Major Factors

Rationale

S&P Global Ratings classifies the banking sector of Argentina (B+/Stable/B) in group '8' under its Banking Industry Country Risk Assessment (BICRA). Other countries in group '8' are Paraguay, Bolivia, Honduras, Russia, and Sri Lanka.

Our bank criteria use our BICRA economic and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. Our anchor stand-alone credit profile (SACP) for a commercial bank operating only in Argentina is 'bb-'.

We've recently revised our economic growth projections for Argentina, with a real GDP increase of 1.5% in 2018, compared to 2.9% in 2017 and a contraction of 1.8% in 2016. We incorporate the impact of the drought in the country on soy crops; the impact of external events related to increasing U.S. interest rates; and internal factors that have resulted in volatile economic variables, with depreciation of the domestic currency and increases in interest rates and projected inflation. Although banks operating in Argentina have made progress in business conditions and resilience over the last two years, we believe that the economic risks are still considerable. These risks relate to high inflation that continues to dent GDP per capita ($14,473 for 2017 and projected to be $12,900 for 2018, mainly due to the currency devaluation), the volatile economy, and its vulnerability to political cycles. Inflation decreased to 25% in 2017 from about 43% in 2016, but we predict it to rise to about 28% in 2018. We expect recent events of volatility in the country to pressure credit quality, but credit metrics are currently healthy. Banks have been increasingly providing dollar-denominated loans, but most of these are to borrowers that generate income in dollars, such as exporters, which alleviates the potential risk. Indexed currency mortgages have significantly grown since 2017, but access to these loans is still low--they're mainly to higher income segments--and we expect mortgage lending during the rest of 2018.

Our industry risk assessment incorporates the country's enhanced institutional framework, stemming from Argentina's stronger regulatory framework after it implemented Basel III principles for capital requirement calculations and liquidity ratios, and rolled out aspects of international accounting rules. These factors align Argentina's financial system more closely with international standards. Despite this progress, risks for banks operating in Argentina are still high, in our view, because of historically weak depositor confidence and the lack of diversified long-term funding. We consider deposit stability to be a major risk, given the country's still recent history of unstable deposits. However, total deposits have stayed relatively stable despite the recent sharp depreciation of the Argentine peso (ARS). Further uncertainty about currency fluctuations could result in deposit withdrawals and pressure banks' funding and liquidity positions. In our opinion, the country also has a narrow capital market and Argentine entities still have limited access to foreign capital markets, resulting in a narrow range of funding sources. The recent approval of the "Ley de Financiamiento Productivo" law would help develop the domestic capital market, but benefits wouldn't be tangible in the short term.

Chart 1

Economic And Industry Risk Trends

The stable economic risk trend captures the more challenging conditions for banks operating in the country. In the current situation, we predict that distortions will diminish and inflation will decrease only gradually. We expect Argentina's recent currency depreciation, higher interest rates, increasing inflation, and consequently lower economic growth to result in slowing credit and some worsening--although manageable--of asset quality metrics.

In our view, Argentina's industry risk trend is stable. Over the next few months, we expect one-time events (including the impact of the recent domestic currency depreciation), holdings in central bank securities, and other holdings to influence banks' profitability. Although the funding structure of the system has somewhat diversified, we expect it to still be mainly funded by deposits and to remain quite stable, even amidst a volatile economy.

Economic Risk

We base our economic risk score for Argentina on our assessment of economic resilience, economic imbalances, and credit risk in the economy.

Economic resilience: Continued economic growth, although affected by the drought and economic volatility

Economic structure and stability.   Economic growth in Argentina resumed in 2017 after the contraction in 2016: its GDP grew 2.9% in 2017, compared to the 1.8% contraction in 2016. Regained growth in the construction sector, including public works; renewed investments in agriculture, energy and auto sectors; and improving consumption due to recovery in purchasing power all helped drive this growth.

However, GDP prospects for 2018 have worsened. We now expect growth of 1.5% (from our previous expected levels of 2.8%), reflecting recent market turbulence, investor uncertainty, and the effects of a drought that will reduce soybean output and exports (although it will affect output more so than exports, given the significant restocking last year). We also expect higher inflation to dampen consumption and increased interest rates to limit private investment. We think growth will likely pick up in early 2019 due to better economic stability, a recovery in agriculture, and some private-sector investment in infrastructure (through public-private partnerships [PPPs]), resulting in growth of 2% for the year.

