U.S. FINANCIAL WOES SPILL OVER INTO MONTERREY'S REAL

UNCLAS SECTION 01 OF 03 MONTERREY 000495 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON EFIN EIND ETRD PGOV MX SUBJECT: U.S. FINANCIAL WOES SPILL OVER INTO MONTERREY'S REAL ECONOMY REF: A) MONTERREY 473; B) MEXICO 3197; C) MONTERREY 489 MONTERREY 00000495 001.2 OF 003 ¶1. (U) Summary. The Monterrey business community has begun to be affected by the U.S. financial crisis, including large derivative losses, abrupt changes in currency values, and restricted credit access. Several large Monterrey companies incurred significant losses due to derivatives contracts gone bad. Local economists think that dollar purchases by these corporations, to fund their derivative losses, helped depress the value of the Mexican peso. The sudden decline of the peso has helped some exporters, but the effect depends on the region and the quantity of U.S. inputs in the finished product. Finally, credit access is tightening for Mexican companies as foreign owned banks withdraw liquidity to cover losses at home. End Summary. ¶2. (SBU) This report is the companion cable to reftel A, which reported on the political and security concerns in Monterrey. Overall, the mood here is dour as business executives and opinion-leaders can't decide which is worse: the economic crisis or the worsening security climate. ¶3. (U) Northern Mexico is just beginning to feel the effects of the U.S. financial crisis, which private economists expect will reduce economic growth at least into the first half of 2009. In a speech to the American Chamber of Commerce, Everardo Elizondo, the Deputy Governor of the Central Bank of Mexico, warned that this was the worst U.S, financial crisis in 50 years. Econoff also attends a monthly meeting of a group of private economists, who predicted that the current U.S. recession would be shaped like a `L' rather than a `V', since the U.S. economy will be flat for at least one year and it could take longer to recover. These economists commented that the `real economy' of Nuevo Leon had only started to feel the adverse impact in September. Monterrey Companies Suffer Substantial Derivative Losses ¶4. (SBU) In the last several weeks, several large Monterrey companies have reported large losses resulting from their purchases of derivatives contracts to hedge on currency or raw materials, such as natural gas. Our contacts believe that these companies generally were not speculating, but were engaged in legitimate hedging since they have large operations in other countries or use energy for their operations. The value of the derivative contracts were marked to market value, so even if they are not immediately due they indicate current estimates of future market losses. The companies with large losses include Cemex ($500 million USD),Alfa ($191 million),Vitro ($360 million),Gruma ($291 Million) and the Saltillo Industrial Group ($55 million) (see reftel B). These losses come at a bad time for Cemex, which is already suffering from high debt load from past acquisitions and weakening demand from key markets in the United States, Spain and England. According to press reports, 76% of Cemex' debt was in dollars, which has sharply increased in value relative to the peso, although Cemex does receive a large portion of its income in dollars. The derivative losses are the worst for the already weak Vitro, and Vitro's stock market value has plunged 70% since July 2007, including down 23% on October 22 alone. However, we understand that Vitro has restructured its debt and will avoid defaulting on its debts. As a result of the derivative losses and market pressures, the credit agencies have lowered their ratings for Cemex and Gruma, and Vitro is under review. ¶5. (SBU) In several cases, the Monterrey companies are closing out their derivative positions, eliminating the risk of additional losses but also foregoing the chance that the market will rebound and cut their losses. The Consul General and Econoff met with Alfa, which stated that they have closed all of their derivative positions and reported the losses to Wall Street. Alfa claims that they will be able to handle these losses and their cash flow to debt ratios are reasonable. Similarly, according to press reports, Vitro is closing its derivative positions, including those due from 2009 to 2011, to provide certainly to their losses. Several economists questioned Vitro's strategy, since they are locking in losses, but since the company could be at risk it may be necessary to have a final accounting of their derivative losses. MONTERREY 00000495 002.2 OF 003 Causes and Results of Dollar Revaluation ¶6. (SBU) Central Bank Deputy Governor Elizondo and private economists concur that the need of these companies to cover derivative losses by purchasing dollars had a significant impact in the revaluation of the dollar in comparison to the Mexican peso. According to this explanation, as the global financial market became worried, there was a `flight to quality' as investors moved away from emerging markets to the stability of the U.S. dollar. These currency shifts resulted in derivative losses, which in turn forced the Mexican companies to dump pesos and buy dollars to cover their derivative losses and debt obligations, further increasing the strength of the dollar. According to Elizondo, investor fear led to the overshooting of market fundamentals, so the dollar rose to 14 pesos/$1 USD, forcing the Mexican Central Bank to intervene to break the market psychology. Although