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Saturday, July 14, 2012

Estimating RCBC/Yuchengco Group's Profits from the PEACe Bonds

Crossposted from my other blog: "The System is Broken"

Editor's Note: This is an update to a previous post entitled "Estimating RCBC's Profits from the PEACe Bonds" that incorporates new and better information.

Much has been written about how CODE-NGO has extracted PhP 1.827 billion in gross profits from the PEACe Bonds. From this bonanza, the PhP 1.338 billion Peace Foundation was born. Yet there have been hardly any articles in the mainstream press as to how much profit RCBC, CODE-NGO's financier, extracted from the transaction. RCBC Capital did extract a PhP 239 million underwriting commission. But this amount is peanuts when you consider the fact that RCBC Capital's parent, namely RCBC itself, risked PhP 11.996 billion or roughly 90% of its capital to earn a measly PhP 239 million or 1.8% of its capital. Given that interest rate fluctuations could cause the value of the PEACe Bonds to decline by PhP 1.275 billion over the course of a year, this seems foolhardy. Why? Because RCBC's risk was more than five times the potential reward. If its profits were limited to underwriting commissions, the transaction's rewards were definitely not worth the risk.

But RCBC and/or RCBC's parent, the Yuchengco Group of Companies, did make money on the transaction. Lots of money. As much as PhP 4.0 billion! How? By reselling the PEACe Bonds to institutional investors at even higher prices.

According to Jaime “Jimmy” Panganiban, RCBC's Treasurer,

“We have a contracted sale for PhP 1.2 billion [out of the PhP 35 billion worth of PEACe Bonds, which is the issue's face value upon maturity], Panganiban said. But given the publicity about the PEACe Bonds, we're not aggressively [selling them in the secondary market]. He admitted that there is demand or keen interest in the bond."

The bonds were sold to RCBC's corporate clients outside the Yuchengco group of companies. Mr. Panganiban said that RCBC has been selling the bonds, which RCBC acquired at an effective cost of 34 centavos per bond unit (PhP 1.00 at maturity in 10 years), for 40 to 45 centavos to undisclosed corporate buyers.3 This translates to an effective yield to maturity rate (YTM) of 8.170% to 9.370%.

In terms of profit, this means that RCBC, by selling PhP 1.2 billion or 10% of the PEACe bonds it acquired from CODE-NGO for PhP 11.996 billion, realized a trading gain anywhere from PHP 201.32 million to PhP 374.94 million from this one transaction alone. If it continued to sell the rest of its holdings at this price, it would reap an additional trading gain ranging from PhP 1.812 billion to PhP 3.374 billion, bringing its total potential profit on the entire PEACe to PhP 2.013 billion to PhP 3.749 billion, just from reselling the PEACe Bonds. If you add back the underwriting commission, RCBC could have earned as much as PhP 4.0 billion on the PEACe Bonds.

But here's the kicker. There could have been even more profits in the offing for RCBC! Why? Two reasons. Time and Interest Rates. The prices of zero coupon bonds go up as the bond nears its maturity date. The closer the bond is to its maturity date, the closer the zero-coupon bond's value approaches par or face value. Interest rates also significantly affect the prices of zero-coupon bonds. The lower the interest rate, the higher the bond price. And interest rates did go down substantially after the PEACe Bonds transaction. And as interest rates go down, bond prices go up. So estimating RCBC's profits are also very dependent on when RCBC sold down the PEACe Bonds to other institutional investors because the bond's time to maturity and prevailing interest rates would have changed.

According to RCBC Treasurer Jimmy Panganiban, RCBC did not aggressively sell the PEACe Bonds in the secondary market because of the controversy they generated. Given that they held at least 90% of the bonds in October 2001, it is safe to assume that all the subsequent PEACe Bond transactions registered with the Bureau of Treasury's Registry of Scripless Securities were RCBC's.

Based on this chart of PEACe Bond Transactions sourced from the Registry of Scriptless Securities, it seems that RCBC had rid itself of its entire PEACe Bond inventory by March 2002.  Or given that RCBC had recently admitted to holding on to PhP 1.388 billion or roughly 4% of the PEACe Bonds Issue (See "With a PEACe Bonds Tax, PBCom is Left Holding the Bag"), they could have disposed of the inventory they wanted to dispose of even earlier, possibly by February 2002.  However, it is not clear if the PhP 1.388 billion in PEACe Bonds held by RCBC were held until maturity or were repurchased from other institutional investors.

