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Monday, September 12, 2011

BSP's Ampaw Accounting System

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 presentation attempts to explain the following points:
  1. How Banco Filipino's attempt to book PHP 12.1 billion in losses as assets is actually a practice prevalent throughout the banking industry.
  2. How the BSP/MB allowed the deferment and amortization of unbooked losses arising from: a) SPV Transactions; b) Acquisitions of failed/failing banks, and c) Large credit losses
  3. Why the BSP/MB action allows some banks to operate as ponzi schemes, with little or no capital cushion to back up the inevitable loan losses that may come from an economic downturn.
In the Congressional Hearings on Banco Filipino's closure last May 17, 2011, Congressman Giorgidi B. Aggabao, who is a CPA, expressed surprise at how Banco Filipino attempted to book PHP 12.1 billion in losses as assets. BSP Deputy Governor Nestor Espenilla characterized Banco Filipino's capitalized losses as “ampaw” or “puffed up” assets. He said that such “ampaw” assets are matched by “ampaw” capital. He also said that the capitalization of losses does not conform to Generally Accepted Accounting Principles, or better known as GAAP. He explained that “there is no jurisdiction that would consider “ampaw' assets to be real assets. The value of such assets is zero.”

However, in the same Congressional Hearing, Congressman Luis R. Villafuerte says that Banco Filipino was really imitating what BSP has allowed many other banks to do, which is to:
  1. Defer the booking of realized losses, and
  2. Amortize realized losses over a period of 10 to 20 years.
Congressman Villafuerte is in a position to know because his wife, Nelly Favis Villafuerte, sits in the Monetary Board.

Congresman Villafuerte is correct. The BSP/MB has allowed many other banks to: 1) defer the booking of realized losses; and 2) amortize the realized losses over 10 years to 20 years. The BSP/MB has allowed this for losses arising from:
  1. The Sale of Non-Performing Loans to Special Purpose Vehicles (SPVs)
  2. The Acquisition by a Bank of another weaker Bank with substantial Non-Performing Assets
  3. Large Credit and Impairment Losses on financial assets of banks that are undergoing a BSP-approved Rehabilitation Plan
SPV Transactions

On December 23, 2002, the Philippine Congress passed R.A. 9182, otherwise known as the “Special Purpose Vehicle Act of 2002”. The Act provided a framework for the creation and regulation of Special Purpose Vehicles (“SPVs”) that acquire and invest in the Non-Performing Assets (“NPAs”) of Financial Institutions. It granted fiscal and tax incentives and exemption privileges for transactions involving the transfer of NPAs to an SPV and from an SPV to a third party. The law was designed to address the burgeoning non-performing asset problems plaguing the Philippine banking sector by:
  1. Encouraging private sector investment in NPAs;
  2. Improving the Liquidity of the financial system as a whole
However, SPV transactions had a very significant problem. Both SPV Investors and Banks faced a classis pricing conundrum. The SPV investors wanted to buy NPAs from the banks at a price low enough for the SPV Investors to make a decent profit that will compensate them for the risks they undertook. Banks wanted to sell their NPAs at a price high enough to minimize losses that will impact their equity capital. Often, the two parties to the transaction could not agree on price.

So BSP rode to the rescue of the banks. On September 26, 2003, the BSP issued a Memorandum regarding the Monetary Board Resolutions No. 917 (dated June 26, 2003) and No. 1199 (dated August 21, 2003) approving certain accounting guidelines on the sale of non-performing assets (NPAs) to Special Purpose Vehicles. The guidelines provided temporary regulatory relief, in addition to tax relief under the SPV Law, particularly in the timing of the recognition of losses so that banks may be encouraged to maximize the sale of their NPAs, even at substantial discounts. The banks would be able to avail of this “regulatory relief” provided that the banks shall fully disclose the impact of this relief in all relevant financial reports, in the interest of upholding full transparency and sustaining market discipline.

BSP allowed banks to book the losses they realize on the sale of their NPAs to SPVs as deferred charges that may be written down over seven years. On February 5, 2004, the amortization period for deferred charges was extended from seven years to ten years, according to the following schedule.

End of Period from Transaction Date
Cumulative Write-down of Deferred Charges
Year 1
5.00%
Year 2
10.00%
Year 3
15.00%
Year 4
25.00%
Year 5
35.00%
Year 6
45.00%
Year 7
55.00%
Year 8
70.00%
Year 9
85.00%
Year 10
100.00%


Rehabilitation Plans

BSP also allowed banks to book losses as deferred charges as part of a BSP-Approved Rehabilitation Plan for:
  1. a bank that acquired a weaker bank with substantial NPAs; and
  2. a bank that incurred substantial credit losses.

