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Revisiting the Mexican Market.

Opportunities exist for American mortgage bankers in today's Mexican housing markets. Progress is being made to build the mortgage finance infrastructure, and the Mexican version of a mortgage banker--the SOFOLES--are showing how profits can be made in this market.


Many U.S. banks and lenders were interested in this market back in the early 1990s, when the economy was booming, but most were scared off by the 1994 currency and banking crisis and have yet to return. A few hardy pioneers, Pulte Mortgage Corporation, Greenwood Village, Colorado, and WSM Services of Mexico, SA de CV (formerly Weyerhauser) have hung on through the bad times and are now showing profits.

On a recent trade mission sponsored by the U.S. Department of Commerce and the Mortgage Bankers Association of America (MBA), we saw evidence of returning strength and long-term potential in the housing-construction and finance sectors. There are still barriers, but there are interesting positive developments as well, which indicate that now is the time to take a good hard look at our neighbor to the south.

The reasons for the early flurry of interest still exist--a housing deficit of around 4 million units with more than 1 million new households added per year, a median population age of 21 and a literacy rate of 88.4 percent. Mexico is accessible, closely tied to the United States through the North American Free Trade Agreement (NAFTA), and has a high number of immigrants living in the United States. Mexican citizens have a strong desire to own their homes and because of their social and family ties will often keep their home for life. According to New York City-based rating agency Fitch IBCA in its May 1998 report, "Guidelines for Rating Mexican Residential MBS," Mexican borrowers will continue to pay their mortgage beyond the point of the average U.S. borrower when economic stresses occur. This trait has been put to the test in the past five years, when many borrowers saw the negative amortization on their loans reach unmanageable levels. Delinquency rates at the banks have been quoted as high as 60 percent on old portfolios. However, new originations during the past two years are per-forming well.

Since the 1994-1995 crisis, there has been slow but steady improvement in the macroeconomic conditions and also in the willingness of the Mexican government to implement changes favorable to the development of a private-sector mortgage finance system. NAFTA has, arguably, helped increase trade between the United States and Mexico and has helped to stabilize the Mexican economy, especially in the border regions. This was in evidence during the Brazilian devaluation in late 1998, which did not create the shock to the Mexican economy that many expected. The Mexican Finance Ministry projects that inflation will be 13 percent this year, with a target of 10 percent in the year 2000.

The average inflation rate for the first quarter of 1999 was 4.87 percent, the lowest first-quarter rate in five years. The average cost of credit has been declining steadily since the first of this year, and the unemployment rate of 2.9 percent for the first quarter of 1999 was the lowest since 1992. The average national minimum wage has more than doubled since 1993, to 31.19 pesos per day. This has two benefits: First, it increases the purchasing power of homebuyers; and, second, it improves the performance of the existing portfolios of dual-indexed mortgages (DIMs). (DIMs calculate interest based upon nominal rates and payments based upon increases in wages. This has resulted in significant negative amortization in the past.) The greatest drag on the economic recovery is the condition of the banking system.

Institutional review

The construction sector is most active in the area of "social housing," targeted to homebuyers with incomes of 1.5 to 15 times the minimum wage (roughly $5 to $45 per day). This is because there is virtually no financing available from banks or other private lending institutions for middle- to high-priced homes. The so-called residential (or higher-priced) houses are being financed by the builders themselves or through "autofinanciamientos," a self-managed system that combines savings with a lottery for mortgage loans.

The builders are putting up low-cost housing because there is financing available through two government agencies, called INFONAVIT and FOVI. INFONAVIT obtains its funds from mandatory pension deposits from private employers; FOVI is funded primarily by the Mexican Central Bank, with support from the World Bank and other miscellaneous sources. Where FOVI originates loans through intermediaries, INFONAVIT originates its loans directly.

