Philippines - Second Private Development Corporation Project

LNK- 4 7 PH RESTRICTED Report No. P- 511 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE- PHILIPPINE NATIONAL BANK September 14, 1966  fITERNITIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LO4N TO THE PHILIPPINE NATIONAL BANK FOR THE SECOND DEVELOPMENT CORPORATION PROJECT 1. I submit the following report and recommendation on a proposed loan, in an amount in various currencies equivalent to $25 million, to the Philippine National Bank (PNB) for relending to the Private Development Corporation of the Philippines (PDCP). PART I - HISTORICAL 2. The Private Development Corporation of the Philippines was established in 1963 with the object of assisting private industrial enterprises in the Philippines. The Corporation's share capital amounts to Ps. 25 million and it received a USAID loan of Ps. 27.5 million in local currency and a Bank loan of $15 million. IFC holds 80,000 shares or 3.2% of the Corporation's capital stock. As of March 31, 1966 loans have been approved for 37 projects, totalling Ps. 89.0 million. 3. By September of 1965 PDCP's foreign currency resources available through the first Bank loan were almost fully committed and the Corporation required assurance of the availability of additional foreign currency to continue its commitments. In anticipation that the session of Congress beginning in January 1966 would enact legislation enabling the Government to guarantee a further loan a mission visited the Philippines in November 1965 to review the Corporation's operations and performance and assess its needs for additional resources over the next two years. The mission found that the Corporation's overall performance had been satisfactory and that its estimate of its foreign exchange requirements of $25 million appeared realistic. Presentation of the loan has however been delayed as the Philippine Congress did not pass the necessary enabling legislation until late August, during a special session. 4. As in the case of the first loan the Borrowers will be the Philippine National Bank (PNB) which will pass on the proceeds to PDCP on terms substantially the same as the Bank loan terms. 5. Negotiation of the proposed loan was completed on June 10, 1966, pending enactment of legislation enabling the government to guarantee the loan. PNB was represented by Mr. Roberto Benedicto, President, and PDCP by Mr. Roberto Villanueva, Chairman of the Board of Directors and Mr. Vicente Jayme, Executive Vice President. Upon enactment of the necessary legislation the Hon. Eduardo Romualdez, Secretary of Finance, approved the terms of the Guarantee Agreement on September 13, 1966.  6. The proposed loan, if approved, will be the Bankts ninth in the Philippines and will increase the total amount lent to $135.8 million. The following is a summary statement of the previous Bank loans to the Philippines as at August 31, 1966. Year Amount of Less Undisbursed Loan Borrower Purpose Cancellations Balance - - -in US$ million - - - - 1957 National Power Power - Binga 18.h Corporation 1961 Republic of the Dredging 8.5 1.1 Philippines 1961 National Power Power - Angat 34.0 4.6 Corporation 1962 National Power Power - Maria 3.7 1.0 Corporation Cristina 1963 Philippine National Relending to the 15.0 h.9 Bank Private Development Corporation of the Philippines 1964 National Waterworks Manila Water Supply 20.2 17.4 and Sewerage Authority 1964 Republic of the Education (University 6.0 5.7 Philippines of the Philippines' College of Agriculture) 1965 Central Bank of the Rural Credit 5.0 4.9 Philippines Total (less cancellations) 110.8 of which has been repaid 6.1 Total outstanding 10h.7 Amount sold 9.8 of which has been repaid h.5 5.3 Total now held by Bank 99.4 Total Undisbursed 39.6 7. The Dredging Project of 1961 has been a disappointment. All floating equipment has now been procured but the operation and maintenance of the fleet has been unsatisfactory. h contract to construct the slipujay  - 3 - was not awarded until late 1965 and work is progressing slowly. Can- cellation of the undisbursed balance is under consideration. The Angat Power Project of 1961 is expected to be completed in June 1967 about 2-2 years after the originally scheduled date. The start of the project was delayed because contracts were not awarded on time and construction has been seriously delayed by typhoon damage in 1963 and 1964 and major cave-ins in June 1965 which led to the termination of the civil works contract. The new contractor is performing well and the revised construction schedule is being maintained. The National Waterworks and Sewerage Authority (NWSA) Project of 1964 has been delayed about one year owing to slowness in awarding civil works contracts, poor contractor performance and litigation over the prin- cipal pipe contracts. One civil works contract has been terminated and re-awarded to a new contractor. Another civil works contract has been renegotiated to give NWSA more control over the contractor's operations. 1iSA have proposed revised procurement procedures in an attempt to avoid further litigation. 6. The new Administration under President Marcos which took office in January of this year has brought about some improvements in the adminis- tration of Bank-financed projects. Recently arrangements were made to provide the peso funds required to complement the loan funds provided for the ThISA project. Peso funds have also been provided for the University of the Philippines, College of Agriculture project which should enable the project to be completed on schedule. The President has also issued directives re-organizing offices closely concerned with the implementation of the development program. Among these measures, of particular interest to the Bank is the setting up of a Coordinating Council charged with correcting the deficiencies in the administration of projects financed by foreign loans and the designation of a special officer on the President's staff to expedite these projects. 