At a time when inflation rate in the Philippines reaches nearly 5% (core inflation year on year as of March 2008), not many people will think of buying government bonds for the purpose of income, and when interest rate is already so low, neither are there likely to be many who will want to buy government bonds for capital gains purpose. Nonetheless, low risk assets like government bonds still have their place in a portfolio, such as to moderate the volatility of the overall portfolio value and periodic returns.
Overall picture
The Philippine government issues local currency bills (with tenor of less than 1 year) and bonds (with tenor of 2 to 28.5 years). The local currency bills are issued by the Bureau of Treasury, (hence called Treasury Bills) and are direct and unconditional obligations of the national government. They can be traded in the secondary market before maturity, but do not bear interest. They are issued and sold at a discount from face value and are redeemed at maturity for the full face value of the instrument. The main type of local currency bonds issued by the Philippine government are called Fixed Rate Treasury Notes (FXTN). They are interest bearing and can be traded in the secondary market before maturity. Their tenor ranges from 2 to over 25 years.
The Philippine government issues two more types of local currency bonds. Retail Treasury Bonds (RTB) are pesos bonds in smaller denominations that aim at retail investors. For example, they can be purchased at units of 50,000 pesos (they can vary by issues) where as Treasury Bills have a minimum size of 100,000 pesos. They are interest bearing and carry a term of three to five years and can be traded in the secondary market before maturity. The Dollar Linked Pesos Notes (DLPN) track the movement of the Philippine Peso and US Dollar exchange rate. Payments of interest and principal are linked to the movement of the exchange rate and computed based on the foreign exchange factor. These were first issued in 2001, and the last issuance was in 2003. All local currency bonds are subject to 20% withholding tax on the interest received.
The Philippine government also issues bonds in foreign currencies. These are called ROP bonds, and the latest issuance was in January 2008 for US$500 million.
Corporations also issue bonds in local and foreign currencies, but the amount of such debt instruments issued is quite small.
The Bureau of Treasury reported in February 2008 that, as of November 2007, total National Government outstanding debt stood at P3.751 trillion of which, P1.570 trillion or 42% is owed to foreign creditors and P2.181 trillion or 58% to domestic creditors. About 60% of the debt to foreign creditors are in the form of ROP bonds (833 billion pesos worth in US dollars, 19 billion pesos in Yen and 73 billion pesos in Euro). It was reported in February 2008 that in the near future the government will issue more local currency debt papers instead of foreign currency bonds, one of the reasons being to stem the appreciation of the pesos.
As of end February 2008, the Philippine government had outstanding local currency treasury bonds of face value of 1.55 trillion pesos, and local currency treasury bills of face value of 668 billion pesos. This means that the total value of Philippine sovereign local currency bond outstanding had a face value of around US 53 billion at today's exchange rate.
According to asiancreditinvestor.com, a very good source of information on Asian bond market, the Philippine government issued USD978 million worth of foreign currency bonds in 2007 (all in USD), while Philippine corporations issued USD1,148 million worth of bonds, over 90% of which was in the local currency.
In its latest report, November 2007, the Asian Development Bank's Asia Bond Monitor web site reported that, in the first half of 2007, the Philippine government issued 45.38 billion US dollars' worth of local currency bonds (equivalent to 33% of GDP), while the corporate sector issued only 4.38 billion US dollars' worth of local currency bonds. Out of the nine emerging East Asian countries tracked by Asia Bond Monitor, the Philippine local currency (government plus corporate) bond market is bigger than Indonesia's and Vietnam's as a share of its GDP, but smaller than that of China, Hong Kong, Thailand, Singapore, Malaysia and South Korea. South Korea's local currency bond market was 109% the size of its GDP in the first half of 2007. According to that report, about half of the Philippine's public debt was in US dollar instruments.
In the view of Asia Bond Monitor, "the
Philippine domestic bond market remains underdeveloped compared with its bank
lending and equity sectors. The market is primarily composed of government bonds
issued by the National Government and long-term commercial papers issued by
prime local corporations. At present, government issues dominate the market with
minimal alternative for other debt instruments.
The corporate bond
sector is less developed in terms of product range, profile of issuers, and
investor base. Debt securities are traded through either bilateral private
negotiations or over-the-counter transactions."
Recently Finance Secretary Margarito Teves announced the government’s intention to cut down on foreign borrowings in favor of local fund sources through the issuance of 91-day, 182-day, and 364-day treasury bills from January to March. It has been reported that the government will issue P9-billion worth of 91-day paper, P12-billion worth of the 182-day paper, and P18-billion worth of the one-year security. For Treasury Bonds, the government will issue P45-billion worth of the debt paper. The Bureau of Treasury also plans to auction off P7.5-billion worth for each of the following tenors: 3-year, 4-year, 5-year, 7-year, 10-year and 20-year T-Bonds.
