LGU GUARANTEE CORPORATION. Unaudited Interim Condensed Financial Statements As of June 30, 2010

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1 Unaudited Interim Condensed Financial Statements As of

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4 INTERIM STATEMENT OF FINANCIAL POSITION AS OF JUNE 30, 2010 (With Comparative Audited Figures as of December 31, 2009) Notes ASSETS Current Cash 3,19 P 8,033,645 P 5,830,435 Available-for-sale securities 4,19 474,800, ,431,131 Other current assets 5,19 10,031,406 12,323, ,865, ,584,747 Non-current Property and equipment 6 12,188,973 12,891,604 Other assets 7 920,381 1,208,946 13,109,354 14,100,550 P 505,974,555 P 488,685,297 LIABILITIES AND EQUITY Current Payables and other current liabilities 8,19 P 8,325,752 P 7,560,351 Unearned guarantee fee* 17 14,445,321 8,915,492 22,771,073 16,475,843 Equity Share capital 9 287,587, ,587,500 Share premium 2,228,804 2,228,804 Treasury share (100) (100) Net unrealized gain on available-for-sale securities 5,041,986 2,942,893 Retained earnings 10 Appropriated 24,870,198 24,870,198 Unappropriated 163,475, ,580, ,203, ,209,454 See accompanying. P 505,974,555 P 488,685,297 * Contingent liability on principal is P 1,930 million and P 1,813 million, and on interest is P 186 million and P 212 million, as of June 30, 2010 and December 31, 2009, respectively. Contingent liability on interest is the summation of all projected interest expenses per guaranteed account based on declining outstanding principal and projected yearly interest for the remaining term for bonds, and one year interest for loans. Details of total contingent liability of P 2,116 million in 2010 are presented in the notes to financial statements number 17. MERCADO CALDERON JARAVATA & CO. 2

5 INTERIM STATEMENTS OF COMPREHENSIVE INCOME FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2010 AND 2009 Notes REVENUES Investment 11 P 17,237,533 P 15,425,768 Guarantee fee 11,759,207 7,795,609 Program management fee 601,290 1,580,973 Others 160, ,766 29,758,392 25,410,116 EXPENSES Salaries and wages 3,820,494 3,509,775 Employee benefits 12 2,304,791 1,927,841 Origination and utilization fees 878, ,012 Depreciation and amortization 773, ,671 Trust fee 611, ,595 Security services 378, ,076 Professional fees 344, ,060 Taxes and licenses 295, ,549 Power, light and water 293, ,241 Transportation and travel 196, ,602 Communication 136, ,918 Entertainment, amusement and recreation 112,865 94,473 Office supplies and stationeries 95, ,331 Others 335, ,744 10,577,859 9,558,888 INCOME BEFORE INCOME TAX 19,180,533 15,851,228 PROVISION FOR INCOME TAX 14 3,325,983 2,920,830 NET INCOME FOR THE PERIOD 15,854,550 12,930,399 OTHER COMPREHENSIVE INCOME/(LOSS) Unrealized gain/(loss) on Available-for-sale securities 2,623,866 4,829,320 Tax effect (524,773) (965,864) OTHER COMPREHENSIVE INCOME FOR THE PERIOD, NET OF TAX 2,099,093 3,863,456 TOTAL COMPREHENSIVE INCOME FOR THE HALF YEAR P 17,953,643 P 16,793,855 EARNINGS PER SHARE 15 Basic P 5.51 P 4.50 Diluted P 5.51 P 4.50 See accompanying. MERCADO CALDERON JARAVATA & CO. 3

6 INTERIM STATEMENTS OF CHANGES IN EQUITY FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2010 AND 2009 Attributable to equity holders Unrealized Share Share Treasury Retained Earnings Gain on AFS Capital Premium Shares Appropriated Unappropriated Securities Total (Note 9) (Note 10) (Note 4) Balance, January 1, 2010 P 287,587,500 P 2,228,804 P (100 ) P 24,870,198 P 154,580,159 P 2,942,893 P 472,209,454 Cash dividends (6,959,615) - (6,959,615) Comprehensive income Net income for the period ,854,550-15,854,550 Other comprehensive income ,099,093 2,099,093 Total comprehensive income for the period ,854,550 2,099,093 17,953,643 Balance, P 287,587,500 P 2,228,804 P (100 ) P 24,870,198 P 163,475,094 P 5,041,986 P 483,203,482 Attributable to equity holders Unrealized Share Share Treasury Retained Earnings Gain on AFS Capital Premium Shares Appropriated Unappropriated Securities Total Share Retained Earnings Gain on AFS Balance, January 1, 2009 P 287,587,500 P 2,228,804 P (100 ) P 24,870,198 P 136,674,244 P 1,913,703 P 453,274,349 Cash dividends (10,065,559 ) - (10,065,559 ) Comprehensive income Net income for the period ,930,399-12,930,399 Other comprehensive Income ,863,456 3,863,456 Total comprehensive income for the period ,930,399 3,863,456 16,793,855 Balance, June 30, 2009 P 287,587,500 P 2,228,804 P (100 ) P 24,870,198 P 139,539,084 P 5,777,159 P 460,002,645 See accompanying. MERCADO CALDERON JARAVATA & CO. 4

