In this issue
Philippine Banks in a Seeming Panic 2.0: As Liquidity Shrinks on Rising NPLs and Investment Losses, Banks Use HTMs to Mask Increasing Fragility!
-Why the Sustained Liquidity Drought, if Banks Have Been Raking Money?
-A Downturn in Unison for Deposit Growth, Domestic Liquidity and Bank Lending; -Surging NPLs as the Main Driver of Liquidity Shortages
-The Panic to Hide Losses? The Banking Industry’s HTM Holding Rockets by 53% in September!
-Liquidity Shortages and the Dearth of Profits are Symptoms of an Underlying Disease
Philippine Banks in a Seeming Panic 2.0: As Liquidity Shrinks on Rising NPLs and Investment Losses, Banks Use HTMs to Mask Increasing Fragility!
Pls find below the final installment of the two-part series on the 3Q performance of the banking industry
Since almost all items on the “balance sheet and the income statement are based on managers’ subjective estimates and projections”, wrote Professor Lev, and that “a few items on the balance sheet, like cash and debt” are factual, the latter should be given the fundamental attention.
The quote divulges two salient or important fundamental points on analyzing financial statements.
One, because net income/eps/profits are subjectively determined, these may or may not reflect on facts or actual conditions. There is a big possibility for its embellishment.
Second, because only cash and debt are the only facts, these may be used to confirm or disprove the declared bottom line of a company or an industry.
Now let us move on to the balance sheet of the banking system.
Why the Sustained Liquidity Drought, if Banks Have Been Raking Money?
If the banking system is truly healthy, then liquidity wouldn’t be an issue.
Figure 1
Yes, the banking system has been lending less, but the lending spree by the biggest banks has been manifested in the record rate of loan-to-deposit ratio!
As of September, the Loan-to-deposit stood at 78.21% higher than 76.82% in August and 76.88% in July. (figure 1, upper window)
And as the momentous rise in bank lending erodes its deposit base, its toll has been manifested in the continuing cascade of liquidity conditions.
The banking system’s most liquid assets “cash and due banks” continue to lose ground swiftly. Cash assets shrank year on year by -11.86% in September, -11.67% in August, and -12.33% in July.
The BSP’s own liquidity ratios reveal the continuing atrophy.
The ratio of “Liquid Assets to Deposits” fell to 45.66% in September from 46.71% in August and 46.07% in July.
The ratio of “Cash and Due Banks to Deposits” slipped to 19.36% after rallying by a margin in August to 20.21% from July’s 19.81%.
As shown in Figure 1, the banking system’s liquidity ratio has been in a steady decline since 2013. However, since the 3Q of 2017, the decay of such liquidity ratios have only intensified!
And liquidity strains have been surfacing even in the treasury markets which are “managed” by the BSP.
The Treasury curve continues to strikingly flatten which has become visible even from a 3-week differential! (figure 1, lowest window)
T-Bill and T-Bond rates continue to move in a diametric path. Sustained increases in T-Bill yields to multi-year highs exhibit the ongoing liquidity shortages.
On the other hand, falling bond yields since mid-October signify the market's outlook of a decline in statistical inflation.
A flattening curve is likely to reduce the banking system’s interest rate spreads or margins that would exacerbate the bank’s grinding quest of bolstering the elusive income.
That said, banks can be expected to keep soliciting financing from the public in a tightening race with the National Government.
Banks create and deal with money, so why should they be short of it?
A Downturn in Unison for Deposit Growth, Domestic Liquidity and Bank Lending; Surging NPLs as the Main Driver of Liquidity Shortages
Figure 2
The banking system’s deposit conditions also showcase its liquidity predicament (figure 2, lower window)
Total deposits grew 9.53% in September, slightly up from 9.18% in August but down from 10.04% in July. Peso deposits grew 10.38% in September, marginally up from 10.12% in August and 10.37% in July. Foreign currency deposits grew 5.61% in September, slightly up from 4.78% in August but likewise significantly lower from 8.43% in July.
Deposit growth rates for both peso and dollar, as manifested by the total, have been in decline since 2013. The difference between then and the present has been that recent declines (since 3Q 2017) have been escalating!
The intensifying liquidity drought in the banking system has likewise become evident in money supply and general bank lending conditions! The growth rate of total bank lending fell to 17.23% in September, from 18.83% in August and 19.49% in July.
If banks are lending less, then demand for sectors dependent on credit should slow. I’m referring to the private sector.The government continues to help vacuum the liquidity in the financial system.
Money supply or domestic liquidity conditions have essentially expressed the mounting slack in deposit and bank lending conditions.
The M3 growth rate dropped to 9.67% in September, from 10.37% in August and 10.98% in July. Currency and transferable deposits or M1 stumbled significantly to 11.34% in September, 11.48% in August and 14.86% in July.
Think of it. Not only have deposits been tumbling, but the banking system has also seen its cash reserves fall. Most importantly, how will there be G-R-O-W-T-H when there have been fewer available cash to finance cash-based transactions?
