IC GFINTER Ingrid 200114 - GBM · GFINTER has a healthier risk profile than the sample, as being...

GFINTER| Banks

Initiating Coverage January 21, 2014

GBM Grupo Bursatil Mexicano, S.A. de C.V., Casa de Bolsa (“GBM”), and its affiliates, may carryout and seek to do business with companies covered in its research reports. Investors should not consider this report as a single factor in making their investment decisions. These materials do not constitute an offer to buy or sell any security or participate in any trading strategy.

GFINTER Market Outperformer 2014 Price Target P$83.0

BV is adjusted to IPO proceeds

Lilian Ochoa

[email protected]

+52(81) 8152 4000 ext. 4014

Jorge Benitez

[email protected]

+52(81) 8152 4000 ext. 4015

We are initiating coverage of GFINTER with a Market Outperformerrating and a 2014 price target of P$83.0. Strong fundamentals, including an attractive valuation, competitive advantage, and growth opportunities, set GFINTER as the most attractive play within our financial sample. GFINTER has a healthier risk profile than the sample, as being highly focused on the government segment turns into lower reserve and capital requirements. The former is reflected in the 3.1% reserves to total loans ratio compared to the 5.2% ratio of the entire system, while the bank’ s loan book mix has caused lower capital requirements, given that the credit risk weight is lower in government loans. Low delinquency rates. GFINTER has stood out for maintaining one of the lowest NPL ratios within the banking system. Currently, the financial group has a 0.2% NPL ratio—compared to the 3.4% of the Mexican market—entirely attributed to the infrastructure and SME segments, while its government exposure keeps a 0.0% NPL ratio. Strong loan book guarantees. 93.5% of the company’ s total loan portfolio is guaranteed by federal contributions or other liquid guarantees. This collection model also eases the risk of default as the bank obtained its payments through a federal trust that acts as a filter between federal contributions and the states and municipalities. High capitalization ratio. By September 2013, GFINTER had a 15.8% capitalization ratio, easily meeting Basel III capital requirements. Moreover, this ratio still does not reflect the most recent public offering,which could add a further P$2.1 billion to the company’ s Tier I Capital, sending the consolidated capitalization ratio to around 19.0%, according to our estimates. Attractive profitability levels. GFINTER’ s solid NII expansion, coupled with low provisioning requirements and highly effective cost-saving strategies, drove ROAE to 17.3% (8.9% adjusted ROAE) compared to the 14.7% ROAE and 6.4% adjusted ROAE reported by the Mexican banking system. The company benefited from a strategic branch-network, as it is divided into regional offices and business centers, which allow the bank to improve its efficiency.

P/E

12M PRICE PERFORMANCE VS. IPC

P/BV

Price 69.0

12M Price Range 58.0 / 77.0

Shares Outstanding (Mill) 270

Market Cap (Mill) 18,636

Float 29.9%

Deposits (Mill) 57,389

Stockholder Equity (Mill) 10,781

Total Loan Portfolio (Mill) 58,409

2012 12M 2013e 2014e

Interest Income 8,031 8,613 8,712 10,040

Financial Margin 1,953 2,297 2,195 2,555

Net Income 1,406 1,429 1,643 1,922

NPL 0.7% 0.2% 0.3% 0.3%

EPS 5.2 5.3 6.1 7.1

P/E 13.3 13.0 11.3 9.7

P/BV 2.4 1.7 1.6 1.5

ROAE 18.8% 17.3% 16.6% 15.8%

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GFINTER IPC

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GBM Grupo Bursatil Mexicano, S.A. de C.V., Casa de Bolsa (“GBM”), and its affiliates, may carryout and seek to do business with companies

covered in its research reports. Investors should not consider this report as a single factor in making their investment decisions. These

materials do not constitute an offer to buy or sell any security or participate in any trading strategy. 2

GFINTER | Banks

January 21, 2014

Index

I. Introduction ……………………………………………………………………………………………………………….. 3 II. Investment Thesis………………………………………………………………………………………………………… 4 Financials………………………………………………………………………………………………………………………… 5 Valuation…………………………………………………………………………………………………………………………. 6 Investment Thesis Pros and Cons……………………………………………………………………………………………. 8 III. Background…………………………………………………………………………………………………………………. 9

A. Mexican Banking Industry………………………………………………………….…………………………………… 9B. Company Background………………………………………………………….………………………………………… 10C. Mexican Environment………………………………………………………….………………………………………… 14

IV. Competitive Advantages and Opportunities……………………………………………………………………….. 21 Loan book guarantees and advantageous collection model……………………………………………………………. 21 Capitalization level…………………………………………………………………………………………………………….. 22 Delinquency levels……………………………………………………………………………………………………………… 23 Reserve requirements…………………………………………………………………………………………………………. 24 Capital requirements………………………………………………………………………………………………………….. 24 V. Risks and Weaknesses…………………………………………………………………………………………………… 28 Active rate……………………………………………………………………………………………………………………….. 28 Loan portfolio concentration…………………………………………………………………………………………………. 29 Assets and Liabilities’ duration GAP………………………………………………………………………………………… 29 VI. Regulation………………………………………………………………………………………………………………….. 31




GFINTER | Banks

January 21, 2014

I. INTRODUCTION The Mexican Financial system is currently composed of 22 major financial groups and 45 multiple banks. Up to September 2013, the total loan portfolio of the private banking system was around P$2.9 trillion, which is roughly 21.7% of the Mexican GDP. This ratio does not include financing from non-bank institutions such as SOFOMs, development banks, credit unions, factoring, and leasing, among others. If we include this financing, total lending to the private sector would represent roughly 26.0% of GDP. Meanwhile, the seven largest banks in Mexico represent 87.4% of the total loan book, reaching P$2.5 trillion; 70.0% of this amount is managed by foreign capital. As can be seen, although there are several financial institutions operating in the country, the industry remains highly concentrated but with significant growth potential, given the low credit penetration as a percentage of GDP. Additionally, during the last decade, the National Banking and Securities Commission has committed to strengthening the financial system by adjusting banks’ risk measurement through standards that demand higher provisioning and capital requirements; this, in turn, has led to consistent but controlled growth with stricter capitalization levels than the international standards, and a high coverage of past due loans. As a result, the Mexican Banking system is considered one of the soundest financially worldwide, due to its strong regulatory framework, healthy balance sheet, and controlled risks. The latter, in our view, will allow the consumer segment to remain as the main growth contributor of the loan portfolio, and in turn, will propel the continuous profitability improvements. Grupo Financiero Interacciones (GFINTER) is a specialized financial group focused on serving the public sector’ s financing needs. Currently, GFINTER is ranked as the tenth largest bank in terms of assets and ninth in total loan portfolio, with 1.8 and 1.9% market share in each of these metrics. The company has three main divisions where Banco Interacciones is the group’ s main subsidiary, specializing in granting credits to the three government levels, but more particularly to states, municipalities, and companies related to the public sector in Mexico; it also provides deposit and savings services, as well as financial advisory services, to all government levels. The bank’ s total loan portfolio amounted to P$58.9 billion, reporting earnings of P$388.1 million up to September 2013; this represents 86.5% of the entire group’ s net profit.

The Insurance division focuses on providing risk management solutions to individuals, corporations, and the three levels of government. The products are offered through independent insurance agents and the promoting force of GFINTER. Lastly, the Brokerage branch provides financial services including equity and debt transactions, advisory services, structuring portfolios, and asset management, both to individuals and enterprises. Since 2011, the company has the ability to process 300.0 thousand transactions per day, which translates into 200 transactions per second, representing 3.9% of all monthly transactions in the Mexican Stock Exchange vs. the industry’ s average of 70 transactions per second.

In October 2013, GFINTER carried out a mixed public offering where it sold 63.6 million shares. The primary offering comprised 30.0 million shares with an additional 9 million shares available for the greenshoe option. Only 40.2% of the latter was exercised, leaving the entire primary offering at 33.6 million shares. As for the secondary offering, Interfondo de Capitales sold 7.3 million shares, while other original shareholders sold 22.7 million, totaling 30 million shares. Some of the main sellers are Carlos Hank Rhon, Carlos Hank Gonzalez, Graciela Hank Gonzalez, and Alejandro Hank Gonzalez. The selling price stood at P$61.0 per share translating into P$3.9 billion for the entire offering; GFINTER will obtain P$2.1 billion in proceeds. In terms of valuation, the transaction took place at 1.6x P/BV, which seemed attractive enough, considering its peers’ multiple valuations.




GFINTER | Banks

January 21, 2014

II. INVESTMENT THESIS We are initiating coverage of Grupo Financiero Interacciones (GFINTER) with a Market Outperformer rating and a 2014 price target of P$83.0; making it the most attractive play within our financial sample. Our investment thesis is based in three main pillars:

• The company’ s attractive valuation, as GFINTER is trading at 2.1x P/BV, which represents a 19% discount vs. the 2.6x average of our banking sample, even without considering the P$2.1 billion in proceeds raised in the public offering; considering the IPO resources, the P/BV should move to 1.7x.

• Low risk profile reflected in lower reserves and capital requirements, its NPL ratio of 0.2%—significantly below the industry average—its strong guarantees and its adequate capitalization ratio of around 19.0% post IPO, surpassing local and international regulations.

• High profitability levels given that controlled cost policies, reflected in an efficiency ratio of 42.3%, led GFINTER’ s ROAE to 17.3%, compared to the Mexican banking system’ s 14.7%. The latter translates into a 8.9% adjusted ROAE—above the 6.4% average of its Mexican peers.

To determine our price target, we used the average of three approaches: the Residual Income model, an implied P/BV ’ 14e, and a P/E ’ 14 target for our Mexican sample. Additionally, we decided to apply a 15% discount to our price target in order to better reflect the low liquidity of the stock which, in our view, should decrease as the shares gain traction in the Mexican market and as the company continues to show attractive results.




GFINTER | Banks

January 21, 2014

Financial Summary — Figures in thousands of nominal pesos.

