An artificially low rate of interest, which might prevail for some time if the Federal Reserve is targeting a low federal funds rate, translates into the business world as longer planning horizons than are justified by people's actual willingness to save. The policy-induced mismatch between production and consumption activities creates the illusion of prosperity but sets the stage for an eventual market correction, which takes the form of an economy-wide downturn—Roger W. Garrison
In this issue
A Critical Chapter Of History Unfolds: Historic Yield Curve Inversion, Banks Panic Borrow Anew in February as NPLs Soar (Again)!
-Record Monetary and Fiscal Stimulus, Debt and Bank and BSP Balance Sheets: Pivotal History Unfolds Right Before Our Eyes!
-First Ever Yield Curve Inversion Since At Least 2001!
-The Bear Steepener: Will the BSP Ease Soon to Recombust Inflation?
-Philippine Banks: February Cash Reserve Bounces, Huge Bond Rally Marginally Helped the Bank’s Financial Assets Trim Losses
-Deposit Liabilities Under Sustained Pressure! Stagnation of February Loan and Investment Growth Persists!
-NPLs Rocket Anew in February! Banks in a Panic Borrowing Spree Again!
-Summary: A Critical Chapter Of History in the Year of the Pig!
A Critical Chapter Of History Unfolds: Historic Yield Curve Inversion, Banks Panic Borrow Anew in February as NPLs Soar (Again)!
Record Monetary and Fiscal Stimulus, Debt and Bank and BSP Balance Sheets: Pivotal History Unfolds Right Before Our Eyes!
Several banks made significant disclosures last week. (All bold fonts mine)
Metrobank (April 4, 2019): Metropolitan Bank & Trust Company (“Metrobank”) successfully raised an additional PHP 17.5 billion worth of 3-year bonds after completing its public offer period last 29 March 2019. The bonds were upsized from Metrobank’s initial target of PHP10 billion to accommodate increased demand from institutional, high net worth and retail clients. The oversubscription of the bonds also allowed Metrobank to price at the tighter end of the indicative price guidance. The bonds have a coupon of 6.30%, and will have quarterly coupon payments.
China Banking Corporation (April 4, 2019): Please be informed that during the regular meeting held this afternoon, 03 April 2019, our Board of Directors approved for the Bank to do a fundraising exercise of up to P75 Billion in several tranches for the next three (3) years which may be in the form of Retail Bonds and/or Commercial Papers. The proceeds shall be used to support the Bank's strategic initiatives and expansion programs.
BDO Unibank (April 5, 2019) BDO Unibank, Inc.’s (BDO) offering of Long-Term Negotiable Certificates of Deposit (LTNCD) was driven by solid demand from retail and institutional investors, resulting in total subscriptions of P7.3 B, almost 1.5 times the original offer. As a result, the issue was upsized from the original offer of P5.0 billion, and the offer period was shortened to April 4, 2019. This latest tranche of LTNCDs has a term of five and a half (5 & 1/2) years with interest rate set at 5.375% per annum. The issue date is scheduled on April 12, 2019, while the maturity date will be on October 12, 2024.
Such massive fundraising exercise has signified one of the symptoms of the continuing deterioration of the balance sheets of the domestic banks.
The yield curve inversion represents the other correlated symptom.
Well, pivotal history unfolds right before our eyes, right here, right now!
1. Despite the 175 bps increase implemented in 6-months last year, the Bangko Sentral ng Pilipinas’ (BSP) overnight RRP policy rate remains at historic lows!
2. The BSP’s direct funding of the National Government (NG) or Quantitative Easing has likewise been at uncharted territory!
3. Public spending expressed as fiscal deficits have raced to unparalleled heights in 2018!
The Philippine political economy runs on unprecedented stimulus in the context of monetary and fiscal policies combined!
In the past, such measures where used as “automatic stabilizers” in the face of economic or financial dislocations or crisis. Not this time.
Today, the public has embraced the hallowed path of attaining socio-economic nirvana through the radical transformation of such "automatic stabilizers" into an orthodox set of economic development tools! These are Keynesian policies running at full throttle.
