This Selected Issues paper analyzes external shocks and business cycle fluctuations in Mexico. The paper examines the relative importance of U.S. demand shocks—and other foreign disturbances—in explaining Mexican output fluctuations. It identifies the dynamic response of Mexico’s output to those shocks. The paper investigates which U.S. variables are most relevant to explaining business cycles in Mexico. It analyses potential spillovers and channels of transmission underlying the linkages between the United States and Mexican economies, and focuses on one aspect of the development of the Mexican private mortgage market, the market for mortgage-backed securities.


This Selected Issues paper analyzes external shocks and business cycle fluctuations in Mexico. The paper examines the relative importance of U.S. demand shocks—and other foreign disturbances—in explaining Mexican output fluctuations. It identifies the dynamic response of Mexico’s output to those shocks. The paper investigates which U.S. variables are most relevant to explaining business cycles in Mexico. It analyses potential spillovers and channels of transmission underlying the linkages between the United States and Mexican economies, and focuses on one aspect of the development of the Mexican private mortgage market, the market for mortgage-backed securities.

II. The Mortgage-Backed Securities Market in Mexico1

A. Introduction

1. Widespread household access to home finance has long been a goal of governments in Mexico. For generations, the Mexican approach focused primarily on redistributive schemes, implemented through state-sponsored housing funds, which were notorious for their inefficiency and poor governance. During the first part of the 1990s, the privatization of the banking sector led to very rapid growth in mortgage loans, but the sharp increase in interest rates following the1994 Tequila crisis contributed to record defaults and the near-collapse of the banking sector, followed by a long period of retrenchment of lending. Since 2001, the Mexican authorities have focused on developing the framework and infrastructure to support primary and secondary mortgage markets; in contrast to previous initiatives, the new approach places emphasis on market mechanisms, such as partial guarantees to private non bank intermediaries, improvements in housing repossession procedures, and improvements in property registries. Both the primary and secondary mortgage markets have been developing in recent years, but remain work in progress as the government continues to adapt best international experiences to Mexican circumstances.

2. This paper focuses on one aspect of the development of the Mexican private mortgage market, the market for mortgage-backed securities. In general, mortgage securitization is a technique which allows mortgage banks to fund new loans while transferring market and credit risk from their balance sheets. In many instances securitization helps to reduce any term-mismatch between assets and liabilities. In a securitization operation, a mortgage originator sells its loans to an independent special purpose company or vehicle (SPE or SPV) which issues mortgage-backed bonds (MBSs) and uses the proceeds to pay the mortgage originator for the loans. The cash flow generated from the interest and principal re-payment of the loans is then used to service the bonds, while the mortgage collateral secures the bonds. (Box 1: Key Features of Securitization).

B. Brief Overview of Housing Finance in Mexico

3. The evolution of housing finance in Mexico can be broadly classified into three stages:

  • Before the 1990s: focused on redistributive schemes and directed lending to support home ownership by low to moderate income households. Initially, these schemes were administered by development banks; since the early 1970s, two government sponsored housing funds, INFONAVIT (funded with a mandatory contribution of 5 percent of private sector employees’ gross wages) and FOVISSTE (funded with mandatory contributions from government employees’ gross wages) have played the leading role. Commercial bank lending for housing was limited, in part because banks had to comply with a requirement that 6 percent of their credit be directed to housing finance at fixed, capped nominal interest rates.

  • 1990–2000: featuring a boom and bust of private mortgage lending followed by a prolonged period of retrenchment. In the early 1990s, the re-privatization of the banking system, the launching of inflation-indexed mortgages, and a benign and liquid global financial environment facilitated a generalized boom in bank lending, including for real estate. Between 1989 and 1994, total bank credit to the private sector increased from close to 13 percent of GDP to more than 50 percent of GDP, while bank mortgage lending jumped from 1.3 percent of GDP to 2.4 percent of GDP (some 4.7 percent of total bank credit, compared with 10 percent in 1989). However, poor risk-management practices in the banking sector, combined with the sharp interest rate spike in the aftermath of the Tequila crisis—which caused rates on the widespread adjustable mortgages to rise to over 100 percent—triggered a wave of bank mortgage defaults and the near collapse of the banking system. Following the 1994 NAFTA negotiations, the government granted the first non-bank license to so-called Sofoles, non-deposit taking institutions which operated mainly with funds of FOVI—a public fund with the central bank—directed at providing housing financing for lower income families. While commercial banks were working-out bad loans and debt, they withdrew from mortgage lending, leaving INFONAVIT and the Sofoles as the main mortgage originators.

