The trigger for the credit crisis is always the same. The general price level threatens to rise uncontrollably, reflecting the loss of the currency’s purchasing power. This forces the central bank to reluctantly raise interest rates to the point where business assumptions about the returns on capital, based on borrowing costs, turn from profit-making to loss-making. At that point, if not before, the accumulated mountain of debt becomes fatally undermined. The timing of the rise and level of interest rates that triggers the crisis is set by the speed with which monetary inflation feeds into prices. And the severity of the crisis depends upon the size of the debt mountain being liquidated—Alasdair Macleod
In this issue
Philippine Banking System’s Underbelly Exposed: Cash Drains at Fastest Rate, Fixed Income Stampedes into HTM Accounts as Concentration Risk Mounts
-BSP’s Zero Bound Policies and QE Fuels the Surge in CPI, TRAIN Compounds Price Distortions
-Inflation Propaganda, Banking System’s Fragile Profits and Mounting Concentration Risks
-As Banks 1Q Profits Ripped, Fixed Income Hold to Maturity Account Surged!
-Domestic Banking System Have Been Running Down Cash as Deposits Growth Fumbles!
-The Underbelly of the Domestic Banking System Exposed!
Philippine Banking System’s Underbelly Exposed: Cash Drains at Fastest Rate, Fixed Income Stampedes into HTM Accounts as Concentration Risk Mounts
In the last issue, I noted how the BSP and the National Government’s policies were aimed jointly at boosting revenues FIRST through liquidity expansion (NEXT) channeled through inflation targeting policies.
You see, all actions have consequences.
When authorities manipulate interest rates, it fuels an artificial boom in the interim while generating and accumulating economic maladjustments overtime. Such malinvestments would have to face a day of economic reckoning. And symptoms of such maladjustments are vented through various prices such as real economy prices and interest rates.
The unfolding business cycle represents a process.
BSP’s Zero Bound Policies and QE Fuels the Surge in CPI, TRAIN Compounds Price Distortions
The first two charts above exhibits the evolution of BSP policies.
When the BSP mimicked the zero bound rates embraced by global central bankers in 2009, bank credit expansion spawned an economic boom. Price pressures in the real economy emerge from the artificial boost in demand relative to supply by cuts in interest rates in 2013-2014. (middle chart).
Here, bank credit expansion drove CPI.
The BSP responded by partial tightening in 2014. Consequently, the fall in money supply dragged CPI lower which prompted then BSP chief Tetangco to utter “disinflation”!
In morbid fear of deflation and from the diminishing returns of bank credit expansion in boosting inflation, the BSP has been prompted to exercise the nuclear option: debt monetization! The ascent of CPI has resonated with the BSP’s Quantitative Easing since 2015. (topmost window)
From 2015 to the present, CPI has been driven mainly by the BSP’s QE.
As one would observe in three charts above, CPI plunged to almost zero and bottomed out in the 3Q of 2015. In response, the BSP unleashed a record torrent of debt monetization to counter deflationary or disinflationary forces!
Needless to say, the principal source of Philippine inflation dynamics has shifted from bank credit expansion in the past to QUANTITIVE EASING today.
Worse, the introduction of TRAIN (RA 10963) has added to the distortions in the pricing system thereby affecting the coordinating and resource allocation mechanisms of the economy.
And the BSP has just proven me right. Last week I wrote,
[See Why Interest Rates Will Rise: 1Q Fiscal Deficit Blowout Financed by BSP’s Debt Monetization (QE) and Spiking Public Debt! May 6, 2018]
What this exhibits is that instead of the BSP in control, interest rates have moved sharply against policy targets and have rendered their policies out of touch with reality.
In that regard, in order not to look silly and present the image that they are on top of the situation, they intervene in the marketplace through the use of highly inflationary policy tool called debt monetization.
The BSP will eventually be forced to align its policies with the market!
The horse is out of the barn door. The BSP raised the policy interest rate last week.