Yet more symptoms…
The total of the banking system’s credit portfolio plus the public debt have rocketed to a milestone of 90.88% of the GDP in 2018!
Public spending to GDP has rocketed from a 32-year average of 17.05% to 19.56%!
To add the proverbial icing to the cake, the inversion of the Philippine treasury yield curve represents next breakthrough repercussion from easy money policies!
First Ever Yield Curve Inversion Since At Least 2001!
Figure 1
Based on the (end of period) monthly data depicting yields of the 3-month and 6-month T-Bills against the benchmark 10-year T-bonds, for the FIRST time since at least 2001, the yield spread has TURNED NEGATIVE! (10-year, 3-month, and 6-month yield data from investing.com)
And that’s not all.
The negative or the convex slope can even be seen at Asian Development Bank’s ASIAN BONDS ONLINE (as of April 4th)! (figure 1, middle chart)
Only the Philippines, among Asian nations in the ambit of the ADB, have been afflicted by an inverted curve!
The closest to the Philippines has been Singapore (partial inversion), Hong Kong (flat) and Japan (flat-front) (as of April 4th).(figure 1, lower chart)
The Bear Steepener: Will the BSP Ease Soon to Recombust Inflation?
Rising yields (falling bond prices), which has accompanied the global Risk ON, has led to the partial widening of spreads.
Some of the negative yield variances, such as in the US, have eased from last week’s bounce in inflation expectations.
Combined with the Philippine government’s announcement of March CPI which stumbled to 3.3%, the slope of the Philippine treasury market had a ‘bear steepener’ or rates of the long-term rising faster than the short-term last week. (figure 2, upper window)
Like in the US, the ‘bear steepener’ has mitigated parts of the inverted curve.
While one week does not a trend make, a persistent ‘bear steepener’ translates to market expectations that the BSP will prospectively conduct easing of its monetary policies soon that should rekindle inflation!
Figure 2
Whether the treasury curve steepens sharply or not, in response to prospective BSP's actions, remains to be seen.
If history should be a guide, the bear steepner would likely have a marginal effect.
In response to disinflation, the BSP’s nuclear option was launched in late 2015 and was followed by an aggressive cut in overnight policy rates in June 2016 to 3%, a historic low, under the camouflage of embracing the corridor system, the treasury curve barely steepened.
With two radical policies in place, short term rates fell modestly at the end of 2016. But this was short-lived. Short-term rates recoiled higher at the close of 2017 and FLEW at the end of 2018! Despite plunging CPI, and last week’s marginal retracements, yields of 1-month and 3-month T-Bills remain HIGHER than 2018’s! (see figure 2, lower window)
Of course, the yield curve inversion signifies one of the many belated symptoms of the easy money policy adopted by the BSP.
Though the BSP’s record low policy rates and QE remain in place, the yield curve inversion reveals the tightening of financial and monetary conditions in the banking and financial sectors. The crowding out effect from the massive public spending projects has also served as an aggravating factor.
As a side note, the BSP has yet to publish the balance sheets of the non-bank with quasi-banking functions. 1Q has come and gone. Why the long delay? Has the industry been late in submitting their reports to the BSP? Has the BSP been withholding the industry’s data? The BSP’s balance sheet has yet to be updated too. November was the last published data. Suddenly, publication of government statistics has lagged, why?
The treasury yield curve conundrum represents the BSP’s Achilles heels.
Philippine Banks: February Cash Reserve Bounces, Huge Bond Rally Marginally Helped the Bank’s Financial Assets Trim Losses
The BSP published an update of the banking system’s balance sheet last week.
First the good news.
Figure 3
The BSP’s liquidity ratios improved last February. The ratio of Cash and due banks climbed to 19.54% from 18.85% a month ago but was down from 21.61% a year ago. The ratio of liquid assets to deposits (cash plus financial assets excluding equity investments) also firmed from 46.81% in January to 47.55% but was slightly lower at 47.61% a year ago. (figure 3, upper window)
The banking system’s cash reserves fell Php 99.8 billion year-on-year, an improvement from January’s contraction of Php 238.9 billion. On a month-on-month basis, cash reserves climbed Php 93.5 billion significantly up from January’s shrinkage of Php 239.8 billion.
