Confidential Standard & Poor’s

Credit Analysis of Naga City

Issuer Credit Rating
City of Naga, Camarines Sur (Bicol Region), B+/Stable/--
Republic of Philippines Philippines National
Scale Rating
phA/--/--
Major Rating Factors
Weaknesses:
• Low-income local economy concentrated in agriculture with limited capacity to
diversify
• Constrained fiscal flexibility with high dependence on central transfers and large
spending on personnel expenses
• Weak intergovernmental system, exacerbated by the absence of institutionalized
policies of city administration

Strengths:
• Healthy liquidity position, coupled with consistent and strong budgetary performance
• Debt burden is at present comparatively low and has been steadily declining
• Management sophistication relatively advanced by local standards

Rationale
The credit ratings on City of Naga, located in the Republic of Philippines (foreign currency
BB-/Stable/B; local currency BB+/stable/B; Philippines national scale ‘phAA+’), reflects the
narrow tax base of the city stemming from a low income and undiversified local economy,
constrained financial flexibility and the weak intergovernmental system the city operates in.
On the other hand, the city’s ratings are underpinned by its strong liquidity position, sound
budgetary performance and a low debt level brought on by prudent fiscal management.

Naga City’s economic base is comparatively less developed than international and domestic
peers. Unlike the more diversified service-based economies of Metro Manila cities, Naga’s
economy is engaged predominately in agriculture. Although also a trading hub for the Bicol
region, much of the trading is linked to the agrarian sector as well. This is reflected in its tax
revenue per capita among the lowest in its peer group, and a low per capita income estimated at
around US$1,600, low by global standards. In addition, efforts to diversify the local economy
has been impeded by the city’s small population size, made worse by the outflow of skilled
workers to the wealthier national capital region. In turn, the low tax base has constrained much
of the city government’s revenue flexibility via lower than domestic average modifiable
revenue. Its overall financial flexibility is further capped by the large proportion of operating
expenditure spent on personnel services (56% as of 2008). In mitigation, some room exists in
capital spending due to Naga’s relatively more developed and well-maintained state of
infrastructure by local standards (albeit still undeveloped by international standards).

The weak intergovernmental system in the Philippines is a key systemic constraint on the
credit ratings of its local governments. The predictability in the system is low with the central
government having a history of passing on unfunded mandates to LGUs. Central monitoring
and oversight over LGUs is weak. Other than limits on borrowings and personnel expense,
 Standard & Poor’s
there is no defined fiscal policy framework to promote fiscal discipline among LGUs. Adding
to the systemic weaknesses constraining Naga’s creditworthiness, the city’s ratings are also
affected by the lack of institutionalized policies at its own level. However in mitigation, Naga
City’s budgetary performance has been sound despite the lack of an explicitly-stated fiscal
framework. To add, in terms of transparency, Naga’s management sophistication stands out
from domestic peers, being one of the few LGUs to have consistently received clean audit
opinions.

The ratings on Naga City are supported by its consistently strong budgetary performance and
solid liquidity position of its current administration. Balances after capital expenditures
averaged 15% of total revenues in 2005-2007, and free cash and liquid assets are estimated to
have reached around 83% of operating expenditures in 2008, one of the strongest liquidity
positions among its peer group.

Another credit strength is that the city government’s direct debt level has declined from a peak
of 32% of operating revenues in 2005 to a much more sustainable level of 13% estimated for
2008. Its current net creditor position is also significantly stronger than many domestic and
international peers in its rating category. Despite the weakened global economic conditions, we
expect Naga to maintain its overall financial profile in the near term in view of the prudent
financial management practices that the current administration has demonstrated so far.
Liquidity
The liquidity position of Naga City is healthy, with free cash and liquid assets rapidly
increasing since 2003. As of December 2008, the city holds around PHP303 million in free
cash. After taking into account the city government’s negative working capital, we
approximate free cash and liquid assets to be sufficient to cover about 83% of 2008 operating
expenditures, which is extremely sound compared with international peers.