Until recently, INFONAVIT loans represented more than double the market share of FOVI. In 1998, the two institutions split market share relatively evenly. This is because of the increasing activity of the SOFOLES (nonbank lenders) and also problems with the quality of the INFONAVIT portfolio. Assuming that INFONAVIT works out those problems soon, it will remain a formidable competitor to any private-sector lender in Mexico because of its heavily subsidized interest rates, capped monthly payment (maximum 25 percent of wages) and flexible collection policies. There have been signs, however, that the government will begin to apply a firmer hand to the management of INFONAVIT, resulting in a more level playing field for the SOFOLES.

The commercial banks are still, for all practical purposes, out of the market. They are occupied with restructuring their portfolios and working out the vast numbers of delinquent loans left over from the crisis. The SOFOLES, however, have been both active and profitable since they work exclusively with the FOVI program. Funding for FOVI has been increased, so the SOFOLES' ability to grow is limited only by their capital base. The efficiency of SOFOLES oper-ations is, by necessity, quite high since their average loan size is very small by U.S. standards. Of course, they would prefer to originate some higher-balance loans, but the private funding sources for middle- and high-income loans still don't exist. Stay tuned, however, as some new players in the market may change that situation.

Private pension funds have been authorized by the government and are expected to generate $30 billion in deposits by the end of 2002, according to FOVI. Currently, these funds prefer short-term government treasury investments, but as inflation rates decline it is expected that demand for long-term investments will increase--which should increase demand for investment-grade mortgage-backed securities (MBS). The other barrier to pension fund investment is the subsidized rates of mortgage loans. Until market-rate Loans can be produced, yields on mortgage-related securities will not be able to compete with alternative investments.

In 1998, Bancomer invested in a state-of-the-art servicing and origination system, with substantial excess capacity to "lease" to other banks or even to lenders outside of Mexico. (A pending joint venture with Banamex was revealed during the trade mission.) Bancomer also structured the first private MBS in Mexico, but was unable to sell it because of adverse market conditions. Several smaller banks in Mexico (Banorte, for example) have not suffered the level of loan defaults of their competitors, and they could enter the market fairly soon. If Bancomer can get its MBS to market shortly, and FOVI succeeds with its new securitization program (details to follow), the seeds will be planted for the expansion of a private secondary market in Mexico. This represents significant opportunity for U.S.-based lenders and service providers.

Update on infrastructure

Progress has been made in a number of areas related to mortgage finance infrastructure. There are credit bureaus operating, but because of bank secrecy laws the banks are not able to contribute their data. This situation limits the value of these systems, but the SOFOLES are building a database that will ultimately provide the kind of information needed by rating agencies and private mortgage insurers to evaluate their portfolios. Title searches and recordation of title transfers are centralized in all states and are increasingly computerized. There is a growing professional appraisal system. Lenders are helped in collections by the lack of personal bankruptcy law in Mexico, but foreclosure and eviction are still major impediments to recovery of collateral. Foreclosure laws have been passed in at least 24 of 32 states, but the judicial foreclosure process is time-consuming and not consistently implemented. There are no laws regarding eviction, which means that borrowers can continue to occupy the house even a fter title has been transferred to the lender. Loans cannot be sold, only assigned, and assignment requires payment of notary and recording fees (1 to 2 percent of the loan amount) plus notification to the borrower of assignment.

Title insurance does not exist yet, except for U.S. citizens acquiring Mexican property. However, Stewart Title Guaranty Co., Houston, is very close to receiving its license to issue Mexican title insurance to Mexican citizens, through its wholly owned Mexican subsidiary. According to Mitch Creekmore, who heads up Stewart's Latin American division, its Mexican title orders have continued to increase, tripling in volume from 1997 to 1998. And there are signs of modernization of land titling and transfer in a number of states, especially those near the border with the United States, such as Sonora and Nuevo Leon. The state of Sonora is working with Arizona to link their title registries to launch a securitization program, for example. According to Creekmore, Stewart Title is "very much committed to the Mexican market."