the Mexican Central bank burned through 10% of its large foreign exchange reserves in 72 hours, Elizondo defended the Bank's decision, maintaining that this was the purpose of the Central Bank's international reserves. A group of private economists agreed that market fear had overshot the market, and they expect that the peso will settle between 11 to 13 pesos per dollar, likely at 12 pesos/$1 dollar. (As of November 4, it stood at 12.6pesos/$1 dollar). ¶7. (SBU) Deputy Governor Elizondo also explained to the Amcham conference how the Mexican Government acted to calm the financial markets, using three prongs. First, the Bank of Development (Nafin) guaranteed commercial paper by large Mexican companies like Cemex and also small enterprises. Second, the Central Bank will provide liquidity for bank to bank loans. Third, the Federal Mortgage Society (SHF) will provide liquidity and credit to the housing sector and support mortgage backed instruments. These measures respond to reported spikes in interbank lending rates in early October. ¶8. (SBU) The market devaluation of the Mexican peso increases the competitiveness of certain exporters, although they will still suffer from decreased demand in the United States. According to American Chamber of Commerce International Trade Director Luciano Escobedo, at the dollar's height Mexican exports were up to 30% more competitive. However, the actual impact depends on the amount of inputs from the United States. For a maquila which uses imported American inputs, they will gain comparatively less, but if a company utilizes Mexican inputs, they could reap a large increase in competitiveness. (Note. We understand that for the maquila industry in general, 70% of the inputs are imported from the U.S. End Note). Overall, Escobedo estimated that maquilas in border towns such as Matamoros and Ciudad Juarez, which depend heavily on U.S. inputs and exports, would lose 30-40% of their jobs, while companies in Monterrey or Saltillo, which have more of a Mexican supplier base and sell partially to the Mexican domestic market, could see employment gains of 4-5%. Impact of Restricting Credit Access ¶9. (SBU) The Mexican financial system is still relatively limited compared to other countries, which reduced its exposure in the current global financial crisis. According to Monterrey TEC professor Alejandro Ibarra, the Mexican banking sector still has not fully recovered from the 1994 banking collapse. In 1993 the financial intermediation level was 47% of Mexico's GDP, but in 2006 it was still only 25% of the Mexican GDP (in comparison, the U.S. ratio is 140%). The Mexican banks focus on consumer credit, which bring strong returns, since there are no limits to legal interest rates, and mortgage loans. However, Mexican mortgages are relatively uncomplicated and do not include the exotic variable rates or no money down loans that have resulted in large losses in the U.S. ¶10. (U) Although the Mexican banking system has not itself suffered significant losses, liquidity has been drained to MONTERREY 00000495 003.2 OF 003 assist the foreign banks. According to a Fitch ratings report in 2007, foreign owned banks control 80% of Mexican commercial banking assets, led by the Spanish owned BBVA/Bancomer (25% of the market),Citibank owned Banamex (19%),the Spanish Santander (14%),HSBC (11%),the Mexican Banorte (9%),the Canadian Scotiabank (5%),the Mexican Inbursa (4%),other Mexican owned banks (7%) and other foreign owned banks (6%). According to our contacts, many foreign banks have withdrawn money to cover losses in other markets. In addition, large Mexican corporations (like CEMEX) generally raise funds through the sale of commercial banks, or borrowing from international banks. ¶11. (SBU) Finally, the Mexican credit markets have tightened for both large and medium Mexican companies. Deputy Governor Elizondo confirmed that Mexican credit is more expensive, and more limited, with much higher credit standards for loans, echoing comments by other business contacts. Mexican borrowers are being to feel the heat. For example, Enrique Garza, a lawyer experienced in investment funds, said that his company used to close 1-2 deals per months, but now all his deals are frozen, and instead several of his companies have come to him discussing bankruptcy. There will less of an impact on small Mexican businesses, because many of them were unable to borrow even before the current credit problems. ¶12. Comment. Until recently, U.S. economic problems had had a limited impact on the real economy of Mexico, hitting vulnerable sectors such as the auto industry and declining remittances, but not affecting the financial industry. However, now it is clear that the U.S. financial crisis is affecting both Mexican companies and the availability of credit. The Government of Mexico is using the financial tools available to assure liquidity, and the government will spend substantial sums on its national infrastructure plans to boost the economy. However, the Mexican economy is still so closely tied to the American economy, since the U.S. is still the destination of 80% of Mexico's exports, Mexicans laboring in the U.S. remitted $24 billion last year (see reftel C),and the U.S. remains the largest source of foreign direct investment. Therefore, although Northern Mexico can take some steps to alleviate the economic problems, our economist contacts think that Mexico will have very low growth through 2009 until the U.S. economy recovers. End Comment. WILLIAMSON