Mortgage Market in Mexico March 18 Content

Mortgage Market in Mexico March 18

Content s I. Introduction II. Demographic Dynamics, Housing Demand Financing Needs III. The Mexican Mortgage Market including FOVI/ SHF role IV. Securitization Model for Mexico and Current Strategy V. Pension Funds & BORHIS VI. Low-Income Mortgage Alternatives VII. Challenges ahead in Housing Finance 2

SHF: Mandate & activities, Mission & Vision SHF was created in 2001 as a government financial institution oriented to foster the development of the primary and secondary mortgage markets. As a Mortgage bank: SHF grants long term financing to financial intermediaries and covers their interest rate risk. SHF does not lend directly to individuals. As a Guarantor: SHF offers products like mortgage insurance and financial guaranties. Until 2013, SHF will have the 100% guarantee from the Federal Government. After 2009 SHF will not be able to grant finance, hence, it is necessary to develop alternative mechanisms of housing financing. Mission: Lead the development of a competitive market in order to allow all Mexicans be able to acquire a residence. Vision: To be an innovative institution in solutions to develop social housing. 3

Content s I. Introduction II. Demographic Dynamics, Housing Demand Financing Needs III. The Mexican Mortgage Market including FOVI/ SHF role IV. Securitization Model for Mexico and Current Strategy V. Pension Funds & BORHIS VI. Low-Income Mortgage Alternatives VII. Challenges ahead in Housing Finance 4

Over the next 25 years, the number of households will grow at an annual rate of 2% and the year of 2012 will have the larger number of household formation. Million Households From 2000 to 2030 the number of households in Mexico will grow 83%. These favorable population dynamics is coupled with an annual per capita income of approximately USD $9, 500* Number of Households in Mexico Source: CONAPO According to official estimates, 672, 018 new households were formed during 2005 throughout the country. This figure will rise up until 2012, when 691, 242 new households will be formed. Population by Age Groups in 2004 Source: CONAPO /* PPP Methodology 5

Housing Demand q In Mexico, there are 26. 7 million families of which: 17. 2 million already have an adequate house. 9. 4 million families do not have an adequate house and haven’t been attended yet. Annually, around 500, 000 new families are generated, of which approximately 60% are in conditions of demanding a mortgage loan. In addition to the families that do not have an adequate house, there are 4 components that together generate the annual housing demand. Source: INEGI. 6

Housing Demand: Strengthening of the Middle Class A gradual increase of the middle class is expected. This will allow a strengthening of the housing demand from financially healthy families. Dollars Earned per Day DISTRIBUTION OF FAMILIES ACCORDING TO THEIR INCOME (%) § Between the year 2000 and 2006, the percentage of families that received more than 12. 9 dollars a day increased from 72. 8% to 80. 2%. § In 2006, 80. 2% of the families received more than 12. 9 dollars a day The low income sectors are the ones that have experienced greater increases in their income per family between the years THE PURCHASING POWER OF THE LOW AND MIDDLE CLASSES STRENGTHENING OF 2000 and Quarterly Income per Family (Dollars) 2006. Source: INEGI. 7

Demographic dynamics: a challenge opportunity in the mortgage market and Even under very conservative assumptions, SHF estimates that the residential mortgage portfolio will grow from USD $80, 724 millions in 2007 to USD $338, 300 millions 2020. Million Dollars MORTGAGE PORTFOLIO IN MEXICO 400, 000 350, 000 300, 000 250, 000 200, 000 ve ulati Cum % 10. 1 Annu wth l Gro : Rate a 150, 000 100, 000 50, 000 - 20062007 20082009201020112012 201320142015 2016201720182019 2020 INFONAVIT and FOVISSSTE SOFOLS and Banks The projections of the mortgage portfolio are based on potential estimated demand assuming an 3% annual growth rate for GDP and the same levels for mortgage rates than those of 2006. ACCUMULATED NET FLOW NEEDED TO FINANCE 2500 MORTGAGE LOANS The flow of financial savings available 2006 Billion Pesos 2000 in the country will not be sufficient to 1500 finance the growth of mortgage 1000 portfolios. The sale of mortgage 500 portfolios to domestic institutional investors as well as foreign investors 0 200620072008200920102011201220132014201520162017201820192020 Private Mortgages Siefores Savings from banks is an absolute must to maintain the To attend the mortgage sector. of mortgage loans in the following years, it was growth of the growing demand necessary to develop a Residential Mortgage Backed Securities market. 8

