ROP 10-Year Yields Yanked Lower as PSEi 30 Bank Profits Grew by Only 6.44% in 2017, Partly Hurt by Rising Yields!

"Do not allow the applicability of mathematical or statistical methods to define the scope of economics." Roger W. Garrison

In this issue

ROP 10-Year Yields Yanked Lower as PSEi 30 Bank Profits Grew by Only 6.44% in 2017, Partly Hurt by Rising Yields!

-Another Policy Panic through Yield Control? ROP 10-Year Yields Yanked Lower!

-Despite BSP Subsidies, PSEi 30 Bank Profits Grew by Only 6.44% in 2017, Partly Hurt by Rising Yields!

-How to Sterilize Inflation? Simple. Overhaul Inflation Statistics!

-January’s Manufacturing Boom or Statistical Hyperbole?

ROP 10-Year Yields Yanked Lower as PSEi 30 Bank Profits Grew by Only 6.44% in 2017, Partly Hurt by Rising Yields!

Another Policy Panic through Yield Control? ROP 10-Year Yields Yanked Lower!

Someone just panicked!

The persistently stubborn ascendant yields must have jolted the financial industry to require market interventions from an unidentified force.

ROP 10 year yields were driven down significantly (88.5 basis points) over the week. Or, differently put, ROP 10 year bond prices were, like the Phisix, pumped up!

Instead of providing relief, the likelihood is that such interventions may have aggravated distortions on the ROP yield curve

That’s because manipulation does not address the root of the problem.

 

The 10-year yield serves as a critical benchmark. In the US, the 10-year yield sets the rates of most mortgage products. And because of the competition for fixed income investors, changes in the “risk-free” yields of government treasuries affect the yields of other fixed income products.

Since long-term yields essentially comprise expectations of the path of short-term rates, the inflation, and the term premium (credit risk and supply issues), ascendant yields have been reflecting real economic factors.

Unless strains in the real economy will be resolved, the continued sell-off in Philippine bonds should be expected. Hence, for as long as the insatiable National Government remains in a spendthrift mode anchored on on the BSP’s free money regime, which continues to blow serial bubbles, rising yields on ROP bonds should be expected.

Despite BSP Subsidies, PSEi 30 Bank Profits Grew by Only 6.44% in 2017, Partly Hurt by Rising Yields!

Symptoms of the adverse impact from rising yields have surfaced in the financial performance of the four largest banks, which are publicly listed and composite members of the PSEi 30.

While the aggregate net interest income growth soared by 19.08%, net profit or income for 2017 was a measly 6.44%!

The BSP’s data on production and construction loans, which grew by an astounding 18.39% in 2017, which incidentally was the third largest, dovetails with the cumulative topline of these banks.

The BSP has provided a silver platter to these banks with gargantuan topline growth that has been backed by mammoth margins. Ironically, the same banks have managed to wangle a paltry nominal 6.44% in earnings growth!

Paradoxically, the subsidies have netted the banks a paltry nominal 6.44% in earnings growth! The gross margins of the four banks in 2017: BDO 81.92%, BPI 72.95%, Metrobank 76.95% and Security Bank 67.32%.

To factor in the government’s average CPI (base 2006) in 2017 at 3.2%, bank earnings were even lower at 3.24%!!

BSP subsidies have resulted in the inefficient deployment of capital!

And even more signs of economic inefficiency has been the frenetic pumping on banking stocks.

With scanty real earnings growth in 2017, chronic imbalances through severe mispricing have been revealed in the huge returns of the bank shares (BDO +46.3% BPI +21.73%, Metrobank +39.73% and Security Bank +32.32%)!

Or, people stunningly overpaid for bank shares: 6.5 years of BDO shares, 10.5 years of BPI, 8.45 years of Metrobank and 1.62 years of Security Bank shares at their respective 2017 earnings!

That is to say, the market has rewarded the banking system’s blatant inefficient use of capital!

Why haven’t the enormous huge topline expansion and wide margins percolated into the bottom line?

It has not just been because banks have been overspending, support from the “other income” subcategory have gone amiss. This category contains the Fair Value through Profit or Loss (FVPL) assets, which includes derivatives and Asset For Sale AFS and Hold until maturity (HTM)

In 2017, the four banks suffered heavily under this category: Metrobank endured a Php 402 million loss, BDO, BPI and Security Bank recorded sharp plunges in revenue growth, specifically, 75.81%, 81.37%, and 81.1% respectively. Trading and Investment Securities constitute the second or third largest components of bank assets.

And since most of the segment’s exposures have been in ROPs and partly in private fixed income, support contribution from non-interest income has been substantially affected by rising yields! The share of equity in this class has been minor.

And this segment has been under pressure since 2014. (Remember the 10-months M3 explosion of 30%++++! It’s all connected)

With banks and non-banks as major holders of debt instruments, the ongoing decay in the “trading and securities” category reinforces my theory that the present bond selling pressures would afflict the financial industry. [Who Suffers from the Turmoil in the Philippine Bond Markets,Bullseye! Panicked BSP Slashed Reserve Requirements in the face of Meltdown in Philippine Bonds! February 18, 2018]

Although larger losses to the banking system have been partly mitigated by the BSP subsidies through extended policy accommodation, executing interventions focusing on temporary fixes will most likely escalate the current dilemma.

