Turning Bad Loans into Good Assets

UNCLAS SECTION 01 OF 02 MANILA 005519

SIPDIS

Sensitive

STATE FOR EAP/EP, EB/IFD, E
STATE ALSO PASS FED RESERVE SAN FRANCISCO
STATE ALSO PASS EXIM, OPIC, AND USTR
STATE ALSO PASS USAID FOR AA/ANE and AA/G
TREASURY FOR OASIA

E.O. 12958: N/A
TAGS: EFIN EINV RP
SUBJECT: Turning Bad Loans into Good Assets


Sensitive but Unclassified - Protect Accordingly.

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Summary
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1. (SBU) The Philippine Central Bank (BSP) has cleaned
up 19% of the non-performing assets (NPAs) in the banking
system through the Special Purposes Vehicle (SPV) law.
Although the BSP target was 50%, it reduced the amount of
NPAs to 9% of total bank assets. By forming an SPV,
companies can buy NPAs, which consist of non-performing
loans and acquired assets, and try to profit from them.
Although the banks recover only 23 cents on the dollar,
it frees up capital for new lending. The RP Congress is
likely to extend the SPV law for another two years by
early 2006. End Summary.

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Selling Off Bad Debts
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2. (SBU) According to Bangko Sentral ng Pilipinas (BSP)
Deputy Governor Nestor Espenilla, the BSP has achieved
modest success in getting rid of bad debts in the banking
sector. Through the Special Purpose Vehicle (SPV) law,
the banking system sold 97 billion pesos (about $1.8
billion) worth of the non-performing assets (NPAs). This
reflected about 19% of the total amount of NPAs in the
banking system. Although the figure fell short of the
BSP target of 50%, it reduced the amount of NPAs from 18%
to 9% of total banking assets. Although SPV law expired
in April 2005, the BSP is hoping to extend Congress will
extend the law for another two years. Espenilla said the
draft bill is the exact same law but gives banks more
time to sell off non-performing assets. The SPV bill is
currently in its second reading in both houses.


3. (U) Espenilla said non-performing assets (NPAs) in
the Philippines consist of two-thirds non-performing
loans (NPLs) and one-third aquired assets (also known as
ROPOA - real and other properties owned or acquired).
Eighty percent of the NPAs addressed to date through the
law were acquired assets, mainly real estate from
foreclosures, because domestic banks and AMCs are more
eager to set up SPVs and prefer concrete assets they can
manage and sell. Real estate prices near metro Manila,
for example, have risen dramatically in recent years.
There are fewer foreign investors interested in setting
up special purpose vehicles, and they are more likely to
buy loans (NPLs) because local property laws prevent
foreign ownership of real estate.


4. (U) By forming an SPV, a bank or Asset Management
Companies (AMC) becomes a legal entity with the rights to
acquire non-performing assets. The SPV may then try to
strike a deal with the borrower, sell the asset to a
collection agency or vulture fund, or try to make a
return on the acquired assets through use, rental, or
resale. The SPV law facilitates the formation of private
and decentralized AMCs. The government provides no
financing but offers incentives, such as reduced transfer
taxes and capital gains taxes for SPVs. The government
also eliminates the documentary stamp tax and gross
receipts tax because these cause friction over the
transaction. Espenilla said the banks are writing off
about 77% of the debt amount, so are getting only 23
cents on the dollar. Banks have to disclose 100% of the
loss on the sale, but are allowed to spread the write-off
of that loss over ten years.


5. (U) In addition to tax incentives, the BSP is
adopting Basel II provisions to punish banks for
retaining bad loans. For example, the GRP increased the
risk weighting that banks must carry on its NPAs from
100% to 125% in 2006 and will be increasing it to 150% by

2007.

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Comment


6. (SBU) Even with the success of the SPV, 20-25% of
many bank loans are classified officially as NPLs or
acquired assets. Changes are still needed in the
Philippine banking system to ensure better transparency,
oversight, and profitability. The Philippine Stock
Exchange, for example, requires no reporting on asset
quality on a quarterly or biannual basis, although some
banks provide a few summary ratios in their interim
accounts. Many banks reported a return on assets of less
than 1% and a return on equity of well under 10% in the
first half of 2005, reflecting a continued large base of
NPLs. Further cleaning up the bad debts and NPLs through
an extended SPV law would create headroom for banks to
fund better-performing loans and profitable investments.

Jones