Interview: Nestor Tan, Gilda Pico, Fabian Dee, Cezar Consing
What opportunities are unlocked by the growing interest of banks to finance the middle markets?
CEZAR CONSING: The last three decades have seen the decline of the Philippine middle market. The hollowing out of domestic manufacturing has been key to this downturn. Fortunately, we are seeing a reversal of this trend due to a combination of business process outsourcing (BPO) growth and manufacturing resurgence, creating opportunities that many banks want to tap.
We are seeing a greater emphasis on small and medium-sized enterprise (SME) lending of all types via loans for expansion and working capital, and on consumer lending to the middle market through housing, auto and personal loans. In fact, we look forward to the day when a greater percentage of the lower-middle and lower-income brackets make the transition to the middle class and become more creditworthy.
In the Philippines, bank loans as a percentage of GDP are in the 30-40% range, whereas in many other countries in the region it stands at over 100%. Similarly, the average GDP per capita of countries with a BBB- rating is about $10,000, which is almost four times that in the Philippines. If our per capita GDP approaches, say, $4000-$5000, the creditworthy percentage of the population will more than double.
FABIAN DEE: Servicing the dynamic middle market will require more than the typical banking products. Banks will need to develop custom solutions, value-added services and formulate strategies on SME business in order to meet the diverse needs of this client base.
Opportunities are aplenty in the areas of cash management, trade financing and treasury hedging tools to manage risks and to preserve customer margins or to lock costs. As these companies look beyond the Philippines there is also a need for global services in order to support their international trade operations and investment banking needs.
GILDA PICO: As economies grow and mature, the middle market expands, which creates opportunities on both sides of the balance sheet for banks. On the asset side, banks can target growth in loans to SMEs, trade facilities, letters of credit negotiations, commercial mortgages, leasing, insurance and wealth management. On the liability side, there is potential demand for more-than-the-basic current account, savings account or time deposits, including more sophisticated cash management and risk management opportunities. Investment outlets such as structured deposits/notes, bonds and equities are in demand from middle-market firms. These can each raise bank fees and sales income, facilitating cross-selling opportunities of various bank products.
What type of consumer lending presents better value proposition for diversifying loan portfolios?
NESTOR TAN: All types of consumer lending are generating good returns for the banks. While there are risk-return trade-offs, the industry has become good at assessing these. Bank portfolios have been historically underrepresented in the consumer sector. Any growth in this sector would be good for the industry.
The real challenge, however, is how to tap the unbanked population, largely the informal sector that has a stable source of income but not the proper documentation to support it.
DEE: Philippine banks have benefitted from the renewed focus on retail and consumer lending, particularly home mortgages, vehicle financing and credit cards. Recent growth in these areas has outpaced that of the commercial banking. The expansion into these segments is currently well supported by the growing young population, increased income levels, improved accessibility to credit facilities, and the low loan penetration ratios compared to regional peers. Aside from supporting consumption in the Philippine economy, these areas have provided banks new outlets for credit. The shift towards retail has improved the loan mix of banks, resulted in neutral to better margins and provided a more balanced risk-weighted asset portfolio.
CONSING: The past two to three years has seen the financial system flush with liquidity, resulting in reduced net-interest margins across all loan types. Many banks have responded by increasing their exposure to consumer loans, which, while exhibiting falling net-interest margins, still offers better returns than corporate or commercial loans.
The best margins are probably in credit cards, while mortgages and car loans are also not bad. By Philippine standards, the margins are now historically thin, while by Asian standards they are still wide. A bank's ability to undertake consumer lending depends on how it is situated. Credit card financing, for example, is a systems game where only a large bank can afford the systems needed to do credit card business. This is less true for mortgages and auto loans, but robust systems are still needed in these areas, so small banks are at a disadvantage in pursuing these loans.
How can the sector capitalise on the credit rating upgrade and expected increase in investments?
PICO: The credit upgrade naturally attracts more potential money into the economy, as there are funds that can only invest if the entity is at least “investment grade”. With this potential influx, banks should look to offer investment outlets for offshore money coming in. For instance, banks can offer structures to clients since it enables the client to potentially get a higher yield, while the bank also benefits from sales margins, potential trading positions and a lot of cross-sell opportunities, whether across different products from foreign exchange, money market, derivatives or options. Depending on the structure, this can be a “cheap” source of funding for the bank, as the high yield to the client is due to the option embedded. There are also opportunities in PPP projects, particularly infrastructure, power, health or education, where investment banking arrangements, syndication and financing are set to increase. Banking mergers may need to happen sooner rather than later to cope with more business opportunities, particularly as ASEAN integration nears in 2015 whereby size will matter in the banking sector.