U.S. companies involved in Mexican market

Aside from Pulte Mortgage and GMAC/RFC Funding Corporation, there are no direct U.S. investments in SOFOLES. Other U.S. activity has centered on servicing (WSM and Auritec SA, Mexico, among others), due diligence and work-outs of defaulted portfolios acquired from FOBAPROA (the Mexican RTC) or under contract with the Mexican government (AMRESCO Inc., Dallas). G.E. Capital Corporation, Greensboro, North Carolina, has a representative in Mexico, but no activity has been reported in recent years. A number of companies, such as Collateral Mortgage Ltd., Birmingham, Alabama; Metrociti Mortgage Corporation, Encino, California; and Bank United, Houston, make dollar-denominated loans to U.S. citizens for second homes in Mexico.

Also, some U.S./Mexican ventures have been pursuing dollar-based loans to Mexican citizens living in the United States who own homes in Mexico. There have been partnerships between Mexican builders and U.S. lenders (with Fannie Mae support) for low-income housing in the border region of Texas. Construction loans are being provided in Mexico by several lenders, including Finova Capital Corporation, Scottsdale, Arizona.

While most of these approaches are limited in scope, they provide a useful starting point to gain market intelligence, build local relationships and, based upon that, develop a strategy for adapting U.S. know-how to the Mexican market. The real long-term potential in Mexico lies with making local currency loans (either pesos or UDIs-an inflation-indexed unit of savings) to Mexican citizens. Indications are that we may not be far from making that leap.

The success story of the SOFOLES

The Mexican version of the mortgage banker is the SOFOL, an intermediary that makes loans under FOVI guidelines for construction and permanent loans and then sells the loans to FOVI. The SOFOL services the loans, and FOVI provides a 50 percent guarantee against loss. While the SOFOL market share has traditionally been small, it is growing rapidly, and SOFOL delinquency rates are less than 1 percent, with returns on equity as high as 30 percent!

Much of this has to do with the innovative servicing and collection methods of the SOFOLES. Su Casita, one of the largest companies (Pulte is part-owner), has established branches in the subdivisions where it has the highest concentrations of loans. Payments are accepted in cash, and partial amounts are accepted as well. Sometimes they are collected in person by Su Casita staff. When a borrower is late, there is immediate, personal contact to determine what the problem is and prevent further delinquency. In the lowest income brackets, it is unlikely that a borrower will find the money to catch up on one payment, let alone two or three. Therefore, the SOFOLES have had to be aggressive in the early collection of delinquent payments. They are also creative in their loss-mitigation methods, finding ways to help the customer leave the house with dignity and find another place to live. This practice alleviates expensive and time-consuming court proceedings to foreclose and gain possession.

AMSOFOL, the association of SOFOLES, has been working on a number of initiatives to increase efficiency and quality in their operations. They have collaborated on a common origination and servicing system, which provides economies of scale and shared costs for their members. They have agreed on a standard documentation package and are working with MGIC Investment Corporation, Milwaukee, to create a database that will allow evaluation of risk and possible development of mortgage insurance products for the SOFOL sector. Other areas for self-regulation, training and building the strength and credibility of the SOFOL institutions are being actively pursued.

Outsourcing of servicing is another small but growing niche in Mexican lending. The banks have tended to rely on traditional collection methods--telephone and mail. When more stringent steps are needed, however, they often use an outsourcing agency. Doing so separates the bank from the adverse public relations of firm-collection practices and allows some economies of scale in defaulted loan management. The banks have also tested some reward-based programs, in which customers who pay on time can earn points to be used to purchase merchandise. The recent visit to Su Casita and Bancomer during the MBA trade mission made it clear that modern and innovative systems for servicing and problem-loan management do exist in Mexico.

FOVI--the Mexican GSE

FOVI is a government trust, administered by the Mexican Central Bank. It provides loans to lenders (banks, SOFOLES) for construction finance to builders and permanent loans to homebuyers. FOVI can finance loans only to borrowers with income no greater than 15 times the minimum. Foreign entities with appropriate bank licenses and capital are permitted to use FOVI funds. FOVI loans are dual-indexed, variable-rate with payment changes based upon annual wage changes and interest accruals based upon monthly inflation rates. The interest rate is calculated by adding 5 percent to the monthly rate of inflation. Unpaid interest is capitalized. FOVI loans can be made in UDIs or pesos. The maximum loan-to-value (LTV) ratio is 90 percent.

