HUI C APY RESTRICTED Report No. DB-40a This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL FINANCE CORPORATION [NTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF FIVE PRIVATE FINANCE COMPANIES IN COLOMBIA May 1, 1968 Development Finance Companies CURRENCY EQUIVALENTS Currency Unit - (Colombian) Peso (Col$) CAPITAL MARKET RATE (fixed) US$1 = Col$ 16. 30 Col$1 = 6. 13 US cents CERTIFICATE MARKET RATE-!1 (variable) US$1 = Col$ 16. 13- Col$ 1 = 6. 22 US cents 1/ Applicable to most exports, imports and foreign loans. 2/ As of April 18, 1968. APPRAISAL OF FIVE PRIVATE FINANCE COMPANIES IN COLOMBIA This report is based on the findings of missions to Colombia in November/December 1966 and January/February, March/April and July 1967 by Messrs. Fernandes, Meier, Luzny and Mendoza, and on subsequent correpond- ence, reports and discussions with the finance companies. TABLE OF CONTENTS Page Para. SUMMARY i - ii i - vi I. INTRODUCTION 1 1 - 2 II. INDUSTRY AND THE FINANCING OF INDUSTRY 1 - 8 3 - 29 Economic Policy and Industrial Development 1 - 3 3 - 10 Recent Policy Developments 3 - 4 11 - 14 Industrial Financing 4 - 5 15 - 16 Equity Finance 5 17 - 18 Loan Finance 5 - 8 19 - 29 III. PERFORMANCE OF THE FINANCIERAS 8 - 28 30 - 82 General 8 - 10 30 -37 Ownership 10 - 38 Resources 11 - 12 39 -. Organization and Procedures 12 - 16 42 - 58 Colombiana 12 - 13 43 -4 Nacional 13 6 -48 Caldas 1 49 -52 Valle 1 - 15 53 -55 General Evaluation 15 - 16 58 Policies and Operations 16 - 20 59 - 68 Financial Results 20 - 26 69 -80 Evaluation 26 - 27 81 Economic Impact 28 82 IV. UTILIZATION OF FIRST BANK LOAN 28 - 32 83 - 89 V. PROSPECTS AND CREDITIORTHINESS 33 - 36 90 - 97 Prospects 33 - 35 90 -95 Creditworthiness 35 - 36 96 -97 VI. CONCLUSIONS AND RECOMENDATIONS 36 - 38 98 -107 LIST OF ANNEXES ANNEX 1 Breakdown of Ownership of the Five Financieras ANNEX 2 Summary of Statements of Policies and Procedures for the Five Financieras ANNEX 3 Equity Investments (as of December 31, 1967) Page 1: Colombiana Page 2: Nacional Page 3: Caldas Page 4: Valle Page 5: Norte ANNEX I Utilization of World Bank Loan 451 OC ANNEX 5 Accounts of Colombiana Page 1: Balance Sheets as of December 31, - 1965-1967 (actual) and December 31, 1968-1969 (projections). Page 2: Statements of Income and Retained Earnings for the years ending December 31, 1965-1967 (actual) and for-the years ending December 31, 1968-1969 (projections). ANNEX 6 Accounts for Nacional Page 1: Balance Sheets as of December 31, 1965-1967 (actual) and December 31, 1968-1969 (projections). Page 2: Statements of Income and Retained Earnings -for the years ending December 31, 1965-1967 (actual) and for the years ending December 31, 1968-1969 (projections). ANNEX 7 Accounts of Caldas Page 1: Balance Sheets as of December 31, 1965-1967 (actual) and December 31, 1968-1969 (projections). Page 2: Statements of Income and Retained Earnings for the years ending December 31, 1965-1967 (actual) and for the years ending December 31, 1968-1969 (projections). ANNEX 8 Accounts of Valle Page 1: Balance Sheets as of December 31, 1965-1967 (actual) and December 31, 1968-1969 (projections). Page 2: Statements of Income and Retained Earnings for the years ending December 31, 1965-1967 (actual) and for the years ending December 31, 1968-1969 (projections). ANNEX 9 Accounts of Norte Page 1: Balance Sheets as of December 31, 1965-1967 (actual) and December 31, 1968-1969 (projections). Page 2: Statements of Income and Retained Earnings for the years ending December 31, 1965-1967 (actual) and for the years ending December 31, 1968-1969 (projections). SUiIARY i. The industrial sector represents one of the most dynamic sectors of the Colombian econony. Manufacturing industry accounted in 1967 for nearly 19.3% of the gross domestic product compared to 14.8% in 1950. Average annual growth has been 6.3% since 1950. However, between 1962- 1967 the average was at a rate of 5.7% annually. In recent times the Government of Colombia has pursued protectionist trade policies in order to stimulate production. Nevertheless, in late 1965 the Government relaxed its import restrictions with the objective, among others, of bringing pressures to bear on high cost domestic manufacturers to produce more efficiently or face competition from imported goods. As a result imports increased rapidly. In November 1966, Colombia experienced acute foreign exchange difficulties and import restrictions were re-imposed. The fiscal and monetary countermeasures which the Government enforced following the difficulties had a detrimental impact on business activity during the first half of 1967. However, this effect seems to have been of a temporary nature and the private sector is now regaining confidence. The future expansion of business is now mainly dependent on the still emerging overall economic policy of the Government and the degree of importance which the public sector is to play in the economic development of the country. ii. The financieras have played a major role in the development of the industrial sector in Colombia by providing medium- and long-term financing as well as equity financing. On December 31, 1967, the aggregate value of their portfolios amounted to Col$ 1.8 billion; their equity investments increased from a mere Col$ 13.0 million at the end of 1961 to Col$ 318.3 million at the end of December 1967. iii. The principal resources of the Colombian financieras have been their own equity, credit lines with Banco de la Repdblica and foreign commercial banks, the Private Investment Fund (PIF), the US$25 million Bank loan granted in May 1966, local bond flotations and deposits. As of December 31, 1967, the Banco de la,Republica credit lines were fully utilized, the Bank loan al ost fully committed and total funds available in PIF for the financieras and commercial banks amounted to Col$ 66 million in counterpart funds and US$3 million in foreign exchange funds. Consequently, the financieras find themselves limited by a shortage of long-term funds. The prospects for replenishment of PIF funds are at the moment somewhat uncertain. The financieras should have no difficulty in utilizing, for foreign currency expenditures, the full amount of the proposed US$12.5 million Bank loan:within a one-and-a-half year period. iv. In spite of certain weaknesses in the financieras noted in this report, their performance can be considered satisfactory and the quality of their management and staff generally high. In the utilization of the first Bank loan it has been found that their appraisals have generally been of a good standard. Moreover, their financial position is satisfactory - ii - and business prospects are good. The financieras are, therefore, considered creditworthy for, and suitable recipients of, the proposed second Bank loan. The Banco de la Republica would be the borrower; funds would be committed to each financiera on a project-by-project basis, after the Banco is satisfied that the loan proceeds are being requested for projects of significance to the economic development of Colombia. The Colombian Government has agreed to give its guarantee to the loan and the Banco de la Repdblica will carry the exchange risk, if requested to do so, but the ultimate borrower retains the option to shoulder the exchange risk himself. v. The loan would be allocated in advance among the financieras, approximately in the following manner: Colombiana and Nacional 30% each, Caldas, Norte and Valle 13-1/3% each. The individual and aggregate limits for investments requiring the Bankts prior approval would be US$250,0O0 and US$1.5 million each for Colombiana and Nacional, and US$100,000 and US$750,000 each for Caldas, Norte and Valle. vi. The loan recommended would have the form normal for Bank lending to development finance companies. Banco de la Repdblica would charge the financieras the rate applicable to the Bank loan plus a maximum of 1% per annum to cover administrative costs. The financieras would charge their borrowers a minimum of 3% per annum to cover operational costs and profit. To this total (10-1/4% at todayfs Bank lending rate), the Banco de la Rep&blica would add 8% to cover the foreign exchange risk, if the ultimate borrower does not himself wish to assume it. Satisfactory assurances have been obtained from each of the financieras that it would add equity features to the loans it makes, whenever possible. Other matters discussed during negotiations are spelled out in paragraph 107. APPRAISAL OF FIVE PRIVATE FINANCE COMPANIES IN COLOMBIA I, INTRODUCTION 1. In May 1966 the Bank made a loan of US$25 million to the Bpnco de la Repilblica, the central bank of Colombia, to be relent in local currency to five private development finance companies (finan- cieras) and to be used by them to finance investment projects in the private sector. The loan has been almost fully committed; as of March 31, 1968, US$24.9 million had been credited to the loan account for 72 projects. At the same date, US$12.2 million had been disbursed. 2. The Government of Colombia and the financieras have asked the Bank for a second loan of US$25 million on a similar basis. The Bank envisaged the possibility of a US$12.5 million loan, expecting other external sources of capital to provide the additional finance which Colombian enterprise could effectively absorb. This report assesses the performance and prospects of the financieras with a view to deter- mining whether they can effectively use the proposed new Bank loan. It is based on missions to Colombia in November/December 1966 and January/February, March/April and July 1967 and on information acquired in the course of continuing and close contact with the five financieras. II. INDUSTRY AND TIE FINANCING OF INDUSTRY Economic Policy and Industrial Development 3. The first industrial plants, as opposed to artisan shops, were established in Colombia in the early.1900ts. Industrial growth proceeded fairly slowly for the first 50 years of the century, so that by 1950 the industrial sector accounted for no more than 14.8% of the Gross Domestic Product comprising mainly firms in textiles, clothing, beer, soft drinks, cigarettes, and cement. These are industries that have a natural advan- tage in that they produce the principal items of mass consumption in a low-income country; their capital requirements are not unduly high, their technology is not unduly complex, and they use mainly local raw materials. These industries were established and developed by Colombians and they continue under Colombian ownership and management. 4. Until 1950, industry developed with little official protection. As a result, these older industries were and still are capable of meeting foreign competition. However, they were not oriented towards export markets. - 2 - 5. Industry has grown more rapidly since 1950, increasing its share of Gross Domestic Product to over 19%. Initially, this was the result of the stimulus provided by the world coffee boom of 1950-56, which accele- rated the general rate of economic growth in Colombia. In the decade since then, manufacturing industry has grown at about 6.5%, even though the rate of growth of GDP declined to 4.4%. The rate of industrial growth since 1957 is accounted for mainly by the utilization of capacity created by investments made in earlier periods. 6. New industries have developed in the last decade against a background of official protection which was not part of a comprehensive blueprint for industrial development. It was rather the by-product of austerity policies designed to deal with the very serious balance of pay- ment difficulties developing in 1957. The main instrument of protection was the introduction of quantitative import controls, accompanied by devaluation. In order to reduce the impact on the cost of living of the reduced level of imports at a higher cost caused by the devaluation, a system of administrative price controls was introduced. As a further consequence of the balance of payments difficulties, the Government had to assume the obligation of repaying rapidly a very large amount of for- eign commercial arrears. The financing of this repayment required a. large increase in revenues which was obtained by imposing an excess pro- fit tax and by prohibiting the revaluation of assets for the purpose of calculating depreciation which in the inflationary setting increased the income tax liability of private enterprises. 7. These measures, initially undertaken to deal with the emergency of 1957, have become more or less permanent features of economic policy in Colombia. Administrative price controls have been employed during the past decade with varying degrees of intensity, and have not in general been used with enough consistency or effectiveness to damage industrial development seriously, although they may have inhibited the potential for development of certain industries, such as cement or steel, where effec- tive price control has been applied for long periods. The prohibition of asset revaluation persists, and by.affecting the industry's ability to maintain its real assets intact may constitute a severe restraint on future development. 8. However, among the measures introduced in 1957, import control has had the greatest impact upon industrial development in the past decade, because it has come to be employed as an instrument of protection. 