Outlook
The outlook on the ratings is stable, which reflect our expectations that Naga’s budgetary
outcomes and debt burden will not deviate significantly from current levels. A noticeable
improvement in medium-term planning and implementation of a comprehensive financial
policy framework, coupled with substantial efforts to structurally broaden its tax base, could
lead to positive rating actions. Conversely, the ratings could come under pressure if persistent
slippages in budgetary outcomes significantly weaken its liquidity or worsen its debt position.

Comparative Analysis
International peers
The Russian entities of Nizhny Novgorod (BB-/Stable/--) and Tver Oblast (B+/Negative/--), as
well as the Ukrainian capital city of Kyiv (CCC+/Watch Neg/--) and the Turkish city of
Istanbul (BB-/Negative/--) are suitable international peers for the City of Naga.

Naga’s local tax base is constrained by an extremely low-income economy in comparison to its
international peers. The city does not compile GDRP figures, but per capita income is believed
to be somewhat similar to the Philippine national average of US$1,600. This is significantly
below higher-rated peers like Istanbul with US$12,000, and even similarly-rated Tver Oblast
has per capita income almost 3 times that of Naga’s. The city’s dependent population
proportion is similar to its peer group. However Naga’s Ukrainian and Russian counterparts
faces a different set of demographic challenges with substantial segment of its dependent
belonging to the elderly category while the bulk of Naga’s dependent constituents are of young
age. Assuming the Naga city government is able to stem the out-flow of skilled workers to the

2
 Standard & Poor’s
wealthier national capital region of Manila, in the long-run, Naga’s higher portion of young-
aged residents could translate into higher growth for the local economy than international
peers. However, Naga’s far smaller population size limits its ability to diversify its economic
base into major national commercial center like Istanbul and Kyiv.

Like some of its peers, the City of Naga has been able to partially fund aggressive capital
expenditure programs in recent years with operating surpluses, which has helped to limit its
borrowing requirements. However, the overall average level of capital expenditure relative to
total expenditure reported by Naga (18.5%) is still below that for its international peers (30%)
from 2005-2007. Although its physical infrastructure is relatively well-maintained by national
standards, it is largely inadequate in the international context.

Naga’s direct debt level has been steadily declining, unlike Istanbul’s. Coupled with a healthy
and fast-rising cash position, the city’s overall debt profile is favourable and compares well to
that of Nizhny Novgorod. Likewise, Naga’s strong budgetary performance stands out among
its peer group. However, this is in part a function of the city’s weaker capacity to administer
capital projects (stemming from lack of benefits of scale), and also a function of the systemic
borrowing constraints faced by Philippine local governments.

Local peers
Unlike its domestic peers who are located in Metro Manila like Quezon City, Taguig and
Mandaluyong, who have relatively more diversified service-base economies, Naga is
predominately engaged in the agrarian sector. The lack of a distinct geographic or industrial
advantage has resulted in lower property value and smaller-scale businesses operating in Naga,
which in turn limits the city’s real property and business tax collection. In mitigation, its local
economy has been relatively more insulated than Metro Manila peers in this current global
downturn. In addition, outside the capital region, Naga’s tax base and per capita income would
compare more favorably than those of Iligan and Tacloban.

Naga’s modifiable revenue is one of the lowest among local peers, which is a function of its
comparatively weaker own-source revenues and also higher dependence on central transfers.
The city’s derived 48% of its revenues from IRA allotment in 2007, significantly higher than
its local peers’ average of 34%. On the expenditure side, the proportion spent on personnel
services is the highest in Naga which appear to further cap the city’s financial flexibility. In
mitigation, the city’s capital spending ratio has been consistently higher than the local average,
and Naga’s state of infrastructure is relatively more developed and well-maintained than some
of its local peers. These afford the city with some flexibility in cutting capital expenditures,
hence putting its financial flexibility above those of Iligan and Tacloban, but behind that of
Quezon City and Taguig who demonstrate far large share of modifiable revenues.

The city’s budgetary performance is nevertheless stronger than all rated Philippines cities,
despite the fact that other cities have far more revenue streams at their disposal. This reflects to
some extent the more advanced financial management practices of the Naga city government
than its peers. Likewise, despite its more limited resources, Naga has been able to maintain
robust liquidity coverage and a direct debt burden better than the average for its peer group.

