Ratings

Key strengths include:

• The experience of Banco BMG in personal lending;
• The sound credit quality of the originator's portfolio;
• The robust credit protection provided by the subordination of shares (20%) and excess spread (initially at 1.7% per year);
• The sound experience of Banco Itaú S.A. as a custodian; and
• The legal structure of the transaction, which has adequate provisions for legally safeguarding the shareholders.

The main concern Standard & Poor's observed is that there might be variations in the credit quality of the underlying pool during the life of the fund due to the revolving nature of the structure. This risk is mitigated by well-defined loan eligibility criteria, which reduce the credit quality deterioration risk of the pool of underlying assets.

Another concern is the originator's role as the agent that receives resources payable to the fund. To cover this commingling risk between the financial resources of Banco BMG and of the fund, the structure plans to set up a reserve account, to be created at the beginning of the transaction. The reserve account will equal 2% of the fund's net asset value.

The fund will be closed-ended and will have a defined final maturity of three years. The issue can be sold in Brazil to qualified investors, including some corporations and private banking clients, pension funds, insurance companies, and other investment funds.

During its life, the fund will make revolving purchases of credit receivables originated by Banco BMG by means of personal loans to retirees and pensioners of INSS backed by the direct deduction on benefits.

Chart 1 illustrates the transaction's structure.

The fund will issue senior and subordinated quotas, which are shares denominated in Brazilian reais.

Those shares will be entitled to receive proceeds resulting from the payment of personal loans denominated in the same currency, if any, and/or other fixed-income instruments, short-term financial investments, and cash from the fund's portfolio. The yield and face value of the senior shares are payable from the cash flow of the loans and the other investments. The originator will hold the subordinated shares, which are not rated by Standard & Poor's.

Contrary to what happens with debt instruments, funds do not promise investors (shareholders) interest payments or principal repayments on any specific date. Thus, each shareholder only expects to receive a target return on its investment, which is only a goal and not a promise. Consequently, the fund will seek to offer a target return on investments to the senior shareholders, corresponding to 110% of the Brazilian Spot Depósitos Interfinanceiros (DI) over rate. The subordinated shares will not have a specific target return, but will benefit from the entire excess flow available in the fund, after it has attained the target return on the senior shares.

The senior shares will be amortized in 36 monthly installments after the issuance date.

To guarantee that the fund has assets with the necessary liquidity to perform the amortizations and/or redemption of senior shares on the dates established in the by-law, the fund manager should keep in cash, or very short-term securities, the sum equivalent to 50% of the next planned amortization, 60 days in advance, and to 100% of the next planned amortization, 30 days in advance.

The subordinated shares cannot be amortized until all the senior shares have been redeemed.

INSS pays its retirees and pensioners and withholds the sum due in the loan agreements backed by the direct deduction on benefits. The sums are then transferred to Banco BMG. Banco BMG, in turn, has up to two business days to transfer the monies to the fund. The sums are reconciled and the payments are made by means of transfers to the fund account at Banco Itaú (custodian).

As soon as the monies are transferred to the fund account, the custodian calculates the daily loss accruals, checks the subordination level, and informs the fund manager (Intrag Distribuidora de Títulos e Valores Mobiliários Ltda.), which, on behalf of the fund, executes the formation of reserves and, if necessary, performs the amortizations and purchases new personal loans from Banco BMG (the originator).

The main eligibility criteria to be met by the receivables are:

• They should derive from personal loan agreements to retirees and pensioners of INSS, originated by Banco BMG at prefixed rates;
• The payment should be made by means of duly authorized payroll consignment;
• They should refer to obligors that do not have other credit receivables overdue and unpaid to the fund upon acquisition by the fund; and
• There cannot be portions of agreements that expire after the validity period of the fund.

Historical delinquency and write-off performance are generally the best indicators of portfolio credit quality. Most Brazilian financial institutions and banks carry delinquent loans or receivables far longer than similar companies would in other nonemerging market countries before writing them off. This can be viewed as positive because loans are worked until collection opportunities are exhausted. However, if charge-off policies are discretionary and subject to manipulation, it is difficult to determine the value of delinquent loans. For this reason, the personal loan-backed criteria focus on analyzing late-stage delinquencies as credit quality indicators.

The term dilution is used broadly to refer to any noncash reduction to a receivable balance that is not attributable to default or write-off. Product returns, cash discounts, advertising allowances, volume rebates, good-customer programs, and pricing disputes are all examples of dilution. Also, dilution encompasses items that may not be taken as an adjustment in the normal course of business, but nevertheless represent a potential future offset. Companies must grant dilutive credits to remain competitive. The level of dilution is driven by factors such as industry practice and product complexity. Due to the nature of assets, dilution risk is not a concern in the case of this FIDC.

