Fitch: Brazilian Covered Bond Rules May Bring Funding Tool

Business Wire

NEW YORK--(BUSINESS WIRE)--

The anticipated Brazilian covered bond legislation could create an important funding alternative for the nation's mortgage market, Fitch Ratings says. However, it must address some key bondholder questions. In the event of insolvency, Brazilian regulations traditionally make labor creditor claims senior to bondholders. The legislation must clarify who and how third parties will be able to effectively manage the collateral. Also, the ability to rate the bonds above the issuer default rating will depend, among other factors, on the strength of the security and the quality of loans in the cover pool.

The push to put Brazil on the covered bond map is part of the government's effort to expand mortgage lending. At 9%, the share of mortgage debt to GDP ratio remains small compared to developed markets. Mortgage lending growth has been largely fueled by government-owned Caixa Economica Federal (Caixa), which represents about 70 percent of the market. However, certain earmarked and on-balance sheet funding sources for mortgage lending by retail savings deposit banks (including Caixa) is expected to lose pace with mortgage growth by 2016. Strong covered bond legislation, in tandem with Brazil's existing RMBS framework could support viable alternative funding sources.

In line with many European covered bond jurisdictions, it will be important to understand how Brazil's legislation will assure priority interest in the underlying collateral. In the past, Brazilian legislation has traditionally subordinated collateral guarantees to the bond issuer's fiscal and labor creditor claims in the event of liquidation. Lack of clarity on this issue could undermine a key pillar in the dual-recourse concept of covered bonds.

In addition, clear rules and responsibilities for third parties to effectively manage the collateral in a liquidation event will be crucial. Major RMBS trustees and servicers and institutions acting as custodians in Brazil's ABS market could ultimately play this role.

Eligibility criteria for loans included in future Brazilian cover pools are not known yet. In other countries, legislation typically sets a maximum loan-to-value (LTV) limit. For instance covered bonds can fund residential mortgage loans with up to an 80% LTV.

Fitch will look for a Brazilian covered bond to offer stronger protection to investors than Chile's recently introduced mortgage bond framework. While the Chilean legislation shares some basic similarities with other covered bond frameworks, it has certain weaknesses, notably regarding investors access to the cover pools in a default situation of the issuing bank.

Covered bonds are expected to appeal to individual investors via tax exemption on interest income (identical to RMBS today). They will also compete with Letras de Cr?dito Imobili?rio, existing mortgage instruments that have the same exemption plus the backing of Brazil's depositor insurance fund (Fundo Garantidor de Credito), but no true security in underlying collateral exists.

In the near term, small- and mid-sized mortgage lenders pose to benefit most from a forthcoming covered bond market as these entities do not have access to the same earmarked funding sources available to retail savings deposit banks. Furthermore, these lower rated mortgage originators may achieve uplift in covered bond ratings from senior unsecured debt ratings, due to the higher recovery-given-default prospects of covered bonds. Brazil's largest mortgage lending banks are already rated 'AAA(bra)' on the national scale.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Contact:
Fitch Ratings
Jayme Bartling, + 55-11-4504-2602
Senior Director
Brazilian Structured Finance
Alameda Santos, 700
Sao Paulo
or
Rob Rowan, +1-212-908-9159
Senior Director
Fitch Wire
33 Whitehall Street
New York, NY
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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