Brazilian Issuer Reins in Costs in Tough Market

Companhia de Saneamento Basico de Sao Paulo (Sabesp), one of the largest water and sewage companies in the Americas is adapting to what is proving to be a very long dry spell for emerging market issuers by living within its means, said director of treasury operations Claudio Gaiarsa.

Although the state-owned company may turn to the international capital markets to roll over short-term lending due over the next 12 months, its financial strategy has shifted towards reducing its level of investment and hence its borrowing needs while searching for more unorthodox sources of credit.

If cash flows can not accommodate for the roughly $60 million Sabesp owes in local currency before the end of the year, the firm is likely to turn to both international and local creditors by taking out a loan or issuing loan participation certificates. The utility will also look to international capital markets to help refinance $180 million in corporate paper which comes due next May, Gaiarsa said, via either a bond sale or a syndicated loan. But as far as additional financing is concerned, the company will be maintaining a particularly conservative approach, he added.

"We are not going to finance investment with short-term money," Gaiarsa said. "If we can get additional long-term financing in the market we will do investments, but for most of our [projects] we're talking about a [pay back] period of at least ten years." Because of steadily declining investor interest in the emerging markets, the price of obtaining such a long tenor would be prohibitive for Sabesp and most other Brazilian companies, he said.

Local factors have also made it more difficult for the company to access financing, as the national government has sharply curtailed lending to utilities from the state run pension fund, O Fundo de Garantia. The fundo, which is financed via an 8% tax on Brazilian workers and is managed by the Caixa Economica Federal, has in the past served as a provider of extremely long-term and low-cost financing for public sector borrowers. Approximately 10% of Sabesp's $3.3 billion in outstanding debt is owed to the fundo, which offered maturity structures of 25 years at a rate of 6.5% over Treasurys. But as the country's fiscal deficit ballooned, the Central Bank and National Monetary Council began restricting the fund's investments in the housing and sanitation sector in 1996 before freezing them in 1998.

In order to cope with these tight credit conditions, Sabesp will be reducing its level of capital expenditures, Gaiarsa said, an action that will be facilitated by the fact that the company has recently achieved a high level of service. Over the next four years Sabesp plans to invest roughly $1.3 billion, he said, compared to the $1.7 billion spent in the period between 1995 and 1998.

Sabesp is continuing to expand, however. The firm is on the verge of winning a concessionary contract to take over the management of sewage in the municipality of Osasco in fall of 1999, and is in negotiations with a number of other municipalities in the state of Sao Paulo to discuss similar concessions.

While Sabesp will pay for most of these expansions with revenues and non-cash transactions involving credit and equity, Gaiarsa is also keeping a sharp eye on borrowing conditions should they improve. But, he added, "I don't expect the market to be back anytime soon."

One source of capital could be the long-closed Fundo de Garantia. The Caixa Economica has presented the fundo's managing board with a proposal to allow investments in securitized bonds issued by sanitation companies. If the board votes in favor of the plan at a meeting later this month, Sabesp could have access to hundreds of millions of reais in credit.

Gaiarsa is also looking into credit enhancement as a means by which to secure long-term borrowing at affordable rates. "We're considering Overseas Private Investment corporation structures, World Bank structures and [InterAmerican Development Bank] structures ranging from credit guarantees to political risk insurance," he said. Although several investment banks have already proposed deals to Sabesp involving such facilities, current market conditions have kept the company from issuing.

Nevertheless, if liquidity does return to the emerging debt markets next year, Sabesp could take these offers up, Gaiarsa said, in order to replace about $290 million in debenture, due in 2002.