Documentof
The World Bank
FOR OFFICIALUSEONLY
ReportNo: 45818-MX
PROJECTAPPRAISAL DOCUMENT
ONA
PROPOSEDLOAN
INTHEAMOUNT OFUS$ 1.01BILLION
TO THE
SOCEDADHIPOTECARIA FEDERAL
WITH THE GUARANTEE OFTHE UNITEDMEXICANSTATES
FORA
PRIVATEHOUSINGFINANCEMARKETS STRENGTHENINGPROJECT
October 15,2008
PovertyReductionandEconomicManagementDepartment
SustainableDevelopmentDepartment
Mexico andColombiaCountryManagementUnit
LatinAmerica andthe CaribbeanRegion
This document has a restricted distribution and may be used by recipients only in the
performance of their official duties. Its contents may not otherwisebe disclosed without World
Bank authorization.
CURRENCY EQUIVALENTS
(Exchange RateEffective as of October 15,2008)
Currency Unit = Mexican Peso
12.7 = US$1
FISCAL YEAR
January 1 - December 31
ABBREVIATIONS AND ACRONYMS
ACCION International ACCION International -Microfinance Group
AMBAC AMBAC Financial Group
APL AdaptableProgramLoan
BBVA BankBilbaoVizcaya
BORHIS Bonos respaldadospor hipotecas- (Mortgage-backedsecurities)
BP BankProcedures
CEDEVIS Certificados de Vivienda- (Housing Certificates -RMBS issuedby
INFONAVIT)
CNBV National Banking and SecuritiesCommission
CONAFOR National Forestry Commission
CONAGUA National Water Commission
CONAVI National HousingCommission (previous to June 06 CONAFOVI)
CPS Country Partnership Strategy
CSI Credit and Savings Institutions
DPL DevelopmentPolicy Loan
EMBI Emerging Markets BondIndex Plus
ESW Economic SectorWork
FGIC FinancialGuaranty InsuranceCompany
FIL FinancialIntermediary Loan
FM FinancialManagement
FMA Financial ManagementAssessment
FMO Guaranteeprovider bilateral agency
FOVI Financial Housing Aid Fund
FOVISSSTE HousingFund, Social Security Services Institute of PublicWorkers
FSAP Financial Sector Assessment Program (IMF andWorldBank)
GDP Gross domestic product
HR HumanResources
HUTAL Housing and UrbanTechnical AssistanceLoan
IADB Inter-AmericanDevelopment Bank
lBRD International Bank for Reconstruction andDevelopment
ICB International Competitive Bidding
ICC International Code Council
IDA International Development Association
IFC International Finance Corporation
IMTA Mexican Institute for Water Technology
INFONAVIT NationalHousing Fundfor Private Sector Workers
i
JT InformationTechnology
LTV Loan to Value
MIS ManagementInformationSystems
MBIA Financialguarantorinstitution
MW MinimumWage
NDP NationalDevelopmentPlan
NGO Nongovernmentalorganization
NLTA NonLendingTechnicalAssistance
OECD Organizationfor EconomicCo-operationandDevelopment
PRONAFIDE NationalProgramfor FinancingDevelopment
PSBR PublicSectorBorrowingRequirements
RMBS ResidentialMortgage-backedSecurities
RRH RemittancesRecipientsHouseholds
SAL StructuralAdjustment Loan
SBD StandardBiddingDocuments
SCI Savings andCreditInstitutions
SEA Strategic EnvironmentalAssessment
SEDESOL SocialDevelopmentSecretariat
SEMARNAT Ministry of EnvironmentandNaturalResources
SENER Ministry of Energy
SEPA Sistemade Ejecucidn de Planes de Adquisiciones (ProcurementPlan
ImplementationSystem)
SHCP Secretaria de Hacienda y Crkdito Pliblico (Ministry of Finance and
Public Credit)
SHF FederalMortgageCorporation
S I L Sector InvestmentLoan
SOFOME SociedadesFinanciera de ObjetoMliltiple (Multi-purposefinancial
companies)
SOFIPO SociedadesFinancieras Populares (Popularfinancialcompanies)
SOFOLs SpecialPurposeFinancialCompanies
TA TechnicalAssistance
TIIE Tasade Znterks Znterbancariade Equilibrio (Equilibriuminterbank
interestrate)
UDI Inflation-adjustedunit of account
Vice President: PamelaCox
' CountryDirector: Axel van Trotsenburg
Sector Directors: Marcel0Giugaleand Laura Tuck
Sector Managers: Lily Chu andGuang Zhe Chen
Task Team Leader: AngClica NufiezandDavid Rosenblatt
11
FOR OFFICIAL USEONLY
This document has a restricted distribution and may be used by recipients only in the performance o f
their official duties. Its contents may not be otherwise disclosed without World Bank authorization.
MEXICO
PrivateHousingFinanceMarketsStrengtheningProject
CONTENTS
Page
I STRATEGICCONTEXTANDRATIONALE
. .................................................................. 1
A. Country and sector issues.................................................................................................... 1
B. Rationale for Bank involvement........................................................................................ 15
C. Higher level objectives to which the project contributes................................................... 17
I1
. PROJECTDESCRIPTION ............................................................................................ 19
A. Lendinginstrument............................................................................................................ 19
B. Project development objective and key indicators ............................................................ 19
C. Project components............................................................................................................ 23
D. Lessonslearnedandreflected inthe project design.......................................................... 25
E. Alternatives considered and reasons for rejection............................................................. 26
I11
. IMPLEMENTATION ..................................................................................................... 27
A. Partnership arrangements................................................................................................... 27
B. Institutionalandimplementationarrangements................................................................. 27
C. Monitoring andevaluation of outcomeshesults ................................................................ 28
D. Sustainability ..................................................................................................................... 28
E. Critical risks and possible controversial aspects ............................................................... 28
F. Loadcredit conditions and covenants ............................................................................... 33
IV. APPRAISAL SUMMARY .............................................................................................. 34
A. Economic and financial analyses....................................................................................... 34
B. Technical............................................................................................................................ 37
C. Fiduciary............................................................................................................................ 38
D. Social................................................................................................................................. 39
E. Environment ...................................................................................................................... 39
F. Safeguard policies.............................................................................................................. 40
G. Policy Exceptions and Readiness...................................................................................... 40
...
111
Annex 1: Country and Sector or ProgramBackground .......................................................... 41
Annex 2: Major Related Projects Financed by the Bank and/or other Agencies ..................62
Annex 3: Results Framework and Monitoring ......................................................................... 63
Annex 4: Detailed Project Description ...................................................................................... 69
Annex 5: Project Costs ................................................................................................................ 73
Annex 6: ImplementationArrangements .................................................................................. 74
Annex 7: Financial Management and Disbursement Arrangements ...................................... 75
Annex 8: Procurement Arrangements ....................................................................................... 81
Annex 9: Economicand Financial Analysis .............................................................................. 84
Annex 10: Safeguard Policy Issues ............................................................................................. 98
Annex 11:Project Preparation and Supervision .................................................................... 101
Annex 12: Documentsinthe Project File ................................................................................ 103
Annex 13: Statementof Loans and Credits ............................................................................. 104
Annex 14: Country at a Glance ................................................................................................ 106
Annex 15: Maps ......................................................................................................................... 109
This loan was prepared as a joint product of the PREM and SD units of the Latin America
and Caribbean region . The project team was co-lead by David Rosenblatt (PREM) and
Angelica Ntiiiez (SD) . The team included Joost Draaisma (Senior Economist). William Britt
Gwinner (Lead Financial Sector Specialist). Ellen Hamilton (Senior Urban Planner). Marja
Hoek-Smit (Consultant). Juan Carlos Mendoza (Senior Financial Specialist and co-team
leader through the Concept stage). Victor Ordoiiez (Senior Financial Management
Specialist). Gabriel Peiialoza (Procurement Specialist). Bias Skamnelos (Financial Sector
Specialist). Steve Weisbrod (Consultant). Juan Carlos Belausteguigoitia (Lead
Environmental Economist). Maria Elena Castro (Senior Social Scientist). Kristine
Ivarsdotter (Senior Social Scientist) and Ming Zhang (Senior Economist). Alejandra
Gonzhlez and Rosa Maria Hernandez nrovided valuable administrative sunnort.
i v
UNITEDMEXICANSTATES
PRIVATE HOUSINGFINANCE MARKETS STRENGTHENING
PROJECT APPRAISAL DOCUMENT
LATINAMERICA AND THE CARIBBEAN REGION
LCSPRAND LCSSD
Date: October 13,2008 Team Leaders: DavidRosenblattand
AngelicaNuiiez
CountryDirector: Axel van Trotsenburg Sectors: 100%Housingfinance andreal estate
Sector Directors: markets
Marcel0 GiugaleandLauraTuck
ProjectID: P112258
LendingInstrument: SDecific InvestmentLoan Safeguard screening cateeorv: C.
" _ _ - _ _ .
O J
~
Project FinancingData
[XILoan [ ] Credit [ 3 Grant [ 3 Guarantee [ ] Other:
ForLoans/Credits/Others:
Total Bank financing(US$m.): 1,010
Proposedterms: US Dollar, FixedSpreadLoanwith a grace periodof five years and a
BORROWER I 0.00 I 0.00
. . I 0.00
INTERNATIONALBANKFOR 1,007.475 2.525 1010.00
RECONSTRUCTIONAND
DEVELOPMENT
Total: 1007.475 2.525 1010.00
Borrower:
SociedadHipotecaria Federal (SHF)with a sovereignguarantee from the UnitedMexicanStates
Responsible Agency:
SociedadHipotecaria Federal
hnual 504 502 2 1 1
C'umulative 504 1,006 1,008 1,009 1,010
Projectimplementationperiod: November2008 to March2012.
Expectedeffectivenessdate: November30,2008
Expectedclosingdate: March30, 2012
V
Does the project depart from the CAS in content or other significant respects? No
Does the project require any exceptions from Bank policies? [ ]Yes [XINO
Have these been approved by Bank management? [ ]Yes [XINO
I s approval for any policy exception sought from the Board? [ ]Yes [XINO
Does the project include any critical risks rated "substantial" or "high"? [XIYes [ ] N o
Does the project meet the Regional criteria for readiness for implementation? [XIYes [ ] No
Project development Objective
The mainobjectives of the project are: (a) to strengthen the financial capacity of SHFto develop
and consolidate markets for housing finance and to expand access to lower income groups over
the medium-term; and (b)to improve SHF's technical capacity to expand accessto lower income
groups over the medium-term.
Project description
The project consists of two components: (i)component that would restructure the short term
a
debt of the Sociedad Hipotecaria Federal; and (ii) a component that would provide technical
assistance for improving the policies, processes and internal organization of SHF so that it can
better facilitate access to housing finance to low income households
Inaccordance with OP 8.30 Financial Intermediary Lending, a compliancereview was prepared
for the proposed loan, and the proposed laon was found to be compliant.
Which safeguard policies are triggered, if any? None.
Significant, non-standard conditions: The eligible expenditures for this loan include the
cancellation of short term debt (for Component 1). A set of special conditions have been
developed to reflect the link between the eligible expenditures and the project's objectives.
Boardpresentation: November 6,2008
Loadcredit effectiveness:
November 30,2008
For effectiveness, approval by SHF's Board of Directors of a policy for managing short term
financial risk
Covenants applicable to project implementation:
For completion of component 1, compliance with pre-agreed indicators.
(See Section II- A)
vi
I. STRATEGICCONTEXTANDRATIONALE
A. Country and sector issues
Macroeconomiccontext.
1. Mexico has experienced moderate growth accompanied by gradual poverty
reduction in recent years. GDP growth averaged 3.8 percent during 2004-2007, and headcount
poverty declined from 50 percent in 2002 to 43 percent in 2006.' The economic turbulence of
the 1980s and 1990s has been replaced by a stable currency, inflation o f 3.8 percent last year,
low levels of external indebtedness as a share o f GDP, declining public debt ratios and a
sovereign credit rating two steps above the lowest investment grade. The main development
challenges over the medium-term are to accelerate growth, enhance economic opportunities both
across regions and across social groups, and assure environmental sustainability.
2. Short run prospectsfor the Mexican economy are influenced by economic events in
the Unites States - the destination of over 80 percent of merchandise exports and the source of
about $24 billion (2.3 percent of GDP) in remittances last year. Duringthe last recession in the
United States, Mexico suffered a slight contraction of GDP in 2001 and very slow growth during
2002 and 2003. During the first half of 2008, the Mexican economy withstood the economic
difficulties of its main trading partner reasonably well, with economic growth of 2.7 percent
(year-on-year). However, with the turbulence in financial markets and the marked deceleration
of the United States economy duringthe second half of 2008, economic growth inMexico i s also
decelerating, with GDP growth expected to be about 2 percent for the whole of 2008.
3. Expectations are for lower growth in2009. The government itself has already lowered
its growth prospects 1.8 percent for 2009. There i s considerable uncertainty surrounding the
growth prospects given the unfolding global financial crisis. Strong economic linkages expose
manufacturing activity and the Mexican economy to a downturn in the U.S. business cycle. On
the other hand, the reduction in Mexico's (external) public debt (as a share of GDP), a reasonably
high level of international reserves and the regained strength and development of the domestic
financial sector does mitigate its exposure to tightening international credit conditions and an
increase in global risk aversion. The government's track record on macroeconomic management
provides reassurance in terms of the adoption of adequate policy responses to emerging
challenges from the international financial and economic environment. In order to mitigate the
impact of the global financial crisis and economic downturn, early October the authorities
activated a rules-based exchange rate intervention mechanism and proposed an expansion of
public expenditure in infrastructure for next year's budget.2 Inaddition, the government's quick
response to the potential social impacts of external shocks - for example, the increase in the
amount for conditional cash transfers during the food price shocks-is a sign that the
government stands ready to address the social consequences o f a potential economic downturn.
' Broadestnationalpoverty definition.
Announcement of the Programto EnhanceGrowth and Employment, last October 8,2008
http://www.apartados.hacienda.gob.mx/novedades/espano1/docs~2008/comunicados~comunicado~079~2008.pdf
1
Figures l(a)-(f)
HousingSector Finance Data
(a)A rapid expansion of the housing sector provided a (b)...and waspossible due to a rapid increase infinance
strong impulse to the construction sector and overall availablefor home acquisition.
economic activitv.. .
GDP, Construction and Housinginvestment Housing Investment and Finance
Annual Growth
10% 800
700 a Inwstment 89 Financd. -- - - -- - -
8%
fn 600
6% ElHousingInvestment 500
a. 400
C
4% -2.-300
zoo
2% a
100
0% 0
2004 2005 2006 2007 Jan-Jun 2003 2004 2005 2006 2007 2008"
2008
(e)A rapid increase in mortgagefinance by public and (d) ... has beenpartly funded by a nascent mortgage
orivate intermediaries ... backed securities industrv.
Mortgage Finance RMBS Issues and Amount Outstanding
(amount outstanding) 80
1,200 t
1,000
p 800
.-0
E 600
E 400
m
200
2003 2004 2005 2006 2007 2008- 2003 2004 2005 2006 2007 2008-
June July
(e) Unanticipated higher levels of domestic inflation (f,) ...on top of higher spreadsdemanded on Borhis
recently led to a sharp increase and steepening of the following the outbreak of the subprime crisis in the US.
yield curve ...
GovernmentBondYields Yield on RMBS Relativeto Government Bonds % ,
1,102
9.20
-Cetes 28 -Bond 3V .....
.................&I---=.J.......
Sources: SHF, SHCP, INEGI; Bankstaffcalculations.
Note that INFONAVIT is a public fund that finances house purchases by formal sector workers.
2
4. Mexico's macroeconomic policies are sound and allow for the adoption of adequate
policy responses to withstand the current financial crisis and economic downturn. Fiscal
policy i s based on a fiscal responsibility law that requires a balanced budget, and net public
indebtedness is just over 30 percent of GDP. The broader Public Sector Borrowing
Requirements (PSBR), which includes off-budget public expenditures, has fluctuated in a modest
range of 1to 2 percent of GDP in recent years. Inresponse to the rapidly deteriorating external
environment, the government reduced its public revenue estimate for the 2009 budget proposal
based on a downward adjustment to economic growth and a lower level of international oil
prices. At the same time the government proposes a public expenditure expansion increasing
next year's PSBR to 2.8 percent of GDP (compared to 2.0 percent projected earlier). The
considerable reduction in the net public debt-to-GDP ratio attained over the past five years
provides the space for the proposed countercyclical fiscal expansion. In terms of external
financing needs, the government acquired $8 billion last July from the central bank's
international reserves to cover its external debt service payments untilthe end of 2009.
5. Monetary policy is based on inflation-targeting that has established substantial
credibility in recent years. While higher commodity and food prices caused an increase in
consumer price inflation and a tightening of monetary policy earlier this year, the downturn in
economic activity may reduce price inflation faster than earlier expected. The accumulation of
international reserves, at $84 billion end-September 2008, allows the authorities to implement (as
of October 8) a rules-based exchange rate intervention mechanism to stem the sharply increased
and highly damaging volatility in the peso/dollar exchange rate during the ongoing global
financial crisis. Under this mechanism, the central bank holds a daily auction offering $400
million from the international reserves if the exchange rate depreciates by more than 2 percent
compared to the previous trading day.
Housing sector context.
6. The housing sector, supported by expanding mortgage finance, has been an
important component of recent economic growth. A detailed account o f the macro-financial
linkages i s provided in Annex 1. Investment in housing, which currently represents almost 6
percent of GDP, experienced a real annual growth rate of nine percent in 2006. An increased
availability of mortgages played an important role in this rapid growth. The total mortgage
portfolio nearly doubled between 2000 and 2007 and new mortgages now make up almost 40
percent of total investment in housing. Growth in the latter decelerated sharply during 2007 to
about three percent and slowed down further to about 1percent during the first half of this year.
Part of this deceleration is a consequence of the overall deceleration of income growth; however,
the maintenance of liquidity in mortgage markets - including the secondary market for mortgage
backed securities-- can limit the real impact on housing markets and the construction sector. See
Figures l(a)-(d).
7. The housing sector expansion in Mexico has been driven mostly by sector reform
and demographic fundamentals, and has resulted in increases in house prices; however
prices are still below the pre-1994 levels in real terms. After the sharp decline due to the mid-
nineties crisis, house prices only started to recover on early 19983. Since then, they have
Additional details are includedin Annex 1
3
increased steadily, but they still remain substantially below pre-1994 values in real terms--
suggesting that there is still room for growth in the ~ e c t o r(See Figure 2.) The median house
. ~
price funded through SHF in 2008 i s around $47,000, and the estimated price-to-income ratio is
4.5, which is considered to be a reasonable ratio by international standards.
Figure 2: HousePrices
UnitedStatesHousePrices Mexican House Prices
(S&P/Case-Shiller Home Price Index, June 2008) (Adjusted for Inflation, March2008 pesos)
UnitedStates HousePrices
(SBPICaseShillerHome Price hdex)
I 2151 I
1 195-
- -TWd
- -
~ 175-
j tm,on
155- :-: ...................................
* Average 8244
t.on.on
135 - f
;-
1
Kaon
Kaon'
rmm,
Source: Standard & Poors and SHF, with data from Sofec.
8. The turbulence inglobal financial markets has led to a rise insovereign spreads and
has had a direct impact on mortgage markets. As of October 13, the Mexico EMBI+ spread
had risen to 447 basis points over United States Treasury bonds after being in the 100 to 250
range for most of the last three years. This increase in the spread has a relatively limited
immediate impact on the fiscal accounts, as the federal government already met most of its
annual external financing needs at the start of 2008. On the other hand, the unexpected rise in
inflation mentioned above has steepened the yield curve in Mexico (see figure l(e)) increasing
the cost of longterm financing.
9. The international flight from mortgage-related securities has affected Mexican
securities markets. Domestic private pension funds are the most important investors in
Mexican residential mortgage backed securities (RMBS), but they have become reluctant to
purchase until the turmoil and uncertainty in international capital markets i s reduced.
International banks have instructed their local Mexican affiliates to reduce exposure to mortgage
backed securities, despite the strong performance and prudent and cautious structuring of these
instruments in Mexico. European hedge funds have sto ped purchasing Mexican RMBS. In
addition, the problems faced by international "monolineY' firms that insured subprime loans in
See the Ministry of Finance's assessment of the housing market in:
http://www.apartados.hacienda.gob.mx/sala~de~prensa/vocero/documentos/2OO8/vocero~4 1-2008.pdf.
"Monoliners" are financial institutionsspecializedin credit enhancement for specific lines of lending.
4
the United States have led them to cease offering guarantees on mortgage backed securities in
Mexico. Figure l(f) displays the impact of these market movements on Mexican residential
mortgage backed securities (Rh4BS) spreads over government bonds. The higher cost and
scarcity of capital market funding particularly harms the competitive position of non-bank
lenders such as "SOFOLES" (Sociedades Financieras de Objeto Limitado) because they lack
alternative deposit funding. Government inaction could have led to a stronger contraction in
mortgage lending, further dampening the construction sector duringthe economic slowdown, but
government agencieshave supported continued RMBS issuance as the crisis continued.
Box 1: Structure of HousingFinancein Mexico.
The Mexican housing finance market is segmented according to level of income and status of employment and can
be separated into public and private systems. The public system is the largest part, serving a limited number of
salaried workers in the formal sector of the economy. For these workers, a payroll deduction of 5 percent is
deposited in a housingsub-accountfor each worker that is managed by a housing provident fund (INFONAVIT for
workers in the private sector and FOVISSSTE for public sector employees). The housing sub-account makes up
part of each worker's pensionsavings and in case an individualhas not claimed resourcesfrom the account previous
to retirement, the accumulated amount (contributions and earnings) makes up part of the total pension savings.
Throughout his or her working life, an individual may request a mortgage loan to the provident fund. The
accumulatedsavings in the housing sub-accountthen serve as a down-payment and debt service payments are made
through automatic payroll deductions to a maximum amount of 25 percent of the wage. In practice, neither
INFONAVIT nor FOVISSSTE are able to meet the total demand for housing loans from qualified borrowers.
INFONAVIT manages this excess demand with a waiting list, which it has dramaticallyreduced in recent years by
improving operations. FOVISSSTE conducts lotteries to assign loans to qualified affiliates. In addition, each
institutionretains as a part of its membershipa populationof savers that do not earn enough to afford a market rate
mortgageon a fully constructedhouse.
A private system of housingfinance has developed to serve two groups: formal sector householdsin the uppermost
quintile of the income distribution who choose not to wait for an INFONAVIT or FOVISSSTE loan, and formal or
informal employees earning between the median and the 80thpercentile. In broad terms, banks serve the upper
quintile and SOFOLESserve the segment between the median and the 80thpercentile. SHF, as a second tier bank,
has supportedthe development of the privatehousingfinance by providingcredit to SOFOLESand mortgagedefault
insuranceto bothSOFOLES and banks.
INFONAVITcontinuesto dominatethe housingfinance market in Mexico with 60 percent of total mortgagefinance
outstanding and about 43 of mortgage originations in 2007. Commercial banks have expanded their mortgage
portfolio rapidly over the past few years and currently hold 30 percent of total mortgages outstanding, whereas
SOFOLESmaintaina market share of about 8 percent.
INFONAVIT, commercial banks and SOFOLES all have issued Residential Mortgage Backed Securities (Rh4BS)
based on their portfolio of mortgages.The RMBS of INFONAVIT have been brandedCEDEVIS, whereas SHF has
supportedissues by banks andSOFOLESunder the nameof Borhis.
10. During the last decade, the government took actions to successfully restart private
housing finance markets. After the crisis in the mid 199Os, commercial banks stopped lending
for residential mortgages. In response, the government adopted a range of policy, legal, and
institutional reforms that produced a doubling in the stock of residential mortgage lending and
started a secondary mortgage market. Thanks to these changes, the total number o f credits
produced now exceeds the rate of family formation. The Housing and Urban Development SAL
series and associated TA loans supported this reform program. Amongst specific policies, the
government:
5
a Fostered the growth of specialized non-bank financial intermediaries, SOFOLES (Sociedades
Financieras de Objeto Limitado). SOFOLESre-started mortgage lending with a combination
of long-term fundingfrom Sociedad Hipotecariu Federal (SHF) and the development of new
underwriting and monitoring technologies. SOFOLES have reached down market: they lend
to households earning an average of 8 minimum wages (MWs) (about $1,200 per month),
and reaching down as far as the median household income. The limited bank financing that
has been available usually has gone to households earning in the top quintile of the income
distribution.
a Helpeddevelop a credit bureau to collect andprovide reliable data to lenders.
e Improved the foreclosure process, as executed by regulators andlocal governments. In2003,
financial laws were enacted to facilitate the use of extrajudicial procedures.
a Developed laws related to asset securitization, such as creating the Certifzcado BursdtiZ
(bankingbond).
a Reformed the Comisio'n Nacional Bancaria y de Vulores (CNBV) to supervise securities
issuance and trading.
a Reformed the operations of ZNFONAVZT, the housing provident fund for private sector
employees, permitting it to contribute significantly to the growth inmortgage lending.
11 The Mexican government created Sociedad Hipotecaria Federal (SHF) in 2001 to
lead the developmentbfresidentialmortgage markets: As a second tier development bank,
SHF's major lending activity i s the extension of long-maturity credits to specialized financial
intermediaries that grant mortgages. To fund these credits, SHF issues long term debt with the
backing of the Mexican government, and at its inception used financing from a World Bank loan
to help initiate its activities. (See Annex 9 for more details on SHF's financing.) SHF has
provided guarantees for short term bank lines of credit to construction contractors to finance
house construction. For smaller SOFOLES, SHF has provided direct construction credit lines.
SHF has introduced mortgage default insurance for moderate income households, an important
credit enhancement at the loan level that contributes to mortgage affordability and facilitates
securitization. SHF sponsored legislation and regulations that permitted the entry of private
mortgage default insurers in the Mexican market, and two are now operating in upper-middle
income segments. SHF has supported legal andregulatory reforms that led to the introduction of
RMBS by SOFOLES and increasingly by commercial banks as they have returned to the
residential mortgage market. SHF acts as a market maker for RMBS issued by banks and
SOFOLs, and provides partial credit guarantees to support RMBS issues. It has started a small
but rapidly growing portfolio of credit lines that support housing micro-finance loans to low
income informal households. Leveraging its technical expertise, SHF has led a range of policy
reforms, including property appraisals, mortgage foreclosure, and title registries at the state level.
12. SHF hasa limitedmandate for privatemarketdevelopment. SHF was created in the
context o f the persistent absence o f commercial banks from mortgage lending after the 1995
crisis. SHF was capitalized with assets from the Fondo de Operacio'n y Financiamiento
6
Bancario a la Vivienda (FOVI).6 SHF's original organic law established a "sunset clause" in
two parts: 1) the provision of credit to financial intermediaries would end in 2009, and 2) the
federal government guarantee of new SHF debt issues would end in 2014.7 The government
intended to mobilize SHF to provide start-up funding for SOFOLES that would provide
mortgage credit to households that banks did not serve. The "sunset" provisions would
encourage SOFOLESto develop private funding through securitization, thereby limiting possible
market distortions and the contingent liability to the government of SHF funding. The sunset
clauses would also ensure that SHF would not be able to use its government backing to
monopolize fundingof mortgage markets. Inpractice, SHF has provided market-rate funding to
SOFOLES, and inturnSOFOLEShave provided market rate mortgages to individuals.' SHF has
been a leader in promulgating strong financial management practices internally and at
SOFOLES. Fundingby SHF and its predecessor FOVI of SOFOLES has been responsible for
the vast majority of private sector lending to households earning between the median and the
eightieth percentile of the income distribution between 1998 and 2006. Several SOFOLEShave
developed a significant market presence, and been purchased by commercial banks or foreign
investors that appreciated the value of their distribution networks for moderate and low income
households. Issuanceby SOFOLESin the RMBS market began in 2003.
13. The relatively small size of the mortgage market and its limited reach to low-
income, informal sector households has prompted the government to lift the sunset
provisionon SHF's second-tierlending. Despite the progress made in the past seven years,
mortgage lending has grown to only 9.2 percent of GDP, much smaller than in other emerging
markets such as Chile (14 percent) or Malaysia (36 percent) and far smaller than the 50 to 100
percent found in developed economies.' In Mexico, almost all mortgages are made to
households earning the median income or more and employed in the formal sector. A large part
of the demand for better quality housing comes from lower income households that are not
currently well served by either SOFOLES or banks." The government, including the Congress,
decided to lift the sunset clause on SHF lending so that it could replicate its success with middle
income earners and SOFOLES by developing other channels of distribution for still lower
income households. There are currently no plans to lift the sunset clause on the government
guarantee for SHFborrowings.
14. LiftingSHF's lendingsunset clause makes sense giventhe state of Mexico's housing
finance market, and the current turmoil in international markets. The eight year sunset
6 Part of the financingwas also providedby World BankLoanSCL-44430, FOVI Restructuring Project. This
project also supportedTA for the designand developmentof financial instrumentsthat SHFinitiated.
'*SHF
Existingcredits and bonds would be grandfatheredat each date.
and SOFOLEShave also collaboratedto distribute capital subsidies funded by the governmentto low income
borrowers. These subsidies take the form of a cash payment at the time of purchasethat reduces the required down
payment from the purchaser.These subsidies arejoined with mortgagedefault insuranceand a market-rate
mortgage, to makehousepurchase possiblefor householdsearning less than the median, between3 and 5 minimum
'
wages.
With a market only 50 percent larger than Mexico's relative to GDP, Chile has the potential to eliminate its
housing deficit within the next five years. Mortgage debt to GDP in 2006 was 100.8 percent in Denmark, 81.7
percent in Australia, 51.3 percent in Germany, and 83.1 percent in the United Kingdom. (Source: World Bank,
compiled by GCMNB from country statistics.)
