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Monday, October 16, 2017

Have Philippine Real Estate and Construction Loans Reached a Permanently High Plateau? - As of June 2017

Have Philippine Real Estate and Construction Loans reached a permanently high plateau? Real Estate and Construction Loans as a percentage of Total Loan Portfolio (TLP) rocketed past its historical range of 12.6% to 16.6% of TLP sometime in 2011.  That ratio peaked at 20.55% as of September 2013 but has bottomed out at 18.61% of TLP as of December 2014. In 2016, this ratio has climbed back up to 19.65% as of June 2017.

Now, are we up to the levels of the previous real estate boom? (as in mid 1990s to 1997?) Honestly, we don't know.  BSP data only goes as far back as 1999 when the previous real estate bubble had already burst and the financial system was most likely deleveraging as evidenced in this chart:

Has the Philippine Real Estate Bubble Already Burst?

Is There a Real Estate Bubble in the Philippines?

Are Philippine Real Estate Loans Out of Whack?

Friday, September 8, 2017

Construction Gross Value as a Percentage of GDP Is at an All Time High! - Updated as of 2nd Qtr. 2017

Last May 4, 2015, we noted that Construction Gross Value (Construction GV) at 11.21% as of the year-end 2014 was already well above its historical average of 9.65% of GDP since 1990.  This ratio has run at an above average rate since 2009 and has already eaten away at the "cumulative underhang" or underinvestment in construction that has taken place since 2004, when the excessive investment in construction that took place in the mid to late 1990's was being absorbed.

As of the 2nd Qtr of 2017, Construction GV as a percentage of GDP now stands higher at 14.31% of GDP - an all-time high for the past 25 years.  But the real story is that Cumulative Construction GV has gone well above equilibrium and now stands at 7.2% above equilibrium, a rise of 7.1% in just eighteen months.  Given all the planned new projects that are already at the execution stage, the momentum in Construction Investment will continue.

Tuesday, August 29, 2017

Philippine House Prices Hit New Peak While Sales Volumes Drop Sharply in the 1st Semester of 2017

In the first half of 2017, the Philippine House Price Index hit a new peak of 232.41. This is 3.09% higher than the previous peak of 225.44 posted in the first quarter of 2017 and 8.05% on a year-on-year basis. From 2004 to the present, the Philippine House Price Index has climbed much faster than inflation. The gap between current house prices and house prices adjusted for inflation stands at its highest ever, 66.52%.  Meaning, had house prices merely tracked inflation since 2004, the Philippine House Price Index would now stand at just 165.89 as of the first half of 2017.

Source: Collier's International Philippines, Makati CBD Prices

Sales volumes, as indicated by the HLURB Licenses to Sell Statistics, have shown a dramatic slowdown in the first half of 2017. Annualized Sales Volumes now stand at 171,172 units for the first half of 2017. This is off by 34.20% since year-end 2016.  This sales volume now stands at slightly higher than the 170,379 level posted at year-end 2011 and below the 172,967 level posted almost ten years ago at year-end 2007.  If sales volumes do not pick up in the second half of 2017, the long-term upward trend in ever increasing sales volumes that has been in place since 2001 would have been broken, indicating a real estate bear market is imminent.

Source: HLURB Licenses to Sell

Sunday, August 20, 2017

Comelec Chairman Andy Bautista"s PHP 1 Billion in Unexplained Wealth May Just Be the Tip of the Iceberg; Most of the Wealth May Lie Offshore

Much has been made in the media of Comelec Chairman Andy Bautista's Php 1 billion in unexplained wealth. Both the mainstream media and the blogosphere have focused on his humongous deposits with Luzon Development Bank (LDB), spread out through as many as 35 different accounts with the same bank. It is understandable for the general public to latch on to Andy's LDB deposits. It's something that the public can easily grasp and relate to. Ordinary citizens have passbooks of their own. Passbooks are also admissible as prima facie evidence of ill-gotten wealth in a court of law.

Little discussion has revolved around the offshore corporate investment vehicles found in Andy's possession by his estranged wife, Patricia Bautista. Not many people are familiar with tax havens. It is a shadowy world inhabited by the extremely rich and the extremely corrupt. Just ask Andy Bautista. He did, after all, spend almost five years in the PCGG going after Marcos wealth hidden in offshore trusts. But it is here that the real wealth may lie.


