Mexico - Power Project

li J /No. P 3 RESTRICTED This report is restricted to use within the Bank. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE BOARD OF EXECUTIVE DIRECTORS ON THE LOAN APPLICATION OF THE MEXICAN LIGHT AND POWER COMPANY, LIMITED April 25, 1950 .-;  INTERNATITONAL BsNK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOIENENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON THE LOAN APPLICATION OF THE MEXICAN LIGHT AND PO7.GER CNMP.Y, L7TfITED I submit the folloving report and recommendations on the loan application of The Mexican Light and Power Company; Limited (hereinafter referred to as "M.exlight" or "the Company"), for a long-term loan of $26,000,000. Part I. Historical 2. in February 19)43, Mexlight applied to the Bank for a long-term loan,of 4,23,689,200 (this amount was subseouently increased) to finance the foreign exchange costs of new electric power plants and transmission lines to be operated by the Company and its subsidiaries in Dlexico City and the surrounding area. The !Jexican Government informed the Bank that it was willing to guarantee the loan. 3. On June 24, 1948, the Bank informed Mexlight that it would not be prepared to consider long-t'erm financing until the Company's capital structure had been reorganized so as to achieve the following purposes: (a) to enable any loan from the International Bank to be adequately secured vis-a-vis any other funded debt of the Company or its subsidiaries; (b) to ensure adequate coverage of the Company's fixed charges; and (c) to establish a capital and debt structure which would facilitate the Company's access to types of financing it might require in the future. The Bank stated that, provided that Mexlight would undertake to carry out" a financial reorganization on these lines by the end of 1949, it would give sympathetic consideration to an interim loan, to be made through the medium of Mexican Government agencies, to enable the construction program to pro- ceed while the reorganization was in progress. The Bank further stated that, if the reorganization were satisfactorily completed during 1949, it would be prepared thereafter to consider a long-term loan of about lf26,000,000 to refund the interim loan and to meet further foreign exchange costs of the expansion program. 4t Un July 28, 19h8, the Companyts Board passed a resoluti6n'of intention to carry out such a reorganization by December 31, 1949. The Bank accordingly opened negotiations as a result of which, on January 6,  - 2 - 19h9, a loan of $10,000,000, maturing on December 31, 1949, was granted to Nacional Financiera, S.A. (hereinafter referred to as "Financiera") and Comision Federal de i lectricidad (hereinafter referred to as "CFE"), agen- cies of the i..exican Government, which in turn lent the proceeds of this loan to I.lexlight. 5. At the time of granting this interim loan, the Bank informed M4ex-light that its intention to negotiate a long-term loan was subject to certain conditions which may be summarized as follows: (a) Specific conditions relating to AMexlight: (i) Completion during '949 of the reorganization of the Company along lines suggested by the Bank; (ii) Ability of the Company to obtain any neces- sary local fin-ncing on reasonable terms; (iii) Granting by the FMexicap authorities of a definitive power rate structure giving the Company prospects of successful operation. (b) General; That no obstacle to the loan shou'd exist' arising out of the condition of the lMlexican economy, the world situation or other rele-P vant conditions. 6. At the same time, the Bank.informed Financiera and CFE that if, due solely to the Gompany's failure to reorganize on the basis suggested by the Bank or to other action or failure to act on the part of the Company, the Bank found itself unable, by December 31, 1949, to grant a further loan on a long-term basis, the Bank would negotiate an extension of'the short- term loan on appropriate conditions.. 