I OAccording to CONAVI, between 2007 and 2012, half of the need for new housing will come from households
earning4 MW or less. CONAVI, Programa-Nacional-De-Vivienda-2007-20 12
7
clause for funding intermediaries envisioned that SOFOLES would develop independent funding
through the capital markets or other sources, thereby obviating the need for SHF funding, but
this objective has not yet been fully achieved. In practice, however, several have been active
issuers of residential mortgage-backed securities. In addition, an estimated 9 percent of
SOFOLES debt takes the form of short term lines of credit from commercial banks. These short
term lines are for three purposes: 1) cash management; 2) to fund construction lending to
contractors; and 3) so-called "warehouse" lines o f credit that fund the accumulation of mortgage
portfolios prior to securitization. A few SOFOLES have also been acquired by international
investors and banks, but have continued to serve moderate and low income customers, funded
with securitization and with funding from their acquirers. In the end, however, all SOFOLES
that have not been acquired by banks remain dependent at least in part on SHF funding,
particularly now that internationalcapital markets have largely ground to a halt.
15. SHFwill facilitate the continuingevolutionof the SOFOLindustry. Inspite of strong
credit performance, the Mexican RMBS market remains small and illiquid both for primary
issuance and secondary trading. (See Box 2.) The subprime crisis inthe UnitedStates has raised
substantial questions about the ability of mortgage lenders to survive with an "originate to
distribute" model that relies exclusively on securitization. Over the next five to ten years, more
SOFOLES are expected to combine or sell themselves to domestic or international institutions
that have sources of long term funding besides the capital markets." As SOFOLES have been
acquired by banks, they have replaced SHF funding with cheaper deposit funding. As SOFOLES
consolidate in the future, SHF plans to shift its lending role to support lenders that serve lower
income segments.
Box 2: Distinctions between SHF, US. Government SponsoredEntities (GSEs),
and Subprime Lending
(a) SHF has a much smaller market share. Where the GSEs back or own 47.9 percent of U.S. mortgages,
SHFfinances or backs6.9 percentof Mexico's mortgages, of 0.6 percentof GDP.
(b) SHF's public ownership eliminates the conflicting incentives that the GSEs faced as a result of their
public mission, private ownership, and public guarantee. SHF cannot issue equity. SHF's bond issues
come under the general government's borrowing limits. SHF's developmental role i s central, and it
has no growth obligation to shareholders.
(c) SHF`s origination standards are comparable to GSE prime loan standards, much stricter than those of
subprime mortgages.
(d) The structure of Mexican mortgage-backed securities (RMBS) i s much simpler and more transparent
than some of the more exotic structures that emerged in the UnitedStates and have been purchasedby
the GSEs.
(e) Issuers of RMBS in Mexico retain credit risk: Mexican issuers retain the servicing role and
subordinate bonds from each issue, thus maintainingan incentivefor the issuer to originate and service
the mortgageseffectively.
(f) The mortgage market in Mexico i s still very small and thin. SHF's mission i s not complete.
I'It should be notedthat other, shorter term consumer lenders are survivingwith capitalmarket funding.
8
Mexico and US.MortgigeMarkets
USD millions, June 2008 Mexico U.S.
GDP2007 1,022,815 13,163.W
Total Mortgages (1) 94,532 11,515,00(
Total RMBS oubtanding (2). (3) 6,516 7,554,16:
Mortgages as percent of GDP 9.2% 87.5'
RMBS aspercent of mortgages outstanding 6.9% 65.6'
SHF mortgage risk heldor guaranteed (4) 6,520
SHF remined RMBS 995
SHF mortgage riskfinancedor guaranteedas percent of market 69%
SHF's RMBS portfolio as percent of RMBS market 15.3%
GSE backedmortgages and securities
- 5.511.26'
GSEson-balance sheet RMBS 1.110,47:
GSEmortgagerisk guranteedas percent of market 41.9'
GSE RMBS on balance sheet as percent ofallRMBS 14.7'
Sources: Wodd Bank (for GDP), Barcode Mexico and FederalReserve(matgage balances), FannieMae andFreddieMac.
(I) includeswhdebans(nasecuritized)inbahnceshaets($88,016)andsecuritized($6,516),U.S.incluckssingle($10,699,903)
Mexico
andmultifamily ($875,100) lesickntial mmggedebt cutstandingat June.2008,wholeloans and securitized.
(2) Mexico includesW 7 3 i n Bmhisand$2,343 in CEDEVlsas of June, 2008 (Sources: SHF and Standardand Pmrs)
(3) US. hcludesGNMA.FNMk andFHUlC RMBS andCMOS and private4abelMBSCMOs, June, 2038. (Source:SIFMA)
(4)lnclu&s:$5560 million in loansto SOFOLS $2,Qr9 millionin rerainedBorhis, and $1,412 million credit expcsureof
mmgage insuranceon $S,409miUion malbalanceof rnongaFs (coverage is 25 percent of bssesin cax ofdefauh).
16. SHF's new business strategy,approvedinMarch 200812seeks to play a key role in
the marketdevelopment of housingfinancefor the householdsearningless thanthe median
(6 MWs or about $933 er month) through the Savings and Credit Institutions (SCI) or
SOFOLES (See Box 1).IT: SCIs are regulated financial intermediaries targeting lower income
households. SCIs include: savings and loan cooperatives (Cujus) and low income finance
companies (Sofipos). These intermediaries have been brought under regulation and supervision
through the implementation of the Popular Savings and Loans Law (Ley de Ahorro y Cridito
Popular), with World Bank support. Of the 660 institutions, 497 have adhered to the Ley de
Ahorro y Cridito Popular and 69 of these - which account for close to 50 percent of the total
membership and roughly the same percentage of total assets--are authorized to operate.
RegulatedSCIs such as Savings and Loans Cooperatives (Cujas),finance companies and micro-
finance banks have expanded their small credit offerings for home improvement. Despite this
expansion, home improvement loan portfolios (average credits of $500 to $750) remain
relatively small as a proportion of housing credit and no medium term and larger housing loans
are offered to date. Interest rates are high on short-term home improvement loans (an average
flat rate of 60 to 70 percent), creating a disincentive for more medium-term products. Yet,
without medium term (e.g. five to seven years) housing loan products, construction of new
houses will be limited - either on households' own plots, or on a subsidized serviced lot
provided by municipalities. The demand for such products is strong, however, according to
SCIs. In addition, SOFOLES themselves may develop products, with SHF's assistance, to reach
12The business strategy is available at www.shf.gob.mx.
l3The median householdincomeis about 5.5 MWs. SHF's strategydefines its target market as householdsearning
6MW or less.
9
the lower income groups. SOFOLES have been an important distribution channel for loans
accompanied by down payment subsidies.
Box 3: SHF's New StrategicPlan
In March 2008, SHF's Board of Directors approved a new strategic plan. It is not a radical departure
from earlier plans; however, SHF now foresees a continued role for lending, reflecting: first of all, the
need for government-sponsored liquidity support to the market for mortgage backed securities on a
temporary, cyclical basis; and secondly, the need to replicate the successful lending experience with
SOFOLES but now targeting the SCIs. The latter is a key factor for reaching the low income segments of
the population.
The strategic plan has ten objectives: (i) Promote greater efficiency and consolidate the housing market
for those who already have access to it; (ii)Promote access to credit and housing solutions for those
lacking access (through "aggressive" strategies of SHF); (iii)Promote a sufficient supply of housing
within a sustainable urban environment; (iv) Provide information and analysis of the housing market to
relevant actors; (v) Offer SHFproducts in a timely manner and with high standards of quality and service;
(vi) Complement and/or substitute SHF's fundingwith products and mechanismsthat satisfy the needs of
SHF's intermediaries; (vii) Provide liquidity to housing and infrastructure financial instruments at prices
that reflect their risk - and with full public information; (viii) Minimize the operational costs associated
with SHF's products and services; (ix) Devote development expenditures to projects with a high social
return; and (x) Obtain an adequate return that assuresthe sustainability of the institution.
17. SHF's role as a second tier lender for low income households may constructively
persist for many years. For all of its funding advantages, SHF's loans and guarantees
currently support only 6.9 percent of the total mortgage market, but provide a much larger
demonstration effect (See Box 2 and Annex 1 for more details). The development of SCIs as
lenders should not be undertaken with excessive expectations for a rapid increase in the volume
of credit disbursed. Rather, it should be measured in terms of the financial quality o f the
portfolios that are developed andthe provision of access to the credit recipients. Other countries
have successfully maintained a limited public presence in low-income lending without distorting
markets or suffering unexpected losses. Like SHF, Cagarnas in Malaysia has acted as an
efficient, publicly-owned second tier lender that has introduced new products and then steadily
reduced its market presence as the market grew around it. The U.S. Federal Housing
Administration (FHA)has provided mortgage default insurance for moderate income households
for more than seventy years without suffering undue losses, without interfering with the growth
of private mortgage insurance, and without becoming ensnared in the subprime crisis. Inrecent
years, 64 percent of loans insured by FHA were for households earning less than the median
income. FHA does this by maintaining actuarially sound reserves and pricing and accepting a
return on equity that i s lower than that earned by private mortgage insurers in higher income
brackets.
18. Given its mandate and experience, SHF is well positioned during this period of
global financial stress to provide liquidity to mortgage lending, and to reprise its role in
providing partial credit guarantees to RMBS issues, without distorting or dominating
markets. SHF's holdings of RMBS have increased from about 7.5 percent of the total
10
outstanding inthe market in mid2007 to 15.3 percent at the end of June, 2008.14 (See Box 1and
Annex 1 for more details.) As a result of rising interest rates on long term peso issuances, the
high cost of hedging prepayment risk, and the expectation that this would be a short-term
phenomenon, SHF financed these acquisitions with short term debt. Inany market conditions, it
would be expected that an institution like SHF would initially fund such purchases with short
termissuesthat are easily acceptedinthe market and inexpensive to issue. SHFhas developed a
short-term debt strategy in coordination with the Bank (see paragraph 41). World Bank funding
will permit SHF to refinance the funding of long term RMBS assets with matching liabilities.
Bank funding will provide a stable base for SHF's continued support of the RMBS market and
for its efforts to promote finance for lower income households via SCIs.
19. SHF has a track record of maintaining strong financial standards, and of
withdrawing from markets that have enjoyed strong private investment. SHF maintained
strong underwriting and documentation standards for mortgages for which it provides default
insurance in the face of substantial industry pressure to relax these standards. SHF withdrew
from the market for mortgage default insurance for upper-middle income borrowers once private
companies entered. SHF withdrew its product for financial guarantees for RMBS when monoline
firms and other multi-laterals provided coverage at more aggressive prices. Were SHF interested
in dominating any of these markets, it could have done so by exploiting its privileged funding
status to offer sub-market prices.
20. SHF has begun to modify its RMBS market support mechanism, and SHF seeks to
work with the Bank to further adapt this strategy with a view to reduceits RMBS holdings.
To support the RMBS market, SHF maintains a commitment to purchase up to 20 percent of
each primary issue. It generally tries to sell those securities to private investors immediately
following the initial issue. SHF also stands ready to purchase outstanding bonds on the
secondary market at market prices. Recently, SHF modified its commitment to support primary
issuances. It now requires that prospective RMBS issuers and underwriters demonstrate demand
for at least 65 percent of the issuance before SHE will agree to back it. This reduces the risk of
SHFtakingmore than 20 percent of the issuance. Beyond this change, SHFseeks to work with
Bank experts on fixed income trading to develop more sophisticated policies for participation in
the RMBS market.
21. SHF has about $6 billion in assets and a strong level of capitalization.'' On the asset
side of the balance sheet, the average remaining maturity i s just over 20 years for loans and 22
years for inflation indexed (UDI) RMBS and 25 years for non-indexed RMBSs. Effective
maturities are shorter due to frequent prepayments - some driven by consumer prepayments but
14Total market is defined as Borhis that are issuedby SOFOLES and banks, an'd CEDEVIS issuedby INFONAVIT.
Note that SHF has an obligation as market maker to purchase up to 20 percent of all new issues. There were two
issues - one in December 2007 and one in February 2008-where SHF purchased 60 and 65 percent of the
respective issues. In later transactions, SHF purchased about 20 percentof the original issue. SHF only initiated its
''
purchases of RMBS at the end of 2005. Precedingthe market turbulence of 2007, SHF generally held less than 10
ercent of the outstandingstock of RMBS.
The National Banking Commission(CNBV) reporteda capitalization index of 14.30percentfor SHF. The CNBV
also reported a delinquency rate of 0.75 percent, for a capital coverage ratio of 1,004.4 percent-higher than any
other Mexican development bank. See CNBV's Boletin de Prensa, Banca de Desarrollo, No. 4412008, dated
September4, 2008. The report is availableat www.cnbv.gob.mx.
11
others driven by financial intermediaries' issuance of RMBSs. The weighted average yield on
the asset side of the balance sheet i s about 10percent.
22. On the liability side, financing is dominated by medium to long term debt
instruments and loans from multilateral agencies. CEBUR (Certificados Bursdtiles) bonds
are of 15 or 25 year maturities, and the current average remaining maturity is about 12 years.
The CEDES (Certificados de Depo'sito)are originally issued as medium-termdebt instruments;
however, as noted inthe table below, about half are now due in the coming 12 months. Pugarks
con rendimiento liquidado a1 vencimiento (PRLVs) are short term liabilities rolled over monthly.
The weighted average yield for SHF's existing debt i s about 8.9 percent. Overall, the average
weighted time to maturity (as of July 2008) for the assets is 18.1 years compared to 8.7 years for
the 1iabilities.l6
23. SHF's relatively low leverage ratio and history of matched funding set itapartfrom
the highly leveraged firms that have recently failed. SHF's 7 to 1leverage ratio i s lower than
Base1 I1norms for commercial banks of 10 to 1, and substantially lower than failed broker-
dealers that reached levels of 31 to l.I7 Where most non-bank lenders in the U.S. funded
themselves exclusively with short term debt, SHF has reached 30 percent short term debt in this
time of crisis, and is actively looking for a means to reducethat percentage in recognition of the
associated risk. SHF's ability to increase its leverage is controlled by the Congress and by
Haciendaas part of the government's borrowingprogram.
Table 1:Simplified SHF Balance Sheet (June 30,2008)
(Dollars, Millions)
Assets I Liabilities
Loansto support mortgages* 4,1131Long term 2,304
Bridge Loans (construction 65 CEBUR (longterm inflation linked bonds) 1,218
Micro-credits 37 CEDES 584
Other loans 142 IDB 232
'IBRD 270
Borhis (Mortgage Backed Securities) 995
Short tern 1,945
CEDES 612
PRLV 993
Cash 27E BANXICOopen marketoperations 340
Reservesrequiredbycentral bank 501 I
Total 6,1291Total** 4,249
Capital(Totalfinancial assets liabilities)
- 1,879
Memorandum:
* Nearly 80 percent are indexedto inflation
** Totalfinancial liabilities represent about 0.5 percent of GDP
Note that the augmented balance sheet includes about $1.2 billion in open swap contracts (interest rate and currency
swaps).that broadly cancel themselves out. See Annex 9 for details. Source: SHF, Bank staff calculations.
l6Refers to contractual time left -- not accounting for possible prepayments.
"Source:LehmanBrothersAnnualReport2007Highlights
12
24. The buildup of short-term debt was a proactive response to short term and longer
term market imperfections in Mexico. Even though SHF borrows at government rates, inlocal
markets it i s not able to find long term peso funding that has an embedded call structure that
matches that of its assets. Were SHF to borrow long term in pesos to match the contractual
maturity of its peso assets, it faces market risk should the RMBS or loans to intermediaries
prepay more quickly than expected. This lack of borrowing choices results from the
underdeveloped Mexican corporate debt and derivatives markets. Domestic credit to the private
sector was 23 percent of GDP in 2006, versus 83 percent in Chile, and 176 percent in the United
Kingdom.'* The relatively small market of RMBS made up 25 percent of corporate debt
outstanding in March, 2008.l 9 Given the turbulence in international financial markets, both
domestic credit and RMBS issuances are likely to fall in 2008 in relation to previous years. Only
recently has the government been able to maintain the yield curve with regular issues out to
twenty years. The market in interest rate derivatives i s small and trading i s thin, contributing to
higher costs. Above all, SHF had not envisioned carrying the additional RMBS portfolio for the
long-run. However, the current investor fear of any security backed by mortgages reduces
demand for the bonds.
25. The proposed operation provides an opportunity to offer the World Bank's position
as a triple-A derivatives counterparty to a second-tier lender that operates in a market that
lacks such products. The Bank may offer a loan with a fixed peso rate and an embedded call
option. Inthis case, the cost of the call would be embedded in the borrowing spread. In general,
the Bank offers a spread that i s 50 basis points below SHF's funding cost. Jf the cost o f the call
proves excessive, then SHF may wish to borrow variable rate pesos at a fixed spread. Then, it
will ensure a match between assets and liabilities on a variable rate basis, and will offer variable
rate funding to its SCIclients.
26. Restructuring short term debt would allow SHF to support mortgage growth by
SOFOLES during turbulent financial conditions in international markets, and it would
provide financial space for implementing its medium term objective of improving access to
affordable mortgages for the poor. Since RMBS and credit to SOFOLs have 20 year
maturities prepayment risk, the World Bank credit will permit SHF to better match the duration
of its assets and liabilities. SHF will continue to play a supportive role for the regular mortgage
sector; however, it will have to refocus its financial support activities much more deliberately to
bridge the current gap in the housing finance market. It i s in this market gap that SHF has
positioned its new strategic role. SHF will develop SCIs as distribution channels for credit to
low income households.
27. SHF will continue to apply prudent origination practices while moving down-
market. The Mexican mortgage market i s comparable to the United States prime market in
terms of origination practices and credit performance. Mortgages that back Mexican RMBS are
underwritten with full documentation of borrowers' credit history and capacity to pay.
Mortgages that benefit from mortgage default insurance from SHF are reviewed twice for
adequate documentation, once by the lender, and once b y SHF as insurer. The private mortgage
insurers that have entered the upper end of the market also review each loan that they insure.
'*Source: DEC
Source: Banco de Mbico, Reporte Sobre el SistemaFinancier0 2008.
13
SOFOLES and banks that act as servicers are rated for the efficiency and quality of their
operations. The averagedefault rate for mortgages at commercial banks fell from 12.6 percent in
2000 to 2.9 percent in 2006, a rate comparable to the recent performance of prime loans in the
As of August 2008, non-performing loans in the housing sector were only 3.2 percent of
portfolios.21 Default rates on securitized SOFOL portfolios have risen in the past year but
remained within expected ranges, as households have suffered from higher inflation and
unemployment. The July, 2008 report for one Su Cusitu security issued in 2006 showed a
weighted averageLTV at origination of 74 percent, and a cumulative 90 day delinquency rate of
2.78 percentinthe two and a half years since origination.22
28. To manage the risk of working with new intermediaries, SHF has developed
eligibility criteria to access funding for new institutions. First, SHF will only on-lend to those
SCIs that have been authorized by the CNBV and hence adhere fully to the Ley de Ahorro y
Crbdito Popular. This implies that intermediaries have capital reserves according to their risk
exposure and minimum capital requirements relative to their assets. They must also have
decision-making proceduresinplace that involve external advisors, general assembliesandcredit
committees. Other requirements include fully established internal control processes and
compliance with the accounting standards issued by CNBV. Secondly, SHF requires a ratio of
non-performing loans below 10percent and a capitalization index above 10percent. Third, SCIs
will have to follow SHF loan origination standards and valuation methodology and will have to
report monthly on their financial information and beneficiaries. Origination standards limit the
monthly payment to income ratio to 30 percent, require mortgage default insurance for loans
with loan-to-value ratios above 80 percent, and require borrowers to make at least a 5 percent
down payment. For long-term funding, SHF will also requirethat SCI staff complete the training
program developedby SHF for SCI staff. SHF's strategy to work with new intermediaries in the
medium-term will only support the primary market. Securitized mortgage lending for low
income households will wait until portfolios are accumulated and additional analysis on the
associatedrisks i s undertaken.
2oSource: BBVA Situacidn Inmobiliaria 2008. The high default rate in 2000 reflected lingering resolutions from the
crisis o f the mid-1990s. Defaults at banks have fallen as they have worked out of old portfolios and increased new
originations. The housing boom in the United States led prime borrowers to borrow increasing amounts against their
homes. As house prices in the United States have fallen, delinquency rates on prime mortgages have risen from 2.58
ercent in the secondquarter of 2007 to 3.71 percent at the end of the first quarter, 2008.
See SHCP, Informe Semanal, October 6-10-available at www.shcp.gob.mx.
22Security number BRHSCCB 0602, performance report available at
http://www.sucasitainvestors.com,mx/Index.aspx?tab=4&seccion=3
14
B. Rationale for World Bank Group involvement
29. Since the late 1990s, the World Bank Group has worked intensively with the
Government of Mexico on housing finance, development banks and financial system
development. Bank Group assistance has included an assortment of instruments: from analytic
reports to targeted technical assistance and from specific investment loans to policy based
lending. Inthe late 1990s the dialogue focused on the recovery of the financial system from the
dramatic 1995 crisis. Later, it was possible to focus on broader issues of access to finance and
the enablingenvironment for housing and urbande~elopment.~~Mexico was an early participant
in the joint Bank-IMFFinancial Sector Assessment Program (FSAP), which was followed by an
update in 2005. An NLTA last year included (among other topics) a review of development
banks. On the lending side, the most recent instrumentsof support were a series of Housing and
Urban Development policy based loans, totaling $500 million-the most recent of which was
approved in December 2007. This series was accompanied by a technical assistance loan that i s
still under implementation.
30. There has been close collaboration across the World Bank Group as well. The IFC
and IBRD worked together on technical assistance for property and commercial registries.
Complementary to IBRD's Housing and Urban Development Structural Adjustment Loan
(HUSAL) series focusing on the policy framework, IFC made investments in private sector
financial intermediaries. The IFC has provided technical assistance for business processes and
information technology to four mortgage SOFOLES and one commercial bank, in partnership
with SHF. The IFC i s also discussing with SHF a plan for providing similar assistance to SCIs
to assist in their outreach to low income households. In the recent past, IFC has made equity
investments in SOFOLES and supported the issuance of several SOFOLES' RMBSs. The IFC
Board recently approved a $150 million equivalent Housing Finance Intervention Facility24
which would offer both unfunded partial credit guarantees, as well as funded mezzanine credit
enhancements for lower middle-income RMBS, and also make case-by-case backstop purchases
of RMBS "senior risk" tranches in order to facilitate full placement of any particular transaction
with private sector investors. The effort i s being coordinated with the private sector branch of
the IDB, which i s setting up a similar $150 million equivalent facility. This facility i s extremely
complementary of this proposed IBRD loan in that it would lower the probability of
interventions by SHF in the RMBS market, thus giving SHF more space to focus on moving
towards lower income segments of the population. The IFC has been consulted fully during the
process of project preparation for this proposed loan.
23 See,for example, Mexico Low Income Housing: Issues and Options, Report No. 22534,2002. FSAP memo
(2002) and FSAPupdate (2006).
24 See Board document IFCR2008-0304. Approved by the Board of Directors on October 2,2008.
15
Schematic: World Bank Group Support
Deepening the RMBS Market Market Access
Beneficiaries:
Beneficiaries: Across the income scale < 6 MinimumWages
RMBS
Sellers n Buvers
Housina Finance Financinq
Providers Source
-
-Banks -1nfonavit _+ -Payrolltaxes
-Deposits
-Banks \ ;;;ita;
SOFOLES Reduced (incipient)
SHF Role for
SHF
I E++NewFacility
-SCls (small
volume)
IBRD IFC
-Propertyregistries -Businessregistries
-FinancialSectorAAA -InformationTechnology
-Regulation and supervisionof SCIs -Advisory servicesto financialinstitutions
31. The Government of Mexico and SHF have requestedBank assistanceto addresstwo
challenges: (1) how to reach further down market with mortgage and micro lending, and
(2) how to consolidate mortgage markets during the current global financial turbulence.
The Bank's support is both financial and technical. The Bank's financing provides the best
terms available to SHF for restructuring its liabilities. Bank's involvement in the technical
assistance component would help SHF identify the best strategies andinstrumentsto reach lower
income households and to align SHF's activities with those of other government agencies
involved in implementing lower income housing policies. The proposed loan represents a
natural continuation of the support the Bank has provided to the government in developing
private housing finance markets during the last decade. It would support SHF as it seeks to
expand access to finance as well as strengthen existing financial intermediation during a period
of marketturbulence.
16
C. Higherlevel objectivesand WorldBankstrategy
32. The Calderdn administration has maintained the previous government's
commitment to address Mexico's critical housing needs. The National Development Plan
(NDP) 2007-2012 aims to increase access to housing for the poorest segments of the population
in an orderly, rational, and sustainablecontext.25 The NDP also promotes the development and
"democratization" of the financial system. The NDP emerged from the consultations conducted
by the federal government in 205 fora during the second semester of 2006. Some key higher
levelobjectivesof the NDP, associated with this proposedloan are as follows:
0 Increasecoverage and variety of available housing finance options.
0 "Democratize" the financial systemwithout putting inriskthe solvency of the systemand
strengthening the system's capacity to unleash growth, equity and economic
development.
0 Increase supply of adequate landfor housing construction and economic development.
0 Consolidate the National HousingSystem.
0 Generate a dynamic usedhousing market and assist the development of an efficient rental
market.
0 Promote housing improvement and create conditions to foster progressive housing and
social housing production through alternative financial products and support for the
lower-income population.
33. One of the strategies for democratizingthe financial system is to improvethe focus
of development banks, like SHF, on expandingaccess for priority groups not serviced by
the privatebankingsystem (see figure 3). SHF's mediumterm strategy is focused on working
with new financial intermediaries (e.g., Savings and Credit Institutions) that have a better
knowledge base for reaching lower income customers. In addition, the government has
implemented a number of measures, including an expansion of the housing subsidy program.
FromJanuary through June this year, 150,000 subsidies have been allocated, 90 percent of these
to householdsearningbelow three minimumwages.26
25 The National Development Plan 2007-2012 may be seen at http:NDnd.presidencia.Eob.mx/index.html.The section
on housing and construction may be seen at
http://pnd.calderon.presidencia.pob.mxlpdflEie2 Economia Competitiva v Generadora de Empleod2 13 Constr
uccion v Vivienda.pdf
26Segundo Informe de Gobierno, Presidenciade la Repdblica, Septiembre 2008
17
Figure 3. Volume of new lending: percentageof total targeted to less than 6 MW,
2005 2013 [2009 2013 projected, excludes micro-loans]
- -
60%
50%
40%
30%
20%
10%
0% 8 - r
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: SHF and Bank staff estimates.
34. The 2008-2013 Country Partnership Strategy (CPS) is aligned with the
government's own development strategy. Inthis sense, the proposedproject is fully consistent
with the CPS in that it addresses the government higher level objectives described above.
Perhaps more importantly is that the proposed loan would follow the "principles of Bank Group
engagement" laid out in the CPS: flexibility, fast response, selectivity, competitive IBRD
pricing, and coordinated World Bank Group support. As a result of the Bank's deep knowledge
of the housing sector and the continuous dialogue on housing issues, the Bank was able to
respondquickly to the Mexican government's request to prepare the proposedloan. Apart from
the Bank's technical assistance, another key element that makes the proposed loan attractive to
SHF is the pricing of the loan - given the IBRD pricing reform of last year -- as well as the
flexibility of financial options offered by the loan (cost effective currency and interest rate swaps
and prepaymentclauses). Finally, the proposedproject represents a continuation of coordinated
efforts across the World Bank Group over the years, as IBRD policy dialogue and lending to
government agencies has been complemented by a strategic alliance between the IFC and SHF,
along with targeted IFC investments and advisory services to incipient private sector financial
institutions.
35. The proposed loan amount implies larger annual financing than established in the
CPS. The CPS envisioned lending on the order of $800 million per year; however, it also stated
that the demand for the Bank's lending would depend upon "IBRD pricing competitiveness and
evolving marketconditions"?' and lending volumes would be adjustedaccordingly.
''Country Partnership Strategyfor the United Mexican States,World Bank Report No.42846-MX, paragraph 43.
18
11. PROJECTDESCRIPTION
A. Lending instrument
36. The proposed project is a sector investment loan (SIL) for $1.01 billion with an
expected implementation period of approximately three-and-a-half years. It has two
components: (a) Component 1 for $1 billion to restructure SHF's short-term debt, in order to
provide SHF with the financial capacity to implement its strategy; (b) Component 2 for $7.5
million that would support technical assistance that enhances SHF's technical capacity to
implement its strategy. Component 1 i s expected to be disbursed in two installments over the
first six months of implementation; however, the smaller amounts associated with the technical
assistance (TA) component are expected to be disbursed more gradually.
37. Since Bank policy does not allow DPLs to state enterprises, and in this case to SHF,
and in view of the country's preference for the investment instrument, the Bank developed
a framework that would allow the structuring of this operation as an investment project.
The eligible expenditures against which the Bank would disburse consist of the payment of S H F
short-term debt, essentially substitutingIBRD long-term debt in its place. This restructuring o f
SHF`s debt profile will strengthen Mexican housing finance markets by enabling S H F to, inter
alia, provide more second-tier support for the issuance of mortgages in Mexico, with a particular
emphasis on supporting the issuance of mortgages for the under-served poorer segments of the
population, which would constitute a productive purpose of the loan.
38. To reflect the link between the eligible expenditures and the project's objectives, the
Bank and the Borrower have developed a set of monitoring indicators that would track
progress in meeting those objectives. These indicators would have to be met in order for the
borrower to receive full disbursement of all loan proceeds allocated to Component 1 of the
proposed project and comply with its covenanted obligations to the Bank. It should be noted that
market consolidation i s an equally important dimension of the project objectives; however, given
changing market conditions, it i s not practical to include binding targets for SHF's activities in
this areainthe short term indicators below.
B. Project development objective and key indicators
39. The main objective of the project is: (a) to strengthen the financial capacity of SHF to
develop and consolidate markets for housing finance and to expand access to lower income
groups over the medium-term; and (b) to improve SHF's technical capacity to expand access to
lower income groups over the medium-term.
