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* LGU FINANCING PRESENT SOURCES,

AVAILABILITY AND TERMS

by

CARLOS B. GAVINO LGU BOT Financial Adviser

CCPAP BOT Center June 1998

United States Agency for International Development (USAID) Philippine Host Country Contract

• Local Government Umt (LGU)

LGU Financing Present Sources, Avazlabzlzty and Terms

TABLE OF CONTENTS

Preface 1

Introduction 3

Objectives 5

Chapter I - Framework for LGU Financing 7 Government's New VIsion and Policy Framework 9

Chapter II - Current Sources and Assessment of LGU Financing 13 Internal Revenue Allotments 13 Local Resource Mobilization 14 Debt FinanCing 15 Public Sources 15

- Government Financial Institutions 15 - OffiCial Development ASSistance 19 - Municipal Development Fund 20 - Bilateral Sources 22

Private Sources 22 - Pnvate Commercial Banks 23 - Municipal Bond Flotations 26

Other Pnvate Sources 29 - BUlld-Operate-Transfer Schemes 29 - Provincial EqUity Funds 35 - LGU Guarantee Corporation (LGUGC) 35 - Other Forms of Private Sector PartiCipation 36 - Joint Ventures 37

New Proposed Multilateral Initiatives on LGU FinanCing 38 - LGU Infrastructure FaCility (LGUIF) 38 - LGU Infrastructure Finance and Development Project 38

Bilateral Programs Involving LGU FinanCing 39 - Governance and Local Democracy Project (GOLD) 39 - Growth with EqUity In Mindanao Project (GEM) 40

Chapter III - Constraints to LGU Access to Private Capital 41

Chapter IV - Recommendations 45

Conclusions 49

Annexes 51

LGU Fmancing- Present Sources, Availability and Terms

ABBREVIATIONS AND ACRONYMS

ADB BAC BOT BSP CCPAP COA CPVDC DBP DOF GEM GFI GOLD GSIS HIGC ICC LBP LGC LOGOFIND LGU LGUGC LGUIF LWUA MDF NCR NEDA ODA PIDS PNB ROI SSS USAID

ASian Development Bank Batangas Assets Corporation Build-Operate-Transfer Bangko Sentral ng Pillplnas Coordinating Council of the Philippine Assistance Program Commission on Audit Cebu Property Ventures Development Corporation Development Bank of the Philippines Department of Finance Growth with Equity In Mindanao Government Financial Institution Governance and Local Democracy Project Government Service Insurance System Home Insurance Guarantee Corporation Investment Coordination Committee Land Bank of the Philippines Local Government Code LGU Finance and Development Project Local Government Unit Local Government Unit Guarantee Corporation Local Government Unit Infrastructure FaCility Local Water Utilities Administration Municipal Development Fund National Capital Region National Economic and Development Authonty Official Development Assistance Philippine Institute for Development Studies Philippine National Bank Rate of Return on Investments SOCial Secunty System United States Agency for International Development

LGU Financing Present Sources, Availabillty and Terms

PREFACE

This paper presents a compilation

and assessment of current

sources of financing for Local

Government Unit (LGU) Infrastructure

projects It was derived mainly from the

presentations of speakers at the 1997 year­

long Regional LGU Flnancmg Seminar se­

ries sponsored by the Bureau of Local Gov­

ernment Fmance (BLGF) of the Department

of Finance (DOF) and the Coord mating

Council of the Philippine Assistance Pro­

gram (CCPAP) BUild-Operate-Transfer Cen­

ter. The semmar series IS the brainchild of

the Department of Fmance and the CCPAP.

Inspired by the SPirit of the Local Govern­

ment Code, the message was clear "Devo­

lution has brought the burden of flnancmg

basIc services and development squarely

on the shoulders of each LGU. Let's help

ease the burden through an Information

campaign by brlngmg the LGU flnancmg

programs of both public and private sector

fmancmg agencies directly to LGUs, start­

Ing from region to region until the whole

country IS covered" Profound gratitude

IS due to the three sponsoring financial in­

stitutions, the Development Bank of the

Philippines (DBP), the Land Bank of the

Phlllppmes (LBP) and the PhilipPine Na­

tional Bank (PNB) whose support has made

the seminar series possible. Gratitude is

also due to my co-speakers m the seminar

series, mcludmg Ms CeCilia Borromeo of

the Land Bank, Mr. Josefmo R. Gamboa of

1

the Philippine National Bank, Mr Armando

O. Samla of the Development Bank of the

Philippines, Mr. Raul Nlvera of the Multina­

tional Investment Bancorporatlon, and

Director Erllto Pardo of BLGF, and others

too numerous to cite. Special thanks goes

to Undersecretary CeCilia G. SOriano of the

Department of Finance (DOF) for frammg

the Government's new Vision for LGU financ­

mg whose implementation she IS vigorously

pursumg The author also Wishes to recog­

nize the assistance provided by Mr Jorge

M Briones, Deputy Executive Director of

the BOT Center, and Mmes. Soledad J Cruz

and Rosalia V. de Leon, Directors of DOF,

who proVided comments on the drafts of

the paper Gratitude IS also expressed to

Messrs. Michael S. Gould and Joseph S

Ryan, Jr of the USAID for their mvaluable

support to the project. Fmally, a word of

thanks to Rommel A. Canuto of the CCPAP

and Mmes Vilma Lopez, Lam P. Barlongay

and Ayan Hazelle L. Flores of the BOT Cen­

ter who helped In the production of thiS

document Any shortcomings m the paper

are purely my own.

Carlos B. Gavino

LGU BOT Financial Adviser

CCPAP BOT Center

LGU Fmancing Present Sources, Availability and Terms

INTRODUCTION

The enactment of Republic Act

No 7160 otherwise known as

the Local Government Code of

1991(LGC) represents a major shift In local

governance In the Philippines It mandates

the devolution to the local government

Units (LGUs) of many functions previously

carried out by the National Government

Implementing Agencies (lAs) SpeCifically,

the LGC's policy declaration states: ". The

State shall proVide for a more responsive

and accountable local government

structure instituted through a system of

decentralization whereby local government

Units shall be given more powers, authority,

responsibility, and resources "1 The LGC

prOVides greater autonomy to the LGUs In

mobiliZing resources and allocating these

for the efficient delivery of basIc serVices,

facilities and other needs To carry out

these functions, the LGC calls for the es-

tabllshment In every local government Unit,

an efficient and dynamic organizational

structure and operating mechanism that

will deliver the basIc services and meet the

Priority needs and reqUirements of ItS

communities.

financing LGUs have traditionally relied on

their share of national government wealth

through the internal revenue allotments

(IRA), their own local resource generation,

and loans from the Government Financial

Institutions (GFls) and the Municipal

Development Fund (MDF). While these

sources adequately served the financing

needs of the 80's and the early 90's, they

have proven to be Inadequate In responding

to the increasing needs of the LGUs today

and In the future This IS eVidenced by the

growing popularity of non-traditional

sources offlnanclng such as Bulld-Operate­

Transfer schemes (BaTs), mUnicipal bonds,

JOint ventures, and lately, the emergence

of an LGU guarantee facility to guarantee

private commercial loans. In addition, a

private sector provincial equity fund has

been established for the first time In the

country While the private sector LGU credit

market IS gradually evolving, the Govern­

ment continues to playa key role In LGU

credit markets by providing the overall

policy framework for LGU financing and

vigorously promoting private sector parti­

cipation In LGU Infrastructure financing.

The paper discusses these tOPICS In detail,

The history of LGU financing and prOVides a directory of sources of LGU

demonstrates the need for new avenues of financing at the end of the paper.

1 Local Government Code of 1991 (Repubhc Act No 7160), SectIOn 2

Previous Pag~ Blank 3

LGU Financing Present Sources, Avmlabllzty and Terms

OB.lECTIVES

The audience of the paper IS

directed mainly to the chief

executives, planning and

development officers, treasurers, assessors

and members of the Sanggunlan Body of

the LGUs and all other local officials

Involved In financing basIc services and

Infrastructure projects of LGUs Through

o

o

proVide an assessment of the current

sources of LGU finanCing terms and

prospects;

d,scuss the constraints In LGU access

of expanded fInanCing sources,

pnmanly from the pnvate sector; and,

these individuals, the commUnities at large 0 formulate recommendatIOns to en­

In the countryside would benefit most from hance financing of LGU basIc services

the Information on the resources available

to LGUs for funding projects In their

respective communities The specific

objectives of the paper are four-fold

and Infrastructure reqUIrements,

The paper IS diVided Into four chapters'

Chapter I sets the framework and the

Government's new vIsion for LGU finanCing,

o update the LGUs on the fmanclng Chapter II descnbes the different sources

programs and polICies of major of long-term finance for LGU projects and

InstttutlOns Involved In LGU flnancmg, proVides an assessment of these sources

including the NatIonal Government and and future prospects Chapter III discusses

Its agencIes, GFls, commercIal banks, the constraints to LGU access of pnvate

multtlateral and bilateral agencies, capital markets, and Chapter IV gives the

mUnicIpal bond underwriters, and summary recommendations and

public and pnvate finanCing sources; conclUSion

PreVious Page ':IIQ'n J,. 5

LGU Financing Present Sources, Availability and Terms

Chapter I - Framework for LGU Financing

, ,

local Government Code of 1991 financial autonomy provided to LGUs, many

(lGC) innovative approaches In financing and

Implementation are now being explored by

Prior to the passage of the LGC, the the more progressive LGUs.

delivery of basIc services and other activi-

ties ofthe LGUs were financed from resour­

ces provided by the National Government

(NG) Thus, Investment plans and PriOrity

development programs were determined by

the national agencies with minimal

consultation and Involvement of the LGUs.

Development In the countryside was

essentially a national activity. This arrange­

ment and budgeting system proved to be

cumbersome and ineffiCient, and subject

to political lobbYing In Manila. The lAs,

rather than the LGUs, determined pnorlties

and plans Realizing this predicament, the

country's legislators drafted the LGC.

To ensure the effective and timely

delivery of basIc services and other

activities, the LGC decentralized the

functions of basIc service delivery,

investment planning and development, and

program formulation, consolidating most

ofthe eXisting laws and regulations covering

local government operations and

Intergovernmental relationships With

decentralized planning, local offiCials have

taken the lead In shaping the pattern of

local development, and Implementing

Priority projects and delivery of basIc

Infrastructure, health, social and

environmental services. Inspired by the

Devolution of basIc services and other

activities as provided for In the LGC IS

expected to lead to a more effective means

for addreSSing the minimum basIc needs

of the local communities. The devolved

activities Include the provIsion of mUnicipal

Infrastructure such as public markets, bus

terminals and roads, water supply and

Sanitation, solid waste management, school

construction, basIc health services, social

welfare, environmental protection and

agricultural extension. While the medium

and long-term prospects for delivering these

basIc services are bright, so far, most

devolved projects that have been or are

being Implemented by LGUs Involve public

markets, water supply and bus terminals

However, many LGUs are now developing

projects In other PriOrity areas such as

airports, land reclamation, small power

projects, and environmental projects

Legal Framework. The legal framework

for LGU financing lies In the LGC, which

provides for the sharing of LGUs In the

proceeds of national taxes, local taxation

and fiscal matters, credit financing, and

build-operate-transfer schemes These

resources and forms of financing are

described as follows

PreyfoWi Page Blank 7

LGU Financing Present Sources, AVailability and Terms

o Internal Revenue Allotments (IRAs) -

These consist of local governments'

share In the proceeds of national taxes

which constitute 40% of total national

Internal revenue taxes, with fixed

percentage allocations to LGUs:

provinces (23%); cities (23%);

municipalities (34%) and barangays

(20%), and for each LGU, on the basIs

of population (50%), land area (25%)

and equal sharing (25%),

o Local Taxation and FIscal Matters -

Local governments have been given the

authority to exerCise their power to

create their own sources of revenue,

and to levy taxes, fees, and charges

subject to specific provIsions,

consistent with the basIc policy of local

autonomy. They also have been given

more responsibility for operating the

real property tax system;

o CredIt Financmg - The LGC provides

more liberal rules for LGU borrowing

loans, credits and other forms of

indebtedness with any government or

domestic private bank and other

lending institutions, deferred payment

and other Investment schemes, bonds

and other long-term securities, Inter­

LGU loans, grants and subsidies, and

loans from foreign sources onlent by

the National Government The process

for availing of credit financing has also

been liberalized No longer are LGUs

required to seek Department of Finance

(DOF) approval before seeking bank

credit approval. Furthermore, they no

longer need Commission on Audit

(COA) certification of their borrowing

capacity prior to applYing for a loan

However, the Code sets a limit on LGU

Indebtedness "the amount of

appropriatIOn for debt servlcmg shall

not exceed 20 percent of the regular

Income of the LGU concerned" 2,

effectively putting a cap on the total

Indebtedness capacity of LGUs,

The basIc policy provides for any LGU 0 BUlld-Operate-Transfer(BOT) Schemes

to create Indebtedness, and avail of

credit facilities to finance local

Infrastructure and other SOCIO­

economic development projects In

accordance With the approved local

development plan and publiC

Investment program The policy allows

2 Local Government Code of 1991 (Republic Act No 7160), SectIOn 324 (b)

8

- The LGC also allows LGUs to enter

Into contracts for financing, construc­

tion, operation, and maintenance of

Viable Infrastructure projects under the

bUild-operate-transfer schemes as

proVided by R.A No 7718 (BOT Law).

LGU Fznancing Present Sources, Avazlabllzty and Terms

Government's New Vision and Policy The vIsion and policy framework

Framework for LGU Financing statement rests on two mam premises

Spurred by the mcreasmg need by 0

LGUs to fmance the devolved services

within the framework of the LGC, the DOF

formulated a new vision and policy

LGUs have varying levels and records

of credItworthiness and bankabillty,

and theIr financing needs are huge; and

framework for fmanclng local governments' 0 the private sector (BOT Investors,

basIc services and development projects

predicated on promoting self-reliance for

LGUs 3. The policy framework defmes the

respective roles of various players Involved

In LGU fmanclng, I.e. the NG, government

financial Institutions (GFls), private

commercial banks and fmanclal sources,

municipal bond market players, the

multilateral agencies, the Municipal

Development Fund (MDF), and BOT

proponents.

The ultimate objective IS to encourage

LGUs to rely less on transfers from the NG,

and more on locally generated resources,

and to mcrease LGU access to private

funds. In order to do thiS, the policy

framework makes recommendations on

rationalizing Official Development

Assistance (ODA), encouragmg LGUs to

raise more locally-generated funds,

enhancmg pnvate sector participation m

flnancmg LGU mfrastructure projects,

building-up project management capacity,

and promotmg LGU creditworthiness.

bondholders, commercIal banks), the

GFls and MDF all have an Important

role to play In meeting LGU financing

reqUIrements.

Taking these Into account, the

Government passed a resolution (the

Investment Coordination Committee or ICC

resolutlon 4) that governs national

government grants, I e that these grants

will be given selectively on the baSIS of

equity, externalities, and economies of

scale

In addition, the Government is puttmg

m place a program to rationalize lendmg of

GFls to LGUs as well as ODA assistance.

The program IS premised on re-focuslng GFI

and ODA lendmgto less-creditworthy LGUs

with limited access to pnvate sources of

financing, and to finance SOCial and

environmental projects. Finally, the

Government IS actively pursuing a program

to expand LGU access to private capital

markets to complement the traditional

3 LGU Financmg of BasIc ServIces and Infrastructure Projects, A New VISIOn and Policy Framework, Department of Fmance, October 1996

4 The ICC resolutIOn prOVIdes NatIOnal Government (NG) support III the form of matching, speCIfic and close-ended grants for LGU devolved

actlvltles WIth SOCtal and/or envIronmental obJectlves III four sectors water supply, health, envIronment and ru~al Illfrastructure (rural roads, communal lITIgatIOn, public markets and slaughterhouse) The grants are gIven to LGUs on a matchmg baSIS by Illcome class and type of devolved aCtlvlty, e.g. for watershed protectIOn or mumclpal fishery management, 4th - 6th class LGUs WIll receIVe NG grants on a 70 30 shanng baSIS

9

LGU Financing Present Sources, AvailabilIty and Terms

sources of LGU financing. The program

Includes the following specific courses of

action·

a. Increase LGUs' use of BOT - like

arrangements and other forms of

private sector participation. BOT

arrangements provide unique

advantages to LGUs which are not

found In other sources of financing.

Among these are little or no initial

Investment requirements; proper risk

allocation where the financing, design

and construction risks are borne by the

private sector; transfer of technology;

effiCiency In operations and financing

of capital requirements through the

long-term concession agreement.

Other forms of privatization (page 36)

are also being promoted by the

Government

b. Develop the LGU municipal bond

market. The Government has

recognized the potential of one

untapped finanCial source - the

muniCipal bond market. Thus, the

Government IS keen on developing,

through the private sector, a credit

rating system for LGUs to support an

LGU muniCipal bond market, and

supporting the credit guarantee

corporation being spearheaded by the

Development Bank of the Philippines

and the Bankers Association of the

Philippines which would provide

guarantees to muniCipal bonds and

commercial credit Instruments

c. Promote LGU access to private

sources. The Government considers

LGU access to private sources of

financing as a key measure In

sustaining long-term economic growth

In the countryside One Issue raised

by pnvate sources IS the lack of a

business relationship between

commercial sources offlnance and the

LGUs due to the eOA ruling on LGU

deposlts5 . To address thiS, two market­

based measures are being explored by

the Government to Improve access to

private sources: (I) liberalizing the LGU

depOSitory bank regulations to explicitly

allow LGUs to establish depOSitory

banking relationships with Bangko

Sentral ng Pillplnas (BSP)-accredlted

private banks, and (II) extending the IRA

Intercept mechanism (allOWing GFls to

hold LGUs' I RAs against debt service

obligations) to Include accredited

private banks.

d. Optimize the involvement of GFls in

LGU financing. Although GFls'

Involvement In LGU finanCing IS

extensive, some measures can be

undertaken to further optimize the GFls

Involvement such as (I) adopting a

graduation scheme to move the more

creditworthy LGUs to the pnvate credit

markets; (II) developing co-financing

5 COA CIrcular 92 mstructs LGUs to open and mamtam depOSItory accounts wIth banks "preferably government-owned" located m or nearest

to thelr respectIve areas of JunsdIctIOn

10

LGU Financing' Present Sources, Avallabiltty and Terms

schemes with private commercial

banks; (III) Improving LGU credit­

worthiness through technical assIs­

tance; (IV) coordinating GFI LGU credit

programs with the MuniCipal

Development Fund (MDF). and (v) g

structuring ODA- sourced lending

programs for non-revenue generating

SOCial projects or for revenue

generating but long-gestating projects

and (IV) proposing amendments to the

LGC to strengthen local treasury

operations and prOViding incentives for

greater local revenue mobilization

e. Restructure and reorient the MOE

As a disbursement mechanism for

ODA-supported loans and grants

administered by the Bureau of Local

Government Finance under the DOF,

the MDF's role can be enhanced to

Implement an LGU graduation policy,

I.e. graduating more creditworthy LGUs

from concesslonal MDF funds toward

GFls or the private sector, and helping

LGUs build a track record of

creditworthiness.

Tap ODA technical assistance and

financing. ODA financing plays a key

role In the Implementation of economic

development programs of LGUs.

Closer coordination between the

donors and the concerned government

agencies and LGUs will faCIlitate the

flow of funds to the LGUs. The

Government IS contemplating ways of

uSing ODA funds to Increase the

partnership with the private sector, and

to target ODA funds so that creditworthy

LGUs are encouraged to tap

commercial sources of funds, and

financial and managerial capacity is

gradually bUilt-up In the less

creditworthy LGUs.

f Improve the capacity of LGUs to

raise their own rev~nues. The

Government recognizes that an

Important factor In enhancing LGU

The Government IS vigorously pursuing

the Implementation of these actions and

recommendations to ensure access of

LGUs to a Wider range offinanclng sources,

and to develop LGU capability for

creditworthiness IS to Increase the Implementing Priority Infrastructure

capacity and Willingness of LGUs to projects.

raise local revenues. Steps are being

taken by the Government to achieve

thiS objective, including: (I) Improving

the mOnitoring of LGU revenues and

expenditures; (il) IntensifYing the

training and supervIsion of local

finance offiCials; (IIi) reviewing real

property taxation rules and procedures,

11

With regard to National Government

guarantees, the Government's poliCY IS

clear toward risk management and

guarantee provIsions for projects

undertaken by LGUs In cooperation with the

private sector Consistent with ItS vIsion

and poliCY framework to wean away the

LGU Fmancmg Present Sources. AVa/labllity and Terms

LGUs from dependence on the National

Government and to support the principle

of devolution espoused by the Local

Government Code, the National

Government IS advocating a proper

unbundling of risk and appropnate nsk­

sharing between the pnvate sector and the

LGUs concerned. For example, In the water

sector, It IS advocating to limit concesslonal

funding and National Government

resources to those smaller I marginal water

dlstncts which are unable to attract pnvate

Investors, but which will eventually graduate

to creditworthy status sometime In the

future. Water dlstncts which are able to

attract pnvate sector investments, would

be directed to tap the private credit market,

the GFls and the pnvate sector for financing

dlstnbutlon system Improvements and bulk

water supply. Advocating the pnnclples of

project finance, the Government believes

that projects with strong private sector

Interest should rely on project cash flows

and project-related credit enhancements

(e.g. escrow accounts, assignment of

receivables and "step-in" nghts) to proVide

comfort to ItS Investors.

