Recognizing the seriousness of the situation, the US government stepped forward with a plan to prop up the peso and stem the hemorrhage of capital from the beleaguered country. The IMF also came to the table, committing an unprecedented amount of funds—up to $17 billion. Meanwhile, Citibank and JP Morgan attempted to rally commercial banks to provide a private package of funds for the country.
Investors represent the wild card of the equation. Having unceremoniously dumped Mexican stocks and bonds following the devaluation, questions remain as to how soon, if ever, they will return to the table in significant numbers. Will the international aid package entice investors back to Mexico? And if not, where will Mexico get the financing it needs to continue its economic development?
In the following pages, LatinFinance addresses several aspects of the crisis. First, Victoria Griffith touches on the root causes of the crisis, how it will affect the Mexican government and its ability to roll over short-term debt and convert it into long-term financing, and where new financing will and will not likely come from. The Mexican banking sector faces serious problems as well, as high domestic interest rates lead to rising defaults and low levels of capital restrict further lending, writes Jim Freer. Finally, Paul Kilby assesses the difficulties faced by Mexican corporations in refinancing existing debt and locating sources of new financing.
There are bright spots in the otherwise dim picture. Mexican exports will likely get a boost from a weaker currency, while foreign direct investment—the type of stable, long-term investment that Mexico desperately needs—should assume a more prominent role. And, as always during difficult periods, new and innovative forms of financing may emerge to add new levels of sophistication to Latin markets in the long run.
Debt-ridden Mexico struggles to find new sources of capital
by Victoria Griffith
Will Mexico be able to service its debt? The question, uttered only by a handful of doubting Thomases just a few months ago, is now on the lips of nearly every Mexico-watcher. Money is fast draining out of the Mexican system, and both the public and private sectors will have to cope with a new tight money environment.
“The only dollars that will arrive in Mexico this year will be those given by Washington,” said Arturo Porzecanski, chief economist at ING Bank. “The US Treasury, the IMF, the World Bank, these will be the funding resources of Mexico in 1995.”
The new Mexican liquidity crunch conjures up nightmarish memories of the 1982 debt crisis. Throughout the build-up of Latin American debt in the 1990s, lenders and investors comforted themselves that the debt was of a very different nature than in the 1970s—largely private this time, rather than public.
“Mexico has attracted $150 billion in foreign capital since 1989, most of which was for the Mexican private sector,” Porzecanski said.
Government Debt, too
In early 1994, however, faced with $30 billion in foreign capital flight on the back of the Chiapas uprising and Colosio assassination, Mexico shifted its policy and began to take on large amounts of government debt as well. The country issued tesobonos to finance the shortfall, with some $50 billion worth outstanding at the end of 1994. The tesobono issues meant the new Mexican debt was not as private in nature as it had been earlier in the decade.
In any case, that most of the capital had been issued to the private sector proved a false comfort. Fittingly, the 1995 debt crisis kicked off with a private sector default—$20 million in commercial paper payments by Grupo Sidek. Although Sidek made payments two days later, it seems almost inevitable that more defaults will follow.
Short-term interest rates in Mexico were boosted in late February to 50%, conforming to US demands. Many companies simply won’t be able to withstand those levels. Mexican banks seem particularly at risk, with expensive dollar-denominated debt and hefty bad loan portfolios. Several large institutions may be merged out of existence,
To pull itself out of the crisis, the government will have to live within limited means. Budget cuts are necessary to ensure long-term fiscal health. What frightens economists and investors is that President Ernesto Zedillo’s administration has not yet come to terms with its diminished resources.
“We haven’t heard anything about spending cuts,” Porzecanski said. “This attitude can be dangerous.”
The private sector also will need to cut back to survive, and layoffs and slow growth are in the cards. Companies will need some form of financing, though, and it still is uncertain where that money is going to come from. Certainly, it won’t be coming from the financially squeezed Mexican banks. US banks also seem unwilling to step up to the plate, and instruments like ADRs, which have become a mainstay for Mexican capital raising, probably will not recover until 1996 at the earliest.
With debt-to-GDP levels rising from about 30% just a few months ago to about 50% today, Mexico now can be classified as a high-debt country.
“Mexico is on the borderline between being a country with a serious debt problem and being a country with easily serviceable debt,” said Luis Luis, principal with fund manager Scudder, Stevens & Clark.
Although that debt may fall abruptly with a peso revaluation, the current situation is dicey. The Clinton rescue package failed to shore up confidence, and Mexico was unable to roll over its debt in weekly tesobono auctions.
“In a credit crunch you don’t want to roll over enormous amounts of debt once a week,” said Kristin Landow, Moody’s Investors Service’s leading sovereign analyst for Mexico.
