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AmericasNovember 1 2016

Mexico’s banks upbeat despite domestic and foreign volatility

With the US as its top export market and substantial exposure to oil prices, Mexico is precariously placed if the US recovery stalls or the oil price remains low. Despite this, the country’s largest banks are well capitalised and remain optimistic for the future, as Jane Monahan reports.
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Pemex embedded

Mexico’s banks are feeling the strain of dealing with both local and international challenges, and their future prospects are under debate. In August, while Moody’s lowered its outlook for Mexico’s banking system from 'stable' to 'negative' for the first time in six years, peer Standard & Poor’s continued to hold a 'stable' outlook for the country’s banks.

Both rating agencies, however, have lowered the outlook for the Mexican economy to 'negative' since April as the country has been facing adverse international conditions in the past few years.

Currency depreciation

Volatility in financial markets has led to a steep depreciation of the Mexican peso, partly due to the prospect of rising US interest rates and, most recently, a possible victory for Republican candidate Donald Trump in the US presidential elections.

Michael Shifter, president of Washington, DC-based Inter-American Dialogue, and Javier Malagon, chief financial officer at BBVA Bancomer, Mexico’s largest and most profitable commercial bank, say a win for Mr Trump could hit Mexico’s trade with the US, remittances from Mexicans, US foreign investment, portfolio flows to Mexico and, once again, the peso’s exchange rate.

BBVA Bancomer – together with other foreign-owned subsidiaries Santander Mexico, Citigroup’s Banamex, HSBC Mexico and Scotiabank Mexico, along with locally owned Banorte and Inbursa – account for about 80% of the Mexican banking system’s total assets, credits and deposits.

Furthermore, economic forecasts continue to be gloomy. In August, Mexico’s Ministry of Finance cut the country's 2016 growth forecast for the second time this year to a range of between 2% and 2.6% of gross domestic product (GDP), after the economy shrunk in the second quarter, dragged down by falling industrial output. The World Bank expects a 2.1% annual rate of growth for Mexico this year.

Tied to US recovery

Another contributor to low growth in Mexico is the slow pace of recovery in the US, the country's main export market, together with persistently low oil prices, after a 50% price drop in 2014 – though how much of a burden this is is disputed by some. Jose Perez-Gorozpe, S&P’s financial analyst for Latin America, says the oil sector is very important for the government’s budget, but according to Ministry of Finance officials, oil revenues accounted for less than 20% of total budget revenues in 2015, against almost 40% in 2012.

Low oil prices have also complicated the implementation of the government’s ambitious reforms, which include ending the monopoly of the state oil company Petroleos Mexicanos (Pemex) and opening up oil and gas to the private sector. “It is one thing to execute an energy reform with oil prices at about $100 a barrel and another when they are at $30 to $40 a barrel,” says Arturo Sarukhan, a former Mexican ambassador to the US who is based in Washington.

Mexico’s own oil production has also declined. This is due to low levels of output by Pemex (which is being restructured), and slower than expected foreign investment in oil production following the country's energy reforms.

Notwithstanding this, according to S&P analysis the importance of oil for the economy as a whole has been declining for years, as the country's economy becomes more diversified in manufacturing and trade. “Mexico is no longer an oil economy. Remittances are going up, and because they are in dollars [with the Mexican currency depreciating], they are worth more in pesos,” says Mr Perez-Gorozpe.

Rating agencies and Mexico’s financial regulators diverge over the repercussions of the oil sector troubles for banks. Moody’s estimates that loans to Pemex account for a comparatively low 6% of all those outstanding at Mexican banks, but at some individual institutions it can be up to 30% to 40% of Tier 1 capital.

Felipe Carvallo, Moody’s lead bank analyst for Mexico, says greater problems lie with Mexico’s state-owned development banks, which have a far bigger exposure to Pemex than most large commercial lenders.

Exposure to oil prices

The six development banks in Mexico have allowed their exposure to Pemex to grow exponentially in the past year and a half, at a rate of eight to 10 times a year on average, “and they are now close to the 100% regulatory limit of capital” that a bank is allowed to have when lending to a state-owned company, says Mr Carvallo. This growth is despite development banks accounting for only 10% of loans to the non-financial sector in Mexico.

By contrast, says Mr Carvallo, “most large commercial banks in Mexico have allowed themselves to have exposures to Pemex that are about 30% to 40% of their [Tier 1] capital, which is in line with the limit the regulator would impose if Pemex was a private company”.

But there are other pressure points. Besides providing loans to Pemex – which also received an emergency cash injection from the finance ministry in April to pay down outstanding bills – the big commercial banks also extend loans to Pemex suppliers, and to state and local government, according to Mr Carvallo. The latter depend on federal government transfers, a significant proportion of which were historically funded with oil revenues.

“There are a lot of sectors that are interconnected and related to the government. And, due to lower oil prices, all these exposures will require higher provisioning requirements,” he says. This could affect bank profitability.

