Part I

Executive Summary

1
EXECUTIVE SUMMARY

BACKGROUND

Under the Local Government Code (LGC) of 1991, LGUs were given more powers
by allowing them the widest possible space to decide, initiate and innovate. Among
the powers given to LGUs under the said Code are the powers to create
indebtedness and to enter into credit and other financial transactions.

LGUs are authorized to avail credit facilities and issue bonds, debentures, securities,
collaterals, notes and other obligations, subject to existing rules and regulations, and
to finance self-liquidating, income-producing development or livelihood projects
identified as priority projects in the approved local development plan or the public
investment program. They may also avail of credit lines from any government or
private banks and lending institutions for purposes of stabilizing local finances.

At present, LGUs are borrowing from government and private financing

institutions, Municipal Development Fund Office and pension funds. Some
large-sized LGUs have also floated bonds to finance income generating and self-
liquidating projects.

Reflected in the Consolidated Financial Report for LGUs, the consolidated loans
and bonds payable of LGUs increased from P35.097 billion as of December 31,
2006 to P44.565 billion as of December 31, 2008, as tabulated below:

(In Million)
Source Bonds Payable Loans Payable Total
2006 2008 2006 2008 2006 2008
Domestic P 2,604.3 P 3,340.3 P 31,944.9 P 36,845.4 P 34,549.2 P 40,185.7
Foreign - - 548.3 4,379.3 548.3 4,379.3
Total P 2,604.3 P 3,340.3 P 32,493.2 P 41,224.7 P 35,097.5 P 44,565.0

While borrowings by LGUs were, to some extent, being monitored by the Bureau of
Local Government Finance (BLGF) of the Department of Finance (DOF), some
legislators expressed alarm over possible abuse by some LGU officials in securing
loans in amounts exceeding their paying capacity. This may result in the need to
allocate a lion’s share of their Internal Revenue Allotment (IRA) to repay the loans,
leaving little or no funds for the delivery of essential public services.

2
 EXECUTIVE SUMMARY

AUDIT OBJECTIVE

The audit was conducted to determine whether loans and borrowings by LGUs were
effectively managed taking into consideration the LGU’s debt service capacity, the
implementation procedures and the benefits derived from such loans and
borrowings.

EVALUATION CRITERIA

The team considered the following evaluation criteria in assessing the effectiveness
of LGUs in managing their loans and borrowings:

• Adequate and appropriate policies for assessing LGU’s

borrowing capacity;
• Proper maintenance of loan records;
• Responsive programs and projects;
• Appropriate loan utilization and project implementation; and,
• Compliance with existing rules and regulations

AUDIT SCOPE AND METHODOLOGY

The audit covered the review of loans and borrowings contracted by selected LGUs
from CYs 2006 to 2008 and evaluation of projects funded therefrom. It also
covered validation of projects implemented/constructed prior to CY 2006 which
were funded out of loans with substantial balances as of CY 2006. The LGUs
covered in the audit are presented below:

Caloocan City
Malabon City
National Capital Mandaluyong City
Region (NCR) Marikina City
Parañaque City
Pasay City

3
 EXECUTIVE SUMMARY

Region I Dagupan City

Angeles City
Region III Bataan Province
Cabanatuan City

Antipolo City
Rizal Province
Region IV Lucena City
Palawan Province
Puerto Princesa City

Region XI Davao City

To achieve the audit objective, the team adopted the following audit techniques,
among others:

• Reviewed existing policies, guidelines and mechanism on contracting loans

and borrowings by LGUs;

• Reviewed LGU’s Annual Development Plan/Public Investment Program to

assess whether the projects identified and funded from loans and borrowings
are aligned to the priority plans and projects of the LGU;

• Reviewed and analyzed loans/borrowing utilization reports and disbursement

vouchers to determine whether loans were utilized for the intended purpose/s;

• Interviewed personnel involved in the implementation of projects funded from

loans and borrowings; and

• Inspected selected projects funded from loans and borrowings to assess their
condition, extent of utilization and conformity with plans,
specifications/requirements and timelines.