9. The machinery of import control relied initially, in 1957, on prohibiting the importation of a wide range of items. Later, the restric- tions were relaxed to free imports of raw materials and other intermediate products. The remaining prohibitions covered mostly imports of manufac- tures, many of which were already produced in Colombia. Thus, the control machinery provided protection for the output of domestic industry while permitting the import of its inputs. - 3 - 10. It is of course in the new industries established under protection during the past decade, that the main effects of protection can be detected. They tend to be industries with relatively small markets and relatively high costs, dependent upon imports for their essential inputs. For instance, 60% of the inputs of the chemical industry are imported, and in durable consumer goods and office machin- ery a similar relationship exists. These industries got their start when imports of the corresponding finished products were restricted, which provided the foreign suppliers of these goods with the incentive to preserve their market in Colombia by establishing local plants. Recent Policy Developments 11. In September 1965 the Government introduced a series of new economic policies designed to remedy acute domestic and external financing difficulties and to provide a basis for the resumption of the development effort (see Economic Reports W4H-172a dated May 23, 1967, Appendix B and VH-177 dated February 14, 1968). Essential elements of these measures were substantial adjustments in the exchange rate system, the initiation of an import liberalization program jointly with a set of tariff adjustments, and the relaxation of price controls. No changes were made in tax legislation affecting the industrial sector, including the prohibition to revalue,assets. The program had a favorable impact in the sense that it produced a general resurgence of economic activity. However, exchange difficulties caused another relapse in November 1966, and import liberalization, which by then was covering 80% of imports, was put in reverse. Total import controls and a general freeze on prices were reintroduced. 12. The new exchange policies, established in March 1967 (see Economic Reports No. WH-172a and WH-177) contain elements that promise to reconcile the balance of paymentst prospects with Colombia's growth objectives. They include a flexible exchange rate policy, that could provide a more appropriate price structure for imported capital equipment and intermediate products, as well as more adequate incentives for the development of non-coffee exports. 13. The new exchange policies,also established a new system for the treatment of foreign investments. The Administrative Planning Department has been endowed with authority to approve all new foreign capital investments in the country. Once approved by that Department, new investments have to be registered in the Exchange Office and this registration entitles the investor to (a) profit remittances up to 10% per year with possible exceptions for larger percentages, (b) capital repatriation in cases of liquidation up to the amount actually brought into Colombia, and (c) repatriation of moderate amounts in cases different from (b). In two cases the authorized level of remit- tances has been raised to'15%. After one year of operation of these regulations, the National Council of Economic Policy recently acted on a recommendation from the Administrative Planning Department, raising the limit on profit remittances from 10% to 14% ner year. So far, the new regulations have been implemented in a flexible manner, and the authorities have announced their intention to keen this line of policy which will reassure foreign investors. 14. The new exchange policies have started to work well, and the economy is getting back into a renewed high level of activity. The Government is aware of the-need to improve the system of incentives for industrial development and is now actively reviewing it. Industrial Financing 15. The principal outlines of the institutional framework for in- dustrial financing in Colombiahave been described in a memorandum attached (as No. 1) to the PresidentIs Report No. IFCR/64-8 of March 17, 1964. Later developments are reported in the "Appraisal of Five Colombian - Private Development Finance Companies", Report No. DB-28a of April 20,1966. 16. Loan finance for the industrial sector was traditionally geared to short-term needs, and capital expansion had to be financed mainly out of earnings and capital increases. Loan financing of expansion became more attractive as inflationary pressures worsened in the early tsixties. At the same time long-term financing became more readily available with the establishment of the financieras and of the Private Investment Fund. Thus equity financing declined in:importance. The following data on the composition of industrial financing from 1959 to 1964 show the direction of this trend (figures in percent of total): 1959 1960 1961 1962 1963 1964 Retained Earnings 1/ 39.0 26.0 31.0 24.3 38.5 32.2 Capital Increases 26.0 46.0 26.0 28.5 14.8 22.8 Loans 35.0 28.0 13.0 47.2 46.7 45.o Total 100.0 100.0 100.0 100.0 100.0 100.0 Although more recent figures are not available, it may be assumed that the relative use of loan and equity funds continued to depend on Govern- ment credit policy and general financial conditions. Today, in the 1/ Reserves and undistributed profits. light of the Government's general anti-inflationary policy, equity probably looms larger as a source of industrial finance than it did a few years ago. Equity Finance 17. The principal source of equity capital continues to be retained earnings. Outside sources are primarily insurance and allied savings companies, which may within certain limits invest in industrial shares and bonds, and the financieras, which are becoming significant in this field. The combined value of the equity portfolios of the financieras rose from Col$ 13.0 million at the end of 1961 to Col$ 318.3 million at the end of 1967. 18, The failure of shares to keep abreast of inflation has limited their attractiveness to the public. For instance, the index of stock prices on the Bogota stock exchange, calculated on an average basis, fell 16% from 1964 to 1966, while the cost of living index increased by about 26% during the same period. Total share transactions were 5% less in 1966 (only Col$ 287.6 million) than in 1965. In 1967, however, the pic- ture has been different. The index of prices on the Bogota stock exchange increased by 14% up to October 31, while the cost of living index increased by only about 6% in the same period. Col$ 395.0 million changed hands during this period, an increase of 60% compared with the same period of 1966. The revitalization that has taken place in the market in 1967 is partly attributable to recent restrictions on speculation in the foreign exchange market, the repatriation of Colombian capital from abroad and the-elimination of guarantees granted by financial institutions,either directly or by endorsement, of local currency obligations. Loan Finance 19. At the apex of financial institutions providing loan capital in Colombia is the Banco de la Republica, followed by the commercial banks, several government and semi-government specialized credit and investment institutions and the financieras. 20. Banco de la Republica. Banco de la Republica provides funds mainly through discount facilities available to commercial banks, and through special credit lines to the' financieras. (These credit lines started in 1963 in place of discount facilities previously provided to the financieras). As of September 30, 1967, commercial banks had out- standing Col$ 1.2 billion, and the financieras as of December 31, 1967, Col$ 455.3 million of Banco de la Republica funds, including PIF funds. 21. Each financiera's credit line, determined by the amount of its subscribed capital and legal reserves and revised from time to time, is scheduled for repayment over 1966-1969. However, the Banco de la Republica has agreed to accept payment in ten-year bonds, thus considerably extending the use of its funds. The credit lines are used for medium-term lending for both working and fixed capital, and cost the financieras 6% p.a. interest. -6- 22. Private Investment Fund. The Private Investment Fund (PIF), establishedin March 1963 as a special account in the Banco de la Repiblica and managed by it, has become a vitally important source of finance to the private sector. Total PIF resources as of .December 31, 1967 amounted to Col$ 743 million. This includes loans available for peso expenditures of Col$ 489 million from US AID and Col$ 12 million from the Netherlands Government. It also includes for foreign exchange expenditure a US$3 million loan from the Inter-American Development Bank (1M), a US$10 million loan from AID and a US$5 million credit line from Kreditanstalt fffr Wiederaufbau.1/ Up to December 31, 1967, PIF had made 200 loans totalling Col$ 695 million in pesos and US$15 million in foreign exchange. 23. PIF loans are made to private businesses through the commercial banking system and the financieras, Up to five years are allowed for agricultural, forestry, and fishing projects; and up to ten years, for industrial projects. PIP charges the intermediaries 1% interest on all loans whose purpose is to increase exports, and 6% on other loans. Relending rates are 12-14 1/2% p.a. on peso loans and 8-10% p.a. on dollar loans. To the end of September 1967, 34% of all loans in pesos and 73% of all loans in foreign exchange had been channeled through the financieras. This fact reflects both their growing importance and the developing differentiation between the commercial banks, which focus on short-term lending, and the financieras, which began that way but are moving increasingly towards medium- and long-term investment. 24. Commercial Banks. Colombiats commercial banking system, consistingof 21 institutions, 16 of which are Colombian, has the traditional role of supplying short and to some extent, medium-term credit and is the major provider of all credit in Colombia. As of September 30, 1967, 76.5% of commercial bank loans were short-term, 15.9% medium-term and only 7.6% long-term. Commercial firms have been the main recipients of bank credit; but in recent years, industry has in- creased its borrowings from commercial banks and in September 1967 had around 34% of total bank lending compared with 26% for commercial firms. At the end of September 1967, the industrial loan portfolio of the com- mercial banks amounted to approximately Col$ 2,100 million, up 50% since the end of 1964. These activities are supported by the Banco de la Repdblica through conventional discount facilities, as well as through special credits designed to promote investment. 25. Instituto de Fomento Industrial,(IFI). IFI, created in 1940 and fully fianced by the Government, was set up to promote and finance industries deemed of special importance for.the country, which because of the large investment involved, special risk or small initial return, 1/ The Dutch loan in the amount of $1.4 million was untied and freely usable for local currency financing, while up to 20% of the German loan was available for such financing, did not attract private initiative. In 1963 IFI was given the status of a government-owned financiera, which gave it access to PIF resources. Also, in 1965, IFI was designated as the Government's financial agent for the administration of AID counterpart loans to the Colombian Govern- ment. 26. It is the policy of the Government to enlarge IFI's role in industrial development. A new management has been appointed and its financial position improved by writing off bad debts. Its financial resources have been greatly enlarged. The Government has increased II's paid-in capital from Col$ 50.0 million at the end of 1966 to Col$ 79.1 million as of December 31, 1967; it has also made provision for a contin- uing supply of new resources by making available to IFI, on an annual basis, .% of the increase of the reserves of the Colombian Institute of Social Security (ICSS).j' In 1967 IFI received Col$ 74.6 million in this way. According to official estimates this amount will increase annually, reaching Col$ h73.2 million in 1970 and Col$ 1.5 billion in 1974. IFi also has access to rediscounting facilities of Banco de la Republica. It has obtained from Spain a line of credit equivalent to US$ 10 million to finance imports of industrial equipment from Spain and another loan of US$ 2 million equivalent from the Netherlands; and it is negotiating similar credit lines with IDB, France, Germany, Japan and Denmark. As of October 31, 1967, IFI had 99 outstanding loans for an amount of Col$ 117.3 million and equity investments in industrial enterprises of Col$ 56.8 million. 27. The revitalization of IFI changes in some ways the environment in which the financieras work. They are faced for the first time with a potential government competitor enjoying a continuing and large supply of fresh capital and having govetmental support in other subtle ways. IFI will have no effect on the financieras' use of the proposed $12.5 million loan: the amount is small, the commitment period is likely to be fairly short and Colombian entrepreneurs generally prefer to deal with a private rather than a public institution. But in the longer run, IFI's impact will depend on what the Government wants to make of IFI: the country's principal source of finance for private investment, or a residual pro- vider of capital others will not provide. IFI's present management con- ceives the institution as primarily a promoter of enterprises of national significance, a provider of capital for enterprises too risky for private financial institutions to support, and a complement to, rather than com- petitor of, the financieras, with which IFI relations are at the present time close. How the relationship develops will also depend on whether the financieras have access to adequate financial resources and on the terms of IFI's loans to industry. 1/ 80% of the annual addition to ICSS's reserve is lent to the Government against the issue of "constant value bonds". 50% of these funds will then, in turn, be relent by the Government to IFI. - 8 - 28. Semi-official Specialized Credit Institutions. The Banco Cen- tral Hipotecario, Banco Popular and Caja Agraria lend to private industry. Banco Central Iipotecario provides mortgage finance to all sectors. The Banco Popular lends to small-scale industry. The Caja Agraria's principal activity is agricultural credit, but it also lends to the mining and man- ufacturing sectors. In all, the role of these institutions is not very significant in medium- and long-term industrial financing. 