In this issue
Biggest Wow, as 1H Net Income Stagnated, Ex-Bank PSEi 30 Debt Swelled by a Staggering 19% (Php 433 Billion)!
-How We Got Here: Negative Real Rates 2011-2015
-How We Got Here: Negative Real Rates 2016-2017, Macro = Micro!
-Side Issues: CPI and Negative Real Rates from the Banking System’s Rates
-Wow. Ex-Bank PSEi 30’s Debt Swelled by Staggering 19.5% or by Php 433.3 Billion!
-Products of Negative Real Rates: Extensive Leveraging, Mounting inflation and Systemic Risks and the Falling Peso
Biggest Wow, as 1H Net Income Stagnated, Ex-Bank PSEi 30 Debt Swelled by a Staggering 19% (Php 433 Billion)!
Economist Roger W. Garrison* wrote “if the interest rate is wrong, possibly because of central bank policies aimed at "growing the economy;" then the market goes wrong. The particulars of just how it goes wrong, just when the misallocations are eventually detected, and just what complications the subsequent reallocation might entail are all dependent on the underlying institutional arrangements and on the particular actions of policy makers and reactions of market participants”
*Roger W. Garrison Introduction: The Austrian Theory in Perspective p.11-12
How We Got Here: Negative Real Rates 2011-2015
Current conditions are manifestations of the consequences of the aggregate present and past policies
In short, how did we get here?
Let me explain through the three charts above.
First, the composition of the charts.
The uppermost chart comprises the difference or spread between the monthly 1-year Philippine Treasury yield and the BSP’s consumer price index. The spread evinces the real rates of interest.
Overlapped with it is the year-on-year % change of the sum of the BSP’s industry and consumer loans per month.
The middle chart demonstrates the same spread between interest rate and inflation. However, this chart has been overlaid by the annual % change of the BSP’s net claim on the National Government.
The lowest chart represents the policy rates of the BSP
In response to the Great Recession, the BSP slashed interest rates from 7.5% in 2007 to 4% at the close of 2009. Because of the relatively clean balance sheets of the Philippine financial system, the law of demand – as the price of a good decreases, quantity demanded increases – worked its wonders. Because credit boomed, GDP and asset prices zoomed!
Just a reminder, the cleansing of the balance sheets of the Philippine financial system has signified as the major ramification of the Asian Crisis. Thus the positive impact from credit easing policies was initially magnified and perceived as self-sustaining.
Now to the narrative.
The response to the BSP’s aggressive easing actions in 2007-2009 prompted for the explosion of credit growth which pushed bond yields to a historic low. I called this then the “convergence trade”. Even when inflation was relatively low (compared to the present), the record low yields produced negative real rates.
Essentially, negative real rates devoured on fixed income earnings. Negative real rates punished savers and rewarded borrowers which goaded on systemic leveraging.
The BSP responded to this credit binge by partial tightening; it raised rates from 4% to 4.5% in 2011.
Credit responded. Credit growth (industry plus consumer) fell rapidly from a record 22.94% in November 2011 to a nadir of 11.1% in July 2013. Seeing this, the BSP aggressively sliced interest rates by 1% or by 100 basis points from 4.5% in 2011 to 3.5% in 2012. The BSP likewise tweaked with debt monetization with an inflation target in mind.
July 2013 turned out to be a crucial inflection point.
This period represented the second round of the credit boom. Because of the aggregate effects of the previous years of credit splurge, which had been compounded by the revival of credit in 2H 2013, as well as, the BSP’s tacit maneuvers on NG debt, money supply growth exploded to a furious over 30% rate for 10 consecutive months!
Real economy prices surged. The composition of negative rates likewise changed. Even as yields rose, raging CPI became the culprit for the deepening of negative real rates.
But the outcome had been the same: savers were crucified for the convenience of fueling an asset boom that pumped the GDP, which consequently served as an indirect subsidy to the government through primarily the revenue channel, as well as the debt channel.
Though the BSP publicly blamed the ferocious money supply growth on SDA rules, it never explained how changes in the SDA affected real economy prices.
To recall, surging garlic prices even reached the halls of the Senate which transformed into a national political issue. The BSP’s thereby responded by modest tightening: it raised the banking system’s capital requirements twice, raised interest rates twice and SDA rates thrice. Importantly, it desisted from tinkering with subsidies to the NG.
Credit growth swiftly decelerated from a high of 19.47% in October 2014 to 13.18% in September 2015. Money supply growth crashed from over 30% to 8.6% in July 2015.
And because of the inflation tax, consumers were penalized. Diminished credit growth rate further compounded on the consumer’s plight. The first signs of shopping mall vacancies emerged. PSEi 30’s net income (-.2%) and revenues (+.2%), as well as the GDP stagnated (RGDP both 6.1% 2014 and 2015, while NGDP fell from 9.5% 2014 to 5.4% 2015). Government revenue growth at 10.5%in 2015 was the lowest since 2011.
