The System is Broken!

Editor's Note:  This blog was inspired by the spectacular failure of Banco Filipino Savings and Mortgage Bank for the second time in its 38 years of existence.  This blog post and other blog posts like it attempt to describe why the bank failed.  But it also attempts to assess what other Philippine Banks have the potential to fail in the not too distant future. To see blog posts on other banks, click on the Banco Filipino Graphic at the top of the blog or click on the blog archive on the right hand column, or simply go to bancofilipinofailure.blogspot.com.

This blog post attempts to explain the following points:

1. Why Banco Filipino Failed
2. Why it should have been closed much earlier
3. Why the regulators failed to act in a timely manner
4. Why the inaction of the regulators led to a costlier failure for all concerned, namely, depositors, investors, and taxpayers
5. Why this inaction leads to an erosion of trust and confidence in the Philippine Banking System
6. Why it also fosters an environment wherein a bank owner can steal from his own bank and do so with impunity

For the first seven years since its reopening, from 1994 until 2001, Banco Filipino remained profitable:

Total Banking Income was up. Earnings were positive. It only began to lose money in 2002, when the bank had to be rescued by the BSP.

Loans grew significantly, climbing 26 percent a year. In 1994, Loans stood at PHP 848 million. By 2002, loans amounted to PHP 5.4 billion. Deposits grew even faster, by 31 percent a year. In 1994, the deposit base was PHP 660 million. By 2002, the deposit base was PHP 5.75 billion.

Meanwhile, Acquired Assets grew just as fast, by 23 percent year. In 1994, Acquired Assets stood at PHP 580 million. By 2002, it stood at PHP 3 billion. Acquired Assets jumped by 83 percent in 2001, after the BSP Comptrollership was lifted in 2000. In 2002, it jumped another 45%. By 2002, Acquired Assets made up almost 25% of the bank's total asset base.

Acquired Assets grew so much that Asset Sales outstripped Banking Revenues by 2001. Banco Filipino looked and performed more like a real estate company and less like a bank.

Without Acquired Asset Income, Banco Filipino was actually losing money, starting in 2000. In 2000, Net Income, net of Acquired Asset Income, was a net loss of PHP 431 million. In 2001, the loss tripled to PHP 1.5 billion. In 2002, it lost PHP 1.1 billion.

Banco Filipino's liquidity position was severely reduced by the conversion of liquid earning assets into Acquired Assets. Its Quick Assets to Total Deposits Ratio, which measures the ability to meet deposit withdrawals, declined steeply. In 1994, that ratio stood at a healthy 91.6 percent. By 2001, the ratio was down to only 22.6 percent. In 2002, it was even lower: 12.2 percent. The largest percentage drops in liquidity occured in 2001 - approximately negative 41.6 percent. And in 2002, liquidity dropped another 45.8 percent.

So liquidity was already very poor by the time the BSP extended a 180-day special liquidity facility to Banco Filipino on December 2, 2002. Of the PHP 3.5 billion package, PHP 1.34 billion was availed of in 2002. By June 19, 2003, Banco Filipino met most definitions of insolvency: 81 percent of its total loan portfolio was non-performing, 67 percent of its total loan portfolio was classified as DOSRI or insider loans. The DOSRI loans were concentrated among just 17 borrowers.

Banco Filipino's troubles in 2002 were not caused by poor management, or by a liquidity crisis, or by a smear campaign. It was caused by fraud.

In 2002 and 2003, minority shareholder Ana Maria Aguirre Koruga, asked the BSP to investigate the bank. She claimed that Banco Filipino's management and directors had: One, engaged in unsafe, unsound, and even fraudulent banking practices. Two, engaged in self-dealing. Three, violated banking laws prohibiting or limiting DOSRI transactions, put the bank and its depositors in jeopardy. The minority shareholder sued not just Banco Filipino's board and management, but also, sued both the BSP and the Monetary Board to replace current board and management and place the bank under receivership.

The complaint documented around PHP 1.95 billion in loans to six dummy borrower corporations made from 2000 to 2002.

These six dummy corporations all operated on a similar modus operandi: Lend favorably to Dummy Corporations affiliated with Banco Filipino Vice-Chairman Bobby Aguirre. These dummy corporations did not have the financial capacity to justify the loans at the time of loan approval. The dummy corporations would then provide Banco Filipino with collateral properties from other corporations affiliated with Banco Filipino Vice Chairman Bobby Aguirre. The bank would then appraise the collateral properties at inflated valuations. The dummy corporations would not pay any interest or principal on the loans. Instead, they would settle their loan obligations via Dacion en Pago within months of loan approval.

