- Latin American banks have been able to handle the pandemic-related crisis in relatively good condition so far, supported by their resilient profitability and their robust regulatory capital.
- However, we see risks ahead as loan deferral programs remain, government support measures end, and economic conditions remain fragile.
- Among the six largest banking systems, Brazil and Mexico have had the most resilient profitability, while Peru and Colombia have been harder hit and Argentine banks continue to be exposed to risk.
Thus far, Latin American banks have navigated through pandemic-related turbulence in relatively good shape. In S&P Global Ratings' view, solid profitability has been a key factor in allowing banks in the region to withstand credit cycles and economic downturns in the past and has once again helped them during the COVID-19 pandemic. The Brazilian and Mexican banking systems' profitability has been the most resilient among the largest banking systems in the region, followed by Chilean banks. The pandemic hit Colombian and Peruvian banks' profitability harder because of their high provisions stemming from the pandemic's toll on their economies and because they entered the crisis with weaker asset quality performance.
Risks To Rise As Borrower Relief Programs Wind Down
Loan moratoriums are delaying worsening nonperforming loan (NPL) ratios and banks are seeing stronger asset quality performance than we expected. However, we think that hurdles remain: High levels of informality and fragile conditions for small and midsize enterprises (SMEs) will pressure financial institutions' loan portfolios as government measures dissipate. The economic rebound we expect in Latin America is a crucial factor that could help cushion asset quality performance. However, a notable downside risk for growth across the region will be the potential for bouts of social instability that could hamper investment because of the pandemic's outsized effect on lower-income households in already polarized political conditions in most Latin American countries.
Sufficient Regulatory Capital Also Bolsters Banks
In addition to resilient profitability, robust regulatory capital is the second pillar that supports Latin America banks, in our opinion. All major banking systems in Latin America have at least a 400 basis point (bps) cushion on the minimum regulatory requirements.
Mexico and Brazil were early adopters of Basel III--with adoption since 2013--and have kept sound regulatory metrics. Peru has also fully implemented Basel III, despite adjustments for the local market. Colombia and Chile have just started to implement Basel III on a gradual basis that should give banks enough time to adjust. We expect the delay in implementing Basel III in Chile to have a limited effect on capitalization metrics and our view of regulatory oversight. However, Chilean banks' buffer--measured as capital excess over its minimum capital required--is lower than other countries in the region. Despite the gradual implementation of Basel III, we consider that the Colombian banking regulator's continued efforts to strengthen and align regulations with international standards are strengthening supervision, proactivity, and transparency to prevent potential deterioration in banks' credit fundamentals.
Uneven Lending Growth In The Region
Lending growth has been robust in countries where we saw stronger incentives from the government to lend, such as in Brazil and Peru. In contrast, lending contracted in Mexico where incentives from the government have been absent. We expect banks' lending to be modest in the region for the next two years because we think they'll take a conservative approach, given the uncertain scenario in most countries.
Capital Buffers Will Help Withstand Stress
We've analyzed how much buffer banks have on their regulatory capital metrics to handle worsening asset quality metrics. We calculated the buffer for the banking system on a consolidated basis, considering the excess capital banks have versus the minimum required, and we added our earnings expectations for 2021. We then compared this result to banks' total loans to see how much nonperforming assets (NPAs) could grow before banks breach the minimum capital ratio. In Peru and Chile, we deducted guaranteed loans from total loans. In other countries, we didn't make this adjustment because guaranteed loans weren't significant.
As illustrated by chart 5 below, Latin American banks have sufficient buffer to cope with eroding asset quality. For example, in Brazil NPAs to total loans are 2.1%, but we estimate that NPAs could grow over 6.5x--up to 13.7%--before they breach the minimum capital requirement. On the other hand, in Chile we estimate that NPAs could grow up to 6.8% from the current 1.5% before they breach the requirement. However, we note that Chile is the strongest financial system in this sample, with stronger fundamentals and a higher percentage of secure mortgage loans in the retail portfolio than those of the other countries.