And it is more than that. The torrent of fund-raising by banks through stock rights offering and Long-Term Negotiable of Time Deposits (LTNCD) is a testament to the scarcity of internal liquidity for specific banks which includes some of the majors. Banks are supposedly earning, but they haven’t been generating sufficient financing and liquidity for their own use! Black is white, up is down!

Yet, the recent spike in long-term yields has steepened the yield curve, which should magnify the margins of the banks. On the other hand, since interest rates signify costs of the credit, rising rates should translate to lower volume. Higher margins would thus offset the slack in volume.

And by forcibly pulling down 10-year yields alone, the spread differentials across the curve narrowed, thereby reducing potential margins for the banks. Under a tightening spread, to meet its profit targets, banks would focus on expanding volume or quantity by sacrificing quality. Doing so translates to the needless absorption of greater credit risks

As the 10-year had been pulled lower, shorter-end yields spiked this week, which narrowed the curve (upper window).

And considering that ROPs have mainly been held by the banking system, as well as, the non-bank financials and the government financial institutions, the BSP (and its agent banks) has most likely been the entity responsible for such interventions.

In the milieu of incumbent ICU policies, the BSP’s latest illogically defying move to cut reserve requirements as price pressures in the real economy strengthens the circumstantial evidence of such interventions – the desire to inundate the system with liquidity aimed at smoothing out issues in the real economy.

How to Sterilize Inflation? Simple. Overhaul Inflation Statistics!

Aside from market interventions and flushing the system with unneeded liquidity, the government’s alternative approach to address economic issues is to arbitrarily modify statistics!

For the month of February, new inflation numbers were released by the BSP and the PSA, calculated under the base year of 2012 compared to the previous base year of 2006.  Though the February CPI surged to 3.9% from 3.4% in January, the 2012 numbers have been significantly lower than the 2006 counterpart at 4.5% and 4.0%.

Structural changes in the statistical construct create a misleading impression of the price pressures in the real economy.

Have such crucial changes been designed as an antiseptic to the lethal mix of the TRAIN and the BSP’s eroding easy money regime?

 

In fairness, the Philippine Statistics Authority proposed to extend the implementation of the “rebasing” in the calculation of the CPI and GDP calculation every 6-years.

However, one would need to ask why so?

The most likely answer is that by adopting a closer base year, which reduces the difference between the current and latest base prices, its effect on statistical inflation is prophylactic. With that in mind, it would justify the entrenchment of the invisible inflation tax on the citizenry through the BSP’s inflation targeting policies.

And back to the BSP and PSA’s inflation data.

Even from the government’s own numbers, price inflation (CPI, General Retail Price Index) has been accelerating. The BSP said that this has been “a result of transitory factors”, which in effect justifies the prolonged engagement in the current emergency measures.

Yet, consumer price inflation trends have had an upward trajectory since the time the BSP initiated a stealth QE at the end of the 3Q of 2015.

The diagnosis of the BSP will unlikely be fulfilled for the simple reason that price pressures are caused by their free-money policies which have now been compounded by the distortions from the new tax regime (TRAIN).

Inflation will be within the BSP’s target because they construct the numbers.

But markets will eventually recognize statistical gymnastics from reality.

And the twin distortions in the domestic economy are the critical reasons behind rising ROP yields and the falling peso. Another crucial factor will be the onrush of ROP issuance to finance the NG’s lavish expenditures. And the private sector funding requirements will compete headstrong with the avalanche of ROP supplies for access to savings (crowding out).

No amount of edicts, market manipulation and fudging of statistics will succeed over the long run. Instead, the distortions spawned by these would accelerate the market-clearing process. The more the contortions, the greater the risk of a disorderly unwind!

After all, we live in a world of scarcity. Unfortunately, such reality has been denied by the mainstream

January’s Manufacturing Boom or Statistical Hyperbole?

And speaking on statistical mirages, the PSA seems to have pulled a rabbit out of the statistical hat.

The PSA claims that manufacturing/industrial production rocketed by 20.4% in January which comes at a curious time when anecdotes of economic strains from the new tax regime have emerged (Coca-Cola and Sardine Manufacturers)

 

While the PSA has been chortling hallelujahs, the private sector Nikkei PMI have stated otherwise, January and February manufacturing PMI has plunged!

Yet if the PSA is right, cement manufacturing continues to massively expand even as deflation in cement prices has re-accelerated. Cement prices come from the PSA’s General Wholesale Prices. Unless “build, build and build” flies, the glut in the supply of cement continues.

And if the PSA is right, since auto manufacturing has crashed in January (-14.9%), auto sales will most likely sink. CAMPI will be reporting February sales next week.

Moreover, deflation in Producers Prices has deepened in January (-2.0%) which hardly corroborates the PSA’s data.

And where does demand from the industrial/manufacturing sector been from? 

 

If the PSA data is right, demand stems certainly not from exports as the January number have barely (+.54) grown in January. And import growth (+11.43%) appears to be rolling over which hardly supports “domestic demand”.

Moreover, January 2018’s trade deficit has ballooned past 2017.

The string of statistical data tells us that January’s manufacturing boom has either been about the unseen forces driving “domestic demand”, regardless of the real-life anecdotes from TRAIN, or about statistical cosmetic embellishments to prove to the world that the Philippines thrives in a surreal world of abundance.

Since most of the data above emanate from the PSA, the irony is that the statistical agency produces self-contradictory numbers.