Document of The World Bank ON A PROPOSED LOAN TO THE REPUBLIC OF LATVIA FOR A HOUSING PROJECT. April 25, 2002

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Infrastructure and Energy Unit Europe and Central Asia Document of The World Bank PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$ 2.03 MILLION TO THE REPUBLIC OF LATVIA FOR A HOUSING PROJECT April 25, 2002 Report No: LV

2 CURRENCY EQUIVALENTS (Exchange Rate Effective 1 February 2002) Currency Unit = Lats (LVL) LVL = US$1.00 USS = LVL 1.00 FISCAL YEAR January 1 -- December 31 ABBREVIATIONS AND ACRONYMS CAS FMS FSU GEF HOA ICR LTV MEPRD MGA NGO PHRD PFI SA SOE SOGI SRA TU Country Assistance Strategy Financial Management Specialist Former Soviet Union Global Environment Facility Homeowners Association Implementation Completion Report Loan to Value Ministry of Environmental Protection and Regional Development Master Guarantee Agreements Non-Governmental Organization Policy and Human Resources Development Participating Financial Institutions Special Account Statement of Expenses Statement of Guarantees Issued Special Reserve Account Technical Unit, Office of the Minister for Special Assignments with International Financial Agencies Vice President: Country Director: Sector Director: Sector Manager: Task Team Leader: Johannes Linn Michael F. Carter Hossein Razavi Margret Thalwitz/Sumter Lee Travers Robert M. Buckley

3 LATVIA HOUSING PROJECT CONTENTS A. Project Development Objective Page 1. Project development objective 3 2. Key performance indicators 3 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 3 2. Main sector issues and Government strategy 4 3. Learning and development issues to be addressed by the project 6 4. Learning and innovation expectations 6 C. Project Description Summary 1. Project components 7 2. Institutional and implementation arrangements Monitoring and evaluation arrangements 12 D. Project Rationale (This section is not to be completed in a LIL PAD) E. Summary Project Analysis 1. Economic Financial Technical Institutional Environmental Social Safeguard Policies 18

4 F. Sustainability and Risks 1. Sustainability Critical risks Possible controversial aspects 20 G. Main Conditions 1. Effectiveness Condition Other 20 H. Readiness for Implementation Compliance with Bank Policies 20 Annexes Annex 1: Project Design Summary 21 Annex 2: Detailed Project Description 25 Annex 3: Estimated Project Costs 28 Annex 4: Cost-Effectiveness Analysis Summary 29 Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary 31 Annex 6: Procurement and Disbursement Arrangements 32 Annex 7: Project Processing Schedule 37 Annex 8: Documents in the Project File 38 Annex 9: Statement of Loans and Credits 39 Annex 10: Country at a Glance 40 MAP(S) IBRD 30692

5 Date: April 25, 2002 Country Manager/Director: Michael F. Carter Project ID: P Lending Instrument: Learning and Innovation Loan (LIL) LATVIA HOUSING PROJECT Project Appraisal Document Europe and Central Asia Region Infrastructure and Energy Unit Project Financing Data -- [Xj Loan [ ] Credit [ ] Grant 1 Guarantee [ ] Other: For LoanslCredits/Others: Amount (US$m): $2.0 Million Borrower Rationale for Choice of Loan Terms Available on File: OI Yes Team Leader: Robert M. Buckley Sector Manager: Sumter Lee Travers Sector(s): FY - Other Finance, UH - Urban Housing Theme(s): Private Sector Poverty Targeted Intervention: N Proposed Terms (IBRD): Fixed-Spread Loan (FSL) Commitment fee: Front end fee (FEF) on Bank loan: 1.00% Initial choice of Interest-rate basis: Type of repayment schedule: [X] Fixed at Commitment, with the lollowing repayment method (choose one): [ Linked to Disbursement Financing Plan (USSm):. Source ' Local Foreign Total BORROWER IBRD Total: Borrower: LATVIA Responsible agency: MIN. OF ENV PROTECTION & REGIONAL DEV'T. Address: 25 Peldu Street, Riga, LV-1494, Latvia Contact Person: Vija Geme Tel: (371) Fax: (371) house@varan.gov.lv Other Agency(ies): Office of the Minister for Special Assignments for Cooperation with Intemational Financial Agencies Address: 1 Smilsu Street, Riga LV-1919, Latvia Contact Person: Roberts Zile Tel: (371) Fax: (371) Roberts.Zile@if.gov.lv The Technical Unit Address: 1/4 Smilsu Street, Riga, LV-1919, Latvia Contact Person: Aivis Reinholds Tel: (371) Fax: (371) tuwbsar@latnet.l.v

6 Estimated Disbursements ( Bank FY/US$m): ; FY -: = Annual Cumulative Project implementation period: FY FY 2005 Expected effectiveness date: 08/30/2002 Expected closing date: 12/31/2005 oa; PRO Fl F_. M 2O -2 -

