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Hit To Mexican Nonbank Financial Institutions' Asset Quality Will Depend On Loan Portfolio Exposure By Sector

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Hit To Mexican Nonbank Financial Institutions' Asset Quality Will Depend On Loan Portfolio Exposure By Sector

NBFIs in Mexico have enacted various relief programs for clients amid the pandemic, most of which were tailor-made to each client depending on asset class, credit risk profiles, and historical performance. However, the breadth of these programs varies depending on each finance company's exposure to higher-risk sectors.

Generally, S&P Global Ratings expects rated Mexican NBFIs' asset quality to weaken and profitability to significantly drop. This will be reflected in worsening capital metrics, reducing firms' ability to manage unexpected losses. However, the impact on each company will depend on the exposure they have to vulnerable sectors and the time it takes for these sectors to recover.

Although we see significant downside risks for finance companies from the fallout of the pandemic, in terms of refinancing risks, the companies have been proactive in refinancing their issuances well in advance of their maturity dates.

S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic. Reports that at least one experimental vaccine is highly effective and might gain initial approval by the end of the year are promising, but this is merely the first step toward a return to social and economic normality; equally critical is the widespread availability of effective immunization, which could come by the middle of next year. We use this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Relief Programs Have Contained Asset Quality Decline

Since mid-March, when the COVID-19 pandemic spread into Mexico, many Mexican NBFIs began implementing relief programs to their most vulnerable clients. Considering that many of the NBFIs are not formally regulated, most of these programs were tailor-made to each client, taking into account asset class, credit risk profiles, and historical performance.

Generally, these relief programs consisted of interest and capital payment deferrals for up to six months. These deferrals allowed the NBFIs to partially contain an immediate and significant asset quality deterioration, and to retain strategic customers that may recover. As shown in table 1 below, as of June 2020 relief programs represented between 10% and 30% of NBFIs' total loan portfolio, depending on each company's main business line. Companies with larger relief programs as a percentage of total loans are those highly exposed to transportation sectors such as Navistar Financial, S.A. de C.V. SOFOM, E.R. (mxBBB-/Watch Pos/mxA-3) and PACCAR Financial Mexico S.A. de C.V. (mxAAA/Stable/mxA-1+), with almost 30% and 25% respectively. Next were companies focused on micro-lending, such as Financiera Independencia (Findep; B+/Negative/--) that reached 18%, while leasing companies like Unifin Financiera, S.A.B. de C.V. (BB-/Negative/--), Mexarrend, S.A.P.I. de C.V. (B/Stable/--), and Operadora de Servicios Mega, S.A. de C.V. SOFOM, E.R. (BB-/Negative/--) stood between 11% and 17%. Finally, for companies focused on payroll loans such as Credito Real, S.A.B. de C.V., SOFOM, E.N.R. (BB/Stable/--) and Alpha Holding S.A. de C.V. (B-/Stable/--), relief programs represented less than 10% of total loans. This is because most payroll loans have maintained a relatively stable performance, especially those from employees of government agencies, which haven't reduced their worker base during the pandemic so far.

In our opinion, some clients won't recover once the first wave of relief programs expire; therefore, we expect more restructured loans in 2020-21 compared to past years. In our view, finance companies will consider restructuring loans before a foreclosure or write-off. These restructures will also be tailor-made solutions depending on each client, circumstance, and/or expected behavior of the client. We'll monitor the restructuring trend.

Chart 1

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Delinquencies Could Rise Once Programs Expire

From a cash flow perspective, interest and capital payment relief programs have decreased loan collections, and consequently, inflows and interest income generation. According to our calculations, NBFIs in Mexico decreased their loan collections by almost 30% in April, May, and June, which was the lowest point since the pandemic and economic lockdown began. We have seen that collection have started to recover, but it remains below pre-pandemic levels, continuing to hamper cash flow generation for the rest of 2020 and potentially part of 2021.

