By David Dale-Johnson and Gene Towne
President Vicente Fox of Mexico has set an ambitious goal. By the time he leaves office in 2006, he wants Mexico to build or finance enough new houses each year to meet the demand created by potential new household formations. Construction of about 750,000 new homes annually (more than doubling current levels of housing construction) will be required to accommodate anticipated new household formations. Demand is increasing as Mexico’s population grows and ages. In the year 2000, more than half of Mexico’s population was under the age of 24. Because of the aging of this population segment during this decade, 10 million people will be added to the 25-50 age cohort by 2010, a 32% increase. People in this age range are in their prime household formation years. By 2010, this cohort will increase to 37% of the total population.
The problem is that the current supply of new housing is not keeping up with demand. Mexico’s housing market has been driven by the availability of mortgage credit and the programs that provide that credit. In the past, these programs have financed houses priced from $12,000 (US) to $38,000 (US). Generally homes in this price range are owned by households earning roughly two to five times the minimum wage, which as of January 2003 was set at 41.53 pesos per day*. It is estimated that traditional intermediaries provided financing for only 315,000 houses in 2002. In recent years, there has been limited new housing production in the market sector, homes above $38,000 (US).
However, housing finance in Mexico is on the verge of dramatic change. How rapidly this change occurs is the key to the success of Fox’s plan.
Sources of mortgage credit
Currently, Mexico’s mortgage credit comes mainly from three entities: FOVISSSTE, INFONAVIT, and SHF (previously FOVI).
FOVISSSTE (Fondo de la Vivienda del Sistema de Seguridad Social de los Trabajadores del Estado) is a combination low cost mortgage fund and pension plan program for public sector employees. It is funded by a 5% mandatory savings program.
INFONAVIT (Instituto del Fondo Nacional de al Vivienda para los Trabajadores) is a combination low cost mortgage fund and pension plan program for employees of all private companies. It is also funded through a 5% mandated savings program.
In both the above programs, qualified borrowers have been able to access the fund to finance the purchase of a new home built by a developer for these programs.
SHF (Sociedad Hipotecaria Federal), previously known as FOVI, is a federal development bank. It emerged from FOVI in 2002 to take on a role much like Fannie Mae’s facilitating mortgage financing for low to moderate income buyers. SHF is a key player in the future of the primary and secondary mortgage markets in Mexico. It lends money to registered financial intermediaries, banks and SOFOLS (non-bank banks), who in turn lend SHF guaranteed funds to individual borrowers and keep the loans on their balance sheets for the duration of the contracts. SHF also has systematically provided construction lending to private housing developers.
Mexico’s housing and mortgage industries have developed a useful matrix, shown in Figure 2, that describes the range of housing products. SHF, INFONAVIT and FOVISSSTE have traditionally targeted the Social and Economic housing segments. Generally speaking, borrowers who qualify for either FOVISSSTE or INFONAVIT loans will not seek an SHF mortgage as the terms will be more onerous.
More than 75% of the households are in the in the Minimum, Social and Economic segments. In the past, few mortgages have been available for buyers in the Middle segment, even though this segment’s absolute growth between 2001 and 2006 is expected to exceed the absolute growth of either the Social or the Economic segments**. Clearly, lenders are anticipating developing products for this market as the Mexican middle class grows.
Mortgage Banks
Key players in the current market are the 17 active mortgage banks or SOFOLs (Sociedad Financiera de Objeto Limitado, limited charter financial corporations created in 1993 that have come to serve as intermediaries in the residential mortgage market). SHF authorized them to originate and administer mortgages within the original FOVI program. The SOFOLs originated more than 95% of the FOVI loans during 2000, 2001 and 2002. The SOFOLs have entered regional markets, and are in the process of growing their existing business lines, building volume originating loans on existing houses and market rate houses and providing banking services to residents in communities where they have located storefronts.
The commercial banks (who exited the market after the Peso crisis in 1994) are slowly reentering the mortgage market as their health continues to improve. Their primary focus is corporate banking, but as the market for non-subsidized mortgages develops, there will be greater interest from the banks and Fox's plan assumes so. The SOFOLs continue to expand in this segment as well but must attract the necessary capital to meet potential demand.
Since 1994, the SOFOLs with the assistance of FOVI have been key players in the mortgage market, originating 20% to 25% of individual mortgages every year, with INFONAVIT and FOVISSSTE funding the rest. The SOFOLs fully expect to continue to play this role but also to be path-breakers in developing the higher end mortgage market***. This segment is currently poorly served due, in part, to the SOFOLs’ inability to tap capital and direct it to this market. SHF clearly is gearing up to help the SOFOLs and the banks in this area. In 2002 about US$350 million of paper was issued by either homebuilders or SOFOLs to provide financing for housing production. There is now a total of about $650 million in circulation, evidence of a nascent secondary mortgage market.
