For the last several years, Brazil's main real estate ABS security, the CRI, has often looked like the poor cousin to the FIDC, a popular vehicle that has proved a good fit for a wide range of assets, even real estate.

Lying behind the also-ran status of the CRI, which stands for certificate of real estate receivables, is the fact that local rules and regulations have for a long time either discouraged or remained indifferent to securitization of real estate receivables. In addition, mortgages remain a paltry percentage of the overall economy in comparison with other countries - about 3.5% at last count - and major originators are still not convinced of the benefits of securitization.

But recent developments are said to be bumping up investor appetite for CRIs, which, in theory at least, should encourage more originators to seek out this funding.

The conduits for change are real estate investment funds (FIIs), which have more incentives now to purchase CRIs following regulations that were tweaked last year. FIIs are closed-ended funds similar to REITs but are not organized as a company or trust.

In an unprecedented move, there is already one fund, FII Excellence, understood to be investing exclusively in CRIs. Future funds are likely to do the same, sources said.

The biggest spur comes from Law 12,024, passed last August, which extended a tax exemption for retail investors holding CRIs to those holding shares in FIIs with investments in CRIs.

"The law was changed so that the [CRI] tax exemption could be passed along to the funds," said Paulo Baroni, a managing partner at Portfolio Asset Management, a new manager of FIIs that received regulatory approval to get started only late last year. "When they extended this, it opened a big market for the CRIs."

The change is substantive largely because the minimal investment required for buying CRIs directly makes it prohibitively expensive for smaller investors. The threshold, R$300,000 ($167,270), is out of reach for many potential buyers in a country where the GDP per capita last year was about $7,737.

A piece of an FII, on the other hand, can be had for far less, typically around R$1,000, and sometimes for less than that. For the retail investor to enjoy the exemption, among other criteria, the FII has to have at least 50 investors and the investor in question cannot hold more than 10% of the fund.

"You can reach a larger audience by repackaging CRIs into an FII," said Luciano Rossi, a partner at local law firm Pinheiro Neto.

FIIs were only able to invest in actal real estate projects until October 2008, when regulatory authority the CVM allowed them to invest in a variety of real estate securities, including the CRIs. But it was clear throughout the first half of 2009 that a glitch in the tax regulation governing FIIs would have to be fixed for the full benefits to accrue to CRIs.

Evidence suggests that this is at least partly responsible for the recent uptick in retail investor demand for FIIs.

Brazilian Real Estate Finance and Securitization 2010, a report put out in March by local ABS consultancy Uqbar, reported a discernible impact on FIIs from hungrier individual investors. "[The signs are] increasing prices in the secondary market and the bulk of new public offers registered at the Brazilian securities authority in the last several months of the year," the report said.

In terms of issuance, FIIs had a record 2009 (see chart 1 on page 26).

On their own, CRIs were already showing better numbers. Trading of CRIs on the clearinghouse known as CETIP shot up last year and remains brisk now, at least by historical standards (see chart 2 on page 27).

CRI registrations at CETIP, on the other hand, dipped a bit last year (see chart 3 on page 27). The trading volumes include primary as well as secondary activity, while registrations could be newly issued securities or old ones that are being listed with the CETIP for the first time.

In addition, new issuance in CRIs was R$3.8 billion in 2009, down from R$4.7 billion in 2008. But the overall drop in ABS activity was even sharper, and the weakest months were earlier in the year, thanks to seepage from the global crisis.

While it is hard to pin down how much increased demand for FIIs stems from the CRI rule change, there is evidence that the funds are already capitalizing on more appetite for CRI exposure.

Baroni points to the fact that a recent offering from FII Excellence is devoted primarily if not exclusively to CRIs, an unprecedented move and a clear indication that CRI-only FIIs are becoming viable. "I believe that this is just the first step," Baroni said.

The prospectus for this R$27 million issue from FII Excellence strongly hints that CRIs are the main focus, with a chapter devoted to this particular instrument, including graphs, tables and historical information. There are no comparable details for any other potential collateral. That offering, registered in February, closed with 169 retail investors purchasing 76% of the total. Neither the structurer of FII Excellence, Brazilian Mortgages, nor manager Banco Ourinvest returned a request for comment.

Apart from the tax change benefitting CRIs and other real estate securities, FIIs also received a regulatory leg-up in September 2009, when CMN Resolution 3,792 upped the ceiling for pension fund investments in higher-risk assets, including FIIs. FIIs were transferred to a different investment category, which effectively raised the total a fund can hold in FII exposure.

While that change did not trigger a rush to FIIs from institutional investors, Rossi said greater demand should materialize as pension funds gradually build up the analytic resources devoted to this particular sector. "The first step is for them to dedicate more time [to FIIs]," he added.