Brazilian Banks Have Fared Well
Lending growth in Brazil was strong in 2020; about 15.5%. Growth was mainly driven by the higher credit demand from corporates as they enhanced their liquidity to prepare for difficult conditions and by the incentives provided by the central bank to boost lending, which included liquidity support, guarantees on loans, and capital and provisioning relief. Moreover, mortgage lending also surged because of the low interest rates. In addition, the depreciation of the Brazilian real also boosted lending growth through the international exposures of the country's largest private bank.
However, in 2021 we expect lending growth to be much lower; about half of last year's level. This is because of the absence of the extraordinary measures from the government and banks' lower risk appetites, given the uncertain conditions stemming from a new wave of infection in Brazil. We expect lending growth this year to stem from retail lending as opposed to corporate lending, because we anticipate less demand from the corporate sector and expect retail expenditures to pick up from lower levels last year as social distancing restrictions are limited.
Brazilian banks' profitability was relatively resilient in 2020. Even though provisioning rose substantially, corporate demand for credit provided business opportunities for banks that were able to take advantage of the liquidity facilities provided by the government. In addition, provisions were already high before the pandemic, which provided some cushion. Finally, lower expenses due to the distancing measures also helped profitability.
We forecast lower provisioning needs for Brazilian banks. As the economy continues to rebound, we expect businesses and individuals' payment capacity to improve. On the other hand, asset quality has so far performed better than we expected, but we expect it to worsen as loan deferral programs end. However, the rise in provisioning coverage last year puts banks in a good position to deal with the possible deterioration.
Higher margins will also support banks' profitability. The shift from corporate to retail lending and increasing interest rates will help restore net interest margins (NIMs). We also forecast fee income to recover thanks to the pick-up in retail spending. On the other hand, continuing need to invest in technology will moderate the anticipated improvement in profitability. As a result, we expect banks to achieve similar profitability levels to those before the pandemic between 2021 and 2022.
COVID-19 Took A Toll On Mexican Banks' Profitability
Economic recovery will take longer in Mexico because of pre-pandemic structural weaknesses and the relatively small policy response to the pandemic-related crisis. Therefore, we expect credit expansion to remain subdued. In general, Mexican banks entered the pandemic with historically low NPAs and credit losses. This reflects the relatively low access to banking and conservative lending practices. However, COVID-19 will hit asset quality and profitability. The banking regulator approved a debt relief program for borrowers, the first phase of which represented about 20% of total loans. However, according to our estimates, restructures under the second phase of the program represent about 6% of the system's total loans, much lower than the 20% of loans in phase one.
We assume the worsening trend in asset quality that we observed in the last quarter of 2020 will continue in 2021. However, we expect the impact will be limited for the banking sector due to banks' conservative lending practices and good results from the debt relief program, which has mitigated the hit to asset quality. Most customers have resumed loan payments. We expect NPAs will peak in 2021 at 3.4% but will be fully covered by provisions and will moderate in 2022 to about 3.0%. We think credit losses will peak at 4% of total loans in 2021 and drop in 2022 to below 3%.
Mexican banks' profitability significantly weakened in 2020 because of three main factors:
- Large commercial banks, which represent more than 80% of total loans in the banking system, have set aside large amounts of provisions to face the dip in asset quality from the recession. At year-end 2020, Mexican banks had increased credit loss provisions 35% versus 2019.
- Demand for credit has also weakened because of lower investment, pressure on companies and households' income capacity, and high unemployment levels and the increasing participation of workers in the informal sector. We observed low credit demand and a 2% credit contraction in the Mexican banking system last year that hurt banks' results.
- Finally, NIMs declined because of the historically low interest rates and more liquidity invested in securities with relatively low risk. The low interest rates resulted from the central bank reducing its policy rate by 300 basis points in 2020. Additionally, because of low credit demand, banks placed their liquidity in securities that, because of their relatively lower risk, have lower margins compared to loans.
We expect Mexican banks' net income to return to 2019 pre-pandemic levels in 2022, but this will depend on the economic recovery in 2021 and 2022.
