Credit Conditions: Subdued Growth Is Increasing Downside Risks For Latin America

Primary Credit Analyst: Marta Castelli, Buenos Aires (54) 114-891-2128; marta.castelli@standardandpoors.com Secondary Contacts: Lisa M Schineller, PhD, New York (1) 212-438-7352; lisa.schineller@standardandpoors.com Eduardo Uribe-Caraza, Mexico City (52) 55-5081-4408; eduardo.uribe@standardandpoors.com Roberto H Sifon-arevalo, New York (1) 212-438-7358; roberto.sifon-arevalo@standardandpoors.com Arthur F Simonson, New York (1) 212-438-2094; arthur.simonson@standardandpoors.com Milena C Zaniboni, Sao Paulo (55) 11-3039-9739; milena.zaniboni@standardandpoors.com Santiago Carniado, Mexico City (52) 55-5081-4413; santiago.carniado@standardandpoors.com Jennelyn U Tanchua, New York (1) 212-438-4436; jennelyn.tanchua@standardandpoors.com

Table Of Contents
The Macroeconomic Environment Global Growth Outlook Revised Down, Including In The U.S. And China Financial Conditions Risks And Imbalances Sector Trends No Major Changes For Banks, Fincos, And Insurers On The Horizon Corporates' Overall Financial Performance Is Stable, But Some Sectors Are Expected To Remain Weak Satisfactory Conditions For Utilities And Strong Performance In Project Finance

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Table Of Contents (cont.)

Stability Remains For Most Latin American Structured Finance Markets Outlook For Credit Trends

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Credit Conditions: Subdued Growth Is Increasing Downside Risks For Latin America
(Editor's Note: Standard & Poor's Credit Conditions Committees meet quarterly to review macroeconomic conditions in each of four regions (Asia-Pacific, Latin America, North America, and Europe, the Middle East and Africa). Discussions center on identifying credit risks and their potential ratings impact in various sectors, as well as borrowing and lending trends for business and consumers. This article reflects the view developed during the Latin American Credit Conditions Committee discussion on Aug. 2, 2013.)) Credit conditions in Latin America have been generally favorable during the first half of the year, but the second half and 2014 looks more challenging. We have lowered real GDP growth projections for many economies across the region given weaker-than-expected performance in the first half of 2013 and a weaker outlook globally. In addition, volatility in global and local financial markets has increased. The expectation of the U.S. Federal Reserve's tapering asset purchases later in 2013 has hit all emerging markets, including Latin America's, and it's pushing financing costs higher, currencies lower, and reducing the pace of global and regional market issuance. We continue to see the regional banking sector's resilient performance, which continues to expand its loan portfolio, albeit at a slower pace. We expect commodity prices to either remain stable or trend lower as a result of slower growth in China. Comparatively low unemployment rates support the regional consumer demand, but labor market conditions in some economies are weakening. Overview We expect stable rating trends for most Latin American sectors in the next 12 months, however, credit conditions face increased downside risk, given our estimate of lower growth prospects in the region of 2.7% in 2013 and 3.0% in 2014 and around the world and tighter conditions in global financial markets. Disappointing economic growth in the first half of 2013 is compounded by increased global financial volatility and our lower growth outlook for the U.S. and China. Our baseline forecast calls for Brazil's real GDP to increase by 2.0% this year and 2.5% next year (compared with our earlier forecast of 2.5% and 3.0%). We now expect Mexico's growth of 2.6% this year, compared to 3.2% in our earlier forecast, and 3.5% in 2014. The smaller economies, such as Chile, Panama, and Peru, remain the most dynamic (despite some downward revisions), growing in the 4.5%-7.0% range due to strong domestic demand. Growth remains low and inflation high in Argentina and Venezuela, given the distortionary macroeconomic policies. The outlooks on sovereign credits are mixed, tilted to the downside. We have three positive outlooks in the region (including on Mexico and Peru) versus six negative outlooks (including on Argentina, Brazil, and Venezuela). Our view on Latin American state and local governments remains largely unchanged from our last review. Our outlook for the banking sector remains unchanged, factoring in moderate economic growth and slight increases in nonperforming loans, albeit very high levels of reserves. We expect stable financial results for the majority of companies in the corporate sector, consumer demand to keep rising, and commodity prices to keep falling, and diverging trends among homebuilders. The infrastructure sector continues to benefit from ongoing spending by the public and private sectors to improve basic infrastructure, particularly in Brazil related to projects for the World Cup and Olympic Games. We don't expect significant changes in the performance of rated structured finance transactions, and we foresee gradual improvements in the sector for new transactions.