Jaime Gonzalez Aguade, chairman of Mexico's financial regulator, the Comision Nacional Bancaria y de Valores (CNBV), offers a different view, as does S&P in its report on Mexican banks. Mr Gonzalez Aguade says: “We don’t see Pemex not performing on any of its loans. We don’t see any actual risk and we are in constant touch with Pemex to see the risks the banks hold.”

Well capitalised 

Meanwhile, at the end of June, the direct exposure of the large banks to Pemex and state-owned electricity company Comisión Federal de Electricidad was about 7% of total commercial bank loans or 4% of total banking system.

“If as much as half of this energy portfolio failed, it would add about 2% to Mexico’s non-performing loan [NPL] ratio which, at mid-year averaged 2.4% – a very low rate,” says S&P’s Mr Perez-Gorozpe. “Even during the 2008-09 global financial crisis, when bank losses amounted to 5.8% of total loans and the NPL rate reached 9.7%, even then the major banks stayed profitable.”

Moody’s and S&P both note that while credit losses in Mexico can be very high, it is a feature of the country's banking system to aggressively write down NPLs. The banks can afford to do this and make healthy provisions, the analysts say, because they are so profitable, principally because net interest margins are high. Coverage of loan loss reserves averaged 1.4 times estimated losses for the past five years, according to the CNBV. “The risks are high but they are able to price them in,” says Mr Carvallo.

Commercial banks are also well capitalised. They had an average capital adequacy ratio at the end of June of 14.8%, above international standards and among the highest in emerging economies, according to the banking regulator.

Mexico has also adopted Basel III rules and, in line with these, the country's seven largest banks (deemed systemically important) are now obliged to add additional capital buffers over four years. Minimum liquidity coverage ratio requirements are also being phased in and the banks’ liquidity coverage ratio averaged 170% at the end of April.

Long-term confidence

Against this background, bankers themselves say they are confident about Mexico’s long-term economic prospects and opportunities for growth in banking. Mr Malagon at BBVA Bancomer thinks corporate, middle-market and consumer lending will continue to grow and, to serve them, the bank is executing a $3.2bn investment plan, in part to develop online digital technology and mobile and smartphone apps to cater to most customer segments. At the end of June, 34% of the bank’s total consumer loans were granted through a digital channel, he says.

One example of how strong credit growth has been is that in the second quarter of 2016, Santander Mexico’s lending rose 14% for large corporates, 10% for small and medium-sized enterprises (SMEs), 10% for mortgages and 4.7% for consumer credits. Rodrigo Brand de Lara, the bank’s chief economist, says Santander Mexico will continue consolidating its leadership in markets the bank considers strategic in the country, which are corporate and SME markets, as well as investment banking.

Indeed, despite a slowing economy and deep cuts in government spending – the Ministry of Finance has announced a fiscal consolidation plan to reduce the budget deficit to 2.5% of GDP in 2018 from 4.1% in 2015. Bank credit has remained dynamic, rising about 1% of GDP a year or between 13% to 15% annually in the three years to the end of June.

Credit growth has been buoyed by high employment, rising wages and, until recently, low interest rates; monetary policy tightened this year with the central bank, Banco de Mexico, raising benchmark rates three times in an attempt to prevent the weak peso sparking a surge in inflation.

The rise in credit is welcome news. Mr Malagon says structural problems, such as the large number of Mexicans on low incomes and with limited financial education, and a big informal economy are impediments to credit expansion. Total lending by banks and non-bank financial institutions to the private sector represented 32% of GDP at the end of 2015, according to CNBV.

While an improvement from three years ago, this is still considerably less than in other major Latin American economies. It is less than the 41% of GDP credit penetration rate before Mexico’s last financial crisis in 1994, says Mr Malagon.

De-risking credit

Experts say Mexican banks have learnt lessons from their financial crises and are now more conservative in their credit processes. Though loans to SMEs (considered a riskier segment) are rising, these still represent a relatively small amount of the total portfolio (10.6% in May 2016). They also benefit most from a state guarantee programme, whereby the government provides a guarantee for first losses or a percentage of the loan.

Similarly, in retail banking banks appear to have been chastened by very high credit card losses during the global financial crisis. “Since then, banks have focused [in retail lending] on credits that have some sort of collateral [such as payroll discount, auto and mortgages] and in the upper band of the formal economy,” says an S&P research note. The agency expects this focus to continue over the next two years and for banks to remain cautious in the credit card and personal loan segments.

Analysts at Moody’s and S&P agree there is no risk or expectation of anything like a recession in Mexico. However, because the economy is not doing so well, the government will have less room for manoeuvre to help banks if needed, says Moody’s Mr Carvallo.

The S&P note says the economic imbalances are limited and manageable, and highlights how the Mexican government has not let a systemically important bank fail for at least the past 30 years. The banking sector has emerged from its past crises stronger and better regulated – but it is also peculiarly exposed to international dynamics out of its control.

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Read more about:  Americas , Americas , Mexico