The disclosure by the Bangko Sentral Pilipinas (BSP) of the banking industry’s P89-billion exposure to the collapsing collateralized debt obligations (CDOs) in the subprime market in the United States is commendable. But not the way it views the exposure as “smallish” when ranged against the banks’ total assets of P4.48 trillion and its dismissive tone in saying the industry is insulated from the effects of the exploding mortgage market, which has so far claimed a writedown or losses of $478 billion for big foreign banks and investment houses.

Although P89 billion is less than 1 percent of the total assets of the banking industry, this “smallish” amount is not that small when viewed from the perspective of the industry’s capital, which, as per the BSP’s own data, is P462 billion as of the end of December 2007. It would be interesting to know how the banking industry would treat this CDO implosion that has already resulted in the wipeout of the erstwhile-respected Bear Stearns in the United States and the huge losses other financial institutions suffered.

Framed from this perspective, the P89 billion in CDO exposure of the banking industry, now in danger of being written off or declared as a loss, assumes an ominous 19 percent. This means that for every P100 of capital that the banking industry has—and this includes the banks’ debt issuances to bolster their capital stock by way of the hybrid and Tier-2 capital—the industry has investment exposures of P19. This is a sizable sum that the BSP has to adequately address by way of whipping the banking industry into line in raising additional capital to insulate it from the fallout of the CDO mess.

And to think that the banking industry has just come out of huge capital charges from their fire sale of foreclosed assets, raising at most P30 for every P100 in so-called nonperforming assets. The fact that the banking industry was not spared from the fallout of the exotic debt instruments that big-name investment banks packaged and then sold as prime-grade investment securities only goes to show that there is no such thing as a safe investment instrument when there are excesses in greed of the global financial industry.

A four-part series of the Financial Times on the subprime mess that tackled also the rescue of US mortgage giants Fannie Mae and Freddie Mac (where the banking industry had “smallish” exposures, too, as per the BSP) paint a rather difficult economic environment ahead: a vicious cycle where banks hurt by the subprime mess cannot be made to lend more, say, for the housing industry, that, in turn, leads to further constriction in the banks’ financial condition. And that could impact on the country’s financial risk profile, too, especially since local banks cannot be made to be forthright in terms of their exposures to CDOs.

That FT analysis showed how greed took the better of the CDO investors as investment banks sold prime-grade-rated debt securities that have as underlying asset base those of mortgage papers that were granted by banks to credit-risk housing borrowers. When banks allow borrowers, who cannot even pay for their car mortgages, to get loans for house purchases, then risk is magnified. We understand that these are the same CDO papers that local banks are invested in, to the tune of P89 billion.

LandBank explanation

Land Bank of the Philippines has reacted to our piece last week regarding the possible loss the bank had to come to grips with insofar as the P3-billion loan that it granted to Quedancor is concerned. That P3-billion loan was said to have been used for a swine loan program that had gone awry. In the interest of fairness, we are reprinting the letter from the bank’s corporate affairs department vice president Agustin F. A. Apilado.

“First, we wish to reiterate that the P3-billion loan granted by LandBank to Quedancor was a stand-alone leg of our lending to Quedancor for the purpose of augmenting its lending operations to small farmers and fisherfolk, SMEs and countryside entrepreneurs. Second, the loan granted to Quedancor was under a structure whereby the principal payment due after seven years will be paid out of the maturity proceeds of zero coupon ROP bonds. The coupon bonds with a face value of P3 billion fully cover LandBank’s loan to Quedancor.

“The P3-billion loan obligation of Quedancor did not specify the program for which the loan will be utilized. Under BSP or BASEL 2/IAS 39 accounting principles applied to banks, as in the case of LandBank, an outstanding loan is not subject to mark-to-market valuation, and therefore does not impact on capital. Third, there should be a distinction made between the balance sheet of LandBank [which is in no way affected by the loan it granted since this is fully covered as to principal] and the balance sheet of Quedancor.

“Obviously, the performance of the swine program or any other loans or credit exposures of Quedancor will impact only its own balance sheet. It must also be stated that LandBank did not incur a huge hit when it lent P3 billion to Quedancor, as the article avers. The loan has, from the very start, been fully covered as to principal by zero coupon bonds. The zero coupon bonds referred to were procured by Quedancor’s special-purpose trust and, to this date, are still held by the Special Purpose Trust as cover of the principal of the loan.

“Furthermore, the zero coupon bonds are not assets of LandBank. They are securities pledged by Quedancor’s special-purpose trust, and this is akin to a regular collateral. This means that the value of such zero coupon bonds under the special-purpose trust is not part of LandBank’s balance sheet. We wish to underscore that any and all lending programs of Quedancor are the responsibility of its management and board of directors. The performance of their lending/financing programs should have no impact on LandBank financial statements since we are two different corporate/legal entities.

“The P3-billion loan LandBank granted to Quedancor, including the structure and collateral, was duly processed and approved by the bank’s approving authorities, including the board of directors. Furthermore, the loan was granted without reference to any specific lending program of Quedancor [much less the swine project] since the purpose stated by Quedancor was for working capital/lending requirements.” 

E-mail: hugagni@yahoo.com

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