Content s I. Introduction II. Demographic Dynamics, Housing Demand Financing Needs III. The Mexican Mortgage Market including FOVI/ SHF role IV. Securitization Model for Mexico and Current Strategy V. Pension Funds & BORHIS VI. Low-Income Mortgage Alternatives VII. Challenges ahead in Housing Finance 9

The industry is still dominated by the two Federal Housing Funds, INFONAVIT and FOVISSSTE. About ¾ of loan originations still do not involve a private intermediary undertaking at least part of the risk inherent to the transaction. FOVI/SHF has greatly diminished its importance as the funding source for mortgages originated by private intermediaries thanks to the development of the market. Mortgages by Financing Source 2002 2006 Total 341, 939 Loans Total 675, 041 Loans 10

INFONAVIT The board of directors is represented by workers, employers and the Federal Government. INFONAVIT receives on a monthly basis, 5% of the formal private sector workers payroll, and credits to personal accounts. INFONAVIT loans, interest rates and payments are indexed to the minimum wage (MW)*. INFONAVIT interest rates are not market rates, there is an implicit interest rate subsidy on all its lending. INFONAVIT relies on payroll deduction for its collections when borrowers are employed by firms in the private sector. Collection mechanisms for unemployed borrowers or those migrating to the public or the informal sectors still need to improve. Average dollar amount of their loans: $22, 000 * MW= usd$ 148. 4 per month 11

FOVISSSTE Similar to the objective and sources of funding from INFONAVIT, FOVISSSTE is a wage-based housing fund for federal employees, and is the institution in charge of providing housing financing to over two million of federal government employees. The board of directors is represented by different government agencies and by ISSSTE (the public pension fund for federal employees). FOVISSSTE receives on a monthly basis, 5% of the federal employees payroll, and also collects through a pay-roll deduction mechanism. FOVISSSTE loans, like those of INFONAVIT, are indexed to the minimum wage and pay lower than market interest rates; however to a greater extent. FOVISSSTE lags behind INFONAVIT on revamping its operating procedures, particularly regarding the servicing of the loan portfolio. 12

BANKS Until 1994, banks were the only private intermediaries doing mortgages in Mexico. In 1995, the “Tequila Crisis” bankrupted the Mexican banking system and private banks abandoned the mortgage market. Pastdue loans became rampant, specially in the mortgage portfolio of banks. Banks did not have efficient collection mechanisms or foreclosure procedures. By 2004 it became clear to banks they had been out of a profitable market, and they entered back aggressively by: Undercutting Sofoles in price Buying up the largest Sofoles Banks originated approximately USD 7, 300 millions of loans in 13 2007.

SOFOLES Sofoles were created in 1994 as a result of NAFTA. They are Nonbanks similar to mortgage banks in US. They have two basic characteristics : ü Cannot take deposits from the public. ü Can only lend to a specific sector: housing, automobiles, education, etc. Since then, Sofoles have successfully been originating and servicing loans under FOVI & SHF programs: ü Relatively homogeneous originating and servicing standards, as well as standardized loan product. ü Sofoles will originate approximately USD 2, 200 million of loans in 2007. 14

FOVI, which was manage by the Central Bank until the creation of SHF, started funding SOFOLES in 1995. Collections on outstanding portfolio Central Bank loans (guaranteed by the Federal Government) World Bank and IADB Sofoles Construction loans for homebuilders and mortgages for individuals Fovi’s funding to Sofoles was long term, fully matched and indexed to minimum wage inflation. Under the macroeconomic environment after de “Tequila Crisis” this was the only source of long term funding for mortgages. 15

SHF started operations in 2002, overtaking the activities of FOVI but with a new capacity to get funding from the capital markets. Local capital and international derivatives markets Central Bank loans World Bank & IADB MI is offered to prepare loans for securitization SHF hedges market and prepayment risk through debt and derivatives markets Mortgage Insurance SOFOLES MORTGAGE LENDING SHF funds SOFOLES on a matched funds basis, absorbing market and prepayment risk 16

Content s I. Introduction II. Demographic Dynamics, Housing Demand Financing Needs III. The Mexican Mortgage Market including FOVI/ SHF role IV. Securitization Model for Mexico and Current Strategy V. Pension Funds & BORHIS VI. Low-Income Mortgage Alternatives VII. Challenges ahead in Housing Finance 17

Participation of SHF in the securitization model SHF does not perform the same activities that Fannie Mae or Freddie Mac: it neither purchases loan portfolios nor does it issue MBSs with its own Guarantee attached. Instead: SHF offers Mortgage Insurance covering the first loss of up to 35% of loans, whether they are part of a pool of an MBS (BORHIS) or not. SHF offers Partial Financial Guarantees to structures that meet certain requirements. These usually do not cover more than 15% of MBS (BORHIS) outstanding balance. SHF supports the liquidity of the MBS (BORHIS) by continuously quoting bid-ask prices (with tight bid-ask spreads) for every issue in the market. All this activity is channelled through one of the eleven “BORHIS Market Makers”. is similar that of the GSEs: to foster However, the goal of SHF the liquidity to the mortgage markets as a means to promote the affordability of mortgages. 18

