Document of

The World Bank

FOR OFFICIAL USE ONLY FILE CO0 PoY

Report No.1900-PH

PHILIPPINES

STAFF APPRAISAL REPORT

ON THE

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

April 11, 1978

Projects DepartmentEast Asia and Pacific Regional Office

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit - Philippine Peso

US$1 = P 7.50 /1p 1 = US$0.133P 1 million = US$133,300P 1 billion = US$133 million

ABBREVIATIONS

ADB - Asian Development Bank

BOI - Board of Investment

CFF - Cooperative Financing FacilityDBP - Development Bank of the PhilippinesDFI - Development Finance Insititute (PDCP)DNBFI - Department of Non-Bank Financial IntermediariesFCDUs - Foreign Currency Deposit UnitsIGLF - Industrial Guarantee and Loan FundLIBOR - London Inter-Bank Offered RateNBFIS - Non-Bank Financial IntermediariesNEDA - - National Economic Development AuthorityOBUs - Offshore Banking Units

PDCP - Private Development Corporation of the PhilippinesPICA - Private Investment Company for Asia (PICA) S.A.PISO - Philippine Investments Systems OrganizationPNB - Philippine National BankUSAID - United States Agency for International Development

FISCAL YEAR

January 1-December 31

/1 The latest change in the exchange rate (US$1 = P 7.40) does not affectthe project in any significant way.

FOR OFFICIAL USE ONLY

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

STAFF APPRAISAL REPORT

TABLE OF CONTENTS

Page No.

BASIC DATA . . ..................... . ..... i-iv

1. THE MANUFACTURING SECTOR ... . . . . . . . . . . . . . ... 1

Recent Developments . .. . . . . ..... ... . . . . .. 1Structure of Manufacturing Industry . . . . . . . . . . . . 1Industrial Investment . . . . . . . . . . . . . . . . . 3Industrial Sector Issues and Policies . . . . . . . . 3Rationalization of the Tariff System . . . . . . . . . . . . 4Prospects . . . . . . . . . . . . ..... 7

2. THE FINANCIAL SECTOR . . . . . . . . . . . . . . . . . . . . . 8

Overview .... . . . . . . . . . . . . . . ...... 8. . BInstitutional Structure ... . . . . . . . ..... . 9Recent Developments . ...... . . ...... . 13Financial Sector Issues . . . . . .. . . . . . . . . . . . 16

3. JUSTIFICATION FOR BANK LENDING TO PISO . . . . . . . . . . . . 17

Perspective ............... . .... . 17Capital Requirements for the Industrial Sector . . .. . . . 17Strengthening the Industrial Structure . . . . . . . 18Development Orientation. . . . .. . . . . . . . . . .. . 18

4. PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION . . . . . . . . . 19

A. Institutional Aspects ... . . . ..... . . . . . . . 19Background, Objectives and Charter . .. . . . . . . . . 19Capitalization and Ownership . . . . . . . . . . . . . . 20Board of Directors and Executive Committee . . . . . . . 21Organization, Management and Staff . . . . . . . . . . . 22Policies . . . . . . . . . . . . . . . . . . . . . . . . 25Project Processing, Evaluation and Supervision . . . . . 26Procurement and Disbursement Practices . . . . . . . . . 27Operating Practices and Procedures . . . . . . . . . . . 27

B. Corporate Strategy and Development Orientation . . . . . . 27

This report is based on the findings of an appraisal mission comprisingMessrs. Zamir Hasan and Hans Lesshafft that visited PISO in July 1977.

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2-

Page No.

C. Operations . . . . . . . . . . . . . . ... . . * *. . * * * * 29

D. Financial Position and Operational Performance . . . . . . . 31

Financial Position . . . . . . . . . . . . . . . . 31

Financial Performance. . . . . . . . . . . . . . . . . . . 32

Quality of Portfolio. . ..... . . . . . . .. . 33

Audit . . . .... .... .......... ... ....... .... ....... ... .. 33

5. PISO: BUSINESS PROSPECTS, RESOURCES AND PROJECTED FINANCES. . . 33

General Outlook .* * *...*..*..*.... . . . .. . . 33

Business Forecast . . . . . . . . . . . . . .. *...... 34Resource Position and Requirements . . . . . . . 36

Projected Financial Position and Performance . . . . . 38

Liquidity . . . . . . . . .. . . . . .. . . . . . . . . . 39

6. CONCLUSIONS AND RECOMMENDATION ... . . . . . . . . . . . . . . 40

Objectives of the Proposed Loan . . . . . . . . . . . . . . 40Expected Utilization of the Proposed Loan . . . . . . . . . 40

Agreements and Understandings ReachedDuring Negotiations .. . . . 41

Recommendation.... . 42

ANNEX 1 - SUPPORTING TABLES AND CHARTS

T-1 List of Shareholders as of December 31, 1977

T-2 Board of Directors as of February 28, 1978

T-3 Staffing PositionT-4 Summary of Operations, March 1, 1974-December 31, 1977

T-5 Details of Syndication OperationsT-6 Audited Balance Sheets, December 31, 1974-77

T-7 Audited Income Statement for Years Ended December 31, 1974-77

T-8 Operational Forecasts, 1978-81T-9 Resource Position as of December 31, 1977T-1O Projected Balance Sheets, 1978-81

T-11 Projected Statement of Income and Expense 1978-81T-12 Actual and Projected Indicators of Financial and Operational

Performance, 1974-81

C-1 Organization Chart as of December 31, 1977

ANNEX 2 - POLICY STATEMENT

ANNEX 3 - STATEMENT OF CORPORATE STRATEGY FOR 1978-80

ANNEX 4 - SELECTED DOCUMENTS AND DATA AVAILABLE IN THE PROJECT FILE

PHILIPPINES

PHILLIPINE INVESTMENTS SYSTEMS ORGANIZATION

Basic Data

1. Year of establishment: 1974

2. Ownership (as of December 31, 1977):Percentage

No. of shares /a of total

Local shareholders (class "A" shares)Private institutions 586,498 24.9Individuals 980,413 41.5

Subtotal 1,566,911 66.4

Foreign shareholders (class "B" shares)

PICA 794,039 33.6

Total 2,360,950 100.0

3. Status of IBRD and IFC lendings:- No previous lending.

/a Par value of one share: P 10.00.

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4. Operations (P 1,000):

(3/1-12/31)1974 1975 1976 1977

Money market operationsShort-term investmentsas of 12/31 29,465 101,571 95,334 93,110

SyndicationsDomestic currency - 10,000 - 193,500Foreign component - 95,930 9,638 43,750

Total - 105,930 9,638 237,250

Guarantees - 2,300 - 5,200

Loans

ApprovalsDomestic currency - 3,000 3,000 1,250Foreign currency - - 7,500 7,500

Total - 3,000 10,500 8,750

CommitmentsDomestic currency - 3,000 3,000 1,250Foreign currency - - 7,500 7,500

Total - 3,000 10,500 8,750

Disbursements - - 3,000 8,120

Equity investments 0,025 - - -

Underwriting/private placements - 5,700 - 3,000

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5. Present interest rates and other charges:

PISO'scharge

Underwriting (on amount underwritten)"best effort" basis 2-4%"firm" basis 3-5%

Syndications (on amount syndicated)Local currency 1-3%Foreign currency 0.75-2%

GuaranteesService charge on issue 1% of amount

guaranteedAnnual fee 1.5-3% on

outstanding balance

Loans (local currency)Term loans (2-5 years) 17-19% p.a.Small business loans /a 12% p.a. + 1% on

undisbursed balances

Loans (foreign currency)Term loans (6-12 years) 12-14%

Commercial papers rates varyaccording to market

conditions

Consulting fee hourly basis(negotiated beforehand)

/a IGLF program.

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6. Financial position (amounts in P million):

December 31, 1974 1975 1976 1977

Total assets 40,254 108,917 116,617 125,529Short-term assets 39,872 108,082 114,279 118,967Short-term investments 29,465 101,571 95,334 93,110Long-term portfolio - - 1,920 7,096Total portfolio 29,465 101,571 97,254 100,206Total liabilities 19,438 84,943 91,466 97,727Long-term liabilities - - - 5,405Shareholders' equity 20,816 23,974 25,151 27,802Current ratio 2.1 1.3 1.3 1.3Total debt/equity ratio 0.9 3.5 3.7 3.8Long-term debt/equity ratio - - - 0.4Reserves and provisions as % of portfolio 2.8 4.0 6.7 6.7

7. Operational performance (amount in P million):

1974 1975 1976 1977(10 months)

Total income 3,185 12,258 13,809 12,978Interest income on long-term loans - - 77 503Syndication income 300 963 842 .2,432Interest and trading income on short-

term operations 2,866 11,038 11,425 9,197Administrative expenses 651 1,972 2,011 3,242Net profit 816 3,044 2,365 3,522Net profit (after tax and provision)

as % of average total assets 4.1 4.1 2.1 2.9Net profit as % of average equity 4.0 13.6 9.6 13.3Administrative expense as % of average

total assets 3.2 2.6 1.8 2.7Earnings per share 0.41 1.51 1.18 1.49 NDividend as % of par value - 6 6 6Dividend pay-out ratio - 31.2 51.1 40.2

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

STAFF APPRAISAL REPORT

1. THE MANUFACTURING SECTOR

Recent Developments

1.01 The manufacturing sector developed rapidly up to the mid-fifties,

the result of a highly sheltered import substitution drive, then entered

into a prolonged period of slow growth. Although investment activities

seemed to improve in late 1972 the sector was particularly affected by the.

recession in the second half of 1974 and its growth rates dropped to below 5%

in 1974 and 1975, while gross value added in the manufacturing sector grew by

4.8% in 1974 (13.9% in 1973), 3.5% in 1975 and 5.8% in 1976 (in constant

prices). Sectors which have shown lower growth rates (at constant prices)

over the past three years and which by the end of 1976 had not recovered to

the high production levels of 1973, include wood and wood products, petroleum

and coal products, metal production and nonelectrical machinery. Some other

sectors, however, showed satisfactory annual growth rates including transport

equipment (15.1%), publishing and printing (10.3%), textiles (8.8%), and

paper and paper products. Food processing, the largest manufacturing

sector accounting for 26% of the gross value added in manufacturing, grew by

5.6%. The manufacturing sector now represents the second largest sector in

the Philippine economy accounting for 24% of GDP in 1976, absorbing about

one-third of fixed investment and providing employment for around 11% of the

total labor force./I

1.02 Preliminary estimates of production for the first half of 1977

indicate that the modest growth performance of 1976 continued in 1977. The

physical volume of manufacturing production grew by an estimated 4.7% in the

first half of 1977, compared to 4.4% during the same period of 1976. Growth

leaders during the first half of 1977 include textiles, clothing, chemicals

petroleum, base metals, fabricated metal products and machinery and

equipment.

Structure of Manufacturing Industry

1.03 The following table shows the changes in the sectoral composition

of manufacturing since 1970.

/I The contribution of the manufacturing sector to employment in the

Philippines is discussed in more detail in paragraphs 1.13 and 1.14.

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SECTORAL COMPOSITION OF MANUFACTURING(Value added in P million at constant 1972 prices)

1970 1973 1976Value Value ValueAdded % Added % Added %

Consumer Goods 6,379 53.9 7,169 50.3 9,184 52.5Food 3,552 30.0 3,871 25.4 4,558 26.0Beverages and tobacco 1,393 11.8 2,049 13.4 2,415 13.8Textiles, clothing and leather 1,172 9.9 1,410 9.3 1,756 10.1Printing and publishing 262 2.2 339 2.2 455 2.6

Intermediate Goods 4,159 35.2 6,174 40.5 6,577 37.6Wood and paper 838 7.1 1,047 6.9 1,096 6.3Chemicals and rubber 1,096 9.3 2,232 14.6 2,694 15.4Petroleum 858 7.3 1,358 8.9 1,134 6.5Nonmetallic minerals 495 4.2 597 3.9 613 3.5Basic metals and metal

products 872 7.3 940 6.1 1,040 5.9

Durable and capital goods 1,029 8.7 1,143 7.5 1,443 8.2Machinery 537 4.5 582 3.9 589 3.4Transport equipment 497 4.2 561 3.7 854 4.9

Miscellaneous 256 2.2 266 1.7 297 1.7

Total 11,823 100.0 15,252 100.0 17,501 100.0

While manufacturing value added grew at an average annual rate of 6.8% overthe six-year period, the relative sectoral share did not change significantly.The first half of the period saw intermediate goods increase their share oftotal value added at the expense of consumer goods which subsequently regainedsome of the lost ground, and during 1976 accounted for 52.5% of total grossvalue added. The fastest growing sector was chemicals and rubber products(16.5%), followed by beverages and tobacco, printing and publishing and trans-port equipment (9.6% each). Exports may be classified in two categories:traditional manufactures (including sugar, coconut products, plywood, veneer,etc.) and nontraditional manufactures (including electrical machinery,electronics, garments, handicrafts, etc.). Traditional export productsproved very vulnerable to slackening of demand in export markets and slumpingworld market prices. However, nontraditional manufactured exports have begunrising rapidly in recent years; the average annual growth rate has been 34%during 1970-76.

1.04 The manufacturing sector is predominantly privately owned and isgenerally concentrated in large-scale, relatively capital-intensive units.In 1973-74, medium and large-scale enterprises accounted for around 88% of

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industrial value added. In terms of employment, however, the small-scalesector (establishments with 1-50 workers) is considerably more important, andin 1973-1974 employed close to 1 million people, or 68% of the total indus-trial labor force. Of the total share of the small-scale sector in grossindustrial value added, roughly one half is accounted for by firms employingless than 5 workers, and the remaining half by establishments employing 5-49workers.

1.05 Geographically, manufacturing enterprises are concentrated in theGreater Manila area and its adjoining provinces. Statistical data relatingto industrial establishments employing five or more workers indicate that theGreater Manila area alone accounted for 39% of all such establishments, 59%of total industrial employment, 49% of gross value added, and 43% of totalfixed assets. If the adjoining Luzon province is also included, these per-centages would rise by a further 20-30%. The geographic concentration ofindustrial enterprises in and around Manila has not lessened in recent years.

Industrial Investment

1.06 Capital expenditures for durable equipment in the manufacturingsector in 1975 increased at the high rate of 27%, reflecting investmentdecisions made in 1973 and 1974 when the strong economy encouraged entre-preneurs to expand. From the beginning of 1975 onwards, the commitment ratefor new investments steadily declined reflecting the slow investor response tothe recession which had first begun to be felt in mid-1974. This was accompaniedby a drop in the paid-in capital of new business organizations registeredduring 1975. The declining trend in investments was also confirmed by theEconomic Development Foundation's survey of business expectations which showeda clear downward trend in investment plans through 1975 from the peak levels of1973 and 1974. For a brief period between March-May 1976, investment plansrose sharply with the business community perceiving encouraging signs ofrecovery in the U.S. and Japan (based on economic data released in the firstquarter). However, later indications that the worldwide recovery was slowerthan initially expected caused another sharp dip in investments from July1976 onwards. Actual growth of expenditures on durable equipment in themanufacturing sector fell to 5% in 1976 (from 27% in 1975) and since overalleconomic recovery has been slow domestically as well as abroad, it is notexpected to grow significantly in 1977.

Industrial Sector Issues and Policies

1.07 As outlined in the World Bank Economic Report,/1 industrial growthin the Philippines will need to be based on balanced investment expansion inexport industries coupled with the diversification of intermediate andconsumer goods production for the domestic market. In terms of scale, theWorld Bank report suggests that the "only rational policy appears to be onethat encourages the development of the most efficient industries regardlessof size." However, the analysis indicates that traditional cottage-type

/1 The Philippines: Priorities and Prospects for Development; The WorldBank, June 1976.

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industries are unlikely to play a significant role in future industrializa-tion although they will need to be relied upon to maintain their presentemployment levels over the next decade. It also stresses the importance ofreviving and sustaining growth in the labor-intensive modern small and mediumindustries sector and orienting the output of this sector toward exportproducts. Investment in a few large, capital-intensive projects is needed tostrengthen the industrial structure and make greater use of the country'snatural resources.

1.08 The following is an outline of some major industrial issues facingPhilippine policy makers together with policy measures, some of which arealready in effect, that would ensure industrialization in the Philippinesmoves in the right direction.

Rationalization of the Tariff System

1.09 The Government is rationalizing the fiscal and tariff incentivesystem to ensure conformity with current development goals. The highlydifferentiated structure of tariff rates presently in effect has remainedbasically unchanged since 1973. In the near term, tariff reforms should aimat a reduction of excessive protective rates, while in the long term, nominaltariffs should be levelled at an average rate of 20-30%. Higher protectiverates, justified by development plans for specific industries, should even-tually be phased out in accordance with time schedules set up in these plans.The Government has started correcting tariff distortions by reducing thenumber of items subject to the highest protective rates of 70% and 100% andlimiting tariff exemptions. The Tariff Commission is holding hearings on thereduction of high tariffs that protect about 300 industries. As an exportincentive a tax deferral for tariff duties on imported capital equipment wassubstituted in 1976 for the exemption previously granted. However, littleprogress on tariff reform has been made because of delays in the outcome ofslow-moving international trade negotiations, the need for improvement inprocedures for protection against dumping, and strong resistance to proposedchanges in the industries affected.

1.10 Developments and Issues Related to Nontraditional Exports. Duringthe 1950s and 1960s, the Philippines followed an industrialization strategybased upon import substitution under highly protectionistic policies. At thesame time, the peso remained overvalued for long periods of time. The resultwas that exporters were not only discouraged but even penalized since they hadto pay more for their intermediate goods and earned less domestic currency fortheir exports. It was realized that exports in general, and nontraditionalexports in particular, needed to be encouraged to relieve what had become aserious balance of payments constraint on growth. Consequently, a series ofcorrective measures were taken such as fiscal incentives for investmentsand exports under the Investment Incentive Act (1967) and the Export IncentiveAct (1970), devaluation of the peso in 1967 and 1970 which was subsequentlyallowed to float, import duty rebates granted to exporters, and the estab-lishment of an Export Processing Zone to facilitate access to importedmaterials. These measures resulted in an increase of nontraditional exportsduring 1968-72. During 1973-76 the export of nontraditional manufacturedgoods grew dramatically, increasing almost fivefold; the increase in volume

was less dramatic but still impressive. The three leading product lines inthis expansion were garments, handicrafts, and electrical and electroniccomponents. This development was mainly attributable to the correctivemeasures, to export promotion, and to procedural improvements initiated bythe Board of Investment. In addition, the strong demand pull from theinternational boom in 1972-73 probably played an important role in theinitial export takeoff and the establishment of marketing contacts.

1.11 To maintain the recent momentum, further institutional support isnow necessary to strengthen contacts with foreign markets, simplify exportprocedures, improve credit resources, and establish trading houses. To thisend, a Philippine Export Council comprising both public and private represen-tatives has been established to study and make recommendations on variousaspects of export promotion; a study for the establishment of large tradinghouses on the pattern of South Korea and Japan is under preparation; theGovernment has established a public sector trading corporation for trade withthe socialist countries; various credit agencies are making an effort toexpand credit to the export oriented industry; and a Presidential Decree hasbeen issued to simplify export procedures. Implementation of these proposalsshould help maintain a 25-30% annual growth rate in nontraditional exports atleast in the near future. Equally important, however, is access to marketsin industrialized countries on favorable terms.

