S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak between June and August, and we are using this assumption in assessing the economic and credit implications. We believe measures to contain COVID-19 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Banks Are Vulnerable To Difficult Economic Conditions

As the coronavirus pandemic escalates and growth stalls against a backdrop of volatile markets and rising credit stress, we now forecast a global recession this year. Even though COVID-19 has reached Latin America later than other regions of the world, local banks are not immune to the phenomenon. We expect the impact to be in the form of risk aversion to emerging markets and a deteriorating asset quality. Companies in sectors such as airlines; oil and gas; metals and mining; forest products; and leisure, lodging and gaming will likely take a hit, including importers due to the region's sharply weaker currencies. Moreover, the local authorities are adopting strong measures to contain the contagion, including full quarantine for weeks in some countries and social distancing or isolation in others, which will impair economic dynamics. This comes while conditions were already shaky in the region prior to the global outbreak of coronavirus, while governments have limited fiscal capacity. In addition, the reduction in rapidly slowing economic activity has lowered the demand for oil, which combined with the disagreement over production cuts between the Organization of the Petroleum Exporting Countries (OPEC) and its allies caused the oil prices to plunge, which could further hurt companies in oil-producing countries such as in Mexico and Colombia.

Asset Quality Will Falter Even If Regulators Forbear Recognition Of Bad Loans

We expect pressure on banks' asset quality to surge and loan growth to slow as the coronavirus outbreak hits trade, and corporate demand for credit and consumer banking. As public health crisis disrupts production and the plunge in consumption interrupts the payment chain, some companies and individual borrowers will have difficulty with debt repayment, but the regulatory measures will mitigate this risk to some extent. However, the extension of the quarantine will determine the degree of detriment to asset quality. We expect small- to midsize enterprises (SMEs) and self-employed workers, who have limited financial flexibility to cope with a sudden stop in cash flows, to suffer the most in Latin America. Local regulators are already relaxing bad loan recognitions and allowing banks to renegotiate existing loans that are performing without penalties (excluding the overdue loans). Governments typically provide assistance to people and businesses after natural disasters, and we have seen this happening in the region during floods and earthquakes. We expect similar reactions to COVID-19, and some local regulatory authorities have already taken the lead. In addition, prior to the coronavirus spread, Chilean banks were in the midst of preparing for the potential impact of social protests during the upcoming constitutional discussions. Therefore, they will have an opportunity to test the effectiveness of their business continuity plans.

We believe the full impact on asset quality will take time to materialize, given the regulatory measures to lessen the strain. We also expect regulators to ease conservation buffers in order to reduce the burden on banks' ability to lend to corporations. The stabilization of lenders' balance sheets will depend on the length of the paralysis in business activity and its effect on economic growth. It's currently uncertain when the spread of COVID-19 will cease because it's still at its early stage, and how deep the economic strain it will cause, because there are no empirical rules to estimate how social distancing could affect key economic variables.

Profitability Will Sink But From A Currently Sound Level

Central banks and regulators are taking measures, such as lowering the reference rates and reserve requirements, to boost liquidity. As such, banks could benefit from lower funding costs. However, it's currently unclear the volume of loans that will be rescheduled and how large will be the impact on lenders' bottom-lines results because banks won't be accruing interest on forebear loans. Although banks will probably try to increase the spreads to mitigate the risk, it will be hard for them to do so given the stressed circumstances. However, the region's banks are in a good position in terms of profitability and provisioning coverage, which provides a cushion.