The Market Place
The primary market for government issued (bills and) bonds is only open to registered dealers and specific investors (see http://asianbondsonline.adb.org/philippines/market_infrastructure/exchanges_and_trading_platforms.php for details), hence members of the public cannot buy bonds directly from the National Government, except for the Small Denominated Treasury Bonds, which are long term debt securities issued by the Bureau of Treasury and traded on the Philippine Stock Exchange, and Retail Treasury Bonds (RTBs). RTBs are sold through banks, and their minimum denomination varies from issue to issue (occasionally as low as 5,000 pesos).
It is recently reported that the government will soon offer overseas Filipino workers (OFWs) and their families an initial $100 million worth of retail Treasury bonds that may include a form of guarantee to protect their dollar earnings. Top officials of the state-owned Land Bank of the Philippines, which acts as an adviser to the government’s OFW offering, along with British bank HSBC, said details of the 2.5-year, dollar-denominated T-bond offering with an annual yield of about 4 percent is currently being worked out, and could be ready by as early as April this year. OFWs and their beneficiaries may buy the retail Treasury bonds (RTBs) for a minimum investment of $500 once they have shown proof that they are working abroad or that they belong to an OFW-supported household. To address widespread concerns about the U.S. dollar’s downtrend against the peso, they said the offering would be structured in such a way that would give a foreign exchange cover to OFWs. This means that the OFWs may be given an exchange rate guarantee so their RTB investments will not be diluted if the peso further strengthens against the U.S. dollar. At this stage, nobody knows for sure what the final product will be like.
Can the public trade bonds in the secondary market? where is the secondary market? The secondary trading of government and corporate bonds in the Philippines is currently traded under a Over-the-Counter model, by which it means that the buyer will negotiate with the seller directly. With the recent implementation of a set of so called OTC rules, the secondary trading of government and corporate bonds must be conducted through a "self-regulatory organization" (SRO). The Securities and Exchange Commission (SEC) prescribed the requirements for becoming a SRO, and secondary trading of bonds can now only be undertaken by members of a SRO.
As of today, there is only one SRO, which is the Philippine Dealing and Exchange Corporation (PDEx), a subsidiary of Philippine System Holdings Corp, which in turn is owned by PDS Group, whose major shareholders include the Bankers Association of the Philippine, the Philippine Stock Exchange, Tata Consultancy, and the Investment House Association of the Philippines. Therefore, any bank who wants to trade government and corporate bonds has to be a member of PDEx.
PDEx charges its member US $500 per month for a terminal
to connect to its bond exchange system, called Fixed Income Exchange (FIE). On
top of that, it charges P25 per million pesos worth of trade. Previously, it
charged P900 per trade. The new fee structure is advantageous to small volume
transactions, but can become expensive for larger trades. The Money Market Association of the
According to Asia Bond Monitor, "The
first stage of the FIE operation is to provide an electronic platform for
inter-bank negotiated market for government securities. The second stage of the
FIE operation will include corporate and retail investors wanting to course
their trading transactions through the exchange.
PDEx market structure
currently operates on two platforms based on bilateral limit system. The
Negotiated Dealing Platform is primarily for the professional markets with
relatively large trading transactions while the Auto Match Platform caters the
public market (through broker participants) with smaller volume.
In
February 2008, PDEx launched its Public Market trading platform where broking
participants can post orders received from retail investors. With this new
platform, retail investors are given equal access to the various fixed income
securities listed on the trading board."
So, does it mean that retail investors can trade Philippine bonds? and online too, in the comfort of our own home?
The Real Market Place
One bank that advertises on its website the offering of secondary bonds is http://www.pnb.com.ph/content/view/26/46/ . According to their website, the minimum amount for buying foreign currency bonds is US$25,000, and their website even provides a list of the latest bonds available. The latest list (dated 4 April 2008) of foreign currency bonds contains 19 sovereign bonds and 6 corporate bonds. The list shows maturity date, coupon rate, and bid/ask prices. You cannot buy the bonds on line, but they provide a phone number that you can call for firm prices. I have not tried to contact them, but after looking at the websites of the other major banks, which seem to treat their investment products as secrets, PNB will certainly be the first bank that I would visit when I have a strong desire to buy Philippine sovereign foreign currency bonds.
