Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility

Debt-fueled booms all too often provide false affirmation of a government’s poli­cies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly—Carmen Reinhart and Kenneth Rogoff 

Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility 

In this issue: 

Part 1: Earnings Erosion and the Mask of Stability

1.A NPLs Fall, But Provisions Rise: A Tale of Two Signals

1.B Philippine Bank’s Profit Growth Falters: Q2 Deficit Breaks the Streak

1.C Universal and Commercial Banks Lead the Weakness; PSE Listed Banks Echo the Slowdown

1.D Income Breakdown: Lending Boom Masks Structural Risk

1.E CMEPA’s Gambit: Taxing Time Deposits to Diversify Bank Income

1.F The Real Culprit: Exploding Losses on Financial Assets

1.G San Miguel’s Share Plunge: A Canary in the Credit Mine? Beneath the Surface: Banks Signal Stress

1.H The NPL Illusion: Velocity Masks Vulnerability

1.I Benchmark Kabuki: When Benchmark-ism Meets Market Reality

Part 2: Liquidity Strains and the Architecture of Intervention

2.A Behind the RRR Cuts: Extraordinary Bank Dependence on BSP

2.B RRR Infusions: Liquidity Metrics Rebound; Weak Money Creation Amid Record Deficit Spending

2.C Rising Borrowings Reinforce Funding Strains, Crowding Out Intensifies, Record HTM Assets

2.D Divergence: Bank Profits, GDP and the PSE’s Financial Index; Market Concentration

2.E OFCs and the Financial Index: A Coordinated Lift?

2.F Triple Liquidity Drain; Rescue Template Risks: Inflation, Stagflation, Crisis; Fiscal Reflex: Keynesian Response Looms

2.G Finale: Classic Symptoms of Late-Cycle Fragility 

Philippine Banks: June’s Financial Losses and Liquidity Strains Expose Late-Cycle Fragility 

From earnings erosion to monetary theatrics, June’s data shows a banking system caught in late-cycle strain.

Part 1: Earnings Erosion and the Mask of Stability 

1.A NPLs Fall, But Provisions Rise: A Tale of Two Signals 

Inquirer.net August Bad loans in the Philippine banking system fell to a three-month low in June, helped by the central bank’s ongoing interest rate cuts, which could ease debt servicing burden. However, lenders remain cautious and have increased their provisions to cover possible credit losses. Latest data from the Bangko Sentral ng Pilipinas (BSP) showed nonperforming loans (NPL), or debts that are 90 days late on a payment and at risk of default, cornered 3.34 percent of the local banking industry’s total lending portfolio. That figure, called the gross NPL ratio, was the lowest since March 2025, when the ratio stood at 3.30 percent. 

But the NPL ratio masks a deeper tension: gross NPLs rose 5.5% year-on-year to Php 530.29 billion, while total loans expanded 10.93% to Php 15.88 trillion. The ratio fell not because bad loans shrank, but because credit growth outpaced them. 

Loan loss reserves rose 5.5% to Php 505.91 billion, and the NPL coverage ratio ticked up to 95.4%. Past due loans climbed 9.17% to Php 670.5 billion, and restructured loans rose 6.27%. Provisioning for credit losses ballooned to Php 84.19 billion in 1H 2025, with Php 43.78 billion booked in Q2 alone—the largest since Q4 2020’s pandemic-era spike. 

So, while the establishment cites falling NPL ratios to reassure the public, banks are quietly bracing for defaults and valuation hits—likely tied to large corporate exposures. The provisioning surge is a tacit admission: risk is rising, even if it hasn’t yet surfaced in headline metrics.

1.B Philippine Bank’s Profit Growth Falters: Q2 Deficit Breaks the Streak

Figure 1

Philippine banks posted their first quarterly profit contraction in Q2 2025, down -1.96% YoY—a sharp reversal from Q1’s 10.64% growth and Q2 2024’s 5.21%. This marks the first decline since Q3 2023’s -11.75%. (Figure 1, upper window) 

Even more telling, since the BSP’s historic rescue of the banking system in Q2 2021, net profit growth has been trending downward. Peso profits etched a record in Q1 2025, but fell in Q2. 

The Q2 slump dragged down 1H performance: bank profit growth slipped to 4.14%, compared to 2H 2024’s 9.77%, though slightly higher than 1H 2024’s 4.1%. 

1.C Universal and Commercial Banks Lead the Weakness; PSE Listed Banks Echo the Slowdown 

Earnings growth of universal-commercial (UC) banks sank from 8.6% in Q1 2025 to a -2.11% deficit in Q2. 

UC bank profits grew 6.33% in Q2 2024. Still, UC banks eked out a 3.1% gain in 1H 2025 versus 5.3% in the same period last year. UC banks accounted for 93.1% of total banking system profits in 1H 2025—underscoring their dominance or concentration but also their vulnerability. 

PSE listed banks partially echoed BSP data. (Figure 1, Lower Table) 

Aggregate earnings growth for all listed banks hit 6.08% in Q2 and 6.77% in 1H—down from 10.43% and 9.95% in the same periods last year. The top three banks in the PSEi 30 (BDO, BPI, MBT) reported combined earnings growth of 4.3% in Q2 and 5.31% in 1H 2025, substantially lower compared to 13.71% and 15.4% in 2024. 

