Proposed secondary legislation for Brazil’s long-awaited covered bonds addresses key issues and would allow the new product to achieve ratings above those of their issuers, according to Fitch, with some smaller banks potentially benefitting from the most significant rating uplift on a national scale.

Draft secondary legislation for Brazil’s new instrument, named letra imobiliária garantida (LIG, or real estate covered bond), were published for public consultation by Brazil’s central bank in January. Supplementing an existing covered bond law that came into force in January 2015, the secondary regulation is the final step in creating a Brazilian framework.

On Wednesday, Fitch said these federal regulations, as proposed, would enable Brazilian covered bonds to be rated higher than their issuers.

The proposals address important issues that did not feature in the primary legislation, it said, noting: the inclusion of liquidity provisions for payments after the event of an issuer default; new standards on asset quality, with LTVs deemed in line with international standards; and definition of the roles and responsibilities of the trustee before and after insolvency.

“The potential rating benefits of the proposed rules vary,” said Fitch. “On the national scale, some smaller lenders’ covered bonds programmes could benefit from significant rating uplift above the issuing institution’s rating, depending on how the issuance is structured and the quality of the portfolio.

“Leading private sector banks would not benefit from such uplift as their ratings are already AAA. Larger, government-owned banks could see ratings rise by one notch above their current AA ratings.”

The rating agency added that international scale ratings for covered bonds denominated in Brazilian reais could potentially be two to three notches above the sovereign rating (currently BB on negative outlook), but the cover pool would need to withstand higher-than-usual stress scenarios.

Covered bonds issued in other currencies would probably not exceed the country ceiling (BB+), it said, unless transfer and convertibility risks are mitigated.

S&P has also previously stated that it believes the proposed secondary legislation would allow Brazilian covered bond ratings to exceed issuer ratings.

Photo: Banco Central do Brasil; Source: Senado Federal/Flickr