Because they are "almost" perfect vehicles for evading taxes and concealing ownership of assets. They are routinely used by gangsters and dictators as well as by spouses seeking to hide wealth from their wives in an impending divorce. Tax havens are secretive, anonymous, and almost downright impenetrable. Half of the world's trade passes through tax havens. Eight percent of the world's wealth resides in tax havens. For developing countries like the Philippines, as much as 20% of the country's wealth resides in tax havens. Tax havens, therefore, are no laughing matter.

Offshore companies are easy to form. Company formation can take as little as three days and can cost as little as US $1,000.00. Companies can be started from scratch or bought off the "shelf" in the form of a dormant ready made company. Bank accounts can be formed in someone else's name, making it almost impossible to trace to the original owner. Company shares of stock can be in the form of bearer shares wherein the name of the owner/holder is not included in a physical stock certificate, concealing the ultimate beneficial owner. For as little as $500.00, company directors/officers can be appointed for you. These very same directors can sign a power of attorney handing control of the company back to you and thus remaining completely ignorant of your company's operations. All this serves to provide a deep level of secrecy that is so effective at hiding wealth, especially ill-gotten wealth.

Secrecy is paramount. Secrecy is often the sole reason that a tax haven exists. The more secretive a tax haven is deemed to be, the more dubious the source of money. The Tax Justice Network, a watchdog group focused on tax havens, has compiled a Financial Secrecy Index that rates the secretiveness of various tax havens. The higher the score on the secrecy index, the more impenetrable and untraceable the money is. The Philippines, for instance, has a secrecy index score of 63. Switzerland, the biggest and most well-known tax haven, scores a high 73.

Andy's Offshore Companies

All three of Andy's offshore companies were formed during Andy's time as PCGG Chairman. Little detail is known about them other than what was declared in Patricia Bautista's affidavit.

The first, called Bauman Enterprises Limited (Bauman), was incorporated in the British Virgin Islands (BVI) on September 29, 2010 - a mere six days after Andy Bautista assumed the office of PCGG Chairman on September 23, 2010. BVI is a well known tax haven. Around 500,000 or 40% of the world's offshore companies are incorporated in BVI. The BVI has a secrecy score of 60, slightly lower than the Philippines. Bauman has a bank account in Singapore, another well-known tax haven. The name Bauman sounds like a contraction of Bautista Management and it is not clear if Andy himself was listed as an incorporator or board member/trustee.

The second vehicle, Mantova International Limited (Mantova), was formed in Brunei Darussalam on April 26, 2011 - a mere seven months after Bauman was born and Andy"s assumption of the PCGG Chairmanship. Brunei is not well known as a tax haven. Instead it is well known for its oil reserves and the riches that oil has brought to its flamboyant King. Brunei's secrecy score is an impenetrable 83, one of the highest in the whole index.

The third vehicle, Mega Achieve Inc., was incorporated in Anguilla, a British Overseas Territory in the Carribbean on July 15, 2014, some three years after the birth of Mantova and towards the waning days of Andy's PCGG Chairmanship. Anguilla's secrecy score is 69, lower than Switzerland's but higher than BVI's.

CompanyLocationDate of IncorporationBank AccountSecrecy IndexGlobal Scale Weight
Bauman Enterprises LimitedBritish Virgin Islands09/29/10Bank of Singapore60.281
Mantova International LimitedBrunei Darussalam04/26/11NA83.000
Mega Achieve IncAnguilla07/15/14NA69.002

Could these be "Shelf" Companies?

Did Andy acquire these companies while he was in PCGG or during his current tenure in the Comelec? Again, we don't know. But a scan of ICIJ's Offshore Leaks Database shows many companies with similar names but formed in other tax havens. Most of them are defunct, having been deactivated long before Andy assumed any government post. Here are some of the closest:

CompanyLocationDate of IncorporationDate of DeactivationIntermediaryOfficer
Mantova Co. Inc.Bahamas11/06/9212/31/93Cititrust (Bahamas) Limited
Bauman LimitedBahamas07/16/9310/31/97Harry B. Sands Lobosky
Mega Achieve Holdings LimitedSamoa10/07/1302/15/15Markland Secretarial Services LimitedYang Hanwan/Mossfon Subscribers Ltd

The similarity of names to the ones in Andy's possession is a strong indication that Andy could have purchased the companies "off the shelf" and in ready made form from a well known purveyor of offshore companies such as Mossack Fonseca, a Panamanian law firm that was subject to a massive information leak in 2016. Quite a few world leaders have already been outed as users of offshore companies. The Prime Minister of Iceland was forced to resign when a previously undisclosed offshore company linked to him popped up in this database.

