Thailand reaches for debt switches

A debt switch is the process whereby a debt issuer swaps a series of eligible bonds (typically shorter-dated and illiquid) for a replacement bond (typically longer-dated and liquid). The purposes of debt switches are to manage the debt profile, reduce refinancing risk and improve market liquidity.

The two most popular methods for debt switches are cash-neutral (as adopted by the Philippines) and nominal-neutral (as adopted by Indonesia and Malaysia). The benefit of a cash-neutral debt switch is that, as the name suggests, no cash is involved in conducting the debt switch. The drawback is that the nominal amount of the replacement bond is usually in odd denominations, which makes computation of coupon payments less straightforward. The benefit of a nominal-for-nominal debt switch is that, as the name suggests, the nominal amounts of the target bond and the replacement bond remain the same, but there is a cash adjustment to take into account the differences between the “dirty” prices of the two bonds. 

We view debt switches as a constructive way to develop the Thai bond market, although many details remain to be ironed out, particularly regarding Financial Institutions Development Fund (FIDF) bonds. In terms of price action, yield curves tend to pivotally steepen during debt-switch bidding periods as investors buy eligible bonds (normally front-end) to participate, while market duration is increased. 

 

The Thai market

The PDMO is still at the early stages of considering debt switches and has time to consider which debt switch method the market will prefer (cash-neutral or nominal-neutral). 

In addition, there are legal issues that need to be addressed regarding loan bonds (LBs) whose proceeds go towards FIDF funding. The government announced at the start of 2012 that it would like to see all outstanding FIDF debt liabilities paid off as soon as possible. Thus, it could appear contradictory if the PDMO swapped a two-year LB (which is used for FIDF funding) to a 20-year LB. Depending on the legal framework, the PDMO may only have the option of switching short-dated LBs, the proceeds of which are used for deficit financing. In such an event, the pool of eligible bonds will be smaller than the pool if all bonds were available for switching.

If the PDMO were to engage in debt switches, we would see this as a constructive development in the Thai bond market. It would give the PDMO more tools to manage its liabilities, such as refinancing risk. It would allow it to increase issue sizes much more rapidly and reduce the number of illiquid bonds. For example, in the Philippines’ debt switch in July 2011, the Bureau of the Treasury took in 323 billion pesos of eligible bonds and issued new 10-year and 20-year Philippine-peso bonds. The outstanding size of the 10-year bond went from zero (as it was a new issue) to PP67 billion in a day, while the 20-year went from zero to PP256 billion. This compares to the average Philippine-peso T-bond auction size of PP9 billion, with a typical frequency of two auctions per month.

 

Danny Suwanapruti is a senior rates strategist for Standard Chartered Bank, based in Singapore.