New growth frontiers in the Philippines

Filipino banks continue to be some of the healthiest lenders in Asia. Now, record volumes in equity and debt capital markets offer a further source of growth in one of the strongest banking sectors in the region. Stefania Palma reports.

The Philippines’ commercial banks have continued growing – some at unprecedented highs – in the past 18 months in spite of external shocks hitting a number of markets in Asia. Some universal banks were even targeted by overseas lenders in mergers and acquisitions (M&A) deals. And now, as local capital markets are breaking records in terms of bond issuance and M&A volumes, the investment banking business could be the next big area of growth for local lenders.

The past 12 months have not been an easy ride for emerging markets in Asia. The US interest rate rise at the end of 2015 triggered strong capital outflows from those economies that benefited from an influx of foreign money after the US and Europe started easing monetary policy to counter slow growth. Indeed, estimates suggest China’s capital outflow amounted to as much as $1000bn in 2015. Some currencies across Asia also weakened considerably on the back of expectations of a US rate rise for most of 2015. The Malaysian ringgit dropped by 18% versus the US dollar in that time period.

The Philippines, though, did not experience strong capital outflows and the peso, if anything, appreciated throughout 2015, hitting a high of 47.5 pesos to the dollar in December.

Top 10 Philippines banks

Philippines strength

Although the slowdown in China’s economic growth affected trade and investment volumes even in the Philippines, its economy remains one of the healthiest among Asian countries. “China's slowdown has partly raised the risks of falls in commodity prices, volatility in currencies and reductions in business confidence. While the Philippines is likely to see a slowdown in exports, domestic demand may be better supported because the country’s sizeable overseas worker remittances have proven to be resilient,” says Standard & Poor’s.

Coupled with Filipino banks’ strong capitalisations and balance sheets, a strong local economy meant the effects of global economic turmoil in 2015 on local lenders were relatively subdued compared with other markets in Asia.

“We have already implemented Basel III fully [in 2015]. The US has not even approved Basel II. Elsewhere, Basel III is being done in phases. Our central bank is advanced. It understood that Filipino banks and their balance sheets are very strong, because of the macro prudential measures implemented after the 1997 Asian financial crisis,” says Rabboni Francis Arjonillo, president of Makati-based First Metro Investment Corporation. In addition to this, the Philippines’ 16.5% capital adequacy ratio is far above the minimum requirement of 10%. 

Security's record growth

Among the Philippines' universal banks, Security Bank stood out in 2015 for its performance. Driven by its three key businesses – retail, wholesale banking and financial markets and treasury – the lender announced record-breaking results for 2015. “Our key successes were in profitability and growth. We posted record high profits and continued to deliver the highest shareholders’ returns among listed universal banks in the Philippines, with a return on equity of 15.2%,” says Alfonso Salcedo, president and CEO of Security Bank. The lender also registered record net profits of 7.7bn pesos ($167m).

According to Mr Salcedo, this performance was partly due to customer loans and deposits growing faster than the industry average. “Net interest margins from this business improved further,” he says. Fuelled by mortgages, some of the bank’s key consumer loan portfolios increased by 67% year on year in 2015. Wholesale loans grew by 21% in the same time period. 

A strong year-on-year increase in fee-based income of 38% was also crucial to the growth of the bank. “There were solid contributions from retail banking services such as bancassurance, credit cards and deposit transactions, as well as from asset management,” says Mr Salcedo.

The fact that a drop in non-performing loans (NPLs) accompanied Security Bank’s significant income would suggest the lender’s expansion is sustainable. Its net NPL ratio dropped from 0.28% in 2014 to 0.14% in 2015. What is more, the bank’s NPL reserve cover of 205% is one of the highest in the industry.

Security Bank also succeeded in containing costs as revenues increased in 2015. Security Bank’s cost-to-income ratio stood at 50%; the Filipino banking industry average is 62%. “All in all, we had a well-balanced result in 2015,” says Mr Salcedo. 

BTMU acquisition

In addition to posting record-breaking results, Security Bank also sold 20% of equity to Bank of Tokyo Mitsubishi (BTMU) – the largest bank in Japan by Tier 1 capital, according to The Banker Database – for 37bn pesos in January 2016.

As with many Japanese banks, BTMU is keen to escape extremely low interest rates and poor margins at home by expanding across Asia via minority equity stakes or acquisitions. Before Security Bank’s deal, BTMU had established a presence in Thailand, Vietnam, Indonesia and Malaysia. “In the Philippines, BTMU chose us as its partner,” says Mr Salcedo. 

Mr Salcedo is excited about the deal for two reasons. First, it helped Security Bank raise capital to boost its retail banking business, and second it will give the lender access to BTMU’s vast global network. “The additional capital helps us have faster execution and larger scale, which supports our strategy to build our retail banking business as a third business pillar alongside wholesale banking and financial markets,” says Mr Salcedo. To this end, Security Bank plans to bulk up its local branch network. 

The acquisition also gives Security Bank access to a new market – Japanese business in the Philippines – and to new business lines. As a result of the acquisition, Security Bank has a higher chance of growing in sectors BTMU is particularly strong in: project finance, securities, asset management, credit cards and consumer finance. 

Security Bank hopes to increase its participation in project finance loans and broaden its deposit services and small and medium-sized enterprise loan facilities. “We will be able to accelerate our coverage to support the Philippines’ growth sectors and sustain our technological edge,” says Mr Salcedo. 

Indeed, Security Bank does not have any presence abroad and is keen to continue focusing on its local market. “We have no direct international presence and we do not plan to have any. We see opportunities for growth domestically. Our priorities are here. Our returns are here. Security Bank is under-represented in many areas of the country. If we see significant business opportunities from abroad – for example, remittances – we will see how we can effectively tap these through BTMU’s or [its owner] Mitsubishi UFJ Financial Group’s international network,” adds Mr Salcedo. 

