A Simple Stress Test of Philippine Banks as of December 31, 2017

In an April 9, 2012 article entitled "Stress Test Proves Strength of PH Banks", "Philippine banks are seen to survive a disaster in which the various lenders are forced to write off loans as large as PhP 36 billion without asking shareholders, the central bank, or the national government for bailout money."  This assertion stems from a recent stress test conducted by the Bangko Sentral ng Pilipinas (BSP) on all 55 regular and commercial and expanded license banks.

For Philippine Banks, these NPLs currently comprise PhP 138.02 billion or 8.28% of the PhP 1,666.09 billion in Stockholders Equity (SE) as of December 31, 2017.  So, writing off 50% of the Philippine Banks NPLs would reduce their aggregate stockholder's equity by a little less than 5%.

Naturally, some banks would be more affected than others.

The stockholder's equity of eight banks would be severely affected.  These banks are:

1. Philippine Postal Savings Bank Inc (152.83% decline in SE)
2. Enterprise Bank Inc (46.66% decline in SE)
3. Luzon Development Bank (43.65% decline in SE)
4. Equicom Savings Bank (40.76% of SE)
5. The Palawan Bank Inc (36.47% decline in SE)
6. UCPB Savings Bank (35.71% decline in SE) 
7. Maritime Savings Bank Corporation (31.30% decline in SE)
8. Legazpi Savings Bank Inc (30.69% decline in SE)
9. Philippine Veterans Bank (29.68% decline in SE)

Some of these banks are distressed. For more information regarding this, please read The Top Distressed Philippine Banks as of December 31, 2017 ).

Are NPLs the Right Numbers to Look At?

In a financial crisis, a loan that is current can very well become past due, and a past due loan can become a non-performing loan, and a non-performing loan can become a loan write-off.  The real number to look at are the loans that the banks and BSP already consider doubtful: Classified Loans.

Investopedia.com defines "Classified Loans" as:

"Any bank loan that is in danger of default. Classified loans have unpaid interest and principal outstanding, and it is unclear whether the bank will be able to recoup the loan proceeds from the borrower. Banks usually categorize such loans as adversely classified assets on their books."

The US Federal Deposit Insurance Corporation (FDIC), similar to our very own Philippine Deposit Insurance Corporation (PDIC), defines Classified Loans as:

"Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future."

In Circular #0247 dated May 19, 2000, BSP defines Classified Loans as loans which possess the following characteristics:

1. Loans especially mentioned because they have potential weaknesses that deserve Management's close attention;
2. Substandard Loans are loans which appear to involve a substantial and unreasonable degree of risk to the institution because of unfavorable record or unsatisfactory characteristics;
3. Doubtful Loans are Substandard Loans with the added characteristics that existing facts, conditions, and values make collection or liquidation in full highly improbable and in which substantial loss is probable;
4. Loss loans are loans that are considered uncollectible or worthless and are of such little value that their continuance as bankable assets is not warranted although the loans may have some recovery or salvage value.

The circular mandates that an allowance for probable losses should be set up in accordance with the following schedule:

1. Loans Especially Mentioned: 5%
2. Substandard - Secured: 6% - 25%
3. Substandard - Unsecured: 25%
4. Doubtful: 50%
5. Loss: 100%

As of December 31, 2017, "Classified Loans and Other Risky Assets" of the Philippine Banks amounted to PhP 353.56 billion or more than two times the size of the Philippine Banking System's NPLs of PhP 138.02 billion for the same period.  Consequently, any write-offs of Classified Loans will have more than twice the impact of an NPL write-off.

This level of classified loans should be measured against the bank's "capital cushion" or its ability to absorb losses.  Capital Cushion is normally defined as a bank's "Tangible Common Equity" plus its Loan Loss Reserves.  Tangible Common Equity (TCE) refers to the subset of shareholders' equity that is not preferred equity and not intangible assets.  So it excludes such items as Hybrid equity (like preferred shares) and goodwill.

By this measure, the level of "Classified Loans and other Risky Assets" amounts to Php 353.56 billion or 20.42% of the Php 1.73 trillion in Total Capital Cushion of Philippine Banks as of December 31, 2017.

Stress Test Scenarios

Aggregate

So how will a 10%, 20%, 30%, 40%, and even 50% write-off of Classified Loans affect the Total Capital Cushion of the Philippine Banking System?

In the aggregate, if Classified Loans amount to 20.42% of the banking system's Total Capital Cushion, then it follows that a 10% write-off of Classified Loans will reduce the total capital by 2.04% and a 50% write-off of classified loans will reduce the banking system's Total Capital Cushion by 10.21%.


Individual Banks

A 10% write-off of Classified Loans would severely impact (by 25% or more) the Total Capital Cushion of three banks (severely affected banks highlighted in yellow).

