The Philippine banking sector expands as deposits and lending increase


As banks expand credit in the domestic economy, the sector is enjoying a period of rapid catch-up growth. A positive feedback loop is at work in which banks are increasingly driving economic growth, supported by inflows from foreign investment and Filipinos working abroad, while growing trust in the banking system is drawing greater volumes of savings.

Peso deposits have more than doubled since 2008, rising from P3.2trn ($72bn) to P6.6trn ($149bn) in September 2014, according to the Bangko Sentral ng Pilipinas (BSP) – the Philippine central bank. This has helped bring down inflation even as the BSP has expanded the monetary base. Bank lending has risen nearly as quickly, but at P5.5trn ($123.8bn) in September 2014 was equal to just over 43.5% of GDP. That is about half the level in Thailand and a third of the level in Malaysia, leaving considerable room for further expansion.

A changing financial climate in 2014 brought both benefits and risks. The strength of the US dollar led some to keep their savings in dollars as a precaution, even though the peso held steady against the dollar, and the economy and banking sector were not heavily dependent on foreign debt. The collapse of energy prices is putting strong downward pressure on inflation, which should further support the peso and sustain the trend of growing trust in the banking system.

The Philippine banking system is currently the only one of Moody’s 69 jurisdictions with positive outlook. The outlook represents Moody’s forward-looking assessment of credit conditions that will affect banks’ creditworthiness over the next 12-18 months. It provides the view of how the operating environment for banks, including macroeconomic, competitive and regulatory trends, will affect asset quality, capital, funding, liquidity and profitability, and it also considers Moody’s forward-looking view of the systemic support environment for bank creditors.

POSITIVE FEEDBACK: The recent history of the banking sector is a demonstration of the kind of long-term benefits a developing country can enjoy in the wake of a long period of high inflation. For the Philippines, the process began during the financial boom in Asian emerging markets in the 1990s, culminating in the Asian crisis of 1997-98. At the time, the country had a far less developed economy, at roughly half its current level of real output per capita. The banking sector was both small and primitive, and trust in the peso had been ravaged by high and erratic inflation, which spiked to 50% in 1984 and averaged 14% in the 1980s.

Nevertheless, growing foreign investment in Asian emerging markets spread to the Philippines, and by the mid-1990s inflation had stabilised at a still high but survivable range of 7-9%. Bank deposits and loans as a share of GDP roughly doubled between 1990 and 1997, as Filipinos learned to put their faith in bank deposits. For banks, lending became profitable.

STRENGTHENING REGULATION: At the same time, the BSP was gaining independence and improving regulation, showing notable foresight in limiting banks’ exposure to real estate. Inward portfolio investment flows proved fickle, cutting the peso’s value by a third when “hot money” fled the country in 1998.

But as banks and the economy of the Philippines held up better than most of South-east Asia, the public’s willingness to hold deposits continued. In the 2000s the BSP followed the regional trend, further strengthening bank regulations. Inflation settled at around 5% on average for the decade.

The positive feedback loop of growing bank deposits, declining inflation and more robust banks was strongest in its initial stages in the 1990s, though it continues to operate as a force in the Philippines’ economic emergence. With real GDP roughly doubling between 1999 and 2014, bank deposits to GDP also rose, from 58.1% in 1999 to 67.4% in 2014, according to BSP data. The number of bank deposit accounts per 1000 adults increased from 356 in 2004 to 542 in 2013. Meanwhile, IMF data shows inflation fell to an average of 3.8% from 2010 to 2014 – a respectable pace given average real GDP growth of 6.3% and population growth of 1.8%.

Juan Placedo T Mapa III, vice-president and the head of investor relations at Metropolitan Bank and Trust Company (Metrobank), told OBG there was still plenty of room to deepen banking penetration. “If you look at the raw number of deposit accounts in the country, it is about 35m or 36m. We estimate that there is an average of 2.5-3 deposits per person who holds at least one account. That means there are 12m-15m people using banks, out of a 100m population.”