  • 2000–2007: characterized by a gradual recovery of private mortgage lending. A series of legal reforms were implemented, including improvements in housing repossession procedures and in property registries, coupled with the creation of Sociedad Hipotecaria Federal (SHF), a housing development bank set up to foster the development of private primary and secondary mortgage markets for low to middle income households. The SHF supported standardization of mortgage origination and underwriting criteria, while providing mortgage insurance and partial financial guarantees. Initially, SHF’s mortgage lending was channeled through the Sofoles, and a primary mortgage market soon took off, displaying Mexico-specific characteristics such as the quoting of repayment in terms of minimum wages (VSMs2) and inflation- indexed repayment (in terms of UDIs3). Soon after, commercial banks re-entered this market. Although inflation has been relatively low and stable in recent years, Sofoles continue to extend most of their lending in the inflation-indexed UDIs, but their peso lending is on the rise. Notably, in order to leave space for private sector involvement in the development of a secondary mortgage market, SHF’s Organic Law established that direct financing to Sofoles would cease by 2009. Supported by SHF’s guarantees, Sofoles gradually began to access capital market financing through direct debt placements and through the securitization of their portfolios, thus providing the impetus for the development of a secondary mortgage market.

Key Features of Securitization

Mortgage securitization is a technique which allows mortgage issuers to gain fresh funding and to transfer market and credit risk imbedded in their existing loans. In a securitization operation, a mortgage originator sells its loan portfolio to an independent special purpose company or vehicle (SPE or SPV). The SPV’s funding comes from its issues of securities to capital market investors. The cash flow generated from the interest and principal re-payment of the loans is used to service the securities backed by assets (ABS) or mortgages (MBSs).

There are a number of legal steps and infrastructure requirements for an efficient securitization of mortgages (see Lea et al 2004). First, the loans in the pool to be the securitized should have uniform characteristics, including terms of the loan, documentation, credit quality and performance history. Second, mortgage foreclosure procedures, which ensure protection of creditor rights, must be relatively speedy and of low cost to ensure high creditworthiness of the securities. In addition, mortgages must be fully transferable, as the SPV needs to acquire full rights over the receivables from the loans, and its claim on the collateral must be senior to any other claim. This is necessary to insure that the creditors of the originators banks will be voided from any claim on the collateral of the securitized loans in the event the originators enter into default. Also, the tax system must be designed so as to allow for the transfer of assets to be securitized without generating costs in the mere swap of funds entailed from the loan originator to the SPV issuer.

The SPV must be an entity of “high credit quality”, and often times in the U.S. it is capitalized to ensure creditworthiness to the securitized issues and to be legally able to issue securities. The SPV in the U.S. would also perform high quality mortgage service, which in the U.S. is paid between 0.25 and 0.5 percent of the loan balance.

The pricing of MBS will have to reflect the historical patterns of re-payments and defaults in the areas where the mortgage loans were originated. Originator banks should therefore maintain data on default rates and–if pre-payment occurs at no fee–pre-payment behavior, which will be crucial to an acurate pricing of the MBSs. Not only the collection of such data but also an agreement that financial institutions will share credit information will be necessary for an MBS market to develop.

Main Benefits

There are benefits in securitizing loans and developing mortgage markets under many different perspectives, both for the mortgage originators for the borrowers and for the investors alike.

Mortgage originators, by securitizing the mortgage loans, will able to book the proceeds from the sale of the mortgages immediately as cash, thus, the operation generating funding for new lending activities. By transforming the loans into securities that can be held in investors’ portfolios, mortgage originators are also be able to access a broader pool of private sector savings. By removing the loans from the balance sheets, mortgage originators will achieve a diversification of credit and market risk. In effect, together with the loans, any term mismatch between assets and liabilities and any credit risk will be removed and dispersed across market investors. As a result, the regulatory capital requirements of the mortgage originators are typically reduced as the loans are taken off balance sheet.

In addition, the securitized bonds backed by mortgage loans (MBSs) can be structured in different ways to either achieve a certain diversification of risk or to cater to the investor base. The most commonly found securities which are backed by mortgage loans are so-called pass-through securities or so-called tranched issues.

Pass-through securities will present exactly the same characteristics as those of the underlying loans in terms of coupon, term, duration and market risk. In particular they will also have the same pre-payment risk as the underlying loans, and all market and credit risk will be passed on to the investors.

Tranched issues will have separated the loan pool in such a way that the higher tranches of the securities are those to which all pre-payments will be imputed and thus have shorter duration but lowest risk, whereas the lower tranche will be redeemed only after the higher tranches have been redeemed in full. This allows investors some choice on the expected duration or risk of the security they acquire. It is typical that MBSs will aim for an investment grade rating so as to be marketed to institutional investors. Since mortgage originators may not have very high credit ratings, mortgage securitization transactions typically require some form of credit enhancement in order to achieve an investment grade rating or, a rating higher than that of the originator bank. Such enhancements can either be included in the structure of the securities, so that, for example, the principal of the underlying pool of loans is greater than the principal value of the securities issued (over-collaterization) or provided by a partial guarantee from a third party.

