PHILIPPINE SAVINGS BANK (A banking corporation organized and existing under Philippine Laws) Php2,000,000,000.00 10.00% Subordinated Notes Due 2016 Callable with Step-Up in 2011 Issue Price 100.00% Philippine Savings Bank (the ‘‘Bank’’ or the ‘‘Issuer’’) intends to issue up to Php2,000,000,000.00 worth of 10.00% Unsecured Subordinated Notes due 2016, callable with step up in 2011 (the ‘‘Notes’’). From and including 27 January 2006 to but excluding 27 January 2011, the Notes will bear interest at the rate of 10.00% per annum and shall be payable quarterly in arrears every 27th of January, April, July, and October of each year, commencing 27 April 2006. Unless the Notes are previously redeemed, the interest rate from and including 27 January 2011 to but excluding 27 January 2016 will be reset at the equivalent of the five-year MART1 FXTN (as of Reset Date) multiplied by 80.00%, plus a spread of 4.2815% per annum, and such stepped-up interest shall be payable quarterly in arrears every 27th of January, April, July, and October of each year, commencing 27 April 2011. The Notes will mature on 27 January 2016 provided that the Notes are not previously redeemed. Subject to satisfaction of certain regulatory approval requirements, the Bank may, one business day after 27 January 2011, redeem all and not less than all of the outstanding Notes, at a redemption price equal to the face value of the Notes together with accrued and unpaid interest based on the Interest Rate thereon. See Terms and Conditions of the Notes. The Notes will constitute direct, unconditional, unsecured and subordinated obligations of the Bank, and will, at all times, rank pari passu and without any preference among themselves and at least equally with all other present and future unsecured and subordinated obligations of the Bank. See Terms and Conditions of the Notes. The Notes have been rated PRS Aa plus by the Philippine Rating Services Corporation (PhilRatings). This rating will relate to the timely payment of interest on the Notes and the full payment of principal of the Notes on or before 27 January 2016. A rating is not a recommendation to buy, sell or hold securities and may be subject to revision, suspension or withdrawal at any time by the rating agency concerned. An application for the issuance of the Notes has been filed with the Bangko Sentral ng Pilipinas (the ‘‘BSP’’) and was approved on 28 December 2005. The BSP takes no responsibility for the correctness of any of the statements made or opinions or reports contained in this Offering Circular. See ‘‘Investment Considerations’’ beginning on page 13 for a discussion of certain factors to be considered in connection with an investment in the Notes. The Notes will be registered in scripless form and in minimum denomination of Php500,000.00 and in increments of Php100,000.00. The Notes will be represented by a Master Note, which will be deposited with the Registry. It is intended that, upon issuance, the Notes will be immobilized and lodged in the Registry. However, a Registry Confirmation will be issued by the Registry in favor of the holders of the Notes in accordance with the regulations of the BSP. Once lodged, the Notes will be eligible for electronic book-entry transfers in the Registry Book without the issuance of other evidences of certificates, and any sale, transfer, or conveyance of the Notes shall be coursed through a Market Maker or the fixed income exchange, as the case may be. See Limitations on Transfers. When the Philippine Dealing & Exchange Corporation (‘‘PDEx’’) becomes operational as the fixed-income exchange for these Notes, the Issuer intends to list the Notes in the PDEx. Upon listing of the Notes in the PDEx, the services of the Market Maker shall cease and secondary trading on the Notes will henceforth be conducted in the PDEx. Lead Manager and Selling Agent Selling Agent Limited Selling Agent MULTINATIONAL INVESTMENT BANCORPORATION Offering Circular 24 January 2006 The date of this Offering Circular is 24 January 2006. The BSP has, on 28 December 2005, approved the issuance and sale of the Notes. The Bank confirms that this Offering Circular contains all information with respect to the Bank and the Notes which are material in the context of the issue and offering of the Notes, that the information contained herein are true and accurate in all material respects, are not misleading, that the opinions and intentions expressed herein are honestly held and have been reached after considering all relevant circumstances and are based on reasonable assumptions, that there are no other facts, the omission of which would, in the context of the issue and offering of the Notes, make this document as a whole or any of such information or the expression of any such opinions or intentions misleading in any material respect and that all reasonable inquiries have been made by the Bank to verify the accuracy of such information. The Bank accepts responsibility accordingly. In making an investment decision, the recipient of this document must rely on his own examination of the Bank and the terms of the offering of the Notes, including the merits and risks involved. By receiving this Offering Circular, the recipient acknowledges that (i) he has not relied on ING Bank, N.V., Manila Branch (‘‘ING Bank’’) (the ‘‘Lead Manager’’), Multinational Investment Bancorporation (‘‘MIB’’), or Philippine Savings Bank (collectively, the ‘‘Selling Agents’’) or any person affiliated with the Lead Manager or the Selling Agents in connection with his investigation of the accuracy of any information in this Offering Circular or his investment decision, and (ii) no person has been authorized to give any information or to make any representation concerning the Bank, or the Notes other than as contained in this Offering Circular and, if given or made, such information or representation should not be relied upon as having been made or authorized by the Bank or the Lead Manager. This Offering Circular contains forward looking statements that include, among others, statements concerning the Bank’s plans relating to (i) the expansion of its business and operations; (ii) the growth in its customer base and loan portfolio; (iii) the implementation of new information and other technologies; (iv) the ability to provide new products and services; and (v) the increase in its operational efficiencies, and other statements of expectation, belief, future plans and strategies, anticipated developments and other matters that are not historical facts and which may involve predictions of future circumstances. Investors are cautioned that these forward looking statements are subject to risks and uncertainties that could cause actual events or results to differ from those expressed or implied by the statements contained herein and no assurance can be given that the future results will be achieved. Actual events or results may differ materially as a result of the risks and uncertainties the Bank faces. Such risks and uncertainties include, but are not limited to (i) actions taken by the BSP, who is the regulator of the banking industry in the Philippines, and by the government of the Republic of the Philippines; (ii) actions taken by the Bank’s competitors; and (iii) general economic and political conditions in the Philippines. No representation or warranty, express or implied, is made by the Lead Manager or the Selling Agents as to the accuracy or completeness of the information contained in this Offering Circular. Neither the delivery of this Offering Circular nor the offer of Notes shall, under any circumstances, constitute a representation or create any implication that there has been no change, material or otherwise, in the condition, operations, or affairs of the Bank since the date of this Offering Circular or that any information contained herein is correct as of any date subsequent to the date hereof. None of the Bank, the Lead Manager or the Selling Agents, or any of their respective affiliates or representatives makes any representation to any purchaser of the Notes regarding the legality of an investment by such purchaser under any applicable laws. In addition, the recipient should not construe the contents of this Offering Circular as legal, business, tax, or investment advice. The recipient should be aware that he may be required to bear for an indefinite period the risks, financial, tax, or otherwise of an investment in the Notes. The recipient is encouraged to consult with his own advisers as to the legal, tax, business, financial, and other related aspects of a purchase of the Notes. This document does not constitute an offer or solicitation by anyone in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it is unlawful to make any such offer or solicitation. Each investor in the Notes must comply with all applicable laws and regulations in force in the jurisdiction in which it purchases or offers to purchase such Notes, and must obtain the necessary consent, approval, or permission for its purchase, or offer to purchase such Notes under the laws and regulations in force in any jurisdiction to which it is subject or in which it makes such purchase or offer, and neither the Bank nor the Lead Manager shall have any responsibility thereof. Interested investors should inform themselves as to the applicable legal requirements under the laws and regulations of the countries of their nationality, residence, or domicile and as to any relevant tax or foreign exchange control laws and regulations that may affect them. 3 TABLE OF CONTENTS TABLE OF CONTENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 OFFERING CIRCULAR SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 SELECTED FINANCIAL INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 INVESTMENT CONSIDERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 TERMS AND CONDITIONS OF THE NOTES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 CAPITALIZATION OF THE BANK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 DESCRIPTION OF THE BANK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 MANAGEMENT, EMPLOYEES, AND SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 THE PHILIPPINE BANKING INDUSTRY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 BANKING REGULATION AND SUPERVISION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 PHILIPPINE TAXATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 PROCEDURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 SUMMARY OF SIGNIFICANT DIFFERENCES BETWEEN INTERNATIONAL FINANCIAL REPORTING STANDARDS AND PHILIPPINE GENERALLY ACCEPTED ACCOUNTING PRINCIPLES . . . . . . . . . . . . . . . . . 91 Index to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-1 4 OFFERING CIRCULAR SUMMARY The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information found elsewhere in this Offering Circular and the agreements regarding the issuance, maintenance, servicing, trading and settlement of the Notes, including the Master Notes, the Trust Agreement, and the Registry and Paying Agency Agreement, and all amendments to each of them (the ‘‘Agreements’’). Defined terms in these Agreements shall have the same meaning when used in this Offering Circular. Prospective investors should read this entire Offering Circular and the Agreements fully and carefully, including Investment Considerations and the Bank’s audited financial statements and the related notes as well as the Bank’s unaudited financial statements. In case of any inconsistency between this summary and the more detailed information in this Offering Circular or the Agreements, then the more detailed portions and/or the Agreements, as the case may be, shall at all times prevail. Description of the Bank Philippine Savings Bank (the ‘‘Bank’’) was established on 30 June 1959 primarily to engage in savings and mortgage banking. The Bank has outpaced some of its key competitors and is, today, the country’s 2nd largest thrift bank in terms of assets. The Bank is the country’s first publicly listed thrift bank. The Bank caters mainly to the retail and consumer markets and offers a wide range of products and services such as deposits, loans, treasury, and trust. As of 30 September 2005, it has 150 branches. The Bank’s total assets stood at Php45.79 billion and Php53.24 billion as of 31 December 2004 and 30 September, 2005, respectively. Its total capital funds were at Php4.25 billion and Php5.01 billion as of 31 December 2004 and 30 September 2005, respectively. The Bank is 74.00%-owned by the Metropolitan Bank & Trust Company (‘‘Metrobank’’), a universal bank that provides a full range of banking and other financial services through its local and international branches. It is the country’s largest private domestic bank with assets of Php478.39 billion as of 30 September 2005 and has an extensive distribution network of over 562 branches nationwide. Strategy of the Bank The Bank’s vision is to be the country’s consumer and retail bank of choice. It also aims to become the country’s largest and most profitable thrift bank. It will continue to harness inherent synergies with Metrobank and, at the same time, differentiate itself and grow the business organically. Its objective is to stay ahead of the profitability curve, and narrow the gap of competition through sustained focus on core markets, customer acquisition programs and expanded customer coverage. These will be achieved through cross-selling better products and services, network expansion, and fostering a customer-centric performance oriented culture within the Bank. See Description of the Bank — Strategy of the Bank. The Offer The Bank intends to issue Php2,000,000,000.00 worth of 10.00% Unsecured Subordinated Notes due 2016 callable with step up in 2011 (the ‘‘Notes’’). From and including 27 January 2006 to but excluding 27 January 2011, the Notes will bear interest at the rate of 10.00% per annum and shall be payable quarterly in arrears every 27th of January, April, July, and October of each year, commencing 27 April 2006. Unless the Notes are previously redeemed, the interest rate from and including 27 January 2011 to but excluding 27 January 2016 will be reset at the equivalent of the five-year MART1 FXTN (as of Reset Date) multiplied by 80.00% plus a spread of 4.2815% per annum, and such stepped-up interest shall be payable quarterly in arrears every 27th of January, April, July, and October of each year, commencing 27 April 2011. The Notes will mature on 27 January 2016 provided that the Notes are not previously redeemed. See Terms and Conditions of the Notes. 5 Risks of Investing Prospective investors in the Notes should consider the current and immediate political and economic factors in the Philippines as a principal risk for investing. Political instability and threats to local and regional currencies may also influence the operations, growth, and profitability of the Bank. Of equal importance are the investment considerations regarding the Bank’s operations. Consideration must likewise be placed on the fact that the Notes are inter alia (i) unsecured; (ii) subordinated in right of payment to claims of all depositors and other creditors of the Bank, except those creditors that are expressly ranked equally with or junior to the Noteholders in right of payment; (iii) not subject to set-off; (iv) not eligible for collateral for any loan made by the Bank or any of its affiliates and (v) not insured by Philippine Deposit Insurance Corporation (‘‘PDIC’’). See Investment Considerations. Use of Proceeds The Issuer expects to raise some Php1.964 billion from the Offer after the deduction of fees, commissions, expenses and the documentary stamp tax. The net proceeds are to be used to raise Tier 2 capital to increase and strengthen the capital base of the Issuer. — See Terms and Conditions of the Notes. 6 SELECTED FINANCIAL INFORMATION The following table sets forth selected financial information of the Bank which has been derived from the audited financial statements of the Bank as of 31 December 2004, 2003, and 2002, including the notes thereto, included elsewhere in the document, and for the unaudited financial information of the Bank for the nine-month period ended 30 September 2005 and 2004. The unaudited interim financial statements are provided for reference purposes only and should not be relied upon by investors to provide the quality of information of the Bank associated with an audit. Neither the Bank nor the Lead Manager or Selling Agents make any representation regarding the sufficiency of the unaudited interim financial statements for an assessment of the statements of condition, income, and cashflows of the Bank. The Bank, in accordance with Philippine regulations and practice, publishes unaudited interim financial statements. The unaudited financial statements of the Bank are not necessarily indicative of their results of operations for the full year. Such audited financial statements and unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the Philippines (‘‘Philippine GAAP’’), which differ in certain significant respects from International Accounting Standards (‘‘IAS’’). A summary of the significant differences between Philippine GAAP and IFRS is contained herein under the heading ‘‘Summary of Significant Differences between IFRS and Philippine GAAP.’’ These financial statements are prepared under the historical cost convention, as modified for the measurement at fair market value of trading account securities. The preparation of the bank statements in accordance with Philippine GAAP requires the Bank to make estimates and assumptions that affect the reported amount of income, expenses, resources and liabilities and disclosure of contingent assets and liabilities. Future events may occur which will cause the assumptions used in arriving at the estimates to change. The effect of any changes in estimates will be recorded in the financial statements when determinable. New accounting standards based on IAS and International Financial Reporting Standards (IFRS), referred to as Philippine Accounting Standards (PAS) or Philippine Financial Reporting Standards (PFRS), respectively, became effective in 2005. The Bank’s results of operations and financial position have been, and will continue to be, affected by certain changes to Philippine GAAP, which are intended to align Philippine GAAP further with IFRS. With the adoption of the new accounting standards effective 1 January 2005, the Bank shall be fully converted and aligned with IFRS except in certain aspects. Set forth below is a summary of the new accounting standards effective for annual periods beginning on or after 1 January 2005, which the Bank believes may have a significant effect on its financial position and results of operations. . PAS 19, Employee Benefits, requires the projected unit credit method to be used in measuring retirement benefit expense and a change in the manner of computing benefit expense relating to past service cost and actuarial gains and losses. PAS 19 requires the Bank to determine the present value of defined benefit obligations and the fair value of any plan assets with sufficient regularity that the amounts recognised in the financial statements do not differ materially from the amounts that would be determined at the balance sheet date. If there is a difference between the defined benefit obligations and the fair value of the plan assets, a transitional liability or asset will be adjusted against retained earnings upon adoption of this standard. The Bank has appointed an actuary to perform an actuarial valuation of the retirement benefit obligations in accordance with PAS 19, and to determine the amount of such transitional liability or asset. . PAS 21, The Effects of Changes in Foreign Exchange Rates, prohibits the capitalization of foreign exchange losses. The Bank believes that the effect of adopting this standard on the financial statements is not material. 7 . PAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, provides for the required disclosure and presentation in respect of the accounts of banks and similar financial institutions. It also provides that provision for general banking risks is treated as an appropriation of surplus and should not be included in the determination of net income for the period. New disclosures will be included in the financial statements, where applicable, upon its adoption. . PAS 32, Financial Instruments: Disclosure and Presentation, covers the disclosure and presentation of all financial instruments. PAS 32 requires disclosures about the Bank’s financial instruments, whether recognised or unrecognised in the financial statements. New disclosure requirements include terms and conditions of financial instruments used by the Bank, types of risks associated with both recognised and unrecognised financial instruments (market risk, price risk, credit risk, liquidity risk and cash flow risk), fair value information of both recognised and unrecognised financial assets and financial liabilities, and the Bank’s financial risk management policies and objectives. PAS 32 also requires financial instruments to be classified as liabilities or equity in accordance with their substance and not their legal form. . PAS 39, Financial Instruments: Recognition and Measurement, establishes the accounting and reporting standards for recognising and measuring the Bank’s financial assets and financial liabilities. The standard requires a financial asset or financial liability to be recognised initially at fair value. Subsequent to initial recognition, the Bank should continue to measure financial assets at their fair values, except for loans and receivables and held-to-maturity investments, which are to be measured at cost or amortised cost using the effective interest rate method. Financial liabilities are subsequently measured at cost or amortised cost, except for liabilities classified as ‘‘at fair value through profit and loss’’ and derivatives, which are subsequently to be measured at fair value. PAS 39 also covers the accounting for derivative instruments. This standard has expanded the definition of derivative instruments to include derivatives (and derivative-like provisions) embedded in non-derivative contracts. Under the standard, every derivative instrument is recorded in the balance sheet as either an asset or liability measured at its fair value. Derivatives that do not qualify as hedges are adjusted to fair value through income. If a derivative is designated and qualifies as a hedge, depending on the nature of the hedging relationship, changes in the fair value of the derivative are either offset against the changes in fair value of the hedged assets, liabilities, and firm commitments through earnings, or recognised in stockholders’ equity until the hedged item is recognised in earnings. The Bank must formally document, designate and assess the hedge effectiveness of derivative transactions that receive hedge accounting treatment. The Bank has identified but not yet determined the value of its derivative and embedded derivative contracts in accordance with PAS 39. The impact of PAS 39 will be retroactively computed, as applicable, and adjusted to retained earnings as at 1 January 2005. Prior years’ financial statements will not be restated, pursuant to Philippines SEC Memorandum Circular No. 19 dated 22 December 2004. . PAS 40, Investment Property, prescribes the accounting treatment for investment property and related disclosure requirements. This standard permits the Bank to choose either the fair value model or cost model in accounting for investment property. Fair value model requires an investment property to be measured at fair value with fair value changes recognized directly in the statements of income. Cost model requires that an investment property should be measured at depreciated cost less any accumulated impairment losses. The Bank opts to adopt the cost model in accounting for its investment property. The effect of adopting the cost method in accounting for the real and other properties owned or acquired (ROPOA) has not yet been quantified. . PFRS 3, Business Combination, which will result in the cessation of the amortization of goodwill and a requirement for an annual test for goodwill impairment. Any resulting negative goodwill after performing reassessment will be credited to income. Moreover, pooling of interests in accounting for business combination will no longer be permitted. The Bank believes that the effect of adopting this standard will not result in material adjustment, except for the non-amortization of goodwill starting 1 January 2005. 8 . PFRS 5, Non-current Assets Held for Sale and Discontinued Operations, specifies the accounting for assets held for sale and the presentation and disclosure of discontinued operations. It requires assets that meet the criteria to be classified as held for sale to be measured at the lower of carrying amount and fair value less costs to sell, and the depreciation on such assets to cease. Furthermore, assets that meet the criteria to be classified as held-for-sale should be presented separately on the face of the statements of condition and the results of discontinued operations to be presented separately in the statements of income. The Bank believes that effect of adopting this standard will not be material on the financial statements. The Bank will also adopt in 2005 the following revised standards: . PAS 1, Presentation of Financial Statements, provides a framework within which an entity assesses how to present fairly the effects of transactions and other events; provides the base criteria for classifying liabilities as current or noncurrent; prohibits the presentation of income from operating activities and extraordinary items as separate line items in the statements of income; and specifies the disclosures about key sources of estimation uncertainty and judgments that management has made in the process of applying the entity’s accounting policies. . PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, removes the concept of fundamental error and the allowed alternative to retrospective application of voluntary changes in accounting policies and retrospective restatement to correct prior period errors. It defines material omission or misstatements, and describes how to apply the concept of materiality when applying accounting policies and correcting errors. . PAS 10, Events After the Balance Sheet Date, provides a limited clarification of the accounting for dividends declared after the statement of condition date. . PAS 16, Property, Plant and Equipment, provides additional guidance and clarification on recognition and measurement of items of property, plant and equipment. It also provides that each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. . PAS 17, Leases, provides a limited revision to clarify the classification of a lease of land and buildings and prohibits expensing of initial direct costs in the financial statements of lessors. . PAS 24, Related Party Disclosures, provides additional guidance and clarity in the scope of the standard, the definitions and the disclosures for related parties. It also requires disclosure of the compensation of key management personnel by benefit type. . PAS 28, Investments in Associates, reduces alternatives in accounting for associates in consolidated financial statements and in accounting for investments in the separate financial statements of an investor. Investments in associates will be accounted for either at cost or in accordance with PAS 39 in the separate financial statements. Equity method of accounting will no longer be allowed in the separate financial statements. This standard also requires strict compliance with adoption of uniform accounting policies and requires the investor to make appropriate adjustments to the associate’s financial statements to conform them to the investor’s accounting policies for reporting like transactions and other events in similar circumstances. . PAS 33, Earnings Per Share, prescribes principles for the determination and presentation of earnings per share for entities with publicly traded shares, entities in the process of issuing ordinary shares to the public, and any entities that calculate and disclose earnings per share. The standard also provides additional guidance in computing earnings per share including the effects of mandatorily convertible instruments and contingently issuable shares, among others. 