40. The proposed project incorporates a set of indicators to monitor achievement of the
outcomes and outputs in three levels:
Higher order outcome indicator: SHF contributes along with other government agencies to the
development of housing markets with the ultimate goal of increasing access to housing for the
population. In line with the CPS results framework, the number of housing solutions delivered
19
per year will be monitored**. This indicator is oriented toward achieving realistic outcomes inthe
overall sector context and is expected to meet target values of one million solutions per year, an
increase from the 750,000 average year housing solutions for the period 2001-2006. This
indicator will be monitored annually.
Table 2: Higher Order OutcomeIndicator
(avg. 2001-2006) (avg. 2007-2012)
Number of housing solutions delivered per 750,000 1million
Short term indicators and targets. These indicators are short term targets relevant for the
implementation of the debt restructuring component. It i s expected that most of the funds would
be disbursedintwo large disbursement advances of approximately US$500million each. Target
values for the indicators in Table 3 will serve to reflect progress towards the productive purpose
of the proposed loan - as such, they are binding targets for the full disbursement of the loan
amounts allocated to debt restructuring.
+ The projected values of the mid-term and final indicators (Columns B and C of Table 3
below) are cumulative starting one year before disbursement of the second advance (in
the case of mid-term indicators in Column B) and one year before any subsequent
disbursement(inthe case of the final indicators inColum C). IfColumn Btargets are not
met, then only an advance will be made proportional to the degree of compliance. The
remainder would be set aside and disbursed at the end of Component 1 only if the
Column C targets are met.
** Housing solutions- a term used by the National Housing Commission -includescredits and subsidies for
acquisition of new or used housing, housingimprovementor self-construction.
20
Table 3: Key Performance Indicators
fl A B C
July 1,2007 Mid-term Finalindicators
Period through Indicators
June 30,
2008 (2nd (Endof
Indicator (Baseline) Disbursement) Component 1)
1. Totalnumber of Micro-credits 73,903 80,000 84,000
supportedby SHF within the period
2. Percentagethat (a) number of 74% 75% 76%
Mortgagessupportedby SHF
duringthe periodto households
earningup to 6MW plus Micro-
credits supportedby SHF duringthe
periodrepresentsof (b) total
number of Mortgagesplus Micro-
credits supportedby SHFduringthe
period
3. Total value of new Mortgages MX$20,700 MX$22,000 MX$23,000
(includes loans supportedin the million million million
primary and secondary market) plus
total value of new Micro-creditsand
Liquidity Linessupportedduring
the period
Fiduciary:
Verification of use of WB funds for
debt restructuring
Financial I
Approval of SHF's new short-term
debt policy by its Board Prior to LoanEffectiveness
To ensure sustainability of the project's objective, SHF has formulated a new policy
statement on short-term debt management, in consultation with the Bank during projet
preparation. The management of short term risks to the balance sheet would be in three
parts: (i) limits on short-term debt (liabilities maturing and amortization due during the
next 12 months) as a share of total liabilities; (ii) a policy target of zero for the duration
of equity (a measure of the mismatch between duration of assets and duration of
liabilities), along with a range of limits that should not be breached during normal and
"exceptional" periods; and (iii) Value at Risk (VaR) analysis of all major categories of
assets. "Exceptional" periods would be determined institutionally via an internal
advisory group on finance and investment matters. This group would evaluate the need
for SHFsupport inconsolidating marketsduring periods of market turbulence.
The critical values in the policy statement are of up to 20 percent of short term debt to
total liabilities for normal times and up to 35 percent during exceptional times. The
21
policy also includes limits of +2 and -2 for duration of equity (a measureof the difference
between the duration of assets and liabilities) during normal times and -4 and +4 for
duration of equity during "exceptional" times and commitment to developing a
methodology for establishing "Value at Risk" (VaR) limits for each category of assets.
(VaR i s a methodology for statistically evaluating the probability that losses from a
portfolio exceedacertain critical threshold.)
* This policy would be approved by the Board of Directors of SHF as a condition of
effectiveness for the proposed loan. In other words, no disbursement advances will be
made prior to approval of the policy by SHF's Board. A minimum of two months will
pass from effectiveness to secondtranche disbursement.
Monitoring indicators*': In the medium term, the proposed loan will enable SHF to increase
access to housing finance for the lower income households. Results would be monitored through
the indicators listed below. SHF and the Bank will monitor this group of indicators will be
monitored bi-annually during the implementation and supervision process.
Table 4: MonitoringIndicators
Indicators Base line
(June 2008)
1.Total number of new mortgage loans 16,342
2. Total amount of mortgage credit to private sector intermediaries 4,113
(US$million)
3. Percentageof mortgage loans to householdsearning between 1- 13%
6 MW from total number of loans
4. Percentageof the amount of new lending to householdsearning 10%
between 1- 6 MW from total amount of lending
5. Percentageof mortgage loans to householdsearningbetween 6 - 25%
16MW to total numberof loans
6. Percentageof the amount of new lending to householdsearning 36%
between 6 - 16 MW from total amount of lending
7. Number of mortgage loans to informal sector workers 3,500
8. Number of additional financial intermediaries working with SHF 23
funding and/or products
9. Amount issued through BORHIS (Banks andSOFOLES) 730
(US$ millions)
10.Percentageof total BORHIS outstanding heldby SHF 25%
11.Percentageof short-term debt as ashare of total liabilities 30%
(including notional value of swap contracts)
12. Duration of eauitv 2.2
*'Annex3 includes a detailed version of this section.
22
Figures4(a)-(f): Selected intermediateindicators
a) Housing solutions have achieved an average of 6 ) ....with the I-6MW population being increasingly dominant
750,000per yearfor theperiod 2001-2006... among the number of new mortgage and micro loans.
-
Housing solutions, selectedyears Number of Mortgageand Micro Loans
WOWS)
1,400 3 / I 70 WO " " _ " ._
I
t
I
1,200 60 ow ,
3 1,000 MWO
Uc 800
Lo
a 600
400
200
0
2000 2005 2006 2007 2008' I
Dee-04 Jun-05 Dee43 hn.06 Dec-06 Jun-07 Dec-07 Jun-08 I
c) Even though the 1-6MWbracket has only reached d) The micro loan category alone (I-6MW)has grownfrom
10%in terms of the total amount of mortgage and 2% in December 2006 to 34% by July 2008 in terms of
micro new lending... number of loans.. .
Numberof Mortgageand MicroLoans Amount of Mortgageand Micro Lending
(%of Total, Flows) I (%of Tolai, Flows)
5% -
___.__....
4
0s- - , ,
Dee- Jun- Dec- Jun. Dec- Jun- Doc- Jun- Dec- Jun- Dec- Jun- Lhc- Jun. Dec- An-
04 05 05 06 05 07 07 08 04 05 05 06 06 07 07 08
e)... and outreach has seen a big increase in 2008 to impact
non wage earners in the I-6MW bracket.
Outreach
byIncome Level and SalaryStatus
23
C. Project components
Component 1:Debt restructuring ($1,000 million).
41. This component would provide long term funding so that SHF can match the
maturity and option structure of its assets, and in order to fund its expansion into lower
income segments on a sustainable basis. In its effort to support the mortgage securitization
market, SHF's RMBS holdings increased from 7.5 percent of total outstanding in the market in
October, 2007 to 15.3 at the endof June, 2008. As notedabove, SHF's long term financing costs
in local marketshave increased. IBRD financing provides lower cost, longer maturity andmore
favorable repayment options compared to current conditions in local markets. The IBRD can
make use of its triple-A status in international capital markets to provide SHF with funding
options that are otherwise not available to SHF even with its sovereignbacking. Without a debt
restructuring, rollover and term mismatch risk could limit SHF's ability to continue supporting
existing markets and limit its efforts to develop lower income housing finance markets via
Savings and Credit Institutions.
42. SHF is well capitalized. The issuanceof short-term debt is an instrument that SHF
has used in the past as an inexpensive means of making purchases of securities in the
RMBS market to be held for short time periods. The level of short-term debt has reached
around $1.9 billion, or about 30 percent of assets. It has reachedthis level before, such as at the
time of the presidential transition, a traditionally turbulent period for Mexican financial markets.
Maintaining a certain amount of short term debt has allowed the institution to adjust
continuously to the pre-payments made by mortgage holders and by SOFOLES in the past as
they accessed other sources of funding. Pre-payment risk is difficult and expensive to hedge
using the domestic capital market. Holding short term debt is not a problemper se, but given
that RMBS and credits to SCIs and SOFOLS are long maturity and many are fixed real rate,
holding too much short term debt raises refinancing and liquidity risk. Indeed all Mexican
development banks hold a large proportion of short term debt relative to their liabilities, as long
term debt instrumentsare relatively new in the market.
43. SHF's balance sheet mismatch, although not desirable, is not the resultof a crisis or
emergency situation with its own finances. The fastest and cheapest way to finance SHF's
RMBS acquisitions has beento issue short term notes with the intention to later refinance them
with longer term debt. As a state-owned entity with the full backing of the national government,
SHF is able to roll over its short term positions as well as the government. However, Mexico is
not a triple-A credit in international markets, and the costs of rolling over its positions may rise.
Refinancing with World Bank debt is a recognition that SHF may need to hold the RMBS it has
acquired for longer than it had expectedto. By refinancing a portion of its short term debt, SHF
gains funding stability in a turbulent time as it supports the consolidation of mortgage markets
andexpands access to lower income segments. The proposedloan-along with financial options
offered by the Bank's Treasury-would improve the financial sustainability of SHF.
24
Component 2: Technical Assistance (TA) critical for the implementation of SHF's new
strategic plan 2008-2012 focused on expanding housing finance to currently underserved
population ($7.475 million).
44. Three main areas for technical assistance were identified linked to priorities in the
strategic plan. These are mentioned below, further detail i s provided inAnnex 4.
1. Development of new business lines and strategies, the related internal re-engineering of
SHF procedures and back-office risk assessment and management systems, including
changes to the mechanism for RMBS market support. The new business lines would be
focused on how to improve access to housing finance for lower income groups.
2. Implementation of data collection systems on the mortgage and broader housingfinance
sector3', and monitoring and evaluation systems for SHF administered programs.
3. Development of instruments and capacity buildingto strengthen existing SCIs and NGO
lenders to become more effective housing finance providers. This capacity building i s
critical for improving housingfinance for lower income groups.
45. To avoid duplication with existing efforts it is envisaged that several activities
included in the technical assistance will be financed jointly with other development or
government agencies and incorporate beneficiary participation. For example, the capacity
building activities to some CSI and NGO lenders could be financed jointly with the IFC through
a co-financing scheme between SHF, IFC and the beneficiary CSI. In this case, each agency
would be responsible for the implementation of their financed activities while keeping and
overall coordination amongst them. In no case can loan proceeds be used to implement, execute
or contract directly with the IFC for these capacity building activities since it i s part of the Bank
Group.
D. Lessonslearnedand reflected inthe project design
46. The proposed loan draws upon a strong dialogue in the housing sector between the
Bank and the Government of Mexico in recent years. Importantly, the proposed loan draws
on the experience and results of the now-closed FOVUSI-IF operation, approved in 1999 and
designed to provide liquidity and technical assistance to reform SHF in its role to lead the
development of primary and secondary mortgage markets for middle-income households. In
2004, 2005 and 2007 the programmatic series of SAL and DPLs supported broader sector
reforms on housing subsidies, expansion of the housing finance and savings programs to lower
income segments, slum upgrading and fostering low- and moderate-income land development.
The associatedHousing and UrbanTechnical Assistance Loan (HUTAL)-which is scheduledto
close in December 2008 - supports the design and implementation of the policies and reforms
under the series of SAL and DPL I1& I11loans. Inaddition, the Bank has worked on two fee
basedcontracts with SHF to provide specific technical assistanceon housing finance.
''Current information on the mortgage sector i s incomplete and does not allow for rigorous analysis of market
behavior. Changes in the Ley de Transparencia y Acceso a la Informacidn ,which are expected to be passed by the
end of this year, have designated SHF as the institution tasked with the collection and analysis of standardized
national mortgage sector information--a task for which it is currently not fully prepared.
25
47. The proposed loan also has benefited from close coordination with the
Environmental Sustainability DPL (P95510) approved by the Board in early O~tober.~'
The main objective of the latter is to mainstreamenvironmental considerations in sector policy-
making and to improve the environmental secretariat's (SEMARNAT) capacity to collaborate
with other agencies. Given the importance of the housing sector to the economy, SEMARNAT
decided to include this sector in the third operation, supporting the efforts being taken by the
National Housing Commission to (a) develop a housing construction code and (b) issue
sustainability criteria for housing developments linkedto the mainup-front subsidy program.
E. Alternatives consideredand reasonsfor rejection
48. Development Policy Loan (DPL) with an accompanying TA loan. Froma substantive
perspective, the proposed operation has a strong development policy base underlying the fast
disbursing component. SHF's actions to support the mortgage-backed security market and the
implementation of its revised mediumterm strategy represent important policy actions. A DPL
could have been accompanied by a small TA loan made up of the activities described in
Component 2 above. This alternative was rejected, since IBRD policies explicitly state that
DPLs can be extended to federal and subnational governments (the latter with a sovereign
guarantee). A development bank like SHF, even if fully owned by the federal government, does
not qualify to be a recipient of a DPL.
49. Adaptable Program Loan (APL). It is possible that the first operation will be followed
by a second loan of a similar structure; however, the need for the type of fast disbursing
financing involved in Component 1 will depend upon market circumstances. Given the
uncertainties in this regard, it would be more prudent to process as a single SIL. If needed, an
additional loan could be prepared in the future in the spirit of the flexible CPS for 2008-2013
(discussedabove).
50. Financial Intermediary Loan (FIL). A Financial Intermediary Loan (FIL) is a
specialized Sector Investment Loan (SIL) geared towards financial intermediaries like the
Sociedud Hipotecaria Federal. They are generally geared for financing direct on-lending by
financial intermediaries. In this case, the loan proceeds would finance debt restructuring that
would permit additional on-lending by SHF; however, the link i s indirect. Thus, the proposed
SIL i s the closest fit. Nonetheless, an OP8.30 review of SHF as a financial intermediary was
conducted as part of project preparation and appraisal, which concluded that the proposed
operation conforms to the requirements of that policy.
31See Report Number 45085-MX. The DPL was approved on October 2,2008.
26
111. IMPLEMENTATION
A. Partnershiparrangements
51. The proposed loan would complement operations from the Inter-American
DevelopmentBank (IADB),including: (i)$2 million grant to SHF and CONAVI to support a
a
framework for the modernization of property registries and its implementation in the States of
Colima, Baja California and Sonora, (ii)a $505 million loan to SHF to expand households'
access to housing finance and promote property registry modernization with all Mexican States,
(iii)a$1.7 milliongrant to implement apilot schemefor the useof remittances inhousing
finance, and (iv) a $0.75 million grant under preparation to support the Mucro-proyectos
Sustentubles Project - a pilot scheme undertaken by SHF to expand access to serviced land for
low-income housing. In addition, it i s expected that the IDB will complement this proposed loan
with a similar operation for SHF.
52. The Bank's housingprogramin Mexico has been complementedby investmentand
advisory projectsfrom the IFC. Working in partnership with SHF, the IFC is implementing a
project to develop a best-practice toolkit for SOFOLES to improve corporate governance,
implementbest-practice in mortgage origination and administration, and tailor-made software to
increase access to finance to the middle and lower income segments. In the last five years the
IFC has also invested around $70 million in equity and debt in housing development and
mortgage lenders operators. Additionally, the Board recently approved an IFC (jointly with the
IDB) $150 million Mezzanine Enhancement Facility to provide partial credit guarantees for
mezzanine/second loss credit risk associatedwith eligible lower-income RMBS.
B. Institutionaland implementationarrangements
53. Sociedud Hipotecuriu Federal (SHF)will bethe implementingagency for the project.
SHFwill execute the activities underthe two components proposed under the project. SHF will
have the responsibility of implementing the operations manual, and will approve, evaluate,
monitor and control the implementationof their corresponding project components.
54. SHF' has extensive experience as the financial intermediary and implementing
agency of Bank-financedprojects. In 1999 SHF acted as implementing agency of the FOVI
Restructuring Loan (P007610), and in 2004, 2005 and 2007 the series of Housing and Urban
SAL and DPLs worth a total of $ 500 million. Currently, SHF is both the financial intermediary
and implementing agency for several components of the Housing and Urban TA (POS8080) loan
which i s expected to close inDecember 2008.
55. Procurement. SHF as the implementing agency will be responsible for bidding,
contracting and paying consultants, for producing adequate procurement reports and for
preparingand submittingannual procurement plans and periodic reports as required by the Bank.
A global procurement plan has been prepared for the first 18 months of project implementation.
27
C. Monitoring and evaluation of outcomeshesults
56. Key indicators are presented in section I1B above. Additional details are provided in
Annex 3. The data are readily available from reliable sources andwill be updated during regular
supervision.
D. Sustainability
57. The proposed project aims to assure sustainability of housing markets. The loan
would enhance SHF's financial capacity to provide funding to mortgage markets during cyclical
downturns. Annex 9 provides more informationon SHF's own financial standing: it i s a highly
capitalized development bank operated on a sound financial basis. The loan would enhance
SHF's ability to expand its activities on a financially sustainablebasis.
E. Critical risksandpossiblecontroversialaspects
58. A major economic downturn inthe United States could lead to a major reduction in
GDP growth in Mexico (Substantial). A major downturn in the Mexican economy could
jeopardize SHF's attempts to expand access to markets and could overwhelm attempts to
consolidate the RMBS market. Mexico's prudent macroeconomic policies and significant efforts
to expand domestic savings and financial intermediation mitigate to some extent this risk.
Despite these factors, progress in meeting the development objectives of the project could be
impacted by macroeconomic circumstances and will require close monitoring by the Bank.
Despite these mitigating factors, the residual risk remains substantial.
59. Further tightening of credit markets could lead commercial banks to terminate
short term lines of credit to SOFOLES, requiring SHF to replace them in this role
(Substantial). SOFOLES have tapped commercial banks for an estimated $724 million in short
term lines of credit for cash management, mortgage warehousing, and construction lines to
developers. If commercial banks fail to renew these lines, SHF would be the logical
replacement, and it would be an appropriate role for S H F to play. Were it to step in and offer
short term lines of credit to SOFOLES,SHF would likely issue matching short term debt to fund
them. Inaddition to short term lines, SHFcould also offer partialcredit guarantees for bank lines
to SOFOLES, as it has done in the past. The risk of the need for support is substantial; however,
as a portion of commercial bank lending these lines are not large, they are secured by mortgage
portfolios and construction assets, and commercial banks have continued to renew these lines
after more than a year of financial difficulties. Inaddition, this type of consolidation of markets
i s one key dimension of the project objectives. Given these mitigatingfactors, the residual risk i s
consideredmoderate.
60. Technical inabilityhnwillingness of new intermediaries to move into lower income
segments (Substantial). As IEGhas pointed out in its review of FIL operations, the ability of
intermediaries to adequately target and service final beneficiaries i s one of the main challenges
faced by projects seeking to develop new financing markets. The process whereby SCIs have
become regulated entities has been slow in part because these institutions have had to
progressively upgrade their internal capabilities. Although SHF has already started pilot
28
programs with Cujas and SoJipos, not all of them will be interested in entering the housing
finance business. Many have expressed interest, and some have begun working with SHF.
Component 2 of the proposed project i s precisely aimed at mitigating the technical capacity risk
of SCIs by ensuring that they receive the support necessary to adapt their products and processes
to the needs of a low income housing finance business model. Given these mitigating factors,
the residual risk i s considered moderate.
61. The lifting of the "sunset" clause on SHF's credit operationsraisesthe risk that SHF
could succumb to the temptation to maximize institutional power without contributing to
market development (Moderate) SHF could buy and hold large portfolios of RMBS, and so
maximize net income without extending new financing to lower income households. SHF could
use its Bank-provided funding advantage to reduce prices for its products below local market
levels, thereby supporting otherwise unsustainable small SOFOLES, monopolizing housing
finance to moderate income households, and creating a substantial off-budget contingent liability
for the government without moving further down market.
62. SHF's governance structure, legal requirements, and its track record mitigate the
risk of SHF acting to dominate or fundamentally distort markets. SHF's Board includes
representation from SHCP (President of the Board) and the Central Bank. Under the current and
past governments, these entities have expressed a strong interest in maintaining a limited role for
SHFin developing markets. When the Congress lifted SHF's lendingsunset clause, it imposed
requirements on its Board in return. The Board i s responsible for approving the objectives,
guidelines, and policies for credit origination. These are to take into account characteristics by
which SHF delineates market segments that merit its intervention without inhibiting private
sector intervention. The Board i s to consider when and for how long SHF i s to intervene in any
given portion of the market and when it should withdraw once adequate private sector
involvement has been achieved. The Board i s also to consider the circumstances by which SHF
may intervene to maintain liquidity and market functionality in the face of unusual market
conditions and crises. In addition, another sunset clause remains intact: the end of government
guarantees for new borrowing in2014.
63. The risk of expanding the RMBS portfolio will be mitigated by providing T A that
will support the development of a more refined approach to SHF's market maker role. The
debt restructuring component provides the sustainable financial footing while the TA component
provides the technical means to mitigate risk.
64. Financial risks due to market conditions could jeopardize SHF financial viability
(Moderate). SHF may have difficulty adapting its balance sheet and business model as it seeks
to create new markets for lower income households while supporting changes in the structure of
the mortgage market. On the one hand, it will take some years for alternative intermediaries
such as the SCIs to develop lending in any volume. On the other hand, SOFOLES may be
acquired by banks or may transform themselves into banks, leading them to prepay large
portions of SHF's UDIand peso assets. The varying speed o f these changes could cause SHF's
balance sheet to weaken and its earnings to decline. In banking terms, SHF is strongly
capitalized, mitigating risk rising from the slow takeoff of new products. Call features in the
proposed loan would significantly help to mitigate the risk of SOFOL prepayments. Mexico's
rate of inflation may rise unexpectedly, reducing SHF's earnings in real terms. There i s an
29
overall risk of rising inflation in the world. The Bank of Mexico recently raised its intervention
rate to counter rising inflation. More than half of SHF's assets are inflation-linked. While peso
lending has become more popular in recent years, inflation-linked mortgages are accepted by
consumers. Lenders and investors may move back to UDI denominated lending in the face of
rising inflation. Rising inflation would also reduce the expected prepayment rate of nominal
peso mortgages that SHF now holds.
65. The size of the loan may affect the overall lending envelope to Mexico and limit
additional lending to Mexico, if required, under a crisis situation (Low). The proposed
operation is large in nominal terms, but it i s of limited size relative to Mexico's total annual
borrowing and its GDP (over $1 trillion). Furthermore, the overall D3RD exposure to Mexico
($4.1 billion), in nominal terms, is at its lowest point in more than 20 years, thus leaving
substantial space if additional lending were to berequired.
Figure 2: Evolution of IBRDExposure to Mexico
66. SHF may loosen origination standards as it targets lower income groups (Low). As
discussed in paragraphs 27 and 28 above, SHF is maintaining strong origination standards as it
moves toward this segment. SHF also has strict eligibility criteria for SCIs seeking S H F loans,
as also discussedabove.
67. The Bank may not be able to adequately supervise the complex operations of a
public financial institution and may actually contribute to private sector crowding out
(Low). SHF may be the government owned development bank that the World Bank knows the
best in Latin America and whose development the Bank has supported the most. SHF i s a
second tier bank that revived private housing finance markets and has nurturedthe development
of new private intermediaries through the provision of financing, technical assistance, and
insurance products. For all of its achievements, SHF finances or guarantees only 6.9 percent of
the overall mortgage market. SHF support leverages additional private sector investment. Its
loans to SOFOLES leverage SOFOL capital, its mortgage default insurance leverages the bank
and SOFOL lendingthat accompanies it, and its bond guarantees leverage the funding raised by
the bondissuer. The Bank, in multipledocuments, has presentedSHF as a best practice example
of what a development bank ought to be. Thus this risk i s mitigated by the substantial
experiencethat the Bank has in working together with SHF.
30
68. Lack of coordination between government agencies responsible for executing
policies and managing instruments for lower income housing (Low). As SHF moves into
lower income segments through SCIs, it will be important to define the targeting mechanism
such that it is coherent with the main subsidy program Estu es Tu Casu. Currently, eligible
beneficiaries for the subsidy program are those earning up to 4 MW, which coincides partially
with the target population under SHF's new business plan. The overriding principle is that
without the subsidy the eligible households would not be able to get a loan for the housing
solution they need, so in principle all loans for households under 4MW should be accompanied
by a subsidy and those between4 and 6 should not. This should be carefully monitored in order
to promote credit markets moving down-market reducing the need for a subsidy. Considering
that the loan will not be financing directly on-lending to Cujus this risk is consideredlow.
69. SHFmay be unableto adjust its operationaland riskstructure to the changesahead
(Low). Today SHF operates with 18 financial intermediaries but plans to operate with 100 in a
year's time as it expands its relationship with smaller SCIs. As this is implemented, SHF's
operational model will need to adjust, moving from working with a reduced number of
intermediaries with high volume and high margin to working with a larger number of less-
sophisticated intermediaries with lower volume levels. SHF has shown flexibility to adjust to
market conditions and is likely to respond to this challenge in the same way. This risk is
considered low.
Summary Matrix of Risksand Mitigating Factors
Risks Mitigation Post-Mitigation
Ratings
A major economicdownturn Sound macroeconomic policies. S
inthe UnitedStatescould
leadto a strongrecessionin
Mexico A major downturn in
the Mexican economy could
jeopardize SHF's attempts to
expand access to markets and
could overwhelm attempts to
consolidate the RMBS market.
Further tightening of credit Strongfinancial managementpolicies M
marketscouldlead and high degree of capitalization of
commercialbanksto SHF. Short-term credit lines are not that
terminateshort term linesof large
creditto SOFOLES,
requiringSHF to replace
them inthis role
(Substantial).
Technical Component 2 of the proposedproject is M
inabilityhnwillingnessof precisely aimed at mitigating the
new intermediariesto move technical capacity risk of SCIs by
into lower income segments ensuring that they receive the support
necessary to adapt their products and
processes to the needs of a low income
housing finance business model.
31
Risks Mitigation Post-Mitigation
-
Ratings
The liftingof the "sunset" SHF's governance structure, legal M
clause on SHF's credit requirements, and its track record
operations raises the risk that mitigate the risk of SHF acting to
SHF could succumb to the dominate or fundamentally distort
temptation to maximize markets. SHF's Boardincludes
institutional power without representation from SHCP and the
contributing to market Central Bank. Under the current and
development. past governments, these entities have
expresseda strong interest in
maintaininga limitedrole for SHF in
developing markets.
Financial risks due to market Inbankingterms, SHF is over- M
conditions couldjeopardize capitalized, mitigating riskrisingfrom
SHF's financial viability. the slow takeoff of new products. Call
features inthe proposed loan would
significantly helpto mitigate the risk of
SOFOL prepayments. SHF
managementhas prepared a short term
risk strategy.
A major economicdownturn Mexico's prudent macroeconomic M
inthe United Statescould policies and significant efforts to expand
lead to a strong recessionin domestic savings and financial
Mexico and this could impact intermediation mitigate to some extent
the project development this risk.
objectives.
The size of the loan may The overall exposure to Mexico, in
affect the overall lending nominal terms, is at its lowest point in
envelope to Mexico and more than 20 years, thus leaving
prevent additional lending if it substantial space if additional lending
was requiredunder a crisis were to be required.
situation.
SHF' may loosen origination As discussedinparagraphs24 and 25
standards as it targets lower above, SHF i s maintaining strong
income groups origination standards as it moves toward
this segment. SHF also has strict
eligibility criteria for SCIs seeking SHF
loans. as also discussedabove.
The Bank may not be able to SHF may be the government owned L
adequately supervisethe development bank that the World Bank
complex operations of a knows the best in LatinAmerica and
public financial institutionand whose development the Bank has
may actually contribute to supported the most.
private sector crowding out
32
Risks Mitigation Post-Mitigation
Ratings
Lack of coordination As SHFmoves into lower income L
betweengovernment segments through SCIs, it will be
agenciesresponsiblefor importantto definethe targeting
executingpolicies and mechanismsuch that it is coherent with
managinginstrumentsfor the main subsidy programEstu es Tu
lower income housing Casu. This will be carefully monitored
inorderto promotecredit markets
movingdown-market reducingthe need
-
for a sibsidy.
SHF may be unable to adjust As this is implemented,SHF's L
its operational and risk operationalmodel will needto adjust,
structure to the changes moving from working with areduced
ahead numberof intermediarieswith high
volume and high marginto working
with alarger numberof less-
sophisticatedintermediarieswith lower
volume levels. SHF has shown
flexibility to adjust to marketconditions
and is likely to respondto this challenge
inthe same wav.
L=Low, M=Moderate,S=Substan 1, H=High
F. Loadcreditconditions and covenants
70. Financial conditions. SHF has requested a US Dollar, Fixed Spread-based Loan with a
grace period of five years and a total repayment term of 30 years with level repayments, and all
standard conversion options. SHF has also opted for the Automatic Conversions into Local
Currency under which disbursements will be automatically converted into Mexican Pesos upon
withdrawal, with the interest payable based on the TIE (Tusa de Znterks Znnterbancaria de
Equilibria). SHF is also interested in accessing enhanced risk management solutions through the
Bank to he1 reduce its balance sheet risks. These enhanced solutions include inflation-linked
conversions , cancellable fixings of the interest rate, and forward TIE spread fixings. The
?*
availability of these enhanced risk management solutions will be subject to the Bank's ability to
efficiently intermediate the products in the financial markets, allowing it to lay off its market
risks. To this end, the Bank i s in the process of developing appropriate valuation models and
setting up the required operational procedures before offering these enhanced options. Upon
approval of the Loan with these customized options, and completion o f the said internal Bank
arrangements, SHF and the Bank would then enter into supplemental legal agreements to
document the enhanced options of the related conversions.