12

LGU Fmancing Present Sources, Availability and Terms

Chapter II - Current Sources and Assessment of LGU Financing

The passage of the 1991 Local sources of financing. The current sources

Government Code signaled the emergence of LGU Financing are shown In Chart A

of a new market for credit financing - the

LGUs No longer confined to sourcing their Internal Revenue Allotments (IRA)

requirements from the GFls and the

MUnicipal Development Fund, which over

the years, has been the LGUs' major source

of long-term credit finance, the LGUs have

taken a keen Interest In tapping vanous

other sources of financing to meet their

financial requirements. The Code allows

the LGUs to directly Incur Indebtedness on

their own account without pnor clearance

from the National Government Thus, LGUs

have floated their own bonds, entered Into

BOT contracts and JOint ventures, and

signed lease agreements with private

Chart A. LGU Financing Options

'--_--' G

13

As a result of devolution, the main

source of LGU finances has been the IRA,

the share of LGUs In the national taxes. In

1996, over P56 billion was transferred to

the LGUs as their share of the national

taxes Over the years, the share of IRA as

a percentage of total LGU revenues

(combined for prOVinces, cities and

municipalities) has been increasing as

shown In Chart B.

In 1991, the percentage of IRA to total

revenues was only 40.7%, gradually nSlng

to 61.9% In 1993, and 61 4% In 1995,

Signaling the LGUs' reliance on the IRA to

fund ItS expenditures However, the

situation has reversed as of late. In 1996,

the share of IRA to total revenues has fallen

to 53.8%, slgnrfylng that LGUs have started

to mobilize financing from other sources

(local resource mobilization and loans). The

annual percentage of IRA to total Income

for the penod 1991-1996 IS shown In Annex

1. If this trend continues, LGUs will, In

future, rely less on the National Government

for financing basIc services and

Infrastructure requirements and more on

other sources of flnancln!5 However, the

LGU Financing Present Sources. AVailability and Terms

Chart B.

Source

Note

Chart C.

IRA as Percentage of Total LGU Revenues (%)

55.9 61.9 61.2 61.4

1991 1992 1993 1994 1995 1996

Bureau of Local Government Fmance (OOF)

Barangay data are not mcluded m the chart

53.8

IRA allocation formula continues to favor

large highly urbanized LGUs For example,

the City of Makatl, which IS finanCially self­

suffiCient, continues to receive substantial

amounts of IRA. Another city In Metro

Manila was able to borrow more than P1.5

billion last year from a GFI while stili

receiVing substantial IRA Many LGUs, on

Local Resources as Percent of Total LGU Revenues (%)

1991 1992 1993 1994 1995 1996

Source:

Note

Bureau of Local Government Fmance (OOF).

Barangay data are not Included m the chart

the other hand, which have limited access

to private resources, receive much less IRA

than these cities. The other Issue with

regard to the IRA formula IS the lack of

incentives for LGUs to generate more local

resources as the formula IS based on

population, land area and equal shanng

Therefore, there has been clamor from

some LGUs for the Government to review

the IRA allocation formula to promote equity

and effiCiency

Local Resource Mobilization

LGUs' local resource mobilization

followed a pattern consistent with that of

the IRA. As shown In Chart C, the LGUs'

local resources In 1991 were about 56.1%

of theIr total Income. The succeeding years

witnessed a gradual decline In the

percentage share of local resources to

36.9% In 1993 and In 1995 Among the

reasons for the decline are the Increases

In IRA allocations and the decline In

revenues from low tax assessments. In a

preliminary study conducted by the World

Bank6, the paper concluded that many large

cities and small towns rely substantially on

non-tax revenues and IRA allocations for

sourcing revenues, and that tax

assessments and business tax compliance

appear to be extremely low. However, the

analYSIS shows that there IS ample

opportunity for LGUs to greatly Improve

financial performance. In fact, the LGUs'

revenue generating performance In 1996

6 LGU Urban Water and SamtatIons Project PreparatIOn MISSIon, World Bank Alde-MemOlre, June 1997

14

LGU Financzng' Present Sources, AVallabzlity and Terms

bears this observation, where LGUs' own

resources as a percentage of total

resources made a dramatic Improvement

to 45 3% from 36 8% the year before. The

annual percentage of locally generated

funds to total LGU Income by type of LGU

IS shown In Annex 2.

considering plans for expanding Into direct

LGU financing.

Private sources consist of financing

provided by the commercial banks

[primarily by the Philippine National Bank

(PNB) which was a GFI until recently

privatized], and mUniCipal bond flotations,

In general, many mUniCipalities also which so far has been In the hOUSing sector

tend to horde surpluses In cash, foregOing but IS now geared to prOVide funding for

the opportunity to leverage funds Into other LGU Infrastructure projects.

higher yielding Investments Furthermore,

Increases In local revenues through more Public Sources of Debt Financing effiCient taxation could prOVide the

necessary resources for LGUs to make Government Financial Institutions

worthwhile Investments In baSIC services (GFls)

such as water and sanitation, health,

education and rural Infrastructure. Thus, Background. Traditionally, the LGUs

opportunities are there for LGUs to expand have turned to the GFls for their short to

their local resource base and benefit from intermediate credit finance requirements

leveraging eXisting resources. GFI lending served the LGUs well until the

mld-1980s, when many LGUs began to

Debt Financing

Apart from IRAs and local revenues,

LGUs have availed of debt finanCing to

finance their capital requirements. Debt

finanCing for LGU projects come from two

main sources

o publiC sources; and,

o private sources

Public sources of debt finanCing

continue to come primarily from the GFls,

I e. the Land Bank of the Philippines (LBP)

and the Development Bank of the

default on their obligations due to the severe

economic slump resulting from the political

uncertainty In the country. Despite the IRA

Intercept mechanism, unpaid obligations to

the GFls rose to as much as P2 1 billion In

1985, which led to the cessation of lending

by GFls to the LGUs. As a result, the

National Government had to carry out a

debt relief program for the LGUs. Since

then, however, With the Increase In IRA

allocations and better fiscal management,

the repayment track record of LGUs has

Improved, allOWing GFls to resume lending

to LGUs.

Philippines (DBP) However, pension funds, To carry out the government's mandate

notably the Government Service Insurance to promote sustainable development In the

System, and the Social Security System are countryside, and encouraged by the

15

LGU FInancing Present Sources, Availability and Terms

Chart D.

8000

7000

6000

5000

4000

3000

2000

1000

decentralization and the greater autonomy

accorded the LGUs, the GFls established

loan funds specifically targeted to LGU

lending The Land Bank of the Philippines'

LGU financing program was In place from

the time of establishment of the Bank In

1963 To date, It has lent over Pll.6 billion

In the country with total resources of some

P134 billion, has been lending actively to

LGUs over the years It has a social mission

of promoting countryside development and

has been a major contributor to rural credit

delivery in the Philippines Though LBP's

main portfolio of loans IS In the agrarian

to LGUs. The Development Bank of the sector, It has a very active LGU finanCing

Philippines established its Countryside

Lending (Window III) to extend loans

exclusively to countryside projects. Two

other government agencies, the Social

Security System (SSS) and the Government

Service Insurance System (GSIS) were also

active, but did not finance capital or

Infrastructure projects The SSS targeted

livelihood and hOUSing projects, while the

GSIS proVided Insurance coverage for LGU

Investments as well as hOUSing loans for

government service personnel

Land Bank ofthe Philippines. Created

In 1963, the Land Bank of the Philippines

(LBP), one of the top five universal banks

Land Bank LGU Financing Portfolio as of March 1997 In Peso Millions

16

program consistent With ItS mission.

Foremost In LBP's LGU finanCing program

IS ItS "Total Development Options - Unified

Land Bank Approach to Development or

TODO-UNLAD program." The program

offers a comprehenSive package of loans

that links farmers' cooperatives, private

companies, rural banks, non-governmental

institutions and LGUs around an Income

generating project In a speCifiC area

The Land Bank's LGU program has

financed projects In various sectors

amounting to over Pll 6 billion as of March

1997, primarily In Infrastructure, bus

terminals, public markets, telecommu­

niCations, hOUSing, water systems, road

construction and traffiC systems Chart D

shows the distribution of the LGU portfoliO

of Land Bank.

The chart indicates that majority of

Land Bank lending to LGUs has been

directed to Infrastructure finanCing (61%).

These projects Included Integrated

development projects In Metro Manila and

Metro Cebu consisting of roads,

reclamation, ports, schools, mUniCipal and

commercial bUildings, etc. The next major

exposure of Land Bank was In heavy

machinery (15%), which are used by LGUs

In carrYing out their development and

LGU Fznancing Present Sources, Avazlabilzty and Terms

Infrastructure projects Lending to Land Bank assistance. Eligible loans

construction projects amounted to 7% and

the rest were for sport complexes, public

markets, bus terminals and others Annex

3 shows the geographical distribution of

Land Bank's LGU lending To assist Land

Bank In making their Investment deCISions,

It has developed a creditworthiness ranking

system for LGUs. This system claSSifies

LGUs Into four credit categories:

LGU Number of

Classification LGUs

Prime 41 J (17.4%) High Grade 252

Medium Grade 666 (395%)

Low Grade 726 (431%)

Total 1685 (100.0%)

Land Bank utilizes a set of criteria for

ItS LGU credit rating system, including

financial capability, socio-economlc profile,

political stability and the technical,

economic and financial Viability of the

proposed project. As shown In the above

table, about 17% of LGUs are classified by

the LBP as prime clients and high grade,

while 40% are claSSified as medium grade.

Land Bank's lending policy IS limited to

LGUs With a medium-grade or higher

claSSification

Terms of Credit. As mentioned In the

prevIous paragraph, Land Bank lends to

proVinces, cities and municipalities that are

rated medium-grade or higher. USing thiS

criterion, some 960 LGUs are eligible for

finance local Infrastructure and other SOCIO­

economic development projects under

LGUs' local development plans. The

maximum loan amount IS based on the

reqUirement of the project but does not

exceed the "Net BorrOWing Capacity"

calculated for LGUs as defined In the Local

Government Code. LGUs tYPically will

contribute 25% of the total project cost; the

terms of the loan will not exceed 5 years

and the maximum grace period on principal

IS two years. Interest rate charged IS the

prevailing market rate. Collateral

requirements can Include a holdout on LGU

depOSits; real estate property, machinery

and equipment and a deed of assignment

on IRA, regular taxes or net Income. The

LGU lending program requirements and

procedures of Land Bank are reproduced

In Annex 4.

Development Bank of the Philippines

(DBP). The Development Bank of the Philip­

pines has been lending to LGUs since its

inception The centerpiece of DBP's coun­

trYSide assistance strategy IS ItS Window III

program which assists activities that

facilitate the delivery of baSIC services that

enhance the quality of life of Filipinos, parti­

cularly those of the disadvantaged groups

In the rural areas. To fulfill ItS commitment

to countryside development, DBP sets aSide

30% of ItS annual net after-tax Income for

ItS Window III program As of the end of

March 1997, a total of 1,517 loans had been

approved under the Program and total loan

releases amounted to P3.4 blillon7 •

7 Although DBP's Wmdow III aSSIsts projects m the countrysIde, only about 15% IS actually lent to LGUs

17

LGU Financing Present Sources, Availabllily'and Terms

Some of the LGU projects supported

by the DBP Include:

0 Expanded Public Transportation

Boundary Hulog Program

0 Schools and Hospitals Financing

0 Rural Electnc Cooperatives Special

Program

0 Damayan sa Pamumuhunan

Program

U Cattle Financing Program

0 Flshenes Sector Financing Program 0 LGU Financing Program

Compared to loans extended to coun­

tryside projects, DBP's direct loans to LGUs

have been fairly limited. As of March 1997,

It has financed some 20 projects amoun­

ting to P395 million as shown In Chart E.

Majonty of DBP's LGU assistance were

for projects Involving heavy equipment or

Chart E. Development Bank of the Philippines LGU Financing Portfolio As of March 1997 In Peso Millions

18

for construction projects amounting to

P85.0 million (21.5%). Next to these are

public market projects amountingto P54 3

million (138%) The DBP also lent for a

diagnostic center (P58 0 million), a major

resettlement project of P50.0 million and

water supply systems costing P45 5 million

(11.5%). The LGU lending program

requirements and procedures of the DBP

are reproduced In Annex 5.

Assessment of GFI Lending

Current Volume and Prospects for

Growth. The portfolio of loans granted to

LGUs between the DBP and the LBP as of

March 1997 amounted to some P12 0

billion, majonty of which was lent by the

Land Bank GFls remain the major source

of credit finance for LGUs Furthermore,

the LGU programs remain a profitable

portfolio for GFls and current recovery rates,

as well as prospects for longer-term

profitability, are good. LGUs have begun to

pursue new Investments In Infrastructure

as the economic development In the

countryside has started to take root The

DBP, In particular, IS a major force behind

the establishment of the LGU Guarantee

Corporation (discussed later In the paper),

which Will enhance commercial lending to

LGUs. The Land Bank, for ItS part,

continues to be a major source of financing

for LGU projects. Because of the presence

of GFI branches In most localities In the

countryside, GFls have established close

relationships with LGUs. Thus, GFI lending

to LGUs IS expected to expand dramatically

LGU Fmancing' Present Sources, Avmlablhty and Terms

over the next couple of years, because of

the market niche It has established.

Loan Distribution and Terms. The

GFls have lent to all classes of

municipalities. Geographically, the

distribution is skewed towards Luzon and

In particular the National Capital Region

(NCR) with over 50% of total LGU lending

because ofthe concentration of commerce

and Industry. The terms of lending ranges

from 3 years to 5 years (In some cases, up

to 7 years) which IS stili short to medlum­

term 8. ThiS IS a major constraint to

Infrastructure project finanCing as the

gestation period of many Infrastructure

projects IS longer In the case of BOT

projects, the concession period goes

beyond (up to 25 years), although cash flow

recovery may be for a much shorter period.

In thiS case, the GFI loans, If availed, Will

need to be re-flnanced or rolled over at the

time the loan repayment IS due

The GFls at the moment are not

Inclined to lend beyond seven years until

such time as the repayment track record

of LGUs IS fully established or once credit

enhancements are In place. One way of

accomplishing thiS IS the establishment of

an LGU credit rating system, which Will

mOnitor, among others, the repayment

capability of LGUs The Government IS

currently pursuing the establishment of an

LGU credit rating agency. As far as the cost

of borroWing IS concerned, market Interest

rates Will continue to favor the more credit-

worthy LGUs (first to third class mUniCipa­

lities). Fourth and fifth class mUniCipalities

Will have to access the more concessionary

terms of the MUniCipal Development Fund

discussed In succeeding paragraphs.

Sector Coverage. For the time being,

the sectoral focus of GFI lending (In terms

of number of projects) continues to be the

small-scale, traditional projects such as

publiC markets, heavy eqUipment/machi­

nery, bus terminals, small waterworks

systems, and others. However, Land Bank

has lent to major Infrastructure projects In

the NCR and In the Vlsayas. As GFls

become more and more comfortable

lending to LGUs, we should expect other

sectors to benefit from GFI lending and the

size of projects to Increase. These sectors

Include transportation, airports, solid waste

management and bigger waterworks

systems or bulk water supply from the

private sector Collateral and loan security

Will continue to figure prominently In LGU

lending and assignment of IRA Will be the

main form of security. However With the

advent of BOT schemes and as more LGUs

and GFls alike become familiar With project

finance, It IS expected that cash flows from

revenue-generating projects Will be the

main criterion for extending GFI loans.

Official Development Assistance

(ODA)

Another major source of public debt

finanCing for LGUs IS OffiCial Development

8 The DBP however, has a limIted loan program for LGUs under Its Wmdow III program that can extend terms up to 12 years

19

LGU Financing Present Sources. AVallabllity and Terms

Assistance (ODA) from multilateral financial

institutions such as the World Bank and

the ASian Development Bank (ADB) which

are channeled through the MUnicipal

Development Fund (MDF). In addition,

there IS also loan funding available through

financial Intermedlanes and counterpart

agencies, and from Bilateral Fmanclal

Agencies such as the Overseas Economic

Cooperation Fund (OECF) of Japan.

Board chaired by the DOF with three other

Government agencies as members, I e. the

National Economic and Development

Authority (NEDA), the Department of Interior

and Local Government (DILG) and the

Department of Budget and Management

(DBM). The MDF consists of two major

units, the Financial Unit, headed by the

Executive Director of the BLGF and the

Central Projects Office (CPO), the project

Implementation Unit for each project located

Municipal Development Fund (MDF) In participating agencies In the MDF ASide

from providing loans, the MDF also

Multilateral lending sources for LGU proVides technical assistance to LGUs for

projects have pnnclpally come from three project Identification and feasibility studies

main sources, the World Bank, the ASian and for other projects such as the Real

Development Bank and the Overseas Property Tax Administration Project, which

Economic Cooperation Fund of Japan aSSisted more than 800 LGUs In Improving

(OECF). The funds have been channeled their real property tax collection

through the MDF, a revolVing fund created

by a Presidential Decree in March 1984 to

consolidate the fragmented and

uncoordinated borrowing and grant system

to the LGUs The MDF is administered by

the Bureau of Local Government Finance

(BLGF) under the DOF Before the creation

of the M OF, the donor agencies reqUired a

central agency for monitonng the foreign

loans and grants With the establishment

of the MDF, a separate monitoring agency

was no longer needed, and thus, the MDF

became the condUit for foreign loans and

grants The MDF also played the role of a

monltonng unit and project accounting

support for foreign funds directed to the

LGUs.

Organization. The MDF operates

under the direction of a Policy Governing

20

Lending Operations. The MDF was

created as a revolVing fund and made

available to LGUs In undertaking their SOCIO-

economic development programs. It was

active in prOViding loans to LGUs In the

1980s when the GFls stopped lending to

the LGUs on account of mounting

uncollectible accounts Dunng thiS time,

the MDF channeled some P79 billion of

long-term finance to LGUs. LGU projects

that have benefited from assistance from

the MDF Include'

0 public markets

0 heavy eqUipment and machinery

0 bus terminals

0 sla ughterhouses

0 drainage and waterworks

0 roads

LGU Financzng Present Sources, Avaziability and Terms

o solid waste

o telephone systems

o health centers

At present, nine loans have been

provided by the World Bank, ADB, OECF

and Eximbank of Korea through the MDF

as shown In Annex 6.

Total loans extended under the nine

projects for all regions amounts to $290

million (PIO.7 billion at current exchange

guarantees the loan repayment. ASide

from providing loans, the MDF can also

provide a package of a loan and a grant,

which effectively lowers the LGUs'

borroWing costs. The loan component

carries the terms and conditions set by the

lender through the MDF Because of the

liberal terms of the MDF, particularly the

long-term prinCipal repayment feature, the

MDF has been extremely attractive to LGUs

Funding Limitation. At the moment,

rates) The greater access by higher MDF funding to the LGUs IS experiencing

Income LGUs to the MDF credit facility can constraints for several reasons:

be attributed to the requirement of financial

capacity and the ability ofthe LGU to repay 0 the Increased demand for MDF credits

the loans Other criteria also favor the

higher Income LGUs, such as urban

population minimum reqUirements and

annual population growth rates, annual

Income and equity requirements, and

by other developing countnes;

o funding limitations of the multilateral

institutions that support the MDF;

commitment to establish a separate project 0 constraints Imposed by the government

office With full-time staff With thiS In mind, budgetary process, and

and considering that the higher Income

LGUs have access to other sources of

funding, the Government, In Implementing

ItS new vIsion for LGU finanCing, IS

diSCUSSing With the multilateral finanCing

agencies, re-focuslng MDF assistance

toward less creditworthy LGUs.

Terms of Credit. The MDF IS, at

present, the only source of credit finance

that IS offering long-term finanCing With a

maturity penod of 15-25 years The Interest

rate IS currently set at 2 percent above the

weighted average Interest rate of 61-90 day

domestic time depOSits. No collateral IS

required since the IRA intercept mechanism

21

o Increasingly limited eligibility for MDF

assistance to the Philippines due to the

Increased economic development of

the country.

