The first sign of corruption in a society that is still alive is that the end justifies the means.—Georges Bernanos (1888-1949)
In this issue
Philippine Banks in a Seeming Panic 1.0: As Interest Margins Shrinks, Some Banks Lent Money at Unprecedented Rates to Generate ‘Profits’!
-Income Divergence! PSEi Banks Income Jumped in the 3Q as Peers Contracted
-The BSP’s Conundrum: Banking System’s Uncooperative Interest Rate Margins
-As Margin Shrinks, Several Banks Gambles With Massive Loan Issuances to Boost Profits
-Hope is NOT a Strategy: Mounting Credit and Concentration Risks!
Philippine Banks in a Seeming Panic 1.0: As Interest Margins Shrinks, Some Banks Lent Money at Unprecedented Rates to Generate ‘Profits’!
Due to limitations on chart space, this will be the first of a two-part series exhibiting the scorecard of the banking sector in the 3Q and the 9-months of 2018.
The first part will cover selected income metrics on the published financial performance (17Q) of listed banks, as well as data from the BSP. The second segment exhibits the industry’s balance sheet data based on the BSP reports.
Let’s dive in.
Income Divergence! PSEi Banks Income Jumped in the 3Q as Peers Contracted
Remember this conclusion from the BSP-led Financial Stability Coordinating Council’s (FSCC) Financial Stability Report?
While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner.
“Shocks that have caused dislocations of crisis proportions” may be one of the principal reasons behind the Insurance Commission’s regulatory bailout of pre-need firms. [See Insurance Commission Launches Regulatory Bailout of Pre-Need Firms, The Twin of Unbridled Fiscal Spending is High Inflation, The Coming Stagflation November 18, 2018]
Not only does “dislocations of crisis proportions” involve the non-bank financials, but also its principal brethren, the banking system.
And behind the supposed sanguine financial results, symptoms of such underlying disease have been manifest.
Figure 1
Net income growth of PSYEi 30 banks catapulted by 18.92% in the 3Q to buoy its 9-month output to a positive 4.75%.
Stellar returns were recorded by Metrobank 37.5% and BDO 17.5% in the 3Q to bolster the former’s 9-month income to 18.07% and eased the slack of the latter to 5.27%. BPI had a modest 10.86% growth in the 3Q which was still insufficient to erase its 9-month deficit of -.78%. Meanwhile, Security Bank glaringly underperformed by posting meager a 4.95% 3Q growth which hardly alleviated its 9-month income shortfall of 11.44%.
But the rest of the playing field didn’t share such optimism.
The 11 non-PSEi banks registered a net income contraction of -6.76% in the 3Q which prompted a downward adjustment of its the net income growth in 9-months to 8.15%
Constituent banks of the Financial Index registered a net income growth of 9.75% in the 3Q to lift 9-month income by 5.63%. Composing the Financial Index are the PSEi 4: BDO, BPI, MBT and SECB plus AUB, CHIB, EW, PNB, RCB and UBP.
In total, 15 listed banks delivered a 9.93% or Php 2.936 billion growth in the 3Q to buoy the 9-month growth rate to 5.87%.
The Financial index accounted for 91.76% share of the Php 5.3 billion net income increment obtained by the 15 banks in 9-months while PSYEi banks had a 54.22% share.
Such numbers reveal how three major players bolstered the overall net income conditions of the banking system!
The BSP’s Conundrum: Banking System’s Uncooperative Interest Rate Margins
NYU Stern accounting and finance professor Baruch Lev tells us that “there are hardly any facts in the information―assets, earnings― you receive quarterly from public companies” because “Except for a few items on the balance sheet, like cash and debt, practically all items on the balance sheet and the income statement are based on managers’ subjective estimates and projections”. (bold added)
And this is the reason why in vetting at the banks, the top-line and their margins matter most, as they lead to the industry’s stream of cash flows.
And here is the Php 16.434 trillion (September banking resources) question: If the nation’s banks have been raking in so much money, why the unremitting quest to solicit funding from the public through various means (stock rights, bonds, Long Term Negotiable Certificate, Medium Term Notes, and combo)?