The discrepancy between BSP and listed bank data likely stems from government, foreign, and unlisted UC banks—whose performance may be masking broader stress. 

1.D Income Breakdown: Lending Boom Masks Structural Risk 

What explains the sharp profit downturn?

Figure 2

Net interest income rose 11.74% in Q2, while non-interest income increased 14.7%—slightly higher than Q1’s 11.7% and 14.5%, respectively. However, net interest income was lower than Q2 2024’s 14.74%, while non-interest income rebounded from -5.71% in the same period. (Figure 2, topmost chart) 

In 1H 2025, net interest income grew 11.7%, and non-interest income rose 14.6%, compared to 15.53% and -8.83% in 1H 2024. Net interest income now accounts for 82.5% of total bank profits—a fresh high, reflecting the lending boom regardless of BSP’s rate levels. 

This share has reversed course since 2013, rising from ~60% to 77% by end-2024—driven by BSP’s easy money policy and historic pandemic-era rescue efforts. Banks’ income structure resembles a Pareto distribution: highly concentrated, and extremely susceptible to duration and credit risks. 

BSP’s easing cycle has not only failed to improve banks’ core business, but actively contributed to its decay.

1.E CMEPA’s Gambit: Taxing Time Deposits to Diversify Bank Income 

The government’s response has been the Capital Market Efficiency Promotion Act (CMEPA). CMEPA, effective July 2025, imposes a flat 20% final withholding tax on all deposit interest income, including long-term placements. 

By taxing time deposits, policymakers aim to push savers into capital markets, boosting bank non-interest income through fees, trading, and commissions. But in reality, this is financial engineering. (Figure 2, middle graph) 

With weak household savings and low financial literacy, deposit outflows will likely shrink banks’ funding base rather than diversify their revenues. 

It would increase time preferences, leading the public to needlessly take risks or gamble—further eroding savings. 

Or, instead of reducing fragility, CMEPA risks layering volatile market income on top of an already over-concentrated interest income model. 

We’ve previously addressed CMEPA—refer to earlier posts for context (see below) 

1.F The Real Culprit: Exploding Losses on Financial Assets 

Beyond this structural weakness, the real culprit behind the downturn was losses on financial assets. 

In Q2 2025, banks posted Php 43.78 billion in losses—the largest since the pandemic recession in Q4 2020—driven by Php 49.3 billion in provisions for credit losses!  (Figure 2, lowest image) 

For 1H 2025, losses ballooned 64% to Php 73.6 billion, with provisions reaching Php 84.19 billion. 

Once again, this provisioning surge is a tacit admission: while officials cite falling NPL ratios, banks themselves are bracing for valuation hits and potential defaults, likely tied to concentrated corporate exposures. 

1.G San Miguel’s Share Plunge: A Canary in the Credit Mine? Beneath the Surface: Banks Signal Stress

Figure 3

Could this be linked to the recent collapse in San Miguel [PSE: SMC] shares? 

SMC plunged 14.54% WoW (Week on Week) as of August 15th, compounding its YTD losses to 35.4%. (Figure 3, upper diagram) 

And this share waterfall happened before its Q2 17Q 2025 release, which showed debt slipping slightly from Php 1.511 trillion in Q1 to Php 1.504 trillion in 1H—suggesting that the intensifying selloff may have been driven by deeper concerns. (Figure 3, lower visual) 

SMC’s Q2 (17Q) report reveals increasingly opaque cash generation, aggressive financial engineering, and unclear asset quality and debt servicing capacity. 

Yet, paradoxically, Treasury yields softened across the curve—hinting at either covert BSP intervention through its institutional cartel, a dangerous underestimation of contagion risk, or market complacency—a lull before the credit repricing storm. 

If SMC’s debt is marked at par or held to maturity, deterioration in its credit profile wouldn’t show up as market losses—but would require provisioning. This provisioning surge is a tacit admission: banks are seeing heightened risk, even if it’s not yet reflected in NPL ratios or market pricing. 

We saw this coming. Prior breakdowns on SMC are archived below. 

Of course, this SMC–banking sector inference linkage still requires corroborating evidence or forensic validation—time will tell.

Still, one thing is clear: banks are exhibiting mounting stress—underscoring the BSP’s resolve to intensify its easing cycle through rate cuts, RRR reductions, deposit insurance hikes, and a soft USDPHP peg. The ‘Marcos-nomics’ debt-financed deficit spending adds fiscal fuel to this monetary response. 

1.H The NPL Illusion: Velocity Masks Vulnerability

Figure 4

NPLs can be a deceptive measure of bank health. Residual regulatory reliefs from the pandemic era may still distort classifications, and the ratio itself reflects the relative velocity of bad loans versus credit expansion. 

Both gross NPLs and total loans hit record highs in peso terms in June—Php 530.29 billion and Php 15.88 trillion, respectively—but credit growth outpaced defaults, keeping the NPL ratio artificially low at 3.34%. (Figure 4, topmost pane) 

The logic is simple: to suppress the NPL ratio, loan velocity must accelerate faster than the accumulation of bad debt. Once credit expansion stalls, the entire kabuki collapses—and latent systemic stress will surface. 