How is the market organized to issue MBS (BORHIS)? Financial Guarantee Insurance Company/Mezzani ne Mortgage Insurance Companies PREMIU M Mortgage Insurance (First loss up to 30%) SOFOL or BANK Loan + Mtg. Insurance $ Mortga ge $ BORROWE R = PREMIU M Total or Partial Financial Guarantee Insurance and Mezzanine SPV (funded and administered by private entities) Depends on the preferences of the issuer, but Mortgage Insurance is necessary unless a 100% Financial Guarantee Insurance on the MBS exists. AAAmx rated MBS (BORHIS) Debt Markets $ SPV acquires mortgage portfolios, structures and issues MBS (BORHIS) 19

The securitization Model Two type of structures are being placed in the market. Mortgage Insurance + Partial Enhancement (Partial Financial Guarantee or Mezzanine Bond) Assets Mortgage Portfolio (100%) + Mortgage Insurance Full Financial Guarantee Insurance (without Mortgage Insurance) Assets Liabilitie s Mortgage Portfolio (100%) Senior Bond 87% Mezzanine Bond 10% Equity 3% Equivalent to a Partial Financial Guarantee Liabilitie s Senior Bond 88% Equity 12% May be partially substitute d by a Mezzanin e Bond 20

SHF has been actively seeking the entrance of private providers of guarantees. The end-game is a market based system relying on private providers of financial solutions. Investor and market maker in initial and secondary markets SPV Mortgage Portfolios Financial Intermediaries • Banks • Sofoles $ L O A N S MB S Capital Markets MBS K Mortgag e Insuranc e $ Financial Guarantee Insurance 21

The number of participants increased, first Sofoles, then an important participation in securitization has steadily banks by 2006 started to have The number of intermediaries participating in securitizations is also higher every year. Bancomer HSBC Banorte Cy. C Patrimonio ING FINCASA GMAC (Patrimonio) GMAC (Cy. C) Metrofinanciera GMAC (HIPNAL) GMAC Su Casita GMAC Su Casita 2005 2006 2007 2008 In 2007, 3 banks have already securitized their mortgages, and we expect this number to keep growing. Metrofinancier a GMAC (HIPNAL) GMAC Su Casita 2004 Scotiabank 22

Securitizing mortgages has proven to be a successful mechanism to originate mortgages recurrently and at competitive rates q Through 2007, we have witnessed important progress on the issuance of mortgage backed securities: q On 2007, $2, 352 million USD were securitized, representing an increase of 107% of the amount observed in 2006. q And also on 2006, banks started working towards securitizing their mortgage portfolios, managing to account for 33% of the issuance of BORHIs in 2007. 23

On 2007, the average size of issuances also increased, making BORHIs a more appropriate instrument for institutional investors Issuances increased their individual volume, averaging around $131 million USD in 2007. 24

BORHIS offer very attractive yields to Foreign Investors: YTM: BORHIS* vs. “Mexican Government Real Rate Benchmark”, “TIP’s + EMBI+”, TIP’s (Dic-2003 – YTD) By the end of 2007, Borhis mantained the same YTM in average. *Weighted Average YTM (calculated, at each time, with the outstanding amount of each issue). Source: VALMER; Mexican Price Vendor. **Government Real Rate Benchmark (with similar duration to that of the BORHIS). TIP’s = Treasury Inflation Protected Bonds; EMBI+ = Emerging Markets Bond Index (Mexico). 25

Today there are 11 Market Makers participating in SHF’s program to foster the liquidity of BORHIS in the secondary market. SHF acts through these institutions, and quotes prices both ways on every security at very tight margins throughout the day. 26

There is a lot of room for efficiencies being translated into more affordable mortgages. FIXED RATE PESO POOL OF MORTGAGES SECURITIZATION 25% First Loss Mortgage Insurance + Mortgage Portfolio 10% Mezzanine Piece 3% Subordinated Security Average rate on mortgage portfolio 87% Senior security 14. 00% 1. 25% Servicing Fee - 0. 85% - 1. 10% - 0. 17% - 8. 34% = 2. 29% MI P&C and Life insurance + structuring and securitization costs Mezzanine Funding rate for MBS Excess Spread 27

