Latin America’s banking system was no stranger to breakdown even before the Mexican peso devaluation spawned the tequila crisis. Even Chile, which has one of the region’s most solid banking systems, experienced a serious banking crisis in the early 1980s. Its banks then underwent massive state-sponsored shock therapy and are now completing a thoroughgoing consolidation.
That pattern has been repeated throughout the region to varying degrees. Although devastating devaluations or severe economic instability are often pointed to as the triggers for banking crises, the shaky foundations of national banking systems are more to blame. Poor asset quality, unfocused regulations, bad credit analysis and good old-fashioned corruption erode a banking system long before the walls finally crumble.
Still, if Chile exemplifies the pattern of banking reform in Latin America, golden days lie ahead. Once the shock treatement is over, Latin banking systems will rebound strong and healthy, ready to take on the new foreign competition. If they follow the Chilean example closely enough, Latin America will boast universal banking for the first time in the region’s history.
In a recent regional banking report, Santander Investment called the Latin banking crisis “an invaluable learning experience for bank managers, industry regulators and deposit holders.” The report concluded: “We also expect overall stronger and wiser financial institutions in coming years throughout Latin America as a result of the recent banking industry shake-outs.”
The tequila crisis stands out as the most recent of these shake-outs, one that mainly affected Mexico and Argentina. Although these countries are now clear of the systemic risks the crisis brought, recovery left their banking systems weak. However, now that the regulatory system is generally in order, both countries’ banks should grow steadily as their economies bounce back from recession. Argentina has already pulled ahead of Mexico in the recovery process. The Mexican system will be haunted by past-due loan portfolios for years to come.
As a region, Latin American economies grew 6.5% last year and 5% growth is predicted for this year. So far, both Argentina and Mexico have experienced slight increases in production, which signals a nascent recovery from the tequila-provoked recessions.
At this juncture, the key for Latin banks is high-quality growth. The region’s banks need to step forward without depending on high-risk lending. Although consumer credit is inadequately catered for throughout Latin America, the region’s banks should approach it with extreme caution. However, the allure of such high growth amid stiff competition may prove too strong. The stakes are high and credit control is crucial.
“The next area of rapid loan growth will come in consumer lending, which is by nature high-risk,” says Laura Bereja, team leader of the Santander Latin banking study. “As a result, credit controls will become all the more important.”
In general, any discussion about the risks of asset growth should be limited to individual countries, and then to the separate tiers of a banking system created by ongoing and recent consolidations. For instance, Chilean banks have grown rapidly without any asset-quality problems. In contrast, Mexican assets skyrocketed in the 1990s with little rhyme or reason. Within a system, as a rule, the larger, stronger banks have the flexibility to move into the consumer lending market. Smaller banks run a higher risk.
Mexico: a long way to go
The tequila crisis hit Mexico hard. In 1995, past-due loans rose 89.5% in dollar terms. Although government support helped reduce the problem, past-due loans will continue to hamper Mexico’s slow-growing economy, especially under the new quasi-US GAAP accounting standards which begin in the first quarter of this year.
“You really don’t have a normalized banking story in Mexico yet,” says Ethan Heisler, fixed-income banking analyst at Salomon Brothers. “There’s been no significant levelling in non-performing loans.”
Under the previous Mexican accounting standards, because of government debt-restructuring programmes and, to a lesser extent, a slight increase in debtors’ cash flows, non-performing loans fell 30% last September from the high of September 1995. As a result of these efforts, the proportion of non-performing loans in the entire system fell to around 7%. If the non-performing portfolios of the 11 institutions in which the government intervened were included, the proportion would rise to 12%. Loan-loss provisions worth Ps19 billion ($2.44 billion) were created by the third quarter last year, which translates into a 91% coverage. If banks that were intervened in are included, it drops to 86.3%.
However, by the first quarter of this year, Mexican banks are required to report quarterly results using a new method that is much closer to international accounting standards. The new standards are expected to have an immediate impact on the amount of past-due loans reported. Under the old method, Mexican banks would only report the unpaid portion of a loan.
Once the new standards take effect, banking income and profits are expected to fall this year. Salomon’s Heisler reckons that once what he calls the “Tex-Mex” accounting figures kick in, Mexican banks will report up to 25% non-performing loan ratios.
Although Argentina’s banking system has almost finished its recovery, Mexico will feel a little hung over for years to come. Because of long-term loan sales to the government in which the banks assumed 20% to 25% of the risk, Mexico’s banks will not be totally free of the tequila crisis for quite some time.
Last September was the official end of the government’s Ps13 billion debt-support programme which subsidised consumer and mortgage debt. At that point, Mexico’s banks, which the government underpinned for more than a year, were supposed to be on their own. However, while the debt-support programmes may be finished, the government has continued to help the banks capitalize through loan sales, most recently to the country’s two largest banks, Banamex and Bancomer, in January.
Earlier this year, the two banks, which have a 43% market share of deposits and loans, announced the sale of Ps8 billion apiece of non-performing mortgage loans to the government. In a mechanism similar to the one used for commercial loans for the past two years, the central bank’s savings guarantee fund, Fobaproa, will pay the banks with 10-year notes that are guaranteed by the government and capitalize interest.
For their part, the banks will increase their capitalization by Ps4 billion each this year. In addition, both banks will keep 25% of the downside risk of the sold portfolio. The loan sale reduces non-performing loans in each bank by one-third under the new international accounting method.
Overall, Mexican society has paid a high price to stabilize its banking system. The rescue cost around 12% of GDP in 1995 and an estimated 8.5% last year. Analysts expect the last remaining capitalizations to consume 6.3% of this year’s GDP. All told, the government bought 22.8% of the 1994 net assets of the system and injected capital worth 15% of the entire system.
Fobaproa capitalizations
The government acquired around 42% of the Ps315 billion of assets in its possession through the Fobaproa capitalization programme. The other 58% corresponds to institutions in which the government has intervened and those under special administrative control.
The crisis claimed the lives of 11 institutions. Some were subjected to government intervention, some were merged and others were sold, or are about to be sold. They include Banco Union, Banca Cremi, Banpais, Inverlat, Banco del Centro, Banco Oriente, Banco Obrero, Banco Interestatal, Banco del Sureste, Capital, and Promotor del Norte. This month the government will start to auction some of those assets in a $40 billion sale expected to last three years. The office of the valuation and sale vehicle (VVA) will organize a US-style savings and loan liquidation sale through straight asset sales, equity offers and securitizations.
The banks have also paid dearly for their survival. By mid-1996, capitalization of the system grew from 8% to 14.5% while loan-loss provisioning increased from 45% to 92%. According to the Mexican banking and securities commission (CNBV), in the last two years system-wide capitalizations have amounted to Ps63.7 billion, a 158% increase on 1994 levels.
Repeated capitalizations have diluted the traditional family networks of bank owners to the point where foreigners now sit on several boards. Further, post-crisis regulations about moral hazard are making it much harder for the previous bank owners to operate in their traditional ways. When former president Carlos Salinas de Gortari privatized 18 commercial banks by 1992, many landed in the hands of large corporations that treated them as their personal financing coffers.
The bleeding of the system is not over. In the last two years, Banamex has sold 20% of its assets to Fobaproa. Banamex’s upcoming capitalization for $500 million will induce a 14% dilution. In addition, the bank plans partial disinvestments as well as subordinated convertible issues later in the year.
Last December, Banamex completed the Ps8 billion capitalization programme which the government initiated in 1995. The bank has restructured some 40% of its portfolios. Banamex recently created “mega” reserve coverage for $830 million, which raised its loan loss coverage to 165% of what was reported under the old accounting system. The institution counts with a 13.1% capitalization index.
Other upcoming capitalizations include those by Banco International (Bital), GBM Atlantico, BanCrecer, Confia, Promex, Industrial and, most important, Banca Serfin.
Last December, Bital started to negotiate a $675 million loan with a foreign bank, which concludes the bank’s second capitalization programme. GBM Atlantico agreed to sell Ps2 billion worth of loans to Fobaproa. In return, the bank raised Ps390 million in non-subordinated convertible debt and Ps500 million in convertible debt.
Bancrecer planned a Ps400 million capital increase that would enable it to sell Ps800 million in loans to Fobaproa. Confia is planning a $250 million capitalization with a Fobaproa sale and equity offer later this year. The US-based Principal Group is said to be a prime participant in these sales.
Serfin: last but not least
Later this year, both the Guadalajara-based Promex and Banco Industrial plan to sell participations to foreign associates. Industrial will boost its capitalization from 15% to 16% through domestic capital increases as well as a sale to a foreign institution, while Promex will sell a 20% share to a foreign bank.
And last, but certainly not least, Serfin, Mexico’s third-largest bank, is still working through its massive capitalization. Salomon’s Heisler views the government’s support for the bank with a 13% market share of deposits as crucial to its viability. Despite the constant efforts, he does not expect the bank’s credit profile to improve without dramatic fundamental changes in credit quality, capital and earnings.
Still, the bank has made some progress. By September 30 last year, its past-due loans were $22 billion less than at the same period in 1995. However, given the overall reduction by $9.5 billion in total loans, non-performing loans as a percentage of related assets increased from 7.7% in the third quarter of 1995 to 8.9% in the same period last year. During that time, Serfin increased loan-loss reserves to 9.1% of total loans, which equaled 103% of past-due loans.
Serfin’s ongoing yard sale, which includes the auction of its leasing company as well as the upcoming sale of a 20% participation, should be completed by the end of the year. As Euromoney went to press, HSBC was in heated negotiations with Serfin.
Given such activity, investors can expect pick-up opportunities for both Serfin’s equity and bonds, except subordinated debt. “There’s a tremendous opportunity for bottom-fishing right now,” says Heisler. “But in terms of fundamentals, we still see support of the government and foreign participation as important in the creation of a solid system.”
Foreign foothold in Mexico
The dramatic capitalizations of the past two years have certainly changed the face, and even the accent, of the Mexican banking system. Of the 18 banks reprivatized by former president Salinas, 13 still exist, and of these three are under the control of foreign investors. Before the foreign takeovers, the government exchanged unsavoury portfolio for capital injections in an effort to sweeten the deals.
Spanish bank Banco Bilbao Vizcaya (BBV) owns the mid-sized former Probursa financial group. Banco Inverlat is controlled by Fobaproa and administered by Canadian bank Bank of Nova Scotia. Spanish bank Santander bought 75% of GF Invermexico, which controls the country’s fifth-largest bank, Mexicano. The new Santander-Mexicano controls 247 branch offices. Bancomer has an alliance with Travelers Group to expand the bank’s consumer credit operations.
In the most recent incursion, US company GE Capital aquired Banco Alianza for Ps210 million. In addition, BBV bought 159 branch offices of the intervened Banca Cremi and Oriente banks. After the buying spree, BBV now has 308 branch offices throughout Mexico and has the fourth-highest amount of deposits.
Local mergers and acquisitions are another part of the consolidation picture. Last year, the Banco del Centro was taken over by the Monterrey-based Banorte. Guadalajara-based Promex bought the offices of the intervened Banco Union. Banpais is on the auction block right now. Next Fobaproa plans to rid itself of the remaining intervened institutions, Sureste, Capital, Interestatal, Pronorte, Obrero and Anahuac later this year.
Despite the continuing inflow of foreign and government capital into the country’s banks, as a whole the system has not resumed lending. After all the sweat, suffering and government support, the Mexican public expected flows of new credit to the starved economy. Unfortunately, in the last year the banks have not been able to do very much lending. Mexican banks have been licking their wounds for two years, with little or no capacity to lend to the private economy. Those assets that have increased constitute mostly restructured credits that capitalize interest.
By the third quarter last year, overall assets fell 19%. Last year, most industries turned to cheaper financing in the money markets instead of the banks. Indeed, last year the Mexican banking system made more of its income on the stock exchange than through credit, notes one economist. In contrast, foreign institutions registered a 66% increase in their assets during the same period.
Overall, the financial margins of the banking system fell some 37% from 1995 because of the general high-interest environment among other factors. In the third quarter, operating costs outweighed income which caused a negative operating earning of Ps903 million. Serfin was the biggest loser in the third quarter with Inbursa reporting the highest profits with the widest margin.
Past-due loan coverage has cost the banks liquidity. Meanwhile, loans outstanding are still diminishing in real terms as inflation keeps lending and funding costs high. According to US rating agency Standard & Poor’s, the Mexican banking system is still too weak to grow substantially. “Banks’ ability to lend in real terms continues to be constrained, with only a few institutions with flexibility to grow,” noted Standard & Poor’s in a recent report.
On the other hand, the CNBV recently announced that the country’s banks “now have the liquidity and the capital to reinitiate credits”. One leading Mexican banker recently estimated that the banking system will pump some $20 billion of credit into the economy this year, which coincidentally is about the same amount of cash the government has pumped into the banking system for the past two years.
Some analysts believe banks are starting to reactivate credit from the wrong side. While the productive plant is starved of reasonably priced credit, some banks have created credit programmes for the purchase of computers and new auto financing as well as credit cards. Representatives of the country’s productive industries have loudly complained about the banks’ consumer-oriented approach since they believe credit should be targeted at overall economic recovery.
In short, in the past two years Mexican banks have had their hands full. They not only fell victim to one of the worst economic crises to date, but also to increased foreign competition and the challenge to meet international accounting standards.
In the long run, the CNBV hopes the standardization will bring genuine transparency to Mexico’s obfuscating reporting. In the fourth quarter of last year, Banamex was the first bank to report under the new accounting standards, even though it had a three-month grace period. Bancomer is expected to follow suit. Although several banks gave examples of how their fourth-quarter figures would look under the new accounting system, they still officially reported under the old method.
In anticipation of the new method, most banks increased provisioning last year as “preshock treatment,” notes Debbie Moronese, a Latin banking analyst with Thomson Bank Watch.
Responding to competition
Under the new standards, Banamex reported an 18.3% past-due loan ratio for 1996. Consequently, the bank made provisions of Ps2.3 billion in the fourth quarter for loan-loss reserve coverage. As a result, Banamex reported a pre-tax income of zero and a net income of Ps939 million for the year, a 32.6% drop in net earnings from 1995.
With the advent of serious foreign competition, Mexico’s banks need more than ever to increase their deposits to maintain their market shares. So far they have responded with publicity campaigns, new branch networks, packages and outreach. By the third quarter last year, the country’s banks had increased branch offices from 4,790 in September 1995 to 5,227.
The giants Banamex and Bancomer are also starting to diversify into telecommunications, insurance, and pension fund management. In competition for the country’s long-distance telephone market, Banacci, the financial group that owns Banamex, is a participant in Avantel while Bancomer is an associate of Alestra.
Such investments should further establish the two banks’ leadership positions in universal banking. Meanwhile, the mid-sized banks such as Banorte and Inbursa will develop their niches as smaller banks are swallowed in the consolidation process.
Argentina: substantial advances
Both through dire necessity and initiative in the last decade, Argentina has advanced considerably in its economic reform programmes. The convertibility plan, which gives the Argentine peso dollar parity, helped to internationalize the country’s banking in one giant step by bringing home some of the $61 billion in Argentine offshore money. In addition, Argentina has developed one of Latin America’s most sophisticated regulatory systems.
The tequila crisis had swept $20 billion in deposits out of the country by May 1995. The run on deposits accelerated Argentina’s consolidation process as 30 banks were sold at bargain prices.
The subsequent increases in interest rates particularly weakened provincial and wholesale banks. In order to stem the flood, the central bank adopted emergency measures, including the creation of two stabilization funds. The Argentine congress also granted the central bank wider powers to limit systemic risk and created a private insurance deposit fund. Last year, the central bank established a $5 billion back-up loan facility with foreign institutions as an emergency measure against any future crises.
In all, the crisis served to accelerate the banking system’s consolidation and to fine-tune banking regulations to decrease the risk of systemic failure. Unlike Mexico’s crisis management, the Argentine banks are not expected to experience significant dilution. And Argentine banks can afford to lend as the economy recovers.
Banking consolidation has been more dramatic in Argentina than in Mexico. Since 1994, the number of banks operating there has dropped from 170 to 125. In addition, in the wake of the tequila crisis, the market share of the largest banks, including Banco de la Nacion de Argentina, Banco de la Provincia de Buenos Aires, Banco Rio, Banco Galicia, Banco Frances, Banco Credito, Banco Roberts, and Bansud, benefited from a flight to quality.
In the past, flight to quality meant going to the two largest foreign banks in Argentina, the Banco de Boston and Citibank. However, since 1995, the largest 20 domestically-owned banks have benefited from an 11 percentage-point increase in their market share to 66%, compared with only a three percentage-point increase in deposit market share for the 30 foreign banks to 16%. As a result of this consolidation, the top 10 banks now account for more than half the deposits held by the private commercial banks.
Furthermore, Argentine’s provincial banks are in the middle of a slow consolidation although the federal government has little jurisdiction over these entities.
However, some clouds loom ahead. A sharp increase in the US interest rate, a depreciation of the Brazilian real, and the congressional elections in October pose potential risks this year.
Before the economy clearly registers a deceleration, Argentine banks are expected to increase lending through the second quarter. Economists expect Argentina to reach its 5% official growth target this year. In the next three years, Santander Investment predicts credit expansion will outpace GDP growth by 4.5 percentage points.
According to Santander, from June 1991 to June 1996, financial system deposits grew at a five-year compound annual rate of 36.1% while system loans increased by 18.9% compounded annually. During that period, US dollar deposits and loans displayed the highest growth at 41.2% and 32% respectively.
However, observers are wary of applauding loan growth. Although high-quality growth is preferable, Argentine banks may be targeting the more high-risk consumer lending. Such services are needed since loans to individuals constitute only 19% of total loans. The amount of desirable growth in this area depends on the bank in question. For instance, the large Banco Frances registered a 4.4% past-due loan ratio by June 1996, compared with a 12.9% ratio for the entire system.
“The quality of bank’s credit scoring and management information systems will become an increasingly important competitive advantage going forward,” noted the Santander report.
Argentina is in the process of developing another competitive advantage over its neighbours. This year its banks will be required to issue a two-year bond for 2% of total deposits every year. The measure was established to use the market to grade a bank’s performance through its bonds.
“The measure makes a lot of sense since investors will have a good indication about the banks,” says Pablo Burbridge, Latin banking analyst for Salomon Brothers’ equity research. Burbridge also expects the measure to accelerate the consolidation of the smaller banks in Argentina which might find it difficult to issue two-year bonds. The central bank will penalize those banks that do not issue bonds by increasing their liquidity or capital adequacy requirements.
The idea of harnessing the perceptions of the market to help regulate a domestic banking system is new in Latin America, says Burbridge. If it works, the measure could later be adopted throughout the region, he predicts.
Chile: the blue-chip system
Since Chile’s banking system collapsed in 1983, it has undergone a radical transformation to become the strongest in Latin America. After 12 years of consecutive economic growth, last year the Chilean banking system reported a 16.7% return on equity with a 1% ratio for past-due loans.
Significant consolidation and regulatory reform left a system in which about 69% of the market share is now concentrated in the top seven banks. In the latest consolidation move, two large bank mergers upped the ante in Chilean banking and created towering giants. Last year Santiago bank merged with O’Higgins bank to create the Grupo O’Higgins, the largest bank in the country commanding a 17.9% market share. In addition, Banco Santander merged with Banco Osorno and became Banco Santander Chile with a 13.4% market share.
Banco de Chile follows with a 12.2% market share. Next in line are Banco de Credito Inversiones (BCI) with 7.7% of the market and Banco de A Edwards with 7.1%. Banco Sur Americano counts with 5.7% of the market and Banco BHIF with a 5% market share. The Banco del Estado, savings and loans companies, and small foreign banks comprise the remaining market share.
As a result of this top-heavy structure, Chile’s three largest banks will be very efficient, with the rest lagging behind, says Valentin Carril, an economist and banking analyst at Santander Chile. Carril expects the large banks further to consolidate their positions as the mid-level banks establish specialized niches. BCI, for example, is targeting its services towards the middle classes, while Edwards has traditionally served the upper classes. There might be further consolidation in the lower tier, smaller banks as they are merged with foreign or larger domestic institutions.
In the rush to maintain market shares, Chilean banks are venturing into consumer lending. Such lending might affect past-due loan growth and subsequently provisioning. According to Santander, while reserve coverage on past-due loans is very strong, reserves on gross loans are among the weakest in the region: 2% compared with a 6.2% regional average.
The economy is expected to bottom out by the first quarter with a gradual recovery by the end of the year. Real GDP growth for 1996 is estimated at 6.7% and 5.7% for 1997, according to Salomon Brothers analysts. Inflation should fall to 6% this year. According to Salomon Brothers, the proposed $75 million budget cut augurs well for a 25 to 50 basis points cut in overnight rates. In general, economists expect an easing of interest rates by the first quarter.
Colombia: second place
Colombia remains on the blacklist of countries that the US deems not to be its allies in the international drugs war. Despite this and the risk of US trade sanctions, the Colombian financial environment should visibly improve throughout the year. Political stability is being established and loan demand, particularly in the commercial and corporate sectors, should be revived later this year.
According to Standard & Poor’s, Colombia has the second-strongest banking system in Latin America after Chile. “Continued system liberalization, recent privatization and increased foreign participation will lead to further consolidation,” notes Standard & Poor’s Latin analyst Victor Herrera Jr.
Standard & Poor’s recently initiated its public information (pi) ratings for seven Colombian banks including Banco de Bogota, Banco Industrial Colombiano, Banco Ganadero, Banco de Colombia, Banco Comercial Antioqueno and Banco Popular. Of those, the ratings agency gave the first three banks an investment grade of triple-B pi.
In the short term, increased competition from foreign banks will probably reduce margins. Last year, Banco Bilbao Vizcaya acquired a 40% stake in Ganadero’s voting stock, which was viewed positively in the market. Other banks, particularly Spanish ones, are expected to follow suit. In the medium term, asset quality issues and a commitment to investments in technology will present challenges to Colombian banks, notes Herrera.
Uncontrolled asset growth with little attention to quality control could consume some of the system’s strength later this year. From December 1993 to June 1996, past-due loans grew twice as much as loans. While loans grew 21.2% during that period, past-due loans grew at a worrying 44.5%.
If such a trend is not reversed, the cost in reserve coverage could erode margins. Still, past-due growth is extremely fragmented. In the first half of last year, for instance, the Banco de Bogota’s past-due loans grew 34% in real terms, while Banco Ganadero’s ratio dropped 4.6% with flat loan growth.
Peru: small but strong
Unlike Mexico and Argentina’s, Peru’s banking system is not expected to follow the consolidation course, although increased foreign participation is likely. The system is already quite consolidated. Banco de Credito, Banco Continental, Banco Weise and Interbanc dominate the market and provide a real challenge to growing foreign competition. Of the 22 private commercial banks these four account for 70.5% of total assets, 70.1% of total loans, 74.1% of deposits and 65.3% of capital. Salomon’s Heisler considers the Peruvian banking sector small with $16 billion in assets by mid-1996, but relatively strong within the region.
This is partly because foreign participation has forced faster modernization on domestic banks. The largest bank, Banco de Credito, which accounts for 29% of total deposits, has met the challenge head-on, and can now compete almost squarely with the foreign banks.
Further consolidation is likely to come in the form of mergers with foreign banks, particularly with Spanish institutions, Heisler says. Probable candidates include Banco Wiese, Interbanc and Banco Latino.
Secondly, the country’s regulatory system is based on the Chilean model, which bodes well for the future. In contrast to much of Latin America’s banking history, Peruvian supervision pays close attention to detail with as many as three examinations a year and weekly bank reports. Indeed, in some respects Peruvian regulations are stricter than US ones.
Still, analysts show some concern about the growth of problem loans as credit expands. According to Salomon Brothers, by the first half of last year the top-five banks registered an 8.85% ratio of past-due and refinancing loans to total loans. Bank assets grew 63% with a 51% increase in deposits in the same period.
Given such asset growth, the larger Peruvian banks are expected to issue debt in the future. Timing will be the big question this year. On the one hand, the Brady bond deal markedly improves the investment environment in Peru. On the other, the continuing hostage situation makes most issuers wary about going to market.
In addition, Salomon Brothers notes: “The occasional enthusiasm surrounding conversion of commercial bank loans into Brady bonds and potential Euro issuances will likely be moderated by fundamental and pricing developments.”
On the macroeconomic level, president Alberto Fujimori’s plummeting popularity could provoke him to accelerate economic growth. Growth slowed to 2% last year with little hope for much improvement this year. If Fujimori uses fiscal policy to ignite the economy, inflationary pressures could threaten interest rate and exchange rate stability.