7 A. Project Development Objective 1. Project development objectiive: (see Annex 1) The project will introduce households, housing associations, and financial institutions to what, for Latvia, would be new financial mechanisms for housing finance. The objective of the project is to determine whether qualified households, housing associations, and financial institutions will use the new financial mechanisms to finance high return investments that currently are not funded by private lenders. Based on the results of the implementation, the project will also attempt to determine the least intrusive and lowest-cost way for the government to proceed. 2. Key performance indicators: (see Annex I) The context for the key performance indicators is whether or not there is sufficient demand for the new products, when they are offered at market prices, which permit them to be supplied on a profitable private-sector basis. In principle this will be based on assessing the satisfaction of the beneficiaries and the financial institutions (both participating financial institutions (PFIs) and nonparticipants). In evaluating satisfaction the indicators will consider: (a) demand and supply for each of the products, and the factors that influence this demand and supply; (b) cost recovery and profitability for each of the products offered. The key performance indicators are: 1. Increasing demand for the three financial products as evidenced by the number, value, and trend of applications received and transactions approved; 2. Satisfaction of beneficiaries; * low down payment * reverse mortgage (includes improved physical quality and reduced operating expenses) * HOAs (includes improved physical quality and reduced operating expenses) 3. Low default rates by product; 4. Satisfaction of financial institutions at end of project (includes continued willingness of PFIs to support sales of the guarantee products and willingness of nonparticipating financial institutions to introduce or use similar products); 5. Willingness of financial institutions to provide rehabilitation and maintenance loans in future to HOAs without guarantees. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: LV Date of latest CAS discussion: 04/25/2002 The project is included in the CAS and it will assist the government in its effort to improve and better target housing related social assistance policy so that this encourages greater private sector participation thus allowing the public sector to reduce its decision-making role in resource requirements. It will be carried out by supporting improvements to the institutional framework and the development of more efficient housing finance in Lat-via. In addition the project will address the issue of improving the capacity of low income households to pay for municipal services by improvement of energy efficiency of housing that will reduce the serious burden of utility costs on these households. It will also enhance private sector - 3 -

8 development by increasing the private role in housing and housing finance, and improve the quality and delivery of housing and utility services in the newly privatized housing stock. 2. Main sector issues and Government strategy: Main sector issues Latvia has created a well-functioning, largely privately-owned financial system; it has privatized most economic activity; and most importantly, it has developed a stable, low inflation, growing economy. However, until recently, it has lagged behind in the process of privatization of housing. It is now making considerable progress in this area as well. As of the end of March percent of housing units have been privatized. This slower start in privatization has meant that Latvia is only now beginning to shift towards a market-based housing delivery system, and as a result, the housing sector is among the least efficient in the economy. This inefficiency, in turn, creates a number of broader public policy problems which the project and the proposed follow-up project address. First, incentives have not yet been established for private management of even the privatized housing stock, with the result that high return energy-efficiency investments are not made. For example, it is estimated that only about 5 percent of the housing stock is now maintained by homeowners' associations established in the multi-apartment buildings by new apartment owners. Municipal maintenance is inefficient, it involves both cross-building and cross-sector (housing maintenance and utilities) subsidies. As a result, a large portion of the country's wealth - housing - continues to deteriorate and remains extremely energy inefficient. This inefficiency imposes unnecessary pressure on households' incomes (17 percent of households' expenditures are on utilities), and correspondingly, on need for public assistance. Second, the inefficient use of housing wealth possessed by elderly population in Latvia reduces their welfare. The share of elderly people in the population of Latvia is one of the largest in the world (21 percent of the total population is above 60 and many of them are poor), and correspondingly public pension expenses are high, more than 10 percent of GDP. In most cases even though the income of these people is low, they often have wealth in the form of privatized or restituted housing, the value of which is frequently 10 times their income. However, because these units were just given away, at present these assets are effectively 100 percent equity financed. Allowing the elderly new owners to reduce their equity in their housing would provide them with the possibility of improving their housing, sometimes alleviating poverty, and generally being able to protect them from disruptions in their current income. The third policy concem relating to the form and availability of financing for housing has to do with the higher costs it imposes on those who did not benefit from privatization. While the private banking sector is well developed and the mortgage loan portfolio is almost doubling every year during the last years, prudent banking practice (down-payment requirements remain as high as percent of the actual purchasing price of the housing) provides limited possibilities for obtaining housing, particularly for the first-time home buyers such as young families and households in restituted buildings. This heavy savings requirement is particularly important considering Latvia's demographic situation (during the last 8 years, Latvia has had a negative natural growth of population), and increasing availability of opportunities for the young and highly educated people outside of the country. Thus, while a well-functioning financial sector is now emerging, under present circumstances problems remain: first, the linkages between investments in housing rehabilitation and the financial sector are weak. Even established HOAs are unable to undertake any large investments in their buildings due to lack of access to financing caused by inexperience of the banking sector in non-collateralized lending; - 4 -

9 second, the large portion of the population which is elderly is unable to access their savings; and finally, those who did not benefit from rirvatization face much higher housing costs. Sector issues to be addressed by the project and strategic choices Danish technical assistance will be provided directly to the Government of Latvia in parallel and in close cooperation with the World Bank, and will be aimed at public education and provision of the necessary advice and assistance in management of multi-apartment buildings. This effort will focus on encouraging private individuals to take over the management of their property, i.e. multi-apartment buildings. The project at the same time will attempt to introduce the private sector in Latvia to different innovative financial instruments to address the following issues in the housing sector in Latvia: (a) lack of financing for high returm capital investments in multi-apartment buildings (homeowners' associations); (b) lack of possibilities for people to utilize their wealth more efficiently (elderly population); and (c) limited accessibility to financing for housing for average households. Government strategy To develop and implement a strategy for the housing sector the Government of Latvia has convened an Inter-Ministerial Working Group for Establishment of Mortgage Lending, which operates under the direction of the Ministry of Finance. While initially the main focus of the Working Group was development of mortgage lending, the scope of work has broadened significantly and concentrates on development of the housing sector as a whole. The Working Group serves as a facilitator for the development of the necessary policy, legal and regulatory framework for the housing and housing finance sectors. The government has also requested World Bank and Danish assistance to provide assistance to the development of this sectoral strategy. Over the longer term, t)ie government is particularly interested in improving its housing assistance policy, and reducing the adverse effects that public sector ownership has on private housing decisions. The public sector's ability to address these concems will be considerably improved after the private sector gets more actively involved in addiessing those housing sector issues where it has a comparative advantage (such as capital investments in multi-apartment buildings). Then, as is the case in developed market economies, the government would be able to reform its assistance policy and mechanisms and reduce its role more efficiently. Therefote, it was decided that housing assistance issues would be addressed in continued dialogue and possibly a follow-up project with the World Bank