4. The emergence of primary and secondary private mortgage markets in Mexico has been facilitated by a series of financial sector reforms. These included:

  • Measures to standardize private mortgages, thereby allowing mortgage loans to be easily pooled. In 2003, new legislation 4 provided specific guidelines for the standardization of mortgage contracts. Standardization was encouraged by the SHF, which set specific loan criteria for providing mortgage insurance and other financial guarantees (see below), among these, that early repayment options for borrowers should be free of penalties or and fees.5

  • Creation of the legal basis for Special Purpose Vehicles (SPVs) which could issue mortgage-backed securities. The new Securities Law of 2000 and amendments to the “Ley General de Titulos y Operaciones de Credito” modified the legal framework of trusts (fideicomisos), to enable them to act as SPVs in securitization operations. Foreclosure procedures were simplified for these trusts by authorizing, in the case of borrower default, financial institutions to act both as trustees and beneficiaries of the trust, and by granting their trustees the right to sell loan collateral in a public auction without a judicial foreclosure process in uncontested cases (Box 2).6 7 8

  • Development of securitization instruments. The new Securities Law introduced the so-called “certificados bursatiles” or ceburs, a flexible type of security that could be also used for securitized issuances.

  • Improvements in contract enforcement and creditor rights, which previously were significantly constrained.9 In 2000, the reform of bankruptcy procedures clarified and streamlined the real estate repossession process, strengthening contract enforcement procedures and creditors’ rights.

  • Development of credit reporting. The lack of comprehensive credit histories had made it difficult to distinguish creditworthy households, and thus to estimate default and pre-payment probabilities. The only credit information sharing mechanism until the early 1990’s was the public credit registry (SENICREB) operated by the central bank, but its use in supporting credit decisions was limited. Reforms included the enactment of a banking secrecy reform, which enabled banking institutions to share information on customer credit operations and led to the creation of a dominant credit bureau (Buró de Crédito). This boosted the credit reporting industry, facilitated the sharing of credit information, and improved the analysis of credit risk.

The Reform Of The Mexican Legal Framework for Trusts

In Mexican law,1/ the trust (fideocommisso) is a contract by which a person designs a property for a special purpose, transfers the title of the property to a fiduciary institution to fulfill that purpose, and appoints a beneficiary of the trust to receive the benefits. Any trust has to be filed in the public registry.

The trustor does not deliver the physical possession of the property, instead he could agree that in the case of his delinquency in the payment of the loan the trustee is allowed to sell the real estate in an auction in order to pay off the credit to the lender. The creditor secured by a guaranty trust (fideicomissos) will receive principal and proceedings from this credit with no exclusion. The law also allows for the trustee and the beneficiary of the trust to be the same.

The procedure which guarantees the trust is stipulated in a federal law and therefore uniform in every court across Mexico. The enforcement allows for extra-judicial execution in the case when there is no controversy among the parties. The trustee takes possession of the collateral in the guaranty trust, after its value and price have been determined, and the collateral shall be sold in a public auction. When the sale of the collateral amounts to the same as the credit, the trustee will be able to gain title to the property of the collateral and to dispose of it freely. If there is a legal controversy, there will have to be a judicial execution of the possession of the collateral and payment of the credit.

5. These financial reforms were supported by the creation of the SHF—with the explicit mandate to promote a secondary mortgage market—in 2002.10 Originally the SHF was seen as playing a role similar to that of the Federal Housing Agencies (FHA) in the U.S., such as Fannie Mae and Ginnie Mae, providing partial mortgage credit guarantees and acting as a second-tier bank for Sofoles.11 However, the SHF was designed to gradually reduce its direct second-tier bank role, shifting toward supporting financial institutions in issuing mortgage-backed securities directly in the capital markets. In this supporting role, the SHF began selling financial guarantees and mortgage insurance to Sofoles in 2004 (Box 3). The partial financial guarantees (Garantia de Pago Oportuno or GPO), relieve investors from a portion of the liquidity risk associated with shortfalls in interest and principal payments of securitized portfolios. In addition, SHF provides mortgage insurance (Garantia de Incumplimiento or GPI), to protect lenders (and thus investors) against default risk up to a certain percentage of the outstanding principal and interest of the loan.12 Such arrangements or “enhancements” are designed to increase the credit quality of securitized loan portfolios, which can exceed the credit quality of the originating institution. The criteria set by SHF for the sale of its programs (GPI or GPO) also have, as noted, the important effect of inducing standardization in mortgage products.13

SHF’s Guarantees Program

Different kinds of guarantee programs are directed both to mortgage borrowers and to lenders seeking to securitized mortgage portfolios. In general, SHF sets specific criteria to qualify for such guarantees.

Guarantees for mortgage borrowers

  • A swap of UDI for minimum salary payments (VSM). This swap allows borrowers in UDI-denominated loans to reduce the risk of mortgage debt by transforming payments in multiples of minimum salaries. The structure of the mortgage for the borrower is similar to that of a loan in UDIs. However, the risk that increase in UDIs is higher than the increase in minimum wages is taken over by SHF upon payment of a fee.

Guarantees for lenders

  • A default payment guarantee (GPI) or mortgage insurance1 will pay to the relevant financial intermediary or the trust up to 35 percent1 of the outstanding balance of the mortgage loan, plus interest thereon, and for unpaid service and insurance fees, after a mortgage loan is delinquent for six consecutive months and foreclosure takes place. The fee for the GPI is paid for by the borrower, through the financial intermediary.

  • A mortgage insurance scheme (GI) which insures the lender for up to 70 percent of the outstanding balance of the mortgage loan, plus interest thereon, and for unpaid service and insurance fees for certain loans, including those that contain an up-front subsidy from the government.

