Completion Report

Project Number: 36419 Loan Number: 2186 October 2010

Philippines: Small and Medium Enterprise Development Support Project

CURRENCY EQUIVALENTS

Currency Unit – peso (P)

At Appraisal At Program Completion (16 August 2005) (13 February 2009)

P1.00 = $0.017 $0.021 $1.00 = P55.75 P47.25

ABBREVIATIONS

ADB – Asian Development Bank BSP – Bangko Sentral ng Pilipinas (Central Bank of the Philippines) BRR – borrower risk rating CIB – credit information bureau CISA – Credit Information Systems Act DTI – Department of Trade and Industry GTZ – Deutsche Gesellschaft für Technische Zusammenarbeit

(German Technical Corporation) JFICT – Japan Fund for Information and Communication Technology KfW – Kreditanshalt fur Wiederaufbau (German Development

Cooperation) MART – Money Market Association of the Philippines MSMEs – micro, small and medium-sized enterprises MTPDP – Medium-Term Philippine Development Plan NPL – nonperforming loan PBR – Philippine business registry PCG – partial credit guarantee PFI – participating financial institution PSOD – Private Sector Operations Department ROA – return on asset SBC – Security Bank Corporation SB Corporation – Small Business Guarantee and Finance Corporation SMEs – small and medium-sized enterprises SULONG – SME Unified Lending Opportunities for National Growth TA – technical assistance

NOTES

(i) The fiscal year (FY) of the Government of the Philippines and its agencies ends on 31 December.

(ii) In this report, "$" refers to US dollars.

Vice-President C. Lawrence Greenwood, Jr., Operations 2 Director General K. Senga, Southeast Asia Department (SERD) Director J. Ahmed, Financial Sector, Public Management, and Trade Division,

SERD Team leader E. Sasaki, Senior Financial Sector Specialist, SERD Team members R. Aquino, Assistant Project Analyst, SERD P. Bracey, Senior Investment Specialist (Capital Markets), Capital

Markets and Financial Sectors Division, Private Sector Operations Department

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

BASIC DATA i

I. PROGRAM DESCRIPTION 1 II. EVALUATION OF DESIGN AND IMPLEMENTATION 1

A. Relevance of Design and Formulation 1 B. Project Outputs 2 C. Project Costs 8 D. Disbursements 8 E. Project Schedule 9 F. Implementation Arrangements 9 G. Conditions and Covenants 9 H. Associated Technical Assistance 10 I. Performance of the Borrower and the Executing Agency 11 J. Performance of the Asian Development Bank 11

III. EVALUATION OF PERFORMANCE 11 A. Relevance 11 B. Effectiveness in Achieving Outcome 11 C. Efficiency in Achieving Outcome and Outputs 12 D. Preliminary Assessment of Sustainability 12 E. Impact 12

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 13 A. Overall Assessment 13 B. Lessons 14 C. Recommendations 14

APPENDIXES 1. Design and Monitoring Framework 17 2. List of Accredited PFIS under the SME Wholesale Lending 20 3. Status of Compliance with Loan Covenants 21 4. An Overview of Small Business Guarantee and Finance Corporation 24

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BASIC DATA A. Loan Identification 1. Country 2. Loan Number 3. Project Title 4. Borrower 5. Executing Agency 6. Amount of Loan 7. Project Completion Report Number

Philippines 2186 Small and Medium Enterprise Development Support Project SB Corporation with a guarantee from the Republic of the Philippines SB Corporation $25 million PCR: PHI 1181

B. Loan Data 1. Appraisal – Date Started – Date Completed 2. Loan Negotiations – Date Started – Date Completed 3. Date of Board Approval 4. Date of Loan Agreement 5. Date of Loan Effectiveness – In Loan Agreement – Actual – Number of Extensions 6. Terminal Date to Commitment – In Loan Agreement – Actual – Number of Extensions 7. Closing Date – In Loan Agreement – Actual – Number of Extensions 8. Terms to the Borrower – Interest Rate – Maturity (number of years) – Grace Period (number of years) 9. Terms of Relending (if any) 10. Interest Rate for Subloans – Original

– Revised

16 February 2005 18 April 2005 16 Aug 2005 16 Aug 2005 29 September 2005 16 December 2005 16 March 2006 28 February 2006 0 October 2013 On-going 0 30 April 2011 13 February 2009 0 LIBOR + 0.60% 15 years 3 years 7.2% - 10.2% 6.3% to 8.5%

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11. Disbursements a. Dates Initial Disbursement

08 March 2006

Final Disbursement 13 February 2009

Time Interval 35 months

Effective Date

28 February 2006

Original Closing Date 30 April 2011

Time Interval 62 months

b. Amount ($ million) Category or Subloan

Original

Allocation

Last Revised

Allocation

Amount

Canceled

Net Amount

Available

Amount

Disbursed

Undisbursed

Balance Phase I 10.000 0 10.000 9.548a 0.452 Phase II 15.000 0 15.000 15.254a (0.254) Total 25.000 25.000 24.802 a 0.198

a Total amount of ¥1,098,650,000 for Phase I and ¥1,647,975,000 for Phase II were fully disbursed; the balance of $0.198 was due to exchange rate at the time of payment. C. Implementation Data

1. Number of Subloans 69

2. Sectoral Distribution of Subloans - wholesale and retail banking Sector Projected Actual

Wholesale Banking 20.000 22.347 Retail Banking 5.000 2.455 Total

3. Size of Subloans (actual)

Range in million US dollars Number of Subloans Aggregate Amount Up to $0.5 million 55 5.743 From $0.501 to $1,0 million 4 2.540 From $1.001 to $2.0 million 8 11.325 Over $2 million 2 5.194

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4. Other Breakdown of Subloans Criteria Projected Actual Wholesale to PFIs - Criteria Three years financial and institutionperformance on: 1. quantitative - profitability, assetquality, solvency and liquidity 2. qualitative - management quality and compliance with the regulatory andindustry standards 3. Composite CAMEL rating of “4.0” 4. Borrower’s Risk Rating of “5.0”

20.000 22.347

Retail Window - Criteria MSMEs in manufacturing, exporting,trading, supplying, exporting activitieswith assets not less than P500 thousandand land not more than P100 millionvalue, one year good track record,except SME contractors

5.000 2.455

Total 25.000 24.802 5. Subloans Above Free Limit

Subloan Aggregate Number Amount None – all subloans were within the limit of P25.0 million per borrower. 0 0 6. Project Performance Report Ratings

Ratings Implementation Period

Development Objectives

Implementation Progress

From 1 July 2006 to 31 December 2006 Satisfactory Satisfactory From 1 January 2007 to 30 June 2007 Satisfactory Satisfactory From 1 July 2007 to 31 December 2007 Satisfactory Satisfactory From 1 January 2008 to 30 June 2008 Satisfactory Satisfactory From 1 July 2008 to 31 December 2008 Satisfactory Satisfactory From 1 January 2009 to 30 June 2009 Successful Successful

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D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Members

Fact Finding Appraisal 16 Feb–18 April 2005 6 36 b, d, e Inception 3–4 April 2006 2 4 b, d Mid-Term Review 1 12–14 February 2007 2 6 c, d Loan Review 2 6 July; 7–10 August 2007 2 10 c, d Loan Review 3 19–26 Sept 2008 1 8 d Project Completion Review 31 May–4 June 2010 2 10 c, d a = economist, b = financial economist, c = project analyst, d = financial sector specialist, e = counsel, f = economist and financial sector officer.

I. PROJECT DESCRIPTION

1. The Small and Medium Enterprise Development Support Project, involved (i) a JPY2,746,625,000 ($25 million equivalent at the exchange rate prevailing at the time of loan effectiveness) project loan from the public sector window of the Asian Development Bank (ADB); and (ii) an up-to P1 billion partial credit guarantee (PCG) and an up-to $1 million equity investment in a credit information bureau from the private sector window. ADB approved the project on 29 September 2005.1 The project loan was signed on 16 December 2005 and became effective on 28 February 2006. The project was designed to help the Government of the Philippines implement its Small and Medium Enterprise Development Plan by: (i) improving the enabling environment for small and medium-sized enterprises (SMEs); (ii) augmenting financial resources at the Small Business Guarantee and Finance Corporation (SB Corporation) and expanding private sector lending to SMEs through a partial credit guarantee; (iii) strengthening SB Corporation's credit underwriting and risk management; and (iv) helping establish a credit information system through an equity investment in the planned credit information bureau. ADB technical assistance (TA) implemented from August 2005 to February 2007 supported item (iii).2 ADB also approved, on 30 August 2005, grant assistance financed by the Japan Fund for Information and Communication Technology (JFICT) for developing the Philippine Business Registry,3 a web-based unified business registry system to support items (i) and (iii). As the Executing Agency, SB Corporation implemented the project and the associated TA. The updated design and monitoring framework of the project is in Appendix 1.

