Summary Opinion SECTOR COMMENT Growth Prospects Rising ...€¦ · Rising Market Penetration Supports Growth Prospects Summary Opinion In Argentina, Reciprocal Guarantors (Sociedades

FINANCIAL INSTITUTIONS

SECTOR COMMENT5 AUGUST 2015

ANALYST CONTACTS

Alejandro Pavlov 5411-5129-2629VP-Senior [email protected]

Diego Nemirovsky 5411-5129-2627VP-Sr Credit [email protected]

Alan Murray 212-553-7787Senior Vice [email protected]

Robert Riegel [email protected]

Argentine Reciprocal Guarantors

Rising Market Penetration SupportsGrowth ProspectsSummary OpinionIn Argentina, Reciprocal Guarantors (Sociedades de Garantias Reciprocas, SGRs) are specialpurpose entities created within the legal framework of the country’s Small and Medium-size Enterprise (SME, or PYME in Spanish) Law, which was passed in 1996. SGRs provideguarantees to help SME’s obtain financing through bank loans and/or local capital marketson better terms (e.g. lower rates and longer maturities) than would otherwise be possible.Through these guarantees, the SGR assures creditors and/or investors that, in the event ofdefault by the borrower, the SGR will reimburse unpaid amounts. Bonds and securitizationsguaranteed by SGRs therefore typically carry the financial strength rating of the SGR that isproviding the credit enhancement. In addition, SGRs provide technical assistance services totheir SMEs members.

Key credit-relevant considerations for this industry sector include the following:

» After consolidation in the number of entities in 2011, the SGR sector is well positioned tocontinue to grow. Tax incentives and the stable regulatory framework that governs SGRshave increased investor interest in these vehicles, allowing the entry of new players. Inaddition, Argentina's economy may be poised for a modest recovery following two yearsof weak GDP, which would reduce credit risks for these entities and encourage demandfor guarantees.

» SGRs have increased their visibility and presence in the capital markets over the years.This has been driven especially by demand from mutual funds for guarantees offered oncertain types of debt instruments issued by SMEs, known as “Secured Checks”.

» Adequate capitalization, low leverage and contained credit losses support the SGRsector's capacity for growth. Because SGRs are structured more like cooperatives,rather than shareholder-based entities, they continue to receive contractual capitalcontributions from sponsors, despite their modest profitability. Regulations establish thatthe ratio of guarantees to investment instruments cannot exceed 4X, which has helpedcontain risk. However, this leverage is significantly higher when evaluated on a risk-adjusted basis, taking into consideration expected default probabilities associated withSGRs’ underlying SME-based credit exposures and investments, which are predominantlyheld in local currency Argentine government bonds.

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This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 5 AUGUST 2015 ARGENTINE RECIPROCAL GUARANTORS: RISING MARKET PENETRATION SUPPORTS GROWTH PROSPECTS

Market Overview and StructureArgentina's SGR sector is highly concentrated, with the two largest firms - Garantizar and FOGABA* (Spanish acronym for “GuarantyFund of Buenos Aires”) - representing nearly 50% of total outstanding industry guarantees.

Rank SGR IFSR Global/NSROutstanding Guarantees Dec.31,

2014 (ARS million)Market Share (% outstanding

guarantees)1) Garantizar -- 3,023.9 30.8%2) FOGABA (*) B3/A2.ar 1,885.6 19.2%3) Don Mario -- 836.7 8.5%4) Agroaval -- 718.6 7.3%5) Los Grobo -- 710.0 7.2%6) Acindar B2/Aa3.ar 649.3 6.6%7) Aval Rural B2/Aa3.ar 481.2 4.9%8) Aval Federal B3/A2.ar 299.6 3.1%9) Cuyo Aval -- 276.9 2.8%10) Intergarantias -- 172.1 1.8%11) Campo Aval -- 165.0 1.7%12) Garantia de Valores B2/Aa3.ar 125.8 1.3%13) Americana de Avales -- 96.8 1.0%14) Cardinal -- 81.0 0.8%15) Avaluar -- 65.5 0.7%16) Affidavit B3/A3.ar 65.0 0.7%17) Confederar -- 35.6 0.4%18) Vínculos B3/A3.ar 34.7 0.4%19) Afianzar -- 32.5 0.3%20) Solidum -- 31.6 0.3%21) Confiables -- 21.7 0.2%22) Fidus -- 21.7 0.2%23) Productos Harmony -- 7.3 0.1%24) BLD Avales -- 0.2 0.0%

(*) FOGABA's legal structure is not that of an SGR, but rather of a Guaranty Fund, created under the laws of the Province of Buenos Aires. But its function in the market is neverthelesssimilar to that of an SGR

Source: Bolsa de Comercio de Buenos Aires (www.bolsar.com) and Moody's.