National Mortgage Bank (Sociedad Hipotecaria Federal)
As previously noted, FOVI has evolved into a Fannie Mae-like national mortgage bank referred to as the Sociedad Hipotecaria Federal (SHF). The goal is for SHF to be the catalyst in the evolution of a strong housing finance system that ultimately will look to the secondary market and long term bond investors for capital. As with Fannie Mae in the U.S., SHF will serve to facilitate standardization of mortgage products and procedures, improve foreclosure, appraisal and registry systems and institutions and encourage the evolution of private mortgage insurance. Most importantly, SHF will take the lead in introducing and issuing mortgage-backed securities (MBS) backed by guarantees to investors of timely payment of principal and interest. The intent is for SHF to be an independent institution capable of obtaining a triple A rating by 2014, after which the back-stop guarantee by the federal government will cease. It is not, however, the intent for SHF to crowd out private players in the secondary market. SHF is not intended to have the competitive advantage garnered by Fannie Mae and Freddie Mac downstream.
SHF is envisaged to provide additional liquidity to the market for no more than eight years. The Mexican government initially has budgeted $4.5 billion dollars. These funds will be directed in new ways relative to FOVI's past activities. Remember that SHF is a new institution with a much broader mandate. New SHF activities are to include the financing of existing homes, residential or market housing units, along with the financing of rental units and serviced land for housing construction. Beginning this year, SHF will act merely as a guarantor of construction lending lines obtained by banks and SOFOLS in the capital markets.
Management of Liquidity and Risk
SHF will undertake activities that will make it easier for institutions to manage the liquidity and risk associated with the mortgage market in Mexico. Along with funding and liquidity operations in the early stages, it will provide effectively three guarantees: one originally provided by FOVI (the UDI**** minimum wage swap which is already in place) and two provided by SHF. In the primary market, SHF will provide a guarantee of the first 25% of loan loss, cost of repossession and legal costs. In the secondary market, SHF will provide a guarantee of timely payment of principal and interest. The intent is for the guarantees to attract private capital.
Mexican Pension Reform
Starting in January 1, 1997, employees began contributing to an individual pension account. These pension accounts are administered by Administradores de Fondos para el Retiro (AFORES). When retired, workers may opt to keep their money with the AFORES or buy an annuity sold by insurance companies. As of Dec 2002, the AFORES had accumulated over US$30 billion in deposits. Estimates are that these holdings will increase by $2 to $5 billion per year for at least the next decade. The availability of long-term funds from the AFORES and insurance companies, together with the low delinquency shown by the SOFOLES and the new UDI mortgage (with a UDI minimum wage swap), offer the possibility of a secondary mortgage market.
Details of Fox’s Plan (Sources of Financing and Types of Units)
Under Fox’s plan, most of the new loan production comes from SHF and from the SOFOLs and banks. So it is clear the Fox program depends critically on the transformation of SHF into a viable national mortgage bank so that it, along with the SOFOLs, are able to tap secondary markets for capital. The following table presents a forecast by Softec of the likely allocation of the 750,000 units in 2006 among housing types.
Note that the 'minimum' segment is for the poor. Current SHF, FOVISSSTE and INFONAVIT programs target the 'social' and 'economic' market segments. The 'middle', 'residential' and 'residential plus' segments are markets which existing programs do not target in large numbers; however, the SOFOLS and banks are expected to expand their activities in these segments with the assistance of SHF. Not only do the SOFOLs and banks need to ramp up their activity in the middle and upper income markets, developers also need to begin to acquire parcels suitable for the development of housing for these market segments as well as to reassert their capability in entitling, planning, developing and building these product types.
Conclusions
The Mexican housing and mortgage market seems to be poised for a dramatic change; however, significant challenges will probably frustrate the achievement of President Fox's goal of constructing 750,000 units per year by 2006. Furthermore, because of NAFTA, the Mexican economy is more dependent on the resilience of the US economy in this uncertain time. Thus potential advances in the housing and mortgage finance sector may be slowed until the U.S. economy begins to improve.
Nonetheless, the start-up of the Sociedad Hipotecaria Federal (SHF) is a critical step if there is to be any hope of reaching this goal even in this decade. The provision of liquidity to SOFOLS and banks, the broadening of the spectrum of loans that can be funded (for middle and residential borrowers as well as investors and developers) and the provision of guarantees are all important steps. The growth of the AFORES provides necessary long-term investment capital while the SOFOLs have evolved into relatively strong well-managed intermediaries that can originate and effectively service residential mortgages using transparent and rigorous underwriting practices. The banking sector has stabilized and will likely begin to play a role in the non-social housing segment. The economic climate, though significantly influenced by the recent US downturn seems to have stabilized. Inflation is low and interest rates, though high relative to the US, are at manageable levels for many borrowers.