9 . PAS 36, Impairment of Assets, establishes frequency of impairment testing for certain intangibles and provides additional guidance on the measurement of an asset’s value in use. . PAS 38, Intangible Assets, provides additional clarification on the definition and recognition of certain intangibles. Moreover, this revised accounting standard requires that an intangible asset with an indefinite useful life should not be amortized but will be tested for impairment by comparing its recoverable amount with its carrying amount annually and whenever there is an indication that the intangible asset may be impaired. The Bank believes that the adoption of these revised standards will not have material impact on the financial statements. See ‘‘Considerations Relating to the Bank — Accounting Principles’’. The amounts presented in the unaudited financial statements of the Issuer as of and for the nine months ended September 30, 2005 and 2004 included in the Offering Circular do not reflect adjustments pertaining to the adoption of the new and the revised Philippine Accounting Standards (‘‘PAS’’) and Philippine Financial Reporting Standards (‘‘PFRS’’) which took effect January 1, 2005. In accordance with Philippines Securities and Exchange Commission (the ‘‘Philippine SEC’’) Memorandum Circular No. 19 dated December 22, 2004, interim unaudited financial statements in 2005 for purposes of submission to Philippine SEC need not reflect the adoption of these new accounting standards. There may be material adjustments that need to be made to the accounts for them to be in conformity with current Philippine GAAP. The following selected financial information should be read together with other portions of this Offering Circular. Table 1. Selected Statements of Income Data For the nine months ended 30 September (In Php) Interest income Interest expense Provision for Probable Losses Net interest income after Provision for Probable Losses Other income Other expenses Income before income tax Provision for (benefit from) income tax Net income 2005 2004 For the year ended 31 December 2004 2003 2002 (Restated) (Restated) 3,634,903,077 1,602,076,059 275,000,000 2,648,613,795 1,242,016,567 41,000,000 3,707,544,188 1,746,419,763 120,900,000 2,724,818,876 1,196,744,901 127,136,284 2,321,731,611 912,006,860 31,446,032 1,757,827,018 535,445,924 1,871,056,799 422,216,143 1,365,597,228 480,505,098 1,522,849,455 323,252,871 1,840,224,425 645,436,686 2,038,318,219 447,342,892 1,400,937,691 550,701,594 1,534,099,681 417,539,604 1,378,278,719 422,720,752 1,503,652,978 297,346,493 (5,568,933) 427,785,076 18,430,868 304,822,003 Source: PSBank 10 (38,210,189) 485,553,081 (53,707,286) 471,246,890 17,614,665 279,731,828 Table 2. Statements of Condition Data For the nine months ended 30 September (In Php) Cash and other cash items Due from Bangko Sentral ng Pilipinas Due from other banks Interbank loans receivable Trading and investment securities — net Available for Sale Securities Investments in Bonds & Other Debt Instruments — net Receivables from Customers — net Bank premises, furniture, fixtures and equipment — net Real and other properties owned or acquired — net Deferred Tax Assets and Other resources — net Total resources Deposit liabilities Bills payable Cashier’s & Gift Checks Accrued interest, taxes and other expenses Other liabilities Capital funds 2005 2004 For the year ended 31 December 2004 2003 2002 (Restated) (Restated) 467,117,281 432,396,699 750,408,617 759,540,596 532,832,207 1,774,617,226 881,213,884 550,000,000 1,057,645,384 1,792,427,729 585,000,000 1,958,275,032 885,962,808 200,000,000 1,651,912,913 837,287,402 — 811,896,670 1,622,442,235 500,000,000 127,302,027 13,164,869,943 79,132,607 — 71,869,207 2,081,332,979 2,725,192 — 11,775,022 — 4,060,661,601 11,348,095,859 11,188,618,814 6,278,262,138 4,614,482,073 26,799,876,607 22,927,211,515 23,649,151,935 19,651,187,233 15,811,346,948 1,780,966,145 1,520,643,095 1,539,244,694 1,503,691,336 1,443,688,894 1,775,978,723 1,694,635,111 1,734,525,166 1,667,809,868 1,602,369,211 1,853,598,659 53,236,202,096 46,807,220,933 — 214,856,674 1,391,052,127 42,828,240,126 37,384,659,781 — 206,385,088 1,729,283,003 45,788,672,255 40,245,584,721 — 211,541,049 1,251,645,215 33,604,061,893 27,772,689,629 656,206,699 135,778,875 718,613,807 27,669,447,067 22,329,386,271 800,000,000 154,659,030 460,704,991 738,478,339 5,014,941,159 330,009,940 710,179,827 4,197,005,490 388,262,862 691,848,865 4,251,434,758 295,326,030 851,877,173 3,892,183,487 224,976,520 452,286,217 3,708,139,029 Source: PSBank Table 3. Selected Financial Ratios For the nine months ended 30 September (In percent unless otherwise stated) Return on assets (1) Return on capital funds (2) Net interest margin (3) Cost to income ratio (4) Gross loans to deposits (5) Core capital ratio (6) Total capital adequacy ratio (7) Total tangible capital funds to total tangible assets (8) Total non-performing loans to total gross loans (9) Allowances for probable loan losses to total gross loans (10) Allowances for probable loan losses to total nonperforming loans (11) Allowance for probable losses to total non-performing assets(12) Specific provisions to nonperforming loans Specific provision to gross loans Earnings per share (PHP) (13) 2005 2004 For the year ended 31 December 2004 2003 2002 1.12 12.07 5.83 72.85 59.72 12.67 13.54 1.07 9.17 5.59 80.70 63.64 13.65 14.41 1.19 11.85 5.57 78.20 60.90 12.49 12.46 1.47 11.20 5.84 73.80 73.14 13.33 13.30 1.14 7.40 6.62 82.06 74.57 13.21 14.04 7.03 8.63 7.66 9.74 10.73 6.28 5.82 6.10 5.65 7.77 4.12 3.64 3.52 3.27 5.04 65.58 62.59 57.64 57.84 64.83 34.70 29.09 28.48 28.49 29.80 50.44 47.52 42.64 42.70 52.74 3.17 3.18 2.76 2.26 2.60 2.71 2.41 2.63 4.10 1.56 Source: PSBank 11 Notes: (1) Net income divided by average total resources for the period indicated. Net income for the nine months ended 30 September 2005 and 2004 is annualized. Average total resources is based on the monthly average balance of total resources for the nine months ended 30 September 2005 and 2004, and for the years ended 31 December 2004, 2003 and 2002. Return on assets for the nine months ended 30 September 2005 and 2004 is based on annualized net income. (2) Net income divided by average total capital funds for the period indicated. Net income for the nine months ended 30 September 2005 and 2004 is annualized. Average total capital funds is based on the monthly average balance of capital funds for the nine months ended 30 September 2005 and 2004, and for the years ended 31 December 2004, 2003 and 2002. Return on shareholders’ equity for the nine months ended 30 September 2005 and 2004 is based on annualized net income. (3) Net interest income divided by average interest-earning assets. Net income for the nine months ended 30 September 2005 and 2004 is annualized. (4) Total operating expenses divided by net interest and other income. (5) Total gross loans divided by total customer deposits. (6) Net Tier 1 capital divided by total risk weighted assets. (7) Total qualifying capital less deductions divided by total risk weighted assets. (8) Total tangible capital funds divided by total tangible assets. (9) Total non-performing loans divided by total gross loans. (10) Total allowance for probable loan losses divided by total gross loans. (11) Total allowance for probable loan losses divided by total non-performing loans. (12) Total allowance for probable losses divided by total non-performing assets (comprising real and other properties owned or acquired (‘‘ROPOA’’) and non-performing loans). (13) Annualized net income divided by weighted average number of outstanding common shares. Source: PSBank 12 INVESTMENT CONSIDERATIONS An investment in the Notes involves a number of investment considerations. Prospective investors should carefully consider all the information contained in this Offering Circular, including the investment considerations described below, before making an investment decision. The business, financial condition and results of operations of the Bank could be materially and adversely affected by any of these investment considerations. The market price of the Notes could decline due to any one of these risks, resulting in loss of all or part of the initial investment in the Notes. The following discussion is not intended to be a comprehensive discussion of the risk and other factors and is not in any way meant to be exhaustive. Investors are encouraged to make their own independent legal, financial, and business examination of the Bank and the market. Neither the Bank nor the Lead Manager makes any warranty or representation on the marketability, price, or market increments or profits that may arise out of any investment in the Notes. General Considerations Political and Economic Developments in the Philippines The general political situation in, and the state of the economy of, the Philippines may influence the growth and profitability prospects of the Bank. Any political or economic instability in the future may have a negative effect on the financial results of the Bank. Political Climate The Philippines has from time to time experienced political and military instability. On 10 May 2004, national elections were held for the positions of President, Vice President, 12 Senators, more than 200 Representatives and all local government posts (excluding Barangay officials). On 24 June 2004, a joint session of Congress declared Gloria Macapagal-Arroyo and Noli de Castro as President-elect and Vice President-elect, respectively. They began their 6-year terms on 30 June 2004. Ms. Arroyo first became president in January 2001 after the impeachment of former President Joseph Estrada. Criminal charges for perjury and plunder have been filed against Mr. Estrada with the Sandiganbayan, a special court with jurisdiction over criminal and civil cases involving graft and corruption. Hearings on these charges are ongoing. Both Ms. Arroyo and Mr. de Castro are members of the ruling Koalisyon ng Katapatan at Karanasan para sa Kinabukasan (‘‘K4’’) coalition. In the elections, the ruling coalition enlarged its majority in the 13th Congress of both the Senate and the House of Representatives, which convened on 26 July 2004. Certain opposition candidates, including defeated presidential candidate Fernando Poe, Jr., questioned the election results, alleging fraud and disenfranchisement of voters. On 23 July 2004, Mr. Poe petitioned the Philippine Supreme Court, acting in its capacity as the Presidential Electoral Tribunal, to order a recount of approximately 60.00% of votes cast nationwide. In response, President Arroyo and VicePresident de Castro asked the tribunal to dismiss the petition for lack of merit. Mr. Poe died on 14 December 2004, after suffering a stroke. The petition of his widow, Susan Roces, in the Supreme Court to pursue the electoral protest on behalf of her late husband was unanimously dismissed on 28 March 2005 on the grounds that no real party in interest had filed a case to intervene or to be a substitute for Mr. Poe. Allegations of fraud and disenfranchisement of voters surfaced thereafter in light of revelations that President Arroyo had spoken with an official from the independent Commission on Elections during the counting of votes shortly after the May 2004 election. President Arroyo has admitted to speaking with an election official, but insists that she did not participate in fraud or induce the Commission on Elections to tamper with the election. The President maintains that she won the 2004 elections fairly since the conversations occurred after the certificates of canvass had been prepared and has cited the approval of international election observers and the Philippine National Movement for Free Elections. 13 On 7 July 2005, President Arroyo asked the courtesy resignations of her entire cabinet to allow the rebuilding of a new administration that could more efficiently implement economic reforms. The next day, 10 of President Arroyo’s senior government officials, including then Finance, Budget, and Trade Secretaries submitted their resignations and urged President Arroyo to resign as well. Subsequently, 3 other officials also tendered their resignations, although 1 of the 3 resigned on 17 July 2005 to focus on his role as government chief negotiator with the Moro Islamic Liberation Front. As of 1 August 2005, President Arroyo had replaced 4 of the senior officials, with Margarito Teves as finance secretary, Romulo Neri as budget secretary, Peter Favila as trade secretary, and Zamzamin Ampatuan as secretary of the National Anti-Poverty Commission. The rest of the affected departments and agencies are currently headed by officers-in-charge. On 25 July 2005, opposition lawmakers in the House of Representatives filed impeachment proceedings against President Arroyo, based on the allegations of culpable violation of the Constitution, graft and corruption, and betrayal of the public trust. At least 79 representatives, or one-third of the 236-member House, must vote in favor of the impeachment complaint before it can go to the Senate for trial. In August 2005, as the pro-impeachment block failed to muster the required 79 votes, the House Committee on Justice reviewed and eventually dismissed the impeachment complaint. The abrupt end to the impeachment proceedings failed to put complete political closure, thus uncertainty still clouds the political climate to a certain extent. However, the Administration believes that President Arroyo has the continued support of a majority of elected officials at all levels of government, as well as the general support of the armed forces and the Catholic Church. The chief of the armed forces has ordered field commanders to ensure the neutrality of soldiers, and the Catholic Bishops Conference of the Philippines (CBCP) has urged the population to respect and uphold the Constitution. In her State of the Nation address on 25 July 2005, President Arroyo called for the adoption of a parliamentary federal form of government to replace the current presidential unitary system. She abandoned her earlier preference of having a constitutional convention to address proposed changes to the Constitution and instead supported the option of having the present Congress sit as a constituent assembly to make such changes, arguing that this was a faster and less costly process. No assurance can be given that the future political environment in the Philippines will be always stable and that current or future governments will adapt economic policies conducive to sustaining economic growth. Peace and Order The Philippines has been subject to various events which threaten the peace and order situation in various metropolitan areas as well as remote areas of the Philippines. In particular, the Philippine military has had sporadic clashes with the communist New People’s Army (‘‘NPA’’) in certain parts of Luzon and the Visayas, and the Moro Islamic Liberation Front (‘‘MILF’’), Jemaah Islamiyah (‘‘JI’’), and Abu Sayyaf in parts of Mindanao. The NPA, JI, and Abu Sayyaf have been branded internationally as terrorist organizations and accordingly are being pursued more vigorously by the military. In contrast, the Government has resumed formal peace negotiations with the MILF. There can be no assurance that the counter-terrorism measures being undertaken by the Government will succeed, or that the Philippines will not be subject to further acts of terrorism. Any further degradation in the peace and order situation of the country may affect the overall business climate in the Philippines, including the financial condition of the Bank. Economic Outlook The Bank’s business operations and assets are based in the Philippines. As a result, the Bank’s operations, and the quality and growth of its assets depend, to a large extent, on the performance of the Philippine economy. 14 The Philippine Government actively encourages domestic and foreign private investment. Since 1991, the Philippines has further liberalized trade and investment in tandem with the deregulation of the financial system, foreign exchange liberalization, tax reforms, acceleration of privatization, enhancement of competition in the provision and operation of public utilities, and deregulation of the oil and power industries. President Arroyo’s policy priorities for her current 6-year term, as announced in mid-2004, include creating jobs, improving education, balancing the Government budget, reducing corruption, promoting the peace process with rebel groups, and reforming the energy and electric power industries. The principal sectors of the Philippine economy are services, industry and agriculture (including fishery and forestry). The services sector accounted for 47.6% of real gross domestic product (‘‘GDP’’) in 2004, including the sub-sectors of trade (17.0% of real GDP), transportation, communications and storage (8.6% of real GDP) and private services (7.7% of real GDP). The industry sector accounted for 33.6% of real GDP in 2004, 24.4% of which came from manufacturing. The agriculture sector accounted for 18.8% of real GDP in 2004. In 2004, real gross national product (‘‘GNP’’) grew 6.2% and real GDP grew 6.1%. For the first 9 months of 2005, real GNP growth was 5.4% and real GDP growth was estimated at 4.6%. Growth has slowed due to high energy prices, fiscal tightening, mild El Nino reducing agriculture growth and expectations of higher inflation and heightened uncertainties. In 2004, the balance of payments recorded a deficit of $280 million, with current account recording a surplus of $2.1 billion. The continued surplus reflected robust net inflows throughout the year, particularly from overseas Filipino workers, which offset a decline in the trade balance. The income account recorded a surplus of $147 million in 2004 on account of higher remittances of Overseas Filipino Workers (‘‘OFW’’). The balance of payments turned into a surplus of US$2.1 billion for the 11 months of 2005 as robust OFW remittances grew a further 27% and foreign investors turned more positive on Philippine assets. For the 11 months of 2005, inflation averaged 7.8% which is well above the government’s fullyear target of 5–6%. Inflation in the last 3 months since September was within expectations at 7% due to easing food and energy price pressures. The improving agriculture output and steadier Dubai crude oil import prices kept inflation relatively tame. However, apprehension over the inflation impact of fiscal reform-related measures keeps economic policy makers cautious. Thus, even if inflation was within BSP’s expectation, monetary policy may continue to look at the inflation pressures for 2006 and try to protect 2007 inflation target of 4–5%. The long monetary policy lag of 15 to 21 months would require the BSP to act again if the inflation trajectory into 2007 would not meet the inflation target for that year. The average interest rates for 91-day Treasury bills increased from 6.0% in 2003 to 7.3% in 2004. For the 11 months of 2005, the 3-month benchmark rate has been lower at around 6.2%. This is despite the higher inflation rate for the same period. In the recent monetary tightening in October, policy makers were concerned about higher than target money supply growth, 2nd round effect, higher inflation expectations, and narrowing interest rate differentials. The US Federal Reserve Board’s FOMC is expected to continue raising its benchmark rate until early 2006 to around 4.5% to 4.75%. Other Asian central banks could follow. If such rate hikes continue, the peso could react and spur the BSP to respond to the rate hikes. OFW USD inflows could moderate the response and help mitigate the impact of narrowing differentials. Standard & Poors, Moody’s Financial, and Fitch Ratings in July 2005 cut their credit rating outlook on the Philippines to ‘‘negative’’ from ‘‘stable’’ citing concerns over the country’s ability to maintain the fiscal consolidation needed to reduce its high debt level of public and external indebtedness. The cut stemmed from the political crisis created in the country by allegations of electoral impropriety by the present administration during the last elections and the Supreme Court’s decision to issue a temporary restraining order (TRO) over the amendments to the EVAT law which removes exemptions and increases the rate from 10% to 12% at the discretion of the President. The election allegations culminated with the Committee on Justice in the Lower House junking the impeachment complaints against the President. On 18 October 2005, the Supreme Court ruled with finality the constitutionality of the EVAT law, thus 15 paving the way for its implementation in November 2005. The TRO lifting will translate to the government meeting its target budget deficit and lower borrowing costs starting 2006, and eventually to meeting its balanced budget target by 2008, or earlier than the promised 2010. On 29 December 2005, the peso-US dollar exchange rate was Php53.09 per US dollar, compared to Php56.27 per US dollar as of 29 December 2004 and Php55.57 per US dollar as of 30 December 2003. Any deterioration in the economic conditions of the Philippines could materially and adversely affect the Bank’s borrowers and contractual counterparties and their ability to service their obligations to the Bank. This in turn could materially and adversely affect the Bank’s financial condition and results of operations, including the Bank’s ability to grow its asset portfolio, the quality of its assets, and its ability to implement its business strategy. Considerations Relating to the Banking Industry Competition As of September 2005, there are 84 thrift banks operating in the Philippines, with the Bank ranked 2nd in terms of assets. As such, the Bank is subject to significant levels of competition in all areas of its business, including from competitors that may have greater financial or capital resources, a greater market share or better name recognition than the Bank. There can be no assurance that the Bank will be able to compete effectively in the face of such competition. Increased competition may likewise make it difficult for the Bank to increase the size of its loan portfolio and low cost deposit base, as well as cause pricing competition which could have a material adverse effect on the Bank’s growth plans, margins, results of operations and financial condition. BSP Regulations on Loan Loss Provisioning BSP regulations require Philippine banks to classify non-performing loans based on 4 different categories: (i) Loans Especially Mentioned, (ii) Substandard, (iii) Doubtful, and (iv) Loss. The standards under these regulations have in the past, and may in the future, change and may result in changes in the classification of certain loans as well as the level of loan loss provisions which the Bank makes. In addition, these requirements in certain circumstances may be less stringent than those applicable to banks in other countries and may result in particular loans being classified as non-performing later than would be required in such countries or being classified in a category reflecting a lower degree of risk. Accounting Principles The Bank is preparing itself for the implementation of new accounting standard Philippine Accounting Standard (PAS) 39 through the establishment of a task force that will implement its provisions. To date, the Bank has not yet determined the total impact of these standards on the financial statements since it is still in the process of updating its system, processes and policies, which will incorporate the requirements of PAS 39. The Bangko Sentral ng Pilipinas (BSP), through the BSP Monetary Board, Resolution No. 1869 dated 23 December 2004 has given banks and financial institutions until 31 December 2005 to ready their infrastructures to be PAS 39 compliant. Interim reports that will be submitted to the BSP for 2005 need not be in compliance with provisions of said standards. Anti Money Laundering Act of 2001 The Bank is regulated and supervised principally by, and has reporting obligations to, the BSP. The Bank is also subject to the banking, corporate, taxation and other laws in effect in the Philippines. In recent years, existing rules and regulations have been modified, new rules and regulations have been enacted and reforms have been implemented which are intended 16 to provide tighter control and added transparency in the Philippine banking sector. These rules include new guidelines on the monitoring and reporting of suspected money laundering activities as well as regulations governing capital adequacy of banks in the Philippines. Furthermore, the Philippines enacted the Anti-Money Laundering Act of 2001 (‘‘AMLA’’) to introduce more stringent anti-money laundering regulations and became compliant with the standards set by the Financial Action Task Force (‘‘FATF’’) in 2003. The Bank may incur substantial compliance and monitoring costs if further rules or regulations are enforced, or if existing regulations are enforced on a more stringent basis. Taxation Currently, Philippine banks and non-bank financial intermediaries are subject to the