Mexican banks rein in as crisis takes hold

The Mexican economy promises to be one of the world’s worst performing this year, against some stiff competition such as Lithuania which may experience a more than 20% fall in GDP. Some economists are predicting that this year may shape up to be the worst since 1932, when Mexico was in the grip of the US depression.

A flood of bad news has seen the Central Bank obliged to lower its forecast for the economy in late July to a grim estimated GDP contraction of between 6.5% and 7.5% this year. That factors in a first-quarter decline of 8.2% and estimated contraction of up to 11% in the second quarter, thanks in part to the early outbreak of swine flu and its particular virility in Mexico. The start of a turn-around is expected in the second half and could alleviate the rate of decline, with a drop of 4.8% for the second half likely; still miserable, but a vast improvement on the second quarter.

Some private analysts are more pessimistic. Goldman Sachs estimates that the economy could decline by 8% over the year although there is a fair chance that May marked the bottom of the current real business cycle, says Alberto Ramos, Goldman Sachs senior economist. Long-term economic growth is forecast to be anaemic too: it will likely average just 1.9% a year during this decade, compared to 3.8% in Chile and 3.2% in Brazil, according to forecasts by the International Monetary Fund.

Analyst forecasts have been revised constantly downwards to reach these levels. Consensus expectations at the start of the year were for zero growth or a decline of up to some 1%, points out David Olivares-Gomez, senior credit officer and head of Mexican bank ratings at Moody’s. Even if the US were to show a fast recovery, there would be a significant lag in Mexico’s response. Analysts are not expecting a recovery before the end of 2010, if then, he says.

The situation has once again highlighted the dangers of dependence on the United States. The northern neighbour accounts for over 80% of Mexico’s trade and the recession there means that such flows between the two dropped 30.2% in the first half of the year. Remittances, the largest single source of dollar flows into Mexico, fell 18% in the second quarter this year over the same period last year.

Home grown issues have compounded these woes and damaged Mexico’s credit rating. Local elections in July saw president Felipe Calderon lose key congressional seats. That has lessened the likelihood that he will be able to push through the level of tax increases needed to curb the budget deficit and that could push down the level of the peso once again.

The rapid deterioration has pushed rating agencies to be cautious. Both Standard & Poor’s and Fitch have moved Mexico’s sovereign outlook down to negative from stable. Standard & Poor’s’ change came in May on a BBB+ rating. Lisa Schineller, director of sovereign ratings group at Standard & Poor’s in New York, says the agency is watching to see if the government is able to reduce its heavy reliance on oil revenues, which have been falling thanks both to falls in the price of the commodity and lower productivity. The Mexican government has says it intends to carry out fiscally-enhancing measures to the 2010 budget, she notes. However, it is not yet clear what and how permanent those measures will be, and what the political will is for the measures, she adds.

Banking blues

The banking sector has been hit at both ends by the crisis. One of the drivers of growth in banks’ profitability and thus a strategic focus in recent years has been lending, particularly to consumers. Higher levels of defaults have led banks to increase provisioning. That comes just as deposits flatten as job losses mount and remittances decline.

The retraction in deposits varies across the system. Total deposits at HSBC, including money market funds, decreased 17.1% to pesos 220.3bn at the end of June, for example, while results from the Mexican operations of Bank of Nova Scotia (BNS) showed that deposits have remained virtually flat throughout the year.

News such as this has led Moody’s to monitor banks’ deposit levels with vigilance and the scope of the dangers associated with deposit levels can be seen in the number of negative actions on evaluations undertaken in recent months. Moody’s put the local currency deposit ratings for Banorte, Banamex and BNS under review for possible downgrade in August following earlier moves to do the same with local units of BBVA, HSBC and Santander. The agency noted that it is seeking to keep bank ratings in line with the government, given the importance of the latter in the event of systemic problems.

In the lending business, banks had been recording 25% growth in lending annually; this year that figure will be less than 10%, says Olivares-Gomez. There has been a significant contraction as banks become more conservative and customers turn more wary about borrowing, he notes. The consumer confidence index has trended down for three quarters now, he points out.

In May, consumer lending was down 15% year-over-year, according to the Association of Mexican Banks. With further drops likely, there could be a fall in the total amount lent this year for the first time in six years, according to Alejandro García, senior director at Fitch in Mexico City.

The recession has led to a marked deterioration in repayment. Not surprisingly, credit card loans have been particularly badly affected. A lending boom earlier in the decade saw banks provide millions of cards to low-income consumers and offer additional cards to existing card users.

The figures speak for themselves. Total non-performing loans rose to 3.86% at the end of May, up from 3.21% in December, according to the National Banking and Securities Commission. Non-performing credit card loans, however, jumped to an eye-popping 12.61% at the end of May, up from 9.37% in December. By May, delinquent credit card debt reached some $1.7bn.