Government-Owned Banks Will Play A Key Role

We expect the regional banks to use loans from government-owned banks to support the troubled sectors, but the trend will vary from one country to another. We expect Mexico's development banks to provide credit lines to commercial banks to support economically sensitive sectors, as it has been the case during stressed circumstances in the past. We believe under AMLO's administration, the role of government-owned banks will rise amid the economic and financial fallout thanks to their solid capitalization. We expect Brazil's public banks to reschedule payments with the vulnerable sectors' players, a similar the trend among private banks, and may offer additional support to such sectors. Although the current administration has been taking steps to reduce the public banks' market share, we expect banks that have a specific public policy role to implement additional measures to relieve the financial stress on particular sectors during the coronavirus outbreak. We view Argentina's government-owned banks to have a small room for maneuver, because of their vulnerable balance sheets. We also expect Banco del Estado de Chile to play a similar role as during the 2008-2009 global financial crisis, thanks to an additional capital injection of $500 million, which was recently announced. In Colombia, through Banco de Comercio Exterior de Colombia S.A. Bancoldex, commercial banks will provide credit facilities to companies to ease the pressure on liquidity.

Deposit-Based Funding Will Help Offset Tighter Access To Capital Markets

We believe that Latin America's major banks can cope with a temporary disruption in capital markets. This is because retail deposits provide the bulk of their funding, and because of the absence of significant debt maturities in 2020, thanks to banks' conservative liability management while investors' appetite for emerging markets was strong. In this context, regional banks are boosting liquidity and taking a conservative approach to lending in order to prepare for the tough economic and financial conditions. Moreover, large banks are benefitting from flight to quality, given that investors and depositors are shying away from the capital markets and funds, while parking their funds in banks. However, smaller banks and financial companies don't benefit from this trend.

We're monitoring closely the impact on niche banks and non-bank financial companies that mainly receive funding from wholesale investors. Many have secured long-term funding amid favorable conditions in capital markets last year. And although there are no major maturities among these entities coming due this year, those with dollar-denominated debts likely need to increase the margin calls for the hedges that they have acquired.

Currency Depreciation Is Having A Mixed Effect

The risk aversion, caused by coronavirus and volatility in commodity prices, has squeezed the regional currencies. The currency fluctuations among the largest six economies in Latin America-- Brazil, Mexico, Argentina, Chile, Colombia, and Peru-- differ in each country, mainly because of respective banking system structures and regulations. However, the effects of the weakening local currencies on these countries have been manageable, because their exposure to foreign exchange rates is fairly low, while loans in dollars are mostly granted to corporations with revenues that are mainly, or fully, in greenbacks (i.e. exporters, etc.). In addition, these five countries' banking systems are subject to regulatory limitations on dollar-denominated lending, mitigating credit losses due to unhedged loans in this currency. The exception is Peru, which has the highest exposure to such loans, despite efforts to reduce dollarization in recent years. And we believe such exposures aren't necessarily hedged, resulting in greater vulnerability to credit risk. However, the falling value of the Peruvian sole in the past resulted in manageable credit losses, while the share of dollar-based lending has shrunk to 28%-30% currently from almost 50% in 2010. A shift in deposits to dollars in Peru is likely, as seen in previous crises, but we expect the central bank to provide swaps to banks in order to reduce their exposure to currency fluctuations.

Risks To Banks' Currently Sound Liquidity Loom

Liquidity is crucial amid the currently volatile financial conditions and slowing economic dynamics, and we're monitoring banks' liquidity positions, including the following factors:

• We're keeping track of the pace of the use of committed credit facilities among SMEs and corporations in order to boost their cash positions to prepare for the effect of upcoming quarantines. So far, banks have sound liquidity levels, but they will depend on the longevity of the business' disrupted operations.
• We're concerned about the banks' exposure to derivatives through the hedges they use for their liabilities in foreign currency, and derivatives they offer to their clients, typically to exporters. Although the coverage secured is back to back with the local clearing houses, banks may receive margin calls to maintain the required margins, potentially weakening their liquidity. We believe this could be a concern for midsize banks that lend mostly to exporters, but not for large banks.
• Financial institutions with large shares of foreign currency liabilities in their funding structures, operating in countries with wide current account deficits. These entities will experience liquidity pressures as long as the high volatility in exchange rates persist for a long period.

