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LATIN AMERICAN EQUITY RESEARCH Sector Report | Brazil | Homebuilders / Macroeconomics 6 JULY 2015 BRAZILIAN HOMEBUILDERS ANATOMY OF A SECTOR TRANSFORMATION (PART 1): RESIZING THE SECTOR Bruno Mendonca* Renan Manda* Éverton Gomes* Brazil: Banco Santander S.A. (Equity Research) Brazil: Banco Santander S.A. (Equity Research) Brazil: Banco Santander S.A. (Macroeconomic Research) +5511-3012-5759 | [email protected] +5511 3012-6535 | [email protected] +5511 3012-7677 | [email protected] Net/Net: The foundations of the homebuilding world in Brazil are shifting. In searching for a new balance in terms of funding costs, we believe the sector will tend to stabilize at a significantly smaller size. In this first report of our Anatomy of a Sector Transformation series (joint reports by our real estate equity research and our macroeconomic teams), we discuss (1) our estimates for the new size of the sector (at least 53% smaller than 2014 in terms of SBPE credit); (2) the potentially negative impact of credit mix (new units vs. second-hand vs. corporate) on the potential sales value of the sector; and (3) the potential impact of sector deceleration on Brazilian GDP. New financing reality suggests a 53% downsizing in SBPE credit supply for the sector. Considering the exhaustion of SBPE (Brazilian savings accounts) subsidized funding and assuming no additional net inflow (or outflow), we estimate that the maximum sustainable SBPE credit concessions (TR-indexed) probably will not be larger than R$53 billion per year (down from R$113 billion in 2014), meaning a 53% reduction and leading the sector’s credit supply back to 2010 levels (in nominal terms). The government measures aim to soften the landing (Minha Casa Minha Vida and other FGTS-funded programs tend to be more protected than the rest of the sector), but the transition still looks rough, in our view, mainly for mid-to-high income projects. Corporate credit may suffer even more during the transition period. We believe the adjustment period may temporarily cause up to 83% of the total corporate credit available for new projects to dry up. We currently see banks prioritizing credit to clients buying units from projects financed in-house to avoid excessive delinquency in construction financing. This means that credit for new units will be temporarily prioritized over second-hand units and construction financing for new projects, in our view. In this report, we present an exercise where we show that, under current rules, SBPE may not be enough to support more than R$10 billion/year in project launches (total PSV Brazil), gradually rising to R$28 billion/year when the sector reaches equilibrium (which could take a couple of years). As a reference, listed players launched R$27 billion and R$20 billion in 2013 and 2014, respectively, down from a peak of R$38 billion in 2011. The sector needs resizing. We estimate that 20% of the Brazilian GDP decline in 2015 may be attributable to the civil construction sector (including infrastructure). Civil construction accounts for 6.5% of total Brazilian GDP. For 2015, we forecast a 4% drop in civil construction GDP, meaning that the direct contribution of the sector to total GDP will be -0.3 p.p. (20% of the expected 1.5% GDP drop for this year). The impact on the unemployment rate is also relevant and may reach +0.9pp if we consider formal and informal jobs under current trends. IMPORTANT DISCLOSURES/CERTIFICATIONS ARE IN THE “IMPORTANT DISCLOSURES” SECTION OF THIS REPORT. U.S. investors’ inquiries should be directed to Santander Investment Securities Inc. at (212) 583-4629 / (212) 350-3918. * Employed by a non-US affiliate of Santander Investment Securities, Inc. and is not registered/qualified as a research analyst under FINRA rules. Contents What is the new size of the sector? A credit supply perspective ........................................................................................................................... 3 The sector needs a new financing structure .......................................................................................................................................................... 