1.12 Most of the export promotion measures adopted so far have onlycompensated for the existing bias towards import substitution. Differ-ential rates of protection combined with selective export incentives tovarious industries are still producing less than optimal overall industrialand export growth and could lead to development of a dualistic industrialstructure that might not be viable in the longer term. Therefore, to ratio-nalize the industrial structure and to provide a solid domestic base forfuture growth of industry and exports, it is necessary to move toward afreer trade regime by removing import restrictions and reducing tariffs.Such a regime would especially help the smaller and less organized firmswhich have not fully benefited from the facilities of bonded warehouses andtax and tariff incentives.

1.13 Employment Creation. Except for the past two years, Philippineindustrialization has done little to alleviate unemployment and underemploy-ment. Between 1960 and 1971, employment in manufacturing grew at an annualrate of about 2.5%, while between 1971 and 1974 it did not grow at all.Employment growth rates in the manufacturing sector were, however, higher in1975 (7.6%) and 1976 (8.4%). The share of manufacturing in total employmenthas actually dropped from 12.1% in 1960 to 10.4% in 1974 and is estimated tohave reached 10.9% in 1976. Confronted with an estimated 3% growth in thelabor force over the next decade, the economy will have to provide almost500,000 new jobs annually over this period. Because the absorptive capacityin the agricultural sector is low, the provision of more work opportunitiesin the manufacturing sector will be crucial.

1.14 The industrial incentives system has been strongly biased in favorof the use of capital. For instance, over the period 1970-71, 80% of thetotal estimated amount of tax relief enjoyed by 301 BOI-approved projects was

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due to capital-favoring incentives. Attempts to counterbalance this bias byintrod&cing incentives for the use of labor in the modern sector havehad limited success. But the overall industrial employment picture didnot show any improvement because of an absolute decline of employment in thelarge traditional cottage sector and stagnant employment in mining. Ifthe manufacturing sector is to provide a substantial share of the requiredjob opportunities, then labor-intensive export industries and some inter-mediate and capital goods industries with a ready domestic market offer thebest hope of achieving this objective. The Government has introduced somepolicy changes and is currently reviewing the entire incentive system to makeit more conducive to employment, export and import substitution needs.

1.15 Promotion of Small-Scale Industry. As in many other countries, thesmall-scale sector faces many problems and artificial disadvantages usuallystemming from incentives systems favoring the large-scale sector. Ineffi-ciencies caused by lack of expertise in organization, management and choiceof technology, difficulties in penetrating the market, deficiencies in thequality and suitability of machinery and equipment employed, restrictedaccess to institutional sources of finance and difficulties in formulatingand implementing project concepts are some of the areas of concern. Recentgovernment efforts have made some progress. The basic organizational frameworkhas been set up to provide a wide range of technical services and expertise.A fairly widespread program (MASICAP) has existed since 1973 to help smallbusinessmen formulate projects and this has led to financing of a substantialnumber of projects by various financial institutions. In 1975, with assistancefrom the Bank through a small component of Loan 1120-PH, the Department ofIndustry began to establish Small Business Advisory Centers (SBACs), of whichthere were 12 by July 1, 1977, which would form a broad network of technicalassistance extension services to be provided to small and medium industriesthroughout the country. Various financial programs have been set up designedto provide easier access to institutional finance for small-scale industries.DBP's Small and Medium Industries Program (partly financed by the Bank), theIndustrial Guarantee and Loan Fund (see para. 2.10) (also partly financed bythe Bank), and PDCP's Small Business Program are some examples.

1.16 Despite the progress made so far, more could be done. Well-organizedproducers and traders cooperatives could perform many useful functions onbehalf of small industrialists, particularly in such areas as loan mediation,organization of bulk purchases, joint marketing services, dissemination oftechnical advice, and training. The links between small and large-sizedindustries also need to be expanded, for instance by establishing informationexchanges to provide supply and demand and technological information. TheGovernment has successfully set up various organizations and mechanisms forthe promotion of small industries, but there is little knowledge available onthe existing cottage and other small-scale industries, and on potentialgrowth areas. A comprehensive survey of the small-scale sector is needed, asare subsectoral and regional studies. As a result of the planned programs ofrural electrification, the growth in rural incomes, the labor-intensiveexports drive, and the policy of industrial decentralization, a fresh lookinto new opportunities for small producers is becoming increasingly necessary.Planning authorities might consider establishing a separate unit to studythese issues on a permanent basis.

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1.17 Regional Dispersion of Industry. As outlined earlier, manufac-turing activity in the Philippines is heavily concentrated in the GreaterManila area and its surrounding provinces. The Government, well awareof the consequences of increasing regional imbalances, has undertaken severalsteps to check expansion in the Manila area and to create conditions for morebalanced growth in the future. These steps include: fiscal incentives toencourage projects to locate in less developed areas (these, however, havehad little impact); promotional measures by the BOI such as regional seminarsand an experimental regional development pilot program in Northern Mindanao;BOI's practice of negotiating the location of a project before it is approved;a ban on the establishment of new plants within a 50 km radius of Manila,except for export industries; and the requirements that financial institutionsin the provinces allocate 75% of their accumulated deposits for loans toprojects in their respective areas. These measures may have had a positiveimpact but judging from the latest figures on BOI-sponsored projects inrecent years, it is obvious that new and stronger efforts are needed to shiftthe balance of industrial investment in favor of other provinces. A realshift in the balance of industrial growth will take place only when it occursin labor-intensive sectors, such as wood processing, textiles, and theproduction of other goods for mass consumption and export.

1.18 The provision of adequate supporting infrastructure, such aselectricity, water, transportation and communications, financial and technicalservices, and the availability of qualified labor are essential to directinvestment into desired locations. Fiscal incentives without such infra-structure are unlikely to induce many new investments in the outer provincesand with such infrastructure, are probably unnecessary. The Government haslaunched several programs to improve the basic infrastructure in areasoutside Manila (such as substantial electricity generation projects inMindanao and the Visayas, road construction, and a ten-year shipping andshipbuilding program). These efforts should be continued and extended toother types of infrastructure as well as to other regions. To promote thecreation of areas of industrial concentration outside Manila, the Governmentin recent years has put considerable emphasis on planning and promoting theestablishment of industrial estates and export-processing zones in a fewselected growth centers. It is possible that many of these export-orientedprojects would have been established anyway, even if the Manila area had beenclosed to them. Therefore, a modification of this policy, together with theestablishment of more free trade zones and bonded factories and warehouses inthe outer regions, could greatly contribute to an effective decentralizationof industries.

Prospects

1.19 The manufacturing sector has continued to grow at the modesthistorical rate of about 7%, with production rising by 6% in 1976 and anestimated 7% in 1977. In 1978, both exports and government expenditureshould give increased stimulus to the economy. With incomes once againrising as fast as production due to the stabilization of the term of trade,consumption demand should also revive. The result should be increasedmanufacturing output followed by a revival of private investment.

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1.20 Over the medium to long term, the Government is committed to astrategy that includes emphasis on accelerated industrialization, bothin capital-intensive basic industries and labor-intensive export indus-tries. The performance of the industrial sector will have to improvesignificantly if the Philippines is to be reasonably successful in easingthe foreign exchange constraint and particularly in expanding productiveemployment, as at least 75,000 jobs a year will need to be provided by theindustrial sector by the early 1980s. To achieve these targets thePhilippines will need to expand investment in export industries and in awide range of intermediate goods industries where domestic demand prospectsare reasonably good. According to the Government's Five-Year DevelopmentPlan (1978-82), the manufacturing sector is expected to grow at an annualrate of 9% over the five-year period. To achieve this target, investmentswill have to grow at an annual rate of 15.5% (from $1.7 billion in 1977 tonearly $3 billion in 1982), of which about 65% would go to larger industries.

1.21 Finished consumer goods industries producing for the domesticmarket are generally labor-intensive; their accelerated growth would thereforebe very beneficial in terms of employment generation and low-cost investment.While the prospects are not bright for further growth of the traditionalcottage industry, which still employs over two-thirds of the industrial laborforce, there is considerable potential for developing the modern small-scalesector in such areas as food processing, handicrafts and apparel. Domesticdemand should rise in the future as a result of rising incomes. A largegroup of intermediate goods industries also offers room for acceleratedgrowth and significant foreign exchange savings in the decade ahead.Domestic demand in these areas is likely to rise much faster than in mostfinal demand categories. In addition to import replacement, industry willhave to play a much greater role in the country's exports. After allowingfor the probable increase in agricultural and mineral exports, some $4 bil-lion of nontraditional manufactured exports would be needed by 1985 (comparedto $550 million in 1976) to finance the projected level of imports. Indus-tries with significant export potential include, clothing, leather goods.,handicrafts, electronics, and nickel and copper goods.

2. THE FINANCIAL SECTOR

Overview

2.01 The Philippines has a relatively well developed and increasinglysophisticated financial system. The core of the system is a large commercialbanking sector, both local and foreign, regulated by the Central Bank of thePhilippines. There are in addition two specialized development financeinstitutions providing long-term capital, and a variety of other financialinstitutions, e.g. investment houses, savings and loan associations, ruralbanks, regional development banks, etc. The Land Bank was recently revi-talized to finance the Government's agrarian reforms. The Government hasalso encouraged the rapid development of a network of small independentlyowned and operated rural banks and private development banks which concen-trate on providing financial resources in their localities. In late 1976 theGovernment allowed the establishment of Offshore Banking Units (OBUs) and

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expanded Foreign Currency Deposit Units (FCDUs) to undertake foreign currency

credit operations. There is also a well developed and very active short-term

money market on which a variety of commercial and industrial issues are

traded. Although three stock exchanges exist, activity on them is concen-

trated on a few speculative issues. Lease financing and mortgage financing

are also relatively less developed.

Institutional Structure

2.02 Commercial Banks. As of December 31, 1976, there were 25 privately-

owned domestic commercial banks, and two government-owned, plus four foreign

banks with branches in the Philippines. Commercial banks operate under a

branch banking system with over 1,100 branches and offices and are the main

source of working capital and trading credits. The largest bank is the

government-owned Philippine National Bank (PNB) with almost 200 branches,

which accounted for over 36% of the banking system's total assets (P 80.0 bil-

lion) at the end of 1976. The commercial banking system has grown rapidly

over the past five years, increasing its assets almost fourfold. Domestic

credit provided by commercial banks during the first seven months of 1976

amounted to P 72 billion, 28% of which went to the manufacturing sector,

mainly for short-term working capital. To strengthen and rationalize the

commercial banking system, the Central Bank instituted a program aimed at

doubling the system's capital base to P 3 billion which by the end of 1975

was exceeded by almost 20%. The program also encouraged increased equity

participation by foreign banks in commercial banks and other intermediaries

(by the middle of 1977, 11 foreign banks and financial institutions held

equity interests in 8 domestic banks) and provided a much needed plan of bank

consolidation and merger which resulted in bringing the number of commercial

banks down to 27 from 34 in 1973.

2.03 Development Finance Institutions. Two institutions, the Development

Bank of the Philippines (DBP) and PDCP are the main providers of long-term

finance with DBP by far the larger of the two (total assets of P 12.7 billion

compared to PDCP's P 867 million at the end of 1976). During FY76 DBP

extended a total of P 3.9 billion in financial assistance. As of June 30,

1976, DBP had over 247,000 loans outstanding, amounting to P 6.4 billion. Of

these, industrial loans accounted for the greatest share (50%), while over

200,000 agricultural loans accounted for 82% of the total loans. DBP's

resources come from government equity contributions, deposits (principally of

the Government), borrowings from the Central Bank, sale of bonds, foreign

borrowings guaranteed by the Government, and internal cash generation.Nearly all of DBP's resources come either directly from public funds or are

raised with government support. Its securities carry relatively low interest

rates that would make them unattractive except for such special features as

exemption from taxation and eligibility for reserve requirements. Because of

the sheer volume and diversity of its operations, DBP plays a prominent and

unique role in Government financing of economic development.

2.04 Although PDCP is considered an investment bank under Philippine law,

its main business is the extension of long-term loans which accounted for 81%

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of its total assets as of June 30, 1977. PDCP also makes equity investments,provides guarantees, underwriting and private placement of equity and debtinstruments and syndicates loans. Its operations are mainly geared towardsassisting private manufacturing enterprises but it also assists all otherproductive sectors which are considered economically beneficial. Up to now,PDCP's main resources were loans from IBRD and ADB (88%) and equity contri-butions (8%).

2.05 Rural Banks. The rural banking system consists of approximately800 privately-owned banks in rural areas with total assets at the end of 1976of P 3 billion with a deposit base of P 850 million. Ninety-three percent ofthe loans made by rural banks during 1976 were for agricultural purposes,mostly seasonal production credits. The Government supports the growth ofrural banks by providing counterpart equity contributions, loans and technicalassistance from the Central Bank along with tax exemption privileges andspecial rediscounting schemes to supplement their credit extension abilities.Over the past five years rural banks have grown almost fourfold, slightly morerapidly than the banking system as a whole.

2.06 Private Development Banks (PDBs). These institutions, of whichthere are now 33, have been promoted by DBP in various regions (with assis-tance similar to that provided by the Central Bank to rural banks) to spe-cialize in the mobilization and lending of long-term resources for smalllocal ventures. As of December 31, 1976, PDBs' total assets amounted toabout P 482 million with a deposit base of P 139 million. Outstanding loansand investments of PDBs as of end-1976 totaled about P 382 million,three fourths of which were in the form of medium and long-term loans.During 1976, PDBs made loans totaling P 242 million. Agricultural loansaccounted for about 49% of total lending while industrial loans accounted for26%, the remainder being for trading/commercial firms (15%) and consumption(10%).

2.07 Savings Banks. There are 10 savings banks in the Philippines witha network of around 60 branches. Drawing funds mainly from households andindustrial savers in the form of time deposits, these thrift institutions hadaggregate total assets of P 2 billion and deposits of P 1.3 billion asof December 31, 1976. Savings banks lend mostly for housing and realestate, although in the past few years an increasing proportion of theirresources have been channeled into government securities (24% of totalportfolio in 1976).

2.08 Savings and Loan Associations (SLAs). SLAs, of which there are200, can be either "stock" companies (132) i.e. they can engage in depositand banking business with the public at large or "nonstock" companies (68)which means they are limited in their banking transactions to members only(credit union). Almost two thirds of all SLAs are located in the GreaterManila area. As of January 31, 1977 SLAs total assets were about P 511 mil-lion with a deposit base of P 371 million. Most of the business of "stock"SLAs concerns financing of home mortgages while nonstock associations

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specialize in personal consumption loans. With the assistance of CentralBank, SLAs have begun diversifying their lending operations to financeagricultural and home-based cottage industries.

2.09 Other Term-financing Institutions. Several other institutionsprovide term finance, a very small proportion of which goes to industry.These include: private investment houses, insurance companies, andpension and trust funds including the Government Service Insurance System(GSIS) and the Social Security System (SSS), whose resources for industryare lent mainly through DBP. While the outstanding loan portfolios ofGSIS and SSS totaled about P 6.1 billion at December 31, 1976, the bulkof their lending is for real estate (53%) and consumer loans (19%).

2.10 The Investment Guarantee and Loan Fund (IGLF). IGLF is a long-termcompensatory financing and guarantee fund owned by NEDA and administered bythe Central Bank. It was established with USAID assistance in 1952 toencourage private banking institutions to provide long-term financing tosmall entrepreneurs. Its compensatory financing function is dischargedthrough a special time deposit provided to sponsoring banks at an interestrate of 7% (to be on-lent at 12%). IGLF also provides an automatic guaranteefor 60% of the amount being loaned, at a cost to the borrower of 2% p.a. of theguaranteed amount. As of March 31, 1977, ten institutions, five commercialbanks and five nonbank financial intermediaries (NBFIs), had been accreditedto the IGLF. Since 1974 the IGLF approved 626 loans totaling P 114.8 millionand at March 31, 1977 its total assets amounted to P 134.1 million.

2.11 Investment Houses. Defined as any enterprise which engages in theunderwriting of corporate securities, an investment house is prohibited fromengaging in deposit banking business. However, it can engage in "quasi-banking"operations by creating deposit substitutes. The minimum paid-in capitalrequirement for an investment house is P 20 million and the majority must beowned by Filipino nationals. There were 12 investment houses at the end of1976 with 5 institutions dominating the industry. Most are linked with majorinternational financial institutions or large local commercial banks. Theiroperations and revenues so far have been heavily based (about 80% on average)on money market operations rather than on development of the securities marketor the provision of corporate merchant banking services. Total assets of theinvestment houses amounted to about P 4.3 billion at the end of 1976. Thetotal capital base of the industry amounted to P 494 million, with paid-incapital stock amounting to P 335 million. Over a third of paid-in capitalwas contributed by foreign sources. For eight years until 1974, the assetsof this segment of the financial sector grew at over 50% annually. However,growth over the last two years has been about 8% only, mainly due to governmentefforts to strengthen the commercial banking system and to curb the growth ofthe short-term money market (see para. 2.17) as a means to develop the longend of the market. The investment houses possess sophisticated financialskills and have great potential for further development. However, theirdevelopment to date has not been in accordance with their aims at establish-ment, largely because of inappropriate policies.

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2.12 Finance Companies. There are 194 finance companies registeredwith the SEC, the 42 largest accounting for 80% of the total business.These companies, mostly subsidiaries of major commercial banks, are heavilyengaged in financing consumer durables on installment payment plans, shortand medium-term credits for local manufacturers or traders for financinginventory, receivables or transport equipment. A few such companies havediversified into equipment leasing. Such firms typically rely on paid-incapital and direct borrowings for cash generation; a few have successfullyplaced-medium-term debentures with the public. As at the end of 1976 totalassets of these companies stood at P 4.6 billion with a total capital baseof P 713 million and outstanding lending volume of P 3.6 billion.

2.13 Offshore Banking Units (OBUs) and Foreign Currency Deposit Units(FCDUs). A significant development in the Philippine banking system wasthe establishment in September 1976 of offshore banking facilities aimed atdeveloping Metro-Manila as a regional financial center. In addition theGovernment has expanded the foreign currency lending authority of a number ofcommercial banks that had been already acting as FCDUs.

2.14 Presidential Decree 1034 issued in September 1976 authorizes abranch, subsidiary or affiliate of a foreign banking corporation, referred toas OBU, to conduct banking transactions in foreign currencies involving thereceipt of funds, principally from external sources, and the subsequentutilization of these funds for borrowers inside or outside the country.Under the system, funds in foreign currencies which are accepted and held byan OBU in the course of its business, are considered as "deposits." Thewithdrawal of equivalent amounts of such funds including interest by ownersof the "deposits" is not subject to restrictions. These transactions areprimarily offshore operations. However, a certain amount of offshore-to-onshore operations are permitted, subject to prior licensing by the CentralBank. Presidential Decree 1035, also issued on September 1976, expands thefunctions of the FCDUs by exempting them from the 15% reserve requirement tobe held in the form of foreign exchange deposits with the Central Bank and byallowing them to extend up to the amount of foreign currency deposits, foreigncurrency loans to any domestic enterprise. As a major incentive to encourageforeign banks to set up OBUs, exemptions are provided from all forms of locallicenses, fees, dues, or any other local taxes or burdens. However, as withtransactions of FCDUs, a tax of 5% on offshore income is imposed. For grossonshore income, a tax of 10% is imposed, based on the amount of gross interestincome from loans granted to onshore borrowers. All regular commercialbanking income is subject to the usual corporate tax.

