Though few economies in Asia have managed to avoid the global economic downturn, the Philippines has come pretty close. While the archipelago has not emerged entirely unscathed from the global slump, which all but devastated economic output in several neighbouring countries, it has proved highly resilient. The country's fledgling banking system also remains robust, boasting both a strong capital adequacy ratio and an enviable pool of free-flowing liquidity. But the gradual restructuring of the Filipino economy, which has served to cushion it against the global slump, is set to promote increasingly intense competition within the banking sector in the near future.
In recent years, the Philippines has been transformed into a service-based economy, with its manufacturing base gradually giving way to sectors such as business process outsourcing, tourism, telecoms and IT. Unlike its many export-dependent neighbours, the country's exposure to the collapse in global trade has been relatively small: while the Philippines saw a sharp downturn in economic output in the first quarter of 2009, gross domestic product (GDP) growth bottomed out at 0.6%, narrowly averting recession. The second quarter brought happier news, leading the Filipino Ministry of Finance to forecast GDP growth of between 0.8% and 1.8% for 2009 and between 2.6% and 3.6% for 2010. While this is a far cry from the near-record 7.3% growth the country enjoyed in 2007, it is still a happy outcome for an economy that, in the view of many onlookers, underperforms even in the most favourable global economic climate.
It is widely recognised that the Filipino Ministry of Finance owes a debt of gratitude to the country's 10 million overseas workers who have continued to remit a growing volume of payments back to the country, in spite of the global slump. Remittances now account for some 10% of GDP and increasingly serve to support domestic consumption, another key driver of growth. Many onlookers believe that it is primarily this source of external liquidity combined with the long-term diminution of the country's export sector that has buffered the country against the crisis.
But this analysis overlooks key liquidity-enhancing measures undertaken by the country's policy-makers in the last quarter of 2008 to prepare for the economic tempest, says Amando Tetangco, governor of Bangko Sentral Ng Pilipinas (BSP), the country's central bank. "Some people have said that we were unscathed because our ship never left the port: my answer to that is that our ship left the port, but it did not reach the perilous high seas. That was not an accident: it was the result of careful and forward-looking policies on the part of the BSP and the national government," he says.
Protective policies
Leading Filipino bankers such as Nestor Tan, CEO of Banco de Oro (BDO), the country's second largest bank by Tier 1 capital, agree that, at least where the banking sector is concerned, the BSP deserves credit. "The reason we are in this situation is because the central bank has really put in good policies to protect the industry from a boom and bust market," says Mr Tan. "It has not allowed us to get too ahead of ourselves. The sector is in a position to support the growth of the economy."
Certainly, the banking sector boasts a number of key strengths. Following the introduction of Basel II in 2007, the system is extremely well capitalised with the BIS capital adequacy ratio approaching 15%, according to the BSP. The central bank has also been cautious in issuing derivatives licences, meaning that the sector's exposure to subprime toxic debt and associated losses has been negligible. With a modest loan-to-deposit ratio of about 60%, the system is hugely liquid. As such, Moody's recently cited the banking system's resilience in its decision to upgrade the country's credit rating from 'stable' to 'positive'.
Carlos Borromeo, chief financial officer of Security Bank
A heavy legacy
This is not to suggest, however, that the sector's assets are impeccable. If the recent crisis has proved relatively undisruptive, the legacy of the Asian financial crisis in 1997 continues to weigh heavily on the sector's balance sheet, with many Filipino banks still holding a large number of non-performing assets (NPAs) resulting from this period. These comprise a chunk of ongoing non-performing loans (NPLs) and a further glut of repossessed real estate and other properties, otherwise known as ROPA assets. At their peak in 2002, these NPAs accounted for a huge 28% of system assets, according to Standard & Poor's. While this ratio has steadily declined during the past seven years, legacy NPAs continue to drag on the sector's profitability, which remains "reasonable, but not solid", says Ritesh Maheshwari, senior director at S&P's.
Most of the top-tier players are still pursuing divestment strategies, including the creation of joint ventures with real estate developers, direct retail sales and wholesale auctions. "Unfortunately, the environment is not too favourable," says Cecilia Tanchoco, vice-president of the asset management and trust group at Bank of the Philippine Islands (BPI), the country's largest bank by Tier 1 capital. The Special Purpose Vehicle Act of 2002, under which Filipino banks were afforded special tax and regulatory incentives to dump their NPAs, expired in the second quarter of 2008. Meanwhile, valuations of commercial property assets amid the current climate have not been encouraging, says Mr Maheshwari. Combined with a dip in sector profitability this year, dumping these assets is likely to become more challenging.
Mr Tetangco says that the industry has demonstrated serious commitment to asset clean-up, as evidenced by a substantial decline in system NPAs between 2002 and June 2009. The total system NPA ratio stands at 4.9% as of June 2009, while system NPLs now hover at near pre-1997 crisis levels of about 3.5%, according to the BSP. Although the central bank's definition of NPL differs from that of the external rating agencies, a relative and steady improvement in asset quality is evident. And, with the introduction of Basel II, Mr Tetangco says that he is able to expedite the ROPA divestment process using a "carrot and stick" policy: "The carrot is concessions. The stick is the tightening of our rules of holdings of bad assets under Basel II by raising the risk weight from 100% to a 150% capital charge." Stick aside, Carlos Borromeo, chief financial officer of Security Bank, the country's eighth largest institution, believes that the next upswing in lending will also encourage banks if not to unload these assets, then to write them off. "As lending really takes off, then banks will start thinking about what they can free up on their balance sheet in order to allocate capital some other way," he says.