9. In contrast to the operational difficulties described above, PDCP, a private institution, has during its first three years established a reputation for sound and efficient operations. PDCP was set up with Bank and IFC assistance, and its performance to date merits continued Bank support. Now that the necessary legislation has been enacted and in view of the developments outlined in the preceding paragraph, I am prepared to recommend to the Executive Directors that the Bank grant a second loan to enable PDCP to continue its work in the development and financing of private enterprise.  -h - PART II - DESCRIPTION OF TIIE PROPOSED LOAN 10. The main characteristics of the proposed loan are as follows: Borrower: Philippine National Bank (PNB) Guarantor: Republic of the Philippines Beneficiary: Private Development Corporation of the Philippines Amount: The equivalent in various currencies of $25 million. Purpose: The loan is to be relent by the Borrower to the Beneficiary to enable PDCP to finance development in the Philippines through loans and other investments to private pro- ductive enterprises for specific projects. Amortization: By semi-annual payments on January 1 and July 1. The amortization schedule provides for repayment beginning January 1, 1968 and is subject to amendment to correspond with repayments to PDCP by enter- prises benefitting from parts of the loan, provided that each part shall be repayable in not more than 15 years. Interest Rate: Variable: When a part of the loan is credited to the Loan Account, the rate of interest charged on that part will be the Bank's current rate for similar loans at the time the credit is made. Commitment Charge: 3/8 of 1% per annum, payable from the time the Loan Account is credited for each part of the loan.  Relending Terms; Additional interest charge of .443% per annum. Prior Approval of Projects: All credits for projects with estimated foreign currency costs exceeding the equivalent of $250,000 and all investments are subject to the approval of the Bank. PART III - THE PROJECT 11. A report entitled "Appraisal of Private Development Corporation of the Philippines" (No. DB-26c) is attached. 12. Manufacturing industry grew rapidly in the Philippines in the 1950's under heavy protection fron quantitative import controls, an over- valued currency and plentiful credit. With the removal of import re- strictions in 1962, when the exchange rate was allowed to rise to the free market rate, industry passed through a difficult phase of re-adjustment which was not made easier by tight credit, and the rise in cost of imported raw materials and capital goods. Falling profit margins were compensated for, however, by increases in output and greater efficiency. The investment required to achieve these improvements has increased the need for more debt financing and aggravated the liquidity problem. Since the beginning of 1964 credit has been very tight and though some easing has been noticed the last few months, shortage of capital remains as one of the chief obstacles to industrial growth in the Philippines. 13. The chief sources of finance in the Philippines are the commercial banks, the insurance companies and the development banks. The commercial banks concentrate on short-term lending and have been severely restricted during the past year by the tight liquidity situation. The insurance com- panies have directed their lending almost entirely toward consumer loans and real estate loans and investments. Of the development banks, the Government- owned Development Bank of the Philippines is the largest. Its lending activities during the recent past have been restricted due to shortage of funds. The private development finance companies, of which PDCP is the largest, thus have an especially important role to play. 1l. PDCP was established in February 1963 with IFC assistance. Its share capital consists of Ps. 25.0 million, of which IFC holds Ps. 800,000 ($205,128). The balance is spread among a large group of Philippine and foreign investors. At the time of its organization, the Bank made a 15- year loan for PDCP of $15 million. In addition, the Corporation has received a 30-year subordinated peso loan from USAID of Ps. 27.5 million.  15. The Corporationts Board is an active group of Filipino business- men and respresentatives of foreign investors, whose knowledge of the Philippine economy and investment judgment are among PDCP's main assets. The Chairman, new in 1966, is one of PDCP's original sponsors and one of the most energetic and capable members of the business community. The day-to-day management is in the hands of a competent Executive Vice President. PDCP is run efficiently and its project appraisal standards, considering the relatively short experience of the staff, are reasonably good. Operating costs have been held at a low level relative to the size of the portfolio. PDCP's relations with the Government are good. 16. On March 31, 1966 PDCP's assistance to Philippine industry (both local and foreign currency) totalled Ps. 89.0 million for 37 projects. The foreign currency component of these totalled $15.0 million, representing the full commitment of the first Banc loan. The portfolio is well diversified with financial assistance spread among several industrial sectors. Net earnings for 1965 amounted to Ps. 3,961,000 which represented a 12.9% return on net worth, and a 15.8% return on share capital. PDCP paid a 10% dividend on its shares in 1965 and expects to do the same in 1966. 