The Philippine’s central bank is scouring the market for potential options and is said to remain optimistic that it will be able to find a cost-effective solution before the end of the year, despite the fact that timing could hardly be more inopportune.
Impeachment proceedings against President Estrada have pushed sovereign spreads deep into single-B territory and prompted concerns that prolonged political risk could see the rating agencies step into action for the first time since the beginning of the Asian crisis. Bankers consequently state that the central bank remains open to all-comers. “Although officials say they have resolved to completely stay out of the international markets for the whole of next year and leave all bond financing to the Department of Finance, they are willing to consider pretty much anything,” says one DCM banker.
With international reserves at a high of $14.6 billion as of mid-October, (equating to an import cover ratio of just under 4.4 times), the central bank could certainly afford to simply pay down the amount. This option, however, has been made difficult by the fact that it previously undertook to build reserves up to $16.1 billion by year-end under its standby facility with the IMF. Indeed, the final tranche of a $1.38 billion loan has already been compromised by the Republic’s continued failure to meet its budget deficit targets and is under review.
Alternatively, the bank could raise funds in the domestic market, although as observers point out, a heavy domestic borrowing programme will further pressure domestic interest rates. The poor performance of the Peso also makes swapping the funds expensive. On the basis of current trading rates, the central bank would effectively have to raise Ps2.78 billion ($5.6 million) more in additional funds now to compensate for the currency’s depreciation since January 1999 when the deal was first launched. Actively buying dollars in the spot market is also an unappealing option since it would almost certainly put additional pressure on the currency, which touched a historic low of Ps49 to the dollar this week
Led by Chase Manhattan, the central bank originally raised $300 million from a two year Eurobond that was a partial re-financing of a maturing $750 million FRCD. Priced at 99.816 with a coupon of 7.75%, the deal yielded 305bp over Treasuries and currently has a bid price of 65. At the time, the transaction was felt to have caught a market window in Europe where investors were looking for short-dated high yielding paper to compensate for volatility at the longer end of the curve. One week later, it was increased by a further $100 million to mop up follow-on demand.
On the surface, bankers say that the Asian loan markets would appear to be the most viable option to re-finance the deal. However, the Republic has only just closed a previous $400 million loan sourced from foreign and local banks’ foreign currency deposit units. With ABN Amro as co-ordinating arranger, the loan was also felt to have struggled under the weight of souring credit perceptions and had to be held open to ensure successful syndication.
Final terms comprised: a one $100 million tranche of three year paper with a launch spread of 110bp over Libor and all-in yield in the mid 130bp range and; a one $300 million tranche of five year paper with a launch spread of 160bp over and all-in at the mid 170bp level.
Yet as one market participant puts it, “There has been some very aggressive lending activity in Asia and banks’ credit committees are beginning to worry that they might be overexposed. It also takes a while for margins to correct in the loan markets because the procedure of getting a deal to market takes a lot longer. But you can almost guarantee that the Philippines would run into a wall if it tried to come back, and particularly so soon after the last deal.”
In the bond markets, meanwhile, Philippines’ spreads have painted an unflattering picture. At its last major outing to the dollar markets in February, the Republic raised $600 million in 10 year financing on a coupon of 9.875% to yield 350bp over Treasuries. By the beginning of this week, spreads had almost doubled to a bid/offer spread of 667bp/640bp.
As HSBC credit analyst David Seto observes, “We maintain our view that ROP spreads will continue to have a greater propensity to widen than tighten in the coming months. This suggests that ROP bonds could assume spread characteristics similar to certain Latam sovereign issuers whereby the investment appeal is driven more by absolute yield than capital gain prospects.”
And an investor adds, “Spreads look cheap on a fundamental basis but there seems to be no cap on the political risk premium at the moment. Aside from the country’s domestic political problems, the Secretary for Finance and the Central Bank Governor have also lost a lot of credibility with recent misleading statements.
“Telling us they were going to bridge the budget deficit with the Marcos' millions hardly filled us with comfort,” he continues. “Their borrowing strategy just seems to be all over the place as well. First they say they’re not going to borrow money internationally next year and then it appears that they may borrow about $750 million.”
With no virtually no bids in the market, investors and even Filipino banks have collectively sold the credit and walked away. For many, the key question is whether the rating agencies will follow suit. Rated BB+/Ba1 just below the investment grade threshold, the Republic has by contrast long hoped for an upgrade.
Some houses are still optimistic that at worst, the agencies will only effect a move to negative outlook. As Steve Taran, Salomon Smith Barney’s global head of sovereign research comments, “We believe that the Philippines sovereign credit rating is not likely to be affected in the near term. The agencies are likely to conclude that there is little risk of a radical policy shift if Estrada leaves office and that investor sentiment might even improve.”
However, even if the Republic manages to hold onto its rating, the current situation marks a far cry from ambitions to shed its emerging market status. Earlier this year, at a time when spreads were first starting to come under concerted pressure, Under-secretary of Finance, Joel Banares, told FinanceAsia that he still believed supporters’ faith in the country would be rewarded by substantive progress. “We don’t realistically expect an upgrade very soon,” he concluded. “But if by the end of the year we can deliver on the issues outlined by the rating agencies concerning fiscal consolidation and structural reform, then I’m confident that we can get a move to positive outlook.”
