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AmericasOctober 4 2009

A ray of light for Mexico

Although Mexico's exports and remittances are in decline, its oil production and tourism sectors weakened and unemployment rising, the country's banking industry entered the global crisis in good shape and may be able to provide the credit needed to reactivate the economy. Writer Jane Monahan
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A ray of light for Mexico

That Mexico's economic downturn was not caused by home-grown problems, but by the US's financial and economic crises, has not diminished the pain of the fallout. How can it? Reflecting how undiversified Mexico's trade is, 80% of the country's exports still go just to the US, and Mexico relies on the US for remittances, foreign investment and tourists.

With exports declining at a year-on-year rate of more than 20%; remittances (which affect purchasing power in Mexico) falling 9% in the first four months of 2009 when compared with 2008 figures; unemployment rising, oil production falling; and the turmoil that surrounded the outbreak of the A/H1N1 'swine flu' virus earlier this year, it is small wonder that, Mexico's economy shrank 10.3% in the second quarter of 2009, the country's worst economic contraction on record.

The International Monetary Fund and the Organisation of Economic Co-operation and Development forecast that gross domestic product (GDP) growth in Mexico will fall by between 7.3% and 8% this year, making its current recession the worst in half a century, worse even than the severe downturn after the 1994 Tequila crisis, which crippled the country's financial industry.

Source of credit

But there are always silver linings. Both Mexico's macroeconomics and the banking industry entered the crisis in good shape. Moreover, because the banks are so strong, bankers believe they can play a positive role in the crisis, keeping credit lines open and helping to reactivate the economy. Bankers are also extremely optimistic about Mexico's long-term opportunities.

Ignacio Deschamps, CEO of the Spanish-owned BBVA Bancomer, Mexico's biggest bank (with a 28% share of the system's credit market and a 25% share of its deposits), says: "Of course the crisis will have a temporary impact [on banks' revenue], but it is easy to make a strong business case for banking in Mexico over the next 20 years. In a developed country such as Spain, credit [to the private sector] represents more than 120% of the country's GDP. But in Mexico, credit creation is still very low." It is about 15% of GDP, according to Mexico's Ministry of Finance.

Furthermore, Mr Deschamps says that because of the demographics of the country and the number of young people that will be joining the workforce, on top of the 45 million currently employed, about 30 million Mexicans are expected to start using banking services over the next 20 years. "So sector by sector, in lending to small and medium-sized businesses [which account for more than 90% of the country's employment], credit card loans in consumer credits, in housing, in deposit growth, the opportunities are huge," he says.

Lessons from the past

"The banking sector learnt the lessons of the Tequila crisis. For 14 years we have been addressing risk analysis," says Alejandro Valenzuela, CEO of Grupo Financiero Banorte, Mexico's fourth largest bank with a 12% share of assets and deposits. Banorte is the only bank among the country's top five commercial banks that remains Mexican-owned; the others, in addition to Spain's BBVA Bancomer in first place, are, in order of size: Banamex (Banco Nacional de México), a wholly owned subsidiary of the US's troubled Citigroup, in second place with about a 20% market share; Spain's Santander Mexico, the country's third biggest bank with a 14.5% share; and the UK's HSBC Mexico, in fifth place with a 9% market share.

Mexico's financial regulatory framework and the capabilities of the National Banking and Securities Commission (CNBV), Mexico's banking regulator, have also been overhauled and considerably strengthened since the 1994 crisis. And to increase competition in an industry characterised by a low level of penetration into the population as well as by significant concentration (BBVA Bancomer and Banamex alone account for 44% of the system's assets), the Ministry of Finance approved three to four banking licences a year between 2004 and 2008, mainly for consumer credit banks linked to retailers, bringing the number of banks in the country to 42.

New entrants included the US retail chain Wal-Mart, with about 950 Mexican outlets (with whom BBVA Bancomer has established a credit card business). Banorte formed an alliance with Telecommunicaciones de México, the state postal service, with 1600 offices, to establish a huge payments network; and Banamex formed a network with 4500 points of service after reaching agreements with various pharmacies, petrol stations and chain stores.

"For us, it is very important to increase access," says Alan Elizondo, vice-president of CNBV, alluding to expanded rules concerning bank partnerships with retailers, which allow retailers and convenience stores to act as bank agents and receive deposits, in turn making it possible for banks to serve new customers without the necessity of making expensive investments to acquire new branches.

The measure, opposed initially by some of Mexico's big banks, which have already made significant investments in branches (BBVA Bancomer, for instance, has nearly 1840 branches; Banamex has 1588 branches), is supposed to accelerate access to financial services in rural areas as well as in low-income Mexico City suburbs, where many Mexicans have never had a bank account.

Mr Deschamps says that banks will now be establishing more correspondent banking arrangements with retailers, providing customers with a broad range of services. By contrast, previous bank-retailer arrangements have tended to focus almost exclusively on issuing and servicing credit and debit cards, he says.