2.15 As of July 30, 1977, the Central Bank had approved 16 foreign banksto operate OBUs in the country. As of the same date, 4 branches of foreignbanks and 13 domestic commercial banks were authorized as expanded FCDUs. Asof August 10, 1977 most FCDUs and OBUs were occupied with organizationalmatters with three OBUs having formally inaugurated their offices.

2.16 Suppliers' Credits. Foreign commercial borrowings guaranteed bydomestic financial intermediaries (principally DBP) have in the past accountedfor 30-35% of total investment in manufacturing. At the end of 1976, theprivate sector accounted for 43% of the outstanding external debt, just over

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one half of which went to the manufacturing sector. Prior to 1970, such

borrowings were obtained on relatively hard terms. As a result of the

stringent debt management measures taken since 1970 by the Central Bank

and the substantial increases in export earnings, the burden of servicing such

debts has been reduced to a manageable level.

2.17 The Money Market. The money market provides the mechanism through

which commercial banks and corporations keep their liquidity position in

4 balance. There are basically three submarkets: (a) government securities;

(b) interbank; and (c) intercompany. The government securities market is the

principal segment, with the Government being the largest trader. The main

securities traded are short-term Treasury Bills, medium-term Central Bank

Certificates of Indebtedness (CBCIs) and Treasury Notes, and long-term

Progress Bonds issued by DBP. While direct trading in Treasury Bills is

heavy, trading in longer term securities is mainly "indirect," i.e., the

securities themselves are not traded but serve as collateral for "repurchase"

agreements. Participation in the intercompany market is restricted to firms

with prime credit ratings. Until January 1976, money market rates were not

subject to the statutory ceilings imposed on bank deposits. Hence there was

a rapid growth in deposit substitutes at the expense of traditional bank

deposits. In an attempt to mobilize savings through the banking institutions,

the Central Bank raised the interest rate on savings and time deposits and

regulated yields on money market instruments. Simultaneously, the minimum

denomination of deposit substitutes was raised from P 50,000 to P 200,000 for

instruments with less than two years maturity and P 100,000 for instruments

with longer maturities. In June 1977, a withholding tax of 35% on interest

paid on short-term financial instruments and 15% on savings and time deposits

was introduced.

2.18 The Securities Market. The Philippine financial system does not

have an active stocks and bonds market. In recent years only a small propor-

tion of the capital expansion of Philippine corporations has been financed

through issues sold in the three stock exchanges which are located in Manila,

Makati, and Quezon City. New firms have generally been unable to sell

equities. The same applies to corporate bonds.

Recent Developments

2.19 Since 1975 the principal objectives of selective monetary and

credit policies have been to promote growth with stability, both in the

external and internal sectors, and to improve the mobilization of financial

resources and their allocation to priority sectors. In particular, monetary

policy was aimed at containing inflation and improving the external balance,

while selective credit policies were geared toward promoting growth through

financing investment expenditures. Major areas of concern for the authorities

included the shift of funds from commercial bank deposits to nonbank financial

institutions and deposit substitutes with commercial banks, and the inadequate

growth of facilities for medium and long-term financing. Both phenomena were

the result of low interest rate ceilings on deposit rates, Usury Law limits

on many lending rates and other administrative regulations. The problems

were exacerbated by high inflation during 1973-74 when real interest rates

became negative.

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2.20 Total liquidity rose by 24% in 1976 and a further 10% during thefirst six months of 1977 to P 39.6 billion as of June 30, 1977. Over thepast 18 months money supply grew by 27%. Various government measures tocheck the growth of deposit substitutes seem to have been successful withdeposit substitutes increasing only 16% over the 18-month period ending June30, 1977, after having more than doubled over the preceding two years. Incontrast, time and savings deposits which had grown only 30% during 1974/75rose by 70% during the same period ending June 30, 1977. Outstandingdomestic credit grew by 24% in 1976 (30% in 1975) and during the first sixmonths of 1977 by only 5%, to reach P 50.5 billion. Through 1976 credit tothe public sector rose by 51%, to P 9.3 billion, mainly because of unusuallyhigh credit demand by Philexco (the Government sugar marketing company).During the first half of 1977, net credit to the Government declined byP 0.2 billion, mainly for seasonal reasons and also Philexco's credit demandwas 8% below the previous year's level because of a changed sugar pricingsystem and a sharp increase in sugar exports. Private sector credit grewmuch more slowly, 18% in 1976 and only 3% in the first half of 1977, reachingP 34.6 billion at June 30, 1977. The weak investment demand in the privatesector was caused by various factors, inter alia, the unfavorable outlook ofeconomic recovery, higher real cost of borrowing due to receding inflation,and excess capacities resulting from the 1974/75 investment boom. Afterhaving risen by 12% in 1973 and 40% in 1974, the growth of consumer pricesslowed markedly to 7% in 1975 and 6% in 1976. The rate for the firsthalf of 1977 was 7%, and for the next five years is expected to be between7% and 8%.

2.21 During 1975/76, several measures were taken to strengthen and expandthe financial system. The final phase of the capital build-up programfor the banking system, which required every private domestic commercial bankto increase its paid-in capital to at least P 100 million, was completed in1975. As of the end of that year, the aggregate paid-up capital of domesticcommercial banks amounted to P 3.6 billion or P 400 million more than theCentral Bank target. The program also encouraged: (a) increased equityparticipation by foreign banks in commercial banks and other intermediaries;and (b) a much needed program of bank consolidation and merger which resultedin reducing the number of commercial banks from 34 to 27 in 1973. In 1975,the Central Bank also embarked on a program of more systematic and stringentregulation of NBFIs and quasi-banking institutions. Other measures takentoward increasing effective intermediation included opening the CentralBank rediscounting window for thrift banks and encouraging the establishmentof bank branch offices, savings agencies and pawn shops in areas inadequatelyserved by commercial banks. At the beginning of 1976, the Central Bankissued a series of circulars aimed at improving the interest rate structure(see para. 2.23) and in September of that year issued two decrees on offshorebanking operations (see para. 2.14). On June 3, 1977 the Government issued adecree instituting a 35% final transaction tax on interest earned on commercialpapers issued in the money market and set a 15% withholding tax on interestpaid on savings and time deposits. This measure was designed to improve tax

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collection and increase borrowing rates on money market instruments, thusreducing yields so that financial savers could be induced to place theirfunds in medium and long-term deposits rather than in short-term moneymarkets.

2.22 Interest Rate Reform. Until January 1976, the interest ratescharged by the banking system were governed by the Usury Laws which allowed amaximum nominal rate of 12% p.a. As the discounting of interest due for upto a maximum of a year was usually applied, the banks in fact realized aneffective yield of 13.6% and 16.3% depending on the security offered. Inaddition, the Central Bank allowed financial institutions to charge servicefees ranging from 0.75% p.a. to 2% p.a. on a graduating scale. In 1974, inresponse to tight money market conditions, interest rates on savings andtime deposits which ranged from 5-9% p.a. were increased to 6% and 11.% p.a.In spite of the increase in the nominal rate of interest, the real rate ofinterest continued to be negative. While the banking sector was subject tothe following regulations, these did not apply to the nonbank financialintermediaries (NBFI). The weighted average rates paid to investors oncomparable money market instruments were often twice as high or higher during1974-75. As a result, there was a considerable flow of funds from depositsto deposit substitutes issued both by banks and NFFIs.

2.23 At the beginning of 1976, the Central Bank enacted a series ofchanges in interest rates and reserve requirements aimed at both the bankingsector and NBFSs. Maximum deposit rates were increased and, for the firsttime, a distinction was made between short and long-term lending rates. Themajor changes enacted were: ceilings on loans with maturities of more thantwo years were raised to 19% p.a.; secured and unsecured loans of less thantwo years continued to have a ceiling of 12% and 14% p.a. respectivelyalthough a service charge of 2-3% p.a. could be added; the maximum yield onmoney market instruments with maturities of up to two years, including allcharges, was set at 17% p.a.; all ceilings on yields of instruments withmaturities of over two years were removed. In the absence of officialstatistics, it is not clear whether there has been a shift towards thelong-term end in the structure of deposits, but deposits as a whole haverisen quite fast since the beginning of 1976 at the expense of depositsubstitutes. On the credit side, while some investment houses and commercialbanks did arrange long-term peso loans, the market for medium and long-termpeso finance remained unproductive (the decline in LIBOR and the readyavailability of suppliers' credits to corporate clients at relatively lowrates may have been contributing factors). It is important to note that withthe unusual level of inflation in 1973-74 having been curbed, these measureshave resulted in real or positive rates of interest on loans, and positiveyields on savings; hence, they represent an important step toward rationa-lizing the level and structure of interest rates.

2.24 In December 1977 further interest rate legislation was introduced.The major changes were: the imposition of an effective interest rate ceiling,exclusive of bank charges, of 12% and 14% p.a. for secured and unsecuredloans with maturities of under two years; the imposition of an effectiveinterest rate ceiling, inclusive of bank charges, of 19% for loans withmaturities exceeding two years; a reduction of the effective maximum yield,

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inclusive of the 35% transaction tax and bank charges, from 17% to 16% ondeposit substitutes with a maturity of two years or less with a furtherreduction in the yield to 15% effective July 1, 1978.

2.25 As a result of this legislation, the yield on deposit substituteshas been brought closer in line with that of traditional bank deposits. Itis hoped that this will result in a shift of resources from nonbankingfinancial institutions to the banking sector. In addition, there has been anattempy to encourage investment by reducing the cost of borrowing. Thisreduction has been affected, however, with no corresponding adjustmentin the deposit rates paid. Consequently, the commercial banks will now beoperating on smaller spreads. The Government claims that the reduction inspreads will compel the banking sector to be more competitive.

Financial Sector Issues

2.24 Aggregate savings performance in the Philippines has improvedgenerally during the last decade and is comparable to that of other countriesat a similar stage of economic development. Since 1975, gross domestic sav-ings have been at a level of 25% of GNP and financed approximately 80% oftotal investment. However, in order to reach a gross investment level ofmore than 31% of GNP by 1982 and reduce the country's dependence on foreignsavings, the Five-Year Development Plan (1978-82) calls for an increase ingross domestic savings to a level of more than 28% of GNP at the end of thePlan period. To achieve this objective, the savings of the household sectorwhich is expected to contribute approximately 40% of the total domestic sav-ings requirement, will need to increase by more than 17% p.a. during thenext five years.

2.27 As more savings flow from households to Government and thecorporate sector through financial intermediaries, interest rate and creditpolicies will become increasingly important. The Government's role will be acritical one in ensuring that the interest rate level and structure are inline with the opportunity cost of capital in the economy and satisfy bothsavers and investors with rates that reflect different maturities and risks.In addition, efforts will be needed to strengthen the institutional frameworkof the financial system in order to enable it to undertake its increasingresponsibilities. The Government, through the Central Bank, has started thisprocess with a program, already completed, to increase commercial banks'capital and attempts are being made through various government programsto increase allocation of institutional credit to small-scale industry. Moreneeds to be done, however, to clarify the allocational role of each type ofinstitution and to improve the quality and broaden the coverage of financialservices. This would involve stimulating the growth of thrift banks,insurance institutions, and the rural banking system. It would also includeencouraging the emergence and development of a stronger securities marketwhich so far has been hampered by the limits on longer term interest ratesand to some extent by the dominance of the term market by government finan-cial institutions because of the preferential treatment given to their debtinstruments. The recent introduction of a 5% development tax on closely heldcorporations to encourage them to go public is a step in the right direction.Finally, financial institutions and credit programs in the Philippines have

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experienced considerable deterioration of loan recovery rates during recent

years which has seriously affected their financial performance. However, theGovernment is increasingly attentive to the problem of arrears so thatrecovery will be improved without closing the essential credit channels.

2.28 The Bank attaches considerable importance to a systematic long-termplan to develop the Philippine financial sector along rational lines. As afirst step towards that end, a detailed discussion and review of the variousissues facing the financial sector is presently under way within the Bank.Depending upon the outcome of these discussions, a special financial sectormission may then visit the Philippines to undertake a thorough first-handstudy. The findings of this mission would provide the basis for a dialoguewith the Government on the measures needed to be taken by the Government.

3. JUSTIFICATION FOR BANK LENDING TO PISO

Perspective

3.01 The proposed Bank loan to PISO is justified because it addressestwo basic objectives to which the Philippine Government attaches highpriority, namely:

(a) increasing the transfer of long-term financial resources to theindustrial sector; and

(b) assisting in strengthening the institutional structure of thefinancial sector, particularly those institutions which allocateterm funds for productive capital investment and which are gearedto mobilize resources as they develop.

Capital Requirements for the Industrial Sector

3.02 For Philippine industry to grow at the rate projected in the WorldBank's recent Basic Economic Report and to provide the needed increase inexports and employment, there is little doubt that the long-term resourcesavailable for industrial investment will need to be significantly increased(para. 1.20). At present the flow of such resources is constricted by thelimited number of institutions capable of mobilizing and rationally allocatingsuch resources. The Development Bank of the Philippines (DBP),/1 which isthe single largest source of term funds, presently accounts for about 80% oflong-term loans to the manufacturing sector. The Private Development Corpo-ration of the Philippines (PDCP) accounts for a further 15% and the balanceof 5% is accounted for by commercial banks and other investment houses.However, such long-term loans provide less than 20% of the estimated totalinvestment required by the industrial sector. The balance is provided byinternally-generated funds, suppliers' credits and capital investmentsfinanced by short-term accommodations on a roll-over basis. Although no

/1 The Bank has so far made 11 loans to DBP amounting to US$245.4 million.

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reliable data are available, informed "guesstimates" are that short-termfinancing accounts for roughly 30-40% of total capital investment in theindustrial sector.

3.03 While DBP and PDCP are expanding their own lending activities to

the extent that long-term resources are available to them, they still con-front limits on institutional, processing and managerial capabilities.Given the likely rate of growth of industrial investment and the need to

diversify sources of funds so as to establish a more competitive financial"market", the Philippine Government is encouraging the diversification ofsuch sources in both the public and private sectors; these considerationssuggest that to build PISO's capacity for long-term financing to industry isjustified.

Strengthening the Institutional Structure

3.04 As suggested in paras. 2.11 and 2.25 the Government has, for sometime, also been concerned with the direction in which some of the recentlyestablished investment houses have developed. These institutions (of whichthere are now 12) were originally expected to specialize in long-term cor-porate financing and assisting in capital market development; they have,however, with the exception of PDCP, focused largely on money market opera-tions. A series of recent policy measures has been instituted to steer them

towards their originally conceived functions (paras. 2.21 and 2.23). Theimpact of such measures would be reinforced by building up long-term deve-lopment financing capability in such institutions through the provision oflong-term funds and institutional support. PDCP has so far been the soleprivate DFC to receive development assistance from either the Bank or ADB;the Government feels it now opportune for the Bank to assist an additionalinstitution in the private sector. This view is based upon a strong feelingthat the Bank's role in PDCP has been a constructive one. The Government'schoice is based upon its assessment of: (a) PISO's willingness to developits long-term financing capabilities further; (b) its ownership pattern,which does not reflect "captivity" to a single family dominated businessgroup; (c) its present size and stage of growth; (d) capable managementand staff; (e) institutional emphasis on corporate client services; and(f) PISO's generally good record of "responsible corporate behavior" andprudent financial management. A review of other similar institutionssuggests that PISO is indeed a good choice for the Bank to work with at thisstage.

Development Orientation

3.05 PISO has realized the danger of relying too heavily on short-termoperations, particularly in the light of the latest government regulations,which aim at a shift of resources from nonbanking financial institutions tothe banking sector and the mobilization of long-term resources. AccordinglyPISO has decided to shift its emphasis from predominantly short-term opera-tions to medium and long-term lending. In this context both its Policyand Corporate Strategy Statements call for the support of new entrepreneurs,of small-scale enterprises and of clients who do not enjoy ready accessto financing elsewhere, but as a newcomer to long-term financing, PISO

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will inevitably start with modest targets and will have to rely to a consi-derable extent on the financing of larger established companies. The Bank issatisfied that PISO's intent is to gradually become an institution financinga wide range of companies in terms of size, and stressing such developmentobjectives as export-orientation, employment creation and regional dispersal.

4. PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

A. INSTITUTIONAL ASPECTS

Background, Objectives and Charter

4.01 PISO was incorporated on March 1, 1974 as a privately-ownedPhilippine corporation. Along with PDCP it is one of the few privatefinancial institutions which is not dominated by, or captive to the interestsof, any particular shareholding group. Its shareholders have diverse back-grounds and interests in mining, construction, textiles, chemicals, shipping,electronics and considerable experience in the financial sphere. These attri-butes should favor objectivity in evaluating investment opportunities andopen the doors to a wide range of business clients.

4.02 In November 1974, PISO's domestic shareholders invited the PrivateInvestment Company for Asia (PICA) S.A. to participate in PISO's ownership.PICA, internationally owned by large multinational banks and industrialcorporations, is a development oriented private sector institution. Theassociation with PICA (which remains PISO's single largest and sole foreignshareholder) over the past three years has served PISO well. Apart fromproviding assistance in mobilizing foreign resources for PISO's syndications,PICA's participation in the Board has proved to be helpful and constructive.

4.03 PISO's corporate philosophy is best reflected in one of its originalbasic documents wherein it committed itself to:

(a) the development of enterprises and financial markets;

(b) the pursuit of the objective of broadening stock ownership (in theenterprises it finances); and

(c) the evaluation of both the financial aspects of projects andtheir contribution to the economy.

These broad objectives are reflected in the Policy Statement which has beenreviewed during negotiations (para. 4.22).

4.04 Charter. PISO's charter, as embodied in its Articles, contains allthe provisions normally associated with development financing/investmentbanking institutions. It allows the corporation, inter alia, to:

(a) develop and promote projects in any business sector; toassist in corporate reorganization/restructuring and toprovide corporate financial advice;

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(b) assist capital market development through the issue, purchase,underwriting, syndicating or trading of various types of financialinstruments and securities, and to engage in providing portfolioadvice and management services;

(c) engage in real estate investments and development;

(d) undertake long and short-term lending, guaranteeing,leasing and direct primary equity investment functions toor for any type of enterprise; and

(e) borrow funds from any sources without any general restric-tions as to types and sources of funds.

Capitalization and Ownership

4.05 Under its Articles, PISO's authorized share capital is P 100 mil-lion: 10 million common shares with a par value of P 10.0 divided into6 million Class A shares and 4 million Class B shares (Class A shares beingrestricted to Filipino ownership)./l As of December 31, 1977, the sub-scribed and paid-in share capital amounted to P 23.6 million (or aboutUS$3.1 million); accumulated retained earnings amounted to a furtherP 4.2 million bringing total stockholders' equity to P 27.8 million (orabout US$3.7 million). PISO's Class A share capital is presently held by sixmajor Philippine shareholders including PISO's President, who holds 12.4%.They collectively own 63.8% of the outstanding stock, while several of PISO'sofficers hold another 2.6%, and PICA owns the balance of 33.6% (see Annex 1,T-1).

