The need to moderate greed

Greed is at the root of the evils we face today as a society. Unless we all moderate our greed, we will all go down in the seeming hopelessness of our problems.

Even otherwise respectable private sector corporates who tout corporate social responsibility are infested by it. That’s why there is government regulation, but unfortunately for us, there is also regulatory capture.

Take that water debate, for example. Almost everybody has been focused on how the water companies are making their customers pay for their income taxes. It is a valid point but we are missing the real problem. Greed rears its ugly head elsewhere.

Every five years, the Regulatory Office of MWSS reviews the performance of the concessionaires, checks claims of what they have done and passes judgment on their proposals for new water rates.

In the past, it would seem that the regulators eventually gave most of what the water companies ask for. This time, Gerry Esquivel, MWSS administrator, told me that they are going through everything with a fine tooth comb.

I am told they have already disallowed a lot of expenses claimed by the water companies for failing to meet the prudence and efficiency standards. This has an impact on the final rate the companies would get.

Gerry wouldn’t talk to me about the details of what they are doing on this round of rate rebasing. What’s different, Gerry explains, is the current staff of the Regulatory Office.

They now have technocrats who are as tough with numbers as the private sector financial advisers to the water companies. And they are driven to ensure good governance, the reason why they are working in government despite the pay and not in some bank or conglomerate.

The complex maze of numbers and formulas aside, the key issue that impacts greatly on the water bill we will pay and on the profitability of the water companies rests on the assumed cost of money. It is a major factor in determining the so called ADR or the appropriate discount rate or the guaranteed return for the water companies.

High cost of money will mean a high ADR, which in turn, will result in higher water charges and higher return for the water companies. The ADR went up quickly between 1997 and 2003, and so did our water charges, in response to higher Philippine government bond yields, a measure used for the cost of funds.

The not so funny thing however is that the sharp drop in bond yields in the last five years is not reflected in the new 8.99-percent ADR the water companies have proposed.

Five years ago in 2008 when the ADR was at 9.3 percent, the yields of government treasury debt was 9.9 percent for the 10-year note and 13 percent for the 25-year bond. These yields have since fallen sharply to 3.40 percent and 4.66 percent, respectively.

Manila Water Co., which provides water service in the eastern half of Metro Manila and surrounding areas, wants to increase rates by P5.83 per cubic meter or 21 percent to P34.12 per cubic meter. Maynilad Water Services, Inc., which runs the water system in the west zone, is proposing to increase average basic rates by P8.58 per cubic meter or 25 percent to P42.55 per cubic meter. The water charges were P2.32 in the east zone and P4.96 in the west zone when the concessions were awarded in 1997.

A PCIJ story by Roel Landingin, who is also the local correspondent of the London-based Financial Times, explains that “apart from being allowed to recover past expenses and future costs from tariffs paid by customers, the two water companies are also allowed to earn a return on those cash outflows.”

For the next five years until 2017, they want an ADR, of 8.99 percent, Roel’s sources told him. That is almost unchanged from the discount rate of 9.3 percent for 2008-2012, and slightly lower than the ADR of 10.4 percent for 2003-2007, despite sharply falling yields on long-term government bonds.

Here is how Roel explained the impact of what the water companies are asking to our water bills:

“The water firms’ proposed 8.99-percent ADR means they will earn almost nine pesos out of every P100 they spend, including that for income taxes. That is apart from rightly getting back the P100 itself.

“The ADR also works like a compounded interest on the water companies’ unrecovered expenses. At nine percent, an unrecovered expense of, say, P100 five years ago is now worth P154.

“As any struggling borrower knows, compounding interest rates can be a heavy burden, making the ADR a central issue in the rate rebasing process.”

MWSS administrator Esquivel told me the MWSS Regulatory Office is due to come out with a decision soon. While Esquivel realizes it is their duty to live by the spirit of privatization and ensure the business viability of the water companies, he also said they strongly feel they must protect the consumers as well. “We are the last chance to look out for the consumers,” he told me.

According to Roel’s PCIJ story, “the regulators think the ADR should drop sharply in line with lower yields on Philippine government bonds.”

Former NEDA chief, Felipe Medalla, who was MWSS’s consultant on determining the ADR in 2002 and 2007 believes the ADR for the water companies should fall to below six percent mainly because the yield on Philippine government debt has plummeted.

Medalla, according to Roel’s story, also insisted on using a shorter-dated instrument, a 10-year bond, pointing out that “current low interest rates are sustainable at least in the next five years due to excess liquidity in the Asian region. Medalla also thinks that “looking backward for 25 years on local interest rates would reflect more the political turmoil of the past rather than the financial fundamentals of the country.”

But the water companies are again pushing for the higher yielding 25-year Philippine bond as benchmark for the risk-free rate to get a higher ADR.

Another source of variance between the regulators and water firms’ ADR estimate is whether the bond yields are averaged over a year or five years. The water companies want to use a five-year mean while the regulators want a period of just a year.

The regulator interviewed by PCIJ wants to use a one-year average because, it was pointed out, past estimates of the risk-free rate, based on a five-year average, overshot the actual average between 2008 and 2012 by around 2.5 percentage points. That added billions of pesos to the present value of the water firms’ unrecovered past claims, which are compounded using the ADR.

The latest disclosure of Manila Water of its 1st half 2013 unaudited financial results the other day show consolidated EBITDA margin was 75 percent and 71 percent in the same period 2012. The after tax net margin was 38 percent with net income at P2.911 billion from P7,632 billion revenues.

These interim half-year results are consistent with the full year 2012 audited results showing a net margin of 37 percent, after tax profit of P5.451 billion from P14.553 billion revenues, as compared with 36 percent, P4.278 billion and P12.003 billion in 2011.

The operating results of Maynilad Water, reported by its parent Metro Pacific Investments (MPIC), were equally impressive. The 2012 audited annual report show net profit margin of Maynilad was 43 percent in 2011 and 40 percent in 2010. 2011 Core EBITDA was P9.394 billion with a margin rate of 68 percent, as compared with P7.907 billion and 66 percent margin in 2010. 2011 net profit was P5.865 billion from revenues of P13.769 billion, as compared with 2010 net profit of P4.780 billion from P12.050 billion revenues.

In comparison, Meralco had after tax net margin of six percent in 2012, five percent in 2011 and four percent in 2010. PLDT’s fixed line business had a net margin of 8.76 percent in 2012 and 10.51 percent in 2011. These companies equally incur heavy capital investments as the two water companies but are apparently doing well with lower margins.

Given their magnificent financial performance, the two water companies have much room to accept a lower ADR arising from the realities of lower borrowing costs and less risk, which are the new normal. Given the country’s poverty incidence, lower water rates constitute real corporate social responsibility, not the token philanthropies they issue press releases on.

I say, a moderation of greed applies to every Filipino today. We all need to do our share to create a more stable society and economy we can all enjoy. –Boo Chanco (The Philippine Star)