Drawing attention to just how limited bank penetration still is in Mexico, Mr Elizondo says: "Twenty-five per cent of the population [109 million people] is banked, 25% is under-banked [meaning people who just use ATM machines] and the rest have no bank account at all."

Retail banking focus

On the plus side, precisely because Mexico, like Brazil, is at an early stage of financial development, Mexican banks have been focused predominantly on retail banking and have a strong domestic franchise, a strong deposit base and a large client base.

In Mexico, bank operations are "very traditional. We manage deposits for the public. We do lending, but no off-balance sheet products or structures. There is no subprime exposure in Mexico, either directly or through securities in other countries," says Mr Deschamps.

Partly as a result of this, capital adequacy ratios, which illustrate how strong a bank's capital is relative to its risk-weighted assets and how prepared it is to weather losses, are very high among Mexican banks, as are the industry's liquidity levels. Even during the weeks of great volatility last October and November in US and European markets, inter-bank funding in Mexico continued calmly.

"In terms of the level of capital and the quality of capital - Tier 1 capital - the adequacy ratios [in Mexico] are much higher than those of other banks around the world," says one CNBV official.

The average non-performing loan (NPL) rate for credit card loans rose to 13% for all banks in May, and NPL rates have been growing in other consumer credit markets and in mortgages - caused in part by the US recession which has increased layoffs, especially in Mexico's export-oriented car and consumer durables factories. Nevertheless, Mexico's NPL rates for all types of loans averaged only 3.8% in June, according to the CNBV.

Prevention over cure

Bankers and regulators have not been leaving anything to chance, however. Most of Mexico's biggest banks strengthened their balance sheets in May. And the ratio of reserves to past due loans was high at the end of March, averaging 160%. Furthermore, that was before new CNBV rules came into effect in August, requiring banks to increase their provisions for credit card loans from 6% to 16% to ensure they are more forward-looking when calculating their reserves against expected losses in credit card portfolios.

Luis Peña, CEO of HSBC Mexico, estimates that the new provisions will cost between 15,000bn pesos ($1130bn) and 16,000bn pesos. Banks have to set aside 50% of them immediately, but have been given until 2012 to make up the rest of the allocation. "That will hurt the banks' bottom lines in a difficult business cycle," he says, a view which other prominent Mexican bankers share.

Mr Deschamps estimates that, on average, bank profits may decline 30% this year compared with 2008, due to higher reserves, lower credit demand and lower interest rates. Mexico's central bank has been lowering its benchmark rate this year to stimulate investment and consumption. The rate was down to 4.5% in July compared with 8.5% in January.

But notwithstanding the pressures, Banamex's net profits of 6bn pesos in the first quarter of 2009 were 20% higher than in the same period last year. Enrique Zorilla, CEO of Banamex, attributes the increase mainly to efficiency gains which, he says, has been a pattern throughout Latin America. "As a result of this effort in productivity, the amount of profits that the region contributes to Citi has trebled between 2002 and the present," he says. BBVA Bancomer's profits in 2008 amounted to 36% of the Spanish parent bank's total €5.02bn net profits that year; and even HSBC Mexico, with a smaller presence in the market, is the UK group's fourth biggest contributor in terms of profits worldwide, says Mr Peña.

Banorte's current capital ratio of 15.6%, the second highest among the big banks, is solid. But, in what analysts describe as another defensive measure, the International Finance Corporation, in accordance with a programme it established this year to bolster locally owned systemic banks in developing countries, is investing about $150m in Tier 1 capital in Banorte, equivalent to a 3.5% to 4% equity share in its financial holding company, says Mr Valenzuela.

"The investment will result in Banorte getting a partner that is world renowned for the quality of its assessment. And, not least, we will get some capital. There is no notion of excess capital these days, especially in the new regulatory environment," he adds.

Between 2005 and 2008, before the current crisis, lending to businesses and consumers grew at a brisk pace of 20% to 50% a year as banks catered to a market starved of financial services after the Tequila crisis of the mid-1990s.

As with the rest of Latin America, consumer credits boomed the most as banks tried to increase the depth of financial intermediation by providing services such as credit card loans, car loans and loans for home appliances, practically for the first time in Mexico. However, deceleration in the consumer credit market started in 2007, before the US financial crisis struck a year later. Then, as the economic slump spread, banks' consumer portfolios plunged. At the end of June 2009, compared with the end of 2008, Mexican banks saw their consumer loan books shrink 11%, according to CNBV.

Demand for housing

By contrast, in the housing market, although the total number of mortgages stabilised in 2007, Mr Zorilla of Banamex says that the bank's mortgage loan portfolio grew by $850m in the year to the end of June 2009. Mr Deschamps, at a July meeting of the Mexican Banking Association, of which he is president, said that private banks' mortgage portfolios had been growing an average 11% year on year until the beginning of May 2009.