1.I Benchmark Kabuki: When Benchmark-ism Meets Market Reality 

This is where benchmark-ism hits the road—and skids. The system’s metrics, once propped up by interventionist theatrics, are now showing signs of exhaustion. 

These are not isolated anomalies, but worsening symptoms of prior rescues—now overrun by the law of diminishing returns. 

And yet, the response is more of the same: fresh interventions to mask the decay of earlier ones. Theatrics, once effective at shaping perception, are now being challenged by markets that no longer play along. 

The system’s health doesn’t hinge on ratios—it hinges on velocity. Velocity of credit, of confidence, of liquidity. When that velocity falters, the metrics unravel. 

And beneath the unraveling lies a fragility that no benchmark can disguise. 

Part 2: Liquidity Strains and the Architecture of Intervention

2.A Behind the RRR Cuts: Extraordinary Bank Dependence on BSP 

There are few signs that the public grasps the magnitude of developments unfolding in Philippine banks. 

The aggregate 450 basis point Reserve Requirement Ratio (RRR) cuts in October 2024 and March 2025 mark the most aggressive liquidity release in BSP history—surpassing even its pandemic-era response. (Figure 4, middle chart) 

Unlike previous easing cycles (2018–2019, 2020), where banks barely tapped BSP liquidity, the current drawdown has been dramatic. 

As of July, banks had pulled Php 463 billion since October 2024 from the BSP (Claims on Other Depository Corporations)—Php 84.6 billion since March and Php 189.2 billion in June. Notably, 40.9% of the Php 463 billion liquidity drawdown occurred in July alone. 

This surge coincides with mounting losses on financial assets and record peso NPLs—masked by rapid credit expansion, which may be a euphemism for refinancing deteriorating debt. Banks’ lending to bad borrowers to prevent NPL classification is a familiar maneuver. 

When banks incur significant financial losses—whether from rising NPLs, credit impairments, or mark-to-market declines—the immediate impact is not just weaker earnings but a widening hole in their funding structure. The December 2020 episode, when the system booked its largest financial losses, highlighted how such shocks create a liquidity vacuum: instead of recycling liquidity through lending and market channels, banks are forced to patch internal shortfalls, draining capital buffers and eroding interbank trust. 

Into this vacuum steps the BSP. Reserve requirement cuts, while framed as policy easing, have functioned less as a growth stimulus and more as a liquidity lifeline. By drawing on their balances with the BSP, banks convert regulatory reserves into working liquidity—filling gaps left by financial losses. The outcome is growing dependence on central bank support: what appears as easing is in fact the manifestation of extraordinary support, with liquidity migrating from market sources to the BSP’s balance sheet. 

This hidden dependence underscores how financial repression has hollowed out market-based liquidity, leaving the BSP as the primary lender of first resort 

2.B RRR Infusions: Liquidity Metrics Rebound; Weak Money Creation Amid Record Deficit Spending

The liquidity drawdown has filtered into banks’ cash positions. As of June, peso cash reserves rebounded—though still down 19.8% year-on-year. Cash-to-deposit ratios rose from 9.87% in May to 10.67% in June, while liquid assets-to-deposits climbed from 47.29% to 49.24%. (Figure 4, lowest image)

Figure 5

RRR-driven cash infusions also lifted deposits. Total deposit growth rebounded from 4.96% in May to 5.91% in June, led by peso deposits (3.96% to 6.3%) and supported by FX deposits (4.42% to 6.8%). (Figure 5, topmost graph) 

Yet paradoxically, despite a 10.9% expansion in Total Loan Portfolio and ODC drawdown, deposits only managed modest growth—suggesting a liquidity black hole. CMEPA’s impact may deepen this imbalance. 

Despite record deficit spending in 1H 2025, BSP currency issuance/currency in circulation growth slowed from 9% in June to 8.1% in July, after peaking at 14.7% in May during election spending. Substantial money creation has not translated into higher CPI or GDP, and the slowdown suggests a growing demand problem. (Figure 5, middle diagram) 

Even with July’s massive ODC drawdown, BSP’s cash in circulation suggests a financial cesspool has been absorbing liquidity—offsetting whatever expansionary efforts are underway. 

2.C Rising Borrowings Reinforce Funding Strains, Crowding Out Intensifies, Record HTM Assets 

After a brief slowdown in May, bank borrowings surged anew by 24% in June to Php 1.85 trillion, nearing the March record of Php 1.91 trillion. Escalating liquidity strains are pushing banks to increase funding from capital markets. (Figure 5, lowest pane) 

This intensifies the crowding-out effect, as banks compete with the government and private sector for access to public savings.

Figure 6

Meanwhile, as predicted, record-high public debt has translated to greater bank financing of government via Net Claims on the Central Government, showing up in banks’ record-high Held-to-Maturity (HTM) assets. HTM assets have become a prime contributor to tightening liquidity strains in the banking system. (Figure 6, topmost graph) 

2.D Divergence: Bank Profits, GDP and the PSE’s Financial Index; Market Concentration 

Despite slowing profit growth, the PSE’s Financial Index—composed of 7 banks (BDO, BPI, MBT, CBC, AUB, PNB, SECB) plus the PSE—hit a historic high in Q1 2025, before dipping slightly in Q2. (Figure 6, middle visual)

Meanwhile, the sector’s real GDP partially echoed profits, reinforcing the case of a downturn. 

