First of three parts
Most of the attention of the local media and domestic investors has been focused on the Philippines’ robust stock market during the past four years, and for good reason. What remains largely unnoticed is the local bond market, which has quietly been enjoying nearly the same level of success.
Although the government bond market has existed for decades, its corporate counterpart—the fixed-income securities market—and the overall modernization of the bond market are relatively recent developments, borne out of the Asian financial crisis of 1997. That crisis caused a shift in attitudes toward debt financing, with investors throughout the region in general, but here in the Philippines in particular, being described as adopting a strongly “risk-off” posture.
That caution has had good and bad consequences.
On the one hand, it has spurred the development of a modern bond market infrastructure, signified by the founding of the Philippine Dealing System (PDS) as the umbrella managing fixed-income and foreign exchange trading, clearing and settlement, depository activities in 2001, and more recently, the announcement of preparations for the merger of the Philippine Stock Exchange (PSE) and PDS.
On the other hand, investors’ conservative approach here and the skepticism, at least until recently, of foreign investors toward regional bond markets, has meant the bond market has not gotten the attention it probably deserves, being almost universally described by analysts as “underdeveloped” or “underutilized.” Foreign investors had been understandably wary of the region’s bond markets as an unfamiliar ground, especially following the 1997 crisis and given that nascent markets like the Philippines naturally tend to be somewhat more volatile in comparison to more established markets.
There are signs those attitudes are changing, however. While still small by global and even regional standards, the Philippine bond market is expanding at an impressive pace, and more importantly, is seeing its composition— which has traditionally been dominated by government bonds in terms of the number of issues and overall market value—slowly shift to a more balanced makeup. This bodes well for the continued evolution and growth of the local bond market, although many challenges still remain. (First installment below)
Corporate bonds on the upswing
IN early June of this year, on the occasion of welcoming what was at the time the newest corporate bond issuer to the PDEx, Cebu Holdings Inc. (an affiliate of Ayala Land), PDEx management announced, not without some justifiable enthusiasm, that Cebu Holdings’ P5 billion offering pushed the year’s total to P114.8 billion, already surpassing the bond market’s biggest year to date in 2012.
The express train of market growth has not shown any signs of slowing down in the three months since Cebu Holdings’ milestone listing. Two more issuances since Cebu Holdings (SM Prime Holdings on August 13 and Century Properties Group on August 18) have pushed year-to-date corporate listings to P154.8 billion; as of Friday, August 22, there were 80 individual securities issued by 28 companies outstanding, with a total value of P451.76 billion, according to PDEx data.
While the numbers for 2014 are impressive and hint at even bigger gains in the near future, the Philippines’ corporate bond market is still a relative lightweight among key Asian economies.
As of the first quarter of last year, the Philippines’ corporate bond market had a valuation approximately equal to 10 percent of GDP, which was only an expansion of about 2 percent from its size at the end of 2005—although to be fair, at the earlier date the corporate bond exchange at PDEx had not even formally begun operations. By this metric, the scale of the Philippines’ corporate bond market pales in comparison to the established markets in the region such as Singapore and Malaysia (both at about 50 percent of GDP), Hong Kong (approximately 80 percent of GDP), and South Korea, whose market nearly doubled in size in the same period to reach nearly 90 percent of GDP (see graphic).
Rapid market expansion
Given the young age of the PDEx corporate securities trading board, what is most remarkable about the Philippines’ corporate market is not its size relative to regional neighbors, but its rapid growth. In November 2007, the maiden corporate issue in the PDEx market was a single fixed-rate bond due in 2012 offered by Ayala Corp. (For trivia buffs, it had an aggregate par value of P6 billion with an annual coupon of 6.825 percent, payable quarterly). PDEx expanded the inter-professional trading market to the public the following year; by 2009, bond issues from banks appeared. By mid-2011, there were already P195.8 billion of outstanding corporate securities; since then, the market has more than doubled in size. As PDEx proudly points out, since 2008, the compounded annual growth rate of the corporate board has been approximately 87 percent.
Oddly enough, robust economic growth in the country has actually tended to disguise the bond market’s expansion; with GDP growing at about 7 percent in three of the last four years, the difference in scales means that even a big increase in bond market value registers as only a small percentage of GDP.