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation

2. The Small and Medium Enterprise Development Support Project was consistent with ADB's country strategy and program update, 2004–2006 for the Philippines,4 which was aligned with the Medium-Term Philippine Development Plan (MTPDP), 2001–2004 focusing on poverty reduction and recognizing SME development through public and private partnership as a potent tool for promoting sustainable growth and generating employment. The country strategy and program, 2005-20075 closely reflected the development agendas in the MTPDP, 2004-2010. It called for supporting entrepreneurs and SMEs to create new jobs and promote broad-based growth. The project, associated TA, and the JFICT project cover a broad area of SME development aimed at improving the enabling environment for SMEs, expanding SME lending through SB Corporation's wholesale and retail lending facilities, strengthening SB Corporation's loan originations and credit management functions, and augmenting the credit authority of selected commercial banks through a partial credit guarantee. Furthermore, the project was designed to complement other development partners' assistance, including assistance from the German Technical Corporation (GTZ) and the Canadian International Development Agency (CIDA) to launch a business development services (BDS) system, and financing for SME development from the German Development Corporation (KfW). Collectively, these

1 ADB. 2005. Report and Recommendation of the President to the Board of Directors: Proposed Loan, Partial Credit

Guarantee, and Equity Investment to the Republic of the Philippines for Small and Medium Enterprise Development Support Project. Manila.

2 ADB. 2004. Strengthening SME Credit Management Systems. Manila. 3 ADB 2005. Grant Assistance to the Republic of the Philippines for Developing the Philippine Business Registry

(Financed by the Japan Fund for Information and Communication Technology). Manila. 4 ADB. 2004. Country Strategy and Program Update, 2004–2006. Manila. 5 ADB. 2005. Country Strategy and Program, 2005–2007. Manila.

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interventions were expected to enhance overall sector investments, outputs, exports, and employment. B. Project Outputs

a. Project Loan 3. The ADB loan of ¥2,746,625,000 ($25 million equivalent at the exchange rate prevailing at the time of loan effectiveness) was fully disbursed in two phases. In the first phase, ¥1,098,650,000 ($9.548 million) was released in five installments during 2006, which was fully utilized for wholesale lending in pesos. Upon the comprehensive review of the first-phase activity, ¥1,647,975,000 ($15.254 million) was released in four installments from 2007 to 2009. In the second phase, the ADB loan was also fully utilized for wholesale (75%) and retail (25%) lending in pesos.

4. ADB Loan Utilization. During project implementation, ADB-funded loan resources were recycled for SB Corporation's lending operations to SMEs. Cumulative lending totaled P3.256 billion, nearly three times larger than the initial drawdown amount. The ADB loan's turnover ratio was 283%. The turnover ratio for wholesale lending was 290%, while that for retail lending was 240%. Short-term loans of a less than 1-year maturity accounted for 89% of wholesale lending and 84% of retail lending. This was because SMEs have high demand for short-term loans to finance working capital. SB Corporation estimates that 90% of SME credit is for working capital financing. Since the latter half of 2006, when KfW started providing its loan to SB Corporation for SME lending, the ADB-funded loan portfolio became more short-term-oriented because of an agreement among ADB, KfW, and SB Corporation that made ADB the main provider of short-term SME loans and KfW the main provider of long-term SME loans. Table 1 shows the ADB-funded loan portfolio breakdown by loan tenures:

Table 1: ADB-Funded Loan Portfolio Breakdown by Loan Tenures (Cumulative loan utilization, February 2006–March 2009)

(P million, unless otherwise indicated)

Loan Term Wholesale Retail Total Less than 6 months

2,107

247

2,354

6 months to 1 year

416

102

519

More than 1 year

317

66

383

Total

2,840

415

3,256

Turnover

290%

240%

283%

Source: SB Corporation.

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5. Historical Loan Origination. Table 2 breaks down SB Corporation's historical loan origination from 2005 to 2009 by number of borrowers, loan release, and average loan amount. A sharp drop in loan release in 2009 was due to declining demands for SME credit amid an uncertain business environment—especially after the second quarter. The global economic and financial crisis negatively affected the SME business environment beginning in the fourth quarter of 2008. Moreover, the Central Bank of the Philippines (BSP) increased the size and lowered the interest rate of its rediscounting facility to provide additional liquidity to the banking system. This directly competed with SB Corporation's wholesale lending operations. The average loan amount under the wholesale lending facility declined gradually from P7.5 million in 2006 to P2.3 million in 2009 as SB Corporation expanded its network to rural banks in remote areas. The average loan amount under the retail lending facility ranged from P2.3 million to P3.0 million during 2006–2009.

Table 2: Historical Loan Origination from February 2006 to March 2009—Number of Borrowers, Loan Release, and Average Loan Amount

Source: SB Corporation. 6. Number of Partner Financial Institutions under the wholesale lending facility. Forty-four partner financial institutions (PFIs), including rural banks in remote areas, participated in the wholesale lending operations of SB Corporation. A list of participating PFIs is in Appendix 2.

Year/Facility

Number of Borrowers

Loan Release (P million)

Average Loan Amount (P million)

2005 Retail Lending

Wholesale Lending Total

241 322 563

440 2,459 2,899

1.8 7.6

2006 Retail Lending

Wholesale Lending Total

212 366 578

536 2,731 3,267

2.5 7.5

2007 Retail Lending

Wholesale Lending Total

161 383 544

426 2,484 2,910

2.6 6.5

2008 Retail Lending

Wholesale Lending Total

166 347 513

501 2,365 2,866

3.0 6.8

2009 Retail Lending

Wholesale Lending Total

158 610 768

360 1,382 1,742

2.3 2.3

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7. Impact on Employment. It is assumed that every P80,000 loan creates one job, and 30% of the jobs created are new jobs. When these formulae, which are used uniformly by the government financial institutions (including SB Corporation), are applied to SB Corporation's lending operations, it is assumed that some 130,000 jobs were created during project implementation, of which about 40,000 were new jobs. The ADB loan accounted for 11% of SB Corporation's total lending in 2006, 51% in 2007, 61% in 2008, and 76% in the first half of 2009. 8. Regional distribution of SME borrowers. Figure 1 and Figure 2 below show regional distributions of ADB-funded retail lending and wholesale lending in terms of loan amount. While wholesale lending has been fairly evenly distributed among Luzon, the Visayas, and Mindanao—especially in 2009— retail lending has been concentrated more in Luzon and less in Mindanao. This is because the average loan size in Mindanao is much smaller than in Luzon and the Visayas. In terms of the number of borrowers, however, Mindanao had 17% while Luzon had 71% and the Visayas only 12% in 2009. SB Corporation targets a regional distribution of 60% for Luzon, 20% for Visayas, and 20% for Mindanao in terms of total loan amount.

Luzon, 72%

Visayas, 16%

Mindanao, 13%

Luzon, 48%

Visayas, 22%

Mindanao, 31%

Luzon, 46%

Visayas, 17%

Mindanao, 37%

Luzon, 38%

Visayas, 29%

Mindanao, 32%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2006 2007 2008 2009 (Jan-Mar)

Year

Figure 1 Regional Distribution of SMEDSP Wholesale Lending (2006 to March 2009)

SMEDSP = Small and Medium Enterprise Development Support Project. Source: SB Corporation.

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Luzon, 84%

Visayas, 15%

Mindanao, 1%

Luzon, 65%

Visayas, 30%

Mindanao, 5%

Luzon, 72%

Visayas, 26%

Mindanao, 3%

0%10%20%30%40%50%60%70%80%90%

100%

2006 2007 2008 2009 (Jan-Mar)

Year

Figure 2 Regional Distribution of SMEDSP Retail Lending

SMEDSP = Small and Medium Enterprise Development Support Project. Source: SB Corporation. 9. Past due. Historical past due ratios of SB Corporation's wholesale lending window have been maintained at less than 3% during the implementation period. SB Corporation's PFI accreditation system, based on borrower risk rating (BRR)—the credit scoring model developed by the associated TA (paras. 26–27)—helped maintain a quality credit standing of PFIs6. Retail lending past due, on the other hand, has stayed at a high level—between 15% and 28%. This is attributed to a limitation that SB Corporation had been suffering from under the previous law governing SME loans, Republic Act 8289. 7 Under that law, SB Corporation had to seek congressional approval to write off nonperforming loans, which hindered SB Corporation's ability to flexibly manage its loan portfolio. In addition, the law forced SB Corporation to keep cumulative nonperforming loans since 1997 (when its retail lending operations commenced) on its books. The law was amended in May 2008 by Republic Act 9501, or the Magna Carta for Micro, Small and Medium Enterprises, which allowed SB Corporation to write off nonperforming loans following its by-laws and BSP rules. It is expected that the new law will reduce the past due ratio of retail loans. Table 3 below tracks the past due ratio of SB Corporation's wholesale and retail loans from February 2006 to March 2009.

6 A PFI must meet the BRR of 5.0 out of 10.0. 7 Republic Act 6977, as amended by Republic Act 8289, known as the Magna Carta for Small Enterprises.