FOVI guarantees the ultimate repayment of the principal due on the loan at the end of its term, if payments cannot amortize the entire balance within 30 years. In the event of default, FOVI guarantees 50 percent of the loan to the lender. Lenders pay a fee to FOVI for a commitment of funds (which are offered periodically through auction). FOVI funds the mortgages directly, and the lender services the loans, passing through payments immediately upon receipt. Lenders keep a spread of 3.00 percent to cover cost of funds and servicing. The lender retains 50 percent of the risk of loss on defaulted loans, which means that the SOFOLES must retain significant capital base to participate--a limiting factor in their growth at this time.

The newest FOVI program

New changes to FOVI's lending program will increase its similarity to U.S.-style secondary market agencies. The government wants to reduce the direct role played by FOVI in housing finance, converting its activities to those necessary to support private-sector institutions and the development of a secondary market for funds. The World Bank has recently approved a new loan to the Mexican government to fund future FOVI activity as well as significant restructuring. The main components of the restructuring are: converting FOVI loan programs to market rates; redesigning the loan product so that it can be securitized; phasing out the government's contingent liability for 50 percent guarantee and replacing it with private mortgage insurance; and strengthening overall secondary-market support structures. In these respects, FOVI will begin to model some of the roles that Fannie Mae and Freddie Mac play in the United States. (In fact, Fannie Mae is consulting with FOVI on this project.)

FOVI plans to act as an overseer of the secondary market institutions, as well as a coordinator of credit guidelines and a consolidator of credit and portfolio performance data, to communicate with potential investors. Under the new plan, lenders would be the securitizers and would hold the junior piece of a senior/subordinated security to encourage the production of quality loans. The size of the junior piece would, of course, be determined by what the rating agencies feel is necessary to reach a triple-A domestic rating on the senior tranche (one concern is how the junior piece will be treated for loan loss reserve calculation). FOVI will provide financing for the lenders that hold the subordinated debt, and it is possible that FOVI would provide a guarantee in the early stages of the program, before private bond insurance is finalized.

The loans themselves would be denominated in UDIs. Since a borrower's income is received in pesos and interest is calculated and paid in UDIs, there is a need for insurance to cover the risk that the borrower's income would be insufficient to amortize the loan. In the past, FOVI has assumed this risk, but the new plan creates an insurance fund that will initially be capitalized by the government. The borrower pays a portion of an annual premium of 1.3 percent of the loan balance with a monthly payment. Monthly payments in pesos will be converted to UDIs and applied to the amount due. Shortfalls will be paid by the insurance fund. Excess payments will be added to the fund so that it becomes self-funding in all but the most catastrophic economic conditions. There is no capitalization of interest, and the payments on the bonds are guaranteed.

Regardless of whether the new program succeeds, FOVI plans to play a much stronger role in regulating the practices of mortgage lenders. There will be a need for expertise in all activities related to securitization, and the structure of the Mexican market will more closely resemble that of the United States--which means that U.S. companies now have an opportunity to add significant value to the Mexican lending process.

Where and how to begin?

If you are new to the Mexican market, it will take time to enter. There is an increasing amount of information available, through the U.S. Department of Commerce, for example, which just published its "Housing Market Study" of Mexico. This report contains numerous sources and references for additional information. There are enough players in the market that on-the-ground market intelligence and support is readily available. Data can be obtained from local companies such as Softec S.C., Mexico, that specialize in the Mexican real estate and banking market. The most successful strategy to date has been partnership with or investment in a local bank or SOFOL. In this way, a U.S. company gains the benefit of the local knowledge and experience of the Mexican staff and avoids an extensive learning and relationship-building curve. Even so, appropriate due diligence and a careful entry strategy are necessary AMSOFOL is also interested in helping U.S. companies find a partner among its members.

