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Outlook on bank stocks mixed amid Q2 letdown

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PHILSTAR/KRIZ JOHN ROSALES

By Jochebed B. Gonzales, Senior Researcher

MARKET volatility has sent shares of bank stocks tumbling in the second quarter as earnings fell below estimates.

The Philippine Stock Exchange index (PSEi) reached the 7,800-level in early June, recovering slightly from its first-quarter slump. However, local equities entered bear market territory when the decline from its January peak reached more than 20%. For the quarter, the PSEi posted a 9.85% loss with 7,193.68 as the market closed for the second quarter.

Data by the Bangko Sentral ng Pilipinas (BSP) show the aggregate net incomes of universal and commercial banks (U/KBs)growing by 7.7% in the first half. Net interest margin of 3.11% during the period was slightly higher than 3.09% previously.

But the general increase in earnings in the UK/B category did not reflect in the stock performance of listed banks. The Philippine Stock Exchange financials index — which included the banks — went down by 14.85% in the second quarter compared to a 6.04% decline in the first quarter.

The so-called “big three” banks in asset terms, which are BDO Unibank, Inc., Metropolitan Bank & Trust Co., and Bank of the Philippine Islands, were not spared from the sector’s plunge. Among this group, BPI posted the biggest decline in the second quarter at 24.35% to P88.50 per share from P117 per share in the first quarter. Meanwhile, MBT and BDO suffered second quarter losses of 14.45% (to P73.40/share from P85.80/share) and 9.71% (P125.50/share from P139/share), respectively.




Other listed banks also saw a decline in their stock prices with Rizal Commercial Banking Corp. (RCB) posting a 38.66% fall in the second quarter, followed by East West Banking Corp. (EW, -25.19%), Security Bank Corp. (SECB, -16.67%), Philippine National Bank (PNB, -10.58%), China Banking Corp. (CHIB, -4.55%), Union Bank of the Philippines (UBP, -2.78%), and Asia United Bank Corp. (AUB, -0.34%).

On a quarter-on-quarter basis, market capitalization, which is equal to the stock’s share price at a point in time multiplied by the number of shares outstanding, of the 10 listed UK/Bs were down 14.87% as compared to the 6.43% fall during the first quarter. Banks that underperformed compared to the sector average were RCB (-34.18%), EW (-25.19%), BPI (-22.22%), and SECB (-16.67%).

“Bank stock prices are down year to date due to the broad market downturn,” Zoren Philip A. Musngi, research analyst at Mandarin Securities Corp. said.

“There was some optimism when Metrobank first reported strong earnings, but it quickly died down as BDO and BPI successively reported disappointing earnings against consensus.”

Rens V. Cruz II, senior equity analyst at Regina Capital Development Corp., concurred, saying that the banking industry slipped in terms of valuation with its price-to-earnings ratio of 15.15 times versus the PSEi’s 19.40 times on account of pressures of continued foreign fund outflows due to “macroeconomic concerns.”

“With the exception of a few names, the banking industry in general missed estimates for the quarter, with earnings pressured heavily by non-interest based income despite decent loan growth, solid margin expansion, and a healthy asset quality,” he said.

“The banking sector greeted 2018 with the best rallies so it is understandable why the industry was also the worst hit following this disappointing earnings period,” he added.

‘DISAPPOINTING’
For analysts, the listed banks either “disappointed” or “underperformed” when it comes to their second-quarter earnings.

“Many analysts were expecting bank earnings to benefit from the strong momentum in industry loan growth and net interest margins improvements as loans reprice due to higher interest rates. However, lower trading gains and one-off items have offset these,” said Mandarin Securities’ Mr. Musngi.

COL Financial Group, Inc.’s John Martin L. Luciano was of the same opinion: “Most banks underperformed versus our forecast… In general, higher interest rates caused the banks’ funding costs to increase. Likewise, this also caused most banks to book poor trading performance.”

For Regina Capital’s Mr. Cruz: “[E]ven if interest-based earnings account for about 60% to 80% of a bank’s total income, the weakness in these non-interest receipt still made considerable dent to the bottom line.”

Meanwhile, other analysts blame the less-than-expected earnings results on rising operating expenses (opex), most particularly on the doubling of the documentary stamp tax (DST) on bank checks, certificates of deposit, and similar financial instruments from the Tax Reform for Acceleration and Inclusion (TRAIN) Law that took effect this year.

“A general slowdown in lending in the midsized banks coupled with higher opex resulted in mixed net earnings performances for the banks,” noted Arabelle C. Maghirang, deputy research head at Papa Securities Corp.