Government Measures Have Propped Up Chilean Banks' Profitability
The pandemic began when Chile was emerging from the effects of social unrest in 2019 and preparing to face potential volatility from the discussions about amending the constitution. However, despite the economic contraction, asset quality indicators improved in 2020 and the impact of the pandemic on profitability was manageable. The growth of the banking industry in 2020 was strongly influenced by coordinated actions taken by the government and regulators in Chile. These actions aimed to ensure the payment chain in the economy and the system's liquidity and solvency amid economic contraction and global and domestic volatilities, considering that Chile is a small and open economy. Measures included the central bank implementing significant credit lines, loans guaranteed by the government under the FOGAPE program, and the release of pension funds savings that gave significant relief to individuals. The release of pension savings totaled $34 billion and was equivalent to 12% of GDP. It was released in two installments, one last August for almost $20 billion and the second one in December for $14 billion.
Credit grew by about 2.5%, helped by the mentioned government-guaranteed FOGAPE loans for about $12 billion and equivalent to approximately 5% of the system's total loan portfolio. This more than compensated for the decline in consumer lending due to lower consumption during the pandemic and debt payments completed after the release of pension savings.
The measures in the country, especially loan extensions, guaranteed loans, and pension fund releases also supported asset quality metrics, with NPLs of more than 90 days amounting to 1.6% by the end of 2020 compared to the 2.0% average over the last five years. This was mainly explained by the consumer lending segment, in which NPLs declined by 110 bps to 1.4% and mortgages by 80 bps to 1.5%. Commercial loans NPLs also slightly improved to 1.7%. The extensions in tenors in the commercial segment granted at the beginning of the pandemic started maturing in November and December last year, with high levels of debt payments. We expect asset quality metrics to deteriorate this year as remaining loan extensions come due, although this depends on economic recovery and the evolution of the pandemic. To date, the country has already vaccinated 15% of the population and continues its efforts to achieve ample coverage by mid-year.
Profitability suffered, but it remains manageable, with a 25% decline in net income (excluding the one-off effect of intangible impairments at Itau CorpBanca of about $1 billion). ROE contracted to about 10.0% in 2020 (from a 12.5% average). This was explained by a significant increase in provisions, with cost of risk mounting to 1.7% of total loans in 2020, compared to the 1.2% average over the last five years. Lower funding costs of central bank lines and retail deposits and higher treasury results helped temper the impact of the increase in provisions and lower fee income during the lockdowns. In our view, provision requirements will gradually decline over the next two years. Assuming economic recovery and lower provisions requirements, we expect profitability to improve, with ROE of about 11% in 2021 but reaching pre-COVID levels of about 12% in 2022.
A Steep Falloff In Colombian Banks' Profitability
After the pandemic hit the economy in 2020, measures to contain COVID-19 and the moderate monetary and fiscal stimulus will help improve economic growth in 2021. We expect credit to expand about 5% in 2021 and about 7% in 2022 from below 4% in 2020. Credit growth will be underpinned by corporate and commercial loans--including infrastructure projects that could boost the economy--and by secured consumer products, such as payroll deductible loans and mortgages.
As a result of the pandemic, asset quality metrics have eroded, pressuring profitability through the increasing credit loss provisions. Loans as part of Colombia's relief program represented about 43% of total loans at the peak. This level was much higher than what we saw in other banking sectors in the region, for instance in Mexico and Brazil. This was because some large banks gave an automatic option to defer payments to their retail customers (including mortgage customers). By the end of June 2020, the banking regulator announced a second phase of the debt relief program. This new phase was aimed at bank customers severely affected by the pandemic. Customers who were not affected and who were part of the first phase were excluded from phase two and resumed loan payments. The second phase of support was also mainly restructures, similar to measures in other countries. As of February 2021, we estimate that restructured loans under the second phase of Colombia's debt relief program represented about 7% of total loans. This is significantly lower versus the 43% of phase one. Around 70% of these restructured loans correspond to retail loans, including mortgages, while the remaining 30% are commercial loans. The debt relief program in Colombia will last until June 2021.
