Better prepared to defy the storms

Given the lessons learnt during the Tequila Crisis of the mid-1990s, analysts and bankers are positive about Mexico’s ability to survive, and even thrive, during current worldwide economic turbulence. Writer Theresa Braine.

by Banker Editor

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As the US financial system burned on September 15, Mexican markets took a hit but its own financial system held strong. Banking experts say that aside from some psychological reverberations, the nation’s banks, having weathered and learned from the so-called Tequila Crisis of 1994–95, are strong enough to withstand the storm.

On the one hand, the major players in Mexico are foreign: Banamex, a subsidiary of New York-based Citibank, Spain’s BBVA Bancomer and Santander, along with the UK’s HSBC. Mexico’s only locally owned bank, Banorte, is Mexico’s fifth largest. On the other hand, despite being mostly foreign-owned, Mexico’s institutions are not overexposed on subprime mortgage securities as US banks are, and neither are they involved with Lehman Brothers, which filed for bankruptcy that day.

That said, the country’s banks are not exactly churning ahead. Faced with the worldwide slowdown and US meltdown, with credit card delinquency at home putting a drag on the banks’ main growth engine of recent years, they are keeping a lowish profile, bank officials and analysts said in mid-September.

The challenge for Mexico’s financial sector “is to consolidate the great growth of the past few years in a decelerating market,” says Enrique Zorrilla, CEO of Banamex. “This involves paying close attention to the increase in delinquent loans and being very prudent in the granting of credit, while at the same time taking advantage of the opportunities that a market such as Mexico’s offers, where the level of bank penetration is still low.”

Analysts pinpoint deteriorating asset quality as a concern.

“Asset quality has started to deteriorate and will continue to deteriorate for a while,” says Alejandro Garcia, an analyst in Fitch’s Monterrey office. Although loans still show growth rates of 10% to 15% in real terms, “there’s still significant room for further deterioration in asset quality, especially in portfolio and asset management”.

This brings other challenges too, he says. The increase in loan reserves is higher than normal, which has put pressure on banks’ earnings.

“However, something that we’re also highlighting is that profitability was coming from an exceptionally strong level, so even though there’s a significant drop in earnings, profitability ratios are still relatively reasonable so those are not dramatically adverse,” says Mr Garcia. “That’s not only the effect of provisions but also of market-related revenues given the volatility in the financial capital markets and the recent upward trend in inflation and interest rates.”

Faced with US economic developments that are worsening daily, plus burgeoning credit card delinquency at home, Mexican bankers are scrutinising consumer loans more carefully and increasing reserves. That, combined with downscaled growth forecasts and rising inflation, are causing what JPMorgan analyst Saul Martinez calls “headwinds” in the short term.

But the lack of bank penetration and the increase in loans to small to medium-sized enterprises (SMEs) reflect an untapped market, say bankers and analysts. And safeguards put in place after the 1994–95 financial crisis will keep Mexico’s banking system firm, even with a wobbly peso, which fell from August’s six-year high during September.

Economy slowing

There is definitely a growth slowdown, but it has yet to lead to a decline. Growth forecasts have been revised to a 2.5% increase in GDP for 2008 and 3%, as opposed to the originally predicted 3.3%, for 2009.

“That’s not bad,” says Banorte CEO Alejandro Valenzuela. “When you look at Mexico for the past 13 or 14 years, the average rate of growth has been a little over 2%. So growing 2.5% in this environment is commendable.”

Likewise with inflation. “People see 5% to 6% inflation as something tragic. They seem to forget that 20 years ago Mexico was experiencing inflation of 160%,” says Mr Valenzuela. “So we have to put everything in perspective... Mexico has 6% inflation this year and somewhere between 4% and 5% next year. I think that in the 10- to 20-year picture it’s one of the best years we have had. So I wouldn’t be too concerned about that right now... The banks are much better prepared today.”

On the downside, Mexico is not growing quickly enough to meet its development needs, say Mr Valenzuela and Mr Zorrilla. They say it would take a 5% annual growth rate to stimulate the job growth necessary for development.

Banking penetration

Despite gains, bank penetration is still both the bad news and good news among Mexico’s banks. On the downside, Mexico’s participation levels lag far behind those of countries at equal levels of development, such as Chile and Brazil. On the upside, that means there is nothing but potential.

The situation is nothing new, but inroads are being made. Several types of financial institutions, ranging from Sofoles (limited-scope financial entities) to about a half dozen regional banks, to retailers such as the US giant Wal-Mart, are getting into the game and bringing new customers into the fold. Microcredit, highlighted by the initial public offering of Mexico’s leading microlender, Compartamos, can bring non-participants onto the lowest rung of the financial system and help them climb. And potential new rules will allow account holders to make deposits at cash registers in retail outlets.

“We will continue growing our distribution network, partly by making strategic alliances such as the one we have with [supermarket chain] Soriana, to continue our incursion into new market segments and deepen our relationships with existing customers,” says Mr Zorrilla. “At the same time we will be very cautious in our risk management to ensure that we have a solid loan portfolio that continues to be highly profitable.

“Likewise we will orchestrate programmes to improve competitiveness and continue improving our efficiency index, which is 44% and is one of the best not only in Mexico but also in all of Latin America,” adds Mr Zorrilla.

US knock-on effect

Even before the US financial markets fell apart in mid-September, the US slowdown was having an effect. In addition, Mexico was showing signs of slowing all on its own.