7 INTERIM STATEMENTS OF CASH FLOWS FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2010 AND 2009 Notes CASH FLOWS FROM OPERATING ACTIVITIES Income before income tax P 19,180,533 P 15,851,228 Adjustments for: Depreciation and amortization 773, ,671 Investment income 11 (17,237,533) (15,425,768) Operating income before changes in working capital 2,716,283 1,291,131 Changes in working assets and liabilities (Increase) decrease in: Other current assets 5,19 10,341 (570,851) Other assets 7 288, ,681 Increase (decrease) in: Payables and other current liabilities 8,19 765,401 (663,479) Unearned guarantee fee 17 5,529, ,533 Cash provided by operating activities 9,310, ,015 Investment income received 16,192,984 14,430,980 Net cash provided by operating activities 25,503,403 15,382,995 CASH FLOWS FROM INVESTING ACTIVITIES Increase in available-for-sale securities 4,19 (16,269,926) (5,879,986) Acquisition of property and equipment 6 (70,652) (1,251,924) Net cash used in investing activities (16,340,578) (7,131,910) CASH FLOW FROM FINANCING ACTIVITY Dividends paid 11 (6,959,615) (10,065,559) NET INCREASE/(DECREASE) IN CASH 2,203,210 (1,814,474) CASH, JANUARY 1 5,830,435 8,821,739 CASH, JUNE 30 3,19 P 8,033,645 P 7,007,265 See accompanying. MERCADO CALDERON JARAVATA & CO. 5

8 LGU GUARANTEE CORPORATION NOTES TO UNAUDITED INTERIM CONDENSED FINANCIAL STATEMENTS 1. Corporate Information LGU Guarantee Corporation (the Company) was incorporated with the Securities and Exchange Commission (SEC) on March 2, 1998 primarily to engage in activities related to the guarantee of loans and other forms of credit accommodations granted to local government units in the Philippines and other entities by financial institutions duly accredited with the said corporation, as well as capital market instruments issued by local government units (LGUs) and other entities, all in accordance with the laws and regulations of the Philippines. The Company s office is at Unit 2801, 28 th floor, Antel Corporate Centre, 121 Valero Street, Salcedo Village, Makati City. These interim financial statements have been approved and authorized for issuance by the Company s Board of Directors on September 6, Summary of Significant Accounting Policies Basis of Preparation The unaudited interim consolidated financial statements have been prepared in compliance with Philippine Accounting Standards (PAS) 34, Interim Financial Reporting. The unaudited interim condensed financial statements have been prepared under the historical cost method, except for available-for-sale (AFS) financial assets that have been measured at fair value. The unaudited interim financial statements are presented in Philippine Peso, which is the Company s functional and presentation currency. All amounts are rounded to the nearest peso unless otherwise indicated. The unaudited interim condensed financial statements do not include all the information and disclosures required in the annual financial statements, and should be read in conjunction with the Company s annual financial statements as of and for the year ended December 31, Changes in Accounting Policies The accounting policies adopted in the preparation of the unaudited condensed interim financial statements are consistent with those followed in the preparation of the annual financial statements as of and for the year ended December 31, Improvements to Standards The omnibus amendments to PFRS issued in 2009 were primarily for clarification and better understanding. The amendments are effective for annual periods beginning financial year January 1, 2010 except when otherwise stated. These changes have no material effect on the financial statements of the Company. PFRS 2, Share-based Payment, elucidate that the contribution of a business on formation of a joint venture and combinations under common control are not within the scope of PFRS 2 even though they are out of scope of PFRS 3, Business Combinations (Revised). The amendment is effective for financial years on or after July 1, PFRS 5, Non-current Assets Held for Sale and Discontinued Operations, make clear that the disclosures required in respect of non-current assets and disposal groups classified as held for sale or discontinued operations are only those set out in PFRS 5. The disclosure requirements of other PFRS only apply if specifically required for such non-current assets of discontinued operations. MERCADO CALDERON JARAVATA & CO 6

