Fitch downgrades outlook for Philippines banks to negative

MANILA, Philippines — Fitch Ratings has downgraded the outlook on the Philippine banking sector to negative from stable as the coronavirus disease 2019 or COVID-19 pandemic is seen testing the asset quality and earnings of major players.

The debt watcher said the revision could lead to a credit rating downgrade over the next 12 to 18 months. The revision took into consideration the rising asset-quality risks amid a deteriorating operating environment as a result of the global outbreak that prompted Malacañang to impose a month-long enhanced community quarantine in Luzon.

 “We also see pressure on revenues from declining interest rates and the resulting economic slowdown as the enhanced community quarantine on Luzon Island, which accounts for more than 70 percent of the nation’s output, dents business operations,” Fitch said. 

The credit rater added further rate cuts would take its toll on the earnings of Philippine banks as the Monetary Board has slashed interest rates by 75 basis points this year to boost market confidence and  prevent potential spillovers from external headwinds as well as to soften the impact of the pandemic.

“We expect pressure on net interest margins from the 50 basis points policy cut by the BSP on March 19, adding to the 25 basis points in February and 75 basis points in 2019,” Fitch said.

It expects more cuts in the next few months even if the central bank has slashed benchmark rates by 150 basis points, almost reversing a tightening cycle that saw interest rates jump by 175 basis points in 2018 due to an inflation breach.

According to Fitch, the reduction in the reserve requirement ratios (RRR) for banks would help offset compression in yields to some degree.

“Lower revenue, in conjunction with slower credit growth, will weigh on banks’ profitability this year,” it said.

The BSP’s Monetary Board has committed to reduce the level of deposits banks are required to keep with the central bank by a maximum of 400 basis points this year, with the initial 200 basis points reduction taking effect on March 30 and freeing up as much as P200 billion to encourage banks to lend more and boost economic activity.

Fitch noted the regulatory relief measures extended by the BSP to Philippine banks to help them survive the impact of the virus outbreak.

“Not with standing such measures, the weaker operating environment is still likely to exert pressure on loan quality, especially as the quality of recent rapid credit growth has not been tested over the course of an economic cycle,” Fitch said.

It warned banks with higher exposures to small and medium enterprise (SMEs) are more vulnerable to deterioration in asset quality.

“Those with outsized exposure to tourism and hospitality will also face extra pressures on asset quality, although this sector accounted for only around two percent of banking system loan exposure at end-2019,” it reported.

It explained the balance-sheet strength of large corporates, which make up the bulk of Philippine banking system loans, would for now help to cushion the impact on banks’ asset quality from a moderate slowdown in business operations.

“Nevertheless, prolonged business disruptions could expose the banks to lumpy asset impairments,” Fitch warned.

Based on its estimates, the proportion of debt-at-risk of those owned by non-financial corporates with interest coverage ratio of less than 1.2 times would only rise marginally from around one percent of total listed Philippine non-financial listed corporate debt at present if corporate earnings were to fall by 30 percent, but could jump to 57 percent assuming a uniform 75 percent shock.

Fitch said a default of large conglomerates would have substantial repercussions on the banking system and the nation’s output, with total outstanding debt of listed non-financial corporates equivalent to around 35 to 40 percent of gross domestic product (GDP).