"Facts are meaningless. You could use facts to prove anything that's even remotely true!" (Homer Simpson)

Would it be too harsh to ask if we, as investors, have gotten too greedy? An unavoidable fact is that the US residential mortgage-backed securities (RMBS) subprime boom required willing lenders. (The term subprime refers to the credit status of a determined borrower – being less than ideal – not the interest rate on a specific loan.) The US stock-market collapse and low interest rates that started in 2001 nurtured a class of investors and pushed structured finance lawyers to come up with new products to feed it. Once we finished our job, Wall Street did its and unveiled the perfect vehicle: securitization, or turning loans that once sat quietly on banks' books into securities that became well accepted and now sell in global markets.

Using a generally accepted definition of securitization, we understand it as: the packaging of designated pools of loans or receivables with an appropriate level of credit enhancement and the redistribution of these packages to investors. Investors buy the repackaged assets in the form of securities or loans which are collateralized (secured) on the underlying pool and its associated income stream. Securitization thereby converts illiquid assets into liquid assets.

As we mentioned above, low interest rates have made many investors buy different or even exotic products in an effort to boost returns. Moreover, because of the way these products have been structured, some have received triple-A ratings from internationally accredited rating agencies, such as Moody's Investors Service and Standard & Poor's, even though they might have contained subprime loans. This lured traditionally conservative investors such as commercial banks, insurance companies and pension funds, avid of higher rates of return, to this market.

As a result, the Mexican RMBS market boomed in recent years. Primarily due to the hunger for higher returns, but also coupled with a very large and still increasing demand for low income housing, which triggered the growth and financial modernization of Mexican construction companies that have helped sustain the industry's growth and the Instituto del Fondo Nacional de la Vivienda para los Trabajadores or Infonavit – Mexico's largest government-owned manager of funds directed to housing – increasing participation in the fund and decrease its delinquent portfolio.

What the Mexican local market had to offer were RMBS and collateralized debt obligations (CDOs) issued either directly by government-sponsored enterprises (GSEs) such as Infonavit and Sociedad Hipotecaria Federal (SHF), through securities commonly known as certificados de vivienda or CEDEVIS (housing certificates) or through bankruptcy-remote special purpose entities (regular trusts) set up by large low-income construction companies such as Corporación GEO, SARE, Homex and the like, primarily using debt instruments known as certificados bursátiles fiduciarios (exchange-traded trust certificates).

SHF and Infonavit as part of their ordinary course of business and financial planning began selling bonds backed or collateralized by pools of mortgages. Both GSEs, in the likes of Ginniemae and several other US government-sponsored enterprises that issue and sell mortgage-backed securities, have no default risk, coupled with an existing law that allows Infonavit to deduct monthly loan payments from borrowers' bank accounts.

Even though in the US and other markets (mostly in Europe) the pain caused by the subprime crisis is getting worse for companies that fund themselves through commercial paper conduits, in some cases creating a liquidity crunch, Mexican companies that fund themselves through commercial paper conduits have not suffered a material contagion, given that almost all of the outstanding CDOs issued by such entities consist, as of this date, of GSEs' guaranteed loans.

Moreover, we coincide with certain analysts in stating that the underlying reasons for the US subprime deterioration are not yet present in Mexico. As a young RMBS market, we have securitized mainly mortgage loans to the low and middle-income segments of the population, which are not necessarily comparable with US subprime borrowers.

Mexican originators which, as stated above, mainly include GSEs and low-income home construction companies using bankruptcy-remote special purpose entities have, up until this point, only securitized hand-picked, quality portfolios that provide good protection against losses at the loan level as well as within the structure. All of the loans in these pools are first liens, have full documentation, and are fully amortizing, with adequate loan-to-value and debt-to-income ratios.

Therefore, although the subprime mortgage crisis will have negative effects in Mexico given that the value of securities of Mexican companies is generally affected by economic and market conditions in other countries, primarily in the US, the reasons for this will not be the same reasons that caused and are causing the US crisis.

Legal aspects of securitization

Legal framework

In addition to the hunger of investors for higher returns, the increase in demand for low income housing, the growth of Mexican construction companies and Infonavit's financial strength, the growth in Mexican securitization is also due to a stronger legal structure for modern transactions. Important to mention are the recent amendments to certain federal laws such as the Ley General de Títulos y Operaciones de Crédito (Law on Negotiable Instruments and Credit Transactions), the Ley de Concursos Mercantiles (Insolvency Law), and most importantly, the issuance of a newly enacted Ley del Mercado de Valores (Securities Market Law), that re-introduced and regulated the use of the certificado bursátil fiduciario, which has become the market standard as the debt security to be issued in securitization.

Bankruptcy-remote entities

As in most securitization processes, a fundamental principle for the success of a securitization in Mexico is the use of a bankruptcy-remote special purpose entity that will issue the certificados bursátiles fiduciarios and hold the pool of mortgage loans generating the cash flow needed to service the payment obligations. Rating agencies have taken a widely-accepted position that bankruptcy remoteness of the issuer reduces the likelihood that the transaction's cash flow is or can be interrupted.

As mentioned, the entity most commonly used in securitization in Mexico is the fideicomiso (trust). The fideicomiso is an unincorporated entity to which a fideicomitente (settler) will transfer the designated pool of loans or receivables to be held and managed by a fiduciario (trustee) (which under Mexican law has to be a financial institution) for the investors. The legal framework and investors alike have become increasingly comfortable investing through fideicomisos, even more so if such fidecomisos are used solely as the securitization vehicle.

Exchange-traded trust certificates

An important aspect of the use of a fideicomiso as the securitization vehicle comes from the amendments in 2001 to the Securities Market Law, which triggered a new Securities Market Law in December 2005, effective June 2006. The Securities Market Law created the certificados bursátiles fiduciarios (exchange-traded trust certificates) and permitted fideicomisos to issue these securities. This development, coupled with those explained above, also gave the securitization market a huge impulse, as it was the first time fideicomisos were permitted to issue debt securities. The Securities Market Law eliminated many of the formal and requirements that previously hindered companies and the fideicomiso, in particular, from issuing debt securities.

What is next?

The market is correcting itself from some excess. But we cannot make RMBSs and securities of similar nature the scapegoats for what is happening in global markets. Securitization has become a necessary tool to continue creating new instruments that could be offered in the financial markets. In Mexico, more than six million homes have to be built to reduce the housing shortage. The resources needed to develop the newly industrialized as well as the emerging markets, in which Mexico is counted, are so large that the markets need to create and accept more innovative instruments. Such instruments would provide the resources to fund not only housing mortgages but also investments in all kinds of infrastructure.

New excesses may occur, and even though historical events and facts are sometimes overlooked or even considered meaningless, the Mexican market needs to learn from foreign markets, often more integrated and deep, to provide well structured instruments with appropriate levels of certainty on intrinsic risk and corresponding prices. The challenge is there, for whoever is willing to take it.

Author biography

Alfonso Castro Diaz Santamarina y Steta Castro Diaz is an associate at Santamarina y Steta and has been with the firm since 1999. He holds degrees from Universidad Aháhuac (2001) and Universidad Iberoamericana (2001) and received his LLM from Northwestern University School of Law in 2004, as well as a Certificate in Business Administration from Kellogg School of Management (2004). Castro Diaz's practice focuses on corporate matters, including securities, structured finance, project finance and real estate transactions. He previously worked as an international lawyer at Cleary Gottlieb Steen & Hamilton LLP in New York. He also teaches Negotiable Instruments and Credit Operations and Financial Law in the Universidad Iberoamericana Law School.