Document of The World Bank Report No: 1 8083-PH PROJECT APPRAISAL DOCUMENT ONA PROPOSED LOAN IN THE AMOUNT OF US$150 MILLION TO THE DEVELOPMENT BANK OF THE PHILIPPINES (DBP) FORA PRIVATE ENTERPRISE CREDIT SUPPORT PROJECT October 26, 1998 Private Sector Development Unit East Asia & Pacific Region CURRENCY EQUIVALENTS (Exchange Rate Effective May 31, 1998) Currency Unit = Peso (P) US$1 = P39.00 PI = $0.026 FISCAL YEAR January I - December 31 ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank GSIS Government Service Insurance System BSP Bangko Sentral ng Pilipinas/ Central JGF Japanese Grant Facility Bank of the Philippines ICR Implementation Completion Report CAR Country Assistance Review IFC International Finance Corporation CAS Country Assistance Strategy IICP Industrial Investment Credit Project COA Commission on Audit IRP Industrial Restructuring Project DBP Development Bank of the Philippines KfW Kreditanstalt fir Wiederaufbau DENR Department of Environment and Natural LOC Line of Credit Resources ODA Official Development Assistance DOF Department of Finance OECF Overseas Economic Cooperation Fund ECAs Export Credit Agencies OED Operations Evaluation Department EIA Environmental Impact Assessment OPG Operating Policy Guidelines of DBP EKB Expanded Commercial Bank or Unibank PDIC Philippines Deposit Insurance Corporation or Universal Bank PECSP Private Enterprise Credit Support Project EMB Environmental Management Bureau PFIs Participating Financial Institutions ERL Economic Recovery Loan PNB Philippines National Bank FRR Financial Rate of Return SME Small and Medium Enterprises FSAL Financial Sector Adjustment Loan SSS Social Security System- GFIs Government owned Financial T-Bill Treasury Bill Institutions TTA Training and Technical Assistance GOP Government of the Philippines Vice President: Jean-Michel Severino, EAPVP Country Director: Vinay K. Bhargava, EACPF Sector Manager: Hoon Mok Chung, EASPS Task Team Leader/Task Manager: Zafar Shah Khan, EASPS Philippines Private Enterprise Credit Support Project CONTENTS A. Project Development Objective ..................................................................2 1. Project development objective and key performance indicators ....................................2 B. Strategic Context ..................................................................2 1. Sector-related CAS goal supported by the project .........................................................2 2. Main sector issues and Government strategy .................................................................3 3. Sector issues to be addressed by the project and strategic choices ................................6 C. Project Description Summary ..................................................................6 1. Project components ..................................................................6 2. Key policy and institutional reforms supported by the project ......................................8 3. Benefits and target population . ................................................................. 0 4. Institutional and implementation arrangements ........................................................... 11 D. Project Rationale ............................................................... II 1. Project alternatives considered and reasons for rejection ............................................I 11 2. Major related projects financed by the Bank and/or other development agencies ....... 12 3. Lessons learned and reflected in proposed project design ........................................... 12 4. Indications of borrower commitment and ownership .................................................. 13 5. Value added of Bank support in this project ........................................................... 13 E. Summary Project Analyses .......................... 13 1. Economic ...................... 13 2. Financial ...................... 14 3. Technical ...................... 14 4. Institutional ...14................... 14 5. Social ...................... 16 6. Environmental assessment ...................... 16 7. Participatory approach ............................ 16 F. Sustainability and Risks ............................ 16 1. Sustainability ...................... 16 2. Critical risks ...................... 16 3. Possible controversial aspects ............................ 17 G. Main Loan Conditions ............................ 17 1. Effectiveness conditions .17 2. Other ...................................... 17 H. Readiness for Implementation ............................................ 18 I. Compliance with Bank Policies ............................................ 18 Annexes Annex Ia. Project Design Summary .19 Annex lb. Key Performances Indicators .20 Annex 2. Detailed Project Description .22 Annex 3. Estimated Project Costs .26 Annex 4. Development Bank of the Philippines .27 Annex 5. Procurement and Disbursement Arrangements .37 Table A. Project Costs by Procurement Arrangements .39 Table Al. Consultant Selection Arrangements ................................. 40 Table B. Thresholds for Procurement Methods and Prior Review .41 Table C. Allocation of Loan Proceeds .42 Table D. Procurement Plan .43 Annex 6. Project Processing Budget and Schedule .44 Annex 7. Documents in Project File .45 Annex 8. Status of Bank Group Operations in Philippines, IBRD Loans and IDA Credits in the Operations Portfolio .46 Annex 9. Philippines at a Glance .47 Philippines Private Enterprise Credit Support Project Project Appraisal Document East Asia & Pacific Region Philippines Department Date: October 21, 1998 Task Team Leader/Task Manager: Zafar Shah Khan Country Director: Vinay K. Bhargava Sector Manager: Hoon Mok Chung Project ID: PH-PE-57624 Sector: PSD Program Objective Category: PV-Private Sector Development Lending Instrument: Loan Program of Targeted Intervention: [ I Yes [x] No Project Financing Data [x ] Loan [] Credit [] Guarantee [ ] Other [Specifyl For Loans/Credits/Others: Amount(US$m): 150. Proposed terms: [ ] Multicurrency [x] Single currency (US Dollar) Grace period (years): 5 [ ] Standard [] Fixed [X] LIBOR-based Variable Years to maturity: 20 Commitment fee: 3/4 of 1% Financing plan (US$m): (Indicative only) Source Local Foreign Total IBRD 150 150 DBP/PFls 50 50 Subborrowers 115 115 Total 165 150 315 Borrower: Development Bank of the Philippines (DBP) Guarantor: Republic of the Philippines Responsible agency: DBP Estimated disbursements (Bank FY/US$M): 1999 2000 2001 2002 2003 Annual 9.0 54.0 57.0 27.0 3.0 Cumulative 9.0 63.0 120.0 147.0 150.0 Financing available without guarantee?: [ Yes [] No If yes, estimated cost or maturity: Estimated financing cost or maturity with guarantee: Project implementation period: Sept. 1998-June 2003 Expected effectiveness date: February 22, 1999 Expected closing date: December 31, 2003 OSD PAD Form: July 30, 1997 Page 2 A: Project Development Objective 1. Project development objective and key performance indicators (see Annex 1). The project would augment long-term resources of DBP and, in turn, of a number of banks with the main objective of assisting private sector enterprises, particularly small- and medium-sized enterprises, affected by the credit crunch and currency crisis. Enterprises would, thus, be able to implement their expansion and modernization plans, to undertake new projects, and to finance permanent working capital requirements. This would help them to alleviate their operational and financial problems and to take advantage of new opportunities created by recent economic developments. Consequently, enterprise performance, as measured by efficiency gains, profitability and export earnings, will improve. The project will also aim at further institutional strengthening of DBP which would, overtime, be able to reduce its dependence on ODA and to mobilize funds from domestic and international markets. Key performance indicators will be: (i) DBP will abide by BSP's the minimum capital adequacy requirement and provision for bad and doubtful loans; (ii) DBP will prepare and implement a plan to bring down its past due loans to no more than the overall average for the banks in the Philippines within the next three years; and (iii) private enterprises to be financed under the Bank loan will meet the revenue and profit targets as given in the subproject appraisal reports to be prepared by PFIs. Output indicators will be: (i) PFIs start lending from the line of credit (LOC); (ii) enterprises have better financial results and debt-servicing; (iii) DBP's arrears on retail loans are brought down to the industry average; and (iv) DBP again start mobilizing long-term funds from the capital market without government guarantee. B: Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project (see Annex 1): CAS document number: 15362-PH (CAS) and R-98-41 (CAS Progress Report) One of the goals of last CAS (April 1996) was to improve private business environment. The recent CAS Progress Report has recognized that despite the Regional financial crisis, the major policy changes as expressed in the last CAS, and the strategic thrusts of the Bank' assistance strategy, remain valid with some adjustments needed to respond to both the Asian financial crisis and the new opportunities in Mindanao. One of these areas is the continiued assistance to enhance the country's international competitiveness through, inter alia, strengtlhening and deepening the financial system. According to the CAS Progress Report, the Bank's assistance will intensify in this area through technical assistance and quick disbursing loans, following up previous work on the banking and non-banking sectors. In addition, the Report has supported lines of credit for agriculture and industry. The urgency for this kind of lending arises because of the sudden drying up of overall foreign capital (net inflow down from US$8 billion in 1996 to less than US$1 billion in 1997) and massive drain of portfolio investment (outflow of US$3.5 billion in 1997). The economy, and the private sector in particular, is starving for long-term investment capital. These operations are envisaged as a transitional measure, as the domestic medium- and long-term market develops, and as external confidence is restored. OED's Country Assistance Review (CAR) of March 1998 has stated that the challenge ahead in the financial sector will be to continue supporting the process of rapid financial deepening, while maintaining a healthy and efficient system, and strengthening its resilience to the volatility of short-term capital flows. In the short time, a prolonged Regional crisis may require much greater involvement on the part of the Bank in the Philippines' banking sector than hitherto expected. The Bank needs to be ready to help in such an eventuality on the basis of a prior understanding with the govemment over the remaining policy and institutional reform agenda. CAR has further recomimended that, under the right macroeconomics and institutional environment as is expected to remain the case in the Philippines, there is a useful role for the Bank in supplementing the supply of private (mostly short- and medium-term) credit with long-term funds. Thus, the Bank should not consider financial intermediary loans taboo and should re-include them in its instrument menu. Page 3 2. Main sector issues and Government strategy: The proposed project is a private sector development operation, which will be implemented through financial intermediaries with the ultimate beneficiaries belonging mostly to broadly defined industrial sector. The following discussion of sectoral issues relates principally to the financial sector but the main points relating to the industrial sector have also been brought out. The Philippines'financial sector has come a long way in the last two decades, and the reforms and strengthening that have been accomplished helped the country withstand the recent Asian financial sector turmoil with much better resiliency as compared with some other countries in the region. In the 1980s, a large number of thrift institutions and several commercial banks failed, and total assets in the banking system contracted substantially in real terms; private sector credit contracted by 63%. Intermediation margins were among the highest in the world. reflecting a lack of effective competition. Two of the largest financial institutions, the Philippines National Bank and the Development Bank of the Philippines (DBP), both government-owned, became, de ifacto, insolvent. Even the central bank of the country became technically insolvent because of accumulated losses, principally on account of bearing exchange risk on large assumed foreign indebtedness. The Government initiated financial sector reforms in the mid -1980s. The Bank has been actively assisting the Government all along. The Economic Recovery Loan (ERL) was made in 1987, and concentrated, among others, on restructuring and restoring solvency to PNB and DBP. The Financial Sector Adjustment Loan made in 1989 concentrated on the central bank's solvency, improvements in the banking related legal framework, streamlining of the process of bank closures including the strengthening of the Philippines Deposit Insurance Corporation (PDIC), and enhancing effective competition in the system. As a result of the reforms already implemented, the central bank has been reconstituted as Bangko Sentral Ng Pilipinas (BSP) and solvency restored to it. It is now a more independent central bank. In addition, the supervisory and regulatory system for the commercial banks has been considerably strengthened. The deposit insurance institution, PDIC, is now an independent and autonomous body (instead of being, de facto, a department of the central bank under one of the Deputy Governors) working in collaboration with BSP to minimize the costs of dealing with failing and failed banks. The banking related legal framework is also much improved as a result of substantive amendments made to the legislation relating to the central bank, commercial banks and PDIC. The commercial banking system is now much more liberal and open. Compared with 27 commercial banks in the late 1980s, there are now 54 banks operating in the country including 14 foreign banks. Banking system credit has grown at compounded annual growth rate of 34% over the last five years. During the same period, deposits have grown at an annual rate of 27%. A notable feature of banking sector development in recent years has been the rapid growth of off-balance sheet activities, particularly trust account business. Commercial banks dominate the financial system, accounting for 76% of the entire system in terms of assets (end of 1997). Overall, the commercial banking system is healthy with a capital to risk assets ratio of 13.4% (minimum regulatory requirement: 10%), and past dues declining from 6.1 % in 1992 to 2.8% in 1996 before rising to 4.7% at the end of 1997 i.e. several months into the Regional currency and financial sector crisis. The profitability of commercial banking improved significantly in 1994-96 after being flat earlier in the decade. In recent years, commercial banks' return on assets has averaged more than 2% and that on equity more than 18%. In the year ended December 31, 1997, profitability deteriorated for understandable reasons, and the returns on average equity and assets declined to 14.9% and 1.7% respectively. Sectorally, commercial banks' portfolio is quite diversified; the three largest sectors are: financial institutions, real estate and business services; manufacturing; and wholesale and retail trade accounting for 31%, 27% and 15% respectively of total outstanding loans at the end of 1997. Page 4 The financial sector reforms undertaken by the Government in the last ten years or so also aimed to restructure and recapitalize PNB and DBP with a view to transforming them into viable institutions. The PNB is now one of the largest EKB (Expanded Commercial Bank or Unibank or Universal Bank) and has been partially privatized. The DBP, the borrower of the proposed loan, has successfully gone through a transformation and is now a different institution from what it used to be until mid-1980s. It was then a huge government owned financial sector bureaucracy undertaking all kinds of projects at the behest of the government. It was, de facto, a bankrupt institution. It is now a well functioning organization undertaking wholesale banking, retail operations, and providing some other financial services. A more detailed description and analysis of DBP is provided in Annex 4. Interest rates were deregulated in the early phase of the financial sector reforms. For most part, interest rates are now market determined (except on certain small government directed credit schemes which still carry an element of subsidy) and the government intervention is limited and selective, confined to small enterprises, low income housing and some agricultural programs. Such credit schemes, together, constitute a small proportion of total credit outstanding in the banking sector. It should be noted that interest rates in the Philippines have remained positive in real terms for a long time. The capital market in the Philippines is relatively less developed as compared to other South East Asian countries. Within the broad capital market, the equities market has grown much faster; the market in fixed income securities is still in its infancy. Starting from a relatively small base, the stock exchange experienced rapid growth beginning in 1993 and saw some lively trading in the following years but it declined rapidly in 1997 from which it has yet to recover fully. To help the development of the capital market, the Bank Group, ADB and some other bilateral agencies have been assisting the Philippines in developing new long-term