LOCAL WATER UTILITIES ADMINISTRATION · PDF filebarangay village BNA basic needs ... MIS management information system ... LWUA − Local Water Utilities Administration . 2,

FINAL REPORT

VOLUME 2: INSTITUTIONAL AND FINANCIAL ASSESSMENT OF LWUA

Asian Development Bank

LOCAL WATER UTILITIES ADMINISTRATION

WATER DISTRICT DEVELOPMENT SECTOR PROJECT

Project Preparatory Technical Assistance (PPTA) TA No: 7 122 - PHI PÖYRY IDP CONSULT, INC., PHILIPPINES in association with TEST Consultants Inc., Philippines PÖYRY Environment GmbH, Germany

April 2010

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TA No. 7122-PHI: Water District Development Sector Project PPTA – Final Report – Vol. 2

This report consists of 12 volumes:

Volume 1 Main Report

Volume 2 Institutional and Financial Assessment of LWUA

Volume 3 Subproject Appraisal Report: Metro La Union Water District

Volume 4 Subproject Appraisal Report: Quezon Metro Water District

Volume 5 Subproject Appraisal Report: Legazpi City Water District

Volume 6 Subproject Appraisal Report: Leyte Metro Water District

Volume 7 Subproject Appraisal Report: City of Koronadal Water District

Volume 8 Report and Recommendation of the President (RRP)

Volume 9 Supplementary Appendices A to G (Technical Aspects)

A Review and Assessment of Water Supply and Sanitation Sector Outside Metro Manila B Water Sector Laws and Policies C Assessment of Existing Water Supply Systems in Pilot Water Districts D Proposed Water Supply Component for Pilot Water Districts E Non Revenue Water Contract Mechanisms F Sanitation G Health

Volume 10 Supplementary Appendices H to J (Social Aspects)

H Socio-economic Survey I Stakeholder Consultation and Participation J Indigenous Peoples

Volume 11 Supplementary Appendices K to S (Financial, Implementation Aspects)

K Financial Management Assessment L Detailed Project Cost and Financing Plans for Water Districts M Financial Analysis N Financial History of Water Districts O Economic Analysis P Institutional Strengthening and Capacity Building Q Indicators for Measuring Development Objectives and Performance R Terms of Reference for Consultants (Project Implementation Support

Services) S Profiles of Priority Water Districts from Long-list

Volume 12 Supplementary Appendices T and U (Safeguard Aspects)

T Initial Environmental Examinations U Resettlement Framework V Resettlement Plans


WATER DISTRICT DEVELOPMENT SECTOR PROJECT — PPTA TA NO. 7122-PHI

FINAL REPORT

INSTITUTIONAL AND FINANCIAL ASSESSMENT OF



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GLOSSARY AND ACRONYMS

ABD Asian Development Bank ACP asbestos cement pipe AIFC average incremental financial cost A/R accounts receivable AP affected person APIS annual poverty indicator survey ARI acute respiratory infection AusAID Australian Aid barangay village BNA basic needs approach BOT build-operate-transfer BSP basic sanitation package BWSA Barangay Water and Sanitation Association CAP community action plan CBO community-based organization CCF community consultation forum CCI cement-line cast iron (pipe) CDA Cooperatives Development Agency CDD community-driven development CFR case fatality rate CFT community facilitator team CI cast iron (pipe) CKWD City of Koronadal Water District CLTS community-led total sanitation COA Commission on Audit C&P consultation and participation CPC certificate of public convenience CSC community sanitation center CSS city sanitation strategy CY calendar year DBL design-build-lease DBO design-build-operate DBM Department of Budget and Management BDP Development Bank of The Philippines DED detailed engineering design DENR Department of Environment and Natural Resources DHF dengue hemorrhage fever DILG Department of Interior and Local Government DMA district metering area DOF Department of Finance DOH Department of Health DPWH Department of Public Works and Highways DRA demand responsive approach DSA delineated service area DSCR debt service coverage ratio EA executing agency (LWUA) EARF environmental assessment review framework EIA environmental impact analysis EIRR economic internal rate of return EMP environmental management plan EO executive order EOCC economic opportunity cost of capital FGD focus group discussion


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FMAQ financial management assessment questionnaire forex foreign exchange FS feasibility study FY fiscal year (1 January – 31 December) GFI government financial institution GI galvanized iron (pipe) GIS geographic information system GOCC government owned and controlled corporation GOP Government of the Republic of the Philippines GR (i) government regulation, (ii) general record (in legal cases) HDI Human Development Index HH household HRD human resources development IA implementing agency IBRD International Bank for Reconstruction and Development (World Bank) ICC Investment Coordinating Council (NEDA) ICG internal cash generation IDAP institutional development action plan IDC interest during construction IDCB institutional development and capacity building IEC information-education-communication IEE initial environmental examination IFS Investment and Financial Services (LWUA) IOL inventory of losses IPDP indigenous peoples’ development plan IRA internal revenue allotment IRR implementing rules and regulations IT information technology IWA International Water Association JICA Japan International Cooperation Agency KABP knowledge-attitudes-behavior-practices KFP an adaptation of KAP (knowledge, attitudes and practices) LCWD Legazpi City Water District LG local government LGC local government code LGU local government unit LIDAP local institutional development action plan LIHH low income household LLI local level institutions LMWD Leyte Metro Water District LOI letter of intent lps, l/s liters per second LWUA Local Water Utilities Administration MDFO Municipal Development Fund Office MDG Millennium Development Goals M&E monitoring and evaluation MFF Multitranche Financing Facility (ADB) MIS management information system MLUWD Metro La Union Water District MOU memorandum of understanding MPA Methodology for Participatory Assessments MTPDP Medium Term Philippine Development Plan MTPIP Medium-Term Public Investment Program


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MWSS Metropolitan Waterworks and Sewerage System (Metro Manila) NAMRIA National Mapping and Resources Inventory Authority NAPC National Anti Poverty Commission NCIP National Commission on Indigenous Peoples NEDA National Economic Development Authority NGA national government agency NGO non-government organization NPV net present value NRW non-revenue water NSCB National Statistical Coordination Board NSO National Statistics Office NSSMP National Sewerage and Septage Management Program NWRB National Water Resources Board OCR Ordinary Capital Resources (ADB) ODA official development assistance OGCC Office of the Government Corporate Counsel OJT on-the-job training O&M operation and maintenance PB polybutylene (pipe) PD presidential decree PFI private funding institution PHAST Participatory Hygiene and Sanitation Transformation Php, PhP Philippine peso PIU project implementation unit PMO project management office PMU project management unit PNSDW Philippine National Standards on Drinking Water PPMS project performance monitoring system PPTA project preparation technical assistance PRV pressure reducing valve PSA poverty and social assessment psi pounds per square inch PSP private sector participation PWSSR Philippine Water Supply Sector Roadmap QC quality control QM quality management QMWD Quezon Metro Water District RA republic act RIAP revenue improvement action plan RRP report and recommendation of the president (ADB) RWSA Rural Waterworks and Sanitation Association SCSS simplified community sewerage system SCU state colleges and universities SES socioeconomic survey SHBC sanitation and health behavioral change SLA sub-loan agreement SPAR subproject appraisal report SSC school sanitation centre SWG sanitation working group SWM solid waste management TA technical assistance TB tubercolosis TOR terms of reference


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TOT training-of-trainers UFW unaccounted-for water UNICEF USAID

United Nations Children Fund United States Agency for International Development

V variation (contract) VIP ventilated improved pit (latrine) WASCO Water Supply Coordination Office (NAPC) WD water district WE Bank WHO

Water and Energy Bank World Health Organization

WPEP Water Supply and Sanitation Performance Enhancement Project WQ water quality WS water supply WSP water service provider WSP-EAP Water and Sanitation Program – East Asia Pacific WSS water and sanitation WTP willingness-to-pay WWTP wastewater treatment plant


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Location Map

Metro La Union WD

Quezon Metro WD Legazpi

City WD

Leyte Metro WD

City of Koronadal WD


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CONTENTS BASIC DATA iii EXECUTIVE SUMMARY

1

A. Institutional Analysis 1 B. Financial Assessment 9 C. Recommendations 13

I. INSTITUTIONAL ASSESSMENT OF THE LOCAL WATER UTILITIES

ADMINISTRATION

16

A. Introduction 16 B. LWUA Functions and Covenants 16 C. Operating Environment 20 D. LWUA Operating Status 32 E. LWUA’s Future Operations 41

F. Recommendations 48 II. ASSESSMENT OF THE LOCAL WATER UTILITIES ADMINISTRATION FINANCIAL PERFORMANCE

50

A. Recent Developments at LWUA 50 B. Assessment of Past and Present Performance of LWUA 56

C. Sector Financing Needs and LWUA Response 60 D. Projected Financial Performance 71 E. Major Concerns and Recommendations 78 APPENDIXES 1 Proposed LWUA Organizational Chart 81

2 Legal Assessment of the Petition of LWUA Employees Association for Progress (LEAP)

82

3 Recommendations of Previous Studies on LWUA 85 4 LWUA Relending Rates 89 5 LWUA Bank Acquisition Assessment 100 6 Assessment of LWUA’s Past Financial Performance 165 7 Water District Loan Receivables and LWUA Debt Profile 190 8 LWUA Action and Proposals to Improve Collection Efficiency 201 9 Financial Management Assessment Report 209 10 The Philippine Water Revolving Fund 230 11 List of Assumptions 234 12 Financial Projections 244 13 Concept Paper: A Business Planning Model for LWUA 250


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LIST OF TABLES Table 1 LWUA’s New Interest Rates 5 Table 2 Summary of Studies on LWUA 7 Table 3 Financing Framework 12 Table 4 Agencies Responsible for Water Supply in Provincial Areas 21 Table 5 LWUA / Water District Coverage 26 Table 6 Water District Grouping by Area 26 Table 7 Water District Size Categorization Parameters 27 Table 8 Creditworthiness Classification of Water Districts, 2008 27 Table 9 Water District Tariffs as of 31 December 2008 (P/m3) 31 Table 10 LWUA Creditworthiness Parameters 34 Table 11a Classification of Water Districts, 2005 35 Table 11b Classification of Water Districts, 2008 35 Table 11c Water District Classification by Location, 2008 36 Table 12 Creditworthiness Criteria of LGU Guarantee Corp 36 Table 13 LWUA’s New Interest Rates 37 Table 14 Number of LWUA Personnel 40 Table 15 Summary of Studies on LWUA 42 Table 16 Usability Status of LWUA Application Systems 48 Table 17 Summary of Key Findings and Recommendations from Recent Studies 52 Table 18 Comparison Between Previous and Revised Relending Rate Policy 53 Table 19 Proposed Funding for the Comprehensive and Interim Improvement Project

for 2009 – 2013 54

Table 20 LWUA Key Financial Data 2005 – 2009 57 Table 21 Comparison of MDG and MTPDP Target vs Actual Performance 60 Table 22 Access to Financing 61 Table 23 Population Served by Water Supply Providers as of 2007 64 Table 24 Current and Projected Population Served 67 Table 25 Additional Population Served by Water Districts, 2009 – 2013 67 Table 26 Current Financing Framework vis-à-vis EO 279 68 Table 27 Features of Proposed LWUA Financing Framework 69 Table 28 LWUA’s Loan Windows and Programs 70 Table 29 Estimated Allocation by Type of Water District, 2009 – 2013 73 Table 30 Scenario Matrix 74 Table 31 Comparison of With and Without Bank Scenarios 75 Table 32 Selected Indicators for LWUA Performance in the WDDSP Base Scenario 76 Table 33 Selected Indicators for LWUA Performance in the Conservative Scenario 77 Table 34 Selected Indicators for LWUA Performance in the Better Scenario 77 Table 35 Selected Indicators for LWUA Performance in the Best Scenario 78 Table 36 Features of Proposed LWUA Financing Framework 80

LIST OF FIGURES Figure 1 Water Sector Institutional Framework of LWUA 22 Figure 2 LWUA Organizational Structure 25 Figure 3 Water Tariffs of LWUA, MWCI and MWSI as of December 2008 31 Figure 4 LWUA Capital Expenditures, 1992 – 2003 62 Figure 5 Funding Needs vis-à-vis WD Creditworthiness 65


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CURRENCY EQUIVALENTS (as of April 2010)

Currency Unit – peso (PhP)

PhP1.00 = $0.022

$1.00 = PhP45.45

ABBREVIATIONS

ADB − Asian Development Bank AR − accounts receivable ARMM − Autonomous Region in Muslim Mindanao AS − application system AusAID − Australian Agency for International Development BCR − billing and collection report BWSA − Barangay (village) Water and Sanitation Association CAR − Cordillera Autonomous Region, capital adequacy ratio CAMEL − capital asses management earnings liquidity CIIP − Comprehensive and Integrated Infrastructure Project,

Comprehensive Interim Integrated Project CR − collection ratio, current ratio DA − deputy administrator DANIDA − Danish International Development Agency DBM − Department of Budget and Management DENR − Department of Environment and Natural Resources DILG − Department of the Interior and Local Government DMC − developing member-country DOF − Department of Finance DOH − Department of Health DPWH − Department of Public Works and Highways DSCR − debt service coverage ratio DSR − debt service ratio EA − environmental assessment EO − executive order FI − financing institution forex − foreign exchange GFI − government financing institution IBRD − International Bank for Reconstruction and Development ISSP − information system strategic plan JBIC − Japan Bank for International Cooperation JICA − Japan International Cooperation Agency KfW − Kreditanstalt für Wiederaufbau LAD − Loans Administration Department LEAP − LWUA Employees Association for Progress LGU − local government unit LTR − long-term receivable LWUA − Local Water Utilities Administration M&E − monitoring and evaluation MDS − monthly data sheet MOOE − maintenance and other operating expense


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MWCI − Manila Water Company, Inc. MWSI − Manila Water Services, Inc. MWSS − Metropolitan Waterworks and Sewerage System NAWASA − National Waterworks and Sewerage Authority NEDA − National Economic and Development Authority NPL − non-performing loan NPR − net profit ratio NRW − non-revenue water NWRB − National Water Resources Board ODA − Official Development Assistance OECF − Overseas economic Cooperative Fund Ofwat − Office of Water Services OPEX − operational expense PBAC − Pre-qualification, Bids, and Awards Committee PEAC − Prequalification Evaluation and Awards Committee PD − presidential decree PFI − private financing institution PMO − project management office PPTA − project preparatory technical assistance PS − personal services RO − regulatory office RWDC − Rural Waterworks Development Corporation RWSA − Rural Water and Sanitation Association SBMA − Subic Bay Metropolitan Authority RWSA − Rural Water and Sanitation Association SBWRB − Subic Bay Water Regulatory Board SDA − senior deputy administrator SR − service connection/staff UFW − unaccounted-for water USAID − United States International Development Agency WD − water district WE Bank WDDSP

- Water and Energy Bank − Water District Development Sector Project

WSP − water service provider

WEIGHTS AND MEASURES

m3 − cubic meter

NOTE

In this report, “$” refers to US dollar.

Executive Summary


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EXECUTIVE SUMMARY 1. The objective of the project preparatory technical assistance (PPTA) was to design the Water District Development Sector Project (WDDSP), which comprises a sector loan project agreed upon by the Local Water Utilities Administration (LWUA), participating water districts (WDs), the Government of the Philippines (GOP), and Asian Development Bank (ADB). The TA was carried out in two phases: one, a study of the sector and LWUA (Phase 1) and two, preparation of subproject appraisal reports (SPARs) for five pilot subprojects (Phase 2).

2. Phase 1 (i) reviewed the water supply and sanitation sector in urban areas; (ii) selected WDs which could serve as drivers for reform in the sector, suitable to participate in the WDDSP, their financial status, and priority investment and institutional development requirements; (iii) assessed the institutional and financial performance of LWUA; (iv) assessed issues, hindrances, and risks; and (v) disseminated information through workshops, seminars, and consultations.

3. This volume deals only with the financial and institutional conditions of LWUA, and highlights the past, present, and projected performance of the agency.

A. INSTITUTIONAL ANALYSIS

1. Historical Perspective 4. Prior to 1973 and the establishment of the Local Water Utilities Administration (LWUA), there were approximately 600 local government units (LGU) utilities operating outside Manila. These utilities were generally the creation of local governments or the National Waterworks and Sewerage Authority (NAWASA).1 They operated either as functional departments of LGUs or provincial branches of NAWASA. The LGU-run utilities were plagued by the following weaknesses:

(i) Low tariff levels, poor collection percentages, and high levels of unmetered connections;

(ii) Minimal cost recovery; (iii) Major constraints on available capital; (iv) Self-regulation and consequent low service standards, particularly for

water quality and continuity of service; (v) Overstaffing with low-level staff competence partially due to the utilities

being regarded as employers of last resort; (vi) Low levels of operating cost recovery and consequently the need for

operating subsidies from central government; and (vii) No regard for long-term sustainability and consequent degradation of

physical assets. 5. The NAWASA systems, while enjoying some measure of independence from the LGUs, suffered from inadequate capital and an inordinately centralized decision-making. Most decisions and purchases had to be approved by the Manila central office. To address these issues, the Provincial Water Utilities Act was issued in 1973 as Presidential Decree (PD) No. 198.

1 NAWASA was a national agency in charge of waterworks development and operation in the Philippines. It was

later converted to Metropolitan Waterworks and Sewerage System but was responsible for the Metro Manila area only.

Executive Summary


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2. Local Water Utilities Administration and Water Districts 6. PD 198 mandated the formation of local water districts (WDs), which were initially formed by resolutions of the LGUs (generally, municipalities) as a single entity or as a combination of LGUs. Once formed, however, a WD becomes legally autonomous of the LGU and has the standing and legal character of an independent government-owned and controlled corporation. It is controlled by a board of directors, appointed by either the mayor or the governor,2 consisting of five members representing various sectors, who in turn appoint the WD’s general manager.

7. LWUA was constituted under PD 198 as a government corporation to promote the development of water districts in the country. As constituted in 1973, LWUA had a clear mandate to “primarily be a specialized lending institution for the promotion, development, and financing of local water utilities.”3 To carry out this mandate LWUA has major subsidiary roles such as:

(i) prescribing minimum standards and regulations in order to assure acceptable standards of construction materials and supplies, maintenance, operation, personnel training, accounting, and fiscal practices for local water utilities; and

(ii) providing technical assistance and personnel training programs.

8. There were a total of five laws or executive fiats aside from PD 198 which guided LWUA’s direction since its formation. These were:

9. Executive Order (EO) No. 577 issued in 1980 − Created and charged the Rural Waterworks Development Corporation (RWDC) with providing water supply in provincial rural areas. The same EO authorized the formation of rural waterworks and sanitation associations to operate the water systems in these areas. LWUA’s provincial domain now had to be shared with RWDC.

10. EO 124 issued in 1987 − Abolished RWDC and transferred all its functions, assets, and responsibilities to LWUA. In effect, LWUA was again responsible for developing water systems outside the Metropolitan Waterworks and Sewerage System (MWSS) domain in all provincial urban and rural areas starting from 1987.

11. NEDA Resolution No. 4 issued in 1994 − reiterated the corporate mission of LWUA as a specialized lending institution financing only viable level III water projects.

12. EO 123 issued on September 12, 2002 − Removed LWUA’s right to regulate water and sewerage tariffs of WDs and transferred this right to the National Water Resources Board (NWRB). However, as of April 2009 NWRB had not yet assumed the function of approving WD tariffs due to limitations in its resources and consequent responsibility.

13. EO 279, issued on February 2, 2004 − Provided for the institution of reforms in financing policies for the water supply and sewerage sector and water service providers (WSPs), and the rationalization of LWUA’s organizational structure and operations in support thereof.4 This EO increased the participation of LGUs, and government and private financing institutions (GFIs/PFIs) in financing the water supply and sewerage sector.

2 Depending on which LGU formed the water district. 3 PD 198 Sec. 50. 4 Executive Order 279, February 2, 2004.

Executive Summary


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14. Throughout LWUA’s existence, LWUA’s role in the development of the provincial water supply sector seems like a pendulum swinging back and forth from one extreme (all areas to be funded) to another (only viable projects to be funded).

3. LWUA/Water District Performance

15. As of December 2008, LWUA has facilitated the formation of 604 WDs. Of these, 479 are operational and have a combined total of 2,627,112 service connections serving a total population of 15.16 million in 587 towns and cities. The total franchise population of the operational WDs is 43,561,0975 for a served population ratio of 35% within their franchise areas. The WD-served population covered in the entire country is 17%.

16. WDs perform generally better than non-WDs, except on tariffs (WDs have the highest) and staff/connection ratios. In more specific terms, key performance indicators in the Department of the Interior and Local Government’s benchmarking exercises reveal that WDs have, on the average, higher coverage rates (69%) compared with non-WD models (62%). Higher service coverage of WDs is complemented by an impressive 99% revenue collection efficiency, which is a testament to consistent policy enforcement and active monitoring of both present dues and arrears. Non-WD models, such as cooperatives and private utilities, comparably enjoy at least 99% collection efficiency within their limited coverage areas. Stricter monitoring of obligations is also reflected in accounts receivables (ARs), where WDs sustain an average of only 1.3 months-worth of ARs. This is lower than the ARs of non-WDs such as Rural Water and Sanitation Associations (RWSAs, 2.5 months) and LGUs (2.3 months). The strong performance also reflects LWUA’s effective assistance in the management of WDs.

17. LWUA sets targets for water districts. NWRB sets targets for those cooperatives/RWSAs and private suppliers that acquire certificates of public convenience, and for LGUs that request for regulatory assistance. LWUA’s targets are: 24-hour supply at a minimum pressure of 7 meters for residential customers and 11 meters for commercial establishments and institutions.6 NWRB sets 8 hours/day minimum supply effective 2007 and minimum pressures of 5 psi for residential users and 25 psi for commercial establishments.

18. Data taken from sampled water districts7 showed that most water districts are able to provide water 24 hours a day. LGU systems, cooperatives/RWSAs, and private systems far exceed the minimum 8 hour NWRB guideline, but fall short of 24-hour supply availability. Water districts are also able to meet pressure requirements,8 but no data are available for the other water systems. Corollary to this WD efficiency, unaccounted-for water (UFW) among sampled WDs is 26% compared with 30% among non-WDs, with LGU-run utilities incurring a considerable 36% UFW due to factors such as declining infrastructure, and socioeconomic and capital financing constraints.

19. There are only three LGUs outside Metro Manila which have existing sewerage facilities, two of which are being managed directly by WDs (viz., Zamboanga and Vigan WDs). The Baguio system is being managed by the LGU itself. These suggest that the current sewerage coverage is still very far from the target set in the Clean Water Act.

20. Although WDs are prepared to take up sewerage operation and maintenance of facilities, capital cost and recovery thereof is a major concern, particularly the (i) source of funds for sanitation, and (ii) affordability and willingness of beneficiaries to shoulder the additional cost burden of sanitation in addition to the cost of access to potable water. As a result, there have

5 NSO 2007. 6 Castalia Strategic Advisors. November 2008. Diagnostic Study of the Water Sector in the Philippines. Draft

Report to the World Bank, Manila. 7 IBRD-WSP, op. cit. 8 World Bank. 2004. Philippine Infrastructure Study.

Executive Summary


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been few feasibility studies done by LWUA on sewerage.9 Of the 12 feasibility studies conducted, only one was implemented and this was in Baguio City with 100% subsidy funding from Japan International Cooperation Agency (JICA). No further LWUA-initiated studies have been done on sanitation projects to be implemented by water districts.10

21. Despite these challenges, LWUA (i) has committed to venture into sewerage and septage management programs and projects beginning 2008, (ii) is initiating steps to source financing assistance from JICA, World Bank, Japan Bank for International Cooperation (JBIC), and other external financing agencies, and (iii) commits to complete the World Bank-funded National Sewerage and Septage Management Program in 2009 to jumpstart planning for sewerage and septage management initiatives in the country.

4. Operating Highlights

22. LWUA’s functions are built around financial management, capital project preparation, and operational management competencies. From sector studies and experience in the sector, LWUA’s core competencies are in the field of technical and institutional development services to utilities and the ability to operationally turn around an unviable WD to a viable one. EO 279 intends LWUA to improve its financial management operations. However, it does so from a perspective of fairly restrictive merchant banking practices and not of a developmental financial institution in a sector with minimum securities and subject to high political and financial risks and resource uncertainties. LWUA’s formula had always been to mix merchant banking practices with those which can somehow offset its developmental financing function in order to attain corporate sustainability; hence, the current LWUA dilemma with the issuance of EO 279.

23. Many believe that implementation of EO 279 will eventually weaken LWUA by making it an unviable corporation. This is particularly so in the uncertain climate currently prevailing in world capital markets. Even the concept of the Philippine Water Revolving Fund (PWRF) is designed to eventually devolve LWUA’s financing function to either the GFIs or PFIs. While DOF expects LWUA to be a financially viable organization, EO 279 may cause it to be unviable by taking away its creditworthy clients and mandating it to service only WDs (and even other WSPs) which are marginally creditworthy without specifically mentioning the source of subsidy funding.

24. EO 279 specifies that the WDs be classified as to their creditworthiness. The creditworthiness criteria are a composite of nine parameters of which five are financial and four are operational. While EO 279 may not prevent LWUA from lending to creditworthy WSPs, it specifies that LWUA should accept the condition that LWUA loans are subordinate to GFI loans through a waiver. This implies that LWUA should avoid lending to creditworthy WSPs and concentrate instead on the lower three strata of borrowing WSPs. EO 279 likewise allows GFIs to provide loans directly to semi-creditworthy WDs. The consequence is that LWUA shifts from its merchant bank role to that of a full development bank given the clients left to it.

25. The exclusion of creditworthy WSPs from the pool of borrowers from LWUA, however, becomes problematic for LWUA in a financial sense since it increases the overall risk applied to LWUA’s loan portfolio with a consequent and potential increase in borrowing costs.

9 In the 1980s, LWUA funded feasibility studies for Butuan, Daet, and the cities of Ozamis, Zamboanga, and

Baguio. In the 1990s, USAID funded feasibility studies for General Santos and Cagayan de Oro cities. World Bank also funded feasibility studies for Calamba, Cotabato, Roxas, Davao, and Dagupan in 1996. 10 At present, the following water districts have agreed with the Philippine Water Revolving Fund to conduct

sanitation feasibility studies: Zamboanga, San Pablo, Cabanatuan, Cebu, and Baliuag WDs.

Executive Summary


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26. Government financial institutions, although represented in the Oversight Committee11, use different criteria for evaluating creditworthiness. As an example, for water projects the LGU Guarantee Corporation (LGUGC)12 uses 11 parameters, which are all financial in nature.

27. This generates a clear conflict. Even when employing their own creditworthiness criteria, Land Bank of the Philippines and Development Bank of the Philippines have arranged with LWUA for a review of studies and engineering designs and even takeover services whenever needed. If a WD can provide sufficient securities for its loan and given the LWUA standing arrangement, GFI lenders can likewise be lenient with their creditworthiness evaluation. Hence, even when a semi- or pre-creditworthy WD applies for a GFI loan, it is possible that the GFI will assign the WD a creditworthy rating and approve the loan request because the lender recognizes that it can still recover its loan behind WD securities and LWUA’s reputable guarantee accord.

a. Interest Rates

28. In an effort to make LWUA’s interest rates, which currently range from 8.5% to 16% depending on the loan amount, competitive with GFI rates, the LWUA Board has come up with a new policy on interest rates effective March 2009. Table 1 shows the new interest rates that will be charged to WDs.

Table 1: LWUA’s New Interest Rates

Item

Previous Policy Revised Policy Cumulative Loan

Granted Existing

Interest Rate per Annum

Loan Repayment

Period

Proposed Interest Rate per Annum

Indicative Interest Rate

First P2 million 8.5% First 10 years 9.2% Next P5 million 10.5 % >10-20 years 9.5%

Next P13 million 12.5% >20-30 years 9.8%


Over P50 million 15.0% Feature of Interest Fixed Repricing as necessary. LWUA

proposed to lend to WDs at a fixed rate but said rate will be adjusted periodically to the Philippine Dealing System Treasury reference rates

Repayment P eriod Maximum 25 years, including a maximum 4-year grace period

Maximum 40 years, including grace period

Interest During Construction

Interest capitalized for the first loan only

Policy under review considering revised relending rates

Periodic Amortizati on Fixed periodic debt service amounts (interest and principal amortization) during repayment period

Floating amortization (periodic principal repayment with the amount depending on the water district’s capacity)

LWUA = Local Water Utilities Administration, WD = water district. Source: LWUA Board Resolution No. 38 s. 2009.

11 A multi-agency committee formed to oversee the implementation of EO 279. 12 A private guarantee corporation which guarantees 85% of water district loans from government and private

financing institutions.

Executive Summary


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b. Information Systems Strategic Plan (ISSP) 29. At LWUA, information systems are being developed but not fully implemented. There is an ongoing contract between LWUA and Nippon Jogesuido Sekkei/Consultants for Engineering Science and Technology to develop integrated computerized operational and management systems. The Phase I contract started in 1997 for seven application systems (ASs) and eight more ASs were added in Phase 2 for a total of 15 ASs. By of end 2008, 12 ASs were being used to some extent by user groups. Optimal utilization had been hampered by many problems, with lack of computer familiarization as one of them.

30. If fully implemented, ISSP promises to improve LWUA’s efficiency. LWUA and its consultants are now discussing a “Responsive Work Plan” which will review the strategic approach to management information system/information technology and is envisioned to make all ASs usable. The timetable for this review is from 8 months to 1 year.

c. Water District Data Gathering

31. Monitoring the performance of WDs is critical to LWUA’s decision making and reporting activities. The basic data source is the monthly data sheet (MDS) which all operating WDs are supposed to submit to LWUA every month. However, not all WDs dutifully comply with this requirement. Many non-complying WDs either have limited staff or are unable to obtain the required data or find that assembling and updating information make compliance cost-ineffective or cumbersome. LWUA is currently redesigning the MDS to simplify the requirements.

d. Human Resources and Capacity

32. As of March 2009, there are about 600 personnel of LWUA with an average age of 50 years. Six years from now, about 60 people are expected to retire at the mandatory age of 65. LWUA is now embarking on a recruitment program to replace the ranks of those who will retire as well as infuse young blood into the organization.

33. There are currently approximately 359 staff in Core Operations, including 58 staff in Water District Development who are generally employed as advisors. This indicates an average responsibility of advisors to water districts of 10 to 1 advisor for every 9 to 10 districts, which seems to be a satisfactory ratio.

5. LWUA’s Future Operation

34. As an institution, LWUA has been reviewed significantly over the last 20 years, as shown in Table 2 .

Executive Summary


7

Table 2: Summary of Studies on LWUA

Year

Report

Initiator

Major Recommendation

1990

Carl Bro International

WB, DANIDA Abolition of LWUA or total restructuring as a commercial bank

1993 Tasman Consulting WB LWUA to be reoriented as a “specialized lending institution” and to privatize commercially viable WDs

1994 NEDA Resolution No. 4 Government LWUA to lend only to credit-worthy WDs 1995 Lotti Consultants ADB LWUA to pursue some changes within its

operating systems 2002 Stone and Webster WB, DOF EO 279 2007−2008 Water Sector Road Map KfW LWUA to assist other WSPs financially

and technically 2008 Castalia WB Enable consumers to hold LGUs

accountable for water service provision ADB = Asian Development Bank, DANIDA = Danish International Development Agency, DOF = Department of Finance, EO = executive order, KfW = Kreditanstalt für Wiederaufbau, LGU = local government unit, LWUA = Local Water Utilities Administration, NEDA = National Economic and Development Authority, WB = World Bank, WS = water district, WSP = water service provider.

a. Economic Regulation

35. There are a number of institutions with economic regulatory responsibilities in the Philippine water supply sector. These include the three primary regulatory agencies − NWRB, LWUA, and LGUs – and special regulatory units such as the Subic Bay Water Regulatory Board (SBWRB) created by the Subic Bay Metropolitan Authority (SBMA) and the MWSS Regulatory Office created by different agencies’ charter and operate on contract-based regulation. Within the existing structure, there are differences in regulatory practices, processes, and fees and cases of overlapping functions or jurisdictions among these agencies. This environment suggests a fragmented regulatory framework and lack of coordination.

36. LWUA had assumed a de facto economic regulatory role given its mandate in PD 198 to promulgate standards for materials and operations, review water rates, and monitor WD performances.

37. Since the issuance of EO 123 in 2002 and up to the present (May 2009), NWRB had not yet assumed the functions of tariff approval of WDs due to its many internal constraints. At present, the tariff approval of WD is still being exercised by LWUA because of an arrangement made by both NWRB and LWUA management. Unfortunately, some WDs are now experiencing injunctions or court cases regarding their adjusted tariffs which do not bear NWRB imprimatur.

38. Some quarters within LWUA are concerned with LWUA’s collection efficiency once the tariff approval function is already assumed by NWRB. LWUA’s collection efficiency is dependent on the timely adjustment of WD tariffs and constant monitoring of WD operations. NWRB must have enough capability and resources to do both tariff review and monitoring of WD operations.

b. Financial Management Role

39. Since 1991, full national government subscription of LWUA’s authorized capital of P2.5 billion had already been fully subscribed. Consequently, LWUA intensified its borrowings from international financing institutions. Actual borrowings from foreign sources are, however, limited by LWUA’s or WDs’ ability to provide local counterpart or equity funding.

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40. Since the 1990s LWUA has sought government approval to increase its capitalization to P10 billion to support its local counterpart funding requirements of its foreign loans. However, congressional approval has not prospered although LWUA is hoping that it could get its bill approved before the end of this year. Nevertheless, national government funding assistance has been provided directly and indirectly through the annual national budgetary appropriations to be accounted for as advances to the increased capitalization of LWUA. In 2009, total grants/ advances secured from the national government amounts to P3.6 billion.

41. Likewise, to strengthen its availment of foreign loans, LWUA secured a total of P1 billion from the Land Bank of the Philippines which it relends as their counterpart fund to their foreign-assisted projects. A standby credit of P500 million from the Philippine Veterans Bank has likewise been obtained.

42. LWUA has been successful in having the “waterless communities” funds transferred to it from the National Anti-Poverty Commission and the Department of Public Works and Highways (DPWH) and is trying to secure additional funds from the government to pursue its funding role. The next few months will gauge the success of LWUA in this endeavor. LWUA needs to manage its pool of funds effectively for relending purposes so it will be able to sustain its WD funding operations.

43. Another issue is in relation to creditworthiness. A well-performing water district manager is potentially faced with a dilemma. If he achieves creditworthiness then his district will have the opportunity to independently source debt from the market place as well as GFIs. However, the creditworthy WD will be excluded from sharing the grant funds that could be made available by government.

c. Proposed Future Structure

44. The Department of Budget and Management had already approved LWUA’s restructuring in conformance with EO 279. However, an injunction is preventing LWUA from implementing the said restructuring. The proposed restructuring means a reduction of about 140 people without special retirement packages; hence, the objection of LWUAns to such restructuring.

45. While the proposed structure may have been appropriate for the implementation of EO 279 at the time it was passed, it may no longer be applicable in view of the new directions or visions of the current LWUA management and Board. Factors like resolution of the current injunction, the creation of a proposed Water Development Bank, the amount of government financing that LWUA has or can secure, and possible new sector13 or LWUA policies14 still in the conceptual stage will have a bearing on the design of a future structure.

d. Environmental Management

46. The government requires environmental assessment (EA) of projects proposed for external financing to help ensure that they are environmentally sound and sustainable. EA is a process whose breadth, depth, and type of analysis depend on the nature, scale, and potential environmental impact of the proposed project. Almost all studies prepared by LWUA do not have a section on the social and environmental safeguards of projects because LWUA had always left it to the WDs or to consultants the safeguard requirements of projects. Having a unit in LWUA overseeing these safeguards would boost LWUA's capability in project implementation as well as provide these needed services to WDs.

13 Like creation of a national regulatory body. 14 Like plan to create another LWUA subsidiary involving research and water development.

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e. Benchmarking 47. Under the current set-up where hundreds of monthly data sheets are submitted manually using mail and manually encoded into a computer, maintaining an updated databank is very costly and time consuming. It is suggested that LWUA undertake a rationalization of the data collection activities and modernize its management information system. A starting point could be the MDS submitted regularly by the WDs being interfaced with the operational management system which has been partially implemented.

48. A solution towards a more efficient system is the creation of an online database system known as Portal and Collaboration System, examples of which are IBM’s Websphere and Oracle 9iAS. Under this system, various WDs will encode their MDS through a website. The website will have verification protocols and is secured. Once the data are encoded by WDs, they are immediately available to area managers for evaluation. Moreover, the data can be made available to Corplan, which can then come up with regular monthly or quarterly industry average. Other monitoring reports outside the MDS will still be forwarded via the traditional route.

B. FINANCIAL ASSESSMENT

1. Past and Present Financial Performance

49. Results of LWUA’s operations during the last 4 years from 2005 to 2008 showed a marked improvement compared with the performance during the period from 2000 to 2005, which was the subject of a similar review of LWUA performance.15 LWUA has been (i) recovering costs of operation as well as financial expenses from their revenues, (ii) generally generating positive cash inflows from operating and financing activities which were used to finance its investing activities, and (iii) enjoying healthy liquidity, profitability, and debt equity ratios. Although the debt service coverage ratio in 2008 was only .99 and was short of the desired 1.3 level, it represented a significant improvement compared with the coverage in year 2002, which was only 0.08.

50. Operations resulted in drastic increases in cash amounts in 2006 and 2008 mainly due to the amounts received from refinancing. During the same period, 13 water districts refinanced a total P3.7 billion of their loans with LWUA.

51. Budget figures for 2009 reflected a slight reduction in revenues and an increase in operating cost resulting in a projected decrease in net profit before tax. The 2009 budget initially provided a very high level of projected investments (P4.4 billion) as LWUA reportedly expected receipt of more funds from the national government under the current administration. Actual investments in projects amounted to P3.6 billion in 2009.

52. LWUA’s current major areas of concern include (i) collection efficiency and receivables management, (ii) fund sourcing for its investment program to arrest the decline in the level of project disbursements, (iii) financial management issues particularly relating to LWUA’s need to respond to Commission on Audit (COA) recommendations, including reconciliation of receivables accounts, and (iv) need for long term business planning.

53. As part of its strategy to establish a more reliable source of funds for water supply development projects, LWUA acquired 60% ownership of a thrift bank, the Express Savings Bank, in the second quarter of 2009. So far, LWUA has reportedly paid out a total of P780 million as its investment in the bank, now referred to as the Water and Energy Bank (WE Bank).

15 C. Virata and Associates, Inc. April 2008. Final Report on the Study on Selected Financial Issues Related to

LWUA as a Consequence of EO 279, Volume 1. Manila.

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The risks include loss of the investment if LWUA is not able to obtain Monetary Board approval and develop a viable business strategy and plan to maximize the benefits of the bank’s resources.

2. Projected Performance

a. Key Assumptions for Base and Sensitivity Scenarios

54. An assessment of the performance of the WE Bank as well as the implications on LWUA’s performance and financing requirements was made. The WE Bank is expected to operate at a much smaller scale of operations of 27% of that projected under the feasibility study prepared early 2009 which was the basis for the acquisition transaction. At this level, the WE Bank is expected to generate income ranging from P30 million in 2010 to P 101 million in 2018 and be able to finance further need for capitalization from its own earnings. LWUA will benefit from this income to the extent of its 60% share.

55. Financial projections of LWUA’s performance were prepared for LWUA under two schemes namely:

• Scheme One – Without Bank which is based on the assumption that LWUA will not operate the bank and all previous investments will be written off.

• Scheme Two – With Bank which assumes continued operation of the bank. 56. For each scheme, projections were prepared under a base scenario and three other scenarios as basis for sensitivity analysis. The base scenario was based on the 10-year financial projections prepared by the LWUA Corporate Planning Department in December 2008. The projections were updated to consider several recent developments, including (i) the revision of the relending rate based on LWUA Board Resolution 38 series of 2009, (ii) the increase in the ADB WDDSP loan from $24 million to the planned investment of $50 million, (iii) updating of the LWUA Comprehensive and Integrated Infrastructure Program (CIIP), and (iv) application of a proposed financial framework following EO 279. The CIIP proposed a total investment plan of P28 billion for the period 2009 to 2013 or around P 5 billion per year. For the year 2009, the actual amount of investment in projects totalled P3.6 billion or 80% of the CIIP projection of P4.5 billion. This is a significant accomplishment for LWUA considering that in prior years from 2005 to 2008, annual investments were at low levels of P1.5 billion and below. It is also noteworthy that most of these investments are funded from government grants (P1.5 billion from the Department of Health and P 0.5 billion from the Department of Public Works and Highways) and government subsidies from the Department of Budget and Management. This is largely attributable to the aggressive efforts of the LWUA Chairman to obtain funds for LWUA projects. For the year 2010, the LWUA CIIP shows an investment of P4.5 billion for projects also mainly funded from government grants and subsidies. To be more conservative in the base scenario, investments in projects are projected at 80% of the budget and the CIIP figures.

57. Three other scenarios were developed to test LWUA’s sensitivity to adverse situations and see how these adverse situations affect LWUA’s long-term viability. The scenarios are referred to as the Conservative Scenario (Scenario A), the Better Scenario (Scenario B), and the Best Scenario (Scenario C). The parameters used include (i) investment, (ii) revenues, (iii) collection efficiency, and (iv) operating costs. Under the most conservative scenario, Scenario A, investment levels were set at 30% of the CIIP figures, 50% of the existing loans in 2008 are refinanced, collection efficiency is assumed at only 75% (compared with 85% in the base scenario), and personal services increase by 3% annually from 2011 levels and maintenance while other expenses will increase with inflation.

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b. Results of Analysis (Assessment of LWUA Projected Performance, Comparison of With and Without Bank schemes, base scenarios)

58. Under the base scenario of both schemes, LWUA will experience continuous growth in income up to 2018. A key assumption here is that LWUA will be able to continue to obtain government grants and subsidies and in certain years even increase the level of its annual investment in projects from P 3.6 billion in 2009 to P 5 billion within the 5 year CIIP period. The projections assume that LWUA will implement its CIIP and adopt the proposed financing framework including ring fencing of loan and grant funds. The future of LWUA funding and the financing strategies it adopts will depend to a huge extent on the leadership in the coming years.

59. The major difference between the results of the two schemes are lower income figures under the Without the Bank scheme considering the amortization of losses from LWUA’s initial investment of P780 million to the WE Bank. Another reason for the higher income under the With the Bank scheme, is the share of LWUA on the estimated WE Bank income. However, the With the Bank Scheme financial projections lack a sound basis because there is currently no business plan for the WE Bank. It was agreed during the Draft Final Report Tripartite Meeting held last February 16, 2010 that the more conservative financial projections under the Without the Bank Scheme should be used.

60. The base scenario of the Without the Bank scheme shows a steady increase in income. Cash position gradually decreased through the years since the projections assumed that internally generated funds will be used as needed for projects and only a minimum level of cash will be retained. Years 2010 and 2011 show a drop in debt service coverage (DSC) as a result of the budgeted major increase in personnel costs from P 546 million in 2009 to P1,098 million in 2010 and higher debt service as LWUA substantially pays most of its local loans during these years. The DSC improves in the succeeding years as revenue levels also increase. As expected, analysis of the results of Scenario A, B and C using different levels of investment, collection efficiency, refinancing and operating costs show that LWUA’s performance is very sensitive to investment levels and collection efficiency. Under the conservative Scenario A, where investment levels are at 30% of the CIIP and collection efficiency is at 75% (base scenario is at 85%), poor performance is expected with the DCR at 1.10 and below during the 10-year period.

3. Major Issues

a. Accounts Receivable and Collection Efficiency

61. WD accounts comprise accounts receivables representing the current portion of WD accounts (P1,653 million), and long-term receivables which are not yet due (P13,736 million). There has been a tremendous increase in the accounts receivable during the last 3 years as this increased from P961 million in 2005 to P1,653 million in 2008. Of the P1,136 million receivables which are supported by subsidiary ledgers as of December, 2008, about 66% or P925 million are considered uncollectible.

62. The above reflects a very serious collection problem that could result in the continuous erosion of the quality and value of the receivables. To cover the risk, LWUA has set up high levels of allowance for bad debts equivalent to 25% of the balance of accounts receivables and 40% of non-performing loans. By end of 2008, allowance for bad debts already amounted to P615 million covering about 65% of the uncollectible accounts or accounts which are due for more than 6 months.

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63. Receivables based on the subsidiary ledgers dropped to P1,032 million as of June 30, 2009 and the amount considered uncollectible likewise dropped to P810 million due to restructuring of accounts. Action is needed on about 78% of these uncollectible accounts to complete the process of restructuring as well as to review what else needs to be done to bring the accounts to paying status.

b. Sources of Financing for Investment Projects

64. Decline in project disbursements have been noted in recent years in view of which LWUA is currently taking aggressive action to secure funds from the departments of Health (DOH), Public Works and Highways (DPWH), and Budget and Management (DBM). At the same time, it is following very closely the approval of the bill that increases capitalization and borrowing capacity of LWUA. The projections assume approval of the bill by the end of the year 2010 paving the way for more local borrowings in 2011. The acquisition of the ES Bank is in fact LWUA’s response to the need to secure financing for its development program.

c. Financing Framework

65. The sector and LWUA need a financing framework to guide future financing schemes. Following existing LWUA practices which are already aligned with EO 279, the proposed financing framework is shown in Table 3 .

Table 3: Financing Framework

Classification Grant Loans with Relending Terms

Creditworthy WDs No grant available No loans available

Semi-creditworthy WDs May be allowed but set at lower levels compared with PCW/NCW16

BR 38, maximum of 40 years repayment period and 10.2% interest

Pre-creditworthy WDs Maximum 90% grant Maximum 10% loan, under following options:

• 7.5–9% interest under the P5 million and P10 million loan windows

• Zero interest under NLIF window

Non-credit worthy WDs Maximum 90% grant Maximum 10% loan, zero interest under NLIF window

Non-operational WDs Maximum 90% grant Maximum 10% loan, zero interest under, NLIF window

BR = board resolution, NCW = non-creditworthy, NLIF = non-LWUA-initiated fund, PCW = pre-creditworthy, WD = water district.

d. Long-term Strategic Planning

66. To achieve its development targets, LWUA administration’s current main concern is towards obtaining funds and implementing an accelerated program for the waterless communities. There is, however, limited information on the existing service coverage of this subsector that could be used in planning for water supply and sanitation financing. The current planning process at LWUA is driven by information on available funds with the premise that the 16 Considering that some proposed projects for semi-creditworthy WDs involve waterless remote barangays

where loan funding at the regular terms will not make the project viable.

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financing need is so huge that whatever funds are obtained can be used to help meet the demand. The link between planning for infrastructure programs and the resulting improvements these programs bring about in terms of sector coverage and other performance indicators is not clearly established.

67. Moreover, LWUA currently prepares 10-year cash flows in three Excel files, one to compute investments, income statements and cash flows; a second to compute debt service; and a third to hold the balance sheet. The files are not capable of sensitivity analysis of various scenarios which will allow the administration to identify various options and select the most appropriate business strategy. Sensitivity analysis is an important tool that will guide management in making decisions to help ensure LWUA’s long-term viability. All the above concerns could be incorporated in a business planning model to guide LWUA management in formulating strategies for the long-term sustainability of its operations.

e. COA Findings

68. LWUA generally follows sound financial management principles in its operations as indicated by the positive responses to the Financial Management Assessment Questionnaire. In the 2007 audit of the LWUA financial report, however, the Commission on Audit issued a qualified opinion on LWUA’s financial reports. This was the result of two items, namely (i) the unreconciled balances of the receivables account amounting to P139 million, and (ii) the lack of valid claims to support the P142 million loan from the International Bank for Reconstruction and Development (IBRD). There were other matters enumerated in COA’s List of Comments and Observations. It is suggested that LWUA address these issues.

C. RECOMMENDATIONS

1. Institutional Component

a. Capitalization 69. LWUA should pursue the increase in its capitalization. The agency must intensify its efforts in lobbying for the enactment of the law increasing its capitalization from P2.5 billion to P10 billion.

b. Fund Management

70. The need to ring fence its loan portfolio is still a longstanding order for LWUA. As a specialized lending institution, it is essential that the agency’s top management establishes a system of maintaining a revolving fund from loan principal collections and limit the utilization of such funds only for loan assistance to water districts and debt servicing requirements.

c. Regulatory Practices

71. LWUA should consult with NWRB and harmonize its tariff review and other economic regulatory processes with it. Unless EO 123 is rescinded or amended, there is no other option left for LWUA if it wants to protect the interests of its client WDs.

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d. Implementation of EO 279 72. The EO 279 Oversight Committee and the LWUA Board of Trustees should review the creditworthiness criteria and reconcile them with the GFIs.

73. LWUA should take steps to clarify with the DOF and even with the Office of the President on the problems that it is or will encounter if its implementation policies will strictly be in accord with E0 279. The consultation process should necessarily involve the LWUA Board.

e. ISSP

74. LWUA should take the proper steps to have the application systems covered by its ISSP fully operational and to improve “front end” access via implementing a web portal. It should budget what it still needs for this endeavor.

f. Training

75. LWUA should continue to take steps to improve its capability in engineering technology, sanitation, regulatory practices and strengthening of advisory services. This was addressed through the training needs analysis and the training plan developed in Phase 2 of the PPTA.

2. Financial Component

a. Accounts Receivable and Collection Efficiency

76. As shown in the financial projections, LWUA’s financial performance is very sensitive to collection efficiency. LWUA is taking steps to address the problem primarily by assessing the condition of the non paying accounts and whenever appropriate, restructuring the accounts. More action is needed however to mitigate the risks related to increasing non payment of water district accounts to LWUA. LWUA should initiate more aggressive action to arrest worsening receivables condition, and identify and strengthen institutional responsibilities in the collection function. LWUA should prepare and commit to a coordinated Time Bound Action Plan to improve collection efficiency involving the Loans Administration Division, the Loans and Water Rates Evaluation Division and the Water District Development Division. This plan includes (i) action on non performing loans, (ii) review and preparation on policy proposals for writing off of accounts and provisioning policy, (iii) reconciling the receivables accounts, (iv) providing several ratios to monitor collection efficiency including monitoring non-performing loan accounts, and (v) restating budget and cash flow projections to reflect account classification to become comparable with Accounting records.

b. Sources of Financing for Investment Projects

77. LWUA should update its database of water districts that it could immediately tap as alternative sources of financing In the event that the bill increasing capitalization is not passed in 2009. In the past, LWUA has accessed reserve funds of WDs, paying them at an interest rate of roughly 7% and allowed them to refinance their existing LWUA loans. LWUA may just have to do the same in to sustain its program. Refinancing of loan funds will, however, only provide temporary cash relief and will not solve the long-term fund requirement needs of LWUA.

78. While LWUA has acquired controlling interest of the ESB (now referred to as the WE Bank) and is set to operate it, it should also resolve outstanding issues as follows:

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• LWUA to get official approval of the Monetary Board • The pro-forma ownership structure of WEB must be made to comply with the

ownership ceiling of 60% imposed by the Central Bank (BSP). Additional capital injections by LWUA into WEB will further complicate this issue, as the existing minority shareholders are unlikely to make additional investments to maintain their proportionate shareholdings.

• The envisioned operation of the Water Energy Development Bank (WEB) is a paradigm shift from how the bank was operated as ESB. LWUA’s mission-vision for WEB however, is still very general, and needs a lot more refinement and detail. To minimize its risks moving forward, LWUA needs to establish a) a clearer definition of this “mission-vision”, and b) a well thought out strategy and c) a comprehensive business plan for WEB.

c. Financing Framework

79. LWUA should start to ring fence all loans and grants to allow the gradual build-up of second generation loans. Funds from collections and refinancing should be relent to semi-creditworthy WDs to keep the base of paying accounts solid. Grant funds will also be provided to pre-creditworthy, non-credit worthy, and waterless municipalities, however, with a loan component. The loan component of these grant funds will form part of loan funds and will be relent to other beneficiaries.

80. LWUA should also revisit the other recommendations in EO 279 and prepare and/or finalize operating guidelines on the financing framework.

d. Long-term Strategic Planning

81. Component 2 of the WDDSP Loan Project, which deals with Capacity Building includes the development of a business planning model for LWUA. The business planning model should allow for scenario analysis and strategy development considering all the concerns and risks involved.

e. COA Findings

82. LWUA should take action on the two COA findings, specifically regarding unreconciled balances and lack of valid claims to support the IBRD loan. It should likewise try to resolve all other matters enumerated in COA’s List of Comments and Observations.


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I. INSTITUTIONAL ASSESSMENT OF THE LOCAL WATER UTILITIES ADMINISTRATION

A. INTRODUCTION

83. This report is being submitted as part of the requirements of Asian Development Bank’s (ADB) Water District Development Sector Project (WDDSP) Project Preparation Technical Assistance (PPTA). The objectives of the PPTA are to (i) formulate a sector investment project (i.e., WDDSP) in the urban water supply and sanitation sector17 with funding from ADB and other investment sources; and (ii) prepare implementation support and institutional development programs addressing sector reform, governance, and public awareness.

84. A requirement of the terms of reference is an assessment of the Local Water Utilities Administration’s (LWUA) institutional and financial capacity to implement the sector projects, which this report covers.

B. LWUA FUNCTIONS AND STRUCTURE

1. Historical Background

85. The Philippine archipelago comprises over 7,000 islands and is politically subdivided into 1,712 local government units (LGUs).18 Of these, only 17 LGUs in Metro Manila and suburbs are under the responsibility of the Metropolitan Waterworks and Sewerage System (MWSS). The country’s demographics present a major challenge to Government’s provision of basic services, such as water and sewerage, and sustaining these services.

86. Prior to 1973 and the establishment of LWUA, there were approximately 600 LGU utilities operating outside Manila. These utilities were generally the creation of local governments or the National Waterworks and Sewerage Authority (NAWASA).19 They operated either as functional departments of LGUs or provincial branches of NAWASA.

87. The LGU-run utilities were characterized by a set of interconnected weaknesses, namely:

(i) Low tariff levels, poor collection percentages, and high levels of unmetered connections;

(ii) Minimal cost recovery; (iii) Major constraints on available capital; (iv) Self-regulation and consequent low service standards, particularly for water

quality and continuity of service; (v) Overstaffing with low-level staff competence partially due to the utilities being

regarded as employers of last resort; (vi) Low levels of operating cost recovery and consequently the need for operating

subsidies from central government; and (vii) No regard for long-term sustainability and consequent degradation of physical

assets. 88. The NAWASA systems, while enjoying some measure of independence from the LGUs, suffered from inadequate capital and an inordinately centralized decision-making. Most 17 Defined as encompassing human waste (“black” water) and wastewater (household “gray” water, industrial effluents, etc.). 18 These Include 81 provinces, 136 cities, and 1,495 municipalities. 19 NAWASA was a national agency in charge of waterworks development and operation in the Philippines. It was

later converted to Metropolitan Waterworks and Sewerage System but was responsible for the Metro Manila area only.


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decisions and purchases had to be approved by the Manila central office. To address these issues, the Provincial Water Utilities Act was issued in 1973 as Presidential Decree (PD) 198.

2. Legal and Policy Framework

a. Presidential Decree 198 (1973 and as amended)

89. PD 198, among other things, (i) authorized the formation of local water districts (WDs), and (ii) created LWUA to financially and operationally assist WDs, and subsequently regulate them.

i. The Water Districts

90. PD 198 mandated the formation of local water districts, which were initially formed by resolutions of the LGU (generally, municipalities) as a single entity or as a combination of LGUs. Once formed, however, a WD becomes legally autonomous of the LGU and has the standing and legal character of an independent government-owned and controlled corporation. It is controlled by a board of directors, appointed by either the mayor or the governor,20 consisting of five members representing various sectors, who in turn appoint the WD’s general manager.

ii. Local Water Utilities Administration and its Function

91. LWUA was constituted under PD 198 as a government corporation to promote the development of water districts in the country. As originally created, LWUA was initially attached to the Office of the President,21 but in 2008 was transferred for policy coordination under the Department of Health (DOH).

92. As constituted in 1973, LWUA had a clear mandate to “primarily be a specialized lending institution for the promotion, development, and financing of local water utilities.”22 To carry out this mandate LWUA has subsidiary roles specified in the same section:

(i) prescribe minimum standards and regulations in order to assure acceptable standards of construction materials and supplies, maintenance, operation, personnel training, accounting, and fiscal practices for local water utilities;

(ii) provide local water utilities technical assistance and personnel training programs;

(iii) monitor and evaluate local water standards; and (iv) effect systems integration, joint investment and operations, and district

annexation and de-annexation whenever economically warranted. 93. While LWUA was specified as a lending institution, it is not necessarily an attractive borrower to capital sources such as banks. Furthermore, Official Development Assistance (ODA) agencies such as ADB and the World Bank require that aid provided as loans must be channeled to sovereign governments. Consequently, the LWUA law provided the following:

20 Depending on which LGU formed the water district. 21 In 1987, LWUA was transferred to the Department of Public Works and Highways. 22 PD 198 Sec. 50.


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The President of the Philippines….is hereby further authorized to guarantee, absolutely and unconditionally, as primary obligor….the payments of the loans, credits, and indebtedness up to the amount herein authorized…23

94. The creation of PD 198 made LWUA, which was attached to the Office of the President, responsible for the development of provincial water supply systems. In 1978, PD 198 was amended to include the provision of subsidies to non-viable WDs.

b. Executive Order No. 577 24 (1980)

95. Executive Order (EO) No. 577 issued in 1980 created the Rural Waterworks Development Corporation (RWDC) which was made in charge of providing water supply in provincial rural areas and other areas not covered by MWSS and LWUA’s water districts. The same EO authorized the formation of rural waterworks and sanitation associations to operate the water systems in these areas. LWUA’s provincial domain now had to be shared with RWDC.

c. Executive Order No. 124 (1987)

96. EO 124 issued in 1987 had the effect of a law due to unique circumstances in the political scenario prevailing at that time. This EO abolished RWDC and transferred all its functions, assets, and responsibilities to LWUA. In effect, LWUA was responsible for developing water systems outside the MWSS domain in all provincial urban and rural areas starting from 1987. At the same time, the EO transferred LWUA from the Office of the President to the Department of Public Works and Highways (DPWH).

d. NEDA Resolution No. 4 (1994)

97. National Economic and Development Authority (NEDA) resolutions are not laws but are more policy and strategy directions for all executive government agencies to adopt. NEDA Resolution No. 4 issued in 1994 reiterated the corporate mission of LWUA as a specialized lending institution financing only viable level III water projects.

98. After NEDA Resolution No. 4, LWUA decided to concentrate its lending to the viable water districts, which for the most part were concentrated in provincial urban areas.

e. Executive Order No. 123 (2002)

99. EO 123 issued on September 12, 2002 generally addressed the restructuring of the National Water Resources Board (NWRB), which at that time was the national economic regulatory body for private utilities. EO 123 had a significant impact on the functions of LWUA since it removed LWUA’s right to regulate water and sewerage tariffs of WDs and transferred this right to NWRB. EO 123 does provide that LWUA “may continue reviewing the rates of water districts which it has financial exposure, with the end view of ensuring their financial viabilities”.25 However, as of April 2009 NWRB had not yet assumed the function of approving WD tariffs due to limitations in its resources and consequent responsibility.

23 PD 198 Sec. 73. 24 Had the force of a law since it was issued during a period wherein the constitution was still suspended. 25 Executive Order 123 Sec. 6, September 12, 2002.


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f. Executive Order No. 279 (2004)

100. EO 279 was issued on February 2, 2004. It provides for the institution of reforms in financing policies for the water supply and sewerage sector and water service providers, and the rationalization of LWUA’s organizational structure and operations in support thereof.26

101. EO 279 prescribes the following:

(i) Improvement of investor confidence in the water supply and sewerage sector; (ii) Rationalization in the allocation of scarce financial resources in the water

supply and sewerage sector through classification and graduation initiatives; (iii) Freedom of choice of water service providers in sourcing financing; (iv) Increased participation of LGUs, and government and private financing

institutions (GFIs/PFIs) in financing the water supply and sewerage sector; (v) Stimulation of improved services and creation of financial self- sustainability

for water service providers (WSPs); (vi) Encouragement of initiatives aimed at self-sufficiency of WSPs, including, but

not limited to, amalgamation, private sector participation, cost-recovery tariffs, and resource pooling;

(vii) Grant of incentives for the improvement and graduation of water service providers;

(viii) Education of consumers towards treating water as a scarce economic good; and

(ix) Establishment of an independent economic regulator for the water supply and sewerage sector.27

102. More directly, EO 279 provides, in respect to LWUA, for the following:

(i) Financially viable WSPs (described as creditworthy) to have clear autonomy in accessing capital markets for system development, i.e., they are no longer restricted to borrowing through LWUA,

(ii) Financially non-viable WSPs to continue to access concessional capital through and with LWUA assistance,

(iii) LWUA to be restructured so that it reports to the Office of the President instead of DPWH, and more specifically shifts its focus to institutional strengthening of financially non-viable WSPs, and

(iv) The extension of the scope of LWUA’s technical assistance provision to include LGUs, i.e., as WSPs which have not been constituted as WDs.

103. Throughout LWUA’s existence, LWUA’s role in the development of the provincial water supply sector seems like a pendulum swinging back and forth from one extreme (all areas to be funded) to another (only viable projects to be funded).

3. Recent LWUA Board Policies 104. Some of the more recent major policies which the LWUA Board has promulgated are the following:

(i) Resolution No. 145 s. 2008 − Establishment of a water development bank. This LWUA subsidiary bank is intended to cater primarily to the financing needs of WDs as well as serve as their depository bank.

(ii) Resolution No. 19 s. 2009 − New Policies Governing Non-LWUA-initiated Funds. This resolution provides that these funds, if loaned, shall be interest-

26 Executive Order 279, February 2, 2004. 27 Executive Order 279 Sec. 1, February 2, 2004.


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free and shall be used for non-operational WDs, waterless municipalities or municipalities with no existing system.

(iii) Resolution No. 38 s. 2009 − Revision of Interest Rates under Loan Window I. This basically reduced the effective interest rates of LWUA loan and increased the loan tenor.

C. OPERATING ENVIRONMENT

1. External Environment 105. Agencies which have responsibilities relative to policy setting, provision, and regulation of water supply in provincial areas are listed in Table 4 .

106. The relationships between the agencies and LWUA are extremely complex and are marked by some duplication (e.g., in tariff setting). These relationships are shown in Figure 1 .


21

Table 4: Agencies Responsible for Water Supply in Provincial Areas

Agency Roles and Responsibilities

Local Government Units (LGUs)

� Plan and implement water supply and sanitation (WSS) programs - prepare WSS master plans - monitor local WSS coverage and update of sector coverage - provide support to WSPs such as RWSA, BWSAs, and Cooperatives, including funding from internal revenue allotment

� Finance, regulate, and operate water systems � Based on the Local Government Code, LGUs bear multiple mandates in the

sector such as resource regulation, water supply provision, and economic regulation of their utilities

Department of Public Works and Highways

� Assist LGUs in implementing water and sanitation projects � Provide technical support to LGUs upon request, including implementation

of level 1 and level 2 projects � Implementing agency for level I and level 2 systems

Local Water Utilities Administration

� Provide capacity-building support to WSPs - provide technical advisory services and financial assistance to WDs - provide technical and institutional support to LGUs and WSPs - set design standards for water supply utilities operated by WDs and other

WSPs

National Water Resources Board

� Regulate WSPs, including some consenting LGU-run utilities - tariff regulation - coverage and service regulation - management of sector database including WSP performance data

� Water resource allocation and economic regulation of WSPs National Economic and Development Authority

� Coordinate the preparation of national development plans and investment programs - formulate sector policies and strategies - monitor implementation of policies, programs, and projects

� Sector macro-planning; approve major sector projects

Department of Finance (DOF)/Government Financing Institutions (GFIs)

� Provide financing support to the water supply sector - DOF: Oversee performance of GFIs - GFIs: Provide funding for the water supply sector

National Anti-Poverty Commission – Water Supply Coordination Office

� Coordinates the president’s priority program on water (p3w) water supply

projects for 432 waterless municipalities outside Metro Manila, 210 communities within Metro Manila, and 201 municipalities in conflict zones

Department of Environment and Natural Resources

� Based on EO 192, DENR serves as the lead agency in promulgating rules and regulations for the control of water, air, and land pollution, and ambient and effluent standards for water and air quality

� Watershed management programs and oversight body for wastewater effluent

Department of Health

� Regulate water quality of WSPs, and formulate water supply and sanitation programs to prevent environmental-related diseases

� Policy supervision over LWUA

BWSA = Barangay Water and Sanitation Association, DOF = Department of Finance, EO = executive order, GFI = government financing institution, LGU = local government unit, p3w = President’s priority program, RWSA = rural water and sanitation association, WD = water district, water service provider, WSS = water supply and sanitation.


22

Figure 1: Water Sector Institutional Framework of LWUA

NWRB

National Government Multilateral Donors

Bilateral Donors

Department of Finance

NEDA

Department of Health

Local Water Utilities Administration (LWUA)

Water Districts and Participating LGUs

Government and Private

Financing Institutions

Administration

Policy

Technical and Institutional Support,

Setting Design Standards

Capital Funding

For Creditworthy Water Districts Only

Financing

Water Resource Allocation, Tariff

Regulation Coverage, and Service Regulation

LGU = local government unit, LWUA = Local Water Utilities Administration, NEDA = National Economic and Development Authority, NWRB = National Water Resources Board.


23

a. Funding Sources

i. Capital 107. LWUA is a government-owned and controlled corporation and its financing transactions are monitored only by the Department of Finance (DOF) and the Commission on Audit. PD 198 specifies28 that LWUA has an authorized capital of P2.5 billion which had already been fully subscribed by the national government since 1991. LWUA has a cap on outstanding domestic borrowings of P1 billion which had already been reached in the late 1990s. As a consequence, LWUA, apart from debt rollover, must source capital through government grants or through foreign debt, generally through ODA. LWUA is authorized to contract foreign credits or borrowings up to an outstanding amount not exceeding $500 million. As of end 2008, LWUA’s outstanding foreign debt is about $200 million. LWUA’s capital funding is sourced from:

(i) Government financial institutions such as Philippine Veterans Bank and Land Bank of the Philippines;

(ii) Multilateral development funding agencies such as the World Bank/ International Development Association, Japan Bank for International Cooperation, and ADB;

(iii) Bilateral (i.e., foreign government) agencies such Danish International Development Agency (DANIDA), Australian Agency for International Development (AusAID), United States Agency for International Development (USAID), Japan International Cooperation Agency (JICA), and Kreditanstalt für Wiederaufbau (KfW).

ii. Recurrent Funding

108. LWUA’s recurrent (operations) funding is generally made up of:

(i) Interest on loans to WDs, (ii) Fees applied to clients (principally WDs) for engineering services such

as design studies and construction supervision, (iii) Well-drilling services, and (iv) Interest on loans to staff.

109. Funding issues are discussed under the financial assessment section of this report.

b. Policy Coordination

110. Figure 1 shows the government policy-making bodies with which LWUA must align its own internal policies and strategies. These are DOF, DPWH, NEDA, the Department of Environment and Natural Resources (DENR), and DOH to which it is currently attached. Capital funding from the national government to LWUA is channelled through DOH. ODA funding has to be channelled to DOF to obtain sovereign guarantees. NEDA has to approve LWUA’s major projects and ODA funding, and LWUA has to follow procurement policies promulgated by DPWH.

28 PD 198 Sec. 67.


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2. Internal Environment a. Policymaking

111. Policymaking within LWUA is the prerogative of the Board of Trustees, which is made up of the chairman and four members. All Board members should be citizens of the Philippines, with each trustee having specific qualifications in engineering, economics, management or banking/finance. In addition, the Administrator is an ex officio member of the Board. Each Board member serves a fixed term of 5 years.29

112. The Board meets every week. Their meetings are generally focused on water rates and WD loan approvals, policy matters on loans, interest rates, takeover of WDs,30 and contract awards.

b. Current Board/Management Directions

113. In June 2008, the President appointed Mr. Prospero Pitchay as LWUA chairman. On several public occasions Chairman Pitchay had the opportunity to talk about LWUA’s directions under his helm. In brief, LWUA would fund all types of WDs regardless of creditworthiness. There are also plans to set up a water development bank to align LWUA’s financial function along commercial banking modes. Other Board directions include the implementation of bulk water projects, reducing LWUA’s interest rates, assisting WDs in reducing their operating cost such as power costs, exempting WDs from paying income taxes, and more training for WD officials.31

c. LWUA Employees Association for Progress (LEAP)

114. LEAP is the official employee association in LWUA. Composed roughly of 70% of the LWUA staff complement, its membership reaches up to the division chief level. LEAP is a very strong organization. It was responsible for unseating a past administrator and is currently fully responsible for getting a court restraining order against the restructuring of LWUA in conformance with EO 279.

3. Current Structure and Roles

115. The LWUA structure is arranged according to functional and geographic areas of responsibility. The financing roles are handled jointly by the Loans and Water Rates Evaluation departments under the Senior Deputy Administrator (SDA) and the units under the Deputy Administrator (DA) for Finance; the engineering services assistance by the DA for Area Operations; and the institutional development and oversight roles by SDA. The current LWUA structure is shown in Figure 2 .

29 Not all appointments of the trustees carries the fixed term of office; hence, they could be replaced any time. 30 LWUA is authorized to take over the operations of defaulting WDs sans judicial proceedings. 31 LWUA. Waterpoint, Issue No. 1, 2009.


25

FIGURE 2: LWUA ORGANIZATIONAL STRUCTURE

Source LWUA Data

Administrator (6)

Management Services Office (2)

Chairman and Board of Trustees

Internal Control (1)

Water Resources and Training

• Commercial Practices & Systems (7)

• Training (13) • Research (9)

Public Affairs (3)

Legal Services • Contracts

(5) • Litigation &

investigation (2)

Institutional and Media relations

(5)

Media Productions (5)

Corporate Planning (7)

Management Info. Systems

(8)

Info. Network and Facilities Management

(3)

Water District Development – Luzon

(26)

Water District Development – Bicol

Visayas (21)

Water District Development – Mindanao (11)

Senior Deputy Administrator (3)

Financial / MIS Audit (3)

Corporate Counsel (1)

Board Secretariat (10)

PBAC/PEAC Secretariat (2)

Operation al Audit (4)

Loans Water Rates Evaltn Luzon (18)

Loans Water Rates Evaltn

Visayas Mindanao (13)

Deputy Administrator – Administration (2)

Deputy Administrator – Investment & Finance (4)

Deputy Administrator – Area Operations (3)

H.R. Management (2) • Personnel (12) • H.R. Development (7) • Medical & Dental ( 3)

Property Management (3) • Property Control (9) • Building & Grounds (11) • Motor pool ( 18)

General Services (3) • Records & Commnictn (20) • General Services (8)

Treasury (2) • Budget (11) • Cash Management (13)

Account ing (1) • Transaction Processing (17) • Bookkeeping & Fin. Records (10) • Cost Accounting (4)

Loans Administration (2) • Billing (9) • Collection (7)

Water District Audit (2) • Luzon (5) • Visayas Mindanao (5)

Special Projects Office (2) • Watershed Mgt & CPSO (2) • Water Resource Devt (46)

Operations Luzon North (6) • Project Planning (20) • Project M&E (15)

Operations Luzon Cent/Sth ( 5) • Project Planning (26) • Project M&E (13)

Operations Bicol Visayas (6) • Project Planning (21) • Project M&E (13)

Operations Mindanao (3) • Project Planning (15) • Project M&E (13)

CPS = Commercial Practices & Systems, Devt = development, Evaltn = evaluation, HR = human resource, Info = information, M&E = monitoring and evaluation, Mgt = management, MIS = management information system, PBAC = Pre-qualification, Bids, and Awards Committee, PEAC = Prequalification, Evaluation, and Awards Committee.


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4. Geographical Service Area

a. Extent of Water District Coverage 116. LWUA had assisted in forming 604 WDs covering 751 LGUs; of these only 479 are operational. Table 5 illustrates the coverage of the operational WDs.