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Credit Conditions: Subdued Growth Is Increasing Downside Risks For Latin America

The Macroeconomic Environment

As global economy slows, so does Latin America's.
We expect growth in Latin America to average about 2.7% in 2013, little changed from 2.8% in 2012, and pick up to 3% in 2014. These projections are about half a percentage point lower for each year than our last Credit Conditions discussion in April. The downward revisions reflect weakness in the first half of the year (though no second-quarter GDP data have been released as of yet), tighter conditions in financial markets, and downward revisions to our forecasts for the U.S. in 2013 and China in 2013 and 2014. Financial market conditions have tightened across the region since May when market sentiment turned amid anticipation of the Fed tapering purchases under QE3 later this year. Currency appreciation has shifted to depreciation and capital inflows have weakened, or reversed. This has occurred for economies that the market perceives as having "strong" fundamentals and policy predictability, such as in Chile, Peru, and Mexico, reflecting the importance of "push", not just "pull" factors associated with the search for yield by investors over the past several years. We have lowered growth in Brazil to 2.0% from 2.5% in 2013 and to 2.5% from 3.0% in 2014 following social unrest in June and the tighter financial market conditions. It is unclear how effectively the government will manage the expectations and demands of the population for improved infrastructure and higher spending on social services in a market-friendly (or fiscally responsible) manner, given the decline in the president's popularity and upcoming presidential elections next year. The uncertainty is reinforced by the government's recent track record of unpredictable and changing policy decisions. We expect the recovery in investment seen in the first quarter to wane, given the falloff in business sentiment following the protests. Consumer confidence has also declined sharply, credit growth from private banks has slowed, job creation and real wage gains have moderated, all pointing to weaker consumption. Exports also declined in the first half of the year. Rising inflation and inflation expectations prompted the Central Bank of Brazil to raise interest rates in April by 25 basis points (bps) and 50 bps in May and July. Given depreciation of the Real, the Central Bank is likely to hike rates by more and for a longer period than initially expected. We also cut Mexico's GDP growth to 2.6% (from 3.2% in May following the first-quarter GDP data and from 3.5% in our last report). The recent revision reflects a cut in our forecast for the U.S. growth and continued signs of weakness in the second quarter, compounded by the less favorable global financial conditions. However, we left our growth expectations unchanged at 3.5% for 2014, given prospects for reform momentum and our projected pickup in U.S. growth next year. The slowdown to date has been sharper than expected, reflecting weak manufacturing exports (with only autos holding on) and soft domestic demand. Consumption is held back somewhat by a weaker labor market, a slowdown in credit growth, and continued contraction in workers' remittances from the U.S. during the first half of 2013. Government spending also contracted in the first half of the year following the transition to a new government, though this should recover somewhat for the remainder of the year. The peso has depreciated sharply amid "tapering volatility," and if it stabilizes and inflation and inflation expectations remain well anchored, the Central Bank of Mexico could cut rates. Despite some downward revisions in Chile and Peru, we continue to expect these and other smaller countries in the region to lead growth because of more robust domestic demand. Strong growth in Panama of around 7% this year and

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Credit Conditions: Subdued Growth Is Increasing Downside Risks For Latin America

next is lower than in the past several years, but reflects significant investment for the canal expansion and other infrastructure projects. Similarly in Chile and Peru, we expect varied strength in consumption and investment to offset lower exports, with growth of 4.5% and 5.5% this year, respectively. Poor policies continue to constrain Argentina's and Venezuela's growth. We have reduced growth in Venezuela to near zero since our last report, given substantial volatility amid problematic macroeconomic policies and a worsening of political tensions under the Maduro administration. Argentina's growth continues to recover from its low point in the second quarter of 2012, but remains constrained by distortionary policies and high inflation.
Table 1

Latin America--GDP Outlook

2012 2013f 2014f Downside scenario Upside scenario (% change) Latin American weighted average Argentina Brazil Chile Colombia Mexico Panama Peru Uruguay Venezuela f--Forecast 2.8 1.9 0.9 5.6 4.0 3.9 10.7 6.3 3.9 5.6 2.7 3.0 2.0 4.5 4.0 2.6 7.5 5.5 3.0 0.5 3.0 2.0 2.5 4.4 4.0 3.5 7.0 6.0 3.2 1.0 0.2 (0.5) (0.3) 1.5 1.0 0.5 4.0 3.0 1.5 (1.8) 4.6 4.0 4.0 6.0 5.3 5.0 10.0 7.5 5.0 2.5

In our downside scenario, which we assign a 25%-30% probability, average growth in the region would essentially be flat, including a slight contraction in Brazil and growth of about 0.5% in Mexico. The downside case reflects weaker global growth and/or some negative domestically-driven factors. Lower global economic activity could result from some combination of recessionary conditions in the U.S., a deeper downturn in Europe, and softer growth in China (below 7%, but not a so-called "hard landing"). This would depress global commodity demand and prices, and in turn weaken Latin American economies, in South America in particular, given their commodity dependence and trade ties with China. A China-driven downside would impact South America more directly, while a U.S.-driven weaker scenario would hit Mexico more directly given its close trade ties. Any increase in risk aversion associated with a weaker global environment, such as greater sovereign and banking sector concerns in Europe, would raise the cost of funds and could curtail capital flows to Latin America. In addition, falling private-sector confidence in Brazil could lead to more aggressive government (namely fiscal policy) actions that could backfire in terms of the markets' reaction and generate increased financial market volatility. For Mexico, any downturn in the U.S. would be magnified by a reversal of positive market sentiment, should the Nieto administration fail to deliver on much-anticipated structural, fiscal, and energy reforms later this year or next. In our upside scenario, to which we place a 15%-20% probability, we could see average regional growth of about 4.5%, with growth of 4% in Brazil and 5% in Mexico. Higher growth across the region would reflect a combination of

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Credit Conditions: Subdued Growth Is Increasing Downside Risks For Latin America

stronger global growth led by the U.S. and China (consistent with our view of a minimal chance of a meaningful upside growth in Europe) and more solid policy responses in several countries in the region. Higher global growth would bolster commodity prices, exports, and investment across South America. This upside also assumes that a stronger U.S. economic growth would more than offset or generate minimal market volatility around higher borrowing costs amid normalization of U.S. monetary policy. Higher growth in Brazil would also reflect an improved and more predictable policy response by the government that in turn revives private-sector sentiment, investment, and consumption, coupled with a more favorable export performance and some recovery in manufacturing. Higher growth in Mexico would also likely reflect political success in advancing potential reforms, with a significant boost in investor sentiment and favorable financing costs.

