Financial Management Assessment (FMA) Report on Naga City

Confidential Standard & Poor’s

Analysis of NagaFinancial Management Assessment

City of Naga, Camarines Sur, Philippines

July 31, 2009

FMA

(Financial Management Assessment)

is a comprehensive assessment of the local or regional government's (LRG) financial management sophistication and quality. Standard & Poor’s evaluateschallenges, strengths, and risks of the entity’s financial management systems and practices inthe context of global good practices and thelocal environment. The evaluation reviews systems and policies that build general financial management capacity, fiscal accountability and discipline, and efficient allocation and use of public funds. Systems and policies are assessed in terms of their progressiveness and performanceconsiderations. Progressiveness and performance of individual elements are thencombined into an overall score, using weighting factors based on local realities.

FMA scores

0 = Underdeveloped, Evolving or Poor 1 = Basic2 = Intermediate3 = Sound4 = Sophisticated5 = Advanced

Government brief

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Status: City government with executive andlegislative branches and autonomous budget.

•

Major revenue sources: Real property tax, business tax and central transfers (IRA)

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Core expenditure mandates : Primary healthcare, garbage collection, waste disposal,social welfare and local infrastructure (e.g.city roads/bridges, school buildings, healthfacilities, housing, water supply,drainage/flood control)

Territory statistics

NagaPhilippinesPopulation, 2007 Mils0.1688.57Economic structure Trading centre for the region.Economy mostly engaged inagriculture and trade.GDP per capita, 2007 US$800*US$1,638

Key elements highlighted in bold

OVERALL SCORE: 2 (Intermediate)Summary

The overall FMA score of

‘Intermediate’

for Naga City reflectsits moderately developed level of financial reporting and fairlyhigh level of disclosure, adequate performance in annual budgeting and debt management skills which are moresophisticated than most local peers. On the other hand, thescore takes into account the

basic

practices of Naga in elementsof FMA like expenditure management and medium-term planning. Notably, Naga City’s overall FMA score is the highest amongassessed Philippines LGUs to date, reflecting the city’s more balanced developments in its FMA practices for most keyareas, as opposed to some local peers who may demonstratesound practices in certain elements such as revenuemanagement, but at the same time scoring poorly in other areaslike debt management, budgeting etc. Nevertheless, the Nagacity government’s lack of computerization in most aspects of financial management such as annual budgeting, financialreporting, tax collection and disbursement have emerged as aconstraint on these respective scores. A comprehensivecomputerization of the city’s system could potentially seeimprovement in Naga’s overall FMA and individual elementscores.In addition to Naga City’s own weaknesses in financial

ScoreAnnual budgeting2

Financial policy and medium-termfiscal framework 1+

Financial reporting and disclosure2+

Revenue management2

Expenditure management1+Debt management2-

Liquidity and cash management2-Management of LRG-ownedcompanies N/APerformance focus and measurement1+

FMA

Financial Management Assessment

*GDP per capita for Bicol Region. Data by city level notavailable.

Budget statistics

(

mil. PHP)

200720062005Operating revenues468.6 425.4 380.4Capital revenues0.017.10.0Operating expenditures309.4 310.7 272.9Capital expenditure98.0 85.8 29.5Direct debt90.0 102.0 122.2Tax-supported debt90.0 102.0 122.2Cash and liquid assets244.7 159.0 152.7Capital expenditure (%of total expenditures) 24.1 21.6 9.8Debt service (% of operating revenues)) 4.7 7.6 8.5Direct debt (% of operating revenues) 19.2 24.0 32.1PHP—Philippines Pesos

management practices, the city’s overall FMA score isconstrained by the poor public finance environment thatPhilippines LGUs operate in. The complicated national set-upto supervise LGUs involves multiple national agenciessimultaneously managing the same local government space,and the general lack of co-ordination among them hascontributed to ineffective oversight. An extremely politicizedenvironment has also brought about general institutionalweaknesses in the city government, although this is not unlikemany other LGUs. In the absence of institutionalized policiesand a medium-term policy framework, the key-man risk factor is significant for Naga City, since elected mayors have almostfull discretion in all key decisions, which is a similar situationto other LGUs.Like many LGUs in the Philippines, Naga have no accountingsoftware in place and still relying on archaic manual procedures that are cumbersome and lengthy. Mitigating this isthe existence of timely and comprehensive audits by thenational Commission On Audit. However, the majority of LGUs received qualified opinions on their financial statements. Notably, Naga City is the only city assessed so far to haveconsistently received a clean opinion from COA on its financialstatements, which placed the quality of its financial reportingconsiderably above domestic peers.

