In a ruling dated October 7, 2011 (BIR
Ruling No. 370-2011), the Philippine Bureau of Internal Revenue (BIR)
ruled that “the PHP 24.3 billion discount on the issuance of the
PEACe Bonds should be subject to 20% Final Tax on the interest income
from deposit substitutes,” as provided in Section 27(D)(1) of the
TaxCode of 1997.
This ruling reversed three previous BIR
Rulings made under former BIR Commissioner Rene G. Banez of the
Arroyo Administration on the PEACe Bonds issued in 2001. (No.
020-2001 dated May 31, 2001 and No. 035-2001 dated August 16, 2001
and No. DA-175-01 dated September 29, 2001).
Rulings under the Negotiated Sale
Mode of Purchase
The May 31 and August 16 rulings were
made at the time that CODE-NGO was attempting to enter into a
negotiated sale of the PEACe Bonds with the Bureau of Treasury. Under
this scenario, the bonds would be sold by the government to a single
entity, RCBC (as a Government Securities Eligible Dealer or GSED) who
would then resell the bonds to another single entity, CODE-NGO.
CODE-NGO would then simultaneously resell the bonds to RCBC Capital
(with a firm underwriting commitment from RCBC Capital).
The May 31, 2001 ruling said that the
PEACe Bonds were not considered to be a “public” borrowing, even
if the bonds would fund the government, because the PEACe Bonds were
to be issued to a single entity, CODE-NGO. Since the bonds complied
with the “19-Lender Rule,” the bonds were not to be classified as
“deposit substitutes.” Under Section 22 (Y) of the 1997 Tax Code,
the borrowing of funds can be classified as deposit substitutes “if
the funds are obtained from twenty (20) or more individuals or
corporate lenders at any one time.”
However, lingering questions remained
on the meaning of the word “public” and the interpretation of the
phrase “at any one time.” Hence, there was a need for a second
clarificatory ruling on August 16, 2001. The ruling stated that
since the bonds will be “issued only to one entity, that is, RCBC,”
there is no borrowing from the public. The ruling also stated that
“the phrase 'at any one time' covers only the origination or
original issuance of the bonds regardless of whether sale or trading
is made in the secondary market.” This ruling effectively allowed
RCBC/RCBC Capital to resell the bonds in the secondary market without
losing the tax-exempt status of the bonds.
However, the ruling required that
CODE-NGO/RCBC warrant that it is acquiring the bond for its own
behalf. The ruling stated that:
“a
representation or warranty should be made to the effect that the
bonds are acquired upon their original issuance by the original
purchaser thereof, for and on its own behalf, or on behalf of a
single purchaser only, and in the latter case, that the purchaser is
acquiring such bonds for its own account and not for the account of
other entities.”
Ruling under Treasury Bond
Auction Mode of Purchase
CODE-NGO's proposed mode of purchase,
through a negotiated sale with the Bureau of Treasury proved to be
problematic for the Treasury. The exclusive purchase offer would
have raised the local financial community's fears of a crony deal in
the making. This was primarily because the approval for such an
offer lies within the Department of Finance headed by Secretary Jose
Isidro Camacho, a brother of CODE-NGO chairperson, Maria Socorro
Camacho-Reyes. On July 12, 2001, National Treasurer Sergio Edeza
wrote a memo to Secretary Jose Isidro Camacho questioning the
propriety of issuing the bonds directly to CODE-NGO because CODE-NGO
was not a Government Securities Eligible Dealer. Sometime in
July/August 2001, Secretary Camacho hosts the infamous “meeting
between CODE-NGO and the Bureau of Treasury wherein both he and his
sister are present.
On September 26, 2001, it became
apparent that a negotiated sale was no longer possible when the
Bureau of Treasury announced that the PEACe Bonds will be sold via
auction to be held on October 2, 2001. As such, there was the
possibility that the bonds may not be issued to a single entity,
since there was a possibility that CODE-NGO may not win all of the
PEACe Bond issue.