Should Andy do the same?

Saturday, August 12, 2017

Comelec Chairman Andy Bautista Placed His Unexplained Wealth in a Failing Bank

Besieged  Comelec Chairman Andy Bautista claimed in an interview with ABS-CBN's Karen Davila (beginning at 21:00 of the above video) that he had been acting as "the designated family treasurer" for his parents and siblings since as late as the 1990s.

“Most of [it] belong[s] to my parents, my brother and my sister,” Bautista told the Inquirer. He was referring to his brother, Martin, and sister, Susan Bautista-Afan. Most of the passbooks were in the name of Bautista and his parents. At least one showed the name of Susan and another was a joint account with Patricia. Martin’s name was not on any of the passbooks in Patricia’s possession
Bautista said Martin was doing well as a doctor in the United States, while Susan also earned substantially when she lived in United States. Susan, a dual citizen, is now with ABS-CBN Foundation.

In a subsequent interview with GMA News, brother Martin Bautista claimed that he had at least US $1.75 million (around Php 87.5 million) with his brother Andy, earned from his successful medical practice in the US.

This information begs several questions:

Why was Andy Bautista continuing to act as a "designated family treasurer" even after he assumed very high profile government posts since 2010?

As an accomplished legal professional, Andy should be very cognizant that any money linked to him, whether from his siblings or parents, must be beyond reproach. As the former head of the PCGG, whose chief job is to go after the hidden wealth of the Marcoses, Andy chased after their money trail (which has long gone cold) and would go after any and possibly all leads that linked onshore and offshore bank accounts to the Marcoses. Was he not aware that these bank accounts could be construed as unexplained wealth? Maybe he did not think that the same standards he applied to the Marcoses could also be applied to him? Or perhaps the lessons of the Corona impeachment, where legitimately obtained assets that remain undeclared in his SALN could be severe grounds for impeachment, did not sink in?

Why didn't Andy Bautista create some form of "blind trust" for his family's money, that would erect a legal barrier between him and his family's money? As a top lawyer, he could have possibly drawn up the trust himself or gotten help from his extensive network in the legal profession.

Why didn't Andy Bautista just hand off the management of his family money to another competent financial professional when he assumed government posts way back in 2010?

As a former head of the Kuok Group Philippines and as a former international lawyer specializing in mergers and acquisitions and/or project finance, Andy Bautista would have had the network to entrust this matter to another very capable finance professional.

Why did Andy Bautista put a significant chunk of his family money in Luzon Development Bank (LDB), a small development bank?

One of the chief tenets of a treasurer is to manage risk. As designated family treasurer, he was tasked with three things:

  1. Preservation of Capital
  2. Liquidity
  3. Growth
Preservation of Capital

A cursory look at LDB's published statement of financial condition as of March 2017 would reveal that the bank is not very stable.

First of all, it is losing money at an annualized rate of -35.01% as of the first quarter 2017. At Php 620.88 million, its Gross Non-Performing Loans (Gross NPLs) is almost twice its Stockholder's Equity of Php 345.43 million. So any large write-off of these NPLs could severely impair a very large chunk of its equity. As of March 2017, LDB's Total Capital Adequacy Ratio (Total CAR), the BSP's preferred measure of financial strength, stood at 6.74, barely above BSP's minimum of 6.00 and way below BSP's recommended minimum of 10.00.

LDB has routinely been flagged by this author as one of the Top Distressed Banks in the Philippines since March 2014. As of March 2017, the ratio of its Distressed Assets to its Total Capital Cushion is 182.24%, significantly above the threshold of 100% at which a bank is considered risky.

If and when the bank goes bust, the deposits of Andy's family would be insured up to a maximum of Php 500,000.00 per depositor. So, if the bank goes bust, Andy's family deposits are insured for less than 1% of what he is purported to have just in LDB.


With only Php 5.75 billion in Assets and only Php 5.07 billion in deposits, LDB is a small bank. By depositing anwhere from Php 200 million to as much as Php 329 million in just one bank, these deposits would amount to as much as 3.94% to 6.57% of the bank's deposity liabilities. This is a fairly sizeable position in the bank. Moreover, as of March 31, 2017, the bank only had Php 141.83 million in cash. So, any substantial withdrawal (like Php 50 million or more) would cause the bank some cash flow problems. It would take a few days for the bank to withdraw some of its reserves with the Philippine Central Bank (BSP) to fund a substantial withdrawal by the Bautista family.