The BSP then kept mentioning of disinflationary pressures while denying deflation risk. [Phisix 7,800: Record Phisix as the BSP Continues with Deflation Spiel! March 9, 2015]
The BSP was actually referring to the sharp rise in POSITIVE real interest rates! B POSITIVE real interest rates indicated that the diversion of resources to the bubble sectors slowed. Hence, the prospects of reduced invisible subsidies to the NG and the banking system SPOOKED the BSP!
How We Got Here: Negative Real Rates 2016-2017, Macro = Micro!
Thus, BSP’s emergency measures came into action. The BSP’s debt monetization program had been jumpstarted by mid-2015. About NINETY percent (90%) or Php 317 billion of 2016’s record Php 353 billion fiscal deficit had been subsidized by the BSP’s program. Proceeds from BSP’s actions had been used to spur the banking system’s credit expansion. Moreover, under the cover of interest rate corridor in June 2016, the BSP aggressively slashed interest rates anew to monumental lows.
Policies produce changes in actions.
Bank lending roared (17.4% in 2016 versus 13.4% 2015%)! Money supply soared from 9.4% December 2015 to 12.8% December 2016! But so did real economy prices. General Retail Prices and CPI jumped 2.3% and 1.8% in 2016 from 1.2% and 1.4% in 2015. General Wholesale Prices turned into inflation 1.1% in 2016 from deflation -3.9% in 2015.
The BSP hence reduced its subsidies to the NG. The result of which was to slow money supply growth (11.2% April 2017). Real economy prices likewise had been tempered from the 2017 heights.
But because treasury yields responded to the rise in real economy prices, throughout the 2015-2016 campaign, negative real rates had been shallow.
The credit boom appears to have gotten significantly LESS traction than its predecessors!
In June and July 2017, real yields even turned slightly positive, specifically .526% and .03%! Thus, the reinstatement of the BSP’s secret stimulus. It bought Php 136.5 billion of NG debt from May to July. Combined with the surge in production loan growth (+18.9%), money supply rocketed to 13.5% this July, a May 2016 high!
Diminishing returns on the monetary mechanism of zero bound policies (ZIRP) have been manifested by its inadequacy to engender deeper negative real rates!
Such fading stimulus has signified the force behind real economic activities, which has likewise resonated with the performance of the PSEi.
Macro = Micro!
Side Issues: CPI and Negative Real Rates from the Banking System’s Rates
As a side note, the BSP in public, media and experts have almost always blamed CPI pressures on oil prices. Oil prices serve as a convenient scapegoat for rationalizations. But just look at BSP’s own econometric formulation: Electricity, gas and fuel and transport services account for a share of 7.02% and 7.81% respectively of the CPI basket. That would only accrue to 14.83% of the total. The percentage point contribution of these categories in July’s 2.8% CPI had only been .3% and .2% or just 17.9% of the month’s numbers. Restaurant which has a basket weight of 12.03% contributed .3% to July’s.
The biggest contributor food and non-beverage represented 1.3% of July CPI or a 46% share. Since the restaurant is also a category of food, hence food inflation accounted for a larger 57.14% share of the CPI basket. This slack in the supply of food signifies underinvestment brought about by domestic protectionism and mainly by the diversion of resources.
Malinvestments, or the essence of bubbles, represents the diversion of resources to unproductive and speculative sectors. These imbalances would not have emerged in free markets. Instead, these are symptoms of the “products of central bank policies aimed at "growing the economy"”.
Second side note.
The banking system’s savings rates were .721% in 2016, .71% in 2015, .626% in 2014 and .827% in 2013. Time deposit rates of under one-year over the same period were 1.509%, 1.462%, 1.084% and 1.444%. Because monetary policies affect people’s economic calculation, punishing prudence and driving people out of cash and into speculation, spending and debt also translate to the shortening of the public’s time orientation.
Wow. Ex-Bank PSEi 30’s Debt Swelled by Staggering 19.5% or by Php 433.3 Billion!
Some notes/caveats:
-Bank debts (notes payables) have not been included. So Total Debt basically represents non-bank PSEi 30.
-Debts of subsidiaries have been accounted for by their respective parent holding companies, so only parent firms have been covered. This is with the exception of Metro Pacific’s holding of Meralco. The latter’s debt has been independent of the parent.
-Since the financial statements of FGEN and ICT have been quoted on USD, numbers above have been computed based on the average peso of the period indicated by the BSP.
-Short term debt: includes bank loans, short term bonds payable and current portion of long term debt
-Long term debt includes bond payables
-total debt: short term PLUS long term debt (local and foreign currency denominated)
-above represents comparison of historical 1H data
-% change numbers are influenced by the base effect. For example, comparison between big numbers produces low % changes even when nominal numbers have been significant.