4.06 In discussions with PISO's management and the Government thedesirability of diversifying PISO's ownership was raised and a consensusreached that PIS0 should, within the next three to five years, aim at havingits shares publicly listed and traded. PISO would proceed with a listing ofits shares as soon as practicable within that period. For the interim it wasindicated that PISO would endeavor to attract more domestic shareholders on aprivate placement basis and that no single domestic shareholding would exceed15%. This agreement has been confirmed at negotiations and recorded in theagreed minutes.

4.07 While its present equity base is sufficient to sustain its currentvolume of operations (in fact, PISO has the lowest debt/equity ratio in thePhilippine investment banking community), PISO recognized the need tostrengthen its equity base if it is to undertake an expanded program of

/1 Corporations are classified as "Filipino" when 60% or more of the sharesare owned by Filipino nationals.

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long-term financing operations with the assistance of the proposed Bank loan,Accordingly, PISO's representatives have agreed during negotiations toincrease its total net worth (share capital plus retained earnings) by noless than P 10 million or about 36% to a total of at least P 37.8 million(or about US$5 million). The agreed upon increase, which shall be a condi-tion of loan effectiveness, has subsequently been approved by PISO's Boardat its meeting on March 29, 1978; the funds are expected to be paid in onApril 3, 1978.

4.08 For PISO to be eligible to obtain a Government guarantee forforeign borrowings, the extent of foreign ownership cannot exceed 30%; thisrequires a reduction in PICA's present shareholding from 33.6% to 30% orless. PICA has already agreed that it would exercise its subscription rightsonly to the extent that its resulting holding would not exceed 30% of thetotal; this has been confirmed at negotiations.

4.09 In connection with the proposed share capital increase, PISO haselicited the interest of the Land Bank of the Philippines (LBP), which willsubscribe 14.6% of PISO's capital. During negotiations, PISO's representa-tives confirmed that they had agreed in principle with LBP on the divestmentof the latter's holdings within the next three to four years and the mecha-nism for such divestment.

Board of Directors and Executive Committee

4.10 Composition of the Board of Directors. As prescribed by PISO'sBy-Laws, the Board of Directors comprises 11 seats of which 9 have presentlybeen filled (see Annex 1, T-2). Domestic shareholder interests are repre-sented by five directors, all of whom are principal shareholders. The soleforeign shareholder has presently four seats, all filled by PICA officers;however, only one of them is "active" in any practical sense. Board membershave shown a keen interest in PISO's affairs; absences from regular monthly /1Board meetings are more the exception than the rule. All Board members arewell qualified and complement each other in terms of their individual andcollective experience, industrial interests, and links with financial/businessgroups. The Chairman of the Board is also PISO's President and ChiefExecutive Officer.

4.11 With the proposed reduction in PICA's holding (para. 4.08) and theentry of additional domestic shareholders, there will be a reconfigurationof PISO's Board. While PICA has agreed to relinquish one seat, the partici-pation of LBP and the provision of a Government guarantee for the proposedBank loan will also result in one representative nominated by the Governmentand two by LBP sitting on PISO's Board. One of LBP's representatives ismost likely to be an ex-officio /2 member.

/1 The By-Laws call for Board meetings at least on a quarterly basis.

/2 This term is commonly used in the Philippines to define Board representa-tives without voting power.

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4.12 Powers of the Board. In addition to the normal powers vested inthe Board of Directors prescribed under Philippine corporation law,/IPISO's By-Laws /2 require that only the Board, with the affirmative vote of

at least two-thirds of its total members, has the power to approve (and/oramend) inter alia, the following:

(a) the annual business plan, budget and projected operations;

(b) policies on money market activity and transactions;

(c) the incurrence or guaranteeing of any debt with a maturityof over one year or to approve any long-term financialtransaction with any one debtor/creditor exceeding P 3.5 million;

(d) a (total) debt/equity ratio of more than 10:1;

(e) capital expenditures of over P 1 million; and

(f) dividend policies, changes in the nature of PISO's businessor entry into any business not expressly provided for in theAnnual Business Plan.

4.13 Executive Committee. PISO's By-Laws also provide for the establish-ment of an Executive Committee (Excom) of the Board comprising a maximum offive directors of whom three represent Class A shareholdings and two representClass B shareholdings. Membership of the committee is based upon appointmentby the full Board, which can also appoint alternates to designated committeemembers. The Chairman of the committee is elected by the members themselves;there is no provision requiring the Chairman of the Board to be either memberor Chairman of the Excom. The Excom, which is presently chaired by theChairman/President of PISO, comprises two other Directors (one of whomrepresents PICA) and is empowered to act for the full Board between itsscheduled meetings and may carry out those functions delegated to it by theBoard. Actions and decisions of the Excom are based upon agreement by asimple majority of its members, who constitute a quorum.

Organization, Management and Staff

4.14 Organization. PISO's present activity mix is handled by fivedepartments, Annex 1, C-1. Broadly, these departments cover the followingfunctions:

/1 These include the powers of appointment and dismissal of PISO's employeesand officers and the powers to fix their compensation, terms of employ-ment and to exercise those powers and functions which are not expresslyrequired to be done only by the stockholders (under the Articles andBy-Laws).

/2 Article III, Section 5 of the By-Laws.

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(a) Corporate Services: including, inter alia, legal services, per-sonnel management, public relations, and general administration.

(b) Corporate Planning and Development (CPD): including economicresearch, business development, mergers, acquisitions and corporatereconstruction, and primary equity investments. The present SeniorVice-President for CPD also manages (c).

(c) Investment Management Office: responsible for investmentanalysis and research, portfolio management services, investmentadvisory services, and secondary equities trading and investment.

(d) Resource Mobilization: covers project evaluation and supervision,clients' financial assistance packages, syndications, underwriting/private placement, and guarantees.

(e) Financial Market Operations: deals with short-term trading incommercial papers and government securities, credit rating services,wholesale securities marketing, and accounting/financial control.Within this departmental group also resides the responsibilityfor Small Business Financing operations and the Capital Marketsdivision.

4.15 PISO's present organization results in some deliberately plannedoverlapping, intended to optimize the use of available staff resources and toexpose officers to a greater variety of tasks. Management reviews the systemconstantly and considers the present setting desirable to foster mutualinterdependence and cooperation among the managers.

4.16 The growth in the volume of PISO's operations may necessitatea reorganization which ought to include the following realignment of functions:

(a) shifting the small business lending function from the MoneyMarket Operations Department to a Term-Financing OperationsDepartment,/l having the latter concentrate primarily on allproject evaluation and supervision work and making it responsiblefor all term-lending operations;

(b) transferring the syndication functions to the Term-FinancingOperations Department;

(c) embodying the underwriting/private placement and corporateservices functions into the Investment Management Office whichshould also undergo reorganization to emerge as a full-fledgeddepartment; and

(d) establishing a separate monitoring and follow-up unit as adivision within the Term-Financing Operations Department.

/1 This Department is presently called Resource Mobilization in PISO'sterminology.

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The suggested revamping of PISO's organization along functional lines as

the volume of activities increases is likely to eliminate potential frictions

and overlaps and would put due emphasis on the term-lending operations.

4.17 Management. PISO's top management team comprises its President,

Mr. Victor S. Barrios, two Senior Vice-Presidents, and three Vice-Presidents.

Of the two Senior VPs, one is a full time staff member of PICA and is under

contract to spend 60 hours per month with PIS0. Mr. Barrios is a prominent

member of, and among the leading spokesmen for, the Philippine financial

community. He has had considerable experience in the development banking

sphere (including working as a senior staff member with PDCP); his ability

and commitment to development financing are respected in both the private and

public sector. The "external" Senior Vice-President /1 plays a constructive

and useful role in PISO's management team, particularly on its Management

Investment Committee (MIC). While he has no full-time assignments or respon-

sibility for any operating or support group in PISO, his availability for

special assignments, general advice and as an objective, impartial sounding

board for other members of the management team have proved to be in PISO's

interest. Moreover, he has been instrumental in arranging participation by

foreign financial institutions in PISO's syndications.

4.18 PISO's full-time Senior Vice President and the other three Vice-

Presidents constitute a good management team whose individual members comple-ment each other well. These managers have demonstrated their competence in

meeting the requirements of their present tasks. In sum, PISO's management

team is well qualified and has the capability for gearing the organization up

to cope with the task of efficiently allocating and monitoring a long-term

line of credit for industrial project financing.

4.19 Staff. During the last six months of FY77, PISO recruited another

7 professionals, an increase of 23%; as of March 15, 1978 its staff totalled

55 compared to a total of 43 some 12 months earlier. With 38 officers, PISO's

professional staff accounts for about 69% of the total and, discounting a

slight predominance of accountants and financial analysts, is fairly evenly

distributed among the various disciplines. As of now, there are eight

engineers, two of whom are Vice-Presidents with backgrounds in chemical /2

and industrial engineering. PISO's present engineering team appears to be

fully adequate for its long-term lending program, even though some may be

still somewhat inexperienced. Twelve of PISO's professional staff have been

involved in project appraisal so far. To gear up for the project evaluation/

supervision/administration workload likely to result from a Bank loan, PISO

will strengthen its staff by approximately 9-10 additional employees by the

end of FY78.

/1 This arrangement was an integrated part of the Investment Agreement

with PICA.

/2 The chemical engineer has 12 years experience in various aspects of the

operations of a major oil company.

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4.20 PISO's history of rapid staff turnover (Annex 1, T-3) is partly

attributable to the general shortage of well trained and experienced staff inthe Philippine financial sector. This development may have been aggravatedby a tendency to recruit over-qualified people for essentially rather lowlevel tasks and the limited opportunities for career development in a smallorganization such as PISO. In late 1976 PISO's management carried out anin-depth study of the causes of the relatively high staff turnover. It wasdetermined that in more than 60% of the cases the turnover was accounted forby staff who werel offered salary levels and positions significantly betterthan those provided by PISO. Management has since taken several remedialsteps including a periodic upward adjustment of salaries and the provision ofmore diversified work assignments to retain career interest. These measureshave proved reasonably effective and since September 1976, turnover hasslowed down perceptibly.

4.21 The quality of work produced by PISO's staff displays a high levelof competence and an unusual degree of analytical ability in the assessmentof long-term investment opportunities.

Policies

4.22 Operating Policies. Since its incorporation, PISO has graduallybeen developing a coherent policy framework to guide its operations. Withbroad directional guidelines for corporate activity having been establishedat the outset by the Board, a series of specific policies governing day-to-day operations continue to be developed. These policies, however, are notembodied in PISO's present Policy Statement. PISO's management recognizesthe usefulness of refining and expanding its Statement to incorporate andexpand upon existing policies relating to the conduct of its operations andthe regulation of its financial affairs. Accordingly the draft Statementhas been discussed and finalized during negotiations; the agreed upon version(Annex 2), which has been formally adopted by PISO's Board in its meeting onMarch 29, 1978, constitutes one of PISO's "basic documents" and has beencross-referred to in the legal agreements between PISO and the Bank.

4.23 The Policy Statement incorporates the following key features:

(a) Investment exposure limits which call for: total financial commit-ments to any single enterprise normally not to exceed 25% of PISO'snet worth; investments in enterprises normally not to exceed 50% ofthe assets of those enterprises if established or 75% if new; nosingle equity investment normally to exceed 15% of PISO's networth; aggregate equity investments not to exceed PISO's net worth;and equity investment in any given enterprise normally not toexceed 35% of the paid-in share capital of that enterprise.

(b) Operating guidelines on portfolio diversification; relation-ships with client enterprises; divestment of equity investmentsand dispersal of ownership; provision for reserves: plow-backof at least 40% of average net earnings as retained earnings.The Statement also includes policies on: the application of

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professional standards to project evaluation and project follow-up;

new entrepreneur/enterprise promotion and small business enterprise

financing; money-market operations; management-board relationships;

relationships with Government authorities; and organization and

staffing.

4.24 The Policy Statement does not include any guidelines on debt/equity

limits (see para. 5.12). Provisions covering these aspects have been sepa-

rately provided for in the legal documents for the proposed loan. In accord-

ance with the Project Agreement, PISO's total debt shall not exceed ten times

and its long-term debt shall not exceed four times its equity, except as the

Bank and PISO shall otherwise agree.

Project Processing, Evaluation and Supervision

4.25 Project Processing. PISO's loan processing procedures have been

established with the view to minimize the time lag between the first applica-

tion by a prospective borrower and the eventual decision by PISO. They

permit efficiency without sacrificing work quality and provide for rational

work flow. As of December 31, 1977, PISO had appraised about 14 operations

of which 11 had resulted in PISO's arranging financial assistance. On

average, the processing period was between 6-12 weeks. Prior to a decision

on proceeding with full-scale project appraisal and before submission to the

Board for approval, every long-term assistance proposal (and each creditrating report for transacting money market business with a new client) is

coursed through a Management Investment Committee (MIC) comprising the

President and Vice-Presidents.

4.26 Project Evaluation. On the basis of a review of all of PISO'sproject appraisal reports and special market studies the existing project

evaluation capability was found to be of uniformly high quality. Market and

financial aspects were dealt with particularly thoroughly, and project

reports were found to be comprehensive documents which provided a reasonable

basis for sound investment decisions.

4.27 On the technical side, the reports were somewhat too descriptive

about production processes and equipment and they needed strengthening in

dealing with such matters as critical points in the process cycle, suitability

of various equipment components, pricing of equipment packages, implementation

schedules, plant layout, and elements of technical service agreements.

4.28 Most evaluation reports did not provide any formal economic justi-

fication but this was not reflective of an absence of expertise in economic

evaluation. Most of PISO's projects were BOI-registered and there was no

demand for such analysis by PISO's syndicate partners. However, during

negotiations an understanding has been reached, reflected in the Project

Agreement, to the effect that PISO would include ERR analysis for all proj-

ects exceeding the free-limit of US$750,000. Apart from this, all appraisal

reports should contain the usual partial economic indicators (e.g., valueadded, new jobs generated, foreign exchange earned or saved).

4.29 Project Supervision. With a small and largely "new" portfolio,

there was no firm track record on which to assess the quality of PISO's

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supervision efforts. Supervision procedures, however, are soundly conceivedand the few supervision reports reviewed were found to be of good quality.In the project implementation stage, supervision over disbursement andphysical progress was tight, with variances between actual performanceand the original cost budget being analyzed on a quarterly basis. PISO alsorequired clients to submit financial statements on a quarterly basis. Thesewere reviewed on receipt and a brief report prepared on borrower performanceand financial standing. In general, PISO's management placed substantialemphasis on regular supervision.

Procurement and Disbursement Practices

4.30 Procedures employed by PISO assured that equipment procurement andcivil works contracting by clients were carried out with due regard foreconomy and efficiency. Clients were required to submit evidence of areasonably broad canvassing effort with competitive quotations (usuallythree) being requested to support such evidence. In reviewing the clients'final choice, PISO's staff frequently checked with known users of chosenequipment to determine the soundness of the choice and the experience ofsuppliers. Disbursement procedures were also soundly conceived and ensuredsufficient safeguards to minimize the possibility of funds misuse. For fixedasset purchase, PISO required the submission of pro-forma invoices againstwhich actual disbursement requests were checked. Clients were generallyrequired to apply equity funds to initial expenses before loan funds werereleased; on occasion, however, a pari passu disbursement request had beenentertained. PISO's loan contracts include general conditions for disburse-ment as well as specific conditions appropriate to each client.

Operating Practices and Procedures

4.31 PISO's establishment and the evolution of its organization haveproceeded in a systematic fashion with internal operating procedureswithin and between operating units being carefully laid down and reviewed.Each department had set out in manual form its departmental role, functions,intra-departmental work-flow and operating procedures. Policies on specificactivities carried out by each department have been modified and translatedinto sets of rules for working level staff. Furthermore, PISO's managementhas adopted a well-controlled system for the planning and budgeting ofoperations for each department, as reflected in its Board-approved BusinessPlan.

B. CORPORATE STRATEGY AND DEVELOPMENT ORIENTATION

4.32 In its operational orientation, PISO has explicitly recognized theimportance of: (a) maintaining a financially sound profile through the expan-sion of a stable portfolio base; and (b) eventually achieving levels ofprofitability which are commensurate with a competitive return to existingshareholders, attractive to potential shareholders and acceptable to commer-cial creditors. These objectives might be achieved without PISO's exertingsubstantial efforts to develop its long-term operations. However, PISO

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realizes the danger of relying too heavily on short-term operations, partic-ularly in the light of the latest Government regulations, which aim at ashift of resources from nonbanking financial institutions to the bankingsector and the mobilization of long-term resources. Accordingly PISO hasdecided to diversify from predominantly short-term operations to medium- andlong-term lending. PISO has also been encouraged to go into medium andlong-term financing by the advantage of its reputation for competence inproject appraisal and supervision, established in connection with its syndi-cation operations.

4.33 PISO plans to play a role in financing of small-scale industries.Both its Policy and Corporate Strategy Statements call for the support of newentrepreneurs, of small-scale enterprises and of clients who do not enjoyready access to financing elsewhere. PISO was accorded accreditation statusunder the Industrial Guarantee and Loan Fund (IGLF) scheme for financingsmall business. Nevertheless, as a newcomer to long-term financing, PISOwill inevitably start with modest targets and will have to rely to a con-siderable extent on the financing of larger established companies.

4.34 However, PISO's general objective is satisfactory, that of graduallybecoming an institution financing a wide range of companies in terms of size,and stressing such development objectives as export-orientation, employmentcreation and regional dispersal. The Bank's institution building role isexpected to be significant in assisting PISO in its efforts to arrive atthese goals.

4.35 Capital Market Development. Over the past year, PISO has expendedconsiderable efforts in establishing contact with international, regional andlocal sources of long-term funds to widen the base of participating institu-tions in its syndications efforts. Particularly noteworthy in this connec-tion are its efforts to arouse the interest of trust and pension funds, andinsurance companies in long-term project financing. To date PISO has hadonly limited success, in both these efforts and in mobilizing peso resources.

4.36 Corporate Strategy Statement. To bring into focus its developmentalorientation, PISO's management has prepared a Corporate Strategy Statementwhich outlines the directions it proposes to take and what it hopes toachieve over the next 3 years. This Statement has been reviewed at negotia-tions. The agreed upon version (Annex 3), which has been formally adopted byPISO's Board in its meeting on March 29, 1978, has been cross-referred toin the legal agreements between PISO and the Bank. The main features of theStatement are PISO's plans to:

(a) maintain its character as an investment house but with increasingemphasis on long-term financing;

(b) increase the proportion of long-term assets to total assets from 2%in 1976 to about 50% by 1981;

(c) attain an average annual growth of its short-term assets of about25% during 1977-81;

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(d) diversify its portfolio with respect to industrial, geographical,and regional distribution and to restrict its exposure in anysingle industry to 30% of its outstanding long-term portfolio;

(e) closely monitor security market conditions with the intent topublicly list its shares and widen its domestic ownership base;

(f) diversify its long-term foreign and domestic resources and to blendmultiliateral official funds with commercial resources; and

(g) evaluate the contribution of all projects to the Philippineeconomy and where possible stress such particular developmentobjectives as employment creation, export orientation and regionaldispersal of industries.