Investment banking soars

At home, the Philippines banking sector is starting to offer a further source of growth – investment banking. The Philippines is flush with liquidity, with one of the highest savings rates in the Association of South-east Asian Nations (Asean) at 30% to 40% of gross domestic product. But investors are starved of investment opportunities. As capital markets have started deepening, banks are rushing to satisfy investor demand for investment banking products. 

In addition to satisfying demand for investment products, banks are keen on investment banking because it is a strong source of fee income. “Trading income from treasury is shrinking. Net interest margins are dropping [due to globally low rates]. Banks need to work harder on [building] net interest income and fee income can add to that,” says Cristina Ulang, head of research at First Metro.  

Interest in investment banking is growing to the point that investment banks such as First Metro, which historically took the lion’s share of the local business, now need to fend off commercial banks joining the race. “We used to comfortably be number one, but now there are new players such as Bank Of Philippine Islands and Banco de Oro building up their investment banking departments. Banks are starting to poach each others’ talent. Our pie is starting to shrink,” says Ms Ulang. 

ECM take off

Although new competitors might be 'shrinking the pie' for firms such as First Metro, the overall investment banking business in the Philippines is growing quickly, especially in the equity and debt capital markets fronts. 

In the equities market, Philippines firms’ outbound M&A volumes reached record highs in 2014 at $2.4bn, according to Dealogic. “Filipino conglomerates have enjoyed up to eight years of growth thanks to the country’s strong economic performance. Their balance sheets have become strong. There is so much liquidity in the system and not too many investment opportunities locally. Also, the value of international assets has cheapened so much that our strong local companies are now looking to buy them,” says Justino Juan Ocampo, head of investment banking at First Metro.  

Buying up foreign firms makes a lot of sense especially now that local currency financing is cost effective. “Fifteen-year financing in pesos is at record lows,” says Mr Ocampo. “The peso has strengthened considerably and this has provided a boost for our local companies to find cheaper offshore markets to invest in,” adds First Metro's Mr Arjonillo.

Filipino companies are also buying up foreign firms to escape a saturated local market and to withstand future competition in the region as the Asean Economic Community integration kicks in, adds Ms Ulang. “Filipino firms’ performance in terms of sales volumes [in Asia] is even stronger than in the Philippines,” says Ms Ulang.

Notable overseas M&A deals by Filipino conglomerates include fast-food chain Jollibee Food’s acquisition of a 40% stake in US burger chain Smashburger; Jollibee buying out the supplier of its Chinese fast-food operator Yonghe King; and Filipino brandy producer Emperador’s acquisition of Spanish brandy and sherry cellar Bodegas Fundador.

DCM acceleration

In a similar vein to the equity capital markets, the debt capital markets business is also accelerating in the Philippines. Bond issuance volumes have reached record highs. In 2014, corporate bond issuance broke records at 100bn pesos. Although volumes in 2015 dropped to 90bn pesos, “it is certainly an upward moving curve”, says Mr Ocampo. 

Testament to the depth of the local bond market development are the larger deal sizes – 10bn pesos to 15bn pesos bond issues are becoming the norm, says Mr Ocampo – and longer tenors, now up to 15 years.

What could help the local bond market develop further is having a more populated yield curve. At the moment, five, seven and 10 years are the most liquid points on the curve. But sometimes, low liquidity means the seven-year yield point is higher than the 10-year mark – this means the curve is inverted, leaving banks with no benchmark to base a deal on. This makes pricing negotiations complex and sometimes discourages issuers from using bonds as a means of funding, say market participants.

Speeding up the implementation of public-private partnerships (PPP) in the country could also help develop capital markets further. “We need to simplify our PPP rules and regulations. Some [bond] issuers have some difficulties with some PPP regulations. In the past six years, we only had a few PPP projects approved so going to market to issue debt on behalf of these [private] conglomerates has been hard. The approval process has been very slow. It needs to be revisited and simplified,” says Mr Arjonillo. 

Muni bond opportunities 

While the PPP system may still need to be tweaked, investment banks are finding another business opportunity in the local municipal bond market. The sector is almost non-existent at the moment, but the potential is strong, according to Mr Arjonillo. 

Filipino municipal governments have high expenditure needs, especially for local infrastructure projects since PPP programmes focus on national rather than local-level initiatives. However, administrations’ financing capacity is limited as they focus purely on state bank loans. These are also tricky to get since they require municipal governments receiving four approvals from different public entities. If administrations have a small tax base, the amount they can borrow from state banks is limited further. Worse still, having such a poorly diversified financing strategy could be risky.  

Mr Arjonillo thinks developing a municipal bond market could solve local governments’ financing inefficiencies. The province of Palawan tried to print a muni bond, but it did not work out well because costs were too high. “This could be an opportunity for us,” says Mr Arjonillo.

Although First Metro would start developing this sector with vanilla muni bonds first, Mr Arjonillo believes there is room for securitised muni notes in the future. “Securitisation would work well, especially if local governments have to finance infrastructure projects,” he says. This would mean exhuming the Philippines asset-backed security (ABS) market, where significant activity dates back to the 1980s. ABS deals have since been few and far between.

The Philippines banking sector has navigated a tough year for emerging markets considerably well. Philippines lenders continue to be attractive targets for foreign acquirers thanks to local banks’ strong capitalisations and the economy’s solid performance. Regulatory reform aimed at deepening local capital markets could help banks grow further. Meanwhile, the race in building up investment banking capabilities – even among commercial lenders – shows growth frontiers in this market are far from extinguished. 


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