Over the next few years, Argentina's GDP growth rate is likely to be 3% (or 2% on a per capita basis). However, we're more uncertain about this estimation than for most countries. Continued growth depends on maintaining access to external funding (from the market and official lenders), in the context of the government's high debt burden and the domestic capital markets' minimal capacity to fund the fiscal deficit.

Adjustment for GDP per capita.   Argentina's GDP per capita is one of the highest in Latin America--about $14,473 for 2017, although we forecast it to decline to about $12,900 in 2018 because of the recent depreciation of the Argentine peso against the dollar. Inflation remains high, undermining real purchasing power and shortening economic agents' planning horizon. We expect inflation to reach about 28% in 2018 from about 25% in 2017, creating distortions and creating difficult product risk pricing for the banking system.

Macroeconomic policy flexibility.   The combination of persistently high inflation, expected higher U.S. interest rates, and lingering uncertainty about the central bank's willingness to tighten interest rates contributed to market turbulence in the second quarter of this year. An outflow of capital led to a depreciation of the local currency and led the central bank to raise its policy interest rate to 40%. In this context, we revised our expected inflation to about 28% for 2018.

However, we expect monetary and fiscal adjustments in the coming months to change inflation dynamics, lowering inflation to 20% in 2019 with substantial further declines in the following two years. We expect the central bank to only gradually loosen monetary policy after the recent tightening. Over the long term, a tighter monetary policy and fiscal austerity should boost the central bank's credibility and reduce inflation to single digits.

Currency depreciation and higher inflation will likely boost net general government debt to 59% of GDP in 2018 from 51% last year (our general government debt figures exclude the debt issued by the central bank, called LEBACs). We expect net general government debt to hover just below 60% of GDP in the next three years, on average. However, government-owned agencies (the central bank, Banco de la Nación Argentina [Banco Nación; not rated], and others) hold about 48% of the debt stock, diminishing the rollover risk. The International Monetary Fund (IMF) program should provide sufficient official lending (through a standby line for $50 billion), if needed, to cover all of the government's remaining budget financing needs in 2018 and 2019.

Political risk.   President Mauricio Macri, leader of the Cambiemos coalition, has been able to govern effectively and pass important laws despite lacking a majority in both the House and the Congress, thanks to support from different factions of the divided opposition Peronist party. Macri's coalition improved its standing in the 2017 midterm congressional elections, winning 40.7% of the national vote. Since coming to office, the Macri Administration has taken substantial steps to stabilize the economy and restore its growth. It released exchange rate restrictions, reduced and eliminated export duties and other export barriers, cut energy and transportation subsidies, and reestablished ties with external capital markets. It also started an ambitious program of PPPs to attract infrastructure investment. It also passed a far-reaching fiscal responsibility law to rearrange general government finances, a pension law, and tax reform. Congress recently approved a new capital markets law designed to deepen domestic financial markets and boost lending. The government has also begun to make progress over the last two years in rebuilding the official statistics agency (INDEC), restoring transparency and credibility to its economic data.

In contrast with previous attempts in Argentina to stabilize the economy over the past couple of decades, the Macri Administration decided to adopt a gradual approach to reducing the economic imbalances that it inherited. However, this gradual approach prolonged its reliance on external markets and on the central bank for financing large budget deficits (given the small size of local capital markets). The government now faces the challenge of credibly accelerating the pace of economic adjustment in the coming months to quickly correct inflation dynamics, reduce the fiscal deficit, and set the stage for a recovery in GDP growth next year (after a dip in the growth rate this year). However, it will be difficult for the government to implement austerity-based economic policies ahead of the national elections scheduled in late 2019.

Table 1

Economic imbalances: Credit growth in real terms should significantly moderate compared to 2017

We believe that Argentina is in an expansionary phase. Since 2017, the system has resumed growth in real terms. We expect growth to continue in 2018, but at a much more moderate pace in light of the recent market volatility that's affecting the country's economy.