From the BSP (bold mine): “The Monetary Board decided to increase the interest rate on the BSP’s overnight reverse repurchase (RRP) facility by 25 basis points to 3.25 percent. The interest rates on the overnight lending and deposit facilities were likewise raised accordingly. In deciding to raise the policy interest rate, the Monetary Board noted that latest forecasts have further shifted higher, indicating that inflation pressures could become more broad-based over the policy horizon. While inflation momentum has started to slow down, inflation may still breach the inflation target range of 3.0 percent ± 1.0 percentage point for 2018 due primarily to temporary supply-side factors. Nevertheless, inflation is expected to return inside the target range in 2019. The Monetary Board assessed that the balance of risks to the inflation outlook continues to lean toward the upside, with price pressures emanating from possible adjustments in transport fares, utility rates, and wages. Given these considerations, the Monetary Board believes that a timely increase in the BSP’s policy interest rate will help arrest potential second-round effects by tempering the buildup in inflation expectations.
You see, the BSP has lost control.
By letting the inflation genie out, the BSP now hopes that a timid tightening will do the trick of bottling it up! Of course, we know that this move was more symbolic than deliberate. The markets have forced them to act.
And in contrast to 2014, the BSP has already used up all its available ammunition. The BSP’s recent action comes in the backdrop of RECORD LOW rates and a RECORD amount of QE.
And the BSP’s move will be more than pacifying public’s anxiety over ‘overheating’ and ‘behind the curve’. The BSP will NOT tolerate a drain in liquidity over its ghastly revulsion to disinflation/deflation.
The BSP will most likely escalate the use of debt monetization (net claims on national government) to offset the huge amount of government debt issuance that will siphon massive amounts of liquidity in the system. As previously explained,
If the NG will use the BSP option, the peso will fall steeply and inflation will rise, which again will ricochet or boomerang on bond yields.
Didn’t the USD peso rally by 1% to Php 52.19 with 75% of the week’s gains acquired from the BSP’s policy hike announcement?
And to be clear, because the BSP will most likely flush liquidity into the system DIRECTLY to secure its funding, this action does not entail that they will succeed in curbing ‘overheating’. The BSP will adamantly remain ‘behind the curve’ until the market forces its hand.
So the BSP is in a big fix right now.
Inflation Propaganda, Banking System’s Fragile Profits and Mounting Concentration Risks
Back to inflation statistics.
Stunningly, as the government’s measure of inflation has impinged most on the households at the bottom 30% or “the lowest 30 percent of the total families in the per capita income distribution, arranged in descending order”, a private survey firm observed that hunger and poverty plunged!!!
According to the SWS, such hunger alleviation marks the “second time Hunger has been in the single-digit range since March 2004” and that “one out of three Filipino families escaped poverty during the first quarter of 2018.”
The surveys tell us that the inflation tax gives MORE purchasing power to the people! What awesome economic logic! Perhaps the households in the bottom 30% have embraced the monastic diet of Buddhist monks or have been affected by hallucination from starvation!
Now, of course, we can be told of anything to influence the way we think, but economic forces eventually reveal the truth.
And one area where economic reality has been flexing its muscle is through the banking system. Escalating cracks in Philippine credit bubble have become more evident.
The banking system reported a big jump in profitability in the 1Q of 2018. The 22.87% profit growth broke out of the tight range of zero to twenty percent from 2015 to 2017.
Since the partial tightening of 2014, bank profits have been lower than when the BSP assimilated a zero bound policy in 2008-2009. (upper window) Bank profits dived since the M3 growth exploded by 30% in 10 successive months in 2H 2013 to 1H 2014. The BSP’s QE in 2015 has hardly helped the banking system’s profitability.
Three of biggest four hardly contributed to this 1Q 2018 outperformance.
Net income growth had been a dismal -.45% for BPI, +1.64% for Metrobank and BDO Unibank +.46%. Though in a press release Security Bank noted that net income growth was sharply lower by 16.6% to Php 2.35 billion primarily due to a 50% decrease in trading gains, the bank hasn’t published their 17-Q or 1Q report.