C. OPERATIONS

4.37 Long-Term Financing Operations. Given its relatively short opera-ting life and the constraints on mobilizing long-term funds, PISO does nothave an established track record (Annex 1, T-4). Apart from one equityinvestment (P 25,000), PISO has not yet taken any risk positions in primaryequity investments. PISO has adopted the prudent approach of avoiding riskyinvestments until its portfolio provides a sufficient cushion to absorb theimpact of potential losses on such investments. The absence of significantactivity in primary equity investment is generally in keeping with theexperience of other similar financial institutions in an environment wheregood primary investment opportunities are confined to tightly-held corpora-tions unwilling to invite institutional participation. The general trend isfor only marginal projects to seek equity participation from external sources.

4.38 PISO has, so far, managed 11 syndications of long-term loans (seeAnnex 1, T-5), in which it has approved loans from its own resources total-ling P 21.3 million /1 and has disbursed P 11.1 million of which P 4.0 mil-lion has already been repaid, leaving a balance of P 7.1 million outstandingas of December 31, 1977. Of the 11 projects, 7 were new and 4 were "pioneer-ing" ventures in product lines not hitherto established in the Philippines.Most of them were, nevertheless, undertaken by established companies or theirsubsidiaries. PISO felt that its initial concentration on established enter-prises was necessitated by a lack of its own resources. Since commercialbanks, participating in syndications, were unlikely to venture into less wellknown corporations, PISO had focused on establishing a reputation withclients whose names could be "sold".

4.39 The average total cost of the indus3trial projects assisted wasabout US$7 million and their financial rates of return, estimated at the timeof project appraisal, were expected to exceed 20%. Clearly, the need tobalance its portfolio will require PISO to do business with established firms

/1 The largest of these was a US$1 million loan for Sarmiento Industriesfrom the US-Eximbank Cooperative Financing Facility.

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undertaking financially viable and economically desirable projects; but, onthe other hand, PISO hopes to reflect its development orientation andefforts in the future distribution of its portfolio.

4.40 In addition to the above, PISO has: (a) privately placed (under-written), on a "best efforts" basis, common stock issues (total valueP 8.7 million) of three of the newer companies /1; and (b) guaranteed partof three commercial loans for a total amount of nearly P 8 million.

4.41 Short-Term Financing Operations. With the obvious limitations onPISO's ability to finance long-term investments directly, the bulk of itsincome is derived from short-term financing operations, money market trans-actions and syndication efforts. The importance of such operations isreflected in the table below:

PISO: SHORT-TERMI (TRADING) ASSETS AND LIABILITIES AS OF DECEMBER 31, 1974-77

12/31/74 12/31/75 12/31/76 12/31/77

A. Total assets/liabilities 40.25 108.92 116.62 125.53

B. Cash in hand 9.50 2.95 9.53 12.03

C. Short-term investments /a 29.47 101.57 95.33 93.11

D. Subtotal (short-term tradingassets) 38.97 104.52 104.86 105.14

D as % of A 96.8% 96.0% 89.9% 83.8%

E. Securities sold /b 7.41 47.25 32.06 55.42

F. PISO notes sold 10.90 33.47 49.34 25.83

G. Subtotal (short-term tradingliabilities) 18.31 80.72 81.40 81.25

G as % of A 45.5% 74.1% 69.8% 64.7%

/a Including promissory notes purchased under agreement to resell,Government and CB securities, certificates of assignment, participationor trust and other commercial papers. This figure is net of provisionsfor doubtful accounts.

/b Under repurchase agreement.

/1 Evertex (amount underwritten was F 5.2 million - secondary issue) LMGChemicals (P 0.5 million - primary issue), and Paper IndustriesCorporation of the Philippines (P 100 million - public issue; PISO'sshare: 3%).

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As shown above, short-term trading assets constitute the bulk of PISO'sportfolio and are financed by short-term borrowings and equity. The volumeof such assets has stabilized since 1976.

4.42 PISO has been prudent in the management of its trading operationswhich are guided by specific Board-approved policies and are based upon anapproved "placement" list /1. The list comprises companies and individualswhose creditworthiness is thoroughly investigated; a rating is applied and anexposure limit is set for each one. PISO's credit rating analysis is quitesophisticated; each recommended addition to the placement list is carefullyvetted by the MIC before approval is provided to place PISO funds. Thepolicies applied include: (a) diversification in company and industry exposureand in PISO's government securities inventory; (b) a minimum current ratio of1:1; (c) matching of assets and liabilities for each 90-day period; (d)maintenance of specified maximum limits on the net short forward position andon minimum forward cover under different market conditions; (e) maintenanceof reserve positions well above the minimum levels required by Central Bankregulations; (f) a single enterprise exposure limit of P 10 million withtypical approvals of P 5 million against commercial paper issues; and (g) aforced "clean-up" period for specific issues to test the ability of clientsto meet maturing obligations without resort to rollover.

4.43 That these policies are prudent vis-a-vis industry practices isreflected in PISO's consistent ranking /2 each year at the top of the indus-try list in comparative analyses of liquidity/solvency ratios in thePhilippine investment banking community. PISO also has the lowest debt/equity position in the industry. The adoption of a liquidity margin hasbeen agreed upon with PISO at negotiations (para 5.13).

D. FINANCIAL POSITION AND OPERATIONAL PERFORMANCE

Financial Position

4.44 PISO's audited balance sheets as of December 1974-77 are shown inAnnex 1, T-6. Total assets have grown by 7.6% during 1977 against 5.7% dur-ing the whole of 1976 and they stood at P 125.5 million (about US$16.7 millionequivalent) as of December 31, 1977. The growth of PISO's operations in 1976was slow because early in the year, there were several new regulations issuedby the Central Bank affecting interest rates and the business of investmenthouses generally which tended to constrain money market operations. Thistrend also continued through 1977 partly due to the additional introductionof a 35% transaction tax in mid-1977 on interest earned on commercial papersissued in the market as primary money market instruments. Almost all assets(95%) as of December 31, 1977 were classified as current assets of which the

/1 As of February 24, 1977, the list included 509 corporations andindividuals (in a roughly 60:40 ratio).

/2 Business Day, Southeast Asia's First Business Daily, Manila, Philippines.

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short-term investments, net of provisions for doubtful accounts, amountedto P 93.1 million or 74%, against P 95.3 million or 82% as of December 31,1976. Although the term-loan portfolio increased by 3.7 times, it remainsrelatively insignificant accounting for only 6% of total assets (P 7.1 mil-lion). PISO's current ratio stood at 1.3:1 as of December 31, 1977 (Annex 1,T-12). With the availability of long-term resources, PISO's balance sheetwould undergo major structural changes. Current assets are projected todecline from about 95% of total assets as of December 31, 1977, to less than50% at the end of 1981.

4.45 PISO's assets were mainly financed by short-term liabilities (96%of all liabilities as of December 31, 1977) principally comprised of securi-ties sold under agreement to repurchase and, to a lesser extent, PISO notes.Current liabilities grew by 2.3% during 1977 against 7.7% in 1976. For thefirst time in its history PISO showed a medium/long-term debt position(P 5.3 million) resulting from its cooperative finance facility with theUS-Eximbank (P 11.3 million). As of December 31, 1977 PISO's total debt/equity ratio stood at 3.8, including contingent liabilities, against 3.7 atthe end of 1976.

Financial Performance

4.46 The audited income statements for FY74-77 and the pertinent ratiosof operational performance are given in Annex 1, T-11 and T-12. Net incomeafter provision and tax recovered substantially in 1977 and amounted toP 3.5 million, an increase of 49% after a sharp reduction in 1976 (by 22%).The recovery took place almost across the board; income from short-termoperations increased in 1977 to P 3.2 million, or by 49%, against P 2.2 mil-lion for the whole of 1976, but did not reach the high 1975 level (P 5.4 mil-lion). The decline in profitability in 1976 was the result of regulatorymeasures introduced by the Central Bank in January 1976 which affected theoperations of all investment houses. Revenues from medium/long-term operations,which went up from P 0.08 million to P 0.5 million in 1977, continue to remaininsignificant. During 1977 there was only a modest income from underwtiting(P 0.08 million) and an insignificant amount received from management andfinancial consultancy services (P 0.08 million), but a substantially increasedincome from PISO's syndication operations (P 2.4 million against P 0.8 mil-lion during 1976). However, part of the effort that led to the high incomefrom syndications was undertaken in 1976. Administrative expenses, which hadstayed relatively stable in 1976, rose steeply by 61% in 1977. This develop-ment is mainly attributable to substantially increased (by 82%) personnelcosts resulting from both an increase in the number of staff (from about 40employees in 1976 to 55 as of now) and an upward revision of salaries.

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Financial expenses of P 9.2 million in 1976 (including provisions) which roseby about 65% in 1976, declined again to P 5.9 million in 1977 or by 36%. Theimproved earnings situation resulted in a better net return on average assetsof 2.9% in 1977 against 2.1% in 1976.

4.47 For 1976, PISO paid the same dividend (on par value) as for 1975(6%) with pay-out ratios of 31.2% and 51.1% respectively. As of December 31,1977 the book value of a PISO share was 18% above par, slightly less than asof December 31, 1976 (25%) due to a 15% stock dividend in 1977 (December).

Quality of Portfblio

4.48 Since PISO has virtually no long-term portfolio, it has had nosignificant experience in containing a problem of arrears. Its disbursementon a medium-term loan is being repaid satisfactorily as are its outstandingguarantee accounts. On its short-term portfolio, PISO has one doubtful,fully secured (real estate with an appraised value of P 4.0 million) accountof nearly P 2 million. In providing for doubtful accounts, PISO has adoptedthe practice of determining the level of provisions on the basis of anaccount-by-account review. In FY75 and FY76 PISO made a provision fordoubtful accounts of P 1.5 million and a further P 1.0 million in FY77 as acharge against earnings. The management's policy is to increase provisionsannually at a rate commensurate with portfolio growth until they correspondto at least 1.5% of total loan portfolio by 1981. As of December 31, 1977,PISO's retained earnings amounted to nearly P 4.2 million or over 18% of thepaid-in share capital including stock dividends.

Audit

4.49 Since its inception, PISO has had its accounts audited by theauditing firm of Sycip, Gorres, Velayo and Co. (SGV), which is well known tothe Bank and familiar with the Bank's "long-form" audit requirements. PISO'saccounts have always been passed by the auditors without qualification.

5. PISO: BUSINESS PROSPECTS, RESOURCES AND PROJECTED FINANCES

General Outlook

5.01 During 1977, the Philippine manufacturing sector is expected tohave achieved a growth of 4-6%. Its lackluster performance over the past fewyears was due to the slow growth of domestic demand coupled with a slowerthan expected recovery in the economies of the Philippines' major tradingpartners. It is expected that with stabilizing terms of trade, demand willrevive in 1978 giving the necessary impetus to the manufacturing sector toachieve a faster growth rate. Subsequently, investments in durable equip-ment, which have remained at low levels since mid 1975 (following the invest-ment boom of 1974/75) are expected to rebound.

5.02 Over the medium to long term, the Government is committed toa strategy that includes emphasis on accelerated industrialization. Theperformance of the industrial sector will have to be significantly improved

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if the Philippines is to be reasonably successful in easing the constraint onforeign exchange resources and in expanding productive employment to therequired level of at least 75,000 jobs a year in the industrial sector by theearly 1980s. To achieve these targets the Philippines will need to expandinvestment in export industries and in a wide range of intermediate goodsindustries where domestic demand prospects are reasonably good. According tothe Five-Year Plan (1978-82), manufacturing is expected to grow at an annualrate of 9% over the plan period. To achieve this target, investments willhave to grow by 15.5% p.a. between 1978 and 1982 to total P 86 billion, ofwhich about 65% would go to larger industries.

Business Forecast

5.03 Except for the US Export-Import Bank's Cooperative FinancingFacility of US$1.5 million),/1 PISO has not had access to any other long-termresources. As the proposed Bank loan would be PISO's first long-term loanfrom an international institution, it is difficult to gauge, without thebenefit of experience, the volume of lending operations PISO can achieve inthe immediate future. Nonetheless, PISO's management has developed operationalforecasts (Annex 1, T-8) on the basis of a pipeline and overall capitalrequirement assumptions which have been carefully reviewed. These aresummarized below:

PISO: PROJECTED COMMITIENTS 1978-81(In P millions)

1977 1978 1979 1980 1981(actual)

Medium/long-term loansForeign currency loans 7.5 38.3 116.3 135.0 165.0Peso loans 0.3 2.0 4.4 5.6 7.1Small business loans 1.0 2.5 5.6 6.6 8.1

Total loans 8.8 42.8 126.3 147.2 180.2

Guarantees 5.2 6.0 8.0 8.0 8.0

Syndications 237.3 150.0 172.5 198.4 228.1

Total commitments 251.3 192.8 306.8 353.6 416.3

Annual growth ratesLoans (-16.7%) 386.4% 195.1% 16.5% 22.4%Guarantees and syndications (2,361.6%) (-35.7%) 15.7% 14.3% 14.4%

Total commitments (1,862.5%) (-23.3%) 59.1% 15.3% 17.7%

/1 This line, approved for the period 1976-78, can only be used if matchedwith an equal amount from other US bank sources (see Annex 1, T-11 -footnote).

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5.04 PISO's operational forecasts are also based on its perception ofinstitutional capability (taking into account its plans for the present aswell as the future for staff strengthening, see para. 4.19) and of whatshare of the potential market it could reasonably capture. Estimated dis-bursements would reach P 164 million in FY78 or about 2.6% /1 of the totalsize of the potential market, i.e., the estimated demand for investment fundsfrom the private corporate sector for the type of projects which PISO iscapable of catering to. This estimate is based on an assumption derived fromhistorical time-series that about 62.8% of national investment in durableequipment and 11% of total investment in non-residential construction in thePhilippines would be undertaken by the private corporate sector, with about60% of the required amount being financed from institutional sources and 40%from internally generated funds. PISO's management believes that it shouldbe able to increase its share of the market up to 3.8% by FY81 as summarizedbelow:

PISO: PROJECTED OPERATIONS VIS-A-VIS THE MARKET FOR LONG-TERM FINANCING(Amounts in P million)

FY78 FY79 FY80 FY81

Foreign currency operations

Total size of market 5,199 6,075 7,110 8,328PISO's disbursements 8 78 123 145Indirect financing /a 117 141 161 184PISO's total share 2.40% 3.60% 3.99% 3.95%

Local currency operations

Total size of market 1,291 1,509 1,767 2,071PISO's disbursements 4 10 12 15Indirect financing /a 35 40 45 52PISO's total share 3.02% 3.31% 3.23% 3.24%

Total operations

Total size of market 6,390 7,584 8,877 10,399PISO's disbursements 12 88 135 160PISO's share 0.19% 1.16% 1.52% 1.54%Indirect financing /a 152 180 206 236PISO's total share 2.57% 3.53% 3.84% 3.81%

/a Including PISO's syndicated loans and guarantees which would not involvePISO's own funds.

/1 Including syndication operations which do not involve PISO's ownresources.

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5.05 However, PISO's share of the total market is reduced to about 0.2%only in FY78, 1.2% in FY79, 1.5% in FY80 and FY81 if syndication operationsare excluded. On a similar scale, projected disbursements of the other twodevelopment banks in the Philippines, DBP and PDCP, show an average marketshare of around 30% and 4% respectively for the same period. On balance,PISO's projected share of the market should be attainable.

5.06 PISO's estimates of its financing activities have been influencedby its current assumptions about resource availability. PISO's projectionshave assumed the availability of the proposed Bank loan of $15 millionin early 1978 allowing it to launch its long-term lending operations fromthat year. This explains the sudden jump of loan commitments in FY78 andFY79. The share of direct lending operations in total commitments has beenprojected to increase from 3.7% in FY77 to 22.2% in FY78 rising to 43.3% inFY81. Foreign currency loans are projected to account for the lion's sharein total loan commitments reflecting PISO's expectation that the prospectsfor long-term local currency resource mobilization will improve very slowly.It also reflects the continuing dependence of the Philippine industrialsector on imports for a major portion of industrial machinery and equipment.

5.07 Though small business loans are projected to increase in absoluteterms, their share in total loan commitments is expected to remain at about4.6% throughout the projected period. In terms of the number of operations,their share will be much larger and will increase. PISO's strategy for smallbusiness loans calls for their promotion to the extent that PISO's manpowerresources will allow in view of the high administrative costs involved insuch operations. Equity investments are projected to be supported morethrough underwriting and private placements rather than direct partici-pations in primary issues. PISO's guarantees, in local as well as foreigncurrencies, are projected to account for a minor portion of its operations.

Resource Position and Requirements

5.08 Local Currency Resources. Details of PISO's resource position asof December 31, 1977 are provided in Annex 1, T-9. As shown, PISO's long-term peso resource base consisted almost only of shareholder's equity amountingto P 27.8 million. As of the same date, PISO had long-term peso loans ofP 1.7 million outstanding. Undisbursed long-term peso resources thereforestood at P 26.7 million which PISO kept in the form of current assets. SincePISO is to maintain a safety margin of 10% in its current ratio, it will needto continue keeping a subtantial portion of its long-term peso resources inliquid form. As a result, only about P 16 million could realistically beregarded as peso resources available for long-term commitments. Against thisamount, PISO's peso commitments for the period 1978-81 are projected to beP 42 million (including small business loans totalling P 22.8 million forwhich refinancing is expected to be obtained from IGLF). The remainder isexpected to be financed through additional paid-in capital, net collectionsand internally generated funds. PISO's future peso resource picture (posi-tion and requirement) is shown below:

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PISO: PESO RESOURCE POSITION AND REQUIREMENTS(In P million)

FY78/79 FY80/81(2 years) (2 years)

Opening balance 16.0 21.0

Add: Internal cash generation 2.2 13.6Net loan collections 2.3 8.4Share capital increase 15.4 17.3Borrowings from IGLF 8.1 14.7

Resources available 44.0 75.0

Less: Long-term commitments 15.5 27.4Fixed asset acquisitions 0.5 0.5Minimum addition to networking capital 7.0 9.0

Closing balance 21.0 38.1

5.09 Foreign Currency Resources. As shown in Annex 1, T-9, PISO's onlysource for long-term foreign funds has been the U.S. Eximbank's CooperativeFinancing Facilities (CFF). Utilization of the CFF by PISO is limited toUS$1.0 million p.a. On the basis of these available resources and PISO'soperational projections, PISO's future foreign currency resource requirementsand position up to December 31, 1979 are summarized below:

PISO: FOREIGN CURRENCY RESOURCE REQUIREMENTS AND POSITION(US$ million)

FY78 FY79

Opening balance 1.0 10.9

Add: CFF - 1.0 /aProposed Bank loan 15.0 -

Resources available 16.0 11.9

Less: New commitments 5.1 15.5

Closing balance 10.9 (-3.6)

/a Extension of the CFF arrangement with the U.S. Eximbank hasbeen assumed.

