IFR Mexico Roundtable 2007: Part 2
IFR: What other infrastructure projects are there? And what sort of structures are we likely to see emerging from these, and are investors interested?
Ricardo Cano: Infrastructure is definitely of interest for investors and I think what we are going to see in terms of structured deals is MBSs, other types of ABS deals and the toll roads.
But it is hard to imagine that some of the energy type infrastructure transactions will go to the local markets, given that it is more a dollar-based sector. Typically the off-takers pay in dollars, so it is harder to go to the local markets with these structures. In terms of structured finance, we are going to be focused on mortgages and other ABS as well as toll-roads. I don't think there is going to be more than that in the local markets.
IFR: How big an impact will the new pension reforms have on the capital markets?
Cabral: The most important thing in this new regulation is the capability from institutional investors to invest in capital-protected projects, or to invest in structured transactions. This is the wording we have seen in the regulation. This is very good news. The market is often not willing to absorb the construction risk, but through this type of regulation we can access pension funds to invest, including construction loans in project finance.
Cano: I agree completely with Humberto, but I am not sure how fast we are going to be moving or how fast the markets are going to adapt to the new regulation. In terms of the construction phase of some of the projects, there will be interest from local investors, but it is going to be limited given the liquidity that we still see on the bank side for that type of transaction.
What we have seen historically in this market is that banks typically finance the construction phase and take a lot of the first risk. Once you have a proven record of cashflows and so forth, then you can take it to the market. I am not sure how much Afores are going to start taking that additional risk right away. It is a process that it is going to happen, but it is going to take a little bit longer. Again these Afores are very concentrated on investment-grade credits and taking very little risk. So it is still a challenge to imagine a lot of activity within these markets
Fernández: I agree. Every thing is going to be in terms of risk appetite of investors. Looking back two or three months ago, the reforms were very positive. It has demonstrated that the more Afores are diversified away from Mexican government securities, the better returns they get. So we were thinking obviously there was going to be a push to lower rated credits. However as Ricardo and Humberto were saying earlier, the market has changed now and it remains to be seen if they are still willing to take that risk.
Nunez: I was going to say, that you have already seen changes in the portfolio composition of the Afores. They are taking more inflation-linked and longer-term paper than they used to. And I think that is good news for the kind of products that we are talking about, such as toll-roads and securitisations in general.
Cano: And they are taking more risk. It is starting to happen. But it is still very concentrated in investment grade, very top rated, corporate and government securities.
Uribe-Caraza: Little by little they are getting more sophisticated. But you have to accept that they have been allowed to invest in other types of securities and so far they have not done so, at least the majority of them.
So it is also a matter of them improving their credit risk management areas so that they can really assess what risk they are taking and what is the ideal mix of return and risk that they want in the long term. Once they have done that I think they can start to diversify into different asset classes.
IFR: What barriers are there to expanding the market further to include, say, more high-yield names. This has always been a problem. Are we any closer to achieving that goal?
Cano: It is a matter of time. There has been a lot of investments made by institutional investors in the credit areas and in infrastructure internally. So it is a matter of time before they start capitalising on those investments. When we talk to investors, we have started to hear a lot of more questions about credit and interest in buying it.
IFR: How are issuers looking at the evolution of these markets, and what investor bases are you looking to tap?
Parra: At least from Su Casita's perspective, we will increasingly target the international markets. This gives us two things, one is we get access to a bigger pool of more sophisticated investors who probably know the risks and are probably willing to invest not only in Triple A paper, but also in mezzanine bonds, etc.
Depending on market conditions, we can either issue locally or in the foreign markets. But it is important to mention that it is a diversification strategy, and it is not that we have all our eggs in the international markets. So from our side, we will probably be issuing 60%–70% locally and 30%–40% abroad
IFR: What impact, if any, is the US sub-prime fallout having on the Sofoles market in Mexico?
Parra: There still hasn't been any spill over into the Mexican mortgage market. We have to differentiate between sub-prime and non-sub-prime mortgages. Sub-prime is a mortgage given to individuals that are not creditworthy. They are probably no docs and they are probably fixed/variable mortgages, where you it is fixed for the first two years and then for the next 28 years it is variable. In Mexico all mortgages are full docs to creditworthy individuals and in fixed pesos or in [inflation-linked] UDIs but capped to the minimum wage.