Very Narrow Definition of the phrase
“at any one time”
Hence, there was a need for a third
clarificatory ruling that was made on September 29, 2001. In that
ruling, the BIR issued a ruling reiterated that the “the phrase 'at
any one time' covers only the origination or original issuance of the
bonds in the primary market regardless of whether sale or trading is
made in the secondary market.” It also stated that the determining
factor of whether or not the bonds were considered deposit
substitutes was the number of purchasers/lenders at the time of
origination/issuance.
It stated that:
“Corollarily, if
the proposed PEACe Bonds are issued to less than twenty (20)
individual or corporate lenders, the borrowing shall not be
considered as “public” borrowing. Hence, the instrument shall
not be classified as “deposit substitutes.” However, in the case
of PEACe Bonds, since the determining factor in ascertaining whether
or not such bonds are deposit substitutes is the original issuance to
more than twenty (20) individuals or corporate lenders, it holds to
say that the issuance to less than 20 individual or corporate lenders
will necessarily exclude them from the coverage of “deposit
substitutes.” Such being the case, the time element, i.e., “at
any one time” required in “public borrowing” shall not apply in
the instant case.”
The September 29, 2001 ruling also
removed the August 16 ruling's requirement that CODE-NGO/RCBC make a
representation/warranty that it was acquiring the bonds “for and on
its own behalf, or on behalf of a single purchaser only”
Implications of the 2001 Rulings
These BIR ruling is very crucial. By
defining the phrase “at any one time” to mean at the time the
PEACe Bonds were first auctioned off to the GSEDs, it allowed the
bonds to be sold in much smaller chunks in the secondary market
without losing its tax-exempt status. Furthermore, there was no need
to implement a tracking system to ensure that the bonds were held by
no more than 19 investors throughout the life of the bond.
If the ruling deemed the phrase “at
any one time” to mean for the life of the bonds, from date of
issuance to date of maturity, the bonds will have to be sold in no
more than 19 very large chunks of PHP 1.842 billion in face value or
over PHP 535.2 million in cash value (at the time of issuance). Any
investor who bought the bonds for resale at a later date will have to
find another investor with the cash to buy at least PHP 535.2 million
worth of PEACe Bonds in one transaction. That investor, in turn,
must have the willingness to hold the bonds until maturity (10 years
later) or have the capability to find another buyer just like him.
The “19-Lender Rule” was meant to be throughout the life of the
bond, it would severely limit the universe of potential bond buyers
to very large institutional buyers of which there are very few. The
limited market means that anyone who buys the bonds had better be
prepared to tie up a very large amount of cash until maturity (when
the bonds are repaid ten years later) if he is unable to resell the
bonds. This market invariably boils down to two types of investors:
Insurance Companies or other large
financial companies with similar long term obligations; or
Banks that need to fund the more
“permanent” core of their liquidity reserve requirements with
higher yielding instruments.
By eliminating the 19-Lender constraint
in the secondary market, the ruling vastly expanded the market for
PEACe Bonds without negating its tax-exempt status because the bonds
now had more uses.
Retail Products
It allowed for the creation of retail
products based on the zero-coupon bonds. According to RCBC Treasurer
Jaime Panganiban, RCBC has thought of creating “principal protected
products” not found locally.
“I can create
from these bonds a fund with a principal-protected product where your
upside potential is unlimited and your worse return is 100 percent of
your principal, because it's guaranteed by government, though we're
not saying we have advanced product knowledge because these products
you can easily find abroad,” he says.
Washing NPLs from a bank's own books
Since the bonds could now be sold in
much smaller chunks, the bonds could ostensibly sold down to the
level of a bank's own delinquent borrower and simultaneously be
repurchased from the borrower in a cashless debit-credit accounting
transaction that allows the borrowers delinquent loans to be
reclassified from an NPL to a receivable from the borrower that is
connected to the PEACe Bond and not the loan (See my previous post
http://systemisbroken.blogspot.com/2011/10/revisiting-peace-bonds.html
for a more detailed description of this process).
