In Brazil, the domestic securitization industry has always been a poor sister to the cross-border, a sad case of unmet potential. A regulatory straightjacket on specialized structurers, hefty taxes and little standardization in key assets have all crippled growth. Add cutthroat competition over the last few years from yieldy treasurys and it is no small wonder deals have broken through at all. But positive changes are afoot and while some smack vaguely of jeitinho (cheeky Brazilian slang for getting around rules), they are sure to animate the languid giant.

Poor foundation

As in other markets, real estate assets have been a focus of Brazilian securitizers. Unfortunately they have been the only focus, as the law forbids these specially designated agencies from working on other assets.

Passed in 1997, Brazil's trust law mimicked Chile's, whereby securitizers are created with the primary mandate of setting up vehicles. In Chile, the system has worked well, with a number of banks building securitization arms and new assets popping up over the last year or so. Much of the muscle stems from modifications introduced in 1999. "They added flexibility to the structure, resolved about 80% of the tax issues, and broadened securitizable assets," to include just about anything, according to Octavio Bofill, a partner at Grasty Quintana Majlis & Cia in Chile.

Meanwhile, in Brazil, the law confining securitizers to real estate assets was never relaxed and the other Chilean improvements failed to cross the Andes. "Brazil never broadened the scope of the agencies," said Frederico Porto, foreign associate at Andrews & Kurth.

In typical jeitinho fashion, players have stretched the limits of the real estate definition to include assets beyond mortgages, such as rental receipts.

But even within the real estate sector, the challenges do not always lend themselves to jeitinho. Mortgages are a case in point. The potential for vigorous securitizations is staggering, with state agency Caixa Economica Federal alone originating US$80 million to US$90 million a month. Yet outstanding real estate securitizations in Brazil, known as CRIs, amount to a yawn-inducing R$550 million (US$189 million) and most of that is not RMBS.

"Recovery is a very difficult thing in Brazil and it is tough to get access to foreclose," said Jayme Bartling, senior analyst at Fitch Atlantic Rating, citing two key obstacles. A system introduced in the last few years aimed to expedite the process, but has not been an unqualified success, sources said. Regulated interest rates have also kept the industry out of whack with the market, and poor standardization is yet another problem. The latter might explain why individual mortgage deals in Brazil tend to be tiny, often under US$10 million in local currency.

A boost may come in the form of recently introduced cedulas de credito imobiliario (CCIs), similar in concept to the mortgage electronic system in the U.S., MERS. The system will effectively centralize mortgage registration and transfers. The idea is to erase the need to prepare and record assignments when trading loans. The U.S. example is heartening. Apart from streamlining transfers, costs have plunged to about US$3.5 from US$50 before the system came on line a few years ago. "CCIs will facilitate and reduce costs," said Brigitte Posch, senior analyst at Moody's Investors Service.

One particular advantage, sources said, is that CCIs will be more successful in isolating risk from developers. This coveted group of lenders presents another obstacle for securitization as well. A go-it-alone approach has hurt standardization. "Construction companies don't have a standardized loan contract," Bartling said. "If you don't have (that), how can you create a liquid market?" CCIs represent a crucial step toward unifying criteria, sources said.

Rich taxes

Not all securitizations in Brazil have been done through specialized agencies. Bold players have structured deals that look more like U.S. trusts and are based on the commercial code, but the lack of a single, umbrella law in those cases makes the process onerous. In any event, both SPVs face painful taxes. Piled on, they are perhaps the biggest drag on the industry. Various taxes add up to around 38% on a regular SPV, according to sources. And that figure does not include the CPMF, a financial transaction tax that can hit multiple stages of the deal.

This has created a rich opportunity for fundos de investimento directo, a relatively new vehicle that has no shortage of champions. While some argue that the FIDCs have a touch of jeitinho - in that regulators could have revamped the whole system instead of creating a vehicle to bypass others - many players feel they hold a rare promise for robust growth in the industry.

Featuring characteristics of both investment funds and traditional SPEs, the FIDCs are analogous to fund vehicles used in France and other European countries. They have taken awhile to get off the ground because of their complex structure, but the tax exemptions they enjoy have kept dealmakers going. "In France, they were created to escape bankruptcy law; here it's to circumvent all those taxes," a source said.

Even for shareholders of open-ended FIDCs, who pay capital gains taxes on their holdings, the burden pales in comparison to taxes on regular vehicles.

Still, the FIDCs are far from trouble-free. Servicing agreements in the initial drafts of currently circulating deals were vague, according to sources. "The documents go back and forth for months," said one source familiar with the process. Servicing, in particular, is often ill-defined in initial documents.

And while they are not saddled with the curbs facing securitizers, FIDCs do not have the same easy legal treatment either. Governed by any number of laws in the commercial code, the funds have not entirely dispelled doubts over assignment of assets, sources said.

Yet despite it all, FIDCs appear to be working. A few have launched. As if to scoff at the narrowly focused securitizers, the first three to hit the market are each tapping a different asset pool, including personal loans, consumer loans, and receivables from foodstuffs company Sadia. Other assets that have fallen under scrutiny are private label credit cards, mortgages, and trade receivables.

A deal backed by school tuition is also rumored to be in the works in the private market. If so, it could mark the third ever tuition deal in Latin America following Chile's Universidad Diego Portales (see ASR 5/19, p.21) and Universidad de Concepcion (see pg. 18)

Another FIDC transaction under consideration in Brazil that may borrow from another Latin market is the securitization of electricity assets. Apparently Brazilian players are studying deals backed by power purchase agreements and electricity bills. This may look something like a transaction that ING Barings closed in Mexico's domestic market in late April.

But, for this particular Brazilian sector, the path ahead is strewn with snags. "In some cases, you couldn't do a true sale because the company with the electricity concession doesn't actually own the asset," a source said.

But even as Brazil's structured finance market churns out more attractive products, investors will remain distracted by treasurys. Their appeal will only fade when interest rates come down significantly, which in Brazil means several hundred basis points.

Luckily for securitizations, the seemingly interminable tightening cycle appears to be over. On June 18 the Central Bank cut the benchmark Selic rate by 50 basis points to 26%. Should current conditions hold, analysts believe they will come down further, perhaps hitting 20% by year-end. By paring down treasury yields, monetary easing should finally give FIDCs, CRIs and their peers a fighting chance.

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