The PNB website is equally informative when it comes to local currency bonds. Their minimum trade size is 100,000 pesos (face value), for Treasury bills, FXTN and RTB. I also made enquiries with three other major local banks regarding the purchase of local currency bonds.
I went to three banks (Metrobank, Banco de Oro, China Bank) whom I believe are also members of PDEx's SRO, and are thus eligible for secondary trading of bonds. One of them, located in a mall, advised me to go to the private banking section of their bank. I thought that was too much trouble, and did not bother. In another bank, a representative showed me a sheet of paper listing a dozen of treasury bonds. When I asked about actual price, the representative made some phone calls for me, and after about fifteen minutes, got hold of someone with the right information. I was told that the minimum amount for a bond trade was 500,000 pesos. If I want a tenor of about 60 days, the gross interest I would get, on an annualized basis, would be 3.4%. After deducting the 20% withholding tax, the interest rate would become 2.76%. Furthermore, I would have to fill up a ton of paper work.The other bank basically said the similar thing. It seems that these banks are not keen to serve retail customers on bond sales, at least those who are not prepared to invest half a million pesos in low interest earning instruments.
I have read that Banco de Oro EPCI, United Coconut Planters Bank, and Land Bank of the Philippines require P100,000 minimum investment in T-bills. BDO and UCPB are said to have the same P100,000 minimum investment requirement for T-bonds, but Landbank's minimum for T-bonds is P1 million pesos. Metrobank's investment house subsidiary, FMIC, is said to have a lower minimum government securities requirement of only P50,000. I have yet to verify the accuracy of this information.
The gap between reality and theory also exists when it comes to RTB. I enquired about RTB at one of these three banks last year. Although the advertised unit value was small, something like 5,000 pesos, the bank manager was not at all enthusiastic when I told him that I was interested in buying about 100,000 pesos of the RTB. I did not understand it at that time, but recent news that reported one Metro Manila city treasurer had invested over 600 million pesos of the city's money in RTB gives a clue : perhaps most of the RTB actually ended up with institutional investors.
Trade bonds online? I have not found one website that offers that service. Even the person that you talk to face to face in a bank may not have access to the bond data on their computer screen. The high minimum trade amount and cumbersome paper work are circumstantial evidence to support a theory that suggests that banks do not really want to deal with individuals on bonds. Reasons for such a reluctance to deal with retail investors? the first logical deduction is that there is a shortage of supply of bonds. Second is cost. It is of course cheaper to deal with institutional investors who transact in much larger sums that retail investors, who, eventhough may be more numerous, has a smaller transaction size. The big bid/ask spread (often over 1 percent, and some even over 2 percents) of the quoted bond prices (for both sovereign and corporate bonds) is another piece of evidence of shortage of supply. Only when there is a shortage of supply is it logical for the middlemen, i.e. banks, to make bond trading so difficult for retail investors.
The shortage of corporate bonds seems particularly acute. Whenever I enquired about local currency bonds in the banks, they would offer Treasury bonds first and foremost. The PDEx currently seems to have only one corporate bond (Ayala Corporation's) available for secondary trading since it obtained its SRO status. Why are corporations unwilling to raise funds through bond issuance? The obvious guess is cost, compared with alternative means of raising funds. By cost it is not only the cost in financial terms, but also in terms of time and procedures. Some have cited complex and onerous taxes on bond transactions as one of the reasons that restrict the growth of the corporate bond market.
The current bond market is like a partially completed bridge. There is ample demand for bonds as an investment instrument from the public, and there are needs for funds by corporations and government. But for various reasons yet to be explored, the middle span and supporting structures are not fully in place, at least for retail investors. It has been reported that PDEx is planning to launch derivative products on its exchange platform. Unless bonds are not intended to be included, I am intrigued to know how popular a derivative product can be if the underlying product has limited liquidity and market depth.
In this article, I have shared my experience as a retail investor with regard to local currency bonds. Maybe readers have other experiences that differ from mine. Many questions remain unanswered, such as :
If any reader can shed lights on these and other questions relating to the Philippine bond market, please let me know (email : cfapweb@gmail.com ) so that we can share the knowledge with other readers, or even spark some healthy debates on what should or should not be done for the Philippine bond market.
References
These sites give some good background information on the Philippine bond market :
http://www.mart.com.ph/fxtn.php
http://www.treasury.gov.ph/news/news/NG%20Debt%20Nov'07.pdf
http://www.treasury.gov.ph/statdata/yearly/yr_cor_financing.pdf
http://asianbondsonline.adb.org/philippines/philippines.php
(Author : Chiu Ying Wong, CFA. 10 April 2008)