Only three decades ago, the Philippines was recovering from the aftermath of a dictatorship, plagued by external debt accounting for 95.2% of gross national product and suffering from devastatingly poor finance management. Today, it promises to be one of the stars of the Association of South-east Asian Nations (Asean).
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When talking about bank expansion in Asean, Indonesia is the market everyone is trying to squeeze into. However, some observers are noting that banks would do well to consider the Philippines just as assiduously.
Though still tackling infrastructure shortcomings via public-private partnerships (PPPs), the Philippines has impressive demographics, considerable annual savings and is flush with liquidity. Its solid banking sector benefits from a central bank whose governor, Amando Tetangco, has made stability and thorough monitoring the ethos of his mandate.
Though the banking sector’s development would be aided by deeper and more sophisticated domestic capital markets, and it is still held back by some regulatory hurdles, the country's finance sector appears to have a blossoming future. Wealth and liquidity continue to grow and more investment outlets are needed. Asset management is a particularly fast-growing business line in the Philippines.
Solid foundations
Strong demographics, liquidity and the increase in gross domestic product (GDP) expected in the next five to 10 years are keeping Philippines banks excited. About 40% of the Philippines’ population is aged between 18 and 60 years and can therefore work.
Meanwhile, the potential for bank growth is enormous considering almost 80% of the population is unbanked and the country’s loan-to-GDP ratio is still about 35%. This potential could grow further once income per capita increases.
“If per capita income grows by another $500 to $1000, a greater proportion of the population will become bankable. The whole system will be able to take more leverage,” says Cezar Consing, president and chief executive of Bank of the Philippine Islands (BPI).
For Fabian Dee, president of Metrobank, the second largest lender in the country by Tier 1 capital according to The Banker's Top 1000 ranking, growing levels of per capita income will in turn generate more growth. “There is a strong trend and belief that once the Philippines per capita income breaks the $3000 level, it will have the potential to generate five to seven years of growth that will be unprecedented,” he says.
The country is also rich in liquidity. It generates 1000bn pesos ($22.5bn) in savings a year thanks to a 36% annual savings rate, offshore Filipinos’ remittances, which amount to between $20bn and $22bn annually, and the business process outsourcing industry, which earned $16bn in 2013 and is expected to grow to the same level as remittances by 2020. These strong savings could also stimulate future private consumption, which HSBC sees growing by 5.5% in 2015.
Comparatively low government spending – which accounted for only 10.3% of total GDP in 2014, down from 10.7% in 2013, according to HSBC – is also a sign of healthy growth. “It is a good time to be a bank in the Philippines. Notwithstanding very low interest rates [in the region], there is real growth,” says Mr Consing.
Regulatory strength
Solid financial regulation has been essential in steering the Philippines away from its disastrous sovereign debt situation in the 1980s, and towards a growth path. Market participants are enthusiastic about the central bank’s use of unconventional monetary tools – such as macroprudential measures – to keep the economy and banking sector under control.
“Some bankers say of macroprudential measures: ‘that's really making things hard for us – increasing costs of capital, reducing returns on equity, etc’. It is true, but if you’re going to take these measures, it is best to do so now that banks are growing, they are liquid, well capitalised and the system as a whole can take it. They're like medicine – they can be painful – [and] they are [also] like vitamins. You need them,” says Mr Consing.
“I think it’s good because it forces self-discipline,” adds Metrobank’s Mr Dee, whose bank has been fully Basel III-compliant for more than a year.
This rigour is especially important as the Philippines prepares for outside competition. In 2014, the country passed a law allowing foreign banks to own 100% of local banks and allowing entry of foreign bank branches with full banking authority.
“This is in response to expressions of interest from foreign banks and in preparation of the banking industry for full Asean banking integration. We want our banks to be Asean Economic Community [AEC]-qualified. I believe we will be getting applications for licences to open in the Philippines in 2015,” says Mr Tetangco. Smaller banks in the country are nervous, but the central bank is promoting consolidation to face competition. “At the beginning mergers and acquisitions happened among big banks. Now we are seeing big banks acquiring smaller banks,” says Mr Tetangco.
Mr Dee sees consolidation as inevitable following increases in capital demands, a tougher regulatory framework and the back offices that banks now need. “If you don’t have scale, you’ll be priced out,” he says.
Staying small
However, Mr Tetangco believes that smaller banks can avoid consolidation provided they identify and service their niche markets properly while retaining good capitalisation, risk management and credit assessment processes.
Mr Consing agrees that consolidation is not a necessity. “As long as growth and liquidity continue, there is no real impetus for consolidation. If growth begins to slow down, liquidity dries up, competition increases and regulation becomes tougher, then there will be reasons to consolidate,” he says.
The only risk Mr Tetangco sees in an AEC-wide banking market is contagion from weaker economies as banks can now do cross-border transactions freely within the region. “It is therefore important to keep your own house in order to make sure macroeconomic policy is sound and that the banking system remains stable. You need to do this on a continuous basis,” he says.
Asean opportunity
The AEC, however, also presents opportunities. Philippines’ banks already have stronger business ties with Japan, for example, as investors look to tap into the country. Local banks are frequently welcoming Japanese business delegations. Metrobank’s two branches in Japan give it access to local small and medium-sized enterprises (SMEs) looking to diversify manufacturing production out of mainland China – where labour is becoming scarcer and more expensive – into the Philippines, Indonesia and Vietnam.