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Table 3: Historical Past Due Ratio of SB Corporation from February 2006 to March 2009 (P million, unless otherwise indicated)

Year/Facility Past Due

Total Loans Outstanding

Loan Loss Provision

Past Due Ratio (Net of Provision)

2005 Retail Lending

Wholesale Lending

151 61

532 1,025

46 15

19.9 %

4.5 %

2006 Retail Lending

Wholesale Lending

203 56

474 1,014

67 41

28.6 %

1.5 %

2007 Retail Lending

Wholesale Lending

210 57

494 1,152

79 43

26.5 %

1.2 %

2008 Retail Lending

Wholesale Lending

220 145

534 1,355

93

104

23.8 %

3.0 %

2009 Retail Lending

Wholesale Lending

195 120

459 857

125 113

15.3 %

0.8 %

Source: SB Corporation.

b. Credit Scoring 10. Associated TA that was integral to the Small and Medium Enterprise Development Support Project was successfully implemented from August 2005 to February 2007. The TA enhanced SB Corporation's institutional capacity by reorganizing its management structure, introducing a credit scoring model, developing a management information system, and improving its products (see paras. 26 and 27 for more on this TA). 8 It has helped SB Corporation utilize the ADB loan efficiently and effectively for SME lending through wholesale and retail facilities. The TA also contributed to the development of the BRR tool, which after completion of the TA was disseminated and shared with SB Corporation's PFIs through workshops funded by KfW. The BRR tool helps PFIs evaluate, monitor, and manage SME loans, and will improve the overall quality of their loan portfolio.

c. Partial Credit Guarantee 11. The project included, as a private sector operation, a PCG for selected commercial banks without sovereign guarantee. The PCG was to have an overall limit of P1 billion (equivalent to $18.40 million at the exchange rate prevailing at the time of appraisal); the PFIs covered the remaining risk of P1 billion. In addition to the proposed 50/50 risk-sharing scheme between ADB and the PFI, ADB will negotiate a first-loss provision (based on the PFI’s loss experience) to be entirely assumed by the PFI. Primarily international banks and local banks

8 ADB. 2007. Technical Assistance Completion Report Strengthening SME Credit Management Systems (TA 4523-

PHI with the approved amount of $500,000). Manila.

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accredited in the ADB regional Trade Finance Facilitation Program9 were to be considered for inclusion in the PCG facility—subject to approval from the Director General of ADB’s Private Sector Operations Department (PSOD) and ADB’s Guarantee Committee, as well as satisfactory due diligence by PSOD. The PCG compliments SB Corporation’s lending operations by focusing on larger SMEs that are not covered by SB Corporation. A PCG can be provided to ADB-accredited banks until 2013. PSOD, in close collaboration with the Office of Cofinancing Operations, was to structure, process, and monitor the PCG facility. Thus far, one bank—Security Bank Corporation (SBC)—has utilized this facility. 12. SBC is a medium-sized bank with total assets of P146.25 billion as of end-2009. Under the program, ADB was to guarantee 50% of SBC’s exposure for SME lending. On 26 April 2007, the Guarantee Facility Deed was signed with SBC for a maximum amount of P500 million (US$10.5 million), of which P100 million (US$2.1 million) is effective. SBC, in a bid to diversify its loan portfolio, entered the higher-yield SME market. The strategy involves program lending for SMEs that are within the value chain of the bank's corporate clients. To contain the risk associated with SME lending, a specific lending program with set parameters was developed for a specific group of SMEs. These SMEs had to meet a pre-approved set of prudent credit criteria and every facet of the credit process had to conform with defined procedures. This enabled SBC to process individual SME accounts faster, yet still follow sound credit underwriting procedures. As of end-2009, SBC had a distributorship program with one major food and beverage company within the Philippines. Given the successful utilization of this program, SBC has requested—and ADB is considering granting—an increase of the program limit for the existing distributor and an expansion of the program to include other distributors. In addition, other banks will be targeted for inclusion in the facility in line with the expansion of the Trade Finance Facilitation Program in the Philippines.

d. Equity Investment in the Planned Credit Information Bureau. 13. On 31 October 2008, the President of the Philippines approved Republic Act No. 9510, "An Act establishing the Credit Information System Act (CISA)." Recognizing the need to collect and disseminate fair and accurate information about the track record of borrowers and the credit activities of all entities participating in the financial system, the CISA established a comprehensive and centralized credit information system. On 27 May 2009, the Implementing Rules and Regulation of the CISA (CISA rules) were approved by the Congressional Oversight Committee and became effective immediately. The CISA rules define which entities must submit credit information, specify the data to be submitted, and outline other rules and regulations. The CISA rules also established the Central Credit Information Corporation.

14. According to the CISA Rules, the authorized capital stock of the Central Credit Information Corporation will be P500 million, divided into 1.250 million common shares with a par value of P100, and 1.875 million preferred shares with a par value of P200. The government will purchase 60% of the common shares through budgetary appropriation. Qualified investors (limited to industry associations of banks, quasi-banks and other credit-related associations, including associations of consumers) will purchase the remaining 40%. The restricted ownership

9 The Trade Finance Facilitation Program (TFP) provides loans and guarantees through banks in support of

international and intra-regional trade. In March 2009, ADB approved the expansion of the TFP, from its initial approval of $150 million in exposure limits in 2003, to $1 billion. TFP expansion has been aggressive throughout 2009 and 2010, including in the Philippines. In February 2010, limits were approved for eight banks, of which four have signed TFP agreements. As of June 2010, the TFP conducted 13 transactions supporting over $4.5 million of trade in the Philippines.

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of the Central Credit Information Corporation precludes an ADB equity investment in a credit bureau (the project originally envisaged such an investment by ADB).

e. Philippine Business Registry 15. The JFICT project of $700,000 was approved by the ADB on 30 August 2005. It was designed to help the government develop the Philippine Business Registry (PBR), with the aim of shortening the time required to license and register businesses, thus reducing the cost of doing business in the Philippines, improving the overall business environment, and ultimately increasing domestic and foreign investment. The PBR is a web-based portal site for providing: (i) unified registration and licensing procedures, and; (ii) business development information to Philippine businesses. Project implementation started in March 2006 and ended in December 2009. The project interfaced the PBR to the registration systems of partner agencies and local government units, which are considered critical to the success of the PBR. So far 18 central government agencies and 30 local government units have been electronically connected with the PBR. The JFICT project has also supported institutional development within 15 National Economic Research and Business Assistance Centers nationwide; these centers are engaged in business development and the facilitation of business registration and licensing.

f. A Blueprint of a Movable Collateral Registry

16. The associated TA was to create a blueprint for a movable collateral registry based on a review of existing laws and recommendations for amending current laws or creating new ones. However, internal consultations found that the Philippines' legal and regulatory environment was sufficiently strong to establish a movable collateral registry. Based on this finding, SB Corporation and ADB agreed that analytical work to formulate a blueprint for a movable collateral registry be dropped from the original TA scope (footnote 7). C. Project Costs

17. ADB's share of SB Corporation funding for relending under the wholesale lending facility and onlending under the retail lending facility is set at a maximum of 65%. This limit was adhered to for the entire implementation period, with the ADB share standing at 54% for wholesale lending and 35% for retail lending. D. Disbursements

18. The Small and Medium Enterprise Development Support Project was to be implemented over 5 years from the effective date of 28 February 2006. The closing date for submission of drawdown applications, and approval and authorization for disbursement from the loan, was to be 28 February 2011. The loan was actually fully withdrawn with the last drawdown in January 2009, 2 years ahead of the planned schedule. This was because the cost of the ADB loan was significantly lower than the cost of SB Corporation's traditional funding, and by utilizing the ADB loan more quickly SB Corporation was able to rapidly lower its average funding costs.10 SB Corporation conducted the ADB-funded operations efficiently for earlier disbursements than planned due to the cost-related incentive. 10 While the Yen-Libor-based ADB loan has provided a funding cost of about 5.2% per annum in peso terms, both

preferred and common shares have been paying a dividend of 8% per annum. As the interest payment is tax- deductable but share dividend is not, the difference is even larger. Early disbursements would also reduce commitment charges payable to ADB, as a commitment charge of 0.75% per annum was charged against the unutilized potion of the ADB loan.

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E. Project Schedule

19. The project was closed in February 2009, 2 years ahead of the planned schedule. F. Implementation Arrangements

1. SB Corporation Relending to PFIs and Onlending to SMEs

a. Relending to PFIs

20. A total of $21.25 million equivalent of the ADB loan has been lent through SB Corporation’s accredited PFIs for onlending to eligible SMEs under the wholesale lending facility. The amount of these loans ranges from P100,000 to P15 million, with maturities from 1 year to 5 years. Since 20 June 2007, SB Corporation has charged PFIs relending rates of 6.3%–8.0% per annum for loans of less than 1 year maturity, and 7.0%–8.5% per annum for loans of more than 1-year maturity. PFIs added charges to cover their costs and reflect the credit risk. SB Corporation created revolving funds from repaid subloans to make new loans under the same criteria. Monthly charges to PFIs are computed based on 80% of the benchmark rate of the Money Market Association of the Philippines (MART I), plus 0.1% plus gross receipts tax. SB Corporation has been accrediting PFIs using the BRR tool, which basically corresponds to ADB Guidelines on Financial Intermediary Loans. b. Onlending to SMEs 21. Of the ADB loan, $3.75 million equivalent has been allocated to SB Corporation’s retail lending. Retail loans have ranged from P200,000 to P5 million, with maturities up to 5 years and interest rates determined based on the BRR and the degree of security. Interest rates since 1 April 2009 have been 10.1% per annum for fully secured loans with up to 1 year maturity, 10.8% per annum for loans with 1–3 year maturity, and 11.9% per annum for loans with 3–5 year maturity. An additional charge of 0.4%–4.4% (depending on the BRR) and 0.1%–0.7% (depending on the degree of security) were imposed. SB Corporation created revolving funds from repaid subloans to make new loans under the same criteria. 22. Since 2007, ADB has provided short-term loans and KfW has provided long-term loans to SMEs in accordance with an operational demarcation agreed upon by ADB, KfW, and SB Corporation. Implementation arrangements have been adequate to fund SB Corporation's SME lending under both its wholesale and retail facilities. Revolving funds have seen a high turnover of 290% for wholesale lending, and 240% for retail lending during project implementation.