Financial Guarantees for RMBS issuers

  • A timely payment partial guarantee program (Garantia de Pago Oportuno or GPO) is designed to provide assurance of timely payment of principal and interest up to 85 percent of the outstanding balance of principal and interest for those loan portfolios that comply with certain requirements. (However, the maximum protection acquired by any institution so far has been 25 percent.) Timely payment guarantee is a credit enhancement at the deal level of the structure, and is similar to a credit line. If the trust does not have sufficient cash to make a given payment, the line of credit can be drawn to pay both interest and principal. Once the line of credit is repaid, it can be drawn down again, if the need arises. The fee to the provider of the GPO is part of the expenses of the trust.

To qualify for SHF’s support, mortgages have to be originated and underwritten following specific requirements–among others, debt-to-income ratios, loan-to-value ratios, property type and values, and reporting requirements for the financial intermediaries. Should a loan not comply with the eligibility criteria, the trust would have to reimburse SHF for any payment made under the guarantee for that specific loan.

C. The Mexican RMBS Market

Structured Finance in Mexico

6. The issuance of structured finance securities in Mexico has experienced veryrapid growth since their introduction. Total issuance of structured securities reached over US$6 billion in 2006—tripling in volume since 200414—the largest annual issuance volume in Latin America, surpassing Brazil. In other emerging market countries in Eastern Europe and Africa, securitized issuance is about ⅓ of Mexico’s volume. However, the volume in Mexico is still very small when compared with the market for domestic government securities (US$255 billion) or with structured finance markets in industrial countries (ranging from US$50 billion in Japan to US$125 billion in the U.K. and US$1.4 trillion in the United States).15

Figure 1.
Figure 1.

Latin America Local Issuance of Securitized Assets 2006

Citation: IMF Staff Country Reports 2007, 378; 10.5089/9781451956061.002.A002

Source: Fitch.
Figure 2.
Figure 2.

Mexico: Domestic Market Private Debt Issues by Structure

Citation: IMF Staff Country Reports 2007, 378; 10.5089/9781451956061.002.A002

7. The structured finance market in Mexico has grown also in terms of asset types and debt structures. Early structured issues comprised primarily bridge loans for construction to developers; federal tax participation revenues (transfers from the federal government to states and municipalities); toll road receivables and consumer credit flows. Mortgage backed securities (MBS) based on residential mortgage loans (RMBS) made their first appearance in late 2003 and by 2006 they had become the largest structured asset class, representing over 25 percent of total local structured issues.16 As of October 2007, there were over US$6.4 billion RMBS issues outstanding in the Mexican bond market, issued by seven different Sofoles, two commercial banks, and INFONAVIT.

8. From the outset, Sofoles have been the most active issuers of the new securitization instruments. SHF’s scheduled withdrawal from direct financing of Sofoles at a time of growing demand for mortgage credit has given Sofoles strong incentives to search for alternative funding sources.

9. Favorable global liquidity conditions and a growing local institutional investor base have supported the new structured issues. Securitized structures are particularly attractive to pension fund managers because they typically carry a high credit rating and long duration which matches their natural liability structure and prudential regulatory restrictions well. In particular:

  • by enhancing the credit profiles through tranching, over-collateralization, and the use of financial guarantees, structured issues achieve an investment grade credit rating that the issuer would otherwise not achieve. In addition, they carry slightly higher yields than comparable government securities.

  • in most cases, the terms of the underlying loans, together with those of the securing collateral, allow structured issues to have a relatively long duration with respect to other instruments in the local market, which tend to be concentrated on the short-end of the yield curve.

Demand by local and foreign pension fund managers for longer duration paper has also spurred sophistication in the structured finance market—the first Mexican collateralized debt obligation (CDO), pooling local RMBSs, was launched in March 2007.

RMBS in Mexico

10. The strong growth in the RMBS in particular has been supported also by SHF, the housing development bank. Unlike Fannie-Mae and Freddie Mac in the U.S., SHF has not bought mortgages to issue RMBSs or underwritten RMBSs. Instead, mortgage loan originators have been issuing directly so-called “pass-through securities” in the market. These RMBS securities have the same characteristics of the underlying loans, in terms of coupon type and term. The RMBSs that satisfy the loan origination criteria making them eligible for SHF’s support, through credit enhancements (mortgage insurance and partial financial guarantees), are commonly referred to as BORHIS17 in the local market; however there are also other types of mortgage-backed securities outstanding. In the case of Borhis, SHF also offers support to the liquidity of the issues by acting as a “market-maker” and thus committing to buy Borhis both in the primary and secondary markets. Under normal conditions, SHF buys at a price based on its own cash-flow projections for the securitized loans and computed according to a methodology based on certain prepayment and default assumptions.

11. More recently, Mexico has adopted the Danish technological platform, enabling mortgage originators to start issuing RMBs closer to the Danish ones. The important difference between the RMBS issued previously and the new “Bohris fungibles” is that an existing series of “Borhis fungibles” can be augmented by re-opening them during the first year, up to a pre-established maximum, thereby increasing the size of each issue in the market and allowing it to achieve higher liquidity.18 A loan’s monthly payments will cause some bonds to be withdrawn from the pool, in the amount that the loan pays down. These pass-through securities will be issued through a centralized agency, HiTo, that provides issuer and data services directly into the mortgage market. The first re-openable RMBSs, so-called “Borhis fungibles,” appeared in late 2006.