Since June 2013, LDB's deposits grew from around Php 2.54 billion as of June 2013 to as much as Php 5.22 billion just three years later - June 2016.

As a consequence of this rapid growth in deposits, it's loan portfolio grew very fast too, from just Php 1.79 billion as of June 2013 to as high as Php 3.49 billion in March 2015. 

However, the growth in LDB's loan portfolio was outpaced by the rapid growth in NPLs. As of June 2013, only 11.67% of the bank's Total Loan Portfolio consisted of NPLs. Today, as of March 2017, that figure now stands at its highest ever: 20.35% of Total Loans.

Since March 2015, LDB began to lose money at an alarming rate. Its Return on Equity dropped to a negative 37.77% annualized rate and has had a negative 30% handle since then.

As a result of its massive losses, LDB's Stockholder's Equity is a shadow of its former self.

Not surprisingly, its Capital Adequacy Ratios, BSP's preferred indicator of financial strength, has consistently gone downhill and has fallen below BSP's own recommended minimum of 10.00%.

Lately, its Distressed Asset Ratio has hit a new high and has climbed above 100%, the threshold at which a bank is considered risky, since March 2015.

What could explain why Andy Bautista put so much money in LDB? Thinking Pinoy has advanced one theory.

But another explanation could be much more prosaic. It's possible that LDB that in this low interest rate environment, the bank was not earning much with a Return on Equity of 1.26% as of September 2013. The bank might have been forced to jack up rates on deposits to enlarge its deposit base. That would have attracted a lot of depositors, including the deposits from Andy Bautista's family.  But LDB had to earn a spread over its jacked up rates, meaning the interest rates on its loans would have been jacked up as well. But the massive growth in deposits meant that this money had to be lent out and soon. Its lending standards could have gone down or the only borrowers who would be willing to take up the higher interest loans would have been the riskier ones. Hence, the massive rise in NPLs and losses for LDB.

Now where have we heard this story before?

Friday, July 21, 2017

A Tale of Two Markets: China vs. Hong Kong Residential Real Estate

Home Prices in China, as measured by Shanghai Home Prices, have recently begun to plateau, signifying a possible slowdown in the real estate sector for 2017. 


Hong Kong Home Prices have resumed their upward trend after dipping in 2016 and have hit new highs as of the first quarter of 2017.

Both real estate markets have surpassed their inflation adjusted levels by a very wide margin.

What happens next is anyone's guess. Stay tuned.

Related Links:

How low can Hong Kong Property Prices Go? Some Clues from the Not Too Distant Past.

After a 10% Market Decline in Late 2015 to Early 2016, Hong Kong Home Prices Resume Their Relentless Upward Trend in late 2016

Friday, July 14, 2017

The (Un)Steady State of Philippine Real Estate in 2016

At 109.77%, 8990 Holdings still has the most Real Estate Receivables relative to its Stockholder's Equity in 2016. Next is Century Properties at 70.49% of Stockholder's Equity, followed by Ayala Land at 46.92% of Stockholder's Equity.

Naturally, 8990 Holdings still has the most problematic Real Estate Receivables. Problem Real Estate Receivables amount to 11.10% of its Stockholder's Equity as of 2016. Believe it or not, this figure is way down from the 20.40% it posted in 2015.  Ayala Land's Problem Real Estate Receivables amount to 6.72% of its Stockholder's Equity in 2016. Neck and neck for third place are SM Prime Holdings and SM Investments with Problem Real Estate Receivables amounting to 3.68% and 3.61% of their respective Stockholder's Equity.

 SM Prime Holdings also holds the dubious distinction of having the highest percentage of Past Due But Not Impaired Real Estate Receivables relative to Total Real Estate Receivables in 2016. This is closely followed by Ayala Land with 14.63% of its Real Estate Receivables in Past Due status. Both Vista Land and 8990 Holdings have similar ratios with 9.58% (Vista Land) and 9.44% (8990 Holdings) of its Real Estate Receivables falling Past Due in 2016.

Related Posts:

Ayala Land's Real Estate Receivables Problem Has Gotten Worse, Not Better

8990 Holdings Inc.'s 2016 Annual Report: What a Difference an Auditor Makes!

8990 Holdings Inc.'s Impaired Installment Contracts Receivable (ICRs): The Pig Has Finally Broken Out of the Python!

The Philippine Real Estate Bubble Has Also Burst For... Ayala Land!

The Philippine Real Estate Bubble Has Also Burst for Vista Land

The Philippine Real Estate Bubble Has Already Burst for HOUSE (8990 Holdings, Inc.)

