Ayala Corp: A Philippine trailblazer

It’s always impressive when companies take it upon themselves to change things for the better. Ayala Corporation, the Philippines’ largest and oldest conglomerate, fits this bill. It has broken new ground in pricing landmark deals and generating growth and innovation in one of the smallest and most underdeveloped bond markets in the region.

Like many countries across Asia, the Philippines suffer from a relatively shallow bond market that makes it difficult for big companies to access cheap long-term funds locally. As a result, they often turn to the offshore markets, making themselves vulnerable to both foreign currency risk, as well as sourcing risk for foreign currency.

Companies with strong expansion plans, however, often have no choice but to go offshore. In the 1990s, Ayala began to invest heavily in its subsidiaries to strengthen its industry position in real estate, banking, telecoms and infrastructure. It started out by borrowing from local banks and raising cash in the capital markets but soon exhausted those options – regulations prevent banks from lending more than 15% of their total capital to a single borrower and local bond offerings are rarely bigger than Ps1 billion ($20 million).

Ayala had little choice but to raise funds offshore, selling fixed and floating-rate bonds, and borrowing from overseas banks. This meant that, at its peak, almost 90% of Ayala’s debt was in US dollars, while its investments were mostly in pesos.

“This created a huge currency mismatch which required expensive hedges in terms of foreign-exchange fluctuations, as well as dollar availability,” says Ayala’s treasurer Ramon Opulencia.

It was evident that Ayala needed to shift more of its borrowing into pesos. “Since the opportunities for substantial fund raising didn’t yet exist, we needed to take a pro-active approach in developing the country’s debt market instead of waiting for bankers or other participants to develop it for us,” says Opulencia. “Our first target was to find a way to issue a peso-denominated instrument in significant size, equivalent to at least Ps5 billion.”

At the time, Ps3 billion was the biggest amount any company in the Philippines had raised, but Ayala had more ambitious plans. In 2004, it issued a record-breaking Ps7 billion five-year bond.

“We had approached a group of banks that we believed could implement our ideas. Since we also required the deal to be fully underwritten, we accordingly appointed a strong group of local and foreign bookrunners operating in the peso market, namely BDO Capital, BPI Capital, First Metro, ING Bank, Land Bank, PCI Capital and Standard Chartered. As a result, we benefited from their combined expertise, teamwork and distribution networks,” says Opulencia.

“The deal was achieved thanks to this collective effort, while the company’s reputation for fairness and transparency also played a key role.”

The offer closed at the wider end of the suggested pricing range but most market participants considered it a success for such a big issue. “We nurture our investors, developing a long-term relationship with them for our domestic market initiatives. When they buy our paper, they know they are gaining access to a strong credit. They can hold the bonds to maturity, or trade them as interest rates head south in the Philippines.”

This led Ayala to another itch it wanted to scratch: to price through the sovereign’s borrowing curve. As a result, in 2005, Ayala tapped the private market and issued two tranches (five and seven years) of peso corporate fixed-rate notes, pricing at an approximate 120bp discount to the sovereign’s borrowing rates.

“A combination of factors allowed Ayala to pull off this deal, including Ayala’s strong credit and a lack of quality [alternative] investment outlets at that time,” says Opulencia, adding that by going private, the bonds gave favourable tax treatment.

“This was an important event that proved that issuers can achieve borrowing rates that are as favourable as the sovereign as long as their transactions are timed right and meet investor needs.”

These early successes encouraged Ayala towards further innovation. In 2006, changes in international accounting standards re-classified the company’s existing preferred shares from equity into straight debt. To convert those shares, Ayala conceived the first peso-denominated corporate hybrid bond, which was also the first local currency hybrid in Asia.

“These hybrid structures were being used mostly offshore by financial companies needing equity treatment on their balance sheets. We tweaked the model and adapted it to local demand,” says Opulencia. “The tax incentives were strong: corporates paid no withholding tax on these shares, while individuals paid just 10% – as opposed to the usual 20%. We managed to price this transaction as cheaply as debt.”

Bankers across the region praised Ayala and its advisers for their innovation and also because the deal showed a keen understanding of investor needs and market sentiment. Notably, Ayala is said to have provided substantial guidance and motivation during the process.

“It’s a feature of Ayala that it tries to accomplish something new with every transaction it brings to market,” says Roberto Fernandez, head of capital markets in the Philippines for Standard Chartered.

Accordingly, in November 2007 the company became the first borrower to price a transaction using the Philippine dealing system treasury reference rate benchmark, or PDST-R2, through its Ps6 billion five-year bond offer. This system uses the average of both morning and afternoon bids for government securities, and was recently introduced by the Philippines’ central bank to get banks to mark their positions to market more frequently.

Previously the Bloomberg MART1 served as the benchmark; a system that relies on the average bids at 11.15am local time. In contrast, PDST-R2 reflects actual completed transactions and is much more transparent and indicative of market dynamics.

Even so, the new benchmark is still unfamiliar to investors, so it was quite an achievement to attract enough orders to allow the deal to upsize from Ps5 billion. “Ayala is a prime name with an impeccable reputation and this has contributed greatly to its ability to pull off innovative and ambitious transactions,” says Lynette Ortiz, head of debt capital markets at HSBC in Manila.

Ayala also took the opportunity to enroll those securities on the Philippines fixed-income exchange, and was the first company to do so. The platform, launched in 2005, is a centralised electronic market place implemented to develop price discovery, efficiency, transparency and investor protection in the fixed-income market.

“Ayala has been trailblazing on achievements like this,” says Standard Chartered’s Fernandez. “Whether attempting to promote liquidity by pricing large-size deals, pushing the boundaries of financial innovation, or taking steps to jump-start government initiatives, Ayala’s innovations are always geared towards helping the capital markets in the Philippines.”

Ayala’s success with these local-currency initiatives can largely be based on its reputation and credit history. However, a treasury of seasoned bankers may also be the driving force behind its confidence and creativity. Opulencia used to work at the Bank of the Philippine Islands, as did the company’s chief financial officer Rufino Luis Manotok, and they actively use Ayala’s particular financial strategy as their trademark.

“Innovation is our way of being unique, of strengthening our brand and of telling the world that we make a difference,” says Opulencia.

And Ayala may have more in store. “It all depends on the market, but we would be keen to be the first to sell peso-denominated bonds, or peso-linked dollar notes, to offshore investors. Making our name attractive to foreign buyers would be a great achievement,” says Opulencia.

In the meantime, Ayala’s impact closer to home is already emboldening other issuers. “The company has set precedents that encourage other highly rated issuers to generate similar financings in the capital markets. We are already seeing more deals, and more volume,” adds Fernandez.

Given the closure of the offshore markets as a result of the global credit crunch, such borrowers will be thankful they can rely that much more on their home markets to raise funds.

This story was first published in the March issue of FinanceAsia magazine.