Structured Finance. Securitization in Latin America 2000

Transcription

1 Structured Finance Securitization in Latin America 2000

2 STANDARD & POOR S President Leo C. O Neill Executive Vice Presidents Hendrik J. Kranenburg, Robert E. Maitner, Vickie A. Tillman STANDARD & POOR S RATINGS SERVICES Chief Rating Officer Vickie A. Tillman Executive Managing Directors Edward Z. Emmer, Corporate Ratings Clifford M. Griep, Financial Institutions Ratings Joanne W. Rose, Structured Finance Ratings Vladimir Stadnyk, Public Finance Ratings Roy N. Taub, Insurance Ratings Petrina R. Dawson, Senior Managing Director & General Counsel RATINGS INFORMATION SERVICES Vice President & General Manager Andrew Cursio Vice Presidents Robert Frump, Production & Electronic Distribution Paul Stanwick, Editorial Marc Anthonisen, Director, Asia-Pacific Matthew J. Korten, Director, Latin America Therese Robinson, Director, Europe Susanne Barkan, Product Manager Sara Burris, Director, Design, Production, & Manufacturing Jean-Claude Bouis, Editor, Franchise Products Donald Shoultz, Editor, Policy & Operations Editorial Arlene Bessenoff, Managing Editor Audrey Kennan, Bernice Landry, Cynthia Michelsen, Jackie Rodgers (London) Lisa Tibbitts (Editorial Managers) Jennifer Bale, Brian Grimm, Gavin Rodney (London) Daniel Warren, Mathew Wiesner (Tokyo) (Copy Editors) Design & Production Sandy Fong, Beth Russo, Michael V. Wizeman (Senior Managers) Elizabeth McCormack (Senior Designer) Barrie Cohn, Maura Gibbons, Heidi Weinberg (Designers) John J. Hughes, Alicia E. Jones, Leonid Vilgorin (Managers) Christopher Givler, Dianne Henriques (Production Coordinators) Stan Kulp, Michelle McFarquhar, Michele Rashbaum (Senior Production Assistants) Subscription Information Hong Kong (852) London (44) Melbourne (61) New York (1) Tokyo (81) Web Site Published by Standard & Poor s, a Division of The McGraw-Hill Companies, Inc. Executive offices: 1221 Avenue of the Americas, New York, NY Editorial offices: 55 Water Street, New York, NY Copyright 2000 by The McGraw-Hill Companies, Inc. Reproduction in whole or in part prohibited except by permission. All rights reserved. Officers of The McGraw-Hill Companies, Inc.: Harold W. McGraw, III, Chairman, President, and Chief Executive Officer; Kenneth M. Vittor, Executive Vice President and General Counsel; Frank Penglase, Senior Vice President, Treasury Operations. Information has been obtained by Standard & Poor s from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, Standard & Poor s does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or the result obtained from the use of such information. Standard & Poor s receives compensation for rating obligations. Such compensation is based on the time and effort to determine the rating and is normally paid either by the issuers of such securities or by the underwriters participating in the distribution thereof. The fees generally vary from US$10,000 to US$100,000. While Standard & Poor s reserves the right to disseminate the rating, it receives no payment for doing so, except for subscriptions to its publications.

3 Securitization in Latin America 2000 Commentary Securitization in Latin America: Growth in Stormy Times Mexico s Secondary Mortgage Market Makes Progress Argentine MBS: Perspectives and Performance Mexican Credit Card Merchant Voucher Securitizations Show Strong Performance Brazilian Domestic Mortgage Market Moves Forward Standard & Poor s Servicer Evaluations: Process and Methodology Political Risk Insurance May Enhance Emerging Market Structured Transactions New Providers of Bond Insurance Broaden the Market but Investors Should Beware How Preferred Creditor Support Enhances Ratings Achieving Investment-Grade Ratings in Brazilian Cross-Border Securitizations Rating Analyses Aguas Argentinas S.A Bancomer S.A.: Servicer Evaluation BHN IV Mortgage Trust Series CHESS Financial Trust Series BPI Cheques I Companhia Petrolifera Marlim Corporación GEO Trust Credit Card Merchant Voucher Receivables Trust Leiser S.A. de C.V MULTIACTIVOS 2000 Financial Trust Pemex Finance Ltd Province of Misiones Province of San Juan

4 RTSA Telecommunications Receivables Trust Transportadora de Gas del Sur S.A U.S.$ Clearing Master Trust Appendix A Latin American Structured Transactions Rated by Standard & Poor s Appendix B Standard & Poor s Issue Credit Ratings Definitions Appendix C National Scale Credit Ratings Appendix D Argentine National Scale Ratings Definitions Appendix E Brazil National Scale Ratings Definitions Appendix F CaVal (Mexican) National Scale Ratings Definitions Appendix G References

