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AmericasMay 1 2006

Profitability and lending boom under threat

Karina Robinson canvasses the CEOs of four of Mexico’s top five banks as the country looks increasingly set to elect a less banker-friendly president.
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Despite publicly pronouncing themselves unworried by hard-hitting criticism from the authorities on their charging levels and the threat of retaliatory sanctions from whoever takes over the government after the July elections, the top banks in Mexico look set to come up with an initiative to forestall official action. But it does not appear that this will be enough and they will surely need to develop a more active voice and lobbying role to offset the threats.

Guillermo Ortiz, governor of the Bank of Mexico, told the 69th annual banking conference in Acapulco in March that: “Today the banking system finds itself among the most profitable in the world, with capitalisation and solvency levels that have no parallel in the history of the country.”

He noted that their cost-income ratios saw a steep drop from 72% in 2000 to 53% in 2005, that Mexican banks on average generated an annual post-tax return on capital of 20% and that the financial margin as a proportion of total assets averaged 4.6%, higher than in a selected number of other Organisation for Economic Co-operation and Development (OECD) economies, while the level of private sector financing as a proportion of total assets is only 24%.

Sky-high interest rates

He did admit that rates in some sectors, notably mortgages and credit to large corporates, had come down on the back of increased competition. However, he also pointed out that commissions – albeit tending lower – were still high and their structure not always related to costs, while interest rates on credit cards had remained “exceedingly high”. According to central bank figures, the annual interest rate on credit cards in January 2006 was 33.78%.

After such an impactful start, Mr Ortiz lightened his remarks by saying that competition in the financial sector could not be delivered “by decree”. Marcos Martínez, head of the Association of Mexican Banks (ABM), told The Banker that the governor was only “doing his job” and “we are not worried because we are following the correct line. Our commissions are going down due to competition.”

Threat from the left

But at the very least, the two more left-wing of the three presidential candidates may well want to hit the banks with some sort of decree when one of them takes power – front-runner from the Democratic Revolutionary Party (PRD) Andrés Manuel López Obrador, known as AMLO, or the Institutional Revolutionary Party’s (PRI) Roberto Madrazo. The National Action Party’s (PAN) Felipe Calderón is unlikely to do so.

“Bankers are very complacent,” says Luis Rubio, president of independent think-tank CIDAC. “I think they have ignored what AMLO could do.” Mr Rubio mentions proposed policies such as forcing banks to dedicate a larger amount of credit to agriculture or having to deposit hefty reserves with the central bank. He also notes – having met Mr López Obrador many times – that the PRD head understands the value of agriculture and industry but not services.

There is also the issue of the regulator and supervisor which, in Mexico’s case, is the Bank of Mexico. Currently, whatever their differences, bankers respect Mr Ortiz as an unbiased technocrat and the central bank as one of Mexico’s stronger institutions. But by 2009, due to existing election rules in the bank, there would be a new governor, assuming the new president does not reappoint Mr Ortiz, plus two new vice-governors out of four. All the new officials would be appointed by the new government.

It is worth noting that Mr López Obrador has expressed public disapproval of Mr Ortiz. He blames the former minister of the economy for privatising the banks and then for Fobaproa, the government-backed plan which helped bring banks out of the crisis in the 1990s, accusing Mr Ortiz of placing “a debt burden of $100bn on the country”.

If the PRI wins in the July elections, the threat to the banks is less severe. However, Francisco Suárez Dávila, who has been mooted as economy minister in a PRI government and is currently secretary of Congress’s commission on the economy, has not been supportive of the banks.

“How can a country advance if there are no tax revenues and no bank loans?” he said in an interview on a trip to London earlier this year. “Banks don’t lend to agriculture or small and medium-sized enterprises [SMEs] and there are no venture capital funds in Mexico. Banks have some of the highest net margins in the world. Bancarización [expanding the universe of bank clients and increasing the use of plastic all over Mexico] of the country is not really happening.”

Without specifying how this might be achieved, Mr Suárez Dávila added: “There will be an inducement to more competition, moral suasion, to get them to lower margins and open more branches, and lend more to agriculture and SMEs.”

Agriculture plan

Meanwhile, the banks are planning to present a plan by September on lending to agriculture and how the new government could work with them on it.

“We have to find out how to lend profitably to agriculture and do so quickly,” says Mr Martínez. There does not, however, appear to be a plan to counter other criticisms. (A managing director at one of the top foreign investment banks suggested bankers should be proactive and tell the incoming president that they would lower commissions but in exchange would want a guarantee that corporate tax rates would not be changed over the six-year term.)

Lending to agriculture is not an easy proposition: the 30% of the population that lives in the countryside generates only 7% of GDP and property rights are ill-defined.

Lending to SMEs is further advanced. A government loan-guarantee scheme led to increases in lending, although banks estimate they still only lend to between 10% and 20% of SMEs. Banorte, which won The Banker’s Bank of the Year for Mexico in 2005 and is the only locally owned bank in the big five, is one of the more active banks in this segment but says the process is not straightforward.

“Banks have to tolerate risk more and companies have to become more transparent in their information,” says Banorte chief executive officer Luis Peña. For smaller companies, Banorte created a special bank which lends on average $2300 per business and by the end of 2005 had $350m on its loan books and non-performing loans of only 5%.