Source: GBM and company data

GFINTER 2012 2013e 2014e 2015e 2016e 2017e 2018e

17.3% 8.5% 15.2% 16.7% 17.3% 17.1% 16.0%

Consolidated Interest Income 8,031 8,712 10,040 11,712 13,742 16,091 18,663

17.1% 12.4% 16.4% 19.8% 18.6% 18.0% 16.6%

Consolidated NII 1,953 2,195 2,555 3,060 3,628 4,280 4,989

9.9% 6.1% 21.7% 23.1% 23.9% 21.8% 19.7%

Provisions for loan losses 773 821 999 1,230 1,523 1,856 2,221

22.4% 16.5% 13.2% 17.6% 15.0% 15.2% 14.2%

NII after provisions 1,180 1,374 1,556 1,830 2,105 2,424 2,768

8.0% 9.3% 15.4% 15.3% 15.1% 16.2% 17.8%

Non-Interest Income 3,271 3,577 4,126 4,757 5,477 6,365 7,497

-15.2% 9.4% 12.4% 13.7% 13.3% 12.4% 13.4%

Non-Interest Expense 2,444 2,673 3,006 3,417 3,872 4,352 4,936

5.2% 16.9% 17.0% 18.3% 18.4% 18.8% 19.5%

Net Income 1,406 1,643 1,922 2,275 2,694 3,201 3,826

27.4% 18.0% 23.1% 23.7% 19.9% 18.1% 16.2%

Loan Portfolio 55,657 65,693 80,890 100,097 120,023 141,744 164,750

Portfolio (Absolute Chg) 11,956 10,035 15,198 19,206 19,926 21,721 23,005

20.3% 17.1% 17.7% 20.0% 17.6% 14.2% 12.9%

Total Assets 140,173 164,097 193,132 231,706 272,444 311,107 351,096

13.2% 50.0% 5.2% 14.6% 15.1% 15.6% 16.2%

Maj. Stockholders Equity 7,927 11,892 12,510 14,342 16,513 19,094 22,184

ROE 17.7% 13.8% 15.4% 15.9% 16.3% 16.8% 17.2%

ROAE 18.8% 16.6% 15.8% 16.9% 17.5% 18.0% 18.5%

ROA 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.1%

ROAA 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.2%

NIM 1.6% 1.6% 1.4% 1.4% 1.5% 1.5% 1.5%

NPL 0.7% 0.3% 0.3% 0.3% 0.4% 0.4% 0.4%

Write-Offs/Loan port. 0.4% 0.1% 0.2% 0.1% 0.2% 0.2% 0.2%

Coverage ratio 550.6% 1230.3% 1059.0% 1040.6% 952.3% 902.4% 843.2%

Reserves/Loan port. 3.6% 3.1% 3.1% 3.6% 3.6% 3.6% 3.5%

Efficiency ratio 46.8% 46.3% 45.0% 43.7% 42.5% 40.9% 39.5%




GFINTER | Banks

January 21, 2014

Considering the financial group’ s expected growth, with a 3.0% long-term perpetual growth and discounted at a 12.2% cost of equity, our Residual Income model points to a 2014 price target of P$82.1.

Residual income model — Figures in thousands of nominal pesos.

Regarding the multiple approaches, we are considering a 2.5x implied P/BV ’ 14e, and a target of 15.0x P/E’ 14e, arriving at impicit prices of P$103.9 and P$106.8 from each. Thus, the average of our multiple approaches and our residual income model set a price target of P$83.0 after the 15.0% liquidity discount mentioned above, with an upside potential of 20.2%. P/BV target approach P/E target approach

Source: GBM Source: GBM

Equity Value 18,636

Beta 1.2

RF** 6.4%

Equity premium 5.0%

Cost of equity 12.2% g 3.0%

**10y Mexican Bond

*** Perpetual growth 3.0%

1.00€ -€ 1.00€ 2.00€ 3.00€ 4.00€ 5.00€

4Q13e 2014e 2015e 2016e 2017e 2018e Terminal Value

Net Income 448 1,922 2,275 2,694 3,201 3,826 41,586

R&D 10.9 46.6 53.0 60.0 67.4 76.5 832

Residual Income 217 518 967 1,108 1,357 1,676 18,221

PV RI 244 518 862 880 961 1,058 10,247

Equity 10,781 Theoretical value 22,162

Leverage stress impact 3,388 Theoretical value per share 82.1

Equity 7,393

P/BV Target 2.5x

BV per share 2014e 41.3

Implicit price per share 103.9

P/E Target 15.0x

EPS 2014e 7.1

Implicit price 106.8

Average price target 97.6

Liquidity Discount 15%

Price Target 83.0

Upside 20.2%




GFINTER | Banks

January 21, 2014

Comparison of Multiples and Profitability TTM

Comparison of P/BV vs. ROE

Source: GBM with companies’ , and Bloomberg data. Source: GBM with companies’ and Bloomberg data.

TTM P/E P/E'14 P/BV ROAEEPS'14e growth

GFNORTE 19.6 15.0 2.1 13.1% 23.9%

SANMEX 12.8 11.8 2.3 18.5% 1.2%

GFINBUR 19.7 14.6 2.4 14.8% 35.9%

GFREGIO 19.7 15.5 3.3 17.6% 16.9%

Actinver 19.4 16.0 2.1 12.2% 28.6%

Bancolombia 12.7 9.7 3.3 27.6% 26.3%

Santander Chile 14.9 12.8 2.5 17.6% 15.7%

Banco de Chile 12.9 11.9 3.0 25.5% 10.0%

Corpbanca 18.2 12.5 1.4 10.2% 22.9%

BCI 11.6 11.1 2.2 20.4% 18.5%

GFINTER 13.0 9.7 1.7 17.3% 17.0%

Average 15.9 12.8 2.4 17.7% 19.7%

GFNORTE

SANMEX

GFINBUR

GFREGIO

Actinver

Bancolombia

BSAN

Banco de Chile

Corpbanc

BCI

GFINTERAverage

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

1.0 1.5 2.0 2.5 3.0 3.5R

OA

EP/BV




GFINTER | Banks

January 21, 2014

Investment Thesis Pros and Cons

Pros Cons

Lower risk profile reflected in lower reserves and capital requirements, given its strong exposure to the government segment.

Lower active rate. GFINTER’ s active rate stands around 6.1% while the interest rate from the performing loan portfolio stands at 7.5%, below the industry’ s 13.0%.

Significantly lower NPL ratio than the industry (0.2%), entirely attributed to infrastructure projects and SME while government loans remain with a 0.0% ratio.

Higher funding cost. The company has more expensive funding sources, given the strong exposure to time deposits rather than short-term liabilities.

Strong loan book guarantees, with 71.0% of the total loan portfolio backed by federal contributions and 22.0% with other liquid guarantees.

Wide asset-liability duration GAP. GINTER has a duration spread of 2.9 years, raising liquidity risk.

Adequate capital structure. With a capitalization ratio of 15.8%, it comfortably surpasses local and international regulations.

High loan book concentration. 72.0% of its total loan portfolio corresponds to the government segment, while 22.0% refers to infrastructure projects.

Supportive financial reform as national regulators will give banks incentives to increase market penetration.

More complex economic environment with lower than expected GDP recovery should lead Banxico to keep the overnight interbank rate at the current low levels, pressuring financial margins.

Attractive valuation. The company is currently trading at 1.7x P/BV considering the P$2.1 billion proceeds raised in the public offering, below the 2.6x average of our banking sample.

Higher competition and new players in the banking business. Niche foreign banks, and multi-purpose finance entities may reduce market share in certain types of products and pressure the company’ s growth.




GFINTER | Banks

January 21, 2014

III. BACKGROUND A. Mexican banking industry1 In Mexico, after the Independence (1810) and before the “Porfiriato” (1876), political institutions provided virtually no protection to property rights. The consequences were twofold: First, private bankers could not enforce loan contracts; and second, private bankers had almost no incentive to obtain charters and expand their operations (taking deposits or selling equity) because doing so would have exposed them to expropriation by the government. Thus, there was only one bank in Mexico based on the contracts structure until the 1880s. The Bank of London, Mexico, and South America was a branch of a British bank established in Mexico in 1864, whose property rights were protected by a foreign authority. The underdeveloped state of Mexico’ s banking system started to change dramatically during the 35-year dictatorship of Porfirio Diaz (1876-1911), who decided to merge two of Mexico City’ s largest banks—Banco Nacional Mexicano and Banco Mercantil Mexicano—creating Banco Nacional de Mexico (BANAMEX). The intention was to model BANAMEX after the Bank of England, granting it a monopoly over the issuance of paper money in return for providing a credit line to the federal government and acting as the treasury’ s financial agent. In turn, for the first time in Mexican history, a stable system of public finance was created. For instance, at that time, BANAMEX’ s directors helped Diaz renegotiate Mexico’ s foreign debt—which had been in default for several decades—and also subsidized the creation of a national railroad system. However, the consequence was a concentrated Mexican banking system. It wasn’ t until 1925 that President Calles established Banco de Mexico (BANXICO), the Mexican central bank. In its initial stage, BANXICO was a commercial bank, owned by the government, which lent most of its resources mainly to private bankers. It even made direct loans to powerful political figures. Through the creation of BANXICO, Mexico’ s bankers mitigated the risk of expropriation by building ties with the government; nevertheless, contract rights remained difficult to enforce. In the midst of the twentieth century, the banking system grew at a reasonably fast pace. Total lending to the private sector grew from around 6.0% of GDP in 1939 to 36.0% in 1969. However, by 1974, it contracted sharply to around 10.0%, mainly because of the expansive monetary policy that propelled a quick and untenable economic growth based on oil exports. By September, 1982, the government’ s strategy had become unsustainable: Mexico was entering into a hyperinflation, much of the private banking system was no longer profitable, and the foreign debt had reached unsustainable levels. The budget deficit reached around 6.6% of GDP, and the government therefore suspended payment on its international creditors, converted dollar denominated bank accounts to pesos at the official exchange rate, and then expropriated the banks. In the 1980s, Mexico’ s banks were essentially run as vehicles to finance the government’ s budget deficits. The government-owned banks took deposits, and later invested the proceeds in government treasury bonds. Political decisions predominated over rational economic decisions. Former President Carlos Salinas de Gortari (1988-1994) thought of privatizing the banks as a way to find revenue sources to balance the federal budget, as well as to improve the efficiency in the management of the Mexican banking system. At the time of privatization, the Mexican banking industry was composed of 18 banks, four of which controlled 70.0% of the total bank assets. In the auction, the government signaled bankers that they were purchasing secure oligopolies, so it structured a process to maximize the offered prices. Finally, between June 1991 and July 1992, the government sold the banks in six bidding rounds, most of them with a substantial premium to their book value.

1 Section A is a briefing from the paper “ Why Institutions Matter: Banking and Economic Growth in Mexico”. Stephen Haber, June 2005. Stanford University.