Overview of Naga City’s key strengths and weaknesses

Not withstanding the systemic constraints and institutionalweaknesses afflicting Naga City, the strongest areas of financial management which drive the overall score for the citygovernment include annual budgeting at

Intermediate

, financialreporting and disclosure at

Intermediate Plus

and debtmanagement at

Intermediate Minus.

Despite the lack of budgeting or accounting software, the city has been accurate inits budgeting performance on both revenue and expenditure.And as mentioned, its audited financial statements are free of material qualifications, a rarity among Philippines LGUs. Thisis a significant driving factor behind the city’s overall score aswell. Naga city has also proven to have the capacity tomanaged debt and demonstrated a relatively high level of quality in its debt monitoring.On the other hand, the overall score is weakened by the city’sdeveloping practices in expenditure management, financial policy and medium-term framework and to a lesser extentliquidity & cash management. Most of Naga city’s systems arenot computerized. Its disbursement process is still manual,resulting in lengthy procedures and slow turnaround in clearing payables. The city also suffers from a lack of explicitly stated polices in liquidity and reserves investment, and mismatchesfrom month to month between revenue collected anddisbursement. The absence of medium or long-term planning isevident in most elements of financial management of Naga(although again this is a prevalent weakness among Philippinelocal governments in general).2

FMA

Financial Management Assessment

The city’s financial statements had received clean auditopinions from COA in the last few years. No notablediscrepancies appeared on Naga’s audited statements except for the usual inconsistency in the valuation of physical assets, andCOA reported that the city is expected to resolve them by end2008. Naga’s transparency in its reporting of financial performance is also noteworthy, with the comprehensive publishing of its annual budget, interim annual and quarterlyfinancial statements released on a timely basis on the citywebsite. However its financial reporting score is constrained bythe lack of accounting software that would potentially reduce paperwork and offer easier access to financial informationwithin the city administration. Nonetheless, Naga has stillmanaged to consistently produce reliable financial statementsdespite the lack of electronic solutions.Likewise, despite the absence of any budgeting software, Naga’s annual budgeting performances have been strong anddemonstrated relative accuracy on both revenue andexpenditure planning. It is conservative on revenue budgeting,with final outcome more often than not exceeding initial budgeted amount. Correspondingly, expenditure outturn has been lower by an average of 1.6% from budgeted amounts inthe period 2005-2007 (albeit with some volatility from year toyear). Though Naga’s annual budgeting process is still largelycharacterized by incremental-based, it is one of the few LGUsto have at least adopt some form of programmatic expenditure planning. Currently, around 15%-20% of the city’s budget isestimated to be program-based.The Naga city government demonstrate adequate capacity indebt management. Unlike most LGUs who have monthly debtrepayment automatically deducted from their monthly IRAtransfers, the Naga administration keeps good track of itsamortization schedule and issue checks on timely basis todirectly repay lending banks. Furthermore, all of the city’sloans are negotiated with clauses that allow prepaymentwithout penalties. The city government actively monitors borrowing rates and would seek cheaper refinancing whenever the opportunity arises. However, like most LGUs, Naga’s debtmanagement score is weakened by the lack of a coherent andexplicit debt policy. Alleviating this is that the city’s medium-term investment plan (LDIP) has acted as a pseudo-debt policyof the current administration.Conversely, a key weakness of Naga’s financial management practices stemmed from its basic to under-developed practicesin expenditure management. Since most processes are still notcomputerized, the city’s disbursement and authorization processes are lengthy and cumbersome. Revenue collection isalso on a manual basis and this lack of computerizationthroughout the whole administration has translated to the city’shigh number of civil servants employed. Personnel expensescurrently stand at around 43% of Naga’s total income, close tothe regulated 45% ceiling.3