10 3. Learning and Development issues to be addressed by the project: The objective of the project is to determine whether qualified households, housing associations, and financial institutions will use the new financial mechanisms to finance high return investments that currently are not funded by private lenders. The project will test whether there is sufficient demand to ensure that the proposed guarantees can be provided on a full cost recovery basis and, hence, could effectively be taken over by the private sector. Based on these results further steps will be evaluated, including the option of continuation of the government's involvement, if the project proves that such instruments are not viable on fully private basis. This exercise involves determining: (a) what design modifications, if any, are required for the guarantees to be able to address sector issues in Latvia while assuring cost recovery; (b) what is the level of demand for such instruments from households, housing associations, and financial institutions at market prices, particularly in the absence of subsidy schemes; (c) how do the costs of such guarantees compare with various subsidy programs; (d) how does the vulnerability and welfare of some of the beneficiary groups - i.e., the elderly and first-time home buyers - change as a result of the instruments; and (e) is the enforcement of the existing legal framework satisfactory for efficient operation of the proposed credit enhancements on the private market basis as is expected. Monitoring of these issues will take place via regular communication between the Technical Unit (TU) established by the Government of Latvia to implement World Bank supported projects (see Project Description) and the World Bank, and the TU quarterly reports. It will also be discussed and considered in more detail during the Project's midterm and completion reviews. In addition, during project supervision, efforts will be made to work with other donors and private financial institutions to extend the financial innovations introduced by the project to other uses than those defined by the Bank's productive purposes requirements. In particular, allowing low down-payment loans to finance existing housing units or permitting low-income elderly borrowers to use the proceeds of the loans to finance basic consumption needs, would be productive ways to extend the innovations to needy lower-income families. 4. Learning and innovation expectations: D Economic [O Technical LI Social O Participation Z Financial 1 Institutional C Environmental C Other Financial. The project will test whether guarantees can be profitably provided at sufficiently low costs so that private individuals-owners, associations, and bankers will be able to exploit the higher retums from maintaining and investing in housing. At the same time, the prices charged must be high enough for the products to be offered on a sustainable basis. By sharing risks with the private sector, the project would encourage greater private sector involvement and learning during the period when the public sector will be under increased pressure to provide subsidies, and the private sector is unwilling to become involved without partial sharing of risks. Institutional. The Govemment of Latvia's sector strategy is to expand private sector involvement so that a better-targeted, more transparent and less regressive public role can be established. The project will attempt to help set the stage for this re-targeting. It will encourage the disengagement of the public sector by helping with the development of more effective decision-making mechanisms in the newly-formed homeowner's associations, and by facilitating the access of these institutions and moderate income households to private finance. -6 -

11 C. Project Description Sujmmary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): The project will provide a $2 million Bank loan to back-stop guarantees provided by the Borrower to local financial institutions (commercial banks and/or insurance companies) under Master Guarantee Agreements (MGA) to be signed by the Borrower and each individual participating financial institution (PFI) with "no-objection" from the Bank. While the MGA will specify procedures for the issuance of such guarantees and contractual obligations between the financial institution and the Borrower (for details, please, see Operations Manual), individual guarantees issued under the umbrella of the MGA for individual Housing Loans granted by the 1FIs would specify details of the individual guaranteed Housing loan and procedures related to the Sub-borrowers. The Project will be implemented and Guarantees administered by the Technical UJnit operating under supervision of the Office of the Minister for Special Assignments for Cooperation withi International Financial Agencies (MSA for CIFA). The guarantees would be offered to PFIs at prices that would ensure full cost recovery (for details, please, see E.2). Guarantee premiums will be reviewed and agreed upon by the Borrower and the World Eank at least annually. Minimum premiums for the initial period will be agreed upon during negotiations. Housing Loan underwriting, administration and foreclosure will be delegated to the eligible lenders (for detailed criteria, please, see Operations Manual). The experience with these guarantees would be used to develop an exit strategy for the government's encouragement of the private sector. At the end of the implementation of the project, the Borrower will undertake a study of the experience of these guarantee operations that will focus on determining the least intrusive and lowest-cost way for the Borrower to proceed. The following three types of guarantees will be offered under this project: Individual-Based Mortgage Lending Component 1: Guarantees for low down-payment housing loans Under this component nuarantees will be provided to the private financial institutions for housing loans secured by mortgages either for capital investments in the housing unit (home improvement loan) or for purchasing of new housing, which is defined as housing built not earlier than two years prior to signing the Loan Agreement between the Bank and the Borrower. Guarantees for both types of Housing Loans would be structured so that homeowners would be required to contribute at least 10 percent of house value, with lenders providing loans of up to 90 percent of house value. The TU would guarantee the repayment of loan amounts above 70 percent of the house value. The only difference between the two types of Housing Loans is that home improvement loans would be secured by second mortgages while home purchase loans would be components of a single mortgage. Home improvement loans would be available only for those households who have exhausted the borrowing capacity of the pledged housing, i.e. that the housing has been obtained by a mortgage loan for the maximum loan to value ratio acceptable to the lender based on general business practice, which currently is percent. If there is no mortgage on the housing and the owner would like to borrow for home improvement purposes, he/she would be able to obtain a loan from the PFI without the guarantee as a general business practice. The guaranteed home improvement loans would be separate loans secured by second mortgages on property up to the maximum total loan to value ratio of all mortgages of 90 percent