7 The Macro View – Construction sector impacting GDP and jobs creation .......................................................................................................... 10 Minha Casa Minha Vida program (funded by FGTS) is less exposed than the rest of the sector........................................................................ 12 The Brazilian financing system ............................................................................................................................................................................ 13 2 WHAT IS THE NEW SIZE OF THE SECTOR? A CREDIT SUPPLY PERSPECTIVE BANKS’ APPETITE FOR GRANTING NEW MORTGAGES IS DIMINISHING . . . Figure 1. Estimating the Breakdown of SBPE Sources: Funding Needs Replenishment – R$ billion We estimate a 53% reduction in yearly SBPE credit supply. Considering the Mortgage Concessions 113 exhaustion of SBPE-subsidized funding from savings accounts and assuming no -53% additional net inflow, we see SBPE outstanding credit growing only in-line with the Untapped Funding Available 44 interest on savings accounts (6%+TR a.a.). Adding the expected average credit Mortgage Concessions 53 Net Inflow 15 Interest 22 turnover (amortizations) to this amount of interest, we estimate that the maximum sustainable TR-indexed credit supply (SBPE) would not be larger than R$53 billion Interest 22 Amortizations (SBPE Turnover) 32 Amortizations (SBPE Turnover) 31 2014 Annual Equilibrium per year (down from R$113 billion in 2014), as shown in Figure 1. Any additional withdrawals from savings accounts may add downside risk to our estimates. Such restrictions are likely to add significant pressure to financing costs for companies and individuals. Sources: ABECIP data and Santander estimates. Figure 2. Annual Mortgage Concessions from SBPE Funding – R$ billion 120 109 113 We see SBPE mortgage concessions returning to 2010 levels. The R$53 billion 100 80 83 potential credit availability figure we forecast is a 53% reduction from 2014’s credit 80 56 60 53 concessions and is comparable to 2010 levels. This sharp reduction stems mostly from a combination of (1) exhaustion of the untapped funding from savings 40 20 30 34 accounts; (2) higher-than-expected withdrawals from savings accounts year to date 18 5 9 (with no signs of recovery in the short term); and (3) a recent hike in the Selic/CDI, Equilibrium 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 0 which increased significantly the marginal cost of funding and limiting banks’ appetite. Sources: BCB and Santander estimates. 3 . . . AND WE EXPECT THE TRANSITION PERIOD TO HAVE A LARGER IMPACT ON CORPORATE CREDIT Figure 3. CEF’s Market Share and SBPE Mortgage Concessions – in R$ millions Caixa Economica Federal (CEF) is pulling the hand break on SBPE mortgage 7,370 credit. According to Valor Economico newspaper (based on data from ABECIP and the -51% ItaúUnibanco 11.4% Brazilian Central Bank), May 2015 data points to an 85% reduction in CEF’s monthly 4,798 Santander 9.1% CEF 65.1% 3,608 840 Banco do Brasil Others 4.7% 671 486 346 228 Apr-15 3.1% credit origination, helping to push the market down 51% MoM. CEF’s May 2015 ItaúUnibanco mortgage lending of R$0.7 billion compares to a monthly average of >R$4.0 billion in Santander 725 Bradesco 6.6% CEF 898 729 Bradesco previous months (this is the only published data after CEF’s changes, so it may be too Banco do Brasil early to call it a new run rate). In May 2015, CEF introduced more restrictive rules for Others mortgage concessions, with (1) higher rates; (2) lower LTV (only 50% for second-hand 735 285 236 May-15 units, down from 80% previously); (3) stricter approval rules for unofficial income; and (4) lower commissioning for its distribution network. In Figure 3, we show the Source: Valor Econômico. significance of Caixa’s restrictions for overall monthly credit concessions. Figure 4. Estimated Breakdown of Credit Concessions with SBPE’s Resources – R$ billion 2014 Transition Period Corporate 21% Corporate 8% Used 30% Used 43% New 62% New 36% Equilibrium Corporate 22% Used 47% New 31% But CEF adjustments tend to temporarily distort credit mix. We expect the transition period to have a major impact on corporate credit (new projects). As an attempt to partially soften credit disruption for the