Economic Resilience | Very High Risk |
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Economic Imbalances | Low Risk |
Credit Risk In The Economy | High Risk |
Institutional Framework | High Risk |
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Competitive Dynamics | Intermediate Risk |
Systemwide Funding | Intermediate Risk |
Major Factors
Strengths:
Weaknesses:
- High level of stable core customer deposits supports banks' funding profiles.
- Moderate, albeit growing, private sector debt.
- Low income economy.
- High credit risk due to weak legal system.
Rationale
S&P Global Ratings classifies the banking sector of the Philippines in group '5' under its Banking Industry Country Risk Assessment (BICRA). Other countries in group '5' are Bermuda, Italy, Malta, Panama, Peru, Hungary, Qatar, Iceland, Mexico, and United Arab Emirates (see chart 1).
Chart 1
In our opinion, the Philippines' low income economy, with an estimated per capita GDP of US$3,512 in 2019, constrains the country's economic resilience.
We expect the Philippine economy to contract by 0.2% in 2020, a broad-based slowdown affecting trade, tourism, investment, and consumption due to the COVID-19 pandemic. Outside of this cyclical event, we believe the economy's long-term growth potential remains strong and will drive constructive development outcomes and close infrastructure gaps. We expect a flattish U-shaped recovery, with GDP growth rebounding to 9% in 2021. Supportive fiscal policies and an improving investment climate should aid growth. All these factors provide sound growth opportunities for the country's banks, in our view.
The Philippine banking sector's asset quality is likely to deteriorate amid the economic slowdown, weighing on profitability. We expect large conglomerates, which form the bulk of the banking sector's loan book, to be able to tide over the challenging operating conditions because of their strong business profiles, diversified revenue streams, and solid liquidity buffers.
Philippine banks have built good financial buffers and are entering this slowdown on a relatively sound footing. The banking sector's good capital position (about 15% Tier-1 ratio) and about 100% provisioning coverage of nonperforming loans (NPLs) should help it manage rising risks in the operating environment.
A high level of stable customer deposits supports Philippine banks' funding profiles. In our opinion, the country's banking regulations are broadly in line with international standards. The New Central Bank Act strengthens the supervisory powers and monetary functions of the country's central bank, in our view. The industry's risk appetite is generally restrained, and banking products are straightforward.
We use our BICRA economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. The anchor for banks operating only in the Philippines is 'bbb-'.
Economic And Industry Risk Trends
The trend for economic risks faced by the banks operating in the Philippines is stable, in our opinion.
We expect low-single-digit credit growth, rising NPLs and credit costs, and declining profitability in 2020 as the economy contracts. In our opinion, the banking system is entering this slowdown from a relatively sound position and should be able to manage the risks owing to the adequate capital and provisioning buffers built in the past. For full-year 2020, we estimate credit losses will be 1.3% of banking sector loans, compared with 0.45% on average in 2015-2019. Support measures by the government and the central bank should reduce the risk of defaults. Forbearance provided by the central bank will provide a breather, especially for rural and thrift banks that typically lend to weaker borrowers. However, this will only delay the recognition of weak loans--and provisioning against the same--to borrowers who are unable to fully regain their financial strength when the moratoriums end.
The effect on individual banks in the coming quarters will be uneven, largely hinging on their exposure to vulnerable segments and whether they adopt relaxed accounting and provisioning standards. The better performing large and midsize commercial banks will likely continue to make increased provisions, when profits permit. Weaker and smaller financial institutions are more likely to utilize regulatory forbearance and relaxed loan classifications.
A longer or deeper economic slowdown than our current forecasts could escalate economic risks faced by the banking industry. It could set off a sharper than expected deterioration in the banking sector's asset quality due to potentially higher large corporate delinquencies.
We view the industry risk trend as stable. We believe Philippine banks' well-established domestic franchise will continue to help them to sustain a strong, stable, and diversified customer deposit profile. The rising trend in the system's loan-to-deposit ratio is likely to continue due to the cuts in regulatory reserve requirement. That's because we expect banks to channelize additional liquidity toward growth.
We believe the banking sector's profitability will decline in 2020 due to pressure on margins and higher credit costs. We believe banks with focus on digital banking will be able to weather higher competitive intensity from fintech players, given the underpenetrated nature of the banking system.
Industry risks faced by the banks in the Philippines could rise if the banking sector's profitability is severely hit, given Philippine banks' pre-provision profits have low buffers to absorb significant unforeseen costs.
Economic Risk | 6
Our assessment of economic risk in the Philippines reflects the country's low income level and weak legal system. Credit growth in the country moderated in 2019 and is likely to be in low single digits in 2020, keeping private sector leverage stable. We expect the increase in credit losses to be manageable, supported by resilient corporate sector balance sheets.
Economic resilience: Structural growth story is intact
Economic structure and stability. We expect the Philippine economy to shrink by 0.2% in 2020, owing to demand and supply shocks caused by the COVID-19 outbreak and proactive domestic containment measures. Although this would be Philippines' slowest economic growth rate since the Asian Financial Crisis, it is in line with the deep downturn we forecast for the global economy. We are forecasting a flattish U-shaped recovery with the Philippine economy likely to expand by almost 9% next year, underpinned by strong growth in investment and exports.
