Will Pressure Increase On Latin American Banks In 2016?
Despite adequate financial performance during 2015, Latin American banks will certainly face a somber and cautious 2016. The region’s lower economic growth, and in some cases economic contraction, could dent asset quality by various magnitudes. The latter could cause provisions to increase, thus squeezing profitability, internal capital generation, and risk-adjusted capital (RAC) ratios. In addition, external risks–such as the U.S. Federal Reserve’s lack of clarity about if and when it will raise interest rates, low commodities and oil prices, and global concerns about China’s economic growth–directly and indirectly affect the region’s financial systems’ performance. These risks cause volatility in global markets given today’s financial and economic interconnection–as seen in the depreciation in Latin American currencies amid low external capital flows. Therefore, they weigh on Latin American economies, and, consequently, on the banks’ creditworthiness. We don’t expect these risks and uncertainties to disappear in 2016.
Some of the risks we see for Latin American banks have already materialized. For instance, we have revised our economic risk scores, which are part of our Baking Industry Country Risk Assessments (BICRA), on Braziland Peru, while the trend on both remains negative. The trend for Brazil and Peru’s economic risk remains negative, and we recently revised our trend for Colombia‘s industry risk to negative from stable. We remain concerned about Brazil’s poor growth prospects and high debt burden. In addition, we’re concerned about the potential for rapid deterioration in Peruvian banks’ asset quality, profitability, and capitalization–in the event that the private-sector debt burden becomes excessive while the economy loses steam. Although to a lesser degree, political risk continues weighing on banking systems in several countries, such as in Argentina. Although we expect stable and resilient performance for Chile and Panama‘s banking systems, they will have to adapt to a new economic reality of lower economic growth than in the past few years. Finally, Mexico‘s so called structural reforms are yet to provide tangible economic results, which in turn could boost credit in a country that has one the lowest credit-to-GDP ratios in Latin America.
- Latin American banks need to be cautious about their growth strategies to keep asset quality in check in 2016.
- Economic easing will be a key challenge in 2016 as Brazil’s economy, the largest in the region, keeps contracting and Mexico’s, the second largest, has subdued growth despite the passing of structural reforms.
- External factors will remain significant risks because they exacerbate volatility and weaken Latin American currencies due to lower capital flows.
- We expect relatively stable performance next year, but we will monitor banks’ internal capital generation capabilities and asset quality metrics to assess any deterioration in creditworthiness.
- Negative rating actions will be mostly linked to sovereign rating actions, or if economic fundamentals continue weakening, or if other systemwide risks arise that could worsen our current BICRA assessments.
Conditions In Argentina Will Remain Challenging At Least In The Short Term
Argentina’s banking sector continues to cope with soft economy. We expect GDP growth of about 0.5% in 2015 and no growth in 2016, compared to a growth of 0.5% in 2014 during which the country entered into selective default. Under this scenario, we expect the sector’s loan portfolio to grow in line with inflation pace at 25%-27% in 2015, compared with 18% in 2014 and 30% in 2013. We expect sluggish economy and policy uncertainties, until the new administration is sworn in and provides more insight on how to grapple with economic malaise, to take a toll on the sector in 2016.
We expect the sector’s profitability to be lower in 2015 than in 2014, because it benefited from the weakening Argentine peso against the dollar during that year. In 2015, we expect revenues related to the banks’ exposure to the central bank’s securities to partly compensate for the latter’s measures to reduce foreign-currency exposure and to higher funding and operating costs. The latter consist of hikes in deposit rates and insurance charges and fixed medium-term rates for loans to the economy’s most vital segments, such as agriculture. In this sense, the banks’ exposure to the central bank’s securities, which currently accrue rates of about 27%, accounted for about 18% of total assets as of July 2015, up from about 10% at the end of 2013. We expect the sector’s return on average assets (ROAA) to remain at about 3.5% in 2015 and the 3% area in 2016, down from 4.1% in 2014.
Despite Argentina’s tough economy, domestic banks’ asset quality metrics remained stable with past-due loans at 1.7% of total loans as of August 2015, compared with 1.8% at the end of 2014 and 1.5% at the end of 2013. We expect this metric to rise to about 2% or slightly above in 2016 because business conditions and real salaries will remain in a slump amid the rising unemployment rate. This scenario is likely because about 57% of the sector’s loans are with individuals.