29. The Financieras. The firncieras have emerged, in the past five years, as theE -main source of medium.- and long-term credit for industry. As of December 31, 1967 the combined value of their total portfolios was Col$ 1,799.0 million.l/ They have become important mobilizers of domestic as well as of foreign capital, channels of official Colombian finance to the private sector and innovators in industrial finance and investment. They have already made an important impact on the development of Colombials industry. III. PERFORIANCE OF THE FINANCIERAS General 30. A detailed description of the emergence of the financieras appears in Appraisal Report No. DB-28a of April 20, 1966. No important changes have been made since that Report in the legislation which authorized the establishment of the financieras or in the regulations which govern their operations. 31. There are now nine private financieras in Colombia, three more than when the first Bank loan was made in May 1966. Paid in Date of Share Total Name of Financiera Headquarters Incorporation Capital' Assets? (Col$ million) Corporaci6n Finan- ciera Colombiana Bogot1 January 1959 118.3 722.6 Corporacidn Finan- ciera Nacional Medell n March 1959 91.3 377.5 Corporaci6n Finan- ciera del Valle Cali April 1961 45.9 201.6 Corporaci6n Finan- ciera de Caldas Manizales May 1961 69.4 268.4 Corporaci6n Finan- ciera del Norte Barranquilla May 1963 24.2 115.0 l/ Only Caldas, Colombiana, Nacional, Norte and Valle. !/ As of December 31, 1967. -9- Paid in Date of Share Total Name of Financiera Headquarters Incorporation Capital Assets 'Col$ million Corporaci6n Finan- ciera del Occidente Pereira July 1966 9.9 21.41/ Corporaci6n Finan- ciera de Santander Bucaramanga July 1966 10.4 13.8 Corporaci6n Finan- ciera Central BogotA August 1966 7.6 54.4L/ Corporaci6n Finan- 3/ ciera del Caribe BogotA N.A. 15.0- 15.2z1 32. Of the new companies, Corporaci6n Financiera del Occidente started in mid-1966, in Pereira, in the same region in which the operations of Caldas have been focussed. About 45%f of the stock is owned by local Pereira interests and the rest by large institutional investors such as banks, insurance companies and industrial enterprises. So far Occidente has confined itself to providing short-term working capital to companies in the region. Corporaci6n Financiera de Santander was established at the same time, in Bucaramanga. Its three largest shareholders are Ecopetrol, the Federaci6n Nacional de Cafeteros and the Fondo de Desarrollo Industrial de Santander. Corporaci6n Financiera Central was organized in August 1966 by the BPnco de-la Sabana. On February 1, 1967, the Banco de la Sabana was bought out by the Grupo Grancolombiano, which consists of the Banco Grancolombiano, Capitalizadora Grancolombiana, S.A., so.me warehousing companies, mutual funds, and two insurance companies. This company is located in Bogoti, the headquarters of Colombials largest financiera, Corporaci6n Financiera Colombiana. 33. Finally, Corporaci6n Financiera del Caribe was recently organized and authorized to operate by the Superintendency of Banks. The companys main shareholders are Banco de Colombia, two insurance companies and four Dutch corporations. 34. On the occasion of the first Bank loan, it was noted that the multiplicity of development finance institutions reflected peculia- rities of Colombia's history and economic development, particularly its regional diversity and resulting competitive spirit. However, each of the institutions was developing staff and techniques, financial resources, and a safe regional base for its activities. Moreover, to some extent, the edge was taken off the dangers,of overcrowding by developing cooperation among the institutions. The four new financieras now in the field will inevitably have a harder time getting started than did their predecessors; and, with the uncertainty about IFITs future role, all the companies will need to watch closely the prospects of competi- tion, cooperation and merger. 1/ As of March 31, 1967. 2/ As of December 31, 1967. T/ As of March 31, 1968. - 10 - 35. Requests have been made by, or on behalf of, the new finan- cieras for access to the proposed new loan. However, several consider- ations suggest the need for caution. The new institutions lack oper- ating experience; their equity base is very small; in the enhanced com- petitive situation among the financieras, the new ones are not now well- equipped; the proposed loan is so small that it would be of little use to any of the companies if it is divided into too many parts. All things considered, it would be best to adhere to the policy the World Bank group has thus far followed in Colombia, of waiting until there was actual operating experience to evaluate, before providing capital to a financiera. During negotiations the representatives of the Colombian Government and the Banco de la Republica, although having requested the inclusion of two of the new financieras as beneficiaries of the loan, agreed to limit this loan to the five oldest financieras. 36. Accordingly, this report is devoted to appraisal of the five oldest financieras.which were the beneficiaries of the first Bank loan. 37. IFK is a shareholder of three of these five financieras: Colombiana, Nacional and Caldas. Original Original Investment Holdings at Par Investment at Par on Mar. 31, 1968 Approved Shares Value Shares Value ( No.) (Col$) -7No-7. Co17) Colombiana Aug 29, 1961 1,791,000 17,910,000 1,936,960 19,369,600 Nacional Aug 29, 1961 1,780,000 17,800,000 1,069,091 10,690,910 Caldas Mar 31, 1964 70,000 7,000,000 85,750 8,,575000 In the case of Colombiana, the increase in IFC's present holdings from the original purchase amount by 165,960 shares was the result of a share option exercised on a dividend on June 29, 1962, and an 8% stock dividend declared on February 28, 1968. IFC's shares held in Caldas increased by 15,753 shares, representing successive 7% stock dividends (4,900 shares on March 30, 1966, 5,243 shares on March 31, 1967, and 5,610 shares on March 29, 1968). The decrease in IFCts holdings of Nacional of 710,909 shares resulted from the sale of 752,909 shares in 1964,, after a stock dividend of 42,000 shares had been received on June 3, 1963. Ownership 38. Few changes of importance have taken place recently in the ownership of the five financieras. As can be observed in Annex 1, fin- ancial institutions, foreign and domestic, continue to dominate Colom- biana and Nacional. Governmental institutions and other investors hold a more important place in the smaller financieras. The only significant change in ownership in the past two years, which occurred in Colombiana, accentuates this picture. There, in early 1967, a group headed by Banco de Bogota and Colombiana de Seguros, respectively the largest bank and largest insurance company in Colombia, increased their combined interests from 11% to 35%. Resources 39. The resources of the financieras total Col$ 2.4 billion, and are derived principally from share capital and surplus, credits from the Banco de la Republica (and PIF), credits from foreign commercial banks and the World Bank. The principal source of increase, since 1965, has been the US$25 million of Bank Loan 451 CO,equivalent to Col$ 406.3 million. Other significant increases have been in PIF funds and lines of credit from foreign banks. The following table shows the resources of the financieras at December 31, 1967 with the whole of the first World Bank loan included (in Col$ million): Financierast Resources on December 31, 1967 Colombiana Nacional Caldas Valle Norte Total Equity Share capital (paid in) 118.3 91.3 69.4 45.9 24.2 349.1 Reserves and surplus 74.2 36.8 23.8 18.5 8.7 162.0 Total equity 192.5 128.1 93.2 64.4 32.9 511.1 Loans BR credit line 63.6 56.7 26.9 26.4 14.5 188.1 BR - PIF 0875.6 25.3 54.6 9.9 267.2 Bank Loan 451 130.7 130.1 44.6 50.3 50.5 406.2 Foreign Banks 337.2 211.3 60.9 36.6 72.1 718.1 Inter-American Development Bank (IDB) 3.3 -- - 3.3 Total loans 636.6 473.7 157.7 167.9 147.0 1,582.9 Bonds 98.9 40.0 46.9 18.4 11.0 215.2 Deposits 13.0 - 24.3 7.1 0.4 44.8 Grand total 941.0 641.8 322.1 257.8 191.3 2,354.0 40. Equity, credits from the Banco de la Rep6blica and the World Bank, and bonds are devoted largely to medium- and long-term loans and investments. Credit lines from foreign banks are of a short-term nature and have been largely devoted to a..ucrative export and import financing business. Bonds and deposits have been of limited significance. Term deposits are acceptable under the law, but prudence in their use has kept them low in amount. 1/ The total for the five financieras amounts to the equivalent of the total Bank loan. The portion for each financiera is estimated on the basis of amounts credited on March 31, 1968 at an exchange rate of Col$ 16.25 per US$1.00. - 12 - 41. It is notable that the financieras have received no long-term subordinated funds from Government, of the kind available to some other development finance companies financed by the Bank group. They have had facilities from the Banco de la Rep6blica and certain tax privileges. These were, however, not subsidies or privileges designed for the finan- cieras alone;.they were available to financial institutions generally. The financieras have had to work in the market, searching for resources and competing for them, and energetically seeking out business while keep- ing expenses to a minimal level in a manner companies in a more favorable environment have not had to do. The financieras have thus had to use their funds so as to prevent their being tied up for too long a period and to assure an early return. In their first years, the stress was on short-term lending and on the provision of a variety of financial services; the for- mer gave place to medium- and lon--term investment as apnronriate resour- ces were found. In general, the experience of having to adapt themselves to the market has made the financieras more resourceful and has reauired more initiative from them than has been the case with institutions based on government finance. Organization and Procedures 42. Fundamentally the organizations of the financieras are similar, as are their methods of work. Differences relate largely to the com- petence and experience of the staff and to the "styles" of the manage- ments, which reflect to a great extent differences in regional outlook. 43. Colombiana. The Board of Directors is elected for a two-year term. As a result of the changes in ownership that took place in early 1967, Banco de BogotA and Colombiaba de Seguros obtained effective con- trol of the financiera and the present board of 5 principals and their alternates took the place of a 10-man board that had served before. Dr. Jorge Mejia Salazar, President of Banco de BogotA, which together with Colombiana de Seguros, dominates Colombiana, remained Chairman of the Board; representatives of Colombiana de Seguros, Banco del Comercio, Manufacturers Hanover Trust and Bank of London and Montreal also re.- tained their seats. The alternate director representing the interest of the German shareholders became adviser to the Board. IFC was offered a seat (principal and alternate) but declined for the time being. The Board meets every second week. It has appointed an Executive Committee consisting of the President, and the representatives of the Banco de BogotA and Colombiana de Seguros. There is-also a Credit and Invest- ment Committee, consisting of three Board members and three vice pres- idents, which meets once a week to make recommendations on all loan and equity investment proposals to be brought before the Board. 44. The shift in Colombianats ownership was reflected in important managerial and staff changes. Dr. Guillermo Herrera Carrizosa retired from the presidency to become Honorary President and was succeeded by - Dr. Ignacio Copete, respected lawyer, central banker and, most recently, Financial Manager of the Inter-American Development Bank. Most of the - 13 - second echelon of the company, all the vice presidents and several de- partment heads, has also changed. There is a vice president in charge of each of the promotion, technical and administration departments. Price Waterhouse has been contracted to prepare a study on a new system of accounting and information for management. There is also a Co- ordination Committee consisting of the senior staff, whose main task is to assist the President in the planning and execution of the re- organization of the company. Colombiana is in the process of overhauling and rationalizing its organization and procedures, which have not kept abreast of the rapid growth of its operations. 45. The procedure for appraisals and follow-up are well conceived although in practice some weakness in these services has been observed. During negotiations the Company's President assured the Bank that this is being corrected. He has organized a system of continuing and frequent staff review of individual investments under his direct supervision. 46. Nacional. The Board of Directors composed of ten principal directors and their alternates is 'elected for a one-year term and it con- tains representatives of the principal shareholders, including three foreign financial institutions. Seven principals representing the major Colombian shareholders regularly attend meetings which are held weekly, The Comp..n;rls Chairman, Dr. Gabriel Angel, participated in the founding of several important commercial banks, insurance companies and industries, as well as of Nacional. He is one of Colombia's most respected businessmen. 47. Management consists of the President, Dr. Jose Gutierrez Gomez, and a vice president. Dr. Gutierrez Gomes, a lawyer by training, has held important business and government positions, including presidency of A.N.D.I. and Ambassador to the U.S.A. He provides dynamic leadership to the corporation and is highly regarded both in Colombian private and government circles and abroad. 