Global Growth Outlook Revised Down, Including In The U.S. And China
Global growth has been slower than we expected in the second quarter, and we have generally lowered our forecasts since our last report. The U.S. economy is expected to gain momentum through 2014, but the negative effects of federal spending cuts related to the sequestration will likely linger through year-end. Due to this drag and a sharp downward revision to first-quarter GDP growth, we now expect the U.S. economy to expand just 2.0% this year--down from our forecast of 2.7% in April. We see some positive factors for the U.S. growth prospects: the surprising resilience in the private sector, the rebound in the housing market and its positive effects on consumer spending, the boom in energy-related production, continued modest employment growth, and the improvement in private balance sheets. In addition, inflation remains low, which we expect will allow the Fed to gradually taper bond purchases and to keep monetary policy accommodative in the near term. Given evidence of China's slowing economic activity and indications that the government has become more willing to tolerate slower growth, we now expect a real GDP growth of 7.3% this year and next (compared with our forecasts of 7.9% for 2013 and 8% for 2014, respectively, in our April report). In general, economies in the Asia-Pacific region have softened this year, with the notable exception of Japan, where attempts to reflate the economy have shown an early positive impact. We still expect the eurozone to remain in recession through year-end, with a meaningful recovery still a ways off. We lowered our base-case growth forecast for 2013 to -0.8% (from -0.5% last quarter) as economic weakness further spread to the core economies, particularly Germany and the Netherlands. The deleveraging process continues to hurt the region, while monetary and financial conditions remain highly fragmented. We continue to forecast a weak and fragile recovery in 2014, with growth of 0.7%. As it stands, we see a one-in-three chance of a deeper recession this year that could continue into 2014.

Financial Conditions
Financial conditions have tightened across Latin America since May once the Fed began to signal a potential start to tapering QE3 asset purchases later this year. The markets shifted quickly away from a search for yield mode that

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dominated the market and facilitated issuance at very low yields, even for low speculative-grade issuers. This reversal in market conditions has weighed, and is expected to continue to do so, on Latin America's global and local issuance. We expect moderation of the pace of abundant capital inflows to the region. Assets under management in emerging market hard and local currency funds (equity and bonds) saw outflows in June and July. Government bond yields have risen and currencies have depreciated. The 10-year bond yield in Mexico and Brazil has risen by about 150 bps since April, higher in Colombia, and lower in Peru. Currencies, except for the Brazilian Real, went from appreciation to deprecation. The Mexican peso had been one of the top performers this year, appreciating to a high of 11.9 pesos per $1 in early May, but has since plummeted--touching as low as 13.4 pesos/$1--and is currently trading at 12.6 pesos/$1. Similarly, the Chilean peso and Peruvian Sol have weakened (about 7% and 9%, respectively) since April. The Brazilian Real has also weakened and hit recent lows of 2.3 Reais/$1 from a high of 1.95 Reais/$1 earlier this year. In response to the tightening in regional financial markets, governments have already begun to adjust reserve management and so-called macro-prudential policies. For example, in Brazil and Peru, central banks have sold dollars (spot or in the futures markets). The Brazilian government removed the 6% financial transactions tax on nonresident holdings of fixed-income assets. The Peruvian central bank lowered reserve requirements on Sol and foreign-currency deposits, and on external issuance with a maturity of less than three years. Despite the volatility in capital markets, it's important to underscore that as the Fed normalizes its accommodative monetary policy stance, we expect rates in the U.S. to remain fairly low for some time. In addition, higher rates would accompany a stronger U.S. economy, which in turn would benefit growth globally in and Latin America.

Risks And Imbalances

Global risks that pose downside to current credit conditions.
We continue to see further fallout from the eurozone crisis as a top risk to global credit conditions. Europe is still grappling with recession and a sovereign-banking crisis. As time goes by, our biggest worries are a persistent lack of vision on how to tackle growth, especially on the periphery of Europe, and the widespread debt overhang in large parts of the region. For Latin America, the contagion from the eurozone distress has dissipated as other external and internal risks took on more relevance during the last quarter. However, should market and economic volatility related to the eurozone resurface globally, it would weaken the Latin America economies through banking sector linkages, increased risk aversion that will crimp capital flows, and trade flows. The Latin American subsidiaries of European multinationals are generally doing well and haven't suffered from lower credit quality of their parents. However, we could lower the ratings on these entities if the parent companies will be downgraded further. While many subsidiaries of European banks operate in Chile, Mexico, and Peru, for example, overall credit growth has not been affected by deleveraging at headquarters, owing in part to the predominance of local funding. However, the risk of contamination under another and prolonged stress scenario cannot be excluded. South America has deeper trade ties with Europe, and another downturn there would hit it more directly than Mexico and Central America. Another key risk to global credit conditions is the U.S. fiscal policy, in our view. The sequestration makes it harder for the private sector to sustain growth, hence our lower U.S. growth forecast for 2013. (Over time, the drag will be