5 Securitization in Latin America: Growth in Stormy Times Latin America provided an eventful venue for major developments in structured finance during the 1990s. Securitization became the decade s new financial instrument and financing alternative for issuers and originators alike. Over this period, securitization gained, and has maintained, its popularity despite the region s recurrent political and economic crises. The year 1999 saw an increase in rated structured transactions, following the financial crises in Asia, Russia, and Brazil. Investors who in 1998 had liquidated a considerable portion of their Latin American securities, regained confidence in the region in That year witnessed the highest volatility of Latin American ratings since the inception of the region s structured finance market as 11 corporate and public entities, along with their related securitizations, were downgraded. These downgrades were a direct result of the economic recession which began in late Within the Latin American region, Argentina is home to the largest number of existing asset-backed securitizations. Most of these transactions are rated by Standard & Poor s. The country is expected to continue to be in the forefront of Latin America s existing asset securitizations, since the legal and regulatory environments, as well as the existing potential for more mortgage transactions, will position Argentina for further growth in the near future. In Brazil, Standard & Poor s has rated six cross-border securitizations, of which five were originally rated investment-grade. All of the transactions are secured by future receivables, which highlights the immature development of the existing asset securitization market in the country. In the short term, existing asset-backed transactions are not expected due to the local capital markets stage of development and the lack of suitable assets for securitization. Mexico has also been an active player in the future receivables market. In the Mexican cross-border market, Standard & Poor s has rated 42 transactions with a value of more than US$19 billion. In terms of existing assets, many state laws and 3

6 regulations have been amended to encourage the standardization of the mortgage market. But mortgage conditions, such as loan payments tied to inflation and wage indices, still pose challenges to the Mexican market. Other Latin American countries, such as Colombia and Peru, have likewise benefited from securitization in the past. However, the financial and economic crises that endured throughout 1998 and most of 1999 have impaired the development of new capital markets structured debt issuances there. Moreover, the region s financial crisis contributed to the rating downgrades of three structured deals in Colombia and Peru. Latin America Embraces Securitization In the 1990s, Standard & Poor s rated 110 structured transactions in Latin America with a value of more than US$27 billion (see table 1). The structures and assets vary across the region, ranging from future export flows to mortgage-backed securitizations (see chart 1). The number of transactions rated by Standard & Poor s in 1999 was 27, valued at US$5.4 billion, compared with the nine transactions for US$2.1 billion rated in This represents a 2.5 times increase in dollar volume relative to the previous year. Only those companies with proven solvency managed to obtain financing in the capital markets, albeit at higher spreads than before the crisis. Rating milestones include the first structured ratings on the national rating scale in Mexico and Brazil, as well as the securitization of new asset types such as deferred checks and auto loans in Argentina. Over the past three years, a combination of changes in the region s regulatory systems and a deeper understanding of securitization by regulators and key participants has caused a sizable increase in the number and types of existing asset-backed transactions. This trend has been most significant in Argentina. Table 1 Latin American Transactions Rated by Standard & Poor s* 1993/ Total ( ) Amount Amount Amount Amount Amount Country Issuances (US$ mil.) Issuances (US$ mil.) Issuances (US$ mil.) Issuances (US$ mil.) Issuances (US$ mil.) Argentina 13 2, , ,540 Brazil 5 1, , ,370 Mexico 28 13, , , , ,557 Others Total 46 16, , , , ,333 *Includes national and global rated issuances. 4

7 Securitization in Latin America: Growth in Stormy Times Argentina Securitization as Financing Source and Investment Since Argentina s trust law was enacted in January, 1995, Standard & Poor s has rated 52 structured transactions representing more than US$4.5 billion. Securitizations include a variety of asset types and structures (see chart 2). Nevertheless, market players agree that securitization has not reached its potential, especially for existing asset-backed transactions. Of the 10 largest private financial institutions, which hold over US$13 billion in mortgages, auto loans, and personal loans, only two have securitized their own assets. Further slowing the trend, in 1999 Argentina experienced the worst economic recession in the region, even though it was not as bad as the country s recession in Additionally, it endured a long and unstable election process. Nonetheless, the local market of institutional investors enabled many structured transactions to get to market in 1998 and 1999 when international investors were reluctant to increase their holdings in the region. Aside from the leading transactions issued in the previous years, in 1999 several innovative deals were issued in the Argentine market. Transportadora de Gas del Sur S.A. issued structured debt (rated BBB- ) that benefited from the preferred creditor status granted by the Inter-American Development Bank (IADB). This was the first rated B loan transaction involving the IADB. Aguas Argentinas S.A. followed a few months later with a similar transaction, also rated BBB-. Chart 1 Latin American Securitizations Rated by Standard & Poor s: Other future receivables 5% Future export receivables 60% Structured notes 7% ABS/MBS 7% Multilaterals 4% Credit card merchant vouchers 17% 5

