Both HSBC and Citi appear to have reached a line in their Latin America retreat: the southern border of Mexico.
In October, first Citi and then HSBC announced capital injections into their Mexican businesses, which were backed up by words of commitment to their presence in the country.
First Citi announced that it will rebrand its Mexico unit Citibanamex, while CEO Mike Corbat said the investment “reaffirm[s] our commitment to Mexico and our confidence in its prospects”.
Mike Corbat, Citi
Then HSBC’s director general Stuart Gulliver said its (smaller) capital injection “reflects our commitment to Mexico”.
The deployment of $1 billion in capital was described by Citi as the “strongest signal from management that the business is worth keeping in the long run”. The injection into the Mexican business is roughly 10% of the capital generated from the sales of its banks in Brazil (to Itaú Unibanco), Argentina (expected to be Santander) and Colombia (rumoured to be Bank Novo Scotia). This investment also follows a $1.5 billion injection announced in 2014.
HSBC has also sold many of its Latin American businesses, including its recent sale of HSBC Brazil to Bradesco.
Moody’s analyst Vincente Gomez describes Citi’s announcement as positive, saying it will “enhance its competitiveness by boosting its market position and operating efficiency, which is weaker than its peers”.
Citi’s cost-to-income ratio was 56.6% in June, well above BBVA Bancomer (41%) for example, mostly because of its relative reliance on a physical network. The capital injection, delivered in stages until 2020, will fund an enhancement in its digital banking platform to address its low efficiency ratio, as well as funding other IT projects, investment in its branch network and ATMs (adding 2,500 new cash machines to its existing network of 7,000) and better retail segmentation.
Citi’s decision to draw a line in its Latin American retreat at Mexico threw a gauntlet down to HSBC – the other universal bank pulling out of countries in the region. On October 11, HBSC responded with the announcement of $294 million-equivalent capital injection into its Mexican bank.
However, unlike Citi, which has always baulked at selling its Mexico unit (although it was rumoured to have come close to a sale to Brazil’s Itaú in the immediate aftermath of the financial crisis of 2008/09), analysts have been reckoning a sale by HSBC of its Mexico unit was somewhere between ‘possible’ and ‘probable’.
This reading largely stems from the tough targets reportedly placed on the business in 2015 as a condition of retaining the unit: by 2017 the bank was supposed to increase pre-tax profits to $600 million (tripling the group’s annualized results for the first half of 2015); increase risk-weighted assets to between 2% and 2.2% (compared with 0.55% in the first half of 2015); and cut expenses by $100 million (roughly 10%).
A spokesman for HSBC said those explicit targets had never been publicly made and couldn’t provide detail of recent numbers because the bank is in its quiet period before the release of its third-quarter results. He also couldn’t provide any detail about how the money would be used (in contrast with Citi’s specified investment plan), saying more information will be provided in November. That will only add to speculation that the bank is strengthening its balance sheet and that a sale remains a possibility.
Stuart Gulliver, HSBC
In response to questions about a possible sale of HSBC Mexico the spokesman pointed to Gulliver’s comments in May, when he said: “We are going to turn the US and Mexico around, not exit them. We never talked about exiting them. They are making some early encouraging signs of travelling in the right direction, but there is still a long way to go.”
However, at the end of June this year Moody’s downgraded HSBC Mexico’s standalone credit rating because of the heightened risks it perceives as stemming from these aggressive growth strategies.
The rating agency said that the pressure to grow rapidly in a sluggish macroeconomic environment could force the bank “to lend aggressively and to lower quality borrowers in order to grow its loan portfolio enough to achieve its earnings targets, which will raise asset-quality risks and boost provisioning needs”.
Moody’s said HSBC Mexico faces a choice of either missing targets or building risky growth.
HSBC Mexico did return to positive net income in the first quarter of 2016 but earnings remain weak. In downgrading the bank, Moody’s points to “increasing loan-loss provisions, which have soared to nearly 90% of the bank’s pre-provision income as of Q1 2016, a figure that is twice as high as the peer’s average.”
The bank’s non-performing loan ratio was 5.1% in the first quarter of 2015 – more than double the sector’s average of 2.1%. In the second quarter of 2016, the bank’s return on RWAs was 0.52% – a long way from the 2% target.
One equity analyst of Latin American banks who declined to be named says the current valuation of Mexican banks is attractive and might lead HSBC’s management to reconsider selling its operations in the country.
“Mexican banks are trading at almost two-times book values, but with much lower ROEs – at around 13% at best – than in markets like Brazil,” he says. “That seems expensive.”
If these high valuations for Mexican banks persist and there is a post-US election boost to the Mexican peso, there could be a very attractive dollar-denominated valuation window for HSBC Mexico at the end of this year.
Scotiabank is also believed to be interested in HSBC’s Mexican unit as it seeks to add scale in the country but faces a severe challenge to get there organically.