Issuers and Investors

12. Sofoles were the first and by far the most active users of the new financial instruments, but INFONAVIT quickly followed. As of October 2007, SOFOLES accounted for 60 percent of total outstanding stock of RMBS, while commercial banks represented around 5 percent of issues. As discussed earlier, the structural decline in Sofoles’ other funding sources, together with the rising demand for housing credit, gave strong incentives to securitize their portfolios. Following the success of the initial RMBS structures, INFONAVIT rapidly became one of the largest issuers in the market, and in October 2007 accounted for around 27 percent of the outstanding stock of RMBS in the market.

13. Local institutional investors dominate the market for structured issues. To date, the bulk of RMBS issues are held by domestic pension funds and insurance companies. Beyond the reasons noted above, this strong demand reflects the fact that Mexican RMBSs are typically denominated in UDIs—see below—and generate inflation-linked returns. More recently, high liquidity in international markets generated some foreign investor interest for RMBS as securities with a relatively higher yield and a low risk profile.

Main Characteristics of Mexican RMBS issues

14. As the RMBS market in Mexico has developed as a “pass-through” securities market, the characteristics of the outstanding RMBS issues reflect the terms of the underlying pools of mortgages of the different issuers.

  • RMBS issues by Sofoles. These are inflation-linked, typically denominated in UDIs, reflecting the underlying mortgages that Sofoles offer. The underlying loans are typically standardized, and carry enhancements purchased through SHF or other insurers (see below).

  • RMBS issues originated by INFONAVIT. 19 The underlying loans tend to be more diverse, although reportedly sharing the same duration of the structured paper that has been issued. INFONAVIT’s loans typically are denominated in VSMs and depend on the borrower’s income level and on the value of the house to be purchased.20 These issues carry no direct financial guarantees but have included over-collateralization as a form of credit enhancement. Because INFONAVIT is a government-sponsored institution, there appears to be a perception, on the part of investors, that these products have an implicit government guarantee.21

  • RMBS issues by commercial banks. Such issuance has picked up strongly recently, so that 2007 seen some of the largest RMBSs issues in the market. These issues are mostly structured to reflect the fixed-rate, peso-denominated characteristics of the mortgages extended by banks. Interestingly, not all of these RMBs carry mortgage insurance and guarantees offered by SHF. Instead, the enhancements in a number of commercial bank issues consist of extended liquidity facilities (or total financial guarantees—see below) by large international insurance institutions and tranched structures to support the credit ratings.

Coupon and Term

15. Interest rates on RMBS issues have averaged between 5 to 6 percent in real terms. Early issues carried a spread of around 120–140 basis points with respect to inflation-indexed government bonds (UDIbonos), this has declined more recently to around 80-90 basis points. Over time the spreads for Sofoles-issued RMBSs have narrowed thanks to the greater demand and higher liquidity of the market provided by SHF’s activity in the secondary market. However, the compression in spreads also reflected changes in the structure of the RMBS, in particular, the increased use of a mezzanine tranches as the market developed (see below). The most recent issues have benefited from a total financial guarantee (rather than just the partial GPO guarantee) on the senior notes which brought a further decline in spreads to around 40–50 basis points.

16. The term of RMBS issues has ranged from 10 to 30 years, lately with most around 30 years. These are the longest maturities available for a private sector security on the market. The typical term for other types of asset-backed issues in Mexico has been five to seven years.

Credit Enhancements

17. Most issues by Sofoles are structured so as to comply with the requirements to qualify for the SHF’s partial financial guarantee (GPO). Initially, SHF was the only GPO provider. However, recent regulatory changes cleared the way for the entry of private sector financial guarantee providers such as Ambac, Genworth FMO, IFC and most recently MBIA, to compete with SHF in providing these guarantees. The qualification requirements for GPO consist of the following:

  • The holders of the underlying mortgages denominated in UDIs, must hold a UDIs-VSM swap offered by SHF. Such a swap protects the borrower against sudden swings in inflation that are not matched by an increase in general wages, while SHF would continue to service the loan in UDIs.

  • The holders of the underlying mortgages must be covered by the mortgage insurance (GPI), which covers the “first loss position” upon default of the borrower for up to 35 percent of the outstanding balance of the mortgage loan.22

18. Most RMBSs have additional credit enhancements in terms of over-collateralization. That is, the value of the principal assets backing a certain issue exceeds the value of the security outstanding. The rates of over -collateralization have varied, from 0.8 up to 15 percent. Over-collateralization tends to be lower for RMBS pools that carry SHF’s guarantees, around 1.3 percent.23

19. As the market has developed, additional types of credit enhancements have appeared. Most recently, several issues included a total financial guarantee (so-called full wrap), which covers 100 percent of shortfalls in principal and interest payments. Such a guarantee is in fact a liquidity guarantee that does not cover against losses due to default but does insure timely payment. However, for those issues carrying such guarantee, there would also be a subordinated tranche (see below) that would be the first to absorb the credit losses.