12 Such loans would be provided for capital improvements of the housing unit (defined in the Operations Manual) such as insulation and other energy efficiency measures, renovation of roofs and walls, installation/replacement of electric wiring, water/sewage system and similar investments. Home purchase loans would be provided for lowering the down-payment required by the commercial banks. The initial risk that is generally accepted by the banking sector (currently percent) will be the responsibility of the eligible lenders. The TU would provide a guarantee for purchase of qualified housing for the portion of the loan exceeding the amount provided by the bank based on 70 percent loan to value ratio (LTV). In both cases, guarantees would be valid for a period until the LTV ratio drops to 70 percent. The guarantee would be effective only after foreclosure and recovery of the debt and it would cover the bank losses up to the amount equal to 20 percent of the initial appraisal value of the housing. Loans to the eligible participants would be disbursed by the private commercial banks on market terms. Underwriting, administration, and foreclosure will be the responsibility of the eligible lenders. World Bank funds would be disbursed against issued guarantees in a ratio determined by the Borrower based on the recommendation of the Financial Supervisory Agency. These funds would allow leverage of commercial bank lending over the amount of the World Bank's support. Component 2: Guarantees for reverse mortgages to elderly Under this component the Borrower will provide guarantees to financial institutions (banks or insurance companies) that would issue reverse mortgage loans to the elderly for home improvements as defined under Component I or as the elderly person's contribution to investments as defined under Component 3. Home improvement could be undertaken either in the elderly person's housing unit or in the common areas of the multi-apartment building where the person's unit is located and for which the person is obligated to make its contribution. The key parameters of the reverse mortgage loans are - payments are made by the financial institution to the elderly against the mortgage on the elderly person's property and the loan consisting of both principal paid out by the commercial bank and the accumulated interest is repaid to the commercial bank when the person leaves the property (due to mortality or moving to another residence) from the proceeds of the sale of the property or by the heirs. Such transactions can easily be misunderstood by the elderly, not only in Latvia, but also in developed economies such as US, so that the private sector, by itself, is often not able to provide the necessary trust that the transaction is fair. Therefore, along with providing partial guarantees the Borrower will make sure that extensive assistance and advice will be provided to the elderly population primarily through the Association of Pensioners and other relevant NGOs. The specific details on ratios of risk sharing will be determined during the negotiations with the private financial institutions. The Bank funds will be disbursed against issued guarantees in accordance with the reserve requirements to be set by the Borrower. Non-Mortgage Lending and Institutional Development Component 3 - Guarantees for common area borrowing Under this component, guarantees will be provided by the Borrower to the commercial banks that would grant loan to HOAs for specific investment projects for capital improvement of buildings' common areas. Such investment projects would include energy efficiency measures, installation of heat sub-stations, - 8 -

13 replacement of wiring, water and sewage systems, renovation of roofs and other capital improvements. This instrument is similar to two IFC-supported projects in Hungary, i.e., Energy Efficiency Co-Finance Programs 1 and 2, that also have provide credit enhancements for energy investments for multi-family residential heating investments. However, in Latvia's less developed financial sector the private sector's involvement in the sector is just beginning. Hence, at the initial stages, this type of support is being encouraged by the public sector in a pilot/learning process. The Borrower will provide guarantees on a co-insurance basis. The banks would, for example, be asked to take the initial risk exposure of percent of the loan value, while the guarantee would, again like the IFC projects in Hungar), cover the subsequent and larger risk. Like the other components, Bank funds would be disbursed to back-stop the guarantees issued by the Borrower with the reserve ratio to be determined by the Borrower. Discussions with a number of commercial banks indicated broad interest in expanding their lending to households on a non-collateralized basis for such purposes with support of guarantees. Such lending by b2anks would leverage World Bank funds with private bank linancing and beneficiary cofmancing. The Danish Technical Assistance in cooperation with the Ministry of Environmental Protection and Regional Development (NIEPRD) of Latvia will provide advice and information on property management as well as information about energy efficiency as they are related to component 3. The Operations Manual, agreed upon during negotiations, provides for a detailed description of the products, project implementation, responsibilities of parties, eligibility requirements, etc. Any material changes in the Operations Manual will be made in agreement between the Borrower and the World Bank. Component 4: Institutional strengthening and Borrower studies This component refers to the institutional strengthening aspects of the continuing development of the TU to discharge its role as a financial services provider. It also includes both the monitoring and evaluation activities that the TU[ will undertake as part of the learning process, (see the Monitoring and Evaluation section below for a description of these) as well as the government study upon closing of the project. The study will attempt 1:o determine the best exit strategy for the project based on the experience during the project's implementation and it will focus on determining the least intrusive and lowest-cost way for the Borrower to proceed. An underlying hypothesis of this study would be determining whether the financial market imperfections, which motivate the government's interventions, have been eliminated. If so, the rationales for continued government involvement would no longer exist and the exit strategy should be either sale of the guarantee portfolios to the private sector or gradual ceasing of operations. If it is, however, determined that private sector is unable to undertake any of these operations fully on its own, that is, explaining why the imperfections have not been eliminated, recommendations will be developed on the most efficient way for the Borrower to proceed. In other words, the study would focus on how a sunset on the government's role could be most effectively structured. The estimated costs for this component is $0.8 million, which will be covered by the Borrower as its contribution. -9-