32Inflation-linked financing is now available for loans funded throughback-to-backbond issuesfollowing the
approval in May 2008 of a proposalto provide local currency through this mechanism(See "Enhancing the Value of
IBRDFinancial Products:Proposalto ProvideLocal Currency Conversionsthrough Back-to-Back Borrowing and
On-Lending Arrangements" R2008-0101).The SHFLoan would be the first time that the Bank has offered
inflation-linked conversions through the derivatives markets.
33
71. Effectiveness conditions. Approval by SHF's Board of Directors of a policy for
managing short term financial risk as describedin Section 1I.B above.
IV. APPRAISAL SUMMARY33
A. Economic and financial analyses34
Assessment of the overallfinancial system3'
72. Mexico has recovered from the long-lasting effects of the financial crisis in the mid-
1990s, but financial intermediation remains comparatively shallow. Strong growth in the
last year restored bank credit and bank deposits to their pre-crisis levels of over 20 percent of
GDP, but this is still comparatively low for acountry of this income leveland size. The financial
system i s diversified across a number of players, with the banking system accounting for 54
percent of total assets, and mutual funds, insurances and pension funds for another 31 percent.
Additionally, small non-Bank financial institutions--like SOFOLES and Savings and Credit
Institutions-- represent 4 percent of assets, and play an important part for lower and middle
income segments of the population. Eighty-five percent of the financial intermediaries are part
of larger financial conglomerates.
73. The banking sector, which accounts for 54 percent of assets of the financial system,
has so far shown resilience to the turbulence in the international financial system. The
Capital Adequacy Ratio remained close to 16 percent in 2008 for all types of banks, and
provisioningand profitability levels continue to be sound. Non-performing loans briefly showed
an upward trend in consumer credit in 2007, but stabilized again at around 6 percent for this
marketsegment. While consumer credits doubled duringthe last four years to now 4.7 percent of
GDP, they still represent only a small share of banks' assets. Mortgage finance accounts for
about 9.2 percent of GDP, but over half of mortgages are provided through the National Housing
FundINFONAVIT, with banks only accounting for athird of housing credits.
74. Financial oversight was enhanced in the last few years and is considered to be
sound. Since 2000, the government undertook a number of reforms to strengthen financial
oversight and bring the legal and regulatory framework in line with international standards. In
the bankingsystem, progresswas made towards risk-based supervision, andinternal organization
and professionalism within the CNBV improved. Furthermore, regulations for SOFOLES,
factoring, leasing as well as savings and loans activities were passed, and consolidated
supervision was strengthened, but further efforts will be required.
33An evaluation of SHFas a financial intermediary was conductedaccording to OP8.30 procedures.
34See Annex 9 for more details.
35The Bank has had an active policy dialogue on financial sector issues in Mexico.
34
\
Assessment of the SOFOL segment of thefinancial system
75. As of June 2008, there were 33 SOFOLES, of which 10 are authorized to extend
housing loans?6 The 2006 law on SOFOLES and SOFOMES led to a decline in the sector's
total assets, which inJune 2008 stood at about US$ 18.5 billion. Nevertheless, the total assets of
the remaining 33 SOFOLES in the sector showed a steady growth over the period 2003-2007,
and dropped slightly in the last six months. The total loan portfolio fell by 2.82 percent in the
first quarter of 2008, with 50 percent of the credits representing housing loans, followed by 29
percent in consumer loans. Part of the drop reflects a decline in lending to public projects (by 34
percent in the last quarter), while mortgage lendinghas continued to increase, albeit at a slower
pace (by 0.35 percent in the last quarter).
76. The SOFOLES sector appears stable overall, although individual SOFOLES could
be subject to market pressures to examine their businessmodel. The sector has recently been
facing challenges as access to funding has become more expensive, investors have turned more
selective, and credit risk has been on the rise; however, the sector overall continues to exhibit
adequate asset quality and financial performance. The Return on Assets (ROA) was 2.4 percent
and Returnon Equity (ROE) was 23 percent inthe first quarter of 2008, which are slightly below
the high rates earned in previous years. As of March 2008, Non-Performing Loans were at 3.9
percent of gross loans, compared to 3.1 percent in December 2007. Capitalization i s at
reasonable levels at about 12.7 percent (capital to total assets) inMarch 2008.
77. SOFOLES are required to register as corporations (Sociedad Ano'nima) and must
obtain a license to operate from the Ministry of Finance (SHCP). They are regulated by the
Mexican Credit Institutions Law and fall under the supervision of SHCP, the National Banking
and Security Commission (CNBV), and the Central Bank (Banco de Mexico). SOFOLES that
are part of a larger financial group must conform to the capital regulations and other portfolio
provisions applicable to the parent financial group. Those that are independent are subject to a
less stringent regulatory framework, since they are non-deposit taking institutions. However,
SHF imposes risk-based capital rules for the SOFOLES that it funds, and also reviews all
individual loans which it insure.
Creditworthiness of SHF
78. As noted above, SHF is highly capitalized. In addition, its delinquency ratio is a low
0.75 percent. According to the latest CNBV report on development banks (June 2008), the
returnon assets fell to 0.15 and the return on equity fell to 0.55 in the first half of this year. This
followed returns on assets and equity of 3.88 percent and 13.79 percent, respectively, reported
for the 2007 accounting period. More recent data from SHF (August 2008) that the decline in
returns was due to temporary factors, including an increase in capital due to a change in the
36The legalframework for SOFOLES, LeasingCompanies(Arrendudorus)and FactoringHouses(Casus de
Fuctoruje) was modifiedon July 18,2006. Their operationswere deregulatedand they were givena seven-year
transition period, during whichtime they are supervisedby CNBV. Authorities no longer grant this type of license,
and presumably SOFOLES couldthen become some other type of financial institution, ifthey meet the requirement,
or simply sell themselves to Banks or other financial institution. The law also provides for other non-regulated,non
deposit taking entities called SOFOMEs(Sociedud Finuncieru de ObjetoMu'ltiple)which do notrequire licensing
by the financialauthorities.
35
mark-to-market value of swaps, and an increasein reserves. InAugust, the returns on assets and
equity were restoredto 2.4 percent and 9.3 percent, respectively, more inline with recent years.
Economic andfinancial assessment of theproject
79. The number of housing loans that a World Bank loan to SHF can support directly is
only a small portion of the country's overall housing needs. In 2007, the average size of a
housing loan along the whole range of public and private sector programs amounted to 251.4
thousandpesos. This implies that funding to SHF of $1 billion could support an approximate 40
thousand housing loans if the average size of an SHF supported operation i s similar to the
average loan size of housing finance solutions provided by the whole range of public and private
institutions. This is equivalent to 8 percent of the housing demand generated annually by the
formation of new householdsand about 4 percent of the government's annual target of additional
housing loans. The number also equals to about 0.4 percent of the estimated backlog in adequate
housing for Mexican households. The amount of finance i s finally equivalent to about 1.5 of
total annual investment in housing in Mexico. On the other hand, the potential financing i s a
direct economic benefit for those beneficiaries.
80. This is precisely the point of providing both financial and technical assistance to
SHFas a way to leverage bank resourcesfor improved housingfinance markets. Through
SHF's role in developing new instruments - for example home improvement loans-and
working with new mortgage intermediaries, the economic impact of the loan can extend beyond
the direct loans that couldbe financed by $1billion.
81. SHF would use the World Bank loan primarily to fund the expansion of its peso
portfolio and also provide financial space for possible continued support of the RMBS
market. In terms of expanding lending, the IBRD i s the best choice for financing, in terms of
maturity and cost. SHF could also exercise its prepayment option if a SOFOL were acquired or
otherwise obtained market funding.37 The reduction of current short term indebtedness levels
would allow SHF to issue new short term debt if neededto engage in short term interventions in
the RMBS market. Borrowing short term for the latter makes financial sense as it i s lower cost
than long term finance, and so long as the interventions are temporary, there is little risk from a
maturity mismatch. In addition, during normal times, the RMBS themselves are liquid as they
can be sold on secondary markets.
82. There would be a savings in term of a lower interest bill; however, this is not the
main advantage of World Bank funding. The all in cost of the Bank loan, considering swap
transactions and other possible prepayment optionality, will depend upon market conditions at
the time of these transactions. It is expected, though, that the long term financing of the Bank
would be about 50 basis points cheaper than alternative short term funding (e.g., PRLVs). On a
$1 billion loan, this implies savings of about $5 million. This i s not an insignificant amount: for
example, it could finance an additional 8,30038housing micro-credits per year. On the other
hand, since SHF is not a profit maximizing institution, the main development benefit from the
37Ifpeso loans to SOFOLES were to decline and SHFprepaidthe World Bank, the equity portion of the balance
sheet would then effectively fund a greater portion of the receive leg of the UDIswap. See Annex 9 for more
details.
38The average housing micro-credit during 2007 was about $600.
36
loan will be SHF's enhanced ability to leverage more mortgage credits-particularly, during a
period where the private sector i s facing greater challenges to finance mortgage markets on its
own. The restructuring of debt with the longer maturity and embedded options will serve this
purpose. It should also be noted that the interest savings could be used for SKF's TA program
and also to finance the costs associated with developing new product lines and new procedures
for operating with SCIs. Monitoring indicators have been established to track the progress in this
regard during the course of the loan (see Annex 3).
B. Technical
83. The technical analysis supportingthis project includes sector work completed by the
diagnostic work financed by the HUTAL, on-going Fee for Service work underway
with SHF and technical analysis of the Bank's team during project preparation. In
particular, the Bank conducted meetings and interviews with market participants in the housing
sector to understand current concerns and current market developments. Managers of private
sector lenders -banks and SOFOLs-were interviewed, as well as government regulators from
the Finance Secretariat, Central Bank and National Banking Commission (CNBV). A variety of
data were collected from these sources. This information, along with the existing extensive Bank
expertise and ongoing policy dialogue, was used for preparing the economic and financial
documentation presented in this report.
84. Technical capacity and institutional arrangements. SHF is a National Development
Bank which created in 2001 to develop the primary and secondary housing finance markets. As
part of the financial sector, SHF is regulated by the Ley de Znstituciones de Crkdito and falls
under the supervision of the National Banking and Securities Commission (CNBV). SHF was
created by the Ley Organica of SHF and its operational rules (Reglamento).
85. SHF Board is comprised of nine members, five of which are representatives of
governmentministries, including:
(a) Finance and Public Credit Minister (Head of the Board)
(b) Vice-minister of Finance and Public Credit
(c) Governor of the central bank
(d) Vice-governor of the central bank (designated by the Governor)
(e) Director of the Housing Commission
The remaining four members are external advisors appointed by the Minister of Finance and
Public Credit on the basis of the characteristics defined inSHF's Organic Law.
86. The current General Director was the CEO of the National Savings and Financial
Services Bank (BANSEFI). Previously he was General Director of Banking and Savings in
SHCP and prior to this he was vice-chairman o f financial analysis and development of the
National Banking and Securities Commission. To fulfill its mandate SHF i s sub-divided in six
39Some of the key documentswereMexico Low Income Housing: Issues and Options, ReportNo. 22534,2002, the
memosof the FSAP(2002) and FSAPUpdate (2006cthe latter including a TechnicalNote on HousingFinance.
An NLTA last year on broaderfinancialsector issuesincludeda discussionof development banksand performance
monitoringof developmentbanks.
37
Direcciones Generales: (1) Housing Market Innovation andDevelopment; (2) Credit Operations;
(3) Finance; (4) Planning, Administration and Risk Assessment; (5) Information Technology;
and (6) Legal. SHF has 365 employees with a high degree of technical training. Many senior
staff have been recruited from experienced positions in private banking, public sector regulatory
agencies and other developmentbanks.
C. Fiduciary
87. The Bank carried out a project Financial Management Assessment (FMA) to ensure that
the project design and institutional capacity support smooth implementation and allow for an
appropriatelevel of transparency, oversight and control.
88. Basedon the resultsof the FMA, the following conclusions were drawn:
a. the overall FM residual risk is modest. The main mitigating measures are related to
timeliness and depth of reporting andauditing arrangements;
b. control of funds andproject recordswill bebasedon the internal control, treasury and
information systems that SHF i s currently using for its current programs, including
another World Bank project that is currently under implementation. These systems
are deemed adequate for the operation, but FM staff in SHF need to ensure that any
additional duties associatedto the specific reporting and auditing arrangementsof this
project will be properly incorporated into their current responsibilities;
c. the loan will utilize two disbursement methods: (1) Advance for Component 1; and
(2) Reimbursementfor Component 2. For Component 1, the Bank will advance loan
proceeds into a Designated Account of SHF for subsequent payment of maturing
short-term debt. For Component 2, the Bank will reimburse SHF for eligible goods
and services pre-financed by SHF with its own resources;
d. SHF will produce semiannual unaudited Interim Financial Reports (IFRs) for the
entire project. Additionally, and only for Component 1, SHF will produce customized
Cash Flow Reports for the World Bank on a weekly basis to confirm the short-term
debt payments;
e. for Component 1, an external firm will audit the entire activities related to each Bank
advance within the next three months after the last debt payment usingBank's funds
has been processed. The auditor's report will be submitted to the Bank within that
period. For the project as a whole, SHF will have the same firm audit the project
financial statements on annual basis, and will include the results in the audit of the
Entity's Financial Statements;
f. the FMsectionof the Operations Manual(OM) will contain information satisfactory
to the Bank on the six elements of FMas defined inOP10.02. The draft O M would be
ready before Negotiations; and
g. the Bank will carry out at least one full FM supervision mission per year for the
project. These missions will be complemented by reviews of the Cash Flow Reports,
IFRs andaudit reports.
38
89. Annex 7 provides more information on financial management and disbursement
arrangements. Annex 8 includes a detailed explanation of procurement capacity assessment and
related issues.
D. Social
90. The proposed loan draws on the continued dialogue of the Bank with the government and
other stakeholders through the Housing and Urban DPLprogram and HUTAL loans. These have
been instrumental in raising critical issues and policy challenges to reduce urban poverty and
vulnerability in Mexico. In particular, the HUTAL supported an Institutional Study on Housing
Policy for the poor, and this report was finalized recently. The team will review with SHF the
findings of this study to assess the best way to incorporate the recommendations in the actions
supported under the TA component.
91. In general the proposed operation will support actions that are likely to generate poverty
and social impacts through: (i) evaluation of the existing micro credit and subsidy programs
operated at federal level; (ii)
expansion of housing credit for individuals earning less that 6MWs;
(iii)strengthening SHF's institutional capacity to move down-market, and (iv) support for the
financial intermediaries to target products to the lower income population.
92. The Bank has been closely involved with the government's National Council of
Evaluation (CONEVAL) which i s responsible both for poverty measurement and for setting the
guidelines of evaluation of social programs. Along with the close collaboration on housing
sector issues, the Bank i s well positioned to assist SHF in monitoring progress in achieving the
social objectives of its medium term plan during project supervision. More specific monitoring
indicators oulined inAnnex 3.
E. Environment
93. The proposed project supports the strengthening of SHF's balance sheet and the technical
capacity to move down-market. As such, no direct investments will be financed under the
project and therefore no direct environmental impacts are expected. The government i s
mainstreaming environmental concerns in the housing sector, as mandated by the new Housing
Law issued in 2006, and implemented by CONAVI. The proposed project will support SHF to
develop a "green" mortgage product following the sustainability criteria set by CONAVI. Annex
10 describes the main challenges and activities being implemented by the government to
improve the environmental sustainability inthe sector.
39
F. Safeguardpolicies
Environmental Category: C
94. The proposed project will not finance any new investment and will have minimal or no
adverse environmental impacts, therefore the project does not trigger any of the Bank's
environmental safeguard policies. Given that the proposed project will not finance any
investments resulting in any adverse impacts on people or their assets, the social safeguards also
are not triggered.
95. Through the technical assistance component, the project will seek to strengthen SHF's
ability to assist the financial intermediaries to incorporate adequate screening criteria for new
housing developments. Additionally, the TA incorporates assistance to SHF to develop tools to
better grasp and address the housing needs of the lower income population, including an impact
evaluation of the subsidy program.
Safeguard Policies Triggered by the Project Yes No
Environmental Assessment (OPBP 4.01) [ I [XI
Natural Habitats (OP/BP 4.04) [ I 1x1
Pest Management (OP 4.09) [ I [XI
Physical Cultural Resources (OPBP 4.1 1) [ I [XI
InvoluntaryResettlement (OPBP 4.12) [ I [XI
Indigenous Peoples (OPBP 4.10) [I [XI
Forests (OPBP 4.36) E l [XI
Safety of Dams (OPBP 4.37) [I [XI
Projects inDisputed Areas (OPBP 7.60)* [I [XI
Projects on International Waterways (OPBP 7.50) [I [XI
G. Policy ExceptionsandReadiness
96. This project complies with all applicable Bank policies.
* By supporting theproposedproject, theBank does not intend to prejudice thefinal determination of theparties' claims on the
disputed areas
40
Annex 1: Country and Sector Background and Macro-Financial Linkages
MEXICO: Private HousingFinance MarketsStrengtheningProject
A. Recent Economic Developments
1. Over the past four years (2004-2007), the Mexican economy has experienced a
period of balanced and broad-based expansion of economic activity at an average annual
rate of gross domestic product (GDP) growth of 3.8 percent. A vigorous global economic
expansion contributed to the enhanced growth performance as exports increased at a double-digit
annual average rate of growth. Enhanced price stability contributed to a healthy growth of
domestic demand as a result of an improved purchasing power of wages and salaries and an
expansion of domestic credit and consumer lending. The evolution of the main macroeconomic
indicators over the past four years confirms a picture of balanced growth (Table 1).
2. Fiscal policy has successfully focused on a reduction of the public sector deficit and
a decline in the public sector debt-to-GDP ratio. Higher-than-expected oil and tax revenue
allowed the public sector to increase current andcapital expenditures and, at the same time, post
a modest fiscal surplus over the past two years. Public expenditure increased by almost 2
percentage points of GDP, providing an additional impulse to domestic demand in this period. A
balanced budget requirement i s part of a federal budget and fiscal responsibility law adopted in
2006. In terms of the broader Public Sector Borrowing Requirements (PSBR) that includes off-
budget spending, the Mexican public sector also has managed to restrain its debt financing
requirements to about 1-2 percent of GDP.
Table 1: Mexico Selected Economic Indicators
-
Source: Bank staff calculation basedon SHCP,Banco de Mkxico and INEGI
3. The Mexican public sector remains heavily dependent on oil revenue which in 2007
made up 35 percent of total public sector revenue, whereas non-oil tax revenue remained at a
modest 10 percent of GDP. Oil production has dropped from a high of about 3.4 million barrels
per day in 2004 to about 3.1 million barrels per day in 2007 and to some 2.8 million barrels per
day in recent months. Current proven reserves of oil are on the order of 10 years of production
41
and Mexico is the only major oil producer to have suffered a dramatic decline (halving) of
known reservesinrecent decades?'
4. International capital markets, credit rating agencies and international institutions
all recognize the progress achieved inmacroeconomic stability and the strengthening of the
fundamentals of the Mexican economy. The GOM maintains an investment grade rating by all
three major credit rating agencies, two of which improved their rating last autumn.41The most
recent IMF Article IV consultation and Board discussion "commended the improvements in
macroeconomic and financial policies that have helped Mexico to reduce significantly external
and internal vulnerabilities over the years."42
5. The recent international financial market crisis is leading to tighter credit
conditions and a global re-pricing of risk. Inline with other major emerging markets, spreads
on Mexican sovereign debt, as measuredby the Emerging Markets Bond Index Plus (EMBI+),
hadrisen to 447 basis points over UnitedStates Treasury bonds on October 13, 2008, after being
in the 100 to 250 range for most of the last three years. This increase in the spread has a
relatively limited immediate impact on the fiscal accounts, as the federal government already met
most of its annual external financing needs at the start of 2008. The immediate impact of the
international financial market crisis on the Mexican financial system has been relatively
moderate as domestic financial intermediaries had almost no exposure to U.S. subprime
mortgage risk. Despite its low level of penetration, domestic savings and credit intermediation
through the Mexican financial systemcontinue to expand at a healthy pace -from 34.8 percent of
GDP in2000 to 51.9 percent in 2007- and, more recently, is reflected in a strong growth of bank
credit to the private sector.
6. The Mexican economy is currently facing a cyclical slowdown of economic growth
and expectations are for more modest growth over 2008-2009. The Mexican economy has
strong links to the Unites States economy - the destination of more than 80 percent of
merchandise exports and the source of about $24 billion (2.3 percent of GDP) inremittances last
year. Duringthe last recessionin the United States, Mexico suffered with a slight contraction of
GDP in 2001 and very slow growth during 2002 and 2003. In the first half of the year, the
Mexicaneconomy withstood the economic difficulties of its maintrading partner and commodity
price pressures well. Economic growth in the first half of 2008 slowed down to 2.7 percent. The
government recently lowered its growth prospects to 2.0 percent for 2008 and 1.8 percent for
2009.43There i s considerable uncertainty surrounding the growth prospects given the unfolding
global financial crisis. Strong economic linkages expose manufacturing activity and the Mexican
economy to a downturn in the U.S. business cycle, though the reduction in Mexico's external
public debt (as a share of GDP), a reasonably high level of international reserves and the
regainedstrength and development of the domestic financial sector do mitigate its exposure to
40Part of this drop was due to a change in the methodology.
41 Fitch Ratings and Standard & Poor's increased their sovereign rating to BBB+ (two notches above investment
grade rating) last September and October, respectively. In addition to strong macroeconomic policies, both rating
agencies refer to the adoption of reform to the civil servants' pension scheme and the fiscal reform package as
critical elements in their decision to increase their credit rating.
42See IMFCountry Report 071379 at http://www.imf.or~/external/~ubs/f~scr/2007/cr07379.odf
43Announcement of the Program to Enhance Growth and Employment, last October 8,2008
http://www .apartados.hacienda.gob.mulnovedadeslespano~docs/2008/comunicados/comunicado~079~2008.pdf
42
tightening international credit conditions and an increase in global risk aversion. In order to
mitigate the impact of the global financial crisis and economic downturn, in early October the
authorities activated a rules-based exchange rate intervention mechanism and proposed an
expansion of public expenditure in infrastructure for next year's budget.
7. International commodity and food prices have driven up domestic inflation hurting
the poor disproportionately and prompting a tightening of monetary policy, though the
downturn in economic activity may reduce price inflation faster than earlier expected. The
sharp increase in consumer price inflation, to a peak of 5.6 percent in August 2008, led the
monetary authorities to hike the overnight interest rate from 7.5 to 8.25 percent over the past few
months and to raise their projected inflation for the next eight quarters. The latter postpones
convergence to the medium-term inflation objective of 3 percent till the end of 2010. More
recently, the balance of risk may have shifted to a downturn in economic activity following the
rapidly unfolding global financial crisis.
8. Food prices were up by 7.6 percent in September 2008 compared to a year earlier.
This above average increase inthe price of food has affected the purchasing power of the poor in
particular, as a larger share of their income -up to 40 percent- is dedicated to food. For this
reason, the government announced a series of measures to moderate food price increases and to
mitigate the impact of price increases on the poor--including a temporary increase of the transfer
to households under its Conditional Cash Transfer program.
9. Domestic fuel pricing policies have moderated the impact of higher international oil
prices on domestic inflation. For more than a decade, the government has maintained a polil Y
of monthly fuel price adjustments largely in
line with domestic inflation. While this GovernmenlBond Yields
policy has been successful in terms of 9.20........-........-..--.....-.--.-
economic stabilization and the generation of -Cetes 28 -Bond 3Y
fiscal revenue, the sharp international price 8.80 -BondPOY
increase has left the level of domestic fuel 8.40
prices behind the international price levels 8.00
for the past two years. As a result, fuel
subsidies -accounted for in the budget as a 7.60
negative excise tax- are estimated to reach 7.20
upto 2 percent of GDP this year. A gradual 111111111111111111111
elimination of these subsidies i s envisaged
over the next few months as a result of slightly higher periodic price adjustments for domestic
sales of gasoline and diesel as well as a moderation of international prices.
10. The unanticipated increase in inflation led to a substantial increase in domestic
interest rates. Yields on reference government bonds increased substantially between April and
July this year, with a particularly steep drop in the price of longer term bonds. More recently, the
bond market stabilized even though interest rates are up by about 100 basis points compared to
the levels observed earlier this year.
11. The GOM aims at enhancing structural economic growth and aspires to reach a
medium-term growth rate of 5 percent. The National Program for Financing Development
43
(PRONAFIDE) 2008-2012 provides a detailed assessment of the public and private finance
needs to attain the economic growth, employment creation and poverty reduction targets set out
in the 2007-2012 National Development Plan (NDP). The program projects a GDP growth of
5.2 percentby 2012 that requires a combination of an increaseof total factor productivity by 1.4
percentage points and an increase of public and Mortgage Finance
private investment by 3 percentage points of GDP
between 2007 and 2012 (Table 2). The 1,200 (amount outstanding)
projections in this medium-term economic
program are based on an output growth in the p1,000
800
United States close to its potential and the 600
.-0
implementation of government policies as set out E 400
rn
in the NDP and the more detailed sectoral 200
programs, inparticular with regard to an ambitious 0
program of infrastructure investments that raises 2003 2004 2005 2006 2007 2008-
June
the level of public investments to 4.3 percent of
GDP on averagefor the 2007-2012 period (compared to a level of 2.1 percent observed between
2001 and 2006). Recent events have moderated the government's economic growth projections
to 2.0 percent for 2008 and 1.8 percent for 2009.
Source: SHCP-Budget proposal and Adjustment to Budget proposal for 2008 and 2009, PRONAFIDE for 2010-
2012
B. HousingSector Developments
12. The construction industry outperformed overall economic growth over the past few
years, largely due to the strong impulse observed in home building. The GDP of the
construction industry expanded at an annual average rate of 4.7 percent compared to overall
economic growth of 3.8 percent over the 2004-2007 period. The development of the housing
sector has a significant impact on the performance of the construction industry. Investment in
housing currently represents almost 6 percent of GDP
and expanded at an average annual rate of 4.6 percent GDP, Constructionand HousingInvestment
between 2004 and 2007. More recently, the Annual Growth
Io%
expansion of the highly cyclical construction and 8% -
housing sector started to slow down anticipating a
moderation of economic growth. 6% Housing Investwi
4%
13. A rapid increase in the availability of
mortgage finance has been a key element in the 2%
development of the housing sector. The number and 0%
amount of mortgages and housing finance provided 2004 2005 2006 2W7 Jan-Jun
annually more than doubled between 2003 and 2007, 2008
44
with a flow of new mortgages currently at about US$24 billion per year. With annual investment
in housing up at about $60 billion by 2007, mortgage and housing finance currently represents
almost 40 percent of investment in housing
compared to less than 30 percent in 2003. Total Mortgage Finance
mortgage debt outstanding increased from about $50 1,200 (amount outstanding)
billion by the end o f 2002 to about $95 billion by 1,000
June 2008. After a long absence from housing a 800
I
finance after the 1995 financial crisis, banks started ;m
to expand mortgage lending as of 2004 and currently e400
rn
200
maintain some 32 percent of the country's mortgage 0
portfolio. SOFOLES, the non-bank banks figure 2003 2004 2005 2006 2007 2006-
introduced under the NAFTA agreement and main June
-
rnndiiit nf onvernment ciinnnrted hniicino finanre ma1 aued tn ernand their market charp tn 17 5 .-
-..-...-A. ..Ab"'v""""L" '"rr"-'v""""""'b *-....*.vv, "'"""e"" .v v,.y--.- .*.-A* I I A I I l A L I C Y l l U - .I Y
percent of the mortgage portfolio by mid 2005. The rapid expansion of bank originated
mortgages as well as a consolidation and take-over of a few SOFOLES by banks has reduced
their market share to 8 percent at the moment. Znfonavit, the formal private sector workers'
housing provident fund has been able to expand the number and amount of mortgages with
significantly improved origination and collection practices and maintain a market share of almost
60 percent of the total mortgage portfolio.
14. The development of a secondary mortgage market as of 2003 provides for a
growing, additional source of funding for housing finance. Major mortgage finance
originators (SOFOLES,banks and Infonavit) issued a total of 63 Residential Mortgage Backed
Securities (RMBS) to a total amount of 75.4 billion RMBS Issues and Amount Outstanding
pesos between 2003 and June 2008. RMBS issues 80
have been growing rapidly and were particularly 70
strong in 2006 and 2007. During the first half of v)60
2008, new RMBS issues totaled some 40 percent of 8 50
40
the amount issued in 2007. O f the total amount of 2 30
3
RMBS outstanding about two-thirds have been 20
issuedby private financial intermediaries, SOFOLES 10
0
and Banks, under the Borhis name supported by 2003 2004 2005 2006 2007 2008-
SHF. Znfonavit also securitizes part of its portfolio JUM
under its own name CEDEVIS.
15. During the last decade the Government of Mexico (GoM) successfully restarted
private housing finance markets. After the crisis in the mid 1990s, commercial banks stopped
lendingfor residential mortgages. In response, the government adopted a range of policy, legal,
and institutional reforms that produced a doubling in the stock of residential mortgage lending
and started a secondary mortgage market (Figures 1 and 2). The flow of new lending and
construction continues to grow. In 2007, the industry produced 1.18 million housing loans worth
$25.7 billion, 175 percent more than 1998. The value of residential construction grew 71.4
percent inreal terms between the year 2000 and 2007. Thanks to these changes, the total number
of credits produced now exceeds the rate of family formation. Specific policies included:
Fosteredthe growth of specialized non-bank financial intermediaries, SOFOLES (Sociedades
Financieras de Objeto Limitado). SOFOLES re-started mortgage lendingwith a combination
45
of long-term funding from Sociedad Hipotecuria Federal (SHF), the government's second
tier housing development bank, and the development of new underwriting and monitoring
technologies. SOFOLES have reached down market: they lend to households earning an
average of 8 minimum wages (MWs), whereas the limited bank financing that had been
available was going to households earning much more.
Helped develop a credit bureauto collect andprovide reliable data to lenders.
