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Bad news for 800,000 commuters:
MRT 3 in dire financial straits

The government is scrambling to find a timely solution to avert a potential financial crisis involving the rail system. For the sake of the 800,000 commuters of the existing rail system along Edsa, the government has to settle a financial problem it caused and is just waiting to explode. The deadline? August. Herein lies the trouble: The government has not been paying the lease rentals on time. Roberto Lastimoso, the general manager of Metro Rail Transit Authority, the Department of Transportation and Communications (DOTC) subsidiary operating MRT 3, admitted in a radio interview that the government agency is eight months behind the lease rental payments. Based on our computation, using the guidelines in the project agreement between the Metro Rail Transit Corporation or MRTC and DOTC, the aggregate amount of the delayed payments is in the vicinity of US$30 million or P1.4 billion. Lastimoso added that even their maintenance payment obligations to Sumitomo Corporation’s Japanese subcontractor, Tespi Corporation, is four months behind. That would amount to something like $7 million or P335 million. Lastimoso attributes this to the fact that they could not raise the train fare to a break-even level because of potential adverse reactions from the very price-sensitive riding public. Bad Deal? The current financial obligations of the government related to the 17-kilometer MRT 3, the rail system along Edsa, can either be seen as a ghost of a bad deal or an opportunity to right a mistake. Just like other major infrastructure projects that highlight the many ways a public-private partnership can go wrong, MRT 3 has its own story to tell. MRT 3 is under a build-lease-transfer (BLT) scheme between a Filipino consortium and the DOTC, on behalf of the government. The consortium, called the Metro Rail Transit Corporation (MRTC), included the following members: Ayala Land, Inc. of Makati’s famed Ayala family; Anglo-Philippine Holdings Corporation associated with the National Bookstore chain; Fil-Estate Management, a subsidiary of the Sobrepena family’s property and pre-need empire (now crumbling); Ramcar, Inc, battery manufacturer and exporter, of the Agustines family, and; Greenfield Development Corporation, the investment arm of pharmaceutical industry leader, United Laboratories. The Filipino investors infused US$190 million (about P9.3 billion) in equity and raised loans worth $462 million (about P22 billion) from a group of international and local banks. The loans had the sovereign guarantee of the Philippine government. Under this BLT scheme, MRTC built MRT 3 as the borrower and project executor while still in-charge of maintaining the system. Since MRT 3 started operating in 2000, government’s lease and its role as the operator of the rail line also commenced. When the lease expires after 25 years, the government will have full control of the project. This scheme is supposed to free the government from the intricate procedures associated with project financing. As the lessee, the government was also supposed to pay lease rentals. But what was harshly criticized about the project were the lease payments payable during the 25-year period. The rental schedule assured MRTC of an after-tax, after-debt-service, after-expense return on their investments of 15 percent per year. Sovereign Guarantee Critics said this put all the business risks and the pressure to increase the usage of MRT 3 on the government since the consortium’s profits were already guaranteed. By 2002, some members of the MRTC, such as the Sobrepenas and the Agustines of the Ramcar Group, were having financial difficulties in their other businesses, while the Ayalas eventually decided to bow out of the consortium. Thus, some of the consortium members decided to cash in, rather than wait for the government to complete all its future lease rental payments. They tapped the capital markets and packaged these future payments into a financial product called zero-coupon bonds. In effect, the original investors who cashed in, such as the Sobrepenas and the Agustineses, passed on the “waiting time" to those who snapped the bonds. To the bondholders, the MRTC bonds are attractive because they get a hefty 15 percent profit on their money. What’s more, the receivables that back these bonds are coming from the Philippine government and have attached sovereign guarantees to them. In other words, they are supposed to be considered a “safe" investment. What this financial exercise did was change the hierarchy of who owes whom. It used to be that the monthly lease rentals of the government were paid to the MRTC consortium. Now those in the consortium who have cashed in are out of the picture, and instead, the government’s lease rentals are paid to the bondholders as part of their regular bond coupon payments, or the equivalent of the interest earnings of, say, a time deposit in a bank. Fare Subsidy Recall that before MRT 3 started operations in 2000, the calculated fare that was approved was about P30 per passenger. The Estrada administration, however, decided to charge only somewhere between P9 and P15 because that’s what they thought the passengers would be able to afford. When President Arroyo took over, her officials decided