117. LWUA has arbitrarily grouped all WDs into nine areas for unifying administrative responsibility and for balancing LWUA personnel resources. The distribution of the operational WDs within the nine areas is shown in Table 6 .

Table 5: LWUA/Water District Coverage

Island No. of WDs No. of LGUs Covered

No. of Connections

Population Served a

Luzon

273

394

1,530,356

8,786,578

Visayas 107 183 458,162 2,647,161 Mindanao 99 174 638,594 3,727,973

Total 479 751 2,627,112

15,161,712

LWUA = Local Water Utilities Administration, WD = water district, LGU = local government unit. a Number of connections x 6.

Table 6: Water District Grouping by Area

Area

Coverage No. of Water Districts Major Island Region/s

Area 1

Northern Luzon

1, 2, CAR

73

Area 2 Central Luzon 3 93 Area 3 Southern Tagalog 4 70 Area 4 Bicol 5 37 Area 5 Western Visayas 6 63 Area 6 Eastern and Central Visayas 7, 8 44

Area 7 Northern Mindanao 10, 13 30 Area 8 Southern Mindanao 11, 12, ARRM 38 Area 9 Southwestern Mindanao 9, 10, 12, ARRM 31 Total

479

ARMM = Autonomous Region in Muslim Mindanao, CAR = Cordillera Autonomous Region.


27

b. Categories and Classification of Water Districts 118. LWUA has categorized the WDs into six sizes based on a point system of six factors shown in Table 7 . The size categories are basically used in determining the compensation levels of WD personnel and the per diem of directors.70 Table 7 shows the relative weight of the different parameters in the said categorization system. 71

119. Table 8 presents the size categories of some operational WDs which have been classified into the creditworthiness typology indicated in EO 279.

120. Not all of the 479 operational WDs have been credit-classified due to their non-submission of required financial and operational data. The bulk (37%) of the WDs is in the semi-credit classification of which more than half are considered small.

Table 7: Water District Size Categorization Parameters

Indicator

Weight (%)

Gross Receipts

30

Size of Fixed Assets 25 Size of Net Income Before Depreciation and Interest 20 Number of Service Connections 10 Complexity of the Nature of Operations 10 Number of Personnel 5 Total Weight 100

Table 8: Creditworthiness Classification of Water Districts, 2008

Category/ Credit Rating

Total Credit Worthy

Semi- credit

Worthy

Pre- credit

Worthy

Non- credit

Worthy

Small 191 17 94 52 28

Average 31 3 19 6 3

Medium 51 20 25 5 1

Big 51 23 24 3 1

Large 15 3 11 1 0

Very Large 7 0 6 1 0

Total 346 66 179 68 33

70 Per Department of Budget and Management recommendation after the classification of water districts as

government-owned and controlled corporations. 71 An unintended effect of this classification system is that it encourages water districts to leverage their equity

(i.e., borrow) and to prioritize the maintenance of capital expenditures to maintain high revenues and profits and a bloated organizational structure without significant increase in new connections.


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5. Water District Performance

a. General

121. As of December 2008, LWUA has formed 604 WDs. Of these, 479 are operational and have a combined total of 2,627,112 service connections serving a total population of 15.16 million in 587 towns/cities. The total franchise population of the operational WDs is 43,561,09772 for a served population ratio of 35% within their franchise areas. The WD-served population covered for the entire country is 17%.

122. WDs perform generally better than non-WDs,73 except on tariffs (WDs have the highest) and staff/connection ratios. This observation was confirmed by Castalia’s Diagnostic Water Sector Study (2008) and even the Water Performance Enhancement Program Study of Small Town Utilities in 2004, both funded by the International Bank for Reconstruction and Development (IBRD).

123. In more specific terms, key performance indicators in the Department of the Interior and Local Government’s74 benchmarking exercises reveal that WDs have, on the average, higher coverage rates (69%) compared with non-WD models (62%). This is adequately explained by a stronger commitment of WDs’ management towards developing and planning infrastructure, and attaining preset service standards. Higher service coverage of WDs is complemented by an impressive 99% revenue collection efficiency, which is a testament to consistent policy enforcement (periodically aided by incentive schemes and payer discounts), and active monitoring of both present dues and arrears. Non-WD models, such as cooperatives and private utilities, comparably enjoy at least 99% collection efficiency within their limited coverage areas. Stricter monitoring of obligations is also reflected in accounts receivables (ARs), where WDs sustain an average of only 1.3 months-worth of ARs. This is lower than the ARs of non-WDs such as RWSAs (2.5 months) and LGUs (2.3 months). The strong performance also reflects LWUA’s effective assistance in the management of WDs.

124. Reliability of supply is measured through two indicators: (i) water availability and (ii) water pressure at the customer meter. These performance indicators not only assure the entire community of clean water at any time of need; there are also implications of contamination, poor sanitation, and difficulty in fire-fighting.

125. LWUA sets targets for water districts. NWRB sets targets for those cooperatives/RWSAs and private suppliers that acquire certificates of public convenience and for LGUs that request for regulatory assistance. LWUA’s targets are: 24-hour supply at a minimum pressure of 7 meters for residential customers and 11 meters for commercial establishments and institutions.75 NWRB sets 8 hours/day minimum supply effective 2007 and minimum pressures of 5 psi for residential users and 25 psi for commercial establishments.

126. Data taken from sampled water districts76 showed that most water districts are able to provide water 24 hours a day. LGU systems, cooperatives/RWSAs, and private systems far exceed the NWRB guidelines, but fall short of 24- hour supply availability, which exposes customers to risk of contaminated water. Water districts are also able to meet pressure requirements,77 but no data are available for the other water systems. Corollary to this WD efficiency, unaccounted-for water (UFW) among sampled WDs is 26% compared with 30%

72 NSO 2007. 73 IBRD-WSP. Philippines Small Towns Water Utilities Data Book, 2004 and 2005. 74 As presented by DILG on July 2008 in ADB for LGU-managed Water Systems. 75 Castalia Strategic Advisors. November 2008. Diagnostic Study of the Water Sector in the Philippines. Draft

Report to the World Bank, Manila. 76 IBRD-WSP, op. cit. 77 World Bank. 2004. Philippine Infrastructure Study.


29

among non-WDs, with LGU-run utilities incurring a considerable 36% UFW due to factors such as declining infrastructure, and socioeconomic and capital financing constraints.

b. Sewerage and Sanitation

127. The Clean Water Act (2004) specifies that by 2009:

(i) 100% of households, commercial centers, and public buildings in urban areas must be connected to a sewerage system; and (ii) national and local governments should have implemented sewage or septage management schemes.

128. There are only three LGUs outside Metro Manila which have existing sewerage facilities two of which are being managed directly by WDs (viz., Zamboanga and Vigan WDs). The Baguio system is being managed by the LGU itself. These suggest that the current sewerage coverage is still very far from the target set in the Clean Water Act.

129. The WD’s role in urban sewerage and wastewater sector, as provided in PD No. 198 − Provincial Water Utilities Act of 1973 (as amended by PD Nos. 768 and1479), is as follows:

Sec. 2. Declaration of policy. The creation, operation, maintenance, and expansion of reliable and economically viable and sound water supply and wastewater disposal systems for population centers of the Philippines is hereby declared to be an objective of national policy of high priority.…”

Sec. 5. Purpose. Local water districts may be formed pursuant to this Provincial Water Utilities Act of 1973 for the purpose of… (b) providing, maintaining, and operating wastewater collection, treatment, and disposal facilities …

130. Based on this, LWUA issued Board of Trustees Resolution No. 261, Series of 2002, defining the LWUA policy statement on urban sewerage, which states that LWUA intends to:

(i) identify low-cost funding sources, preferably subsides and grants-in-aid, to implement sewerage projects;

(ii) strengthen cooperation among LWUA, WDs, LGUs, other national government agencies, and non-governmental organizations concerned with water and sewerage issues;

(iii) harness LWUA’s technical capability in sewerage system planning, design, and construction; and

(iv) enhance the application of low-cost, affordable, and indigenous technologies to reduce cost impact on sewerage infrastructure for collection, treatment, and disposal of liquid fluid.

131. LWUA’s statement of commitment also discusses that the major issues affecting sanitation are funding and cost recovery. While for the most part, WDs are prepared to take up operation and maintenance of facilities, capital cost and recovery thereof is a major concern, particularly the (i) source of funds for sanitation, and (ii) affordability and willingness of beneficiaries to shoulder the additional cost burden of sanitation in addition to the cost of access to potable water. As a result, there have been few feasibility studies done by LWUA on sewerage78 funded by LWUA internal funds and grants from USAID and the World Bank. Of the 12 feasibility studies conducted, only one was implemented and this was in Baguio City with

78 In the 1980s, LWUA funded feasibility studies for Butuan, Daet, and the cities of Ozamis, Zamboanga, and

Baguio.In the 1990s, USAID funded feasibility studies for General Santos and Cagayan de Oro cities. World Bank also funded feasibility studies for Calamba, Cotabato, Roxas, Davao, and Dagupan in 1996.


30

100% subsidy funding from JICA. No further LWUA-initiated studies have been done on sanitation projects to be implemented by water districts.79

132. Despite these challenges, LWUA (i) has committed to venture into sewerage and septage management programs and projects beginning 2008, (ii) is initiating steps to source financing assistance from JICA, World Bank, JBIC, and other external financing agencies, and (iii) commits to complete the World Bank-funded National Sewerage and Septage Management Program in 2009 to jumpstart planning for sewerage and septage management initiatives in the country.

c. Average Tariffs of Water Districts

133. The average tariffs of WDs are posted in Table 9 and are compared with Metro Manila tariffs. Figure 3 graphically shows the comparison.

134. From Table 9 and Figure 3, it is apparent that the average tariffs of WDs are higher than that of the Metro Manila concessionaires by an average of 24% for 30 m3 consumption. This is due to the cost recovery concept that the LWUA had introduced since its inception as well as some loan write-offs which MWSS was able to get from the government. In addition, Metro Manila has the advantage of economies of scale for its utilities which only a few WDs enjoy.

79 At present, the following water districts have agreed with the Philippine Water Revolving Fund to conduct

sanitation feasibility studies: Zamboanga, San Pablo, Cabanatuan, Cebu, and Baliuag WDs.


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Table 9: Water District Tariffs as of 31 December 2008 (P/m 3)

ARMM = Autonomous Region in Muslim Mindanao, CAR = Cordillera Autonomous Region, m3 = cubic meter, MWCI = Manila Water Company, Inc., MWSI = Manila Water Services, Inc.

Figure 3: Water Tariffs of LWUA, MWCI, and MWSI as of December 2008

LWUA = Local Water Utilities Administration, m3 = cubic meter, MWCI = Manila Water Company, Inc., MWSI = Manila Water Services, Inc., WD = water district. Source: LWUA, MWCI, and MWSI websites.

Region Water District Count

Min. Charge 10 m3

11-20 m3

21-30 m3

31-40 m3

41-50 m3 51-up m 3 Cost per 30 m3

1

42 202.83 21.63 23.39 25.55 27.41 28.00 653.17

2 26 196.11 21.48 23.37 25.88 27.91 27.91 644.71

3 82 165.35 17.75 19.28 21.17 23.11 25.09 535.71

4 73 154.28 16.83 18.59 20.84 23.03 23.35 508.60

5 38 169.29 19.14 21.15 23.86 26.66 26.78 572.31

6 63 179.91 20.96 23.26 26.32 28.84 29.24 622.24

7 17 116.74 13.41 15.32 19.47 21.75 22.16 404.09

8 27 155.93 17.45 19.24 21.54 24.16 24.24 522.90

9 14 155.04 19.22 21.12 23.38 24.78 25.18 558.57

10 19 144.98 17.72 20.80 24.07 27.23 28.11 530.22

11 26 159.57 17.33 19.41 21.70 24.31 24.45 527.13

12 13 163.88 17.70 19.64 21.75 23.14 24.09 537.38

ARMM 8 124.77 13.44 15.27 18.00 19.31 19.31 411.96

CAR 6 195.08 21.76 24.77 27.95 30.48 30.48 660.50

Caraga 20 166.16 20.19 23.44 27.22 31.08 32.10 602.51

Average 474 166.87 18.62 20.61 23.14 25.44 26.09 559.24

MWCI 69.16 8.44 16.00 16.00 21.07 21.07 395.21

MWSI 77.62 9.47 17.95 17.95 23.64 27.62 459.97


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D. LWUA CURRENT OPERATING STATUS

1. Charter 135. As previously noted, EO 198 explicitly mandates LWUA to be primarily a lending institution with associated roles as tariff regulator and technical and institutional development advisor.

136. Currently, however, the corporate charter of LWUA is unclear. This is because of the effect of EO 123 which assigns the tariff-setting responsibility to NWRB, and EO 297 which reduces the lending scope of LWUA to client water districts that have marginal creditworthiness.

2. Corporate Plan, Mission, and Core Competence

137. The LWUA Corporate Plan for 2008-2010 contains a clear mission statement:

To develop water districts and other water service providers into self-sustaining institutions by providing financial, technical, institutional, and regulatory assistance (and) by being a viable, effective, and world-class organization. 80

138. In essence, LWUA operates to develop water and sanitation services outside the greater Metro Manila area, which is serviced by MWSS through concession agreements.

139. LWUA’s functions are built around financial management, capital project preparation, and operational management competencies. From sector studies and experience in the sector, LWUA’s core competencies are in the field of technical and institutional development services to utilities and the ability to operationally turn around an unviable WD to a viable one. EO 279 intends LWUA to improve its financial management operations. However, it does so from a perspective of merchant banking practices and not of a developmental financial institution in a sector with minimum securities and subject to high political and financial risks and resource uncertainties. LWUA’s formula had always been to mix merchant banking practices with those which can somehow offset its developmental financing function in order to attain corporate sustainability; hence, the current LWUA dilemma with the issuance of EO 279.

140. Many LWUAns and other non-LWUAns in the sector believe that implementation of EO 279 will eventually weaken LWUA by making it an unviable corporation. Even the concept of the Philippine Water Revolving Fund (PWRF) is designed to eventually devolve LWUA’s financing function to either the GFIs or PFIs. LWUA is a financing corporation and its performance is being monitored by DOF. While DOF expects LWUA to be a financially viable organization, EO 279 will cause it to be unviable by taking away its creditworthy clients and mandating it to service only WDs (and even other WSPs) which are marginally creditworthy without specifically mentioning the source of subsidy funding.

3. Setting Prices

141. In view of EO123, NWRB nominally now has the duty of price regulator for WDs. However, it has been observed that 7 years after the transfer of responsibilities through EO 123, NWRB has not really assumed this duty. This is due to a lack of NWRB competency and resources. NWRB is primarily a resource manager and allocator, and while it is the economic regulator for private utilities, it has limited knowledge of the tariff methodology adopted by LWUA as contained in PD 198. Furthermore, major conflicts may apply, such as implementing government policy decisions in regard to allocation (e.g., between irrigation and urban consumption). There is often the irresistible incentive to cross-subsidize between recipients of

80 LWUA Corporate Plan (2008-2010) adopted by the Board of Trustees, 18 September 2007.


33

raw water in the interest of policy but with a resulting major impact on economic efficiency. An international example is that of India where allocation of irrigation water to the agrarian poor is subsidized by the water resource drawing right payments from urban authorities.

142. NWRB was nominated by EO123 as a tariff regulator rather than as an economic regulator (as is the case of the MWSS Regulatory Office) where measurement of performance is the primary requirement. This issue requires clarification.

143. The separation of direct economic regulation from resource management is typified in the United Kingdom where water sector privatization was initiated and resource management was established as the responsibility of the National River Authority (since it was absorbed into the Environment Agency of England and Wales) and economic regulation is the responsibility of the Office of Water.

4. Implementation of EO 279

144. EO 279 specifies changes in two dimensions: (i) capital financing for WSPs, and (ii) the structure of LWUA, both of which are relevant to LWUA. In addition, EO 279 promotes reform with respect to the establishment of an independent economic regulator for the water supply and sewerage sector but does not specify the way forward.

145. In regard to providing capital financing, EO 279 stratifies water supply providers based on their financial condition. This stratification is as follows:

(i) Creditworthy WSPs – are financially self-sustaining WSPs capable of accessing financing from GFIs and or PFIs;

(ii) Semi-creditworthy WSPs – refer to WSPs with the demonstrated ability to achieve creditworthiness in the short-term based on relevant financial and operational indicators set by the Oversight Committee, but either lack the full criteria for creditworthiness or do not meet the criteria consistently;

(iii) Pre-creditworthy WSPs – allude to WSPs which are not likely to become creditworthy in the medium-term due to performance issues but demonstrate the potential for creditworthiness in the long term based on relevant financial and operational indicators set by the Oversight Committee;

(iv) Non-creditworthy WSPs – are WSPs with the potential to reach pre-creditworthy status in the medium term based on relevant financial and operational indicators set by the Oversight Committee.81

146. Table 10 shows the criteria framework adopted by the Oversight Committee of EO 279 and LWUA for assessing credit worthiness

81 EO 279 Sec. 2.


34

Table 10: LWUA Creditworthiness Parameters

Total Weighted Score

CW Semi-CW Pre-CW Non-CW Weight

(%) 8.5 - 10 5.5 - 8.4 3.0 – 5.4 0.0 – 2.9

RANGE (points) Points

10

6

3

0

Financial Parameters

Current Ratio (CR) = Current assets / Current liabilities

If CR>2.0 If CR >1.2 but < 2.0

If CR > 0.9 but < 1.2

If CR < 0.9 20

Debt Service Ratio (DSR) = Operating income before interest and depreciation / Debt obligations (including principal repayments and lease payments)

If DSR > 2.3 If DSR >1.2 but < 2.3

If DSR > 0.9 but < 1.2

If DSR < 0.9 20

Net Profit Ratio (NPR) = Net operating profit/ Net revenue

If NPR > 0.08

If NPR > 0.05 but < 0.08

If NPR > 0.03 but < 0.05

If NPR < 0.03 5

Debt Equity Ratio (DER) = Debt / Owner’s equity

If DER < 0.75

If DER > 0.75 but < 0.85

If DER > 0.85 but < 1.0

If DER > 1.0 5

Operational Parameters

Collection Ratio (CR) = Revenue collections / Revenue billed

If CR > 87% If CR > 78% but < 87%

If CR > 70% but < 78%

If CR < 70% 20

Non- Revenue Water (NRW) = Water metered as supplied / Water extracted and treated

If NRW < 25%

If NRW > 25% but < 45%

If NRW >45% but < 55%

If NRW > 55%

20

Service Connection/Staff (SR) = Water service connections / WD staff (including long term contractors)

If SR > 120 If SR > 100 but < 120

If SR > 80 but < 100

If SR < 80 10

TOTAL 100

CR = collection ratio, current ratio; CW = credit worthiness, DER = debt equity ratio, DSR = debt service ratio, NPR = net profit ratio, NRW = non-revenue water, SR = service connection/staff, WD = water district. 147. These criteria are quite stringent. For instance, a current ratio of 2 or greater is generally recognized as indicative of a financially very sound entity. A debt-to-equity ratio less than 0.75 is similarly very sound. Operationally, it is recognized that non-revenue water percentages below, say, 20% are difficult to achieve due to unavoidable losses from evaporation, system flushing, etc., and in many cases it may not be economically justified to pursue lower rates.

148. As a benchmark, a basic assessment of Manila Water Corporation Inc. (MWCI) has shown that it would be currently rated as semi-creditworthy due to its prevailing current ratio and NRW percentage in 2006.82 This is at a time when MWCI is recognised as an extremely well-performing company.

149. The general principle of stratification of WSP’s is appropriate and consistent with the role of LWUA as a sector “merchant bank.” However, while EO 279 may not prevent LWUA from lending to creditworthy WSPs, it specifies that LWUA should accept the condition that LWUA loans are subordinate to GFI loans through a waiver. This implies that LWUA should avoid lending to creditworthy worthy WSPs and concentrate instead on the lower three strata of

82 As assessed from published financial statements and annual reports of Manila Water Company, Inc.


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borrowing WSPs. EO 279 likewise allows GFIs to provide loans directly to semi-creditworthy WDs. The consequence is that LWUA eliminates its merchant bank role to a full development bank given the clients left to it.

150. The exclusion of creditworthy WSPs from the pool of borrowers from LWUA, however, becomes problematic for LWUA in a financial sense since it increases the overall risk applied to LWUA’s loan portfolio with a consequent and potential increase in borrowing costs. Tables 11a−−−−11c show the creditworthiness classification (stratification) of water districts against size and location.

151. A classification of water districts based on credit worthiness against location (undertaken in 2008) shows almost a similar distribution of creditworthiness (Table 11c).

Table 11a: Classification of Water Districts, 2005

Category /

Credit Rating

Number

Credit- worthy

Semi-credit-

worthy

Pre-credit-

worthy

Non-credit-

worthy Small

144

11

75

39

19

Average 32 3 19 8 2 Medium 52 18 29 4 1 Big 35 15 15 4 1 Large 13 3 10 0 0 Very Large 4 1 3 0 0 Total 280 51

(18%) 151

(54%) 55

(20%) 23

(8%)

Source: LWUA.

Table 11b: Classification of Water Districts, 2008

Category / Credit Rating Number

Credit- worthy

Semi-credit-

worthy

Pre-credit-

worthy

Non-

creditworthy

Small

191

17

94

52

28

Average 31 3 19 6 3

Medium 51 20 25 5 1

Big 51 23 24 3 1

Large 15 3 11 1 0

Very Large 7 0 6 1 0

Total 346 66 (19%)

179 (52%)

68 (20%)

33 (9%)

Source: LWUA-approved Board Memo, August 2008.

Table 11c: Water District Classification by Location, 2008

Area

Number

Credit- worthy

Semi-credit-

worthy

Pre-credit-

worthy

Non-

creditworthy

Luzon 219 (63%) 50 113 39 17

Visayas 53 (15%) 3 28 16 6

Mindanao 74 (22%) 10 41 13 10

Total 346 (100%) 63 (18%) 182 (53%) 68 (20%) 33 (10%)


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152. In relation to creditworthiness, it should be noted that creditworthy water districts are ineligible for allocation of grant funding for projects.

153. GFIs, although represented in the Oversight Committee, use different criteria for evaluating creditworthiness. As an example, for water projects the LGU Guarantee Corporation (LGUGC)83 uses 11 parameters, shown in Table 12 , which are all financial in nature.

154. This generates a clear conflict. Even when employing their own creditworthiness criteria, Land Bank of the Philippines and Development Bank of the Philippines have arranged with LWUA for a review of studies and engineering designs and even takeover services whenever needed. In addition, since the loans extended by GFIs are often covered by LGUGC guarantees, terms are ostensibly more flexible and opportune for borrowing districts. If a WD can provide sufficient securities for its loan and given the LWUA standing arrangement, GFI lenders can likewise be lenient with their creditworthiness evaluation. Hence, even when a semi- or pre-creditworthy WD applies for a GFI loan, it is possible that the GFI will assign the WD a creditworthy rating and approve the loan request because the lender recognizes that it can still recover its loan behind WD securities and LWUA’s reputable guarantee accord.

155. To date, while no one has questioned the Oversight Committee’s creditworthiness criteria, the efficacy and relevance of these criteria imposed by EO 279 only on LWUA may be questioned as other financial institutions do not subscribe or honor them. For instance, it is relatively easy for commercial banks to identify which WDs can readily access commercial financing sources due to revenues, profits, connection size, and projected income. WD creditworthiness, in contrast, is an actual decision rendered by a GFI credit committee. LWUA is not purely a commercial bank nor does it claim to be one. It is also a developmental institution mandated to improve the provincial water sector and hence assists WDs whatever their size or creditworthy status.

156. A World Bank study on LWUA84 concluded that the degree of creditworthiness does not depend entirely on the length of time that a WD has been operating or on the magnitude of its tariffs. Creditworthiness instead is influenced by the growth rate of connections (where creditworthy WDs have higher growth rates), and are generally more efficient in terms of manpower utilization as indicated by larger connections per employee ratio. The average number of connections influences economies of scale as the creditworthiness classification improves with increasing connection size.

Table 12: Creditworthiness Criteria of LGU Guarantee Corporation

Leverage Efficiency Debt Ratio (TL/TA) Fixed Asset Turnover (OR/FA) Debt to Equity Ratio (TL/E)

Total Asset Turnover (OR/TA)

Liquidity Profitability Current Ratio (CA/CL) Net Profit Margin (NI/OR) Quick Ratio (LA/CL) Gross Profit Margin (GP/OR)

Return on Fixed Assets (NI/FA) Return on Equity (NI/E) Revenue Growth Rate

CA = current assets, CL = current liabilities, E = equity, FA = fixed assets, GP = gross profit, LA = liquid assets, NI = net income, OR = operating revenue, TA = total assets, TL = total liabilities. Source: LGU Guarantee Corporation, 2008.

83 A private guarantee corporation which guarantees 85% of water district loans from government and private

financing institutions. 84 IBRD. March 2009. Developing a Capacity Building Program for LWUA.


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157. To upgrade the creditworthy classification of WDs, it is necessary for them to attain economies of scale (increase their number of connections, have higher coverage ratios) and operate more efficiently (reduce NRW and operating ratios and improve manpower efficiency).

5. Interest Rates

158. Interest rates are set by the LWUA Board. In the volatile global economic climate, interest rate policy is being impacted by restrictions on available funds, particularly as international governments such as the USA and the UK embark on very substantial stimulus packages funded by government borrowings. At the same time, governments are seeking to maintain consumption levels which would otherwise fall if consumer interest rates rise. The predictability of interest rate is severely limited.

159. In an effort to make LWUA’s interest rates, which currently range from 8.5% 16% depending on the loan amount, competitive with GFI rates, the LWUA Board has come up with a new policy on interest rates effective March 2009. Table 13 shows the new interest rates that will be charged to WDs.

Table 13: LWUA’s New Interest Rates

Item

Previous Policy Revised Policy Cumulative Loan

Granted Existing

Interest Rate per Annum

Loan Repayment

Period


Indicative Interest

Rate




Over P50 million 15.0%

Feature of Interest Fixed Repricing as necessary. LWUA proposed to lend to WDs at a fixed rate but said rate will be adjusted periodically to the Philippine Dealing System Treasury reference rates

Repayment Period Maximum 25 years, including a maximum 4-year grace period





Periodic Amortization Fixed periodic debt service amounts (interest and principal amortization) during repayment period



6. Project Management 160. The present system adopted by LWUA for project implementation purposes is through the various area managers for operation who are all under the Deputy Administrator for Operations. There are various modes being used and the differences lie in funding source for the project and WD capability.


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a. Locally Funded Projects 161. Locally funded projects are implemented directly by WDs by force account (or by administration). This implies that the loan funds are either (i) transferred to the WD accounts, or (ii) the WD implements the projects through a contractor with LWUA paying for the contractor’s accomplishment upon recommendation by the WD, or (iii) LWUA implements everything for the WD. The manner depends on WD capability and loan amount and is subject to an agreement between LWUA and the WD concerned.

162. Generally, loan amounts of up to P10 million are done via mode (i) wherein the WD procures the materials and contracts labor to implement the project. This mode will have a LWUA account officer visiting the project from time to time for verification purposes.

163. For mode (ii), a contractor responsible for both labor and materials is selected by the WD through a bidding process. Progress payments are generally made by LWUA directly to the contractor against a recommendation by the WD. Again, project monitoring is done by a LWUA account officer.

164. For mode (iii), LWUA selects and pays the contractor. The implementation is supervised by a LWUA resident engineer with inspectors from the WD. Mode (iii) is usually done for a newly formed WD or for existing WDs with no project implementation capability.

b. Foreign-funded Projects 165. The mode for foreign-funded projects depends on the funder’s loan or project covenants with LWUA. A project management office (PMO) is created for coordination and monitoring purposes. The ADB-PMO unit, for example, acts as a central clearinghouse for all communications, lender requirements, budget control, and external liaison with other agencies. For the engineering portion, LWUA usually appoints consultants for the work. LWUA usually chooses the contractor through a joint bidding committee composed of LWUA and WD members. The contract award is done by the LWUA Board. A LWUA or consultant resident engineer supervises construction with the assistance of WD engineers.

166. For small sector loan projects, mode (ii) of the locally funded projects is generally applied for capable WDs.

7. Systems and Resources

a. Information System Strategic Plan (ISSP) 167. There is an ongoing contract between LWUA and Nippon Jogesuido Sekkei/ onsultants for Engineering Science and Technology to develop integrated computerized operational and management systems. The Phase I contract started in 1997 for seven application systems (ASs) and eight more ASs were added in Phase 2 for a total of 15 ASs. By of end 2008, 12 ASs were being used to some extent by user groups. Optimal utilization had been hampered by many problems, with lack of computer familiarization as one of them.

168. If fully implemented, ISSP promises to improve LWUA’s efficiency. However, the LWUA ISSP was started in the late ‘90s using Oracle 8 and Windows 98 as platform. There is a need to upgrade the existing ISSP platform to make subsequent purchases of hardware and software compatible. Upgrading to Oracle 11G may cost the agency around P10 million.


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b. Water District Data Gathering 169. Monitoring the performance of WDs is critical to LWUA’s decision-making and reporting activities. The basic data source is the monthly data sheet (MDS) which all operating WDs are supposed to submit to LWUA every month. However, not all WDs dutifully comply with this requirement. Many non-complying WDs either have limited staff or are unable to obtain the required data or find that assembling and updating information make compliance cost-ineffective or cumbersome. LWUA is currently redesigning the MDS to simplify the requirements.

170. There are no penalties imposed on WDs that do not comply with the MDS submission. However, this requirement can be enforced even if there are no penal provisions in PD 198 for non-compliance with LWUA directives. LWUA should impress on WDs the routine submission of the MDS as basis for and prior to approval of the WD’s applications for tariff adjustments, approval of financial assistance, or size re-categorization.

171. After receipt of these MDS by LWUA, the Institutional Development Group can encode the information in the WD Operations Monitoring System 85 which can be accessed by Corplan and other LWUA units for their specific needs. Transmittal to LWUA can either be in soft (through E-mail) or hard copies through the advisors.

c. LWUA Staff Complement 172. An analysis of the employee data in the current structure shown in Figure 2 indicates the breakdown shown in Table 14 .

173. While it is not within the scope of this report to assess the absolute employment levels, it is apparent that:

(i) Staff attributable to income generation and WD development (core operations) account for over half or 61% of total employment,

(ii) The management overhead employment includes 62 employees attributable to back- office financial operations which would seem to be appropriate for a quasi-banking institution, and

(iii) Board support and top management are less than 5% of total employment. 174. However, EO 279 calls for some personnel structuring of LWUA and in September 2006, the Department of Budget and Management (DBM) approved a revised structure for LWUA per EO 279. The proposed structure in Appendix 1 shows the number of positions is 447, indicating a reduction of 26% of its current staff complement. Hence, on October 18, 2006, the LWUA Employees Association for Progress, which is nominally the LWUA employees union, sought and successfully obtained a court injunction against the LWUA restructuring. Appendix 2 details the legal injunction issues of the LEAP’s petition. As of May 2009, the injunction still stands.

85 One of the 15 application systems under LWUA ISSP.


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Table 14: Number of LWUA Personnel

Item

Number

Total

Administration 25 Office of the Chairman and Board of Trustees/Support Staff 16 Officer of the Administrator 6 Office of the Senior Deputy Administrator 3 Core Operations 359

Water District Development (Water Development) 58 Loans Management (Water Development Finance) 31 Area Operations (Technical Support) 209 Training and Research (Operations Support) 29 PBAC 2 Loans Administration 18 Water District Audit 12

Management Overhead 98 208 Administration 62 Investment and Finance 13 Management Services 20 Internal Control 8 Legal Services 7

Total 592 LWUA = Local Water Utilities Administration, PBAC = Pre-qualification, Bids, and Awards Committee.

d. Water Supply and Sanitation Management Capacity

175. In the LWUA stakeholder opinion poll survey funded by World Bank in 200786 various LWUA stakeholders (viz., donor agencies and other government water sector agencies) opined “that technical competence of LWUA is one of its foremost strengths.” In fact, in the current foreign-funded project of LWUA (i.e., KfW-3), LWUA engineers prepared the program of work and supervise an estimated 30 WDs.

176. As far as sanitation projects are concerned, LWUA has limited experience to implement septage management projects or a sewer system. Although LWUA has many sanitary engineers, some of LWUA’s technical staff who were involved in either the preparation of past sewerage studies or the implementation of the Baguio sewerage treatment plants are no longer connected with LWUA. This poses an obstacle to LWUA’s purported advocacy role for sewerage, particularly now when most of its staff have neither the knowledge nor experience needed to carry out the technical functions of the job.

8. General Comments on LWUA’s Operating Capacity

a. Human Resources and Capacity

177. As of March 2009, there are about 600 personnel of LWUA with an average age of 50 years. Six years from now, about 60 people are expected to retire at the mandatory age of 65. LWUA is now embarking on a recruitment program to replace the ranks of those who will retire as well as infuse young blood into the organization.

178. As could be noted in Table 11 there are currently approximately 359 staff in Core Operations, including 58 staff in Water District Development, generally employed as advisors. This indicates an average responsibility of advisors to water districts of 10 to 1 advisor for every 86 Conducted by the University of Santo Tomas Graduate School.


41

9 to 10 districts, which seems to be a satisfactory ratio. This does not yet include the officers from other LWUA units which act as sixth WD board members representing LWUA’s interests.

179. Because of the range of issues that are dealt with by advisors, there is no specific professional qualification required of them. Instead, emphasis is placed on the appointees’ experience and ability to analyze a problem and resolve pertinent issues. Advisors are also assigned the task of taking over operations of defaulting WDs and have been successful in this endeavor despite the risks involved in this activity.

180. While technical competence of LWUA is one of its foremost strengths, LWUA management and WDs on the other hand point out that LWUA’s technological expertise needs intensive updating and retooling. Interviews with LWUA officers conducted by the consultant reinforce the need for continuing technical education for LWUAns.

181. Many large WDs are beginning to accept the fact that sewerage will be the predominant focus of future investments of the sector. WDs likewise recognize that there are many pre-investment activities that need to be finished before the actual construction of facilities takes place. Examples of pre-investment activities are the preparation of information, education, and communication materials; needs analysis and survey; preparation of feasibility and engineering studies; securing funding sources; and implementation of a pilot demonstration project. Such information are simply unavailable (or limited) in LWUA. As mentioned, some of LWUA’s technical staff who were involved in either the preparation of sewerage studies or the implementation of the Baguio sewerage treatment plants are no longer connected with LWUA; hence, the need for training and on-the-job experience for its engineers.

b. Motivation 182. Given the different policy directions enunciated by EOs 123 and 279, it is not surprising that some of LWUA staff‘s motivation has been somewhat diluted. While there are still many whose idealism for public service still exists, many are now wondering why the government treats LWUA as if it were a non-performing agency despite its contributions to the provincial water supply over the years. However, with the vision of the new Board and management, many are now optimistic that the government will recognize LWUA’s potential contribution to countryside development.

c. Operational Management System

183. Many of the application systems under the LWUA information system strategic plan (ISSP) are not yet operational. While many LWUA senior managers and professionals have expressed their concern to have these fully operational, top management currently has too many concerns and are unable to give this the priority it deserves.

E. LWUA’S FUTURE OPERATIONS

1. Introduction 184. The original charter for LWUA, as specified by PD 198, was to “primarily be a specialized lending institution for water utilities.” Within this role, PD 198 specifies that LWUA has subsidiary roles as a regulator (in particular, as a determiner of tariff) and advisor.

185. More clearly, LWUA was established to operate as a merchant bank for a specific clientele, i.e., the water service providers outside Manila. The subsidiary roles of advisor and price setter are apposite to the banking role since they allow LWUA to sustain their client borrowers financially and physically, and to step in and take over assets (in the same manner as a mortgagee) if debt servicing is being compromised by lack of borrower performance. While


42

water assets (and to a lesser extent, sewer assets) are private rather than public goods, they are quite explicitly sunk assets, i.e., they have no real recovery value and they provide an essential public need.

186. As a result, financiers of the assets have no recourse if a borrower defaults other than to take over operation of the assets in an attempt to trade out of difficulties.

187. As an institution, LWUA has been reviewed significantly over the last 20 years, as shown in Table 15 .

Table 15: Summary of Studies on LWUA

Year

Report

Initiator

Major Recommendation

1990

Carl Bro International

WB, DANIDA

Abolition of LWUA or total restructuring as a commercial bank

1993 Tasman Consulting WB LWUA to be reoriented as a “specialized lending institution” and to privatize commercially viable WDs

1994 NEDA Resolution No. 4 Government LWUA to lend only to credit-worthy WDs 1995 Lotti Consultants ADB LWUA to pursue some changes within its

operating systems 2002 Stone and Webster WB, DOF EO 279 2007−2008 Water Sector Road Map KfW LWUA to assist other WSPs financially

and technically 2008 Castalia WB Enable consumers to hold LGUs

accountable for water service provision

ADB = Asian Development Bank, DANIDA = Danish International Development Agency, DOF = Department of Finance, EO = executive order, KfW = Kreditanstalt für Wiederaufbau, LGU = local government unit, LWUA = Local Water Utilities Administration, NEDA = National Economic and Development Authority, WB = World Bank, WS = water district, WSP = water service provider.

2. Challenges

a. Economic Regulation

188. The establishment of clear and effective regulatory systems is critical to the autonomy and efficient operations of water service providers. They are established to constrain service providers’ operations so as to avoid exploitation of the environment and customers in the utility’s pursuit of its commercial or political objectives. The framework also has a provision to provide protection to other stakeholders, particularly in regard to exploitation of the natural environment.

189. Competitive markets operate to provide constraints on price and standards of service. These constraints operate in two dimensions:

(i) The cost/service standard combination should be competitive, and (ii) The cost/service standard combination should be sustainable, i.e., the service

standard meets market requirements at a price which is economically efficient.

190. In water and wastewater systems, however, the physical characteristics are such that the systems generally exist as natural monopolies, that is, they do not have competitors to consistently maintain an economic discipline. The absence of this discipline becomes critical when natural monopolies are reformed so that they are autonomous and have clear commercial objectives. Without market discipline the monopolies can charge excessive prices or can degrade service standards to improve profits. Alternatively, they may have political objectives


43

which require them to provide services at a price/service standard combination which is not sustainable or is cross-subsidized by other service charges.

191. To replace the market competitors, governments set up regulators of various kinds. In Britain, the privatized companies are controlled by the Office of Water Services (Ofwat)87 which sets prices on a 5- and 10-year basis, specifies minimum standards of service, and maintains extensive sets of comparative performance indicators.

192. In the U.S.A., regulators vary with the type of service provider. Where services are provided by private companies a regulator is put up to set prices on an annual or biennial basis. Typically the price is set so as to ensure that providers earn an adequate return on their investments. This is known as rate of return regulation.

193. In the case of Britain’s Ofwat, it monitors 10 private companies and its responsibility is only in the water/wastewater sector.88 Thus, there are economies of scale which allow Ofwat to develop a high level of competence in the sector. A similar approach has been taken in the energy and telecommunications sectors. The supervisory approach is to set a price framework and continuously monitor companies’ service performance. Sanctions are only formally applied if major transgressions occur. Each year, however, a comparison of performance of each of the companies is published and promoted to the public. It is notable that in Britain, the private companies have title to all of the assets employed. As a consequence, they have a clear title to physical sustainability.

i. Current Regulatory Framework 194. There are a number of institutions with economic regulatory responsibilities in the Philippine water supply sector. These include the three primary regulatory agencies − NWRB, LWUA, and LGUs – and special regulatory units such as the Subic Bay Water Regulatory Board (SBWRB) created by the Subic Bay Metropolitan Authority (SBMA) and the MWSS Regulatory Office created by different agencies’ charter and operate on contract-based regulation. Within the existing structure, there are differences in regulatory practices, processes, and fees and cases of overlapping functions or jurisdictions among these agencies. This environment suggests a fragmented regulatory framework and lack of coordination.

ii. National Water Resources Board

195. NWRB is the national regulatory agency primarily vested with resource management and economic regulatory functions over private utilities such as cooperatives, subdivision developers, homeowner associations, rural water and sanitation associations (RWSAs), condominiums, private companies as well as non-piped water providers. NWRB’s main functions are resource regulation (through the issuance of water rights), and economic regulation through the issuance of certificates of public convenience and approval of utility tariffs.

iii. Local Government Units 196. The Philippines is politically subdivided into local government units composed of provinces, which are subdivided into towns and cities.89 Towns and cities are further subdivided into barangays (villages). Republic Act No. 7160 or the Local Government Code of 1991 and its implementing rules and regulations (Administrative Order No. 270) provide the basis of LGUs’

87 Ofwat is now formally named Water Services Regulation Authority but is still referred to as Ofwat. 88 In addition to the 10 major water and sewerage service providers privatized in 1988-89, there are 14 water only

service providers and 4 specialized service providers. 89 As of 2008, the Philippines is subdivided into 81 provinces, 136 cities, and 1,495 municipalities.


44

power to allow the establishment and operation of waterworks or water supply systems within their area of jurisdiction as well as provide for their regulation. Some industrial zones in the country, like SBMA and Clark Development Corporation are also considered LGUs and have their own charters (special laws) which give them the authority to regulate economic activities within their jurisdiction.

iv. Contract-based Regulation

197. A good example of contract-based regulation in the water and sewerage sector is the Regulatory Office (RO) established by the Concession Agreements for water and wastewater services in Manila, which were negotiated in 1997. The RO addresses both the physical performance of the concessionaires against service standards established by the Concession Agreements, and the prices charged by the concessionaires. Because the concessions nominally expire in 2022, there is an incentive present for the concessionaire to allow the assets to deteriorate toward the end of the concession period. As a result, the RO also addresses asset management.

198. The same is true for the Subic Bay Water Regulatory Board which was created by SBMA to act as the regulatory body covering the private utility serving the SBMA areas. Tariffs approved by SBWRB are subject to SBMA’s Board review.

v. Local Water Utilities Administration (LWUA) 199. LWUA had also assumed a de facto economic regulatory role given its mandate in PD 198 to promulgate standards for materials and operations, review water rates, and monitor WD performances. The most recent executive fiat with respect to the regulatory agencies is the issuance of EO 123 in 2002. EO 123 reorganized the NWRB Board membership and transferred the approval of WD tariffs from LWUA to NWRB. LWUA, however, retains the tariff review function for those WDs in which it has loan exposures.

200. Since 2002 until May 2009, NWRB had not yet assumed the functions of tariff approval of WDs due to its many internal constraints. At present the tariff approval of WD is still being exercised by LWUA because of an arrangement made by both NWRB and LWUA management. Unfortunately, some WDs are now experiencing injunctions or court cases regarding their adjusted tariffs which do not bear NWRB imprimatur.

201. Some quarters within LWUA are concerned with LWUA’s collection efficiency if the tariff approval function can already be assumed by NWRB. LWUA’s collection efficiency is dependent on the timely adjustment of WD tariffs and constant monitoring of WD operations. NWRB must have enough capability and resources to do both tariff review and monitoring of WD operations.

b. Financial Management Role

202. There are two issues related to this role. The clientele of LWUA according to EO 279 are the less creditworthy WDs which need subsidies to be viable. If the national government provides equity funding to LWUA and there are no definite or mandated sources of subsidy funds for these WDs, LWUA will have to source the subsidies from its equity funds and thereby jeopardize its own financial sustainability even in the medium term.

203. Since 1991, full national government subscription of LWUA’s authorized capital of P2.5 billion had already been fully subscribed. Consequently, LWUA intensified its borrowings from international financing institutions like ADB, JICA, KfW, and AusAID but limited these to a


45

maximum of $500 million as provided for by PD198. Actual borrowings from foreign sources are, however, limited by LWUA’s or WD’s ability to provide local counterpart or equity funding.

204. Since the 1990s LWUA has sought government approval to increase its capitalization to P5 billion (and subsequently increased this to P10 billion) to support its local counterpart funding requirements of its foreign loans. However, congressional approval has not prospered. Nevertheless, national government funding assistance was provided directly and indirectly through the annual national budgetary appropriations to be accounted for as advances to the increased capitalization of LWUA. To date, total advances secured from the national government amount to P2.6 billion.

205. Likewise, to strengthen its availment of foreign loans, LWUA secured a total of P1 billion from the Land Bank of the Philippines which it relends as their counterpart fund to their foreign-assisted projects. A standby credit of P500 million from the Philippine Veterans Bank has likewise been obtained.

206. LWUA has been successful in having the “waterless communities” funds transferred to it from the National Anti-Poverty Commission and DPWH and is trying to secure additional funds from the government to pursue its funding role. The next few months will gauge the success of LWUA in this endeavor. LWUA needs to manage its pool of funds effectively for relending purposes so it will be able to sustain its WD funding operations.

207. Another issue is in relation to creditworthiness. A good performing water district manager is potentially faced with a dilemma. If he achieves creditworthiness then his district will have the opportunity to independently source debt from the market place as well as GFIs. However, the WD will be excluded from sharing the grant funds that could be made available by government. This may lead to gaming by water district managers where they may contrive to move between creditworthiness and the lower strata and back again. And as aptly stated by a LWUA manager, “What will motivate a WD to graduate to full creditworthy status?”

3. Organizational Development a. Proposed Future Structure

208. LWUA Board Resolution No. 69, Series of 2006 which outlined the proposed organizational structure of LWUA was in conformance with EO 279. However, an injunction is preventing LWUA from implementing the said restructuring. The proposed restructuring means a reduction of about 140 people without special retirement packages; hence, the objection of LWUAns to such restructuring.

209. While the proposed structure may have been appropriate for the implementation of EO 279 at the time it was passed, it may no longer be applicable in view of the new directions or visions of the current LWUA management and Board. Factors like resolution of the current injunction, the creation of the Water Development Bank, the amount of government financing that LWUA has or can secure and possible new sectors90 or LWUA policies91 still in the conceptual stage will have a bearing on the design of a future structure. The proposed structure will be finalized later in 2009. It will be reviewed and presented in the final report.

b. Human Resources Development

210. Human resources development is basically the adoption of appropriate practices and policies in the field of recruitment, training, compensation and to ensure efficiency and effectivity of the staff in doing the work to be assigned. 90 Like creation of a national regulatory body. 91 Like plan to create another LWUA subsidiary involving research and water development.


46

211. Recruitment for cadet engineers is currently ongoing and is seen to complement the work of LWUA senior engineers implementing project activities.

212. The human resource and development group within LWUA has been busy implementing about an average of 15 training programs per year for LWUAns, ranging from value formation, use of computer for the ranks to WD advisory training. The types of training are finalized after a training needs analysis has been conducted. A review of the in-house-training programs did indicate a lack of technical topics covering new technology.

4. Training

a. Client Service

213. While ongoing unstructured interviews are on-going among various staff levels, there is already a consensus that LWUA technical staff need a continuous training program to keep abreast with new technologies, sanitation and refresher courses for regulatory practices, engineering for level II systems, and refocusing of advisory services. A comprehensive training program will be developed following a training needs analysis and included in the final report.

b. Environmental Management

i. Social and Environmental Safeguards

214. Environmental and social safeguard studies are designed to avoid, mitigate, or minimize adverse environmental and social impacts of projects

215. The government requires environmental assessment (EA) of projects proposed for external financing to help ensure that they are environmentally sound and sustainable. EA is a process whose breadth, depth, and type of analysis depend on the nature, scale, and potential environmental impact of the proposed project. EA evaluates a project’s potential environmental risks and impacts in its area of influence; examines project alternatives; identifies ways of improving project selection, siting, planning, design, and implementation by preventing, minimizing, mitigating, or compensating for adverse environmental impacts and enhancing positive impacts; and includes the process of mitigating and managing adverse environmental impacts throughout project implementation. Preventive measures are generally preferred over mitigatory or compensatory measures, whenever feasible.

216. Almost all studies prepared by LWUA do not have a section on the social and environmental safeguards of projects because LWUA had always left it to the WDs or to consultants the safeguard requirements of projects. Having a unit in LWUA overseeing these safeguards would boost LWUA's capability in project implementation as well as provide these needed services to WDs.

217. An introductory course for LWUA engineers should be undertaken as well as an in-depth training program for those who will be tasked with this function. The course could include topics such as environmental assessment, dam safety, physical cultural resources, natural habitats protection, pest management, involuntary resettlement, indigenous peoples, and forest protection. While LWUA is not expected to come out with the EA per se, some knowledge is required for proper liaison with WDs, the affected public, DENR, and other concerned agencies.


47

c. Financial Management Capability 218. To improve the staff’s capability for financial management, we have to define the type of financial institution that LWUA is. Should it follow the “commercial bank” approach as desired by DOF or should it be a “development bank” as envisioned by its current management?

219. LWUA should have elements of both commercial and developmental institutions. Commercial banks cannot fund newly formed WDs without capability and collaterals, which LWUA should develop. LWUA should, however, also follow commercial banking practices to ensure its corporate viability and sustainability.

220. The current LWUA financial capability as a development bank has been shown to be sufficient as evidenced by WDs’ contribution to countryside water development. There are, however, some areas dictated by commercial banking practices which can still be improved like securing security for forex risks, ring fencing of its principal collections for its debt repayment, and writing off some loans which can no longer be paid, thus allowing capable WDs to be responsible for project implementation and requiring borrowers to submit business plans above a certain loan amount. Training courses will be developed to improve financial capability, and included in the final report.

d. Systems

i. Gathering of Water District Data

221. Collecting reliable performance data in a timely manner for analysis by LWUA is extremely important in fostering better WD performance via benchmarking and standard setting. Under the current set-up where hundreds of monthly data sheets are submitted manually using mail and manually encoded into a computer, maintaining an updated databank is very costly and time consuming. It is suggested that LWUA rationalize data collection activities and modernize its management information system. A starting point could be the monthly data sheets submitted regularly by WDs.

222. A solution towards a more efficient system is the creation of an online database system known as Portal and Collaboration System, examples of which are IBM’s Websphere and Oracle 9iAS. Under this system, various WDs will encode their MDS through a website. The website will have verification protocols and is secured. Once the data are encoded by WDs, they are immediately available to area managers for evaluation. Moreover, the data can be made available to Corplan, which can then come up with regular monthly or quarterly industry average. Other monitoring reports outside the MDS will still be forwarded via the traditional route.

ii. ISSP Application Systems

223. The systems training required will be dependent on the information system strategic plan systems that will ultimately be completed and utilized or to be formulated. The systems training are included in the ISSP developer contract and will no longer be included here. Table 16 highlights the usability of the different LWUA ASs:


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Table 16: Usability Status of LWUA Application Systems

Application System

Usability Status Regularly

Used Partially

Used Not

Used Financial Management System 1. Billing and Collection System X 2. Disbursement System X 3. Cash Management System X 4. General Accounting System X 5. Project Cost Accounting System X 6. Loans Payable and Other Liabilities Monitoring

System X

7 Budget Planning and Control System X 8. Payroll System X Administrative Support System 9. Personnel Information System X 10. Field Asset Management System X 11. Supplies Inventory System X 12. Document Management System X Operations Management Information System 13. WD Operations Monitoring System X 14. WD Financial and Loan Evaluation System X Management Information System 15. Strategic Management Information System X

224. Out of the 15 AS developed by LWUA’s consultants, only 2 are regularly used, 6 are partially used, and 7 are not used by the system owners. Regular Use means that the system is working and operational producing some outputs but not necessarily 100% of the “user requirements”. Partially Used means that only a number of modules are used by the system owners. Not Used means that the application system hardly did, or did not at all justify its use due to any of the following reasons: (i) not user friendly, (ii) cumbersome to operate, and (iii) some programs hang (no processing was being done) such that outputs were not valid, accurate or reliable.

225. The LWUA and its consultants are now discussing a “Responsive Work Plan” which is envisioned to make all the AS on usable status. This is expected to be completed in late 2010.

F. RECOMMENDATIONS

226. It could be noted in Table 15 that there have been seven institutional reviews of LWUA since 1990. This is a real example of “paralysis by analysis” of what is apparently a well-performing entity. The recommendations that follow are consequently aimed at enhancing rather than changing.

1. Capitalization

227. LWUA should pursue the increase in its capitalization. The agency must intensify its efforts in lobbying for the enactment of the law increasing its capitalization from P2.5 billion to P10 billion.

2. Fund Management

228. The need to ring-fence its loan portfolio is still a longstanding order for LWUA. As a specialized lending institution, it is essential that the agency’s top management establishes a


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system of maintaining a revolving fund from loan principal collections and limit the utilization of such funds only to loan assistance to water districts and debt servicing requirements.

3. Regulatory Practices

229. LWUA should consult with NWRB and harmonize its tariff review and other economic regulatory processes with it. Unless EO 123 is rescinded or amended, there is no other option left for LWUA if it wants to protect the interests of its client-WDs.

4. Implementation of EO 279

230. The EO 279 Oversight Committee and the LWUA Board of Trustees should review the LWUA creditworthiness criteria and reconcile them with that of LGUGC and GFIs.

231. LWUA should take steps to clarify with DOF and even with the Office of the President issues encountered or will encounter if its implementation policies will strictly be in accord with E0 279. The consultation process should necessarily involve the LWUA Board.

5. ISSP

232. LWUA should take steps to have the application systems covered by its ISSP fully operational and improve front-end access via a web portal. It should budget what it needs for this endeavor.

6. Training

233. LWUA should continue to take steps to improve its capability in engineering technology, sanitation, and regulatory practices. It should strengthen its advisory services. This will be addressed through the training needs analysis and the training plan to be developed in Phase 2 of the PPTA.


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II. ASSESSMENT OF THE LOCAL WATER UTILITIES ADMINISTRATION FINANCIAL PERFORMANCE

A. RECENT DEVELOPMENTS AT LWUA

234. In 1973, LWUA was created to form water districts and act as a specialized lending agency, providing WDs with financial support. LWUA and the water district concept were created through Presidential Decree 198 of 1973, also known as the Provincial Water Utilities Act of 1973. This law authorized local governments to form autonomous water districts to develop and operate local water supply systems. It also established LWUA as a national-level agency to cater to the needs of these water districts. PD 198, as amended by PD 768 of 1975, states that LWUA shall “primarily be a specialized lending institution for the promotion, development, and financing of local water utilities.” To carry out this function, according to the PD 768 amendment, LWUA may also:

(i) Prescribe minimum standards and regulations in order to assure acceptable standards of construction materials and supplies, maintenance, operation, personnel training, accounting and fiscal practices for local water utilities;

(ii) Furnish technical assistance and personnel training programs for local water districts;

(iii) Monitor and evaluate local water standards; and (iv) Effect system integration, joint investment and operation, annexation and de-

annexation whenever economically warranted. 235. In recent years, several developments changed the original mandate of LWUA. These are discussed in the succeeding sections.

1. Status of Recent Policy Pronouncements and Studies

a. Executive Order No. 279 and LWUA

236. EO 279 was issued in 2004 to rationalize the organizational structure and operations of LWUA and change the financing policies for the sector. In particular, it set out a program to categorize water districts based on a mix of financial and technical parameters, and to “graduate” well-performing water districts from LWUA’s financial support towards financing by government financial institutions and private financial institutions.

237. EO 279 marked a drastic change in the vision of LWUA’s role in the sector. Under said EO, LWUA would no longer lend to creditworthy water districts as they would now have to obtain financing from government and private financial institutions on commercial terms. EO 279 directed LWUA to do the following:

(i) Determine credit-worthiness criteria and classify WSPs, (ii) Develop graduation plans for WSPs, (iii) Cease lending to creditworthy WSPs and lend to less creditworthy WSPs, (iv) Offer technical assistance on competitive basis, (v) Streamline waiver procedures, (vi) Develop and implement restructuring plan, and (vii) Ring-fence loans made under EO 279.

238. Of the recommendations above, only the recommendation to determine credit-worthiness criteria and classify WSPs has been fully implemented (see Appendix 3). The EO 279 Oversight Committee, currently chaired by Department of Finance Undersecretary Jeremias Paul, and the Philippines Development Forum’s Sub-Working Group on Water Supply


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and Sanitation are concerned that EO 279 is not being implemented as expected. The slow and partial implementation is due to legal barriers and operational difficulties92 within LWUA, as follows:

(i) The full implementation of EO 279 is being blocked by a restraining order issued by the court in connection with the case filed by the LWUA Employees Association for Progress. The union seeks principally to annul the reorganization plan that was prepared for LWUA under EO 279 in protest over the proposed severe staff reduction, and the provision which prohibits staff who lose their jobs from working in any other executive branch agency for 5 years. The court issued a restraining order prohibiting LWUA from implementing its rationalization plan and the rest of EO 279. The case is still ongoing.

(ii) Operationally, the implementation of EO 279 has been difficult because:

• There appears to be no comprehensive strategy for LWUA to carry out the new role assigned to it, i.e., financing semi- and less creditworthy water districts. LWUA is apprehensive over its new role under EO 279 because its sources of revenue are decreasing after some WDs started to seek re-financing of their loans with capital from GFIs and other lenders.

• LWUA has had little access to low-cost funds from development banks to on-lend to less creditworthy water districts. The Administration felt that without these low-cost funds, the spread between the interest rate LWUA pays and the interest rate it charges to water districts would be too small to make lending to semi- and less creditworthy WDs an attractive (or possibly even viable) business. In recent months, however, LWUA has received more allocation from the national government since it has taken over from Department of Public Works and Highways the responsibility of implementing water supply projects for waterless communities. A special allotment release order (SARO) for P500 million has been issued to LWUA, out of which a notice of cash allocation for P28 million has already been received. In addition to the P500 million, a total of P1.5 billion has also been allocated in the General Appropriations Act (GAA) under the Department of Health for the development of water supply projects which will likewise be implemented through LWUA.

• Even with access to low-cost funds, LWUA may still not be able to avail of this because it is reaching the borrowing ceiling and capitalization limit. The borrowing ceiling is P1 billion for domestic borrowing (P800 million as of December 2008) and $500 million for foreign borrowing ($175 million used as of December 2008). The proposed amendment to PD 198 increasing capital stock to P25 billion and borrowing ceiling to $900 million, which has been passed in the House of Representatives, is expected to be approved by the Senate and signed into law at the earliest by the last quarter of 2009.

239. One of the action agendas of the Philippines Development Forum’s Sub-Working Group on Water Supply and Sanitation is to have operating guidelines on a water sector financing policy issued by the national government. These operating guidelines would support the financing framework set out in EO 279 and establish a clearer program for WSS involvement. The guidelines could be set out in either a new EO, amendments to EO 279, or refinement of

92 Castalia Strategic Advisors, November 2008. Diagnostic Study of the Water Sector in the Philippines. Report to

the World Bank. Draft Final Report.


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the EO 279 Implementing Rules and Regulations. This action agenda will be developed in more detail by the Task Force on Financing and Infrastructure Investment.

b. Other Studies

240. In addition to the Stone and Webster Study which served as the basis for EO 279, several other studies have been conducted touching on LWUA’s performance. These include:

(i) Study on Selected Financial Issues Related to LWUA as a Consequence of Executive Order No.279 (Volumes I and II), Report submitted to the World Bank in April 2008

(ii) Preparation of an Incentive Framework for LWUA and the Water Districts to Support the Graduation Process under Executive Order No. 279, Report submitted to the World Bank in December 2007

(iii) Development of a Program for the Capacity Building of LWUA and Water Districts (Component B) of the Local Government Support for Regional Water Supply Project, Report submitted to World Bank, February 2009.

(iv) Policy Issue Paper on Credit, Financing and Investments in the Water Supply Sector (Annex 3 of the Philippine Water Supply Sector Roadmap), and

(v) Diagnostic Study of the Water Sector in the Philippines, Report submitted to the World Bank in March 2009.

241. Table 17 summarizes the key recommendations of these studies.

242. The recommendation on LWUA establishing competitive rates has been followed with the issuance of LWUA Board Resolution 38 which revised the relending rates. Appendix 3 presents the extent of EO 279 implementation and the major recommendations of various studies.

Table 17: Summary of Key Findings and Recommendations from Recent Studies

Area Recommendations Competitive Rates • Undertake periodic reviews of interest rates to make these

competitive Collection and Receivables Management

• Review accounts receivables and finalize repayment schedules, and take over or take to court WDs that cannot pay

• Enhance monitoring and collections systems as well as credit screening process

• Reduce gap between payments to LWUA creditors and collections from WDs

Assistance to WDs • Update the framework for monitoring WDs to include indicators of water supply coverage, customer satisfaction, quality of service, sanitation, etc.

• Provide WDs access to a project preparation fund that can help finance feasibility studies and engineering studies with training and technology transfer components

Sources of Financing • Initiate discussions with PFIs on possible modalities to tap private capital

• Support PWRF and explore possible arrangements to co-finance Expenses • Reduce operating expenses to improve cash flow EO 279 and Long-term Planning

• Present to the Oversight Committee (i) activities to implement EO 279, (ii) medium-term capital expenditure program and defend request for subsidies and pass-on subsidies to deserving WDs, and (iii) long- term strategic plan to support bills on increasing capitalization and borrowing ceilings

EO = executive order, LWUA = Local Water Utilities Administration, PFI = private financial institutions, WD = water district.


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2. Revision of Relending Terms to Water Districts – Board Resolution 38

243. The LWUA Board recently approved Board Resolution 38 revising the relending terms to water districts, essentially reducing the rates and making them more competitive with the current market rates. Table 18 compares the revised relending terms with the previous terms.

244. The revised relending policy has significantly made the terms more competitive with the market. The average interest rate based on the previous policy is around 11.6%93 compared with 9.675% based on the revised policy.94 The LWUA rates are now lower than the terms of GFIs, PFIs, and even the Philippine Water Revolving Fund. The LWUA rates are higher by less than 1% compared with that of the Land Bank of the Philippines, but this is compensated by a longer 40-year repayment period.

245. The revision also relaxed the terms and made borrowing much easier for water districts. First, the repayment period has been extended from 25 years to a maximum 40 years. Secondly, instead of a fixed periodic payment, repayment terms were made more flexible depending on the WD’s capability. Thirdly, revised interest rates at 9.2% to 10.2% are now more affordable compared with the previous from 8.5% to 15%.

246. At the minimum rate of 9.2%, the LWUA rate results in an increment of 1.29 over the PDST rate for 10 years of 7.91%. Estimates of the cost of lending show that at a 92% collection efficiency, cost of lending is 4.12% generating a LWUA spread of 5.08%. Using a 75% collection efficiency reduces the spread to 5.05%.

247. The lower interest rates still give appear to give LWUA a comfortable spread of 7.25% for the proposed ADB WDDSP loan, based on an indicative lending rate of 1.95% from ADB to LWUA (including a 1% guarantee fee) and assuming LWUA’s preferred arrangement of passing the forex cost risk to the borrower- WDs. Even considering the mismatch of repayment terms (ADB’s 25 years and the likely WD preferred repayment terms of 30 years), it appears that the spread will allow LWUA to repay the ADB loans in spite of the shorter repayment period. However, the revised rates may not stop water districts from refinancing their loans with GFIs and PFIs. The existing LWUA loans have higher terms and refinancing does present some interest expense savings to water districts. Appendix 4 discusses the relending rate in more detail.

Table 18: Comparison between Previous and Relending Rate Policy

Item

Previous Policy Revised Policy

Cumulative Loan Granted

Existing Interest Rate per Annum

Loan Repayment Period



First P2 million 8.5% First 10 years 9.2%

Next P5 million 10.5 % >10-20 years 9.5%








Source: LWUA Board Resolution No. 38 s. 2009.

93 Estimated based on the ratio of interest income over WD accounts receivables and long-term receivables

balance in 2008. 94 Supporting memo from the Administrator, LWUA Board Resolution 38, March 2009.


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3. Funding Initiatives

a. Status of Funding Initiatives 248. LWUA is currently chasing a number of possible sources of new funds that it can use for its water supply development projects. Based on LWUA’s Comprehensive and Interim Improvement Project for 2009−2013, project funds totalling P28 billion are estimated to come from (i) Official Development Assistance loans, (ii) LWUA internal cash generation, (iii) LWUA bond flotation and local loans with LBP, and (iv) government subsidy. LWUA has received more allocation from the national government since it has taken over from DPWH the responsibility of implementing water supply projects for waterless communities. A special allotment release order for P500 million has been issued to LWUA, out of which a notice of cash allocation for P28.55 million has already been received. In addition to the P500 million, a total of P1.5 billion has also been allocated in the General Appropriations Act under DOH for the development of water supply projects which will likewise be implemented through LWUA (Table 19) . LWUA reportedly received this amount in October 2009.

Table 19: Proposed Funding for the Comprehensive and Integrated Infrastructure Program for 2009-2013

Source of Funds

Amount (P billion)

Percent (%)

ODA Loans

5.18

18

Foreign Grant .04 1 Bond Flotation 7.88 28 Subsidy 10.58 37 LWUA ICG/ Local borrowings 4.88 17 Total

28.56

100

ICG = internal cash generation, LWUA = Local Water Utilities Administration, ODA = Official Development Assistance.

b. Increase in Borrowing and Capitalization Limits

249. As of December 2008, actual borrowings have stayed within borrowing capacity with actual foreign loans payable of $175 million against the borrowing capacity of $500 million. On the other hand, local loans totaled P800 million against a borrowing capacity of P1 billion. The borrowing capacity issue is now more critical for local loans since the ceiling for capitalization in the form of government equity of P2.5 billion has been reached. The proposed amendment to PD 198 regarding LWUA borrowing ceiling and capitalization has already passed the Lower House of Representatives. This bill provides for an increase in authorized capital to P25 billion and an increase in aggregate loan ceiling to $900 million. LWUA had hoped to have the law approved by end of 2009, but this did not materialize.

4. LWUA Acquisition of Controlling Interest over the Express Savings Bank 250. During the first half of 2009, based on LWUA Board Resolutions 56,120,129A, 129 B, and 183 series of 2009 LWUA purchased controlling interest (60%) in the Express Savings Bank (ESB), a thrift bank operating its head office in Cabuyao, Laguna, with branches in three other locations in Laguna, Binan, Sta. Rosa, and Calamba. The prime movers of this initiative expect that the Bank will eventually provide a partial solution to one of the major problems of LWUA, that of fund sourcing for the financing of its various development projects. In fact, the


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draft LWUA Assessment Report95 confirmed that the decline in project disbursements has been noted in recent years and this has led to reduction in revenues. LWUA is currently taking aggressive action to secure funds from DOH, DPWH, and DBM. At the same time, it is following very closely the approval of the bill increasing capitalization and borrowing capacity of LWUA. The acquisiton of ESB is part of LWUA’s strategy secure fund sources for its projects.

251. Details of the acquisition are as follows:

• Shares Purchased represents 60% of the outstanding stock of ESB which was founded in 1981

• Purchase Price P80.0 million paid to Wellex Group, which is owned and controlled by the family of William Gatchalian, whose main businesses are involved in the manufacture and sale of a wide range of plastic products.

• Purchase Price Determination was most probably a negotiated figure based on the offer of the original owners to sell controlling interest in ESB since its equity and liquidation values were already known to be negative during the negotiations.96

• Adjusted ownership structure of ESB following the acquisition is 60% LWUA, 24% Wellex Group, and 16% Founding Investors.

252. The ESB has since been referred to as the Water and Energy Bank (WE Bank) since the envisioned target markets for deposits and loans, are the water and energy sectors. Initially several issues currently hamper normal operations of the bank. First, in the absence of the required Monetary Board approval, legal formalities such as the change in ownership cannot be affected. Second, the negative equity status of the bank prevents it from booking new loans since its Single Borrowers Limit (SBL), which is a percentage of capital, is theoretically negative. In addition to this, the banks insolvency (liabilities exceed assets), disqualifies it from access to emergency liquidity windows of the Central Bank designed to assist banks in coping with unusual spikes in deposit withdrawals and other such cash needs. More importantly, LWUA has yet to develop the strategy and plan to operate the bank according to its conceptual “mission-vision”. The financial deficiencies have since been substantially addressed as follows:

• In September 2009, LWUA released another P400 million for the Bank, representing the following probable approximate allocation; (i) P36 million to offset the negative capital, (ii) P20 million to provide for cash operating requirements for the remaining 9 months in 2009 while the bank was being rehabilitated at P1.6 million per month, (iii) P10 million to provide coverage of DOSRI loans, and (iv) the balance of P325 million to cover the minimum capitalization requirements to move the bank headquarters to Manila.

• Theoretically, if the ownership ceiling for LWUA of 60% is to be maintained, 40% of the P400 million capital increase, or P160 million, should be shouldered by the minority shareholders and reimbursed to LWUA. If this does not happen, then LWUA will be in violation of the imposed ownership ceiling. With this cash infusion, all deficiencies will be corrected, and what remains to be done are the formulation of both the interim and long term strategies, simultaneous with the accompanying detailed business plan for the implementation of these strategies.

• In October 2009, LWUA released another PhP 300 Million for the WE Bank. • Approval of the Monetary Board is still pending but LWUA has reportedly received

approval of the Office of the President for the acquisition transaction. LWUA’s request for approval has reportedly been included for consideration in the agenda of the Monetary Board.

95 Draft Final Report on Institutional and Financial Assessment of Local Water Utilities Administration, Water Development Sector Project, PPTA: 7122 – PHI, May 2009. 96 The Audit Report shows that ESB has a capital deficiency of P36 million as of March 31, 2009.


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253. Two major issues that need to be resolved are:

� LWUA is still needs to get the official approval of the Monetary Board. � 60% ownership issue - The ownership ceiling of 60% by any single entity in a non-

GFI bank, was communicated in writing to LWUA by the Central Bank, as early as when consultations were being made by LWUA on the establishment of a Water Bank.

254. LWUA needs to invest serious effort in establishing a detailed strategy for this bank and come up with a Business Plan that will indentify and recognize key issues that will define its integration into LWUA’s own strategies and business plan. The probable benefits of this careful planning are the efficient management of the bank, and the eventual optimization of its synergies with LWUA. The dearth of data on such strategies/business plan made it necessary for the consultants to make too many major assumptions in coming out with some sort of projection of the future results of the operations of the WE Bank and its impact on LWUA’s operations. See Appendix 5 for the Report on the LWUA Bank acquisition.

B. ASSESSMENT OF PAST AND PRESENT PERFORMANCE OF LWUA

1. Past and Present Financial Performance

255. Results of LWUA operation during the last 4 years from 2005 to 2008 showed a marked improvement compared with the findings in the Study on Selected Financial Issues Related to LWUA97 covering the period from 2000 to 2005. LWUA has been (i) recovering costs of operation as well as financial expenses from their revenues, (ii) generally generating positive cash inflows from operating and financing activities which were used to finance its investing activities, and (iii) enjoying healthy liquidity, profitability, and debt equity ratios. Although the debt service coverage ratio in 2008 was only .99 and was short of the desired 1.3 level, the significant improvement starting from 2002 when it had the lowest coverage of only .08 is very noticeable.

256. Operations also resulted in positive cash positions at year-end although this does not show any trend that could reasonably be used in projecting future performance. The drastic rise of the cash amounts in 2006 and 2008 was mainly due to the amounts received from refinancing. During the same period, 13 water districts refinanced a total P3.7 billion of their loans with LWUA.

257. Budget figures for 2009 reflected a slight reduction in revenues and an increase in operating cost resulting in a projected decrease in net profit before tax. Initially, the 2009 budget, provided a very high level of projected investments (P4.4 billion) as LWUA reportedly expected receipt of more funds from the national government under the current administration. The updated Comprehensive and Interim Improvement Project projected an even higher investment level of P7.5 billion for 2009. These figures are optimistic considering that the highest level of investment which LWUA was able to achieve in previous years was only P1.7 billion. In November 2009, LWUA adjusted its projected investments in 2009 to a more realistic level of P 2.44 billion.

258. LWUA’s current major areas of concern include (i) collection efficiency and receivables management, (ii) fund sourcing for its investment program to arrest decline in project disbursements, (iii) financial management issues particularly relating to LWUA’s need to respond to COA recommendations, including reconciliation of accounts receivables , and (iv)

97 C. Virata and Associates, Inc. April 2008. Final Report on the Study on Selected Financial Issues Related to

LWUA as a Consequence of EO 279, Volume 1. Manila.