Improved the foreclosure process, as implemented by regulators and local governments. In
2003, financial laws were enactedto facilitate the use of extrajudicial procedures.
Developed laws related to asset securitization, such as creating the CertiJicado Bursa'til
(banking bond).
Reformed the Cornisio'n Nucional Bancaria y de Valores (CNBV) to supervise securities
issuanceand trading.
Reformed the operations of INFONAVIT, the housing provident fund for private sector
employees, permittingit to contribute significantly to the growth inmortgage lending.
Figure 1:Rateof GrowthHousingCredit
45 -
35 1
=Banks
ONon-banks
n
2006 2007 2008
Year
-25
46
Figure 2: Total Housing Credit
1,000,000
900,000 0NonBanks
800,000
h
.-fn5
- 700,000
600,000
v
2
8 500,000
fn
E 400,000
E
m
`E
0
300,000
200,000
100,000
Q1 2000 Q1 2001 Q1 2002 01 2003 Q1 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008
Year (Quarterly)
16. While SOFOLES have brought mortgage lending down to the median household
income level, Mexico's housing finance market remains small relative to the economy. In
the past seven years, mortgagelendinghas grown to only 9.2 percent of GDP, much smaller than
more advanced emerging markets such as Chile (14 percent) or Mala sia (36 percent) and far
smaller than the 50 to 100 percent found in developed economies' InMexico, almost all
mortgages are made to households earning the median income or more and employed in the
formal sector. A large part of the demand for better quality housing comes from lower income
households that are not currently well served by either SOFOLES or banks.45 SOFOLES have
reachedthe middle and lower income segments including informal sector workers with support
from SHF (e.g., long term funding, financial guarantees and mortgage insurance) and mortgage
linked subsidies; however, the progress moving below the median household income is slow.
This is mostly due to two factors. First,there is unequalcompetition between SHFproducts and
the main housing provident fund - INFONAVIT - whose implicit subsidies and recent
elimination of maximum price values result in a bias towards INFONAVIT-linkedhousing being
built by developers. Secondly, the lower cost of deposit funding relative to SHF, and a recent
change in regulations for the financial sector have prompted several SOFOLES to either
44 For example, mortgagedebt to GDP in 2006 was 100.8 percent inDenmark, 81.7 percentin Australia, 51.3 percent in
Germany, and83.1 percent inthe UnitedKingdom. (Source: World Bank, compiledby GCMNB fromcountry statistics.)
45 According to CONAVI, between 2007 and 2012, half of the needfor new housingwill come from households
earning4 MW or less. CONAVI, Programa~Nacional~De~Vivienda~2007-2012
47
transform into banks or allow themselves to be acquired by banks, making it less likely that they
will try to serve more risky households, or serve the moderate cost usedhousing market.
17. Important challenges lie ahead, notably increasing access to housing finance for
lower income and informal sector households which requires expanding the role of non-
traditional financial intermediaries. The vast majority of public and private sector financing
targets those earning the median household income or more. Households earning 6 MWs or
more, representing the top half of the income distribution (Figure 3) are able to buy completed
houses, while informal and low income workers generally build their own lower quality homes.
Of low income households, 75 percent work inthe informal sector, leaving only 25 percent with
access to INFONAVIT and FOVISSSTE46,which combined account for about 60 percent of
total housing lending in Mexico. Estimates show that around 50 percent of the population in
urbanareas is still not eligible for a mortgageloan given their low incomes. The housing finance
needs of such lower income and informal sector earners should be addressed through other
instruments such as a combination of savings, subsidies and micro-credit. This represents an
important challenge as the Savings and Credit Institutions (SCI) segment - the type of regulated
financial intermediaries that target lower income population - is lagging behind in addressing
housing microfinance gaps and still faces deficiencies in accounting, governance and self-
regulation. These deficiencies are being addressed through the implementation of the Ley de
Ahorro y CrkditoPopular.
Figure 3: Market Segmentation by Income Leveland Employment Status
Market segmentation by incomesegment and employmentstatus
(excludes rural population)
DeOa3 De386 D e 6 a 9 Mas de 9
M o n t h l y I n c o m e (MW)
Traditionally notsewed by credit= INFONAVlTl FOVISSSTEI SOFOLES/Bancos
institutions
B. Secondary Market Developments and Challenges
18. Policy and legal changes have permitted SOFOLES, commercial banks, and
INFONAVIT to tap capital markets, linking privatized pensions and other institutional
investors to the mortgage market in a virtuous circle of savings and investment. Since 2003,
54 separate residential mortgage backed securities (RMBS, or Borhis) issues have come to
market, for a total of $4.7 billion. With amortization, $4.1 billion remained outstandingat June,
2008, representing 4.9 percent of the $94.5 billion of mortgage debt (Figure 4). Mortgage
SOFOLES were the first to securitize in 2003, and their debt now constitutes 25 percent of
outstanding corporate debt issues. INFONAVIT also started issuing its CEDEVZS in 2003, and
46The housingprovident fund for governmentemployees
48
by June, 2008 had $2.1 billion outstanding. Banks came to the market at the end of 2006, and by
April 2008 their RMBS constituted 19.5 percent of outstanding issues. RMBS have been
purchased by a diverse range of investors, including 34 percent by private pension funds (known
as Siefores), 13 percent by insurers, 11 percent by commercial banks, and 21 percent by SHF.47
Figure 4: Borhis (Mortgage backed securities) Issues
BorhisIssues
2,500 20
18
2,000 16
v)
.-.-g Q
-
v) 1,500 12 -$
e r
E 10 0
90 k
1,000
z
6
500 4
2
0 7 - 0
19. At 6.9 percent of mortgages outstanding, Mexico's secondary mortgage market is
small in relation to the primary market, and its growth has been affected by the U.S.
subprime crisis. 48 The government has encouraged the development of the RMBS market, so
that the market could replace SHF as the primary funding source for SOFOLES. Before the
subprime crisis began in July 2007, the larger SOFOLES have developed the scale, systems, and
market presence to securitize, and most had issued at least some securities. Smaller SOFOLES
remained dependent upon SHF for their funding because they lack the scale of portfolios
necessary, and in some cases the standardization o f processes and loan doc~mentation.~~Since
the subprime crisis began and the cost of securitization rose, SOFOLESof all sizes have returned
to SHF for increased funding. Banks primarily finance themselves with deposits and have
securitized only as their mortgage portfolios became large enough to create a significant asset-
47Sources: SHF, Banco de Mexico
48In addition to Borhis issues by banks and SOFOLES,there are CEDEVISissuedby INFONAVIT. There were
$4,173 million in Borhis and $2,343 million in CEDEVIs outstandingas of June, 2008
49Inresponse, SHFhas supported the creationof a facility, known as HITOS, that is intendedto provide a means by
which multiple smaller Sofols could assemble portfolios of adequate size to securitize. The IFC is just now
completing a technical assistance program by which it provided information technology and business process
improvementsto five small SOFOLES.
49
liability term mismatch, and to prompt a need to securitize to manage capital. Larger
international banks, such as HSBC and BBVA Bancomer, have continued to securitize, but have
taken advantage o f SHF's support at the time of issuance.
20. International demand for Mexican RMBS has dried up. Prior to the subprime crisis,
Mexican pension funds, European hedge funds and Latin American insurers bought both senior
and subordinated Mexican RMBS. As the subprime crisis emerged there has been widespread
flight from any asset connected with residential mortgages from any country, regardless of its
inherent quality or distance from subprime collateral. Internationaldemand for new Borhis issues
evaporated during 2007, and some international institutions with presence in Mexico insisted on
divesting themselves of their Borhis portfolios.
21. The structure of Mexican RMBS is relatively simple and transparent, and their
performance has been strong. Mexican RMBS are issued as structured securities, with senior
bondsrated triple-A becauseof the highquality of the mortgage collateral, the issuance of lower-
rated or unrated subordinate bonds, and the presence o f third party credit enhancement^.^' More
than other securitized financial assets, mortgages require years o f historical data to determine
typical default rates for a given market. In all countries, default rates for mortgages rise during
the first two to three years as any marginal borrowers in the pool have difficulties making
payments. After that, increased amortization reduces the incentive to default, and delinquency
rates fall. Mexican RMBS are new as an asset class, and their data history is short. Securities
issued during 2002 and 2003 have experienced default rates within expectations set by issuers
and rating agencies. These expectations dictate triple-A ratings and the level of required
subordination. Overall, ninety day delinquencies have risen to 3 percent on average for the
industry, a healthy level by international standards.
22. The market circumstances that led to the U.S. subprime boom and bust are very
different from the circumstances of Mexican housing and mortgage markets. The US.
subprime mortgage bubble began to grow in 2000 and 2001 as rising house prices and falling
interest rates convinced consumers to increase borrowing (Figure 5). Part of the housing boom
was finance driven. As subprime lending expanded, it drove house price growth in lower cost
neighborhood^.^' In some of these neighborhoods, mortgages were made available to borrowers
that hadpreviously been rejected because of deficient credit histories or inadequate incomes. At
the same time, the deflation o f the technology equity bubble led international investors to seek
new opportunities for yield. Triple-A rated securities backed b y subprime mortgages yielded 3
to 4 percent more than other triple-A rated securities with apparently little additional risk. The
50 In a senior-subordinate structure, the senior bonds have priority over principal and interest payments from the
collateral pool. Subordinate bonds bear the cost of any defaults that the pool experiences. In a severe default
scenario, senior bonds would suffer losses only once the subordinate bonds are exhausted. The level of
subordination, or the volume of subordinatebonds relative to the pool, is tantamount to an equity position, in that it
reflects unexpectedcredit losses. Subordinate bonds in Mexican RMBS have constituted between 5 and 20 percent
of different issues. The re-securitization of subordinate bonds, a common practice during the subprime boom, has
not occurred inMexico. Instead,issuers retain equity bonds in their portfolios.
51Mian and Sufi (2008) show that an expansionin the supply of subprime mortgagecredit to certain neighborhoods
led to the rapid increase in house prices from 2001 to 2005 and subsequent increase in defaults from 2005 to 2007.
Mian, Atif and Amir Sufi. 2008. "The Consequences of Mortgage Credit Expansion: Evidence from the 2007
Mortgage Default Crisis," January, http://ssrn.com/abstract= 1072304
50
strength of the property market led many market participants to underestimate the risk of
mortgage lending. In 2005 and 2006, an average of 40 percent of subprime loans was made
without any documentation of the borrower's income or assets, and many of these were made for
95 and 100percent of the value of the house. In 2005 and 2006, half of subprime loans were for
refinancing rather than acquisition. As house prices continued to rise, loans were made on the
assumption that within a year or two, they could be refinanced to more affordable terms on the
basis of higher property value.
Figure 5: US Market
House Prices and MortgageOriginations
1 ,4,500
190 - I I - -
-- 4,000
-- 3,500
-- 3,000
fn
.-0
-- 2,500
I
.-c
- -- z
2.ooof
.-=8110 House Prices
c . (Left Hand Scale) -- 1,500
-- 1,m
c
Y -- 500
7 0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Standard and Poors, Officeof FederalHousingEnterprise Oversight
23. The growth in Mexican residential mortgages and construction has been driven by
demographic fundamentals rather than by an expansion of credit to previously rejected
applicants. Of the 26.7 million households in Mexico, 4.3 million are housed in overcrowded
conditions or substandard structures. Many of these live in informal settlements, in substandard,
self-built structures that lack access to municipal water and sewer systems. It has only been
since 2006 that formal sector housing production has exceeded the annual household formation
rate of between 500,000 and 750,000. Of the new households' that form each year, about 60
percent can afford a mortgage loan. The recent, gradual growth in the middle class i s expected to
continue, providing more households with the means to afford a mortgage on a fully completed
house.
51
24. Increasing production, along with reforms to cadastre and property registration
systems, have kept houseprices from rising excessively. The value of residential construction
grew 71.4 percent in real terms between 2000 and 2007. House prices grew 39.6 percent during
the same period, but remain 8 percent below the levels registered in 1994 and 53.7 percent below
the levels of 1991. (Figure6.)
Figure 6: House Prices
United States HousePrices Mexican House Prices
(S&P/Case-Schiller HomePriceIndex, June 2008) (Adjustedfor Inflation, March2008 pesos)
200.00
150.00 'm,m:l n I, ...................................
..-Average02.94
LDR.W
100.00
mKm
50.00 - -.
uD.m' y ' 1 1 '
Source: SHF, with data from Standard & Poors and Softec.
25. The Mexican mortgage market is comparable to the U.S. prime market in terms of
origination practices and credit performance. The prime market in the U.S. refers to
borrowers with strong credit ratings and loans that are conservatively underwritten with a
demonstratedcapacity to pay the loan through verified documentation of income and assets and a
ratio of loan amount to house value (LTV) between 80 and 95 percent. Mortgages that back
Mexican FWBS are underwritten with full documentation of borrower's credit history and
capacity to pay. Mortgages that benefit from mortgage default insurancefrom SHF are reviewed
twice for adequate documentation, once by the lender, and once by SHF as insurer. The private
mortgage insurers that have entered the upper end of the market also review each loan that they
insure. SOFOLES and banks that act as servicers are rated for the efficiency and quality of their
operations. Data on the performance of securitized portfolios is available over the Internet. The
average default rate at commercial banks fell from 12.6 percent in 2000 to 2.9 percent in 2006, a
rate comparable to the recent performance of prime loans in the U.S.52Default rates on
52Source: BBVA Situacidn Inmobiliaria 2008. The high default rate in 2000 reflected lingering resolutions from the
crisis o f the mid-1990s. Defaults at banks have fallen as they have worked out of old portfolios and increased new
originations. The housing boom in the US.led prime borrowers to borrow increasing amounts against their homes.
52
securitized SOFOLportfolios have risen in the past year but remained within expected ranges, as
households have sufferedfrom higher inflation and unemployment. The July, 2008 report for one
Su Casita security issued in 2006 showed a weighted average LTV at origination of 74 percent,
and a cumulative 90 day delinquency rate of 2.78 percent in the two and a half years since
~ r i g i n a t i o nThere has been no phenomenon of early payment defaults.
. ~ ~
26. SHF has maintained strong underwriting standards for its mortgage default
insuranceproduct. In introducing its new mortgage default insurance product, SHF required
that each loan that was to be insured be subject to SHF's review of the loan's documentation and
underwriting parameters. The review process was replicated as SHF purchased reinsurance from
U.S. private mortgage insurers such as Genworth, which also reviewed each loan for the quality
of its underwriting. In the initial months of the new product's offering, SHF rejected thousands
of mortgages as inadequate, and endured substantial pressure from SOFOLES and banks to relax
its standards. The definition of a Borhis RMBS includes standards for loan underwriting and
documentation, and for third party enhancements. These public standards have become accepted
by investors, and are particularly important for smaller SOFOLissuers.
27. SHF has promoted consistent standards for RMBS quality and it has supported
RMBS issuanceand trading. SHF has promoted a definition of RMBS that includes standards
for the quality of the loans included in the portfolios, mortgage default insurance for the loans,
and standards for levels of bond credit enhancement and subordination. Bonds that meet these
requirements are known as Bonos respaldados por hipotecas, or B ~ r h i sSHF . ~ ~ commits to
support the issuance and secondary trading inBorhis by purchasing up to twenty percent of each
new issue and offering quotes inthe secondary market.
28. Distinct from many subprime RMBS, Mexican mortgage securities are simple
senior-subordinatewaterfall structures. SHF has chosen not to replicate the role of U.S.
government housing agencies and provide full backing for SOFOLor bank RMBS.55As a result,
each Mexican RMBS issue requires credit enhancement by two means: 1) internal enhancements
via the creation of senior and subordinate bonds; and 2) external partial enhancements by third
parties such as U.S. monoline bond insurers, multi-lateral agencies (IFC or FMO), or SHF itself.
A senior-subordinate structure with a third party enhancement enables the issuer to obtain cost-
effective funding and obtain a triple-A rating for its senior bonds. The issuer generally retains the
most subordinate bonds, often referred to as the "equity" bonds. Such senior-subordinate issues
are transparent and relatively simple to model and analyze. Such issues are substantially simpler
to understand and less leveraged than the complex re-securitizations that were common at the
peak of the subprime boom inthe United States.
As U.S. house prices have fallen, delinquency rates on prime mortgages have risen from 2.58 percent in the second
quarter of 2007 to 3.7 1percent at the end of the first quarter, 2008.
Security number BRHSCCB 0602, performance report available at
http://www.sucasitainvestors.com.mx/Index.aspx?tab=4&seccion=3
54The other type ofRMBS that is present inthe market is the CEDEVIS,issuedby INFONAVIT.
55The U.S.housing agenciesFannieMae and Freddie Mac provide 100percent credit guaranteesto RMBS for loans
that meet their underwritingcriteria. SHF provides two partial insurance coverages: 1) mortgage default insurance
for 20 percent of the losses resulting from a loan default, and 2) timely payment coverage for RMBS coupon
payments. SHF's more limited credit coverage maintains better incentives for mortgage originators and RMBS
issuers to manage credit risk.
53
29. Distinct from many U.S. non-bank mortgage lenders, mortgage SOFOLES that
have securitized have retained incentives to underwrite well and to service loans effectively.
SOFOLES that securitize typically retain the responsibility for servicing the securitized loans
and they retain the most junior subordinated bonds (the equity bonds) from each transaction.
Issuer ownership of the equity bond has value in connection with the issuer's servicing capacity
because the equity bond only receives cash flows after the senior and mezzanine bonds have
received their cash flows. To the degree the issuer/servicer is ineffective in collecting loan
payments, its equity bond loses cash flows. So, the issuer/servicer can only realize the value of
the equity bond if it can successfully service the loans inthe collateral pool. Retention of at least
a portion of the equity bonds has been suggested as a reform in the U.S. and other markets. The
SOFOL thus has two incentives to underwrite and service effectively: maximizing servicing fees,
and maximizingthe returnon the subordinatedbond.
30. Mexican mortgage-backed security trading has suffered as a result of the
international crisis in capital markets, but issuance has continued, partly as a result of
SHF's role as market maker. As part of its effort to support the growth of mortgage
securitization, SHF commits to make a market in RMBS that meet certain standards, known as
Borhis. SHF will support new issues by buying up to a limit of 20 percent of the transaction's
volume and occasionally more if required. S H F also maintainsa commitment to purchaseon the
secondary market.
31. Inthe months after the subprime crisis hit inAugust, 2007, SHF was called upon to
participate increasingly at the issuance stage and to buy existing portfolios at market
prices. As the subprime crisis evolved during 2007, many international investors sold off any
and all securities connected to mortgages, often at steep discounts. In a typical flight to quality
and liquidity, investors moved to shorter maturities, to be as close to cash as possible given the
market turmoil. Mexico was no exception; longer term liquidity has been reduced, at least as
reflected by security sales and increasing Borhis spreads. h2006, at the time of the presidential
transition, uncertainty in capital marketsled S H F to hold about 30 percent of outstanding Borhis.
Subsequently, it was able to sell most of this portfolio as markets stabilized and it continued to
provide daily quotes. As investors shed mortgage exposure, SHF's holdings increased from 7.5
percent of total RMBS outstanding in mid-2007 to 15.3 percent by June 2008.56 Mortgage
backed securities spreads against Mexican government bonds widened from about 0.55 percent
inAugust of 2007 to 1.2 percent in May, 2008. As actual mortgage default rates have remained
generally stable, this suggests a market risk related phenomenon where longer term peso
denominated funding i s becoming scarce (Figure 7). As a result of scarce long maturity peso
funding, SHF has relied on short term commercial paper to fund its longer term liabilities. The
resulting rollover and term mismatch risk put at risk not only SHF's ability to continue
supporting existing markets but also its role in developing lower income housing finance
markets.The persistence of the international credit crunch has reduced SHF's ability to shed its
RMBSportfolio.
32. The drying-up of monoline guarantees has affected the Mexican R M B S market and
may lead SHF to again offer financial guarantees for RMBS issues. Monoline firms such as
56Note that the share of the total RMBS market includes non-Borhis RMBS in the market as well (mainly
CEDEVIS issuedby INFONAVIT.)
54
AMBAC, FGIC, MBIA, and others provide financial guarantees to improve the credit ratings of
bonds. As of September, 2007, these predominately US.firms had insured about $114billion of
U.S. single family mortgage backed structured bonds across approximately 130 transaction^.^^
Since such guarantees are generally not required for prime mortgages, the vast majority of these
were securitizations of subprime or Alt-A loans. As subprime defaults rose, the loss assumptions
and pricing employed by monoline insurers came into question, as did their capital adequacy,
and they stopped offering insurance on new issuances, contributing to the international credit
contraction. Monoline insurers were active in Mexico prior to 2007. Out of the $4.7 billion of
Borhis RMBS outstanding, approximately 21 percent have a monoline guarantee. Inthe presence
of monoline guarantees and guarantees from bilateral agencies such as FMO, SHF's timely
payment guarantee had not been competitive. The withdrawal o f monoline guarantors from the
Borhis market has requiredSHF to reprise its former role of bond guarantor.
Figure7: Evolution of Borhis spreads, SHF' Borhis Holdingsand Default Rates
A. InflationIndexedBorhis Spreads B. Pesos Borhis Spreads
Rndimmnlo 5.n.A Udu 4 % R.ndCnUnlOSer*APe.ol
Sobretasa= Spread; Rend-Vencimiento = Borhis yield to maturity; Referencia Guber: MexicanTreasury referencerate
C. SHFParticipation in Borhis Auctions 2007-2008 D.Adjusted Default Rate (%) HouseholdCredit
14
12
10
8
6
4
2
0
2004 2005 2006 2007 MOB
Household credit is composed of Consumer plus Housing credit.
The adjusteddefault rate considers inaddition to Non Performing
Loan, also write-offs made during the last 12 months.
Source: SHF, Banco de MCxico
57Source: FitchRatings.
55
C. The Liftingof the Sunset Provisionand SHF's Strategy for Reaching DownMarket
33. The government created SHF with a limited mandate for private market
development. SHF was created in the context of the persistent absence of commercial banks
from mortgage lending after the 1995 crisis. By supporting the development of new financial
products such as mortgage default insurance and securitizations, and new non-depository
intermediaries such as SOFOLES, SHF would increase access to mortgage finance. SHF was
capitalized with assets from the Fondo de Operacidn y Financiamiento Bancario a la Vivienda
(FOVI), which had already beenfunding SOFOLES.
34. SHF has successfully fostered the rebound in mortgage lending, but significant
weaknesses remain. Funding by SHF and its predecessorFOVI of SOFOLES lending drove the
vast majority of private sector lending to households earning between the median and the soth
percentile of the income distribution between 1998 and 2006. SeveralSOFOLES have developed
a significant market presence. Three of the largest have received significant investments by
foreign depository in~titutions.~~These investors appreciate the value of the SOFOL processing
and distribution networks for moderate and low income households. Issues by SOFOLES
initiatedthe RMBSmarket in2002, and continue to account for the majority of RMBS issuance.
35. SHF's original organic law included two "sunset" provisionsfor market support. It
terminated the provision of credit to financial intermediaries in 2009, and ended the government
backing of SHF debt issues in 2014. The sunset provision on credit to SOFOLES would insure
that they would develop private funding through securitization, thereby limiting possible market
distortions and the contingent liability to the government of SHF funding. The sunset would also
insure that SHF would not be able to use its government backing to monopolize funding of
mortgage markets. Inpractice, SHF has provided market-rate funding to SOFOLES and SHF has
been a leader in promulgating strong financial management practices internally and at
SOFOLES.
36. The limited progress made in extending housing finance to low-income, informal
householdshas prompted the government to lift the sunset provision on SHF's second-tier
lending. Despite the progress made in the past seven years, a number of weaknesses remain in
the domestic market:
Mortgage lending has grown only to 9.2 percent of GDP, much smaller than Chile (14
percent) or Malaysia (36 percent) and far smaller than the 50 to 100 percent found in
developed economies.
0 Low income informal households are not well served by either banks or SOFOLES; almost
all mortgages are made to formal sector households earningthe medianincome or more.
The current disruption in international credit markets has constrained the ability of even
larger SOFOLES to tap capital markets. Several smaller SOFOLES remain constrained in
their ability to tap capital markets by a lack of scale and resulting lack of operating
efficiency.
BBVA Bancomer bought Hipotecaria Nacional, Su Casita has been purchased by Caja de Madrid, and
Metrofinanciera has recently benefitted from a substantial private equity investment.
56
Warehouse lines of credit are not offered by Mexican commercial banks. Non-depositary
lenders in other countries rely on one and two-year lines of credit from commercial banks to
finance the accumulation of portfolios of adequate size to securitize. To date, this market has
not developed in Mexico, and so SOFOLES continue to rely on SHF or a few foreign banks
and multi-laterals for matched funding that they prepay when they go to market with a
securitization.
In spite of strong credit performance, the Mexican RMBS market remains small and illiquid
both for primary issuance and secondary trading.
SHF can continue to play an important role in market development by providing credit to
SOFOLESand to other intermediaries that provides them with flexibility in approaching the
capital markets, and by acting as a market maker for RMBS.
37. The sunset clause was lifted with the understanding that SHF would define its new
primary strategic role as developing lending for underserved low and informal income
earners. SHF will continue to play a supportive role for the regular mortgage sector, e.g., as a
liquidity provider and insurer of last resort and as the focal point for industry information and
data analysis; however, it will have to refocus its financial support activities much more
deliberately to bridge the current gap in the housing finance market. This means a re-orientation
of the bulk of its operations towards alternative lenders and housing finance products more
appropriate for the below median income groups. As shown in Figure 8, SHF has already
increased the amount of funding that it provides to lower income households. The horizontal
axis presents minimum wages, and the vertical represents the percent of households and the
percent of credits made. The highest "spike" represents credits made in the first half of 2008, the
lower "spike" represents credits made in the second half of 2007, and the middle line represents
the national household income distribution. The bias of SHF lending over the past year has
moved markedly towards those earningless than the median household income.
57
Figure 8: Distribution of SHF Credits and the National Income Distribution
I n
0 2 4 6 8 I O 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60
Numberof MinimumWages
Source: SHF
38. SHF has a policy of limited interventions to support weak SOFOLES and had
expected more SOFOLES to move to market funding before the subprime crisis hit. Some
SOFOLES have run into trouble as housing markets in some regions have slowed. As the sales
of new homes declines, some developers have been delinquent on their bridge loans, causing
liquidity problems for SOFOLES such as Metrofnanciera. When SOFOLES have liquidity
difficulties SHF lends against acceptable collateral, including otherwise unencumbered
mortgages and RMBS. SHF will lend to alleviate liquidity difficulties, but not solvency
problems. SHF has cooperatedwith investment banks to facilitate the merger of weak SOFOLES
with stronger ones. The advent of the subprime crisis has led large and small SOFOLES to
return to SHF funding as demand for RMBS has declined. SHF management expects the
consolidation of the SOFOL industry to continue, with banks buying SOFOLES, smaller
SOFOLES merging, and some acquiring banking licenses or changing their business models to
become mortgage originators without holdingportfolios.
39. SHF will take a number of actions to reduce exposure to more expensive markets,
and increase exposure to underserved households. For instance, the only financing available
for houses valued at more than MXP 600,000, or roughly $60,000, will be in the form of short
term warehouse lines of credit that permit lenders to accumulate portfolios for securitization.
SHFwill also promote mortgage restructuring products for delinquentborrowers, it will promote
58
new mortgage loan products, and encourage greater flexibility in programs with ZNFONAVZT.
SHF will leave the mortgage insurance market for houses valued at more than MXP 600,000 to
private insurers, compete to insure houses less than that through the use of reinsurance or simply
by takingthe exposure on its balance sheet.
40. UnderSHF's new businessstrategyit will playa key role inthe marketdevelopment
of housing finance for the households earning less than 6 MWs through the Savings and
Credit Institutions(SCI). SCI's are regulated financial intermediaries targeting lower income
population. These SCIs include: savings and loan cooperatives (Cajas) and low income finance
companies (Sofpos). These intermediaries have been brought under regulation and supervision
through the World Bank-assisted implementationof the Popular Savings and Loans Law (Ley de
Ahorro y Credito Popular). Of the 660 institutions, 497 have adhered to the Ley de Ahorro y
Crkdito Popular and 69 of these - which account for close to 50 percent of the total membership
and roughly the same percentage of total assets- are authorized. Regulated SCI's such as Savings
and Loans Cooperatives (Cajas), finance companies and micro-finance banks have expanded
their small credit offerings for home improvement. Despite this expansion, home improvement
loan portfolios (average credit of $500 to $750) remain relatively small as a proportion of
housingcredit and no medium term and larger housing loans are offered as yet. Interest rates are
highon short-term home improvement loans (an average flat rate of 60 to 70 percent), which in
turn makes medium-term housing loan products neither affordable to consumers nor attractive
for lenders to develop. Yet, without medium term (e.g. five to seven.years) housing loan
products, construction of new houses on household's own plot, or on a subsidized serviced lot
providedby municipalities i s extremely difficult and will take a long time. The demand for such
products i s big, however, according to SCIs.
41. Implementationof this strategy would require strengthening SHF and financial
intermediaries'housingmicrofinancecapabilities. SHF started efforts to develop the housing
micro finance market in 2005. That year it signed agreements with two financial intermediaries
targeting low income households for credit lines for housing improvement. Since then, 74,000
loans have beenoriginated that resulted ina volume of credit lines of around US$lOOMM. It has
signed agreements with six additional financial intermediaries (three Sofipos, three SOFIMOS
and one rural housing bank) and expects to deliver more than 85,000 new micro loans for
housing in 2008. The credit-linked subsidy scheme launched by the federal government in 2007,
the Esta es tu Casu program operated jointly by CONAVI and SHF, supports these efforts
through an up-front subsidy for housing improvements and self-construction. Duringthis three
year learningperiod, SHF faced important challenges working with SCIs targeting lower income,
both for housing micro-credits and mortgage lending, amongst the most important are:
Heterogeneous market. Given the diversity in size and capacity the Ley de Ahorro y Crkdito
Popular categorized the SCIs (Types I-IV) depending on their legal status, ability to accept
deposits and capacity to issue banking instruments and established a gradual approach to
address the different problems faced. Despite the efforts, there are still challenges in terms of
financial management or accounting procedures. As these develop, SHF will initially work
with the relatively more developed (Types I11& IV), of which there are 20-25 SCI identified.