And if credit transactions fall how would these not be symptoms of a slowdown?
And how will banks generate profit and liquidity, when demand for credit falls in the face of shrinking margins, and when deteriorating financial conditions should spur more incidences of the spoilage of credit?
Proof?
Figure 3
September’s Net Non-Performing Loans ratio rockets to 1% from .9% in August. (upper window, figure 3)
The BSP-led Financial Stability Coordination Council’s (FSCC) 2017 Financial Stability Report (FSR) already pointed this out last June: “The concern on the sustainability of debt is magnified by the increasing level of delinquent loans. The non-performing loans (NPLs) level of the banking system was generally declining at the onset of the GFC but has increased since late 2015” (bold mine)
So the trend persists.
And you can bet that these numbers don’t reflect on the truth/facts. NPLs must have been significantly understated.
It’s the primary reason why banks have been short in liquidity: bad loans have been devouring cash assets.
And some banks have unleashed a tsunami of lending!
The Panic to Hide Losses? The Banking Industry’s HTM Holding Rockets by 53% in September!
And there’s more.
It’s not just bad loans. Plaguing the banking system has been sustained investment losses!
Accumulated losses at Php 15.471 billion almost reached a January 2014 of Php 17.05 billion.
And the degeneration of the banking system’s investment performance hasn’t been an anomaly; returns have decayed since it peaked in July 2016! (figure 3 lower window)
Figure 4
Losses from Held to Maturity (HTM) assets must be one of the principal contributors to the banking system’s investment losses!
Debt securities under held to maturity are recorded at the market value (original cost) on the date of acquisition. Or because these are not subject to mark-to-market, banks can hide their losses by classifying them as HTM!
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 (Figure 3.8). Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity
So what registers as losses are credit securities that have matured!
And by re-categorizing these debt securities to HTMs such allows banks to conceal their investment losses!
And the banking system has been frantically CRAMMING their Financial Assets with HTMs!!!!
Some numbers.
HTM’s growth has been spiraling higher this year! (figure 4, upper window)
September HTM growth rocketed by a staggering 53% in September from 37.06% in August and 38.01% in July!!! HTM’s share of Gross Financial assets zoomed to a stunning 70.95% in September from 64.09% in August and in 64.17% in July! (figure 4, lower window)
Incredible!
Figure 5
HTM’s of the 4 PSYEi banks surged 32% or Php 240.256 billion to Php 991.06 billion in the 3Q! (figure 5, lower window)
BPI’s HTM holdings have grown in a steady pace (+5% in 3Q 2018) while Security Bank reduced it by 25%. On the other hand, Metrobank and BDO added the most. BDO’s HTM portfolio jumped 17%. Meanwhile, Metrobank, which had zero HTM holdings in 2017, reclassified all of its available for sale assets to Hold-to-Collect!
Metrobank’s shift from ‘available for sale assets’ to HTC (2018 3Q 17Q and 2017 3Q 17Q) serves as a vivid example of the FSCC’s observation that “some banks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM)”
Awesome isn’t it?
By % share, BPI ranked first 28.54%, MBT was next at 26.77% with BDO and SECB at 23.03% and 21.65% respectively.
Now you see why the largest banks have embarked on a massive campaign to raise funds from the public?
Oh, you won’t hear or read anything related to this from the mainstream. Remember, if such sort of stuff spreads, access to the public’s savings may become more difficult for the industry.
Liquidity Shortages and the Dearth of Profits are Symptoms of an Underlying Disease
Net income and liquidity are outcomes of actions undertaken by the banking industry.
Several possible factors could be the cause of its slack. One, the banks haven’t been generating sufficient profits (if they are making profits at all!). Two, the banking industry has been understating their losses. Three, it’s a combination of both.
And to reinforce such paucity in profits and liquidity backdrop, the banking industry relied on the capital markets to shore up its finances.
Bonds payable vaulted 94.05% in September, 118.67% in August and 120.16% in July. Bills payable crept higher by 1.52% in September, +4.67% in August and -9.05% in July. (Figure 5, lower window)
A seeming overhaul of the banking industry’s debt profile has been in the works. They are recalibrating the maturity of debt exposures to rely on long-term funding than the short-term. This squares with the plans by major banks to solicit funds via bond and commercial paper programs. The BSP has encouraged this by relaxing rules for borrowing from the capital markets,
However, unless the complications that have strained the industry's profits have been resolved, liquidity will remain under pressure. Besides, the escalating competition with the government for access to funding has already been compounding on the banking industry’s dilemma.
That said, if cash and debt are the only reliable facts to gauge the industry’s health, then its 3Q performance reveals that the banking system has become increasingly anxious.
Not only are they using accounting artifices to camouflage the intensifying fragility, but the industry has also resorted to gambling away financial stability by overextending loans to window dress the 3Q activities.
As economist Herb Stein popularly said, "If something cannot go on forever, it will stop."
