llte COPY DB-62a INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL

Transcription

1 Public Disclosure Authorized llte COPY RESTRICTED Report No. This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. DB-62a Public Disclosure Authorized INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Public Disclosure Authorized APPRAISAL INDUSTRIAL DEVELOPMENT BANK OF ISRAEL, LTD. OF Public Disclosure Authorized May 1, 1970 Development Finance Companies Department

2 CURRENCY EQUIVALENTS 1 Isreli pound =.285 U.S. dollars 1 U.S. dollar = 3.5 Israeli rounds

3 APPRAISAL OF INDUSTRIAL DEVELOPMEUKT BANK OF ISRAEL LTD. TAMLE OF CONTENTS Paragraph Page S twyatry 1-8 i-ii i3asic DATA iii-v I. INTRODUCTION 1 1 II. ENVIRONMENT AND ROLE General Economic Setting Industrial Setting Financial Setting Role of IDBI 12 3 III. DESCRIPTION OF IDBI Establishment and Purposes 13 4 Share Capital and Ownership Organization, Management and Staff Procedures Resources IV. POLICIES AND OPERATIONS Policy Loan and Guarantee Operations Government Guaranteed Loans Investment in Shares Investment Company of IDBI V. FINAlNCIAL PERFORMANCE Income Performance Financial Position Quality of Portfolio Share Value and Audit VI. PROSPECTS General ID3I's Requirements and Resources Projected Income and Profitability Projected Balance Sheet Debt Service Cover VII. CONCLUSION AND RECOMMENDATIONS Conclusion Recommendations ANNES This report is based mainly on the findings of a mission consisting of Messrs. Powell and Takaramura who visited Israel in October-November 1969.

4 LIST OF ATITEXES 1. Shareholders as of December 31, Shares Other than Ordinary A Shares as of December 31, Board of Directors and Committees as of December 31, Organization Chart 5. Composition and Conditions of Share Capital as of December 31, Status of Debentures as of December 31, Summary of Loan Operations Analysis of Loans Approved 9. Investment Company of IDBI, Balance Sheets, December 31, Investment Company of IDBI, Statements of Income, Years Ended December 31, Statements of Income, Years Ended December 31, Balance Sheets, December 31, Delinquent loans as of December 31, Bad Investments Written Off, Loans Undergoing Legal Proceedings and Loans in Arrears 15. Projections of Loan Operations, Projected Statements of Income, Projected Balance Sheets, Projected Cash Flow Statements,

5 SUMMARY 1. The Industrial Development Bank of Israel, Limited (IDBI) was established in 1957 to assist private industrial development in Israel. The Bank has so far made IDBI tw-o loans, totalling US$35 million; the first loan of $20 million in September 1965 and the second of $15 million in November Of IDBI's presently issued share capital of IS 379 million, only Ordinary A shares of IL 15 million carry full voting rights. 55% of the Ordinary A shares are held by private domestic investors, 26% by the Government and 19% by foreign investors. IDBI's Board of Directors numbers 56, and its functions have largely been delegated to three committees on which the main share holding groups are represented. 3. IDBI is well organized and expertly managed. Its staff is competent and experienced. The standard of appraisal work is satisfactory, and IDBI's investment decisions are soundly based. Its follow-up work is well performed. 4. Although IDBI is empowered to undertake a wide variety of functions, IDBI has concerned itself almost exclusively with lending. As a general rule, IDBI does not make equity investments. From its inception to December 31, 1969, IDBI had approved 2,568 operations for a cumulative total of IL 1.39 billion. As of December 31, 1969, the loan portfolio amounted to IL 901 million, of which the repayment of IL million or about 12% is guaranteed by the Government. As of the same date, IDBI ' s investment in shares amounted to IL 33.7 million or 3.5% of its total portfolio. 5. IDBI's financial record is satisfactory. Net earnings increased from IL 21.9 million in 1966 to IL 25.1 million in 1969, representing a range from about 13% to 15.5% of average year-end share capital. The amount overdue is relatively smxall and actual losses to IDBI are likely to be minimal. The ratio of non-current debt and guarantees to equity was about 1:1 at the end of Reserves and retained earnings increased from IS 12.5 million in 1966 to Il 22.4 million in Total reserves together with provisions amounted to about 9% of the total portfolio as of December 31, IDBI is an institution of national importance. The average annual amount of IDBI's financing for industrial development has been equal to about 25% of total gross industrial investment in the country. IDBI's relations with the Government and the commercial banking system are close and harmonious.

6 - ii - 7. IDBI has projected loan commitments of about IL 475 million (US$ 136 million) during the two years from July 1970 to June The projections appear reasonable and attainable. During the same period, IDBI will need additional capital of around IZ 319 million to help meet expected demands for financing. IDBI has made considerable efforts to raise funds from as many sources as possible. It expects to obtain IZ 169 million out of the required IL 319 million from dcmestic and foreign markets. For the shortfall of I 150 million or US$ 43 million IDBI is relying heavily on the Bank. The provision of around half this sum, up to US$ 25 million, would keep the pressure on IDBI to continue searching for new capital while assuring it of resources until about February A loan of $25 million is recommended. 8. IDBI is a sound development finance company and continues to deserve the support of the Bank. The financial projections for the next two years are satisfactory and debt service cover will be adequate throughout the projected life of the loan. The proposed loan should be on the Bank's usual terms for recent loans to development finance companies. In view of the high standard of IDBI's operation, the "free limit" should be raised to US$ 750,000, with a limit on the aggregate to be credited below the free limit of 50% of the amount of the loan. A debt-to-equity ratio should be included in the loan agreement and the limit should be set at 3:1.

7 - iii - BASIC DATA INDUSTRIAL DEVELOPMENT BANK OF ISRAEL Year of Establishment: 1957 Ownership (as of December 31, 1969) IZ ('000) Percent Ordinary A (voting) Shares, issued and subscribed Government 3, Private Domestic 8,275 5h.8 Foreign 2, Sub-total Non-Voting Shares, issued and subscribed Government 191, Private Domestic 12, Foreign 101, Mixedl/ 58, Sub-total 36k, Total 379,217 Resource Position (as of December 31, 1969) Domestic Currency (I million) Equity Borrowings (less cancellations and repayments) Debentures 24.8 Long-term deposits of Israel Treasury A.I.D. loan 35.6 A.I.D. (Cooley) special deposits 25.5 Participation of third parties in loans granted 9.7 AMAAL-ISRAEL Development Corporation Limited 1.1 Short-term loan Less: Miscellaneous adjustments 1.5 Total Domestic Currency Resources / Entities owned jointly by domestic and foreign shareholders.