9 PFRS 8, Operating Segment Information, states that segment assets and liabilities need only be reported when those assets and liabilities are included in measures that are used by the chief operating decision maker. PAS 1, Presentation of Financial Statements, states that the terms of a liability that could result, at anytime, in its settlement by the issuance of equity instruments at the option of the counterparty do not affect its classification. PAS 7, Statement of Cash Flows, clearly states that only expenditure that results in a recognized asset can be classified as a cash flow from investing activities. PAS 17, Leases, removes the specific guidance on classifying land as a lease. Prior to the amendment, leases of land were classified as operating leases. The amendment now requires that leases of land are classified as either finance or operating in accordance with the general principles of PAS 17. The amendments will be applied retrospectively. PAS 36, Impairment of Assets, clear up that the largest unit permitted for allocating goodwill, acquired in a business combination, is the operating segment as defined in PFRS 8 before aggregation for reporting purposes. PAS 38, Intangible Assets, states that if an intangible asset acquired in a business combination is identifiable only with another intangible asset, the acquirer may recognize the group of intangible assets as a single asset provided the individual assets have similar useful lives. It also clears up that the valuation techniques presented for determining the fair value of intangible assets acquired in a business combination that are not traded in active markets are only examples and are not restrictive on the methods that can be used. PAS 39, Financial Instruments: Recognition and Measurement, clarifies the following: that a prepayment option is considered closely related to the host contract when the exercise price of a prepayment option reimburses the lender up to the approximate present value of lost interest for the remaining term of the host contract. that the scope exemption for contracts between an acquirer and a vendor in a business combination to buy or sell an acquiree at a future date applies only to binding forward contracts, and not derivative contracts where further actions by either party are still to be taken. that gains or losses on cash flow hedges of a forecast transaction that subsequently results in the recognition of a financial instrument or on cash flow hedges of recognized financial instruments should be reclassified in the period that the hedged forecast cash flows affect profit or loss. Amendment to Philippine Interpretation IFRIC 9, Reassessment of Embedded Derivatives, clarifies that it does not apply to possible reassessment at the date of acquisition, to embedded derivatives in contracts acquired in a business combination between entities or businesses under common control or the formation of joint venture. Future Changes in Accounting Policies The Company will adopt the following interpretation when this becomes effective. The Company does not expect the adoption of this new Philippine Interpretation to have significant impact on its financial statements. Effective 2012 Philippine Interpretation IFRIC 15, Agreement for Construction of Real Estate This Interpretation, effective for annual periods beginning on or after January 1, 2012, covers accounting for revenue and associated expenses by entities that undertake the construction of real estate directly or through subcontractors. The Interpretation requires that revenue on construction of real estate be recognized only upon completion, except when such contract qualifies as construction contract to be MERCADO CALDERON JARAVATA & CO 7

10 accounted for under PAS 11, Construction Contracts, or involves rendering of services in which case revenue is recognized based on stage of completion. Contracts involving provision of services with the construction materials and where the risks and reward of ownership are transferred to the buyer on a continuous basis will also be accounted for based on stage of completion. 3. Cash This account consists of: June 30, December 31, (Unaudited) (Audited) Cash on hand P 15,000 P 15,000 Cash in banks 8,018,645 5,815,435 P 8,033,645 P 5,830, Available-for-Sale Securities This account consists of: June 30, December 31, (Unaudited) (Audited) Debt securities Government securities P 364,751,892 P 331,911,300 Corporate debt instruments 53,346,639 74,285,115 Private bonds 35,901,619 30,234, ,000, ,431,131 Equity securities Quoted 20,800,000 20,000,000 P 474,800,150 P 456,431, Other Current Assets This account consists of: June 30, December 31, (Unaudited) (Audited) Accrued interest receivable P 5,812,869 P 5,825,357 Others 4,218,537 6,497,824 P 10,031,406 P 12,323, Property and Equipment During the six-month period ended, the company acquired office equipment amounting to P70,651. MERCADO CALDERON JARAVATA & CO 8

11 7. Other Assets This account consists of: June 30, December 31, (Unaudited) (Audited) Prepaid benefit obligation P 684,562 P 934,562 Prepaid tax MCIT 197, ,684 Others 38,700 38,700 P 920,381 P 1,208, Payables and Other Current Liabilities This account consists of: June 30, December 31, (Unaudited) (Audited) Advances from World Bank P 4,393,120 P 4,393,120 Accounts payable 1,824,401 1,088,828 Deferred tax liability 1,260, ,723 Accrued expenses 231, ,304 Others 615, ,376 P 8,325,752 P 7,560, Share Capital As of and 2009, the Company has authorized capital of P500,000,000, of which 2,875,875 shares were issued and outstanding at P100 par value per share. The Company has three (3) shareholders owning 100 or more shares each of the Company s share capital as at the date of financial position. 10. Retained Earnings This account consists of: June 30, December 31, (Unaudited) (Audited) Appropriated for probable losses P 24,870,198 P 24,870,198 Dividends (6,959,615) (10,065,559) Unappropriated 170,434, ,645,718 December 31 P 188,345,292 P 179,450,357 On June 8, 2010, the Board of Directors approved the declaration and payment from unappropriated retained earnings of cash dividends of P2.42 per share for shareholders on record as of December 31, Total cash dividends declared amounting to P6,959,615 were settled on June 16, MERCADO CALDERON JARAVATA & CO 9

