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Issuer: Republic of the Philippines Amount: $690 million Launched: September 20 Lead manager: JP Morgan Type of issue: Brady exchange The idea was easily sold to Roberto de Ocampo. “It sounds like an offer we cannot refuse,” the Philippines’ finance minister told jp Morgan’s Simon Paterno in his ministerial office. Morgan was offering the tempting prospect of following Mexico’s example of swapping distressed Brady debt for new bonds. The deal, if it happened, would signal the Philippines’ full rehabilitation in the eyes of the international capital markets. Little wonder de Ocampo was keen. It wasn’t a sudden proposal. Outgoing undersecretary of finance, Romeo Bernardo, had been in negotiations with Morgan’s long-serving head of investment banking in the Philippines, Simon Paterno. The two had known each other since they had returned home from the us in 1990. Bernardo was due to retire from his post on June 30, and Paterno wanted him to go out on a high note. Bernardo, a risk-averse man, told him, “Show me a deal where Morgan will pay all the expenses in case it doesn’t happen.” Paterno went to New York in April with just this in mind. He put a one paragraph presentation on the table, suggesting to his bosses the Brady exchange, with Morgan carrying all the expenses. The paragraph projected the upside. It also gave the downside. It would cost Morgan $1 million if it didn’t happen. Paterno, 37, has been with the firm for 13 years and, as he puts it, “They know I’m no wild man.” The risk with a Brady exchange is that no-one comes to the party – that holders of the Brady debt prefer not to swap their bonds. However, Morgan was confident that the resurgent Philippine economy and the prospect of an upgrade to investment grade in the near future would make the deal fly. One man was particularly confident – Martin Matsui, Morgan’s Hong Kong general manager. He offered to split the cost of the expenses with Paterno should it fail, meaning it would not be only the Filipino’s budget that took a hit. This show of generosity by Morgan was not born out of the need to buy a deal, however. It was based on a long-standing relationship which, in the case of the Brady, dates back to 1990. Paterno recalls he started in the Philippines on March 10 that year and, on his second day, was pitching to then finance secretary, Jesus Estaniflao, for Morgan to structure the Brady. In the event the Philippines rejected the pitch but was given advice by Morgan, for free, anyway. Brady bonds are securities created from defaulted sovereign loans. The Philippines issued $2.4 billion of them when it finally hammered out a deal with its creditor banks in 1992. Various complex structures were used, such as front-loaded interest reduction bonds that pay a below-market interest rate, and thus allowed banks to absorb the hit from the default gradually. The most popular instrument, however, was the par bond – of which $1.9 billion were issued. These 25-year bonds disguise banks’ capital losses until the bonds mature. Pars are collateralized with us treasuries. This means that the sensitivity of the price to bad news from the Philippines is also less, giving the bonds a portfolio-style profile. The pars were sold at 55 cents on the dollar, a price which reflected the proportion of the principal the Philippines looked likely to repay when the bonds matured (at the time of the Brady exchange the price was 83 cents, a reflection of growing investor confidence in the country). The Morgan relationship was further cemented by a $150 million three-year Eurobond it launched for the republic in 1993. Morgan also organized a syndicated loan for the republic during the Mexican crisis, but left the pre-crisis pricing unchanged and took a third of the deal itself. For the Brady exchange, secrecy was essential, as any sniff of an exchange always creates speculation in the underlying Bradys. jp Morgan, to limit the circle of those who knew, did not even use an outside counsel, preferring its own emerging markets lawyer. The key man in structuring the deal was New York-based Richard McNeil, a Jamaican vice-president in the emerging markets debt group. What jp Morgan was keen to avoid was the need to reprice the deal, a fate suffered by the lead managers in the Mexican Brady swap. Some key judgements had to be made. Morgan decided to limit its own order for bonds to 25% of the deal. It was also decided that the deal would be split between a fixed-rate and a floating-rate tranche, with each of them a minimum of $200 million in size – the aim being to ensure that the bonds were more liquid than the thinly-traded Bradys themselves. (However, the frn option proved dramatically less popular than the fixed rate and was later abandoned.) The deal was originally slated for June to coincide with Romeo Bernardo’s retirement. However, Bernardo asked that the deal be postponed, because much of the interest in the deal would be from Japan, and the Philippines was doing a samurai in June – this was already public, unlike the Brady swap. But Bernardo wanted to finish the transaction he started and stayed on as a special adviser to the finance ministry after his June 30 retirement. According to those working on the deal, it was the first time they have found e-mail so useful as a means of exchanging notes, maths and documentation. There were people working in Hong Kong, Manila, Singapore, New York and London doing all of the above. The universal hour was 10pm Hong Kong time, the most convenient for all three time zones. Conference calls occurred once a week over the summer and lasted two to three hours with around 20 people listening in. On one occasion a senior member of the team in Asia fell asleep in his bed during the call, only waking up five hours later when the phone fell on the floor. The deal was announced on September 2 at a roadshow in Manila where finance minister de Ocampo was supposed to be delivering a speech on the state of the economy. The first slide, however, read “Brady swap”. A rush of fingers reached for their mobile phones. An exchange period of three weeks was announced. This was almost three times that of Mexico but it was felt investors might take longer to get approvals for the transaction. It was emphasized on the roadshow that investors were able to pick-up almost 1% of extra yield. The Bradys were exchanged at 130bp over treasuries into new bonds yielding 225bp over. The differential largely resulted from a mispricing of the us treasuries contained in the Bradys that acted as collateral. Restructuring the Bradys into uncollateralized Eurobonds released that value. Investors also benefitted from a greater exposure to pure Philippine risk – a good place to be with it two notches away from an investment grade and looking certain to get theirs very soon, which should positively affect spreads. Those that remained in the Bradys instead of swapping also knew the bonds would be even more illiquid than before. The Philippines likewise benefitted. It retired a third of its Brady debt (along with all of its stigma), issued $690 million of bonds with a 20-year maturity (including a last-minute tranche of new money worth $137 million) and freed up $160 million of us treasuries. The recouping of the latter, the collateral, booked the sovereign an estimated “profit” of $67 million. A number of investors who cannot buy Bradys, bought the new bonds. The proof that the pricing was right was in the take-up. Had it not been, the exchange, by definition, would not have come off. “It was a sign of the success of the bond,” says Richard Luddington, head of emerging markets debt syndicate in London, “that it was issued at the minimum spread and $634 million of Brady bonds were tendered.” After six years working on the Bradys and then the exchange, Simon Paterno must see this as the highlight of his career. “Crowning triumph? I hope not. I’m only 37,” he says. |
