The following was forwarded to me, and I assume that it is genuine. It may be useful to readers in terms of planning their family and personal finances for the coming year. Montinola expects two major difficulties: first, as Chinese exports to America are affected, Philippine exports, mainly oriented towards China, will be affected; second, layoffs of Filipinos overseas will start having an impact on remittances and investments.
Fellow Unibankers,
Attached please find a piece that I was supposed to write for an outside publication – unfortunately, I cannot submit it as the ending is perpetually changing.
What I thought to be a gathering storm to hit in the first quarter of 2009 has hit our beaches yesterday – the Philippine Stock Exchange had its highest (12. 27 %) drop in history a single day, and the Peso Dollar exchange rate is creeping back from around P 41: $ 1 to almost P 50 : $1. Like other markets in the region, the PSEI has dropped 50% ytd, and people are getting nervous.
It has now become a Fundamentals versus Emotion issue – Philippine economic fundamentals relative to the world and even Asia are good, and the banking system is stable, but Bloomberg 24×7 Television, local media reports, and cocktail party talk make people fear the worst, and then expect the worst.
We know however from experience that Filipinos are resilient and have survived the economic crises of the foreign debt moratorium in the 1980s and the Asian Crisis in the 1990s.
BPI remains well capitalized, strong, and prudent – and both our customers and the market analysts appreciate this. 2008 will show lower earnings than our banner year in 2007, and we must now worry about what 2009 will bring.
As in the past, this negative cycle will eventually pass, but in the meantime, we will have to prepare for the typhoon.
Let us all work together to take care of our customers, and in the process, keep BPI strong and our employees safe and secure in their jobs.
All the best,
Gigi Montinola
FINANCIAL TSUNAMI 2008
On Sept 15 2008, the unthinkable happened. Lehman Brothers, a Triple A credit rated, 4th largest, and 158 year old US investment bank, filed for bankruptcy. Merrill Lynch was rescued and sold to Bank of America, and one day later, AIG, the world’s largest insurer, announced its effective nationalization. This set off a chain of notorious “firsts” – a $ 700 billion bailout of the US banking system that almost did not pass, a country (Iceland) almost going bankrupt, and the largest UK banks in trouble.
By the IMF meeting on Oct 13, two additional unthinkables were unfolding. Global stock markets had fallen 20% in a week, the entire global banking system had almost collapsed, and it took the collective resolve of 27 European governments and the US to institute forceful emergency circuitbreaker measures to temporarily calm the world and prevent a catastrophic breakdown of financial markets worldwide. However, in the most free market oriented countries of the developed world, the US and the UK had effectively partially nationalized the largest banks without a public outcry.
How did this happen, and what is the effect on the Philippines, and the Pinoy citizen?
Act 1 – 2007 Housing Collapse
Home ownership ($ 20 trillion) and equities ownership ($ 20 trillion) are central to the American middle class dream of becoming wealthy. Borrowing money is equally ingrained – the US household debt today is larger than what the US can produce through its GDP (Gross Domestic Product). America became the world’s largest consumer of cheap imported goods, and China became the world’s largest producer.
Through a confluence of events, a deadly cocktail was being concocted.
First was increased home ownership demand in a boom time. Next was easy credit (1% US Fed Funds rate), and commercial banks relaxing credit standards (zero down payment) to lend to subprime borrowers (with minimal income) due to the belief that home prices would forever rise and therefore this would protect the loan from default. Third were investment banks securitizing or packaging a pool of these loans (“mortgage backed securities” ) backed up by credit agencies rating the top slices as Triple A credits. Finally, there were commercial banks and hedge funds with sophisticated risk models who greedily bought into these instruments as a means of increasing the yields on their books.
Initially, home prices soared 20% as the bubble grew with triple leverage (housing loan, investment bank securitization, and hedge funds buying). What was not apparent was that due to lax US regulations, investment banks had leverage (debt to equity ) ratios of 35 to 1, and unregulated Hedge funds had a 30:1 debt to equity ratio. Going up (2002 to 2007), everyone made money.
Suddenly, in 2007, some subprime borrowers defaulted, homes were foreclosed, and home prices fell. Countryside Financial, a US institution, almost failed, while Northern Rock, a UK institution, failed due to bad loans and falling house prices. The housing bubble had burst, and attention shifted to major commercial and investment banks with exposure to the housing sector.
Act 2 – 2008 Financial Markets Meltdown
First to go were the investment banks and AIG.