First, the worldwide demand for MDF

assistance and the Increase In

requirements by other less-developed

countries In the world has constrained the

availability of funds to meet the Increased

demand for MDF~funds from the

Philippines. The multilateral agencies, In

the pursuit of poverty alleViation objectives,

are shifting attention to poorer regions of

the world such as Africa. Second, the

LGU Financing' Present Sources, AVailability and Terms

multilateral mstltutlons that support the

MDF are expenencmg fundmg limitations

themselves and are encouragmg LGUs to

tap private sources of financing for

development assistance worldWide. Third,

the MDF's present lending capacity IS

constramed by the budgetary process of

the Government Each department of the

national government observes a budgetary

ceiling Imposed by Congress and the

Development Budget Coordinating

Government for LGU fmanclng, the MDF IS

bemg re-onented to be a more effective

Instrument In lending to lower class

municipalities, which have limited access

to pnvate sources of capital Reform of the

MDF IS bemg undertaken with World Bank

assistance. Because of the favorable terms

of MDF lendmg, the MDF IS expected to

continue to be attractive to LGUs for

fmancmg basIc services and mfrastructure

Committee. In practice, the budget Bilateral Sources of Debt Financing

submissions of the National Government

departments, which mclude budgetary

requests for MDF counterpart funds, are

subject to the ceilmg Fmally, as the

Philippine economy progresses, ItS

eligibility for mcreased MDF assistance IS

adversely affected, as one of the principal

cnterla for MDF assistance IS the economic

standing of the recIpient country

Assessment

Prospects for Growth. The MDF

continues to be a major source of

concessionary credit finance for LGUs

Smce ItS first loan (MUnicipal Development

Project I of the World Bank), the MDF has

been actively contnbutmg to the economic

development of LGUs by provldmg long­

term fmanclng for LGU projects. It IS the

Another source of flnancmg for LGU

projects IS proVided by bilateral agencies

such as the Overseas Economic

Cooperation Fund of Japan (OECF) which

channels funds to national Implementmg

agencies for national projects In addition

to ItS assistance to agnculture and transport

projects at the local level, the OECF has

been active m proViding concessionary long­

term lendmg to Water Dlstncts (WDs) all

over the country through the Local Water

Utilities Administration (LWUA) as described

m Box A. Although the WDs are stnctly not

a part of the LGUs (although ItS Board

members are appomted by the LGU chief

executive), they proVide basIc water services

to LGUs by constructmg, operating and

mamtammg the water systems of LGUs.

long-term feature of MDF loans and the Private Sources of Debt Financing

concessionary rate that has attracted the

LGUs Lately, however, some LGUs have Before the passage of the LGC, pnvate

vOiced concern regarding the long fmancmgfor LGU projects has been virtually

processmg time of MDF loans Therefore, non-existent as the LGU credit market was

steps need to be taken to streamline the dominated by the traditional "offiCial"

approval process. At the same time, sources offmancmg, I e the GFls and ODA

consistent With the new Vision of the However, smce then, pnvate fmanclng has

22

LGU Financing' Present Sources, AVailability and Terms

Box A

Local Water Utilities Administration (LWUA)

In order to promote, develop and finance local water utili­ties, optimIze public service water operations, and facIlitate the Improvement of local water servIces, the Local Water UtilitIes AdministratIOn (LWUA) was created m September 1972 under the Provincial Water Utilities Act. The LWUA is a specialized lending institution, which provides financing to water districts for water supply development, expansion and improvement. L WUA has evolved to be primarily a financmg agency wIth the following functions: .

• provide loans to quahfied local water utlhtles for theIr capi­tal expenditure programs;

• establish standards for local water utIlities such as water quahty, design and construction of new or addItional fa­cilities for water supply, treatment, transmission and dIS­tribution, and for wastewater collection, treatment and dis­posal;

• furnish technical assIstance and personnel traming pro­grams for local water utilities;

• effect systems integratIOn, joint investments, water district annexatIOn and de-annexatIOn.

L WUA has, over the years, on-lent funds from ODA sources at concessionary rates. As of February 1998, L WUA has given loans of about P12.3 billion to 462 water districts. LWUA has also extended loans to rural waterworks and sanitation associa­tions, whIch are non-stock, non-profit cooperative associatIOns, and franchised to operate rural water supply systems in remote areas where access to a water district is dIfficult. Many water distrIcts have benefited from low-interest, long-term loans of up to twenty-five years with ample grace periods. However, be­cause of funding source constramts from its Donor agencies, L WUA has not been able to accommodate fundmg requests from all the water districts. As a result, some water districts (Bulacan, Metro Cebu, Puerto Princesa and Batangas CIty) have turned to alternative sources of financing such as BOT schemes and jomt ventures.

23

began to gain a foothold In the LGU credit

market as a result of the expanded

borrowing powers under the LGC, and as

the resource requirements of the LGUs

grew, creating a new, untapped market

With these developments, the LGU credit

market has opened up vast financing

opportunities for the private sector. For the

first time, the LGUs have a variety of private

funding sources for their projects. These

Include commercial bank lending which IS

expected to materialize with the creation

of a guarantee faCility, lending from the

Philippine National Bank, now clasSified as

a private commercial bank, and mUniCipal

bond flotations With adequate credit

enhancements these funding sources are

expected to fill a major gap In LGU

financing. These sources are discussed In

the follOWing paragraphs

Private Commercial Banks

Commercial Banks' Lack of

Interest in LGU Financing. In the past

and to some extent the present, there was

little Interest by the private banks In LGU

financing There were vanous reasons

including:

o the lack of expenence In dealing with

LGUs. Traditionally, private commercial

banks served pnvate corporate clients

who formed part of their deposit base.

The relationship resulted In a regular

exchange of information regarding

projects and the banks were able to

periodically assess the continued

finanCial viability of the clients'

business With the absence of a

LGU Financing' Present Sources, Avallabllzty and Terms

Chart F.

6000

4000

2000

0

~ ~.~ '" " ~ C' :t:<'l

banking relationship, the commercial

banks had little Incentive to lend to

LGUs;

o the dearth of information about the

creditworthiness of LGUs. An LGU

credit rating agency IS yet to be

established which could provide

Information on the credit-worthiness of

LGUs which IS one of the basIc

requirements of commercial lenders;

o the short-term orientation of most

commercial banks' lending policies.

Commercial bank loans are mostly

short-term (letters of credit, export

credits, working capital loans) which

do not suitthe long-term nature of LGU

Infrastructure projects,

poses unnecessarily high risks because

of the political succession Issue

However, one commercial bank

(previously a GFI) that has been very active

in lending to the LGUs IS the Philippine

National Bank.

Philippine National Bank (PNB).

Consistent With ItS mission of achieving an

"endUring Involvement In SOCIO-CIVIC

endeavors that uplift the quality of life", the

PNB IS among the largest, most active

institutions lending to LGUs Until recently

a GFI, PNB, which was privatized In May

1996, has total resources amounting to

P197 billion as ofthe end of 1996 Its loans

to LGUs have reached Pll 4 billion as of

end-March 1997 for 225 different projects

(See Chart F).

o the high transaction cost of lending to

LGUs, and The types of projects that were lent to

LGUs Include Income-generating and cost­

o the perception that lending to LGUs saving projects such as commercial

centers, public markets, transport Philippine National Bank LGU Financing Portfolio As of March 1997 In Peso Millions

~ ~ • ~ :E~ .

5 . .f~ ""

;S

= 0

".

'"

P 1460M

24

terminals, slaughterhouses, power

generators, water systems, construction

projects and acquIsition of heavy

eqUipment Other projects supported by

PNB lending Include telecommunications

facIlities, grains procurement, and post­

harvest facilities. As shown In Chart G,

lending to the NCR accounted for 56% of

the total amount (P6 3 billion) Luzon

projects accounted for 26% (P3 0 billion),

Vlsayas, 10% (Pl.l billion), and the rest was

for Mindanao, 8% (PO 8 billion). On a per

project basIs, Luzon projects averaged

P3l.0 million per project, Mindanao, P22.2

million and the Vlsayas at P20.6 million per

Chart G.

LGU FmancIng' Present Sources, AVailability and Terms

project Majority of the loans lent to LGUs

were for heavy eqUipment, Infrastructure

and publiC markets Annex 7 'shows the

geographical distribution of PNB's LGU

lending.

term If Justified. The Interest rate IS pnme

rate-based subject to periodic Interest

resetting. Collateral requirements can

Include the assignment of applicable

regular Income of the LGU, IRA share and

the revenues generated by the project

Terms of Credit. Eligible loans for financed. Other collateral can Include the

PNB finanCing under ItS LGU finanCing chattel mortgage of eqUipmentflnanced by

program Include those which finance the the loan and real estate mortgage on

establishment, development or expansion patrimonial property of LGUs. The LGU

of income-generating projects. Other lending program requirements and

projects that qualify Include Irrigation, procedures of the PNB are reproduced In

construction of municipal halls, sports Annex 8

complex, medical diagnostic eqUipment,

road construction, hospitals and school Prospects for Commercial Bank

buildings. Lending to LGUs. Recently, commercial

banks' attitude toward LGU finanCing has

undergone a transformation. Indications

Philippine National Bank LGU Lending as of March 1997

Mindanao - 8%

The maximum loanable amount can

from commercial banks are that a shift In

attitude towards LGU lending IS In the offing.

Some commercial banks now recognize

that LGUs represent a potential market for

credit lending because ofthe large finanCing

requirements of LGUs associated With the

devolutIOn of baSIC services and

Infrastructure requirements Other reasons

for the attractiveness of LGUs as a growing

market for commercial lending are.

o the Increase In LGUs' share of the

national wealth;

be as much as 100% of the project 0 presence of a legal framework for LGU

requirements but Will not exceed the

aggregate of five times the sum of the 20%

portion of the annual regular Income and

the IRA share of the LGU The term of the

loan IS generally up to 7 years, but the

finanCing;

o flexibility and expanded borrOWing

powers of LGUs under the LGC,

Board of Directors may consider a longer 0 increasing finanCial sophistication of

25

LGU Fznancing Present Sources, AVailability and Terms

some LGUs (some provinces are regulations of the Bangko Sentral ng

exploring private foreign financial Plilplnas (BSP) and the Securities and

Instruments), and Exchange Commission (SEC), to "Issue

bonds, debentures, secuntles, collateral,

o the growing market opportunity In notes and other obligatIOns to finance self­

financing LGU Infrastructure requlre- liqUidating, income-producing development

ments (some P20 billion are In the or livelihood projects pursuant to the

project pipeline of LGU BOT Projects). pnontles established In the approved local

Commercial lending to LGUs will also

get a boost from the establishment of the

LGU Guarantee Corporation, which will gua­

rantee commercial loans to LGUs. In the

past, the lack of a guarantee faCility was a

major factor that inhibited commercial

lending to LGUs as commercial banks were

concerned with the certainty of repayment.

As the guarantee faCIlity will prOVide the

repayment "comfort" to commercial banks,

It IS expected that private commercial

lending to LGUs Will finally develop.

Municipal Bond Flotations

Municipal bond flotation IS another

pnvate source of debt finanCing that IS gene­

rating a lot of Interestfrom LGUs. MUniCipal

bonds represent an additional source of

finanCing for LGUs, which hitherto had not

been tapped. To date, SIX LGU bond flota­

tions have been successfully floated, the

first one In Infrastructure development

(Cebu equity bonds), and the rest In

hOUSing

Legal Framework for Bond

Flotations. The 1991 Local Government

Code allows, subject to the rules and

9 Local Government Code of 1991 (Republic Act No 7160), SectIOn 299

26

development plan or the public Investment

program"9. ProVinces, cities and

mUniCipalities are authOrized under the

LGC to Issue mUniCipal bonds under two

conditions: (I) the obligation should finance

self-liqUidating, Income prodUCing

development or livelihood projects; and (II)

the projects to be financed must be In

accordance With pnontles established In the

approved local development plan or the

public Investment program.

Thus, at the moment, LGUs cannot

utilize a bond flotation for recurrent

obligations or general obligations of LGUs

and other non-revenue earning expen­

ditures such as the construction of a City

or muniCipal hall or payment of staff

salaries. In addition, the LGU concerned

IS obligated to formally adopt a public

Investment program for the province, City

or muniCipality, and the project to be

financed through a bond flotation must be

part of the publiC Investment program.

Bond flotations require endorsement;

approval of the BSP.

National ~overnment Guarantee.

In order to enhance the market prospects

of bond flotations, some LGUs, such as the

LGU Fznanczng Present Sources, AVa/labilzty and Terms

province of Palawan, have requested a

national government guarantee for their

planned foreign bond flotations, However,

the national government IS not empowered

to grant a guarantee to LGU foreign bond

Issues by virtue of R.A. 4860 (Foreign

Borrowings Act) which limits the Issuance

of sovereign guarantees to loans of

government-owned or government­

controlled corporations and government

financial institutions With regard to local

bond flotations, there have been Instances

where a national government agency has

guaranteed the obligations of an LGU. Of

the fl ve LGU housing bond Issues floated

In the country, four have carned a partial

guarantee from the Home Insurance

Guarantee Corporation (HIGC), a national

successfully float the first few non-hOUSing

mUnicipal bond flotations.

Bond Flotations Issued. The

Province of Cebu pioneered LGU bond

flotations In the country when they floated

the first bond Issue in July 1990 (Cebu

Equity Bond Unit). The P300 million Issue

had a term of three years, tax free Interest

Income at 16 percent and called for

principal repayments In five (5) equal semi­

annual installments In the form of class "A"

shares of Cebu Property Ventures and

Development Corporation (CPVDC), a JOint

venture of Cebu Province and Ayala Land,

Inc (ALI) Cebu had contributed land and

ALI contributed cash for their shares In

CPVDC. With the tax-free feature, the

government agency. The hOUSing bond Investors effectively earned 20% on their

issue floated In Sto Domingo, Nueva ECIJa,

however, did not carry an H IGC guarantee,

but nevertheless was fully subscribed.

For non-hOUSing bond Issues, It IS

unlikely that a National Guarantee would

be granted primarily because such

guarantees run counter to the principles

laid down In the Local Government Code,

I.e. with the Increase In the share of LGUs

In the national wealth, and allOWing LGUs

the freedom to obtain finanCing from

various sources, the LGUs should assume

responsibility for finanCing baSIC services

and Infrastructure requirements In

addition, the Government's fiscal poliCY IS

to limit extension of guarantees In order to

protect ItS fiscal position. Because of the

absence of a National Government

guarantee, one can surmise that only the

most creditworthy LGUs would be able to

27

Investment plus the capital appreciation

prospects of the CPVDC shares.

Since the Cebu bond flotation, there

have been five more Issues (all In the

hOUSing sector):

o Victorias Pabahay Bonds - Negros

OCCidental (P8.0 million)

o Legazpl Suerte Bonds - Albay (P26 0

million)

o Clavena HOUSing Bonds - Mlsamls

Oriental (P20.0 million)

o Sto. Domingo HOUSing Bonds - Nueva

Ecija (PlO 0 million)

o Puerto Pnncesa HOUSing Bond -

Palawan (P20 0 million)

LGU Financmg Present Sources, Avazlabilzty and Terms

These bonds were issued on a taxable

basIs with Interest rates ranging from 14-

16%. The term of the Issues ranged from

2-3 years. All Issues carned the guarantee

of HIGC except the Sto. Domingo housing

bonds. A description of the bond Issuance

process IS presented by the Multinational

Investment Bancorporatlon, one of the

major underwriters in the mUnicipal bond

market (Annex 9). Since the bonds floated

were of relatively small size and short in

maturity, It IS clear that additional Incentives

are needed to promote development of a

broader mUnicipal bond market. In this

regard, the Government IS taking concrete

steps through ItS policy initiative, New VIsion

and PoliCY Framework for LGU Financing,

to initiate poliCies that Will develop the

mUnicipal bond market.

Assessment

that It could be a cheaper source of

financing, for example, when bank lending

Interest rates are very high.

One Issue that has been raised by

some quarters IS the taxation of mUnicipal

bonds At the moment, Interest Income

from bond flotations IS subject to a 20%

withholding tax. Proponents of the tax

exemption of municipal bonds cite the

experience In the United States, where most

municipal bonds are tax-exempt The

Government IS presently looking Into the

revenue Implications to the national

treasury of the tax exemption. Another Issue

IS the short-term nature of the mUnicipal

bonds so far floated (2-3 years). Better

terms have to be sought for the bonds to

finance long-gestating Infrastructure

projects However, there eXists the POSSI­

bility that credit enhancements such as the

proposed LGU Guarantee Corporation can

Prospects for Growth. As shown be used to lengthen the maturity of bonds

above, municipal bonds that have been

Issued so far have been limited to housing

projects. ThiS was partly because there

was a government agency that guaranteed

part or all of the repayment of the bond

Issues The other reason IS that many

Investors have a greater propensity to Invest

In time-tested treasury bills or in housing

and property development However, the

situation IS changing. From a social

ViewpOint, many LGUs are beginning to see

the advantages of floating project revenue

bonds (the project will likely get community

support If ItS members partiCipate In the

finanCing of the project), the addltlonality

of an untapped source of financing for

Infrastructure projects, and the possibility

28

through the guarantee mechanism Finally,

the lack of a secondary market for bond

flotations limits the liqUidity of the bonds

In many cases, the bondholders have to

hold on to the bonds until maturity because

of the absence of a secondary market.

Despite these factors, bond flotation offers

great advantages for LGUs ASide from the

community support mentioned earlier,

mUnicipal bonds offer a distinctly separate

and additional source of financing for LGU

Infrastructure projects, and could be a

cheaper source of financing depending on

the terms of the bond flotation

Sector coverage. Municipal bond

Issues offer good prospects for projects In

LGU Financing' Present Sources, AVaIlability and Terms

sectors other than housing Based on bond system In the United States, where

recent mandates received by private sector most municipal projects are financed

municipal bond underwriters, different through mUnicipal bonds.

Box B

sectors are now being explored for

municipal bond offerings, Including

airports, water supply, and food terminals.

For example, a P40 million bond flotation

IS now being packaged to finance general

Infrastructure requirements of the province

of Aklan It IS expected that once poliCY

issues are resolved, (tax exemption, credit

rating agency, etc ) municipal bond

flotations Will go the way of the mUnicipal

Characteristics and Advantages of BOT Schemes

Characteristics:

A private company or consortium is given the right to bUlld and operate a facility previously provided for by the govern­ment; The private company is responsIble for financing, designing, constructing, operatlllg and mallltaining the project; Lenders look to the project's assets and revenue stream for repayment; Concession period is agreed (typically 20-25 yrs.) afterwhich the facilIty IS transferred to the LGD.

Advantages:

BOT offers an alternative source of financing; A transparent legal framework already exists for BOT financ­ing; LGUs benefit from a project wIth typically no or very lIttle imtiallllvestment; BOT schemes offer proper allocation of risks; BOT projects usually result in better and reliable service and consistent supply; Long conceSSIOn period and contractual agreements assure project sustainability; Technology and skills transfer usually result from BOT projects; BOT Projects may stimulate local capital market development.

29

Other Private Sources of LGU Financing: BOT Schemes and Provincial Equity Funds

Build-Operate-Transfer (BOT)

Schemes

Background. BOT or "Bulld-Operate­

Transfer" IS a project finanCing scheme that

uses private Investment to undertake

mfrastructure projects histOrically fmanced

and Implemented by the public sector Box

B Illustrates some characteristics and

advantages of a BOT scheme.

BOT schemes are generally

charactenzed by the participation of the

pnvate sector as the major sponsor of the

project The pnvate sector proponent IS

given the nghts and pnvlleges by the publiC

sector (the LGU) to build and operate the

faCility, transferring the faCility to the LGU

after the concession penod. One very

Important characteristic of BOT schemes

IS that they allow proper allocation of nsks.

The pnvate sector proponent assumes

certam nsks, which are traditionally borne

by the public sector, e g the finanCing risk,

the deSign, construction, and operating and

maintenance nsks

In addition, BOT schemes, by virtue of

requiring little or no upfront Investments,

prOVide local governments With a Viable

vehicle to overcome their budgetary

resource constramts and accelerate the

LGU Financing Present Sources, AVailability and Terms

Implementation of Infrastructure projects.

With BOTs, local govemment Units need not

depend on financial assistance from the

National Government. If a local

government Unit can develop and package

a financially viable project, It only needs to

solicit Investor Interest in the project and

undergo the processing procedures

prescribed under the BOT Law and the

LGC

Legal Framework of the LGU BOT

Scheme. The Local Government Code of

1991 allows the LGUs to tap both

Government and private sources of capital

to finance basIc serVices, local

Infrastructure and other development

projects Reallzlngthatthe cost offlnanclng

these services and Infrastructure projects

IS huge and consldenngthatthe Philippines

had a highly successful BOT program at

the national level, the LGC made speCifiC

and liberal provIsions for the use of BOT

schemes by LGUs. Section 302 of the

LGC states; " Local government Units may

enter Into contracts with any duly pre­

qualifIed indIVIdual contractor for the

fmanclng, constructIOn, operation and

maintenance of any financIally-vIable

mfrastructure facility, under the bUlld­

operate-transfer agreement, subject to the

applicable prOVISIOns of RA 6957, as

amended by R.A. 7718 (the BOT Law)."

Coverage of LGU BOT Scheme and

LGU BOT Pipeline. In the late 1980s

and early 1990s, the BOT scheme was the

Government's answer to solving the power

CriSIS. Since then, the BOT scheme has

been utilized to finance other Infrastructure

30

projects at the national level (transportation,

information technology and water) Under

the BOT law, LGUs would be able to utilize

the BOT scheme In many sectors so long

as they are revenue-generating Thus far,

BOT schemes are being planned for

Infrastructure requirements In the LGUs

such as water supply and sewerage, solid

waste management, commercial centers,

public markets, slaughterhouses, and

telecommunications. One example of a

successful LGU project Implemented under

a BOT scheme IS the Mandaluyong Public

Market (Box C).