A Bloomberg headline, republished by the Manila Bulletin, read: Philippine bonds blow away global peers as inflation slides. What the headline failed to mention was that T-Bills didn’t rally with the bonds, hence the inverted curve.
Here’s the other unstated effect: the buying blitzkrieg of Philippine bonds reduced, but has not eliminated, the banking system’s stashing of fixed income assets to Held-to-Maturity.
Year on year, HTM assets grew by a still significant 26.52%, but this was down from 32.73% in January and 56.54% in December. On a nominal basis, Php 510.3 billion was added to the HTM category, year on year. On a month on month basis, HTM assets fell -.2%, the first m-o-m decline since November 2017. The banking system’s HTM assets dropped by Php 516.3 million in February from an increase of Php 20.6 billion a month ago.
As a share of gross financial assets, HTMs contribution decreased 68.71% in February from 68.99% a month ago. The share contribution of Available for Sale (AFS) and Held for Trading (HFT) assets improved to 23.5% and 7.31% in February from 23.28% and 7.09% in January. (figure 3, middle window)
The marvelous 'blow out' rally in Philippine bonds, brought about by the global risk ON and collapsing inflation ameliorated, marginally, the banking system’s financial asset performance.
The banking system’s accumulated gains/losses revealed a material improvement. Though it still registered a loss of Php 1.49 billion in February, this was 44% lower than January’s Php 2.7 billion. Since November 2017, banks reported deficits in fourteen of the fifteen months. February’s red ink was, by far, the least during the given period. (figure 3, lower window)
But will such conditions last?
Should the “bear steepener” persist and inflation rekindled, will these interim gains reverse? What would happen when markets begin to smell of the credit risk issues?
Finally, banks continue to pile in on direct investments on their subsidiaries or joint ventures. February registered a 15.9% gain year on year or Php 42.5 billion.
Deposit Liabilities Under Sustained Pressure! Stagnation of February Loan and Investment Growth Persists!
Now the unpleasant developments.
If the banking system’s cash reserves had been enhanced in February, what was the source of their improvements? Since financial investments produced still negative returns, have banks been issuing more loans? Have delinquencies been abated?
Figure 4
The banking system’s total net investment growth slumped to 14.57% in February from 18.7% in January and 18.98% in December 2018.
On the other hand, the growth of total net loan portfolio inclusive of interbank lending and repurchase agreements was almost unchanged in February at 12.6% from 12.62% in January but was steeply down from 13.9% in December 2018. (figure 4, upper window)
Bluntly put, the first two months of 2019 has exhibited a considerable slowdown of the banking system’s core business.
And nope, the banking system’s core business, as well as investments, hasn’t been the source of cash reserves growth.
To the contrary, February's data showed the acceleration of the corroding trend of the deposit liabilities of the Philippine banking system.
Total deposit growth registered 6.25% in February sharply down from 6.91% in January and 8.82% in December 2018. (figure 4, middle window)
Peso deposits growth slid to 6.89% in February from 7.74% in January and 9.13% in December. Savings deposit growth, which accounted for 46.3% of peso deposits, fell 6.34%, from 7.69% and 7.9%. Time deposit growth, which has a 23.97% share, also dived to 7.25% from 8.3% and 11.21%, respectively. Demand and NOW accounts, which has a 27.53% share of peso deposits, gained slightly to 6.65% from 6.34% but was down sharply from December’s 8.575.
In the meantime, foreign currency deposits eked out a 3.21% gain in February, better than 3.02% in January, but remains more than half lower than December 2018’s 7.26%.
As one can see, the funding base for the sector’s loan issuance or core business continues to SHRINK BIG TIME!
Except for cash reserves, the growth rate of peso deposits, the Banking system’s loans outstanding (production plus household loans), and M3 have continued with its streak of declines! And the 5-month 50% collapse of the CPI rate from 6.7% in October 2018 to 3.3% in March 2019 has only reinforced the spreading of the slowdown in the REAL economy.(figure 4, lower window)
In explaining their policy of inflation targeting, the BSP wrote: “Given the desired level of inflation consistent with economic growth objectives, it is assumed that the BSP can determine the level of money supply needed; thus, the BSP indirectly controls inflation by targeting money supply”
February’s M3 growth at 7.21% has astoundingly plumbed to 2012 levels!