8 - iv - Foreign Currency (less cancellations and repayments) (If million) European bonds 1972/ IBRD loans A.I.D. loan 20.5 Loan from U.S. Export-Import 3ank 52.3 Loan from U.K. Export-Credit Guarantee Department 41.1 Belgian loan 35.0 Israel Development Corporation 14.0 Sundry loans Less: Exchange adjustments 10.4 Total Foreign Currency Resources Grand Total of Domestic and Foreign Currency Resources 1,004.6 Loans, Equity Investments Outstanding Long-term loans Equity investments outstanding 29.8 Subsidiary Company Resources Available for Disbursement 57.5 Commitments of Loans and Investments (IL in million) Loans Equity investments Total Loans and Investments Disbursed Earnings Record (percentage) Profits before financial charges and tax to average total assets Profits before tax and provisions to average total assets Profits before tax and provisions to average equity 1/ Net profit to average year-end share capital 2/ Dividends paid to year-end share capital / Excluding Ordinary 3 and Preference A shares owned by the Government, but including net linking funds. 2/ Excluding Ordinary 3 and Preference A shares owned by the Government.

9 - v - Financial Position (as of December 31, 1969) Total debt/equity ratio 1.3:1 Reserves and provisions to loan and investment portfolio 9% Interest Rates and Charges (as of December 31, 1969) Interest rates on loans Variable ranging from 6.5% to 9% p.a. Commitment fee Guarantee fee No commitment fee, but a onetime commission of 1% on the amount of each loan. 2% per annum.

10 APPRAISAL OF INDUSTRIAL DEVELOPM1ENT BANK OF ISRAEL, LTD. I. INTRODUCTION 1. The Industrial Development Bank of Israel (IDEI) has applied to the Bank for a third loan, of $55 million, to cover part of its projected foreign exchange requirements for a period of five years. So far, the Bank has granted two loans: the first loan, US$20 million, in September 1965 and the second, US$15 million, in November This report, which examines the suitability of IDBI to receive a third Bank loan, is based on a continuing relationship between the Bank and IDBI since the first Bank loan was made and on the findings of a Bank mission that visited Israel in October-November II. ENVIRONMENT AND ROLE 2. A review of the economy of Israel is given in the economic report dated July 22, 1969 "Current Economic Position and Prospects of Israel" (EM4A-7b). This was updated by a memorandum dated March 20, 1970 (EMA-18a). General Economic Setting 3. Israel's economic growth in the past has been remarkable considering her scarce natural resources, limited domestic market and inability to establish trade relationships with neighboring countries. Between 1960 and 1966, real MNP expanded at an average of 9%d a year while per capita production increased by about 5%. Investment rose to an average annual rate of 26%. The rate of export growth was about 15% per year. This growth performance was made possible mainly by a relatively large and sustained inflow of foreign capital and by a broad base of well-educated people. 4. More recently Israel's resources have been strained by heavy defense expenditure. This strain was reflected in growing budgetary and balance of payments deficits. The balance of payment deficit was further aggravated by the high growth rate of the economy. The 1969 deficit on the current account of the balance of payments was estimated at about $930 million which was some 30% higher than the 1968 deficit and about double that of The Bank of Israel lost foreign exchange reserves of more than $250 million during A large increase in the price level was avoided. Wages, which have been frozen for the past two years, were renegotiated early in 1970 and effectively the freeze has been reimposed for a further two years. Rates of savings and investment declined sharply in 1967 and despite some revival in the following two years remain well below levels recorded in the first half of the 1960's. The Government faces a difficult task in containing internal demand and the balance of payments deficit, and in rebuilding the country's foreign exchange resources.

11 -2- Industrial Setting 5. The industrialization of Israel has played a key role in the country's economic growth. From 1950 to 1968 industrial output rose at an average rate of over 10%. In 1968, industrial output accounted for 27% of MP and for some three-quarters of the yearly export of commodities excluding diamonds. Employment in the industrial sector was 226,000 or about 25% of the total of gainfully employed in the country. The strong upsurge in the industrial sector has continued through Industrial output increased 28% in 1968 and is estimated to have increased 17% in 1969 at constant prices. Industrial investment amounted to IL 470 million in 1968 and is expected to have reached about I 750 million, in 1969, or about 19% and 22% of the total fixed investment in the country, respectively. 6. The impressive industrial development in the past would not have been possible without substantial Government support and encouragement. As early as 1950, the Law for Encouragement of Capital Investment was enacted to attract foreign capital to IsraeL, to channel domestic investments into key sectors, to increase exports, to reduce reliance on imports, to absoxb immigrants and to populate the underdeveloped areas. The Law has been amended from time to time to meet changing conditions. The latest amendments were made in Investment projects which assist in the achievement of the aims of the Law may benefit from special advantages and financial assistance; incentives include tariff protection, cash grants, subsidies, drawback of customs duties, and low cost financing. Applications for such incentives are filed with and processed by the Investment Center, a Government body created to administer the Law. 7. Aware of the possibility of distortions in production costs that could result from protection and Government subsidies, the authorities have been taking steps to rationalize the existing structure and increase the intexnational competitiveness of the industrial sector. Following the 1962 devaluation, quantitative import restrictions were replaced primarily by tariff protection. Since the 1967 devaluation, the Government has been making efforts to reduce the effective tariff levels and to rely less on subsidies and preferential treatment. At the time of the 1967 devaluation, for instance, tariff protection of at least 50% was given to two-thirds of total industrial output exposed to foreign competition. One-third enjoyed more than 100% protection. However, tariff reductions of between 10% and 30% were announced for a wide range of industrial commodities in October 1968 and January In May 1969, the Ministry of Commerce and Industry approved a five-year plan to reduce average duties to under 3)% by January 1, Also, the Government has promoted mergers and modernization and expansion of enterprises, to improve efficiency of output, by providing low cost long-term financing and sometimes Government subsidies. Although the present level of protection remains high, the gradual reduction of tariffs and the encouragement of various measures for cost reduction are significant steps in the right direction.