Mexico has two options. It can either try to restore faith in itself as a short-term creditor, or it can try to convert its short-term debt to medium and long term. In the end, the country will probably try to do a little of both. If it is successful, some of the focus will shift to the country’s longer-term solvency.
Oil and other exports probably will be key sources of revenue for the government. Privatization will help but will not provide any major impetus. Total privatization revenues this year are estimated at about $1.5 to $3 billion, and after this phase, the government will be left with little to sell off.
There are too many factors involved to say with any certainty whether the country will be able to service its debt five or ten years from now.
“No one’s predictions five years out are credible,” said Ernest Brown, Latin strategist for Morgan Stanley. “You have to consider too many things. Exports, currency rates, GDP growth, and other factors all play into the equation.”
One of the scariest factors for investors is that Mexico’s sovereign debt is set to rise this year, by some $29 billion, according to Lindow of Moody’s. Although most analysts see this increase as a temporary blip on the Mexican debt screen, the prospect is bound to make investors nervous.
To make matters worse, the Mexican political situation, whose stability investors had seen as a selling point, now is in turmoil. The Chiapas uprising continues to haunt Zedillo, and observers fear that the income compression caused by the peso collapse may cause the public to lose faith in the Mexican government.
Banking on Exports
Economists are more optimistic about the longer run, however, when they hope that a surge in exports will buoy the country. “In the longer run, export-led growth should kick in,” said Riordan Roett, head of Latin American studies at Johns Hopkins’ School of Advanced International Studies.
The Mexican corporate sector has been even more shell-shocked by the crisis than the public sector. Sidek’s refusal to honor its debt in February sent shivers through the bond and stock markets in the entire region. A number of Mexican companies have large commercial paper programs, including Cementos Mexicanos, and Grupo Alfa. Although these are considered blue chip stocks, with investors demanding rates of 60% or more, anything could happen.
The main impact of the crisis on Mexico’s private sector, however, probably will be in the form of dashed expansion plans. “We will see a major scale back of investment plans for Mexican corporations,” said Brown of Morgan Stanley.
The construction group Tribasa was one of the first companies to publicly acknowledge the devastation the peso collapse had wreaked on its operations. Tribasa has announced plans to cut its work force by 50%, and to drop most of its construction projects. As a result, investors in the company cannot expect big returns for some time to come.
In fact, construction probably will be one of the hardest hit sectors in the Mexican economy. “Access to financing is the life blood of this industry,” said Federico Laffan, Mexican analyst for fund manager Foreign & Colonial. “Their future growth depends on it.”
However, with, interest rates nearing three digits in some cases, most projects will have to be dropped. Returns of 30% or more, which looked attractive just a few months ago, would now provide investors with a loss if financed with borrowed capital, as is the case with most construction projects.
Tribasa’s example will probably be followed by much of Mexico’s private sector. “Companies will enter into a vegetative state,” said Laffan. Companies with high overheads will have a harder time idling their engines and will be among the hardest hit. Low-geared companies are among the most promising investments.
Some Mexican sectors may even benefit from the crisis. Exporters are often identified as an obvious winner, but companies which have faced fierce competition from US products recently may also score some points in the long- run. “Many companies look set to recapture market share lost to US products,” said Carmen Campollo, analyst at the IFC.
Industries to Watch
Among the most favoured post-crisis industries are beverage and food groups which have been losing share to US imports. “People will always have money to buy Pepsi, products like that,” said Roett of Johns Hopkins. “Companies like Gemex (a bottler) may suffer, but they’ll do better than other sectors.”
In the medium-term, some financing should come on line for Mexican companies. “Mexican companies will have to be more imaginative in finding ways to tap the capital markets,” said Luis of Scudder.
One of the first forms of finance to recover may be mergers and acquisitions. Wal-Mart set a sour note for direct investment shortly after the peso collapse by scuttling plans for a major Mexican invasion. However, analysts are predicting renewed interest in mergers & acquisitions by the end of the year.
Foreigners apparently were already gearing up for more direct investment before the peso debacle. One of the few pieces of good news in the finance ministry’s February report was that foreign direct investment had surged 64% last year. Although that figure is coming off a low base (foreign direct investment totalled $7 billion a year at last count), it’s moving in the right direction. Direct investment often has been hailed as the kind of long-term commitment Mexico needs to jump-start economic growth.
Two factors may contribute to a strong mergers and acquisitions revival. One is that Mexican companies are severely strapped for cash. Selling off pieces of themselves, either in the form of spin-offs or large equity blocks, is a preferable alternative to bankruptcy. And foreign companies may be in the market for bargains. Although most interest probably will come from the US, a few European and Asian groups may get involved. Samsung of South Korea was rumored to have been sniffing around the Mexican market recently for some good deals.