We have not heard of any concerns from investors. If you have looked at MBSs and how they have behaved during the past years, they have behaved as expected. If you go to market now with these types of issue, we would probably see investors price them 5bp–15bp wider than what we had before. It is just a matter of how the market is behaving currently.
IFR: How are the rating agencies viewing the Sofoles in light of what is happening in the US?
Uribe-Caraza: As Jorge mentioned, Mexican Sofoles' portfolios look different from the ones you see in the States. But I think in general this is a warning for what could happen in Mexico if we are not careful. The Sofoles have been growing at a very fast pace over the last year and continue to do so. You have to be very careful that you continue to originate well, giving credit to people that really deserve it and not stretching it to the point where it becomes too risky as part of these mortgages are securitised and it could become a problem in the future.
So I think that as long as companies have good controls, good processes and really assess risks on a continued basis, they should be alright. But I think this is a warning for all the industry in general.
Boulay: There are two sides to this issue. First one is the quality of the mortgages which are being repackaged into MBSs. I think it is fair to say that [in Mexico] these are not sub-prime, and not the kind of loans that there are in the US, with no documentation, no reviews, etc.
On the other side you have the funding of the Sofoles, and they have to be very careful not to rely too much on short-term funding. We have seen what has happened to the US commercial paper market. So the Sofoles have to be very careful not to mismatch their funding too much because they could fall into a crisis that is not related to the quality of the assets, but to the situation in the market.
Parra: The US housing boom came about because of price speculation. In Mexico the boom has come about because of a lack of housing. In Mexico there is an estimated housing deficit of about five million homes and we are not near reaching that target. It is totally different. You have construction companies that build houses, and mortgage companies that get the credit and package that and sell them. As long as there is enough demand and we continue using the same standards as we have used in the past, nothing will happen. As Eduardo said, when competition closes up, probably in the next five to ten years within the sector, then we have to make sure that we do not use the same lax practices as in the US.
Cabral: The market is going to be more cautious about whether it will or will not buy MBSs, even though they know that the sub-prime is different from the low income mortgages in Mexico.
If you are going to issue MBSs, it is important to conduct a roadshow and demonstrate to investors why these mortgage portfolios are different, why this originator is better than others and why the servicing company is different from others. This is going to be the way to return to market with MBSs.
Parra: Clearly before the sub-prime problem, we did not even have to go on roadshows, as the paper was sold by itself. But probably on our next issue we will have to go investor by investor explaining why we are different from other Sofoles. Beforehand, the paper was Triple A rated, but investors did not differentiate between originators and servicers, even though between the Sofoles we have different corporate and servicer ratings. The paper is Triple A but the originator and the servicer of the portfolio are rated differently and that should be priced into the transaction.
Fernández: There have been maybe 50 MBS transactions so far in the Mexican market since 2003 when this market started, and I think all of them are performing relatively well. And that should be key for investors when they are looking at these deals.
Yes, market conditions are different, but the structure itself is what matters. What you are going to see in the future is that the structures may change again. We are might go back to what we saw earlier with partial guarantees, instead of having subordinated tranches, which are really tough to sell in these market conditions. But the fundamentals are there, albeit we have seen delinquencies going up in the local mortgage market in general. But it is still relatively low compared to other markets.
Going back to the originations standards, that is going to be key going forward. Just playing devil's advocate, with such a growing market and with the government targeting lower income segments and pushing homebuilders to provide houses to that sector and with the competition among Sofoles and banks intensifying over the past year, we have to be careful with those origination standards.
The sub-prime crisis has been a painful learning experience, but people forget, and people will start being aggressive again. I do not know who is going to monitor it. Is it going to be rating agencies or investors? That is going to be important.
IFR: When you said these structures are performing well, were you referring to secondary market performance?
Fernández: I didn't mean performing well in terms of pricing in the secondary markets, but in terms of the structure itself. In other words, investors are receiving payments and principal is flowing. There may be a couple where the OC has been struggling a bit to get built, but in general they have been performing very well. I think the structures we saw in the beginning were over enhanced, but those structures have been enhanced lately to benefit the issuers. But as long as those structures keep performing and prove to the market that they work, investors will get enough comfort to keep buying.
IFR: Deutsche Bank came out with the first CDO backed by MBS (Borhis)? What was the significance of that and will we see more?
Cano: It was a repackaging of previous transactions sold in the market.