PFRS/PAS Compliance

As BSP Deputy Governor Nestor Espenilla said, the booking of losses as deferred charges does not conform to generally accepted accounting principles, or GAAP. The booking of deferred charges does not conform to the provisions of Philippine Financial Reporting Standards (PFRS) or Philippine Accounting Standards (PAS) in the preparation of audited financial statements. Banks will still be required to comply with PFRS/PAS for the purpose of preparing audited financial statements. Banks that do not comply with PFRS/PAS will show a qualified auditor's opinion that:

  1. States that the bank's booking of deferred charges does not comply with the provisions of GAAP/PFRS/PAS.
  2. Discloses the impact such compliance would have on the bank's financial statements had the losses been recognized.
In 2005, BSP Governor Amando M. Tetangco, Jr. warned that: “availing of the regulatory incentives involves a trade-off in the sense that audited financial statements may warrant a qualified opinion from external auditors.” Banks “with strong balance sheets may very well opt not to defer the booking of losses to avoid a qualified auditor's opinion.”

Findings

As of 2009 and 2010, the audited financial statements of at least ten Philippine banks show a qualified auditor's opinion. These banks:
  1. range from small to large in asset size;
  2. have a total of PHP 70.1 billion in deferred charges
  3. have unbooked losses that will result in a reduction of total bank capital funds ranging from as low as 11.48% to as high as 721.43%. For some banks, a recognition of unbooked losses may completely wipe out the bank's shareholder capital.
Asset Size


The ten banks with a qualified auditor's opinion range in asset size from:

  • Small: PHP 11.6 billion in Assets (Asiatrust Development Bank)
  • Large: PHP 515.6 billion in Assets (Land Bank of the Philippines)

These ten banks have a combined asset base of PHP 1,612.5 billion.



Capital Funds

The ten banks with a qualified auditor's opinion range in capital funds size from:
  • Small: PHP 1.4 billion in Capital Funds (Export and Industry Bank) 
  • Large: PHP 53.1.3 billion in Capital Funds (Land Bank of the Philippines)
These ten banks have a combined capital funds base of PHP 156.0 billion.


Deferred Charges

The deferred charges discussed here refer to the unbooked losses quantified and disclosed by the bank's external auditor. Recognition of these deferred charges as actual losses will reduce bank assets and capital by a corresponding amount.

The ten banks with a qualified auditor's opinion have deferred charges that range in size from:
  • Small: PHP 1.1 billion in Deferred Charges (Philippine Veterans Bank) 
  • Large: PHP 28.0 billion in Deferred Charges (United Coconut Planters Bank) 
The ten banks with a qualified auditor's opinion have a combined deferred charges base of PHP 70.1 billion.

Amortization Period for Deferred Charges

The amortization period for deferred charges range from:

  • Minimum: 10 years (Asiatrust Development Bank, Bank of Commerce, Export and Industry Bank, Land Bank of the Philippines, Philippine Bank of Communications, Philippine National Bank, Philippine Veterans Bank, Planters Development Bank, Rizal Commercial Banking Corporation, United Coconut Planters Bank) 
  • Middle Range: 12 years to 15 years (Planters Development Bank, Export and Industry Bank)
  • Maximum: 20 years (Philippine Veterans Bank) 


Impact on Each Bank's Capital Funds

Had the unbooked losses or deferred charges been booked or recognized, the capital funds of these banks would be greatly reduced. The impact on capital funds would range from:
  • Low: 11.5% reduction in Capital Funds (Land Bank of the Philippines) 
  • High: 721.4% reduction in Capital Funds (Export and Industry Bank) 
Some will have at least a 50% reduction in capital funds (Bank of Commerce).


Quite a few will experience a complete wipe-out of capital funds:

  • Asiatrust Development Bank (100%) 
  • Philippine Bank of Communications (163.9%) 
  • United Coconut Planters Bank (190.5%) 
  • Export and Industry Bank (721.4%) 


Overall Impact on the Philippine Banking System

The unbooked losses or deferred charges represent a significant chunk of the Total Capital Funds of the Universal and Commercial Banking System as of December 2010. The total deferred charges amount to PHP 70.1 billion out of the PHP 711.5 billion in Total Capital Funds of the Universal and Commercial Banking System.

In other words, around 10% of the Total Capital Funds of the largest Philippine banks has to be written down to zero.

Overstated Profits and Capital Funds

As early as June 19, 2006, Moody's Investor Services said that the earnings and capital of Philippine banks were overstated due to: “lax regulations on losses booked from the sale of assets using the Special PurposeVehicle framework.”

As BSP Deputy Governor Nestor Espenilla explained, “ampaw” assets equals “ampaw” capital.. Their real value is zero. This means that, for some of these banks, there is very little to no capital to cushion the bank against further losses. A deterioration in the economy, credit conditions, or liquidity, could cause these banks to suddenly implode - as did Banco Filipino last March 17, 2011.