14 ''I: U~r -~.,..,,,., Indicative _ Bank- 0%Aof -.-,7''. Comp1Ronenlt;~ t i t~4-sector-'- -- Cots 7 f flnancng-- Bank 'xs-.-. ~ ---,_ '. ~ ;--(US$M) ':.' A -T6talf- -(USSM)'-i ifinancing Component 1: Credit enhancements Urban Housing for first-time home buyers Component 2: Guarantees for reverse Urban Housing mortgages to elderly Component 3: Guarantees for common Urban Housing area borrowing Component 4: Institutional Institutional Strengthening Development Total Project Costs Front-end fee Total Financing Required Institutional and implementation arrangements: Implementation period is expected to be 36 months from 2001 to Executing agencies. The MEPRD has the main responsibility for implementing the Borrower's overall Housing Strategy, particularly with respect to policy and institutional capacity building issues as well as public education and training. As such, the MEPRD will be responsible for the management and administration of the Danish TA under Component 3, as well as coordinating the preparation of the larger follow-up project that addresses policy reform issues under preparation financed from a PHRD grant. The Implementing Agency for this project will be the TU. It will operate as an autonomous body under the supervision of the Government. It has extensive experience from involvement in past and ongoing World Bank projects. It will be responsible for the administration and coordination of project activities, which will include: (a) implementation of the project; (b) development of annual work plan and budget; (c) monitoring and reporting on project activities; (d) organization of training sessions on the proposed financial instruments; and (e) management of funds, accounting and reporting to the Borrower and the World Bank. Detailed description of the TU's duties is included in the Project Operations Manual to be approved by the appropriate Government authority and the World Bank. The TU will carry out an evaluation of the potential participating financial institutions (PFIs) and preparation of the recommendations for their approval by the Ministry of Finance and "no-objection" by the World Bank. The Ministry of Finance will sign Master Guarantee Agreements with approved PFIs with "no-obejction" by the World Bank. The Housing Loans guaranteed by the Borrower will be reviewed and guarantees administered by the TU. The PFIs will act in a partnership arrangement with the TU. They will assist in the customer research and development of the loan products by the active involvement of their retail banking staff, "fine-tuning" of the loan products, market launch, market promotion, and product support. The results of market research and product development achieved during the LIL will be shared among all participating PFIs. Financial Management. The TU will be responsible for the management of project funds and would maintain the accounts for the project. A Financial Management Specialist (FMS) conducted a review of the

15 financial management systems of the TU, and found the systems adequate for the purpose of inplementing the project. However, the FMS also prepared an action plan to strengthen the financial management system before full project implementation is launched, which includes inter alia updating accounting procedures and job descriptions, customization of the accounting software, development of computer system for monitoring of guarantees and underlying loan portfolio. Details of the financial management arrangements, disbursement, special account management and action plan are in Annex 6 and presented in the project's Operations Manual. Project accounts, including Special Account and Special Reserve Account, and financial statements of the TU, will be prepared by the TU and audited by an independent auditor acceptable to the World B3ank. In addition, the PFIs will provide the TU with its audit reports and the TU will make them available to the Bank. Audit reports will be submitted to the World flank no later than six months after the end of the fiscal year. Project coordination. Co-,ordination between the Project activities and other government initiatives in the housing sector including legislative developments and policy guidance will take place via the Inter-Ministerial Working Group for Establishment of Mortgage Lending. However, since the purpose of the Working Group is to exchange information and opinions and develop governmental policies and legislation in the housing sector., the TU will have no formal reporting obligation towards the Working Group. The direct reporting responsibility of the TU will be to the MSA for CIFA and the Ministry of Finance. The TU will also be responsible for day-to-day operational coordination of the project with the MEPRD, Ministry of Finance, Ministry of Welfare, MSA for CIFA, Danish TA and other related parties. For project purposes a separate sub-group has been established under the Working Group to discuss project-related issues as needed, and to inform different institutions about progress and issues on a regular basis. Procurement. Procurement arrangements are summarized in Annex 6. Bank funds will be used to back stop guarantees issued by the TU on a portion of commercial bank loans (financed from their own resources) to homeowner's associations, home buyers and the elderly, all of which are private sector operators and as such select contracting parties with due attention to economy and efficiency. Thus, the project will not involve procurement as has been the case in similar Bank operations in Albania (Private Industry Recovery Project) and ltunisia (Export Development Project). Disbursement. As is the case for the Export Development Project in Tunisia, Private Industry Recovery Project in Albania, and Emergency Industrial Restart Project in Bosnia-Herzegovina, the trigger for disbursement of the Bank Loan proceeds is guarantee issuance. For the purposes of disbursements from the Word Bank Loan Account to SA and/or SRA no detailed tracking of flows of actual eventual use of Bank Loan proceeds through the borrower's economy will be made and therefore, the Bank's normal supporting documentation requirements (receipt of invoices, bills, contracts., etc) are not relevant. Funds disbursed to the Borrower to baclc-stop a guarantee and which are not being called during the lifetime of the guarantee shall be used as revolving funds in accordance with the procedures laid out in the Project Operations Manual unless agreed differently between the Borrower and the Bank. Disbursement documentation will be prepared by the TU and reviewed and approved by the State Treasury which has an extensive experience in cash flow management for the World Bank projects. Disbursement arrangements are summarized in Annex