RECENT PERFORMANCE: The sector has decelerated in 2014 amid global weakness in emerging markets and a strengthening US dollar. Peso deposits grew by 15.8% in the first nine months of 2014, according to BSP data, less than half the 34% growth recorded over the same period in 2013 but similar to previous years, with peso deposits increasing by an average of 15.3% per year from 2009 to 2013. Meanwhile, foreign currency deposits were up 20.7% year-on-year (y-o-y) in September 2014, compared to 28% y-o-y growth in September 2013 and just 11.3% growth in 2013.

Asset expansion also slowed slightly in 2014, though lending growth held roughly steady at 12.1% in the first nine months after 15.7% growth in 2013. Headline financials weakened somewhat, as aggregate sector net income fell to P97bn ($2.2bn) in the first nine months of 2014, down y-o-y from P126bn ($2.8bn). However, underlying profitability appeared to improve, with an unusual P60bn ($1.4bn) gain on “non-trading financial assets and liabilities” helping to make up the difference.

Bankers told OBG the slowdown in peso deposit growth in 2014 was actually a relief, as liquidity had been increasing more quickly than they could deploy it. Indeed, peso deposits grew by some 37% in 2013, while banks’ cash assets accounted for 25.6% of total sector assets by the end of 2013. Reggie L Ocampo, president of First Macro Bank, told OBG, “We do no marketing to attract deposits at all, unless you count offering services such as payment processing that the people who use are likely to also bring in deposits, and we have still been getting deposits faster than we can keep up with. There is just so much liquidity out there.”

STEPPING BACK: The 2013 surge in deposits was driven in part by a BSP decision to prohibit some investment trust funds from its special deposit account (SDA) facility beginning in 2013. The operational adjustment was motivated by the need to encourage trust entities to shift funds to other investment vehicles and thereby help promote the development of domestic capital markets and support domestic economic activity.

SDAs are similar to the interest-paying cash deposit accounts many central banks offer to commercial banks. But, unusually, SDAs are also offered to other financial institutions and initially paid more significantly than short-dated sovereign debt or retail bank deposits. Until May 2013, SDAs could be de facto accessed by corporate cash managers and higher-end retail investors through widely offered pass-through accounts. The BSP’s move to ban pass-through accounts created a surge in bank deposits and resulted in a temporary increase in BSP measures of domestic liquidity, The move happened to coincide with the onset of the so-called taper tantrum, when the dollar began to strengthen as the US signalled an end to quantitative easing. This led to some investor flight from emerging markets, which together with the surge in peso liquidity, weakened the peso by 7% in May-June 2013.

UP & AWAY: The hike in the BSP’s benchmark interest rate from its record low of 3.5%, in place since October 2012, to 4% between July and September 2014 helped keep the peso stable in the range of 43-45 per dollar through early 2015. The broad stability of the peso during this period was supported by steady inflows of foreign exchange from overseas Filipinos (OF), foreign direct and portfolio investments, as well as receipts from tourism and business process outsourcing.

By holding dollars, some Filipinos – particularly beneficiaries of OF remittances – were evidently hedging against the risk of a change in BSP policy. However, the collapse of oil prices in late 2014 should counter recent depreciation and inflationary pressure on the peso.

THE BIG THREE: The banking sector is dominated by three large private banks, which account for 38.4% of sector assets (on a solo basis, excluding affiliates and subsidiaries) as of September 2014, according to BSP data. The top three are in a league of their own in terms of penetration and the diversity of their businesses, and all three are universal banks. Each is controlled by a major local business group, with a minority stake floated on the bourse, as are all private banks in the top 10.

The largest bank by assets, BDO Unibank, had P1.75trn ($39.4bn) in assets as of end-September 2014, or around 16.3% of sector assets, including its BDO Private Bank and its BDO Elite Savings Bank subsidiaries. BDO attained its leadership position with the support of its parent SM Group, and through a series of mergers and acquisitions. BDO has since pulled further ahead of the competition thanks to organic growth and small acquisitions, and in January 2015 it was in the process of acquiring a second savings bank. While BDO also has leasing, insurance and investment banking subsidiaries, and over 850 branches and 2400 ATMs.

