permissible tenor on payroll loans to eight years from five. Under the latest proposal, the additional permissible borrowing amounts can only be used for the reduction of payroll credit card debts for retirees and pensioners of Brazil's Social Security Service (INSS).
The increased risk tolerance that comes with lengthened payroll loan tenors and higher borrowing amounts is a sign that bank regulators are accommodating borrowers' needs amid Brazil's rising household indebtedness and the country's economic slowdown. Typical payroll loan borrowers are medium to low income public sector employees and retirees, both of which have less flexibility in managing their modest, but stable income streams. These borrowers often seek to restructure their debts. Lower income levels tend to correlate with higher credit risk on payroll loans.
In spite of modest borrower credit profiles, payroll lending over the past several years has been a positive for the retail loan mix of large Brazilian banks. Lengthening tenors and the proposed higher maximum borrowing amounts somewhat offset the mix improvement. Payroll loans typically have low delinquency rates, consistent with residential mortgages, and are normally less risky than traditional unsecured personal loans, auto loans and credit cards.
Banking regulators recognize payroll loans as a form of consumer lending acceptable for higher growth, mostly due to these loans' track records of good asset quality. Payroll deductible loans reached BRL353 billion at year-end 2014, up from BRL73 billion at year-end 2009, a compound annual growth rate (CAGR) of 37% over the period. Payroll deductible loans now represent 30% of domestic consumer loans, up from 15% at year-end 2009. The average interest rate on payroll loans was approximately 26% in March 2015, versus 45% on average for other types of consumer credit, according to the Brazilian Central Bank.
The average tenors on new payroll loan originations rose quickly last year in reaction to new maximum permissible tenors, in part because lending rates on these loans, while high relative to most developed-market interest rate averages, remain lower than other types of consumer and personal loans in Brazil. As seen in the https://www.fitchratings.com/web_content/images/fw/fw-chart-20150520.htm of the average tenors of newly originated payroll loans jumped to a peak of 70 months in December 2014, up from 62 months in December 2013.
Banks that are active in payroll loans include Itau, which created a joint venture with BMG in 2013, and Santander Brazil, which has a joint venture with Banco Bonsucesso. Banco do Brasil, Caixa and Bradesco also have seen strong growth in their own payroll lending businesses.
Fitch believes that additional risks facing payroll loans include the possibility of a future reduction in the regulatory mandated interest rate caps placed on them. Changes in retirement plans or public servants' work stability schemes (common in Brazil) or salary changes could also affect payroll loan portfolio risk. The regulatory changes add risk to loan pricing and raise mortality risks borne by banks.
On a positive note, Fitch believes that the changes to payroll loan rules should lead to higher payroll loan growth in a year when traditional consumer lending, mortgage lending and commercial lending will face more limited growth prospects.
Regulators lengthened permissible payroll loan tenors last year under Bacen Circular Instruction no. 8321/14. Also around that time, they increased the maximum tenor for payroll loans to retirees to six years from five. We anticipate a final outcome on the proposed maximum payroll loan amount increase to be reached within the next several months.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.