We think that the growth in the residential mortgage lending and the increase in property prices seen after the creation of an indexed currency (UVA; Unidad de Valor Adquisitivo) in mid-2016 won't significantly heighten economic imbalance risks. Mortgage lending is still developing and banks mainly granted loans to medium- to high-income clients.

Private sector credit growth.   Credit to the private sector in real terms resumed in 2017 at a rate of 27% (from a contraction in real terms of 11% in 2016) because of better economic conditions and declining inflation (from peak levels in 2016). However, credit access in Argentina is still the lowest in Latin America, representing 16% of GDP at the end of 2017. Credit growth was driven to an significant extent by mortgage loans in UVA from private and especially state-owned banks that have a mandate to facilitate access to mortgages to all population segments. Credit growth also came from the corporate and enterprise segments and, to a lesser extent, from consumer loans.

We expect lending to slow in 2018 to 5%-12% in real terms as a result of lower demand from corporates, because investment will likely moderate and higher interest rates will pressure the operating performance of some companies. Demand for mortgages could also stall because property acquisitions tend to be postponed during turbulent market scenarios. Some purchases may not move forward, given that property prices in Argentina are set in dollars and so will rise following a weaker peso, and given the fact that banks implemented stricter conditions to grant loans and interest rates have increased.

Real estate prices  There is no official data on the average annual change in inflation-adjusted residential housing prices in Argentina.

Over the last few years, real estate prices were influenced by high inflation and restrictions in access to foreign currency, because assets in the country are mainly traded in dollars. Prices in 2016 were affected by the significant depreciation of the currency after the removal of exchange-rate restrictions, since transactions are set in foreign currency. In 2017, the residential market picked up, thanks to the allocation of funds from the tax amnesty program, the implementation of the inflation-adjusted currency, UVA, and the relaunch of mortgage lines, especially from public banks and the Procrear Program (this government program offers mortgages for lower-income borrowers). Residential mortgage loans accounted for 6.9% of total loans as of March 2018, compared to 2.9% in December 2016. These loans are almost all denominated in local currency.

According to data from Reporte Inmobiliario (a real estate platform with information about South America), the four-year average of real estate prices has grown in real terms by around 8.2% as of December 2017. However, this data is only from the city of Buenos Aires.

Equity prices.   Inflation-adjusted equity prices increased by about 26% in real terms over the past two years, given improved economic fundamentals and the consolidated position of the current administration after the legislative elections. Index movements don't affect the banking sector because its exposure to these instrument types is very low.

Current account and external debt position.   The combination of a weaker currency and tighter fiscal and monetary policy should reduce the current account deficit in 2018 to 3.9% of GDP from 4.8% last year. Weak imports should outweigh the loss of some agricultural exports this year due to the drought. The current account deficit could approach 3.0% of GDP in 2019 and hover around that level, on average, over the long term, with the trade account close to being in balance. Slow economic growth will restrict imports in 2018 and 2019, especially of capital goods.

We expect Argentina to continue to depend on external financing (both official and commercial) to cover its fiscal and current account deficits, making it vulnerable to a shift in global market conditions, which happened in April to May 2018. However, Argentina's access to external funding should improve because it recently entered into a program with the IMF, which provides enough official lending, if needed, to cover the government's entire remaining budget financing needs for 2018 and 2019.

Table 2

Credit risk in the economy: Low private sector leverage, but still poor rule of law

Private-sector debt capacity and leverage.   Although Argentina's GDP per capita of $14,473 in 2017 is much higher than its BICRA peers' average, it's still low and mainly responsible for a fairly limited debt capacity. At the same time, leverage is also low. For 2018, we expect per capita GDP to decline to about $12,900, reflecting domestic currency depreciation and lower growth.

Despite some improvement, credit access in Argentina has remained low since the 2001-2002 crisis, with credit access as a percentage of GDP of 16% at the end of 2017--the lowest level among BICRA peers. The private sector's lack of confidence in the banking system, the volatile economy, and the high cost of credit has moderated investments, credit growth, and economic recovery. Furthermore, the still large portion of the population in the informal economy and banks' conservative underwriting standards continue to limit credit expansion in the retail sector. In our view, a consolidation in lending growth and lending access would need to be tied to consistent economic growth and declining inflation and interest rates.

