Chile Central Bank Gives 'Yellow Card' to Real Estate Sector

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Apart from the famous asado, one of the great Chilean national pastimes is soccer.  Rather than one of the players on the famous Universidad de Chile or Colo-Colo teams, however, the most recent recipient of a yellow card was the Chilean real estate sector. 
 
In reports to the Chilean Senate, the President of the Central Bank, Rodrigo Vergara, stated that increasing price trends observed in certain areas earlier in the year have deepened and widened.   Without stating that a real estate bubble has formed, the Central Bank has become more concerned regarding the real estate sector, and its potential impact on the financial sector, due to evidence of increasing indebtedness of real estate companies, the possibility in the medium term of increased credit, a relaxation of credit standards and the prospect of increased real estate investment.   While overdue loans as a percentage of bank credit portfolios have declined, Loan to Value ratios have reportedly increased from 79% in July of 2011 to 86% in July of 2012.
 
There is active debate over whether the real estate sector is overheated.   The Chilean Minister of Finance, Felipe Larrain, stated that "there is no real estate bubble in Chile" and many other real estate sector players have argued that rapid price increases have been primarily driven by increased purchasing power and disposable income due to Chile's continuing economic growth and rising land costs.  Chile's GDP is forecasted to grow 5.5% in 2012. Sector participants have also pointed out that there have been relatively low levels of speculative real estate investment, credit volumes as a percentage of GDP remain low and banking credit practices continue to remain conservative.
 
Gauging real estate sector risk in Chile is challenging due to the fact that the country is witnessing a largely unprecedented improvement in its macroeconomic profile, potential demand for its core exports continues to strengthen, the middle class continues to grow and inflation remains largely under control.   The fact that the Chilean economy has qualitatively and quantitatively entered new growth territory makes it difficult to establish clear benchmarks regarding price increase limits and sustainable debt levels.
 
Considering downside scenarios, however, it is likely that the largest threat to the sector is not credit-financed speculation but rather the risk of an economic downturn.    While Chile's economy has continued to diversify, it remains heavily dependent on mining exports, and the mining boom due in key part to China imports has been responsible for a significant amount of residential sector growth.    If a combination of a drop in Chinese demand and increased energy and labor costs cut substantially into mining company margins and cause significant layoffs, a fall in take up could cause prices to significantly drop, particularly in areas in northern Chile that are heavily dependent on the mining industry.
 
From a financial sector perspective, while debt levels remain relatively low, Chile does not have a widely developed secondary credit market.  While this has helped keep overall debt levels down, it also means that banks have less ability to structure and spread out credit exposure.  As a consequence, if bank or systemic financial risk increases banks may more quickly stop lending activity, causing liquidity levels to fall faster than they might in markets with larger secondary credit pools.  This in turn could amplify the negative impact of a potential economic slowdown and further drive down housing affordability.