2004 and 2005 BIR Rulings
BIR's October 7, 2011 ruling was not
the first time the BIR reversed the 2001 PEACe Bond Rulings. The BIR
Rulings made in 2001 were first reversed in 2004 under BIR
Commissioner Guillermo L. Parayno (also of the Arroyo Administration)
by BIR Ruling No. 007-04 dated July 16, 2004, BIR Ruling No.
DA-491-04 dated September 13, 2004 and BIR Ruling No. 008-05 dated
July 28, 2005.
BIR's July 16, 2004 ruling (No. 007-04)
stated that:
“since the
object of the issuance is to obtain the required government funding,
the issuance and subsequent distribution (exchange and trading) of
Government debt instruments and securities in the secondary market to
other market participants, specifically, the investors, is in itself
a public borrowing of the government...It is, however, in the
secondary market that the investing public makes the indirect
investment in the borrowing entity, in this case, the Government.
...the mere
issuance of government debt instruments and securities is deemed as
falling within the coverage of “deposit substitutes” irrespective
of the number of lenders at the time of origination.”
...the phrase “at
any one time” in relation to public borrowing is deemed to refer to
the flotation of the debt instrument or security. In other words,
since the actual number of bondholders or investors may be at
maturity date of the financial instrument, more than 20 individuals
or corporation[s], the said direct lenders (origination) and indirect
investors (secondary market) are deemed to be what constitute
“public.”
Furthermore, the ruling stated that it
“effectively modifies and supersedes BIR Ruling Nos. 020-2001 dated
August 16, 2001 and DA-175-2001 dated September 28, 2001, as well as
other BIR rulings dealing on the matter.”
BIR Ruling No. DA-491-04 dated
September 13, 2004
This BIR ruling reiterated BIR Ruling
No. 007-04, stating that the matter of determining the number of
lenders does not come into play insofar as government debt
instruments and securities are concerned.” The ruling reinstated
the applicable provision of Revenue Regulations (Rev. Regs.) No.
17-84 which defined “deposit substitutes” to include “all
borrowings of the national and local government and its
instrumentalities... as evidenced by debt instruments denoted as
treasury bonds, bills, notes, certificate of indebtedness and similar
instruments...Consequently, the interest income derived therefrom by
the corporate or institutional lender shall be subject to the twenty
percent (20%) final tax imposed under Section 27(D)(1) of the Tax
Code of 1997.
BIR Ruling No. 008-05 dated July 28,
2005
This BIR ruling determined that the
twenty percent (20%) final tax is required to be withheld upfront.
Prospective or Retroactive? Or was it
overlooked?
It is unclear as to whether Rulings No.
007-04, DA-491-04, and 008-05 were meant to be applied retroactively
or prospectively. Given the lack of uproar at that time, it is safe
to assume that the ruling was presumed to be prospective. In a
petition before the Court of Tax Appeals, RCBC said that the BIR
itself signaled that the 2004 ruling will only cover future bonds.
It is also a distinct possibility that
this ruling may have been overlooked at the time it was issued
because the bondholders were not set to receive any imputed interest
income until the bond matured six to seven years later. The banks
affected claim to be utterly surprised by BIR's stance. However, BIR
Commissioner Kim Henares strongly doubts this: “I don't believe
that banks don't know about it because if you look at the history of
the trading of that bond, right after we issued the 2004 ruling, the
trading became markedly decreased.”
A chart of the PEACe Bonds trading volumes provided by the Philippine
Center for Investigative Journalism shows that trading in the bonds
dropped to almost zero after the BIR issued its July 16, 2004 ruling.
Trading only resumed in February 2006, but only sporadically and in
much smaller volumes.
BIR Ruling No. 370-2011 dated
October 7, 2011
The current BIR ruling states that BIR
Ruling No. 007-04 makes the case that the Tax Code is clear that:
“the term
“public” means borrowing from twenty or more individual or
corporate lenders at any one time,” wherein “the word 'any'
plainly indicates that the period contemplated is the entire term of
the bond, and not merely the point of origination or issuance.”
