The Home Truths about Non-Bank Mortgage Lending in Mexico

Among the many effects of the recent financial crisis in Mexico, perhaps none made more headlines than the dramatic collapse of the country’s non-bank mortgage lenders. The two types of non-bank lending institutions — Sofoles and Sofomes — managed many billions of dollars in home loans, much of it to borrowers working in Mexico’s enormous informal economy who have not had access to bank and government financing. Now, three years since the financial crisis began, the question is whether non-bank lenders will ever get back on their feet again.

The odds look increasingly grim. Delinquency rates are still rising in the institutions' beleaguered portfolios, averaging nearly 20% across the residential mortgage-backed securities (RMBS) issued by non-bank lenders, according to Standard & Poor's (S&P). The lenders’ own books look worse, with non-performing loans accounting for as much as half of their total portfolios in some cases. This means the lenders need to be cleaning up their portfolios rather than growing them. At the same time, even if lenders wanted to grow their portfolios, they don’t necessarily have the resources. Although funding from government development banks is still forthcoming, non-bank mortgage lenders do not have deposits. At the same time, Mexico’s debt markets remain closed to them.

The situation is bad news for the government’s efforts to cover a housing gap estimated at around 10 million units. Nonetheless, observers are cautiously optimistic, noting that some of the most troubled lenders are returning to viability. Possible regulatory improvements, too, are providing a ray of hope, says Marja Hoek-Smit, director of the International Housing Finance Program at Wharton's Zell/Lurie Real Estate Center. But observers also note that important changes will have to take place if the non-bank mortgage-lending model is to survive.

Mexico's troubles have "many echoes of what has happened in the United States," according to Wharton real estate professor Susan M. Wachter, referring to the federally sponsored mortgage giants Fannie Mae and Freddie Mac that have needed a taxpayer bailout costing more than US$130 billion for many of the same reasons facing Mexico's non-bank mortgage lenders. That's not to say, however, that the U.S. can offer much guidance — it, too, has yet to find a reassuring solution. "We are in a holding pattern [in the U.S.]," says Wachter. "The problem is recognized, but how we restructure it is unclear."

Similar to Mexico, Wachter adds, the U.S. is "now almost entirely reliant on the federal government for mortgage financing. The problem [as a result] is that private capital is not at risk, [while] the taxpayer is on the hook for any mortgage default. This is not something that the American public is ready for or wants."

As for Mexico, its government development banks have historically been the main players in the country’s mortgage market. According to a 2008 report from the International Monetary Fund, new bank lending in 2000 made up only 0.2% of the total mortgage market, with the rest covered by government bodies. Although that has been changing, two state institutes — Infonavit (which lends to private sector workers) and Fovissste (which lends to public sector workers) — still account for about 70% of the country’s mortgage portfolio. And that portfolio is relatively small. According to S&P estimates, it is the equivalent of only about 10% of GDP, compared with, for example, an average 40% in Europe, according to the European Central Bank.

The Sofoles and Sofomes represent the government’s attempt to address the low lending rates and close the housing gap. The government set up the Sofoles structure in 1995. These limited purpose finance corporations are not allowed to take deposits from the public, but neither are they supervised in any meaningful way by bank regulators. They mainly received funding from the Federal Mortgage Corporation (known under its Spanish acronym as SHF). Sofomes, multiple purpose finance corporations, came along later, in 2005, for similar reasons. Even less regulated than Sofoles, there are thousands of Sofomes, most being small operations specializing in consumer lending.

The largest of these non-bank lenders have always been in the mortgage business. Because they are unregulated, it is difficult to put an exact figure on their size and importance. According to SHF, the credit portfolio of Sofoles at the end of 2008 was 72.5 billion pesos (US$5.8 billion). A more recent estimate from Mexican bank Ixe put the combined Sofoles and Sofomes mortgage portfolio as of the first quarter of 2010 at 134.6 billion pesos.

Claudia Sánchez, an S&P analyst, says the non-bank mortgage lenders' share of the Mexican mortgage market is an estimated 5.5%. “It’s a very small percentage," she notes. "But their participation is important because they were serving sectors not necessarily served by banks.”

Boom and Bust

In the run-up to the financial crisis, non-bank mortgage lending seemed like a rousing success. Over the years, these lenders were responsible for roughly half of all mortgage loan placements. That explains why they became attractive acquisition targets for banks, which were envious of the non-bank mortgage lenders’ portfolios and experience in lending to and collecting from Mexico’s enormous informal workforce. The most significant acquisition was in 2005, when BBVA Bancomer — the second largest bank in Mexico in terms of assets — purchased the largest non-bank mortgage lender, Hipotecaria Nacional, for about US$375 million.

By 2007, three large independent non-bank mortgage lenders stood out: Hipotecaria Su Casita, Metrofinanciera and Crédito & Casa. Receiving funding and guarantees from SHF, they issued debt on the Mexican market and securitized their portfolios through facilities set up by — again — the government. When the financial crisis hit, they were pinched from two sides. On one hand, many of their borrowers started defaulting. Delinquency rates were off the charts, sometimes as high as 80% in RMBS vehicles, according to ratings agencies. On the other hand, their funding from non-collateralized debt issues disappeared, leaving them with serious short-term liquidity problems. While all the non-bank mortgage lenders struggled, these three took the worst of it.