GFINTER | Banks

January 21, 2014

In that period (1991-1994), real bank lending doubled in the space of a couple of years. Mortgages, real estate, and consumer loans nearly trebled; nonetheless, lending growth was not matched by an increase in deposits, because private banks started to get funds on the interbank market, mainly from foreign banks and in foreign currency. Therefore, foreign currency denominated liabilities grew rapidly from around 11.0% in December 1991 to 27.0% in December 1994. When the peso crisis started in December 1994, the declining foreign reserves, the increasing NPL ratios in commercial banks, and the high political risk, given the rebellion in Chiapas and the recent assassination of presidential candidate Luis Donaldo Colosio, were all factors that increased investors’ perception of risk. Together with a general speculative feeling, this worsened the devaluation of the Mexican Peso. The collapse of the exchange rate buckled the Mexican banking system. First, foreign loans represented roughly one third of the total loans in the banking system; and second, the collapse of the peso gave incentives to investors to pull their funds out of Mexico. Then, BANXICO pursued a tight monetary policy, which in turn increased interest rates; for instance, mortgage interest rates jumped to 74.0% in March 1995, from 22.0% just five months before. This environment sharply boosted delinquency rates, which in turn put pressure on the solvency of the banking system. In reaction, the government responded with a bailout program through FOBAPROA, the government’ s banking insurance institution, and the creation of a trust named PROCAPTE with funds provided by BANXICO. The trust lent capital to banks in order to maintain at least a 9.0% capitalization ratio in exchange for a five-year subordinated debenture. FOBAPROA also cleaned the banks’ balance sheets through a loan repurchase agreement, giving banks’ non-tradable, zero coupon ten-year FOBAPROA promissory notes, which carried a slightly lower rate than CETES. We should highlight that the FOBAPROA bailout was not a one-time event; non-performing loans were still being transferred until 1999. Mexican banking regulation and monitoring started to improve in subsequent years; changes were made in reserve requirements, risk management, capitalization levels, and accounting standards. In 1997, the government lifted restrictions on foreign ownership; hence, foreign ownership in Mexican banks increased from 7.0% of total assets in December 1996 to 82.0% at the end of 2003. In 1997, Congress also approved the replacement of FOBAPROA with a more autonomous deposit guarantee agency named IPAB; therefore, most of FOBAPROA’ s bonds were swapped for IPAB bonds, giving the new entity the task of recouping and liquidating the assets backed by those bonds. This action was a de facto admission that the assets backed by the loans were unrecoverable, assuming the status of sovereign debt, given that the government would pay the rescue on each annual budget. Lastly, private economists argued that the overall cost of the bailout program could have reached around 15.0% of Mexican GNP. Given the bailout cost and in order to maintain a resilient financial system, on October 3, 2005, the CNBV published the agreement signed by the ABM (Mexican bankers association, for its acronym in Spanish) in order to implement the new capital guidelines issued by the Basel Committee on Banking Supervision from the Bank for International Settlements (Basel II). After that, on September 16, 2010, the Basel Committee on Banking Supervision issued the Basel III rules text, which presented the details of the new global regulatory standards on bank capital adequacy and liquidity. To date, the entire Mexican banking system has fully adopted Basel III capital requirements, becoming one of the first countries worldwide to do so. It is worth mentioning that, Mexico’ s banks adopted capital requirements without compromising growth or stability, given its solid balance sheet before the implementation was enforced. However, there are banks, mainly in Europe that, in order to comply with capitalization levels, should post a slowdown in their portfolio growth.

B. Company Background

Grupo Financiero Interacciones has managed to grow organically since the acquisition of its insurance business division in 1966, while in 1978 the company created the brokerage firm. Around the same time, GFINTER began structuring credit vehicles to finance infrastructure projects, such as toll roads, airports, and water dams.

With the new financial regulatory policies coming into effect in the early 1990s, the company decided to create the Financial Group in 1992 by combining the insurance and brokerage business units. One year after that episode, the




GFINTER | Banks

January 21, 2014

company obtained the banking license. Finally, in 2001, GFINTER created a mutual fund company, completing the expansion into a Financial Group.

In 2000, Carlos Hank Gonzalez was appointed the new CEO of GFINTER, marking a key period for the company. Carlos Hank’ s responsibility was to set the strategy and direction of the group to deliver growth and profitability through focusing on government and infrastructure financing. Thereby, GFINTER is now the third largest government lending operator in the system.

Lastly, in October 2013, the company carried on a mixed stock offering where it raised P$2.1 billion, considering the 40.2% overallotment option exercised, which will be used to enhance its core business focused on the infrastructure and government businesses.

Business model

GFINTER focuses on financial services, risk management and financial advisory services, primarily for the Mexican public sector, which includes the federal government, states, municipalities, and decentralized entities such as PEMEX and CFE. Also, the company provides financial services to companies that work as government suppliers.

The company’ s clients include state and municipal entities that serve through a nationwide structure that allows the bank to improve its efficiency. Unlike other financial institutions focused on the consumer segment, GFINTER does not require a wide branch network. Indeed, the company operates through 6 regional offices: West (Guadalajara), Center (Mexico City), Gulf-East (Puebla), Southeast (Cancun), Northeast (Monterrey), and Northwest (Hermosillo), and 7 business centers located in 7 states (Campeche, Tabasco, Yucatan, Tamaulipas, Guanajuato, Zacatecas, and Michoacan). This structure allows GFINTER to maintain operating costs under control and maximize earnings without compromising service quality for the clients.

The financial group is composed by three main subsidiaries: the banking unit, insurance division, and brokerage business.

Banking unit. Banco Interacciones is the group’ s main subsidiary and is specialized on granting credits to the three government levels, but more particularly to states, municipalities, and companies related to the public sector in Mexico, while it also provides deposit and savings services and financial advisory to all government levels. The bank’ s total loan portfolio amounted to P$58.9 billion, while it reported earnings of P$388.1 million up to September 2013; this represents 86.5% of the entire group’ s net profit.

The insurance division is focused on providing risk management solutions to individuals, corporations, and the three levels of government. The products are offered through independent insurance agents and the promoting force of GFINTER. The insurance division provides a specialized and quality service reflected on the more than 80.0% reassurance rate of the insurance policies related to government risk and infrastructure projects. This specific division represents around 1.6% of consolidated earnings for the group.

Brokerage provides financial services including equities and debt transactions, advisory services, structuring portfolios, and asset management, both to individuals and enterprises. Since 2011, the company has had the capability of processing 300.0 thousand transactions per day, which translates into 200 transactions per second, representing 3.9% of all monthly transactions in the Mexican Stock Exchange vs. the industry’ s average of 70 transactions per second.

GFINTER’ s Corporate Structure

Source: GFINTER

GFINTER

Interacciones Bank99.99%

Brokerage99.97%

Insurance99.99%




GFINTER | Banks

January 21, 2014

Key Financials

Total loan portfolio

Total loan portfolio amounted to P$58.4 billion, and has shown a 34.0% CAGR in the last seven years, mostly attributed to the government loan portfolio, which represents 71.6% of the consolidated loan book. Moreover, the financial group has managed to maintain delinquency rates under control, as its NPL ratio stands at 0.2% and has a 0.8% average ratio since 2006, compared to the 2.7% average of the entire financial system in Mexico. Loan portfolio by segment Loan portfolio by productive sector

Source: GFINTER

Source: GFINTER

Net interest income The company’ s net interest income has remained historically pressured, given that—although being focused on the government segment provides an advantageous risk profile—the active interest rate is below the system’ s average. Indeed, the consolidated active rate of GFINTER’ s performing loans stands at around 7.5% compared to the 13.0% reported by the Mexican banking system’ s average. Also, according to our estimates, its funding cost stands around 4.6% vs. the 2.4% reported by the Mexican market. This is mainly caused by its strong exposure to time deposits rather than demand deposits. This characteristic could be attributed to the company’ s business model, given that the duration of its assets is around 4.4 years, forcing the bank to fund its operations with medium-term deposits, as they have a higher interest rate than resources to fund Consumer loans. In sum, 12M net interest income has had a 17.0% CAGR in the last 6 years, standing below the loan book’ s performance, but still showing attractive expansions. Interest Rates Net Interest income’ s historic performance

Source: GFINTER, CNBV and GBM

Source: GFINTER Figures in MXN Millions

Government77%

Commercial22%

Financial Institutions

1%

Mortgage0%

Consumer0%

Government72%

Infrastructure22%

SME6%

Others0%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

09

-04

02

-05

07

-05

12

-05

05

-06

10

-06

03

-07

08

-07

01

-08

06

-08

11

-08

04

-09

09

-09

02

-10

07

-10

12

-10

05

-11

10

-11

03

-12

08

-12

01

-13

06

-13

Margin rate spread Performing loan's interest rate Funding cost

-60.0%

-40.0%

-20.0%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

160.0%

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

1Q

07

2Q

07

3Q

07

4Q

07

1Q

08

2Q

08

3Q

08

4Q

08

1Q

09

2Q

09

3Q

09

4Q

09

1Q

10

2Q

10

3Q

10

4Q

10

1Q

11

2Q

11

3Q

11

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

Net Interest Income YOY% Growth




GFINTER | Banks

January 21, 2014

Provisions for loan losses Interest margins could be conservative compared to the financial system in Mexico, due to the high exposure to the government segment; however, this effect is entirely offset by lower reserve requirements caused by its significantly low risk profile. GFINTER has a reserves to total loan ratio of 3.1%, below the 5.2% shown in the banking system, while the coverage ratio stands around 1,282.5%, given its almost null past due loans. Net income and profitability The company reported P$1.4 billion in net income in the last twelve months and has a 12.8% CAGR in the last six years. Thus, in 3Q13, GFINTER had a 17.3% ROAE vs. the 14.7% of the Mexican banking system. GFINTER’ s banking unit contributed 86.5% of consolidated earnings, followed by the brokerage house, which reported a P$51.0 million net income, translating into an 11.4% share, while the insurance division contributed 1.6% of consolidated earnings. Quarterly net income and ROAE Net Income breakdown

Source: GFINTER Figures in MXN Millions

Source: GFINTER

Shareholders’ Structure On October 2013, the company carried out a mixed public stock offering where it sold 30 million shares through a primarily offering, 30 million shares in the secondary, and 3.6 million shares related to the overallotment option. The main sellers were Carlos Hank Rhon, Carlos Hank Gonzalez, Graciela Hank Gonzalez, Alejandro Hank Gonzalez, and Interfondo de Capitales. Shareholder Structure

Source: GFINTER

The shareholder structure considers the 40.2% exercised from the greenshoe, 7.3 million shares sold by Interfondo de Capitales, 22.7 million shares sold by original owners, and 30.0 million shares offer through the primary share offering.