Time To Deploy Business Continuity Plans

Another consideration is that banking services are considered as 'essential' during the quarantines, while other business activities are shut down. The good news is that due to the fintech boom in the region during the past few years, banks were already making substantial investments in order for their systems to compete with the newcomers. We believe large banks offer clients sufficient remote solutions, while trends among smaller players are mixed. Some have embraced the fintech boom, while others are trying to catch up. Banks, which are struggling to invest and adapt to the new technologies, will confront considerable pressure from COVID-19. In addition, cyber security will becomes a huge factor, given that cybercrime is likely to increase during the outbreak.

Several Industries Reeling From COVID-19

Airlines, oil and gas, metals and mining, forest products, leisure, lodging, and gaming, along with importers, are in the first line of contagion. Some key commodities produced in the region are hit hard by the global shock, and we believe the recovery could be gradual. For airline companies, the situation is critical, given that they're announcing massive capacity cuts to lower costs. They're suffering not only from collapsing demand but also from weakening local currencies, which are battering operating profitability and leverage profiles. Although Latin American banking systems don't have major exposure to these sectors, we're monitoring the situation at the individual bank level.

Ratings On Argentine Banks Have Some Room For Operating Slippage

Argentine banks were already operating in a very tough economy before the spread of coronavirus across the globe. We currently rate domestic banks at B-/Watch Neg/--, with the exception of Banco Hipotecario S.A., which we downgraded to 'CCC' this month due to weakening financial conditions. Argentina's stressed economy weakened banks' asset quality mainly due to individual cases, while deposits shrank following the presidential election in October and concerns over the direction of government policies. The Argentine government has taken strong measures to contain the virus, including a mandatory quarantine across the nation, while offering some alleviating measures to the most vulnerable individual borrowers and small companies. This will crimp an already weak economic activity and further stress banks' balance sheets.

Diverging Prospects For Brazilian Large And Midsize Banks

Brazil's sluggish economic recovery and still low investment in general have resulted in low credit demand from the corporate sector. In addition, low interest rates have prompted corporations to refinance their debt in the domestic capital market. As a result, credit growth remains subdued, but the trend is diverging between private banks and their government-owned peers. While private banks posted credit growth of about 15% during 2019, lending among public banks contracted about 1.3%. With the coronavirus spread in Brazil and several measures taken at the country and state level to contain the contagion and reduce the circulation of the population, we expect economic activity to plunge and credit growth to suffer.

Brazilian banks' profitability has improved since the country exited recession in 2017 thanks to lower provisioning needs and diversified business activities. However, banks still have meaningful levels of renegotiated loans on their balance sheets, waiting for the strengthening recovery to shrink them. Although the financial regulator and government are taking measures to mitigate the impact including reduction in reserve requirements and banks are offering reschedules in loan instalments to their clients, a sustained drop in economic activity due to the need to maintain a quarantine for a long time could increase the volume of bad loans sharply and hurt banks' asset quality. The mitigating factors include banks' low exposure to refinancing risk and foreign currency loans, and high liquidity levels.

Chilean Banks To Absorb The Hit From Coronavirus

Following the social unrest late last year, COVID-19 and measures to control its spread will further pressure banks' asset quality and profitability. The impact will depend on the duration and intensity of the effects on the economy. However, domestic banks have enjoyed healthy asset quality and profitability prior to these adverse events, providing cushion which better positions them to face the looming tough conditions. Moreover, the banking regulator and central bank are taking measures to contain the risk by lowering rates. Likewise, measures have been taken to ensure access to foreign currency (extending the term of the foreign exchange sales program until January 2021) and to sustain liquidity, including the purchase of bank bonds and the use of corporate bonds as collateral, which would grant flexibility to entities.