Metrobank is the second-largest bank, with P1.2trn ($27bn) in assets, or 11.8% of the sector total, as of September 2014, including its Philippine Savings Bank subsidiary. Metrobank is a broader holding company than BDO, owning a major electric power generator, Global Business Power, plus an investment bank, securities broker, asset management company, investment company, and a seven-branch bank in China. It also has joint ventures in credit cards, leasing and motorcycle finance. In addition, Metrobank and its parent holding company, GT Capital, are partners in a life insurance joint venture with AXA, and Metrobank also cooperates with GT Capital’s non-life insurance subsidiary and its automotive finance joint venture with Toyota. According to Metrobank’s Mapa, now is the perfect time to be involved in the automotive lending business. “As per capita GDP crosses $2500, the economy gets into the car acquisition stage. On top of that, there is a demographic bulge in the 25-35-year age bracket. Car sales are up 40% over last year,” he told OBG.

Bank of the Philippine Islands (BPI) is the third-largest bank, with P1.1trn ($24.8bn) in assets as of September 2014, or 10.2% of the sector total. BPI includes subsidiaries BPI Family Savings Bank, BPI Direct Savings Bank and BPI Globe BanKO. The bank is controlled by the Ayala Group, one of the biggest local business groups. BPI also acts as a broad financial holding company, owning a securities broker, a leasing company, a foreign exchange trading firm and three investment companies. The bank also has joint ventures in non-life and life insurance with Japan’s Mitsui Sumitomo and Hong Kong’s American International Assurance, respectively.

THE PROUD MIDDLE: Another seven banks each control between 3% and 9% of overall sector assets. The government and the central bank would like to see more mergers of institutions in this range, as they believe consolidation would allow larger banks to better compete with other ASEAN players, as the bloc moves towards a 2020 target for banking integration.

However, banking executives and observers told OBG that mergers of top banks are difficult because most are owned by business conglomerates whose owners are reluctant to give up their banking arms to rivals. Furthermore, the BSP moved in June 2014 to lift restrictions on new branches in areas that had been designated as having a sufficient number of branches, which serves to undermine some consolidation benefits.

“Since branching was fully liberalised we do not acquire purely for branch networks. Unless the branches are accompanied by an established deposit base, it is easier for us to start from zero,” Louis S Reyes Jr, the senior vice-president and head of investor relations at BDO Unibank, told OBG, Similarly, Mapa of Metrobank told OBG. “We opened 71 branches in the past two years. That is the size of a number 12 to number 18 bank.”

The most recent large merger was between the Philippine National Bank (PNB) and Allied Bank, which took four years to clear regulatory hurdles, including those of foreign regulators. PNB is now the fifth-largest bank, with P581bn ($13.1bn) in assets, or 5.6% of the sector, in September 2014, including its subsidiary Allied Savings Bank. The banks already had a common controlling shareholder, the LT Group, prior to the merger.

Number seven – China Banking Corporation ( Chinabank) – could eventually be a merger target, as control is currently split between the SM Group and the Yuchengco Group, which control the number one and number seven banks, respectively. In January 2015 it was in the process of acquiring its second savings bank, Planters Development Bank. All told, Chinabank had P389.1bn ($8.8bn) in assets, or around 4.1% of the sector’s total, as of September 2014.

The number eight bank is Rizal Commercial Banking Corporation (RCBC), with P365.6bn ($8.2bn) in assets, equal to 3.9% of the sector, including RCBC Savings Bank. RCBC is controlled by the Yuchengco Group in an alliance with Taiwan’s Cathay United Bank. Cathay’s parent, Cathay Financial Holding, signed a deal in December 2014 to pay P17.92bn ($403m) for a 20% stake in RCBC. Cathay Financial has said it could increase its stake to 30% by buying from the stock market.

