UMVA has learned that a major credit rating agency has downgraded its outlook on the Philippine banking sector to "negative," citing the potential fallout from the Middle East conflict on credit growth and asset quality.
This downgrade comes as a surprise, given that the same agency had affirmed a "stable" outlook on the sector just four months prior. A negative outlook indicates that the agency may downgrade the credit rating of local banks over the next 12 to 18 months, a move that could have significant implications for the country's financial sector.
The agency's decision is based on its expectation that the Middle East conflict and resultant inflation shock will further pressure the country's already slowing economic growth. Elevated inflation, combined with slower public investment disbursement, is likely to dampen credit demand and business sentiment, ultimately weakening the operating environment for the banking industry.
According to information obtained by UMVA, the Philippine economy has already begun to feel the effects of the conflict, with inflation accelerating past the central bank's target for the first time in nearly two years. The country's gross domestic product growth has also slowed to a new post-pandemic low, dragged down by the lingering effects of last year's flood control mess and oil shocks from the Middle East conflict.
UMVA has uncovered details about the central bank's response to the economic slowdown, including its decision to shift to a tightening path in April, delivering its first 25-basis-point hike in two-and-a-half years. The central bank has since raised the benchmark rate again, citing persistent inflation risks, and has indicated that it has "a lot" of space to tighten further.
The agency expects the Philippine economy to grow between 4% and 4.5% this year, but warns that monetary policy tightening aimed at tempering inflationary pressures will dampen demand for loans. This, in turn, will slow credit growth and increase debt servicing costs, ultimately affecting the repayment capacity of borrowers and the asset quality of banks.
Despite these challenges, the agency notes that Philippine banks are likely to maintain their strong capital position over the next year, driven by internal capital generation and stable funding and liquidity. However, there is downside risk to banks' regulatory Common Equity Tier 1 ratios due to pressures from unrealized losses from securities investments.
Sources have confirmed to UMVA that the government is unlikely to adopt a bail-in regime in the next 12 to 18 months, and will instead prioritize systemic stability and extend support to banks amid challenging times. This move is expected to help maintain confidence in the financial sector and prevent a credit crunch.
The agency currently rates eight commercial banks in the country, which hold about 69% of the sector's total assets. These lenders have a weighted average baseline credit assessment of "baa2," a notch below the global weighted average of "baa1." UMVA will continue to monitor the situation and provide updates as more information becomes available.