homebuilders, we see Caixa (and all other banks) prioritizing the transfer of clients from projects financed in-house to avoid excessive delinquency in construction financing. This means that credit for new Mortgage Concessions: 113 Corporate: 23.3 Used: 48.5 units will be prioritized over second-hand units and construction financing for new -83% Mortgage Concessions: 53 -67% Corporate: 4.1 Used: 16.2 New: 41.0 -20% 2014 New: 32.8 Transition Period Mortgage Concessions: 53 projects. In this sense, we expect distortions in the credit mix in the short term, with the bulk of the adjustment in second-hand units initially, but also significantly Corporate: 11.7 pressuring the availability of subsidized corporate credit (SBPE) during the transition Used: 25.0 period (Figure 4). We estimate corporate credit supply may be cut by 83% during the New: 16.4 transition period, before banks find a new credit mix equilibrium (details on page 6). Equlibrium Sources: BCB and Santander estimates. 4 WITH LIMITED CORPORATE CREDIT AVAILABILITY, NEW LAUNCHES SHOULD DROP SIGNIFICANTLY Figure 5. Potential SBPE Market Size – PSV (launches) in R$ billion The SBPE market’s potential sales value (PSV) will decline significantly, in our New Market Size view. Considering our estimated amount of SBPE credit available for new projects (R$4.1 billion/year during the transition period), and using an estimated average cost PSV 29.2 structure of a project, the reverse math suggests that SBPE may be enough to 10.2 PSV 10.2 11.7 support only R$10 billion/year in launches, gradually rising to R$28 billion/year when the sector reaches equilibrium. As a reference, listed players alone launched R$27 14.6 billion and R$20 billion in 2013 and 2014, respectively, down from a peak of R$38 3.6 5.1 4.1 Corporate Transition Period Corporate Equilibrium Land billion in 2011. 4.4 1.5 Corporate Transition Period Corporate Equilibrium Construction Cost Gross Profit PSV Source: Santander estimates. Homebuilders dilemma: reduce corporate structure or inject equity. Not an easy choice, mainly because it is still hard to precisely time the transition period. Reducing Figure 6. CNI Survey – Construction Companies’ Expectations launches indefinitely will hurt future results and eventually force managements to 70 significantly reduce corporate structure (which is – or at least should be – already 65 happening in most companies). On the other hand, maintaining the level of future 60 launches will likely demand additional equity in the projects to offset the mild credit 55 Optimism supply in the period (also potentially pressuring returns). Currently, we would rather 50 45 see companies maintaining launches as low as possible, mainly considering the Pessimism 40 current level of inventories in the market. 35 33 Current Credit Availability Note: Construction companies ex-infrastructure. Source: IBGE. 1T15 4T14 3T14 2T14 1T14 4T13 3T13 2T13 1T13 4T12 3T12 2T12 1T12 4T11 3T11 2T11 1T11 4T10 3T10 2T10 1T10 4T09 30 Reality check on expectations. According to a survey conducted by the National Construction Confederation (CNI), companies’ expectations on credit availability have been gradually deteriorating since 2011 (Figure 6). After CEF’s recent restrictions, we believe this relative pessimism seems reasonable.… 5 BUT RESTRICTIONS ON SECOND-HAND UNITS MAY NOT BE SUSTAINABLE INDEFINITELY; BANKS SHOULD PURSUE A BALANCED MIX Without additional funding, banks need to reach cash-flow equilibrium for self- Figure 7. Outstanding Credit Mix for Cash Flow Equilibrium – R$ Billion Construction New sufficiency. For a non-growing housing financing system to remain balanced, the Second-Hand 41.3 cash inflow from mortgage amortizations must equal the cash disbursements for financing new projects (corporate financing). An unbalanced credit mix may lead the 47% Credit Mix 22% banks to inject additional resources in the system, in our view, which may not be 25.0 desirable in a scenario of funding constraints. 