The momentum reflects a large and real demand for housing as well as a lot of pent-up demand due to the shrinking of the credit market after the Tequila crisis. Also supporting the housing market in Mexico are its government-backed mortgage agencies - Infonavit (for private sector employees) and Fovisste (for public sector employees) - which co-finance mortgage programmes for lower-income employees, with mortgages paid out of payrolls. Regulators estimate that there will be about 500,000 new mortgage contracts this year, the same as in 2008, but down from a peak of 750,000 in 2006.

The continued strength of the residential mortgage market during the recession is also striking considering the collapse of Mexico's recently developed private sector housing finance market. Its debacle occurred not because mortgages backing bonds in the market were risky. There are no Alt-A mortgage schemes in Mexico or, as Mr Valenzuela, says: "We never support negative amortisation schemes in our mortgages in Mexico where, for example, a mortgage has a higher value than the value of a house." Rather, as subprime lending problems spread in the US and Europe, Mexico's housing finance market - which financed 45% of 250bn pesos-worth of outstanding loans granted by financial institutions for mortgages in 2008 - was damned by association. As a consequence, a number of special-purpose housing finance intermediaries, called sofoles, found themselves under pressure. Regulators say, however, that a solution to this problem is well under way: where necessary, sofoles are either being merged or bought by commercial banks.

Even so, bank regulators recognise that the origination standards for issuing mortgages have been better among commercial banks than sofoles.

Also reflecting Mexico's macroeconomic stability, banks have been able to provide mortgages for 20 years at fixed rates of about 12%. "That is one of the reasons why there hasn't been a mortgage crisis in Mexico. People make the same monthly payments for years. They are immune from variable interest rates," says Mr Peña.

Supporting small business

Another area where bankers believe they have also been making a positive contribution during the recession is by continuing to lend to small and medium-sized companies, which account for 90% of businesses in Mexico and are known as pymes. In the absence of credits from suppliers, their traditional creditors, because many pymes are short of money, they have increasingly turned to banks for funds.

Lending to pymes has also been boosted by the co-financing and guarantee programmes of Mexico's state business lender, Nacional Financiera (Nafsina). For instance, the swine flu virus had devastating effects on the tourist industry, which employs 2 million people and is the country's third biggest source of foreign exchange. Following the outbreak, Nafsina launched programmes totalling 7.5bn pesos for small businesses, such as restaurants, hotels and shops, affected by the temporary suspension of businesses because of the health emergency.

Several banks reported increases in lending to pymes in the first quarter of 2009 compared with the same quarter in 2008, suggesting continued momentum in the market. But, at the end of June, after declining for three consecutive months, overall business lending was flat compared with the end of 2008. This outcome prompted analysts, such as Fitch Mexico, to predict that bank credit in the country might contract in 2009 as a whole, for the first time since 2003, due to the dramatic slowdown and the growing risks for banks of lending to individuals, businesses and housing in such a weak economy.

Commercial banks reported total loans of 1840bn pesos at the end of June 2009, down 2% in nominal terms from the end of 2008. And regulators said that commercial credits accounted for about 60% of total bank lending, housing and mortgages for about 25% and consumer credits for about 15%.

In June, the average NPL rate for commercial credits was low at 2.04%, but CNBV officials, taking no chances, have recently changed the reserve rules for pymes loans. As with credit card loans, the risk analysis is now based on an analysis of individuals, or in this case, the business owners.

Mexican bank regulators do not hide the fact that they are watching banks' commercial credit portfolios closely, not least because of the high concentration of such lending. This is not because commercial credits represent a high proportion of total bank lending - about 60%. It is because 80% of that, according to regulators, goes to just 15 Mexican companies, including Telefonos de Mexico in fixed-line telephony and Telcel in mobile telephones (both controlled by Mexican entrepreneur Carlos Slim, one of the world's wealthiest individuals), Pemex, the state oil company, and Comisión Federal de Electricidad, the state electricity generator.

Advantageous predicament

On the positive side, as the demand for credit declines during recession times and bank lending slows, delinquency rates also usually fall. Moreover, unlike in the US and Europe, neither Mexico's economy nor banks were highly leveraged at the beginning of the crisis. "That's why, in spite of the contraction, we have been able to continue growing the business," says Banorte's Mr Valenzuela.

Mr Peña believes that banks and the government can co-operate in the crisis in two ways. One way is through devising "sensible" programmes, such as Infonavit's housing programme and Nafinsa's plan to assist tourism-related businesses hit by the flu scare. But the next way, he says, is "to let everybody and every business which has a cash-flow problem know that help is there and that something can be worked out".

The upshot is that all of Mexico's big banks, beginning with Banamex, now engage in debt-repayment discussions, extending repayment periods and cutting interest rates on loans to clients who have fallen behind on credit card or mortgage debts, as well as with pymes' owners in arrears on business loan payments. At the end of June, a total of 4380 cases of debt restructuring had been arranged between banks and pymes, amounting to 1.3bn pesos, according to the Mexican Banking Association.

"We are going through a very difficult period. But I think the banking system is not a problem in Mexico now. It is part of the solution," says Mr Deschamps.

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