Gross Receipts Tax (GRT). Section 108 of the Tax Code of 1997 as amended by R.A. 9337 imposes GRT on income derived by all banks and non-bank financial intermediaries. The Philippine banking industry also faces the threat of the Bureau of Internal Revenue (‘‘BIR’’) imposing new tax regulations that could result in the Bank’s taxation charge being increased considerably, which may have a material adverse effect on the financial condition and results of operations of the Bank. On 24 May 2005, President Gloria Macapagal-Arroyo signed into law the Republic Act No. 9337 known as ‘‘The New VAT Law’’. The law became effective on 1 November 2005. The new VAT law has introduced major provisions not only regarding value-added taxes but also on corporations’ income taxes and gross receipt taxes. Presented below are the salient features of the new VAT law, as applicable with the operations of the Bank. . The income tax rate applicable for domestic corporations was increased to 35.00% from the lower 32.00% income tax rate for the taxable years 2005–2008. Effective 1 January 2009, the rate of income tax shall be 30.00%. . The new 35.00% corporate income tax rate shall be applied on the amount computed by multiplying the number of months covered by the new rate within the fiscal year by the taxable income of the corporation for the period, divided by twelve. . The percentage by which the taxpayer’s allowable deduction for interest expense shall be reduced, has been increased from 38.00% to 42.00% of the interest income subjected to final tax. Effective 1 January 2009, the percentage of allowable deduction shall be 33.00%, when the rate of income tax goes down to 30.00%. . The gross receipts tax (GRT) rate for banks and non-bank financial intermediaries performing quasi-banking functions is increased to 7.00% from 5.00% for: Royalties, rentals of property, profits from exchange and other items treated as gross income under Section 32 of the 1997 Tax Code. Likewise, GRT at the rate of 7.00% is applicable on net trading gains within the taxable year on foreign currency, debt securities and other similar financial instruments. Basel II Continuing initiatives to build up its risk management capabilities should enable the Bank to comply with the new standards that will be required upon Basel II implementation. Under Basel II, universal banks, commercial banks, and thrift banks are expected to comply with the standardized approach for credit risk, and the basic indicator or standardized approaches for operational risk by 2007. By 2010, these banks may move to the foundation internal ratings based (IRB) or advanced IRB approaches for credit risk, and advanced measurement approaches for operational risk. Between now and 2007, certain provisions of Basel II will be gradually incorporated into the current risk-based capital adequacy framework, including lower risk weights for highly-rated corporate exposures, higher risk weights for past 17 due claims (net of specific provisions), standardized approach for investments in securitization structures (i.e., risk weights would depend on external ratings), standardized computation of liquidity risk and interest rate risk in the banking book, and broad guidelines on operational risk management. The rest of the provisions of Basel II standardized approach for credit risk, and basic indicator and standardized approaches for operational risk will be implemented by 2007. The Bank currently has a Risk Management Unit that closely works with its policy-setting Risk Management Committee. Key officers have been assigned to monitor the Bank’s market, credit and operational risks. The Bank’s risk policies and credit models are regularly reviewed to ensure that they remain adequate in the nature of risks dealt with. The Bank aims to become a Basel compliant institution and obtain proper risk management capabilities consistent with its business risk aspirations. Working towards qualifying for Basel Advanced IRB status by 2010, the Bank’s Risk Management Committee shall ensure the establishment of a risk management infrastructure that integrates all phases of customer management. The Basel exercise shall be focused on staffing for analytics, data build-up and quality, data capture and systems, and risk controls. Considerations Relating to the Bank Significant Shareholding by Metrobank A significant portion of the equity of the Bank (approximately 74.24%) is owned by Metrobank. The next largest shareholder is the Dolor Family, which owns 19.77% of the Bank. There can be no assurance that the interests of Metrobank will necessarily coincide with the interests of the Noteholders. Concentration of Loan Portfolio As of 30 September 2005, the Bank’s top 10 largest exposures account for 13.59% of the Bank’s total loan portfolio. The next 10 largest exposures account for an additional 4.04% of the loan portfolio. While there are currently no non-performing loans (‘‘NPLs’’) in the top 10 exposures, there can be no assurance that these exposures would continue to perform their obligations to the Bank. High Level of Regulation The Bank, being subject to the supervision and regulation of the BSP, is periodically audited by the BSP through the appropriate Supervision and Examination Sector for compliance with banking rules and regulations. While the Bank believes that as of 30 September 2005, it is fully compliant with all applicable rules and regulations and has effectively and efficiently implemented all corrective actions required, if any, to the satisfaction of the BSP, there can be no assurance that the Bank will at all times be compliant or that the BSP will find the operations or corrective measures taken by the Bank to be proper, acceptable or sufficient. In such cases, the Bank could be reprimanded, fined, or in extreme cases, have its banking license revoked, but at all times after due notice and hearing. Level of Non-Performing Loans The current level of the Bank’s NPLs at 6.28% as of September 2005 compares favorably with the industry average of 9.10% among thrift banks in the Philippines. Through the implementation of stringent credit policies, the Bank expects its NPLs to further taper off. Ongoing volatile economic conditions in the Philippines may adversely affect the ability of the Bank’s borrowers to service their indebtedness and as a consequence the Bank may experience an increase in NPLs and provisions for probable losses. Although the Bank monitors closely current and future credit risk exposures, no assurance can be given that the amount of NPLs will not increase and will not have a material effect on the Bank’s capital adequacy ratio, its operations, and financial condition. 18 Accounting Principles The Bank’s financial position and results of operations will be affected by the implementation of new Philippine Accounting Standards. The Bank’s results of operations and financial position have been, and will continue to be, affected by certain changes to Philippine GAAP, which are intended to align Philippine GAAP further with International Financial Reporting Standards (IFRS). With the adoption of the new accounting standards effective 1 January 2005, the Bank shall be fully converted and aligned with IFRS except in certain aspects. See Summary of Significant Differences between International Financial Reporting Standards and Philippine Generally Accepted Accounting Principles. With effect from 1 January 2005, the Bank is required to adopt these new accounting standards which may have a significant effect on its financial position and results of operations. In particular, Philippine Accounting Standards (PAS) 39 which establishes the accounting and reporting standards for recognizing and measuring the Bank’s financial assets and financial liabilities and derivative instruments (including derivatives and derivative-like provisions embedded in non-derivative contracts) will result in a reduction of surplus as of 1 January 2005. With the exception of PAS 32 and 39, all of the new accounting standards will be retroactively applied. The Bank, however, has not yet determined the effect of adopting these new accounting standards. See Selected Financial Information. As a result, the financial statements for the years ended 31 December 2002, 2003 and 2004 included in this Offering Circular have not yet been restated to reflect the adoption of the new standards. The Bank expects that the main adjustment will be in respect of surplus, however, such adjustment cannot currently be quantified. In addition, in accordance with Philippines Securities and Exchange Committee (the ‘‘Philippine SEC’’) Memorandum Circular No. 19 dated 22 December 2004, interim financial statements in 2005 for purposes of submission to Philippine SEC need not reflect the adoption of these new accounting standards. Accordingly, the financial statements for the nine months ended 30 September 2004 and 2005 included in this Offering Circular have not been adjusted to effect the implications of the new accounting standards. As required by the Philippine SEC, the financial statements for the year ending 31 December 2005 should fully comply with Philippine GAAP aligned with IFRS. There may be material differences between the interim financial statements and the financial statements for the year ending 31 December 2005. The Bank’s financial results for subsequent periods may be adversely affected by the effect of the new accounting standards, which may also have an adverse effect on the trading price and liquidity of the Notes. Considerations Relating to the Notes Unsecured Subordinated Notes The Notes will constitute direct, unconditional, unsecured and subordinated obligations of the Bank, and will at all times, rank pari passu and without any preference among themselves and at least equally with all other present and future unsecured and subordinated obligations of the Bank. The Notes are not deposits and are not guaranteed nor insured by the Bank or any party related to the Bank, such as its subsidiaries, if any, or affiliates or the Philippine Deposit Insurance Corporation, or any other person. In the event of any insolvency or liquidation of the Bank, the claims of Noteholders will be subordinated in right of payment to the prior payment in full of all liabilities (actual or contingent, present or future) of the Bank including all deposit liabilities and other liabilities of the Bank and all offices and branches of the Bank except those liabilities which by their terms rank equal with or junior to the Notes. However, the claims of Noteholders will have priority over the rights and claims of holders of all classes of equity securities of the Bank, including holders of preference shares, if any. 19 Limitation as to Use as Collateral The Notes may not be used as collateral for any loan made by the Bank or its subsidiaries, if any, or its affiliates. The Noteholders are not allowed to set off any amount that may be due to the Bank against the Notes. Limited Right to Accelerate If the Bank fails to make a payment on the Notes when due, the Noteholders thereof may not accelerate payment of such Notes. However, the Noteholders may institute proceedings to enforce the obligations of the Bank to make such payment and may institute proceedings for the insolvency and liquidation of the Bank. The Noteholders may accelerate the Notes only if an insolvency or liquidation proceeding is commenced by or against the Bank or upon the occurrence of other certain related events. See Terms and Conditions of the Notes. Limitation on Transfers The Notes may be issued or transferred to any person of legal age, regardless of nationality or residency, or any corporation, association, partnership, trust account, fund, or entity, regardless of place of incorporation or domicile, subject to submission of the appropriate documents to the Registry. The following persons and entities are prohibited from purchasing and/or holding any Notes of the Bank: (1) subsidiaries, if any, and affiliates of the Bank, including the subsidiaries and affiliates of the Bank’s subsidiaries, if any, and affiliates; or (2) common trust funds/unit investment trust funds managed by the Trust Department of the Bank, its subsidiaries, if any, and other related entities; or (3) other funds being managed by the Trust Department of the Bank, its subsidiaries, if any, affiliates or other related entities where (a) the fund owners have not given prior authority or instruction to the Trust Department to purchase or invest in the Notes or (b) the authority or instruction of the fund owner and his understanding of the risk involved in purchasing or investing in the Notes are not fully documented. For purposes hereof, an ‘‘affiliate’’ refers to a related entity that is linked by means of ownership of at least 20.00% to not more than 50.00% of its outstanding voting stock. The Registry is authorized to refuse any transfer or transaction in the Registry Book which may be violative of these restrictions. There is no assurance that the secondary trading of the Notes may not be affected given these restrictions. Transfer of the Notes between persons of different tax status shall be made effective only on an Interest Payment Date (the ‘‘Transfer Date’’). Any change in tax status shall be recorded only upon submission of: (x) written notification of the transfer from the transferor; and (y) a sworn statement of the tax status of the transferee claiming tax exemption/preferential tax treatment and other Tax Exempt/ Tax Treaty Documents from such transferee, to the Issuer, through the Registry. Such change in tax status shall take effect beginning on the 1st day of the Interest Period subsequent to the Transfer Date; provided that notification is made and sufficient Tax Exempt/ Treaty Documents are sent to the Issuer, through the Registry no later than 5 Banking Days prior to the record date of such Interest Period, otherwise, the Registry shall be entitled to presume, without liability to the Issuer, that the relevant Noteholder/ Transferee is not taxexempt or does not enjoy preferential tax treatment. In such case, the change in tax status arising from the transfer between a taxable and a tax-exempt individual shall take effect starting from the Interest Period of the relevant record date on or before which a written notification and submission of the Tax Exempt/Tax Treaty Documents are made which should be no later than 5 Banking Days prior to the relevant record date. In determining and recording such tax status, the Registry shall exercise such judgment and care, under the circumstances then prevailing that individuals of prudence, discretion and intelligence and familiar with such matters exercise in the management of their own affairs. 20 Liquidity of the Notes There is no existing established market for the Notes. The Lead Manager and the Selling Agents have made no commitment and have no obligation to make a market in the Notes. No assurance can be given that the Lead Manager or the Selling Agents will actually make a market in the Notes, or if it does, that it will continue to make a market in the future. Ultimately, no assurance can be given that an active trading market for the Notes will develop or will be maintained throughout the life of the Notes. Taxation of the Notes Interest income on the Notes held by Noteholders shall be subject to a final withholding tax of 20.00% or such rate as may be provided by law or regulation, which shall be withheld at source. Interest income received by non-resident individuals not engaged in trade or business in the Philippines shall be subject to a final withholding tax of 25.00%. Interest income received by non-resident foreign corporations shall be subject to a final withholding tax of 35.00%. The tax shall be for the account of the affected Noteholder, and shall be withheld at source. The foregoing rates may be subject to further reduction by any applicable tax treaty. However, under the Tax Code, interest income from long-term deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments with a maturity period of not less than 5 years, the form of which shall be prescribed by the BSP and issued by banks only (not by non-bank financial intermediaries and finance companies) to individuals in denominations of P10,000.00 and other denominations as may be prescribed by the BSP, is exempt from income tax. Provided that, should the holder pre-terminate the deposit or investment before the 5th year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the long-term deposit or investment certificate based on the remaining maturity thereof: 4 years to less than 5 years — 5.00%; 3 years to less than 4 years — 12.00%; and Less than 3 years — 20.00%. Thus, all payments of principal and interest in respect of individual Noteholders who are (i) Philippine citizens; (ii) resident aliens; and (iii) non-resident aliens engaged in trade or business within the Philippines, shall be made free and clear of, and without withholding or deduction for, any taxes, duties, assessments, or governmental charges of whatever nature imposed, levies, collected, withhold, or assessed by or within the Philippines or any authority therein or thereof having the power to tax, unless such withholding or deduction is required by law. In such event, the Bank shall pay such additional amount as will result in the receipt by such Noteholders of such amounts as would have been received by them had no such withholding or deduction been required. In accordance with Clause D(7)(e) of the BSP Rules, negotiations/transfers from one holder to another do not constitute pre-termination. If tax status being claimed by an applicant is ‘‘exempt’’ or ‘‘reduced tax treaty rates’’, the following documents should be presented or attached to the application: (i) Certified true copy of the original tax exemption certificate, ruling or opinion issued by the Bureau of Internal Revenue on file with the Applicant as certified by its duly authorized officer; 21 (ii) With respect to tax treaty relief, proofs to support applicability of reduced treaty rates, consularized proof of tax domicile issued by the relevant tax authority of the Noteholder and original or SEC-certified true copy of the SEC confirmation that the relevant entity is not doing business in the Philippines; (iii) Original of the duly notarized undertaking, in the prescribed form, declaring and warranting its tax exempt status or entitlement to reduced tax treaty rates, undertaking to immediately notify the Issuer and the Registry and Paying Agent of any suspension or revocation of its tax exempt status or treaty privileges and agreeing to indemnify and hold the Issuer and the Registry and Paying Agent free and harmless against any claims, actions, suits, and liabilities resulting from the non-withholding or reduced withholding of the required tax; and (iv) Such other documentary requirements as may be required under the applicable regulations of the relevant taxing or other authorities which, for purposes of claiming tax treaty withholding rate benefits, shall include evidence of the applicability of a tax treaty and consularized proof of the Noteholder’s legal domicile in the relevant treaty state. Rating of the Notes The Notes have been rated Aa plus by PhilRatings. This rating will be subject to regular annual reviews, or more frequently as market developments may dictate for as long as the bonds are outstanding. A rating is not a recommendation to buy, sell or hold securities and may be subject to revision, suspension or withdrawal at any time by the assigning rating organization. There is no assurance that the rating will be maintained throughout the life of the Notes. Under the ratings definition of PhilRatings, being included within the PRS Aa plus class of ratings indicates that the Bank has a strong capability to pay its debt issue. A PRS Aa plus rating means that margins of protection may not be as large as in PRS Aaa issues. Fluctuations of protective elements may be of greater amplitude or there may be other elements present, which make the long-term risks, appear somewhat larger than for PRS Aaarated securities. In assigning the rating, PhilRatings considered the Bank’s market position as one of the leading players in the attractive consumer-banking sector, solid support from parent Metrobank and synergies realized from being part of the Metrobank Group, and management’s focused vision and coherent strategy. PhilRatings likewise took into account the Bank’s strong core earnings, its good asset quality, sound funding base, and acceptable capitalization level. Registry Fees The Registry shall charge an annual maintenance fee of 0.04% per annum based on the face value of the Notes which shall be deductible from the Interest Payment. Should the Notes be subsequently transferred, a minimal fee shall be charged by the Registry. 22 TERMS AND CONDITIONS OF THE NOTES The following do not purport to be a complete listing of all the rights, obligations, and privileges of the Notes. Some rights, obligations, or privileges may be further limited or restricted by other documents. Prospective investors are encouraged to carefully review the Agreements, other information in this Offering Circular, and all amendments thereto. Master Note Philippine Savings Bank (the ‘‘Issuer’’) hereby promises to pay the holders of its Unsecured Subordinated Notes (the ‘‘Notes’’) the principal and interest due on the Notes under the following terms and conditions: Total Amount P = 2,000,000,000.00. Denomination Minimum of P = 500,000.00 and in increments of PhP100,000.00. Governing Regulation Bangko Sentral ng Pilipinas (BSP) Memorandum to All Banks and Non-Bank Financial Institutions dated 17 February 2003 and Circular No. 280 (2001) on the issuance of unsecured subordinated debt instruments eligible as Tier 2 capital and other related circulars and issuances, as may be amended from time to time (BSP Rules). Issue Price 100.00% of the face value of each Note. Offer Period The period when the Notes were offered for sale by the Issuer through the Selling Agents to prospective Eligible Noteholders, which commenced on the start of business hours of 11 January 2006 and ended on the close of business hours on 20 January 2006. Issue Date 27 January 2006. Settlement Date 27 January 2006. Purpose of Issuance To raise Tier 2 capital to increase and strengthen its capital base. Interest The Interest Rate (or Step-Up Interest Rate) multiplied by the face value of the Note, multiplied by the actual number of days lapsed in the given Interest Period (which shall be from and including the first day of the Interest Period up to but excluding the last day of such Interest Period), divided by 360 days. Interest Rate 10.00% per annum, payable to the Noteholder for the period from and including the Issue Date up to but excluding 27 January 2011 (if the Call Option is not exercised) or the Call Option Date (if the Call Option is exercised). Interest Periods Consecutive three (3) calendar month period reckoned from the Issue Date up to the 27th of April 2006, and every 27th of the succeeding three (3) calendar month periods thereafter, until the Maturity Date, except that if the last day of a given period is not a Banking Day, then the given period is extended to the immediately following Banking Day. Interest Payment Date The last day of an Interest Period. 23 Step-Up Interest Rate 5-Year Mart1 FXTN as of Reset Date multiplied by 80.00%, plus the Step-Up Credit Spread, payable to the Noteholder in lieu of the Interest Rate beginning on the twenty-first (21st) Interest Period up to the last Interest Period in the event that the Issuer does not exercise the Call Option. Step-Up Credit Spread 150.00% x {Interest Rate – (5-Year Mart1 FXTN as of Issue Date x 80.00%)}, which is equivalent to 4.2815%. Reset Date 27 January 2011. 5-Year Mart1 FXTN as of Issue Date 8.9321%, which is the rate for the Money Market Association of the Philippines Philippine Treasury Notes Benchmark for notes with the time to maturity equal to 5 years, appearing on the Bloomberg Page MART1 under the heading ‘‘Bid Yield’’ as of 11 : 16 a.m., Manila time, on the last Banking Day of the Offer Period, which is 20 January 2006. 5-Year Mart1 FXTN as of Reset Date The rate for the Money Market Association of the Philippines Philippine Treasury Notes Benchmark for notes with the time to maturity equal to 5 years, appearing on the Bloomberg Page MART1 under the heading ‘‘Bid Yield’’ as of 11 : 16 a.m., Manila time, on the Banking Day immediately prior to the Reset Date. If there is no rate appearing on the Bloomberg Page MART1 under the heading ‘‘Bid Yield’’ as of 11 : 16 a.m., Manila time, on the Banking Day immediately prior to the Reset Date, the Public Trustee will request appropriate quotes for bid yields for a 5-Year FXTN from 4 reference banks (which shall be selected by the Public Trustee) and will determine the arithmetic mean of these bid yields (rounded upwards, if necessary, to the nearest onesixteenth of one per cent) provided that at least 3 rates are so quoted. Payment Any payment of principal or interest under the Notes shall be made through the Paying Agent based solely on the records of the Registry. Penalty Interest 1.00% per month on the defaulted amount payable to the Noteholder from the time the amount fell due until it is fully paid which will be in addition to the Interest Rate (Step-Up Interest Rate). Call Option On the Call Option Date, upon (x) prior approval of the BSP subject to the following conditions: (i) the capital adequacy ratio of the Issuer is at least equal to the required minimum ratio; (ii) the Note is simultaneously replaced with the issues of new capital which are neither smaller in size nor lower in quality than the original issue; and (y) 30-day prior written notice to the then Noteholder on record, all and not less than all of the outstanding Notes may be redeemed at the instance of the Issuer by paying the Noteholder the Call Option Amount. Call Option Date The day when the Call Option is exercised by the Issuer which day shall be the 1st Banking Day after 27 January 2011. Call Option Amount The face value of the Note, plus accrued Interest covering the 20th Interest Period at the Interest Rate as of but excluding the Call Option Date. 24 Maturity Date 27 January 2016. Maturity Value The Notes will be redeemed on Maturity Date at their face value plus unpaid accrued applicable Interest. Non-Preterminability The Notes shall not be redeemable or terminable at the instance of any Noteholder before Maturity Date, unless otherwise expressly provided herein. Form The Notes will be issued scripless and will be maintained in electronic form with the Registry, subject to the payment of fees to the Registry. However, a Registry Confirmation will be issued by the Registry in favor of the Noteholders in accordance with the BSP Rules. Registry & Paying Agent Development Bank of the Philippines — Trust Services Department Public Trustee Development Bank of the Philippines — Trust Services Department Selling Agents ING Bank N.V., Manila Branch (‘‘ING’’), Multinational Investment Bancorporation, and, to a limited extent, Philippine Savings Bank Eligible Noteholders The Notes may be issued or transferred to any person of legal age, regardless of nationality or residency, or any corporation, association, partnership, trust account, fund or entity, regardless of place of incorporation or domicile, subject to the submission of the appropriate documents to the Registry & Paying Agent. Noteholders The Eligible Noteholders who are actual holders of the Notes. Prohibited Noteholders The following persons and entities shall be prohibited from purchasing and/or holding any Notes of the Issuer: (1) subsidiaries and affiliates of the Issuer, including the subsidiaries and affiliates of the Issuer’s subsidiaries and affiliates; or (2) common trust funds/unit investment trust funds managed by the Trust Department of the Issuer, its subsidiaries, and affiliates, or other related entities; or (3) other funds being managed by the Trust Department of the Issuer, its subsidiaries and affiliates or other related entities where (a) the fund owners have not given prior authority or instruction to the Trust Department to purchase or invest in the Notes or (b) the authority or instruction of the fund owner and his understanding of the risk involved in purchasing or investing in the Notes are not fully documented. For purposes hereof, an ‘‘affiliate’’ refers to a related entity linked by means of ownership of at least 20.00% to not more than 50.00% of its outstanding voting stock. Market Makers ING and MIB shall initially perform the functions and duties of the Market Maker pursuant to the BSP Rules. When the Philippine Dealing & Exchange Corp. (PDEx) becomes operational as the fixed-income exchange for these Notes, the Issuer intends to list the Notes in PDEx. Upon listing of the Notes in PDEx, ING and MIB shall cease to act as Market Maker. 