Absence of long-term funding availability for these institutions. Today 70 percent of the
funding for SCI comes from short term deposits, limiting their availability for mortgage
lending.
59
Focus of SOFIPOs business models on community or group loans rather than individual
loans.
Lack of housing-specific products. Estimates suggest that as much as 25 percent o f SCI's
standard business or consumer loans are used for housing; however there are no housing-
specific products available.
Lack of IT and HR capacity within SCI to operate mortgage loans. In particular, there is
little experience in collecting relevant information from clients to adequately measure risk
exposure.
42. SHF's actions as RMBS market maker should be reviewed in light of its new
strategy and funding. As credit markets stabilize, SHF should seek to reduce the RMBS
portfolio that it as accumulated. It i s not clear that all issuers need an SHF backstop at issuance,
and it is unclear whether all issuers need a backstop that i s in place regardless o f market
conditions. For example, while SOFOLES access to the RMBS market has been made more
expensive by the sub-prime crisis, it appears that commercial bank access has been much less
seriously affected. Through May 2008 bank issuances of RMBS appears to be on track to
surpass last year. Bancomer's issue has recently brought an issue to market denominated in UDI
and primarily consisting of mortgages to traditional SOFOL customers. Su Cusitu, after
completing its capital injection from Cuja de Madrid, is scheduled to come to market in
September of 2008. Thus it appears that the difficult issuingenvironment resulting from the sub-
prime crisis has fallen most heavily on the weakest SOFOLES.
43. SHFhasexpresseda needto reconsiderthe mechanismbywhichit intervenesinthe
R M B S issuance market. For instance, a strategy based on price intervention rather than a set
quantity may reduce SHF's purchases. For example, when it appears that bidding is likely to
lead to pricing that i s out of line with recent issues o f comparable risk, SHF might intervene to
bring pricing back into line. With this strategy, it is likely that SHF will not bidon most bank
issues at all. SHF could then use its balance sheet only where it i s needed by supporting the
primary issuance duringperiods of stress and only supporting those institutions suffering unduly
from that stress.
44. SupportingSHF's new strategy impliesa range of technicalassistancethat is meant
to address questions about the future of SOFOLES and SHF's role as market maker for
RMBS. One study would evaluate the state of the remaining independent SOFOLES, and their
chances for survival given the technical assistance provided by IFC, the funding provided by
HITOS, and their ability to achieve economies of scale. It would explore the economics driving
further consolidation and the costs of serving the medium and lower income segments. The
operation would provide advice on the rules and mechanism by which SHF acts as market
maker, with reference to fixed income markets in other countries.
45. Liftingthe sunset clause on SHF's lendingto intermediariesis warrantedby SHF's
institutionaltrack record,by the state of Mexico's mortgagemarket,andby capitalmarket
conditions. SHFhas a history of strong financial management. It has exited markets served by
the private sector. Its corporate governance structure has resisted exploiting its privileged
borrowing status to dominate markets in which it is active. (Board members have actively
supported the development of the new strategy to move down market.) Public liquidity facilities
in other countries have persisted without dominating the market, for example Cagamas in
60
Malaysia and the Federal Home Loan Banks inthe United States. Withdrawal of SHF support for
SOFOLESat this point could result inreduced access to finance for households earning between
the median and 70thpercentile of the income distribution. The precarious state of Mexican
mortgage securitization markets warrants providing SHF with the capacity to support smaller
SOFOLES with direct credits when the market is not accepting of their securitizations at a price
that i s competitive for them. The government, however, will continue to monitor the status of
markets and SHF's role in market development to see where SHF's activities may need to be
phasedout.
61
Annex 2: Major Related ProjectsFinanced by the Bank andor other Agencies
MEXICO: Private HousingFinanceMarkets Strengthening Project
Sector Project Bank Latest Supervision
Issue Approval (ISR)Ratings
Progress I Objective
GoMlow PO88080-MXHousing I11/09/2004 7.77
I
income and UrbanTechnical
housing AssistanceProject (closingon
program (HUTAL) Dec 2008)
support
Bank Financed Projects Closed
-
GoMlow P101342- MX 11/27/2007 200.50 MS MS
income AffordableHousingand
housing UrbanPovertyReduction
program DevelopmentPolicy
support Loan 111(HUDPL111)
PO89852- MX 11/29/2005 200.50 S S
Affordable Housingand
UrbanPovertyReduction
DevelopmentPolicy
LoanI1(HUDPL 11)
PO70371- MX 06/08/2004 100.00 S S
Affordable Housingand
UrbanPoverty
ProgrammaticSector
Adjustment Loan
(HUSAL I)
FOVI PO07610- MX FOVI 03/04/1999 505.5 S
reform Restructuring
FOVI IADB HousingFinanceProject (1298/OC-ME), $505M,closingon Dec
reform 2008
RRH IADBFacilitationof Access to HousingFinancingfor Remittances
housing RecipientsHouseholds(RRH) (ATN-MT-9138-ME), $1.7Mnon-
reimbursablefinancing, closingon Dec 2008
62
Annex 3: Results Framework and Monitoring
MEXICO: Private HousingFinanceMarkets StrengtheningProject
Results Framework
The main objective of the project is: (a) to strengthen the financial capacity of S H F to
develop and consolidate mortgage markets and to expand mortgage access to lower
income groups over the medium-term; and (b) to improve SHFs technical capacity to
expand mortgage access to lower income groups over the medium-term.
Strengthen the financial Numberof housing As a key part of the housing
capacity of SHF to develop solutions delivered per year sector, SHF contributes
and consolidate mortgage with policies and programs
marketsand to expand to the country's overall
mortgage access to lower housing goals. The number
income groups over the of housing "solutions" i s in
medium-term; and (b) to part also a reflectionof how
improve SHFs technical SHF's financial and
capacity to expand technical capacity can help
mortgage access to lower to develop and consolidated
income groups over the mortgage markets.
medium-term.
Intermediate Use of Intermediate
Indicat Outcome Monitoring
Strengthen the financial Average duration of assets/ Monitor the strengthening
capacity of SHF average duration of of SHF's balance sheet
liabilities
Percentage of total Monitor the role of SHF as
BORHIS outstanding held marketmaker for the
by SHF secondary market
Develop private housing Total number of new Monitor if SHF's financial
markets mortgage loans strengthening results in an
increase in access to
housing
Total amount of mortgage Monitor market
credit to private sector development and ability to
intermediaries design and implement new
products
Numberof additional Monitor the pace of
financial intermediaries implementation of SHF's
working with SHF funding strategic plan 2007-2012
and/or products which includes addressing
lower income segments
63
through new financial
intermediaries such as CSIs
Amount issuedthrough Monitor secondaryhousing
BORHIS (Banks and market development
SOFOLs)
Expand mortgage access to Percentageof mortgage Monitor the pace of
lower income groups over loansto households earning implementation of SHF's
the medium-term. between 1- 6 MW from strategic plan 2007-2012
total number of loans which includes addressing
lower income segments
Percentageof the amount of Monitor the pace of
new lendingto households implementation of SHF's
earning between 1-6 MW strategic plan2007-2012
from total amount of which includes addressing
lending lower income segments
Percentageof mortgage Monitor the pace of
loansto households earning implementation of SHF's
between6 - 16MW to total strategic plan 2007-2012
number of loans which includes addressing
lower income segments
Percentageof the amount of Monitor the pace of
new lending to households implementation of SHF's
earningbetween6 - 16 strategic plan 2007-2012
MW from total amount of which includes addressing
I lending lower income segments
Number of mortgage loans Monitor the pace of
to informal sector workers implementation of SHF's
strategic plan 2007-2012
which includes addressing
lower income segments and
the development of new
instruments andproducts
for households without
access to housing finance
Numberof housing micro Monitor the pace of
credits implementation of SHF's
strategic plan 2007-2012
which includes addressing
lower income segments
through new financial
intermediaries such as SCIs
64
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Annex 4: Detailed Project Description
MEXICO: PrivateHousingFinanceMarketsStrengtheningProject
Component 1. Debt Restructuring.
1. This component would provide longterm funding so that SHF can matchthe
maturity and option structure of its assets and fund sustainably its mandate to consolidate
markets and expand access for lower income segments. Inits effort to support the mortgage
securitization market, SHF's RMBS holdings increased from 7.5 percent of total outstanding in
the marketin October, 2007 to 15.3 at the end of June, 2008. As noted above, SHF's longterm
financing costs in local marketshave increased. IBRDfinancing provides lower cost, longer
maturity and more favorable repayment options compared to current conditions inlocal markets.
The IBRDcan makeuse of its triple-A status ininternational capital markets to provide SHF
with funding options that are otherwise not available to SHFeven with its sovereign backing.
Without a debt restructuring, rollover and term mismatchrisk could limit SHF's ability to
continue supporting existing markets and limit its efforts to develop lower income housing
finance markets via Savings and Credit Institutions.
2. SHF is well capitalized. The issuance of short-term debt is an instrument that SHF
has used in the past as an inexpensive means of making purchases of securities in the
RMBS market to be held for short time periods. The level of short-term debt has reached
around $1.9 billion, or about 30 percent of assets. It has reached this level before, such as at the
time of the presidential transition, a traditionally turbulent period for Mexican financial markets.
Maintaining a certain amount of short term debt has allowed the institution to adjust
continuously to the pre-payments made by mortgage holders and by SOFOLES in the past as
they accessed other sources of funding. Pre-payment risk i s difficult and expensive to hedge
using the domestic capital market. Holding short term debt is not a problem per se, but given
that RMBS and credits to SCIs and SOFOLS are long maturity and many are fixed real rate,
holding too much short term debt raises refinancing and liquidity risk. Indeed all Mexican
development banks hold a large proportion of short term debt relative to their liabilities, as long
termdebt instruments are relatively new inthe market.
3. SHF's balance sheet mismatch, although not desirable, is not the result of a crisis or
emergency situation with its own finances. The fastest and cheapest way to finance SHF's
RMBS acquisitions has been to issue short term notes with the intention to later refinance them
with longer term debt. As a state-owned entity with the full backing of the national government,
SHFis able to roll over its short term positions as well as the government. However, Mexico is
not a triple-A credit in international markets, and the costs of rolling over its positions may rise.
Refinancing with World Bank debt i s a recognition that SHF may need to hold the RMBS it has
acquired for longer than it had expected to. By refinancing a portion of its short term debt, SHF
gains funding stability in a turbulent time as it supports the consolidation of mortgage markets
and expands access to lower income segments. The proposed loan-along with financial options
offered by the Bank's Treasury-would improve the financial sustainability of SHF.
69
Component 2. Technical Assistance
4. A. Development of new business lines, strategies and procedures. This area i s the
core of the TA requirements and the most urgent to implement. SHF needs to implement a new
strategy and credit policy, including new products, that is focused on the needs of new clients.
Activities likely to be included are:
o A market study to assess demandfor difSerent types of housing products (incremental,
new, used, and rental) and credit products by different income and employment groups.
Such a study should guide the specific product line proposalsby the re-engineering study.
1 Current information i s piecemeal but will form a sound basis for further detailed
quantitative surveys and focus group work.
o Consulting support for the re-engineering process for SHF given its new strategic
orientation on down-market lending. While an internalcross-departmentalteam will lead
this effort and already has prepared the framework for the re-engineering plan, outside
consultants may assist in the analysis and review. Support will be required in the
following areas: i)identify new housing finance and savings products SHF should
prioritize for its financial support activities (with inputs from the market demand study),
new types of clients that could deliver such products and ways to bring such activities to
scale, ii)develop a franchise for SHF to engage and strengthen new clients, iii)establish
efficient procedures for the delivery of new (and existing) SHF financial and insurance
products, iv) propose staffing and capacity needs to implementSHF's new strategic plan
and prepare aplanfor staff re-allocation and re-tooling.
o Consulting support to develop risk assessment and risk based credit guidelines for
liquidity lending and guarantees to new categories of clients and for different credit
products. Again, while the credit assessment and management department will lead the
effort, a consultant more familiar with the proposed alternative housing finance products
and client institutions could assist SHF staff to deliver new credit procedures in a timely
way. This type of TA has to follow urgently after the completion of the re-engineering
studies and agreement on recommendations.
o TA to develop a proto-type muster servicer contract for mortgage portfolios, and possibly
alternative housing credit loan portfolios. Many such prototypes exist for mortgage
portfolios and a law firm familiar with Mexico's mortgage market would be able to assist
SHF put together some alternative models. For non-collateralized short term credit
portfolios, intermediary institutions such as ACCION International may be*ableto assist
SHF. However, the secondary credit market for this type of product is still to be
developed.
o Consulting support to optimize SHF's RMBS market maker role. The preparation team
and managementhave discussed alternate modesby which SHF could support RMBS (in
particular Borhis) issuance and secondary trading while maintaining a smaller retained
portfolio of RMBS. This consulting work would examine inmore detail SHF's processes
for quoting prices and quantities, make comparisons to other fixed income markets, such
as the U.S. Treasury bond market, and make recommendations for changes to SHF's
pricing and purchasing rules..
o Developmentof a scoring systemfor borhis
70
o Design of an "innovation fund" that allows for testing of new credit products and
different incentives to SCI client institutions. Fast track testing of experimental products
will provide critical information before a large-scale launch i s contemplated.
5. B. Implementation of data collection systems on the mortgage sector and
monitoringand evaluation systems for SHFprograms.
o Assistance to establish a state-of-the-art data base and data analysis modelhnit for the
mortgage sector to fulfill SHF's proposed role as the agency in charge of such data
collectiodanalysis across all financial institutions involved in mortgage lending.
Standardized data will need to be collected on different mortgage products' size, term,
performance over the life of the loan, on a confidential basis. Ongoing analysis has to be
carried out and published regularly. Support i s needed to develop a proto-type system for
data collection following best international practice, and to develop a plan to establish the
functions, reporting system, staffing and cost o f such an. expanded information
unitjcentre.
o Assistance to establish an information and coordination centre for housing micro-finance
products, which will collect data on size, terms, performance from all lenders that will be
published regularly. A plan needs to be developed to set up such a centre, including its
functions, reporting requirement, staffing needs, and cost.
o Technical support to establish a monitoring and evaluation unit that will provide timely
information on the effects of the varied household subsidy programs (upfront mortgage
subsidy and savings products, home-improvement- and progressive building subsidies)
and the effectiveness of incentives provided to new intermediaries (e.g., guarantees,
liquidity loans, technical advice). Reporting by such M&E unit would allow timely
adjustments of products and implementation procedures and a better alignment of
programs and financial sector inputs across agencies.
o Study to analyze loss-given-default on bridge loans. Current information on LGD is
limited because defaults on bridge-loans are worked out over an extended period, i.e.
these loans are not called or written off. This study would provide information on the
actual loss in case of default in order to price this risk/loss more accurately. (A
counterpart internal study should be conducted on the loss-given default profile of the
current individual mortgage loanportfolio and of new housing finance credit products.)
6. C. Development of instruments and capacity building to strengthen existing SCIs
and NGO lenders to become more effective housing finance providers. The re-engineering
study will provide general recommendations on the possible role of SHF in strengthening and
speeding up the consolidation of the micro-finance for housing market. But more specific
analysis on the specific type of assistanceto different market players will be needed.
7. The market is currently characterized by rapid growth, very high levels of
profitability (ROE'Sof 50%+), high interest rates (typically 60-loo%), and limited direct
competition on price. SHF's involvement in this market should be carefully assessed. The
existing players in that market are well capitalized and professionally operated, making it
difficult for new firms to enter. SHF can assist in facilitating new entrants and hence increase
competition. Risks are that an aggressive facilitation approach (including through the use of
upfront subsidies) may stimulate rapid credit expansion through groups that are not used to
71
manage credit risk (e.g., often cujus do not use credit bureaus), and that SHF will be exposed to
political criticism if they are associated with institutions that have such high profitability (see
Porteous, 2006). SHFmay hire consultants to help them inthe following areas:
o Define a detailed strategy and credit policy to support identified new categories of
clients. Consultants may prepare a broad needs assessment study for micro-finance
banks, cujus and NGO institutions to expand housing finance products, and understand
broader issues related to the transformation of weak institutions. Consultants should
identify institutions other than SHF to assist in broader restructuring of alternative
lenders.
o Support SHF indeveloping arating systemfor new client institutions.
72
Annex 5: ProjectCosts
MEXICO: PrivateHousingFinanceMarketsStrengtheningProject
ProjectCost By Componentandor Activity Local Foreign Total
US$million US$million US$million
Component 1 1,000 1,000
component 2 7.475 7.475
Total Baseline Cost 1,007.475 1,007.745
PhysicalContingencies
Price Contingencies
TotalProjectCosts' 1,007.475 1,007.475
Interest duringconstruction
Front-endFee 2.525 2.525
Total FinancingRequired 1,007.475 2.525 1,010
73
Annex 6: ImplementationArrangements
MEXICO: PrivateHousingFinanceMarketsStrengtheningProject
1. Sociedad Hipotecaria Federal (SHF) will be the implementing agency for the proposed
project and also serve as the financial intermediary to channel funds. SHF will execute the
activities described under the two components proposed under the project. SHF will have the
responsibility o f defining an action plan, andwill approve, evaluate, monitor and control the
implementation of their corresponding project components.
2. For component 2, SHF will have inplace a full-time team to manage the project, and hire
consultants to dedicate to the project as required. The main functions will be:
Act as executive secretariat for corresponding components of the project
Identify the technical studies required and prepare the relevant TORS,
Assist inprocuring and contracting the required consultants, technicians and services
Provide adequate facilities for the implementation team, consultants and technicians
Evaluate consultants' and technicians' performance
Review all documents and reports produced
Adjust the operational plan for the relevant components, as required
Perform the financial management of the corresponding components of the project
Provide support to auditors
Holdperiodic reviews of the project together with the Bank, provide support for Bank
supervision missions and prepare the Borrower's contribution to the project
Implementation Completion Report
3. As mentioned in the text, SHF has extensive experience as financial intermediary and
implementing agency o f Bank-financed projects. The Bank conducted financial management
and procurement reviews. Further details on financial management and disbursement
arrangements can be found in annexes 7 and 8 respectively
74
Annex 7: FinancialManagementandDisbursementArrangements
MEXICO: PrivateHousingFinanceMarketsStrengtheningProject
1. Background. SHF's financial management (FM) arrangements are consistent with
Bank's principles and practices on the subject. Therefore, the proposed Private Housing Finance
Markets Strengthening Project would allow for the use of existing FM arrangements (country
systems that are satisfactory to the Bank), complemented as needed given the particularities and
size of the operation.
2. Financial Management Assessment. The Bank carried out a project Financial
Management Assessment (FMA) to ensure that the project design and institutional capacity
support smooth implementation and allow for an appropriate level of transparency, oversight and
control. Specifically, the aim of the FMA was to assess the project FM arrangements, identify
risks, and ensure these are properly mitigated in a structured manner throughout the life of the
project. In addition, the Bank provided advice to Sociedad Hipotecaria Federal (SHF) on the
design of the FMarrangements.
3. Based on the results of the FMA, the following conclusions were drawn:
h. the overall FMresidual6' risk is modest.The main mitigating measures are related to
timeliness and depth of reporting and auditing arrangements;
i.controloffundsandprojectrecordswillbebasedontheinternalcontrol,treasuryand
information systems that SHF i s currently using for its current programs, including
another World Bank project that i s currently under implementation. These systems
are deemed adequate for the operation, but FM staff in SHF needs to ensure that any
additional duties associatedto the specific reporting and auditing arrangements of this
project will be properly incorporated into their current responsibilities;
j. the loan will utilize two disbursement methods: (1) Advance for Component 1; and
(2) Reimbursement for Component 2. For Component 1, the Bank will advance loan
proceeds into a Designated Account of SHF for subsequent payment of maturing
short-term debt.61For Component 2, the Bank will reimburse SHF for eligible goods
and services pre-financed by SHF with its own resources;
k. SHF will produce semiannual non-audited Interim Financial Reports (IFRs) for the
entire project. Additionally, and only for Component 1, SHF will produce customized
Cash Flow Reports for the World Bank on a weekly basis to confirm the short-term
debt payments;
1. for Component 1, an external firm will audit the entire activities related to each Bank
advance within the next three months after the last debt payment using Bank's funds
has been processed. The auditor's report will be submitted to the Bank within that
period. For the project as a whole, SHF will have the same firm audit the project
financial statements on annual basis, and will include the results in the audit of the
Entity's Financial Statements;
Residualrisk i s the combination of the project's FMinherent andcontrol risks as mitigatedby the combination of
SHF'scontrolframeworksandBanksupervisionefforts.
Q2 and the second duringthe FY0943.
It is estimatedthat two advances of about US$500million each will be made for Component 1,one during FY09
75
m. the FMsection of the OperationsManual (OM) will contain information satisfactory
to the Bank on the six elements of FMas defined in OP10.02. The draft O M would be
ready before Negotiations; and
n. the FM team will carry out at least one full supervision mission per year for the
project. These missions will be complementedby reviews of the Cash Flow Reports,
FRs andaudit reports.
4. Risk Assessment. On the basis of the FMA, the overall FM residual risk is considered
Modest, as explained by the following table:
Risk rating Summary
I Conditions of I
Negotiations,
Residual Board or
Risk Comments/ Risk Mitigating Measure Incorporated Effectiveness
Risk rating into Project Design (Y/N?)
The mainaspect considered for the inherent risk is the
size of the operation, specifically of the two advances for
Component 1. Mitigating measuresfor prompt
documentation and audit of advances were incorporated
Control M
Budgeting N
Accounting N
I
Internal Control N
Funds Flow N
Financial s
SHFs project reportingrisk is only modest. However, in N
Reporting order to further mitigatethe inherent project FM risk,
weekly Cash Flow Reportsto document use of the
advances will be requiredfor this project, Le. in addition
to semiannual IFRsand annual financial statements. The
format of the reportswill be included in the Operations
Auditing M SHF's project audit risk is only modest. However, in order
to further mitigatethe inherent project FM risk, the useof
advances will be subject to immediateaudit, i.e. in
additionto the annual audit report. The special audit
TORSwill be includedin the 0 erations Manual.Risk ratings:
1
L: Low
M: Modest
S: Substantial
H: High
Notes:
PHFMS = Private HousingFinance Markets Strengthening Project
76
GeneralArrangements
5. Implementingentity. SHF will be the implementing entity and financial agent for the
project. SHF has extensive experience as financial intermediary and executing agency of Bank-
financed projects, including the FOVI Restructuring Loan (ID: P007610) and the series of
Housing and Urban SAL and DPLs worth a total of US $500 million (e.g. ID: P089852).
Currently, SHF i s responsible for the Housing and UrbanTAL (ID:P088080).
6. SHF is satisfactorily staffed, as key FM personnel have acceptable credentials and
experience to carry out all FM-related responsibilities associated to the project. Still, FM SHF
needs to ensure that any additional duties associated to the specific reporting and auditing
arrangementsof this project will be properly incorporated into their current responsibilities
7. Disbursementtable.
Component Financing Bank Description(use) Expenditures'
percentage share recognition
(US$
million)
1. Debt restructuring 100% 1,000.00 Paymentof SHF`s short-termdebt: Payment,at
maturity,of
3 financingthesuspensionof PRLVs and
rolloverof PRLVs:short-termbonds OMAs
(Pugarks con Renditniento Liquidable
a1 Vencimiento);and
3 financingthepaymentofOMAs:
Central Bank Open Market
Operations(Prkstamos interbancarios
con Banco de Mkxico garantizados por
el Depdsito de Regulacidn Monetaria)
2. Technical 100% 7.48 Financethe implementationof SHF's Paymentof goods
Assistance new strategicplan 2008-2012 focused or services
on expandinghousingfinance to
currently underservedpopulation
Unallocated 0.00
FrontEndFee WEF. 100% 2.52 Automatic charge
25 basis pointsj
Total (Loan) 1,010.00
8. Accountingsystem. In accordance with SHF most recent audited financial statements, it
maintains records and accounts adequate to reflect its operations and financial condition, in
accordance with accounting norms established by the National Banking and Securities
Commission (CNBV). In terms of project cash-based financial statements, such as for the project
financed by Bank loan 7261-ME (ID: P088080), SHF has a satisfactory record. The same
acceptableproject accounting practices and information systems will apply to the new operation.
9. Internalauditing. SHFhas an internal audit function which is carried out by its Organo
Znterno de Control (OIC). This unit executes planned financial reviews of SHF's operations and
programs. Ingeneral, the internal control environment i s satisfactory.
77
10. Financial reporting. For the project as a whole, unaudited Interim Financial Reports
(IFRs)will be semiannually submitted by SHF to the Bank (andon a quarterly basis to the Public
Administration Ministry (SFP, Secretaria de la Funcidn P~%Zica),in accordance with standard
formats agreed with SFP for projects financed by multilateral banks.
11. The annual Project Financial Statements will follow the IFR format, include all
applicable notes, and be part of the annual audit report (see below).
12. External audit. Annual financial audits will be carried out according to Bank policy, as
reflected in the Memorandum of Understanding on Auditing agreed between SFP and the Bank.
The terms of reference for annual financial audits are agreed with SFP. An external private audit
firm designated by SFP and acceptable to the Bank will carry out the project financial audits.
The Bank has recommended that the auditor that audits SHF, as entity, audits the project as well.
As such, the results of the project audit would form part of SHF's own audit report.
I Audit report I Duedates I
Entity Financial Statements: SHF Within the six months following the end of the audited
year, starting by June 30, 2010 (which will cover from
effectiveness to December 31, 2009), and until the last
transaction has been audited.
r The standard covered period will be the fiscal year of SHF
(from January 1 to December 31).
Designated Account Same due dates as the Entity Financial Statementso f SHF.
A single report will be submitted to the Bank for all
designated accounts administrated by SHF.
13. Operations Manual (OM) and Written Procedures. SHF will include a FM section in
the project's Operations Manual (OM). Specific Project FM-related procedures will be
documented inthis section to define roles andresponsibilities and project-specific arrangements.
14. SupervisionPlan. Based on the results of the FMA, the Bank will carry out at least one
full FMsupervision mission per year duringthe entire implementing period. Additionally, a FM
specialist will review the IFRs, audited financial statements and the special audit reports and the
cash flow reports for Component 1(see below).
FMArrangementsSpecificto Component1
15. Flow of funds Proceeds of the loan in U S Dollars will flow from the Bank to SHF's
designated account in BANXICO, in the form o f two advances. Subsequent to each advance,
SHF will deposit the funds in its local currency account for payment of short-term bonds
(PRLVs) and central bank open market operations (OMAs) as they mature.
78
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ I
SCEs, Weektj
bOAN ACCOUNT) cashflow reports 8
specIat aJaits
us$ I #' !
3EP0RTE
IDESGNATEO ACCOUNT
Managedby S-IF]
intormatonrtov
Funds flow
16. Financialreporting. SHF will produce and submitto the Bank, on a weekly basis, Cash
Flow Reports to document use of the advances. The format of the reports will be included in the
Operations Manual, containing at least: (i) pertinent information on PRLVs and OMAs e.g. value
and maturity; (ii) actual payments made during the week -identifying PRLVs and OMAs; (iii)
reconciliation of the advance against payments documented to date; and (iv) estimated future
payments.
17. Disbursementarrangements. As noted earlier, the Bank will disburse two advances of
about US$500 million each to SHF's designated account in US Dollars in BANXICO. These
advances will be documented promptly afterwards by SHF through Statements of Expenditures
(SOEs) containing the Cash Flow Reports mentioned above.
18. Disbursement of the second advance will be subject to full documentation of the first
advance at Bank's satisfaction, and compliance with other disbursement conditions (see binding
indicators intable 3, short term targets, of the PAD).
19. External audit. A specific financial audit per advance will be carried out and its report
submitted to the Bank within three months after the last PRLV/OMA payment financed by each
advance has been made. The project external auditor will certify whether the SOEs and Cash
Flow Reports used by SHF to document the advance are supported by adequate documentation
and represent eligible payments (for PRLV and OMAs). This special audit TORS will be
included in the Operations Manual.
Audit report Duedates
Component 1 Within three months following the last financial transaction
financed by each advance.
79
FMArrangementsSpecificto Component2
20. Budget arrangements. Under the "non-additionality' principle, project expenditures
have to be timely allocated under the existing budget of SHF. This i s a regular, well-known
practice of projects in Mexico, including those executed by SHF. Therefore, SHF will provide
funding in local currency (Mexican Pesos) to pre-finance the project, and the Bank will
reimburse ex-post only for eligible expenditures that were registered in budgetary lines
earmarked for the project. Budget execution i s regulated by national legislation, particularly the
Ley Federal de Presupuesto y ResponsabilidadHacendaria and its regulations.
21. Flow of funds Proceeds of the loan will flow from the Bank to SHF's account in US
Dollars in BANXICO, as reimbursement of documented eligible expenditures pre-financed by
SHF.
#1 MX$orUS$
PAYMENT +
(ti SUDDien) I SHF
I
#
II
WORLD BANK
604NPCCOUNT]
I I
us$ #3
Nuk
Inform9tio'lflow
Fundsflow
22. DisbursementArrangements. The expenditures to be reimbursed by the Bank will be
documentedby SHF through Statements of Expenditures (SOEs).
80
Annex 8: ProcurementArrangements
MEXICO: PrivateHousingFinanceMarketsStrengtheningProject
A. General
1. Procurement for the proposed project would be carried out in accordance with the World
Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" dated May 2004
reviewed October 2006; and "Guidelines: Selection and Employment of Consultants by World
Bank Borrowers" dated May 2004, reviewed October 2006, and the provisions stipulated in the
Legal Agreement. The various items under different expenditure categories are described in
general below. For each contract to be financed by the Loan, the different procurement methods
or consultant selection methods, the need for pre-qualification, estimated costs, prior review
requirements, and time frame are agreedbetween the Borrower and the Bank in the Procurement
Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual
project implementationneeds and improvements ininstitutional capacity.
