Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production. Thus, the Misesian theory of the business cycle accounts for all of our puzzles: The repeated and recurrent nature of the cycle, the massive cluster of entrepreneurial error, the far greater intensity of the boom and bust in the producers' goods industries—Murray N. Rothbard
In this issue
2023 Philippine Banking Profits Up by 17.7%; BSP’s Twin Dilemma: Promoting Capital Markets by Subsidizing Universal Banks? The Real Estate Paradox
I. 2023 Philippine Banking Profits Up by 17.7%: Powered by Net Interest Income as Non-Interest Income Declined
II. Corroding Bank Liquidity Amidst Record Peso Profits?
III. Underreported NPLs? The Slowing Real Estate Industry
IV. Market Losses Ease as Record Held-to-Maturity Assets Worsened Bank Liquidity Conditions
V. 2023: Universal-Commercial Bank Monopolization of Philippine Financial Resources
VI. BSP’s Twin Dilemma: Promoting Capital Markets by Subsidizing Universal-Commercial Banks? Real Estate Contradictions
2023 Philippine Banking Profits Up by 17.7%; BSP’s Twin Dilemma: Promoting Capital Markets by Subsidizing Universal Banks? The Real Estate Paradox
Though profits of Philippine banks increased by 17.7% in 2023, the industry's liquidity gap has only widened. Why? This post explains the BSP's Twin Dilemma on promoting the capital markets and the real estate paradox.
I. 2023 Philippine Banking Profits Up by 17.7%: Powered by Net Interest Income as Non-Interest Income Declined
Businessworld, February 12, 2024: THE NET INCOME of the Philippine banking industry rose by 14.4% last year amid higher interest income and trading gains, according to central bank data. Banks’ net income rose to P354.93 billion from P310.12 billion in 2022, spurred by a 20% year-on-year increase in net interest income to P906.872 billion. Noninterest income fell by 15.8% to P218.93 billion from P259.89 billion in 2022.
Figure 1
The Philippine banking system reported 17.7% net income in 2023, down from 34.34% and 35.06% in 2022 and 2021. (Figure 1, topmost graph)
The 14.5% net income growth reported by the media accounted for the Q4 2023 performance. (Figure 1, middle chart) Q4's 14.5% was above Q3's 11.3% but signified the second-lowest growth rate since Q1 2021. Rising rates have capped bank net income.
Interestingly, interest income represented the bank's primary source of earnings, as non-interest income fell by 12.6% in 2023 and 15.8% in Q4, mainly from the decrease in profits from the sale of assets. (Figure 1, lowest diagram)
Figure 2
Yet, the ratio of net interest income to total operating income surged to record highs last Q4. (Figure 2, topmost chart)
Fascinatingly, the net interest income record surge comes amid the falling bank lending growth rate, whereas financial investments bounced in Q4. (Figure 2, middle pane)
Last December, bank lending (exclusive of Interbank loans and Repo transactions) increased by 7.6%, the slowest rate since April 2022's 7.34%.
Despite surging consumer loans, cascading supply-side loans—which made up the bulk—resulted in its slowdown. Nonetheless, compared to the previous rate hikes of 2019, the impact of multi-year high rates has been minimal.
On the other hand, net investments jumped by 10.96%, the highest since August 2023.
Paradoxically, despite the record 2023 profits in peso, some banks continue to raise funding via the capital markets in 2024, namely, BDO's Php 63 billion sustainable bonds, Rizal Commercial Bank's USD 400 million unsecured sustainable bonds, and Union Bank's 10 billion stock rights offering.
Ironically too, the record net income comes amidst the surge in the banking system's funding costs, which have risen alongside the BSP's rates to 2019 levels. (Figure 2, lowest graph)
Figure 3
Further, despite higher rates, December reinforced the decreasing trend of deposit liabilities growth with 7.05%—a five-month low. Peso deposits grew by 6% compared with the 13.2% of FX accounts. (Figure 3, topmost graph)
Last December, peso deposits comprised 84% of the total, while FX deposits accounted for the remaining 14%.
II. Corroding Bank Liquidity Amidst Record Peso Profits?
Because of the insufficiency of deposit growth, banks have tapped the pricier capital markets for funding—mainly tilted towards short-term T-bills. (Figure 3, middle window)
It has also increased access to the BSP's repo facilities. December repo transactions hit a record high. (Figure 3, lowest graph)
Figure 4
BSP data also shows the biggest-ever use of BSP securities (bills) by the financial system. (Figure 4, topmost window)
That's right. Despite the profusion in published profits, the industry has been raising funding for short-term requirements. Why?
Based on BSP metrics, bank liquidity continues to erode.
No matter how one slices and dices the data (monthly or annually), cash-to-deposits and liquid assets-to-deposits continue with their downtrend. (Figure 4, middle graph)
Corroding liquidity has not only been evident in the decreasing growth of bank loans, peso deposits, and cash reserves, but it also became apparent in M3 (from 7.01% in November to 5.9% in December). (Figure 4, lowest chart)
As a caveat, these conditions are in general. However, several sectors have benefited from bank credit expansion or implied (selective) loosening of financial conditions, like the government, consumers, and real estate.