The Philippine economy is among the fastest growing in the world on a 10-year weighted average, per capita basis. This is a reflection of its supportive policy dynamics and improving investment climate. Philippines has a relatively diversified economy with an increasingly strong record of high and stable growth. We estimate GDP per capita will rise to almost US$3,540 in 2020 (we include nonresident nationals in our population data) and project real GDP per capita growth will average approximately 4.2% per year over 2020-2023. The economy's growth trajectory is underpinned by strong household and company balance sheets, sizable inward remittance flows, and an adequately performing financial system. Prior to the outbreak of COVID-19, the country's unemployment rate declined for a few years, signaling the economy's strengthening labor market even as the working-age population continues to grow.
Uncertainty in export markets and modest, though improving, transport infrastructure are the main constraints the Philippine economy faces. As such, we continue to view as imperative ongoing work to close infrastructure gaps and improve the business climate through greater political stability and regulatory reforms. This should help the economy to continue to expand at or near its long-term potential growth rate.
Macroeconomic policy flexibility. The Philippine government has enacted effective fiscal policies in recent years, resulting in improved quality of expenditure, manageable fiscal deficits, and low levels of general government indebtedness. This record of sustainable public finances underpins the country's institutional capacity to respond to the pandemic. We expect the government to run a materially higher fiscal deficit in 2020 to address the economic contagion effect.
The Philippine government has launched a four-pillar socioeconomic strategy in response to the COVID-19 pandemic. The package, worth about Philippine pesos (PHP) 1.7 trillion (approximately US$33.5 billion) or approximately 9.1% of GDP, includes support to vulnerable groups and individuals, additional resources for frontline medical workers, as well as a slew of ad hoc fiscal and monetary measures. Part of the resources needed for the stimulus program will be reallocated from the existing budget and generated savings. Consequently, we expect the general government deficit will widen to a historical high of 7.3% of GDP in 2020, which will push the net general government debt stock to almost 35% of GDP, a level not seen since 2010. Nevertheless, this level of indebtedness is lower than international peers'.
The administration of President Rodrigo Duterte has carried over the constructive economic and fiscal policies of the previous government. These have more than halved the government's net indebtedness as a share of GDP to 26.0%, compared with levels in 2003-2014. While the government has adopted a more aggressive expenditure program to address the country's infrastructure needs in recent years, this has been supported by higher tax collection and robust economic growth, resulting in a low and stable level of debt stock.
The Philippine central bank, the Bangko Sentral Ng Pilipinas (BSP), has a history of independence and sound record in keeping inflation low. The BSP has acquired additional legal protections and capabilities following amendments to the BSP Charter last year. We believe the credibility and effectiveness of the BSP will improve over the medium term owing to the central bank's additional scope for use of market-based monetary instruments and a gradual reduction of its reliance on reserve requirement ratios.
To support the government's COVID-19 response and in accordance with the New Central Bank Act, the BSP has so far in 2020 announced a series of measures to boost domestic liquidity. These include purchases of government securities in the secondary market and a repurchase (repo) agreement with the National government. Under the repo agreement, the central bank will provide funding of PHP300 billion (approximately US$5.8 billion) to the Bureau of Treasury with an initial repayment period of three months, and extendable to a maximum period of six months. These measures will allow the government to access funds in a timely manner and manage its borrowing costs during periods of extreme market volatility and dysfunction.
In our view, a deeper and more diversified financial and capital market would further increase the effectiveness of policy transmission and facilitate improved credit metrics.
Political risk. The Philippine government has so far achieved partial success with its "Comprehensive Tax Reform Program," or CTRP. The program aims to ensure that finances remain sustainable while addressing the nation's pressing infrastructure needs and chronic underinvestment. CTRP is partially intended to fund the administration's "Build, Build, Build" scheme, through which the government plans to significantly boost infrastructure spending. The first package of the "Tax Reform for Acceleration and Inclusion" measure was implemented in 2018, supporting the expansion of national government revenues to 16.1% of GDP in 2019, from 15.6% in 2018.
While we anticipate further measures over the remainder of President Duterte's term, opposition to some components of the broader tax reform program has been vigorous. The Corporate Recovery and Tax Incentives for Enterprises Act (CREATE), formerly CITIRA, aims to rationalize foreign investment incentives by lowering the corporate income tax rate. Former versions of the Act faced considerable delays at the legislative stage. If passed into law, CREATE would lower corporate income tax rates to 25%, from 30% previously, by as early as July 2020. This would likely support the economy. However, the latest version of the Act could also entail a net loss of revenue for the government over time.
Table 1
Philippines--Economic Resilience | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
--Year ended Dec. 31-- | ||||||||||||||
2016 | 2017 | 2018 | 2019 | 2020F | 2021F | |||||||||
Nominal GDP (bil. $) | 318.6 | 328.5 | 346.8 | 376.8 | 384.5 | 421.0 | ||||||||
Per capita GDP ($) | 3,108.0 | 3,153.0 | 3,280.0 | 3,512.0 | 3,536.0 | 3,821.0 | ||||||||
Real GDP growth (%) | 7.1 | 6.9 | 6.3 | 6.0 | (0.2) | 9.0 | ||||||||
Inflation (CPI) rate (%) | 1.3 | 2.9 | 5.2 | 2.5 | 1.0 | 2.2 | ||||||||
One-year government borrowing rate (%) | 1.8 | 3.0 | 6.5 | 3.5 | 3.9 | N.A. | ||||||||
Net general government debt as % of GDP | 27.5 | 27.9 | 28.0 | 28.0 | 34.9 | 35.3 | ||||||||
F--Forecast. N.A.--Not available. Source: S&P Global Ratings. |
Economic imbalances: Credit growth to pick up after a sharp but temporary decline in 2020
We believe the Philippine economy is in an expansionary phase, characterized by above-average growth and modest, but steady, growth in housing prices. Given the slowdown in the economy amid the COVID-19 outbreak, credit costs will likely remain elevated in fiscal 2020, but we expect them to decline thereafter.
