The Republic of the Philippines returned to the international bond markets for the second time this year on Wednesday, raising $500 million from a 10-year global.
Under the lead management of Credit Suisse First Boston, HSBC and UBS, the Ba2/BB rated credit priced its deal at 99.138% on a coupon of 8.875% to yield 9%. This equated to 528bp over Treasuries or 487bp over Libor. Fees amounted to just 7bp.
Market participants concluded the deal was well executed and pitched at the right size and right price in the circumstances. But the circumstances were far from ideal.
Deep-rooted concerns about the Philippines' credit profile have once again reared their head and pushed spreads out nearly 100bp since the beginning of the year. In addition, the Department of Finance has often been unlucky with its market timing and this week proved no different.
Launch of the deal ran headlong into comments about a potential sovereign debt restructuring by Presidential hopeful Fernando Poe. The problem of the Philippines growing debt burden is one that continues to gain an ever wider audience.
Where one year ago, local politicians were talking about a debt to GDP cap, many are now considering the merits of a wholesale sovereign debt restructuring. Towards the end of February, a group of prominent businessmen and one former Finance Secretary published a report entitled, "The Presidential Business Agenda: the first 100 days."
In it, they recommended the new government "renegotiate and restructure its foreign debt" to avoid having to pay more than one peso in four as interest payments. Their recommendations have now been adopted by two of the three leading Presidential candidates - Poe and Roco.
The whole of Philippines credit curve has not surprisingly reacted extremely badly and the government's benchmark January 2014 bond has widened from a three month low of 396bp over Treasuries, to 494bp over as of yesterday (Thursday).
On a like-for like basis, the new 2015 also had to pay a roughly 25bp new issue premium in order to clear the market. It was priced about 124bp wider than B2/B rated Indonesia's recent 10-year and in line with single B rated Latin American credits such as Brazil.
Since the Philippines started to gear up its sovereign funding requirements in 1997, the country has only had to pay more than 500bp for a 10-year bond on a couple of occasions.
Investors buy the Philippines on a yield basis. But in a declining interest rate environment, it is the sovereign's spread to Treasuries, which gives the most telling indicator of market sentiment over the past few years. Most sovereign deals have spanned 350bp to 450bp over Treasuries.
At the end of 2002, however, the Philippines drastic miscalculation of its budget deficit led to a series of difficult deals. The first to top 500bp over Treasuries was a $500 million 10-year in November that co-incided with unfounded speculation that Finance Secretary Jose Camacho was resigning. The deal was priced at 507bp over Treasuries on a 9% coupon.
Two months later, the ROP returned to the market again with a $500 million 10-year that priced at 553bp over Treasuries on a yield of 9.509%. This deal priced against a backdrop in which the Philippines was accused of miscalculating its current account. It also followed confirmation of a budget deficit that had soared past the government's 3.3% target to end the year at 5.4%, its highest level ever.
During 2003, the Philippines was able to claw back lost ground and investors found some comfort from the fact it was meeting its deficit targets again. As recently as October, the government was able to price a $750 million tap of its 2014 bond at 386bp over Treasuries to yield 8.32%.
However, ratings downgrades by Moody's and Standard & Poor's, Poe's emergence as a Presidential candidate and talk of a debt restructuring have completely compromised the sovereign curve. In this context, some argue it made sense to lock in some funding as an insurance policy against further credit deterioration in the event of a messy election. At least now, the sovereign has been able to relieve some pressure on its funding programme and may find that spreads settle down again over the coming few weeks.
However, others say the size of its order book for the current deal does not bode well. Even at such historically high pricing levels, the Republic was only able to achieve $800 million in demand. A total of 132 investors participated with a split that saw 51% placed in Asia (of which just over one half went to the Philippines), 29% to the US and the remaining 20% to Europe.
By investor type, 52% went to asset managers, 35% to banks, 11% to retail and 2% to insurance companies.
There are also those who argue that the situation is far more dangerous now than it was back in the spring and summer of 2000 when disenchantment with Estrada's presidency saw secondary spreads spike well past 500bp. Back then the government had a less onerous funding requirement on behalf of both itself and Napocor. The Department of Finance could afford to stick to smaller, structured deals and many argued a change of presidency could help right the country's fiscal imbalances.
However, national finances continued to deteriorate under the Arroyo administration and many now wonder just how much more damage a Poe Presidency could inflict. Others worry that 2004 deficit targets may also be breached by pump priming ahead of the election - Arroyo is the first sitting President since the Marcos era to stand for re-election.
Over the past few years, attention has become increasingly focused on more fundamental problems such as a narrow tax base, which has pushed out the deficit and the lack of a liquid domestic bond market, which has led to ever greater foreign debt levels.
In 1997, the Philippines ran a Ps1.56 billion budget surplus and tax as a percentage of GDP hit a historical high of 19.4%. By 2003 the budget deficit had ramped up to 4.7% of GDP and tax as a percentage of GDP had dropped to 12.4%.
In 1997, national government debt to GDP stood at about 35% and interest payments amounted to roughly 15% of GDP. By the end of 2003, debt to GDP had soared to just above 80% and interest payments to just above 35%.
But there are those who argue all the negative news has now been priced into the Philippines curve and it is time to accumulate. "It's hard to be negative about spreads at these levels and there is an awful lot of local liquidity, which is likely to grow just ahead of the election," says one specialist. "International investors keep setting up short positions and getting squeezed by the locals. Things changed this week because of Poe's comments, but the local investors will be back."