… But challenges still exists in moving forward

Credit conditions are improving in Latin America and the Caribbean (LATAM), as the recovery accelerates in these economies and vaccination progresses.

The pandemic-induced economic stress of 2020 has caused deterioration in the operating environment of many corporations operating in LATAM states with weakening balance sheets and financial position while triggering numerous rating downgrades and defaults. In 2020 there were 1,554 downgrades by S&P Global Ratings, more than twice the 753 in 2019 and surpassing the previous high of 1,326 during the 2009 sub-prime crisis.

Nevertheless, risks are still high in LATAM, as uncertainty prevails and many sectors continue to struggle amid an uneven economic recovery and still frail domestic demand.

Further, as pandemic programmes such as a moratorium on loans implemented to ease the financial stress on consumers and businesses end, NCB Capital Markets, in its assessment, suggests that LATAM financial institutions run the risk of seeing asset quality deteriorate.

Financing activity to remain strong

Global rating agency S&P sees favourable credit conditions for the region’s corporate sector and expects financing activity to remain strong into the second half of the year. The US Federal Reserves’ decision to keep its reference rate unchanged between the 0.0 per cent – 0.25 per cent range and brightening growth prospects for the global economy, are keeping credit spreads at historically low levels.

Increases in global demand for goods and services and an improvement in commodity prices are also supporting a recovery in profitability, liquidity and potential solvency positions, thereby reducing default risks for LATAM corporations. Additionally, high market liquidity and rising investor appetite towards the region should continue to drive affordable funding, particularly for debt refinancing, reducing corporates’ interest burdens.

However, at the same time, NCB Cap Markets highlights that, “the pace of recovery in LATAM remains uneven across countries and sectors and this will continue to weigh on credit quality. COVID-19 risks persist due to a generally slow rollout of vaccination programmes, and social-distancing fatigue, which is driving the population in large urban centres to relax sanitation safeguards”.

COMMODITY PRICES CORRECTED UPWARD

The brokerage and investment banking outfit cited that a few weeks ago countries like Brazil, Colombia, Argentina and Mexico saw record highs of new daily COVID-19 cases, which will likely dent corporate earnings in the first quarter of this year. The upward correction of various commodity prices has improved growth prospects for several players in the metals, mining, protein, agribusiness, as well as oil and gas sectors.

Although crude prices have reversed last year’s plunge, oil consumption is not expected to fully recover until 2023 thereby limiting financial performance over the next 24 months. Further upside potential for oil prices could be constrained in the medium term by the energy transition to cleaner sources.

The highest risk exposure to investors remains in sectors that rely on close human interaction, such as restaurants, transportation, gaming, and leisure. While demand has begun to recover, full recovery will not materialise until immunisation programmes across the region and around the world enable socialising and mass interactions.

LATAM banking sector held up well during the pandemic

NCB Cap Markets reports that, “the LATAM banking sector has held up relatively well during the pandemic-induced turbulence due to strong past profitability, built-up capital, as well as pandemic relief programmes. However, the end of these moratorium programmes will likely cause deterioration in asset quality until domestic economic activity improves further.”

The company points out that solid profitability has been a key factor in allowing the regional banks to withstand credit cycles and economic downturns in the past in S&P’s view, and it has once again helped them during the pandemic. The Brazilian and Mexican banking systems’ profitability has been the most resilient among the largest banking systems in the region, followed by Chilean banks.

“The pandemic hit Colombian and Peruvian banks’ profitability harder because of their high provisions given the pandemic’s toll on their economies and weaker asset quality prepandemic. In Jamaica, the financial sector expanded substantially over the review year despite the adverse impact of the COVID-19 pandemic on economic activity,” NCB Cap Markets has reported.

However, there was deterioration in the deposit-taking institutions (DTI) sector’s profitability and asset quality. Loan moratoriums have been delaying nonperforming loan (NPL) ratios from worsening. However, fragile conditions for small and medium-sized enterprises will pressure loan portfolios as governments phase out borrower relief measures.

Most moratoriums across LATAM ended in the last quarter of 2020 and it is translating into higher delinquency which is now being reflected in credit quality metrics for many banks. In Jamaica, the financial sector’s high exposure to the tourism industry is also a risk to asset quality deterioration in coming quarters, especially if the projected recovery takes longer than expected to materialise.

Furthermore, the region’s low appetite to provide credit under stressed conditions, weak consumer and investor confidence, and the low-interest-rate environment will continue to pressure banking system profitability.