2001 Rulings Erroneous (or Anomalous?)
Furthermore, the current ruling stated
that the 2001 Rulings took the PEACe Bonds:
“out of the
ambit of deposit substitutes and exempting it from the 20% Final
Tax, an exemption in favour of the PEACe Bonds was created when no
such exemption is found in law. Thus, the 2001 Rulings are null and
void and cannot be given legal effect for being contrary to law. It
is a basic principle in administrative law that the interpretation
given by an administrative agency cannot run contrary to the law
which it seeks to implement.”
The current ruling deemed 2001 Rulings
erroneous but given the other controversial aspects of the PEACe
bonds such as the information asymmetry, the wide bids, the vast gap
in YTMs at the point of auction to the point of sale to institutional
investors, the purported cronyism, it is easy to think of this
“error” as anomalous.
The ruling went on to state that
CODE-NGO should be held liable to pay the 20% Final Tax on interest
income it realized from its purchase of the PEACe Bonds. Had CODE-NGO
paid this tax at the time of issuance, it would have paid PHP 1.4
billion in addition to the PHP 10.169 billion purchase price of the
PEACe Bonds. But since no final tax was paid by CODE-NGO upon
issuance of the PEACe Bonds, CODE-NGO is liable to pay 20% final tax
on the entire PHP 24.3 billion discount, or approximately PHP 4.86
billion.
Retroactivity
The ruling said that CODE-NGO/RCBC may
not invoke the principle of non-retroactivity because Section 246 of
the 1997 Tax Code allows for retroactivity in cases where:
the taxpayer deliberately
misstates or omits material facts from his return or any document
required of him by the Bureau of Internal Revenue;
the facts subsequently gathered by
the Bureau of Internal Revenue are materially different from the
facts on which the ruling is based; or
the taxpayer acted in bad faith.
The BIR said that there is:
“ample legal
authority to conclude that the non-retroactivity principle does not
apply when the ruling involved is null and void for being contrary to
law, such as the 2001 Rulings. Well-entrenched are the principles
that the Government is never estopped from collecting taxes because
of mistakes and errors of its agents and there are no vested rights
in a wrong interpretation of the law.”
Wrong Target
Although the ruling found CODE-NGO
liable for PHP 4.86 billion in taxes, it decided to collect this tax
by withholding 20% of the PEACe Bonds imputed interest income prior
to its payment on the maturity date. Since neither CODE-NGO nor RCBC
holds the bonds, the parties affected will be the final bondholders,
in other words, those institutional investors who bought the bonds in
the secondary market after CODE-NGO/RCBC had sold them down.
The Department of Finance issued two
directives which compounded the problem:
The Department of Finance issued a
Memorandum dated October 11, 2011 which barred the sale and transfer
of the PEACe Bonds from October 12, 2011 until the bonds were
redeemed on October 18, 2011. Institutional investors who were
uncomfortable with the October 7, 2011 ruling could not rid
themselves of the PEACe Bonds they held.
The BIR issued Ruling No.
DA-378-2011 dated October 17, 2011 which revised the previous
October 7, 2011 ruling to withhold the taxes due not only from
CODE-NGO/RCBC but also to all subsequent bondholders. As a
consequence, all subsequent bondholders were made liable for the 20%
Final Tax.
Left Holding
the Bag
A total of nine banks have reportedly
been adversely affected. Eight of these banks, namely Banco De Oro,
Bank of Commerce, China Banking Corporation, Metropolitan Bank &
Trust Company, Philippine Bank of Communications, Philippine National
Bank, Philippine Veterans Bank, and Planters Development Bank, have
petitioned the Supreme Court to annul the October 7, 2011 BIR Ruling.
The ninth, BPI Family Bank, declined to participate in the petition
but stated that it held around 5% of the PEACe bonds.
RCBC, in a separate petition, also questioned the propriety and
legality of the BIR ruling
but did not indicate as to whether it still held some PEACe Bonds.
