Business World
Introspective
The Peace Bonds have become a live issue again with the 10-year bonds maturing early next year. The analysis (below) of the Foundation for Economic Freedom in 2002 came to the conclusion that taxpayers were not disadvantaged. This paper is an abridged version of what was drafted by former FEF President Francis Varela, FEF Chairman Philip Medalla, and myself.
Critics have alleged that there was an anomaly involved in the sale of the P1.4-billion Peace Bonds, allowing CODE-NGO to generate a fantastic windfall and leading to significant losses on the part of government. To our mind, the key question toward developing a dispassionate and rational perspective on the whole issue is:
What was the appropriate value of these bonds when they were issued in October last year?
First, the pertinent facts:
The Bureau of Treasury sold (through a bidding process) 10-year zero- coupon bonds with a face value of P35 billion to a bank (RCBC) which acted on behalf of CODE-NGO. The bonds were sold at a total price of P10.2 billion, thus implying a yield of 12.75% per annum. The bonds are effectively tax exempt and eligible as liquidity reserves for banks and quasi-banking institutions. Simultaneously, or within a very short period of time, CODE-NGO sold the bonds to RCBC Capital at a gross profit of P1.8 billion or a total consideration of P12.0 billion. At this price, the implied yield of the bonds to the end-buyer (RCBC Capital) goes down from 12.75% to only 11 percent.
Was the appropriate value of the bonds upon issuance P10.2 billion or P12.0 billion? Or, alternatively, was the appropriate yield of the bonds 12.75% or 11%?
We have to note that the difference between the two yields is very significant and non-trivial in a reasonably efficient financial market. Thus, if this wide a yield movement takes place without the occurrence of a major market-shaking event, then the conclusion is that either the issuer paid too high a yield or the final buyer overpaid for the bond and is now suffering below-market yields. As the Philippine financial market was relatively calm when the Peace Bonds were auctioned, clearly, therefore, one of the yields was wrong.
If 11% was indeed the appropriate yield for the bonds, then the Department of Finance/Bureau of Treasury committed a serious mistake in the sale of the bonds and were remiss in their duty to protect the interests of government. Notwithstanding the openness of the auction and without having to allege that it was rigged, one could nevertheless argue that they should have devoted more time and effort explaining the features of the bond to more market participants in order to achieve the lower yield. If this were the case, then the critics are right and we, as taxpayers, should all join in condemning the issue as a major anomaly.
On the other hand, if the appropriate yield of the bonds was 12.75%, then clearly there could have been no anomaly involving government funds and the only logical conclusion is that RCBC overpaid for the bonds, and the extraordinary profit enjoyed by CODE-NGO could not have come from government.
We now proceed to analyze the features of the bond to determine its appropriate value. First, we would like to note that the main features that enhanced the value of the bond were the tax exemption and the liquidity reserve eligibility. Second, we also wish to note that the zero-coupon feature did not add any value to the bond. Normally, a zero-coupon bond issued by the same issuer and with the same tenor would trade at a slightly higher yield than an ordinary coupon-bearing bond.
Thus, conservatively (from the issuer's standpoint) we can compare the Peace Bonds with the regular 10-year Treasury note. At the time of the auction, the regular 10-year T-notes were trading in the secondary market at a yield of 16.9%. Since the regular 10-year T-note is subject to the 20% final withholding tax, the after-tax yield of the 10- year T-note was 13.5%. Thus, if the Peace Bonds had no other enhancement aside from the tax exemption, then it should have traded at around 13.5% or higher, not 12.75% and DEFINITELY NOT 11%. On the other hand, considering that the difference between the regular T-bills and the reserve eligible ones is only 0.5%, then the fair yield of the Peace Bonds was approximately 13%.
Based on the foregoing, it is our conclusion that the 12.75% original yield of the Peace Bonds was favorable to government and that it was RCBC, not government, that bore the cost of the P1.8-billion windfall that was enjoyed by CODE-NGO by suffering an inordinately low yield on this instrument when they bought the bonds on a secondary basis from CODE-NGO. Whether this resulted from philanthropy and social spirit, miscalculation or contractual constraints that required RCBC to provide fees to CODE-NGO even in a transparently bid auction where they would have been entitled to participate anyhow, or a combination of the above, is a private matter.
Now, looking at this issue in its entirety, we believe that it was inappropriate, if not outright wrong, for CODE-NGO to have attempted to conduct this transaction on a negotiated basis, as they themselves have admitted. We believe it is fair to surmise that, if there was no auction, the government would have ended having to bear the cost of the CODE-NGO windfall. Thus, instead of being pilloried and maligned, the DOF and the BTr deserve our congratulations and commendation for having resisted the strong overtures of CODE-NGO to conduct a negotiated sale. In particular, we have to thank Treasurer Sergio Edeza for having been so clear and unswerving in his position on the matter, and for taking only the highest interest of the Republic into account in his actions. Clearly, the government did not lose a single centavo in the transaction, thanks to their efforts.
Mr. Romeo Bernardo is Global Source Philippine advisor and board member of The Institute for Development and Econometric Analysis, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
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