Concentration risks have been mounting as the distribution share of the banking system’s operating income have been patently skewed towards income from loans. In the 2H of 2017, the share net interest income has risen to 74% to 76% as non-interest income fell below 25%. In the 1Q 2018, the distribution share was 73.87% and 26.13%
From 2008 to 2014, the balance of distribution was about 65% to 35% in favor of income from loans.
Security Bank’s decline in profit due to lower trading income hasn’t been isolated. The diminishing role of trading income has signified a crucial factor in the decline of the banking system’s non-interest income. In the meantime, Fees and commission have hardly grown enough to replace the loss of share in trading income.
Fees and commission and trading income accounted for 14.05% and 8.94% share of the banking system’s operating income in Q1 2018 and grew by 24.7% and 96.5% over the same period. The latest bounce may be a response to the recent crash.
Please do note that the banking system’s operating model has radically changed since 2013.
Since 2013, in the backdrop of heavy loan issuance, the banking system has been confronted with fragile profitability and mounting concentration risks.
And that's not even half of it.
As Banks 1Q Profits Ripped, Fixed Income Hold to Maturity Account Surged!
That jump in 1Q profitability has been captured by Union Bank.
From the press release of Union Bank (April 27, 2018): UnionBank Net Income surges 33% in 1Q 2018: UnionBank of the Philippines (PSE:UBP) posted a net income of Php2.9 billion in the first quarter of 2018 as compared to the Php2.2 billion recorded in the same period last year. These results were behind robust net revenue growth of 21.5% to Php6.9 billion.
Such booming profits should be nice except that…
From another Union Bank press release (April 30, 2018): Please be informed that the Board of Directors of Union Bank of the Philippines in its meeting held on April 27, 2018, approved to raise additional capital of up to Php 10 Billion through a stock rights offer. The additional capital will increase the Common Equity Tier 1 and Total Capital Adequacy Ratio of the Bank. The proceeds from the stock rights offer will be useto allow for continued growth of assets of the Bank.
Stock Rights Offering came after…
From a February press release (February 21, 2018): Union Bank of the Philippines (“UnionBank” or “the Bank”) has successfully raised ₱3.0 billion worth of Long-Term Negotiable Certificates of Time Deposit (“LTNCDs”). This is the first tranche from its ₱20 billion worth of LTNCDs approved by the Bangko Sentral ng Pilipinas (“BSP”). The Bank’s LTNCDs, with a tenor of 5 years and 6 months, will bear interest at the rate of 4.375% per annum and will mature on August 21, 2023. The LTNCDs have been listed today on the Philippine Dealing Exchange Corporation (“PDEX”). It is the Bank’s first instrument listed on PDEX’s platform and also PDEX’s first listing for the year.
Domestic offering LTNCD offering was after…
From a November press release (November 27, 2018): Further to our disclosures dated 15 and 22 November 2017, please be informed that Union Bank of the Philippines (“UnionBank”) has launched an upsize of USD 100 million of its 3.369% Senior Notes (“Notes”). After theupsize, the total Notes maturing on 29 November 2022 amount to USD 500 million. The Notes are issued under UnionBank’s Medium Term Note Programme (“MTN Programme”), which was established on 14 November 2017. The Notes are rated Baa2 by Moody’s and will be listed in the Singapore Stock Exchange. The proceeds of the Notes will be used to refinance UnionBank’s existing liabilities, expand its funding baseand for other general corporate purposes.
Huh? Supposedly blessed with a deluge of profits, why have most banks been raising funds left and right by issuing SROs and LTNCD and/or MTN?
Please be advised that I am using UnionBank as an example or a representative of the industry.
The banks have been in stiff competition with the government to raise financing.
2013 overhauled the banking system’s asset and income mix.
The banking system’s investment portfolio has drastically shifted from Available for Sale (AFS) and Held for Trading (HFT) assets to Held to Maturity (HTM)!
In the 1Q 2018, HTM grew by a staggering 44.4% in January, 40.65% in February and 38.23% in March or for an average growth of 41.11%!! Meanwhile, HFT grew by 11.61%, 32.74% and 30.27% as AFS shrank -17.83%, -15.16% and -13.27% over the same period.