Private sector credit growth. The risk of a credit-fueled asset bubble is low in the Philippines, in our view. High credit growth has contributed to the increase in the ratio of private sector credit to GDP to 56% at end of 2019, from 50% in 2016. Despite the steady rise over the past several years due to high credit growth, the ratio of private sector credit to GDP remains among the lowest in the region.
Credit growth in the Philippines slowed down in 2019 as demand for corporate loans softened due to a delay in the passing of the Philippines budget and U.S.-China trade tensions. We project Philippine banks' loan growth will be in low single digits (in nominal terms) in 2020 due to the COVID-19 triggered economic slowdown (see chart 2).
Chart 2
The Duterte administration's infrastructure push, which had come to a standstill due to lockdown on Luzon island, could likely revive the economy and improve demand via the multiplier effect. Over the longer term, the country's robust economy is likely to drive expansion in domestic credit at under 1.5x the pace of nominal GDP growth.
We expect the corporate segment, particularly larger companies with long credit histories, to continue to account for a large share of banks' loans, with the proportion of consumer loans gradually increasing. Credit demand in 2020 will be driven by the corporate sector's working capital requirements as well as drawdown on bank lines to maintain liquidity.
Consumer loan book is likely to remain flat in 2020 because major purchase decisions such as housing and automobiles will likely be postponed until the health risk abates. In 2021, as credit growth normalizes, consumer loan growth is likely to outpace corporate growth due to pent-up demand.
Real estate prices. We estimate that inflation-adjusted average real estate prices in the Philippines will remain broadly flat on a national level over the next 12-18 months. Residential property prices increased about 0.1% over 2016-2019 on an annual inflation-adjusted basis, based on BSP's residential real estate price index. We could attribute the increase in prices to strong demand from both local and foreign buyers along with a decline in interest rates, which further boosts demand.
Philippine banks' total exposure to real estate stood at about 19% in 2019 (against a regulatory cap of 20%), of which 35% was to residential real estate and the rest was to commercial real estate. Demand for commercial office space in recent years is driven by the thriving business process outsourcing (BPO) industry. The country's offshore gaming sector, which primarily comprises offshore gaming firms from China, has also contributed to commercial real estate transactions. The slowdown in business activities, rise in unemployment, and drop in remittances from Filipinos working abroad are likely to result in softer demand for condominium units in Metro Manila in 2020. Nevertheless, low mortgage rates should propel the Metro Manila condominium market once the pent-up demand kicks from the first quarter of 2021.
We see some risk of higher credit losses for banks from the real estate sector as the COVID-19 pandemic is likely to hit both commercial and real estate demand. However, the BSP's comprehensive collateral caps and stress tests for the real estate sector should lower ultimate losses. Since 2014, the BSP has adopted a pre-emptive stance to curb potential overheating in the real estate sector. It placed a 60% cap on the value of real estate collateral for the purpose of treating a loan as secured and increased the provisioning requirement for the unsecured portion. Furthermore, the BSP also adopted a real estate stress test (REST) limit of 25% write-off rates on real estate exposures to ensure banks have sufficient capital buffer to withstand a property price correction. These measures have moderated growth in real estate loans from high levels.
In our base case, we believe a sharp correction and the consequent surge in banks' credit losses is unlikely in the near term. Nevertheless, a longer or deeper economic slowdown than our current forecasts could set off a sharper than expected deterioration in the banking sector's asset quality, due to potentially higher large corporate delinquencies and sharp fall in asset prices.
Equity prices. In our view, the trend in equity prices does not indicate any significant additional build-up of economic imbalances. That said, since the start of this calendar year, markets across the globe, including in the Philippines, have been very choppy and volatile. Nonetheless, the banking sector's direct exposure to equities is minimal.
Current account and external debt position. Philippines' external position is a key credit strength. The peso's stability and the Philippines' rising foreign exchange reserves amid the current economic and health crisis are testaments to the country's external resilience. The current account deficit narrowed to 0.12% of GDP in 2019 from a multi-year high of 2.65% in 2018, driven by strong growth in services export, slower investment growth, and lower energy prices. We expect the current account to register a modest surplus as robust services exports (mainly tourism, healthcare, maritime, and BPO) and large remittance inflows temper the impact of rising investment. The Philippines' competitive unit labor costs relative to peers such as Thailand and Indonesia, combined with a large young, educated, and flexible labor market, should strengthen its services exports over the next five years.
We forecast the Philippines will retain its narrow net external asset position, with liquid external assets exceeding external debt by an average of 25.6% of current account payments over 2020-2023. External liquidity needs (as measured by gross external financing needs as a percentage of current account receipts plus usable reserves) will remain moderate at an average of 68.8% over 2020-2023.