By regulatory fiat after the Great Depression, investment banks were separated from commercial banks. By anti regulatory bias in the past decade, Alan Greenspan, the US free market “maestro” of financial policy, and the Federal Reserve Bank took away a 12:1 debt to equity regulatory ceiling, and allowed investment banks to use “sophisticated” risk models to justify 35:1 debt to equity levels and help sell billions of dollars of CDOs (“collateralized debt obligations” ) that eventually peaked at $ 55 trillion, which is the size of the world’s GDP! Worse, AIG sold $ 400 billion CDSs (“Credit Default Swaps”) insuring against the default of housing related securities.
The result should have been obvious. Normal leverage is 2:1 for a manufacturing company, 3:1 for a trading company, and 12:1 for a commercial bank. At 35:1, an investment bank happily made a 35% return on its capital if its position income only rose 1%; however, if the position dropped 10%, it would lose 350% of its position, and severely erode its capital.
Banks operate on liquidity (free flow of funds), solvency (amount of capital to pay for obligations) , and Trust (market confidence in normally operating institutions) .
Once the market saw the falling home prices deteriorating into potentially illiquid asset prices, counterparties started holding back and stopped dealing with suspect investment banks. Bear Stearns was rescued by JP Morgan at fire sale prices. Lehman had $ 19 billion in cash the day it went bankrupt; not enough counterparties could be found to deal with them. Merill Lynch was rescued by Bank of America, and Morgan Stanley by Mitsubishi UFJ. Even the proud and mighty Goldman Sachs announced it would become a commercial bank with lower leverage.
Next to go were the global stock markets, which acted more in unison even if the events were initially US based., In the Great Depression, 90% of the stock market value was lost from 1929 – 1932. Today, $ 9 trillion and 40% has been lost since the 2007 peak, and RBS, the largest UK bank, lost 40% in a day! Bloomberg became the most watched 24×7 television show in the world, and fear and panic begun to spread. Most felt “poorer”.
Third to go were the commercial banks.
Regulators, analysts, and banks themselves started becoming suspicious that other commercial banks held more “toxic” (illiquid or low priced) assets that they admitted, and that potential solvency issues lurked if asset positions in a suspect bank wiped out capital. Recent “Fair Value ” accounting practices amplified reporting earnings volatility, as once any item (housing prices) dropped, the industry was compelled to “Mark to Market” these items to the new low level. If Lehman could go, so could a commercial bank.
Since 2007, banks have reported $ 633 billion in losses, but have raised only $ 418 billion in new capital. If things got worse, who would they raise additional capital from?
In simple terms, Trust, as expressed in interbank (banks lending to each other) lending availability and price, is the Oxygen of the financial system. When it slows to a crawl, the whole system is prone to massive cardiac arrest. Most businesses and consumers operate on a certain assumed debt level, and once this breaks down, prices rise astronomically if funding disappears.
Suddenly, from easily accessible global financial markets fuelled by cheap and available money worldwide, an “Ice Age” of banking started. Banks with high loan to deposit ratios requiring them to borrow from the previously free capital markets were hit badly. Neither a US $ 700 billion troubled asset purchase program (“TARP”), or piecemeal European home country deposit guarantees initially helped.
Washington Mutual was bought by JP Morgan, and Wachovia by Wells Fargo in the US. The European solution was government based, as the UK, Dutch, and French governments offered massive government capital to save and strengthen household names like RBS and ING.
Effectively, 27 European governments voted together for 3 measures – partially nationalizing large “significant” banks, partially guaranteeing retail deposits, and guaranteeing interbank lending. The US followed by offering funding and partial nationalization to 9 banks, and direct lending to US corporations through the commercial paper market. The IMF put a brave front announcing the measures, but many wondered why the IMF was not more active in the process.
Act 3 – 2008 Countries in Crisis
Even countries started running into trouble – as of press date, Korea, Pakistan, and Argentina were in various forms of funding problems, and the latter two were rumored to have to go to the IMF. Iceland became the first Western country in 40 years to seek IMF help.
Act 4 – 2009 Real Economy Recession
Clearly, the next wave would be a real economy US and European recession, which would then overflow to the emerging market countries.
In the US, massive deleveraging has started, and unemployment has risen. The consumer spends 75% of a $ 14 trillion economy, and financial sector debt is 115 % of the GDP. Working capital bank lines are cut, while people strive to pay back credit card debt. Businesses are closing, and consumer related industries will suffer the most.