DEE: The recent upgrades for the Philippines should boost investor confidence in the country, which in turn will bode well for the banking sector. We continue to see offshore interest to invest in the areas of tourism, infrastructure, manufacturing, provision of BPO services and trade. Banks are well-capitalised, and loan-to-deposit ratios are below regional norms. Given the amount of liquidity in the system and the current interest rate environment, the banking sector is well-positioned to support and benefit from the anticipated increase in business activities CONSING: The credit rating upgrade is a boon to investments. First, it tells foreign investors that we make good on our debts. Second, and perhaps more important, it encourages domestic investors to invest with long-term horizons. Most of the country's big domestic groups are now making long-term investment bets, many in the power, infrastructure and manufacturing areas, and these represent very meaningful financing opportunities for banks.
The Philippines has been big in the BPO space, and to some extent, the growth of the BPO business made up for the decline in the manufacturing base, however, these do not need financing in the scale offered by manufacturing firms. Resurgence in manufacturing and the Public-Private Partnership (PPP) Programme, under which many infrastructure projects will be undertaken, could bring significant benefits to banks.
Given low rate of tax collections as a percentage of GDP, the government needs to involve the private sector in power and infrastructure projects. The ability of the banks to lend to large domestic conglomerates is a tremendous opportunity.
How can domestic banks compete regionally in anticipation of ASEAN economic integration?
DEE: Philippine banks have long had a regional and even global footprint, mainly through offshore offices and subsidiaries meant primarily to service the overseas remittance business. Locally, Philippine banks have become more sophisticated as evidenced in the development of new products and services, improved operational and efficiency standards, and compliance with international accounting and governance policies, all of which augur well for local banks to grow and mature.
Regulatory changes are still needed in order for foreign banks to fully operate domestically, so the foreign threat may be limited in the short to medium term. The concept of the Qualified ASEAN Bank (QAB) as laid out under ASEAN integration can propel the regulatory harmonisation within the region and help our local banks to access other markets, however, the criteria to be a QAB is still under consideration. Nonetheless, domestic banks, especially large commercial players, are already well poised for increased competition. While there are opportunities for local banks to expand within the region, the focus is likely to be on obtaining a greater share of the largely untapped local market.
TAN: Philippine banks are small relative to their ASEAN counterparts; therefore, integration presents the potential threat of being overtaken by the regional giants.
If we are going abroad, we need to evaluate what value proposition we offer to the non-Filipino market. Compared to other multinational banks, we may not be competitive at all. We would be better off focused on the Philippines, as we still have a lot of ground to cover with 80% of the population still unbanked.
PICO: With regards to capital adequacy ratios (CAR), the domestic banking system has a healthy CAR, averaging 17.69% in the first half of 2013, demonstrating the banks’ strength and ability to absorb losses from credit risk, market risk and operational risk. However, Philippine banks may still be too small relative to their regional counterparts. Mergers and acquisitions need to happen to enable them to muscle their way through the big regional banks so that potential borrowers can take notice. Expansion plans around the region also require massive funding. A number of big regional banks already have a head start in terms of brick and mortar presence. Sophistication of product offerings is also an area of improvement, particularly as competitors try to distinguish themselves from one another.
In what way can banks encourage credit expansion while also preventing overheating?
PICO: One is by trying to achieve a loan growth in line with the deposit growth the bank is experiencing. Another is by maintaining a healthy advance-decline ratio. In the Philippines, given the 18% reserve on private sector deposits, banks can only use 82% of any deposit, whereas only 50% of government deposits can be lent out because of the liquidity floor requirement. A good level to be is the one that supports credit expansion but not really over lending.
Credit policies, both with retail and corporate clients, should likewise be reviewed regularly. If previously, a bank did not want to lend to a particular sector, it is possible things have changed and that sector has become bank-able. For instance, private banks are now increasingly looking at countryside lending. In addition, ensuring that concentration in certain sectors of the economy, such as in the real estate sector, does not happen – to prevent asset bubbles from forming – is one way for overheating to be prevented.
Tight documentation processes and prudential equity participation will also help minimise a repeat of the 2008 global financial crisis.
TAN: Most of our concerns arise due to the experiences of more advanced economies where increased demand in loans is assumed to mean over-leverage or a potential for an asset bubble. However, if one looks at a growing economy like the Philippines, supply is limited but easily expandable. And, unlike in advanced countries where the borrowing population is close to saturated, the increase in demand here is largely coming from new borrowers, particularly consumers. We have a different driver for the growth. Still, we have to be watchful of asset price bubbles and the over-extension of credit. On the latter, we need a good credit bureau to help ensure we catch over-borrowing before it is too late.
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