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Securitization 101- A Primer for Terminology and Concepts Specific to the Mexican ABS Market

Securitization 101- A Primer for Terminology and Concepts Specific to the Mexican ABS Market. Juan P. De Mollein Managing Director Latin America/Emerging Markets Structured Finance Standard & Poor’s. October 29, 2007. Agenda. Introduction

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Securitization 101- A Primer for Terminology and Concepts Specific to the Mexican ABS Market

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  1. Securitization 101- A Primer for Terminology and Concepts Specific to the Mexican ABS Market Juan P. De Mollein Managing Director Latin America/Emerging Markets Structured Finance Standard & Poor’s October 29, 2007

  2. Agenda • Introduction • Standard & Poor’s Mexican RMBS Methodology Overview • Specifics of the Mexican Securitization Market • Case Study

  3. Agenda • Introduction • Standard & Poor’s Mexican RMBS Methodology Overview • Specifics of the Mexican Securitization Market • Case Study

  4. Introduction: Global Expansion of Securitization Markets Source: Standard & Poor’s

  5. Introduction – Mexican Structured Market Development Source: Standard & Poor’s

  6. Introduction - ABS Asset-Backed Securities (ABS): A secured debt obligation backed by a pool of financial assets as collateral. Two main different approaches to rating ABS deals • Existing Assets: • RMBS (NBFIs, Banks, Infonavit) • Construction Loans (NBFIs) • CMBS (Acosta Verde) • Consumer Finance (Infonacot, Liverpool) • Commercial Finance (Vitro, Navistar, Unifín, Planfía) • Future Flows: • Federal Participations (States, Municipalities) • Own Tax Revenues (Nuevo León, Veracruz, Chiapas) • Financial Flows (DPRs) • Export Flows (Pemex Finance, Peñoles)

  7. Introduction – Potential in Mexico • High growth rates in ABS issuances are expected for Mexico: • Small Bond Market as % of GDP • Small Structured Finance market as % of total market Source: Standard & Poor’s

  8. Agenda • Introduction • Standard & Poor’s Approach for Rating Mexican ABS • Specifics of the Mexican Securitization Market • Case Study

  9. Standard & Poor’s Approach for Rating Mexican ABS • S&P’s analysis is performed at several levels Macroeconomic and market-specific risks Legal Structure Underlying Collateral Rating of an ABS Servicer Cash Flow Analysis

  10. Standard & Poor’s Approach for Rating Mexican ABS • Standard & Poor’s assumes that as the economic environment declines, the credit risk associated with the underlying collateral will increase. • At higher rating levels, S&P applies higher stress scenarios and therefore, requires higher loss protection or credit enhancement levels. • Existing Assets: • Transaction can survive if originator defaults and ceases to operate. • Assets belong to a bankruptcy-remote entity (Trust). • Backup Servicer performs collections and transfer of flows from assets in custody. • Future Flows: • Typically, transaction will not survive if originator defaults and this causes it to cease operations. • Originator must operate in order for flows to continue flowing into a trust.

  11. Agenda • Introduction • Standard & Poor’s Approach for Rating Mexican ABS • Specifics of the Mexican Securitization Market • Case Study

  12. Specifics of the Mexican Securitization Market Construction Loan Securitization Construction Loan: Bridge financing provided by NBFIs and Banks to housing developers for land acquisition, urban development and housing construction. Mix of different projects by several developers across the country, where each project is typically financed by one or more loans. Analyzed as a pool of loans with similar default probability, using a Monte-Carlo simulation for the pool’s overall Scenario Default Rate (higher SDRs for higher target ratings). Cash Flow modeled in order to obtain a scenario’s Break-even Default Rate. Compare SDR vs. BDR

  13. Specifics of the Mexican Securitization Market RMBS Mortgage Loans very different than the pre-94 crisis ones. 1st-Lien, Fully documented loans with adequate LTVs. Mostly UDI-denominated loans to mid/low, low income population. Payments made as a factor of Minimum Wage, differences between MW payments and UDI calculated installments covered by Sociedad Hipotecaria Federal (mxAAA)’s MW-UDI swap. Fixed-rate loans, for both UDI and Peso-denominated, protect the borrower and the lender from high economic stress and hyperinflation scenarios.

  14. Specifics of the Mexican Securitization Market RMBS (continued) Risk is distributed among many parties: Originators (holders of residual interest in equity), Mortgage Insurance providers, Monoline Insurers, Investors. Tranching allows investor to obtain securities that match their different risk profiles (Subordination, Time-tranching). Continued Innovation in Structuring has lead to improved efficiencies economic sense in securitizing. Growing interest from domestic and international investors based on highly protected structures with attractive yields.