Number nine was Security Bank, with P356.4bn ($8bn), or 3.8%, of sector assets, and number 10 was Union Bank, with P334.8bn ($7.5bn) in assets, or 3.6% of the total, including their respective subsidiaries, City Savings Bank and Security Bank Savings. Union Bank is controlled by the Aboitiz Group, while Security Bank’s ownership is unclear. Another eight domestically owned universal and commercial banks controlled P960bn ($21.6bn), or around 9%, of sector assets. Together, the 16 private, domestically owned universal and commercial banks controlled 73% of sector assets.

PROPOSED MERGER: The government is proposing to merge two large state-owned universal banks – Land Bank of the Philippines (Landbank), the fourth-largest bank as of September 2014 with P911bn ($20.5bn) in assets, or 8.7% of the sector total, and Development Bank of the Philippines (DBP), the sixth-largest bank with P437bn ($9.8bn) in assets, equivalent to 4.2% of the sector. The government’s Governance Commission for Government-Owned or Controlled Corporations proposed the merger in 2014, arguing that it would reduce duplication and increase efficiency.

Landbank was originally dedicated to serving farmers and fishers, but has leveraged its large nationwide branch network to transform itself into a major retail bank as outlying areas have developed. DBP remains a vehicle of state economic development, but has also been developing as a commercially oriented retail bank.

One of the business areas that a merged government bank might compete for is the many large infrastructure projects recently announced by the government. Most of the big projects are public-private partnerships, with financing to come from the banking sector in return for control of revenue streams such as highway tolls. The major private conglomerates that own large banks have so far been the main bidders.

FOREIGN BANKS: Foreign-owned banks also have a substantial presence, and look set to grow after a major liberalisation of foreign access in 2014 following the enactment of Republic Act No. 10641, also known as the Amended Foreign Banks Law. According to BSP, 19 foreign banks controlled 10.4% of sector assets as of September 2014. Most foreign banks specialise in corporate lending or capital markets, with many focused on serving foreign investors from their home countries. Most of these banks hold charters as branches of foreign-owned banks, which limit them to a maximum of six locations, and these are the only variety of new charters that the BSP will issue to foreign banks. They had been unavailable for many years because the total number of them was capped by law at 10 (not including four branches of foreign banks present prior to 1948). However, the 2014 reform eliminated this quota, and is expected to draw new foreign applicants.

Foreign-owned banks can also be chartered as subsidiaries of foreign banks. Such charters are crucial for breaking into the retail banking market, as they do not limit the bank’s number of locations. However, they can only be obtained by acquiring an existing bank. That said, most of the nine foreign banks that have ever obtained such charters ended up selling out to locals or not taking advantage of the branching privilege. Four banks still hold such charters, but only two had more than six branches as of January 2015: Malaysia’s Maybank with 79 and Taiwan’s CTBC Bank with 24. HSBC’s subsidiary bank had six locations, while a subsidiary bank of Singapore’s United Overseas Bank had just one after selling a 66-branch network to BDO in 2005. For their part, Banco Santander, GE Money and Citibank sold their subsidiary banks to BDO in 2003, 2009 and 2013, respectively. Singapore’s DBS Group and Hong Kong’s Dao Heng Bank merged their subsidiary banks in 2001 with BPI and BDO, respectively, and then later sold their resulting minority stakes.

The 2014 reform, aimed at preparing for ASEAN banking integration, seeks to revive broader foreign investment in the sector by easing other obstacles that have disadvantaged foreign banks. For example, the reform introduced a mechanism through which foreign-owned banks can foreclose on land, despite the constitutional ban on foreign ownership of land.

In terms of assets, the largest foreign banks are those that have had the most success in corporate banking, investment banking and/or capital markets. Citibank is the leader, with P283bn ($6.4bn), or 2.7%, of sector assets, as of September 2014. HSBC comes second, with P186.5bn ($4.2bn), or 1.8%, of sector assets. By comparison, Maybank had just P74bn ($1.7bn), or 0.7%.

HUNDREDS OF SMALL BANKS: Consolidation is proceeding at a relatively fast pace among the smaller domestically owned banks. Larger banks are strongly encouraged to buy small banks, especially when the BSP determines that a smaller bank is undercapitalised and unable to raise financing except via a sale.