financial instruments through securitization, establishing a new credit rating agency, and drafting of a new securities law. At some point, the Philippines will also need to overhaul its contractual savings schemes and the institutional arrangements therefor (i.e. the Social Security System (SSS) and the Government Services Insurance System (GSIS). Despite the reforms already undertaken and the significant progress made, there is now a clear need for further reforms and actions. It is not that, in the past, the Government (and the Bank) took only half hearted measures or showed lack of resolution during implementation. The recent CAR judged the 1989 FSAL as "one of the most successful of Bank's financial sector operations anywhere." Financial sector reforms are inherently a continuous process and, in the Philippines, the need for further actions arose also from internal as well as external developments as a result of globalization of economies and markets, particularly given the openness of the Philippines' own economy. The Regional crisis and its impact on the Philippines have raised concern with the commercial banks' capital adequacy, loan classification and provisioning practices, deterioration in non-performing loans, effectiveness of on-site inspection and off- site monitoring, off balance sheet activities, lack of transparency, entry and exit requirements and mechanisms, liquidity in the system, and the availability of term credit. The Government, in consultation with the Bank and the Fund, has initiated a number of reforms to address these issues and the proposed Philippines Banking System Reform Loan of the Bank would focus thereon. The proposed Private Enterprise Credit Support Project is also a step in the same direction. The recent Asian financial crisis has aggravated the already severe shortage of long-term debt capital. Up to early 1 990s, a principal source of long term debt capital for the private sector was ODA channeled through the government and later through DBP and LBP when all lending programs were transferred out of the government. In the last several years, with stable exchange and interest rates, commercial banks increasingly used resources raised by themselves to make long term credit available to the private sector. The commercial banks even assumed maturity mismatclh and exchange risks in the process. Direct foreign investment became another important source of long term capital. The Asian regional crisis changed the environment very quickly. With the sharp depreciation of the Peso and jump in interest rates, commercial banks were financially squeezed. The overall foreign capital flows dried up (net inflow declining from US$8 billion in 1996 to less than US$1 billion in 1997) and there was an outflow of Page 5 US$3.5 billion in portfolio investment in 1997. The result has been an acute shortage of long term capital for private sector development. The industrial sector now accounts for 35% of GDP and is composed of manufacturing, construction, mining and quarrying, electricity, gas, and water. Manufacturing is by far the largest component, accounting for 70% of the industrial sector and 25% of GDP. Because of the events of the last quarter in 1997, the overall growth of manufacturing slowed to 4% (in gross value added) in 1997 compared with 5.6% in 1996. Some sub-sectors still showed vigorous growth e.g. electrical machinery which had a growth of 30.8% reflecting the increased demand worldwide for semi-conductors. During the last few years, there has been a gradual shift towards export based industries. This shift has taken place both for traditional industries such as garments, footwear, food and agricultural processing industries, and for the newer information and technology intensive sectors. Exports of manufactured goods grew at an average rate of 22.6% per annum during 1992-97. As a proportion of the total, exports of electronics, electrical equipment and parts, and telecommunication equipment grew steadily from 28% in 1992 to 52% in 1997. This increase primarily reflects the high global demand for electronics components. It also reflects the Philippine manufacturers' competitive performance as reflected in continued strong exports in the very recent past when such exports slowed down from some other countries in the region. However, the output and exports of traditional industries in recent periods have stagnated and, in the case of some sub-sectors, even declined. For example, the growth in the food sub- sector, which accounted for about 34% of the manufacturing sector in 1996, was drastically reduced to less than I% in 1997 from 6.6% in 1996. Other traditional sub-sectors with negative growth rates include textile (-3.6%), basic metal (-4.5%), rubber ancl rbber products (-4.9%), and paper and paper products (-7.3%). These declines may be partly a result of changing emphasis (from East Asia to Latin America) on the part of the Philippines' largest market i.e. the U.S. Also, it seems that the Philippines manufacturers are falling behind in the needed restructuring and new investments particularly in the light of relatively high minimum wages and the significant real exchange rate appreciation between 1990 and mid 1997. Even in the information and technology-based industries, which have so far fared very well, the problem is that there is heavy concentratiorn in semi-conductors. Potentially, there is a risk that this sector may migrate to lower wage countries with educated labor, which may be embarking on their first step towards low technology/information age industrial development. What the Philippines needs now is to step up to higher level sub-sectors of information and technology-based industry. The Philippines has gone through steady liberalization and deregulation of the economy in recent years. The deregulation of prices and entry into the downstream oil sector and privatization of certain infrastructure facilities have enhanced the competitive environment. The entry and exit of corporate entities has also been facilitated. The Philippines has moved rapidly on tariff reforms in recent years and has announced its intention to move to a uniform rate of 5 per cent by 2004 for nonagricultural commodities. The industrial sector, however, still remains highly concentrated and fragmented. There are large numbers of small, low-productivity enterprises accounting for a small proportion of total value added at one end, and a relatively few large enterprises dominating production at the other, with a dearth of medium-size firms. This is not most conducive for competitive new activities and enterprises. While policies are being reformed, there still seem to be gaps in the competitive regime and in its enforcement. SMEs face particular hurdles in accessing finance, information, technology and skills. The inadequate infrastructure, particularly transportation, communication, and water supply, is another major constraint faced by the industrial sector. The Government is aware that the current environment presents tremendous opportunities as well as challenges. It also recognizes the urgent need ito undertake new investments and industrial restructuring as part of the effort to enhance competitiveness. Its National Development Plan: Directions for the 21st Century (Plan 21), emphasized the importance of market competition through further liberalization, deregulation and privatization. In particular, the Government proposes to promote the modernization of the industrial sector; continue industrial deepening and diversification; encourage the production of higher Page 6 value added products and services; continue the implementation of reforms aimed at trade and investment liberalization; and enhance the competitiveness of the Philippines as an investment site. These would be achieve through policies that will (a) strengthen the country's macroeconomic fundamentals and ensure macroeconomic stability and sustained growth; (b) continue the re-orientation of the industrial sector to global competition; (c) improve further the investment climate to reduce the cost of doing business; and (d) encourage strong institutional and infrastructure support structures and expanded public-private sector coordination. 3. Sector issues to be addressed by the project and strategic choices: In the wake of the Regional financial crisis, the paucity of long term capital for investment has been exacerbated because of drying up of the direct foreign investment and massive withdrawal of portfolio investment. The proposed project will directly ease this capital shortage particularly for the private sector, by immediately making available US$146.0 million equivalent in long-term funds for investment purposes. The project also supports government policy objectives and priorities by providing long term capital for private sector development without which industrial deepening, restructuring and diversification would not be achievable. It is also relevant to note that the Bank is currently conducting an enterprise survey in the Philippines; its results to be available later in the year will also be helpful to DBP, PFIs and the prospective final borrowers in pin-pointing the specific problems being faced by different subsectors and suggesting the actions needed to solve these problems. By the strategic design choice of lending to DBP to qualified PFIs to ultimate industrial borrowers, the project would ensure proper evaluation and selection of investment projects so that maximum benefit is derived from the new investments. This specific project design would also enable the Bank to help DBP determine and embark on its long term goals. One of the principal aims in this regard will be to enable DBP in the future to raise long-term capital from the market without government guarantee. A sum of US$4 million is included as TA component in the Bankc loan to support DBP's future institution-building which would directly or indirectly help achieve the above objective. C: Project Description Summary 1. Project comnponents (see Annex 2for a detailed description and Annex 3for a detailed cost breakdown): C.omponent Category Cost Incl. % of Bank- % of Contingencies Total financing Bank- - (US$M) (US$M) financing Line of Credit Credit 309.0 98.1 146.0 97.3 Technical Assistance for DBP's Institution- 6.0 1.9 4.0 2.7 Institutional Development building I__ _ Total 315.0 100.0 150.0 100.0 The main project component is the line of credit (LOC). It would be onlent by DBP to eligible enterprises through participating financial institutions (PFIs). The project will focus on the industrial sector but viable private sector projects in other sectors like utilities, power and telecommunications will also be eligible for assistance provided these have a strong linkage to manufacturing, and located in the country-side and would significantly contribute to the provision of essential services, not currently available. There are no more price controls and quantitative restrictions on industrial subsectors except for the meat and meat products subsector which still has excessive protection and will not be financed under the project. Furthermore, those enterprises which require regulatory and/or other non-financial support/adjustment, will not be financed until such changes have been implemented or made a part of subproject conditionality. As in the case of IRP (the last Bank loan to DBP), all lending rates will be market based, variable, and denominated in Peso. DBP will be free to negotiate its onlending rates to PFIs which will, in turn, be free Page 7 to negotiate their lending rates to the ultimate corporate borrowers. It is expected that DBP's onlending rate to PFIs, ar.i PFIs' lending rate to the ultimate corporate borrowers, would start taking into account their relative financial strength and other risk factors and, therefore, would vary from PFI to PFI or from one corporate borrower to the other in the case of lending by PFIs. In an environment of open exchange regime and market based interest rates, this methodology would result in a competitive pricing of Bank funds both at the PFIs and ultimate borrowers levels. In the absence of market availability of long term funds, the proxy of the rate on the most commonly used instrument in the market (91-day T-bill rate) will be used to determine the cost of Bank funds to DBP. The Bank loan will be priced out to DBP based on the weighted average interest rate (WAIR) of 91-day T-bills for the first three weeks of the month prior to the period, and the rate will be recalculated and refixed on a monthly basis to ensure close-to-market pricing of new loans, although once loans are established, they would normally be reset quarterly. The difference between DBP rate and the Bank's lending rate will accrue to GOP as the guarantee fee (1%) and the fee for providing the foreign exchange risk cover. While the subloans will be at variable rate as is the market practice, a one time option to convert the subloans into fixed rate will be allowed to the sub-borrowers. In the absence of a well developed market in commercial (or even government) paper of varying maturities which would indicate fixed rate premium over variable rate, a committee will be set up (with representatives from DOF, DBP and LBP who may co-opt a technical expert as the fourth member) to determine, on a quarterly basis, the conversion premium. During negotiations, an agreement was reached with the Government and DBP on the policy applicable to onlending rates and the fee for foreign exchange risk coverage under the proposed loan. In order to ensure that the loan is made available to a large number of enterprises, a maximum subloan limit for an individual company will be US$8 million equivalent; in the case of loan syndications, the maximum subloan will be US$15 million. The free limit (the limit above which Bank's prior approval of a subloan is required) will be US$8 million for all subloans (as under IRP). Bank loan proceeds would also be available to enterprises for the preparation of their restructuring plans and export studies. All eligible subprojects will have a minimum FRR of 15 per cent. Detailed onlending terms and eligibility criteria, that will be largely consistent with IRP, are given in Annex. 2. The second project component is DBP's institution building. In the last ten years since the Bank became actively involved in DBP's restructuring and transformation (in the context of the Economic Recovery Loan, 1987), the DBP has already come a long way, to a point where it is no longer the old insolvent institution financing all kinds of government behest projects. It is now a major, solvent, financial institution in the country providing a range of financial services. However, given the rapid evolution of the financial sector since then and particularly in view of the recent Regional financial crisis, the DBP is now once again embarking on a major course adjustment, and the Bank will be providing institution building assistance in the context of the proposed project. The institution is currently in the process of defining anew its role and niche in the Philippines financial sector. Whatever the corporate role and strategy, the aim is to make DBP financially and institutionally strong enough to be able ultimately to raise all required resources independently (without government guarantee) and hedge foreign currency risks without government assistance. The Bank's institution building effort will be focused on helping DBP undertake the following critical actions: (i) define its long term role and strategies to achieve the goals; (ii) undertake an in depth review of its portfolio and financial condition as a part of annual audit to be carried out with the assistance of internationally reputed experts/auditors; (iii) devise a scheme to hedge foreign exchange risk in a satisfactory manner; (iv) improve its loan recoveries; (v) convert its existing computer systems to make them Year 2000 compliant; Page 8 (vi) strengthen the Treasury functions of DBP through the use of modem computer hardware and software for information management and analysis; and (vii) prepare and implement a comprehensive staff-training program to help successful implementation of the new corporate strategies and to further develop PFIs staff. The above thrusts of the Bank's institution building effort are discussed in more detail in the following section. 