BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

 

The short end of the UST curve is highly influenced by the Federal Reserve’s monetary policies while the long end clarifies those policies through the prism of risk/return. A steep yield curve…is one that suggests a low rate, accommodative monetary policy that is likely to work over time. This accounts for the curve’s steepness. A flat and inverted curve is the opposite. Whatever monetary policy is being conducted, the long end is interpreting that policy as well as other conditions as being highly suspect—Jeffrey P Snider 

In this issue:

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion!

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion!

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion? 

BSP Reduces Banks' Reserve Requirement Ratio (RRR), Fed's 50-bps Rate Cut Sends Philippine Yield Curve into Full Inversion! 

The Philippine yield curve inverts as the BSP significantly reduces the Bank RRR, while the US Fed embarks on a "Not in Crisis" 50-bps rate cut. 

The BSP has been telegraphing cuts to the banking system’s Reserve Requirement Ratio (RRR) since its last reduction in June 2023. 

For instance, Philstar.com, May 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking at a significant reduction in the level of deposits banks are required to keep with the central bank after it starts cutting interest rates this year, its top official said. BSP Governor Eli Remolona Jr. said the Monetary Board is planning to cut the reserve requirement ratio (RRR) of universal and commercial banks by 450 basis points to five percent from the existing 9.5 percent, the highest in the region. 

Four months later. 

GMANews.com, September 18, 2024: The Bangko Sentral ng Pilipinas (BSP) is looking to cut the reserve requirement ratio, the amount of cash a bank must hold in its reserves against deposits, “substantially” this year and reduce it further in 2025. BSP Governor Eli Remolona Jr. said on Wednesday that the cut in the reserve requirement is being considered, with the timing being discussed. He earlier said this can be reduced to 5% from the present 9.5% for big banks. 

Two days after. 

ABSCBNNews.com, September 20, 2024: The Bangko Sentral ng Pilipinas is reducing the reserve requirement ratio (RRR) for universal and commercial banks by 250 basis points (bps).  This RRR reduction will also apply to non-bank financial institutions with quasi-banking functions, the BSP said… The reduction shall bring the RRRs of universal and commercial banks to 7 percent; digital banks to 4 percent; thrift banks to 1 percent; and rural and cooperative banks to zero percent, the central bank said. The new ratios take effect on October 25 and shall apply to the local currency deposits and deposit substitute liabilities of banks and NBQBs. (bold mine) 

I. 2024 Reserve Requirement Ratio Cuts to Designed to Plug the Banking System’s Worsening Illiquidity 

Bank lending growth has been accelerating, while broad economic liquidity measures have been rising, so why would the BSP opt to inject more liquidity through Reserve Requirement Ratio (RRR) cuts? 

The following data set may provide some answers.

Figure 1

Although lending by Universal and Commercial Banks is at a record high in nominal peso terms, the growth rate remains far below pre-pandemic levels. (Figure 1, topmost image) 

The RRR cuts from 2018 to 2020 appeared to have worked, as the loans-to-deposit ratio rose to an all-time high in February 2020 but the pandemic-induced recession eroded these gains. (Figure 1, middle graph) 

It took a combination of historic BSP policies—record rate cuts, an unprecedented Php 2.3 trillion liquidity injection, and extraordinary relief measures—to reignite the loans-to-deposits ratio. Nonetheless, it still falls short of the 2020 highs. 

A likely, though unpublished, explanation is that bank liquidity continues to decline. 

As of July, the cash and due-to-bank deposits ratio was at its lowest level since at least 2013. The BSP policies of 2020 and subsequent RRR cuts bumped up this ratio from 2020-21, but it resumed its downtrend, which has recently worsened. (Figure 1, lowest chart)

Figure 2

After a brief recovery from the RRR cuts of 2018-2020—further aided by the BSP’s historic rescue measures in 2020—the liquid assets-to-deposits ratio has started to deteriorate again. (Figure 2, topmost pane) 

Additionally, Q2 2024 total bank profit growth has receded to its second-lowest level since Q2 2021. (Figure 2, middle diagram) 

From this perspective, liquidity boost from increased bank lending, RRR cuts, and reported profit growth has been inadequate to stem the cascading trend of cash and liquid assets. 

Furthermore, despite subsidies, relief measures, and a slowing CPI, Non-Performing Loans (NPLs) and distressed assets appear to have bottomed out in the current cycle. (Figure 3, lowest visual) 

Increasing NPLs in the face of a slowing CPI is indicative of demand. Refinancing has taken a greater role in the latest bank credit expansion. 

To wit, rising NPLs contribute significantly to the ongoing drain on the banking system’s liquidity. 

II. Bank Liquidity Drain from Held to Maturity (HTM) and Growing Non-Performing Loans (NPL)

Figure 3

A primary source of the downtrend in the cash-to-deposits ratio has been the banking system's Held-to-Maturity (HTM) securities. (Figure 3 upper image)

Once again, the BSP has acknowledged this. 

Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtM losses. Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity. [BSP, 2018] (bold mine) 

Even though rates have dropped, HTM (Held-to-Maturity) assets remain at record levels but appear to be plateauing. Falling rates in 2019-2020 barely made a dent in the elevated HTM levels at the time. 

Yet, a principal source of HTMs continues to be the bank's net claims on central government (NCoCG). (Figure 3, lower graph) 

That is, banks continue to finance a substantial portion of the government's deficit spending, which has represented an elementary and major contributor to the deterioration in bank liquidity. 

Why has the BSP been doing the same thing over and over again, expecting different results? Some call this "insanity." 