12 8- In the early 1950's, owing in large part to the need to absorb immigrants, Government support for industrial development was directed principally to labor intensive industries for domestic market consumption, such as textiles and food processing. Increasing emphasis has been placed on capital-intensive metal, chemical, and rubber industries. Recently, such sophisticated science-based industries as electronics, scientific instruments and netro-chemicals have been encouraged. An increasing demand for industrial development loans is expected from such new science-based industries. Financial Setting 9. There are 27 commercial banks with 648 branches, 17 credit cooperatives with 83 branches and 20 mortgage banks operating in Israel at the present time. Twenty-two of the banks are authorized to deal in foreign currency. These banks mainly make short-term credit and participate in industrial financing by providing working capital. 10. Investment banks, as distinguished from commercial banks, provide medium- and long-term credit for industry, construction, public services and the like. The most important investment banks in the respective sectors are: IDBI in the industrial sector; the Israel Bank of Agriculture Limited in the agriculture sector; Tefahot Mortgage Bank Limited in the construction sector; and Tourist Industry Development Corporation Limited in the tourist and transportation sectors. The Israel Corporation Limited, established in April 1968, may become important in channeling funds from abroad to finance industrial and other projects and in providing managerial services. Two-thirds of the funds available to investment banks are derived from the Government, particularly from the development budget. In addition to this source, the investment banks mobilize funds by issuing securities in the local market and abroad. 11. The Minister of Finance is authorized by Law to fix maximum interest rates for loans. However, at the end of March 1970 the ceiling on interest rates for commercial credits was removed. Until 1967, IDBI charged 12%. However, under an agreement with the Government effective October 1, 1967, DBI charges interest rates ranging from 6.5% to 9% per annum for its long-term loans to industry, the rate depending on the location and nature of projects. When IDBI charges an interest rate of less than 9% per annum, the Govermment pays IDBI the difference between 9% per annum and the rate charged to the borrower. Role of IDBI 12. IDBI is the largest institution in Israel providing medium- and long-term credit for industrial development. Its assets amount to about 80% of the assets of all the investment banks operating in the industrial field. IDBI's loan approvals have represented, on the average, about one-fourth of gross annual investment in industry. IDBI administers some Government funds for certain development loans to Government-controlled enterprises, and acts as agent for the U.S. Agency for International Development. It closely cooperates with the Government in implementing industrial development programs and continues to play a key role in financing the Israeli private industrial sector.

13 - 4 - III. DESCRIPTION OF IDBI Establishment and Purposes 13. IDBI was established in 1957 on the joint initiative of the Government of Israel, the three largest commercial banks in Israel, the Histadrut (General Federation of Labor) and the Manufacturers' Association. Its main objective is the provision of medium- and long-term finance to private industrial enterprises in Israel. DBI is also empowered by its Articles of Association to undertake a variety of functions including participation in equity capital of entexprises, underwriting and promoting security issues, guaranteeing obligations and providing managerial, financial and technical assistance to industries. Share Capital and Ownership 14. Of the presently authorized share capital of I 417 million, only Ordinary A shares of I116 million carry full voting rights, of which I 15.1 million had been issued and subscribed as of December 31, The Ordinary A shares were widely distributed among the Government, private domestic and foreign investors, as shown in Annex 1; the Government held 26%; private domestic investors, 55%; and foreign investors, 19%. The proportion of the Government's shareholding gives it, in terms of Israeli Company Law, veto power in regard to major changes in IDBI's Charter. 15. Other than the Ordinary A shares mentioned above, there were eight classes of ordinary or preference capital stocks issued, totalling about I 364 million, as of December 31, Of these shares, Government held about 52%, foreign investors 28%, private domestic investors 4% and enterprises jointly held by the private domestic and foreign investors 16%. Annex 2 describes the distribution of the shares other than Ordinary A. Organization,_Management and Staff 16. Board of Directors. IDBI's Board has 56 members representing the Ordinary A shareholders. All holders of I 250,000 or more in Ordinary A shares are entitled to appoint one director. 12 directors represent the Government, 13 represent foreign shareholders, and the remaining 31 represent domestic shareholders and the enterprises jointly owned by domestic and foreign interests. The Board represents a broad cross-section of financial and business institutions in the country, and foreign investors. IDBI's Board members are listed in Annex 3(A). The Board meets three or four times a year, reviews the record of activities of the Executive Committee and decides key policy matters referred to it by the Executive Committee. The Board is responsible for the election of the Chairman and the appointment of the Managing Director. 17. Dr. Y. Foerder who had been the Chairman of the Board since IDBI's inception relinquished office in March 1970 because of ill health. Mr. Moshe Sandberg, Executive Vice-Chairman, who was active in IDBI's day-to-day management on a full-time basis from his appointment in 1968 until November 1969, is now acting as Chairman and works on a part-time basis.

14 Committees. Three committees operate in IDBI: The Executive Committee, the Vice-Chairments Committee and the Loan Committee. The powers and duties, chairman, members and the number of meetings of these committees are described in the following. Executive Committee Vice-Chairmen's Committee Loan Committee.All powers of the Major administrative and Reviews and Board, except to personnel matters and a decides on elect the Chairman sounding board for policy loan applica- Powers and of the Board and to matters likely to prove tions up to Duties appoint the Managing controversial. cumulative Director. Reviews total of and decides on loan I 500,000 for applications beyond individual the authority of the projects. Loan Committee. Chairman The Board Chairman or, in his absence, The Board Chairman or, in The Managing his absence, the Execu- Director. the Executive Vice- tive Vice-Chairman. Chairman. 20 Board members or The Board Chairman, the 15 Board Members their alternates. five Vice-Chairmen and members or the Managing Director. their alternates. Number of Twice a month. Once a month, or as Once a week. Meetings necessity arises. Mlembers of both Executive and Loan Committees are listed in Annex 3(B). 19. Management. Dr. Avraham Neaman has been the Managing Director, who is the chief operating executive, since He has four senior assistants: the Deputy General Manager who directly supervises the Economics, Engineering and Follow-up Departments; the Assistant General Manager who is responsible for the Implementation, Collection, and Accounting Departments; the General Counselor and Assistant Manager who heads the Legal Department; and the General Secretary who heads the Secretariat Department which is also in charge of Administration and Statistics. The day-to-day management team consists of these five members plus the Executive Vice-Chairman and meets once a week to discuss management problems. IDBI is well led and well managed. 20. Organization and Staff. IDBI is organized in eight departments, mentioned above. The staff numbers 135, including 6 members of the management team and 43 professional staff members. The professional staff includes 15 economists, 10 engineers, 8 lawyers and 6 accountants. The staff are generally competent and experienced. IDBI has been training less-experienced