Financial GDP dropped sharply from 6.9% in Q1 2025 and 8% in Q2 2024 to 5.6% in Q2 2025. It accounted for 10.4% of national GDP in Q2, down from the all-time high of 11.7% in Q1—signaling deeper financialization of the economy. (Figure 6, lowest chart)

Figure 7

Bank GDP slowed to 3.7% in Q2 from 4.9% in Q1 2025, far below the 10.2% growth of Q2 2024. Since Q1 2015, bank GDP has averaged nearly half (49.9%) of the sector’s GDP. (Figure 7, topmost window) 

Thanks to the BSP’s historic rescue, the free-float market cap weight of the top three banks (BDO, BPI, MBT) in the PSEi 30 rose from 12.76% in August 2020 to 24.37% by mid-April 2025. As of August 15, their share stood at 21.8%, rising to 23.2% when CBC is included. (Figure 7, middle chart) 

This concentration has cushioned the PSEi 30 from broader declines—suggesting possible non-market interventions in bank share prices, while amplifying concentration risk. 

2.E OFCs and the Financial Index: A Coordinated Lift? 

BSP data on Other Financial Corporations (OFCs) reveals a dovetailing of ODC activity with the Financial Index. OFCs—comprising non-money market funds, financial auxiliaries, insurance firms, pension funds, and money lenders—appear to be accumulating bank shares, possibly at BSP’s implicit behest. 

In Q1 2024, BSP noted: "the sector’s claims on depository corporations rose amid the increase in its deposits with banks and holdings of bank-issued equity shares." 

This suggests a coordinated effort to prop up bank share prices—masking underlying stress. (Figure 7, lowest graph) 

Once a bear market strikes key bank shares and the financial index, losses will add to liquidity stress. Economic reality will eventually expose the choreography propping up both the PSEi 30 and banks. 

2.F Triple Liquidity Drain; Rescue Template Risks: Inflation, Stagflation, Crisis; Fiscal Reflex: Keynesian Response Looms 

In short, three sources of liquidity strain now pressure Philippine banks:

• Record holdings of Held-to-Maturity assets
• Rising Financial losses
• All-time high non-performing loans 

If BSP resorts to its 2020–2021 pandemic rescue template, expect the USDPHP to soar, inflation to spike, and rates to rise—ushering in stagflation or even possibly a debt crisis. 

With the private sector under duress from mounting bad credit, authorities—guided by top-down Keynesian ideology—are likely to resort to fiscal stimulus to boost GDP and ramp up revenue efforts. 

2.G Finale: Classic Symptoms of Late-Cycle Fragility 

The Philippine banking system is showing unmistakable signs of late-cycle fragility.

Velocity-dependent metrics are poised to unravel once credit growth stalls. Liquidity dependence is paraded as resilience. Market support mechanisms blur price discovery. Policy reflexes recycle past interventions while ignoring structural cracks. 

Losses are being papered over with liquidity, fiscal deficits are substituting for private demand, and the veneer of stability rests on central bank backstops. This choreography cannot hold indefinitely. If current trajectories persist, the risks are stark: stagflation, currency instability, and a potential debt spiral. 

The metrics are clear. The real story lies in the erosion of velocity and the quiet migration from market discipline to state lifelines. What appears resilient today may be revealed tomorrow as fragility sustained on borrowed time. 

As the saying goes: we live in interesting times. 

____

Prudent Investor Newsletter Archives: 

1 San Miguel

• Is San Miguel’s Ever-Growing Debt the "Sword of Damocles" Hanging over the Philippine Economy and the PSE? December 02, 2024 (substack)
• Escalating Systemic Risk: As Cash Reserves Plummeted, San Miguel’s 9M Debt Zoomed to an Astonishing Php 1.405 TRILLION! November 20, 2023 (substack)

Just among the many…

2 CMEPA

• The CMEPA Delusion: How Fallacious Arguments Conceal the Risk of Systemic Blowback July 27, 2025 (substack)
• The Seen, the Unseen, and the Taxed: CMEPA as Financial Repression by Design July 20,2025 (substack) 

Global Real Estate Services Cautions on Rising Office Vacancies, Top 5 Philippine Property Developers: Mounting Signs of Liquidity Crunch

Causa remota of any crisis is the expansion of credit and speculation while causa proxima is some incident that saps the confidence of the system and induces investors to sell commodities, stocks, real estate, bills of exchange, or promissory notes and increase their money holdings. The causa proxima may be trivial: a bankruptcy, a suicide, a flight, a revelation of fraud, a refusal of credit to some borrowers, or some change of view that leads a market participant with a large position to sell. Prices fall. Expectations are reversed. The downward price movement accelerates. To the extent that investors have used borrowed money to finance their purchases of stocks and real estate the decline in prices is likely to lead to calls for more margin or cash and to further liquidation of stocks or real estate. As prices fall further, bank loan losses increase and one or more mercantile houses, banks, discount houses, or brokerages fail. The credit system appears shaky, and there is a race for liquidity—Charles P. Kindleberger and Robert Z. Aliber 

