The Philippines returned to the Asian bond market on Monday to raise another $750 million towards its gaping budget shortfall, and as expected, investors rallied around and allowed it to price tight.
The offering was supported by a significant rally in US equities during the final hours of marketing, which gave investors the confidence to buy despite a sharp contraction in credit spreads over the past few months. It also helped that the sovereign set clearly defined terms which it stuck to throughout the marketing. During the final few hours of the bookbuilding investors even had a fixed yield as a reference point for their investment decisions.
"It went out with a finite size and well-defined terms and it didn't move the goal posts. But the tight pricing was also possible because of the deep domestic investor base," said a source close to the offering, who noted that it was primarily the local investors who were driving up the price in the secondary market yesterday too.
The 10.5-year bonds -- they mature on January 20, 2020, in order to stagger the government's repayment obligations -- were at 100.25 by the close of Asian trading yesterday after being re-offered at 99.065. They changed hands as high as 100.5 intraday.
The bonds were priced with a coupon of 6.5%, which at the re-offer price gives a yield of 6.625%. This corresponded to the tight end of the initial yield guidance of 6.625% to 6.75% that was set by the three bookrunners early on during marketing. The guidance was firmed up in the early evening Hong Kong time, when investors got the message that the final yield would be fixed at 6.625%.
At the time of pricing, the yield resulted in a spread of 332.6bp over the 10-year US Treasury maturing in May 2019. This marked a sharp tightening versus the 599.9bp spread that was required when the Republic of the Philippines sold $1.5 billion of 10-year bonds due in June 2019 in January this year and shows how much the market has improved since then. The yield on the 2019 bonds has dropped to about 6.4% now from 8.5% at the time they were issued.
Even more impressively though, sources said the new bonds priced right in line with the implied Philippines curve as interpolated from the yield levels of the Philippines 2019s and 2024s. In other words, investors received no new issue premium at all.
Not that this seemed to worry them. The offering attracted $4.4 billion worth of demand split on 202 orders, even though the term sheet clearly stated that the $750 million deal size would not be increased. As usual for Philippine issues (this is after all the country that "gave a name to the Asian bid", as noted by one analyst), a large chunk of that demand came from domestic investors, and in the end, 40% of the deal was allocated to Philippine accounts. Investors based in the rest of Asia took another 20%, while 25% went to the US and 15% to Europe.
In terms of investor type, funds took 50%, banks 39% and retail investors 6%. The remaining 5% went to insurance companies and "others".
Back in January, the Philippine government said the proceeds from the $1.5 billion bond issue covered its entire international borrowing requirements for this year. In other words, it would not return to the market this year. However, the global economic downturn in the wake of the financial crisis has hit the country hard and led to a decline in tax revenues. The result is a much larger budget deficit that forecast at the beginning of the year - the latest official forecast calls for a shortfall corresponding to 3.2% of GDP - and thus a renewed need for more funds.
However, the government has been open about the situation and has flagged the new supply to the market for some time. Therefore investors seemed entirely comfortable with the fact that there was a second sale. In fact, many of them were likely pleased to get something other than Korean debt to put in their portfolio, given the deluge of quasi-sovereign corporates and banks from Korea have almost hijacked the new issuance market lately.
And observers say the market would likely be willing to absorb even more Philippine paper should the need arise.
"People believe the government when it says it has no intention of coming back, but I also think that they understand that situations change and that the government will be opportunistic if it needs to come back to the market and find that conditions are favourable," said Tim Condon, chief economist at ING.
He notes that while Indonesia has replaced the Philippines as the region's largest opportunistic issuer over the past couple of years, the Philippines has returned to that spot in 2009 because of the larger-than-expected fiscal deficit.
"But I think people are of the view that this is a transitory phenomenon and probably they (the Philippines) will be back to fiscal consolidation in 2010. The government fundamentals are positive and that is a good story for the bonds," Condon said.
Not everyone is that positive, though. Fitch Ratings argued that the government's continued weak revenue performance implies an underlying structural fiscal weakness which "needs to be addressed in addition to the cyclical deterioration and in spite of the improvement in the overall fiscal balance in recent years."
"To a large extent, the sharp fall in fiscal revenues this year can be explained by cyclical factors, but offsetting measures that could have moderated the fiscal slippage were not forthcoming," added Standard & Poor's.
However, while acknowledging that the fiscal conditions are strained, Moody's Investors Service gave the 2020 bonds the same positive outlook that it awarded the sovereign earlier this year, noting that the country's balance of payment and financial system remain resilient even in the face of the global recession.
"The country's fortified external payments position is reflected in its maintenance of a historical high level of official foreign exchange reserves, which helps to buffer the economy and government finances from external shocks. As a result, the peso has been very stable this year," the ratings agency said in a ratings notice which also took note of the low inflation rate.
Moody's rated the bond issue B1, while S&P and Fitch gave it a BB- and a BB rating respectively, both with a stable outlook. Alongside its concerns about the inadequate revenue base and the slow progress in addressing this, S&P noted the resilient inflow of remittances, a growing surplus in service exports and prudent exchange rate management as positive factors for the credit rating.
The offering was brought to market by Citi, Credit Suisse and Deutsche Bank. The latter two also arranged the first Philippine bond issue this year together with HSBC.