As we already noted when we initiated our credit research coverage of Operadora Mega in October 2022, the accounting methodology set by Mexico’s CNBV regulator was not necessarily designed with the leasing business of non-bank financial institutions (NBFI) in mind. The CNBV-compliant financials inflate certain profit & loss (P&L) lines with non-cash flow items, and for that reason we have preferred to rely on the earnings presented in Mega’s quarterly press releases, which remove the FX profit and losses, as well as some of the income and expenses from derivative contracts, from the interest income and expenses (See the 2Q22 Credit Report for a further explanation).

In the recent Part I of our 4Q23 Credit Report for the company, we highlighted that a heavy decrease in the percentage of Mega’s loan portfolio that the upfront deposits paid by the clients of the leasing business represent doesn’t make sense to us. As such, we came up with some potential explanations.

During the 4Q23 earnings call, the management indicated that those deposits depend on each transaction, and that they shouldn’t be looked at as a percentage of the portfolio. Also, they attributed the decrease in the stock of those deposits to the reduction of the loan origination lately.

However, those explanations didn’t comfort us entirely. Furthermore, some of the income statement numbers from the earnings report added to the apparent inconsistencies.

In the leasing business, Mega calculates the so-called commercial margin from the difference between the leasing value of the asset and the purchase price (the company claims to be able to acquire the assets at a discount). As Mega records it as a revenue upfront at the beginning of the contract, the lower the origination the lower the commercial margin.

Certainly, the company aggressively slashed its loan origination in 2023 when compared to the prior year. Therefore, it is normal that the commercial margin also fell. However, the reduction of the commercial margin has been much more pronounced than the one experienced by the origination.

For instance, while the loan origination fell 49% year-over-year (YoY) in 4Q23 and 43.7% in FY23 when compared to FY22, the commercial margin decreased 97.4% and 80.5%, respectively. As a result, the percentage relation between the commercial margin and the loan origination has dropped significantly (See Figure 1).

This trend seems to imply that Mega would be now finding it difficult to secure the price discounts for the assets that it used to achieve in the past. Alternatively, it could be the case that the company has focused the reduced origination lately on the agro industry, as in this segment it traditionally passes through the discounts obtained in the acquisition of the assets to the clients.

In any case, this would add to the negative effects of the potential explanation number 2 for the reduction in the leasing client deposits that we presented in Part I of the report – a weakening of the deposit protection feature.

Meanwhile, the interest income as per the earnings release decreased 39.2% YoY in 4Q23 to MXN 429m. The company said that a year-end “adjustment” of MXN 80m-MXN 100m (apparently, its system recorded in the previous quarters some interest income that shouldn’t have been recorded yet) impacted the 4Q23 figure. But, even when excluding that one-off, the interest income would have fallen by 25%-27.8% YoY.

It’s true that the loan portfolio has shrunk, but at a much lower rate (-5.6% YoY in 4Q23) than the reduction experienced by the interest income. Furthermore, we believe that, if anything, the interest income should have increased, as a repricing of the loan portfolio initiated with new clients in July 2022 should have offset the mild loan portfolio reduction.

The reduction in the interest income, though, could be consistent with a drastic aging of the loan portfolio due to the low origination lately, as the proportion of total collections that interest represents would be low. In that scenario, however, the collections of principal should be very high.

In theory (although we have shown in the past that this may not work for Mega), the period-end loan portfolio should be equal to the beginning-of-period portfolio minus the collections of principal and the net write-offs, and plus the origination. As such, rearranging the terms, we get that collections of principal would have amounted to ~MXN 3.9bn in FY23.

For a steady-to-slightly decreasing total loan portfolio, we estimate that collections of principal in FY23 should have been ~MXN 3.2bn, around 61% of the total collections.

But the hypothesis of a rapidly aging portfolio can be ruled out, as management said during the earnings call that the average tenor of the outstanding portfolio currently stands at 38 months (which implies a pretty young portfolio, as Mega usually grants 42-month loans).

Based on that, we estimate that the collections of principal in FY23 amounted to ~MXN 2.2bn, or 42% of the total.

Collections of interest, meanwhile, would have been the remaining 58%, or ~MXN 3.1bn. And it is precisely because of this high percentage that the poor performance of the interest income in 4Q23 becomes shocking.

In any case, whatever happened in 4Q23, the interest income in FY23 as per the earnings release accounting did increase 23.6% when compared to FY22, totaling MXN 2.6bn.

Higher interest expense causes negative financial margin

However, amid a continuation in the gradual increase of the average cost of debt (See Figure 2), interest expenses rose at an even faster rate. For 4Q23, interest expenses grew 50% YoY to MXN 555m, while for FY23 they increased 25.3%, to MXN 2.2bn.

As a result, Mega recorded a financial margin of MXN -123m in 4Q23, compared to MXN 451m a year earlier, marking the first negative number on record.

Consequently, the net interest margin (NIM) stood at -3% in the quarter, also the first negative figure ever (although the NIM including provisions formation had already been slightly negative in 3Q23) (See Figure 3).

Collections would be enough to address 2024 maturities

Mega faces debt maturities of USD 160m in 2024 (See Figure 4). However, most of the debt with commercial and development banks can be rolled over upon maturity, as long as renewed loan portfolio is offered as collateral.

As such, the amount that the company will have to repay or refinance (although the latter seems unlikely now, given the drought of fresh funds for the Mexican NBFI industry) no matter what this year are the USD 67m from international funds that are due, as well as a portion of the debt with HSBC that isn’t revolving.

During the call, the management indicated that the collections expected for 2024 would be enough to cover the debt maturities due during the year.

As we noted in Part I of the report, with the cash generated with the collections (principal and interest) in FY23, Mega was able to cover not only its administrative expenses and the interest payments on its debt, but also to reduce its net debt.

For FY24, the management has guided a reduction of the loan portfolio similar in percentage to the one recorded in FY23 (-5.6%).

Based on all that, and with our estimates for collections and cash origination, we believe that the company in fact may be able to muddle through in 2024. However, absent new financing lines, it would finish the year with a cash position below USD 30m, less than what it considers necessary to operate normally (See Table 1).

Bond refi: sometimes saying nothing says a lot

The maturity of the international bond in February of 2025, however, is a different story, as collections obviously won’t be enough for that.

Following a failed exchange offer late last year, we indicated that knowing the reason for the low participation achieved was critical, and pointed to a potential explanation (See our 3Q23 Credit Report (Part II)).

During the 4Q23 earnings call, the management said that it remains in conversations with different financial intermediaries for a refinancing, but that the confidential nature of the talks prevented them from making additional comments for the moment.

To be fair, nothing surprising there.

However, what caught our attention was the lack of active participation in the call by buysiders. Unlike previous calls, when investors bombarded the management with questions, this time around the only queries came from the sell-side.

Therefore, it seemed to us as if the main holders may have already engaged in direct talks with the company following the failed exchange offer, therefore not needing to seek visibility on the company’s operations and refinancing plans at the call.

If that’s the case, we assume a potential new refinancing attempt by the company would come with, if not the agreement of, at least the feedback from the principal bondholders.