“Manufacturing production remains relatively strong but now shows clear signals of being negatively affected by lower demand from the US,” says Mr Zorrilla. “On the other hand, the deceleration in industrial production in Mexico has intensified, but principally caused by internal factors that have nothing to do with the economy of the US. These factors are a more pronounced decline in petroleum production and disappointing results in the construction sector.”

The government’s answer has been to increase public spending on infrastructure, says Mr Zorrilla, noting: “Nevertheless, the hoped-for stimulus is still modest.”

All this has caused Banamex to downscale its growth forecast for 2008 to 2.5%, he says, and even into 2009, revising its forecast downward from 3.3% to 3%.

Banamex’s main source of income has been the “strong reactivation” of credit that Mexico has seen over the past few years. Consumer credit such as credit cards and automotive and personal loans, as well as mortgages, have seen accelerated growth in recent years and are still growing, albeit moderately, says Mr Zorrilla. Balancing that out, he adds, is business loans, especially to SMEs, which are showing strong growth and will assume greater importance.

Perhaps the most troublesome area of consumer credit, which until recently was banking’s main growth driver, is the credit card sector. The decision to give out many cards to people with little income or experience and education in handling finances is taking its toll. The bubble is bursting, and bankers are giving consumer credit a sharper look. They are not giving out credit cards as freely as they have over the past few years, when cards were the main driver of bank growth.

A good part of this growth stems from tapping people who previously had no banking relationships. “In general, the banks have been conscious that the incursion into low-income sectors carries greater risk, and this naturally would imply an increase in delinquencies, and that in time would require the creation of more reserves and provisions,” says Mr Zorrilla.

Banks have been increasing their reserves and provisions in response to an increase in delinquencies, especially in consumer credit, over the past few months, though not to an alarming level. “The great majority of banks, moreover, are well capitalised and have more than needed to cover their bad loans, so this is not seen as becoming a problem,” says Mr Zorrilla.

Most debtors are paying on time: “But in some cases we’re beginning to notice that they are nearing their credit limit. Given this scenario against the backdrop of economic deceleration in Mexico, we banks are paying particular attention to growth in delinquent loans and being more cautious than before,” says Mr Zorrilla. They will be slower to grant credit for cards and mortgages.

“We have seen some of our clients showing some distress with their credit card balances,” says Mr Valenzuela. “The name of the game has been to find ways to restructure them with a flexibility that’s more in accordance with what they can do at this time of the economic cycle.”

In Mexico’s favour is that it is less leveraged in terms of consumer credit than other countries are, notes Mr Valenzuela. “Mexico’s consumer credit portion of gross domestic product [GDP] is about 12%, whereas in other countries with a similar level of development, it’s two times that – 24% to 25% with Chile, and if you go to countries such as Spain, it’s 70% or 80%.”

When it comes to commercial loans, SMEs are clearly the engine of growth. Shut out for years following the mid-1990s crisis, they have been able to borrow in recent years and are now increasing in importance as consumer credit slides.

“Business credit, especially in SMEs, is beginning to grow with more strength and should begin occupying a larger space in the bank’s total portfolio,” says Mr Zorrilla.

In 2003 private-sector loans were at 6% of GDP, Mr Valenzuela notes. “Right now it’s closer to 20%... So that represents a very impressive rate of growth, that is starting to normalise its level where it should be. But definitely there’s still a long way to go, so I think that today we are much better off than three or four years ago.”

New business

Secondary markets are also increasing in importance. In the past few years Mexico’s banking sector, led by the foreign heavyweights that now dominate, has developed its secondary markets and built up customer bases. Banamex, for example, has grown its investment businesses, life insurance and other products, says Mr Zorrilla. Remittances are becoming increasingly important, both Banamex and Banorte say, and are expected to play a growing role in the future.

“Remittances in Mexico are very important as the country’s second-largest source of income after petroleum,” says Mr Zorrilla. “Without a doubt remittances have played an important role in the country’s economic growth, principally in the increase in demand for goods and services, which has spurred growth. Its strongest impact is at a regional level, in states, cities and communities that are highly dependent on receiving remittances.”

Regulatory environment

Mr Zorrilla describes the sector’s relationship with the regulatory boards as amiable and characterised by constant communication between the Ministry of Finance and Public Credit, the National Commission of Banking and Assets, the Bank of Mexico, and the National Commission for the Protection and Defense of the Users of Financial Services (Condusef), and the Institute for the Protection of Bank Savings (IPAB).

The strategy of Mexico’s financial authorities in recent years has been to promote a greater level of bank participation and more competition in the sector, says Mr Zorrilla.

“After the Mexican Tequila Crisis there were huge changes in regulation in Mexico. I think that both the authorities and the banks learned a lot from that painful lesson,” says Mr Valenzuela.

Mexico is also in the process of complying with ISR international financial reporting standards as well as with conditions of Basel II.

“I think that in terms of transparency, checks and balances and corporate governance, we are where we need to be, and we are as good as any other bank pretty much worldwide. So the improvements have been very, very important,” says Mr Valenzuela. “Especially if you look at these changes over a 10-year period, I think it’s dramatic.”

Analysts and bankers are positive about Mexico’s ability to withstand, and even thrive, during the current economic storm.

As analyst Saul Martinez puts it in a July 2008 report by JPMorgan: “Once inflationary pressures subside, macroeconomic stability coupled with low financial sector penetration and well-capitalised banks provide a favorable backdrop for profitable growth.”