The first research on asset-backed securities industry Brazil

The first research on asset-backed securities industry Brazil, rising consumer delinquencies and the biggest win of a bank deposit in more than a decade are opening cracks in the country's financial system.

borrowing costs for smaller banks have risen from 09 November a plan to rescue the Banco Panamericano, SA triggered the probe, pushing the average yields on certificates of deposit to 12.9 percent from 11.8 percent. The market for the sale of portfolios of loans has dried up, and funds from asset-backed commercial paper has had 2.3 billion reais (U.S. $ 1.3 billion) in writedowns since the rescue, according to the capital of Brazil, association markets.

The tension in credit markets in Brazil is the damping euphoria among investors that helped the Bovespa index gain of 81 percent since December 2008. The index is the only benchmark stock index in the Americas to decline this year.

"Pan was the wake-up call," said Denise Debiasi, vice president for Latin America of the FTI Consulting Inc., a Baltimore-based firm started in 1982 to advise on compliance, risk and finance. "There are risks people can be seen, as credit quality as the market boom."

Late payments on credit cards and other consumer loans rose 23 percent in November from a year earlier, the biggest increase since 2001, according to Experian plc, a credit risk consulting firm in Dublin. Brazil, the fourth fastest growth in the Group of 20, is also attracting an influx of foreign capital and facing its highest inflation rate in five years.

"It's not sustainable"

"They are growing at these levels because of the enormous growth of domestic credit and loans from the government development bank," said Simon Nocera, co-founder of San Francisco hedge fund Lumen Advisors LLC and former chief economist of the International Monetary Fund . "But this is in a country where there is no real credit. It is not sustainable."

Brazil's central bank tightened rules on capital on December 3 at the top what happened in the U.S. two years ago after investors poured money into the market for subprime mortgages. Far more limited financing options for small lenders, like Pan, which helped fuel a five-fold expansion of consumer credit in Brazil to 743.5 billion reais in October from 137.9 billion reais in December 2002, according to central bank.

Dilma Rousseff, 63, who becomes president of Brazil January 1, is trying to convince investors it will cut spending and credit subsidized by the government to curb inflation. She succeeds, Luiz Inacio Lula da Silva, whose policies promoted an increase of 500 percent in the Bovespa index since 2002.

64 percent drop

Pan, the 21st largest bank in the country by assets, was rescued by a loan of 2.5 billion reais from its majority shareholder, Silvio Santos, the host of 80 years, a variety show Sunday. The rescue prompted investigations into the accounting practices of the bank, the loan portfolio purchases and industry asset-backed securities.

Shares of Pan American, based in Sao Paulo, sank 64 percent this year high on 13 October, the biggest fall in a Brazilian financial stock bull during a rally in the Bovespa index, at least since 2000.

Accounting inconsistencies in the Pan American are "isolated incidents", said the central bank in an email response to questions on 17 December.

"The problem was found only in that institution," said the central bank.

Pan does not comment on ongoing investigations, according to a spokesman for the bench press agency in Sao Paulo external. Officials at the Silvio Santos Group did not return calls to an email or phone after office hours.

'Plan dirty'

Lula, a former union leader who won the presidency in 2002 amid concern that defaults had debt of the nation, has praised the Brazilian banks to withstand the global credit crisis, which he described in a speech in May 2009 in Istanbul as "the dirty regime of a system that was totally out of control in the rich countries." said the Brazilian system has "rules more."

Brazil's economy, growing at its fastest pace in more than two decades, emerged more quickly from the financial crisis than other countries. The currency gained 32 percent against the dollar since December 2008, as foreign investors last year served 20.6 billion reais in the stock market.

Much of the recovery of Brazil was funded by the Government Development Bank, known as BNDES, which more than doubled their lending to businesses last year to 137.4 billion reais, up from 72.2 billion U.S. dollars paid at world by the World Bank in the fiscal year ended in June.

Notes FIDC

"It was good during the crisis, but now that is causing all sorts of inefficiencies of credit," said Nocera, a former fund manager of Soros Fund Management LLC. "They lend at rates so low that private banks can not compete."

Credit growth has also been reinforced by the emergence of a asset-backed securities after regulators allow the issuing and trading of credit-linked notes in 2001. Call collect funds, known as FIDC and backed by future cash flow credit card, auto loans and payroll grew to 59.6 billion reais from 1 billion reais in 2003, making largest domestic issuer of Brazil in Latin America asset-backed securities, according to data compiled by Economática regulation.

FIDC are typically sold to pension funds in Brazil and the asset management companies. They offer yields of 12.2 percent per year for funds rated AAA to as much as 18.8 percent for the values of lower-rated, said Jean-Pierre Costa Gil, director of finance in Latin America structured to Standard & Poor's in Sao Paulo. Ten-year U.S. Treasury notes yield 3.32 percent, according to BGCantor Market Data, and denominated in Brazilian reais for government bonds in 2021 yield 12.36 percent.