Colombian banks' profitability suffered the most in 2020 among this group of countries. ROE was only 38% of what it was in 2019, mainly due to the spike in loan loss provisions. Given the high level of loans under the debt relief program and significant uncertainty about how these loans will perform, large banks significantly boosted their provisioning levels. In addition, the historically low interest rates, lower fee income and low credit demand in the first three quarters of 2020 also contributed to the lower revenues. We expect Colombian banks' net income to gradually increase in the next two years, reaching 2019 pre-pandemic levels in 2022, mainly due to higher NIMs as credit demand rises, higher fees, and lower provisioning needs.
Despite Government Support, Peru's Banks Continue To Struggle
Lending growth in Peru in 2020 was mainly propelled by the government's "Reactiva" program, which has unique characteristics that makes it less risky for banks. Peru's central bank auctions the funding through repurchase agreements, and the banks that intend to lend the guaranteed loans with the lowest margins are those that are granted the auctions. Banks then offer those loans to SMEs for working capital purposes. Businesses can't use these funds to refinance existing debt, but can use them to repay future installments. At the same time, development bank COFIDE (Corporacion Financiera de Desarrollo; BBB/Stable/A-2) makes sure those loans meet the guarantee requirements. As such, banks are not liable for the guaranteed portion. The guarantee ranges from 80% for the larger amounts up to 98% for the smaller amounts. Given the lower risks this product has, banks have been growing in this segment substantially. As of November 2020, it represented about 24% of total loans. The lending portfolio grew 12.4% last year, but if we excluded the Reactiva program, the portfolio would have decreased about 5.0%.
Credit losses significantly picked up in Peru because of the lengthy and strict lockdown implemented in March last year, resulting in one of the largest economic contractions in the region. Given Peru's low per capita GDP and large informal sector, this resulted in a very difficult scenario for the population, even though the government made significant efforts to back the private sector through fiscal support.
Due to the weak economic performance in 2020, banks have significantly raised provisioning levels, leading to weaker profitability. In addition, the lower margins on government-guaranteed loans and lower fees also weakened bottom-line profits. However, we expect profitability to improve in the next two years as provisioning needs lessen as the economy rebounds, , and as margins improve while the share of Reactiva loans decreases.
Economic Woes And Government Meddling Are Squeezing Argentine Banks
Argentina had one of the largest GDP contractions among its Latin American peers in 2020 and we only expect a mild recovery in 2021. Nonetheless, the Argentine banking system has remained relatively resilient, thanks to conservative policies and regulation. This has resulted in low access to credit--one of the lowest globally--and we estimate credit to GDP at about 12%. This has helped banks to keep relatively manageable asset quality metrics despite some deterioration, with NPLs to total loans at about 4.2% as of December 2020 (2.2% for private banks). Profitability last year weakened because of higher provisions and lower margins but stayed fairly healthy with an ROE of about 15% for the banking system. However, we expect profitability to weaken this year due to the inflation adjustment and banks' continuing need to raise provisions amid the recession.
We consider that Argentine banks are exposed to extraordinary measures from the government such as additional initiatives on direct lending, but so far, they have been able to fulfill the requirements on direct lending while remaining profitable. The city of Buenos Aires recently created a new tax on credit card transactions, which could discourage credit card use. We expect banks' revenue generation from credit cards to be weaker than absent this tax, but still to remain profitable. We expect lending growth to be relatively conservative, because we think banks will wait for economic growth before they take on the risk of boosting lending, so we forecast credit growth to be slightly above inflation and dollar-denominated loans and deposits to continuously decrease.
This report does not constitute a rating action.
|Primary Credit Analyst:||Cynthia Cohen Freue, Buenos Aires + 54 11 4891 2161;|
|Secondary Contacts:||Alfredo E Calvo, Mexico City + 52 55 5081 4436;|
|Guilherme Machado, Sao Paulo + 30399700;|
|Ivana L Recalde, Buenos Aires + 54 11 4891 2127;|
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