Fitch: Mexican Banks Most Exposed in LatAm after US Election

NEW YORK--(BUSINESS WIRE)-- Mexican banks would be among the most exposed in Latin America should any change in US economic policy under President elect Donald Trump significantly affect trade and growth within the region, says Fitch Ratings. Over the short to medium term, the effects to Mexican banks would likely be partially contained by the banks' strong financial fundamentals. However, over the longer term, there could be downside potential for asset quality, loan growth and profitability if there is shift toward US protectionism.

Mexico's macroeconomic linkages with the United States are deep. The bilateral relationship accounts for a significant proportion of trade, investment and inward remittance flows. Uncertainty over the future direction of US policy has already increased currency and capital market volatility this year at a time when Mexican trade growth has been falling due to weaker US industrial output.

The potential downward risks to Mexico's economic outlook would have direct effects on the banking sector. Prolonged and heightened uncertainty could weigh on consumption and investment growth, potentially acting as a drag on lending and overall profitability. Additionally, the recent price decline in Mexican sovereign debt could translate into charges against valuations in the banks' investment portfolios, representing earnings challenges in trading income.

Beyond the broad-based macroeconomic feedthroughs, Mexican banks' sizable portfolios of loans to major conglomerates that are heavily reliant on external trade could also be a key source of vulnerability. Corporate and commercial lending accounts for over 40% of major banks' loan portfolios. Several key Mexican corporate sectors, especially those with large export and dollar-denominated debt exposures, could be at risk in the event of a sharp protectionist turn in the US. Fitch believes asset quality could deteriorate slightly over the medium term, owing to higher loan growth in recent years, and this trend could be exacerbated should risks to corporate credit rise.

Retail and public sector portfolio risks could also rise under an adverse economic scenario. Unemployment would rise under a less benign business environment, affecting retail credit quality. Banks' exposure to public sector borrowers, including state-owned energy companies and subnational governments, could be further tested under the current environment of constrained fiscal flexibility.

Nevertheless, Mexican banks are entering into this period of uncertainty from a position of relative strength. Bank credit profiles have continued to benefit from strong capitalization, adequate funding and liquidity profiles and recently improved asset quality, as well as stable and resilient earnings in recent years. The sector's average Fitch core capital to risk weighted assets ratio stands around 15%, which compares positively to other banking systems in the region.

The risks could also be mitigated by active management decisions in recent years. Banks have already shifted their retail portfolio mix to less risky segments, and they have proven capable of managing corporate portfolio concentrations in past downturns. Widening net interest margins from further likely increases in the local policy interest rate would also help buffer profitability.

Other Latin American banking sectors could also face downside risks from changing US policy, though to a lesser degree. The direct impact of rising protectionism on other major banking systems in Brazil, Argentina, Colombia, Peru and Chile would be substantially less than for Mexico. That said, these economies' high reliance on the commodities sectors would leave them vulnerable to a broad-based weakening in global economic growth that would result from a decline in global and regional trade.

Though smaller than other regional peers, Central American banking systems could also be exposed given their strong trade linkages to the US and the relative high inflows of remittances from the US, with the latter ranging from 5% to 20% of GDP in Honduras, El Salvador, Guatemala, Dominican Republic and Nicaragua.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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