16 3. Monitoring and evaluation arrangements: The three proposed guarantee products are new to the Latvian market and there are no "before" and "after" situations to compare. Therefore, success will be demonstrated by a high level of satisfaction among stakeholders, both PFIs and beneficiaries (see below). The evaluation must answer the question of when/whether this innovation (the three new products) is ready to be scaled up from test products to full private production and how it will relate to the proposed follow-up housing project. While assessing the full impact of these new financial products will take time, the 3 years of the pilot should be sufficient to infer whether or not there is a demand for the products and satisfaction with the products, and if not, why. The Operations Manual outlines the Project's monitoring and evaluation activities in more detail. The assessment of satisfaction will be carried out considering demand at two levels. First, at the retail level by each of the three sets of target customers. Second, demand at the "wholesale" or industry level for private sector financial institutions to offer the guarantee products similar to those provided by the Borrower. Evidence of satisfaction will be based on the opinion of the beneficiaries, after purchase, as measured by sample surveys and on the opinion of the PFIs and their willingness to continue selling the products, as measured by discussions with each PFI (a census). The TU, with the assistance of the PFIs, will have the main responsibility for collection of a set of monitoring indicators and for developing a system for their quarterly collection, update, monitoring, and analysis. Financial, market, and social information will be collected. The involvement of the PFIs is critical. It will provide valuable information to them which will allow them to make informed decisions on the future implementation of the similar products after completion of the project. The PFIs will provide information on applications, approvals, and portfolio results and present data on transactions and feedback from customers to the TU. In addition to the on-going monitoring activities and reports described above the state of the project will be reviewed and summarized at two points during its implementation. First is a mid-term review of results, particularly satisfaction of PFIs and beneficiaries. Second is the final evaluation of the project including the Implementation Completion Report (ICR). In the final evaluation financial reviews will focus on the extent of demand for these products at market prices, the cost structure for these products and their financial soundness. In addition, an analysis would be provided of the sorts of institutional changes, capacity building efforts and changes in legal enforcement practices that are necessary for broad supply of such enhancement services would be provided. Finally, an examination of the sensitivity of these kinds of guarantees to economic shocks will be understood and estimated. A Social Assessment (SA) will be undertaken as part of this project and in complement with the project monitoring and evaluation activities. The SA is described in Section E 6.5 below. The sample survey, drawn from customers, before the mid-term review will include questions relevant to the SA as well as gauging satisfaction. A second survey, at the time of the final evaluation, will again examine social issues and satisfaction. In order to measure impact on households over time this second survey will draw on the same set of individuals as the first survey (a panel). The TU will administer one or more consulting assignments to undertake the SA and the two surveys. Lessons learned from the project will be discussed through workshops, stakeholder forums, and the mid-term review. Lessons leamed will help feed into the preparation of a possible proposed follow-up operation on housing reform - Phase II Housing Project. The full impact of this Project (LIL) and the background studies for the possible Phase II Project, which will be financed from a PHRD grant, will take place during the implementation of the LIL. Under the LIL, the assessment of risks and measures to

17 mitigate the impact of potential risks related to specific credit enhancement products will lead to improved results, performance and institutional learning, and ultimately as complimentary inputs into the policy and institutional alternatives to be considered under the broader Phase II Housing Project. The TU will be responsible for monitoring and evaluation, and will report to the Bank through quarterly progress reports. Areas of risk in the Project will be monitored through the quarterly reports by the TU and during Bank supervision. Situations of high or substantial risk will be reported in the Project supervision reports. The TU will ensure that project information has been consolidated in advance of the mid-term review for use in the review. The TU will prepare the Borrower's contribution to the Implementation Completion Report (ICR). D. Project Rationale [This section is not to be completed in a LIL PAD. Rationale should be implicit in paragraph 13: 3.] E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): [For LIL, to the extent applicable]l O Cost benefit NPV-US$ mnillion; ERR = % (see Annex 4) * Cost effectiveness O Other (specify) Because of the demand driven nature of the project, it is difficult to determine what will be the final sub-projects implemented by the final beneficiaries. However, it is expected, based on the experience in Lithuania, that the project will have a positive economic effect on its most direct beneficiaries - middle and lower income Latvian families, and financial institutions - as well as the economy in general, most immediately through energy savings. By building more credible links between private lenders and privately-owned housing the project would also support the Borrower's objective of shifting the provision of housing services from the public to the private sector. Such a shift would improve efficiency and enable the public sector to concentrate oll reforming housing subsidy mechanisms and public assistance to those in most need. A sununary analysis of institutional profitability and sustainability as well as a review of what the pilot implies about Borrower disengagement from the sector will be carried out within six months after the project's closing date. 2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = % (see Annex 4) [For LIL, to the extent applicable'l The project mainly concentrates on determining whether specific financial services can be provided on a full cost recovery basis. Guarantee premiums to be charged to the beneficiaries will be estimated based on the potential demand for the various products under various scenarios, and estimated per unit costs. Specific reserve requirements wtill be determined to ensure consistency with Latvia's regulations on provision of such guarantees and that the Borrower's risk exposure is limited to its initial contribution of $2 million. Based on estimates finamcial statements for the operations will be developed against which the project's performance will be monitored, evaluated, and if necessary, revised. The income statements and balance sheet will be integrated into a financial stress test model which will allow the Borrower and the Bank to be assured that even wuder pessimistic macroeconomic scenarios the Borrower's risk exposure - 13-