31% Cash Flow Equilibrium Different durations of corporate credit and mortgages mismatch cash flows. The longer duration of mortgage loans versus corporate loans (project financing) leads to 16.4 3.9 11.7 2.4 3.9 Corporate Loans Avg. Annual Disbursement an imbalance between the cash received from individual mortgage amortizations 1.5 (Figure 7.2) and the cash needed to finance the next round of new projects (Figure Avg. Annual Amortization Mortgage Loans 7.1). This gap must be filled by second-hand units. Source: Santander estimates. Second-hand market is needed to rebalance cash flows. In order to rebalance the system’s cash flow, an additional source of amortization is needed, namely secondhand units. Figure 7 shows an equilibrium exercise assuming (1) 70% LTV; (2) 20% of units paid in cash (no mortgage); and (3) 80% construction financing. Figure 8. Breaking Down the Credit Mix to Reach Cash-Flow Equilibrium with a Constant Amount of Available Funding – R$ Billion Corporate Mortgage – Second-Hand Units Mortgage – New Units Transfer to Banks 10.7 5.8 7.0 29.2 35.7 29.2 16.4 14.6 11.7 Value Financed Construction (80%) Cost + PSV PSV Paid in Cash Downpayment Mortgage (70% (30%) LTV) Mortgage (70% LTV) Avg. Duration: 11 Years Avg. Maturity: 3 Years Avg. Annual Disbursement: 3.9 1 = Avg. Annual Amortization: 1.5 25.0 Downpayment (30%) PSV Avg. Duration: 11 Years 2 + Avg. Annual Amortization: 2.4 3 Sources: Santander estimates. 6 THE SECTOR NEEDS A NEW FINANCING STRUCTURE Exhaustion of SBPE-subsidized funding pressures banks to fund new projects and mortgages with alternative sources, most likely through CDI-linked securities such as LCI/LH. This need comes at a time when the interest rate continues to rise, widening the minimum spread necessary to continue having a profitable credit line for new concessions. Altogether, this puts additional pressure on the banks to continue raising interest rates for new projects and new mortgages. Current market rates (and/or home prices) are only sustainable with the Selic/CDI at <9% a.a. This is an old discussion, but increasingly relevant currently, in our view. Considering average mortgage rates currently at 9.4% (Figure 9) and assuming banks’ marginal funding through a 90%-of-the-CDI LCI/LH (currently a 12.4% a.a. funding cost), banks’ minimum demanded profitability (e.g., a 150-200-bp spread) will likely cap the homebuilding sector’s growth until the Selic/CDI stabilize at <9%, when non-SBPE financing becomes sustainable. Before that, equilibrium will require significantly higher mortgage rates (putting pressure on home prices and/or demand). The timing of the transition still looks like a two-year rolling target. The sector needs resizing. Santander’s macroeconomic team estimates the Selic at 11% by YE2016 (down from 13.75% currently). Even if our scenario is confirmed (considering we are below consensus and the Brazilian Central Bank still sounds hawkish), an additional two-year period for a natural rebalancing may seem too optimistic. Until then (and for as long as it may take), the sector needs resizing, in our opinion. Figure 9. SBPE Funding for Mortgages Is Fully Used . . . (in R$ billions) Figure 10. . . . and Current Market Rates Are Lower Than the Banks’ Marginal Cost Of Funding (CDI), Putting Pressure on Banks to Raise Rates and Cap Credit Growth 15% 14% 65% 13.25% 13.75% 13% 12% 11% 510.1 10% 331.6 349 9.37% 9% <9% 8% -18 7% 6% Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 SBPE Earmarked for housing Granted Available SELIC SBPE: Savings Account. Sources: BCB, CEF, ABECIP, and Santander estimates. Mortgage Rates - Total Source: IBGE, BCB, and Santander estimates. 7 SO WHERE IS THE ADJUSTMENT COMING FROM? It is hard to precisely quantify the impact during the transition period (which we expect to take two to four years, depending on an economic recovery and/or government bailouts/stimulus), but based on the current situation, we believe that: Mortgage rates will tend to go even higher: With limited subsidized funding, we expect banks to be more restrictive and, mainly, more selective in granting credit. So we see room for additional increases in financing costs (for companies and individuals). Low average income may not absorb higher rates/lower LTV. Brazil is an “installment market”: In Figure 13, we present a sensitivity of rates and LTV, and their impact on housing affordability (maximum income commitment with installments). For example: a 150-bp increase in rates (already a reality), combined with a 10-pp reduction