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

1Q

07

2Q

07

3Q

07

4Q

07

1Q

08

2Q

08

3Q

08

4Q

08

1Q

09

2Q

09

3Q

09

4Q

09

1Q

10

2Q

10

3Q

10

4Q

10

1Q

11

2Q

11

3Q

11

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

Net Income ROAE

Bank86.5%

Brokerage11.4%

Insurance1.6%

Corporate Services

0.5%

Carlos Hank Rhon40%

Carlos Hank Gonzalez

20%

Graciela Hank Gonzalez

9%

Alejandro Hank Gonzalez

1%

Float30%




GFINTER | Banks

January 21, 2014

C. Mexican environment In order to better reflect the current position of the banking system, in this section, we will look in depth at the characteristics and windows of opportunity that differentiate the Mexican system as one of the strongest financially worldwide with an attractive outlook. Indeed, we will analyze the banking penetration and financial inclusion, as well as the concentration of the system, to put into perspective Mexican banks’ potential growth, in addition to the development level in terms of financial access for the population. Additionally, we will consider the trends in portfolio growth and their impact on asset quality and profitability, as well as the controlled risk management of the whole system, emphasizing the stable NPL ratios, high coverage, and capitalization levels. Mexico is still an under-banked economy Mexico’ s banking system still has low penetration compared to other LatAm and developed economies, which could translate into great potential growth as the Mexican banking system continues to expand at faster rates. The latter is reflected in the total loan portfolio as a percentage of the country’ s GDP, which in Mexico stands at 22.0%, below the 47.9% of all LatAm economies’ weighted average, whose banking systems’ performed similarly to Mexico in terms of loan growth and profitability indicators. Additionally, moving on to more developed countries, the Eurozone’ s total loan portfolio as a percentage of GDP is 128.6% while in North America it represents 192.4% of total GDP. On the other hand, according to the last “Credit Market Evaluation Survey” released by BANXICO regarding the main financing sources used by the private sector, in 3Q13, 89.2% of the enterprises financed their operations through suppliers, followed by commercial banks (36.8%) which, together with development banks (8.1%) and foreign banks (6.8%), accumulate 51.7% of private companies’ funding. Regarding the SME segment, only 28.9% of the companies with less than 100 employees finance their operations through commercial banks, and barely 3.6% do so through development banks, also pointing out the low penetration of the system. However, it is important to highlight that the Mexican banking system’ s performance going forward seems promising on this subject, as the Financial Reform considers strategies targeting the Mexican financial system’ s low banking penetration, including the strengthening of Development Banking, with the aim to increase credit dynamism, placing special emphasis on priority areas for national development, such as infrastructure and SMEs and the reinforcement of Commercial Banks by boosting credit granting, but at the same time reducing credit costs in order to reach more socioeconomic segments. Mexican authorities have mentioned that, considering Mexico’ s current macroeconomic data, the banking penetration should be at least twice current levels, and the Financial Reform’ s objective is to develop and boost credit granting. However, just to put into perspective the potential growth in the timeline mentioned above, if we consider a recovery in GDP growth levels in coming years, while starting 2018 with a GDP forecast of 5.5% (as could be the new GDP potential growth due to structural reforms), Mexico will reach current LatAm banking penetration levels (47.9%) in around 8 years. As for 2014, credit growth will remain pressured by a lower credit demand, mainly in the Consumer and Corporate segments.




GFINTER | Banks

January 21, 2014

Domestic credit to private sector (%GDP) Mexico’ s banking penetration as a percentage of GDP

Source: World Bank Source: Bloomberg and CNBV

The financial infrastructure network in Mexico is lagged. Access to financial services in Mexico has been limited, given the high concentration of branches in some states and the lack of availability of financial services. In response, the 2007-2012 National Development Plan focused on increasing financial inclusion. Thus, the National Banking and Securities Commission (CNBV) set a strategy to expand access to financial services, given that 57.3% of the total municipalities in Mexico lack access to these resources, including branches, correspondent units, and ATMs. Among those strategies is the development of payment vehicles like mobile accounts, and facilitating sending and receiving international remittances, as well as decreasing costs. Thereby, according to the last Financial Inclusion Report (Reporte de Inclusión Financiera) released by the CNBV, this metric improved to 53.3% in 2012, still leaving an interesting upside potential in terms of geographic penetration. According to the same report mentioned above, Mexico had 9.9 regulated access points for cash in/cash out transactions for every 10,000 adults. Indeed, by 2012, the total financial system had 1.98 branches for every 10,000 adults through a network of 15.8 thousand branches, highly concentrated in 6 states, as around half of the system’ s total branches are located in Mexico City, the State of Mexico, Jalisco, Nuevo Leon, Guanajuato, and Veracruz, giving coverage to around 44.6% of the total adult population. Additionally, it had 5.0 and 2.9 ATMs and correspondent units, respectively, for every 10,000 adults. It is worth mentioning that the correspondent units have acted as the main driver in the improvement of financial access, as they have a 93.9% CAGR in the last two years, reaching 22.7 thousand units. Other Latin American economies have also been using correspondent units as a financial service penetration strategy. Examples of this are Brazil and Peru which, by 2000 and 2008, respectively, implemented the correspondent model resulting in ratios of 10.45 and 4.31 correspondent units for every 10,000 adults. Total Branches and ATMs per state

Source: CNBV

Branches and Correspondent Units penetration

Source: CNBV

0.0%

50.0%

100.0%

150.0%

200.0%

250.0%

Arg

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Ven

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Gu

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Mex

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Per

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Bra

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Ch

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Ger

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Fra

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Po

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US

Spa

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World's Average 129.6%

14%

15%

16%

17%

18%

19%

20%

21%

22%

23%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Sep

-08

Dic

-08

Mar

-09

Jun

-09

Sep

-09

Dic

-09

Mar

-10

Jun

-10

Sep

-10

Dic

-10

Mar

-11

Jun

-11

Sep

-11

Dic

-11

Mar

-12

Jun

-12

Sep

-12

Dic

-12

Mar

-13

Jun

-13

Sep

-13

Commercial and Corporate Financial InstitutionsGovernment ConsumerMortgage GDP%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

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Branches ATMs

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

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Total Branches per 10,000 adults

Total Branches and correspondent units per 10,000 adults

Mexican Average: 1.83

Mexican Average: 4.47




GFINTER | Banks

January 21, 2014

In our view, both the low banking penetration and the lack of a financial infrastructure network in Mexico could translate into potential growth going forward, given that the banking system has enough resources to increase credit dynamism, unlike other economies with lower capitalization levels. Additionally, further expansion should also benefit from government stimuli as, like we mentioned above, the President has indicated his intention to tackle the lack of penetration, boosting both traditional and development banks’ growth. The highly concentrated Mexican banking sector, waiting for a more competitive environment. Since the development of the banking system and the creation of BANAMEX in the late 19th century, the Mexican banking system has been highly concentrated. Up to September 2013, the banking system was made up of 45 institutions, around 24 SOFOMs (multi-purpose financial entities), and 55 SOFOLs (limited-purpose financial entities), among others; however, around 84.9% of total loan portfolio was held by the seven largest banks in Mexico. The latter could affect the smaller banks in terms of profitability. It is worth mentioning that starting in October 2013, Fundación Dondé and Inmobiliario Mexicano will be included as commercial banks. In order to encourage a more efficient financial system, with a better quality in products and services and lower costs, as well as to improve banking penetration, the CNBV recently reiterated its commitment to boost competition through the entry of new institutions into the system. There is no specific number of new banks for the next years, but it is known that there are SOFOMs and SOFOLs with the intention to become commercial banks, given the access to lower-cost funding. In the same framework, the National Antitrust Agency (CFC) also plans to encourage competition within the Mexican banking system, which seems to be in line with the president’ s initiatives established in the “Pact for Mexico”. Some of the strategies that have been mentioned in recent days talk about decreasing credit costs and strengthening development banks. Market share by Institution (Total Loan Portfolio)

Source: CNBV

Market share comparison (Total Loan Portfolio)

Source: CNBV

The loan portfolio growth tends towards a more profitable mix. The Mexican banking system continues to recover the profitability levels it lost due to the asset quality deterioration, coupled with the global financial crisis implications. From mid-2006 to the end of 2007, the profitability indicators of the Mexican banking system were at their highest levels in history, with ROAEs above 20% and ROAAs surpassing 2.0%. These levels were strongly benefited by the mix in the total loan portfolio, reflected in the fact that the Consumer segment moved from a 3.9% share of the total loan book in 2000 to a range between 27.0-28.0% during 2006 and 2007. This particular segment charges higher interest rates, which in turn boost the bank’ s financial margin. However, the highest weight of the consumer portfolio, together with an adverse economic environment, began to cause asset quality deterioration, which later affected earnings generation and profitability.

BBVA Bancomer27%

Banamex19%

Banorte16%

Santander15%

HSBC8%

Inbursa8%

Scotiabank5%

Interacciones2%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

0

100

200

300

400

500

600

700

800

BB

VA

Ban

com

er

Ban

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Ban

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e

San

tan

der

HSB

C

Inb

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a

Sco

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Inte

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es

3Q11 3Q12 3Q13 CAGR (2Y)




GFINTER | Banks

January 21, 2014

Indeed, the Consumer segment began to gain share in loan portfolio boosting ROAE to its historical high of 24.3% in late 2006. However, provisions for loan losses started to increase abruptly to the point where the higher interest rates charged in the Consumer segment could not offset the provisioning requirements. The latter was caused by a significant NPL deterioration; NPL moved from 1.8% in early 2006 to its maximum point of 3.9% in May 2009. To clarify further, in the period from 2006 to May 2009, the Mexican banking system’ s financial margin increased 75.8%, while provisions for loan losses hiked 498.7%; hence, bottom line posted a 6.8% advance in the 3.4-year period, deteriorating the bank’ s ROAE. In recent times, we have witnessed that provisions for loan losses and reserves have stabilized on the back of a better asset quality, in turn once again benefiting the banking system’ s profitability, which has been showing a slow but constant recovery to levels of 14.7%. Additionally, after seeing the continuous deterioration in the efficiency level of the banking system in 2010, we have seen a recovery, as banks started to stabilize their consolidation cost and executed all the synergies coming from recent consolidation. In this picture and supported by a stricter risk management and a positive economic outlook, the Consumer segment is gaining share in the total loan portfolio, to reach a 22.6% share in total loan portfolio in September 2013 (+90 bps vs. September 2012 and +290 bps vs. September2011). Going forward, we expect this trend to remain, given the low penetration of the system and considering that the banks’ ability to maintain asset quality at controlled levels remains. By September 2013, the Consumer NPL ratio stood at 5.0% compared to its highest point in July 2009 (9.5%). Although we are not expecting the system to peak again, we could see that there is still maneuvering room to sacrifice NPL and provisions for loan losses in order to improve profitability. The SME loan book should also act as a catalyst in growth portfolio and profitability, as this kind of credits charges the highest interest rate within the Commercial & Corporate segment, and stable NPL ratios. By September 2013, the Commercial & Corporate segment showed a 9.0% YOY increase, thanks to the SME segment, as the number of credits granted to this specific segment hiked 18.0% YOY, mainly for micro and small companies, while the number of credits to large enterprises dropped 26.3% YOY. Additionally, the president of Mexico has expressed his intention to incentivize this segment by strengthening development banks and offering better credit conditions. Interest Income by type of Product — Data in millions of nominal pesos.

Mexican Banking System profitability indicators — Data in millions of nominal pesos.