Public debt closed the year at a record high of Php 14.62 trillion. Total systemic leverage (bank credit and public debt) rose 8.53% YoY in December to a record Php 26.94 trillion. The PSEi posted a 2.04% return in Q4 2023, fundamentally from the 7.97% November and December returns.
Basically, while bank credit expansion slowed, it closed the year at record levels in pesos.
III. Underreported NPLs? The Slowing Real Estate Industry
Figure 5
Non-performing assets have reportedly been declining. (Figure 5, topmost chart)
Increasing performing loans should optimize the use of bank resources, which should add to the bank's liquidity—unless underreporting has been rampant (also possibly shielded by relief measures).
The media provides clues on the likely understating of credit delinquencies.
Businessworld, February 13, 2024: THE VACANCY RATE for residential property in Metro Manila will likely hit up to 18% in the first quarter of 2024 due to the sizable completions of new condominium units, Colliers Philippines said. “Residential vacancy definitely will not drop below 17%. Between 17.5-18%, that’s the vacancy that we’ll likely see for the first quarter of 2024,” Colliers Philippines Research Director Joey Roi H. Bondoc told BusinessWorld on the sidelines of a briefing last week. You still have sizable number of completed units on the market so it will take time before the vacancy drops,” he added. According to Mr. Bondoc, there is a “lukewarm demand” in the pre-selling or primary market due to higher interest rates and mortgage rates which discourage investors to buy completed condominium units. (bold mine)
The real estate sector is the biggest client of the banking system.
Because the total bank's real estate supply-side loans bounced strongly in the last three months of 2024 (October 8.2%, November 11.6%, and December 10.6%), their % share of total bank lending spiked to approach their highs in the 1H 2022. (Figure 5, middle pane)
In the meantime, total bank construction loans also soared by 9.8% in October, 8.9% in November, and 10.1% in December.
"Real" Household construction GDP surged 9.6% in Q4 2023, while Financial and non-financial construction GDP grew by 5.6%.
Meanwhile, "real" real estate (transactional: buy, sell, rent, and others) GDP grew by 5.6% in Q4 2023.
According to the BSP's real estate index as of Q3, NCR (all types of housing) prices surged by 12.3%, while national prices jumped by 12.9%.
The point of the above is that there was a brisk uptake in the supply side in the real estate sector nationwide, unsupported by demand for residential projects (in the NCR).
And in support of these has been heightened speculative demand in the secondary market (reason for price increases).
The real estate sector has used excess liquidity (bank credit expansion) to bridge its financial deficits or liquidity gap.
Since the sector breathes in the oxygen of credit, it can't afford a genuine tightening by the BSP. Also, the BSP won't tolerate a deflation in real estate values that adversely impacts collateral values, which backs bank loans that would rattle the banking sector's balance sheets. That's why the BSP enforced an asymmetric policy, focusing on headline tightening accompanied by various exceptions.
Yet, due to the BSP's Universal Commercial bank lending restriction (which was extended from 20% to 25% in 2020), the published Real Estate loans could be underreported and shifted into other categories.
Most importantly, the real estate's contribution to the national GDP has dropped to a record low in Q4 2023, even as their % share of the total bank lending rebounded to 20.2% (Figure 5, lowest chart)
And as previously predicted, due to "integrated communities," once confined to office spaces have spread to residential areas.
The thing is, though office spaces are the concern here, all other segments of the property sector constitute part of such "integrated communities," which therefore extrapolates to interconnection.
By extension, it also means that the paradigm of "integrated community" is codependent not only on the vibrancy of the office properties but also residential, shopping malls, hotels, logistics and commercial hubs, and other related structures.
Indeed, the dilemma of the office segment, the weakest link of the commercial real estate sector (CRE), should spread to other areas. (Prudent Investor 2013)
Therefore, unless disposable income and savings rise, high rates of vacancies are likely symptomatic of present and forthcoming credit delinquencies—which are also symptoms of overspending and malinvestments—that are about to impact the liquidity, balance sheet and income statements of the banking industry. It should affect the economy, over time, as well.
Surprisingly, the BSP noticed this too. But they have been caught in a pickle (see below discussion on their 2023 Financial Stability Report).
IV. Market Losses Ease as Record Held-to-Maturity Assets Worsened Bank Liquidity Conditions
Back to the bank’s balance sheet.
Figure 6
Net financial assets slipped from its All-Time High last December. However, buoyant capital markets (fixed income and stocks) mitigated its mark-to-market losses by 59.8%, from Php 68.234 billion in November to Php 49.343 billion in December. (Figure 6, topmost graph) Easing losses should have allayed the liquidity strains.
Last but not least, despite a bounce from a growth slowdown due to falling yields, the bank's held-to-maturity (HTM) continued to carve a streak of record highs. (Figure 6, middle window)
HTMs grew by 5.7% in December— to a record high of Php 4.022 trillion. HTMs accounted for 16% of the banking system's total assets, 21.1% of deposit liabilities, and 138% of cash reserves.