If the goal is to remove distortions—however ambiguously defined—why not eliminate the RRR entirely? 

It seems the BSP is merely buying time, hoping for a magical transformation of unproductive loans into productive lending. Besides, a complete phase-out of the RRR would leave the BSP with fewer "tools," or bluntly speaking, strip them of excuses. 

Thus, they’d rather have banks continue to accumulate unproductive loans in their portfolios and gradually subsidize them with relief from RRR cuts, rate cuts, various subsidies, and later direct injections—a palliative/band-aid treatment. 

III. Philippine Yield Curve Shifts from an Inverted Belly to a Full Inversion! 

Figure 4

Rather than steepening, the Fed's "not in a crisis" panic 50-basis-point cut also helped push the Philippine Treasury yield curve from an "inverted belly" to a "full inversion" on September 20! (Figure 4, tweet)

Figure 5

While yields across the entire curve plunged over the week, T-bill yields declined by a lesser degree relative to medium- and long-term Treasuries. (Figure 5, topmost window)

As a result, yields on Philippine notes and bonds have now fallen below T-bills!

Although one day doesn’t make a trend, this current inversion is the culmination of a process that began with a steep slope, then an inverted belly, and now a full inversion since June 2024. (Figure 5, middle chart)

The spreads between the 10-year bonds and their short-term counterparts are at the lowest level since March 2019! (Figure 5, lowest graph) 

And an inverted curve could serve as a warning signal/alarm bell for the economy.

From Investopedia: 

>An inverted yield curve forms when short-term debt instruments have higher yields than long-term instruments of the same credit risk profile.

>The inverted curve reflects bond investors’ expectations for a decline in longer-term interest rates, a view typically associated with recessions.

Further, it is a sign of tight liquidity: short-term borrowing costs rise or remain elevated, leading to higher yields on short-term debt instruments compared to long-term yields.

Moreover, expectations of slowing growth or economic recessions can also lead to decreased demand for riskier assets and increased demand for safer long-term bonds.

Again, the inverted curve must have resulted from the BSP’s announcement of a sharp reduction in the RRR in October, along with the Fed’s 50-basis point rate cuts.

Bottom line: cuts in the banks’ RRR were meant to address the banking system’s liquidity challenges as manifested in the Philippine treasury markets. The Fed’s 50-bps rate cut has exacerbated these distortions.

IV. Was San Miguel’s September 20th Pre-Closing Dump Related to the Liquidity Strained Yield-Curve Inversion?

Figure 6

Finally, it is interesting to observe that following the PSEi 30's intraday push above 7,300 last Friday, September 20, foreigners sold off or "dumped" SMC’s shares by 5% during the pre-closing five-minute float, contributing to the sharp decline in SMC’s share price and diminishing gains for the PSEi 30. (Figure 6, tweet) 

While we can’t directly attribute this to the inversion of the Philippine term structure of interest rates (yield curve), SMC’s intensifying liquidity challenges—evidenced by deteriorating cash reserves relative to soaring short-term debt in Q2 2024—should eventually influence its slope. (Figure 6, lower chart) 

In sum, as a "too big to fail" institution, SMC’s difficulties will inevitably reflect on the government’s fiscal and monetary health as well as the banks and the economy. 

____

references

FINANCIAL STABILITY COORDINATION COUNCIL, 2017 FINANCIAL STABILITY REPORT, p. 24 June 2018, bsp.gov.ph

Q2 2024 6.3% GDP? Stagnation in PSEi 30’s Q2 and 1H 2024 Performance as Debt-to-Income Ratio Soared to an All-Time High!

 

True, governments can reduce the rate of interest in the short run. They can issue additional paper money. They can open the way to credit expansion by the banks. They can thus create an artificial boom and the appearance of prosperity. But such a boom is bound to collapse sooner or later and to bring about a depression—Ludwig von Mises

In this issue: 

Q2 2024 6.3% GDP? Stagnation in PSEi 30’s Q2 and 1H 2024 Performance as Debt-to-Income Ratio Soared to an All-Time High!

I. Introduction: The Growing Disconnect Between PSEi 30 Fundamentals, Prices, and the GDP

II. 1H 2024: PSEi 30 Firms Insatiably Gorge on Debt: More Borrowing, More Trouble?

III. PSEi 30: The Mirage of Profit Gains Amidst Explosive Rise in Debt

IV. PSEi 30: Caveats in Corporate Reporting and Governance: The PLDT 4-Year Budget Overrun Example 

V. BSP’s Inflationism: The Slowing Growth of PSEi 30 Revenues and Its Implications 

VI. Impact of BSP’s Inflationism: PSEi 30’s Deepening Signs of Illiquidity

VII. San Miguel’s Intensifying Debt and Cash Crunch: Implications for Financial Stability

VIII. Analyzing the PSEi’s Impact on Financial Liquidity: The Surge in PSEi and Bank Borrowings Increases Financial Fragility

IX. PSEi 30 1H Analysis: A Concise Industry Overview

X. Q2 GDP Growth of 6.3% Highlights a Two Speed Economy: Stagnation in PSEi 30 Revenues and Net Income

XI. The PSEi 30 Nears 7,000: The Widening Discrepancy Between Prices and Fundamentals

Q2 2024 6.3% GDP? Stagnation in PSEi 30’s Q2 and 1H 2024 Performance as Debt-to-Income Ratio Soared to an All-Time High!

In a detailed analysis, we highlight the growing disconnect between PSEi 30 fundamentals (for Q2 and 1H 2024), PSEi 30 prices, and GDP.