Source: CNBV Source: CNBV The Mexican Banking system is one of the strongest financially worldwide. The strength of the Mexican financial system is based on controlled risk management, stable NPL ratios with high coverage, and capitalization levels. Regarding the NPL ratio, the Mexican banking system has a 3.4% NPL ratio strongly affected by the homebuilders’ crisis. However, after excluding this non-recurring and systemic event, the NPL ratio stands below 3.0%, under the World’ s and the OECD’ s averages of 3.7 and 3.1%, respectively, which are strongly affected by the European economies. In Mexico, banks have managed to constantly improve their delinquency rates during the last decade when the NPL ratio ranged around 9.0%, strongly affected by the Commercial & Corporate loan book, whose NPL ratio was around

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Ene-

11

Mar

-11

May

-11

Jul-

11

Sep

-11

No

v-1

1

Ene-

12

Ma r

-12

May

-12

Jul-

12

Sep

-12

No

v-1

2

Ene-

13

Ma r

-13

May

-13

Jul-

13

Sep

-13

Commercial Financial Entities Government Consumer Mortgage

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Sep

-10

No

v-1

0

Ene-

11

Mar

-11

May

-11

Jul-

11

Sep

-11

No

v-1

1

Ene-

12

Mar

-12

May

-12

Jul-

12

Sep

-12

No

v-1

2

Ene-

13

Mar

-13

May

-13

Jul-

13

Sep

-13

Net Income ROAE

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%

ROAA




GFINTER | Banks

January 21, 2014

17.0%, but also affected by all segments. These negative figures have gradually reverted until now. Indeed, even during the last financial crisis where the Mexican banking system showed a strong default rate mostly from the credit card segment due to clients’ high indebtedness levels, the worst NPL ratio reported was 4.0%, significantly below the figures from ten years ago. As we mentioned above, we are expecting a slight deterioration in the consolidated NPL ratio, due to a more profitable mix, as we are expecting a higher share of the Consumer and SME segments in the total loan portfolio, but not due to asset quality deterioration. Said deterioration in NPL ratios, as well as the fast growth expectation for the Consumer and SME loan portfolios, should be supported by the adequate coverage ratio, in order to anticipate the expected losses involved in the credit portfolio. It is worth mentioning that, since 2009, the CNBV began several accounting and regulatory changes in order to better reflect the financial situation of the banks’ performance and to minimize the risk of client defaults, including all segments. The Commercial & Corporate segment was the last one to adopt the “expected losses” methodology as should be fully enforced in 2014. However, most banks anticipate the regulation and have been adjusting their coverage levels in order to fully reflect new standards. It is worth mentioning that the coverage level has dramatically dropped as it moved from 185.9% in September 2012 to 153.2% given that a larger amount of past due loans were represented from homebuilders’ exposure which has stronger guarantees and demand lower coverage ratios than the Consumer portfolio. Lastly, in terms of capitalization, we believe Mexico stands at one of the most attractive levels worldwide, which in turn translates into lower risks for the Mexican financial system. After comparing the banks’ total equity regarding total assets, the LatAm area’ s average seems more attractive than other developed economies, as it has a 10.3% capital to total assets ratio, while its banking penetration level stands at 47.9%. The latter leaves us with the idea that in addition to the strong potential growth—given the low banking penetration—LatAm banks have enough capital resources to support higher credit demand. The case of Mexico seems similar to the LatAm average, except that it has a slightly higher capital to assets ratio (by 40 bps) while its banking penetration stands at 22.0%, which is one of the lowest levels worldwide. North America’ s outlook does not seem as attractive as LatAm’ s and Mexico’ s, given that its capital to assets ratio stands at 8.0% (270 bps below the Mexican banking system), and its potential growth could be limited given that its total loan portfolio is 1.9 times higher than the North American countries’ GDP. Meanwhile, the Euro area looks even worse, as the capital to assets ratio stands at 7.1%, creating uncertainty on whether their banks have enough capital to support the countries’ credit expansion, in addition to their deteriorated loan portfolios, which could translate into massive defaults that could affect their capitalization levels even more. All in all, the strong balance sheet of the Mexican system is another plus that reiterates the potential growth of the total loan portfolio, as banks used capital to boost their credit portfolio; at the same time, this capital injection translates into higher banking penetration, and as was shown, Mexico has enough capital to support higher credit dynamism. NPL ratio Capital to Assets ratio

Source: World Bank Source: World Bank

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

Gre

ece

Ru

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Ita

ly

UA

E

De

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Fra

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Ecu

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Bra

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Me

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Ric

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Bo

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Pe

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No

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Arg

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Uru

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Euro Area World OECD

0%

50%

100%

150%

200%

250%

0%

2%

4%

6%

8%

10%

12%

Mex

ico

LATA

M

Mid

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Inco

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Wo

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East

Asi

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Pac

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No

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Am

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a

OEC

D

Euro

Are

a

Euro

pea

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Capital to Assets Loan portfolio % GDP




GFINTER | Banks

January 21, 2014

Mexico, one of the first countries to comply with Basel III requirements Basel III regulation established that the total capitalization level should be at least 10.5%, considering the capital conservation buffer of 2.5%—totally composed by common equity—which will be used to absorb future periods of financial and economic stress. It is worth mentioning that banks that do not maintain the capital conservation buffer could face restrictions in dividend payments and share buybacks, among others. Thus, the total capitalization level without considering the conservation buffer mentioned above should remain at least at 8.0%, composed by 6.0% of Tier I (which in turn should be covered by at least 4.5% of common equity compared to the Basel II standard of 2.0%), leaving the remaining 1.5% to additional Tier I capital—financial instruments that fulfill the Tier I requirements. The residue between the total Tier I requirements and 8.0% of the total capitalization level set in the regulation could be covered with Tier II capital. Currently, the Mexican banking system has 14.3% of Tier I and 1.8% of complementary capital, fully meeting international standards. However, it is important to mention that the seven largest banks in Mexico represent 84.5% of the system’ s net capital. According to the most recent data published by the CNBV, the bank with the lowest capitalization ratio is Banco del Bajio, with 12.5% of net capital as a percentage of its total risk weighted assets, followed by Banregio, whose capitalization level stands at 12.9%. Mexican bank’ s capitalization level

Source: CNBV and BIS data

General view of the government segment As is known, the Mexican banking system is largely underpenetrated, and the government sector is no exception. To date, this specific segment’ s total banking credits represent 2.9% of the country’ s GDP, which has been slightly increasing over the years, considering that in 1994 this ratio stood around 2.0%. Government loans comprise credits to the federal government, states & municipalities, and decentralized entities. It is worth mentioning that most of the banking loans to this segment are concentrated in states and municipalities, which represented 72.7% of the total exposure, while loans to decentralized entities represent 24.3%, leaving the remaining 3.0% to federal government debt. To date, states and municipalities in Mexico total P$452.0 billion in interest-bearing debt, where 60.9% refers to credits from commercial banking in Mexico, and the remainder from development banks, debt issuances, and trusts,

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Ban

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Tier I Capitalization Ratio Basel III




GFINTER | Banks

January 21, 2014

among others. However, 5 years ago, states funded their operations mostly through development banks and debt issuances, while only 46.8% of total debt was from commercial banks, showing the banking system’ s efforts to expand and diversify their portfolios. States and municipalities’ debt breakdown — Data in millions of nominal pesos

Source: Ministry of Finance

States’ debt to GDP Total states’ liabilities performance

Source: SHCP Source: SHCP Analyzing states’ debt exposure in depth Total states loans from the banking industry are highly concentrated as 5 states represent almost half the entire debt. Coahuila, the State of Mexico, and Nuevo Leon accrue 35.0% of total banking debt in the sector, followed by Veracruz and Mexico City. However, in terms of indebtedness level, different states came into the spotlight, in detail:

• Quintana Roo is the most indebted state in the country with a 7.7% total debt to GDP ratio. After three years eluding the spot, this state stands, once again, as the most indebted state in Mexico, since its banking debt has been growing at almost twice the rate shown by the entire states’ debt in the country.

• Coahuila’ s total banking debt as a proportion of GDP stands at 7.1%. For this state, 2011 was the

inflection point as it moved the government’ s debt penetration from 2.1% in 2010 to 8.5%; this was the same year when it defaulted its banking debt and drove the consolidated NPL ratio of the entire government segment in the system to 2.3%. Coahuila’ s banking debt has a 140% CAGR in the last five years and represents 12.7% of total state debt in Mexico.

• Chihuahua is the third most indebted state in Mexico, as its banking debt rises to P$15.1 billion

(equivalent to 7.0% of the state’ s GDP). The total exposure represents 5.5% of the government’ s entire banking liabilities.

3Q08 3Q09 3Q10 3Q11 3Q12 3Q13 Weight CAGRCommercial Banks 99,958.7 111,961.9 139,616.4 190,218.6 246,103.4 275,380 60.9% 22.5%Development Banks 45,877.3 59,762.0 69,208.8 71,508.3 87,953.8 88,441 19.6% 14.0%Debt Market 41,926.0 42,621.1 52,036.6 55,816.0 58,612.3 75,796 16.8% 12.6%Trust 6,082.2 6,550.7 18,098.7 20,070.8 8,008.4 8,003 1.8% 5.6%Others 0.0 0.0 0.0 20,886.8 6,086.7 4,431 1.0% NSTotal 193,844 220,896 278,961 358,501 406,765 452,051 18.4%

1.0%

1.2%

1.4%

1.6%

1.8%

2.0%

2.2%

2.4%

2.6%

2.8%

3.0%

19

94

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

3Q

13

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

450.0

500.0

3Q08 3Q09 3Q10 3Q11 3Q12 3Q13

MXN

Billions

Commercial Banks Development Banks Debt Market Trust Others




GFINTER | Banks

January 21, 2014

• Nayarit, Chiapas, and Veracruz followed in the list, as the former has a 6.3% bank debt to GDP ratio, while Chiapas and Veracruz have 6.1 and 5.5% ratios in the same order. All together, they accrue 17.9% of the total banking debt in this segment.

Total states’ debt breakdown Loans to GDP per state (20 most indebted

states)

Source: SHCP Source: SHCP

IV. COMPANY’ S COMPETITIVE ADVANTAGES AND OPPORTUNITIES

Currently, GFINTER is ranked as the tenth largest bank in terms of assets and ninth regarding total loan portfolio, with 1.8 and 1.9% market shares in both metrics, respectively. Also, it is important to mention that the bank has certain features that stand out over the Mexican banking system’ s average, such as an attractive collection process, low delinquency ratios and strong capitalization and profitability levels. Strong loan book guarantees and advantageous collection model GFINTER has been known for operating with a low-risk profile and the idea gains strength after looking the bank guarantees related to its total loan portfolio. To date, 93.5% of the government loan portfolio is backed by government contributions or liquid guarantees, while 5.5% of the exposure is protected from factoring guarantees. Also, the government business model has an advantageous collection strategy where the company obtains the payments directly from a trust, before the resources are transferred to the states and municipalities. To add more color to the latter, the process starts when the states and municipalities require funding. Then, the states address the National Entities Coordinating Unit (UCEF) to allow them to use federal contributions in order to send the resources—that GFINTER will lend to the state or municipality—to a federal trust. This trust will be in charged of paying the capital and interests to GFINTER before the resources are sent to the state indebted, while the remaining resources after the payment of obligations are sent to the final destination: the states and municipalities. Summarizing, the federal trust acts as a filter between federal contributions and the states and municipalities, as it is in charge of directing the resources required, paying the lender’ s exposure first.