2. Partial Credit Guarantee 23. Since April 2007, one commercial bank—SBC—has been utilizing the partial credit guarantee facility with a maximum amount of P500 million, of which P100 million is effective. ADB is considering increasing the program limit in response to SBC’s request. Other banks will be targeted for inclusion in the facility. G. Conditions and Covenants 24. SB Corporation complied with almost all of the covenants, with some delay in the submission of the financial reports. SB Corporation partly complied with the return on asset (ROA) and nonperforming loan (NPL) ratio requirements. In 2007, the ROA was 2.3%—higher

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than the covenanted figure of 2%. However, in 2006 the ROA was 1.7% and in 2008 the ROA was only 0.4%. The low 2006 ROA figure was mainly attributable to increased assets on ADB loan release. The low 2008 ROA Figure was mainly attributable to a large “other income” deduction (mainly comprising the foreign exchange loss caused by the utilization of the KfW loan in 2008). SB Corporation partly complied with the required NPL ratios. It complied with the required NPL ratio for wholesale lending,11 but not for retail lending. Annual NPL ratios for retail banking were much higher than banking industry averages because of the reasons mentioned in para. 9. The retail lending NPL ratio was 26.5% in 2007 (industry average 5.1%), 23.8% in 2008 (industry average 3.9%), and 15.3% in 2009 (industry average 3.1%). The status of compliance with loan covenants is in Appendix 3). Key financial data for SB Corporation from 2002–2009 are in Appendix 4. 25. According to the historical data, the submission of annual audited financial reports by SB Corporation ranged from 7 months to 9 months after the close of the fiscal year—longer than the covenant requirement of not later than 6 months after the close of the fiscal year. SB Corporation explained that the delay was due to the Commission on Audit's heavy workload (the commission is tasked with auditing a large number of government owned and controlled corporations and other government agencies).

H. Related Technical Assistance

26. TA 4523 PHI: Strengthening SME Credit Management Systems was approved on 23 December 2004 and implemented from June 2005 to February 2007. The TA completion report was submitted in December 2007 (see footnote 7). The TA was designed to expand the quantity and improve the quality of SB Corporation's lending operations, while lowering risk by (i) enhancing the management information system; (ii) updating and/or redesigning SME loan products incorporating cash flow, character, and nontraditional collateral into underwriting; (iii) developing a credit scoring model for SB Corporation's retail lending, and; (iv) creating a blueprint for registry of movable collateral. The consultants successfully met the terms of reference of the TA and delivered their reports on time. The following is a summary of key outputs:

(i) Lending Business—The TA provided international expertise to SB Corporation managers and staff in support of building efficient, profitable lending businesses that can achieve substantial outreach.

(ii) Underwriting Process—The TA provided a specialist in loan product

development who worked with SB Corporation management to ensure that non-asset-based lending methodologies are incorporated into their underwriting process.

(iii) Credit Scoring Model—The TA assisted SB Corporation in developing a proprietary credit scoring model that incorporates SB Corporation's own underwriting standards and draws upon lessons learned from its own lending experience. Based on the available database, the credit scoring model was further developed into the BRR system, which associates classes of borrowers with various empirically determined default probabilities.

11 Wholesale lending NPL ratios were 1.5% for 2006, 1.2% for 2007, 3.0% for 2008, and 0.8% for 2009.

11

27. Overall, the TA was successful, as it achieved its objectives. The formulation of the TA scope and design was coordinated closely with the Executing Agency, SB Corporation, resulting in a strong partnership. The various training workshops utilized case studies and discussion methods and drew strong participation from the officers and management of SB Corporation. The expected outcome—to improve the quality of lending operations of SB Corporation—has been achieved through reorganization and establishment of a good risk management system. Since the completion of the TA, SB Corporation has continued to improve its systems. I. Performance of the Borrower and the Executing Agency

28. SB Corporation, as Executing Agency and borrower, implemented the Small and Medium Enterprise Development Support Project and the associated TA effectively, meeting fully the responsibilities assigned in the implementation plan, with no performance weaknesses identified. The institutional capacity of SB Corporation in implementing the TA was adequate. This facilitated an earlier-than-projected closing of the credit line operation and timely completion of the TA. Furthermore, the TA improved SB Corporation's SME lending capacity by reorganizing its management structure, improving its underwriting process, and introducing a credit scoring model. The performance of SB Corporation as borrower and Executing Agency is rated highly satisfactory. J. Performance of the Asian Development Bank

29. ADB, with SB Corporation’s assistance, carried out a comprehensive review of the project in February 2007, 12 months after loan effectiveness. The review assessed progress of lending under the first phase of the loan and analyzed the deliverables from the associated TA to evaluate SB Corporation's progress in strengthening its credit evaluation and risk management practices. ADB conducted annual project reviews in August 2007 and September 2008. In addition, ADB coordinated with KfW to ensure complementarity between the ADB and KfW credit lines and associated TA. SB Corporation's completion report confirmed that three ADB project review missions were conducted, and determined that ADB guidelines conformed with and did not contradict government and SB Corporation guidelines. The report noted that ADB provided training on ADB policies and guidelines, and that this training helped SB Corporation better manage the project and minimize problems. ADB's project implementation was adequate and timely. The performance of ADB is rated satisfactory.

III. EVALUATION OF PERFORMANCE

A. Relevance

30. The design of project was relevant. The project design was consistent with ADB's country strategy and program, the government's MTPDP, and other development partners' assistance in recognizing SME development as a potent tool for generating employment and reducing poverty. The project aimed to expand SME lending through SB Corporation, strengthen SB Corporation's credit management functions, and augment the credit authority of selected commercial banks through a PCG. The associated TA and the JFICT project were integral to the project. B. Effectiveness in Achieving Outcome

31. Neither SB Corporation's wholesale nor its retail SME lending saw growth during the implementation period. As Table 2 indicates, annual lending from 2005–2008 fluctuated from

12

P420 million to P530 million for retail lending, and from P2.3 billion to P2.7 billion for wholesale lending. During the same period, gross outstanding loans in the Philippine banking system ranged between P2,153,568 billion (December 2005). Because of the business slowdown and BSP's move to increase the size and lower the interest rate of its rediscounting facility (para. 5), SB Corporation saw a sharp drop in lending in 2009. Retail lending declined 28% and wholesale lending declined 40% compared with 2008. Meanwhile, the number of SME borrowers taking out wholesale loans increased dramatically from about 320–380 to 610 in 2009, as SB Corporation expanded its wholesale lending network to include smaller borrowers in the countryside. This brought down the average wholesale loan amount to about P2.3 million—roughly the same average as retail loans. 32. Past due ratios improved from 28% in 2005 to 15% in 2009 for retail lending, and from 4.5% to 0.8% for wholesale lending. There had been a structural constraint to flexibly writing off nonperforming loans in retail lending (see para. 9). Under the new law, it is expected that past due ratios in retail lending will continue to decrease. The introduction of the BRR in retail lending and SB Corporation's move to share BRRs with PFIs have also improved the quality of SB Corporation's wholesale and retail loan portfolios. While ADB-funded SME credit lines failed to reach growth targets in lending, the improvement of SB Corporation's loan portfolio and its expanded outreach are positive signs. The project is rated effective. C. Efficiency in Achieving Outcome and Outputs

33. The ADB loan was utilized extremely well over the 3-year implementation period recycled through revolving funds for SB Corporation's lending operations. Cumulative lending to SMEs was almost three times larger than the initial drawdown amount. Against the original planned completion date of 28 February 2011, the project loan was closed on 13 February 2009—2 years ahead of schedule. That SB Corporation was able to make disbursements much earlier than planned is a sign of its efficiency. The project is rated highly efficient. D. Preliminary Assessment of Sustainability

34. Under Republic Act 9501 (para. 9), SB Corporation is mandated to champion national SME development through financial and related technical assistance, including information services, training, and marketing.12 Given its enhanced role in implementing comprehensive SME development policies and programs, SB Corporation is likely to sustain its operations in the future, provided that the government remains committed to SME development. E. Impact

35. The ADB loan has replaced traditional funding resources for SME lending and reduced SB Corporation's average funding cost. Since the project commenced, traditional funding resources have been freed up for a new operation—the Microfinance Wholesale Lending Facility for refinancing microfinance institutions' lending to their clients, which has seen good growth. Figure 3 shows the performance of the Microfinance Wholesale Lending Facility. The ADB loan has thus helped SB Corporation diversify its operations and become the leading government corporation engaged in microenterprise and SME development. 12 Securities and Exchange Corporation. 13 of RA 9501 stipulates, “SB Corporation …. shall be charged with the

primary responsibility of implementing comprehensive policies and programs to assist MSMEs (Micro, Small and Medium Enterprises) in all areas, including but not limited to finance and information services, training, and marketing.”