48. Although the second in terms of resources and volume of busi- ness, Nacional's staff is among the smallest of the five financieras. The level of the personnel in the operational departments is among the best to be found in the Colombian financieras. The quality of the cor- poration's appraisal reports has been generally satisfactory, and loan applications are adequately processed. During the construction period, projects are closely watched to ensure funds are used by clients for the purposes originally agreed upon, However, follow-up has been spor- adic after construction is completed. It is not standardized to pro- vide for regular periodic :visits except in cases of projects financed by PIF resources. Improvement of follow-up was discussed during negotia- tions. - l4 - 49. Caldas. The Board of Directors consists of eleven principal members and their alternates, elected by the General Shareholderst Meeting for a one-year term. Four,principal directors and five alternates regularly attend meetings which are normally held once every two weeks. These nine directors represent the coffee interest, local industrial enterprises and three Colombian financial institutions. IFC has been represented on the Board since 1arch 1966 by Mr. A. G. Arango who attends meetings about once every two months. 50. The Companyts management consists of the President, Dr. Roberto Ocampo Mejfa, a recently appointed Executive Vice President and a Vice President who is in charge of the BogotA office. The President is a dynamic personality and has:been in office almost since the Corporation began operations. 51. Caldas has experienced difficulties in recruiting and retaining the services of qualified personnel. However, to cope with this problem, the level of staff remuneration has been raised and, in addition to the appointment of a new Executive Vice President, the staff has been reinforced with three new engineers and an econo.mist; and a former Vice President of the company, who was managing a consulting firm, was brought back into the company, in charge of promotions. One of the engineers recently appointed is in charge of follow-up and end-use procedures. The Vice President in charge of the Bogotd office is at present attending the Industrial Projects Course at the EDI. 52. In the reorganization now taking place, the Executive Vice President (Dr., Mario Calder6n) plans to establish new procedures and to define more clearly the responsibilities of the department heads and their staffs, and greater care will be taken with end-use supervision. During negotiations these matters were discussed with Caldast representative, and it is expected that the reorganization under way will greatly improve the Company's performance. 53. Valle. The Board of Directors consisting of nine principals and their alternates is elected for a two-year term. The directors who attend meetings regularly represent the main Colombian shareholder groups. The Board must meet at least twice a month, but does in fact hold weekly meetings. 5h. Considerable changes were made in the Company in 1966 and early 1967 following the resignation of its President. Dr. BenjamIn MartInez Mbriones, former Executive Vice President, became its new President. Dr. Martfnez is well experienced and has a thorough knowledge of Valle del Caucats business community. - 15 - 55. Loan applications are first reviewed by a management committee which decides whether or not they should be studied by a technical department. Then the appraisal is prepared by the technical department and again reviewed by the Management Committee which may approve loans of up to Col$ 200,000 and submits its recommendations to the Board in the case of larger operations. Procedure for handling loan applications is satisfactory. During negotiations, the Company's President stated that the technical department has been recently strengthened: it now has eight members including seven economists. The reorganization of the technical department will ensure regular half-yearly visits to all borrowing clients. 56. Norte. The Board of Directors composed of ten principals and ten alternates is elected for one year. The directors represent two U.S. banks which are the lartest private shareholders and the regional interests of the North of Colombia, in accordance with their economic importance: Barranquilla (3), Cartagena (3), Santa IMJarta (2). The Board meets once or twice a month. The Chairman of the Board and Chief Executive is Karl Parrish, a U.S. citizen and prominent businessman who has lived in Barranquilla all his life. Management is in the hands of the President, Dr. Alvaro Jaramillo Vengoechea, who has considerable business experience as a member of the management of several important industrial and commercial enterprises. He is assisted by two Vice prosidents. The Company is organized into technical, administration and legal departments and has offices in Barranquilla, Cartagena and Santa Marta. Engine erinr consultants are engaged from time to time. Project appraisals, elaborated by the technical department, are first discussed in a Technic'l Committee and then with a Credit Committee which rejects or endorses proposed investments. Final approval of projects is given by the Board, excepting that of projects up to Col$ 0.2 million, which has been delegated to the President. Subsequent follow-up on loans and investments are also handled by the technical department. 57. Project appraisals by Norte, the smallest of the five financie- ras, are generally of good quality) well organized and comparable to the ones of the more experienced and larger Colombian finance companies. Its follow-up reviews are made on scheduled visits and have been reasonably up-to-date. During negotiations, the Companys President stated that measures have been taken to make more frequent follow-up reviews. A staff member, an industrial and mechanical engineer, is in charge of these procedures. Norte also intends to engage a market specialist. 58. General Evaluation. The managements and Boards of Directors of the financieras are composed of successful bankers and businessmen who have the respect and goodwill of government and private business circles in Colombia and abroad. Their staffs are reasonably well trained and are gaining experience. All suffer from certain common weaknesses, chiefly inadequate engineering advice and wieak follow-up procedures. Financial analysis is generally well done; but market studies are generally .- 16 - deficient and conclusions tend to rely excessively on tariff protection. However, they enjoy the strength deriving from vigorous chairmen, presi- dents, and boards of directors whose members are familiar with the business of the community. Moreover, their experience with the first Bank loan has significantly improved the financieras' performance and helped them not only to expand their operations but also to achieve higher standards of investment appraisal. Policies and Operations - 59. Policies. The statements of operational policies of the five financieras are similar. They contain most of the elements of statements guiding the affairs of other private development finance companies. No change has been made in them since the first Bank loan was granted. A summary of the policy statements is attached as Annex 2. 60. In general the five financieras have abided by the provisions of their policy statements. However, with respect to cash dividends in light of the need to maintain provisions and reserves at a level appro- priate to the size and condition of their portfolios, Colombiana, some- what imprudently, in 1967 declared a cash dividend of 11% representing an 88% pay-out. To remedy this situation, the capany in 1968 reduced the size of the dividend to 8% and substituted shares for cash. Valle in 1967 declared a 7% dividend to be paid either in cash or in shares at the shareholders' option. Although this was done with the expecta- tion that most of the dividend would be paid in shares, as was the case in practice (95%), the alternative decision on the part of the share- holders would have resulted in a pay-out of over 100%. During negotia- tions the Presidents of these two financieras gave specific assurances that their companies will annually allocate a suitable portion of their net profits to provisions and reserves. 61. Operations. Loan and equity commitments made since the begin- ning of 1966 have been substantial, despite the general slowdown of business activity in late,1966 and in 1967. The principal rise has been in medium- and long-term loans, primarily the result of the availability of the Bank loan; equity investments also rose significantly. Although a large proportion of the commitments made during this period has yet to be disbursed, the following tabulation of the portfolios of the financieras at the end of December 1967 shows an increase of 24% over the comparable figures for the end of December 1965. - 17 - Loans and Investments Outstanding on December 31, 1967 (Col$ million) (Dec. 31, Colombiana Nacional Caldas Valle Norte Total 1965) Loans in pesos 1/ 336.2 249.6 148.9 152.2 71.4 958.3 (628) Foreign exchnge financing = 194.5 29.1 24.7 13.3 26.4 288.0 (428) Equity invest- ments 143.4 80.0 60.7 25.7 8.5 318.3 (224) Sub-total 674.1 353.7 234.3 191.2 106.3 1;6Z.6 (,T7 Underwriting commitments - 2.3 1.5 - - 3.8 (37) Guarantees 73.4 2.1 17.0 23.0 3.1 118.6 (714) Others 19.8 37.1 36.9 15.3 2.9 112.0 (52) Total 767.3 400.2 289.7 22905 112.3 1,799.0 (1,443) 62. The table reflects the continued trend which is away from short- tem lending and towards medium- and long-term operations as a result of the greater availability of long-term resources. The origin of the re- sources at their disposal has been a principal determinant of the way in which the financieras invest and the terms on which they make capital available. Thus, PIF resources and credits from the Banco de la Republica can be relent only for a period of one to 10 years; credits from foreign banks are generally available only for 6-month periods; the Bank loan is for medium and long-term use. The,shifting mix of these and other funds deeply affects the composition of the portfolios of the financieras. 63. The close link between the financieras' borrowing and lending terms is also reflected in the differences in interest rates charged under the various lines of credit,which in turn has led to a certain stratification of terms. Thus, on all their own funds, including pro- ceeds from bonds, the financieras generally charge 11-13%, plus a com- mission of 1%. On proceeds from the Bank loan(cost, 9") and on PIF funds(cost, 6) denominated in pesos, the financieras charge 12% on loans repayable in up to five years, and an additional 1/2% for each additional year up to a maximum of 14-1/2/. On dollar loans 1/ Mostly medium- and long-term. The proceeds of the Bank loan are in- cluded in this category, because the foreign exchange risk is taken by the Banco de la Republica. 2/ Mostly short-term. - 18 - made available through PIF,(cost, 4-6%) the financieras charge 8% on loans repayable within three years: 90 on loans repayable in five years; and 10% on loans, for industry only, repayable in more than five years. Interest charged on capital derived from the Banco de la Republica credit lines (cost, 6%) is 11% plus 1% commission. On foreign exchange loans (cost, around 6-8%) the interest charges are from 11% for export financing and from 12-13% from import financing plus commission varying from 3/4% to 1%. The linking of use and terms to the sources of capital is an aspect of the general adaptation of the financieras to market conditions, which has been referred to earlier. 64. The financieras' loan operations show a wide diversification and the distribution of loan portfolios by main economic sectors as of December 31, 1967 was the following:(in per cent): Colombiana Nacional Caldas Valle Norte Agriculture and livestock 40 2 5 10 26 Food, beverages and tobacco 6 16 10 321/ 15 Textiles and apparel 8 33 18 9 15 Metals and engineering 8 7 20 14 14 Chemicals 10 3 16 6 10 Paper and printing 10 12 5 17 13 Other 12 -27 26 12 7 100 100 100 100 100 As of December 31, 1967, the distribution of the financieras' loan port- folio was as follows: agriculture and livestock (Col$ 254.8 million), textiles (Col$ 175.7 million), metals and engineering (Col$ 171.0 million), food and beverages (Col$147.4 million), paper and printing (Col$ 124.2 million), chemicals (Col$102.2 million) and other sundry activities (Col$177.5 million). The average amount of these loans was less than Col$ 0.5 million and were for a duration of five years or less. 65. Except for Colombiana, where 60% of the loan portfolio is to enterprises located outside its home state, the financieras tend to focus 1/ Including sugar. - 19 - their activities in the regions in which they are located. On the other hand, there are cases in which two or more of them have joined in finan- cing a project that proved too large a commitment for the one that ori- ginated the project. 66. The financieras" equity investments have risen steadily as a result of their underwriting and promotional activities and the thinness of the local capital market and its inability to absorb shares in new enterprises. During 1966 and 1967, total equity investments of the five financieras increased by Col$ 94.3 million (a 42% increase) from Col$ 224.0 million as of December 31, 1965, to Col$ 318.3 million at year-end 1967. Comparative-expbsures in equity investments as of December 31, 1967 and of December 31, 1965,were as follows: Dec.31, December 31, 1967 1965 Colom- biana Nacional Caldas Valle Norte Total Equity portfolio (in Col$ million) 143.41/ 80.0 60.7 25.7 8.5 318.3 (224.0) % of total loan and equity portfolio 30 24 29 14 11 21 18 % of net worth 74 62 65 40 26 62 (53) Thus, aggregate equity investments of Co1$ 318.3 million in 1967 repre- sented 21% of the combined loan and equity portfolios, ranging from a low of 11% in the case of Norte (the newest and smallest of the five financieras) to a high of 30% in the case of Colombiana (the oldest and largest of the financieras); likewise, aggregate equity investments re- presented 62% of the combined net worths, ranging from 26% in Norte, to 74% in Colombiana. 