Rapidly cooling demand for credit and increased concerns about asset quality have led Moody’s to lower the outlook for Paraguay’s banking system.
Banks in Paraguay have had a good run in recent years as rising demand for credit exceeded strong GDP growth. However, the economy has slowed, from 14.2% in 2013 to the 3% expected for this year, largely driven by the slowdown in neighbouring Brazil, which has exacerbated the fallout from the country’s narrow-based economy. Loan growth is expected to be just 9% this year, down from 20.7% last year.
“Net margins will continue to narrow,” says Moody’s analyst Alexandre Albuquerque, who is based in Sao Paulo. “Banks are focused on managing a slowdown in credit demand and on preventing a more pronounced rise in problem loans. As a result, they will not likely be able to offset their rising funding costs with increased lending rates. Instead, many lenders have been offering high-quality borrowers more favourable terms, which could lead to a slight decline in overall lending rates.”
The problem loans Albuquerque refers to go beyond the increase in system-wide NPLs, which have risen from 1.8% at the end of 2014 to 3% in June 2016. Beyond this, banks have been increasingly renewing and restructuring loans, which combined now account for 17% of bank loans at the end of June 2016, compared with 11.8% (also end 2014). Renewed loans, which include loans that were up to 60 days past due when their tenors were due, increased to 14% from 10.7% in that period, while restructured loans rose to 3% from 1.2%.
“Banks remain heavily exposed to the performance of the agribusiness sector, which continues to face liquidity strains,” according to Albuquerque. “However, asset risks may be higher than reflected by the delinquency ratio as banks have started actively to renegotiate loans, especially in the agriculture industry.”
The drop in global soy prices has fuelled a steady rise in problem loans, and the outlook is for a further weakening of loans to the agriculture and consumer segment. Soy beans account for 42% of Paraguay’s total exports. According to data from Paraguay’s central bank, 22.8% of banks’ loan exposures are related to agriculture (not including the 10.2% to the cattle raising industry, which is also expected to suffer fall out from depressed demand for beef from Brazil due to its neighbour’s recession). There has also been a ripple effect from these leading sectors; consumer loan NPLs rose to 5.9% in June 2016 from 4.1% at the end of 2014.
Net margins will continue to narrow. Banks are focused on managing a slowdown in credit demand and on preventing a more pronounced rise in problem loans.
- Alexandre Albuquerque, Moody's
Paraguay’s banking system is expected to pass the coming solvency test, but there are areas of clear weakness: reserve coverage is already insufficient to cover problem loans in many asset classes and a sharp deterioration in loan performance compromises banks’ capital ratios. The system’s tier-1 ratio at December 2015 was 11.6% – well above the 8% regulatory minimum – but specific banks have reported sharp falls: Banco Amambay’s capitalization (tangible common equity/risk weighted assets) fell from 18.2% in December 2014 to 10.8% in December 2015 (the last reported figure), while BBVA Paraguay also slipped from 11.8% to 10.5% in the same period.
The banking system also has a high degree of dollarization, with foreign currency loans representing 48.6% of total loans in June. A report by Juan Carlos Barboza at Itaú, notes the sharp local-currency slowdown in deposits and loans denominated in Paraguayan guarani. Private sector deposits grew by just 1.3% year-on-year in July, down from 15% in the same month of 2015. Similarly, loans denominated in local currency grew by 12%, down from 20%. However, most dollar-denominated loans are extended to corporates in the agriculture and cattle industries, which have a natural hedge through dollar-denominated revenues. This is an added challenge for Paraguay’s banks’ net interest margins, given local currency lending carries average yields of 12.5%, compared with 6.7% for foreign currency lending.
However, Barboza sees signs that the government’s policy of diversifying the economy is paying off and he recently upgraded his expectations of GDP to an above-consensus 4% for this year, from 3% previously. The government has been fostering the development of light industry, given its competitive position regarding cheap and abundant hydroelectric energy – as well as expansion in the construction and infrastructure sectors.
Weak loan growth will lower interest income generation and will be the main driver behind a decline in profitability over the next 12 to 18 months. However, Albuquerque says: “Banks will also face a host of other profitability pressures, including rising funding costs and credit costs, and diminished pricing power stemming from the drop in credit demand.”
NIMs are also likely to continue to narrow, given banks’ focus on managing the slowdown in credit and preventing further deterioration in their loan portfolio. This will also feed into a further weakening of the system’s efficiency ratio, which has risen to 53.8% in December 2015 from below 50% in 2011, driven by weakening interest income in the face of stable personnel and administrative expenses and, in some cases, IT expenditures.