25 Secondary Trading All secondary trading of the Notes shall be coursed through the Market Maker, other Selling Agents authorized by the BSP or PDEx (upon the listing of the Notes in PDEx), subject to the payment by the Issuer of the corresponding listing fees, and payment by the relevant Noteholder of the proper fees, if any, to the Market Maker or PDEx, and the Registry. Transferability Negotiations or transfers of the Notes to one other than the Issuer prior to Maturity Date shall not constitute pre-termination. Each Selling Agent (in the case of initial issuance of the Notes) and Market Maker (in the case of negotiations/transfers of the Notes) shall verify the identity and other relevant details of each investor and ascertain that the proposed Noteholder or transferee of a Note is an Eligible Noteholder and is not a Prohibited Noteholder. Final determination shall, however, vest with the Issuer. Qualification Determination The Eligible Noteholder shall immediately submit any and all information reasonably required by the Selling Agents and/or Market Makers with respect to the qualification of the proposed Noteholder or transferee in order to determine that such Eligible Noteholder or transferee is an Eligible Noteholder and is not a Prohibited Noteholder. Status and Subordination The Notes will constitute direct, unconditional, unsecured, and subordinated obligations of the Issuer. Claims of all the Noteholders in respect of the Notes will at all times rank pari passu without any preference among themselves. However, claims of all Noteholders will enjoy priority over the rights and claims of holders of all classes of equity securities of the Issuer, including holders of preference shares, if any. Noteholders or their transferees shall not be allowed, and hereby waive their right, to set off any amount that may be due the Issuer against the Notes. Upon any distribution to creditors of any assets of the Issuer in the event of any insolvency or liquidation of the Issuer, the claims of Noteholders for principal and interest in respect of the Notes shall be subordinated in right of payment to claims (whether actual or contingent, present or future) of all depositors and creditors of the Issuer, except those creditors that are expressly ranked equally with or junior to the Noteholders in right of payment. The Notes, like other subordinated indebtedness of the Issuer, are subordinated to the claims of depositors and ordinary creditors, are not a deposit, and are not guaranteed nor insured by the Issuer or any party related to the Issuer, such as its subsidiaries and affiliates, or the Philippine Deposit Insurance Corporation, or any other person. The Notes shall not be used as collateral for any loan made by the Issuer or any of its subsidiaries or affiliates. 26 Representations and Warranties The Issuer hereby represents and warrants to the Noteholders, as follows: (a) Corporate existence. The Issuer is a corporation duly organized, validly existing, and in good standing under and by virtue of the laws of the Republic of the Philippines, is registered or qualified to do business in every jurisdiction where registration or qualification is necessary, and has the corporate power and authority to conduct its business as presently being conducted and to own its properties and assets now owned by it as well as those to be hereafter acquired by it for the purpose of its business, to incur the indebtedness and other obligations provided for in the Notes. (b) Corporate Approvals and Registrations. All corporate authorizations, approvals, and other acts legally necessary for the offer and issuance of the Notes, for the circulation of the Preliminary and Final Offering Circulars and for the Issuer to enter into and comply with its obligations under the Notes, have been obtained or effected. (c) Government Approvals. All government authorizations, approvals, rulings, registrations, and other acts legally necessary for the offer, issuance, and payment of the Notes, their terms, as may be amended or supplemented, and for the Issuer to enter into and comply with its obligations under the Notes, have been obtained and remain valid. (d) Compliance with Conditions. All conditions imposed or required under the BSP Rules, as well as regulations of the Bureau of Internal Revenue and other relevant agencies, in respect of the offer, issuance, and payment of the Notes, have been or will be complied with by the Issuer as of the date and/or time that they are required to be complied with. (e) Documents/Information. None of the information, data, or submissions made by the Issuer, including those made available to the Noteholders, in connection with the Notes violate any statute or any rule or regulation of any government agency or office, and do not contain any untrue or misleading statement of a material fact, or omit any material fact necessary or required to be stated. (f) Obligations under the Notes. The obligations of the Issuer under the Notes, when issued, constitute the Issuer’s legal, valid, binding, direct, and unconditional obligations, enforceable in accordance with their terms, and the compliance by the Issuer with its obligations under the Notes will not conflict with, nor constitute a breach or default of, the articles of incorporation, by-laws, or any resolution of the board of directors of the Issuer, or any rights of the stockholders of the Issuer, or any contract or other instrument by which the Issuer is bound, or any law, regulation, or judgment or order of any office, agency, or instrumentality applicable to the Issuer. 27 (g) Compliance with Law. The Issuer is compliant with all Philippine laws, statutes, regulations, and circulars, including without limitation the circulars, rules, regulations, and orders issued by the BSP. (h) Compliance with Banking Laws/Regulations. The Issuer has all authorizations, approvals, permits, licenses, and privileges from all governmental and regulatory bodies necessary to carry on its banking business and operations as well as those of its subsidiaries and affiliates as currently conducted; has not violated any of the terms and conditions of such authorizations, approvals, permits, and licenses; and will have free and continued use and exercise thereof. (i) Compliance with BSP. The Issuer has complied with, corrected, and successfully and effectively implemented, to the satisfaction of the BSP, all final findings and recommendations of the BSP resulting from all past audits and examinations conducted by the BSP on the Issuer. (j) Litigation. There are no legal, administrative, or arbitration actions, suits, or proceedings pending or threatened against or affecting the Issuer which, if adversely determined, would have a material adverse effect on the business operations, properties, assets, or financial conditions of the Issuer, or which enjoin or otherwise adversely affect the execution, delivery, or performance of the Notes, or its offer or issuance. (k) Financial Statements. The audited financial statements of the Issuer are in accordance with the books and records of the Issuer, are complete and correct in all material respects, have been prepared in accordance with generally accepted Philippine accounting principles and practices, and fairly represent the Issuer’s financial condition and results of operations. There has been no material change in the financial condition or results of operations of the Issuer sufficient to impair its ability to perform its obligations under the Notes according to their terms. (l) Material Obligations. The Issuer has, as of the date hereof, no liabilities or obligations of any nature, whether accrued, absolute, contingent, or otherwise, including but not limited to tax liabilities due or to become due, and whether incurred in respect of or measured by any income for any period prior to such date or arising out of transactions entered into or any state of facts existing prior thereto, which may in any case or in the aggregate, materially and adversely affect the Issuer’s ability to discharge its obligations under the Notes. 28 (m) Change in Financial Condition. Since issuance of the various approvals by the relevant government agencies for the offer or issuance of the Notes, there has been no change in the financial condition, assets, and liabilities of the Issuer, other than changes that do not, either in any case or in the aggregate, materially and adversely affect the Issuer’s ability to discharge its obligations under the Notes. (n) Default. No event has occurred and is continuing which constitutes a default by the Issuer under or in respect of any agreement binding upon the Issuer, and no event has occurred which, with the giving of notice, lapse of time, or other condition, would constitute a default by the Issuer under or in respect of such agreement, which default shall materially affect the Issuer’s ability to comply with the Notes and pay the principal and interest that may be due on the Notes. (o) Title to Property. The Issuer has good and marketable title to all its properties, free and clear of liens, encumbrances, restrictions, pledges, mortgages, security interest, or charges. (p) Compliance with Law/Taxes. The Issuer is conducting its business and operations in compliance with the applicable laws and regulations, has filed true, complete, and timely tax returns, and has paid all taxes due in respect of the ownership of its properties and assets or the conduct of its operations, except to the extent that the payment of such taxes is being contested in good faith and by appropriate proceedings. (q) Insurance. The Issuer maintains insurance with responsible and reputable insurance companies in such amounts, covering such risks, and under such terms and conditions, as are prudent and appropriate and as are usually carried by companies engaged in similar business and owning similar properties in the same geographical areas as those in which the Issuer operates. (r) Auditor. The Issuer maintains the services of a responsible and reputable external auditor. (s) Offering Circular. The Preliminary and Final Offering Circulars issued in connection with the Notes present a fair, complete, and accurate description of the Issuer, the Notes, and the considerations that any investor in the Notes needs to know before making an informed decision to invest in the Notes. These representations and warranties are true and correct as of the Issue Date and shall remain true and correct as long as the Notes or any portion thereof remain outstanding. 29 Affirmative Covenants The Issuer hereby covenants and agrees that, for as long as the Notes remain outstanding: (a) Payment of Taxes and Lawful Claims. The Issuer shall pay and discharge all taxes, assessments, and government charges or levies imposed upon it or upon its income or profits or upon any properties belonging to it prior to the date on which penalties are assessed; pay and discharge when due all lawful claims which, if unpaid, might become a lien or charge upon any of its properties; and take such steps as may be necessary in order to prevent its properties from being subjected to the possibilities of loss, forfeiture, or sale; provided, that the Issuer shall not be required to pay any such tax, assessment, charge, levy, or claim which is being contested by it in good faith and by proper proceedings or as could not reasonably be expected to have a material adverse effect on its condition, business, or properties; provided, that in the case of a tax, assessment, charge, levy, or claim which is being contested in good faith and by proper proceedings, the Public Trustee shall be notified by the Issuer within 30 days from the date of the receipt of written notice of the resolution of such proceedings. (b) Corporate Existence. The Issuer shall preserve and maintain its corporate existence. (c) Financial Records. The Issuer shall maintain adequate financial records and prepare all financial statements in accordance with generally accepted accounting principles and practices in the Philippines consistently applied and in compliance with the regulations of the government body having jurisdiction over it, and, subject to receipt of a written request within a reasonable period before the proposed date of inspection, permit the Public Trustee or its duly designated representatives to inspect the books of accounts and records pertinent to the compliance by the Issuer of its obligations under the Notes. (d) Compliance with Laws/Contracts. The Issuer shall comply with all the requirements, terms, covenants, conditions, and provisions of all laws, rules, regulations, orders, writs, judgments, indentures, mortgages, deeds of trust, agreements, and other instruments, arrangements, obligations, and duties to which it, its business, or its assets are legally bound, where non-compliance would have a material adverse effect on the business, assets, condition, or operations of the Issuer, or would materially and adversely affect the Issuer’s ability to duly perform and observe its obligations and duties under the Notes. 30 (e) Compliance with BSP Rules. The Issuer shall fully and promptly comply with all final BSP directives, orders, issuances, and letters, including those regarding its capital, licenses, risk management, and operations; promptly and satisfactorily take all corrective measures that may be required under BSP audit reports; and promptly furnish the Public Trustee with a copy of all the audit reports of, and its submissions to, the BSP. (f) Use of Proceeds. The Issuer shall use the net proceeds from the Notes to raise Tier 2 capital to increase and strengthen its capital base (g) Performance of Obligations. The Issuer shall promptly and satisfactorily pay all indebtedness and other liabilities and perform all contractual obligations pursuant to all agreements to which it is a party or by which it or any of its properties may be bound, except those being contested in good faith and by proper proceedings or as could not reasonably be regarded to have a material adverse effect on its business, assets, condition, or operations. (h) Performance of Obligations under the Notes. The Issuer shall pay all amounts due under the Notes at the times and in the manner specified in, and perform all its obligations, undertakings, and covenants under the Notes. (i) Audited Financial Statements. The Issuer shall, as soon as available and in any event within 120 days after the end of each fiscal year of the Issuer, or at such later date on which it makes such information publicly available, furnish the Noteholders through the Public Trustee with audited financial statements, consisting of the balance sheet of the Issuer as of the end of such fiscal year and statements of income and retained earnings and of the source and application of funds of the Issuer for such fiscal year, such audited financial statements being prepared in accordance with generally accepted accounting principles and practices in the Philippines consistently applied and being certified by an independent certified public accountant of recognized standing in the Philippines; and shall furnish the Public Trustee no later than 45 days from the end of each calendar quarter with its quarterly financial statements; and shall further furnish the Public Trustee within 10 days from written request with such updates and information as may be reasonably requested by the Public Trustee pertaining to the business, assets, condition, or operations of the Issuer, or affecting the Issuer’s ability to duly perform and observe its obligations and duties under the Notes. 31 (j) Notice of Litigation and Other Matters. The Issuer shall give to the Noteholders through the Public Trustee written notice of: (i) all assessments, litigation, or administrative or arbitration proceedings before or of any court, tribunal, arbitrator, or governmental or municipal authority affecting the Issuer or any of its assets regarding any claim in excess of P = 100,000,000.00; (ii) any labor controversy resulting or threatening to result in any action against the Issuer that may materially and adversely affect its operations or may result in a strike against it, (iii) any Event of Default or any event, which, upon a lapse of time or giving of notice or both, would become an Event of Default, (iv) any damage or destruction or loss which might materially and adversely affect its assets, business or financial conditions or (v) any other matter or conditions affecting the Issuer or which might have a material adverse effect on the business, assets, condition, or operations of the Issuer, or which might materially and adversely affect the Issuer’s ability to duly perform and observe its obligations and duties under the Notes, immediately upon becoming aware that the same is pending or has been commenced or has occurred. (k) Additional Instruments. The Issuer shall, when so requested in writing, provide any and all information reasonably needed by the Public Trustee to enable it to comply with its responsibilities and duties under the BSP Rules, the Notes, and the Trust Agreement; provided, that, in the event that the Issuer cannot, for any reason, provide the required information, the Issuer shall so immediately advise the Public Trustee. (l) Cease and Desist Order. The Issuer shall promptly advise the Noteholders through the Public Trustee: (i) of any request by any government agency for any information related to the Notes, and (ii) of the issuance by any governmental agency of any cease-and-desist order suspending the distribution or sale of the Notes or the initiation of any proceedings for any such purpose; provided, that no amendments or supplements to any selling materials, offering circulars, or other documents pertaining to the offer of the Notes have been or will be made without the prior written notice to, and without the approval of, the Public Trustee. (m) Suspension Orders. The Issuer shall obtain at its sole expense the withdrawal of any order suspending the transactions with respect to the Notes at the earliest time possible. (n) Maintenance of Records related to the Notes. The Issuer shall ensure that any documents related to the Notes will, at all times, comply in all material respects with the applicable laws, rules, regulations, and circulars, and, if necessary, make the appropriate revisions, supplements, and amendments to make them comply with such laws, rules, regulations, and circulars. 32 (o) Maintenance of Other Records. The Issuer shall execute and deliver to the Noteholders through the Public Trustee such reports, documents, and other information respecting the business, properties, condition, or operations, financial or otherwise, of the Issuer as the Public Trustee may from time to time reasonably require. (p) Notice of Default. The Issuer shall, as soon as possible and in any event within 5 days after the occurrence of any default on any of the obligations of the Issuer, or other event which, with the giving of any notice and/or with the lapse of time, would constitute a default under the agreements of the Issuer with any party, serve a written notice to the Noteholders through the Public Trustee of the occurrence of any such default, specifying the details and the steps which the Issuer is taking or proposes to take for the purpose of curing such default, including the Issuer’s estimate of the length of time to correct the same. (q) SEC/PSE Filings. The Issuer shall make available to the Public Trustee financial and other information regarding the Issuer by filing with the SEC and/or PSE, at the time required or within any allowed extension, the reports required by the SEC and/or PSE, as the case may be, from listed companies in particular and from corporations in general. (r) Services of External Auditor. The Issuer shall maintain the services of its current external auditor and in any event where the current external auditor of the Issuer shall cease to be the external auditor of the Issuer for any reason, the Issuer shall appoint another reputable, responsible and internationally accredited external auditor. Negative Covenants (a) Encumbrances. The Issuer shall not permit any indebtedness to be secured by or to benefit from any Lien in favor of any creditor or class of creditors with respect to any present or future property or the right of the Issuer to receive income, nor will the Issuer permit any creditor to receive any priority or preference arising under Article 2244(14) of the Civil Code of the Philippines over the claims of the Noteholders hereunder, which claims shall at all times rank pari passu in all respects with all other unsecured obligations of the Issuer covered thereunder, provided however, that this restriction shall not apply to: (i) any Lien the benefit of which is at the same time or prior to its creation extended equally and ratably to the Noteholders and all other sums due and to become due from the Issuer under the Notes in a manner and in all respects (including in particular, but without limitation, as to documentation) acceptable to the Majority Noteholders; 33 (ii) any Lien over any asset created or assumed at the time of the purchase by the Issuer of such asset to secure payment of the purchase price of such asset or to secure the payment of any indebtedness in respect of borrowed money (including extensions and renewals thereof and replacements therefore) incurred for the purpose of financing the purchase of such assets; (iii) any Lien created for the purpose of paying current taxes, assessments or other governmental charges which are not delinquent or remain payable without any penalty, or the validity of which is contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof; (iv) any Lien to secure: (a) surety or appeal bonds; (b) bonds for release of attachment, stay of execution or injunction; (c) performance of bids, tenders, contracts (other than for the repayment of borrowed money) or leases in the normal course of the Issuer’s business; (v) Liens on the properties and assets of the Issuer (a) imposed by law, such as carriers’, warehousemen’s and mechanic’s liens and other similar liens arising in the ordinary course of business and not material in amount; (b) arising out of pledges or deposits under workmen’s compensation laws, unemployment insurance, old age pensions or other social security or retirement benefits or similar legislation; (vi) any Lien existing on the date of this Agreement which is disclosed in writing by the Issuer to the Public Trustee or in the Offering Circular or the Issuer’s 2004 audited financial statements; and, (vii) any Lien which secure (x) letters of credit, bid bonds, performance bonds or similar instruments procured by the Issuer in the ordinary course of business, and/or (y) foreign currency and interest rate swap and derivative transactions undertaken by the Issuer in the ordinary course of business. (b) Unauthorized Business. The Issuer shall not engage in any business except that authorized by its Articles of Incorporation. (c) Material Change of Corporate Structure. Except if the Issuer is the surviving entity and provided that such event will have no material adverse effect on the financial condition of the Issuer, the Issuer shall not effect any merger, consolidation or other material change in its ownership, corporate set-up or management or character of business. (d) Sale of Assets. The Issuer shall not sell, transfer, convey, lend or otherwise dispose of all or substantially all of its assets. 34 (e) Loans/Advances. The Issuer shall not extend any loan or advances to its directors and officers, except loans or advances granted pursuant to benefits, compensation, reimbursements, and allowances as may be allowed under existing Issuer policies and practice and such loans and advances as may be allowed under existing laws and regulations. (f) Assignment. Except by way of security as may be permitted above, the Issuer shall not assign, transfer or otherwise convey any right to receive any of its income or revenues except in the ordinary course of its business. (g) Guaranty. Except in the ordinary course of business, the Issuer shall not purchase, repurchase or otherwise acquire, assume, guarantee, endorse or otherwise become directly or contingently liable (including, without limitation, being or becoming liable by way of agreement, contingent or otherwise, to purchase, to use facilities, to provide funds for payment, to supply funds to or otherwise invest in the debtor or otherwise to assure the creditor against loss) for or in connection with any obligation or indebtedness, stock or dividends of any other person. (h) Dividends. The Issuer shall not declare or pay any dividends (other than stock dividends) during an Event of Default or if payment would result to an Event of Default. (i) Treasury Shares/Decrease of Authorized Capital Stock. The Issuer shall not acquire into treasury outstanding shares or decrease or reduce its authorized capital stock during an Event of Default or if such acquisition or decrease/reduction in the authorized capital stock would result to an Event of Default. (j) Suspension of Business Operations. The Issuer shall not voluntarily suspend all or substantially all of its business operations. (k) Payment Set-Offs. Except as otherwise allowed hereinabove, the Issuer shall not grant, in any of its future loan or credit agreements, any creditor any right above and beyond what is provided under Philippine laws to apply amounts on deposit with or in possession of any such creditor by way of set-off in reduction of any amount owing under said loan or credit agreements. 