Recently, banks have been coping with two major central bank regulatory reforms: implementation of Basel III, which is not scheduled in most countries until 2019, and stress test limits that further tighten control of exposure to real estate, which became effective in July 2014. Universal and commercial banks are required to adopt capital adequacy standards under Basel III, while the smaller banks – including rural banks, cooperative banks and stand-alone thrift banks – are under Basel 1.5, a simplified risk-sensitive capital adequacy framework.

Diwa Guinigundo, the BSP’s deputy governor for monetary stability, told OBG that Basel III’s tighter risk-weighting standards would bring down banks’ average capital adequacy ratios by 100-200 basis points to between 14% and 15%, compared to the standard Basel III minimum of 10%. “Most of our banks are already compliant, so why postpone it?”

Many banks, however, are being forced to raise capital, and a niche business has emerged in arranging “Basel III issues” of Basel III-compliant Tier 2 capital instruments. Fitch Ratings wrote in July 2014 that there had been P50bn ($1.1bn) of such issues to date, with more expected in the future. For many smaller banks, not meeting Basel III requirements will likely mean greater pressure to merge. BSP has been busy arranging mergers among rural banks where it deems a combined bank would better weather stress (see analysis).

Excluding the 15 savings banks owned by universal banks or foreign banks, there were another 54 savings banks as of September 2014, with a combined P190bn ($4.3bn) in assets, or 1.8% of the sector total, according to the BSP. On top of those were another 516 rural banks and 31 cooperative banks, with total assets of P211bn ($4.7bn) as of September 2014, or just 2% of the sector. That number of rural and cooperative banks has fallen from 703 in 2008 and 809 in 1999 as a steady stream have been liquidated or merged.

Major banks are also looking into buying small banks in outlying areas. In January 2015 BDO was in the process of buying the largest rural bank, One Network Bank (ONB), which had 105 branches and micro-banking offices, mainly in Mindanao. ONB had total assets of P28bn ($630m) as of September 2014. While the asset counts of universal banks listed above do not include some of their rural bank subsidiaries, in most cases the difference is negligible.

Savings banks, formally called thrift banks, are not allowed to engage in asset management, securities brokerage or retail foreign exchange. Small neighbourhood banks like rural banks and cooperative banks are restricted to local currency deposits and lending to individuals and small businesses. The rural name is misleading as urbanisation has turned many banks with rural charters into de facto city neighbourhood banks.

Branch numbers give another indication of the relative scales of the different types of banks. The 15 domestically owned universal banks had a combined 5235 locations as of September 2014, or 349 each on average, according to BSP data. Meanwhile, the five domestically owned commercial banks had a combined 362 locations, for an average of 72 each.

For their part, the 67 domestically owned savings banks had 1866 locations, or an average of 28 each, while the 547 rural and cooperative banks had a combined 2556 locations, or an average of about five each. Among foreign-owned banks, the four chartered as subsidiaries had 110 locations, or an average of 28 each, and the 14 chartered as branches had a combined 38 locations, or an average of about three each.

OUTLOOK: Given the amount of ground that Philippine banks have covered in such a short period of time, it is inevitable that the pace of their growth will moderate from here. Similarly, the BSP has enjoyed a long run of favourable economic winds at its back that will be blowing less strongly in the future. Still, Philippine banks have so much going for them: rapid economic development; a young demographic; a largely under-banked country; and a government that is boosting infrastructure spending. Another positive is their strength relative to the government. While this has some downsides, it could serve Philippine banks well in an environment of regional integration, where rivals may be more accustomed to having government bring business to them.

Although Philippine banks have largely been sheltered by restrictions placed on foreign banks, there is another reason that many foreign banks have withdrawn: it simply is not that easy to compete with the country’s local banks. Indeed, by the time regional integration comes to pass, Philippine banks may be more competitive across South-east Asia than many are expecting.


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The Report: The Philippines 2015

Banking chapter from The Report: The Philippines 2015

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