 

In this issue 

Global Real Estate Services Cautions on Rising Office Vacancies, Top 5 Philippine Property Developers: Mounting Signs of Liquidity Crunch   

I. Global Real Estate Services Cautions on Rising Office Vacancies and Depressed Rents: Blames Hybrid Remote Work and Global Markets 

II. Q3 Real Estate GDP Buoyed by Sales Transactions as Rents Stagnated 

III. Update on Real Estate Malinvestments: Rising Leverage Amidst a Downtrend in the Sector’s Share of GDP  

IV. The Seen: Top 5 Property Developers: Tepid Revenue Growth, Margin Fueled Net Income BOOM! 

V. The UNSEEN: Top 5 Property Firms: 9M Cash Reserves Plunged, Debt and Interest Expense Zoom to Historic Highs! 

VI. Property Industry’s Demand for Rent: Follow the Money and the Slowing Revenue Growth of Retail and Food Chains  

VII. Q3 & 9Ms Financial Performance of the Property Index; REIT Did Better than their Parents 

VIII. Mainstream’s Addiction to Inflationism, Real Estate Bubble Equals the "Fictitious Wealth." 

 

Global Real Estate Services Cautions on Rising Office Vacancies, Top 5 Philippine Property Developers: Mounting Signs of Liquidity Crunch   

The weakest link of the Philippine real estate bubble has been office spaces.  However, the financial performance of the top 5 developers showed that this has spread. 

I. Global Real Estate Services Cautions on Rising Office Vacancies and Depressed Rents: Blames Hybrid Remote Work and Global Markets 

 

Different surveys generate different results. 

 

First, elevated office vacancy rates have capped rent increases, a global real estate services firm recently reported. (all bold mine) 

 

Businessworld, November 16: In a statement on Wednesday, Cushman & Wakefield said office vacancies in Metro Manila rose by 72 basis points (bps) to 16.83% by the end of the July-to-September period from 16.12% in third quarter a year ago. It noted the office market is in a “slow recovery” as remote work schemes remain prevalent among local information technology and business process management (IT-BPM) companies. Quarter on quarter, the Metro Manila office vacancy rate was down 6 bps from 16.9% in the second quarter…Amid the high vacancy rates, landlords have delayed rent increases. Ms. Castro noted average asking rents to have only gone up by 0.15% year on year to P1,042.17 per sq.m. per month as of the end of the third quarter…Claro dG. Cordero, Jr., Cushman and Wakefield director and head of research said, vacancy rates are expected to remain high. “The current structural shift in office space occupation sweeping the global market has also been manifested (despite the relatively higher return-to-office ratio) in the local market, particularly in major CBDs (central business districts). Elevated vacancy rates are likely to persist, as global corporate occupiers brace for hybrid work arrangements and a new legislation is underway that will allow local IT-BPM companies to implement remote work schemes,” he said. 

 

For them, these vacancies were about shifting work preferences (hybrid/remote).   Embedded in it was an appeal to popularity: it's a global trend! 

 

But there's more.  Other factors may be behind these, too. 

 

Mr. Cordero noted that elevated inflation and high interest, along with geopolitical conflicts, may create more market jitters and dampen the market’s recovery. “Lingering prospects of slower economic growth and the high-interest rate environment challenge the expansion of the Philippine REIT (real estate investment trust) market. The onset of a hybrid work scheme, early exit of POGO companies, and ongoing office space rationalization of corporate occupiers generally weigh on expectations of the future growth of office space demand,” he added. 

 

In a nutshell, aside from hybrid work, inflation, high rates, lower economic growth, the exit of POGOs, and cost-cutting measures were also factors.  

Figure 1 

 

Sure, elevated office vacancies signify a worldwide phenomenon post-pandemic. (Figure 1, topmost chart) 

 

But office and commercial real estate vacancies existed before this material shift in consumer demand.  

 

The changing consumer preferences only exposed the unstated portion of the commentary: oversupply or malinvestments. 

 

Put differently, vacancies represent excess inventories.  Such excesses wouldn't have emerged had supplies been controlled or limited.   

 

Importantly, it is a domestic dilemma. Global dynamics only reveal that local developers embraced the perspective that the demand for office spaces was linear. 

 

That's right.   Such excesses represent an error in their business models.  

 

Yet, why have developer-entrepreneurs not forecasted and acted on this?  Why the cluster of entrepreneurial errors that have led to such excesses? And why have incumbent developers been adamantly asserting that demand will recover in the face of the critical shifts in consumer preferences? 

 

II. Q3 Real Estate GDP Buoyed by Sales Transactions as Rents Stagnated 

 

Before continuing, let us shift to the other survey, the Q3 GDP.  

 

According to the Q3 government national account data, real estate was one of the few industries that resisted the general downturn, which had deficit spending as its engine, as earlier explained.  

 

But the sector's activities diverged.  Real estate and ownership of dwellings are its two components.   