We expect uncertainty regarding the COVID-19 pandemic and the government's proposed rationalization of tax incentives under the CREATE Bill to weigh on foreign direct investments (FDI) in the Philippines in the near term. Deliberations on former versions of the CREATE Bill have contributed to a decline in FDI inflows, in our view, and these dynamics are likely to persist until a new law is finalized. Furthermore, global economic and financial volatility could give rise to periods of acute risk aversion. However, we do not anticipate significant risks to the country's external position from either a marked deterioration in FDI or portfolio investment.
Other factors that mitigate risks associated with the Philippines' international liabilities include a low reliance on external savings by bank and corporate sectors, as well as the low and mainly long-term nature of the government's external borrowings.
Table 2
Philippines--Economic Imbalances | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
--Year ended Dec. 31-- | ||||||||||||||
2016 | 2017 | 2018 | 2019 | 2020F | 2021F | |||||||||
Annual change in claims of resident depository institutions in the resident nongovernment sector in % points of GDP | 2.9 | 3.3 | 2.0 | 0.7 | 0.8 | 1.6 | ||||||||
Annual change in key index for national residential house prices (real) (%) | 1.9 | 2.8 | (4.6) | 7.8 | (2.6) | (0.6) | ||||||||
Annual change in inflation-adjusted equity prices (%) | (2.9) | 22.3 | (18.0) | 2.2 | N.M. | N.M. | ||||||||
Current account balance/GDP (%) | (0.4) | (0.7) | (2.5) | (0.1) | 0.5 | 0.7 | ||||||||
Net external debt / GDP (%) | (12.9) | (13.4) | (11.3) | (12.6) | (13.5) | (13.1) | ||||||||
F--Forecast. N.M.--Not meaningful. Source: S&P Global Ratings. |
Credit risk in the economy: Asset quality to deteriorate due to economic slowdown
Private-sector debt capacity and leverage. Private sector debt in the Philippines is moderate, in our view, at about 56% of GDP in 2019. We expect debt levels to continue to rise steadily owing to above-average credit growth. We believe low per capita GDP of about US$3,512 in the Philippines limits the private sector's debt-bearing capacity because it does not provide sufficient buffer in an economic downturn.
Philippine banks' asset quality largely depends on the performance of the corporate sector, which accounts for 82% of banks' loan books (see chart 3). While macroeconomic conditions have turned adverse in 2020, large conglomerates should be able to tide over the near-term challenges owing to their strong business profiles, diversified revenue streams, and solid liquidity buffers. A significantly longer and deeper slowdown than our base case forecast could expose banks to bulky weak loans due to their concentrated corporate book. Top 20 loans for larger banks typically comprise about 20% of total loans and 100%-120% of total capital.
Chart 3
Micro, small, and midsize enterprises (7% of the banking sector's books) and leveraged corporates may face stress in coming quarters. The Philippine government has mandated banks to offer a moratorium on loan payments for affected borrowers during the lockdown. This action, along with rate cuts, rental fee waivers from mall owners, and some debt restructuring should partly mitigate the risk of defaults. Rural and thrift banks could see higher capital impact because they have higher exposure to consumers and small and midsize enterprises (SMEs). However, at 1% and 6% respectively, their share in the banking sector's assets is small and limits contagion impact.
Growth in consumer loans (five-year average of 16.1%) has contributed to a steady rise in household debt as a percentage of GDP. The rise in unemployment and decline in remittances would affect the repayment capacity of the household sector. However, at 10% as of end-2019, household indebtedness in the Philippines remains among the lowest in the region. We expect debt levels to continue to rise modestly as banks increase their retail exposures. However, consumer loan growth will be muted in 2020 as households prioritize savings until things are back to normal.
Banks' exposure to highly affected sectors such as hotels and catering (2% of bank lending), wholesale and retail trade (12%), transportation (3%) and manufacturing (10%) are particularly at risk (see chart 4). Retail loans, which form 18% of the banking sector's books, could see higher defaults in credit cards (3.5%) and unsecured personal loans (1.5%). Secured retail loans such as mortgages and auto loans will not likely be in the first wave of nonperforming assets, but will see some stress as unemployment rises.
Chart 4
Household leverage in the Philippines is very low and lending rates are on a decline. These factors should support the sector's repayment capacity. We assume a 2.0 percentage point rise in nonperforming assets (including restructured loans and repossessed assets) to 5.5%. For full year 2020, we estimate credit losses will rise threefold, or by Philippine peso 100 billion, equal to 1.3% of banking sector loans. This metric averaged 0.45% in the five years from 2015-2019.
Lending and underwriting standards. Philippine banks' lending and underwriting standards are somewhat conservative, in our view. Banks predominantly lend to the corporate segment, particularly larger companies with long credit histories and strong repayment track records. The credit approval process is typically well established for these borrowers. The NPL ratio has remained at about 2% over the past several years (see chart 5). Lending to cyclical industries such as commodities and related sectors is low. The exposure to the real estate sector is 19% as of March 31, 2020, fueled by commercial real estate development for the BPO sector. However, this includes mortgage loans to individuals, forming about 7.1% of the total portfolio.