67. The financieras' equity portfolios generally appear to be sound. They have been made substantially in existing enterprises which, with a few exceptions, have experienced managements and attractive pro- fitability prospects. Accordingly, as shown in the following tabulation (for details see Annex 3), at year-end 1967, three-fourths of the share investments of the five financieras were in the shares of companies in operation, and the remaining one-fourth in companies which had not started.operations because they were still under construction, were in the promotional stage or were experiencing some kind of special market, raw material supply or financial difficulty: 1/ Including advances on underwriting contracts. - 20 - Colombiana Nacional Caldas Valle Norte Total (In Col$ million) Operating 101.7 72.8 39.2 16.8 8.0 238.5 Non-operating 41.7 7.2 21.5 8.9 .5 79.8 Total 143.4 80.0 60.7 25.7 8.5 318.3 (% of total) Operating 71 91 65 67 94 75 Non-operating 29 9 35 33 6 25 Total 100 100 100 100 100 100 Not all the operating comanies are making profits. Among these are some new enterprises just starting up. Noteworthy, also, is the fact that Colombiana has' a large exposure in one non-operating enterprise (a cement plant under construction and with prospective serious market problems) amounting to Col$ 32.7 million in shares, or 23% of its equity investment portfolio, plus Col$ 6h.1 million in loans and guarantees. 68. The financieras have been active in underwritings and promo- tions; partly as a result of this, their combined equity portfolios have grown by h2% over the period 1966-1967 as mentioned in Paragraph 66. The greatest growth was that.of Caldas (140%) followed by Norte (93%), Valle (40%), Colombiana (39%) and Nacional, the most conserva- tive of the financieras, (14%). Over-all, the most active financiera with respect to promotions, has been Colombiana: as of December 31, 1967, 87% of its equity portfolio was in the shares of 15 companies which had been promoted by Colombiana itself. By contrast, Nacional, with a more cautious approach, had only 46% of its equity portfolio in its own promotions and, significantly, received in 1967 about three times as much in dividends (Col$ 6.1 million) than Colombiana (Col$ 2.3 million), whose equity investments were nearly twice as large (Col$ 143.4 million vs. Col$ 80 million). While the financieras intended to carry some share investments in the promoted companies, their actual interests in these enterprises are larger than was originally estimated, primarily because of higher-than-anticipated investment costs resulting from local currency devaluation and the difficulty in placing industrial shares in recent years. Accordingly, while the promotional activity of the financieras undoubtedly has been important for Colombia, it has thus far proven demanding and risky for the financieras. Financial Results 69. The following table summarizes the financieras' net income before and after taxes, in millions of pesos and in percentage of average equities, during the years 1965 to 1967: - 21 - 1965 1966 1967 Before After- Before After Before After taxes taxes taxes taxes taxes taxes (in Col$ million) Colombiana 15.31/ 14.9 21.51/ 14.8-1/ 25.01 15. 4/ Nacional 19.8 15.5 17.8 14.6 20.W 1. 3Z./ Caldas 10.0 8.3 9.1 6.8 10.7- 8.3 .' Valle 6.7 5.6 7.2 4.6 11.6 7.3 Norte 2.5 2.5 2.92/ 2.72 4.2 2.6 (in % of average equity) Colombiana 9.6 9.4 11.8 8.1 13.2 8.1 Nacional 20.1 15.8 16.0 13.3 17.1 12.6 Caldas 15.2 12.6 11.7 8.8 12.1 9.4 Valle 14.9 12.4 14.0 8.9 19.7 12.3 Norte 11.7 11.6 10.6 9.8 13.4 8.4 Profitability of the financieras has varied from year to year and from company to company. Net income before taxes, which had been reduced during 1966 in the case of Nacional and Caldas, again increased in 1967 to levels slightly higher than in 1965. On the other hand, Colombiana, Valle and Norte showed steady and substantial increases during the period. After-tax results, however, are different: despite substantial increases in pre-tax income registered in Colombiana and Norte, and modest increases in Nacional and Caldas, after-tax net income was substantially the same in 1967 as in 1965 for these four financieras. Valle was the only one that showed an appreciable gain during the period 1965-1967. Such differences in before- tax and after-tax incomes is largely explained by a higher incidence of taxation in 1967 resulting mainly from the fact that provisions for the 1/ For comparison purposes, reported net incomes, before and after taxes, were adjusted, based on Price Waterhouse 1967 Audit Report, as follows: 1965 1966 1967 Accrued interest receivable, included as income in 1965-66 but not included in 1967 (10.0) (6.2) - Provision for bad debts and write-offs - 8.5 0.1 Excess tax provision in 1967 to cover income tax liability underestimated in 1966 - (3.4) 3.4 Total adjustment (10.0) (1.1) 3.3 2/ Unaudited amounts. 3/ For comparison purposes, reported net income for 1966, before and after taxes, was reduced by Col$ 0.4 million, based on Price Waterhouse 1967 Audit Report, representing accrued interest receivable included as income in 1966 but not included in 1967. - 22 - protection of portfolios are not deductible beginning in 1967, and because Nacional and Caldas have a higher proportion of their total net income in tax-exempt items, such as dividends from investments. Financial results, as measured in terms of percentage of average equities, are somewhat less satisfactory since net worths increased at a faster pace than net profits did. Finally, the lower returns on average equity of Colombiana and Caldas partially reflect these financieras' higher proportionate invest- ment in equities, most of which do not yet produce income, to the financieras. In the case of Norte, the lower return is mainly due to the still high incidence of administrative expenses on gross income (30% in 1967 and the highest for all fin'ancieras). 70. The good profit record of the financieras results generally from the substantial spreads which they receive on the funds provided by Banco de la Republica and PIF, proportionately low administrative costs, substantial income for services of various kinds, and the active searching out of any, and every, opportunity to do business, even if it is not the kind of business an investment bank normally does. While seizing the main chance in the interest of profitability, the financieras have not lost sight of their objectives as developmental institutions. 71. However, financial results are less than satisfactory, if measured in real terms. Over the five years ended December 31, 1967, the cost of living in Colombia rose by about 15% per annum and the exchange rate for the peso depreciated a total of about 83% from the 1/ beginning to the end of the same peridl/. If one adjusts the rates of net income on average equity shown in Para. 69 by the rate of inflation, the real rate of return to domestic investors is greatly reduced in 1965 and is actually negative for 1966 and 1967. When the same adjustments to net income are made to compensate for the depreciation of the peso, the same results follow. 72. This evidences the lack of protection against erosion in the value of the peso afforded by conventional rates of profit and the need for a sharp improvement in profitability before the financieras will be able to mobilize additional equity funds on their own. The finan- cieras are expecting increases in profitability during the next few years. The Government's initial successes during 1967 in arresting the rate of inflation and in progressing towards attainment of stability in the balance of payments give some hope that the financieras' expec- tations will be realized. It is to aid the prccez3 of profit improve- ment that the financieras have agreed to make it a policy to include equity features, whenever possible, to the terms on which they lend to their clients. 1/ Based on changes in the cost-of-living index for workers and on the effective average import rate. - 23 - 73. The financieras generally have followed a prudent dividend policy; they have waited fran four to six years before declaring a dividend. Colombiana, starting in 1962 (its fourth year of operation) paid cash dividends at the rates of 3%, 6% and 4% during 1962, 1963 and 1964, respectively, representing an average pay-out of 56% of net income earned during the period 1961-1963; during 1965,and 1966 its shareholders agreed to forego dividends to strengthen the equity base; in 1967 an 11% cash dividend was declared, representing an 88% pay-out, and ii 1968 an 8% stock dividend was declared to resume increasing the equity base. Nacional, while simultaneously allocating part of its net earnings to the building up of reserves, has managed to pay an increasing cash dividend since 1963 (its fifth year of operations) amounting to 6%, 8% and 9% during 1563, 1964 and 1965, respectively, and to 10% since then. Nacional's current pay-out ratio is 53%. Caldas, during 1966 (its fifth year of opera- tions) declared a 7% stock diviBE, and in 1967 and 1968 has declared 7% stock dividends plus 1% cash dividends, the latter dividends representing a modest average pay-out of 9% of net income earned during 1966-1967. Valle declared its first dividend in 1967 (its sixth year of operations) amounting to 12%, to be paid in cash or in shares at the shareholders' option. This dividend was declared with the clear expectation on the part of management that the major part would,be paid in shares; in effect, as of December 31, 1967, 95% of the dividend had been paid in shares. An 8% dividend was declared in 1968 with the same cash or shares option and equal expectation with regard to shareholders' 5hoice. Norte during the current year (its fifth year of operations) declared its first dividend of 6%, payable in cash or in shares, at the shareholders' option. Norte's management, as in the case of Valle, has the understanding that most of the dividend will be received in shares. The dividend record of the financieras may be summed up in the following table: First Dividend Current Dividend 1/ Current Year of Cash Year Operation In Cash In Stock Pay-out 2/ Colombiana 1962 4th - 8% 0% Nacional 1963 5th 10% - 53% Caldas 1966 5th 1W% 7% 8% Valle 1967 6th 8 3/ - 50% Norte 1968 5th 6%/ - 56% 74. Until the end of 1966, Colombian tax legislation permitted the financieras to build up reserves for protection of their loan portfolios- by tax-free appropriations from gross income, up to 10% of the loan port- folio. The tax did not become payable until the reserve was reassigned or actually distributed. This provision helped the financieras in their policy of building up their reserves. Recently, as part of a general tax revision mentioned earlier, the Government abolished this privilege 1/ Declared in 196 f/ Calculated on the basis of cash dividends only. In the case of optional, cash or share, dividends, it is assumed that the entire dividend is paid in cash. 3/ OnMr%rni - nnol r -n ony- A 4 -c-;A -A - 24 - with the result that the financieras have lost part of their incentive for a rapid build-up of reserves. This fact, taken together with the tendency among the financieras to put more emphasis on establishing a good dividend record as a means of attracting additional risk capital, creates a situa- tion which warrants close attention. 75. The following t ble shows the main features of the balance sheets of the financieras as of December 31, 1967 and various financial ratios. Balance Sheets as of December 31, 1967 (in Col$ million) Colombiana Nacional Caldas Valle Norte Amt, Amt. % Amt. % Amt. T. Amt. % Assets Short-term assetsYl 221.2 31 48.3 13 135.9 51 72.9 36 55.5 48 Medium and long-term loans and equity investments 495.,8 68 327.4 86 127.6 47 126.7 63 58.0 50 Fixed assets (net) 1.2 nil 0.5 nil 0.7 nil 0.5 nil 0.4 1 Other 4.4 1 1.3 nil 4.2 2 1.5 1 1.1 1 Total 722.6 100 377.5 100 268.4 100 201.6 100 115.,0 100 Liabilities Short-term liabilities/ 238.8 33 42.0 11 85.1 32 32.3 16 18.5 16 Medium and long- term borrowings 288.6 40 205.1 54 81.7 30 100.2 50 56.0 49 Shareholders' equity 192.5 27 128.1 34 93.2 35 64.4 32 32.9 29 Other 2.7 - 2.3 1 8.4 3 4.7 2 7.6 6 Total 722.6 100 377.5 100 268.4 100 201.6 100 115.0 100 Contingent Labilities Guarantees and unused letters of credit 73.4 2.1 17.0 23.0 23.0 Underwriting contracts - 2.3 1.5 - - Total 796.0 381.9 286.9 224.6 118.1 Financial Ratios Current 0.9:1 1.2:1 1.6:1 2.3:1 3.0:1 Total debt/equity 3.1:1 1.8:1 2.1:1 2.5:1 2.6:1 Reserves/total loan and investment portfolios 11% 10% 11% 10% 8% Arrearsi/ /loans outstanding 1.1% 0.2% 0.5% 1.2% 1.9% 1/ Within one year. T/ Principal of loans and acceptances in arrears. - 25 - 76. The financieras' debt-to-equity ratios are low and well within the limits agreed upon with the Bank (five times for Colombiana and Nacional and four times for Caldas, Valle and Norte). Accordingly, there is ample room for additional borrowing.. Except for Valle's and Norte's, the current ratios are on the low side. This is especially so in the case of Colombiana, whose current ratio at the end of 1967 was 0.9 to 1. However, its immediate liquid- ity was adequate; liabilities maturing within 30 days were covered more than three times by cash and readily marketable securities. Colombiana's manage- ment was aware of this situation and was taking appropriate measures. 77. The financieras' loan portfolios are of a generally satisfactory quality and are adequately backed by collateral, reserves and equity. Arrears of principal as of December 31, 1967 in no case exceeded 2% of the total loans outstanding, and represented a substantial reduction in the levels recorded as of September 30, 1967, particularly in the case of Colom- biana. The total loans outstanding to clients in arrears as of December 31, 1967 amounted to 2.4% of the loan portfolio in the case of Colombiana, 0.4% in the case of.Nacional, 1.9% in the case of Caldas, 1.2% in the case of Valle and 10.0% in the case of Norte. During negotiations the President of Norte stated that the high percentage of loans in arrears to clients was due to a temporary situation and that collections since that date had greatly improved the picture. 78. In most cases the financieras' loans have been secured by adequate collateral. The need for adequate collateral was discussed with the finan- cieras' representatives during negotiations, specifically with Nacional and Caldas which had some major credit operations with personal guarantees. 79. As indicated earlier (para. 67) the financieras' equity invest- ments have been mainly in existing' enterprises, generally with sound manage- ment and favorable prospects. However, their investment portfolios contain a large proportion of participations in new enterprises which have still to prove themselves. Of course, the financieras' equity portfolio must also be viewed from the point of view of the financieras' primary function; namely, to promote and develop new industrial activities, in which their role has been important. 80. There is no market value for the financieras' shares. Only those of Caldas and Nacional are listed on the stock exchanges, but they are not actively traded, and sales of shares of the other financieras are infrequent and prices often reflect buying or,selling objectives rather than real value. At the end of December 1967 the unadjusted book values per share (before divi- dends) were as follows: Colombiana Col$ 16.27, Nacional Col$ 14.03, Valle Col$ 14.03 and Norte Col$ 13.60, per share of Col$ 10.00 par values, and Caldas Col$ 134.29 per share Col$ 100.00 par value. However, in Colombia, dividends paid, rather than the value of equity, largely determine the prices of shares; and in all cases, dividend yields are still low. Moreover, as has already been noted, the erosion of the peso has been such that prospective capital gains and' past dividends would not make up for the depreciation in - 26 - value of local currency, especially for foreign investors. None of the finan- cieras has yet solved the problem of maintaining the value of its equity in an inflationary economy. Perhaps the recent changes in the relationship between share price and cost-of-living trends referred to in paragraph 18 will improve the situation. More likely, however, the value of their shares will rise only over the long run, which suggests that they will be attractive for the time being only to investors whose objectives include something more than direct financial gain. Evaluation 81. The performance of the individual five financieras over the past two years may be summarized as follows: Colombiana has in general performed creditably. It is the oldest and largest of the five financieras. Its total resources on December 31, - 1967 were 47% larger than' Nacional's and the amount of its loans and invest- ments outstanding 92% greater. Of the five financieras Colombiana is the one where investments are most widely distributed geographically: most of its loan portfolio is in enterprises located outside its home state. It has a good staff and the quality of its appraisals is satisfactory. Notwith- standing, it is faced with problems, in both organization and portfolio.- It has had difficulties with staff and procedures. Several enterprises, in- cluding some in which Colombiana has a large exposure, are in difficulty. However, its new President, a seasoned and experienced banker, is dealing with the organizational problems, and should be able to solve them. The volume of principal in arrears which on June 30, 1967 represented 11% of total loans then outstanding was reduced by 90% during the second semester to an accept- able level of slightly over 1% at year-end 1967. The portfolio problem is less tractable. While the equity;base is sufficient to reassure creditorsi it is clear that reserves and provisions should be closely watched. Colom- biana's profitability has been adequate and the company in general has ob- served a prudent cash dividend policy. A sizable cash dividend was paid in 1967 (the first time since 1964), a decision which seemed imprudent in light of the organizational and portfolio problems which became apparent at that time. However, the situation was corrected in 1968 when a stock dividend was declared in lieu of cash, and during negotiations, the company has agreed to set aside at least 40% of profits before considering a cash dividend. The soundest of the five financieras appears to be Nacional. It is the second in resources, and loans and investments outstanding. The manage- ment is conservative. Its staff is competent and effective, and the quality of its project appraisals is satisfactory. Its loan portfolio is sound and the incidence of arrears is negligible. Its equity investments, relatively small in relation to the total portfolio, have been well selected and produce a high rate of return. Nacional's net income as percentage of average equity has been the highest of the financieras, a fact which has enabled it to pay cash dividends since 1963. - 27 - Caldas is making a significant contribution toward industrial diversificatio in the Mani.zales region, hitherto largely confined to coffee. As indicated earlier, it has found it difficult to retain suf- ficient and competent staff which, to a large measure, has been respon- sible for the poor quality of its appraisals until early 1967. However, management has taken steps to improve the number and quality of the staff, and appraisals have improved significantly during the administration of Loan 451 CO. A considerable amount of Caldas' energies has been devoted to promotional activities, more than that of other Colombian financieras. One result has been that an unusually large number of its equity invest- ment is not yet operational, and that its equity portfolio yields rela- tively little. A high level of arrears a year ago, which has since been brought down to a reasonable size, and other problems, persuaded the com- pany to go a little more slowly in this regard. The presence of an IFC director on Caldas' Board has helped stimulate some of the recent improve- ment both in Caldas' situation and in its relations with the World Bank group. Regarding dividends, since 1966 Caldas has pursued the policy of paying primarily stock dividends; cash dividends have been minimal. Valle's performance to date has been satisfactory. It shows the greatest relative gain in volume of business during the period 1966-67 as measured by increment in total assets; its growth of 84% in total assets compares favorably with gains during the same period of 69% by Norte, 59% by Caldas, 9% by Nacional and less than 1% by Colambiana. This impressive increase in total business was achieved without comparable increases in costs. One result has been the net, after-tax income, as a percentage of average equity, was second only to Nacional's during 1967. While Valle had the second largest proportion of equity investments in enterprises which are not in operation, the impact on its over-all business is not serious, since its total exposure in equities amounts to only 14% of its portfolio. However, the quality of these investments still needs testing. The loan portfolio is more solid as evidenced by a sustained low volume of arrears and negligible write-offs. In March 1967 the company declared a 12% divi- dend; 95% of this dividend was taken in shares. In 1968, an 8% dividend was declared. During negotiations Valle reaffirmed its policy of allocat- ing an appropriate portion of funds to reserves each year. Norte is the newest and smallest of the five financieras. It succeeded in quickly building up a well-knit staff which has resulted in good project appraisals and follow-up procedures. Norte's management is sound and has followed a cautious policy with respect to equity invest- ments. The proportion of these investments to total loan and equity port- folios (11%) is the lowest for the financieras and, while 52% of total equity investments by Norte was in the shares of companies promoted by Norte itself, only 6% of its investments were in companies not yet in operation at the end of 1967. Although the volume of arrears was low at December 31, 1967 (1.9% of total loans then outstanding), the total value of the loans outstanding to clients in arrears was 10% of its loan port- folio, the highest percentage for the five financieras. While Norte's profitability was the second lowest of the financieras during 1967, it is expected to improve as its total volume of business increases and admini- strative costs remain fairly constant. - 28 - Economic Impact 82. The financieras have established their position in the Colombian economy. They have concentrated their lending and investment activities in the dynamic sectors of the economy so that their importance is greater than the volume of resources at their disposal would suggest. They have tapped sources of capital that might not otherwise have become available to the Colombian economy'and utilized this capital creatively in promoting enterprises that without this timely assistance might not have been organ- ized at all. They are serving as a conduit for transplanting modern meth- ods of financing and of evaluating financial opportunities from the indus- trial economies in which they were developed, and in so doing they have had an impact on the economy out of proportion to their actual size. Because statistics are inadequate, this impact is hard to quantify. It will become more apparent in future years as more of the ventures promoted by bhe finan- cieras reach profitable operation and begin to make their own contribution to industrial growth. The financieras estimate that up to June 1967, their loans and investments had helped create industrial employment opportunities for more than,13,000 workers. IV. UTILIZATION OF FIRST BANK LOAN 83. The Bank Loan signed on May 31, 1966, became effective on October 13, 1966. During the intervening period IFC informally received project appraisals from the financieras and reviewed them pending the effectiveness of the Loan and official receipt from the Banco de la Repu- blica. The object of this work was to take advantage of the interval to give guidance in project appraisals to the staffs of the financieras and to build up a backlog of approved projects, so that, once the loan became effective, it would be committed rapidly. Moreover, IFC staff visited each of the financieras for several days, immediately after the loan was signed, in order to discuss appraisal techniques with the staffs. In a larger number of cases questions were raised which resulted in reappraisals of projects, or their withdrawal or rejection. These preliminary appraisals afforded useful "dry runs" for the financieras. 84. Projects were examined, and the proceeds of the loan credited on a first-come-first-served basis. There was no prior allotment of the loan among the five financieras, because it was felt that such allotment would work to the disadvantage,of the more active and efficient institutions. The result, however, may have been to induce the financieras to submit projects before they were adequately appraised, in the hope that, by doing so, funds for them would somehow be earmarked. Certainly, the Bank staff was faced with a flood of projects, a large portion of which (especially at first) had to be rejected or questioned. A total of some 74 projects were reviewed between August 29, 1966 and September 1, 1967, some several times, as new information or revisions1were received. Some form of prior allotment among - 29 - the companies would have allowed them to proceed at a more deliberate pace, and to spend more time on selecting the more desirable projects from the large numLer of applications they received. 85. The loan was virtually commited by the end of October 1967. Use of its proceeds by the financieras is shown below as of March 31, 1968: Projects Credited to the Loan Account I(in US$ '000) Projects, Projects Total above the free limit belbw the free limit IO. Amount % I. Amount % . Amount % Colombiana 9 5,684.1 27 15 2,324.1 57 24 8,008.2 32 Nacional 9 6,682.9 32 10 1,292.1 31 19 4,975.6 32 Caldas 8 2,445.5 12 9 286.9 7 17 2,732.4 11 Valle 7. 3,036.8 15 1 48.2 1 8 3,085.0 13 Norte 10 2,916.7 1 )4 174.7 4 1. 3,091.4 12 43 20,766.0 100 39 4,126.6 100 821/24,892.6 100 The only unexpected aspect of this distribution is the relatively small amount credited to the account of Caldas, which is the third largest of the financieras. 86. Annex 4 shows a composite result of the utilization of the Bank loan by size of project, 'economic, activity and duration. The largest num- ber of projects credited were for amounts between US$100,000 and US$250,000 but they varied in size from less than US$50,000 to more than US$1 million. About 68.7% of the total amount of the loan was utilized for projects of more than US$500,000. More than a quarter of the loan (27.4%) went to projects in the textile and clothing sector; followed by food, beverages and tobacco (14.1%), agriculture (10.8/0), non-metallic minerals (9,3%), chemicals (9.1%) and metals and engineering (6.6/%). This reflects the diversification of the operations of the financieras. On the other hand, the Bank loan was used for longer-term operations than was generally the case. Only 2.5% of the total amount had been granted for'loans of 5 years' duration (the minimum allowed under the Loan Contract),while 63.0W had durations of between 5 and 10 years, and 34.6% between 10 and 15 years. The Bank loan iindoiibtedly facilitated the financieras' efforts to extend the average maturities of their loan portfolios. 1/ Projects shared by two or more financieras have been counted as indi- vidual projects for the participation of each financiera in the project. The actual number of projects credited is 72. - 30 - 87. The most unusual aspect of the use of the first loan was the speed with which it was credited. Expectations were that the financieras would be able 'to commit more than $25 million in foreign exchange over a two-year period. But commitment of the loan in 18 months, against a back- ground of economic recession was startling. The speed with which the loan was committed was the more surprising, if one considers that the financie- ras had thought of working capital, rather than capital to finance fixed assets, as the most pressing need of Colombian industry and had warned that a loan limited to financing payments for imports would not move rapidly. Part of the explanation for the speed no doubt lies in the prepa- rations made before the loan became effective and in the unexpected effect of the first-some-first-served principle (see para. 84 above). But another factor which must have weighed heavily was the pricing of the capital. The Banco de la Republica charged 3% in addition to the World Bank's inter- est rate (a total of 9%), of which a large portion was designed to cover the exchange risk. The relending rate of the financieras was supposed to conform to market rates, in this case the same rate charged for PIF funds, and 12% to 14-1/2% uas cheap for financing capital imports without an exchange risk. This fact was implicitly acknowledged in mid-1967, when the Government, the Banco de la Republica and the financieras agreed that 80 would be an appropriate charge for covering the exchange risk under the proposed second loan. It is thus difficult to avoid the conclusion that entrepreneurs might have sought to borrow from the proceeds of the Bank loan in part at least as :a hedge against inflation and devaluation with resulting uneconomic or unnecessary investment. No amount of careful screening of projects could completely eliminate such cases. Particular care needs to be taken, in future, to assure adequate pricing in relending the proceeds of Bank loans. 88. During negotiation of the first Bank loan, there was much discus- sion of the role of the Banco de la Republica in screening projects submitted for financing from the proceeds of the loan. It was understood that the Banco de la Republica would limit its review to considerations of economic priority, but,would refrain ffrom looking into the projects' business merits. However, with the worsening of the general economic and exchange situations of Colombia, the extent of official examination was broadened. The Banco de la Republica became increasingly concerned with managing effectively the over-all exchange resources of Colombia and occasionally diverted projects originally proposed for Bank financing to other sources of capital to which no objection could be raised as long as price and terms were similar. Also, the Superintendencia del Comercio Exterior, responsible for import licensing, went deeply into the merits of individual proposals. One result was delay in the submission of projects; another was an increasing examination of the business aspects of projects. In judging an investment proposal, it is not always easy to draw a clear line between general economic and specific business aspects. During negotiation of the new loan, the Bank, while appre- ciating the objective of'the Government's more careful review of the economic aspects of projects, insisted that they steer clear of business decisions. - 31 - The representative of Banco de la Republica assured the Bank that, while administrative delays occurred at first, they were in due course elimi- nated and that the processing of sub-projects proceeded smoothly. These views were shared by the representatives of the five financieras. In addition, Banco de la Republica stated that it would expect the Bank promptly to raise the question if it considered that the review of sub- projects went beyond the limits prescribed in the loan documents. 89. Ekperience with the first loan suggests that certain changes be made in the terms of a second. a. The first-come-first-served principle used in the allocation of Loan 451 CO would create problems in dealing with a loan as small as US$12.5 million. Prior allocation among the financieras would assure each financiera a proportion of the loan, which it could then allocate to its projects after more delib- erate study and careful choice of the best among them. This matter was discussed with the financieras, which were agreeable to a prior allocation and, unable to do so themselves, were prepared to accept IFC's recommendation. IFC proposed $3.75 million each, for Colombiana:and Nacional, and an equal division of the remaining $5.0 million among the other three finan- cieras, a division which approximates the actual uti- lization of the first loan. All five financieras accepted this allocation. b. During negotiations it was agreed that projects exceeding the equivalent of US$25Q 000 would require Bank approval for Colombiana and Nacional, and pro- jects exceeding the equivalent of US$100,000 will need Bank approval before crediting to the loan account for Caldas, Valle and Norte. The aggregate total for projects not needing the Bank's approval was agreed as follows: US$1.5 million each, for Colombiana and Nacional, and US$750,000 each, for the other three financieras. c. As regards the interest rate at which the proceeds of the loan would be lent to its ultimate benefi- aries, the 'Government, the Banco de la Republica and the financieras agreed in maid-1967 that the Banco de la Republica would charge a maximum of 1% for administration and 81% to guarantee the exchange risk; that the financieras would require a minimum - 32 - spread of 3%; finally, that the ultimate borrower would have the option of taking the exchange risk or of paying the 8% to have it covered. In later discussions with the financieras they affirmed that they could live with the 3% spread; that 8% was an appropriate price for the exchange risk; that the resulting total relending rate of 18-1/4% (assuming a Bank rate of 6-1/4%), without risk of devaluation, was not low under current conditions, would be felt by the borrowers and would not stimulate unproduc- tive borrowing. Nevertheless, it was felt by the financieras 'that there was little chance any borrower would elect to take the exchange risk at a price 8% lower. During negotiations the repre- sentatives of the Government and the Banco de la Republica stated that the Government's policy was at present that the cost to the ultimate borrower should not be more than 18% per annum. Banco de la Republica agreed to absorb the resulting excess of 1/4% (assuming the present Bank rate of 6-1/41), by an equal reduction of the 1% maximum for admin- istrative expenses. In case the Bank rate is increased further, the Banco de la Republica and the Colombian Government will reconsider the pre- sent policy with a view to increasing the interest rate to the ultimate borrower. d. The more frequent addition of equity features to loans made by the financieras has also been dis- cussed with them. Doing so would enable the fi- nancieras to build up a portfolio of securities which could later be s6ld to the public, in accord- ance with their corporate objectives. It would also provide a' possibility for increasing the returns to the financieras beyond the minimum 3% they have agreed with the Government to charge the ultimate,borrower. Given the present economic climate of the country, this would be a more pru- dent approach to participating in the equity of companies than the direct purchase of shares. The financieras have agreed with this view and, more- over, feel that, in the present environment of capital shortage, equity features will be more acceptable than they have been previously. Dur- ing negotiations the financieras agreed to change their policy statements by stating that they would add equity features to loans whenever possible. - 33 - V. PROSPECTS AND CREIETWORTHINESS Prospects 90. Annexes 5 to 9 contain detailed balance sheets and statements of income and retained earnings for each financiera as of December 31, 1965, 1966 and 1967 (actual-/) and December 31, 1968 and 1969 (projected). 91. Projections are based on data supplied by the financieras and revised by IFC to incorporate changes suggested at the time of negotiations. In view of the present general economic situation, it would not be fruitful to attempt more refined projections (detailed forecasts of demands and resources). 92. It is particularly difficult at this time to forecast the level of private investment in Colombia, the corresponding demand for capital and, thus, the prospective business of the financieras. Although signifi- cant improvements have been observed recently in the over-all investment climate of the country, private confidence has not been fully restored yet. This is due mainly to the fact that the Government is still shaping its general economic policy, including the implementation of a new exchange system, the full impact of which is not easy to assess. 93. The following table summarizes the projected changes in the port- folio, as shown,in the balance sheets for the period 1968-1969, compared with actual changes during the period 1966-1967 (in Col$ million) (decreases are shown in parenthesis). Loans Equity Total Loans In Pesos In foreign Ex. Investments & Investments 196IT8-7196-- 196d- 1966- 1968- 1966 1968- 1966 1969 1967 1969 1967 1969 1967 1969 1967 Colombiana 302.4 109.1 ( 8.7) ( 98.2) 26.8 39.9 320.5 50.8 Nacional 239.1 68.5 5.7 ( 54.3) 19.3 lo.o 264.1 24.2 Caldas 217.4 56.9 2.9 14.5 39.6 35.4 259.9 106.8 Valle 192.9 68.0 144.2 8.9 49.3 7.3 386.4 84.2 Norte 76.3 29.1 9.7 7.4 9.8 4.1 95.8 Lo.6 Total 1,028.1 331.6 153.8 (121.7) 144.8 96.7 1,326.7 306.6 1/ All are based on audit report figures, with the exception of Caldas' and Nacional's for the year 1967. - 34 - During the earlier period, loan and investment portfolios increased by Col$ 306.6 million. A larger expansion of the financieras' business was no doubt hindered in part by shortage of funds, particularly of resources suitable for medium- and long-term financing. While increased avail- ability of suitable funds may be expected in the near future, the finan- cieras' projections of loans and investments (Col$ 1,326.7 million in 1968-69, more than four times the increases registered over the period 1966-67) appear optimistic, given the continued uncertainties of the future, the unclear prospects in the industrial sector and the volume of funds likely to be available in the next two years. 94. Resources are also difficult to forecast. The following table, however, summarizes the resources expected to be utilized by the five financieras at the end of the forecast period (projected balance sheet figures), compared with actual resources utilized at the end of 1967 (in Col$ million): Dec.31,1967 Dec.31,1969 Increase % of (Decrease) Total Equity Share capital 349.1 412.8 63.7 8 Reserves and surplus 162.0 246.0 84.0 10 Total equity 51i.1 658.8 147.7 18 Loans BR credit line 188.1 279.1 91.0 11 BR-PIF 267.2 609.0 341.8 41 IBRD 1/ 89.0 521.8 432.8 52 Foreign banis 718.1 436.8 (281.3) (34) Inter-American Development Bank (IDB) 3.3 1.7 (1.6) nil Total loans 1,265.7 1,848.4 582.7 70 Bonds 215.2 283.7 68.5 8 Deposits 44.8 72.4 27.6 4 Grand Total 2,036.8 2,863.3 826.5 100 Of the total net increase in resources expected by the financieras (Col$ 826.5 million), 70% is to come from net increases in loans, 18% from gains in equity and the remaining 14% from increases in peso bonds and deposits. The main sources of new loan funds are the existing and proposed Bank loans, which alone represent 52% of the total increase. 1/ Amounts shown correspond to actual (December 31, 1967) and anticipated (December 31, 1969) disbursements. The amount of Col$ 521.8 million shown for year-end 1969 represents 85.6% drawdown of the US$ 25 million Loan 451-CO plus the proposed US$ 12.5 million second Bank loan to the financieras. - .35 - While a significant increase in funds from the Banco de la Republica is forecast based 'on current negotiations between this institution and the financieras, increased funds from this source are expected to come mainly from PIF. This anticipation is based on discussions held between the Colombian authorities, Banco de la Republica and members of the consult- ative group following their meetings in Paris in June 1967. Discussions have been held,with Societe Generale de Banque (Belgium), Banque de Paris et des Pays-Bas (France), ,Union Bank (Switzerland), Banca Nazionale del Lavoro (Italy), Bank of London and South America (United Kingdom), Banco Urquijo (Spain), Svenska Handelsbanken (Sweden), Kreditanstalt fur Wiederaufbau (Germany) and the authorities of Japan, Denmark and the United States.' The size of bond issues will depend on the Government's general policy'toward expansion of the private sector, which at present appears to be favorable; it is expected that flotations to finance pro- jects in the public sector will not curtail the placing of private bond issues. 95. The proposed size of the Bank loan leaves little doubt of the ability of the financieras to put it to use in a relatively short time. The financieras themselves have forecast the foreign exchange require- ments of their business, after exhaustion of the first Bank loan, at about US$35 million. This estimate is based on projects at present under study by the financieras as well as projects to be received in the near future. Taking into consideration the still uncertain outlook for the replenishment of PIF and that financing under the credit lines with for- eign commercial banks is of a short-term nature, the financieras should be able to use long-term foreign exchange resources well in excess of the proposed US$ 12.5 million within the next one-and-a-half year period. Creditworthiness 96. As indicated in Para. 81, the financieras have performed credit- ably: their loans and equity portfolios are, in general, of a satisfac- tory quality and protected by equity; their profitability record is acceptable, particularly considering recent adverse economic circumstances, and when compared with those of other development finance companies which the World Bank group has helped to finance. 97. The financieras' prospects of business appear favorable. Their total debt-to-equity ratios which, up to December 31, 1967, have remained low, are projected to remain, with the exception of Norte and Valle, within the limits provided in their statements of policy. Norte shows pro- jected total indebtedness of 4.1 to 1 in 1969 and Valle of 4.1 to 1 in 1968 and 4.6 to 1 in 1969. Both these,financieras should be able to manage their affairs in such a manner as to conform to their contractual debt limitations. Profitability of the five financieras also is expected to increase satisfactorily. At the end of 1969, pretax profit as a percentage of average equity will have increased as follows: - 36 - 1967 1969 For Colombiana - from 11.3 to 14.8 For Nacional - from 17.1 to 17.7 For Caldas - from 12.1 to 14.8 For Valle - from 19.7 to 31.7 For Norte - from 13.4 to 19.4 Although the financieras' own estimates of future business may be on the optimistic side, the projected interest coverage appears ample, as shown in the following table: , 1965 1966 1967 1968 1969 (Actual) (Actual) (Actual) Projected Projected Colombiana 3.3 2.5 2.1 2.0 1.7 Nacional 2.3 1.8 1.7 1.7 1.8 Caldas 4.0 3.5 3.0 2.2 2.1 Valle 2.6 2.3 2.5 1.8 1.7 Norte 3.4 3.0 2.5 2.6 2.6 VI. CONCLUSIONS AND RECOMMENDATIONS 98. The performance of the five financieras has been generally satisfactory. The quality of their work has shown steady improvement. They are playing an increasingly important role in the industrial develop- ment of Colombia as sources of medium- and long-term capital, as promoters of new enterprises and as disseminators of modern methods of financial management; they have made,a substantial impact on industrial development. Their appraisal methods have improved steadily, particularly during the period of cornitment of the Bank loan. Their profits are good, the results of seizing every opportunity for useful revenue-earning business. But rates of profitability have failed to keep ahead of the cost-of- living and of deterioration of the peso; the shares of the financieras are thus relatively unattractive both to Colombian and foreign investors. 99. The financieras have been adversely affected by Colombia's foreign exchange crisis and by credit restrictions and other actions designed to strengthen Colombia's economic situation. This has resulted, in the case of some financieras, in clients in trouble, lower profits on equity investments and a generally more difficult investment environment. The impact has differed, depending on policies and portfolio. In general, the companies most heavily invested in equities are the most seriously affected. Despite these adverse factors all the financieras are basically creditworthy, taking into account the weaknesses in their portfolios com- pared with their equity and their earning power. - 37 - 100. Much of the difficulty of the financieras stems from their vigor in promotion (one of their principal objectives), and the fact that their main investments are in naw companies which they have promoted. In Colombia's environment, promotion means equity investment, and that means being locked, for a-significant period of time, into enterprises which are not earning. 101. The environment in which the financieras operate has changed. Apart from the'general economic and financial problems of the country, the number of financieras has grown and they face the prospects of com- petition from a revitalized government-owned development finance company. 102. The financieras', prospects depend partly on the Government's general econonic policy and particularly on its success in holding down the rate of inflation. Measures taken over the past year reflect a determined effort to deal ,with inflation and to bring the balance of payments under control, and have achieved some success. Business confi- dence appears improved. Nevertheless, it is impossible to predict with assurance the volume of business the financieras could do in the near future, even if their resources were unlimited. 103. Although business forecasts cannot be accurately made, the financieras could certainly commit foreign exchange resources in the coming year in excess of the US$ 12.5 million that the Bank contemplates lending at this time. 104. The financieras are suitable recipients for a new Bank loan. Such a loan would help ensure continued improvement of their operations and help strengthen their role in the economic development of Colombia. 105. The loan would be made to Banco de la Republica. Its proceeds would be made available to the five Colombian financieras which were recipients of the first loan for use in accordance with their statutes and stated policies. 106. The loan would have, in general, terms and conditions similar to the first, except in the following respects: (a) The interest rate and amortization schedule would be flexible, as in the case of other loans to development finance companies. (b) The loan would be allocated in advance among the five financieras., During negotiations, allocation was agreed as follows: 30% for each, Colombiana and Nacional, and 13-1/3% for each, Caldas, Valle and Norte. (c) As already agreed between the Banco de la Republica and the financieras, Banco de la Republica would charge the financieras interest at a rate equal to the sum of the rate applicable to the Bank loan plus a maximum of 1% - 38 - to cover administrative costs. The financieras would charge the ultimate borrower a minimum of 3% p.a. to cover their costs, risks and profits. Borrowers would have the option of taking the exchange risk; if they did not wish to take it, the Banco de la Republica would do so at a cost of 8%. (d) The limit for projects not needing the Bank's prior approval would' be set as follows: US$ 250,000 each, for Colombiana and Nacional, to an aggregate total of US$ 1.5 million each; US$ 100,000 for the other financieras, to an aggregate total of US$ 750,000 each. 107. Agreements were reached during negotiations with the repre- sentatives of Banco de la Republica and the financieras on the following matters: (a) The financieras agreed to add equity features to their loans whenever possible. (b) The Government and Banco de la Republica will continue to restrict their review of sub-projects to matters of economic priority. In case that interferences or delays are observed during commitment of the loan, the matter will be promptly called to the attention of the Government. (c) The financieras agreed on strengthening their engineering and follow-up services and their market analysis. (d) The financieras will give particular attention to whether their clients have adequate supplies of working capital and of the peso requirements of their investment projects. IFC/DFC April 22, 1968 BREAKDDWN OF OWNERSHIP OF THE FIVE FINANCIERAS (As of December 31, 1967 by number of shareholders and % of ownership) COMIANA NACIONAL CAIDAS VALLE NDRTE No. % No. % No. No. % No. I. Local Financial Institutions .5 41.3 7 22.6 10 20.4 2 21.2 11 20.9 Governmental Institutions -1 4.3 - 1 14.5- 3 -1.5 -1 12.0- -1 8.3 Others 170 8.6 n.a. 33.1 2 53.3 150 48.8 5 44.2 Sub-totals 176 54.2 n.a. 60.2 226 75.2 153 82.0 546 73.4 II. Foreign 15 27.3 3 27.2 4 13.2 2 18.0 2 20.3 III. Foreign Controlled 3 3.2 2 0.9 - - - - 5 6.3 IV. IFC 1 15.3 1 11.7 1 11.6 - TOTAL 195 100.0 n.a. 100.0 231 100.0 155 100.0 553 100.0 Companies with 50% or more of their share capital owned by foreign partners. IFC/DFC April 22, 1968 ANNEX 2 Page 1 SUMMARY OF THE STATEMENTS OF POLICIES AND PROCEDURES OF THE FIVE FINANCIERAS 1. As stated in paragraph 59 of the report, the statements of operating policies for the five financieras contain most of the ele- ments guiding the affairs of private development finance companies. 2. The main provisions may be summarized as follows: (1) The corporations will invest principally in manufacturing enterprises although not to the exclusion of agriculture, cattle raising, min- ing, transportation, hotel and tourist enter- prises and others authorized by Colombian.leg- islation. Except Valle the other four finan- cieras are excluded from being engaged in real estate or housing operations. (2) The corporations will use a progressively larger proportion of their resources for equity invest- ments and for loans with final maturity of five years or more, especially loans with equity fea- tures. (3) The corporations will finance, invest in or guar- antee operations only of privately controlled enter- prises. In the case of Norte, as an exception, the corporation will finance, invest or guarantee opera- tions on enterprises in which the Government has a controlling interest if the result of such actions facilitates private sector production. For such cases, a unanimous vote of the Board is required. () The corporations will conduct their operations so as to assist in the growth on the capital market in Colombia and to improve facilities for market- ing shares and securities. ($) The corporations will pursue a prudent dividend policy that will enable them to provide sharehold- ers with an adequate return of their investments, while at the same ti-ie ensuring that their reserves grow at a reasonable rate. The corporations will annually appropriate a portion of their net income to reserves. ANNEX 2 Page 2 (6) Colombiana and Nacional will not incur, assume or guarantee any debt if at the time, or as a result thereof, the total amount of debt incurred, assumed or guaranteed by the corporations and then outstand- ing, exceeds an amount equal to five times the aggre- gate of the corporations' equity. For Caldas, Norte and Valle the amount of debt incurred, assumed or guaranteed is limited to four times the aggregate of the corporations' equity. (7) Barring exceptional circumstances or circumstances of a temporary nature, the corporations' equity par- ticipation in an individual enterprise will not be so great as to give it primary responsibility for management of the enterprise. This means that the corporations' participation will normally not exceed 25% of the enterprise4s subscribed capital. (8) The total amount of the corporations' equity invest- ments will not exceed the value of the corporations' net worth. (9) The maturities of the corporations' assets will cor- respond with or be shorter than the maturities of its liabilities. (10) The corporations will protect themselves adequately against foreign exchange risks arising out of their operations. (11) The corporations will place constant emphasis on enhancing and strengthening technical, commercial and financial managements of enterprises that they finance by furnishing them the advice and assistance either of,their own staff or suitably qualified con- sultants or experts. (12)' The corporations will build and strengthen their managements and staffs so as to achieve well- balanced organizations capable of assuring proper appraisal of projects, as well as proper follow-up after loans and equity investments have been made. These staffs will include specialists in engineering and in financial and economic analysis. (13) The corporations will retain independent public accountants to conduct an annual audit of their books and accounts. ANNE 2 Page 3 (1)) In the case of Caldas, Colombiana and Nacional, the corporations' managements will submit to the Boards of Directors monthly reports includ- ing (a) investigation of new projects; (b) pro- gress of investments already made; (c) financial statements;- (d) arrears; (e) other matters of importance to the financial positions and opera- tions of the corporations. (15) Norte will not invest less than Col$ 100,000 in a single operation. For Caldas and Valle, this limit is Cpl$ 300,000. Colombiana and Nacional have no minimum size of operation. IFC/DFC April 22, 1968 CORPORACION FINLNCIERA CDIDMBIANh Sluity Investments as of December 31, 1967 Investment . Estimated Dividends received at Cost A of Share Vali of Investment in 1967 Companes in Uperation Actii - (in Col$ million) Capital (in Col$ million) (in Col thousani) Observations Abo Col ianos S.A. Chemical 35.1 35.o 23. - Acciulated losses, but had profit in 1967 EL brado .A. Agriculture 12.0 48.0 13255 Operating profitably Industria Ganadera Colombiana S.A. Livestock 16.9 40.0 21.71/ 1,2 Operating profitably Nylon Colombiana S.A. Chemical 11.1 40.0 .1. - aeriencing financial difficulties Petroquiinca Colombiana S.A. Chemical 3.9 13.0 3. - Operating at a loss Financiera Centroamericana Finance 6.o 60.0 9. - Operating profitably Hilanderia del Fonce S.A. Tetiles 1.2 34,0 2.0w 240 Operating profitably Trefilco S.A. Metals and -engineering 0.5 - 7.0- 0.f 163 -OperatiEg profitably V. Borros Industrias El Fraile S.A. Chemical 1.5 21.0 1.t - Operating profitably &..presa Colombiana de Cables S.A. Wires 0.7 15.0 1.f/1 69 Operating profitably idustrias Metalurgicas Apolo S.A. Metalurgie 2.0 1h.0 2.2W 275 Operating profitably rennessee Colombians S.A. MLning-Petrolem 4.3 3.0 6. - Carrying out drilling operations - future uncertain orjas do Colombia Farge 10.0 - Ewperiencing maket problems - outlook yet uncertain Sub-total 101.7 98.7 2,251 Non-perating Comnanies carrollo Agricola S.A. Agriculture 0.8 2.0 0.8 - In period of arganLsation Cales y Cosentos de Toluviejo S.A. Cament 32.7 71.0 30.O - Enpected to start operations in 1968. Eperiencing mrket and financial difficulties. Future uncertain Consorcio Pesquero Colombian, S.A. Fishing 0.1 - 0.2_/ - Under stuf4 Ingenio Risaralda S.A Sugar 5.0 2h.0 3.5V - In liquidation, estimated loss Col$ 1.5 million Gu cho El Sol Rabber products 0.5 5.0 0.51/ - In liquidation etalurgicas Larco S.A. Metalurgie 0.4 25.0 0.3T - In liquidation Metales y Baterias S.A. Car Batteries 1.4 40.0 0.fV - In liquidation Other Promoting Companies ..1_ -m3 - Under study Sub-total l 3A -A. Total 132.- 225 1/ Unadjusted book value. 2/ At cost. 3/ Stock dividend. 4/ Book value adjusted for deferred charges (organization and pre-operating expenses). 1FC - DECD April 22,1966 CORURACION FINAICIERA NaCIONML E4uity Investmenta as of December 31, 1967 Investmnt Estimated Dividends received at cost % of Share Valne of Investeent in 1967 Companies in Operation