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PISO's projected requirements of foreign currency resources between FY78-79amount to about US$20.6 million. The proposed Bank loan of US$15 millionwould meet the bulk of PISO's needs of foreign currency resources overthat period.

Projected Financial Position and Performance

5.10 Projected Financial Position. Based upon its operational fore-casts, PISO's total assets are expected to grow by 47.6% in FY78 to P 186 mil-lion (Annex 1, T-10). Thereafter, spurred largely by long-term financingoperations, assets are expected to increase at an average annual rate ofabout 50% to P 626 million in FY81. The projected asset growth will beaccompanied by a noticeable structural change in asset composition with thesignificance of long-term loans /1 in the total asset base increasing from4.2% in FY77 to 6.8% in FY78 and further to 31.6% in FY79 and 52.2% in FY81.Current assets (including current maturities of long-term loans), on theother hand, are projected to grow by 43.1% in FY78 and at an average annualrate of 20.4% thereafter but their share in the asset base is expected todecline gradually from 98.0% in FY76 to 47.2% in FY81. On the other side ofthe balance sheet, long-term liabilities are expected to increase sharplyfrom P 4.2 million in FY77 to P 321.5 million in FY81 and their share inPISO's resource base is projected to rise from 3.3% in FY77 to 51.3% in FY81.Short-term liabilities /2 are projected to increase in absolute terms fromP 93.5 million in FY77 to P 229.0 million in FY81, but their share in theresource base is expected to decline gradually from 74.5% in FY77 to 36.6%in FY81.

5.11 Capital Base and Structure. PISO's current equity base ofP 27.8 million (consisting of paid-in capital of P 23.6 million and accumu-lated retained earnings of P 4.2 million at end FY77) is only sufficientto sustain its current volume of operations. PISO recognized the need tostrengthen its equity base to undertake an expanded program of long-termfinancing operations with the assistance of the proposed Bank loan. Accord-ingly, agreement has been reached during negotiations to increase PISO'sequity by P 10 million./3 PISO's Board has approved the capital increasein its meeting on March 29, 1978; the funds are expected to be paid in onApril 3, 1978. PISO's reserves are expected to grow by a rate averaging 55%annually between FY77-81 to P 20.0 million; they are expected to account for26.4% of net worth in FY81.

/1 Excluding current maturities of long-term loans.

/2 Including current maturities of long-term liabilties.

/3 Another equity increase of P 10 million is envisaged by 1981.

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5.12 On the basis of PISO's financial projections, the total debt equity

ratio is expected to rise from 3.8:1 in FY77 and FY78 to 5.7:1 in FY79 andfurther to 7.6:1 in FY80 before it decreases slightly to 7.5:1 in FY81; itscontractual limit is 10:1. Correspondingly, the long-term debt/equity ratiois expected to rise from 0.4:1 in FY77 to 0.5:1 in FY78, Z.2:1 in FY79, 4.1:1in FY80, and further to 4.5:1 in FY81; its limitation to 4:1 has been agreed

upon during negotiations.

Liquidity

5.13 In addition to the recommended total debt/equity and long-termdebt/equity ratio limits (para. 5.12), the Bank has discussed with PISO,at negotiations, the desirability of maintaining a minimum liquidity ratio,in view of the significance of its short-term operations and portfolio.(According to PISO's projections, the current liquidity ratio is not expec-ted to fall below 1.2:1). Moreover, confirmation was sought at negotiationsthat PISO will continue to adhere to prudent policies with respect to main-taining debt service and interest coverage at satisfactory levels. Accordingto PISO's projections, the debt-service ratio would be 3.1 times in FY78(when the long-term debt service burden is negligible) and would, in subse-quent years, decline to 2.8, 2.9 and 2.0 in the years FY79 to FY81 respec-tively (Annex 1, T-12), remaining well within prudent limits at all times.The understanding was reached during negotiations, reflected in the AgreedMinutes, that PISO will continue to adhere to prudent liquidity policies andwill use as a guideline a 10% margin for the current, debt service andinterest coverage ratios.

5.14 Projected Financial Performance. PISO's projected statements ofincome and expenses are shown in Annex 1, T-11. Net income is expected toincrease from P 3.5 million in FY77 to P 16.6 million in FY81, reflecting a

yearly average increase of about 48%. The income contribution from thelong-term portfolio is expected to increase from 8.8% of total income in FY77to 67% in FY81. Operating expenses are projected to increase from P 3.2 mil-lion in FY77 to P 9.1 million in 1981, which is not adequately reflected by theratio of average total assets (2.7% and 1.7% in the years FY77 and FY81) dueto the substantially increased asset base. PISO's projections show graduallyincreasing net returns on average equity from 13.3% in FY77 to 25.7% in FY81in spite of the fact that PISO's long-term operations are expected to yieldonly marginal profit during the period 1978-81; this conclusion is based on aconservatively assumed spread of 3.5%, however. In accordance with itspolicy guidelines, PISO intends to pursue dividend policies which will allowfor reasonable returns to shareholders along with a satisfactory build-up ofretained earnings. PISO intends to plow back at least 40% of its average netearnings every year to strengthen its capital base. In line with thispolicy, PISO plans to maintain a cash dividend rate of 6% (of par value)through FY77, and projects increases in the dividend rate to 8% in FY78, 9%in FY79 and eventually to 10% in FY81. The cash dividend payout ratio willrange between 57.5% in FY78 and 33.5% in 1980.

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6. CONCLUSIONS AND RECOMMENDATION

Objectives of the Proposed Loan

6.01 At the moment there are only two specialized sources of long-termcapital in the Philippines: the Government-owned Development Bank of thePhilippines and the Private Development Corporation of the Philippines. Theprimary objective of the proposed Bank loan to PISO is to improve the institu-tional arrangements for providing long-term capital to the private sector bycreating one more source in addition to the existing two, thereby increasingboth the availability of long-term capital and easing the institutionalbottlenecks to the flow of such resources. These objectives are consistentwith the Philippine Government's efforts to strengthen the operations ofprivate financial institutions and to re-orient their financing activitiestowards longer maturities. The proposed loan is consistent with the Bank'slending strategy in the country in that it will meet the investment needs ofan increasingly important industrial sector. Another important objective ofthe proposed loan is the traditional institution-building role for the Bank.PISO is just beginning to undertake long-term operations. It is, however, adynamic institution and has considerable potential and promise. The Bank'sinvolvement from this early stage will have an impact on the institution thatshould prove mutually beneficial in the long run.

Expected Utilization of the Proposed Loan

6.02 The proposed loan will be made to the Philippine National Bank(PNB) for the use of PISO. PNB will be used as a conduit because, underPhilippine law, the Government may guarantee a loan to a public entity only.The Bank will have a direct contractual relationship with PISO by means of aProject Agreement. PNB is expected to charge PISO a service fee of 0.75% tocover its adminstrative cost and Central Bank charges (0.20% of the value ofits assets related to the loan). The proposed loan will be used by PISO inmaking a number of subloans. Since PISO does not have a history of long-termlending, it is difficult to be precise about the size distribution of thesubloans. The foreign exchange risk will be fully borne by the subborrowers.

6.03 As usual with Bank Loans to DFC's, the proposed loan would have aflexible amortization schedule conforming substantially to the aggregate ofthe repayment schedules of the subloans made by PISO. The maximum term forsubloans would be 15 years including an appropriate grace period not toexceed 3 years. PISO will charge an interest rate on subloans of up to12-14% (including all service charges). Based on the Bank's currentlyprevailing interest rate, PISO's spread could be between 3.75% and 5.75%.Its actual spread, however, is expected to be on the lower end because thereis considerable competition from the new Off-Shore Banking Units and PISOwould not want to be priced out of the market.

6.04 It is recommended that the limit for subloans not requiring priorBank approval be fixed at US$750,000. Based on PISO's pipeline, this limitwould assure that at least between two-thirds and three-fourths of the sub-loans by amount and 50% by number will be subject to the Bank's prior review.It is recommended, in addition, that an aggregate free limit of US$5 millionshould also be fixed to assure that no more than one-third of the proposedloan amount would be accounted for by below the free-limit projects.

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6.05 Procurement for subprojects financed from the Bank loans wouldbe in accordance with the standard practice for DFC projects, i.e., PIS0will require subborrowers to submit several bids to PIS0 before final se-lection of the supplier is made, after giving due regard to economy andefficiency. Disbursements under the proposed Bank loan would be: (a) 100% ofthe foreign exchange cost of direct imports; (b) the equivalent of 50% (beingthe estimate of the foreign exchange component) of such amounts expended forgoods locally procured; and (c) the equivalent of 40% (being the estimate ofthe foreign exchange component) of expenditure for civil works.

Agreements and Understandings Reached During Negotiations

6.06 During negotiations, the Bank reached agreement with PIS0 to theeffect that:

(a) PIS0 will increase its equity by P 10 million prior to loaneffectiveness (para. 4.08);

(b) PISO will adhere to a long-term debt/equity ratio of 4:1(para. 5.12); and

(c) PIS0 will adhere to a total debt/equity ratio of 10:1(para. 5.12).

6.07 During negotiations, the Bank reached agreement with PISO withrespect to:

(a) PISO's adoption of a Policy Statement, acceptable to the Bank,as a Condition of Board presentation of the proposed Loan(para. 4.22);

(b) the incorporation of ERR analysis in reports for projectsexceeding the free-limit of US$750,000, and incorporation of theusual partial indicators into all appraisal reports (para. 4.28).

6.08 During negotiations, the Bank reached an understanding withPIS0 on the following (reflected in the Agreed Minutes of Negotiations):

(a) PISO's adoption of liquidity and debt servicing policiesacceptable to the Bank (para. 5.13); and

(b) limiting the maximum holding of a single domestic investor to15% of PISO's total share capital (para. 4.06);

(c) the arrangements to be made for PICA's waiver of subscriptionrights so that its holding in PIS0 are not more than 30% of PISO'stotal share capital (para. 4.08);

(d) the target date for a public listing of PISO's shares on the stockexchange (para. 4.06);

(e) the possible timing and mechanism of a divestment of LBP's holdingsin PISO (para. 4.09); and

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(f) the contents of PISO's Corporate Strategy Statement.

Recommendation

6.09 A loan of US$15 million is recommended for use by PISO in financingthe foreign exchange component of imported capital goods and services foreligible productive enterprises in the Philippine private sector on the termsand conditions usual for Bank loans to development finance companies.

ANNEX 1

T-1

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

List of Shareholders as of December 31, 1977

Number of Percentage Number of PercentageShareholders shares /a of total shares /b of total

Local: (Class "A" Shares)Inco Mining Corporation 459,999 19.5 460,000 14.56Victor S. Barrios 292,982 12.4 356,815 11.30Victor S. Chiongbian 250,994 10.6 305,706 9.67Antonio M. Garcia 250,994 10.6 305,706 9.67Lex Development Corporation 126,499 5.4 126,500 4.00Augusto Y. Carpio 124,493 5.3 124,493 3.94Others (Individuals) 60,950 2.6 72,640 2.30Land Bank of the Philippines - - 460,000 14.56

Subtotal 1,566,911 66.4 2,211,860 70.00

Foreign: (Class "B" Shares)Private Investment Companyfor Asia (PICA), S.A. 794,039 33.6 947,940 30.00

Total 2,360,950 100.0 3,159,800 100.00

/a Par value of one share is B 10.00.

/b After capital increase, agreed at negotiations.

AEP Projects DepartmentMarch 20, 1978

ANNEX 1T-2

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Board of Directors as of February 28, 1978

Name Major Position

1. Victor S. Barrios Chairman of the Board and(Filipino) President (Chief Executive Officer)

of PISO;Director of Evertex Industries, Inc.

2. Rafael M. Atayde Vice Chairman(Filipino) President of Inco Mining Corporation

and four other mining companies

3. Victor S. Chiongbian Director(Filipino) President of William Lines, Inc.,

Manila Shipping Corporation andDirector of four other companies

4. Antonio M. Garcia Director(Filipino) President of Chemical Industries

of the Philippines, Inc., andthree other companies in thechemical industry, as well asDirector of two companies in theshipping and insurance industry

5. Andres G. Gatmaitan Director(Filipino) Partner of Sycip, Salazar, Feliciano,

Hernandez and Castillo Law Office

6. Kerry St. Johnston Director(British) President and Chief Executive Officer

of PICA (elected 2/2/77)

7. Eldridge D. Wood, Jr. Director(American) Vice President and Investment Manager,

Central Region and PhilippineRepresentative for PICA

8. Makoto Yasuda Director(Japanese) Executive Vice President

PICA

9. Hyoung Mo Kim Director(Korean) Vice President and Investment Manager,

Northern Region, PICA

AEP Projects DepartmentMarch 20, 1978

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Staffing Position

1974 1975 1976 1977

Beginning Additions /a End Additions /a End Additions /a End Additions /a Endresignations FY74 resignations FY75 resignations FY76 resignations FY 1977

By Department

1. Executive Staff + 4 4 + 1 - 3 2 2 + 1 3

Support Staff for Exec. Offices __ + 3 - 1 2 + 1 3 - 1 2 2

Subtotal +7 -1 6 +2 -3 5 -1 4 +1 5

2. Corporate Services DepartmentProfessional Staff + 1 1 +1 - 1 1 + 1 2 2

Support Staff + 4 4 + 3 -3 4 + 5 -3 6 + 2 -1 7

Subtotal +5 5 + 4 -4 5 +6 -3 8 +2 -1 9

3. Corporate Planning and Dev. Dept.

Professional Staff + 3 3 + 2 -1 4 + 4 8

Support Staff _ _ + 2 -1 1 1 + 1 - 1 1

Subtotal + 5 -1 4 + 2 -1 5 + 5 - 1 9

4. Resource Mobilization DepartmentProfessional Staff + 2 2 + 3 5 + 1 -2 4 + 4 8

Support Staff +1 _I 1 1

Subtotal +2 2 + 3 5 +2 -2 5 +4 9

5. Financial Markets Department

Professional Staff + 6 6 + 6 - 2 10 + 7 -5 12 + 8 - 5 15

Support Staff _ + 1 + 7 - 3 5 + 4 -2 7 + 2 - 3 6

Subtotal + 7 7 +13 - 5 1 10 8 21

6. Investment Management Office

Professional Staff + 1 1 + 1 2 + 2 -2 2 + 1 - 1 2

Support Staff

Subtotal + 1 +-1 -2 +2 -2 2 +1 -1 2

7. Total StaffProfessional Staff +14 14 +15 - 6 23 +13 -10 26 +18 - 6 38

Support Staff + 8 - 1 7 +13 - 7 13 +10 - 6 17 + 5 - 5 17

Grand total +22 - 1 21 +28 -13 36 +23 -16 43 +23 -11 55

By Profession/Background

Engineers + 2 2 + 2 -1 3 3 + 5 8

Accountants + 2 2 + 6 -4 4 + 2 -2 4 + 7 -2 9

Financial Analysts + 4 4 + 5 -2 7 + 5 -3 9 -2 7 w z

Economists + 2 2 + 5 4 +1 - 2 3 + 1 4 -

Lawyers +1 1 + 1 -1 1 + 1 2 2 X

Secretaries + 6 -1 5 + 4 -4 5 + 7 -4 8 + 2 -3 7

Others + 5 5 + 8 - 1 12 + 7 -5 14 + 8 - 4 18

Total +22 - 1 21 +28 -13 36 +23 -16 43 +23 -11 55

/a Additions are denoted by plus (+) sign and resignations are denoted by minus (-) sign.

AEP Projects DepartmentMarch 20, 1978

ANNEX 1

T-4

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Summary of Operations, March 1, 1974 - December 31. 1977(P million)

3/1/74- Cumulative

12/31/74 1975 1976 1977 total

No. Amount No. Amount No. Amount No. Amount No. Amount

Approvals

LoansDomestic currency - - 1 3,000 1 3,000 3 1,250 5 7,250Foreign currency - - - - 1 7,500 1 7,500 2 15,000

Subtotal - - 1 3.000 2 10,500 4 8.750 7 22,250

Equity investment 1 0,025 - - - - - - 1 0,025

Subtotal 1 0,025 - - - - - - 1 0,025

GuaranteesDomestic currency - - - - - - 1 1,000 1 1,000

Foreign currency - - 1 2,300 - 1 4,200 2 6,500

Subtotal - - 1 2,300 - 2 5.200 3 7.500

Underwriting/privateplacements - - 2 5,700 - - 1 3,000 3 8,700

Subtotal - - 2 5,700 - - 1 3,000 3 8,700

SyndicationsForeign component - - 4 95,930 2 9,638 3 193,500 9 299,068Local component - - - 10,000 - - 2 43,750 2 53,750

Subtotal - - 4 105.930 2 9638 5 237,250 11 352,818

Total approvals 1 0.025 8 116,930 5 20.138 12 254.200 25 391.293

Commitments /aLoans

Domestic currency - - 1 3,000 1 3,000 3 1,250 5 7,250Foreign currency - - - - 1 7,500 1 7,500 2 15,000

Subtotal - - 1 3,000 2 10,500 4 8,750 7 22.250

Equity investment 1 0,025 - - - - - - 1 0,025

Subtotal 1 0,025 - - - - - - 1 0,025

Guarantees issuedDomestic currency - - - - - - 1 1,000 1 1,000Foreign currency - - - - 1 2,300 1 4,200 2 6,500

Subtotal - - - - 1 2.300 2 5.200 3 7,500

Total commitments 1 0,025 1 3,000 3 12,800 6 13,950 11 29,775

Disbursements /a

LoansDomestic currency - - - - 1 3,000 3 2,000 4 5,000Foreign currency - - - - - 1 6,120 1 6,120

Subtotal - - - - 1 3,000 4 8,120 5 11,120

Equity investment - - 1 0,013 - - - - 1 0,013

Subtotal - - 1 0.013 - - - - 1 0,013

Guarantees issuedDomestic currency - - - - - - 1 500 1 500

Foreign currency - - - - 1 2,300 1 4,200 2 6,500

Subtotal - - - - 1 2_300 2 4.700 3 7,000

Total disbursements - - 1 0,013 2 5,300 6 12,820 9 18,133

/a Excluding underwriting and syndication operations.

