Credit Growth Set To Cool Over The Medium Term
BMI View: Nicaragua's banking sector looks set to continue see ing strong credit growth over the coming months , buoyed by robust demand and steadily improving risk metrics. However, with the expansion in credit underpinned by short-term liquidity-boosting measures, such as a drawing down of reserves and repatriation of foreign investment, we believe the current loose credit conditions will prove unsustainable over the a multi-year time frame .
After posting robust loan growth in 2012, we expect Nicaragua's banking sector to continue rapidly expanding its credit portfolio in the short term . Indeed, after several years of tight credit conditions there is substantial consumer and commercial demand, and with improving risk metrics this has increased financial entities' willing ness to lend. However, while willingness to lend has increased, we have significant doubts about the financial sector's ability to maintain the current rate of credit growth. Indeed, Nicaragua's looser credit conditions have not been accompanied by a substantial uptick in deposit growth, such that we have seen the financial sector's available liquidity plummet and the loan-to-deposit ratio soar. W hile these metrics are still in stable territory for now, if we see a continuation of the current divergence between loan and deposit growth, this will expose the sector to substantial instability . We therefore expect a considerable cooling in credit growth over the medium term.
Sector Looks Strong For Now…
The health of the Nicaraguan financial sector has improved substantially in recent years - a trend we expect to continue in the short term. In the wake of the global financial crisis, a rapid deterioration in the sector's credit portfolio combined with weak deposit growth promoted a prolonged credit crunch. Since then, however, we have seen the rate of non-performing loans (NPLs) drop rapidly, hitting 1.4% as of April 2013. Meanwhile, the proportion of 'high risk assets', defined as those assets that have some sort of impairment, ranging from being past due, to restructured to in judicial collection proceedings, has also eased to pre-crisis levels.
|Loan Delinquency Falling|
|Nicaragua - Non-Performing Loans (LHS) & High Risk Assets (RHS), % Total Portfolio|
This steady improvement in risk metrics has helped to support a boom in credit growth, and while there has been a modest deceleration in the first four months of 2013, we expect the expansion in loans to remain relatively robust in the coming months. Indeed, after ending 2012 with average 29.7% year-on-year (y-o-y) expansion in total credit, the first four months of the year have seen average growth of 27.7% y-o-y. Moreover, with anecdotal evidence suggesting that there is still considerable pent-up demand in the wake of several years of tight credit conditions, we believe that growth is likely to remain relatively buoyant.
|Booming Credit Growth|
|Nicaragua - Total Credit (LHS) & Growth (RHS)|
…But Substantial Risks Over The Long Term
That said, while in the short-term we believe Nicaragua's current credit boom may continue, over a multi-year time horizon the expansion in loans must slow, or it risks creating substantial instability within the sector.
|Unattractive Deposit Rates Weigh On Growth|
|Nicaragua - Deposits Total (LHS) And Growth (RHS)|
In 2012, with real deposit rates in negative territory, the financial sector saw deposit growth drop from 19.1% y-o-y to 5.5% y-o-y. As such, financial entities began to draw down excess reserves and repatriate investment from abroad in order to help meet demand for credit growth, prompting a rapid drop in liquidity (as measured by the ratio of cash-to-total portfolio), from a high of 71.8% in July 2011 to 39.1%, as of April 2013.
|Banks Repatriating Assets|
|Nicaragua - Total Financial Sector Investment (LHS) & Growth (RHS)|
In the short term, we do not believe this poses a major risk of instability to the sector. Indeed, the cash-to-portfolio ratio has just returned to its historical average, and while excess reserves have fallen noticeably, they are still comfortably above the minimum requirements. Ultimately, our core view is that growth in the banking sector will likely begin to moderate over the medium term. We have already begun to see average deposit rates rise modestly in the past year. While this could prompt a narrowing of the margin between loan and deposit growth for a time, eventually we would expect the sector to also begin to raise lending rates to ensure strong profits, cooling the expansion in credit growth.
That said, we cannot completely rule out the risks associated with such a substantial mismatch between loan and deposit growth, especially if the trend continues for several more years before we see a significant correction. First of all, if interest rates on deposits and loans rise more slowly than we expect, prompting stronger than anticipated credit growth and a continued reduction in liquidity, this could pose a serious threat in the event of a rapid uptick in NPLs. Indeed, as of April 2013, loans-to-deposits stood at a relatively stable 75.9%, implying that loans are comfortably covered by deposits. However, in the past year this ratio has climbed more than 10 percentage points, from 62.3% as of April 2013, and if we see a similar trajectory in the coming years, we cannot rule out potential for another credit crunch.
|Still Under 100%, But Rising Fast|
|Nicaragua - Loans-to-Deposits Ratio|
Second, we highlight the potential risk to the sector posed by a change in Venezuelan policy toward Nicaragua (see 'Uncertainty In Venezuela Threatens Nicaragua's Economic Outlook', January 30), specifically that such a shift could result in a reduction in flows into the financial sector and destabilise it if liquidity buffers continue to be drawn down much further. The IMF reports that any excess funding from oil cooperation with Venezuela is deposited in Nicaragua's commercial banking system. In 2012 alone, the unused funds equalled approximately NIO2.1bn, which our calculations suggest represent nearly 10% of the sector's total investment portfolio. Ultimately, while in the short term, we take a relatively sanguine view of the banking sector, we note that over a multi-year time horizon, if we do not see Nicaragua's financial entities find a more sustainable way to boost liquidity buffers, the sector could face substantial instability.