First Metro Investment Corporation’s collaboration with securities house Tokai Tokyo is proving fruitful now that yield pick-up in Japan is so limited. “Interest in Japan is 0% so the Philippines is the perfect market for these clients. Equity returns here are about 20%,” says Roberto Dispo, president of First Metro, the investment banking arm of Metrobank. The bank is in talks with Malaysia’s Affin Bank, Indonesia’s Bank Mandiri and Vietnam’s Saigon Securities for future collaborations.
The AEC also offers useful knowledge transfer, according to Mr Tetangco. “There will be new transport technology, the introduction of new products and services, and greater competition leading to more efficiency and benefits for the consumer,” he says.
For Mr Consing, the AEC also represents lucrative returns. “Let’s face it. A global regime of relatively low interest rates will allow for some risk taking. There is money to be made,” he says.
Popping PPP
The Philippines' central bank has been instrumental in tackling the infrastructure shortcomings plaguing urban centres and remote areas in the country, which at times are reachable only after days of boat travel.
The metropolitan areas of capital city Manila are particularly congested. “Everyone flocks to Manila because commuting to work is too expensive if you live outside the metro. PPP projects will encourage people to live in nearby towns and cities, and hopefully businesses will also follow,” says Gilda Pico, president and chief executive of state-owned Land Bank.
The central bank is working with the government, which aims to raise the infrastructure budget from 3.4% of GDP in 2014 to 5% by 2016, and the Asian Development Bank to convince the private sector to participate in PPP projects. Though these are often seen as long-term and low-yielding, Philippines banks are now involved in a number of these initiatives.
“We are interested in financing PPPs if projects are solid. We have a growing power portfolio. We are even lending to alternative energy projects such as solar. With the yield curve being relatively flat, you can go longer and hold on to longer assets and even finance projects traditionally with your medium- and long-term deposits, although there are limits,” says BPI’s Mr Consing.
Elsewhere, Metrobank is involved in power projects in the Visayas region. “It was a successful venture. That’s why our group chairman is a visionary. He believed in the country’s future and thought demand would outpace supply,” says Mr Dee.
What is even more significant to market participants is that Filipino conglomerates are now bidding for government projects, involving power, skyways and roads. “They have realised that even if yields are not that rich, returns are recurring, continuous and ensured for an extended period of time. PPP investment also includes safeguards such as automatic rate adjustments and certain triggers nowadays. The big groups – such as Aboitiz, Lopez, Ayala, MetroPac, San Miguel Corporation and [businessman Henry] Sy – are all looking at PPPs,” says Mr Dee.
Deepening capital markets
What could help the Philippines develop further are deeper and more efficient capital markets. The number of investment banks in the country is quite limited – First Metro alone accounts for some 70% of the sector – as are the depth and variety of both the bond and equity markets. In equities, the number of firms listed is still small as most large corporations are owned by Filipino Chinese families, who are reluctant to go public.
“Families fear they’ll be exposed to taxation and regulation. We have a different pitch now: for the sake of sustainability, introducing institutionalised good governance, transparency and succession management is necessary. When you list on the stock exchange you are subjected to regulation that requires you to be transparent; a good corporate citizen,” says Mr Dispo of First Metro.
As the conglomerate space is saturated – “you can count business conglomerates on your fingers,” says Mr Dispo – First Metro is looking for new corporate names and SMEs to nurture, grow and introduce to capital markets.
Pioneering products
When it comes to introducing pioneering products, First Metro is blazing a trail. It launched the Philippines’ first exchange-traded fund in December 2013. The fund is now one of the best performing equity products in the country with a net rate of return of 24%, as of November 2014.
In the bond market, liquidity is too low as there are insufficient investors and issuers. To make matters more complex, the Philippines’ bond tax regime is particularly intricate. A person buying bonds is taxed 20%; if an individual buys preferred stocks, he or she is taxed 10%, while institutions are exempt. In addition, the Philippines has different tax treaties for investors based on nationality.
“This doesn’t promote active and liquid trading. In the Philippines, the only ones who are making a lot of money are the lawyers who have to deal with all these regulations,” says Mr Dispo.
A positive signal in the local bond market, however, is First Metro’s introduction of a sovereign onshore dollar bond product to take advantage of local banks’ significant foreign currency deposits, now at $25bn. The state raised $500m onshore, almost on par with offshore costs.
What could promote further growth in capital markets is the formalisation of the AEC and subsequent cross-border flows. “We need world-class trading, clearing and registry systems. We need to open up our market to the region to have cross-border flows and acquire best practices and foreign global standards,” says Mr Dispo.
Asset management promise
In line with fast-growing prosperity across Asia, wealth in the Philippines is also accumulating. With local private banking still relatively undeveloped, the potential for asset management is enormous. As the number and sophistication of investors grow, local capital markets could also benefit as providers of investment opportunities.
“Asset management is the business of the future for the Philippines. People have liquidity, there is broadening economic affluence and increasing per capita income. They’re all hungry for investment outlets,” says Mr Dispo. “There are private bankers in hotel lobbies all around the Philippines trying to encourage wealthy local families to enter private banking.”
Metrobank, for instance, has so far brokered private banking behind the scenes, focusing on its existing commercial client base. It is now planning to set up its own private banking brand and start looking for customers outside its own network.
As far as likely Asean flyers go, the Philippines is high on the list. Not only is GDP growth on the horizon, but it is approached in a healthy and sustainable way due to the country's thorough regulations. Continued private-public collaboration in resolving infrastructure hurdles will be key in sustaining this positive trajectory. And with appropriate regulatory reforms, even capital markets can fulfil their potential now that wealth and liquidity in the country and in Asean are growing faster than in any other part of the world.