Coahuila 12.5%

State of Mexico12.4%

Nuevo Leon10.1%

Veracruz7.4%

DF6.3%

Chihuahua5.5%

Sonora5.2%

Others40.7%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

Q. Roo

Coah

uila

Chihua

hua

Nayarit

Chiapa

s

Veracruz

Zacatecas

Micho

acán

Sono

ra

Nuevo

León

Colima

BC

México

BCS

Jalisco

Sina

loa

Oaxaca

Duran

go

Tamau

lipa

s

DF




GFINTER | Banks

January 21, 2014

Guarantees’ breakdown Collection model

Source: GFINTER

Source: GFINTER

Strong capitalization levels Given that the Mexican banking system has been facing new regulatory changes regarding provisioning and capital requirements, banks have been taking the appropriate measures to comply with these new methodologies, and at the same time try to minimize the impact on their results. Referring specifically to the capital requirement regulation, during 2013 banks adjusted their capitalization levels to the new Basel III requirements, which demand at least an 8.0% capitalization ratio, plus the addition of a 2.5% capital buffer. The latter’ s aim is to absorb losses during periods of financial and economic stress. By September 2013, GFINTER had a 15.8% capitalization ratio, easily meeting the requirements. However, the company has a 4.0% complementary capital leaving doubts on how the bank is going to replace Tier II with core capital or Tier I instruments, as the new banking capitalization methodologies are highly focused on increasing not only the capital requirements but also the quality, by demanding higher basic capital, eliminating Tier III, and gradually lowering the complementary capital. However, there is no reason to be alarmed as 3Q13 results have not considered the resources gained from the stock offering held in October 2013, which would add a further P$2.1 billion to the Tier I ratio, sending the consolidated capitalization ratio to around 19.0%. Capitalization ratio Historic Capitalization Ratio

Source: CNBV and GBM

Source: CNBV

Unsecured loans1.0%

Development bank0.4%

Federal Contributions

71.0%

Other guarantees

22.0%

Factoring5.5%

FEDERAL GOVERNMENT

Trust GFINTER

States

Municipalities

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

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Mexican System's average Basel III

Share offering

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

01

-06

05

-06

09

-06

01

-07

05

-07

09

-07

01

-08

05

-08

09

-08

01

-09

05

-09

09

-09

01

-10

05

-10

09

-10

01

-11

05

-11

09

-11

01

-12

05

-12

09

-12

01

-13

05

-13

09

-13

Tier II Tier I




GFINTER | Banks

January 21, 2014

Government loans: Historically attractive for banking business Being focused on the government segment implies other competitive advantages as this segment has historically been one of the less risky sectors in the financial system in Mexico, since it possesses the lowest probability of default and almost null delinquency levels, resulting in lower reserve and capital requirements. Lower risks implied in the government segment derived into three main characteristics in the sector.

• Lower delinquency levels This specific sector has an average 0.1% NPL ratio in the last 13 years, compared to the 3.4% of the total loan portfolio. The NPL ratio reached its highest level in November 2011 when Coahuila defaulted. Indeed, GFINTER has a 0.2% NPL ratio compared to the 3.4% reported by the entire Mexican banking system. It is important to mention that GFINTER’ s ratio represents the SME and infrastructure projects as the government exposure continues with a 0.0% delinquency ratio. Recently, there have been concerns regarding GFINTER’ s loan restructuring process, raising doubts on the real delinquency ratio if credits are restructured before loans enter the non-performing period. However, it is worth clarifying that although the company has around 45.0% of its total government loan portfolio restructured, not a single credit has been restructured based on deteriorated performance; all restructured credits have been based on better conditions for both parties, depending on the debtor’ s needs without compromising GFINTER’ s profitability. Mexican banking system’ s NPL NPL GFINTER vs. Banking System

Source: CNBV

Source: CNBV and GFINTER

GFINTER’ s Total loan portfolio and NPL Breakdown

Past due loans’ performance — Data in millions of nominal pesos.

Source: GFINTER

Source: GFINTER

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

En

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3

Mexican Banking System States and Municipalities

Coahuila'sDefault

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

1Q

06

2Q

06

3Q

06

4Q

06

1Q

07

2Q

07

3Q

07

4Q

07

1Q

08

2Q

08

3Q

08

4Q

08

1Q

09

2Q

09

3Q

09

4Q

09

1Q

10

2Q

10

3Q

10

4Q

10

1Q

11

2Q

11

3Q

11

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

GFINTER Banking System

Government72% NPL 0.0%

Infrastructure22% NPL 0.3%

SME6% NPL 0.7%

Others0%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

0

500

1,000

1,500

2,000

2,500

1Q

06

2Q

06

3Q

06

4Q

06

1Q

07

2Q

07

3Q

07

4Q

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1Q

08

2Q

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3Q

08

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1Q

09

2Q

09

3Q

09

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1Q

11

2Q

11

3Q

11

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

Non-performing loans NPL ratio




GFINTER | Banks

January 21, 2014

• Lower provisions for loan losses requirements Although the total government loan portfolio represents around 13.8% of the total performing loans in the banking system, in the last twelve months, total provisions created represented only 2.7% of total provisions from the outstanding loan portfolio. In terms of coverage, the government segment demands to reserve around 1.7% of the total loan portfolio, which has gradually increased from the 0.1% coverage in 2003, but lower than the 2.5% reported in late 2011. This contrasts highly with the 5.2% reserves to total loans ratio of the banking system. In sum, the attractiveness of a specific segment lies not only in the interest rate charged, but also considering the net margin after provisions as the risks involved in each credit demand a different amount of reserves. Thus, despite the low interest rates charged in the government segment, lower reserve requirements turn it into an attractive business. Indeed, after considering the gross amount of income from each sector, the government front is the most attractive, given that from all interest income gained, the bank holds 94.3% after provisions, compared to the 71.1% of the total loan portfolio, or the 59.1% obtained from the Consumer segment after provisions. Interest Income after provisions per segment Reserves to total loans

Source: CNBV Source: CNBV In the case of GFINTER, total reserves as a percentage of the total loan portfolio are 3.1% vs. the 5.2% of the total banking system, while lower provisioning requirements also benefit consolidated figures. The latter is reflected in the fact that total provisions in the last 12M represent 10.3% of total interest income vs. the 28.9% of the entire banking system, as its Consumer exposure in commercial banks is greater and riskier, resulting in higher reserve requirements.

• Lower capital requirements As is known, capital requirements depend on the total risk weighted assets where a specific bank has exposure, credit risk being the most relevant player in the system. Hence, we decided to prove that government loans are the second segment with the lowest capital needs, just after the financial institutions segment. This could translate into more resources available to satisfy credit demand. To date, the Mexican banking system has P$2.9 trillion credits, while credit risk assets only from credit operations stand at P$2.0 trillion excluding derivative transactions, implying a weight risk ratio of 69.5%. The latter is complied with all segments’ risk weight, multiplied by its respective exposure. According to our estimates, the government segment’ s risk weight stands at 26.7%, one of the lowest within the banking system. In order to analyze the government credit risk weighting and to prove its low risk profile, we decided to measure the risk involved in each segment in Mexico, based on the regulatory framework established by the CNBV in the “general criteria applicable to credit institutions”.

71.1%

81.9% 77.5% 94.3%59.1%

84.6%0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

Per

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Interest Income after Prov Provisions

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Ene-

04

Jun

-04

No

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4

Ab

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5

Sep

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Feb

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Jul-

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Jul-

11

Dic

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May

-12

Oct

-12

Ma r

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Ag

o-1

3

Commercial & Corporate Financial Institutions

Government ConsumerMortgage




GFINTER | Banks

January 21, 2014

Credit risk weighted assets per segment — Data in millions of nominal pesos.

Source: CNBV

- Commercial and Corporate we estimate should have a 54.7% risk weight. First, we decided to separate the SME from the Commercial & Corporate, based on the amount of the loan granted. For this, we took the G7 group as a sample, and note that around 21.0% of total enterprise loans corresponded to credits worth less than P$20.0 million, which according to CNBV standards, could be considered as SME segment, leaving 79.0% of the total exposure to the Commercial & Corporate loans. The SME segment was weighted with a 100% risk ratio, while the rest of the Commercial and Corporate sector was measured according to the standard method established in the third chapter of the general criteria applicable to credit institutions. This section of the regulation divides all business segments according to the risk implied in the credit. Commercial & Corporate loans are categorized in group VII-A, and the credits will be measured according to the ratings assigned by the official rating agencies. The regulation assigned a specific weight risk ratio to each credit depending on the credit rating established by the agencies. Thus—taking the G7 as a sample for the entire system—we find that 79.0% of total performing loans are rated as “A”, which corresponds to a 20% risk weight , 7.7% are rated as “B1” translating into a 50% risk weight, while the remainder is weighted with a 100.0% ratio as they stand between “B2” and “B3”. Hence, after adding up all risk weights, we conclude that the Corporate segment possesses a 42.7% ratio leaving the entire Commercial & Corporate sector with a 47.0% risk weight. Corporate Credit Risk Assets

Source: CNBV

Credit Weighted Risk

Total Loan portfolio

Credit Risk Assets

Commercial & Corporate 54.7% 1,245,033 681,622 Corporate 42.7% 984,105 420,694 SMEs 100.0% 260,928 260,928Financial Institutions 20.0% 93,856 18,771Government 26.7% 388,179 103,548 Federal Government 0.0% 19,195 0 States and municipalities 30.8% 275,380 84,827 Decentralized entities 20.0% 93,604 18,721Consumer 100.0% 627,213 627,213Mortgage 57.1% 469,175 267,730Performing loans 2,823,456 1,698,884

Past due loans 125.0% 99,779 124,724Total loan portfolio 2,923,234 1,823,607

G7 Group WeightWeighted Risk ratio

Total system's

credit Risk Assets

A1 530,359,689 56.3% 20.0% 110,718

A2 152,287,351 16.2% 20.0% 31,792

B1 66,272,522 7.0% 50.0% 34,588

B2 43,711,385 4.6% 100.0% 45,626

B3 71,203,688 7.6% 100.0% 74,323

C,D y E 78,972,487 8.4% 150.0% 123,648

Total 420,694

Ra

tin

gs




GFINTER | Banks

January 21, 2014

- Financial Institutions segment was classified with a 20.0% risk ratio

This specific segment is governed under Annex 1B of the general standards applicable to credit institutions, where it established that all credits to financial institutions have a 20% risk weight, unless it is not rated by at least 2 rating agencies. For this exercise, we considered a 20% ratio for the entire segment.