Chart 5
Loan losses in real estate lending have been under control over the past few years due to measures implemented by the central bank. Gross NPLs in the residential and commercial real estate segments stood at 3.1% and 1.0%, respectively, as of Dec. 31, 2019. Direct foreign exchange exposure of Philippine banks is low. The use of securitization or derivatives to shift credit risks off balance sheet is also negligible.
Philippine banks' lending and underwriting standards in consumer lending have improved. This segment accounts for 18% of total loans as of end-2019. The setting up of a public credit registry is positive for this segment where asset quality has historically been constrained by lack of centralized credit history data. Mortgages and auto loans, which are secured lending, account for 41% and 32%, respectively, of the consumer portfolio. The asset quality of the consumer loan segment has steadily improved with the NPL ratio declining to 4.1% in December 2019 from 9% in 2009. While the ratio remains higher than the overall NPL ratio of 2%, the declining gap between consumer NPLs and total NPLs points to banks' refining their underwriting practices in this segment (see chart 6).
Chart 6
Philippine banks have a pool of foreclosed assets of about 1% of total loans. This pool has declined over the years from 1.9% of total loans in 2013 following public auctions, sales to asset managers, and write-offs. A significant portion of these assets are foreclosed properties that originated from the 1997 Asian Financial Crisis. These include residential properties, factories, commercial spaces, and warehouses. In our view, provision coverage on these foreclosed assets is low and insufficient to cover the valuation shortfall in a forced-sale scenario. That said, banks have been able to achieve generally favorable valuations upon disposal by waiting for good opportunities. Consequently, we expect that the disposal process will continue to be gradual.
Payment culture and rule of law. The payment culture and rule of law in the Philippines are weak, translating to high credit risk in the economy. Weakness in the country's legal system causes significant delays in resolution of NPLs and low recoveries. As per the World Bank's "Doing Business Report 2020," Philippines ranks 95 out of 190 countries, in ease of doing business, up from 124 in 2019. The same report highlights the weak insolvency metrics--the average time taken to resolve insolvency in the Philippines is 2.7 years and the recovery rate is low at 21.1%. Most of the country's peers have a better recovery rate. The World Bank's 2018 governance indicators for "rule of law" and "control of corruption" at minus 0.5 for the Philippines also indicate the weaknesses in the country.
Table 3
Philippines--Credit Risk In The Economy | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
--Year ended Dec. 31-- | ||||||||||||||
2016 | 2017 | 2018 | 2019 | 2020F | 2021F | |||||||||
Claims of resident depository institutions in the resident nongovernment sector as a % of GDP | 49.7 | 52.9 | 54.9 | 55.6 | 56.5 | 58.1 | ||||||||
Household debt as % of GDP | 8.4 | 9.0 | 9.1 | 9.7 | 9.7 | 10.2 | ||||||||
Household net debt as % of GDP | 8.4 | 9.0 | 9.1 | 9.7 | 9.7 | 10.2 | ||||||||
Corporate debt as % of GDP | 37.6 | 40.8 | 42.6 | 43.1 | 43.8 | 45.0 | ||||||||
Real estate construction and development loans as a % of total loans | 20.9 | 21.0 | 21.0 | 22.2 | 22.0 | 22.0 | ||||||||
Foreign currency lending as a % of total domestic loans | 10.0 | 9.9 | 9.6 | 9.5 | 9.3 | 9.4 | ||||||||
F--Forecast. Source: S&P Global Ratings. |
Base-Case Credit Losses
We expect credit losses for Philippine banks to rise to 1.3%, compared with a low five-year average of 0.45%, based on the following assumptions:
- The Philippine economy will contract by 0.2% in 2020. We expect a flattish U-shaped recovery with GDP growth of 9% in 2021. Weak economic activity and increase in unemployment will affect both corporate and retail segments.
- Slippages (or the rate of new NPL formation) will be high at 2.2% of gross loans compared to a five-year average of 0.2%. The government's stimulus packages and the central bank's moratorium could take care of temporary liquidity issues and partly mitigate the risk of defaults.
- Large corporates will sustain their credit profiles due to strong financial buffers. Sectors such as hotels and catering, wholesale and retail trade, transportation, and manufacturing are likely to be at risk. Credit cards and unsecured personal loans will also see higher delinquencies.
- The banking sector will maintain 65% coverage ratio on incremental NPLs.
- Philippine' banking sector's exposure to vulnerable segments such as SME and unsecured consumer loans, at 7% and 5% respectively, is far lower than that of regional peers. The peers have 20%-25% SME exposure and 10%-15% unsecured consumer loans.
- The policy rate will be cut by another 75 bps in 2020, on top of the 125 bps reduction so far, lowering the policy rate to 2% by end-2020. We expect the lower interest rates to help the repayment capacity of borrowers.
- The better performing large and midsize commercial banks will likely continue to make increased provisions in the coming quarters, when profits permit. Weaker and smaller financial institutions are more likely to utilize regulatory forbearance and relaxed loan classifications.
- The effect on individual banks in the coming quarters will be uneven, largely hinging on their exposure to consumer and SME segments and whether they choose to utilize relaxed accounting and provisioning standards.