Despite the ballyhooed profits, three of the biggest banks have embarked on a massive billion borrowing spree (by installments) amounting to Php 250 billion! [See The Crowding-Out: Wave of Announcements for Another Round of Massive Bank Financing! The Minsky Cycle to the Minsky Moment September 23, 2018]
For instance, from the select bank’s disclosure of the week:
Metrobank [PSE: MBT] will reopen to the public its existing PHP10 billion 2-year 7.15% Fixed Rate Bonds due 2020 issued on November 9, 2018 (the “Bonds”) and currently listed on PDEx. The Offer Period will be from November 28 to December 7, 2018. Issue date will be on December 17, 2018. Metrobank is targeting to add at least Php 5 Billion to the existing Bonds.
On November 13, 2018, Bank of the Philippine Islands [PSE: BPI] priced its offering of ₱25 billion, 1.25 year fixed rate bonds due March 2020. The fixed rate bonds will pay a coupon of 6.7970% per annum, payable quarterly. The coupon represents a spread of 20 bps over the interpolated 1.25 year BVAL government benchmark rate, and is at the tight end of the spread range of 20 to 40 bps communicated to institutional investors during the institutional bookbuilding period.
Big profits eh?
The compression of interest margins has been one of the paramount reasons behind the banking system’s recentstruggle to generate profits.
Figure 2
The Philippine banking system (Universal/commercial, Thrift and Rural/cooperative banks) posted a 6.6% profit in the 3Q, a marginal improvement compared to the 2Q’s 5.51%. This rate pales in comparison to the above 20% rate of growth from 2009 to 2013.
Yes, a convenient scapegoat for the mainstream would be the US Federal Reserve.
But the banking system has been laboring to eke out profits since 2013 even with record high gross interest margins. Such high margins have signified a product of the BSP’s various interventions: artificial lowering of interest rates, yield curve controls, and 2015’s quantitative easing! (figure 2 upper window)
That’s why I said “recent”. If banks struggled to produce profits in days where margins were high, what more if margins decline? And this characterizes the present scenario.
When interest margins climbed in 2013 to hit a record high in 2014, profits didn’t follow! That’s because many real factors were involved, such as real economic conditions, bank loan penetration level, credit distribution, credit quality, street inflation, regulatory, fiscal, tax and economic policies and more.
From 2014 to March of this year, interest margins drifted slightly off its pinnacle. But then momentum turned south. Interest margins plunged with the substantial declines happening in the 2nd and 3rd quarters of 2018.
2013 to 2014 highlighted the explosive 10-month 30% money supply growth which ignited street and statistical inflation that prompted the BSP to hike rates twice in the 2H of 2014.
Before 2014, the banking system depended less on loan issuance and high margins to generate profits or net income growth.
Since the BSP spiked its monetary inflation in 2013-14, loan issuance became the PRIMARY bread and butter for the banking system. (Figure 2, lower window) As such, the BSP and the banking system thought that the combination of rapid volume growth and high margins would be its elixir.
Interest income accounted for 77% share of the banking system’s operating income in September 2018 significantly higher than 75.27% in August and 74.44% in July. Obviously, the non-income component share of operating income continues to dwindle 23%, 24.73% and 25.6%, respectively, over the same period.
And because of such goals, the BSP had been forced to use emergency policies of ultralow rates and the nuclear option of QE. Following QE in 2015, the BSP used the interest rate corridor as cover to drive policy rates to 3.5% a historic low.
And instead of bolstering profit, paradoxically, the industry's liquidity has shriveled! Banks had assiduously been raising from the public funding to plug its liquidity deficiency. Until today.
The BSP’s subsidies to the banking system have boomeranged!
The compression of interest margins weighed significantly on the banking system profits, so banks resolved this through different means. The variability of approach resulted in the divergence in the net income performance.
That being the case, revenues had been a primary channel to distinguish actions undertaken by PSEi banks relative to the rest.
As Margin Shrinks, Several Banks Gambles With Massive Loan Issuances to Boost Profits
The income statement of listed banks has daintily captured such an overview.
Figure 3
You see, bank margins have astoundingly plummeted.