AEP Projects DepartmentMarch 20, 1978

PRILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Details of Syndication Operations

Projecttype Financial

Indostry/ new/ Frolect cost Syndications: aaount & terms P150 exnmare rate ofFirm location existing Foreign Domstic Total Foreign Domestic Total Foreign Domestic Total return

(US$OOO) (P million) (USS'000) (P million) (UD$000) (P million) (X)

1. Porceless Marivasa (1975) Dinnerware New 6,500 4.00 52.75 4,000 L. - 30.00 39.0(Metro Manila) 2% over LIBOR

(2-6)

2. Evertex Industries (1975) Textiles New 7,500 33.00 89.25 6,800 /b 7.00 LA 58.00 - - - 23.2(Metro Manila) 1-1/2Z over LIEOR 12-141

(3-12) (2-5)

2. samma Computer Services (1975) Conpater Services New 930 2.16 9.14 930 /c - 6.98 - - 31.5(Metro Manila) 21 over LIBOR

(2-5)

3. LMr Chemicals (1975) Chemicals (Rixal) New 5,364 29.47 69.70 1,050 /d - 7.88 300 - 2.25 20.12% over LIBOR (guarantee) (guarantee)

(1-8)

5. Proton Chemicals (1976) Chemicals (Qoexon) New 347 5.40 8.00 560 Ic - 4.20 - - - 25.021 over LIBOR

(2-5)

6. Swinstim_ Philippines (1976) Watch cases New 705 6.15 11.44 725 /e - 5.44 - - - 44.5(Metro Manila) 2S over LIBOR

(2-5)

7. Sarmilento Indostrieas (1976/77) Logging Existing 6,406 56.96 105.00 8,000 /f - 60.00 1,000 - 7.50 35.4(N. Mindenso) 2% over LIBOR (US Exim CFF) (loan)

(2-5

8. Philippine Blooming Mills (1977) Steel rolling Working - 42.00 42.00 - 41.00 /h 41.00 - 1.00 /i 1.00 -(Metro Manila) capital (17S) (in)

(1-3)

9. El Salvador Timber Corp. (1977) Tiber New 2,540 12.49 31.54 2,800 - 21.00 Li 560 - 4.20 18.12% over LIB R (guarantee)

(2-5)

10. Sabena Mining Corp. t1977) Copper New 16,400 87.80 210.80 15,000 Lk 10.00 122.50 - 14.9(mixed)

11. Vicor Music Corp. (1977) Phonograph Expansion 300 2.79 5.05 - 2.75 2.75 /1 _ 1.25 1.25 52.0records (19%) (1.00 guarantee)

(0.25 loan)

Ls Taken up by Crocker National Bank guaranteed by the Manila Banking Corporation./b Taken up by PDCP, PICA and Manufacturers Hanover. The rate charged by PDCP was 12Z; terms of PICA and MH loans were 10 and 8 years

respectively./c Taken up by Continental 11linois through Philippine Veterans Bank./d Taken up by Orion Pacific and PICA. The terms of OP and PICA loans were 5 and B years respectively, with PICA granting a

2-year grace

period. OP loan guaranteed by Insular Bank of Asia and America.Le Taken up by PICA and Republic National Bank of N.Y. (guaranteed by Manila Bank).Lf Taken up by City Bank, China Banking Corporation, Metropolitan 6 Trust Co., Philippine Veterans Bank and provided by Citibank, Rainier

National Bank, Bank of Californis and PICA.a Local portion syndicated between RCBC, PCIB and Manila Bank with a tern of 5 years (2 years grace) and at a rate of 12% on land-macured

portion, 14% on chattel secured portion./h Syndicated between Contrust, Insular Bank, Consolidated Bank and Trust Corporation./i Amount approved by PISO Board wan P 3.0 million of whiCh only P 1.0 million has been otilieed by P6M./4 Taken up by Philippine Banking Corporation and the Manila Banking Corporation and provided by United California Bank and PICA./k US$7.5 millios provided by DBP (2-75) and another US57.5 million by PICA, Girard Trust, Swins Banking Corp.. Tad Lee Bank and Hong-

Eong and Shanghai Banking Corporation at 1.75% over LIBOR (2-4)./1 Syndicated between Land Bank of the Philippines, Far East Bank and Trust Co., PISO, and a Trost Fund.

AEP Projects DepartmntMarch 20, 1978

ANNEX I

T-6

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Audited Balance Sheets, December 31, 1974-1977(In thousand pesos)

1974 1975 1976 1977

ASSETS

Current AssetsCash on hand and in bank 9,496 2,953 9,528 12,028Short-term investments (netof provisions for doubtfulaccounts) 29,465 101,571 95,334 93,110

Medium/long-term loan duewithin one year - - 480 1,779

Interest receivable 735 3,149 4,013 4,546Prepaid expenses (and othercurrent assets) 176 409 4,924 7,504

Total current assets 39,872 108,082 114,279 118,967

Medium/Long-Term Loans (net ofcurrent portion) - - 1,440 5,317

Property and Equipment (net ofdepreciation) 330 657 759 725

Other Assets 52 178 139 520

TOTAL ASSETS 40,254 108,917 116,617 125,529

LIABILITIES AND STOCKHOLDERS' EQUITY

Current LiabilitiesAccounts payable and accruedexpenses 441 2,421 7,615 8,842

Income tax payable 164 62 47 -Interest payable 528 1,761 2,400 2,225Securities sold under agreementto repurchase 7,408 47,253 32,060 55,424

PISO notes sold 10,897 33,446 49,344 25,831Medium/long-term debt due

within one year - - - 1,215

Total current liabilities 19,438 84,943 91,466 93,537

Medium/Long-Term Debt - - -_4,190

Stockholders' EquityPaid in capital 20,000 20,115 20,135 23,609Retained earnings

Appropriated to reserves - - 200 200Unappropriated 816 3,859 4,816 3.993

Stockholders' Equity 20,816 23,974 25,151 27,802

TOTAL LIABILITIES AND STOCKHOLDERS'EQUITY 40,254 108.917 116,617 125,529

CONTINGENT LIABILITIES 2,002 6,605

AEP Projects DepartmentMarch 20, 1978

ANNEX 1T-7

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Audited Income Statements for Years Ended December 31, 1974-1977(P '000)

1974 1975 1976 1977(10 months)

INCOMERevenuesMedium/long-term operations:

CFF program - - 77 142

Medium-term loans - - - 361

Subtotal - - 77 503

Syndication fees 300 963 842 2,432Underwriting fees - - 60 77

Guarantee fees - - 62 292/a

Management and financialconsultancy fee - - 101 82

Short-term operations:Interest income 2,866 9,469 7,908 7,235Trading income - 1,569 3,517 1,944

Subtotal 2,866 11.038 11,425 9,179

Other income 19 257 1.242 413

Total revenues 3,185 12,258 13,809 12,978

EXPENSESFinancial expensesInterest on short-term borrowings 1,183 5,394 7,945 4,934Provision for doubtful accounts - 200 1,300 1,000

Subtotal 1.183 5.594 9,245 5,934

General and administrative expensesManpower cost 391 1,118 1,107 2,010Transportation and travel 9 113 66 167Representation expenses 33 85 91 103Depreciation and amortization 11 78 118 158Printing and other supplies 14 61 62 71Postage, cable and telephone 14 42 49 52Light and water 35 36 33 33

Advertising and promotion 10 117 120 108Professional fees 20 41 50 65Charitable contributions 16 31 35 69Miscellaneous expenses 98 250 280 406

Subtotal 651 1,972 2,011 3,242

Total expenses 1,834 7.566 11.256 9,176

Operating income before taxes andlicenses 1,351 4,692 2,553 3,802

Taxes and licenses 535 1.648 188 280

TOTAL NET EARNINGS 816 3.,044 2.365 3 522

/a Estimate

AEP Projects DepartmentMarch 20, 1978

ANNEX 1

T-R

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Operational Forecast, 1978-81(P '000)

Years ending December 31 1977 1978 1979 1980 1981(Actual)

Approvals

LoansForeign currency loans

Cooperative financing program 7,500 7,500 7,500 7,500 7,500Other sources - 56,250 112,500 135,000 165,000

Local currency loans 250 3,000 4,500 6,000 7,500Small loans 1,000 4,000 5,500 7,000 8,500

Total 8.750 70.750 130,000 155.500 188,500

GuaranteesForeign component 4,200 6,400 6,400 6,400 6,400

Local component 1,000 1,600 1,600 1,600 1,600

Total 5,200 8.000 8,000 8,000 8,000

Underwriting/private placements 3,000 12.000 14.400 17,400 20,800

SyndicationsForeign component 193,500 116,000 134,600 154,700 177,900Local component 43,750 34,000 37,900 43,700 50,200

Total 237,250 150.000 172,500 198,400 228,100

Total approvals 254,200 240,750 324.900 379,300 445,400

Commitments

LoansForeign currency loansCooperative financing program 7,500 7,500 7,500 7,500 7,500Other sources 250 30,750 108,800 127,500 157,500

Local currency loans - 2,000 4,400 5,600 7,100Small loans 1,000 2,500 5,600 6,600 8,100

Total 8,750 42,750 126,300 147,200 180.200

GuaranteesForeign component 4,200 4,800 6,400 6,400 6,400Local component 1,000 1,200 1,600 1,600 1,600

Total _5200 6.000 8,000 8.000 8,000

Total Commitments 13,950 48,750 134,300 155,200 188,200

Disbursements

LoansForeign currency loans

Cooperative financing program 6,120 6,800 7,500 7,500 7,500Other sources - 1,500 70,500 115,500 137,500

Local currency loans 2,000 1,500 4,300 5,400 6,900Small loans - 2,000 5,400 6,400 7,900

Total 8.120 1 87.700 134,800 159,800

GuaranteesForeign components 500 1,000 6,200 6,400 6,400Local components 4,200 1,000 1,600 1,600 1,600

Total 4,700 2,000 7,800 8,000 8,000

Total Disbursements 12.820 13,800 95,500 142,800 167.800

AEP Projects DepartmentMarch 20, 1978

ANNEX 1

T-9

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Resource Position as of December 30, 1977

1. Long-term resources (P million)

A. Local currencyEquity: share capital reserve & 23.6

retained earnings 4.2Long-term borrowings 0.6

Total local currency resources 28.4

Less: Local currency loans outstanding 1.7Equity investments .0

Equals: Available for disbursement 26.7Less: Undisbursed peso commitments -

Available for commitment 26.7

B. Foreign currency (US$ million)

Exim loans 1.5 /aOther loans 1.5 /aForeign exchange loans committed 1.0Approved by PISO Board, not yet committed 1.0

Available for commitment 1.0 /a

C. Total long-term resources (P million) /b

Total resources 50.9Available for commitment 34.2

2. Short-term peso resources (P million)

Short-term investments outstanding 93.1Short-term notes & commercial papers sold 81.3

Subtotal 11.8

Add: Remaining current assets minus current liabilities 13.6

Net shortfall 25.4

/a The US-Exim Bank has approved a credit line of US$1.5 million under itsCooperative Financing Facility" program for the period 1976-1978; these fundscan only be used if matched with an equal amount from other US bank sources. Onemillion has been matched so far with funds from the Continental Bank InternationalPacific and Rainier National Bank; the remaining US$0.5 million has been approvedby the same finance institutions but the arrangement has yet to be finalized.

/b Peso equivalent converted at $1.00 - P 7.50.

AEP Projects DepartmentMarch 20, 1978

ANNEX 1

T-10

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Prolected Balance Sheets, December 31, 1978-81(P '000)

(Actual) (Est.) Projected laAs of December 31 1977 1977 1978 1979 1980 1981

ASSETS

Current assetsCash on hand & in banks 12,028 7,186 8,200 9,075 9,950 11,025Short-term investments /b 93,110 108,867 140,106 157,048 177,600 216,542Portion of medium/long-term

loans due within 1 year 1,779 1,754 3,929 7,521 18,991 39,306Interest/principal receivable 4,546 4,496 4,981 6,417 7,585 8,990Prepaid expenses & other

current assets 7,504 11,189 12,987 14,917 17,136 19,688

Subtotal 118,967 133,492 170,203 194,978 231,262 295,551

Long-term assetsMedium/long-term loans

outstanding /c 5,317 5,693 12,664 91,630 206,766 326,693Property & equipment /d 725 733 908 1,200 1,400 1,700Other assets 520 861 1,980 2,058 2,176 2,341

TOTAL ASSETS 125,529 140,779 185,755 289,866 441,604 626,285

LIABILITIES

Current liabilitiesAccounts payable & accrued

expenses 8,842 10,336 11,886 13,669 15,719 18,077Interest payable 2,225 2,875 3,995 4,651 5,307 6,034Securities sold underagreement to repurchase 55,424 73,682 86,000 103,500 121,000 134,500

PISO notes sold 25,831 20,047 28,000 28,000 28,000 36,000Medium/long-term debt duewithin 1 year 1,215 1,274 3,199 5,957 15,740 34,118

Subtotal 93,537 108,214 133,080 155,777 185,766 228,955

Medium/long-term debts /dUS Eximbank 3,626 4,283 9,059 11,285 12,986 13,799Industrial Guarantee &

Loan Fund (IGLF) 564 450 1,975 5,786 9,083 12,056Other long-term sources - - 1,500 72,000 180,592 295,623

Subtotal 4,190 4,733 12,534 89,071 202,661 321,478

EquityPaid-in capital 23,609 23,587 33,587 38,595 38,595 55,854Retained earnings 4,193 4,245 6,554 6,423 14,582 19,998

Subtotal 27,802 27,832 40,141 45,018 53,177 75,852

TOTAL LIABILITIES 125,529 140,779 185,755 289,866 441,604 626,285

CONTINGENT LIABILITIES 6,605 6,845 7,888 9,612 15,527 20,850

/a PISO's projection for the years 1978-81 is based on the latest revised estimate for1977; since the projection is unlikely to change significantly if based on the actual1977 data, it has not been adjusted.

/b Net of provisions for doubtful accounts./c Net of provisions for doubtful accounts and current maturities./d Net of depreciation./e Net of current maturities.

AEP Projects DepartmentMarch 20, 1978

ANNEX 1

T-11

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Projected Statement of Income and Expense 1978-81(P '000)

Years ending December 31 1977 1977 1978 1979 1980 1981(Actual) (Estimate)

IncomeShort-term operations 4,245 4,028 9,160 10,745 12,050 15,231Medium/long-term loans

CFF program 375/b 429 853 1,409 1,809 2,050Small business loans 11 4 156 672 1,248 1,824Medium-term loans 350 500 327 907 1,600 2,320Project loans - - 471 5,708 19,546 36,136

Subtotal 4,981 4,961 10,967 19,441 36,253 57,561

Guarantee fees 292/c 292 169 137 266 369Commitment fees 47 45 135 887 1,110 1,365Syndication &

underwriting fees 2,509 2,395 1,675 2,085 2,419 2,801Consultancy fees 82 46 175 500 600 700Insurance agency

commission 10 12 550 330 400 480Other 403 415 150 210 220 230

Total 8,324 8,166 13,821 23.590 41,268 63,506

ExpensesOperating expenses 2,820 2,808 4,128 4,954 5,942 7,131Financial expenses &

commitment fees onlong-term borrowings 280/d 280 750 5,739 16,968 29,782

Provision for doubtfulaccountsShort-term operation 1,000 700 700 700 700 700Medium/long-term loans - 300 1,300 1,700 2,500 3,300

Incentive bonus 422 - 520 845 1,279 1,941

Subtotal 4.522 4,088 7,398 13,938 27,389 42,854

Income before taxes 3,802 4,078 6,423 9,652 13,879 20,652

Taxes & licenses 280 556 1,746 2,050 2,367 4,082

Net income 3,522 3,522 4,677 7,602 11,512 16,570

/a PISO's projection for the years 1978-1981 is based on the latest revisedestimate for 1977; since the projection is unlikely to changesignificantly if based on the actual 1977 data, it has not beenadjusted.

/b Net income (P142) plus estimated financial expenses minus commitment fees.

/c Estimate.

/d Estimated amount added back to net CFF income.

AEP Projects DepartmentMarch 20, 1978

ANNEX 1

T-12

PHILIPPINES

PHILIPPINES INVESTMENTS SYSTEMS ORGANIZATION

Actual and projected Indicators of Financial and Operational Performance, 1974-81(P '000)

Actual Projected1974 1975 1976 1977 1978 1979 1980 1981

I. Financial DataTotal assets 40,254 108,917 116,617 125,529 185,755 289,866 441,604 626,285of which:

short-term portfolio 29,465 101,571 95,334 93,110 108,867 140,106 157,048 177,600medium/long-term portfolio - - 1,920 7,096 16,593 99,151 225,757 334,857

Total long-term debts - - - 5,405 15,733 95,028 218,401 355,596Equity 20,816 23,974 25,151 27,802 40,141 45,018 53,177 75,852Contingent liabilities - - 2,002 6,605 7,888 9,612 15,527 20,850

II. Financial Performance

Percentage of average total assets1. Total gross income 15.8 16.4 12.2 10.7 10.7 18.4 12.1 12.62. Total financial expense 5.9 7.5 8.2 5.1 3.6 7.7 6.4 7.13. Gross spread (1-2)

(Total operations) 9.9 8.9 4.0 5.6 7.1 10.7 5.7 5.54. Gross spread (medium/long-term

operations) - - - 0.4 0.0 1.5 1.6 2.05. Administrative expenses 3.2 2.6 1.8 2.7 3.0 4.0 2.0 1.76. Provision for doubtful loans - 0.3 1.2 0.8 1.3 1.7 0.9 0.87. Taxes & licenses 2.6 2.2 0.2 0.2 1.1 1.4 0.7 0.88. Profit before provision 4.1 4.3 3.3 3.7 4.3 6.9 4.0 3.99. Net profit 4.1 4.1 2.1 2.9 3.0 5.2 3.1 3.1

Net profit as % of averagenet worth 4.0 13.6 9.6 13.3 13.8 17.9 23.4 25.7

III. Other Ratios

1. Provisions & reserves as % oftotal loan portfolio 2.8 4.0 6.7 6.7 8.8 5.6 6.4 6.7

2. Book value as % of par value 104 119 125 118 120 117 138 1363. Earnings per share 0.41 1.51 1.18 1.49 1.39 1.97 2.98 2.974. Dividends as % of par value - 6 6 6/a 8 9 10 105. Dividend payout ratio - 31.2 51.1 40.2 57.5 45.7 33.5 33.76. Debt service cover ratio - - - - 3.1 2.8 2.9 2.07. Current ratio 2.1 1.3 1.3 1.3 1.3 1.3 1.2 1.38. Total debt/equity ratio 0.9 3.5 3.7 3.8 3.8 5.7 7.6 7.59. Long-term debt/equity ratio - - - 0.4 0.5 2.2 4.1 4.5

/a In addition to a stock dividend of 15%.

AEP Projects DepartmentMarch 21, 1978

PHILIPPINESPHILIPPINE INVESTMENTS SYSTEMS ORGANISATIONORGANIZATION CHART AS OF DECEMBER 31,1977

| Board of Directors lChairman

Victor S. Barrios

Executive CommittenChairman_

Victor S. Barrios

I

PresidentVictor S. Barrios

| Senior L aaeet netntVice-President (Special) nateEldridge D. Wood Jr.

ICorporateServices Coprt PlnIn Invesmet MngmentReoreMblisto Fiaca MarketVcPresident Cone S eeomentorVice-President V ice-Presid ent Vice-President-Tes e

Jorge M. Juco lcro .uii Glicerio V. Sicat (Tmoay Roan U. Youn Fraci R. *Yuseco

q Personnel l _{ Business Development l _| Portfolio Management | -| Syndication Credit Rating

-1 Administration l 5 Corporate Reconstruction Investment Advisory Underwritings Securities Marketing

{ Public Relations l { Primary Equities l { Secondary Equities l | Primary Placements l |Small Business Financing |

Staff: Professional: 2 Staff: Professionals 8 Staff: Professionals 2 Staff: Professionals 8Others 7 Others 1 Others - Others 1 Accounting

Total 9 Total 9 Total 2 Total 9

Staff: Professionals 15Others 6

Total 21

World Bank-17276AEP PROJECTS DEPARTMENT

April 1,1977

ANNEX 2Page 1

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Policy Statement

A. PISO's Role and Objectives

1. Corporate Character. PISO is a financial institution which is:

essentially Philippine in origin, sentiment and character; committed to the

active promotion of development-oriented investments and to the provision offinancial assistance and related services to ensure the success of suchinvestments; systems oriented in its approach and operations; and reliantupon the strength derived from its organization and the diversity of itsownership. Its primary role will be to mobilize and allocate financialresources as efficiently as possible to further the process of economicdevelopment.