3
 Standard & Poor’s

Table 1
Naga (City Of)
2007
Domestic Peer
Comparison
Naga (City Iligan Malabon Mandaluyong Marikina Quezon Tacloban Taguig
Of) (City (City Of) (City Of) (City Of) (City Of) (City Of) (City Of)
Of)

Issuer credit rating B+/Stable

National scale
ratings phA

Three-year
averages, using
actual results only
Operating balance
(% of operating
revenues) 29.7 (2.2) 9.4 12.2 7.6 36.9 18.8 21.4

Balance after capital

expenditures (% of
total revenues) 14.7 (12.7) (18.1) (1.4) 3.5 16.9 (24.4) 8.3
Capital
expenditures (% of
total expenditures) 18.5 8.7 22.2 16.1 4.4 25.9 33.7 21.2
Transfers received
(% of total
revenues) 48.1 44.6 52.0 16.9 23.7 20.4 53.0 27.8
Total revenues
(US$, mill) 10.2 39.3 15.2 43.5 32.8 195.1 12.0 44.6
Modifiable revenues
(% of operating
revenues) 30.9 15.2 38.4 68.1 43.0 64.0 30.5 60.0
Direct debt (at year-
end) 2.0 6.6 8.2 10.1 6.1 0.3 9.0 5.3
Direct debt (% of
operating revenues) 19.2 16.8 54.3 23.9 18.6 0.2 74.8 13.3
Tax-supported debt
(% of conso oper
revenues) 19.2 16.8 54.3 23.9 18.6 0.2 74.8 13.3
Net financial
liabilities (% of
conso oper rev) (33.0) (1.9) 46.0 21.2 (25.4) (73.0) 38.8 (24.1)
Interest (% of
operating revenues) 2.2 1.9 3.7 2.2 1.2 0.0 0.1* 1.0
Debt service (% of
oper revenues) 4.7 7.8 4.5 7.2 7.2 0.0 6.2 3.1
Free cash & liquid
assets as % DS 1,103.9 238.6 183.6 37.3 614.9 4,830.0¶ 585.4 1,218.7
Population 160,500 335,000 363,000 305,000 490,000 2,679,000 217,000 613,000

* Figures for 2004.

¶ Figures for 2006.
N.A.--Not available.

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 Standard & Poor’s

Table 2

Naga (City Of) 2008

International Peer
Comparison
Naga (City Istanbul (City Kyiv (City Of) Nizhny Novgorod Tver Oblast
Of) Of) (City Of)

CCC+/Watch B+/Negative/-
Issuer credit rating (LC) B+/Stable/-- BB-/Negative/-- Neg/-- BB-/Stable/-- -
CCC+/Watch B+/Negative/-
Issuer credit rating (FC) B+/Stable/-- BB-/Negative/-- Neg/-- BB-/Stable/-- -

National scale ratings phA/--/-- --/--/-- --/--/-- ruAA-/--/-- ruA+/NM/--

Three-year averages, using actual

results only

Operating balance (% of operating

revenues) 29.7* 51.3* 15.4 9.8* 6.4

Balance after capital expenditures

(% of total revenues) 14.7* (12.8)* (4.3) 5.4* 0.2

Capital expenditures (% of total

expenditures) 18.5 60.7 27.5 11.8 10.5

Transfers received (% of total

revenues) 48.1* 12.1 23.3* 26.3

Total revenues (US$, million) 10.2* 2,516.3* 2,479.7 687.0 1,007.1

Modifiable revenues (% of
operating revenues) 30.9* 18.1* 8.6 27.7 11.8

Direct debt (at year-end) 2.0* 837.6* 700.0 12.3 168.8

Direct debt (% of operating
revenues) 19.2* 34.6* 30.7 2.1 17.6

Direct debt (% of GDP) 0.6* 3.9 2.5

Tax-supported debt (% of conso

oper revenues) 19.2* 105.1* 30.7 2.1 20.7

Net financial liabilities (% of conso

oper rev) (33.0)* 95.9* 28.1 2.1 11.6

Interest (% of operating revenues) 2.2* 1.6* 2.3 0.1 0.5

Debt service (% of oper revenues) 4.7* 6.8* 7.2 0.4 12.1

Free cash & liquid assets as %
DS 1,103.9* 135.1* 36.6 1,672.7* 74.9
Population 160,500.0* 12,573,000.0* 2,740,200.0* 1,286,433.0* 1,379,542.0

Unemployment rate (%) 11.4¶ 3.1* 0.5* 5.1

GDP (nominal) per capita,
unscaled 12,105.3* 8,346.6* 4,412.2*

GDP per capita (% of national

average) 221.1* 300.8* 53.5*

GDP (real) growth (%) 5.4* 11.0* 7.5* 7.7*

Total revenues (% of GDP) 1.7* 13.7 15.7*

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 Standard & Poor’s

* Figures for 2007.