13

36. The ADB project loan was the first development-partner-funded credit line to SB Corporation. It was followed by the KfW credit line and a credit line provided by the International Fund for Agricultural Development (IFAD).13 The ADB project helped catalyze this additional development partner funding on favorable terms and conditions, thus improving SB Corporation's long-term funding status.

Figure 3: Microfinance WholesaleFigure 3: Microfinance Wholesale

16 41 43 123

358

646

913

1,067

0

200

400

600

800

1,000

1,200

in m

illio

n pe

sos

2002 2003 2004 2005 2006 2007 2008 2009Year

Source: SB Corporation.

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS

A. Overall Assessment

37. The Small and Medium Enterprise Development Support Project has helped SB Corporation expand its outreach, improve the efficiency of its loan operations, and strengthen the quality of its loan portfolio. The project and associated TA have helped SB Corporation strengthen its capacity and grow into the government's leading microenterprise and SME development corporation. The project has also helped catalyzed funding on favorable terms from other development partners to improve SB Corporation's funding base. While the project failed to achieve numerical targets in terms of loan growth set out in the design and monitoring framework, the project is rated successful based on the aforementioned positive institutional impacts.

13 The loan from KfW is an €11.7million denominated loan, effective in August 2006, to finance loans for micro, small

and medium-sized private enterprises mainly in Mindanao and the Visayas. The loan has a 40-year term, including a grace period of 10 years, with an interest rate of 0.25% per annum. The loan form IFAD is a peso-denominated subsidiary loan from the Republic of the Philippines in the amount of SDR10 million equivalent, effective October 2006, to finance the Rural Micro Enterprise Promotion Programme. The loan has a 25-year term, including an 8-year grace period, with an interest rate of 4.75% per annum.

14

B. Lessons

38. A credit line operation can be efficiently conducted through a sound operating financial institution focused on sector development. SB Corporation's healthy institutional and operational structure (supported by the associated TA—see para. 10), coupled with clear, effective laws (see paras. 9 and 34), have helped it conduct lending operations efficiently and effectively. In other words, vibrant SME lending operations must be supported by effective policy and institutional arrangements. C. Recommendations

39. Indicators in the design and monitoring framework should be realistic, focusing broadly on institutional development in SME financing rather than narrowly discussing loan growth. 40. The executing agency's 6-month window for submitting audited financial reports should be expanded. Delays in submission of these reports in this project were beyond the control of the executing agency, as the reports were prepared by the Commission on Audit. It is recommended that the submission deadline be extended to least 9 months from the close of the fiscal year. 41. Follow-up. The project augmented SB Corporation's lending resources to the extent that the ADB loan accounted for 51% of SB Corporation's total lending in 2007, 61% in 2008, and 76% in the first half of 2009. The ADB loan carries a 15-year term, with principal repayment starting in 2009. SB Corporation will need to seek alternative funding sources to sustain the current level of lending, as the outstanding ABD loan is declining year by year, and will become nil in 2021. Alternative funding sources might include commercial borrowing, capital markets, additional lending from development partners, or SB Corporation's preferred share and/or liability instruments subscription by lending institutions as an alternative compliance with the mandatory credit allocation to the micro, small and medium-sized enterprise sector under Republic Act 950114. The future funding status of SB Corporation should be monitored to confirm whether it can finance the level of SME lending supported by the project. 42. Figure 4 below shows SB Corporation's wholesale lending performance in recent years. The stagnancy witnessed in the last 3 years is mainly attributable to the BSP increasing the size and lowering the interest rate of its rediscounting facility to provide additional liquidity to the banking system in late 2008 (para. 5). The comparative advantage in price and size of the BSP facility has resulted in a sharp drop in SB Corporation's wholesale lending operations.15 How SB Corporation locates its wholesale lending facility and develops other products in response to the BSP move and changing market conditions needs to be monitored.

14 RA 9501 mandates that all lending institutions allocate 8% of their total lending to micro and small enterprises, and

2% of their total lending to medium-sized enterprises. 15 BSP's rediscounting facility of P40 billion was activated in November 2008 to cope with possible adverse effects on

the economy stemming from the global financial crisis. The BSP uses the facility to set monetary policy, provide liquidity, and act as the lender of last resort. It can be tapped at a rate referred to as the overnight reverse repurchase rate, which is substantially lower than SB Corporation's wholesale lending prime rate. The rediscounting facility has been almost fully utilized by the banking system. Its size was increased to P60 billion in March 2009 amid fears of an economic slowdown, before being decreased to P40 billion in February 2010 and P20 billion in May 2010 amid possible signs of inflationary economic expansion.

15

Source: SB Corporation. 43. Additional assistance. Republic Act 9501 charges SB Corporation with primary responsibility for SME development in a broad range of areas, including finance, information services, training, and marketing (see footnote 10). During implementation of the project, SB Corporation disseminated and shared with PFIs the BRR developed by the associated TA, and conducted a financial literacy program for raising entrepreneurs' awareness of the importance of various financial concepts, including book-keeping, application of management information systems, business plans, and debt management. SB Corporation's effort to develop the capacities of PFIs and SMEs can be supported by future ADB assistance to fill the gap of financing its nonlending activities. 44. Figure 5 shows SB Corporation's guarantee operation performance since 2002. The low profile of the guarantee operation vis-à-vis lending operations is due to the corporate status of the guarantee, which requires PFIs to accept a 100% risk weight. The current governing law does not confirm the sovereign status of SB Corporation's credit guarantee, which would be of a 0% risk weight. While SB Corporation can seek endorsement of the national congress to the sovereign status granted to its guarantee products, it would benefit from ADB guaranteeing to back up its credit guarantee products, which would be 20% risk-weighted—substantially lower than the current 100%. An ADB guarantee to back up SB Corporation's credit guarantee products would better meet the needs of SME financing institutions seeking a lower risk weight.

Figure 4: Wholesale Lending

795 1,275

2,227 2,459 2,730

2,484 2,365

1,411

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000in

mill

ion

peso

s

2002 2003 2004 2005 2006 2007 2008 2009Year

16

Source: SB Corporation. 45. Timing of the project performance evaluation report. The project performance evaluation report can be prepared after 2013 when the implementation period of the PCG facility is over.

Figure 5: Credit Guarantees

119

272 288

229

316

213167

83

0

100

200

300

400

500in

mill

ion

peso

s

2002 2003 2004 2005 2006 2007 2008 2009Year

Appendix 1 17

DESIGN AND MONITORING FRAMEWORK Design Summary

Performance Indicators/Targets

Actual Achievements

Monitoring Mechanisms Assumptions and Risks

Impact Improve the contribution of small and medium-sized enterprises (SMEs) to economic growth and employment

Increase in formal employment in SMEs. The government’s goal is at least 6 million jobs created by 2010 based on the growth projections in the Medium Term Philippine Development Plan (MTPDP). Increase SMEs' share in value added. The government’s target is an increase from 32% in 2002 to 40% in 2010 based on growth projections in the MTPDP. The Medium Term Philippine Development Plan (MTPDP) builds on a benign external environment to support annual real gross domestic product (GDP) growth of at least 6%.

Total employment generated by MSMEsa are the following: 2006 = 3,327,855 2007 = 3,355,742 2008 = 3,395,505 2009 = 3,595,641 Government data is not available yet. Growth rates of real GDP were 5.3% in 2006, 7.1% in 2007, 3.7% in 2008 and 1.1% in 2009.