Table 4
Philippine--Projected Credit Loss Rates* | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
--Year ended Dec. 31-- | ||||||||||||||
(%) | 2016 | 2017 | 2018 | 2019 | 2020F | 2021F | ||||||||
Total | 0.43 | 0.41 | 0.34 | 0.50 | 1.30 | 1.00 | ||||||||
*As a percentage of lending; Credit loss rate is calculated as provisions for credit losses divided by on-balance-sheet credit exposures. F--Forecast. Source: S&P Global Ratings. |
Industry Risk | 5
Banking regulations in the Philippines are broadly in line with international standards, and in some instances more stringent. We believe the New Central Bank Act strengthens the supervisory and monetary functions of the central bank. The industry's risk appetite is generally restrained, and banking products are straightforward. A high level of stable customer deposits supports banks' funding profiles.
Institutional framework: Regulations are in line with international standards
Banking regulation and supervision. In our view, banking regulation and supervision in the Philippines are broadly in line with--in some cases, more stringent than--international standards. The amendment of BSP charter in 2019 has widened the coverage of institutions under the central bank's supervision. The BSP now also regulates money service businesses, credit granting businesses, and payment system operators. We believe the central bank can now better address potential risks arising from interconnectedness of entities in the financial system. The Act utilizes a prompt corrective action framework to detect emerging weaknesses in licensed institutions and helps take preventive measures.
The BSP implemented the Basel III capital requirements in full in 2014, for all universal and commercial banks in the Philippines. We note that minimal regulatory capital requirements in the Philippines are higher than the minimum that the Basel III framework prescribes. We view BSP's 60% cap on the value of real estate collateral and REST for ensuring capital buffer as pre-emptive measures against any negative impact if the economy took an unfavorable turn. Philippine banks also adopted PFRS 9 starting January 2018 with minimal impact on capital or asset quality ratios.
Domestic systemically important banks (D-SIBs) in the Philippines have a 1.5-2.5 percentage point higher minimum capital requirement than other banks. Since January 2019, Philippine banks are complying with 100% liquidity coverage ratio (LCR); they hold easily convertible assets to cover total net cash outflows. In addition, universal and commercial banks and their select subsidiaries have been complying with the 100% net stable funding ratio (NSFR) rule at both solo and consolidated levels since January 2019.
The BSP has progressively lowered the reserve requirement over past several years to bring it at par with other banking systems in the region. There was a 400 bps reduction in 2019 to 14%, and a 200 bps further reduction so far in 2020 to 12%. The central bank plans to bring the ratio down to single digits by 2023. This will free up liquidity and boost credit growth.
Regulatory track record. We view the regulatory track record in the Philippines as intermediate. The amendment of the BSP charter offers greater protection to supervisory staff when performing their duties. The clauses providing full indemnity to BSP officials until they are finally adjudged to be in willful violation of the Act are stringent and make it more difficult for the officials to be sued them compared with the previous act. We view these amendments as a positive step toward greater independence and more effective implementation of prudent policies and measures. Previously, supervisors were civilly liable if they had not applied "extraordinary diligence" in carrying out their supervisory duties. This was an onerous requirement, in our view. While this requirement has not deterred the BSP from executing its supervisory functions, time and resources are required to defend against lawsuits. In the recent past, most lawsuits pertained to closure of very weak financial institutions, and the new Act strengthens the BSP's ability to do so. The amendments also prohibit any injunction or restraining order on the regulator except by the Philippines' two highest courts. These enhancements augment BSP's powers to exercise its core mandate of promoting a sound financial system, in our opinion.
Governance and transparency. Governance and transparency in the Philippine banking industry is weak, in our opinion. We observe gaps in the disclosure of banks' quarterly and semi-annual financial statements. The statements have inadequate notes to accounts and lack detail, particularly on asset quality disclosures. In contrast, the annual report provides comprehensive information on a bank's financial position. Enhanced year-end reporting, however, does not sufficiently compensate for the lack of comprehensive quarterly reporting, in our opinion.
Competitive dynamics: A simple business mix and moderate profitability reflect restrained risk appetite
Risk appetite. In our view, Philippine banks have a restrained risk appetite. Banking sector earnings over the years have been lower than that of non-financial sectors. They are also at the lower end in a regional context, with a five-year average return on equity of 10.1%.
Philippine banks' profitability is constrained by a high cost-to-income ratio and the large share of low-yielding corporate loans in the portfolio. Earnings trends have been largely stable and dominated by net interest income generated from the traditional lending and deposit business in recent years. Philippine banks had significant trading gains prior to 2014 due to declining interest rates. Banks have since refocused their attention on lending, particularly to the higher-yielding consumer segment. In 2019, the profitability of the banking system improved on account of higher trading income and better interest margins. In the quarter ending March 2020, major banks saw good trading gains amid falling interest rates. This partially offset the impact of higher provisions and kept the sector's return on assets stable at 1.3% (see chart 7).
Chart 7
We expect profitability to decline in 2020 due to a decline in margins and higher credit costs, and recover in 2021. Philippine banks will likely find it challenging to replicate the trading gains of the first quarter during the year, given volatile financial markets. The banks will use a combination of controls over cost of funds and operating expenses to offset some of the effect of higher provisions. A longer or deeper economic slowdown than our current forecasts could lead to a sharper decline in profitability due to potentially higher large corporate delinquencies.