This sector concentration is a consequence of the large size of the two market leaders' main shareholders: Banco de la NaciónArgentina (the country's largest and state-owned bank, unrated) is the main shareholder of Garantizar (unrated) while The Provinceof Buenos Aires (Caa1, NEG), the country's largest province, is the main shareholder of FOGABA. Given the public sector nature of themain shareholders of these two entities, their alignment with the social and macroeconomic objectives of the system (i.e. to promoteeconomic growth and the development of the SME sector) helps to ensure the sector's continuation.



Overview and Market Dynamics:Overview: Market Structure and Dynamics:Reciprocal guarantees are financial instruments that involves three parties:the guarantor, the small or medium-size enterprise (“SME”) and the financialcreditor. In exchange for a fee paid by the borrower, the SGR assurescontractual performance of a specific financial obligation, including principaland interest. The financial obligations include bank loans, secured corporatechecks, etc. SGRs also provide ancillary financial, economic and technicaladvisory services to the SMEs but to a much lesser extent.

The Sponsors of an SGR provide the initial cash resources (capital) that fundsits initial investments. This fund constitutes the ‘capital reserve’, which isavailable to pay a guarantee in the event the SME is unable to make paymenton its obligation; this is the fund’s only permitted use. In this manner, theSGR provides credit enhancement to different types of financings, such asbank loans, short term asset-backed securities, listed checks, etc.

SGRs were created under Argentine Law Nº 24.467 and are regulated byResolutions issued by the Secretary of Small and Medium-size Enterprises(“Secretaría de la Pequeña y Mediana Empresa y Desarrollo Regional”), anagency of the Argentine Government.

The reciprocal guarantor sector is a very concentrated market, with the top 2SGRs accounting for nearly 50%, and the top 5 around 75%, of total industrypar outstanding.

SGR’s are constituted by two kinds of shareholders: Sponsors (or “SociosProtectores”) and the SMEs (or “Socios Partícipes”) which are themselves thesmall and medium size companies that use the guarantees to facilitate theirfinancing activities. Each of the two types of shareholders must contributetheir share of required capital: sponsors can provide up to a maximum of50% of the SGR´s paid-in capital, whereas each of the SMEs are limitedto a maximum of 5%, a guideline that helps to ensure that SGRs serve adiversified and granular client base, and that they not be excessively alignedwith any one of them. To establish an SGR, a minimum number of 120 SMEsis usually required, but under certain conditions a lower number of SMEscould also be allowed. According to the law, SMEs are required to pledgecollateral – e.g. mortgages, pledges on equipment, machinery or personalbonds, as consideration to obtain the SGRs’ guarantee, and to reduce theSGRs’ risk exposures to net credit losses.

The system was originally created with two SGR business models. “OpenSGRs” were not vertically integrated or affiliated to the supply or distributionchain of a large Sponsor or shareholder, while “closed SGRs” predominantlyserved the SMEs associated to the supply or distribution chain of theirmain shareholder or sponsor, which was often an industrial group (verticalintegration). Over time, however, all SGRs have started to provide theirservices to both related and non-related SMEs.

SGRs’ underwriters emphasize loss-mitigation/prevention and, in theory,the reciprocal guarantor does not expect significant net losses given theexistence of the collateral. Losses can be reduced through subrogation of thecollateral held by the SGR against the SME.

Competition among SGRs is in general not strong because the commercialrelationships created between the SMEs and SGRs are normally long term innature. In addition, fees charged do not differ significantly from one SGR toanother.

The sponsor’s contribution to the SGR’s capital base has tax benefits andgrants it the right to receive its proportionate share of the fund’s investmentincome associated with contributions made during its sponsorship. Capitalcontributions from sponsors must remain invested in the SGR for at least 2years, and the SGR has to achieve a leverage ratio of 0.8x in order to benefitfrom the income tax deduction available for sponsors that invest in SGRs.The ratio is calculated as the percentage of average outstanding guaranteesdivided by average liquid investments in a given period.