7. During 1949, Mexlight, with the advice of First Boston Corporation of New York, and in consultation with the Bank, proceeded with the prepara- tion of a reorganization plan and also with negotiations with the Mlexican authorities for the award of definitive power rates and for a long-term local currency credit. On September 8, I vas able to report to the Board of Zxecutive Directors that: (a) A Plan of Arrangement had been drafted in general conformity with the Bankl's suggestions; (b) Financiera had undertaken to grant '.exlight a credit' of 44 milliop pesos wqhich, in conjunction with the prospective earnings of the Company, gave assurance that local currency financing would be available for the project op reaspnable terms;  - 3 - (c) The i.fexicah authorities had decided upon a new power rate structure for Mexlight which gave reasonable prospects for the successful operation of the recapi- talized Company; (d)' There had been no change in the Mlexican economic situ- ation which would justify a change in.;the Bank's inten- tions. 8. The Board accordingly approved my recommendatior. that the Bank write to Mexlight stating that the Bank was prepared to enter into a long- term loan agreement substantially in the form of the draft then presented, subject to conditions which may be summarized as follows: (1) That prior to December 31, 1949, or such later date as might be agreed upon, the Plan of Arrangement shloul'd receive the necessary approvals of the security-holders of 1`:iexlight and the competent Canadian Court; (2) That the United.Jlexican States should enter into a guarantee agreement with the Bank substantially in the form of the draft then presented to the Board; (3) That between the date of such letter and the time iwhen LMlexight's security-holders took the action contemplated by the Plan, there should have occurred no adverse change in the circurmstances of the Company and its suzbsidiaries, in the condition of the Mexican economy, in the relation- ship of the United Texican Stites with the International Bank or the International Yonetary Fund, or in the world situation sufficiently serious in the Bank's opinion to preclude the granting of the long-term loan. A letter in this sense was sent to i'.exlight on December 19, 1949. 9, Events did not move as rapidly in the latter part of the year as had been hoped. The devaluation of sterling and other currencies in September 1949 made it necessary to revise those provisions of the Plan of Arrangement which,called for the exchange of existing sterling and Canadian dollar securi- ties for new U.S, dollar securities.. The new power rate structure for M4ex- light was not finally promulgated by the Government until December 14. It was therefore impos4sible to complete the reorganization by December 3;, 1949, and X accordingly sought and obtained on December 1 the Board's approval for an extension of the maturity and closing dates of the interim loan until July 1, 1950... 10. On February 10, immediately before the. security-holders' meetings,. the -Sank wrote to the Company cQnfirming,that the Bankts position was still as stated in its, letter of December 19,. 19)491,and that,.in its-opinion, no serious adverse change in the sense of condition (3) (paragraph 8 above). had taken.place.  -44-.. 11.. Wleetings of M.1exlight security holders to consider the Plan of Arrangement were held in Toronto February 14 - 17, 1950. Ample quorums were present, and the securities represented in each class voted overwhelm- ingly in favor of carrying out the Plan. t.Mexlight accordingly applied to the Supreme Court of Ontario for an order sanctioning the Plan.. This order was made on April 12,. 1950. Part II. Description of the Proposed Loan Borrower 12. The Borrowver would be The 1:Texican Light and Porrer Company, Limited,. a company incorporated by Letters Patent under the Companies Act of Canada.. Guarantor 13. United li,exican States would guarantee fully the Company's obli- gations under the loan agreement.. A law enacted by the .iAexican Congress on December 22,. 1949, and published in the Diario Oficial of December 28,., 1949,. authorized the Federal Executive to guarantee, as above, through the intermediary of Financiera, a long-term loan of *P26,.000,.000 to be made by the Bank to lliexlight. Amount 14.. The loan would be in the amount of U.S.. $26,.000,000 or its equiv.- alent in other currencies., Purposes 15. The proceeds of the loan would be applied:. (a) to the refunding of the interim loan of $10,000,000 made by the BanL to Financiera and CFE on January 6, 1949, and re-lent by them to Mexlight; (b) to the financing of foreign exchange expenditures on account of a specific four-year construction program now being carried out by PMexlight for the expansion of its electric porrer generating, transmission and distributing f cilities in >;iexico, with the provision that iJ.exlight may purchase wArithin Miexico from the pro--* ceeds of the loan, certain electrical equiipment esti- mated to cost not in excess of $3,000,000 (including $600,.000 heretofore approved by the Bank out of the proceeds of the interim loan) of which components valued at approximately $1,.800,000 are imported into lexico for assembling.  -5- Term and Amortization Arrangements 16. The loan would be for a period of 25 years. Amortization would begin on August 1, 1953, and would be on a level payrents basis calculated to retire the loan by its maturity on February 1, 1975. Interest and Commitment Charge 17. The loan would bear interest at the rate of 4-% per annum (includ- ing the usual commission at the rate of 1% per annum). A comrmitment charge would be payable on the undisbursed portion of the loan in accordance with the Bank's current practice. Legal Instruments 18. (i) Drafts of the following legal instruments vwere distributed to the Board on September 8, 1949, (R-250): (a) A Loan Agreement between M1exlight and the Bank; (b) A Guarantee Agreement between United M1exican States and the Bank; (c) A Novation Agreement between the Bank, Financiera, CFE and 1.exlight and Mexlight's subsidiaries.. Comments on the salient points of these instruments w.rere given'in R-299, with which earlier drafts were circulr:ted to the Board, An amortization schedule not included in the draft Loan Agreement already circulated is attached hereto as Annex A. (ii) There is attached hereto, as Annex B, the report of the Committee provided for in Article III, Section 4 (iii) of the articles of Agreement of the Bank. Security and Debt Limitation 19. The Bank would receive from i,.exlight bonds representing equivalent amounts of the.principal of the loan and constituting Series B bonds of the new First M4ortgage and Collateral Trust Bonds to be issued under the Plan of Arrangement. Such Series B, as well as the other bonds issued unde'r the Plan, would be equally secured by a mortgage on fixed and immovable proper- ties of iiexlight under the terms of a ?Jortgage Indenture .. A draft of this Indenture was distributed to the Board on April-10, 1950 (R-319). 20, The MYlortgage Indenture imposes certain restrictions on the issue of further series of bonds. In addition, Article VI, Section 10 of the Loan awgreement imposes fuirther limitations on the Company's freedom to issue further bonds,, to dispose of assets, and to perform various actions which might prejudice the position of Series B Bonds.  Part III. Fulfillment of Conditions Prescribed by Bank 21. All that remains to be done at the present stage is to consider whether there has been since February 10, 1950, any adverse change in the various factors referred to in condition (3), paragraph 8 above, suffi- ciently serious in the opinion of the Bank to preclude the granting of the proposed loan, The Circumstances of the Company and its Subsidiaries 22. Since my Report to the Board of Executive Directors of September 8, 1949, l.exlight has had to face two factors which at that. time had not entered into its calculations, and which have had an adverse bearing on estimates of cash flow and earnings. 23. In the first place, the seasonal rainfall, which occurs betiween June and uctober, was in 1949 abnormally low. as a conseouence, the Company has had to rely less on hydroelectric generation and more on higher-cost thermal generation. Besides operating its established thermal plants more intensively, it has had to obtain electricity from einergency diesel units operated by itself and by OFE. These steps have not been enough to maintain normal output, and since January this year restrictions on power consumption have been in force in the iCexico City area. Industrial consumers have had to reduce by 151J', and commercial and domestic consuners by 40% their consump- tion of power. This has meant a fall in 1Mlexlight's sales revenue of the order of 25%. 24. Secondly, the new definitive power rates, which it had been hoped would become effective in September, vrere not promnulgated until December 14, 1949, and were not ref'.ected in increased collections until February 1950. 