  15. Specifics of the Mexican Securitization Market Federal Participations & Own Tax Securitizations Proven track record of existence and stability of flows. Incentives aligned so that the flows keep on existing, and to avoid disturbing these flows. Recourse to State/Municipality in case actions are taken/not taken that result in a reduction of flows to the issuing Trust. Generally, State/Municipality is the ultimate obligor. Substitute source of tax revenues may be pledged to a Trust if primary source disappears or is strongly reduced.

  16. Agenda • Introduction • Standard & Poor’s Approach for Rating Mexican ABS • Specifics of the Mexican Securitization Market • Case Study

  17. Case Study Typical RMBS deal, from a Sofol (non-bank lending originator) ranked ABOVE AVERAGE as a residential servicer. • Pool characteristics: • UDI denominated • LTV: 80% weighted average (current) • Seasoning: 18 months WA • DTI: 20% WA • Inadequate geographical concentration (top state or region > 25%) • Mortgage Insurance: 20% WA • Sound excess spread • 5% concentration of borrowers in the informal economy • Arrears: 2% of the pool are currently two or more months delinquent • Delinquency history: 3% of the pool has been 90+ days delinquent

  18. Case Study Foreclosure Frequency adjustments: ‘mxAAA’ base case for UDI denominated, non-Infonavit loans: 32.5% • Adjustments: • LTV: • Seasoning: • DTI: • Servicing: • Geographic concentration: • Informal economy: • Arrears & delinquency history: • Adjusted FF = 35%

  19. ‘mxAAA’ Loss Severity Calculation Original property value 100.0 Minus market value decline (42.7% for ‘mxAAA’) (42.7) New market Value 57.3 Minus loan balance (80% LTV) 80.0 Equals market loss (22.7) Realization Costs 39 months accrued interest at 9.50% 24.7 Foreclosure Expenses at 25% 20.0 Loss before MI (62.7) MI recovery (20% coverage) 20.2 Total loss (42.8) Loss severity = total loss divided by loan balance 53.5% Case Study Loss Severity calculation (WA basis): * Note: Standard & Poor’s will soon publish an updated RMBS Mexican rating criteria. Some of the figures presented in this case may be changed as a result of this review.

  20. Case Study • Structure characteristics: • Senior / subordinated + Equity (89% / 10% + 1% initial) • Equity or overcollateralization (OC) grows to a target 3.5% by paying down Class A and then Class B using excess spread • First Loss absorbed by the OC & Excess Spread (if available) • Second Loss absorbed by the Class B InitialTarget 89% 86.5% 10% 10% 1% 3.5% 100% 100% Class A (Senior) Class B SECOND LOSS Residual / Equity FIRST LOSS

  21. Case Study Structure: Funding provider $ Proceeds $ Proceeds Bankruptcy Remote Trust Originator / seller Class A Mortgages transferred Capital Markets Class B Residual / Equity UDI Swap MI MI Provider SHF

  22. Case Study Stress tests scenarios for Mexican RMBS Total Credit Loss = Default Frequency x Loss Severity Recoveries = 100% – Loss Severity • Example for an ‘mxAAA’ target rating: • Pool characteristics + high quality servicer →35% default frequency • 20% MI coverage + high quality servicer →53.5% loss severity • TCL = 35% x 53.5% = 18.73% • Recoveries = 100% – 53.5% = 46.5%

  23. Case Study Stress Test for Class A (rated mxAAA): • Transaction builds OC and Credit Enhancement through the use of ES • After target OC is reached, excess spread is released to residual • If OC falls below target, excess spread is re-captured • Recoveries kick-in; Class A gets timely repaid OC Build-up Recovery CLASS A CAN THEREFORE BE RATED ‘mxAAA’

  24. Key Contacts Standard & Poor’s Latin America Structured Finance New York: Juan P. De Mollein, (1) 212–438–2536 juan_demollein@sandp.com Mexico: Maria Tapia, (52) 55–5081–4415 maria_tapia@sandp.com Mauricio Tello, (52) 55–5081–4446 mauricio_tello@sandp.com Alvaro Rangel, (52) 55–5081–4419 alvaro_rangel@sandp.com Sergio Figueroa, (52) 55–5081–4484 sergio_figueroa@sandp.com Armando Noriega, (52) 55–5081–4490 armando_noriega@sandp.com www.standardandpoors.com.mx

  25. www.standardandpoors.com Analytic services and products provided by Standard & Poor’s are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Standard & Poor’s has established policies and procedures to maintain the confidentiality of non-public information received during each analytic process.

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