Banks continue to amass HTMs primarily via net claims on central government (NCoCG) or due to the monetizing of public debt. Bank NCoCG closed 2023 with Php 5.19 trillion. (Figure 6, lowest chart)
As previously explained, shielding mark-to-market deficits via juggling accounting identity through HTMs erodes bank liquidity.
The ultimate paradox is that market losses, under-declared NPLs, and record HTMs have drained bank liquidity conditions in the face of supposed record earnings.
V. 2023: Universal-Commercial Bank Monopolization of Philippine Financial Resources
But there is more.
In their latest Financial Stability Report, the BSP-led Financial Stability Coordinating Council (FSCC) argued that the capital markets must increase their contribution to economic financing.
Banks have long been the major funding source for the economy. Nothing in the current environment will change that. But bank loans must price credit risk and liquidity risk because the money they lent out is itself borrowed from the public. Provisioning takes the conservative view by adjusting the size of the balance sheet, but it does not rectify the liquidity gap should a loan account become payment impaired.
This is where we heed Greenspan’s reminder that spare tires are necessary where there is that unexpected flat tire. Capital market development has been a longstanding mantra, but this segment of the market remains modest vis-Ã -vis bank loans. Several initiatives have already been put in place. We look forward to more initiatives and, in particular, our attention is to provide corporates from different credit backgrounds with access to this market. This will require better signaling of risk pricing:
a. Updating of issuer and issue ratings through the credit cycle.
b. Determining spot rates to ensure comparability through properly discounted future cashflows.
c. Aligning risk pricing between loans and securities to reflect structuring and information costs (BSP FSCC, 2024) [bold original, italics mine]
Fascinating. But the BSP's data shows otherwise.
Figure 7
In 2023, the total financial resources grew by 7.59% to an unprecedented Php 31.06 trillion or a record 147% of the 'real' GDP. (Figure 7, upper chart)
Bank financial resources grew by 8.62% to a milestone of Php 25.86 trillion or an unparalleled 122.8% of the GDP. The bank's share of the total financial resources hit a historic 83.3%!
The gist of this growth emanated from Universal-Commercial banks, which expanded 8.43% to a landmark high of Php 24.26 trillion, or a monumental 115.2% of the headline GDP. The UC bank share reached an epic 78.1% of the total! (Figure 7, lower diagram)
VI. BSP’s Twin Dilemma: Promoting Capital Markets by Subsidizing Universal-Commercial Banks? Real Estate Contradictions
Despite the fog of technical gobbledygook supposedly aimed at improving capital markets, the BSP seems to have ignored the following basics and facts:
-UC banks have been monopolizing financial resources at the expense of non-UC banks, non-bank financials, and the capital markets. Monopolization (Too big to fail) redounds to mounting concentration risks.
-UC bank borrowings from the public (to fund the government) have contributed to the crowding out of the economic resources.
-The BSP seems to have forgotten a fundamental political-economic adage, popularly attributed to ex-US President Ronald Reagan, "If you want more of something, subsidize it; if you want less of something, tax it."
Historic injections, unprecedented monetary policies, and unmatched relief measures have supported and continue to subsidize UC banks.
-Permitting the price rigging of the marketplace (or mispricing/falsified price signals) impacts the economy via the aggravation of the accumulation of misallocation of resources (malinvestments).
-Boom-bust cycles from the constant intervention or manipulation of interest rates (low rates) consume savings and capital, weakening the economy over time (via malinvestments) while increasing various credit-related and market risks channeled through the banking system. The growing liquidity gap is an expression of this.
Present or incumbent policies contribute to entropy and not the development of the capital markets.
Going back to the quandary over real estate conditions, the BSP seems caught in a bind.
Real estate will always be closely monitored given its stylized role in the boom-and-bust cycle. At present, there seems to be some surprising trends in the residential sector, with prices rising in tandem with vacancies. With the loan portfolio of banks significantly invested in real estate activities, prudence requires a second look. Are housing prices rising because of the rising cost of construction and development? Is this, instead, an indication of generational wealth planning getting ahead of the supply that has been delayed by COVID-19? Or is this a more ominous sign? (BSP FSCC, 2024) [bold italics mine]
The boom cycle is not a sign of strength. Instead, these are speculative activities funded by easy money or loose financial conditions that lead to a bust. In short, the artificial boom results in a bubble bust.
Engineering a stock market bubble, comprising part of boom-bust cycles, only worsens such imbalances.
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References
Murray Rothbard, Economic Depressions: Their Cause and Cure, Mises.org, June 25, 2012
Prudent Investor, Philippine Real Estate: Mainstream Expert Worried Over Increasing Demand-Supply Gap; Q1 2023 Data of Top 5 Listed RE Firms and the Property Index, May 29, 2023
FINANCIAL STABILITY COORDINATION COUNCIL, 2023 FINANCIAL STABILITY REPORT December 2023, BSP.gov.ph, p.39 and p.38
