Banking: Argentina is back where it started

Long road ahead… again

Argentina’s banks are having an odd kind of crisis.

This is typified by one of the country’s leading banks, Banco Galicia, which reported its results recently. If anyone had expected the collapse in the currency – and subsequent hike in interest rates to over 70% – to lead to almost zero demand for new lending and a surge in delinquencies, they would have been right.

Both those things happened and a big recession has hit the country. GDP fell by 2.5% and is expected to fall by another 1.3% this year.

Yet the banks are fine: Galicia reported strong first-quarter results that beat market consensus by 33%. Even excluding the non-recurring gain related to the sale of its stake in Prisma, a payment processor that had been co-owned by the country’s biggest banks, net income rose 38% quarter on quarter, to Ps6.1 billion ($143.8 million) and representing a 41.2% return on equity.

The reason the banks are doing so well in such a tough operating environment is that this is pretty much just a return to the normal before the election of Mauricio Macri as president in 2015.

The banks had begun shifting their operational models to those of more orthodox countries (revenues based on lending and selling other financial products), but it could be argued that this latest Argentine crisis came so quickly, in 2018, that the banks hadn’t had time to shift their models very much.

True, delinquency has risen – sharply in many cases. Galicia has seen its non-performing loan formation rate jump to 9.3% in the most recent quarterly report (well above the 3.4% in fourth quarter 2018 and 3.1% of the first quarter of 2018).

The bank’s exposure to higher risk segments has caused it to suffer more than the system. Its NPLs, at 4%, are much higher than the average; it has therefore had to provision more than most (up 57% quarter on quarter and a whopping 238% year on year).

The bank can absorb this deterioration in asset quality and associated costs because much of its revenues are from government securities.

With very little in the way of depth in the banking market (credit is just 15% of GDP, compared with 78% in Chile and 67% in Brazil), banks have largely placed deposits and other funding with the government and so have reaped the benefit from the surge in interest rates caused by the new central bank’s monetary policy.

And so while Galicia’s net interest income fell by 60.2% year on year to Ps1.8 billion in the first quarter, net income from financial instruments (mainly Leliqs) was up 153.7% in the quarter (830% for the year) at Ps15.3 billion.

Argentina’s banks have reverted to how they have traditionally made money in a thin, transactional economy. As well as the boost from government securities, Galicia cut operational expenditures by putting new branch growth plans on ice, for example.

Fabián Kon, Galicia’s chief executive, argues, however, that some costs can’t be delayed, especially those related to cybersecurity, which he believes are critical for his bank and others.

“Cybersecurity is the very top of our agenda,” he says. “The financial risks from hacking and reputational risk are the biggest risks for any bank, and the two go hand in hand.

“Somewhere in the world we are going to see a bank go under because of a cyber-related issue that leads to a run because they lost client money. It will happen somewhere, someday.”

He says that hackers from many parts of the world “are attacking all the banks in South America”.

Kon clearly feels this existential threat.

“In the past, we were concerned with physical robbery – but how much can a man physically take?” he asks.

But absent serious hacking incidents, the Argentine financial system is responding well to its domestic crisis: system-wide ROE is 37.1%, return on assets is 4.1% and the efficiency ratio is 52.3%. It is highly liquid and adequately capitalized.

Clearly there is good news in all this: the financial system isn’t going to collapse and cause the recession to deepen. However, is it not all good news: an apparently impressive ROE of 41.3% is still below the inflation rate, 48% in 2018, according to the OECD. The main cost for Galicia and the country’s banks generally isn’t higher NPLs, it’s opportunity.

Kon remains optimistic about Argentina’s growth potential. The bank had wanted to be at the leading edge of the sector by organic lending growth and to lead local consolidation in the heady early days of the Macri administration – there was even short-lived but vigorous growth in mortgage lending.

“With our brand and our geographical coverage we had a very good opportunity to grow more than the competition,” says Kon. “We also have a very good opportunity to buy smaller banks in Argentina because we have the capital and we proved when we conducted our follow-on that we are able to collect more capital if needed.”

Galicia’s 2017 follow-on transaction raised $550 million as the bank looked closely at an ultimately unsuccessful Banco Patagonia sale.

The equity deal was successful. But given the equity value destruction since the crisis, with banks not able to generate returns on equity above inflation, it is questionable whether or not there would be demand for more fresh equity from Argentine banks.

Kon disagrees, on one condition: “We are able to get capital from the market… if Argentina is normal.”

Sadly, that’s a big if. The collapse in the economy since those 2017 equity deals may mean that investors hold the country to a higher bar in the future.

Nevertheless, Kon is convinced the country can become a sustainable success story – again with a caveat.

“Argentina is an economy that can grow very fast if the conditions are there,” he says.

Kon has led the bank’s strategy to turn its Naranja brand – a credit card company exposed to higher-risk consumer segments – into a standalone, full-service bank. He is convinced this will deliver stronger than average growth once risk appetite returns.

Kon had been targeting this October as the date to start the campaign to convert card holders into account holders, although this deadline, as with much in Argentina, may see some slippage.

But, Kon says, the logic remains: “We have more clients within Naranja than we do at Banco Galicia – and they are also much more diverse geographically. It’s also in many ways a better brand because it wasn’t a bank during the financial crises and so it hasn’t been affected by all the criticism.”

However, Kon says that not all the effort has been wasted. The bank continues to invest in its digital capabilities because efficiencies help banks in good times and bad. He acknowledges that domestic banks are at a disadvantage with IT spending compared with the foreign-owned banks operating in the country. For instance, Banco Santander Rio is the biggest private-sector bank in the system, with 12.4% of deposits and 11.2% of loans, compared with Galicia’s 11% and 10.4% respectively. BBVA, HSBC and ICBC are also in the top 10.

“It’s true that global banks have the ability to invest more money in technology globally than local banks, but it also not true that the deployment of this technology has created the difference in any country in south America,” he says. “It didn’t happen in Brazil, Colombia, Chile or Peru – or here.”

The ability of Latin America’s local banks to fight to maintain market leadership in recent decades in the face of competition from the international banks leads Kon to be confident of the sustainability of Galicia’s independence.

“You don’t see investors punishing BCP in Peru or Banco de Chile in Chile,” he says. “So far, [local ownership] has helped in terms that the banks that dominate the region are local players rather than international banks.”

Kon also says the authorities haven’t been simply been waiting the crisis out: recent regulatory improvements to the financial system will deliver once the crisis passes.

He cites the wide-ranging reforms led by Marcos Ayerra, chairman of the country’s securities and exchange commission, CNV, as very positive for the future.

“We have a positive view of the reforms. They are important modernizations,” he says, in regards to the liberalization of the rules governing foreign capital coming onshore and digitization of local securities issuance, before adding the almost ubiquitous qualifier: “Of course, you won’t see the results in terms of growth because of the crisis.”

How long that qualifier of macroeconomic context will be needed is the key question, both for Kon and for all Argentines.

October’s close-run presidential election will be important for the economy, although perhaps not critical. After all, those who predicted that the election of Macri would lead to economic normalization would not have expected to be talking about fighting the next election in the second year of a recession.

The consensus view is that the economy will grow again next year by around 2.2% as confidence returns. The government’s primary fiscal deficit is expected to be eliminated by the end of the year, giving stability to the currency and debt projections.

Inflation is projected by the market to be down to 25% next year and 19% in 2021, from 40% this year. But if the country retains positive interest rates, then banks are not going to see normal credit conditions for a while yet.