Asset Quality Will Influence Brazilian Banks’ Performance In 2016
Asset quality among all Brazilian took a beating in 2015, both in retail and wholesale segments. The smaller banks are more vulnerable to this trend due to their narrow business scope. On the other hand, the country’s largest banks are more resilient. They compensated for rising credit losses through higher fees and margins thanks to business diversification and ability to quickly reprice the spreads of their fundamentally short-term portfolios. These large players can withstand currently difficult credit markets and have a proven track record in Brazil’s past economic/financial crises. Higher interest rates also bolstered all Brazilian banks’ returns in 2015 and should continue to do so in 2016. Nevertheless, lending growth pace in Brazil has continued to slow: less than 8% at the end of the third quarter of 2015, compared with 13% in 2014, 15% in 2013, 22% in 2012, and 40% in 2010. These numbers underscore the peak of the country’s credit cycle that started before the 2008 global financial crisis. We’re particularly concerned about the market share gains among public banks, loans from which currently account for 54% of total credit in Brazil, up from 42% in 2010. Moreover, these banks continue to account for two-thirds of all monthly credit origination in the country.
While ratings on these banks are mostly closely linked to the sovereign, we view these entities incurring a sharply higher risk in their portfolios than their private peers. Their nonperforming loans (NPL) ratios are lower than those of large private banks. However, that’s mostly due to a much faster growth pace that dilutes the impact of bad loans and due to monopoly of the payroll discounted loans to public employees. Still, both private and public banks continue to seek growth mainly in payroll discounted loans and those to large corporations and exporters, while shifting away from vehicles, small- to mid-size enterprise (SME), and other retail loans. The growth in mortgages also significantly decelerated in 2015, as tighter credit for this sector began to squeeze home prices. We expect these trends to continue in 2016, with slow to modest credit growth mainly among public banks, which we believe will continue to distort the market. We revised our economic risk trend to negative from stable in our BICRA analysis of Brazil during 2015 to reflect this scenario, the outlook revision on the sovereign to negative, and absence of any Brazilian bank with ratings higher than those on the sovereign. The latter is despite the fact that most private banks’ stand-alone credit profiles are above the sovereign ratings.
Chile’s Banks Are On Stable Footing Despite Slowing Economy
We expect Chile’s economy to remain weaker than historical levels amid less favorable global economy and commodity prices. We expect GDP to grow 2.1% for 2015 and 3.0% in 2016, compared with 1.9% in 2014 and the 5.2% average for 2011-2013. Under such scenario, we foresee the domestic banking sector’s loan portfolio to grow 7%-9% in nominal terms in 2015 and 9%-10% in 2016, compared with 11% in 2014. Such a slower growth pace than those of its regional peers points to Latin America’s highest credit penetration in Chile, with credit as a percentage of GDP of about 80%, followed by Brazil with about 55%.
Inflation remained high in 2015 at the expected level of 4.6%, the same as in 2014, due to the impact on domestic prices amid the Chilean peso’s slide, which was mitigated by lower oil prices. We expect inflation to decline to 3.3% in 2016 due to stabilization of the exchange rate to about CLP690 per dollar by the end of 2015 and to about CLP675 in 2016, compared with CLP607 as of the end of 2014. The higher inflation should help banks’ profitability, given their structural higher position of indexed currency assets (Unidad de Fomento) compared with liabilities. In this sense, we expect the sector’s ROAA to remain at 1.2%-1.3% for 2015 and 2016.
We expect banks to maintain adequate asset quality despite slower economy and credit growth rates in 2015 and 2016. Nonperforming assets (NPAs) slid to 2.0% of total loan portfolio as of August 2015 from 2.1% at the end of 2014 and the 2.2% average for the past three fiscal years. We expect delinquency levels to increase but remain below 2.5% in 2016 amid sufficient provisioning levels. The weaker Chilean peso has mitigated the shock of higher interest rates and lower economic activity among the country’s exporters. We foresee the unemployment rate to rise but stay at manageable level as workforce shifts from the mining sector to those devoted to the reconstruction of areas that suffered from the September 2015 earthquake. As a result, credit losses in the retail segment should remain moderate. We’re monitoring the development of the new labor legislation, given its potential impact especially on the SMEs, which are the largest employment generators.
Financial regulators are likely to send a draft of a new banking law to Congress by the end 2015, which would touch aspects on Basel II and III implementation, resolution regime, and the supervision of banks. Upon the law’s passage, we will assess its impact, more specifically the new capital buffers and government support during the financial crisis.
Colombian Banks Will Struggle Amid Weakening Credit Conditions
Total loans in Colombia expanded by about 15% in 2014. Although we expect a slower pace of growth for the remainder of 2015, we believe it will still be in double digits. We forecast that the Colombian economy will slow this year because of weaker domestic demand and the impact of lower oil prices on investment in the country’s energy sector. This in turn will weigh on the lending growth pace for 2015. We expect real GDP growth of about 2.5% in 2015 and to pick up to 3.0% in 2016 and 3.5% in 2017, down from 4.6% in 2014. We expect credit expansion of 14%-15% in 2016 because of increased dynamism in the economy and as the government will roll out its major infrastructure investment initiative (the 4G highway project), assuming the successful arrangement of financing for it late this year.