Asset quality metrics worsened slightly over the last three years, but remain sound when compared to those of peers with the same economic risk assessment. Non-performing loans (NPLs) were 1.9% by the end of March 2018, compared to 1.8% as of Dec. 2016 and 2017 (and 1.7% as of Dec. 2015), explained by higher delinquency in the consumer and credit card segments, although this was compensated for by improvements in the corporate and enterprises sector. As of March 2018, NPLs in the corporate segment were 1.0% (compared 1.1% in March 2017), while in retail, they were 3.0% (compared to 2.8% a year earlier). We expect the struggling economy to hurt banks' asset quality. The weaker economy will pressure the already struggling small and midsize enterprises (SMEs) sector, while households will further struggle to cope with rising living costs, especially those with mortgages and personal loans denominated in UVA. However, the low proportion of credit to GDP, and banks' low exposures to loans to SMEs and lower-income borrowers, will mitigate the asset quality deterioration.

Adjustment for lending and underwriting standards.   We continue to view lending and underwriting standards in Argentina as moderately conservative. Although mortgage lending spiked in 2017, the share of these loans in the total loan portfolio is small and limited to prime lending. The use of collateral and cash flow analysis is common. As of March 2018, mortgages accounted for 9% of total loans in the system, of which 70% were residential and the rest were commercial real estate loans. Only 3% of mortgage loans were foreign-currency denominated, and almost all of these were non-residential. In addition, the conditions of loans in UVA include the possibility of extending the tenor of the loans in cases where the inflation rate exceeds salary increases by 10% (this mechanism allows one to extend the tenor of the loans up to 25%). For the rest of 2018, we expect loan growth in UVA to moderate because of projected higher inflation and exchange rates, and tighter conditions for loan granting.

On the other hand, dollar-denominated loans have increased to 18% of total loans as of March 2018 from 5% in 2013-2015 under the previous administration. However, banks have mainly granted them to dollar-generating companies such as exporters, which alleviates the potential risk. We expect dollarization in the system to remain below 20% in 2018-2019.

The banking segment provides traditional banking products. Banks don't use derivatives and only use a small amount of securitizations to shift risks off their balance sheets.

Adjustment for payment culture and rule of law.   Low confidence in the legal system is a major weakness in Argentina, and could lead to worsening credit quality during economic distress. Although the insolvency regime improved after the last economic crisis, the bankruptcy process is still very long and inefficient, and the execution of guarantees can be lengthy.

Overall, Argentina's low ranking in international indicators (such as World Bank governance indicators and transparency indices), the nationalization of the energy company Yacimientos Petrolíferos Fiscales—YPF (B+/Stable/--) and the pension fund AFJPs, allegations of high-level corruption, and amnesties for tax evaders are evidence of poor rule of law.

Table 3

Base-Case Credit Losses

Credit losses have remained low over the past five years, despite the struggling and volatile economy. We expect some increase in the system's losses (from charge-off levels of around 1% in 2017) because of Argentina's currency depreciation, higher interest rates, rising inflation, and lower economic growth. However, we predict that losses will remain manageable and at stronger levels compared to regional and global peers. Our credit loss estimate for Argentina for the next two years incorporates the following assumptions:

• GDP growth of 1.5% for 2018 and 2.0% in 2019;
• Inflation of 28% in 2018 and 20% in 2019; and
• Unemployment of 7.6% in 2018 and 2019.

Industry Risk

We base our industry risk score for Argentina on our assessment of its institutional framework, competitive dynamics, and system-wide funding.

Institutional framework: Regulation now aligning with international standards

Banking regulation and supervision.  We assess Argentina's regulation and supervision as intermediate because it's made important progress in aligning with international standards that will allow the central bank to adequately oversee the industry. As a member of the Basel Committee, Argentina progressed in implementing Basel III. Specifically, it has defined regulatory capital levels that are in line with Basel III standards; introduced credit, market, and operational risk requirements; and established regulation for the pillars of Basel II. Moreover, since January 2014, banks have disclosed their Pillar III reports. From 2015 onward, the financial regulatory bodies introduced a liquidity calculation--they're aiming to fully implement this measure by 2019.