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need for long term business planning. Table 20 shows the historical trend of key financial data. A more detailed account of LWUA’s performance can be seen in Appendix 6 .

Table 20: LWUA Key Financial Data 2005-2009 (P Million)

Results of Operations A U D I T E D Unaudited Budget

2005 2006 2007 2008 2009 Total Revenues 1,790 1,950 1,889 1,972 1,952 Income From lending Operations 1,595 1,730 1,727 1,821 1,673 Service Income 177 131 41 31 147 Other Income 18 89 121 120 132 Total Expenses 1,387 1,268 1,709 1,410 1,588 Personal Services 417 447 461 562 546 Maintenance and Other Operating Expenses Cash 349 257 106 126 220 Non-cash 126 113 606 317 278 Service Expenses 17 0 26 6 177 Financial Expenses 478 451 510 399 367 Net Profit Before Tax 403 682 180 562 364 LIQUIDITY AND CAPITAL RESOURCES Cash Flow Provided by Operating Activities 516 475 454 736 632 Cash Flow Provided by Investing Activities -1,686 -1,324 -619 -682 -4,410 Cash Flow Provided by Financing Activities 1187 1397 -52 834 3068 Net 17 548 -217 888 -710 CAPITALIZATION Income from Operations 403 682 180 562 364 National Government Equity Contribution 2,500 2,500 2,500 2,500 2,500 National Government Subsidy 0 10 Foreign Borrowings 10,056 10,111 9,398 8788 Domestic Borrowings 900 995 933 808 CASH POSITION 438 1,310 762 1,650 941 LWUA STANDARD RATIOS Current Ratio 1.11 1.20 1.46 1.88 1.44 Debt Equity Ratio 2.92 2.85 2.19 2.01 1.46 Operating Ratio 0.50 0.43 0.64 0.55 0.48 Debt Service Coverage Ratio 1.27 1.09 1.00 0.97 0.99

2. Receivables Profile 259. One of the more serious problems LWUA is facing is the management of its receivables as indicated by the following:


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(i) Based on the financial reports prepared by the Accounting Department, total WD accounts receivable increased by 72% from P961 million in 2005 to P1,653 million in 2008.

(ii) The Loans Administration Department (LAD) subsidiary ledger accounts total P1,136 million of which P925 million are uncollectible as follows:

Performing Loans 211 million Uncollectible Accounts

Non-performing Loans 73 Deferred Accounts 50 Non-operating WDs 14 Accounts with Collection Action Plans 788 Sub-total 925 million

Total 1,136 million Note that the total of accounts receivable based on LAD’s subsidiary ledgers is much less than the amount in the Financial Reports. These figures need to be reconciled.

(iii) Aging of receivables prepared by LAD show that 85% or P974 million out of the total of P1,140 million are over 6 months due. The total of the Aging of Receivables also need to be reconciled with the Accounting Department and other LAD reports.

(iv) Allowance for bad debts amount to P615 million in 2008 represent 37% of the AR-WD balance of P1,653 million This covers about 65% of the P925 million uncollectible accounts and approximately 75% of accounts which remain unpaid after 10 months.

(v) Based on the Billing and Collection Report (BCR), collection efficiency computed at 95% in 2008 is based on the amount collected over the amount considered collectible excluding non-performing loans (NPL), deferred accounts, and accounts with collection action plans. This method of calculation does not give a complete picture and could lead one to complacency as to the high levels of collection efficiency achieved. It is suggested that LWUA also use other computations of actual collection efficiency to guide management in selecting the appropriate intervention. For example, the LWUA budget and cash flow projections target 85% collection efficiency computed as % of gross billings net of non-performing loans, deferred accounts, and accounts of non-operating WDs. Actually the LAD also uses the same computation for the projected receivables and collection report. The resulting collection efficiency will be 81% if BCR is recalculated on the same basis as the budget and projection targets. Other indicators include movements in NPL and deferred accounts as well as accounts of non-operational WDs. Management can require regular reports on these indicators as a basis for aggressive action to improve performance.

(vi) Similarly, long-term WD receivables need to be reconciled as December 2008 balance stands at P13.74 billion per Accounting records against P14.1billion per LAD records.

260. An aggressive receivables management is suggested, including (i) identifying and strengthening institutional responsibilities in collection efforts, (ii) reconciling accounts, (iii) providing several ratios and corresponding levels of monitoring of collection efficiency, and (iv) restating budget and cash flow projections to reflect account classification to become comparable with Accounting records. Appendix 7 presents more details of LWUA’s receivables and Appendix 8 for LWUA’s action and proposals to improve collection efficiency


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261. Due to the seriousness of the collection problem, the accounts receivable situation as well as LWUA action was updated from December 2008 up to June 2009 and presented in Appendix 8. The appendix provides a deeper assessment as to the real causes of the water district arrearages from both LWUA and the water district perspectives, makes a risk assessment and proposes several mitigating measures.

3. Debt Profile 262. As of December 31, 2008 long-term liabilities totaled P8.96 billion of which P 430 million represented the current portion. The LWUA Loan Portfolio is composed mainly of foreign loans amounting to Php 8.78 billion in 2008. Annual debt service amounting to around P1.3 billion is currently covered by cash inflows from operating and financing activities.

263. The major issue facing debt is the borrowing capacity ceiling particularly for local funds. LWUA has almost reached its borrowing capacity limit as follows:

(i) Domestic borrowing – P1 billion limit (P800 million used as of December 2008)

(ii) Foreign borrowing – $500 million ($175 million used as of December 2008)

264. A bill under review by the Senate proposes increasing the borrowing ceiling for all loans to $900 million. Similarly, the bill also increases the capitalization of LWUA to allow infusion of government capital. This is currently considered as subsidy but will be converted into government equity upon approval of the bill. This bill is expected to be approved by 2011. Appendix 6 provides more details on LWUA’s long-term loans.

4. Financial Management Assessment Questionnaire (FMAQ)

265. LWUA generally follows sound financial management principles in its operations as indicated by the positive responses to the financial management assessment questionnaire (See Appendix 7). In the 2007 Audit of LWUA Financial Report, however, the Commission on Audit issued a qualified opinion on LWUA’s financial reports. This was the result of two items, namely (i) the unreconciled balances of the receivables account amounting to P139 million, and (ii) the lack of valid claims to support the P142 million loan from the International Bank of Reconstruction and Development (IBRD). There were other matters enumerated in COA’s List of Comments and Observations, including (i) overstatement/understatement of cash-in-bank amounts resulting from the non-preparation of periodic bank reconciliation, (ii) non-collectibility of receivables from officers and employees, (iii) P4 million loan from non-operational WDSs outstanding for more than 14 years, and (iv) delays in payment of foreign loans.

266. The matter of the unreconciled balances has not yet been corrected as observed in Section B2. Receivables Profile above. The amount to be reconciled for long-term receivables has in fact increased to P374 million (P13.74 billion per Accounting records against P14.1 billion per LAD records). Accounts receivables also have an unreconciled amount of P517 million (P1.653 billion based on Accounting records against P1.136 billion based on LAD records). It is suggested that LWUA take action to resolve these.

267. FMAQ results are presented in Appendix 7 .


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C. SECTOR FINANCING NEEDS AND LWUA RESPONSE

1. Development Targets 268. The Midterm Progress Report for the Millennium Development Goals98 reported that (i) based on the 2004 Annual Poverty Indicator Survey (APIS) conducted by the National Statistics Office (NSO), the target for access to sanitary toilet facility has been achieved, and (ii) there is a high probability that the targets for water supply will be achieved. The Medium-term Philippine Development Plan 2004-2010 has actually set a target higher than the MDG targets as shown in Table 21 .

269. While data from APIS indicate that access to safe drinking water increased from below 75% in 1990 to about 80% in 2005−−−−2006, data from other sources such as the World Development Indicators, the World Health Organization, and UNICEF, on the other hand, show a decrease in access to an improved water source between 1990 and 2004. The recently conducted Diagnostic Study of the Water Sector in the Philippines,99 in acknowledging the problem reports that data on access to drinking water in the Philippines are sparse, conflicting, and creating a real difficulty in measuring progress in the sector.

270. Correct assessment of the current sector coverage is critical as a starting point in the measurement of the gap to be filled in the coming years. This will be the heart of the design of a sector program that will gradually bridge the gap, including estimation of the costs of such an effort as well as the identification of possible sources of financing.

Table 21: Comparison of MDG and MTPDP Target vs Actual Performance

Items

Baseline 1990 (Actual)

2005-2006 (Actual per APIS (NSO)

MDG Target (2015)

MTPDP Target (2004−−−−2010)

% Households with Access to Safe Drinking Water

73.7

80.2

86.8

92−−−−96

% Households with Sanitary Toilet Facility

67.6

86.2

83.8

86−−−−91

APIS = Annual Poverty Indicator Survey, MDG = Millennium Development Goals, MTPDP = Medium-term Philippine Development Plan, NSO = National Statistics Office.

Source: National Economic and Development Authority and UNDP, 2007. Philippines Midterm Progress Report on the Millennium Development Goals. Manila.

2. Sources of Financing 271. Access to financing may be viewed from the water supply providers’ perspective and from LWUA’s perspective.

a. WSP Sources of Financing

272. Water service providers in the Philippines have accessed financing through a number of channels as follows:

98 National Economic and Development Authority and United Nations Development Programme. 2007. Philippines Midterm Progress Report on the Millennium Development Goals. Manila. 99 Castalia Strategic Advisors. March 2009. Diagnostic Study of the Water Sector in the Philippines. Report to the World Bank. Final Report. Manila.


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(i) LWUA, (ii) Government financial institutions such as Development Bank of the

Philippines and Land Bank of the Philippines, and (iii) Private financial institutions such as Philippine National Bank and Bank of

the Philippine Islands.

273. Table 22 shows the sources of financing that various types of water service providers have accessed over the past eight years. Access to finance in the sector however tends to be driven by the source of funds, for example, specific donor projects. In making lending decisions, LWUA, GFIs, and the Municipal Development Fund Office (MDFO) tend to respond to specific priorities linked to the source of their funds.

274. A new source of funds is the Philippine Water Revolving Fund which targets creditworthy WDs following the EO 279 concept. The less creditworthy WDs are expected to remain under the LWUA financing package and will undergo a reform program to become creditworthy. The PWRF loan terms, however, are not very much attractive compared with the new LWUA terms. The LWUA interest rate for a 10 year loan of 9.2% is lower than the indicative rate for a PWRF loan which is 9.6%. Moreover, the LWUA repayment period is longer and its floating amortization feature make it more flexible and affordable to water providers. LWUA’s new strategy is to provide more concessional terms to less creditworthy water districts which cannot access private financing such as the PWRF.

Table 22: Access to Financing

Items

LWUA

DBP (2000–2007)

LBP (1999–2007)

MDFO

Commercial Banks

LGU Systems

None P1,333 million, 54 projects; World Bank and internal funds

P7,228 million, 556 projects; on-lends donor and internal funds

Targeted to least credit worthy LGUs

No evidence

Water Districts

Main source of financing for Water Districts; LWUA on-lends donor and internal funds

LWUA loan refinancing projects: P2,486 million, 16 projects; on-lends World Bank and internal funds

No evidence Not part of mandate

2007-2008: P424 million, 5 WD projects (including bulk water) and refinancing

Private Systems

No evidence P701 million, 3 projects; on-lends World Bank and internal funds

No evidence Not part of mandate

No evidence

Lending Strategy

Driven by source of funds



Donor priorities

Line of business

DBP = Development Bank of the Philippines, LBP = Land Bank of the Philippines, LGU = local government unit, LWUA = Local Water Utilities Administration, MDFO = Municipal Development Fund Office, P = Philippine peso, WD = water district. Source: Castalia Strategic Advisors. March 2009. Diagnostic Study of the Water Sector in the Philippines. Report to the World Bank, Final Report.


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275. So far, no water service provider has availed of loans from the PWRF. While four water districts have already applied for loans not one has been granted loans yet from PWRF because LWUA still has to sign the waivers for these WDs (a precondition for WD loans outside LWUA). See Appendix 10 for more details on the PWRF.

b. LWUA Sources of financing

i. LWUA Water Supply Projects

276. For the last 30 years, significant investments in the water supply sector were made through public financing, mainly in the form of loans from LWUA, through subsidiary loan agreements (SLAs), with the water districts. These loans were made for water supply projects and were guaranteed by the national government through the Department of Finance. LWUA has also been a recipient of grants from international funding agencies.

277. Figure 4 shows that up to year 2003, foreign borrowing was the dominant and growing source of LWUA’s financing. National government subsidy (NG Subsidy) was the next major source during the study years. National government subsidy and internal cash generation are the main sources of LWUA’s counterpart funding for its foreign-assisted projects. The government has had increasing difficulty in providing subsidies to LWUA in view of its worsening fiscal deficit as manifested in delays in cash releases. This has been aggravated by the continuing rise in the cost of servicing its foreign debt, making it difficult for LWUA to generate surplus for counterpart funding despite having a captive market of water districts and a monopoly in lending for technical assistance to WDs. Foreign loans continue to dominate the funding sources of LWUA up to the present with foreign loans representing around 60% of debt and equity in 2008.

Figure 4: LWUA Capital Expenditures, 1992-2003 (P Million)

Source: LWUA


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278. While the Law does not limit local water districts to borrow only from LWUA, LWUA’s requirement for a prior claim on the water district’s revenues in case the water district has outstanding loan obligations and wants to borrow from other sources, has made it difficult for WDs to access the capital market. Also, water districts have found it difficult to comply with requirements of financial institutions on e.g., collateral, equity, etc.; LWUA does not require collateral from the water district but has the power to take over the water district’s management in case of loan default. LWUA is undergoing reform that would involve redirecting its attention to the development of less creditworthy WDs and other water service providers, in the process, weaning the creditworthy WDs from its financing support and encouraging them to source their financing needs elsewhere.

279. With the appropriate business strategy and plan, the WE Bank can also prove to be a valuable source of financing for the sector. Please see Appendix 5 for more details on the WE Bank.

ii. LWUA Sanitation Projects

280. Based on the Midterm Progress Report for the Millennium Development Goals,100 the target for access to sanitary toilet facility has already been achieved. In spite of this LWUA, realizing its mandated responsibilities over the urban sewerage and wastewater as provided in PD No. 198, issued Board of Trustees Resolution No. 261 Series of 2002 defining the LWUA Policy Statement on Urban Sewerage, which states that LWUA intends to:

(i) Identify low-cost funding sources, preferably subsidies and grants-in-aid, to implement sewerage projects;

(ii) Strengthen cooperation among LWUA, WDs, LGUs, other national government agencies, and non-governmental organizations concerned with water and sewerage issues;

(iii) Harness LWUA’s technical capability in sewerage system planning, design, and construction; and

(iv) Enhance the application of low-cost, affordable, and indigenous technologies to reduce cost impact on sewerage infrastructure for collection, treatment, and disposal of liquid fluid.

281. LWUA’s Statement of Commitment also cites that the major issues affecting sanitation are funding and cost recovery. While for the most part, WDs are prepared to take up operation and maintenance of facilities, capital cost and recovery thereof is a major concern particularly the (i) source of funds for sanitation, and (ii) affordability and willingness of beneficiaries to bear the additional cost burden of sanitation in addition to the cost of access to potable water.

282. The LWUA Comprehensive and Interim Improvement Project includes the Provincial Urban Sewerage and Septage Management Programme to fund sanitation projects. The ADB WDDSP also includes a sanitation component. The ongoing ADB PPTA for WDDSP is currently considering financing schemes combining grant for capital works, community or beneficiary contributions for operation and maintenance, charging and incorporation of sanitation costs in the water bill, and creation of a revolving fund to ensure coverage of all beneficiaries. While most sanitation projects are implemented through LGUs, there is one particular case in Dumaguete where sanitation facilities were constructed by the LGU and is now in the process of being turned over to the water district for operation and maintenance as well as collection of fees. The Consultant shall study the case of Dumaguete Water District to see opportunities to replicate the experience in ADB-assisted cities.

100 National Economic and Development Authority and UNDP, 2007. Philippines Midterm Progress Report on the

Millennium Development Goals. Manila.


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2. Sector Financing Framework a. Targets

283. Planning for the water supply sector has been done as part of the preparation of the Philippine Water Supply Sector Roadmap (PWSSR), and the Medium-term Philippine Development Plan. The ADB Water District Development Sector Project deals with the subsector covering water districts under LWUA. PWSSR shows that these water districts serve about 76%101 of the water supply sector outside Metro Manila as shown in Table 23 .

284. As mentioned in Section C1 above, there is a serious lack of data on sector coverage and data on other performance indicators. The PWSSR also states that 24.15% of households or around 6.86 million people have access to Level III water supply systems of water districts.102 This represents a discrepancy of around 6 million from the LWUA figures which report that the water districts serve around 13 million of the population representing around 27% of the city/municipal population.103

Table 23: Population Served by Water Supply Providers, as of 2007

Items

Population Served Number (In Million) Percent (%)

Water District (1) 6.85 76 LGU 1.15 17 RWSA/BWSA .30 3 COOP .10 1 MWSS .02 0 Private/NGO .29 3 Total 9.06 100 LGU = local government unit, MWSS = Metropolitan Waterworks and Sewerage System, NGO = non-

governmental organization, BWSA = Barangay Water and Sanitation Association, RWSA = Rural Water and Sanitation Association.

Source: Philippine Water Supply Sector Roadmap.

b. Financing Framework Principles

285. The financing framework for the sector and should include the following:104

i. Policy that Differentiates between Financing and Subsidies

286. A water sector financing framework should ensure that water service providers have access to capital for investments that can be recovered in the future. A financing framework may address both access to finance and access to subsidies. While it is common for financing frameworks to blend these elements, they should be considered separately, as they address needs that are very different, as follows:

(i) Access to financing involves ensuring only that water service providers have access to this finance, that is, entities with funds to lend (banks and other financial institutions) are paired with clients (water service providers) that need to borrow.

101 Philippine Water Supply Sector Roadmap, Secretariat’s Report to the Infracom Sub-Committee on Water

Resources, November 2008. 102 ibid. 103 Based on LWUA Corporate Planning Department data. 104 Castalia Strategic Advisors. March 2009. Diagnostic Study of the Water Sector in the Philippines. Report to

the World Bank. Final Report.


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(ii) Subsidies involve supplementing water service providers’ income in a reliable way when tariffs do not cover the cost of debt servicing. To secure a loan, a water service provider must first demonstrate to a financial institution that it is capable of repaying the loan. Thus, subsidies may be required before a water service provider can get a loan, but the concept is different from pure access to financing.

287. Figure 5 illustrates the main funding needs of water service providers which depend on their degree of creditworthiness, using the terminology set forth in EO 279. Water service providers that are not creditworthy require pure subsidies, while those that are creditworthy only require access to financing. Water service providers in the middle of the spectrum require a blend of subsidy and financing. Water service providers may “graduate” up this spectrum as their financial viability improves.

288. A creditworthy service provider is defined as a bankable institution capable of obtaining a loan on commercial terms. LWUA’s categorization under EO 279 involves additional elements such as size and technical capacity. Some water districts that LWUA has identified as semi-creditworthy have in fact obtained loans on commercial terms, for example, Metro Cebu Water District has borrowed from DBP.

Figure 5: Funding Needs vis-à-vis WD Creditworthiness

Source: Castalia Strategic Advisors. March 2009. Diagnostic Study of the Water Sector in the Philippines. Report to the World Bank. Final Report.

ii. A More Detailed and Comprehensive Water Sector Financing Strategy

289. There are several gaps in the financing framework under Executive Order 279 as concessional lending in the sector tends to be driven by the source of funds rather than by a comprehensive sector financing strategy. A more detailed and comprehensive sector financing strategy will have to be established by the government which donors and other providers of funds can support and which should not interfere with commercial banks’ operations in the sector.

Creditworthy Semi- Pre- Non creditworthy creditworthy Creditworthy

Pure

Access to Financing

Pure Subsidy

Water Service Providers (WDs, LGUs, Others, Excl. Metro Manila Concessionaires

CWs

SCWs

PCWs

NCWs

GFIs. PFIs, commercial

lending rates

Concessional Funds

Grants & Deep Concessional

Funds

LWUA, MDFO, LGUs, and

DILG


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3. LWUA Financing Framework

a. Development Targets 290. LWUA is gearing its efforts towards its goal of providing water supply to the countryside in line with the government’s targets as follows:

(i) The Millennium Development Goals aim to ensure that 86.8% of the population has access to safe drinking water by 2015.

(ii) The Medium-term Public Investment Program (2005-2010) seeks to ensure the provision of water to all barangays (villages). Based on this target, the investment program established by the government gives priority to 212 waterless areas in Metro Manila and 633 waterless communities outside Metro Manila.

(iii) The Medium-term Philippine Development Plan for 2004-2010 aims to “provide potable water to the entire country by 2010.”

291. The LWUA administration’s current main concern is towards obtaining funds and implementing an accelerated program for the waterless communities. There is however very little information on the existing service coverage of this subsector that could be used as basis in planning for the water supply and sanitation infrastructure financing. Current planning process at LWUA is driven by information on available funds on the premise that financing need is so huge and that whatever funds are obtained can be used to help meet the demand.

292. Based on LWUA data, WDs serve a total of 13.135 million population representing 27.54% of the total population in the municipalities/cities covered by WDs. An illustrative model for the business planning model (see Appendix 11 ) shows that the coverage can increase from the current 27.89% to 31.06% with an investment of P7.5 billion under certain assumptions, namely capital cost of P20,000 per connection and five persons served per connection (Table 24). If the investment plan is further extended to cover the entire CIIP period from 2009 to 2013, and targeted to specific categories following EO 279, the same illustrative model shows that the population served would increase to 43%, and semi-creditworthy WDs could be credited for serving the most number of persons (Table 25) .

293. In the medium to long term, however, the critical aspect of LWUA’s operation is to ensure its long-term viability. A proposal on the development of a business planning model for LWUA is shown in Appendix 11. The business planning model will address the issues of LWUA’s achievement of its mandate vis-a-vis sustaining its operations viably in the long term.


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Table 24: Current and Projected Population Served

Region

Population Served

% of Municipal Population

Investment 2009 (P

billion)

Additional Population

Served

New Coverage of City/

Municipal Population (%)

Region 1

632,160

18.86 768,200 192,050 24.59

Region 2

284,730

15.35 167,200 41,800 17.61

Region 3 2,752,790 34.20 993,700 248,425 37.29

Region 4 2,886,290 41.31 1,010,800 252,700 44.92

Region 5 856,110 25.31 308,500 77,125 27.59

Region 6 911,450 16.38 1,085,000 271,250 21.25

Region 7 979,055 32.32 392,058 98,015 35.56

Region 8 400,305 18.92 137,500 34,375 20.55

Region 9 399,305 22.95 99,400 24,850 24.38

Region 10 646,420 35.74 564,000 141,000 43.53

Region 11 1,251,065 30.45 113,300 28,325 31.14

Region 12 258,900 18.22 67,500 16,875 19.41

Region 13 411,675 27.24 151,000 37,750 29.74

CAR 239,700 33.89 67,500 16,875 36.27

ARMM 225,635 15.36 56,000 14,000 16.31

Total 13,135,590 27.89 5,981,658 1,495,415

31.06 ARMM = Autonomous Region in Muslim Mindanao, CAR – Cordillera Autonomous Region, P = Philippine peso.

Table 25: Additional Population Served by Water Districts

Water District Classification

No. of Water

Districts

Population Served

Investment 2009

(P Billion)

Additional Population Served

Number % of City/ Municipal Population

New Population

Served a

New Total Population

New % Population Coverage

Creditworthy WDs

57 2,902,635 45.85 0.00 0.00 2,902,635 45.85

Semi-creditworthy WDs

178 7,811,980 34.40 18.52 4,630,000 12,441,980 54.78

Pre-creditworthy/ Non-creditworthy WDs/Others

369

2,420,960

12.97

10.10

2,525,000

4,945,960

26.50

Total 13,135,575 27.54 7,155,000 20,290,575 42.53

P = Philippine peso, WD = water district. a Assuming investment cost per connection is P20,000 and five persons are served per connection.


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b. Current Financing Framework

294. Table 26 compares the sector’s current financing framework with the principles set out in EO 279.

Table 26: Current Financing Framework vis-à-vis EO 279

Type of WD/WSP

Target (EO 279) Actual – LWUA Actual – Others

Creditworthy WSPs

Borrow from GFIs and PFIs at commercial rates

LWUA has focused on most creditworthy WDs since 1994.

LWUA reached domestic borrowing ceiling in December 2006. It is at approx. $370 mn of $500 mn foreign borrowing ceiling.

Perception that remaining ceiling is not enough to reach targets – new lending will be difficult and is likely to target more CW WDs

P1.5 billion from DOH will be targeted to 122 non-operational WDs

Some have accessed private financing.

Refinancing of LWUA loans from DBP and private bank (one case).

Newly-formed Philippines Water Revolving Fund targets these.

Semi-CW WDs

Borrow from GFIs, PFIs, and on concessional terms from LWUA

Can access financing from commercial banks and DBP only if found creditworthy according to the loan terms

Pre-CW WDs

Borrow from LWUA on concessional terms Grants from donors

Can access financing from DBP only if found creditworthy according to the loan terms

Non-CW WDs

May continue to borrow from LWUA on concessional terms Financial support from LGUs, DILG, MDFO

Other WSPs Access financing from GFIs, PFIs, MDFO, and LGUs

LWUA is not currently lending to systems that are not WDs.

No evidence of borrowing from commercial banks

LGU systems borrow from LBP, DBP, MDFO

Private systems borrow from DBP

MDFO focuses on less-creditworthy LGUs

CW = creditworthy, DBP = Development Bank of the Philippines, DILG = Department of the Interior and Local Government, DOH = Department of Health, LGU = local government unit, MDFO = Municipal Development Fund Office, GFI = government financing institution, LBP = Land Bank of the Philippines, LWUA = Local Water Utilities Administration, mn = million, PFI = private financing institution, WD = water district, WSP = water service provider. Source: Castalia Strategic Advisors. November 2008. Diagnostic Study of the Water Sector in the Philippines. Report to the World Bank. Draft Final Report.


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c. Initial Financing Framework for LWUA

295. As discussed in the preceding section, there are still no operating guidelines on water sector financing that could serve as basis for a financing strategy to better define LWUA’s role and to direct resources it would receive to provide loans to semi-creditworthy and pre-creditworthy water districts in line with EO 279. However, EO 279 has identified the sources of financing for water service providers according to the degree of need. It specifically addresses the second element of the financing framework—how concessional loans and grants may be channeled to water service providers whose revenue is insufficient to repay loans for the investments they must make.

296. This section attempts to establish a conceptual framework for LWUA’s financing to ensure (i) its responsiveness to the sector needs and (ii) long-term viability. Very often these two objectives of service and viability run against each other. In fact, many times in the past LWUA has been pushed from one objective to the other. In 1994, the NEDA Board Resolution No. 4 required LWUA to serve only creditworthy WDs. However, in 2004, EO 279 shifted LWUA’s focus to less creditworthy WDs.

297. The suggested strategy105 now involves positioning LWUA as an administrator of grants to these water districts. The grants however will be designed to provide incentives for water districts to graduate to the next level of creditworthiness. These grants will be combined, in a coordinated fashion, with commercial loans from GFIs, so that the blend will result into a concessionary loan to the water district. LWUA will receive a “success fee” when water districts successfully complete stages of their graduation plans.

298. Pending issuance of the operating guidelines on a water sector financing policy, LWUA needs to provide an initial clarification and some details as to how the financing framework can be worked out within LWUA. Some of the initial features are shown in Table 27 .

Table 27: Features of Proposed LWUA Financing Framework

WD Classification Grant Loans with Relending Terms

Creditworthy WD No grant available No loans available

Semi-creditworthy WD Lower levels of grant may be made available106


Pre-creditworthy WD 90% grant 10% loan, under following options:

• 7.5 – 9% interest under the P5 million and P10 million loan windows


Non-creditworthy WD 90% grant 10% loan, zero interest under NLIF window

Non-operational WD 90% grant 10% loan, zero interest under NLIF window.

BR = board resolution, NLIF = non-LWUA-initiated fund, P = Philippine peso, WD = water district.

105 Castalia, op. cit. 106 If the proposed project involves waterless remote barangays and where loan funding at regular terms will not

make the project viable.


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299. Expanding service outside the poblacion (town center) or to the more remote and sparsely inhabited barangays will not, however, be attractive even for the semi-creditworthy service providers. If funding for said projects is maintained at commercial terms, the service providers may just opt to do nothing. There is no sanction after all for those who do not extend service nor incentives for those who do strive to serve all the potential customers within its area of responsibility. Given this reality, some further refinements in the strategy could be developed without going outside the framework. Some amount of grant may be allowed for this class of WDs provided the funds are used for expansion to the non-viable areas within its franchise area.

300. Following the above, and considering the existing LWUA investment program, Table 28 shows the existing loan windows and programs offered by LWUA and how they can be structured within the proposed LWUA financing.

Table 28: LWUA’s Loan Windows and Programs

Financing Windows Existing Policy Proposed Realignment of

Target Beneficiaries

Sample Projects in 2009

No loan window open

Creditworthy WDs

Loan Window 1 for ODA

Comprehensive and Interim Improvement Projects are regular projects for semi- creditworthy WDs under Loan Window 1.

Semi-creditworthy WDs

ODA Projects Locally funded projects: - Comprehensive/Interim improvement projects - Bulk Water Project - Semi-creditworthy WD improvement projects - Watershed projects

Special Loan Windows for P5 and P10 million loans

Creditworthy, semi-creditworthy, and non- creditworthy WDs (BR No. 61 and 82 Series of 2008)

Pre-creditworthy WDs

- Less creditworthy WD projects - Projects for waterless municipalities

NLIF Loan Window Included here are projects for non-operational WDs, waterless municipalities, municipalities with no existing water supply systems, and existing WDs. Projects for Less Creditworthy WDs (BR No. 19 Series of 2008)

Pre-creditworthy, non-creditworthy, non--operational, waterless, non- WDs to be converted to WDs Total

- Projects for non- operational WDs - DOH projects - DPWH projects

NLIF Grant Window

BR = Board Resolution, DOH = Department of Health, DPWH = Department of Public Works and Highways, NLIF = non-LWUA-initiated fund, ODA = Official Development Assistance, WD = water district.

d. LWUA’s Long-term Viability

301. Given the above framework or the shift of LWUA’s resources towards less creditworthy WDs, the question now is “How will LWUA manage the various risks involved and maintain its long term viability?” Many LWUANs feel that EO 279 has made LWUA’s position less financially sustainable because of the following:

(i) focus on less creditworthy WDs would lead to increased non-performing loans,

(ii) graduation of semi-credit WDs (79% of LWUA’s portfolio) to creditworthy


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will reduce LWUA’s market, (iii) refinancing loan of creditworthy WDs will result in LWUA losing its main

source of income.

302. However, some action steps can be taken to mitigate these risks. Assuming that LWUA is able to source funds to meet the needs of its WDs for both subsidies and financing, the major effort will be for LWUA to intensify its role to develop the water districts to become bankable entities capable of repaying loans to LWUA. LWUA was able to achieve this with its now mature WDs.

e. Second Generation Loans

303. After 36 years in operation, LWUA still has not generated second generation funds and remains dependent on fresh capital infusion. Since most of the loans provided to WDs are composed of about 60% loan and 40% equity, and since LWUA has exhausted its P2.5 billion equity, the general consensus is that it should have already built a substantial amount for second generation loans. The supposed second generation funds apparently were either used as counterpart equity funds or used to absorb LWUA’s losses in years 2004–2006.

304. Ring-fencing is part of the recommendations of the EO 279 particularly for several aspects of LWUA operations. Grant funds received should be provided as grants and loan components should be ring-fenced and provided again for other grant projects.

305. ODA loan funds and Internal cash generation used as counterpart funds, resulting in loans to water districts should be ring-fenced such that when they are eventually repaid, they become part of funds for a second generation loan.

f. Business Planning Model

306. All the above concerns, risks, and strategies could be laid out in a Business Planning Model (Appendix 13) which will allow for scenario analysis and development of strategies. Key scenarios that could be built into the model should cover (i) availability of a lower level of investment funds as expected, (ii) more refinancing from creditworthy WDs with these funds lent again to less creditworthy WDs, (iii) lower collection efficiency, and (iv) different levels of operating expenses.

D. PROJECTED FINANCIAL PERFORMANCE

307. This section shows the results of the assessment of the projected financial performance LWUA. The future performance of LWUA was projected to determine whether LWUA’s financial performance continues to be positive up to year 2018 which is the second year after LWUA begins to repay the ADB loan. The projection is based on LWUA’s financial performance in the previous years and assumptions of the LWUA Corporate Planning Department. A sensitivity analysis was also conducted to assess the impact of three scenarios on revenues, cash position, and other financial indicators.

308. As part of its strategy to establish a more reliable source of funds for water supply development projects, LWUA acquired 60% ownership of a thrift bank, the Express Savings Bank, In the second quarter of 2009 So far, LWUA has reportedly paid out a total of P780 million as its investment in the bank, now referred to as the Water and Energy Bank (WE Bank).


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1. Key Assumptions 309. An assessment of the performance of the WE Bank as well as the implications on LWUAs performance and financing requirements was made and presented in Appendix 5. The WE Bank is expected to operate at much smaller scale of operations than projected under the feasibility study prepared early 2009 which was the basis for the acquisition transaction. At this level , the WE Bank is expected to generate income ranging from P30 million in 2010 to P 101 million in 2018 and to be able to finance further need for capitalization from its own earnings. LWUA will benefit from this income to the extent of its 60% share.

310. Financial projections of LWUA’s performance were prepared for LWUA under two schemes namely:


• Scheme Two – With Bank which assumes continued operation of the bank. 311. For each scheme, projections were prepared under a base scenario and three other scenarios as a basis for sensitivity analysis. The base scenario was based on the 10-year financial projections prepared by the LWUA.

a. Base Scenario

312. The base scenario was based on the 10-year financial projections prepared by the LWUA Corporate Planning Department in December 2008 and which were updated to consider several developments, including the following:

(i) revision of the relending rate based on BR 38 Series of 2009, (ii) increase in the ADB WDDSP loan from $24 million to the planned

investment of $50 million, (iii) loans were limited to the amount needed by the investment level, (iv) reclassification of the accounts receivable and other receivable accounts

to be consistent with the LUWA Financial Reports prepared by the Accounting Department, and

(v) updates in the LWUA Comprehensive and Integrated Infrastructure Program (CIIP)

313. The updated Comprehensive Integrated Infrastructure Project shows a total investment of P28 billion for the 5-year period 2009 to 2013, which was generally funded as shown in Table 29. However, in years when LWUA operations resulted in significant ending cash balances, more financing was sourced from LWUA internal funds rather than from borrowings. For the year 2009, the actual amount of investment in projects totalled P3.6 billion or 80% of the CIIP projection of P4.5 billion. For the year 2010, the LWUA budget shows an investment of P4.5 billion for projects. To be more conservative in the base scenario, it is projected that investments in projects are 80% of the budget and the CIIP figures.

314. Table 29 also shows the uses of funds particularly the loan windows which apply. It also discusses the terms of loan window used following the financing framework discussed in Section C. Sector Financing Needs and LWUA Response above.


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Table 29: Estimated Allocation by Type of Water District, 2009−2013

ICG = internal cash generation, NLIF = non-LWUA-initiated fund, P = Philippine peso, WD = water district

b. Sensitivity Analysis

315. Three other scenarios were developed to test LWUA’s sensitivity to adverse situations from the perspective of how these adverse situations affect LWUA’s long-term viability. The scenarios are referred to as the Conservative Scenario (Scenario A), the Better Scenario (Scenario B), and the Best Scenario (Scenario C). The parameters used include (i) investment, (ii) revenues, (iii) collection efficiency, and (iv) operating costs. Table 30 presents a scenario matrix.

316. Investment levels were set at 30% of the CIIP investment levels for Scenario A. Scenario B assumed investment levels at 60%, while the investment program in Scenario C is based on 80% of the CIIP figures.

317. Revenues decrease as more WDs opt for refinancing. There will be a reduction in revenues even assuming that the funds are relent right away to other semi-creditworthy WDs since the new interest rates average about 9.67% compared with the existing average of 11.6%. Under Scenario A, 50% of the existing loans in 2008 will be refinanced, 25% under Scenario B and no refinancing assumed under Scenario C.

318. Scenario A assumes the lowest possible collection efficiency at 75% which approximates LWUA collection efficiency on gross accounts receivables which include non-performing loans, accounts of non-operating WDs, and deferred accounts. For Scenarios B and C, collection efficiency was set at 85% and 90%, respectively.

Type of Water

District

Financing Windows

Assumptions

Estimated

Amount to be Allocated (P

billion)

Percent

(%)

Creditworthy

No loan window open

Semi-creditworthy


BR 38, likely terms: 30 years repayment, 9.8% interest, 10% equity counterpart from ICG

18.52

65

Pre-creditworthy

Special loan windows for P5 million and P10 million loans

Average terms,15 years repayment, average 8% Interest, no equity counterpart?

2.50

9

Pre-creditworthy, Non-credit worthy, Non-operational, Waterless WDs

Non-LWUA Initiated Fund window

Average loan financing is 25% of project cost, with 30 years repayment, zero interest

1.90

6

Pre-credit worthy, Non-creditworthy, Non-operational, Waterless Non-WDs to be converted to WDs

NLIF grant window

Average grant financing is 75%

5.70

20

Total

28.00

100


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Table 30: Scenario Matrix

From the Perspective of LWUA

Viability Original

Base

Scenario A Scenario B Scenario C

(Conservative) (Better) (Best)

Project Disbursements/ Investment ODA/Local grants and loans Investment plan and

disbursement as of December 2008

Updated May 2009

Investment figures

are P3.6 billion in 2009 (actual) and 80% of 2010 budget and CIIP figures thereafter.

Only 30% of funds available so only 30% disbursement is realized

Only 60% of funds available so only 60% disbursement is realized

80% of funds are available

Revenues Reduced interest revenues due to refinancing

No refinancing 50% refinancing 25% refinancing no refinancing

Collection Efficiency Collection efficiency on billings net of non performing, deferred accounts and accounts of non operating WDs

85% 75% 85% 90%

Operating Costs

Personal Services (Organization/Staffing)

Maintained at 2009 levels (P546 million/year)

P1,098 million in 2010 based on Budget, 3% increase thereafter

15% reduction by year 2013

Maintenance and Other Operating Expenditures

Maintained at 2009 levels (P206 million/year) and increased with inflation

Increased with inflation



I Increased with inflation

CIIP = Comprehensive and Integrated Infrastructure Program, ODA = Official Development Assistance, WD = water district.


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319. For operational expenses, i.e. it is assumed that personal services will increase at 3% per year based on 2011 levels. For maintenance and other operating expenses, it was assumed that these expenses will increase by inflation.

2. Assessment of LWUA Projected Performance

320. In determining the implications of the above set of projections on LWUA, the consultants used the WE Bank base scenario to be more conservative, and considered two possible scenarios of how the WE Bank will impact upon LWUA operations, namely (Table 31) :

• Scenario One – Without Bank. This scenario is based on the assumption that LWUA will not operate the bank and all previous investments will be written off.

• Scenario Two – With Bank. This assumed continued operation of the bank.

321. The financial projections show that assuming LWUA is able to develop an appropriate strategy and business plan to operate the WE Bank, then the WE Bank scheme appears to be better due to the following:

• Under the Without Bank scheme - the negative effect of amortizing the P780 million loss assuming the bank related disbursements are written off

• Under the With Bank scheme - the positive effect of LWUA’s share in the WE Bank’s projected income

322. What cannot be quantified here is moral obligation on the contingent liabilities that continue to accrue as LWUA continues to operate the WE Bank.

Table 31: Comparison of With and Without Bank Scenarios

Without Bank With Ba nk (operated a a thrift bank)

Investment P780 million investment written off over 10 years

P780 million cash payments in 2009 comprising: -P80 million paid to owners and P 420 million (60% of P700 million additional investment as LWUA investment in subsidiaries) released in September and October -P280 million (40% of P700 million assuming LWUA funds minority stockholders, as due from minority stockholders) -Future Capital contributions to the bank is unprofitable etc.

Profitability P780 million payment will be treated as losses and amortized over 10 years

60% of annual income (averaging P20 million from 2018 onwards)

Risks No moral obligation beyond P780 million

Moral obligation to make depositors and creditors whole, as majority owner and controlling party


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i. Comparison of With and Without Bank schemes, base scenarios

323. Under the base scenario of both schemes, LWUA will experience continuous growth in income up to 2018. A key assumption here is that LWUA will be able to continue to obtain government grants and subsidies and in certain years even increase the level of its annual investment in projects from P 3.6 billion in 2009 to P 5 billion within the 5 year CIIP period. The projections assume that LWUA will implement its CIIP and adopt the proposed financing framework including ring fencing of loan and grant funds. The future of LWUA funding and the financing strategies it adopts depend to a large extent on the leadership in the coming years. The major difference between the results of the two schemes are lower income figures under the Without the Bank scheme considering the amortization of losses from LWUA’s initial investment of P780 million to the WE Bank. Another reason for the higher income under the With the Bank Scheme, is the share of LWUA on the estimated WE Bank income. However, the With the Bank Scheme financial projections lack a sound basis because there is currently no business plan for the WE Bank. It was agreed during the Draft Final Report Tripartite Meeting held last February 16, 2010 that the more conservative financial projections under the Without the Bank Scheme should be used.

324. The base scenario of the Without the Bank scheme shows a steady increase in income as shown in Table 32 . Cash position gradually decreased through the years since the projections assumed that internally generated funds will be used as needed for projects and only a minimum level of cash will be retained. Years 2010 and 2011 however show a drop in debt service coverage (DSC) as a result of the budgeted major increase in personnel costs from P 546 million in 2009 to P1,098 million in 2010 and an increased debt service as LWUA substantially pays most of its local loans. The DSC improves in the succeeding years as revenue levels also increase. Appendix 12 shows the projected financial statements and ratios for the base scenario.

325. The succeeding discussions relate to the Without-the-Bank scheme.

Table 32: Selected Indicators of LWUA Performance - Base Scenario: Without the Bank

i. With the Bank, Scenario A, Conservative Scenario

326. Under the conservative scenario, LWUA’s performance is significantly lower than the base scenario. Very minor improvement in performance is expected after the significant drop in profitability in 2009 resulting from the higher operating costs and debt service considering that investment in projects is at very low levels of 30% of the CIIP. As a result, DSC is lower than 1.10 throughout the projection period and the ideal DSC is never reached. The high cash balances are the result of the assumed loans which were kept at the same level as that projected in the base scenario. This was done to keep the variables used for the scenarios to a minimum. (Table 33) .


BASE SCENARIO: WITHOUT THE BANK

SELECTED INDICATORS 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Financial Performance (P million)

Net Income After Taxes 435 272 439 826 735 985 809 1,010 1,144 1,261Ending Cash 1,180 1,175 277 1,097 1,842 1,229 483 374 375 422

Financial Ratios

Current Ratio 2.60 2.41 2.36 2.73 3.54 2.54 2.74 2.67 2.57 3.32 Debt Service Coverage 1.09 0.85 0.68 1.49 1.34 1.78 1.55 1.69 1.71 1.63 Operating Ratio* 52% 67% 63% 56% 55% 53% 52% 50% 49% 48%

Long Term Debt Equity Ratio 0.42 0.53 0.42 0.32 0.33 0.29 0.28 0.24 0.23 0.23


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Table 33: Selected Indicators of LWUA Performance – Scenario A : Without the Bank, Conservative Scenario


SCENARIO A: 30% OF INV ; 75% COLLECTION EFFICIENCY; 50% REFINANCING; WITHOUT THE BANK

SELECTED INDICATORS 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018


Net Income After Taxes 156 435 272 391 479 300 404 309 352 365 356Ending Cash 1,651 1,180 1,175 717 1,222 1,633 1,702 1,584 1,851 2,148 2,589

Financial Ratios

Current Ratio 2.44 2.60 2.37 2.59 2.82 3.34 2.68 3.27 3.47 3.43 5.25 Debt Service Coverage 0.97 1.09 0.85 0.63 1.09 0.89 1.05 0.94 1.02 0.99 0.89 Operating Ratio* 37% 52% 67% 66% 65% 67% 68% 70% 71% 72% 73%Long Term Debt Equity Ratio 0.53 0.42 0.53 0.42 0.32 0.32 0.29 0.28 0.23 0.22 0.23

ii. Without the Bank, Scenario B, Better Scenario

327. In the better scenario, LWUA will have a positive performance in the key indicators of viability. Similar to the base scenario, there will be a drop in DSC position in 2010 and 2011. Performance improves beyond 2011 in all aspects of financial performance (Table 34) .

Table 34: Selected Indicators of LWUA Performance - Without the Bank, Better Scenario


SCENARIO B: 60% OF INV ; 85% COLLECTION EFFICIENCY; 25% REFINANCING ; WITHOUT THE BANK



Net Income After Taxes 156 435 272 407 673 546 737 594 731 816 882Ending Cash 1,651 1,180 1,175 473 1,174 1,781 1,434 934 969 1,079 1,270

Financial Ratios


iii. Without the Bank, Scenario C, Best Scenario

328. The Scenario C reflects the best scenario that LWUA could attain under the following assumptions: investment will be at 80% of the CIIP investment figures, collection efficiency will hit a high 90% and there will be zero refinancing of loans. Since the investment level is the same as that for the base scenario, the resulting performance is almost similar to that under the base scenario. See Table 35 .


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Table 35: Selected Indicators of LWUA Performance - Without the Bank, Best Scenario




Net Income After Taxes 156 435 272 425 809 716 964 790 989 1,122 1,237Ending Cash 1,651 1,180 1,175 284 1,116 1,863 1,252 510 402 400 438

Financial Ratios


SCENARIO C: 80% OF INV ; 90% COLLECTION EFFICIENCY; NO REFINANCING; 15% REDUCTION IN PERSONNEL COSTS (2013) ; WITHOUT THE BANK

E. MAJOR CONCERNS AND RECOMMENDATIONS

1. Accounts Receivables and Collection Efficiency

329. Water district accounts comprise accounts receivables representing the current portion of WD accounts (P1,653 million), and long-term receivables which are not yet due (P13,736 million). There has been a tremendous increase in accounts receivable during the last 4 years, from P961 million in 2005 to P1,653 million in 2008. Of the P1,136 million as of December 2008 which are supported by subsidiary ledgers, about 66% or P925 million is uncollectible. This includes about P138 million representing non-performing loans, deferred accounts, and accounts of non-operating water districts.

330. The above reflects a very serious collection problem that could result in the continuous erosion of the quality and value of receivables. To cover the risk, LWUA has set up high levels of allowance for bad debts equivalent to 25% of the balance of accounts receivables and 40% of non-performing loans. By end of 2008, allowance for bad debts already amounted to P615 million covering about 65% of the uncollectible accounts or accounts which are due for more than 6 months.

331. Suggested action steps include: (i) aggressive receivables management action to arrest worsening receivables condition, and (ii) identifying and strengthening institutional responsibilities in collection efforts. Efforts are also needed to do some internal housekeeping aimed at (i) reconciling the receivables accounts, (ii) providing several ratios to monitor collection efficiency including monitoring non-performing loan accounts, and (iii) restating budget and cash flow projections to reflect account classification to become comparable with Accounting records.

2. Sources of Financing for Investment Projects

332. Decline in project disbursements has been noted in recent years in view of which LWUA is currently taking aggressive action to secure funds from DOH, DPWH, and DBM. At the same time, it is following very closely the approval of the bill increasing capitalization and borrowing capacity of LWUA. The projections assumed approval of the bill by the end of 2009 paving the way for more local borrowings in 2010.

333. In the event that the bill increasing capitalization is not passed in 2009, LWUA will need to tap other sources of financing. In the past, LWUA has accessed reserve funds of the water districts and may opt to do the same again. Water districts deposit these funds in LWUA and


79

LWUA pays 7%interest for these deposits. LWUA may also allow some water districts to refinance their existing LWUA loans as it did in the past. Refinancing of loan funds will provide temporary cash relief but will not solve the long-term fund requirement needs of LWUA.

334. As part of its strategy to establish a more reliable source of funds for water supply development projects, LWUA acquired 60% ownership of a thrift bank, the Express Savings Bank, In the second quarter of 2009 So far, LWUA has reportedly paid out a total of P780 million as its investment in the bank, now referred to as the Water and Energy Bank (WE Bank). Since this appears to be the only strategy LWUA is pursuing in order to establish a solid source of financing, LWUA should be able to give immediate attention to the major recommendations presented in Appendix 5 namely:

• LWUA should resolve outstanding issues including getting official approval of the Monetary Board and complying with the ownership ceiling of 60% imposed by the Central Bank (BSP)

• LWUA needs to establish a) a clearer definition of this “mission-vision”, b) a well thought out strategy and c)a comprehensive business plan for WEB.

• Ring fence LWUA loan operations by controlling loan disbursements and water district loan payments such that the amount available for debt service is known and managed so that LWUA can take timely action to avoid default.

3. Financing Framework 335. The sector and LWUA need a financing framework to guide future financing schemes. Following existing LWUA practices which are already aligned with EO 279, the features of the proposed financing framework are shown in Table 36 .

336. To implement the framework more effectively, loans and grants provided should be ring-fenced. Funds from collections and refinancing will be relent to semi-creditworthy WDs to keep the base of paying accounts solid. Grant funds will also be provided to grant projects for the pre-creditworthy, non-credit worthy, and waterless municipalities. The loan component of these grant funds will be relent to other beneficiaries. Ring-fencing of funds will allow the gradual build-up of second generation loans.

337. LWUA can also revisit the other recommendations under EO 279 and prepare and/or finalize operating guidelines on the financing framework.


80

Table 36: Features of Proposed LWUA Financing Framework

Classification Grant Loans with Relending Terms

Creditworthy WDs No grant available No loans available

Semi-creditworthy WDs May be allowed but set at lower levels compared with PCW/NCW69


Pre-creditworthy WDs Maximum 90% grant Maximum 10% loan, under following options:

• 7.5–9% interest under the P5 million and P10 million loan windows


Non-credit worthy WDs Maximum 90% grant Maximum 10% loan, zero interest under NLIF window

Non-operational WDs Maximum 90% grant Maximum 10% loan, zero interest under, NLIF window

BR = board resolution, NCW = non-creditworthy, NLIF = non-LWUA-initiated fund, PCW = pre-creditworthy, WD = water district.

4. Long-term Strategic Planning

338. LWUA currently prepares 10-year cash flows in three (3) Excel files, one to compute investments, income statements and cash flows, a second to compute debt service, and a third to hold the balance sheet. The files are not capable of sensitivity analysis for various scenarios which will allow the administration to identify various options and select the most appropriate business strategy. This is an important tool that can guide management in decision-making to ensure long-term viability.

339. LWUA’s current main concern is to obtain funds and implement an accelerated program for waterless communities. There is, however, limited information on the existing service coverage of this subsector that could be used in planning for water supply and sanitation infrastructure financing. The current planning process at LWUA is driven by information on available funds on the premise that the financing need is so huge that whatever funds are obtained can be used to help meet the demand.

340. All the above concerns, risks, and strategies could be laid out in a business planning model which will allow for scenario analysis and development of strategies. A business planning model is proposed for LWUA’s long-term strategic planning.

5. COA Findings

341. LWUA generally follows sound financial management principles in its operations as indicated by the positive responses to the financial management assessment questionnaire. In the 2007 audit of the LWUA Financial Report, however, the Commission on Audit issued a qualified opinion on the administration’s financial reports. This was the result of two items, namely (i) the unreconciled balances of the receivables account amounting to P139 million, and (ii) the lack of valid claims to support the P142 million loan from IBRD. LWUA should take action on the above two findings and likewise resolve all other matters enumerated in COA’s List of Comments and Observations.

69 Considering that some proposed projects for semi-creditworthy WDs involve waterless remote barangays

where loan funding at the regular terms will not make the project viable.

Appendix 1


81

PROPOSED LWUA ORGANIZATIONAL CHART LEGAL ASSESSMENT OF THE PETITION OF LWUA EMPLOYEES ASSOCIATION FOR

PROGRESS (LEAP) AGAINST THE LOCAL WATER UTILITIES ADMINISTRATION (LWUA) AND THE DEPARTMENT OF BUDGET AND MANAGEMENT (DBM) BEFORE

THE REGIONAL TRIAL COURT OF QUEZON CITY AND ITS EFFECT ON THE CURRENT PROJECTS OF THE WORLD BANK

Appendix 2


82

LEGAL ASSESSMENT OF THE PETITION OF LWUA EMPLOYEES ASSOCIATION FOR PROGRESS (LEAP)

A. The Petition

1. Docketed as SP No. 06-59047 and filed with the Regional Trial Court of Quezon City, Branch 92, on October 18, 2006, the Petition of the LEAP seeks to:

(i) annul the DBM-approved staffing pattern, the LWUA Board Resolution No.

69, series of 2006 and Executive Order Nos. 279, 366 and 421;

(ii) prohibit LWUA and DBM from implementing them; and

(iii) compel LWUA and DBM to recognize the right of LEAP to security of tenure.

2. The petition prayed for issuance of a temporary restraining order (TRO) and

preliminary injunction directing LWUA and the DBM to cease and desist from proceeding to enforce and effect the staffing pattern, the Board Resolution, and the Executive Orders.

B. The Status of the Petition

1. LWUA, represented by the Office of the Government Corporate Counsel, and DBM, represented by the Office of the Solicitor, answered the Petition and particularly opposed the petitioners’ application for the issuance of a writ of preliminary injunction and temporary restraining order.

2. The petitioners contended that they are entitled to a TRO and/or injunction. On

the other hand, LWUA contended that there is no violation of the constitutional right of petitioners to security of tenure in the implementation of LWUA’s rationalization plan, that the injunctive relief sought is premature as no single LWUA employee has been named as affected personnel, and that the affected employees under the plan are given the option to remain in the service or avail of retirement/separation benefits.

3. On December 7, 2006, the trial court issued an Order directing the issuance of a

writ of preliminary injunction, to wit:

WHEREFORE, let a writ of preliminary injunction be issued, restraining the respondents from enforcing and effecting the assailed questioned (sic) DBM-approved Staffing Pattern dated 27 September 2006, LWUA Board Resolution No. 69 , series of 2006, and Executive Order Nos. 279, 366, and 421, including the issuance of any orders, resolutions and/or decisions relating to the same, upon the filing of a bond in the amount of one hundred thousand (P100,000.00) pesos for any damage that may be sustained by the respondents by reason of the injunction if the Court will finally decided that the petitioners are (sic) entitled thereto.

4. Later, on January 15, 2007, the Branch Clerk of Court issued a writ of preliminary

injunction directing the court sheriff to serve a copy of the writ upon the respondents and enjoining them from continuing with the acts subjects of the writ and as contained in the court order.

Appendix 2


83

5. On February 6, 2007, LWUA and DBM both moved for reconsideration of the

order of the trial court. The motions were opposed by the petitioners.

6. On June 6, 2007, the trial court issued a resolution denying the motions for reconsideration of LWUA and DBM and setting the main action for hearing on August 29, 2007 at 8:30 in the morning.

C. Assessment

1. The function of a preliminary injunction order issued by the trial court is to maintain the status quo before the controversy arose, in the meantime that the issues are being heard and resolved by the court. The issues of the case have not yet been resolved, more specifically the main issue of whether or not the proposed reorganization or rationalization is valid. The trial court in its resolution, has acknowledged that the issue of the validity of the reorganization has to be settled. It will, therefore, conduct a hearing to determine and resolve the issue.

2. For how long the case will last will depend largely on the court. It may allow

presentation of testimonial and documentary evidence by both parties which normally would take time to finish. Or it may be agreed upon during the hearing that the parties no longer present evidence and just submit their respective memorandum on the main issue of whether or not the reorganization or rationalization is valid and legal. That way the proceedings is shortened.

Another option/possibility is that the LWUA and the DBM can appeal the

preliminary injunction order of the trial court to the Court of Appeals for review on the ground of error of law and facts committed by the trial court. They can pray for the lifting of the preliminary injunction order in the meantime that the appeal is being resolved. Once the injunction is lifted, the implementation of the Executive Orders (EOs) can proceed.

4. There are two requisites for a reorganization of a government office or

corporation to be valid:

(i) There has to be a law or legal basis for the reorganization. (ii) The reorganization or abolition of office is done in good faith.

5. Based on established jurisprudence, reorganization or abolition office is a valid

ground for termination of government employment provided it be done in good faith. Hence, it is incumbent upon LWUA and DBM to stress to the court that the reorganization or rationalization is done and being implemented in good faith.

6. The four consultancy studies presently undertaken by the World Bank, namely:

(i) Integration of Water Supply Business (ii) Report on Selected Financial Issues (iii) Incentive Framework for LWUA and Water Districts (iv) Stakeholder Opinion Poll

are not affected or covered by the preliminary injunction order of the trial court. Firstly, the injunction order is specifically directed to LWUA or DBM. Secondly, they are prohibited from issuing any order, resolution or decision relating to staffing pattern, the Board Resolution No. 69, and the questioned EOs.

Appendix 2


84

7. The consultancy studies are not being done in the implementation of the staffing

pattern, Board Resolution No. 69, and the EOs pertaining to the reorganization or rationalization of LWUA as it affects the security of tenure of employees. They rather deal on the other aspect of reforms in the financing policies of LWUA.

8. While the petition seeks to nullify the EOs, the trial court in its resolution has

clearly mentioned and recognized that the issue in the case is confined to the validity of the reorganization or the violation of the petitioners’ right to security of tenure.

Submitted by:

Atty. Roberto A. Demigillo

June 28, 2007

Appendix 3


85

RECOMMENDATIONS OF PREVIOUS STUDIES ON LWUA 1. Table A3.1 below presents the various components of Executive Order (EO) 279, the degree to which they have been implemented, and why they have or have not been implemented based on the Diagnostic Study of the Water Sector.1 Table A3.2 shows the recommendations contained in other recent studies on the Local Water Utilities Administration (LWUA).

Table A3.1: Executive Order 279 and the Extent of Its Implementation Recommendation Degree of

Implementation Why and How?

Determine classification criteria

Implemented Oversight Committee established the criteria.

Classify water service providers (WSPs) according to the criteria

Partially implemented

LWUA had presented to the Oversight Committee its classifications of 347 water districts (as of July 2008) for its approval. Other WSPs (LGU-run systems, privately-run systems, etc.) have not been classified since LWUA does not have ready access to data on these WSPs.

Develop graduation plans for WSPs

Not implemented

The WD Development Department came up with a draft graduation plan, but was not approved by LWUA management since the latter asserts that there is a need for LWUA to be reorganized to provide the proper institutional framework to develop graduation plans and monitor WDs’ performance against the plans.

Cease lending to WSPs classified as creditworthy

Not implemented

No policy directive has been issued on this. LWUA lends to clients who approach it for loans for which it has funds to lend out.

Lend to WSPs classified as less than creditworthy


No policy directive has been issued on this, but LWUA is implementing initiatives to lend to less creditworthy WDs. These include: (i) Window 5 (approved in June 2008), under which LWUA

charges for loans equal to or less than P10 million with an interest rate of 7.5% to 9% for 10 to 20-year loans. This is meant to assist less creditworthy WDs and for LWUA to offer competitive rates.

(ii) Some donors require LWUA to work with less creditworthy WDs. Examples include: � A KfW program (“KFW 3”) designed for less

creditworthy WDs. � The 5-year, P100 million JBIC-funded Small Water

Districts Improvements Project, which targets marginal and non-operational WDs and provides grants of up to P5 million to small WDs for technical assistance and civil works.

(iii) The LWUA Board has streamlined procedures for approving small loans in July 2008 by increasing the ceiling on loans that need Board approval from P5 million to P10 million.

1 Castalia Strategic Advisors. March 2009. Diagnostic Study of the Water Sector in the Philippines. Report to the World Bank. Manila.

Appendix 3


86

Recommendation Degree of Implementation

Why and How?

Streamline waiver procedures


In September 2003, and as a consequence of the Stone & Webster report, LWUA and DBP entered into a memorandum of agreement (MOA) designed to facilitate DBP’s lending to creditworthy WDs, including streamlining LWUA’s waiver procedures for these loans. However, only a few loans have been finalized under this agreement.

Develop and implement a restructuring plan

Not implemented

As directed under EO 279, LWUA management developed a restructuring plan that would include staff reduction of about 25%. It is supported by attractive retirement packages for affected staff with a significant number of employees signing on. LWUA intended to borrow to pay for these packages.

However, the IRR of EO 279 states that LWUA employees who retired under the EO will not be eligible to work in the executive branch of government for 5 years after their retirement. LWUA Employees Association for Progress (LEAP) filed a court case in October 2006 against LWUA and DBM related to the implementation of EO 279. The petition sought to: (i) Annul the DBM-approved staffing pattern; EO 279, EO

3662, and EO 4213; and LWUA Board Resolution No. 69 of 2006 (Board approval of the staffing plan);

(ii) Prohibit LWUA from implementing the plan; and (iii) Compel LWUA and DBM to recognize the right of LEAP

members to security of tenure.

On December 7, 2006, the court issued a writ of preliminary injunction “restraining the respondents from enforcing and effecting the assailed DBM-approved staffing pattern dated September 27, 2006, LWUA Board Resolution No. 69 s. 2006, and EO Nos. 279, 366, and 421 including the issuance of any orders, resolutions, and/or decisions relating to the same…” This TRO was meant to preserve the status quo while the case was being heard in court. The case is still ongoing.

“Ringfence” loans made under EO 279 from other loans

Not implemented

Few loans have been made under the EO 279 framework, and legally, the implementation of EO 279 has been blocked.

DBP = Development Bank of the Philippines, EO = executive order, IRR = implementing rules and regulations, JBIC = Japan Bank for International Cooperation, KfW = Kreditanstalt für Wiederaufbau, LBP = Land Bank of the Philippines, LEAP = LWUA Employees Association for Progress, LWUA = Local Water Utilities Administration, MOA = memorandum of agreement, P = Philippine peso, TRO = temporary restraining order, WD = water district, WSP = water service provider.

2 EO 366 directs all executive branch agencies to conduct a strategic review of their operations and organization, and come up with a rationalization plan. 3 EO 421 directed the DBM-approved staffing pattern for LWUA to be implemented.

Appendix 3


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Table A3.2: Recommendations of Other LWUA Studies

Report Recommendations C. Virata and Associates. Final Report on the Study on Selected Financial Issues Related to LWUA as a Consequence of Executive Order No. 279 (Volumes I and II) submitted to the World Bank, April 2008.

(i) LWUA should accept and understand its new function. Aside from providing financing to less creditworthy water districts, LWUA should assist them to graduate and become creditworthy WDs.

(ii) LWUA should leverage its financial function with its technical capabilities. (iii) Loans should be packaged according to specific needs of WDs. Credit

analysis should be done on a case-to-case basis since different WDs have different operational situations and, therefore, different funding requirement.

(iv) LWUA should assign different lending officers to different WDs who will be in charge of credit analysis and loan packaging.

(v) LWUA should enhance its monitoring and collection system as well as its credit screening process.

(vi) LWUA should strive to reduce its operating expenses to improve its cash flows.

(vii) LWUA should reduce the gap between payments to LWUA creditors and collections from WDs.

(viii) LWUA Financier Group should adopt competitive and market-oriented financing policies; upgrade the loan evaluation process; strengthen/upgrade management and monitoring system on lending operations.

(ix) LWUA Water Development Group should strengthen/upgrade managerial/administrative capacity, technical and financial management competency and should instill corporate culture and governance values.

(x) The LWUA Water Technical Group should reduce or refrain from undertaking technical works i.e., preparation of program of works, well-drilling and bulk procurement; and upgrade the skills and technical capacity of management and staff.

(xi) The National Government should seriously consider creation of an independent economic regulatory body for water utilities.

Soriano, Ma. Cecilia, Demigillo, R. , and Cortez, M. Final Report for the Preparation of an Incentive Framework for LWUA and the Water Districts to Support the Graduation Process under Executive Order No. 279 submitted to the World Bank, December 2007.

(i) LWUA should report to the Oversight Committee activities undertaken to implement EO 279 to give progress report on updating and completing the classification of WDs.

(ii) LWUA should present to the Oversight Committee its medium-term program for capital expenditure and cash flow projections and defend request for subsidies and pass-on subsidies from the 2009 national government budget to deserving WDs.

(iii) LWUA should keep ongoing projects on track to build donor confidence, look for other more concessional loans and grants, and finalize agreements with donors to finance proposed projects.

(iv) LWUA should initiate discussions with private financing institutions (PFIs) on tapping PFI funds in the medium term and on possible modalities to tap private capital through PFIs and enter into loans, securitization or other agreements with PFIs.

(v) LWUA should prepare and present to the Oversight Committee a long-term strategic plan, and propose amendments as appropriate to draft bills, particularly on the levels of authorized capital and limits on foreign and domestic borrowings.

(vi) LWUA should review all its accounts receivables, finalize repayment schedules, take over or take to court those that cannot pay, and enforce all repayment/restructuring agreements and take necessary recourse against those who fail to comply.

(vii) LWUA should conduct workshops and focus group discussions with less creditworthy WDs that have borrowing potential, and set up mechanisms to minimize risk that prospective borrowers back out from undertaking a project.

(viii) LWUA should use existing personnel to achieve the reform objectives of

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Report Recommendations

EO 279 and consider the interim organizational structure. (ix) LWUA should continue to report ongoing efforts of the USAID Philippine

Water Reform Fund Support Program and to explore possible arrangements to co-finance with and provide project technical assistance to PFIs interested in lending to WDs.

(x) LWUA should task its area managers under modified EO 286 − Organ-izational Structure – to link up with LGUs and develop a closer relationship with them.

Local Government Support for Regional Water Supply Project. Development of a Program for the Capacity Building of LWUA and Water Districts (Component B) submitted to the World Bank, February 2009.

(i) LWUA should look into the roster of non-operating WDs and look for integration possibilities in areas where water is scarce, and to provide financial assistance as a prerequisite to the integration process.

(ii) LWUA should undertake periodic reviews of its interest rates for its main lending window to ensure that these are competitive or on a par with prevailing interest rates of other institutions.

(iii) LWUA should update the framework for monitoring WDs to include indicators of water supply coverage, customer satisfaction, quality of service, sanitation, etc.

(iv) LWUA should adopt regulatory reforms that signal serious intention to promote good performance.

(v) LWUA should put in place a system for maintaining a revolving fund from loan principal collections and stop the utilization of such funds other than for loan assistance to WDs.

(vi) LWUA should intensify efforts to lobby for the enactment of the increase in its capitalization.

Soriano, Ma. Cecilia. Policy Issue Paper on Credit, Financing and Investments in the Water Supply Sector (Annex 3), Philippine Water Supply Sector Roadmap.

(i) LWUA should update the categorization of WDs and make this available to interested parties, including government financing institutions and PFIs.

(ii) LWUA should organize training courses, study tours, and mentoring programs for WD key officials and staff to train them in good governance, business planning, etc., with support from USAID, JBIC, and other donors.

(iii) LWUA should provide WDs access to a project preparation fund that can help finance feasibility and engineering studies with a training and technology transfer component.

(iv) LWUA should streamline waiver procedures and refrain from offering loans for water supply projects to WDs that could access private capital except as co-financier.

(v) LWUA should encourage WDs to undertake sewerage projects by offering them long-term loans with use of long-term ODA funds.

(vi) LWUA should simplify its loan products, terms, conditions, and proced-ures and offer more competitive rates.

(vii) LWUA should offer LGUs fee-based technical assistance in operating and

maintaining water supply facilities. (viii) LWUA should set up a specialized group to set up standards for corporate

water service providers, excluding WDs and those regulated by contract, and to offer technical assistance, institutional advice, and training programs for a fee.

EO = executive order, JBIC = Japan Bank for International Cooperation, LGU = local government unit, LWUA = Local Water Utilities Administration, ODA = Official Development Assistance, PFI = private financing institution, USAID = United States Agency for International Development, WD = water district.

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LWUA RELENDING RATES

A. Revised Relending Rates (2009)

1. The Local Water Utilities Administration (LWUA) Board of Directors has recently approved Board Resolution No. 38, revising relending terms to water districts (WDs). The revised terms essentially reduce the relending rates and make them more competitive with the current market rates. The revision is also expected to result in the following: (i) the lower interest will limit future WD water rate increases, (ii) loan refinancing will no longer be attractive to WDs, and (iii) the floating amortization will be more affordable to WDs. Table A4.1 compares the revised terms with the previous terms.1

Table A4.1: Comparison Between Previous and Revised Relending Rate Policies

Item Previous Policy Revised Policy

Cumulative Loan Granted


Loan Repayment

Period


Indicative Interest

Rate





Feature of Interest Fixed Repricing as necessary. LWUA proposed to lend to WDs at a fixed rate but said rate will be adjusted periodically to the Philippine Dealing System treasury reference rates









B. Revised Relending Rates

1. Objectives

2. The revised relending policy has significantly made the terms more competitive with the market. The average interest rate based on the previous policy was around 11.6%2 compared with 9.675% in the revised policy.3 The LWUA rates are now lower than the terms of government financing institutions, private financing institutions, and even the Philippine

1 Supporting memo from the Administrator, LWUA Board Resolution No. 38, March 2009. 2 Estimated based on the ratio of Interest Income over WD Accounts Receivables and Long-term Receivables

balance in 2008. 3 Supporting memo from the Administrator, LWUA Board Resolution 38, March 2009.

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Water Revolving Fund. The LWUA rates are higher by less than 1% compared with that of the Land Bank of the Philippines, but this is compensated by a longer 40-year repayment period (Table A2.1). 3. The revision also relaxed the terms and made borrowing much easier for the water districts. First, the repayment period has been extended from 25 years to a maximum 40 years. Secondly, instead of a fixed periodic payment, repayment terms were made more flexible depending on the WD’s capability. Thirdly, revised interest rates at from 9.2% to 10.2% are now more affordable compared with the previous from 8.5% to 15%. 4. It is likewise expected that the policy will discourage refinancing of future loans. However, the previous loans of WDs still carry the old loan terms which are higher than that in the market.

2. Likely Repayment Period

5. For purposes of determining LWUA’s projected performance, assumptions need to be made regarding the most likely terms for WDs. Looking at Table A4.1, it appears that the 40-year repayment term with the highest interest rate at 10.2% will not significantly ease the debt servicing of WDs. For a P1 million loan, the annual amortization will only decrease by 17% with the extension of the repayment terms from 30 years to 40 years. It is, therefore, safe to conclude that WDs would likely opt for a 30-year loan at 9.8% interest rate per annum. An illustrative example of annual amortization based on repayment period is shown in Table A4.2.

Table A4.2: Illustrative Example of Annual Amortization Based on Repayment Period

Repayment Period

Amortization for every P1 million Loan (P)

Decrease in Annual Amortization

10 years

157,194.50

20 years 113,476.70 27.81%

30 years 104,313.50 8.07%

40 years 104,139.70 0.17%

3. Comparative Relending Rates

6. The LWUA Loans Administration Department has prepared draft guidelines for the implementation of the relending rates. The draft guidelines are pending approval with LWUA management. The Project Preparation Technical Assistance (PPTA) reports assume (i) continuation of the LWUA practice providing a grace period of 5 years, including about 2 years construction period, and (ii) capitalization of interest whenever needed by the WD. Table A4.3 presents the various loan financing available to WDs and their respective lending terms.

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Table A4.3: Loan Financing Available to Water Districts

Items

LWUA

LBP

DBP

MDFO

PWRF a

Repayment Period

40 years (maximum) 10 years (maximum)

15 years (maximum)

15 years 10 years

Grace Period 3 years 2 years (maximum)

3 years (maximum)

3 years 3 years (maximum)

Capitalized Interest

Yes, depending on WD’s capability

No No No

Interest Rate (per annum)

Loan Repayment

Period

Interest Rate

Prevailing market rate

Current average = 9.5%

9% to 11%

Current average = 10.5%

7% fixed (specific for water supply projects)

Blended interest rate (DBP and PFI)

75-25 ratio = 10.44%

50-50 ratio = 11.13%

First 10 years

9.2%

>10-20 years

9.5%

>20-30 years

9.8%

>30-40 years

10.2%

Average = 9.675%

Repricing LWUA proposes to lend at a fixed rate to be adjusted periodically based on Philippine Dealing System treasury reference rates

Quarterly Interest during loan signing remains fixed.