Payroll Loans

About a third of the FDIC Brazil are backed by loans on which credit payments are deducted from the payroll of public employees or the income of pensioners, said S & P Coast Gil. The rest are mostly repackaged commercial loans, car loans or credit card payments, he said.

payroll loans in Brazil are similar to payday loans in the U.S., but the Brazilian government allows banks to deduct payments directly from the payroll and pension payments before consumers increasingly view their controls, make them safer.

An increase in the issuance of credit cards - tripled from 2003 to 153,400,000 in circulation, according to the national industry association - has helped the debt of Brazilian consumers to 18 percent of total disposable income compared to 13 percent in the U.S. , According to data compiled by Morgan Stanley.

Late payments

The deteriorating consumer credit quality, is becoming a concern, although FIDC are structured to mitigate the default risk for investors, Costa said Gil.

"As the economy takes the credit market a type of consumer who is not accustomed to credit, in addition to the level of risk," he said in a telephone interview. "As much as you can have credit policies and models of the structure to eliminate losses, continue adding the risk anyway."

Delinquencies rose for the seventh consecutive month in November, according to Experian, based on data from credit card payments, utility bills and bank loans. Total defaults on consumer loans - credit arrears for 90 days or longer - fell to 6 percent in October from 8.1 percent a year earlier, according to the central bank.

Credit cards and vehicle financing are lucrative for banks looking to buy loan portfolios, said Andrew Frank Storfer, president of Anefac, an association based in Sao Paulo of finance and accounting executives. The owner of the average credit card pays 238 percent of the outstanding principal each year, according to Anefac. payroll loans, perceived as less risky, yield up to 30 percent a year, Storfer said.

Credit Growth

Smaller banks that offer credit to businesses and consumers who normally do not receive loans from Brazil's largest banks, including BNDES, is "enormously important" to the Brazilian financial system, said Sergio Taboada, partner and director of institutional relations Rio de Janeiro-based Banco de Maxima SA, which provides loans to small businesses and has created one of the first funds FIDC in August 2002.

"The big banks do not have access to the consumer or retail, private companies," said Taboada. "That's why smaller banks are important for the growth of credit."

smaller banks in Brazil receives most of its funding from the sale of loan portfolios of the largest banks, according to Peter Shaw, managing director of Fitch Ratings Latin America in New York, who said he already had the lower grades to small and medium-sized country banks Moody's Investors Service because they are more vulnerable to liquidity runs.

Achilles heel '

"There is a much wider range of banks that have a business model that is highly dependent on wholesale funding," said Shaw. "That's not just Brazil but seems to be the Achilles heel of the world," said Shaw.

The loans are usually sold with recourse, ie the author has to honor those who go wrong. An accounting rule allows banks to set aside the proceeds from the sale of loans, and all projections of future interest income as revenue when the loan is sold, even though no money has been collected from borrowers and the seller can not see any of that income.

"You are the income accounts not paid yet and did not take into account the default, so you are moving something that was not paid, it is not effective, however," said Edward Dias, lead analyst for Bank Fitch Ratings Brasil Ltda. in Sao Paulo. "And that goes in the results, which falls in equity, increasing its influence so that you can pay more and sell more."

Not all banks take advantage of the rule, said Dias. Only small and mid-market banks that rely on sales of the finance portfolio use, and not all at the same level, he said.

"Significant distortions"

The central bank postponed until January 2012 a rule prohibiting the practice of booking future revenue, Dias said that "creates considerable distortions" in revenue, earnings and capital levels of some banks. The changes, which are supposed to enter into force in 2009, has been postponed three times to the banking system for a longer period to recover.

In the fraud investigation of Pan, the biggest lender to Brazil for used cars, researchers found 2.1 billion reais in losses resulting from improper accounting of sales of loan portfolios, Central Bank president, Henrique Meirelles, said in an interview Nov. 17. The central bank also discovered that the company's credit card group owed to the lender 400 million reais.

Regulators identified the issue seven weeks ago when they realized Pan was recording in loans it had sold assets to other institutions, and there was no evidence that the loan portfolios sold more than once, Alvir Hoffmann, director of supervision central bank, told reporters in November. 10.

Search Homes

Brazilian federal police seized documents and computers from the homes of former Pan American executives on 16 December. Deloitte & Touche LLP, the auditors of the bank, also is questionable because of accounting inconsistencies that go back four years, a person close to the probe of 13 November, he said, asking not to be identified because the investigation, the largest in the industry since the 2004 collapse of Banco Santos SA, is confidential. Deloitte declined to comment, according to a statement by email.

As the investigation was announced, demand for loan portfolios has been arrested, according to Bank Taboada Maxima.

"The big banks stopped buying these portfolios after Pan," Taboada said in an interview. "The reason: no one knows exactly what happened. It looks like a fraud, but what the institution does not see it?"

"Internal problem"

André Gustavo Jorge Rodrigues, who FIDC structures based on cash flow from lawsuits and mortgages Vision Investments in Sao Paulo Brazil, said the issue is not one of accounting, the value structure.