4
 EXECUTIVE SUMMARY

AUDIT CONCLUSION

Overall, the audit concluded that the LGUs’ loans and borrowings may not be
considered effectively managed due to deficient criteria for evaluating LGU’s debt
service capacity, unrecorded loans and borrowings, and deficiencies in the
implementation procedures. These deficiencies resulted in financial difficulty for a
number of LGUs to meet loan obligations, wastage of government resources, and
non-attainment of the LGUs’ development objectives.

The results of deficient criteria for evaluating LGU’s debt service capacity are
evident in the following:

• The LGUs’ borrowing capacity was assessed based only on the debt service
ceiling set under the LGC of 20% of their regular income. The net available
funds of LGUs prior to contracting were not considered. Thus, seven (7)
LGUs with net available funds ranging only from zero to P0.19 million were
able to contract loans with required yearly amortizations of P0.75 million to
P25.13 million. In effect, the LGUs were allowed to contract loans in excess of
their borrowing capacities. This eventually resulted in payment of additional
interest and penalty, forfeiture of projects funded therefrom and continuous
cycle of loan restructuring. A number of these LGUs could hardly provide
sufficient budget to meet their yearly amortization even if the same were way
below the 20% debt service cap.
• The economic or useful life of the projects and the remaining term of the
incumbent officials were not considered in determining the maximum
repayment period for each loan. Loans were contracted for as long as
seventeen (17) years which exceeded the economic or useful life of the
financed projects and the remaining term of incumbent officials. Thus, out of
the loan balance of P3.80 billion as of December 31, 2008 of nine (9) LGUs,
twenty-one (21) projects financed therefrom in the amount of P1.34 billion
were no longer functional, not being used or abandoned. A number of loans
contracted as early as CY 1979 to CY 1987 have also remaining substantial
unpaid balances of P45.10 million as of December 31, 2008.

These problems were compounded by deficiencies in the implementation

procedures as discussed below:

• The specific programs and projects to be implemented within a specified

period were not defined in the development plans and programs of some
LGUs. Despite absence of specific programs/projects for implementation,
loans were continuously contracted. In other cases, loans were contracted for
the implementation of projects not covered in the development plans and
programs. This is true in the case of a number of loan-funded projects costing
P3.79 billion which were neither specifically identified in the loan agreements
nor included in the list of priority projects. The necessity of these projects are,
therefore, questionable.

5
 EXECUTIVE SUMMARY

• Around P1.03 billion were used by six (6) LGUs for purposes other than those
for which the loans were contracted at the expense of intended projects which
remained unimplemented, partially completed or unpaid as of December 31,
2008.

• The projected revenues of a number of projects were not realized due to

delayed/non-completion of projects, unutilized rentable spaces and delayed
collection of rental fees on occupied spaces. Thus, LGUs continuously
subsidize amortization and operating expenses of these projects in amounts
ranging from P64.96 million to P296.29 million. In other cases, projects were
contracted without adequate study and evaluation resulting in the termination
of some project components and delayed completion of the projects.

• Implementation of loans intended for lending to micro, small and medium

enterprises was not closely monitored resulting in substantial uncollected
balances from beneficiaries. Thus, loan repayments, which were likewise
delayed, were shouldered by the concerned LGUs.

• School building projects funded out of loans of LGUs covered in the audit
were constructed without proper coordination with the Department of
Education (DepEd). As a result, a number of additional school buildings were
constructed in schools without need for the same in the presence of other
schools with pupil-classroom ratio of 65:1 to as high as 447:1. School chairs
purchased by the Provincial Government of Bataan also exceeded the total
requirements by 4,834 units.

• Three (3) LGUs availed of bond flotation which may not be considered cost
effective as this entailed higher incidental expenses than regular loans.

