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