Philippines initiates debt consolidation programme

The Philippines looks to create liquid domestic benchmarks to entice offshore investors into the peso bond market.

The Republic of the Philippines is seeking to initiate a domestic debt consolidation programme to strengthen the government debt market and reduce the country's dependence on the international bond market. The programme is akin to a foreign debt consolidation programme instigated by the sovereign in 1996.

Under the consolidation programme the government is inviting any holders of two-year to seven-year Philippine treasury bonds to exchange them for an inaugural series of domestic benchmark bonds. The new bonds will have three, five and seven year maturities.

Eligible bonds will consist of three buckets of previous domestic issuance. The three-year exchange pool, worth approximately Ps 490 billion ($9 billion), consists of 47 series of bonds maturing between January 27 2007 to January 15 2009. The five-year exchange pool, worth approximately Ps293 billion($5 billion), consists of 32 series of bonds maturing between January 16 2009 to December 21 2010. The seven-year exchange pool, worth approximately Ps92 billion ($1.7 billion) across 11 series of bonds maturing between December 22 2010 and January 5 2013. Only fixed rate treasury and retail bonds will be eligible for the exchange.

Participation in the exchange will be wholly voluntary and the terms of the exchange will be determined by a separate auction for each of the series of eligible exchangeable bonds. Both competitive and non-competitive bids will be allowed under the terms of the exchange, and a proxy style voting structure will be in place for retail investors.

In terms of size for the new benchmark bonds, the 2009, 2011 and 2013 series will have a minimum issue size of Ps30 billion ($600 million), Ps25 billion ($500 million) and Ps20 billion ($400 million), respectively.

The new benchmark bonds will inject much needed liquidity into a market that has had little to no active trading. The Philippines' domestic bond market has been frequently criticized for its poor trading performance and highly volatile pricing, both of which have kept international investors away.

The introduction of three established benchmark deals may provide the domestic market with the liquidity it has been lacking in the past and help create a viable yield curve attractive to offshore investors. This in turn may reduce the country's cost of debt and pass on the weighty foreign exchange risk onto the offshore investors, both of which have, in the past, impeded the country's growth potential.

"We are signaling to the investment community that we are going to manage our debt actively, and gradually reduce our dependence on foreign debt," says Secretary of Finance Margarito Teves. "In this case, foreign investors will likely take the foreign exchange risk associated with a peso investment. When the country borrows in US dollars, the currency risk is borne entirely by the Philippine government."

Teves also cited the importance of relying less on foreign markets, where Philippine access can be disrupted by extraneous events unrelated to our country. She comments, "The international markets have been closed or have become very expensive for emerging countries like the Philippines, for totally extraneous reasons such as a default. By relying more on our domestic bond market, we increasingly become masters of our own fate."

Additionally, the new measures may help provide Philippine corporates with a more attractive avenue for long-term financing.

"The creation of large liquid benchmarks will improve the trading turnover in the secondary market as this is expected to, among others, reduce the bid-offer spreads on bond prices," says Amando Tetangco, Jr. Governor of the Bangko Sentral. "Participants will be able to get in or out of the benchmark issues more easily, making trading in Philippine bonds comparable to those in other emerging markets. This will be highly attractive to foreign investors in the market and bring additional business opportunities to the local financial community. This effort will complement earlier initiatives in capital market development, including the creation of the Fixed Income Exchange."

International investors believe that the success of the exchange could be enhanced if the federal government decides to implement the 2% EVAT increase prior to the commencement of the tender's bidding process.

In its most recent research report, Citigroup stated, "Fiscal interest savings from the switch auction, however, would be muted, in our view. We estimate Ps2.4 billion of total interest savings, or roughly 2.3% of the annual interest bill from the universe of total eligibles. We attribute the subdued interest savings to the modest size of the switch auction. The largest savings of about Ps1 billion came from the three-year exchange offer of Ps30 billion.

The report adds, "It would be ideal to have the 2% EVAT tax hike prior to the first switch auction schedule of February 10-11. Having an EVAT hike prior to the switch auction would help ease uncertainty of potentially higher bond supply. Potential revenues from an EVAT hike provides a strong backdrop for bond investors to feel more confident that the government would stick to the parameters of the switch auction. We think a favourable market reception for the switch auction amid a favorable fiscal backdrop with the EVAT tax hike, should spur more frequency of switch auctions in the future. This improves the potential for higher interest savings in the future."

The tender will open on February 6, with submission of competitive and non-competitive bids beginning on February 10. Settlement is scheduled for February 17.

Credit Suisse is acting as financial arranger of the programme.