Unlike insurers in Argentina, SGRs are regulated by the Secretary ofSmall and Medium-size Enterprises, rather than the National InsuranceCommission. They are therefore not classified as insurers, and do not chargepremiums, but rather fees for their services. However, their operations aresimilar to insurers elsewhere that provide credit protection or enhancement.

Key Credit Considerations:

Improved Market Visibility Supports Increased Business VolumesReciprocal guarantors continue to gain visibility in Argentina's capital markets and have successfully improved access to financing withlower borrowing costs and/or longer debt maturities for SMEs. In some cases, they have also provided financial advisory or technicalservices to their SME clients. The number of SGRs operating in Argentina is on the rise again after a consolidation in 2011 (see Exhibit1, below), in response to the sharp rise in the number of SMEs participating in the SGR system, and expectations for at least a modestrecovery of the Argentine economy in 2016. There are now 24 SGRs in the market, up 14% from 21 in 2011.



Exhibit 1

Number of SGRs in Operation Continues to Rise, Despite Argentina's Economic Slowdown

Source: Secretaría de la Pequeña y Mediana Empresa y Desarrollo Regional (www.industria.gob.ar/secretaria-pyme (number of authorized SGRs); Moody’s Analytics (Argentina GDP)

The volume of outstanding guarantees offered by SGRs has also risen (see Exhibit 2, below), driven by increased development of theSGR industry, and by Argentina's high inflation rate and the depreciation of the peso. The two latter developments have driven up thecost of capital goods and labor, leading to higher funding needs for SMEs.

Exhibit 2

SGR Development and Inflation Have Driven a Surge in Outstanding Guarantees (Nominal amounts of SGR guarantees outstanding, ARSMillion)

Source: Secretaría de la Pequeña y Mediana Empresa y Desarrollo Regional (www.industria.gob.ar/secretaria-pyme)

Guarantees have also grown in real, inflation-adjusted terms. Given widespread questions about the credibility of the government'sofficial inflation index, we use Argentina's annualized salary index as a proxy for inflation (see Exhibit 3, below). This is a more reliablegauge, as union salaries are frequently adjusted based on a more realistic inflation rate. Even when adjusting for this measure ofinflation, SGR industry growth has exceeded 10% a year for the past two years.



Exhibit 3

Growth Rates of the Sector: Outstanding Guarantees In Comparison to Standard Economic Benchmarks

Source: Secretaría de la Pequeña y Mediana Empresa y Desarrollo Regional (www.industria.gob.ar/secretaria-pyme) and www.indec.gob.ar

In this high-growth environment, SGRs have been able to diversify their risk exposures (the guarantees they offer) by economic sector,geography, currency and maturity. Their exposures to different economic sectors are reasonably balanced, reflecting Argentina'sdiversified economy (see Exhibit 4, below).

Exhibit 4

Guarantees Issued by Economic Sector, 4 Q 2014


However, geographic concentrations remain high, which reflects the fact that a handful of urban areas and provinces account for themajority of Argentina's economic activity (see Exhibit 5, below).



Exhibit 5

Guarantees Issued by Jurisdiction (4th Quarter 2014)


Growth of the sector will likely remain strong, based on the sustainability of the most important industry drivers, which include: 1)expectations for at least a modest recovery in economic growth in the medium term; 2) the continued leading position of government-related guarantors Garantizar and Fogaba, which will drive sector growth; 3) efforts at privately-owned SGRs to promote the benefitsof the sector within the SME universe; 4) the fact that less than 10% of total SMEs currently benefit from SGR guarantees; and 5) thelegal and operating framework governing SGRs.

SGRs Presence in Capital Markets RisesA key driver behind SGR growth has been increased demand for Secured Checks among mutual funds that specialize in SME-backedassets. Funding to SMEs through these Secured Checks grew significantly over the last two years, with the volume of secured Checksheld by the mutual fund industry at the end of last year representing more than 50% of the total outstanding guarantees of the SGRsector.

In part, this increased demand among mutual funds has been triggered by the insurance investment guidelines reform of 2011, whichmandated that insurance companies allocate a minimum portion of their total investments to debt instruments issued by SMEs. Somespecial-purpose mutual funds were launched specifically to cover rising demand for SME-based investment instruments. In addition,SMEs increasingly prefer to finance capital needs through SGR Checks because they have negative real financing costs, making them acheap funding source. Interest rates on these instruments typically range from 15-19%, which is much lower than most private sectorestimates of real inflation, which generally range from 30%-34%. Finally, the short-term nature of these instruments (with a maximumof 360 days) matches the productive cycle of many SME-related economic activities, including agriculture.