Interest margins for the 15 listed firms in the 9-months of 2018 plunged by an aggregate 6.66% to 69.61% from 74.58% a year ago! (figure 3, upper window) Interest margins dropped by even more (-7.89%) in the 3Q to 68.26% from 74.11% a year ago!
Since the establishment’s thinking evolved around the premise of interest margins EQUALS profits, then how do you think would the banks respond to the present environment of shrinking margins?
Well, if your answer is for them to offset this margin decline by expanding the volume of their lending, then B-I-N-G-O!
Some banks have revved up lending at a pace unmatched in their respective histories! (see lower window)
And here’s the thing.
The major banks are taking such dicey derring-do gambit of throwing money into the system in the face of escalating liquidity pressures vented through rising interest rates! (NPLs have been rising too!, see part 2)
Yes, this has produced outsized profits in 3Q for PSEi banks! Apparently, such profit boost also percolated to levitate the 9-month net income.
But generating short-term profits comes at what costs?
And banks didn’t just try to prop the profit picture by reckless lending, some even used accounting acrobatics such as downsizing published loan “impairments” significantly. But this would be minor compared to the former.
Shown below are several banks that have undertaken to gamble with unprecedented rates and amounts of loan issuances to counterbalance the shriveling interest margins with the goal of wangling profits in the 3Q.
Included are PSEi banks and select banks of the Financial Index.
First, the PSYEi banks. (see figure 4)
Figure 4
BDO’s 9-month loan revenues (only) rocketed to a record 28.68% from 18.7% last year and the second highest growth rate of 19.4% in 2015. Total Revenues soared 27.05% powered by the 3Q’s stunning 29.6%! (Figure 4, upper window)
Formerly conservative BPI’s 9-month loan revenues (only) vaulted to an unprecedented rate of 24.24% from 15.91% last year, the second highest. Total Revenues surged 18.82% energized by the 3Q’s sizzling 24.59%! (Figure 4, middle window)
MetroBank’s 9-month loan revenues (only) growth seethed at 22.98%, the second hottest rate from last year’s 24.43%. Total Revenues spiked to 18.99% principally from the 3Q’s astonishing 20.7%! (Figure 4, lowest window)
Figure 5
From select banks of the Financial Index.
PNB’s 9-month loan revenues (only) spiked at a whopping breakneck speed of 32.66% which was 142.8% from 13.45% last year’s growth rate and more than twice the second highest growth rate of 15.02% in 2016! Total Revenues zoomed by a momentous 28.19% powered by the 3Q’s staggering 33.23%!
China Bank’s 9-month loan revenue (only) growth bristled at a phenomenal rate of 28.44%, the second hottest from 2014’s 44.85%. Total Revenues spiked by a colossal 29.98% principally from the 3Q’s titanic 37.36%!
So much effort and so much risk have been taken to generate headline gains! Whew.
Hope is NOT a Strategy: Mounting Credit and Concentration Risks!
In perspective, total bank lending based on the BSP data during the last quarter slowed steeply: 17.23% September, 18.83% August, 19.49% July relative to the 2Q’s 19.06% June, 19.26% May and 19.58% in May.
That being the case, only a handful of banks have become responsible for the bulk of the industry’s credit expansion! In doing so, these banks are putting to the fore mounting systemic concentration risk.
Truly breathtaking developments!
And in spite of such desperate moves to boost the bottom line, the BSP’s Key Performance measures of profitability have barely improved!
Return on assets (ROA) in the 3Q remained at the same level as the 2Q at 1.15%. Return on Equity (ROE) dropped to 9.45% in the 3Q from 9.5% in the 2Q. Both ROA and ROE have been in a declining trend since 2013. Recent declines have only accelerated such trend. (figure 5 lowest window)
Some domestic banks operate in the hope that throwing away money through such massive loan issuances
More importantly, they also seem to have dismissed the possibilities and probabilities of the festering of an overextended loan portfolio into distressed or non-performing loans as interest rates rise as the economy slows.
And whatever buffers built to protect the system from "dislocations of crisis proportions” are being eroded fast.
Hope, by the way, is not a good strategy.
Continued in part 2: Philippine Banks in a Seeming Panic 2.0: As Liquidity Shrinks on Rising NPLs and Investment Losses, Banks Use HTMs to Mask Increasing Fragility
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