It has been three years since S&P Global Ratings rated the first Argentine securitization backed by residential mortgages denominated in Unidad de Valor Adquisitivo (UVA). The transaction, Fideicomiso Financiero Cedulas Hipotecarias Argentinas UVA Serie I (FF CHA UVA I), closed in April 2018 (see "Informe de Calificación Fideicomiso Financiero Cédulas Hipotecarias Argentinas UVA Serie I," published March 20, 2018, and "Trending Assets In First-Quarter 2018 Signal Big Potential For Structured Finance In Latin America," published May 8, 2018). Since launching in 2016, there has been a surge in the popularity of UVA-denominated mortgage loans. However, consistent high inflation rates, together with recent government initiatives, could continue to reduce the supply of mortgage funding and erase the past five years of progress in the Argentine mortgage market.

During the past 30 years, there have been several attempts to boost mortgage credit in Argentina. Most had limited success due to high interest rates and tight eligibility conditions, but the UVA mortgage loan, which was created in 2016 to provide mortgage credit amid an inflationary environment, saw greater success. UVA-denominated loans are linked to a coefficient that varies with the Argentine Consumer Price Index (CPI). The loans are structured so that, under certain conditions, the borrower's debt-to-income (DTI) ratio does not increase. This type of loan gained popularity because the initial installment the borrower pays is lower than it would be for fixed- or adjustable-rate loans (see "Economic Stability In Argentina Could Lay The Foundation For Its RMBS Market," published Dec. 18, 2017).

Inflation And The UVA Freeze

Economic conditions have been deteriorating in Argentina since 2018, and the economy has seen accumulated inflation of 228% between January 2018 and February 2021. Mortgage origination has also been declining due to rising inflation and interest rates, salary deterioration, and tightened underwriting conditions by banks extending credit. However, mortgage loan delinquency rates remain low for now, though it is becoming increasingly difficult for obligors to make regular payments.

In August 2019, in the first of several measures it would implement in an attempt to stop the deterioration of real income, the Argentine government through the Central Bank of the Argentine Republic froze the UVA value for mortgage loans that met certain conditions. The freeze was meant to be a temporary measure, but the unprecedented conditions of the COVID-19 pandemic in 2020 resulted in its continuation, though with minor adjustments.

From the start of the UVA freeze through February 2021, the UVA value paid by the obligors, as a percentage of actual UVA value, decreased over time to approximately 80%, while inflation continued to increase. Chart 1 shows the impact the freeze had on the UVA relative to the counterfactual trajectory that would have occurred absent government intervention. We believe the ongoing pandemic and challenging economic conditions increase the probability that these or other similar measures will continue.

The Impact On The FF CHA UVA I Transaction

While the results of the UVA freeze are beneficial to mortgagors, at least temporarily, because they get to pay their mortgage payments at a lower UVA value, we believe it could eventually erode the credit enhancement of the FF CHA UVA I transaction. As a result, on June 16, 2020, we lowered our ratings on the class VDF A notes from FF CHA UVA I to 'raAA+ (sf)' from 'raAAA (sf)' and affirmed our 'raAA- (sf)' and 'raC (sf)' ratings on the class VDF B and CP notes, respectively (see "Informe de Cambio de Calificación Fideicomiso Financiero Cédulas Hipotecarias Argentinas UVA Serie I," published June 16, 2020). The downgrade also reflected our view of the impact the pandemic and the perception of increased risk and uncertainty in Argentina could have on the transaction. We believe the challenging macroeconomic conditions and the impact of the measures implemented to avoid the spread of COVID-19 on obligors' income could hurt the performance of UVA mortgage-backed notes.

The transaction's assets and liabilities are denominated in UVA. However, only the liabilities are currently being adjusted at the actual CPI rate. This asset-liability mismatch means the cash flow into the transaction structure may not meet the requirements of the bondholders. Further, with assets remaining constant under the central bank's freeze, there may be additional pressure on the outstanding notes' available subordination levels, which could hurt the transaction's performance. As of February 2021, the transaction's subordination levels were 70%--a relatively high figure due to its solid performance to date--and the 90-plus-day delinquency ratio has remained stable at about 1.1%. But this could change if the economy doesn't bounce back soon.

In March, S&P Global Ratings increased its 2021 GDP forecast for Argentina to 6.1% from 4.0%, mainly because performance improved more than we had expected in 2020 and resulted in a statistical 5% carryover for this year (see "Economic Outlook Latin America Q2 2021: Despite Growth Picking Up, Pre-Pandemic Weaknesses Remain," published March 25, 2021). However, Argentina's economy continues to face severe constraints, including persistently high inflation, a heavy foreign-currency debt burden, and low foreign-exchange reserves, which have led to a scarcity of U.S. dollars in the economy.

A History Of Asset-Liability Mismatch

In the 1990s, a one-to-one convertibility existed between the ARS and the U.S. dollar (1 ARS equaled US$1), and many people purchased their homes through mortgage loans denominated in U.S. dollars. However, with the 2001-2002 economic crisis, these loans were subject to an asymmetric pesification, which meant that the loans were converted to Argentine peso (ARS) at rate of US$1 to ARS 1.4, while the U.S. currency had peak values of close to 4 ARS. As a result, Argentine RMBS were also subject to a mismatch between assets and liabilities.

Following the pesification, the mortgage loans started to be adjusted at the CPI and funds continued to flow to investors. But the funds were not in the amounts or denomination needed to satisfy the original terms of the trusts' obligations. As a result, all rated mortgage-backed notes defaulted.

A potential solution

One of the most discussed proposals to address rising inflation rates and eliminate the UVA freeze, which could continue increasing the current asset-liability mismatch, is to replace the CPI variable to which the UVA is pegged in UVA mortgage loans with the Coeficiente de Variación Salarial (CSV), a salary growth index. This scenario could be beneficial for obligors and would not necessarily result in an immediate default of the rated UVA notes because the assets and liabilities would continue to be payable in Argentine pesos.

However, it could result in defaults if the mismatch between wage adjustments and the inflation rate is significant enough to erode the available subordination, leading to insufficient funds to repay the noteholders in full. Although unlikely, this could be offset by a scenario of a noteholders' assembly being held after the UVA variable changes to CSV to propose the same change to the rated notes, which, if approved, would result in a temporary default until the new terms and conditions are applicable.

What's Next?

It remains to be seen whether banks will suffer losses derived from the difference between real inflation and the frozen UVA value or, eventually, the CSV. More problematic, we believe, is the potential that the extended UVA freeze or the change of the UVA reference variable to CSV from CPI could discourage banks from making UVA loans and investors from entering into UVA-related transactions, including RMBS or other investments linked to UVA such as private bonds. This would further contract the already limited supply of mortgage credit that is available in the system, resulting in a reversion to the economic conditions prevalent in the 2001-2002 housing market crisis.

For now, we believe the Argentine mortgage market will continue to shrink as political and economic challenges and risks persist. This in turn will reduce banks' incentive to increase the loan supply as well as the number of potential borrowers whose income are outpacing inflation, putting further pressure on the existing UVA securitization. We will continue to monitor the FF CHA UVA I transaction, including any initiatives and policies that could affect it, and take rating actions as we deem appropriate.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.