I assign a “Neutral” rating to Philippines-listed Bank of the Philippine Islands (OTCPK:BPHLF) [BPI:PM] or BPI. I like BPI’s advantages in cost of funding and operating cost management, which gives the bank an edge in growing its loan book. Loan growth is expected to improve from the high single digit in 2019 to the low teens in 2020, due to a rate cut, infrastructure project roll-outs, and a reduction in reserve requirement ratio, or RRR.
However, BPI’s loan exposure to Manila Water (OTCPK:MWTCF) (OTCPK:MWTCY) [MWC:PM] and its prior partnership with LitePay are key concerns, which could potentially result in bad debts and financial penalties respectively. This is the key reason for my “Neutral” rating despite the fact that BPI’s valuations are undemanding relative to history.
BPI currently trades at 1.44 times P/B, which represents a discount to its historical three-year and five-year average P/B multiples of 1.9 times and 2.1 times respectively. BPI is also valued by the market at 11.7 times consensus forward FY2020 P/E versus the bank’s historical three-year and five-year average forward P/E multiples of 15.3 times and 16.0 times respectively. The stock also offers a consensus forward FY2020 dividend yield of 2.1%.
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Started in 1851, Bank of the Philippine Islands, or BPI, is the oldest bank in the Philippines and Southeast Asia. BPI is the fourth largest bank in the Philippines with respect to asset size, after BDO Unibank (OTC:BDOUF) (OTCPK:BDOUY) [BDO:PM], Metropolitan Bank & Trust Company (OTCPK:MTPOF) (OTCPK:MTPOY) [MBT:PM] and Land Bank Of The Philippines. The bank boasts a network of 1,167 branches and 2,822 ATMs (Automated Teller Machines) and CAMs (Cash Accept Machines) as of end-December 2019. BPI has an 8.7 million-strong client base which is supported by more than 20,000 employees at the bank.
BPI’s Business Segments
Better Loan Growth Expected For FY2020
Loan growth for the overall Philippine banking industry has slowed from +16.6% in FY2016 and +16.5% in FY2017 to +13.7% in FY2018 and +8.7% in 11M2019 (first 11 months of 2019). Similarly, BPI’s loan growth was at +8.9% for FY2019, representing a slowdown from the bank’s historical loan growth rates of +19.2%, +15.5% and +12.7% for FY2016, FY2017 and FY2018 respectively.
BPI consistently traded above 2 times P/B between January 2010 and June 2018, but its valuation fell below 2 times P/B since July 2018 and it is currently valued by the market at 1.44 times P/B. Slowing loan growth for the Philippine banking industry and BPI has been a key contributing factor in BPI’s valuation de-rating.
Nevertheless, loan growth is expected to be better this year. S&P Global (SPGI) is forecasting a loan growth of +10%-12% for Philippines banks in 2020, while BPI has guided for a similar loan growth of +10%-12% this year as disclosed at its 4Q2019 earnings call on January 31, 2020.
There are several reasons for the renewed optimism on loan growth.
Firstly, the Philippine central bank Bangko Sentral ng Pilipinas cut the benchmark interest rate by -25 basis points to 3.75% on February 6, 2020. Earlier, slower loan growth in 2019 was partly attributed to both retail and corporate borrowers adopting a “wait-and-see” approach in anticipation of lower interest rates.
Secondly, there are expectations that the pace of infrastructure projects could accelerate this year. The Philippine government allocated PHP972.5 billion to President Rodrigo Duterte’s “Build Build Build” infrastructure program as part of the country’s 2020 budget. The roll-out of planned infrastructure projects has been delayed in the past, which has tempered expectations. But the Philippine government has recently optimized the list of infrastructure projects in the pipeline, switching its focus to projects that are “economically feasible and doable” based on Economic Planning Secretary Ernesto Pernia’s interview with Reuters in October 2019. More importantly, President Rodrigo Duterte’s term ending in June 2022, an acceleration of government infrastructure projects in the next two and half years is very likely.
Thirdly, Philippines banks’ reserve requirement ratio, or RRR, was reduced by -100 basis points to 14% with effect from December 2019. Prior to this, the Philippine central bank Bangko Sentral ng Pilipinas has already cut RRR by a cumulative -300 basis points earlier. In an October 2019 interview with local media The Philippine Star, Rizal Commercial Banking Corporation’s economist Michael Ricafort estimated that every 100 basis points cut in RRR “would infuse about P110 billion in additional funds into the banking system.” This should enable BPI and other Philippine banks to drive loan growth without a need for further capital raising. The Philippine central bank had set a target of reducing RRR to the single digit prior to 2023.
