MOODY'S REPORTS: ARGENTINE BANKS ARE INSOLVENT
Moody's Investors Service says that the lack of a coherent monetary and banking policy framework coupled with paralysis in the local financial markets are jeopardizing the credit health and future of the banking system.
In a Special Comment released today, " Argentine Banks Face Insolvency", Moody's assesses the potential impact on the Argentine banks of the recent devaluation and imposition of deposit and foreign exchange controls.
Moody's says that Argentine banks are insolvent even under a benign scenario in part as a result of the asset-liability mismatch created by the devaluation of banking assets, unaccompanied by the redenomination of dollar liabilities.
The agency adds: "At a minimum, a general write-down of dollar-denominated obligations, including deposits, throughout the Argentine financial system is required to fundamentally rebalance the economy. Popular opposition to a write-down of deposits is quite strong, however. The reluctance to recognize these deposit losses is key to understanding the economic and monetary problems presently facing the country. The price distortions created by the present exchange rate regime are clearly exacerbating the downturn in economic activity."
"The devaluation of the Argentine peso has also reduced the repayment ability of debtors in foreign currency, " the agency notes, "and presents the potential for extremely high credit losses for the banks, resulting from an across-the-board deterioration in asset quality. "
According to the agency, the cost to the Argentine financial system will potentially represent a multiple of the system's present capitalization levels unless liabilities are reduced via redenomination; the system will therefore need considerable external support to recapitalize.
"Right now, " the report concludes, "the asset side of the banks' balance sheets is severely impaired, while the liability side remains where it was before the crisis, resulting in severe insolvency. The policy of forcing the banks to repay peso and dollar deposits with dollars is unenforceable, since the banks don't have the money, and neither does the government. "
"Therefore, the government's simplest option would seem to be to 1) declare the banks insolvent, 2) nationalize them, 3) convert deposits into devalued pesos or into government bonds, 4) recapitalize the banks with peso bonds, and 5) auction them off."
Following is the full text of Moody's comment:
"ARGENTINE BANKS FACE INSOLVENCY"
The lack of a clearly defined and comprehensive monetary and banking policy framework, together with paralysis of the local market, should have a significant adverse effect on the Argentine financial system during the next few months. We believe that this situation is jeopardizing the credit health and future of the banking system, and is chipping away at the backbone of a system built and strengthened in the 1990s through abundant reform and investment.
Through foreign exchange and deposit controls, a month of bank holidays, and restrictions on the repayment of foreign currency debt, the Argentine banks have effectively been intervened by the government. They remain captive to public policy, not only as the government's principal financiers and investors, but also because their role has essentially been reduced to acting as instruments of monetary policy. This is hindering their ability to conduct normal operations as commercial, moneymaking entities. Given the continuing volatility of Argentina's political and financial situation, we would expect the banks to operate as such for at least the rest of the year.
Financial performance and franchise values are practically impossible to evaluate. Balance sheets are at a standstill, as the payment system has virtually stopped, and asset values cannot be projected as future interest and dollar rates remain unclear. Even though the financial markets opened on Friday, January 11th, we suspect that the market has yet to determine the true price of the peso, given that bank accounts have been frozen.
The devaluation of the Argentine peso on January 7, 2002, following the banking controls that came into force on December 3, 2001, forebodes extremely high credit losses for all banks and raises the question of whether full shareholder support will be available to cover those losses.
We expect a rapid deterioration in asset quality which, if current market conditions persist, could lead to a tripling or even a quadrupling of non-performing loan levels that would wipe out earnings and capital by several times. We are also concerned that full shareholder support may not be forthcoming, even from well-heeled foreign bank parents, as such loss levels may be too onerous for individual entities to cover.
For international banks with strict head office regulators and consolidated operations that could be impaired as a result of losses in the Argentine market, the decision of whether or how much to recapitalize is a major one. Most of these banks have been in Argentina for decades, survived and prospered through the 1980s debt crisis and the Tequila crisis of the mid-1990s, investing for the long haul in order to serve their globally-oriented client base. However, given the high loss potential of Argentina's current banking crisis, they may not be able or willing to shoulder the full cost arising from a systemic crisis. In the case of the public sector banks, most of their owners are presently unable to foot the bill.
In our view, this systemic risk precludes any differentiation among the banks in terms of credit quality, whether they are locally or foreign owned, public sector or private. Therefore, all rated private and public sector Argentine banks are now rated at the same level for financial strength and deposits, at E and Ca, respectively.
BANK ASSET QUALITY, OVERALL FINANCIAL STRENGTH THREATENED BY PESO DEVALUATION AND DEPOSIT CONTROLS
The muddle of economic policies surrounding the exchange rate is untenable over time. The government is in a political bind. At a minimum, a general write-down of dollar-denominated obligations, including deposits, throughout the Argentine financial system is required to fundamentally rebalance the economy.
