The year 1994 saw the birth of the SOFOLs[1] in Mexico. These societies are non-bank financial institutions (NBFIs). One feature of these institutions is that the financial resources they supply must be exclusively directed to funding a market niche, e.g. consumption credit, commercial credit, mortgages, or credit cards. Moreover, SOFOLs are not allowed to take deposits from the public. During 2000-2010, these institutions placed a significant amount of financial funds in almost every market niche, and many of them consolidated over time.
The stronger growth and best performance was registered by the SOFOLs that granted mortgages (mortgage SOFOLs). By the end of 2005 the financial resources granted by these institutions accounted for over 60% of the credit balance of all SOFOLs in México. However, their good performance did not last long: their funding flows and the number of societies began to decline in 2006. The global financial crisis of 2008 also affected their financial performance. See graph below.
What happened to SOFOLs specialized in mortgages? Why did they implode? Financial authorities and various economic analysts have emphasized liquidity risk as the main cause that explains the fall of mortgage SOFOLs. They claim that those institutions made use of a significant amount of short-term liabilities to finance their long-term assets—mainly by issuing short-term debt securities. The mismatch between assets and liabilities’ maturities placed the SOFOLs in an unfavorable financial situation. Once the local debt market dried up—due to the global financial crisis of 2008—they had serious problems refinancing.
Although the argument above seems plausible, the empirical evidence to support it has not been properly examined. In order to fill this gap, the National Banking and Securities Commission (CNBV) in Mexico recently published an empirical study. The analysis focuses on factors that led the mortgage SOFOLs to obtain financing issuing short-term debt. The study provides a consistent framework to investigate the economic behavior of the SOFOLs—and the role of the credit rating agencies—in that scenario
First, the study finds that mortgage SOFOLs contracted large amounts of short-term funding due to the low cost of issuing it in the local debt market. Those institutions took advantage of the low relative price of this funding in order to maximize their profits. In other words, they took a gamble. The resulting rise in liquidity risk was not a serious problem at that time given the stability of the Mexican financial system. However, the situation suddenly got out of control with the global financial crisis in 2008. The new scenario made clear the fragile financial position of mortgage SOFOLs, diminishing their ability to refinance liabilities on the local debt market and the subsequent decline of these financial institutions.
Second, the study finds that the rating processes applied by the credit rating agencies (CRAs) were adequate but not timely. The findings support the presence of “lags” in the evaluation processes. There were temporal rigidities or gradual adjustments in the ratings assigned by the CRAs to the short-term debt securities issued by mortgage SOFOLs. CRAs did not provide timely warnings of the increasing liquidity risk—originated by the growing mismatch between the maturities of the liabilities and assets of mortgage SOFOLs. This is an important result. The role of CRAs has been mentioned as a factor that contributed further to increase the liquidity risk, and the evidence provided supports that fact.
The study is a first approach to analyze mortgage SOFOLs. The arguments discussed are not new to financial specialists. However, its main goal is to provide both a consistent economic framework and a well-structured methodology to disentangle and empirically weigh factors that contributed to the fall of those financial institutions. A Spanish version of the study can be found at this link.
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