Concerning countrywide LGU BOT

projects, there are a number of projects In

an advanced development stage These

projects are In the following areas bulk

water supply, solid waste management,

public markets, slaughterhouse, Integrated

bus terminals, and commercial complexes

The largest projects are the Batangas Water

Supply Project which IS at the conceptual

stage ($275 million), the Metro Manila Solid

Waste Management Project under

negotiation (US$270 million); the Metro

Cebu Water Supply Project ($1l0 million)

and the Bulacan Bulk Water Supply Project

($50 million). The current pipeline of LGU

BOT projects and their status IS shown In

Annex 10. There are eight projects In an

advanced stage of development with a

project cost of US$188 million or about P7

billion, consisting of commercial centers,

public markets, a waste recycling plant,

slaughterhouse, solid waste management

and a combined power and water supply

project. In addition, there are 21 other

shortllsted projects amounting to $690

LGU Financing Present Sources, Avazlabllzty and Terms

Box C

MANDALUYONG PUBLIC MARKET

Objective:

To bulld a publIc market and multi-story commercial complex to replace the market gutted by fire m 1990

Project Description:

A seven story commercial complex with a publJc market, banks, pawnshops, grocery, service shops at the ground floor; eatenes and dry goods stores at the sec­ond and third floors; two parkmg floors at the fourth and fifth floors; four cmemas at the sixth floor, and fast foods, billIard hall, bowlmg lane, amusement center and a multi-purpose center at the sixth and seventh floors

Contracting Method: PublIc Blddmg

Method of Financing: BT Scheme (BUIld and Transfer) for the Pubhc Market

DOT (Develop-Operate-Transfer) for the Commercial Complex

In August 1990, the Mandaluyong pubhc market was totally razed down by fire. The City of Mandaluyong needed to rebUIld the market Immediately, but was confronted wIth a major problem -- financing. Mandaluyong's Mayor Benjamm Abalos scouted for developers, mvestors and busmessmen, Imtlally attracting ten contractors but eventually reduced to two who were wlllmg to finance the proJect. Of the two, Macro Funders and Developers, Inc. was selected to construct the proJ ect The tenns ofthe agreement between the City and Macro Funders (Contractor) were as follows

• The Contractor wlll develop, finance, construct a public market cum commer­Cial complex on a land owned by the City

• The City will operate, mamtam, control and supervise the public market. • The Contractor wlll operate the commerCial complex for a penod of forty (40)

years. • Upon completion ( of construction), the ownership of the BUIlding Will be trans­

ferred to the City. The operatIOn of the commerCial complex wlll be trans­ferred to the City after forty years

• The City will lease the bUlldmg (except the public market) to the Contractor

The publIc market was turned over to the City forJree for Its exclusive supervi­sIOn and control m 1993 The City government constructed half of the stalls mSlde the market with the rest constructed by the stallholders themselves. The City col­lects the stall fees and mamtains the pubhc market The rest of the complex wlll be operated and managed by the pnvate sector contractor for 40 years, leasmg tenant­able areas to third parties to enable It to recover the cost of Its mvestment and to realIze a reasonable return on ItS mvestment. Afttjr the concessIOn penod, the opera­tion of the commercial complex (including collection of fees) will be transferred to the City. Without any imtial investment, the City IS now generatmg additIOnal rev­enues from new taxes, hcenses and fees charged to lessees of the commercial com­plex as well as revenues from the operation of the wet pubhc market

31

million or about P27 6 billion, which

are In vanous stages of processing

Coordinating Council of the

Philippine Assistance Program

(CCPAP) - BOT Center. The

CCPAP, an agency attached to the

Office of the President, was created

to facilitate mobilization and

administration offunds generated by

the Philippine AssIStance Program

(PAP) and to ensure ItS successful

Implementation Under the CCPAP

IS the BOT Center whose main

functions Include:

o promoting the BOT Program,

o providing technical assistance to

LGUs as well as lAs on project

evaluation and preparation of

bidding documents;

o providing adVice on project

finanCing and finanCing sources;

o BOT project processing, and

o conducting institutional capa­

bility seminars and BOT training

sessions for national Imple­

menting agencies (lAs), LGUs

and the private sector

As a background, PreSident

Fidei V. Ramos, In September 1993,

Issued Memorandum Order No 166

deSignating the CCPAP Chairman as

Action Officer for the BOT Program

and subsequently tasked the CCPAP

Secretariat to establish a BOT

Center With thiS mandate, the BOT

Center's main functions initially

focused on the promotion of the BOT

LGU Financing. Present Sources, Availability and Terms

Program (also known as the Philippine

Infrastructure Privatization Program or

PIPP) and the conduct of BOT Training

programs to lAs, LGUs and the private

sector. With the passage of R.A. 7718 (An

Act Authorizing the Financing,

Construction, Operation and Maintenance

of Infrastructure Projects by the Pnvate

coordinate and mOnitor the Implementation

of BOT projects Box D describes the

vanous functions and services offered by

the CCPAP BOT Center.

The CCPAP BOT Center's core units

consist of:

Sector and for other purposes), otherwise 0 The National Projects Desk. Provides

known as the amended BOT Law, CCPAP technical assistance to national

BOT Center was further tasked to

Box D

CCPAP BOT CENTER FUNCTIONS AND SERVICES

Functions: • promote the BOT Program, also known as the Philippme

Infrastructure Privatization Program; • provide technical assistance to executing agencies in pack­

aging and promoting proJects; • conduct BOT tramlllg to national Implementing Agencies,

LOUs, and the pnvate sector, • coordinate and mOllitor the implementatIOn of BOT projects;

and • facilitate the development and ImplementatIOn of BOT

proJects.

Services Offered: • BOT Database: project information

- project monitoring - data commUllicatlOns

• Marketlllg / Promotion - Investment roadshows

•

•

- seminars and conferences - brochures/publications Technical Assistance - project development - evaluation/negotiation - preparation of bidding documents Training - advance project development and management program - LOU-BOT trainlllg program - train-the-trainer program - on-the-Job trailling

32

Implementing agencies In the

generation, development, evaluation

and Implementation of viable

Infrastructure projects In the power,

transportation, information technology

and tounsm sectors

o Environmental Projects Desk.

Provides technical assistance

specifically to government entities

Involved In the generation,

development, evaluation and

Implementation of viable water,

wastewater, and solid waste projects.

o Local Government Unit (LGU) Desk.

The BOT Center believes that

Implementation of vanous projects for

the LGUs would be a feasible alternative

In the scarcity of funds for a nationWide

sustained economic growth Thus, the

LGU Desk provides technical

assistance to LGUs In the generation,

development, evaluation and

Implementation of BOTabie

Infrastructure projects

o Training and Promotions Desk.

ResponSible for the development and

conduct of training programs for

LGU Financzng. Present Sources, Avazlabllzty and Terms

instItutIonal strengthening and capa­

bJlJty building of vanous government

agencIes and LGUs. Also promotes the

PhilIppine BOT program and assIsts In

the marketIng of projects In the

pIpeline.

Center are now being developed.

USAID BOT Assistance Program. USAI D IS proVIding technical assIstance to

LGUs through consultants In support of the

LGU BOT assIstance program ofthe CCPAP

BOT Center The objectIves of the program The assIstance proVIded by the BOT are as follows:

Center to promote BOT projects throughout

the whole country has been WIdely recog­

nIzed In a study commIssIoned by

USAIDJO, the study concluded that the BOT

Center had a "sIgnifIcantly posItIve Impact

on the mobIlizatIon of efforts to develop

the publlc-pnvate partnershIp In infrastruc­

ture projects". Furthermore, the study also

added that the BOT Center "plays a key

role In the success of pubhc tender offenngs

acceptable to private Investors and In

negotiated contract terms" ASIde from thIS

role, the BOT Center has filled an Important

gap by acting as a useful source of

Information on the BOT program for pnvate

foreIgn and natIonal companIes.

o ProVIde LGUs with the capabIlIty to

undertake BOT projects, partIcularly for

environmental Infrastructure;

o Demonstrate the feasIbilIty of

undertakIng envIronmental infrastruc­

ture projects through BOT schemes;

o Promote and aggressIvely market the

PhilIPPine BOT Program;

o Address POlICY, legal, regulatory and

adminIstratIve constraints that Impede

LGU BOT ImplementatIon.

The program IS beIng Implemented

satlsfactonly. Focused on development of

LGU BOT envIronmental Infrastructure

projects such as water supply, wastewater WIth regard to specIfIc regions where and solId waste facilItIes, the consultants

the NatIonal Government has attached have so far provIded assIstance In the

pnonty, the Government IS makIng a special follOWing areas:

effort to dIsseminate the functIons and

servIces provided by the BOT Center. Thus

In MIndanao, former PresIdent Ramos

Issued Memorandum Order No. M970160

to create a BOT center In the SpecIal Zone

for Peace and Development (SZOPAD)

covenngfourteen provInces In the area. The

mechanIcs and admInIstratIve

arrangements for the establishment of the

o Policy advocacy - the consultants

developed for the BOT Center the fIrst

AVOIded Cost Methodology (ACM)

model The ACM IS a computer-based

evaluatIon tool whIch will allow Water

Dlstncts (WDs) In the LGUs to compare

BOT Investment proposals wIth the cost

of the project If constructed by the WDs

10 Phlhppmes EvaluatIOn of the BOT Center, USAID Project No 2352-003, July 1997

33

LGU Fmancing Present Sources, Availability and Terms

themselves. A series of seminars was urban transport projects, sewerage,

conducted by the BOT Center to train housing, resort development and multl­

the WDs on the use of this computer purpose power schemes are being

model Implemented At the local level, there are

a total of 29 LGU projects currently In the

o Project development - the BOT Center pipeline with a project cost of about $900

with the assistance of ItS consultants

has provided advice to LGUs on finan­

cial modeling, preparation of bid docu­

ments and bid evaluation critena,

negotiations support, review of conces­

sion agreements, evaluation of unsoli­

cited proposals and assessment of

pnce challenges;

million or P36.0 billion About a third are

In an advanced stage of processing, either

under bidding or negotiation, or an unsoli­

cited proposal from a pnvate sector propo­

nent IS under evaluation These projects are

part of the provincial, city or mUnicipal

master plan and are sanctioned by the res­

pective Sanggunlan Bodies It IS

anticipated that as more and more LGU

o InstitutIOn buildmg - the BOT Center BOT projects are successfully Implemented,

has provided training to LGUs to

develop the capability In prepanng and

Implementing environmental infra­

structure projects under the BOT

scheme. The BOT Center designed and

conducted several Infrastructure

training sessions In Luzon, Vlsayas and

Mindanao, and

o Marketing and promotIOns - various

Investment missions have been held

both locally and overseas to promote

the Philippine BOT program.

Assessment

Prospects for Growth. The BOT

scheme has been one of the recent success

stones In financing Infrastructure projects

In the PhilipPines At the national level,

some 27 power projects have been

Implemented, helping solve the power cnsis

that gnpped the country In the late 80s and

many LGUs will follow SUIt and finance their

Infrastructure requirements uSing the BOT

scheme Because of the recognition by the

LGUs of the work so far accomplished by

the BOT Center located In Manila, some

regions have called for regional BOT centers

to be established, and one center IS planned

to be set up In Mindanao.

Sector Coverage. BOT projects offer

the best prospects for vaned sectoral

coverage GFls or other financing inStitu­

tions may have a preference for certain

types of projects where collateral IS a major

consideration. However, under the BOT law,

practically all developmental and revenue­

generating projects are eligible for BOT

financing (Annex 11) By definition, what

are attractive to pnvate sector entrepre­

neurs can generally be financed under BOT

arrangements and ItS vanants. However,

Infrastructure projects are espeCially

attractive because of the steady cash flows

the early 90s At the moment, various through user charges associated with these

34

LGU Fmancing Present Sources, Availability and Terms

Box E

types of projects.

Provincial Equity Funds

One commercial bank, (Bank of the

Philippine Islands) has taken an innovative

approach toward LGU finanCing. Its wholly-

Batangas Assets Corporation

To promote the economic development of the provmce of Batangas, the BPI Capital CorporatIOn created the Batangas Assets Corporation (BAC) m December 1996 The SEC-registered corporatIOn capltahzed at PI 0 b!llion will Illvest III eqUity and quasi-eqUIty of private unhsted compames, mfrastrucrurelBOT-type projects and real estate companies m the provmce of Batangas. The shareholders of BAC are some 16 major mstlrutlOnal mvestors, mcludmg Ayala CorporatIOn, EEl CorporatIOn, First Batangas Industnal Park, Inc , First Phllippme Holdmgs, etc who see slgmficant retl!ms from domg busmess m the provmce of Batangas. BPI Capital CorporatIOn acts as the AdVisor and Manager of the Company. The mvestment targets for BAC are:

• BOT-type infrastructure projects • export-onented mdustnes • food processmg companies and manufacrurmg firms • real estate and property development • tounsm and leisure-related projects • education and human capital development

The Manager of the Company discharges the followmg responsibili­ties: (I) Identlfymg mvestment opportunities and projects for finanCial par­tiCipatIOn; (il) recommending investment/divestment deciSIOns; (ni) deter­mmmg additional eqUIty calls, and (iv) mvestmg short-term unused funds. The adVISOry services of BAC mclude

• targetmg potential proJects, • asslstmg m the preparation of feaslbihty srudles, • analyzmg vJablhty of alternative finanCIal structures; • strucrunng of appropnate financing vehicles and formulat­

ing a project financmg plan;

The benefits afforded by the BAC are numerous. The company will generate economic actiVity and prOVide employment opportumtles for resI­dents ofBatangas; It w!ll provide seed capital to Batangas-based compames, and m general, improve the hving standards of ItS cItizens. For the mvestors ofBAC, the project Will generate good prospects for earnmg higher rates of rerum than traditIOnal mstruments, focus mvestments m high-growth areas, and promote good relatIOns With the commumty at large

35

owned investment banking subSidiary (BPI

Capital Corporation) created a separate

speCial-purpose corporation, the Batangas

Assets Corporation (BAC) to prOVide equity

finanCing for development projects In the

province of Batangas (Box E).

Depending on the success of the BAC

In attracting finanCing for various

Investment opportunities In Batangas, the

concept of proVinCial eqUity funds can be

replicated In other provinces What IS

needed IS a vIsion and commitment from

the chief executives of a proVince, and the

services of an Investment adVisory firm to

initiate the establishment of a prOVinCial

eqUity fund

LGU Guarantee Corporation

(LGUGC)

Aware of the funding problems

besettlngthe LGUs, particularly their limited

access to commercial finance, the

Development Bank of the Philippines (DBP)

and the Bankers ASSOCiation of the

Philippines (BAP) took the initiative In

establishing the LGU Guarantee

Corporation (LGUGC) The LGUGC IS

expected to enhance the flow of commercial

funds to the LGUs, and playa "catalytiC"

role by proViding a guarantee on loans and

credits granted to LGUs from commercial

funding sources, and to municipal bond

flotations. Box F gives details on the role

and proposed administration ofthe LGUGC.

Ultimately, the LGUGC Will enable

LGUs to expand their borrOWing capaCity,

develop their ability to Issue a variety of

LGU Financing Present Sources, AVailability and Terms

BoxF The LGU Guaranty Corporation (LGUGC)

The establishment of the LGUGC was necessItated by the mability of LGUs to access prIvate sector fundmg chIefly because of the perception of lack of credItworthmess and political succession risk. To rmtIgate these "perceived" rIsks, the DBP and the BAP, composed of some 53 different universal and commerCIal banks operating in the country, established the LGU Guaranty CorporatIOn to guarantee loans and credIts granted by partICIpating member commercIal banks for vanous capital investment projects ofLGUs. The jomt venture partnershIp between DBP and the BAP IS geared towards acceleratmg the competlttve access of LGUs to financial markets, especially private sector credit. So far, twenty local banks and three foreIgn banks have signed up as partIcipating investmg banks The specific objectives ofthe LGUGC are as follows:

• expand the LGUs' borrowing capacIty and credit availabIlity; • reduce the LGUs' financing costs; • improve the operatmg and financial flexlbihty of the LGUs; • reduce the credIt and other perceived risks (e.g. polittcal risk)

of lenders; and • contrIbute to the development of the local capItal market by

creattng a market for a vanety of credIt instnunents.

The corporation is capitahzed at P500 million WIth paId-up capItal of P250 million. As a first step, the LGUGC will set-up an LGU database, and develop an internal LGU credit ratmg system. Next, the LGUGC will accredit financial mstitutlOns whIch have expressed mterest III partlclpatmg m the guarantee program as Illvestmg banks Fmally, the LGUGC will receIve and process the guarantee applicatIOns from the appropnate bank under the BAP, which WIll provide financing for the LGU project. In case of default by the LGU on the loan, the guarantee can be called or a restructJmng exerCIse undertaken by the lendmg financial mstitution. The guarantee facility will have a geanng ratIO of 10 times Its paId-in capItal, therefore, It can provide guarantees of up to P2.5 bllhon. Initially, the LGUGC can provide a credit guarantee of up to 85% of the LGU loan untt! a credit rating mechanism IS put m place Based on recent discussions, LGUs are excited about the prospects of obtaimng a guarantee faclhty for ItS loans to finance ItS vanous projects.

credit Instruments, reduce their finanCing

costs and improve their operating fleXibility

The LGUGC's Implementing rules and

regulations, gUidelines and by-laws are

being drafted, and formal Incorporation was

completed In March 1998. It IS expected

that the guarantee facility will begin

operations by the mid-part of 1998.

36

Others Forms of Private Sector

Participation in LGU Infrastructure

Projects

ASide from BOT schemes and the

Innovative prOVinCial equity funds, there are

other forms of private sector participation

In LGU Infrastructure projects (mostly In the

water sector) which have Improved service

delivery and facilitated Increased access to

finance for new Investments Table 1 lists

these other forms of private sector

participation. It shows how responSibility

for certain funcbons are allocated, such as

asset ownership and how these different

schemes Impact on certain parameters

such as level of Investments by LGUs and

consumer tariffs These schemes vary In

the type of private sector participation'

o Service contracts are short-duration

engagements for specific tasks to be

undertaken by the private sector

participant The purpose IS to utilize

certain expertise considered to be more

cost-effectively undertaken by the

private sector Overall coordination

remains to be the function of the utility

o Management contracts have a longer

term duration giving the private sector

a larger operational role In the utility.

Similar to the purposes of service

contracts but In more expanded form,

management contracts allow the

private sector to Introduce effiCiency In

operations (usually through perfor­

mance obJectives) for a management

fee. Responsibility for Investments

remain With the Government.

LGU Financing Present Sources, Availabzlzty and Terms

Table 1. Alternative Water and Wastewater Public/Private Partnerships 11

Type

ServIce Contract

Management Contract

Lease (affermage)

BOT

ConcessIOn

DIVestIture

Asset LGU Investment Technology Ownerhip Requirements Transfer

PublIc MedIUm Low

PublIc HIgh MedIUm

PublIc MedIUm-HIgh HIgh

PrIvate & PublIc Low MedIUm

PublIc MedIUm HIgh

PrIvate Low Low

o Leases or affermage contracts allow

the private sector to lease the assets

of a utility and takes on the respon­

sibility for operating and maintaining

them. The contractor (lessor) makes

Service Tariff Improvement Impact Duration

Operating Efficiency

HIgh Low I - 2 years

HIgh Medium 3 - 5 years

HIgh MedIUm 8 - 15 years

MedIUm MedIUm 20 - 30 years

HIgh Low-MedIUm 25 - 30 years

MedIUm-HIgh MedIUm Indefimte

the right to bUild, operate and transfer

the facility to the utility or the

Govemment after a fixed period oftlme

(see section on BOT schemes).

lease payments to the utility in 0 Dlvesttture involves the outright sale of

exchange for the operation of the

assets and the revenue collections

a utility's assets to the private sector

from operations. Similar to manage- It IS Important that the LGUs truly

ment contracts, responsibility for understand the different forms of private

Investments remain with the sector participation and evaluate which of

Government. Commercial nsk IS borne these schemes IS most sUitable and cost­

by the contractor. effective for achieVing their objective of

Improving the delivery of baSIC services.

o ConcessIons give the private sector the

right to operate and maintain the Joint Ventures

assets of the utility and to make

necessary Investments In exchange for Many LGUs also contemplate on

fixed concession payments paid to the entenng Into JOint venture partnerships with

utility or the Government the pnvate sector. Indeed, what IS reqUired

In a JOint venture undertaking IS the

o BOT contracts give the private sector consummation of the legal agreements and

11 Based on a report prepared by the World Bank entItled "ToolkIts for PrIvate Sector PartICIpatIOn In Water and SamtatlOn" The author has

Introduced some vanatIons In the table whIch are purely hIS own

37

LGU Financing' Present Sources, Avazlabillty and Terms

once the financing and the contractors are

In place, the project can commence.

However, JOint ventures do not have any

specific legal framework at the moment

such as the one for BOTs, which makes

the arrangement subject to potential legal

difficulties In companson, BOT schemes

have the legal framework with ItS own

specific law and Implementing rules and

regulations, mitigating the likelihood of a

protracted legal challenge if legal Issues

anse.

New Proposed Multilateral Initiatives on LGU Financing

LGU Infrastructure Development

Facility (LGUlF) - Asian

Development Bank (ADB)

In order to further enhance financing

of development projects In the countryside,

the ADB IS spearheading the establishment

of a proposed US$50 million facility

managed by DBP to support Infrastructure

development In the LGUs. The facility

would finance revenue-generating

Infrastructure projects sponsored by the

private sector and/or by creditworthy LGUs

Under the proposed LGU Infrastructure

Facility, the ADB would provide limited long­

term funds for LGU projects to. (I)

complement commercial short and

medium-term sources of funds WhiCh, on

their own, would not meet the term

requirements of most Infrastructure

projects; and (ij) facilitate the underwriting

financing for Infrastructure projects at

competitive market rates The facIlity will

finance up to 30% of the total project cost.