In Europe, the housing collapse in Spain and Ireland has spread to the financial services layoffs in the UK to overall demand cut everywhere.
A year ago, Asia hoped to “decouple” from the US; today , this is fantasy. Once the world’s largest buyer (the US) stopped buying, the world’s largest producer (China) would have growth cutbacks, with corresponding effects on the rest of Asia. GDP in the US and Europe could fall to zero or negative, but in Asia it would be lower growth, but still positive.
The Philippines – A Gathering Storm
Fortunately, the Philippines is small, far away, and of less marketing interest to sophisticated financiers. Also, its banking and insurance industries are more heavily regulated. In addition, the painful 1997 Asian crisis has left Filipino businessmen and bankers more cautious and more resilient than their Western (former) idols.
Given this, the Philippines dodged the Housing Subprime bullet, and was only minimally affected by the US investment bank and UK commercial bank crisis.
Philippine local currency banking operates normally, as Sept yoy lending growth remains close to 20%, while the deposit market remains fairly liquid.
We will go through dollar funding strain just like all other emerging market countries, but hopefully this storm will pass.
Banking is all about Growth and Earnings in good years, and about Liquidity, Solvency, and Trust in bad years. While growth and earnings will be significantly lower in 2008 and 2009, hopefully they will still be positive. Liquidity and Solvency should be manageable for as long as Filipinos continue to Trust the banking system to function normally.
However, we will be hit hard in 2009 – the first wave will probably be trade related, as the US cuts back on imports from the Philippines and China (which imports from the Philippines) .
The second wave could be more fearful – a significant drop in OFW remittances as some lose their jobs or need more for their overseas needs. Today, we contend that we are more insulated due to global OFW diversification and higher level jobs, but in a global recession, we will not be spared.
What to Do
Just as we prepare for a typhoon, we have to prepare for potentially rainy days in 2009.
For businesses, your balance sheet will become critical. You must reduce your debt to acceptable levels, and you must think through your business model in a low growth economy. Fro example, can a 20% drop in revenue cover your overhead? If not, some serious cost cutting is needed.
For consumers, it will be time to reduce unnecessary expenses (electricity consumption, gasoline, impulse purchases) and to start saving even a small portion of your monthly income. Capital preservation is critical, so think through your KYC (“Know Your Counterparty” ), and your asset allocation. If you can, keep 25% in cash or bank placements, and 75% in fixed income instruments until you are brave enough to reenter the stock market.
If you want to spend anything, either ask yourself twice or postpone the decision for a day – you will be surprised how many items will feel less necessary or desirable the day after.
However, we Filipinos are resilient, and we will survive this crisis as we survived the bank moratorium in the 80s and the Asian Crisis in the 90s.
Good luck to us all!
AURELIO R. MONTINOLA, III
President
Bankers Association of the Philippines
President
Bank of the Philippine Islands
October 27, 2008
What is good for the individual (or family) is not necessarily good for the economy as a whole. If everyone cuts down on ‘unecessary expenses’, then there will be fewer items to sell resulting in loss income which will then result in further reduced expenses which will then result in further loss of income which will further reduced expenses which will result in fewer items to sell which results in further loss of income…(in a cycle that leads to a deeper and deeper recession).
The best thing that these bright boys from the banking sector should do is expose their holdings in the so called shadow banking system. Our net value on our physical exports are a very small portion of our economy. We are a net importer of capital to pay for our trade deficit.
The off balance sheet entities that were created during the 90’s iot the crux of the problem. It’s the securitization process without safeguards that lies at the root of this crisis.
These jokers including Montinola should expose those off balance sheet special purpose vehicles to whom they transferred their distressed assets.
That unresolved problem for the 97 crisis will reappear as the slowdown might hit the real estate sector once again.
Already mark to market rules on financial assets are being postponed for financial institutions as their wholesale investments in financial assets have turned sour. Most especially for the FCDU accounts. They have been allowed the time to postpone their loses until better times.
Less than 1% of families in the Philippines have holdings in the financial markets.
For a net borrower in the capital markets to pay for consumption (in an economic sense) and a highly indebted economy where will the funding come from?
BSP eases dollar loan requirements until March
By Des Ferriols
Sunday, November 02 2008 (www.philstar.com)
The Bangko Sentral ng Pilipinas (BSP) has agreed to relax its asset cover requirements for dollar loans until March next year in an attempt to ease the demand for dollars and stabilize the foreign exchange rate.