2. Key policy and institutional reforms supported by the project: Major banking sector objectives currently being pursued by the Government, in consultation with the Bank and the Fund, relate to banks' capital adequacy, non-performing loans, loan classification and provisioning, off balance sheet activities, transparency in financial presentations, entry and exit policies and mechanisms and systemic liquidity. To the extent that DBP is a major financial institution in the country and because the design of the project and the associated conditionality are fully consistent, the proposed project would also help attain some of the same policy reforms and objectives. The proposed loan to DBP does directly help ease one overall sectoral concern i.e. systemic liquidity. By providing US$146 million equivalent in long term credits, the proposed project is expected to ease the systemic liquidity tightness to some extent. Given the nature of the proposed project, however, it is clear that it would also pursue institution building and reforms in DBP. The main elements of the institutional reform are the following: Corporate Goals and Strategy. At the time ERL was made in 1987, the Bank agreed with DBP's goal of ultimately becoming a wholesale bank by which it was meant to be a banker to other banks. It was envisaged that DBP would initially continue to mobilize long-term resources from ODA but that in course of time and increasingly it would raise resources from the market, and onlend the proceeds to other banks for retailing to the ultimate borrowers. It was understood that DBP would give up (at least significantly curtail) its retail banking operations. There were two main reasons for this planned transformation: First, DBP was expected to focus on mobilizing long-term resources which no other bank was doing at that time. Second, it was considered that private commercial banks were in a better position to hire well-qualified staff and effectively carry out retail banking. DBP has increased wholesale operations and, at the end of 1997, the wholesale and retail lending was about 50:50 but the transformation envisaged ten years ago has not fully taken place. (A few large IBRD and KfW loans onlent to the Manila Electric Company and the Philippines Long Distance Telephone Company through DBP and a low cost housing finance scheme if properly classified would increase the share of wholesale operations to about 60%.) The institution has, in fact, obtained a "unibank" or EKB license which indicates an intention to remain active in not only retail commercial banking operations but also provide other kinds of retail financial services. At the same time, DBP's long-term strategy still aims at its conversion into a wholesale bank or a long term lending institution for other banks. Its other products and services would be spun off into several specialized subsidiaries; some of the subsidiaries would be partly privatized in course of time. DBP has agreed to revisit this issue with the objective of developing a future role and corporate structure that is more consistent with the changed environment wherein many banks have started to mobilize long-term resources (at least before the current crisis) and, therefore, DBP does not have to take up the exclusive role of wholesale operations, and, on the other hand, DBP is no more constrained to hire competent staff for retail banking by offering competitive emoluments. The Bank intends to act as a catalyst and help DBP, with the participation of the government, defiiie its future role and the.strategies to achieve the agreed goals. During negotiations, assurances were obtained that DBP would complete, by June 30, 1999, a study of its corporate goals and strategies along with a detailed time-bound implementation plan. The study would be finalized and implemented taking into account Bank's comments. Policy Statement. Now that DBP is an EKB, it is subject to new rules and regulation of BSP, covering such aspects as capital adequacy, provisioning, limits on equity investments etc. It has, Page 9 therefore, revised its Policy Statement to incorporate the needed changes/additions. Its adopted policies are consistent with the new requirements of BSP for financial prudence for commercial banks. The Statement also reflects decisions regarding its major or special thrusts. The revised Policy Statement was discussed and agreed with the preappraisal mission and later approved by DBP's Board on June 26, 1998. Once DBP completes its corporate goals and strategies review (see above paragraph), the Policy Statement may need to be revised again. Any future changes in the Policy Statement will be subject to the Bank's prior approval. There is a policy issue that has not been dealt with in earlier or current policy statements, i.e., DBP's dividend policy. This policy is covered under the Law (Republic Act 7656) and requires DBP to pay out 50% of its pre-provision net profit as dividend to the government. Basing dividend payment on profits before making provisions for doubtful and bad debts is not consistent with sound financial and accounting policies as it may erode the equity base, particularly in inflationary periods. During negotiations, an agreement was reached with the government and DBP that actions will be taken to pay dividends only out of inflation- adjusted profits after provisions and taxes. Comprehensive Financial Review. Being a government owned institution, government auditors (Commission on Audit- COA) have been auditing DBP's accounts. The audit has focused largely on compliance with various regulations and has so far been satisfactory. It is, however, considered necessary that the audit of DBP's accounts should, in future, be done in greater depth to ascertain the quality of its portfolio, adequacy of provisions, and other related aspects of its financial position. The present government auditors need to engage the services of international experts who can help them to carry out such an audit and to build-up relevant expertise for future purposes. This would reassure the Government and DBP's present and fiture creditors that DBP meets (or how it could meet) the international standards and best practices. It would also be a timely check of the impact of recent regional crisis on DBP's financial condition and indicate any needed remedial or financial strengthening measures. Furthermore, sooner or later, DBP has to test the market again to raise long term funds. In addition, DBP is currently considering the option of privatizing some retail branches and/or spinning off some functions in the form of partially privatized subsidiaries. It would be particularly necessary to provide DBP's operational and financial record, audited and certified by private sector independent auditors/experts of international repute or with their assistance, as a prelude for such operations. As a condition of negotiations, DBP has entered into a Memorandum of Agreement with COA in regard to the tenns of reference, process, and timetable for the proposed in- depth audit beginning 1998 with the audit of 1998 accounts. * Hedging Foreign Exchange Risk. So far DBP's long term foreign currency resources, with two exceptions, have been obtained from ODA sources through the government. The government, in terms of a formal agreement between itself and DBP, assumes the foreign exchange risk on these resources. The government charges a fee for assuming the exchange risk. The fee charged has so far been adequate to cover the actual exchange losses. However, the government understandably wishes not to assume the exchange risk on foreign exchange resources which are ultimately utilized by the private sector. In any case, it is expected that DBP would be gradually weaned away from ODA resources and start raising funds commercially without government guarantee. To the extent DBP raises such funds in foreign currencies, it should be able to find ways to manage the exchange risk involved either by self-insurance or by using the exchange risk cover mechanisms available in the market or a combination of alternatives. DBP has agreed to carry out a study with the assistance of international experts to determine its options and choices for managing/hedging foreign exchange risk. During negotiations, an agreement was reached with DBP on the TOR of the study on management of foreign exchange risk on its foreign borrowings and the completion of study by June 30, 2000. * Improving Loan Recovery. At the end of 1997, DBP's arrears on its retail banking operations were 8.4 per cent of total retail loans outstanding that was considerably higher than the national average of commercial banks at 4.7 percent as of the same date. DBP has initiated special efforts to reduce this Page 10 gap between its own past dues and the national average for commercial banks, with some success in the early part of 1998. During negotiations, DBP agreed to reduce its arrears on retail banking operations to no more than the national average for commercial banks latest by December 31, 2000. * Compliance with Year 2000 Computer Needs. DBP attaches high priority to the conversion of its computer systems to make them Year 2000 compliant. It is planning steps that would ensure the collection and processing of information by hardware, software and data feeds to continue smoothly after December 31, 1999. In addition, it needs to meet with all regulatory guidelines regarding Year 2000 issues. DBP has already completed an inventory of its hardware, application systems, and data feeds and adopted a plan for their replacement and/oir up-grading. During negotiations, it was agreed that the proposed TA component for the project will include the financing of necessary imported equipment and that this sub-component will be completed by December 31, 1999. * Strengthening Treasury Function. DBP plans to improve its Treasury function, particularly the matching of assets and liabilities and optimal utilization and placement of funds at it disposal. This would require the installation of necessary computer hardware and software. At present, DBP has a Money Market System only which is not Year 2000 and European Monetary Union (EMU) compliant and can not process Fixed Rate Treasury Notes transactions. The bulk of the transactions are in Fixed Rate Treasury Notes so most of the documentation and bookings are done manually. DBP also needs a system that can strengthen Asset and Liability Management. Furthermore, a treasury system is needed to computerize the operations. Having a treasury system that includes a derivatives module will facilitate compliance with derivative license. Presently, these transactions are still being serviced manually. The new computerized systems will help to consolidate data and reports, perform technical analysis, support the growing demand of clients, strengthen internal controls, and improve risk management. During negotiations, it was agreed that the proposed TA component for the project will include the financing of necessary imported equipment and that this subcomponent will be completed by June 30, 2000. * Staff Training. DBP will be introducing new financial products and, at the same time, its management and staff, as well as those of PFIs, will have to be more cautious of the quality control at the entry of all financial products to assure a good quality of portfolio. Consequently, more extensive staff training is needed in handling new financial products and credit risk analysis. Additional training is also envisaged for environmental risk assessment and mitigation of such risk. Bank staff discussed and agreed with DBP on a broad framework for its medium-term-training program (including its estimated cost and financing plan). It was also agreed that DBP will prepare a detailed annual training program and present it to the Bank for comments by October 31 of the preceding year during project implementation. This would be reconfirmed during negotiations. 3. Benefits and target population: One of the major negative impacts of the still continuing Regional financial crisis has been the paucity of investment capital; working capital shortages have also become endemic. As a result, the needed restructuring of industrial enterprises (including modernization and upgrading of plants), which requires additional capital, has considerably slowed down. This is, in tum, affecting the competitiveness of the Philippine's industrial sector and its export potential. Layoffs are a natural consequence and are already reported at more than 40,000 in January-April 1998 in the formal sector. The employment gains of recent years are in danger of being reversed because of slow job creation following the reduced overall economic growth. The proposed loan will provide the ur,gently needed funds for private sector investment. It would help enterprises to restructure and also meet their permanent working capital requirements. The project will, therefore, help minimize the negative impact of the Regional financial crisis on the Philippines' private sector development. Enterprises will be able to improve their operational efficiency and productivity and, thus, maintain/enhance their global competitiveness. Page 11 The project will have major institutional development impact on DBP. This aspect has been discussed in detail in C2 above. Finally, the lending under the line of credit will help to restore the confidence of both local and foreign investors and would serve as a catalyst for further domestic and foreign investment. 4. Institutional and implementation arrangements: The loan will be made to DBP which will, as the wholesale bank or the apex institution, relend the proceeds to a number of participating financial institutions, PFIs, which will be the institutions that will select the final borrowers, appraise the specific investment projects and administer the individual loans. The PFIs would be duly accredited institutions. The financial intermediaries already accredited under the Industrial Restructuring Project (Loan 3287-PH) and which have remained sound and in good financial standing would maintain their status as PFIs, at their option. Other financial institutions interested in participating would be accredited by DBP using criteria which include: (a) a track record of profitable operations and sound capitalization; (b) an ability to maintain a sound and healthy portfolio as demonstrated by the PFI's level of arrears; (c) a qualified management team of good reputation; (d) adequacy of trained staff, established systems and procedures to be an efficient and reliable provider of retail credits; and (e) project analysis capability and experience in corporate finance. Failure to meet these criteria would disqualify PFIs from further participation in the project. The accreditation of PFIs will be regularly reviewed during Bank supervision. DBP has adopted a set of Operating Policy Guidelines (OPG) which outlines the policies and procedures that will apply to its wholesale role under the project. The OPG spell out, among other things, the following: accreditation criteria for PFIs, exclusion of DBP as a retailer of funds under the proposed project, sub-project eligibility criteria and minimum and maximum subloan sizes, conditions and interest rates to the PFIs, on-lending terms, conditions and interest rates to sub-borrowers, minimum loan participation by PFIs and minimum equity contribution by sub-borrowers, procurement, free limit and subproject documentation requirements, and conformance with environmental laws. These policies to govern the use of the proposed loan are generally satisfactory. During negotiations, assurances were obtained from DBP that it will follow OPG during project implementation and that OPG will be revised only after consultation with and agreement of the Bank. The approval of OPG, satisfactory to the Bank, by DBP's Board will be a condition of loan effectiveness. The PFIs, which would bear the subloan credit risk, would be responsible for subproject appraisal and supervision. DBP would review the documentation submitted by the PFIs for subproject approval to determine whether the eligibility criteria for subborrowers and subprojects have been met. Neither the World Bank nor DBP would duplicate the credit or project analysis of the PFIs and pass upon individual subloan applications except for very large projects involving subloan amounts beyond the free limit of US$8 million. The responsibility for supervision and monitoring of PFIs will rest primarily with DBP, and cover not only the aspect of the use of the Bank loan proceeds but also the PFIs' overall financial condition. The Bank will itself supervise and monitor DBP's performance, making sure also that DBP's supervision and monitoring of the PFIs is effective. The Bank will receive semi-annual and annual reports from DBP; in addition, there will be regular supervision visits by Bank staff. There will be a requirement for DBP to submit its audited annual account within six months of the close of its financial year. Furthermore, the Bank will undertake a mid-term review of onlending rates and critical project conditions and adjustments will be agreed with DBP, as necessary. DBP will be responsible for the implementatiion of the technical assistance component of the project. D: Project Rationale 1. Project alternatives considered and reasons for rejection: Alternative 1. The Bank would have extended the loan directly to a number of PFIs but it would be too Page 12 difficult to appraise and supervise a large number of banks. The last IRP had 34 PFIs. Furthermore, this alternative would tantamount to administrative allocation of funds whereas the proposed arrangement would induce competition among PFIs in the utilization of funds. Alternative 2. The Bank would have selected a few enterprises and made direct loans to them. This would confine Bank's assistance to a small number of enterprises. The Bank had a very satisfactory experience with IRP and basically the same project design has been replicated. 