National Statistics Office database to determine number of employees by sector and size distribution National Statistics Office database to determine changes in value added (census) by SMEs and size distribution

Assumptions • Continued strong political commitment and support for SME development • Continuous implementation of the MTPDP and SME Development Plan Risk • Deteriorating macroeconomic environment

Outcome Improve the enabling environment for SMEs and facilitate greater access to finance

Increased SME lending at SB Corporation (a 250% increase in wholesale lending and a 300% increase in retail lending) by 2009. Aggregate lending target through SB Corporation is at least $7 million under the first $10 million, in the first 18 months after the first withdrawal. Increased SME lending in terms of SME borrowers and SME lending volume at participating financial institutions (PFIs) under the partial credit guarantee (PCG). Credit information bureau (CIB) and

No increase in SME lending, however, outreach, efficiency and quality of SME lending at SB Corporation have improved. Achieved Not available yet CIB will be established in

Data from SB Corporation and selected participating financial institutions for the SB Corporation component Data from the selected participating financial institutions for the PCG component Review missions to assess

Assumptions • Continued strong political commitment and support for SME development and implementation of the SME Development Plan • Delay in passing the enabling legislation for the CIB • Delay in release of budget funds for the PBR Risk • Deteriorating macroeconomic environment that make financial institutions more cautious in SME lending

18 Appendix 1

Design Summary

Performance Indicators/Targets

Actual Achievements

Monitoring Mechanisms Assumptions and Risks

Philippine Business Registry (PBR) established. within 1 year of law enactment and operating within 1 year of release of funds.

accordance with the new law. PBR framework has been developed by the JFPR project for full operation.

operations

Outputs 1. Increased SME lending by SB Corporation and participating financial institutions under the credit line and the PCG 2. Equity investment in the CIB 3. SB Corporation’s credit underwriting and risk management practices, developed under the associated TA, are strengthened 4. Associated project to implement phases one and three of the PBR with support from the

SB Corporation’s number of SME borrowers to increase by 250% by the end of 2009. SB Corporation’s retail lending to increase by 250% during 2005–2009, and wholesale lending to increase by 300% over the same period. Increased number of SME borrowers at the accredited participating financial institutions under the PCG. The enabling legislation passed and the credit bureau operational, as envisaged. The target is for the CIB to be operational within 1 year of legislation being passed. Return on assets of not less than 2.0% for SB Corporation, 2005–2009 Capital adequacy ratio of not less than 10%, 2005–2009 Nonperforming loans as percent of total loans of not more than the industry average by 2009 Hardware and software procured and installed or upgraded at participating

Number of borrowers increased by 36% from 2005 to 2009. Due to the global economic crisis in 2008, 2009 lending declined both for wholesale and retail lending. Not available yet. The legislation passed already. Under the new law the CIB is being established for operation. 1.6% in 2005, 1.7% in 2006, (2.3%) in 2007, 0.4% in 2008, and 0.9% in 2009. Achieved Yes for wholesale lending, no for retail lending because of the institutional constraint Achieved

Data from SB Corporation and its PFIs. Data from SB Corporation and its accredited PFIs Data from PFIs Enacted law, equity investments made, and CIB operational Deliverables of the associated TA and review missions to assess processes and implementation same SB Corporation data SB Corporation data verified by BSP Review missions and progress reports to evaluate hardware, software, interface

• SB Corporation able to effectively relend and onlend the Asian Development Bank (ADB) loan • Consultants recruited in a timely manner and effective delivery and implementation of deliverables under the TA for credit underwriting and enhanced risk management, and the information and communications technology component for the PBR Risks • Delay in passing the enabling legislation for the CIB • Delay in release of budget funds for the PBR

Appendix 1 19

Design Summary

Performance Indicators/Targets

Actual Achievements

Monitoring Mechanisms Assumptions and Risks

Japan Fund for Information and Communication Technology (JFICT) 5. Simplified SME registration and annual licensing processes, undertaken under the associated JFICT project. 6. A blueprint for a movables collateral registry developed under the associated TA.

government agencies. Electronic interfaces developed and operationalized between participating government agencies. Data flow between the government agencies linked under phases one and three of the PBR. Streamlined and standardized requirements, documents, and forms available online, and reduced processing time. Blueprint and a strategy for implementation ready by the completion of the TA, targeted by July 2006.

Developed but not operational yet Achieved The unified registration system developed but not yet operational Not relevant (dropped from the TA scope)

and usage, and data flow TA deliverables and review missions to assess new processes TA deliverable and review missions and workshops to disseminate findings

Activities with Milestones 1. Provision of a credit line through SB Corporation for onlending to SMEs

Start: October 2005 Complete: October 2010 Responsibility: ADB Southeast Asia Governance, Finance and Trade

Division (SEGF)and SB Corporation 2. Provision of private sector PCG through the PFIs for financing SMEs

Start: October 2005 Complete: October 2013 Responsibility: ADB Private Sector Operations Department (PSOD),

Office of Cofinancing Operations and SEGF 3. Equity investment in the planned CIB start: when legislation has been

passed and investments have been finalized by all sponsors Target date: end of 2005 Responsibility: ADB PSOD and the Central Bank of the Philippines (BSP)

4. Associated TA for Strengthening SME Credit Managementb

Start: August 2005 Complete: August 2006 Responsibility: ADB SEGF, SB Corporation, and the Department of Trade and Industry

5. Associated JFICT project to support (i) phase one and three of the implementation of the Philippine business registry, and (ii) facilitation and streamlining of registration and licensing processes.

Start: September 2005 (expected release of budget funds) Complete: September 2006

Inputs 1. $25 million equivalent in yen credit line from ADB’s ordinary capital resources 2. Up to P1 billion in PCG (equivalent to $18.4 million) 3. Up to $1 million 4. $500,000 from the Japan Special Fund and $218,500 from the Government of the Philippines 5. $700,000 from JFICT

a Since May 2008, under Republic Act 9501, Magna Carta for Micro, Small and Medium Enterprises (MSMEs), SMEs has included micro enterprises with value of not more than three million pesos.

b ADB. 2004. Technical Assistance to the Republic of the Philippines for Strengthening SME Credit Management Systems. Manila.

Source: Asian Development Bank.

20 Appendix 2

LIST OF ACCREDITED PARTICIPATING FINANCIAL INSTITUTIONS UNDER THE SMALL AND MEDIUM-SIZED ENTERPRISE WHOLESALE LENDING COMPONENT

(as of December 2009)

• Commercial Banks

– Banco de Oro Unibank – Bank of Commerce – Landbank of the Philippines – Philippine Bank of Communications – Philippine Veterans Bank

• Thrift Banks

– Asiatrust Development Bank – First Consolidated Bank – Planters Development Bank – World Partners Bank (A Thrift Bank) Inc.

• Rural Banks

– 1st Valley Bank, Inc. – Asian Hills Bank – Bangko Nuestra Señora del Pilar, Inc. – Bangko Pangasinan – A Rural Bank, Inc. – BMS Rural Bank – Cantilan Bank, A Rural Bank – Cooperative Bank of Benguet – Cooperative Bank of Ilocos Norte – Cooperative Rural Bank of Cavite – Countryside Cooperative Rural Bank of Batangas – Enterprise Bank – Enterprise Capital Bank – First Agro Industrial Rural Bank – First Macro Bank – Green Bank – Lapu-Lapu Rural Bank Inc. – Limcoma Rural Bank – Metro South Cooperative Bank – New Rural Bank of San Leonardo – One Network Bank – People’s Bank of Caraga – Producers Rural Banking Corporation – Rural Bank of Alabang (Muntinlupa), Inc. – Rural Bank of Florida Blanca – Rural Bank of Pres. M.A. Roxas – Rural Bank of San Jose Camarines Sur Inc. – Tiaong Rural Bank – Valiant Rural Bank, Inc.

Appendix 3 21

STATUS OF COMPLIANCE WITH LOAN COVENANTS

Covenant

Reference in Loan

Agreement

Status of Compliance The Borrower shall carry out the Project with due diligence and efficiency and in conformity with sound banking, administrative, financial, environmental and business practices under the supervision of competent and experienced management and personnel and shall actively promote the utilization of the SME facility; Except as ADB may otherwise agree, the Borrower shall not substantially amend the credit manual; The Borrower shall at all times make adequate provision to protect itself against any loss resulting from changes in the rate of exchange between Philippine Pesos and the currency or currencies in which the Borrower's outstanding money obligations will have to be met; The Borrower shall enter into appropriate fee-based foreign exchange hedging arrangements with the Guarantor in respect of the Loan; The Borrower shall ensure that all local currency funds and other resources which are required by the Qualified Enterprises for the carrying out of their respective Qualified Activities shall be available to such Qualified Enterprises promptly as needed; The Borrower shall exercise its rights under the Subsidiary Loan Agreements and the subloan agreements in such a manner as to protect the interests of the Borrower and ADB and to accomplish the purposes of the Loan; No significant rights or obligations under a Subsidiary Loan Agreement shall be assigned, amended, abrogated or waived without the prior concurrence of ADB; The Borrower shall maintain and ensure each PFI maintains legal documentations and records adequate to record and monitor the use of Loan proceeds and to ensure compliance by each PFI and each respective Qualified Enterprise with the terms and conditions of the subloans and Credit Manual as the case may be, all in accordance with the standards of a prudent lender. The Borrower shall enable ADB's representatives to inspect such and any other relevant records and documents maintained by the Borrower and the PFIs and goods, where available, financed out of the proceeds of the Loan;

Sec. 5.01 (a) Sec. 5.01 (b) Sec. 5.02 (a) Sec. 5.02 (b) Sec. 5.03 Sec. 5.04 (a) Sec. 5.04 (b) Sec.5.05

Complied with. Complied with. Complied with. Complied with. Complied with. Complied with. Complied with. Complied with.