 

"Real" real estate GDP jumped from 3.7% to 6.2%, the highest since Q4 2022, while "real" "ownership of dwelling" GDP remained stagnant for four straight quarters with a 2.1% GDP.  The data extrapolates to activities related to buying and selling properties that boosted its GDP, while rental activities had been static for several quarters. (Figure 1, middle graph) 

 

Yet, the industry posted a 4.2% GDP, the highest quarterly growth this year.  

 

As it is, because the property sector outperformed the others, its share of the national pie rebounded to 5.9%, the highest since Q3 2022 of 6%.  

 

In any event, its "outperformance" came amidst a stalling private sector economy, which hardly qualifies as creating more "value added." 

 

III. Update on Real Estate Malinvestments: Rising Leverage Amidst a Downtrend in the Sector’s Share of GDP  

 

Of course, as repeatedly stated here, despite its falling share of the GDP, the property sector's share of banking loans remains in an uptrend.   (Figure 1, lowest chart) 

 

More than anything else, there is a disproportionate distribution in bank financing and the GDP: the sector's share of universal commercial bank loans represented 20% even as its GDP share was only 5.9% (Q3).  

 

Further, the downtrend in the GDP share and the uptrend in the bank loans reveal the impact of diminishing returns of the sector’s leveraged-driven GDP. 

 

A back-of-the-napkin calculation shows that the sector uses a 3.39% share of bank (lending) resources to generate 1 GDP.   Or, to produce more GDP requires even more leveraging! 

 

To cut a long story short, the divergence view of the private sector survey could imply that the real estate GDP may have puffed up the actual contributions of the sector. 

 

What's more.  The public has turned the real estate sector into a casino backed by rapid trade churning in the hope of making a quick buck.  This dynamic comes as vacancy rates in the commercial sector remain elevated. 

 

So many gambled as risks continued to escalate. 

 

But the real estate sector is interconnected. 

 

There has been little realization that the industry has invested primarily in the foundation of the so-called "integrated community structure," anchored on urbanization and its extension of "satellite communities." 

 

Yet, the dynamic preference of consumers became one of the challenges of this model. 

 

And so, influenced by digitalization and pandemic policies, the transformation to hybrid/remote work has rendered a massive "sunk cost" or capital decumulation—signified by oversupply.   

 

Of course, the predicament of the expert assumes a perspective based on the present rates of GDP. 

 

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. (Prudent Investor, May 2023)  

 

IV. The Seen: Top 5 Property Developers: Tepid Revenue Growth, Margin Fueled Net Income BOOM! 

 

The florid 3Q news headlines may have overstated the financial performance of the listed top 5 developers.  Sure, net income supposedly boomed, but it came amidst a mixed performance of their revenues and other financial aspects. 

 

That is to say, reading between the lines is a sine qua non for any prudent investors. 

 

After all, revenues, a component of aggregate spending, should resonate with the current or nominal GDP. 

 

We shall harmonize the macro picture with the micro developments using the financial performance of the nation's listed top 5 (TOP 5) property developers.   

 

Figure 2 

 

The aggregate revenues of the top 5 (TOP 5) listed developers (SMPH, ALI, MEG, RLC, and VLL) jumped from 8.42% in Q2 to 14.03% in Q3 as real estate revenues grew from -2.5% to 10.7% over the same period.  (Figure 2, topmost graph) 

 

However, the total and real estate nominal revenues remain distant, -12.9% and -24.6%, from the pre-pandemic Q4 2019 record levels, respectively.  

 

Nota Bene: Since Ayala Land's topline bundled sales and rent revenues, we incorporated it with real estate revenues—likely overstating the total.  

 

Nevertheless, despite the aberrant pop in Q4 2020, the corroding share of real estate to total revenues reached its 2nd lowest level in Q3 2023, which indicates that property firms have become dependent on rent for their core revenues. (Figure 2, middle graph) 

 

From here, retail conditions become a principal factor in establishing rent and total revenues. 

 

A second important point: the share of the top 5's aggregate revenues to the sector's NGDP in 2020-2021 has barely recovered from the plunge in 2020-2021.   The sector seems to be an outlier in the context of the deepening concentration trend in the economy.  That is conditional on the accuracy of the estimated data.  

 

The revenue-to-NGDP share declined from 30.9 to 28.8. However, NGDP has outsprinted the total revenues in Q3 of the top 5 developers. (Figure 2, lowest chart) 

 

It reveals a wide dispersion in the supply component as mom-and-pop entities may have joined the speculative leveraged shindig of the build, sell, or rent model. Developments in my neighborhood could be a testament to this dynamic.  

 

Figure 3 

 

Circumstantial evidence shows that the sharp contraction of construction permits for single houses and apartments by 19.6% and 42.2% in Q3 2023 may be in response to rising vacancies amidst higher rates and a slowing economy. (Figure 3, topmost chart) 

 

Since the Q3 2022 peak, construction permits for these sectors have declined.   

 

Construction activities (via permits) of single houses and apartments could be the best representation of the participation of the mom-and-pop segment in the real estate bash. 

 

In any case, widening margins of the TOP 5 have delivered the headline net income boom.  Gyrations of the core inflation have correlated with margins.   

