Over the past few weeks, Brazil has experienced its own version of the flight-to-quality that's torn through the U.S. and Western European money markets. Small and medium banks are seeing depositors defect to larger competitors, while funding sources have evaporated.
These smaller lenders are behind deals backed by automatically deducted payroll loans, one of the most active ABS spaces in the reais market. For now, the transactions appear to be weathering the more difficult environment faced by their originators and, by extension, servicers. Credit quality, while on the decline, has held up well. The outlook for future issuance, however, is undoubtedly impaired.
"There are no problems with the performance of the asset class," said Jean-Pierre Cote Gil, associate director of Standard & Poor's. He added that the agency expected delinquencies and loss rates to rise slightly, but that this was basically a function of the fast growth in the loan books over the past few years.
Among the banks that have collateralized payroll deductible loans are Banco BMG, Banco Cruzeiro do Sul, BicBanco, Banco Rural, Parana Banco, Sabemi and Banco Pine.
That growth has dropped off as credit flows tighten and the banks retrench. "These banks...have reacted pro-actively to rapidly changing market conditions; previously aggressive growth plans have been abandoned in favor of managing liquidity to meet the pressures on liabilities," said Fitch Ratings in a report last week.
Also last week, Moody's Investors Service performed negative ratings actions on four Brazilian banks. "Unfavorable funding conditions and availability in the local and international markets may challenge these banks' recurring earnings generation capability," the agency said. Among the affected parties were BMG and Cruzeiro do Sul.
Payroll deductible lending has fallen along with other business lines. Cote Gil pointed out that the slowdown is likely to be harsher for payroll deductible loans to retirees and federal employees, since these tend to impose more restrictions on the lenders, such as caps on the spread charged on the loan. Lending to civil servants on the state and municipal level is more laissez faire. With margins as squeezed as they've been for these banks, they will probably lean heavier on those products with fewer pricing restrictions.
Tackling the flight-to-quality issue, the Brazilian Central Bank, in co-ordination with other regulatory entities, issued rules designed to stimulate liquidity for the small-to-medium banks. Chiefly, the authorities loosened reserve requirements and enabled large banks to use what remained of their requirement to buy pools of loans from the small-to-medium banks. In addition, Brazil's Deposit Guarantee Fund (FGC) is able to use about R$2.5 billion ($1.1 billion) of funds to purchase loans to individuals and secured by autos or payroll deductions. "Several banks have already been building liquidity through access to these facilities," Fitch said.
The agency also pointed out that the pools "have performed well to date." The kind of bottlenecking we've been seeing in the developed markets - thanks to an abiding fear of "rotten assets" - appears to be far less likely to happen in Brazil.
But the drop in origination among these lenders can still make its presence felt in outstanding transactions. The deals are generally revolvers. If origination falls to drastically low levels, a bank's ability to replace loans is diminished. While this isn't a performance issue, in extreme cases the lack of fresh collateral could lead to a liquidation of the transaction in question, Cote Gil said.
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