to continue subsidizing the fares. The subsidy comes from the national government budget, and needs to go through the usual time-consuming government appropriation and disbursement routes. Unlike the debt rental payments, which are covered by automatic appropriations in the national budget, the lease rentals are not. That explains the late payments, but not why the allocated budgets are still inadequate to cover the lease rental dues even when the budget is disbursed on time. According to Philratings, the local rating agency monitoring debt instruments like the MRTC bonds, subsidy received from the national budget in 2006 was only P1.2 billion, or half the requested subsidy of P2.1 billion for that year. They expect the subsidies for 2007 will also not be enough. In its February 2007 report, Philratings said, “The government agency is not likely to achieve a significant reduction in past due rentals without increasing national government budget subsidies to MRT operations, as fare box revenues of the MRT 3 system are not sufficient to fully pay monthly [lease rental payments]." The budgeted subsidy itself needs to be adjusted because when the project was finalized in 1997, the going rate of the peso to the dollar was P27. Currently, even if the peso rates are stronger in the P48-level coming from previous highs of P54, the discrepancy is still too wide. All the obligations—the lease rentals, maintenance, and the debt rental—are denominated in US dollars, but the revenues from the fare box are in pesos. With all these factors, DOTC will naturally fall behind its obligations. Can DOF meet the deadline? The big difference since 2002, however, is that one of the obligations, the lease rentals, is now the an obligation due to bondholders, some of whom are handled by fund managers who don’t want to upset their clients because they invested in something that could not pay on time. So far, even if the government has been perennially late in dispensing the required monthly lease rental payments to the trustee bank, in this case, the Bank of New York, which pools all these monthly payments in time for the semi-annual coupon payments, the funds in the pool have been enough to meet the scheduled coupon payments. However, the perennially late monthly payments underscore the possibility that there will not be adequate accumulated amounts by August 7, 2007, when the first tranche of bonds will mature. By that time there should be about US$69.2 million or P3.4 billion in the bag already, which may not be likely. It is because of this upcoming date in August that the officials of the Department of Finance—not the DOTC—are rushing to find a way to refinance or re-package their obligations. Meeting the August deadline is now out of the hands of the DOTC because when the bondholders decide to call the government in default of its obligations to them, it is automatic that the other foreign denominated obligations of the government will also be set in default. This will wipe out whatever goodwill or excellent payment records the Philippines has with the international capital markets. Hostile Bondholder But besides the capital markets, the finance department might have to face the possibility of dealing with a hostile bondholder. A Newsbreak source familiar with the details of the bond obligations said that most of the bonds are now in the hands of Elliot Associates, a financial outfit known as a “vulture fund," or one that is expert in buying distressed and cheap debt assets mostly from emerging markets. They scour all possible means, including bankruptcy laws and international litigation, to push for their target to settle with them. Elliot is famous for having compelled the government of Peru to settle a sovereign-bond related issue after Elliot won court cases all over Europe, US and Canada. Meantime, the option to buy out the bondholders, which was floated as early as 2005, was supposed to lessen the pressure on the government as far as meeting the rentals is concerned. If the bondholders are out of the way, then the government will not have to be concerned with the threat of a default call or go through a negotiation process with a hostile vulture fund. Recently, too, the Philippine’s good reputation in the international capital markets has been highlighted in media to push the option of borrowing to fund the buy-out. Why not take advantage of the cheap interest rates, observers say. After all, the government can borrow funds from the capital markets way below the 15 percent cost of the bonds. Buy Out Bondholders? But these are not without flaws. The option of buying out the bondholders just relieves the government of the fact that the MRT 3 is not profitable and will still keep on bleeding the national government’s coffers with annual subsidies. Newsbreak asked Finance Secretary Margarito Teves about the MRTC bonds but he prefers not to give out details. “We will are still talking to the justice department so we will know what should be our parameters if we restructure the contract or seek appropriation from Congress [to finance the buy-out.]" Restructuring the contract may mean the bondholders will have to take a cut, or the government will have to find a new partner that will consent to lower profits. How the finance department will balance everybody’s interest is worth watching. - Newsbreak