Banking sector weathers the storm

The local banking sector has been under the spotlight lately. There was concern that prices of banking stocks may drop as a result of an ongoing Senate investigation on the $81 million cyberheist involving stolen funds from the Bangladesh brand Bank. Rizal Commercial Banking Corp. is in the eye of the storm for the alleged involvement of its branch manager in the matter. RCBC's stock price fell when the Senate investigation started. Recently, however, RCBC's stock price has stabilized and has bounced sharply from its lows. Moreover, the banking sector as a whole has stood strong and has withstood the backlash and negative publicity.

Still better than the West. The whole world is now watching how this scandal will be resolved by our regulators. While local banks have suffered from negative publicity, recent events have not undermined the sector's strong fundamentals. Local banks continue to benefit from our country's above-trend economic growth. Further, there still aremany unbanked segments and underpenetrated regions in the country, proof the potential for sustained growth is still there. More importantly, local banks are not hobbled by capital or growth issues that have plagued its Western counterparts.

Growing foreign interest. The local banking sector continues to benefit from a growing interest from foreign investors and banks. Asian banks who want to establish a stronger regional presence are looking to set-up shop in the Philippines in order to participate in our country's growth story. This follows the liberalization of foreign bank entry, which allows more foreign banks to enter the country and own up to 100 percent of the voting stock of an existing domestic bank. Since then, six foreign banks have received approval to operate in the country: Japan's Sumitomo Mitsui, Korea's Shinhan Bank and the Industrial Bank of Korea, Yuanta Bank from Taiwan, Cathay United Bank from Taiwan and Singapore's United Overseas Bank. According to the BSP, there are more foreign bank applications in the pipeline.

Brewing ASEAN integration. Foreign interest in the local banking sector is also being driven by the impending financial integration among members of the Association of Southeast Asian Nations (ASEAN). The pact seeks to strengthen intra-region trade and investment flows while promoting the opening of ASEAN qualified banks among member countries. Last month, the Philippines and Malaysia inked the first bilateral agreement under the ASEAN Banking Integration Framework. The deal paves the way for the entry of up to three ASEAN qualified banks in each country. It will take a number of years for the Philippines to ink bilateral agreements with various ASEAN countries. Nonetheless, we expect regional developments to continue driving foreign interest in the local banking sector.

 Another mode of entry.  Aside from setting-up shop and opening branches, foreign banks can also enter the country by forging partnerships with local banks. It is a potential win-win scenario for both parties, as each side brings something unique to the table. On the one hand, foreign banks with global or regional networks can tap a diverse set of .act m-international clients who are also looking to set up shop in the Philippines. They also benefit from best practices and specialized expertise that have allowed them to thrive in different countries.

Locals know best. On the other hand, Philippine banks clearly have a better understanding of the local playing field. They have a deep knowledge of the Philippine market and long-standing relationships with corporate and individual clients. Further, local banks utilize the contacts and network their owners, directors and officers provide. Philippine banks are usually owned by conglomerates which also have stakes in other big corporations and listed companies. Hence, local banks benefit immensely from associations with sister companies and related businesses. These become captive clients for the core lending and deposit-taking businesses of local banks.

Growing number of partnerships. In the past few years, there has been steady growth in the number of partner-ships between Philippine banks and foreign entities. We enumerate some examples below.

Partnerships between local banks and foreign entities

Source: Company data

The partnership template. The recent purchase by Bank of Tokyo-Mitsubishi UFC (BTMU) of a 20 percent stake in Security Bank (SECB) has put the Philippine banking sector under the spotlight. BTMU is the banking unit of Mitsubishi UFJ Financial Group, one of the largest financial conglomerates in Japan. This follows the investment of Cathay Life Insurance Corp. in RCBC, which has now been built to 22.7 percent even amidst the backlash of the ongoing Senate investigation. We note that both investments made by foreign banks into SECB and RCBC were priced at sizable premiums to book and market value.

Current landscape opens up M&A possibilities. Changes in regulations have liberalized foreign bank entry. Meanwhile, regional developments are also pushing for the opening of ASEAN qualified banks in member countries. There is also growing interest among other Asian countries to establish their banking presence in ASEAN countries such as the Philippines. These developments open up possibilities for M&As and lay the groundwork for further consolidation in the local banking sector.

Almost but not quite. Note that in 2012, Philippine National Bank (PNB) was almost acquired by Bank of the Philippine Islands (BPI) before the deal was scuttled at the last minute (Hunt for Banking Supremacy, Nov. 26, 2012). The serious merger talks at that time prompted many analysts and market pundits to explore various M&A permutations among local banks. With a number of local banks currently trading below or near book value, we think the landscape is being laid out for another wave of M&A activity. Further, we believe the local banks which are trading at attractive valuations are the same ones that can immensely benefit from the synergies a partnership with a foreign institution may bring.

Potential M&As—a catalyst for the stock market. In the past, we have written extensively about M&A in the banking sector and how it has propped up banking shares and stock market sentiment. Readers may refer to Chapter 9 of our book "Opportunity of a Lifetime.” Time and again, we have said that mergers and acquisitions—or even just talks of potential M&As among banks—have served as strong catalysts not only for the banking sector, but also for the stock market as a whole.

Philequity Management is the fund manager of the leading mutual funds in the Philippines. Visit www.philequity.net to learn more about Philequity’s managed funds or to view previous articles. For inquiries or to send feedback, please call (02) 689-8080 or email [email protected]