In our opinion, the Colombian banking system’s profitability would remain adequate in 2016, despite higher funding costs stemming from a potential hike in U.S. interest rates. This is due to the system’s relatively low dependence on dollar-denominated funding–and an already executed 75-basis-point hike in domestic interest rate to 5.25%. We estimate the system’s return on assets (ROA) will be about 1.6% in 2016. In our view, the high share of deposits in the banks’ funding, which is a cheaper source, will also allow banks to maintain adequate profitability. However, funding is a potential risk. Although we expect credit growth to slow down this year, deposits in the system will likely grow at an even slower pace. This, along with the relatively low share of retail deposits in the banking system, could expose Colombian banks to external shocks that could squeeze wholesale funding markets.
Despite rising household debt levels, we expect the Colombian banking system will maintain sound asset quality in 2016 as a result of the likely moderate loan growth and prudent underwriting standards. In addition, labor conditions will be relatively stable, with an unemployment rate between 9.8% and 10.0% next year. Credit losses will likely represent about 1.5% of total loans in 2016. In our opinion, Colombian banks’ capitalization will keep lagging behind their Latin American peers’. This reflects the aggressive growth strategies among the largest banks for the past few years, and the steep depreciation of the domestic currency. Their relatively lower RAC ratios also reflect the large amounts of foreign currency-denominated goodwill on their balance sheets resulting from acquisitions.
Rapid Credit Growth Could Elevate Risk For Mexican Banks In 2016
In our view, the accelerating lending growth in Mexico could heighten the risks for the financial system, especially as SME and consumer loans continue to gain traction within the mix. We view these segments as more susceptible to economic downturns. Sustained double-digit growth in the Mexican financial system could pressure our assessment of economic imbalances and credit risk in the economy and, consequently, of our ratings on banks.
Credit growth in Mexico continued to gain pace during the third quarter of this year, and we currently expect it will reach 15% for 2015. This recent uptick is mainly due to greater credit demand in the commercial segment, particularly the expanding tourism and manufacturing sectors. As we expected, the volume of SME loans continues to grow at a fast clip thanks to the government’s guarantee programs for this segment. Consumer loans are also picking up, and we expect them to maintain this trend for the rest of the year, especially considering the local “Black Friday” during November. Bank loans to government enterprises, such as Petroleos Mexicanos and Comision Federal de Electricidad, are also accelerating, bolstering overall credit growth. We expect lending to expand 15%-16% in 2016 amid improving economy, tighter liquidity markets, and increasing demand for bank loans to substitute for market debt. We also expect mortgage lending will maintain double-digit growth as homebuyers continue to take advantage of historically low interest rates for these loans stemming from stiff competition and mortgage portability. Finally, we expect consumer loans to grow about 10% in 2016, up from 6% in 2014 amid the robust labor market and improving consumer confidence.
Asset quality continued to improve in 2015 in line with our expectations as the impact of losses–from fraudulent loans to Oceanografia and from defaults of the three largest Mexican developers–recedes and as lending grows. In our base case, NPAs and credit losses should continue to decline in 2016 as economic prospects and labor markets remain favorable. However, as we stated before, increasing SME and consumer loans in the mix could expose Mexican banks to an economic downturn.
Panama’s Banking System Should Remain Resilient In 2016
After Panama’s economy expanded at a 9.8% annual average in 2011-2013, the pace decelerated to 6.2% in 2014. The slowdown was due to the shrunken activity in Colon’s Free Trade Zone, and in public infrastructure, construction, and agricultural sectors. As a result, we’re forecasting GDP growth of 5.5% in 2016. Consequently, our baseline scenario is a 9%-10% credit growth in the Panamanian banking system in 2016, after several years of double-digit growth. We also believe that banks will have to cope with lower structural economic growth that will keep a lid on credit demand.
Panama’s banks have consistently posted solid asset quality indicators, and we don’t expect a significant increase in NPAs related to slower economic activity. We forecast NPAs at about 1% and credit losses to be below 1% in 2016. We believe prudent underwriting and collections standards restrained these two metrics. As such, we expect low provisioning, at 6%-8% of total revenues, will continue to support bottom-line results in 2016. We forecast ROAA at about 1.6%, while there’s little room to improve net interest margins given high competition.
Certainly the Panamanian banking system faces challenges in 2016. The Financial Action Task Force’s 2014 placement of Panama on its “grey list” illustrates the vulnerabilities in the regulatory system. While the government is working intensely to remove Panama from that list, we will see in February 2016 if that will occur. Otherwise, this could have broader implications on the banking system and could further delay the implementation and adoption of Basel III guidelines. Although banks have modest exposure to commercial real estate, we expect vacancy rates to remain high in 2016 which could, in turn, increase price volatility in this sector.
