The Brazilian asset class known as precatorios made its debut earlier this year in a receivable investment fund (FIDC) called Polo, which included a foreign investor among the buyers, according to an issuance document.
Whether overseas funds or banks will even approach future precatorio-backed deals will depend on the strength of the structures, sources said. Another catalyst will be just how deep the hunger for yield runs among the foreign investors most apt to look at domestic Brazilian product. Interest in one deal won't necessarily have knock-on effects for others in this asset class, as precatorios are far from homogeneous. While the single closed transaction was deemed on par with sovereign risk by Standard & Poor's, because of the asset class's diversity, transactions can be - and an upcoming one already has been - rated much lower.
Precatorios are obligations that the government, at the federal, state or municipal level, has been ordered by a court to pay an entity. Often it is generated after a protracted legal drama, in which a government contests an alleged debt and loses in court. But the debtor often keeps finding new ways to challenge the claim, even after the precatorio is issued.
There are R$6 billion ($3.1 billion) in performing federal precatorios, according to Michael Altit, a partner at Motta, Fernandes Rocha.
A transaction that is due out shortly - the second in the market - will be an interesting test case to see just how strong investor appetite is for deals backed by precatorios that haven't completely run their course. Any interest from foreign investors would also be a powerful indication that they are willing to clamber down the credit ladder, after mostly staying on the top rungs for domestic transactions.
Led by Standard Bank, the upcoming FIDC collateralizes a single precatorio that was issued in 1998 affirming the right of construction company Tratex to receive R$378.5 million from the state of Sao Paulo's department of highways. After winning a bid from the state, Tratex began to build a road in the city of Campinas. In the middle of construction, the state agency halted the payments to Tratex agreed to under the bidding process. Tratex then secured a loan from the Banco do Estado de Sao Paulo (Banespa) and finished the project in 1994.
In 2004, six years after the precatorio was issued for R$378.5 million and was still unpaid, a court adjusted the amount upward to R$771.8 million. That sparked a new round of legal proceedings, with the state government disputing the interest rate and inflation assumptions that the court used in its upward adjustment. As of March 2007, the precatorio backing the Tratex FIDC is, according to the court settlement, R$976 million.
The legal proceedings are now at the state justice department, typically the end of the road for a state government's efforts to alter the terms, said Bernardo Costa, an analyst at Fitch Ratings. "All that is left is for the state justice department to recognize that [Sao Paulo's] last request has no legal grounds," Costa said. "In every precatorio, [the government] tries to contest it so it goes into next year's budget."
Partly in recognition of these risks, Fitch has assigned a B(bra)' to this transaction, sized at up to R$350 million, with a subordinated tranche of up to R$10 million. The maturity of the fund is 12 years, with a grace period on the first annual payment of two years.
A Standard Bank official did not return calls for comment.
The high legal drama behind Tratex's precatorio is not atypical for the state and municipal precatorios, and it underlines how crucial the legal opinion is for deals in this asset class. Pinheiro Neto is counsel for this particular deal.
Also, while the risk is closely linked to the obligor, the credit standing of the company also plays a large role in the ability of the precatorio to withstand legal challenges. "The seller has to be one hundred percent immaculate," said Altit of Motta, Fernandes. "I can't buy it from a company that is full of problems."
The asset class's dizzying diversity is nurtured by the fact that the governments that have been issued precatorios could be on any rung of the credit ladder, and their stamina for fighting the claim in the court system runs the gamut as well. "There is a lot of speculation about the price of these assets," said Patricia Bentes, managing director of local shop Hampton Solfise. "It's not straightforward. I wouldn't say it's a bad thing, but each case is different."
Federal precatorios are generally considered more solid than those linked to states and municipalities. The federal government has yet to win a legal challenge to a precatorio, translating into a reliable track record for that portion of the asset class, sources said. Still, many federal precatorios face uncertainty about when, exactly, the first payment will come.
Across the spectrum of federal and subnational governments, once a precatorio is placed within a government's budget, then it's a fairly solid asset, according to Fitch's Costa.
The risky profile of the Tratex FIDC contrasts with the only precatorio-backed deal that has closed so far, a transaction backed principally by past-due export subsidies that the federal government owes Citoma, a coffee-trading company.
Named Polo - after the structurer Polo Capital Management - that deal is rated brAAAf' on the national scale by S&P. In the agency's view, the deal's risk is basically the same as for any bond from the central government.
"We don't see room for the government to dispute [these precatorios]," said Jean-Pierre Cote, associate director of structured finance in S&P's Sao Paulo office. He added that the agency required opinions from two different law firms affirming that the government will have to pay the amount stipulated in the precatorios. Motta, Fernandes was a public adviser to the Polo transaction; Cote declined to name the second counsel on that deal.
The Polo deal was backed by two precatorios totaling roughly R$105 million at the time the deal launched in January. So far, about $80 million in senior shares have been sold from a capped amount of R$95 million. The transaction has a maturity of 11 years. The yield more or less mirrors that on the underlying precatorios, which is 6% over the inflation index IPCA.
Banco do Brazil unit BB Investimentos was the lead on Polo, while Deutsche Bank was co-lead.
Precatorio terms can vary, but those linked to legal actions commenced before the end of 1999 are paid over a 10-year period in annual installments, according to Motta Fernandes's Altit. Two big exceptions to this are precatorios alimentares - linked to labor-related claims - and pequeno valor ("small amounts"), which ought to be paid within a year. Precatorios issued since 1999 generally must be paid in a lump sum, Altit said.
Apart from Tratex, more deals are on the way. Oliveira Trust, which acted as fund manager for both Tratex and Polo, has two deals it is in the process of structuring, said Alexandre Lodi, managing partner at the firm. Talk is that Deutsche has more as well.
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