Edition 36, Finance

SOFOLES, Risk and Liquidity

By: Renata Herrerías
Business School, ITAM

No company is immune to liquidity risks. There may be businesses that are “more liquid” than others but the little availability or pressure to obtain resources to face short and medium term commitments is one of the determining factors for the long term feasibility for any and all businesses.

If an organization tries to grant credits by using resources from third parties, the liquidity issue is still more critical. In general terms it will be highly leveraged and it is precisely this leverage that allows businesses to do business. In general terms, this is the business of banks and intermediaries.

Since General Electric Capital Corp., appeared in the 30s in the United States and the 90s in Mexico, an alternate system to the banking system was developed and was engaged only in granting consumer or mortgage credits. This parallel system formed by financial companies not financed by traditional deposits, contributed to give access to credit to a large number of families and companies that traditional Banks did not serve. At times when economies grew and banks did not fully meet the entire demand for credits – especially in Mexico after the 1995 crisis – the financial companies started to cover those spaces left by banks. In general, these were lightly regulated intermediaries, financed with loans obtained from other financial institutions, loans from their Industrial segment (parent company) or from the financial markets.

It seems that only 15 years after they appeared in the Mexican financial system, the Sociedades Financieras de Objeto Limitado (Non-Bank Financial companies, or SOFOLES as per initials in Spanish) are condemned to extinction. Of the almost 60 SOFOLES in 2005 -when there were 29 commercial banks – only 20 survive today. Either because they were acquired by a financial group or because they became a Sociedad Financiera de Objeto Múltiple (Multiple purpose Financial Associations or SOFOMES as per initials in Spanish) or because they went bankrupt, the specialized financial intermediaries have gradually disappeared from the Mexican market.

In October 2007, Paul A. McCulley, in his presentation at the New Frontiers Conference in Institutional Asset Management explained that liquidity, more than a monetary policy issue is a phenomenon related to the risk appetite of lenders. For McCulley this liquidity is a mental state about risk. It is the result of the appetite of investors to assume risk, and of the savers’ appetite to help leverage the investors that want to take it. Because the government financial companies are not covered by deposit insurance as traditional banks, the financial companies become much more vulnerable to the movements in the appetite for the investors’ risk and therefore to changes in liquidity.

Can the disappearing process of the SOFOLES be explained by the changes in the risk appetite? Or rather what happened to the Mexican SOFOLES is only a reconfiguration of the market in which the commercial factors are the only ones that explain the contraction of the sector?

Up until before 1993, the mortgage and consumer credit offer in Mexico was limited only to banks. As part of the agreement to enter the North America Free Trade Agreement, the Mexican government was asked to promote the creation of specialized financial intermediaries so that there would be more financing alternatives. The idea was to allow the existence of specialized financial intermediaries similar to those that exist both in the United States and Canada (Non-Bank Banks). Besides specializing in some type of credit, an important aspect of this kind of institutions is that the resources to grant credits do not come from the savings of the population.

As a result of the severe banking crisis of 1994-1995 and the consequent withdrawal of banks from the credit market, SOFOLES experienced a boom as they covered the spaces that traditional banks left empty. The SOFOLES grew exponentially even in deceleration periods, at rates way higher than the growth of the economy (Figure 1). The end of the 90s and the first half of the 2000 decade marked the best period for this sector.

During the second half of the 2000 decade, the market started to reshape. First, traditional banks intensively returned to the credit market and their objective was to recover their participation in it, hence the SOFOLES became their natural target. Several banks acquired SOFOLES consolidated in their specific niche. An example of this is BBVA Bancomer and Hipotecaria Nacional or Ixe and Fincasa.

On the other hand, given the market conditions and in trying to deregulate and contribute to the diversification of their assets, in July 2006 the creation of SOFOMES was approved. This is how starting at the end of 2006 the number of SOFOLES independent from banks or financial groups decreased little by little, and this left the space to the SOFOMES or to the financing companies under the tutorship of a large financial group. Even so the loans channeled through the non-banking financial companies represented almost 3% of GDP, as compared to 1.1% they managed in 2000.

Figure 1: Total Loan-Portfolio and Annual % Growth in Total Loan Portfolio, SOFOLES (1997-2005).

Fuente: Elaboración propia con datos del Banco de México


Before 2000, the main funding sources for the SOFOLES were banks, government support programs. As of 2000, the SOFOLES started to have access to the financial markets that represented up to 24% of the liabilities obtained in 2006. There was a great appetite in the market for profitable investments. In a growing sector and with favorable perspectives in every way, the loans from other financial intermediaries decreased little by little and representing less than 20% in 2003.

From the analysis of the composition of the liabilities one can see how the real estate SOFOLES controlled the industry. With the government housing programs of the previous administration, the resources obtained from government programs represented almost 60% of the funding obtained by the SOFOLES in 2003 (Figure 2).