In a typical personal loan-backed transaction, a reserve is needed to cover interest and fees, such as servicing and trustee, which are expected to be incurred over the amortization period. Due to the interest-bearing nature of the personal loans, Standard & Poor's should be comfortable with the excess spread level observed between underlying assets and the senior shares.

Commingling risk can arise because collections can be commingled with those of other receivables of Banco BMG. In this case, the commingling risk is limited, as Banco BMG needs to transfer the financial resources belonging to the FIDC within two business days after their receipt. Additionally, a reserve account will be created at the beginning of the transaction in a sum equal to 2% of the net equity of the fund to mitigate this risk.

The fund manager of this FIDC (Intrag Distribuidora de Títulos e Valores Mobiliários Ltda.) is independent and separate from the asset originator.

For structured finance transactions, Standard & Poor's performs an in-depth analysis of the funds flow sufficiency throughout the transaction's life to make a timely repayment to shareholders at the maturity date. To determine the 'brAAAf' rating, Standard & Poor's submitted cash flows to various stress scenarios, considering as a base case the maximum delinquency level for the selected pool as a proxy for credit default. Once the behavior of the selected pool was analyzed, this maximum delinquency level was multiplied by a credit stress factor, which was determined by the scenario built for the target rating. To determine the strength and the resilience of the cash flows and structure, this percentage was then stressed with different variables to test the share repayment feasibility.

Once the selected pool information was analyzed, the loss severity proxy used for credit losses was the over-180-day delinquency information. This percentage was then stressed, using a credit loss factor to reflect the 'brAAAf' rating scenario. Consequently, the resulting cash flow was also tested at a credit loss severity rate equal to 15%, according to different scenarios, two of which are shown in table 2.

Table 2 – Loss Severity
	Scenario 1	Scenario 2
Credit losses	15%	15%
Timing of credit losses	Months 1 to 6: 100%	Month 1 to 6: 50%, months 13 to 36: 20%
Senior shares yield	110% of DI	110% of DI
DI—Brazilian Spot Depósitos Interfinanceiros.

Standard & Poor's assumed the historical delinquency worst-case scenario after its analysis of both static and dynamic pools from the underlying credits originator, thus allowing the evaluation of the real effect of the delinquency as a proxy for credit loss in the selected pool.

The prepayment rate assumed was close to zero according to the behavior showed in historical information and the characteristics of the collection mechanism. Since the loan payment installments are deducted directly from the pensioners' and retirees' benefits, there is little incentive to prepayment in this form of financing.

To cover the risks related to personal loan portfolios backed by the direct deduction on benefits, and related to the specifics of the Brazilian credit receivables fund environment, credit enhancement for an FIDC has to be structured at the 'brAAAf' level. The credit enhancement will afford credit support for the FIDC senior quotas and will be provided in the form of minimum structural subordination of 20% and of excess spread, initially at 1.7% per year.

There is no foreign exchange risk for the quotaholders because they are issued in Brazilian reais and backed by credit receivables denominated in reais.

Any of the following events will be considered an evaluation event, which, in turn, will oblige the fund to call a general assembly for the shareholders to decide on the procedures to be adopted.

The most relevant evaluation events are:

• Nonperformance of the fund manager's or fund custodian's duties and obligations;
• Dissolution or termination of the selling agreement or custody agreement;
• Nonpayment of amortizations and/or redemptions of senior shares on the expected dates;
• An increase of over 130% in the DI rate on a business day; and
• A breach of the following performance trigger: If the moving average of the last three months of the rate of delinquency (defined as the ratio between the total overdue and unpaid credit receivables and the total overdue credit receivables) is higher than 3%, or if the delinquency rate is higher than 5% in a single month.

The occurrence certain events will be considered a liquidation event, which in turn will oblige the fund to:

• Inform the shareholders of such event;
• Interrupt the purchase of credit receivables;
• Start the fund liquidation procedures; and
• Call a general assembly for the shareholders to decide whether the anticipated liquidation procedures should continue.

The most relevant liquidation events are:

• The bankruptcy, reorganization, or liquidation of Banco BMG;
• The shareholders' decision to declare a liquidation event in a general assembly called for this purpose; and
• A failure to maintain the floor subordination level of 20% for more than five consecutive business days.