The project sponsors will finance at least

25% of the total project cost and the balance

of 45% will be financed from commercial

borrowings and/or mUnicipal revenue bond

Issues

To complement the facility, a technical

assistance loan that will help LGUs manage

private sector participation Irl Infrastructure

projects IS being conSidered. ThiS assIs­

tance would offer LGU adVisory services

and training In the preparation of feaSibility

studies, the preparation of bidding docu­

ments Including appropriate performance

criteria and risk-sharing arrangements, the

evaluation of bids, the preparation of BOT

contracts and the negotiation With private

sector promoters A pipeline of pOSSible

LGU Infrastructure projects IS currently

being reviewed

LGU Finance and Development

Project (LOGOFIND) - World Bank

Consistent With the objective of assIs­

ting LGUs Implement their development

plans, the World Bank IS proposing a project

that would assist In financing Infrastructure

and environmental projects and In bUlldlng­

up LGU institutional capacity for finanCial

planning and management. The proposed

LOGOFIND project has the follOWing

objectives:

of bonds Issued by LGUs and project 0 assist participating LGUs In expanding

companies. It IS currently contemplated

that the Facility will provide long-term

38

and upgrading their Infrastructure and

LGU Fznancmg Present Sources. Avazlabllzty and Terms

In pnontizlngenvlronmental and social by USAID to bnng about more responsive

Investments;

o Improve the financial performance of

participating LGUs, and thus enhance

their creditworthiness, and

o strengthen the National Government's

LGU programs to develop LGU

Institutional capacity

LOGOFIND will prOVide long-term

financing on a "demand basIs" to LGUs

for a wide range of both revenue and non­

revenue-generating Infrastructure projects,

selected SOCial and environmental projects,

and for Improving LGU financial perfor­

mance to enable LGUs to eventually grad­

uate to GFI or pnvate sector financing. The

Project will also assess, strengthen and

Improve the MUnicipal Training Program

under the MDF, and help enhance the

democratic institutions with greater citizen

participation for local governance and

development. The project has Identified

three action areas In local governance.

o Fmanclal mobilIzatIOn and manage­

ment - the project supports actions to

Increase the amount of finanCial

resources available to local commu­

nities and to Improve the local technical

and administrative capabilities to

manage such funds. In thiS respect,

technical support IS being proVided to

LGUs for project development

financing, to Institutionalize a

transparent and rational budget

process, and to Improve LGUs' tax

collection efforts;

ability of the BLGF to mOnitor and assess 0 Development Investment assIstance -

the fiscal performance of LGUs. Finally, Includes development Investment

the Project will assist the Government In

Implementing ItS New Policy Framework for

LGU Credit FinanCing discussed In the early

part of the report. The Project IS now In ItS

preparatory stage.

Bilateral Programs Involving LGU Financing

Governance and Local Democracy

Project (GOLD) Project - United

States Agency for International

Development (USAID)

Cognizant of the need to accelerate the

development process and Improve govern­

ment performance in the delivery of baSIC

serVices, the GOLD project was launched

39

priOritization, project identification,

feaSibility assessment, financial

adVisory aSSistance, and Investment

promotion through local government

Initiatives and public/private

partnerships The program has

published occasional papers With

assistance from conSUltants on:

financial management, local taxation

and other revenue generation, local

Investment planning, budgeting, and

revenue shanng and grants. Recently,

GOLD completed ItS mUnicipal bond

Simulation study entitled, "BUilding a

Stronger Municipal Bond Market In the

Philippines". The study proVides an

overview of major concerns about the

state of muniCipal bond use In the

LGU Fznanczng Present Sources, AVaIlability and Terms

country and presents recommen­

dations for developing the bond

market The simulations also consider

the Impact of tax exemption of LGU

bond flotations.

o EnvIronmental planning and

management - the GOLD project

With respect to Infrastructure, It provides

technical assistance to LGUs on project

Identification, pnontlzlng and Implementa­

tIOn of projects, Including those to be

implemented under BOT schemes Further­

more, GEM provides assistance In market

Identification and access, JOint venture

matching, technology transfer and training,

intervention also focuses on assisting and financial packaging to cooperatives,

local governments to better understand Investors, sma II and med I u m sca Ie

the local environmental situation, businesses and producer associations

develop and prioritize options and

undertake actions to promote

environmental planning and

management

Growth with Equity in Mindanao Project (GEM) - USAID

GEM IS a bilateral program of the

United States Intended to accelerate

economic growth In Mindanao, focusing on

development of pnvate enterpnse, essential

Infrastructure, and needed policy changes.

GEM provides limited, "deal-specific"

financial support on a cost-shanng basIs

for technical assistance and training to

groups and organizations working toward

equitable economic growth In Mindanao.

40

As of June 1997, GEM has assisted a

total of 109 "on the ground" projects In

Mindanao with an aggregate Investment

level of P6 2 billion. These projects are In

the areas of agnbuslness development,

support to small and medium enterpnses,

Investment promotion and job creation and

Infrastructure assistance With regard to

the latter, GEM developed a comprehensive

database of eXisting Infrastructure In

Mindanao, prepared 19 detailed BOT

Infrastructure Investment profiles and

proVided assistance to twelve Infrastructure

projects leading to over P5.0 billion of new

investment In telecommunications

LGU Financing Present Sources, Avazlabllzty and Terms

Chapter 111- Constraints to LGU Access to Private Capital

The recent Interest generated by the

private sector In providing financing for LGU

Infrastructure projects highlights the need

to address constraints to LGU access

private capital. Some of these Include

o regulatory constraints on LGU

deposits

o IRA allocation formula and local

resource mobilization efforts

o remaining policy Issues on LGU

financing

o creditworthiness of LGUs

o political risk

o limited Investment planning

capacity and project pipeline

o limited capacity for project and

financial management

Some of these constraints are of a

policy nature, e.g. regulatory constraints to

LGU deposits and other remaining poliCY

Issues. Others are embedded In law and

therefore would need legislative action (IRA

formula). The rest are constraints that are

inherent In many LGUs (lack of capacity

for Investment planning, project and

financial management, etc.). These are

desCribed in more detail In the following

paragraphs.

12 Local Government Code of 1991 (RepublIc Act No 7160), SectIOn 311

41

Regulatory Constraints to LGU

Deposits. It IS a general commercial

banking practice that bank borrowers

maintain deposits with the lending

institution This IS to ensure that the

lending institution can utilize part of the

deposits to secure the borrower's obligation,

and also proVide the mechanism to obtain

regular credit information regarding the

borrower In the case of LGUs, however,

CGA Circular No. 92 Instructs LGUs to open

and maintain depository accounts "With a

government-owned bank located In or

nearest the locality" It also states that In

case there is no government-owned bank

located In the nearest locality, depository

accounts may be opened with a bank duly

designated as government depository by the

Bangko Sentral ng Plllplnas, upon prior

authority of the Sanggunlan Body and the

approval of the chief executive The CGA

Circular IS based on the provIsion In the

LGC pertaining to depository accounts,

which states, "Local treasurers shall

mamtain depository accounts in the name

of their respective local government umts

with banks, preferably government-owned,

located m or nearest to their respective

areas of JunsdlctlOn" 12. The CGA Circular

appears to Interpret the LGC provIsion

narrowly.

LGU Financing' Present Sources. AVailability and Terms

Thus, LGUs, because of the stnct

Interpretation of the LGC prOVISion, are

constrained to maintain deposits only with

government or government-designated

banks. As a result, the information on the

finanCial standing and performance of

LGUs, the collateral that LGUs can offer,

remedies In case of default, and other

Information are not available with lending

Institutions other than govemment financial

institutions Without these Information,

many private commercial banks and

finanCial institutions are reluctant to lend

to LGUs, constraining the extension of

pnvate commercial credit to the LGUs.

IRA Allocation Formula and local

Resource Mobilization Efforts. There IS

concern thatthe IRA allocation formula, not

being linked to resource mobilization efforts

or to priority sector efforts, has resulted in

the decline of LGU local revenue generation

efforts as LGUs seem to substitute allot­

ments for revenue that should have been

locally raised It IS noteworthy, however, that

based on recent data, the share of IRA to

total LGU revenues has declined (53.8% In

1996 compared to 61 4 % dUring the pre­

VIOUS year), while local resource mobiliza­

tion Improved to 45.3% compared to 36.8%

In 1995. Although a positive trend toward

more self-reliance may be developing, there

IS stili room for revIsing the formula to

further promote local resource mobilization

efforts, possibly linking IRA allocation to

local revenue generation performance.

Moreover, resource mobIlization efforts

In order for LGUs to finance not only the

delivery of basIc serVices, but also proVide

the ability to finance critical development

projects and timely maintenance and

operation of existing projects LGUs must

take full advantage of the taxing autonomy

provided under the LGC, and review

Individual tax rates, property value

assessments and tax collection effiCiency

regularly. ThiS Will effectively narrow the

revenue-expenditure gap or resource

mismatch that plagues many LGUs

Remaining Policy Issues on lGU

Financing. Until the Government

formulated ItS New VIsion and PoliCY

Framework for LGU Financing, there was

no clear policy and institutional framework

to promote LGU access to private capital

The GFls continued to favor the large,

creditworthy LGUs for their lending

programs With limited coordination With

other offiCial sources of financing for LGUs,

and very little coflnanclng With private

sources of funding LikeWise, the MUnicipal

Development Fund, which was adminiS­

tered by the Government, focused ItS

lending on the creditworthy LGUs, resulting

In an excellent repayment record, but

unable to address the needs of the less­

creditworthy LGUs. Other poliCY Issues

remain such as the tax exempt status of

LGU bonds and development of a credit

rating agency for LGUs, the lack of a

secondary market for mUniCipal bonds, and

the ability of private banks to avail of the

IRA Intercept mechanism

of LGUs through cost-recovery, charges, Creditworthiness of lGUs. Because

fees and tax revenues need to be enhanced of the absence of readily available Indicators

42

LGU Financing· Present Sources, Avazlabilzty and Terms

of LGU credltworthmess coupled with the

absence of any formal relationships with

LGUs, private commercial banks and other

sources of fmancIng find It difficult to

determme the loan repayment capacity of

LGUs. Atthe moment, an LGU's repayment

capacity IS determined on the basIs of the

LGU's IRA and local taxes and fees

generated In general, the varymg mcome

generated by LGUs determme the varymg

capacities to service debt Since the LGUs'

share of the national wealth IS a fixed

percentage, the capacity to repay

obligations m a particular project IS, to a

large extent, determined by the ability of

the LGUs to Implement user fees as a cost-

recovery mechanism for timely debt

service

has remamed m the mmds of many pnvate

commercial lenders and mvestors In 1991,

the province of Cebu floated a P300 million

equity bond Issue to raise development

funds The bond Issue had mnovatlve

features where the City government, 1he

pnvate busmess and the fmanclal sector

all participated m the bond Issue. After

the bonds were successfully floated in the

market, a new provmclal admmlstratlon

took over, and raised some legal Issues on

the appropnateness of the transaction,

threatenmg to repudiate the obligations

entered Into by its predecessor Though

the fears of the Investors, m the end, were

unfounded as the Province honored the

mterest payment obligations as they fell

due, the perception of political risk

associated with LGUs has remained.

However, the reluctance of many LGUs However, there has not been an mCldent

to raise local tax rates has not helped on record to substantiate a similar sltuatloh.

enhance their fmanclal capacity, and hence

their creditworthiness For example,

although the LGC allows LGUs to charge

real estate taxes of up to 1% ofthe assessed

value, some LGUs have cut this rate to % %,

reducing their revenue Intake. Though

politically popular, these measures have

resulted in a weakening of the LGU's

revenue base, limiting the prospects for

lendmg from pnvate sources Lenders

generally are not as much concerned With

foreclosure of collateral to recover loan

losses of LGUs, as With the commitment

and ability of LGUs to service their debt

obligations out of local revenues generated.

Misconception of Political Risk.

LGUs contmue to be plagued by the "Cebu

Equity Bond" syndrome, a perception that

43

Limited Investment Planning

Capacity and Project Pipeline. A

carefully conceived medium to long-term

investment plan can translate goals and

strategies Into specific implementable

programs. Histoncally, local mvestment

planning at the LGU level was limited to

hasty annual preparation of a capital

Improvement program, though now they are

required by the COA to develop medium to

long-term Investment targets. ThiS has led

to a haphazard list of projects, which the

LGUs wanted to Implement but was unable

to attract mvestors or creditors. To some

extent, thiS is stIlI happenmg m some of

the LGUs. The LGC sought to significantly

strengthen local Investment planning,

providmg for the establishment of local and

LGU Financing Present Sources, AVailability and Terms

regional development councils charged with

formulating "the medium-term and annual

Investment programs" of the LGUs

Though some LGUs have formulated

master plans for their communities and In

the process, developed a robust project

pipeline, the majority of LGUs continue to

be hampered by limited investment

planning capacity. In addition, many LGUs

do not have the resources to develop

master plans and to conduct proper

feaSibility studies In some sectors such

as water and wastewater, feaSibility studies

can cost up to P20 million depending on

the size and complexity of the projects.

Thus, a mechanism must be developed to

allow LGUs to finance feaSibility studies for

their development projects.

Limited LGU Capacity for Project

and Financial Management. It IS widely

perceived that capacity for service delivery,

project and finanCial planning, project

implementation and project monitoring

varies greatly among LGUs. Thus, while

some LGUs (principally large urban cities)

are advanced In their financial planning and

project execution capability and are able

to access private sources of capital, many

others do not have the capacity to prepare

project feasibility studies, much less

detailed master plans for their

communities. ThiS weakness has

dampened the attractiveness of LGU

flnanclngto the pnvate sector. One example

44

IS In the area of accounting. Pnvate

finanCing sources require accounting

methods In accordance with commercial

accounting pnnclples. However, many LGU

accounts are not. Thus, there IS difficulty

for the private sector to reconCile and

analyze the LGU accounts and thiS

Jeopardizes the LGU 's chances of attracting

financing Another area IS budgeting.

Many LGU offiCials have a limited view of

the development process, and the practice

of planning for a single-year period remains

common. Furthermore, many capital

expenditures are spent for "unfunded

mandates" with little real analysIs, resulting

In sub-optimal Investment deCISions.

Though some LGUs are turning to local

consultants and Investment adVisers for

speCific-prOject assistance, thiS appears to

be only a short-term solution What IS

reqUired IS upgrading of the permanent

staffing complement of LGUs through

proper recrUitment, training and

educational opportunities Although

training In project management and

finanCial analysIs IS being proVided to LGUs

by respective agencies Involved In local

governance, e.g. the Local Government

Academy of the Department of Intenor and

Local Government and other agencies and

organizations such as the NEDA and the

CCPAP BOT Center, much work IS stili to

be done to bUild-up the technical and

finanCial capability of LGUs

LGU Financing Present Sources, AvazlabIllty and Terms

Chapter IV - Summary of Recommendations

The devolution of basIc services and

Infrastructure development to the local

government units poses both an

opportunrty and a challenge for LGUs. They

now formulate and implement their own

development plans, which hitherto was

done by National Government agencies;

this opportunity cames the greater

challenge of securing finanCing for these

proJects. The paper has provided the

framework for LGU finanCing, and has given

an assessment of the different sources of

finanCing currently available to local

government units. The assessment of each

finanCing source discussed the prospects

for expanding the fmancing sources and

identified the constramts that need to be

addressed and offered some

recommendations. FollOWing IS a summary

of these recommendations and specific

courses of action that can be undertaken

to expand the sources of fmancmg for LGUs

and develop their financial capacity:

a. Government to Implement it's New

Vision and Policy Framework for

LGU Financing. The Government's

new vIsion and poliCY recommen­

dations to enhance LGU finanCing

provide an excellent list of

recommendations to enhance

finanCing for LGU Infrastructure

projects and develop local managerial

capability. The recommendations

45

Which are now In various stages of

implementation, include the follOWing:

(I) Increase LGU use of BOT

arrangements and other forms of

private sector participation In

coordination with the CCPAP-BOT

Center; (II) develop the LGU muniCipal

bond market; (III) promote LGU access

to private credit markets; (iv) optimize

and expand GFI mvolvement In LGU

flnancmg; (v) restructure and re-onent

the MDF, (VI) Improve the capacity of

LGUs to raise their own revenues, and

(vii) tap ODA technical assistance and

flnancmg These proposed measures

are embodied in the Government's New

ViSion and Policy Framework on LGU

Fmanclng reproduced in Annex 12.

b. Government to recommend

legislative action to rationalize IRA

formula (possibly link IRA to resource mobilization efforts) and

to promote equity in distribution in

favor of lesser-creditworthy LGUs.

The LGC proVides for the proportionate

sharing of IRA resources to proVinces,

cities and mUnicipalities regardless of

local Income generated or financial self­

suffiCiency. Because the IRA formula

IS not Imked to the financial capacity of

LGUs, meqUitles prevail as some cIties

that are fmanclally self-sufficient receive

more IRA allocations than some

LGU Financzng Present Sources, AVailability and Terms

municipalities that have insufficient

financial resources and limited access

to finanCing.

c. LGUs to improve local resource

mobilization and enhance credit­

worthiness through progressive

expansion of their local resource

base. LGUs should Implement steps

to enhance their local resource base,

Including timely review and update of

property assessment rates, efficient

collection of business, community and

assistance to LGUs should Include thiS

type oftechnlcal assistance. LGUs will

require Institutional development

assistance, In financial planning,

treasury management, budgeting,

Investment PriOritization, project

development and evaluation ASide

from thiS, stand-alone LGU capaclty­

bUilding programs coordinated with

different agencies such as the DILG and

the DOF, GFls and private sector

agencies, should be explored

real property taxes and prudent, e. Government and private sector to

transparent and JudicIous use of LGU

resources and proper financial

planning The National Government

thru the DOF, should also review the

tax administration policies embodied

In the LGC to maximize the tax

revenues for LGUs such as the extent

of exemptions, differential tax rates, tax

collection and tax collection costs and

revenue administration among

different local governments.

d. Government and Multilateral and

Bilateral Agencies to formulate

together with the LGUs, programs

to develop a "fast-track" LGU

"capability building" training

program. DISCUSSions are now being

conducted between the OOF and

multilateral and bilateral agencies to

provide technical assistance to LGUs

for project preparation and execution,

financial capacity building and

performance monitoring. The

Government has to ensure that new

programs extending financial

46

aggressively promote alternative

LGU financing schemes and

establish an LGU credit rating

agency. The paper analyzed different

finanCing options and credit

enhancements available to LGUs, for

example, municipal bond finanCing,

multilateral Infrastructure funds, and a

private sector guarantee faCility

Current efforts to promote these

alternative finanCing options such as

the monthly LGU finanCing seminar

series sponsored by the OOF and the

CCPAP BOT Center should be

expanded A systematic and sustained

promotional effort should be developed

With participation of the government

and the private sector financial

Institutions Current efforts to establish

an LGU credit rating agency must be

pursued to gUide lenders and Investors

In making good Investment deCISions.

The DILG and OOF should formulate

programs to enhance the credit­

worthiness of LGUs, and to Improve the

credit rating of the less-creditworthy

LGU Financing Present Sources, Avatlabilzty and Terms

LGUs to Improve their access to

financing sources

f. CCPAP BOT Center to continue to

participation To effectively carry out

these tasks, the BOT Center staff

complement should be strengthened.

aggressively promote BOT schemes g. Government to explore creation of suitable for LGU infrastructure a fee-based "Project Development

projects. BOT schemes provide the Fund" for LGUs. The lack of financing

LGUs an alternative source offlnanclng

that has proven to be efficient,

attractive and effective The CCPAP

BOT Center should continue to expand

Its efforts to promote BOT schemes to

LGUs Because of the recent Initiatives

of LGUs to consider other forms of

private secto r pa rtl c I patio n In

Infrastructure development, such as

JOint ventures, leasing and

conceSSions, the mandate of the BOT

Center should be expanded to promote

and provide technical assistance on

these other forms of private sector

47

for project feasibility studies has been

a major Impediment In Implementing

Infrastructure projects by LGUs. One

possible solution IS to explore

establishment of a revolving fund that

will finance project feasibility studies

for LGU projects. The fund could be

participated In by a number of Investors

Including GFls, multi-lateral and

bilateral agencies, and private sector

Investors. The funds disbursed to

finance the feasibility studies could be

repaid by the successful proponent of

the project to ensure sustalnabllity.

LGU Financmg Present Sources, Avazlabihty and Terms

CONCLUSION

The Local Government Code (LGC)

represents landmark legislation In the local

economic and political governance In the

Philippines Consistent with the objectives

ofthe LGC, the devolution of baSIC services

and Infrastructure developmentto the LGUs

has brought these progra ms closer to those

who would directly benefit from It, I.e the

LGUs and ultimately, the people at large

Local officials In prOVinces, cities,

municipalities and barangays are

increasingly taking the lead In shaping the

Bilateral and multilateral institutions are

now actively Involved in proViding long-term

finanCing with their various programs. New

financing options for the LGUs are gaining

a foothold - BOT schemes, mUniCipal bond

finanCing, and provincial equity funds.