On the asset quality side, relief programs have somewhat mitigated a fast deterioration of NBFIs' delinquency ratios. However, it's still unclear if clients will have the capacity to restore regular payments once the relief programs expire. This is on top of the uncertainty about how long it will take to fully reopen the Mexican economy, the negative prospects for unemployment rates, and our expectation of a slow economic recovery for 2021-2022. In this context, we consider that NBFIs' delinquency levels and credit losses could rise significantly depending on asset class and loan diversification.

Hit To Asset Quality Will Depend On Loan Portfolio Exposure By Sector

As mentioned above, the impact to asset quality ratios will partly depend on how each NBFI's loan portfolio is allocated by economic sector. The table below shows a heatmap by industry depending on the potential downturn caused by COVID-19. The impact descriptor (high, moderate, or low) is our qualitative view of the degree of impact to the sectors' operations and credit metrics.

Some industries, notably those that involve groups of people in close proximity (e.g., cruises, airlines, airports, gyms, theaters, restaurants, retail, etc.), may not return to pre-pandemic revenue levels for several years. These sectors may face ongoing social distancing rules, leading to capacity restrictions, higher operating expenses, and reluctant consumers until there is widespread vaccination. More broadly, we expect consumers will make permanent shifts in how they work, shop, and spend their leisure time even after a vaccine becomes available (" COVID-19 Heat Map: Updated Sector Views Show Diverging Recoveries," Sept. 29, 2020).

Based on this analysis, most of the Mexican NBFIs have exposure to high-risk sectors--between 20% and 70% of their commercial loan portfolios. Credito Real and Alpha Holding have relatively low exposure to these sectors, at about 20% and 5%, respectively, because the vast majority of their operations are payroll loans within government agencies. For leasing companies (Unifin, Mexarrend, Engencap Holding, S. de R.L. de C.V. [BB-/Stable/--], and Operadora Mega), high-risk exposures represent between 50% and 70% of total loans. This is because commercial loans make up the majority of these companies' operations, so we expect additional pressure on their delinquency levels and loan loss reserves.

There are also specific cases such as Toyota Financial Services Mexico, S.A. de C.V. (mxAAA/Stable/mxA-1+), Paccar, and Navistar, which historically have focused solely on the auto and transportation industries, respectively. Therefore, exposure to high-risk sectors represents all of their operations. However, all three of these entities have parent support and maintain solid asset quality indictors to contain further asset quality dips and credit losses. Another case is Findep, which has all of its exposure in microfinance. In our view, this sector has been one of the most affected in the short term by the pandemic effects, but also could be one of the first to recover.

Table 1

image

Base-Case And Stress Scenarios Both Include Asset Quality Slumps

We expect significant shocks to NBFIs this year depending on the duration and intensity of the pandemic's effects on the economy. Generally, we forecast weakening asset quality indicators and significantly lower profitability levels. The latter will be directly reflected in lower capital metrics; reducing finance companies' (fincos) ability to support unexpected losses.

Our base-case assumptions for rated fincos reflect a Mexican GDP contraction of 10.4% during 2020 and then growth of 3.7% in 2021. We expect NBFIs' loan portfolios to range from a 5% contraction to flat growth in 2020, reflecting their dependence on the small to midsize enterprise segment and riskier economic segments, which the recession will severely hurt. On the profitability side, bottom-line results will be significantly worse, dropping by between 60% and 70% compared with previous year figures. The lower results will primarily stem from higher new loan loss provisions--increasing almost 65% compared to last year--, fewer fees and commissions, and pressures on net interest margin due to lower interest rates and asset quality deterioration. Efficiency levels will increase about 350 basis points (bps) reflecting the deeper drop in operating revenues than expenses. Thus, return on average assets (ROAA) will diminish about 250 bps.