Banco BMG started its credit operations targeting INSS retirees and beneficiaries in September 2004. This analysis focused on loans granted between September 2004 and June 2005. During this period, loans granted by Banco BMG resulted in receivables amounting to BrR4.482 billion, which corresponds to a monthly average of BrR484.270 million. Chart 2 demonstrates the monthly development of the amount originated by the concession of loans.

Charts 3 and 4 represent the distribution of the sum originated in concession of loans by quantities of installments. Around 80% of generation is concentrated in contracts with 36 installments.

Chart 5 demonstrates the flow of maturities of the loans granted by Banco BMG in the assessed period.

The tables and charts below demonstrate the performance of retiree-targeted loans granted by Banco BMG. Delinquency by generation date demonstrates the quality of loans granted in a given month and their lifetime behavior.

Table 3 demonstrates the good performance of Banco BMG's loans, where around 98.7% of the sum with a maturity date until June 2005 was paid on time.

Table 3 - Delinquency By Generation Date
Generation date	Monthly generation (BrR)	Generation with maturity date until June 2005 (BrR)	Timely payments*	Overdue between 6 and 30 days	Overdue between 31 and 90 days	Overdue between 91 and 180 days	Overdue more than 180 days (a)	Not settled until June 2005 (b)	(a) + (b)
September 2004	288,338,934.16	68,144,468.08	97.50	1.65	0.27	0.05	0.00	0.53	0.53
October 2004	638,569,427.81	136,780,987.16	99.04	0.35	0.18	0.03	0.00	0.41	0.41
November 2004	478,557,157.10	88,002,993.66	99.11	0.16	0.21	0.04	0.00	0.48	0.48
December 2004	342,776,182.75	52,753,092.56	97.23	1.04	0.12	0.02	N.A.	1.59	1.59
January 2005	562,060,274.51	64,376,459.07	99.60	0.03	0.06	0.01	N.A.	0.30	0.30
February 2005	539,700,037.41	50,836,238.06	99.07	0.06	0.63	0.00	N.A.	0.24	0.24
March 2005	621,785,332.53	41,428,832.61	99.27	0.37	0.08	N.A.	N.A.	0.28	0.28
April 2005	527,400,930.28	17,753,164.88	99.00	0.03	0.79	N.A.	N.A.	0.17	0.17
May 2005	417,089,511.84	1,174,557.81	92.25	0.09	N.A.	N.A.	N.A.	7.65	7.65
Total	4,416,277,788.39	521,250,793.89	98.74	0.48	0.23	0.02	0.00	0.52	0.52
Maximum	—	—	99.60	1.65	0.79	0.05	0.00	7.65	7.65
*Sum of installment payments until five days overdue. BrR—Brazilian reais. N.A.—Not available due to lack of minimum data required for calculation.

Charts 6 and 7 presents the development of delinquency of the Banco BMG loans by generation date.

Table 4 shows the performance of loans targeted to INSS retirees and pensioners by due date.

Table 4 - Delinquency By Due Date
Maturity month	Flow of maturities (BrR)	Timely payments*	Overdue between 6 and 30 days	Overdue between 31 and 90 days	Overdue between 91 and 180 days	Overdue more than 180 days (a)	Not settled until June 2005 (b)	(a) + (b)
October 2004	1,812.13	4.52	95.48	0.00	0.00	0.00	0.00	0.00
November 2004	9,822,655.59	92.08	7.02	0.57	0.16	0.03	0.14	0.17
December 2004	28,859,954.18	96.82	2.42	0.55	0.09	0.00	0.12	0.12
January 2005	43,234,709.36	99.09	0.23	0.39	0.10	N.A.	0.19	0.19
February 2005	52,980,189.71	98.00	1.22	0.23	0.05	N.A.	0.50	0.50
March 2005	71,752,740.83	98.79	0.09	0.62	0.02	N.A.	0.49	0.49
April 2005	88,061,186.74	99.12	0.26	0.08	N.A.	N.A.	0.54	0.54
May 2005	105,539,774.20	99.20	0.04	0.18	N.A.	N.A.	0.57	0.57
June 2005	120,997,771.15	99.23	0.02	N.A.	N.A.	N.A.	0.75	0.75
Total	521,250,793.89	98.74	0.48	0.23	0.02	0.00	0.52	0.52
Maximum	—	99.23	95.48	0.62	0.16	0.03	0.75	0.75
*Sum of installment payments until five days overdue. BrR—Brazilian reais. N.A.—Not available due to lack of minimum data required for calculation.

Charts 8 and 9 present the development of delinquency of the Banco BMG loans by due date.