MRT III’s Asset-Backed Securities (ABS) Rated PRS Aa

“MRT III Funding Corporation’s (MRT III) ABS have been rated PRS Aa,” PhilRatings announced as it completed its first credit rating of ABS. Tranche details of the ABS are as follows:

US$66,000,000 9.50% Tranche 1 due 2007

US$30,972,000 zero-coupon Tranche 2-A due 2008

US$30,972,000 zero-coupon Tranche 2-B due 2009

US$33,885,000 zero-coupon Tranche 2-C due 2010

US$81,464,000 zero-coupon Tranche 2-D due 2011

US$99,913,000 zero-coupon Tranche 2-E due 2012

US$100,884,000 zero-coupon Tranche 2-F due 2013

US$100,884,000 zero-coupon Tranche 2-G due 2014

US$1,197,155,660 Pass-through Tranche 3 due 2025

A rating of PRS Aa, the second highest possible rating on PhilRatings’ long-term rating scale, is defined as: “Margins of protection may not be as large as in PRS Aaa issues. Fluctuations of protective elements may be of greater amplitude or there may be elements which make the long-term risks appear somewhat larger than for PRS Aaa-rated issues.” PRS Aaa-rated securities, on the other hand, are defined as those with the “smallest degree of investment risk.”

In arriving at the rating, the following major considerations were taken into account: the Republic of the Philippines (ROP) as ultimate obligor to pay rental fees; the strong set of warranties and representations made by Metro Rail Transit Corporation (MRTC), holding companies Metro Rail Transit Holdings II (MRTH II) and Metro Rail Transit Holdings (MRTH), and by the individual sellers who own a majority of the voting stocks in MRTH; the liquidity support in the forms of letters of credit (LCs), cash reserves, and other enhancements; and the legal adequacy of the transaction structure.

The MRT III Notes are backed by future dividends from MRTC, arising from equity rental payments (ERPs) of the Department of Transportation and Communications (DOTC) to MRTC under a build-lease-transfer (BLT) agreement for the construction of the Light Rail Transit System, Phase 1 (LRTS Phase 1 or MRT-3) in Metro Manila. The ERPs under the BLT agreement constitute a direct obligation of the DOTC, an unincorporated government agency. The ERPs are thus direct, unconditional, and general obligations of the government, which acknowledged that DOTC’s obligations under the project agreement carry the full faith and credit of the ROP.

The dividends, or share distributions, will flow through a series of holding companies and special purpose vehicles to MRT III, the ABS Issuer, for the benefit of the noteholders or investors. The MRTC and MRT holding companies, as well as the individual sellers, are not strictly bankruptcy-remote. However, their constitutive documents, as well as the project agreement, financing agreements, and issuance documents provide restrictions and covenants that adequately mitigate against the risk of insolvency.

In assigning the rating, PhilRatings also notes that the government has incurred delays in the payment of ERPs and maintenance rental. At the time of this rating, the government has unpaid past due maintenance fees to MRTC which is a pass-through obligation of MRTC to Sumitomo Corporation, the maintenance provider. This amounts to US$21 million. In connection with this past due amount, MRTC has assigned, with the concurrence of Sumitomo and DOTC, the past due maintenance fees receivable from the DOTC to Sumitomo, which cures this particular event of default on the part of MRTC. The Assignment Agreement contains a “with recourse” clause which provides that the obligation to pay the overdue amounts will revert to MRTC and the unpaid amount will become due and payable if no settlement or restructuring is achieved within ninety days or by December 17, 2003. PhilRatings, however, is of the view that a settlement or restructuring of the past-due maintenance fees in the near-term is reasonably assured, considering the strong personal assurance of DOTC Secretary Leandro R. Mendoza and the vital social importance of the MRT-3 system. Secretary Mendoza, in an interview with PhilRatings, had stated that DOTC “cannot afford to have the trains stop,” because adequate public transportation in Metro Manila is of paramount public concern.

Developments regarding the settlement of maintenance fees will be monitored closely. Realignment of funds at DOTC, for example, is seen as a source of payment settlement of maintenance fees. Regarding more recent maintenance payments due to Sumitomo, MRTC recently advanced USD 1.1 million to update payments up to August 2003.

On the delays in the ERPs, these are addressed by the payment structure of the Notes and the stand-by LC maintained by DOTC with Philippine National Bank (PNB) in favor of MRTC, in an amount at least equivalent to the amount of the next monthly ERP. The DOTC is required to reinstate the LC to the required amount within 20 days after each drawing. Since last year, MRTC has called on the LC five times to date. Up till the middle of 2003, there was some delay in the reinstatement although this has already been addressed more recently. More drawings on the LC are projected going forward to ensure that delays in ERPs if any occur, do not become too significant. This LC arrangement, by experience, has already been proven to work as an effective credit enhancement. A drawing was scheduled on October 29, after which the ERPs will only be 1.5 months delayed. Earlier, the sellers had advanced the amount necessary to reduce the delay in ERP payments from four months to two months. The ERPs (or any payment due for that matter) not being delayed by more than two months is one of the conditions necessary for the PRS Aa rating that has been assigned. This is based on the provision in the BLT that specifies a 60-day period within which to remedy non-performance of obligations.

In addition to the LC, the sellers have committed under a formal warranty to provide US$3.15 million as liquidity reserve, equivalent to one coupon payment of the Tranche 1 Notes. This, as well as the prospective issuance by MRTC of an “irrevocable instruction” to its on-shore collateral agent to directly transfer funds received from DOTC to the MRT III trust account with the Bank of New York (BONY) also significantly alleviate the risk of payment delays. PhilRatings views that the assigned rating is commensurate to the level of risk that these payment delays pose.

PhilRatings will likewise monitor closely developments relating to a proposed increase in MRT fares which will greatly improve the system’s ability to cover all related expenses, particularly over the long-term.

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