22 Appendix 3

Covenant

Reference in Loan

Agreement

Status of Compliance The Borrower shall have its accounts and financial statements (balance sheet, statement of income and expenses, and related statements) audited annually, in accordance with appropriate auditing standards consistently applied, by independent auditors and shall furnish to ADB (i) certified copies of such audited accounts and financial statements, and (ii) the report of the auditors relating thereto (including the auditors' opinion on the use of the Loan proceeds, compliance with the financial covenants of this Loan Agreement, and the use of the imprest account and SOE procedures), all in the English language not later than six months after close of the fiscal year. The Borrower shall enable ADB, upon ADB's request, to discuss the Borrower's financial statements and its financial affairs from time to time with the Borrower's auditors, and shall authorize and require any representative of such auditors to participate in any such discussions requested by ADB, provided that any such discussions shall be conducted only in the presence of an authorized officer of the Borrower unless the Borrower shall otherwise agree; The Borrower shall enable ADB's representatives to inspect any Qualified Enterprise, any Qualified Activities, the goods financed out of the proceeds of the Loan, and any relevant records and documents maintained by the Borrower; The Borrower shall, promptly as required, take all action within its powers to maintain its corporate existence, to carry on its operations and to acquire, maintain and renew all rights, properties, powers, privileges and franchises which are necessary in the carrying out of the Project or in the conduct of its business; The Borrower shall at all times conduct its business in accordance with sound administrative, financial, environmental and business practices, and under the supervision of competent and experienced management and personnel; The Borrower shall not (i) sell, lease or otherwise dispose of any of its assets, except in the ordinary course of its business; or (ii) establish or acquire any subsidiary; The Borrower shall, for each year through 2009, reach and maintain the following performance targets: (a) an annual return on assets (i) through end-

FY2008, above the banking sector industry

Sec. 5.06 (a) Sec. 5.06 (b) Sec. 5.07 Sec. 5.08 (a) Sec. 5.08 (b) Sec. 5.08 (c) Sec.5.09

Delayed compliance. Complied with. Complied with. Complied with. Complied with. Complied with. Not complied in FY2006 and FY2008. ROA for FY2006, FY2007, and FY2008 are 1.7%, 2.3%, and

Appendix 3 23

Covenant

Reference in Loan

Agreement

Status of Compliance average for each FY, and (ii) for FY2009, 2.0% or above the banking sector industry average, whichever is higher;

(b) the ratio of its qualified capital to risk weighted assets (capital adequacy ratio) shall be not less than 10%; and

(c) a nonperforming loans ratio that is less than or equal to the banking sector industry average as reported by BSP quarterly;

The Borrower, for the period of the Loan, shall not propose, or cause to be proposed, amendments to any provisions of the Act, which in the reasonable opinion of ADB will or may adversely affect the carrying out of the Project or the ability of the Borrower to perform any applicable obligations under this Loan Agreement. The Borrower shall not take, or cause to be taken, any action which would have the effect of amending, abrogating, assigning or waiving any provision of, or any right or obligation of the Borrower under the Guarantee Agreement.

Sec. 5.11 Sec. 5.12

0.4%, respectively. Complied with. Complied with for wholesale banking. Not complied for retail banking. NPL ratios in 2007, 2008, and 2009 are 26.45%, 23.82% and 15.31%. Complied with. Complied with.

ADB = Asian Development Bank, BSP = Bangko Sentral ng Pilipinas, FY = fiscal year, NPL = non performing loan, PFI = participating financial institution, ROA = return on assets, SME = small and medium-sized enterprises. Source: Asian Development Bank.

24 Appendix 4

AN OVERVIEW OF THE SMALL BUSINESS GUARANTEE AND FINANCE CORPORATION A. Ownership, Management and Organization, and Supervision 1. The Small Business Guarantee and Finance Corporation (SB Corporation), a government financial institution, was created on 24 January 1991 through Republic Act 6977, also known as the Small and Medium Enterprise Magna Carta, to function as the small and medium-sized enterprise (SME) financing champion of the national government. It became operational on 16 July 1992, with a subscribed and paid-up capital amounting to P1.8 billion from five government entities,1 as of December 2003. 2. An 11-member board of directors2 governs SB Corporation, comprising the Secretary of the Department of Trade and Industry, the Secretary of the Department of Finance, the SBC President as Vice Chairman, a private sector representative, and seven representatives of the common stockholders, who are elected based on proportional distribution. The chairman and chief executive officer are selected from among the members and are appointed by the president of the Philippines. The chairman is responsible for overall operations of SB Corporation, assisted by the president and chief executive officer, three sector heads, and 15 group heads.3 SB Corporation’s head office is in Makati City, Metro Manila. It has four regional offices (in Makati, Baguio, Cebu, and Davao) and 10 desk offices in selected provinces. The number of employees as of August 2010 was 178. As a government financial institution, SB Corporation has been exempted from the Salary Standardization Law. 3. On 16 November 2001, SB Corporation merged with the Guarantee Fund for Small and Medium Enterprises, with SB Corporation as the surviving entity. The Guarantee Fund for Small and Medium Enterprise was operated by the Livelihood Corporation attached to the office of the president. It offered guarantee services to participating financial institutions (PFIs) that had been lending to SMEs since 1984. With the merger, the national government became the largest shareholder of SB Corporation.4 4. Republic Act 9501 placed SB Corporation under the supervision of Central Bank of the Philippines (BSP). It adheres to BSP rules and regulations, e.g., on loan classification, provisioning, and single borrower’s limit, as a nonbank financial institution. 5 Likewise, SB Corporation is audited annually by the Commission on Audit, which publishes the audit financial statements on its website, as well as providing print copies. 5. In March 2004, an Oracle-based database system was put in place containing information on SB Corporation's retail lending, wholesale credit lines, and guarantees. The standardized features ensured that all data were entered into the database. Performance analysis and evaluations could be done by line of business or refined even further, such as by subsector, geographic region, company asset size, or loan size. Retail lending data for all retail loans since 2002 have been inputted into the system to allow effective follow-up and analysis of

1 Land Bank of the Philippines, Development Bank of the Philippines, Social Security System, Government Service

Insurance System, and Philippine National Bank. 2 The composition of the Board of Directors was changed under Republic Act 9501. 3 Following the reorganization last March 2010. 4 The current shareholdings are: national government 44.30%, Landbank of the Philippines 20.05%, Development

Bank of the Philippines 11.14%, Social Security System 11.14%, Government Service Insurance System 11.14%, and Philippine National Bank 2.23%.

5 The BSP now considers SBC as a nonbank financial institution with quasi-banking functions.

Appendix 4 25

loan performance and defaults.6 The plan is to input all data on retail lending since 1998 into the system to form the basis of a credit-scoring model. The number of accounts was not sufficient to create a full-fledged statistical model, but was sufficient to support work on a judgmental model and provide data for ADB technical assistance aimed at improving SBC’s credit underwriting process. Likewise, the database provided SB Corporation’s management and board with detailed data to on which to base decisions on the various lending and guarantee programs, as well as facilitate financial management and planning. B. Operations 6. SB Corporation’s operations cover three areas: guarantees, wholesale lending (for SMEs and microfinance), and retail SME lending. The target markets are microenterprises and SMEs, which are further classified into three groups: bankable, near bankable, and pre-bankable but viable SMEs. For bankable SMEs, SB Corporation offers wholesale lending facilities to help SMEs obtain funding from the formal financial sector at reasonable interest rates with longer repayment terms. For near bankable SMEs, the corporation offers guarantee facilities allowing SMEs to access credit from the formal financial sector by securing a certain percentage of the loan (up to 85%). For pre-bankable but viable SMEs, SB Corporation provides direct loans for short-term receivables, purchase order, and/or letter of credit financing, as well as working capital and fixed asset financing. Features that differentiate SB Corporation’s lending from banks are smaller loan amounts, longer repayment terms, and fixed interest rates. In terms of collateral, the corporation accepts a broader range of collateral (e.g., real estate, chattel, receivables, purchase orders, and corporate guarantees) than banks, which mainly accept titled real estate. Collateral is valued at 64% of principal in order to reach the target SMEs with smaller financing needs that commercial banks do not normally accommodate. 7. Guarantee operations started in 1992, and by 31 December 2003 SB Corporation had guaranteed 4,675 accounts with a total loan value of P8.66 billion. Cumulative guarantee payments from 1993 to 2002 reached P101.64 million ($1.8 million equivalent), with recoveries of P44.86 million ($0.8 million equivalent). The payments represented 4.8% of total guarantees approved and issued by SB Corporation for the same period. 8. The process for guarantees is as follows. Applications received from PFIs are reviewed by the Micro, Small and Medium Enterprise (MSME) Development and Credit Guarantee Group at SB Corporation. They undertake a second due diligence of the application and, if complete and favorably evaluated, the application is then presented to the Credit Committee for approval. The corporation’s lack of a sovereign guarantee, however, has been cited by banks as reason for their limited use of SB Corporation’s guarantee facility. 9. The wholesale lending window was introduced in 1994. SB Corporation’s board accredits financial institutions if they meet specified criteria. Financial institutions can be accredited either through a fast-track or a regular process. The fast-track process applies to the top 50% of expanded commercial banks in the Philippines and the top five commercial banks. The minimum criteria for these banks are (i) they must be in good standing with BSP and/or listed on the Philippine Stock Exchange, (ii) they must have a satisfactory track record of dealing with credits with other government financial institutions, (iii) they must have a nonperforming loan ratio below 20%, and (iv) they must have a capital adequacy, asset quality, management quality, earnings, liquidity, and sensitivity to market risk (CAMELS) rating of at

6 Before the merger, another program—FoxPro—was used to maintain SBC’s database on its loan and guarantee

portfolio.