Periodic Amortization

Floating amortization based on WD’s financial capacity

Monthly payments of principal and interest

Monthly payments of principal and interest

Quarterly payments of principal and interest

Other Fees/ Charges

Processing Fee

½ of 1% of approved loan amount

1% of loan amount

Negotiable 0.5% of total approved loan amount

Front-end Fee 1% if loan => P20 million;

0.5% if loan < P20 million

Commitment Fee

1% of loan amount

.25% of unreleased loan amount

0.1% pa of undisbursed amount to start from date of NTP to date of loan disbursement

Documentary Stamp

Based on loan release

On the account of borrower

Gross Receipt Tax

5% of interest billing

1% of loan amount

On the account of borrower

Other Requirements/ Remarks

Application submitted to Regional Lending Center covering the

Minimum average daily balance of WD deposit to DBP is required.

MDFO loans are only available to LGUs. The LGU may borrow for the WD through a

Maintenance of average daily balance on deposit of not lower than 3%of

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Items

LWUA

LBP

DBP

MDFO

PWRF a

area. Terms are negotiable depending on creditworthy-ness of WD.

Additional 1% is added to amortization if ADB is not maintained.

MOA between LGU and WD.

outstanding principal balance

ADB = Asian Development Bank, DBP = Development Bank of the Philippines, FOREX = foreign exchange, GOP = Government of the Philippines, LBP = Land Bank of the Philippines, LGU = local government unit, LWUA = Local Water Utilities Administration, MDFO = Municipal Development Fund Office, MOA = memorandum of agreement, NTP = notice to proceed, pa = per annum, PFI = private financing institution, PWRF = Philippine Water Revolving Fund, WD = water district. a Indicative based on Subicwater Loan Case. C. LWUA Spread

1. Calculation of Relending Rate

7. LWUA Board Resolution No. 38 shows the calculation of the relending rate, as follows (Table A4.4):

Table A4.4: Computation of Base Relending Rate

LWUA = Local Water Utilities Administration, PDST =Philippine Dealing System Treasury.

a Philippine Dealing System Treasury reference rate for the given tenor of 10 years posted on a particular date.

2. Estimates of Cost of Lending

8. Table A4.5 shows LWUA’s estimated lending cost culled from LWUA’s own computation. This, however, uses only the operating cost (and excludes net income) in the calculation of LWUA’s operating requirement. The table also compares loan collection efficiency at 75% and 92%.

Items Relending Rate

PDST for 10 yearsa

7.91%

Add LWUA Fixed Increment Prime Rate 1.29%

Repriced Interest Rate 9.20%

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Table A4.5: Estimated Cost of Lending

Items

For Existing Lo ans

Indicative Cost of Lending of

ADB Loan

Collection Efficiency at 92% a

Collection Efficiency at 75% b

Blended Cost of Capitalc 2.88 2.88 2.11

Cost of Capital to Cover Time Lagc 0.65 0.65 0.65

Cost of FOREX Fluctuationd 0.45 0.45

LWUA Operating Requiremente 0.14 0.17 0.17

Total 4.12 4.15 2.93

ADB = Asian Development Bank, FOREX = foreign exchange, LWUA = Local Water Utilities Administration. a As used in the LWUA study. b Assumed minimum level of loan collection efficiency. c Source: Supporting memorandum from the Administrator, Board Resolution 38, March 2009. d No cost of FOREX fluctuation for ADB; FOREX cost passed on to water districts. e Recalculated operating requirement (P):

Operating Requirements 833,038,952 Non-operating Requirements 915,109,824 Total 1,748,148,776

Collection Efficiency 92% 75% Outstanding loans receivable 12,479,445,233 10,173,460,788 Ratio of LWUA operating requirement/outstanding loans 0.14 0.17

9. Even using the conservative collection efficiency of 75%, the estimated lending cost of 4.15% gives LWUA a spread of roughly 5.05% out of the minimum revised relending rate of 9.2%.

D. Impact of Revised Relending Rate on the ADB WDDSP Loan

1. Indicative Matching of LWUA and WD Amortizations

10. Even assuming that most water districts will opt for a 30-year repayment period, there is still an apparent mismatch of the ADB and LWUA repayment terms. Table A4.6 illustrates the annual amortization of LWUA and WDs. The table shows that at the most likely repayment period of 30 years, LWUA only has to achieve a collection efficiency of 59% from its loan to WDs to fully cover the amortization due to ADB.

2. Projected Cash Flows

11. The table does not show the effect of timing considering that there will be some years when LWUA will need to start amortizing loans of WDs, during which time WDs are not yet due to pay their loans to LWUA. However, this will be considered in the cash flow projections shown in this report.

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Table A4.6: Loan Terms of ADB to LWUA and LWUA to WD

A. Loan Terms

ADB Loan to LWUA LWUA Loan to WDs

Repayment Period Interest Rate Repayment Period Interest Rate

25 years 2.93% a 10 years 9.2%

20 years 9.5%

30 years 9.8%

40 years 10.2%

B. Estimated Annual Amortization

Items Repayment Period

10-year 20-year 30-year 40-year

Annual Amortization of ADB loan to LWUA (US$) b

3,469,099.43 3,469,099.43 3,469,099.43 3,469,099.43

Annual Amortization of LWUA loan to WDs (US$)c

8,802,892.06 6,354,694.93 5,841,556.11 5,831,823.10

Minimum Collection Efficiency (%) 39.41 54.59 59.39 59.49

Water District Amortization for a P1 million loan (P)

157,194.50 113,476.70 104,313.50 104,139.70

ADB = Asian Development Bank, LWUA = Local Water Utilities Administration, P = Philippine peso, US$ = United States dollar, WD = water district. a Estimated cost of lending as presented in Table A4.5. b ADB loan to LWUA is estimated at US$50 million. c Total LWUA loan to WDs is estimated at US$56 million assuming that the ADB loan is 90% of total project cost.

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REPORT ON LWUA BANK ACQUISITION

PAGE EXECUTIVE SUMMARY 96 I. BACKGROUND 101

II. RATIONALE 102

III. ABOUT THE ACQUISITION 102

IV. STATUS OF THE NEWLY ACQUIRED EXPRESS SAVINGS BANK (ESB) 103

V. IMPLICATIONS AND NEED FOR AN INTERIM STRATEGY FOR THE BANK 105

VI. MAJOR CONCERNS FOR THE FORMULATION OF AN INTEGRATION 108 STRATEGY AND BUSINESS PLAN

VII. COMMENTS AND ISSUES 111

VIII. FINANCIAL PROJECTIONS 112

IX. RISK ASSESSMENT/MITIGATING MEASURES 116

ANNEXES Annex 1: Comparative Audited Financial Statements (2007-2008) 118

a. Statement of Condition b. Statement of Income c. Statement of changes in capital Deficiency d. Statement of Cash Flows

Annex 2: Organizational Chart 123 a. Proposed Organizational Chart of ESB as of June 1, 2009

Annex 3: Financial Management Assessment Report 124 Annex 4: Central Bank Memorandum for Bank Branches 133 Annex 5: Financial Projections - Feasibility Study 145

a. Income Statement b. Statement of Condition c. Cash Flow Statement

Annex 6: Key Assumptions – Financial Projections 149 Annex 7: Implications of Water Energy Development Bank of LWUA 153 Annex 8: Base Scenario Projections 152

a. Base Case - Income Statement b. Base Case - Statement of Condition c. Base Case – Cash Flow

Annex 9: Optimistic 157 a. Optimistic Case - Income Statement b. Optimistic Case - Statement of Condition c. Optimistic Case - Cash Flow Statement

Annex 10: Comparative Results of Feasibility Base and Optimistic Scenario 161

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EXECUTIVE SUMMARY

A. LWUA Acquisition of Express Savings Bank

1. During the first half of 2009, based on LWUA Board Resolutions 56,120,129A, 129 B, and 183 series of 2009 LWUA purchased controlling interest (60%) in the Express Savings Bank (ESB), a thrift bank operating its head office in Cabuyao, Laguna, with branches in three other locations in Laguna, Binan, Sta. Rosa, and Calamba. The prime movers of this initiative expect that the Bank will eventually provide a partial solution to one of the major problems of LWUA, that of fund sourcing for the financing of its various development projects. In fact, the draft LWUA Assessment Report76 confirmed that the decline in project disbursements has been noted in recent years and this has led to reduction in revenues. LWUA is currently taking aggressive action to secure funds from DOH, DPWH, and DBM. At the same time, it is following very closely the approval of the bill increasing capitalization and borrowing capacity of LWUA. The Acquisiton of ESB is part of LWUA’s strategy secure fund sources for its projects.

2. Details of the acquisition are as follows:

• Shares Purchased represents 60% of the outstanding stock of ESB which was founded in 1981

• Purchase Price P80.0 million paid to Wellex Group, which is owned and controlled by the family of William Gatchalian, whose main businesses are involved in the manufacture and sale of a wide range of plastic products.

• Purchase Price Determination was most probably a negotiated figure based on the offer of the original owners to sell controlling interest in ESB since its equity and liquidation values were already known to be negative during the negotiations.77

• Adjusted ownership structure of ESB following the acquisition is 60% LWUA, 24% Wellex Group, and 16% Founding Investors.

3. The ESB has since been referred to as the Water and Energy Bank (WE Bank) since

the envisioned target markets for deposits and loans, are the water and energy sectors. Initially several issues currently hamper normal operations of the bank. First, in the absence of the required Monetary Board approval, legal formalities such as the change in ownership cannot be affected. Second, the negative equity status of the bank prevents it from booking new loans since its Single Borrowers Limit (SBL), which is a percentage of capital, is theoretically negative. In addition to this, the banks insolvency (liabilities exceed assets), disqualifies it from access to emergency liquidity windows of the Central Bank designed to assist banks in coping with unusual spikes in deposit withdrawals and other such cash needs. More importantly, LWUA has yet to develop the strategy and plan to operate the bank according to its conceptual “mission-vision”. The financial deficiencies have since been substantially addressed as follows:

• In September 2009, LWUA released another P400 million for the Bank, representing the following probable approximate allocation; (i) P36 million to offset the negative capital, (ii) P20 million to provide for cash operating requirements for the remaining 9 months in 2009 while the bank was being rehabilitated at P1.6 million per month, (iii) P10 million to provide coverage of DOSRI loans, and (iv)

76 Draft Final Report on Institutional and Financial Assessment of Local Water Utilities Administration, Water Development Sector Project, PPTA: 7122 – PHI, May 2009. 77 The Audit Report shows that ESB has a capital deficiency of P36 million as of March 31, 2009.

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97

the balance of P325 million to cover the minimum capitalization requirements to move the bank headquarters to Manila.

• Theoretically, if the ownership ceiling for LWUA of 60% is to be maintained, 40% of the P400 million capital increase, or P160 million, should be shouldered by the minority shareholders and reimbursed to LWUA. If this does not happen, then LWUA will be in violation of the imposed ownership ceiling With this cash infusion, all deficiencies will be corrected, and what remains to be done are the formulation of both the interim and long term strategies, simultaneous with the accompanying detailed business plan for the implementation of these strategies.

• In October 2009, LWUA released another PhP 300 Million for the WE Bank. • Approval of the Monetary Board is still pending but LWUA has reportedly received

approval of the Office of the President for the acquisition transaction. LWUA’s request for approval has reportedly been included for consideration in the agenda of the Monetary Board.

4. Major issues that need to be resolved are: LWUA still needs to get the official approval of the Monetary Board. 60% ownership issue - The ownership ceiling of 60% by any single entity in a non-GFI bank, was communicated in writing to LWUA by the Central Bank, as early as when consultations were being made by LWUA on the establishment of a Water Bank. LWUA needs to invest serious effort in establishing a detailed strategy for this bank and come up with a Business Plan that will indentify and recognize key issues that will define its integration into LWUA’s own strategies and business plan. The probable benefits of this careful planning, are the efficient management of the bank, and the eventual optimization of its synergies with LWUA. The dearth of data on such strategies/business plan made it necessary for the consultants to make too many major assumptions in coming out with some sort of projection of the future results of the operations of the WE Bank and its impact on LWUA’s operations.

B. Financial Projections

1. Assumptions a. Feasibility Study Projections. The financial projections prepared, were derived

from a feasibility study (FS) prepared for LWUA as part of the due diligence conducted prior to the acquisition of ESB. In preparing the projections, two scenarios were prepared, namely:

b. Base Scenario projections. The FS projections were used as the primary basis

for the Base Scenario projections with the following major adjustments

• The Base Case assumed an upfront capital infusion of P700 million from all shareholders. The resulting capital base was 27% of the projected year-end 2009 capital base. The FS base year asset and liability figures were then scaled down to 27% of the projected levels. Loans and deposits were then projected forward using similar year-on-year growth assumptions to the FS for a few years, then a lower growth rate more in line with the 10% experienced by the sector.

• Projected income is much lower for three reasons: • The smaller base of interest earning assets,

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98

• Past due loans equal to 5% of current loans from day one (compared with zero until year-end 2015 for the FS) which results in an additional bad debt expense,

• Profitability was adjusted to reflect the Philippine commercial banking sector’s average cost-to-income ratio.

c. Better Scenario . The better scenario was prepared with the following

assumptions:

• The same year-end 2009 starting point as the Base Case scenario was used. • Growth was assumed to be much higher (the objective was for the bank to

achieve loans and deposits equal to roughly half of the FS levels by 2018). Given that the starting is 27% of the FS levels, the actual growth percentages are indeed very high and assume early and steady penetration in their targeted sectors of water and energy.

• Profitability was also assumed to be slightly better. A cost to income ratio of 60.69% was used, which is the lowest commercial bank sector average experienced in the past year.

• Again no specific branch expansion plans (and the resulting regulatory capital requirements) were taken into account in these capital calculations

• At best, the projections will simply reflect a scaled down version of the feasibility study, using a much more conservative/realistic profitability ratios. They are not based on any assumed operating structure, and hence do not consider any specific cost, income and expense aspects directly associated with any particular assumed operating structure.

2. Results of the Projections

• The detailed results of the financial projections for the WE Bank can be

summarized as follows in Table 1 .

Table A5.1. Comparison of Results Under the Base Scenario and Better Scenario

See the details of comparison between FS projections, base and optimistic scenario in Annex 10 .

Base Scenario Better Scenario Profitability -Net Income in 2010 (P m) -Net Income 2011 to 2018 (range in Pm)

PhP 29.7m PhP 37.8m to Php 100.7m

PhP 27.3m PhP 41.1m to PhP 338.4m

Cost to Income 69.57% 65.92% Net Interest Margin 5.85% to 6.60% 4.80% to 6.60% Cash -Ending Cash in 2010 (Pm) -Ending Cash 2011 to 2018 (range in Pm)

PhP 96.6m PhP 147.0m to PhP 393.4m

PhP103.4m PhP 102.0m to PhP 308.9m

Past Due Loans 5% to 10% 5% to 10% Capital Adequacy (rough) 18% to 38% 10% to 38%

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99

C. Implication on LWUA

1. The implications of the above set of projections on LWUA, is shown in Table 2 using two possible scenarios of how the WE Bank will impact upon LWUA operations, namely:

• Scenario One – Without Bank. This scenario is based on the assumption that

LWUA will not operate the bank and all previous investments will be written off. • Scenario Two – With Bank. This assumed continued operation of the bank.

Table A5.2. Comparison of With and Without Bank Scenarios

Without Bank With Bank (operated a a

thrift bank) Investment P780 million investment

written off over 10 years P780 million cash payments in 2009 comprising: -P80 million paid to owners and P 420 million (60% of P700 million additional investment as LWUA investment in subsidiaries) released in September and October -P280 million (40% of P700 million assuming LWUA funds minority stockholders, as due from minority stockholders) -Future Capital contributions to the bank is unprofitable etc.





D. Risk Assessment/Mitigating Measures

Implication of the WE Bank on LWUA’s position to pay the WDDSP Loan stems from two sources namely (i) LWUA’s exposure to the WE Bank and (ii) risk that loan funds and Water District collections are diverted to other purposes including financing the WE Bank.

1. LWUA exposure to WE Bank • Risks can be generally classified as “investment risks”, and “operating risks”. • The investment risk is associated with the extent of investment of LWUA in this

bank, whether it is in the form of equity investment or any other form of exposure. So far LWUA has paid out cash of P780 million for the WE Bank. This is the extent of its investment risk.

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100

• The “operating risks” are not as limited as investment risks, as these include all risks associated with the asset and liability management of the bank.

• Under the base scenario projections for the WE Bank, it is estimated that the bank will generate net income starting 2010. However there are other contingent liabilities in operating the WE Bank. For example, in eventual negotiations with other banks for inter-bank credit lines for the Water and Energy Bank (WEB), LWUA will probably be asked for its guarantees to secure these facilities.

2. Fund Management

It is probable that LWUA sourced the funds for investment into WEB, from its “pool” of funds, which at this point is composed of funds from collections and credit facilities from creditors. Unless there is an immediate plan to re-capitalize it. Future capital or fund injections into WEB, if any, will probably be sourced similarly.

E. Risk Minimization/ Mitigating Measures

a. LWUA should resolve outstanding issues as follows:

• LWUA to get official approval of the Monetary Board • the pro-forma ownership structure of WEB must be made to comply with the


b. LWUA needs to establish a) a clearer definition of this “mission-vision”, b) a well

thought out strategy and c)a comprehensive business plan for WEB

c. LWUAs creditors usually take steps to control the disbursements of their loans, such that these are channeled to the intended recipients. LWUA can also take steps to ring fence, water district loan payments such that the amounts available for debt service is known and managed so that LWUA can take timely action to avoid default.

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I. BACKGROUND

By definition of its charter, LWUA is a specialized lending institution created primarily for the purpose of promoting, developing, and financing local water utilities. As a Government owned and controlled corporation or GOCC, its financing activities (borrowing and lending) are monitored by the Department of Finance (DOF), and the Commission on Audit (COA). LWUA is capitalized at P2.5 billion, and its domestic borrowing capacity is capped at P1.0 billion. LWUA is authorized to source funds through foreign borrowings, and may do so to the maximum extent of US$500 million. As of 2008, LWUA’s outstanding debt was at the US$200 million level, while its domestic borrowing ceiling was reached prior to the year 2000. Aside from its own capital, LWUA is funded primarily by loans from Government Financial Institutions (GFIs), Multilateral Development Funding Agencies, and Bilateral Agencies. It is also authorized to act as a depository of excess/reserve funds of water utilities. On the initiative of LWUA Chairman, Prospero Pichay, the idea of creating a “Water Development Bank”(WDB) was moved forward during the last quarter of 2008. Initial inquiries on the legalities were made with the Department of Justice, more specifically, the Office of the Government Corporate Counsel. In a written opinion from said office in October 2008, LWUA was advised that the set-up and operation of a Water Development Bank would be legal and allowable within its charter. Within the same communication however, LWUA was advised that any proposal regarding the same would be subject to review by the Department of Finance (DOF), and the approval of the President of the Philippines. They were likewise advised that the operation of said entity would be regulated under the banking laws, as monitored and implemented by the Bangko Sentral ng Pilipinas or BSP. After consultations regarding the legality of doing this under the LWUA framework, Chairman Pichay likewise solicited the support of the Office of the President for this project, simultaneously seeking approval/endorsement from the Department of Finance. In its response to LWUA, dated November 28, 2009, the DOF enumerated certain pre-requisites in moving consideration of the proposal further. These pre-requisites included the submission by LWUA to the DOF, of its Board Resolution approving the creation of the proposed WDB, a Feasibility Study concerning the same, a detailed Written Rationale for creating the WDB, Projected Financial Statements of LWUA and the proposed WDB for the years 2009-2018, and the Proposed Business Plan of the WDB for the years 2009-2018. Director IV of the Office of the President in turn, indorsed the proposal of LWUA to the BSP for comment and recommendation in November 2008. In its response to said endorsement in January 2009, LWUA was advised by BSP to switch track in pursuing this concept, due to the ongoing BSP policy, establishing a moratorium on the issuance of “new” banking licenses. In the communications exchange, BSP suggested the alternative of acquiring instead an existing Finance Company which could subsequently apply for a “Quasi-Banking” license from the BSP.

In April 2009, the BSP responded to a letter from Chairman Pichay, signifying LWUAs intention to acquire a bank instead of establishing one, in view of the moratorium on the establishment of new banks. In this communication, the BSP affirmed that LWUA was well within its charter to invest into shares of stock of banks and non-banks, but advised that the ownership ceiling in this case would be 60% of the bank’s outstanding stock. This opened an issue of who would hold the remaining 40%. In the same letter, The BSP reiterated that such an acquisition was subject to the review of the DOF and approval by the President of the Philippines. The BSP also stated that “Prior Monetary Board Approval” would be required for “any transaction involving a change in majority ownership or control of the voting stock of the bank from one group of persons to another”

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Following these, LWUA has gone on to purchase the Express Savings Bank (ESB), a thrift bank with its head office and three branches located in Laguna. The decision to acquire this bank was partially a function of a comparative analysis between ESB and another “thrift” bank.

II. RATIONALE

From various written communication, documents, and verbal interviews on this subject, the rationale and/or business strategy for LWUAs acquisition of a bank as a majority owned subsidiary revolves around its concept of “operating a Water Development Bank”. Later on the strategy was adjusted to include electric power distribution utilities, thus coining the name Water and Energy Bank, or WEB. In general, the move in acquiring such an entity is envisioned to “enhance the capacity of LWUA in the performance of its mandate”. Expanding this trend of thought, LWUA believes that the ownership of a banking license is not only complimentary to its banking functions, but will expand and enhance its capabilities in terms of affording it added flexibility in sourcing or generating funds for its lending operations. Presumably, LWUA also believes that the banking license will enable it to be more dynamic in doing treasury operations, or funds management.

More specifically, the business strategy of LWUA, is to operate a Water and Energy Bank with its Head Office located in Metro Manila. The primary purpose of the bank is defined to be “to utilize/manage LWUAs excess/idle funds and the reserve funds of water districts, to generate additional income by offering loan services to local water districts and other water utilities, and eventually expand its activities into the power sector”. Understandably, LWUA claims a definite edge in lending to the water sector because of its extensive experience in financing this sector. Adding to this of course, LWUAs technical and management competence translates to its ability to take over and manage water districts or utilities in the event of non-performance in loan repayments. LWUA also believes that the banking license will expand its fund generation capability as this will enable the solicitation of various types of deposits from the water districts and the general public.

III. ABOUT THE ACQUISITON

1. The Transaction: a. Shares Purchased represents 60% of the outstanding stock of Express Savings

Bank (ESB). All of the shares purchased, belonged to the Wellex Group, which is controlled by the family of William Gatchalian, whose primary business is the manufacture and distribution of a wide variety of plastic products. Previous to the transaction, the Wellex group controlled 84% of the bank. They therefore still retain 24%. The remaining 16% is owned by a group of small investors affiliated with the original owner and founder of the bank.

b. Purchase Price for 60% of ESB, was negotiated at the price of P80.0 million. The initial offer price was P100.0 million, but this was negotiated downwards based on the banks DOSRI accounts outstanding at the time of acquisition.

c. Payment Terms involved a downpayment of P40.0 million, and the balance was paid upon completion of the documentation of sale.

d. Pending Matters have mainly to do with the major formalities which are pre-requisite to the actual transfer of ownership and controlling interest in ESB. Foremost among these, is the formal approval of the Monetary Board and BSP. LWUA has reportedly complied with the submission of documents requested by the BSP regarding this transaction.

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2. The Selection Process: a. The shortlist in the selection process, involved two banks, ESB and another thrift

bank, the Inter-Asia Development Bank (IADB). The latter is a “one office” operation based in Tagaytay City.

b. The Criteria used in comparing the two banks zeroed in to the comparative resources, liabilities, equity, net income, gross income, expense profile, and the capital adequacy ratio. IADB was better in most of the financial benchmarks due to the fact that it was operating on positive capital, while ESB was, and is on a negative capital base. In terms however of gross and net incomes relative to total assets, ESB was better because of its larger asset base. The capital adequacy ratio (CAR) analysis was not really a heavily weighted criterion here, as ESB was already known to be capital negative since the beginning of the selection process.

c. The Final Selection Criteria focused on the comparative goodwill of the candidates, and presumably, the price. Being in a more distressed position, and having the larger balance sheet, ESB apparently was considered the better buy. Aside from that, ESB was the only one to come out with a formal offer to sell its majority/controlling stake. It is impossible to make a value judgment of price justification based on a comparative analysis, due to the obvious absence of a comparative offer. It is likewise difficult to justify the negotiated price based on ESB’s balance sheet, as this was clearly a distressed one from the start. The acceptability of the negotiated price from LWUAs viewpoint, was apparently based on its perception of the “going value of a bank license”, in view of the fact that no new licenses are being granted by the BSP. LWUAs investment analysis, however, should consider the development costs involved in remolding this bank according to its intended role and function. The “goodwill” value that it may have carried during the time of its previous owners, will probably be reduced to insignificant levels given the transformation that the bank will probably be made to undergo.

IV. STATUS OF THE NEWLY ACQUIRED EXPRESS SAVINGS BANK (ESB)

The status of ESB is established mostly per the Acquisition/Due Diligence Audit done by J.U. Pontiveros & Associates CPAs. The audit was conducted between May 6-16,2009 using a cut-off date of March 31, 2009 for the data used in said audit. Said audit was carried out at the request of LWUA, and the salient findings of the audit team, were as follows:

1. Financial Condition

• ESB is insolvent. Total Liabilities exceed Total Assets by P34,386,606. • ESB Capital accounts show a negative balance of P34,388,000., largely a result

of operating losses over the past five (5) years. • The ratio of Liquid Assets to Deposit Liabilities is 28.3%, still slightly higher than

the industry average of 17.5%. Total Deposit Liabilities stood at P199,467,645., with the total number of depositors standing at around 5,000.

• Significant levels of foreclosed/acquired assets translate directly to the very high “Non-Performing Assets” ratio of 20.6%, versus an industry average of 9.5%.

• Gross Loans stood at approximately P71,000,000. Of this amount, almost 30% was classified as DOSRI or loans to related parties (owners).

• The bank does not own any of the properties where their offices are located. These are all leased from different owners.

• To minimize labor liabilities, all of the bank employees were terminated, given separation pay, and then re-hired in 2007.

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2. Others

• The day to day administration of the bank seemed to be in order. • The bank’s failure was attributed specifically to the excessive dealings with its

former owners on terms unfavorable to the bank, rather than as a result of the incompetence of its management and people.

• Deposit levels over the period 2005-2008 remained fairly constant. This may indicate that the deposit base is not dominated by a few big accounts, and that there is a fair amount of depositor loyalty in the areas where the bank presently locates its offices. The average annual growth for deposits was 8.5%. The deposit base is composed of approximately 5,000 depositors/deposit accounts for an average of P40,000./account.

• Based on the opinion of the Audit team, the Liquidation Value of ESB is negative at this point.

• Comparative Audited Financial Statements of ESB for the years 2007-2008 are presented as ANNEX 1

3. General Information

• ESB is a savings or thrift bank operating four offices, a head office and three branches. The bank was established in February 1980, about 29 years ago.

• The head office of ESB is located in Cabuyao, while its other branches are likewise located within the province of Laguna, in Sta. Rosa, Binan, and Calamba. The special authorities granted to it by the BSP are limited to the authority to accept demand deposits, savings deposits and time deposits. It has no quasi-banking license, and is therefore not allowed to accept “deposit substitutes”.

• ESB was formerly majority owned by the Wellex Group Inc, which is controlled by the Gatchalian family, whose main business is the manufacture and distribution of plastics. The Wellex (Gathcalian) Group previously controlled 85.4% of the bank. The remaining 14.6% was owned by the original incorporators, or founders of the bank. The Founding Group was apparently composed of a group of small investors from Cabuyao, Laguna.

• Strategic direction and supervision was previously carried out by a 9 member Board of Directors.

4. Recent History/Background of Express Savings Bank

• Upon acquisition of ESB by LWUA, the president of the bank was Mr.Ferlan Balbido, who joined the bank as president in 2006. Following said acquisition, Mr. Balbido was asked to report to the LWUA headquarters and hold office there at least three times a week. According to Mr. Balbido, most of the work done by him at LWUA, in terms of the bank’s integration into LWUA, had to do with aligning the bank’s loan documentation to the current documentation being used by LWUA for its lending operations. Mr Balbido was also instrumental in providing some insight and information on the past operations and activities of ESB. He has since then resigned from the bank.

• Past Strengths of ESB- The bank was originally founded and incorporated in 1980 by investors from the Cabuyao, Laguna area. The willingness and desire of clients to place deposits with the bank, were primarily based on the familiarity of the local community with the owners. Rightly or wrongly, this is a value/criteria widely used especially by provincial Filipinos in choosing the bank with which they want to do business. The lending business of the bank was apparently confined to Cabuyao,

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and eventually the nearby towns of Sta. Rosa and Calamba, although the latter are both bigger in terms of population, than Cabuyao. Presumably, familiarity of the bank management with the business community within its immediate proximity, was perceived as a positive edge in building the bank’s loan portfolio. Under the stewardship of Mr. Balbido, starting in 2006, the bank embarked on several deposit taking innovations to build up its deposit base. This specifically involved the offering of special deposit products catering to the needs of a wider base of clientele.

• Past Weaknesses- Evidently, the past weaknesses of ESB were in their lending activities. Upon the entry of Mr. Balbido in 2006, the bank’s capital was already negative, as the capital base had already been eroded by previous year’s losses. The apparent cause of this was bad or non-performing loans, which partially explains the extremely high percentage of ROPA (Real Properties Owned or Acquired) in the banks balance sheets as of March 2009. ROPA, as of that date stood at 41.7% of the banks total loan portfolio. However, the total assets classified under “Non-Performing Assets”, stood at just over 50% of the total loan portfolio. In February, 2007, the bank was placed under “Prompt Corrective Action” status by the Monetary Board, per its Resolution No.162. Since then, the former owners started urgently seeking potential investors who they could sell out to, and had the necessary financial muscle to carry out the necessary corrective measures in the bank.

• Deposits/Depositors Profile- At the time of the acquisition, total deposits stood at P199,467,645, spread out over an estimated total of 5,000 depositors. The majority of these depositors are reportedly individuals. Corporate depositors maintaining small current accounts form only 5% of that total. “Special Savings deposits” account for 55% of total deposits, while the balance, or 40% is in the form of savings deposits. This configuration reportedly yields an average term of one year, and a nominal interest rate of 6% per annum on the banks deposits.

• Loan Portfolio/Borrower Profile- As of March 2009, total DOSRI loans stood at P20,842,807, carrying maturities in excess of 5 years. While some of these are reportedly secured against certain assets, the acquisition audit team took exceptions to the imperfect documentations covering these transactions. Outside of the DOSRI accounts at the time of the acquisition, the typical borrower of ESB was classified under the “small enterprise” category, including among others, trading businesses, groceries and small stores, agri-business enterprises, and hardware stores. ESB also apparently did a fair amount of salary loans. Most of these salary loans were granted to employees of companies/factories located within the immediate vicinities of ESB’s offices. Aside from being secured by co-makers, these salary loans also carried guarantees from the employers in many cases. The average nominal yield of ESB’s loan portfolio is 18% per annum.

V. IMPLICATIONS AND NEED FOR AN INTERIM STRATEGY FOR THE BANK

1. Definition- As of this writing, written formal approval of the Monetary Board for the acquisition of Express savings Bank (ESB) by LWUA had not been communicated. The interim strategy is defined as the roadmap for the continuance of operations of ESB until such time that Monetary Board approval is obtained, and a basic plan for integration of this bank into the LWUA framework based on its perceived role, has been established. The defined timetable for said interim strategy continues until such time where the major institutional (change of Head Office and organizational) and ownership re-structuring has been completed. Pending matters with regards to this have to do with the pro-forma shareholdings of the bank, after infusion of the funds required to correct its capital deficiency. The shares bought by LWUA for the amount of P80 million, represent 60% of ESB’s outstanding stock. To change the bank’s head office to Manila, and to correct the

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capital deficiency, P700 million has been infused by LWUA as of October 2009. However, it is unlikely that the remaining minority shareholders will agree to put in additional cash to keep their proportionate shareholdings in the bank. They will most likely allow themselves to be diluted. This will therefore leave LWUA with holdings of over 60%, which will be in violation of the legal ceiling of ownership. This problem will be further magnified with additional infusions in the future. It is therefore something that LWUA needs to resolve right away. Under the “re-organized” institution, the new management will be instrumental in carrying out the bank’s integration into the LWUA business plan, and the formulation and eventual implementation of its business strategy and plan.

2. Status/Issues

a. Monetary Board Approval - While the acquisition has presumably taken place,

the Monetary Board Approval has not yet been communicated in writing to LWUA, and hence transfer of ownership, has not been formalized. In the interim, this presents numerous operational problems requiring formalities especially from the bank’s Board of Directors. Even if LWUA now “calls the shots” legal formalities cannot flow from it since ownership and authority transfer has still not been formalized. Also, fresh funds cannot be infused in the form of capital, until formal Monetary Board approval for the acquisition is given.

b. Financial Deficiencies

With LWUA’s infusion of PhP700 million, the bank’s various operating financial deficiencies existing at the time of acquisition, will be corrected. At the time of this writing however, the absence of the formal Monetary Board approval for LWUA’s acquisition of ESB prevents the formal entry of these funds as a capital injection into the bank. The formal transfer of controlling interest from the former owners to LWUA is also pending said approval. The implications of the major deficiencies prior to fund injections are nevertheless discussed in the following paragraphs, as formal correction of these are still pending the legal formalities attendant to the Monetary Board approval.

•••• Insolvency- Failure to correct the situation of insolvency will normally trigger the option of BSP to place a bank under receivership. Technically the bank remains insolvent (Liabilities Exceed Assets) until the fund infusions are formally recognized and booked as capital injections. It seems that the issue of ownership ceiling will still present problems though for LWUA. Specifically, this bank needs urgently to be re-capitalized through new, formal infusions.

• Negative Equity- Strictly speaking, the Single Borrowers Limit (SBL), is

pegged at a percentage of the Bank’s equity. In this case, the equity is negative, and therefore the bank cannot lend out money until this is technically corrected. The minimum unimpaired capital requirement for a thrift bank to establish an office within Metro Manila is P 325,000,000. Because of the negative equity position of ESB, the new owner(s) needed to invest around P360 million to enable the move. Putting this into perspective, this is around double the bank’s current total resources, at the time of acquisition. In 2008, the operating losses of the bank amounted to around P15.0 million, or P1.25 million/month. Net Loss for the year was not as big, and stood at P5.4 million, mainly due to “other income” amounting to P9.6 million. Of this figure however, P5.8 million came from the non-recurring item, “gains from the sale of acquired assets”. It might be reasonable to assume therefore, that net of non-recurring items such as this, the Net Loss given the existing profile of ESB would be more in the vicinity of around P11.0 million/year. Due to the

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inactivity brought about by the entry of new owners this year, the projected losses this year could be close to that figure.

c. Cash Needs- At status quo, ESB carries close to P200 million in deposit liabilities,

and has monthly cash operating needs of approximately P2.0 for its expenses and payroll. Because of its below par financial condition, ESB is not entitled to any of the BSP emergency liquidity facilities that would normally be available to a bank to enable it to cope with extraordinary deposit withdrawals.

d. Statutory Requirements- Until the fulfillment of the attendant formalities, the bank will be unable to operate normally. Keeping track of these, and acting on the same, is a major component of the “interim and integration” strategy of LWUA for this bank. The regulatory framework (operational and legal) for banks is still something that the new owners need to familiarize themselves with. At this point, this aspect obviously requires the “full attention” of the new owners.

e. Controls- Since ESB is relatively inactive at this point, the focus of interim controls,

should perhaps be on the conservation and preservation of the bank’s resources. In order to do this, an effective mechanism to ensure the “continuity” in the operation of this bank, must be put in place. This is especially significant in the light of Mr. Balbido’s resignation. The parameters under which the bank will operate in the interim period need to be carefully and clearly defined. The “Organizational Chart” of ESB is attached as Annex 2. In reality, it is quite a “flat” set-up where all of the operating levels report directly to the President. With the position of Vice-President for Branches vacant, the chart becomes even flatter, since all of the Branch Managers report directly to the President, who also concurrently holds the position of Head of Loans and Discounts, which is also vacant. Following Mr. Balbido’s resignation, the bank’s Acting President is Mr.Wilfredo Feleo, who is also the LWUA Acting Deputy Administrator for Investment and Financial Services. The point emphasized here, is that the continuity of ESB’s operation is significantly compromised, given that Mr. Feleo is obviously unable to give his full attention to the bank in the light of his numerous responsibilities in LWUA. There is an obvious sense of urgency in addressing this in the Interim Strategy. The Organizational Deficiencies in ESBs current set-up are reflected in the notable gaps in the Financial Management assessment Questionnaire (FMAQ) attached as ANNEX 3.

f. Human Resources- The attitude and performance of its human resources, will always

play a stellar role in the success or failure of a bank. The interim strategy should initiate the process of aligning these resources to the “vision” of the bank’s new owners and management. Proper handling of the existing work force will also ensure continuity of operations in the existing branches, and a smoother transition to the redefined operations of the bank. A good start would be to align the compensation and benefits structures of LWUA and ESB, simultaneously with the various job levels/grades. It might also be advisable at this point, to create a team with the specific responsibility of updating information regarding the process and pre-requisites of applying for BSP approval for new branches. In addition, this team should also research the updated requirements of applying for and obtaining a quasi-banking license.

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VI. MAJOR CONCERNS FOR THE FORMULATION OF AN INTEGRATION STRATEGY AND BUSINESS PLAN

1. Definition

The integration study begins, or takes off where the interim strategy ends. It presumes that the initial concerns having to do with the deficiencies of the bank under the regulatory framework of the BSP have already been addressed and corrected. The Integration Strategy will be the roadmap that LWUA will follow in the execution of its vision of how this bank will “fit” in to its overall plans and general business strategy. Coming up with such a strategy will necessitate from LWUA, a very clear and comprehensive statement of what its objectives are for this bank. This in turn will determine WEB’s role within, and possibly outside of LWUA. It is only upon the formulation of the integration strategy, that a meaningful business plan and corporate strategy for the bank itself can be established.

2. Characteristics of the Primary Target Market

This has been defined to be the Water and Energy sectors. The water sector is an obvious result of LWUA’s core competence, that is, its expertise in lending to this sector. The energy sector however, while bearing many similarities to the water sector, is a relatively underdeveloped one in the Philippines, and is to some extent, still evolving. Hence, a functional level of expertise in lending to this sector, is still something that has to be acquired and developed by LWUA and its development bank.

a. Funds Usage (Loans and Investments) A significant common characteristic of the

water and energy sectors, as it relates to the funds usage of a bank, is that both require mainly the “development finance” type of credit as against the “commercial” type of financing. Thus, lending to these sectors is best done by a financial institution that is development finance “oriented”, and development finance “capable”. The orientation of banks in doing credit analysis and evaluation is largely directed towards the commercial credit needs of its clients, which normally involve shorter credit maturities, and are structured to optimize loan disbursement schemes suited to the cash flow needs of the clients. In the case of ESB, its orientation was limited not only to commercial credit, but to “micro-commercial” credit. This is a world apart from the type of transactions that LWUA does. This was brought about both by the environment within which ESB used to operate, and more importantly, the profile of its funding, which is generally short term in nature. Investments on the balance sheets of medium sized thrift banks, are normally limited to highly liquid and short term investments such as government securities and other financial instruments. They very rarely take equity positions in anything, let alone development ventures. Obviously, this is also quite different from the orientation of LWUA, whose loans and investments are normally structured on a long term basis. A major issue that will probably constrain the establishment and development of a loan portfolio of the bank in the water sector, is the issue of collateral. The typical balance sheet of a water supply business, is such that a significant part of its assets is composed of underground distribution pipes, inclusive of the costs incurred in installing these. Unfortunately however, existing banking standards and practices determine these types of assets to have a collateral valuation of nil, and this has been one of the major constraining factors in the flow of private debt capital into the water supply sector. The obvious implication of this nil valuation with regards to the bank’s loan portfolio,, is that these loans will be assigned a higher “risk weighting” because of the lack of, or absence of collateral cover, eventually impacting on capital adequacy and other risk asset standards imposed by the BSP on banks. Hence,

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even in a case where a potential borrower is top rated in terms of its loan repayment capability, a bank will be constrained to lend on a “clean” or under-collateralized basis given the regulatory framework within which it operates.

b. Funds Sourcing (Deposits, Deposit Substitutes, Credit Lines, Capital) LWUA is targeting the water districts (WDs) as the primary source in the

development of the bank’s deposit base. This money will supposedly come from the excess/idle funds of the WDs, pending usage of the same for capital expenditures involving their programmed maintenance and expansion projects. The magnitude of the availability of these types of funds needs validation. Additionally, the conditions of availability of such funds for deposit into LWUA’s bank needs to be analyzed. Such analysis must include the profiling of the same in terms of average tenure, and the practicability of depositing these funds with the WEB. Logically, the primary criteria in determining practicability, would be the WEB’s accessibility to its target market. This would necessitate the development of a branching strategy that would enable it to address the issue of “accessibility” in fulfilling its role of taking care of the banking needs of its target market. The geographical coverage of the target market, is the primary concern in the establishment of a branching strategy for the WEB. The majority of WDs that make up the target market of WEB, are located outside of Manila. To service their banking needs, WEB needs to make itself “accessible”, and justify its being the “bank of choice” of these WDs. In embarking on the expansion of its branching network, WEB needs to study the implications of such a move very carefully:

• Basic Requirements- To set up a branch, a bank must seek the approval of

the BSP for doing so. A branch application needs to be accompanied by a full feasibility study and business plan that must necessarily justify the request to establish the branch in terms of its own financial viability and its effects on the business environment in the chosen location. The branching strategy must likewise recognize that certain areas are considered to already be over-banked, and are not open to the establishment of new bank branches.

• Capital Requirements- Approvals for the establishment of new bank branches are normally accompanied by “minimum assigned capital” requirements per branch, prescribed by the BSP. The “prescribed assigned capital per type of branch” is presented as Annex 4.This annex comprehensively lists all of the pre-requisites and criteria used by the central bank in considering applications for the establishment of new bank branches.

• Criteria for Prioritization of Branch Development- Since branch expansion and development is severely demanding on both the monetary and human resources of a bank, the branching strategy needs to establish the criteria by which it will prioritize the locations in which it wants to set up its branches. While considering the internal objectives of the bank, this set of criteria must be consistent with the evaluation criteria used by the BSP in considering branch application proposals. Aside from the criteria of “proximity to target market”, the economic and cost-benefit aspects are primary considerations in justifying the establishment of a branch. These are always analyzed in the light of existing and potential characteristics of the business, social and economic environment in the potential locations. Among others, an environmental analysis should always consider the competition, in tempering the assumptions used in making the business plan. In the case of WEB, where preferred locations tend to be prioritized by the locations of its potential WD clients, the cost-benefit and investment analyses become more relevant. The investment analysis becomes significant in the light of “branch assigned capital” requirements. While there may be certain benefits attached to having a “niche captive market” it is rare that the existence of a branch can be

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justified by its potential business with only a couple of clients, particularly if these clients are presumed to compose both its deposit base and loan portfolio. Under this scenario, the client would in effect be borrowing his own money, and this does not become economically sensible, unless there are “tax shield” or other such benefits to be derived from it.

c. Funding from other potential fund sources, will most likely be an area that needs

close attention. As mentioned previously, prudence dictates that there must be serious efforts to match the maturities of both the sources and the uses of funds. The typical deposit base of banks in the Philippine context is such that it is composed mainly of short to medium term funds. For WEB, this will be a major constraint in developing its loan portfolio within the same credit market within which LWUA presently operates, i.e., one where long term credit is predominantly in demand. This implies a scenario wherein LWUA and WEB could work side by side to do “co-financing”, LWUA for the long term funds, and WEB for the short term needs of the water districts. The latter of course, presumably has a much smaller demand, and still carries collateral issues for such a portfolio. Access to longer term deposit substitutes and other capital market instruments , is one way of aligning WEB’s funding base to enable it to make loans with extended maturities. This option would probably require that it apply for a quasi-banking license from the BSP. Another option would be through tie-ups with institutions that make “medium to long term equipment suppliers credit” available. This implies however, the need for an automatic upgrade in WEB’s treasury and foreign exchange capabilities.

3. Organizational Issues:

a) Human Resources; Given the need to expand its branch network, WDB will need to assume a more sophisticated organizational structure to cope with the handling of a much larger amount of financial resources than what was being handled by the bank as ESB. This will necessitate the adoption of a totally new culture and discipline in the management and operation of the bank, and the simultaneous upgrade of the systems and products. The two main areas that will require the full time attention of the new owners in reorganizing the bank will be “control and development”. One part of the organization will focus on the upgrading of the control and operating systems, while the other will have to concentrate on developing the markets of the bank in accordance with its eventual business plan. The bank personnel will obviously need quite a bit of “capacity building” to help them cope with this transformation, and will go though a learning curve for this process.

b) Systems and Equipment: Since the operations will involve a fairly wide geographical coverage, the equipment and systems of the bank will need to be upgraded to address this. The coordination between the bank headquarters and its branches will have to be online to ensure smooth and reliable management of the bank’s assets and liabilities. The planning and establishment of these operating systems, together with all its backup systems should be a priority item in the planning budget of the bank.

c) Branch Banking; The new organization will have to accommodate a separate division for branch banking given the number of intended branches within the immediate and foreseeable future. Such a division will probably play a significant role in the operations, since most of WEBs target market will only be accessible through the branch network.

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VII. COMMENTS AND OBSERVATIONS

• LWUAs primary purpose in acquiring ESB, or a bank license, is “to improve its funding capabilities, by giving it access to fund sources that would otherwise not be available to it”. A bank license would indeed provide access to a wider array of funding sources, mostly via a well managed development of its deposit base. The initial strategy indicated by LWUA however, which is to concentrate on the solicitation of deposits from the WDs , does not seem to be consistent with the stated purpose since LWUA, as a specialized lending institution, already has access to the WD excess funds, even without the banking license. It would seem therefore, that the development of its base of “deposits from the public” would warrant at least the same level of priority as the deposits that will be sourced from the WDs.

• The loan portfolio characteristics of a financial institution, are to a significant extent, constrained by its funding base. Development loans are typically medium to long term in nature, and thus require matching sources of funds with approximate tenures. The typical funding base of thrift and commercial banks is short term in nature, hence defining their preference toward shorter maturities on their loans. The strategy of LWUA for this bank must address this issue, and find ways to reconcile or manage this imbalance, since the target market requires the development type of credit. As mentioned in the main body of the report, they can probably explore the applicability of a “quasi-banking license” for their purposes, aside from forging tie-ups with institutions that can provide “supplier’s credit” for major equipment used in the water and energy sectors. Depending on the type of equipment, this financing can carry at least a medium term tenure.

• The Collateral Issue is one that needs close attention in the business plan formulation, especially for water sector loans. Risk weighting computations for unsecured and under-secured loans will severely constrain the bank’s ability to develop its water sector loan portfolio. Water supply businesses will always be challenged to put up adequate collateral for their loans, since a significant part of the assets on their balance sheets are in the form of distribution pipes, which carry nil collateral valuations.

• Loan Pricing is a function of the “cost of funds”. Factors such as reserve requirements, mandatory loan loss reserves, Agri-Agra and SME loan allocations, gross receipts tax on interest earnings, etc., directly affect the cost of funds of banks, and is the reason that banks charge a spread even to clients who want to “borrow their own money”. This needs to be considered especially in the light of LWUAs traditional loan market, which normally seeks credit facilities that carry preferential interest rates.

• The Competitive Edge of any business is largely what determines the extent of its success. The strategy and business plan of this bank needs to focus on this aspect, and how it will make itself the “bank of choice” of clients in its intended target market. Banks are primarily service oriented institutions, and the level of service to be offered by WEB will have to be at par with the competition if it is to succeed in its target market. The business plan must therefore assume realistic development costs in achieving this level of service.

• The BSP Regulatory Framework is something that LWUA needs to be sufficiently oriented with in terms of operations, branch expansion, and loan portfolio development. Banking is a highly regulated industry in the Philippines, and exceptions are difficult to come by. A business plan that will operate under assumed exceptions/exemptions, is probably not a dependable one.

• The DOSRI regulation limiting loans to “related interests” may become a problem in cases where LWUA may need to “step in” and take over the management of non-performing water supply utilities who are concurrently loan clients of the bank. This is a potential issue that may be considered in the bank’s business strategy formulation.

• An exemption from the Agri-Agra and SME Loan Allocation regulation may be a justified one since the water sector development deserves equal priority beside the

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agricultural and small business sectors. It would significantly enhance the average yield picture of WDB at the same time. Prior to this however, the bank must show its unique capabilities in developing a loan portfolio in the water sector, not only in terms of its project and loan evaluation capabilities, but also in its ability to fund these types of loans. In the long run, the development of “water development capital instruments” in cooperation with government financial institutions (GFIs) would even be a better alternative than simply seeking exemptions from the Agri-Agra and SME loan allocation regulations.

• LWUA control in this bank is a double edged blade. It can work in such a way where it attracts private investment as an entry into the water sector, or, it can work against attracting private funds because of the political color that can be associated with LWUA. The bank charter, ownership structure, and organization can be used in tweaking that perception either way.

• The intention of LWUA, is to have this bank operate side by side with it in financing the development of the water sector. This may be carried out under various scenarios, mostly having to do with varying degrees of LWUA involvement in the bank. This is still one aspect that has to be clearly defined after being well thought out. The lack of orientation of LWUA of operating within the BSP regulatory framework would encourage a scenario where the bank management has a high degree of autonomy, and the LWUA involvement is limited to the Board and Executive committee levels.

• Given the primary target markets, WEB has to be an accredited “government depository” bank. Approvals to put this into effect need to be sought out at an early stage. Before even applying for this status, WEB must determine the criteria and pre-requisites that it must comply with to obtain said accreditation.

VIII. FINANCIAL PROJECTIONS

LWUA acquired the WE Bank as part of their strategy to establish an added major source of funds for water development projects by gaining access to reserve funds of Water Districts and public deposits. Funds of the WE Bank are expected to be loaned out directly to water districts or as counterpart funds mixed with donor funds (co-financed loans with LWUA). The LWUA Assessment Report established that the decrease in source of funds for developmental work was a serious problem and the major reason why loan releases and consequently revenues has slowed down in the previous years.

While the basic instinctive premise of LWUA’s acquisition may be valid, a sound business strategy and business plan and military-like precision execution are critical if the WE Bank will indeed be able to deliver this expectation as the stakes are very high. The succeeding section attempts to determine the combination of parameters that will result in a likely scenario of performance.

1. Assumptions

A. Feasibility Study projections. The financial projections prepared, were derived from a feasibility study prepared for LWUA as part of the due diligence conducted prior to the acquisition of ESB. The study’s projected income statement and statement of condition, and a cash flow statement reconstructed from these documents, are referred to as FS projections and are shown in Annex 5.

Please note that the FS projections were likely prepared in Q2 2009. It is unclear whether the party which prepared the FS projections had the benefit of the bank’s March 31, 2009 Financial Statements (BFS) which was already available during the preparation of the WE Bank Study and the Audit Report. For example the Audit Report reported a capital

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deficiency of P34 million as of March 31, 2009. The FS Study assumes that the bank will make P452.2 miilion for the full year 2009 (compared with its actual loss of P31.6 million for the full year 2008) and that the bank will have unimpaired capital of P2 billion for a total capital based of P2.42 billion by the end of December 31, 2009. The FS projections out until 2018 presumably incorporated key assumptions provided by LWUA.

B. Base Scenario projections. The FS projections were used as the primary basis for

the Base Scenario projections with several adjustments made as listed in the List of Assumptions for the financial projections is shown as in Annex 6.

The Base Case scenario was prepared by adjusting the FS projections as follows:

• The Base Case assumed an upfront capital infusion of P700 million from all

shareholders. The resulting capital base was 27% of the projected year-end 2009 capital base. The FS base year asset and liability figures were then scaled down to 27% of the projected levels. Loans and deposits were then projected forward using similar year-on-year growth assumptions to the FS for a few years, then a lower growth rate more in line with the 10% experienced by the sector.

• Projected income is much lower for three reasons: 1. The smaller base of interest earning assets, 2. Past due loans equal to 5% of current loans from day one (compared with

zero until year-end 2015 for the FS) which results in an additional bad debt expense,

3. Profitability was adjusted to reflect the Philippine commercial banking sector’s average cost-to-income ratio.

• The Base Case assumed that non-interest expenses (net of impairment losses) would be equal to 69.57% of operating income (commercial bank average, as we assume that the cost structure of larger thrift banks is more comparable to commercial banks). (The FS had assumed a ratio in the teens.)

• As a regulated entity, the capitalization requirement for a thrift bank is a function of the envisioned size of this bank’s assets (as Basel I only accounts for credit risk, albeit crudely). A smaller asset/loan base means lower regulatory capital requirements, requiring less mandatory capital infusion from LWUA and other shareholders. (The shareholders can voluntarily infuse capital; our assumption was that other than the initial P700 million infusion, capital would only be raised if necessary to meet regulatory requirements.) We believe that the projected size of operations is more consistent with well planned steady growth in line with the industry and more realistic given the increasing competition for deposits and loans in the sector. Despite lower profitability and organic capital generation, the bank did not need additional capital infusions in the Base Case Scenario focusing only on regulatory capital for credit risk.

• No specific capital calculations were made in the absence of details of their branch expansion plan. The capital requirements of converting the bank to a commercial bank (LWUA’s long-term plan) and undergoing a massive branch expansion could be substantial. • All banks require prior approval from BSP to establish branches. (A “branch” is

an office at which deposits are regularly received or withdrawn and which is manned by three employees at any time.)

• BSP’s guidelines for capital adequacy for purposes of evaluating branch applications are the following:

1. A minimum capital level, as follows: • Non-expanded Commercial Banks: P2.4 billion

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• Thrift Banks with Head Office within Metro Manila: P325 million 2. Theoretical capital for each branch to be established, including

approved but unopened branches/offices, to be deducted from existing capital for purposes of determining compliance with the 10% risk-based capital adequacy ratio as shown in the Table A5.6.

Table A5.6: Theoretical Capital

Location/Type of Bank (millions) CB TB RB 1) NCR, Cebu and Davao P 50 P 15 P 5 2) 1st to 3rd class cities P 25 P 5 P 2.5 3) 4th to 6th class cities P 25 P 5 P 1.5 4) 1st to 3rd class municipalities P 20 P 5 P 1.0 5) 4th to 6th class municipalities P 15 P 2.5 P 0.5

• The BSP’s guidelines also require that the bank has been operating profitably for

the year immediately preceding the date of application. For WE Bank, this may mean waiting until such condition is met as the bank has not been profitable for several years.

See Annex 7 for Comparison of assumptions of the FS projections and the base scenario projections.

C. Optimistic Scenario . The Optimistic scenario was prepared with the following

assumptions: • The same year-end 2009 starting point as the Base Case scenario was used. • Growth was assumed to be much higher (the objective was for the bank to

achieve loans and deposits equal to roughly half of the FS levels by 2018). Given that the starting is 14% of the FS levels, the actual growth percentages are indeed very high and assume early and steady penetration in their targeted sectors of water and energy.

• Profitability was also assumed to be slightly better. A cost to income ratio of 60.69% was used, which is the lowest commercial bank sector average experienced in the past year.

• Again no specific branch expansion plans (and the resulting regulatory capital requirements) were taken into account in these capital calculations

At best, the projections will simply reflect a scaled down version of the feasibility study, using a much more conservative/realistic profitability ratios. They are not based on any assumed operating structure, and hence do not consider any specific cost, income and expense aspects directly associated with any particular assumed operating structure.

2. Results of the Projections

The detailed results of the financial projections for the WE Bank are shown in Appendix 11, Annexes 8 (base scenario) and 9 (Optimistic scenario) and can be summarized as follows in Table A5.7.

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Table A5.7. Comparison of Results Under the Base Scenario and Better Scenario

Base Scenario Optimistic Scenario Profitability -Net Income in 2010 (P m) -Net Income 2011 to 2018 (range in Pm)

PhP 29.7m PhP 37.8m to Php 100.7m

PhP 27.3m PhP 41.1m to PhP338.4m

Cost to Income 69.57% 65.92% Net Interest Margin 5.85% to 6.60% 4.80% to 6.60% Cash -Ending Cash in 2010 (Pm) -Ending Cash 2011 to 2018 (range in Pm)

PhP 96.6m PhP 147m to PhP 393.4m

PhP 103.4m PhP 102.0m to PhP 1.31b

Past Due Loans 5% to 10% 5% to 10% Capital Adequacy (rough) 17% to 38% 10% to 38% See the details of comparison between FS projections, base and optimistic scenario in Annex 10 .

3. Implication on LWUA

In determining the implications of the above set of projections on LWUA, the consultants used the WE Bank base scenario to be more conservative, and considered two possible scenarios of how the WE Bank will impact upon LWUA operations, namely:

• Scenario One – Without Bank. This scenario is based on the assumption that LWUA will not operate the bank and all previous investments will be written off.

• Scenario Two – With Bank. This assumed continued operation of the bank.

Table A5.8. Comparison of With and Without Bank Scenarios

Without Bank With Bank (operated a a thrift bank) Investment P780 million investment written

off over 10 years P780 million cash payments in 2009 comprising: -P80 million paid to owners and P 240 million (60% of P700 million additional investment as LWUA investment in subsidiaries) -P280 million (40% of P700 million assuming LWUA funds minority stockholders, as due from minority stockholders)





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IX. RISK ASSESSMENT/MITIGATING MEASURES Implication of the WE Bank on LWUA’s position to pay the WDDSP Loan stems from two sources namely (i) LWUA’s exposure to the WE Bank and (ii) risk that loan funds and Water District collections are diverted to other purposes including financing the WE Bank.

A. LWUA exposure to WE Bank

• Risks can be generally classified as “investment risks”, and “operating risks”. • The investment risk is associated with the extent of investment of LWUA in this bank,

whether it is in the form of equity investment or any other form of exposure. So far LWUA has paid out cash of P480 million for the WE Bank. This is the extent of its investment risk.

• The “operating risks” are not as limited as investment risks, as these include all risks associated with the asset and liability management of the bank.

• Under the base scenario projections for the WE Bank, it is estimated that the bank will generate net income starting 2010. However there are other contingent liabilities in operating the WE Bank. For example, in eventual negotiations with other banks for inter-bank credit lines for the Water and Energy Bank (WEB), LWUA will probably be asked for its guarantees to secure these facilities.

• The profitability of a bank is a function of its leverage. The higher the leverage, the higher the profitability of a bank will be, assuming that it is properly managed. Correspondingly however, as the leverage increases, so does the risk. While it is easy to assume optimistic increases in deposit levels, the “usage” these funds must be equally efficient, but at the same time prudent! The funding base of a bank is always considered as one of the key drivers of its growth. If capital growth is limited to the contribution of retained earnings, and the expansion is a leveraged growth, where the funding base is primarily driven by increases in liabilities, then the amount of risk increases more in a geometric rather than an arithmetic proportion.

B. Fund Management

It is probable that LWUA sourced the funds for investment into WEB, from its “pool” of funds, which at this point is composed of funds from collections and credit facilities from creditors, unless there is an immediate plan to re-capitalize it. Future capital or fund injections into WEB, if any, will probably be sourced similarly. In terms of the funds flow relationship between both institutions, it would be easier for LWUA to place funds rather than source funds from WEB. This is due to the regulatory framework of the Bangko Sentral ng Pilipinas (BSP). It can however “borrow” funds from WEB to the extent of its shareholdings, or an amount equivalent to 10% of WEBs loan portfolio, whichever is smaller. In other words, if LWUAs capital investment into WEB is P260 (example only) million, then that is the maximum amount of money it can borrow from WEB. When a shareholder borrows money from a bank, the corresponding amount is directly deducted or netted out from the capital base of the bank, which is used as the denominator in computing its Capital Adequacy Ratio (CAR). There will always be risks of fund diversions from LWUA not only into this bank, but to any other conduit that may be available at the time. There is however an added degree of transparency involved if funds are diverted to/through this bank because of the close degree of supervision of the BSP.

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C. Risk Minimization/ Mitigating Measures

1. LWUA should resolve outstanding issues as follows:

• LWUA to get official approval of the Monetary Board • the pro-forma ownership structure of WEB must be made to comply with the


2. The envisioned operation of the Water Energy Development Bank (WEB) is a

paradigm shift from how the bank was operated as ESB. LWUA’s mission-vision for WEB however, is still very general, and needs a lot more refinement and detail. To minimize its risks moving forward, LWUA needs to establish a) a clearer definition of this “mission-vision”, b) a well thought out strategy and c)a comprehensive business plan for WEB. Primary among its considerations in the formulation of its strategy and business plan would be the following:

a. A clear definition of its target markets, both for loans and funding. This should be

done in consideration of WEB’s existing and potential limitations and constraints, and the inherent characteristics of these target markets in the light of these constraints.

b. A well thought out “Organizational Structure” that will enable the execution of the business plan and strategy. The business plan and strategy must incorporate a full awareness of the regulatory framework within which the bank will be operating.

c. A reasonable pace for the buildup of WEB’s human resources to fill in the organizational structure. It should be noted here, that the officers and management of any bank, are to a certain extent “screened” by the Central Bank, in that they must possess prescribed “minimum qualifications” to qualify them for the various positions.

d. Well planned buildup and development of WEBs operating systems to cope with the projected expansion.

e. Establishment of a program for the development of the bank’s human resources to cope with the “expanded demands” in terms of the operations, business development (for funding and loans), and control, associated with its projected growth. A learning curve needs to be assumed here, as the organization will be operating under completely different circumstances compared to when it was operating as ESB.

f. Planned capital build-up to fit into the business plan. g. Adoption and implementation of a “Risk Management” framework to address the

credit and investment risks, and the “interest rate and maturity risks” that will be the probable result arising from the potential “mismatches” between the sources and uses of funds of the bank, as discussed in various sections of this report.

3. For efficient fund management and control of loan funds as well as collections from WDs for loan payments, LWUAs creditors could perhaps take steps to control the disbursements of their loans, such that these are channeled to the intended recipients. Also, water district loan payments can be ring fenced such that the amounts available for debt service is known and managed so that LWUA can take timely action to avoid default.

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EXPRESS SAVINGS BANK, INC. Statements of Condition

December 31

2008 2007 RESOURCES

Cash and Other Cash Items-notes 2, 5 and 15 P5,140,810 P6,285,633 Due from:Bangko Sentral ng Pilipinas - notes 2, 4, 5 and 15 10,665,495 9,465,805 Due from Other Banks - notes 2, 4, 5 and 15 42,317,655 14,903,982 Loans and Receivables (net) – notes 2, 3, 4, 5, 6, 15, 23 and 27 88,544,877 78,086,712 Bank Premises, Furniture, Fixtures and Equipment (net) - notes 2, 3 and 7 1,985,871 2,424,092 Investment Properties (net) - notes 2 and 8 23,395,003 28,233,871 Assets Held for Sale (net) - notes 2 and 9 5,781,840 15,001,761 Other Resources (net) - notes 2, 10, and 15 917,877 894,073 P178,749,428 P155,295,929 LIABILITIES AND CAPITAL DEFICIENCY Deposit Liabilities - notes 2, 4, 5, 12 and 15 P202,171,146 P178,142,197 Accrued Expenses and Other Liabilities – notes 2, 5, 13 and 15 8,239,596 3,167,819 210,410,742 181,310,016 Capital Deficiency - notes 1 and 14

Capital stock 72,517,075 72,517,075 Surplus reserve 2,212,448 2,212,448 Surplus free (100,974,512) (92,500,358) Undivided loss (5,416,325) (8,243,252)

(31,661,314) (26,014,087) P178,749,428 P155,295,929 (The accompanying notes are an integral part of these financial statements)

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EXPRESS SAVINGS BANK, INC. Statements of Income

Years Ended December 31 2008 2007 INTEREST INCOME

Loans and receivables - notes 2 and 6 ` P 15,757,119 P 10,000,602 Deposits and investments 998,079 766,678

16,755,198 10,767,280 INTEREST EXPENSE ON DEPOSIT LIABILITIES 10,041,748 10,213,802 NET INTEREST INCOME 6,713,450 553,478 OTHER INCOME

Gain on sale of assets acquired 5,187,260 4,264,551 Service charges and fees 3,557,961 3,946,468 Rental income - notes 2 and 8 262,700 707,600 Others - net - note 18 686,306 3,141,300

9,694,227 12,059,919 OTHER EXPENSES

Compensation and employee benefits - notes 20 and 23 7,591,484 7,887,891 Occupancy - notes 21 and 23 4,259,859 4,016,601 Taxes and licenses 2,046,628 2,000,545 Depreciation and amortization - notes 2, 7 and 8 939,456 862,465 Other operating expenses - note 19 6,986,575 6,089,147

21,824,002 20,856,649

NET LOSS FOR THE YEAR (P5,416,325) (P8,243,252)

(The accompanying notes are an integral part of these financial statements)

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EXPRESS SAVINGS BANK, INC. Statements of Changes in Capital Deficiency

Years Ended December 31 2008 2007 CAPITAL STOCK - note 14

Common Stock - P100 par value per share Authorized - 1,000,000 shares Subscribed - 742,296 shares (net of subscriptions receivable of P1,712,525) P 72,517,075 P 72,517,075

SURPLUS RESERVE - notes 14 2,212,448 2,212,448 SURPLUS FREE

Balance at beginning of year (92,500,358) (75,712,005) Transfer from undivided profits (8,474,154) (16,788,353)

(100,974,512) (92,500,358) UNDIVIDED LOSS

Balance at beginning of year as previously reported (8,243,252) (22,330,765) Prior period adjustments - note 27 (230,902) 5,542,412 Balance at beginning of year as restated (8,474,154) (16,788,353) Net loss for the year (5,416,325) (8,243,252) Transfer to surplus free 8,474,154 16,788,353

(5,416,325) (8,243,252)

(P31,661,314) (P26,014,087) (The accompanying notes are integral part of these financial statements)

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EXPRESS SAVINGS BANK, INC. Statements of Cash Flows

Years Ended December 31 2008 2007

CASH FLOWS FROM OPERATING ACTIVITIES

Loss before tax (P5,416,325) (P8,243,252) Adjustments for: Depreciation and amortization 939,456 862,465

Gain on sale of assets held for sale and investment properties (3,937,127) (4,500,859) Loss on disposal of bank premises, furniture, fixtures and equipment 236,308 Interest income (16,755,198) (10,767,280) Interest expense 10,041,748 10,213,802 (15,127,446) (12,198,816) Operating loss before working capital changes (15,127,446) (12,198,816)

Increase in: Loans and receivables (6,938,795) (26,863,498) Other resources (23,804) (47,503) Increase (decrease) in: Deposit liabilities 24,028,949 14,730,164 Accrued expenses and other liabilities 4,121,012 (2,744,178)

Cash from (used in) operations 6,059,916 (27,123,831) Interest received 17,026,898 10,389,190

Interest paid (9,090,983) (10,050,206) Net cash from (used in) operating activities 13,995,831 (26,784,847)

CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of investment properties and assets held for sale 14,287,605 7,477,954 Decrease (increase) in investment properties (456,474) 741,031 Additions to bank premises, furniture, fixtures and equipment (370,007) (1,752,833) Proceeds from sale of bank premises, furniture, fixtures and equipment 11,585 10,918 Net cash from investing activities 13,472,709 6,477,070

CASH FLOWS FROM FINANCING ACTIVITIES

Payments of bills payable - (1,300,000) Additional subscription - 23,700,000 Net cash from financing activities - 22,400,000

NET INCREASE IN CASH AND

CASH EQUIVALENTS 27,468,540 2,092,223 (Forward)

Annex 1

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CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

Cash and other cash items 6,285,633 5,517,893 Due from Bangko Sentral ng Pilipinas 9,465,805 8,280,242 Due from other banks 14,903,982 14,765,062

30,655,420 28,563,197 CASH AND CASH EQUIVALENTS AT END OF YEAR

Cash and other cash items 5,140,810 6,285,633 Due from Bangko Sentral ng Pilipinas 10,665,495 9,465,805 Due from other banks 42,317,655 14,903,982

P58, 123,960 P 30,655,420 (The accompanying notes are an integral part of these financial statements)

Annex 1

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123

Edison O. Nuñez SM – Compliance Officer &

Internal Audit Head

BOARD OF DIRECTORS

Ferian A. Balbido President

Ronald N. Abadicio Audit Assistant

Rodolfo M. Baustista

Security Officer (Concurring GS Head)

BRANCH BANKING CORPORATE SUPPORT

PROPOSED ORGANIZATIONAL CHART EXPRESS SAVINGS BANK As of June 1, 2009

- - - - - - - - - -

Vacant II - Admin. Asst.

Eileen C. Siongco Treasury Officer

(concurring BM / MOB)

LOANS & DISCOUNT

VACANT VP -Branch Mktg. &

Operations Head

Eileen C. Siongco M. Main Office Br.

Jaime G. Escueta M. Binan Br

Ruby A. Bagos M, Calamba Br

Ma. Violeta S dela Cruz M. Balibago Br

Eurrie Lou A. Alum to

OIC, Gen. Acctg.

Melchor G Ge.nac.ias

II - Arclg. Staff

Rodolfo M. Bautista M, Head, Gen. Services

(concurring Sec. Officer)

CREDIT, LEGAL & COLLECTION

Clarence B. Tapaoan CI/Appraiser/Coll.

Rizaldo F. Cabarte M. Head, CLC

VACANT M. Head, Loans &

Discount

Rolando R. Santos Loans Supervisor

Ana Khristina A. Tibay Loans Assistant

Ma. Theresa V. Santos Loans Assistant

Aileen C. Buenaflor M, Head, Admin/HR

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ANNEX 3: FINANCIAL MANAGEMENT ASSESSMENT REPORT

Topic Response Remarks

1. Implementing Agency

1.1 What is the entity’s legal status/registration?

The Express Savings Bank, (ESB), now majority owned by LWUA, was incorporated in February 1980, and registered with the Securities and Exchange Commission (SEC) on May 1, 1980. The majority owner, LWUA, is a government-owned and controlled corporation established, as reaffirmed in NEDA Board Resolution 4, to operate primarily as a specialized lending institution for the promotion, development and financing of local water utilities.

1.2 Has the entity implemented an externally-financed project in the past (if so, please provide details)?

The bank (ESB), has not done any Project Financing.

1.3 What are the statutory reporting requirements for the entity?

All of the applicable reportorial requirements required of all Philippine corporations imposed by the SEC and the Bureau of Internal revenue. In addition, the primary regulatory agency, the Bangko Sentral ng Pilipinas (BSP), imposes reportorial requirements on a monthly basis, as specified in its Manual of Regulations governing the operations of all banks within the Philippine Banking System.

1.4 Is the governing body for the project independent?

1.5 Is the organizational structure appropriate for the needs of the project?

At this point, the acquisition by LWUA of controlling interest in ESB, is classified as an “investment”. Reclassification to the status of “project” would probably require an eventual comprehensive definition of LWUA’s strategy and business plan for ESB, eventually to become Water and Energy Bank (WEB). The team that will implement the strategy and business plan, would preferably be involved in the formulation of the same.

2. Funds Flow Arrangements

2.1 Describe (proposed) project funds flow arrangements, including a chart and explanation of the flow of funds from ADB, government and other financiers

2.2 Are the (proposed) arrangements to transfer the proceeds of the loan (from the government / Finance Ministry) to the entity satisfactory?

2.3 What have been the major problems in the past in receipt of funds by the entity?

2.4 In which bank will the Imprest Account be opened?

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2.5 Does the (proposed) project implementing unit (PIU) have experience in the management of disbursements from ADB?