The impact of the pandemic will also hurt NBFIs' capital levels. Flat or negative loan growth, higher past due exposures, and a significantly drop in firms' internal capital generation will decrease our average risk-adjusted capital (RAC) ratio forecast for 2020 by 100 bps. Finally, despite the measures implemented to support clients during the recession, some clients won't recover, reflected in higher past due exposures. In this sense, we expect nonperforming assets (NPAs) plus net charge-offs (NCOs) to increase between 40%-50% this year and slightly recover in 2021. Cost of risk will also rise notably--between 35%-50%--reflecting the abovementioned deterioration, and the rising cost of risk will maintain NBFIs' actual reserve coverage.

In our downside scenario, which reflects a slower economic recovery and escalating effects of the pandemic, we anticipate the loan portfolio to contract up to 15% while operating revenues decrease between 15% and 25%. Profitability levels will be negative in some cases and for others, net income will decrease about 80% and efficiency levels will worsen about 430 bps. Therefore, ROAA could be negative or decreasing 320 bps. The low internal capital generation could diminish our RAC ratio about 200bps compared to last year's. In this scenario, we would also expect NPAs plus NCOs to rise 80% compared to 2019, with reserve coverage decreasing 15% and cost of risk rising almost 90%.

Table 2

Forecast Impacts To Mexican NBFIs' Key Metrics For 2020
Downside scenario Base-case scenario
Growth portfolio (%) (15.0)-(5.0) (5.0)-5.0
Operating revenue growth (%) (25.0)-(15.0) (15.0)-(5.0)
New loan loss reserve growth (%) 85 65
Net income growth (%) (100.0)-(80.0) (70.0)-(60.0)
Cost to income (bps) 430 350
Return on assets (bps) (320) (250)
Risk-adjusted capital (bp) (210) (100)
NPAs + NCOs (% growth) (80.0)-(70.0) (50.0)-(40.0)
Cost of risk (% growth) (90.0)-(80.0) (50.0)-(35.0)
Loan loss reserves/Gross NPAs (% growth) (15) 0
Source: S&P Global Ratings.

Table 3

NBFIs' Key Metrics As Of September 2020
NBFI Global scale rating National scale rating Main business line Return on average assets (%) NPAs/Customer loans + foreclosed assets (%) NCOs/Average customer loans (%) Coverage (%) Cost of risk (%)* S&P risk-adjusted capital (%)** Stress liquidity coverage (x)
Unifin BB-/Negative/-- mxA-/Negative/mxA-2 Leasing/SME 1.7 6.9 0.0 49.2 2.5 6.7 1.2
Mexarrend B/Stable/-- mxBB+/Stable/mxB Leasing 0.2 8.9 0.2 49.7 0.9 10.8 5.7
Engencap Holding *** BB-/Stable/-- N.R. Leasing 1.8 4.7 0.3 50.6 1.6 10.3 1.1
Crédito Real BB/Stable/-- mxA/Stable/mxA-1 Payroll 1.3 1.6 3.2 217.3 3.7 12.7 3.4
Operadora de Servicios Mega BB-/Negative/-- mxA-/Negative/mxA-2 SME 3.2 3.5 0.0 57.0 1.5 13.1 2.1
Cargill N.R. mxA+/Negative/mxA-1 Agro financing 2.5 7.3 0.0 76.4 1.1 16.7 3.6
Financiera Independencia B+/Negative/-- mxBBB-/Negative/mxA-3 Micro-lending (0.2) 7.2 17.3 184.5 24.7 8.8 2.5
Alpha Holding *** B-/Stable/-- N.R. Payroll (7.3) 5.2 27.9 160.8 10.0 (0.4) 1.3
Toyota Financial Services Mexico N.R. mxAAA/Stable/mxA-1+ Auto financing 2.1 1.1 1.7 198.8 2.0 12.8 1.5
Paccar Financial N.R. mxAAA/Stable/mxA-1+ Truck financing/leasing 5.0 4.8 0.1 84.5 1.5 40.7 20.9
Navistar N.R. mxBBB-/Watch Positive/mxA-3 Truck financing/leasing 2.5 3.6 1.5 92.8 1.7 25.5 2.0
N.R.--Not rated. *Cost of risk: new loan loss provisions/average customer loans. **Data as of December 2019. *** Data as of June 2020

