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Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

A certain nervousness is creeping up on the Philippines, and a plunging stock market is not the only sign of trouble ahead.

President Rodrigo Duterte's antics and a weakening peso are giving bond investors the jitters. They're seeking protection from defaults by tying down borrowers with conditions on everything from credit ratings to debt-servicing ratios. Three out of five Philippine debt issues this year have come with covenants. That's a sharp jump from 2015, and double the average of the past seven years.

Not Taking Chances
Philippine bond investors are insisting on covenants, suggesting they fear a deterioration in credit profiles
Source: Bloomberg
*As a percentage of all issues by listed companies, their parents and subsidiaries.

Given the deteriorating credit profiles of Philippine companies, investors might be doing the prudent thing. If their worries become self-fulfilling, however, tighter credit conditions could drag on earnings next year.

Leverage is already an issue. San Miguel Corp.'s obligations are as high as 77 percent of its market capitalization, compared with the average for the MSCI Asia index ex-Japan of 27 percent. Ayala Corp.'s net debt is approaching five times Ebitda, the most in more than a decade.

Conglomerates like Ayala, SM Investments Corp. and Aboitiz Equity Ventures Inc., controlled by the country's three richest families, are still among the most creditworthy Philippine issuers. Even so, the default risk of Ayala Corp. and Ayala Land Inc. has risen by one notch over the past month, according to a Bloomberg metric.

Leverage Loses Luster
With profitability declining, piling up debt can only give an artificial boost to Philippine companies' shareholder returns
Source: Bloomberg
*For Philippine Stock Exchange PSEi composite index.

Loading up on debt was a good idea when it helped carve out a return on equity of 15 to 16 percent for the Philippine Stock Exchange PSEi composite index, from a return on assets of 3.5 to 4 percent. But those days are over.

Profit margins have shrunk from four years ago for the 19 nonfinancial companies in the benchmark gauge, even as their assets are still producing roughly the same revenue. Leverage can mask the problem for a while. But with debt investors becoming cautious, the moment of reckoning for equities might arrive sooner rather than later.

It's unlikely that problems will arise from some terrible mismatch between dollar liabilities and assets. Both Alliance Global Group Inc. and SM Investments, two of the four Philippine conglomerates that feature among the 10 Southeast Asian companies with the most dollar bonds due in the next 12 months, say they're well hedged in case the peso extends its 5 percent drop since Duterte took office June 30.

Still, both borrowers are switching to local-currency debt. That's fine for now because the local banking system is flush with funds. That ease of financing could vanish if Duterte's deadly anti-drug campaign, liberal spending policies, foreign policy flip-flops and bungling of domestic politics end up curtailing lenders' access to dollars.

After a 16 percent tumble in dollar terms over the past six months, stocks look dangerously out of breath: Only 20 percent of the shares in the benchmark index are above their 200-day moving average, which makes the Philippines the second-weakest Asian market after Mongolia.

With bond investors expressing their concerns in more subtle ways, things could get uglier yet.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net