The share of HTMs in the Banking System’s Financial Assets (gross, net of amortization) pie ballooned to an astronomical 61-62% from the average 52.36% in 2017!
This marks a major gravitation towards HTMs as the core financial holdings of the banking system.
Like the intensifying skew towards net interest as a share of the banking system’s operating income, the lopsided flow to HTMs underscores fast expanding concentration risks!
Recall that in 2014, the state-owned DBP’s proverbial hand was caught in a cookie jar with an attempt to sanitize the bank’s losses bywhitewashing transactions from AFS to HTMs?
HTMs are where financial institutions tend to conceal their losses through accounting gymnastics.
Domestic Banking System Have Been Running Down Cash as Deposits Growth Fumbles!
And the final stunner.
By the way, the BSP’s data on the banking system balance sheet and income statement can be downloaded by pressing on their respective links.
Ever since 2013, the growth of cash and due from banks, the most liquid of banking assets, have begun to crumble. It partly recovered in 2015, peaked in 1Q 2017, reverse or begun to descend from then and plunged to the negative territory since December 2017. Cash and due from banks shrunk by a stunning 9.32% in March 2018! The decline has been ostensible even from nominal figures (upper chart)
In 2013, the growth of Total Loan Portfolio (TLP) and cash as a share of the banking system’s assets marked their respective inflection points. Both went in the opposite direction. Or, TLP’s share bottomed and soared from then as cash’s share peaked and crashed.
The Loans-to-Deposit and Cash-to-Deposit ratio reveals the same dynamics.
On the face of it, banks have been lending out their cash reserves!
That could be partly true. Except that as total loan portfolio share of total assets continues to screech higher, bank asset growth has dropped. After peaking in August 2017 at 15.07%, March growth registered a mere 11.33%. Cash and investment conditions have weighed considerably on the banking system’s asset growth.
And what’s even more striking, deposit growth has been slowing. Deposit liabilities have been dragged mostly by the sharp decline in foreign currency (+7.06% March, +11.59% February and +12.31% January). Even growth in domestic currency deposits have slowed modestly (+13.73%, +12.99 and 12.94%). (middle window)
It becomes clear why Unionbank had to raise US $100 million in the 4Q of 2017.
US dollar holdings have been in a substantial decline in both the banking system and the BSP.
The Underbelly of the Domestic Banking System Exposed!
It stands to reason that notwithstanding profitability, the aggressive loan issuance hasn’t been generating adequate liquidity for the banking system. The Php 18.9 trillion question is WHY? Total Domestic Bank Resources as of February 2018 is Php 18.9 trillion.
Though published reports say that delinquency and bad loans have remained low, why have the banks been starving for resources? Why the massive issuance of LTNCDs and SROs?
Even more, why the stampede to shelter fixed-income holdings into HTMs? Could it be because ROPs have been crashing??? And that the current bond selloffs have surpassed the scale of 2013???? With investment losses, liquidity naturally shrinks.
If loans haven’t been generating sufficient liquidity and if investments haven’t been profitable, would this not entail escalating liquidity shortages? Has the accelerating surge in benchmark T-bill rates, in spite of the BSP’s interventions been a symptom? (see bottom)
If so, have rising yields begun to incorporate credit quality or credit risk?
With the government aggressively competing for access to savings, would heightened demand for liquidity in the banking system translate to further increases in ROP yields/interest rates?
And why hasn’t such immense bank credit growth transformed into deposits growth? Has there been significant leakage in them? Could this have been a product of undeclared delinquent or bad debts?
With the growing concentration of the banking system’s portfolio towards HTMs and Loans, in the investment and income components respectively, what happens if yields of ROPs continue to spike or if the delinquency in credit conditions exacerbates or both?
The BSP says they have been in control of the situation. Yet, market actions and their response suggests otherwise.
Worst, the dramatic deterioration in the banking system’s health conditions exposes its underbelly
Enough capital exists to protect the system says the BSP. But capital adequacy depends on the underlying conditions of the assets that constituteit. The proof of the pudding will be in the eating.
Nevertheless, given the current conditions expect the BSP to expand its QE program.
Bye, bye the peso.