12 11. Investment Income The details of this account as of June 30 follow: June 30 Available-for-sale income: Interest P 16,365,223 P 13,965,958 Cash dividends 872,310 1,459,810 P 17,237,533 P 15,425, Employee Benefits Employee benefits expense consists of wages and salaries, fringe benefits, retirement expense and other remunerations. Retirement expense amounted to P250,000 and P402,935 for the six-month periods ended and 2009, respectively. Retirement Plan The Company has a funded non-contributory retirement plan covering all its regular officers and employees. The benefits are based on a percentage of latest monthly basic salary and credited years of service. The plan provides retirement, separation, disability and death benefits to its members. The fund is administered by a Trustee appointed by the Company. Actuarial valuation is made at least every 2 years. 13. Related Party Transactions Key management personnel of the Company include all directors and senior management. Details are as follow: June 30, December 31, (Unaudited) (Audited) Senior management P 1,730,400 P 3,517,248 Director's fee 96, ,000 P 1,826,400 P 3,670,248 There are no services rendered and non-interest/interest bearing advances to/from associates, stockholders and other related parties. 14. Income Taxes Provision for income tax consists of: June 30 Final tax on investment Income P 3,273,045 P 2,920,830 Income tax - current 52,938 - P 3,325,983 P 2,920,830 MERCADO CALDERON JARAVATA & CO 10

13 15. Earnings Per Share The computation of basic/diluted earnings per share is as follows: June 30 Net income P 15,854,550 P 12,930,399 Divided by outstanding shares 2,875,874 2,875,874 P 5.51 P 4.50 There were no potential dilutive shares as of and Escrow Agreement As of and 2009, total guarantee fund under the escrow agreement amounted to P108 million and P125 million, respectively. Total investment under escrow agreement is shown in the statements of financial position under Available-for-sale securities. As of, there were no defaults on the payments of debts guaranteed by the Company. MERCADO CALDERON JARAVATA & CO 11

14 17. Contingent Liability In the normal course of its business, the Company entered into agreements to guarantee the bond issuances and loan availments of various LGUs and the loan availments of water districts and private companies. Details of outstanding guarantees as of are as follow: Name of Borrower Date of Amount of Guaranteed Interest Guarantee Bonds Issued / Principal Contingent Total Rate Agreement / Date of Loans Released Outstanding Interest Contingent (Base plus Enrollment Maturity (In Millions) (In Millions) Exposure Liability Spread) A. Municipality of Imus, Cavite Dec. 12, 2003 Aug. 10, MART 1 (Slaughterhouse) 6-month +3.25% B. Municipality of Carmona Feb. 5, 2004 Mar. 11, MART 1 6-month + 3% C. City of Pasay Aug. 4, 2004 Aug. 6, MART 1 6-month +3.25% D. Metro Iloilo Water District Mar. 13, 2006 Mar. 31, MART 1 3-month +3% E. Municipality of Mar. 20, 2006 Jun. 19, MART 1 Baliwag, Bulacan 6-month +3% F. Legazpi City Water District Jun. 19, 2007 Oct. 5, % a G. Silang Water District Aug. 2, 2007 Nov. 29, % b H. Laguna Water District Dec. 18, 2007 Dec. 19, PDST-F 3-month+3% I. City of San Fernando Mar. 7, 2008 Apr. 9, PDST-F Water District 3-month+2.5% J. Indang Water District May 5, 2008 May 5, PDST-F 3-month+3% K. Cabanatuan City June 27, 2008 June 27, PDST-F Water District 3-month+1.5% L. Municipality of Agoo, July 3, 2008 July 3, PDST-F La Union 3-month+2.5% M. Municipality of Imus, Cavite July 18, 2008 July 18, PDST-F (Multi-Purpose Cadastral 3-month+2.5% Survey) N. Mabalacat Water District Aug. 8, 2008 Dec. 5, PDST-F 3-month+2.5% O. Norzagaray Water District Mar. 31, 2009 Mar. 31, % a P. Municipality of Rosario Nov. 17, 2009 Nov. 17, PDST-F 3-month+2.5% Q. Province of Aklan Dec. 17, 2009 Dec. 17, PDST-F (Caticlan Super Marina) 3-month+2% R. Municipality of Alfonso Lista Dec. 22, 2009 Dec. 22, PDST-F (Water System) 3-month+3% S. City of Angeles Nov. 13, 2009 Oct. 27, PDST-F Dec. 22, 2009 Oct. 27, month+3% Dec. 22, 2009 Oct. 9, T. City of Trece Martirez Dec. 22, 2009 Dec. 22, PDST-F 3-month+3% U. Province of Zamboanga Dec. 23, 2009 Dec. 21, PDST-F Sibugay 3-month+3% V. City of Toledo Mar. 29,2010 Nov. 25, PDST-F 3-month+3% W. Worldchem Enviro May 17, 2010 May 06, Bank Base Technologies, Inc. Rate X. Healthserv Los Banos, Inc. June25,2010 June25, Bank Base June25,2010 June 25, Rate P 2,969 P 1,930 P 186 P 2,116. The maximum interest rate guaranteed for loans with variable interest rates shall not exceed the sum of (a) three percentage points plus (b) average of (i) the weighted average interest rate for 182-day T-bill issued by the Philippine Treasury during the immediately preceding twenty-four months, and (ii) the average Philippine Interbank Offer Rate (PHIBOR) during the immediately preceding 24 months. MERCADO CALDERON JARAVATA & CO 12