8 The provinces of San Juan and Misiones, as well as the Argentine government, made use of guaranteed debt structures in San Juan issued bonds backed by the government of Argentina s irrevocable and unconditional guarantee. The bonds were rated raaaa on Standard & Poor s Argentine national scale. The province of Misiones used the federal tax co-participation guarantee to issue bonds in the local market, which were rated raaa- and raa (senior and junior securities, respectively). The Argentine government obtained an AAA global scale rating when it issued its series A bonds in October These bonds were issued with five additional series (B through F) each rated BBB. The series A bonds have a renewable guarantee from the World Bank (also rated AAA ), while the other series have a renewable, nonaccelerable World Bank guarantee for the payment of the debt service under the bank s Partial Credit Guarantee program. The existing-asset-backed market also showed some innovations. In December 1999, ABN AMRO issued a transaction backed by deferred checks, the Chess Trust Series BPI Cheques I. Bansud S.A. issued its first auto loan transaction in Both transactions are rated by Standard & Poor s. The only existing asset transaction receiving a global rating in 1999 was that of RT Finance II. This transaction, rated AA, involves promissory notes of cellular telephone companies and is backed by a credit swap from XL Insurance Ltd, also rated AA. Chart 2 Argentine Structured Transactions Rated by Standard & Poor s: Structured notes 20% Future export receivables 40% ABS 5% MBS 11% Other future receivables 18% Future flows: public entities 6% 6

9 Securitization in Latin America: Growth in Stormy Times Developmental Challenges The Argentine structured market has benefited from deep economic reforms introduced in the last decade, a supportive legal and regulatory framework for securitization, and a strong local institutional investor base. However, several factors have prevented securitization from further developing, including the following: Future flow securitizations, while reducing sovereign risk, do not eliminate corporate risk, and only highly creditworthy companies can typically benefit from this type of financing; Banks with sizable asset portfolios still hold excess capital relative to regulations in force, and therefore do not need to sell assets to improve capital needs; Lending banks are reluctant to share information with other banks (who may act as trustee) about their customers; The financial system appears unwilling to support the development of third party trustees, and Financial crises have stunted asset origination growth. The Growing Role of the IFC and IADB B Loan Programs Both the International Finance Corporation (IFC) and the Inter-American Development Bank (IADB) are multilateral institutions; that is, financial institutions created, owned, and controlled by a group of sovereign governments. The entities provide loans to creditworthy foreign borrowers. Each loan is divided into A and B portions, which are pari passu. The A loan is funded from the multilateral s own resources, while the B loan is funded via participations to investors. These participations represent an undivided security interest in the B loan. A 100% participation in the B loan can be sold either directly to investors via a participation agreement, or alternatively into a trust, which then issues certificates to investors. The benefits of B loan programs to borrowers include the following: The rating is unconstrained by the sovereign foreign currency rating which, for the most creditworthy entities, may mean a higher rating; There is no need for the rated entity itself to generate foreign hard currency (though in many cases it is the exporters in the emerging market countries that have the highest ratings); and The underlying loan from the multilateral institution may be unsecured. The rating on the loan participation or the certificates is based on the issuer credit rating of the borrower and represents the entity s overall capacity and willingness to meet its financial obligations. The multilateral s de facto preferred creditor status with the respective sovereign government suggests that the transaction will be spared transfer and convertibility controls that could arise. Thus, the rating is not constrained by the sovereign foreign currency rating, but instead can be assigned a foreign currency rating equal to that of the local currency issuer rating. Standard & Poor s has rated transactions with B Loans in Argentina, Brazil, and Mexico. 7

10 2000 and Beyond Standard & Poor s expects Argentina to continue to lead the Latin American market in existing asset securitizations. Securitization in this country will accelerate again once the economy rebounds, political uncertainty fades, and the country proves to investors that it is committed to the economic reforms that first attracted investors in the 1990s. Argentina can be expected to issue new transactions, both local and international, with varying underlying assets, such as mortgages, personal loans, post-dated checks, and federal tax coparticipations. Additionally, the new century is being built with the right foundations for large financial institutions to securitize their asset portfolios. Table 2 Securitizations in Brazil Rated by Standard & Poor s Issuance Collateral type Issuance date Current rating Initial rating Alcoa Aluminio S.A. US$180 million, secured export notes Aluminum exports 09/16/93 BBB- BBB US$190 million, secured export notes Aluminum exports 08/23/95 N/A BBB US$400 million, secured export notes Aluminum exports 11/18/96 BBB- BBB Bunge Trade Ltd. US$225 million collateralized Soy exports 5/05/99 BBB- BBBexport notes Ceval Export Securitization I Ltd US$ 150 million, securitized Soy exports 12/06/96 BBB- BBBexport notes Companhia Petrolífera Marlim R$600 million promissory notes Future oil sales 6/25/99 N/A bra-2 R$600 million promissory notes Future oil sales 12/21/99 bra-1 bra-2 R$100 million promissory notes Future oil sales 12/27/99 N/A bra-2 RG Receivables Co. Ltd. US$100 million, 9.6% credit Credit cards 02/10/98 CCC+ BBcard-backed notes due 2005 vouchers Sadia IFC Trust US$165 million, trust certificates IFC B Loans 12/30/96 BB+ BBB- Trikem Export Trust US$100 million, investor certificates Chemical 08/01/97 A A products exports N/A not applicable since issue no longer outstanding. Current ratings as of June 1,