20. Initially, given the absence of a market for securities rated below investment grade, only one tranche was sold in the market and this carried SHF’s guarantees. The originator retained, and fully provisioned for, a small equity position, typically around 4 percent.

21. More recently, issues have had a senior and a subordinated tranche structure, as is typical in mature debt markets, and a broader variety of credit enhancements. When issues are tranched, receipts are distributed by tranche seniority, i.e. accruing to the senior tranches first, while losses are distributed inversely.24 Equity positions between 4 and 8 percent have been retained by the originating institutions. Reportedly, junior tranches have had less appeal, but appetite for such tranches appears to have been growing recently. Mutual funds and foreign investors are attracted by the high yield they offer, but some have also been retained by some commercial banks; senior tranches have been eagerly received by local investors.

Valuation and Rating

22. In Mexico, there is a high degree of uncertainty surrounding the parameters used to model the cash flows from the RMBSs’ underlying assets. In particular, there is a lack of comprehensive historical data on default rates, prepayment rates, and recovery rates and on the length of the foreclosure process. In addition, recent legislative reforms affecting the foreclosure process (as discussed above) may have altered the significance of the available historical information, so that most of the relevant parameters in the valuation process have to be assumed.25

23. The lack of historical and market data housing prices further complicates assessment of loan-to-value ratios and of the over-collateralization of portfolios. In principle, house values for mortgages in portfolios guaranteed by SHF must be formally appraised, however, most of the time, house prices for loan purposes have been supplied directly by the constructors. The authorities are also aware of the need to deter fraudulent appraisals as these would compromise the valuation of RMBS, and the integrity of the investors’ (e.g. pension funds’) portfolios.

24. The government bonds denominated in UDIs (Udibonos) used as benchmark bonds for the pricing of the securities have been illiquid, complicating the price discovery process for the securities valuation in the RMBS market. These bonds were the only local UDI-denominated securities with a term structure relevant to RMBSs. However, historically, the Udibono market usually has been very illiquid (it is heavily influenced by pension funds that do not trade Udibonos actively).

25. Currently, the only source of information for RMBS prices in the secondary market are the local price vendors. 26 The models used by these agencies to price the securities are not fully clear; SHF is working with the price vendors to improve practices. SHF is not required to buy the bonds at the prices announced by the vendors.

26. The valuation of RMBS relies heavily on rating agencies’ review process. High ratings make securities suitable for pension funds’ portfolios. Factors behind the high rating of the early Borhis, beyond SHF’s partial financial guarantee, include SHF’s incentives to Sofoles to issue loans with conservative loan-to-value ratios, mortgage insurance, and the UDI -VSM swap for all UDI-denominated loans. In more recent issues, since the junior tranches27 effectively provide an additional buffer for the senior tranches, the senior tranches have not needed a financial guarantee to attain a “AAA” rating on the local Mexican scale. Some issues which had a senior tranche with a total financial guarantee were rated “AAA” on the global ratings scale. Because the mortgages in most securitizations are covered by mortgage insurance for up to 35 percent of the losses, even the junior tranches still qualified for an “A” rating.28 However, for the initial rating of the securities, rating agencies have tended to rely heavily on SHF’s due diligence on the quality of the loan portfolio to be securitized. Furthermore, some have suggested that rating agencies should play a more proactive role in the rating review of RMBS, as there are reports that downgrades to RMBSs have occurred only after irregularities had become readily apparent.

D. Concluding Remarks

27. The recent rapid growth in housing finance through private mortgages appears grounded on more solid primary and secondary markets than in the past. Private mortgage lending has been steadily increasing since the beginning of 2003, and all expectations are that the trend will continue. Although such rapid growth could raise concerns about a repeat of the mortgage market collapse during the Tequila crisis, there are a number of important differences this time:

  • Most mortgages are inflation-indexed or have fixed-peso rate interest, and the bulk of the origination has taken place through non-deposit taking institutions.

  • Financial sector reforms and SHF actions have supported the standardization of mortgage issuance, including SHF’s requirements of strict origination practices in terms of underwriting and eligibility criteria, thus facilitating access by mortgage issuers to capital markets.

  • The development of the mortgage bond market with pass-through securities has enabled financial institutions to reduce on-balance sheet credit, market and maturity mismatch risks, while also creating increasingly liquid bond pools in the local capital markets. Most importantly, RMBS have allowed mortgage issuers to tap capital markets funding directly.

  • Sofoles have progressively moved away from reliance on direct public funding and have been able to access market funding, with average rates about 100 basis points above similar sovereign issues.

28. Nevertheless, a number of issues merit close attention to improve the outlook for the future:

  • The need to improve public property registries. These registries are still paper based and not systematized, raising the cost of collateral verification.