Metrofinanciera was the first to go under. Its executives were charged with embezzling funds and in 2009, it went into a concurso mercantil, roughly like a Chapter 7 bankruptcy in the U.S. Later, in mid-2010, Crédito & Casa bit the dust following a default on more than 1.5 billion pesosof obligations. It closed shop and was sold to ABC Capital, which also owns a large stake in cement and construction giant Cemex.

Su Casita’s collapse was more drawn out, reaching its conclusion in August. Larger than Crédito & Casa and without the fraud that characterized the Metrofinanciera case, it was thought to be a good acquisition target for a bank interested in picking up its lending expertise. Yet the first half of 2010 saw suitor after suitor — from BBVA Bancomer to Banorte to Scotiabank Inverlat –  take a look at Su Casita and then walk away. Su Casita defaulted on obligations to creditors at the end of last year. After negotiating a restructuring of its debt (including a serious "haircut" for investors) the lender has secured a promise of financing from SHF and appears ready to lend again soon, albeit not in large quantities.

Limping Back to Business

Although the show is mostly over, the outlook for non-bank mortgage lenders remains frustratingly poor. As analysts watched the slow motion collapse of these lenders in 2009 and 2010, it was assumed that delinquencies would stop rising soon, and financing would again become available so the lenders could limp back into business. So far, however, that hasn’t been the case. According to a recent report from S&P on Mexico’s RMBS market, delinquency in structured products originated by non-bank mortgage lenders was 19.8% at the end of 2010, compared with 15.6% a year prior.

Also, non-bank mortgage lenders have issued no new debt, nor have there been any securitized mortgage issues, since 2008. The new assumption is that lenders like Su Casita and Metrofinanciera will take at least another 18 to 24 months to stabilize their portfolios before they can focus on new growth in any sort of significant way.

“Their portfolios will have to be in survival mode for the next two years,” says José Antonio Quesada, head of the technical committee of the Instituto Mexicano de Ejecutivas en Finanzas (IMEF), a trade group for finance professionals.

Additionally, the consolidation and M&A activity that was expected hasn't happened, and no banks are expressing interest in bailing out the floundering institutions. Although Su Casita and other smaller mortgage lenders like Crédito Inmobiliario are partly owned by Spain’s cajas, those financial institutions are grappling with their own serious problems at home and can’t afford to pump more capital into their minor Mexican holdings.

Desperately Seeking Funding

Now that the weaknesses of Sofomes and Sofoles have been exposed, will Mexico's non-bank lending model be able to survive? “We’re going to need time to really evaluate whether the business model continues to be successful," notes S&P mortgage market analyst Arturo Sánchez. "I think that Sofoles and Sofomes are going to have to work hard during the … next two years to get back to significant levels of growth and adequate revenue generation, as the problems with asset quality continue.”

Sánchez and others say the central issue remains funding. Until a reliable, cost-effective source of capital is found, non-bank mortgage lenders will not be able to get back in business. While Metrofinanciera, Su Casita and others have access to SHF funding, it is expensive and Quesada notes that lenders are constrained by SHF conditions, which can change at the drop of a hat.

What options does that leave? “I definitely think they’re going to have to go back to the debt market,” Quesada says. He adds that once non-bank mortgage lenders have access to Mexico’s debt market, they will likely have to pay a premium. However, the premium will decline as investors gain more experience with the sector.

But if the U.S. experience is anything to go by, Wharton's Wachter says restructuring and reforms should take priority — including " regulatory oversight that is complete and covers the system as a whole."

Wharton's Hoek-Smit points to new regulations requiring Sofoles and Sofomes that issue debt to meet the same accounting and transparency requirements as banks. "This requires [Sofoles and Sofomes] to raise more capital and comply with new loan-loss provisioning rules. In the longer term, this will allow S&S to diversify their lending and funding activities and partner with other financial institutions," she predicts. "Trust in the remaining Sofoles and Sofomes may gradually return under the new financial regulatory framework … and with assistance from SHF," she adds. "SHF is also working on new lending products aimed at the lower income and informal market together with Sofoles and Sofomes."

In the meantime, Metrofinanciera and Su Casita will putter along, paring the losses from their portfolios and working with what little funding they have. Banks — which make up about a quarter of total mortgages — are trying to fill some of the gap left by the non-bank lenders. Sánchez says they are lending at a healthy rate and their portfolio is set to grow by about 10% this year, and some banks are lowering interest rates aggressively to do so.

Still, Mexico’s banks typically focus on serving the middle and upper classes with formal employment. That means that for the time being, borrowers from Mexico’s informal economy — or 40% of the labor force, according to Hoek-Smit — who had depended on the non-bank mortgage lenders are left high and dry. “The banks are much more focused on the formal economy,” Quesada says. “So when the Sofomes come back, that market will still be there for them to lend to.”

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