¶ Figures for 2005.
N.A.--Not available.

System Support and Predictability

The level of system support and predictability in the Philippines intergovernmental system is
generally weak. Please refer to Appendix “Philippines Intergovernmental System Overview”.

Economy
The City of Naga is located in the Bicol Region of Luzon, one of the 17 regions in the
Republic of Philippines. Classified as an Independent Component City, Naga enjoys
administrative and political powers similar to those of Metro Manila Cities in the national
capital region. It comes under the direct jurisdiction of the central government rather than the
provincial government of Camarines Sur.

Like most cities in the Philippines, Naga does not collate detailed socio-economic or industrial
data at the local level. The recent 2007 national census has gotten less detailed in its coverage,
with most figures available only on a regional basis. Sub-regional and city-level socio-
economic data are now sorely lacking by international standards. The last available
demographic data for Naga dates back to the 2000 national census. It puts Naga’s population
who are of dependent age at around 40%, of which the bulk stems from its high proportion of
young population at 36%, suggesting potential heavy social expenditure requirements on the
city government especially in terms of education. Naga’s elderly population at 4% is around
the same as the national average. The proportion of elderly population in the Philippines is
generally very low due to the country’s relatively high fertility rate. Fertility rate was 4.3 child
born per woman in the 90s, but it has since come down to about 3.4 (which is still a higher
replacement rate than most international peers).

Naga’s small population of around 160,000 constraints its capacity to support major
manufacturing activities. The local economy is concentrated in the agrarian sector, and the city
land-use plan drawn up in 2000, indicated around 75% of its land was being used for
agriculture activities. And though the city’s central location has enabled it to become the
trading hub for the Bicol region, much of the trading is also in agriculture produce. Initiatives
by the city government to diversify the local economy into BPOs and other areas has been met
with significant challenges due to Naga’s limited supply of skilled workers. The largest
employer in the city is SM City Naga; a shopping mall owned and operated by SM Prime
Holdings, the largest mall operator in the Philippines. Recently opened in May 2009, the mall
employs around 1,000 staff. No other significant large employer exists in Naga.

Bicol region’s per capita GDP, estimated at US$800 in 2007, is extremely low by international
standards. Being one of the major commercial centres of the region, Naga City’s per capita
income is expected to be higher and somewhat closer to the national average of around
US$1,600. However this is still considerably low for its rating category. The city government
does not compile the city’s total output, structure of economy or employment figures.
Reportedly, the management deems Naga’s growth to be on par with that of the national
average (3.8% in 2008, 7% in 2007). Though Naga’s poverty incidence rate of around 19% is
comparatively high in the international context, it is significantly lower than the national 27%
and the region’s 40%. Likewise, the city’s unemployment rate is believed to be slightly lower
than the national average of 7.6%.

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 Standard & Poor’s

Table 3
NAGA (CITY OF) --Year ended
Economic Statistics Dec. 31--
2010f 2009f 2008f 2007 2006 2005 2004 2003
Population '000 167.8 165.3 162.9 160.5 158.5 156.6 154.7 152.7
Population growth (%) 1.5 1.5 1.5 1.3 1.2 1.2 1.3

Management Sophistication and Institutional Legitimacy

The level of management sophistication of Naga City is ahead of many of its local peers, but
still behind in terms of international best practices. For details, see ‘Naga City FMA Analytical
Report’.