The key downside risk to loan growth recovery in FY2020 is the further spread of the Wuhan coronavirus, which could dampen economic growth and loan demand. At the time of writing, there are two confirmed cases of Wuhan coronavirus infection in the Philippines.
Advantages In Cost Of Funding And Operating Cost Management
BPI has an edge in growing its loan book compared with its peers, thanks to its funding and cost advantages.
BPI’s cost of funds was relatively low at 2.0% for FY2019, as the bank has a high CASA (Current Account Savings Account) ratio of 69.1% as of end-December 2019 implying good access to low cost funding. There is also an opportunity for BPI to further lower its cost of funds, as the bank replaces part of its time deposits (higher funding cost) with the issuance of new bonds (lower funding cost).
BPI’s Recent New Bond Issuance
Source: BPI’s 4Q2019 Results Presentation Slides
BPI also has good operating cost management. The bank’s cost-to-income ratio was 53.1% for FY2019, representing a significant improvement from 55.5% in FY2018. In contrast, Philippines’ largest bank by asset size, BDO Unibank has a much higher cost-to-income ratio of 64.7% for 9M2019.
BPI’s superior cost-to-income ratio is largely due to the bank’s higher operating efficiency and conservatism with respect to new branch expansion. Looking ahead, BPI expects annual new BPI family bank branch additions in the 10-20 range in the next few years. At the same time, BPI has been growing its digital banking channels and estimates that digital banking penetration has exceeded 20%.
Improving Asset Quality But Manila Water Exposure Is A Concern
BPI’s asset quality showed improvement in the past year. The bank’s Non Performing Loan, or NPL, ratio declined by -19 basis points from 1.85% in FY2018 to 1.66% in FY2019, while NPL coverage improved from 85.45% to 102.14% over the same period.
BPI’s credit cost increased slightly from 40 basis points in FY2018 to 43 basis points in FY2019. The bank has guided for a credit cost of 40 basis points in FY2020 at the 4Q2019 results briefing in end-January 2020.
However, BPI’s loan exposure to Manila Water Company is a potential concern. Manila Water “holds the exclusive right to provide water and used water services to the eastern side of Metro Manila” as per the company’s profile on its website. Manila Water’s concession agreement with the Metropolitan Waterworks and Sewerage System will expire in 2022, after the original extension of the concession agreement to 2037 was revoked.
Ongoing Investigation With Respect To LitePay Partnership
BPI was a remittance partner for LitePay in the Philippines, a service launched by Australia’s Westpac.
The LitePay service was terminated in November 2019, after Australia’s regulators alleged that LitePay was used for money laundering activities. Earlier in December 2019, local media reported that the Philippine central bank was currently investigating the matter.
In an interview with The Business Mirror on January 9, 2020 regarding the LitePay partnership, BPI Executive Vice President and Corporate Banking Head Juan Carlos L. Syquia was quoted as saying that “BPI has complied with all AML [anti-money laundering] standard.” Nevertheless, there is still a possibility of financial penalties and other sanctions, if the Philippine central bank’s ongoing investigations find BPI to be in breach of any regulations.
BPI trades at 1.44 times P/B based on its share price of PHP85.50 as of February 6, 2020. In comparison, the stock’s historical three-year and five-year average P/B multiples were 1.9 times and 2.1 times respectively.
BPI is also valued by the market at 11.7 times consensus forward FY2020 P/E and 10.9 times consensus forward FY2021 P/E. The bank’s forward FY2020 P/E represents a discount to its historical three-year and five-year average forward P/E multiples of 15.3 times and 16.0 times respectively.
The bank offers consensus forward FY2020 and FY2021 dividend yields of 2.1% and 2.3% respectively. It has paid out a consistent PHP1.80 in annual dividends per share (or two semi-annual dividend payments of PHP0.90 each) for the past two fiscal years, FY2018 and FY2019. At the bank’s 4Q2019 earnings call on January 31, 2020, the bank guided that “we might be able to sustain a higher dividend payout from 2020 onwards.” Market consensus expects a dividend payout per share of PHP1.80 (same as FY2019) and PHP1.93 for FY2020 and FY2021 respectively, so there could be still upside to BPI’s actual dividend payout for FY2020.
The key risk factors for BPI are a further spread of the Wuhan coronavirus, which could dampen economic growth and loan demand, potential financial penalties associated with any investigations by the Philippine central bank regarding the partnership with LitePay, slower-than-expected loan growth, poorer-than-expected asset quality, and lower-than-expected dividend payout.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.