Years of capital buffering will help Mexican banks navigate rocky waters ahead, experts say, as a perceived lack of fiscal support from the government aggravates conditions in an economy already battered by the coronavirus pandemic.

Throughout the crisis, Mexico has stood out in its unwillingness to deploy the same kind of large fiscal stimulus packages seen elsewhere in the region and around the world. President Andrés Manuel López Obrador held fast to his want for fiscal austerity and sought to limit the scope of any rescue plans, even as Mexico's central bank has steadily easing interest rates and introduced new measures to help boost system liquidity.

"In a crisis, both [the central bank and the federal state] must have countercyclical policies," said Jorge Sanchez Tello, a director at financial think tank Fundef. "And so far, the government is the one that has fallen short."

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The government's aversion to spending could exacerbate Mexico's economic downturn in the years ahead, analysts said. "We expect the Mexican economy to improve next year, with GDP growth of 2.9%," S&P Global Ratings analyst Alfredo Calvo said. "However, large economies are going to report stronger recovery ratios, including the U.S., where we expect a 6.2% expansion. Mexico will not take advantage of this strong recovery in other countries."

This also will create "a more complex and difficult operating environment for Mexican banks," Calvo warned, echoing a sentiment expressed by the banks themselves. Banco Santander México SA recently noted that the absence of further government programs was having a "material adverse effect" on its operations.

"If the government does not make an adequate fiscal policy, it will have a negative impact on banks due to credit falling amid less economic activity," Fundef's Sanchez said.

Both large and medium-sized Mexican banks have seen relatively low nonperforming loan ratios in recent years, with the major players in each group averaging just north of 2.20% as of year-end 2019.

However, the crisis will likely "[erase] the lows in delinquencies that we have been seeing in the last two years or so," Fernando Calvaho, an analyst with Moody's, said. Consumer financing and SME lending are particularly likely to see greater asset quality deterioration, both segments that make up a big chunk of several banks' loan books.

Sizing up

Given the more challenging outlook, large Mexican banks likely will fare better than their smaller counterparts in addressing increased operating risks. For one, major banks benefit from more diversified portfolios, as opposed to smaller, niche banks, which rely on more expensive deposits and have higher concentrations in their books.

On average, business activity loans accounted for about 45% of the total credit portfolio of the three largest Mexican banks in 2019. But for the country's three biggest midsize banks, the segment had an above 65% share in their books. Banco del Bajío SA alone had more than 80% of these loans in their portfolios.

Meanwhile, Banco Azteca SA, a subsidiary of financial and retailing conglomerate Grupo Elektra SAV de CV, had more than 55% of its portfolio dedicated to other consumer loans.

"If one of those business activities experience difficulties then you can see these banks' profitability and capitalization suffering," Calvo of S&P Global Ratings said.

Retail deposits serve as an important component of large banks' funding structure, providing them with cheap financing options, a luxury not afforded by midsize banks. "Within this environment, volatile funding sources represent a weakness," Calvo noted.

Foresight is key

Still, the overall banking sector should have enough buffers to keep itself afloat through the crisis. "For many years, Mexican banks have been proactive in improving their risk management measures," Calvo said. "If you compare the nonperforming loan ratio for Mexican banks against other banking systems in Latin America, you can see that Mexico is the one with the healthiest metrics."

Banks also benefit from a continued reliance on core deposit funding, which better enables them to turn a profit even as credit costs rise, he added. For the three largest Mexican banks, the ratio of gross total loans to core deposits ranged from between 85% and 100% in 2019.

Trepidation to increase lending to troubled state-owned oil company Petróleos Mexicanos SA de CV in the past should also benefit banks in the current scenario, given that the energy industry is one of the hardest hit by the pandemic. According to Market Intelligence's Market Signal probability of default model, the Mexican energy sector has the biggest risk of nonpayment among industries at 17.6%, followed by the consumer discretionary and materials sectors.

"The regulation allows banks to lend much more, the equivalent of almost 100% of their capital, to Pemex, but most of them lowered those exposures to levels more comfortable to the maximum lending limit of a normal company," Calvaho said.

As for large banks, exposure to other heavily impacted industries such as tourism-tied sectors and manufacturing is a problem spot. But even these vulnerabilities are "relatively manageable" given ample risk management tools, Calvo said.

"The outlook for banks is complicated; but unlike other crises, today they are part of the solution and not the problem," Sanchez noted.