17. During its three years of operation PDCP has established itself as an efficient and useful organization making a worthwhile contribution to the development and financing of private enterprise. Although the financial assistance it has extended has not been more than a small fraction of total industrial investment, it has been spread through a representative cross- section of industry and has made a useful impact on production, incomes and employment. By its pioneering work in underwriting it has made a useful contribution to the development of the capital market. It has also rendered appreciable advisory services to the companies it has financed. 18. PDCP's forecasts are not based on the assumption that there will be a substantial increase in business activity. It is still too early to forecast the effect of the new Government's economic policies on invest- ment but their intention certainly is to facilitate industrial development. PDCP believes that with its resources replenished, and its staff now strengthened, it will be in a position, even with the same general level of investment, to increase its assistance to industry by as much as 25% above the 1965 level. On this assumption, the Corporation expects to be able to commit in loans and equity investments about Ps. 70 million a year, of which about two-thirds or the equivalent of about $12 million, would be in foreign exchange. These forecasts seem reasonable. I believe, therefore, that the Bank would be justified in providing $25 million to meet the estimated foreign exchange component of PDCP's operations in about the next two years. 19. PDCP will need to replenish its local currency resources within a year or so. The management is exploring the possibility of selling a peso bond issue and will also actively seek partners in its financing to a greater extent than in the past. We have encouraged PDCP to look to IFC whenever a suitable project, which was beyond PDCP's own means, comes forward.  - 7 - 20. PDCP will continue to play an important role in meeting the financial requirements of Philippine industry. I believe that PDCP has established itself as a useful and worthwhile organization to which further Bank lending is well justified. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 21. The following documents are being distributed to the Executive Directors separately: (1) the draft Loan Agreement between the Bank and P\B; (2) the draft Guarantee Agreement between the Republic of the Philippine. and the Bank; (3) the draft Project Agreement between the Bank and the Corporation; (4) the draft Subsidiary Loan Agreement between PNB and the Corporation; (5) the draft letter from the Corporation to the Bank regarding the limit applicable for approval of investment projects by the Bank (Section 2.02(c) of the draft Loan Agreement); and (6) the Report of the Committee provided for in Article III, Section h (iii) of the Articles of Agreement of the Bank. 22. The draft Loan, Project, and Subsidiary Loan Agreements which follow closely the pattern of the corresponding agreements providing for the first loan to the Corporation, contain the covenants usually included in agreements with development finance companies. Article VI of the draft Loan Agreement modifies the loan agreement covering the first loan to the Corporation so as (i) to provide that any default under the loan, guarantee or project agreements for the first loan or the proposed loan would entitle the Bank to suspend and/or premature both loans (Sections 6.01, 6.02); and (ii) to make uniform for both loan agreements provisions regarding certain instances in which compulsory prepayment is provided for (Section 6.03). The execution and delivery of the Subsidiary Loan Agreement and of the Project Agreement are made additional conditions to the effectiveness of the Loan Agreement (Section 8.01). The draft Guarantee Agreement follows the usual form. PLRT V - THE ECONOMY 23. The last economic report entitled "Current Economic Position and Prospects of the Philippines" was distributed to the Executive Directors on June 2, 1965. An economic memorandum updating the report is attached. The Philippines has a ratio of service on public and private debt to foreign exchange earnings of about 9% at present, which is expected to reach a peak of 13% - 14% in 1970. In view of the potential of the economy for growth in production and export, the Philippines is considered creditwTorthy for additional foreign borrowing on conventional terms.  - 8 - PART VI - COMPLIANCE WITH ARTICLES OF AGREEMTENT 2h. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOMMENDATION 25. I recommend that the Executive Directors adopt the following resolution: RESOLUTION NO. Approval of Loan to Philippine National Bank (Second Development Corporation Project) in an amount equivalent to US$25,000,000 to be guaranteed by Republic of the Philippines RESOLVED: THAT the Bank shall grant a loan to the Philippine National Bank to be guaranteed by the Republic of the Philippines, in an amount in various currencies equivalent to twenty-five million United States dollars (U.S. $25,000,000), to mature on and prior to the date or dates to be determined as set forth in the form of Loan Agreement (Second Development Corporation Project) between the Bank and the Philippile National Bank which has been presented to this meeting, at the rate or rates to be deter- mined as set forth therein, and to be upon such other terms and conditions as shall be substantially in accordance with the terms and conditions set forth in the said form of Loan Agreement, and in the form of Guarantee Agreement (Second Development Corporation Project) between the Republic of the Philippines and the Bank, the form of Project Agreement (Second Development Corporation Project) between the Bank and the Private Development Corporation of the Philippines, and the form of Subsidiary Loan Agreement (Second Development Corporation Project) between the Philippine National Bank and the Private Development Corporation of the Philippines, which have been presented to this meeting. Attachments George D. Woods President Washington, D.C. September 14, 1966