Funding And Liquidity Risks Still A Challenge

Funding sources remain one of the main challenges for Mexican NBFIs. Given that NBFIs don't receive deposits, they mainly depend on bank loans and debt market issuances. However, we've seen rated NBFIs further diversifying their funding sources in the past decade--entering the pandemic-related recession healthier than in the past.

The largest NBFIs have been able to tap global markets, which has decreased their refinancing risk because this debt has longer tenors than bank loans and previous debt issuances. Additionally, these fincos have proactively refinanced these issuances well in advance of maturities--unlike during the 2008 financial crisis when NBFIs had large short-term maturities and significant refinancing problems.

NBFIs' funding mix is now divided between about 50% market debt and 50% banks, while in the past it was primarily banks. On the market debt side, 30% of total market debt is global issuances, followed by 12% securitizations and 8% local debt. On the banking side, the funding is a mix between different commercial lines and development banks. For the next 12 months, we expect fincos to rely more on their credit lines with development banks--shifting the funding mix more to banking--until the firms see market opportunities, which will depend on the duration and intensity of the pandemic's effects on the economy.

Chart 2

image

Mexico's independently owned NBFIs have mainly issued debt in the long-term market, while those that are subsidiaries of international groups have tapped both the short- and long-term markets. In addition, the entities' issuances that we rate on the national scale have shorter tenors than those we rate on the global scale. In pursuit of longer tenors, Mexico's most sophisticated NBFIs have increased their presence in global markets.

For the next 18 months, domestic issuances will make up the majority of the maturities (about US$200 million). These issuances are primarily issued by subsidiaries of international groups, which generally have higher ratings and have parent support, so refinancing risk should be relatively low. However, in 2022 Mexican NBFIs have a significant amount of global issuances due--about US700 million and increasing to US850 million in 2023. Considering this, we'll monitor how open the market will be in 2021 and each firm's refinancing strategy.

Chart 3

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Finally, our cash flow analysis for the next 12 months is positive in our base-case and stress scenarios. As mentioned above, although NBFIs' collections have dropped up to 30%, the fincos have been able to maintain liquidity levels above 1x by reducing origination and having adequate refinancing structures.

Some fincos have higher liquidity levels than peers because of two main factors. First, some of them issued at least US300 million in debt just before the pandemic, so they have excess cash. Second, some have more financial flexibility because they're part of an international group, reflected in committed credit facilities. We expect collection to begin improving in the following months once the relief programs expire; however, we will continue monitoring NBFIs' cash flows and maturity profiles.

Downside Risks For The Ratings Are Rising

So far this year, we have lowered our ratings on eight Mexican NBFIs, mainly fueled by the sovereign downgrade. In our view, Mexican fincos now face higher economic risks because of the continued weakening economy, the global turbulence resulting from COVID-19, and plummeting oil prices. Most of our rated fincos have speculative-grade ratings between 'BB' and 'B-'. Additionally, almost 60% of NBFIs' outlooks are negative, indicating there's a one-in-three chance of a downgrade. We'll continue to monitor how the effects of the pandemic influence Mexican fincos' asset quality, profitability, and capital levels, and how this could affect ratings.

Chart 4

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Chart 5

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This report does not constitute a rating action.

Primary Credit Analyst:Ricardo Grisi, Mexico City (52) 55-5081-4494;
ricardo.grisi@spglobal.com
Secondary Contact:Jesus Sotomayor, Mexico City (52) 55-5081-4486;
jesus.sotomayor@spglobal.com
Research Assistant:Juanjaime R Romero, Mexico City

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