15 - 6 - staff on the job and sends its staff members to various training courses outside IDBI. It also plans to add new staff members, provided qualified professionals are found, to enable it to deal with an expected increase in the volume of appraisal and end-use work, The organization chart is shown in Annex 4. Procedures 21. Appraisal of Investment Proposals. Loan applications are given a preliminary review by an initial screening committee consisting of the management, department heads concerned, two representatives from the Government, one from the government's Investment Center and three Board members. This committee decides whether an application deserves further examination or should be rejected for reasons of Governmental priority or on various other grounds. If the committeets decision is favorable, an appraisal team, consisting of one engineer and one economist, is assigned to the project. The Engineering and the Economics Departments, acting together, prepare the appraisal report and recomendations, assisted by the Legal and other departments. The appraisal report thus prepared is reviewed by a working party, consisting of the management team, the department heads concerned and their deputies. This working party decides whether to present the appraisal to the Loan Committee (or the Executive Committee), possibly with revisions of the terms and conditions, or whether to return the report for further study and justification. The Loan Committee or the Executive Committee reviews the report screened by the working party and makes a final decision on the project. 22. IDBI's appraisal is carefully done; the appraisal report covers all pertinent aspects, including prospects for the international competitiveness of the project. The standard of the underlying appraisal work is satisfactory; IDBI's investment decisions are soundly based. 23. Follow-up. The Engineering Department closely follows the project during the construction. Engineers visit the project site several times to assure proper performance of construction and installation. Upon the completion of the project, the Follow-up Department is responsible for obtaining the reports and accounts from clients and examining them, for making site inspections and for recommending actions to the management where necessary. Because of the relatively large number of clients (about 850 as of December 31, 1969), the Follow-up Department has adopted a policy of selection and reviews about 10 clients per month. The firms which are selected are in arrears, or in default, or in some difficulty. The selection of clients is made mainly on the basis of a monthly t t collection status report" prepared by the Collection Department, supplemented by other available information. The Follow-up Department produces about 120 follow-up reports in a year. The reports are well organized and comprehensive, and contain necessary recommendations. In general, the follow-up work is well done. Nevertheless, IDBI feels that this activity creates a heavy load on its staff and, therefore, has recently commissioned a consultant firm to devise a more efficient method to select clients which require close attention. IDBI will inform the Bank of any revisions in its procedures arising from the consultantst recommendations.

16 -7- Resources 24. IDBI's main resources consist of its paid-in share capital, reserves and retained earnings, Government deposits, debentures, loans from AID and IBERD, bonds floated in Europe and other borrowings. The resource position as of December 31, 1969, is summarized in Basic Data, shown in pages iii-iv. 25. Share Capital. As of December 31, 1969, the authorized share capital was17;million of which I million was issued and paid-in. At present, there are 9 classes of authorized capital, each having, istinctive characteristics as to voting powers, redeemability, value-linking _, dividend rights, profit participation and rights in liquidation. 26. Two of the classes of non-voting shares, one ordinary and one preference (redeemable), are fully owned by the Government and carry dividends at the rate of 3% and 3.5% respectively; these in effect provide a subsidy. The five classes of shares held by private investors and the Government are exchange-linked and are entitled to dividends at the rate of 6% (three classes), 7%" and 7.5%othe first three also participate in profits. The highest fixed dividend is 8%, paid on the preferred ordinary shares. A detailed description of each category of shares is given in Annex Reserves and Iletained Earnings. As of December 31, 1969, IDBI's linking fund, reseirves and retained earnings amounted to I 71.6 million. 28. Government Deposits. IDBI receives deposits from the Government from time to time. The Government deposits are classified into three categories: (1) the Government places its funds from time to time to cover the defaulted amount of IDBI loans, the repayment of which is guaranteed by the Government (ai8.6 million as of December 31, 1969); (2) the Government makes deposits, from which IDBI withdraws funds for loans to projects designated by the Government on the terms specified by the Government (I 74 million as of same date); (3) the Government places long-tern deposits with IDBI at an interest rate of 3% per annum to augment IDBI's resources (I 45 million as of same date). The Government deposits totalled I million as of December 31, Debentures. Five issues of debentures bearing interest at the rate of 6% totalled I i54.8 million, of which I 24.8 million was outstanding 1/ In Israel, Government bonds are issued with the principal linked to the cost of living index. Other financial transactions in the private sector are often likewise index-linked. Also, financial transactions connected with foreign currency borrowings are sometimes linked with exchange rate. Until 1963 IDBI loans Ere linked with both the cost of living index and exchange rate. IDBI abolished linking loans in 1963, but both assets and liabilities linked with exchange and index still remain in connection with these transactions. IDBI also holds some Government bonds which are index-linked. In addition, IDDI has a part of its equity linked to the U.S. dollar. IDBI maintains a special account, "linking fund"., for the adjustments on such linking transactions (see also paragraph 65).

17 - 8 - (including linking increments of I 11 million) as of December 31, A description of those debentures is presented in Annex 6. Since December 31, 1969, IDBI has issued additional debentures totalling If35 million which consist of I 2l million, cost of living index-linked, with interest at 5.5%, and IL1h million, dollar-linked, with interest at 7%, both redeemable during AID Loans and Managed Funds. IDBI received two AID U. S. dollar loans, one in 1959 and the other in 1961, each $10 million at an interest rate of 5% per annum for 12 years, including two years of grace. I S20.5 million equivalent in total was outstanding as of December 31, IDBI also received an AID counterpart fund loan of I 40 million in 1964 at an interest rate of 3.5% per annum for 25 years including three years of grace. IZ35.6 million was outstanding as of December 31, Furthermore, IDBI acts as agent for the U.S. Governmento administer local currency loans which AID grants to Israeli industrial enterprises within the framework of the Cooley fund authorization.!/ IDBI is responsible for the disbursement and collection of the loans; it occasionally guarantees the loans. For its services, IDBI receives a one-time commission of 1% on amounts up to I l million and 0.5% on amounts exceeding I M million. As of December 31, 1969, the managed fund amounted to about I 25.5 million. 31. IBRD Loans. The terms, conditions, and the status of two IBRD loans are summarized below: (US$ million) First Loan (1965) Second Loan (1967) Amount Date of Approval September 1965 September 1967 Interest Rate 5.5% per annum Variable rates Amortization Flexible Flexible Status on ]Narch 31, 1970 Credited Disbursed Outstanding As of December 31, 1969, the World Bank loans represented 11.1% of IDBI's total resources. 32. European Bonds. IDBI issued bonds in the amount of $15 million, which were fully subscribed in the Eurcpean market in The bonds carry a 7% coupon, giving an effective cost to IDBI of about 8.23%. The bonds are redeemable in eleven installments by / The fund was created under Section 104(e) of the U.S. Agricultural Trade Development and Assistance Act of 1954 and was available from accruals in local currency of the proceeds from the sales of U.S. agricultural commodities.