The BSP said it would allow foreign currency deposit units (FCDUs) some relief until March 2009, by ignoring losses that they would sustain from marking their assets to the current market value.
The BSP was careful to pick its words but the move, in effect, suspended the mark-to-market rule, at least on the net unrealized losses of financial assets and liabilities of FCDUs for the purposes of calculating asset cover and only until March next year.
“This is another measure taken by the Monetary Board in recognition of the extraordinary circumstances in the global financial market that has created unprecedented market volatility,†said BSP Governor Amando Tetangco Jr.
Under existing regulations of the BSP, FCDUs are required to provide a 100 percent asset cover for FCDU loans. This means that for every dollar lent out, they are required to have a corresponding asset worth one dollar.
Items eligible as asset cover include securities such as foreign exchange-denominated debt instruments issued by the Republic of the Philippines, known as dollar ROPs.
When the prices of the assets in the pool are marked to market, FCDUs have to make adjustments by buying up more assets to meet the 100-percent asset cover requirements.
Marking to market is also a requirement of the BSP to ensure that banks are properly declaring the value of their assets based on current prices. When an asset is marked to market, its value is written down based on what it would be worth if sold today.
But Tetangco said the fallout from the meltdown in the US financial market is causing prices to drop precipitously and as a result, FCDUs are meeting the 100-percent asset cover only at great cost to them and the system as a whole.
“Because of the drop in the prices of these securities, a lot of these FCDUs would be short of the 100-percent asset cover that the BSP requires,†said Tetangco.
To cover for the shortfall, Tetangco said the regular banking unit would normally lend to their FCDUs to maintain the full cover. But to do this, he said the banks end up buying dollars from the open market, creating even more demand for dollars.
As a result, the strong demand for dollars in the open market has been causing the peso to plummet by as much as 19 percent so far this year, with no relief even with the inflow of remittances from overseas Filipinos.
To relieve this, Tetangco said the BSP is allowing the relief for the purposes of calculating the asset cover.
“Basically we will assume they have no losses until March,†he said. “But that’s only as far as unrealized losses are concerned. When they sell those assets eligible as FCDU cover, then this relief does not apply.â€Â
Under the revised guidelines, Tetangco said net unrealized losses from marking to market of financial assets or liabilities in the FCDU book would not be deducted from the asset cover for a limited period until March 31, 2009.
By doing this, Tetangco said banks would no longer be pressured to keep buying dollars from the open market just to comply with the 100-percent cover requirement since the decline in asset values would not be deducted from the books anyway.
“This should help stabilize the foreign exchange market,†he stressed.
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way – in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”Charles Dickens
I was expecting we have at least until next year, since we’re a little country with not much exposure in markets abroad. OFW are menial workers so that’s quite recession immune.
Personally I’ll be the kind of employee companies want, a person who likes to do everything himself and has little fondness for delegating work load.
This is the perfect time to have a nationwide financial literacy drive.
A lot of people get scared when they hear alien financial terms and big finance words.
But if the common Juan De La Cruz would actually understand such issues, like this letter, it’s actually not that “scary”.
Fear is what kills a good economy. And without enough knowledge and awareness, people get fearful.
The Philippines is actually in a “safer” position and what happened to the US is so unlikely to happen in the Philippines. Here in our country, we do not have such a thing as “Sub Prime” loans. All loans here are prime. Taking out a loan here is like entering the eye of a needle. Banks here are too cautious. We think it sucks that banks are so strict in approving our loans here to the extent that they ask everything about us, and take all possible securities from us (title of properties, passports, visas, heck even marriage certificates). But during bad times, that is something that is greatly appreciated. This extremely cautious and “segurista” attitude of Philippine banks is what prevents catastrophes like what happened in the US from happening here.
And luckily, as if it was something that was orchestrated by a God who practices favoritism in favor of dear Philippines, we are enjoying a real estate boom now. Lots of buildings and houses are being built, hence lots of new jobs, big consumption, etc. While other countries slow down, we have built momentum. And hopefully this continues, or at least, if it does slow down, it would hopefully maintain a green status.
One more thing is that we have a very conservative financial system, that we do not have or allow complicated financial instruments as “mortgaged backed securities” and those sorts of scary greed-driven options. We don’t insure bad loans here (credit default swaps). We are very conservative. It may suck that we are during the good times when the rest of the world (or at least those who aren’t as conservative as we are) are making tons and tons of cash and we aren’t. But this same “extremely conservative” attitude is something so nice to have during bad times.