26 Appendix 4

least “3”. All other banks are accredited through the regular process, which includes a qualitative evaluation of the financial institutions’ performance for the 3 years preceding accreditation. Ratios are calculated for profitability, collection efficiency, solvency, liquidity, and portfolio quality. The qualitative evaluation includes assessments of (i) the management, board, and key offices; (ii) ownership structure; (iii) background and history of the bank; (iv) compliance with BSP’s regulations—e.g., DOSRI (director, officer, shareholder of the bank or their related interests) rules, loan loss provisioning, and capitalization; (vi) compliance with the legally mandated lending to MSMEs; and (vii) rate of lending activity. Accredited financial institutions are then granted a credit line for onlending to MSMEs and given access to its guarantee facility. As of August 2010, 98 PFIs had been accredited and active. Some banks reportedly seek SB Corporation accreditation more as a seal of good standing than as a means to augment their lending resources, and thus tend to make limited use of SB Corporation’s wholesale funds. The most active PFIs promote SB Corporation’s products to the intended target groups. A strong feature of SB Corporation’s products is that the interest rates are fixed, while the PFIs usually revise interest rates monthly for their own lending products. 10. Eligible SMEs cannot be engaged in extractive industries (mining or quarrying); trading of imported goods, liquor, or cigarettes; housing projects; or trading of banned substances. The loans range from P200,000 to P25 million, with maturities of 1–5 years. In the wholesale lending program, for August 2010 SB Corporation’s pass-on interest rates under the SME wholesale program were: 6.3%–6.5% for short-term loans and 7.0%–7.2% for medium-term loans. The PFIs add charges ranging from 4% to 8% to cover their costs and reflect the perceived risk. Monthly charges to PFIs are computed based on 80% of the benchmark rate of the Money Market Association of the Philippines (MART I) plus 0.1% plus gross receipts tax. From 1994 to December 2009, P22.23 billion was disbursed, benefiting 6,354 MSMEs. 11. The accredited and active financial institutions include (i) commercial banks such as Banco de Oro, Bank of Commerce, and the Philippine National Bank; (ii) thrift banks First Consolidated Bank and Planter’s Development Bank; (iii) rural banks Cooperative Rural Bank of Bulacan and Enterprise Bank; and (iv) nonbank financial institutions such as Landbank of the Philippines Leasing and Majalco Finance. Through this network of accredited financial institutions, SB Corporation has a nationwide reach for its products. 12. Retail lending was started in 1999 following a government decision to ensure that SMEs had access to credit after the Asian financial crisis. SMEs course their applications through SB Corporation’s offices in Manila, Cebu, or Davao, where they are evaluated by account officers. A site visit is undertaken before applications are sent to the Credit Committee in the Manila office for approval. From 1999 to December 2003, P4.3 billion had been disbursed to 1,870 SMEs. The nonperforming loan ratio of direct lending was 17.5% as of 31 December 2009. 13. SMEs eligible for loans under the retail lending window must have between P500,000 and P100 million in assets, be at least 60% Filipino owned if it is a corporation, and must have at least a 1-year profitable track record. Eligible SMEs cannot be engaged in extractive industries (mining and quarrying), trading of imported goods, housing projects, or vice-generating activities (tobacco). The minimum loan amount granted is P200,000 and the maximum is P15 million. The repayment term is up to 5 years and interest rates are fixed. The range of acceptable collateral includes real estate, motor vehicles, equipment, assignment of receivables, and corporate guarantees. The interest rates as of 1 August 2010 were 10.5% for fully secured loans up to 1 year, 12.0% for 1–3 years, and 14.0% for 3–5 years. An additional charge of 1% per annum is made for partially secured/at least 50% secured loans, and a charge of 2% per annum is made for partially/less than 50% secured loans. Interest rates on retail loans

Appendix 4 27

are computed based on SME unified lending opportunities for national growth (SULONG) rates determined by the government financial institutions. 14. In 1997, SB Corporation opened a microfinance facility in compliance with the Social Reform Agenda. This facility has continued to expand through the years, and in 2009 it grew even faster than the wholesale lending facility for SMEs. From a mere P1.0 million in 1997, it grew to P81.12 million loan origination performance in 2003, and to P1.07 billion in 2009. Microfinance loan release has increased on average 83% per year since the rationalization of its program features in the last quarter of 2005. From 2003 to end-2009, P3.29 billion loans were disbursed to the microfinance partners and to almost 300,000 microentrepreneurs. Microfinance wholesale lending accounted for 42% of SBC’s portfolio as of FYE 2009. 15. In 2004 SB Corporation revived its support for SMEs through its Equity Ventures Program, which aimed to support the financing needs of SMEs that are “ready to develop into a higher level of marketing, technical, management and operation.” SMEs must be sole proprietorships or partnerships and must meet several requirements. The amount of investment is limited to the lower of P20 million or 40% of the authorized capital of the SME. Together with a private venture capital firm, SB Corporation can provide equity investments on a 50:50 basis through an investment fund. The investment fund will exit after 4–5 years through redemption of stock, an initial public offering, or sale to a third party. The first equity investment was approved in 2004, for P6 million in convertible notes. 16. In July 2003, SB Corporation appointed a senior officer as environmental rules and standards compliance officer. SB Corporation is using the Handbook of Environmental Standards and the Manual on Environmental Due Diligence in Project Evaluation developed by the Development Bank of the Philippines. The manual has a step-by-step procedure for applying environmental due diligence to the evaluation of loan applications, and guidelines for site visits, environmental audits, and performance monitoring. The Development Bank of the Philippines was ISO 14001 certified by SGS Switzerland SA from 2002–2004 for its successful implementation of an environmental management system. In addition to the environmental due diligence undertaken by SB Corporation, banks require an environmental compliance certificate from the Department of Environment and Natural Resources from companies involved in manufacturing.

28 Appendix 5

KEY FINANCIAL DATA OF SB CORPORATION, 2002–2009 (P million)

2002 2003 2004 2005 2006 2007 2008 2009

(unaudited) Balance Sheet Assets

Current Assets 1,644.05 2,015.11 2,290.68 2,548.61 2,079.09 2,749.60 3,895.40 5,003.47 Fixed Assets 404.49 580.51 626.17 586.17 1,647.33 945.36 103.44 214.09 Other Assets 1.17 0.68 0.71 0.74 37.58 39.37 184.49 693.98 Total Assets 2,049.71 2,596.30 2,917.56 3,135.51 3,763.99 3,734.33 4,183.33 5,911.54

Liabilities & Shareholders' Equity Current Liabilities 32.05 32.93 164.4 258.46 550.16 451.18 259.49 1,460.05 Long-term liabilities 501.5 676.5 785.79 1,058.43 1,075.77 1,700.27 2,004.13 Total Liabilities 32.05 534.43 840.9 1,044.25 1,608.58 1,526.95 1,959.76 3,464.18

Shareholders' Equity Capital Stocks & Paid-in Capital 1,874.62 1,874.52 1,826.96 1,951.42 1,951.42 1,951.42 1,968.74 1,889.23 Retained Earnings & Net Income 143.05 187.25 249.69 139.84 203.99 255.96 254.84 558.13 Total Shareholders Equity 2,017.67 2,061.77 2,076.66 2,091.26 2,155.41 2,207.38 2,223.57 2,447.36

Total Liability and Shareholders Equity 2,049.71 2,596.20 2,917.56 3,135.51 3,763.99 3,734.33 4,183.33 5,911.54 Income Statement

Interest Income 144.1 137.78 189.13 239.56 256.08 255.41 253.38 290.41 Interest Expense 1.69 3.38 30.85 64.72 69.34 62.1 34.66 34.71 Other Income/Expense (88.25) (91.93) (137.32) (133.33) (116.68) (108.58) (202.03) (192.99) Net Income (before tax) 54.16 42.47 20.97 41.5 70.06 84.73 16.69 58.53 Net Income 54.16 42.47 14.79 49.02 64.15 84.73 16.69 53.95

Liquidity 51.30 61.19 13.93 9.86 3.78 6.09 15.01 3.43 Debt/Equity 1.59% 25.92% 40.49% 49.93% 74.63% 69.17% 88.14% 142% EBIT/Total Asset 2.64% 1.64% 0.72% 1.32% 1.86% 2.27% 0.40% 0.99% ROA 2.64% 1.64% 0.51% 1.56% 1.70% 2.27% 0.40% 0.91% ROE 2.68% 2.06% 0.71% 2.34% 2.98% 3.84% 0.75% 2.20%

EBIT = earnings before interest and taxes, ROA = return on assets, ROE = return on equity. Source: SB Corporation.