Fernández: I think it was more of a CDO type structure rather than a REIT. I personally don't see the benefits of doing it, just because of the way the Borhis trade by themselves. But I mean it was interesting to see that it was placed in the market.
Parra: I think they were very innovative and eventually they will help the market as it evolves, but you see that CDOs have been hit hard in the US market. But I think that is an instrument that would help the market in the near future.
Cabral: Most of these Borhis are in institutional investors' portfolios not on the banks' balance sheets. Because of the size or the volume of these transactions I would not expect a lot of deals trying to repackage Borhis
Fernández: And when people think CDOs, a lot of this sub-prime crisis has been based on the CDOs that were repackaged, not on Triple A credits but on lower rated credits which is repackaging Triple B credits and getting them a Triple A rating. Those are the structures that are really suffering and investors will be a little careful, at least under current market conditions.
IFR: Several states and municipalities have issued bonds of late. Is this a market that is set to take off?
Cabral: For sure we are expecting to see more activity from the states and municipalities, especially because they have a lot of infrastructure needs. What we can't be sure of is what their assets will be. But we are expecting to see a lot of activity in the markets from the states.
They have tapped the loan market for many years because of the excess of liquidity at banks, but at the end of the day with the [funding] needs they have, they will have to access the market directly. I do not know how many transactions we'll see over the coming months, but it is clear that the states are thinking about accessing the capital markets very soon.
IFR: What about payment risk or political risk as I understand that some states have to get approval from their local legislature before making payments. What happens if there is a change in government?
Uribe-Caraza: In general the state governments and even municipal governments have become more institutional so once they contract debt, that is recognised as public debt and if another government comes along and wants to change that, they have to go through their own constitution to avoid that payment. And that would clearly be a default, and we haven't seen that happening.
If you compare the leverage of the states and municipalities to their international peers, I would say they are under-leveraged. But the problem is that in Mexico most of the states' revenues are very low. So in order to fund projects in the medium and long term, they have to keep improving their own source of fees and income, so that they can pay with their own money and not depend so much on the federal government. They still have a lot of expenses such as teachers and pensions, which are also important, and you cannot use this money for infrastructure projects. So their financial flexibility is limited.
I agree with Humberto that you would most probably see several states going to market with certificados bursatiles issues. Some of them will be just for refinancing, while others will be for financing new projects. But I don't think they will go crazy and take on a significant amount of debt because I do not think investors would buy it. Investors will be looking very carefully at how leveraged they are and what proceeds are being used for.
IFR: Just returning to the high-yield markets, how do you see this developing going forward?
Cano: Just going back to what we were talking about earlier with investment and credit management. There has been quite a lot of activity in sub-investment grade transactions within the mutual funds and private banking in Mexico. It is much more limited when you compare it to investment-grade activity, but there has been activity in the last two years. Very soon we are going to see long-term investors looking at the high-yield market. It is just a question of time until they can start taking more credit risk. But it will happen.
We are going to see the market buying more sub-investment grade paper, but then we are going to have another problem. We are not going to have enough supply of paper. You don't have that many sub-investment grade companies that have the critical mass that is necessary to go to the bond market and at the same time are willing to go through corporate governance issues, disclose their financials and so forth. The universe of potential candidates is not that huge in Mexico. There are a lot of companies that could go, but we are not going to change the markets completely. A lot of things are being worked on, but are we going to see 300 new names? I don't think so.
Cabral: We are taking more non-investment grade companies to access the institutional investor market, but the way we are doing this is with partial guarantees. But given the current environment it is hard question to answer. If we are going to push more for non-investment grade issuers, it is clear that investors are going to be more cautious now about the company and management before they invest.
Fernández: There are two other considerations. One is what is going to happen with the bank market because obviously all these issuers have typically accessed the bank market, rather than tapping the capital markets, since there have been banks willing to lend at cheaper rates. What is going to happen with all this re-pricing? That is going to be one thing to keep an eye on.
The other thing is that you are starting to see issuers that could potentially access the local high-yield market, but given recent events and that local investors are questioning whether they should buy Double A or even Single A rated names, these borrowers are also looking at going to the US markets. And there is an interesting pipeline that is expected for September if the markets improve.
There are companies that need funds, but are not there in terms of size and certain requirements for the local markets, so they are looking at the US high-yield markets. Obviously it is going to be much more expensive than two or three months ago, but there are still opportunities.
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