2.6 Does the entity have/need a capacity to manage foreign exchange risks?

ESB has never had foreign exchange dealings, and therefore does not possess forex management capabilities. The controlling owner, LWUA deals with forex risks only by absorbing it, passing it on to its borrowers, or purchasing forward cover on its forex exposure. LWUA, by itself does not “manage” forex risk through its own treasury functions.

2.8 How are the counterpart funds accessed?

2.9 How are payments made from the counterpart funds?

2.10 If part of the project is implemented by communities or NGOs, does the PIU have the necessary reporting and monitoring features built into its systems to track the use of project proceeds by such agencies?

N/A

2.11 Are the beneficiaries required to contribute to project costs? If beneficiaries have an option to contribute in kind (in the form of labor), are proper guidelines formulated to record and value the labor contribution?

N/A

3. Staffing

3.1 What is the (proposed) organizational structure of the accounting department? Attach an organization chart.

3.2 Identify the (proposed) accounts staff, including job title, responsibilities, educational background and professional experience. Attach job descriptions and CVs of key accounting staff.

3.3 Is the project finance and accounting function staffed adequately?

.

3.4 Is the finance and accounts staff adequately qualified and experienced?

3.5 Is the project accounts and finance staff trained in ADB procedures?

3.6 What is the duration of the contract with the finance and

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accounts staff?

3.7 Indicate key positions not contracted yet, and the estimated date of appointment.

3.8 Does the project have written position descriptions that clearly define duties, responsibilities, lines of supervision, and limits of authority for all of the officers, managers, and staff?

3.9 At what frequency are personnel transferred?

3.10 What is training policy for the finance and accounting staff?

4. Accounting Policies and Procedures

4.1 Does the entity have an accounting system that allows for the proper recording of project financial transactions, including the allocation of expenditures in accordance with the respective components, disbursement categories, and sources of funds? Will the project use the entity accounting system?

The accounting systems of the bank are presumably adequate to cope with the statutory reportorial requirements, given its current scale or level of

operations. These will have to be upgraded on the assumption that the operations will expand.

4.2 Are controls in place concerning the preparation and approval of transactions, ensuring that all transactions are correctly made and adequately explained?

4.3 Is the chart of accounts adequate to properly account for and report on project activities and disbursement categories?

Yes.

4.4 Are cost allocations to the various funding sources made accurately and in accordance with established agreements?

4.5 Are the General Ledger and subsidiary ledgers reconciled and in balance?

4.6 Are all accounting and supporting documents retained on a permanent basis in a defined system that allows authorized users easy access?

Segregation of Duties

4.7 Are the following functional responsibilities performed by different units or persons: (i) authorization to execute a

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transaction; (ii) recording of the transaction; and (iii) custody of assets involved in the transaction?

4.8 Are the functions of ordering, receiving, accounting for, and paying for goods and services appropriately segregated?

4.9 Are bank reconciliations prepared by someone other than those who make or approve payments?

Budgeting System

4.10 Do budgets include physical and financial targets?

4.11 Are budgets prepared for all significant activities in sufficient detail to provide a meaningful tool with which to monitor subsequent performance?

4.12 Are actual expenditures compared to the budget with reasonable frequency, and explanations required for significant variations from the budget?

4.13 Are approvals for variations from the budget required in advance or after the fact?

4.14 Who is responsible for preparation and approval of budgets?

.

4.15 Are procedures in place to plan project activities, collect information from the units in charge of the different components, and prepare the budgets?

4.16 Are the project plans and budgets of project activities realistic, based on valid assumptions, and developed by knowledgeable individuals?

Payments

4.17 Do invoice-processing procedures provide for: (i) Copies of purchase orders and receiving reports to be obtained directly from issuing departments? (ii) Comparison of invoice quantities, prices and terms, with those indicated on the purchase order and with records of goods actually received? (iii) Comparison of

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invoice quantities with those indicated on the receiving reports? (iv) Checking the accuracy of calculations?

4.18 Are all invoices stamped PAID, dated, reviewed and approved, and clearly marked for account code assignment?

4.19 Do controls exist for the preparation of the payroll and are changes to the payroll properly authorized?

Policies And Procedures

4.20 What is the basis of accounting (e.g., cash, accrual)?

4.21 What accounting standards are followed?

Philippine Accounting Standards issued by the Accounting Standard Council as well as the Financial Accounting Standard applicable to banks and other financial subsidiaries.

4.22 Does the project have an adequate policies and procedures manual to guide activities and ensure staff accountability?

4.23 Is the accounting policy and procedure manual updated for the project activities?

4.24 Do procedures exist to ensure that only authorized persons can alter or establish a new accounting principle, policy or procedure to be used by the entity?

4.25 Are there written policies and procedures covering all routine financial management and related administrative activities?

4.26 Do policies and procedures clearly define conflict of interest and related party transactions (real and apparent) and provide safeguards to protect the organization from them?

4.27 Are manuals distributed to appropriate personnel?

Cash and Bank

4.28 Indicate names and positions of authorized signatories in the bank accounts.

4.29 Does the organization maintain an adequate, up-to-date cashbook, recording receipts

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and payments?

4.30 Do controls exist for the collection, timely deposit and recording of receipts at each collection location?

4.31 Are bank and cash reconciled on a monthly basis?

4.32 Are all unusual items on the bank reconciliation reviewed and approved by a responsible official?

4.33 Are all receipts deposited on a timely basis?

Safeguard over Assets

4.34 Is there a system of adequate safeguards to protect assets from fraud, waste and abuse?

4.35 Are subsidiary records of fixed assets and stocks kept up to date and reconciled with control accounts?

4.36 Are there periodic physical inventories of fixed assets and stocks?

4.37 Are assets sufficiently covered by insurance policies?

Other Offices and Implementing Entities

4.38 Are there any other regional offices or executing entities participating in implementation?

4.39 Has the project established controls and procedures for flow of funds, financial information, accountability, and audits in relation to the other offices or entities?

4.40 Does information among the different offices/implementing agencies flow in an accurate and timely fashion?

.

4.41 Are periodic reconciliations performed among the different offices/implementing agencies?

Other

4.42 Has the project advised employees, beneficiaries and other recipients to whom to report if they suspect fraud, waste or misuse of project resources or property?

5. Internal Audit

5.1 Is there a internal audit

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department in the entity?

5.2 What are the qualifications and experience of audit department staff?

5.3 To whom does the internal auditor report?

The Internal Auditor reports Board of Directors of the bank.

5.4 Will the internal audit department include the project in its work program?

5.5 Are actions taken on the internal audit findings?

6. External Audit

6.1 Is the entity financial statement audited regularly by an independent auditor? Who is the auditor?

The firm of Diaz Murillo Dalupan and Company Certified Public Accountants

6.2 Are there any delays in audit of the entity? When are the audit reports issued?

6.3 Is the audit of the entity conducted according to the International Standards on Auditing?

Yes

6.4 Were there any major accountability issues brought out in the audit report of the past three years?

Stated in the most recent Audit Report containing the Comparative Financial Statement for 2007 and 2008, it was emphasized that due to continued losses suffered by the bank, it was in a state of capital deficiency, resulting in a negative Capital Adequacy ratio of 20.25%, and hence was placed under a Prompt Corrective Action by the monetary Board in its Resolution No. 162 in February 2008.

6.5 Will the entity auditor audit the project accounts or will another auditor be appointed to audit the project financial statements?

6.6 Are there any recommendations made by the auditors in prior audit reports or management letters that have not yet been implemented?

6.7 Is the project subject to any kind of audit from an independent governmental entity (e.g., the supreme audit institution) in addition to the external audit?

6.8 Has the project prepared acceptable terms of reference for an annual project audit?

7. Reporting and Monitoring

7.1 Are financial statements prepared for the entity? In

Yes

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accordance with which accounting standards?

7.2 Are financial statements prepared for the implementing unit?

7.3 What is the frequency of preparation of financial statements? Are the reports prepared in a timely fashion so as to useful to management for decision making?

Financial statements are prepared monthly and audited annually.

7.4 Does the reporting system need to be adapted to report on the project components?

7.5 Does the reporting system have the capacity to link the financial information with the project's physical progress? If separate systems are used to gather and compile physical data, what controls are in place to reduce the risk that the physical data may not synchronize with the financial data?

7.6 Does the project have established financial management reporting responsibilities that specify what reports are to be prepared, what they are to contain, and how they are to be used?

7.7 Are financial management reports used by management?

7.8 Do the financial reports compare actual expenditures with budgeted and programmed allocations?

7.9 Are financial reports prepared directly by the automated accounting system or are they prepared by spreadsheets or some other means?

8. Information Systems

8.1 Is the financial management system computerized?

8.2 Can the system produce the necessary project financial reports?

8.3 Is the staff adequately trained to maintain the system?

8.4 Does the management organization and processing

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system safeguard the confidentiality, integrity and availability of the data?

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Bangko Sentral ng Pilipinas MAYNILA, PILIPINAS

OFFICE OF THE GOVERNOR

Circular No. 505 Series of 2005

Subject: Branching Policy and Guidelines

Pursuant to Monetary Board Resolution No. 1605 dated 16 December 2005, the Manual of Regulations for Banks (MORB) is hereby amended, as follows:

Section 1. Sec. X151. Establishment/Relocation/Voluntary Closure/Sale of Branches . THE BANGKO SENTRAL NG PILIPINAS SHALL PROMOTE HEALTHY COMPETITION IN THE BANKING SYSTEM AND MAXIMIZE THE DELIVERY OF EFFICIENT BANKING SERVICES ESPECIALLY IN UNDERSERVED AREAS. TOWARD THIS END, THE FOLLOWING RULES AND REGULATIONS THAT SHALL GOVERN THE ESTABLISHMENT, RELOCATION, VOLUNTARY CLOSURE AND SALE OF LOCAL BRANCHES OF DOMESTIC BANKS, INCLUDING LOCALLY INCORPORATED SUBSIDIARIES OF FOREIGN BANKS, ARE HEREBY ISSUED. THE ESTABLISHMENT OF BRANCHES OF FOREIGN BANKS IN THE PHILIPPINES SHALL CONTINUE TO BE GOVERNED BY THE PROVISIONS OF SEC. X121 OF THE MORE.

Subsec. X151.1 Prior Monetary Board approval . No bank operating in the Philippines shall establish, open or operate branches, or transact business outside the premises of its duly authorized principal office without the prior approval of the BSP. FOR PURPOSES OF THIS SECTION, THE TERM "BRANCH" SHALL REFER TO ANY OFFICE OR PLACE OF BUSINESS IN THE PHILIPPINES OUTSIDE OF THE HEAD OFFICE AT WHICH DEPOSITS ARE REGULARLY RECEIVED OR WITHDRAWN BUT SHALL EXCLUDE STAND ALONE AUTOMATED TELLER MACHINE (ATM) OR CASH-ACCEPTANCE MACHINE AND AD HOC TELLERING BOOTH. OTHER BANKING OFFICES SUCH AS CONVENIENCE BANKING CENTERS, EXPRESS BANKING CENTERS, REPRESENTATIVE OFFICES, SALES/SERVICE OUTLETS AND BANKING KIOSKS SHALL BE CONSIDERED A "BRANCH" SUBJECT TO BRANCHING/ APPLICATION RULES IF MANNED BY AT LEAST THREE (3) OFFICERS/EMPLOYEES AT ANY TIME, AND DEPOSITS ARE RECEIVED/ACCEPTED EVEN THROUGH ATM OR CASH ACCEPTANCE MACHINE. IT SHALL MAINTAIN SEPARATE BOOKS OF ACCOUNTS AND SHALL BE SUBJECT TO THE REPORTORIAL REQUIREMENTS OF THE BSP.

PANANALAPING MATATAG, BANSANG PANATAG

A. Mabini St., Malate 1004, Manila, Philippines • Trunkline (632) 524-70-11 • URL: www.bsp.gov.ph 6 e-mail: bsprnail@bsp_gov.ph

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BANKING OFFICES OTHER THAN "BRANCH" AS DEFINED HEREIN MAY BE ALLOWE ANYWHERE, WITHOUT PRIOR BSP APPROVAL, SUBJECT TO THE SUBMISSION OF A CERTIFICATION BY THE HEAD OF THE BRANCHES DEPARTMENT WITH THE RANK OF VICE PRESIDENT OR ITS EQUIVALENT OR BY A HIGHER RANKING OFFICER THAT SAID BANKING OFFICE SHALL NEITHER ACCEPT DEPOSITS NOR SERVICE WITHDRAWALS. THE CERTIFICATION SHALL BE SUBMITTED TO THE APPROPRIATE SUPERVISING AND EXAMINING DEPARTMENT OF THE BSP NOT LATER THAN FIVE (5) BANKING DAYS FROM DATE OF OPENING.

Subsec. X151.2 Prerequisites for the grant of authority to establish a branch/banking office . WITH PRIOR APPROVAL OF THE MONETARY BOARD, BANKS MAY ESTABLISH BRANCHES SUBJECT TO THE FOLLOWING PRE-QUALIFICATION REQUIREMENTS: 1. COMPLIANCE WITH THE MINIMUM CAPITAL REQUIRED OR AS MAY

BE REQUIRED UNDER EXISTING REGULATIONS, WHICH AT PRESENT ARE AS FOLLOWS:

Bank Category Minimum Capital (in

Millions) Expanded Commercial Banks Php4,950 Non-expanded Commercial Banks Php2,400 Thrift Banks: With Head Office within Metro Manila With Head Office outside Metro Manila

Php325 Php52

Rural Banks: Within Metro Manila Cities of Cebu and Davao 1st/ 2nd/ 3rd class cities and 1st class municipalities 4th/5th/6th class cities and 2nd/3rd.4th class

municipalities 5th and 6th class municipalities

Php26 Php13 Php6.5 Php3.9

Php2.6

2. THE BANK'S RISK-BASED CAPITAL ADEQUACY RATIO AT THE TIME

OF FILING THE APPLICATION IS NOT LOWER THAN TWELVE PERCENT (12%);

3. THE BANK'S CAMELS COMPOSITE RATING IN THE LATEST EXAMINATION IS AT LEAST "3", WITH MANAGEMENT COMPONENT SCORE NOT LOWER THAN "3";

4. The bank has established a risk management system appropriate to its operations, characterized by clear delineation of responsibility for risk management, adequate risk measurement system, appropriately structured risk limits, effective internal control system and complete, timely and efficient risk reporting system;

5. NO MAJOR SUPERVISORY CONCERNS OUTSTANDING ON SAFETY

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AND SOUNDNESS, I.E., THE BANK HAS COMPLIED, DURING THE PERIOD IMMEDIATELY PRECEDING THE DATE OF APPLICATION WITH THE FOLLOWING REGULATORY CHECKPOINTS:

a) No unbooked valuation reserves as of date of application

b) Regular and liquidity reserve requirements on deposits and deposit substitutes 12 weeks

c) Asset and liquidity cover for EFCDU/FCDU liabilities 3 months

d) Ceilings on loans to DOSRI 3 months e) Liquidity floor on government

deposits 3 months

f) Loans-to-deposits ratio 2 quarters g) Past due loans ratio does not

exceed twenty percent (20%) of total loan portfolio as of date of application

h) No outstanding violation on single borrower's loan limit and limit on total investment in real estate and improvements including bank equipment as of date of application

i) No past due obligation with the BSP or with any financial institution as of date of application

j) No float items outstanding in the "Due From/To Head Office/Branches/ Offices" and "Due from BSP° accounts exceeding 1% of the total resources as of end of preceding month 3 months

k) Mandatory allocation of credit resources to small and medium enterprises 2 quarters

I) Mandatory allocation of loanable funds

for agrarian reform and agricultural credit in general 2 quarters

m) Real estate loans ratio does not exceed twenty percent (20%) of total loan portfolio (for EKBs/KBs only) as of date of application

n) No findings of unsafe and unsound banking practices 6 months

o) Accounting records, systems, procedures and internal control are adequate as of date of application

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p) The applicant bank has generally complied with banking laws, rules and regulations, orders or instructions of the Monetary Board and/or BSP Management as of date of application

q) Member in good standing of the Philippine Deposit Insurance Corporation as of date of application

6. FOR PURPOSES OF EVALUATING BRANCH APPLICATIONS, THEORETICAL CAPITAL SHALL BE ASSIGNED TO EACH BRANCH TO BE ESTABLISHED, INCLUDING APPROVED BUT UNOPENED BRANCHES/OFFICES, AS FOLLOWS (IN MILLIONS):

LOCATION/TYPE OF BANK UB/KB

TB/ NATIONAL

COOP

RB/ LOCAL COOP

1) National Capital Region and the Cities of Cebu and Davao

Php 50 Php 15 Php 5 2) 1st to 3rd class cities

Php 25 Php 5 Php 2.5 3) 4th to 6th class cities

Php 25 Php 5 Php 1.5 4) 1st to 3rd class municipalities

Php 20 Php 5 Php 1.0 5) 4th to 6th class municipalities

Php 10 Php 2.5 Php 0.5 THE ASSIGNED THEORETICAL CAPITAL SHALL BE DEDUCTED FROM EXISTING QUALIFYING CAPITAL AS DEFINED UNDER SUBSEC. X116.1 FOR PURPOSES OF DETERMINING COMPLIANCE WITH THE TEN PERCENT (10%) RISK-BASED CAPITAL ADEQUACY RATIO. IF THE APPLICANT BANK'S RISK-BASED CAPITAL ADEQUACY RATIO AFTER . DEDUCTING THE ASSIGNED CAPITAL FOR THE PROPOSED BRANCH FROM THE EXISTING QUALIFYING CAPITAL WOULD BE LESS THAN TEN PERCENT (10%), ITS APPLICATION SHALL NOT BE PROCESSED UNLESS IT INFUSED SUCH AMOUNT AS MAY BE NECESSARY TO MAINTAIN ITS RISK-BASED CAPITAL ADEQUACY RATIO TO AT LEAST TEN PERCENT (10%). 7. The bank has been operating profitably FOR THE YEAR IMMEDIATELY

PRECEDING THE DATE OF APPLICATION, Or in the case of newly established banks, the submitted projection shoWE that profitability will be attained on the third year of operations, at the latest;

8. Additional requirements for the establishment of branches of microfinance- oriented banks and/or microfinance-oriented branches of regular banks:

a) Manual of operations on micro financing duly approved by the board

of directors (for microfinance-oriented branches of regular banks only);

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b) The branch shall have an adequate loan tracking system that allows daily monitoring of loan releases, collections and arrearages, and any restructuring and refinancing arrangements;

c) The proposed branch shall be managed by a person with adequate

experience or training in micro financing ACTIVITIES; and

d) At least seventy percent (70%) of the deposits generated by the branch to be established shall be actually lent out to qualified microfinance borrowers and the microfinance loans of said branch shall at all times be at least fifty percent (50%) of its gross loan portfolio (for microfinance-oriented branches of regular banks only).

For purposes of this Section, a microfinance-oriented bank or a microfinance-oriented branch is a bank or branch, respectively, that provides financial services and caters primarily to the credit needs of the basic or disadvantaged sectors such as farmer-peasants, artisanal fisherfolk, workers in the formal sector and migrant workers, workers in the informal sector, indigenous peoples and cultural communities, women, differently-abled persons, senior citizens, victims of calamities and disasters, youth and students, children, urban poor and low income households for their microenterprises and small businesses so as to enable them to raise their income levels and improve their living standards. Microfinance loans are granted on the basis of the borrower's cash flow and are typically unsecured.

Subsec. X151.3 Application for authority to establish branches . An application for authority to establish a branch shall be signed by the president of the bank or officer of equivalent rank and shall be accompanied by the following information/documents: 1. Business plan detailing the primary banking activities/products and

services to be offered; competition analysis to show that its application will not lead to overbanking in the target market; and financial projections for the first three years of operations showing sustained viability, as may be required by the appropriate supervising and examining department. In the evaluation of the business plan, due consideration shall be given to banks that are able or are committed to invest or deploy branch resources in their area of operations;

2. Certified true copy of the resolution of the bank's board of directors authorizing the establishment of the branch and indicating its proposed site;

3. Organizational set up of the proposed branch showing the proposed staffing pattern; and

4. Certification/Undertaking signed by the president or the executive vice president that the bank has complied or will comply, as the case maybe, with the prerequisites for the grant of authority to establish a

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branch/banking office under Subsec. X151.2.

Subsec. X151.4 Branching Guidelines . BRANCHES MAY BE

ESTABLISHED, SUBJECT TO THE FOLLOWING GUIDELINES: 1) ONLY ONE (1) BRANCH APPLICATION MAY BE SUBMITTED AT

ANY TIME EXCEPT FOR BANKS WITH AT LEAST R 100 MILLION UNIMPAIRED CAPITAL ACCOUNTS WHICH MAY BE ALLOWE A MAXIMUM OF FIVE (5) INCLUDING APPROVED BUT UNOPENED BRANCH APPLICATIONS, AT ANY TIME;

2) ONLY COMPLETE APPLICATIONS SHALL BE ACCEPTED. PROCESSING SHALL BE ON A FIRST-COME, FIRST-SERVED BASIS.

3) INDUSTRY/MARKET NOTICE OF APPLICATION FOR AUTHORITY TO ESTABLISH A BRANCH SHALL BE POSTED AT THE BSP WEBSITE UPON RECEIPT THEREOF;

4) BANKS SHALL BE ALLOWE TO ESTABLISH BRANCHES ANYWHERE IN THE PHILIPPINES, EXCEPT IN THE CITIES OF MAKATI, MANDALUYONG, MANILA, PARANAQUE, PASAY, PASIG AND QUEZON AND THE MUNICIPALITY OF SAN JUAN, METRO MANILA: PROVIDED, THAT BRANCHES OF MICROFINANCE-ORIENTED BANKS, MICROFINANCE-ORIENTED BRANCHES OF REGULAR BANKS AND BRANCHES THAT WILL CATER PRIMARILY TO THE CREDIT NEEDS OF BARANGAY MICRO BUSINESS ENTERPRISES (BMBEs) DULY-REGISTERED UNDER R.A. No. 9178 MAY BE ESTABLISHED ANYWHERE, SUBJECT TO COMPLIANCE WITH THE MINIMUM CAPITAL REQUIREMENTS UNDER SUBSEC. X151.2 AND THE FOLLOWING CONDITIONS:

a) A MICROFINANCE-ORIENTED BANK WITH HEAD OFFICE

OUTSIDE THE NCR MAY ESTABLISH A BRANCH IN THE NCR AFTER IT HAS PUT UP THE MINIMUM CAPITAL REQUIRED FOR A THRIFT BANK WITH HEAD OFFICE IN THE NCR; AND

b) A BANK WITH HEAD OFFICE OUTSIDE THE NCR MAY BE ALLOWE TO ESTABLISH A MICROFINANCE-ORIENTED BRANCH IN THE NCR ONLY AFTER IT HAS PUT UP THE MINIMUM CAPITAL REQUIRED FOR A THRIFT BANK WITH HEAD OFFICE IN THE NCR;

5) THE PROPOSED BRANCH SHALL BE LOCATED AT LEAST 200 METERS AWAY FROM AN EXISTING BANKING OFFICE: PROVIDED, THAT SAID DISTANCE REQUIREMENT SHALL NOT APPLY IN SHOPPING MALLS OR COMMERCIAL CENTER COMPLEXES, INCLUDING BUT NOT LIMITED TO SPECIAL EXPORT PROCESSING ZONES, 'PUBLIC MARKETS, FISH PORTS, LIVESTOCK/ AGRICULTURAL TRADING CENTERS, BIR COLLECTION OFFICES AND INDUSTRIAL/TECHNOLOGICAL PARKS;

6) MAXIMUM OF TWO (2) BANKING OFFICES SHALL BE ALLOWE IN 4TH TO 6TH CLASS MUNICIPALITIES;

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7) A RURAL BANK AND A LOCAL COOPERATIVE BANK SHALL ONLY BE ALLOWE TO ESTABLISH A BRANCH IF THEIR UNIMPAIRED CAPITAL ACCOUNTS IS AT LEAST P 10 MILLION.

8) A QUALIFIED RURAL BANK OR LOCAL COOPERATIVE BANK WITH UNIMPAIRED CAPITAL ACCOUNTS OF AT LEAST P 10 MILLION BUT LESS THAN P 50 MILLION MAY ESTABLISH A BRANCH ANYWHERE WITHIN TWO (2) - HOUR NORMAL TRAVEL TIME BY LAND/SEA PUBLIC TRANSPORT FROM THE HEAD OFFICE, EXCEPT IN THE NCR;

9) A RURAL BANK WITH UNIMPAIRED CAPITAL ACCOUNTS OF AT LEAST P 10 MILLION BUT LESS THAN P 50 MILLION MAY ESTABLISH BRANCHES IN ANY ISLAND GROUP (LUZON, VISAYAS OR MINDANAO) WHERE THE HEAD OFFICE IS LOCATED, EXCEPT IN THE NCR;

10) A LARGE RURAL BANK WITH AT LEAST P 100 MILLION UNIMPAIRED CAPITAL ACCOUNTS MAY ESTABLISH BRANCHES ANYWHERE IN THE PHILIPPINES, EXCEPT IN THE NCR;

11) A QUALIFIED BANK WITH UNIMPAIRED CAPITAL ACCOUNTS AT LEAST EQUIVALENT TO THE MINIMUM CAPITAL REQUIRED FOR A THRIFT BANK WITH HEAD OFFICE IN THE NCR MAY ESTABLISH BRANCHES ANYWHERE, EXCEPT IN THE CITIES OF MAKATI, MANDALUYONG, MANILA, PARAI AQUE, PASAY, PASIG AND QUEZON, AND THE MUNICIPALITY OF SAN JUAN, METRO MANILA, UNLESS QUALIFIED UNDER ITEM (4) ABOVE; AND

12) THE BSP MAY DECIDE TO DISAPPROVE AN OTHERWISE

QUALIFIED BRANCH APPLICATION IF IN ITS DETERMINATION SUCH BRANCH APPLICATION WILL LEAD TO AN OVERBANKING SITUATION IN THE SPECIFIC MARKET: PROVIDED, SUCH DISAPPROVAL SHALL BE SUBJECT TO CONFIRMATION BY THE MONETARY BOARD.

Subsec. X151.5 Branch processing fee . BRANCH PROCESSING

FEE SHALL BE AS FOLLOWS: • MICROFINANCE-ORIENTED BRANCHES/BANKS P 5,000 • RURAL BANKS /LOCAL COOPERATIVE BANKS P 25,000 • NON-AFFILIATED THRIFT BANKS/NATIONAL COOPERATIVE BANKS - P 100,000 • UNIVERSAL BANKS/COMMERCIAL BANKS/ AFFILIATED THRIFT BANKS P 200,000

PROVIDED, THAT A PROPOSED BRANCH TO BE MANNED BY NO MORE THAN THREE (3) OFFICERS/EMPLOYEES AT ANY TIME SHALL BE ASSESSED HALF (1/2) OF THE ABOVE BRANCH PROCESSING FEES: PROVIDED, FURTHER THAT BRANCHES OF THRIFT BANKS, RURAL BANKS AND LOCAL COOPERATIVE BANKS TO BE ESTABLISHED WITHIN THE REGION WHERE THE HEAD OFFICE IS LOCATED SHALL BE FREE FROM ASSESSMENT.

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Subsec. X151.6 Date of Opening. Approved branches shall be

opened within six (6) months from the date of approval thereof: Provided, That an applicant bank may be given a final extension of another six (6) months by the Deputy Governor, Supervision and Examination Sector, subject to the presentation of justification and valid reason for the bank's failure to open within the original six (6)-month period and proof that said branch/es can be opened within the succeeding six (6)-month period.

Subsec. X151.7 Requirements for opening a branch . After a bank's application to establish a branch has been approved, it may open the same subject to the following conditions: a) Submission of the personal information sheet (bio-data) of the proposed

manager and other officers of the branch at least thirty (30) days prior to the intended date of opening; and

b) A certification signed by the officer-in-charge of the Branches

Department with the rank of a vice president, or its equivalent or by a higher officer that:

1) Installation of the required security devices under Subsec. X165.4 has been complied with; and

2) Requirements enumerated under Subsec. X151.2 have been

complied with up to the time of actual opening.

A bank that fails to continuously comply with the requirements under Subsec. X151.2 shall be given an extension of time to open such branch after it has shown compliance for another test period of the same duration for each requirement under said Subsection: Provided, That the provisions of Subsec. X151.6 shall be observed if the branch cannot open within six (6) months from the date of approval thereof: Provided, further, That before such branch opens for business, the bank shall submit to the BSP the requirements under items "a" and "b(1)" of this Subsection; and a certification by the bank officer mentioned under item "b" hereof that upon opening of the branch, the bank has complied within the period prescribed therein.

Banks shall submit a written notice to the appropriate supervising and examining department of the BSP of the actual date of opening of their branches not later than FIVE (5) banking days from such opening.

Subsec. X151.8 Relocation/transfer of branches. Transfer/ relocation of branches shall be alloWE without prior BSP approval subject to the following conditions:

a. Notice of transfer to depositors and other creditors by registered mail

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OR PROOF OF DELIVERY (POD) SERVICE BY THE PHILIPPINE POSTAL CORPORATION (PHILPOST) OR OTHER MAIL COURIERS and posters in

conspicuous places in the premises of the banking office to be transferred at least three (3) months prior to the transfer: Provided, That said notification period may be reduced to forty-five (45) days under any of the following circumstances:

1) as an incentive to merger or consolidation of banks.; 2) as an incentive to purchase or acquisition of majority or all of the

outstanding shares of stock of a distressed bank for the purpose of rehabilitating the same; or

3) the proposed transfer site is within the same barangay or district of the same city or municipality of the branch to be relocated.

b. A certification signed by the head of the Branches Department with the

rank of Vice President or its equivalent or by a higher ranking officer informing the appropriate supervising and examining department of the BSP of the transfer and that the above requirements have been complied with, which shall be submitted not later than five (5) banking days from the date of transfer. The certification shall be accompanied by a certified true copy of the resolution of the bank's board of directors authorizing the transfer;

c. BRANCHES LOCATED IN THE CITIES OF MAKATI,

MANDALUYONG, MANILA, PARAFAQUE, PASAY, PASIG AND QUEZON, AND THE MUNICIPALITY OF SAN JUAN, METRO MANILA MAY BE RELOCATED/TRANSFERRED ANYWHERE; AND

d. BRANCHES LOCATED IN OTHER AREAS MAY BE

RELOCATED/TRANSFERRED ANYWHERE EXCEPT IN THE CITIES OF MAKATI, MANDALUYCNG, MANILA, PARANAQUE, PASAY, PASIG AND QUEZON, AND THE MUNICIPALITY OF SAN JUAN, METRO MANILA: PROVIDED, THAT BRANCHES OF RURAL BANKS AND LOCAL COOPERATIVE BANKS MAY BE RELOCATED/TRANSFERRED ONLY IN AREAS WHERE THEY ARE ALLOWE TO ESTABLISH BRANCHES: PROVIDED, FURTHER, THAT EXISTING RURAL BANKS AND LOCAL COOPERATIVE BANKS IN CITIES AND MUNICIPALITIES OF METRO MANILA OTHER THAN MAKATI, MANDALUYONG, MANILA, PARANAQUE, PASAY, PASIG, QUEZON, AND SAN JUAN MAY BE RELOCATED/TRANSFERRED ANYWHERE, EXCEPT IN THE AFOREMENTIONED CITIES AND MUNICIPALITY.

Subsec. X151.9 Voluntary closure/sale of banking offices.

A. Voluntary closure Voluntary closure of banking offices may be effected only with prior approval of the Bangko Sentral and shall be subject to the following conditions: 1) Notice of closure to depositors and other creditors by registered mail

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OR PROOF OF DELIVERY (POD) SERVICE OF THE PHILIPPINE POSTAL CORPORATION (PHILPOST) OR OTHER MAIL COURIERS and posters in conspicuous places in the premises of the banking office to be closed at least three (3) months prior to the closure;

2) A certification signed by the head of the Branches Department with

the rank of Vice President or its equivalent or by a higher ranking officer informing the appropriate supervising and examining department of the BSP of the closure and that the above requirements have been complied with, which shall be submitted at least ten (10) banking days prior to the date of closure. The certification shall be accompanied by a certified true copy of the resolution of the bank's board of directors authorizing the closure.

B. Sale of branches. 1) Sale of branches may be alloWE with prior approval of the

Monetary Board and subject to the following conditions:

a) The selling and. purchasing banks shall secure the prior written consent of the PDIC in the transfer of assets and assumption of liabilities as provided under Section 21 of the PDIC Charter (R.A. No. 3591), as amended by R. A. No. 9302;

b) The selling bank shall get the prior approval of the BSP to

close the branches to be sold SUBJECT TO THE FOLLOWING CONDITIONS:

I. Notice of sale to depositors and other creditors by registered mail OR PROOF OF DELIVERY (POD) SERVICE OF THE PHILIPPINE POSTAL CORPORATION (PHILPOST) OR OTHER MAIL COURIERS and posters in conspicuous places in the premises of the banking office at least three (3) months prior to the closure: Provided, That said notification period may be reduced to forty-five (45) days when there is no actual branch closure or disruption of branch operations. The depositors shall likewise be informed of their option to withdraw their deposits or to maintain the same with the acquiring bank;

ii. A certification signed by its President or Executive Vice President

(EVP) informing the appropriate supervising and examining department of the BSP of the closure and that the above requirements have been complied with, WHICH SHALL BE SUBMITTED AT LEAST TEN (10) BANKING DAYS PRIOR TO THE DATE OF CLOSURE The certification shall be accompanied by a certified true copy of the resolution of the bank's board of directors authorizing the closure.

2) The acquiring bank shall pay a licensing fee per branch as follows:

Appendix 5 Annex 4


143

Within Outside

Type of Bank Metro Manila Metro Manila UBs and KBs P 1 million P 500,000 TBs P 500,000 P 250,000

Subsec. X151.10 Sanctions. 1) Any violation of the provisions of Subsections X151.2 to X151.4 shall

be a ground for the cancellation of the franchise and closure of any branch established hereunder without prejudice to the imposition of the applicable criminal and administrative sanctions prescribed under Sections 36 and 37, respectively, of R.A. No. 7653.

2) If any part of the certification submitted by the bank as required in this Section is found to be false, the following sanctions shall be imposed: a. On the bank. Suspension for one (1) year of the privilege to establish and/or to open approved banking offices. b. On the certifying officer. A fine of P 5,000 per day (P 200 per day

for RBs/Coop Banks) from the time the certification was made up to the time the certification was found to be false for each banking office opened, transferred or closed without prejudice to the sanctions under Section 35 of R. A. No. 7653.

Subsec. X151.17 RelocationfTransfer of branch licenses of closed banks. Buyers of closed banks shall be alloWE to relocate/transfer acquired branches subject to the conditions stated under Items "c." and "d." of Subset. X151.8.

Section 2. Items "a.", "b.", and "c." of Sec. X213 of the MORB is hereby amended to read as follows:

"Servicing Deposits Outside Bank Premises . Banks may

be authorized by the BSP to solicit and accept deposits outside their bank premises, subject to the following conditions:

a. MINIMUM CAPITAL REQUIREMENT IS MET;

b. NO MAJOR SUPERVISORY CONCERNS AFFECTING

SAFETY AND SOUNDNESS;

c. THE AREA OF OPERATIONS SHALL BE WITHIN ONE (1)- HOUR NORMAL TRAVEL TIME BY LAND/SEA FROM ANY HEAD OFFICE OR BRANCH, EXCEPT IN REMOTE AREAS WHERE MORE THAN ONE (1)- HOUR NORMAL TRAVEL TIME MAY BE ALLOWED." Section 3. Repealing Clause. The provision/s of the Manual

of Regulations for Banks (MORE) and existing circulars/regulations

Appendix 5 Annex 4


144

which are inconsistent with the provisions of this Circular are hereby repealed and/or amended accordingly_

This Circular shall take effect fifteen (15) days following its publication either in the Official Gazette or in a newspaper of general circulation.

x x x

22 December 2005

Appendix 5 Annex 5


145

FINANCIAL PROJECTIONS – FEASIBILITY STUDY

INC OME S TATE ME NT - F eas ibility S tudy (C orrec ted)(based on F eas ibility S tudy, in Millions )

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

INC OME

Interest Income

L oans and Discounts 532,440 783,360 1,006,740 1,302,833 1,750,030 2,080,176 2,653,942 3,433,680 4,505,193 5,657,341

Investments - for R eserve P urposes 6,784 8,819 11,465 14,904 18,631 23,288 29,110 36,388 46,394 59,153

Investments - for Agri-Agra 65,059 84,905 110,779 144,462 180,947 226,398 283,328 354,532 452,410 577,045

Investments - for S ME 18,739 24,328 31,586 41,017 51,234 64,022 80,309 103,608 135,539 177,309

Depos it with C entral Bank 2,544 3,307 4,299 5,589 6,986 8,733 10,916 13,645 17,398 22,182

Depos it with L ocal Banks 48,964 55,690 66,828 80,194 100,242 125,302 156,773 176,370 201,879 226,048

O ther Income 0 0 0 0 0 0 0 0 0

S ervice F ees/C harges 138,656 41,597 54,076 102,620 111,172 138,965 180,654 245,133 336,183 437,038

Miscellaneous Income (1) 0 20,000 21,600 23,328 25,194 27,210 29,387 31,737 34,276 37,019

Total Inc ome 813,186 1,022,007 1,307,373 1,714,948 2,244,436 2,694,093 3,424,420 4,395,093 5,729,273 7,193,136

L ess : Interest E xpense 0 0 0 0 0 0 0

S avings 52,000 67,600 87,880 114,244 142,805 178,506 223,133 278,916 355,618 453,413

T ime 140,800 183,040 237,952 309,338 386,672 483,340 604,175 755,219 962,904 1,227,702

B ills P ayable - Others 0 0 0 0 0 0 0 0 0 0

L ess : Bad Debt E xpens e 63,750 82,875 107,738 140,059 175,073 218,842 413,611 529,422 688,249 894,723

L ess : O perating E xpenses 0 0 0 0 0 0 0 0 0

C ompensation / F ringe Benefits 13,280 13,870 14,497 15,166 15,877 16,612 17,392 18,198 19,052 19,960

Management & Other P rofess ional F ees 3,108 3,108 3,108 3,108 3,108 3,108 3,108 3,108 3,108 3,108

Depreciation / Amortization (2) 6,000 6,720 7,080 7,120 7,160 7,680 8,000 8,040 8,080 11,576

P lus (L ess ) Add'l Depreciation / Amortization (3) 0 0 0 0 0 240 240 240 0 -2,352

T axes and L icenses 72,115 91,376 118,207 154,989 198,955 243,326 307,191 390,767 505,773 640,942

R ent 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200

S tationery & S upplies Used 2,000 2,000 2,000 2,000 2,000 2,400 2,400 2,400 2,400 2,400

Miscellaneous - R epairs , P ower, Water, etc. 6,640 6,935 7,249 7,583 7,939 8,306 8,696 9,099 9,526 9,980

S ub-total 104,342 125,208 153,341 191,165 236,239 282,872 347,988 433,052 549,140 686,813

Total E xpens es 360,892 458,723 586,911 754,806 940,789 1,163,560 1,588,907 1,996,609 2,555,910 3,262,652

Net O perating Income (L oss ) 452,294 563,284 720,462 960,142 1,303,647 1,530,534 1,835,513 2,398,484 3,173,363 3,930,484

E xtraordinary C redit / (C harges ) 0 0 0 0 0 0 0 0 0 0

Net Income before T ax 452,294 563,284 720,462 960,142 1,303,647 1,530,534 1,835,513 2,398,484 3,173,363 3,930,484

L ess : Income T ax 0 0 0 0 0 0 0 0 0 0

Net Inc ome after Tax 452,294 563,284 720,462 960,142 1,303,647 1,530,534 1,835,513 2,398,484 3,173,363 3,930,484

Dividends dec lared (4) 0.00 0.00 200,000 200,000 200,000 200,000 200,000 200,000 200,000 200,000

C os t to Inc ome R atio 16.82% 16.23% 15.62% 14.80% 13.78% 13.92% 13.40% 12.88% 12.45% 12.46%

O perating E xpenses 104 125.21 153 191 236 283 348 433 549 687

O perating Income 620 771 982 1,291 1,715 2,032 2,597 3,361 4,411 5,512

Appendix 5 Annex 5


146

S TAT E ME NT OF C ONDITION - F eas ibility S tudy (C orrec ted)(based on F eas ibility S tudy, in Millions )

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

AS S E TSC AS H IN HAND/IN B ANK S

C as h in Hand 184,746 177,937 213,416 267,423 366,068 402,134 476,502 542,992 673,317 725,461

Due from C B P 84,800 110,240 143,312 186,306 232,882 291,103 363,878 454,848 579,931 739,412

Due from G overnment B anks - L B P 610,000 701,500 841,800 1,010,160 1,262,700 1,578,375 2,051,888 2,308,373 2,654,629 2,986,458

Due from G overnment B anks - DB P 610,000 701,500 841,800 1,010,160 1,262,700 1,578,375 2,051,888 2,308,373 2,654,629 2,986,458

Due from O ther B anks 412,120 453,332 543,999 652,799 815,998 1,019,998 1,121,998 1,262,248 1,420,028 1,562,031

S ub-total 1,901,666 2,144,509 2,584,327 3,126,848 3,940,349 4,869,984 6,066,153 6,876,834 7,982,535 8,999,821

L O ANS AND DIS C O UNT S

C urrent L oans 6,375,000 8,287,500 10,773,750 14,005,875 17,507,344 21,884,180 26,195,363 33,530,065 43,589,084 56,665,809

P as t Due 1,378,703 1,764,740 2,294,162 2,982,411

T otal L oans 6,375,000 8,287,500 10,773,750 14,005,875 17,507,344 21,884,180 27,574,066 35,294,805 45,883,247 59,648,220

L es s : L oan L os s P rovis ion

B eginning B alance

P lus : B ad Debt E xpense, C urrent L oans (82,875) (107,738) (140,059) (175,073) (218,842) (275,741) (352,948) (458,832) (596,482)

P lus : Additional Amount (1) (82,875)

P lus : B ad Debt E xpense, P as t Due L oans (137,870) (176,474) (229,416) (298,241)

L oan L os s P rovis ion (63,750) (165,750) (107,738) (140,059) (175,073) (218,842) (413,611) (529,422) (688,249) (894,723)

L oans , net of L oan L os s P rovis ion 6,311,250 8,121,750 10,666,013 13,865,816 17,332,270 21,665,338 27,160,455 34,765,383 45,194,998 58,753,497

INVE S T ME NT S - B O NDS & O T HE R DE B T INS T .

G ov. B onds /S ecurities - for R es erve R equirements 169,600 220,480 286,624 372,611 465,764 582,205 727,756 909,695 1,159,862 1,478,823

G ov. B onds /S ecurities - for Agri-Agra (L B P B onds ) 1,626,475 2,122,635 2,769,469 3,611,552 4,523,679 5,659,945 7,083,203 8,863,309 11,310,250 14,426,125

G ov. B onds /S ecurities - S B G F C Debt Ins truments 468,478 608,199 789,654 1,025,426 1,280,859 1,600,539 2,007,725 2,590,207 3,388,475 4,432,737

E quity Inves tment/O ther Inves tment 0 250,000 270,000 291,600 314,928 340,122 367,332 396,719 428,456 462,733

S ub-total 2,264,553 3,201,314 4,115,747 5,301,190 6,585,230 8,182,812 10,186,016 12,759,931 16,287,042 20,800,419

B ANK P R E MIS E S , F UR NIT UR E , F IX T UR E S & E QUIP ME NT

B ank P remis es - L and 62,500 62,500 62,500 62,500 62,500 62,500 62,500 62,500 62,500 62,500

B uilding 40,000 48,000 52,000 52,000 52,000 52,000 56,000 56,000 56,000 56,000

L es s : Accumulated Depreciation-B uilding 2,000 4,400 7,000 9,600 12,200 14,800 17,600 20,400 23,200 26,000

B ook Value-B uilding 38,000 43,600 45,000 42,400 39,800 37,200 38,400 35,600 32,800 30,000

F urniture & E quipment 8,000 9,600 10,400 10,800 11,200 11,600 12,000 12,400 12,800 13,200

L es s : Accumulated Depreciation-F urn. & E qt. 800 1,760 2,800 3,880 5,000 6,160 7,360 8,600 9,880 11,200

B ook Value-F urn. & E qt. 7,200 7,840 7,600 6,920 6,200 5,440 4,640 3,800 2,920 2,000

T rans portation E quipment 12,000 12,000 12,000 12,000 12,000 26,400 26,400 26,400 26,400 43,680

L es s : Accumulated Depreciation-T rans. E qt. 2,400 4,800 7,200 9,600 12,000 14,880 17,760 20,640 23,520 29,856

B ook Value-T rans . E qt. 9,600 7,200 4,800 2,400 0 11,520 8,640 5,760 2,880 13,824

L eas ehold Improvements 8,000 9,600 10,400 10,400 10,400 10,400 11,200 11,200 11,200 11,200

L es s : Accumulated Depreciation-L eas e. Imp. 800 1,760 2,800 3,840 4,880 5,920 7,040 8,160 9,280 10,400

B ook Value-L eas e. Imp. 7,200 7,840 7,600 6,560 5,520 4,480 4,160 3,040 1,920 800

S ub-total 124,500 128,980 127,500 120,780 114,020 121,140 118,340 110,700 103,020 109,124

O T HE R AS S E T S

Mis cellaneous (including s tationery and supplies ) (2) 2,000 2,200 0 0 0 0 0 0 0 0

TO TAL AS S E TS 10,603,969 13,598,753 17,493,587 22,414,634 27,971,869 34,839,273 43,530,965 54,512,847 69,567,595 88,662,860

Appendix 5 Annex 5


147

S TATE ME NT OF C ONDIT ION - F eas ibility S tudy (C orrec ted)(based on F eas ibility S tudy, in Millions )

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

L IAB IL IT IE S & C AP ITAL

L IAB IL IT IE S

DE P O S IT L IAB IL IT IE S

Demand Deposits 240,000 312,000 405,600 527,280 659,100 823,875 1,029,844 1,287,305 1,641,313 2,092,675

S avings Deposits - from R eserve F unds of Water Dis tricts 5,200,000 6,760,000 8,788,000 11,424,400 14,280,500 17,850,625 22,313,281 27,891,602 35,561,792 45,341,285

T ime Depos its 2,560,000 3,328,000 4,326,400 5,624,320 7,030,400 8,788,000 10,985,000 13,731,250 17,507,344 22,321,863

S ub-total 8,000,000 10,400,000 13,520,000 17,576,000 21,970,000 27,462,500 34,328,125 42,910,156 54,710,449 69,755,823

B O R R O W ING S

O T HE R L IAB IL IT IE S

Unearned Interes ts (interest collected in advance?) 79,560 91,800 119,340 187,463 203,085 203,085 330,013 447,803 614,130 798,368

Withholding T ax, VAT , other taxes 72,115 91,376 118,207 154,989 198,955 243,326 307,191 390,768 505,773 640,942

S S S , Med., P ag-Ibig , P hilHealth & E C C P 'ble 0 0 0 0 0 0 0

Dividents P ayable 200,000 200,000 200,000 200,000 200,000 200,000 200,000 200,000

O ther L iabilities 0 0 0 0 0 0 0

S ub-total 151,675 183,176 437,547 542,452 602,041 646,411 837,205 1,038,570 1,319,903 1,639,311

TOTAL L IAB IL ITIE S 8,151,675 10,583,176 13,957,547 18,118,452 22,572,041 28,108,911 35,165,330 43,948,727 56,030,352 71,395,133

C AP ITAL

C apital S tock-C ommon 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000

C apital S tock-P referred 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000

S urplus (F ree) 452,294 815,577 1,336,040 2,096,182 3,199,828 4,530,362 6,165,635 8,364,121 11,337,243

Undivided P rofits

Donated C apital-L and & B uilding

Net Income (L oss) 452,294 563,284 720,462 960,142 1,303,647 1,530,534 1,835,273 2,398,486 3,173,123 3,930,484

TOTAL C AP ITAL 2,452,294 3,015,577 3,536,040 4,296,182 5,399,828 6,730,362 8,365,635 10,564,121 13,537,243 17,267,727

TOTAL L IAB IL ITIE S & C AP ITAL 10,603,969 13,598,753 17,493,587 22,414,634 27,971,869 34,839,273 43,530,965 54,512,847 69,567,595 88,662,860

C AP ITAL ADE QUAC Y R ATIO (roug h c alc ulation)

10% Assumed R egulatory C apital R equirement for L oans 38.47% 36.39% 32.82% 30.67% 30.84% 30.75% 30.34% 29.93% 29.50% 28.95%

E stimated R egulatory C apital S hortfall - - - - - - - - - -

Appendix 5 Annex 5


148

C AS H F L OW S T ATE ME NT - R ec ons truc ted from F S

(based on F eas ibility S tudy) 2010 2011 2012 2013 2014 2015 2016 2017 2018

563,284 720,462 960,142 1,303,647 1,530,534 1,835,273 2,398,486 3,173,123 3,930,484

Depreciation / Amortization 6,720 7,080 7,120 7,160 7,680 8,000 8,040 8,080 11,576

Due from C B P (25,440) (33,072) (42,994) (46,576) (58,221) (72,776) (90,970) (125,083) (159,481)

Due from G overnment B anks - L B P (91,500) (140,300) (168,360) (252,540) (315,675) (473,513) (256,486) (346,256) (331,829)

Due from G overnment B anks - DBP (91,500) (140,300) (168,360) (252,540) (315,675) (473,513) (256,486) (346,256) (331,829)

Due from O ther B anks (41,212) (90,666) (108,800) (163,200) (204,000) (102,000) (140,250) (157,781) (142,003)

Decrease (increase) in Net L oans and D iscounts (1,810,500) (2,544,263) (3,199,804) (3,466,454) (4,333,068) (5,495,118) (7,604,928) (10,429,615) (13,558,499)

Increas e (decrease) in O ther L iabilities

Unearned Interests (interest collected in advance?) 12,240 27,540 68,123 15,622 0 126,928 117,789 166,327 184,239

Withholding T ax, VAT , other taxes 19,261 26,831 36,782 43,966 44,371 63,865 83,576 115,006 135,169

Decrease (increase) in O ther Ass ets

Miscellaneous (including s tationery and supplies ) (200) 2,200

(2,022,131) (2,884,950) (3,576,292) (4,114,562) (5,174,587) (6,418,125) (8,139,713) (11,115,579) (14,192,657)

B ank P remises - L and

B uilding (8,000) (4,000) (4,000)

F urniture & E quipment (1,600) (800) (400) (400) (400) (400) (400) (400) (400)

T ransport. E quipment (14,400) (17,280)

L eas ehold Improvements (1,600) (800) (800)

G ov. Bonds /S ecurities - for R eserve R equirements (50,880) (66,144) (85,987) (93,153) (116,441) (145,551) (181,939) (250,166) (318,962)

G ov. Bonds /S ecurities - for Agri-Agra (L B P Bonds ) (496,160) (646,834) (842,083) (912,127) (1,136,266) (1,423,258) (1,780,107) (2,446,941) (3,115,875)

G ov. Bonds /S ecurities - S B G F C Debt Ins truments (139,722) (181,455) (235,772) (255,433) (319,680) (407,186) (582,482) (798,267) (1,044,262)

E quity Investment/O ther Inves tment (250,000) (20,000) (21,600) (23,328) (25,194) (27,210) (29,387) (31,737) (34,276)

(947,962) (920,033) (1,185,842) (1,284,440) (1,612,381) (2,008,405) (2,574,315) (3,527,512) (4,531,056)

Dividends P aid (2) (200,000) (200,000) (200,000) (200,000) (200,000) (200,000) (200,000)

Increas e (decrease) in Depos it L iabilities

Demand Depos its 72,000 93,600 121,680 131,820 164,775 205,969 257,461 354,009 451,361

S avings Depos its - from R eserve F unds of Water D is tricts 1,560,000 2,028,000 2,636,400 2,856,100 3,570,125 4,462,656 5,578,320 7,670,190 9,779,493

T ime Depos its 768,000 998,400 1,297,920 1,406,080 1,757,600 2,197,000 2,746,250 3,776,094 4,814,520

2,400,000 3,120,000 3,856,000 4,194,000 5,292,500 6,665,625 8,382,031 11,600,293 14,845,374

(6,809) 35,479 54,007 98,645 36,065 74,369 66,490 130,325 52,145

Net c as h flow from financ ing ac tivities

Net inc reas e (dec reas e) in "C as h in Hand" (1)

Increas e (decrease) in Bank P remis es , F urniture, F ix. & E quip.

Increas e (decrease) in Inves tments - B onds/O ther Debt Ins t.

Net c as h flow from inves ting ac tivities

F INANC ING AC TIVITIE S , c as h flows provided by or us ed in:

S ale (repurchas e) of s tock

Increas e (decrease) in Borrowings

INVE S TING AC TIVITIE S , c as h flows provided by or us ed in:

NE T INC OME

OP E R ATING AC TIVIT IE S , c as h flows provided by or us ed in:

Non-C ash E xpenses

Decrease (increase) in C as h in Banks

Net c as h flow from operating ac tivities

Appendix 5 Annex 6


149

KEY ASSUMPTIONS – FINANCIAL PROJECTIONS

a.--

-

b.---

c.

d.

1.• P80 million, as the purchase price paid to the banks majority owners

2.

Transactions (peso millions) 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Purchase of 60% Share:C redit: Investments 80

Debit: C ash 80

Recapitalization of the Bank:C redit: Investments [700] T B D T B D T BD T B D T B D T B D T B D T B D T B D

Debit: C ash [700] T B D T B D T BD T B D T B D T B D T B D T B D T B D

3.

Transactions (peso millions) 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Purchase of 60% Share: None as this was a transaction between a shareholder and L WUA, and the bank was not involved.

Recapitalization of the Bank:C redit: C ash [700] T B D T B D T BD T B D T B D T B D T B D T B D T B D

Debit: C apital S tock [700] T B D T B D T BD T B D T B D T B D T B D T B D T B D

1.--

2. The starting point, year-end 2009:

a.

(34,386,607)

(12,274,707)

700,000,000

C apital pos ition as of 12/31/2009 (adjus ted) 653,338,686

Two scenarios were prepared:--

LWUA’s purchase of 60% share of Express Savings Bank is assumed to be recorded on the books of LWUA as follows:

The Statement of Condition and the Statement of Income and Expenses in Feasibility Study were reconstructed and corrected as A Cash Flow Statement was prepared based on the information provided.

Year-end 2009 figures assumed a recapitalization of the banks by its shareholders (no specific attribution of recapitalization funds to any shareholder group).

LWUA’s purchase of 60% share of Express Savings Bank is assumed to be recorded on the books of Bank as follows:

C apital infus ion from the bank's shareholders

Annual growth projections assumed were broadly in line with the Feasibility Study.

Our Base Case assumed a capital base of P653 million as of 12/31/2009, growing at roughly the same pace as the FS.

As sume loss for calendar year 2009 and recapitalization of bank from a negative capital position of -P 34million as of 3/31/2009 as a res ult of a capital infus ion

by bank's shareholders .

C apital position as of 3/31/2009, per audit report

T his may be suffic ient capital for the bank to es tablish its Head O ffice in Metro Manila (which requires a capital bas e of P 325 million). A larger capital base is

likely to be necessary for additional branches in key c ities .

LWUA's cash outlay in connection with the bank would likely include:

The projection period covers 9 years from year-end 2009 to year-end 2018 using the projections in the Feasibility Study as a starting point.

Our Optimistic Case assumed the same capital base of P653 million as of 12/31/2009, but with far higher growth rates (to achieve a size of roughly half the FS by 2018) and a slightly more favorable cost-to-income ratio.

ANNEX 6 – KEY ASSUMPTIONS – FINANCIAL PROJECTIONS

It will be a material transition exercise to expand and reorient the bank, and mobilize the Water Districts for deposits and loans.

Raising significant funding by accessing reserve funds of Water Districts (akey factor in the projected profitability of the bank) has to be validated.

No revenues/expenses/income in 2009 in the absence of any information; we also understand that the bank has lost money for the past few years.

These assumptions could be considered aggressive based on industry statistics.However, there is apparently significant pent up demand for credit of the Water Districts.

Operating expenses were adjusted significantly upwards, to be more in line with the industry averages for thrift banks and commercial banks.

A smaller scale of operations as of 12/31/2009 was assumed for the following reasons: There is limited time to ramp up operations

A bank of the size projected in the Feasibility Study would rank 12th in terms of assets and 5th in terms of deposits, among thrift banks (based on BSP data as of March 2009). A Base Case sized thrift would rank 25th (by assets) and 24th (by deposits).

• Its share of the capital infusion required to recapitalize the bank in order to meet its current regulatory capital requirements and to support the growth projected, while maintaining an ownership interest no greater than the 60% limit indicated

A. LWUA Purchase Transaction

B. General Assumptions

Net los s for last three quarters of calendar year 2009

Appendix 5 Annex 6


150

b.

T otal L iabilities 8,151,674,812

T otal C apital 2,452,293,844

T otal L iabilities & C apital 10,603,968,655

F rom S tep 2a above:

C apital pos ition as of 12/31/2009 (adjus ted) 653,338,686

As of % of T otal C apital as of 12/31/2009, per F eas ibility S tudy 26.64%

Multiply each As s et and L iability item on the S tatement of C ondition as of 12/31/2009 by this factor

- 2,825,103,103.39

2,171,764,417.39

653,338,686.00

3. From 2010 and for each year until 12/31/2018:

a.

--

C alculating the S tatement of Income and E xpenses for the calendar year 2010:

P er F eas ibility S tudy, S tatement of Income and E xpens es for 2010:

Interes t Income 960,409,733

O ther Income 61,596,875

T otal O perating Income 1,022,006,608

L es s : Interes t E xpens e (250,640,000)

Net O perating Income 771,366,608

L es s : B ad D ebt E xpens e (82,875,000)

L es s : O perating E xpens es (125,208,094)

Net Inc ome 563,283,514

T o calculate Bas e C as e and O ptimis tic C as e income and expenses :

T otal O perating Income times (% of Int-earning Ass ets vs . F S ) 272,282,401

L ess : Interes t E xpens e times (% of Depos its vs . F S ) (66,775,362)

Net O perating Income 205,507,039

L es s : B ad D ebt E xpens e times (22,079,509)

L es s : O perating E xpens es recalculated to be in line with bank peers

Net O perating Income times (S ee below) (142,971,247)

Net Inc ome 40,456,283

C os t to Inc ome R atio (B as e C as e) 69.57%

P er BS P , P hilippine Banking S ystem : C ommerc ial B anks T hrift B anks

March-09 * B as e C as e 87.02%

D ecember-08 86.53%

S eptember-08 91.57%

J une-08 * O ptimis tic C as e 93.32%

Average 89.61%

b. Calculating the Statement of Condition as of 12/31/2010 and each year-end until 12/31/18:

- Key year-on-year growth assumptions:2010 2011 2012 2013 2014 2015 2016 2017 2018

FS 30% 30% 30% 25% 25% 20% 28% 30% 30%

Base 25% 25% 20% 20% 10% 10% 10% 10% 10%

Optimistic 63% 63% 50% 40% 25% 25% 25% 25% 25%

Deposits FS 30% 30% 30% 25% 25% 25% 25% 28% 28%

Base 38% 30% 24% 24% 10% 10% 10% 10% 10%

Optimistic 79% 66% 48% 41% 25% 24% 24% 24% 25%

-- 1%

- 10%

----

c.

60.69%

63.24%

69.57%

For both the Base Case and the Optimistic Case, as of 12/31/2009:As s ets

L iabilities

P er F eas ibility S tudy, S tatement of C ondition as of 12/31/2009:

65.92%

Assumptions:

C apital

General Loan Loss Provision

26.64%

of Past Due Loans

BS P 's "C os t-to-Income R atio": R atio of Annualized Non-Interes t E xpens e, Net of Impairment L os s es to Annualized T otal O perating Income (Net Interes t

Income + Non-Interes t Income)

26.64%

26.64%

Capital Infusions - only as required to meet regulatory capital requirements (roughly estimated to be 10% of Gross Loans).

No borrowings through the projection period (per FS).

The assumption that deposits will grow faster than loans is necessary for the Base and Optimistic Cases due to the assumption that the bank will not borrow and will not require additional capital infusions, to the extent possible.

No dividends paid (FS assumed P200 million declared and payable by year-end 2011 and annually thereafter).

70.19%

No "Equity Investment/Other Investment" ever; FS assumes P250 million annually, with an annual increase

Using the Adjusted Statement of Condition as of 12/31/2009 as a starting point, asset and liability items were increased by annual percentages, as summarized on the attached table. In general, the percentages used were equal to or slightly less than the percentages used in the Feasibility Study.

Loans

Specific Loan Loss ProvisionNot much adjustment was given to "Bank Premises, Furniture, Fixtures & Equipment" as operating costs were adjusted upwards by

Adjus ting the S tatement of C ondition as of 12/31/2009:

Scaling Assets & Liabilities

"Operating Income" and "Interest Expense" actual figures as projected in the Feasibility Study, were then be multiplied by these percentages.

Past due loans as % of Current Loans: 5% until year-end 2012, thereafter 10%

69.57%

of Current Loans

Scaling Income - In the absence of meaningful information on the income projections in the Feasibility Study, "Operating Income" and "Interest Expense" figures would be adjusted by calculating two percentages at the beginning of each year:

Interest-earning Assets per [Base][Optimistic] Case/ Interest-earning Assets per Feasibility StudyDeposits per [Base][Optimistic] Case/ Deposits per Feasibility Study

Appendix 5 Annex 6


151

C. General Observations 1.

Base Case Total Assets adjusted as described above, increases to P1.75 billion as of 12/31/2009. While this is 10 times the 3/31/2009 balance sheet, it is only 16% of the equivalent figure in the Feasibility Study. At year-end 2009 - Base Case:

- Total Loans of P1 billion - Total Deposits of P1.3 billion 2.

Internally generated capital (through earnings) grew at a significantly slower rate than projected in the FS due to the following:

- Significantly smaller operations as of 12/31/2009 (Interest-earning Assets are 16% of the equivalent figure in FS) - Significantly higher "Cost-to-Income

Ratio"

Per FS 16.23%

(for 2010)

Per Base Case 69.57%

Per Optimistic Case 60.69%

- We have therefore assumed NO dividends will be paid throughout the projection period - for both Base and Optimistic Cases.

3.

On the assumption that the bank does NOT borrow, and that no capital infusions are made until absolutely necessary to meet the minimum regulatory capital requirement, there is significant dependence on deposits to grow faster than loans. In the Optimistic Case, capital infusions were required in the later years due to the lower capital initially, and the strong loan growth.

D. Other Points to Consider As a general comment, it is difficult to prepare meaningful financing projections with limited information and time. The points enumerated below are additional considerations for refining any financial projections for the Bank. 1. Required Capital Infusions: To correct the capital deficiency problem of the bank, and make it eligible to transfer its head office to Manila, at least P400 million needs to be infused. LWUA reportedly has set aside and released P400 million of funds for this in September and another P300 million more in October, and formal infusion will be effective upon Monetary Board Approval of the acquisition. Assuming that capitalization of Express Bank remains at P400 million in 2009, then LWUA would have disbursed a total of P780 million for this project within 2009. It is realistically assumed that the minority shareholders have allowed themselves to be diluted, and therefore have not paid in additional cash to keep up their pro-rata share in the bank. This presents a problem for LWUA, in that it will be above the 60% legal ownership ceiling. This will be even more pronounced in 2010 when the capitalization is increased to P2.0 billion projected. Assuming however that a suitable minority partner is not yet found w

Appendix 5 Annex 7


152

IMPLICATIONS OF WATER ENERGY BANK OF LWUA

Initial Purchase Price, paid to majority owners of bank

As of 12/31 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Capital contributions to the bank FS 2,452 - - - - - - - - - -> Contributed by shareholders and/or new investors Base 700 - - - - - - - - - -> No assumption is made about LWUA's share Optimistic 700 - - 36 290 119 142 166 182 248

Full Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Share in Earnings/Losses (assuming a 60% stake) FS 271 338 432 576 782 918 1,101 1,439 1,904 2,358

Base 18 23 31 27 34 40 47 58 60 Optimistic 16 25 45 44 72 94 126 175 203

Dividends declared (assuming a 60% stake) FS - 120 120 120 120 120 120 120 120 Base - - - - - - - - - Optimistic - - - - - - - - -

As of 12/31 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Savings Deposits - Reserve Funds of Water Districts FS 5,200 6,760 8,788 11,424 14,281 17,851 22,313 27,892 35,562 45,341

Base 1,385 1,905 2,476 3,071 3,808 4,188 4,607 5,068 5,575 6,132 Optimistic 1,385 2,476 4,111 6,084 8,566 10,708 13,278 16,464 20,416 25,520

Increase in Savings Deposits (year-on-year) FS 1,560 2,028 2,636 2,856 3,570 4,463 5,578 7,670 9,779 Base 520 571 594 737 381 419 461 507 557 Optimistic 1,091 1,634 1,973 2,482 2,142 2,570 3,187 3,951 5,104

Loans to Water Districts FS 6,375 8,288 10,774 14,006 17,507 21,884 27,574 35,295 45,883 59,648 Base 1,698 2,229 2,786 3,344 4,204 4,624 5,086 5,595 6,154 6,770 Optimistic 1,698 2,898 4,709 7,064 10,360 12,950 16,188 20,235 25,293 31,617

Increase in Loans to Water Districts (year-on-year) FS 1,913 2,486 3,232 3,501 4,377 5,690 7,721 10,588 13,765 Base 531 557 557 860 420 462 509 559 615 Optimistic 1,200 1,811 2,355 3,296 2,590 3,238 4,047 5,059 6,323

B. Potential for Earnings/Losses

(pesos million)Annex 7 – IMPLICATIONS OF WE BANK ON LWUA

A. Cash Requirements from LWUA

80

-> Available to shareholders only if paid out as dividends or through shareholder loans

C. Sources/Uses of Funds from the Sector

Appendix 5 Annex 8


153

BASE SCENARIO PROJECTIONS

INC OME S T AT E ME NT - B as e C as e ( In Millions ) 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

(bas ed on F S (C orrected), as per Methodology) (F rom F S )

At beginning of calendar year S caled vs . F S S caled vs . F S S caled vs . F S S caled vs . F S S caled vs . F S S caled vs . F S S caled vs . F S S caled vs . F S S caled vs . F S

Adj. Interes t-earning As s ets /F S 26.64% 26.42% 25.75% 23.90% 23.52% 20.72% 18.16% 15.92% 13.71%

Adj. Depos its /F S 26.64% 28.18% 28.18% 26.88% 26.66% 23.46% 20.65% 18.17% 15.68%

INC OME

Interes t Income

L oans and Discounts 532,440 208,702 265,995 335,429 418,189 489,186 549,997 623,580 717,327 775,639




Depos it with C entral Bank 2,544 881 1,136 1,439 1,669 2,054 2,262 2,478 2,770 3,041

Depos it with L ocal B anks 48,964 14,837 17,657 20,647 23,954 29,467 32,489 32,030 32,144 30,992

O ther Income


Mis cellaneous Income 0 5,328 5,707 6,006 6,020 6,399 6,090 5,764 5,458 5,075

Total Inc ome 813,186 272,282 345,427 441,532 536,333 633,558 709,668 798,179 912,227 986,201

L es ss : Interes t E xpense

S avings 52,000 18,010 23,219 29,413 34,125 41,979 46,242 50,653 56,622 62,164

T ime 140,800 48,765 62,870 79,642 92,400 113,665 125,208 137,153 153,316 168,322

Bills P ayable - O thers 0 0 0 0 0 0 0 0 0 0

S ub-total 192,800 66,775 86,090 109,056 126,524 155,643 171,449 187,806 209,938 230,486

L es s : Bad Debt E xpense 63,750 32,907 41,134 49,360 80,251 88,276 97,103 106,813 117,495 129,244

L es s : Operating E xpens es (1) 0 0 0 0 0 0 0 0 0 0

C ompensation / F ringe B enefits 13,280 0 0 0 0 0 0 0 0 0

Management & O ther P rofes s ional F ees 3,108 0 0 0 0 0 0 0 0 0

Depreciation / Amortization 6,000 0 0 0 0 0 0 0 0 0

P lus (L ess ) Add'l Depreciation / Amortization 0 0 0 0 0 0 0 0 0 0

T axes and L icens es 72,115 0 0 0 0 0 0 0 0 0

L itigation / Ass ets Acq. E xpenses 0 0 0 0 0 0 0 0 0 0

R ent 1,200 0 0 0 0 0 0 0 0 0

S tationery & S upplies Us ed 2,000 0 0 0 0 0 0 0 0 0

Mis cellaneous - R epairs , P ower, Water, etc. 6,640 0 0 0 0 0 0 0 0 0

S ub-total (1) 104,342 142,971 180,421 231,304 285,104 332,485 374,439 424,637 488,583 525,751

Total E xpens es 360,892 242,654 307,644 389,720 491,879 576,404 642,991 719,256 816,016 885,481

Net Operating Income (L oss ) 452,294 29,629 37,783 51,812 44,454 57,154 66,677 78,923 96,212 100,720

E xtraordinary C redit / (C harges) 0 0 0 0 0 0 0 0 0 0

Net Income before T ax 452,294 29,629 37,783 51,812 44,454 57,154 66,677 78,923 96,212 100,720

L es s : Income T ax 0 0 0 0 0 0 0 0 0 0

Net Inc ome after Tax 452,294 29,629 37,783 51,812 44,454 57,154 66,677 78,923 96,212 100,720

Appendix 5 Annex 8


154

S TATE ME NT OF C ONDIT ION - B as e C as e 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

(based on F S (C orrected), as per Methodology), In Millions

AS S E TS

C AS H IN HAND/IN B ANK S

C ash in Hand 49,220 96,568 146,991 282,345 298,653 289,003 304,564 327,120 361,189 393,414

C hecks & C ash Items 0 0 0 0 0 0 0 0 0 0

Due from C BP 22,592 28,240 35,301 40,596 46,685 51,354 56,489 62,138 68,352 75,187

Due from G overnment B anks - L B P 162,516 203,145 253,931 292,021 335,824 369,406 406,347 446,981 491,680 540,848

Due from G overnment B anks - DB P 162,516 203,145 253,931 292,021 335,824 369,406 406,347 446,981 491,680 540,848

Due from O ther B anks 109,797 137,246 171,558 197,291 226,885 249,573 274,531 301,984 332,182 365,400

S ub-total 506,641 668,344 861,711 1,104,274 1,243,871 1,328,742 1,448,277 1,585,204 1,745,082 1,915,696


C urrent L oans 1,698,424 2,123,030 2,653,787 3,184,545 3,821,453 4,203,599 4,623,959 5,086,355 5,594,990 6,154,489

P ast Due 0 106,151 132,689 159,227 382,145 420,360 462,396 508,635 559,499 615,449

T otal L oans 1,698,424 2,229,181 2,786,476 3,343,772 4,203,599 4,623,959 5,086,355 5,594,990 6,154,489 6,769,938

L ess : L oan L oss P rovis ion

B eginning B alance

P lus : Bad Debt E xpense, C urrent L oans (16,984) (22,292) (27,865) (33,438) (42,036) (46,240) (50,864) (55,950) (61,545) (67,699)

P lus : Bad Debt E xpense, P as t Due L oans 0 (10,615) (13,269) (15,923) (38,215) (42,036) (46,240) (50,864) (55,950) (61,545)

L oan L oss P rovis ion (16,984) (32,907) (41,134) (49,360) (80,251) (88,276) (97,103) (106,813) (117,495) (129,244)

L oans , net of L oan L oss P rovis ion 1,681,440 2,196,274 2,745,343 3,294,411 4,123,348 4,535,683 4,989,251 5,488,177 6,036,994 6,640,694

INVE S T ME NT S - B O NDS & O T HE R DE B T INS T .

