After Crash, Brazilian ABS Poised to Recover

After contracting sharply last year amid regulatory uncertainty and an economic slowdown, Brazil’s structured finance market now appears to be poised for a recovery.

Issuance of Certificados de Recebíveis Imobiliários (CRIs), Brazil’s version of mortgage-backed securities (MBS), fell by about one third in 2012 to R$9.5 billion from R$13.5 billion in 2011, according to financial research firm Uqbar.

Issuance of Fundo de Investimento em Direitos Creditórios (FIDCs), Brazil’s version of asset-backed securities (ABS), fell by more than half, to R$16.8 billion from R$37.2 billion.

The Brazilian central bank’s pressure to tighten the controls of securitization vehicles as well as a greater than anticipated economic slowdown are the most often cited reasons for the drop.
A burdensome tax system and weak infrastructure were continuing challenges to economic growth and therefore asset generation, although a concerted governmental effort to improve the latter could soon prove to be a major new source of securitizations.

This year, the structured finance market should have the wind at its back. Regulations finalized in early February should reduce certain perceived conflicts of interest that have concerned investors.
The economy is also on the mend: Fitch Ratings expects growth of 3.7% in 2013, compared with only 1% last year.

But perhaps the most important reason that structured finance is expected to rise may be Brazil’s precipitous drop in interest rates, which should boost demand for higher yielding assets. Since August 2011, the central bank has lowered the Selic benchmark rate by a total of 525 basis points to the current 7.25%, pushing nominal and real rates to historically low levels, according to Fitch.

Low rates have sent Brazilian institutional investors, accustomed to double-digit returns, in search of yield. Jean Pierre Cote Gil, a portfolio manager at Western Asset Management, noted that just two years ago government bonds, with virtually no credit risk and high liquidity, were paying double-digit rates.

“In the past, there was much less incentive to receive a 2% risk premium over a government bond with a yield of 12% or 13%,” said Cote Gil, noting that in addition to their relative illiquidity, structured credit products’ complexity requires significant research efforts.

Cote Gil added that the Selic’s current rate of 7.25%, as the central bank seeks to stimulate the economy, is historically very low for Brazil. “But even if they return to a level around 9%, that should still prompt investors to look at other types of investments in search of the additional yield,” Cote Gil said.

Uqbar tallies securities backed by auto loans, personal loans, business loans, payroll deductible loans, and trade receivables as the most common FIDC offerings. Securities backed by auto loans have made up the largest asset class in terms of volume and likely will again in 2012 (relevant data were not available at press time), bolstered last year by a R$1 billion offering by Volkswagen Financial Services, the first issue by a global company in the FIDC market.

In the CRI market, which comprises mostly mortgage-backed securities, approximately two thirds of the R$13.5 billion of issuance in 2011 was backed by commercial real estate; the remainder was backed by residential real estate. CRIs backed by residential mortgages are almost entirely purchased by individual investors, who receive tax benefits.

Participants generally expect issuance to increase in 2013 across existing asset classes as the economy continues to strengthen, with the potentially biggest growth stemming from real estate and infrastructure, both areas where Brazil lags behind other countries.

A more immediate boost may arrive from long-awaited regulations issued in early February.

The new regulations aim to remove the types of conflicting interests that arguably led to defaults in 2012 by two mid-tier Brazilian banks, Banco Panamericano and Banco Cruzeiro do Sul (BCSul). Fitch noted in its Dec. 13 Latin American outlook report that the default of BCSul, with five securitizations outstanding, had the greatest impact on the local securitization market, adding that Brazil’s central bank intervened with four small- and mid-sized financial institutions with outstanding securitizations.

Marcos Wanderley, executive director at BTG Pactual, said registering public offerings often took more than a year as the Comissao de Valores Mobiliarios (CVM), Brazil’s securities commission, deliberated on the new rules.

That may have created pent up deal supply that could ultimately boost issuance, although market participants must adjust to the new rules, which require a firewall between the custodian and the administrator servicing the assets.

Wanderley said that the regulations are good for the long-term health of Brazil’s structured finance market but may hinder near-term activity because they make offerings more expensive to pursue. “The regulations are positive, but they’ll bring more costs to structured deals,” he said.