As 2007 came to a close, MBS players around the world steeled themselves against subprime contagion. But Hipotecaria Total (HiTo) took a bold step forward unveiling a highly innovative, mortgage securitization vehicle in Mexico and issuing the first so-called Bonhitos on December 20. HiTo was founded barely a year earlier for the sole purpose of creating and sponsoring an efficient platform for the securitization of mortgages in Mexico.
HiTo combines securitization technologies from Europe and the U.S., traditional Mexican mortgage funding methods and its own structural variations to create a product tailored to Mexico but with features that can apply to other emerging or developed markets. But its benefits hinge on the integrity of a highly complex, untested system and the behavior of a secondary market that is still nascent.
Among HiTo's innovations are:
* An extended issuance period where a single securitization continues to issue fungible Bonhitos for a period of up to three years, resulting in a constant source of mortgage funding. This shrinks the origination-to-securitization cycle to a week, from close to a year for many conventional deals.
* Funding availability to any mortgage lender, which provides capital market access to lenders too small to securitize on their own. A two-tier securitization structure facilitates the inclusion of multiple lenders in one issuance. At the first tier, lender specific trusts buy loans from the lender and sell senior securities to a second tier trust. The second tier trust is a simple pass-through re-securitization vehicle that issues the Bonhito, a senior security backed by multiple senior securities from the lender-specific trusts. The two-tier structure adds complexity to the transaction but also allows for the lender-specific assignment of credit enhancement requirements.
* The introduction of a Balance Principle concept, commonly used in mortgage funding in Denmark, but substantially altered in HiTo's implementation. It gives borrowers the ability to prepay at a discount when interest rates rise or credit spreads widen, without reducing the trust assets or the payment promise to the investor.
* An automated underwriting system developed and maintained by HiTo. This provides consistent underwriting and risk-based pricing across the program. Similar to Fannie Mae and Freddie Mac in the United States, HiTo's automatic underwriting provides pre-closing approval for loans to be funded under the program.
* Cash, rather than mortgages, backs the subordination enhancement in HiTo transactions. This is equivalent to having the subordinate and residual certificates backed by cash-collateral accounts held by the lender-specific trusts.
* Additional support from dynamic cash reserves that are funded based on borrower updates from credit bureaus and loan delinquency status. While the depth of credit information provided by credit bureaus in Mexico is still developing, the dynamic reserves enables the transactions to use whatever information is available on the borrower, in addition to the borrower's payment behavior on the mortgage.
These features underscore HiTo's potential to bring positive changes to the Mexican market, but they also show how dependent the product's success is on uncertain factors.
Enacting the balance principle concept provides a good example.
Before HiTo, balance principle was limited to the Danish mortgage market. Mortgage lending there is primarily funded by placing mortgage covered bonds. The Danish balance principle implementation often means loan prepayments must be made exclusively through the delivery of the same bonds that financed the loan. A borrower who wants to prepay her mortgage buys mortgage bonds from the same batch of bonds that funded her loan, and returns those bonds to the originator. The face value of the bonds equals the prepayment amount.
If the bonds trade at a premium, the borrower pays more. If they trade at a discount, she pays less.
In Mexico the market consists of fixed-rate mortgages and fixed coupon MBS, heightening the chance of steep premiums or discounts for prepayments made by purchasing matching securities. However, HiTo loans can always be prepaid with cash at par, removing the risk of prepayment premiums. In fact, HiTo borrowers make all prepayments with cash and the servicer accounts for the prepayment following the method most advantageous to the borrower. If the matching Bohhitos are available in the secondary market and trading at a discount, the prepayment is made through the delivery of the certificates. Otherwise it is done at par as a cash prepayment.
HiTo's balance principle implementation can ultimately benefit both borrowers and investors. Market-driven discounts give borrowers the opportunity to prepay at a discounts but this also benefits investors who see additional pricing support as prepaying borrowers become Bonhito buyers. In addition, the faster amortization rates for mortgages prepaid at discounts improve the credit quality of the mortgage pool and even losses on defaulted loans may drop as proceeds from the liquidation of homes are applied to the transaction through the delivery of securities purchased at a discount.
But the benefits of HiTo's balance principle implementation are predicated on a number of conditions. In a stable market where yields stay flat or edge down, Bonhitos are unlikely to see the pricing discount that triggers the balance principle benefits. In addition, these benefits depend on the liquidity of a secondary market that does not exist today. Even if it did, there's no guarantee that investors will sell these securities if price points indicate discounts.
Beyond the operational and market factors that limit the certainty of HiTo benefits, the fact that HiTo transactions securitize unseasoned loans point to higher collateral delinquency and default expectations than for traditional MBS deals in Mexico.
Traditional transactions securitize seasoned mortgages where all loans are current or near current in payment. The current payment status of seasoned loans provides a performance filter that excludes loans that fell significantly delinquent early on. The lack of this early delinquency filter in HiTo securitizations is likely to lead to somewhat higher collateral delinquency and default levels.
An expectation of weaker collateral performance does not necessarily imply a weaker transaction but must naturally be taken into account. Default estimates for HiTo should be based on origination-based loan performance information rather than from previously securitized pools and higher expected default rates can be offset with additional credit support.
The HiTo system that assigns subordination levels to the mortgages it funds is based on total origination data sets and the ratings assigned to Bonhitos are subject to credit enhancement sufficiency agreement by the rating agencies. While those subordination levels and the dynamic credit reserve feature of the system may prove sufficient to offset the risk of higher default numbers, these features are subject to accuracy of default projections and the ability of the dynamic reserve mechanism to build up credit enhancement if delinquencies mount.
Ultimately, Bonhitos have great potential to benefit lenders, borrowers and investors, but their promise won't be fully realized for some time. Until then, HiTo's goal should be to ensure that, at worst, its transactions perform in line with existing RMBS deals.
Carlos Maymi (camaymi@yahoo.com) is an independent expert in U.S. and Latin America securitization markets, and a former analyst with Moody's Investors Service. This article is based on the author's analysis of HiTo documents filed with regulatory entities in Mexico and interviews conducted by him in January 2008.
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