Veneer of Health

The overstatement makes weak banks look healthier than they really are. Weak banks that should be recapitalized, merged with stronger banks, or liquidated are kept alive unnecessarily. It allows the creation of a system wide ponzi scheme wherein some banks stay alive through the influx of new depositors. Most losses don't read financial statements before they open an account in a bank. Moreover, the losses are not readily apparent. It will require someone to dig deep into the financial statement to arrive at true picture of a bank's financial condition. As the global financial crisis has shown, even some supposedly sophisticated professional investors don't dig deep into financial statements to find out the true financial condition of a bank or a financial institution.

Moral Hazard

The lax regulatory environment, the abundance of BSP-approved financial rehabilitation plans create a moral hazard. Weak banks, like Banco Filipino, have come to expect the BSP/MB to ride to their rescue and provide regulatory relief, financial assistance.

Essentially, Banco Filipino, in its attempt to book losses as assets, was merely attempting to duplicate the generous financial accommodations that the BSP/MB have allowed for other banks. This attempt was coupled by Banco Filipino's threat of punitive litigation and legal harassment against BSP and its officials. Had Banco Filipino succeeded, it would have allowed Banco Filipino to continue their unsafe, unsound, and fraudulent banking practices.


Moral Hazard should be avoided as much as possible.

Recent Developments

Bank of Commerce: 

In May 2009, San Miguel Corporation's property arm and retirement fund have acquired a 51% stake in Bank of Commerce with an additional equity infusion of PHP 2 billion. As of December 31, 2010, Bank of Commerce's Capital Funds was increased to PHP 12.5 billion from PHP 6.7 billion in year-end 2009.

Export and Industry Bank (EIB)

On July 30, 2010, the board of Export and Industry Bank (EIB)approved the sale of all EIB's bank assets to Banco De Oro Unibank, Inc. As of April 13, 2011, PDIC gave its approval for the transaction.

Philippine Bank of Communications

On July 27, 2011, the group of Roberto Ongpin acquired a 97.28% stake in Philippine Bank of Communications from the Chung, Luy, and Nubla families for PHP 4.68 billion


Sources:

Regulations:
  • Transcript of the Philippine Congressional Hearings on Banco Filipino, May 17, 2011
  • Republic Act 9182: Special Purpose Vehicle Act of 2002
  • Monetary Board Resolution 917 (6/26/2003) and Monetary Board Resolution 1199 (8/21/2003)
  • Accounting guidelines on the sale of non-performing assets (NPAs) to Special Purpose Vehicles (SPVs) and to qualified individuals for housing under "The Special Purpose Vehicle (SPV) Act of 2002"
  • Monetary Board Resolution 135 (2/5/2004)
  • Revised accounting guidelines on the sale of non-performing assets (NPAs) to Special Purpose Vehicles (SPVs) and to qualified individuals for housing under "The Special Purpose Vehicle (SPV) Act of 2002"
Audited Financial Statements:
  • Asiatrust Development Bank (As of June 30, 2009; Notes 8, 10, and 23)
  • Bank of Commerce (As of December 31, 2009; Notes 14, 15, and 34)
  • Export and Industry Bank (As of December 31, 2010; Notes 2, 12, 17, and 27)
  • Land Bank of the Philippines (As of December 31, 2009; Note 12)
  • Philippine Bank of Communications (As of December 31, 2010; Notes 15 and 32)
  • Philippine National Bank (As of December 31, 2010; Notes 9 and 10)
  • Philippine Veterans Bank (As of December 31, 2009; Notes 7 and 28)
  • Planters Development Bank (As of December 31, 2010; Notes 32 and 34)
  • Rizal Commercial Banking Corporation (As of December 31, 2010; Note 11)
  • United Coconut Planters Bank (As of December 31, 2010; Notes 1, 12, 13, and 23)
Press Releases:
  • BSP: "Press Statement on the Amendments to the Accounting Guidelines on the Sale of NPAs to SPVs and Qualified Individuals for Housing" - December 23, 2005
  • San Miguel Corporation: "SMC to Strengthen Capital Position of Bank of Commerce" - June 8, 2009
Publications:

Philippine Daily Inquirer:
  • "Moody's says RP banks' profits 'overstated'", by Doris Dumlao, June 19, 2006
  • "Ongpin bloc takes over PBCom in P4.7B deal; ISM-led consortium assumes 97.28% bank stake", by Doris C. Dumlao, July 27th, 2011
Bangko Sentral ng Pilipinas
  • Consolidated Statement of Condition as of December 31, 2010, Universal and Commercial Banking System
Website:
  • Bank of Commerce Website on Financial Information: http://www.bankcom.com.ph/abtfi.php






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