The situation changed radically between 2007 and 2008. Asides from the transformation of SOFOLES into SOFOMES to operate in an unregulated scheme, the contraction of the financial markets and poor performance of some institutions left the surviving SOFOLES without access to resources; 76% of the resources to operate the few institutions still alive had come from banks and today only 15% comes from the financial market. Financing from the government and other financial intermediaries only represents 9% of the funding.

Figure 2. SOFOLES, balance and % composition of funding sources, millions of MXN pesos (1997-2010) (Loans from financial intermediaries, government funding and public debt)

Source: Prepared with data obtained from Banco de México


During the first seven years of the 2000 decade the markets clearly had high appetite for risk, there were liquid resources channeled to more attractive investments, not necessarily because of their optimum ratio between risk and return, but simply because they offered higher returns. In general, investors risk aversion decreased and therefore appetite for risk increased.

More liquid markets, better interest rate conditions, a growing economy and a bank sector that did not service the credit market explain why the SOFOLES grew exponentially. However, as history has always proven, the accelerated growth of credit markets almost always is accompanied by a decrease in the quality of the debtors. The history of 1994 was repeated by the SOFOLES, although it was not a problem of the same dimensions and consequences, the bankruptcy of companies such as Metrofinanciera or the solvency problems of Hipotecaria Su Casita are clear proof of how fragile the sector was when liquidity contracted.

Risk was perceived in several areas: deterioration of the assets, lack of liquidity, decrease in the intermediation margin and decrease in capitalization ratios. For example, Figure 3 shows the sudden drop of the net interest income and the net interest margin. Both are explained by the deterioration of the assets that as they became non-performing they stopped accumulating financial income, and the increasing interest rates paid for liabilities from bank lending (figure 4).

The liquidity problem became more acute when the portfolio deteriorated. The delinquency index of SOFOLES, from being at a 2% optimum level at the closing of 2010 had higher than 12% levels (Figure 5). If the client does not pay, the intermediary in turn cannot comply with its commitments and specially when it does not have government guarantees or deposits insurance as banks have.

Figure 3. Net Income (millions of MXN pesos) and Net Interest Margin, SOFOLES (1997-2010)

Source: Prepared with data obtained from Banco de México.

Figure 4. SOFOLES, funding cost, measured as the ratio of interest paid over total liabilities (1997-2010)

Source: Prepared with data obtained from Banco de México

Figure 5. Delinquency Index, Non-Performing Portfolio / Total Portfolio, SOFOLES (1997-2010)

Source: Prepared with data obtained from Banco de México

Leverage, Deregulation and Crisis; the Perfect Storm?

This is a known history. Between 2007 and 2008 the biggest financial crisis happened in the United States since 1929. The bubble of real estate prices burst and collapsed the value of the structured instruments that financed those transactions. The perfect storm of the financial markets materialized: the riskiest debtors went into default, the collateral value of the credit transactions collapsed and therefore the structured instruments that financed the subprime mortgages entirely lost their value. All of this broke not only investment banks, but also complete economies like the Icelandic. Of course Mexico was not an exception and it also suffered from the contraction of the generalized liquidity contraction of the financial markets. Capitals returned to risk free investments such as the United States Treasury Bonds.

Regarding the less regulated-high levered parallel financial system, McCulley explains that the pressure to reduce leverage, increase the collateral value and the refusal to refinance transactions by the investors, transformed an unlimited liquidity situation into a sudden contraction of the resources to refinance transactions. If the main financing sources of SOFOLES were banks and the financial markets, when funding was reduced in general, both banks as well as investors channeled their funds to less risky, less leveraged and with higher liquidity entities. The appetite for risk dropped and the markets were no longer willing to support leverage and the growing risk. Intermediaries such as SOFOLES could not sell their assets fast enough to meet the growing risk aversion of the investors.


McCulley states that liquidity is a state of mind of investors. The development of the specialized financial intermediaries industry happened at a market crossroads in which the traditional channels closed and there was a great deal of liquidity. Both conditions no longer existed and the risk appetite had dropped significantly.?Despite the fact that the credit market in Mexico is very big and continues without being completely serviced by banks, the recovery of the sector shall be slow and difficult. It appears that access to stable long term financing sources and at a reasonable price shall be the factor that will determine if the sector will survive or disappear.?


McCulley P.A., “The liquidity Conundrum”, New Frontiers in Institutional Asset Management Conference. Sacramento California, Oct. 2007.

Comisión Nacional Bancaria y de Valores (National Banking and Securities Commission), “Boletín estadístico, Sociedades Financieras de Objeto Limitado” (Statistics Bulletin, SOFOLES). Several issues.

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