in LTV (also happening), leads to a 16% reduction in affordability. Without additional income or subsidized funding, the liquidity of the market is sustainable only if home prices adjust downward. At a time when stagnation in income growth is evident, we see pressure on home prices. Although each city (or even neighborhood) may present different realities, we see the transition period, on average, as being characterized by a combination of a lower number of deals and higher discounts. In a forthcoming report, we will provide more details on the following: (1) the role of private banks on credit supply for the sector; (2) home prices and particular drivers; and (3) the housing deficit and the relation with the level of income in Brazil. Figure 11. Sensitivity Analysis of Change in Purchasing Power vs. LTV and Mortgage Rates – Base 100 Effective Interest Rate -16% Initially Planned 11.0% Income Commitment 35.0% LTV 80.0% Loan Term 80 100 70 64 84 LTV Interest Rate p.a. -7% 11.0% 11.5% 12.0% 12.5% 13.0% 40% -40% -41% -43% -43% -45% 50% -30% -32% -33% -34% -36% 60% -20% -22% -24% -25% -27% 70% -10% -12% -15% -16% -18% 80% 0% -3% -6% -7% -10% 30 years 20 PSV Initially Planned 20 20 -10p.p. in +150bps in Purchasing LTV Mortgage Power Rates Down Payment Mortgage Sources: ABECIP and Santander estimates. 8 OUR SCENARIO HAS DOWNSIDES AND UPSIDES Record-high withdrawals from savings accounts in 2015 are driving the sector Figure 12. SBPE Net Inflow vs. Mortgage Concessions – in R$ billions into a perfect storm. If the overall macro environment is already challenging, it adds to 35 what we see as the main disruption for the sector: exhaustion of subsidized funding for 25 mortgages (savings accounts). In light of the unexpected record-high withdrawals from 15 savings accounts (Figure 11), public banks like Caixa Economica Federal are being 5 forced to reduce significantly the credit offered to the sector. CEF is historically the main provider of mortgages and construction credit in Brazil, with a 65% market share -5 -5 -15 in Brazil, please refer to page 13 of this report.) 1Q15 4Q14 3Q14 2Q14 1Q14 4Q13 3Q13 2Q13 1Q13 4Q12 3Q12 2Q12 1Q12 4Q11 3Q11 2Q11 1Q11 4Q10 3Q10 2Q10 1Q10 4Q09 3Q09 2Q09 1Q09 Mortgage / Construction Loans Origination Apr/15 -19 -25 through March 2015. (For details on the structure of the financing system for the sector Savings Account Net Inflow Higher duration of new mortgages adds downside to our estimates. In addition to the risk of additional withdrawals from savings accounts, we note that new concessions Sources: ABECIP data and Santander estimates. have higher average maturity (Figure 12). In this sense, credit turnover (amortizations) tends to decrease, potentially reducing the amount of funding available for new credits. Figure 13. Average Maturity of New Mortgages Is Higher than Outstanding Portfolios 35 On the upside, net inflow may recover, in our view, once the economy rebounds and interest rates retract. 30 29.0 25 What could change this scenario? We do not rule out additional government measures to ease this transition. We acknowledge that there is a significant number 20 of assumptions in the conclusions here presented, but we believe the big picture would 15 be changed significantly only if (1) interest rates in Brazil drop faster than we expect, 10.6 10 5 0 Mar-11 finding a new balance (Selic <9%) before YE2017; or (2) there are significant changes in the structure of the Brazilian financing system (e.g., reserve requirements or changes Sep-11 Mar-12 Sep-12 New Mortgages - Maturity Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Mortgage Portfolio - Duration in the rules for use of FGTS as a financing source). So far, we see the government’s measures as providing only brief temporary relief. Sources: ABECIP data and Santander estimates. 