- The Consumer loan portfolio was assigned a 100% weighted risk ratio Consumer credits are the riskier segment in the Mexican banking system and according to the CNBV’ s regulation, most of these credits should be considered with a 100% risk weight.

- We estimate a 57.1% risk weight for the Mortgage segment According to the general standards applicable to credit institutions, mortgage credit risk will be measured based on the percentage of the loan to value, where credits with more than a 30% down payment will be weighted with a 50% ratio while credits with a down payment between 20 and 30% should be weighted with a 75% risk ratio. In order to forecast the real risk implied in the sector, we used the G7 group as a sample for the entire system, and we calculate the credit risk assets per socioeconomic sector in the country. We note that almost one third of low-income segment mortgages have an initial down payment below 30%, which would imply a credit risk weight of 75.0% while the remaining 69.0% has a 50% risk weight as they had a down payment of over 30%. On the other hand, all residential mortgages have a 50.0% risk weighted ratio, as all have a down payment close to 50%. Mortgage segment’ s credit risk weighted assets

Source: CNBV Figures in MXN thousands Hence, after adding up the credit risk per segment, we conclude that the mortgage sector in Mexico implies a 57.1% credit risk weight.

- The government segment is one of the less risky segments with a 26.7% estimated credit risk weight The government loan portfolio could be divided into three main segments: federal, decentralized entities, and credits to states & municipalities. The former has a 0% credit risk ratio according to the National regulators’ standards. Credits to decentralized entities have a 20% credit risk weight, as they correspond to group IV of the “general standards applicable to credit institutions”, which also includes credits to development banks and federal trusts. Lastly, we estimate a 30.8% credit risk weight to the states and municipalities segment. The most relevant segment within government loans is the state and municipalities exposure, as they represent 72.1% of the total segment. Thus, we decided take a detailed look at the credit risk weight estimations for this specific sector.

Weighted Loan-to-

value

Weighted Down

payment

Credit Risk Assets

30% Down payment

Credit Risk Assets

20% Down payment

Total Credit Risk Assets

G7 Loan Portfolio

Risk Weight

Social Interest 66.7% 33.3% 28,249,185 18,858,207 47,107,393 81,642,647 57.7%Middle-income 67.1% 32.9% 31,982,981 43,447,236 75,430,217 121,895,610 61.9%Residential 64.0% 36.0% 35,223,803 14,577,944 49,801,747 89,884,864 55.4%Residential Plus 54.7% 45.3% 34,684,842 0 34,684,842 69,369,685 50.0%Total 63.4% 36.6% 130,140,812 76,883,387 207,024,199 362,792,806 57.1%




GFINTER | Banks

January 21, 2014

National regulators established that these government loans should be categorized according to the credit ratings assigned by official agencies. Hence, we gathered the debt ratings of each state in Mexico, and assigned their specific credit risk weight, according to CNBV specifications. If the state is rated above or even two steps below the Federal government’ s credit rating, it will be weighted with a 20.0% ratio. However, if the states’ credit rating assigned by at least two rating agencies stands three or four steps below the Federal debt rating they will be classified with a 50.0% credit risk ratio, while loans with a more deteriorated risk profile are considered with an 115.0% risk weight. Lastly, if any state does not have at least two ratings from different agencies, it will be categorized with a 150.0% credit risk weight. Government credit risk assets forecast

Source: SHCP, CNBV, Bloomberg and Fitch Ratings Figures in MXN millions In sum, GFINTER’ s total Credit Risk Assets from lending operations represent around 51.2% of the total loan portfolio, while the Mexican banking system has a 70.0% ratio. The latter implies that the amount of capital

Mexico A- A- Baa1

Weighted Risk

Banking debt exposure

Credit Risk Assets

Fitch Ratings

S&P Moody's

Aguascalientes AA AA- 20% 2,324.5 464.9Baja California AA- Aa2 20% 6,479.5 1,295.9Baja California Sur A- BBB+ 20% 2,174.7 434.9Campeche A+ 20% 940.2 188.0

Coahuila BBB- 50% 34,480.0 17,240.0Colima A A 20% 961.9 192.4Chiapas A- A A2 20% 3,866.7 773.3Chihuahua A A+ A2 20% 15,121.9 3,024.4Distrito Federal AAA 20% 17,222.0 3,444.4Durango A- A- A1 20% 3,398.9 679.8Guanajuato AA AA Aa1 20% 6,081.3 1,216.3Guerrero A- 20% 2,678.8 535.8Hidalgo A A A2 20% 2,017.7 403.5Jalisco BBB A+ A2 20% 14,242.5 2,848.5México A+ 20% 34,041.8 6,808.4Michoacán BBB- 50% 8,888.4 4,444.2Morelos A A2 20% 2,529.6 505.9Nayarit BBB A- A3 20% 5,098.1 1,019.6Nuevo León BBB+ A Aa2 20% 27,912.5 5,582.5Oaxaca A- BBB A2 20% 300.0 60.0Puebla AA- A+ Aa3 20% 6,511.0 1,302.2Querétaro AA AA Aa1 20% 1,688.1 337.6Quintana Roo BBB- 50% 11,980.1 5,990.1San Luis Potosí 150% 4,330.7 6,496.1Sinaloa A+ A A1 20% 5,618.7 1,123.7Sonora A A2 20% 14,352.5 2,870.5Tabasco A 20% 4,229.3 845.9Tamaulipas AA- AA Aa3 20% 9,249.3 1,849.9Tlaxcala A- Aa3 20% 0.0 0.0Veracruz BBB- A+ A2 50% 20,246.0 10,123.0Yucatán A A A2 20% 1,604.4 320.9Zacatecas BBB- 50% 4,808.6 2,404.3Total weighted risk assets 30.8% 275,379.7 84,826.8




GFINTER | Banks

January 21, 2014

required to operate GFINTER is lower than the Mexican banking system’ s average, resulting in higher resources to expand its total loan portfolio without compromising capital adequacy.

V. COMPANY RISKS AND WEAKNESSES.

Lower active rate Entering the government segment has a negative side, given that its low risk also implies lower interest rates charged. At present, banks charged a 6.2% interest rate on government loans, standing 680 bps below the consolidated active rate in the system, due to the lower default risk and guarantees involved in some credits, such as federal contributions from states. This contrasts highly with the 13.0% active rate charged on the consolidated loan portfolio, mostly backed by the Consumer segment. Interest rates per segment Government loans interest rate spread

Source: CNBV data Source: CNBV data In GFINTER’ s case, the company has a consolidated active rate of 6.1%, while its performing loan portfolio has a 7.5% interest rate. It is worth mentioning that the company’ s government loan portfolio charged an interest rate of around 7.3% vs. the 6.2% of the same segment of the system, which could derived from two aspects: 1) Higher exposure to states and municipalities, which are a riskier asset than federal loans, and 2) better negotiating conditions with clients, given its strong position in the market and its expertise in the matter. Monthly interest income from the bank’ s loan portfolio — Data in millions of nominal pesos.

Interacciones’ consolidated interest rate

Source: CNBV Figures in MXN Millions

Source: CNBV

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

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4.0%

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8.0%

10.0%

12.0%

14.0%

16.0%0

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09

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-10

01

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Spread Consolidated Government

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Commercial Government Consumer

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5.0%

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a r-0

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-13

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YOY Change (bps) Consolidated interest rate




GFINTER | Banks

January 21, 2014

High loan book concentration The company has a highly concentrated loan portfolio as its entire exposure is linked to government activities. Indeed, credits to states and municipalities represent 71.6% of the total loan portfolio. However, financing infrastructure projects and SMEs that work as suppliers for the government add risk to the bank, as it is highly concentrated in a single economic segment. Loan book breakdown Performing loans income breakdown

Source: GFINTER

Source: GFINTER Assets and liabilities’ duration gap GFINTER has historically been struggling with the duration gap between assets and liabilities, as the former has a wider maturity, increasing liquidity risk. However, the company has constantly mentioned that they planned to reduce the gap that has been gradually accomplished so far.

Source: Company data

Government72%

Infrastructure22%

SME6%

Others0%

Government77%

Commercial22%

Financial Entities

1%

Mar-12 Jun-12 Sep-12 Dec-13 Mar-13 Jun-13 Sep-13

Assets 4.86 4.54 4.44 4.32 4.37 4.43 4.44

Agribusiness 0.56 0.37 0.27 0.19 0.22 0.19 0.27

Construction 2.02 2.10 1.88 1.65 1.39 1.14 1.88

Instruments' discount 0.18 0.27 0.05 0.64 0.44 0.23 0.05

Corporate and Business 1.26 0.84 0.75 0.49 0.66 1.46 0.75

Government 5.55 5.38 5.03 4.74 4.74 4.81 5.03

Infrastructure 5.96 5.24 4.98 4.83 4.78 4.40 4.98

Mortgage 1.72 2.47 2.35 2.36 2.52 2.61 2.35

Liabilities 1.26 1.36 1.54 1.31 1.41 1.40 1.54

Short-term deposits 0.00 1.00 0.40 0.40 0.40 0.40 0.40

Call Money 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Obligations 6.60 6.16 5.94 6.58 6.50 6.15 5.94

CEDES 0.18 0.13 0.19 0.11 0.70 0.46 0.19

CEBUR 1.77 1.54 1.29 1.50 1.28 1.30 1.29

Development banks 4.16 3.06 4.36 3.54 3.89 3.74 4.36

Indeval notes 0.06 0.07 0.07 0.07 0.10 0.13 0.07

Short term notes 0.12 0.12 0.39 0.39 0.39 0.39 0.39

GAP 3.60 3.18 2.90 3.01 2.96 3.03 2.90




GFINTER | Banks

January 21, 2014

It is worth mentioning that GFINTER has a diversified funding mix composed of deposits, debt obligations, debt certificates, development banks’ revolving lines, and short-term notes. However, the company has not exercised the full amount authorized of specific obligations; if they are fully exercised, the duration GAP should decrease. Hence, we elaborate an exercise considering that the financial group exercises the full amount authorized for the development banks’ revolving lines, which could add around P$8.4 billion with a 4.6-year duration, coupled with P$150.0 million pending from an obligations program with an estimated duration of around 5.9 years. Resources pending to be exercised in the obligations program

Figures in MXN Millions After including all resources available, we estimate a 1.95-year duration of total liabilities, which should reduce the asset-liability GAP from 2.9 to 2.5 years.