These should be further refined, enhanced

and promoted. Lastly, the Government IS

actively pursuing institutional development

and capacity-building programs for LGUs

Now the challenge IS for the LGUs to

pattern of development. However, the do their share. They must Improve their

main challenge of how to finance thiS

Increased responsibility remains The

paper assessed the means and

recommendations to address thiS

challenge; what IS needed IS for those

Involved In LGU financing to be Vigilant In

pursuing their objectives and Implementing

their respective programs

The Government, through the OOF, IS

setting the pace for developing the LGU

finanCing market. It's new viSion and policy

framework for LGU finanCing has been

widely disseminated, and Implementation

IS being vigorously pursued. Government

financial institutions continue to be In the

forefront, plaYing an active role In the

finanCing of LGUs' development projects

creditworthiness by Intensifying their

revenue-collection efforts to increase local

finanCial resources. They must proactively

strive to correct the market perception that

lending to LGUs entails high risks because

ofthe political succession issue They must

build-up their operational and financial

capacity to be able to take full advantage

ofthe finanCing programs offered by various

financial institutions. Finally they must

come up with financially viable and

economically sustainable projects to attract

various sources of finanCing. It IS with the

cooperation of every Individual entity

Involved In LGU flnanclngthatthe LGUs will

be able to successfully Implement their

development programs and Improve

delivery of baSIC services and Infrastructure

Commercial banks are now becoming requirements

aware ofthe large and lucrative LGU market

and with the advent of the LGUGC, are 0 0 0

expected to playa major role in the market.

Previous-Page :Blank 49

ANNEXES

51

Previo'LlS Page Blank

~ I I

PERCENTAGE OF IRA TO TOTAL LGU INCOME 1991-1996

YEAR PROVINCES CITIES

1991 46.6 33.0 1992 70.2 47.2 1993 75.7 52.5 1994 76.1 50.8 1995 74.9 45.9 1996 72.9 32.5

Source: Bureau of Local Government Finance, Department of Finance (DOF)

MUNICIPALITIES ALL LGUs

43.6 40.7 55.1 55.9 62.6 61.9 61.3 61.2 67.8 61.4 64,3 53.8

~ >< .......

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PERCENTAGE OF LOCALLY GENERATED FUNDS TO TOTAL LGU INCOME

1991-1996

YEAR PROVINCES CITIES

1991 31.2 66.2 1992 28.0 52.6 1993 22.9 47.0 1994 22.1 48.9 1995 21.3 53.7 1996 26.5 67.1

Source: Bureau of Local Government Finance, Department of Finance (DOF)

MUNICIPALITIES

54.0 42.8 35.8 36.9 30.1 34.0

ALL LGUs

56.1 42.8 37.0 , 37.6 36.8 45.3

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55

ANNEX 4 Page 1 of 8

LANDBANK

TheLGU Lending Program

57

~LANDBANK LAND BANK OF THE PHILIPPINES LGU LENDING PROGRAM

ELIGIBLE BORROWER

Provinces Cities Municipalities

LOAN PURPOSE

That are rated Medium grade or higher

ANNEX 4 Page 2 of 8

To finance local infrastructure and other socio-economic development projects under the LGU's local development plan

LOAN AMOUNT

Based on the requirement of the project, but not to exceed the Net Borrowing Capacity as defined in Art. 419 of the Local Gov't Code.

LOAN TERM

Based on LGU's cash flow, but not to exceed 5 years.

Maximum grace period on the principal is 2 years.

INTEREST RATE

Prevailing Market Rate

COLLATERAL

• Hold-out on Deposits

• Real Estate Properties - not devoted or intended for public use or public service for the development of national wealth.

• Machineries & Equipment

• Deed of Assignment on:

LANDBANK OF THE PHILIPPINES 319 Sen Gil PuyatAvenue Ext MakatiCity Tel Nos. 818-9411t029

58

IRA Regular Taxes Net Profit I Income

P.O. BOX 1108 Cable "LANDBANK"

~LANDBANK ANNEX 4 Page 3 of 8

CONSIDERATIONS LGUs MUST TAKE FOR CREDIT FINANCING TO PROSPER

• Project a strong image political leadership. Local government of­ficials must assume the role of marketing managers -- projecting a lot of sense and a lot of savvy.

• Have the right projects. In the final analysis, the financial market will support only those bond issues which will be used for produc­tive markets. In the same say, project viability is a major criteria used by banks in evaluating loan applications.

• Project a positive image in the market. Clean, peaceful, and work­ing communities attract the markets attention.

• Have the properties to back up the security.

• Display disciplined and progressive management of its financial resources.

• Exhibit continued improvement in its non-debt related finances. LGU capacity to pay will be determined by the taxes and fees it can collect.

The potential for LGU credit financing are vast ifLGU s pursue the appro­priate structures conducive to the market and a stable macroeconomic environment for savings and investment is established.

LANDBANK OF THE PHILIPPINES 319Sen Gil PuyatAvenue Ext. MakatiCrty Tel. Nos. 818-9411 to 29

59

PO. BOX 1108 Cable "LANDBANK"

~LANDBANK ANNEX 4 Page 4 of 8

SPECIFIC ACTIONS LGUs MUST TAKE PRIOR TO AVAILING OF A CREDIT FINANCING SCHEME.

• prepare an inventory ofLGU assets which can serve as collateral or security to credit or bond finance.

• establish and maintain a local revenue data which is the key to an effective and efficient revenue collection system.

• create a team to identify and evaluate projects.

• task the Local Development Council and the Local Finance com­mittee to: 1. formulate realistic, cost effective, long-term and medium­

term economic development plans and policies. 2. formulate medium-term and annual public investment pro­

grams. 3. conduct an inventory of critically needed, potential high

return, revenue-generating projects.

• get the attention of banks and other potential investors.

• seek and respond to special training and orientation oportunities that will be established on credit finance by varied institutions.

• have sustained public information system that will educate the LGU populace.

• provide for an improved and efficient fiscal administration system.

LANDBANK OF THE PHILIPPINES 319 Sen Gil PuyatAvenue Ext. MakatlCrty Tel. Nos 818-9411 to 29

60

P.O. BOX 1108 Cable "LANDBANK"

•

(i)LANDBANK ANNEX 4 Page 5 of 8

GENERAL PRINCIPLES LGU POLICY MAKERS SHOULD CONSIDER

LGU must maintain its fiscal credibility always.

It must aim to have a sound record of meeting programmed fiscal obliga­tions at all times.

•

•

•

Accept that expanded local financial resources will be essential in order to meet increased local powers and obligations.

Consider a second policy judgement that in all probability the LGU by itself will lack the human and financial resources to mobilize and operate the necessary development and revenue-generating projects essential to support effective local economic and social growth un­der the new Code. Hence, it will have to engage the private banking and business sectors with vigor and care.

The LGU leadership (executive, legislative & technical) MUST start and sustain the initiative.

LANDBANK OFTHE PHILIPPINES 319 Sen Gil Puyat Avenue Ext MakatlCrty Tel Nos. 818-9411 to 29

61

P.O. BOX 1108 Cable "LANDBANK"

~LANDBANK ANNEX 4 Page 6 of 8

LANDBANK OF THE PHILIPPINES LGU LENDING PROGRAM

PRE-RELEASE REQUIREMENTS

Loans to LGUs shall be covered by the regular documentary requirements for regular loan accounts. In addition, the following documents shall be required.

a. BORROWING RESOLUTION passed by the Sangguniang Panglungsod and ex­pressly: • confirming, approving and ratifying all previous representations and warran­

ties and all the terms and condjtions of the loan, and authorizing the Local Chief Executive to sign all documents pertaining to the loan;

• designating the person authorized to negotiate and sign all documents per­taining to the loan;

• authorizing the mortgage/assignment of certain personal and/or real proper­ties and declaring that the properties offered as collateral are patrimonial and not actually devoted to public use and prohibiting the conversion of said properties to public use or service;

• committing not to contract other loans/credits with other creditors/banks as to impair the LGU's paying capacity for the duration of the loan;

• directing the LGU Treasurer and the accountant to enter the loan in the ap­propriate books of the LGU;

• designating LBP as the LGU's major depository bank for IRA and for its other deposits which designation shall be revoked while the loan obligations remain outstanding and directing the LGU Secretary to provide a copy of this Resolution to DBM or other IRA-administering office;

• appropriating the amount for loan repayment in the LGU's annual budget until the loan, interest and other charges are fully paid;

• undertaking by the LGU to secure from DBM a written certification of its commitment to withhold the LGU's IRA in favor of LBP in the event of payment default;

• authorizing LBP to deduct for set-off and/or deduct amounts from any de­posits or funds of the LGU with LBP and apply the same to the payment of the loan or any portion thereof, or interest and penalties thereon as may be deemed necessary to LBP.

LANDBANK OF THE PHILIPPINES 319 Sen Gil Puyat Avenue Ext. Makati City Tel. Nos. 818-9411 to 29

62

P.O. BOX 1108 Cable "LANDBANK"

(i)LANDBANK

LAND BANK OF THE PHILIPPINES LGU LENDING PROGRAM

PROCESSING REQUIREMENTS:

ANNEX 4 Page 1 of 8'

• Sangguniang Resolution authorizing the Local Chief Executive to negotiate a loan with LBP

• Budget for the Current Year • COA Audited Financial Statements for the past 3 years • List of Elected Officials and Key officers • Schedule ofLGU's IRA for the past 2 years • Feasibility Study • Regular Documentary Requirements pertaining to offered collaterls • F or Projects involving Construction

• Cost Estimates • Plans and Specifications • Bill of Materials • Work Program / Schedule duly approved by the Local Chief Executive and the

CitylDistrict Engineer • F or Acquisition of Machinery and Equipment

• List of Machinery and Equipment, its Description & Estimated Cost based on firm Quotation

• Guarantee from the Dealers/Suppliers as to the Availability of Spare parts in the Local Market

LANDBANK OF THE PHILIPPINES 319 Sen. Gil PuyatAvenue Ext. MakatiCrty Tel Nos. 818-9411 to 29

63

P.O. BOX 1108 Cable "LANDBANK"

~LANDBANK ANNEX 4 Page 8 of 8

• authorizing the local chief executive to sign, execute, endorse and deliver any and all deed of assignments, loan agreements, real estate mortgage and other docu­ments, papers and deeds as may be necessary and proper for the implementatIOn of the authorities and directives contained in the resolution.

• authorizing DBM to deposit and remit directly the LGU's IRA to LBP for the LGU's account.

b. BUDGET APPROPRIATION OR CERTIFICATION of the budget officer and local treasurer, noted by the Governor that; • the prmcipal and interest repayments on the loan have been duly appropriated,

and • full provision has been made by the LGU for all its obligations.

The LOU shall annually appropriate in their respective budgets such amounts sufficient to pay the loans and other indebtedness or contractual obligations. For this purpose the LGU shall annually submit to LBP a certification on the appropriation.

C. CERTIFICATION BY THE LGU TREASURER, noted by the Local Chief Executive, that the proposed sources of repayment are available and not restricted by law or Its other obligations.

d. DEED OF ASSIGNMENT OF THE IRA in favor ofLBP containing the following: • Said assignment shall be irrevocable until the loan, including interest and other

charges due thereon is fully paid; • In the event the IRA is directly remitted by the DBM to the LGU, the LGU shall

agree to deposit immediately to LBP the proceeds of the said IRA;

e. DEED OF UNDERTAKING by the LGU to secure from DBM a written certfication of its commitment to withhold the LOU's IA in favor of LBP in the event of payment default;

f. CERTIFICATION BY THE LGU'S TREASURER AND ACCOUNTANT, noted by the Governor, that the contractual obligation I loan was entered in the LGU books of account.

LANDBANK OF THE PHILIPPINES 319 Sen Gil PuyatAvenue Ext Makati City Tel Nos 818-9411 to 29

64

P.O. BOX 1108 Cable "LANDBANK"

ANNEX 5 Page 1 of 6

DEVELOPMENT BANK OF THE PHILIPPINES

LENDING PROGRAM FOR

LOCAL GOVERNMENT UNITS (LGUs)

65

ANNEX 5 Page 2 of 6

I. Objective:

Provide loans to qualified LGUs for projects which will enhance/facilitate the delivery of basic services to their constituents and at the same time, capture sizeable deposits from LGUs.

ll. Pregualification Criteria for Eligible LGUs:

To qualify under the Program, the province, municipality or city shall:

1. have beneficiary population of at least 10,000;

2. perform important local, commercial, transportation, industrial, educational or similar activities;

3. have gross annual average revenues of at least P3. 0 MM over the last three years;

4. have balanced or surplus prospective income streams for the next three years (computation to be validated by the concerned RMTlBranch;

5. have no adverse findings from banks and major suppliers both for the LGU and the current Chief Executive and Treasurer; and

6. have shown efficiency in the collection of real estate and other local taxes based on the steady growth rates over the last three (3) years.

ID. Eligible Projects:

1. Revenue-generating projects include, but not limited to public markets, slaughterhouses, transport terminals, municipal water systems, storage/refrigeration facilities, and hospitallhealth facilities which are self­liquidating;

2. Projects under the PCCD-CEP are primarily designed for income generation by barangay residents who will be organized into 4 to 6 member groups which will be funded by the LGUs out of the loan proceeds from GFIs like DBP. Initially, the pilot operation will cover 40 pre-identified barangays located at the 20 priority provinces. For the expanded operation, 4,000 out of 42,000 barangays will be targeted annually;

3. Non-revenue generating projects include but not limited to construction of roads and bridges, and acquisition of heavy equipment which are not intended to generate revenues but to enhance efficiency in the provision of services to their constituents;

66

ANNEX 5 Page 3 of 6

4. The project to be financed shall have passed the first and second screenings following the Simplified Screening Criteria of World Bank (available with DBP);

5. The project to be financed shall be included in the approved local development plan and public investment program (Local Government Code Section 296);

6. The project shall be duly endorsed by the local council as evidenced by the relevant enabling resolution.

"IV. Features ofthe Loan:

1. Amount of Loan:

a Window ill Loans

I. Revenue-Generating Projects - The minimum-maximum loan limits shall be PIMM and P50MM, respectively, subject to periodic review by WINCOM, and with a minimum equity participation of at least 15% of the total project cost;

2. PCCD-CEP Projects - P1.5MM per Barangay Business Center

b. Loans Secured by Deposits - Total project cost but not to exceed 50% of the ADB deposits of the past six-month period reckoned from the preceding month which shall be maintained during the term of the loan and covered by a "Hold Out Agreement".

2. Terms of Payment:

a. Window ill Loans

1. Revenue-Generating Projects - The term of the loan shall be kept within project requirements and projected cashflows. Maximum term of the loan is twelve (12) years inclusive of a maximum grace period of two (2) years. The loan shall be payable monthly, quarterly or semi-annually depending on the cash generation of the project.

2. PCCD-CEP Projects - Maximum of 5 years inclusive of up to one year grace period payable quarterly. The on-lending terms from Barangay Business Centers to their respective group members is maximum of 2 years inclusive of up to 6 months grace period payable monthly.

b. Loans Secured by Deposits - Maximum of five (5) years payable monthly.

67

ANNEX 5 Page 4 of 6

3. Interest Rate:

a. Window III Loans -_ Variable and reviewable every January 1 and July 1 based on prevailing 91-day T -Bill rate plus two (2 %) provided that the rate is not higher than "AAAA" .

PCCDP-CEP - The LGU shall be charged 12% p.a. to be passed on to the BBC without spread. The on-lending rate by BBC is 14% p.a.

b. Loans Secured by Deposits - Based on the formula prescribed in ALMA Circular No. 01-95 covering the Revised Guidelines for Loans Secured by Deposits.

4. Drawdown:

Drawdown shall be one time or in multiple basis. The loan proceeds shall be credited to a special project account to be opened by the LGU with DBP, withdrawals of which shall be subject to approved operating guidelines of the loan.

5. Collateral Requirements:

F or Window III Loans:

Loans with maturities beyond 5 years shall be secured by:

a. Registered fIrst real estate mortgage andlor registered fIrst chattel mortgage in favor ofDBP, with loan values based on existing DBP policy, subject to fInal verifIcation by DBP;

b. Such other collateral or security arrangements as may be acceptable toDBP.

Loans with maturities of up to 5 years shall be on best efforts basis. In addition, the following shall be obtained:

a. Assignment of a specifIed portion/amount of the LGU's Internal Revenue Allotment (IRA) in favor ofDBP in an amount at least equivalent to one (1) amortization payment which shall be maintained while the loan is outstanding. For PCCD-CEP Projects, this would be sufficient;

b. Assignment of profIts or income from the project to be fInanced until the loan is fully paid;

68

ANNEX 5 Page 5 of 6

c. Endorsement in favor ofDBP of insurance policies on mOr):gaged properties. The insurance shall be placed, based on sound value, by DBP, through its appointed insurance broker.

For Loans Secured by Deposits :

Project assets and deposit agreement with a minimum balance of 200% of the outstanding balance of the loan and shall automatically be applied to the loan in the event of default.

6. Other Conditions:

a. The LGU shall include appropriation for debt amortizations in its annual budget in accordance with the LGC until the loan shall have been fully paid.

b. The LGU shall maintain a Special Depository Account under the General Fund, where repayment of obligations to DBP shall take precedence after operating expenses of the project. Only when the debt amortizations have been satisfied will excess form part of the General Fund.

c. The LGU shall open a CASA account for the assigned IRA with the understanding that DBP shall automatically offset the amortization for the period against this deposit account. A minimum balance equivalent to one amortization payment shall be imposed.

d. The LGU shall execute a Deed of Undertaking making DBP its main depository bank.

e. The LGU shall maintain a debt service cover of at least 1.2 times. Debt service coverage is defined as yearly revenue from all sources less operating costs and maintenance expenditures, divided by yearly debt service to all creditors.

f. The LGU shall constitute a Local Prequalification, Bids and Awards Committee (pBAC), which shall primarily be responsible for the conduct and prequalification of contractors, bidding, evaluation of bids and recommendation of awards concerning the Project, with at least one (1) DBP representative as an observer.

g. The LGU shall constitute a Local Technical Committee, which shall primarily be concerned with providing technical assistance to the local PBAC, with at least one (1) DBP representative.

69

ANNEX 5 Page 6 of 6

h. The LGU shall commit to establish a project office with full-time staff and operating budget for project preparation/implementation.

1. The LGU shall constitute and commission a competent consultancy firm to be tasked with validating and certifying the acceptability and compliance with the approved specifications of all acquired materials and supplies.

J. The LGU shall only engage the professional services of such parties and commission such works as are customary for industrial development operations and projects similar to the financed project, which services must be reasonably priced, considering the quality and competence of the parties rendering them and in case of works, the technical quality and competitive costs of the same, if approved in writing by the DBP.

k. The LGU shall submit resolution passed by the appropriate Sangunnian Board (panlalawigan, Panlunsod or Pambayan) expressly authorizing the ff.:

1. The loan being contracted by the local Chief Executive;

2. The Authority of the local Chief Executive (Governor or Mayor) to negotiate and enter into the contract of the loan applied for and to mortgage or assign or otherwise into a collateral agreement to secure the payment of the loan applied for;

3. The continuing assignment of the LGU's applicable portion of its IRA, realty taxes and all other revenues to DBP until the loan is fully paid;

4. The continuing assignment of profits or income from the project/economic undertaking to be financed until the loan is fully paid;

5. Authorization to the DBM for it to remit the IRA for deposit to the account of the LGU with DBP duly acknowledged/received by

DBM, Manila;

6. The authority for the Mayor and/or Treasurer to open and maintain deposit account with DBP where its IRA and revenues shall be deposited during the term of the loan; and

7. Authority for DBP to debit the LGU's deposit account to cover payments of its loan obligation with the Bank.

70

;fl

"-I 1-1

MUNICIPAL DEVELOPMENT FUND LENDING (MDF) As of March 1998

PROJECT

Regional Cities Development Project

Program for Essential Municipal Infrastructure Utilities, Maintenance and Engineering Development I (PREMIUMED I)

PREMIUMED II Project

Second Municipal Development Project

Metro Cebu Development Project I

Metro Cebu Development Project I

Bukidnon Integrated Area Development Project

Philippine Regional Municipal Development Project

Misamis Oriental Telephone Extension Project

TOTAL

11 At current exchange rates. 21 Overseas Economic Cooperation Fund of Japan

AGENCY

World Bank

World Bank

World Bank

World Bank

OECF 21

OECF

Asian Development Bank

Asian Development Bank

Korean Exlm Bank

AMOUNT OF LOAN (US DOLLAR EQUIVALENT) 11

39.5

40.0

68.0

40.0

16.0

33.5

20.0

30.0

3.0

290.0

§ ~

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ANNEX 7

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72

ANNEX 8 Page 1 of 13

PHILIPPINE NATIONAL BANK

LOANS TO LOCAL GOVERNMENT UNITS (LGUs)

73

ANNEX 8 Page 2 of 13

PNB LOANS TO LOCAL

Go UN II'S

L Purpose of the Loan

II Eligible Borrowers

ill. Amount of the Loan

N. Term of the Loan

v. Interest Rate

VI. Collaterals

VII. Other Terms and Conditions

VTII. CJhecklistofProcessb1g Requirements

:IX. Pre-Approved Credit Facility for all LGU's

74

L Purpose of the Loan

1. To imance the establishment,

development, or expansion of income

generating projects

such as:

a. ) Revenue-Generating / Cost Savings

• Public Market

• Trading Center / Tenninal

• Water System (Construction /

Expansion)

• Asphalt Plant

• Heavy Equipment

• Telephone System

• Commercial Center

• Slaughter House

• Grains Procurement / Trading

• Post-Harvest Facilities

75

ANNEX 8 Page 3 of 13

ANNEX 8 Page 4 of 13

b) Others

• Irrigation

• Renovation / Construction of City /

Capital Town's Municipal Hall

• Purchase of Lots

• Reclamation

• Sports Complex

• Diagnostic Equipment / Building

• Road Construction / Repair

• Hospital Building with Pay Wards

• School Building

2.) To finance acquisition of property, plant, machinery, equipment, and necessary accessories for the implementation of the items enumerated in the preceding section.