G ov. B onds/S ecurities - for R eserve R equirements 45,185 56,481 70,601 84,721 101,666 111,832 123,015 135,317 148,849 163,734

G ov. B onds/S ecurities - for Agri-Agra (L B P B onds) 433,325 541,656 677,070 812,483 974,980 1,072,478 1,179,726 1,297,699 1,427,468 1,570,215

G ov. B onds/S ecurities - S B G F C Debt Ins truments 124,812 156,014 195,018 234,022 280,826 308,908 339,799 373,779 411,157 452,273

E quity Investment/O ther Inves tment 0 0 0 0 0 0 0 0 0 0

S ub-total 603,321 754,151 942,689 1,131,226 1,357,472 1,493,219 1,642,541 1,806,795 1,987,474 2,186,222

B ANK P R E MIS E S , F UR NIT UR E , F IX T UR E S & E QUIP ME NT

B ank P remises - L and 16,651 16,651 16,651 16,651 16,651 16,651 16,651 16,651 16,651 16,651

B uilding 10,657 21,314 21,314 21,314 21,314 31,970 31,970 31,970 31,970 31,970

L ess : Accumulated Depreciation-B uilding 533 1,066 1,599 2,131 2,664 3,197 3,730 4,263 4,796 5,328

B ook Value-B uilding 10,124 20,248 19,715 19,182 18,649 28,773 28,240 27,708 27,175 26,642

F urniture & E quipment 2,131 2,344 2,344 2,344 2,344 4,689 4,689 4,689 4,689 4,689

L ess : Accumulated Depreciation-F urn. & E qt. 213 234 256 277 298 320 341 362 384 405

B ook Value-F urn. & E qt. 1,918 2,110 2,089 2,067 2,046 4,369 4,348 4,327 4,305 4,284

T ransportation E quipment 3,197 3,197 3,197 3,197 3,197 6,394 6,394 6,394 6,394 6,394

L ess : Accumulated Depreciation-T rans . E qt. 639 1,279 1,918 2,558 3,197 3,836 4,476 5,115 5,755 6,394

B ook Value-T rans . E qt. 2,558 1,918 1,279 639 0 2,558 1,918 1,279 639 0

L easehold Improvements 2,131 4,263 4,263 4,263 4,263 8,525 8,525 8,525 8,525 8,525

L ess : Accumulated Depreciation-L ease. Imp. 213 426 639 853 1,066 1,279 1,492 1,705 1,918 2,131

B ook Value-L ease. Imp. 1,918 3,836 3,623 3,410 3,197 7,247 7,033 6,820 6,607 6,394

S ub-total 33,169 44,764 43,357 41,950 40,544 59,598 58,191 56,785 55,378 53,971

O T HE R AS S E T S

Miscellaneous (including s tationery and supplies ) 533 559 587 617 648 680 714 750 787 827

TOTAL AS S E TS 2,825,103 3,664,092 4,593,687 5,572,479 6,765,882 7,417,922 8,138,974 8,937,710 9,825,716 10,797,409

Appendix 5 Annex 8


155

S TATE ME NT OF C ONDIT ION - B as e C as e



2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

L IAB IL IT IE S

DE P O S IT L IAB IL IT IE S

Demand Depos its 63,941 87,918 114,294 141,724 175,738 193,312 212,643 233,908 257,299 283,028

S avings Depos its - from R eserve F unds of Water Districts 1,385,381 1,904,899 2,476,368 3,070,697 3,807,664 4,188,431 4,607,274 5,068,001 5,574,801 6,132,281

T ime Depos its 682,034 937,796 1,219,135 1,511,728 1,874,542 2,061,997 2,268,196 2,495,016 2,744,517 3,018,969

S ub-total 2,131,355 2,930,614 3,809,798 4,724,149 5,857,945 6,443,739 7,088,113 7,796,925 8,576,617 9,434,279

B O R R O WING S


Unearned Interes t (interes t collected in advance?) 21,196 26,495 33,119 39,743 47,692 52,461 57,707 63,478 69,825 76,808

Withholding T ax, VAT , other taxes 19,213 24,016 30,020 36,024 43,229 47,552 52,307 57,537 63,291 69,620

S S S , Med., P ag-Ibig , P hilHealth & E C C P 'ble 0 0 0 0 0 0 0 0 0 0

Dividents P ayable 0 0 0 0 0 0 0 0 0 0

O ther L iabilities 0 0 0 0 0 0 0 0 0 0

S ub-total 40,409 50,511 63,139 75,767 90,921 100,013 110,014 121,015 133,117 146,428

TOTAL L IAB IL IT IE S 2,171,764 2,981,125 3,872,937 4,799,916 5,948,865 6,543,752 7,198,127 7,917,940 8,709,734 9,580,707

C AP ITAL

C apital S tock-C ommon 694,730 694,730 694,730 694,730 694,730 694,730 694,730 694,730 694,730 694,730

C apital S tock-P referred 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000

S urplus (F ree) (106,391) (121,391) (91,762) (53,979) (2,167) 42,287 99,441 166,118 245,041 341,253

Undivided P rofits 0 0 0 0 0 0 0 0 0 0

Donated C apital-L and & B uilding 0 0 0 0 0 0 0 0 0 0

Net Income (L oss ) (15,000) 29,629 37,783 51,812 44,454 57,154 66,677 78,923 96,212 100,720

TOTAL C AP ITAL 653,339 682,968 720,750 772,562 817,017 874,170 940,847 1,019,770 1,115,982 1,216,702

TOTAL L IAB IL IT IE S & C AP ITAL 2,825,103 3,664,092 4,593,687 5,572,479 6,765,882 7,417,922 8,138,974 8,937,710 9,825,716 10,797,409

C AP ITAL ADE QUAC Y R ATIO (roug h c alc ulation)

10% Assumed R egulatory C apital R equirement for L oans 38.47% 30.64% 25.87% 23.10% 19.44% 18.91% 18.50% 18.23% 18.13% 17.97%

E stimated R egulatory C apital S hortfall - - - - - - - - - -

Appendix 5 Annex 8


156

C AS H F L OW S TATE ME NT - B as e C as e 2010 2011 2012 2013 2014 2015 2016 2017 2018


29,629 37,783 51,812 44,454 57,154 66,677 78,923 96,212 100,720

Depreciation / Amortization 1,407 1,407 1,407 1,407 1,407 1,407 1,407 1,407 1,407

0 0 0 0 0 0 0 0 0

Due from C B P (5,648) (7,060) (5,295) (6,089) (4,669) (5,135) (5,649) (6,214) (6,835)

Due from G overnment Banks - L B P (40,629) (50,786) (38,090) (43,803) (33,582) (36,941) (40,635) (44,698) (49,168)

Due from G overnment Banks - DBP (40,629) (50,786) (38,090) (43,803) (33,582) (36,941) (40,635) (44,698) (49,168)


Decrease (increase) in Net L oans and Discounts (514,835) (549,069) (549,069) (828,937) (412,335) (453,568) (498,925) (548,818) (603,699)

Increase (decrease) in O ther L iabilities 0 0 0 0 0 0 0 0 0

Unearned Interes ts (interes t collected in advance?) 5,299 6,624 6,624 7,949 4,769 5,246 5,771 6,348 6,983


Decrease (increase) in O ther Assets 0 0 0 0 0 0 0 0 0

Miscellaneous (including stationery and supplies) (27) (28) (29) (31) (32) (34) (36) (37) (39)

(617,708) (678,006) (642,271) (935,697) (496,390) (546,168) (600,924) (661,155) (727,410)

B ank P remises - L and 0 0 0 0 0 0 0 0 0

B uilding (10,657) 0 0 0 (10,657) 0 0 0 0

F urniture & E quipment (213) 0 0 0 (2,344) 0 0 0 0

T ransport. E quipment 0 0 0 0 (3,197) 0 0 0 0

L easehold Improvements (2,131) 0 0 0 (4,263) 0 0 0 0

0 0 0 0 0 0 0 0 0

G ov. Bonds/S ecurities - for R eserve R equirements (11,296) (14,120) (14,120) (16,944) (10,167) (11,183) (12,302) (13,532) (14,885)

G ov. Bonds/S ecurities - for Agri-Agra (L B P B onds ) (108,331) (135,414) (135,414) (162,497) (97,498) (107,248) (117,973) (129,770) (142,747)

G ov. Bonds/S ecurities - S BG F C Debt Instruments (31,203) (39,004) (39,004) (46,804) (28,083) (30,891) (33,980) (37,378) (41,116)

E quity Investment/O ther Investment 0 0 0 0 0 0 0 0 0

(163,831) (188,538) (188,538) (226,245) (156,208) (149,322) (164,254) (180,679) (198,747)

Dividends P aid (2)

Increase (decrease) in Deposit L iabilities

Demand Deposits 23,978 26,376 27,431 34,014 17,574 19,331 21,264 23,391 25,730

S avings Depos its - from R eserve F unds of Water Dis tricts 519,518 571,470 594,328 736,967 380,766 418,843 460,727 506,800 557,480

T ime Deposits 255,763 281,339 292,592 362,815 187,454 206,200 226,820 249,502 274,452

0 0 0 0 0 0 0 0 0

799,258 879,184 914,351 1,133,796 585,794 644,374 708,811 779,692 857,662

47,348 50,423 135,354 16,308 (9,650) 15,561 22,556 34,070 32,224


F INANC ING AC TIVITIE S , c as h flows provided by or us ed

NE T INC O ME

Non-C ash E xpenses

Decrease (increase) in C ash in B anks

O PE R ATING AC TIVITIE S , c as h flows provided by or us ed

Increase (decrease) in Investments - B onds/O ther Debt Inst.


INVE S T ING AC TIVITIE S , c as h flows provided by or us ed

Increase (decrease) in B ank P remises , F urniture, F ix. & E quip.

S ale (repurchase) of stock

Increase (decrease) in B orrowings



Appendix 5 Annex 9


157

OPTIMISTIC CASE INC OME S T AT E ME NT - Optimis tic C as e 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

(based on F S (C orrected), as per Methodology) (F rom F S )

In Millions At beginning of calendar year S caled vs . F SS caled vs . F SS caled vs . F SS caled vs. F SS caled vs. F SS caled vs . F SS caled vs . F SS caled vs . F SS caled vs . F S

Adj. Interes t-earning As s ets /F S 26.64% 33.07% 40.65% 46.36% 52.95% 52.62% 52.04% 51.53% 50.15%

Adj. Depos its /F S 26.64% 36.63% 46.78% 53.25% 59.99% 59.99% 59.51% 59.03% 57.41%

INC OME

Interest Income

L oans and Discounts 532,440 208,702 332,960 529,651 811,233 1,101,554 1,396,478 1,786,864 2,321,579 2,837,251




Depos it with C entral Bank 2,544 881 1,422 2,272 3,239 4,625 5,744 7,101 8,965 11,125

Depos it with L ocal Banks 48,964 14,837 22,102 32,602 46,468 66,354 82,492 91,782 104,030 113,367

O ther Income


Miscellaneous Income 0 5,328 7,144 9,484 11,679 14,409 15,463 16,516 17,663 18,565

Total Inc ome 813,186 272,282 432,388 697,191 1,040,417 1,426,653 1,801,896 2,287,177 2,952,361 3,607,477

L esss : Interest E xpense

S avings 52,000 18,010 29,065 46,445 66,198 94,528 117,410 145,146 183,254 227,394

T ime 140,800 48,765 78,698 125,757 179,243 255,952 317,911 393,011 496,196 615,713

Bills P ayable - O thers 0 0 0 0 0 0 0 0 0 0

S ub-total 192,800 66,775 107,763 172,202 245,441 350,480 435,321 538,157 679,450 843,107

L ess : Bad Debt E xpense 63,750 42,779 69,516 104,274 197,784 247,230 309,038 386,297 482,871 603,589

L ess : O perating E xpenses (1)

C ompensation / F ringe Benefits 13,280 0 0 0 0 0 0 0 0 0

Management & O ther P rofess ional F ees 3,108 0 0 0 0 0 0 0 0 0

Depreciation / Amortization 6,000 0 0 0 0 0 0 0 0 0

P lus (L ess ) Add'l Depreciation / Amortization 0 0 0 0 0 0 0 0 0 0

T axes and L icenses 72,115 0 0 0 0 0 0 0 0 0

L itigation / Assets Acq. E xpenses 0 0 0 0 0 0 0 0 0 0

R ent 1,200 0 0 0 0 0 0 0 0 0

S tationery & S upplies Used 2,000 0 0 0 0 0 0 0 0 0

Miscellaneous - R epairs , P ower, Water, etc. 6,640 0 0 0 0 0 0 0 0 0

S ub-total (1) 104,342 135,475 214,001 346,086 524,068 709,440 900,880 1,152,998 1,498,360 1,822,342

Total E xpens es 360,892 245,030 391,280 622,562 967,293 1,307,150 1,645,239 2,077,452 2,660,681 3,269,038

Net O perating Income (L oss) 452,294 27,253 41,108 74,629 73,124 119,503 156,657 209,725 291,680 338,439

E xtraordinary C redit / (C harges) 0 0 0 0 0 0 0 0 0 0

Net Income before T ax 452,294 27,253 41,108 74,629 73,124 119,503 156,657 209,725 291,680 338,439

L ess : Income T ax 0 0 0 0 0 0 0 0 0 0

Net Inc ome after Tax 452,294 27,253 41,108 74,629 73,124 119,503 156,657 209,725 291,680 338,439

Dividends dec lared (2) - - - - - - - - - -

C os t to Inc ome R atio (1) 16.82% 65.92% 65.92% 65.92% 65.92% 65.92% 65.9% 65.9% 65.9% 65.9%

O perating E xpenses 104 135 214 346 524 709 901 1,153 1,498 1,822

O perating Income 620 206 325 525 795 1,076 1,367 1,749 2,273 2,764

Appendix 5 Annex 9


158

S T AT E ME NT OF C ONDIT ION - Optimis tic C as e 2009 2009 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

(based on F S (C orrected), as per Methodology) Adjusted (F rom F S )

In Millions (Base C ase)

AS S E T SC AS H IN HAND/IN BANK S

C as h in Hand 49,220 184,746 49,220 103,402 160,698 137,204 101,962 200,051 198,192 173,608 115,548 308,926

C hecks & C as h Items 0 0 0 0 0 0 0 0 0 0 0 0

Due from C BP 22,592 84,800 22,592 28,240 35,301 40,596 46,685 51,354 56,489 62,138 68,352 75,187

Due from G overnment Banks - L BP 162,516 610,000 162,516 203,145 253,931 292,021 335,824 369,406 406,347 446,981 491,680 540,848

Due from G overnment Banks - DBP 162,516 610,000 162,516 203,145 253,931 292,021 335,824 369,406 406,347 446,981 491,680 540,848

Due from O ther Banks 109,797 412,120 109,797 137,246 171,558 197,291 226,885 249,573 274,531 301,984 332,182 365,400

S ub-total 506,641 1,901,666 506,641 675,178 875,418 959,132 1,047,179 1,239,790 1,341,905 1,431,692 1,499,441 1,831,208


C urrent L oans 1,698,424 6,375,000 1,698,424 2,759,939 4,484,900 6,727,350 9,418,290 11,772,863 14,716,079 18,395,099 22,993,873 28,742,342

P ast Due 0 0 0 137,997 224,245 336,368 941,829 1,177,286 1,471,608 1,839,510 2,299,387 2,874,234

T otal L oans 1,698,424 6,375,000 1,698,424 2,897,936 4,709,145 7,063,718 10,360,120 12,950,149 16,187,687 20,234,608 25,293,261 31,616,576

L ess : L oan L oss P rovis ion

Beginning Balance 0 0 0 0 0 0 0 0 0 0 0 0

P lus : B ad Debt E xpense, C urrent L oans (16,984) (63,750) (16,984) (28,979) (47,091) (70,637) (103,601) (129,501) (161,877) (202,346) (252,933) (316,166)

P lus : B ad Debt E xpense, P ast Due L oans 0 0 0 (13,800) (22,425) (33,637) (94,183) (117,729) (147,161) (183,951) (229,939) (287,423)

L oan L oss P rovis ion (16,984) (63,750) (16,984) (42,779) (69,516) (104,274) (197,784) (247,230) (309,038) (386,297) (482,871) (603,589)

L oans , net of L oan L oss P rovis ion 1,681,440 6,311,250 1,681,440 2,855,156 4,639,629 6,959,444 10,162,335 12,702,919 15,878,649 19,848,311 24,810,389 31,012,987

INVE S T ME NT S - BO NDS & O T HE R DE BT INS T .

G ov. B onds /S ecurities - for R eserve R equirements 45,185 169,600 45,185 73,425 119,316 178,974 250,563 313,204 391,505 489,382 611,727 764,659

G ov. B onds /S ecurities - for Agri-Agra (L B P Bonds) 433,325 1,626,475 433,325 704,152 1,144,248 1,716,371 2,402,920 3,003,650 3,754,562 4,693,203 5,866,504 7,333,129

G ov. B onds /S ecurities - S B G F C Debt Instruments 124,812 468,478 124,812 202,819 329,580 494,371 692,119 865,148 1,081,436 1,351,794 1,689,743 2,112,179

E quity Investment/O ther Investment 0 0 0 0 0 0 0 0 0 0 0 0

S ub-total 603,321 2,264,553 603,321 980,396 1,593,144 2,389,716 3,345,602 4,182,003 5,227,503 6,534,379 8,167,974 10,209,967

BANK P R E MIS E S , F UR NIT UR E , F IX T UR E S & E QUIP ME NT

Bank P remises - L and 16,651 62,500 16,651 16,651 16,651 16,651 16,651 16,651 16,651 16,651 16,651 16,651

Building 10,657 40,000 10,657 21,314 21,314 21,314 21,314 31,970 31,970 31,970 31,970 31,970

L ess : Accumulated Depreciation-B uilding 533 2,000 533 1,066 1,066 1,066 1,066 1,066 1,066 1,066 1,066 1,066

Book Value-B uilding 10,124 38,000 10,124 20,248 20,248 20,248 20,248 30,905 30,905 30,905 30,905 30,905

F urniture & E quipment 2,131 8,000 2,131 2,344 2,344 2,344 2,344 4,689 4,689 4,689 4,689 4,689

L ess : Accumulated Depreciation-F urn. & E qt. 213 800 213 234 256 277 298 320 341 362 384 405

Book Value-F urn. & E qt. 1,918 7,200 1,918 2,110 2,089 2,067 2,046 4,369 4,348 4,327 4,305 4,284

T ransportation E quipment 3,197 12,000 3,197 3,197 3,197 3,197 3,197 6,394 6,394 6,394 6,394 6,394

L ess : Accumulated Depreciation-T rans . E qt. 639 2,400 639 1,279 1,918 2,558 3,197 3,836 4,476 5,115 5,755 6,394

Book Value-T rans . E qt. 2,558 9,600 2,558 1,918 1,279 639 0 2,558 1,918 1,279 639 0

L eas ehold Improvements 2,131 8,000 2,131 4,263 4,263 4,263 4,263 8,525 8,525 8,525 8,525 8,525

L ess : Accumulated Depreciation-L ease. Imp. 213 800 213 426 639 853 1,066 1,279 1,492 1,705 1,918 2,131

Book Value-L ease. Imp. 1,918 7,200 1,918 3,836 3,623 3,410 3,197 7,247 7,033 6,820 6,607 6,394

S ub-total 33,169 124,500 33,169 44,764 43,890 43,016 42,142 61,729 60,856 59,982 59,108 58,234

O T HE R AS S E T S

Miscellaneous (including s tationery and supplies ) 533 2,000 533 559 587 617 648 680 714 750 787 827

TOTAL AS S E TS 2,825,103 10,603,969 2,825,103 4,556,054 7,152,669 10,351,925 14,597,907 18,187,122 22,509,627 27,875,114 34,537,699 43,113,223

Appendix 5 Annex 9


159

S TAT E ME NT OF C ONDITION - Optimis tic C as e 2009 2009 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

(based on F S (C orrected), as per Methodology) Adjusted (F rom F S )

In Millions (B ase C ase)


L IAB IL ITIE S

D E P O S IT L IAB IL IT IE S

D emand Depos its 63,941 240,000 63,941 114,294 189,728 280,797 395,363 494,203 612,812 759,887 942,260 1,177,825

S avings Depos its - from R eserve F unds of Water D istricts 1,385,381 5,200,000 1,385,381 2,476,368 4,110,772 6,083,942 8,566,190 10,707,738 13,277,595 16,464,218 20,415,630 25,519,538

T ime Depos its 682,034 2,560,000 682,034 1,219,135 2,023,764 2,995,171 4,217,201 5,271,502 6,536,662 8,105,461 10,050,772 12,563,465

S ub-total 2,131,355 8,000,000 2,131,355 3,809,798 6,324,264 9,359,911 13,178,754 16,473,443 20,427,069 25,329,566 31,408,662 39,260,827

B O R R O WING S


Unearned Interest (interest collected in advance?) 21,196 79,560 21,196 34,444 55,972 83,957 117,540 146,925 183,657 229,571 286,964 358,704

W ithholding T ax, VAT , other taxes 19,213 72,115 19,213 31,221 50,734 76,101 106,541 133,176 166,470 208,088 260,110 325,137

S S S , Med., P ag-Ibig, P hilHealth & E C C P 'ble 0 0 0 0 0 0 0 0 0 0 0 0

D ividents P ayable 0 0 0 0 0 0 0 0 0 0 0 0

O ther L iabilities 0 0 0 0 0 0 0 0 0 0 0 0

S ub-total 40,409 151,675 40,409 65,665 106,705 160,058 224,081 280,101 350,127 437,659 547,073 683,841

TOTAL L IAB IL ITIE S 2,171,764 8,151,675 2,171,764 3,875,462 6,430,969 9,519,969 13,402,836 16,753,544 20,777,196 25,767,224 31,955,735 39,944,669

C AP ITAL

C apital S tock-C ommon 74,730 0 694,730 694,730 694,730 694,730 730,357 1,020,348 1,139,351 1,281,548 1,447,281 1,629,675

New Issuance of C apital S tock-C ommon 620,000 0 0 0 0 35,627 289,991 119,004 142,197 165,734 182,394 248,151

S ub-total 694,730 1,600,000 694,730 694,730 694,730 730,357 1,020,348 1,139,351 1,281,548 1,447,281 1,629,675 1,877,827

C apital S tock-P referred 80,000 400,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000

S urplus (F ree) (106,391) 0 (106,391) (121,391) (94,138) (53,030) 21,599 94,723 214,226 370,883 580,608 872,288

Undivided P rofits 0 0 0 0 0 0 0 0 0 0 0 0

D onated C apital-L and & B uilding 0 0 0 0 0 0 0 0 0 0 0 0

Net Income (L oss) (15,000) 452,294 (15,000) 27,253 41,108 74,629 73,124 119,503 156,657 209,725 291,680 338,439

TOTAL C AP ITAL 653,339 2,452,294 653,339 680,591 721,700 831,956 1,195,071 1,433,577 1,732,431 2,107,890 2,581,964 3,168,554

TOTAL L IAB IL ITIE S & C AP ITAL 2,825,103 10,603,969 2,825,103 4,556,054 7,152,669 10,351,925 14,597,907 18,187,122 22,509,627 27,875,114 34,537,699 43,113,223

Appendix 5 Annex 9


160

C AS H F L OW S T AT E ME NT - Optimis tic C as e 2010 2011 2012 2013 2014 2015 2016 2017 2018

(based on F S (C orrected), as per Methodology)

In Millions

27,253 41,108 74,629 73,124 119,503 156,657 209,725 291,680 338,439

Depreciation / Amortization 1,407 874 874 874 874 874 874 874 874

Due from C B P (5,648) (7,060) (5,295) (6,089) (4,669) (5,135) (5,649) (6,214) (6,835)

Due from G overnment B anks - L B P (40,629) (50,786) (38,090) (43,803) (33,582) (36,941) (40,635) (44,698) (49,168)

Due from G overnment B anks - DB P (40,629) (50,786) (38,090) (43,803) (33,582) (36,941) (40,635) (44,698) (49,168)


Decrease (increase) in Net L oans and Discounts (1,173,717) (1,784,473) (2,319,815) (3,202,892) (2,540,584) (3,175,730) (3,969,662) (4,962,078) (6,202,597)

Increase (decrease) in Other L iabilities

Unearned Interests (interest collected in advance?) 13,248 21,528 27,986 33,583 29,385 36,731 45,914 57,393 71,741


Decrease (increase) in O ther Assets

Miscellaneous (including stationery and supplies) (27) (28) (29) (31) (32) (34) (36) (37) (39)

(1,261,436) (1,885,530) (2,372,826) (3,261,315) (2,578,244) (3,208,839) (3,995,664) (4,977,635) (6,203,384)

B ank P remises - L and 0 0 0 0 0 0 0 0 0

B uilding (10,657) 0 0 0 (10,657) 0 0 0 0

F urniture & E quipment (213) 0 0 0 (2,344) 0 0 0 0

T ransport. E quipment 0 0 0 0 (3,197) 0 0 0 0

L easehold Improvements (2,131) 0 0 0 (4,263) 0 0 0 0

G ov. B onds/S ecurities - for R eserve R equirements (28,240) (45,891) (59,658) (71,590) (62,641) (78,301) (97,876) (122,345) (152,932)

G ov. B onds/S ecurities - for Agri-Agra (L B P B onds) (270,828) (440,095) (572,124) (686,549) (600,730) (750,912) (938,641) (1,173,301) (1,466,626)

G ov. B onds/S ecurities - S B G F C Debt Instruments (78,007) (126,762) (164,790) (197,748) (173,030) (216,287) (270,359) (337,949) (422,436)

E quity Investment/Other Investment 0 0 0 0 0 0 0 0 0

(390,077) (612,748) (796,572) (955,886) (856,862) (1,045,501) (1,306,876) (1,633,595) (2,041,993)

Dividends P aid (2) 0 0 0 0 0 0 0 0 0

0 0 35,627 289,991 119,004 142,197 165,734 182,394 248,151

Increase (decrease) in Deposit L iabilities

Demand Depos its 50,353 75,434 91,069 114,565 98,841 118,609 147,075 182,373 235,565

S avings Deposits - from R eserve F unds of Water D istricts 1,090,987 1,634,403 1,973,170 2,482,248 2,141,548 2,569,857 3,186,623 3,951,412 5,103,908

T ime Depos its 537,102 804,629 971,407 1,222,030 1,054,300 1,265,160 1,568,799 1,945,311 2,512,693

1,678,442 2,514,466 3,071,274 4,108,835 3,413,692 4,095,823 5,068,230 6,261,490 8,100,317

54,182 57,297 (23,494) (35,242) 98,090 (1,860) (24,584) (58,060) 193,378

INVE S T ING AC TIVITIE S , c as h flows provided by or us ed

NE T INC OME

OP E R ATING AC T IVIT IE S , c as h flows provided by or us ed

Non-C ash E xpenses

Decrease (increase) in C ash in B anks




Increase (decrease) in B ank P remises, F urniture, F ix. & E quip.

Increase (decrease) in Investments - B onds/Other Debt Inst.


F INANC ING AC TIVITIE S , c as h flows provided by or us ed

S ale (repurchase) of s tock

Increase (decrease) in B orrowings

Appendix 5 Annex 10


161

COMPARATIVE RESULTS OF FEASIBILITY BASE AND OPTIMISTIC SCENARIO

Source: BSP Supervisory Data Center, Supervision and Examination Sector, http://www.bsp.gov.ph/banking/bspsup_pbs.asp

As of 12/31 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

1. Assets FS 10,604 13,599 17,494 22,415 27,972 34,839 43,531 54,513 69,568 88,663 Base 2,825 3,664 4,594 5,572 6,766 7,418 8,139 8,938 9,826 10,797 Optimistic 2,825 4,556 7,153 10,352 14,598 18,187 22,510 27,875 34,538 43,113

Annual Growth Rate (% year-on-year) FS 28% 29% 28% 25% 25% 25% 25% 28% 27%Base 30% 25% 21% 21% 10% 10% 10% 10% 10%Optimistic 61% 57% 45% 41% 25% 24% 24% 24% 25%Philippine Banking System (as of end of 03/2009)

All three cases are well above the industry average. 10.77%

2. Liabilities FS 8,152 10,583 13,958 18,118 22,572 28,109 35,165 43,949 56,030 71,395 Base 2,172 2,981 3,873 4,800 5,949 6,544 7,198 7,918 8,710 9,581 Optimistic 2,172 3,875 6,431 9,520 13,403 16,754 20,777 25,767 31,956 39,945

3. Capital FS 2,452 3,016 3,536 4,296 5,400 6,730 8,366 10,564 13,537 17,268 Base 653 683 721 773 817 874 941 1,020 1,116 1,217 Optimistic 653 681 722 832 1,195 1,434 1,732 2,108 2,582 3,169

As of 12/31 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

1. Loans, gross FS 6,375 8,288 10,774 14,006 17,507 21,884 27,574 35,295 45,883 59,648 Base 1,698 2,229 2,786 3,344 4,204 4,624 5,086 5,595 6,154 6,770 Optimistic 1,698 2,898 4,709 7,064 10,360 12,950 16,188 20,235 25,293 31,617

Annual Growth Rate (% year-on-year) FS 30% 30% 30% 25% 25% 20% 28% 30% 30%Base 25% 25% 20% 20% 10% 10% 10% 10% 10%Optimistic 63% 63% 50% 40% 25% 25% 25% 25% 25%

Past Due Loans (% of Loans, gross) FS 0% 0% 0% 0% 0% 10% 10% 10% 0%Base 5% 5% 5% 10% 10% 10% 10% 10% 10%Optimistic 5% 5% 5% 10% 10% 10% 10% 10% 10%Philippine Banking System (as of end of 03/2009)

FS zero assumption in early years is very low. 5.48%

2. Deposits FS 8,000 10,400 13,520 17,576 21,970 27,463 34,328 42,910 54,710 69,756 Base 2,131 2,931 3,810 4,724 5,858 6,444 7,088 7,797 8,577 9,434 Optimistic 2,131 3,810 6,324 9,360 13,179 16,473 20,427 25,330 31,409 39,261

Annual Growth Rate (%) FS 30% 30% 30% 25% 25% 25% 25% 28% 28%Base 38% 30% 24% 24% 10% 10% 10% 10% 10%Optimistic 79% 66% 48% 41% 25% 24% 24% 24% 25%

Total Assets

Past Due Ratio

ANNEX 10 – RESULTS – FINANCIAL PROJECTIONS(peso millions)

A. Scale of Operations

B. Loans and Deposits

Appendix 5 Annex 10


162

As of 12/31 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

1. Loans, gross to Deposits FS 79.7% 79.7% 79.7% 79.7% 79.7% 79.7% 80.3% 82.3% 83.9% 85.5%Base 79.7% 76.1% 73.1% 70.8% 71.8% 71.8% 71.8% 71.8% 71.8% 71.8%Optimistic 79.7% 76.1% 74.5% 75.5% 78.6% 78.6% 79.2% 79.9% 80.5% 80.5%Ratio of Total Loans, gross to Total Deposits

All B anks T hrift B anks R ural B anks

In general, slightly above the sector. As of 3/2009 69.06% 76.42% 100.83%

2. Liquid Assets to Deposits FS 52.1% 49.0% 47.6% 46.3% 46.5% 46.3% 46.3% 44.8% 43.6% 42.1%Base 52.1% 48.5% 47.4% 47.3% 44.4% 43.8% 43.6% 43.5% 43.5% 43.5%Optimistic 52.1% 37.3% 28.5% 23.9% 19.7% 17.1% 15.1% 13.4% 11.9% 10.4%Ratio of Liquid Assets (Cash and Due from Banks + Financial Assets, Net of Allowance for Credit Losses) to Total Deposits


Rosy Case falls well below the sector. As of 3/2009 51.21% 32.90% 33.31%

3. Cash and Due from Banks to Deposits FS 23.8% 20.6% 19.1% 17.8% 17.9% 17.7% 17.7% 16.0% 14.6% 12.9%Base 23.8% 22.8% 22.6% 23.4% 21.2% 20.6% 20.4% 20.3% 20.3% 20.3%Optimistic 23.8% 17.7% 13.8% 10.2% 7.9% 7.5% 6.6% 5.7% 4.8% 4.7%Ratio of Cash and Due from Banks to Deposits


Rosy Case falls well below the sector. As of 3/2009 18.22% 11.35% 26.63%

4. Total Capital to Total Assets FS 23% 22% 20% 19% 19% 19% 19% 19% 19% 19%Base 23% 19% 16% 14% 12% 12% 12% 11% 11% 11%Optimistic 23% 15% 10% 8% 8% 8% 8% 8% 7% 7%Ratio of Total Capital Accounts ( for ratio analysis consists of Total Capital Accounts + Redeemable Preferred Shares) to Total Assets


FS remains higher than the sector due to high earnings. As of 3//2009 10.98% 10.97% 16.26%

5. Capital Adequacy Ratio* FS 38% 36% 33% 31% 31% 31% 30% 30% 30% 29%*R oug h calculation, ass umed to be [10% of L oans, gross] Base 38% 31% 26% 23% 19% 19% 18% 18% 18% 18%

Optimistic 38% 23% 15% 12% 12% 11% 11% 10% 10% 10%

Full year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

1. Income FS 813 1,022 1,307 1,715 2,244 2,694 3,424 4,395 5,729 7,193 Base 272 345 442 536 634 710 798 912 986 Optimistic 272 432 697 1,040 1,427 1,802 2,287 2,952 3,607

2. Expenses FS 361 459 587 755 941 1,164 1,589 1,997 2,556 3,263 Base 272 345 442 536 634 710 798 912 986 Optimistic 272 432 697 1,040 1,427 1,802 2,287 2,952 3,607

3. Net Income FS 452 563 720 960 1,304 1,531 1,835 2,398 3,173 3,930 Base 30 38 52 44 57 67 79 96 101 Optimistic 27 41 75 73 120 157 210 292 338

Univers al/C ommercial B anks



67.38%

53.67%

10.81%

18.71%


C. Key Ratios - Statement of Condition

D. Profitability (For the periods indicated)

Appendix 5 Annex 10


163

Full year 2010 2011 2012 2013 2014 2015 2016 2017 2018

1. Earning Assets Yield FS 9.27% 9.15% 9.21% 9.51% 9.14% 9.31% 9.50% 9.85% 9.67%Base 9.27% 9.15% 9.21% 9.51% 9.14% 9.31% 9.50% 9.85% 9.67%Optimistic 9.27% 9.15% 9.21% 9.51% 9.14% 9.31% 9.50% 9.85% 9.67%


Projections are higher than the sector. As of 3/2009 7.96% 9.47% 14.35%

2. Funding Cost FS 3.13% 3.13% 3.13% 3.01% 3.01% 3.01% 3.01% 3.07% 3.07%Base 3.13% 2.94% 2.86% 2.68% 2.66% 2.66% 2.65% 2.69% 2.69%Optimistic 3.13% 2.83% 2.72% 2.62% 2.66% 2.64% 2.63% 2.68% 2.68%


As of 3/2009 3.21% 4.27% 5.08%

3. Interest Spread FS 6.14% 6.02% 6.07% 6.50% 6.12% 6.30% 6.49% 6.78% 6.60%Base 6.14% 6.22% 6.34% 6.83% 6.48% 6.65% 6.85% 7.16% 6.98%Rosy 6.14% 6.33% 6.48% 6.89% 6.48% 6.67% 6.87% 7.17% 6.99%



4. Net Interest Margin FS 5.93% 5.88% 5.88% 6.30% 5.96% 6.11% 6.31% 6.52% 6.38%Base 5.90% 5.86% 5.95% 6.16% 6.23% 6.41% 6.60% 6.90% 6.73%Optimistic 5.18% 5.16% 5.44% 5.89% 6.05% 6.19% 6.39% 6.68% 6.52%



5. Net Interest Income to Total Operating Income FS 92.01% 92.29% 90.25% 92.05% 91.82% 91.91% 91.76% 91.60% 91.40%Base 92.01% 92.29% 90.25% 92.05% 91.82% 91.91% 91.76% 91.60% 91.40%Optimistic 92.01% 92.29% 90.25% 92.05% 91.82% 91.91% 91.76% 91.60% 91.40%


The bank's ratios show high dependence on interest income. As of 3/2009 69.74% 72.75% 75.20%

6. Cost to Income Ratio FS 16.82% 16.23% 15.62% 14.80% 13.78% 13.92% 13.41% 12.88% 12.46% 12.46%Base 69.57% 69.57% 69.57% 69.57% 69.57% 69.57% 69.57% 69.57% 69.57%Optimistic 65.92% 65.92% 65.92% 65.92% 65.92% 65.92% 65.92% 65.92% 65.92%Ratio of Annualized Non-Interest Expense, Net of Impairment Losses to Annualized Total Operating Income (Net Interest Income + Non-Interest Income)


FS ratios are significantly lower than average for all banks. As of 3/2009 72.86% 87.02% 71.36%

7. Return on Assets FS 4.14% 4.12% 4.28% 4.66% 4.39% 4.22% 4.40% 4.56% 4.43%Base 0.81% 0.82% 0.93% 0.66% 0.77% 0.82% 0.88% 0.98% 0.93%Optimistic 0.60% 0.57% 0.72% 0.50% 0.66% 0.70% 0.75% 0.84% 0.79%


FS ratios are significantly higher than average for all banks. As of 3/2009 0.78% 0.09% 1.88%

8. Return on Equity FS 18.68% 20.37% 22.35% 24.14% 22.74% 21.94% 22.70% 23.44% 22.76%Base 4.34% 5.24% 6.71% 5.44% 6.54% 7.09% 7.74% 8.62% 8.28%Optimistic 4.00% 5.70% 8.97% 6.12% 8.34% 9.04% 9.95% 11.30% 10.68%


FS ratios are significantly higher than average for all banks. As of 3/2009 6.86% 0.78% 12.43%

Ratio of annualized Interest Expense to Interest Bearing Liabilities ( Deposit Liabilities + Bills Payable + Unsecured Subordinated Debt + Bonds Payable, Net + Redeemable Preferred Shares

Universal/C ommerc ial B anks

7.56%

Ratio of Annualized Interest Income to Average Earning Assets (Total Loan Portfolio, Net of Amortization + AFS Debt Securities, Net of Amortization + HTM Financial Assets, Net of Amortization + Unquoted Debt Securities Classified as Loans, Net of Amortization + Financial Assets Held for Trading - Held for Trading Equity Securities + Financial Assets Designated at Fair Value Through Profit of Loss-Debt Securities + Due From other Banks


4.53%


4.38%


3.03%

Earning Assets Yield - Funding Cost


7.26%

Ratio of Net interest Income to Total Operating Income


68.97%

Ratio of Net Income to Total Capital


71.29%

Ratio of Annualized Net Interest Income (Interest Income - Interest Expense) to Average Earning Assets

Ratio of Net Income to Total Assets


0.81%

E. Key Ratios - Income and Expenses

Appendix 6


164

ASSESSSMENT OF LWUA’S PAST FINANCIAL PERFORMANCE 1. This financial analysis examines the financial state of the Local Water Utilities Administration (LWUA) through a review of income statements, balance sheets and cash flow statements, and existing loan repayments leading to an analysis of major constraints to the financial sustainability of LWUA. The analysis presents the results of such examination and recommends options for improved competitiveness, cost recovery, and financial sustainability. 2. The approach and methodology used in the assessment included (i) an analysis of historical trends in absolute values as well as in percentages, and (ii) ratio analysis. The period studied covered the period from 2005 to 2007 (based on audited reports) and year 2008 based on LWUA’s internal reports. Available secondary data for previous years (2000–2004) were also used as reference points for some discussions. Budget figures for 2009 are shown to provide a basis for comparison of actual and planned performance for the current year. A. General Comment on Actual Budget and Projected Financial Reports 3. The Accounts Receivable account seems to be presented differently in various reports of the LWUA Finance (Loans Adminstration), Treasury (Budget), and Management Services Office (Corporate Planning) departments. Audited financial reports in previous years until 2005 reported the current portion of long-term receivables as loans receivable – current portion and used the accounts receivable account to refer to transactions relating to interests on loans, penalties, interest on bank deposits, seminar income, and other miscellaneous receivables. From 2006 onwards, loans receivable – current portion were reclassified as accounts receivable in the audited and unaudited financial reports and the other receivables account was set up to handle transactions related to miscellaneous receivables. However, annual budgets and the 10-year cash flow prepared by Corplan continue to use the old accounts classification. 4. Analysis of present and projected levels of the accounts receivable account is a key factor in receivables management. Actual, budgeted, and projected figures need to be stated on a comparable basis to allow appropriate analysis and action to be taken by LWUA management. B. Summary of Performance 5. Results of the LWUA operation during the last 4 years or from 2005 to 2008 showed a marked improvement compared with the findings in the Study on Selected Financial Issues Related to LWUA Report1 covering the period from 2000 to 2005. LWUA has been (i) recovering costs of operation as well as financial expenses from their revenues; (ii) generally generating positive cash inflows from operating and financing activities which was used to finance its investing activities; and (iii) enjoying healthy liquidity, profitability, and debt equity ratios. Although the debt service coverage ratio in 2008 was only .99, and was short of the desired 1.3 level, this represented a significant improvement compared with the situation in 2002 when it had the lowest coverage of only .08. The major problems facing LWUA are the collection of receivables and the decline in investment funds and consequently project disbursements. Although the debt service coverage ratio in 2008 was only 0.99, and was short of the desired 1.3 level, this represented a significant improvement compared with the situation in 2002 when it had the lowest coverage of only 0.8.

1 Virata and Associates, Inc. April 2008. Final Report on the Study on Selected Financial Issues Related to LWUA as a Consequence of EO 279, Volume 1. Manila.

Appendix 6


165

6. Operations also resulted in positive cash positions at year-end although this does not show any trend that could reasonably be used in projecting future performance. The drastic rise of the cash amounts in 2006 and 2008 was mainly due to the amounts received from refinancing. During the same period, 13 water districts refinanced a total P3.7 billion of their loans with LWUA. 7. Adjusted budget figures for 2009 reflect a slight reduction in revenues and a lower expense levels. The overall result is a substantial (around 18%) increase in net income. See Table A6.1 for the historical trend of key financial data and Annex 1 of this appendix for details of the financial reports. 8. A more detailed account of LWUA’s performance can be seen from an examination of the trend of its revenues and expenses, cash flows, collections and payments of debt service. These are discussed in succeeding sections followed by a presentation of the results of the ratio analysis.

Table A6.1: LWUA Key Financial Data 2005 −−−−2009

(P Million)

Results of Operations A U D I T E D Unaudited Budget 2005 2006 2007 2008 2009 Total Revenues 1,790 1,950 1,889 1,972 1,952 Income from Lending Operations 1,595 1,730 1,727 1,821 1,673 Service Income 177 131 41 31 147 Other Income 18 89 121 120 132 Total Expenses 1,837 1,268 1,709 1,410 1,588 Personal Services 417 447 461 562 546 Maintenance and Other Operating

Expenses Cash 349 257 106 126 220 Non-cash 126 113 606 317 278 Service Expenses 17 0 26 6 177 Financial Expenses 478 451 510 399 367 Net Profit Before Tax 403 682 180 562 364 LIQUIDITY AND CAPITAL RESOURCES Cash Flow Provided by Operating Activities 516 475 454 736 632 Cash Flow Provided by Investing Activities -1,686 -1,324 -619 -682 -4,410 Cash Flow Provided by Financing Activities 1,187 1,397 -52 834 3068 Net 17 548 -217 888 -710 CAPITALIZATION Income from Operations 403 682 180 562 364 National Government Equity Contribution 2,500 2,500 2,500 2,500 2,500 National Government Subsidy 0 10 Foreign Borrowings 10,056 10,111 9,398 8,788 Domestic Borrowings 900 995 933 808 CASH POSITION 438 1,310 762 1,650 941

Appendix 6


166

LWUA STANDARD RATIOS Current Ratio 1.11 1.20 1.46 1.88 1.44 Debt Equity Ratio 2.46 2.37 1.82 1.61 1.08 Operating Ratio 0.70 0.59 0.58 0.55 0.67 Debt Service Coverage Ratio 1.27 1.09 1.00 0.97 0.99

LWUA = Local Water Utilities Administration, P = Philippine peso. C. Trend Analysis

1. Trends in Revenues and Expenses

a. Project Disbursements and Revenues

9. LWUA derives 90% of its revenues from interest, and the remaining 10% from service income, fines and penalties, and miscellaneous income. Interest revenues depend on relending rates and the level of project disbursement since this is composed mainly of loans to water districts. Project disbursements have been on an increasing trend from 2002 to 2004, then experienced sharp decreases in 2005 to 2007 as there were no new foreign-assisted projects due to the following:

(i) The lack of local counterpart funding for foreign-assisted projects, (ii) LWUA had reached its statutory debt ceiling of P1 billion for local

borrowing, and (iii) LWUA’s inability to generate second-generation funds

10. As a result, total revenue figures also show increasing trends from 2000 to 2006 before leveling off starting 2006 up to 2008 as project disbursements started to drop. Average growth rate of revenues for the period 2000 to 2008 is 12% per annum while project disbursements average decrease is 3% per annum. See Table A6.2 and Figure A6.1.

Table A6.2: Project Disbursement and Revenues, 2000 −−−−2009 (P Million)

Year Project Disbursement Revenues % of Project

Disbursement to Revenues

Amount % Inc/Dec Amount % Inc/Dec

2000 798 1,016 79 2001 775 -3 997 -2 78 2002 1,121 45 1,338 34 84 2003 1,483 32 1,418 6 105 2004 2,218 50 1,776 25 125 2005 1,518 -32 1,790 1 85 2006 1,130 -26 1,950 9 58 2007 498 -56 1,889 -3 26 2008 586 18 1,972 -4 30

Ave Inc/Dec (%) -3 12

Budget 2009 4,521 672 1,952 -1 232 Ave Inc/Dec = average increase/decrease, P = Philippine peso.

Appendix 6


167

Figure A5.1: Disbursements vs Revenues, 2000-2009

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Year

P m

illio

n

Project Disbursements LWUA Revenues

b. Revenues and Income

11. Net income exceeded the 12% growth rate of revenues posting a higher average growth rate of 44% from P124 million in 2000 to P562 million in 2008. The resulting net income ratio (net income divided by revenue) also increased from 12% in 2000 to 28% in 2008. See Table A6.3 and Figure A6.2.

Table A6.3: LWUA Revenues and Income, 2000 −−−−2009

(P Million) P = Philippine peso. 12. While net income was generally increasing, years 2002 to 2005 posted significant losses due to foreign currency exchange losses.2 In subsequent years, LWUA successfully managed its foreign exchange problem by either utilizing foreign exchange risk guarantees

2 Virata, ibid. p.22.

Year Revenues % Growth Net

Income % Growth

Net Income

Ratio (%) 2000 1,016 124 12

2001 997 -2 24 -81 2

2002 1,338 34 -197 -921 -15

2003 1,417 6 -574 -191 -41

2004 1,776 25 -260 55 -15

2005 1,790 1 403 255 23

2006 1,950 9 682 69 35

2007 1,889 -3 180 -74 10

2008 1,972 4 562 212 28

Average 1,572 12 105 44 7 2009

Budget 1952 -1% 364 -35%

10

Figure A6.1: Disbursements vs Revenues, 2000-2009

Appendix 6


168

provided by the national government or passing the risk to water districts. There was also a sharp decline of net income in 2007, but this was due to increase in provision for bad debts and depreciation expense at P606 million.

Figure A5.2: LWUA Revenues and Net Income, 2000-2009

-1000-500

0500

10001500

20002500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Year

P m

illio

n

Revenues Net Income

c. Revenues and Relending rates 13. LWUA’s interest rates on water districts loans are more than enough to cover its interest on borrowings. Table A6.3 and Figure A6.3 show that the low proportion of interest expense against interest income decreased further from 50% in 2004 to 22% in 2008, indicating that LWUA’s spread in its relending rates has become bigger in recent years. This trend is expected to change in the coming years, however, as interest income on the new loans are expected to be lower since Board Resolution No. 38 series of 2009 reduced the LWUA relending rate to water districts. See Appendix 4 on relending rates.

Table A6.3: LWUA Interest Income vs Interest Expense

Items 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Interest Income (P million)

655 690 760 865 923 1,595 1,730 1,727 1,821 1,673

Interest Expense (P million)

213 260 298 298 462 478 451 510 399 367

Percentage (%) 32 38 39 34 50 30 26 30 22 22

Figure A6.2: LWUA Revenues and Net Income, 2000 -2009

Appendix 6


169

Figure A5.3: Interest Income vs Interest Expense 2000-2009

0200400600800

100012001400160018002000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Year

P m

illio

n

Interest Income Interest Expense

d. Operating Expenses

14. Total operating expenses (OPEX) increased from P630 million in 2000 to P1.41 billion in 2008, or an average annual increase of 15%. The ratio of OPEX to revenues, averaged 85% leaving an average net profit margin of about 15% (Table A6.4). From its high levels in 2002 to 2004, OPEX has generally declined to lower levels allowing LWUA to generate more profit from its operations in recent years.

Table A6.4: Ratio of Operating Expenses to Revenues, 2000 −−−−2009 (P Million)

Items

2000

2001

2002

2003

2004

2005

2006

2007

2008 2000-2008 Ave

2009

Personal Services

286 347 432 438 406 417 447 461 562 546

MOOE 120 307 743 822 955 491 370 449 449 675 Financial Expenses

224 214 242 274 274 478 451 510 399 367

Total Expenses

630 868 1,417 1,534 1,534 1,378 1,268 1,709 1,410 15% 1,588

Revenues 1,016 997 1,338 1,417 1,417 1,790 1,950 1,889 1,972 12% 1,952 Ratio of Operating Expenses to Revenues (%)

62 87 106 108 101 77 65 90 72 85% 81

Ave = average, MOOE = maintenance and other operating expenses, P = Philippine peso. Note: LWUA also uses another indicator, i.e., operating ratio, which is computed as total operating expenses less non-cash items divided by operating revenues.

15. OPEX comprises (i) personal expenses (PS), (ii) maintenance and other operating expenses (MOOE), and (iii) interest and other debt service charges. Personal expenses include salaries and wages, bonuses and allowances, additional compensation and benefit

Figure A6.3: Interest Income vs. Interest Expense

Appendix 6


170

clothing allowances, and contributions to various government agencies. Personal expenses share an average of 33% of the total OPEX and increased at an average rate of 12% per year from 2000 to 2008. 16. The MOOE, which includes other services, utilities, supplies, materials, bad debts, and depreciation, constituted the largest portion of the total operating expenses. On the average, MOOE shared almost 40% of the total expenses from 2000 to 2008. It reached its peak in the years 2003 and 2004, figuring at P822 million and P955 million, respectively. As mentioned earlier, this was due to the amortization of foreign currency exchange losses which is lodged under this account. MOOE was also high in 2007 due to increase in the provision for bad debts and depreciation expense. Bad debts shared the biggest portion of MOOE, at 80% and 68% in 2007 and 2008, respectively. MOOE also registered the highest increase at an average rate of 34% per annum during the 8-year period. 17. Interest and other financing charges registered at 27% of the total operating expenses, reaching its highest in 2007 at P510 million. Financial expenses increased at an average rate of 10% per annum. 18. For 2009, LWUA budgeted a substantial 50% increase in MOOE, but with slightly lower budgets for personal and financial expenses. See Table A6.5 and Figure A6.4.

Table A6.5: LWUA Operating Expenses, 2000 −−−−2009 (P Million)

Year

Personal Services MOOE Financial Expenses Total

OPEX Amount % to Total

% Inc/Dec Amount

% to Total

% Inc/Dec Amount

% to Total

% Inc/Dec

2000 286 45 120 19 224 36 630 2001 347 40 21 307 35 156 214 25 -4 868 2002 432 30 24 743 52 142 242 17 13 1,417 2003 438 29 1 822 54 11 274 18 13 1,534 2004 406 23 -7 955 53 16 425 24 55 1,786 2005 417 30 3 492 35 -48 478 34 12 1,387 2006 447 35 7 370 29 -25 451 36 -6 1,268 2007 461 27 3 738 43 99 510 30 13 1,709 2008 562 40 22 449 32 -39 399 28 -22 1,410 Ave 422 33 12 555 39 34 357 27 10

2009 546 36 -3 675 45 50 367 24 -8 1,502

Ave = average, Inc/Dec = increase/decrease, MOOE = maintenance and other operating expenses, OPEX = operationg expense, P = Philippine peso.

Appendix 6


171

Figure A5.4: Revenues vs Operational Expenses, 2000-2009

-500

0

500

1000

1500

2000

2500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year

P m

illio

n

Personal Services MOOE Financial Expenses Net Income

2. Cash Flow 19. LWUA cash flow comes from (i) operating activities, (ii) investing activities, and (iii) financing activities. Cash flow from operating activities includes receipts from water district loans, interest on bank deposits, cash receipts from services rendered for engineering studies, and disbursements including payment of operating expenses and income tax. Cash flow from investing activities includes receipts from withdrawal of investment in securities and disbursements for foreign and local projects, capital expenditures, loans to officers and employees, and payment of professional tax. Cash flow from financing activities involves receipts of proceeds from government subsidies, local and foreign borrowings, and proceeds from water district long-term loans. Disbursements include principal payments of loans and dividends paid to the national government. 20. LWUA’s operations in the last 5 years resulted in positive cash positions although this does not show a trend that can reasonably be used for future projections as shown in Figure A6.5. The drastic rise of the cash amounts is mainly due to the amounts received from refinancing. Between the years 2006 to 2008, 13 water districts refinanced a total P3.7 billion of their loans with LWUA.

Figure A6.4: Revenues vs Operational Expenses, 2000 -2009

Appendix 6


172

Figure A5.5: LWUA Cash Position, 2005-2009

438

1310

762

1650

941

0200400600800

10001200140016001800

2005 2006 2007 2008 2009

Year

P m

illio

n

Cash Balance, end

Source: LWUA Cash Flow Statements, 2005-2009. 21. The effect of refinancing inflows can also be seen in Figure A6.6, which shows the annual net cash effect or difference between cash inflow and outflows. The years 2006 and 2008 were a positive period when there were huge inflows from refinancing activities.

17

548

-217

888

-709

-800-600

-400-200

0200

400600

8001000

P m

illio

n

2005 2006 2007 2008 2009

Year

Figure A5.6: Net Cash Effect, 2005-2009

Source: LWUA Cash Flow Statements, 2005-2009.

22. Table A6.6 and Figure A6.7 show the cash movements based on LWUA activities. Net cash flow from investing activities is always on the negative since this is composed mostly of disbursements to projects and capital expenditures. Investing activities is generally financed through positive inflows from financing activities and operating activities. However, in 2007 cash flow from financing activities posted a low of negative P52 million due to low collection on WD loans and increase in principal payments of foreign loans. 23. Investing activities have been also decreasing reflecting the general decline in project disbursements. This situation is, however, expected to be arrested in 2009 as more funds are expected to come in to finance more projects.

Figure A6.5: LWUA Cash Position, 2005 -2009

Figure A6.6: Net Cash Effect, 2005 -2009

Appendix 6


173

Table A6.6: LWUA Cash Position, 2005 −−−−2009 (P Million)

Items 2005 2006 2007 2008 2009

Budget Operating Activities 516 475 454 736 632 Investing Activities -1,686 -1,324 -619 -682 -4,410 Financing Activities 1,187 1,397 -52 834 3,069 Net Cash Effect 17 548 -217 888 -709 Balance, beginning 414 431 979 762 1,650 Cash Balance, end 431 979 762 1,650 941

P = Philippine peso.

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

P m

illio

n

2005 2006 2007 2008 2009

Year

Figure A5.7: Breakdown of LWUA Cash Flow, 2005-2009

Operating Activities Investing Activities Financing Activities

3. WD Debt Service vs LWUA Debt Service based on Cas h Flows

a. Interest

24. The cash received from payments of WDs interest and loans was matched against LWUA debt service payments to determine sufficiency of cash inflows. The receipts from interest on WD loans for the last 5 years had increased at an average rate of 7% per year compared with the increase in LWUA interest payments which averaged 11%. The amount collected from WDs covered twice the amount of interest payable each year but the gap between the two has been generally decreasing.

Figure A6.7: Breakdown of LWUA Cash Flow, 2005-2009

Appendix 6


174

Table A6.7: LWUA Interest vs WD Interest Payment, 2005 −−−−2009 (P Milllion)

Items

2005 2006 2007 2008 2005-08 Ave %

2009 Budget

Amount Amount % Inc/Dec

Amount % Inc/Dec

Amount % Inc/Dec

%Inc/Dec

WD Interest Repayment

1,052 1,165 11 1,267 9 1,268 0 7 1,520

LWUA Interest Repayment

394 429 9 459 7 520 13 10 367

Difference 658 736 808 748 1,153 Ave Inc = average increase, Inc = increase, LWUA = Local Water Utilities Administration, P = Philippine peso, WD = waster district. 25. Figure A6.8 shows that collection of interest from WDs is sufficient to cover interest payable for the years 2005 to 2009.

Figure A5.8: LWUA Interest Repayment vs WD Interest Repayment, 2005-2009

0

200

400

600

800

1000

1200

1400

1600

2005 2006 2007 2008 2009Year

P m

illio

n

WD Interest Repayment LWUA Interest Repayment

b. Principal

26. The amount of collection from WD principal had been very erratic as presented in Table A6.8 due to huge amounts from refinancing in 2006 and 2008.

Figure A6.8: LWUA Interest Repayment vs WD Interest Repayment, 2005-2009

Appendix 6


175

Table A6.8: LWUA Principal vs WD Principal Payments, 2005 −−−−2009 (P Million)

Items

2005 2006 2007 2008 Ave Inc 2005-08

2009 Budget Amount Amount % Inc Amount % Inc Amount % Inc

WD Principal Repayment

303 1,644 443 431 -74 2,150 399 203 532

LWUA Principal Repayment

397 711 79 831 17 798 -4 34 1,017

Difference -94 933 -400 1,352 -485 Ave Inc = average increase, Inc = increase, LWUA – Local Water Utilities Administration, P = Philippine peso, WD = waster district. 27. As can be seen in Figure A6.9, only refinancing allowed full LWUA repayments to be covered since collection on WD principal was sufficient to pay LWUA’s principal payments only in the years when there were huge inflows due to refinancing.

Figure A5.9: LWUA Principal Repayment vs WD Principal Repayment, 2005-2009

0

500

1000

1500

2000

2500

2005 2006 2007 2008 2009

Year

P m

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n

WD Principal Repayment LWUA Principal Repayment

c. Total Debt Service

28. The collection from WD principal and interest were matched against LWUA debt service. The total amount collected was twice the amount needed for LWUA debt service payments (Table A6.9).

Figure A6.9: LWUA Principal Repayment vs WD Prinicpal Repayment, 2005-2009

Appendix 6


176

Table A6.9: LWUA Debt Service vs WD Debt Service, 2005 −−−−2009 (P Million)

Items

2005 2006 2007 2008 Ave % Inc

2009 Budget Amount % Inc Amount % Inc Amount % Inc Amount % Inc

WD Principal and Interest 1,355 2,809 107 1,698 -40 3,418 101 51 2,052 LWUA Debt Service 791 1,140 44 1,290 13 1,,318 2 22 1,384 Difference 564 1,669 408 2100 668

Ave Inc = average increase, Inc = increase, LWUA – Local Water Utilities Administration, P = Philippine peso, WD = waster district. 29. Figure A6.10 shows that there were enough funds from collection of WD loans for debt servicing. A large portion of these collections were available for project disbursements.

Figure A5.10: LWUA Debt Service vs WD Debt Service, 2005-2009

0

500

1000

1500

2000

2500

3000

3500

4000

2005 2006 2007 2008 2009

Year

P m

illio

n

Total Collections from WD loan LWUA Total Debt Service

1

4. Receivables 30. Total accounts receivable (AR) grew by as much as 389% in a span of 8 years or an average of roughly 50% per year primarily due to the increasing amount of accounts with collection problems including non-performing loans, deferred accounts, and accounts of non-operational water districts. The highest increase was recorded in 2002 and 2004 at 95% and 56%, respectively. While there was a decline in 2006 and 2008, this was partly due to the refinancing of at least 13 water district loans. Moreover, allowance for bad debts was increased significantly to 25%. As of December 31, 2008, total AR accounts amounted to P1.665 billion. These include interest receivable on loans, current portion of long-term loans, receivables from officers and employees, receivables from LGUs, and miscellaneous receivables. 31. The total long-term loans receivable (LTR) amounted to P13.936 billion. These include loans receivable from water districts, unbilled loans, and account receivable from water districts, restructured receivables from water districts, and loans receivable from rural water and sanitation associations (RWSAs). In a span of 7 years, total LTR increased by

Figure A6.10: LWUA Debt Service vs WD Debt Service, 2005-2009

Appendix 6


177

almost 90% from the year 2000 to 2006, and gradually declined until it reached a balance of P12.61 billion in 2008 (Table A6.10). 32. See Appendix 7 for details of AR-WD accounts and Appendix 8 for LWUA Action and Proposals to improve collection efficiency.

Table A6.10: Total Accounts and Long-term Receivables Net of Allowance for Bad Debts (2000 −−−−2009)

(P Million)

Year

AR

% Growth

LTR

% Growth

Total

% Growth

2000 214 7,501 7,715 2001 258 21 8,028 7 8,286 7 2002 504 95 9,166 14 9,670 17 2003 509 1 10,633 16 11,142 15 2004 795 56 12,841 21 13,636 22 2005 1,145 44 14,264 11 15,409 13 2006 905 -21 14,279 0 15,184 -1 2007 1,220 35 13,971 -2 15,191 .05 2008 1,047 -14 12,611 -10 13,658 -10 2009 1,962 87 16,282 29 18,244 34 AR = accounts receivable, LTR – long-term receivable, P = Philippine peso. 5. Payables

33. LWUA liabilities are composed mainly of interests and loans from local and foreign borrowings, note payable to Philippine Veterans Bank, income taxes, guarantee deposits, and advances for the Bureau of Treasury. Current liabilities are at P1.8 billion in 2008, representing 14% of total liabilities and non-current liabilities are at P9.4 billion, resulting in total liabilities of P11.2 billion. (Table A6.11). Liabilities declined by 9% or P1.14 billion from 2005 to 2008 primarily due to LWUA’s gradual payment of its long-term loans and the reduction in new loans contracted in recent years. 34. Table A6.12 and Figure A6.11 show the declining trend of liabilities from 2005 to 2008. They also presents the relationship of current and non-current liabilities to the totality of the payables. The projected increase of liabilities in 2009 can be attributed to the P1.25 billion bond flotation that LWUA projects for 2009.

Table A6.11: LWUA Total Payables, 2005 −−−−2006

LWUA = Local Water Utilities Administration.

Items 2005 2006 2007 2008 2009

Budget Current Liabilities 1,643 1,852 1,673 1,831 1,533 Non-current Liabilities 10,706 10,716 9,981 9,376 10,315 Total Liabilities 12,349 12,568 11,655 11,207 11,848

Appendix 6


178

A5.11: LWUA Total Payables, 2005-2009

0

5,000

10,000

15,000

2005 2006 2007 2008 2009

Year

P m

illio

n

Current Liabilities Non- Current Liabilities

35. Almost 88% of the total liabilities account is from local and foreign borrowings, and 92% of this mostly comes from foreign borrowings. Table A6.12 and Figure A6.12 show the percentage of foreign and local borrowings to total liabilities. Details of the loan payable account are further discussed in Appendix 6.

Table A6.12: Percentage of Foreign and Local Borrowings to Total Liabilities, 2005-

2009

Items 2005 2006 2007 2008 2009

Budget Total Foreign and Local Borrowings 10,956 11,106 10,331 9,588 8,811 Total Liabilities 12,349 12,568 11,655 11,207 11,848 Percentage to Total (%) 89 88 89 86 74

Figure A5.12: Foreign and Local Borrowing vs Total Liabilities, 2005-2009

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2005 2006 2007 2008 2009Year

P m

illio

n

Total Foreign and Local Borrowings Other Liabilities

A6.11: LWUA Total Payables, 2005 -2009

Figure A6.12: Foreign and Loca l Borrowings vs Total Liabilities, 2005-2009

Appendix 6


179

D. Financial Ratios

36. Two sets of ratios were used in the analysis of LWUA performance. The first set consists of the standard ratios used by LWUA in its financial reports, namely current ratio, debt−equity ratio, and operating ratio. The second set of ratios includes financial indicators used to assess performance of financial institutions and which were also used in a separate study on LWUA issues funded by the World Bank.3 These indicators are also referred to as the capital asset management earnings liquidity (CAMEL) framework ratios and can be classified broadly in terms of (i) capital adequacy indicators, (ii) asset quality indicators, (iii) management quality indicators, (iv) earning performance indicators, and (v) liquidity indicators.

1. LWUA Standard Ratios

37. The three key financial indicators being used by LWUA are the current ratio, operating ratio, and debt-equity ratio. As presented in Table A6.13 and Figure A6.13, LWUA appears fairly liquid and can cover its maturing liabilities. This is indicated by its favorable current ratios which showed a continuous growth from 2005 to 2009 and resulted in a current ratio of 1.88 in 2008. Likewise, operating ratios from 2005 through 2008 showed that operating revenues are more than enough to sustain LWUA’s operations. The debt−equity ratio also has been going down as LWUA gradually paid off its loans and shifted financing through equity rather than debt.

Table A6.13: LWUA Financial Indicators

LWUA Fin ancial

Indicators 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Budget Current Ratio 1.11 1.20 1.46 1.88 1.44 Debt−Equity Ratio 2.46 2.37 1.82 1.61 1.08 Operating Ratio 0.70 0.59 0.58 0.55 0.67

LWUA = Local Water Utilities Administration.

Figure A5.13: LWUA Current Ratio, Operating Ratio, and Debt-Equity Ratio, 2005-2009

0

0.5

1

1.5

2

2.5

3

2005 2006 2007 2008 2009

Year

Rat

io

Current Ratio Operating Ratio Debt Equity Ratio

3 Virata, ibid.

Figure A6.13: LWUA Current Ratio, Operating Ratio, and Debt-Equity Ratio, 2005-2009

Appendix 6


180

2. Capital Asset Management Earnings Liquidity Framework a. Capital Adequacy Ratio

38. The capital adequacy ratio (CAR), which is also known as the capital risk (weighted) asset ratio, is a tool to measure a financing institution’s (FI) financial strength as well its ability to cover its operational and abnormal losses. Capital adequacy relates to asset structure than to the volume of liabilities. It is expected that most financial institutions have adequate capital to support its risk assets in accordance with the risk-weighted capital ratio framework. This indicator requires that assets be classified by reference to their demands on the equity (capital) structure of the FI.4 39. The CAR indicator is derived by comparing the ratio of an entity’s equity to its assets at risk. A mandatory minimum CAR of 8% is recommended. However, the ADB Developing Member-Countries Guidelines recommends a minimum CAR of 12%. The LWUA CAR is beyond the minimum required which ranged from 28% to 41% covering the years 2005 to 2008. Capital adequacy ratios were obtained by adding total paid in capital, reserve funds, and net income and dividing the total by the net AR-WD and net LTR-WD. 40. Debt service coverage ratio (DSCR) is the amount of cash flow available to meet interest and principal payments of loans. The standard ratio is 1.3, as this would mean that an FI has the ability to generate enough income to pay its debt obligations. This ratio is obtained by dividing the net operating income (before interest and non-cash expenses) by annual debt service. Table A6.14 shows that while the ratio significantly improved to 0.97 in 2008 from a low DSCR of 0.08 in 2002, it is still a little bit short of the desired level.

Table A6.14: Capital Adequacy Indicators

Indicators 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Capital Adequacy Ratio 29% 26% 20% 28% 29% 37% 41% Debt Service Coverage 1.03 0.61 0.08

-0.42 0.17 1.27 1.09 1.00 0.97 0.99

Source: Years 2000-2004 ratios from Virata and Associates, Inc. April 2008. Final Report on the Study on Selected Financial Issues Related to LWUA as a Consequence of EO 279, Volume 1. Manila; Years 2005-2008 data from LWUA Financial Statement.

b. Asset Quality Indicators

41. The quality of an FI’s assets particularly loans and investments is the attribute that influences its financial performance. The effect of the asset quality on the FI’s operations can be gauged through the loan loss provision ratio and portfolio in arrears ratio. 42. The loan loss provision ratio indicates provisioning requirements on the loan portfolio for the current period and is computed by dividing the provision for bad debts by the net AR-WD and net LTR-WD less non-performing loans and deferred accounts. 43. The portfolio in arrears shows the percentage of overdue accounts to the outstanding loan. The figures used in the computation were from the schedule of the aging of receivables furnished by the LWUA Loans Administration Department. The results show that the percentage of receivables in arrears had grown from 69% to 86% from year 2006 to 2008.

4 ADB. 2005. Financial Management and Analysis of Projects.

Appendix 6


181

44. The loan loss ratio shows the percentage of amounts written off over average outstanding receivables. LWUA still has to take action on the accounts to be written off in response to the Commission on Audit recommendation on the collectibility of the receivables.

Table A6.15: Asset Quality Ratios

Asset Quality

Indicators 2000 2001 2002 2003 2004 2005 2006 2007 2008 Loan Loss Provision (%) 9 9 1 3 4 1 1 4 2 Portfolio in Arrears (%) 69 72 86 Loan Loss Ratio (%) 9 9 1 3 5 Source: Years 2000-2004 ratios from Virata and Associates, Inc. April 2008. Final Report on the Study on Selected Financial Issues Related to LWUA as a Consequence of EO 279, Volume 1. Manila; Years 2005-2008 ratios from LWUA Financial Statement.

c. Management Quality Indicators

45. LWUA’s management efficiency and competence as well as its efficiency in distributing loans can be measured by the cost per unit of money lent. As can be seen in Table A6.16, this has been on the decline since 2002 indicating improving efficiency of operations. In 2002, LWUA spent around P1 on operating expenses for every peso lent. In 2008, this went down to P0.32 and is expected to further drop to P0.19 in 2009. The increase in 2007 reflects the effect of the drop in project disbursements.

Table A6.16: Management Quality Ratios

Management Quality Indicators

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Budget Cost per Unit of Money Lent (P)

0.51

0.82

1.05

0.85

0.61

0.45

0.39

0.63

0.32

0.19

P = Philippine peso. Source: Years 2000-2004 data from Virata and Associates, Inc. April 2008. Final Report on the Study on

Selected Financial Issues Related to LWUA as a Consequence of EO 279, Volume 1. Manila; Years 2005-2008 data from LWUA Financial Statement.

d. Earnings Performance Indicators

46. The earnings performance indicators measure the efficiency of an FI in managing its assets and liabilities to earn reasonable profits. These profits in turn will help build adequate reserves, promote asset growth, and build confidence of investors and creditors to provide more loans. The FIs’ quality and trend of earnings can be gauged by the use of ratios such as return on assets, return on equity, interest mark-up, earnings spread ratio, and intermediation cost ratio. 47. Based on Table A6.17, LWUA’s spread between interest revenues and interest expense has been increasing in recent years compared with the negative ratios up to year 2004 and stabilized at around 3.5 in 2008. As a result of the higher revenues and net income in recent years, returns as a percentage of asset and equity had shown significant improvements.

Appendix 6


182

48. The earnings spread ratio is between 8% to 9%. Intermediation cost ratio shows that operating cost is only between 6% to 8% of the average total assets.

Table A6.17: Earnings Performance Ratios

Earnings

Performance Indicators

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Return on Assets 1% 0% -2% -5% -2% 2% 3% 1% 2% 1%

Return on Equity 3% 0% -4% -

13% -7% 7% 10% 3% 7% 4% Interest Mark-up 3.45 2.45 2.34 2.83 2.40 3.56 3.56 Earnings Spread 9% 8% 8% 9% 8% 9% 8% Intermediation Cost 2% 4% 8% 8% 7% 6% 5% 7% 6% 7%

Source: Years 2000-2004 data from Virata and Associates, Inc. April 2008. Final Report on the Study on Selected Financial Issues Related to LWUA as a Consequence of EO 279, Volume 1. Manila; Years 2005-2008 data from LWUA Financial Statement.

e. Liquidity Indicators

49. The percentage of receivables from WDs against loans payables showed a downward trend from 2000 to 2006 and gradually increased from 2005 to 2009 (Table A6.18). LWUA’s liquidity indicators are favorable ranging from about 130% to 150%.