15 Details of bonds fully redeemed and loans fully paid or taken out as of are as follow: Name of Borrower Total Amount Paid to Total Amount Creditor Amount of Paid to Including Those Date of Bonds Issued/ Creditor Not Due to Date of Guarantee Loans Released During Take Out Take Out Take Out/ Agreement (In Millions) (In Millions) (In Millions) Payment A. City of Iloilo Mar. 9, 2001 P 130 P 130 P 130 May 10, 2002 B. City of Caloocan - Series A Nov. 15, May 14, 2003 C. City of Urdaneta May 27, May 28, 2003 D. City of Tagaytay Mar. 6, Oct. 11, 2004 E. Province of Leyte Feb. 28, Mar. 6, June 30, 2009 F. City of Puerto Princesa Feb. 18, Apr. 29, 2005 G. Municipality of Daraga, Albay May 22, May 30, 2005 H. Municipality of Bayambang, Jul. 26, Nov. 18, 2005 Pangasinan I. Municipality of San Juan Jul. 23, May 31, 2006 J. Province of Aklan Jun. 30, Jul. 1, 2006 K. City of Caloocan - Series B Nov. 15, Dec. 5, 2007 L. City of Caloocan - Series C Nov. 15, Dec. 5, 2007 M. Calamba Water District Jun. 28, Oct. 21, 2009 N. Laguna Water District Dec. 18, Oct. 19, 2009 P 2,206 P 1,278 P 1, Commitments Agreement with United States Agency for International Development (USAID) On September 15, 2000, the Company entered into a guarantee agreement with USAID where the latter committed to reinsure up to thirty percent (30%) of the Company s risk on enrolled LGU loans with respect to Qualifying Loans covered under the agreement. In connection with the services provided, the Company paid a one-time origination fee and shall pay a utilization fee with respect to each six-month period ending March 31 and September 30 of each year. The guarantee agreement ended on September 30, 2008 after five successive extensions solely for water projects. A new guarantee agreement was signed on September 24, 2008 intended to strengthen LGUGC s ability to enhance lending to water supply and sanitation services and facilities projects of Local Government Units ( LGUs ), Water Districts and private sector water service providers in the Philippines. MERCADO CALDERON JARAVATA & CO 13