Institutional Legitimacy
The current mayor of Naga City, Jesse M. Robredo, has been in office since 1988, making him
one of the longest serving city mayors in the Philippines. Holding a Masters in Public
Administration from the John F. Kennedy School of Government at Harvard University, mayor
Robredo is regarded as an expert in local governance in the Philippines. He appears to adopt a
more transparent and consultative approach to local governance in comparison to his peers. For
example, each time after winning the mayoral election, mayor Robredo will formulate a 3-year
investment plan (LDIP), laying out the agenda for his term of office. Notably, before the LDIP
is formed, series of discussions will be conducted with external stakeholders first, and their
views will be factored into the medium-term investment plan.

With Naga city being landlocked and densely populated (it measures just 84 km2), the top
priority of the current administration centers around the freeing up of space. Measures include
the development of infrastructure in the lesser-used northern area of the city. Other key
priorities include education, and further urbanization.

Beginning from 2001, national legislations allow local elected officials to hold up till three
consecutive terms of office with each term lasting three years. Hence Mayor Robredo cannot
stand for re-election in 2010. It is believed that the current vice-mayor would run for office in
the next election. Having been the acting City Administrator as well, continuity in the current
administration’s policies would likely carry on if the vice-mayor wins the next election. Thus
far, the city government had also not encountered significant political problems in passing
ordinances. For the last 18 years, the mayor and city council members had run on a single
ticket in every local election.

Though the key-man risk factor still constitutes a credit weakness for Naga City, it is of a
lesser extent that other Philippines LGUs. Although institutionalized polices are still lacking,
the city government at least made a step towards medium-term planning through its use of the
LDIP. Also, continuity in the administration has thus far been maintained due to the long
period of time the current mayor has been in office. However that remains to be seen come
2010. Further more, Naga City nonetheless operates in a highly-politicized public finance
environment. Funding for projects has proven difficult to obtain with central government
reluctant to offer grants as Naga City is an opposition LGU.

Financial Flexibility
The city’s revenue flexibility may appear higher than international peers, but is however
behind that of other Philippines LGUs. Currently, almost half of Naga’s budget is dependent
on central government IRA transfers. Its share of modifiable revenue at 34% of 2008 operating

7
 Standard & Poor’s
revenue (made up of Real Property Tax and Business Taxes) is below that of the 44% average
among rated domestic peers. Moreover, even though most local tax rates and fees are
modifiable by law, it is often difficult in practice. RPT rate has been kept unchanged since
1991, but the fair market valuation has been increased three times in the last decade, with the
last revision recently passed in 2008. Notably, the last revision of market valuation was an
increase of 100% but the increase would be staggered; taxpayers would be assessed on RPT
base on 20% incrementally more of the property value over the next five years effective from
2009. This effectively means the city government would not able to revise RPT again till 2013.
On a similar note, the city administration does not plan to increase business tax rates as its
current rates are already set close to the ceiling mandated by the Local Government Code.
Furthermore, competition from other regional centers to attract investments and businesses
would likely compel Naga City to maintain its current business tax rates.

Naga’s relatively narrow local tax base (at least in comparison to Metro Manila cities),
combined with a higher than average dependency on IRA, has constrained the city
government’s ability to invest in potentially revenue enhancing capital projects. In mitigation,
some room exists for improving tax collection efficiency. Currently, collection efficiency is
estimated to be around 85%. The city administration has indicted plans to computerized
revenue collection and stepping up efforts in chasing up of tax arrears.

Tax Revenue per capita (PHP)

2007 2006 2005 2004 2003
Naga 902 858 711 675 775
% chg 5.1% 20.8% 5.2% -12.8% n/a
Mandaluyong* 4,353 4,515 4,219 4,202 3,376
% chg -3.6% 7.0% 0.4% 24.5% n/a
Marikina* 1,531 1,518 1,417 1,276 1,972
% chg 0.9% 7.1% 11.1% -35.3% n/a
Quezon City* 2,035 2,000 1,955 1,865 1,752
% chg 1.8% 2.3% 4.8% 6.4% n/a
Taguig* 1,793 1,394 1,152 1,094 991
% chg 28.6% 21.0% 5.3% 10.4% n/a
Malabon* 740 701 674 499 563
% chg 5.6% 4.0% 35.1% -11.4% n/a
Iligan 823 864 562 545 500
% chg -4.7% 53.7% 3.1% 9.0% n/a
Tacloban 780 821 796 669 605
% chg -5.0% 3.1% 19.0% 10.6% n/a
*Metro Manila LGUs
Source: Philippines National Statistical Office, COA Audit Reports