11 Securitization in Latin America: Growth in Stormy Times Brazil Awaiting Economic Stability Standard & Poor s rated only four Brazilian transactions in 1998 and During 1999, the following three transactions were issued in the local market: Ceval, through the Bunge Trade Ltd. Trust, securitized future revenues from commodity exports, and Companhia Petrolífera Marlim issued two securitizations backed by future income revenues derived from oil production, with both transactions originally rated bra-2 on the Brazilian national rating scale (outstanding notes are rated bra-1 ). These were the first structured transactions rated by Standard & Poor s on its Brazilian national scale. Overall, Standard & Poor s has rated six Brazilian cross-border securitizations, all of them future flows. This low volume highlights the poor development of the local securitization market in Brazil to date, the more so when compared with the size of Brazil s economy (see table 2). Brazilian cross-border structured transactions have the potential of achieving investment-grade ratings when the companies or the specific business segments being securitized have adequately low performance risk. Nonetheless, this remains a challenge, mainly due to the existing performance risk for companies in a speculative-grade country such as Brazil. Good Prospects for ABS and MBS The prospects for the securitization of existing assets in Brazil are favorable, despite the fact that present volume of eligible assets is relatively low. Two securitization laws enacted in Brazil in the late 1990s have served as catalysts for change, since they have helped spawn the right environment for credit-originating institutions. Mortgage foreclosures or auctions are now allowed in Brazil, and banks are authorized to transfer assets to non-financial institutions. Investors are now likely to be more interested in investing in mortgage-backed securities (MBS) and asset-backed securities (ABS) in Brazil than in the past. Auto loans, credit card vouchers, and consumer loans also hold the potential for securitization in the next few years. Car makers sell more than two million vehicles per year in Brazil, out of which 70% is financed by banks or financial subsidiaries. The result is a high volume of homogenous loans to be securitized. However, two main difficulties for loan securitization in Brazil remain: the constantly changing regulatory environment, and the fact that the government has a track record of unilaterally changing terms and conditions of some consumer loans. Like Argentina, Brazil s market growth will improve as local institutional investors increase their interest and investments in structured securities. The major investors 9

12 in ABS and MBS are pension and mutual funds and insurance companies. Foreign companies that have invested in properties in the Brazilian market might also be interested in this type of long-term security. Locally, pension and mutual funds by year-end 1999 accumulated total assets of US$220 billion. Mexico The Leader in Future Flow Transactions Since the debt issuance of Teléfonos de México S.A. de C.V. backed by telephone receivables in 1987, Mexico has been an active player in the future receivables flow market. Standard & Poor s has rated 42 transactions for more than US$19 billion. In 1998 and 1999, ratings were also assigned to a program for the securitization of oil exports by Petróleos Mexicanos (Pemex) for US$5 billion, and notes within the same program for US$2.6 billion. Pemex had already used this structure in In 1999, Standard & Poor s rated the first structured Mexican transaction. This transaction, by Hipotecaria Nacional S.A. de C.V., consisted of a program for the issuance of peso-denominated medium-term promissory notes. These securities have a guarantee provided by Mexican Federal Government bonds or Development Banks, with additional enhancement from a pledge agreement of Caución Bursátil and overcollateralization. The transaction was rated mxaaa on the national scale for Mexico. Challenges for Securitization in Brazil The challenges ahead for both the MBS and ABS markets are rife. Interest rate volatility and inflation rates will present structured transactions with difficulties in forecasting and establishing rates of return. Other potential challenges are the small number of experienced servicers and trustees, as well as the possibility that lenders might not wish to furnish sufficient information on their portfolios for competitive reasons. Other obstacles that might prevent the prompt development of the MBS market are: Only mortgages originated after November 1997 are apt for securitization, therefore the volume of standardized mortgages available is still low; Lack of information on loan performance, property valuations, and debtors credit track record; and Issuers will have to prove they can manage mortgage loans despite limited experience. 10

13 Securitization in Latin America: Growth in Stormy Times Also during 1999, Standard & Poor s rated the issuance of Banorte s U.S. $ Clearing Master Trust s US$200 million, a securitization of paper check remittances that was given an AA rating. This transaction benefits from a credit insurance policy provided by Asset Guaranty Insurance Co. (AGIC). By the end of 1999, Leiser S.A. de C.V. issued notes guaranteed by receivables of its sale of gas and electric ranges to General Electric Co. This US$250 million issuance was rated BBB. Also in the banking industry, Bancomer and Banamex issued transactions backed by credit card vouchers in 1998 and 1999 for a total amount of US$700 million. Both banks have used this structure in the past, selling the assets to a special purpose vehicle. Bancomer and Banamex both enhanced their transactions with a financial guarantee provided by MBIA Insurance Corp., thus achieving AAA ratings. Other Relevant Issues In 1997, Grupo Minero S.A. de C.V. issued exports-backed notes ( AAA ) backed by Capital Markets Corp. (CapMac). The mining company and silver producer Industrias Peñoles S.A. de C.V. also issued in that year, the first Latin American transaction rated by Standard & Poor s with a payment in kind structure. This US$380 million transaction was rated BBB. In 1996, Standard & Poor s assigned a BBB- rating to the Mexican government s five year variable-rate notes and certificates for US$6 billion. This investment-grade rating was higher than the BB speculativegrade rating assigned to the Mexican government s foreign currency debt, since these notes benefited from a credit guaranty agreement linked to the crude oil export proceeds as well as its oil derivatives from Pemex, Mexico s state-owned oil company and its affiliates. Mexico used the proceeds from these notes and other additional funds to prepay US$7 billion on a loan granted by the United States treasury in The Mexican market has also had other structured transactions, with a wide range of assets, including toll road receipts (MC - Cuernavaca Trust, rated BBB-r, issued in 1994) and securitizations of A and B loans from the IFC (Gibsa IFC Trust I in 1996, rated A-, and Apasco IFC Trust I in 1995, rated BBB+ ). Securitization of Existing Assets: In Progress The development of Mexico s secondary mortgage market is progressing once again, after being stalled by the devaluation of the Mexican peso in In addition, changes have occurred in some laws which are now making securitization more achievable. While the current mortgage finance system is still unable to adequately meet consumer demand, the Mexican government believes that securitization is the way to increase both the affordability and availability of housing. The 1997 creation of a private pension fund system, meanwhile, has indirectly aided the development of securitization by broadening its investor base. However, further growth will be hampered by the weak banking and legal systems. 11

