New government measures are driving Argentine banks to dramatically expand lending to small businesses, potentially raising their risk to a segment seen as especially vulnerable in the COVID-19 crisis.

Between March 19 and May 6, 199.7 billion pesos' worth of SME working capital loans were approved, 156.8 billion pesos of which have already been disbursed, Fernando Alonso, a spokesman at Banco Central de la República Argentina told S&P Global Market Intelligence. The former amount is equivalent to 9.6% of the entire banking system's peso-denominated loans to the private sector, including those to individuals, according to May 12 central bank data.

Banks were left with few alternatives after the central bank, or BCRA, limited March 19 the amount of Leliqs — short-term central bank notes that currently offer an annual interest rate of 38% — they can hold. The BCRA also reduced minimum reserve requirements and suspended dividend payments until after June 30, in an attempt to funnel the money that banks had stashed in central bank notes into lending to strapped-for-cash micro- and SMEs at a capped rate of 24%, more than 20% below expected inflation for 2020.

"At that rate, banks are practically gifting money away," Erik Schachter, an equity analyst at Consultatio SA, told S&P Global Market Intelligence.

"Banks have exchanged 14- or 30-day Leliqs positions with a 38% interest rate, which they knew the central bank would not default on, for longer-term loans at 24%, to companies with higher risk," Schachter continued, also pointing out that net interest margins were worn down further in April by the BCRA's decision to place a minimum interest rate which banks must pay on fixed-term deposits, equivalent to 70% of the benchmark rate.

With a total of 100,332 companies flocking to finance their working capital expenses to compensate for the impact of the country's lockdown on revenues, according to central bank data, banking majors such as Grupo Financiero Galicia SA and Banco Santander Río SA saw their SME lending soar. In less than a month and a half, they disbursed the equivalent of 39% and 56% of their total credits to SMEs in the fourth quarter of 2019 respectively, just with the subsidized credit line.

In a bid to reduce banks' perceived level of risk in a third consecutive year of a recession that has been aggravated by the coronavirus pandemic, the central bank announced that such loans will be backed up by the Argentine Guarantees Fund, or Fogar. The guarantee scheme will cover a total lending volume of 220 billion pesos, with the government backing up 25% of every loan disbursed to midsize companies, and 100% of each credit line to micro- and small businesses.

"The guarantees can be activated as soon as the company misses a repayment," Hernán Dearriba, head of communications and institutional relations at the ministry of productive development, told S&P Global Market Intelligence. Banks can request the execution of the guarantee within 90 calendar days of non-repayment, after having sent the SME a formal notice, he added.

But if banks had been skeptic to lend in current conditions, concerns were heightened on May 7 when the central bank announced a further 22 billion credit line for micro firms and SMEs that have never had access to a loan. Unlike the previous scheme, which was voluntary, banks are obliged to lend to such first-time borrowers, granted the borrowers obtain a guarantee from Fogar.

The value of government guarantees

With Argentina at odds with bondholders over debt talks to restructure some $65 billion in sovereign bonds and a looming May 22 deadline which could trigger default, questions remain about the government's capacity to offer guarantees to banks.

Moody's analyst Marcelo De Gruttola said that Moody's "rates the government, and they have a very low rating, which is Ca Negative." But he added that the Fogar funds are already available, which adds some value to the guarantees.

A source at one bank, who asked not to be identified, told S&P Market Intelligence that lenders "are sufficiently capitalized and liquid to handle these loans, considering also that the starting point for delinquency is low," adding that the government's guarantees "should be OK, because they are pesos for peso-denominated loans, although it would be best to avoid a default."

"Forecasting delinquency rates is difficult right now, but we are clearly expecting deterioration in the quality of banks' portfolios, and these loans, which are the only ones that are truly growing, are part of the reason why," Moody's De Gruttola said.

Similarly, Consultatio's Schachter, who emphasized that these loans are being used to pay wages rather than to invest, warned that if the lockdown continues, borrowing SMEs may find themselves unable to repay, needing even more loans.

"This will definitely hit profitability in the short-term due to higher delinquency, for which they will have to make provisions," he said, noting however that "once the quarantine is over and companies are back up and running, the loans won't be hard to repay because of the negative rate in real terms."

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As of May 14, US$1 was equivalent to 67.64 Argentine pesos.