Number of Transactions Face Amount Cumulative Face Amount
Date # (In PhP) (In PhP)
October 2001 8 10.96 10.96
November 2001 20 3.82 14.78
December 2001 17 3.83 18.61
January 2002 29 7.41 26.02
February 2002 34 5.65 31.67
March 2002 22 3.53 35.20

Jaime Panganiban, RCBC's Treasurer, said that RCBC sold at least 10% of their PEACe Bond holdings at YTMs ranging from 8.170% to 9.370% soon after the PEACe Bond auction, meaning October 2001. If RCBC had sold the last 90% of their holdings at the upper end of this YTM range, meaning at 9.370% YTM by October 2001, RCBC would have reaped PHP 2.013 billion in gross profits. But they didn't. Instead, they held on. Holding on to the bonds proved beneficial to them. The bonds accrued interest and went up in value. Even if interest rates or YTMs remained constant, at the 8.170% to 9.370% YTM range, the bonds would go up in value. By how much?

If YTMs remained at 9.370% (the upper end of its previous selling range) and the bonds were fully sold by March 2002, the profit would have been PHP 2.00 billion.

PEACE Bond Sales Price to Institutional Investor Cost to RCBC

Face Amount At 9.370% YTM At 11.000% YTM RCBC's Profit
Date (In PhP Billions) (In PhP Billions) (In PhP Billions) (In PhP Billions)
October 2001 10.96 4.39 3.76 0.63
November 2001 3.82 1.54 1.32 0.22
December 2001 3.83 1.56 1.34 0.22
January 2002 7.41 3.03 2.61 0.42
February 2002 5.65 2.33 2.01 0.32
March 2002 3.33 1.38 1.19 0.19
Total 35.00 14.23 12.23 2.00

If YTMs remained at 8.170% (the lower end of its previous selling range) and the bonds were fully sold by March 2002, the profit would have been PhP 3.71 billion.

PEACE Bond Sales Price to Institutional Investor Cost to RCBC

Face Amount At 8.170% YTM At 11.000% YTM RCBC's Profit
Date (In PhP Billions) (In PhP Billions) (In PhP Billions) (In PhP Billions)
October 2001 10.96 4.92 3.76 1.16
November 2001 3.82 1.73 1.32 0.41
December 2001 3.83 1.74 1.34 0.4
January 2002 7.41 3.39 2.61 0.78
February 2002 5.65 2.61 2.01 0.6
March 2002 3.33 1.55 1.19 0.36
Total 35.00 15.94 12.23 3.71

This profit calculation assumes that interest rates remained constant.  But interest rates didn't remain constant.  Instead, to RCBC's great benefit, they declined.

If the YTMs at which the PEACe Bonds were sold to investors declined with interest rates (with a floor of 7% - the yield of reserve eligible securities at the time of the PEACe bonds auction), RCBC's interest rate spread would be as follows:

Bureau of Treasury Institutional Investor Cost to

Month (In %) (In %) (In %) (In % Spread)
October 2001 12.750% 8.170% 11.000% 2.830%
November 2001 12.750% 7.459% 11.000% 3.541%
December 2001 12.750% 7.000% 11.000% 4.000%
January 2002 12.750% 7.000% 11.000% 4.000%
February 2002 12.750% 7.000% 11.000% 4.000%
March 2002 12.750% 7.000% 11.000% 4.000%

12.750% 7.000% 11.000% 4.000%

At these rates, RCBC's profits on the PEACe Bonds could have been as high as PhP 4.91 billion or 30.97% higher than the PhP 3.749 billion estimate had the PEACe Bonds been sold in October 2001 at an 8.170% YTM.

PEACE Bond Sales Price to Institutional Investor Cost to RCBC

Face Amount At Fluctuating YTMs At 11.000% YTM RCBC's Profit
Date (In PhP Billions) (In PhP Billions) (In PhP Billions) (In PhP Billions)
October 2001 10.96 4.92 3.76 1.16
November 2001 3.82 1.85 1.32 0.53
December 2001 3.83 1.95 1.34 0.61
January 2002 7.41 3.79 2.61 1.18
February 2002 5.65 2.91 2.01 0.9
March 2002 3.33 1.72 1.19 0.53
Total 35.00 17.14 12.23 4.91

1“Raid on the Treasury - JPE on the PEACe Bonds Scandal, by Butch Fernandez and Erik de la Cruz, Reporters, February 13, 2002, Today Newspaper.
2“Internal Revenue bureau defends tax break for PEACe bonds,” by L.M. Gallardo with C.E. Yap, February 13, 2002, Businessworld
3“Enrile sees wholesale ruse in CODE-NGO deal,” by Angie M. Rosales and Jun Vallacera, February 13, 2002, Daily Tribune


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