Philippines banks mandate sub debt

Metrobank launches the Republic''s first public subordinated debt issue as Equitable-PCI mandates a December deal.

UBS Warburg will lead manage both transactions, with Deutsche Bank joining it as joint bookrunner for Equitable-PCI, the Philippines' third largest bank by assets, which hopes to bring a transaction about a month after Metrobank, the country's largest.

Roadshows for a 10 non-call five transaction by Ty family-owned Metrobank will begin next Wednesday in Manila, followed by Singapore and Hong Kong over Thursday and Friday, then Europe the week after. Pricing of the $100 million to $150 million Reg S deal is provisionally scheduled for Wednesday November 20.

The lower tier 2 transaction marks the Republic's first public subordinated debt transaction since the central bank formulated regulations at the end of last year and should provide an interesting addition to the country's credit spectrum. Early indications suggest it will price relatively aggressively to the sovereign curve, with investors reporting an indicative premium of about 100bp.

This means a yield around the 8% mark. The sovereign's September 2007 bond, for example, currently yields about 7.03% or 420bp over Treasuries. By contrast, Bangkok Bank, which has a Ba2 sub debt rating from Moody's, has a March 2007 transaction outstanding yielding 5.13% or 229bp over Treasuries.

Metrobank's prospects were further boosted by Moody's yesterday (Thursday), after the rating agency surprised the market by announcing that it had rated the deal at the sovereign Ba1 ceiling. Given that it normally rates subordinated debt one notch lower than senior debt (Standard & Poor's automatically applies two notches), this would indicate the bank has an implicit senior debt rating one notch above.

However, as observers point out, the move is not without precedent and in its rating assessment, the agency says its decision reflects a belief that subordination risk is, "mitigated by the low likelihood the bank will face a regulatory intervention that could possibly cause credit losses to noteholders given the bank's systemic importance."

The deal is expected to attract heavy domestic demand both from private banks looking for yield pick-up and commercial banks looking for portfolio diversification. And bank capital experts argue that commercial banks should still participate even though the central bank has assigned subordinated debt a 100% risk weighting and no one bank will be allowed to purchase more than 10% of any individual deal.

Its ruling is much stricter than that of the Indonesian regulator, which has actively tried to boost its domestic market by assigning subordinated debt a 20% risk weighting, thus making it much cheaper for banks to hold on their books.

Where the central bank has been more relaxed is with its overall criteria for tier 2 capital. It has said that it will allow lower tier 2 debt to constitute a bank's entire tier 2 capital (most jurisdictions allow a 50% ratio). Tier 2 can also constitute up to 50% of overall capital.

As one specialist explains, "From a regulatory perspective, more lower tier 2 relative to upper tier 2, means weaker capital ratios overall. But the BSP is trying to promote market development and it's well aware how challenging and expensive it would be for a non-investment grade rated domestic bank to launch a dollar denominated upper tier 2 deal."

Actively encouraging banks to re-build their capital ratios is seen as a precursor to more aggressive NPL write-offs. Prior to the Asian financial crisis, a 16% minimum CAR ratio was imposed on domestic banks, well above the 8% minimum laid out by the BIS. Analysts believe these strong capital bases helped the banking sector weather the financial crisis, although they proved costly and most banks report very low ROE.

At the end of June 2002, Metrobank reported a CAR of 12.2% and at the end of 2001, an ROE of 3.9%. It has Ps444 billion ($9.1 billion) in assets. Equitable-PCI, which has Ps260 billion in assets, reported a CAR of 19.3% and ROE of 0.3% over the same time period. Observers say the new deal should take Metrobank's CAR back past 13% again.

Analysts also say it is more cost efficient for Filipino banks to fund in the dollar-denominated sub debt market at an all-in cost around the 8% mark, rather than with equity (11%), or in the domestic bond market, where five-year Treasuries yield 11.3%.

And indeed, Metrobank is already said to have completed one privately placed subordinated debt issue earlier this year. Under the lead management of Merrill Lynch, a $100 million deal is believed to have been sold to Singapore-based venture capital fund Dunmore, although some bank capital specialists speculate this vehicle was a front for existing shareholders.

In its research, investors say UBS Warburg argues that Metrobank's credit ratios stand on par with BB rated peers around the region. Analyst Scott Wilson is also said to argue that, "Metrobank's capital position is substantially stronger than many of its rating peers and it enjoys a high degree of liquidity given its lower loan-to-deposits ratio (65.8%).

"Asset quality and profitability," he concludes, "are generally in line with many of the bank's peers in the Philippines and with the major Thai banks."

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