Windfall profits over for Philippine lenders – S&P

MANILA, Philippines - Standard and Poor’s (S&P) believes the days of windfall profits for Philippine banks are over amid the expected deterioration of assets quality of banks in Southeast Asia over the next 12 to 18 months.

S&P credit analyst Ivan Tan said earnings of Philippine banks fell in 2014 due to an industry-wide slump in one-off gains from their trading activities.

“The banking system posted its first decline in net profits in five years in 2014 as the hefty gains from selling government bonds to institutional investors decreased substantially,” Tan said.

The report said Philippine banks’ return on average assets dropped to 1.27 percent in 2014 from a peak of 1.61 percent in 2013.

Tan said profitability among banks shifted toward trading gains in 2013 on improved market conditions, positive investor sentiment, and an upgrade of the Philippine government to investment-grade status.

 “We believe the days of windfall profits for Philippine banks are over and that trading gains will remain muted this year and into 2016,” he said.

According to Tan, rising interest rates would continue to cut local bank’s gains from fixed-income investments, which account for over a quarter of their total assets.

Philippine banks, he explained, have large holdings of government bonds while rising interest rates have caused valuation declines on these investments.

Tan said S&P sees the Bangko Sentral ng Pilipinas (BSP) raising key interest rates by 25 basis points this year and another 75 basis points next year.

 “We forecast policy rates will continue to increase to 4.25 percent in 2015 and five percent in 2016, from four percent in 2014. In addition, the stable outlook on the Philippines government will limit further marked-to-market gains from rating upgrades,” he said.

The BSP has kept interest rates steady since September last year. The overnight borrowing rate is currently pegged at four percent while the overnight lending rate is at six percent.

“The dissipation of trading gains marks the shift to more recurring sources of income, with banks re-focusing their strategic direction on their core lending and related fee income business,” Tan said.

Tan said large banks with sizable distribution networks have focused on growing their higher-yielding consumer loan books to help arrest the profit slump.

However, he said consumer lending that accounts for 20 percent of the total loans would take some time to pick up because Philippine banks have traditionally focused on large corporate entities.

The S&P analyst said the banking industry’s average return on assets would decline to a range of 1.2 to 1.3 percent this year from a peak of 1.6 percent in 2013.

 “The overall profitability upside should be limited in 2015,” he added.

Tan said the strong performance of banks in the Association of Southeast Asian Nations (Asean) over the past few years would enable them to survive deteriorating asset quality.

Tan said risks have been building up for Asean banks after several years of smooth sailing.

These include credit risk due to rising property prices and household indebtedness, funding pressure from tight liquidity, and market risks from rising interest rates in certain countries.