Stock Market Bargains
Healthy Mexican companies may take advantage of a weakness in the stock market to grab some bargains themselves. Already, we’ve seen some activity. Grupo Carso, for instance, has increased its holdings in a number of Mexican companies, including Apasco and Telmex. Although Telmex profits have not shined recently, the company does generate large amounts of cash, which Carso could use to finance other purchases.
Share buy-backs also seem to be an early trend. Grupo Carso and Grupo Sidek have both taken advantage of weaknesses in their stock price to pick up their own shares.
In addition to purchases of Mexican companies, analysts predict that American groups soon will take advantage of the peso’s weakness to set up shop there. “US companies will want to use Mexico as an export base,” forecast Lindow of Moody’s.
However, interest in foreign direct investment in the country will depend on investors’ faith in Mexico’s ability to stabilize its exchange rate. Plant and equipment are not as easy to abandon as equities or debt. If companies put their money into Mexico because it is a low-cost export base, they must be assured that the currency will not become seriously overvalued in the future. The government’s success in convincing foreign investors of the involatility of the peso will be key to foreign direct investment.
Portfolio investment will probably be anemic throughout 1995, although a few companies may test the waters with capital-raising issues towards the end of the year. Commercial paper also will fail to offer companies any substantial stream of capital, since interest rates are almost prohibitive and short-term confidence poor.
Neither will bank debt be a solution, either for the Mexican government or for the private sector. Spirits rose on the back of JP Morgan and Citibank’s rollover of Cemex debt. However, the same two institutions failed to put together a $3 billion syndicated loan for the Mexican government in February.
Memories of the 1982 crisis still loom large and few banks were willing to put up $200 million each, the amount Citicorp and JP Morgan had requested. Mexico currently owes some $68 billion to foreign banks, about $18 billion of which is to US banks.
Mexican banks look ill-equipped to provide much financing. Many are suffering from liquidity problems themselves, having been caught out in the crisis with blocks of unhedged dollar-denominated debt. Mexican banks also are likely to suffer from a ballooning bad-debt portfolio, as the private sector faces a declining growth and surging interest rates.
Asset-backed securities stand to make a comeback. “At times of uncertainty, the markets usually turn to collateralized transactions to secure their investments,” said Luis of Scudder. Exports, which are set to surge on back of the weak peso, may prove one of the most popular forms of collateralization.
Exports may prove the key to solving many of the country’s financial problems over the next few years. Exports could eventually pull many corporations into a growth phase, and a boost in exports will help to erase Mexico’s current account deficit, the source of many of its macroeconomic difficulties.
With financing sources limited, though, extreme budgetary discipline also will be necessary, in both the private and public sectors. A lot will depend on the Mexican government and Mexican corporations’ ability to adjust to tougher times. Unless both sectors show a willingness to penny pinch, Mexico probably will take a long time to get back on its feet again.
Money in the Banks?
Mergers likely as government strives to keep system afloat
by Jim Freer
Mexico is looking to its beleaguered banks to see if they can help it through its financial crisis by living up to this challenge: With the peso severely weakened and with interest rates at sky-high levels, will banks be able to restructure loans to businesses and consumers? If they do, will they still have enough resources to stay alive and help the economy through an almost certain recession?
Mexico’s banks are restructuring some loans (permitting delayed payments, etc.) and preparing for losses on others—a step that would erode capital which already is low at some banks.
A consensus among securities analysts and other observers is that those steps will leave Mexico’s banks seriously damaged, but that they will be able to meet their tests with the help of Mexico’s government.
“I believe the Mexican government will do whatever it can to keep the system afloat,” said Rafael Bello, vice president for Latin American equities research at Morgan Stanley & Co. “If you let it (the banking system) lose liquidity it would send terrible signals to the international markets.”
In doing “whatever it can,” Mexico’s government is considering an aid program that could give it a future stake in some banks. It also is ready to approve mergers that would enable healthier banks to take over seriously troubled ones. In addition, it has proposed legislation that would let foreign banks help in a bailout of Mexican banks—by permitting foreign investors to own as much as 49% of a Mexican bank, rather than the current 30% maximum.
Meanwhile, some observers expect that several of the US and other foreign banks that recently opened full-service Mexican subsidiaries might use their resources to take some stronger corporate clients away from Mexican banks.
Even Mexican banking leaders admit the situation is extremely serious, although they believe their industry can maneuver through the crisis.
