Why Mexico’s Shadow Banks Are Raising Investor Fears

Spooky things can come out of the shadows, and shadow banks, as non-bank lenders are called, have been a source of unpleasant surprises for markets across the globe over the years. Now shadow banks in Mexico, where they have boomed recently, are giving investors the willies after two of the largest of them announced sharp revisions to their financial statements. Bonds for a range of lenders plummeted on fears of what else might be lurking in the sector -- fears compounded by the deep cuts made to Mexico’s financial regulator last year amid the stresses created by the pandemic.

1. WHOSE BONDS FELL?

Companies including Alpha Holding SA, Credito Real SAB de CV, Financiera Independencia SAB de CV, Unifin Financiera SAB de CV, Operadora de Servicios Mega SA and Mexarrend SAPI de CV, saw their bonds fall sharply in April after Alpha and Credito Real revised annual financial statements.

2. WHY DID THEY REVISE THEIR STATEMENTS?

Alpha Holding -- better known as AlphaCredit -- had the first disclosure, saying in a statement it had found an error in its derivatives accounting. The discovery meant the majority of 4.1 billion pesos ($206 million) previously reported as other assets and accounts receivable could be impaired. Just days later, Credito Real said it would revise its 2020 financial statement, showing a portfolio of non-performing loans that was 82% greater than previously disclosed.

3. WHAT ABOUT THE OTHER COMPANIES?

No other non-bank lender in Mexico has reported a significant revision to their financial statements. Still, debt sold by all the companies is under pressure as contagion fears ripple through the bond market.

4. HOW IMPORTANT ARE MEXICO’S SHADOW BANKS?

Non-bank lending has exploded in Latin America’s second largest economy in recent years. Total non-bank lending for consumer credit, mortgages and company financing has eclipsed the formal banking sector, rising to 6.9 trillion pesos ($341 billion) versus 5.2 trillion pesos ($257 billion) for banks in the fourth quarter of last year, according to central bank data. The industry, which typically lends in smaller amounts to lower-income people, has been hard hit by the pandemic, compounding fears that issues in Mexico’s shadow banks could spill over into the broader financial system at a precarious time for the country’s economy.

5. WHERE ARE REGULATORS IN ALL OF THIS?

Mexico’s Comision Nacional Bancaria de Valores (CNBV) saw its budget slashed in President Andres Manuel Lopez Obrador’s austerity push and the watchdog’s power may be waning. In October, the CNBV was criticized for missing years of related-party loans above regulatory limits made by Banco Ahorro Famsa SA. Regulators eventually pulled the lender’s banking license and the company entered bankruptcy protection, first in the U.S. and then in Mexico. The upshot is that while the CNBV does oversee the non-bank lending sector, the companies have a much lower regulatory burden than deposit-taking banks, and it’s not clear how closely regulators have been watching.

6. WHAT ARE THE WORRIES?

Nobody is sure what else regulators might have missed. Stifel strategist Alexis Panton says there’s concern that companies, particularly Credito Real, could be underreporting delinquencies. Concerns about the company have been rising since a sharp drop in revenue at the start of 2020. He says the company’s latest balance sheet change was because of just one large loan that wasn’t accounted for properly, and similar problems could exist. “Suspicions are growing that something might be amiss here,” he wrote in an April 14 note. Barclays analyst Gilberto Garcia said in a note that Credito Real management wouldn’t confirm how many big loans are on its books. He downgraded the stock to underweight. LM Capital Group co-founder Luis Maizel, who holds Credito Real bonds, described shadow banks as having opened “Pandora’s box” and said he’ll stay away from the sector until there’s more clarity.

7. WHAT ARE THE COMPANIES SAYING?

Credito Real has sought to downplay the issue. In an earnings call, Chief Executive Officer Carlos Ochoa said he expects the non-performing loan ratio to fall to 3% from 3.9% by the end of the year, and that there’s no systemic issue. Financiera Independencia Chief Financial Officer Enrique Brockmann said in an interview that the company has a robust auditing process and doesn’t see any issues like those found of AlphaCredit and Credito Real. While Brockmann acknowledged Financiera Independencia bonds have been hit by contagion, he said the company remains in a solid position. AlphaCredit, Unifin and Mexarrend representatives declined to comment.

8. WHAT’S THE BULLISH CASE?

Apart from AlphaCredit, the other four major non-bank lenders are trading above 87 cents on the dollar, despite a selloff. Some have even seen small rebounds. The main driver is investors thinking that the bonds could be a good bet if there are no further accounting issues, particularly for companies that haven’t revised financial statements. And the Mexican economy is recovering after the worst contraction in almost a century, and some investors may be figuring that post-pandemic shadow bank bonds could be worth the risk.