The approval of Brazilian covered bond legislation by the government last Tuesday is credit positive for Brazil’s largest banks, according to Moody’s, in providing alternative long term funding for lenders’ growing mortgage books, with Caixa Econômica Federal seen as a key beneficiary.

Caixa Brazil branch image

The Brazilian government on Tuesday of last week (7 October) passed Provisional Measure 656 to introduce the instrument Letra Imobiliária Garantida (LIG). As a Provisional Measure, the ruling is effective immediately and will become law unless the Brazilian congress rescinds the measure within 60 days (although it may approve the measure before then). The plan to introduce the law was announced in August. (See previous coverage.)

Moody’s said yesterday (Monday) that the instrument will strengthen banks’ liquidity and help fund more sustainable growth, providing benefits that far outweigh the subordination risk for existing debtholders.

“The LIG regulation will lead to an increase in the issuance of longer-tenor securities shielded from a failure at the issuer bank, which will attract more investors to Brazil’s capital markets,” said the rating agency. “Covered bonds’ tax-exempt status will further enhance the attractiveness of the instrument among domestic and foreign investors.”

Moody’s noted that banks will be able to complement short term savings deposits – the predominate source of mortgage finance – with LIGs, and that rapid growth of mortgage lending has outstripped that of savings deposits in recent years.

State-owned Caixa Econômica Federal (Baa2, on negative outlook) has a 68% share of the mortgage market and its loan book grew 27.3% in the year to June in response to government housing policies, according to Moody’s, which said that LIGs will particularly benefit the bank.

“Caixa’s real estate credit now exceeds its level of savings deposits, which means it must fund lending through other deposits and market funds,” it said.

The rating agency said that although other, private sector lenders have expanded their mortgage books, such loans still account for a “modest” proportion of their total loans, and it does not expect them to use LIGs as frequently. Such banks cited by Moody’s included Itaú Unibanco (Baa1, negative), Banco Bradesco (Baa1, negative), Banco do Brasil (Baa2, negative), and Banco Santander Brasil (Baa2, negative).

According to Moody’s, the real estate asset pool backing LIGs will remain on a bank’s balance sheet, but will be protected from a bankruptcy stay if the bank undergoes intervention or insolvency.

“In case of an issuer default, the cashflow from the segregated cover pool of assets will be monitored by a fiduciary agent until full amortisation of the security,” it said. “In case of a bank failure, the segregated assets will not be affected by the financial institution’s taxes, labour or pension liabilities, a feature that will better protect investors than instruments backed by real estate receivables but issued by Brazilian securitisation companies.”

The Provisional Measure also requires minimum overcollateralisation of 5%, although the calculation method has not been addressed, said Moody’s, which also noted the dual recourse nature of the instrument including the senior unsecured claim against the financial institution’s balance sheet in the event that the collateral is not sufficient to pay an LIG.

“These features may support a higher rating on the LIG than on the financial institution’s unsecured debt,” said the rating agency.

It noted that regulators are still to provide additional clarity on the eligibility criteria for the underlying loans and conditions for management of the underlying assets by the fiduciary agent if the financial institution fails.