The eight banks asked for and received
the immediate issuance of a temporary restraining order (TRO) and/or
Writ of Preliminary Injunction. The PHP 4.86 billion tax to be
withheld was placed in escrow while the balance of PHP 30.14 billion
was paid out to the bondholders. The banks have argued that the
imposition of the 20% Final Tax on the PEACe Bonds was:
“extremely
prejudicial to the bondholders, including petitioners who relied in
good faith on the BIR declaration that the bonds are exempt from
final tax...Such unilateral imposition of the 20 percent final
withholding tax on the interest/discounts realized on the government
bonds only on the eve of its maturity with nary any prior
consultation with the petitioners and other bondholders also amounts
to confiscation of the petitioners’ property without due process...
Threatened refusal of the government to pay the full face value of
the government bonds to its contractual undertaking and material
representation at the time of their issuance, operates as a fraud on
investors to their grave or irreparable injury or prejudice, which,
in turn, adversely affects their perception of the Philippines as an
investment destination,”
According to the petitioning banks:
“The
repercussions of the Government's threatened intent of reneging on
its commitment on the Government Bonds have far-reaching implications
which are too important to ignore. There will be heightened
perception that the Philippine Capital Markets are volatile and
unpredictable...The Government will suffer from damaged credibility
in terms of investor confidence (whether current or prospective,
local or foreign) relative to the legitimacy of its commitments
which, by reason of the 2011 BIR Ruling, may now be perceived as
subject to arbitrary reversals and/or modifications.”
The petitioning banks also added that
the unilateral amendment of a material term of the contract between
the bondholder and the government was never agreed to by the
petitioners, thus a violation of the contract. Moreover, the
imposition of a 20% Final Withholding Tax (FWT) on the eve of the
bond's maturity was done “without any prior consultation with the
petitioners and other bondholders or a hearing amounted to
confiscation of the petitioners' property without due process.”
Flawed Ruling
There are also strong indications that
BIR did not give a lot of thought to the mechanism of collecting back
taxes on the PEACe Bonds. BIR collection mechanism is flawed
because:
Final Bondholders
It extracts the back taxes from
the funds that will be remitted to the final bondholders upon
maturity, while the main beneficiaries and proponents of the
erroneous 2001 rulings, namely CODE-NGO and RCBC, get away
Scot-free.
Moreover, the ruling extracts the
20% FWT irregardless of the length of time the bond was held.
Therefore, it disproportionately punishes the more recent
bondholders who will bear brunt of the taxes even though they earned
the least of the imputed interest. As an example, an investor who
decided to park PHP 1.0 million of his money in the supposedly
risk-free PEACe Bonds for a month or two before maturity will lose
14.19% of his principal even though he earned a few months of
imputed interest. Similarly, because the ruling takes away 14.19% of
the bond's redemption proceeds at maturity irregardless of the
bondholder's holding period, an investor who bought the bonds at its
accreted value one year before its maturity will lose 2.92% of his
capital instead of earning the expected 12.75% YTM on the bond.
Those bought the bonds at their accreted value and who held the
bonds longer will only lose the imputed interest and not principal.
Given that
interest rates have gone down substantially since 2001, the bonds
were most likely purchased at a premium to their accreted values,
therefore it is highly likely that investors who have held the bonds
for less than four years will suffer a loss of principal as well.
Subsequent
Bondholders
Under BIR Ruling
No. DA 278-2011 dated October 17, 2011, the BIR has found
“RCBC/CODE-NGO” and “all subsequent holders” of the PEACe
Bonds liable for the 20% FWT. This implies that the 20% FWT may be
netted out from the sale and resale of the bonds and that the
bondholder may only be liable for the taxes on the imputed interest
accreted during the time the bond was held by the investor. In other
words, an absolute 20% FWT becomes a 20% FWT proportionate to the
imputed interest earned by the bondholder.
This arrangement
is more equitable to the final bondholders. The 20% FWT would only
then cut into the imputed interest earned by the bondholder over the
life of his holding period and not into the principal, whether or not
the bond was purchased at its accreted value or at a premium to its
accreted value.