• Out of 113 loan-funded projects inspected by the team, 54 projects were

neither in accordance with plans and specifications nor of acceptable
workmanship. Eleven (11) projects implemented by two (2) LGUs were found
deficient by P6.28 million, while deficiencies of 43 other projects implemented
by three (3) LGUs could not be quantified due to the absence of detailed
computations. These projects are of poor workmanship, with missing/
uninstalled items or with changes in designs.

The legal requirements on the disposition of loan proceeds were, likewise, not
observed in the following instances:

• Loan proceeds and interest income from bond flotation amounting to P2.33
billion were utilized by six (6) LGUs without covering appropriation or in
excess of the approved appropriation in violation of existing regulations.
These loans, along with the interest income derived from bond flotation, were
also not included in the LGUs’ budgets as among the sources of income.

6
 EXECUTIVE SUMMARY

• Payments out of loans by the City Government of Dagupan for the

construction of Malimgas Market costing P283.47 million and by the City
Government of Puerto Princesa for the supply/installation of synthetic track
oval costing P17.50 million were not fully documented in violation of Section
4(4) of P.D. 1445. As such, the validity, propriety and legality of the said
claims cannot be assessed.

• Loan releases, repayments and disbursements in the total amount of P460.78

million were not recorded in the books of accounts of four (4) LGUs.

In addition, a number of LGUs were not maintaining subsidiary ledgers to record

loan/bond transactions by loan/bond issues which resulted in difficulty of
monitoring correct balances of the accounts and propriety of expenses charged
thereon.

MANAGEMENT’S REACTION TO AUDIT OBSERVATIONS

The team issued, on various dates, audit observation memoranda highlighting the
deficiencies noted during the audit. In a number of cases, these observations were
discussed with the concerned officials of the LGUs in an exit conference conducted
after each audit. In addition, the team forwarded a copy of the draft audit report to
the 16 LGUs covered in the audit, and to the DOF, Department of the Interior and
Local Government (DILG) and BLGF between March 17 to 19, 2010 for comments.
Except for the DILG and three (3) LGUs, all the concerned agencies submitted their
comments on one or some observations contained in the audit observation
memoranda or draft audit report which were incorporated in the audit report, where
appropriate.

Generally, the LGUs claimed that:

• On the contracting of loans with term in excess of the economic life of

the projects and beyond the remaining term of the incumbents

− The loan term was agreed upon by the lending institutions and the
LGUs, and longer repayment period would require lower loan
amortization and less financial burden to the LGUs.

• On unused garbage bins

− Garbage bins found by the team during inspection to be

unused/undistributed are being deployed/used during special events
or reserved for contingencies.

7
 EXECUTIVE SUMMARY

• On loans in excess of borrowing capacity

− The City Government of Antipolo’s loan under the Special

Education Fund (SEF) is still within its borrowing capacity.
Computation of borrowing capacity should consider available funds
under the General Fund.

− The team’s computed maximum borrowing capacity for the

Provincial Government of Palawan was incorrect. The Annual
Regular Income (ARI) for CYs 2006 to 2008 presented by the team
is relatively lower than the figures reflected in the records of the
Province.

• On deficiencies noted in the LGUs’ development plans

− The Annual Investment Programs (AIPs) and other development

programs were prepared in accordance with established guidelines.
The Programs, Projects and Activities (PPAs) were defined in
general terms to allow flexibility, and that specific PPAs were
indicated in the Comprehensive Development Plans (CDPs) of
cities/municipalities in the case of a province.

• On the implementation of school building projects without proper

coordination with DepEd

− The Medium Term Development Plan (MTDP) and AIP were

prepared as a result of planning workshops and conferences and
that the projects were identified with the aid of the Local School
Board/DepEd and based on requests from or priorities submitted by
various school officials.

• On the deficiencies noted in the implementation of projects

− The costs corresponding to the deficiencies noted in a number of

projects implemented by the City Government of Parañaque were
used in the implementation of projects in other locations/barangays,
some items were not included in the plans and/or not installed and
replaced with other items of work.

