Betting on Philippine banks

THE PHILIPPINE Stock Exchange Index (PSEi) recently broke out of a long consolidation.

For over 50 trading days, the index was caught in a tight 300 point/4% range; an event so rare that the only analog we could find happened in 2003. Foreign funds have returned as net buyers in a big way since the start of April but the source of the market’s optimism is from domestic investors and is apparently based on the purported benefits of proposed tax reform measures and the administration’s promised infrastructure push.

Market prognosticators and investors, in general, have swept negative factors aside including regulatory, policy, and legislative changes that affect a majority of listed companies.

Mining companies, for example, have been hit hard by the Environment Department’s decision to suspend or close dozens of mines. On the other hand, labor and related costs are expected to increase over time on the back of the Department of Labor’s DO 174 and the imminent hike in social security pension contributions ( a back of the envelope calculation shows that the business process outsourcing industry alone will have to shoulder approximately P7 billion annually if both the contribution rate and maximum salary credit are raised to 12.5% and P20,000, respectively, as proposed by SSS management).

Meanwhile, housing-focused property companies will be impacted by the proposed withdrawal of VAT (value-added tax) exemptions for low- cost units. Also, the Philippine Competition Commission remains keen to review the buyout deal involving San Miguel Corp., PLDT and Globe Telecom and has promised to look into alleged anti- competitive behavior in several industries including cement and power generation.

Next, taxes on consumption will effectively rise with the looming excise tax hikes on fuel and automobiles. This list can go on but the bottom line is that little or no heed has been paid to a tightening regulatory environment that threatens to erode the aggregate profitability of publicly listed companies.

To be sure, many of the regulatory changes are necessary. The rights of labor to security of tenure, for example, as embodied in DO 174 is expected to benefit a large swathe of the labor force. Nevertheless, the market’s seemingly cavalier attitude toward these threats should be considered a red flag.

So, should investors totally avoid Philippine equities? Not at all. Despite the aforementioned concerns, some sectors stand out for their potential to deliver strong returns both in the near term and for the long haul. One of these is the banking industry.

Banks are no strangers to regulation.

To avoid a repeat of the Asian financial crisis, the Bangko Sentral ng Pilipinas (BSP) mandated reforms and benchmarks that are stricter than international standards. The latest round of initiatives, in fact, forced many banks to shore up their respective capital bases in order to meet present and future requirements.