Mexican banks’ balance sheet exposure to downgraded sovereign debt and government-related entities (GREs) is a growing risk to capital levels and credit profiles, Fitch Ratings says.
Exposure is expected to remain significant, with increasing concentration risk, which will continue to weigh on Mexican banks’ creditworthiness due to the country’s weakened credit profile and slowly recovering economy.
Fitch’s worsening Mexican banking sector outlook primarily reflects the challenging local operating environment. While the country’s largest banks have sufficient capital to meet minimum regulatory requirements amid the pandemic’s economic fallout, under Fitch’s Moderate Stress Scenarios, four banks would fall below the threshold to maintain a ‘bb’ capitalization and leverage score. Nevertheless, there would still be ratings headroom in this scenario as we expect ordinary support to mitigate this risk.
Fitch incorporates asset quality concentration of sovereign debt and the potential for lower investment returns in its assessment of bank capitalization. These sizable government securities holdings have come under pressure, with market volatility reducing net income due to trading and mark-to-market losses.
Fitch expects lending to municipalities to remain relevant for banks with the ability to finance this highly specialized sector. Holdings of Mexican government debt and GREs (e.g. Petroleos Mexicanos [Pemex] with standalone credit profile of ‘ccc-‘ and Comision Federal de Electricidad [CFE], ‘bb’) have increased risks for Mexican banks amid asset quality pressures and low business growth that continue to weigh on returns.
Major Mexican banks’ overall public sector exposure was approximately 27% of total assets, or 3.2x the seven largest banks’ CET1 at 3Q20 versus 24% of total assets, or 2.7x CET1, at YE19. Banks allocated excess liquidity to Mexican government securities (41% growth), while lending contracted 2.4% in 2020.
Significant bank deposits from GREs and other public entities such as states and municipalities can also be more unstable in times of market stress.