Mexico has been facing headwinds during 2013, with a lower rate of economic growth as a result of reduced government spending, lower construction and infrastructure development, a contraction in consumption and retail activity, and weaker foreign trade.
The economy has also been affected by the volatility in the international financial markets, as a result of the uncertainty behind the FED’s tapering. This has led to movements in the forex markets and the Mexican yield curve, which in turn have led to higher risk aversion.
Mexico’s economy was expected to grow more than three percent when the first forecasts for 2013 were released, yet it has been revised downwards to growth rates of just over one percent.
Current market challenges
There are various challenges of operating in today’s financial environment. The most significant difficulties have been to achieve quality growth in spite of a weak economy, manage the troubled exposures of the main home developers, and maintain sound fundamentals.
The first one is exogenous and difficult to control. The bank has adapted its operations to the challenging economic environment by being more cautious on the risks that it undertakes, and follow up with existing clients to sense any changes in their payment capacity. The bank tends to be more conservative in terms of its growth and capital deployment under this type of environment.
The bank has adapted its operations to the challenging economic environment by being more cautious on the risks that it undertakes
In terms of the exposures to the three main home developers, Banorte has been very proactive in managing the potential losses from those loans. The bank frontloaded provisions and received payments to minimise the potential losses from those exposures.
It has also been working with companies to find solutions to restructure their liabilities, and help them face their financial difficulties. It’s confident that the home development sector in Mexico has great potential because of the housing deficit that the country faces.
Ensuring its balance sheet is resilient to adverse conditions, Banorte proactively manages asset quality, liquidity and capitalisation levels. Its efforts are focused to ensure that its asset growth is matched by liquid low cost liabilities, and also that any maturity mismatch is hedged properly.
Additionally, the bank tries to keep stable asset quality indicators through strict underwriting standards and advanced collection and recovery processes, maintaining capital levels that are sufficient to balance the rapid growth in its loan portfolio with strict internal and external capitalisation requirements.
The performance fundamentals
Under this backdrop, Grupo Financiero Banorte’s performance during 2013 has been relatively positive. It has been able to partially offset a lower expansion in its loan portfolio and an unfavourable interest rate environment with an improvement in its funding and loan mix, as well as the payment of some high interest paying liabilities, such as a syndicated loan and a perpetual bond.
Core deposits are growing close to 15 percent on a yearly basis, while consumer loans are increasing close to 20 percent. As a result, the bank’s net interest margin (NIM) is expanding this year, which is a positive development compared to the last time Mexico started an easing monetary cycle in 2008 – at that time Banorte’s NIMs contracted by over 300 basis points.
As a result of higher NIM’s and non-interest income, total revenues have grown by 12 percent over the last 12 months, and expenses by three percent. Provisioning costs are normalising after having to cover the expected losses of the bank’s home builder exposures during the first half of the year.
All in all Banorte is on track to delivering a significant expansion in earnings on the back of positive operating leverage and the integration of Afore Bancomer’s results. ROE currently stands at 14.3 percent despite the dilution to EPS and ROE that stemmed from a recent equity offering, and ROA is 1.4 percent expanding 20 basis points over the past 12 months.
Banorte’s capitalisation levels are adequate, reaching almost 15 percent, and its leverage ratio is above 12 percent. It is fully Basel III compliant in terms of capitalisation requirements, which allows it to concentrate more on achieving growth targets and less on complying with the new regulation, as other banks in the world are doing.
On the negative side, non-performing loans have risen lately to 3.2 percent due to the homebuilder exposures, but are relatively stable excluding this effect. Also, the corporate loan portfolio is contracting, as a result of weaker demand and pre-payment activity.
Capital to enhance future growth
Banorte’s sound fundamentals and positive outlook were recognised by local and global investors in a recent follow on offering in the local and international ECM markets, which became the most significant transaction in Mexico’s history, especially because all the shares were sold through the Mexican Stock Exchange (see Fig.1).
There was an over subscription of 3.4 times with a demand of more than $8.5bn, for a total amount issued of $2.5bn. The funds of the equity offering were used to pay for recent strategic initiatives, and to have the capital to continue feeding its growth prospects.
Since acquiring Afore Bancomer at the beginning of 2013, Banorte is the most significant player in the pension fund management industry, with a 28 percent market share. It also recently acquired the 49 percent minority stake that Generali held of its insurance and annuities business, and embarked in a transformational programme of its processes and IT in partnership with IBM.
Since acquiring Afore Bancomer at the beginning of 2013, Banorte is the most significant player in the pension fund management industry
All these moving parts have posed the important challenge of transforming the bank, while running it at the same time. In the coming months, Banorte needs to implement a number of initiatives.
It needs to extract the cost and revenue synergies from the recent acquisitions, integrate their operations to the rest of the organisation, industrialise its processes and IT, transform its operations from a product to a client driven institution, and upgrade its risk management systems to the new dynamics in the organisation.
The bank needs to execute these transformations almost flawlessly in order to achieve its strategic goals and profitability targets. Another important strategic priority is to continue enhancing its market position as one of the leading and most profitable financial institutions in Mexico, while at the same time focusing more on attending to its existing client base.
In the past, Banorte grew by expanding loan volumes and bringing more clients to the bank, without considering the value propositions that it could offer to the new client base. This led to high client attrition rates and low profitability per customer. Under its new model, Banorte will segment its client base more efficiently and provide targeted value propositions per client. This will lead to an expansion in the number of products per client, and in turn will help the bank enhance its market position and overall profitability.
Medium term perspectives
In the medium term, Banorte will continue its commitment with its home market, where it still sees significant growth opportunities. The prospects for Mexico’s economy and its financial sector are positive. The Mexican market continues to be under penetrated with one of the lowest loans to GDP indicators in the region – below 20 percent versus an average of more than double for Latin America.
Part of this low level of banking penetration is a result of the stringent regulation implemented after the crisis in the 1990s, which makes capitalisation and reserve requirements much tougher compared to other countries.
It is no coincidence that Mexican banks weathered the past economic crisis without many problems, and have been able to effectively adopt the Basel III requirements and expected loss provisioning.
Nonetheless, the stability of the banking system has been on the back of a smaller banking system. This is where the recently announced financial reform could play an important role. If the government effectively uses the development banks to provide special funding programmes and guarantees for risk sharing with the banking system, there could be a significant boost to credit penetration.
Also, if the foreclosure of collateral becomes more effective, banks will be able to lower the costs of financing, and more people will have access to credit at lower costs. This will generate a virtuous circle, which should translate into higher credit penetration and economic growth.
Banorte estimates that banking penetration could be at least 30 percent of GDP if all the right policies are implemented. There are many opportunities to continue growing the bank’s funding and lending activities by expanding its retail network though traditional and non-traditional channels, and also to reach out to the unbanked with specific product offerings such as micro loans and insurance.
In the medium term, the prospects for the Mexican economy continue to be favourable, and this will allow Banorte to expand its loan portfolio at a multiple of two to three times nominal GDP. There are few countries in the world that provide this type of opportunity.
Additionally, Mexico is finally moving forward in the reform agenda. A series of structural reforms have been approved on the labor, energy, fiscal, education, financial and telecommunications fronts. These reforms, if they are well executed, might give Mexico a higher level of potential GDP growth rate of at least four percent, but its adequate implementation will be fundamental to propelling Mexico’s medium-term growth rate.