14 Growing Local Investor Base Until 1998, every pension fund in Mexico was managed by the Instituto Mexicano de Seguridad Social (IMSS), which was created in The National Social Security Law was amended in December 1995, making it possible to privatize IMSS s pension fund management-related transactions. The purpose was to foster domestic savings, generate capital for local investments, and provide retirees with other options when investing their funds. The system should have approximately US$25 billion in assets by the end of the year 2000, and it is expected to reach US$93.6 billion in the next 15 years, which would account for 29% of gross domestic product. Other Countries in the Region Slower Development Colombia, Peru, and Costa Rica have employed structures already used in the region, and have developed different and innovative structures of their own. Issuances would have been more numerous had the Latin American region not been hit by recessions and political instability in recent years. In Peru, with a BB foreign currency rating, various companies have issued investment grade securities. Southern Peru Ltd., a subsidiary fully controlled by Southern Peru Copper Corp., issued a 10-year export receivables transaction in June 1997 which was rated BBB- (subsequently lowered to BB+ in Nov. 1999). The interest rate on the notes is only 135 basis points over 10 year U.S. treasury bonds. This issue took place after another successful transaction backed by exports receipts carried out by Minera Yanacocha. Yanacocha Receivables Master Trust, the first Peruvian issue Challenges for the Development of the MBS Market in Mexico Structural problems inherent in the mortgage market include: Difficulties in the securitization of standard mortgages that are adjusted according to two indices; Insufficient volume of mortgages originated through the government s new low-income housing program, due mainly to its recent creation; Need for increased liquidity in the banking system to allow for lending to resume; Present state of legal reforms, including frameworks for insolvency and foreclosures; and Further development of capital markets for long-term investments. 12

15 Securitization in Latin America: Growth in Stormy Times backed by raw materials with an investment-grade rating ( BBB- ), paid 185 basis points over U.S. treasury bonds. In 1997, the Instituto Costarricense de Electricidad (ICE) issued the first securitization of telephone invoices in Costa Rica. ICE securitized net settlements payments involving many telephone companies from various countries. The transaction was rated BBB-. Through the securitization of the future settlement payments, ICE was able to surpass sovereign constraints and issue debt with costs lower than for bank borrowing. In 1997, Standard & Poor s rated Colombia s first oil receivables-backed transaction. This transaction was issued through a special purpose entity (Oil Purchase Co.) created by Ecopetrol, Colombia s state-owned oil company. In 1999 Ecopetrol issued a second transaction (Oil Purchase Co. II) with the same characteristics. Both issues were rated BBB and lowered to BBB- as a consequence of Colombia s sovereign rating downgrade to BB+ from BBB- in September, Securitization Will Continue To Be a Necessary Financing Source Standard & Poor s believes that in the near term, investors will continue to reinvest their capital in Latin America. As a result, the securitization market will grow in amount and in asset types. Issuers will continue issuing future flow transactions to lower their financing costs relative to those of corporate issues. However, the issuing market must adapt to different economic and financial scenarios such as recurrent volatility and political instability. The market must also cater to the demands imposed by international investors, who will be more selective and choose only transactions with very solid structures. Multilateral institution guaranties, such as the IFC and IADB, and companies providing insurance against credit or political risk will provide their services to help the region s companies and banks mitigate sovereign risks. Jorge Solari, Buenos Aires (54) Juan Pablo De Mollein, Buenos Aires (54)