I. Introduction: The Growing Disconnect Between PSEi 30 Fundamentals, Prices, and the GDP 

The PSEi 30 soared by 7.03% in Q1 2024, plummeted 7.12% in Q2, or was almost flat with a slight decrease of 0.6% in the first half of the year. 

However, two months into Q3, the PSEi 30 has fully recovered its Q2 losses and was up 7.94% YTD as of August 22nd.

Despite the fragile consumer conditions, owing to the "Marcos-nomics stimulus" channeled via record deficit spending, Q2 GDP rose to 6.3%.

Nevertheless, the dynamics in motion in Q1 extended through Q2 2024 and in the first half of the year.

In our conclusion last May, 

In the end, the loosening of financial conditions has led to an increasing divergence between corporate share prices and fundamentals. 

Furthermore, the PSEi 30’s Q1 2024 financial performance demonstrates a two-speed economy: a private sector slowdown, which has even affected the elites, translating to further hardship for the middle and lower classes, and a booming government. (Prudent Investor, May 2024) 

Let's compare the debt conditions of the non-financial members of the PSEi 30 with its entire constituents. 

However, there are some caveats regarding the presented statistics. 

Nota bene:  

-Older data, representing PSEi members of the specified Q2 end-of-period, presents an apples-to-oranges scenario. The PSEi periodically updates its constituents, which we labeled as 1A data. 

-The older data also excludes data revisions. 

-Current or 2023-2024 Q2 data provides a more accurate comparison as it reflects present members, labeled here as 1B data. 

-The aggregates are overstated due to holding companies incorporating subsidiaries. 

II. 1H 2024: PSEi 30 Firms Insatiably Gorge on Debt: More Borrowing, More Trouble?

Figure 1

The table presented is an example of 1B data. It compares the recently published first half (1H) of 2024 numbers with the first half of 2023 figures of PSEi firms. (Figure 1, top table) 

The 2023 headlines and the rest of the historical data are referred to as 1A. 

Despite coming from a high base, the debt of non-bank PSEi 30 members increased by 5.9% or Php 308.5 billion to Php 5.535 trillion, which is the second highest on record, following last year's Php 5.6 trillion (1A). (Figure 1, middle graph)

The net debt increase of Php 308.5 billion was the fourth highest, after 2022, 2020, and 2023 (1A).

While fifteen of the 27 non-bank PSEi 30 firms posted increases in debt (1B), San Miguel’s eye-popping PHP 147 trillion accounted for 53% of the total. 

The other top borrowers were Ayala Corp (Php 46.3 billion), Ayala Energy subsidiary ACEN Corporation (Php 34.5 billion), and Aboitiz Equity (Php 26.85 billion). 

It's important to note that this discussion does not include the borrowings of PSEi 30 banks. 

The good news is that despite the massive debt increase, soaring bank assets have led to a reduced PSEi 30 Debt-to-Total Financial Resources ratio, which has dropped below 2019 levels. (Figure 1, lowest image) 

But here's the caveat: while bank assets outgrew the PSEi 30’s non-bank debt—partly due to the non-inclusion of bank debt data—banks still represent a substantial source of lending to PSEi firms.

Furthermore, the outperformance of bank assets has been driven by the steep growth in consumer credit exposure and holdings in Philippine government debt. 

Additionally, some companies may have tucked away debt through other classifications (e.g., lease liabilities) or via off-balance sheet arrangements, which may result in an understated actual debt position. 

Figure 2

For instance, while Wilcon Depot has no published debt, interest expenses (from lease liabilities) have been on an uptrend. (Figure 2, topmost chart)

In this way, understanding the mechanics behind the statistics can help strip away the façade of good news based on headline metrics.

III. PSEi 30: The Mirage of Profit Gains Amidst Explosive Rise in Debt 

Second, media headlines captivate their audiences by focusing on the percentage gains in revenues and income of the most prominent members of this elite group. 

However, they rarely mention that these gains largely stem from the illusion of the low-base effects.

In reality, these exciting profit gains represent only a small fraction of the increases in debt. 

In the first semester, the published net income of the PSEi 30 rose by a modest 4.36%, or Php 20.4 billion, reaching the second-highest level of Php 487.12 billion. 

Yet, this growth rate marks the slowest increase since 2021. (Figure 2, middle image) 

Net income of non-financial companies grew by 2.03%, with one-third of these companies experiencing a decline in profits.

Meanwhile, the headline performance was primarily driven by the big three banks, whose profit growth of 15.4% significantly boosted the overall.

In context, the non-bank debt growth of 5.9% eclipsed the PSEi 30’s net income growth of 4.36%. 

Crucially, the net debt growth of Php 308.5 billion represents a staggering 15.2 times the net profit increase of Php 20.4 billion! Fifteen times! An all-time High! (Figure 2, lowest pane)

Strikingly, as a proportion of income, the net debt growth of Php 308.5 billion accounted for 63% of the aggregate net income of Php 487 billion in the first semester! 

Essentially, this demonstrates the law of diminishing returns in action: while debt used to be a significant contributor to (demand) revenue and income growth, malinvestments have resulted in corrosive effects. 

Worse yet, unbeknownst to the public, this marks a substantial buildup in credit risks, channeled through balance sheet mismatches of the nation’s largest firms. 

Amazing. 

IV. PSEi 30: Caveats in Corporate Reporting and Governance: The PLDT 4-Year Budget Overrun Example

Another cautionary note is that elite firms may be prone to exaggerating their top and bottom lines to convincingly portray their financial viability to the public.