Under an absolute
20% FWT, the bond's 12.75% YTM would now range from 11.13% YTM if the
bonds were bought at time of issuance to -14.19% YTM if the bonds
were bought right before maturity. If the 20% FWT were proportionate
to the imputed interest earned, the bond's revised YTMs would not
decline so drastically: from 11.13% YTM if the bonds were bought at
time of issuance to 10.26% YTM if the bonds were bought right before
maturity.
Collection Problem
However, there is
a problem with this scenario: The government claims it does not even
know who the final bondholders are unless they come forward to claim
the redemption proceeds of the bond at maturity date (although the
Registry of Scripless Securities “RoSS” under the Bureau of
Treasury is primarily tasked with monitoring and maintaining official
records of ownership of government securities). According to BIR
Commissioner Kim Henares:
“We don't have
the list of the banks holding the PEACe Bonds. Supposedly under the
bank secrecy law, it is supposed to be confidential. The instruction
is to hold the 20% of the PHP 25 billion,”
If this is the
case, only the final bondholders would be affected. Unless the
government recreates the chain of sale and resale from CODE-NGO/RCBC
to the final bondholders, the final bondholders would have to
recreate this process via a chain of litigation, meaning the final
bondholder would have to sue the previous bondholder to collect the
20% FWT that the final bondholders are not liable for, and that
previous bondholder would have to collect from the previous
bondholder, and so on and so forth, until the chain of sale is
retraced back to CODE-NGO/RCBC, the original bondholders. Needless
to say, this would create a gigantic legal mess.
The only advantage to the current
ruling is that it reduces the cash outflow of the government by 20%.
But in the long run it will turn off potential investors because the
bond buyers, who bought the bonds in good faith, were harmed and the
bonds themselves did not prove risk free. In the future, buyers of
government securities will attach a higher risk premium to government
debt, especially government debt securities with all the extra
features, to compensate themselves for the regulatory risk that the
government will rescind these embellishments when the bonds mature,
leading to higher interest rates for the entire country.
The BIR should have assessed
CODE-NGO/RCBC for the PHP 4.86 billion in back taxes which would have
wiped-out the endowment of the PEACe Foundation and put a big dent in
RCBC's earnings and capital. But the ruling would not have angered
the rest of the investment community and the country would not have
to pay for the arbitrariness of the ruling in terms of higher debt
costs. No one else but CODE-NGO/RCBC would have been affected and
given how controversial the transaction is perceived to be even ten
years later, the action would have been seen as just.
Impact on Bank's Bottom Line
The surprise imposition of the 20%
Final Withholding Tax will affect the bottom line of the banks. None
of them have properly accrued for the presumed tax liability and none
of them have prepared themselves to receive less cash from the
redemption payment of the PEACe Bonds.
To assess this impact, an analysis was
made of the affected bank's holdings of government debt securities.
With the exception of BPI Family Bank (who already disclosed
ownership of 5% of the PEACe Bonds),
the analysis makes a critical assumption that each bank's PEACe Bonds
holdings would be proportionate to their holdings of government debt
securities as indicated in their latest available audited financial
statements.
Under
this scenario, the most adversely affected bank is Planters
Development Bank with a 4.92% hit to their capital base, followed by
Philippine Bank of Communications, with a 3.43% hit to capital,
followed by Philippine National Bank (2.42% hit), and China Banking
with a 2.06% hit to their capital. Of course, depending on the
circumstances, each bank may have much higher or much lower PEACe
Bonds holdings than dictated by their government debt securities
holdings. So this analysis, with the exception of BPI Family bank, is
just a guesstimate.