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Credit Conditions: Subdued Growth Is Increasing Downside Risks For Latin America

absorbed more easily than this year and next.) In addition, the continuing resolution is set to expire in September and the debt ceiling will likely be breached in early fall. The risk is that Congress won't reach a compromise on these issues and contentious negotiations will harm business investment and consumer spending. A hit to the U.S. economy stemming from a fiscal shock would affect all of Latin America via capital markets channels (be it increased risk aversion across financial markets and/or the Fed's policy response). However, it would impact Mexico and Central America through their strong trade ties with the U.S. The risk of a sharper-than-expected economic slowdown in China is increasing, as the government aims to transform the economy--so that it relies less on investment growth and more on consumptionand has indicated increased tolerance for a slower pace of growth. The challenge in rebalancing the Chinese economy lies in sufficiently growing consumption to counter a slowdown in investment. The potential fallout from the recent credit boom, which the government wants to slow, and frothy real estate market are also ongoing concerns. An abrupt slowdown in China would have important implications for Latin America--directly and via its global impact. For example, a potential sharp decrease in commodity prices is a key risk for Latin America's economies that have strong commodity links and/or important trade and investment ties with China. These would include Argentina, Brazil, Chile, Colombia, Peru, and Venezuela. Along with the economic slowdown in China year-to-date, many commodity prices (metals and agriculture) have already declined. Nevertheless, companies continue to generate free cash flow at these pricing levels. However, the decline has already led some companies to review investment plans; a more pronounced weakness could lead to delays and/or suspension of expansion plans in the region. Finally, we consider a disorderly market response associated with the end of quantitative easing in the U.S. as a significant risk because of its potentially unanticipated and disruptive consequences. The Fed's shift from an accommodative to neutral monetary policy stance, even under orderly and ordinary circumstances, could still weigh on credit conditions, resulting in higher borrowing costs for consumers and businesses, weaker collateral performance, and losses for financial institutions. Hence, a move from an extraordinary to more normal monetary policy stance could generate even stronger market reactions. Indeed, the market has responded swiftly and strongly in trying to anticipate when the Fed begins to taper its purchases of assets under QE3, let alone, raise rates or reduce the size of its balance sheet. We have already seen financial outflows from emerging markets, rising bond yields, and depreciating currencies across Latin America since May. The outflows from emerging markets have included not only hard currency, but also local currency holdings. The increasing proportion of local currency debt held by nonresidents, which accelerated under the loose global monetary conditions during QE1, 2, and 3, is a structural change for Latin American markets and another factor to monitor. Continued, and more pronounced, bouts of volatility in financial markets with higher financing costs or issuers being shut out of the markets is a risk for Latin American sovereigns, corporates, and financial institutions.

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Table 2

Top Global Risks Third-Quarter 2013

Risk Contagion from eurozone problems Likelihood Plausible Trend Stable Potential causes Eurozone banking sector problems deepen and spread; systemically important financial institution collapses; eurozone recession becomes deeper/longer; radical, noneuro aligned political parties are elected in key eurozone countries Policy mistake/gridlock Investment correction; disorderly deflation of real estate bubble; uncontrolled bank/non-bank sector and local government debt problems; social unrest leading to loss of confidence and economic disruption Adverse market reaction to monetary policy shift; policy mistake Potential effects Financial market turmoil; increased investor risk aversion, with capital outflows from risk assets; funding markets stressed; credit spreads widen; loose monetary policy continues; flight to safe haven currencies; lower commodity prices; tighter trade and capital flows; uncertainty hurts consumer/business confidence, spending and investment, including global FDI; China slows down further; U.S. recession/slowdown Loose/easing monetary policy; U.S. recession/slowdown; credit spreads widen Reduced Chinese imports of commodities, raw materials, capital equipment; Chinese consumer spending weakens, Chinese government spending increases; adverse impact on global trade and growth; lower commodity prices; deeper/longer eurozone recession; U.S. recession/slowdown; credit spreads widen Asset repricing/deflation (e.g., Treasuries, equity markets, high-yield, emerging markets); higher interest rates and cost of capital; higher financing costs weigh on business investment, consumer spending, and housing market; U.S. recession/slowdown; slower capital flows to and growth in emerging markets

U.S. fiscal policy shock/uncertainty Sharper-than-anticipated slowdown in China

Plausible Plausible

Stable Increasing

Disorderly market response from end of quantitative easing

Plausible

Stable

Sector Trends
Mixed sovereign outlook.
Although the growth outlook for Brazil and Mexico has been cut, we see different trends for their sovereign ratings. The outlook on Mexico's sovereign rating is positive while that for Brazil is negative. We expect recent social protests to undercut the Brazilian economy's already weak recovery. Private sector--business and consumer--confidence has dropped sharply. The government's erratic policy response had already undermined private-sector confidence, making it harder to manage the fallout from the protests. The risk is that low GDP growth (and the social protests) may lead to more expansionary fiscal policy, pressuring the sovereign rating. Mexico's growth has slowed sharply in the first half of the year, but is expected to recover in early 2014 as the U.S. economy gains momentum. In addition, the recent weakening of the Mexican peso (given the changing global liquidity backdrop) reverses some of the strengthening in early in 2013 and could support higher remittances and export momentum later in the year. In addition, these trends could be bolstered following passage of fiscal and energy reforms at the end of 2013 or early next year. The positive outlook on the sovereign rating reflects the possibility of such a passage. The risk is a political setback for the Nieto administration and market negative reaction. Elsewhere in South America, we also see growth lower this year. Commodity prices have moderately declined and may fall further. Despite some downward revisions to our GDP growth forecasts, robust domestic demand compensates for weak external demand and business conditions are generally positive. Economic conditions have