Figures in MXN Millions Source: GFINTER and GBM estimates

Issuance Amount MaturityYears

pending

BINTER07 NA 700 Nov-17 3.9

Programa Obligaciones

BINTER08 First 500 Nov-18 4.9

BINTER10 Second 650 Dec-20 7.0

BINTER12 Third 700 Nov-22 8.9

Amount exercised 1,850

Authorized amount 2,000

Resources available 150

Average Maturity 5.9

Amount Weight Amount Weight

Liabilities 51,284 1.40 59,888 1.69 1.95

Short-term deposits 15,514 30.3% 15,514 25.9% 0.40

Call Money 1,797 3.5% 1,797 3.0% 0.00

Obligations 1,850 3.6% 2,000 3.3% 5.94

CEDES 540 1.1% 540 0.9% 0.19

CEBUR 3,500 6.8% 3,500 5.8% 1.29

Development banks 12,056 23.5% 20,510 34.2% 4.36

Indeval Notes 4,961 9.7% 4,961 8.3% 0.07

Short-term Notes 11,066 21.6% 11,066 18.5% 0.39

Current Estimated Estimated Duration




GFINTER | Banks

January 21, 2014

Extensions of existing regulations New regulations or policies regarding the issuance of specific loans; restrictions on interest rates and fees charged; higher capitalization levels or excessive diversification rules can reduce the earnings power of the bank. Besides these factors, we also consider as risk factors the introduction of new accounting methodologies, which can seek to raise provisions for loan losses, or new policies for rating Non Performing Loans, as well as risk management policies. Overall, all of these factors may harm GFINTER’ s loan-granting ability. Higher competition in its main sector, government loans. Given that GFINTER’ s book is focused on the government sector, which represents around 71.6% of the total loan portfolio, and considering that the bank expects to continue with the same growth strategy ahead, higher competition and new players in the banking business, niche foreign banks, and multi-purpose finance entities may reduce market share in certain types of products and pressure the company’ s growth. More complex economic environment with a lower than expected GDP recovery. The company could face an adverse economic environment given the recent slowdown in GDP growth and slower dynamism in credit dynamism. So far this year, the Mexican banking system has experienced a slowdown compared to the strong dynamism reported in 2011 and 2012, while at the same time moving down to growth levels similar to 2009. There are two main reasons behind this:

• Strong prepayment effect from the Corporate front as debt markets keep becoming more attractive due to a lower reference rate.

• Slowdown of the Consumer portfolio started this year as the main growth contributor for the system, since it was growing above 20% vs. the 13.1% posted in September 2013.

Also, 2013 was marked by two important events that shook up the entire system’ s provisioning requirements as they grew 27.5% YOY in the last twelve months:

• Line-up with new Commercial & Corporate provisioning methodology, which changed from incurred losses to the estimated loss in the next 12M.

• Homebuilders’ crisis ended up affecting banks’ asset quality, forcing them to create reserves equivalent to the expected losses 12M forward.

Although GFINTER is not focused on any of these specific segments, a generalized slowdown in the economy and credit dynamism could hamper its growth strategy and pressure funding dynamism.

VI. REGULATION As a financial holding company (Grupo Financiero), Grupo Financiero Interacciones is regulated and supervised by the National Banking and Securities Commission (CNBV), which is a government agency of the Ministry of Finance (SHCP).The CNBV is the agency in charge of issuing the general and particular rules for the players in the Mexican financial system, including multi-purpose financial entities (SOFOMs) and auxiliary organizations; however, the Ministry of Finance has the authority to issue specific standards if it considers such additional capital requirements pertinent, or revoke banking licenses if an institution fails to comply with all the required rules. The Mexican financial system also includes preventive and corrective institutions, such as the National Commission for the Protection and Defense of Users of Financial Services (CONDUSEF, Comision Nacional para la Proteccion y Defensa de los Usuarios de Servicios Financieros), which is responsible for encouraging the education and protecting the interest of the users of financial services. Finally, IPAB, the institute for the protection of bank savings, is the entity in charge of assuming control if a bank becomes insolvent; the institute also guarantees a maximum of 400,000 UDIs (P$1.69 million) for each user of the banking system. The most important updates on the rules for the Mexican banking system are as follows:




GFINTER | Banks

January 21, 2014

Moving from Basel II to Basel III in January 2013. On October 3, 2005, the CNBV published the agreement signed by the ABM (Mexican bankers association, for its acronym in Spanish) in order to implement the new capital guidelines issued by the Basel Committee on Banking Supervision from the Bank for International Settlements (Basel II); this agreement contains the standards and principles of how much capital the banks have to put aside to guard against the types of financial and operating risk (credit, market, and operating risks). The agreement established that banks must have at least 8.0% of capital to risk weighted assets. Tier I or core capital, which is considered the most reliable form of capital, such as common stock and retained earnings, must be at least 4.0%, plus Tier II or supplementary capital, such as subordinated debt, hybrid instruments, or general provisions, must also be at least another 4.0% of the total risk weighted assets. Moreover, Basel II allowed banks to include Tier III as net capital. After that, on September 16, 2010, the Basel Committee on Banking Supervision issued the Basel III rules text, which presented the details of the new global regulatory standards on bank capital adequacy and liquidity. Basel III establishes the elimination of Tier III capital, coupled with a harmonized Tier II ratio. Moreover, Basel III demands a higher total capital requirement of 10.5% of the risk weighted assets, compared to the 8.0% required previously, given the addition of a capital conservation buffer of 2.5%. Additionally, these new standards require higher capital quality by focusing on common equity. Basel III adoption timeline Banxico restricted bank fees and commissions. On July 26, 2010, Mexico’ s central bank announced new policies on bank fees and commissions charged for banking transactions occurring in the country. The new regulation was approved in August 2010, and became effective as of January 2011. The reform curtails overdraft fees and minimum account balance fees, and eliminates fees for late payments on loans and fees charged for not using a credit card. Moreover, the reform requires banks to show all ATM customers’ fees incurred when using the ATM. As a result, the net fees and commissions to interest income ratio declined from 3.8% in 4Q10 to 3.4% in 4Q11, partially offset by the higher volumes of transactions, and with no significant effect on the group’ s profitability. General regulations applied to controlling companies of financial groups subject to supervision by the CNBV, and homogeneous accounting approaches to financial entities. On January 31, 2011, the CNBV issued general regulations applicable to controlling companies of financial groups, in order to compile in a single legal instrument the regulations applicable to these entities. Additionally, the regulation considers homogeneous accounting approaches applicable to financial entities. Thus, as of the start of 2011, consolidated financial Groups’ figures include the insurance and bonding sector, which used to be accounted through the equity method until 2010. Additionally, “Other Operating Income (Expenses)” from Insurance and Annuities, which was previously consolidated under the participation method, and “Non-Operating Income (Expenses)”, previously reported after “Operating Income”, are registered under “Other Operating Income (Expenses)”.

Basel II 2012 2013 2014 2015 2016 2017 2018 2019Minimum Common Equity Capital Ratio 2.0%

3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%

Capital Conservation Buffer 0.6% 1.3% 1.9% 2.5%

Minimum Common Equity plus Capital Conservation Buffer 2.0%

3.5% 4.0% 4.5% 5.1% 5.8% 6.4% 7.0%

Minimum Tier I Capital 4.0% 4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%

Minimum Total Capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%

Minimum Total Capital plus Conservation Buffer

8.0% 8.0% 8.0% 8.0% 8.6% 9.3% 9.9% 10.5%

* Source: Bank for international settlements, Basel Committee on Banking Supervision.

Total Tier I Capital with Conservation Buffer 4.0%

4.5% 5.5% 6.0% 6.6% 7.3% 7.9% 8.5%

Percentage of Tier I Capital of Total Capitalization Level

50.0% 56.3% 68.8% 75.0% 76.8% 78.4% 79.7% 81.0%




GFINTER | Banks

January 21, 2014

Changes in the methodology to rate credit cards. On August 12, 2009, the National Banking and Securities Commission issued changes in the accounting criteria applicable to credit institutions, which modify the rating methodology for revolving consumer portfolios, so that the parameters used to estimate preventive reserves reflect an estimated 12M loss for credit cards, based on the current environment. Changes in the methodology to rate non-revolving consumer and mortgage loans. On October 25, 2010, the Mexican National Banking and Securities Commission published a resolution that modifies the methodology for rating non-revolving Consumer and Mortgage loans, so that allowance for loan losses will be calculated based on the expected loss, instead of the incurred loss. Changes in the methodology to rate government portfolio. On October 5, 2011, the Mexican National Banking and Securities Commission published a resolution that modifies the methodology for the commercial portfolio granted to federal entities and their municipalities. This resolution modifies the current model for reserves based on public qualifications, to a model that qualifies and reserves the portfolio according to the potential expected losses for 12FWD. The resolution came into effect on October 6, 2011, and was applicable in an optional way during the third or fourth quarter of 2011.

Changes to criteria B-6 “Loan Portfolio”. The criterion establishes the applicable treatment for restructuring and renewal of credit and clarifies the conditions for considering a loan as current or expired. There were changes regarding fees for restructuring; the conditions to consider loan repayments as sustainable include the treatment for loans with amortization of principal and interest, among others. This amendment became effective on March 1, 2012. The legal framework of Mexican financial institutions is based on the Law of Credit Institutions (“Ley de Instituciones de Credito”), a general law for credit institutions in Mexico; the law to regulate financial groups (“Ley para regular las Agrupaciones Financieras”) is the one that establishes rules and guidelines for the operation of a financial group; and the “Circular Unica de Bancos”, a more specific guideline that banks must follow, such as accounting standards, risk management policies, levels of provisions, important disclosures, etc. GFINTER

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Stock Price Performance vs Analyst Estimates

Price Price Target

21/01/2014 83.0 Market Outperformer




GFINTER | Banks

January 21, 2014

Important Disclosures: The analyst or analysts involved in the creation of this document hereby certify that the views expressed in this document accurately reflect their personal opinions and that they have not and will not receive direct or indirect compensation for expressing specific recommendations or views in this report. This report has been prepared by GBM and is subject to change without notice. GBM and employees shall have no obligation to update or amend any information contained herein. This report is for informational purposes only, based upon publicly available information, which we believed is reliable, but its accuracy and completeness cannot be guaranteed. GBM makes no express or implied representations or warranties that such information is accurate or complete and, therefore, GBM and employees shall not in any way be liable for related claims. This report does not constitute an offer to buy or sell any security or participate in any trading strategy. The information and analyses contained herein are not intended as tax, legal, or investment advice and may not be suitable for your specific circumstances. Each investor shall make their own determination of the suitability of an investment of any securities referred to herein and should consult their own tax, legal, investment, or other advisors, to determine such suitability. This report may discuss numerous securities, some of which may not be qualified for sale in certain countries or states therein and may therefore not be offered to investors in such countries or states. This report or any portion hereof may not be reproduced, reprinted, sold or distributed without the written consent of GBM.

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