On the expenditure side, Naga’s expenditure flexibility is constrained by personnel expenses,

not unlike many Philippines LGUs. The city spends around 43% of its income on wages, just
below the upper limit of 45% established by the LGC. Upwards revisions to base public sector
compensation levels as a result of national legislation, or increased wage demands in response
to bouts of inflation, could push this wage share of revenues towards the ceiling, creating the
politically difficult scenario of mandatory staffing reductions to comply with the Code. In
addition, Naga’s large total personnel expenses at 56% of 2008 operating revenues, ranking the
highest among its peer group, is perhaps a reflection of its largely un-computerized systems
which require large number of employees to be hired.

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 Standard & Poor’s
On capital expenditure, Naga more often than not spends a higher proportion of its expenditure
on capital needs than domestic peers. Some flexibility could be exercised in this aspect should
the city face liquidity problems. By local standards, Naga’s level of infrastructure can be
considered more than adequate. Over 90% of its roads are already laid with concrete, drainage
is efficient and the city has 100% access to clean water and sanitary facilities. The city
government is hence more concerned with the maintenance of present infrastructure rather than
the construction and investing in new capital projects. In addition, the management had
expressed at our meetings that should there be shortages in funds, capital expenditures would
be first to be scaled back, but essential services like education (subsidized school fees) and
healthcare would continue.

Table 4
NAGA (CITY OF)
Financial
Statistics

Unit Scale
As of Dec. 31 2010f 2009f 2008f 2007 2006 2005 2004 2003
Currency PHP PHP PHP PHP PHP PHP PHP PHP
Currency Scaling Millions Millions Millions Millions Millions Millions Millions Millions
Exchange Rate to USD 45.0 45.7 43.9 46.2 51.3 55.1 56.0 54.2
Operating revenues 522.0 505.0 488.0 468.6 425.4 380.4 349.9 469.2
Operating expenditures 414.2 393.0 361.1 309.4 310.7 272.9 264.7 361.1
Operating balance 107.8 112.1 126.9 159.1 114.7 107.5 85.2 108.1
Operating balance (%
of operating revenues) 20.7 22.2 26.0 34.0 27.0 28.3 24.4 23.0
Capital revenues 17.1 10.0
Capital expenditures
(capex) 120.0 110.0 69.0 98.0 85.8 29.5 75.6 119.3
Balance after capex (12.2) 2.1 57.9 61.1 46.0 78.0 9.6 (1.2)
Balance after capex (%
of total revenues) (2.3) 0.4 11.9 13.1 10.4 20.5 2.8 (0.3)
Debt repaid 17.0 14.0 27.0 12.0 20.2 22.7 13.4 12.6
Net budget loans
Balance after debt
repayment and
onlending (29.2) (12.0) 30.9 49.2 25.8 55.3 (3.8) (13.7)
Balance after debt
repayment and
onlending (% of total
revenues) (5.6) (2.4) 6.3 10.5 5.8 14.5 (1.1) (2.9)
Gross borrowings 29.0 12.0 47.6 30.3
Balance after
borrowings (0.2) 0.1 30.9 49.2 25.8 102.9 (3.8) 16.6
Balance after
borrowings (% of total
revenues) (0.0) 0.0 6.3 10.5 5.8 27.1 (1.1) 3.5
Total revenues (% of
GDP)
Modifiable revenues (%
of operating revenues) 34.5 34.3 34.2 30.9 32.0 29.2 29.9 25.2
Capex (% of total
expenditures) 22.5 21.9 16.0 24.1 21.6 9.8 22.2 24.8
Operating-revenue
growth (%) 3.4 3.5 4.2 10.2 11.8 8.7 (25.4)
Operating-expenditure
growth (%) 5.4 8.8 16.7 (0.4) 13.9 3.1 (26.7)
Direct debt (debt
outstanding at year-end) 73.0 61.0 63.0 90.0 102.0 122.2 97.2 111.0
Direct debt (% of
operating revenues) 14.0 12.1 12.9 19.2 24.0 32.1 27.8 23.7
Tax-supported debt (%
of conso oper revenues) 14.0 12.1 12.9 19.2 24.0 32.1 27.8 23.7