Note: Combination of revenue & non-revenue generating project in one loan package.

76

II. Eligible Borrowers

•

•

•

Municipality

City

Province

III. Amount of the Loan

ANNEX 8 Page 5 of 13

The amount of the loan is equivalent to

the project's requirement (100%) but not

to exceed the aggregate of five times (5x)

the sum of the 20% portion of the Annual

regular income and the Annual Internal

Revenue Allotment (IRA) share of the

LGU.

77

ANNEX 8 Page 6 of 13

IV. Term of Loan

Maximum of seven (7) years provided

that amortizations shall be payable on a

monthly or quarterly basis. A longer

term may be considered by PNB Board

of Directors, if justified.

v. Interest Rate

Interest rates shall be Prime Rate Based subject to periodic interest resetting.

78

ANNEX 8 Page 7 of 13

VI. Collaterals

Assignment of applicable regular income

of the LGU, Internal Revenue Allotment

share of LGU and Net Revenue

generated by the project financed.

Chattel Mortgage of Equipment Financed by the Loan.

Real Estate Mortgage on Patrimonial property of Local Government Units.

79

ANNEX 8 Page 8 of 13

VII. Standard Conditions

A. COIYfMON CONDmON

1. Submission of a Resolution of the Sangguniang Bayan / Panlungsod authorizing the loan and designating the Local Chief Executive (LCE) as the authorized signatory. The resolution should also

contain the following:

a) The continuing assignment to PNB of the project revenue (if applicable), LGU's applicable portions of the Internal Revenue Allotment (IRA), realty taxes and all other revenues until the loan is fully paid;

b.) The authorization of the LGU to the Department of Budget and Management (DBM) for the remittance of all its IRA thru PNB for deposit to the LGU's account maintained WIth PNB;

c.) The duly notarized undertaking of the LCE and / or Treasurer to remit to PNB applicable portion of the LGU's realty taxes and other revenues on a monthly basis as payment of the amortIZations on the loan~

d.) The authority for the LCE and/ or Treasmerto maintain the LGU's deposit account with PNB wherein the project's revenues, the LGU's IRA and other revenues shall be deposited until the loan is fully paid and the PNB to debit the LGU's deposit accounts to cover payment of its obligations;

e.) The duly notarized undertaking of the LGU to include in its annual budget its loan obligations with PNB:

80

ANNEX 8 Page 9 of 13

9.) All insurable improvements fInanced by the loan shall be insured up to the full insurable value and policy endorsed in favor of the Bank.

10.) All applicable provisions ofPNB's standard loan conditions and such other conditions our Legal Department may impose to protect the interest of the Bank.

B.) LOANS FOR MACHINERY / EQUIPMENT / VEHICLE

1.) Loan proceeds shall be paid directly to the supplier I seller of the equipment I vehicle in an amount equal to the selling price or amount of the approved loan whichever is lower.

2.) If to be imported, the letter of credit shall be opened at the Bank and the loan proceeds be equivalent to the:

a) corresponding import bill upon negotiation .computed at the prevailing selling rate at the time of negotiation.

b. ) amOlmt of the LC in case of cash LC computed at the prevailing selling rate on LC opening date.

3. ) LGU to execute a chattel mortgage on the equipment within 60 days upon acquisition.

4.) Submission of a duly notarized certification that all govern­ment policies rules and regulations in the award of the con­tract to the local supplier have been complied with.

81

ANNEX 8 Page 10 of 13

2. Submission of the LGU~s letter-authorization to the DBM forthe latter to remit all IRA directly to PNB for deposit to the LGU's account with PNB until the loan is fully paId, duly aclmowledged / received by DBM, Manila

3.Submission of a duly notarized-certification by LGU that:

a.) the 20% limit provided under Law in the servicmg of loan obligations have not been exceeded;

b.) Legible copies of the Loan Agreement and Secmity Agreement have been posted at the conspicuous place in the Municipality / City Hall / Provincial Capitol;

c.) The proposed sources of repayment of the loan are available and not restricted by law.

4.PNB shall continue to be the LGU's principle depository Bank until such time the loan is fully paid.

5. Approval and confirmation by the Sangguniang BayaniPanlungsod of the terms of the covering Credit Agreement and all other documents executed by the LeE in the implementation of the loan.

6. Undertaking by the LGU that they will not incur additional obligation/indebtedness without the written consent ofPNB which consent will not be unreasonably withheld.

7. Any amount :in excess of the approved amount of loan shall be shouldered by the LGU.

8. S ubj ect to SEL C ir. 4-3 15/94 Of May 1 7, 1994 on Interest Rate Setting and Adjustments.

82

ANNEX 8 Page 11 of 13

C. FOR CONSTRUCTIONIDEVELOPMENT LOANS

1. Releases shall be on staggered basis which are to be made only upon presentation of progress report and billing certi­fied by the project engineer and the MunicipallCity/Provin­cial Engineer and approved by the project owner and to be validated by the Bank appraisers.

2. Where the contract calls for a mobilization outlay, such amount for initial release shall not exceed 15% of the ap­proved loan.

3. SubmissIOn of a duly notarized certification that all f!ovem-~ -

ment policies, rules and regulations in the award of the project to the contractor have been complied with.

4. PNB shall have the option to buy or lease a space of its choice for a branch site within the project to be financed.

83

ANNEX 8 Page 12 of 13

CHECKLIST OF PROCESSING REQUIREMENTS

Name of Applicant Loan Applied for

1. Application letter or duly accomplished application for loan.

2. Sangguniang Resolution authorizing the Chief Executive of the LGU to negotiate and enter into a contract in behalf of the LGU for the purpose of securing a loan with PNB.

3. Charter or equivalent document creating the LGU.

4. Profile of the LGU. (Background, locatio~ land area., popu­lation, economic activity~ etc.)

5. List of elected and key officers.

6. COA audited financial statement for the past three (3) years.

7. In case there are COA exceptions in the financial statements, submIt eOA certifications and/or LGU's statement of compliance / actions being taken on these exceptions, duly noted by e~A.

8. Notarized Summary Statement of all Statutory and Contractual Obligations certified by the CitylMunicipa1i Provincial Treasurer/Accountant.

9. Budget for the current year and Projected Income Statement for the term of the loan applied for (max. of7 years).

10. LGU's Internal Revenue Allotm~t (IRA) for the past three (3) years and PrQjected IRA for the term of the loan (max. 7 years).

84

ANNEX 8 Pag-c.; 13 of 13

11. Project Feasibility Study and Projected Cash Flows of the project.

12. Summary of Projects and Acnvlties to be accomplished.

13. A Certification from the LGD that the proposed sources of repayment are available and not restricted by law or its other obligations.

If the purpose of loan IS for the acquzsitzon of machinery and eqUlpment:

14. Price quotations from at least three (3) suppliers. Provision for spare parts maintenance (Motor pool) team for the preservation & service of machinery and equipment

If [he purpose of loan IS for the constractzon of a commercIal building:

15. Canvass of prevailing lease rates of similar commercial/ stalls/spaces in neighboring towns/cities.

If collateral offered znclude real estate property:

16. a) Torrens Title; b) Building plans, ifland has improvements; c) Certified location plan~ d) Real Estate Tax receipts for the current year; e) Tax Declaration; f) Photographs of improve ments.

17. Others: (CIR.;lAR; to be conducted by the nearest PNB Branch).

NOTE: Processing of loan application will start only upon sub­mission of the complete requirements.

85

ANNEX 9 Page 1 of 8

MULTINATIONAL INVESTMENT BANCORPORA TION

MUNICIPAL BOND ISSUANCE

87

ANNEX 9 Page 1. or S

BRIEFING ON MUNICIPAL BOND ISSUANCE

1. What is a Municipal Bond? 2. Legal Basis for Bond Issuance 3. Advantages of Issuing a Municipal Bond 4. Participants and their Roles 5. Bond Flotation Mechanics 6. Timetable for Bond Issuance 7. Collateral for Bond Issuance 8. Approval/Clearances required from Government Agencies 9. Constraints of Bond Flotation on the part of the LGUs & the Investors

FINANCING OPTIONS FOR LGUs

LGUPROJECT

BOND

A promise to pay a specified sum of money at a fixed time in the future at a given number of years from issuance and a promise to pay interest periodically at specified dates at a fixed rate or floating rate.

A bond similar to a promissory note but is made in standard denominations and is negotiable.

88

MUNICIPAL BOND

ANNEX 9 Page 3 of8

A Bond issued by a Province, City or Municipality to finance self-liquidating, income-producing development or livelihood projects as provided for by the Local Government Code of 1991 (RA 7160)

ADVANTAGES OF MUN1CIPAL BONDS

o Generates people participation in Local Governance o Enhances transparency in Project Development o Enables LGUs to establish Creditworthiness in the financial market o Eases pressure on taxes as primary source of funding o Stimulates Local Economy o Harnesses Countryside Capital o Contributes to the country's Capital Markets

LEGAL BASIS FOR BOND ISSUANCE

o Republic Act 7160 - Local Government Code of 1991

o Section 296. General Policy - (a) It shall be the basic policy that any local government unit may create indebtedness, and avail of credit facilities to finance local infrastructure and other socio-economic development projects in accordance with the approved local development plan and public investment program.

o Section 299. Bonds and other Long Term Securities - Subject to rules and regulations of the Central Bank and the Securities and Exchange Commission, provinces, cities and municIpalities are hereby authorized to issue bonds, debentures, securities, collaterals, notes and other obligations to finance self-liquidating, income-producing development and livelihood projects.

89

ANNEX 9 P,lge 4 of 8

BASIC P ARTICIP ANTS AND BOND MECHANICS

TIlE BORROWERS TIlE INVESTORS BORROW FROM ... ...

Indivlduals Provinces .. CorporatlOns Cities LEND TO Municipalities Financial Institutions

Other Accounts

WITH THE ASSISTANCE

TIlE UNDERWRITING TEAM

Financial Advisor Managing Underwriter

Guarantor Trustee Bank Bond Counsel

LEGAZPI CITY SUERTE BONDS

o ISSUER o PURPOSE

o AMOUNT o TERM o INTEREST

o PRINCIPALPAYMENT o SECURITY o DENOMINATION

City of Legazpi To partially fund a Socialized Housing Project Php 26 Million 2 years 15% per annum payable Quarterly in arrears Bullet Guaranteed by the HIGC Php 5,000; Php 10,000; Php 100,000 & Php 500,000

COLLATERALS THAT CAN BE USED FOR A BOND ISSUE

o 20% of the IRA o For housing projects - an HIGC guarantee o For other projects - guarantee by LGU guarantee Corporation o A standby LC issued by a GFI o Prime Real Estate Property

90

1HE BOND ISSUANCE PROCESS

1 PROJECf IDENTIFICATION & EVALUATION 0 Type of ProJect/Busmess Activity

0 Project SIZe .. 2 SANGGUNIAN APPROVAL FOR THE PROJECf AND AUTHORITY TO

ISSUE BONDS TO PARTIALLY FINANCE THE PROJECT .. 3 HllUNG OF FINANCIAL ADVISOR

• 4 DESIGN OF A FINANCIAL PLAN

.... 5 SELECfION OF THE UNDERWRITING TEAM ..

6. NEGOTIATION ON BOND TERMS AND CONDITIONS .. 7. PREPARATION OF DOCUMENTS AND AGREEMENTS

... 8 SANGGUNIAN APPROVAL ON FINAL BOND TERMS AND

INCLUSION IN THE BUDGET

... 9. IF A HOUSING PROJECf, ARRANGE GUARANTEE BY HIGC

... 10 SECURE APPROVAL FOR CONVERSION OF AND FROM

AGRICULTURAL TO HOUSING COMMERCIAL PROPERTY IF REAL ESTATE WILL BE INVOLVED ..

11 PREPARATION OF UNDERWRITING DOCUMENTS AND OFFERING PROSPECIDS ..

12. OBTAIN BSP'S FAVORABLE OPINION ON BOND ISSUE

... 13. GET SANGGUNIANG PANLALAWIGAN APPROVAL ON THE ISSUE

IF A CITY OR MUNICIPALITY

.... 14 BOND OFFERING SALE AND ISSUANCE

+ 15 DEBT SERVICING BY THE ISSUER

91

ANNEX 9 Page 5 of 8

ANNEX 9 Page 6 of 8

GOVERNMENT AFPROV ALS/CLEARANCES

o Sangguniang Panlalawigan approval of Bond Issuance by the LGU o BSP opinion on effects on monetary aggregates, price level and balance of payments o DAR clearance for conversion of land from agricultural to residential

CONSTRAINTS IN A BOND ISSUE

A. On the part of the LGUs:

o Some projects have long payback periods o LGUs want to tie up non-revenue infrastructure projects with self liquidating

projects o Preparation of project studies o Self liquidating projects are less than Php 10 million o LGUs do not have sufficient collaterals o Bond term is too short

B. On the part ofthe Investor:

o Interest income is subject to 20% withholding tax o No guarantee on loans (other than housing) o No secondary market for bonds o Issue size is small

ENHANCING THE BOND'S A TIRACTIVENESS

A. Making the interest income tax exempt

o Without tax exemption: 15 x .8 equals 12% effective rate

o With tax exemption: 15 x 8.5% (tax exemption) equals 6.5% x.8 equals 5.2% 8.5 % plus 5.2% equals 13.7% effective rate

B. Adding eligibilities to the Issue

o As liquidity floor reserves for banks o As quasi-bank deposit liabilities for non-bank financial institutions o As security deposit for insurance companies

92

EFFECT OF 20% WITHOLDING TAX ON INVESTORS WITHOUT TAX EXEMPTIONS

o 20% final witholding tax means: 15 % Interest Income

x 20% Witholding tax

3 % Tax wit held

o Therefore, effective interest rate is: 15% Interest Income

less 3 % Tax withheld

equals 12% Effective interest rate

INVESTORS WITH TAX EXEMPTIONS AS PER RA 580 "HOME FINANCING ACT"

o Sec. 25 (a) and (b) EO 535 Sec. 15 provides tax exemptions on their interest income to the extent of 9.5% these are:

o Banking and finance institutions o Trust Companies o Personal Finance and Mortgage Companies o GSIS, SSS, DBP and other GFIs o Building, Loan and Savings Association

EFFECT OF 20% WITHOLDING TAX ON INVESTORS WITH TAX EXEMPTIONS

o

o

less equals

x

less

15.0% Interest income 8.5% Tax exemptions 6.5% Interest income subject to witholding tax

20.0% Witholding tax

1.3% Tax witheld

15.0% Interest income 1.3% Tax witheld

equals 13.7% Effective interest rate

93

ANNEX 9 Page 7 of 8

ANNEX 9 Page 8 of 8

COST OF BOND FLOTATION 17.25% PER ANNUM

o Assumptions:

Php 10M 15% per annum

o Payments

1. Trustee 2. HIGC 3. Interest

% of Issue

1.00% 1.25%

15.00%

Pesos

100,000 125,000

1,500,000

COST OF BOND FLOTATION FRONT-END FEES

o Out of Pocket Expense o Printing Costs o Documentary Stamps o Advisory Fee (2.5%) o Underwriter's Fee (2%) o Selling Commission (1 %) o Bond Counsel

TOTAL Php

50,000 75,000 15,000

250,000 200,000 100,000 100,000

790,000

NET PROCEEDS OF BOND FLOTATION

Php 10,000,000 Less 790,000 Front End Fees

Php 9,210,000

94

PHILIPPINE INFRASTRUCTURE PRIVATIZATION PROGRAM PROJECT SUMMARY LIST

LOCAL GOVERNMENT UNITS (as of May 1998)

PROJECT NAME PROJECT SITE! EST. REMARKS! IMPLEMENTING COST STATUS

AGENCY (In US$ M)

ANNEX 10 Page 1 of 2

A. Completed 1. Mandaluyong Marketplace Mandaluyong Clty/ 23 Completed/operational

City Government Sub-total 23

PROJECT NAME PROJECT SITE! EST. REMARKS! IMPLEMENTING COST STATUS

AGENCY (rn US$ M)

B. Projects Under Development 1 Dapltan Public Market Dapitan, Quezon City/ 1.25 Construction on-going.

City Government 2. Binlrayan Adminrstratlve/ Blnirayan, San Jose, 3.75 Contract Awarded to

Commercial Center Antlque/ Provincial PrrmeTek Konstrukt Devt. Corp., Government Construction on-going.

3. Pateros Commercial Center Pateros, Metro Manila! 1.8 Contract awarded to Municipal Government Mega Gen.Bullders on Dec. 19, 1997;

Construction on-going. 4 Bocaue Public Market! Bocaue, Bulacan/ 5 Contract awarded to Medltech, Inc

Commercial Center Municipal Government on March 27, 1998. 5. Bacolod City Slaughterhouse Bacolod Clty/ 125 Under re-biddrng;

City Government Pre-qualification of bidders on-going. 6. Manlao Public Market! Marilao, Bulacan/ 5 Project approved by

Commercial Center Municipal Government Mun Devt Council and Sanggunrang Bayan; Study under preparation.

7. Batangas City Solid Waste Batangas Clty/ 1.6 Conceptual plan/project studycompleted; Management City Government For approval of project by city government.

Sub-total 19.65

95

ANNEX 10 Page 2 of 2

PROJECT NAME PROJECT SITE! IMPLEMENTING

AGENCY

C. Other Potential Projects Shortlisted 1. Waste Recycling Plant Payatas, Quezon Clty/

City Government 2. Caplz Hydro-Power and Water Panay River, Capizl

Supply Project Provincial Government 3 Batangas Water Supply Batangas/Provincial

Government

4 110110 City Central Public Market! Iloilo City/ CommerCial Complex City Government

5. Iloilo City Bagsakan Center/ Iloilo City/ Bus Terminal City Government

6. Butuan City Solid Waste Butuan City, Agusan Management del Norte/ City

Government 7 Butuan City Toll Bridge Butuan City, Agusan

del Norte/ City Government

8. GSC Bagsakan Center/ Bus General Santos City/ Terminal City Government

9 Solid Waste Management San Jose del Monte, Improvement Project Bulacan/ Municipal

Government 10. Bacolod City Sanitary Landfill Bacolod Clty/

City Government 11. Cotabato City Sanitary Landfill Cotabato City/

City Government 12. Davao City Sanitary Landfill Davao City/

City Government 13. Bacolod City Public Market & Bacolod City/

Commercial Center City Government Sub-total

96

EST. REMARKSI COST STATUS

(In US$ M)

106 UnsoliCited proposal of Guoco Holdings under evaluation by ICC-Technical Board

60 Updating of project study on-going

161 Updated unsoliCited proposal by H. Lawson Associates under evaluation by provincial government

22.5 Unsolicited proposal by S-Mart Centre Construction Group and RSBS; Complete proposal to be submitted

3.75 Unsolicited proposal by S-Mart Centre Construction Group under evaluation by city government

3 Feasibility study being revised; For bidding

30 Feasibility study under evaluation by city mayor

6.25 Feasibility study under preparation by Sunshine Agri-Industrial Marketing

0.5 Pre-feasibility study completed; Geo-technical study under preparation by municipal government

475 Feasibility study under preparation

1.75 Feasibility study under preparation by Vector Engg., Inc.

10.84 Preliminary proposal submitted by ECFM under review by city government

125 Feasibility study under preparation

422.84

• Power Plants

• Highways/Toll Roads

• Ports

• Land Reclamation

• Sewerage, Dredging,

Solid Waste Management ~I • Railways

• Airports

• Tourism, Education, Health Facilities

• Water Supply

• Transport Systems

• Telecommunications

• Industrial Estates

• Public Markets, Slaughterhouses

• Information Technology· Housing • Canals, dams, irrigation· Other Infrastructure

Projects ~ trJ ~

i-' i-'

PreyioWJ Paae :8lanJr

ANNEX 12 Page 2 of 15

LGU fiNANciNG of BAsic SERvicES ANd INfRASTRUCTURE PROjECTS:

A NEW VISION OF POLICY FRAMEWORK

Introduction

Devolution of Services and Financing Sources

The enactment of the Local Government Code (LGC) of 1991 represents a major paradigm shift in governance. It mandates the devolution to local government units (LGUs) of many functions previously carried out by national government agencies (NGAs). It provides for a higher LGU share in internal revenue taxes and taxes on national wealth. It also allows LGUs greater autonomy not only in mobilizing resources but also in allocating these resources to their various needs. This new scenario calls for LGUs to learn new ways of doing things. They must establish an accountable, efficient and dynamic organizational and management structure. They must formulate a local development plan and prioritize investment projects. Lastly, they should have access to financial resources to implement these plans and projects.

This paper discusses the Department of Finance (DOF) vision and policy framework for LGU financing of basic services and infrastructure projects and presents a plan of action to realize the envisaged framework.

The devolution of certain services and activities to LGUs is expected to lead to a more effective mechanism for addressing the minimum basic needs of the people and advancing the Social Reform Agenda of the government. The devolved activities include the provision of municipal infrastructure such as public markets, bus terminals and roads, water supply and sanitation, solid waste management, school construction, basic health services, social welfare, environmental protection and agricultural extension.

To realize the objectives of devolution, the LGC has empowered the LGUs to access various financing sources such as the internal revenue allotment (IRA), official development assistance (ODA), loans from government and private banks, bonds, local taxes and enterprise revenues and build-operate-transfer (BOT) arrangements. Using a variety of financing instruments,

100

ANNEX 12 Page 3 of 15

LGU FiNANCiNG of BAsic SERvicES ANd INfRASTRUCTURE PRojECTS: A NEW VISION OF POLICY FRAMEWORK

the LGUs are expected to depend less on transfers from the national government (such as the IRA and other grants) and eventually, ODA and to rely more on locally­generated revenues and private sector participation through commercial bank loans, bonds and BOT -like arrangements.