  • The need to strengthen the role of auditors and credit rating agencies. In many instances, auditors are reportedly able to check only 5 to 10 percent of titles of a portfolio pool. And, as recommended in the 2006 FSAP Update, issuers and regulators should consider standards for the inclusion of due diligence firms to review the files of the loans that make up collateral pools.29 (To illustrate the concern, the FSAP technical note reported that 30 percent of a pool for which SHF was asked to provide mortgage insurance, suffered from deficiencies in documentation, ranging from missing credit bureau reports to missing or deficient appraisals. Furthermore, the rating agency did not review any loan files, nor did the institutions that were offering credit enhancements.)

  • The need to adapt the securities valuation methodology to the Mexican reality. Although reliance on highly theoretical models is a common problem with the valuation of structured products in general, for the case of Mexico, the problem compounds due to a lack of mortgage pre-payment and default history. SHF has been cognizant of this problem and has sought to develop centralized prepayment and default databases, but these are not fully operational at this time.

  • Low liquidity in the RMBS may represent a contingent fiscal liability under stress events. As a market maker, SHF has an explicit commitment to buy Borhis, both in the primary and secondary markets, even under stress events. So far, no limit has been explicitly set as to the total amount of Borhis that SHF could buy. In the event of stressed-induced off-load of RMBS, the SHF would step in to maintain liquidity, leaving the bank vulnerable to market losses.

  • SHF would benefit from stress test analysis to periodically reassess its level of liquidity. Appropriately, SHF creates provisions in its portfolio on the basis of expected losses, reinsures part of the risk from its mortgage insurance products with international insurance corporations, and fully hedges its VSM-UDI liabilities with FOVI. However, it would be important to assess on a regular basis the institution’s liquidity under stress events.

  • The absence of a market for lower-rated securities means that the mezzanine or junior tranches of the securitized portfolios are held by the originating institutions. This tends to reduce the risk-diversification value of securitization for those institutions, as well as the capital relief they can obtain from securitization.

  • While there is little risk of providing incentives for overbuilding, incentives for substandard house construction may exist. The program of guarantees for constructors—which effectively relieve the lender from the market risk associated with construction activity—are directed at increasing further the amount of funding directed to the housing sector without increasing the associated risk to the lenders.

  • Large securitizations by INFONAVIT might complicate RMBS pricing in the market and crowd-out private sector issuers. INFONAVIT has been able to issue RMBS at very compressed spreads relative to the benchmark government bonds. This is somewhat surprising given that its mortgages are not, generally, standardized and there are significant problems in valuing the housing constituting its collateral. This highlights, as discussed earlier, the importance that markets assign to implicit public guarantees on the securities. Such guarantees, which constitute a contingent liability for the government, may lead to crowding-out other private sector issuers while obscuring the pricing process in the market.

29. The recent troubles in the U.S. mortgage market have raised questions about the possibility of a similar replay in Mexico—but there are significant differences between two markets. The fast pick up in private mortgages in Mexico was preceded by several years of stagnation and is from a low level. Furthermore, RMBS remains a very small share of the domestic mortgage market in Mexico, with much lesser systemic implications. Finally, the complex securities currently generating volatility in the U.S. markets, such as CDOs, are practically non-existent in the Mexican financial sector.

30. Nevertheless, the recent troubles in the U.S. mortgage market may provide lessons—for Mexico and other countries—about vulnerabilities of the securitization model, in particular:

  • The RMBS valuation process is intrinsically complex.

  • Rating agencies face a conflict of interest because the issuers of the structured products pay the rating agencies for their opinions. Rating agencies seem to have been slow to adjust the methodology used to evaluate the default probabilities of subprime mortgage-backed securities.

  • Financial institutions’ sale of loans to independent vehicles seems to have relaxed their origination standards; there appears to be an inherent weakening of the borrower-lender relationship within the securitization vehicle structure.

  • In the event that securitization vehicles run into liquidity problems, either because of rising defaults or because of inability to place new issues (as is currently the case with asset-backed commercial paper conduits), the sponsoring financial institution may have to step in, either through the extension of credit lines or outright buy backs. That is, even though sales of loans are final in legal terms, financial institutions may be forced to buy back their loans. Fideicommisos in Latin America may be even more vulnerable to this problem than SPV structures in the U.S., because they do not have their own capital.

Figure 3.
Figure 3.

Mexico: Historical Trends in Credit to Housing

Citation: IMF Staff Country Reports 2007, 378; 10.5089/9781451956061.002.A002

Source: CONAVI, Bank of Mexico, Dealogic and Fund Staff calculations.
Figure 4.
Figure 4.

Mexico: Structure of Housing Finance, 2000-2005

Citation: IMF Staff Country Reports 2007, 378; 10.5089/9781451956061.002.A002

Source: Conavi, Bank of Mexico, Dealogic and Fund Staff calculations.


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Prepared by Luisa Zanforlin and Marco Espinosa. The authors thank David Robinson and Steve Phillips for useful comments and suggestions, and Claudia Pescetto for her able research assistance. Special thanks to Alan Elizondo and Oscar Grajales Herce in SHF for very informative and candid communications, and to staff of the Bank of Mexico and Hacienda for helpful comments and suggestions.


Veces Salario Minimo or times minimum wage: effectively an index for wage levels which is adjusted once a year following contractual negotiations. For example, workers would be earning 1, 2 5 times the VSM and thus each increase in the VSM would translate in an equivalent wage increase. This wage structure applies predominantly to lower income wage earners.


