The warrants will allow holders to exchange ROPs into local currency (peso) debt in case of a credit default by the government, and resolve a problem caused by the implementation of the Basel II framework, which should be fully effective from January 1, 2009. Under Basel II, ROPs held by Philippine commercial banks would be 100% risk-weighted and banks would have to set aside $10 for every $100 face value of those bonds they hold.
There is no similar requirement for peso-denominated government debt, which has 0% risk-weighting. Since the warrants will allow banks to exchange their ROPs into local currency government debt if a default occurred, they will not need to set aside capital for ROPs when they are paired with warrants. Should a credit event take place, the bonds can be converted into the peso-denominated 8.5% 2032 bonds at the prevailing exchange rate.
The transaction was arranged by Credit Suisse, which also arranged a similar deal for the Philippines in February, when it issued $2 million of warrants for bonds with maturities of less than 10 years and a face value of $2 billion. Combined, the two series cover about 20% of all outstanding ROPs. Future warrant sales cannot be ruled out if the sovereign were to issue foreign currency bonds with maturities longer than 2032.
Domestic banks own around 60% of ROPs, which are their preferred exposure to the sovereign credit rather than to peso bonds, and almost all the warrants were taken up by domestic banks, with 15 involved in the transaction. This contrasts with the February sale when there was a 43% allocation to international investors, according to a source close to the deal.
The same source added that initially the Philippines planned to sell warrants representing a face value of between $1.25 billion and $1.75 billion, but the issue size was increased after the offer attracted bids worth $2.9 billion. A minimum price of $10.5 was set, but they cleared at $10.75.
The Philippine government benefits by preserving local bank demand for ROPs which should help reduce government borrowing costs and lower financing costs for corporate borrowers who price their bonds off the government yield curve. Philippine banks will also be able to assign more capital to fund loan growth.
Other emerging market sovereigns might be tempted to transact similar deals if there is high domestic bank ownership of their foreign currency bonds and if a change is planned in the risk-weighting regime from 0% to 100%.
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