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 Standard & Poor’s
Interest (% of operating
revenues) 1.9 1.6 1.6 2.2 2.8 2.5 3.4 2.4
Debt service (% of oper
revenues) 5.2 4.4 7.1 4.7 7.6 8.5 7.2 5.1
Free cash & liquid assets
as % operating
expenditures 70.0 76.4 82.9 79.1 51.2 56.0 22.3 8.3
Free cash & liquid assets
as % DS 1,074.1 1,363.6 859.0 1,103.9 495.1 474.8 233.5 125.6

f--Forecast.
b--Budgeted.
e--Estimated.
p--Planned.
N.A.--Not available

Budgetary Performance
The budgetary performance of Naga City has been exceptional in the last few years. Operating
surpluses often exceed well in excess of 25% of operating revenues and in parallel, balances
after capital expenditures has been consistently strong too with an average surplus of 15% of
revenues over the period 2005-2007. Preliminary financial statements released for fiscal 2008
indicate a slight deterioration from 2007 figures, but nonetheless a still healthy operating
balance of 26% and balances after capital expenditure of 12%.

Naga’s budgetary results are driven in part by its conservative budgetary planning measures—
the city government has an “80:20” budgeting rule in place, whereby department heads must
try to generate results with 80% of funds requested and 20% to be set aside as savings.
However, Naga’s strong budgetary performance in part also masks the greater problem of the
city government’s low capacity to manage infrastructure projects/programs. Only about 50% or
less of the city’s LDIP is implemented after each term of office, yet large surpluses occur year
on year, leading to quick accumulation of reserves.

Although tax revenues could come under pressure in the near term, Naga’s economy which is
more dependent on local consumption, would be relatively more insulated to the global
downturn then Philippines cities located in Metro Manila like Mandaluyong and Taguig. Tax
revenue growth has been healthy since 2005, due to the city’s implementation of better
collection strategies (see ‘Naga City FMA Analytical Report—Revenue Management
section’). Also, starting from 2009, the regional offices of the Bureau of Internal Revenue are
required to share tax information with LGUs. Hence the Naga management has expressed
upbeat sentiments that tax revenue would increase due to the more realistic (and higher)
business tax assessments based on BIR returns. In addition, contribution of revenue from Naga
City’s public markets has experienced double-digit growth in the last five years. Profits from
economic enterprises owned by the city now contribute around 9% of total revenue, and that is
likely to increase with the completion of the 10,000 seater Naga City Coliseum (convention
center), which is expected to generate revenue of around PHP24 million annually.

As is the case in LGUs in the Philippines, political cycles can have a strong effect on budgeting
outcomes. Leading up to the upcoming city election in 2010, spending could be ramped up by
the current administration. In the near term, though Naga’s budgetary perform could come
under some pressure, we expect it to still maintain budgetary performance better than most
domestic peers judging by the city government’s track record, conservative budgeting and
steady revenue growth.

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 Standard & Poor’s

Liquidity and Debt Management

Naga City’s free cash has been rapidly increasing since 2003. Its current liquidity position is
robust, with free cash and liquid assets estimated to have reached 83% of operating
expenditures at end 2008, comfortably above the median for its rating category. As Naga’s
debt burden is low, its free cash provides an even wider margin of coverage for debt servicing.
Though there is no written policy, the management internally agrees that daily disbursement
should not exceed daily collection. Thus far for the past one year, Naga had managed to
maintain on average, cash coverage of 9X monthly operating expenditures.

The current management has a proven track record in achieving large budget surpluses year
after year which has contributed to its growing reserves position. However given the lead-up to
the 2010 city elections and the current economic situation, maintaining high balances after
capital expenditures in the near term appears less likely. Although the city’s free cash and
liquid assets position may fall as a result, we do not expect it to contract drastically in the near
term. Its ample liquidity position should also act as sufficient buffer for most fiscal shocks and
we do not expect liquidity shortfall in the near term.