Table A6.18: Liquidity Ratios

Liquidity Ratios 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Loans to “Liabilities to Lenders” (%)

151

153

145

128

126

134

136

144

141

185

Source: Years 2000-2004 data from Virata and Associates, Inc. April 2008. Final Report on the Study on Selected Financial Issues Related to LWUA as a Consequence of EO 279, Volume 1. Manila; Years 2005-2008 data from LWUA Financial Statement. E. COA Findings 50. The Commission on Audit had qualified their opinion on the 2007 LWUA Financial statements on the following grounds:

(i) The non-reconciliation of receivables per general ledger and subsidiary ledger balances amounting to P139 million, and

(ii) The existence of long-standing loans from the International Bank for Reconstruction and Development amounting to P142.2 million without valid claims from the Bureau of Treasury.

51. Other major findings include the collectibility of loans from non-operational water districts which have remained outstanding for 14 years; the failure of LWUA to pay its loans on time, thus the incurrence of P26 million penalty charges; the understatement of allowance for bad debts; non-reconciliation of cash accounts; and overdue accounts of loans from officers and employees.

183 Appendix 6


ANNEX 1a - DETAILS OF FINANCIAL REPORTS PART I – FINANCIAL REPORTS

A. LWUA Financial Indicators 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

1. Current Ratio 1.11 1.20 1.46 1.88 1.44 Formula: Current Assets/Current Liabilities

2. Debt - Equity Ratio 2.46 2.37 1.82 1.61 1.08 Formula: Long-term Liabilities/Total Equity

3. Operating Ratio 0.70 0.59 0.58 0.55 0.67 Formula: Operating Expense/Operating Revenues (Total OPEX - Non Cash) B. CAMEL Framework

1. Capital Adequacy Indicators

a. Capital Adequacy Ratio 29% 26% 20% 28% 29% 37% 41% Formula Paid in Capital+Reserve Funds+Net Profits/ Total Assets-Loan Loss Prov-Risk free assets b. Debt Service Coverage Ratio 1.03 0.61 0.08 -0.42 0.17 1.27 1.09 1.00 0.97 0.99 (Net Income before non-cash items and financing charges/Debt Service) Formula Net Revenue/Annual Debt Service

2. Asset Quality Indicators

a. Loan Loss Provision Ratio 9% 9% 1% 3% 4% 1% 1% 4% 2% Formula: Loan loss Provision/Ave. Performing Assets

b. Portfolio in Arrears 69% 72% 86%

184 Appendix 6


Formula: 30% Balance of Loans in Arrears/Value of Loans Outstanding

c.Loan Loss Ratio 9% 9% 1% 3% 5% Formula: Amount Written Off/Ave. Loans Outstanding

3. Management Quality Indicators

a.Cost per Unit of Money Lent 0.51 0.82 1.05 0.85 0.61 0.45 0.39 0.63 0.32 0.19 Formula: Operating Costs/Total Amount Disbursed

4. Earnings Performance Indicators

a. Return on Assets 1% 0% -2% -5% -2% 2% 3% 1% 2% 1% Formula: (Net Income after tax/Total assets)x 100

b. Return on Equity 3% 0% -4% 13% -7% 7% 10% 3% 7% 4% Formula: (Net Income after tax/Ave.total Equity)x100

c. Interest Mark-up 3.45 2.45 2.34 2.83 2.40 3.56 3.56

Formula: ( Interest Revenue/Interest Expense)-1 d. Earnings Spread Ratio 9% 8% 8% 9% 8% 9% 8% Formula: (Total Income-Non-operating Income x100/Ave Total Portfolio) - (Interest Expense+Other Finance Charges/Ave. Total Resources) x100

e. Intermediation Cost Ratio 2% 4% 8% 8% 7% 6% 5% 7% 6% 7% Formula: (Total Exp.-Interest Exp./Ave.Total Assets)x100

5. Liquidity Ratios

a. Loans to "liabilities to lenders" 151% 153% 145% 128% 126% 134% 136% 144% 141% 185%

185 Appendix 6


Formula: (Loans to WD/Loans from Creditors)x100

Appendix 6


186

PART II - FINANCIAL REPORTS

Local Water Utilitites Administration Comparative Financial Statements December 21, 2005-2009

Balance Sheet In P Million

Assets Audited Audited Audited Unaudited Budget Current Assets 2005 2006 2007 2008 2009

Cash and cash equivalents 438 979 762 1,651 137 Accounts Receivables 753 905 1,220 1,047 947 Current Portion of long-term receivables-net 392 0 0 0 1,015 Receivables from government agencies 0 186 327 600 0 Other Receivables, net 0 34 29 44 103 Inventories 2 3 1 3 6 Prepaid Expenses 0 0 1 0 0 Other Current Assets 235 116 108 105 1 Total 1,820 2,223 2,449 3,451 2,210

Non-Current Assets Long-term receivables 0 Investments 14,264 14,279 13,971 12,611 16,282 Property and Equipment - net 290 334 365 397 413 Deferred Charges 95 134 139 146 213 Other Assets 102 0 0 0 76 Total 3 14 64 171 44 Total Assets 14,754 14,761 14,539 13,325 17,028

16,574 16,983 16,987 16,775 19,238

Liabilities and Equity

Current Liabilities Accounts Payable and Accrued Expenses 385 280 573 101 491 Current Portion of Long term debt 549 540 Payables to Government Agencies 273 218 587 Accrued Interest on Foreign Loans 133 Trust Liabilities 231 Other Current Liabilities 345 1,299 882 1,143 502 1,643 1,852 1,673 1,831 1,533

Non-current Liabillties Long-term Liabilities 10,408 10,484 9,728 8,966 8,811 Deferred Credits 298 232 254 410 254 Bonds Payable 1,250 10,706 10,716 9,981 9,376 10,315 Total Liabilities 12,349 12,568 11,655 11,207 11,848 Equity 4,225 4,416 5,332 5,568 7,390

Total Liabilities and Equity 16,574 16,983 16,987 16,775 19,238

Appendix 6


187

ANNEX 1b. LWUA INCOME STATEMENT, 2005 – 2009 In P Million Audited Audited Audited Unaudited Budget 2005 2006 2007 2008 2009 Income Interest Income 1,595 1,730 1,727 1,821 1,673 Service Income 177 131 41 31 147 Fines and Penalties 3 14 26 48 0 Miscellaneous Income 10 44 89 71 132 Other Income 4 31 5 Gross Income 1,789 1,950 1,889 1,971 1,952 Operating Expenses Personal 417 447 461 562 546 Maintenance and Other Operating Exp 349 257 132 126 397 Financial Expenses Interest Expense 474 450 508 399 367 Other Financial Charges 3 2 2 6 0 Loss on Forex 17 Total Operating Expenses 1,261 1,155 1,103 1,093 1,310 Income from Operations 529 795 786 878 642 Non-Cash Charges Bad Debts Expense 116 106 593 13 278 Depreciation Expense 10 7 13 303 Total 126 113 606 317 278 Net Income Before Income Tax 403 682 180 562 364 Provision for Income Tax Current Tax 38 168 (229) (299) 120 Deferred Tax 88 65 172 106 0

Net Income after income Tax 278 449 123 369 244

Appendix 6


188

ANNEX 1c: LWUA CASH FLOW STATEMENT, 2005-2009 (P Million)

Audited Audited Audited Unaudited Budget 2005 2006 2007 2008 2009 Cash Flows From Operating Activities Interest from loans and accounts of WDs/RWSAs 1,052 1,166 1,267 1,268 1,520 Principal payments from loans and accounts receivable 271 311 350 387 Interest from ba nks deposits and short -term investments 29 32 32 18 26 Cash received for engineering services rendered 10 1 16 57 102 Other collections 48 179 6 684 125 Cash paid to suppliers and employees (499) (763) (581) (680) Interest and other debt service charges (395) (429) (459) (520) Payment of income taxes (21) (128) (478) (375) Payment of dividend (50) Operating Expenditures (766) Net cash from operating activities 516 475 454 736 632 Cash flows from investing activities Disbursements for projects: Foreign Cost (1,077) (654) (111) (27) (111) Local Cost (440) (476) (387) (559) (4,410) Withdrawal of investment in securities 50 46 39 35 80 Payment of long-term liabilities (136) (105) (53) 0 (1,017) Investments in agrarian reform bonds (49) (96) (73) (70) (80) Loans to officers and employees (29) (24) (34) (43) (55) Bond floatation 0 0 0 0 1,250 Acquisition of property and equipment (6) (16) (1) (17) (67) Net cash used in investing activities (1,686) (1,324) (619) (682) (4,410) Cash flows from investing activities Proceeds from government subsidies 300 10 2,200 Proceed from local borrowings 214 240 342 0 200 Proceeds from foreign borrowings 0 0 0 0 111 Proceeds from long-term debts 1,299 534 56 7 0 Proceeds from water districts' long-term loans 33 1,335 81 1,763 532 Proceeds from wate district reserve deposits 39 0 0 39 26 Principal payments of loans from foreign and local lending 0 0 0 0 0 institutions (397) (711) (832) (798) 0 Dividends paid to the national government 0 0 0 (188) 0 Net cash provided by financing activities 1,187 1,397 (52) 834 3,068 0 0 0 0 0 Net decrease in cash and cash equivalents 17 548 (217) 889 (710) Cash and cash equivalents at beginning of year 414 431 979 762 1,651 Cash and cash equivalents at end of year 431 979 762 1,651 941 Note: Beginning cash balance for budget 2009 was corrected to 2008 ending cash balance.

Appendix 7


189

WATER DISTRICT LOAN RECEIVABLES AND LWUA DEBT PROFILE A. LWUA Receivables

1. Water District Account Balances 1. Water district (WD) accounts comprise (i) the current portion due in the current year, which are called accounts receivables (AR-WD) and shown as part of current assets in the balance sheet; and (ii) the amounts due beyond the current year referred to as long-term receivables (LTR- WD) shown as part of non-current assets. As of December 2008, gross AR-WD balance stood at P1.65 billion consisting of interest and current portion of outstanding long-term loans classified as (i) performing loans, (ii) non-performing loans (NPL) including accounts with non-operational WDs, and (iii) deferred accounts (DA). LTR-WD loans include (i) loans receivable from WDs, and (ii) unbilled loans, AR-WD, and restructured receivables totaling P13.7 billion as shown in Table A7.1. WD accounts totaled P15.4 billion as of December 31, 2008.

Table A7.1: Balances of Water District Accounts Receivables and Long-term Receivables, December 2008

Items

Accounts Receivables (AR -WD) Long -term Receivables (LTR -WD) 2008 AR Balances

Less Allowance

for BD

Net AR

2008 LTR Balances

Less Allowance

for BD

Net AR

Based on LWUA Financial Reports Interest 950 Principal 703

Loans Receivable from WDs 13,251 Unbilled loans and WD AR 96 Restructured Receivables 389

Total 1,653 615 1,038 13,736 1,326 12,410 % of Allowance to AR and LTR 37% 10% Total AR and LTR 15,389 1,941 13,448 % of Allowance to Total AR and LTR

13%

Based on Loans Department Records Per Loan Subsidiary Ledgers/Billing and Collection Reports

14,110

Performing Loans 211 Uncollectible Accounts 925

1,136 Per Aging of Receivables 1,141 Differences for Reconciliation 517 to

512

(374)

Reconciliation of WD Accounts with Total AR and LTR per Financial Report WD Accounts 1,653 13,736 Non-WD Accounts 10 201 Total AR and LTR 1,663 13,937

AC = accounts receivable, BD = bad debt, LTR = long-term receivable, WD = water district.

Appendix 7


190

2. Growth Trends

a. Gross AR-WD and LTR-WD

2. LWUA’s receivables from water district loans have grown as much as 72% in a span of 3 years, representing an annual average increase of 24% during the period 2005−2008. Table A7.2 and Figure A7.1 show the increase in AR-WD and LTR-WD. The highest increase (36%) registered from 2006 to 2007, and this was primarily due to the increase in accounts with collection problems (see section on Non-performing Loans and Deferred Accounts of this Appendix). Collection efficiency was calculated at 81% of receivables net of non-performing loans and deferred accounts (see section on Collection Efficiency of this Appendix). The composition of the aging of receivables as of December 2008 also reflects this serious problem, since almost 85% of accounts billed are past due (over 6 months) and 1% are accounts from non-operational water districts (see section on Aging of Receivables of this Appendix). 3. There was no significant movement in the long-term loan receivable accounts for WDs. In fact, this account decreased by 9% in 2008 due to loan refinancing. Several water districts refinanced their LWUA loans through other financing institutions such as Development Bank of the Philippines and Land Bank of the Philippines. From 2006 to 2008, 13 water districts refinanced their loans totaling P3.7 billion. Table A7.2: Trend of Water District Accounts Receivables and Long-term Receivables

2005-2008 (P Million)

Items

2005

2006

2007

2008

Ave Inc/ Dec

Amount % Amount % Amount % % Accounts Receivables 961 1,137 18 1,548 36 1,653 7 24 Long-term Receivables 14,773 14,948 1 15,125 1 13,736 -9 -2 Total 15,734 16,085 2 16,667 4 15,389 -8 -1 Percentage of Total (%)

Accounts Receivables 6 7 9 11 Long-term Receivables 94 93 91 89

Total 100 100 100 100 Ave Inc/Dec = average increase/decrease, P = Philippine peso. Source: LWUA audited financial statements.

Appendix 7


191

Figure A6.1: Gross Water District Accounts Receivables and Long-term Receivables, 2005-2008

02000400060008000

1000012000140001600018000

2005 2006 2007 2008

Year

P m

illio

n

Accounts Receivables Long term Receivables

Gross AR and LTR (WD loan)

b. AR-WD and LTR-WD Net of Allowance for Bad Debts

4. LWUA’s AR-WD net of allowance for bad debts increased at an average of 8% per year. Year 2007 posted a marked increase of 37%, reflecting collection problems as discussed in the previous section. See Table A7.3 and Figure A7.2. 5. As mentioned earlier, the lack of significant movement on the long-term loans receivables is a manifestation or an indication of slack in project activities for water districts from 2005 to 2008 and reflects the re-financing of WD loans.

Table A7.3: Trend of Water District Accounts Receivables and Long-term Receivables (Net of Allowance for Bad Debts), 2005-2008

(P Million)

Items

2005

2006

2007

2008

Ave Inc/ Dec

Amount % Amount % Amount % % Accounts Receivables 828 801 -3 1,098 37 1,038 -5 8 Long-term Receivables 14,117 14,239 1 13,937 -2 12,410 -11 -4 Total 14,945 15,040 1 15,035 -.03 13,448 -11 -3 Ave Inc/Dec = average increase/decrease, P = Philippine peso.

Figure A7.1: Gross Water District Accounts Receivables and Long-Term Receivables, 2005-2008

Appendix 7


192

Figure A6.2: Net WD Accounts Receivables and Long-term Receivables, 2005-2008

0

2000

4000

6000

8000

10000

12000

14000

16000

2005 2006 2007 2008Year

P m

illio

n

Accounts Receivable (Net) Long term Receivables (Net) Total AR and LTR (Net)

3. Collection Efficiency

a. Collection Efficiency on Interest and Principal

6. There are several definitions of collection efficiency, as follows:

(i) Based on collectible accounts – The Billing and Collection Report (BCR) prepared by LWUA Loans Administration Department (LAD) for 2008 reports a collection efficiency of 94% on collectible accounts, that is AR balance less non performing loans (NPL), accounts of non-operational WDs and problematic accounts with collection action plans (Table A7.4.)

(ii) Based on AR less NPL and DA only – The LAD also prepares a projected

receivables and collection report which uses a more conservative collection efficiency figure of 85% based on AR balance less NPL and DA accounts only. Using the same figures in the 2008 BCR results in a collection efficiency of 81%. This calculation, also used for LWUA’s cash flow projections, was used in the cash flow projections prepared in this report.

(iii) Based on Gross Billing – Using the same figures in the 2008 BCR, collection

efficiency is computed at 77%.

(iv) The BCR collection efficiency based on the amount collected over the amount considered collectible does not give the complete picture and could lead LWUA to complacency as to the high levels of collection efficiency achieved. It is suggested that LWUA monitor performance using other computations of actual collection efficiency as a management guide in identifying appropriate intervention. Other indicators to be monitored could include movements of NPL, DA and accounts of non-operational WDs. Management can require regular reports on these indicators as bases for aggressive action to improve performance.

Figure A7.2: Net WD Accounts Rece ivables and Long-Term Receivables, 2005-2008

Appendix 7


193

7. Collection efficiency based on collectible accounts improved from 84% in 2006 to 95% in 2008. However, collection efficiency based on AR net of NPL and DA went down from 86% to 81% (Table A7.4).

Table A7.4: Computation of Collectible Accounts (P Million)

Items 2008 2007 2006

Amount Percent (%)

Amount Percent (%)

Amount

(1) Gross Billing 5,045.63 100.00 2,767.93 100 (2) Less Uncollectible Accounts

Non-performing Loans 72.68 1.44 Deferred Accounts 50.44 1.00 Accounts of Non-operational WDs

14.41 .29

Accounts with Collection Action Plan

787.95 15.62

Subtotal 925.48 18.34 824.52 30 (3) Total Collectible accounts 4,120.15 81.66 1,943.41 70 (4) Less Collections 3,909.11 77.48 1,780.67 64 2,803.43 (5) Ending Balance (1-4) 1,136.52 987.26 Ending Balance, including amount in transit

1,168.72

1,022.42

Collection Efficiency (net of uncollectible accounts)

95 92 84

Collection Efficiency (net of NPL and DA)

81 86

Collection Efficiency (gross billing)

77 64

DA = deferred account, NPL = non-performing loan, P = Philippine peso, WD = water district.

b. Collection Efficiency on Interest 8. The collection rate on interest receivables from water districts ranged from 63% to 73% for the years 2003-2008 (Table A7.5). The low collection efficiency rate on interest alone is one of the main reasons why the receivables continue to pile up over the years. The 2009 LWUA budget targets a collection rate of 90%, 20% higher than the collection rate in 2008. 9. To gauge LWUA’s collection rate on interest from water districts loans, the interest billings were matched against interest collection for the years 2005−2009 (Figure A7.3). Interest billing figures were from the income statements while interest collection figures were obtained from the cash flow statements.

Appendix 7


194

Table A7.5: Collection Efficiency Rate (Interest Billings vs Interest Collection)

Year

Collection Efficiency Rate (%)

2003 71a 2004 63a 2005 66 2006 67 2007 73 2008 70 2009 90b

a Source: C. Virata Report. b Source: LWUA Annual Budget.

Figure A6.3: Interest Billing vs Interest Collection 2005-2009

0

500

1000

1500

2000

2005 2006 2007 2008 2009

Year

P m

illio

n

Interest Collection Interest Billings

c. Non-Performing Loans and Deferred Accounts 10. Of the P5.05 billion gross billings reported in the Billing and Collection Report in 2008, P925 million or 18% referred to accounts with serious collection problems. For this reason, this amount was deducted to come up with the value of the accounts which were collectible. 11. Non-performing loans amounting to P73 million in 2008, comprise loan accounts with no payments for several years. This was more than 1% of gross billing and 17% of the year-end 2008 AR-WD balance of P1,168 million.1 LAD prepared projections of the movements of these accounts for the period 2009−2018. Based on the projections, LWUA estimates that over the 10-year period ending 2018, NPL is estimated to increase to P162 million out of which around 60% will not be collected. 12. In their review of the 2007 financial report, the Commission on Audit (COA) commented that NPL accounts included existing loans from 18 non-operational water districts amounting to P4 million. These loans remained outstanding for more than 14 years as these were availed of in 1992 and 1993. There are indications that these loans will not be collected and there has been no action on the part of LWUA for the write-off of the said

1 P1,168 million includes amount in transit. LAD balances in process of being reconciled with balances in the

financial report.

Figure A7.3: Interest Billing vs Interest Collection, 2005-2009

Appendix 7


195

uncollectible accounts. COA recommended for LWUA to institute measures and legal action to demand payments from these non-operational water districts so that possible write-off of accounts that may be requested of them will be properly supported and documented.2 LAD recognizes that action needs to be done on the NPL accounts, particularly those which are doubtful of collection. They plan to submit to management a recommendation on this matter.

13. Deferred accounts had a balance of P50.4 million in December 2008. These refer to accounts with WDs which have requested financial relief and are having their requests for restructuring approved by LWUA management. Once the deferment is approved by the LWUA Administrator the account is reclassified as part of restructured receivables account under long-term receivables. Deferred accounts are merely restructured accounts and so LWUA believes that ultimately these accounts will be collected.

d. Aging of Receivables

14. Table A7.6 summarizes the aging of AR-WD. This table shows that the percentage of accounts within 6 months has decreased significantly from 32% in 2006 to 15% in 2008. By the end of 2008, 85% of AR-WD accounts have been due more than 6 months. As a result, the total of unpaid accounts increased by as much as 63% from P700 million in 2006 to P1.14 billion in 2008 or a net increase of P440 million. Accounts which have been due for more than 10 months comprise 72% of the P1.14 billion3 AR balance in 2008.

Table A7.6: Aging of Receivables, 2006-2008 (P Million)

Items 2006 2007 2008

Amount Percent (%)

Amount Percent (%)

Amount Percent (%)

Up to 6 months 220 32 287 28 166 15 6 to 10 months 105 15 148 15 153 13 10 months to 2 years 198 28 315 31 447 39 More than 2 years 164 23 253 25 360 32 Non-operational 13 2 14 1 14 1 Total 700 100 1,016 100 1,140 100

P = Philippine peso. 15. Figure A7.4 shows further that the receivables aged 10 months to 2 years and those more than 2 years dominate the bulk of the receivables.

2 COA Report on the 2007 Audited Financial Statements. 3 LAD balances in process of being reconciled with balances in the financial report.

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Figure A6.4: Aging of Accounts Receivables, 2006-2008

0

200

400

600

800

1000

1200

Year

P m

illion

Up to 6 mos. 220 287 166

6 to 10 mos. 105 148 153

10 to 2 yrs. 198 315 447

more than 2 years 164 253 360

non-operational 13 14 14

2006 2007 2008

4. Allowance for Bad Debts 16. As contained in LWUA’s annual audit reports, the estimated uncollectible accounts for performing loans are determined at 25% of interest receivable and current portion of long-term loans receivable, and 4% of long-term loans receivables. In the 2007 LWUA Annual Report, non-performing loans were provided with a 40% allowance. The rates of the allowance for bad debts are based on the evaluation of existing loan portfolio composition, past and expected loss experiences and percentage of receivables performed by the LWUA Accounting Department. This was not formalized into written policy.4 COA recommended that the setting of the rates of allowance for bad debts be formalized into a written policy. 17. As shown in Table A7.7 below, AR-WD increased at an average rate of 24% per year, while allowance for bad debts increased at an average rate of 121% per year. The highest recorded rate of increase in the provision for doubtful accounts is 153%, or an increase of P203 million in 2006. While there is no significant increase in LTR from 2005 to 2008, allowance for bad debts increased at an average rate of 27%. 18. As of December 2008, allowance for bad debts on AR was at P615 million, while that for LTR was at P1.3 billion, representing 37%and 10% of the respective account balances.

4 COA findings per audited Financial Statement 2007.

Figure A7.4: Aging of Accounts Receivables, 2006-2008

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Table A7.7: Allowance for Water Districts’ Bad Debts, 2005-2008

(P Million)

Items

2005 2006 2007 2008 Average % Inc/ Dec

Amount

% Inc/ Dec

Amount

% Inc/ Dec

Amount

% Inc/ Dec

Amount

Accounts Receivables 961 18 1,137 36 1,548 7 1,653 24 Allowance 133 153 336 34 450 37 615 121

Net AR 828 801 1,098 1,038 % of AR 14 30 29 37

Long-term Receivables 14,773 1 14,948 1 15,125 -9 13,736 -2

Allowance 656 8 709 68 1,188 12 1,326 27 Net LTR (WD loans) 14,117 14,239 13,937 12,410 % of LTR 4 5 8 10

Total AR and LTR 15,734 2 16,085 4 16,673 -8 15,389 -1 Less Allowance 789 32 1,045 57 1,638 18 1,941 49 Net 14,946 15,040 15,035 13,448 % of AR and LTR 5 6 10 13 AR = accounts receivable, Inc/Dec = increase/decrease, LTR = long-term receivable, P = Philippine peso, WD = water district. 19. Figure A7.5 below shows the percentage of the allowance for bad debts against AR-WD and LTR-WD. The allowance for bad debts of P615 million provides for 100% of AR-WD accounts which are beyond 2 years due, including non-operational WD account and about 54% of accounts above 10 months but less than 2 years. Further analysis of the accounts is needed and action has to focus on accounts which are above 6 months to ensure that these do not turn out to be non-performing accounts in the future. 20. The LTR-WD balance of P13.4 billion as of December 2008 includes P389 million which refers to restructured accounts that also require close monitoring in the coming years. This provision of allowance of P1.326 billion needs further analysis to determine its adequacy.

0

2000

4000

6000

8000

10000

12000

14000

16000

2005 2006 2007 2008

P m

illio

n

Year

Figure A6.5: WD Accounts Receivables and Long-term Receivables vs Allowance for Bad Debts, 2005-2008

AR-Allowance AR-WD

Figure A7.5: WD Accounts Receivables and Long Term Receivables vs Allowance for Bad Debts, 2005-2008

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5. Reconciliation of Accounts

21. Figure A7.5 shows differences between the balances in the unaudited LWUA financial reports for 2008 and reports prepared by the Loans Administration Department. There is a difference of around P517million for AR accounts, and P374 million for LTR accounts. LAD started the ongoing reconciliation process in 2005. They report that the major reconciling item represents a timing difference from the time receivable transactions are recorded by the Finance Department based on journal voucher approval and the recording by LAD based on the date the approved journal vouchers are transmitted to them. It is highly recommended that LWUA reconciles its loan accounts to assure itself that the receivables represent amounts which are collectible. Collection of the unreconciled amounts were excluded for purposes of the WDDSP projection in this study.

22. As contained in the LWUA audited financial report, COA had reiterated its past recommendations on the periodic reconciliation between LWUA’s record and LWUA against WDs’ records. Periodic reconciliation of LWUA’s general ledger and subsidiary ledger balances were also included as part of the recommendations as 2007 findings reveal P139 million unreconciled balances in the receivables account. This is one of the reasons why COA issued a qualified opinion on the LWUA 2007 financial reports. B. Debt Profile

1. Loans Payable Balances 23. As of December 31 2008, long-term liabilities totaled P 8.96 billion of which P630 million represented the current portion. LWUA’s loan portfolio is classified mainly into foreign and local borrowings. Foreign loan borrowings amounting to P8.78 billion, represent loans received through subsidiary loan agreements with the national government from foreign creditors mainly to finance, on a long-term basis, the development of various water systems in cities, municipalities, and rural areas in the country. The biggest loan is with the Overseas Economic Cooperation Fund amounting to P2.014 billion to be paid until 2027. The Kreditanstalt für Wiederaufbau (KfW) loan will have the latest payments with principal and interest payments running until 2039. 24. The local loan borrowing totaling P808 million is composed of drawings against the P1 billion term loan from the Land Bank of the Philippines. The loan is payable in 20 equal quarterly installments with interest at prevailing prime lending rate plus 2% spread. The current portion of this loan is P200 million. 25. LWUA’s long-term debt increased at an average rate of 25% per annum from 2000 to 2005. Total loans reached their peak at P11.2 billion in 2005 and gradually declined to P9.6 billion in 2008 (Table A7.8). This is due to the marked increase in principal and interest payments from 2006 to 2008.

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Table A7.8: Total Foreign and Local Loans Outstanding, 2000-2009 (P Million)

Year Foreign Loan Local Loan Total % Increase

2000 4,978

2001 5,257 5.6 2002 6,307 20.0 2003 8,319 32.0 2004 10205 23.0 2005 10,193 1013 11,206 10.0 2006 10,111 995 11,106 -1.0 2007 9,397 933 10,330 -7.0 2008 8,788 808 9,596 -7.0 2009 8,581 770 9,351 -2.5

P = Philippine peso. Source: 2000-2004 data from C. Virata and Associates, Inc. Final Report on the Study on

Selected Financial Issues Related to LWUA as a Consequence of EO 279, Volume 1. Manila; 2005-2008 data from LWUA audited financial statements.

2. Borrowing Capacity Ceilings

26. As of December 2008, actual LWUA borrowings stayed within borrowing capacity with actual foreign loans payable at around $175 million against the borrowing capacity of $500 million. On the other hand, local loans totaled P808 million against the borrowing capacity of P1 billion. Likewise, the ceiling for capitalization in the form of government equity has been reached. The proposed amendment to the presidential decree on LWUA capitalization has already passed the House of Representatives. While the bill has already passed the committee deliberation, the Senate still has to schedule the interpellation of the bill. After hurdling the interpellation, the bill will be put into its final form by another committee after reconciling differences, if any, between the Congress and Senate versions. LWUA hopes to have the law approved before the year ends.

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APPENDIX 8 – LWUA ACTION AND PROPOSALS TO IMPROVE COLLECTION EFFICIENCY

1. As reported in Appendix 7, LWUA’s accounts receivable increased tremendously during the last 3 years or from P961 million in 2005 to P1,653 million in 2008 based on figures from the Accounting Department. Of the P1,136 million receivables which are supported by subsidiary ledgers1 as of December, 2008, LWUA Loans Department considered about 66% or P925 million as uncollectible. Unless attended to, this very serious collection problem could result in the continuous erosion of the quality and value of the receivables. 2. To cover the risk, LWUA has set up high levels of allowance for bad debts equivalent

to 25% of the balance of accounts receivables and 40% of non-performing loans. With a relatively high spread, LWUA has managed to remain profitable despite the high provision for bad debts. While this initiative appears prudent in the light of the current situation, LWUA may have to update their own policy guidelines together with COA to consider this change in practice.

3. LWUA is taking some action to improve the worsening receivables condition, however more aggressive action by the concerned LWUA units is needed. LWUA has already in place the basic structural units needed to be able to enforce collection, specifically the Loans Operations and the Water District Development Department. All that is needed is identify the necessary actions and strengthen the institutional responsibilities of said departments in regard to the collection function.

A. Update/Status of Accounts Receivables

4. Based on Accounting records, Accounts Receivables from water districts loans decreased by 18% from P1.641 billion in December 2008 to P1.610 billion in June 2009. Based on LAD records, the reduction was from P1,168 million to P1,052 million as shown below:

AR balance, beginning (per BCR) P1,1682 million Billings (Jan-June 2009) 768

Total 1,936 Less: Collections 884 Balance, June 2009 1,052

B. Non-Performing Loans

5. It is significant to note that non-performing loans (NPL) decreased by 12% from P925 million in 2008 to P810 million as of June 2009 due to restructuring of loans. This signifies LWUA action to clear up the receivables accounts. However, as of June 2009, there still are about 120 water districts whose loans are considered uncollectible or classified under non-performing loans. This represents around 40% of the total of 306 water districts with

1 Accounts receivable general legers (kept by the Accounting Department) and subsidiary records (maintained by the Loans Administration Department), are to be reconciled by LWUA. 2 Total AR for Subsidiary Ledgers from LAD total P1.168 billion as of Dec.2008, against GL from Accounting which total P1.653 billion.

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outstanding receivables. Table A81.1 shows the summary of AR of P810 million as of June 2009.

Table A8.1 – Uncollectible Accounts as of June 30, 2009 Category Number of WDs Amount

Percentage to Total Amount

For Financial Relief 55 422,761,631* 52%

FR in Process 1

214,309,539** 26% Non - operational 13 7,563,353 10% Other NPL (Collection Action Plan, Deferred, Non-Performing 51 166,053,160 12% Total 120 810,687,683 100%

* Metro Roxas WD committed to settle arrearages by 2011(without restructuring) ** Santiago WD FR for finalization 2009

6. Following COA recommendations, the uncollectible accounts or non-performing loans are currently being evaluated by the Loans Department to assess the possibility of collections. These accounts are grouped and classified according to their perceived chances of being collected.

7. Fifty-five (55) water districts or about 52% of uncollectible accounts have approved recommendations for financial restructuring (FR); fifty one (51) water districts or around 12% fall under other non-performing loans which are further classified as with Collection Action Plans (CAP), Deferred or NPL. Accounts with Collection Action Plan belong to WDs who have committed to settle their arrearages within a prescribed timeframe with moratorium on penalties (CAP) without the benefit of restructuring. NPL accounts belong to WD who have not submitted any request for restructuring while accounts under Deferred refer to those whose restructuring is pending approval. The remaining 10% refers to accounts of 13 water districts that are no longer operational. In the meantime, LWUA is still studying if the infusion of new funds to these non-operational water districts (through the NILF loan) will help turn these water districts into fully operational WDs.

C. Reasons for Non-Payment of Loans

8. Water districts with account balances of P3 million and above and with arrearages beyond two years were selected from the 306 WDs with outstanding balances as of December 2008 and subjected to further study to determine possible reasons for non-payment of loans. Accounts from said water districts numbering 67 represent 86% of total outstanding receivables.

9. As shown in Table A8.2, the two major reasons for the WDs failure to pay their debt service are their inability to meet the projected number of service connection and problems with their water source which are either inadequate or have water quality problems. Some water districts also claim that the projections are overstated and are simply unattainable.

10. Other reasons cited contributing to the WDs non-payment of loans are political intervention, institutional problems or mismanagement, peace and order problems, delay in project implementation, deferment of implementation of tariff increases, high NRW, high operational costs, and poor collection performance.

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Table A8.2 – WD Reasons for Non-payment of Loans

Reasons No. of Water District Slow service connection growth/ projected number of connections unattainable

13

Water supply and water quality problem 17 Project Delay, Institutional Problem, Failure/delay in the implementation of tariff increase, Peace and Order Problem, Competing with another service provide, Poor Collection, High NRW, High pumping cost

11

Source: Responses from Management Advisors for Areas 1 to 3 and Areas 7 to 9 only. D. Overall Performance of Water Districts 11. WD non payment of accounts is mainly due to operational and financial difficulties. A review of the performance of the water districts as a whole, is presented in this section to get an indication of the extent of this problem. 12. LWUA periodically undertakes an assessment of the WDs financial and operational performance to determine and establish the yearly Water District Industry Average. Based on the Financial Statements submitted by the WDs to LWUA, the water districts’ liquidity, profitability, cost control, production efficiency, personnel management, marketing and collection effort are being examined and summarized in order to come up with a bench mark for each WD category and the industry as a whole. 13. In 2007, LWUA was able to evaluate the performance of 144 WDs or 30% of the total 473 WDs with sizes ranging from small to very large WDs. Based on the results of the assessment, the water district industry performance is highly satisfactory, showing significant improvements compared to previous years. The overall industry average in 2007 shows current ratio at 6.13:1, debt service ratio at 4.30, collection efficiency at 92% and NRW of 26%. 14. In addition to the industry averages, LWUA is mandated under Executive Order 279 to classify all water districts and all water service providers according to its creditworthiness. The categorization is being done to provide a basis for allocation of LWUA’s limited funds for financing as well as a guide for other financial institutions in the sector. 15. As of October 2008, 345 water districts or 73% have already been classified. The evaluation was based on the 2005 to 2007 financial statements of the water districts. The evaluation revealed that 18% or 62 water districts have performed very well and thus were classified as creditworthy. Around 181 water districts or 52% were categorized as semi-creditworthy WDs while the remaining 30% or 102 water districts were classified as pre-creditworthy and non-creditworthy, respectively. 16. Following this analysis, it appears that at least 30% of the water districts are financially depressed and would need more assistance from LWUA. Note that Table A8.1 shows that around 40% of the WDs with current receivables are considered non performing.

E. LWUA organization, policies and processes

1. Organization and processes

17. The problems indicated in the major accounts which are overdue point to many possible areas of improvement in LWUAs strategies, policies and processes. The following

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sections present a discussion of the organizational roles and tasks/activities done in each stage of the project development cycle from project/loan approval to collection monitoring and enforcement. 18. The key units involved are the Loans and Water Rates Department (LWRED) involved in the financial evaluation of projects and in the determination of the loan/grant mix provided to water districts; the Water District Development Department (WDDD) staffed by management advisors which regularly visit water districts to monitor their performance, and the Loans Administration Department (LAD) involved in the billing and in monitoring collection of water district receivables. See Table A8.3 for full list of key functions and LWUA units responsible for water district payment of accounts.

2. Mechanisms Open to LWUA

19. Based on existing policies, LWUA imposes penalties on arrearages. These penalties unfortunately failed to discourage WDs from non-payment gauging on the number of WDs now in arrears. These WDs in arrears failed to pay their debt service primarily because they are financially in distress and don’t have adequate funds. 20. LWUA also takes over the management function of WDs that are in arrears for more than 6 months. Recently though, this take over function is being used sparingly because of limited resources and/or capable people trained for the job. Some WDs which have been taken over also remain in arrears even after years of take over leading some to assume that the take over manager or Interim General Manager lacks the necessary skill unless otherwise LWUA fails to provide the necessary support to the take over manager. LWUA is also being cautious in taking over water districts particularly if the problem is overwhelming and there is no slight indication that LWUA’s intervention can change the picture.

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Table A8.3 Responsibilities in Water District Payment of Accounts Project

Development CycleUnit/s

ResponsibleActivities Observations/Issues

WDDD/ IDS Recommends WD/municipalities Criteria for selection not clear

AOS Finalizes list Decision to include municipality comes from top management

Project/POW preparation

AOS Undertakes technical study and prepares program of work

LWRED/ IDS Evaluates financial viability and recommends approval

Determines financing mix (loan/grant) depending on affordability

Top management exerts some pressure to pass and recommend financial assistance

Project/Loan Approval

Administrator Upon recommendation of DAs, approves POW and recommends Board approval of financial assistance

Board of Trustees

Approves financial assistance

Project Implementation

LAD/ FS Prepares loan documentation and secures signatures of parties concerned

Records loan disbursementsand sends bills to WD borrowers

AOS Handles the following: (i) Design and tendering, (ii) construction supervision, and (iii) monitoring

Implementation delays increase loan amount/ debt service signficantly

Project Operation WD Operates WS system, implements tariffs and collects bills

The WDs faces financial difficulties when:

(i) required tariff per feasibility study/ loan review is not implemented(ii) projected number of connections are not met(iii) supply as designed is not attained, this constrains growth in connections(iv) problems in water quality hinders growth in connections

Iv) they have a passive management/BoardWDDD/ IDS Monitors results of operation through Monthly

Data Sheets (MDS) and regular visits to WDsNot all WDs are able to submit MDS

Advisors are unable to closely monitor WD performance

Upon advice of LAD, initiates action to make sure WDs pay their debt service

Recommends financial relief and coordinates with LWRED for necessary documentation and evaluation

LAD/ FS Sends bills to WD borrowers LAD is unable to regularly advise IDS re WD repayment performance

Records WD payments of loan principal and interest

LD can not pressure IDS to take action on WD with arrearages

Monitors WD arrearages, advises IDS of mounting arrears and asks for plan of action

LWRED/ IDS Prepares documentation and recomments financial relief package for WDs in arrears

WDDD/ IDS In cases of weak management/board, may recommend 6th board member from LWUA or a take over General Manager from LWUA

Legend:LWRED Loans and Water Rates Evaluation DepartmentWDDD Water District Development DepartmentLAD Loans Adminsitration DepartmentWD Water DistrictIDS Institutional Development ServicesFS Financial ServicesAOS Area Operations Service

Project Identification/ Prioritization

Implements loan restructuring based on Board approved schemes, issues repayment schedules to WDs

In some cases, assumptions re number of connections and consumption are very high and are not realized

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F. Proposals 1. Proposal for Loans Administration Department (LAD)

21. The Loan Administration Department is the key player in improving LWUA’s collection performance. While they will need the support and assistance of IDS, they will remain the focal point of all collection efforts.

a. For a start, LAD should clean up and reconcile all accounts, some of which have already been noted by COA. Currently, LAD and Accounting have already identified some of the items for reconciliation by individual loan accounts. However, they are still in the process of summarizing the results to be presented to COA in order to effect the needed adjustments.

b. LAD should aggressively take action in clearing up Accounts Receivables of accounts which cannot be paid within the current period. Table A8.1 shows LWUA’s action in clearing up its accounts during the first half of the year. This initiative should be sustained as this improves the chances of being able to collect from these accounts and eventually clear the AR list of problematic accounts. This also provides the basis for a clear and transparent computation of collection efficiency following managements approved account adjustments.

c. LAD should improve its database in order to be able to provide a good basis for whatever action is needed next. This includes maintaining the 10 year Collection Projection Estimates which can feed into LWUA’s Overall Corporate Plan and Business Plans. The collection projection helps assess effects of restructuring on the value of the receivables accounts as well as on LWUA’s revenues.

d. LAD can also streamline the reporting system and define the specific action needed by each of the concerned player:

• 1 to 2 months overdue – notify water districts • 3 months overdue – Inform IDS and provide list • 6 months overdue - advise IDS to take appropriate action including possible

FR or take over

e. Loans to review the write off policy and the provisioning policy with the Accounting Department and come up with appropriate policy changes.

(i) LWUA considered writing off loans in the past but this was not pursued due to the very stringent rules and documentary requirements of COA before it can be effected. Instead of writing off loans which cannot be repaid, LWUA has implemented a policy for debt relief in the form of a (a) suspension of interest and/or principal repayment including penalties, if any, (b) waiver of interest charges and/or penalties and (c) provision of grant. These forms of debt relief are made available for specific cases where water districts are in arrears or are experiencing financial problems and cannot settle their outstanding obligations since this will require frequent adjustments and increases in excess of what is legally allowed.

In effect, the policy is that future uncollectible billings (part of Loans Receivable Accounts) are charged to/absorbed by LWUA and are no longer

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billed to the WD. However, the practice does not resolve the issue of what to do with the amounts already billed which cannot be collected and which remain as part of Accounts Receivable. In discussions with Finance and Loans, the units concerned agreed to review the need for a policy on write-off of accounts which cannot be resolved by the Debt Relief Policy.

(ii) As contained in LWUA’s annual audit reports, the estimated uncollectible accounts for performing loans are determined at 25% of interest receivable and current portion of long-term loans receivable, and 4% of long term loans receivables. In the 2007 LWUA Annual Report, non-performing loans were provided with a 40% allowance. The rates of the allowance for bad debts are based on the evaluation of existing loan portfolio composition, past and expected loss experiences and percentage of receivables performed by the LWUA Accounting Department. However, this was not formalized into written policy. COA also recommended that the setting of the rates of allowance for bad debts be formalized into a written policy.

Based on latest discussions with Finance, they said they will present recommendations to management regarding how to address the collection problems including writing off of loans and provisioning policy

2. Proposals for Institutional Development Services (IDS)

22. IDS through its WDDD and LWRED should assume clear responsibilities in the collection effort.

a. IDS to closely monitor restructured accounts

Once a WD loan is restructured, both LAD and IDs should closely monitor and provide regular feedback to make sure that the FR covenants are complied with. IDS can consider this as a key result area and could even use this as a measure of performance of the advisors. IDS current decision to install a 6th member to WDs which have been granted financial relief is a welcome initiative and should be sustained as this will afford LWUA to take direct and immediate intervention and participate in planning to address WDs existing problems. All LWUA sixth members should however be adequately briefed as to their primary role and regularly evaluated to help ensure that their supposed mission is successfully carried out.

b. IDS to review non-performing loans and non-operational accounts

In preparing the financial relief recommendations including the restructuring, LWRED should properly consult the advisors and WD to make sure that the proposed actions are doable and both the WD and the advisor commit to its implementation. It can try to consider any of the actions and/or strategies to address the Non Performing loans as shown in Table A8.5.

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Table A8.4 Possible Action to Address Non Performing Loans

Situation Proposal • Connections not enough and can not be

increased further and/or required tariffs are beyond affordability

• Existing facilities sufficient to supply existing

demand

• Financial Relief • Consider conversion of loan

component to grant within existing guidelines/ extended restructuring, balloon payment, etc.

Need additional facilities and/or additional investments source problem, loan too big (too optimistic feasibility projections) consumer base cannot support loan weak management, GM not performing

• Provide NLIF or Loan, new Loan • Financial relief to include loan

restructuring • Consider conversion of loan

component to grant within existing guidelines/ extended restructuring, balloon payment, etc.

• LWUA should be ready to intervene

either in the WD policy making or management function or both

c. IDS can also start to address their lack of resources specifically competent take over managers through in house capacity building programs, through recruitment of new employees who can be potential managers and by expanding the field of choices for take over managers.

A pool of trained take over managers can again be established similar to what LWUA had in the eighties. Training programs using actual case studies of problematic WDs should help provide proposed takeover managers with adequate preparation to assume the job. A screening process can be developed so that only those with the necessary potentials will be considered in the pool. IDS may also seriously try to consider managers of adjacent WDs who are performing well and even retirees from LWUA to take over a specific water district whenever practical. Their years of experience and skills developed could be harnessed to best use to assist ailing WDs specifically those in arrears to improve their performance. Such recruitment by outsourcing can be institutionalized through a certification program, an orientation program and by clearly defining the terms of reference to ensure that they will primarily work for the interest of LWUA.

d. IDS can institute radical changes or solutions to problematic water districts by recommending their annexation or mergers and the possible dissolution of non-operational water districts if their operations cannot be turned over to the LGUs.

3. Proposal for Management 23. Some of the proposed actions above will possibly need amendments to existing policies. WDDD and LWRED can jointly initiate the review of relevant policies and propose amendments as are necessary to support the collection initiatives. This will include review of write off of accounts, provision for bad debts, extended restructuring, (BR 38 benefits 40

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years and balloon amortization) and guidelines for conversion of loans to grant. This will also possibly need COA consultations.

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209

FINANCIAL MANAGEMENT ASSESSMENT REPORT

A. INTRODUCTION

1. Financial management assessment (FMA) is an attempt to determine the capacity of the executing or implementing agency to effectively manage its financial resources. Such a capacity is critical for the success of the project. FMA involves a review of the accounting system, reporting, auditing, internal controls, cash disbursement and cash flow disbursement arrangements.

2. The main instrument used to facilitate the financial management assessment was the questionnaire furnished by ADB, which was discussed with the Deputy Administrator for Financial Services, and the Manager of the Accounting Department and managers of other relevant units of LWUA by the consultants in March 2008. Follow-up interviews were conducted by the consultants to better appreciate some of the responses and to fill up the unanswered items in the questionnaire. Most of the items in the questionnaires were filled up and consolidated by May 2008.

B. FINDINGS

3. Based on the responses to the financial management assessment questionnaire (FMAQ, see Annex 1 of this appendix), records review, and follow-up interviews, the following observations were made:


4. The Local Water Utilities Administration (LWUA) was established under Presidential Decree 198 which is known as The Provincial Water Utilities Act of 1973. LWUA is a government-owned and controlled corporation created as a specialized lending institution for the promotion, development and financing of local water utilities. This was reaffirmed by the National Economic and Development Board Resolution 4 on the strengthening and upgrading of its banking and finance expertise. The LWUA has the power and duty to prescribe minimum standards for local water utilities (called water districts) and adopt rules and regulations for enforcement.

5. The Administration is also empowered to provide technical assistance and personnel training programs for local water utilities, monitor and evaluate local water standards, and effect system integration, joint investment and operations, district annexation and de-annexation whenever economically warranted.

6. The LWUA has the legal status to incur debts in the pursuit of its projects subject to limits prescribed under PD 198. It has implemented a number of loan projects with ADB (6 projects), IBRD (3 projects) IDA (1 project) OECF (5 projects), USAID (2 projects) and one project each for DANIDA, AusAID, French Protocol, and KfW.

7. LWUA projects are reviewed and endorsed by the Department of Finance for approval by the National Economic and Development Authority - Infrastructure and Coordinating Council.

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8. Funds received from either ADB, World Bank or any other donor agency are deposited to the Land Bank of the Philippines (LBP). Through LBP LWUA can disburse for project expenditures. LWUA releases fund to suppliers and contractor following their usual payment procedures

9. The funds that will be available for this project is likely to be considered as a sector loan whose proceeds will be disbursed in four batches over a period 2011-2016. Usually re-lending terms include (i) Interest rate 9.2% - 10.8% (ii) maturity period up to 40 years, and (iii) grace period of 4 years. The LWUA relending rate averaging 9.65% per annum is much higher than the indicative interest rate from the Asian Development Bank (ADB)/Department of Finance (DOF) of about 3%. The DOF covers the foreign exchange risk for some of the more recent loans of LWUA. For the ADB WDDSP, however, LWUA prefers to pass on the foreign exchange risk to the water district. For earlier loans, LWUA absorbs foreign exchange risks. The re-lending conditions should be reviewed in consideration of the overall debt service which LWUA should bear as a result of the new borrowings. Refer to Annex 1a for Relending Rates.

10. Counterpart funds are provided from LWUA ICG funds, LWUA local loans and WD Equity.

3. Staffing and Organization

11. Under the existing structure, LWUA’s financial functions are under the responsibility of the Deputy Administrator (DA) for Investment and Financial Services. The DA for Finance is duly supported by department managers of the Treasury, Accounting, Loans Administration, and Water District Audit departments. Each department is further subdivided into divisions each having its own division manager. Presently, LWUA’s total workforce is 592. See Annex 1b of this appendix for the LWUA organizational chart.

12. The Accounting Department comprises Transaction Processing, Bookkeeping and Financial Reporting, and Cost Accounting divisions. The Cost Accounting Division is adequately staffed by qualified and experienced personnel who are responsible for undertaking project finance and accounting. All key positions are filled out and most of the staff hold permanent positions. See Annex 1c for the finance organizational chart and Annex 1d for the job description of the project accounting staff.

13. Training is usually provided to inform the accounting staff about changes in government policy such as the National Government Accounting System.

a. Accounting Policies and Procedures

14. LWUA has an accounting system that allows proper recording of project financial transactions, including allocation of expenditures in accordance with respective components and sources of funds. Controls are in place concerning the preparation and approval of transactions, ensuring that all transactions are correctly made and adequately explained.

15. The information system strategic plan (ISSP) is currently being developed as part of LWUA’s integrated computerized operational and management systems. This includes an application system for general accounting systems which is expected to become operational in 2010. When fully implemented, the ISSP is expected to improve LWUA efficiency.

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16. Project implementation is being handled by either LWUA’s operating units or consultants. The Project Management Unit basically coordinates and monitor project activities.

17. The Cost Accounting Division handles cost allocation to the various funding sources. All project accounts are incorporated in the final account of LWUA.

18. The chart of accounts is adequate to account for all activities of LWUA. LWUA follows the standard chart of accounts for government agencies and adopts the prescribed coding system.

19. LWUA does have a file management system and important papers are kept on a permanent basis while others (such as vouchers) are kept for a period of 10 years as per government rule (Chapter 2. Section 26, PD 1445 - Auditing Code of the Philippines).

20. A number of deficiencies have been noted in the management reports and audit reports prepared by the auditors. Some of the more critical deficiencies include lack of accountability and internal control mechanisms as evidenced by the lack of periodic of bank reconciliation, non reconciliation of accounts (receivables, fixed assets, inventory and payables).

b. Segregation of Duties

21. Functional responsibilities are segregated as responsibilities for budget, payment, recording, reporting and audit are assigned to separate groups of officers and staff.

c. Budgeting System

22. The LWUA budget is prepared by the Budget Department and the Administrator recommends the budget for approval to the Board of Trustees. From the Board, it is submitted to the Department of Budget and Management for approval.

23. The budget is prepared for all significant activities in sufficient detail for monitoring. It includes physical as well as financial targets for the year. A quarterly variance analysis report is being prepared and submitted to the Administrator for proper notification. A budget variance in excess of 25% needs the approval of the Board.

24. Capable and knowledgeable staff prepare project plans and budget based on valid assumptions.

d. Payments

25. Invoice processing and payroll preparation procedures are adequate to provide check and balance of the transactions. However, invoices were not usually stamped “PAID.” LWUA will implement this control procedure.

e. Policies Procedures

26. The basis of accounting is modified accrual consistent with the policies of the New Government Accounting System. LWUA adopts the Philippine Accounting Standards issued by the Accounting Standard Council as well as the Financial Accounting Standards applicable to banks and other financial subsidiaries.

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27. The Manual of Operations which contains the policies and procedures that will guide the project activities will be developed during the loan implementation phase.

28. The LWUA ISSP includes the preparation of a policy and procedural manual. The policies and procedures of the ISSP encompass financial management and administrative activities which clearly defines conflict of interest and related party transactions. Any major changes on the application of the accounting principle and procedure will require management approval and in certain cases will require the approval of the Commission on Audit.

4. Cash and Bank

29. The Approving authorities for bank transactions are the Administrator, Senior Deputy Administrator, Deputy Administrator for Investment and Finance and Deputy Administrator for Operations.

30. All receipts are deposited intact on a timely basis and at present, banks and cash balances are reconciled on a monthly basis. All unusual items for reconciliation are reviewed and approved by a responsible official. LWUA has instituted adequate controls and procedures for recording receipts and payments.

31. A major concern expressed in the past Audit Reports is that the bank reconciliation is not periodically performed resulting to discrepancies in cash balances.

5. Safeguard Over Assets

32. The Property Department is responsible for monitoring LWUA’s fixed assets. They follow the General Accounting and Auditing Manual which contains the policies and procedures to safeguard assets. Office orders are issued to implement these procedures. An annual physical inventory of assets is performed and the results are reconciled with control accounts. An application system on property management is included in the information system strategic plan (ISSP), and once this is operational, reconciliation of accounts will be facilitated. Fixed assets are sufficiently covered by insurance.

6. Other office and Implementing Entities

33. The water districts are entities that implement projects together with LWUA. Periodic reporting and reconciliation of accounts between LWUA and the water districts are carried out. Information dissemination and project monitoring are carried out through officers and staff assigned in each particular area or region.

7. Internal Audit

34. An Internal Audit Department is directly under the control of the Office of the Administrator. This department is being handled by eight personnel who specialize in accounting; three of them are certified public accountants. The internal audit findings and recommendations are coursed through the Administrator to ensure implementation of proposed actions.

8. External Audit

35. Statutory audit is done by an external auditor appointed by the Commission on Audit (COA). Audit reports are issued on or before the end of the second quarter of the

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succeeding year. This is performed in accordance with the international standards on auditing. Projects are also subject to the audit of COA as part of their regular audit activities.

36. Among the major findings contained in the 2007 Annual Audit Report are as follows:

(i) The overstatement/understatement of cash in bank accounts due to non-performance of periodic bank reconciliation;

(ii) The non-collectibility of receivables from officers and employees on medical loan, housing loan, and multi-purpose loan since these have been outstanding from 9 to 26 years;

(iii) The unreconciled balances of accounts receivables, long-term receivables, and non-performing loan accounts per general ledger and subsidiary ledgers and against balances per billing and collection report and the aging schedule;

(iv) The P4 million loan from non-operational WDs outstanding for 14 years; (v) The understatement of allowance for BD by P67 million; (vi) Failure to pay foreign loans on time and the incurrence of P26 million

penalty charges; (vii) The existence of two IBRD loans worth P3.9 million and P138 million which

have remained outstanding for 5 to10 years, and absence of BTR billings from the Bureau of Treasury.

37. As a result of non-reconciliation of the balances of receivables per general ledger and subsidiary ledger, and the existence of the two IBRD loans for 5 to 10 years without valid claims, COA issued a qualified opinion on the 2007 Financial Report.


38. LWUA financial statements are prepared in accordance with the Philippine Accounting Standards issued by the Accounting Standard Council. These financial statements are prepared monthly and are audited annually. The water districts prepare periodic financial reports and they are required by LWUA to submit their annual audited financial statements.

10. Information System

40. The financial management system will be fully automated by 2010 through ISSP. This system is being developed to produce the required financial reports and assure safeguarding of data confidentiality, integrity, and availability.

C. CONCLUSION AND RECOMMENDATIONS

41. LWUA generally follows sound financial management principles in its operations as indicated by the positive responses to the Financial Management Assessment Questionnaire.

42. One of the critical findings from the review of LWUA’s past performance (which is also contained in the COA comments on the 2007 Financial Report) is on the management of receivables and payables accounts. The unreconciled balances of the water districts’ accounts receivable and long-term receivables per general ledger, subsidiary ledger, billing and collection report, and the schedule of aging of receivables make it difficult to conduct a reliable analysis of the accounts. Major concerns include the proliferation of long overdue accounts from loans to officers and employees as well as the continuous piling of receivables from water districts loans, more particularly the non-performing loans.

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43. Other concerns in the COA report include the non-performance of periodic bank reconciliation, the non-collectibility of receivables from officers and employees, failure to pay foreign loans on time and the existence of two IBRD loans which remain outstanding for 5 to 10 years.

44. At present, LWUA is conducting institutional strengthening initiatives to answer the present needs and demands of its operations, to identify areas for reforms and be more responsive to the needs of the water districts and the water sector as a whole. The Millennium Development Goals seek to increase potable water service coverage area. The Water Supply Sector Roadmap is geared towards water sector defragmentation and role definition of stakeholders as a part of its sector planning activities. LWUA, being a major player in the sector, needs to reorient its goals and objectives towards strengthening its financing and lending functions.

45. As part of this PPTA, the consultants prepared a concept paper for a business planning model for LWUA in order to establish sector accomplishments, service coverage as well as provide for the right channeling and conduits of the funds. The primary objectives of the model are to provide information on the status of LWUA’s accomplishments as a specialized lending institution, provide financing institutions and donor agencies a marketing tool that would facilitate identification of viable projects, and determine the WDs’ demand for financing and assess LWUA’s capacity to meet this demand. The model will also help to gauge LWUA’s overall performance based on performance indicators, including servicing its debts both in the medium and long term. The Business Planning Model has three components namely: (i) Water District Investment Model (ii) LWUA Investment Model and the (iii) Financial Model.

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ANNEX 1: FINANCIAL MANAGEMENT ASSESSMENT QUESTIONNAIRE



1.1 What is the entity’s legal status/registration?

LWUA is a government-owned and controlled corporation established, as reaffirmed in NEDA Board Resolution 4, to operate primarily as a specialized lending institution for the promotion, development and financing of local water utilities.

1.2 Has the entity implemented an externally-financed project in the past (if so, please provide details)?

Yes ADB:

i. 545-PHI USD 23.9 (1987) ii. 1056 PHI USD 14.06 (2001) iii. 1057-PHI USD 2.7 (1995) iv. 1269-PHI USD 21.1 (1999) v. 1472-PHI USD 45 (2002) vi. 1599-PHI 292T

Subic Bay Area Municipal Development Project DANIDA

i. DKr 95M (1992) IBRD

i. 1710 PHI USD 16 (1985) ii. 2206 PHI USD 8.061 (1988) iii. 920 PHI USD 14M (1989)

OECF

i. PH-P82 Y.945B (1998) ii. PH-P124 Y.789B (2000) iii. PH-P154 Y6.131B (2005) iv. PH-P149 Y6.212B (2004) v. PH-P181 Y7.228B (2007)

Australian Aid

i. USD14.8M (2001) French Protocol

i. FF2M (1990) USAID

i. 033 –USD 15M (1985) ii. 042 – USD 20M (1987)

KFW

i. PTWSP I &II Euro 14.7M IDA

i. 920-PHI USD 14M (1988)

1.3 What are the statutory reporting requirements for the entity?

The Auditing Code of the Philippines (P.D. 1445) Chapter 3. Sec. 121. Financial Reports and Statements. (i) The financial reports shall comply with the specific requirements of applicable laws and regulations as to nature, accounting basis, content, frequency, and distribution as well as with all applicable restrictions pertaining to information that is

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classified for national security purposes, and (ii) the financial statements shall be based on official accounting records kept in accordance with law and the generally accepted accounting principles and standards.

1.4 Is the governing body for the project independent?

The Board of Trustees is the Governing Body of LWUA. In the spirit of PD 198, Sec. 54 Chapter 1, Title II, the Board should perform its functions in full autonomy mainly to establish policy and not to engage in the detailed management of LWUA.

1.5 Is the organizational structure appropriate for the needs of the project?

Yes. LWUA has always used a project management unit (PMU) since it started in implementing Official Development Assistance projects. The PMU is basically a one-man operation but it has the authority to cut across all functional and geographical units of LWUA. The PMU does not implement the project. The projects are implemented by either LWUA’s operating units or by consultants. The PMU is basically a coordinating body ensuring that projects are with enough resources and monitoring timetable. The LWUA Project Manager assigned to the ADB project is the most senior and competent among LWUA’s current project managers.


2.1 Describe (proposed) project funds flow arrangements, including a chart and explanation of the flow of funds from ADB, government and other financiers.

The Project is likely to be structured as a sector loan whose proceeds will be disbursed in four batches over the period 2011−2016. The funds will be lent to GoP/DOF which in turn will re-lend them to LWUA for relending to the water districts. AusAID also provided co-financing for the sanitation component.

2.2 Are the (proposed) arrangements to transfer the proceeds of the loan (from the government / Finance Ministry) to the entity satisfactory?

The relending terms for water districts are lighter particularly in terms of the repayment period and the periodic amortization amount (see Annex 1a).

2.3 What have been the major problems in the past in receipt of funds by the entity?

No major problem.

2.4 In which bank will the Imprest Account be opened?

Land Bank of the Philippines

2.5 Does the (proposed) project implementing unit (PIU) have experience in the management of disbursements from ADB?

Yes. LWUA and the water districts have acted as the executing agency and project implementing unit for two ADB Loans: ADB:

vii. 545-PHI USD 23.9 (1987) viii. 1056 PHI USD 14.06 (2001)

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ix. 1057-PHI USD 2.7 (1995) x. 1269-PHI USD 21.1 (1999) xi. 1472-PHI USD 45 (2002) xii. 1599-PHI 292T

Subic Bay Area Municipal Development Project

2.6 Does the entity have/need a capacity to manage foreign exchange risks?

Yes. Previous experience shows that LWUA deals with forex risks as follows: 1. For the earlier loans, LWUA absorbs forex exchange risks and recognizes loss on foreign exchange fluctuation resulting from the devaluation of the peso. 2. More recently, LWUA paid fee for DOF to assume the forex risk. 3. For some projects LWUA passed on the risks to the water districts. For this project LWUA prefers to pass on the risks to the water districts.

2.8 How are the counterpart funds accessed?

Counterpart funds are provided from (i) LWUA internal cash generation funds, (ii) LWUA local loans, and (iii) WD equity. These are a part of the usual commercial transactions of LWUA.

2.9 How are payments made from the counterpart funds?

LWUA releases the funds to the suppliers/contractors following their usual payment procedures.

2.10 If part of the project is implemented by communities or NGOs, does the PIU have the necessary reporting and monitoring features built into its systems to track the use of project proceeds by such agencies?

N/A

2.11 Are the beneficiaries required to contribute to project costs? If beneficiaries have an option to contribute in kind (in the form of labor), are proper guidelines formulated to record and value the labor contribution?

N/A

3. Staffi ng

3.1 What is the (proposed) organizational structure of the accounting department? Attach an organization chart.

Please see Annex 1b for the organizational chart of LWUA and Annex 1c for the organizational chart of the Finance Department.

3.2 Identify the (proposed) accounts staff, including job title, responsibilities, educational background and professional experience. Attach job descriptions and CVs of key accounting staff.

Please see Annex 1d for the job description of accounting staff.

3.3 Is the project finance and Yes, the project finance and accounting function is

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accounting function staffed adequately?

staffed adequately.

3.4 Is the finance and accounts staff adequately qualified and experienced?

Yes, the finance and accounts staff is adequately qualified and experienced.

3.5 Is the project accounts and finance staff trained in ADB procedures?

Yes, the project accounts and finance staff is trained in ADB procedures.

3.6 What is the duration of the contract with the finance and accounts staff?

Most the staff are permanent.

3.7 Indicate key positions not contracted yet, and the estimated date of appointment.

All key positions have been filled out.

3.8 Does the project have written position descriptions that clearly define duties, responsibilities, lines of supervision, and limits of authority for all of the officers, managers, and staff?

Yes

3.9 At what frequency are personnel transferred?

Generally, no personnel transferred.

3.10 What is training policy for the finance and accounting staff?

No recent training. Training is usually provided to inform the accounting staff about changes in government policy such as the National Government Accounting System (NGAS).

4. Accounting Policies and Procedures

4.1 Does the entity have an accounting system that allows for the proper recording of project financial transactions, including the allocation of expenditures in accordance with the respective components, disbursement categories, and sources of funds? Will the project use the entity accounting system?

Yes, LWUA has an accounting system that allows for the proper recording of project financial transactions, including the allocation of expenditures in accordance with the respective components and sources of funds.

4.2 Are controls in place concerning the preparation and approval of transactions, ensuring that all transactions are correctly made and adequately explained?

Yes, controls are in place concerning the preparation and approval of transactions, ensuring that all transactions are correctly made and adequately explained.

4.3 Is the chart of accounts adequate to properly account for and report on project activities and disbursement categories?

Yes, the chart of accounts is adequate to properly account for and report on project activities and disbursement categories. LWUA follows the standard chart of accounts for government offices. It also adopted the prescribed coding system.

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4.4 Are cost allocations to the various funding sources made accurately and in accordance with established agreements?

Yes, the Project Accounting Division handles this.

4.5 Are the General Ledger and subsidiary ledgers reconciled and in balance?

Yes, the general ledger and subsidiary ledgers are reconciled and in balance. Discrepancies if any, are adjusted accordingly through an approved journal voucher.

4.6 Are all accounting and supporting documents retained on a permanent basis in a defined system that allows authorized users easy access?

Preservation of vouchers for a period of 10 years (Chapter 2. Section 26. PD 1445- Auditing Code of the Philippines)

Segregation of Duties

4.7 Are the following functional responsibilities performed by different units or persons: (i) authorization to execute a transaction; (ii) recording of the transaction; and (iii) custody of assets involved in the transaction?

Yes, these functional responsibilities are performed by different units/persons.

4.8 Are the functions of ordering, receiving, accounting for, and paying for goods and services appropriately segregated?

Yes, these functions are appropriately segregated. The General Services Department handles the in-house procurement services; the Property Management Department handles the receipt and inspection of all procured equipment, materials and supplies; the Accounting Department handles the accounting thereof while the payment for goods and services is handled by the Treasury Department.

4.9 Are bank reconciliations prepared by someone other than those who make or approve payments?

Yes, bank reconciliations are prepared by the Accounting Department staff, someone other than those who make or approve payments.

Budgeting System

4.10 Do budgets include physical and financial targets?

Yes, key result areas include : (i) access to potable water through increased in

population served by 586,444 covering 130 waterless municipalities within the WD coverage and 101 non-operational WDs; allotting P4.5 B in project disbursements,

(ii) self-sustaining WSPs through the graduation of 85 pre-credit and semi-creditworthy WDs to the next level of creditworthiness, and

(iii) LWUA’s financial viability through the setting of targets towards financial liquidity and stability, cost control, and sourcing of project funds.

4.11 Are budgets prepared for all significant activities in sufficient detail to provide a meaningful tool with which to monitor subsequent

Yes

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performance?

4.12 Are actual expenditures compared to the budget with reasonable frequency, and explanations required for significant variations from the budget?

A quarterly variance analysis is prepared and a memo is submitted to the Administrator summarizing the results of the budget variance analysis.

4.13 Are approvals for variations from the budget required in advance or after the fact?

Budget variations in excess of 25% need approval of the Board.

4.14 Who is responsible for preparation and approval of budgets?

The LWUA Budget Department prepares the budget, the Administrator recommends approval, the Board approves. The budget is also submitted to the Department of Budget and Management for approval.

4.15 Are procedures in place to plan project activities, collect information from the units in charge of the different components, and prepare the budgets?

Yes, a memo is sent to the LWUA Administrator regarding the budget preparation guidelines Once approved, the memo is disseminated to the different LWUA departments. LWUA departments submit budget appropriation requests and the Budget Department consolidates all the requests into the LWUA budget.

4.16 Are the project plans and budgets of project activities realistic, based on valid assumptions, and developed by knowledgeable individuals?

Yes

Payments

4.17 Do invoice-processing procedures provide for: (i) Copies of purchase orders and receiving reports to be obtained directly from issuing departments? (ii) Comparison of invoice quantities, prices and terms, with those indicated on the purchase order and with records of goods actually received? (iii) Comparison of invoice quantities with those indicated on the receiving reports? (iv) Checking the accuracy of calculations?

Yes. The invoice-processing procedures provide for (i) copies of purchase orders and receiving reports to be obtained directly from issuing departments, (ii) comparison of invoice quantities, prices and terms, with those indicated on the purchase order and with records of goods actually received, (iii) comparison of invoice quantities with those indicated on the receiving reports, (iv) checking the accuracy of calculations.

4.18 Are all invoices stamped PAID, dated, reviewed and approved, and clearly marked for account code assignment?

No

Accounting staff will adopt the practice of stamping paid invoices.

4.19 Do controls exist for the preparation of the payroll and are changes to the payroll properly authorized?

Yes, controls do exist for the preparation of the payroll. Any changes to the payroll are properly authorized.

Policies And Procedures

4.20 What is the basis of LWUA employs the modified accrual basis of

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accounting (e.g., cash, accrual)?

accounting consistent with the policies of the New Government Accounting System.

4.21 What accounting standards are followed?

LWUA adopts the Philippine Accounting Standards issued by the Accounting Standard Council as well as the Financial Accounting Standard applicable to banks and other financial subsidiaries.

4.22 Does the project have an adequate policies and procedures manual to guide activities and ensure staff accountability?

To be developed during the loan implementation phase.

4.23 Is the accounting policy and procedure manual updated for the project activities?

The LWUA information system strategic plan (ISSP) is currently being developed for implementation in 2010. It includes policy and procedures manuals. The Commission on Audit (COA) tried to install the National Government Accounting System at LWUA but conversion required such a huge effort that COA allowed LWUA to continue using the current system as long as the final reports follow the NGAS formats.

4.24 Do procedures exist to ensure that only authorized persons can alter or establish a new accounting principle, policy or procedure to be used by the entity?

Yes. Major changes need management approval and in certain cases these need COA approval.

4.25 Are there written policies and procedures covering all routine financial management and related administrative activities?

Part of ISSP

4.26 Do policies and procedures clearly define conflict of interest and related party transactions (real and apparent) and provide safeguards to protect the organization from them?

Part of ISSP

4.27 Are manuals distributed to appropriate personnel?

Planned in 2010 upon implementation of ISSP

Cash and Bank

4.28 Indicate names and positions of authorized signatories in the bank accounts.

Administrator (AA Daniel Landingin), Senior Deputy Administrator, Deputy Administrator (ADA Willy Feleo), DA Boy Malicdem

4.29 Does the organization maintain an adequate, up-to-date cashbook, recording receipts and payments?

Yes, LWUA maintains an adequate, up-to-date cashbook, recording receipts, and payments.

4.30 Do controls exist for the collection, timely deposit and recording of receipts at each collection location?

Yes, controls do exist for the collection, timely deposit, and recording of receipts at each collection location.

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4.31 Are bank and cash reconciled on a monthly basis?

Yes, bank and cash are reconciled on a monthly basis.

4.32 Are all unusual items on the bank reconciliation reviewed and approved by a responsible official?

Yes, all unusual items on the bank reconciliation are reviewed and approved by a responsible official.

4.33 Are all receipts deposited on a timely basis?

Yes, all receipts are deposited on time.

Safeguard over Assets

4.34 Is there a system of adequate safeguards to protect assets from fraud, waste and abuse?

Yes, Property Department follows the General Accounting and Auditing Manual which lists policies and procedures to safeguard assets. Office orders are issued to implement these procedures.

4.35 Are subsidiary records of fixed assets and stocks kept up to date and reconciled with control accounts?

There is an annual reconciliation of balances. An application system on Property Management is included in IISP. Once implemented, reconciliation will be facilitated.

4.36 Are there periodic physical inventories of fixed assets and stocks?

Yes, physical inventories of assets and stocks are performed annually.

4.37 Are assets sufficiently covered by insurance policies?

Yes, assets are covered by insurance policies.

Other Offices and Implementing Entities

4.38 Are there any other regional offices or executing entities participating in implementation?

Yes, there are water districts implementing the project.