At a recent meeting of the Housing Roundtable, Inc. (a U.S.-based policy group whose members represent all aspects of housing development and finance), Michael Marez, senior vice president of Pulte Mortgage, was asked to list the most common issues confronting U.S. companies in their attempts to enter foreign markets. According to Marez, they are:

* Unrealistic expectations of the nature and size of the opportunity;

* Oversimplification of strategy and the local system (which results in understatement of expenses and overstatement of income);

* Ethnocentrism--the inability to adapt methods to new situations;

* Unrealistic perception of acceptable risk versus return--the "risk bar" is higher in developing markets, and the U.S. risk benchmarks cannot be fairly applied to them. Companies must be prepared to accept an overall higher level of risk;

* Level of willingness to take time to learn by participating in the market--reading about a new market is not enough to prepare a company to do business there.

The Mexican market has its challenges, and yet it has been proven that it is possible to make a profit there. The pace of change has been slow, and, realistically, we can't expect it to move much faster. However, recent indications are consistently positive. U.S. companies that wait the five years needed for the Mexican market to develop further will be eight years behind the long-term players like Pulte, G.E. Capital and GMAC/RFC, given the time it takes to establish a local presence. Not only are there opportunities for high returns in the Mexican marketplace, but there are synergistic opportunities to support existing U.S. operations. The efficiencies that the SOFOLES have developed in servicing small loans can be valuable to U.S. companies. Low wages (relative to U.S. wages), bilingual staff and multicurrency systems can make Mexican platforms for origination and servicing useful for the management of operations throughout the Americas-not to mention in the U.S. Hispanic communities.

Developing a pilot program

The MBA is interested in working with public and private organizations in the United States and Mexico to develop a pilot project in one of the Mexican border states. This project would bring in U.S. funding to support the funding currently being provided by FOVI. One or two success stories can set precedents for U.S. companies and also encourage other Mexican states to make the changes necessary to attract similar investment. The pilot will require the support of local government, major employers and developers in the state, as well as in counterpart organizations in the United States. Cooperative efforts among government agencies in both countries are already under way.

The first step is to select a state or city to work with. During the MBA trade mission, we identified the city of Monterrey in the state of Nuevo L[acute{e}on as an excellent target market, for the following reasons:

* The state has a good track record of supporting lenders' rights in the courts.

* It is close to the border (and has access to the border), but does not have the political and economic difficulties of the border states.

* It has a population of 3.9 million--a significant market.

* Its level of education is higher than the national average, and it is home to the leading technical university in Mexico.

* Forty-five percent of Mexican banking assets are controlled by Monterrey families.

* It has a very strong employment base, with an almost paternal attitude toward employees--providing them with scholarships for university education and long-term employment tenure.

* There are several SOFOLES here; Citibank and Banorte are based here as well.

* Many of the companies in Nuevo L[acute{e}]on are global, which means they are better hedged against internal economic shocks.

* There is a strong state and local government agenda to support housing, which is badly needed.

* Builders are primarily medium-sized, and some are providing their own financing for medium-priced homes.

* It has a diverse industrial base, including high-tech, and diverse income levels--there is upward mobility for workers.

* Sixty-two percent of production is sold to the United States (primarily Texas).

Nuevo L[acute{e}]on is not the only prospect, by any means (Sonora state is another possibility), but based upon our visit earlier this year, it represents a good place to start.

News to come

Keep your eyes open in the months to come for a new MBS transaction in Mexico, the expansion of activities of the existing U.S. players, the results of the latest FOVI lending program and improvements in the operations of INFONAVIT.

The MBA will continue to work with its sister associations in Mexico and will support the activities of the World Bank, HUD and the Office of Federal Housing Enterprise Oversight (OFHEO) as they work with the Mexican government to strengthen and modernize the housing finance system. There are opportunities, the trends are positive and, as we always say to our customers here in the United States, now is the time to take another look at Mexico.

Debra Erb is president of Societas, International Institute for Real Estate Finance. She was previously senior director of the Mortgage Bankers Association of America's International Division.
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Title Annotation:opportunities for US mortgage bankers in Mexico
Publication:Mortgage Banking
Geographic Code:1USA
Date:Nov 1, 1999
Previous Article:Tackling SECTION 8 REFORM.
Next Article:THINKING ABOUT the Internet.

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