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Credit Conditions: Subdued Growth Is Increasing Downside Risks For Latin America

worsened in Venezuela and Argentina as political risk remains high. In general, falling commodity prices, rising risk aversion in global capital markets, and poor policy response to external shock could sharply reduce liquidity. Sudden loss of funding for banks or corporates could weaken economy and sovereign debt profile. Peru has a positive outlook, Argentina and Venezuela have negative outlooks, and the others are stable. Despite a slow recovery in tourism in Central America and the Caribbean, the growth outlook remains very poor. Grenada, Belize, and Jamaica defaulted this year, and we downgraded Aruba. High debt levels and poor external liquidity remain our key concerns. We have a negative outlook on El Salvador, Honduras, and The Bahamas and stable outlooks on the remaining countries in these two subregions. A spike in oil prices or fall in tourism could result in recession and more downgrades amid limited policy room for maneuver.
Table 3

Sovereign/International Public Finance Sector Conditions

Sector Brazil Mexico South America (excluding Brazil) Central America and the Caribbean Mexico IPF Argentina IPF Brazil IPF Current business conditions Weak Satisfactory Strong Weak Satisfactory Weak Satisfactory Business outlook (next 12 months) Somewhat weaker No change No change No change No change Somewhat weaker No change Financial trends (next 12 months) Same Same Same Same Same Lower Same Sector outlook (next 12 months) Negative Positive Stable Negative Stable Negative Stable

Subnational governments' fiscal performance remains stable, but weak institutional framework is still a risk.
Our view for the credit conditions for Latin American regional and local governments (LRGs) has changed little since our last report. We continue to see risks in Argentina as the federal government funds transfers may turn more volatile and reflect political decisions in light of the upcoming October legislative elections. Overall, Brazilian LRGs are expected to maintain a stable fiscal performance as they must comply with the Fiscal Responsibility Law, which we don't expect to be changed in the medium term. Despite Congress's several initiatives to modify the distribution of tax revenue, we don't expect significant movements at the moment. Due to their spending restrictions, Brazilian LRGs continue to face huge challenges in funding infrastructure needs. Pension expenses are already factored in our ratings, but they may become burdensome in the next two-three years. Additionally, debt levels are still high among some Brazilian LRGs and, in certain cases, they have issued debt in foreign currency to refinance high-interest debt in local currency. Since those foreign bonds are issued through a special purpose vehicle and guaranteed by the federal government, we don't expect the foreign-exchange risk to weaken the LRGs finances. More LRGs could issue debt under these structures, but we don't expect this to become a widespread trend. We revised our institutional framework risk score for Mexican LRGs to group '5' from group '4' to reflect significant weaknesses in fiscal regulations, controls, and practices. The revised score resulted in several negative rating actions. We believe that there is less predictability in the federal funds transfers to the municipalities because the states receive

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them first. On the positive side, the recent initiatives at the national level to control debt issuance, the new law to standardize accounting rules among LRGs, and fiscal reform to be proposed at the end of the year may help lower the institutional framework risk. Amid upcoming legislative elections in October, the political risk in Argentina is increasingly weakening the LRGs' creditworthiness, as federal funds transfers are becoming more discretional. In addition, due to high inflation, demands for higher salaries for government workers, which account for about 60% of the LRGs' budgets, are squeezing their finances. As a result, we recently revised our institutional framework risk score to group '6' from '5'. Additionally, constitutional limits on spending, increasing funding needs for infrastructure and social services, and rising debt service costs will continue pressuring the ratings on LRGs for the remainder of 2013. Any devaluation of the peso could put additional pressures on LRGs that still hold debt in foreign currency.

