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Friday, November 11, 2011

PEACe Bonds: RCBC's Slow Road to Financial Ruin

RCBC, CODE-NGO's financier and the largest PEACe Bond beneficiary, now claims that the BIR's belated imposition of a 20% Final Withholding Tax on the PEACe Bond's final bondholders will lead to the bank's “financial ruin.”1 Why? Because BIR's October 7, 2011 ruling will “unduly expose” it to “unjustified third-party claims.” Now, who are these third party claimants? Its fellow banks, of course. Nine of them, to be exact. These nine banks were left holding the bag because the BIR chose to collect back taxes on the PEACe bonds from the final bondholders, instead of CODE-NGO/RCBC, the main beneficiaries of the “erroneous” 2001 Banez Rulings, even though the government found CODE-NGO/RCBC liable for the PHP 4.86 billion in unpaid taxes.

A previous post, “A Tax on the PEACe Bonds - Who is Left Holding the Bag? ( predicted this would happen:

“Unless the government recreates the chain of sales and resale from CODE-NGO/RCBC to the final bondholders, the final bondholders would have to recreate this process via a chain of litigation, meaning the final bondholder would have to sue the previous bondholder to collect the 20% FWT that the final bondholders are not liable for, and that the previous bondholder would have to collect from its previous bondholders, and so on and so forth, until the chain of sale is retraced back to CODE-NGO/RCBC, the original bondholders. Needless to say, this would create a gigantic legal mess.”

RCBC also admitted that it was one of the final bondholders. It holds PHP 1.4 billion or 4% of the PEACe bonds. So now, RCBC is the tenth bank left holding the bag on the PEACe Bonds.

Now how will this lead to the RCBC's financial ruin? Let us count the ways...

As Final Bondholder

The first and most direct way is through its holding of the PEACe Bonds.

RCBC holds PHP 1.4 billion or 4% of the PEACe Bonds. As such, it is liable for 4% of the PHP 4.86 billion tax due on the PEACe Bonds. This amounts to a mere PHP 194.40 million or 0.60% of the bank's Capital Funds of PHP 32.412 billion as of December 31, 2010.

The loss will sting RCBC like an antbite. But it certainly will not kill it.

All Roads Lead to RCBC

But RCBC is not just liable to pay only PHP 194.40 million of the PHP 4.86 billion in back taxes. It is liable to pay the entire PHP 4.86 billion in back taxes. Under BIR Ruling No. 370-2011, “RCBC is held liable to pay 20% final tax on the entire PHP 24.3 billion discount, which is the present value of the original discount to date, or approximately PHP 4.86 billion.”

So if the BIR does not work to extract this sum from RCBC, you can be sure that nine of RCBC's fellow banks will work to extract this sum, via litigation, from RCBC. Hence, RCBC's claim in its Supreme Court petition that the BIR's October 7, 2011 ruling raises “the possibility that petitioner-intervenor RCBC may be called upon to pay third parties” and this will “immeasurably damages petitioner-intervenor RCBC's financial standing and reputation.”

Barring a BIR collection, collection of this sum via litigation of third party banks will be a slow process given how slowly the wheels of justice turn in the Philippines.

But if it does happen, how will RCBC be affected?

Taking PHP 4.86 billion from RCBC is tantamount to a 15% hit to RCBC's capital funds of PHP 32.412 billion as of December 31, 2010. But not all of RCBC's capital funds are common equity. RCBC has PHP 207 million in preferred stock. It also has PHP 4.883 billion in Hybrid Perpetual Securities (a quasi debt quasi equity investment instrument that the company can count as its capital). We also have to back out PHP 426 million in “goodwill” on RCBC's books. If you net these out, RCBC's capital funds amounts to only PHP 26.896 billion. So a PHP 4.86 billion hit in PEACe Bond back taxes amounts to a more damaging 18.07% hit to RCBC's capital funds. This hit will certainly wound RCBC but not kill it.