16 Agreement with International Bank for Reconstruction and Development (IBRD) On May 5, 2004, an agreement was entered into between the Republic of the Philippines (the Recipient) and the International Bank for Reconstruction and Development (the Bank) acting as an implementing agency of the Global Environment Facility (GEF) in respect of grant funds provided to the GEF Trust Fund by certain members of the Bank as participants of the GEF. The Bank has agreed to make available to the Republic of the Philippines a GEF Trust Fund Grant in an amount in various currencies equivalent to US Dollars: Eleven Million One Hundred Twenty Three Thousand ($11,123,000) (the RoP GEF Trust Fund Grant) to assist in financing the $10 million Partial Credit Guarantee Program and $1,123,000 Department of Energy (DOE) s Capacity Building and Implementation support for key stakeholders of the Project in accordance with the terms and conditions set forth in the RoP Grant Agreement. The project aims to assist the Recipient in promoting energy efficiency improvements for the provision of reliable and least-cost power supply and the reduction of carbon dioxide emissions and other pollutants through commercial lending and private investments in electric cooperatives (ECs). The project established a credit guarantee program to support financing power distribution system upgrade projects for selected ECs, which would achieve substantial reduction in power losses, improve distribution system efficiency and hence reduce greenhouse gas emissions. The guarantee program is managed by LGUGC as the Guarantee Program Manager. The guarantee program will be available to support loans from banks. A main goal of the program is to recruit commercial lenders to the EC market and demonstrate the viability of EC project finance. The guarantee will partially mitigate borrower credit risks and assist private banks to enter this market and to provide financing with extended loan maturities and reduced collateral requirements. On November 5, 2004, the Guarantee Program Implementation Agreement was signed between the Recipient and LGUGC, where the Recipient appointed the Company as the exclusive Guarantee Program Manager for purposes of implementing Parts A and B.1 of the Project. The allocated amount of Ten Million US Dollars ($10,000,000) will be withdrawn from the proceeds of the GEF Trust Fund Grant Account and deposited into the Guarantee Reserve Account with an escrow agent in accordance with the agreement. The Guarantee Reserve Account will be managed and made available to LGUGC as Guarantee Program Manager as set forth in the Guarantee Program Implementation Agreement. Under the Global Environment Facility Trust Fund Grant Agreement between the Company (LGUGC) and the Bank dated May 4, 2004, the Bank has agreed to make available to the Company a GEF Trust Fund Grant in an amount in various currencies equivalent to US Dollars: Eight Hundred Seventy Seven Thousand ($877,000) (the LGUGC Trust Fund Grant) to assist in financing LGUGC s Capacity Building and Implementation Support for key stakeholders in accordance with the terms and conditions set forth in the LGUGC Grant Agreement. Pursuant to the grant s withdrawal arrangement, LGUGC opened and maintained a Special Account (IBRD Special Account) with United Coconut Planters Bank under Account No and received an initial allocation amounting to Eighty Thousand US Dollars ($80,000) for eligible expenditures. The Special Account fund balance is part of the Company s Cash and the $80,000 initial allocation is included in the Current Liabilities portion of the Company. The proceeds of the World Bank grant have been expended in accordance with the intended purpose as specified in the agreement. Agreements with Department of Energy CBRED-LGF On November 9, 2006, the Department of Energy (DOE) and LGU Guarantee Corporation (LGUGC) executed a Program Implementation Agreement for the Capacity Building to Remove Barriers to Renewable Energy Development (CBRED) Loan Guarantee Fund (LGF) Program to provide partial loan guarantee to eligible borrowers. MERCADO CALDERON JARAVATA & CO 14

17 Accordingly, for purposes of implementing the program, DOE appointed LGUGC as CBRED-LGF Program Manager to perform principal guarantee operations and program management functions. To finance the implementation of the program, DOE shall make available to the LGUGC One Million Six Hundred Six Thousand Five Hundred United States Dollars ($1,606,500) held in escrow by the LGF Escrow Agent. Any and all income and repayments (interest on investments, principal and other charges) shall be re-channeled to the Program fund in accordance with the LGF Escrow Agreement. The LGUGC undertakes to manage the program in accordance with policies and guidelines set forth in the Program Design and Operating Guidelines. LGUGC, as LGF Program Manager, shall be entitled to a program management fee of twenty-five percent (25%) share of all income accruing to the Program fund from the following: (1) interest on investments; (2) guarantee fees; and (3) filing fees. Unless extended by the written agreement of the parties, the Agreement shall be effective from the date of execution until its termination. Thus, the Agreement shall be terminated upon written notification by DOE to the LGF Program Manager, and it shall expire to all parties simultaneously thirty (30) days after receipt by LGUGC of said notice. The proceeds of the grant have been expended in accordance with the intended purpose as specified in the agreement. RPP-LGF On December 18, 2006, DOE and LGUGC executed a Memorandum of Agreement for the implementation of the Rural Power Project (RPP) - Loan Guarantee Fund (LGF) to undertake a special program to provide credit enhancements including loan guarantees to eligible lenders to cover partially the risks they face when financing Photovoltaic Systems to individual households in rural areas. DOE appointed LGUGC as the exclusive Program Manager to perform principal guarantee program operations and program management functions. To finance the program, the DOE shall make available to LGUGC funds held in escrow by the Escrow agent of at least One Million United States Dollars ($1,000,000), at no cost to the latter. Any and all investment and fee income and repayments (interest on investments, principal collateral recoveries, guarantee fees and other charges) accruing to the program shall be re-channeled to the RPP-LGF Escrow sub-accounts maintained with the Escrow Agent, in accordance with the LGF Escrow Agreement as amended. LGUGC, as Program Manager, shall be entitled to program management fee of fifty percent (50%) share of investment income accumulated to the Program fund, and shall promptly receive from DOE full cost recovery for consulting service fees, goods and all incremental and operating expenses incurred in the implementation of the program. Moreover, for consulting services rendered and expense incurred for the 2007 implementation of the program, the DOE shall pay or reimburse LGUGC an amount not to exceed Two Million Eight Hundred Thirty One Thousand Pesos (P2,831,000) pursuant to the annual budget. Thereafter, LGUGC shall submit an annual operating budget to the DOE before the start of the present year for approval funding. The proceeds of the grant have been expended in accordance with the intended purpose as specified in the agreement. The RPP-LGF program was terminated on September 30, 2009 in accordance with the DOE-WB RPP Project Agreement. MERCADO CALDERON JARAVATA & CO 15