The analysis
Two weeks back I reported that the stock market has become detached to reality. The Phisix raced to 8,000 even when 2Q net income registered a contraction (negative growth), and even when 1H net income was a no-bearing or nearly ZERO growth! [Phisix Surged to 8,000 even as Net Income Posted a CONTRACTION in the 2Q and Stagnated in the 1H! August 20, 2017]
Moreover, I uncovered that to produce 9% net income growth for the 1H, parent SM Investments had gorged so much debt [More Wow. SM Investment’s 1H Debt Swelled by a Whopping Php 81.8 Billion (Almost 2 years of Income)! August 28, 2017]
Now for the bigger picture.
While net income was almost unchanged, total debt of the ex-bank PSEi 30 sprung by a whopping 19.46%!
SM’s case was hardly isolated. Many holding firms wantonly borrowed!
To put into perspective the above numbers:
-PSEi 30 Net income grew by about a measly Php 600 million but generated Php 433.3 billion in DEBT! So PSEi 30 borrowed Php 720+ for every peso of net income.
Such signifies an astounding or breathtaking degree of leveraging!
-Ex-banks PSEi 30 net income grew by only Php 407 million which brings about even deeper leveraging of Php 1000+ for every peso earned!
-The PSEi 30’s total debt of Php 2.66 trillion accounts for about 14.88% of the total resources of the Philippine financial system!
-PSEi 30 borrowed more than the banking system’s nominal borrowing growth of Php 347 billion for the 1H of the year! Of course, PSEi borrowings were partly financed by domestic banks, others by bonds, by foreign borrowing and other instruments.
-The biggest borrowers in the context of nominal amount were SM Php 81.8 billion, Aboitiz Equity Php 79.8 billion, Metro Pacific Php 78.04 billion, Alliance Global Php 71.51 billion, San Miguel Php 49.3 billion, JGS Summit Php 31.64 billion, and Ayala Corporation Php 31.02 billion.
-There were only 4 companies that reduced debts: GTCAP Php 20.289 billion, EDC Php 4.54 billion, LTG Php 2.5 billion and DMC 1.81 Php billion
-Debt composition has also changed. Short term debt (+28.11%) grew faster than long term debt (+17.11%). Thus the share of short term debt to total debt increased to 22.85% in 1H 2017 from 21.31%
Substantial increases in short term debt hardly have been about capital expansion but about liquidity or cash flow issues.
The biggest borrowers have mostly focused on short term debt expansion: SM, San Miguel, Alliance Global, Metro Pacific and Aboitiz Equity Ventures.
SM had little growth in long term debt. SMC’s long term debt fell marginally. Metro Pacific, Alliance Global and Aboitiz Equity were heavy borrowers in both the long and short term spectrum.
Ayala Corp, JG Summit, and PLDT posted significant increases in long term debt.
Meanwhile, LT Group and EDC were consistently pruning debt in both the long and short term dimensions. EDC has brought down debt to 2015 levels. At the same time, LTG has been rapidly paying down its debt. Total debt in 1H 2014 was at Php 17.5 billion. In 2017, at Php 3.3 billion LTG’s debt levels signified a fading shadow of the former. The company appears to have embraced a defensive mode! LTG would seem like a company to look at.
Most major companies have been borrowing wildly in the assumption of sustained free lunches in money (perpetual low-interest rate environment) and in the economy (the race-to-build-supply for market leadership). For these companies, risk has virtually vanished.
San Miguel should be a shining example.
In five years, the company’s ANNUAL net income growth totaled Php 198.662 billion. On the other hand, despite the sale of Meralco and its telecom firm, SMC’s accrued ANNUAL 5-year debt amounted to Php 223.9 billion! This debt data excludes the 1H 2017 numbers.
SMC’s income looks like a mirage. The firm’s income comprises nothing but debt!
Unbridled leveraging, which is unsustainable, will virtually haunt the company. When the burden of rising financing costs reaches a level where the firm’s cost of debt can only be paid by debt rollovers or by asset sales, then it has reached “Ponzi Finance” state as explained by Hyman Minsky.
The sale of Meralco and of the telco assets of Liberty Telecoms to Globe and PLDT operated like a black hole in SMC’s financial position. That’s because SMC's debt continued to mount!
Even worst, short term debt has become the focal point of SMC’s recent debt burden. Have these been symptoms of emerging strains in SMC’s internal liquidity?
SM appears to be following SMC’s footsteps.
In five years, the company’s ANNUAL net income growth accrued to some Php 205.598 billion. Since SM constantly does restatements, the reconciliation of current data with the adjusted revenues and net income numbers of the previous years may present inconsistencies in my numbers. However, debt numbers have been constant.