Furthermore, "errors" could also be a factor, reminiscent of the PLDT's 4-year "budget overrun" debacle. Local authorities drew a veil over the reporting fiasco of the largest telecommunications company and allowed them to escape unscathed, despite the company settling with plaintiffs of a class action suit for a paltry sum of USD 3 million. 

In our humble opinion, the PLDT case exemplifies the decay of corporate governance, where elite companies can evade accountability for misdeclarations (whether accidental or intentional). 

Instead of being transparent, they may choose to pay small fines, raising the question: what would prevent other elite companies from following suit?

V. BSP’s Inflationism: The Slowing Growth of PSEi 30 Revenues and Its Implications

Figure 3

Meanwhile, corporate revenues grew by 8.71% in the first semester (1B). Non-bank PSEi 30 expanded by 7.4% while bank revenue growth of 24.2% delivered the gist of the PSEi 30’s semestral expansion. (Figure 3, table)

Twenty-three of the 30 constituents posted positive YoY growth while seven saw a contraction. In pesos, San Miguel was the leader with an increase of Php 103.8 billion followed by JGS with Php 24.8 billion, BDO and BPI with Php 24.1 billion and Php 23.1 billion respectively.

1H revenue growth of 8.71% resonated with its equivalent in (nominal) GDP of 9.5%.  If the GDP numbers are close to accurate then PSEi 30’s share of revenues amounted to 27.8% of the NGDP. 

Yes, 30 firms accounted for over a quarter of the statistical economy in 2024.

And that's only the 30 firms—a hallmark of the trickle-down, plutocratic political-economic structure.

The slowing NGDP and PSEi 30’s revenue growth are symptoms and manifestations of the corrosive nature of the BSP’s inflationism, expressed through over-indebtedness and price instability, which negatively impact profits and liquidity.

Importantly, because this increases the public’s time preferences or short-term orientation, the public becomes inclined toward activities that cater to instant gratification, such as speculation and gambling.

This inclination also permeates into the political spectrum, raising the public’s desire for more interventions and resulting in the deepening politicization of the socio-economic sphere.

VI. Impact of BSP’s Inflationism: PSEi 30’s Deepening Signs of Illiquidity

This leads us to the fourth component: cash.

It is no surprise that the mounting imbalance between profits and debt has resulted in deepening signs of illiquidity, as the cash reserves of the PSEi 30 constituent firms continue to decline. (Figure 3, lower visual)

In addition to borrowing, PSEi 30 corporations have partially used their cash reserves to bridge the liquidity gap in their financing operations.

Yet, despite the massive borrowings, the aggregate cash reserves (1A) have fallen to their lowest level since 2021, with 14 of the 30 firms posting cash contractions.

Aboitiz Equity and gaming company Bloomberry recorded the largest cash decreases, while Meralco and LTG registered the most significant gains.

VII. San Miguel’s Intensifying Debt and Cash Crunch: Implications for Financial Stability

San Miguel’s situation appears to be a poster child for the entropic process leading to illiquidity and insolvency.

Despite the astonishing Php 147 billion surge in borrowing from the first semester of 2023 to 2024, and a published net income of Php 13.6 billion, SMC’s cash reserves fell by Php 8.31 billion to Php 253.9 billion—its lowest level since 2018. (And that’s assuming that the reported cash reserves are accurate)

Why wouldn’t it?

Figure 4

Short-term debt skyrocketed from Php 363.8 billion in 1H 2023 to Php 533.67 billion in 1H 2024, an increase of Php 169 billion! (Figure 4, topmost chart)

Both the level of short-term debt and the annual increase in short-term debt are all-time highs!

More importantly, SMC’s short-term debt now exceeds 100% of its cash reserves!

Additionally, interest payments, which amounted to Php 24.12 billion and counting, have not been included in this analysis.

In context, SMC’s Php 1.484 trillion in debt represents about 4.6% of the Php 32.33 trillion in total financial resources and 5.9% of the 2024 annualized Php 25.2 trillion NGDP! (Figure 4, middle and lowest charts)

Incredible.

In simple terms, SMC needs to generate funds to pay or refinance both its massive short-term and long-term obligations.

Rising interest payments will further erode its profits.

With vastly insufficient profits and cash flows, SMC will naturally have to draw on its most liquid reserves: cash.

The company may also need to increase its borrowing rate or resort to selling assets or dilute its equity to meet its operational liquidity requirements.

Keynesian economist Hyman Minsky theorized the transition from financing stability to instability phenomenon as "Ponzi Finance."

Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts. (Minsky 1992)

Regardless of interest rates, SMC’s debt stock has reached a fragile state, increasingly vulnerable to a bout of perilous illiquidity. 

If SMC cannot raise the required amount, it may exhaust all its cash or, alternatively, embark on a selling spree of its assets or dilute its equity.

New ventures like the Bulacan-based New Manila International Airport (NMIA) project are unlikely to generate sufficient cash flows to meet its skyrocketing obligations.

However, in our humble opinion, the company must convince the public that it is viable enough to continue with its borrowing orgy. 

Yet, what happens at SMC will not stay at SMC. A "tail event" for San Miguel could send shockwaves through the banking system, financial markets, and the broader economy—which relies on elite firms for GDP growth.

Of course, we would expect the BSP or the government to mount a bailout. However, doing so could accelerate other negative feedback loops in the financial system.

VIII. Analyzing the PSEi’s Impact on Financial Liquidity: The Surge in PSEi and Bank Borrowings Increases Financial Fragility

The PSEi’s mounting liquidity shortage has been mirrored in the banking system.