No Major Changes For Banks, Fincos, And Insurers On The Horizon

We expect the outlook for the Latin American banking sector to remain stable. Economic variables influencing the performance of the financial industry, such as employment, inflation, interest rates, personal income, and consumer confidence, remain relatively stable. In addition, we expect the large banks to continue taking advantage of their predominant positions, while smaller participants concentrate on niches. We expect the loan growth to be in the 12%-17% range for 2013 and 2014: Brazil 17%, Chile 12%, Colombia 15%, Mexico 13%, Panama 14%, and Peru 12%. This growth in the loan portfolio shouldn't significantly pressure operating performance, given lower, but still resilient, economic growth and high levels of bad loans reserves, which are at, or above, 150% in most countries of the region. Capitalization levels vary significantly by country: we estimate the risk-adjusted capital (RAC) ratios for Colombian and Brazilian banks at a moderate level, of 5%, and for Mexican and Panamanian banks at about 10%. Only Mexico began adopting the Basel III standards in the region, and we don't expect it to fully implement them in the medium term. We expect the banks' debt issuance to be at the same levels as in 2012; however, higher volatility could delay some issuances. We expect some banks to issue equity or hybrids to complement their capital and funding requirements. Foreign investors' risk perception on Latin America is still positive, although market volatility and credit spreads have increased and will likely continue to do so in parallel with higher U.S. interest rates. In some countries, the lower reference rates will require to improve efficiency levels. We continue to see the relaxation of origination standards due to a lower-than-expected credit demand as one of the main risks. In addition, we are monitoring refinancing alternatives for the less capitalized banks and the ability of small banks to fund new assets, particularly in Chile and Peru, under a more volatile global financial market. Standard & Poor's expects nonbank financial companies (fincos) to continue posting stable results as loan volumes grow moderately and asset quality hasn't deteriorated. A modest improvement in profitability is also expected to further reinforce capital levels. This stems from somewhat conservative origination policies and still favorable economic conditions in most countries of the region, including in Mexico where most of the companies that we rate operate. However, the dependence on wholesale funding remains the biggest vulnerability, as it limits the ability of

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funding new assets and augments refinancing risk. Despite the recent market volatility, rated fincos have refinanced their debt in the local markets, but at a higher rate. A lower GDP and higher unemployment are other risks, as many fincos target individuals and SMEs, though we exclude these risk factors in our base-case scenario. Argentine fincos face additional challenges, such as the sovereign and country risks, which we incorporate in our ratings. Along with low insurance penetration, we expect business conditions for Latin American insurance companies to remain satisfactory. Pressures on profitability come from low interest rates and the dependence on interest income from government securities investments. For example, we currently rate Jamaica at 'CCC', and its potential default would jeopardize the investment portfolios of insurers holding Jamaican government securities. The majority of rated insurers, which are generally the largest regional players, meets minimum capitalization requirements and are expected to implement Solvency II requirements (the amount of capital that EU insurance companies and their Latin American subsidiaries must hold to reduce the risk of insolvency) in 2014. On the other hand, we expect small- and midsize insurance companies to struggle implementing Solvency II because they would need to raise capital or restructure their operations. The possibly higher rates in the near future could boost the sector's interest income and profitability, in our view. Brazil's ongoing sluggish economic growth could weaken the whole financial industry as several insurers are part of large financial groups and products are sold through the same distribution channels. In Mexico, low interest rates limit the insurers' income, and companies are looking for investment alternatives, although regulations don't provide much room to do so.
Table 4

Financial Services Sector Conditions

Sector Banks Financial companies Insurance Current business conditions Satisfactory Satisfactory Satisfactory Business outlook (next 12 months) No change No change No change Financial trends (next 12 months) Same Same Same Sector outlook (next 12 months) Stable Stable Stable

Corporates' Overall Financial Performance Is Stable, But Some Sectors Are Expected To Remain Weak
Credit conditions in the Latin American corporate sector remain largely satisfactory, although some sectors suffer from weak business conditions and/or a negative rating trend stemming from external factors, such as falling commodity prices, or from internal factors, such as worsening fundamentals in the Mexican housing industry. Overall, we expect the corporate financial performance to remain in line with that in 2012, with marginal increases in sales and cash flow generation. The investment-grade issuers' balance sheets remain strong with low debt and high cash balances; however, speculative-grade companies remain highly leveraged and exposed to changing conditions in the economy. Furthermore, refinancing risk for these issuers has risen as volatility increased in the global financial markets in recent weeks.

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Table 5

Corporates Sector Conditions

Sector Consumer products Retail Telecom, media, tech Transportation Auto suppliers Oil and gas Chemicals Forest products Metals and mining Building materials Homebuilders/shopping malls Conglomerates Current business conditions Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory Satisfactory Weak Satisfactory Weak Satisfactory Business outlook (next 12 months) No change No change No change No change No change No change Somewhat weaker No change No change Somewhat weaker Somewhat weaker No change Financial trends (next 12 months) Same Same Same Same Same Same Same Same Lower Same Same Same Sector outlook (next 12 months) Stable Positive to stable Stable Stable Stable Stable Stable Stable Stable to negative Stable Stable to negative Stable

As shown in table above, the homebuilders and metals and mining sectors are currently facing the most challenges. On the other hand, we see a slightly positive trend for retail operators. These main sectoral trends are described below.

Real estate (homebuilders/shopping malls).

Reduced sales in the low-income housing segment, large land inventories, and high debt burden continue to take a toll on large Mexican homebuilders. Three Mexican homebuilders have defaulted on their financial obligations and are likely to restructure their financial and business models to meet increasing demand for in-city vertical housing units (as opposed to suburban horizontal housing units) and adapt to recent regulatory changes. We expect improving profitability among diversified midsize developers, as they take advantage of the bigger players' distress and focus on the more profitable business segments. We expect profitability for Brazilian homebuilders and shopping malls to keep improving as they take on higher-margin projects and benefit from continued funding through the Brazilian development bank, Caixa Economica Federal. In the case of Brazilian homebuilders, the improvement in cash generation comes from a low base after several of them recognized high losses with cost overruns and inflation pressures on their cost structure. We expect the sector's financial metrics to remain weak in the next few quarters, and many Brazilian companies still have a negative outlook after recent downgrades, as execution risk remains high. We are also concerned about the potential deterioration in employment and family income, and rising inflation and interest rates, which could further delay the future launches and hamper the expected recovery.

