Banks on track to exceed 2010 profit

Most Philippine banks appear on track to post another year of record profits this year on the back of more earnings from core lending and fee-based services even as treasury gains are tempered by the volatile global financial environment.

But while net income in peso terms may outpace last year’s level as suggested by banks’ interim results, return on equity (ROE) has moderated as last year’s extraordinary trading gains were difficult to replicate. Analysts agree that this year’s earnings are of better quality, as banks have become less dependent on windfall from moody financial markets as they scale up loan books and beef up other fee-based businesses.

Based on the latest report from the Bangko Sentral ng Pilipinas, bank lending (net of short-term placements with the central bank) grew at a brisker pace in June at 18.8 percent year on year—the fastest since 2009 when the US subprime crisis resulted in a global credit crunch. As a strategy, most local banks are now more proactive in growing their business with consumers—such as through credit cards, personal loans, auto and mortgage loans—as  well as small and medium enterprises (SMEs) where interest margins are higher.

ROE ratios declined for many banks in the second quarter compared with a year ago but the levels mostly improved from the first quarter, which was a tough period as region-wide inflation fears and the consequent monetary-tightening cycle depressed the valuation of treasury assets. The second quarter was a different story. “There was a point at which treasury rates dropped in the second quarter so many treasurers profited,” said Aurelio Montinola III, president of Bank of the Philippine Islands and the Bankers Association of the Philippines.

Ayala-led BPI remained as the most profitable bank with P6.2 billion in six-month net income but Metrobank is fast catching up with its P6.1 billion in net profit. Nine of the 10 most profitable Philippine banks posted higher profits in the first semester compared with a year ago and eight of them posted double-digit expansion, led by Metrobank’s 45-percent profit growth. The close battle between BPI and Metrobank for the bragging right to be the country’s most profitable bank is something to watch this year.

Among the few that bucked the sustained upswing in the first semester was state-owned Development Bank of the Philippines, which reported a 39-percent contraction in profit compared to a year ago. The bank has been mired in controversy amid the scrutiny of alleged anomalous transactions in the past by the new stewards appointed by the Aquino administration.

PNB also booked a 36-percent year-on-year decline in net profit to P1.15 billion mainly due to lower gains from trading and investment securities. Though PNB ranks fifth-biggest among the country’s banks in terms of resources, it has fallen out of the top 10 most profitable (in peso terms) for the first six months of 2011.

While returns on asset are lower this year for Philippine banks, they are still “satisfactory,” according to global credit-watcher Fitch Ratings, which projected returns to fall this year and next as treasury gains moderate.

In a research note issued after the second-quarter income reporting season, stock brokerage DA Market Securities said banking stocks were expected to post record profits “due to improved core operations and less risky revenue stream.”

Alex Pomento, head of research at Macquarie Securities Philippines, is also bullish on the banking sector, as well as the property sector. “They are the best proxy to our view that Philippine overall economic growth over the next two years is driven by domestic consumption.”

“We like banks in general because of their healthy, liquid balance sheet,” said April Lynn Lee-Tan, head of research at leading online stock brokerage CitisecOnline.

For every P1 in loan extended by commercial banks, about 2.8 centavos turned sour as of end-May, BSP data showed. The 2.8-percent non-performing loan ratio has improved from 3.31 percent a year ago and now matched the level before the 1997 Asian crisis.

“We like the bigger banks because they have access to low-cost deposits, so they can compete better in lending,” Lee-Tan said.

BDO, which has outpaced its peers in asset growth, is still the country’s biggest bank and the first to hit the P1-trillion asset mark. It also has the largest loan book (P589 billion) and deposit base (P787 billion).

Loan-to-deposit ratios (LDRs) averaged at 64 percent for the country’s 10 largest local lenders, indicating more room to acquire more earning assets.

With the stiff competition among banks on the lending side, consumers are benefiting in the form of cheap financing. “It’s good for the consumer but bad for bank margins. The only way to grow is by increasing volume,” said fund manager Paul Joseph Garcia, senior vice president at BPI asset management and trust group.

But even as margins between cost of money and loan pricing have narrowed, Garcia said local levels were still very good compared with margins in the Asian region. At the same time, he said the increasing focus on SMEs and consumers would allow banks to unlock higher margins compared with loans to top-tier corporations.

Garcia, who was CEO of the local asset management unit of ING that was acquired by the BPI, also sees a new wave of merger and acquisitions in the local banking system.

“Everyone’s on the lookout for someone to make the first move. It’s like the 1990s again,” he said.

One key structural challenge for Philippine banks, according to Fitch, is the low provisioning of real and other properties owned and acquired (Ropoas). These are real estate collateral repossessed by banks and are shown separately as investment properties and “non-current assets held for sale” in banks’ annual reports and are taken out of NPL portfolios.

Banks generally consider foreclosed properties as tangible assets to have better recovery prospects than NPLs, the rating firm noted. It estimated the reserve coverage for rated banks at only 11 percent as of end-2010, up slightly from 9 percent at end-2009.

“Based on banks’ own appraisals, the market values of foreclosed properties hover above book values by about 30 percent on a portfolio basis. This explains the low reserve coverage. Most rated banks have been able to dispose of them at a gain over the past few years.”

Overall, Fitch expects asset quality risks for Philippine banks to remain “subdued” this 2011, citing “stable” credit conditions. Moreover, the credit watcher said large domestic corporations—which still represent the majority of banking sector loans—can reasonably cope with a modest rise in interest rates and inflation, in view of their modest debt burden.

With an average core tier 1 capital adequacy ratio (excluding hybrid and preferred shares) of 12 percent at end-2010, Fitch also assesses the capitalization of many rated Philippine banks as “satisfactory” and expects this trend to continue.

Top 10 most profitable Philippine banks (in peso terms)*

1H               Profits            Year-on-Year Growth

1. BPI                              P6.2B                     12%

2. Metrobank                 P6.1B                     45%

3. Land Bank                 P5.52B                    20%

4. BDO                              P5.02B                    21%

5. UnionBank                 P2.86B                    29%

6. Security Bank              P2.44B                    33%

7. ChinaBank                 P2.35B                    11%

8. RCBC                             P2.23B                    5.4%

9.  DBP                             P1.74B                    -39%

10. UCPB                            P1.3B                     18%

*excluding foreign banks