This modus operandi became the preferred method for drawing large amounts of cash out of Banco Filipino for the benefit of BF Vice Chairman Bobby Aguirre. It was a way of disposing or selling unsaleable real estate to Banco Filipino. It allowed Banco Filipino to continue to reflect a profit and deflect regulatory scrutiny.

The Dacions made by the Dummy Corporations explain the jump in Acquired Assets from 2000 to 2002

The six dummy corporations had no financial capacity to justify the loans at the time of loan approval.

On the balance sheet side, The size of their assets were small relative to the size of the loan. Paid-up capital was also small relative to the size of the loan. For instance, one dummy corporation had assets and paid-up capital of less than PHP 1.0 million in the year before it received a PHP 350 million loan from Banco Filipino.

On the income statement side, net sales was minimal. Net Income was often negligible or even negative. Dummy Corporation BF Home Depot had no revenues and had lost  PHP 1.0 million the year before it received a loan of PHP 359 million from Banco Filipino.

The dummy corporations had a common cast of interlocking directors and officers.

This common cast of characters all have business and personal links to BF Vice-Chairman Albert C. Aguirre.

Dummy Corporations all had interlocking ownerships. In other words, they own or are owned by other dummy corporations that have borrowed, defaulted, and settled their loan obligations via dacion en pago. For instance, Taurus Land, which borrowed PHP 270 million, owned 81 percent of Glamor World, which also borrowed PHP 270 million. Glamor World, in turns owns 74 percent of its parent, Taurus Land.

The Dummy Corporations all had common corporate addresses. Filipino Vastland listed its corporate address as 1015 Executive Center, Tropical Avenue, Las Pinas City - the personal residence of Banco Filipino Vice Chairman Bobby Aguirre.

The loan proceeds were not applied to the borrower's stated purposes. For instance, BF Home Depot, which was approved for a PHP 359 million loan on March 24, 2000 for the purpose of financing inventory to stock a retail establishment selling home furnishings and fixtures. BF Home Depot never paid any interest or principal on the loans but settled its loans via Dacion en Pago on July 24, 2001. The site of its proposed retail establishment has remained a chicken coop years after loan disbursement.

Collateral was provided by corporations related to Albert C. Aguirre.

Collateral values were often grossly over inflated at the time of loan approval.

The loans were often settled via dacion within months of the loan release. In the case of Glamor World, which borrowed PHP 270 million, the time from loan release to dacion took only 22 days!

Given these dubious transactions, it is not surprising that Banco Filipino needed BSP's help in 2002. It would not be surprising if there were many more such dubious transactions. However, BSP did nothing to address the concerns of the minority shareholders. It reinstalled a Comptroller as a condition of the emergency loans it extended in December 2002.

Meanwhile, Banco Filipino operations continued to deteriorate. Losses accumulated, reaching PHP 12.1 billion from 2003 to 2008. From 2007 to 2010, losses vastly exceeded its capital base of PHP 1.6 billion as of March 2004 every year. It lost PHP 4.2 billion in 2007, PHP 2.4 billion in 2008, PHP 2.6 billion in 2009, and PHP 2.7 billion for the first nine months of 2010.

Banco Filipino's loan portfolio has remained stagnant despite the PHP 9.2 billion growth in deposits. With NPLs at 77 percent, the bank had very little in terms of unencumbered earning assets to generate additional banking revenue and curb losses. BSP characterized this as a ponzi scheme. The bank was kept alive by the infusion of new deposits. The bank grew deposits by offering interest rates as much as 5.75% above market rates.

BSP had many chances to close the bank. The bank could have been closed in 2002, when the bank experienced a run and was rescued by BSP. It could have been closed in 2004, when 86% of the loans were non-performing. It could have been closed in 2007, when losses reached PHP 4.2 billion. Or it could have been closed in the first quarter of 2009, when the bank experienced another liquidity crisis and needed a cumulative total of PHP 4.1 billion in Overnight Clearing Lines from the BSP.