9 THE MACRO VIEW – CONSTRUCTION SECTOR IMPACTING GDP AND JOBS CREATION CONSTRUCTION GDP WEAKER THAN OVERALL AVERAGE, BUT CONTAMINATION RISK IS LOWER THAN OTHER INDUSTRIES’ AVERAGE We estimate that 20% of the Brazilian GDP decline in 2015 may be Figure 14. Construction GDP Growth (including infrastructure) 15.0 attributable to the civil construction sector. Civil construction accounts for Civil Construction Boom 6.5% of total Brazilian GDP (including infrastructure, which represents ~45% of 9% 10.0 this figure). For 2015, we forecast a 4% drop in civil construction GDP, meaning that the direct contribution of the sector to total GDP will be -0.3 pp (20% of the 4% 5.0 expected 1.5% GDP drop for this year). All the drivers are in the negative 0.6% 0.0 -1.2% -5.0 Civil Construction GDP -4.0% direction: (i) interest rates are increasing; (ii) total wages are expected to fall 4% this year; (iii) consumer confidence is at its lowest level in the data series; and (iv) the Car-Wash federal police investigations. GDP excluding Civil Construction -10.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E2016E The intra-sectoral impact matrix (Leontief Matrix) is used to indicate cross- Sources: IBGE and Santander estimates. sector impact of changes in demand from a given industry. For example, the matrix can be used to estimate the potential impact of the downturn of the Figure 15. Leontief Matrix’s Multiplying Factor on Intrasectoral Impact construction sector on the overall Brazilian economy, as a consequence of the 2.5x deceleration in the sector’s supply chain. For each R$ 1 in demand reduction in the construction sector, the Leontief Matrix estimates a total of R$1.7 of demand 2.2x Average: 2.0x 1.9x reduction in the overall economy. 1.7x The ripple effect of the construction sector is relevant, but lower than 1.3x 1.1x average. The constructions sector’s multiplying effect (1.7x) is slightly lower than the average of all other sectors (2.0x), but significantly lower than industries such Automakers Sources: IBGE. Machinery & Equipment Oil & Gas Civil Works Public Education Real Estate Brokerage and Rental as the automakers (2.5x) or industrial machinery & equipment (2.2x). This exercise does not consider other indirect impacts such as additional layoffs or changes in consumer confidence and unemployment, which may create another round of ripples. 10 WE EXPECT A REDUCTION OF 290,000 FORMAL JOBS IN THE CONSTRUCTION SECTOR IN 2015 (+0.3 P.P. IN UNEMPLOYMENT RATE) The impact on the unemployment rate may reach +0.9pp if we consider informal jobs following the same trend. The sector already reduced 106,000 formal jobs year to date (until May/15). Brazilian government data lacks a detailed breakdown just for homebuilders, but we estimate the subsector breakdown of total jobs as follows (based on IBGE): 1) 40% building construction (residential and corporate); 2) 34% infrastructure (e.g. roads, airports); and 3) 25% construction services (e.g. ground leveling, detailed finishing). # of jobs in the sector is dropping faster in the North and Mid-West regions, but the trend is negative in all regions. Figure 16 shows the breakdown of net formal jobs creation by region in the construction sector in Brazil. The sector trends down, but the impacts are not the same throughout the country. In absolute terms, the southeast region is cutting the largest number of employees in the last twelve months, with -137,900 jobs (a 9.7% YoY drop in the total number of jobs), being 93,300 cuts in the last six months, showing acceleration in the negative trend. In relative terms, the impact was worse on the Mid-West (-18% YoY) and North (-14%YoY) regions. The most impacted state in Brazil was Pernambuco (one of the Northeast’s most relevant states), with an impressive 26% reduction in formal jobs since May/14. Construction was responsible for 54% of formal jobs cut in the last twelve months. The construction sector created 2.7 million formal jobs between 2006 and 2013, which accounted for 20% of total jobs created in Brazil in the period (Figure 18). More recently, after the trend reverted, the construction sector (including infrastructure) was responsible for 54% of the reduction in formal jobs in the country in the last twelve months (from May/15). Currently, jobs in civil construction represent 6.7% of the total formal jobs in Brazil (a total of 38.9 million formal jobs in May/15). NE -30.1 -30.4 MW S -25.8 -16.2 SP PE -34.2 -20.9 -45.2 -5.4% -93.3 -8.0% -89.7 -13.1% -137.9 -9.7% Last 12 Months Last 6 Months 55 50 -26.3% 15% 400 65 10% 300 60 -35.5 -57.1 -18.4% SBPE: CAGED. 