Banking Reform Bears Fruit

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Reforms in the banking sector are beginning to bear fruit, according to the latest central bank report. In its status report on the Philippine financial system for the second semester of 2006 released last month, the central bank said that the key performance metrics of the banking system at the close of 2006 - double-digit expansions in assets, deposits, loans and capital accounts as well as higher profit intake and better returns for banks' shareholders - reflected its overall soundness.

In a drive for greater efficiencies and higher profits, and faced with tougher foreign competition, more demanding standards and stringent regulations, the banking sector is witnessing renewed interest in consolidation, according to the report.

The central bank has approved the merger of two Philippine banks, Banco de Oro Universal Bank (BDO), the country's fifth largest bank in terms of assets and Equitable PCI Bank, which places third. The $12.9bn deal will result in a new entity, which will be known as Banco de Oro-EPCI. Both entities are now awaiting final regulatory approval from the Securities and Exchange Commission.

According to BDO, under the proposed terms, BDO will serve as the surviving entity, and EPCI shareholders will receive 1.8 BDO common shares for every EPCI share. The name of the combined institution will be Banco de Oro - EPCI.

Another merger in the offing is that of state-owned entities Land Bank of the Philippines and Development Bank of the Philippines although observers, such as global investment bank Bear Stearns, are not convinced the consolidation will happen in the near term. Such a move would, however, put the government "in a much better position to encourage consolidation of private sector banks if it set a good example itself by consolidating the public sector banks," John Stuermer, an analyst at the investment bank said last month.

Consolidation is one of three key areas the central bank has been encouraging banks to focus on to get them to strengthen their balance sheets. The other two are asset clean-up and capital build-up. The central bank's efforts are aimed at ushering in a more dynamic banking landscape, which it sees populated by "stronger financial institutions and effective market competition".

The central bank's status report said that asset quality had remarkably improved with non-performing loans (NPL) and non-performing assets (NPA) ratios standing at 6.1% and 6.9% respectively, bringing them less than 3 percentage points away from the 4% levels they stood at before the 1997 East Asian financial crisis. In contrast, their highest ratio was recorded in 2001 when they stood at 16.9% and 14.6% respectively. The Special Purpose Vehicle act of 2002 has been instrumental in the improvement of NPL and NPA ratios. In its latest East Asia and Pacific report, the World Bank noted that the extension of the legislation until 2008 had enabled universal and commercial banks to reduce their stock of NPLs by another 18% in 2006. The World Bank said that the central bank has estimated an additional $2.1bn worth of NPLs/NPAs will be sliced from bank balance sheets during 2007.

Ridding themselves of burdensome NPLs/NPAs is helping banks gear up for the impending stricter Basel II-compliant regulations that will come into force in July this year. Under the regulations, the risk weight for NPLs will be increased to 150%. There are other benefits to decreasing NPL ratios. According to Deloitte's report on bank consolidation "Changing Banking Landscape in Asia Pacific", lower NPL ratios mean domestic banks will be able to access capital markets at a reasonable cost of capital and see their attractiveness to foreign investors improve.
In January this year the Executive Board of the International Monetary Fund (IMF) called for further steps to strengthen the banking sector. While welcoming the recent consolidations and efforts by banks to raise new capital, it stressed that the BSP should maintain pressures on banks with regard to the latter.

On capital build-up, central bank figures show that total USD-related capital of the banking system climbed by 48.9% to $1.6bn in 2006 from $1.1bn in 2005.

Some banks have taken to launching follow-on offerings to raise additional capital. The trend began last year when Metropolitan Bank and Trust (Metrobank) sought to strengthen its capital ahead of the implementation of Basel II compliant regulations through an international offering of shares. The exercise brought it more than $126m in capital and followed an earlier capital-raising move in February from issuing notes.

Follow-on offerings, or re-IPOs as they are also known, allow companies that are already listed to issue primary or secondary shares in a public offering. Motivations usually include boosting liquidity of stock through a broadening of the shareholder base and strengthening of capital adequacy ratio.

Rizal Commercial Banking Corporation recently raised almost $106m from an additional share offering. The move put it in the top four private banks in terms of capital. At the launch of the additional shares, RCBC executive vice-chair and chief executive officer Lorenzo V Tan said that the bank is looking to get rid of "almost all" of its NPL inventories this year.

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