2. Major related projectsfinanced by the Bank and/or other development agencies (completed, ongoing and planned): Sector issue Project Latest Supervision (Form 590) Ratings _________ ________ (Bank-financed projects only) Implementation Development Progress (IP) Objective (DO) Bank-financed To support efficient industrial Industrial Restructuring Project. HS S restructuring and development of US$175 millions in 1990 DBP. (completed). Other development agencies To augment medium- and long-tenn IFC US$75 millions in 1997 for Far financial resources of banks and East Bank & Trust Co. their efficient allocation. Same as above IFC US$60 millions in 1998 for Far East Bank & Trust Co. To support SMI financing. DBP 11-ADB US$100 millions in 1991 (completed). To augment term resources of DBP. ADB US$50 million credit line planned for 1998 to finance small infrastructure projects To finance cottage enterprises. Cottage Enterprise Finance Project. KfW's DM 17.5 million loan in 1991 (completed). To provide technical and other Industrial Support Services support services for the industrial Expansion Program. OECF's sector. Y22,500 million loan in 1994 (completed) To augment term resources of DBP. DBP III. JEXIM's Y31,500 million loan in 1996. (Amount fully committed.) IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: OED has issued in March 1998 its Country Assistance Review (CAR) for the Philippines. The report has concluded that the overall impact of the Bank's financial assistance has been highly satisfactory. Domestic financial markets have become considerably stronger, deeper, and better regulated since the crisis of mid- 1980s. Along with the Bank, the Government deserves high credit for its strong commitment, decisive action , and exemplary leadership. The report has, however, pointed out that the Page 13 financial sector in the Philippines still needs further deepening and strengthening. In particular, the regulatory and supervisory regime has to be improved. As regards the Bank's assistance to SMEs, the report calls it "an effective credit allocation program, but a modest job-generating one". The report has recommended that the Bank's future country assistance strategy should, inter alia, include financial intermediary loans. Under the right macroeconomic and institutional environment, as is expected to remain the case in the Philippines, there is a useful role for the Bank in supplementing the supply of private (mostly short and medium-term) credit with long-term funds. The ICR on IRP, prepared in July 1995, had noted three main lessons: (a) efforts should be directed to develop the private sector, (b) the Government should have a firm commitment to create conducive policy environment, and (c) DFIs should give more attention to environmental protection in their operations. The proposed project is consistent with the recommendations of the CAR and also takes into account the lessons from IRP. The Bank loan proceeds will be used by private sector only. As OED's report has stated, the Government has an impressive record of creating a conducive policy environment and is fully committed to this objective. PFIs under IRP have complied with Bank's guidelines as well as those of the country on pollution control and similar assurances will be obtained under the proposed loan. In addition, new procedures and staff training will be introduced for reviewing environmental aspects of subprojects (see E6). 4. Indications of borrower commitment and ownership: The Government and DBP have a very good record of project implementation. DBP has achieved substantial institutional growth and has an excellent operational relationship with PFIs. It has helped prepare this project with great speed and has promptly provided all the information requested by the Bank during the processing of the project. DBP has shown keen interest in the project and it is expected that it would implement it as successfully as the last credit line--IRP. 5. Value added of Bank support in this project: The Bank will provide much needed long-term financial resources for the private sector. As a result, the enterprises which have cut down their operations due to working capital shortages and shelved restructuring plans due to credit squeeze, will be able to normalize their operations and implement their investment plans, particularly taking advantage of new opportunities created by the Peso devaluation. All this will be beneficial to the economy. The institution-building of DBP would enhance its ability to raise long-term funds from the capital markets without government guarantee. E: Summary Project Analysis (Detailed assessments are in the project file, see Annex 7) 1. Economic: Cost-Benefit Analysis: Not applicable; Cost Effectiveness Analysis: Not applicable The paucity of long-term funds, resulting from the current financial crisis, has adversely affected the private sector, particularly small- and medium-sized industrial enterprises. They are facing serious difficulties in maintaining their operations and/or restructuring their production facilities in response to the changed country and regional economic environment. The proposed Bank loan will help to restore the economic activity, with all its benefits in terms of productivity gains, employment, exports, etc., by injecting much needed long-term funds for private sector enterprises. The subprojects to be financed under the proposed loan will have a financial rate of return of not less than 15 per cent, ensuring their commercial viability. As the price distortions in the industrial sector in the Philippines are already very small, the economic rate of return of these subprojects should also be highly satisfactory. The project is also considered to be the best option for assisting private enterprises because using a wholesale approach provides every-financial institution operating in the country, that meets the accreditation criteria, the opportunity to participate in the project and accommodate its clients. Furthermore, the government (which will carry the foreign exchange risk for a fee) and DBP will be able to recover the cost of channeling the Page 14 proposed loan (see E2 below). 2. Financial: NPV= Not applicable; FRR= Not applicable Fiscal impact: As the project would be implemented by DBP and the private sector, it would not require any government counterpart funding. The actual cash flow to the government depends on future inflation and interest rates, but in the base case, assuming a 12% T-bill rate, 7% inflation and a nominal 6% cost of Bank funds, the net cash flow to the government is estimated to rise from about P 87 (US$2.2 million) in year one to about P 825 million (US$21 million) by year five, before falling as the foreign exchange risk fund becomes drawn on. Direct inflows to the government would include a Guarantee Fee of 1% p.a. (about US$1.5 million per year once funds are fully disbursed) and adequate foreign exchange risk coverage fees, averaging about 3.3% of the outstanding balance. lin addition, under present legislation there would be gross receipts tax of 0.65% p.a. on loans from DBP to the PFIs and about a further 1% on the larger loans to sub-borrowers (together totaling about US$2.1 million p.a. by year 5). In addition, the government would benefit from taxes on incremental profits of DBP, PFIs and subborrowers. Total taxes on incremental profits are estimated at about US$1 1 million p.a. upon full disbursement of the Bank loan and start of full capacity operation by subborrowers. Finally, DBP, after its future institutional development, should be able to borrow with out government guarantees and, to this extent, government's future contingent liabilities will not increase. The project would, thus, have a positive fiscal impact. 3. Technical: Technical aspects of the project relate to the capability of DBP and PFIs to appraise technology, suitability of plant and equipment, cost estimates, etc. of subprojects proposed for their financing and to supervise their implementation. The Bank experience under IRP indicates that both DBP and PFIs have necessary expertise for this purpose and would appraise and supervise subprojects satisfactorily. 4. Institutional: a. EXECUTING AGENCIES: The Borrower of the proposed loan will be the Development Bank of the Philippines (DBP). It was established in 1958 to succeed an institution set up a decade earlier to help in the rehabilitation and reconstruction of the Philippines after World War 11. The mandate given to DBP was to help in the national development by financing projects in all sectors. For the next three decades, DBP operated as an all-purpose development finance institution. Operationally, it was guided by govemment directives and eventually financed government development programs in all sectors, and provided funding to large projects of doubtful viability and to distressed companies at the behest of the government. Efforts to strengthen its operations were unable to stop or reverse the deterioration in its financial condition. It became a large politicized bureaucracy with low collections and poor portfolio. By the mid 1980s, there was no hiding the fact that DBP had became financially insolvent. A new government initiated a major restructuring and rehabilitation program in 1986, which was undertaken with the active support of the Bank in the context of the Economic Recovery Loan of 1987. DBP was given a new Charter, and a new management took over. DBP was freed of many of its non- performing assets (transferred to a new Asset Privatization Trust) and relieved of the corresponding liabilities. Board composition was changed with greater representation of the private sector. Systems and procedures were revised and streamlined. The institution was drastically downsized with staff reduced from 3,500 to 2,000. The orientation of DBP was changed to become principally a wholesale bank by which it was meant to be a banker to other banks, particularly in providing long term capital. Page 15 The restructuring and rehabilitation of DBP was successfully implemented and the institution was transformed as envisaged. By the end of 1996, DBP's whole sale loans accounted for 64% of total loans. DBP also became a profitable and viable finaincial institution although the profitability declined (mainly due to higher provisions) and the financial position came under some stress in the last completed year, 1997 (because of the Regional financial crisis which adversely affected DBP's borrowers). DBP's total assets now amount to P 105 billion and its equity to P 13 billion. Its net income increased about 25% between 1995 and 1997 but was almost totally offset by an increase in expenses, the principal item of which was the write off and provisions (see the following para). The return on equity in 1996, the last completed year before the Asian financial crisis, was 15.6%, that on average assets was 2.8%. Both were satisfactory but both declined significantly in 1997, to 9.8% and 1.4% respectively. In the second half of 1997, due to depreciation of the currency and higher interest rates, many businesses in the Philippines suffered severe stress. As a result, DBP's past due loans increased appreciably. DBP has made considerably higher provisions for bad and doubtful loans for the year ended December 31, 1997. At the same time, it has put in place a task force headed by an Executive Vice President to manage problem loans with specific objective of reducing and restructuring past due and problem loans. The task force reviews all loans and ensures that appropriate action plans are put in place for those which are showing any signs of stress. This has helped to keep the rate of increase in DBP's past dues at a level which is lower than the overall average for commercial banks in January-April 1998. It should be noted that the portfolio problems are confined to DBP's retail banking operations. While DBP's operational transformation proceeded as envisaged until 1995-96, there has lately been a noticeable increase in retail banking operations. In 1995, the institution obtained the EKB license which allows it not only to undertake the normal commercial banking but also to provide many other financial services which are typically provided by merchant/investment banks. DBP increased its retail banking branches from 57 to 72. Between 1995 and 1997, its retail portfolio increased by 80% while the wholesale portfolio increased by 37%; by the end of 1997, on an outstanding basis, the retail and wholesale portfolios were almost equally divided (A few large IBRD and KfW loans onlent to the Manila Electric Company and the Philippines Long I)istance Telephone Company through DBP and a low cost housing finance scheme if properly classified would change these percentages significantly). DBP's current strategy still aims at the ultimate transformation into a wholesale bank based on decisions taken in mid-I 980s. However, this strategy seems to have lost its relevance due to changed banking sector environment and new developments within EIBP and needs to be re-assessed. DBP would, therefore, undertake, by mid-1999, an in-depth review of its future role and niche in the Philippines financial sector and prepare a new corporate strategy and its implementation plan. As mentioned in Section C4, DBP will onlend the Bank loan proceeds to accredited PFIs following its selection criteria. DBP has been very careful in selecting PFIs and, as a result, its loan recovery under wholesale operations is almost 100 per cent. Also, PFIs have financed viable and creditworthy subprojects and, therefore, their loan recovery is also highly satisfactory. The Bank's previous loan for the Industrial Restructuring Project (Loan 3287-PH) was onlent to 34 PFIs which, in turn, onlent to 76 private enterprises. At the end of 1997, only two sublborrowers were in arrears with overdue amount of P10.7 million. It is expected that the DBP will select sound PFIs for the proposed project and they will maintain their past standards of subproject selection and financing. b. PROJECT MANAGEMENT: The information on this subject is covered in Section C 4 above. It may, however be mentioned that the proposed project is similar to the very successful Industrial Restructuring Project made in 1990, and DBP is, therefore, experienced in project management, including the implementation and supervision/monitoring. No particular difficulty is expected in project management. Page 16 S. Social: Not applicable. There will be no involuntary resettlement as the Bank loan will be used mainly for industrial projects and the maximum subloan size is not very large at US$8 million for standard subloans and US$15 million for syndicated subloans. 6. Environmental assessment: Environmental Category []A [x] B [] C The environmental assessment will be done for individual subprojects by PFIs during project implementation under the supervision and guidance of DBP. DBP had implemented a Training and Technical Assistance grant of SEK10.5 million for strengthening the institutional infrastructure for environmental protection as part of IRP. DBP is quite strong in this area and has closely supervised and guided PFIs during the implementation of IRP. It will play the same role under the proposed project. The Bank proposes to make this project as a model for financial intermediary operations for environmental protection purposes. Consequently, PFIs' capacity to recognize and properly handle the environmental risks will be further developed through: (i) review of generic EIA outlines prepared by the Environmental Management Bureau in the Philippines by the Bank, (ii) application of IFC's checklist during subproject appraisal and a format for an annual report by DBP on its and PFIs' due diligence practices to be submitted to the Bank, and (iii) training of DBP and PFIs' staff under a regional program to be offered by IFC in early 1999. 7. Participatory approach: The Bank staff had detailed discussions in the field with the Bankers' Association of the Philippines, Federation of the Philippines Industries, Chamber of Commerce and Industry, and commercial banks. They advised on fund requirements of the industry, private enterprise problems, impact of the financial crisis, and terms and conditions of the Bank loan. In addition, the Bank staff had consultations with the officials of the Asian Development Bank, UNIDO, Japan Exim-Bank, and the Overseas Economic Cooperation Fund in view of their existing/planned assistance to DBP and/or the industrial sector and exchanged information on mutual experiences, plans and strategies for assistance to the private sector in the Philippines. F: Sustainability and Risks 1. Sustainability: The project's sustainability is assured because: (a) DBP is a well-established institution and the recent Government decision to allow DBP to offer market based emoluments to its staff will further help in its development, and (b) PFIs are quite conservative in their investment decisions and will select only highly viable and creditworthy projects for financing. Also, the current financial crisis is expected to pass in about two-year time and, thereafter, DBP and PFIs should be able to mobilize funds on their own, particularly after further institutional development of DBP. 2. Critical Risks (reflecting assumptions in the fourth column of Annex 1): Risk Risk Rating Risk Minimization Measure Annex 1, cell "from Outputs to Objective" The government may back track or slow down on N The government has an impressive its strategy to develop financial and private sectors record of reforms and has continued and to promote private financing of economic commitment to stronger and deeper activities. reforms. Page 17 Demand for long-term funds may decrease and/or N PFIs and enterprises have repeatedly PFI may become too risk-averse under present indicated strong demand for long-term circumstances and, as a result, the loan may not be funds. utilized on time. Annex 1, cell "from Components to Outputs" The government may influence DBP in its N DBP is now a fully autonomous onlending decisions. organization. The past experience does not show govt. interference in its lending decisions. DBP may renegade on its commitment to M DBP management is very serious in implement the institutional development program. carrying out the institutional development program and necessary legal assurance will be obtained during loan negotiations. Overall Risk Rating N Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk) 3. Possible Controversial Aspects: None G: Main Loan Conditions 1. Effectiveness Conditions. * DPB's Board of Directors would have approved the Operating Policy Guidelines (OPG) satisfactory to the Bank. * DBP would have executed subsidiary loan agreements, satisfactory to the Bank, with at least five accredited PFIs. 2. Other * DBP will not revise its Policy Statement without mutual agreement between the Bank and DBP. * DBP will pay dividend out