Procurementof Works:Not expected inthe project.
2. Procurement of Goods: Based on the recommendations of the studies and the technical
assistanceto be conducted during the first year, some goods and non- consulting services could
be procured under the project in order to support the redesign of SHF organization's processes.
Under Components 2 goods would include network equipment, peripherals, software and IT
accessories to support SHF's redesign organization processes; in addition the project would
finance computers, printers, specialized software, office equipment and furniture. There are no
ICBs expected under the Project. The procurement will be done using the Bank's Harmonized
National Standard Bidding Documents (SBD) including the revised clause on fraud and
corruption.
3. Procurementof non-consultingservices: All contracts for services not related to consultant
services for the redesign of SHF organization processes as data center, data warehouse, operating
and supporting hardware, closed virtual private network logistics, organization of seminars,
workshops, travel and printing services may be procuredunder same methodologies specified for
goods above.
4. Selection of Consultants: Components 2 of the project will require the assistance of
consultants to carry out specialized studies, analysis and technical assistance including technical
assistance to redesign SHF organization's processes which i s a technical assistance proposed to
be finance under retroactive financing. These consultant services would be procured following
Bank's policies and using Harmonized Standard Documents including the revised clause on
fraud and corruption. Short lists of consultants for services estimated to cost less than
$500,000.00 equivalent per contract may be composed entirely of national consultants in
accordancewith the provisions of paragraph 2.7 of the Consultant Guidelines.
5. Most contracts for firms are expected to be procured using Quality and Cost-Based Selection
methods (QCBS). Complex assignments that can be carried out in substantially different ways
may be procured under Quality-Based Selection (QBS), studies o f limited scope and not to
81
complex assignments may be procured using Selection under Fixed Budget (FBS). Audits and
other consultant services of a standard or routine nature may be procured using Least Cost
Selection Method (LCS), selction Based on Consultants' Qualifications may also be used (CQS)
for small assignments. Consultant assignments of specific types, and previously agreed with the
Bank in the Procurement Plan, may be exceptionally procured using Single Source Selection
(SSS) methods, and under circumstances explained in paragraph 3.9 of the Consultants'
Guidelines.
6. Selection of Consultants: Individuals. Specialized advisory services would be provided by
individual consultants selected through comparison of qualifications of at least three qualified
candidates.
7. Operating Costs: Reasonable expenditures to carry out the project such as travel and per
diem cost for supervision activities and training for staff directly related to the project, sundry
items and office utilities, maintenance o f project facilities, equipment and vehicles, will be
financed by the project and procured using SHF's administrative procedures which were
reviewed andfound acceptable to the Bank.
8. The procurement procedures and SBDs to be used for each procurement method, as well as
modelcontracts for goods and consultant services, are presented inthe Operational Manual.
B. Assessment of the agency's capacityto implementprocurement
9. All procurement activities will be carried by SHF. The agency is staffed with at least one
official directly involved in procurement in the administrative area and other two staff members
inthe technical area that will supervise the procurement carried out for the Project.
10.An assessment of the capacity of the Implementing Agency to implement procurement
actions for the project has been carried out by the PAS assigned to the Project in August 2008.
The assessment reviewed the organizational structure for implementing the project and the
interaction between the project's staff responsible for procurement.
11.The key issues and risks concerning procurement for implementation of the project have
been identified and include the complexity of some of the consultant and non consultant services
to be procured. To mitigate the risks o f the project SHF has agreed to maintain well trained staff
members with experience on Bank's procurement rules, the Bank will provide training to related
staff members in SEPA and SHF will include in the chapter on procurement in the Operational
Manual a flow diagram on procurement transactions.
12. The assessment indicates that SHF has well trained staff with experience in Bank
procurement, the overall project riskfor procurement i s AVERAGE
82
C. ProcurementPlan
13. The Borrower, at appraisal, developed a procurement plan for project implementation which
provides the basis for the procurement methods. This plan has been agreed between the
Borrower and the Bank on September 26, 2008 and will be available in SEPA. It will also be
available in the project's database and in the Bank's external website. The Procurement Planwill
be updated in agreement with the Bank annually or as required to reflect the actual project
implementation needs and improvements ininstitutional capacity.
D. Frequencyof ProcurementSupervision
14. In addition to the prior review supervision to be carried out from the Mexico team, the
capacity assessment of the Implementing Agency has recommended two supervision missions
annually to visit the field and to carry out post review of procurement actions.
E. Detailsof the ProcurementArrangements InvolvingInternational Competition
1.
(a) ICB contracts for goods estimated to cost above $3'000,000.00 per contract (not expected )
and all direct contracting will be subject to prior review by the Bank as agreed in the
Procurement Plan.
2. Consulting Services
(a) List of consulting assignments with short-list of internationalfirms.
3 4 5 6 7
Estimated Selection Review Expected Comments
cost Method by Bank Proposals
(Prior / Submission
Post) Date
Reengineering of $500,000.00 QCBS Prior October Retroactive
2008 financing
(b) Consultancy services estimated to cost above $500,000.00 per contract and single source
selection of consultants (firms) will be subject to prior review by the Bank as agreed in the
Procurement Plan.
(c) Short lists composed entirely o f national consultants: Short lists of consultants for services
estimated to cost less than $500,000.00 equivalent per contract may be composed entirely of
national consultants in accordance with the provisions of paragraph 2.7 of the Consultant
Guidelines.
83
Annex 9: Economicand Financial Analysis
MEXICO: Private HousingFinance MarketsStrengtheningProject
A. EconomicAnalysis
Overview
1. A sustained increase in access to housing finance is high on the agenda of the
Mexican government. Over the past few years, the country has observed a substantial increase
in the number and amount of housing loans provided by public and private institutions. The
number of annual housing acquisition and home improvement loans increased from 512
thousand on average between 1995-2000 to 777 thousand from 2001 to 2006, and the National
Housing Program 2007-2012 aims for some 6 million'housing loans during the current
administration or an averageof 1million loans per year.
2. Increased access to housing finance systems expands the supply of housing and is
associated with fewer slums. When long-term finance is available to consumers it reduces
capital costs for developers, which otherwise would have to engage directly in leasing or
installment sale contract with consumers, which would tie up capital. With reduced capital
requirements, developers are more profitable at the same ratio of house prices to other
construction-related costs. As developer profits rise, construction grows, and income rises as a
result of the multiplier effects of greater employment and consumption. In many emerging
markets, construction sectors have higher shares in GDP than in developed countries and the
direct impact i s thus likely to be significant. Within the limits of a well-behaved interest rate
scenario and in the absence of large swings in house prices, these effects will lead to a virtuous
circle of increasing demand and supply, i.e. economic growth. In the initial phase of
development, mortgage markets can add 0.5 percent of fixed investmentas a percent of GDP for
each one percent increaseinthe size of the market.62(Figure 1)
62Duebel, Hans-Joachim2007. "Does HousingFinancePromoteEconomic and Social Development?", mimeo,
InternationalFinanceCorporation; Li,Xiaowei 2001. "Mortgage Market Development, Savings and Growth, IMF
Working Paper WP/01/36; Learner, Edward E.2007. "Housing is the BusinessCycle", National Bureauof
EconomicResearchWorking Paper 13428.
84
Figure 1:Fixed Investment and Housing Lending SelectedEmerging Markets
-
3. Increased access to housing finance contributes to sector specific objectives as well
as broader economic growth and poverty reduction goals. Sector specific objectives include
an increase in the supply of housing to meet the demand from a growing number of households
and from the need to substitute older, deteriorated, inadequate and overcrowded dwellings.
Demand for housing enabled by increased access to finance has boosted activity of the
construction industry generating jobs and value added in the industry itself as well as in
numerous other sectors of domestic economic activity due to strong backward and forward
linkages presented by housing construction. In addition to improving the living conditions,
adequate mortgage finance contributes to the creation by households of an asset or equity base,
an important element inthe poverty reduction strategy of the government.
4. Recent growth in housing finance also enabled the creation of virtuous circles
between saving and investment and makes up an important element of financial sector
development in Mexico. There i s a growing literature that finds a relation between financial
sector development and depth on the one hand and economic growth and the level o f GDP per
capita on the other. A broad cross-country analysis using averages for the years 1995-2005 finds
a significant and positive relationship between the level o f GDP per capita and the levels of
savings, financial depth, private sector credit and stock market capitali~ation~~. With regards to
this type of analysis two things stand out in the case of Mexico. First, Mexico has a level of
gross domestic savings close to the level that one would expect given its GDP per capita.
Second, Mexico has levels of financial depth, private sector credit and stock market
63See Levine, Ross (2005), "Finance and Growth: Theory and Evidence," inHandbook of Economic Growth, Eds
PhilippeAghion and Steven Durlauf,Elsevier,pages 865-934.
85
capitalization significantly below the levels one would expect in view o f its GDP per capita.
This suggests that a large part of savings is intermediated outside the financial system, which
may lead to inefficiencies and a sub-optimal allocation of resources. Even though there has been
a significant improvement in indicators o f financial depth and penetration, there still exist
important lags.
5. Access to housing finance in Mexico is segmented according to level of income and
status of employment (formal vs. informal sector). Growth of housing finance over the past
few years in Mexico has been brought about by a substantial increase in lending of both the
housing provident funds (INFONAVIT and FOVISSSTE) for salaried workers in the formal
sector as well as of commercial banks and SOFOLES that attend both formal and informal sector
income earners. SHF support has been oriented towards the development of the latter non-
provident fund segment of the mortgage market, mainly through credit lines to SOFOLES and
the development of the secondary mortgage market for bothbanks and SOFOLES. During2007,
housing provident funds originated almost 50 percent of new housing finance, commercial banks
and SOFOLES about 46 percent with the remainder distributed among a host o f smaller federal
and local government program and institutes.
6. The proposed loan to SHF enables the institution to consolidate its support to the
development of the non-provident fund segment of the mortgage market and to develop
housing finance solutions for lower income earners. The economic impact of strengthening
SHF's balance sheet extends beyond the number and amount of mortgages and housing finance
solutions that can be supported directly or indirectly by the loan amount. The role and mandate
of SHF includes the development o f primary and secondary housing finance markets and the
present analysis of the impact in terms o f (i) the demand for housing and market segmentation
according to income levels and employment status; (ii) economic growth and employment
generation as a result of enhanced activity in the construction sector; and (iii)financial sector
development, i s thus related to the broader housing sector developments inMexico.
Demand for Housing
7. Demand for additional, new or improved housing in Mexico stems from population
growth, the increase in the number of households, and the need to substitute older,
deteriorated, inadequate and overcrowded dwellings. According to the most recent household
survey64,Mexico had in 2006 a population of 104.3 million people and 26.5 million households
that live in 24.5 million houses. Though population growth has moderated to an annual rate of
1.0 percent, the average size of households continues to decrease leading to and increase in the
number of households at an average annual rate of 1.9 percent. Growth in the number of
households would require almost half a million new houses per year. In addition, there continues
to be a considerable backlog of older deteriorated, inadequate and overcrowded dwellings
estimated at about 9.5 million houses that require substitution or considerable improvement.
With a supply of 1 million housing loans per year, the National Housing Program 2007-2012
envisages a reduction in the backlog of adequate housing solutions by about 3 million houses
duringits implementation period.
Income and Expenditure Survey (ENIGH), 2006.
86
8. Lower income households and those that are not affiliated to a social security
program present the highest levels of inadequate housing. Out of the 9.5 million households
that currently live in inadequatehouses, 7.9 million households (83 percent) are not affiliated to
social security and 59 percent of these households have a family income of less than 3 minimum
wages. Slightly more than half of these households, 4 million, live in urban and semi-urban
areas, Le. localities of more than 2,500 inhabitants.
9. Access to housing finance is largely oriented to middle and higher income families
and to those affiliated to social security. As can be observedfrom the table below this excludes
almost 46 percehtof the households living inurbanand semi-urban areas from access to housing
finance. Banks and Sofoles orient their mortgage finance largely towards the segment of middle
and higher income households (those earning 6 Minimum Wages or more); whereas housing
provident funds, INFONAVIT and FOVISSSTE, provide housing finance to affiliated
households, which requires that at least one member of the households holds an employment in
the formal sector. Limits on the maximum amount of mortgage finance provided by these
institutes and affordability of mortgage finance drive them towards the middle income segment
(3-6 MW) of the affiliated population. More recently, co-financing schemes between
INFONAVIT and private financial intermediarieshave allowed for the origination of more loans
in the higher middle income segment (6 to 9 MW) of affiliated population as this arrangement
allows for the provision of a higher mortgage loan (and the use of accumulated savings in the
individual housing savings account as a down payment).
10. The role of SHF as a development bank is to develop housing finance solutions for
unattended market segments. SHF i s thus shifting its focus towards lower income earning
households,i.e. below 6 MW, the majority of which are not affiliated to the formal sector social
security programs. Affordability criteria of housing finance imply that only part of this group
will be able to obtain a full mortgage for a new, finished house. Subsidy programs as well as
efforts to lower the cost of houses (and the land) can extend the level of income with which one
i s able to afford a mortgage for the acquisition of a house. Other housing finance solutions and
instruments, such as micro-credit for home improvements are another channel that SHF is
developingthrough Savings and Credit Institutions.
Economic growth
11. The construction industry outperformed overall economic growth over the past few
years, largely due to the strong impulse observed in home building. The GDP of the
construction industry expandedat an annual average rate of 4.7 percent, in real terms, compared
to overall economic growth of 3.8 percent between 2004 and 2007. Value added by the
construction industry amounts to 6.4 percent of total GDP and growth of the construction sector
contributed with 0.3 percent to total annualeconomic growth over the past few years.
12. The development of the housing sector has a significant impact on the performance
of the construction industry and overall economic activity. The construction industry and the
construction of housing in particular have strong backward and forward linkages to the rest of
the domestic economy as its inputs, such as bricks and mortar, are obtained from domestic
sources of production. In addition to the GDP generated by housing construction, total
investment in housing is another relevant variable to indicate the impact of housing on economic
87
activity. Housing investment expanded at an average annual rate of 4.6 percent, in real terms,
between 2004 and 2007 and increased its participation in GDP from 5.3 percent in 2003 to 5.8
percent in2007.
13. Access to housing finance has been critical for the growth in housing investment.
Investment inhousing, in nominal terms, expanded from 402 billion pesos in2003 to 647 billion
pesos in 2007, whereas housing finance increased from 115 to 252 billion pesos over the same
period. Housing finance as a percent of investment in housing increased from 28.6 to 39.0
percent between 2003 and 2007. Over the same period, the nominal increase in housing finance
made up 56 percent of the nominal increase inhousing investment.
Financial sector development
14. Over the past decade, significant efforts have been made to overcome obstacles to
financial sector development in Mexico. A number o f legislative and regulatory efforts were
directed to improve the ability of financial institutions to achieve creditor information and to
improve contract enforcement. Banking secrecy reform enabled banking institutions to share
information on customer credit operations, providing a strong impetus to the credit reporting
industry. A new Securities Law together with the Law on Guaranteed credit allowed guarantee
trusts to act as a full-fledged special purpose vehicle. The Securities Law also introduced a new
market instrument, the "certificados bursatiles", which were sufficiently flexible to be used as a
vehicle for securitized issues.
15. There has been a significant improvement in the intermediation of savings and the
allocation of credit through the domestic financial system in Mexico, despite an overall low
level of financial sector depth. The stock of domestic savings intermediated through the
financial system in Mexico amounted to 51.9 percent o f GDP in 2007, up from 34.8 percent of
GDP in 200065.A large part of this increase can be attributed to the growth of resources in
custody o f institutional investors such as the pension savings system, mutualfunds andinsurance
and annuity providers.
16. The increased availability of resources has allowed a significant credit expansion to
different sectors of economic activity. A significant increase in domestic savings channeled to
the public sector is a reflection of the latter to finance a larger part of public debt domestically.
Finance to the private sector also expanded considerably, mainly through an increase o f bank
credit in areas such as consumer credit andhousing finance.
65Domesticfinancial savings is definedas M4a (M4ais the broadestmeasureof money includingcurrency, demand
and time deposits, public and private sector bonds and other instruments of financial intermediation held by the
general public and by public sector institutions) minuscurrency holdings.
88
Table 1:
Mexico: Domestic Financial Savings and Credit, 2000-2012 1
as a percentageof GDP
2000 2007 2012
Total Domestic FinancialSavings 34.8 51.9 64.8
Bank deposits 14.2 17.3 20.9
Pension system savings 5.3 11.2 15.9
Mutual Funds 2.6 7.8 11.5
Insurance and Annuities 1.4 3.0 4.5
Non-BankIntermediaries 4.3 5.1 4.2
Non Financials 6.9 7.5 7.8
Total DomesticCredit and Finance 34.8 51.9 64.8
Public Sector 16.5 27.3 24.2
Private Sector 14.4 23.3 39.6
Uses
Commercialand Infrastructure 8.0 9.9 17.6
Consumption 0.7 5.0 8.6
Housing 5.6 8.4 13.4
Sources
Banks 7.1 13.2 20.0
Development Banks 1.6 1.o 1.2
Capitaland Debt Markets 1.2 1.7 6.8
INFONAVIT 3.3 4.9 6.5
Non-bankBanks 1.2 2.6 5.0
Other 3.9 1.2 1.o
Source: SHCP PRONAFIDE2008-2012
17. For the next few years a continued, gradual expansion of financial savings is
projected with a growing participation of institutional investors in the administration and
management of these resources. Projections on the growth of financial savings and the use of
finance by different sectors of economic activity up to 2012 are included in the National
Program of Finance for Development 2008-2012 (PRONAFIDE) publishedby the Ministry of
Finance. These projections include a substantial increase of finance to the private sector as the
public sector plans to continue with the reduction in its annual Public Sector Borrowing
Requirementsand will no longer substitute external for domestic debt.
18. As institutional investors become a mayor source of finance for a range of private
sector activities, an increasing part of financial intermediation will take place through
capital and debt markets. The development of a RMBS market inMexico should be considered
in this perspective.Continued growth of financial savings managedby institutional investors as
projected in the PRONAFIDE provides for a promising environment for the channeling of
savings managedby institutional investorsto housinginvestmentthrough the RMBS market.
Impact of the World Bank loan
19. The number of housing loans that a World Bank loan to SHF can support directly is
minor to the country's housing needs. In 2007, the average size of a housing loan along the
whole range of public and private sector programs amounted to 251.4 thousand pesos. This
implies that funding to SHF of $1 billion could support an approximate 40 thousand housing
89
loans if the average size of an SHF supported operation i s similar to the average loan size of
housing finance solutions provided by the whole range of public and private institutions. This is
equivalent to 8 percent of the housing demand generated annually by the formation of new
households and about 4 percent of the government's annual target of additional housing loans.
The number also equals to about 0.4 percent of the estimated backlog in adequate housing for
Mexican households. The amount of finance i s finally equivalent to about 1.5 percent of total
annualinvestment inhousinginMexico.
20. The ability of SHF to consolidate and develop primary and secondary mortgage
markets with the support of adequate funding should allow for the intermediation of
additional private savings to housing finance. Housing finance in Mexico has increased
significantly over the past few years and previously unattended market segments currently
receive a higher level of funding from an increased pool of, mostly private, domestic savings. In
the case of the primary mortgage markets this included the incursion of banks into segments
previously attended by SHF-supported SOFOLES, as well as the ability o f the latter to access
alternative ways of funding (RMBS, warehouse credit lines etc.). Inthe case o f the development
of an RMBS market despite the commitment of SHF to purchase up to 20 percent o f a primary
issue, the remainder i s purchased by private investors thereby providing for an alternative to
channel private, domestic savings to the mortgage markets.
B)Financial analysis
Overview.
21. SHF has about $6 billion in assets and a strong level of On the asset
side67of the balance sheet, the average remaining maturity i s just over 20 years for loans and 22
years for inflation indexed (UDI) RMBS and 25 years for non-indexed RMBSs. Effective
maturities are shorter due to frequent prepayments - some driven by consumer prepayments but
others driven by financial intermediaries' issuance of RMBSs. Asset durations are shorter due to
variable interest rates.
22. On the liability side, financing is dominated by medium to long term debt
instruments and loans from multilateral agencies. CEBUR (Certificados Bursa`tiles) bonds
are of 15 or 25 year maturities, and the current average remaining maturity is about 12 years.
The CEDES (Certificados de Depdsito) are originally issued as medium-term debt instruments;
however, as noted in the table below, about half are now due in the coming 12 months. Pagarbs
con rendimiento liquidado al vencimiento (PRLVs) are short term liabilities rolled over monthly.
The weighted average yield for SHF's existing debt i s about 8.9 percent. Overall, the average
66The National Banking Commission (CNBV) reportedacapitalization index of 14.30 percentfor SHF. The CNBV
also reportedadelinquency rate of 0.75 percent, for acapital coverage ratio of 1,004.4 percent-higher than any
other Mexican development bank. See CNBV's Boletin de Prensa, Banca de Desarrollo,No. 4412008, dated
September 4,2008. The report is available at www.cnbv.gob.mx.
67Note that prior to July 2006, SHF's balancesheet was almost twice as large as it is today. SHF usedto receive
credits from FOVISSSTE that it used for lending to SOFOLs. The loan portfolio shrank from a historic maximum
of 104 billionpesos in April 2006 to less than 50 billion pesos after the end of this FOVISSSTE role.
90
weighted time to maturity (as of July 2008) for the assets is 18.1 years compared to 8.7 years for
the liabilities.68
Table 2: Simplified SHF Balance Sheet (June 30,2008)
(Dollars, Millions)
Assets Liabilities
Loans to support mortgages* 4,113 Long term 2,304
Bridge Loans (construction 65 CEBUR (longterm inflationlinkedbonds) 1,218
Micro-credits 37 CEDES 584
Other loans 143 IDB 232
IBRD 270
Borhis (Mortgage Backed Securities) 995
Short tern 1,945
CEDES 612
PRLV 993
Cash 276 BANXICOopen market operations 340
Reservesrequired bycentral bank 501
Total 6,129 Total** 4,249
Memorandum:
* Nearly 80 percent are indexed to inflation
** Totalfinancial liabilities represent about 0.5 percent of GDP
Note that the augmentedbalance sheet includes about $1.2 billion in open swap contracts (interest rate and currency
swaps).that cancel themselves out. Source: SHF, Bank staff calculations
23. I t is important to distinguish the risks inherent in both the UDI (inflation indexed)
side of the balance sheet from those in the nominal peso side of the balance sheet. The
presentation above provides only an aggregate picture, while below we will disaggregate across
these components of the balance sheet. Inaddition, we will add the gross positions with regards
to "currency" swaps (inflation indexed UDIunits versus pesos) and interest rate swaps to get a
more detailed picture of the finances.
UDIdenominatedcomponent
24. SHF's lending in inflation indexed "UDI" loans peaked in late 2005. In January
2003, SHFheld 15 billion pesos ininflation-indexed (UDI)loans to SOFOLES. This figure rose
to a peak of 51 billion pesos in UDI loans in November 2005. B y July 2008, the UDI
denominated loans outstanding had dropped to 35 billion pesos (approximately $3.5 billion). In
July, SHF also heldabout 6.7 billionpesos ($670 million) inUDIdenominated RMBS.
68 Refers to contractual time left-- not accounting for possible prepayments.
91
Figure 2:
UDI Ledger, July 2008
(in milllions of pesos)
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
Assets Liabilities
Source: SHF.
25. To fund its UDI loans to SOFOLES SHF issued UDI liabilities with an original
maturity of 15 to 25 years, although with a considerably shorter duration. In addition, it
purchaseda UDI-pesoswap in which SHF pa s the counter-party a UDIdenominated stream of
payments and it receives floating rate pesos? As of July 2008, the weighted average time to
maturity of the UDIliabilities was 14years (durationof 5.1 years.).
26. Net interest margins are narrowing as interest rates rise, older higher-earning loans
amortize, and mortgage risk spreads widen. The weighted average interest spread on UDI
assets in July was 1.31 percent, some 0.22 percent less than at the beginning of the year. This
resultedfrom lower spreads earned on newly-placedassets.
27. SHF chose relatively long maturities for its UDI liabilities because it did not
anticipate that SOFOLES would be able to access competitive market funding any time
soon. However, in late 2005, Bancomer purchased a large SOFOL, and it began to pay down
69The peso leg of the swap, in which SHFreceives pesos, pays a floating peso rate based on the implied rate in a
forward contract to buy pesos for dollars. This was the result of the fact that the counter-parties to the swap are US
and western European investment banks.
92
SHF liabilities, which are more expensive than the deposit funding that the new bank parent
could provide. As a result, UDI loans to SOFOLES declined from 51 billion pesos to 40.5
billion pesos between November and December 2005 alone. SHF has no prepayment option in
its UDI liability contracts, so it has been unable to adjust its liability position to match its
changed asset position.
28. Inaddition, the RMBSmarket began to take off during2006, with total issuancesof
BORHIS, the name for the SHF-sponsored RMBS, which increased from 2.9 billion pesos
in 2005 to 12.5 billion pesos in 2006. Eighty-five percent of this volume was issued by
SOFOLES. Increased reliance of SOFOLESon securitization for their funding continues to be a
major goal of SHF. However, increased securitization reduces the demand for SHF long-term
funding. This trend away from SHF funding reversed itself in 2008 as a result of the credit
crunch that resulted from the subprime crisis inthe United States.
29. The decline in direct lending to SOFOLES was somewhat offset by SHF purchases
of BORHIS in the primary market, which it began to do in December 2005. By mid-2006
these SHF purchases represented thirty percent of B O N I S issues outstanding, as SHF actively
supported the market. This support was apparently successful since by year end 2006 SHF had
reduced its holdings to about 15 percent of the market or 1.5 billion pesos in UDI-denominated
BORHIS.
30. From these experiences, SHF management concluded that it could not accurately
predict the size of its UDI balance sheet: SOFOLES pre-pay if they are acquired by non-
SOFOLES, and they pre-pay when the RMBS market is conducive to absorbing mortgage
volume. Prepayment options for SHF on the liability side of the balance sheet are not available
in the domestic market at a reasonable cost. SHF does not believe that it can predict either of
these events with sufficient accuracy to hedge pre-payment risk dynamically by issuing a mix of
long and short liabilities.
Peso denominated component
31. These lessonsfrom the UDIside of the balance sheet informed the funding decisions
for the peso portfolio as well. The peso side of the balance sheet can be broken down into a
ledger of fixed rate instruments and a ledger of variable rate instruments. As the popularity of
fixed rate pesos mortgages has expanded, SHF has supported SOFOLs with loans in those terms.
Because of high financing costs and the prepayment risk described above, SHF finances fixed
rate peso loans and peso RMBS with its substantial capital base. Thus, prepayment risk in the
fixed rate peso book is currently covered by equity.70
32. The net interest margin in pesos is much narrower than in UDIs. The weighted
average peso funding spread is 0.16 percent, some 0.13 percent lower than at the beginning of
the year. As with the UDIbook, the runoff o f older, higher-earning assets reduces spreads.
70Equity i s an expensive butreliable hedge. With an asset funded by an interest bearing liability, prepayment
subjects the institution to the risk that it cannot find an asset earning sufficient income to cover its liability cost.
With equity, there is no liability cost. Instead owners receive less income because the balance sheet is less levered.
93
33. . Interms of direct lending to SOFOLES, the peso portfolio is much smaller than the
UDI portfolio. As of July 2008, peso loans to SOFOLES equaled about 9 billion pesos,
compared to 35 billion pesos in UDIS. Peso-denominated BORHIS purchased equaled 4.1
billion pesos compared to UDI-denominated BORHIS of 6.7 billion pesos. (See Figure 2
below.)
Figure 3: Peso Ledger (fixed and variable rates)
Fixed Rate PesosLedger, July 2008 Variable Rate Pesos Ledger,July2008
I
I (in milllions of pesos) (in milllions of pesos)
~
I !5000
I 16000 MafginCalls
, Dura!iowJ.01
1 14000
I !OOOO
I
i '
*Oo0
~
5000
i 8000
I
i
1 0000
6000
!
I
4000
5000
I
2000
~
I
I o 0
I Assets Liabilities Assets Liabilities
I
Source: SHF.
34. As noted above, SHF has funded peso loans to SOFOLES and its peso BORHIS
portfolio mostly with equity. It has a small long-term fixed rate peso liability of approximately
one billion pesos that it acquired through a swap for variable rate pesos (note the swap asset on
the variable rate side of the ledger on the right infigure 2).
35. SHF also has a substantial investment invariable rate pesoassets equal to 22 billion
pesos, which exceeds its fixed rate loan and M B S portfolio by about 8 billion pesos. The
largest single asset in this category is 11.4 billion pesos representing the "receive" leg of its UDI
swap. SHFreceives a floating peso rate on its UDIswap. I t funds the asset legs of its UDIswap
with short-term peso liabilities.
94
36. The remainder of the variable rate peso ledger is a set of short term assets and
liabilities. On the asset side, there are some small short term credit lines, cash deposits, and
regulatory deposits with the Central Bank. On the liability side, there are short term borrowings
from the Central Bank and Pagarbs con rendimiento liquidado al vencimiento (PRLVs). The
latter are short-term zero coupon bonds that are rolled over every month. In addition, it should
be noted that the CEDES bonds listed above come due over the coming year - despite having
had a longer original maturity. While the interest rate risk to this particular funding strategy is
minimal, SHF faces rollover risk if spreads on its debt widen or it should not be able to place its
paper inthe market.71
37. Funding fixed rate assets almost exclusively with equity is an inefficient use of the
balance sheet. If SHF could fund its fixed rate peso assets at a positive interest rate spread with
matching maturity and with matching prepayment capability, it could better deploy its capital.
For instance, instead of hedging market risk, equity could be assigned to fund more micro-credits
that carry higher credit risk. The provision of callable World Bank funding with matching
prepayment optionality would enable such a reallocation.
