Philippine banks are expected benefit from the economy’s good growth prospects but the industry’s increasing exposure to consumer loans could become a concern, Standard and Poor’s (S&P) Ratings Services said.
The debt watcher, in a report, said it expected real gross domestic product (GDP) growth of 5.7 percent for 2016, which will likely again make the Philippines one of the fastest-growing economies in Southeast Asia.
“We attribute the Philippine economy’s good growth trajectory in recent years to ongoing structural changes on the fiscal and economic front (such as the current administration’s thrust to promote sustainable public finances and address corruption) and to improved business conditions and a pickup in public spending on infrastructure in recent months,” S&P said.
Its forecast falls below government’s target of 6.8 percent to 7.8 percent and is also lower than last year’s actual growth of 5.8 percent.
S&P said remittance inflows from Filipinos working abroad and improving domestic employment conditions were supporting domestic consumption — the main driver of GDP growth.
“A large, young educated labor market underpins these strengths,” it added.
S&P expects credit expansion to decline to roughly 8 percent to 12 percent per year in 2015 and 2016 from 19 percent in 2014 after the government introduced measures such as a cap on the value of real estate collateral to cool the property sector, particularly in commercial real estate.
“Loan growth, particularly to the corporate sector, will likely keep moderating as well unless public infrastructure and development projects kick in under the government’s public-private partnership (PPP) scheme,” it said.
“Over the longer term, the Philippines’ robust economy will likely continue to drive expansion in domestic credit at about 2x-3x GDP growth,” it said, stressing that its loan growth forecasts for 2015 and 2016 remains high by regional standards.
Low credit penetration in the Philippines still allows significant room for expansion, it noted.
The Philippine banking system, however, is not without its challenges.
“Loan growth has started to moderate, prompting banks to search for higher yields to offset lower volumes. We’ve observed a shift in lending appetite toward more lucrative (and higher-risk) consumer loans, which could cause credit costs to rise,” it said.
S&P said the pursuit of consumer loans could result in higher credit costs for Philippine banks, given the inherently higher risk in a growing economy.
It pointed out that consumer loans had grown by 18 percent per year on average over the past three years, slightly faster than the 16 percent increase in system-wide loans.
Consumer loans only made up about 17 percent of total banking-system loans in the Philippines as of September 2015, it noted.
“The ratio of non-performing consumer loans to total consumer loans has consistently been double that of total non-performing loans to total loans, although both the ratios have been improving,” it said.
S&P said Philippine banks were traditionally strong in corporate lending but risk management in consumer lending was still not fully developed. In addition, the country was said to have a weak payment culture and low income levels.
“While we believe credit costs will rise, we don’t expect a sharp spike. Furthermore, the bulk of consumer lending is secured: Mortgage lending forms the largest proportion of consumer loans (42 percent), followed by auto lending (27 percent),” it said.
Overall, S&P said supportive economic conditions and sound financial fundamentals underpinned a stable outlook on the Philippine banking sector.
“The banking system’s capital adequacy ratio of 16.1 percent as of June 30, 2015, is comfortably above the regulatory minimum,” it said.
Since 2013, it noted that Philippine banks have been actively raising external capital, which more than covers the gap between internal capital generation and growth in risk-weighted assets.
The Philippine central bank’s transition to adopting Basel III norms has promoted prudential capital management, it added.
“Philippine banks also maintain a sizable amount of liquid assets, most of which are in the form of cash and domestic government bonds,” it said.
The debt watcher noted that liquidity levels remained stable throughout the global financial crisis in 2008-2009, demonstrating the Philippine banking system’s considerable resilience to external shocks.
In addition, it said, banks’ healthy funding positions contribute to their loan-to-deposit ratio of 69 percent one of the lowest in Asia-Pacific.
“We believe the combination of sound capital and funding profiles is an enduring strength of the Philippine banking system and will continue to underpin bank ratings in 2016,” it concluded.