of inflation-adjusted profits after provisions and taxes. * DBP will apply its Operating Policy Guidelines to the project which will include: 0 accreditation criteria for PFIs 0 subproject eligibility criteria and maximum subloan size 0 minimum loan participation by PFIs and minimum equity contribution by subborrowers 0 procurement guidelines 0 conformance with environmental laws and guidelines 0 free limit and subproject documentation requirements * Relending terms, conditions, and rates to PFIs. * Onlending terms, conditions, and interest rates to subborrowers. * Reporting and auditing requirements. * DBP's accounts for 1998 and later years will be audited with the assistance of internationally reputed experts who will particularly focus on the portfolio, provisions, and related financial issues. The selection of experts and their TOR will require the Bank's prior approval. The use of foreign experts will be discontinued after the local expertise has reasonably developed. Page 18 * DBP will commission a study on feasibility of hedging against foreign exchange risk on its borrowings. The study would be completed by June 30, 2000. * DBP will preparc a revised corporate stratcgy and its implemcntation plan by June 30, 1999 and finalize and implcment it after incorporating Bank's conuncnts. * DBP will convert its computer systems to makle them Year 2000 compliant. * DBP will strengthen its Treasury function. * DBP will furnish to the Bank for commcnts a detailed staff training program for each year, focuscd on new financial products and credit risk analysis, by October 31 of preceding year during the projcct implementation period. * DBP will reduce the percentage of its arrears on retail loan portfolio to a level that would not exceed the industry average for commercial banks in the Philippines by December 31, 2000. * The Bankl will have a mid-term revicw of onlending rates and critical project conditions. H. Readiness for Implementation [] The engineering design documents for the first year's activitics are complete and ready for the start of project implementation. [xl Not applicable. [ ] The procurement documents for the first year's activities are complete and ready for the start of project implementation. [x] Not applicable [x] The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. [I The following items are lacking and are discussed under loan conditions (Section G): 1. Compliance with Bank Policies [x I This project complies with all applicable Bank policies. Task Team Leader Zafar Shah Khan, EASPS Sector Manager: Hoon Nok Crung,EXS4S Country Director: Vinay CPF Page 19 Annex la Project Design Summary Philippines: Private Enterprise Credit Support Project Narrative Summary Key Performance Monitoring and Critical Assumptions Indicators Evaluation Sector-related CAS Goal: -Policy, regulatory, and Govt. laws, regulations, and The Government will Improve private business institutional framework procedures continue its policy of environment including becomes more conducive liberalization and private availability of long-term for investment and banks' sector development. finance sound development. Project Development DBP and PFIs increase term DBP and central bank Enterprises will be ready to Objective: lending to private statistics on the banking restructure and borrow for Alleviate term credit enterprises sector operation. their permanent working constraint for private capital needs. enterprises. Outputs: LOC becomes available. PFIs' periodical reports. LOC will alleviate the credit PFIs start lending from DBP complies with capital constraint and improve LOC. adequacy requirement and financial performance of DBP starts mobilizing funds provisions. subborrowers. from capital markets. Enterprises carry-out DBP's periodical reports. The debt-servicing of DBP's DBP's arrears on retail restructuring. retail borrowers will loans come down to the DBP long-term funds from improve. industry average. non-ODA sources increase. Enterprises have better financial results. Project Components/Sub- LOC is committed within DBP's periodical reporting. There is sufficient demand components: two years. for long-term funds. Line of credit. DBP submits its revised Govt. and DBP are fully Institutional development of corporate strategy by June committed to further DBP. 30, 1999. institutional development DBP carries out its staff and autonomy of DBP. training program. Independent experts will assist in the external audit of DBP beginning 1998. DBP will commission a study of hedging FX risk DBP will put in place a more effective credit risk assessment and loan recovery program. Page 20 Annex lb Philippines: Private Enterprise Credit Support Project Key Performances Indicators Project Objectives Key Performance Indicators Base Line 1998 1999 2000 2001 2002 2003 Year (1997) A. Alleviate term credit . Impact Indicator P 15.5 b. P 11.3 b. P5.4 b. P7.1 b. n.a. n.a. n.a. constraint for private DBP increases its long-term borrowing enterprises (draw downs) Output Indicator P 64.1 b. P 64.3 b. P 66.5 b. P 69.7 b. n.a. n.a. n.a. DBP increases term lending to enterprises (total outstanding) B. Maintain and/or further Impact Indicators strengthen DBP's financial Auditors to perform a comprehensive audit Agree with Perform audit same same same same position of DBP auditors on for previous TOR for year expanded audit Complete a study and implement its lHire Finish Study Implement recommendations for hedging foreign consultants recommen- exchange risk dations Install computer equipment to improve 30% 100% treasury operations. System Conversion to Y2000 10% 100% Put in place a more effective credit risk 80% 100% assessment and loan recovery program Performance Indicators DBP will maintain a satisfactory capital Not less than same same same same same same adequacy ratio of net worth to risk adjusted 10% assets DBP will reduce its ratio of arrears to retail DBP's arrears at DBP's arrears same same same loans to a level not less that of national 8.4% compared to be not average for commercial banks. to 4.7% for more than commercial commercial banks banks In compliance with BSP regulations, DBP 1% 2% 2% 2% 2% 2% will increase its general provision for bad Page 21 Annex lb Project Objectives Key Performance Indicators Base Line 1998 1999 2000 2001 2002 2003 Year (1997) and dreadful loans (in addition to specific provisions) C. Enhance operational Impact Indicators 40% 70% 100% efficiency and Appraise and approve subloans (by number) competitiveness of private sector enterprises based on commercial viability and Bank- agreed criteria Implement subprojects 20% 40% 70% 100% (by number) Output Indicators 10% 25% ' 60% 100% Subprojects operate at a minimum of 80% (by number) capacity Subprojects have a minimum FRR of 15% 10% 25% 60% 100% (by number) Enterprises have a debt-service coverage of 10% 25% 60% 100% at least 1.5 times, a current ratio of at least (by number) 1.5:1 and a long-term debt/equity ratio of no more than 60:40. Enterprises service their debt as per 100% 100% 100% 100% agreement with PFIs (by number) Page 22 Annex 2 Detailed Project Description Philippines: Private Enterprise Credit Support Project Project Component 1 - US$309 million (total tentatively estimated cost of component) Line of Creditfor Equipnient and Permanent Workinig Capital. The line of credit (LOC) for US$146.0 million will be the main project component, accounting for 97.3% of the Bank loan. The loan will be made directly to DBP, and will be guaranteed by the Republic of the Philippines. The Bank loan will finance principally plant and equipment to be purchased by private sector corporate borrowers; permanent working capital financing will also be eligible. In addition, expenditure incurred by the borrowers in preparing plans for their corporate restructuring and for export market exploration and development will also be eligible. Medium and long term financing only will be eligible. Refinancing will not be allowed. While DBP will be the Borrower, the LOC will be made available to the ultimate users of the Loan proceeds through a number of Participating Financial Institutions (PFIs). Relending Mechanisnm, Termns and Conditions SELECTION OF THE PARTICIPATING FINANCIAL INSTITUTIONS (PFIs). The DBP will select the participating financial institutions, PFIs, from among those which are in good standing of BSP. The accreditation criteria will include: (a) a track record of profitable operations and sound capitalization: (b) an ability to maintain a sound and healthy portfolio as shown by the institution's level of arrearages; (c) a qualified management team of good reputation and (d) adequacy of trained staff, established systems and procedures to be an efficient and reliable purveyor of retail credits. DBP will also include the off balance sheet items of PFIs as a new criticism. The PFIs accredited under the IRP (Loan 3287-PH) will continue to be eligible, at their option, provided DBP certifies that they continue to meet the eligibility criteria. SECTORAL ELIGIBILITY. There is no sector and subsector specific eligibility list. The loan proceeds will be available for use by the private corporate sector belonging to broadly defined industrial sector. In addition, private sector corporate borrowers in the land transport, power and other utilities, telecommunication, and storage sectors (except industrial estates) would be eligible to borrow for viable projects provided they have a strong linkage to manufacturing, are located in the country-side, and would significantly contribute to the provision of essential services, not currently available. However, projects in the meat and meat products subsectors will not be eligible because these products still have excessive protection. In addition, projects, which require regulatory and/or other non-financial support/adjustment, will not be eligible for financing until the required changes have been implemented or made a part of subproject conditionability. RELENDING MECHANISM. Under contractual arrangements satisfactory to the Bank, DBP would pass on the proceeds of the Bank loan to the PFIs which would onlend the funds to Specific Eligible Private Sector Enterprises. DBP will not lend the project funds directly to eligible enterprises, in line with its wholesale banking function. It would establish a separate project account to channel project funds to the PFIs and to accumulate repayments by PFIs to DBP until they become due for repayment under the Bank loan. The funds (loan principal) thus accumulated would be used for further on lending for similar purposes and on similar conditions. COST OF FUNDS TO DBP AND FOREIGN EXCHANGE RISK. The World Bank-would lend to DBP at its standard variable rate. However, the Bank loan will be priced out to the DBP based on the weighted average interest rate of 91-day T-bills, the most commonly used instrument in the market. The difference between DBP's interest rate thus determined and the World Bank lending rate minus a guarantee fee of Page 23 Annex 2 1% p.a. would be the fee to the government for assuming the exchange risk. This would be adjusted every six months in line with the movements in the two rates and shall be paid to the Bureau of Treasury. Since domestic interest rates in the Philippines are market-determined and the capital account is essentially open, this market-based variable formula provides a reasonable estimate of FX risk. RELENDING RATE OF DBP TO PFIs. In line with market conditions, it is anticipated that DBP lending to PFIs would be at variable rates and in local currency. It is expected that the on-lending rate between DBP and the PFIs would approximate the cost to the PFIs of borrowing similar funds in the market. In addition, DBP would start taking into account the relative strength and other risk factors of each PFI in determining the onlending rate. ON-LENDING RATE OF PFIS TO SUBBORROWERS. PFIs will be free to charge market rates of interest, allowing them flexibility in assessing risks and differences in creditworthiness, or covering administrative costs associated with individual clients or loans. This mechanism is also expected to increase competition among the PFIs whichi would bear the full credit risk of each subloan made. ELIGIBLE SUBPROJECTS. The Project would finance technically, financially, environmentally, and economically sound investment subprojects of viable private sector corporate borrowers. The maximum subloan amount to be lent to any individual company by PFIs would not exceed US$8 million equivalent; in case of loan syndication, this limit would be set at US$15 million equivalent. For each subproject, the PFIs would be required to finance at least 1(0% of the financing package from their own funds; this may include the working capital loans they normally extend. The minimum equity contribution by the subborrower would be 30% of total project cost for new projects; for expansion and modernization projects, subborrowers are required to maintain a maximum 50:50 debt-equity ratio and a minimum debt service coverage ratio of 1.5 during the life of the subloan. New subprojects would be subject to a minimum debt service coverage ratio of 2.0. Any variation from these ratios will require the Bank's prior consultation. Subprojects would have to yield a financial rate of return of not less than 15% in real terms. MATURITIES AND GRACE PERIODS. The maturity of equipment and permanent working capital subloans would vary from 3 to 15 years and 3 to 7 years, respectively. The maximum grace period would be 3 years for subloans. ELIGIBLE EXPENDITURES. The proceeds of the loan would be used to finance 100% of amounts disbursed under subloans. Project related expenditures made within 90 days of receipt of subloan application/information by the Bank would be eligible for financing. In addition to financing investments in plant and equipment, expenditure incurred by eligible subborrowers for restructuring plans and to explore and develop foreign markets for their products would be eligible. FREE LIMIT AND SUBPROJECT DOCUMENTAT-ION REQUIREMENTS. The free limit would be set at US$8 million. The proposed free limit would allow the Bank to focus subloan evaluation efforts on larger and more complex projects. If the Bank's share in the subloan made by the PFI were below the free limit, the Bank would not carry out an individual subproject review, but would make periodic sample analysis during supervision missions. DBP would submit to the Bank the original subloan application (submitted by the subborrower to the PFI); the PFI's credit evaluation and appraisal report, and the subloan agreement between the subborrower and the PFI. The Bank would, then, issue authorization to withdraw funds for approved subprojects. If the Bank's share in a subloan is above the free limit of US$8 million, DBP will carry out an independent appraisal of the subprojects before seeking the Bank's approval. The subproject documentation submitted to the Bank would then have to include, in addition to the items mentioned above, a separate feasibility study of the investment project and an extensive analysis of the operational and financial condition of the subborrower. DISBURSEMENTS. The Bank would disburse against 100% of expenditures for the subloans financed by DBP to the PFIs up to the financing share made up by the eligible expenditures and requested for the respective subproject. A Special Account (revolving fund) of US$10 million would be established in Page 24 Annex 2 DBP to finance the Bank's share of subloans, thus helping to expedite project execution. For withdrawals made from the loan account on the basis of Statements of Expenditures, DBP would ensure that all supporting documentation is being adequately maintained and that it would be available for review upon the Bank's request. DBP would submit to the Bank a monthly statement of the transactions of the Special Account. The Bank loan is expected to be disbursed in about five years, based on the disbursement profile for IRP with some adjustment. PROCUREMENT. Procurement procedures for goods, works, and services financed with loan funds would comply with those customary for industrial development finance operations and consistent with the Guidelines for Procurement under IBRD Loans and IDA Credits as of January 1995 and revised in January and August 1996 and September 1997. DBP and PFIs will satisfy themselves that the goods, works, and services to be purchased are for the investment subprojects and are reasonably priced, by ensuring that the subborrowers have canvassed the main sources of supply and purchased from the most advantageous source. Contracts above US$5 million equivalent will normally be procured by International Competitive Bidding (ICB). Exceptions to ICB in large contracts will be allowed in the following cases: (a) Direct contracting would be used in rnodernization or expansion projects if standardized equipment or proprietary parts are needed for compatibility with existing equipment; (b) Limited International Bidding (LIB) would be used for the machinery that is available only from a limited number of suppliers worldwide; and (c) where the procedures are otherwise justified for technical reasons. Contracts below US$5 million would be awarded after evaluation and comparison of quotations solicited from at least three qualified suppliers from at least two countries. Goods of a proprietary nature may be procured by direct contacting, subject to the Bank's prior agreement. All consultancy services will be procured in accordance with the Guidelines for Selection and Employment of Consultants by the World Bank Borrowers, dated January 1997 and revised in September 1997. Furthermore, all consultancy assignments will follow the Bank's Standard Request for Proposals dated January 1997, revised