8
 EXECUTIVE SUMMARY

TEAM’S REJOINDER

The team agrees that longer repayment period would result in lower amortization.
However, it would no longer be reasonable both to the next administration and the
City/Provincial Government if the loan term would still exceed the economic life of
the project implemented, and way beyond the remaining term of the incumbent
officials. Likewise, the next administration may have different thrusts and
priorities. It may not also be appropriate for the City or Provincial Governments to
contract loans for the purpose of purchasing goods and equipment which are not
really needed and intended merely to be used during special occasions.

Moreover, while it is true that during CYs 2006 to 2008, amortization for loan under
the SEF of the City of Antipolo can still be fully serviced, its net income is
relatively lower than the required yearly amortization, for principal alone, of the
new loan. The LGU’s loan even exceeded the BLGF’s certification, which was
already based on the total income generated under the SEF and the City’s share
from IRA. It cannot, therefore, be claimed that the loan under SEF is still within its
borrowing capacity. The team’s computation of the maximum borrowing capacity
of LGUs is based on the LGU’s actual regular annual income and not on the total
income as reflected in the LGU’s Annual Budget.

On the other hand, projects to be funded out of loans should be specifically

identified before contracting for loan. Ideally, these projects should have been
included and specified in the AIP and development programs.

The alleged requests from the the DepEd officials for the construction of additional
school buildings were not forwarded to the team. Nonetheless, granting that the
DepEd officials indeed requested for these projects, such requests should have been
validated with Basic Education Information System (BEIS) - Quick Counts
Instructional Analysis, which is readily available. The Instructional Room Analysis
provided by the School Divisions of Cabanatuan City and Provinces of Palawan and
Rizal clearly identified the schools actually in need of classrooms. As discussed in
the report, some additional school buildings were constructed in schools without
need for the same.

Lastly, it cannot be said that costs equivalent to project deficiencies were used in the
implementation of other projects and/or replaced with another work item as these
were not reflected in the documents supporting the payments. The accomplishment
reports supporting payments disclosed that these projects were reported
accomplished in accordance with plans and specifications. It cannot, therefore, be
claimed now that the costs of deficiencies were used in other projects and/or
replaced with other items. The team was, likewise, not informed of any changes
during inspection and was not provided copy of change/variation orders.

9
 EXECUTIVE SUMMARY

RECOMMENDATIONS

Considering that LGUs are continuously securing loans and borrowings to finance
development and investment projects, the team recommended measures under Part
IV of the report to address these deficiencies.

In general, the team recommended that the DILG, DOF, National Economic and
Development Authority (NEDA) and Department of Budget and Management
(DBM) should consider establishing appropriate guidelines for managing LGUs’
loans and borrowings to avoid contracting of loans beyond their paying capacity and
ensure that these are used for the purpose(s) intended. The guidelines should
prescribe the following, among others:

• the maximum borrowing capacity should not only consider the 20% debt
service ceiling but also the LGUs’ net available funds prior to contracting of
loans/borrowings;
• the loan/borrowing terms should consider the type/nature and economic or
useful life of the projects to be financed and the remaining term of the
incumbent LGU officials;
• the alignment of loans to support development plans and investment programs
identifying their priority projects;
• the specific purposes for which loan may be secured; and,
• the requirement for the LGUs to maintain subsidiary ledgers for each
loan/borrowing.

On the other hand, the LGUs should conduct self-assessment of their capacity to
repay the loan taking into consideration their net available funds, ensure that
utilization of loan proceeds is covered by appropriation ordinance, determine the
most cost effective borrowing scheme, contract loans only upon proper evaluation
of priority projects, and allocate sufficient funds to cover total contracted liabilities.
The implementation of projects should also be closely monitored to ensure that
construction conforms with plans and specifications.

To further ensure that the loans were used only for the purpose(s) intended, the
LGUs should maintain complete subsidiary ledgers for loans and borrowings to
record all transactions, particularly releases, repayments and all charges thereon.

10