18 Loans from the U.S. Export-Import Bank. IDBI has utilized lines of credit at an interest rate of 6$ per annum from the U.S. Export-Import Bank for financing imports of capital goods from the U.S. The amount outstanding as of December 31, 1969 was I 28 million. 34. Loans from the U.K. Export-Credit Guarantee Department. IDEI received two 'ana at an interest rate of 6.47$ per annum from the U.K. Export-Credit Guarantee Department, totalling UK 5 million in 1968 and The outstanding amount as of December 31, 1969 was I1F23.0 million. 35. Participation of Third Parties in Loans Granted. IDBI has received loans fro -local commercial banks and American Palestine Association to participate in IDBI-financed projects. IDBI is responsible for repayment of such loans, The amount outstanding as of December 31, 1969 was I 9.7 million. 36. Other Sources. IDBI borrows, from time to time, at short-term from the Bank of Israel to accommodate its short-term needs. The amount outstanding as of December 31, 1969 was I 15 million. IDBI has recently entered into an agreement with a consortium of four Belgian banks for a loan of $10 million equivalent at an interest rate of 7% per annum, for a period of up to ten years. As noted above, IDBI has made considerablefforts to raise funds from many sources.

19 IV. POLICIES AND OPERATIONS Policy 37. IDBI does not have a comprehensive statement of general business policies. Its lending policy has evolved in the course of operations, guided by its Articles of Association and the Government's policies for industrial development. Individual loan applications are judged on their own merits, and profitability for IDBI is an overriding consideration. 38. Although the Articles of Association provide IDBI with a wide variety of functions, IDBI has concerned itself almost exclusively with lending. Loans are granted for fixed capital including land, buildings and equipment for industrial projects, primarily in the private and cooperative sectors. With minor exceptions, IDBI does not provide loans for working capital. It has not lent to Government-controlled enterprises from its own resources including the proceeds of Bank loans. Loans to Government-controlled enterprises are made only from special funds so provided or arranged by the Government. IDBI has no stated policy on lending in the occupied territories, and would consider such applications, if any, on an ad hoc basis on their own merits, but only against full Government guarantees. So far, IDBI has made only two such loans, neither involving Bank funds. The proposed Bank loan 4 would finance only projects within the borders of the state of Israel as of January 1, 1967, and would be used only for t "productive purposes", i.e. it 0 'would not be used for investments in projects primarily or mainly devoted t the production of defense items. 39. IDBI also engages in two types of guarantee operations: first, guarantee of letters of credit to finance imports of equipment abroad; and secondly, guarantee of long-term loans including AID (Cooley) loans. Loan and Guarantee Operations 10. Summary of Operations. IDBI's statistics and accounts show, from its inception, not only loans from its own resources but also Cooley loans and long-term guarantees, on the ground that all these operations have involved management decisions on the part of IDBI. From its inception to December 31, 1969, IDBI had approved 2,568 operations for a cumulative total of l 1.39 billion. Loan approvals, commitments and disbursements since 1966 have been as follows: (IL million) Approvals Commitments Disbursements

20 It is apparent that IDBI's operations have grown since 1967, reflecting the strong upsurge in industrial activity, following the recovery from the 1966 recession. The growth of loan activities in 1969 is particularly noteworthy. A summary of loan operations since 1958 is shown in Annex 7, and an analysis of loans approved in Annex Size of Loans. IDBI is reluctant to consider applications for loans below IU50,000, but about one-fifth by number (only 1.2% by value) of loans approved are below that figure. There are no specific restrictions on the maximum size of a loan or on total commitment to a single enterprise. The largest loan so far made and the maximum exposure in a single enterprise is I 4 4 million to a chemical company, equivalent to about 10% of IDBI's equity as at December 31, The average size of loans is IF 540,000. Loans above I 1 million account for 11% in number, but 64% in amount. 42. Commitment Fee and Other Charges. IDBI does not impose a uniform rate of commitment fee, but passes on the same amount of commitment fee to the borrowers as it must pay to its lenders, when the lenders charge a commitment fee. It charges a one-time commission of 1% on the amount of each loan and a guarantee fee of 2% per annum on the guaranteed amount outstanding. 43. Interest Rate and Exchange Risk. As noted in paragraph 11, IDBI charges rates up to 9% per annum. In cases where it charges less than 9%, the Govermment pays IDBI the difference. By agreement with IDBI, the Govexnment assumes the exchange risk on foreign borrowing without charging any premium. IWhenever IDBI negotiates foreign credits from abroad, it does so only with the prior approval of the Government, which approval also conveys the Government's undertaking to assume the foreign exchange risk on the credit. 44. The Government's interest rate policy is part of a complex system of incentives, which include development grants, export subsidies, drawbacks of customs duty and other devices, designed to promote economic and social objectives such as the encouragement of exports and the development of underpopulated areas. During negotiations, the Bank received assurances from the Government and IDBI that they recognize the importance of adequate economic justification of investment projects, and that economic as well as financial costs and benefits were being carefully assessed. IDBI's representative confirmed that IDBI would continue to address itself with particular care to the economic justification of projects during their appraisal, and that the reports submitted to the Bank would reflect the economic analysis made. h5. Security. IDBI's loans are made on a secured basis, mainly against first mortgage but sometimes supplemented by the guarantee of either sponsors or third parties including the Govermment. Collateral is assessed, based on estimated realization on liquidation. The size of the loan is usually limited to 55% of the estimated project cost.