in September 1997, which includes the Standard Form of Contracts. All consultancy contracts in excess of US$100,000 equivalent for firms and US$50,000 equivalent for individuals, and all contracts for selection of consultants through single source selection, or for assignments of a critical nature, would be subject to the Bank's prior review. Regardless of the contract value, consulting contracts would be subject to the Bank's prior review and approval for terms of reference. SUPERVISION AND MONITORING. Given the importance of DBP's institution building, the project will be actively supervised and its progress closely monitored. Adequate budgetary provision will be made. In the immediate future, emphasis will be on (i) the progress made by DBP on redefining its role and functions and determination of strategies to achieve the agreed goals, (ii) the in depth review of DBP's financial condition and portfolio during annual extemal audit with the assistance of experts of international repute, (iii) designing a new suitable scheme to cover foreign exchange risk, (iv) a new system of reporting on DBP's and PFI's environmental due diligence practices. Apart from these specific aspects of institution building, the normal progress of the project and loan utilization will be monitored through semi-annual and annual reports that DBP would be required to submit to the Bank. DBP will be required to submit to the Bank its audited annual accounts within six months of the close of its financial year. In addition to the monitoring of the project progress through reporting, the project will be supervised by regular field visits by the Bank staff. The Bank would also undertake a mid-term review with focus on adequacy of onlending terms and other critical project conditions during its implementation. The principal responsibility for supervising the PFIs will rest with DBP, and that for supervising the subprojects and the ultimate corporate borrowers would rest with the PFIs. The Bank will through its own supervision make sure that DBP and PFIs discharge their supervision responsibilities satisfactorily. Page 25 Annex 2 Project Component 2 - US$6 million (total cost of component) TA for DBP 's Institutional Development As analyzed in detail in Annex 4, DBP would undertake, within 1998, a critical review to determine its future role and strategies to achieve those goals. Whether DBP becomes predominantly a wholesale bank, or a major Expanded Commercial Bank (EKB or unibank or universal bank), or a merchant/investment bank are three major options. The Bank is acting as a catalyst in this process which would be completed by June 30, 1999. Once decisions have been made about its future role, there will be the need to formulate suitable policies to achieve the goals that DBP would set for itself; there will also be a need to acquire the needed management and staff expertise. A specific aspect of DBP institution building is to help promote its financial credibility in the financial markets (domestic as well as international) so that it may, in course of time, raise long term funds on its own without government guarantee. Towards this end, the Bank will be assisting DBP to have an in- depth review of its financial condition and portfolio undertaken with the assistance of independent auditors/experts of international repute, as a part of its annual audit beginning 1998. Another specific aspect of DBP's institution building is to find ways to manage foreign exchange risk on its borrowings in foreign currencies. So far, the government, for a fee, has assumed the exchange risk but it is now reluctant to continue the arrangement. DBP proposes to commission a study to be undertaken by outside experts to suggest a suitable scheme tco manage/hedge the risk. As a part of the Industrial Restructuring Project (Loan 3287 - PH) made in 1990, the DBP had implemented a TTA grant of SEK 10.5 million to strengthen its institutional infrastructure for environmental protection. Considerable progress has been made and DBP's coverage of environmental aspects in its reports is generally satisfactory. To further strengthen environmental protection, the proposed project provides for (i) a review by the Bank's Environment Unit of the generic EIA prepared by the Philippine Environment Management Bureau, (ii) application of the IFC's checklist during subproject appraisal and (iii) an annual report by DBP (according to a prescribed format to be prepared by the Environment Unit on its and PFI's environmental due diligence practices to be submitted to the Bank. In addition, the Project also provides for the training of DBP and PFIs' staff at a regional program to be offered by IFC in early 1999. DBP will strengthen its Treasury functions, particularly in the areas of matching assets and liabilities, and optimizing the management of its financial resources through procurement and installation of necessary computer hardware and software. DBP will al[so convert its computer systems to make them Year 2000 compliant. DBP will prepare and implement a staff training program to improve credit risk analysis skills and proficiency in new products and services. Page 26 Annex 3 Estimated Project Costs Philippines: Private Enterprise Credit Support Project Project Component Local Foreign Total -----------------------US $ million-------------------- Line of Credit Component!' 163.0 146.0 309.0 Technical Assistance Financial Review -- 0.3 0.3 Systems Conversion to Y2000 1.5 1.7 3.2 Strengthening of Treasury -- 1.3 1.3 Study of Hedging against FX Risk 0.1 0.1 0.2 Staff Training 0.4 0.6 1.0 Total 2.0 4.0 6.0 Total Project Cost 165.0 150.0 315.0 Financing Plan IBRD -- 150.0 150.0 DBP/PFls 50.0 00.0 50.0 Subborrowers 115.0 -- 115.0 Total Financing 165.0 150.0 315.0 ' Tentative estimates including land, buildings, machinery & equipment, duties, contingencies, etc. Final estimates would depend on individual subproject cost estimates that PFIs would prepare at the time of subproject appraisal. Page 27 Annex 4 The Development Bank of Philippines DBP Before and After Rehabilitation. The origin of DBP was the Rehabilitation Finance Corporation (RFC) which was created in 1947 to provide credit facilities for the rehabilitation and reconstruction required after World War 11. Eleven years later in 1958, the Development Bank of the Philippines (DBP) was established with a mandate of national development by providing expanded lending operations for all sectors in the economy. In 1986, through Executive order No. 81 and a new Charter, the DBP implemented its major rehabilitation program. For almost three decades until 1986, the DBP operated as an all-purpose development financing institution. Its coverage was all sectors of the economy and its main objectives were to increase food production, develop small and medium and export industries, encourage countryside development, and promote wider wealth distribution. Operationally, it was guided by government directives and eventually financed government development programs, behest projects, and distressed companies, including some very large projects. Efforts to strengthen its operations and financial position were unable to stop or reverse the deteriorating trend in DBP's operations. DBP faced major financial problems due to low collections and poor loan and investment portfolio; it survived only through government financing and deposits. By the mid-1980s, DBP was bankrupl: and required a full-scale and complete institutional rehabilitation and financial restructuring. DBP's rehabilitation in 1986 was initiated by a new government with Bank assistance and participation under its Economic Recovery Loan of 1987. The Bank's active involvement in DBP transformation and progress has continued in the context of FSAL anLd IIC both made in 1989, and IRL in 1990. The rehabilitation started with a new DBP Charter which formed the basis for its financial restructuring and sustainable operations. DBP was freed of many of its non-performing assets (transferred to the government's Asset Privatization Trust) and provided new capital which was required to implement a rehabilitation program. The program called for DBP's financial restructuring, down-sizing through privatization of a number of its retail banking branches, a new organizational structure and corporate culture with a drastic reduction in total staff, increased private sector representation on its Board, and lending thrusts for agriculture, small and medium scale enterprises, and housing. During 1987-1989 period, DBP implemented its institutional strengthening program which called for the improvement of critical management and functional areas, e.g., credit, financial, treasury, planning, budgeting, internal controls/audit, MIS, and human resource management. The institutional development of DBP has since continued. It has evolved into an institution with basically three operating categories-wholesale, retail, and a special funding unit called Window III operations. DBP's rehabilitation was a success both in financial and institutiorial aspects. It has since posted record profitability and growth in operations. DBP now has a smaller but more effective organization and operates as a fairly autonomous financial institution mindful to remain financially sound and sustainable. It assists government programs on an agency basis that protects its financial integrity, i.e., no funding and credit risks. While its goal ito privatize its retail banking branches is still to be achieved, DBP is taking its development banking role beyond providing term financing. In February 1998, new amendments to DBP's charter were approved. These amendments have made DBP more autonomous and independent of the govemment. As a result, DBP is no longer covered by the government's standardized salary levels. When implemented, DBP should be able to attract and retain qualified staff. Its Board of Directors is now authorized to approve and adopt DBP's staffing requirements without prior approval of the Department of Budget and Management of the govemment. A new part-time chairman will henceforth chair the Board meetings while the former full-time chairman will become the full-time president and CEO. Page 28 Annex 4 DBP Changing Role and Functions The new DBP Charter calls for DBP's role and functions to be complementary to the private sector in its operations. It has a license as an Expanded Commercial Bank (EKB or unibank or universal bank) and is, therefore, legally authorized to undertake the full range of commercial banking activities and, in addition, also provide many other financial services which go beyond traditional commercial banking (i.e., those in the nature of investment/merchant banking). On the other hand, at the time of its last major restructuring in the context of the Bank's ERL made in 1987, it was agreed that DBP would, in course of time, become principally a wholesale bank, and gradually give up (or at least reduce considerably) its retail banking operations. In the role of a wholesale bank, DBP was expected initially to become the principal channel for ODA assistance to the private sector but, later, to be able to raise funds on its own standing without government guarantee. In fact, DBP has become one of the largest financial institutions in the Philippines, with three principal categories of operations: (a) wholesaling of long term resource, obtained from ODA through the government's blessings; (b) normal retail banking; and (iii) "Window 111" operations which are "developmental" in nature, i.e., do not qualify unlder the normal commercial criteria of viability (these are funded by up to 30% of annlual profits and are thus limited). During 1995-1997, retail banking operations increased more rapidly than the wholesale operations, and, at the end of 1997, wholesale and retail portfolios outstanding were almost equally divided. DBP's future course of evolution and development in not entirely clear at this stage. Under its current strategy, DBP itself would remain a development bank doing mainly wholesale banking operations in the medium term. Its other activities would be spun-off into other companies which will either be wholly- owned DBP subsidiaries or joint ventures with private (including foreign) sector partners, e.g., in the areas of insurance brokerage, investment banking, venture capital, and leasing operations. It would continue its retail banking although, relatively, on a smaller scale. Sale or privatization of its retail banking branches and/or creation of a joint venture subsidiary to handle retail banking would be postponed. Meantime, DBP would restructure and improve its branch banking in preparation for its ultimate "privatization." However, the privatization could be accelerated through the conversion of a thrift bank currently being rehabilitated by DBP as its commercial bank subsidiary together with a strategic partner (possibly with a foreign bank). In the longer term, however, as the Philippine economy and financial sector are further developed and term finance becomes more generally accessible in the market, DBP's wholesale operations could diminish. Under this situation, the operational focus would be on the EKB functions. DBP may still remain a major financial institution in providing innovative development and financial advisory services. This would require the development of necessary core competencies, the current management plans are to acquire them not only through training but also through the recruitment of external expertise including foreign as necessary. The institution would have to make a final choice as to its future role and functions. It may decide to become predominantly a wholesale bank raising long term resources (domestically as well as in foreign currencies) on its own standing without government guarantee. Or, it may decide to become a major EKB undertaking not only commercial banking activities but also providing all kinds of other financial services. Either choice would be justified and should be acceptable. However, DBP should not undertake, on one hand, the full range of activities that other private sector institutions do and in direct competition with them, and on the other hand, to enjoy special privileges and arrangements with the government, e.g., becoming the designated channel for all ODA loans to the private sector with the guarantee of the government. DBP has agreed to review and prepare new corporate goals and strategy which would help it to remain financially viable, sustainable, and respond to the changing economic and financial sector environment. The new strategy and its implementation plan will be completed by June 30, 1999. Page 29 Annex 4 Organization, Management, Staff Policies Organization and Management. With the recent amendments to its Charter, DBP will be governed by a Board of Directors composed of nine members to be appointed by the President of the Philippines. The Chairman will be elected from among the members and his main function will be to preside over the Board meetings. He will, therefore, be a part time Chairman. The President and CEO will also be a member of the Board. At least four members will be from the private sector. The new Charter amendments are significant in that the Charter now provides full autonomy to the Board for DBP's affairs, including approval of its budget, staffing and compensation which heretofore were subject to government's prior approval. The President and CEO is the only full-time management staff who is also a member of the Board-previously, the chief operating officer was also the vice-chairman and a board member; this position has been abolished. This arrangement is appropriate as it more clearly separates management from the policy making Board of Directors. Following the Charter amendments and rethinking about its role and functions, a reorganization is imminent. The present organization structure provides for five major functional areas called sectors: financial resource sector (treasury, resource development & mobilization, and trust services); operations sector (administration, accounts/loans servicing, client/insurance services); marketing sector (institutional banking, merchant banking, mortgage banking); wholesale banking sector (upgraded from the group level in 1997); and branch banking (branch services and branch credit, with a 72 branch network). The support groups include comptroller's office, human resource, credit policy, strategic planning and research, and legal; all these report to the CEO. The internal audit appropriately reports to the Board. It is expected that the new organization would result in streamlined and quicker decision making. Staffing. During the early period of the 1986 rehabilitation program, DBP reduced its staff from 3,500 to 2,000 mainly through an early retirement scheme. However, by the end of March 1998, its staff had increased to over 2,900. Almost one-fourth are officer level (equivalent to division chief or supervisory level) with the remaining 75% considered "rank and file" starting with grade 4 to grade 22 while grade 23 up to 31 would cover the officer level. Most of the additions in staff occurred in the branches as these increased from about 57 to 72 branches, five regional offices and two agencies. DBP's goals are to maintain the staff at the 3,000 level despite its growing operations and to decrease the number of grades leading to a flatter organization. To implement its new salary scheme now that it does not have to be tied to the civil service level and structure, DBP plans to engage external consultants to undertake an integrated process analysis and formulate corresponding job descriptions. Private sector comparators will be utilized to establish the salary levels and ranges. Initial indications are