After a decade of central government intervention in the central bank, we're seeing the latter gradually regaining independence; bolstering its authority and capacity to effectively address potential problems in the banking sector. The current administration removed some of the measures its predecessor introduced, including the caps on loan rates, minimum rates on term deposits, the lending quotas for loans to SMEs, and the authorizations for fee increases.

As part of Argentina's recent program with the IMF, its government has committed to implement specific measures that would strengthen the central bank's autonomy, including:

• Giving the bank the power to set inflation goals (three years ahead) in conjunction with the Ministry of Finance;
• Eliminating the central bank's transfers to the treasury (financing to the central government amounted to ARS150 billion in 2017, equivalent to 1.5% of GDP, down from about 5.0% of GDP in 2015);
• Improving the central bank's balance sheet through the repurchase of "Letras Intransferibles" (treasury bonds acquired by the central bank that cannot be sold in the market) of the bank, and reducing the stock of LEBACs (central bank securities).
• Submitting a project to the congress to reform the central bank's charter in order to reinforce its autonomy.

Regulatory track record.   In response to the 2001-2002 financial crisis, the government instituted a deposit freeze to stop a run on banks--in our view, this was the result of regulatory weakness. At that point, banks' balance sheets were mostly dollarized, foreign currency lending wasn't hedged, and banks' exposure to the public sector was very high. The former administration's many reforms mainly had a political and social agenda, rather than a preventive one to ensure the health of the financial system. The central bank's lack of independence and limited authority to address problems more or less ensured that it concentrated its efforts on using the financial system to support government policies.

Adjustment for governance and transparency.   Argentina's governance and transparency is adequate, in our view. The banking system discloses sufficient information, and banks' reports and financial statements are standardized. The central bank publishes a semiannual Financial Stability Report and a monthly Banks Report. Furthermore, since January 2014, banks also disclose Market Discipline reports, which are in line with Basel's Pillar III guidelines. The banking system began implementing some International Financial Reporting Standards (IFRS) this year.

Competitive dynamics: Still profitable banking system despite some decline in metrics

Risk appetite.   The Argentine banking system's average return on assets (ROA) over the past three years was 3%-4%. High inflation influences profitability ratios in Argentina, but even if we adjust for it, banking ROAs have been somewhat higher than those of other sectors. Banks benefited significantly in previous years from extraordinary events such as peso depreciation, high rates on central bank securities, and, in many cases, negative real interest rates for funding costs with deposits. In 2017, the system's ROA was 3.3% (compared to 3.7%), which incorporates the impact of high lending growth in real terms and somewhat higher funding costs related to positive interest rates for funding. In 2018, banks will benefit from the higher rates on central bank notes and securities and will likely increase their share on their balance sheets; factors that will help to boost their profitability and mitigate the expected slower credit growth and higher provisions. All these trends could moderate if the government succeeds in gradually reducing the interest rate while lowering inflation and stabilizing the currency.

The Argentine banking system offers traditional banking products with no high-risk lending. Asset growth has been moderate over the past few years amid high inflation and subdued economic growth, and commercial practices are generally conservative. Although the profitability of the banking system is higher than those of other sectors, we don't think it's due to a high risk appetite. In our view, the improvement of competitive dynamics in Argentina depends on a more favorable economic outlook, better political conditions, and lower inflation and interest rates.

Adjustment for market distortions.  We believe the banking system in Argentina has certain market characteristics that could distort competition and earnings:

• The significant presence of government-owned banks or government-related entities (GREs). The largest bank in the country, government-owned Banco Nación, held about 23% of the system's deposits and 14% of loans as of December 2017. Banco Nación and the other 16 government-owned banks and GREs account for about 49% of total deposits and 34% of total loans. These banks tend to have competitive advantages, such as cheaper funding, because they benefit from a portfolio of captive clients--public-sector employees--and some receive deposits from the judicial system. Also, some offer subsidized interest rates for certain types of loans and have guarantees from their respective local governments for their deposits.
• We expect inflation to remain high, making risk pricing difficult and hindering long-term lending.
• Government-directed lending (Linea de Créditos Para la Inversión Productiva) is still in place, but the regulator aims to eliminate this by the end of 2018.