18 19. Financial Risk Management In the ordinary course of business, the Company manages a variety of risks, principally credit, market and liquidity. These risks are identified, measured and monitored through a variety of control mechanisms, which are in place at different levels through organization. Credit Risk The Company is exposed to credit risk in various capacities including that of an issuer of financial guarantees and a holder of investment securities. All financial guarantees issued are subject to a formal underwriting process. Various factors affecting the creditworthiness of the underlying obligations are evaluated during the underwriting process. The Board of Directors approves all transactions. Subsequent to the issuance of a financial guarantee, the Company s management periodically reviews and monitors the project and financial status of the borrowers using the Portfolio Risk Management Manual. The Company limits its exposure to losses from financial guarantees by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous collateral requirements on asset-backed obligations as well as through co-guarantee. For information on the Company s financial guarantee exposure see Notes to Financial Statements on Contingent Liability (Note 17). The Company manages credit risk associated with its investment portfolio through adherence to specific investment guidelines. These guidelines establish limits on single risk concentrations and minimum credit rating standards. The Board of Directors is responsible for the formulation and implementation of these investment policies upon the recommendation of the Board Audit Committee. Additionally, senior management monitors the portfolio on a continuous basis. Credit risk exposure from cash deposits with banks arises from default of the counterparty, with a maximum exposure equal to the fair value of these investments. The Company maintains its deposits with reputable banks and financial institution. The Company s financial assets, stated in its carrying amounts, which are neither past due nor impaired, is as follows: (Unaudited) Neither Past Due Nor Impaired Past Due But Class A Class B Not Impaired Total Cash P 8,033,645 P - P - P 8,033,645 Available-for-sale securities Government securities 364,751, ,751,892 Corporate debt securities 53,346, ,346,639 Private bonds 35,901, ,901,619 Quoted equity securities 20,800,000-20,800,000 P 482,833,795 P - P - P 482,833,795 MERCADO CALDERON JARAVATA & CO 16

19 December 31, 2009 (Audited) Neither Past Due Nor Impaired Past Due But Class A Class B Not Impaired Total Cash P 5,830,435 P - P - P 5,830,435 Available-for-sale securities Government securities 331,911, ,911,300 Corporate debt securities 74,285, ,285,115 Private bonds 30,234, ,234,716 Quoted equity securities 20,000,000-20,000,000 Credit Quality P 462,261,566 P - P - P 462,261,566 Cash To minimize credit risk exposure from cash, the Company maintains its cash deposits in commercial/universal banks with good credit ratings and have demonstrated financial soundness for several years amounting to P8,018,645 and P5,815,435 as of and December 31, 2009, respectively. Available-for-sale securities Available-for-sale securities consist of investments in government securities, corporate debt instruments, private bonds and quoted equity securities. These investments are considered to be of high credit quality. Class A High Grade are accounts with strong financial capacity and business performance and with the lowest default risk. Class B Moderate Grade refers to accounts of satisfactory financial capabilities and credit standing but with some elements of risk where measure of control is necessary in order to mitigate risk of default. Market Risk Market risk or price risk is the risk that movements in the level or volatility of market prices will adversely affect the Company s financial conditions. It is the management s thrust to attain its objectives and profitability. This would mean that the nature, extent as well as degree and impact of risk must be determined. The market risks that would impact on the value of the Company s financial instruments are interest rate risk and foreign currency risk. Interest rate risk The primary objective in managing the Company s investment portfolio, including those under trust agreement, is the generation of an optimal level of after-tax investment income while preserving capital and maintaining adequate liquidity. Investment strategies are based on many factors including the Company s tax position, fluctuation in interest rates, regulatory and rating agency criteria, and other market factors. The Company s investment portfolio holdings are primarily Philippine peso-denominated fixed-income securities as of December 31, The fair value of fixed-income securities is dependent on the movement of the interest rate in the market. The sensitivity analysis for interest rate risk illustrates how changes in the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates at the reporting date. Management monitors the sensitivity of reported interest rate movements periodically by assessing the expected changes in the portfolio due to parallel movements of 100 basis points in all yield curves. MERCADO CALDERON JARAVATA & CO 17