Of note is the presence of high level of payables on Naga’s balance-sheet. At 37% of total
expenditures estimated as of end 2008, it is among the highest among peers, indicating slow-
turnaround on its disbursement process and/or overdue payables that should be reclassified as
long-term liabilities instead. Alleviating this is that some of these payables arise from the city’s
RPT collected for Special Education Fund being parked under General Fund instead, which
results in inflated current liabilities due to the inclusion of funds ‘owed’ to the SEF under
‘Intra-Agency Payables’ (for more details, see ‘Naga FMA Analytical Report – Expenditure
Management’ section). Excluding these would yield significantly lower payables at 30% of
total expenditures. Notably, some of its receivables might have a low likelihood of recovery,
especially with regards to socio-loans made out for the city’s micro-credit Livelihood Program
for market vendors. Taking these into consideration, we have offset the negative working
capital in our calculation of free cash and liquid asset position.

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Despite the large reserves it holds, Naga does not have a stated policy on investment of cash
reserves. The city invests its cash based solely on which bank offers the best time deposit rates.
This lack of risk assessment could potentially be damaging to the city’s financial health. In
mitigation, LGUs can only place funds with Government Financial Institutions (GFIs) and they
have access to special savings deposit accounts that offer higher interest rates. Nevertheless, an
additional risk factor comes from the lack of clearly stipulated policies relating to liquidity
targets, which could lead to temptations to spend excess funds on hand without adequate
consideration for future obligations.

Naga’s current debt burden is relatively low and the city has not defaulted on debt before. In
this aspect, it does not have a dedicated debt management unit. However the city’s debt
management skills are significantly savvier than many Philippines LGUs who demonstrates
almost no capacity. Though there are no explicit debt policies in place, the LDIP has acted as a
pseudo medium-term borrowing plan. Unlike other LGUs who have monthly debt repayments
automatically deducted from IRA transfers, Naga’s city treasurer keeps track of loan payment
dates and issue checks to repay directly to the lending banks. This has so far been done on a
timely basis. Furthermore, its loans are negotiated with clauses that allow prepayment without
penalties incurred, and the administration monitors current market interest rates and will seek
refinancing whenever the opportunity arises. The administration keeps good track of all
existing and past loans, and the amortization schedule, and summary details of loans are
publicly available (for more details, see ‘Naga City FMA Analytical Report, Debt Management
section’).

Debt Burden
Naga City’s current debt burden is relatively low at 13% of 2008 operating revenues. Its
healthy cash position amply covers all debt obligations, and the city’s net direct debt position
at -48% of operating revenues in 2008, ranks among the best for both international and
domestic peers. All of the city government’s debt is long-term in nature and borrowings have
only been for capital projects. Its historical levels of debt service to operating revenues appears
higher than what its outstanding borrowings would suggest, driven by the city government
actively prepaying some loans to reduce the overall debt burden. Nonetheless, at 7% of
operating revenue in 2008, Naga’s debt servicing is still well within the 20% cap set out in the
LGC. Going forward, we expect the city’s debt servicing to hover around 5% or less.

Naga’s direct debt burden had peaked at 32% of operating revenues in 2005, in part due to the
PHP47.5 million loan from DBP for the construction of the Naga City Coliseum. As
construction costs subsequently came down, the convention centre was eventually completed
for PHP30 million. The remaining loan funds which were parked in an escrow account with the
DBP, was repaid by the city government at one go, hence the swift decline in its direct debt
level. We do not expect a drastic increase in debt burden leading up to the 2010 elections.
Also, systemic borrowing constraints will remain in the medium-term. However, the possibility
of large swings in debt levels cannot be ruled out with the implementation of large one-off
infrastructure initiatives, owing to the absence of stipulated debt policies and/or a
comprehensive medium-term fiscal framework.

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Off-Balance-Sheet Liabilities
Given that the city of Naga does not own or control any commercial companies other than
public markets, city hospital and other policy-based assets, as well as the fact that the

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obligations of all of these entities are consolidated on the city government’ balance sheet, it
does not appear to have any material off-balance-sheet liabilities. Although it is possible, due
to incomplete disclosure in commercial relationships between the city government and third
parties, the city government could face contingent liabilities. Nevertheless base on information
submitted by the city administration and interviews with the management, its financial profile
does not appear to be at significant risk from contingent obligations.

30

25
%)

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