that salaries of the rank and file staff are up to or above comparators; the salary gaps exist starting with the junior officers level and is widest at the executive vice-president levels. DBP will also examine the experience of other government financial institutions such as the central bank and the Land Bank. After the completion of the consultants' study, salary adjustments are expected but would probably be implemented selectively and in phases. Most of DBP staff are experienced and trained in project finance. However, DBP has recruited selective staff from the private sector banks to handle the new products and services such as short-term working capital financing and investment banking. Most of its training in new areas are provided on the job. Training of its staff in the wholesale banking group was provided by a grant under the Bank's FSAL and involved the criteria, systems, and procedures in assessing the participating financial institutions (PFIs). Now that DBP will have the authority to fix its own salary levels, it expects to improve retention of its experienced staff as well as its recruitment from other private sector financial institutions to handle new products and services. Part of its strategy is to obtain the needed expertise through joint ventures with strategic partners both domestic and foreign. Policies and Procedures. DBP's major policies are contained in its revised Policy Statement which was approved by its Board on June 26, 1998. The revisions reflect its current strategies and policies resulting from amendments to its Charter and introduction of new products and services under its EKB license. Page 30 Annex 4 The Policy Statement has provisions regarding capital adequacy, single borrower (group) exposure, adequacy of provisions, and its commitment to environmental protection and sustainable development. It has provisions for DBP's autonomy in its decision making and for its financial viability (it will assist government programs on an agency basis without assuming funding or credit risks and such activities will be off balance sheet). The revised Policy Statement is satisfactory except in one respect . A law (Republic Act 7656) requires DBP to pay annual divided to the government at the rate of 50% of profits and that, too, of the pre-provisions profits. This payout ratio is to high and may result in the erosion of equity in inflationary periods. It would be prudent for DBP to pay dividend out of inflation-adjusted profits after provisions. When the review about its future role and strategies has been completed, DBP may need to amend the Policy Statement once again. As regards procedures, the system for accreditation of participatory finanicial institutions, PFIs, is noteworthy. Set up with the assistance of the Bank, DBP has good accreditation standards and processes for its wholesale banking. Financial institutions are examined in sufficienlt detail to ensure that they comply with agreed criteria, e.g., adequate track record of profitable operations, sound portfolio and financial condition, adequate trained staff and competent management. The limits for each institution are reviewed annually. DBP's direct loan operations are properly appraised to ensure their viability and suitability for financing. Subproject end-use and supervision is done throughl its branch network. DBP also has a "credit policy supervision" group reporting to the president; this group assists in maintainiing DBP's portfolio quality and credit processes through regular monitoring and reviews of credit policies. Aided by computerization, the management information system is efficient and working well. By early 1998, DBP had computerized its general ledger system which complies with the new charts of accounts prescribed by the Bangko Sentral ng Pilipinas (BSP). The branches are now all linked up with the head office which facilitates monthly reports and consolidation of accounts. Computerization also facilitates the preparation of regular reporting required by BSP. Internally, each unit prepares regular reports on its operations. Various reports are also prepared for specific committees. For example, the assets/liabilities management committee receives the following: weekly reports-liquidity position, deposit/lending rates, market and foreign exchange highlights; monthly reports-projects in the pipeline, DBP financial performance, institutional banking group (IBG) and branch credit group (BCG) loan portfolio. Due to the unusual rise in the level of past dues, a special task force headed by an EVP was formed to monitor and implement special and intensive collection efforts. Detailed listing of statistics on past due accounts and responsible account officers has been prepared and weekly and even more frequent meetings are held to monitor progress of agreed action plans. These include regular visits, preparation of work out arrangements, loan restructuring and additional financing as necessary. Data and information requested from DBP have been readily available; DBP's management information and accounting systems are operating well and considered adequate though they would have to be made Y2000 compliant. Operations and Financial Situation Changing Mix of Operations. Three years after ERL (1987) which envisaged the transformation of DBP into a wholesale bank, its wholesale lending was understandably still a small proportion of its total operations; the ramp up takes time. Thus in 1990, wholesale lending represented 12% of total outstanding portfolio. But given the emphasis on this line of business, wholesale lending grew to 64% of total loans by the end of 1996. Since then, there has again been a change. In 1995, DBP obtained the EKB license and, this combined with certain special operations, resulted in an expansion of retail banking. The number of retail branches increased from 57 to 72, spread all over the country and several regional offices were opened. Between 1995 to 1997, its retail loans increased from P17.3 billion to P31.8 billion (i.e., by 80%) while its wholesale loans increased from P23.9 billion to P32.7 billion (i.e., by 37%). Its portfolio is now divided almost equally between wholesale and retail. One reason for the increase in retail lending share in 1997 was the implementation by DBP of a policy-based program for FPage 31 Annex 4 shipping modernization and funding of a P5 billion loan to the Home Development Mutual Fund-both treated as retail operations. DBP has raised long terms funds independently throtugh one Euro-dollar issue for US$175 million of medium term maturity. DBP's operations during 1995-97 are shown in the table. DBI' Loan Portfolio (Peso billion) 1995 1996 1997 Retail 17.3 20.1 31.8 Wholesale 24.0 26.5 32.7 Total 41.3 46.6 64.5 The total portfolio increased by 56% during 1995-97, which was in linle with increases recorded by other banks in the country during the same period. Financial Condition. DBP's financial performance during 1995-1997 is summarized in the following table: Summary of DBP's Financial Performance 1995-1997 (Peso millions) 1995 1996 1997 Total Assets 67,531 75,726 105,243 Total Loans 40,486 47,191 64,411 Total Deposits 11,633 14,292 15,104 Total Borrowings 38,897 42,982 71,154 Net Income 3,656 4,240 4,540 Administrative Expenses 1,645 1,945 2,301 Profit after Tax 1,901 2,054 1,316 Return on Assets (%) 2.98 2.87 1.45 Returns on Equity (%) 15.5 15.6 9.8 Admin. Expenses/Net Interest Income (%) 45 46 51 DBP's net income increased about 25% between 1995 and 1997. However, this almost was totally offset by an increase of more than P650 million in administrative expenses. Payroll type expenses increased by 28% between 1995 and 1997 and all other administrative expenses increased by a sharp 87%. The most significant increases occurred in loss on acquisition of assets, bad debt and investment write-offs, professional fees, and promotional and staff assistance expenses. A number of these items such as loss on acquisition of assets, (which refers to assets repossessed for sale), bad debts, and professional fees may not reoccur at the same level in the future. In the second half of 1997, due to the depreciation of the currency, higher interest rates and problems in the region, many businesses in the Philippines suffered severe strain. As a result, DBP's past-due loans in 1997 increased to 4.2% which when compared to the overall average for the commercial banks in the Philippines at 4.7% appear low, but one needs lo take into account that the relevant comparison on an industry basis is against retail past-dues, which puts DBP (with 8%) well ahead of the industry average. Part of the increase can be explained by a small number of large loans which are in the process of being restructured and at that stage, the past-due level should reduce. As mentioned before, a task force, to manage problem loans with the specific objective of reducing and restructuring past-due and problem loans, reviews and ensures that appropriate action plans are put in Page 32 Annex 4 place for all loans which are showing any sign of stress. At the same time, DBP increased its bad debt provisions significantly in 1997 by creating a 1% general provision on loans which was in line with BSP regulation. It is planned to increase the general provision by a further 1% in 1999. As all write-offs and past due loans have been in the retail sector, the level of general provision which is related to exposures in that sector is effectively 2%. DBP has not had any bad debt problems to date with wholesale loans which represent 51 % of total lending at the end of 1997. These loans are all made to qualified PFIs for onlending to specific customers. The ultimate customer credit risk is carried by the PFI and DBP's credit risk is with the PFI. The majority of the PFIs are well established licensed banks, and DBP has a fairly good system in place to determine and monitor credit lines at these institutions. The credit lines incorporate both wholesale and money market facilities and are reviewed on a regular basis. Whilst in terms of scale a PFI loss, if it were to occur, could be greater than any retail loan loss, it should be noted that this is only likely to arise in the vent of the failure of another bank. In such a scenario, DBP has a further fall-back position whereby under its loan documentation, provision is made to take over the PFI loans to customers made as a result of the DBP facility. Even though the PFI itself would have failed, one would expect DBP to be able to recover at least a proportion of the loans from the businesses concerned. Return on equity increased marginally in 1996 to 15.6% but declined significantly in 1997 to 9.8% which was mainly due to the creation of the 1% general provision, and also due to the continuing upward drift of administrative expenses. Return on assets followed a similar pattern, remaining relatively flat between 1995 and 1996 and declining significantly to 1.45% in 1997. Liquidity Management. DBP's resource base is as follows: 1995 1996 1997 (Peso millions) Private Deposits 3,046 4,061 7,042 Government Deposits 8,587 10,231 8,062 Borrowings Retail 11,541 13,045 30,361 Wholesale 27,356 29,937 40,793 DBP is heavily reliant on borrowings to fund its activities. It has two main sources of borrowings-ODA which funds its wholesale activities, and bank borrowing which is utilized to fund a significant proportion of its retail activities. In relation to wholesale lending, it generally does not have any negative funding maturity mismatch. It lends for shorter periods than the maturity of the ODA facility and does riot carry any interest or exchange rate risk. However, in relation to its retail lending, the position is quite different. DBP's deposit base is small, and despite an increase of P3 billion in 1997, it only represents 22% of total retail lending. It also has govemment-type deposits which fund about 25% of retail lending. The remainder of its retail lending is funded by borrowings from banks, domestic and international. The largest international facility was a Eurobond Issue in 1993 of US$175m (P6.9bn), and was due for repayment in one installment in July 1998; this has been done by borrowing short-term in foreign markets. Historically in the Philippines, most banks, funded themselves short-term and provided loans on various terms without taking any action to protect the maturity mismatch. DBP, which is funded up to 80% by long-term resources from ODA and ECA, had an Eurobond facility due for repayment in July 1998, but a sinking fund to enable redemption was not built. Because the currency had been effectively "pegged" to the dollar for many years, there was an expectation that the funds could be rolled over or a new loan easily arranged. Due to the recent currency turmoil, banks including DBP have now become much more conscious of the need to match the maturity profile of their assets and liabilities and also to protect themselves against currency and interest rate fluctuations. DBP's action in this regard should focus particularly on retail assets and liabilities, and DBP should take steps to build a retail deposit base Page 33 Annex 4 to fund activities in that area unless retail lending is reduced substantially as a result of rethinking about its future role. Equity Investments. Total equity investments at the end of 1997 amounted to P1.1 billion. In relation to DBP's total assets, these are very small. In general the equity investments are in related businesses such as a data center, services corporation and stock brokerage. In some cases, DBP owns one hundred percent of the shareholding, whereas in others, such as the stockbrokerage and depository firms, it is in a minority position. These investments are generally valued at cost and an allowance is made for possible potential losses. Financial Projections. Given the impact of the Regional financial crisis, there are more than normal uncertainties not only for the financial sector but also for the real sectors. Nevertheless, DBP has prepared financial projections for the next three years, making conservative assumptions. The projections include the balance sheets, income statements, cash flow statements, financial performance indicators, and a schedule of deposits and borrowings identifying as far as possible the sources of borrowings to fund future operations. Projected balance sheets and income statements together with indicators of financial performance are attached. These show continued satisfactory financial conditions and operational performance although the operating results are not projected to be as profitable as in 1995 - 1997 years (this is partly a result of making conservative assumptions given the setback experienced in 1997 including higher provisions for bad debts.) Page 34 Annex 4 Attachment I Actual and Projected Income Statements 1997-2000 (Peso millions) 1997 1998 1999 2000 Actual ------------- Projected --------------------- Operating Income Interest on Loans & Advances 5,765 7,778 8,313 8,751 Earnings on Funds & Securities 2,192 2,058 2,079 2,465 Other Income 1,217 729 765 798 Total Operating Income 9,174 10,565 11,157 12,014 Operating Expenses Cost of Funds 4,601 6,363 6,562 7,016 Salaries and other People Costs 1,106 1,119 1,207 1,328 Other Admin Expenses 1,234 1,188 1,278 1,394 Provision for Bad Debts 737 1,102 748 457 Gross Receipts/FCDU Tax 180 209 390 420 Total Operating Expenses 7,858 9,981 10,185 10,615 Income before Tax 1,316 584 972 1,399 Provision for Tax 0 159 163 129 Profit after Tax 1,316 425 809 1,270 Flage 35 Annex 4 Attachment 2 Actual and Projected Balance Sheets 1997-2000 (Peso millions) 1997 1998 1999 2000 Actual --------------- Projected --------------- Assets Cash and Deposits with Banks 4,868 4,267 4,621 6,536 Loans and Advances 64,087 64,271 66,526 69,702 Investment in Bonds, Securities and 17,064 17,226 18,425 19,672 Inter Bank Fixed Assets 1,057 1,034 1,103 1,160 Equity Investments 1,124 857 746 742 Other Assets 17,043 17,916 17,810 17,715 Total Assets 105,243 105,571 109,231 115,527 Liabilities and Shareholders Funds Deposits :15,104 15,123 15,879 16,832 Borrowings 71,154 71,714 73,865 77,558 Interest and Fees Payable 4,011 3,711 3,989 4,931 Deferred Credits 1,782 1,395 1,465 1,538 Shareholders Equity 13,192 13,628 14,033 14,668 Total Liabilities and Net Worth 105,243 105,571 109,231 115,527 Page 36 Annex 4 Attachment 3 Summary of Key Financial Indicators (Peso millions) 1995 1996 1997 1998 1999 2000 --------- Actual ---------- ------ Projected --------- Operating Statistics (P million) Operating Income 7,348.0 8,417.0 9,174.0 10,565.0 11,157.0 12,014.0 Cost of Funds 3,692.0 4,177.0 4,601.0 6,363.0 6,562.0 7,016.0 Net Interest Income 3,656.0 4,240.0 4,573.0 4,202.0 4,595.0 4,998.0 Salaries and Other Personnel Expenses 849.0 1,002.0 1,106.0 1,119.0 1,207.0 1,328.0 Net Income (after tax) 1,901.0 2,053.0 1,316.0 425.0 809.0 1,270.0 Total Assets (P Billion) 67.5 75.7 105.2 105.6 109.2 115.5 Financial Ratios (P billion) Efficiency- Salaries etc./ Net Income(%) 44.7 48.8 12.1 10.6 10.8 11.5 Capital Adequacy Capital/Total Assets 18.7 18.1 12.5 12.9 12.9 12.7 Earnings Performance (Percentages) Average Yield on Loans: Retail 14.8 14.1 11.0 11.0 12.0 12.3 Wholesale 8.7 8.7 10.7 13.3 13.3 13.3 Average Cost of Borrowings 7.9 7.6 7.8 8.7 10.2 10.3 Return of Assets 2.8 2.7 1.25 0.4 0.7 1.1 Return on Equity 15.1 14.9 9.9 3.1 5.8 8.7 Ratio of Retail/Wholesale 35 39 41 39 39 39 Page 37 Annex 5 Procurement and Disbursement Arrangements Philippines: Private Enterprise Credit Support Project Procurement Procurement methods (Table A) 1. Procurement procedures for goods, works, and serviced financed with loan funds would comply with those customary for industrial development finance operations. DBP and PFIs will satisfy themselves that the goods, works, and services to be purchased are for the investment subprojects and are reasonably priced, by ensuring that the subborrowers have canvassed the main sources of supply and purchased from the most advantageous source. Contracts above US$5 million equivalent will normally be procured by International Competitive Bidding (ICB) in accordance with Bank procurement guidelines ("Guidelines for Procurement under IBRD Loans and IDA Credits" of January 1995 revised in January and August 1996 and September 1997), including the use of Bank's standard bidding documents. In evaluating ICB tenders, a margin of 15% of the c.i.f. or c.i.p bid price or actual custom duties, whichever is less, would be allowed for preference to domestic manufacturers. All ICB packages will be subject to Bank prior approval. Exception to ICB in contracts costing more than US$5 million equivalent will be ailowed in the following cases: (a) Direct contracting will be used in modernization or expansion projects if standardized equipment or proprietary parts are needed for compatibility with existing equipment; (b) Limited International Bidding (LIB) will be used for machinery that is available only from a limited number of suppliers worldwide; and (c) where the procedures are.otherwise justified for technical reasons. These cases would be subject to Bank prior approval. 