CRIs On Their Own

Even with the exorbitantly high minimum purchase, upper-income retail investors are still investing directly in CRIs, and signs point to further interest. According to Uqbar's report, retail investors' share of CRIs edged up to 25% of the total in 2009, from about 10% in previous years. "This trend is in line with the recently enhanced capacity that banks have to place private sector fixed income securities with their Private Banking clients," the report said. The trading figures could be reflecting this as well (see chart 2 on page 27).

Indeed, retail investors are being aggressively courted by securitizers such RB Capital. Last year, the shop structured and distributed about R$1.2 billion in CRIs, some 26% of the market's total. About 27% of RB Capital's CRIs ended up in the hands of private banking clients (see chart 4 on page 28). Their share rises significantly if one strips out the CRIs that RB sold to banks looking to comply with a rule that requires them to put the equivalent of 65% of savings deposits into real estate-related assets.

RB has indicated in the local press that the volume of CRI deals will grow significantly this year.

Apart from local demand, players said that overseas buyers are taking a gander at FIIs, including ones with CRI exposure. "Foreign investors are looking at them," said Rossi. Sources added that it might prove a good complement to the private-equity approach of participants from abroad, as shares in an FII can be more easily bought and sold, even though liquidity is still lacking.

The greater facility and interest in buying CRIs has no doubt boosted demand from the dip posted in the first half of 2009. But there are still challenges up ahead, especially on the supply side of the equation.


Residential CRIs:

Promise of the Future, Still

CRIs backed by residential mortgages, for instance, remain a lackluster sector and still appear to be well behind their potential in terms of volume and number of issuers. Last year, CRIs backed by residential home loans were nearly one third the total, higher than in the prior four years. Still, at R$1.44 billion, they are far from fulfilling a potential that has recently been growing at breakneck speed.

Construction companies and real estate developers remain the main securitizers of residential credit in the country, even though the banking system has been bursting at the seams with home loans.

Government-owned Caixa Economica Federal, for instance, originated R$47 billion in home loans in 2009, slightly more than double the R$22.1 billion generated in 2008 and 9.4 times the amount in 2003, according to the bank.

Meanwhile, real estate loans funded by savings deposits at banks totaled more than R$25 billion last year, having surpassed R$5 billion annually only in 2006.

These figures, which represent only a portion of the market, suggest that R$1.44 billion in residential mortgage-backed CRIs is barely scratching the surface, but the reticence of banks to securitize has proven remarkably stubborn. Executives at Caixa, for instance, have spoken publicly about the prospects of securitization and yet nothing concrete appears to be in the works.

The truth can be said for other large banks as well.

"If you consider the volume of residential mortgages being originated by the banking sector, there's still almost nothing happening in terms of securitization of this asset type," said Johann Grieneisen, assistant vice president at Moody's Investors Service. "[But] there's a lot of talk of what the future is going to hold, particularly regarding capital markets complementing funding currently provided by banks' balance sheets." He added that strictly from a credit standpoint there are no impediments for banks engaged in mortgage lending to securitize their portfolios.

Even the developers and construction companies that make up the bulk of originators behind residential CRIs do not appear to be scrambling to catch up with current or projected demand. "Not all developers look at this as a viable alternative," said Pinheiro Neto's Rossi, adding that some pledge receivables to bank loans and others have capitalized through the stock market. Last year saw eight IPOs from companies in the real estate sector, for a total R$5.75 billion, according to Uqbar.

Banks in general in Brazil are subject to the aforementioned requirement to hold real estate assets on their books equal to 65% of their savings deposits. This can drive demand for CRIs in some institutions as a way to meet the requirement but can also act as a deterrent for a bank to securitize its own portfolio.

Still, as demand for real estate grows, and loan origination is stimulated by the government on more than one front, it is likely that banks will be more compelled to look beyond the savings deposit system and other funding sources to finance home loans, sources said.

Some see activity starting up at the small- to medium-sized banks. "It's very likely that the mid-sized banks will start to look to securitization, the ones that typically need more funding and look for alternative sources," said Jean-Pierre Cote Gil, an analyst at Standard & Poor's. This is the same category of banks that were once avid securitizers of payroll deductible loans, a sector that did not turn out any deals last year.

Still, for the foreseeable future it appears that commercial real estate CRIs will continue to dominate. The two main subcategories in this class are build-to-suit and sale and lease-back. The former category of transaction collateralizes credits stemming from a build-to-suit contract between a construction company or developer and a company or group of related companies. The obligor is often a big name, with past examples such as Carrefour, Petrobras, Nestle and Volkswagen. As Brazil's economic growth speeds up, this is an attractive vehicle for financing construction on the back of a strong credit.

While far more common in other asset classes, the FIDC vehicle is also used in real estate. Issuance by real estate-related FIDCs totaled R$289 million last year, according to Uqbar. Nonetheless, its potential is more limited than the CRI due in part to fewer tax benefits. Sources said there could be sporadic deals in this area at best.

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