Commercial competition
It remains uncertain, however, when the next credit cycle will move into full swing. Since the 1997 crisis, the Filipino banking sector has dedicated its excess liquidity to buying up government bonds rather than lending. Only in the past two to three years have banks begun to beef up their lending portfolios, although the rate of expansion continues to lag behind that of neighbouring banking sectors. Domestic credit accounts for 49% of GDP, from a high of 65% in 2001, according to the BSP. "The banks are very conservative: they will choose carefully what loans they are going to take on," says Ng Seow Pang, head of global markets at Standard Chartered, Philippines. "There is a lot of headroom for banks to extend credit facilities: but is there credit out there that's worth lending?"
This question is particularly pressing in the commercial sector. In the past six months, the major players have experienced the most marked deceleration in their corporate loan books: BPI, for example, has seen its commercial loan growth shrink from 21% in 2007 to 5% in the first six months of 2009, with the decline sharpest among the top-tier market segment, says Ms Tanchoco. BDO's working capital lending growth is also in the low single digits, says Mr Tan. Rather than a symptom of the global economic climate, the decline signals increasingly intense competition among the top-tier market segment, say bankers. "Most of the big banks, both local and foreign, are going after the same names," says Gigi Pio de Roda, chief operating officer of HSBC Philippines. "Our challenge is no longer just to compete against the foreign banks, but to increase our performance against the big local banks," she adds.
The development also reflects a broader structural shift in the Filipino economy, which now comprises fewer manufacturing companies with heavy financing needs, says BDO's Mr Tan. Moreover, many organisations are increasingly raising finance in the debt capital markets. Bankers cite San Miguel Brewery, the Filipino beverage company, which raised 38.8bn pesos ($803.3m) in March in the country's biggest bond deal, as an example of the abundant liquidity available in the domestic debt capital market - although the corporate bond market is just in its "infancy", says Mike Aguilar, managing director and head of client origination at Standard Chartered, Philippines.
Nevertheless, bankers still see opportunities in the wholesale business. Burnt by the 1997 crisis, the country's large corporates have been highly conservative in recent years, carefully rebuilding their balance sheets. Security Bank's Mr Borromeo believes that there is still major lending growth to be had from this segment with the resumption of the next credit cycle. "I would anticipate a very sharp jump in lending. We're talking about entities that have sat on capital expenditure for a very long time and we're beginning to see some of that capital spending go back."
The power industry, which is in the process of privatisation, is one source of potential growth, with investment already beginning to trickle into the sector. "There are still a lot of opportunities in power plants: when the economy starts to grow again, there is an anticipated shortage of power and those deals are big," says Mr Pang. Sitting on an estimated $2000bn of untapped mineral reserves, the Philippines also offers tantalising prospects for mining conglomerates, provided they can overcome the political hurdles that have historically constrained mining in the country. As with many developing countries, such infrastructure and project finance opportunities are hotly anticipated, not least because the Philippines is entering an election year and infrastructure investment is a sure-fire vote-winner. Indeed, Standard Chartered forecasts another 24 months' growth in such infrastructure and project financing deals.
The retail scramble
In the growing absence of investment-grade commercial customers, however, banks will have to scramble for the remaining borrowing base. "The remaining borrowing base [that is] very attractive to the banks has been the consumer sector and we believe that is where the growth will come from," says Mr Tan. "The problem is that it may not be enough for the number of banks we have in the country: we expect some stronger competition for a limited pool of good creditworthy borrowers."
For the top players, growth on this side of the business has remained reasonably strong, hovering around the mid-teens. Metrobank, the country's third largest player, has seen its consumer book grow at a rate of 25% to 30% in recent years, although lately this has slowed to about 12% to 15%, says Jette Gamboa, head of investor relations at Metrobank. Consumer lending accounts for 14% to 16% of system loans, according to Moody's, but this is expected to grow significantly in coming years. Macroeconomics is also on the sector's side. The ongoing growth in remittances is likely to fuel the retail business, as consumers recognise the need to save and fund long-term investments.
HSBC, which began expanding into the Filipino consumer segment in 2005, has identified about 9 million 'bankable' consumers that it plans to target, says Ms Pio de Roda. Credit card loans, which account for more than 80% of the bank's consumer loan portfolio, will be its primary focus, but it will have stiff competition from the big local and foreign players. Onlookers believe that the forthcoming creation of a retail credit bureau will aid the safe expansion of the retail lending market, although Blesilda Pestano, a partner in the financial services practice at Isla Lipana, a local partner of PricewaterhouseCoopers, says that the BSP is keeping a particularly watchful eye on credit card expansion.
Mortgages also represent a key growth market for the major players. "There is really unmet demand in terms of housing. Especially at the low end, the demand will continue to be there," says Ms Gamboa. Both BDO and BPI are focusing on the home loans market as well, forming each bank's fastest growing segment. Through a joint venture with Philamlife, a local insurance arm of AIG, BPI is also hoping to expand its insurance activities, as well as grab more of the overseas Filipino market. "Our strategy is to reach out to them to have a full banking relationship with them," says Ms Tanchoco.
For established players, such as PBI and Metrobank, expanding the retail infrastructure is not a strategic priority. But for smaller and younger institutions, such as Security Bank and BDO, acquiring so-called 'productive capacity', in the form of highly sought-after branch licences, may be necessary. Security Bank is setting its sights on expansion, says Mr Borromeo, with a licence application in the pipeline and an eye on potential acquisition targets.
But as competition heats up, the industry's gaze will fall on the growth-hungry BDO, which has made impressive progress during its 12-year life as a universal bank. Rival bankers privately admit that BDO is a highly competitive force as it aggressively expands its asset-base. Mr Tan's ambitions are clear: "In an emerging market, it is a vast frontier and you have a choice: invest in efficiency or go to where opportunity beckons. We try to balance it, but we believe opportunity does not wait. The opportunities are there to expand our market share by creating the market and that's what we are doing."
