These repeated victories certainly cost much blood to the Spaniards, as the governor after this last action withdrew to St Jago to await the reinforcements he expected from Peru, and to raise as many recruits as possible in the northern provinces of Chili. As the reinforcements did not appear to him sufficient for continuing the war with a reasonable prospect of ultimate success, he even went into Peru in person to solicit more effectual succours, leaving the charge of the civil government daring his absence to the licentiate Pedro Viscarra, and the command of the army to the quarter-master. On his arrival at Lima, Sotomayor met with a successor who had been appointed to the government of Chili, by the court of Spain. This was Don Martin Loyola, nephew of St Ignatius, the celebrated founder of the order of the Jesuits, who had acquired the favour of the viceroy of Peru by taking prisoner Tupac Amuru the last Inca of Peru. In requital for this service, he was not only gratified by being appointed to the government of Chili, but was rewarded by obtaining in marriage the princess or coya Donna Clara Beatrix, the only daughter and sole heiress of the former Inca Sayri Tupac. Loyola arrived at Valparaiso, in 1593, with a respectable body of troops, and immediately proceeded to St Jago, where he was received with every demonstration of joy by the citizens; but during his administration the Spaniards experienced the severest disaster that had ever happened to them in Chili.

After the defeat and death of Paillaeco, the Araucanians elected Paillamachu to the supreme command, who was hereditary toqui or prince of the second Uthulmapu. This military dictator was already much advanced in years, yet a man of wonderful activity and resources, and was so fortunate in his enterprises that he far surpassed all his predecessors in military glory, and had the singular felicity of restoring his country to its ancient independence by the entire expulsion of the Spaniards from its territories. Immediately on his elevation to the supreme dignity of toqui, he appointed two officers of great valour and merit, Pelantaru and Millacalquin to the important employments of vice-toqui, deviating from the usual custom of the nation, which allowed only of one lieutenant-general. And, as the military force of the confederacy had been greatly diminished by the late unfortunate incidents in the war, he followed the example of Antiguenu, a former toqui, by withdrawing into the almost inaccessible marshes of Lumaco, where he used his utmost efforts to collect and discipline an army for the execution of the extensive plans he had formed for the entire liberation of his country.

After having regulated the police of the capital and the civil government of the kingdom of Chili, Loyola proceeded to the city of Conception, where he established his headquarters in order to be at hand for conducting the operations of the war. The toqui of the Araucanians, on hearing of his arrival, sent an intelligent and sagacious officer named Antipillan to compliment him, but charged at the same time to obtain information of his character and designs. In frequent conferences with this person, the new governor endeavoured to impress him with an idea of the vast power and immense resources of the Spanish monarchy, against which it was impossible as he said for the Araucanians to contend successfully, and insinuated therefore the necessity of their submitting to an accommodation. Pretending to be convinced by the reasoning of Loyola, the ambassador acknowledged the prodigious power of the Spanish monarchy in comparison with the Araucanian state; which, notwithstanding the vast disproportion, had hitherto been able to resist every effort of the Spaniards. He acknowledged even the propriety of his nation entering into negotiations for peace, but alleged that the Spaniards affixed wrong ideas to that word; as, under the semblance of peace, they sought to subject the Araucanians to their authority, which they would never agree to while one of them remained alive. And finally, that the only peace to which they would consent, must consist of an entire cessation of hostilities, a complete restoration of all the lands which were occupied by the Spaniards within the Araucanian territory, and an explicit renunciation of every pretence to controul or interfere with their independent rights.

As Loyola was of a generous disposition, he could not avoid admiring the noble and enlightened sentiments of the barbarian ambassador, and dismissed him with the strongest demonstrations of esteem. Yet so far was he from any idea of abandoning the posts already established in the Araucanian territory, that he crossed the Biobio in 1594, and founded a new city at a short distance from that river, giving it the name of Coya in honour of his wife a Peruvian princess. This place was intended to protect the rich gold mines of Kilacoyan, and to serve as a place of retreat for the inhabitants of Angol in case of need; and in order to render it more secure, he constructed two castles in its immediate neighbourhood, named Jesus and Chivecura, on either shore of the Biobio. Solicitous to destroy this new settlement, which he considered as a disgrace to his administration, Paillamachu sent in 1595, one of his officers named Loncothequa, with orders to destroy the fort of Jesus. After twice penetrating within the works, and even burning a part of the interior buildings of this place, Loncothequa lost his life without being able to accomplish the enterprise.

In 1596, the toqui made frequent incursions into all the Spanish districts, both within and adjoining the Araucanian territory, on purpose to subsist his troops and to inure them to a military life. The Spanish army attempted in vain to prevent or pursue these predatory detachments, as the wary Paillamachu took the utmost care to avoid any encounter, determined to reserve his force for some favourable occasion. On purpose to restrain these incursions Loyola erected two additional forts in the neighbourhood of the encampment or head-quarters of the toqui, one on the scite of the old fort of Puren, and the other on the borders of the marshes of Lumaco, which he garrisoned with the greater part of a reinforcement of troops which he had just received from Peru. He sent the remainder of these in 1597 to the province of Cujo, where they founded a new city, called San Luis de Loyola, which still subsists in a miserable condition, though placed in a very advantageous situation.

The fort of Lumaco was soon afterwards taken by storm, by the toqui in person, who gave orders to two of his officers to reduce that of Puren. In ten days they reduced the garrison to the last extremity, but had to desist from the enterprise by the approach of a reinforcement under the command of Pedro Cortes, a Spanish officer who acquired great reputation in the Araucanian war. The governor Loyola arrived there soon afterwards with his army, and gave orders to demolish the fortifications and to remove the garrison to Angol, lest it might experience a similar fate with what had so recently happened to the fort of Lumaco. He then proceeded to Imperial, Villarica and Valdivia, the fortifications of which places he carefully repaired, to secure them against the increasing strength of the enemy, and then returned towards the Biobio under the security of an escort of three hundred men. As soon as he thought himself in a place of security, he ordered back the escort, retaining only along with himself and family sixty-two half-pay officers and three Franciscan friars. Paillamachu had secretly followed and watched all the motions of the governor, and concluded that he had now found a favourable opportunity to attack him. Finding him accordingly encamped in the pleasant valley of Caralava, he attacked him with a select band of two hundred Araucanians, on the night of the 22d November 1598, and slew Loyola and all his retinue.