20 Foreign currency risk The Organization s foreign currency risk results primarily from the foreign exchange rate movements of the Philippine peso against the United States dollar. The Organization resolved to mitigate this risk by taking advantage of market trends. Proper timing is adhered in order to realize a foreign currency gain. Liquidity Risk Liquidity risk relates to the possible inability to satisfy obligations when due. This risk is present in financial guarantee contracts. The Company manages its liquidity risk through a comprehensive daily analysis of cash flows. Additionally, the Company maintains a minimum level of cash and short-term investments at all times. The Company also manages liquidity risk by monitoring and matching the effective duration of its investment assets with the effective duration of its financial guarantee contracts. Most importantly, the Company maintains an escrow fund with a third party trustee bank, the amount of which is reviewed yearly and is based on the estimated expected loss on its financial guarantee contracts. Maturity Profile of Financial Assets and Liabilities The tables below summarize the maturity profile of the Company s financial assets and liabilities as of and December (Unaudited) On demand and less than 1 to 3 3 years a year years and above Total Assets: Cash P 8,033,645 P - P - P 8,033,645 Available-for-sale securities 474,800, ,800,150 Accrued interest receivable 5,812, ,812,869 P 488,646,664 P - P - P 488,646,664 Liabilities: Payables and other current liabilities Advances from World Bank P 4,393,120 P - P - P 4,393,120 Accounts payable 1,824, ,824,401 Accrued expenses 231, ,852 P 6,449,373 P - P - P 6,449,373 December 31, 2009 (Audited) On demand and less than 1 to 3 3 years a year years and above Total Assets: Cash P 5,830,435 P - P - P 5,830,435 Available-for-sale securities 456,431, ,431,131 Accrued interest receivable 5,825, ,825,357 P 468,086,923 P - P - P 468,086,923 Liabilities: Payables and other current liabilities Advances from World Bank P 4,393,120 P - P - P 4,393,120 Accounts payable 1,088, ,088,828 Accrued expenses 343, ,304 P 5,825,252 P - P - P 5,825,252 MERCADO CALDERON JARAVATA & CO 18

21 Capital Management The Company s objectives when managing capital are to safeguard the Company s ability to continue as a going concern and to maintain an optimal capital structure so as to maximize shareholder value. In order to maintain or achieve an optimal capital structure, the Company may adjust the amount of dividend payment, return capital to shareholders, issue new shares, buy back issued shares, obtain new borrowings or sell assets to reduce borrowings. Management monitors capital based on a gearing ratio. The Company s strategies, which were unchanged from 2009, are to maintain gearing ratios within 10% to 50%. The gearing ratio is calculated as net debt divided by total capital. Net debt is calculated as unearned guarantee fee plus payables and other current liabilities less cash and cash equivalents. Total capital is calculated as equity plus net debt. June 30, December 31, (Unaudited) (Audited) Net debt P 14,737,428 P 10,645,408 Total equity 483,203, ,209,454 Total capital P 497,940,910 P 482,854,862 Gearing ratio 2.96% 2.20% The capital structure of the Company consists of equity attributable to equity holders comprising issued share capital, share premium, treasury shares and retained earnings. Fair Value Measurement The fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction. In determining the fair value of its financial assets and liabilities, the Company takes into account its current circumstances and the costs that would be incurred to exchange or settle the underlying financial assets and liabilities. June 30 December 31 (Unaudited) (Audited) Carrying Carrying Amount Fair Value Amount Fair Value (In Thousands) Assets: Cash P 8,034 P 8,034 P 5,830 P 5,830 Available-for-sale securities 474, , , ,431 Accrued interest receivable 5,813 5,813 5,825 5,825 P 488,647 P 488,647 P 468,086 P 468,086 Liabilities: Payables and other current liabilities Advances from World Bank P 4,393 P 4,393 P 4,393 P 4,393 Accounts payable 1,824 1,824 1,089 1,089 Accrued expenses P 6,449 P 6,449 P 5,825 P 5,825 MERCADO CALDERON JARAVATA & CO 19

22 The carrying amount of cash and cash equivalents approximates fair value due to the short-term maturity of these financial instruments. Similarly, the historical cost carrying amounts of receivables and payables approximate their fair values. The fair value of available-for-sale securities is measured using effective interest rate method with reference to the securities quoted market price as at the date of financial position. Fair Value Hierarchy The Company uses the following hierarchy for determining and disclosing the fair value of financial instruments by valuation technique: Quoted prices in active markets for identical assets or liabilities (Level 1); Those involving inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices) (Level 2); and Those with inputs for the asset or liability that are not based on observable market data (unobservable inputs) (Level 3). As of and 2009, the Company s financial instruments are all valued at Level Contingencies As of, the Company has no contingencies since the Company is neither a plaintiff nor a defendant in any legal action in or out of court cases. MERCADO CALDERON JARAVATA & CO 20