Ms. Maghirang added that inflation was “not much of an issue,” saying that in terms of cost, it was still the increased DST that drove up operating costs. “The rate hikes, coupled with regulatory requirements on the funding side, kept interest expenses elevated,” she said.

STOCK PICKS
“We recommend sticking to the big banks: MBT, BPI, and BDO,” AP Securities, Inc. Research Analyst Rachelle C. Cruz said.

“With the big three having the deposit franchise in the industry, they are also the best beneficiaries of the BSP’s rate hikes amid tighter liquidity in the system.”

Meanwhile, MBT is the top pick for COL Financial’s Mr. Luciano: “We continue to like Metrobank as it is expected to be one of the major beneficiaries of the growing demand for loans given its size, and highly liquid and healthy balance sheet.”

Mandarin Securities’ Mr. Musngi recommended BPI shares as a “buy” on account of its “industry-leading” return on equity (ROE) and cost efficiency ratios as well as its robust loan growth and its current price-to-book (P/B) valuation that is “very much below historical averages.”

Also on Mr. Musngi’s buy list is BDO, citing the lender’s core lending performance in the first two quarters while dismissing second-quarter earnings drag as “one-off.”

“We expect the [BDO] to hit its P31-billion net income guidance as lending in the teachers’ segment resumes. We also take into account in our ‘buy’ rating on BDO’s position as the largest bank in terms of assets, its large branch network, and membership in the [PSEi],” he said.

The analyst was referring to the suspension last November of the Department of Education’s (DepEd) Automatic Payroll Deduction System, which catered to the salary loans of public school teachers. The suspension was implemented as DepEd worked on new guidelines.

Aside from BDO, EW and UBP also have considerable exposure to these types of loans.

“We have a HOLD on UBP and EW as its earnings in Q1 2018 have been largely hit by the issues in teachers’ loans, given their large exposures to this segment,” said Mr. Musngi.

“There was uncertainty on whether they can continue lending to the segment, but recent data show that lending to the segment have resumed,” he added, expecting earnings of BDO, UBP, and EW to recover in the third quarter.

SECB has a “hold” rating with the mid-tier bank trading closer to its analysts’ target price.

“[SECB’s] transition towards retail lending seems to be taking long due to their concern of immediately gaining back their double-digit ROE. Competition is also intense in the corporate and middle market segment, where bulk of SECB’s loan book is,” said AP Securities’ Ms. Cruz.

She also gave PNB a “hold” rating for its “choppy non-core income” which contributes to volatility in its earnings: “[it’s] too early to assess sustainability of core income,” she said.

OUTLOOK
The rising interest rate environment may be favorable for the banks’ core lending segments, but the strain in the trading of securities and funding costs may extend through the third quarter.

“While the 1% rate hike year to date bodes well for 3Q18 net interest margin improvement, we are wary of its impact on funding cost as well which may limit the positive impact to the bottom line,” said Papa Securities’ Ms. Maghirang.

“We expect core lending (net interest income) growth to further accelerate on the back of increasing interest rates and the 50-bp hike done by BSP [in August],” said Ma. Katrina Patricia G. Mercado, equity research analyst at First Metro Securities Brokerage Corp., adding that liquidity is “not as ample as before” and could drive up funding costs.

“We would also be looking at the performance of the capital markets, as we have seen sluggish fee income growth by the banks in 1H18 due to lack of capital market deals,” Ms. Mercado said.

For COL Financial’s Mr. Luciano, the long-term outlook for the banking sector continues to be positive.

“However, in the short term, the sector’s performance may be weighed down by the continued rise in interest rates. Note that industry Loan to Deposit Ratio has risen gradually since January 2017 from 69.1% to 73.1% in May 2018, indicating tighter liquidity in the system. We believe that this caused banks to raise deposit rates to attract funding, increasing the funding costs of most banks,” he explained

“Likewise, the higher interest rates also drag the trading performance of banks. However, these risks should be tempered as loans gradually re-price.”

Giving a more upbeat projection this quarter, Mr. Musngi of Mandarin Securities said: “In Q3, we expect prices of banks to recover as they report better earnings and as sentiment for PHL equities generally improve.”

“Bank valuations are currently attractive, with P/B ratios below 3-, 5-, and 10-year averages. We also expect banks to benefit from the expected passage in the TRAIN Package 2, which the government targets to pass by end of this year,” he said, referring to the second package of the tax reform program that aims to reduce corporate income taxes alongside the rationalization of tax incentives. — with a report from MMMR