1. Bank of China Limited - Manila Branch (52.07% reduction in Total Capital Cushion)
2. Inter-Asia Development Bank (41.28% reduction in Total Capital Cushion)
3. United Coconut Planters Bank (28.35% reduction in Total Capital Cushion)

A 20% write-off of Classified Loans will totally wipe out the Total Capital Cushion of one bank and severely impact the Total Capital Cushion of six more banks:

1. Bank of China Limited - Manila Branch (104.13% reduction in Total Capital Cushion)
2. Inter-Asia Development Bank (82.56% reduction in Total Capital Cushion)
3. United Coconut Planters Bank (56.70% reduction in Total Capital Cushion)
4. Philippine Postal Savings Bank Inc (44.89% reduction in Total Capital Cushion)
5. Yuanta Savings Bank Philippines (29.26% reduction in Total Capital Cushion)
6. Luzon Development Bank (26.44% reduction in Total Capital Cushion)
7. Philippine Resources Savings Banking Corporation (25.69% reduction in Total Capital Cushion)
   

A 30% write-off of Classified Loans will totally wipe out the Total Capital Cushion of two banks and severely affect (reduce by 25% or more) the Total Capital Cushion of eight other banks:

1. Bank of China Limited - Manila Branch (156.20% reduction in Total Capital Cushion)
2. Inter-Asia Development Bank (123.84% reduction in Total Capital Cushion)
3. United Coconut Planters Bank (85.05% reduction in Total Capital Cushion)
4. Philippine Postal Savings Bank Inc (67.34% reduction in Total Capital Cushion)
5. Yuanta Savings Bank Philippines Inc (43.90% reduction in Total Capital Cushion)
6. Luzon Development Bank (39.66% reduction in Total Capital Cushion)
7. Philippine Resources Savings Banking Corporation (38.53% reduction in Total Capital Cushion)
8. Malayan Bank Savings and Mortgage Bank (35.94% reduction in Total Capital Cushion)
9. Bataan Development Bank (30.25% reduction in Total Capital Cushion)
10. Legazpi Savings Bank (27.06% reduction in Total Capital Cushion)

A 40% write-off of Classified Loans will totally wipe out the Total Capital Cushion of three banks and severely affect (reduce by 25% or more) the Total Capital Cushion of eleven more banks:

1. Bank of China Limited - Manila Branch (208.26% reduction in Total Capital Cushion)
2. Inter-Asia Development Bank (165.12% reduction in Total Capital Cushion)
3. United Coconut Planters Bank (113.40% reduction in Total Capital Cushion)
4. Philippine Postal Savings Bank Inc (89.78% reduction in Total Capital Cushion)
5. Yuanta Savings Bank Philippines Inc (58.53% reduction in Total Capital Cushion)
6. Luzon Development Bank (52.88% reduction in Total Capital Cushion)
7. Philippine Resources Savings Banking Corporation (51.37% reduction in Total Capital Cushion
8. Malayan Bank Savings and Mortgage Bank (47.92% reduction in Total Capital Cushion)
9. Bataan Development Bank (40.34% reduction in Total Capital Cushion)
10. Legazpi Savings Bank Inc ( 36.08% reduction in Total Capital Cushion)
11. Maritime Savings Bank Corporation (31.52% reduction in Total Capital Cushion)
12. Equicom Savings Bank (31.21% reduction in Total Capital Cushion)
13. Robinsons Bank Corporation (29.20% reduction in Total Capital Cushion)
14. Philippine Savings Bank (26.34% reduction in Total Capital Cushion)

A 50% write-off of Classified Loans will totally wipe out the Total Capital Cushion of four banks and severely affect (reduce by 30% or more) the Total Capital Cushion of fifteen more banks:

1. Bank of China Limited - Manila Branch (260.33% reduction in Total Capital Cushion)
2. Inter-Asia Development Bank (206.40% reduction in Total Capital Cushion)
3. United Coconut Planters Bank (141.75% reduction in Total Capital Cushion)
4. Philippine Postal Savings Bank Inc (112.23% reduction in Total Capital Cushion)
5. Yuanta Savings Bank Philippines Inc (73.16% reduction in Total Capital Cushion)
6. Luzon Development Bank (66.10% reduction in Total Capital Cushion)
7. Philippine Resources Savings Banking Corporation (64.22% reduction in Total Capital Cushion
8. Malayan Bank Savings and Mortgage Bank (59.90% reduction in Total Capital Cushion)
9. Bataan Development Bank (50.42% reduction in Total Capital Cushion)
10. Legazpi Savings Bank Inc (45.10% reduction in Total Capital Cushion)
11. Maritime Savings Bank Corporation (39.40% reduction in Total Capital Cushion)
12. Equicom Savings Bank (39.01% reduction in Total Capital Cushion)
13. Robinsons Bank Corporation (36.51% reduction in Total Capital Cushion)
14. Philippine Savings Bank (32.93% reduction in Total Capital Cushion)
15. UCPB Savings Bank (30.37% reduction in Total Capital Cushion)
16. China Bank Savings Inc (27.76% reduction in Total Capital Cushion)
17. Philippine Veterans Bank (27.13% reduction in Total Capital Cushion)
18. RCBC Savings Bank (26.82% reduction in Total Capital Cushion)
19. Penbank Inc (26.34% reduction in Total Capital Cushion)

Please bear in mind that a number of these banks are already very weak and are in distress.  Please see a previous blog post: "The Top Distressed Philippine Banks as of December 31, 2017".  Moreover, their capital can be overstated.  See a previous blog post "Overstated Capital of Philippine Banks as of December 31, 2017".  As such, any reduction in their capital cushion could knock down an already weak bank.

 Source: www.bsp.gov.ph