Affected
Banks
Analysis
of Impact of 20% Final Withholding Tax
on
Affected Bank Capital
As of December 31, 2010
|
Bank
|
Total
Holdings of Government Debt Securities
(In PHP
B)
|
%
|
PEACe
Bonds Holdings
(In PHP
B)
|
FWT
Due
(In PHP
B)
|
Capital
Funds
(In
PHP B)
|
Capital
Affected
(In %)
|
Banco
De Oro
|
143.26
|
29.58%
|
10.200
|
1.416
|
88.302
|
1.60%
|
Bank
of Commerce
|
14.178
|
2.93%
|
1.010
|
0.140
|
14.569
|
0.96%
|
BPI
Family Bank
|
17.279
|
3.57%
|
1.750
|
0.243
|
12.564
|
1.93%
|
China
Banking Corporation
|
67.007
|
13.84%
|
4.77
|
0.663
|
32.221
|
|
Metropolitan Bank and Trust Company
|
143.690
|
29.67%
|
10.232
|
1.421
|
95.772
|
1.48%
|
Philippine
Bank of Communications
|
13.988
|
2.89%
|
0.996
|
0.138
|
4.033
|
3.43%
|
Philippine
National Bank
|
69.906
|
14.44%
|
4.978
|
0.691
|
28.527
|
2.42%
|
Philippine
Veterans Bank
|
8.583
|
1.77%
|
0.611
|
0.085
|
5.391
|
1.57%
|
Planters
Development Bank
|
6.345
|
1.31%
|
0.452
|
0.063
|
1.276
|
4.92%
|
Total
|
484.234
|
100.00%
|
35.000
|
4.860
|
282.656
|
1.72%
|
These five, as indicated in
the table below, have a high amount of Non-Performing Assets or
Distressed Assets on their balance sheets relative to their Total
Capital Cushion, which is their ability to absorb losses from the
deterioration of the value of their Distressed Assets. These five,
namely Bank of Commerce, Philippine Bank of Communications,
Philippine National Bank, Philippine Veterans Bank, and Planters
Development Bank, have a Distressed Assets to Total Capital Cushion
Ratio greater than 100%, which indicates a heightened risk of
insolvency. A sixth bank, namely BPI Family Bank, has a ratio of
93.73%, which is borderline close to the 100% danger line.
Affected Banks
Distressed Assets to Total Capital Cushion
As of June 30, 2011
|
|
Total
Distressed Assets
(In PHP B)
|
Total
Capital Cushion
(In PHP B)
|
Distressed Assets/
Total Capital Cushion (In %)
|
| Banco De Oro Unibank |
66.86
|
109.86
|
60.86%
|
| Bank of Commerce |
34.08
|
18.57
|
183.54%
|
| BPI Family Bank |
11.78
|
12.56
|
93.73%
|
| China Banking Corporation |
18.93
|
35.38
|
53.51%
|
| Metropolitan Bank and Trust Co. |
61.2
|
91.21
|
67.10%
|
| Philippine Bank of Communications |
9.6
|
6.1
|
157.41%
|
| Philippine National Bank |
67.33
|
38.26
|
175.98%
|
| Philippine Veterans Bank |
10.79
|
6.1
|
176.82%
|
| Planters Development Bank |
13.53
|
3.76
|
360.14%
|
| Total |
294.1
|
321.8
|
91.39%
|
NPL Washing
The high incidence of distressed and
near distressed banks (six out of nine banks) indicates that these
banks may have used the PEACe Bonds for their ability to “window
dress” bank NPLs (see a previous October 7, 2011 post “Revisiting
the PEACe Bonds under the section “What else can RCBC do with the
PEACe Bonds?,
http://systemisbroken.blogspot.com/2011/10/revisiting-peace-bonds.html).
Most likely, the affected banks used
the PEACe Bonds to wash NPLs from their own books in cashless
debit-credit accounting transactions.