35 (l) Management Contracts and Other Arrangements. The Issuer shall not enter into any management contracts, profitsharing or any similar contracts or arrangements whereby its business or operations are managed by, or its income or profits are, or might be shared with, another person, firm or company, which management contracts, profit-sharing or any similar contracts or arrangements will materially and adversely affect the Issuer’s ability to perform its material obligations under the Notes. (m) Amendment of Articles and By-laws. The Issuer shall not amend its Articles of Incorporation or By-laws if such amendments have the effect of changing the general character of its business from that being carried on at the date hereof. (n) Subordinated Debt. As long as any obligations under the Notes remain outstanding, the Issuer shall not create, issue, assume, guarantee, or otherwise incur any bond, note, debenture, or similar security which shall be or purport to be subordinated obligations of the Issuer, or which shall be considered capital of the Issuer for any regulatory purposes, unless such obligation ranks pari passu with, or junior to, the Issuer’s obligations under the Notes in any proceedings in respect of the Issuer for insolvency, winding up, liquidation, receivership, or other similar proceedings (the Winding-Up Proceedings). The Notes shall not be used as collateral for any loan made by the Issuer or any of its subsidiaries, if any, or affiliates. These covenants of the Issuer shall survive the issuance of the Notes and shall be performed fully and faithfully by the Issuer at all times while the Notes or any portion thereof remain outstanding. Events of Default The Issuer shall be considered in default under the Notes in case any of the following events shall occur: (a) Payment Default. The Issuer fails to pay any principal and/or interest due on the Notes. (b) Representation/Warranty Default. Any representation and warranty of the Issuer or any certificate or opinion submitted by the Issuer in connection with the issuance of the Notes is untrue, incorrect, or misleading in any material respect. (c) Covenant Default. The Issuer fails to perform or violates its covenants under the Notes, and such failure or violation is not remediable or, if remediable, continues to be unremedied for a period of 10 days from notice by the Public Trustee to the Issuer, Provided that the negative covenants specified above shall not be remediable. 36 (d) Other Provisions Default. The Issuer violates any term or condition of any contract executed by the Issuer with any other bank, financial institution, or other person, corporation, or entity for the payment of moneys which constitutes an event of default under said contract; or, in general, the Issuer violates any contract, law, or regulation which (i) if remediable, is not remedied by the Issuer within 10 days from notice by the Public Trustee to the Issuer, or is otherwise not contested by the Issuer, (ii) results in the acceleration or declaration of the whole financial obligation to be due and payable prior to the stated normal date of maturity, or (iii) will, in the reasonable opinion of the Public Trustee, adversely and materially affect the performance by the Issuer of its obligations under the Notes and pay any amount outstanding on the Notes, Provided however that, the Events of Default specified in Items (a), (e), (f) and (g) shall not be remediable. (e) License Default. Any governmental consent, license, approval, authorization, declaration, filing or registration which is granted or required in connection with the Notes expires or is terminated, revoked or modified and the result thereof is to make the Issuer unable to discharge its obligations hereunder or thereunder. (f) Legal Default. It becomes unlawful for the Issuer to perform any of its material obligations under the Notes. (g) Expropriation Default. The government or any competent authority takes any action to suspend the whole or the substantial portion of the operations of the Issuer, or condemns, seizes, nationalizes or expropriates (with or without compensation) the Issuer or any material portion of its properties or assets. (h) Insolvency Default. The Issuer becomes insolvent or is unable to pay its debts when due or commits or permits any act of bankruptcy, including (i) filing of a petition in any bankruptcy, reorganization, winding-up, suspension of payment, liquidation, or other analogous proceeding; (ii) appointment of a trustee or receiver of all or a substantial portion of its properties; (iii) making of an assignment for the benefit of its creditors of all or substantially all of its properties; (iv) admission in writing of its inability to pay its debts; or (v) entry of any order or judgment of any court, tribunal, or administrative agency or body confirming the insolvency of the Issuer, or approving any reorganization, winding-up, liquidation, or appointment of trustee or receiver of the Issuer or a substantial portion of its property or assets. 37 (i) Judgment Default. Any final and executory judgment, decree, or arbitral award for the sum of money, damages, fine, or penalty in excess of P = 100,000,000.00 or its equivalent in any other currency is entered against the Issuer and the enforcement of which is not stayed, and is not paid, discharged, or duly bonded within 30 days after the date when payment of such judgment, decree, or award is due under the applicable law or agreement. (j) Writ and Similar Process Default. Any writ, warrant of attachment or execution, or similar process shall be issued or levied against more than half of the Issuer’s assets, singly or in the aggregate, and such writ, warrant, or similar process shall not be released, vacated, or fully bonded within 30 days after its issue or levy. (k) Closure Default. The Issuer voluntarily suspends or ceases operations of a substantial portion of its business for a continuous period of 30 days, except in the case of strikes or lockouts when necessary to prevent business losses, or when due to fortuitous events or force majeure, and, provided that, in any such event, there is no material adverse effect on the business operations or financial condition of the Issuer. Effects of Default Events The Public Trustee shall, within 3 Banking Days after receiving notice of the occurrence of any Event of Default, give to the Noteholders notice of the occurrence of an Event of Default. If any one or more of the Events of Default shall have occurred and be continuing, after any applicable cure period shall have lapsed, the Public Trustee may, upon the written direction of persons holding at least 51.00% of the aggregate principal amount of the issued Notes (the Majority Noteholders), require the Issuer to perform any act as the Majority Noteholders may reasonably require in order to cure the default as may be allowed under the BSP Rules, without prejudice to any other remedies to which the Noteholders may be entitled; provided, that in case of an Insolvency Default, the Public Trustee shall on its own (i) institute any Winding-Up Proceedings in accordance with applicable laws or perform any act for the enforcement of any obligation under, or collection of the principal and interest on, the Notes on the understanding that the Notes shall be subordinated in the right of payment of principal and interest to all depositors and other creditors of the Issuer, except those creditors expressed to rank equally with, or behind holders of the Notes, and/or (ii) declare the principal of the Notes to be immediately due and payable, without prejudice to the other remedies available to the Noteholders, in accordance with the BSP Rules. Meetings of Noteholders All meetings of the Noteholders shall be held in Makati City upon prior notice. 38 Notice of Meeting of Noteholders Subject to the terms of the Trust Agreement, notice of every meeting of the Noteholders, setting forth the time, place, and purpose of such meeting in reasonable detail, shall be sent by the Public Trustee to the Issuer and to each of the registered Noteholders not less than 15 days nor more than 45 days prior to the date fixed for the meeting and shall likewise be published in at least 2 newspapers of general circulation in the Philippines (with one newspaper being the Philippine Daily Inquirer) for 2 consecutive days at any time prior to the date stated in the notice for the date of the meeting; provided, that all reasonable costs and expenses incurred by the Public Trustee for the proper dissemination of required information on the requested meeting shall be reimbursed by the Issuer within 3 Banking Days from receipt of the duly supported billing statement. Taxation Interest income on the Notes held by Eligible Holders shall be subject to a final withholding tax of 20.00% or such rate as may be provided by law or regulation, which shall be withheld at source. Interest income received by non-resident individuals not engaged in trade or business in the Philippines shall be subject to a final withholding tax of 25.00%. Interest income received by nonresident foreign corporations shall be subject to a final withholding tax of 35.00%. The tax shall be for the account of the affected Noteholder, and shall be withheld at source. The foregoing rates may be subject to further reduction by any applicable tax treaty. However, under the Tax Code, interest income from long-term deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments with a maturity period of not less than 5 years, the form of which shall be prescribed by the BSP and issued by banks only (not by non-bank financial intermediaries and finance companies) to individuals in denominations of Php10,000.00 and other denominations as may be prescribed by the BSP, is exempt from income tax. Provided that, should the holder pre-terminate the deposit or investment before the 5th year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the long-term deposit or investment certificate based on the remaining maturity thereof: 4 years to less than 5 years — 5.00%; 3 years to less than 4 years — 12.00%; and Less than 3 years — 20.00%. 39 Thus, all payments of principal and interest in respect of individual Noteholders who are (i) Philippine citizens; (ii) resident aliens; and (iii) non-resident aliens engaged in trade or business within the Philippines, shall be made free and clear of, and without withholding or deduction for, any taxes, duties, assessments, or governmental charges of whatever nature imposed, levies, collected, withhold, or assessed by or within the Philippines or any authority therein or thereof having the power to tax, unless such withholding or deduction is required by law. In such event, the Issuer shall pay such additional amount as will result in the receipt by such Noteholders of such amounts as would have been received by them had no such withholding or deduction been required. In accordance with Clause D(7)(e) of the BSP Rules, negotiations/ transfers from one Noteholder to another do not constitute pretermination. Banking Day Any day in a week, other than Saturday or Sunday or holidays, when banks are not required or authorized to close in Makati City. 40 CAPITALIZATION OF THE BANK The following table sets out the unaudited capitalization of the Bank and indebtedness of the Bank (i) as of 30 September 2005, and (ii) as adjusted for the proposed issuance of the Notes. This information has been extracted from the unaudited financial statements of the Bank as at and for the nine months ended 30 September 2005. Such unaudited financial statements are not necessarily indicative of the results of the operations of the Bank for the full year. The following selected financial information should be read together with other portions of this Offering Circular. Table 4. Capitalization of the Bank As of 30 September 2005 (Php millions) As adjusted (Php millions) Short-term liabilities Deposit liabilities Bills payable and other liabilities 41,223 1,414 41,223 1,414 Total short-term liabilities 42,637 42,637 Long-term liabilities Deposit liabilities Bills payable and other liabilities Subordinated Notes due 2016 (currently being issued) 5,584 0 5,584 0 2,000 Total long-term liabilities 5,584 7,584 Capital funds Capital stock Surplus Surplus reserves Net unrealized gains/loss on ASS and other investments 1,795 2,435 388 397 1,795 2,435 388 397 Total capital funds 5,015 5,015 53,236 55,236 Total capitalization and indebtedness Source: PSBank Notes: (1) Par value Php10 per share; authorized: 425,000,000 shares; as at 30 September 2005, 179,501,520 shares of common stock were issued and outstanding. (2) Since 30 September 2005, there has been no material change in the capitalization of the Bank. 41 DESCRIPTION OF THE BANK Introduction Philippine Savings Bank (the ‘‘Bank’’) is a thrift bank based in the Philippines. It offers a wide range of banking and other financial products and services, including deposits, loans, treasury, credit card, and trust. It caters mainly to the retail and consumer markets. The Bank is ranked 2nd among the country’s 84 thrift banks in terms of assets as of 30 September 2005 based on data from the Bangko Sentral ng Pilipinas (‘‘BSP’’). The Bank’s total assets were Php45.79 billion and Php53.24 billion as at 31 December 2004 and 30 September 2005, respectively, and total capital funds were Php4.25 billion and Php5.01 billion as at 31 December 2004 and 30 September 2005, respectively. As of end-September, 2005, the Bank has a network of 150 branches nationwide. Of these, 93 branches are strategically located in Metro Manila and 57 are situated outside Metro Manila. The Bank also has 127 ATMs, which are part of the Bancnet consortium. The Bank is listed on the Philippine Stock Exchange (the ‘‘PSE’’) with a market capitalization of Php6.28 billion as of 29 December 2005 with approximately 6.00% of the Bank’s outstanding shares held by the other minority shareholders and the public. As of 30 September 2005, the Bank’s total capital adequacy ratio was 13.54%. History The Bank was established by the late Dr. Guillermo Picache on 30 June 1959 primarily to engage in savings and mortgage banking. Its first head office was located in Quiapo, Manila. In 1973, the Bank’s ownership changed from the Picache family to the Dolor family. In 1983, Metrobank acquired majority share in the Bank, and in 2004 further increased its shareholdings to the present level of 74.23%. In 1991, the Bank was authorized to perform trust functions, and in 1995, was granted a quasi-banking license. In 1994, its shares were listed on the PSE and made it the 1st publicly listed thrift bank in the country. The 1st offering of 25.00% stock rights to the public raised Php602.00 million, and the 2nd, done the following year, provided Php544.00 million, accounting for the 63.00% growth in capital funds. The Bank de Roxas the Bank construed moved its principal office to its current address at the PSBank Center, 777 Paseo corner Sedeno St., Ayala Avenue, Makati City, Philippines in 2003. The website of is www.psbank.com.ph. No information on the website should be considered or as part of the Offering Circular. Strategy of the Bank Throughout its 45 years of operations, the Bank’s philosophy is that of being responsive to its client’s needs. While its capitalization of Php5.00 billion qualifies it to become a commercial bank, the Bank has decided to remain a thrift bank and use its resources to aggressively compete in retail banking. The Bank will continue to harness inherent synergies with Metrobank but will remain resolute in differentiating itself in terms of markets and products. The Bank and Metrobank have distinct core market focus and have agreed on a coherent strategy on market segmentation. Operational synergies are achieved through coordination on branch expansion, sharing of integrated data and ATM infrastructure, coordination on group-wide concentration limits, and maximization of each institution’s competitive advantage such as the credit card business. In 2002, the Bank assembled a new management team with fresh ideas and strong experience in consumer marketing to champion the business platform of becoming the country’s consumer and retail bank of choice. The new team has grown the Bank’s business, 42 guided by more than the traditional banking mindset of harnessing its members’ different fields of expertise and adopting best consumer marketing practices that support the Bank’s vision and objectives. The years 2002 to 2004 were focused on 1) launching key pioneering products backed by customer acquisition programs and expanded customer coverage, 2) designing new and more powerful technology applications that reduced the Bank’s turnaround time, now considered to be the fastest in the industry, in processing of loan applications 3) re-imaging of the Bank, and 4) promoting a customer-centric performance oriented culture. The Bank’s strategy is focused on Service Quality Management, to differentiate the ‘‘PSBank Experience’’ of its customers in an industry where homogenous products and services are on offer. The Bank has been constantly at the forefront of developing new products to widen and expand its customer reach. From 2002, the bank made it simpler than ever for its customers to avail of auto loans via fast approval rates, low interest payments, flexible payment terms and convenient modes of payment. Based on data from the Chamber of Automotive Manufacturers of the Philippines Inc., an association of car manufacturers in the Philippines, the Bank has been able to capture 10.40% share of industry sales estimated at 71,936 units as of end-September 2005. The thrift bank auto loans market is worth Php34.57 billion as of end-June 2005, according to BSP data. During this period, the Bank’s auto loans were at Php8.15 billion, which translates to a market share of 23.58%. Different mortgage and personal loan products have also been launched over the years, all aimed at improving its share in an increasingly competitive market. More specifically, the Bank’s mortgage loan portfolio was at Php6.13 billion in end-June 2005 or approximately 14.26% of the total residential loan market. Total mortgage loans of the thrift bank sector reached Php42.96 billion in June 2005. In 2003, 3 pioneering products were introduced in the market, namely, the Flexi Credit Line (eventually re-launched as Money Card), which is the first and only multi-purpose, no collateral loan accessible via ATM; the Home Credit Line, a revolving credit facility based on the appraised value of a residential collateral; and the Business Credit Line, which provides individual homeowners and small and medium entrepreneurs flexibility and convenience in accessing their revolving credit facilities through personal checks. In 2004, the Bank launched its own credit card, the PSBank Mastercard, and the 3-in-1 Premium Checking Account. Technological applications were the engine powering the Bank’s growth over the past few years. It has put in place continuous system and process improvement projects, which enabled it to deliver faster turnaround time for loan approvals. Today, the Bank offers a 6-hour turnaround time for Auto Loan applications, 3 days for Personal Loans, and 5 days for Home Loans. The Bank invested in the Integrated Loans System (ILS), Integrated Customer Database (ICDB), and the Intranet Loans Application Processing System (iLAPS) to meet increased business volumes and to provide the entire PSBank branch network with quick access to information critical to efficient customer service. Other technology applications that were harnessed include Info Channel, an integrated source of information on any bank-related policy and activity, Operation and Processing Integrated Control System (OPICS) which automated the entire Treasury operations from deal entry to accounting and reporting; Collection and Asset Management System (CAMS) which automated all phases of collection, remedial account management, legal account management, and asset recovery management; PDC.net, a web-based solution that enables the automated management and control of postdated checks; Integrated Financial Accounting System (IFAS), and the Signature Verification System (SVS). In September 2005, the Bank became the 1st bank to fully deploy and launch a new Software Delivery Management System (SDMS) that allows the Bank to update its ATM screens from a central location. SDMS enables the Bank to promote its products, services, on-going promotions, properties for sale, among others, on the ATMs, rather than just providing its clients the facility for dispensing cash and bills payment. 43 The Head Office and Business Units of the Bank have moved to a more accessible area in Makati and a new design for its corporate signage was developed. Both print and TV advertisements were also undertaken to improve product and name recall. In 2005, the following advertising campaigns were carried out: 1) ‘‘Simple lang’’ for Auto Loan, 2) ‘‘Itaga mo sa bato’’ for Home Loan, 3) ‘‘Tulad mo, maaasahan’’ for Money Card, and 4) ‘‘Strictly family matters’’ for PSBank Mastercard. The Bank’s Service Quality Division, in tandem with the newly set up Customer Service Department, focuses on complaints management. In 2006, a ‘‘Complaints Infrastructure’’ will be implemented to further standardize the process and facilitate complaints resolution. Process standardization is on-going in all units of the Bank, including the measurement of efficiency of delivery or turnaround time of each business unit. The Bank also launched 4 major training programs in 2005, namely 1) ‘‘It’s Showtime’’ for selected branches and loan divisions to further improve customer servicing, 2) ‘‘In-Branch Selling Program’’ for all branch personnel to convert operations-oriented branches into strong ‘sales’ teams, 3) ‘‘Corporate Ethics’’ for all Bank employees to strengthen character and integrity, and 4) ‘‘Information Technology Security Awareness Workshop’’ for all staff to maximize technology and automation of operations. Strategic Initiatives From a #4 industry ranking in 2001 in terms of assets, the Bank has grown to become the 2nd biggest thrift bank in the Philippines today. Strategic initiatives have been undertaken to solidify the Bank’s market leadership and sustain growth. However, these anticipated developments are not assured and actual results may materially differ as a result of risks and uncertainties the Bank faces. Achieve Top Industry Standing. The Bank aims to achieve top industry standing in the Thrift Bank sector by 2010 in terms of balance sheet and profitability. The Bank is focusing on generating low cost deposits and maximizing relationship potential through product innovation and cross-selling efforts. By 2010, the Bank aims to make at least 90.00% of its branches profitable. It is also open to the acquisition of loan portfolios or institutions that are similarly placed, provided these are aligned with the Bank’s stated vision and strategy. Redefining Business Divisions. To meet the challenges in an intensely competitive market and to manage the business more effectively, the Bank will continue its initiative of reviewing and reorganizing business unit structures and reorienting management perspective to be more customer-centric. Branch managers and business unit heads are expected not only to profitably manage current business operations but also have an entrepreneurial mindset. Performance is measured against pre-determined Key Result Areas (KRA) that help management and staff focus their efforts on the Bank’s objectives. To equip front liners with tools to meet growth objectives, the Bank continues to invest in product, sales, and customer service training. Sustained Network Expansion. The Bank is firm in its resolve to achieve dominance in the consumer banking industry. Towards this end, it will pursue further network expansion to improve market coverage nationwide through expanding its branch and ATM network and developing eBanking. The Bank aims to have 200 branches in the next 5 years. The bias will be towards key cities or municipalities in the countryside that have untapped sizable levels of deposits and demand for consumer and SME loans. The Bank is also targeting the installation of 180 ATMs by 2008, consistent with its intention of becoming closer to its market. eBanking is another channel for remote, real-time loan and deposit inquiries and applications, requisitions, account statements generation and payments. The project commenced in 2003 and consists of developing and implementing internet and mobile banking services. The Bank’s internet service will be launched in phases over a 3-year period starting in the 2nd quarter of 2006. 