Circular Letter CVM/SIN/SNC 03/2009: Constitution of Provision for Doubtful Collection Credit Rights in FIDC Funds

CIRCULAR LETTER CVM/SIN/SNC No. 003/2009
Rio de Janeiro, October 8, 2009
Subject: Constitution of Provision for Doubtful Collection Credit Rights in FIDC Portfolios

Dear Sirs,

This Circular Letter aims to guide administrators of investment funds in credit rights and non-standardized investment funds in credit rights (collectively referred to as FIDC) regarding the correct application of CMN Resolution No. 2,682/99 in the constitution of provisions for doubtful collection credit rights.

The Resolution, which "establishes criteria for the classification of credit operations and rules for the constitution of provisions for doubtful collection credits," is an integral part of the Accounting Plan of Institutions of the National Financial System – COSIF. Thus, it is a norm applicable to FIDCs, in accordance with Article 44 of CVM Instruction No. 356/01, transcribed below:

Article 44. The annual financial statements of the fund shall be subject to accounting standards issued by the CVM and shall be audited by an independent auditor registered with the CVM.

Sole Paragraph. While the CVM does not issue the standards referred to in the main text, the provisions of the Accounting Plan of Institutions of the National Financial System – COSIF, issued by the Central Bank of Brazil, apply to the fund.

In order to verify the adherence of the value of provisions for doubtful collection credits in the FIDC industry to current regulation, this CVM conducted a thematic supervisory action on the matter.

The motivation for the action was the finding that delays in the payment of credit rights from the portfolios of the FIDC industry, as a whole, are usually at levels significantly higher than the provisions for doubtful debtors.

It was suspected that the provisions did not adequately represent the likely losses of the industry, which would mean that the value of the fund's net equity was not adequately reflecting its economic-financial situation.

This problem is especially serious in open FIDCs, insofar as an overvalued net equity may cause an undue transfer of wealth between the fund's unitholders.

Applied the metric developed by the technical area, a sample was drawn from the industry composed of ten funds, being nine FIDCs and one non-standardized FIDC. Once the funds were selected, explanations were requested from the administering institutions regarding the discrepancies between the values of the delays and the provisions.

Administrators of eight funds – 80% of the sample – submitted documents demonstrating that, in their judgment, the provisioned values were calculated based on CMN Resolution No. 2,682/99.

As provided for in Article 6 of the Resolution, the provision to cover doubtful collection credits must be constituted monthly, by applying percentages to the value of the operation, observing that the applicable percentages are related to the risk level at which the credit right was classified.

The aforementioned percentages will increase over time as the payment delay persists, according to the table below:

Delay	Minimum Risk Level	Percentages
15 to 30 days	B	1%
31 to 60 days	C	3%
61 to 90 days	D	10%
91 to 120 days	E	30%
121 to 150 days	F	50%
151 to 180 days	G	70%
Over 180 days	H	100%

The majority of administrators based their response on the aforementioned Article 6, i.e., they defended the thesis that the methodology provided for in the norm must be applied only after the delay in the payment of the credit right is confirmed. The administrators also understand that they have the freedom to increase the values of the provisions, through the incidence of progressive rates, solely due to the passage of time.

Ultimately, if the interpretation used by the administrators could be accepted, it could be inferred that only after 180 days of default would the amounts related to the delays necessarily be equal to the amounts provisioned for doubtful collection credit rights. Thus, the discrepancy that originated the supervisory action would be explained.

We disagree with the manner in which the administering institutions have applied the Resolution, with respect to the provisioning of doubtful collection credit rights. This is because Article 6 of the Resolution manifestly does not have standalone applicability, disregarding the other provisions that make up the norm.

Article 1 of the Resolution establishes that credit operations be classified in increasing order of risk levels, without conditioning such classification to the occurrence of delays.

Although the activities of FIDCs are not strictly "credit operations," the applicability of the provision to the funds should not be restricted by a mere semantic issue, given that they acquire rights originating from credit operations.

Article 2 establishes aspects to be considered by the holder of the credit right when "classifying the operation at the corresponding risk level."

By virtue of Article 4 of the norm, the aforementioned classification must be reviewed periodically. The review must be (i) monthly, in case of delays; (ii) semi-annually, according to criteria defined in Articles 2 and 3, for credit rights originating from the same debtor or economic group whose amount exceeds 5% of the fund's net equity; and (iii) annually, in all situations, except with respect to credit rights originating from a debtor whose responsibility is less than R$ 50,000, in which case the review may be solely due to the occurrence of delays (Article 5).

That is, by analyzing the aforementioned provisions together with Article 6 of the Resolution, it is concluded that:

i. Every credit right must be classified at a certain risk level as soon as it enters the FIDC's portfolio;
ii. Its classification must be made based on consistent and verifiable criteria, as well as supported by internal and external information to the administrator; and

iii. The granted classification must be periodically reviewed, observing that such review must occur in accordance with Article 4 of the norm, and must be, at a minimum, monthly, in the event of delays.

Thus, the provision for doubtful collection credits must be made starting from the acquisition of the credit right, based on its risk level, which will be determined by the administering institution, and not solely as a result of actual delays in its payment.

In summary, there are FIDC administrators who constitute provisions only from the occurrence of delays, whereas this Agency understands that delays should trigger reviews of the provisioning levels for credit rights that have already been acquired and classified.

This understanding is reinforced by reading Article 5 of the Resolution, transcribed below:

Article 5. Credit operations contracted with a client whose total responsibility is less than R$ 50,000.00 may have their classification reviewed automatically solely due to the delays stated in Article 4, item I, of this Resolution, observing that the original classification must be maintained when the review corresponds to a lower risk level.

Given that only certain operations can be reviewed "automatically solely due to delays," all others require reviews due to events that are not only delays in the payment of principal or interest. Moreover, for the risk level of a certain credit right to undergo review, at some point in the past it must have been classified.

Notwithstanding the above, this Commission also considers resolved, in accordance with the command of Article 3 of CMN Resolution No. 2,682/99, the issue of applying the "wagon effect" in operations where the debtor is the same. That is, the classification of credit operations of the same debtor must be defined considering that which presents the highest risk.

In this sense, if there is a need to review the risk level of a certain credit operation of a debtor due to a verified delay, all other operations, where the debtor is the same, must be reviewed, admitting diverse classification, according to the application of the exceptionality provided for in the same article.

In light of all the above, this CVM guides FIDC administrators to apply the provisions of CMN Resolution No. 2,682/99 for the calculation of the provision for doubtful collection credits, as determined in Article 44 of CVM Instruction No. 356/01. These provisions also apply to credit rights originating from non-financial institutions.

Finally, we alert that it is the duty of independent auditors to verify the adequacy of the criteria and procedures used by the administering institution for the calculation and recording of provisions for doubtful collection credits in relation to the guidelines of CMN Resolution No. 2,682/99.

Sincerely,

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

(Signed Original)
Antônio Carlos de Santana
Superintendent of Accounting Standards and Audit