A Pause In Colombia's Credit Growth

In 2019, Colombia's economic performance strengthened and lending picked up in the second half of that year, after three years of sluggish expansion. We expect the virus and collapse in oil prices to cause economic growth to slow, but the country should avoid a recession. We also expect asset quality to slump on lower spending on discretionary goods and services, with greater impacts on banks that are more exposed to economically sensitive sectors, such as oil, transportation, tourism, and importers. However, the banking industry's overall exposure to such sectors is manageable. In our opinion, the government and regulatory measures will prevent asset quality from deteriorating sharply. The Colombian peso fell sharply during the first quarter of this year; however, banks' relatively low exposure to foreign currency loans (3.7% of total loans as of February 2020) cushioned them from this shock. We'll be paying close attention to potential pressures on financial institutions with concentrated funding structures and exposure to external financing. However, banks' capital metrics will suffer due to the impairment of the goodwill they have in their Central American subsidiaries.

COVID-19 Will Exacerbate The Already Weakening Outlook For Mexican Banks

We expect Mexico's recession to extend to 2020. So far, the Mexican banking system has remained resilient and can cope with stressful conditions, because its past experience. The global financial crisis of the last decade placed Mexico in a very difficult scenario. This is because the U.S. (Mexico's main trading partner) and other developed economies contracted, which along with the H1N1 virus outbreak, caused Mexico's unemployment to rise and economy to shrink 5.3%. Prior to that crisis, Mexican banks were growing at aggressive rates that weakened asset quality (with the sum of nonperforming loans and credit losses representing 8.75% of total loans). However, the industry was able to post sound profitability (net interest margins of 6.75%-7.00% and return on assets around 1.4%) and capitalization levels, and adequate liquidity. Lending growth for the past three years was modest amid conservative lending standards and sound balance sheets. In our opinion, financial entities that are more dependent on wholesale funding sources and/or with financing in foreign currency will experience amid the upcoming stressful conditions.

Peruvian Banks' Strongest Profitability In The Region Will Help Face Adversity

Peru's sluggish economy in 2019 and low investment dented the corporate sector's credit demand, and we originally expected credit growth to pick up in 2020 if political uncertainties dissipate. However, given that the authorities are taking strong measures to reduce the spread of the virus including a mandatory quarantine across the nation, we now expect credit growth to be subdued. The tepid operating conditions and low credit growth have eroded asset quality, and as asset quality was stabilizing, we now expect further deterioration. Nevertheless, banks' operating performance remains sound, and we expect their profitability to remain among the highest in the region, although likely to slip. In addition, the central bank is taking measures to provide liquidity to the system and mitigate the impact of a falling currency.

Latin American Insurers' Operating Performance Will Be Tested In 2020

We expect Latin American insurers' business growth prospects to moderate this year, and to pick up in 2021 amid a likely synchronized economic rebound in the region. In our view, the insurers' operating performance will take a hit from the effects from COVID-19, in particular, weakening economic prospects, volatile markets, and rising credit stress. However, we expect sound capitalization levels and liquidity, in general, will allow insurers to navigate the challenging year ahead.

We expect an increase in the number of claims for life and health insurers stemming from the spreading virus. While the cost of claims among property and casualty insurers will rise as an indirect impact from coronavirus and the collapse in oil prices, following the sharp depreciation of Latin American currencies during the past few weeks. However, we don't expect a significant deviation in loss ratios, in general. Moreover, we expect the insurers' profitability to be pressured by lower local interest rates and, to a lesser extent, financial market volatility, given the modest exposure to equity instruments in the investment portfolios, in general. In this sense, this will prevent insurers from strengthening their capital bases meaningfully. However, in addition to the insurers' capitalization, the use of reinsurance represents an additional source of flexibility to protect their bottom-line results and capital.

One of the main challenges that the region's insurance sector faces is raising awareness among the population about the importance of insurance protection. This stems from the relatively low levels of insurance penetration in Latin America. However, we believe that COVID-19 could foster greater acceptance of insurance policies.