Strong Loan Growth And Improving Asset Quality Underpin Bullish Case For These Out-Of-Favored Banks

| About: Grupo Financiero (BSMX)
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Mexico's central bank published aggregate results for the sector.

Sector’s credit growth was strong with corporate loans up 19% y/y.

Asset quality trends continue to improve.

Inbursa and BSMX are our top picks among Mexican banks.

Mexico's central bank published aggregate November results for the Mexican banking sector.

Strong loan growth and decent credit quality

According to the regulator, total sector's credit portfolio increased by 16.1% y/y in November. As the chart below demonstrates, this is the highest annual growth rate since December 2011.

Source: Banxico

Corporate loans grew by 19.3% y/y, partially driven by FX revaluation effects due the recent MXN devaluation.

Source: Banxico

Retail loans increased by 12.5% y/y, thanks to strong car lending dynamics (+18.2% y/y).

Notably, the sector's asset quality continues to improve. Total NPL ratio decreased by 6bps m/m and 65bps y/y to 2.7% in November.

Margin tailwinds ahead

Mexico's central bank has recently started a monetary tightening cycle. The regulator has raised the policy rate by 255bps since December 2015 pushing the benchmark rate to 5.75%.

Source: Bloomberg

More importantly, the market expects the policy rate to reach 6.4% in 2017, implying a further 65bps hike.

Source: Bloomberg

Policy rate hikes should support Mexican banks' margins. According to Santander Mexico (NYSE:BSMX), a 100bps rise in the policy rate would boost its net interest income by MXN850mn (around 4% of BSMX's pre-tax income), all else remaining equal. As such, policy rate hikes could alleviate potential earnings pressure from weaker loan growth and asset quality issues.

Most of the downside is priced in

In our recent articles on Inbursa (OTCPK:GPFOF) and Santander Mexico, we noted that uncertainties related to a potential break-up of the North American Free Trade Agreement (NAFTA) do pose a risk to Mexico's economic growth, the sector's credit portfolio and asset quality. However, Mexican banks have already underperformed the rest of the LatAm region and current market valuations suggest that most of the downside have been already priced in.

Moreover, from a long-term fundamental view, Mexican banks remain very attractive as credit penetration in the country remains among the lowest in emerging markets, suggesting that the sector still has several years of robust loan growth.

Bottom line

Despite the ongoing macroeconomic uncertainties following the U.S. presidential elections, Mexican banks still offer an attractive case for long-term fundamental investors. The latest data from Banxico suggests that Mexican banks look to be in a much better position than many had feared they would be.

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Disclosure: I am/we are long BSMX.

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