Figure 5

In the first semester, cash growth among listed banks increased by a mere 1.82% year-over-year (boosted by the big three of the PSEi 30 at 3.36%), while bills payable soared by 39.2% across all banks, driven higher by a 68.12% surge from the PSEi 30’s big three. (Figure 5, table) 

Nota Bene: BPI categorizes its borrowing under "Other borrowed funds," making the time element of its debt distribution ambiguous and therefore not included in our data. 

In any case, universal-commercial (UC) banks have ramped up their borrowing activities, with bills and bonds payable growing at accelerated rates of 40.62% and 11.78%, respectively, resulting in a total increase of 27.8% as of June. (Figure 5, middle graph) 

UC bank borrowings in pesos reached an all-time high of Php 1.401 trillion last June! 

UC banks have not only increased their borrowing but have also shifted focus to short-term debt, reflecting the industry’s deteriorating liquidity conditions. 

The long-term decline in cash-to-deposits and liquid assets-to-deposits ratios continued in June. (Figure 5, lowest diagram) 

Bank client issues are also reflected in the banks' health reflecting on liquidity conditions—despite the accounting charade surrounding Held-to-Maturity (HTM) assets and various relief measures that have obscured the actual conditions of Non-Performing Loans (NPL).

If banks are as profitable as claimed, why is financial liquidity deteriorating and why are borrowings at record levels? 

IX. PSEi 30 1H Analysis: A Concise Industry Overview

Figure 6

By industry, debt grew the most in the holding sector, while the property sector came in a distant second in the first semester. (Figure 6, top table)

The holding sector accounted for the largest share representing 74%, while the property sector 11%.

Similarly, banks generated the most significant net income gains, followed by the service sector.

Banks' net income comprised 61.6% of the total or the PSEi 30’s net income, while services had a 28% share.

The holding sector dominated revenue growth, with a share of 54.7%, while banks accounted for 21.9%.

Cash increased the most in the industrial sector, with banks in second place.

X. Q2 GDP Growth of 6.3% Highlights a Two Speed Economy: Stagnation in PSEi 30 Revenues and Net Income

Moving to the second quarter, "Marcos-nomics" powered the GDP growth of 6.3%.

The poor top-line performance of several PSE-listed firms, which have reported their Q2 2024 results, underscores this issue.

… 

Fifth and finally, the PSE-GDP data indicate that there is confusion in associating a high GDP with the performance of the PSEi 30, which is currently in a bear market. (Prudent Investor 2024) 

This context is further validated by examining the revenues and net income of the 30 elite companies in the PSEi 30, some of which are even involved in government projects. 

Whereas Q2 NGDP grew from 9.1% in Q2 2023 to 10.1% in Q2 2024, the PSEi 30’s gross revenues climbed from 8.24% to 9.14% over the same period, despite the significant increase in debt. (Figure 6, lower graph) 

Similar to the first half of the year, Q2 revenues of the elite firms, amounting to Php 1.799 trillion, signified 28% of the Q2 NGDP, which stood at Php 6.486 trillion—once more, the trickle-down, plutocratic political economy. 

Revenues grew, but there is a catch. 

The net income of the PSEi 30’s non-bank firms showed a slight decline of 0.13% year-over-year. 

However, the bank's net income, which expanded by 13.7%, boosted the aggregate net income growth to 2.35%. This figure represents gross net income.

Figure 7

Alternatively, the real net income for the PSEi 30 stagnated or even contracted by -1.45% in Q2 2024! That’s right; net income shrank. (Figure 7 top and bottom tables) 

Outside the banking and property sectors, there was hardly any increase in net income in real terms. 

Net income for thirteen of the PSEi 30 firms (43%) decreased in Q2. Semirara, DMC Holdings, GT Capital, JG Summit, and Bloomberry led this decline. 

Conversely, Ayala Corp, SM Investments, ICT, and Meralco led the gainers.

In the meantime, SMC and Meralco posted the most significant revenue gains, while DMC and Semirara experienced revenue contraction.

XI. The PSEi 30 Nears 7,000: The Widening Discrepancy Between Prices and Fundamentals

In line with global stocks, the PSEi 30’s relentless climb toward the 7,000 level has been primarily driven by the local version of the "national team" and supported by foreign funds, thanks to the "Powell Pivot" towards easier monetary conditions.

While this surge has largely been driven by price-multiple expansion or speculation, it has overlooked critical concerns that have been festering beneath the surface.

Or, stocks have departed from the ongoing stagnation in fundamentals.

However, if higher interest rates did not put a brake to the government's and the PSEi 30's insatiable debt absorption and immersion, easier money conditions will surely intensify it.

What could possibly go wrong?

___

References: 

Ludwig von Mises, OMNIPOTENT GOVERNMENT THE RISE OF THE TOTAL STATE AND TOTAL WAR, p.251; 1944 & 2010, Mises Institute, Mises.org

Prudent Investor Newsletter, Despite the PSEi 30 FOMO, Q1 2024 PSEi 30 Financial Performance Unveiled a Two-Speed Economy, May 19,2024

Hyman P. Minsky, The Financial Instability Hypothesis, p.7 Levy Economics Institute, May 1992, levyinstitute.org

Prudent Investor, Philippines' Q2 GDP Growth of 6.3%: Unpacking the "Marcos-nomics" Stimulus, June 2024 Philippine Employment Rates—A Statistical Pump August 11, 2024 

 

Despite the PSEi 30 FOMO, Q1 2024 PSEi 30 Financial Performance Unveiled a Two-Speed economy

 

Mega-politics tells us that people don’t always say what they want, know what they want, or get what they want. Instead, they think what they need to think... do what they want to do... and get what they deserve. And they end up where they ought to be... carried along by the deep currents of history—Bill Bonner