Metals and mining.

We believe the drop in prices for metals and mining products will continue at a gradual pace for the remainder of 2013 and into 2014, which we already incorporated into our forecasts. We expect that slower growth in China, marginal recovery in other regions, and overcapacity in certain products will continue pressuring prices across the board. The volatility in the financial markets also caused gold prices to decline sharply. Operating margins and cash flow are expected to decrease; however, regional producers are expected to remain profitable based on high quality ore and

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low production costs, compared with their global peers. Although we recently took several negative rating actions on Brazilian steel companies due to high debt and lower profitability, we don't expect the sector's credit metrics to deteriorate significantly in the next few quarters. This stems from the mining companies' relatively low debt levels, strong liquidity, and announced plans to reduce capital expenditures. In addition, the recent depreciation of the Brazilian Real and other currencies has bolstered the regional companies' exports. M&A activity in the industry remains a risk for certain companies, given the potential increase in debt and tighter conditions to refinance debt.

Retail.
The outlook for the Latin American retail industry is stable to positive, especially for the department store segments in Mexico and Chile. We expect a slightly positive growth in the same store sales (SSS) in all segments in the region, outperforming the GDP growth. Despite a slower economic growth among the larger regional economies, high employment rates and rising personal income continue to boost consumer credit availability. We expect stable or rising profitability due to efficiency gains and economies of scale. Department stores/home improvement companies in the region will continue benefiting from credit available for consumptionmore than 50% of sales are generated through credit--and low interest rates, with the SSS real growth of 2%-7%. Supermarkets and convenience stores will continue to be resilient to downside economic scenarios, although less dynamic than department stores with a flat SSS growth.

Chemicals.
Price spreads continue to be narrow and oil prices volatility persists due to slim global growth and oversupply in certain products. Likely low natural gas prices over the long term, as a result of shale gas boom in the U.S., will pose challenges for naphta-based crackers. Still, we believe that sales volume in the sector will continue growing from a modest to normal pace depending on each company's portfolio end market and regional footprint. Foreign exchange and oil prices are important factors for regional producers. We expect stability in noncyclical products, such as food packaging. We still believe that spreads will improve by 2014 due to a moderate rise in oil prices based on futures quotes, given that end petrochemical product prices are highly correlated to those of oil. Companies with an extensive vertical integration will cope better with lower margins and maintain profitability. The Brazilian companies' debt levels may rise due to a current unfavorable exchange rate, depending on their debt currency mix and use of derivatives. Potash producers' and potash-based fertilizers' performance may weaken from lower potash prices following the major Russian producer's, Uralkali, announcement to operate at full capacity after changing some of its trading policies. We expect fertilizer producers to improve their margins, given lower prices for some raw materials, such as ammonia, and still high prices of food commodities, as these stimulate the fertilizers demand and prices.

Building materials.
Distress in the Mexican low-income housing segment has weakened the construction sector and its suppliers, and a recovery depends on the ability of large housing developers to restructure their operations and bolster their growth, which is not expected to happen in the near future. On the other hand, despite expectations of Brazil's slower economic growth, housing deficit and significant infrastructure projects shore up cement demand and prices in a market dominated by few large companies. Local producers are benefitting from sustained demand for infrastructure in Central America (Panama Canal expansion), the Caribbean (Haiti and the Dominican Republic), Colombia, and Peru. Increasing competition with a stronger focus on value-added products will require higher capital investments in

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logistics and service improvements. The industry remains highly dependent on GDP growth and public and private spending, all which have been slowing in the major regional economies in recent quarters. Inflationary pressures and higher interest rates could also take a toll on the industry's performance.

Branded consumer products.

Similarly as in retail, we expect economic drivers to remain generally favorable for the performance of the branded products sector and to remain closely tied to the overall performance of the regional economies. Positive demographic trends and marketing strategies are also likely to raise the consumption of branded products at moderate growth rates. We're forecasting stable cash flows and strong financial metrics for branded food and soft-drink producers, despite the ongoing acquisitions.

Other industries.
We expect the Latin American auto suppliers to continue benefiting from the auto industry recovery in the U.S., while regional markets grow marginally. Operating margin for the sector should remain stable despite a lower capacity use, as companies ramp up large expansion projects due to increased demand from overseas. There has been little change in business and profit trends for the transportation sector. Overall we expect higher volumes and rates for the shipping industry, and slightly improved demand for logistics. However, the toll-road revenues are expected to reflect changes in GDP growth and may go down as economic activity slows. Railroads also have generated stable results, and despite the global slowdown in demand for iron ore and other commodities, we don't expect any deterioration in credit metrics for these rated companies. Airlines continue to adapt to the current demand levels, mainly through reduction in capacity and increase in yields. The shipping industry in Latin America has also benefited from a stable global demand for agricultural products amid stronger production in Brazil, Argentina, and Paraguay. Trends among the regional conglomerates are not uniform and will depend on each group's business portfolios; however, diversification and good levels of cash provide some cushion. We expect price pressures in the forest products industry, primarily in the pulp segment, due to a slower global demand. We have already downgraded some companies in this industry, but the vertical integration and a good share of products sold regionally should protect some companies from further financial deterioration. We believe the regional oil and gas producers will continue performing well, thanks to somewhat volatile but still high oil prices. Our price deck assumptions continue to be at $85 for WTI and $80 for Brent per barrel. Moreover, most of our rated companies in this sector have stable outlooks, which we expect to remain unchanged over the year even amid some price fluctuations. Capital expenditures are likely to remain high, given the major companies' plans for reserves and production expansion. In addition, we don't expect any short-term changes in their financial results, as most of them are government-related entities. During the past couple of years, the telecom and media sectors have been growing consistently. However, we expect their growth to moderate amid continuing lower prices. Mobile telecom companies are subsidizing the cost of smartphone purchases and increasing investments in content amid low debt levels and high cash balances. Given the larger companies' strong business risk profiles, we don't expect significant financial credit deterioration in the sector in the short to medium term.