At a wider level, the Monterrey-headquartered bank is planning to deal with its low market share in Mexico City – 5.5% versus 11% on a national basis and 28% in Monterrey – by remodelling existing branches or setting up new ones in the capital. This involves 148 branches.

Its January acquisition of Texas-based Inter National Bank will allow it to offer services to the 1.3 million population of south Texas who are of Mexican origin, as well as wealthier northern Mexicans with second homes over the US border.

International transfers

Banorte has not been heavily involved in the lower end of the remittances market, unlike BBVA Bancomer, owned by Spanish bank BBVA, which has bought Laredo National Bank in Texas and Valley Bank in California. About 40% of Mexican remittances come through the country’s leading retail bank and about 6 million families receive funds from their relatives living abroad.

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On mortgages, Jaime Guardiola of BBVA Bancomer, the only Spanish CEO of a top-five bank, notes with pride that, following the bank’s 2005 acquisition of mortgage institution Hipotecaria Nacional, “we consolidated our leadership of that market and sold 50,000 mortgages last year. This is double what we lent the year before and is more than the rest of the banks put together or the Sofoles [institutions specialising in the low-income mortgage market] put together by themselves.”

 

There is an estimated deficit of about 800,000 houses a year in Mexico, along with a young population, which is why mortgages have grown non-stop over the past 30 months, although they still represent a small percentage of banks’ assets.

Total credit lent by commercial banks in 2005 was equal to 15.6% of GDP. Critics point out that this is only about what it was in the mid-1990s in Mexico and that in Brazil it is about 26% of GDP. However, that is 1.8 percentage points more than in 2003 and excessive risk taking has been avoided. In a February report, ratings agency Moody’s called the Mexican banking system “quite sound” and said there were “no signs of credit overextension, in, for example, the consumer credit market – by far the most active area – as delinquency and provisioning indicators are sound (delinquency remains comfortably below 3%).”

Consumer credit grew at an annual, real average rate of 40% over the past three years.

Mr Martínez, who is CEO of Santander (which has just dropped the second part of its Santander Serfin name in Mexico) as well as head of the ABM, says that when outsiders say how frightening it is to see consumption credit growing that fast, it is not at all so. He says: “We are expanding into a bigger universe.”

Credit expansion

Until two years ago, the minimum monthly salary banks demanded for a consumer credit was 7000 pesos ($634). It has now fallen to 2700 pesos. As a result, the amount of potential clients has expanded by an enormous 16.6 million people.

Corporate credit has been growing more slowly at about 15.8%; however, this statistic includes credit to large corporates (which are able to access international capital markets), medium-sized ones (from which there is not enough demand, say bankers) and SMEs. President Vicente Fox told bankers at their Acapulco meeting that there was a lot to do on this front.

Mr Ortiz was most critical about the interest rates charged on credit cards. These can rise to 40%. Manuel Medina Mora, CEO of Banamex, the second largest bank in Mexico and the largest issuer of credit cards, notes that his bank, owned by Citigroup, charges between 20% and over 30%, although it currently has some six-month interest-free promotions. He believes there are sound reasons for the interest rate levels on the cards.

“Our price strategy is about [the consumer’s] credit history,” he says in his office, a five-minute walk from competitor Santander in the Santa Fe area of Mexico City. The regulator wants [rates to go down] faster but it has to do with competition and volume. We are the biggest with five million credit cards. The total market for credit cards in Mexico is over 15 million. Citigroup in the US has more than 120 million.”

“Margin evolution over the past few years has been about volumes growing and margins falling. It’s the same with commissions.”

Whatever the next government does with the banks, there are two other risks to the current boom in lending and increased bank profitability. One threat is global, one is local.

The Mexican economy looks relatively stable in its growth, especially with the US expected to continue its trend, with growth there of about 3.3% in 2006, according to the International Monetary Fund. However, the threat of a messy unwinding of global imbalances (see Bracken column page 8) could affect this benign economic scenario. Any drop in US growth has an even larger effect on the Mexican economy, which has always been tied closely to it, and even more so with the North American Free Trade Agreement (Nafta).

Local threat

The local threat comes from a win by Mr López Obrador. Analysts and economists believe his economic policies could well lead to a crisis as markets punish an irresponsible expansion of government spending (see article page 106). Banks, though, believe they are in a healthy enough state to withstand this. Most loans are at fixed rates, there are credit bureaux and banks have better hedging techniques. This is a very different situation compared with the 1982 and 1994 crises.

There are also high capitalisation levels and the support of foreign parents in all cases except Banorte’s, which in any event is amply capitalised. Moody’s notes that “the system is supported by a core of strong, profitable and well-capitalised banks.”

Even though these banks can withstand a crisis, their foreign parents would find that the return they promised shareholders on their Mexican investments – dependent on healthy annual profits – is extended to a further time horizon. Currently, say bankers, it varies from three to seven years depending on the bank. From 2000 to 2005, $32.9bn or 32% of total foreign direct investment to Mexico flowed into the financial sector. Another $4.9bn flowed into the sector in 1995-2000, according to the Ministry of Economy.

Although foreign banks are strongly committed to Mexico because of the amount they have invested there and the long-term prospects for the economy, they appear more likely than not to suffer a rocky patch in the next year or more.

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