 

The average total margins raced to an unparalleled height of 42% in Q3.   As such, net income ballooned by 37.4% to Php 29.27 billion, 9.7% shy of the Q4 2019 record Php 32.41 billion. (Figure 3, middle and lowest window) 

 

These represent the "seen" part as published in social media headlines. 

 

V. The UNSEEN: Top 5 Property Firms: 9M Cash Reserves Plunged, Debt and Interest Expense Zoom to Historic Highs! 

 

But here is the "unseen."  

  

First, if the property firms have been raking a fortune from margins—which oddly benefited from inflation—why have their cash positions plunged? 

Figure 4 

TOP 5 cash reserves plummeted 34.8% in Q3 2023 YoY and have contracted during the last four quarters. (Figure 4, topmost chart) 

 

Cash reserves hit an all-time high in Q1 2021, but the ensuing downtrend has led it to erase its recent gains.  In Q3 2023, it plumbed to Q2 2020 lows! 

 

Next, why have the same firms been on a borrowing spree?  In Q3, aggregate borrowings of Php 952 billion and interest expenses of Php 11.04 billion have reached historic highs! (Figure 4, middle window) 

 

Here is the thing.   In Q3, net debt increased by Php 35.97 billion.  On the other hand, the total Net income was Php 29.267 billion.  Or, marginal income was higher by Php 7.927 billion YoY from last year's Php 21.295 billion.  (Figure 4, lowest diagram0 

 

No matter how one twists the angle, debt grew faster than income.  From a net margin perspective, the top 5 RE firms borrowed 4.51 pesos for every peso income they generated.  Incredible.  That's if the reported income is accurate at all.   

 

That's not all.   

 

Despite the BSP rate hikes, interest expenses—though at unprecedented levels—remain subdued, which most likely represents debt contracted before the rate increases.   

 

If rates remain elevated for longer, rolling over these liabilities should translate to substantial increases in refinancing costs. 

 

This mounting mismatch—debt growing faster than net income—explains the deterioration of liquidity.  Aside from increasing debt levels, RE firms drew from their cash reserves to finance internal spending and debt repayments. 

 

The data and its extrapolation corroborate the cautious outlook of the global real estate services firm quoted above. 

 

VI. Property Industry’s Demand for Rent: Follow the Money and the Slowing Revenue Growth of Retail and Food Chains  

 

As noted above, because rent has transformed into the anchor of the revenues of the TOP 5 property firms, aside from financing, the health of the retail sector becomes the most crucial factor in forecasting the property sector's prospects and risks. 

Figure 5 

 

First, there is a close correlation between rent revenues and universal commercial bank lending conditions.  Since peaking in Q3 2022 at 13.54%, bank lending growth has halved to 6.65% in Q3 2023.   Rental growth of the top 4 (excluding ALI) culminated in Q3 2022 at 67.34% and has slowed to 14.8% in Q3 2023.  (Figure 5, upper graph) 

 

Second, the frenzied increase in household borrowings coincided with nominal rent revenue growth. (Figure 5, lower chart) 

 

In short, bank lending has financed demand for rent.  

 

Third, the credit boom has created the illusion of "sustainable" consumer spending, which prompted the "race to build supply" response.  

 

Figure 6 

 

However, the moderating bank lending growth has led to slowing revenue for the six biggest (non-construction) retail chains: namely, SM Retail, Puregold, Robinsons Retail, Metro Retail, SSI Groups, and Philippine Seven.  (Figure 6, upper graph) 

 

Since the Q2 2022 pinnacle of 28.6%, revenue growth has slid to 8.27% in Q3 2023 but was up from 6.5% in Q2. 

 

It isn't a coincidence that the oscillation of percentage change has been synchronous. 

 

There has also been a tight correlation between revenues of the four biggest food chains—Jollibee, McDonald's, Shakeys, and Max's—and the TOP 5's rent revenues. (Figure 6, lower chart)  

 

However, growth YoY trends appear symmetrical with TOP 5's rent, as the aggregate revenue growth of Food chains culminated in Q3 2022 at 50.9%, then slowed to 12.9% in Q3 2023. 

 

As a caveat, much of the splendid % growth represents a function of base effects—or comparing a normalized economy with the transition from partially opened post-pandemic conditions.  

 

Human activities are interconnected.  Feedback loops constitute a process and diffuse into a broader segment of the economy over time. 

 

For instance, slowing consumer spending (due to inflation, too much leverage, decreases in passive income, etc.) leads to lower retail revenues (eventually income), which reduces demand for commercial rent.  Stagnant investments or cost rationalizations could lead to reduced profits (or even losses) that could diminish demand for other real estate products, such as office, retail, factory, storage, logistics, and warehouse spaces. 

 

This pressure build-up may also spread to other business edifices such as the MICE (meetings, incentives, conferences, and exhibitions) as well as luxury establishments like accommodations (hotels, resorts, etc.), sports clubs, galleries, and more.  Adjustment to structural malinvestments (sunk costs) will also lead to disemployment, which should expose the surpluses among residential spaces and other institutional structures (schools, health clinics, hospitals, etc.)  