The UDI (Unidad de Inversion) is a unit of account, the value of which is updated daily and reflects the changes in the consumer price index. On the 10 and the 26 of each month the Bank of Mexico publishes the UDI’s value for the next fifteen days. On the 10 and the 26th day of the month the change in UDI value will be equal to the change in the consumer price index in the previous 15 days of the month, the value for the days between the 10 and 26th will be computed by distributing the total increase in the CPI across the number of days in the period. The UDI had a value of 1 on April 4, 1995 (as of April 2007 approximately 3.85).


Ley de Transparencia y de Fomento a la Competencia del Credito Garantizado.


See Section B of Appendix C in Ley de Transparencia y de Fomento a la Competencia del Credito Garantizado.


Only in the cases whereby the foreclosure process is not contested, in all other cases the foreclosure has to be ordered by a court.


Only in the cases whereby the foreclosure process is not controversial, in all other cases the foreclosure has to be ordered by a court.


Under Mexican law, the transfer of real estate titles must be registered with a central registry office—a lengthy and costly process—and the law pertaining to real estate foreclosures established other creditors as senior to mortgage lenders during foreclosure procedures. The use of trusts allows mortgages loan rights to be transferred without registration and the application of trusts foreclosure procedures rather than real-estate procedures.


Historically, foreclosures in Mexico could take up to 5 years and home owners were protected against negative equity. Under Mexican law, the transfer of real estate titles must be registered with a central registry office, a lengthy and costly process. And, the law establishes other creditors as senior to mortgage lenders during foreclosure procedures, dis-incentivating investor participation in securitization issuances.


The SHF took over most of the responsibilities of the FOVI, which since 1963 had directed government resources, and World Bank loans, to fund housing mortgage and construction loans for low to moderate income households.


Direct SHF financing of Sofoles is to be discontinued in 2009 and, by 2013, SHF is to be a self-sufficient agency. The latest data available show that, as of the end of 2005, the agency held close to US$ 15 billion in direct home loans, from US$ 13 billion in 2002.


This is called a “first loss” position.


In particular, to qualify for GPI mortgages have to meet certain debt specific income ratios, loan to value ratios, property type and values, and reporting requirements for the financial intermediaries.


Data according to Fitch. There were two operations in 2004 and 2005 identical in nature for US$ 4.5 billion and US$ 2.4 billion by Banamex and Banorte respectively. However, the two operations, which concerned the securitization of a loan by IPAB (the deposit insurance agency), were only possible because of a legal loophole in the terms of the original loans which is not present in other loans by IPAB. Therefore, similar operations cannot be repeated and are considered of one-off nature, therefore excluded from the total for comparison purposes.


All data by Fitch.


Data by Fitch.


Bonos Respaldados por Hipotecas.


Every fungible Borhi structure has reopening periods ranging from one to three years.


Infonavit is a housing fund, funded with private sector worker contributions. It provides housing credit for low-income workers. Infonavit is currently the largest housing fund with total credit of about 30 percent of GDP. In the case of an increase in inflation (UDI) not matched by increases in VSM, INFONAVIT remains responsible for the servicing of the RMBSs in UDIs.


Payments due to Infonavit for mortgage credit are automatically deducted from payroll wages and thus offer a certain degree of payment assurance. However, when the workers are unemployed, Infonavit typically allows for extensive grace periods on its loans.


This is reflected, for example, in the following quote from From S&P’s Presale report for CEDEVIS5U-2, of September 2005: “Infonavit’s rating …reflect the institution’s strong importance in the implementation of the housing policy followed by the Mexican government and incorporate a degree of implicit government support.”


Mortgage insurance allows the borrower to increase the maximum allowed loan-to-value ratio. While, in general, loan-to-value ratios have been around 65 percent at mortgage origination, if the borrower qualifies to receive mortgage insurance (GPI) then the loan-to-value ratio is increased to 80 percent for UDI-denominated mortgages and to 90 percent for peso-denominated loans.


In more recent deals, the initial collateralization has been close to 1.0 percent, with the over-collateralization expected to build to a higher target value as the bond principal amortizes.


Senior tranches have represented about 80 percent of the portfolios, while junior or “mezzanine” tranches have ranged from 3 to 12 percent.


For example, repayments rates are typically assumed to be constant, imputed either to the loan pool or to each single loan. While in Mexico typically there are no restrictions or penalties on prepayments, the cost of re-financing mortgages is high, thus prepayment rates have tended to be less sensitive to interest rates than in the U.S. Market reports suggest the constant pre-payment rate has been assumed at 5 percent, and indeed according to an SHF White Paper, historical experience with prepayments has been around this level.


Price vendors are a figure created in Mexico because of the structural illiquidity of the private issues market. Such institutions are supposed to be independent and to provide price information for market operators.


Junior tranches are also referred to as “mezzanines.”


Local scale A is equivalent to BB- on the international scale.


Technical Note on Housing Finance, prepared for the 2006 FSAP Update (

Mexico: Selected Issues
Author: International Monetary Fund