Banks in the Philippines are expected to continue growing rapidly but profitability faces headwinds, S&P Global Ratings said in a new report.
Overall loan growth is estimated to be between 15 percent and 17 percent in 2017 and 2018 following a 16.5-percent expansion in 2016, S&P said in its “Philippine Banks To Continue To Ride Robust Economic Growth” report released on Wednesday.
“We believe that the credit cycle in the Philippines has further to run. Most of the factors that drive credit cycles — corporate profits, low interest rates, and abundant liquidity — still look very much in place,” it said.
Conditions for sustained growth remain intact, the debt watcher added.
“Interest rates have stayed low by historical standards. Banks have abundant liquidity to lend. Credit penetration is moderately low, with private sector credit-to-GDP (gross domestic product) ratio of about 50 percent, and with room to rise,” it said.
S&P also said the consumer loans segment had considerable potential for growth and that proposed tax reforms could reinforce the positive credit cycle.
“Lower personal income tax rates could boost the spending power of wage earners while the reduced corporate income tax rate could encourage investments,” it added.
However, high branching costs were cited as hindrance. Banks are also justifiably cautious, S&P said, given the lack of comprehensive consumer data and high reported consumer NPLs.
The debt watcher pointed out that while growth was robust for banks in the Philippines, returns have been low with 2016 recording a 1.2 percent return on assets and 9.5 percent return on equity.
“This is uncharacteristic of a country with very favorable demographic dynamics, a strong structural growth story, and low credit penetration,” it said.
Weakness in profitability was attributed to high exposure to low-yielding corporate loans and poor cost efficiency.
“[T]he portfolio mix of Philippines banks is heavily tilted toward low-yielding corporate loans, resulting in narrow interest margins. Although expanding into higher-yielding retail loans (such as mortgages and auto loans) has been a commonly discussed strategy for most Philippine banks in recent years, a significant shift in the loan mix is yet to be seen,” it said.
“The second commonly cited reason is the poor cost efficiency of Philippine banks. The banking system’s cost to income ratio of 63 percent in 2016 is notably higher than the 40 percent to 50 percent norm in Asean (Association of Southeast Asian Nations) countries,” it added.
S&P expects profitability of Philippines banks to continue to face headwinds as the rebalancing of the loan portfolio will likely to be protracted.
“Meanwhile, these banks’ high costs remain a key hurdle in improving their profitability. However, the quality of profits is likely to remain good, with a significant share of recurring interest and fee income from long-standing corporate customers,” it nevertheless said.
S&P said the outlook for banks in the Philippines was stable over the next year, reflecting supportive economic conditions and sound financial fundamentals.
The banking system’s capital adequacy ratio of 15.3 percent as of March 2017 was comfortably above the regulatory minimum.
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, adding that liquidity levels remained stable throughout the global financial crisis in 2008-2009, demonstrating the banking system’s considerable resilience to external shocks.
“In addition, banks’ healthy funding positions contribute to their loan-to-deposit ratio of 72 percent, one of the lowest in Asia-Pacific. These strengths provide a solid foundation for the Philippine banking system to continue on the growth path,” it said.