Overstated Capital

The trouble is that things are not what they seem. RCBC's auditor, Punongbayan & Araullo, has been issuing a qualified auditor opinion on RCBC's financial statements which essentially say that everything in RCBC's financial statements is kosher except for the fact that RCBC has unbooked losses relating to the sale of its Non-Performing Assets (NPAs) to various Special Purpose Vehicles (SPVs).

RCBC “deferred the recognition of the losses resulting from the sale of the NPAs transferred and the additional allowance for impairment on such NPAs had these not been derecognized, such losses and additional allowance for impairment are instead being amortized over a period of 10 years in accordance with MB Resolution No. 135.”

In other words, RCBC booked these losses as deferred charges and put them in the “Other Assets” bucket of its balance sheet.

How big are the unbooked losses? Note 11.2 “Special Purpose Vehicle (SPV) Transactions” of RCBC's audited financial statements has some answers: PHP 6.072 billion as of December 31, 2010.

“Had the Parent Company...derecognized the allowance for impairment related to the NPAs transferred that qualified for derecognition at the time of sale...Deferred Charges (part of Other Resources account in Note 15) would have decreased by P6,072 and P 7,047 in 2010 and 2009, respectively; ...and Surplus would have decreased by P6,072 and P7,047 in 2010 and 2009, respectively.”

What this is saying is that RCBC's actual common capital funds is PHP 20.824 billion - PHP 6.072 billion or 22.58% lower than the PHP 26.896 billion figure arrived at in our last calculation. So a PHP 4.86 billion hit to capital in the form of unpaid PEACe Bond taxes would amount to a 23.34% or almost a 25% hit to capital, bringing it down to only PHP 15.964 billion.

Heightened Risk of Insolvency

On a standalone basis, RCBC having a common capital fund of PHP 15.964 billion is meaningless. But relative to the rest of its balance sheet, this figure speaks volumes. Because roughly PHP 16 billion in capital will have a harder time supporting an asset base 20 times bigger - roughly PHP 320 billion as of year end 2010.

Moreover, the quality of this asset base is suspect. A substantial amount is held in the form of risky assets whose values are often indeterminate and can deteriorate substantially, further eating into the bank's capital base. These assets take the form of classified loans, acquired real estate and real estate assets held for sale. To absorb losses, the bank must have a substantial capital cushion consisting of the bank's tangible common capital plus its loss reserves. A ratio of Distressed Assets to Capital Cushion of greater than 1:1 puts the bank at a heightened risk of insolvency. Why? Because if these distressed assets were written down to zero, the bank's shareholders would be wiped out. Prior to adjustments, RCBC's ratio was already high at 1.17 to 1. In other words, the bank was already relatively weak and was well within the danger zone of insolvency. Netting out the deferred charges and the PEACe Bond taxes only serves to heighten this risk. The ratio climbs by 21.37% to 1.42 to 1. So the imposition of the PEACe Bonds Tax will only further weaken an already weak bank.

Rizal Commercial Banking Corporation
Distressed Assets and Capital Cushion
As of December 31, 2010

Distressed Assets

Unadjusted Amount
(In PHP Million
Adjustments for Deferred Charges & PEACe Bond Taxes
(In PHP Million)

Adjusted Amount
(In PHP Million)
Classified Loans

Acquired Real Estate

Other Assets
Total Distressed Assets

Capital Cushion

Common Capital
Allowance for Losses

Total Capital Cushion

Distressed Assets/Capital Cushion Ratio



Reputation and Goodwill

But there is a qualitative aspect to this: RCBC claims that the imposition of the tax may immeasurably damage RCBC's reputation and goodwill in the financial community. Investors may lose confidence in RCBC as an intermediary. Investors may question RCBC's “judgement on the stability of transactions it participates in, or underwrites and the reliability of the parties involved in the transaction.”

In Banking and Finance, confidence is everything. And once that confidence is lost, no one will continue to do business with RCBC. RCBC is right, the run on the bank may have already started.

1“RCBC files petition vs. PEACe bond tax,” by Ina Reformina, November 4, 2011, ABS-CBN News
2PHP 6,072 million in Deferred Charges
3PHP 6,072 million in Deferred Charges plus PHP 4,860 million in PEACe Bond Taxes

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