13 Jul, 2021
New regulation, solid banking system key for payroll loan growth in Mexico
By Steven Baria and Rehan Ahmad
Payroll lending has been growing among Mexican lenders over the past two decades. For banks, these loans that are granted to workers whose salaries are deposited to an enrolled payroll account, are considered to have low risk because they are auto-deductible from the salary accounts.
The biggest payroll lenders among banks include Grupo Financiero BBVA Bancomer SA de CV, Grupo Financiero Citibanamex SA de CV and Grupo Financiero Banorte SAB de CV, which are also the largest banking groups in the country. They account for more than 75% of these loans among banks as of 2020, according to Banco de México.
"Payroll loans are increasing in importance in [banks'] portfolios," according to Alfredo Calvo, a senior director at S&P Global Ratings. "As of March, payroll loans represent 25% of total consumer loans. Banks are trying to grow in business lines that represent less risks, including payroll, so there is opportunity for this business line."
Nonetheless, the volume of payroll loans originated by Mexican banks pales in comparison to those granted by NBFIs or shadow banks, locally known as sofomes. Crédito Real SAB de CV, the largest NBFI in the country, has 29.4 billion pesos in payroll lending for 2020, more than 300x that of BBVA Bancomer, the largest banking payroll lender.
Payroll lending among NBFIs reached 6.9 trillion pesos, compared to 5.2 trillion pesos among banks, in the fourth quarter of 2020, according to the central bank.
Coming out of the dip
In the past year, payroll lending has seen a decline in demand and activity due to the pandemic's impact. According to data from securities regulator CNBV, the system-wide payroll loan portfolio declined 2.4% in 2020, the segment's first recorded dip in a decade. Tepid demand for payroll loans continued early in 2021, regressing 3% year over year in February.
"Credit demand is very low, especially for consumer products," Calvo said. "Banks are willing to grow those loans, but the challenge is if they can find demand for credit."
Jorge Sánchez Tello, head of think tank Fundación de Estudios Financieros, still holds a positive outlook for payroll lending, noting that the segment's recovery will depend largely on Mexican banks' strong fundamentals and the post-pandemic economic recovery.
"We have a strong and well capitalized banking system in Mexico. It has resources to lend, but it is a matter of lack of demand," Sánchez Tello said. For the analyst, it is natural for demand to fall as entities practice prudence following increased borrowing at the start of the pandemic as they support liquidity needs.
Moreover, the regulatory reform, which is still in the legislative stage, is expected to bolster the payroll credit segment's regulatory framework by boosting legal security, minimizing unfair competition, and refining agreements between borrowers and employers, Fitch Ratings said in a report.
Although payroll lending has been offered for more than 20 years in Mexico, this is the first time that it is included in a regulatory reform. Sánchez Tello believes this is "a positive and very important change."
"It will have the immediate effect of greater financial inclusion and access to credit, but there will also be better mechanisms to try to eradicate the abuses that have occurred [especially in NBFIs]."
Controversies around NBFIs
The country's largest NBFIs have recently been impacted by controversies surrounding their accounting and credit standards. In May, Crédito Real and private company Alpha Holding SA de CV shook investors as they announced significant revisions in their financial statements.
Alpha Holding bond prices fell sharply after it revealed an error in its derivative accounting that will result in the restatement of its past financial statements. According to Jesus Sotomayor, associate director at S&P Global Ratings, the company's expected impairment of a majority of its 4.1 billion pesos of other assets and other accounts receivable exceeds its capital levels, which could lead to insolvency issues.
In the case of Crédito Real, its nonperforming loans jumped by 82%, which it attributed to a single problematic loan to a small and midsize enterprise, or SME, client. The news caused Crédito Real's stock price to plunge, although not as severely as Alpha Holding's, given the former's relatively better fundamentals.
However, contagion fears have spread to other NBFIs, causing bond prices of Financiera Independencia SAB de CV, Unifin Financiera SAB de CV, Operadora de Servicios Mega SA de CV and Mexarrend SA de CV to nosedive.
While the performance of these NBFIs' assets modestly recovered in the past weeks, analysts are wary that other controversies such as underreported delinquencies may sprout given the precarious nature of these entities. Crédito Real possibly undertaking further risk management to contain liquidity and solvency issues could also impair loan growth.
Still, Sotomayor noted that despite the issues Crédito Real is facing, it keeps a manageable nonperforming loan ratio for its payroll loanbook, ranging between 1% and 2%.
Niche segment, niche risks
Payroll loans operate differently for NBFIs, which cater mostly to government workers. They rely on agreements with agencies and unions that act as intermediaries for employees of government-owned entities who want to contract a loan — giving rise to intermediary risk. At times, these intermediaries fail to deliver the payments on a timely basis, which is considered an "intrinsic risk" for entities dealing with the government, Sotomayor said.
Hazards also emanate from the fact that several NBFIs are not regulated by the central bank. Furthermore, NBFIs charge far higher interest rates in their payroll portfolios compared to banks, and excessive lending is also a widely criticized practice by these entities.
"Some of these companies are having problems in their portfolios because they have granted credit in an irresponsible way, unlike banks that are well capitalized and with relatively low delinquency rates," Sánchez Tello said.
Fitch believes that the regulation could temper collection and liquidity risks in agreements between NBFIs and agencies. Shadow banks that partner exclusively with federal entities could also slowly widen their operations to states and municipalities, with the expansion opening up growth opportunities and increasing financial inclusion.
An opportunity for banks?
Although Fitch expects the regulation to have a greater benefit for NBFIs, banks could gain from the potential to enter into agreements with both private and public entities to extend loans to their employees or pensioners under a clearer regulatory framework. Fitch also expects the relationship between banks and NBFIs to remain complementary rather than competitive.
Calvo echoes the sentiment, noting that despite issues faced by major NBFIs as well as opportunities presented by the proposed reforms, banks may not penetrate the segment in which shadow banks have a stronghold, especially given that banks' and NBFIs' customer bases do not intersect.
This divide between banks' and NBFIs' customer profiles makes it unlikely that banks will be able to grow their payroll loan portfolios in the short term even with a more transparent regulatory framework, according to Sotomayor.
"Maybe in the future, if these laws start to materialize and strengthen the regulatory framework in the segment, there could be potential players within regulated banks. But right now, it is not a short-term expectation," Sotomayor added.
As of July 12, US$1 was equivalent to 19.86 Mexican pesos.
This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.