16 Mexico s Secondary Mortgage Market Makes Progress The development of Mexico s secondary mortgage market is making progress after being stalled by the devaluation of the peso in There have been changes in some of the legal, disclosure, and structural aspects affecting securitization, and these changes are setting the foundation for a secondary market. The current mortgage finance system is still unable to adequately meet consumer demand for housing, and the Mexican government believes that securitization is the way to increase housing availability. Other events, like the mid-1997 commencement of a private pension fund system, are indirectly contributing to its development by broadening the investor base. However, the development of a secondary mortgage market also faces challenges, such as the fragile condition of Mexican banks as well as legal and judicial systems that are still weak. The Housing Shortage Remains Like many other emerging markets, Mexico suffers from a large housing deficit. The two main reasons for the deficit are the high rate of population growth in Mexico in the last 20 years, combined with the decreased affordability of housing and related financing. During the last two decades, population has grown at a 2.5% compounded annual rate, while wages have declined by 20% in real terms compared with 1993 levels. High regulatory and financial costs in the construction industry and the lack of financing from lenders in recent years add additional constraints to the supply side of the equation. Government estimates put the deficit at close to 3 million units. This figure does not consider the needs of single individuals old enough to marry and find a home. Moreover, of the 19.4 million households in the country considered in a 1995 census, 4.6 million homes were not in adequate condition. Additionally, there have been changes in the population growth rates by age group, with a larger increase among 15

17 the younger age groups, meaning that more new households usually are needed. Currently, around 60% of the population in Mexico is under age 24, which will result in additional housing demand in the future. Also, as in many other emerging markets, the general economic conditions in Mexico have prevented the country from developing a long-term mortgage market, mainly because of interest rate volatility and high inflation. Given the economic situation, government agencies working to meet housing needs are almost the only source of funds currently available in Mexico. Commercial banks have been restraining their mortgage-lending operations since 1994, despite a fivefold increase in mortgage lending by banks from Structure of Mexican Homebuilding Market Payroll Home Buyer Mortgages INFONAVIT 5% Payroll Contribution Federal Government FOVI Mortgages World Bank Mortgages Sofoles Funding Funding sources Developer Bridge financing Banks Funding Payment after completion 16

18 Mexico s Secondary Mortgage Market Makes Progress Low-Income Housing Approximately a third of the population in Mexico could be considered eligible for low-income housing. As a result, the low-income housing industry has received steady support from the government since the early 1970s, despite the country s economic instability. The low-income housing system is currently structured so that developers participate in the government-sponsored programs, where either a financial institution or the government itself provides the final borrower with a mortgage loan. Developers obtain their financing mainly from banks or other financial institutions, namely sociedades de objeto financiero limitado (sofoles) (see chart). Currently, the existing low-income housing system does not provide commercial banks with what they consider adequate returns; they continue to address the asset quality problems of their existing loan portfolios, leaving most of the lending in this segment to sofoles. The Housing Agencies There are four government housing agencies in Mexico: Instituto Nacional del Fondo para la Vivienda de los Trabajadores (Infonavit), Fondo de Operación y Financiamiento Bancario de la Vivienda (FOVI), Fondo de Vivienda para los Trabajadores al Servicio del Estado (Fovissste), and Fideicomiso del Fondo Nacional de Habitaciones Populares (Fonhapo). Infonavit and FOVI together account for more than 75% of the total financing provided by agencies. Both organizations have taken important steps to restructure their operations in recent years. Infonavit, established in 1972, is a pension fund that provides its members with mortgage loans. The organization is funded by a 5% payroll tax on all Mexican private sector workers. The fund provided approximately 1.7 million mortgages by mid-1999 and, within its 1999 budget, Infonavit planned to issue a total of 160,000 mortgages. During recent years, the organization has introduced a number of important reforms, including changes in top management, increased organizational transparency, and improved systems and collection procedures. Previously, the main criticisms against the company had been poor credit analysis and collection procedures, and lack of transparency. FOVI, a trust created in 1963, is managed by the Mexican central bank, Banco de México. In addition to its general cash from operations, the trust is financed by a combination of funds from the country s finance ministry and the World Bank. Unlike Infonavit, FOVI does not service its mortgages, but instead acts mainly as a second-tier bank, providing financial institutions with funds and guarantees. All mortgages granted using FOVI funds have a partial subsidy from FOVI that is paid to the financial institution granting the loan. 17

19 FOVI has also undergone significant changes since the 1980s, including the 1989 introduction of an auction system to allocate funds for mortgage lending. Recently, the trust has shifted its focus toward the poorest segments of the population through its Programa de Subsidio a la Vivienda (PROSAVI), and into the middle-income segments through the B2 and B3 programs (see table 1). FOVI was planning to auction the equivalent of 160,000 units in Table 1 Basic Terms and Conditions of FOVI Mortgages PROSAVI A B-1 B-2 B-3 Maximum house value (UDIs)* 40,000 55,000 71,500 88, ,500 Initial loan-to-value ratio (%) Implicit interest rate (30 year-loan) Traditional mortgage product (%) N/A New mortgage product (%) N/A *1 UDI = 2.6 Mexican pesos as of Sept. 24, UDI Inflation-adjusted pesos, or unidades de inversión. N/A Not applicable. Table 2 Mexican Sofoles * Institution Assets Equity Hipotecaria Nacional 4, Hipotecaria Mexicana 2, Hipotecaria Su Casita 2, Crédito Inmobiliario 2, General Hipotecaria 1, Financiamiento Azteca 1, Hipotecaria Crédito y Casa Patrimonio Metro Financiera Financiera México Terras Hipotecaria Financiera Comercial America Fomento Hipotecario Hipotecaria Associates Financiera Inmobiliaria Fincasa Hipotecaria Total 17,470 1,462.0 *Millions of Mexican pesos as of Sept. 30, March 31,

