OREANDA-NEWS. Brazilian non-bank financial institutions (NBFIs) are seeing increased benefits from issuing certificates of deposit called "Letras de Cambio" (LCs), says Fitch Ratings. LCs are diversifying NBFIs' funding sources, extending the average tenor of liabilities, and improving overall asset-liability management.

LCs are being issued by medium and small commercial lenders with tenors up to five years, with average maturities of about two years and no limit on issuance amount. Among Fitch-rated NBFIs, Omni, Dacasa and Santinvest are increasingly issuing LCs, which now comprise approximately 35% of their total funding. At year-end 2014, LCs accounted for about 15% of NBFI system's total funding, versus 11% in March 2014.

For Brazil's retail investors, LC yields are attractive enough to drive the demand that is helping to fuel issuance. LC issuers are paying up to 130% of Brazil's interbank deposit certificate rate, the CDI. This is a lower cost of debt than otherwise available to many issuers. By comparison, small and midsize banks will typically pay in a range between 105% of CDI to 120% of CDI.

Other forms of funding for NBFIs, often viewed as less stable and more expensive than LCs, include time deposits covered by the Credit Guarantor Fund's insurance scheme (DPGE), loan portfolio sales and asset-backed securities (FIDCs). The first generation of DPGEs -- referred to as DPGE I -- were introduced as a temporary source of funding and are being phased out, while portfolio sales and ABSs are dependent on the continued interest of investors in the underlying assets and increase asset encumbrance.

LCs have provided meaningful improvement to many lenders' liability diversification because the retail holders of LCs represent a wider investor base relative to institutional-only funding sources. Another positive credit element of LCs has been the greater degree of transparency provided by issuers in order to meet the requirements to sell LCs to retail investors.

Despite being a relatively old instrument in the Brazilian financial system, LCs have grown rapidly over the past three years to total BRL4.8 billion. 

Investors' demand for LCs was boosted after deposit insurance coverage provided by Fundo Garantidor de Credito was increased to BRL250,000 from BRL70,000 per investor in May 2013.

Securities distributors and brokerage houses have held key roles in LCs' distribution, as brokers have been the main avenue for these instruments reaching small and less sophisticated investors. Many finance companies are not well known in the market and operate regionally. LCs are still emerging in terms of public understanding, thus we expect that as investors become more comfortable with these instruments, their issuance will grow. In Fitch's opinion, LCs' spreads are affected by the lack of a secondary market, similar to other senior debt instruments issued by banks and NBFIs.

The majority of LCs are issued without an immediate redemption clause, although some are. LCs are not tax exempt and investors pay progressively lower taxes as maturity lengthens. Rates on LCs are maturity dependent, with longer maturities (over two years) presently lower.