Circular Letter CVM/SIN/SNC 02/15

SECURITY AND EXCHANGE COMMISSION OF BRAZIL
Rua Sete de Setembro, 111/2-5º and 23-34º Floors – Center – Rio de Janeiro - RJ – ZIP: 20050-901 – Brazil Tel.: (21) 3554-8686 - www.cvm.gov.br Circular Letter No. 2/2015/CVM/SIN/SNC Rio de Janeiro, October 13, 2015.
To
Administrators and Auditors of Credit Rights Investment Funds ("FIDC") Subject: Establishment of provision for losses due to reduction in the recoverable value of credit rights.

Dear Sirs/Madams,

1. This Circular Letter aims to guide administrators and auditors of FIDCs regarding the procedures to be observed in the establishment and examination of the provision for losses on credit rights invested by FIDCs, with a view to estimating the recoverable value of these assets, calculated in accordance with the provisions of CVM Instruction No. 489/11 ("ICVM 489"). We emphasize that this Circular Letter also aims to reinforce the guidelines already published on the subject and contained in the Explanatory Note to ICVM 489 and in Circular Letters/CVM/SIN/SNC Nos. 1/2012 and 1/2013.

2. First, we clarify that the provision establishment model described by ICVM 489 is the expected loss model, which is characterized by representing the administration's expectations regarding the non-receipt of the cash flow generated by financial assets recognized in the fund's equity and valued at cost or amortized cost. In other words, it is a model that aims to reflect, in the fund's financial statements, the expected amount of future cash flows from financial assets originally measured at cost or amortized cost that the administration expects not to realize.

3. The model avoids financial assets valued at cost or amortized cost being overstated in the fund's financial statements, with the negative difference (provision) or positive difference (reversal of provision) between the previous estimate of asset realization and the current estimate being subject to recognition by the administrator in the fund's financial statements. This comparison must always be prepared based on estimated cash flows, taking into account, for the new estimate, the impact of new factors and conditions on the debtor's payment capacity and the future realization of the respective values.

4. However, we note that some participants justify presenting recoverable amounts of credit rights significantly lower than the recorded values, with the justification presented by the administration, and corroborated by auditors, being: (a) the assigned credits have risk retention by the assignor; (b) the subordination is sufficient to cover expected losses and not prejudice the profitability expectation of senior unitholders; (c) the funds have sufficient resources to pay senior unitholders; and (d) the initially estimated losses are higher than the losses incurred up to the reporting date.

SECURITY AND EXCHANGE COMMISSION OF BRAZIL
Rua Sete de Setembro, 111/2-5º and 23-34º Floors – Center – Rio de Janeiro - RJ – ZIP: 20050-901 – Brazil Tel.: (21) 3554-8686 - www.cvm.gov.br

5. In this sense, we ratify the provisions of Article 12 of CVM Instruction No. 489/2011, highlighting that it is not the objective of the expected loss model to compare the initially estimated loss value, at the time of acquisition of said right, with an incurred loss base to verify the need or not for a new adjustment. The comparison with an incurred base does not take into account future loss estimates, therefore not conforming to the methodology in force. For example, when the acquisition of a credit right considers an expectation of expected losses in the cash flow to be generated by such an asset, and during its stay in the fund's portfolio, the administrator finds that, due to changes in economic conditions or the macroeconomic scenario, the calculation of the new estimated cash flow of this asset indicates the need to increase its expected losses, a new provision for losses must be recorded. This recording is independent of whether the new estimate is supported by subordinated shares issued by the fund.

6. Therefore, it is not possible to admit the non-recognition of a provision under the justification that the level of subordination is sufficient to pay senior unitholders. By proceeding thus, the fund's administration distorts the evaluation of subordinated shares and delays the need to call for resources from the subordinated unitholder in case of non-compliance with the guarantee ratio level. Regardless of the existence or not of subordination, the provision, if necessary, must be recorded, with the loss being absorbed differently between senior and subordinated unitholders. We highlight at this point that the fund is a separate entity with its own equity that does not coincide with any other. The fund's equity is composed of senior and subordinated shares that, in accordance with contractual conditions, may be impacted differently by the cash flow generated by the receivables that make up its portfolio.

7. Finally, we understand that the level of subordination corresponds to a guarantee of the securitization structure and should not be considered by the administrator when estimating the recoverable value of credit rights for the fund, since it is part of it. The accessory guarantees, to be considered in the estimation of the recoverable value, are those attached to the credit rights, and the administration must analyze the term and the necessary conditions for the transformation of these guarantees into current currency for the fund.

8. Finally, with a view to obtaining the necessary comfort regarding the sufficiency of the provision for losses on these credit rights, auditors must observe the minimum procedures highlighted by these technical areas in Circular Letter/CVM/SIN/SNC No. 1/2012, in addition to adopting others they deem necessary.

Sincerely,

(Signed Original)
Francisco José Bastos Santos
Superintendent of Institutional Investor Relations

(Signed Original)
José Carlos Bezerra da Silva
Superintendent of Accounting Standards and Auditing