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.
As one of the more active investors in Brazil’s structured finance market, Western Asset has leverage over how deals are structured. In 2011, only R$150 million of its R$35 billion portfolio was invested in structured credits, and that number has grown to R$1.1 billion today, from 30 different transactions.
“We have increased allocation in ABS over the last few years because we perceive value in securities that, for the same credit risk, sometimes pay100 or 200 basis points in additional premium,” Cote Gil said.
Cote Gil said that FIDCs already benefited from strong regulation, and problems in the market resulted more from fraud than weak rules.
His firm views the new regulations favorably, he said, because standardizing them strengthens the market overall and reassures investors that may not have Western Asset’s clout to shape deals.
However, the small and midsize financial institutions that have used securitization to finance their lending activities are still working through the rules’ impact on their balance sheets, said Jayme Bartling, an analyst at Fitch Ratings.
Bartling added that the recent consolidation in the banking sector may damp issuance. Many smaller banks, which have originated the bulk of securitized assets, have been acquired by larger institutions. In July, for example, Itau Unibanco Holding, Latin America’s largest lender by market value, entered a joint venture with Banco BMG, a major securitizer of payroll loans.
“A lot of major originators of consumer loans have been bought by other banks. In the case of Itau’s deal with Banco BMG, Itau probably has better funding sources than securitization,” Bartling said.
The regulatory clarity may prompt some market participants to participate more actively in the structured finance market, but significant growth will almost certainly come from generating more assets to securitize.
Frederico Porto, an executive managing director of Brazilian Mortgages, said that the legal framework for structured finance has been routinely strengthened since it was first instituted in 1997. Even so, mortgage originations make up only about 7% of Brazil’s GDP, compared to more than 17% in Chile and Mexico, and that has resulted in pent up demand from consumers. As a result, Porto said, Brazil’s MBS market is likely to see significantly more activity.
“Once we see economic growth in Brazil return, we’re going to see more and more MBS transactions, more in line with other countries. As a percentage of GDP, mortgage originations are likely to exceed 10% and perhaps reach closer to Mexico’s 17% or 18%,” Porto said.
He added that five years ago, Mexican mortgage related transactions were far more sophisticated, but Brazil has caught up and perhaps even surpassed Mexico in terms of the number and variety of real estate investment trusts (REITs)—all potential buyers of CRI securities.
“We now have over one hundred REITS [called Fundos Imobiliários], with several emerging every week,” Porto said.
On the residential mortgage side, according to Michael Morcom, head of Latin American agency and trust sales at Citigroup’s Transaction Services division, Brazil’s current administration has emphasized the need to develop the mortgage market, in order to boost mortgage originations to at least 10% of GDP over the next few years.
“In most other economies, securitization has been a big factor in driving the development of the secondary mortgage market,” Morcom said.
Another potentially major source of assets to securitize is financing for infrastructure projects, both because Brazil’s basic infrastructure lags behind other developing nations and because it will be hosting the World Cup in 2014 and the summer Olympics in 2016. Morcom said that, until recently, most infrastructure financings were provided by the Brazilian Development Bank (BNDES).
However, the magnitude of the country’s financing needs has prompted the government to take recent measures to encourage more investment from international investors, such as providing tax exemptions for FIDC deals that are linked to infrastructure projects.
“It’s become a common view that financing infrastructure is going to require participation by foreign investors,” Morcom said.
Another benefit of the regulatory changes introduced earlier this year, according to Wanderley, is that the receivables securitized in an FIDC deal can be unrelated to the specific project.
That makes securitization relatively more attractive than bonds and debentures, which must be secured by the company sponsoring the infrastructure project or by receivables directly related to the project.
Cote Gil said the FIDC structure is particularly appropriate for infrastructure deals because BNDES typically retains 70% to 80% of a project’s credit exposure. “Using the FDIC structure, you can combine the BNDES and private investor exposures in the same legal structure,” he said.
Some debentures supporting infrastructure projects came to market last year, but so far there have not been any using the FDIC structure.
“We’ll probably see the first of these deals in 2013 and more in 2014,” Wanderley said, adding, “I think the government has finally concluded that the major thing hindering Brazil’s growth is infrastructure, so its very focused on solving this question.”