20 Mexico s Secondary Mortgage Market Makes Progress Sofoles The government has been promoting mortgage lending through sofoles due to the lack of mortgage lending from commercial banks, especially since the 1994 peso devaluation. Created in 1994, the sofoles operating in the housing sector of the economy are nondeposit-taking institutions that focus on providing financing for low-income housing. Because sofoles do not accept deposits, they obtain the majority of their funding from FOVI, and in some cases from commercial banks. Sofoles have been able to implement rigorous underwriting and servicing procedures and have maintained good asset quality indicators to date. Some of the factors that give sofoles an edge when it comes to servicing loans are a strict credit approval process, payment booths at the developers sites, and good monitoring and collection procedures (see table 2). Developers To support low-income housing, the government had played the role of developer until the early 1990s, after which the current low-income housing developers appeared. Despite consolidation in recent years, there are still a large number of developers, although the largest 10 now have close to a third of the market share. The four largest are Corporación GEO ( mxa-2 ), Consorcio ARA S.A. de C.V. ( mxa+ ), Grupo URBI S.A. de C.V., and Consorcio Hogar de Occidente S.A. de C.V. ( mxa-2 ). Moving in the Right Direction During 1999, as in recent years, President Ernesto Zedillo s administration continued working to develop a secondary mortgage market in Mexico. In order to substantially decrease Mexico s housing deficit, developers should be able to continue to obtain adequate financing and a secondary mortgage market needs to be developed. The government believes that securitization is the way to provide lower mortgage costs and increase the availability of mortgages. In March 1999, FOVI received a US$505 million loan from the World Bank to promote the development of securitization in the housing industry. The loan will be used to create an adequate framework for a secondary mortgage market, increase the number of financial institutions working with FOVI, and eventually allow the trust to access funds from the capital markets, based on its own financial strength. Within the framework of this loan, FOVI progressively will increase interest rates charged on mortgages and eventually eliminate current subsidies. As part of the development process, FOVI launched a new type of mortgage on Aug. 1, It is denominated in inflation-adjusted pesos, or unidades de inversión (UDIs), instead of pesos with a higher real interest rate. As before, the mortgagor 19

21 will pay a fixed installment every month. The installment amount owed by the mortgagor will be adjusted by changes in the minimum wage; however, the actual payments due to the lender every month will be adjusted for inflation. The difference between the two payments will be paid every month by FOVI through what it calls the FOVI swap. This new kind of product will make it easier to securitize future mortgage portfolios by allowing for higher interest rates, thus increasing the transaction s feasibility from an economic perspective. The previous kind of mortgages had very low interest rates around 8.2% and 11.6% real interest rates for type A and B homes, respectively, compared to a 8.5% real rate for inflation-adjusted government bonds, known as Udibonos. A and B homes have approximate values of US$15,000-US$30,000. Previous mortgages also had a dual-index structure that made it very difficult to estimate FOVI s final payment at the end of a maximum 30-year period. The new mortgage rates are 9.9% and 12.3% (see table 1). Nonetheless, mortgage-backed securities are not the only securitization opportunities in this sector. Standard & Poor s has received numerous requests from both developers and sofoles to rate a variety of housing-related transactions, including the securitization of accounts receivable derived from home sales performed by Corporación GEO S.A. de C.V., rated mxaa last April For the sofoles, being able to securitize part of their assets would decrease their current dependence on FOVI funding, thereby providing them with access to capital markets and regulatory capital relief. Indeed, sofoles are an integral part of FOVI s securitization plans in the future. Current efforts by FOVI and the sofoles to implement self-regulation, standardization, disclosure, consumer protection, credit risk analysis, and servicing will contribute to the development of securitization. Because FOVI has requested that the sofoles diversify their funding sources, some sofoles are already working on structured transactions. Finally, the role of the sofoles as servicers can also contribute to the development of capital markets. The need to service all the loans purchased by the government during the banking crisis might be an interesting business opportunity for sofoles in the near future. Finally, growth in the private pension fund system, one of the most dynamic in Latin America, provides issuers with a growing investor pool. Pension fund administrators Administradoras de Fondos para el Retiro (AFORES) had US$5.7 billion at year-end 1998, and will receive deposits from roughly 10 million workers in This growth, together with the investment needs of insurance companies and other institutional investors, will increase the need for longer-term investments. 20