18 would be limited to its current capital contribution. Full financial evaluation and analysis of the project and the underlying modeling that will be used to forecast cost and premium structures will be carried out during the project's implementation. At the end of the pilot, the Borrower will undertake a study that will focus on determining the exit strategy and the least intrusive and lowest-cost way for the Borrower to proceed. The study will evaluate the possibilities of the TU continuing operations on a self-financing basis, as well as develop a strategy for the full transfer of the operations to the private sector if the pilot demonstrates that the products can be supplied on a financially sustainable basis. Fiscal Impact: The immediate impact and the repayment of the proposed loan of $2 million on the budget of the Borrower is negligible. Precise estimate of the benefits realized by the Borrower due to the proposed project are impossible to estimate at this point. However, if the pilot is successful the project could reasonably be expected to result in potentially large savings of public and private funds from lower utility costs. It could also result in considerably increased efficiency of both the housing stock and the arrangement of household savings. Finally, if successful, it should reduce the need for housing subsidies. For instance, if only 1 percent of pensioners participate in the program, that would mean that more than 5,000 families would be able to access wealth that they cannot access now. 3. Technical: [For LIL, enter data if applicable or 'Not Applicable'] Not applicable. 4. Institutional: 4.1 Executing agencies: The TU has extensive experience in implementation of World Bank projects. It was the project implementation unit for the two other World Bank projects - Enterprise and Financial Sector Restructuring and the Rural Development project. In addition, it is the administration unit for the Borrower for a PHRD grant for a Phase II Housing Project as well as for the Danish - Latvian Mortgage Project. It has a well established management structure. Internal procedures and functions were established for the implementation of the Bank financial sector project and acconmmodate the specific needs of implementation of this type of projects. It has accumulated knowledge and established good business reputation and relationships with the financial sector as well as ministries and governmental institutions. The staffing and skills of the TU are strong on accounting and finance. A professional accountant knowledgeable of Bank procedures and requirements for disbursements and financial management will be responsible for accounting and disbursement. However, to ensure adequate internal control procedures are followed, the accountant will report directly to the TU Director. Details of the arrangements for internal control will be included in the Operations Manual. The TU has been closely involved in the preparation of the project and has an in-depth understanding of the issues as well as the proposed instruments. Additional skills will be hired by the TU, if and as determined necessary. With technical assistance, from the Netherlands, additional expertise will be provided, on an on-going basis if and as needed

19 4.2 Project management: Overall project management will be carried out by the TU Committee, which includes representatives from the Ministry of Finance, Ministry of Environmental Protection and Regional Development and Ministry of Economy. The TU serves the role of the secretariat for the Committee and it has the relevant experience from the previous World Bank project, where a similar project management structure was established. For the purposes of learning and exchange of information, the Committee and the TU will also provide informai:ion to the Inter-ministerial Working Group chaired by the Ministry of Finance on a regular basis. The TU is managed by the Director appointed by the Minister for Special Assignments for Co-operation with Intemational Financial Agencies. For the preparation and implementation of this project the TU has a core staff of two people that is experienced in implementation of the World Bank projects and has been closely involved in the preparation of this project. Support staff - accountant and assistant - has an extensive experience in implementation of the World Bank projects and prudent accounting procedures and practices (for specific skills in regards of financial management see the respective chapter below). A detailed assessment of needs for and adequacy of staff skills for the implementation of the project was carried out during appraisal. Based on that the detailed action plan for strengthening of the TU capacity was developed (see Annex 6). 4.3 Procurement issues: There are no procurement issues under this project. 4.4 Financial management issues: The TU has already handled two World Bank projects and is familiar with Bank requirements. It has the necessary intemal stnrcture to ensure reasonably adequate intemal control. The disbursement function is separated in the Treasury department. The Accountant will report directly to the Director of the TU to obtain the signature for preparing and recording disbursements and expenditures. Disbursements may be handled through Special Account (SA) and/or Special Reserve Account (SRA) based on Statements of Expenditures-type spreadsheets (Statements of Guarantees Issued - SOGI). Financial management will track disbursements and reconcile them with the balances in the escrow account: (a) (b) (c) The TU will retain an accountant responsible for accounting statements, disbursement issues and flow of funds, as well as a computerized financial management system, where all project relevant data, can be stored, reproduced, analyzed and updated; intemal control system was reviewed by the FMS during appraisal and determined to be adequate; The participating banks are and will be audited annually as under Latvian law requirements and practices; Reporting requirements and formats appropriate to the LIL will be developed before the implementation of the Project is launched. The following are the audit requirement under the Project: (a) Project account flows, including counterpart funds, and the SA and/or SRA will be annually audited according to the Intemational Standards on Audit by an auditor approved by the World Bank. There shall be one set of financial statements and auditor's opinion on all three components of the project. The auditor will state in the audit report a separate opinion on the use of the SOGI and the SA and/or SRA. The terms of reference for the audit will be reviewed

20 (b) and agreed by the Bank by negotiations. A copy of the standard Bank terms of reference for audit has been provided to the TU during appraisal and has been included in the Operations Manual. It is customary in Latvia that the State Treasury, which handles World Bank disbursements, hires an international auditor who audits all project accounts. Audit of Project Financial Statements shall include Sources and Uses of Funds including counterpart funds, Uses of Funds by Project Activity, Project Balance Sheet, Summary of Statement of Expenditures, Special Account Statement and Special Reserve Account. The detailed scope of audit is presented in the Operations Manual. Audit of the TU. The financial statement should include disclosure of "off balance sheet" items (guarantee exposure). TU should perform monitoring of the guarantees and make provision reflecting the possible risk of defaulting the loan. The auditor should check whether the risk is adequately presented in TU financial statement. (c) Audit of the participating financial institutions - PFIs will be required to provide audit reports according to International Accounting and Auditing Standards. (this is normal requirements for financial institutions in Latvia). Financial management arrangements in the TU were reviewed by the FMS during appraisal and determined to be adequate. FMS developed an action plan for strengthening financial management system at the TU (see Annex 6), which was discussed and agreed upon with the TU. More detailed accounting procedures are documented in the Annex 6 and the Operations Manual. 5. Environmental: Environmental Category: F (Financial Intermediary Assessment) 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis. A recent review of the Latvian environmental legislation indicates that Latvia has a well developed environmental assessment system. In the cases of construction and reconstruction, contractors performing such works will be required to obtain all the necessary permits to carry out the works in accordance with the legislation of Latvia. The participating financial institutions will be required to ensure that the contract between the contractor and the sub-borrower requires the construction company to obtain all such permits. Supervision of the compliance with the appropriate legal requirements will be performed by the respective authorities as stipulated in the legislation of Latvia. A sample EMP will be prepared before project effectiveness and will be attached to the Operational Manual. 5.2 What are the main features of the EMP and are they adequate? Not applicable. 5.3 For Category A and B projects, timeline and status of EA: Date of reccipt of final draft: Not applicable. 5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms of consultation that were used and which groups were consulted? Not Applicable. 5.5 What mechanisms have been established to monitor and evaluate the impact of the project on the environment? Do the indicators reflect the objectives and results of the EMP? Not Applicable

