Michael Manuel and J. Edmond Garcia of Sunlife

With Banco de Oro posting a P1.3-billion loss in the third quarter due to its exposure to bankrupt Lehman Brothers there’s bound to be questions on how the banking industry will fare as a whole, considering that this crisis has its roots in the financial sector.

Here is the transcript of portions of a recent interview I had with J. Edmond Garcia, director for investments of Sun Life Financial Philippines, and Michael G. Manuel, chief investment officer of the same company. These guys have been watching different sectors of the Philippine economy closely since they were stock analysts more than 10 years ago.

MoneySmarts: What are your thoughts about how this crisis will affect the Philippines and the financial sector here?

Michael Manuel: Obviously people are concerned about how we are tied up to the US with regard to export and OFW remittances. Obviously there will be a slowdown on both fronts. But it seems that OFW remittances are very resilient.

The obvious tie is really the export side. But the US is not our major trading partner anymore. Even with the possibility of recession in the US, the economic forecast is still a 4.6% growth in the Philippines. While that may pale in comparison to 7.3% (in 2007), 5% is still respectable growth.

There might be some concerns, but from a fundamental macroeconomic perspective, I wouldn’t be too worried about that because we are still plodding along with a 5% growth.

MoneySmarts: What is your forecast for 2009?

Manuel: Around 5% to 5.5%.

MoneySmarts: Do you really think remittances will not be affected?

Manuel: Filipinos employed in the US may be suffering, but Filipinos in the Middle East are taking up the slack. That’s why you see OFW remittances going up.

MoneySmarts: How about interest rates? What’s the trend now?

Manuel: There is room for BSP policy rates to move up. Why? Your real interest rate remains negative. Inflation is at 9.2%, 3-month T-bill is at 5.7%. There is a little bit of catching up to do.

Now, whether your market interest rates will follow the trend in BSP policy rates, my sense is that it won’t. Why? One, inflation is trending downwards. Second, banks remain very liquid.

If you look at your banking sector, the loan to deposit ratio is at 55% to 60%, there is P3.3 trillion in deposit, P1.5 trillion in cash. Even if policy rates move up, there is no reason to believe that market interest rates will move in the same magnitude because there is so much cash in the system.

MoneySmarts: That’s assuming that banks are not greedy enough to take advantage of the situation and raise rates.

Manuel: Look at how the government and the banks interplay with each other. Some banks try to put up the rates during auctions, but the government doesn’t bite knowing they have so much cash. When banks keep on pushing, what does the government do? Punish the banks by increasing reserves. They have always set that signal that’s why I see no real danger for market interest rates to move up significantly.

MoneySmarts: Come to think of it, home lending rates have gone up but only a couple of basis points.

Garcia: You will also notice that corporates aren’t borrowing. If you look at their balance sheets, they all have cash. Their problem is they don’t know what to do with that cash.

Manuel: The years 2003 to 2007 were really very profitable years for corporates. Debt to equity ratios went down. They have so much internally generated cash that is why we don’t expect them to be borrowing.

MoneySmarts: Any points of concern?

Garcia: There may be some tapering off in the property sector but far from a collapse. More of a flattening or a slowdown.

Manuel: The scenario is not necessarily like 1997, which was based on speculation. During those years, people were buying to flip. Condos were being built left and right because of speculative demand. Obviously after market prices peaked, there was nothing to support that demand. This time, property companies have learned from experience. There may be a slight dip to 10% but not more than that.

Garcia: There might be some reallocation within the sector. For example, in this building (The Enterprise), we have call centers. Some property companies are building especially for call centers in other places, and these are offered at a lower price. There may be a reallocation with that sector. You will see a lot of call centers moving out to cheaper buildings that are more suitable for their type of business.

This means if I were building grade A buildings, I’ll be a little worried. But if I were the other guy, there’s an opportunity for me. Call centers will yield a little less, but in general the sector will stay healthy, but it will flatten somewhat.

MoneySmarts: What about banks?

Manuel: Our banks are great. We are not worried about exposure. I think the banks here over the past two years have beefed up significant capital to act as buffer for losses. Banks here are very profitable. Look at interest margins here compared with Asian banks. Interest spreads are near 4% when everyone else is at 1% to 2%. That will give you an idea of banks’ profitability.

The central bank recently said there has been 19% loan growth. Last time we saw that figure was in 1996. That’s a very good sign. Banks have cash and they are lending it out. That’s very good.

Garcia: it is also important to look at how local banks are capitalized. Banks’ last buffer is capital. A lot of banks here have capital adequacy ratio of more than the 10% mandated by BSP. Some even have 35% CAR. For me, that’s too high. A lot of banks now are overprovided with regard to possible losses. You will see them with 100% to 150% provision against loan losses.

Why are provisions for loan losses significant? In 1997, when banks suffered a lot of losses, NPLs went up when provisions were at 40%. Some banks even had only 10% in provisions. So what happened? The NPLs were declared as a loss, and when you only have a 10% buffer, obviously the 90% will come from capital.

However, these days, banks are much better prepared to take on possible losses—this time around.

Manuel: Assuming there are some banks that have exposures. But then you have very strong banks just waiting for opportunities. What will probably happen is that you’ll always have stronger banks buying the weaker ones. What you don’t want to have is a systemic problem where everybody has exposure to the same thing. That’s not happening. There are banks in the system big enough and just looking for a good buy.

Banks’ net worth are also stronger. Philippine banks have very good risk management and they are very conservative. At the end of the day, we are left with cleaner, better banks because of the 1997 crisis.

MoneySmarts: Talk to me about timeframe. Do we just follow the US or will there be a lag time?

Manuel: We are in different parts of the cycle. Theirs was the classic—nice boom from 2001-2007, and now the inevitable bust. Where are we in the cycle? We never had a boom. We are somewhere in the middle and we are in some sort of a pause. What does that mean? We think maybe it will be a slower trajectory but still obviously a lot of room to grow.

We are not over leveraged; we haven’t done these complex deals. Our companies are very healthy balance-sheet wise. From our economy’s perspective, it will be ok. We are not going to have stratospheric growth, but we are not going to have a bust like in the US.

Our companies are not over-invested, not like in 1997 when there were huge expectations of expansion during the Ramos years. What they used for the expansion was a lot of loans; the loan to deposit ratio was 110. Loans were more than the deposit base, which meant the banking sector was overextended in loans.

So the corporate sector was over-expanded, the expansion finished in 1998 and was not serving any market. Your banking sector was overlent and when companies who were over-expanded and couldn’t pay anymore, it affected the banking sector.

This time, companies have not expanded or are expanding in a very rational way through internally generated funds.

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The figures tell the story—Philippine banks are healthy. The million-dollar question is, why are financial markets—and sometimes consumers–scared?

You guessed right. It’s a confidence game rightly or wrongly. All’s fair in love and financial crises?