21 Maturity. With a few exceptions, IDBI does not lend for less than four years. Its longest maturity has been 20 years. The maximum grace period for repayments is two years and a half. Of the loans approved up to December 31, 1969, about 71% by value were repayable over nine years, but about one-half by number were repayable in between six and eight years. The average maturity is about eleven years. 47. Industrial Distribution. Loans are fairly evenly distributed among various industries. The textile and leather industries have received about 24% of the total loans by value, the metal industry about 17% and the chemical and rubber industry about 16%, the food and tobacco industry about 12%, nonmetallic minerals about 10%, paper and printing about 5% and miscellaneous about 16%. Loans to the chemical and rubber industries and the metal industry have proportionately increased by value recently. No statistical data on export industries as distinguished from industries producing goods for domestic use are available. Howvever, IDBI estimates that more than two-thirds of the enterprises it finances are export-oriented. 48. Geographic Distribution. The regional distribution of loans approved indicates Government's emphasis on development areas, i.e. on the borders where the availability of infrastructure and skilled labor is inadequate, and risks are substantial, as are also the Government's incentives. Loans do not show heavy concentration in a particular region. 49. Mew or Existing Industries. About three-fourths of IDBI's lending by amount has been to existing enterprises for modernization and expansion. The balance of one-fourth has gone to support new ventures. Recently, loans for expansion and modernization have further increased, reflecting the necessity and efforts for balancing and rationalization of existing industries for cost reduction. 50. Guarantees. IDBI's guarantees outstanding amounted to I$39.8 million, I 30.9 million and I 29.3 million as of December 31, 1967, 1968 and 1969 respectively. Government-Guaranteed Loans 51. As of December 31., 1969, an outstanding amount of about I 275 million or 31% by value of IDBI's portfolio consisted of loans which were partially or wholly guaranteed for repayment by the Government of this total, the portion guaranteed by the Government was IL1O6.5 million. The Government guarantees repayment of IDBI's loans because of its interest in stimulating the growth of development areas, in promoting exports or import substitutes, and in encouraging projects with a high value added, especially those based on local raw materials. IDBI seeks Government guarantees for projects located in areas which are handicapped by inadequate infrastructure and skilled labor supply. Over 80% of the Government-guaranteed projects are in such areas. Another group for which guarantees are sought is projects

22 which meet the criteria set by the Law for the Ecnouragement of Capital Investments, but for which the security is inadequate in IDBI's judgment. 52. The Government guarantees are of two types, "general" and "special". The Government obligations in the "general" guarantees are met from a fund to which the Government credits an amount (according to an agreed formula) for each guarantee given. The present size of this fund is adequate in relation to the size of the outstanding amount of guaranteed loans and to the likely claims. In the event of default, IDBI is compensated up to 8O% of the outstanding balance of a loan. As of December 31, 1969, the amounts covered by the "general" guarantees totalled IT million. The "special" guarantees may be extended up to 100% of the value of the loans and are given on an individual basis without using the funds for the "general" guarantees. The value of outstanding loans covered by the "special" guarantees was IL 6.4 million, as of the same date. 53. The Government guarantees are not conditional on the exhaustion of legal remedies by IDBI. In the event of default, the amount of repayment due, both principal guaranteed and interest accrued is immediately paid to IDBI. 54. Before the second Bank loan was made, the Bank noted IDBI's inadequate appraisal reports on a few projects guaranteed by the Government. In making the second loan, the Bank required IDBI to obtain the Bank's prior approval on all sub-loans to be guaranteed by the Government, regardless of their size. This has helped ensure adequate appraisals. Also, about two years ago, it was determined that Government guarantees would be given only after specific approval by the Israeli Legislature. This requirement too has prevented IDBI from excessive reliance on Government guarantees, which can now be obtained only rarely and with difficulty. In view of the good standard of IDBI's appraisal work and the more stringent conditions for the grant of Government guarantees, it is no longer necessary for the Bank to stipulate prior approval of all projects guaranteed by the Government for which Bank funds are used. 55. IDBI made two loans totalling about IL 4.5 million to enterprises in the occupied territories in 1968 (Bank funds were not involved), but it has made no such loan in IDBI's loans to Government-controlled enterprises made through special funds provided by the Government amounted to IS 74 million or rather less than 10% of its portfolio, as of December 31, Risks in all these loans are fully assumed by Government. Investment in Shares 56. IDBI, as a general rule, does not make equity investments, except when necessary to rescue its borrowers or in connection with mergers or the reconstruction of clients' companies. In fact, IDBI has been inactive in new share investment since 1965 when the first Bank loan was granted. This inactivity largely resulted from the fact that Israeli industry is characterized by a high proportion of debt and considerable reluctance to expand

23 equity ownership. The depressed condition of the stock market in recent years has further aggravated the difficulty of making good equity investments. IDBI's present management believes that development lending should not be mixed with share ownership. Many of IDBI's investments in shares were made in connection with its loan operations in earlier years. 57. As of December 31, 1969, IDBI's investment in share capital, including its holding in its subsidiary investment company, amounted to I 33.7 million, 3.6$ of its total portfolio. The bulk of the share investments are not quoted on the stock exchange. As of December 31, 1969, the market value of the quoted shares and securities was about 88% of cost. Investment Company of IDBI 58. The Investment Company of IDBI was established in 1963 to operate in the field of equity investment, following legal advice on the requirements of the U.S. Security and Exchange Commission, in order to enable IDBI to continue to be exempt from SEC's classification "investment company". If IDBI had not remained exempt it would have been able to seek funds in the U.S. capital market only after complying with substantial restrictions. (For example, IDBI's Board would have had to include United States citizens as a majority.) The share capital of the Investment Company, I 20 million, is owned by IDDI (74.9%) and Government (25.1%). The Investment Company operates in accordance with IDBI's policy towards investments in shares mentioned above, and functions virtually as a department of IDBI, having no separate staff of its own. The Investment Company was originally intended to take over most of the equity investment activity of IDBI, but in the circumstances its activity has been limited mainly to rescue operations of IDBI's clients in trouble. 59. The Investment Company's total assets amounted to about I 32.6 million, 3.3% of IDBI's total assets, as of December 31, Its total portfolio, consisting of investments in shares, debentures and loans, amounted to about I 26 million at cost, of which I M9.6 million or about 75% was invested in share capital. Quoted securities amounted to IL 11.2 million, the market price of which was about IL11.8 million, slightly higher than the cost. The balance sheets and income statements of the Investment Company since 1966 are shown in Annexes 9 and 10, respectively.

