Napocor stumbles towards finishing line

After a day fuelled by rumours that its bond deal was about to be pulled, the electricity utility puts out wider-than-expected indicative pricing.

A $500 million seven-year bond deal remains on schedule to price in New York tonight (Friday) on an indicative yield of 9.25% to 9.50%. With Bear Stearns as bookrunner and JPMorgan as joint-lead, the deal carries a Baa3/BBB- rating, one notch above the sovereign ceiling, as a result of its political risk insurance (PRI).

Outside the lead management group, however, there is virtually no one who considers the whole process to have been anything other than a complete farce and many bankers believe a deal is only being printed because of the presence of Arroya, Camacho and Edeza in New York.

"Edeza has been with Napocor on roadshows, while Camacho and Arroya are at the World Economic Forum," says one banker. "To come back to the Philippines empty-handed would be highly embarrassing. They have to put something together."

Yet at current indicative pricing levels the transaction is set price up to 60bp over the sovereign curve and with the additional 35bp cost of the PRI guarantee fee from Sovereign Risk Ltd, will become uneconomic. It is a far cry from hopes of pricing flat to the sovereign curve at the beginning of roadshows and even further still from the lead's initial promise to secure pricing 50bp through it.

From the very beginning, Asian DCM specialists have said the deal is misguided and at the very least will disrupt the sovereign yield curve. Instead of pounding unwilling investors with an illiquid and ill-conceived transaction, most argue that the sovereign should simply borrow in its own name and on-lend the proceeds.

As roadshows got underway and a myriad of other problems surfaced, the refrain has got ever louder. As one banker puts it, "When you peel away the layers of this deal, you soon realise that the so-called guarantees smack of the Emperor's new clothes."

For most investors, the key concern has been the peso guarantee from the Republic of the Philippines. Normally the sovereign would issue a blanket dollar guarantee covering interest and principal re-payment, but in this instance it has not. Some observers believe this is because Napocor does not want to account for the deal as a contingent external liability on its balance sheet.

The leads argue that there is a peso guarantee because this is what was required by the rating agencies to assign the sovereign's domestic rather than foreign currency rating. They also take issue with investors who have been demanding a significant yield pick-up on the basis of calculating present value by discounting the principal re-payment using a peso rather than a dollar rate.

The problem arises because domestic seven-year Treasuries are currently yielding 13.8%, while the Republic's six-year dollar bond is bid at an 8.7% yield and its eight-year dollar bond at a 9.13% yield.

For the defense, one banker says, "This argument about using a peso discount rate instead of a dollar one is ridiculous. At maturity, it's simply a question of where the peso/dollar exchange rate is, nothing more."

For the prosecution, a second banker comments, "The fact is that Napocor is counting this as a domestic liability and in the event of a default, international bond holders will not be sitting with other international creditors but on the same table as the domestic banks. In fact, they won't be sitting at the table at all, as they have no direct claim on the company, only the trust which issues the notes."

The issue of structural subordination is the deal's second main Achilles heel. In particular, critics say the deal will not be deliverable into a sovereign default.

"For investors looking to buy default protection, there are very stringent definitions of what securities can be delivered into a sovereign default and this deal will not be one of them," a banker explains.

This is chiefly because it does not have a fixed tenor. Although the deal matures after seven years, a convertibility or transferability event will result in an extension out towards a further two years.

This falls under the remit of the PRI, which covers three coupons on a rolling basis. From the agencies standpoint, this period is deemed long enough for the sovereign to sort a convertibility or transferability issue - an issuer's inability to either exchange pesos for dollars, or transfer dollars offshore.

Bankers conclude that while a deal now looks like it will be completed, it has done little to re-assure investors that the Republic is a sophisticated practitioner in the international debt markets. The manner in which the deal was mandated and role played by Synergy, one of the Philippine's ubiquitous consultancy firms, has also raised more questions than are ever likely to be answered.

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