However, popular opposition to a write-down of deposits is quite strong. The reluctance to recognize these deposit losses is key to understanding the economic and monetary problems presently facing the country. The price distortions created by the present exchange rate regime are clearly exacerbating the downturn in economic activity. As the days go by, the Central Bank of Argentina's ability to act as a lender of last resort in US dollars also grows increasingly limited.
We believe that the Argentine financial system could be bankrupted in the very near term by the standstill prevailing in the market as a result of confusion over the unpredictability of monetary policy and banking controls. With this backdrop, the chain of payments among corporations, individuals and the banks -- the lifeblood of the financial market -- has been broken. The financial markets have been at a virtual standstill since December 3rd, and normal business activity has ceased.
As a result, an absence of liquidity is rapidly weakening the ability of Argentine companies and individuals to repay their debts. All borrowers, both public and private sector, are already in, or are about to enter into, default. With no clear direction discernible for the new monetary regime, it is inevitable that non-performing loans and charge-offs will increase rapidly due to the inability and unwillingness of debtors (who also do not have free access to their cash in banks) to make good on their loans, whether denominated in pesos or in dollars.
We do not believe that the government's efforts to pesoize certain dollar obligations to alleviate the impact of the devaluation on small borrowers will work, given the restrictions on cash withdrawals and the funding mismatch it creates for the banks. We therefore expect the same level of deterioration for both peso and dollar denominated loans. We also believe that the coming liquidity crunch for the non-pesoized dollar borrowers will pose an even bigger problem for the banks, and that pesofication of all dollar loans (and, hence, deposits) is ultimately likely, despite promises to the contrary.
While it is difficult to make projections in this environment, we have tried to assess the damage to the banks by running various scenarios using very simple assumptions regarding possible losses from the banks' public and private sector portfolios (see Figure I).
Our exercise should help in observing the high level of risk being borne by the banks as a result of the current regime as well as the potential financial damage. Our conclusion is that the cost to the banks exceeds their capital under all scenarios.
Our back-of-the-envelope analysis assumes a 75% write-off of all public sector loans and securities, a 50% write-down of private sector loans, and a 100% write-off of all non-performing loans. The analysis suggests that the cost to the banks could reach $54 billion, or 3.3 times the system's total equity of $16.5 billion as of September 30, 2001.
This amount could be reduced by at least $16 billion (depending on the exchange rate) if deposits are converted to pesos, but it would still be equal to more than twice the system's equity.
GOVERNMENT DEBT RESTRUCTURING AND ASSISTANCE PACKAGE KEY TO RESTORING CONFIDENCE IN BANKS
Further delay in the renegotiation of federal and provincial government debt would exacerbate the current situation and exact an increasing toll on the financial system from the perspective of financial performance and, most importantly, of depositor and creditor confidence. However, solution to the government debt problem is contingent upon presentation of a coherent and credible budget and federal tax-sharing plan to multilateral and bilateral creditors.
Banks hold about $29.3 BN of public sector assets (both securities and loans). The loss to the banks in a worst case, blanket moratorium scenario, would be substantial.
Market quotes have fluctuated in the range of 20-25% of face value for traded securities for some time now. Banks offshore have already begun to write down their government exposure, and we would expect further writedowns as a result of the formal renegotiation of the debt. Assuming potential haircuts of between 50% and 75%, the cost to the banks for their government exposure alone could range between $15 billion and $23 billion, representing 89% of total equity or 1.3 times equity, respectively.
It is our view that without clarity on the government debt restructuring, which will set market benchmarks and establish terms for the ultimate repayment of external debt, the market will stagnate. Much needed new investment and lending -- activities that rely heavily on confidence in the country's political, socio-economic, and financial framework -- will remain on the sidelines.
WHAT'S GOING TO HAPPEN?
Right now, the asset side of the banks' balance sheets is severely impaired, while the liability side remains where it was before the crisis, resulting in severe insolvency. The policy of forcing the banks to repay deposits with dollars is unenforceable, since the banks don't have enough dollars, and neither does the government. Therefore, the government's simplest option would seem to be to:
· Declare the banks insolvent
· Nationalize them
· Convert deposits into devalued pesos or into government bonds
· Recapitalize the banks with peso bonds
· Auction them off.
If pesoization/devaluation of deposits is politically unacceptable, and if IMF support is not forthcoming (and it is unlikely), then the banking system will ultimately run out of dollars and collapse. Since this is unthinkable, it would seem that the above scenario is ultimately inevitable: either deposits will be pesoized, or they will be exchanged for long term bonds, as happened in 1991. The banks will be nationalized, recapitalized with peso bonds, and sold off. External dollar liabilities will be defaulted upon.
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