From “What else can RCBC do with the
PEACe Bonds?:
For instance, an
NPL that is on the bank's books for PHP 1.0 billion may only have a
recoverable value of PHP 500.0 million (Step 1). The bank can sell a
PHP 1.0 billion Face Value PEACe Bond (with a discounted value of PHP
500.0 million) to the delinquent borrower (Step 2). But on the books
of both the bank and the delinquent borrower, the amount owed to the
bank is recorded at the face value of the PEACe Bond, which is PHP
1.0 billion (Step 3). The bank then simultaneously buys back the
PEACe bond from the delinquent borrower (Step 4). The repurchase of
the PEACe Bond creates a payable on the right side of the bank's
balance sheet and puts the bank in a situation where its has itself a
shadow indebtedness to the borrower in the same exact amount as the
NPL. The bank then offsets its account payable to the borrower
against the NPL (of the same amount) of the delinquent borrower on
the asset side (Step 5). This way, the indebtedness of the borrower
remains on the accounts receivable portion of the asset side of the
bank's balance sheet but it is no longer an NPL and is not connected
to a loan. Thus the bank's balance sheet is laundered in a way by
simply removing the stain of non-collectibility or ageing. The new
receivable derived from the sale and repurchase of the PEACe Bond is
after all exactly that - new.
Overstated Capital
Although the estimated impact of the
abrupt imposition of the 20% FWT on bank capital is estimated to be
only a 1.72% reduction in bank capital, five of the banks in question
are distressed and their capital is already overstated. In some
cases, the overstatement is so severe, that any additional reduction
in capital from the 20% FWT may severely impair the bank's actual
capital beyond the point of solvency. (See “BSP's Ampaw Accounting
System”
http://bancofilipinofailure.blogspot.com/2011/09/bsps-ampaw-accounting-system.html)
The reason for the overstatement is
that the BSP has granted regulatory relief to these banks and allowed
them to:
Defer the booking of realized
losses arising from:
The Sale of Non-Performing Loans
to Special Purpose Vehicles (SPVs);
The Acquisition by a Bank of Bank
of another weaker Bank with substantial Non-Performing Assets;
Large Credit and Impairment Losses
on financial assets of banks that are undergoing a BSP-approved
Rehabilitation Plan
Amortize the realized losses over
a period of 10 to 20 years
As a result of this regulatory relief,
losses were not realized on these banks books. Instead, the
unrealized losses were swept into the “Other Assets” accounting
bucket as deferred charges. Although the BSP mandated regulatory
relief allowed the banks to look stronger than they are, such
bookings do not comply with Philippine Financial Reporting Standards
(PFRS). As a result, banks that availed of the regulatory relief
show a qualified auditor's opinion that:
States that the bank's booking of
deferred charges does not comply with the provisions of
GAAP/PFRS/PAS
Discloses the impact such
compliance would have on the bank's financial statements had the
losses been recognized.
Banks with Qualified Auditor's Opinions on
Deferred Charges
As of December 31, 2010
|
Bank
|
Deferred Charges
|
Unadjusted Capital Funds
|
Adjusted Capital Funds
|
% Reduction in Capital Funds
|
| Bank of Commerce |
PHP 4.4 B
|
PHP 7.6 B
|
PHP 3.2 B
|
57.90%
|
| Philippine Bank of Communications |
5.9 B
|
3.6 B
|
-2.3 B
|
163.90%
|
| Philippine National Bank |
5.6 B
|
33.3 B
|
27.7 B
|
16.80%
|
| Philippine Veterans Bank |
1.1 B
|
5.0 B
|
3.9 B
|
21.70%
|
| Planters Development Bank |
1.6 B
|
3.7 B
|
2.1 B
|
43.20%
|
| Total |
PHP 18.6 B
|
PHP 49.6 B
|
PHP 34.6 B
|
30.24%
|
Conclusion
Although the Aquino Administration has
given some thought as to the errors of the 2001 Banez rulings on the
PEACe Bonds, it seems that it has not given much thought as to the
methods by which these “errors” could be rectified. Instead of
targeting CODE-NGO/RCBC, the main beneficiaries and proponents of the
2001 rulings, for collection of unpaid taxes, it chose to extract
these back taxes from the final bondholders. More so, it did this
in a manner that disproportionately punishes the the investors who
acquired the bonds on a more recent basis. The 2011 BIR rulings are
undoubtedly flawed. As to whether they will weaken an already
weakened banking system remains to be seen. But they have already
achieved the unintended consequence of seriously damaging the
government's credibility not only with regards to the sanctity of its
contractual obligations but also with regards to its ability to
thoroughly think through the ramifications of its decisions.