What must happen is a rapid expansion of the capacity of SOFOLs and banks as well as homebuilders and developers. The SOFOLS need to broaden their product lines and develop the capability of underwriting, originating and servicing 'market' loans and offering savings products. to facilitate the accumulation of down-payments. This will require building capacity in underwriting, originating and servicing in new market segments.
Not only that, local governments must recognize that without entitled land and infrastructure, no houses will be built. There needs to be a cooperative effort between local governments and the development community to facilitate competitive land development. While prosperity and expansion of the housing market through access to capital will likely yield higher land values, regulatory (administrative or political) bottlenecks may exacerbate price effects offsetting the benefit of greater liquidity among buyers.
The guarantees to be provided by the SHF are key, but the hope is that they can be reduced over time because SHF is to be a stand-alone A rated entity by 2014. This will require that investors are comfortable with the system: if a borrower defaults, lenders must be able to gain control of the asset quickly and at minimal cost. Significant progress has been made towards the President’s goal, but tough challenges remain.
Sidebar
Hypotecaria Su Casita, S.A. de C.V., has completed four securitizations and has two more in the works.
The secondary market appears to be taking off if we examine some of the activities of individual SOFOLs. Hipotecaria Su Casita (the second largest SOFOL) has completed four securitizations since 2000, one collateralized by middle income and residential mortgages and three collateralized by pipelines of construction loans where the ultimate collateral are take-out loans by INFONAVIT, FOVISSSTE, SHF (FOVI), MBS or banks. The total face amount of the deals (two Peso denominated and two UDI denominated) approached $100,000,000 (US). For the first issue in 2001, Moody’s Investors Service assigned a rating of Aa2.mx and a local currency rating of Baa2 to the bonds issued by Hipotecaria Su Casita, S.A. de C.V., which were to be backed by a pool of residential mortgage loans extended to middle-income borrowers located in Mexico. Moody's assigned the rating based on various factors including: (1) Isolation of the assets in the trust ; (2) the presence of a contingency reserve accounts), which represented 10.98% of the total issuance at closing; (3) Two months of interest, principal, and expense reserves maintained in the trust; (4) 1.40x over-collateralization such that, at the outset, there were $140 dollars of mortgage loans outstanding for every $100 in bonds; and (5) the track record and strength of Su Casita.
The investors in the MBS were primary institutional investors including insurance companies, AFORES (Pension funds), private pension funds and mutual funds. The bonds were used to fund middle income residential 10 year term mortgages. The maximum LTV was 65%, the average LTV was 49% and the average loan had a principal amount of $60,000 (US). The average real rate at the time of issues was 11.9%. All the issue was placed in just under 200 loans. So far, the delinquency rate has been 0% and there have been no defaults.
In the late spring of 2002, Su Casita undertook a 715 million Peso senior subordinated asset-backed issue. Class A bonds totaled 600 million, Class B, 72 million and the Residual Class, 43 million. Moody's rated the Class A securities Aa2.mx and the Class B securities Baa2.mx. The bonds were variable rate with proceeds to provide advances to housing developers based on construction in progress.
Su Casita is also working on two more MBS issues for the 3rd quarter of 2003. The first is a CMO like structure with three senior tranches with expected lives of 5-7, 10-12, 15-17 years, mezzanine and residual tranches with a total face mount of $100 million (US). The second is a construction loan securitization with a face value of about 1.5 billion Pesos.
*With an exchange rate of 11.00 pesos per US dollar, that amounts to $3.77 (US) per day. Assuming 1.78 workers per household, a household or family earning the minimum wage would receive $6.71(US) per day.
**These are based on forecasts by Softec, S. C. and depend on assumptions about economic growth, and increasing numbers of 'middle class' buyers.
***Developers are building limited amounts of the Middle and Residential products (US$30-$200K). What is being built is offered to the consumer with construction financing and limited permanent financing. Obviously, with capital, product will be developed. A concern, however, is whether planners and local governments along with the homebuilding sector can effectively gear up to provide the need product even with avaialable capital.
****UDI denominated loans are typical and are price level adjusted mortgage or PLAMs where there is a CPI-based unit of account known as the 'Unit of Investment' that is quoted daily by the Banco de México. The swap hedges the risk associated with variation between wage rates and prices where wage rates constrain the allowable mortgage payment.
David Dale-Johnson is Associate Professor of Finance and Business Economics, Marshall School of Business and Lusk Center for Real Estate, University of Southern California in Los Angeles. Gene Towle is Managing Partner, Softec, S. C. Mexico and Professor of Real Estate Marketing, Universidad del Valle de México in Mexico City.