44 Optimize Marketing Efforts. Aggressive marketing efforts begin in-branch by providing staff with adequate product and sales training and easy access to information on bank products, policies, and other activities via the in-house Info Channel. In terms of infrastructure, the Bank will maximize the use of its new Software Delivery Management System (SDMS), which allows it to update its ATM screens from a central location. The screens will be used for marketing messages and information dissemination to users of PSBank ATM. In the marketplace, the Bank’s television, radio, and print advertisements will aim to reinforce the Bank’s image as customer-focused in the consumers’ consciousness. Support Initiatives Internal Processes. In 2005, the Bank spearheaded the improvement and streamlining of internal processes to complement business growth. Various surveys were launched to enable the Bank to capture client perceptions and work on exceeding performance expectations. Technology Applications. The Bank will launch Phase I of its Internet service in 2006, and begin planning for its Mobile banking service before 2008. The Bank will also work at a structure where customers can directly apply at the offices of its business partners namely, dealers for Auto Loans, developers for Home Loans, and corporations for Personal and other loans. Up to Php100.00 million in Information Technology (IT) investments are expected yearly to complement powerful key core systems already in place to support its growth strategy. Resource Requirements. Aside from investing in technology, the Bank will continue to invest in the development of its people through continued training on the Bank’s sales culture, new products, risk appreciation, customer service and other development programs. The Bank also has appropriate incentive packages in place to encourage expansion of the marketing channels of the Bank’s products. Product Development, Communications and Marketing. The Bank utilizes various consumer research studies to develop new or enhance existing products and marketing programs. It will continue to maximize the use of customer surveys to measure customer satisfaction drivers such as speed in processing, complaint handling, and problem resolution, and, as a feedback mechanism, to improve customer service. The Bank utilizes external communications to effectively build and reinforce its story among its markets. The Bank has contracted the services of top advertising agencies to launch its advertising campaigns and provide supplemental public relations efforts. Organizational Structure The Bank’s principal business activities are organized as follows: Consumer Banking, Corporate Banking, and Treasury. Organization Structure 45 The table below shows the contribution of each business segment for the period ending 30 September 2005. Table 5. Segment Report (In Php millions) Net interest income and other income Other expenses Income before provision for probable losses and income tax Consumer Banking Corporate Banking 1,672.24 1,381.67 631.34 462.47 264.69 26.91 2,568.27 1,871.06 290.56 168.87 237.78 697.22 Treasury Total Source: PSBank Consumer Banking Group The Consumer Banking Group principally handles individual customer deposits and provides consumer-focused loans, and fund transfer facilities. Its loan products are comprised of loans for mortgage, auto and personal purposes. Retail deposit products include current and savings accounts (CASA) and time deposits in peso and US Dollar. Services offered include bills payment, safekeeping of post-dated checks, among others. The group offers the PSBank Credit Card, the back office operations of which is outsourced to the Bank’s sister company, the Metrobank Card Corporation. Commercial Banking Group Commercial Banking Group principally handles loans and other credit facilities for small and medium enterprises (SMEs), corporate and institutional customers. The banking products and services offered by the group include SME business credit line secured by real estate mortgage, term loans, short-term credit lines, floor stock financing lines, standby letters of credit, domestic letters of credit, and deposit collateral loans. Treasury Group The Treasury Group provides money market, trading, and treasury services, as well as manages the Bank’s funding operations by use of treasury bills, government securities and placements with other banks. The group is composed of the Liquidity and Reserve Management Department, Foreign Currency Deposit (FCDU) Department, Government Securities Trading Department, and Treasury Marketing Department (TMD). Treasury products and services available through the group include peso and USD trading government securities, commercial papers sales and regular foreign exchange transactions. Trust Division The Bank has a Trust Division engaged in trust and fiduciary activities, which include living trust and employee benefit trust. Its agency functions include investment management agreements, escrow agency, and safekeeping and custodianship. Description of Assets and Liabilities of the Bank Loan Portfolio As of 30 September 2005, the Bank’s total gross loan portfolio amounted to Php30.00 billion, representing approximately 56.00% of total assets as of that date. As of 30 September 2005, consumer loans represented approximately 67.00% of the Bank’s total outstanding loans, with commercial lending amounting to approximately 31.00%, and the balance of 2.00% representing loans to other sector. 46 Industry Concentration Thrift banks are provided with more relaxed statutory limits by the BSP. While the BSP requires commercial banks to limit exposure to the real estate industry to 30.00% of its loan portfolio, this level represents a prudential, rather than mandatory, limit to thrift banks. As of 30 September 2005, the Bank has an aggregate risk exposure to the Real Estate sector of 21.23%. The bulk of the Bank’s exposure is in the Other Community, Social and Personal Activities sector with 31.07% of its total loan portfolio, followed by Wholesale and Retail Trade sector with 27.00%. The following table sets out an analysis of the Group’s total loan portfolio by economic activity (in accordance with the BSP criteria): Table 6. Breakdown of Loans by Economic Activity As of 30 September (In Php billions, except for Percentages) 2005 Other community, social, and personal activities Wholesale and retail trade Real estate Agriculture Manufacturing, banks, insurance and other financial institutions Mining and quarrying Others Total % As of 31 December 2004 % 2003 % 2002 % 8.685 7.548 5.934 2.032 31.07 27.00 21.23 7.27 10.94 3.001 5.390 1.590 44.63 12.24 21.99 6.49 8.077 5.316 5.096 1.200 39.76 26.17 25.08 5.91 5.118 2.255 5.958 1.089 30.74 13.54 35.78 6.54 1.570 0.016 2.166 5.62 0.06 7.75 2.025 0.016 1.55 8.26 0.07 6.32 0.105 0.001 0.520 0.52 0.00 2.56 1.005 0.015 1.211 6.04 0.09 7.27 27.951 100.00 24.512 100.00 20.315 100.00 16.651 100.00 Source: PSBank Note: Loans to Other Community, Social, and Personal Activities sector include exposures to private households with employed persons. Breakdown of Loans is net of unearned discount. The Bank monitors its exposure to specific sectors of the economy such as agriculture and small and medium-sized enterprises. BSP regulations currently require all Philippine banks to set aside 25.00% of their loanable funds to the agricultural sector or invest in eligible securities as an alternative form of compliance. As with most banks in the Philippines, the Bank is in compliance with this requirement through its investments in government securities. Likewise, banks are also required to set aside at least 6.00% for small enterprises and 2.00% for medium-sized enterprises (altogether, the ‘‘SMEs’’), of their total loan portfolios. As of September 2005, its loans to small enterprises comprised 30.00% of its loan portfolio while 7.00% was allocated to medium-sized enterprises. Loan Maturity Profile The following table sets out an analysis of the Bank’s total loan portfolio by maturity: Table 7. Breakdown of Loans by Maturity As of 30 September (In Php billions, except for percentages) Due within one year Due within one to five years Due after five years Total 2005 % As of 31 December 2004 % 2003 % 13.431 48.05 6.433 26.24 5.610 27.62 10.665 3.855 27.951 38.16 13.79 100.00 12.025 6.054 24.512 49.06 24.70 100.00 8.955 5.750 20.315 44.08 28.30 100.00 Note: Breakdown of Loans is net of unearned discount. Source: PSBank 47 As of 30 September 2005, the bulk of the Bank’s loan portfolio totaling 86.21% had maturities within 5 years largely accounted for by its core product, which is consumer loans including mortgage and auto loans. The growth in the loan portfolio was a result of intensive marketing efforts complementing new product introductions and technology applications speeding up loan application processing. The medium term profile of the loan portfolio is 50.00% matched by Term Deposits with the balance funded with shorter-dated maturing deposits. Interest Rates As of 30 September 2005, 54.00% of the Bank’s total loan portfolio was on a fixed rate basis while the remaining 46.00% is regularly repriced. The Bank sets interest rates based on the Philippine Treasury Bill rate plus a spread that takes into account its view of the credit risk, interest rates, product types, and tenors. The fixed rate loans are priced based on the prevailing cost of the Bank for its term deposits. Floating rate loans are repriced for interest periods of typically 30 to 90 days with a margin of between 5.00% and 6.00% per annum. Size and Concentration of Loan The Bank monitors its financial exposure to its customers in order to ensure that concentration risk is prudently managed. As of 30 September 2005, the Group’s single largest corporate borrower accounted for 3.00% of the Bank’s total outstanding loan portfolio. As of 30 September 2005, the Bank’s 10 largest borrowers in the aggregate accounted for Php4.08 billion, or 14.00% of its outstanding loan portfolio. All of these are performing. Moreover, 50.00% of these loans will mature in 1 year while the remaining 50.00% will mature between 3 and 10 years. The BSP has set a prudential limit for thrift bank to maintain a financial exposure to any single person or group of connected persons at a maximum of 25.00% of the Bank’s unimpaired capital and surplus, which includes combined capital accounts, paid-in-capital and surplus, but excludes reserves for valuation purposes, liabilities and deferred income tax. As of 30 September 2005, the Bank is in compliance with this single borrower’s limit with all of its loans. The following table sets out a breakdown of the Bank’s total loan portfolio by principal amount as of 30 September 2005 : Table 8. Breakdown of Loans by Principal As of 30 September (In Php billions, except for percentages) 2005 % Less than 1.000 million 1.001 to 2.000 million 2.001 to 3.000 million More than 3.000 million 12.85 4.34 1.48 9.28 45.98 15.53 5.29 33.20 Total 27.95 100.00 Source: PSBank Note: Breakdown of Loans is net of unearned discount. About 61.00% of the Bank’s loans are in the Php2.00 million and below bucket given its focus on consumer loans. This provides a wide diversity of credit risk and avoids over-concentration on a few borrowers. 48 The following table sets out an analysis of the Bank’s total loan portfolio by product: Table 9. Breakdown of Loans by Product As of 30 September (In Php billions, except for percentages) Commercial (corporates and SMEs) Auto Mortgage Personal Others Total 2005 % As of 31 December 2004 % 2003 % 9.30 8.95 6.81 2.23 0.65 33.28 32.03 24.37 7.98 2.34 8.83 7.30 5.77 1.89 0.73 36.02 29.77 23.53 7.70 2.98 8.61 5.59 4.53 0.91 0.67 42.38 27.54 22.29 4.46 3.32 27.95 100.00 24.51 100.00 20.31 100.00 Source: PSBank Note: Breakdown of Loans is net of unearned discount. As of 30 September 2005, 64.00% of the Bank’s total loan portfolio was in consumer loans, of which 56.00% were in auto and mortgage loans. Over the past years, the Bank has deliberately pursued a strategy of de-emphasizing on commercial loans, with a shift in focus on mortgage, auto, and SME loans. The following table provides an overview of the Bank’s loan portfolio by type of borrower: Table 10. Breakdown of Loans by Type of Borrower As of 30 September (In Php billions, except for percentages) 2005 % As of 31 December 2004 % 2003 % Government Private Residents .01 27.94 0.03 99.97 24.51 0.00 100.00 20.32 0.00 100.00 Total 27.95 100.00 24.51 100.00 20.32 100.00 Source: PSBank Note: Breakdown of Loans is net of unearned discount. Security While the BSP does not impose a regulatory limit on any Bank’s unsecured aggregate risk exposure, the Bank has an existing policy to limit its aggregate exposure for total unsecured loans to an amount less than its single borrowers limit (SBL) or 25.00% of its unimpaired capital and surplus. For DOSRI loans, the bank has an unsecured limit equivalent to 30.00% of the total exposure. The Bank is in compliance with this DOSRI limit. 49 The following table sets out a breakdown of the Bank’s total loan portfolio by security as of 30 September 2005. Table 11. Breakdown of Loans by Security As of 30 September As of 31 December (In Php billions, except for percentages) 2005 % 2004 % 2003 % 2002 % Secured Real estate Deposit hold-out Chattel Securities Others Unsecured 21.060 11.079 0.354 8.713 0.695 0.219 6.891 75.35 39.64 1.27 31.17 2.49 0.78 24.65 18.379 10.025 0.444 7.029 0.00 0.881 6.133 74.98 40.90 1.81 28.68 0.00 3.59 25.02 16.008 9.098 0.379 5.413 0.951 0.167 4.307 78.80 44.78 1.87 26.65 4.68 0.82 21.20 13.265 8.120 0.306 3.168 1.592 0.079 3.385 79.67 48.77 1.84 19.03 9.56 0.47 20.33 Total 27.951 100.00 24.512 100.00 20.315 100.00 16.65 100.00 Source: PSBank Note: Breakdown of Loans is net of unearned discount. Credit Management Policies and Procedures Approval Limits and Authorities To properly manage credit risk, select credit officers and committees are assigned authorities to approve credit applications based on their credit expertise and prudence in judgment. The credit limit delegated to credit officers and committees takes into consideration the Bank’s internal credit policies, market competition and regulatory requirements. For consumer loans, all credit proposals undergo a preliminary credit scoring system in iLAPS. The system has a built-in credit-scoring engine that automates the evaluation and approval process based on a pre-defined credit-scoring model. For consumer loans, the entire application process is automated from application up to booking. Loan applications are encoded in HO and branches nationwide and are prescreened using pre-defined credit acceptance parameters. During this process, names are matched against the Bank’s Integrated Customer Data Base (ICDB) and credit checking is done to validate and evaluate information. The system then decides through a built-in credit-scoring engine that employs a behavioral scoring model. Deviations are routed to credit committee members for approval. All approved loan applications are processed for booking by the Loans Operation Group using the iLAPS Documentation Module that interface with ILS for creation of loan account. For commercial loans, the Commercial Banking Group prepares Offering Slips and initially evaluates all credit proposals based on quantitative and qualitative factors. The evaluation is backed up by financial spreads/ratios, bank statement analysis and credit investigation conducted by the Credit Administration Group. These proposals undergo screening and approval processes by the Credit Committee, Executive Committee or Board of Directors in accordance with the approved credit delegations. The internally developed ICDB system facilitates the processing of both consumer and commercial loans. This file contains a consolidated customer database gathered from internal and external sources developed to support the iLAPS and other processing systems of the Bank. Committees Board of Directors. The Board of Directors (‘‘BoD’’) is the Bank’s highest credit approving authority. The BoD is responsible for establishing the Bank’s overall credit risk capacity and delegating authority to Credit Committees in the approval of credit extensions within specified limits. The BoD has authority to approve all types and amounts of credits, up to the Single 50 Borrower’s Limit set by regulatory bodies. It also has sole responsibility over loan approvals to any director, officer, stockholder, and other related interest of the Bank (‘‘DOSRI loans’’) and Restructured Loans. The BoD has delegated limited credit-approving authority to the Executive Committee and the Credit Committee, with the exception of DOSRI and Restructured Loans. Credit items requiring BoD approval must first be presented to the Credit Committee and the Executive Committee for approval and endorsement to the BoD. Executive Committee. The Executive Committee (Excom) reviews and approves substantial loan proposals, recommends additional conditions, requirements and changes in loan applications. It consists of at least 5 members: the Bank’s BoD Chairman, Vice Chairman, and members of senior management including the President and Executive Vice President. Credit Committee. Credit approval is obtained from the collective approval of Credit Committee (Crecom) members. A Crecom, with at least 2 members, is required to approve the Bank’s consumer loans while 3 members are required to approve Commercial and Other Loans. For the latter type of loans, one committee member should have required approving authority. Single signatures are also in place for specific transactions as defined in the credit delegations approved by the BoD. The Crecom is also responsible for recommending DOSRI and restructured loans to the Excom and BoD. Table 12. Loan Approval Limits (In Php millions) Board of Directors Executive Committee President Executive Vice President Branch Banking Group Head Credit Administration Group Head Commercial Credit Evaluation Head Deposit Secured over Php20 million up to Php20 million Php20 million Php10 million Php10 million Php5 million Real Estate Secured over Php25 million up to Php25 million up to Php15 million Php10 million Php3 million Php3 million Php2 million Source: PSBank Asset and Liabilities Committee. The Asset and Liabilities Committee (ALCO) is composed of 12 senior officers with 2/3 being considered a quorum. ALCO oversees the structure of the Bank’s entire Balance Sheet. It is responsible for monitoring and assessing the current business environment. Based on present and projected scenarios, the ALCO decides on the appropriate short- and long-term strategies for the Bank. These scenarios determine pricing matrices for deposit and loan products. Its members include the President and all senior officers Risk Management Committee. The Risk Management Committee (RMC) consists of 3 members of the BoD with a 7-member sub-committee comprising of the President, Audit Head, Compliance Head, Operations Head, Credit Head, Treasury Head, and Risk Management Head. It is responsible for the development and oversight of the Bank’s risk management process. Core responsibilities of the RMC include identification and evaluation of risk exposures, developing risk management strategies, implementing a risk management plan, and reviewing and revising these plans as needed. Audit Committee. The Audit Committee is composed of 3 Board members and the Internal Audit Head. The committee is responsible for emphasizing the importance of maintaining a sound system of internal control and the BoD’s oversight responsibility. The committee provides oversight of the Bank’s internal and external auditors, reviews their reports and reports of regulatory agencies, and ensures that management is taking appropriate corrective actions in a timely manner. All regular and special audits are reported to the Audit Committee and to the BoD during its monthly meetings. Trust Committee. The Trust Committee supervises the proper exercise of the Bank’s fiduciary powers with respect to the establishment of overall principles and policies, including those for general administration, investment policies, new business derivation and major 51 assignments of functional responsibility. It is responsible for direction and review of affairs and actions of all officers and employees designated by the Committee in exercise of its fiduciary powers. The Committee meets at least quarterly or as the need arises. The Trust Committee is composed of the President, Trust Officer and 3 Directors appointed by the BoD. Corporate Governance Committee. The Corporate Governance Committee (CGC) ensures the BoD’s effectiveness and due performance of corporate governance principles and guidelines. It supervises the periodic performance evaluation of the BoD, its committees and executive management. The CGC shall decide the manner by which the BoD’s performance may be evaluated and propose, for the BoD’s approval, an objective performance criteria to address how it has enhanced long-term shareholder value. Loan Administration and Loss Provisioning The Bank adheres to the general BSP guidelines in administering and classifying loans. Accordingly, the Bank’s loan portfolio is grouped based on risk profile into Classified and Unclassified accounts. Classified accounts are loans considered to have a higher risk than normal. Classified accounts are further subdivided into: Loans Especially Mentioned. These are loans and advances that are superior in quality to those classified as substandard but have potential weaknesses which if uncorrected may expose the Bank to greater credit risks, and thus, require closer management supervision. Substandard Loans. These are loans and advances or portions thereof which appear to involve a substantial and unreasonable degree of risk to the Bank because of unfavorable record or unsatisfactory characteristics. There is a possibility of future loss to the Bank unless given close supervision. Those classified as ‘‘Substandard’’ must have a well-defined weakness or weaknesses that jeopardize their liquidation. Such weaknesses may include adverse trends or development of financial, managerial, economic or political nature, or a significant weakness in collateral. No loans/advances are classified ‘‘Substandard’’ if repayments/collections seem reasonably assured. Doubtful Loans. These are loans and advances or portions thereof which have the weaknesses inherent in those classified as ‘‘Substandard’’, with the added characteristics that existing facts, conditions, and values make collection or liquidation in full highly improbable and in which substantial loss is probable. Loss Loans. These are loans and advances or portions thereof which are considered uncollectible or worthless and of such little value that their continuance as bankable assets is not warranted although the loans may have some recovery or salvage value. The amount of loss is difficult to measure and it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be obtained in the future. In accordance with BSP guidelines, the Bank appropriates specific loan loss allowance as follows: Table 13. Loan Loss Allowances Credit Classification % Reserves Loans Especially Mentioned Substandard — Secured — Unsecured Doubtful Loss 5 10 25 50 100 Source: PSBank The Bank is in compliance with these loan loss allowances. 52 The table below is a summary of the risk classification of the aggregate loan portfolio (as a percentage of total outstanding loans) and allowance for probable loan losses of the Bank: Table 14. Loan Portfolio Risk Classifications As of 30 September (In Php billions) 2005 % As of 31 December 2004 % 2003 % Risk classifications: Especially mentioned Substandard — Unsecured — Secured Doubtful Loss Total Classified Unclassified 0.17 0.60 0.22 0.91 0.41 2.02 0.31 1.09 0.02 0.77 2.36 25.59 1.10 3.92 0.08 2.77 8.46 91.54 0.36 1.32 0.02 0.45 2.38 22.13 1.47 5.39 0.09 1.84 9.71 90.29 0.30 0.53 0.22 0.23 1.69 18.63 1.46 2.59 1.09 1.14 8.30 91.70 Total 27.95 100.00 24.51 100.00 20.31 100.00 Allowance for probable loans losses: Specific General 0.88 0.27 76.89 23.11 0.64 0.22 74.01 25.99 0.49 0.17 73.80 26.20 Total 1.15 100.00 0.86 100.00 0.66 100.00 Source: PSBank Note: Breakdown of Loans is net of unearned discount. Real estate collaterals are appraised bi-annually. The following table sets forth details of the Bank’s non-performing loans, ROPOA, nonperforming assets (as described below), restructured loans, and write-offs for loan losses for the specified periods: Table 15. Non-Performing Assets and Corresponding Allowances As of 30 September (In Php millions) 2005 (1) Non-performing loans Total loans (net of unearned discounts) NPL as a percentage of total loans (%) ROPOA — gross Non-performing assets NPA as a percentage of total resources — ADB (%) NPA as a percentage of total loans and ROPOA (%) Allowance for probable loan losses Allowance for probable losses (ROPOA) Allowance for probable loan losses as a percentage of total non-performing loans (%) Allowance for probable losses as a percentage of total non-performing assets (%) Total restructured loans 53 As of 31 December 2004 2003 2002 1,754 27,951 6.28 1,890 3,644 1,496 24,511 6.10 1,815 3,311 1,147 20,314 5.65 1,862 3,009 1,294 16,650 7.77 1,637 2,931 7.14 8.34 9.82 12.00 12.21 1,150 114 12.58 862 81 13.57 663 194 16.03 839 34 65.58 57.64 57.84 64.83 34.70 772.10 28.48 1,021.60 28.49 1,235.80 29.80 1,323.40 (1) Based on the old BSP definition. The BSP issued Circular No. 351 in September 2002 allowing banks that have no unbooked valuation reserves to exclude from non-performing classification loans classified as ‘‘loss’’ in the latest examination of BSP which are fully covered by allowance for probable loan losses, provided that interest on said loans shall not be accrued. As of 30 September 2005, NPLs fully covered by allowance for probable losses amounted to Php325.60 million. Source: PSBank Loans are classified as past due if (i) any repayment of principal at maturity or any scheduled payment of principal or interest due quarterly (or longer) is not made when due or when the total amount of arrearages reaches 20.00% of the total outstanding balance of the loan regardless of the number of installments in arrears, and (ii) in the case of any principal and interest due monthly, if the amount due is not paid and has remained outstanding for three months or when the total amount of arrearages reaches 20.00% of the total outstanding balance of the loan regardless of the number of installments in arrear. In the case of (i), loans are considered non-performing if the payment is not made within 90 days. In the case of (ii), such loans are considered non-performing upon the occurrence of the default in payment. Loans, which have been foreclosed or transferred to the ROPOA account, are no longer classified as ‘‘non-performing’’ loans. Accrued interest arising from the loan accounts are classified according to the classification of their corresponding loan accounts except for those which remain uncollected after 6 months from the date such loans or installments have matured of have become past due for which a 100.00% allowance is set up for uncollected accrued interest receivables. Loans are restructured on a case-to-case basis. In accordance with BSP guidelines, NPLs, which are successfully restructured, are considered current and no longer non-performing, in general, following a seasoning period of 6 consecutive payments on the restructured loan. Restructured accounts are considered NPL again if payment is not made a day after the due date. As of 30 September 2005, the Bank had a portfolio of Php772.00 million of restructured loans, of which Php418.00 million are considered performing while the remaining Php354.00 million were non-performing. The following table sets out the Group’s reconciliation of its non-performing loans over the periods indicated: Table 16. Movements in NPLs As of 30 September (Php millions, except percentages) 2005 Balance at beginning of period Additions Deductions: (Recovery/Cash Foreclosure) Paid/Reversed to current status Balance at end of period Source: PSBank 54 % As of 31 December 2004 % 1,496 878 (620) 85.29 50.06 (35.35) 1,147 849 (500) 76.67 56.75 (33.42) 1,754 100.00 1,496 100.00 The following table sets out the Bank’s reconciliation of its balance of reserves for loan losses over the periods indicated: Table 17. Reserves for Loan Losses As of 30 September (Php millions, except percentages) Balance at beginning of period Additions charged to expense Charge-off Reversal and others Balance at end of period 2005 % As of 31 December 2004 % 2003 % 862.28 74.95 663.42 76.94 839.02 126.47 288.20 0 0 1,150.48 25.05 — — 100 198.86 0 0 862.28 23.06 — — 100 0 0 (175.60) 663.42 — — (26.47) 100 Source: PSBank Sectoral analysis of non-performing loans The following table sets out the Bank’s gross non-performing loans by the respective borrowers’ industry or economic activity and as percentage of the Bank’s gross NPLs: Table 18. Breakdown of NPLs by Sector As of 30 September (In Php millions, except percentages) 2005 Manufacturing Wholesale and retail trade Financing, insurance and other business services Real estate Other community, social, and personal activities Mining and quarrying Agriculture Others (1) Total % 19.42 86.25 6.09 110.22 778.19 0.03 13.19 740.91 1.11 4.92 0.35 6.28 44.36 0.00 0.75 42.23 1,754.30 100.00 Source: PSBank (1) Others include employee loans, deposit-collateralized loans, post-dated checks rediscounting. As of 30 September 2005, the Bank had no DOSRI loans that are non-performing. Top 10 NPLs As of 30 September 2005, the Bank’s top 10 NPLs amounted to Php408.52 million representing 23.29% of total NPLs. The next 10 accounted for only Php82.57 million or 4.71% of total. As of 30 September 2005, the Bank’s largest NPL amounts to Php157.68 million or 8.99% of total NPLs. Remedial Management The Bank has a Remedial Management Group (‘‘RMG’’) that manages and administers problem loan accounts and ROPOA. RMG seeks to maximize the recovery of loans through continued payments, rehabilitation of problem accounts or through alternative means of payment. 