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Rating Action:

Moody's upgrades Banorte's local currency deposits to A2; outlook stable

 The document has been translated in other languages

19 May 2014

Mexico, May 19, 2014 -- Moody's de México has today upgraded Banco Mercantil del Norte, S.A.'s (Banorte) long- and short-term global local currency deposit ratings to A2/Prime-1, from A3/Prime-2. At the same time, Moody's raised Banorte's standalone baseline credit assessment (BCA) to baa1, from baa2. Moody's also upgraded the bank's global local currency subordinated and junior subordinated debt ratings to Baa2 and Baa3, from Baa3 and Ba1, respectively. The outlook on all these ratings is stable. These actions conclude the review for upgrade initiated on 12 February 2014.

A detailed list of ratings affected is provided below.

LIST OF RATINGS AFFECTED

Banco Mercantil del Norte, S.A.

The following ratings were upgraded:

- Long-term global local currency deposit rating to A2, from A3

- Short-term global local currency deposit rating to Prime-1, from Prime-2

- Long-term global local currency subordinated debt rating to Baa2, from Baa3

- Long-term global local currency subordinated debt program rating to (P)Baa2, from (P)Baa3

- Long-term Mexican National Scale subordinated debt rating to Aa1.mx, from Aa2.mx

- Long-term Mexican National Scale subordinated debt program rating to Aa1.mx, from Aa2.mx

- Long-term global local currency junior subordinated debt rating to Baa3 (hyb), from Ba1 (hyb)

- Long-term global local currency junior subordinated debt program rating to (P)Baa3, from (P)Ba1

- Long-term Mexican National Scale junior subordinated debt rating to Aa2.mx (hyb), from Aa3.mx (hyb)

- Long-term Mexican National Scale junior subordinated debt program rating to Aa2.mx, from Aa3.mx

- Bank Financial Strength Rating affirmed at C-, BCA raised to baa1

RATINGS RATIONALE

STANDALONE BASELINE CREDIT ASSESSMENT

In raising Banorte's standalone BCA to baa1, from baa2, Moody's took into account the bank's stronger franchise value and increased earnings diversification derived from the significant expansion of the bank and its holding company, Grupo Financiero Banorte's (GFNorte) in the last few years, as well as meaningful improvements in capitalization and corporate governance.

GFNorte's expansion has been driven by a combination of organic growth and strategic acquisitions. With the 4th largest branch network and 14% of all deposits in the country, Banorte has consolidated its competitive position among the top three deposit-takers in the country. This deposit base provides a stable source of financing for continued organic growth, particularly in retail banking and lending to small and medium-sized enterprises (SMEs), which the government aims to promote through the recently approved financial reforms. In addition, recent acquisitions have complemented the bank's core lending operations with new non-capital intensive, fee-driven businesses particularly in asset management. Its subsidiary Afore XXI Banorte is now Mexico's largest pension fund manager. These acquisitions have given the bank access to the country's largest customer base with more than 24 million clients spread across GFNorte's new and old business units. According to Moody's Senior Credit Officer David Olivares, "the acquisitions should provide ample cross-selling opportunities that will support earnings growth going forward."

Moody's also cited improvements in Banorte's capitalization and corporate governance as positive credit drivers. The bank has utilized the proceeds of a capital injection funded by its parent's recent equity offering to pay off expensive subordinated debt, thereby replacing Tier 2 with higher quality Tier 1 capital and at the same time improving its funding profile. Banorte's capitalization has improved relative to that of its key peers, providing it a larger cushion to absorb potential unexpected losses. The bank has made significant improvements in corporate governance, including increasing the number of independent board members, reducing the amount of loans to related parties, and changing GFNorte's ownership structure to diminish potential influence of a single shareholder to a more broad and diversified shareholder influence in the board's decisions.

Nevertheless, Banorte's standalone intrinsic credit strength continues to be constrained by business integration challenges related to the bank's recent acquisitions. These challenges are reflected in the bank's low operating efficiency, which continues to limit its profitability.

Although the bank's new businesses will support growth in the future, Olivares noted that "it will take time for management to consolidate and streamline processes, centralize control, and realize opportunities to grow revenues derived from its more diversified product offerings and larger customer base." Timely and successful cost cutting efforts are also needed to achieve management's goal of bringing the operating cost to income ratio of the banking business to a medium-term target around the mid-40%s, from its current 51%, which is considerably higher than the bank's peers. In turn, management hopes that this will drive an improvement in its return on equity and assets in 2014 from 14% and 1.4%, respectively, reported as of 1Q2014. However, management's ability to cut costs will be limited by its need to retain its recently acquired customers. Consequently, "we believe its efficiency target is ambitious," Olivares said.

The rating agency also noted the bank also continues to face periodic challenges with asset quality, which have required high levels of provisions, thereby affecting profitability. Although delinquencies remain elevated by historical standards at 3% (as of 31 March 2014) after a sharp rise just last year, they appear to have peaked and should remain manageable. However, the bank's growing appetite for the riskier consumer and SMEs loan segments heightens credit risk. In addition, exposures to large single borrowers persist, leaving the bank vulnerable to a decline in credit quality of certain large individual borrowers. This concentration risk is somewhat mitigated because many of the bank's largest exposures are to sub-sovereign borrowers secured by participations in transfers from the federal government.

RATINGS OUTLOOK

With limited capacity for further acquisitions, Moody's expects the bank's expansion to slow going forward as it focuses more on organic growth. The stable outlook balances Banorte's significant opportunities for organic growth and potential improvements in profitability from efficiency gains with the challenges of integrating its new businesses while reducing costs and managing asset quality risks. The rating could face upward pressure if the bank is able to capitalize on its opportunities for cross selling and to realize further gains in efficiency.

UPGRADE OF LOCAL CURRENCY DEPOSIT RATINGS

The upgrade of Banorte's global local currency deposit rating by one notch to A2 reflects both the improvement in the bank's standalone BCA and a higher probability of support from the Mexican government in a stress situation given the bank's growing systemic importance as a leading deposit-taker and lender in the Mexican market.

UPGRADE OF SUBORDINATED AND JUNIOR SUBORDINATED DEBT RATINGS

Given the absence of parental support factored into Banorte's rating, its subordinated debt ratings are maintained one notch below its standalone BCA. They have been upgraded to Baa2 from Baa3 in line with the upgrade of the BCA. In turn, junior subordinated debt ratings are notched from the BCA by two notches and thus have been upgraded to Baa3 from Ba1.

Banorte is headquartered in Monterrey. As of 31 March 2014, the bank reported Mx$861.0 billion in assets (source: Issuer's financial statements).

The principal methodology used in this rating was Global Banks published in May 2013. Please see the Credit Policy page on www.moodys.com.mx for a copy of this methodology.

Moody's National Scale Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".mx" for México. For further information on Moody's approach to national scale ratings, please refer to Moody's Rating Methodology published in October 2012 entitled "Mapping Moody's National Scale Ratings to Global Scale Ratings".

The period of time covered in the financial information used to determine Banorte's rating is between 31 December 2006 and 31 March 2014 (source: Moody's, Issuer's financial statements, CNBV and Banxico).

The sources and items of information used to determine Banorte's rating include 2012, 2013 and 2014 interim financial statements (source: Grupo Financiero Banorte); year-end 2012 and 2013 audited financial statements (source: Grupo Financiero Banorte, audited by Deloitte Touche Tohmatsu Limited); financial statements and information on market position (source: CNBV); regulatory capital information (source: Banxico); debt offering memorandum (source: Grupo Financiero Banorte).

REGULATORY DISCLOSURES

Information sources used to prepare the rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's information.

The rating has been disclosed to the rated entity prior to public dissemination.

A general listing of the sources of information used in the rating process, and the structure and voting process for the rating committees responsible for the assignment and monitoring of ratings can be found in the Disclosure tab in www.moodys.com.mx.

The date of the last Credit Rating Action was 12 Feb 2014.

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.mx.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

This Rating is subject to upgrade or downgrade based on future changes in the financial condition of the Issuer/Security, and said modifications will be made without Moody's de México S.A. de C.V accepting any liability as a result.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see Moody's Rating Symbols and Definitions on www.moodys.com.mx for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com.mx for the last rating action and the rating history. The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see our website www.moodys.com.mx for further information.

Please see www.moodys.com.mx for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

The ratings issued by Moody's de Mexico are opinions regarding the credit quality of securities and/or their issuers and not a recommendation to invest in any such security and/or issuer.

Please see the ratings tab on the issuer/entity page on www.moodys.com.mx for additional regulatory disclosures for each credit rating.

David Olivares Villagomez
VP - Senior Credit Officer
Financial Institutions Group
Moody's de Mexico S.A. de C.V
Ave. Paseo de las Palmas
No. 405 - 502
Col. Lomas de Chapultepec
Mexico, DF 11000
Mexico
JOURNALISTS: 001-888-779-5833
SUBSCRIBERS:52-55-1253-5700

Maria Celina Vansetti-Hutchins
MD - Banking
Financial Institutions Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's de Mexico S.A. de C.V
Ave. Paseo de las Palmas
No. 405 - 502
Col. Lomas de Chapultepec
Mexico, DF 11000
Mexico
JOURNALISTS: 001-888-779-5833
SUBSCRIBERS:52-55-1253-5700

Moody's upgrades Banorte's local currency deposits to A2; outlook stable
No Related Data.
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