In this issue:

Despite the PSEi 30 FOMO, Q1 2024 PSEi 30 Financial Performance Unveiled a Two-Speed Economy

I. The Incredible Q1 2024 FOMO in the PSEi 30

II. The Two-Speed Economy: Q1 2024 PSEi 30 Firms Posted a Substantial Slowdown

III. Despite Tapering Financial Performance, Debt Absorption Increased for the PSEi 30

IV. Q1 2024 Consumer Slowdown: Decreasing Growth Rates in Retail Chains (Non-Construction and Food Services)

V. Q1 2024 Consumer Slowdown: Declining Sales Growth in the Midstream and Downstream Real Estate Industry

VI. The SSI Group's Fear of Missing Out (FOMO)

VII. The Financial Index’s Fear of Missing Out (FOMO)

VIII. Q1 2024 Financial Performance by Sector

IX. Q1 2024 Financial Performance by Members

X. San Miguel’s Debt Hit Php 1.44 Trillion as the Spike in Short-term Debt Has Exceeded the Firm’s Cash Reserve

XI. Summary and Conclusion

 

Despite the PSEi 30 FOMO, Q1 2024 PSEi 30 Financial Performance Unveiled a Two-Speed Economy

 

The financial performance of the PSEi 30 and its members and the economy have departed from the price actions of the PSEi 30. Why this is unsustainable.

 

I. The Incredible Q1 2024 FOMO in the PSEi 30

 

The principal Philippine equity benchmark, the PSEi 30, found an interim trough at the end of October 2023 and rallied until April Fool’s Day 2024.

 

The PSEi 30 returned 2.04% in Q4 2023 and 7.03% in Q1 2024. Better yet, the PSEi returned 15.8% from its provisional nadir on October 27, 2023, through the end of March 2024.

 

Has the panic bidding spree been justified in the context of the economy or corporate fundamentals?

 

First, Q1 2024 GDP posted a slower-than-expected 5.7%.

 

As we previously explained, despite the diminishing trend in consumer spending, the "money illusion" or the devaluation of the Philippine peso magnified net export contribution to GDP on the expenditure side.

 

At the same time, "financialization" or extensive gearing of the bank-led financial industry played a crucial role in the growth of the industry side of GDP. (Prudent Investor 2024)

 

How about the Q1 2024 performance of the nation’s elite firms?

 

Nota bene: 

 

-Older data, representing PSEi members of the specified Q1 end-of-period, presents an apples-to-oranges scenario. The PSEi periodically updates its constituents, which we labeled as 1A data.

 

-The older data also excludes data revisions.

 

-Current or 2023-2024 Q1 data provides a more accurate comparison as it reflects present members, labeled here as 1B data.

 

-The aggregates are overstated due to holding companies incorporating subsidiaries. (Prudent Investor 2024)

 

Here’s the summary of Q1 2024 YoY performance of the elite members of the PSEi 30.

 

II. The Two-Speed Economy: Q1 2024 PSEi 30 Firms Posted a Substantial Slowdown

 

-Using 1B, total revenues grew 8.3% or Php 129.64 billion

-Aggregate net income expanded by 6.5% or Php 14.92 billion

-Total cash reserves increased by 14.5% or Php 196.2 billion

-Published aggregate non-financial debt grew by 7.8% or Php 396.25 billion

Figure 1

 

The sectoral performance distribution table represents 1B. (Figure 1: topmost table)

 

Though revenue growth hit a record high in pesos compared to previous years (1A), Q1 2024 net revenue gains of Php 129.64 billion signified the smallest increase since 2021. (Figure 1: middle window)

 

The deceleration of revenue growth (1B) from 17.8% to 8.3% echoed the GDP. NGDP slowed from 14% in Q1 2023 to 8.8% in Q1 2024, while headline GDP eased from 6.4% to 5.7%. (Figure 1: lowest image)

Figure 2

 

Q1 2024 revenues-to-NGDP ratio hit 27.8%, the second highest in the last five years. If the GDP estimates are accurate, then the firms of PSEi 30 accounted for more than a quarter of the GDP.

 

Profits also took a breather. Net income growth dropped substantially from 20.6% in Q1 2023 to 6.5%, as reflected by the marginal differences, even as the net income aggregate hit a record high. (Figure 2, topmost chart)

 

That said, since the elite firms demonstrated a material slowdown in both revenue and income growth, this indicates that the GDP weakened more than the headline numbers suggest.

 

Self-evidently, the government was the primary beneficiary of the Q1 2024 5.7% GDP growth.

 

In other words, the government strengthened at the expense of the private sector.

 

III. Despite Tapering Financial Performance, Debt Absorption Increased for the PSEi 30

 

While the economy decelerated considerably, these firms worryingly gorged on more debt.

 

Non-financial debt expanded by 7.8% to a second all-time high of Php 5.48 trillion, a net increase of Php 396 billion (1A). The net peso increase fell slightly below Php 400 billion in 2022. (Figure 2, middle window)

 

The ratio of net non-financial debt to the PSEi net income surged from 12.8 in Q1 2023 to 26.6 in Q1 2024. Put another way, it required Php 26.6 of non-financial borrowings to generate Php 1 of income! This is assuming that the published bottom line is an accurate representation.

 

As a reminder, this buildup of debt excludes the banking sector. However, banks have utilized capital markets, particularly T-bills, to raise capital.