Friday, July 7, 2017

The Unbearable Volatility of BSP's Residential Real Estate Price Index

Perhaps because the index has been in its infancy but according to BSP's Residential Real Estate Price Index (RREPI) investors in residential real estate have been experiencing a nausea-inducing roller-coaster ride in terms of asset prices.

The swings in the areas outside the National Capital Region (Ex-NCR) are particularly problematic. Within the past two years, RREPI - All Types for the Ex-NCR area has swung from a high of 125.7 in the second quarter of 2016 from a low of 106.2 as of the 2nd Qtr. of 2015, an increase of 15.51% in just one year. Then in the next quarter, the index drops by 10.74% to 112.2 as of the 3rd Qtr of 2016. The RREPI - All Types index for the Ex-NCR area now rests at 116.8 as of the 1st Qtr 2017 or 4.10% higher than what it was just two quarters ago.

This volatility of the Ex-NCR RREPI-All Types has influenced large swings in the overall Philippine RREPI-All Types. Since its inception, the nationwide index has swung 10.18% from bottom to top. No doubt, the volatility of the Philippine-wide RREPI-All Types was tempered by the low volatility of the NCR RREPI - All Types, which fluctuated by only 2.63% from peak to trough.

The same dynamic has been playing out as you drill down into the index's sub-sectors, whether they be Single Detached Homes, Duplex, Townhouses, or Condominiums. Ex-NCR is volatile while NCR has smoother fluctuations, leading to a more volatile nationwide index for each sub-sector.

The Philippines was one of the last countries in the ASEAN to institute a National Residential Real Estate Index. Other countries have done this much sooner. However, late is better than never. In the meantime, for planning purposes, the index has limited utility.

Tuesday, July 4, 2017

Great Depression vs. Great Recession GDP Growth Rates - Third Estimate of the First Quarter of 2017

Last Thursday, June 29, 2017, the Bureau of Economic Analysis released their third estimate of 2017's first quarter GDP growth rate: 1.40%. For the fourth quarter of 2016, GDP grew by 2.1%.

The economic recovery from the Great Recession has been downright sluggish, never taking off beyond the 3.00% growth rate that signals a robust economic recovery and always flirting with the 1.00% growth rate that signals a stalling economy.

On a nominal basis, the economy is 31% larger than what it was ten years ago. In real terms, it's just 13% larger.

On a per capita basis, real GDP grew by only 5.34% for the past ten years, for a compounded annual average growth rate of only 0.52% per annum - far less than the so-called "Hindu Rate of Growth" threshold of 1.30% per annum. This growth rate is so slow that it is almost imperceptible.

To top it all, the growth has not been evenly distributed. As of year-end 2015, Real Median Household Income stood at $56,516 or 1.58% below the Real Median Household Income of $57,423 in 2007 and 2.41% below that of 1999 ($57,909). Almost all the gains in the economy have been going to the upper echelons of US society.

Friday, June 23, 2017

Construction Gross Value as a Percentage of GDP Is Near a 25 Year High! - Updated as of 1st Qtr. 2017

Last May 4, 2015, we noted that Construction Gross Value (Construction GV) at 11.21% as of the year-end 2014 was already well above its historical average of 9.65% of GDP since 1990.  This ratio has run at an above average rate since 2009 and has already eaten away at the "cumulative underhang" or underinvestment in construction that has taken place since 2004, when the excessive investment in construction that took place in the mid to late 1990's was being absorbed.

As of the 1st Qtr of 2017, Construction GV as a percentage of GDP now stands higher at 12.01% of GDP -near the all-time high of 12.22% (posted in the 4th Qtr 2016) for the past 25 years.  But the real story is that Cumulative Construction GV has gone well above equilibrium and now stands at 4.9% above equilibrium, a rise of 4.9% in just fifteen months.  Given all the planned new projects that are already at the execution stage, the momentum in Construction Investment will continue.

Friday, June 16, 2017

Singapore Continues its Controlled Slide of House Prices While Philippine House Prices Hit New Highs in 2017 Q1

Almost all countries discussed in this blog post, with the exception of Thailand, have been experiencing rapid growth in home prices that have outstripped inflation by a wide margin.  The gap between home prices and their inflation adjusted levels are at the widest ever, particularly in Singapore, Hong Kong, and the Philippines.