"In the U.S., which had several levels from the liquidation of mortgage assets, and Brazil does not use derivatives," said Rodrigues. "Whenever a problem arises at a financial institution that would like to investigate further in this asset class. But in this case, I think it was an internal problem in the audit did not succeed."

earnings growth and consumer lending will slow and small banks struggle to raise capital and meet strict requirements of the central bank, Ceres Lisboa, an analyst at Moody's America Latina Ltda., said on December 9 after cutting outlook to negative for the ratings of four banks that specialize in payroll loans and vehicle.

"The issue is the capital of liquidity and sustainability of these franchises," Lisbon said in a telephone interview. "The credit sales have declined due to Pan, which was an important financing alternative."

Used Cars

Car loans account for about half of the Pan American loans, Lisboa said.

"We are talking about selling used cars to low-income people," he said. "That's an asset class that involves risk."

The increased perception of risk of smaller banks is characterized by increasing returns on certificates of deposit, one of the most important forms of financing for the industry, "said Taboada.

Bond prices for lenders with assets of less than $ 2 million have not recovered since the collapse on 10 November. The bond yields of Banco Industrial e Comercial SA of 8.5 percent due in 2020 has risen 81 basis points, or 0.81 percentage point, from 09 November. Daycoval Bank SA 6.5 percent bond due in 2015 rose 85 basis points in that period.

Credit bubble

Brazil's Central Bank is acting to prevent a credit bubble by increasing reserve requirements and capital to reduce consumer loans. Reserve requirements on term deposits will increase to 20 percent from 15 percent and an additional requirement for non-interest bearing accounts amount to 12 percent from 8 percent. Banks will also have to use more capital to support consumer loans whose repayment terms over 24 months.

The Finance Minister Guido Mantega, who shall hold office when Rousseff inauguration next month, said in a Nov. 30 interview that Brazil has cut funding for its development bank by 50 percent next year part of a plan to curb public spending.

The government is also trying to control the unregulated industry of credit card Brazil, Meirelles said in an interview last month. The central bank chief said there should be greater oversight and that a working group will consider the need for government oversight.

"Some of monitoring may be appropriate," said Meirelles. "The case of Pan how this is important."

'Performance Chasing "

Brazil's securities regulator, which oversees the funds FIDC, is working with the central bank to ensure that enough information is provided to investors, according to Francisco José Bastos Santos, head of institutional investor relations agency in Rio de Janeiro based, known as CVM.

"Securitization as FIDC and real estate values are at the moment the big challenge in the development of our regulations," Santos said in an interview from 02 December.

Adding to the anxiety of credit are foreign investors attracted by an interest rate adjusted for inflation of 5.12 percent, second only to Croatia from the 46 countries. Investors "chasing performance" are taking the liquidity of the Federal Reserve is pumping into the U.S. economy and investment in emerging markets like Brazil and China, where profits are larger, said Russ Certo, a managing director and head of the bargain-rates in New York-based Gleacher & Co.

The Fed is "sowing the seeds of the next volatile movements in the markets because these policies are destabilizing," said Certo. "These economies are afraid of what happens when all this hot money is going, because when you leave, it will be tumbleweeds."

"The cycles of boom and bust '

The flow of capital into emerging markets "can be overwhelming," said Mantega in a statement of 09 October the IMF, as some countries' struggle with the rapid credit growth. "

That view was echoed an October report of the IMF said that large capital inflows to countries like Brazil, combined with monetary policy in developed countries increases the chances that the financial system becomes over-indebted and "increases the risk of asset prices, the boom-bust cycles. "

"It's time to be a bit careful with the B in BRIC" he said. "There is better value elsewhere, I think."

Brazil's new capital and reserve requirements, while manageable, reduced profit margins as much as 2 percent and make it "increasingly difficult for banks to grow at record levels, led by Morgan Stanley analysts Jorge Kuri wrote in a December 03 research report.

Profit margin

It said the new rules affect reservation as Banco Santander Brasil SA, the Brazilian unit of Spain's largest bank, followed by Banco do Brasil SA, Latin America's largest bank by assets, Banco Bradesco SA, Osasco, Brazil, the second largest bank by market value, and Sao Paulo-based Unibanco Itau Holding SA, the largest lender.

Brazilian banks had an average profit margin of 15.31 percent in 2009, almost three times more profitable than U.S. lenders, which had a profit margin of 5.7 percent during the same period. Financial shares have almost tripled since its October 2008 low, compared with a gain of 14 percent for banks worldwide, according to MSCI indices.

"Swimming Naked"

Now the world's largest banks are vying for a share of these benefits. Citigroup Inc., the U.S. bank third largest by assets, already owns 8 percent of the Brazilian market of credit cards, Manuel Medina-Mora, executive director of Citigroup Global Consumer Bank, said at an investor conference last month. JPMorgan Chase & Co., the U.S. bank the second largest, acquired a majority stake in Gavea Investimentos Ltda, a Rio de Janeiro, a firm that oversees $ 6 billion, private equity and hedge funds securities and is managed by former Brazilian central banker Arminio Fraga.

"When you have rapid loan growth and credit expansion, all is well," said Eric Conrad, who helps manage $ 12 billion in emerging market funds at ING Investment Management in New York. "But if the feeling comes back, and get more stringent reserve requirements, what matters is the quality of assets. When the pool water starts to go down, see who's been swimming naked."