The effect of the consumer downturn is magnified on the largest banks as the sector is highly consolidated. The two main institutions are Grupo BBVA Bancomer and Banamex, both with long histories and strong franchises. Between them, they control 57% of the credit card market. The banking system remains highly concentrated in the second tier of financial institutions as well with four banks dominating. They are Santander, HSBC, Banorte and Scotia, who between them mop up much of the rest of the country’s banking business.

The results from lending and credit cards are particularly worrying for Banamex and closest rival BBVA Bancomer. Not surprisingly, Mexico’s largest bank, BBVA Bancomer, owned by Spain’s second largest banking group, reported a significant drop in profits in the first quarter out of its Mexican business. Profits at the Mexican unit fell by 28% to €363m and bad loans as a proportion of total loans increased to 3.6% from 2.1%.

Moreover, locally-listed banks are still suffering as investors rush to dump shares as they announce weaker-than-expected results. Shares of Banorte sank 6% when it announced first half results, which highlighted poor results in the second quarter. Net profit fell 27% to Pesos1.3bn after the bank was forced to set aside more than Pesos2bn to cover burgeoning consumer credit defaults.

In this hostile environment, some major banks have seen capital adequacy ratios slip. HSBC has been particularly badly affected by the default levels of credit cards, with non-performing loans standing at 17% and the bank’s capital adequacy ratio has slipped to 11.69% in May, edging down closer to the 10% level at which banks in Mexico are obliged to present a plan to boost their capitalisation.

Finally, the predominance of foreign, particularly US and Spanish-owned banks, can mean that the Mexican operations of a foreign bank gets paid scant attention in a time of crisis when the parent tends to concentrate on bailing itself out in its home market. A full 90% of the banking system is in foreign hands. BBVA, parent of Bancomer, has had a smoother ride and it seems that the bank is pulling out the recession fast. In the second quarter, the bank reported that profits had climbed 34% in part on the back of higher loan revenue. The bank admits that the recessions in both Spain and Mexico, which together account for about 80% of profits, have slashed the demand for credit. However, BBVA was able to announce that bad loans had slowed from the previous quarter and that the bank had been cutting costs. The Spanish bank announced that net income from Mexico in constant currency terms fell 10% to €356m.

Banamex, owned by Citigroup, has faced two uncertainties. Difficulties in Citi’s home market led to rumours earlier this year that Banamex would be sold to raise capital. That was compounded when the US parent took a loan from the US government which led the latter to become a substantial shareholder. It was thought that the Mexican government might force Citigroup to sell its Mexican arm to avoid a situation in which the US government was a key shareholder in a systemically-important bank in the country. Those fears have now receded.

The trauma through which Banamex has passed makes the results coming out of the bank all the more surprising. Although 2008 was marked by a severe downturn—the bank announced this February that profits had slumped 28% last year on higher reserves against bad loans—there have been signs of improvement recently. In April, the bank reported first-quarter profit rose 20% to Pesos6bn (around $451m) compared to the same period the year before.

Green shoots

The Mexican economy is battering all banks and could even lead to further consolidation as smaller banks are rescued by mid-sized and larger banks. That experience could, however, leave top banks like Banamex in better condition than ever, leaner and more ready to respond to rapid changes in fortune.

There are also one or two bright spots amid what many have been calling a perfect storm. The weak peso, which has had the unfortunate effect of reducing repatriated profits for the foreign-owned banks, has shown some signs of recovery. The currency had declined from 9.96 to the US dollar 12-months ago to 12.97 on August 8. But that still represents a recovery compared to levels of 14.5 reached in February this year. Surprisingly lending has held up in one key area. Lending to the private sector has continued growing and expanded 3% year-over-year to Pesos1.592trn ($117.6bn). Lending to businesses was particularly strong, posting 14% growth and mortgages continued to expand at an 11% clip.

One of the keys to watch for within individual banks is the reaction of management to the crisis. Banks that are likely to best weather the crisis are those that acted promptly to adapt to the new operating environment, says Olivares-Gomez. Management needs to be proactive in slowing lending and cleaning the balance sheet through recognition of losses as soon as possible, he says. Growth expectations for lending portfolios and profits need to be revised downwards too, he says.

A final significant driver of Mexican banks’ success is diversification of business lines, such as excellence in areas including payroll or higher-value added areas, including investment and wholesale banking.

The perfect storm is far from over in Mexico but there are signs that with the US recovery looking underway, the most severe problems for the banks may already have arrived. A slow recovery, though, is likely to ensure that Mexico remains a lower priority than before for foreign banks.

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