2. Objectives. As a participant in the process of resource allocation,PISO will actively seek out and assist the development of productive ventures

and income-generating projects undertaken by privately-controlled /1 businessenterprises in various sectors of economic activity. PISO will assist onlythose projects and ventures which, in its judgment, are or will be financially,economically and technically viable, and are properly organized and soundlymanaged. PISO will likewise participate actively in furthering the develop-ment of the capital market in the Philippines especially by way of long-term

domestic and foreign resource mobilization.

3. Activities. PISO will provide a full range of financial services,and technical and management assistance as provided for in its Articles ofIncorporation. These will include (but not be restricted to): (a) the pro-vision of medium and long-term financing facilities /2 by way of domestic andforeign currency loans, guarantees and equity participation; (b) syndication,underwriting, private placement activities; (c) the provision of financialpackaging, consultancy and investment portfolio management services; (d) leas=ing and hire-purchase facilities; and (e) management consultancy assistancein association with its financial services. On the resource mobilizationside, PISO will continue in expanding and diversifying the supply of financialinstruments to stimulate savings and channel them into longer-term maturities.

/1 As used here, the term applies to enterprises in which private-ownershiprepresents a majority (greater than 50%) share. In this connection, PISOexplicitly recognizes the role that Government participation in ownershipmay need to play in accelerating investment in certain areas.

/2 For financing fixed assets and working capital.

ANNEX 2Page 2

B. Guidelines for Operations

4. Project Evaluation and Follow-up. In providing assistance to anyproject or enterprise, PISO will apply high professional standards in evaluat-ing: managerial aspects; technical aspects; market prospects; financialviability and debt-service capability; and the economic viability and desir-ability of such projects/enterprises. It will closely monitor the implemen-tation of projects and the eventual operations of the enterprises to which itprovides long-term assistance. Whenever it considers necessary, PISO willprovide constructive remedial advice to those enterprises it perceives inpresent or eventual difficulty.

5. Collateral. In accordance with normal business practices, PISO willobtain adequate security for the financial assistance it provides. PISO willalso take steps to have adequate insurance coverage obtained for its security.Its investment decisions, however, will be guided primarily by considerationsrelating to project merits.

6. Investment Exposure Limits. To ensure that its resources are widelyspread and prudently diversified, PISO shall adopt the following guidelines:

(a) Total financial commitment /1 (including amounts of outstanding andundisbursed commitments) to any single enterprise /2 shall notnormally exceed an amount equivalent to 25% of PISO's net worth(defined as the sum of its paid-in unimpaired capital, surplusesand reserves).

(b) Total investment in any enterprise shall not normally exceed 50% ofthe assets of that enterprise if it is already established or 75%if the enterprise is being newly established.

(c) No outstanding equity investment made by PISO in any one enter-prise shall normally exceed 49% of the paid-in share capital ofthat enterprise and 15% of PISO's own net worth. This limitationwill not apply to a subsidiary, if and when established by PISO.

(d) The aggregate sum of PISO's equity investments shall not exceedPISO's own net worth.

/1 This term includes equity investments, loans and guarantees (excludingshort-term for the latter 2 categories). The term excludes exposurescovered by hold-out agreement or any firm off-setting arrangements ondebt extended to PISO.

/2 The term enterprise as used in this Statement shall include the enter-prise and its subsidiaries whenever PISO has any investments in suchsubsidiaries.

ANNEX 2Page 3

7. Portfolio Diversification and Divestiture

(a) PISO will endeavor to diversify its loan, equity and guaranteeinvestments in a wide variety of sectors and industries. It will

also exert its efforts to encourage investment in underdeveloped

regions and to actively promote the location of investment outside

the Metropolitan Manila Area.

(b) In accordance with its views on capital market development and to

maximize the use of its own resources, PISO shall dispose of its

equity investments as early as practicable. In selling its hold-

ings, PISO shall consider, in addition to its own interests, the

interests of the other original participants in the investment as

well as the interests of the concern whose shares are being dis-

posed of. PISO will endeavor to diversify, as widely as possible,

ownership in the entities in which it invests.

8. New Entrepreneur/Enterprise Promotion. In its operations, PISO

will stress the promotion of new entrepreneurs and enterprises. Broadening

the entrepreneurial base in the Philippines will be one of PISO's operational

objectives. To this end, PISO will exert reasonable efforts to: (a) extend

financial and technical assistance to small and medium scale enterprises /1;

and (b) attempt to develop a client base of enterprises which, by virtue of

their size, age, ownership or location, have not enjoyed ready access to

financial assistance as have larger, more established and better-known

corporations.

9. Relations with Client Enterprises. Recognizing the value and

implications of sound lender-borrower relationships, PISO will adhere to the

following policies in its dealing with client firms:

(a) PISO shall not normally seek to control any of the enterprises that

it finances nor to assume primary responsibility for the management

of such enterprises, except in the event that its interests are

jeopardized, in which case, it may take such action as may be

necessary to protect its interests. A higher percentage of equity

holding than mentioned in 6(c) above may also result from an under-

writing commitment undertaken with the expectation that the eventual

investment would be within the cited limit. Every attempt will be

made to reduce the equity holding to the maximum limit mentioned in

6(c) above as soon as practicable, all factors considered.

/1 As defined by the Department of Industry.

ANNEX 2Page 4

(b) PISO shall request its clients to establish and maintain up-to-daterecords and accounts in accordance with generally accepted account-ing practices, and furnish whatever information it may reasonablyrequest on their operations and accounts. Under its financialcontracts, PISO will establish its right to inspect the enterprisesit finances as well as their operations and accounts.

(c) PISO shall honor the confidences of its clients. In this connection:no member of PISO's Board, by virtue of his/her membership, shallhave access to information submitted by clients to PISO's managementor staff when, in the view of management, such access would prejudicethe interest of the client.

10. Dispersal of Ownership. PISO will strive to broaden its ownershipbase as widely as possible. PISO will take all possible steps to prevent anyone person, entity or group from dominating its ownership or management.

C. Financial Policy Guidelines

11. Capital Structure, Liquidity and Debt Service. In the conduct ofits business affairs, PISO shall exercise due financial prudence and shallensure that its capital structure remains sound, a reasonable liquidityposition is maintained and that its cash inflow is always sufficient to allowa comfortable margin for servicing its debt.

12. Reserves and Dividends. PISO will adhere to a prudent dividendpolicy which will allow it to provide a fair return on shareholders' invest-ments and simultaneously allow for building-up retained earnings and reservesat a reasonable rate. At a minimum, PISO shall plow back at least 40% of itsaverage net earnings in any given fiscal year as retained earnings. PISOwill provide, by charges against income, valuation reserves consistent withthe size and quality of its loan and equity portfolio. From time to time,PISO shall appropriate as necessary a portion of its retained earnings tosurplus reserves to ensure that they adequately reflect the size and risksof its portfolio and to protect its equity against erosion.

13. Foreign Exchange Risk. It is PISO's policy not to expose itselfto foreign exchange risks associated with foreign currency obligations/trans-act ons. Accordingly, PISO shall, to the extent possible, pass such risks onto its clients or arrange, on behalf of clients, for forward cover on suchrisks at no cost to itself, or make any other arrangement which insulatesPISO from bearing any part of such risks.

D. Relationships with Government Authorities

14. PISO shall, at all times, maintain cooperative working relation-ships with various government agencies and authorities with respect to itsinvestment operations and its activities toward capital market development.Its operations will be consistent with overall government economic policies.

ANNEX 2Page 5

E. Organization and Staffing Policies

15. In furtherance of its institutional capabilities and to assist its

clients to the fullest possible extent, PISO shall, on a continuing basis,

build and strengthen its management and staff, and evolve an efficient and

sound organizational structure. To those ends, it shall adopt equitable and

competitive recruitment, employment and compensation policies. PISO shall

provide for continuous training of its staff, realizing as it does, the

importance of human resources. PISO shall endeavor to ensure that its staff

are of a high professional calibre and represent an appropriate mix of pro-

fessional qualifications, ability and experience to permit the achievement

of its corporate objectives in the most efficient manner.

F. Revision of Policies

16. This Policy Statement may be amended only by the affirmative vote

of at least two-thirds of all directors.

AEP Projects DepartmentApril 1, 1978

ANNEX 3Page 1

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Statement of Corporate Strategy for 1978-80

1. In the conduct of its operations, PISO will be guided by the PolicyStatement approved by its Board on March 29, 1978. This Statement ofCorporate Strategy enunciates the general directions of PISO's operations andactivities, frames in broad terms its objectives over the next three yearsand outlines the course which Management proposes to chart to achieve them.Clearly, adaptive changes in strategy will be necessary to respond flexiblyto changes that may ensue in government policy, overall economic conditionsand the regulatory environment in which PISO must function. Management, withthe approval of PISO's Board, therefore reserves the right to change strategicthrusts in the best interests of sound and balanced long-term corporategrowth.

2. Support for Economic Development. PISO's corporate strategy willbe consistent with the Government's efforts at achieving stable long-termeconomic growth and the efficient mobilization and allocation of financialresources. Its efforts on the allocation side will be to concentrate onfurthering the development of the industrial, agro-industrial, tourism,transportation, and services sectors by encouraging directly productive,revenue generating and privately controlled business investments in thesesectors. In financing specific investments, PISO's strategy will be toadhere to the policy established by regulatory agencies such as the Board ofInvestments, Department of Tourism, etc. On the resource mobilization side,PISO's strategy will be to support actively the development of a market forlong-term capital through the direct issue of suitable financial instruments,support for the establishment of an effective secondary market for long-termsecurities trading, encouragement for the diversification of industrialenterprise ownership by persuading client enterprises to go public, andcooperation in the establishment of a sound regulatory framework for theoperations of financial institutions.

3. Operational Strategy. With the stage of its corporate formationand of the establishment of its reputation in the financial and businesscommunities coming to a close, PISO will, over the next three years, embarkon a growth path along the following lines:

(a) While PISO will maintain its character as an investment banking-type institution, emphasis will be placed on long-term resourcemobilization and financing operations with PISO attempting todevelop a direct long-term loan portfolio (resources permitting).Resource mobilization activities to be emphasized alongside directlong-term financing are so-called "off-balance" sheet activities

ANNEX 3Page 2

consisting of underwritings, private placements, syndications andguarantees. Specifically, PISO will aim to increase its share ofthe long-term financing market (for durable equipment and non-residential construction) by about four times from a level of 1.0%in 1977 to a level of about 3.9% by 1980. In.monetary terms(current pesos), PISO will endeavor to provide (on an approvalbasis) aggregate long-term financial assistance, by way of directloans, guarantees, syndications and underwriting, totaling overF 350 million annually by 1980; of this amount, PISO's strategywill be to achieve a balance between its direct long-term loans andother forms of term financing.

(b) Recognizing that the gestation period for developing a maturelong-term portfolio yielding a stable revenue stream will be around3-5 years, PISO will continue to follow a balanced approach inrestructuring of its assets to ensure the generation of income at asatisfactory level. In relative terms, PISO will aim at reducingthe proportion of short-term assets (from trading operations) inits total asset base from around 80% in 1977 to less than 50% by1980. PISO will maintain an average annual growth rate in itsshort-term asset base of around 25% for the period 1977-80.

(c) Growth in both short- and long-term financing operations will bebased upon a strategy of risk and portfolio diversification byindustry, by geographic region and by business groups/client firms.PISO will aim at spreading its available funds as widely aspossible between industries, entrepreneurs and regions. Specialemphasis wil be given to the establishment of "pioneer" projectsundertaken by newer or lesser established entrepreneurs. To theextent possible, it will actively encourage investment outsideregions where industry is presently concentrated. While beingguided primarily by considerations of individual project merit andthe investment priorities of the Government, PISO's strategy willbe to review investment proposals with particular care if suchinvestments cause PISO's exposure in a given industry /1 to exceed30% of its outstanding (including committed but undisbursed funds)long-term /2 portfolio. The limits will not be applied as arbitrary

/1 Industries here will be defined as those categories of activity at the2-digit level using the standard international industrial classificationcode.

/2 Long-term in this connection, includes PISO equity investments, and itsloans and guarantees with a maturity of over one year at the time originallycontracted.

ANNEX 3Page 3

cut-off points but as guidelines beyond which PISO's management andBoard will require special justification before approving suchinvestments. Exposure limits in client firms and business groupswill be based upon the guidelines embodied in PISO's Policy Statement.

4. Financial Strategy. In keeping with its policy of maintaining asound financial structure of improving financial performance as rapidly asoperational constraints will allow, PISO aims to adopt the following strategicobjectives:

(a) A reasonable increase in paid-in share capital that enables PISOto maintain its solvency and liquidity, and at the same time areasonable return on capital. PISO's objective is to retain 40% ofits net earnings. During the 1978-80 period, PISO will closelymonitor securities market conditions with a view to the publiclisting of its shares and the widening of its domestic ownershipbase.

(b) Diversification of sources of long-term foreign and domestic funds.PISO will aim, to the extent possible, to reduce reliance on anyone source of funds. While PISO recognizes that it may be hardpressed to achieve, by 1980, levels of financial performance whichwould permit access /1 to foreign commercial credit on reasonablemarket terms, it will keep this goal in mind as one to be achievedas soon as circumstances permit. One financial strategy to betested is the blending of funds from multilateral financial insti-tutions with those from commercial sources, hoping to yield blendedcosts and repayment terms that meet the requirements of the countryand projects assisted.

(c) An annual growth rate in earnings per share that will enable PISOto attract additional equity capital, when needed.

(d) The broadening of the company's ownership base is considered as animportant objective. A gradually increasing dividend rate isconsidered an essential element in the process of widening PISO'sownership base and making its shares attractive to smaller investors.

5. Promotional Strategy. Between 1978-80, PISO's strategic objectivesin its promotional activities will include:

(a) Promoting (by way of identification, prefeasibility analysis,persuasion of business groups, and financial packaging) the devel-opment of projects in industries which: (i) utilize indigenous rawmaterials; (ii) increase the value-added component in existingproduct lines; (iii) create substantial employment; and (iv) further

/1 Without support by way of government guarantees.

ANNEX 3Page 4

diversify the range of nontraditional manufactured exports. Speci-fically, PISO will attempt to identify and promote projects whichmanufacture a wider range of intermediate an; finished products:wood nnd lumber-based products; copper and nickel-based products;copra and coconut oil-based products; leather-based products;construction-related products and activities; and sugar andmolasses-based products. PISO will also attempt to identifyand develop smaller projects which result in the development andutilization of domestic energy resources (e.g. coal mining).

(b) Promoting the developing of adaptive/intermediate, i.e., labor-intensive technology in industrial operations. While recognizingthe limitations on its abilities to convince business groups andentrepreneurs of adopting more labor-intensive methods of produc-tion, PISO will endeavor to support its attempts at persuasion,with the development of close relationships with faculties ofengineer-.ng and with domestic institutes for science, appliedtechnolog,y and development. PISO will actively cooperate with theTechnology Resource Center in its aim to promote commercially new,appropriate technologies. PISO will also attempt in its projectevaluations to consider whether more labor-intensive modes ofproduction are known which are economically feasible and point outthe advantages/difficulties of adopting such methods in a proposedinvestment.

(c) Promoting the development of indigenous capital goods and engineeringindustries especially in the production of general purpose equipmentcommonly used by other domestic industries.

(d) Promoting small business development. PISO will aim to increaseits operations in this area from around 4-6 projects for loanstotaling P 2 million in 1978 to 15 projects for loans totaling aboutP 7 million by 1980. PISO will actively participate, in a prudentmanner, in the program of the Industrial Guarantee and Loan Funddesigned to assist small entrepreneurs. In this connection, PISOwill attempt to establish formal links with smaller financialinstitutions (such as private development banks and some of thelarger, better-run rural banks) to finance on a joint basis smallbusiness projects in the regions to undertake an analysis intothe feasibility of launching a leasing and hire-purchase financingsubsidiary to address the equipment acquisition problems of smallerenterprises.

(e) Promoting joint ventures and foreign investment in pioneer indus-tries within the framework of established incentives and regula-tions. PISO will actively seek out suitable foreign partners toparticipate in projects which would benefit through the introduc-tion of foreign capital and technology. It will actively assist

ANNEX 3Page 5

domestic entrepreneurs with contractual arrangements with foreignpartners on terms which would equitably meet the mutual interestsof project participants and would yield a substantial benefit tothe domestic economy.

AEP Projects DepartmentApril 1, 1978

ANNEX 4Page 1

PHILIPPINES

PHILIPPINE INVESTMENTS SYSTEMS ORGANIZATION

Related Documents and Data Available in the Project File

A. General Reports and Studies on the Sector or Subsector /1

Al. PDCP, Philippine Business Review: A Report on the Twelfth PDCPSurvey of the Manufacturing Outlook for the year 1976,Manila, II/1976

A2. PDCP, Industry Digest, Studies on Various Industries, Manila,January through June, 1977

A3. PDCP, Studies on Philippine Industries: No. 16 - The Wood Industries,Manila, 1977

A4. Business Day's, 1,000 Top Corporations in the Philippines, Manila,VIII, 1976

A5. Manila Stock Exchange, Investment Guide 1976, Manila, 1976

A6. World Bank, Report on the Small Business Advisory Centers Programof the Department of Industry, Government of the Philippines,(white cover), June 1977

A7. Central Bank of the Philippines, 28th Annual Report, Manila,March, 1977

A8. Central Bank of the Philippines, Statistical Bulletin, Manila,December, 1975

A9. Vicente Muro, Philippine Finincial Institutions, Manila, 1976

A10. Vicente Muro, Philippine Development Banks, Manila, 1976

All. Equityman, The First Asian Securities Industry Forum, variousarticles on industrial finance in the Philippines, ManilaNovember, 1975

A12. Equityman, 1976 IMF- World Bank Annual Meeting, various articleson Banking in the Philippines, Manila, September - October, 1976

B. General Reports and Studies Related to the Project

Bl. PISO, Operational Procedures

B2. PISO, Business Plan 1977, Manila, December 27, 1976

/1 Literature related to the sector and subsector (Al-A12) is catalogued in thePDCP Project File.

ANNEX 4Page 2

B3. PISO, Materials Prepared for Appraisal Mission (operational,financial data and projections)

B4. PISO, Minutes of Shareholders and Board Meetings, Semi-StandardContract Forms, Corporation Documents, Structure andPerformance of Investment Houses,Staff Curricula

B5. PIS0, Business Plan for 1978 and Medium-Term Corporate Plan,Manila, December 16, 1977

B6. PISO, Annual Reports - 1974-76 and 1977 (draft)

B7. SGV, PISO's Audited Financial Reports 1974-77

AEP Projects DepartmentMarch 20, 1978