BSP cited the need for complete due process as a rationale for the long closure process of Banco Filipino. It claimed that the standard of extraordinary diligence in banking supervision was a factor for the length of time it took to close Banco Filipino. This due process took almost nine years. This process was so long and slow to the point of negligence. It also enlarged the problem.

Had Banco Filipino been closed earlier, the ultimate cost to uninsured depositors may not have been as big. At the time of closure, the estimated deposit base of Banco Filipino was PHP 15 billion, or PHP 8.5 billion bigger than its deposit base of PHP 6.5 billion in 2004. The estimated uninsured deposit base at the time of closure was PHP 5.6 billion or roughly 86 percent of the 2004 total deposit base. PDIC could have saved a substantial portion of the estimated PHP 9.4 billion it has to pay out to insured depositors from its deposit insurance fund and from public funds.

The regulators were impotent with Banco Filipino. They could not compel the bank, a publicly-listed firm in a highly regulated sector to change management responsible for the bank's precarious financial condition. They could not get Banco Filipino to significantly reduce Executive Compensation running at PHP 600 million a year while the bank was losing over PHP 2.0 billion a year every year. BSP could not persuade Banco Filipino to realize the supposed value of its acquired assets through genuine asset sales that will recapitalize the bank with hard cash, instead of inflated properties. It could not mandate Banco Filipino to reverse the deferment of its PHP 12.1 billion in operating losses despite numerous Monetary Board directives to do so. BSP could not get Banco Filipino to issue audited financial statements since 2002. It did not force Banco Filipino to resume holding formal board meetings that have not taken place since 2002. It could not do this despite the presence of a BSP installed Comptroller as a condition of the rescue package it extended Banco Filipino in 2002.

Banco Filipino faced no repercussions for its actions. It correctly assumed that financial assistance will always be forthcoming. As late as September 2010, despite no visible improvement in the bank's operations, Banco Filipino was able to negotiate a rehabilitation plan with BSP and the Monetary Board that seemed to leave the bank's board and management intact, allow the deferral or capitalization of losses, allow the recapitalization of the bank with real estate properties. The main reason why this plan was not operationalized was only because Banco Filipino refused to drop its PHP 18 billion damage suit against BSP and its officials as BSP's precondition for the adoption of the rehabilitation plan.

The only thing that had changed was that Banco Filipino, at that time, seemed willing to drop its damage claim against the BSP as a precondition of the adoption of the rehabilitation plan. It seems that the regulators overriding concern was the removal of the risk of punitive litigation and legal harassment. That concern overshadowed the safety and soundness of the banking system, the defrauding of minority investors, and the depletion of the deposit insurance funds.

Meanwhile, the minority shareholders were stymied at every turn. Their fraud complaint was characterized by both the media and by the regulators as a family squabble among the members of the Aguirre family. The real issue, however, was massive fraud. The BSP and the Monetary Board blocked numerous efforts of minority shareholders to assess the true financial condition of the bank and bring about a change in bank management and policies.

On June 19, 2009, in the case "Koruga vs. Arcenas", the Supreme Court ruled that all bank fraud cases are the exclusive jurisdiction of the BSP. The minority shareholder had no recourse to the Regional Trial Courts even if the BSP did not act on their complaints. This means that the BSP is the sole venue for resolving disputes among bank shareholders. This ruling applies to all bank fraud cases. It represents a severe diminution of investor protections, particularly for foreign investors who lack the political connections of their local partners. It may dissuade further investment into the Philippine Banking Sector.

Regulators want Congress to amend the degree of diligence required from BSP and its officers in bank supervision duties from extraordinary to reasonable. It also wants better mechanisms for the quick resolution of problem banks. For instance, PDIC supports a Closed Bank Liquidation Act that ties all laws with respect to bank liquidation in one comprehensive act.

The System is Broken. Bank management can commit fraud with relative impunity. Regulators are reluctant to act in a timely manner for fear of years of punitive litigation and legal harassment. Minority Shareholders have no legal recourse to fight bank fraud if the regulators refuse to act.

This will lead to a continued erosion of confidence in the banking system. It fosters a control fraud environment wherein a bank owner or executive uses the bank he controls as a weapon to commit fraud. A determined and criminally minded bank owner can steal from his own bank and get away with it. The fraud will exist and go unreported for years on end. Regulators are unable to stop the fraud. Fraud only stops when the bank collapses.

In the Philippines, the best way to rob a bank might be to own one.