25. The effect of these unexpected setbacks, in the absence of reme- dial action, wiould have been to reduce the cash margins given in Daragraph 20 of my Report of September 8, 1949, by about 20 million pesos. Tlexlight accordingly plans: (a) To reduce by 1a0% its 1950 expendituires on construction outside the Bank-financed progranm. This can be done without any significant effect on eprnings over the next four years, and, according to 11exlight, will con- serve about 8 million pesos of cash, (b) To draw down more rapidly than was originally contem- plated the 44 million peso loan granted by Financiera towards the local currency cash of the project. Present estimates indicate that the following changes in the planned rate of drawing down will be necessary:  -7- Pesos Dlillion Originally As now revised 1949 4 0.78 1950 10 19.22 1951 20 24.0 1952 10 - The 44 million long-terrm peso loan agreement betwreen Financiera and Mexlight was signed on April 18. It permits Ilexlight to draw down the proceeds at the revised rate, insofar as this proves to be necessary. 26. Cash flow estimates, revised by IMlexlight in the light of these changes, are attached hereto as Annex C. The margins are obviously thin, and it will be seen that a cash deficit of $165,000 is shown at the end of 1952. Nevertheless, if better than average rainfall is experienced during the next three years, or if, ap is not altogether improbable, CFE's "Miguel Aleman" hydroelectric system is in a more advanced stage by the end of 1952 than has been assumed, thus providing a greater supply of relatively cheap power, this deficit need not arise at all. As far as can be seen, should the threatened deficit appear, it is likely to be of proportions easily manageable by such means as a further advance from Financiera, short-term borrowing, or a'fuirther postponement of some construction failing outside the Bank-financed program. 27. These cash flow estimates take into account estimates of earnings over the construction period which show that, after fixed financial charges have been covered, there will bq balances which, transferred to earned sur- plus and invested in construction, will suffice, in conjunction with the loan from Financiera, and subject to the qualification in the preceding paragraph, to finance the peso costs of the construction program. 28. The cash and earnings estimates have been prepared on the assump- tion that wages and salaries remain as at present. Existing regulations for determining electric power rates provide that when wages and salaries are raised, an appropriate increase of rates must be awarded, so that no adverse disturbance of present estimates should arise from this cause. Mexlight is in fact at present negotiating with its labor syndicate on demands which the latter has presented for a revision of the existing labor contract and, if agreement is'not reached by May 16, the syndicate's present intention is to call a strike. MIexican labor law, however, gives the Government consider- able powver to influence the terms of settlement of such disputes and, on the basis of Government action in other recent disputes, the Company believes that any concessions it may have to make should not increase its labor costs by more than 10%. The Condition of the Mexican Economy 29. Since the devaluation and stabilization of the peso at 8.65 pesos to the dollar in June 1949, the Mexican econormy has generally shown favorable tendencies. The gold and foreign exchange reserves of the Bank of Mexico  - 8 - almost doubled during the last six months of the year, and in January 1950, Miexico was able to repay to the U. S. Stabilization Fund 422 million out of the $37 million borrowed in 1947, Imports have fallen and tourism has shown a marked increase. There are indications that some repatriation of capital may be taking place, and foreign enterprises are investing in Iqexico at the same slow but continuous rate. 30. These favorable tendencies have been due, not solely to devalua- tion, but also to some extent to restrictions on imports and, to a much greater extent, to credit restrictions and the enforcement of a balanced budget. These measures have prevented any substantial rise of prices and have thus made the devaluation effective. 