500 70 -22.6 -80.9 -14.9% SE Figure 18. Civil Construction Formal Job Creation 200 Optimism 5% 100 Pessimism 45 45 44 40 0 0% -100 -95 -200 35 -300 30 -400 4T09 1T10 2T10 3T10 4T10 1T11 2T11 3T11 4T11 1T12 2T12 3T12 4T12 1T13 2T13 3T13 4T13 1T14 2T14 3T14 4T14 1T15 N Figure 17. CNI Survey – Construction Companies’ Expectations indicates additional job cuts Business Activity Expectation Source: IBGE. Workforce Expected -5% -290 -10% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E Figure 16. Sector’s Net Job Creation by Region – 000’s of Jobs and % Variation YoY Formal Jobs Net Creation ('000) Civil Construction GDP Growth (%) Sources: CAGED and Santander estimates 11 MINHA CASA MINHA VIDA PROGRAM (FUNDED BY FGTS) IS LESS EXPOSED THAN THE REST OF THE SECTOR Units from the MCMV have regulated mortgage rates and are funded through FGTS (Brazilian workers’ mandatory savings accounts). CEF manages 100% of the FGTS funds, but rates and credit offered through FGTS-funded mortgages have not yet been directly affected by the recent hike in mortgage rates by the banks and more restrictive credit. The risk for the segment is more on the macro side, in our view, as, in a scenario of low GDP growth, a rising unemployment rate, high inflation, and high interest rates, disposable income for low-income families tends to be the most affected, potentially jeopardizing their ability to purchase a new home. Recent delays in CEF payments are worse for Group 1. Delays in payments tend to have a higher impact on Group 1 developers, as they have shorter working capital cycles and are much more dependent on cash inflow to continue advancing production. Group 1: Subsidies from FAR (government) account for up to 96% of the unit’s value and have regulated mortgage rates The remainder is financed through CEF at fixed installments and with no downpayment. Group 2: Subsidies from FGTS and regulated mortgage rates. Conventional sales (downpayment, mortgage, credit screening). Group 3: No subsidies and regulated mortgage rates. Conventional sales (downpayment, mortgage, credit screening). The next stage of the program, still to be announced by the government, is Figure 19. FGTS Net Inflow – from 2000 to 1Q15 20 18.0 likely to have broadly the same format as the current one, albeit with a 18.8 18.4 potential additional group parallel to Group 1 with subsidies from FGTS, in order 18 16 14.6 14 to minimize government spending. As the inflow to FGTS comes from compulsory 11.9 contributions from payrolls, and any withdrawals or use of its funds have strict 12 requirements, its net inflow remains strong at R$6.1 billion in 1Q15 compared to 10 8 6.2 6 6.8 6.0 6.9 6.1 the savings account’s net outflow of R$19 billion (and R$24 billion until Apr/15). 2.3 2.8 2002 1.5 2001 4.6 4 2 6.3 3.3 1Q15 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2000 - Source: FGTS. 12 THE BRAZILIAN FINANCING SYSTEM (AS OF APRIL 2015) Figure 20. Brazilian Mortgage Financing System Source of Funding Contributors CEF Infrastructure FGTS Total Assets: R$405 billion (Nov/14) Employers Unit Prices Borrowers 3% p.a. + TR FGTS Resources From 5% + TR to 8.16% + TR SBPE Resources Borrowers Units up to R$190 thousand SFH 80% 65% Mortgage Lending From 9.4%¹ + TR to 12% + TR Savings Deposits Total Assets: R$510 billion (Apr/15) 20% Reserve Requirements Interest Rate 6% p.a. + TR If Selic<8,5% p.a. 70% of Selic + TR 10% Additional Reserve Loans at Market Rate Non-SFH 20% 5% Units from R$190 To R$650³ thousand Borrowers Starting from 11.0%² + TR Resources Available Units above R$650³ thousand Borrowers Other Sources Starting from 10%² + TR (1) If the client has a salary account in CEF the interest rate can reach 9.0%+TR; (2) If the client has a salary account in CEF the interest rate can reach 10.7%+TR. (3) For SP, RJ, MG, and DF the ceiling price is R$750,000. Sources: BCB, FGTS, CEF, and Santander. 