While Secured Checks have come to be a primary contributor to industry growth in recent years (see Exhibit 6, below), we believethe industry's expansion will continue uninterrupted even if market dynamics shift, given 1) the sector’s historical growth, even duringperiods when other alternative funding instruments for SMEs were also expanding; 2) the local currency denomination of the checks,which supports repayment capacity for the SMEs; and 3) the SGR industry’s active role in the development of new funding instrumentsto address the long term needs of SMEs.



Exhibit 6

Growth of the Sector: Number of Transactions Per Year

Source: Secretaría de la Pequeña y Mediana Empresa y Desarrollo Regional (www.industria.gob.ar/secretaria-pyme)|

Capitalization Is Adequate, while Net Losses Remain LowDespite growth in SME borrowing through SGR guarantees, which might raise questions about credit quality, leverage at SGRs remainslow, particularly in comparison to other guaranty industries worldwide. This is supported by cash contributions made by sponsors tothe SGR’s pool of investments (which can only be used to make payments on SMEs’ delinquent obligations and to absorb investmentlosses), and regulations that cap leverage ratios at a relatively low 4x (see Exhibit 7, below). In addition, unlike most other financialinstitutions, SGRs don't rely on earnings to generate fresh capital. Capital contributions from sponsors, made with funds generatedthrough other profitable industries, have far surpassed the yields that SGR's earn through their investments and operating resultsover time. Total fees less administrative/commercial expenses normally deliver net profits or losses in the range of -1 to 1% of totalrevenues.

However, when adjusting for Argentina's high operational risks, and for high economic concentrations in the case of some SGRs,leverage is much higher. Our risk adjustments reflect the fact that the majority of SGRs' investments, which are comprised mostly ofgovernment securities that are rated Caa1 with a negative outlook, carry a high probability of default.

Exhibit 7

Sector Leverage (Outstanding Guarantees / Investments)




Net losses (after recoveries) have generally been between 1-5% of investments, reflecting the important role of collateral as a lossmitigation tool, as well as SGRs' high capitalization. (see Exhibit 8, below)

Exhibit 8

Losses Net of Recoveries as % of Average Investments and Issued Guarantees


The leverage ratio for each entity at the end of the last fiscal year is shown in table below:

SGR IFSR/Global/NSROutstanding Guarantees Dec.31,

2014 in ARS million [a]Investments Supporting

Guarantees in ARS million [b] Underwriting Leverage[a] / [b]Garantizar 3,023.9 1,378.2 2.19xFOGABA B3/A2.ar 1,885.6 668.7 2.82xDon Mario 836.7 238.6 3.51xAgroaval 718.6 363.8 1.98xLos Grobo 710.0 187.3 3.79xAcindar B2/Aa3.ar 649.3 305.9 2.12xAval Rural B2/Aa3.ar 481.2 199.7 2.41xAval Federal B3/A2.ar 299.6 131.6 2.28xCuyo Aval 276.9 82.5 3.36xIntergarantias 172.1 90.9 1.89xCampo Aval 165.0 108.4 1.52xGarantia de Valores B2/Aa3.ar 125.8 73.7 1.71xAmericana de Avales 96.8 32.7 2.96xCardinal 81.0 48.7 1.66xAvaluar 65.5 24.1 2.72xAffidavit B3/A3.ar 65.0 34.0 2.08xConfederar 35.6 26.9 1.32xVínculos B3/A3.ar 34.7 25.6 1.36xAfianzar 32.5 26.3 1.23xSolidum 31.6 16.8 1.88xConfiables 21.7 14.2 1.53xFidus 21.7 14.5 1.50xProductos Harmony 7.3 15.0 0.48xBLD Avales 0.2 91.2 0.00x

Source: Bolsa de Comercio de Buenos Aires (www.bolsar.com) and Moody's.



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http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1003869

https://www.moodys.com/research/Brazilian-Insurance-Industry--PBC_1001050



https://www.moodys.com/research/Mexico-Insurance-Industry--PBC_173078

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AUTHORAlejandro Pavlov

COLLABORATORFlorencia Calvente

Documents

Summary Opinion SECTOR COMMENT Growth Prospects Rising ...€¦ · Rising Market Penetration Supports Growth Prospects Summary Opinion In Argentina, Reciprocal Guarantors (Sociedades