As Michele Leung, associate director of fixed income indices for Standard & Poor’s Dow Jones Indices (S&P tracks both the Philippines and Pan-Asian corporate bond markets), points out, the Philippines’ corporate bond market is the second-fastest growing among the 10 countries tracked by the S&P Pan Asia Bond Index.
“While Indonesia and Philippines bond markets are more volatile [than other regional markets, whose average price volatility is around 2 percent], they also have the strongest growth in size among the 10 countries, as they expanded more than fourfold and threefold since December 2006,” she explained. And as far as S&P is concerned, growth in the market has been appropriately matched with good returns; since August 2011, the S&P Philippine Corporate Bond Index has consistently outperformed the Pan Asia Corporate Index.
Local market bucks regional pattern
As Mark Hack of the Reserve Bank of Australia’s (RBA) International Department pointed out, the initial growth of bond markets in the Philippines and elsewhere in the region was the result of a sudden reversal of fortunes for companies relying mainly on intermediate financing through banking systems in the Asian Financial Crisis. A rapid influx of foreign currency encouraged short-term loans, creating what Ooi Boon Peng, chief fixed income investment officer for Eastspring Investments, described as a “tenor mismatch:” Short-term foreign currency financing for long-term domestic investments. The collapse of exchange rates and capital flight in the crisis created a huge credit crunch, and led to the development of comparatively more stable bond market options.
“Corporate bonds can enable firms to access funding for longer durations than may be available from alternative sources,” RBA’s Hack explained. “This helps them to better match their liabilities with the maturities of assets being funded, lowering refinancing risk. Local currency bonds also have the added advantage of reducing corporations’ exposures to foreign exchange risks,” thus, eliminating one of the biggest hazards that had been encountered during the Asian Financial Crisis.
Until very recently, however, it seemed that pre-crisis habits persisted in the local market. Along with a healthy stock market, high levels of liquidity and an abundance of credit in the Philippine financial system may actually have limited bond market growth, impressive as that has been.
According to data from the Asian Development Bank’s Asia Bonds Online market monitoring facility, corporate debt funding options (bonds, bank credit, or equity financing) have actually shifted toward equity in recent years, which now accounts for about half of corporations’ domestic financing profile – a consequence, most analysts agree, of the particular success of the local stock market in the past few years. Meanwhile, the proportion of bond financing, despite the rapid expansion of the market, has declined by about 2 percent per year.
“Issuance [of bonds]in the Philippines remains relatively subdued and has been limited to a small number of borrowers,” RBA’s Hack explained. The profile of the current market certainly bears that out; the largest five corporate issues account for 51 percent of the market, while the largest 20 issuers account for 99 percent of it by value.
For its part, German banking giant Deutsche Bank AG expressed concern over the rise in corporate leverage by way of the bond market the somewhat peculiar Philippine approach has created. In a report published at the beginning of the year, the bank pointed out that Philippine companies’ debt-to-equity ratio had reached 96.3, second only to China in the key Asian markets it tracks.
Without necessarily suggesting that Philippine companies were getting in over their heads – something that recent positive earnings reports that have driven the PSEi to a series of yearly highs would contradict anyway – Deutsche Bank did sound a note of caution. “More needs to be done to build a framework that is both conducive to market innovation and enables companies to seek funding from a broader range of sources without increasing vulnerability to shocks,” its report said.
There are indications, however, that recent changes in the economic environment might bode well for increasing the depth and diversity of the local bond market. Decisions by the BSP in recent months to tighten monetary policy, which were taken to curb the country’s increasing inflation rate, may actually encourage a further shift from intermediate and equity financing. And the recent announcement of the buyout by the PSE of the shares in PDS owned by the Bankers’ Association of the Philippines as a prelude to merging the country’s two major trading markets may help to extend the bond market’s reach.
WITH KRISTYN NIKA M. LAZO
On Wednesday: Part two of our special report on the Philippine bond market will examine the market’s “bread and butter”—government securities, which are a key source of financing for national development, as well as an important product to attract and maintain investment flows.