I don’t think that the 175 bps of increase in the overnight policy rates constitutes as “BSP indirectly controls inflation by targeting money supply”.
NPLs Rocket Anew in February! Banks in a Panic Borrowing Spree Again!
The deflationary impulse that the banking system has presently been undergoing must have emanated from the undeclared Non-Performing Loans (NPLs).
Figure 5
Net Non-Performing Loans rocketed anew in February. The Net NPL ratio soared to 1.26% from 1.07% in January. The Net NPLs signifies the declared bad loans.
What must be the scale of bad loans embedded in the sector enough to shrivel money supply growth and the banking system’s cash reserves?
Aside from malinvestments and the apparent fall in lending standards as demonstrated by the Hanjin debacle, would the closure of Boracay not have escalated the surging trend of bad loans?
The corrosion of the banking system’s ability to fund its core business has been evident by the escalation in bad loans. To offset these and to replenish reserves to serve as financing base for its loans, banks have been increasingly relying onmore expensive source of funding.
The banking system continued their panic borrowing spree in February!
Bills payable growth year on year jumped 31.96% in February from 26.06% in January and 18.64% in December 2018. Bonds payable growth skyrocketed 163% in February from 142.13% and 150.42%! Long Term Negotiable Certificate of Deposits (LTNCD) advanced 18.86% in February, but down from 21.63% in January and 21.62% in December.
In pesos, year on year, T-bill borrowing rose Php 196.9 billion while Bond borrowing also registered a hike of Php 196.3 billion. From a month-on-month perspective, banks reduced T-bills by Php 8.97 billion but added Php 48.3 billion in T-Bonds
The select bank disclosures presented above accentuates such dynamic going forward.
Plainly stated, these disclosures will reveal itself as the deepening entrenchment of the current dynamic through future bank statistics.
And as the competition for access to the public’s diminishing savings between the National Government and Banks, such pressures have been ventilated in the treasury markets through higher short-term yields.
And even if the BSP eases by freeing up the Reserve Requirement Ratio (RRR) to increase the banking system’s cash reserves, or chop rates all the way down to 3% or lower, or print with reckless abandon peso to fund public expenditures, for as long as undeclared NPLs remain unresolved, pressures on liquidity will continue to mount.
Summary: A Critical Chapter Of History in the Year of the Pig!
Through negative spreads or yield curve inversion, the domestic treasury markets have been pushing back against record amounts of stimulus injected on the system.
Another symptom of the backlash from the BSP’s easy money policies has been the deteriorating balance sheet of the banking system.
In February, the banking system saw slight gains in cash reserves. Brought about by global risk ON and falling inflation, the banking system’s financial asset, and investment performance improved as well.
With the appearance of the “bear steepener” such investment gains are likely to be capped. A sustained bear steepener signals possible easing by the BSP that may reignite inflation. And a return towards a steep slope is unlikely given the banking system’s conditions. Furthermore, history has reinforced such perspective.
The radical easing espoused by the BSP in 2015 and 2016 had ephemeral positive effects. In contrast, it has only intensified the imbalances that have resulted to “shocks that have caused dislocations of crisis proportions have come as a surprise” as admonished by the Financial Stability Coordinating Council (FSCC).
To add salt to the injury, not only has the FSCC’s repricing, refinancing and repayment risks (3Rs) become apparent, via the banking system’s NET NPL, but it continues to bulge.
Even more, falling cash reserves, dropping growth rates of bank lending, M3 and CPI confirm the ongoing slowdown in the real economy.
With deposit base under pressure, banks have shifted its funding operations through borrowing binge! Such borrowing spree would raise the cost of funding and reduce the industry’s interest margins.
Moreover, the competition for access to the public savings between the NG and the banking system will only accelerate that would likely intensify the anomalies in the Treasury's yield curve.
As you can see, a critical chapter of history has been unfolding in the year of the pig!
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