2. Other procurement would follow established commercial practices which are satisfactory to the Bank. Contracts below US$5 million equivalent would be awarded after evaluation and comparison of quotations solicited from at least three qualified suppliers from at least two countries. Goods of proprietary nature may be procured by direct contacting, subject to the Bank's prior agreement. Prior review thresholds (Table B) 3. All contracts above US$500,000 for goods to be procured under the TA component of the project will be subject to Bank's prior review. All consultancy services will be procured in accordance with the Guidelines for Selection and Employment of Consultants by World Bank Borrowers, dated January 1997 revised in September 1997. Consequently, contracts will follow the Bank's Standard Requests for Proposals dated July 1997, revised in April 1998, which includes the Standard Forms of Contracts. 4. All consultancy contracts in excess of US$100,000 equivalent for firms and US$50,000 equivalent for individuals, and all contracts for selection of consultants through single source selection, or for assignments of a critical nature, would be subject to the Bank's prior review. Regardless of the contract value, consulting contracts would be subject to the Bank's prior review and approval for terms of reference. Disbursement Allocation of loan proceeds (Table C) 5. The Bank would disburse against 100% oif expenditures for the subloans financed by DBP to PFIs up to the financing share made up by eligible expenditures and requested for the respective subproject. Page 38 Annex 5 Use of statements of expenses (SOEs): 6. Disbursements would be made on the basis of statements of expenditures for subloan contracts valued at less than US$5 million equivalent; contracts for goods for DBP's institutional development valued at less that US$500,000 equivalent; consulting services contracts valued at less than US$100,000 for firms and US$50,000 for individuals; and training expenditure of up to US$50,000. DBP would retain documents supporting the statement of expenditures and would make these statements available for inspection and review by Bank supervision missions. All other disbursements will be made against fully documented expenditures. The projected disbursement schedule is based on standard disbursement profile for financial intermediary loans in the Philippines. Special account: 7. To facilitate efficient disbursement, a special account in dollars with an authorized initial allocation of US$ 10 million (based on four months of estimated average disbursement) would be established. It would be replenished monthly or whenever the special account was drawn to 50 per cent of its initial deposit, whichever occurred first. Financial Management Requirements 8. DBP has been a borrower of several Bank loans including credit lines. Subloan accounts of DBP and its financial statements are prepared in accordance with generally accepted accounting principles and have been acceptable to the Bank. The Commission on Audit (COA) is responsible, under the Philippines constitution, to carry out an external audit. COA has carried out audits on the Bank financed projects and the financial statements of the DBP and has expressed satisfactory opinions. Based on the above assessment, the DBP financial management system is considered capable of producing timely and accurate information on the status of subloan disbursements financed by the project. One of the project objectives is to improve overall financial management of DBP operations which goes far beyond ensuring adequate project related financial management. In order to achieve this objective, the Government, the Bank and DBP have agreed to require COA to carry out expanded financial statement audits and submit long-form audit reports commencing with the Financial Statements to be prepared for the year ending December 31, 1998. Agreement of COA and DBP to carry out an expanded audit based on terms of reference acceptable to the Bank and with the assistance of an internationally acceptable experts auditors was a condition of negotiation which was fully met. The audit shall be conducted in accordance with the International Auditing Standards issued by the International Federation of Accountants. The auditors would also follow the latest guidelines on Audit and Accounting for Banks and Savings Institutions issued by the American Institute of Certified Public Accountants. The audit will assess, inter alia, the adequacy of systems of internal control, quality of the loan portfolio including the adequacy of loan loss provisioning, exposure risks on key projects, borrowing groups, connected parties or major economic sectors and the quality of liquidity, asset and solvency management. The auditors are also required to make recommendations on capital fund adequacy based on the above review. Detailed terms of reference for COA and the assisting auditors, as agreed, are given in the Project Implementation File. The agreements would ensure that the international consultants will actively participate in the expanded audit and the services of the international consultants will be contracted as long as considered necessary by the Government and the Bank. It is expected that the quality of the COA audits and the resulting recommendations to DBP management will enhance the financial soundness of DBP. The Bank will follow up on the implementation of the recommendations through its supervision of project implementation. Page 39 Annex 5 Annex 5, Table A: Project Costs by Procurement Arrangements (in US$ rmillion equivalent) Expenditure Category Procurement Method Total Cost (including contingencies) ICB NCB Other N.B.F 1. Works 80.00 80.00 (0.00) 2. Goods 40.00 174.00 214.00 (28.00) (121.00) (149.00) 3. Services 1.00 1.00 (1.00) (1.00) 4. Miscellaneous 20.00 20.00 (0.00) (0.00) Total 40.00 - 175.00 100.00 (315.00) (28.00) (122.00) (0.00) (150.00) Note 1: (a) N.B.F. = Not Bank-financed includes elements procured under parallel cofinancing procedures, consultancies under trust funds, any reserved procurement, and any other miscellaneous items. (b) Figures in parenthesis are the amounts to be financed by the Bank loan. (c) Other includes procurement under limited international bidding, direct contracting, and international shopping. (d) Miscellaneous items include taxes, duties and freight, etc. Note 2: The procurement arrangements given in Tables A and B are of an indicative nature. This project is basically a credit line operation where PFIs will select and approve subloans during project implementation. It is only at that stage that contract sizes will be determined and procurement: arrangements will be made. Page 40 Annex 5 Annex 5, Table Al: Consultant Selection Arrangements (optional) (in US$ million equivalent) Consultant Selection Method Total Cos! Services (including Expenditure contingencies) Category QCBS QBS SFB LCS CQ Other N.B.F. A. Firms 0.70 0.70 (0.70) (0.70) B. Individuals 0.30 0.30 (0.30) (0.30) 0.70 0.30 1.00 Total (0.70) (0.30) (1.00) Note: QCBS = Quality- and Cost-Based Selection QBS = Quality-based Selection SFB = Selection under a Fixed Budget LCS = Least-Cost Selection CQ = Selection Based on Consultants' Qualifications Other = Selection of individual consultants (per Section V of Consultants Guidelines), Commercial Practices, etc. N.B.F. = Not Bank-financed. Figures in parenthesis are the amounts to be financed by the Bank loan. Page 41 Annex 5 Annex 5, Table B: Thresholds for Procurement Methods and Prior Review Expenditure Contract Value Procurement Contracts Subject to Category (Threshold) Method Prior Review / Estimated Total Value Subject to Prior Review US $ millions US $ millions 1. Works 2. Goods LOC 5.00 ICB 40.00 TA 0.50 ICB/other modes 1.00 3. Services 0.10 QCBS and Individual 1.00 Selection 4. Miscellaneous Total value of contracts subject to prior review: 42.00 Page 42 Annex 5 Annex 5, Table C: Allocation of Loan Proceeds Expenditure Category Amount in US$ Financing Percentage million Part A Line of credit component 146.00 100% of amounts disbursed under subloans Part B Goods 3.00 100% of foreign expenditures, 100% of local expenditures (ex-factory cost) and 75% of local expenditures for other items procured locally. Consultant services and training. 1.00 100% of expenditure. Total 150.00 Page 43 Annex 5 Annex 5, Table ]D: Procurement Plan International Competitive Bidding (ICB) An Indicative List of Actions and Time-Frame for a Typical Procurement Package Activity Responsibility No. Days 1. Draft bidding documents including advertisement Borrower 60 2. Reviews bidding documents Bank (HQ) 14 3. Publish Specific Procurement Notice Borrower 7 4. Issuance of bidding documents and preparation of bids Borrower/bidder 45 5. Bid opening Borrower I 6. Evaluation of bids Borrower 30 7. Review of bid evaluation report Bank (HQ) 14 8. Approval of evaluation Borrower 15 9. Issuance of award Borrower 7 10. Preparation of contract Borrower 15 1 1. Furnish copy of signed contract to Bank Borrower 7 Page 44 Annex 6 Project Processing Budget and Schedule Philippines: Private Enterprise Credit Support Project Planned Actual (Atfinal PCD stage) A. Project Budget (US$000) 219.0 B. Project Schedule Time taken to prepare the project (months) Tlhree months First Bank mission (identification) 03/09/1998 03/09/1998 Pre-Appraisal mission departure 05/14/1998 05/14/1998 Negotiations 06/25/1998 08/31/1998 Planned Date of Effectiveness 02/22/99 / /19 Prepared by: Development Bank of the Philippines Preparation assistance: None Bank staff who worked oni the project included: Name Specialty Zafar Shah Khan Task Team Leader/Finance Tomoko Matsukawa Guarantee Operations Aloysius Ordu Industrial Sector Margaret Png Legal Counsel Vimala Abraham Disbursement Cecilia Vales Procurement Carla Sarmiento Team Assistant Consultants who worked in the project included: Name Specialty Jin Lacey Banking Sector Zamir Hasan Financial Institutions Ravi Nangia Financial Economist Carlo Punsalan Development Banking Page 45 Annex 7 Documents in the Project File* Philippines: Private Enterprise Credit Support Project A. Project Implementation Plan Prepared by the Development Bank of the Philippines B. Bank Staff Assessments A note on1 the financial sector in the Philippines A note on the corporate/industrial sector in the Philippines C. Other Various data and information provided by DBP on its operations, resources, portfolio, and financial position *Including electronic files. Page 46 Annex 8 Status of Bank Group Operations in Philippines IBRD Loans and IDA Credits in the Operations Portfolio Difference Between expected Original Amount in US$ Millions and actual Fiscal disbursements a/ Project ID Year Borrower Purpose IBRD IDA Cancellations Undisbursed Orig Frm Rev'd Number of Closed Projects: 126 Active Projects PH-PE-4566 1998 REP OF PHILS EARLY CHILD DEV. 19.00 0.00 0.00 19.00 0.00 0.00 PH-PE-4576 1998 GOP WATER DISTRICT DEV. 56.80 0.00 0.00 56.80 3.80 0.00 PH-PE-4595 1998 GOP COMMUNITY BASED RESO 50.00 0.00 0.00 50.00 2.77 0.00 PH-PE-51386 1998 GOP SZOPAD SOCIAL FUND 10.00 0.00 0.00 9.75 1.50 0.00 PH-PE-37079 1997 GOP AGRARIAN REFORM COMM 50.00 0.00 0.00 46.72 3.12 0.00 PH-PE-40981 1997 SUBIC BAY METRO. AUTH. SECOND SUBIC BAY 60.00 0.00 0.00 58.92 37.92 0.00 PH-PE-4602 1997 REP OF PHILS. THIRD ELEM EDUCATION 113.40 0.00 0.00 110.40 35.56 0.00 PH-PE-4613 1997 GOP WATER RESOURCES DEVE 58.00 0.00 0.00 56.01 18.52 0.00 PH-PE-4571 1996 GOP TRANS GRID REINFORCE 250.00 0.00 0.00 153.24 -43.91 0.00 PH-PE-4611 1996 GOP MNLA 2ND SEWERAGE PR 57.00 0.00 9.00 48.00 31.99 1.00 PH-PE-4614 1996 LBP RURAL FINANCE II 150.00 0.00 0.00 34.58 -27.42 0.00 PH-PE-4567 1995 GOVT OF THE PHILS WOMENS HEALTH & SAFE 18.00 0.00 0.00 15.77 3.72 0.00 PH-PE-4584 1994 NPC AND PNOC LEYTE CEBU GEOTHERMA 211.00 0.00 0.00 31.86 31.85 0.00 PH-PE-4607 1994 GOV OF PHILIPPINES LEYTE LUZON GEOTHERM 227.00 0.00 0.00 87.31 79.89 0.00 PH-PE-4609 1994 SBMA SUBIC BAY FREEPORT 40.00 0.00 0.00 3.18 1.99 0.00 PH-PE-4568 1993 GOP URB HEALTH & NUTRITI 0.00 70.00 0.00 51.36 31.59 0.00 PH-PE-4589 1993 GOP IRRIG OPER SUPP II 51.30 0.00 0.00 20.08 17.30 0.00 PH-PE-4599 1993 GOVT. OF PHILIPPINES TAX COMPUTERIZATION 63.00 0.00 0.00 23.98 24.01 0.00 PH-PE-4538 1992 GOP SECOND VOCATIONAL TR 0.00 36.00 0.00 10.18 9.06 0.00 PH-PE-4592 1992 GOP MUNICIPAL DEV III 68.00 0.00 0.00 30.83 26.88 7.84 PH-PE-4597 1992 GOP HIGHWAY MANAGEMENT P 150.00 0.00 0.00 47.36 43.31 -.77 PH-PE-4558 1991 GOVT. OF PHILS. ENV. & NAT. RES. MGT 158.00 66.00 0.00 17.00 13.71 0.00 PH-PE-4572 1991 ROP COMMUNAL IRRIG. II 46.20 0.00 3.34 14.77 18.13 .93 PH-PE-4552 1990 R.P. COCONUT FARMS DEVT. 121.80 0.00 .85 35.38 36.24 19.84 Total 2,028.50 172.00 13.19 1,032.48 401.53 28.84 Active Projects Closed Projects Total Total Disbursed (IBRD and IDA): 1,160.22 6,824.59 7,984.81 of which has been repaid: 42.17 3,652.48 3,694.65 Total now held by IBRD and IDA: 2,145.13 3,213.37 5,358.50 Amount sold 0.00 31.35 31.35 Of which repaid : 0.00 31.35 31.35 Total Undisbursed : 1,032.48 41.23 1,073.71 a.Intended disbursements to date minus actual disbursements to date as projected at appraisal. Note: Disbursement data is updated at the end of the first week of the month. Page 47 Annex 9 Philippines at a glance East Lower- POVERTY and SOCIAL Asia & middle.- Phillppines Pacific Income Development diamond' 1997 Population, mid-year (millions) 73.4 1,753 2.285 Life expectancy GNP per capita (Atlas method, US$) 1.220 970 1,230 GNP (Atlas method, US$ billions) 89.6 1,707 2.818 Average annual growth, 1991-97 Population (%) 2.3 1.3 1.2 GNP Gross Labor torce (%) 2.7 1.4 1.3 Gmss per --prmaty Most recent estimate (latest year available, 1991-97) capita enrollment Poverty (% of populahon below nabonal poverty line) 54 Urban population (% of total population) 56 32 42 Life expectancy at birth (years) 66 69 69 Infant mortalKy (per 1,000 live bifths) 36 38 36 Child malnutrition (% of children under 5) 30 16 .. I Access to safe water Access to safe water (% of populaton) 85 84 84 Illiteracy (% of population age 15+) 5 17 19 ! Gross primary enrollment (% of school-age population) 116 115 -I1 Phlippines Male .. 118 116 - Lower-middle-income group Female .. 116 113 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1976 1986 1996 1997 r---- ;Economic ratioe GDP (US$ billions) 17.2 29.8 82.8 82.2 Gross domestic investment/GDP 32.9 16.0 24.0 24.8 Trade Exports of goods and services/GDP 19.3 26.3 40.5 49.0 Gross domestic savings/GDP 26.9 19.9 15.2 14.5 Gross national savings/GDP 27.7 19.3 19.3 18.8 Current account balance/GDP -6.4 3.2 -4.8 -5.2 1n.st Interest payments/CDP 1.0 3.8 2.1 2.3 Domestic Investment Total debt/GDP 35.1 94.5 49.7 vings Total debt service/exports 16.9 33.7 14.4 .. Present value of debt/GDP .. Present value of debtlexports .. IIndebtedness 1976-86 1987-97 1996 1997 1998-02 I (average annual growth) GDP 1.8 3.2 5.7 5.3 I Philippines GNP per capita -0.8 1.4 4.5 3.3 .. ---Lower-middle-Income group Exports of goods and services 6.0 9.5 15.4 17.5 STRUCTURE of the ECONOMY 1976 1986 1996 1997 Growth rates of output and Investment (%1 (X of GDP) 20 Agricufture 29.3 23.9 20.6 18.7 20 Industry 35.7 34.6 32.1 32.2 Manufacturing 25.4 24.6 22.8 22.3 lo 92 93 94 95 96 97 Services 35.1 41.5 47.3 49.2 - 20 9 Pnvate consumption 62.3 72.1 72.8 72.5 ,-301 General govemment consumption 10.8 8.0 11.9 13.0 i GD - 0 GDP Imports of goods and services 25.2 22.4 49.3 59.4 I (average annual growth) Groh197646 1987-7 1 1997 Gowthrates of exports and imports I% Agricuture 1.4 1.8 3.0 3.7 25T Industry 0.7 3.1 6.3 6.0 '20 Manufacturing 0.5 3.0 5.6 4.2 is Services 3.2 3.9 6.5 5.4 1so Private consumption 2.4 3.7 5.3 3.7 General govemment consumption -0.3 3.9 5.2 0.6 j Gross domestic investment -3.2 6.3 15.6 9.2 1 92 93 94 95 55 97 Imports of goods and services 2.1 11.3 16.7 14.4 i Expors a Imporb Gross national product 1.5 3.8 6.9 5.5 Note: 1997 data are preliminary estimates. The diamonds show four key indicators in the country (in bold) compared with s Income-group average. If data are missing, the diamond will be incomplete. Page 48 Annex 9 Philippines PRICES and GOVERNMENT FINANCE 1976 1986 1996 1997 Inflatlon (%) Domestfc prtces (% change) Consumer prices 9.2 0.8 8.4 5.1 Implicit GDP deflator 8.3 3.0 7.8 6.0 10
Groupe de la Banque mondiale · Project Appraisal Document
Philippines - Private Enterprise Credit Support Project
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