The first Brazilian covered bonds could be issued in the second half of 2018, according to Felipe Pontual of Abecip following the completion of Brazil’s framework last month, with the market having scope to grow to $190bn. Moody’s said the legislation aligns the framework with global peers.

Secondary regulation defining and governing the new Brazilian product received final approval and was published on 29 August, supplementing primary legislation enacted in 2015. Speaking at a European Covered Bond Council (ECBC) plenary in Barcelona on Wednesday, Pontual (pictured speaking), managing director of the Brazilian Association of Real Estate Loans & Savings Companies (Abecip), said the Brazilian central bank had done “a very good job” of understanding international markets and best practices in covered bonds.

“It is a happy time for us,” he added.

Pontual said that there is still “a lot to do” before issuers can open the market, such as the setting up of systems and putting in place of fiduciary agents, but that the first issuance could come in the second half of 2018.

The first Brazilian covered bonds (letras imobiliárias garantidas, or LIGs) have been widely expected to be denominated in Brazilian reais, and Pontual said the initial deals will probably be targeted at local investors, with international issuance to follow.

The secondary legislation introduced a limit on covered bond issuance of 10% of an issuer’s total assets. Pontual estimates banks could therefore issue up to $190bn (Eu160bn, BRL595bn) of covered bonds at present.

“So, there is some nice room there until we reach the 10%,” he said.

Other features defined by the secondary legislation, Pontual noted, include a 5% minimum overcollateralisation requirement, rules on stress tests for cover pools and on the role of fiduciary agents, and the requirement of a post-default operational procedures plan.

The task of writing the secondary legislation was delegated to the Monetary National Council (Conselho Monetário Nacional, or CMN), which includes the minister of finance and Brazil’s central bank. A draft version of the secondary legislation was released for public consultation in January, and the final approved version included only minor changes.

In a sector comment published on Monday of last week (4 September), Moody’s said the regulation aligns Brazil’s covered bond framework with other frameworks around the world, and is credit positive for Brazilian banks as it provides a new longer term source of funding for the country’s growing mortgage business.

Noting that LIGs will have a minimum weighted average tenor of two years, Moody’s said their issuance will improve banks’ liquidity compared with existing funding sources such as deposits and letras de crédito imobiliárias – banknotes linked to real estate financing which offer redemption to customers at any time.

“We expect LIG tenors to lengthen over time as Brazil’s economic growth proves sustainable, with LIG maturities lengthening gradually to the 11 year average duration of mortgages in Brazil,” said the rating agency.

Moody’s said the main issuers of LIGs will be Brazil’s five largest commercial banks, which have a 97% share of the country’s mortgage market: Banco do Brasil, Itaú Unibanco, Banco Bradesco, Banco Santander Brasil, and Caixa Econômica Federal.

Based on these banks’ financial data, the rating agency gave a similar figure for the potential size of the Brazilian market as that provided by Pontual, of BRL600bn. This, it said, would allow banks to almost double the current size of Brazil’s housing segment.

“As Brazil pulls out of its recession, low inflation and single-digit policy interest rates will stimulate banks to increase lending activities, primarily focusing on less risky segments such as housing,” said Moody’s. “At the same time, low benchmark interest rates will attract investors to seek investment alternatives as returns on government bonds decline, compressing portfolio targets.

“The LIG regulation provides a tax exemption for local and foreign investors, which will stimulate demand for these securities.”

Moody’s said the new regulation will allow LIGs to receive higher ratings than those assigned to their respective issuer’s senior unsecured bonds, as the cover pool will be ring-fenced within the bank’s balance sheet.

Before the publication of the final secondary regulation, Fitch and S&P also said the proposed rules would allow LIGs to achieve ratings above those of their issuers.