Another thing is that, while we are “expecting” a decline in OFW remittances, we should note that there still are more than 3,500 NEW skilled Filipino laborers who leave the country to work abroad every single day. These modern day heroes are the ones who will keep us afloat with their remittances to their families here, and I salute them. So “expecting” a decline is actually good, because we are preparing. We are on our toes. We are alert. That’s good. But we also have enough reason to be positive. So let’s expect the worst and hope for the best.
If all Filipinos would be financially literate, if everyone would maintain a positive attitude, if everyone would still continue to feel good, we’ll be okay. Again, FEAR is what would kill (or injure) our economy. It’s Christmas time once again. Let’s be happy. Let’s buy our loved ones gifts and give aguinaldos to our inaakaks, and let’s pump money into the economy! See? Even our culture was designed to help the economy! Haha!
Oh, I love being Filipino!
Suspending the mark-to-market rule means that Philippine banks can keep saying that they have assets to cover their liabilities (without saying that those assets when sold will not be enough to cover the liabilities // that no one wants to buy the assets for the price that the bank says that they are worth ).
The ‘What To Do’ portion of the email shows that the guy is an idiot.
Tetangco and Montinola must have been former classmates. Suspending the mark-to-market rule will only benefit the rich owners of these financial institutions. The middle class and the the poor are left to bear the brunt of this coming ‘storm’.
I didn’t catch what gigi montinola said until just now — a lot of unhappy rich people (and they better be worried about their dividends, which are now at serious risk) —– …. the PSEI has dropped 50% ytd …
I like that Montinola (or his underling) writes in an english that I can understand.
I wish everyone was like this. (Lawyers especially.)
Whether he is telling the truth and/or complete picture is another thin
Compare his writing to…….
This Montinola is an executor of the Collantes will.
The letter is an optimistic view of a truly declining market. I’m pessimistic about it.
One would think that China will be better able to handle any economic crisis. Their government has more $$$ in reserve; their government has better control of the population; and they are Chinese — BrianB and many more will swear on a stack of the Economist Magazine that Chinese businessmen simply outclass the Filipino businessmen.
So watch out, then, because from China come reports of factory wages being delayed — Chinese workers not being paid for 2 months or 3 months or longer, to be “capped” by the bosses disappearing.
What is the unemployment coverage for Filipino factory workers?
UPn, the problem is that China’s economy is dependent on US consumers so any downturn in the US economy affects them. An even bigger problem is that they let inequality grow which is not a political problem as long as times are good. China has to use this crisis to address its problem of inequality. They have the reserves to do so although once they start liquidating their US Treasury holdings, it will more badly hit the United States.
what to do is to keep spending to keep the local economy humming.
besides only the rich can afford to save, the rest of us get by from day to day with our daily pay.
and even if montinola believes that everybody should hold back on spending, count on high society pretenders to keep up their travel, nightlife & party lifestyles going til kingdom come.
what, me worry?
AM III’s prediction is true but there is more to it in the current situation of our country’s real economy. In the manufacturing sector, where we belong, several companies (including ours) has suffered substantial shrinkage (more than 50%) in sales. In the news, large publicly listed companies are also experiencing the same. We thought that it could be due to the imports of similar products that are eating our market but it wasn’t. It was a confluence of earlier events that significantly eroded the purchasing power of the consumers such as the food and fuel crisis.
Now comes the global financial crisis spilling to the real economy (producer of goods and services), with manufacturers/exporters in Cebu and some in NCR started laying off their employees. We will likely do the same as this crisis will ripen early 2009.
Many sectors of the society will certainly be affected. While the “D” sectors of our society are now in unbearable conditions, the next in line will be the “B” and “C” class (small businesses/suppliers, professionals, workers) by next year. My justification in including the “B” and “C” is that when large companies cut their costs and production, it will affect those down the chain. Of course those in the provinces are also vulnerable.
While Sec. M Teves think that it will be a slowdown, i think its recession and government seems impervious to its impact (increase unemployment, reduced production, less taxes,etc.). But its not yet too late, its high time for the government to pump prime the economy – such as lending to small businesses/suppliers medium terms and low interest bearing loans to stimulate consumption and businesses, forced reduction in the price of power and fuel costs (every company shall share the burden to counteract the effects of the crisis), banks and financial institutions shall likewise lend their funds at reasonable interest rates and minimal requirements, the same with the GSIS/SSS which shall lend to their members instead of placing it offshore or in equities and many other measures.