The BORHIs market is still on its early stages, so it is important to correct and adjust some aspects in order to improve its efficiency Some aspects must be strengthened to continue providing this market with dynamism, sustained growth and security for the investor. § Homologation and standardization of the periodic information reported by servicers and trustees, aiming to add transparency to the analysis and monitoring of the structures. § Value the bonds in terms of prices instead of rates to provide simplicity to their valuation. § Establish a standardized public calculator to price the structures. § Make structures homogeneous. § Adjust the rules that define the characteristics of BORHIs to line up the incentives and distribution of risks between participants. § Adjust the operation rules of market makers. 28

In order to satisfy the demand of institutional investors and widen the range of BORHIs available, different types of issuances have been promoted: We have worked to generate a great variety of types of BORHIs with the objective of attracting different investors through diverse tranches. Likewise, SHF participated in the creation of Hipotecaria Total (Hi. To), a company that allows the securitization of mortgages at real time, in a similar way as the Danish model. We are supporting Covered Bonds as another securitization option. These schemes offer different options for both, investors and issuers. 29

Content s I. Introduction II. Demographic Dynamics, Housing Demand Financing Needs III. The Mexican Mortgage Market including FOVI/ SHF role IV. Securitization Model for Mexico and Current Strategy V. Pension Funds & BORHIS| VI. Low-Income Mortgage Alternatives VII. Challenges ahead in Housing Finance 30

Mexico Pension Funds System Individual Pension Fund Account* AFORES Pension administrator PUBLIC EMPOYE R $ SIEFORES PRIVATE EMPOYE R $$ $ Pension Investment Fund § Invests Pension Funds § Regulated by CONSAR who defines investment policies * Mexican pension funds have an investment portfolio of around $79, 000 Million USD (8. 21% of the GDP in 31 Mexico)

SIEFORES & BORHIS: matching necessities One of the aim objectives of the SIEFORES is to invest the income of pension funds in order to obtain the best returns with financial instruments that comply with the regulator investment policies. Taking into account that pension funds look for a long term basis investment, there is a need for long term financial instruments to match the necessities of the pension saving accounts. The regulator of SIEFORES establishes strict conditions for the type of financial instruments that could comply with the pension funds portfolio. BORHIS are an attractive investment option for SIEFORES in terms of: üRisk Level üTerm üQuality of the bond & bond underlying üTiming of the issuances 32

SIEFORES & BORHIS: matching necessities The 70% of BORHIS investors is distributed within SIEFORES, Banks and stock exchange specialists. The participation of BORHIS within the SIEFORES portfolio represents the 1. 7% Although the participation of BORHIS in the SIEFORES portfolio is important, the % of such bonds is limited. SHF is working together with CONSAR to increase the % of participation of MBS. 33

Content s I. Introduction II. Demographic Dynamics, Housing Demand Financing Needs III. The Mexican Mortgage Market including FOVI/ SHF role IV. Securitization Model for Mexico and Current Strategy V. Pension Funds & BORHIS| VI. Low-Income Mortgage Alternatives VII. Challenges ahead in Housing Finance 34

In order to prevent the low-income population from living in irregularity or illegality and in stark conditions, it is necessary to provide it of housing. Historical Mortgage Loans 1 The interest rates decrease observed during the last years has benefited the mortgage loan market. Housing Demand by Income Level 2 Potential Market (Houses) Housing Demand Target Segment Attended Segment Familiar Income in Mimimum Wages This has traduced into an increase of the housing supply and demand, as well as of mortgage loans. However, the main beneficiaries have been the formal workers. The housing supply for informal and/or low-income workers is still too limited. New mechanisms should be created in order to supply housing to this segment of the market, which represents more than 80% of the population. To attend the low-income and informal workers, this market should be provided of attractive characteristics Housing Overview 2006” to constructors. Source: Softec, “Mexican 1 2 Source; Softec, “Mexican Housing Overview 2006” and figures from SHF 35

In spite of the development of the mortgage market and of the diminish in the interest rates, the increase in the prices of houses has not allowed the low-income sector to be benefited. q The government has established the need to generate 6 million mortgage loans during the period 2006 -2012, which traduces in 339, 762 acres of urban ground with the required infrastructure and equipment*. q In Mexico, many urban development programs have been carried out. However, the following is necessary to benefit the low-income population: § The State and Municipalities should influence the type of housing that the constructors build. § Alternative financing sources for the development of infrastructure should be explored. § The urbanization process – equipment of land, construction of housing, and individual sales - should be enhanced in order to reduce the cost of land to give to quality houses to the low-income population, the To give access to housing to the low-income population. participation of the States and Municipalities is needed, as well as the creation of attractive conditions for the investment of constructors in social housing. *Source: Softec, “Mexican Housing Overview 2006” 36