Table 4

Systemwide funding: Mainly funded by deposits, but stability has historically been a risk

Core customer deposits.   The Argentine banking system's main source of funding is deposits, which represented around 83% of total liabilities as of March 2018. The issuance of senior and subordinated bonds is very limited, representing less than 4% of total liabilities as of the same date.

Considering 100% of retail deposits and a haircut of 50% of corporate deposits, our funding ratio estimates that domestic core customers have funded an average of about 89% of system-wide loans for the past five years. At the end of 2016, this metric jumped to 107% from 90% at the end 2015 because of the growth in deposits after the tax amnesty program. We expect this ratio to be between 90%-95% for the next two years (compared to 94% at year-end 2017), considering moderate credit growth.

While banks' dependence on deposits should indicate lower funding risks, deposits have been volatile in the past in Argentina, thus, we consider deposit stability to be a major risk. This risk is also important in light of the larger deposit base in foreign currency (21% of total deposits at the end of March 2018, from 11% at the end of 2015), after the release of foreign restrictions in late 2015 and the enactment of the tax amnesty program in 2016-2017.Total deposits have remained relatively stable in light of the currency's sharp depreciation. However, further currency fluctuations could result in deposit withdrawals, pressuring banks' funding and liquidity positions.

External funding.   Banks have a low dependence on external funding, stemming from limited availability, given the high economic and political risks, and banks' experience during the 2001 crisis, when the government froze deposits. The banking sector's net external position over system-wide loans was negative in 2016 because of the tax amnesty. This ratio then became slightly positive in 2017, and we expect continued low dependence on external funding for the next few years.

Adjustment for domestic debt-capital markets.   The domestic capital market remains very shallow and narrow. It's mostly dominated by sovereign bonds and GREs, such as YPF. We expect the capital market in Argentina to gradually benefit from the recently approved "Ley de Financiamiento Productivo.". The pre-financing of sovereign needs in the external market for 2018-2019 could result in some additional funding room for other entities in the market.

Adjustment for government role.   We assess the government's role in providing liquidity and guarantees during periods of market turmoil as weak. In 2001, when Argentina fell into an economic and financial crisis, the government imposed a deposit freeze that lasted for almost a year. Although the freeze halted a systemic bank run and prevented bank failures, the regulator was unable to provide liquidity at the right time and regain depositor confidence.

However, liquidity in the banking system has improved since 2001, and during the 2008-2009 global financial crisis, the central bank was able to use several tools to maintain liquidity in the financial system. With the new administration, the central bank's effectiveness, economic agents' confidence, and the economy have gradually improved. International reserves have been rebuilt to about $50 billion as of June 2018 (that already factors in reserves the central bank used to contain volatility in April and May 2018), from their lowest level of $24.1 billion on Dec. 17, 2015.

Table 5

Peer BICRA Scores

Argentina has similar economic resilience to its regional peers. The country has the highest GDP per capita in its BICRA group, but is still negatively influenced by high inflation that distorts the purchasing power of individuals and makes it difficult for banks to adjust prices. Despite lower credit access than peers and the country's lack of asset bubbles, the Argentine system is subject to higher risk of economic imbalances because the sovereign is vulnerable to external risks. The still low access to credit and focus on more secure segments have resulted in domestic banks' better asset quality metrics and lower credit risk compared to peers. Although we expect some worsening in metrics because of the struggling economy for upcoming quarters, we still think the system's credit metrics will remain healthy and below peers.

Table 6

Government Support

Although the central bank has the explicit purpose of acting as a lender of last resort and the country has a deposit insurance framework, we consider the Argentine government's support to the banking sector to be uncertain. The government has a poor track record of supporting the banking sector, as seen during the 2001 financial crisis. Furthermore, even though the government's financial flexibility and reserves have improved, we're uncertain about its ability to effectively support banks in the event of financial distress.

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Related Criteria

• Banking Industry Country Risk Assessment Update April 2018, April 26, 2018
• Sovereign Rating Methodology, Dec. 18, 2017
• S&P To Publish Economic And Industry Risk Trends For Banks, March 12, 2013
• Analytical Linkages Between Sovereign And Bank Ratings, Dec. 6, 2011
• Banks: Rating Methodology And Assumptions, Nov. 9, 2011