The explosion in Brazil’s securitization and structured finance markets in the past five years has unearthed a deep and varied pool of assets that are being repackaged in a variety of new ways. These offer investors high grade, and in most cases still, high-yield investments, while giving borrowers unprecedented access to funds and ways to manage the balance sheet.
An odd combination of stable macroeconomic indicators and the highest real interest rates in the world draws a strong foreign investor bid to Brazil. And local investors are following suit. Hedge funds are setting up new vehicles designed to invest in local corporate credit; pension funds are building out new credit teams to tackle this emerging asset class; and some specialized investors are even starting to trade securitized corporate credit in a nascent secondary.
“We are on the verge of seeing spreads tighten considerably in [structured] products,” says Bernardo Aleluia, of Merrill Lynch’s emerging markets institutional sales desk in São Paulo. He predicts more foreign investor participation, as well as local investors getting more aggressive, including pension funds setting up dedicated structured product departments, while asset managers also develop expertise.

Real Assets Take Center Stage
The sheer size and depth of Brazil’s economic base promises a constant flow of structured finance innovation and expansion. A snapshot of the assets being securitized in Brazil today reveals a preponderance of auto and consumer loans, and future flows. But there is less than 10% in mortgage-backed securities (MBS) and virtually no investment in non-financial assets.
“We are at the beginning of a new era marked by a movement into real assets,” says Amaury Junior, head of São Paulo-based Vision Investments, which manages $1.1 billion in offshore funds largely in structured finance investments. He believes an improved legal and regulatory framework and the eventual emergence of a secondary will set the stage for a major move into Brazil’s most plentiful economic agents: agriculture and real estate.
Junior says Brazil has 499 million hectares of unutilized arable land, which is by far the largest amount of any country in the world. The US and Russia trail with 167 million and 150 million respectively. “We expect a tremendous expansion in Brazilian agricultural credit.” Vision is an active player in Brazil’s agricultural sector with hundreds of millions of reais invested, though none of the structured deals have been publicly distributed. Junior has a credit team of around 50 analyzing and structuring investments with agricultural companies, among others, in Brazil. But he wants other market participants, such as rating agencies, to get involved.
Maria Muller, senior vice president at Moody’s, agrees that the agricultural sector will yield a sizable amount of issuance as new types of assets emerge for the Brazilian structured market. But Moody’s has not yet rated a domestic agriculture securitization. “We understand that these are complicated companies with a several risks to be mitigated. There are a lot of new elements to consider and instruments to be developed in order to do this.”
Some help has come from the government, says Rodrigo Azevedo, former director for monetary policy at Brazil’s central bank, pointing to Law 11076, passed at the end of 2004, which created of a number of new securitization instruments to aid agriculture finance. These include warrants, depository funds and receivables funds called WA, CDCA and CRA. They are still relatively untested but will support market growth, says Junior.

Land Grab
Real estate is as another emerging asset class with enormous potential for deal flow. Last year, MBS accounted for almost 40% of securitizations in Mexico, but just 8% in Brazil, according to Standard Bank. Fabio Nogueira, president of real estate securitization firm Brazilian Securities, expects volume to multiply by several times through the use of CMBS and RMBS. He sees pension funds and individual investors increasingly being drawn to CRI, or real estate receivable quotas, as these are usually tax-free.

But Nogueira notes that valuations on local real estate securities are distorted. “Today [Brazilian investors] demand a premium that is disproportionate to what goes on in the rest of the world,” he says. In the US, MBS pay close to similarly dated Treasury bills, while in Brazil, investors charge a 15% yield on CRI quotas. “Investors need to understand this risk better,” adds Nogueira.
Once they do, and yields on real estate transactions come down to the 8%-10% range, the market will evolve even further, says Nogueira. One effect will be the lengthening of maturities, which today stand at around four years. Another will be the emergence of low-income housing credit as a securitizable asset, which will bring in a vast segment of Brazil’s demographics. Vision’s Junior notes that in Brazil today, there is a housing deficit of more than 8 million homes, the majority for poor families.
Fields of Streams
Another sign that Brazil’s structured finance market is evolving is the constant emergence of new kinds of financial receivables. Among the most exotic getting attention is the precatório, a court ordered payment the government must make to an individual or company for damages. Valuing the credit risk behind a precatório securitization is the largest challenge because although the payments by the municipal, state or federal government are backed by the Constitution, the whimsical nature of political offices and the relative inefficiency of the Brazilian legal system pose uncertainties.

Furthermore, the track record for these deals is limited to a single issue. On the positive side, the federal government has a sterling track record of paying precatórios, which last year represented 0.27% of the country’s GDP and 0.33% of public debt. The one offering that was completed – Polo Precatório Federal, structured by Deutsche Bank – got a sovereign rating. But it is uncertain whether this asset class will take off or only generate a limited number of time consuming and structurally complex transactions.
Among other frequently discussed financial streams are commercial future flows and auto loans. These correspond to 13% and 39% of the total securitized assets in the country, and novel developments in each are expected to continue to take place, in tandem with improving economic and demographic trends. In 2006, individual loan growth expanded by 33.4%, while auto loans rose by 21.3%.

An expected pickup in infrastructure projects in Brazil paves the way for increased future flow deals, like Standard Bank’s FIDC for Paulista de Trens Metropolitanos. In February, the bank helped set up a trust that offered 150 million reais in senior quotas and 50 million reais in subordinated notes that pay 104 basis points over the government’s inflation-linked NTN-B. The 3.7-year average life deal was rated by Moody’s and is based on future sales of train tickets.
Still a Way to Go
For all of its growth and innovations, the Brazilian securitization market is lacking in a number of basic elements. “The absence of a secondary market is an impediment [for investors],” says Nicholas Reade, CEO of São Paulo-based Rio Bravo Securitizadora. He refers in particular to foreigners, whose participation in many of the subordinated tranches of securitization issuances has played an important role in the development of high-yield products. While some specialized funds have begun swapping structured finance holdings in Brazil, the activity is a rare exception to the rule for the country’s buy and hold corporate market.

Most foreign buyers participate in the local markets on a limited basis through credit linked notes tailored specifically for an offshore base by a small number of foreign investment banks. Or they buy fully funded swaps. One thing that keeps them offshore is Brazilian red tape. “A 2689 account is still very costly for foreign investors to set up,” says Merrill’s Bernardo Aleluia, referring to the local investment account offshore buyers, many of which are Brazilian, have to set up to be in accordance with the Central Bank’s rules on capital movements. “They have to deal with bureaucracy, which is time-consuming, and they’re still faced with high taxes,” he adds.
Vision’s Amaury Junior also has a wish list that includes better tax treatment for long-term investors, lower regulatory costs for structuring so that smaller transactions can become more economically viable, and a simpler legal framework to allow for negative pledge, which protect bondholders.
Despite these shortcomings, there is no doubt that Brazil’s securitization market will continue to be the fastest growing and deepest in Latin America for the next several years. In 2006, Brazilian local issuance accounted for 40.6% of the total LatAm volume, overtaking Mexico according to Standard Bank. And the gold rush mentality of structuring agents and investment banks will ensure a healthy dose of competition for assets, which in turn will continue to unearth new ones to collateralize for yield hungry investors. LF