 

Office vacancies represent the weakest industry link.   However, as demonstrated above, stress has been building throughout the industry.  Thus, fragility should spread from "satellite enclaves" to the "integrated structural communities" or from the periphery to the core.  

For want of doubt, unless credit conditions improve or unless productivity gains take over (ideally), the financial and liquidity challenges of the industry, as showcased by the TOP 5, will likely see further corrosion. 

 

To this end, solvency issues among many heavily leveraged property firms should emerge, affecting the balance sheets of banks, which should escalate strains on systemic liquidity.  The ensuing feedback loops raise the risks of economic recession, and worst, a financial crisis. 

 

VII. Q3 & 9Ms Financial Performance of the Property Index; REIT Did Better than their Parents 

Figure 7 

 

Since the top 5 issues comprise over 80% of the PSE's property index, 9M and Q3 revenue, net income, cash, and debt conditions resonate with our earlier discussions. 

 

Anyway, a short note on the REITs included in the PSEi's property index.  

 

In the three quarters of 2023, the Property Index's REITs, which had little leverage, posted net income and cash growth of 8.3% and 11%, respectively.  Supporting the 9M performance was Q3 revenue and net income growth of 15.7% and 10.6%, respectively.  

 

REITs accounted for 5% of the index revenues for both periods.  It also had an 11.4% (9M) and 11.14% (Q3) pie of the net income of the property index. 

 

As a byproduct of the BSP's EZ money regime, REITs are unlikely to elude the coming market clearing process on malinvestments. 

 

VIII. Mainstream’s Addiction to Inflationism, Real Estate Bubble Equals the "Fictitious Wealth." 

 

Finally, in a recent forum, a top official of one of the nation's leading property firms admitted to the industry's addiction to inflationism. 

 

While inflation poses a threat, it also can serve as a boon to the industry because we know that real estate investment still remains to be a very good hedge against inflation. On one hand, there is the threat posed by inflation as a deterrent to the impulse to invest but on the other hand, it can be the same impulse that will generate more interest in the industry,” Mr. Hernandez said. (Businessworld, November 2023) 

 

Because of duration risk, credit-financed real estate can hardly be a hedge against inflation.   

The collateral function of real estate is the anchor of the present bank credit cycle. 

 

Moreover, the performance of RE sales disputes such claims. 

 

Though popular, credit-driven asset bubbles are unsustainable, as the great Austrian Economist Ludwig von Mises warned. 

 

The point of view prevails generally among politicians, business people, the press and public opinion that reducing the interest rates below those developed by market conditions is a worthy goal for economic policy, and that the simplest way to reach this goal is through expanding bank credit. Under the influence of this view, the attempt is undertaken, again and again, to spark an economic upswing through granting additional loans. At first, to be sure, the result of such credit expansion comes up to expectations. Business is revived. An upswing develops. However, the stimulating effect emanating from the credit expansion cannot continue forever. Sooner or later, a business boom created in this way must collapse. (Ludwig von Mises, 1978) 

 

Circling back to the original thesis on the mounting vacancies: Why the cluster of errors? 

 

Central banks (BSP) tampering with interest rates induced false signals that misled entrepreneurs to deploy capital into speculative activities rather than productive investments, resulting in capital consumption. 

 

As the dean of the Austrian School of Economics, Murray N. Rothbard explained: 

 

The cluster of error suddenly revealed by entrepreneurs is due to the interventionary distortion of a key market signal—the interest rate. The concentration of disturbance in the capital goods industries is explained by the spur to unprofitable higher order investments in the boom period. (Rothbard, 2004) 

 

Therefore, because the industry embraced the contortions of Say's Law, "supply creates its own demand," through "build and they will come," their excesses were exposed by the shift to hybrid work and all other factors cited by the global real estate services firm: inflation, high rates, lower economic growth, the exit of POGOs, and cost-cutting measures—most of which are symptoms of malinvestments.   

 

In a recent tweet, economist Michael Pettis described China’s bursting real estate bubble as the unraveling of "fictitious wealth." 

 

Over the past 2-3 decades a huge amount of fictitious wealth was created, with most bank, business, household and government balance sheets, and a great deal of economic activity, being organized around this "wealth" creation. 

 

Rings a bell? 

 

Sadly, the employment of inflationism to generate "wealth," representing a form of redistribution (reverse Robin Hood), would lead to unexpected outcomes for the mainstream. 

 

Yet, this cycle requires the washing out of "fictitious wealth" before a new beginning. 

 

___ 

References  

 

Charles P. Kindleberger and Robert Z. Aliber; Manias, Panics, and Crashes A History of Financial Crises, 5th edition, 2005, p.104  

 

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 28, 2023 

 

Businessworld, Real estate’s return to pre-pandemic levels seen November 24, 2023 

 

Ludwig von Mises, THE NATURE AND ROLE OF THE MARKET, THE CAUSES OF THE ECONOMIC CRISIS: AN ADDRESS (1931) p 161 The Ludwig von Mises Institute, 1978  

 

Murray N. Rothbard, MAN, ECONOMY, AND STATE A TREATISE ON ECONOMIC PRINCIPLES, The Ludwig von Mises Institute P 1000, 2004 

 

Michael Pettis Tweet on China’s "fictitious wealth," November 24, 2024