24 V. FINANCIAL PERFORIANCE Income Performance 60. ID3I's income statements for the years 1966 through 1969 are given in detail in Annex 11 and are summarized below. (I million) Gross income Expenses: Financial charges Administrative and general expenses Allowance for doubtful loans and investments, etc T6 W37 = Total net income, before taxes Net earnings Profit before financial charges and tax as % of average total assets Profit before tax and provisions as % of average total assets Profit before tax and provisions as f of average equity 1/ Profit after tax and provisions as % of average year-end share capital 2/ IDBI's income performance is satisfactory. Gross income increased from I 72 million in 1967 to I 83.7 million in Net income increased from If, 22.7 million in 1967 to IL 28.6 million in 1968, but decreased to If 25.1 million in 1969 owing to higher tax payments. Administrative and general expenses have been below 0.6Z of average total assets. 1/ Excluding Ordinary B and Preference A shares owned by the Government, but including net linking funds. 2/ Excluding Ordinary B and Preference A shares owned by the Government.

25 IDBI's calculation of the difference betwieen yield from funds used and cost of resources (including in cost the payout on shares which rank for dividends ahead of Ordinary A shares) was 155% in The margin increased to 2.05c- in 1967, 2.11% in 1968 and 2.51s in 1969 owing to the new arrangement with the Government whereby payment to the Government of insurance premiums by ID3BI for exchange risk was eliminated. Financial Position 63. IDBI's balance sheets as at December 31, from 1966 through 1969, are given in detail in Annex 12 and are summarized below: Assets (I million) Short-term assets and deposits Long-term deposits Loans Investments in shares and subsidiary company Fixed assets and deferred charge Liabilities Short-term liabilities Special deposits and participation Long-term debt Linking funds Share capital and retained earnings Except in 1967, IDBI's current ratio was less than 1.0. However, IDBI has been able to meet short-term requirements through long-standing arrangements for short-term accommodation with the Bank of Israel. The annual rate of growth of total assets was 4.9% in 1968 and 8.3% in Reserves and retained earnings increased from It 16.5 million in 1967 to IZ 22.4 million in IDBI's financial position is generally sound, although its liquidity position remains tight. 64. The only restriction on IDBI's borrowings in relation to its equity is contained in the first AID loan agreement, which provides that IDBI's indebtedness should not be more than twice the share capital and surplus. The ratio of non-current debt and guarantees to equity was 0.92:1 in 1968 and 1.06:1 in In view of IDBI's low debt to equity ratio, the Bank did not impose any such restriction for the previous loans. However, IDBI's first AID loan is scheduled to mature in For a new Bank loan, it would be prudent to limit IDBI's indebtedness to not more than three times the share capital and surplus. The draft documents for the proposed loan have been negotiated accordingly.

26 Linking Funds. Since April 1963, IDBI has not made loans linked with the dollar or the cost of living index. All linking increments accrued on linked loans made before that date were cancelled effective January 1967 under an agreement with the Government, whereby the Government undertook to compensate ID3I for any amounts that would otherwise have become due to IDBI. Linking increments on linked loans will remain as assets in IDBI's accounts until the final settlement is made. Also, IDBI has index-linked assets in certain local bonds, as well as dollar and index-linked liabilities in connection with its shares and borrowings. The combined net balance shows a surplus of linked assets over linked liabilities. As of December 31, 1969, the net balance in the linking funds amounted to If 32.6 million, out of which the sum of If 28.1 million wlas earmarked to adjust the par value of the linked share capital. 66. Dividends. All classes of shares except Ordinary A shares carry the right, statutory or conventional, to certain minimum rates of dividend. Consequently, dividends have commanded a substantial share of disposable income. IDBI has also paid dividends on Ordinary A shares at moderate rates since 1959 and has since 1967 maintained a rate of 8.9% per annum on those shares. Total dividends paid amounted to I 24.0 million or about 76%0lo of disposable income in 1968, and I 19.5 million or about 78% in Reserves. The Articles of Association require that after payment of dividends and dividend arrears on all Preference shares, a part of "ordinary" profit, up to 10%, must be credited to a reserve fund. There is no lower limit, so that theoretically even a token sum can be set to reserve. Further amounts (unspecified) may be credited to the reserve fund at two stages: after payment of the specified dividends on Ordinary shares; and after distribution of specified participating dividends on Preference shares. The reserve fund may also be credited with sums from the surplus of the linking accounts. As of December 31, 1969, the general reserve was IL 18.5 million. 68. The following table lists the various items of reserves and shows the reserves position in the past three years: (I million) December General reserves Other free reserves Share premiums Capital linking fund Unappropriated Total WI 9J7 Total reserves at If 62.5 million as of December 31, 1969, represented 6.7% of IDBI's total portfolio. 69. Provisions for Bad Debts. The cumulative provisions for bad and doubtful debts, net of amounts written off, as of December 31, 1969 were If 8.1 million. A provision has also been made of about IL 4.5 million for

27 diminution in value of share investments. The provisions appear to be adequate in the light of the position described below. Quality of Portfolio 70. As of December 31, 1969, the amount of overdue installments on loan repayments was It 16.5 million (of which I 15.1 million had been in arrears for more than a year). The amount in arrears was less than 2% of the loan portfolio and the total principal of loans in arrears was I million, or about 12.6% of the loan portfolio (Annex 13). Legal proceedings were in progress in respect of outstanding loans amounting to Ia 16.9 million, of which I 8.3 million was guaranteed by the Government for repayment. 71. Of the amount of I 16.5 million in arrears, IL 13 million was due from one textile company, Wooltex. The loans to Wooltex were made early in IDBI's life, and Wooltex has long been in difficulties. Its present management was installed by IDBI in an attempt to improve its condition, but the attempt has not been successful. IDBI is considering whether to change the management again, or to secure the appointment of a Receiver.!rjhatever the outcome, IDBI does not expect to lose any part of its loan. IDBI has collateral security as well as an 80% Government guarantee. 72. As of December 31, 1969, the total amount of loans and investments in shares written off from provisions for bad debts was I 3.3 million, of which the Government, under its guarantees, reimbursed IDBI IL 2.8 million (Annex 14). As of the same date the Government had a deposit with IDBI of Ir 8.4 million in respect of Government-guaranteed loans in default which were undergoing legal proceedings. 73. IDBI's portfolio is fairly well diversified in various industrial fields. Bearing in mind that IDBI deliberately takes risks, within limits, the proportion of its outstanding loans which are in trouble is not excessive. Actual losses to ID3I are likely to be minimal, taking into account the Government guarantees and collateral security. IDBI's portfolio is satisfactory and its reserves and provisions are adequate. Share Value and Audit 74. IDBI's Ordinary A shares, Preferred Ordinary shares and the dollarlinked Preference B, C, CC, CC1 and D shares are listed on the Tel Aviv Stock Exchange. Quoted prices on December 31, 1969, were about 70% of par (except Preference D share which were quoted at about 90%), reflecting generally depressed conditions in the stock market. The average book value of all classes of shares as of the same date (including the reserve for linked share capital) was about 117% of par. 75. IDBI's accounts are audited by Messrs. Somekh Chaikin, Citron and Company, a firm of independent public accountants acceptable to the Bank. The 1969 accounts were certified by the auditors without qualification.