Our assessment of Philippine banks' risk appetite also takes into account these banks' limited use of innovative, complex, and risky products. Although the banking sector has sizable exposure to real estate loans, loan losses in this segment have declined over the past few years, and have been trending closer to the overall level of credit losses.
Industry stability. The Philippine banking industry has some overcapacity, in our opinion, due to the large number of financial institutions. The country has a crowded banking system with 46 commercial banks, 49 thrift banks, and 447 rural banks as of March 31, 2020. The BSP has been actively working to create a less fragmented banking environment and strengthen the balance sheet of lenders. The new central bank Act makes it easier for the BSP to close weak financial institutions. The bulk of the central bank's effort has been aimed at reducing the number of small-scale lenders, particularly the rural banks; their numbers have declined from 500 as of Dec. 31, 2016. Meanwhile, commercial banks continue to dominate the market, with about 91% share of total banking system loans. The family-owned structure of large banks in the Philippines is to a significant extent responsible for lack of meaningful consolidation among top banks. There is limited appetite for the families to relinquish their stakes in the banks and/or partner with peer conglomerates.
Banking sector forms 82% of financial sector assets in the Philippines. Non-bank finance companies form about 2%-3% of assets and typically serve underbanked consumers and SMEs in the provinces. The share of non-bank participants has remained steady over the years and does not impose any significant threat to the competitive environment.
The liberalization of entry norms for foreign banks' has not fundamentally altered the competitive landscape in the Philippine banking sectors because these banks mostly service their home-country customers. Majority foreign bank presence is from East Asia i.e. Japan, Taiwan and Korea. As of end-2019, the Philippines had 29 foreign banks (branches and subsidiaries), which contributed to 7% of the banking sector's assets. Overall, large domestic banks that are part of family-owned conglomerates will likely continue to dominate the system.
Market distortions. We believe market distortions arising from the government's influence on the Philippine banking sector are limited. The government generally does not influence the system's competitive dynamics, and commercial banks exercise autonomy over product pricing and customer selection. Two government-owned banks--Land Bank of Philippines and Development Bank of the Philippines--account for 15% of total assets at end-2019. They predominantly focus on fulfilling their social mandate of promoting economic development in selected priority sectors. While the government has mandated minimum credit allocation to micro, small, and midsize enterprises (8% for micro and small, and 2% for medium enterprises) as well as to agrarian and agriculture sectors (25%), the penalty for non-compliance is not significant.
Table 5
Philippines--Competitive Dynamics | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
--Year ended Dec. 31-- | ||||||||||||||
(%) | 2016 | 2017 | 2018 | 2019 | 2020F | 2021F | ||||||||
Return on equity (ROE) of domestic banks | 10.5 | 10.2 | 9.4 | 10.5 | 7.0 | 10.3 | ||||||||
Systemwide return on average assets | 1.2 | 1.2 | 1.1 | 1.3 | 0.8 | 1.0 | ||||||||
Net operating income before loan loss provisions to systemwide loans | 2.8 | 2.6 | 2.5 | 3.0 | 2.8 | 2.8 | ||||||||
Market share of largest three banks | 43.6 | 43.7 | 43.3 | 44.0 | 44.0 | 44.0 | ||||||||
Market share of government-owned and not-for-profit banks | 14.2 | 14.6 | 15.1 | 15.3 | 15.6 | 16.0 | ||||||||
Annual growth rate of domestic assets of resident financial institutions | 12.4 | 11.5 | 11.5 | 8.4 | 5.0 | 15.0 | ||||||||
F--Forecast. Source: S&P Global Ratings. |
Systemwide funding: Strong retail deposit base provides a stable funding profile
Core customer deposits. The Philippine banking system is characterized by a strong core customer deposit base that funds about 104% of customer loans at the end of 2019 (see chart 8). The established domestic franchise and large branch network of Philippine banks supports their deposit-raising capability. Confidence in the banking system is generally good and banks can easily access retail deposits via their broad branch network. Low-cost savings and demand deposits constituted the bulk of the deposits and accounted for 73.3% of local currency deposits (70% of total deposits) as of end-2019. Deposits grew by 7.3% in 2019, slower than loans. We expect the loan-to-deposit ratio to improve in 2020 due to muted credit growth, and continue to gradually rise in 2021 onward. As of March 2020, the LDR was 79.6% reflecting comfortable liquidity in the banking system.
Chart 8
Philippine banks have been focusing on low-cost funding to preserve interest margins. They have also been allowing more expensive fixed deposits to run off. We expect Philippine banks' funding strengths to endure in 2020, given their established branch networks and franchise for securing a strong deposit base, especially among the large domestic banks.
External funding. The Philippine banking sector has a net creditor position over past several years, reflecting a very high degree of customer deposit funding and domestic banks' limited access to the external debt markets. Philippine banks are less reliant on external funding and typically borrow in foreign currency in order to match their foreign currency lending. Large banks have reasonable access and have tapped external debt markets periodically. Part of external borrowings are by branches or offshore banking units of foreign banks operating in the Philippines from their head office.
Domestic debt-capital markets. In our opinion, the Philippines has a narrow and shallow debt capital market. Although issuances have steadily increased in the past couple of years, the private sector's outstanding bonds and commercial papers represented only 7.9% of GDP in 2019. Government bonds continued to dominate the domestic securities market, constituting about 77% of total bonds outstanding, with the remaining made up of issuances by private sector firms mainly from real estate and banks.