55 The RMG manages the entire remedial cycle from normal collection, account management, loans litigation, foreclosures and ROPOA management. It is supported by a system that automatically triggers classification of these accounts based on pre-set criteria. The Bank has also been conducting a monthly review of the iLAPS and has revised its credit model to make credit parameters more in line with its current market experiences. Technology, which enables RMG to generate the delinquency profile of the Bank, is being harnessed to speed up collection. Processes are being improved to integrate asset recovery efforts under one functional group which is RMG. An internal legal counsel provides RMG with any legal assistance that may be required for ROPOA management. Foreclosure and Disposal of Assets The following table sets out the movement in the Bank’s ROPOA (gross of allowance): Table 19. Movements in ROPOA As of 30 September (Php millions, except percentages) 2005 % As of 31 December 2004 % 2003 % Balance at beginning of period Additions Sold/Disposed 1,734 461 (419) 97.64 25.96 (23.59) 1,668 420 (354) 96.19 24.22 (20.42) 1,602 322 (256) 96.04 19.30 (15.35) Balance at end of period 1,776 100.00 1,734 100.00 1,668 100.00 Source: PSBank The Bank had a net ROPOA of Php1.73 billion and Php1.78 billion as of 31 December 2004 and 30 September 2005, respectively, consisting of various real estate properties and automobiles. The Bank has a centralized collection infrastructure under its Remedial Management Group (RMG) that manages all loans on a bankwide basis. This has resulted in improved delinquency and NPL levels, consistent and quality implementation of collection processes, higher cost efficiency as branches and other business units were unloaded of their collection functions, and stronger controls and productivity monitoring. The Bank’s end-to-end remedial management system integrates all units and processes involved in the remedial cycle. These units include Collections, Special Accounts Management, Loans Litigation and Asset Recovery. RMG implements an intensive portfolio management process using the bucket collection approach, accelerated legal and foreclosure processes, outsourced collection for skips and hardcore accounts under a ‘‘no cure, no pay’’ scheme, short messaging system (SMS) for collection purposes, and quota and rewards system for collection productivity. The group is also in the process of building a robust collection and asset management system (CAMS) to further improve productivity and efficiency using advanced features such as automated cycle flows and workflow grids, parametric work loadings, SMS interactive connectivity, and online productivity monitoring. Securities Portfolio There are 3 types of investment securities — Available For Sale (AFS), Trading Account Securities (TAS) and Hold to Maturity (HTM). Securities are classified as AFS when purchased and held indefinitely, but which the Bank anticipates to sell in response to liquidity requirements or in anticipation of changes in interest rates or other factors. TAS consists of government and private debt securities purchased and held principally with the 56 intention of selling them in the near term. HTM are debt securities where the Bank has the positive intent and ability to hold to maturity. The Bank’s investment securities are comprised mostly of AFS. As of 30 September 2005, the Bank’s AFS amounted to Php12.77 billion, or 75.03% of the Bank’s total investment securities. The table below compares the book value of the investment securities to their market value as of 30 September 2005. Table 20. Breakdown of Securities Portfolio as of September 30, 2005 (In thousands) Book Value TAS (Php) AFS (Php) HTM (Php) 127,395 12,770,136 4,122,808 Market Value 127,302 13,164,870 4,366,177 Source: PSBank Both TAS and AFS are carried in the Bank’s books at fair market value. While HTMs are carried at amortized cost, the Bank does a mark-to-market review of its portfolio monthly. As of 30 September 2005, there was no impairment in the value of the Bank’s investment securities. The Bank’s AFS and HTMs are primarily invested in low risk and largely liquid assets in Peso and US Dollar ROP bonds. As of 30 September 2005, Php2.97 billion of AFS and Php2.17 billion of HTM were invested in Peso sovereign bonds and USD175.13 million and USD34.82 million, respectively in US Dollar sovereign bonds. Funding and Liquidity Overview Savings, demand, and time deposits primarily provide the Bank’s funding. Of the total amount of deposits of Php46.81 billion as of 30 September 2005, these amounted to 21.84%, 11.68% and 66.48%, respectively. The Bank also sources part of its funding requirements from the interbank market from time to time, particularly in periods of high liquidity that generally results in lower overall funding cost. 57 Sources of Funding Deposit liabilities are the primary source of funding for the growth in the Bank’s assets. Growth in deposits has been attributed to intensified efforts to bring in new depositors, products and branches in recent years. There is no concentration or reliance on deposits of a single entity or individual. Around 90.00% of total deposit liabilities have outstanding balances of less than Php50.00 million, which represent stable deposits. The Bank also sources funds in the interbank market. The following table sets forth the principal sources of funding and the average cost of each funding source: Table 21. Funding Sources (In Php ’000) For the nine months ended Sep 2005 Average Cost (%) For the year ended Dec 2004 Average Cost (%) For the year ended Dec 2003 Average Cost (%) Deposits By Type Demand Savings Time 30 to 90 91 to 180 Over 180 Total 5,468,626 10,221,021 31,117,574 15,634,634 7,168,726 8,314,214 46,807,221 3.41 4.00 5.35 2,071,542 24,247,860 13,926,182 6,015,315 2,899,623 5,011,244 40,245,585 2.08 5.55 4.62 715,858 20,716,617 6,340,215 2,696,949 832,689 2,810,577 27,772,689 0.06 4.87 4.76 By Currency Peso Foreign Total 34,445,611 12,361,610 46,807,221 5.36 3.02 4.75 29,941,297 10,304,288 40,245,585 5.83 2.99 5.14 23,368,445 4,404,244 27,772,689 5.12 2.33 4.72 Source: PSBank The Bank has successfully grown its deposits by 45.00% to Php40.24 billion as of 31 December 2004 and by 16.00% to Php46.81 billion as of 30 September 2005. While the cost of deposits have largely been driven by interest rate movements, the Bank’s average cost of deposits remains relatively low as it is driven by the continued rise in the share of checking and savings accounts (‘‘CASA’’) to total deposits. The Bank will continue to focus in growing its CASA through launching new deposit products. The maturities of the Bank’s funding portfolio allow funding stability and liquidity and achieve the targeted loan and deposit maturities profile. The Bank’s deposits are typically rolled over on maturity, effectively providing the Bank with a stable base of liquidity. Liquidity — Regulatory Requirements Currently, peso deposits and deposit substitutes are subject to 6.00% statutory and 2.00% liquidity reserve requirements. At least 25.00% of the statutory reserve requirement must be deposited with the BSP, which earns 4.00% interest per annum. The balance of 75.00% may be in one or a combination of deposits with the BSP, cash at hand and/or in vault of the Bank. All of the liquidity reserve may be held in the form of BSP-eligible Government securities. In connection with foreign currencies, the BSP requires banks to maintain an asset cover of 100.00% for foreign currency liabilities, of which 30.00% must be in liquid assets. Risk Management The Bank is committed to applying the best market practices for risk management by adopting the recommendations and guidelines of the relevant regulators and advisory bodies. The Bank believes the ability to develop and maintain sufficient risk management skills in monitoring, interpreting, and forecasting its risk profile will be an important factor in its future success and building shareholder value. This focus has several components including 58 comprehensive risk management processes, accurate risk measures, investments in people and technology to interpret and manage risk, stress testing and comprehensive process reviews in connection with internal auditors and regulatory officials. The Bank’s risk management structure is a top-down organization that commences with the Board of Directors (BoD). The Bank’s Executive Committee (Excom) is in charge of reviewing and approving substantial loan proposals up to its credit limit per approved delegation, recommending additional conditions and requirements on applications for approval of the BoD. Senior management is actively involved in planning, approving, reviewing, and assessing all risks involved through the following committees: Credit Committee for credit risks; Asset and Liabilities Committee (ALCO) for structural interest rate and liquidity risks; Risk Management Committee (RMC) for overall risk management, including trading market risk; Audit Committee for operations risks. These committees serve as a mechanism for taking a panoramic view across products and counterparties on and off the balance sheet of risks in the Bank’s day-to-day business activities. The Bank’s risk management organization is comprised of the Board of Directors (BOD), Committees for Risk Management, Credit, Assets and Liabilities and Audit, the Risk Management Unit, Internal Audit and Compliance Unit. Committee Membership Primary Duties Frequency of Meetings Board of Directors Full Board, President/ CEO Monthly Overall credit policies; Approval of all DOSRI and restructured loans regardless of amount; Approval of Board strategies and policies; Approval of risk management strategies and policies; Approval of loan proposals up to its credit limit which is the Bank’s Single Borrowers’ Limit Executive Committee Chairman, Vice Chairman, President, Executive VP, AVP, Secretary Bi-monthly Reviewing substantial loan proposals up to its or as credit limit and all loans needed for endorsement and approval by the Board of Directors Credit Committee President, Executive VP, Credit Administration Head, Remedial Management Head, SFVP Area Head Reviewing loan proposals Weekly and recommending additional conditions, requirements, changes on loan applications up to its credit limit and all loans for approval by the Excom and Board of Directors 59 Committee Frequency of Meetings Membership Primary Duties Asset and Liabilities Committee President, Executive VP, Chief Operating Officer, Chief Finance Officer, Treasury Head, Branch Banking Head, Commercial Banking Head, Marketing and Communications Head, Mortgage Banking Head, Auto Loans Division Head, Personal Loans Head, Risk Management Head Overseeing the Bank’s balance sheet structure and deciding on appropriate structural mismatch, liquidity and other asset and liability positions; ensuring effective management of the Bank’s liquidity risks Risk Management Committee 3 members of the Board with a supporting management-level subcommittee comprised of the President, Audit Head, Compliance Head, Operations Head, Credit Head, Treasury Head, Risk Management Head Formulating policies and Monthly strategies to manage and limit the Bank’s risks and recommending limit on decision making authority Audit Committee Monthly 3 members of the Board, Responsible for Internal Audit Head emphasizing the importance of maintaining a sound system of internal control and the Board of Directors’ oversight functions Trust Committee President, Trust Officer, 3 Responsible for members of the Board establishing fiduciary policies and principles and monitors all trust activities of the Bank Corporate Governance Committee Meet as 4 members of the Board, Ensure that the Necessary conditions whereby the 3 of whom should be Independent members bank’s Board of Directors and management acts are in the interest of the firm and its shareholders. Weekly Quarterly Risk Management Unit The Risk Management Unit (RMU) is a separate and an independent business function within the Bank that has no risk-taking functions. It is the central resource for quantifying and managing the portfolio of risks taken by the Bank as a whole. The RMU analyzes, implements, maintains, develops, and communicates the RMC-approved risk management frameworks. It also supports the ALCO and RMC in the performance of their responsibilities and in reporting risk exposures to the BoD. 60 Treasury The Treasury Group supports the ALCO by providing timely market information and executes ALCO policies and decisions. It identifies profit opportunities, takes commensurate risk positions, and actively monitors, evaluates and adjusts those positions in line with the Bank’s objectives. Credit Risk Management Credit risk is the risk that obligations will not be repaid on time and in full as contracted, resulting in a financial loss. It is the broadest category of risk in the bank and is closely linked with other risk categories. Exposure to credit risk arises primarily from lending, sales and trading activities. Managing credit risk has both qualitative and quantitative aspects. Credit officers must evaluate the credit quality of the counter parties while an automated system assigns an internal credit score on loan applications. The Bank conducts a portfolio review that focuses on collections and classification of accounts. The portfolio collections review also includes identification of delinquent accounts and accounts to be written off. The classifications review involves a credit re-evaluation and remedial management. Credit portfolio review is an ongoing activity done monthly. The latest credit portfolio review was concluded in September 2005, resulting in changes in the internal classification of some accounts due to delinquency, write-off level and some qualitative factors. Credit process review has been incorporated into the bank’s credit administrative and internal audit functions. In managing credit risks, the Bank also estimates potential losses associated with credit exposures. This process involves some judgment and considers a number of variables including the credit quality of counter parties, tenor of the Bank’s credit exposure, default probabilities and their volatilities, collateral values, expected recovery rates in the event of default as well as the diversification across counter parties and industries. Credit approval limits are established in the Delegation of Credit Authority manual. Continued monitoring, evaluation, and supervision of credit risks is undertaken by the Credit Administration Group, taking into account policies and guidelines established by senior management. These limits are recommended by the ExeCom and approved by the BoD. Market Risk Management Market risk is the risk that the Bank’s earnings decline, either immediately or over time, as a result of a change in market factors. The level of market risk to which the Bank is exposed varies continually as a result of changing market expectations and changing market conditions as well as the composition of the Bank’s trading and non-trading portfolios. The Bank marks-to-market its trading portfolio to determine end of day profit & loss and monitor stop-losses. To enhance the management of market risk exposures, the Bank uses Daily Value-at-Risk (DVaR) to measure the possible maximum loss in the market value of its trading portfolio. Only the BoD, or its delegated authority, can approve Strategic Limits for the Bank. The Treasury Head has the authority to design and approve detailed sub-limits within the parameters established by RMC. RMC, supported by RMU, is responsible for managing the trading market risk of the Bank. It aims to ensure that the Bank’s trading market risk position conforms to policies and risk appetite of the Bank. 61 Structural Interest Rate Risk Management and Sensitivity ALCO has the responsibility for managing structural interest rate exposure of the Bank. Its primary focus is to achieve a desired overall interest rate profile, which may change over time based on management’s long-term view of interest rates and economic conditions. ALCO, with the support of RMU, reviews the composition of the Bank’s assets and liabilities including interest rate mismatch positions. The Bank maintains a prudent policy in managing its assets and liabilities to ensure that exposure to fluctuations in interest rates is kept within acceptable levels. A substantial portion of the Bank’s loan portfolio is on a fixed rate based on an internal transfer-pricing rate reflective of market sources of funding. The average yield on loans as of 30 September 2005 is 13.50% while the average cost of deposits is 4.75%. The spread varies for various types of peso loans and, as of 30 September 2005, averaged 6.39%. Commercial loans are repriced every 30, 60 or 90 days while revolving loans are repriced every 30 days. Mortgage loans are priced almost yearly. Personal and auto loans are not repriced once granted. The primary tool to measure the bank’s structural interest rate risk is the monthly interest rate sensitivity gap report. The report also shows balance sheet positions together with performances of the Bank’s major products. The interest rate gap profile is then subjected to scenario analysis, which measures the impact of interest rate movements on gain/loss assumptions. Liquidity Risk Management Liquidity means having available funds at all times to meet promptly all maturing liabilities, including demand deposits and off-balance sheet commitments. Liquidity Risk relates to the Bank’s ability to generate sufficient cash or equivalents from internal or external sources, in a timely and cost-effective manner, to meet its commitments as they fall due. Mismanagement of liquidity will have quicker and more severe repercussions than errors in managing other risks. The Bank’s objective in liquidity management is to ensure that the Bank has sufficient liquidity to meet obligations under normal and adverse circumstances and is able to take advantage of lending and investment opportunities as they arise. ALCO and the RMC, supported by RMU, are responsible for managing the liquidity of the Bank. As of 30 September 2005, the scheduled maturity of the Bank’s investments securities is as follows: Table 22. Maturity of Investment Securities as of 30 September 2005 Tenor % 1 to 5 years 5 to 10 years Over 10 years 35.80 63.43 0.76 Source: PSBank The Bank’s funding comes from its retail clients in the form of savings, current and time deposits. Although majority of the Bank’s customer deposits are short-term, these are typically rolled over at maturity, effectively providing the Bank with a source of long-term funds. 62 Operational Risk Management Operations risk is the risk to earnings or capital arising from problems with service or product delivery. This risk is a function of internal controls, information systems, employee integrity and operating processes. Operations risk has a very broad category that encompasses ‘‘any risk not categorized as market, structural interest rate, liquidity, or credit risk’’. Although presently unpredictable quantitatively, these types of risks may still cause severe impact on the Bank’s profit and loss, and must be controlled primarily by processes and procedures. Key factors in mitigating these risks are the development of both a strong ‘‘control culture’’, and an effective internal control system that constantly monitors and updates operational policies and procedures of the Bank’s activities and transactions. The Bank’s Audit Committee, supported by the Internal Audit Department, has the responsibility of managing operations risks. Other Risks Legal Risk. Legal risk covers the potential for the Bank to suffer a financial loss due to nonexistent, incomplete, incorrect, and unenforceable documentation used by the Bank to protect and enforce its rights under contracts and obligations. This risk is closely related to credit risk as it most often involves legal problems with counterparties to the Bank’s transactions. A legal review process, performed by the Legal Department, is the primary control mechanism for legal risk. Other than just validating the existence, propriety and enforceability of documents, the review also aims to verify the capacity and authority of counterparties and customers to enter into transactions. Regulatory Risk. Regulatory risk (also referred to as Compliance Risk) covers the potential for the Bank to suffer a financial loss from changes in laws, monetary, tax, or other governmental regulations of a country. This risk is increased in highly regulated jurisdictions, and especially in turbulent market conditions when rules and regulations are constantly changing. It is an important qualitative risk that must be monitored and managed, as regulatory sanctions from non-compliance, especially in extreme cases, may involve not just mere loss of reputation or financial penalties, but a revocation of banking charter or franchise. The Bank’s Compliance functions are implemented by the Compliance Officer, who has the responsibility to maintain an on-going monitoring and assessment of regulations, especially in dynamic regulatory environments. Successful programs have the characteristic of clear communication and rapid dissemination of new rules and regulations to all units, timely analysis and addressing of all compliance issues, periodic and consistent compliance testing for all products, and timely, clear and consistent reporting of compliance findings to the Audit Committee. Personnel Risk. Personnel risk covers the Bank’s risk of financial loss due to the inadequate training, inexperience or illegal activities of risk-taking and other personnel. It highlights the human side of risk-taking, role and adequacy of institutional trading guidelines, codes of conduct, personnel policies, and training and development programs in overall bank risk management. Business Continuity Plan The Bank’s operations are substantially automated with adequate safeguards to guarantee business continuity during unforeseen events. It has designated a business recovery center in another office building, not only as compliance to BSP regulations, but to affirm its commitment to ensure continuous business and system operations in any kind of disaster scenario. A Business Continuity Exercise was conducted in early September 2005 to test critical systems, part of an annual exercise to ensure all critical systems continue operating even during unforeseen events. All business units have dedicated resources to update the bank’s Business Continuity Manual that covers back-up procedures, recovery procedures, 63 database synchronization procedures, systems hardware inventory, application inventory and database allocation. The BSP has also given the Bank a certificate of substantial compliance to minimum requirements provided under current regulations. Corporate Governance In compliance with the requirements of SEC Memorandum Circular No. 2 dated 5 April 2002, the Bank submitted on 22 July 2002 its Code of Corporate Governance, which institutionalizes the principles of good governance in the Bank. In observance of the provisions of the Code of Corporate Governance, the Bank’s BoD designated Paterno Satur as Compliance Officer of the Bank per approval of the Monetary Board. As Compliance Officer, Mr. Satur established an evaluation system to determine and measure compliance with the Code of Corporate Governance. Capital Adequacy The Bank’s capital funds as of 30 September 2005 amounted to Php5.01 billion. The Bank’s capital ratio (the ratio of total capital to risk weighted assets) was 13.54%. This remains above the BSP minimum requirement of 10.00% and the international standard of 8.00%. The following table sets out the capital adequacy ratios of the Bank as of the dates indicated: Table 23. Capital Adequacy Ratios As of 30 September (In percent) As of 31 December 2005 2004 2003 Core Capital Ratio (Tier 1) 12.67 12.49 13.33 Total Capital Adequacy Ratio 13.54 12.46 13.30 Source: PSBank The following table sets out a breakdown of the Bank’s capital base by category of capital as of the dates indicated: Table 24. Capital Base by Category As of 30 September As of 31 December (In Php thousands) 2005 Tier 1 Capital Paid-up common stock Surplus Surplus reserves Undivided profits Deductions from Tier 1 Unsecured DOSRI Deferred income tax Goodwill Net Tier 1 capital General Loan Loss Provisions 4,617,583 1,795,015 2,006,676 388,107 427,785 (748,029) (345,201) (384,141) 18,687 3,869,554 265,607 4,270,035 1,795,015 1,601,356 388,111 485,553 (749,723) (434,072) 285,693 29,958 3,520,312 224,399 3,892,183 1,795,015 1,286,365 339,556 471,247 (754,937) (547,215) 159,664 48,058 3,137,246 218,204 Total Gross Qualifying Capital Deductions 4,135,161 3,744,711 0 3,355,450 Total Qualifying Capital 4,135,161 3,744,711 3,355,450 Source: PSBank Note: Adjustments were made to conform with the audited balances. 