31. It is generally expected, however, that further increases of prices will take place as the hi-her costs of imports and of public services (rail- roads, electricity, telephone) spread through the economy. Furthermore, miners, oil, railway, sugar, textile and public utility workers are pressing for wage increases. These wage conflicts are not expected to be violent; the good relations between the Government and the unions lead to a willing- ness to make concessions on both sides, and increases of wages are likely to be kept below the point at which they would dangerously strain the price structure and thereby the balance of payments. It will remain essential that the Government should continue to follow its non-inflationary budget and credit policies, lest excessive investment and consumption demands should change what now seems to be an adjustment to the new rate of exchange into a renewed inflation. 32. There has been no substantial change in "exico's external indebted- ness since last 5eptember. ,he 19M6 plan' for a settlement of the debt of the exoropriated railways became effective on Jrnu.ry 1,. 1950. The accumu- 'ations of interest since 1946 virill be discharged by providing, during each of the four years 1950-1953, two years' service instead of one; so that dur- ing these years annual payments of about t6 million will have to be made, falling to $2.7 million thereafter. Previous Bank assessments of Fexico's external debt burden had taken these railway debts into account, however, and the coming into effect of the settlement therefore introduces no new factor into the situation. 33. bliexico's rapid economic develooment, which inevitably entails a constant pressure upon both internal and external credit, will continue to place a heavy responsibility on those in charge Qf its financial and economic policy, I believe, however, that the present admini4tration has shown com- mendable skill and determination in its approach to these matters, and I see nothing in the present economnic situation of !.flexico which would warrant a change in the Bank's intention to make the Dresent loan. Other Factors 3h. i'iexico continues in good standing with the Bank and with the International l?onetary Fund, and there has been no alteration in the world situation which, in my opinion,, would preclude the granting of the loan.  - 9 - 35. I am satisfied that due regard has been paid to the prospects that Mexlight and the Guarantor will be in a position to meet their respec- tive obligations under the proposed loan, and I am satisfied that, in makming this loan, the Bank will be acting priudently in the interests both of IMIe-ico and of the members of the Bank as a whole. Part IV. Compliance with the Articles of Agreement 36. I am satisfied that the proposed loan complies with the require- mnents of the Art.cIes of Agreement of the Bank. Part V. Recommendations 37. I recommend that the Bank at this time grant to The i4exican Light and Power Company, Limited, a loan-of $26,000,000 for a term of twenty-five years,, with interest (including cormission) and commitment charge at such rates, and on such other terms, as are specified in the forms of Loan, Guarantee, and Novation agreements presented to the Board on September 8, 1949, (R-250). (Siglled) R. Lo Garner Vice-President for President April 25, l950  ANEX "All SCHEDULE 3_ Table of Amortization Date Payment Principal amount payment of outstanding after due principal each pavment Feb. 1,. 1953 - `26,000,000 Au-. 1, 1953 *t3352,000 25,648,000 Feb. 1, 1954 360,000 25,288,000 Aug. 1, 1954 368,000 24,920,000 Feb. 1, 1955 376,000 24,544,000 Aug. 1, 1955 385,000 24,159,000 Feb. 1,.1956 394,000 23,765,000 Aug. 1,: 1956 402,000 23,363,000 Feb. 1, 1957 411,000 22,952,000 Aug. 1, 1957 421,000 22,531,000 Feb. 1, 1958 430,000 22,101,000 Aug.. l, 1958 439,000 21,662,000 Feb. 1, 1959 450,000 21,212,000 Aug. 1, 1959 460,000 20,752,000 Feb. 1, 1960 470,G00 20,282,000 Aug, 1-7 1960. 481,000 19,801,000 Feb. l, 1961 491,000 19,310,000 Aug. 1, 1961 503,000 18,807,000 Feb. 1, 1962 514,000 18,293,000 Aug. 1, 1962 525,000 17,768,000 Feb. 1, 1963 537,000 17,231,000 Aug. 1, 1963. 550,000 1.6,681,000 Feb. 1, 1964 561,000 16,120,000 Aug. 1 1964 574,000 15,546,OQO Feb. 1, .1965 588,000 14,958,000 Aug. 1, 1965 600,000 14,358,000 Feb. 1, 1966 614,000 13,744,000 Au-. 1, 1966 628,000 13,116,000 Feb. 1, 1967 642,000 12,474,000 Aug. 1, 1967. 656,000 11,818,000 Feb. 1, 1968 671,000 11,147,000 Aug. 1, 1968 687,000 10,460,000 Feb. 1, 1969 701,000 9,759,000 Aug, 1, 1969 718,000 9,041,000 Feb. 1, 1970 733,000 8,308,000 Aug. 1, 1970 750,000 7,558,000 Feb. 1, 1971 767,000 6,791,000 Aug. 1, 1971 785,000 6,006,000 Feb. 1, 1972 801,000 5,205,000 Aug. 1, 1972 820,000 4,385,000 Feb. .1, 1973 839,000 3,546,000 Aug. 1, 1973 857,000 2,689,000 Feb. 1, 1974 867,000 1,813,000 Aug. 1, 1974 897,000 916,000 Feb. 1, 1975 916,000 - The above Table shows the dates on which the instalcents of the principal of the Loan phall be repaid and the respective amounts of such instalments.  