Singapore's home prices have now been declining for fourteen straight quarters, which, according to Bloomberg, is the longest losing streak in five years.  Home prices are still  66.32% above their year-end 2004 levels. Overall prices levels, as measured by inflation have just increased by 29.19% since year end 2004.  In other words, for the past ten years, Singaporean home prices have outpaced inflation by almost than 40 percentage points.


Neighboring Malaysia's House Price Index now stands at 262.42 as of the third quarter 2016, 162.42% higher than year-end 1998 levels.  General price levels as of the third quarter 2016 are only around 48.41% higher than their year-end 1998 levels.


In Thailand, which has been experiencing political turmoil for some time, home prices have remained essentially flat since the end of 2004. Home Prices ended 2013 with the index at 100.54, just 0.54% higher than the end of 2004, but showing a substantial recovery since the recent low of 74.08 posted in the third quarter of 2009. Since 2013, home prices have rebounded to 114.50 or 14.50% higher than its year-end 2004 levels, way below its expected inflation adjusted levels. General Price levels are 34.51% above their year-end 2004 levels. In other words, Thailand Home Prices have lagged inflation by as much as 20.01% since their year-end 2004 levels.


Meanwhile, in Indonesia, home prices have shown no signs of slowing down their upward trajectory.  In fact, prices are now at 146.32 or 46.32% above their first quarter 2007 levels. Inflation, however, has marched higher.  General prices are 77.52% above first quarter 2007 levels, lagging inflation by 31.20%.


Philippine house price index stands at 225.44% as of the first quarter 2017 or over 125.44% above their year-end 2004 levels.  Philippine home prices have posted one of the largest 10 year gains among all the countries considered in this blog post.  Philippine home prices have outstripped inflation by more than sixty percentage points.  General prices stood at 164.63% or 64.63% above their year-end 2004 levels. Like Indonesia, Philippine home prices have so far no signs of slowing down their upward trajectory for the foreseeable future.   The question is, is this momentum sustainable?  Or will the Philippines and Indonesia follow its ASEAN neighbors, Singapore, Malaysia, and Thailand, in exhibiting plateauing or declining house prices?  That remains to be seen.

Friday, June 9, 2017

Ayala Land's Real Estate Receivables Problem Has Gotten Worse, Not Better

At around this time last year, in a blog post entitled "The Philippine Real Estate Bubble Has Also Burst For... Ayala Land!", we wrote about how the company's past due installment contract receivables (ICRs) for real estate have quadrupled in 2015 from Php 1.95 billion in 2014 to Php 8.80 billion in 2015. Much of the past due ICRs were severely past due - over 120 days past due.

Total past due ICRs comprised as much as 13.4% of the entire Real Estate ICR portfolio in 2015.

Today, that figure is even higher. As of year-end 2016, 14.63% of Real Estate ICRs are now past due. More than one in seven Real Estate ICRs is now past due.

The credit quality has gotten worse, not better.

The amount of severely past due Real Estate ICRs (over 120 days past due) has grown by almost 80% in just one year, from Php 3.58 billion in 2015 to Php 6.43 billion in 2016.

Real Estate ICRs over 120 days past due now comprise 8.11% of total Real Estate ICRs in 2016.

Past Due But Not Impaired Real Estate ICRs now comprise 6.72% of the company's Stockholder's Equity as of 2016, up from 5.88% in 2015 and more than four times the 1.60% level the company posted in 2014.

Despite this, the company's Impaired Real Estate ICRs have dwindled to zero in 2016. Around Php 9.55 million of Impaired ICRs, which have been impaired since at least 2012, were written off in 2016.

Sooner or later, the company will have to recognize these past due Real Estate ICRs as impaired and the impairments will have to be written off... someday. We just don't know when. But if Ayala Land, one of the country's most prestigious and largest real estate companies, cannot handle its growing Real Estate ICR problem amid a booming economy, this does not bode well for the rest of the industry.

Friday, June 2, 2017

8990 Holdings Inc.'s 2016 Annual Report: What a Difference an Auditor Makes!

On May 18, 2016, 8990 Holdings Inc. finally filed its 2016 Annual Report with the Philippine Securities and Exchange Commission as well as the Philippine Stock Exchange. The said Annual Report looked fine, albeit slightly disappointing. The company's "problem accounts," meaning both Past Due But Not Impaired as well as Impaired Installment Contract Receivables had gone down by almost 40% (39.54% to be exact) or Php 1.39 billion since 2015.  The pig was almost out of the python!