Participation of Constructors in the Housing Market The costs of investing in social and economical housing are duplicated with respect to the residential housing costs. The contrary happens with the profit margin. % with respect to sales One of the problems regarding the lack of attention to the low-income market consists in the fact that the constructors found this segment less profitable and more risky. The typical cost structure for constructors according to the market segment is showed below. * Social Economical Middle Residential Plus Profit Margin (before taxes) Concept / Housing Type 10% 15% 18% 20% Unforeseen Expenses 5% 5% 5% Financial Costs 8% 8% 6% 4% 4% Sales and Merchandising 5% 5% 5% Administrative Costs 4% 4% 4% Project and Supervision 4% 4% 4% Processes and Licenses 2% 2% 2% Construction 40% 39% 38% 33% Infrastructure 14% 12% 8% 5% 3% Ground 8% 10% 12% 15% 20% *Source: Softec, “Mexican Housing Overview 2006” 37

SHF has, among its objectives, the promotion of accessibility to housing. As a result, it has taken an active role in the development of ground that can be used for the development of social housing. SHF, in coordination with BANOBRAS and several Financial Institutions, has defined and implemented different projects known as “Macrodesarrollos”. These have the objective of creating management and financing methodologies for the States and Municipalities in order to generate low cost housing in a sustainable environment. These “Macrodesarrollos” consider the creation of: § A self-sustainable city, adjacent and complementary to the already existent one, that offer jobs and services to the population –health, education, diversion, transport, etc. - (avoiding to create dorm cities or isolate urban developments). § Spaces that allow housing meant to all social classes (providing urbanized and well located grounds). § Public spaces that allow to develop a communitarian life – centers and sport areas, among others-. § Spaces for the environmental protection and enhancement. § Open spaces for primary activities – agriculture and farming-. § Legal and political certainty that will allow to offer housing at lower costs. 38

To improve the access to mortgage loans, all participants and markets developed for the Residential Mortgage Backed Securities should be directed to the steps currently unattended and to the lowincome population. All the advances achieved in the market and the products developed by SHF to promote the Residential Mortgage Backed Securities, should be used to attend the steps in the chain that are actually unattractive. Housing Demand Acquisition of ground Primary Infrastructure Equipment Current Cover 6 a- 25 Mimimum Wages Future Cover 0 - 5 Mimimum Wages Sale of Urban Ground Construction of houses Sale of Houses Maintenance Current Participation of SHF Securitization • Investors • Mortgage insurers • Financial guarantors • Structuring agent Future Participation of SHF 39

The advantages of this model can be observed in three different directions: q. States and Municipalities § § § Obtain a financing source to promote an ordered urban development. Line up the constructors’ interests with the urban development planning. Stimulate the development of social housing projects. Is an important instrument to confront the illegal development of cities. Besides, the States and Municipalities might attend the low-income population, subsiding the land for social housing through the urbanization of ground. q. Low-income population § § Urban developments with adequate equipment, services, employment sources, and infrastructure linked to public spaces. Access to houses with infrastructure, at regular prices and with the possibility of obtaining credits and subsidies. q. Urban Developers § § § The State or Municipality will guarantee the legal security of the project, as well as its basic infrastructure and urbanization. Permissions and licenses are previously granted. Urban design and individualization scheme with loan products of SHF, INFONAVIT, and other entities. Obtain financing for business lines that were previously unfeasible. 40

Content s I. Introduction II. Demographic Dynamics, Housing Demand Financing Needs III. The Mexican Mortgage Market including FOVI/ SHF role IV. Securitization Model for Mexico and Current Strategy V. Pension Funds & BORHIS| VI. Low-Income Mortgage Alternatives VII. Challenges ahead in Housing Finance 41

Challenges ahead in Housing Finance To attend the population that has not been attended, SHF has the following actions to achieve: § Strengthening and consolidating the Residential Mortgage Backed Securities Market. § Promoting the entrance of new specialized financial institutions in the unattended sectors: microfinance institutions, non-banks, and savings and credit institutions. § Developing of adequate products for these markets: savings and leasing. § In coordination with other housing institutions, adjust the Program of Subsidies to extend the access to mortgage loans. § Development of financial markets to attend the financing of infrastructure, equipment, and maintenance of the production of sustainable housing. § With respect to the previous point, SHF will take advantage of its experience in the development of securitization markets to securitize the franchises and flows of these Macrodesarollos. 42

Contacts: Paloma Silva Edith Castro ‘msilva@shf. gob. mx ‘ecastro@shf. gob. mx March 18