ANNEX "B9 STATUTORY LOAN COMMITTEE REPORT To: The President1 International Bank for Reconstruction and Development' Report of Loan Committee under Article 'III, Section 4 (iii), of the-Articles of Agreement on the proposed Loan to The Mexican Light and Power Company, Limited. The undersigned Committee, constituted under Article V. Section 7, of the Articles of Agreement of International Bank for Reconstruction and Development (hereinafter called the Bank) hereby submits its report pursuant to Article IIU, Section 4 (iii), of said Articles in respect of the proposal that the Bank grant to The i'mexican Light and Power Company, Limited (hereinafter called the Borrower) a loan in the principal amount of .26,000,000. The purpose of said loan is: (a) to permit the refunding of the interim loan of tl10,000,000 made by the Bank to Nacional Financiera, S.A. and Comision Federal de Electricidad on January 6, 1949, and r'e-lent by them to the Borrower; (b) to'finance foreign exchange expenditures on account of a specdfic four-year construction program nowv being carried out by the Borrower for the expansion of 'its electric- powver generating, transmission and distributing facilities in Mlexico, with the provision that the Borrowver may purchase within M.exico from the proceeds of the loan, certain electrical equipment estimated to cost not in excess of $3,0CO,000 (including $600,OO0 heretofore approved by the Bank out of the proceeds of the interim loan) of which components valued at approximately $1,800,000 are imported into Y:exico for assembling. 1. The Committee has carefully studied the merits of the proposal to' grant such a loan and the purposes to which the proceeds of the loan are to be applied. 2. The Committee is of the opinion that the project toward the financing of.which the proceeds of such loan are to be applied comes within the purposes of the Bank as set'forth in Article I of.said  -2- Articles of Agrcement and that the said project is designed to promote the development of the productive facilities and resources of Mexico and is in the interests of 'L.exico and of the members of the Bank as a whole. 3. Accordingly, the Comnmittee finds that said project merits t'ne financlal assistance of the Bank and hereby recomraends said project for such assistance. GOISfTITTEE /sl R. I.. Garner R. L. Ga H bri - .'. B. BIlff "J. A. B. Iv.fTfT _ZsZ T, Rist > i s t /s/ Davidson Sommers TE-[avids9on Toiaers * fr/ sHenry lv. Riley Henry 1:.Riley /s/ A. Cortina Alfonso Cortina Dated at llashi.ngton, D. C. April 25, 1950.  ANBMX "C" THE MEXICAi'T TIGHT AND PF01FER COMPANY. LI4ITED ASD SUBSIDIARIES CASH PLOWJ (THOUSI'TNDS OF U.S. DOLLARS) Required Funds'. 1950 1951 1952 1953 1954 Operating-expenses .............. ,.-.,. 14,127 14,416 15,156 16,566 18,358 (1) Does not include l/6 to Government . ............ 22 - 717 - 983 payment of divi-' Income Tax ................. 1,503 1,930 2,636 3,295 3,272 dends on Common Construction expenditures . ..... 14,_257 20,340 8X,.20 5,030 5,206 Stock which ought Payment for Financial Obligations__ 1,732 2,144 2,587 3,482 4,904 (1) to be paid in 1954 Reorganization Expenses ................ 400 - - - - from earnings of .. 1953. Total Required Funds 32,041 3S,830 29,516 23j,373 32,723 Available Funds: Cash at beginning of year ............. . 1,600 2,126 1,083 - 165 1,350 Gross Earnings . ......................... 20,798 23,988 26,243 28,763 31,561 Available part of Retirement and Replacement Fund ................... 925 925 925 Loan from International Bank . . 9,200 10,500 1,500 600 - Loan from Nacional Financiera ......... 2,222 -2,774 - - Lag in collections .................... - 578 - 400 - 400 - 400 - 400 Total Available Funds 34,167 39,913 29,351 29,723 33,436 Cash at end of year ................ , 2,126 1,083 - 165 1,350 713 Note: This forecast wias prepared on the ass-mption that the diversion of the waters of the Tuxpan and Zitacuaro Rivers and the construction of the San Bartolo plant of the Federal Power Commission will not be completed by the 1st of January 1953, as planned by the Federal Power Commission. April 13, 1950