It was all good. Except for one thing. The so-called "problem accounts" for 2015 had undergone a major revision as well in the 2016 Audited Financial Statements. What was once in the "Impaired" column was reclassified as "Past Due But Not Impaired", resulting in an astounding 95.80% reduction in Impaired Installment Contract Receivables in 2015. (Note: This is not the first time this has happened)

What could account for the difference? For one thing, there was a change in external auditors last July 29, 2016 from Sycip Gorres Velayo & Co. (SGV) to Punongbayan & Araullo (Punongbayan).

"The appointment of the external auditors of the Company is presented for approval of the stockholders annually. In the last annual stockholders' meeting held on 25 July 2016, the Management considered the options available to the Company in relation to the appointment of external auditors. Instead of renewing the engagement of the former external auditors, the Management recommended the delegation to the Board of Directors of the authority to appoint the external auditors for the fiscal year 2016. Pursuant to such authority, the Board appointed Punongbayan & Araullo."

And Punongbayan saw things differently. They largely deferred to management's judgment on the matter, subject, of course, to their own audit procedures.

From Punongbayan's 2016 Auditor's Report:

Realizability of Installment Contract Receivables 
Description of the Matter 
As at December 31, 2016, the Group's installment contract receivables amount to Php 21.1 billion, net of allowance of impairment of Php 143.5 million, which details are disclosed in Note 9 to the consolidated financial statements. The installment contract receivables, which represent 44% of the total assets, are the most significant assets of the group at the end of the reporting period. The Group's management exercises significant judgment and use subjective estimates in determining when and how much to recognize impairment loss on receivables. These judgment and estimates, which are detailed in the Group's significant accounting policies, judgments and estimates in Notes 2 and 3 to the consolidated financial statements, including the identification of objective evidence that such assest is impaired (e.g. indications of significant financial difficulty, default or delinquency in interest and principal payments, etc. of the buyer) and estimation of future cash flows based on payment history, past due status and term, including the net realizable value of the related real estate inventory, which serves as collateral. 
Because of the significance of the amounts involved and subjectivity of managment's judgment and estimates used, we identified the valuation of installment contracts receivables to determine its realizability as at the end of the reporting period as a significant focus area during our audit. 
How the Matter was Addressed in the Audit 
Our audit procedures to determine the realizability of installment contract receivables and the adequacy of the allowance for credit losses on installment contract receivables included, among others, the following:
  • obtaining an understanding and testing the application of the Group's policy on impairment of installment contract receivables; 
  • checking the mathematical accuracy of the aging of installment contract receivables and testing the accuracy of the aging classification of selected buyer's accounts; and 
  • determining the net realizable value of real estate inventories collateralized against selected past due or delinquent buyers' accounts.
And this is how management makes those judgments:

From Note 2 of the 2016 Audited Financial Statements:
Impairment of Financial Assets 
The Group assesses at each reporting date whether there is objective evidence that a financial asset or group of financial assets is impaired. A financial asset or a group of financial assets is determined to be impaired if, and only if, there is objective evidence of impairment as a result of one or more events that has occurred after the initial recognition of the asset (an incurred loss event) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or the group of financial assets that can be reliably estimated. Evidence of impairment may include indications that the borrower or a group of buyers is experiencing significant financial difficulty, default or delinquency in interest or principal payments, the probability that they will enter bankruptcy or other financial reorganization and where observable data indicates that there is a measurable decrease in the estimated future cash flows, such as changes in arrears or economic conditions that correlate with defaults. 
Loans and receivables 
For loans and receivables, the Group first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant. If there is objective evidence that an impairment loss has been incurred, the amount of loss is measured as the difference between the asset's carrying amount and the present value of the estimated future cash flows (excluding future credit losses that have not been incurred). The carrying amount of the asset is reduced through the use of an allowance account and the amount of loss is charged to profit or loss in the consolidated statement of comprehensive income. Interest income continues to be recognized based on the orignal EIR of the asset. Financial assets, together with the associated allowance accounts, are written off when there is no realistic prospect of future recovery and all collateral has been realized. If subsequently, the amount of the estimated impairment loss decreases because of an event occuring after the impairment was recognized, the previously recognized impairment loss is reversed. Any subsequent reversal of an impairment loss is recognized in the profit or loss, to the extent that the carrying value of the asset does not exceee its amortized cost at the reversal date. 
If the Group determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses for impairment. Those characteristics are relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtors' ability to pay all amounts due according to the contractual terms of the assets being evaluated. Assets that are individually assessed for impairment and for which an impairment loss is, or continues to be recognized are not included in a collective assessment for impairment. 
For the purpose of a collective evaluation of impairment, financial assets are group on the basis of such credit risk characteristics as type of counterpary, credit history, past due status and term. Future cash flows in a group of financial assets that are collectively evaluated for impairment are estimated on the basis of historical loss experience for assets with credit risk characteristics similar to those in the group. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss estimates and actual loss experience.
From Note 3 of the 2016 Audited Financial Statements:
Significant Accounting Judgments and Estimates 
Impairment of Loans and receivables 
The Group reviews its receivables at each reporting date to assess whether an allowance for impairment losses should be recorded in the consolidated statement of financial position and any changes thereto in profit or loss. In particular, judgment by management is required in the estimation of the amount and timing of future cash flows when determining the level of allowance required. Such estimates are based on assumptions about a number of factors including, but are not limited to payment history, past due status and term. Actual results may also differ, resulting in future changes to the allowance. 
The disclosures on the carrying values of trade and other receivables, and amount of impairment losses recognized and the details of receivables written-off are in Note 9.
The Group had directly written-off receivables amounting to Php 3.8 million in 2015  (nil in 2016 and 2014), recorded as Write-off of assets under Operating Expenses in the 2015 consolidated statements of comprehensive income (Note 23).