28 VI. PROSPECTS General 76. Industrial Investment. The Government is now preparing an industrial investment plan for the period through IWhile no definitive figures are yet available, the present draft envisages an average annual growth rate of industrial output of 10.4% over the next ten years at 1968 prices. Gross industrial investments of more than IS 16 billion are projected for the period. This level appears feasible on the basis of current favorabl economic conditions, accomplishments in the past and the need for replacement of the fixed capital already invested. The annual gross investments in industry in are estimated as follows: Year Amount (I. million) , ;350 Total 5, IDBI's Share in Industrial Investment. In the past, the average amount of IDBI's financing for industrial development has been about 25% of total industrial investment in the country, and the ratio was as high as 36% in one year. IDBI envisages the amount of its financing for the next five years to be about the same proportion of total industrial investment as the average in the past. IDBI's Requirements and Resources 78. Projections of IDBI's loan operations for the five years from 1970 through l974 appear in 'nnex 15. Sums of past and projected loan approvals, commitments and disbursements are summarized below: (IL million) Approvals Commitments Disbursements 1967 (actual) (actual) (actual) (estimate) (estimate) (estimate) (estimate) (estimate)

29 On the basis of these projections, IDBI will commit IS 1,200 million and disburse the same amount over the next five years. The projected disbursement of IL 1,200 million is about 23% of the projected total gross investment in industry, or slightly less than IDBI's average share in total industrial investment in the past. 79. IDBI has projected loan commitments of about IS 475 million ($136 million) during the two years from July 1970 to June On the basis of IDBI's past and present performance, the current economic outlook, the Government's industrial investment plan and loan applications already in the pipeline (IL 243 million, as of December 31, 1969), IDBI's projections appear reasonable and, if resources become available, practicable. 80. Resources projected for the same tio-year period from July 1970 to June 1972 are summarized as follows: Equivalent in Domestic sources IL million $ million Government deposits, debentures, etc Loan collections (net) and retained earnings Sub-total Foreign sources Uncommitted funds under existing agreements New borrowings from abroad (of which Exim Bank) (28) (8) Sub-total Total Of the total resources requirements projected for the two-year period, IS 475 million, IDBI estimates that IL 105 million will become available from loan collections (net) and retained earmings and IL 51 million from funds uncommitted under existing agreements with financial institutions abroad. Thus, IDBI will have to seek additional financing from domestic and foreign sources of around IL 319 million or US$91 million equivalent. IDBI expects to raise I;J 141 million from domestic sources, including the Government. The balance, II 178 million or US$ 51 million equivalent, it will seek from abroad. Of the amount of IS 178 million, IDBI expects to receive I628 million or $8 million equivalent from the U.S. Export-Import Bank, of which $5 million is already under negotiation. IDBI therefore proposes to seek IS 150 million or US$ 43 million equivalent abroad to fill the remaining gap in its projected resource requirements.

30 Assuming that imports (including the identifiable foreign exchange component of local expenditure) constitute the same proportion of IDBI's commitments in the two years ending June 1972 as in the recent past, IDBI will need about $66 million for use in that period. The proposed Bank loan of $25 million could therefore be used entirely to finance imported goods and services. A part of the equipment requirements of investment enterprises can be met from goods manufactured in Israel from imported raw materials and components; another part can be met from off-the-shelf purchases of imported goods. It is proposed that the foreign exchange component of such goods be financed out of the loan, and for the sake of administrative convenience it is intended to use as the measure of the foreign exchange component 20% of the cost of goods produced in Israel and 50% of the cost of goods produced outside Israel and purchased from local suppliers. As usual, the loan will be subject to the 90 days restriction on the financing of prior expenditures but in order to provide continuity of Bank financing (the second Bank loan being fully credited by January 31, 1970), the loan documents provide that the Bank will consider applications for withdrawals covering expenditures incurred after February 1, Projected Income and Profitabilit 82. Projected income statements for the five years ending December 31, 1974 are given in Annex 16. Net income is expected to grow from Ib 32.3 million in 1970, to IA 34.6 million in The ratio of profit before taxes to average net worthi/ should be maintained at around 20% to 21% throughout With payment of required dividends, IDBI should be able to appropriate to the reserve account Il 7.5 million in 1970, IL 8.6 million in 1971 and IS 10 million in 1972, amounts slightly higher than those in the past. Projected Balance Sheet 83. Projected balance sheets for the forecast period are presented in Annex 17. Although the current ratio is less than one throughout the projected period, IDBI will be able to manage current requirements through the Bank of Israel's short-term accommodation, as it has done in the past. Loan portfolio is expected to increase to Ib 1,093.7 million in 1970 and to IL 1,320.3 million in Pnnual rate of growth of total assets is estimated at 10.4% in 1971 and 6.5% in Debt Service Cover 84. On the basis of projected cash flow statements (Annex 18) and the projected income statements (Annex 16), debt service cover would be 1.67:1 in 1970, 2.16:1 in 1971 and 2.01:1 in Because of the relatively large net worth against debt (debt equity ratio being less than 3:1 throughout the projected period), a sound debt service cover will be maintained during the life of the proposed loan. 1/ Excluding Ordinary B and Preference A shares owned by the Government, but including net linking funds.