Argentina’s banks are facing a difficult transition period as the government and the central bank (BCRA) attempt to lower inflation and the country’s base rates, as well as facing subdued credit demand thanks to the economic recession.
The banks also have high valuations, caused by the exuberance of investor confidence after President Macri won power, that has led to most equity analysts having neutral or sell ratings on the country’s large banks. In the first six months of 2016 an index of Argentina’s banks gained 14%, a clear underperformance relative to the MSCI Latin Banks, which increased by 46%.
However, there are already signs of economic normalisation and other positive factors, such as Argentina’s likely re-inclusion in the MSCI index in 2017 and a possible wave of consolidation in the sector, mean that banks could still outperform in the near term.
Demand for loans, consumer and business, has been tracking below inflation in 2016. The most recent central bank data (for April) showed loan growth of 32.6% – negative in real terms as annual inflation was still tracking at 44% in June. However, the short-term data points to a quick fall-off in inflation: month-on-month results are down to 2% in August and, with the Supreme Court barring the government’s increase in energy prices, Goldman Sachs predicted that the legal decision “may bring August inflation close to zero” (albeit temporarily).
This slowdown in inflation will have the positive effect of turning loan growth positive but the central bank’s aggressive stance on cutting interest rates adds a further complication. Despite moving to an official inflation-targeting regime in 2017 the bank still has multiple mandates that incentivize it to reduce rates to foster growth and remove FX pressures.
On August 31, BCRA took advantage of falling inflation to cut the base rate to 28.25%, down 975bp this year. This is having an effect on net interest margins, which, at a system average of 10.7% in the first quarter of 2016, are still one of the highest in the world.
The impact of the cuts to the financial system’s interest rates will be uneven: Frederic de Mariz, banking analyst at UBS in Brazil, estimates that every 5% reduction in the Lebac rate (short-term central bank securities) reduces banks’ earnings per share by about 5%, and more so for banks that are reliant on ‘the float’ (investing cheap deposits into high yielding securities), such as Banco Macro and BBVA Francés. Others, such as Galicia, that have a larger source of deposit funding and reliance on fees will be better positioned for the normalisation process.
Round of consolidation
Analysts say that the stress on business models could also lead to a round of consolidation in the banking sector – especially as the larger banks are able to lower their cost of financing by tapping the international markets. There are market rumours that Citi is looking to sell its operation in the country for between $180 million and $250 million and the deal could spark further M&A deals in the sector.
“Decreasing inflation will go hand in hand with margin compression,” says de Mariz. “Lower margins will lead to consolidation as less efficient banks are forced out of business.”
Most agree that 2017 will still be a transition year and growth in real terms may not come until later (especially as rising unemployment clouds demand for credit). The longer-term opportunities seem brighter: the country has the most underpenetrated banking sector in Latin America, with loans-to-GDP at 13%, and with consensus forecasts of GDP growth of between 3.5% and 5% a year from 2018 the opportunity for growth is significant. Only 30% of Argentineans have a bank account.
Regulations have also started to be dismantled, with mandated interest rate floors and ceilings for different segments being dismantled and more bank-friendly regulation is expected in the next 12 months.
Analysts say beyond the short term issue of valuation the longer-term opportunity looks sound, just as long as the country, and the banking system, successfully ride out the political and economic challenges of 2017.