Philippines achieves record low coupon

Declining Treasury yields allow the Republic to lock in low cost borrowing despite wide spread levels.

With a final order book just north of $500 million, lead manager ING Bank successfully upsized a $200 million transaction for the Republic of the Philippines yesterday (Thursday). Raising a total of $300 million, the five-year fixed rate deal was priced at 99.794% with a record low coupon of 7.5% and re-offer yield of 7.55% equating to 458bp over Treasuries.

After its two large benchmark offerings earlier this year, the new deal sees the Philippines revert to 2001's strategy of taking advantage of market windows to launch small-sized deals that fit its budgetary requirements at times of unfavourable spread levels. Winning the deal also marks a great coup for ING, which has always had a strong banking platform in the Philippines but has not led a sovereign bond issue for some time. Successful execution has also been rewarded by fees that represent a market standard 37.5bp. Alongside ING, there are three other syndicate banks, BDO Capital, EquitablePCI and Rizal Commercial Banking Corp.

Books for the deal opened at Asia's close on Tuesday and are said to have been full within a half a day of marketing. At the final count, just over 70 investors participated, with a geographical breakdown which saw 90% of bonds placed in Asia, of which just over half went to the Philippines. By investor type, asset managers accounted for 37%, private banking 47% and financial institutions 21%. A smattering of corporate investors are said to have participated as well.

Pricing came at 3bp over the interpolated curve, tightened in from 5bp during marketing. At the time of pricing, the Republic's 2006 bond was bid at 109.125% to yield 6.91% while its 2008 bond was bid at 104.188% to yield 7.931%.

For the Philippines the deal made strategic sense since the government has been able to take advantage of a steep decline in Treasury yields, which stood at 4.5% in mid May and 2.99% yesterday. Raising five-year money was also a sensible move since the Philippines' yield curve is very steep, but well supported by domestic demand at the short end. In addition, it has also been able to fill out the curve given that it currently has no outstanding maturity in 2007.

The deal's investor breakdown re-emphasizes the importance of the Asian bid and observers argue that local investors believe Latin American contagion fears and budget deficit concerns have been fully played out and exaggerated in secondary market spread levels.

On a historical basis, the Republic is paying a much higher spread to Treasuries than it has for a long time and supporters consequently argue that investors have far greater upside potential than downside risk at current levels. Similarly rated Paraguay, for example, is currently trading slightly wider at 480bp over five-year Treasuries, but runs a government debt to GDP ratio of 204% compared to 73% for the Philippines and maintains import cover of only 1.8 month compared to 4.5 months for the Philippines.

The Philippines government has also pointed out that while it has failed to meet its Ps130 billion ($2.58 billion) 2002 target after only seven months, it still hopes to achieve a lower absolute level relative to GDP than it did in either 2001 or 2000. In 2001, for example, the deficit ran to 4% of GDP and 4.1% in 2000. Most houses, however, are now forecasting a full year deficit of Ps150 billion to Ps160 billion, equating to a 3.8% to 4.1% ratio to projected GDP.

Analysts also consistently highlight the problems with tax collection which underly the deficit and have now fallen to their lowest level in over 12 years. According to figures compiled by Lazaro Bernardo Tiu and Associates, tax collection fell to just 12.7% of GDP during the first six months of 2002. At the beginning of the 1990's, by contrast, the Philippines was achieving a 14% ratio, with collections peaking at 17% in 1997 and in decline ever since.

The ballooning deficit means that the government will have to make greater recourse to the international debt markets, in turn pressuring the country's ratio of foreign currency government debt to GDP. According to Lazaro Bernardo Tiu and Associates, foreign currency debt has now topped the 30% mark and stands close to its highest level in 15 years.

Finance Secretary Camacho recently told investors that the government intends to borrow $2.3 billion from the offshore markets during 2003 (including bilateral borrowings for 33% of the total). However, this figure does not include potential borrowings on behalf of Napocor, which will add a further $2 billion to the figure if the privatization process becomes stalled. At $3.5 billion, this would equal 1999's record fundraising year when the sovereign raised just over $3.5 billion from a total of nine international deals.

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