Since the passage of the LGC in 1991, there have been many positive steps in the right direction. However, the following had been noted with concern:

• continued involvement of national government agencies in devolved activities;

• increased financial burden on some LGU s despite the increase in IRA;

• increased risks in service and delivery; and

• lack of clear policies, programs and mechanisms for channeling funds to LGUs beyond the IRA.

Recent Initiatives of the To address these concerns, the National Government Government (NG) with World Bank support undertook the

preparation of two policy studies on: (1) the financing of local government projects with environmental and/or social objectives; and (2) local government units' access to the private capital markets. The first study was undertaken by a team of professors from the University of the Philippines under the direction of the National Economic and Development Authority. The second study was done for the Department of Finance by a team of economists from the Philippine Institute of Development Studies.

(1) ICC Policy Resolution on National Govemment Grants

101

ANNEX 12 Page 4 of 15

lGU FiNANciNG of BAsic SERVicES ANd INfRASTRUCTURE PROjECTS: A NEW VISION OF POLICY FRAMEWORK

On the basis of findings from the first study, a Policy Framework for National Government Assistance for the Financing of Local Government Projects with Environmental andlor Social Objectives was formulated and approved in May 1996 by the Investments Coordination Committee (ICC) of the NEDA Board (please see Annex A). The basic objective of the ICC Policy Resolution is "to define appropriate financing policies and assignment of roles in government to facilitate the transition towards new arrangements by the LGC."

The new ICC resolution provides for a co-financing scheme under which the NG would support devolved activities with social andlor environmental objectives and which meet one or more of the three criteria: equity, externalities and economies of scale. This support which is over and above the IRA would be in the form of matching, specific and closed-ended grants. These grants could be sourced either from foreign grants, concessional loans or internally generated revenues. While equal sharing between the LGUs and NG is the rule of thumb, NG share could be bigger for the poorer LGU s or smaller for revenue-generating projects. LGU share can be in the form of equity, funds onlent by the national government or in kind.

While upholding the basic principles of the devolution policy and supporting local autonomy, accountability and prionties, the ICC resolution defines a transitional role for NGAs as "champions" of sectoral co-financing programs. The NGA champion would be responsible for program development, securing ICC approval, and program monitoring. The participating LGUs would undertake project identification, planning and implementation. The specific arrangements for each program will be embodied in a Memorandum of Agreement between the NGA champion and each participating LGU.

102

Present Situation of LGU Financing

ANNEX 12 Page 5 of 15

LGU FiNANciNG of BASic SERvicES ANd INFRASTRUCTURE PROjECTS: A NEW VISION OF POLICY FRAMEWORK

(2) Expanding LGU Access to PrIvate Capltal Markets

The second study was conducted in order to identify policy and institutional measures that will enable LGu's to tap the private capital markets for local development and infrastructure projects The rationale is clear. Government resources are insufficient given various competing demands for them and limits on resource mobilization. LGUs should therefore be encouraged to tap private sources of capital for their financing needs.

However, there was no clear policy and institutional framework that would help and encourage LGUs to gain access to private capital. Some of the constraints identified by the study were: (a) lack of infonnation on the financial situation of the LGUs; (b) uncertainty about the ability of LGUs to manage projects, (c) risk of LGUs not honoring their debts after a change in administration; and (d) inability of LGU s to service their debts from internally generated funds.

There is, thus, a need to define the "catalytic" role of government including government financial institutions (GFIs) and the Municipal Development Fund (MDF) At the same time, there is a need to rationalize the various ongoing credit programs of the government for LGUs and to harmonize the new co-financing system approved by the ICC with the proposed credit policy framework (please see Annex B)

The LGU credit market is still undeveloped. The GFIs have fe-opened LGU loan windows but these are mostly for medium-term, revenue-generating projects. Private banks are generally adopting a '\vait and see" attitude. While BOT projects are being actively explored, only a handful have materialized so far<D

Q) For example, Mandaluyong City had a public market constructed under a BOT arrangement. Lucena City has a public market operated thro~h a concession. Other proposed BOT projects are the water supply of Cebu City and Zamboanga City.

103

ANNEX 12 Page 6 of 15

LGU FiNANCING of BASic SERvicES ANd INfRASTRUCTURE PROjECTS:

A NEW VISION OF POLICY FRAMEWORK

A New Vision and Credit Policy Framework

While a few LGUs have floated bonds, the bond market is yet to be fully developed ~. Thus, only the GFIs and the MDF are there to provide medium and long-tenn financing to LGU s, with the latter serving as the main conduit for ODA funding to LGUs.

Based on the above, the Department of Finance has developed a new vision and credit policy framework that will wean away the LGUs from dependence on the national government, and promote effective partnership with the private sector. This vision is anchored on two preIDlses:

First, LGUs have varying levels and records of creditworthiness and bankability. Second, their financing needs are huge.

Therefore, the private sector (BOT investors, bondholders, commercial banks), the GFIs and MDF all have a role to play in meeting LGU financing needs.

The ultimate objective is to graduate the more creditworthy LGUs to private sources of capital which are vast and promising but remain largely untapped.

To achieve this objective, the national government can use the GFls and MDF as catalysts to bring LGUs to the mainstream of the private capital markets in the following manner:

Role oj Government Financial Institutions (GFIs)

1. GFls will lend to creditworthy LGU s that cannot yet tap private capital.

<2>The following have floated bonds: Cebu provmce, the City of Legaspi, and the municipalities of Victoria and Claveria. The last three LGUs lIoated hOUSIng bonds guaranteed by the HIGC and purchased by HDMF. Cagayan de Oro City and the provinces of Palawan, Pangaslnan and Laguna are ecpIonng the issuance of bonds for revenue generating projects.

104

ANNEX 12 Page 7 of 15

lGlJ FiNANciNG of BAsic SERvicES ANd INfRASTRUCTURE PROjECTS: A NEW VISION OF POLICY FRAMEWORK

2. GFis will develop co-financing arrangements or project referral schemes with commercial banks.

3. GFls will provide limited technical asSistance to enhance LGU creditworthiness, particularly in the areas of financial and project management.

Role ~llhc lvilf1llClpal D~vel(}p111e711 Fund (A,fDF)

1. The 1v.IDF will target its financing to less creditworthy LGUs and to

somali environmental projects

2. The MDF will refrain from providing grants and credits to LGUs that are qualified to obtain GFI loans or have viable BOT projects.

3 The MDF will link its fundmg to techmcal assistance to improve LGU capacity and creditworthiness for graduation to other sources of credit

4. The 1v.IDF will promote more direct access of LGUs to ODA sources.

Figure 1 summarizes the new vision and credit policy framework for LGUs.

105

ANNEX 12 Page 8 of 15

lr,U FiNANciNG of BASic SERvicES ANd INfRASTRUCTURE PROJECTS: A NEW VISION OF POLICY FRAMEWORK

On the vertical axis, LGUs are classified according to creditworthiness, with the most creditworthy on the top and the marginally or non-creditworthy at the lower end. On the horizontal axis, revenue-generating projects are on the right hand side and projects with social and/or environmental objectives, usually with long gestation, are on the left hand side.

The first quadrant shows that creditlVorthy LGUs with revenue-generating projects can get financing from GFIs (from their own funds), private commercial banks, the bond market or enter into BOT arrangements. The rationale is clear: revenue-generating projects of creditworthy LGUs can be funded mostly from private sources of capital.

The second quadrant shows that margznally or 11011-

creditworthy LGUs wUh revenue-generatmg projects could have funding from BOT arrangements, GFI loans with technical assistance, and limited MDF loans and technical assistance. The key element here is the revenue-generating nature of the project. With viable and sustainable projects, the LGU could enter into BOT arrangements or obtain GFI or MDF loans with supplementary technical assistance grants to improve creditworthiness. The LGUs may have the financial resources but lack the project management capability to be truly creditworthy.

In the third quadrant, creditworthy LGUs undertaking social/environmental projects whose return are low or long in coming could be allowed to tap long­term, lower-cost ODA funds through the GFls or MDF

In the fourth quadrant, the margznally 01' 11011-

creditworthy LGUs with social/environmental projects could be assisted by matching grants through the MDF, in accordance with the approved policy of the NEDA­ICC.

106

Program of Action

ANNEX 12 Page 9 of 15

LGU FiNANciNG of BASic SERvicES ANd INfRASTRUCTURE PROjECTS. A NEW VISION OF POLICY FRAMEWORK

The following are recommended to fulfill the new vision and credit policy framework:

1. Increase LGU use of BO T GlTangements.

There is a need to coordinate and pursue the government's overall efforts through the CCP AP BOT Center. Some of its ongoing activities for LGUs are the following: (a) development of market-oriented financing techniques to reduce BOT project risks; (b) promotion and educational campaign for BOT projects, (c) promotion of LGU/private sector partnership projects and «blended" project financing; (d) assistance in arranging financing for BOT projects; and ( e) exploring new long­term financing instruments such as infrastructure funds and asset participation certificates

2 Develop the LGU bond market.

The 1991 Code did not provide for tax exempt status for LGU bonds and this has often been cited as a major impediment to the development of the LGU bond market However, the DOF believes that lack of information on or track-record of the LGUs contemplating a bond issue or the arrangement fees being charged for these issuances could just as well be the major disincentives to bond market development.

Streamlining regulations and procedures for municipal bond issuances with the cooperation of the Bangko SentraI ng Pilipinas, Securities and Exchange Commission and the Commission on Audit will also encourage such issuances. Development of a credit rating system for LGUs or even a private sector credit guarantee corporation could also be very useful.

Already, the Land Bank of the Philippines (LBP) has developed a systematic credit appraisal

107

ANNEX 12 Page 10 of 15

lGU FiNANCiNG of BASic SERvicES ANd INfRASTRUCTURE PRojECTS: A NEW VISION OF POLICY FRAMEWORK

system for LGUs. The other GFls also have their own credit evaluation schemes. Together with an improved monitoring system for LGU revenues and expenditures by the concerned national government agencies, these existing systems could be further developed into a credit information and rating system that could be shared with the private sector. For its part, the Development Bank of the Philippines (DBP) is working with the private sector to jointly establish a credit guarantee corporation for LGU borrowings.

3. Promote LGU access to private banks.

The main issue which has led to the perception that lending to LGUs is a risky business is the possibility that a new local chief executive would refuse to service debts incurred by his predecessors. Two market -based mechanisms for reducing political succession risk are the liberalization of LGU depository bank regulations and extension of the IRA intercept mechanism to include private banks. While the LGC allows the use of private banks as depository banks but gives preference to government banks, the Commission on Audit has chosen to interpret this provision strictly in favor of GFls. For its part, the Monetary Board of the Bangko Sentral ng Pilipinas which has to accredit banks first before they could accept government deposits has so far allowed only the Philippine National Bank (PNB) which used to be majority­owned by the national government and which continues to be partly owned by the government.

On the IRA intercept provision, there is a need for closer coordination with the Department of Budget and Management, the government agency presently tasked with the release of the IRA, to make it a more effective instrument in securing LGU loans. However, care must be exercised to avoid the situation where lenders

108

ANNEX 12 Page 11 of 15

LGU FiNANciNG of BASic SERvicES ANd INFRASTRUCTURE PROjECTS: A NEW VISION OF POLICY FRAMEWORK

become less careful with loan appraisal because of the assurance provided by the IRA intercept mechanism. The economic and financial viability of the project and creditworthiness of the LGU should still be the main considerations for lending toLGUs.

4. Optimize the involvement of GFIs In LGU financing.

The GFIs have recently become very active in lending to LGUs The PNB alone has allocated some P8.S billion for loans to LGUs. It has already provided some P4.3 billion to 140 LGUs, mostly for heavy equipment purchases and revenue - generating projects. The LBP has provided over P5 billion to some 100 LGUs, also for revenue-generating projects. This has been facilitated by its familiarity with LGUs whose deposits it services. The DBP has about P500 milhon in LGU loans and is very active in catalyzing private sector resources through the creation of a credit guarantee corporation.

The following could still be done: (a) adopt a built-in graduation scheme to move the more creditworthy LGU s to the private credit markets; (b) develop co-financing schemes or project referral systems with private commercial banks; ( c) improve LGU creditworthiness through limited technical assistance, (d) coordinate their LGU credit programs with the MDF; and (e) structure their ODA-sourced relending programs to make optimal use of these funds for non­revenue generating or long-gestating projects. They should also continue with their market­oriented interest rate policy.

5. Restructure and reorient the A1DF

The Municipal Development Fund or MDF was created in 1984 by Presidential Decree No.

109

ANNEX 12 Page 12 of 15

LGU FiNANCiNG of BASic SERvicES ANd INfRASTRUCTURE PROjECTS: A NEW VISION OF POLICY FRAMEWORK

1914 as a revolving fund for ODA-supported projects. It is presently a disbursement mechanism for ODA loans and grants to over a thousand LGUs. It charges market-based interest rates and has excellent loan recovery. It is being administered by the Bureau of Local Government Finance under the Department of Finance.

Under the new framework, the 1IDF has an enhanced role of implementing the graduation policy and helping LGUs build a track record of creditworthiness. Towards this end, it needs to work more closely with the GFls, private banks, leagues of local government officials and concerned national government agencies in order to harmonize lending policies and address capacity-building needs. It must strengthen its own technical capacity to evaluate project proposals, assess credit risk and monitor project implementation.

While its lending operations had been aimed primarily at helping rapidly urbanizing areas meet their infrastructure requirements, the 1IDF will be focusing on less creditworthy LGUs and sociaVenvironmental projects in accordance with Figure L To also promote more direct access of LGUs to ODA, the 1IDF will be opening "windows" for urban, rural and social projects. While initially these windows are groupings of similar types of projects which have their own selection criteria and operating guidelines, the long-term goal is to have each of these windows have just one set of rules for LGU availment of resources that may be made available by more than one donor. Each framework would reflect the best practices in the relevant sector and allow the LGU s the maximum flexibility in approaching the lending windows whenever they want to and for whatever priority projects they would like to undertake. The loan application and approval process would be sped up by the use of prototype projects, simplified evaluation

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LGU FiNANciNG of BASic SERVICES ANd INfRASTRUCTURE PROjECTS. A NEW VISION OF POLICY FRAMEWORK

procedures and streamlined disbursement procedures but with adequate safeguards for proper accounting and reporting on the use funds While the interest rate for loans would continue to be market -based, the matching grants policy of the government could be used to provide transparent subsidies to the poorer LGUs for the softer project components such as social preparation or capacity building or for social/environmental projects.

6 Improve the capacity of LGUs to raise own revenues.

The linchpin of LGU creditworthiness is the increased capacity and willingness of LGUs to raise local revenues. Although the increased IRA has to some extent been a windfall to many LGUs, this is clearly not enough if the infrastructure requirements for local development and basic needs of a growing popUlation are to be met. While IRA flows could be leveraged into investment funds through availment of credit, loans will still have to be paid over time and it is important to build up ability to pay at an early stage There is therefore no substitute for sustained local revenue mobilization, including the collection of user charges both for revenue and project maintenance purposes

The following actions will help achieve this objective' (a) improve the monitoring of LGU revenues and expenditure; (b) intensify training and supervision of local finance officials; ( c) review/revise real property taxation rules and procedures, and (d) propose amendments to the 1991 Local Goverment Code to strengthen local treasury operations and provide incentives for greater local revenue mobilization.

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LGU FiNANCi,'1G of BASIC SERvicES ANd INfRASTRUCTURE PROjECTS:

A NEW VISION OF POLICY FRAMEWORK

7. Tap ODA techmcal assistance andjinancing.

Clearly, the above-stated vision and policy framework on LGU financing will have wide­ranging effects on how ODA funds are channeled to LGUs. This calls for closer coordination between the donors and the concerned goverment agencies including the oversight agencies so that projects are developed along mutually satisfactory lines. Thought should also be given as to how ODA funds could be used to increase partnership with the private sector not just in implementing projects but also in financing them. ODA funds should also be carefully targeted so that creditworthy LGU s are encouraged to tap market sources of funds and capacity is gradually built up in the less creditworthy ones. Creditworthy LGUs could also be encouraged to undertake social/environmental projects by making ODA funds available to them through GFls. The MDF could also be assisted in its effort to rise up the challenge of disbursing loans and grants to the less creditworthy LGUs for a variety of projects in the urban, rural and social sectors and of monitoring project implementation and funds utilization by LGU s.

New directions for ODA support include the following:

• Participate in building up the LGUs' infrastructure pipeline by providing technical assistance to finance project feasibility studies

• Support an LGU capacity building fund to promote LGU institutional development in the areas of revenue mobilization, budget administration, development planning, capital budgeting and investment programming, project preparation, contract management and construction supervision

• Participate in establishing market-based credit enhancement mechanisms for LGU BOT

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LGU FiNANciNG of BAsic SERvicES ANd INfRASTRUCTURE PROjECTS: A NEW VISION OF POLICY FRAMEWORK

infrastructure projects

• Provide grants and long-term credits for poorer LGDs and for social/environmental projects through the l\1DF, GFIs and other facilities and promote innovative LGU­implemented projects and/or greater LGU participation in NGA-sponsored projects

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DIRECTORY OF SOURCES OF LGU FINANCING AND CONTACT PERSONS

BATANGAS ASSETS CORPORATION and PROVINCIAL EQUITY FUNDS

Mr. Senen L. Matoto Executive Director, BPI Capital Corporation 6th Floor, BPI Building Ayala Ave., cor. Paseo de Roxas Makati City, M.M. Tel. Nos. 816-9387/891-0188/845-5446 Fax No. 818-7809 E-Mail: slmatoto@globe.com.ph

BUILD-OPERATE-TRANSFER CENTER

Mr. Jorge M. Briones Deputy Executive Director, BOT Center E-Mail: bot@ccpap.admu.edu.ph

Mr. Ignacio F. Santos-Diaz, Jr. Project Manager LGU Desk, BOT Center

Mr. Carlos B. Gavino LGU BOT Financial Adviser, BOT Center E-Mail: cbgavino@i-next.net

CCP AP BOT Center Podium Level, Department of Finance Bldg. Bangko Sentral ng Pilipinas Complex A. Mabini, Errnita Manila Tel. No. 526-2237 to 40 Fax No. 521-4263 or 525-7126 Internet homepage: http://www3.admu.edu.ph/ccpap/

DEVELOPMENT BANK OF THE PHILIPPINES (DBP)

Mr. Armando O. Samia Senior Vice President, Merchant Banking Group Development Bank of the Philippines Sen. Gil Puyat Ave., cor. Makati Ave. Makati City Tel. No. 812-6536 Fax. No. 817-1639

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GROWTH WITH EQUITY IN MINDANAO (GEM - USAID)

Mr. Charles E. Feibel Chief of Party Growth with Equity in Mindanao (GEM) Program CFC Bldg., Lot 22, Block 3 Phase 7, Ecoland Subdivision Matina, Davao City Tel. No. (082) 298-2192 to 94 Fax No. (082) 298-2195

GOVERNANCE AND LOCAL DEMOCRACY PROJECT (GOLD - USAID)

Mr. Kenneth Ellison, Ph. D. Associates in Rural Development 7th Floor, ALPAP 1 Building 140 Alfaro Street, Salcedo Village Makati City, M.M. Tel. No. 893-9647/9760 19766 Fax. No. 893-9602 E-Mail: ardgold@mnl.sequel.net

LAND BANK OF THE PHILIPPINES (LBP)

Ms. Cecilia C. Borromeo Vice President, Branch Credit Management Land Bank of the Philippines 315 Sen. Gil Puyat Avenue Extension Makati City Tel. No. 818-9411 to 2910c. 2240/2501 Fax. No. 812-4056

LGU INFRASTRUCTURE FACILITY (LGUIF)

Mr. Marietto A. Enecio Vice President, Industrial Restructuring and Special Programs Office Development Bank of the Philippines Sen. Gil J. PuyatAve., Makati City P.O. Box 1996, Makati Central Post Office, Makati City, M. M. Tel. No. 819-1409/817-0473 Fax No. 815-1517

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LGU GUARANTEE CORPORATION (LGUGC)

Mr. Jesus G. Tirona President/CEO LGU Guarantee Corporation 28IF, Antel 2000 Corporate Center 121 Valero St., Salcedo Village Makati City TellFax No. 750-4166

ANNEX 13 Page 3 of 3

LOCAL GOVERNMENT FINANCE AND DEVELOPMENT PROJECT (LOGOFIND - WORLD BANK)

Mr. Jose Antonio League Operations Officer World Bank 23rd Floor, Taipan Place Bldg. Emerald Avenue, Ortigas Center Pasig City Tel. No. 637-5855 to 64 Fax No. 637-5870/917-3050 E-Mail: ileague@worldbank.org

MULTINATIONAL INVESTMENT BANCORPORATION

Ms. Ellen L. Magtira Senior General Manager Multinational Investment Bancorporation 9th Floor Prudential Bank Bldg. Ayala Avenue, Makati City Tel. No. 817-1511 to 15 Fax No. 819-0347

PHILIPPINE NATIONAL BANK (PNB)

Mr. Josefino R. Gamboa Senior Vice President-Government Banking Group Philippine National Bank PNB Financial Center Roxas Blvd., Pasay City Tel.lFax No. 526-3488

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