22 Mexico s Secondary Mortgage Market Makes Progress Some Challenges Remain Despite the fact that both FOVI and Infonavit have been working in recent years to streamline their operations, improve systems, and increase transparency, there is still work to be done to adopt stricter credit criteria, standardize mortgages, raise interest rates, and eliminate direct subsidies. FOVI faces important challenges in the future. Its mission providing affordable housing to the Mexican population has to be combined with providing investors with adequate real rates of return when it becomes more independent from government funding and starts to access the capital markets. To accomplish this, FOVI probably will have to obtain some kind of government guarantee for its initial securitizations (see box). The securitization of current mortgages is a challenging task. FOVI introduced the dual-index mortgage in the 1980s to address the problems of mortgage lending in an inflationary environment using either fixed or floating rates. Using fixed rates negatively impacts the lender, and using a variable rate substantially increases defaults when rates increase, so the dual-index mortgage seemed to be a good alternative. Borrowers pay a fixed installment that is adjusted with changes in minimum wages, linking it to their purchasing power while the outstanding balance of the loan is adjusted for inflation, eliminating that risk for the lender. FOVI was providing a subsidy between all payments made by the borrower and the outstanding balance at the end of the term of the loan. Nevertheless, the fact that wages have not kept pace with inflation for quite some time substantially increased the outstanding amount to be eventually paid by FOVI, but reduced cash payments in real terms. The new FOVI mortgages, Challenges Ahead for Mexico s Developing Secondary Mortgage Market Loan structural issues involve: Difficulties in securitizing traditional dualindex loans, and Not enough new mortgage origination to securitize loan pools under the new type of mortgage loans. Need additional reforms in the government agencies to: Increase transparency, and Need increased capital in the banking system. Need legal reforms, including: Foreclosure and bankruptcy legal framework, and Other legal reforms for some states. Need larger capital market for long-term investments. Improve systems and controls. 21

23 with higher real interest rates, will be relatively easier to securitize, but it will be still some time until there have been enough mortgage loan originations to provide loan pools for that purpose. One major obstacle to mortgage lending is the Mexican banking system itself and its current lack of capital. Not only do banks require additional capital for their present balance sheet structure, but the quality of their current capital also must be improved. Currently, the main sources for additional capital could be international investors (as shown by the recent acquisition of Bancomer S.A. (BB+/Stable/B) by the Spanish bank BBVA (AA-/Watch Neg/A-1+)) or mergers among banks. In either case, the process will take some time and will constrain the banks ability to increase their lending. Another area where the federal government has continued working but still requires additional effort is legal and regulatory reform. Mexico is a civil code jurisdiction, but many legal issues are regulated through state laws. This makes the progress of legal reforms uneven across the country. For example, the PROSAVI program for the lower-end segment of this market has been implemented mainly in the states that had already accomplished some of the needed reforms currently more than two-thirds of them. Within those states, the main change involves allowing for the transfer of a mortgage without the borrower s approval. Despite recent changes, the country s weak legal and judicial system has been an obstacle to the advancement of securitization in Mexico, primarily because of the still-pending reforms to the legal framework concerning mortgage foreclosure and bankruptcy proceedings. The proposed legal reform to strengthen foreclosure procedures already has been submitted to congress, and the government has announced modifications to its bankruptcy laws. Overall, the evolution of the secondary mortgage market in Mexico currently benefits from the continued resilience of its economy to external shocks and consistent macroeconomic policies. At the same time, as in many other areas of the economy, it is constrained by the fragility of the banking system, the potential political interference deriving from Mexico s currently incomplete transition to democracy, and, partially due to the latter, the stalled reform process. Nonetheless, Standard & Poor s believes the advances and changes in recent years are undoubtedly leading the Mexican secondary mortgage market in the right direction. José Ramón Torá, Structured Finance Ratings, New York (1) Rosario Buendía, Structured Finance Ratings, New York (1)

24 Argentine MBS: Perspectives and Performance The growth of the Argentine real estate market has been directly influenced by the country s political and economic history, so it is not surprising to see direct correlation and fluctuations in housing investments and the capital markets. Although Argentina s economic recovery becomes a prerequisite for the growth and development of a regular housing finance market, there are at least two key indicators in the domestic market that have been showing a new path and further perspectives: the good performance of the bonds backed by residential mortgages and the improvement of mortgage loan terms. During the second half of 1998, the global market crisis and especially the financial troubles of Argentina s biggest neighbor and key commercial buyer, Brazil, hurt Argentine financial institutions by closing financing lines and increasing the cost of those left in place. This led to a deterioration in mortgage loan conditions offered to debtors. Also, the deterioration of economic conditions and expectations led to a decrease in consumers willingness to incur additional debt. Political uncertainties created by the presidential elections in late October 1999 also dampened consumers appetites for mortgages. The resulting decrease in the growth of banks mortgage portfolios further lessened banks desire to securitize mortgages. Despite Economic Recession, a Strong MBS Performance Although securitized dollar-denominated mortgage portfolios show an increase in delinquency levels, portfolio performance comfortably fits within the scenarios that Standard & Poor s used when determining the ratings on the securitizations. With the performance of the dollar series of mortgage-backed securities (MBS) depicted in charts 1 and 2, where there are loans with payments overdue by at least 60 days and 90 days respectively, the following can be deduced: Loans with 60 or more days delinquency, including foreclosed loans, never reached 12%, while those with 90 or more days delinquency remained at an average level of 4.2%, with a maximum of 7.8% (in the case of BHN III). This confirms 23