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We expect stability and satisfactory business conditions in the nonbranded food products sector for the next 12 months and positive free cash flow generation among beef and processed food branded producers.

Satisfactory Conditions For Utilities And Strong Performance In Project Finance

The infrastructure sector, including utilities and project finance transactions, continues to benefit from the ongoing spending by the public and private sectors to improve basic infrastructure, boost energy sources to satisfy rising demand and improve service levels, and construct infrastructure related to the World Cup and Olympic Games in Brazil. Business conditions for the electric utility sector are satisfactory, as power consumption continues to grow at a higher rate than GDP growth in some countries of the region. The expected increase in interest rates could slow down issuers' plans to tap the capital markets and hinder the funding of new projects and/or power plant expansions, as seen in Odebrecht OffShore Drilling Finance Ltd.'s $1.6 billion debt issuance in the last week of July, but originally planned for three weeks earlier. However, overall appetite for infrastructure financings remains strong. The outlook for the project finance transactions is stable to positive due to their strong financial and operating performance. Most of the projects are exposed to volume risk, which in turn is highly correlated to GDP.
Table 6

Infrastructure And Utilities Sector Conditions

Sector Utilities Infrastructure and project finance Current business conditions Satisfactory Strong Business outlook (next 12 months) No change No change Financial trends (next 12 months) Same Same Sector outlook (next 12 months) Stable Positive to stable

Stability Remains For Most Latin American Structured Finance Markets

We expect satisfactory business conditions for structured finance and a stable outlook across markets and asset classes in Latin America. In the consumer assets sector (i.e. personal and auto loan securitizations), we have seen a stable to strong performance in rated transactions. Nevertheless, the sector is exposed to risks, such as higher unemployment, a weakening of real salaries in Argentina due to high inflation, and slower growth in Mexico. Operational risks continue to be the focus of attention in the Brazilian sector, although many have been addressed through the recent regulatory changes for securitization vehicles. Our expectations for the commercial assets sector (i.e. trade receivables, equipment lease, and SME securitizations) is for continued steady performance across the region, with unpredictable weather conditions in Argentina impacting transactions linked to agriculture. Still, the potential for economic slowdown in Mexico and Brazil could result in higher delinquencies across asset classes. Areas of focus in Mexico include asset classes, such as equipment leasing that are linked to industrial output and exports. In Brazil, SME securitizations could exhibit a weakening over time, given high obligor and sector concentrations.

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Table 7

Structured Finance Sector Conditions

Sector Consumer assets Future flows Commercial assets Commercial assets mortgages Current business conditions Satisfactory Satisfactory Satisfactory Satisfactory Business utlook (next 12 months) No change No change No change No change Financial trends (next 12 months) Same Same Same Same Sector outlook (next 12 months) Stable Stable Stable Stable

Mortgage-backed securities in Mexico continue to be the largest market in Latin America, and our forecast calls for business conditions in Mexico to remain stable during the second half of 2013 for both government-related housing agencies (i.e. Infonavit and Fovissste) and retail banks. We continue to observe signs of stabilization in the nonbank financial institution sector in Mexico, though some transactions continue to show weak performance. The cross-border financial future flow securitizations (i.e. diversified payment rights and merchant vouchers) performance continues to be strong across the region, as seen in high debt service coverage ratios.

Outlook For Credit Trends

Lower growth and global financial market volatility could weaken currently stable rating trends.
Overall, we see downside risk to credit conditions in Latin America, following similar risks in other parts of the world, as we have revised downward our expectations for real GDP growth in the region amid increased volatility in financial markets. Just the anticipation of the end of Fed's quantitative easing has pushed up interest rates, raising the funding cost for Latin American corporates and generated financial outflows, creating volatility in the local debt and capital markets. We revised growth down in the region, and expect it to be little changed this year at 2.7% compared with that in 2012, and to pick up to 3% in 2014. This remains below the 3.7% average growth of the past decade. Growth in Brazil and Mexico is likely to be among the slowest in the region, with the smaller economies continuing to hold up better despite a more adverse global backdrop, thanks to a more robust domestic demand. A sharper decline in commodity prices and higher interest rates are some of the risks that could potentially weaken the Latin American companies' performance, but at current and projected levels through the next 12 months, it should remain relatively strong. As a result, we expect rating trends to remain mostly stable and the regional default ratio to be similar to that in 2012. Nevertheless, we continue to recognize the potential downside risk emanating from a weaker global and Latin American economy.

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