On the other hand, the cumulative growth of SM’s ANNUAL 5-year debt has at Php 157.710 billion! This excludes the 1H 2017 numbers. Hence, SM borrows .77 cents for every peso net income growth it generates.
If the company sticks with the current growth model, it would effectively mimic SMC’s seeming state of Ponzi leveraging.
Products of Negative Real Rates: Extensive Leveraging, Mounting inflation and Systemic Risks and the Falling Peso
The above numbers confirm my suspicions! Because of the low penetration levels of the formal banking and financial system and the capital markets, leveraging has been confined to a few quarters with liberal access to credit! PSEi companies virtually show the way.
Ironically the BSP seems to have glossed over the explosive growth of PSEi’s debt.
And such massive debt buildup hasn’t been a one-time affair.
For companies with a five-year track record (SM, JGS, AC, AEV, TEL, GTCAP, ICT, JFC, DMC, AGI, EDC and SMC), the CAGR of the cumulative total debt has been at 15.38% while the CAGR of long term debt at 15.72%. Debt has grown so much faster than net income! (upper window)
Yet, think of what the PSEi 30’s 1H debt of Php 433.3 billion does to the economy.
While part of that money would be used to pay for operating expenses and also pay down existing debt, expansions would also account for a significant portion of expenditures
These expenditures would constitute “new demand”. New personnel hired, office logistics acquired, new plant and property built and more translates to broadened “demand” for goods and services. Yet such “demand” has not been organically generated but arose from credit expansion. The chain effect (not multiplier effect) from such credit financed spending will only be seen from the disclosures of these companies and from portions of BSP’s data. But the entire transmission mechanism of such leveraged chain of spending would hardly be accounted for by statistics.
Negative real rates have only incited these companies to absorb more debt than necessary. That has mainly been because of redistributive effects of credit inflation.
Since bank loans translate to the issuance of “money from thin air”, thereby affecting money supply, the first recipients, and thus as the first spenders, benefit from prices at the point of entry of new money.
Prices will be higher for the latter recipients of the spending chain process from such bank issued money. The process also means that the latter recipients essentially subsidize the bank borrowers, as well as, the banking system as issuers of the exchange media. And the gap in the prices between money spent by the first receivers and the money spent by latter receivers represents the “profits” generated by the companies.
Such dynamic does NOT represent productivity based growth but redistributive growth from credit inflation.
And since the massive issuance of new money doesn’t instantaneously create additional supply of goods and services, imbalances emerge. New money, which represents expanded demand, would operate in the presence of existing inventories. Hence, price increases for goods and services would be relative, particularly to areas where new money would be spent
Excess issuance of money may find its way to chase asset prices and thus provide the illusion of increases in wealth. The PSEi has practically coincided with bank credit conditions with a time lag! (lower window). Each time bank credit grows beyond 18%, the Phisix flows to the upside. This credit-stock price relationship suggests why the PSEi remains at 8,000
Higher stock prices do not increase productivity. The stock of real investments, as an outcome of previous savings, which transforms into long-term streams of cash flows, that fulfills such role.
The idea of prosperity from stock market inflation signifies a popular illusion.
Since somebody has to hold a specific security, which represents a claim on such stream of cash flows, asset inflation merely transfers wealth from the new owner (buyer of overvalued securities) to the previous owner (seller). This wealth illusion applies to the real estate industry too.
Also, the mounting in leverage by PSEi 30 firms and the elevated PSEi index has some direct linkages.
As previously pointed out, part of SM Prime’s borrowing or Php 4.9 billion had been used to purchase “related party shares”! [SM Prime’s Growth Model: In 1H 2017, Every Peso of Growth Was Funded By SIX Pesos of DEBT! SMPH Bought Php 4.9 Billion of Related Party Shares! August 13, 2017]
The SM Prime experience tells us that some companies may have used credit money to inflate their stock prices. Such stock market interventions only translate to intensified needless risk taking activities, and most importantly, the aggravation of the inefficient use of capital.
With the likely exception of two firms, LT Group and Jollibee, the PSEi 30’s growth model has been built largely on debt expansion. And this free lunch credit money greatly depends on the BSP’s ability to generate negative real rates.
And since the BSP has revived the use of its secret stimulus, such actions will have costs.
The yoke would be borne by the peso and by real economy prices.
And if the latter, an expanded invisible tax on consumers will have a spillover effect on retail companies which has resurfaced anew in the 1H of 2017 [Wow. Revenues of Listed Retail Firms Validate Slowdown of Consumer Spending GDP in 1H! August 28, 2017]
In gist, the following costs have appeared.
Extensive leveraging or expanded credit risks. Growing disparity between asset prices and real economy or Market risks. Inflation and interest rate risks. Currency risks. Geopolitical risks. Domestic Political risk.
Something will give. Soon.
