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As Argentina Combats Crisis, Banks Set to Feel Short-Term Pain

Argentina's banks could be in for a trying second quarter as the central bank's sharp and sudden interest rate hikes compress profit margins and slow loan growth.

Faced with above-target inflation and a depreciating currency, Banco Central de la República Argentina earlier in May raised its benchmark rate to a multiyear high 40%. The Argentine government, meanwhile, is in talks with the International Monetary Fund for a lifeline, with recent reports suggesting the country may pursue a full-blown bailout, known as a stand-by agreement, rather than the flexible credit line or precautionary liquidity line that were previously touted.

The swiftness and severity of the rate hikes — 1,275 basis points over the course of a week — will temporarily squeeze bank margins as they work through the mismatch of assets and liabilities. It will also likely dampen loan growth and could spur an uptick in delinquencies, analysts said.

"The first thing that's going to happen is lending activity is going to decrease," said Juan Manuel Vazquez, head of equity and credit research at Buenos Aires-based Puente, adding that earlier guidance for 20%-plus loan growth for 2018 is now "very difficult to reach."

"The second thing is that net interest margins are going to compress because funding costs are going to increase."

Term deposits, which have market-driven interest rates, make up about half of Argentine banks' total funding in the aggregate, according to Moody's. More than 70% of banks' lending, however, is fixed rate. As a result, banks will have to pay higher interest rates on those deposits almost immediately, but will have to wait to reprice many of their loans. While the average duration of fixed-rate loans is only about a year, banks will face notable margin compression in the meantime.

The exact impact on bank margins will vary depending upon the make-up of their balance sheets, Moody's senior analyst Maria Valeria Azconegui said. "The impact is more limited for those entities that have a broad, retail-based business model because they have different sources of funding and so on," she said in an interview. "Those that have more of a wholesale funding structure ... are going to be hit harder."

Banks with a greater focus on corporate and small and medium-sized enterprise lending — which typically reprice in as few as 30 days — will also be better able to stave off margin compression, she added.

Still, variable-rate loans also present issues. The higher rates will mean borrowers' repayment costs will also rise, which in turn could lead to more delinquencies.

"With interest payments on variable-rate loans ... set to increase by nearly 50%, we expect impaired loans to increase," Azconegui, who called the rate hikes a credit negative for banks, wrote in a report. "As a result, the increase in delinquencies will force banks to raise their loan-loss provisions, negatively affecting profitability."

Any rise in delinquencies, though, will be coming off of a low base. Argentine banks have to-date enjoyed nonperforming loan ratios well below their regional peers, amounting to just 1.6% of total loans as of year-end 2017. That is partially thanks to the fact that traditional bank lending is a relatively new concept for Argentina, analysts noted.

For years, Argentine banks shied away from retail lending, choosing instead to pump their liquidity into central bank instruments carrying high interest rates, a model known as transactional banking. It has only been in the past few years — effectively since Argentina moved away from populism with the 2015 election of President Mauricio Macri — that banks have turned toward a more traditional lending model.

As a result, the country has seen rapid loan growth in recent years, and most had expected that to continue, given that Argentina still has much more room to grow. Mortgages, for instance, still only represent about 1% of GDP, far below regional peers like Chile, Mexico and Brazil, where such loans equate to around 9% to 26% of GDP.

That loan growth, however, will likely stall as result of the central bank's recent measures, as higher interest rates dissuade consumers and small business owners from taking on new loans, analysts say. This is especially true of Argentina's nascent home lending market, which has become a major driver of growth with the advent of the UVA mortgage, a product that carries an interest rate pegged to an inflation-adjusted unit. Since their launch in 2016, UVA mortgages have grown rapidly to total some US$101.2 billion as of April.

Going forward, "people are going to be more nervous before embarking on these sorts of [loans], and banks are going to be a little more reluctant to lend as well, while you have this inflationary environment," Vazquez said.

Compounding the issue, Argentina's state-owned banks, which have issued the bulk of UVA mortgages so far, are going to be increasingly strained as the national treasury, in search for local market funding, competes for those institutions' funds. Meanwhile, private banks will likely struggle to push forward with UVA securitizations to fund future growth.

Last month, just days before the central bank began hiking rates, Banco Hipotecario SA successfully placed 440 million pesos in UVA mortgage-backed securities, but Vazquez expects such sales to be far more difficult in the current climate.

Given the expectation for weaker loan growth, banks will almost certainly turn back to allocating resources to high-yielding central bank notes, which should help to stem the impact on their bottom line. However, neither Vazquez nor Azconegui believe this shift will lead Argentina's banking industry to drift back toward its transactional business model for long.

"In the short run — perhaps in the coming one or two months — banks are going to return to this type of [transactional banking]," Azconegui said. "But this will be temporary ... We have to get through the quarter, but then the system is well-prepared to grow."

Vazquez broadly echoed that assessment: "The banks need to grow, and they're in a very good position to grow organically — provided, of course, that the macro environment makes that possible."

When Argentina's economy will allow that is still uncertain. Economists at Capital Economics said they now expect Argentina's economy to contract by 0.5% in 2018, having previously forecast 2.5% growth; they also lowered their 2019 growth forecast to 1.5% from 3.2%.

"At this stage ... deal or no deal [from the IMF], the economy looks set for an abrupt slowdown," they wrote in a May 10 report.