 

Last March, bond holdings of Philippine banks increased by 6.4%, while T-bills jumped 21.7%. The aggregate T-bill holdings of two PSEi 30 banks soared by 46.6%, or by Php 124.8 billion! (Figure 2, lowest graph)

 

To simplify, the PSEi 30 soared by 7% in Q1 2024, dismissing the risks of a slowdown as the economy continues to pile up leverage.

 

Incredible.

 

IV. Q1 2024 Consumer Slowdown: Decreasing Growth Rates in Retail Chains (Non-Construction and Food Services)

 

Nevertheless, the mounting strains on consumers were conspicuous.

 

Figure 3

 

While top consumer retail chains and property firms have been afflicted by decaying growth rates since 2022, Q1 2024 reinforced these underlying trends.

 

First, the non-food and construction retail chains.

 

SM retail’s revenue growth plunged from 10.6% in Q4 2023 to 2.7% in Q1 2024. Puregold sales increased from 5.3% to 6.7%, Robinsons retail slowed from 4.24% to 2.9%, Philippine Seven grew from 18.33% to 19.44%, SSI Group almost halved from 8.4% to 4.8%, but MRSGI expanded from 1.6% to 5.2%. (Figure 3, topmost image)

 

In aggregate, revenue growth slid from 8.23% to 5.1%, its slowest growth since 2021. Yes, revenue growth included the increased capacities from Q1 2023 to Q1 2024!

 

Next, the biggest food retail chains.

 

While growth improved marginally from Q4 2023, Q1 2024 reinforced the downtrend in sales growth of the largest food retail chains.

 

International sales pushed Jollibee’s aggregate sales higher from 8.4% in Q4 2023 to 11.3% in Q1 2024. AGI’s McDonald's posted slower growth, declining from 15.2% to 13.8%. Shakey’s sales growth more than halved, dropping from 16.22% to 6.3%, and the MAX Group suffered a revenue recession with two straight quarters of contraction at -0.14% and -2.1%. (Figure 3, middle window)

 

In aggregate, while sales growth of the four listed food retail firms increased from 9.3% to 10.9%, Q1 2024 signified the second slowest sales growth since 2021, largely driven by Jollibee’s dominant 77.5% share of the total.

 

Once again, this slowdown comes despite the added capacity!

V. Q1 2024 Consumer Slowdown: Declining Sales Growth in the Midstream and Downstream Real Estate Industry

 

How about the firms representing the downstream of the real estate industry?

 

Third, the leading home improvement and construction supplies retail chains, Wilcon Depot and All Home, also registered sales revenue growth recessions.

 

Despite store expansions, Wilcon posted -2.11% in Q4 2023 and -2.5% in Q1 2024. All Home likewise saw growth contraction of 5.0% and 5.5%. (Figure 3, lowest graph)

 

Rising accounts of vacancies were reflected in their sales.

 

Figure 4

 

Lastly, the biggest real estate companies.

 

Revenues of the top four real estate firms mirrored those of their consumer retail peers.

 

Sales growth of SM Prime Holdings dropped from 10.33% to 7.05%. While Ayala Land increased from 30.31% to 32.7%, smaller rivals Megaworld and Robinsons Land saw decelerations from 23.87% to 16.31% and 21.3% to 18.8%, respectively. (Figure 4, topmost chart)

 

Cumulative sales growth of the top four property firms slowed from 24.6% in Q1 2023 and 21.7% in Q4 2023 to 19.4% in Q1 2024.

 

VI. The SSI Group's Fear of Missing Out (FOMO)

 

Let me cite a specific example, a non-PSEi 30 issue.

 

While share prices of the largest high-end specialty retailer, the SSI Group, returned 68.3% in Q1 2024, ironically, sales growth year-over-year (YoY) eroded to 5.2% in Q1 2024 compared with 8.4% in Q4 2023 and 38.9% in Q1 2023. As such, net income dived 21.1% in Q1 2024, vis-à-vis the 4.5% growth in Q4 2023 and 573.4% in Q1 2023. (Figure 4, second to the highest and lowest graphs)

 

SSI expanded its stores from 516 in Q1 2023 to 534 in Q1 2024 (up 3.4%), supported by the increase in selling area from 99,597 sqm to 107,439 sqm (higher by 7.9%). SSI also increased its brands from 87 to 93 (up 7%).

 

Here is what they reported: “Sales during the 1st quarter of the year were impacted by the timing of the Easter holidays which occurred during the 1st quarter of this year, weaker spending, as more consumers traveled abroad, and the closure for renovation of one (1) Zara store, and the partial closure, also for renovation, of another Zara store, as well as by delayed deliveries for one of our larger footwear brands.” (PSE, 2024) [bold added]

 

Amazing rationalizations.

 

In any case, have the wealthy embraced parsimony?

 

So, riding on the FOMO (Fear of Missing Out) momentum from what seems like an orchestrated pump on the PSEi 30, speculators manically bid up on SSI shares, paving the way for increasing maladjustments between prices and its Q1 financial performance.

 

SSI plunged 10.6% this week, a day after its announcement (and after my tweet).

 

VII. The Financial Index’s Fear of Missing Out (FOMO)

 

More importantly, a similar displacement from the FOMO phenomenon has plagued the banking system.

 

Since the acme of 2022, the industry’s profit growth rate has steadily declined. It was up by only 2.95% in Q1 2024, down from 13% in Q4 2023 and 34.97% in Q1 2023 (let us close our eyes on their record Held-to-Maturity HTM holdings). (Figure 4, lowest graph)

 

Yet, the financial index soared by 12.4% YoY in Q1 2024 and 17% on YTD last March. As it stands, the index reached a 6-year high!

 

Even better, the three biggest banks of the PSEi 30 delivered a 17% net income growth in Q1 2024, a smidgen compared to the 40.9% in Q1 2023.