4.39 Has the project established controls and procedures for flow of funds, financial information, accountability, and audits in relation to the other offices or entities?

Yes

4.40 Does information among the different offices/implementing agencies flow in an accurate and timely fashion?

Yes

.

4.41 Are periodic reconciliations performed among the different offices/implementing agencies?

Yes

Other

4.42 Has the project advised employees, beneficiaries and other recipients to whom to report if they suspect fraud, waste or misuse of project resources or property?

To be done before project implementation

5. Internal Audit

5.1 Is there a internal audit department in the entity?

Yes, there is an internal audit department in the LWUA organization.

5.2 What are the qualifications All eight managers and staff are accounting

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and experience of audit department staff?

graduates, 3 are certified pubic accountants.

5.3 To whom does the internal auditor report?

The Internal Auditor reports to the Administrator.

5.4 Will the internal audit department include the project in its work program?

Yes, the Internal Audit Department includes the project in its work program

5.5 Are actions taken on the internal audit findings?

Yes, recommendations are coursed through the Administrator.

6. External Audit

6.1 Is the entity financial statement audited regularly by an independent auditor? Who is the auditor?

Yes. The auditing unit headed by an Auditor assigned by the Commission on Audit who is a certified public accountant.

6.2 Are there any delays in audit of the entity? When are the audit reports issued?

None. Audit reports are issued on or before the end of the second quarter of the succeeding year.

6.3 Is the audit of the entity conducted according to the International Standards on Auditing?

Yes

6.4 Were there any major accountability issues brought out in the audit report of the past three years?

1. The overstatement/understatement of cash in bank accounts due to non-performance of periodic bank reconciliation.

2. The non-collectibility of receivables from officers and employees on medical loan, housing loan, multi-purpose loan since these were outstanding from 9 to 26 years;

3. The unreconciled balances of AR, LTR, and NPL accounts per general ledger and subsidiary ledgers;

4. The 4M loan from non-operational WDs outstanding for 14 years;

5. The understatement of allowance for BD by 67M; 6. Failure to pay foreign loans on time – incurrence

of penalty charges of 26M 7. The existence of two IBRD loans - 3.9M and 138M

- which remain outstanding for 5 to 10 years. No BTR billings from Bureau of Treasury

LWUA is studying the recommendations as basis for taking action.

6.5 Will the entity auditor audit the project accounts or will another auditor be appointed to audit the project financial statements?

Only COA can audit LWUA.

6.6 Are there any recommendations made by the auditors in prior audit reports or management letters that have not yet been implemented?

To document measures undertaken on collections of long-overdue accounts and subsequent recommendation for write-off if deemed uncollectible

6.7 Is the project subject to any kind of audit from an independent governmental entity (e.g., the supreme audit institution) in addition to the external audit?

Yes, the project is subject to audit by the Commission on Audit as part of the regular audit.

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6.8 Has the project prepared acceptable terms of reference for an annual project audit?

No. To be done as necessary


7.1 Are financial statements prepared for the entity? In accordance with which accounting standards?

Yes. LWUA adopts the Philippine Accounting Standards issued by the Accounting Standards Council, which include among others the following: PAS 1-Presentation of Financial Statements PAS 8-Accounting Policies, Changes in Accounting

Estimates and Errors PAS 12-Income Taxes PAS 16-Property, Plant and Equipment; and PAS 21-The Effects of Changes in Foreign Exchange

Rates

7.2 Are financial statements prepared for the implementing unit?

Yes, financial statements are prepared for water districts.

7.3 What is the frequency of preparation of financial statements? Are the reports prepared in a timely fashion so as to useful to management for decision making?

Financial statements are prepared monthly and audited annually.

7.4 Does the reporting system need to be adapted to report on the project components?

Yes

7.5 Does the reporting system have the capacity to link the financial information with the project's physical progress? If separate systems are used to gather and compile physical data, what controls are in place to reduce the risk that the physical data may not synchronize with the financial data?

Yes, project management guidelines will later be established to link financial information and physical progress of the project.

7.6 Does the project have established financial management reporting responsibilities that specify what reports are to be prepared, what they are to contain, and how they are to be used?

This is to be established upon establishment of the PMO at the start of the project implementation.

7.7 Are financial management reports used by management?

Monthly financial reports are submitted to management.

7.8 Do the financial reports compare actual expenditures with budgeted and programmed allocations?

Budget variance reports compared actual with budgeted expenditures.

7.9 Are financial reports Currently prepared by spreadsheets. Fully automated

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prepared directly by the automated accounting system or are they prepared by spreadsheets or some other means?

by 2010 through the ISSP

8. Information Systems

8.1 Is the financial management system computerized?

Currently prepared by spreadsheets. Fully automated by 2010 through the ISSP

8.2 Can the system produce the necessary project financial reports?

Yes

8.3 Is the staff adequately trained to maintain the system?

Yes

8.4 Does the management organization and processing system safeguard the confidentiality, integrity and availability of the data?

Yes

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ANNEX 1a: RELENDING TERMS Item

Previous Policy Revised Policy Cumulative Loan Granted


Loan Repayment Period

Prop osed Interest Rate per Annum


First P2 million 8.5% First 10 years 9.2% Next P5 million 10.5 % >10-20 years 9.5% Next P13 million ,mmmmillionmimill

12.5% >20-30 years 9.8% Next P30 million 14.0% >30-40 years 10.2% Over P50 million 15.0%

Feature of Interest Fixed Re-pricing as necessary. LWUA proposed to lend to WDs at a fixed rate but said rate will be adjusted periodically to the Philippine Dealing System Treasury reference rates









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Source LWUA Data

Administrator (6)

Management Services Office (2)

Chairman and Board of Trustees

Internal Control (1)

Water Resources and Training

• Commercial Practices & Systems (7)

• Training (13) • Research (9)

Public Affairs (3)

Legal Services • Contracts

(5) • Litigation &

investigation (2)

Institutional and Media relations

(5)

Media Productions (5)

Corporate Planning (7)

Management Info. Systems

(8)

Info. Network and Facilities Management

(3)

Water District Development – Luzon

(26)

Water District Development – Bicol

Visayas (21)

Water District Development – Mindanao (11)

Senior Deputy Administrator (3)

Financial / MIS Audit (3)

Corporate Counsel (1)

Board Secretariat (10)

PBAC/PEAC Secretariat (2)

Operation al Audit (4)

Loans Water Rates Evaltn Luzon (18)

Loans Water Rates Evaltn

Visayas Mindanao (13)

Deputy Administrator – Administration (2)

Deputy Administrator – Investment & Finance (4)

Deputy Administrator – Area Operations (3)

H.R. Management (2) • Personnel (12) • H.R. Development (7) • Medical & Dental ( 3)

Property Management (3) • Property Control (9) • Building & Grounds (11) • Motor pool ( 18)

General Services (3) • Records & Commnictn (20) • General Services (8)

Treasury (2) • Budget (11) • Cash Management (13)

Account ing (1) • Transaction Processing (17) • Bookkeeping & Fin. Records (10) • Cost Accounting (4)

Loans Administration (2) • Billing (9) • Collection (7)

Water District Audit (2) • Luzon (5) • Visayas Mindanao (5)

Special Projects Office (2) • Watershed Mgt & CPSO (2) • Water Resource Devt (46)

Operations Luzon North (6) • Project Planning (20) • Project M&E (15)

Operations Luzon Cent/Sth ( 5) • Project Planning (26) • Project M&E (13)

Operations Bicol Visayas (6) • Project Planning (21) • Project M&E (13)

Operations Mindanao (3) • Project Planning (15) • Project M&E (13)

ANNEX 1b: LWUA ORGANIZATIONAL CHART

Appendix 9


228

ANNEX 1c: FINANCIAL ORGANIZATIONAL CHART

Appendix 9


229

ANNEX 1d: JOB DESCRIPTION, ACCOUNTING STAFF

PROFESSIONAL EXPERIENCE AND DETAILED RESPONSIBILITIES

1. Overall in-charge of the following foreign loan packages:

� ADB Loan Packages 1056 and 1057 PHI (1994-98) � JBIC Loan Package PH-P181 (PCWSPV) (1998-05) � Japan Government Grant (2003) � World Bank Grant 057794 (2009)

2. Authorized user of ADB/WB websites 3. Provide input in the preparation of TPD operations manual 4. Prepare/maintain monthly disbursement report of loan packages 5. Process the consultants/contractors’ request of payments

a) Review the validity of the receipts, invoices, official receipts b) Ensure the accuracy of the computations/amount presented c) Validate the Consultant/Contractors’ accomplishment/monthly

progress reports d) Counter check the completeness of essential documentations e) Verify the authenticity of the claims submitted f) Ensure compliance on the provisions of the contract, and with

the accounting, auditing and government rules and regulations 6. Prepare and facilitate

a) Disbursement Request b) Letter Request c) Withdrawal Application d) Disbursement/Journal Voucher

7. Maintain effective indexing/ledgers of all transactions effecting individual loan utilization of funds

8. Handle record keeping of documents pertaining to the abovementioned loan packages Coordinate/Assist the PMO and lending institution officials concerning relevant data/documentation requested

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230

THE PHILIPPINE WATER REVOLVING FUND

A. Objectives 1. The Philippine Water Revolving Fund (PWRF) was created with the following primary objectives:1

(i) Use limited public resources to leverage private sector financing in the water sector,

(ii) Limit the use of sovereign guaranteed loans from multilateral and bilateral banks or foreign donors to fund local water projects,

(iii) Bring private sector financing to the water sector on terms and conditions that are affordable to local users, and

(iv) Implement Executive Order (EO) No. 2792 in the most effective manner.

2. PWRF proposes to combine Official Development Assistance (ODA), local and national government funds, and local bank financing into a package that can serve as a source of funding for water and sanitation infrastructure projects that have a 20 to 30 year economic life at terms that are affordable to rate payers. It creates a long-term alternative to the current financing schemes that rely heavily on ODA relending. It features private sector participation, perpetuity of operation, acceptability to private financing institutions (PFIs), and affordability to water service providers (WSPs). PWRF supports the implementation of EO 279, which calls for the shift of financing of creditworthy water service providers (WSPs) to private or government financing institutions (PFIs/GFIs) at market-based terms.

B. Financing Structure

3. The loan to water service providers will consist of Japan International Cooperation Agency (JICA) funds lent to the Development Bank of the Philippines (DBP), and funds from PFIs. The loan to WSPs will have a blended rate based on fixed interest rate from DBP and the PFI’s floating rate, and up to a 20-year tenor inclusive of a 3-year maximum grace period. The financing ratio will be up to 75% JBIC-DBP funds and at least 25% PFI funds. The Local Government Unit Guarantee Corporation (LGUGC) will provide PFIs credit risk guarantee of up to 85% of the loan. USAID Development Credit Agency will issue a co-guarantee to the LGUGC guarantee of the PFI loan.

4. The PFI loan will have a 10-year tenor. The loan will be retired in 10 years if the cash flow can support the repayment schedule. If not, the principal will be amortized over 20 years while the 10-year tenor is maintained. PFIs will have an option to extend the maturity beyond 10 years but if they opt not to, they will be assured of a balloon payment for the outstanding balance at the end of the 10 years. The source of the balloon payment will be a take-out loan from the Municipal Development Fund Office (MDFO) for local government unit (LGU) loans, and from DBP for water district (WD) loans executed under the same terms as the PFI loan.

5. The MDFO or DBP take-out loan will be executed on the same day as the PFI loan. These loans will take effect the day the PFI loan expires and the balloon payment is triggered. This arrangement allows the amortization of the PFI loan principal over 20 years, thus reducing the annual debt service on the WSP cash flow.

6. DBP will serve as the PWRF administrator. It will establish a special lending window for its operation and a ring-fenced account that will capture the re-flows of principal payments

1 Development Alternatives, Inc. (DAI) 2006. The Philippine Water Revolving Fund. Design and Implementation

Framework (Final Report). Forward Philippines. Manila. 2 EO 279 set the financing policy guidelines for the water sector.

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231

from WSPs for the JICA-DBP loan component during the JBIC loan grace period. This account will constitute the PWRF Special Account, which can be used to re-finance PFI loans, for new loans, or as a reserve to leverage additional private sector participation in the loan program.3

7. The financing structure of PWRF is shown below.4

PWRF FINANCING STRUCTURE

DBP = Development Bank of the Philippines, DCA = Development Credit Agency, GRP = Government of the Republic of the Philippines, JBIC = Japan Bank for International Cooperation, LGU = local government unit, LGUGC = Local Government Unit Guarantee Corporation, MDFO = Municipal Development Fund Office, PFI = private financing institution, PWRF = Philippine Water Revolving Fund, PWRFSF = Philippine Water Revolving Fund Special Fund, USAID = United States Agency for International Development, WSP = water service provider.

C. PWRF Relending Terms

8. A recent loan provided to Subicwater showed the following indicative terms of a P280 million PWRF loan:

(i) Financing ratio: 50% from DBP and 50% from any partner financial institution; (ii) Repayment term: up to 20 years with a maximum 3-year grace period (cash flow-

based), and (iii) Interest rate based on an indicative blended rate of 9.39%.

3 DAI, op.cit. 4 ibid.

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232

9. The table below shows that LWUA relending terms are competitive with those of PWRF. The LWUA interest rate of 9.2% for a 10-year loan is lower than that of PWRF. Moreover, the LWUA repayment period is longer and its floating amortization feature makes it more affordable to water service providers.

COMPARISON OF LWUA AND PWRF RELENDING TERMS

Items

LWUA

PWRF (Indicative Based on Subicwater

Loan Case)

Repayment Period 40 years (maximum) 20 years, cash flow-based

Grace Period 3 years 3 years (maximum)

Capitalized Interest Yes, depending on WD’s financial capability

Interest Rate (per annum)

Average = 9.675%

Repayment Period Interest Rate First 10 years 9.2% >10-20 years 9.5% >20-30 years 9.8% >30-40 years 10.2%

(i) Development Bank of the Philippines and private financing institutions financing ratio of 50-50

(ii) Blended interest rate = 9.39%

Repricing LWUA proposes to lend at a fixed rate but to be adjusted periodically based on the Philippine Dealing System treasury reference rates.

Periodic Amortization Floating amortization based on WD’s financial capability

Other Fees/Charges

Processing Fee ½ of 1% of approved loan amount 0.5% of total approved loan amount

Commitment Fee 0.1% p.a.of undisbursed amount to start from date of notice of loan approval up to date of loan disbursements

Documentary Stamp On the account of Subicwater

Gross Receipt Tax On the account of Subicwater

Other Requirements/Remarks

(i) Prepayment penalty at 3% of the amount to be prepaid;

(ii) Maintenance of average daily balance on deposit of not lower than 3%of outstanding principal balance.

LWUA = Local Water Utilities Administration, PWRF = Philippine Water Revolving Fund, WD = water district. D. Creditworthy Water Districts as a Primary Market of PWRF

10. PWRF was operationalized in 2008 and is now being implemented by Development Bank of the Philippines under the guidance of the PWRF Steering Committee. The Steering Committee was created through a memorandum of understanding with the Department of Finance as chair, and the National Economic and Development Authority, Bankers Association of the Philippines, JICA, and the USAID as members. Consultants of Development Alternatives, Inc. will continue to advise and assist in implementing PWRF until 2011.

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233

11. Recent and ongoing PWRF activities include capacity building of WDs on strategic business planning and septage management program; ring-fencing of LGU water utilities, strengthening economic regulatory capacity of NWRB and preparation of implementation plan to rationalize public resource allocation for water supply and sanitation projects, including the corresponding financing/resource allocation mechanism. So far, no water service provider has availed of PWRF loans. Around four WDs have applied for loans but none has been granted loans from PWRF. This was because LWUA has not yet signed waivers for these WDs, a precondition for WD loans outside LWUA. At present, PWRF consultants are doing sanitation studies for five WDs.

12. PWRF supports EO 279 by providing a market-based financing alternative that mobilizes funds from private financing institutions. PWRF caters to creditworthy water service providers, as will be assessed by banks.

13. In the meantime, LWUA has also been exploring other options for financing water supply projects, including the creation of a water bank.

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234

LIST OF ASSUMPTIONS A. General Assumptions

1. The projection period covers 10 years from 2009 to 2018 based on the following assumptions:

(i) the loan will be effective in 2011, (ii) the 6-year disbursement period will be completed in 2016, (iii) repayment period for the Local Water Utilities Administration (LWUA) loan

will cover a maximum of 25 years until 2036, and (iv) repayment period for the water district (WD) loans to LWUA will average

30 years. 2. Year 2009 figures were based on the 2009 LWUA budget but adjusted based on

recent developments. The LWUA projected financial statements for calendar years 2010-2018 prepared by the Corporate Planning Department in December 2008 were used as the basis for the projections. These were updated to consider the major changes in the investment plan and in LWUA’s relending rates resulting from Board Resolution (BR) 38 series of 2009.

3. Investment figures were based on 2009 prices. In 2009, an exchange rate of

P45:$1 was used partly based on LWUA estimates, it is assumed that this will increase based on an annual increase of 1% based on the peso depreciation from 2003 to 2004. These were the latest years when a gradual peso depreciation was experienced. The peso depreciation vis-a-vis other currencies followed the depreciation of the peso against the US dollar.

4. Cost-escalation factors were based on the inflation forecast for the Philippines

presented in the ADB website. For local costs, these factors are 9.3% (2009), 3.2% (2010), 4.7% (2011), 4.6% (2012), and 4.5% (2013 thereafter). For foreign costs these are 1.5% for 2010, 0.7 for 2011, 0 for 2012, and 0.5% thereafter.

B. Financial Projection Model and Scenario Analysis

1. Key Assumptions

An assessment of the performance of the WE Bank as well as the implications on LWUAs performance and financing requirements was made and presented in Appendix 5. The WE Bank is expected to operate at much smaller scale of operations than projected under the feasibility study prepared early 2009 which was the basis for the acquisition transaction.

Financial projections of LWUA’s performance were prepared for LWUA under two schemes namely:


• Scheme Two – With Bank which assumes continued operation of the bank. For each scheme, projections were prepared under a base scenario and three other scenarios as a basis for sensitivity analysis. The financial projections for the with the Bank scheme appears baseless in the absence of business plan for the WE Bank. Considering this, the base scenario for the LWUA financial projection is based on the without the Bank scheme.

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1. Base Scenario

5. The base scenario was based on the 10-year financial projections prepared by the LWUA Corporate Planning Department in December 2008 which was updated to consider several developments, including the following:

(i) revision of the relending rate based on BR 38 series of 2009, (ii) increase in the ADB WDDSP loan from $24 million to the planned

investment of $50 million, (iii) loans were limited to the amount needed by the investment level, (iv) study period was extended from 10 years to 27 years covering 2009 to

2036 (iv) reclassification of the Accounts receivable and Other receivable accounts

to be consistent with the LUWA Financial Reports prepared by the Accounting Department, and

(v) recent developments as shown in the LWUA Comprehensive and Interim Improvement Project (CIIP) which shows a total investment of P28 billion for the 5-year period 2009 to 2013, including actual investment figure of P3.6 billion in 2009. Investment figures for 2010 thereafter adjusted at 80% of budget and CIIP figures to be conservative.

a. Sensitivity Analysis 6. Three other scenarios were developed to test LWUA’s sensitivity to adverse situations from the perspective of how these adverse situations affect LWUA’s long-term viability. The scenarios are referred to as the Conservative Scenario (Scenario A), the Better Scenario (Scenario B), and the Best Scenario (Scenario C). The parameters used include (i) investment, (ii) revenues (iii) collection efficiency, and (iv) operating costs. Table A9.1 presents the scenario matrix. 7. For Scenario A, investment levels were set at 30% of the investment levels in the CIIP. Scenario B assumed investment levels at 60%. The investment program in Scenario C is based on 80% of the base scenario. 8. Revenues decrease as more WDs opt for refinancing. Revenues will be reduced even assuming that the funds are relent right away to other semi-creditworthy WDs, since the new interest rates average about 9.67% compared with the existing average of 11.6%. In Scenario A, 50% of the existing loans in 2008, and 25% in Scenario B are assumed to be refinanced. No refinancing is assumed in Scenario C. 9. Scenario A assumes the lowest possible collection efficiency at 75%, which approximates LWUA collection efficiency on gross accounts receivables which include non-performing loans, accounts of non-operating WDs, and deferred accounts. For Scenarios B and C, collection efficiency was set at 85% and 90%, respectively. 10. For operational expenses, it is assumed that the personal services expense level will increase annually by 3% and maintenance and operating expenses will increase with inflation.

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Table A11.1: Scenario Matrix

From the Perspective of

LWUA Viability Original

Base

Scenario A Scenario B Scenario C

(Conservative) (Better) (Best)

Project Disbursements/Investment ODA/Local grants and loans Investment Plan and

disbursement as of December 2008

Updated May 2009

Investment figures are

P3.6 billion in 2009 (actual) and 80% of 2010 budget and CIIP figures thereafter.

Only 30% of funds available

Only 60% of funds available

80% of funds are available

Revenues Reduced interest revenues due to refinancing

No refinancing since LWUA is not supporting this

50% refinancing 25% refinancing No refinancing

Collection Efficiency Collection efficiency on billings net of non-performing, deferred accounts and accounts of non-operating WDs

85% 75% 85% 90%

Operating Costs

Personal Services (Organization/Staffing)

Maintained at 2009 levels (P546 million/year)

P1,098 million in 2010 based on Budget, 3% increase thereafter

15% reduction by year 2013

Maintenance and Other Operating Expenses

Maintained at 2009 levels (P206 million/year) and increased with inflation





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237

C. Investment Program

1. The investment plan follows the financing framework discussed in the section on LWUA Financing Framework of this report.

2. Non-operational water districts are expected to be operational with LWUA

assistance in the coming years. The unclassified WDs will also be classified in the coming years. Both non-operational and unclassified WDs are assumed to be classified as non-creditworthy WDs.

3. The total number of semi-creditworthy and non-creditworthy water districts is

assumed to remain the same as those that are upgraded to creditworthy are being replaced by districts in the lower classification that are likewise upgraded.

4. There are two sets of plans. The short-term plan for 2009 to 2013 was based on

LWUA’s Comprehensive and Integrated Investment Program. The long-term investment plan beyond 2013 was assumed at the same level as the 2009-2013 CIIP as discussed with officers of the LWUA Corporate Planning and Finance departments.

a. Short-term Investment Plan

11. The Comprehensive and Integrated Infrastructure Program shows a total investment of P28 billion for the 5-year period 2009−2013. Some P13 billion, or 46%, is expected to be funded by loans (P5.1 billion from Official Development Assistance or foreign loans, and P7.9 billion from bond flotation). Subsidies in the amount of P10.2 billion from the national government are estimated to finance 36% of the investment for the period. The remaining 18%, or P5.2 billion, will come from LWUA internal cash generation or LWUA domestic borrowings. The funds provided will be used to finance projects as shown in Table A11.2 which also summarizes the projected amounts to be allocated by WD classification. 2009 and 2010 investment figures were based on the adjusted budget for 2009 and the budget for 2010. 12. Table A11.3 shows the details of the fund sources and uses as well as the general profile of projects under CIIP.

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238

Table A11.2: Estimated Allocation by Type of Water District, 2009−2013

Type of Water

District

Financing Windows

Assumptions

Estimated Amount to

be Allocated (P billion)

Percent

(%)

Credit worthy

No loan window open

Semi-credit worthy


Board Resolution 38 likely terms: 30 years repayment, 9.8% interest, 10% equity counterpart from ICG

18.52

65

Pre-credit worthy

Special loan windows for P5 million and P10 million loans

Average terms:15 years repayment, 8% Interest, no equity counterpart

2.50

9

Pre-creditworthy, Non-credit worthy, Non-operational, Waterless WDs

Non-LWUA Initiative Fund loan window

Average loan financing is 25% with 30 years repayment, zero interest

1.90

6

Pre-credit worthy, Non-creditworthy, Non-operational, Waterless Non-WDs to be converted to WDs

NLIF loan window

Average grant financing is 75%

5.70

20

Total

28.00

100

ICG = internal cash generation, NLIF = Non-LWUA Initiative Fund, ODA = Official Development Assistance, WD = water district.

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239

Table A11.3: Investment Level, 2009−2013 (P Million)

ADB = Asian Development Bank, DOH = Department of Health, DPWH = Department of Public Works and Highways, ICG = internal cash generation, JICA = Japan International Cooperation Agency, KfW = Kreditanstalt für Wiederaufbau, LWUA = Local Water Utilities Administration, m = million, NLIF = non-LWUA-initiated fund, PCW = pre-creditworthy, SCW = semi-creditworthy, WB = World Bank, WDDSP = Water District Development Sector Project.

JICA KFW 3 package WDRSP (WB)

WDDSP (ADB) PUSSMP

Less Credit-worthy Water

Districts

Waterless Municipa-

lities

Non Operational

Comprehens ive/ Interim Improve-

ment

Other DOH (P1.5

B)DPWH

(P69.25 B)DPWH

(P430 B) Bulk Water

Semi Credit-worthy and Precredit-

worthy

Watershed Manage-

ment

Disbursement years2007-2010 2009 - 2012 2010-2014 2011-2015 2009 2009 to 2013 2010 to 2013 2009 to 2010 2009 2009 2009 2009 2009 2009 2009

PART 1: LOANS PAYABLE OF LWUA

2,400.00

LWUA FlowsA Foreign

Loan 712.00 2,375.00 1,193.00 896.00

Grant 40.00

B Local

Bond 4,880.00

3,000.00

Subsidy 485.00 418.00 150.00

2,353.00

4,277.00

999.00

1,400.00

70.00

430.00

C LWUA ICG 0.72 88.00 475.00 142.00 0.60 4,010.00

120.00

40.00

TOTAL PROJECT COST 0.72

1,285.00

2,850.00

1,335.00

1,354.60

150.00

2,353.00

4,277.00

4,010.00

999.00

1,400.00

70.00

430.00

5,000.00

3,000.00

40.00

PART 2: LOANS RECEIVABLE OF LWUA

A SCW (Window 1) 1,285.00 2,850.00 1,335.00 4,010.00

999.00

5,000.00

3,000.00

40.00 -

-

B PCWs: P5 m and P10 m loan windows 150.00

2,353.00

-

C PCW/NCW (NLIF window) 1,283.10

420.00

21.00

129.00

PART 3: GRANTS provided by LWUA

A PCW/NCW 0.72

1,354.60 2,993.90

980.00

49.00

301.00

B GRANTS provided to non water districts

TOTAL INVESTMENT OUTFLOW TO WDS 0.72

1,285.00

2,850.00

1,335.00

1,354.60

150.00 2,353.00

4,277.00

4,010.00

999.00

1,400.00

70.00

430.00

5,000.00

3,000.00

40.00

FOREIGN ASSISTED Locally Funded - ProposedLocally Funded - On Going

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240

13. Key projects are as follows:

i. Foreign-assisted Projects, Ongoing 14. JICA Assistance. Japan International Cooperation Agency assistance amounting to P0.72 million will benefit 20 small pre-creditworthy and non-creditworthy WDs to be identified. The project enhances operation and maintenance and does not increase coverage of the population served. Project implementation is ongoing and scheduled to be completed in 2010.

15. KfW Assistance. The KfW 3 package amounting to P1.285 billion will be invested in 31 unidentified semi-creditworthy WDs. The project is ongoing and expected to be completed in 2012.

ii. Foreign-assisted Projects, Proposed

16. Provincial Urban Sewerage and Septage Management Programme (PUSSMP). It is planned that a total of P3.84 billion comprising P2.62 billion forex loan, P0.040 million forex grant, P1.18 billion subsidy, and P0.600 LWUA internal cash generation be disbursed to fund sanitation projects.

17. The Local Government Support for Regional Water Supply Project amounting to P2.85 billion is expected to be implemented from 2010 to 2014 based on CIIP. LWUA is looking for other sources of financing since the World Bank is no longer financing this project. It was included in the investment program on the basis that the financing arrangements will be similar to the expected terms of the World Bank loan.

18. The Water District Development Sector Project funded by ADB is expected to be implemented starting 2011 to benefit about 5 water districts. The project appraisal reports for five pilot projects and the project proposal for the $50 million loan are currently being prepared under an ADB technical assistance and are due for completion in 2009.

iii. LWUA-funded Projects, Ongoing

19. Projects for Less Creditworthy and Waterless Municipalities. These projects are programmed in CIIP in the amount of P150 million and P2.35 billion, respectively. Funds for 2009 (P150 million for less creditworthy and P150 million for waterless municipalities) came from the Department of Budget and Management. 20. Non-LWUA-initiated Funds (NLIF) Projects. NLIF projects, which comprise DOH-funded projects (P1.4 billion), DPWH-funded projects (P500 million), and projects for non-operational WDs (P4.3 billion), are projects that are being implemented by LWUA using non-LWUA-initiated funds. The funds are provided by the national government as part of the Government Appropriations Act.

21. Comprehensive and Interim Improvement Projects. These are regular projects for semi-creditworthy WDs under Loan Window 1.

iv. The LWUA-funded Projects, Proposed

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241

22. Semi-creditworthy and Pre-creditworthy Projects. These are extensions of the ongoing Comprehensive and Interim Improvement Project and other locally funded projects. These are expected to be funded through the issuance of bonds. 23. Bulk Water Project. The feasibility study for the bulk water project is presently being initiated by LWUA. Financing for the project is expected to come primarily from the private sector.

a. Long-term Investment Plan 24. Beyond 2013, it is assumed that the investment plan will be maintained at previous levels. However, the % of funds to be allocated to SCWs will gradually decrease as more funds are provided to develop less creditworthy WDs. D. Revenues

1. Operating Income

25. The major revenue item is the operating income from interest on loans to water districts, which is based on projected billings on existing loans and estimated billings on new loans. Projected interest billings on existing loans comprise interests on loans in the disbursing stage, capitalized interest on loans in the disbursing stage, and interest on loans in the amortizing stage. For years 2009 to 2013, these are computed by the LWUA Loans Administration Department (LAD) based on loan contracts and amortization schedules. 26. Estimated billings on new loans are based on the LWUA Investment Plan. They also consist of interests on loans in the disbursing stage, capitalized interest on loans in the disbursing stage, and interest on loans in the amortizing stage. These are based on the assumptions for new loans discussed in Section C. Investment Program of this appendix.

2. Service Income

27. LWUA charges 9% of the loan amount for the preparation of feasibility and design for projects and 4% for construction supervision (CS). Lower rates are charged whenever LWUA merely reviews the studies (2%) and monitors CS (1%). This account also includes income from well-drilling operations. E. Receivables and Long-term Receivables

1. Water District Account Balances

28. The water district accounts are broken down into (i) the current portion due in the current year, which are called accounts receivables (ARs) and shown as part of current assets in the balance sheet, and (ii) the amounts due beyond the current year referred to as long-term receivables (LTRs) and shown as part of non-current assets. As of December 2008, AR balance stood at P1.65 billion comprising interest and current portion of outstanding long-term loans classified as (i) active accounts, (ii) non-performing loans (NPLs), and (iii) deferred accounts (DAs). LTR comprises (i) loans receivable from WDs, (ii) unbilled loans and accounts receivables from WDs, and (iii) restructured receivables all totaling P13.74 billion (see Appendix 7 for details of receivables accounts).

2. Non-performing Loans and Deferred Accounts

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242

29. NPL accounts amounted to P87.09 million in 2008. For the period 2009 to 2018, the LWUA LAD projected the movements of these accounts. By the end of 2018, NPL is estimated to amount to P162 million. For the period 2019 to 2028, it is estimated at about 60% of NPL as of 2018 will not be collectible and will eventually be written off by 2019. The balance of P 62 million is estimated to be paid by 2028.

30. Deferred accounts refer to accounts of WDs which have requested financial relief based on collection action plans and other pending requests for restructuring. Deferred accounts are merely restructured accounts. These accounts have a balance of P50 million as of December 2008. LWUA believes that ultimately these accounts will be collected within the 10-year period from 2019 to 2028.

3. Reconciliation of Accounts

31. There are differences between the balances of the WD accounts which need to be reconciled. For purposes of the projection, the lower figures were used as December 2008 balances as follows:

(i) Accounts Receivables - P1.136 billion from LAD records (P1.653 based on Accounting records)

(ii) Long Term Receivables – P13.736 billion from Accounting records (P14.11 billion from LAD records)

4. Allowance for Bad Debts

32. According to the LWUA Finance Department, allowances for bad debts are set at 25% of AR, 40% of non-performing loans, and 4% of LTR. As of December 2008, the allowance represented 37% of AR and 9% of LTR.

5. Collection Efficiency

a. Collection from Performing Loan Accounts of Existing Loans

33. LAD segregates calculation of collection efficiency by types of accounts. The Billing and Collection Report for 2008 indicated a collection efficiency of 94% on performing accounts, that is, AR balance less NPL and DA. The Budget Department targets a total collection efficiency figure of 85% based on gross receivables less NPL and DA. The latter calculation was used in the projections.

b. Collections from NPL and DA from Existing Loans

34. Assumptions on collections from NPL and DA are discussed in the section on Non-performing Loans and Deferred Accounts of this appendix.

c. Collections from New Loans 35. The projections used the target collection efficiency of 85% as shown in the 2008 budget for the base case scenario. F. Loans Payable and Disbursements

1. Existing Long-term Liabilities

36. As of December 31 2008, long-term liabilities totaled P9.4 billion of which P622 million represented the current portion of loans payable accounts. Projected debt service on

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these existing loan balances was calculated by LWUA based on the loan agreements’ amortization schedule from funding institutions.

2. Future Loans Until 2013 37. For future loans for the investments covered by CIIP 2009−2013, the expected sources are as follows:

a. ADB 38. The $50 million ADB loan is expected to be provided at the following terms: 25-year repayment period, inclusive of 6-year grace period, and interest capitalized during construction, which approximates the grace period and a 1.8% interest rate per year. These are indicative terms subject to revisions based on the financing terms for the Water District Development Sector Project which is currently under study under PPTA 7122.

b. Other ODA Loans 39. Loan terms for the other ODA loans are shown in Table A11.4.

Table A11.4: Loan Terms for Projects Funded by Other ODA Loans

Projects

Interest Rate (%)

Grace Period (yr)

Repayment Period (yr)

Provincial Urban Sewerage and Septage Management Programme

6

15

20

Local Government Support for Regional Water Supply Project (World Bank)

6 4 20

KfW 0.75 10 30

c. Local Loans and Bonds 40. It is assumed that the terms of the local loans include an interest rate of 7% and a repayment period of 10 years. LWUA can borrow up to a maximum of P10 billion from this source. A bond flotation amounting to P1.2 billion is assumed in year 2011 which is payable in 10 years.

3. Future Loans Beyond 2013

41. Terms similar to those of ADB are assumed for long-term investments beyond 2013.

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FINANCIAL PROJECTIONS


PROJECTED INCOME STATEMENT

(In Million Pesos)

BASE SCENARIO: WITHOUT THE BANK 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

INCOME

Operating Income 1,673 1,863 2,455 2,979 3,059 3,329 3,482 3,770 3,957 4,156

Service Income 143 588 404 641 475 443 384 501 501 496 Miscellaneous Income 136 111 99 111 112 115 116 137 193 237

TOTAL INCOME 1,952 2,562 2,958 3,732 3,646 3,886 3,981 4,408 4,650 4,890

EXPENSES

Personal Services 546 1,098 1,098 1,131 1,165 1,200 1,236 1,273 1,311 1,350

Maintenance & Other Operating Expenses 122 359 359 375 392 410 428 448 468 489

Interest Expense & Debt Charges 367 370 367 323 443 276 406 416 397 414 Non-Cash Expenses (Bad Debts & Depreciation) 38 30 36 41 46 50 301 289 301 294

Loss from Investment in Subsidiary Bank 0 94 94 94 94 94 62 62 62 62

ESE/CS/WDr & Other Expenses: 173 210 357 552 426 408 359 434 428 425

TOTAL EXPENSES 1,245 2,161 2,311 2,517 2,565 2,437 2,792 2,921 2,967 3,035

NET INCOME (LOSS) BEFORE INCOME TAX 707 401 647 1,215 1,081 1,448 1,189 1,487 1,683 1,855

LESS: PROVISION FOR INCOME TAX 272 128 207 389 346 464 381 476 539 594

NET INCOME (LOSS) AFTER INCOME TAX 435 272 439 826 735 985 809 1,010 1,144 1,261

PROJECTED

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PROJECTED BALANCE SHEET

(In Million Pesos)

BASE SCENARIO: WITHOUT THE BANK2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

ASSETS

CURRENT ASSETS Cash 1,180 1,175 277 1,097 1,842 1,229 483 374 375 422

Accounts Receivable 1,355 2,287 2,310 2,676 2,987 3,350 3,805 4,324 4,822 5,310

Other Receivables 1,078 1,165 1,208 1,259 1,315 1,377 1,414 1,458 1,506 1,558

Inventory 3 3 6 8 11 13 16 18 21 23

Receivables from Govt Agencies & Bank Shareholders 760 728 693 659 624 590 587 585 582 580

Other Current Assets 89 22 22 22 22 22 22 22 22 22

LONG TERM RECEIVABLES 14,485 16,874 21,386 23,429 25,571 28,652 31,219 33,631 35,922 38,135

INVESTMENTS 1,017 955 893 831 769 707 645 583 521 459

FIXED ASSETS

Land & Land Improvements 2 2 2 2 2 2 2 2 2 2

Building and Structures 73 73 73 73 73 73 73 73 73 73

Furniture, Fixtures, Equipment & Books 129 210 254 294 329 359 387 411 432 451

OTHER ASSETS 164 164 248 379 477 569 649 752 856 958

TOTAL ASSETS 20,335 23,658 27,371 30,728 34,021 36,944 39,302 42,233 45,133 47,992

LIABILITIESCURRENT LIABILITIES Accounts Payable and accrued expenses 127 127 127 127 127 127 310 310 310 310

Current Portion of Long-term Debt 430 906 440 443 415 630 293 375 594 43

Other Current Liabilities 570 611 755 936 793 1,247 1,122 1,266 1,361 1,444

LONG-TERM LIABILITIES To Other Government Corporations - - - - - - - - - - To Foreign Creditors 7,900 7,453 7,650 7,775 8,097 8,076 8,275 8,445 8,447 9,155

To Domestic Creditors 624 200 116 36 106 77 369 595 763 873

BONDS PAYABLE - - 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200

DEFERRED CREDITS 410 410 410 410 410 410 410 410 410 410

TOTAL LIABILITIES 10,648 10,316 11,305 11,534 11,756 12,374 12,586 13,209 13,693 14,042

CAPITAL FUNDPAID IN CAPITAL 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500

DONATED CAPITAL 6,798 9,998 12,190 14,390 16,618 18,058 19,498 20,938 22,378 23,818

RETAINED EARNINGS 389 843 1,376 2,304 3,147 4,012 4,718 5,586 6,562 7,632

TOTAL CAPITAL FUND 9,687 13,341 16,066 19,194 22,265 24,569 26,715 29,024 31,440 33,950

TOTAL LIABILITIES & CAPITAL FUND 20,335 23,658 27,371 30,728 34,021 36,944 39,302 42,233 45,133 47,992

PROJECTED

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LOCAL WATER UTILITIES ADMINISTRATIONPROJECTED CASH FLOW STATEMENT

(In Million Pesos)

BASE SCENARIO: WITHOUT THE BANK 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

CASH BALANCE, BEGINNING 1,651 1,180 1,175 277 1,097 1,842 1,229 483 374 375

Add: Receipts

I. Operations

A. Interest Revenues - Loans to WDs 1,520 1,677 1,993 2,336 2,566 2,827 3,026 3,253 3,451 3,654 B. Interest Revenues - Investments - - 9 9 9 9 9 9 9 9 C. Processing Fee/Guarantee Fee - - - - - - - - - - C. Interest Revenues-Bank Deposits 26 19 29 31 25 20 14 29 78 116 D. Coll. from Engineering Cost 134 460 84 131 98 92 80 103 103 102 E. Collection from Training & Seminars - - 5 5 5 5 5 5 5 5 F. Collection - Housing/Car Loans - - 45 47 49 50 51 52 53 54 G. Miscellaneous 122 36 60 70 76 84 91 99 106 111 II. Government Subsidy/DPWH Grant 3,600 3,200 2,192 2,200 2,228 1,440 1,440 1,440 1,440 1,440 III. Coll. of Principal Loan from WDs 532 592 819 949 1,042 1,149 1,290 1,433 1,539 1,595 IV. Foreign Borrowings - - 604 544 757 720 720 720 720 720 V. Foreign Grant - - - - - - - - - - VI. Local Borrowing 16 111 11 - - - 360 360 360 350 VII. Refinancing of WD Loans (DBP) - - - - - - - - - - VII. Reserve Deposits 27 20 - - - - - - - - VIII. Withdrawal of Investments 16 68 - - - - - - - - IX. Bond Floatation - - 1,200 - - - - - - -

- - - - - - - - - - TOTAL RECEIPTS 5,992 6,182 7,050 6,322 6,855 6,395 7,086 7,504 7,864 8,156

TOTAL CASH AVAILABLE FOR DISBURSEMENTS 7,643 7,362 8,226 6,599 7,951 8,237 8,315 7,987 8,238 8,532 - - - - - - - - - -

Less: Disbursements

I. Operations

A. Operating Expenditures - - - - - - - - - - a. Personal Services 784 1,522 1,098 1,131 1,165 1,200 1,236 1,273 1,311 1,350 b. MOOE - - 359 375 392 410 428 448 468 489 C. Capital Outlays 58 81 81 81 81 81 81 81 81 81 D. Payment of Acc. Exp./Div./Inc.Tax 179 86 64 207 389 346 700 575 719 814 II. Loans to Employees(Housing,Car, etc.) - - 55 55 55 55 55 55 55 55

III. Project Disbursements - - - - - - - - - - A. From Foreign Sources 551 111 604 544 757 720 720 720 720 720 B. From Local Sources 3,049 3,489 4,317 2,248 2,288 3,408 3,408 3,408 3,392 3,355 IV. Investment in Stocks & Bonds - - - - - - - - - - V. Debt Service 1,017 898 1,371 861 983 789 1,021 1,053 1,117 1,246 VI. Withdrawal of WD Reserve Deposits - - - - - - 183 0 - - VII. Investment in Bank Purchase 780 VII. Others - Miscellaneous (including Advances to Bank Shareholders)44 - - - - - - - - - TOTAL DISBURSEMENTS 6,463 6,187 7,948 5,502 6,110 7,008 7,832 7,613 7,863 8,110

CASH BALANCE, END 1,180 1,175 277 1,097 1,842 1,229 483 374 375 422

Debt Service Ratio 0.85 0.68 1.49 1.34 1.78 1.55 1.69 1.71 1.63

PROJECTED

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BASE SCENARIO: WITHOUT THE BANKLOCAL WATER UTILITIES ADMINISTRATION

STATEMENT OF FUNDS FLOW

2010 - 2018

(In Million Pesos) 2009 2010 2011 2012 2013 2014 2015 2016 2017 2016

Cash Flows from Operating Activities

Interest from loans and accounts of WDs/RWSAs 1,520 1,677 1,993 2,336 2,566 2,827 3,026 3,253 3,451 3,654

Withdrawal of Investments 16 68 - - - - - - - -

Collection of principal payments received from loans & A/Rs 532 592 819 949 1,042 1,149 1,290 1,433 1,539 1,595

Cash received from engineering services rendered 134 460 84 131 98 92 80 103 103 102

Interest earned from savings deposits 26 19 29 31 25 20 14 29 78 116

Other receipts including dividends 122 36 73 83 90 98 105 113 119 125

Cash paid to suppliers and employees (784) (1,522) (1,457) (1,506) (1,557) (1,610) (1,664) (1,721) (1,779) (1,839)

Interest and other debt service charges paid (367) (370) (367) (323) (443) (276) (406) (416) (397) (414)

Income taxes paid (179) (86) (64) (207) (389) (346) (464) (381) (476) (539)

Net Cash Provided by Operations 1,019 873 1,110 1,494 1,433 1,954 1,981 2,414 2,638 2,800

Cash Flows from Investing ActivitiesProject Disbursements

Local Cost (3,049) (3,489) (4,317) (2,248) (2,288) (3,408) (3,408) (3,408) (3,392) (3,355)

Foreign Cost (551) (111) (604) (544) (757) (720) (720) (720) (720) (720)

Investment in Subsidiary Bank (780) - - - - - - - - -

Loans to officers/employees including Subsidiary Bank shareholders(44) - (10) (8) (6) (5) (4) (3) (2) (1)

Investments in agrarian reform bonds - - - - - - - - - -

Fixed assets acquisition (58) (81) (81) (81) (81) (81) (81) (81) (81) (81)

Net Cash Used in Investing Activities (4,483) (3,681) (5,011) (2,880) (3,132) (4,214) (4,213) (4,212) (4,194) (4,156)

Cash Flows from Financing ActivitiesProceeds from grants/government subsidies 3,600 3,200 2,192 2,200 2,228 1,440 1,440 1,440 1,440 1,440

Proceeds from local borrowings 16 111 1,211 - - - 360 360 360 350

Proceeds from Long term debts - - 604 544 757 720 720 720 720 720

Principal payments of loans from foreign-lending institutions (651) (527) (469) (442) (460) (483) (586) (576) (586) (640)

Principal payments of loans from local-lending institutions - - (535) (96) (80) (29) (212) (62) (134) (192)

Dividends paid to the national government - - - - - - (236) (194) (243) (275)

Proceeds from WDs' LT loans & reserve deposits 27 20

Net Cash Provided by Financing Activities 2,992 2,804 3,003 2,206 2,444 1,647 1,486 1,688 1,557 1,403

Net Increase in Cash and Cash Equivalent (471) (4) (898) 819 745 (613) (746) (109) 1 47

Cash and Cash Equivalent at the Beginning of the Year 1,651 1,180 1,175 277 1,097 1,842 1,229 483 374 375

Cash and Cash Equivalent - Ending Balance 1,180 1,175 277 1,097 1,842 1,229 483 374 375 422

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LOCAL WATER UTILITIES ADMINISTRATIONFINANCIAL INDICATORS

2010 2011 2012 2013 2014 2015 2016 2017 2018

1. Current Ratio 2.41 2.36 2.73 3.54 2.54 2.74 2.67 2.57 3.32

Formula:

Current Assets/Current Liabilities

2. Debt - Equity Ratio 0.53 0.42 0.32 0.33 0.29 0.28 0.24 0.23 0.23

Formula:

Long-term Liabilities/Total Equity

3. Operating Ratio 0.67 0.63 0.56 0.55 0.53 0.52 0.50 0.49 0.48

Formula: Operating Expense/Operating Revenues (Total OPEX - NonCash)

B. CAMEL Framework

1. Capital Adequacy Indicators

a. Capital Adequacy Ratio 70% 68% 74% 78% 77% 76% 76% 77% 78%

Formula

Paid in Capital+Reserve Funds+Net Profits/

Total Assets-Loan Loss Prov-Risk free assets

b. Debt Service Coverage Ratio 0.85 0.68 1.49 1.34 1.78 1.55 1.69 1.71 1.63

(Net Income before non-cash items and 767,038 938,050 1,284,616 1,317,275 1,404,585 1,577,129 1,778,808 1,905,513 2,031,831

financing charges/Debt Service) 897,708 1,371,327 861,213 983,041 788,539 1,020,726 1,053,332 1,117,084 1,246,141

Formula

Net Revenue/Annual Debt Service

2. Asset Quality Indicators

a. Loan Loss Provision Ratio 7% 7% 7% 7% 8% 8% 8% 8% 8%

Formula: 1,507 1,790 2,028 2,235 2,483 2,715 2,957 3,190 3,416

Loan loss Provision/Ave. Performing Assets 20,279 24,179 27,596 29,972 32,866 36,168 39,329 42,371 45,298

b. Portfolio in Arrears 1% 1% 1% 1% 1% 1% 1% 1% 1%

Formula:

Balance of Loans in Arrears/Value of Loans 199 230 268 308 332 357 382 407 431

Outstanding 21,940 26,419 28,774 31,171 34,561 37,775 40,884 43,859 46,738

c.Loan Loss Ratio 4% 4% 3% 3% 3% 3% 3% 2% 2%

Formula: 106.51 116.27 125.67 134.95 138.88 144.99 150.86 156.73 162.29

Non-Performing Loans/Ave. Outstanding Loans Receivables 2,452.95 3,164.08 3,748.43 4,349.07 4,875.24 5,385.68 5,908.45 6,453.99 6,985.8

3. Management Quality Indicators

a.Cost per Unit of Money Lent 0.56 0.44 0.85 0.80 0.55 0.65 0.68 0.70 0.72

Formula: 2,003 2,180 2,381 2,422 2,286 2,674 2,823 2,874 2,941

Operating Costs/Total Amount Disbursed 3,600 4,920 2,792 3,045 4,128 4,128 4,128 4,112 4,075 4. Earnings Performance Indicators

a. Return on Assets 1.15% 1.61% 2.69% 2.16% 2.67% 2.06% 2.40% 2.54% 2.63%

Formula: 272 441 826 735 985 809 1,012 1,146 1,261

(Net Income after tax/Total assets)x 100 23,658 27,371 30,728 34,021 36,944 39,302 42,233 45,133 47,992

b. Return on Equity 2.37% 3.00% 4.69% 3.55% 4.21% 3.15% 3.63% 3.79% 3.86%

Formula: 272 441 826 735 985 809 1,012 1,146 1,261 (Net Income after tax/Ave.total Equity)x100 11,514 14,704 17,630 20,729 23,417 25,642 27,869 30,232 32,695

c. Interest Mark-up 403% 568% 822% 591% 1107% 758% 807% 897% 904%

Formula: 1,863 2,455 2,979 3,059 3,329 3,482 3,770 3,957 4,156

( Interest Revenue/Interest Expense)-1 370 367 323 443 276 406 416 397 414

d. Earnings Spread Ratio 10 10 12 10 10 9 10 10 10

Formula: 11 12 13 11 11 10 11 11 10

(Total Income-Non-operating Income x100/Ave Total 370,429 367,276 323,171 442,511 275,823 405,689 415,579 396,983 414,011

Portfolio) - (Interest Expense+Other Finance 23,076,749 24,108,593 28,100,832 32,309,617 33,950,853 35,842,452 38,437,347 41,025,284 44,399,645

Charges/Ave. Total Resources) x100 19,820,264 23,076,749 24,108,593 28,100,832 32,309,617 33,950,853 35,842,452 38,437,347 41,025,284

e. Intermediation Cost Ratio 7% 7% 7% 6% 6% 6% 12% 6% 5%

Formula:

(Total Exp.-Interest Exp./Ave.Total Assets) 1,633 1,813 2,057 1,980 2,010 2,269 2,407 2,477 2,527

removed (x100) in the formula 21,996 25,514 29,050 32,374 35,482 38,123 19,651 43,683 46,563

5. Liquidity Ratios

a. Loans to "liabilities to lenders" 250% 264% 290% 304% 342% 356% 371% 391% 387%

Formula: 19,162 23,695 26,105 28,558 32,002 35,024 37,955 40,744 43,445

(Loans to WD/Loans from Creditors)x100 7,654 8,965 9,011 9,403 9,353 9,844 10,240 10,410 11,228

PROJECTED

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CONCEPT PAPER: A BUSINESS PLANNING MODEL FOR LWUA

1. Sector planning for the entire water supply sector is preliminary and critical to the preparation of the Water Supply and Sanitation Sector Roadmap and the Medium-term Philippine Development Plan (MTPDP). With different government agencies pursuing their respective agendas for the sector, there is a need for institutional defragmentation and role definition as well. The Asian Development Bank (ADB)-funded Water District Development Sector Project (WDDSP) is concerned with the smaller subsector and deals specifically with water districts (WDs) under the Local Water Utilities Administration (LWUA).

2. The current planning process at LWUA is driven by information on available funds. This is premised on the idea that the financing need is so huge that whatever funds are obtained can be used to help meet the demand for financing the water supply and sanitation subsector. There is, however, very little information on the existing service coverage of this subsector that could be used as basis for assessing WDs’ demand for financing water supply and sanitation infrastructure. While the sector roadmap states that “according to LWUA, 24.15% had access to level III water districts”1 there is only minimal effort to relate fund sourcing to achieving targeted levels of service coverage. 3. LWUA has an estimate of the municipal and area populations served by water districts, but there is no agreed-upon method through which WD service coverage can be decisively determined.2 In the same manner, there is no deliberate strategy for WDs, municipality, city, province or region to increase this coverage to target levels. There is also no existing linkage between the LWUA planning process and individual WD planning efforts and infrastructure programs. The current focus is to develop and improve the water supply service in the waterless communities, the non-operational water districts, and cities/municipalities that are interested to organize into water districts. 4. This draft concept paper on a business planning model is intended to fill in the gaps noted above. In line with LWUA’s current institutional strengthening initiatives, the business planning model is intended to help the agency manage and process information on investment proposals and costs, sector-wide performance benchmarks, and perceived project impacts (i.e., scope and coverage) in the long term. The model also supplements LWUA’s efforts to institute key reforms in the water supply and sanitation sector. A. Objectives

5. The business planning model has the following primary objectives:

(i) to inform stakeholders of the status of accomplishment of LWUA’s mandate as a specialized lender, particularly to smaller, less creditworthy WDs as well as waterless municipalities attached to WDs;

(ii) to provide LWUA, government financing institutions, donor agencies, and the

private sector a tool for identifying viable technical, financial, and institutional interventions to improve the delivery and quality of WD products and services;

(iii) to determine WDs’ demand for financing and the extent to which LWUA could

respond to this demand given the total programmed investment; and

1 Philippine Water Sector Roadmap, 2004. 2 Service coverage may refer to different approaches, including municipal population served against total

municipal population, and total population served in franchise area as against franchise population.

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(iv) to gauge LWUA’s financial performance, particularly its profitability, liquidity, and ability to service debts in the medium and long terms.

B. Business Planning Model 6. A business planning model using Microsoft Excel was developed under ADB Project Preparation Technical Assistance (PPTA) 7122. The investment model compares coverage figures with that of the Philippine Water Supply Sector Roadmap (PWSSR)3. Although PWSSR data on population served is significantly lower than LWUA’s tallies, the roadmap is able to provide the proportion of households (27.2%) accessing levels I and II water systems of non-WD water service providers (WSPs) such as municipal water systems, cooperatives, and community-based water and sanitation associations. Using and assembling sector data from the LWUA Corporate Planning Department, the model is capable of summarizing served populations more purposely according to different parameters such as area, region, creditworthiness, and programmed funding.

7. The Business Planning Model consists of three invariably linked components. These are the (i) WD Investment Model which comprises 5-year investment plans of each WD and indications of need for LWUA financing, (ii) the LWUA Investment Model which consolidates the WD investment plans and shows how various levels of funding for the investment program affects sector service coverage, and (iii) the Financial Model, which shows the impact of the investment program on the financial performance of LWUA. The outputs of the WD Investment Model are consolidated into the LWUA Investment Model, results of which provide inputs to the Financial Model.

1. The Water District Investment Model

a. The WD Investment Database

8. As a core recommendation to the business planning concept, individual WDs will be instructed to prepare, refine, and transmit their 5-year proposals for infrastructure investments, capital improvements, and institutional development to the central WD investment database. Complementary to the first tranche of activities accomplished under ADB PPTA 7122, the WD investment databank acts as a repository of programmed investments mapped out and designed by each operating WD to reflect the true demand for improved water supply of the serviced communities, and the present financial disposition and capacities of a water district at any given period. The WD investment figures will be fed into the larger business planning model as concrete inputs to the overall investment financing demand in the WD sector.

b. Information Databank

9. This database will be accompanied by a fully functional and user-friendly data network where WDs will submit key financial and operations reports such as income statements, balance sheets, and monthly data sheets. This will enable the data administrator to track and determine demand for investment financing from both available and prospective funding sources. Collating these data in an online databank will expedite information processing, and improve period-on-period analysis and accuracy. As an outcome, real operating and financial data, namely average non-revenue water, billed water and collection, and production, from WDs can be disaggregated or clustered when needed. Investment information, defined in the 5-year capital outlay programs of each WD, can also be grouped together according to specific parameters.

3 A specialized planning document that rationalizes the targets and initiatives of different WS sector institutions into a unifying long-term strategy for sector financing, institutional capacity reform, and infrastructure building.

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2. The LWUA Investment Model

a. LWUA Investment Database

10. To prepare a comprehensive WD financing plan for urban water supply, there is a need to prepare a database consisting of information on water supply per city and municipality, as follows:

(i) Current service coverage by city or municipality, (ii) Water service providers within the city or municipality covered by the water

district and the coverage of each WSP and WD, (iii) Existing coverage vis-a-vis targets for the Millennium Development Goals

(MDG) and the Medium-term Philippine Development Plan, (iv) Gap between existing and target coverage and a reasonable timetable to

gradually meet the MDG and MTPDP targets by individual cities/ municipalities and on a broader, national scale. (this links to the WD investment database),

(v) Total investment required based on the annual physical targets and possible sources of financing,

(vi) Loan and grant financing needed by water districts alone, by category of creditworthiness, and

(vii) For financing semi-creditworthy WDs, ADB interventionsin terms of time or areato be financed by the current sector loan being packaged by the PPTA.

11. As earlier mentioned, the LWUA Investment Model determines how varying levels of funding in the WD sector affects overall water service coverage in urban areas outside Metro Manila. The model presents investment funding directed at specific WDs using selected parameters such as size, area, and creditworthiness. The model identifies current gaps in LWUA’s annual capital expenditure program.

12. The key tables from the LWUA Investment Model are discussed in the succeeding sections.

i. Sector Service Coverage

13. The Investment Model is designed to help LWUA to plan based on priorities like water districts with the lowest service coverage. The business plan thus proposes to present government, creditors, and investors useful information on how to address these disconnects and gaps by directly correlating the scheduled investments with concrete increases in service connections, population coverage, and the total number of persons provided adequate water supply. Tables A13.1 and A13.2 describe the service coverage of water districts by administrative region and by operating area, as defined by LWUA.4 Table A9.1 indicates that on the average, the WD subsector is responsible for extending piped water supply to 27% of provincial populations where WDs are in operation. This underscores the huge opportunity for WD sector expansion, particularly in emerging urban towns and communities that have limited water supply sources, but are willing to and have the capability to install or finance for additional infrastructure.

4 Area refers to an arbitrary clustering of regions (9 areas) used by LWUA to enable a more efficient administration of its

internal management, technical support, and monitoring duties directed at WDs located in these sites.

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Table A13.1: LWUA Water District Population Coverage by Area, 2008 a

Area Service Connections Population Served a

Area Population b

Coverage (%) Number Percent (%)

ONE 231,318 8.81 1,156,590 5,913,754 19.56 TWO 550,558 20.96 2,752,790 8,049,325 34.20 THREE 577,258 21.97 2,886,290 6,987,434 41.31 FOUR 171,222 6.52 856,110 3,382,569 25.31 FIVE 182,290 6.94 911,450 5,564,579 16.38 SIX 275,872 10.50 1,379,360 5,144,502 26.81 SEVEN 194,932 7.42 974,660 2,993,203 32.56 EIGHT 314,454 11.97 1,572,270 5,835,892 26.94 NINE 129,214 4.92 646,070 3,229,289 20.01 Total 2,627,118 100.00 13,135,590 47,100,547 27.01 a Average household size is assumed to be 5 persons. b Refers to population of franchise sites in an area. Source: LWUA Corporate Planning Division.

Table A13.2: LWUA Water District Population Coverage by Region, 2008

Region Service Connections Populati on Served

Regional Population a

Coverage (%) Number Percent (%)

Region 1 126,432 4.81 632,160 3,351,830 18.86 Region 2 56,946 2.17 284,730 1,854,559 15.35 Region 3 550,558 20.96 2,752,790 8,049,325 34.20 Region 4b 577,258 21.97 2,886,290 6,987,434 41.31 Region 5 171,222 6.52 856,110 3,382,569 25.31 Region 6 182,290 6.94 911,450 5,564,579 16.38 Region 7 195,811 7.45 979,055 3,028,868 32.32 Region 8 80,061 3.05 400,305 2,115,634 18.92 Region 9 79,861 3.04 399,305 1,739,579 22.95 Region 10 129,284 4.92 646,420 1,808,871 35.74 Region 11 250,213 9.52 1,251,065 4,108,546 30.45 Region 12 51,780 1.97 258,900 1,420,938 18.22 Region 13 82,335 3.13 411,675 1,511,324 27.24 CAR 47,940 1.82 239,700 707,365 33.89 ARMM 45,127 1.72 225,635 1,469,226 15.36 Total 2,627,118 100.00 13,135,590 47,100,647 25.77 ARMM = Autonomous Region in Muslim Mindanao, CAR = Cordillera Autonomous Region. a Refers to population of franchise areas in a region. b Includes Regions 4a and 4b. Source: LWUA Corporate Planning Division.

ii. Philippine Water Supply Sector Roadmap (PWSSR)

14. The PWSSR study was initiated in 2007 as a result of several consultative dialogues with water and sanitation proponents, and generally aspires for the same comprehensive, strategic direction shared and implied in the business planning model. PWSSR builds on the sector vision of “access to safe, adequate, and sustainable water supply for all.” It is anchored on the medium-term sector challenges and objectives of MTPDP and MDG. The roadmap envisions through its program recommendations adequate water service at a price reasonable and accessible to all, but without diminishing the ulterior capacities of water utilities to invest in welfare-enhancing services, programs, and infrastructure.

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15. Premised on the fundamentals of PWSSR, the Business Planning Model attempts to resolve the needs-investment gap between viable and non-viable WDs by recognizing investment requirements within the water district sector, and the implications of being able to implement those projects. Where earmarks in water supply distribution and transmission infrastructure translate to immediate consumer benefits (viz., health, consumption, agricultural produce), investments may also target reductions in unaccounted-for water and introduce technological upgrades to reduce operating losses and improve sustainability. To achieve this, the model consolidates and summarizes official information compiled and obtained from LWUA (2007-2008), which includes comprehensive data on the performance and scale of the WD sector in terms of existing service connections, non-revenue water, and size. Data on large, very large, and metro-sized WDs spanning a number of contiguous cities and municipalities within its service coverage are also presented.

16. Secondary data from the National Statistics Office were used to determine the municipal population (2007) of towns and cities within the spatial jurisdiction of WDs. To derive the proportion of the town/city population extended services by the WD, the number of service connections multiplied by an assumed factor of five persons is divided by the municipal population. Under the empirical model being developed in the PPTA, WDs have an average coverage of 27% across 624 municipalities.

ii. Water District Classification by Creditworthiness

17. A central feature of the Business Planning Model is its ability to disaggregate subsector results by area, region, and size. The model has sufficient capability to sort water district information according to LWUA’s creditworthiness rating scheme. The model is thus able to present tables to assist LWUA in refocusing its capital expenditure programs to pre-selected categories of WD creditworthiness. This capability is important as it describes the varying levels of public sector investment being programmed for viable and less viable WDs, and takes into account the coverage attributed to distinct creditworthiness levels. Creditworthiness also defines the readiness and capacity of WDs to access various loan channels such as commercial banks, government financing institutions (GFIs), LWUA, or mere grant funding, i.e., non-LWUA-initiated fund.

18. Numerous water districts that have not been assigned creditworthiness ratings by LWUA are likewise incorporated in the model with the intention of demonstrating the level of financing assistance – soft loans, government grants and long-term loans – being afforded to these less progressive WDs5. Investment strategies for these unclassified and non-creditworthy WDs furthermore define the present direction of the WD sector, particularly where larger, performing WDs are already exposed more intensively to GFIs, commercial lenders, and other market-based financing instruments. 19. Table A13.3 highlights the window of opportunity for less creditworthy WDs to expand their existing service coverage in growing urban populations outside Metro Manila. Non-creditworthy WDs, mostly found in smaller low-income provinces and towns, only connect 10.3% of the average municipal population to their formal systems. In contrast, creditworthy WDs account for nearly 46% of local towns and cities covered. The credit ratings supplement the annual investment plan which will be summarized and used extensively as input to the Financial Model.

5 Due to several reasons, including but not limited to the absence of three consecutive annual income statements

and financial documents.

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Table A13.3: LWUA Water District Population Coverage by WD Creditworthiness Classification

Creditworthiness Classification

No. of WDsa

No. of Service

Connections

Ave. No. of Connections

Per WD

Population Served

Area Population b

Coverage of Area

(%) Creditworthy 57 580,527 10,185 2,902,635 6,331,280 45.85 Semi-creditworthy 178 1,562,396 8,778 7,811,980 22,712,285 34.40 Pre-creditworthy 69 196,011 2,841 980,055 4,841,406 20.24 Non-creditworthy 36 47,607 1,322 238,035 2,310,795 10.30 Unclassified 264 240,574 922 1,202,870 11,509,165 10.45 Total 604 2,627,115 4,350 13,135,575 47,704,931 27.54 a Includes both operational and non-operational WDs. b Refers to population of franchise sites in an area; based on 2007 census, www.census.gov.ph. Source: LWUA Corporate Planning Division. 20. Towns and municipalities presently unserved by WDs that seek to form a WD, or are being eyed under the expansion initiatives of specific WDs meanwhile account for 41%. This indicates that there is a concerted effort to provide waterless municipalities and peri-urban communities in areas outside Metro Manila low-cost financing for investments in water supply and resource development, septage and health management, maintenance, repair and upgrading of resource infrastructure. 21. Further expounding on the window of opportunity present to less viable WDs, the figure below illustrates the aggregate population being served by WDs by creditworthiness classification. Where WDs connect 13.14 million persons to its system, creditworthy and semi-creditworthy districts are responsible for roughly 81.6% of this sum. The remainder is served by smaller, less-organized and non-creditworthy water districts.

iii. Investment Program by WD and Creditworthiness Classification

22. The result WDDSP Phase 1 is an investment plan that consists of funding sources and the corresponding increases in population served. Table A13.4 presents a preliminary summary of programmed investments for 2009 broken down per major investment source. Where new service connections are pegged at P20,000 each, per working cost estimates of LWUA engineers, the model is able to come up with the total number of new service connections under the aggregate investment program. To come up with the new population served, the model again assumes a factor of five persons per new projected connection. Under LWUA’s 2009 comprehensive investment and implementation plan, water districts would serve about 478,778 new connections or 2.39 million new additional individuals upon the successful completion of its program of work.

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Table A13.4: Summary of Capital Investment and Projected Population Served, 2009

Fund Sources Total

Investment (P’000)

Indentified Existing

Connections

New Connections

New Population

Served ADB WDDSP 1,250,000 94,164 62,500 312,500 Bulk Water Supply 120,000 0 6,000 30,000 DOH 1,500,000 44,367 75,000 375,000 DPWH 500,000 0 25,000 125,000 ICG Borrowings 4,662,058 322,961 233,103 1,165,515 KfW 3 1,143,500 100,879 57,175 285,875 LWUA (Grant) 400,000 111,198 20,000 100,000 Total 9,575,558 673,569 478,778 2,393,890

ADB = Asian Development Bank, DOH = Department of Health, DPWH = Department of Public Works and Highways, ICG = internal cash generated, KfW = Kreditanstalt für Wiederaufbau, LWUA = Local Water Utilities Administration, WDDSP = Water District Development Sector Project. Source: LWUA Corporate Planning Division.

23. The model is refined further by matching the fund sources with levels of creditworthiness. Investment data from LWUA and WDDSP (Table A13.5) show that substantial capital investments (47.6%) are being channeled to creditworthy and semi-creditworthy WDs. A possible reason for this inflow is that viable WDs are more readily able to repay their outstanding loans, and thus have a greater inclination to borrow for their projects and other WD initiatives. Semi- and creditworthy WDs are also relatively more competent in developing and packaging project proposals that directly impact service coverage, infrastructure, and overall product. Meanwhile, the uneven financing received by less-creditworthy WDs compounds existing water source problems, poor coverage of their franchise areas, and end-user affordability issues.

Table A13.5: Investment Financing and Programming for Water Districts by WD Category (P’000)

WD Category

ADB WDDSPa

Bulk Water

Supply

DOH

DPWH

ICG Borrowings

KfW 3

LWUA

Total (P)

Creditworthy 0 0 20,000 0 653,000 55,000 15,500 743,500 Semi-creditworthy

750,000 0 15,000 0 2,451,058 526,500 78,000 3,820,558

Pre-creditworthy

0 0 17,000 0 55,000 49,000 68,300 189,300

Non-creditworthy

0 0 29,000 0 75,000 15,000 28,700 147,700

Unclassified 500,000 0 106,800 0 324,000 235,000 102,500 1,268,300 Other WSPs and Towns

0 120,000 1,312,200 500,000 1,104,000 263,000 107,000 3,406,200

Total 1,250,000 120,000 1,500,000 500,000 4,662,058 1,143,500 400,000 9,575,558 ADB = Asian Development Bank, DOH = Department of Health, DPWH = Department of Public Works and Highways, ICG = internal cash generation, KfW = Kreditanstalt für Wiederaufbau, LWUA = Local Water Utilities Administration, P = Philippine peso, WD = water district, WDDSP = Water District Development Sector Project, WSP = water service provider. a Assuming only 50% of ADB loan through 2013 per LWUA program. Source: LWUA Corporate Planning Division.

3. Financial Model

24. The financial model comprises the third component of the Business Planning Model. The Financial Model illustrates the impact of the investment program on LWUA’s financial

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performance over a longer planning period. Initially, base costs of the model are lifted from regular capital expenditure projections of LWUA’s original program from 2010 through 2018. Under the WDDSP planning model, the financial performance is estimated up to year 2036 compared with the present 10-year plan. 25. Replacing the original capital expenditure program with the latest financial assumptions from LWUA management, the model proceeds to update the base LWUA model with readjusted investment plan targets, performance indicators, and relending terms deemed crucial for borrowing WDs. The revised base scenario under the Financial Model is capable of undertaking scenario analysis and strategic planning, which, in turn, would be used to (i) assess the overall financial disposition of LWUA, (ii) assist LWUA in long-term planning and budgeting of its capital expenditure allocations, (iii) determine internal financing requirements and debt service demands over time, and (iv) establish a functional framework for ADB sector loan management and planning.

a. Financial Reports and Financial Indicators 26. Using data of the LWUA Corporate Planning Department, Management Services Office, finance, treasury and budget offices, the Financial Model generates reports such as funds flow, balance sheets, income statements, debt service accounts, and performance indicators. The model also presents financial indicators such as interest and lending rates, repayment periods, loan disbursements and size, and overall debt service coverage, and lists down the key assumptions used.

b. Sensitivity Analysis

27. Sensitivity analysis refers to the capability of the Financial Model to incorporate various scenarios (best-to-worst cases) in its analysis. This provides LWUA with a tool for anticipating sudden losses or insufficiencies in terms of debt refinancing, collection efficiency, fund sourcing, and overall performance liquidity. Three major scenarios were formulated and imputed in the model:

(i) Scenario 1: Only 50% of investment funds materialize. (ii) Scenario 2: There is additional refinancing among creditworthy WDs. Viable

WDs approach private financial institutions and other market-based options instead of LWUA to settle or restructure debts.

(iii) Collection efficiency drops to 70%.

28. Parameters typically used in the sensitivity analysis include investment levels, collection efficiency, and operating expenses.

C. Strategic Planning

29. There is strong recommendation that the Business Planning Model should adopt a bottoms-up approach, where water districts are able to supply their annual operating and financial information to the LWUA-WDDSP business model through electronic transfer. LWUA, in this context, acts as a clearing house which coordinates and valuates the individual business and investment proposals of the water districts. This approach enables the water districts themselves to design projects that are more responsive to the needs of their concessionaires/consumers, thereby endowing these investment proposals weight and purpose across prospective funders. The participatory element further encourages community and WD stakeholders to get involved with and support the different

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developmental initiatives in their local WD, which increases the end-users’ propensity or willingness to pay for improved service.

D. Implementation Strategy

30. LWUA currently prepares three excel files for (i) a 10-year cash flow comprising an investment program, actual and projected income statement, and cash flow; (ii) the actual and projected balance sheet; and (iii) the debt service tables for LWUA Loans. The business plan will consolidate this information on file, and proceed to expand them to contain the database for the three components of the Business Planning Model.

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