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Higher interest rates seen benefiting Mexican banks' Q2 results

Banking Essentials Newsletter December Edition Part 2

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University Essentials | COVID-19 Economic Outlook in Banking: Rates and Long-Term Expectations: Q&A with the Experts

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Higher interest rates seen benefiting Mexican banks' Q2 results

Analystsexpect Mexico's major banks to show expanded net interest margins when theypost their second-quarter results in the coming days, thanks largely to thecountry's rising interest rate environment, along with stable loan growth.

"Idon't expect any surprises, Mexican banks have maintained solid profitabilityin the early part of this year," Fitch Ratings' Director of Latin AmericanFinancial Institutions, Alejandro Tapia, told S&P Global MarketIntelligence.

Goingforward, Banco deMéxico's most recent increase in its benchmark interest rate is expected tohave a positive impact on banks' profitability through higher net interestmargins, Tapia said.

Inaddition, Mexican banks generally have very low funding costs so higherinterest rates should not negatively impact their profits, he added.

Overall,higher interest rates, combined with the negative impact of credit lossesrelated to the default of some large homebuilders in 2015, should mean banks'second-quarter profits are higher year over year, said Jose Pérez-Gorozpe,director of Financial Institutions Ratings at S&P Global Ratings Services.

Therecovery in Mexico's retail banking segment seen in early 2016 compared to theprevious year has also benefited banks' earnings, he noted.

"Asthe retail banking segment gains market share, net interest margins for thebanks also improve," he said, adding net interest margins should graduallyrise for the rest of 2016.

OfMexico's major banks, BBVABancomer SA Institucion de Banca Múltiple Grupo Financiero BBVABancomer is the best positioned to benefit from higher interestrates given the high share of retail banking in its portfolio, Pérez-Gorozpesaid.

BBVABancomer "has been growing a lot and taking market share from ['s subsidiaryBanamex] in recent months," he said.

Asfor Mexico's other major banks, S&P Capital IQ estimates for theirprojected earnings are mixed.

is expected to post second-quarter net income of 3.10 billionpesos, down from 3.31 billion pesos in the same period of 2015. Earnings forGrupo Financiero Santander MexicoSAB de CV, however, are expected to improve to 3.70 billion pesosfrom 3.31 billion pesos a year earlier. Grupo Financiero Banorte SAB de CV is also projected topost a rise in its second-quarter profit compared to year-ago levels; consensusestimates have the bank's net income at 4.69 billion pesos, up from 4.05billion pesos a year earlier.

Thereason for Inbursa's poor performance relative to the other banks is loweroperating income from some trading activities, specifically its hedgingstrategy related to derivatives, Arturo Sanchez, an analyst at S&P GlobalRatings Services, said.

"Thisis something we've seen for a long time, so it's no surprise that [Inbursa's]operating income is lower than expected in the current interest rateenvironment," he noted.

Rising interest rates

Analystssay the central bankcould raise interest rates further in 2016 given that its mandate is to ensurethe depreciation of the peso does not translate into higher inflation.

"Iwouldn't rule out [further rate increases]," Pérez-Gorozpe said.

Asfor recent volatility in the exchange rate, partly related to the Brexitreferendum outcome in the U.K., Pérez-Gorozpe said Mexican banks are notheavily exposed because they do not have a large proportion of loansdenominated in foreign currency.

"Bankshave been very cautious over the years in terms of lending in foreigncurrencies, so we're not worried about the potential impact on NPLs," hesaid.

Inaddition, some Mexican banks that profit from volatility through forex trading,such as Banco Base SA Instituciónde Banca Múltiple Grupo Financiero Base, InterBanco and , should do well in the current environment, he noted.

Inthe longer term, the performance of the U.K. economy, particularly a potentialrecession, could have negative consequences for Mexican banks, but that remainsto be seen, he added.

Asset quality stabilizing

Despitean increase in loan provisions by Mexico's major banks in the first quarter,their NPLs are improving, which is reflected in stronger asset quality, Fitch'sTapia said.

"Bankshave learned from the past because their underwriting standards are veryconservative," said Tapia, adding that growth in credit card loans hasslowed while growth in lower risk personal and payroll loans has increased.

ButS&P's Pérez-Gorozpe is more cautious. "Asset quality will probablystabilize, I'm not saying it will begin deteriorating… but we will probably notsee any more improvements through the rest of the year," he said.

Continuingvolatility in the world economy and, particularly in the U.S. economy, couldmean slower credit growth in the second half of 2016, he warned, although thisshould be offset by higher net interest margins.

TheROA for the Mexican banking system is expected to be around 1.3% for 2016 andthe ROE around 13%, or slightly higher, Pérez-Gorozpe noted.

As of July 15, US$1 was equivalentto 18.51 Mexican pesos.

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