38. SHY faces market risk inits short-term peso liabilities. SHF's sovereign backing does
not make it immune from volatility in risk spreads and overall market liquidity. Mexico has
suffered substantial financial crises in recent memory, including a temporary collapse in the
credibility of government debt. While such a crisis appears to be remote now, to the degree that
SHF can extend the maturity of variable rate peso liabilities while fixing their funding spread, it
will remain a sure source of funding for low and moderate housing finance needs, even if market
conditions worsen.
Summary financial indicators
39. As noted above, SHF is highly capitalized. Inaddition, its delinquency ratio is a low
0.75 percent. According to the latest CNBV report on development banks (June 2008), the
return on assets fell to 0.15 and the return on equity fell to 0.55 inthe first half of this year. This
followed returns on assets and equity of 3.88 percent and 13.79 percent, respectively, reported
for the 2007 accounting period. More recent data from SHF (August 2008) that the decline in
returns was due to temporary factors, including an increase in capital due to a change in the
mark-to-market value of swaps, and an increase in reserves. InAugust, the returns on assets and
equity were restored to 2.4 percent and 9.3 percent, respectively, more inline with recent years.
There is also a basisrisk inherent in the UDI-Peso swap contract. Foreigncounterparties to the swap were
interested in implied peso rate relative to dollar interest rates. The reference peso interest rate for this implied
forward rate is lower than the TIIE based rate for borrowing, creating some losses over the last year and a half as the
two rates have diverged.
95
Table 3: SummaryFinancialIndicators
(96, June 2008)
Delinquency Ratio a: 0.75
Capital Coverage of Delinquent Loans b: 1004.4
Returnon Assets ': 0.15
Returnon Equityd: 0.55
Adjusted Financial Margine: 2.95
Operational Efficiency *: 1.05
Impactof the WorldBankloan
40. SHF' would use the World Bank loan primarily to fund the expansion of its peso
portfolio and also provide financial space for possible continued support of the RMBS
market. Interms of expanding lending, the IBRD is the best choice for financing, in terms of
maturity and cost. SHF could also exercise its prepayment option if a SOFOL were acquired or
otherwise obtained market funding.72 The reduction of current short term indebtedness levels
would allow SHF to issue new short term debt if needed to engage in other interventions in the
market, such as to replace commercial bank short term lines of credit were they not to be
renewed. Borrowing short term for the latter makes financial sense as it i s lower cost than long
term finance, and so long as the interventions are temporary, there i s little risk from a maturity
mismatch. Inaddition, duringnormal times, the RMBS themselves are liquidas they can be sold
on secondary markets. Due to the potential for interest rate changes mentioned above, it makes
sense for SHF to fix the spread on peso funding with an embedded call via IBRD, which has
access to derivatives marketas AAA ratedcounterparty.
41. There would be a savings in term of a lower interest bill; however, this is not the
main advantage of World Bank funding. The all in-cost of the Bank loan, considering swap
transactions and other possible optionality, will depend upon market conditions at the time of
these transactions. It is expected, though, that the long term financing of the Bank would be
about 50 basis points cheaper than alternative short term funding (e.g., PRLVs). On a $1 billion
loan, this implies savings of about $5 million. This is not an insignificant amount: for example,
'*Ifpesoloans to SOFOLES were to decline and SHFprepaid the World Bank, the equity portion of the balance
sheet would then effectively fund a greater portion of the receive leg o f the UDIswap.
96
it could finance an additional 8,30073 housing micro-credits per year. On the other hand, since
SHF is not a profit maximizing institution, the main development benefit from the loan will be
SHF's enhanced ability to leveragemore mortgage credits-particularly, during a period where
the private sector is facing greater challenges to finance mortgage markets on its own. The
restructuring of debt with the longer maturity and embedded options will serve this purpose.
Monitoringindicators havebeenestablishedto track the progress inthis regard during the course
of the loan (see Annex 3).
73 The averagehousingmicro-creditduring2007 was about $600.
97
Annex 10: Safeguard Policy Issues
MEXICO: Private HousingFinance MarketsStrengthening Project
1. The housing sector has experienced a major expansion in recent years. This
expansion has represented an important increase in the housing stock in Mexico which has
increased from 24.7 million units in 2000 to 30.4 million in 2006. In many cities, the rapid
growth has surpassed the ability of the local governments to adequately provide basic
infrastructure and services, such as adequate land for housing, water, sanitation, public transport,
solid waste management and energy. For example, out of the 18,000 hectares that were
earmarked for urban development in the year 2000, 85 percent lacked a comprehensive urban
development plan that would allow an orderly and planned provision of infrastructure. This
problem is exacerbated to the extent that most of the responsibilities are at the municipal level.
Mexico has approximately 2,500 municipalities, resultingin 104different regulatory frameworks
for housing constructionfor the 55 metropolitan areas where 70 percent of the population lives74.
2. The lack of orderly expansion of the cities, of which housing is a large proportion,
has generated excessive exploitation of natural resources, especiallywater and forestry and
is endangering the sustainability of some cities. Water scarcity represents an important
challenge for the expansion of the housing sector. Mexican cities use 10.7 cubic kilometers of
water annually, of which 36.4 percent derives from surface water and 63.6 percent i s extracted
from aquifers. These amounts are equivalent to eight percent of the total national consumption
of surface water, and 24 percent of aquifers. As a reference, the agricultural sector accounts for
81 percent of the use of surface water and 70 percent of aquifers. In terms of wastewater
treatment, Mexican cities generate 242 cubic meters of residual water, of which 85 percent are
collected but only 30.8 percent i s treated.
3. In 2006, Mexican cities generated 36.1 million tons of solid waste in urban areas.
These are mostly producedinthe central region (50 percent), followed by the North (27 percent)
and the Mexico City metropolitan area (13 percent). The country has achieved important results
in the creation of new sanitary landfills as the number of sanitary landfills tripled between 1995
and 2006, increasing their capacity from 5.9 tons to 20 tons on average per year. For the year
2006, this amount accounts for 55 percent of the total solid waste generated. The remaining45
percent i s either delivered to other "controlled zones" (11percent) or deposited to open dumps
(34 percent). Inaddition, the residential sector has been the largest electricity consumer, not only
in terms of quantity but also in the number of users. It represents 25percent of total energy
consumption (total consumption is 160,384GWh). Of this, 61 percent is used for cooking, 28
percent for water heating, 5 percent for lighting and 3 percent for temperature conditioning. In
comparison, in OECD countries the largest share of total energy consumption goes towards
temperature conditioning and water heating.
.
4. In2006, Congressapproved a new HousingLaw which incorporated a new mandate
for sustainability of the housing sector. The new Housing law, approved in June 2006,
provides a more comprehensive institutional setting and mandates for the first time the
14CONAVI, ProgramaNacional de Vivienda2007-2012(NationalHousingProgram).
98
environmental sustainability of the housing sector.75 The law defines the National Housing
Systemincorporating other relevant sectors such as environment, transport, andfinance in policy
discussions. It defines the National Housing Commission (CONAVI) as the mainpolicy body --
where Energy, Economy, Water, Transport, Environment, and Finance Secretariatsparticipate -
and CONAVI is responsible for the federal housing programs. In particular, the law mandates
that the housing policy should incorporate environmental considerations and an efficient use of
resources, fostering programs that provide sustainability as well as orderly territorial and urban
development.
5. The main responsibilities on environmental sustainability of the housing sector are
at the municipal level; however, the federal government has started several efforts to
promote within local governments and housing developers sustainable practices, including:
Publication of "Green Guidelines" for the: (i)design and incorporation of green spaces into
housing developments, (ii) eficient use of energy, and (iii) efSicient use of water resources in
housing developments. These guidelines defined good environmental practices establishing
alliances among agencies working on sustainable housingdevelopment.
Implementation of three pilot programs for green housing design in the States of Baja
California, Nuevo Leon and San Luis Potosijointly with CONAGUA, Trust Fundfor Electrical
Energy Savings, CONAFOR, Mexican Construction Industry Association, and National
Industry Association of HousingDevelopment andPromotion.
CONAVI, in close coordination with SEMARNAT, established the Programa Transversal
para el Desarrollo Sustentable de la Vivienda in 2007. This cross-agency program seeks to
guarantee that a maximum number of new housing constructions incorporate a sustainability
criterion. This program includes:
Reform and creation of necessary regulatory framework, and standardization of
norms;
Certification programsfor housingdevelopments;
Creation of financial schemes to foster environmentally sustainable housing
developments;
Promotion of research and development, capacity building, and dissemination of best-
practice, and;
Generationof incentives for densification of cities.
*Development of a Housing Construction Code. With support from the Bank, CONAVI is
developing a federal construction code that will provide a framework for the standardization
and a continuous update of the existing local construction codes. As municipal governments
are autonomous to a large extent, the federal government can only provide incentives for local
governments and housing developers to foster adherence by linking the code in later stages to
federal loan and subsidy programs. The federal construction code is expectedto bring about a
decrease in the risks associated with exposure to natural disasters and to foster the housing
insurance market in Mexico. A first draft of the Construction Code has been prepared and
75 www.di~utados.nob.mdLeyesBiblio/docLViv.doc
99
shared through three consultation forums with the main stakeholders, including developers,
financial institutions, State and municipal governments and civil society.76 The code was
developed as a modular system (based on the International Code Council (ICC) model)
whereby the local government can adopt gradually different modules according to their
priorities, which should facilitate implementation in aheterogeneousenvironment.
.Strategic Environmental Assessment of the Housing Sector. InJanuary 2007, CONAVIstarted
the process of conducting a strategic environmental assessment (SEA) that would serve as a
master plan that would include environmental considerations in its policies and programs in
coordination with SENER, CONAGUA, IMTA (Mexican Institute for Water Technology) and
SEMARNAT. Importantly, SEMARNAT would partially finance this project, which reflects
the importance of the project for both institutions and the coordinated approach. The SEA i s
expected to be finalized in September 2008. The Housing and Urban Technical Assistance
Loan (HUTAL) i s financing the SEA. The SEA calls for regional diagnoses and
recommendations relating to zoning and land use (including considerations on water
availability, air quality, and green areas); technologies (building materials and systems);
demography ;financing (innovative instruments to finance environmentally friendly houses);
utilities and public services (transport, access, energy use, water use, drainage, solid waste
disposal); and standards (such as construction).
Development and approval of cross-sector guidelines for incorporating environmentally
sustainable practices into housing developments, financed under the main up-front federal
subsidy program. The Esta es tu Casu subsidy program's guidelines establish that those
housing units that incorporate certain sustainability criteria will be eligible for a 20 percent
greater subsidy from the federal government. To define and measure this "sustainability
criteria" CONAVI issued in February 2008 the Criteria and Indicators for Sustainable
Housing Developments prepared together by CONAVI, SEMARNAT, SENER, CONAGUA
(Comisih Nacional del Agua), SEDESOL (Secretaria de Desarrollo Social), andtwelve other
institutes and associations. These criteria set the basic standard for housing construction for:
(i) use, and site locations andcharacteristics; (ii)energy consumption; (iii)water
land
resources; and (iv) solid waste management. They include (a) a set of criteria for the design
and construction of sustainable housing developments; and (b) a set of indicators that
determine the degree to which the housing unit can be considered "sustainable." The criteria
fully factor in the housing development's impact on the environment (including an
examination of the disposal of residual material from housing construction and the building
techniques employed), while the indicators measure the development's energy efficiency and
conservation of water resources.
76The Construction code can be seen at: hnp://www.conavi.gob.mx/publicaciones/cev001-332.pdf
100
Annex 11:Project Preparation and Supervision
MEXICO: Private HousingFinanceMarkets StrengtheningProject
Planned Actual
PCNreview July 11,2008 July 11,2008
Initial PIDto PIC July 16,2008 September 2,2008
Initial ISDS to PIC July 16,2008
Appraisal September 22-24,2008 September 23-24,2008
Negotiations October 9,2008
Board/RVPapproval November 6,2008
Planneddate of effectiveness November 30,2008
Planneddate of mid-ternreview March2010
Plannedclosingdate December2011
Key institutionsresponsiblefor preparationof the project:
SociedadHipoteca'riaFederal
Bank staff and consultantswho workedon the projectincluded:
Name Title Unit
DavidRosenblatt LeadEconomist and Sector LCSPR
(co-teamleader) Leader
AngClicaNuiiez UrbanSpecialist LCSUW
(co-teamleader)
William Britt Gwinner LeadFinancial Sector GCMNB
Specialist
Juan CarlosMendoza Specialist Assistant to the LCRVP
RVP
Ming Zhang SeniorEconomist LCSUW
Jozef Draaisma SeniorEconomist LCSPE
SteveWeisbrod Consultant
Marja de Hoek Consultant
Ilias Skamnelos FinancialSector Specialist LCSFP
JC Belaustiguigoitia LeadEnvironmental LCSEN
Economist
Kristine Ivarsdotter Senior SocialDevelopment LCSSO
Specialist
MariaElenaCastro Senior SocialDevelopment LCSSO
SDecialist
Bank funds expended to date on projectpreparation:
1. Bankresources: $139,000
2. Trust funds: 0.00
3. Total: $139,000
101
EstimatedApprovalandSupervisioncosts:
1. Remainingcosts to approval: $50,000
2. Estimatedannualsupervisioncost: $86,000.
102
Annex 12: Documents inthe Project File
MEXICO: Private HousingFinance Markets StrengtheningProject
Sociedad Hipotecaria Federal, S.N.C.; Institucidn de Bancade Desarrollo; Manualde
Procedimientos de Planeacidn Financiera. Procedimiento: Integracidndel Flujo de Efectivo
Proyectado. Versidn 1, Cddigo DGAF-MP-FLUJO EFECTIVO.
Sociedad Hipotecaria Federal, S.N.C. Poblacidn Atendida por SHF.
Sociedad Hipotecaria Federal, S.N.C. Monto de CrCdito Poblacidn Objetivo. Monto de
CrCditos Otorgados por Nivel de Ingreso
Sociedad Hipotecaria Federal, S.N.C. Situacidn actual del mercado de BORHIS y
perspectivas para 2008. Junio 2008.
Sociedad Hipotecaria Federal, S.N.C. Informe Sobre las Caracteristicas de las Entidades de
Ahorro y Cridito Popular Sobre las Que la Sociedad Hipotecaria Federal, Sociedad de Cridito,
Banca de Desarrollo, (SHF) Opera y ElFinanciamiento Que les Otorga.
Sociedad Hipotecaria Federal, S.N.C. Caracterizacidn Simple de la posicidn del Balance a131
de Mayo del 2008.
Sociedad Hipotecaria Federal, S.N.C. Hipotecas con Subsidio Parala PoblacidnNoAfiliada.
Sociedad Hipotecaria Federal, S.N.C. Evolucidn del Financiamientode SHF en el period0
2003-Junio 2008.
Apoyo de SHF a1Mercado de BORHIs ante la crisis de liquidez.
Sociedad Hipotecaria Federal, S.N.C. Informes Financieros de SHF, Balance General a131de
marzo de 2008.
Sociedad Hipotecaria Federal, S.N.C. Plan EstratCgico (Resumen) 2008-2012.
103
Annex 13: Statement of Loans and Credits
MEXICO: Private HousingFinance Markets StrengtheningProject
IBRD
OperationsPortldio(IBRWIDAand Grants)
A S ~ I ~ ~ K I U X M
ClosadP m j c s P3
lRwr!A'
TcialDBtursd (Acthe) 980.35
dwhthhabemrepaid 9.65
TcialDbtursd(Cbsd) 32,317.76
dwhchhabemrepaid 3 1 . 4 ~ 1 . ~
TcialDibursed(Active +Cicsfd) 33,298.11
dwhthhasbeen rf@d 31.4es.m
TatalUrdiBursd (Mive) 1,13240
TcialUrdiBursd (CYmed) 0.00
TdalUrdiBursed(Mive+Cb&) 1,13240
ActkePmirts DifferencaBelwen
La$ PSA ExpdedandACIUd
SupavidonRaYng Glghal Amunt InUS$Millions
Pmhd ID P m j r t Nme IBRD IOA GRAM CmmL Undbb. O N . FrrnFiev'd
I :z
PO85593 MX (APL I)TertiaryEducSbdentAss 1801 I
I I o,331
I I 143.741 66.731
PO88728 MX (APL1)School-BasadManagemntPrcg MS MS 2006 2401 59.701 6.451
PO87152 MX (CRLl)Savings& FurlFinance(BANSEF1) S S 104.5 4.60 -2882
PO88996 MX (CRL2)integratedEnergyS d c e s MS S
PO88732 MX Access to Land(or YoungFarmers Mu MS 2wB
Pi10849 Mx ClimateChange DPLlDtC S S 2008
PO35751 MX Cornunity ForestryI1(PROCYMAFII) S S 2004 4.95 495
W80149 MX Dmbaiized Infrastrwure Developm S S 2004 19.56 1556
PO67033 MX EnvironmentalServices Project S S 2006 31.10 9.10
PO59161 MX GEFClimateMeasuresinTransport S S 2003 0.47 0.47
po659ea MX GEFConsdidatProtAreas (SIMP 11) S S 2002 1.49 -586
PO89171 MX GEFEnvironmentalServices Prqed S S 2006 0.26 13.20 638
PO77717 MX GEFLargeScaleRE Dev (La Venta 3) Mu MS 2006 25.00 350
Po60908 MX GEFMESOAMERCANCORRIDOR S S 2001 3.66 386 3.68
PO88080 MX Housing&UrbanTechnicalAssistance MS MS 2005 4.89 1.09 562
P106589 MX IT MudryDevelopmentProjed w # 2 m 80.00
PO91695 MX ModernizationWater 8 SanitSectorTA S S 2006 0.19 15.06 1225
PO70106 Mx Savings8 CreditSectorSbenghening S S 2003 23.n 2.77
PO74755 MX Stab JudicialModernizadonProjed Mu MU 2005 30.00 28.00
PO89865 MX-IAPLl) hnov. k r ConmeMivmess S S 2005 109.97 2292
MS S 2wB
It #
MS MS
104
-
w , , , , , . % , -, P
MIS International FinanceCorporation Report Run Date. 08/1912008
Statementof IFC's Committedand OutstandingPortfolio
Amounts in US Doliar M&foos
country:Mexico AccountrngData As Of 06/30Q008 Page1
2003 2 la 2 #e
20.m 2020 633 0 33
l O i l 7.92 17s3 7.12 i12
.fa:m ai41 5.2.43 5941
1.78 170 1.70 170
750 12 30
5349 33 48 24 00
3137 11m 3.M 3 58
1Q57 0.42 1030 C.42 012
8 52 652 B r n
3 73 0.30 424 8 . S 8.24 4 24
31 Ob 0.76 3134 O.?., 2042
M67 7647
*e 3 E467
%.Ui 12625 2i.2f a9 81
5585 3.16. 58 M 2.43 lBJ0
D e 4 064 1268 OM t 2 . I
1.a 11 eo l0.OQ $0M1
175 278 528 2 7% 3.28
14.75 1478 74.76 10 ?e
e m 630 5.73 673
?rim 50 90
8.03 e m 4.m R c13
0.01 0 31 P.Zf 051
12.0 1 2 3 11.12 11 12
5 31 5 DO
22 25 2225 41.24 2225 41.24
0.a3 0 60 C.80 0 60
0.33 0 50 c.ec 0 60
m:x 20 30 4.C4 B 54
l a 3 18 30 24.40 18 30 24.40
8.D 8PQ 8.B e88
6.58 6$8 8.U s 68
850 0.1e i35e 71.00 5.00 0.12 13 62 1i.w
5 89 see 5 69
1.10 1 70 3.w 170
0t0 OW 0.W 0 570
7 % T 50 7 50
211 82 111$2 21i 62
O 58 4 51 2.38 3.92 451 2.m
1321 <O.W 23 21 i0.m *Ob10
20ce LEla M30 40 30 2204
zoc2 5.53 653 4.B 478
105
Annex 14: Countryat a Glance
MEXICO: PrivateHousingFinanceMarketsStrengtheningProject
pegs iof 3
Mexico at a glance HYD8
tatn ~m
m c a mddie
Mexico & ara i n m A g distribution.2006
Fe?naa
la52 5% 811
1,958 20 411 41466
10 13 0 8
76 79 75
389.9 2,661 4,797
9,410 4,785 5,513
11,930 8,632 15,679
3 2 5 5 57
2.2 4 2 4 9
5
74 73 70
23 22 22
5
93 91 94
30 a9 92
111 121 '115
110 116 111
9% 91 93
77 Tf 81
55 156 -56 247
9 23 24 $54
15 9 15 26
15 51 -1f 22
0 0 O f 0 0 0 5
1 2 -1 2
263 267 9 5 4 0
334 281 12 1 4 7
0 0 28 9 5 $09
494 1s iD0 114
198a-80 199O-Moo 2000-07
(8vcrageannualgrowth%f
616 832 Sa0 105 2 2.1 1 1 1.0
194357 262,710 S81,426 1,022.815 11 2 8 2.6
(X CfGDP)
9 0 7 8 4 2 3 7 0 5 15 2 0
336 284 B O 359 1 1 3 9
223 208 203 186 15 4 3 o1 s5
574 637 678 Eo3 14 2 9 31
651 696 670 654 14 2 3 36
I D 0 8 4 11 1 to2 2 4 i a 10
272 231 239 256 -33 4 7 1 8
107 186 M9 183 7 0 146 57
230 15.7 329 a 9 10 123 63
220 203 205 254
106
Page 2 of 3
Mexico
Balanceof PaymentsandTrade 2000 2007
-)
Totalmercimnjisee x m (fob] 166,455 271.875
Total nwchaxllae mpoas(c@ 174.458 281,949
Na( wdenpoodeandeeNIcas -10,651 -16,013
Casa%dGDPc ~ k ~ c e
~ a c -18*684 5,525
3.2 -0.5
Worked remittancesand
=mmsabon of employees(nmptsl 7,525 25,052
Reserves.mctudinppdd 35,585 87.211
CentralGovernment Finance
(96 d GOP)
Currentrevenue@%dqgntnts) 21.6 222
Tax r e w e 10.6 9.0
CurrentexpendrhKe 20.1 17.3
Technologyand Infrastructure 2000 too6
Overdlsurplusldshcd -l.z 0.0
Paw8Foads(%oftotar) 32.8 37.0
Highestmargnalfaxrate(%) Fixedlfneand m&le phone
ln8WdOal 40 29 saxc&ea (pet 100P W I 27 74
corps* 3 5 2 9 Hightechnoicgy exports
(16d memrfactundexporb) 22.4 18.9
External Debt and ResourceFlows
Environment
(US$mrufoosl
T&a bebtoutsbnang and chskursed 150,901 193,293 Agncvltunri land(%oflandarea] 55 a
Fwestarea(%of landarea) 28.9
NatlonalLy protectedarea (Xcf landmea: 10.2
Totalabt('A ofGDP) z6.0 18.9 Freshweterwurccs per cam(w.mttenl 3,967
FreshwaterUithdrwl(%of m t e dresoured: f9 I
17,977 24,686 c02crmsdcm pelcap& (mt) 4.3 4.3
447 4 2
GOPpermd d energy we
I fmoS PPP0 per kgof otl equivelent) 7.1 6.6
Compositionof totalextemaldebt, toD7 I
Energyuse par capita{kgof5s equivalent) 1334 1,712
11,444 4,s@
i,748 671
1,330 342
890 232
mate.m1,m
US$mi'ms J
Privatesector Oevebpment mo 2007
Time requtredtostart a bushes (days:
Costto start a busnas (96 of GNI w capita) - n
133 1,234 1,146
Time requm8to registerproperty{days: -- 74 723 711
179 92
Ranked83 amjcfconstrainttobmss
(%ofmanagerssunreyedwtmagreed: 66 188
AnbcanipttmueOT mfonnslpracbces 190
C m W ... 178
Stodr marlretcapialaabm(%cf GDP) 21 5 389 Newguanmees -- --
Bank capelto asel ram{%) 96 132
Note.F minbhcsaretw yean otherthanhosespeufied. -2X7 dataare p&mnt%rr, 8/15x18
hQcatesdtttaererotava#Ia&d ndicateso b s e d m iarotapplicaMe
-
DevempmentE r n e s DevelopmentDataQwp (DECDD)
107
Page 3 of 3
Millennium Development Goals Mexico
Wthselected targetsto achievebetween 1990and 2015
(estknak closest to W eshauur, +/- 2yeemj
Goal 1:halveMeraesfor $3 a daypovertyandmalnutritior 1990 1995 2000 2006
Povertyheedcount ratioatti a day (PPP, %d popdabon) 8.3 37.r
8.f 6.3 4.5
PovertyheedcountratioatnalicMlpoverbjline@of popuMhm) 22.4 24.2 17.6
%are d incomeOT amsumptiontothe pamdqunMeI%) 3.5 3.6 3 3
RevelencedmlnuMim(%oFchik&enunder5) 76.6 169 7.5
Goal 2: ennurethat childrenareableto completeprimaryschooling
primsryschoold l m c n t(I?&,%) 99 99
RimaryIXmpkbmrate(%of&%ant agegoup) 66 95 99 103
Secmbrysehodenro#ment(grass,%) 53 72 85
Youthliteracyrate (% of pe@e ages 1524: 95 96 97 98
Goal 3: eliminategender drwflty ineducationand empowerw o r n
R&oofgirktoboysinprimaryandsecandaryedutabDn(%) 98 101
W- mploVed inthenaragricukralKdoc(% dnamgriadturalmrployment) 35 36 37 37
PmporEmbseatqheldbym ninnaticnalparliament(%) 12 14 18 23
Goal 4: reduceunder4mortalitybytwo4hirda
Under-5mortadyrate(per 1.ooO) 46 36 30 28
Infantnwtarltyd e (I#I1 . m hve btrIhS) 37 xi 2s 23
Measlesimrmyufatian(proporbanof one-yearoldsI-&, % 75 90 96 96
Goal 5: reducematernalmatalilybythrrc-fwrthr
Maternalmatalkyratio(nmdekd &male, per loQ,oOOlivebn-ths1 83
BBma anenckd byskatedtreatthslaff(* of W) 86
Goal 6:hdtandbeginto reverse Mespreadd HlVlAlOS andothermajordisease$
Revaienceof HIV(% of poputaticnapes 15-49] 0.3
Contraceptiveprevalence(%ofwomenages 1549) 65 70
Incidenceof hrkmAcsm(pet ~ 0 O " ~ w O p l e ~
. 49 42 37 33
TubemuloPircasesdetectedmder DOTS(K) 15 68 81
Goal 7: halvethe propoltionotpeoplewithout sustainablee c 6 t tobask need!
Acoes%to80 mpmved water scum(% ofpopui&?) 8(1 91
ACC-8 to imprartdsanitatbnfacilib;es(Xof popltgtan) 66 77
Forestarea 0% dtotallandafea) 32.2 28.9
Nsticsrallypoteetedareas(%of totalJandafea) 15.2
c02missions (mehiC tms prrcapita) 5.0 4.4 43 4.3
GOP perunital energyuse(crmptsnt2005 PPPS per kg ofoilequivaknf) 6 1 6.2 7.1 6.6
Goal a: devdo(, a alobalpahernipfor devdopmuit
Fixed b e n dmobilephonesutsaiben(wa 100people) 7 10 27 74
0 0 5 18
1 3 6 f4
5.4 9.6 4.4
MeralwimmunizationpCof I-year dds) ICTindicators@er100&e)
Note:Ftgvresin Aalasarefor yearso mmanthosespeemed. ._ind~cates
data are not availabk w1 ma
DevefopmentE m c s . DevelopmentDataGmup (DECDO).
108
To
Los Angeles 115�W 110�W 105�W 100�W 95�W 90�W 85�W
To
Albuquerque
To To
Gila Bend Alamogordo
Tijuana
Mexicali UNITED STATES OF AMERICA
Ensanada
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San Ciudad Ju�rez To
Felipe Midland
Nogales
BAJA G Agua
Prieta MEXICO
CALIFORNIA Rio Brav o
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30�N ulf San Antonio
of SONORA Yaqui C H I H U A H U A To
Ojinaga San Antonio
C Hermosillo To
Guaymas
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Sal
BAJA a l i f o r n i a Sierra Houston
Chihuahua
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CALIFORNIA Fuert C O A HMU I LFrontera
SUR O e
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25�N ccidenta Matamoros
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PACIFIC S I Nl O
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Cabo San Lucas
Zacatecas SAN LUIS
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QUER�TARO
San Luis
This map was produced by the Map Design Unit of The World Bank.
The boundaries, colors, denominations and any other information NAYARITLeAguascalientes Potos�
Potos� YUCATAN Cancun
shown on this map do not imply, on the part of The World Bank Tepic rma VERACRUZ Merida
Group, any judgment on the legal status of any territory, or any GUANAJUATO Guanajuato HIDALGO
endorsement or acceptance of such boundaries. 110�W Cozumel
PuertoVallerta Guadalajara Quer�taro
Quer�taro DISTRITO FEDERAL
JALISCO Pachuca TLAXCALA Campeche
MEXICO 20�N QUINTANA
MEXICO MEXICO
Morelia Jalapa
CITY Bay of Campeche ROO
Tlaxcala Veracruz
Colima Toluca Chetumal
Citlalt�petl (5,747 m)
Citlalt�petl
COLIMA Cuernavaca
MICHOACAN Puebla CAMPECHE
SELECTED CITIES AND TOWNS PUEBLA TABASCO
Ba lsa s Villahermosa Gulf of
STATE CAPITALS GUERRERO Chilpancingo BELIZE Honduras
NATIONAL CAPITAL Oaxaca CHIAPAS Usumacinta
RIVERS Acapulco S i e r r aM a d r e OAXACA Tuxtla
Gutierrez
MAIN ROADS d e l S u r Tehuantepec
MORELOS Puerto
NOVEMBER RAILROADS 0 100 200 300 Kilometers Escondido Gulf of GUATEMALA 15�N
Tehuantepec HONDURAS IBRD
STATE BOUNDARIES 15�N Tapachula To
0 50 100 150 200 Miles San Salvador
EL 33447
2004 INTERNATIONAL BOUNDARIES
105�W 100�W 95�W SALVADOR