Bloomberg: Disappearing Asset-Backed Money Signals Overhaul: Brazil Credit

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By Blake Schmidt and Gabrielle Coppola

Nov. 8 (Bloomberg) — An interruption in payments to asset- backed funds issued by Banco BVA SA is putting pressure on authorities to overhaul regulation and reverse a record plunge in offerings that’s cutting mid-sized banks off from one their most important sources of financing.

The decline in cash flows to the four funds issued by BVA in September was a sign the money earmarked to investors may have been intercepted by the bank as it struggled with a cash shortage, according to Standard & Poor’s. The mid-sized lender was seized by Brazil’s central bank last month, becoming the seventh bank taken over or bailed out by regulators since 2010.

Four years after the U.S. asset-backed market was frozen following the failure of Lehman Brothers Holdings Inc., issuance of asset-backed funds in Brazil has plunged 72 percent this year as investors shun the securities that let banks in charge of passing payments to investors dip into cash flows. Issuance of FIDCs, as the funds are known, may rebound once new regulations alleviate that risk, Western Asset Management said.

“The FIDC instrument wasn’t segregated enough, but with this new regulation, you’re eliminating that problem,” Jean- Pierre Cote Gil, a fixed-income manager at Western Asset, which oversees $491 million of structured credit, said in an interview at his office in Sao Paulo. “You’re going to have more people looking at this market.”

Yields on dollar bonds sold by Brazilian midsize lender Banco Bonsucesso SA have risen 13 basis points in the last 10 months to 13.73 percent, while average yields on emerging-market financial debt have declined 169 basis points to 4.49 percent, according to JPMorgan Chase & Co. indexes.

Regulatory Revamp

Brazil’s securities regulator, known as CVM, proposed rules for structuring and managing FIDCs on Sept. 6 to ban sellers from passing payments through their own accounts, give custodians more oversight to reduce fraud risks and eliminate conflicts of interests between sellers, custodians and managers.

Public comments on the rules are being assessed and there is no set date for when the final changes will be published, according to a CVM official in Rio de Janeiro who asked not to be identified in accordance with internal policy.

Asset-backed funds, which bundle consumer or corporate loans and other receivables, were created in 2001 and used by smaller banks to raise money at lower rates than was available in the domestic market. A lack of local, long-term funding has pushed lenders to rely on FIDCs, the sale of loan portfolios and the international bond market for financing.

Issuance Plunge

Issuance of asset-backed receivables funds plunged to 3.8 billion reais ($1.9 billion) this year through October, from

13.6 billion reais in the same period last year. Issuance in Brazil is headed for its biggest annual drop since 2009, according to data compiled by Brazil’s capital markets association. Asset-backed sales in the U.S. jumped 82 percent to

$206 billion in 2012 from about $112.9 billion at the same time last year, data compiled by Bloomberg show.

BVA, a Rio de Janeiro-based lender that specializes in loans to mid-size companies, was seized by the central bank on Oct. 19 after regulators uncovered violations of industry standards and deteriorating finances. Brazil’s privately owned deposit-insurance fund said Oct. 20 it will pay 1 billion reais to some of BVA’s local bondholders

BVA used FIDC flows to make other payments as depositors withdrew money from the bank, newspaper Valor Economico reported Oct. 29, citing unidentified officials at the bank. BVA declined to comment through its press office in Sao Paulo. The central bank’s press office in Brasilia declined to comment.

Credit Quality

BVA paid a 9.125 percent interest rate on three-year international bonds sold in 2011. The bonds were being bid at five cents on the dollar yesterday, according to prices compiled by Bloomberg. The Brazilian unit of Madrid-based Banco Santander SA, Brazil’s sixth-largest lender by assets, paid 4.25 percent on five-year bonds issued in January 2011. The bonds currently yield 3.04 percent.

Holders of BVA’s FIDC Multisetorial BVA Master, Master II and Master III funds voted last week not to liquidate the funds, according to regulatory filings. Holders of BVA’s FIDC Multisetorial Italia were set to meet yesterday, though assembly minutes have yet to be made public.

Default rates on Master II and III rose to 11.6 percent and

12.6 percent on Oct. 5, from 2.8 percent and 6.7 percent on June 30, according to a regulatory filing. Multisetorial Italia’s default rate rose to 3.5 percent, from 0.3 percent in the same period.

‘Lower Return’

Austin Ratings, a Brazilian credit rating company, cut its ratings on the Master II and III funds by five levels to brBBB+ and Italia by four levels to brA- on Oct. 11, citing the rising default rates.

“We observed an increase in defaults and a comingling risk that could eventually lead to the bank retaining flows that it shouldn’t,” Luis Miguel Santacreu, an analyst at Austin, said by phone from Sao Paulo. Santacreu also cited concern over a lack of information as BVA stopped reporting earnings after 2011.

S&P analysts Hebbertt Soares and Leandro de Albuquerque placed the four BVA FIDCs, which have total assets of 838 billion reais, on review for downgrade on Oct. 19, citing operational difficulties the funds face from the central bank intervention and the possibility of a change in management.

Interruptions in payment flows and increases in default rates will be “temporary,” according to S&P, which assigns the Master I FIDC a brAAA rating, the highest on the local scale.

S&P has brAA ratings for Master II, III and Italia.

Default Swaps

Banks oppose the new rules being considered by regulators because they will increase costs, which will end up reducing returns on the securities, according to Andrew Storfer, a former president of Brazil’s association of financial executives, known as Anefac.

“At the end of the day it will be the investor who pays for this, he’s going to have a lower return,” Storfer said in a telephone interview from Sao Paulo.

Disappearing Asset-Backed Money Signals Overhaul: Brazil Credit

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries fell three basis points, or 0.03 percentage point, to 141 basis points at

10:08 a.m. in Sao Paulo, according to JPMorgan Chase & Co.

Default Swaps

The cost of protecting Brazilian bonds against default for five years was little changed at 100 basis points, according to prices compiled by Bloomberg. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.

The real was little changed at 2.0351 per dollar. Rates on interest-rate futures contracts due in January 2014 were unchanged at 7.33 percent.

Investors in BVA’s FIDCs will probably wait to see results of the central bank intervention before making further decisions on whether to push for liquidating the funds, Santacreu said.

“The central bank in its intervention could directly recover the flows from debtors and give them to investors without passing them through the bank,” he said. “It’s the central bank’s obligation to identify which money is going to the bank and see to it that it goes instead to the funds.”

For Related News and Information:

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Most-Read News on Brazil: MNI BRAZIL <GO> Bloomberg News in Portuguese: NH PBN <GO>

–With assistance from Sarah Mulholland in New York and Francisco Marcelino in Sao Paulo. Editors: Brendan Walsh, Robert Jameson