As of December 31, 2016 and 2015, trade receivables used as collateral to secure borrowings from banks amounted to Php 4.4 billion and Php 3.8 billion, respectively (Note 18). 
Had those impairments continued in 2016, 8990 Holdings most likely would have been forced to write-off a significant chunk of the impaired assets. After all, the longer an asset is impaired, the lower its realizability.

It could very well be the case that a fresh new set of eyes was all that was needed to settle the matter. Maybe 8990 Holdings Inc.'s fortunes are improving and these assets have improved in their realizability. But there are also some indications that these impaired assets have begun to hamper the company's liquidity and growth.

 For instance, the company barely grew in 2016. For all of last year, the company grew by 2.31% from Php 10.63 billion in revenues in 2015 to just a smidge over Php 10.87 billion in 2016.  This happened despite being a dominant player in mass housing in a red-hot economy which grew by 6.8% in real terms, the fastest in three years. Moreover, the housing market itself was robust both in terms of sales volumes and house prices.

The company likes to blame delays in securing permits as a major factor in its anemic growth in 2016. That may very well be true. But liquidity could also be a factor. The money that was supposed to be sloshing around in the company's financial ecosystem may have been severely reduced by the impaired assets that could still be present on its balance sheet.

In 2017, this has already translated to a 21.91% dip in sales for the first quarter of 2017 when compared to the same period in 2016. Revenues now amount to Php 2.04 billion as of March 31, 2017 vs. Php 2.61 billion as of March 31, 2016.

The company is already talking about "sacrificing growth for liquidity" because it expects its interest expense to double this year as interest rates rise. What has been left unsaid is that the company has already breached some of its debt covenants on its bonds. Its debt to equity ratio now stands at 1.65 to 1.0 vs. a maximum of 1.0.  It is also dangerously close to breaching another debt covenant - that of a minimum current ratio of 1.0. That ratio now stands at 1.06 to 1.0 as of March 31, 2017, which is a drop from the already low level of 1.10 it posted at the end of 2016.

For all we know, the company may already be in technical default as we speak.  The company has around Php 7.6 billion in loans due this year. That money can be raised but it can induce a nail-biter of a cash crunch throughout the year.

The company is already talking of partially abandoning its much-vaunted Contract-To-Sell (CTS) In-house financing (the very business model that propelled it to the top of the mass housing market) for buyers funded by housing financing agencies like Home Development Mutual Fund (HDMF) or PagIBIG fund - all in the name of efficiency and cash generation. That model made it easier for its buyers to obtain homes with very little equity and bypass the bureaucracy of the housing finance agencies. But the CTS model also exposed the company to a whole lot of credit and liquidity risk. Under this model, the company spends a large chunk of money upfront to build and sell the homes and gets back a trickle of that each year in terms of monthly installments that can go on for as long as 25 years.

What's worse is that the company recognizes revenue from these sales up front using the full accrual method at the discretion and judgment of management. Any error in the application of these judgments could result in a material misstatement of the company's financial statements.

While this post may be characterized as unduly alarmist and 8990 Holdings may very well muddle through its challenges, the Philippine real estate market has been littered with the bodies of once high flying real estate companies. Fil-Estate, anyone? If 8990 Holdings falters, it could very well become the proverbial canary in the Philippine real estate coal mine.

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