 

Strikingly, their PSEi 30 free float market cap weighting stormed to 21.3% at the end of March, an all-time high, and further expanded to a historic 22.8% at the week ending May 3rd.

 

As in the past, were the Other Financial Corporations (OFC) responsible for this?

 

Importantly, were such actions at the behest of financial authorities to impress upon the public the supposed "soundness" of the banking system?

 

The thing is, because "markets" have been running ahead or deviating from their fundamentals, this melt-up can be reckoned as "unsustainable."

 

Nonetheless, the partial divergence between corporate performance and GDP, on the one hand, and the surge in share price returns and actual corporate results, on the other, reflects the mounting distortions in market pricing caused by the BSP’s monetary and regulatory policies, as well as regulatory lapses in containing repeated attempts to manage market prices by undisclosed entities with likely access to depository accounts.

 

The deepening mispricing of the stock market exacerbates financial instability and market fragility, which could have severe economic repercussions.

 

VIII. Q1 2024 Financial Performance by Sector

 

By sector, financials and the property sector registered the fastest sales growth at 26.9% and 20.5%, respectively. (Figure 1, topmost table)

 

Nonetheless, holding firms and financials led the growth in the peso, with Php 68.9 billion and Php 32.7 billion, respectively.  The same industries accounted for the largest share (in net gains) of the total with 53% and 25.2%, correspondingly.

 

The property and financial sectors also reported the swiftest net income growth at 22% and 17.1%, respectively. However, financials and services recorded the largest peso gains—Php 6.73 billion and Php 3.7 billion, respectively. Financials and services held the biggest shares at 45% and 24.5%, respectively.

 

While all non-financial sectors experienced similar growth rates of over 7%, holding firms accounted for the largest borrowings at Php 267.5 billion, followed by services at Php 59.1 billion.

 

In the meantime, the holding firms and services also saw the most significant net gains in cash reserves, with Php 94.1 billion and Php 30.05 billion, respectively.

It's likely that their substantial borrowings contributed to this surge in cash reserves.

IX. Q1 2024 Financial Performance by Members

Figure/Table 5

Among members of the PSEi 30, San Miguel Corporation recorded the largest net revenue increase of Php 46 billion, followed by JG Summit with Php 14.5 billion. In contrast, Aboitiz Equity experienced the largest sales contraction of Php 6.8 billion. Twenty-two of the 30 PSEi members posted net revenue increases in Q1 2024.

 

JG Summit and Converge reported the highest net income growth in pesos, with Php 6.849 billion and Php 3.393 billion, respectively. Conversely, San Miguel Corporation posted the largest deficit of Php 8.85 billion. Twenty-one of the 30 PSEi members saw increases in net income.

 

Meanwhile, LT Group and Meralco recorded the largest cash increases, with Php 69.945 billion and Php 36.6 billion, respectively, while Aboitiz Equity accounted for the largest deficit of Php 16.9 billion. Nineteen of the 30 PSEi members experienced increases.

In contrast, San Miguel, Ayala Corp, and Aboitiz Equity reported the highest debt increases, amounting to Php 162.76 billion, Php 36.2 billion, and Php 33.2 billion, respectively.

 

Eighteen of the twenty-seven non-financial firms reported increases in debt. San Miguel accounted for 41.08% of the Non-Financial’s Php 396.3 billion total.

 

The crux: What happened to the BSP’s monetary policies? Why the sustained rapid debt expansion?

 

X. San Miguel’s Debt Hit Php 1.44 Trillion as the Spike in Short-term Debt Has Exceeded the Firm’s Cash Reserve

Figure 6

Despite a slight drop in interest expense, San Miguel Corporation’s debt skyrocketed to an electrifying Php 1.441 trillion in Q1 2024! (Figure 6, upper chart)

 

Meanwhile, SMC’s interest coverage ratio (ICR) fell to 1.6, its second-lowest Q1 ratio since 2020.

 

In this context, SMC’s debt levels accounted for 4.6% of the Philippines' total financial resources—its third-highest level—indicating a heightened concentration of leverage and systemic risk, akin to being "Too big to fail."

 

The surge in short-term debt relative to the firm’s declining cash reserves in Q1 2024 has led to the widest spread in San Miguel’s history.

 

Essentially, this is symptomatic of SMC’s escalating liquidity challenges, necessitating the firm to draw more liquidity from its internal finance and the financial system by borrowing more. SMC intensified its borrowing in 2021 and 2022 in response to the lowest ICR in 2020, and it's likely to continue this trend in the coming quarters.

 

It's crucial to understand that "what happens to San Miguel wouldn’t stay in San Miguel." As a systemic risk, SMC’s debt challenges can easily magnify into a ripple effect—or the intensifying risk of financial and economic contagion.

 

XI. Summary and Conclusion

 

In the end, the loosening of financial conditions has led to an increasing divergence between corporate share prices and fundamentals.

 

Furthermore, the PSEi 30’s Q1 2024 financial performance demonstrates a two-speed economy: a private sector slowdown, which has even affected the elites, translating to further hardship for the middle and lower classes, and a booming government.

 

___

References:

 

Prudent Investor Newsletters, Philippine Q1 2024 5.7% GDP: Net Exports as Key Driver, The Road to Financialization and Escalating Consumer Weakness May 12, 2024

 

Prudent Investor Newsletters, Analyzing the 2023 Performance of the Philippine PSEi 30 Constituent Firms, May 5, 2024

 

SSI Group Q1 17-Q, May 15, 2024, pse.com.ph