Peru’s Banks Will Continue To Face Significant Economic Risk In 2016
We believe that economic risk for banks operating in Peru has increased in 2015, and it will remain so in 2016. Economic growth has slowed significantly since 2014 to 2.4% from more than 5% in previous years because of the weak public-sector investment and private consumption. We expect growth be 3.5% and 2.4% in per capita terms in 2016, which will delay Peru from catching up to its more developed peers in the intermediate term. Credit growth has slowed since 2014 as well, but it continues to add more than 2 percentage points to leverage (credit to GDP) annually. We expect loan growth to be 10%-12% in 2016. We have lowered our growth projection for loan growth because we believe available funding in domestic currency would contract, increasing the risk of economic imbalances.
Although we forecast credit losses to rise in 2015, we believe they will start to stabilize in 2016. Credit losses have been growing during the past three years primarily due to poorer credit quality among SME, microenterprise, and consumer loans. Micro and small enterprise portfolios grew rapidly in 2011 and 2012, and resulted in somewhat weaker underwriting by incorporating new clients with poorer payment capacity. Over the past two years, financial institutions have tightened underwriting standards in these lines, thereby substantially reducing growth and the burden of written-off bad loans. However, mid-size enterprises and consumer portfolios picked up rapidly in 2013 and 2014. Therefore, we expect to see some weakness in these loans in 2016. Consequently, we expect NPAs at 3.1% and credit losses at 3.1% in 2016.
For the past two years, the system’s overall profitability has been sound, but we expect it to be slightly impacted in 2016 by deteriorating asset quality that could result in increased provisions. Nonetheless, we expect ROAA to be at about 2%, which would be higher than those of regional peers, but it will certainly be lower than in previous years of more than 2%. High competition is also slightly pressuring net interest margins, but the domestic loan portfolio’s share of higher-return asset classes, such as microfinance and SMEs, will alleviate such pressures in 2016.
We expect Peruvian banks’ exposure to external funding to remain either unchanged or to slightly drop in 2015 and 2016. Furthermore, we expect the central bank to continue providing liquidity in Peruvian Nuevo Soles to domestic banks throughout 2015. However, we believe the central bank will gradually withdraw this support as dollarization levels in the system fall. Dollarization (in loans) has dropped consistently in the past decade, particularly in the last year, but remains relatively high–about 34% of total lending as of June 2015. We estimate the central bank intends to reduce foreign currency lending to 25%-30% of total loans.
Existing Risks Will Stick Around In The Next Year
We expect Latin American banks’ performance to hold up in 2016. This is despite the slowing or contracting economies in the region. External shocks–in the form of higher U.S. interest rates, low commodities prices, and China’s slowing economy–will weigh on Latin America’s economies and consequently could take a toll on banks. Lending growth pace will moderate, except in Mexico, raising risks for domestic banks. We will be monitoring for signs of weakening–or a further slide in–asset quality among banks in Brazil, Argentina, and Peru. Banks in Chile, Colombia, and Panama are likely to post stable performance despite slowing economies in both countries.
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We have determined, based solely on the developments described herein, that no rating actions are currently warranted. Only a rating committee may determine a rating action and, as these developments were not viewed as material to the ratings, neither they nor this report were reviewed by a rating committee.
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- Latin America Buffeted By Winds From China And Brazil, Oct. 15, 2015
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- Top 100 Banks: Risk-Adjusted Capital Ratios Continue To Differentiate Banks, Aug. 11, 2015
- Higher U.S. Interest Rates Could Be Bittersweet For Mexican Banks, Aug. 4, 2015
- Would A Potential Rise In U.S. Interest Rates Add To Brazilian Banks’ Dilemmas?, July 30, 2015
- As Credit Growth Eases, Asset Quality Should Be The Focus For Latin American Banks, July 22, 2015
- Will Peru’s Banking Sector Become Dependent On Central Bank’s Funding?, July 15, 2015
- Mexican Banks’ Profits Are Strong Enough To Absorb Their High Credit Losses, July 14, 2015
- Economic Slump Will Largely Bypass Large Latin American Banks But May Take A Toll On Their Smaller Peers, July 9, 2015
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- Mexican Banks’ New Liquidity Requirements Will Boost Transparency But Don’t Affect Our Assessments, March 11, 2015
|Primary Credit Analyst:||Arturo Sanchez, Mexico City (52) 55-5081-4468;
|Secondary Contacts:||Edgard Dias, Sao Paulo +55 (11) 30399771;
|Alfredo E Calvo, Mexico City (52) 55-5081-4436;
|Jose M Perez-Gorozpe, Mexico City (52) 55-5081-4442;
|Ivana L Recalde, Buenos Aires (54) 114-891-2127;