13 IMPORTANT DISCLOSURES Key to Investment Codes Rating Buy (B) Definition Expected to outperform the local market benchmark by more than 10%. Hold (H) Expected to perform within a range of 0% to 10% above the local market benchmark. Underperform Expected to underperform the local market benchmark. Under Review (U/R) % of % of Companies Provided Companies Investment Banking Covered with Services in the Past 12 This Rating Months 47.62 9.89 42.49 6.96 9.89 1.10 0.00 0.00 The numbers above reflect our Latin American universe as of Sunday, July 05, 2015. For a discussion, if applicable, of the valuation methods used to determine the price targets included in this report and the risks to achieving these targets, please refer to the latest published research on these stocks. Research is available through your sales representative and other electronic systems. Target prices are year-end 2015 unless otherwise specified. Recommendations are based on a total return basis (expected share price appreciation + prospective dividend yield) unless otherwise specified. Stock price charts and rating histories for companies discussed in this report are also available by written request to Santander Investment Securities Inc., 45 East 53rd Street, 17th Floor (Attn: Research Disclosures), New York, NY 10022 USA. Ratings are established when the firm sets a target price and/or when maintaining or reiterating the rating. Ratings may not coincide with the above methodology due to price volatility. Management reserves the right to maintain or to modify ratings on any specific stock and will disclose this in the report when it occurs. Valuation methodologies vary from stock to stock, analyst to analyst, and country to country. Any investment in Latin American equities is, by its nature, risky. A full discussion of valuation methodology and risks related to achieving the target price of the subject security is included in the body of this report. The benchmark used for local market performance is the country risk of each country plus the 1-year U.S. Treasury yield plus 5.5% of equity risk premium, unless otherwise specified. The benchmark plus the 10.0% differential used to determine the rating is time adjusted to make it comparable with the total return of the stock over the same period. For additional information about our rating methodology, please call (212) 350 3974. This research report (“report”) has been prepared by Santander Investment Securities Inc. ("SIS"; SIS is a subsidiary of Santander Investment I, S.A. which is wholly owned by Banco Santander, S.A. "Santander"]) on behalf of itself and its affiliates (collectively, Grupo Santander) and is provided for information purposes only. This report must not be considered as an offer to sell or a solicitation of an offer to buy any relevant securities (i.e., securities mentioned herein or of the same issuer and/or options, warrants, or rights with respect to or interests in any such securities). Any decision by the recipient to buy or to sell should be based on publicly available information on the related security and, where appropriate, should take into account the content of the related prospectus filed with and available from the entity governing the related market and the company issuing the security. This report is issued in Spain by Santander Investment Bolsa, Sociedad de Valores, S.A. (“Santander Investment Bolsa”) and in the United Kingdom by Banco Santander, S.A., London Branch. Santander London is authorized by the Bank of Spain. This report is not being issued to private customers. SIS, Santander London and Santander Investment Bolsa are members of Grupo Santander. The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed, that their recommendations reflect solely and exclusively their personal opinions, and that such opinions were prepared in an independent and autonomous manner, including as regards the institution to which they are linked, and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report, since their compensation and the compensation system applying to Grupo Santander and any of its affiliates is not pegged to the pricing of any of the securities issued by the companies evaluated in the report, or to the income arising from the businesses and financial transactions carried out by Grupo Santander and any of its affiliates: Renan Manda*, and Bruno Mendonca* *Employed by a non-US affiliate of Santander Investment Securities Inc. and is not registered/qualified as a research analyst under FINRA rules and is not an associated person of the member firm, and, therefore, may not be subject to the FINRA Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. 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