Alfonso Gonzalez Migoya, chief financial officer of Bancomer, Mexico’s second largest bank, said he believes his industry is facing “a deterioration in asset quality” and that it “will consolidate faster” this year. But, in written responses to LatinFinance questions, he said he believes that “bank defaults will be completely prevented” because Banco de Mexico, the nation’s central bank, will “provide temporary equity support through Fobaproa (Mexico’s Banking Savings Protection Fund) or a similar mechanism.”
Those steps, or other urgent measures, could prove necessary because anticipated loan defaults would result in heavy 1995 losses for most Mexican banks.
The Mexican banking system’s problem loans were growing steadily even prior to the crisis that began with the December 20 peso devaluation. According to a recent analysis by Salomon Brothers Inc., the share of the Mexican banking industry’s loans carrying “high-risk” grew from 32.7% on September 30, 1994 to 41.5% at the end of last year.
Morgan Stanley’s Bello and other analysts say they won’t be able to gauge the full impact of the crisis until next summer, when banks must report their June 1994 data to regulators. In Mexico, as well as many other countries, banks can carry problem loans for at least several months before classifying them as non-performing or taking writeoffs.
As of last December 31, several major Mexican banks already had capital-to-total assets ratios below or near 4% (see chart on next page), the minimum level that generally is considered adequate under international regulatory standards.
The industry’s total non-performing loans, those 90 days or more delinquent, were at a dangerous level of 7.4% at the end of last year, according to Salomon Brothers’ estimates. Analysts anticipate those numbers will grow steadily this year.
With those problems and with quoted rates on 28-day loans in the 40% range in February, bank lending has become virtually non-existent in Mexico, Bello said.
Bello said his firm’s research indicates that only several of Mexico’s 30 banks will not need assistance this year from Fobaproa. He said Banamex, Mexico’s largest bank, and Banorte, its 14th largest, are among those that would not require aid under a proposed government program in which Fobaproa would inject capital certificates—through purchase of subordinated debt which the government could convert to stock if a bank does not repay within three years. Under the plan, all banks whose capital falls below 8% of risk-based assets would be eligible for assistance.
The $50 billion international aid package, announced by President Clinton last month, should assist Mexico in restoring liquidity to its banking system, Bancomer’s Gonzalez said.
Once it adds those dollars to its reserves, Mexico’s Treasury would again be able to start providing dollars to its banks in exchange for pesos.
“The aim of the aid package is to increase confidence in the country and to therefore avoid a capital flight,” he said. “Liquidity in foreign currency will be available, eliminating pressure on the exchange rate and therefore driving domestic interest rates down.”
Rates on the vast majority of Mexican loans carry floating rates, a factor that has led to huge increases in payments that businesses and consumers must make to banks.
Bancomer is among major Mexican banks that are giving customers considerable leeway. In January, it introduced a restructuring program under which mid-sized companies with peso loans are granted a seven-year restructuring, including a two-year grace period on principal payments and a partial refinancing of interest payments.
Last year, Mexico’s Ministry of Finance permitted 18 foreign banks to open full-service offices under terms of the North American Free Trade Agreement. Gonzalez said he doesn’t anticipate that foreign banks will make major inroads into Mexican banks’ business this year.
But John Donnelly, managing director of Chemical Bank Mexico, the new full-service subsidiary of New York-based Chemical, said he believes his bank will have opportunities to attract major Mexican companies as clients. “A big difference between now and December is that Mexican companies won’t have the dollar funding that they were able to provide to large corporations,” Donnelly said. He said Chemical will be “looking at the top 100 corporate clients” in Mexico.
Bello said he does not expect foreign banks to be major lenders in Mexico this year. “I don’t see banks like Citibank and First Interstate quickly setting up units to lend money to corporations and individuals in Mexico.”
Bello added that foreign banks should be very cautious about potential purchases of Mexican banks, even if the government permits 49% ownership.
“The situation is changing every minute in Mexico,” he said.
Data provided by Morgan Stanley (see chart) show that four major banks reduced their percentage of problem loans during last year’s fourth quarter. But Morgan’s research indicates those reductions stemmed from decisions by those banks to write off heavy volumes of loans during the quarter. Most other Mexican banks took similar end-of-year clean-up steps. That enabled those banks to reduce their volumes of problem loans— and thus lower their ratios of problem loans to total loans. But the writeoffs cut into those banks’ critical reserves for problem loans. During the quarter most Mexican banks also made heavy additions to their reserves for problem loans, thus cutting into their capital.
Morgan Stanley’s data indicate that Mexico’s banks have a combined $4 billion in dollar-denominated debt, mostly in short-term certificates of deposit. Mexico’s banks had a Mal of $116 billion in total deposits at the end of 1993. LF