Market conditions are primed for the realisation of
Brazilian banks’ efforts to build a covered bond
market. The only thing missing is the legislative framework
being considered by the country’s central bank,
and reform of an outdated bank capital rule.
The combination of falling interest rates, a growing middle
class, an inadequate mortgage market structure and issuer
appetite has almost exhausted Brazil’s limited
mortgage finance options.
Rumours are circulating that this year – six years
after the country’s first attempts to structure
covered bond-like instruments – a regulatory framework
for the instrument will emerge.
In July 2011, the Brazilian Association of Real Estate Loans
and Savings Companies (Abecip) provided Banco
Central do Brasil with a suggested framework for a covered
bond-like instrument known as letras finceira
A Banco Central do Brasil spokesperson declined
IFLR’s request for comment on the grounds
it does not speak on proposals or possible future decisions by
But LFIs are gaining support and those familiar with the
proposal believe it to be adequate. It segregates an
overcollateralised cover pool that would survive insolvency,
and offers investors tax incentives, said Howard Goldwasser, a
partner at K&L Gates.
The 65% rule
The market and authorities are both aware of the need for
covered bonds. "They know they need to take this further step
if they want to develop a proper mortgage market in Brazil,"
said Guilherme Balieiro from BBVA credit research.
What’s held this back to date is the legal
requirement for banks to channel 65% of savings deposits into
The rule was implemented in times of high inflation, to
ensure there was sufficient funding for mortgages. It has been
outdated for some time, but Brazil’s rapidly
growing middle class combined with lowered interest rates means
banks are now pushing the limits of this requirement.
This 65% rule and lack of standardisation by developers
means off-balance sheet residential mortgage backed securities
(RMBS) have not developed.
The incompatibility of RMBS with a rule that encourages
banks to keep mortgages on their balance sheets accentuates the
need for a long-term funding alternative for mortgage
origination, according to Goldwasser.
And covered bonds, albeit for different reasons, have fared
Goldwasser was involved in attempts to structure Brazilian
covered bonds as early as 2006. He said that without
legislation, it proved difficult to use mortgage assets as
collateral without moving them off a bank’s
balance sheet. It also proved difficult to isolate the cover
pool so that it survived any bank insolvency.
If LFIs are to succeed as a mainstream form of mortgage
finance, loans counting towards the 65% rule must be eligible
for covered bond pools, on the basis that they remain
"This law should evolve. The 65% rule should change to give
banks the flexibility to issue covered bonds," said Balieiro.
"It should be clarified if loans financed through savings can
be included as collateral for covered bonds."
On the frontline
If this is done, the likes of Itaú, Banco Bradesco
and Banco do Brasil – names foreign investors are
familiar with – are expected to make offerings.
"Brazilian banks already active in the international markets
will be on the frontline to issue covered bonds," said
These banks have seen the popularity among foreign investors
of covered bonds issued under new frameworks in the likes of Australia and New Zealand.
One notable absentee is expected to be Caixa Economica
Federal (CEF), the government-owned bank which has a 75% share
of the residential mortgage market. CEF has access to cheaper
funding than private banks so has less of a need to issue
This would increase competition and be good for the
country’s banking sector as a whole.
Aside from confirmation that mortgages counting towards the
65% rule can be included in LFI pools, the
instrument’s success will come down to three
Firstly, investors must have access to the underlying assets
without a specified contractual right to do so.
"The future of covered bonds depends primarily on dual
recourse. The framework must replicate foreign systems where
the investor has access to the collateral in case of default,"
Secondly, any perception that Brazil is entering a real
estate bubble must end. People have been shut out of Rio de
Janeiro, Sao Paulo and Brasilia’s housing markets
because of rising prices. To draw the interest of foreign
investors, this perception must be shown to be wrong.
Finally, it must be shown that Brazil has a strong and
liquid secondary market where investors could sell their
mortgage assets in the event of an insolvency.
Why LatAm covered bonds are set for