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Sovereign debt solution could reignite Argentine bank ADRs in the short term

The market capitalization of the four Argentine banks that trade American Depositary Receipts, or ADRs, on the New York Stock Exchange has cratered near historic lows since peaking in 2018, although a price rally could be around the corner, analysts told S&P Global Market Intelligence.

Between the end of the first quarters of 2018 and 2020, the aggregate market capitalization of Grupo Financiero Galicia SA, Banco Macro SA, Banco BBVA Argentina SA, and Grupo Supervielle SA sank by more than 85%. The drop was on par with the S&P/BNY Mellon Argentina ADR Index, a benchmark for the 17 Argentine companies that are listed in the United States, which also plunged by 85% between March 29, 2018, and March 31 this year.

ADRs for these banks account for a significant percentage of the total ownership structure, with their volume often doubling the amount of shares traded on the Buenos Aires Stock Exchange.

At the beginning of 2018, the combined market capitalization of these four banks was greater than that of Latin America's e-commerce giant, MercadoLibre Inc. Two years later, those same banks were worth $3.53 billion, or less than 15% of MercadoLibre's market capitalization.

In the same two-year period, the four banks' average price to book ratio saw a sharp decline to 59.57% from 342.27%, while return on average equity slumped to 18.13% from 24.35%.

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Short term vs. medium term

But Argentine bank ADRs have been edging up since March, with the market growing increasingly expectant of a positive outcome to the Argentine government's negotiations to restructure $65 billion in foreign bonds, and a sharper hike could be on the cards.

Banks' ADRs traditionally have the highest beta among stocks traded within the S&P/BNY Mellon Argentina ADR Index. They tend to show great volatility as they are where investors look first when positioning themselves in Argentina, according to Erik Schachter, an equity analyst at Consultatio Investments.

"In the short term, if the debt issue is resolved and Argentina is no longer in default, there's an upside [for Argentine banks' ADRs] of between 20% to 30%, or perhaps slightly more," he added.

The lower the exit yield that the government achieves on restructured debt, the higher the margin for banks' market capitalization to rise will be, as the country's sovereign risk premium has an impact on valuations, Schachter explained.

In the medium term, however, banks could quickly find resistance, because there are several macroeconomic issues that are still latent, and lenders are by no means immune to them.

“Share prices are at almost ridiculous levels,” Supervielle's Treasury and Investor Relations Manager Ana Bartesaghi said, but noted that they would only represent an opportunity if Argentina's economic imbalances are addressed.

"For a potential rally to be sustainable in the medium term, not only would the debt issue have to be resolved, but there would have to be a normalization of the economy over the next two years," she said. Argentina's chronic ailments, such as recurring devaluation and persistent inflation, have worsened due to a bloated budget deficit, and the country is now into its third consecutive year of recession.

Since 2018, savings and dollar deposits have plunged, and credit has been shrinking in real terms, taking the financial system’s penetration back to levels seen in the 1970s, she added.

Any short-term recovery in banks' valuations could be short lived, due to the deepening recession amid the pandemic and a lack of expectations for a recovery, according to Ramiro Marra, Chief Strategy Officer at Bull Market Brokers.

"The great dilemma in the market right now is knowing whether or not...we can start to talk about [prices having touched] bottom," said Marra, who noted that credit continues to shrink in real terms.

According to the strategist, the potential restructuring deal with foreign creditors would generate a hike in prices that would have to be validated thereafter by an economic plan, which would stem from a separate agreement with the IMF.

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Increased exposure to the central bank

Banks' profitability this year will be pressured by slimmer margins and higher provisions, Moody's Analyst Marcelo De Gruttola said, adding that he did not rule out potential for losses in real terms.

The only credit segment that has grown are loans to SMEs that have been capped by the central bank at an interest rate of 24%, the analyst noted. These state-backed rates are well below the 2020 inflation forecast of 40.7%, from June's central bank's market expectations survey.

Although the banking system is very liquid and deposits have been rising, their exposure to the central bank's short-term Leliq and Pase instruments, measured as a percentage of total assets, has doubled to an estimated 30% from 14% since April, De Gruttola added. The system's total loans, by contrast, amount to approximately 40% of total assets, he pointed out.

While the sharp increase in the balance of Leliqs provides banks with some stability in terms of income, it also exposes them to changes in monetary policy, since the central bank notes are the reference to the benchmark rate.

"The orderly resolution of debt negotiations would imply a better operating environment for banks, with more business opportunities," said De Gruttola. But even so, it will be remain a challenging environment, with deteriorating asset quality due to the significant amount of loans that have been restructured, he added.

As of July 28, US$1 was equivalent to 72.14 Argentine pesos.