21 6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes. Initial project surveys an-id discussions have been undertaken with pensioners, commnercial banks, building maintenance companies, and representatives of homeowners associations, which indicate that demand for the proposed guaranmee instruments will materialize if structured properly. A social assessment will be performed during the implementation of this project and in preparation for the possible follow up project, including a housing demand study and a study of the effectiveness of the current housing subsidy program. Within the frameworlc of project monitoring and evaluation (see the respective chapter above) social reviews of the beneficiaries will be carried out focusing on how the products affect the welfare of the target groups. However, in addition, it is expected that the project will have a positive impact on a range of social groups that will participate in the demonstration projects mainly in terms of improving their living conditions. For instance, the project will afford a means of providing on-going counseling assistance to the elderly which should also have beneficial effects. Though the project does not target the urban poor as a group, it will deliver tangible benefits to low income households, particularly those squeezed by the disproportionately high energy costs, and the elderly, as indicated by the Bank project in Lithuania. The social impacts for the Bank-supported energy efficiency project in Lithuania have been well documented, and along with the IFC-GEF vwork in Hungary, may provide important benchmarks of social attitudes toward energy renovation in the region. 6.2 Participatory Approach: How are key stakeholders participating in the project? Homeowners' associations, the association of pensioners and commercial banks have been actively involved in the project design. Their participation will continue during the implementation of the project, monitoring and evaluation. Homeowners' associations and commercial banks have been instrumental in defining project priorities and type of intervention. Their views on affordability aspects, capital improvements as well as perceptions on housing quality and services, will define the scope of individual projects and their financial feasibility. More fundamentally, however, the project supports a decidedly demand-driven approach where stakeholders will have made ex ante decisions to purchase the guarantees offered under the project. By purchasing or using the guarantees, stakeholders directly reveal how much they value the new products. The public advisory and information campaign will introduce new processes that would build capacity of the HOAs and other stakeholders up to a level where they will be able to make informed decisions about participating in the project. 6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations? Project components have been designed and Operations Manual is being developed in close cooperation with the Association of Homeowners' Associations, Association of Pensioners, and Union of Local Governments. The Technical Unit as well as MEPRD will cooperate closely with these organizations during the implementation of the project and will provide active assistance to the beneficiaries, monitor progress and launch public information programs based on the experiences gained during this pilot project. 6.4 What institutional arrangements have been provided to ensure the project achieves its social development outcomes? The participating institltions - Borrower agencies, commercial banks, NGOs, and HOAs - will have a very important facilitating role in raising public awareness, providing the necessary assistance to the - 17-

22 potential beneficiaries in their decision making, training in the establishment of HOAs and the dissemination of leaming experiences. Particular attention has been paid to ensure that appropriate links between each level of the project's participants is established with particular emphasis on establishing an effective grassroots-level network. The Association of Pensioners will provide extensive advice and assistance to the elderly population in collaboration with the TU and the MEPRD (component 2). Special public awareness and training program is being designed within the framework of the Danish Technical Assistance, which among other activities envisages establishment of regional advisory centers and organizing workshops and stakeholder forums (component 3). 6.5 How will the project monitor performance in terms of social development outcomes? Scope and methodology of social assessment to monitor the social impacts of the project was agreed during negotiations with the Borrower, to be carried out in cooperation with the Ministry of Welfare, and the respective social welfare departments in the municipalities participating in the project. The project will utilize participatory workshops and information sessions during preparation and implementation to solicit the views of stakeholders and beneficiaries, based on which the project implementation techniques would adjust accordingly. During the periodically planned workshops, training sessions, homeowners and representatives of their associations, as well as representatives from the involved national agencies, municipalities and participating commercial banks will be invited to discuss the project rationale, exchange experiences and views based on its implementation design and progress. The social assessment will use existing sources of data (including surveys by the Pensioner's Association of its membership and by the TU of HOAs) and the results of the personal and social information gained from product applications to formulate an initial profile of the beneficiary population. Focus groups will be used to assist in identifying issues of importance. The sample survey, drawn from customers, before the mid-term review will include questions relevant to the social assessment as well as gauging satisfaction. A second survey, at the time of the final evaluation, will again examine social issues and satisfaction. In order to measure impact on households over time this second survey will, to the extent possible, draw on the same set of individuals as the first survey (a panel). In the evaluation of the project the SA will examine on how the products affect the welfare of the target groups - i.e., home buyers using low down payments, the elderly, and housing associations and their members. 7. Safeguard Policies: 7.1 Do any of the following safeguard policies apply to the project? Environmental Assessment (OP 4.01, BP 4.01, GP 4.01) Natural Habitats (OP 4.04, BP 4.04, GP 4.04) Forestry (OP 4.36, GP 436) Pest Management (OP 4.09) Cultural Property (OPN 11.03) Indigenous Peoples (OD 4.20) Involuntary Resettlement (OP/BP 4.12) Safety of Dams (OP 4.37, BP 437) Projects in International Waters (OP 7.50, BP 7.50, GP 7.50) Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60)* 0 Yes 0 No 0 Yes * No 0 Yes 0 No 0 Yes 0 No 0 Yes 0 No 0 Yes 0 No 0 Yes * No 0 Yes 0 No 0 Yes 0 No 0 Yes * No 7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies