Business World
Introspective
The latest World Bank Philippines Quarterly Update, Sailing through stormy waters (July 2009), has some good news to tell. Tucked among pages discussing the country's expected poorer economic prospects this year is a box that begins with the conclusion that alert levels on the Philippine banking system have come down over the past six months. This is a relief for many who late last year had been bracing for more contagion from the US financial turmoil.
Transmission of turbulence from developed markets to local shores in the September/October period last year had mainly come through falling prices of dollar-denominated Philippine government securities (popularly called ROPs) that comprise an important portion of bank assets.
Notwithstanding this generally favorable conclusion, the report observes that banks continue to have a large exposure to interest rate risks with about P700 billion, representing 12% of total assets, subject to fair value accounting. For a 100-basis-point increase in spreads on all types of government securities, it is estimated that banks can potentially lose about 50 to 70% of average annual profits on account of lost value from government security holdings.
This consideration provides yet another important reason why Philippine fiscal authorities have been quite cautious in joining full steam the fiscal stimulus bandwagon. The other reasons being the more generally known effect of high interest rates (and thus debt service) in crowding out essential public social and infrastructure spending, and in discouraging private investments and job creation. (Finance officials have been emphatic on their having a medium-term fiscal program that tries to bring back the debt-to-GDP ratio to a downward trajectory by steadily bringing the deficit from 3.2% of GDP [P250 billion] this year, back to near balance by 2013.)
The World Bank Quarterly update likewise observes that concerns over market and liquidity risks have given way to worries about credit risk that follows weaker economic prospects. Bankers I've talked to tell me that they are already seeing upticks in default rates in industries that have been directly affected by the economic downturn. These include exporters and overseas workers and their families who have taken out loans to purchase homes in the Philippines. Of the two, housing loans appear to be more worrisome as this has been an important growth area in past years, having benefited from the rapid remittance growth.
Nevertheless, the continuing growth in remittances offer comfort (as well as the fact that Filipinos put great store on housing investments and can be expected to keep up mortgage payments - even dipping into savings - for as long as possible).
While the entire real estate sector is being watched closely for potential problems, a collapse similar to what happened in the aftermath of the 1997 Asian crisis can be ruled out; most real estate companies today are profitable with relatively low debt ratios.
Some of the big real estate firms, e.g., Ayala Land, Megaworld, have also started to rely less on banks for financing, instead tapping lenders directly with bond issuances. Any remaining bank financing had been done against company balance sheets rather than project cash flows, adding a layer of protection for banks. Meanwhile, a new mode of housing finance, based on developers' contracts to sell, have been done with recourse to developers, minimizing risk to banks.
Apart from real estate, another area which has shown dramatic growth in bank exposure has been the power sector. This is driven in part by real need to invest in capacity after years of under-investment in this sector, and in part by financing for the acquisition of plants being privatized by government.
By and large the lending has been to borrowers with good credit rating and good track records in operating in this industry. What is needed to make sure these chunky loans perform well is the maturing of the regulatory environment. This includes, the functioning of the Energy Regulatory Board, so that it's rate setting does not get politicized (even as we enter a political season), and tweaking the operations of the Wholesale Electricity Spot Market (WESM) to more fully reflect true electricity supply/demand conditions. (Ditto for loans to the water sector and the sometimes idiosyncratic regulatory regime governing it.)
Another somewhat related and more long-term concern is increased concentration of lending to conglomerates, something that the World Bank report also mentioned.
An example of this is San Miguel's venture into regulated industries such as oil, power, and water that require lumpy investments that need to be financed.
Although a large chunk has been borrowed from the capital markets, banks have also bought these bonds adding to their exposures to San Miguel. While the single borrower's limit mitigates against concentration risk, banks will increasingly find it hard to find other lending outlets to diversify risk.
The report further observes that risks that may eventuate in a scenario of low growth are drags on banks' earnings resulting from a more difficult operating environment that will see banks' interest rate margins squeezed, loan growth decelerating, and cost of lending rising.
This setting may also test the appropriateness of individual bank capital in terms of covering unexpected losses and/or higher risk taking. While the big banks may have no problem raising capital in the current environment of high liquidity, the smaller banks may find it more difficult - and could result in pressure for further consolidation of the banking system, arguably a good thing.
Mr. Romeo Bernardo is Global Source Philippine advisor and board member of The Institute for Development and Econometric Analysis, Inc.