Government role. In our view, the Philippine government and the central bank play strong roles in supporting the funding needs of domestic banks. The government has an effective record of providing liquidity to distressed institutions. For example, in late 2000, Philippine National Bank faced a liquidity crisis and the government injected PHP25 billion to support the bank.
Emergency liquidity facilities are also well designed and easily accessible by banks. We believe the government has sufficient resources, relative to the system's modest funding needs, to provide liquidity support in the event of a crisis. To ensure the banking sector has adequate liquidity amid volatile financial markets due to COVID-19, the BSP has opened a special window to buy government securities from banks at market prices.
Table 6
Philippines--Systemwide Funding | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
--Year ended Dec. 31-- | ||||||||||||||
2016 | 2017 | 2018 | 2019 | 2020F | 2021F | |||||||||
Systemwide domestic core customer deposits by formula as a % of systemwide domestic loans | 119.1 | 111.9 | 106.1 | 104.2 | 106.2 | 103.4 | ||||||||
Net banking sector external debt as a % of systemwide domestic loans | (5.2) | (4.8) | (3.9) | (3.0) | (3.2) | (3.0) | ||||||||
Systemwide domestic loans as a % of systemwide domestic assets | 51.3 | 54.4 | 55.8 | 56.3 | 55.2 | 55.2 | ||||||||
Outstanding of bonds and CP issued domestically by the resident private sector as a % of GDP | 6.0 | 6.3 | 7.3 | 7.9 | 7.0 | 6.9 | ||||||||
Total consolidated assets of FIs as a % of GDP | 89.8 | 91.6 | 92.6 | 93.9 | 97.2 | 100.0 | ||||||||
F--Forecast. Source: S&P Global Ratings. |
Peer BICRA Scores
The summary scores for some of the Philippines' peers show that the component scores for the Philippines are broadly in line with other banking systems in BICRA group '5'.
Table 7
Peer BICRA Scores | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Philippines | Malta | United Arab Emirates | Panama | Qatar | Hungary | Iceland | Bermuda | Peru | Italy | Mexico | ||||||||||||||
BICRA group | 5 | 5 | 5 | 5 | 5 | 5 | 5 | 5 | 5 | 5 | 5 | |||||||||||||
Economic risk | 6 | 4 | 5 | 5 | 5 | 6 | 4 | 6 | 6 | 6 | 6 | |||||||||||||
Industry risk | 5 | 6 | 5 | 5 | 5 | 5 | 6 | 3 | 3 | 5 | 3 | |||||||||||||
Country classification of government support | Highly supportive | Uncertain | Highly supportive | Uncertain | Highly supportive | Uncertain | Uncertain | Supportive | Supportive | Uncertain | Supportive | |||||||||||||
Source: S&P Global Ratings. |
Government Support
We classify the Philippine government as highly supportive of the country's banking system, reflecting our expectation of timely financial support from the government to ensure the stability of the financial system, if needed. This is indicated by the government's record of providing extraordinary support to troubled financial institutions. For example, the government supported United Coconut Planters Bank (the 10th-largest commercial bank at that time) in 2002 when the bank fell into financial distress. The government purchased about PHP13 billion of the bank's NPLs and, later in the year, subscribed to its PHP7 billion 10-year subordinated debt issue.
We believe the Philippine government demonstrates both the willingness and ability to ensure that Philippine financial institutions are well capitalized and that depositor confidence remains strong.
Table 8
Philippines--Five Largest Financial Institutions By Assets | ||||
---|---|---|---|---|
Assets (Bil. PHP)* | ||||
BDO Unibank | 3,145.2 | |||
Metropolitan Bank & Trust | 2,450.8 | |||
Bank of the Philippine Islands | 2,205.0 | |||
Land Bank of the Philippines | 2,033.4 | |||
Philippine National Bank | 1,142.3 | |||
*Data as of Dec. 31, 2019. PHP--Philippine peso. Source: S&P Global Ratings. |
Related Criteria And Research
Related Criteria
- Analytical Linkages Between Sovereign And Bank Ratings, Dec. 6, 2011
- Banks: Rating Methodology And Assumptions, Nov. 9, 2011
- Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011
- Sovereign Government Rating Methodology And Assumptions, June 30, 2013
Related Research
- How COVID-19 Is Affecting Bank Ratings: June 2020 Update, June 11, 2020
- Philippine Banks Bolster Buffers For Turbulence Ahead, May 6, 2020
- Asia-Pacific Financial Institutions Monitor 2Q2020: COVID-19 Crisis Could Add US$440 Billion To Credit Costs, May 14, 2020
- COVID-19 Means Another Year Of Single-Digit Loan Growth For Philippine Banks, March 9, 2020
- S&P To Publish Economic And Industry Risk Trends For Banks, March 12, 2013
This report does not constitute a rating action.
Primary Credit Analyst: | Nikita Anand, Singapore + 65 6216 1050; nikita.anand@spglobal.com |
Secondary Contact: | Ivan Tan, Singapore (65) 6239-6335; ivan.tan@spglobal.com |
Sovereign Analyst: | Andrew Wood, Singapore + 65 6239 6315; andrew.wood@spglobal.com |
Research Contributor: | Monish Rajpal, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
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