64 2004 2003 The following table sets out the breakdown of the Bank’s risk-weighted assets by category as of the dates indicated: Table 25. Risk Weighted Assets by Category As of 30 September (In Php thousands) 2005 As of 31 December 2004 2003 On Balance Sheet Assets 20% 50% 75% 100% 125% Off Balance Sheet Exposures 20% 50% 100% Total risk — weighted interest rate and exchange rate related Gross risk — weighted assets Deductions 393 2,751,048 6,736,581 19,846,594 1,956,465 0 350 2,424,341 — 26,511,737 22,278,073 0 0 0 31,291,081 748,029 0 28,936,428 749,723 0 24,289,642 754,937 Total risk-weighted assets 30,543,052 28,186,705 23,534,705 660 2,010,909 Source: PSBank Insurance It is the Bank’s policy to adequately insure all chattels and real estate collaterals are covered during the term of the loan. It also adequately insures all of its properties including foreclosed assets against fire and other usual risks. The Bank has mortgage redemption insurance that covers the outstanding loan balances in the case of borrowers’ death. It likewise has credit life insurance on all applicants for select mortgage and commercial loans. The Bank also maintains insurance for operational risks. Financial losses due to employees’ infidelity or dishonesty, loss of money inside premises and loss of money in-transit are covered by a bankers’ blanket bond. The Bank does not maintain any personal liability insurance for senior officers or directors. The Bank’s insurance policies are subject to exclusions, which are customary for insurance of the type held by the Bank, including those exclusions that relate to war and terrorism-related events. Lastly, the Philippine Deposit Insurance Corporation covers the Bank’s deposits on a per account basis up to Php250,000.00. The Bank believes that its insurance policies as described above are appropriate for its business. Legal Proceedings The Bank is a party in legal proceedings that arise in the ordinary course of its business activities. None of such legal proceedings arising in the ordinary course, either individually or in the aggregate, are expected to have a material adverse effect on the Bank or its financial condition. In addition, the Bank together with a number of other banks in the Philippines has been challenged by the BIR with respect to potential tax liability on interbank call loans (IBCL’s) with more than 5 days term; and in connection with its practice of issuing passbooks for higher interest rate deposit accounts. The BIR has claimed that documentary stamp tax is payable on such transactions and has assessed the Bank for aggregate deficiency taxes of 65 approximately Php469.97 million for the taxable years 1995, 1996 and 1997. While the Bank believes that it has a valid defense against these assessments pending with the Court of Tax Appeal, it expects the proceedings to continue for some time in the future. However, given the fact that a law was recently passed, which expressly provided for the imposition of documentary stamp taxes on this type of deposit transactions, and considering its prospective application, the Court of Tax Appeal will be properly guided in its determination of the issues, and in the eventual resolution of the pending case. Capital Expenditures Capital expenditures, particularly in information technology, have been an integral part of the Bank’s strategy in the past few years. The efficient use of technology is expected to further speed up customer service, enhance productivity, improve management information preparation and delivery, and promote more efficient internal and external business communications which would result in new product innovations and more timely risk management. It also minimizes operations at the branch level, thereby allowing branch personnel to focus more on sales and customer service. Capital expenditures relating to the development of the Bank’s information technology are as follows: Table 26 : IT-Related Capital Expenditures 2005 Capital Expenditures (in ’000) Ratio to Income (in %) 82,296 19.24 2004 99,383 20.47 2003 143,255 30.40 2002 34,615 12.37 Source: PSBank The Bank is expected to continue investing in both hardware and software to continually improve on its delivery infrastructure and support its expansion of the consumer banking business. 66 MANAGEMENT, EMPLOYEES, AND SHAREHOLDERS ORGANIZATIONAL CHART Directors The names, ages, positions, and educational attainment of the Bank’s directors follow. The members of the BoD are elected at the annual stockholders’ meeting to hold office until the next annual meeting and until their respective successors have been elected. Table 27. Board of Directors Name Position Jose T. Pardo Jovencio F. Cinco Arthur V. Ty Pascual M. Garcia III Margaret Ty-Cham Danilo L. Dolor Jose Macario L. Laurel IV Alberto A. Pedrosa Regis V. Puno David Ong Chua Rolando A. Rodriguez Chairman Vice Chairman Vice Chairman Director/President Director Director Director Director Director Director Corporate Secretary Age 66 73 39 52 37 66 73 72 47 37 54 Source: PSBank JOSE T. PARDO, Chairman: Mr. Pardo has been Chairman of the Bank since 2003. He is a former Secretary of Finance. Mr. Pardo also significantly served as Chairman to other key government organizations such as Landbank of the Philippines, Philippine Deposit Insurance Corporation, Trade & Investment Development Corporation, Economic Coordinating Council, 67 among many others. Mr. Pardo earned a Masters degree in Business Administration from the De La Salle University. He is the first graduate produced under the Harvard-DLSU Advisory Program in 1963. He holds a Bachelor of Science degree major in Accounting from the same university. ARTHUR V. TY, Vice Chairman: Mr. Ty has been Vice Chairman of the Bank since 2003. Mr. Ty is a Director of Metrobank Card Corp, Vice Chairman of Metropolitan Bank and Trust Company, President of Systematics Technology Services, Inc, and Horizon Royale Holdings Corporation. He was formerly the President of PSBank. Mr. Ty holds a Masters degree in Business Administration from Columbia University. JOVENCIO F. 2003. He is PentaCapital Incorporation. CINCO, Vice Chairman: Mr. Cinco has been Vice Chairman of the Bank since currently President and Director of PentaCapital Investment Corporation/ Finance Corporation. He is also Chairman of Intra Invest Securities Mr. Cinco holds a Bachelor of Laws degree from Far Eastern University. PASCUAL M. GARCIA III, Director/President: Mr. Garcia has been the President of the Bank since September 2001. He is also part of the Board of Directors of Metrobank Card Corporation. He was formerly the President and Director of the Bank of Southeast Asia and DBS Bank Philippines, Inc. Mr. Garcia holds a Bachelor of Science degree major in Commerce from Ateneo de Zamboanga. MARGARET T. CHAM, Director: Ms. Cham has been one of the Bank’s Directors since 2003. Ms. Cham is also the Director of Orix Metro Leasing Corporation. She is the Corporate Secretary of Federal Land Inc., and Assistant Corporate Secretary of Baywatch Realty Corp. Apart from these corporate involvements, Ms. Cham is also the active President of Joy In Living Cancer Foundation. Ms. Cham holds a Bachelor of Science degree major in Humanities from De La Salle University. DANILO L. DOLOR, Director: Mr. Dolor has been a long time Director of the Bank. Mr. Dolor is currently acting as Chairman to several other institutions such as YLFU Emilio Aguinaldo College, St. Patrick School of Quezon City, House of Knowledge Inc., and Batangas Sugar Central Inc. Mr. Dolor holds a Bachelor of Science degree major in Commerce from Colegio De San Juan De Letran. JOSE MACARIO LAUREL IV, Director: Mr. Laurel has been one of the Bank’s Directors since April 2003. He is the Chairman Emeritus of President Jose P. Laurel Rural Bank. He was formerly the Philippine Ambassador to Brazil and Congressman of the third district of Batangas. He is a retired Colonel of the Philippine Army. Mr. Laurel holds a Bachelor of Laws degree from the Lyceum of the Philippines. ALBERTO A. PEDROSA, Director: Mr. Pedrosa has been one of the Bank’s Directors since 2002. He is also currently the Board Director of Petron Corporation, Vice Chairman and Director of Peace Inc. He was formerly a Director of the Philippine National Oil Company, and Philippine Ambassador to the European Union, Belgium and Luxembourg. Mr. Pedrosa holds a Bachelor of Arts degree major in Economics from the University of the Philippines. REGIS V. PUNO, Director: Mr. Puno has been one of the Bank’s Directors since May 2004. He is Senior Partner at Puno and Puno Law Office, Director of Asia Recovery Corporation, President and Director of Pasay Hongkong Realty Development Corporation, and Director/ Trustee of CBP-1 Association. He is formerly the Undersecretary of the Department of Justice. Mr. Puno holds a Bachelor of Laws degree from the Ateneo de Manila University. He also earned a degree in Masters of Laws International and Comparative Law from Georgetown University Law Center. DAVID ONG CHUA, Director: Mr. Chua joined the roster of the Bank’s Directors only in September 2005. He is at present the President of Cathay Pacific Steel Corporation (CAPASCO), Asia Pacific Capital Equities and Securities Corporation and Compass, Inc. He is a former member of the Board of Directors of the Philippine Banking Corporation (which merged with Global Business Bank — Metrobank) and PBC Capital and Investments 68 Corporation. He finished his Masters in Business Administration from the J.L. Kellogg School of Management (Northwestern University) and Hong Kong University of Science and Technology (HKUST) Graduate School of Management. He took his undergraduate studies at St. Mary’s School of Management, graduated with honors, and finished Bachelor of Science in Financial Services Management. ROLANDO A. RODRIGUEZ, Executive Vice-President: Mr. Rodriguez is the Corporate Secretary of the Bank. He has been the Executive Vice-President of the Bank since August 2003. He was formerly Senior Vice President for the Marketing & Retail Banking Group of Equitable-PCI Bank. Mr. Rodriguez holds a Bachelor of Science major in Accounting and Bachelor of Arts major in Economics degrees from De La Salle University. Executive Officers The names, ages, positions and educational attainment of the Bank’s executive officers follow. The Executive Officers are appointed/elected by the BoD at the organizational meeting following the stockholders’ meeting, each to hold office for a period of 1 year. Table 28. Executive Officers Position Position President Executive Vice President Senior Vice Presidents Senior First Vice President First Vice Presidents Vice Presidents Name Pascual M. Garcia III Rolando A. Rodriguez Jaime Valentin L. Araneta Noli S. Gomez Yolanda L. dela Paz Consolacion R. Saur Marieta Bernadette A. Sevilla Elizabeth T. Miranda Ma. Patricia L. Castañeda Grace G. dela Cruz Jose Jesus B. Custodio Leonardo Roberto A. Disini Rebecca R. Igot Arnel R. Lopez Adelisa A. Mijares Paterno A. Satur Arnold D. Tolentino Ma. Priscilla M. Torres Franklin S. Umadhay Mary Jane M. Valero Jose Martin A. Velasquez Age 52 54 49 40 57 52 47 43 33 49 45 36 56 49 55 42 42 37 55 36 40 Source: PSBank Aside from Mr. Pascual M. Garcia III, President, and Mr. Rolando Rodriguez, Executive Vice President, the other key senior officers of the Bank are: JAIME VALENTIN L. ARANETA, Senior Vice President: Mr. Araneta is the Head of the Bank’s Branch Banking Group. He joined the Bank in August 2001. He used to be the Group Vice President for Branches of Associates Finance Inc. (Citigroup), and Vice President for Head Office Sales & Corporate Services of Jardine Pacific Finance Inc. He is also the former General Manager of Business Works Inc. Mr. Araneta holds a Bachelor of Arts degree major in Philosophy from Ateneo de Manila University. NOLI S. GOMEZ, Senior Vice President: Mr. Gomez is the concurrent Head of the Bank’s Operations Group and Finance Group. He joined the Bank in October 2001. He used to hold the posts of Systems and Methods Risk Management Officer of DBS Bank Phil, Inc., and 69 System Management Officer from the Bank of the Philippines Islands (BPI). Mr. Gomez is a Bachelor of Science degree holder in Civil Engineering from Mapua Institute of Technology and is a licensed Civil Engineer. YOLANDA L. DELA PAZ, Senior First Vice-President: Ms. Yolanda dela Paz is the Area Head of Downtown Metro. She joined the bank in September 1983. She used to be the Supervisor of Equitable Computer Services. She was also the Officer-in-Charge in one of the branches of Equitable Banking Corporation. Mrs. Dela Paz holds a Bachelor of Business Administration degree major in Accounting from University of the East. CONSOLACION R. SAUR, First Vice President: Ms. Saur is the Head of the Bank’s Credit Administration Group. She joined the Bank in November 2001. She used to be the Credit Administration Head and Credit Cycle Division Head of DBS Bank Phils, Inc. She was also the former Credit Acceptance Division Head of the Consumer Mortgage Loans of BPI Family Bank and Credit Settlements Head for Consumer and Commercial Loans of Citytrust Bank. Ms. Saur is a Certified Public Accountant. She holds a Bachelor of Science degree major in Accounting from the University of Santo Tomas. MARIETA BERNADETTE A. SEVILLA, First Vice President: Ms. Sevilla is the Head of the Bank’s Commercial Banking Group. She joined the Bank in November 2004. She used to be with PCIBank where she held the posts of Small Business Group Head, Specialized Lending Unit Head, and Area Credit Marketing Officer. She was also previously connected with BanCom as Project Finance Officer. Ms. Sevilla obtained her Masters in Business Administration degree from the University of the Philippines, Diliman. She also graduated with a degree in Bachelor of Science major in Business Economics from the same university. ELIZABETH T. MIRANDA, First Vice President: Ms. Miranda is the Head of the Bank’s Marketing and Communications Group. She joined the Bank in April 2002. She was previously connected with Colgate-Palmolive as Category Marketing Manager, Senior Product Manager and Category Financial Manager; MV Villar Group of Companies as Marketing Head; Shoemart, Inc. as Audit Supervisor and Sycip, Gorres, Velayo and Co. as Senior Auditor. Ms. Miranda is a CPA and holds a Bachelor of Science degree in Business Administration and Accountancy from the University of the Philippines, Diliman. MA. PATRICIA L. CASTAÑEDA, Vice President: Ms. Castañeda is the Chief Risk Officer of the Bank reporting to the Risk Management Committee. She joined the Bank in August 2005. Prior to joining PSBank, she was the Market Risk Officer of BDO Private Bank (formerly Banco Santander Phils. Inc). She was also previously connected with TA Bank as Corporate Finance Manager and with BPI as a Risk Management officer. Ms. Castañeda holds a Bachelor of Science degree major in Business Economics from the University of the Philippines, Diliman. GRACE G. DELA CRUZ, Vice President: Ms. Grace Dela Cruz is the Division Head for Processing Services Division under the Operations Group. She joined PSBank in January 2001. She was formerly Assistant Vice President for Retails Systems Support and Operations of PCI Bank, and Assistant Vice President for Systems Support of Philippine Commercial International Bank. Ms. Dela Cruz holds a Bachelor of Science degree major in Business Administration from Mindanao State University. JOSE JESUS B. CUSTODIO, Vice President: Mr. Jess Custodio is the Head of the Bank’s Auto Loans Division. He joined PSBank in December 2001. He is the former Head for Auto Loans Division - Retail Sales of Citytrust Banking Corporation. He also assumed the post of Fleet and Floorstock Department Head under the Consumer Finance Division of BPI Family Bank. Mr. Custodio holds a Bachelor of Science degree major in Business Management from the Ateneo de Manila University. LEONARDO ROBERTO A. DISINI, Vice-President: Mr. Bobby Disini is the Head of Mortgage Banking Division. He joined the Bank in June 2003. Prior to PSBank, he held several managerial posts in BPI including Unit Head/Senior Product Manager for BPI Express Credit Card, Product Manager for Auto Loans and Repossessed Assets, and Accounts Officer/ 70 Product Manager for Housing Loans. Mr. Disini obtained his Masters in Business Administration from the University of the Philippines, Diliman and a Philosophy degree from the same university. REBECCA R. IGOT, Vice President: Ms. Igot is the Head of the Bank’s Internal Audit Group. She joined the Bank in February 2002. She was formerly Vice President for Global Consumer Bank Internal Audit Division of Citibank, Head for the Internal Audit Group of Asiatrust Bank, and Head of Branch Accounting and Control Division of Global Business Bank. Ms. Igot is a Certified Public Accountant. She holds a Bachelor of Science degree in Business Administration major in Accounting from the University of the Philippines, Diliman. ARNEL R. LOPEZ, Vice President: Mr. Lopez is Head of Branch Banking Group — Operations Control and Administration Division. He joined the Bank in January 2002. He was formerly Vice President and Area Head of Makati Branches of Globalbank. Mr. Lopez also worked as Vice President and Area Head of Downtown Center Branches of Philbank. He started his career in the consumer and retail banking divisions of Citytrust Banking Corporation. He graduated from Adamson University with a Bachelor of Science degree in Industrial Engineering. ADELISA A. MIJARES, Vice President: Ms. Lisa Mijares is the Head of the Bank’s Loans Operations Group. She joined the Bank in February 1998. She worked with BPI Bank as Manager of Direct Marketing Department, and as Supervisor of the Appliance and Auto Processing Section for Filinvest Finance & Leasing Corporation. She holds a Bachelor of Science degree in Commerce major in Accounting from Far Eastern University. PATERNO A. SATUR, Vice President: Mr. Pat Satur is the Head of the Bank’s Compliance Office. He joined the Bank since August 1990. He is formerly PSBank’s Chief Accountant and Senior Manager of Financial Accounting Services Department. Mr. Satur holds a Bachelor of Science degree major in Accounting from Ateneo De Davao. ARNOLD D. TOLENTINO, Vice President: Mr. Tolentino is the Head of the Bank’s Remedial Management Group. He joined the Bank in September 2000. Prior to joining the Bank, he was the ROPOA Manager under the Retail Banking Group of Solid Bank. Mr. Tolentino holds a Bachelor of Science degree in Civil Engineering from Silliman University. He is a registered civil engineer and has passed government licensure examinations for real estate brokers, real estate appraisers and futures traders. MA. PRISCILA M. TORRES, Vice President: Ms. Torres is the Head of the Bank’s Human Resources Group. She joined the Bank in September 2000. She was the former Head of Corporate Communications and Employee Relations Division under Human Resources Management Group of SolidBank Corporation, and Department Head of Allied Bank’s Corporate Affairs Department. She was also formerly with Planter’s Development Bank as Marketing Services Officer. Ms. Torres holds a Bachelor of Arts degree in Communication major in Journalism from the University of the Philippines, Diliman. ATTY. FRANKLIN S. UMADHAY, Vice President: Mr. Umadhay is the head of the Bank’s Legal Division. He was former head of the Bank’s credit division from 1993 to 2000. He earned his Bachelor of Laws from Far Eastern University and has a Bachelor of Science degree major in Accounting from Letran College. MARY JANE M. VALERO, Vice President: Ms. Valero is the Head of the Bank’s Service Quality Division. She joined the Bank in August 2002. She served as Duty Manager of Westin Philippine Plaza and as Front Office Manager of Mandarin Oriental Manila. She also worked with Far East Bank and Trust Company. Ms. Valero holds a Bachelor of Science degree major in Psychology and a Bachelor of Arts degree major in Guidance and Counseling from St. Scholastica’s College. JOSE MARTIN A. VELASQUEZ, Vice President: Mr. Velasquez is the Head of the Bank’s Treasury Division. He joined the Bank in September 2004. He was formerly Deputy Treasurer of First Metro Investment Corporation and Senior Dealer of BPI Capital Corporation. Mr. 71 Velasquez holds a Masters degree in Business Administration from De La Salle University Professional School of Business. He graduated with a Bachelor of Arts degree major in Economics and Bachelor of Science in Commerce major in Management Financial Institution from the same institution. The following senior officers joined the Bank in October and November 2005 : EDEZA A. QUE, Vice President: Ms. Que is Credit Risk Manager and reports to the Chief Risk Officer and the Risk Management Committee. She was formerly with Standard Chartered Bank as Risk Manager for Credit. She began her career in BPI where she was Actuarial Officer. She then moved on to AIG where she was Risk Management Officer. She earned her Master of Science Degree in Statistics and graduated cum laude with a degree in Bachelor of Science major in Statistics both from the University of the Philippines, Diliman. JAN NIKOLAI M. LIM, Vice President: Mr. Lim is Head of Personal Loans Division and reports to the Office of the Executive Vice President. Prior to joining the Bank, Mr. Lim was with Standard Chartered Bank as Senior Assistant Vice President for Credit Cards and Personal Loans, and head of the Bank’s Cross Sell Team. Mr. Lim started his career as a Product Associate at RFM Corporation. He graduated from the De La Salle University with a degree in Bachelor of Science in Manufacturing Engineering and Management. The following senior officer will join the Bank in early 2006 : PERFECTO RAMON Z. DIMAYUGA, JR., First Vice President: Mr. Dimayuga was formerly Head of Treasury Division at the Bank from June 2002 to May 2004 before he migrated to Canada. Prior to joining the Bank, he was with the treasury departments of Bank of the Philippine Islands and DBS Bank Phils, Inc. He also worked with Mindanao Development Bank, Citytrust Banking Corporation, Rizal Commercial Banking Corporation and First Malayan Development Bank. He graduated with Masters in Business Administration degree from the University of the Philippines and has a Bachelor of Arts in Economics degree from the Ateneo de Manila University. Employees As of 30 September 2005, the personnel complement of the Bank is comprised of 1,613 permanent and 112 probationary employees. Of the total, 35.00% are engaged in a professional managerial capacity and classified as Bank Officers. The rank-and-file employees of the Bank meanwhile account for 65.00% of the total as of the same period. Although its rank and file employees are unionized, the Bank has been strike-free for its entire history. It had its last Collective Bargaining Agreement (CBA) negotiations in December 2003. Its current CBA is effective from January 2004 to December 2008. The Bank is slated to have an economic CBA review every 3 years after a successful CBA or at the end of 2006. The Bank recognizes the importance of becoming successful not only in its products and services but also in its human resources. Emphasis is now on employee training and development to achieve the Bank’s current mindset on operations quality and efficiency, service quality and effective sales. 72 Shareholders The Bank’s Top 10 shareholders as of 30 September 2005 are as follows: Table 29. Top 10 Shareholders Stockholder % to Total Metropolitan Bank & Trust Company Danilo L. Dolor Soledad L. Dolor Erlinda L. Dolor Fe Cecilia L. Dolor PCD Nominee Corp. — Filipino PSD TID PCD Nominee Corp. — non-Filipino James Go Philippine Charter Insurance Corp. 74.236 5.627 5.023 4.563 4.563 1.122 1.045 0.840 0.107 0.097 Source: PSBank The Bank’s principal shareholders are comprised of 2 major groups with Metrobank, owning 74.24%, and the Dolor Family collectively owning 19.78%. Other minority shareholders and the public hold the balance of 5.99%. As of 30 September 2005, the assets of Metrobank amounted to Php478.39 billion. 73 THE PHILIPPINE BANKING INDUSTRY The following is a general discussion of the Philippine Banking Industry. It is based on the laws, regulations and administrative rulings in force as at the date of this Offering Circular and is subject to any changes in law occurring after such date, which changes could be made on a retroactive basis. It does not purport to be a comprehensive description of all of the aspects of the industry that may be relevant to a decision to purchase, own or dispose of the Notes. Prospective purchasers should consult their advisors as to the consequences of acquiring, holding and disposing of the Notes. The banking industry in the Philippines is composed of universal banks, commercial banks, savings banks, savings and mortgage banks, private development banks, stock savings and loan associations, rural banks, and cooperative banks. As of 31 March 2005, the commercial sector consisted of 42 commercial banks, of which there are 21 private domestic banks and 21 branches of foreign banks and Government-controlled banks. Of the 42 commercial banks, 18 are universal banks, of which 3 are foreign bank branches. Commercial banks are organized primarily to accept drafts and to issue letters of credit, discount and negotiate promissory notes, drafts, bills of exchange and other evidences of indebtedness, receive deposits, buy and sell foreign exchange and gold and silver bullion, and lend money on a secured or unsecured basis. Universal banks are banks that have authority, in addition to commercial banking powers, to exercise the powers of investment houses, invest in the equity of business not related to banking and own up to 100.00% of the equity in a thrift bank, a rural bank, or financial allied enterprise. A publicly-listed universal or commercial bank may own up to 100.00% of the voting stock of only one other universal or commercial bank. Thrift banks primarily accumulate the savings of depositors and invest them, together with their capital, in secured or unsecured loans, or in financing for home building and home development, readily marketable debt securities, commercial paper and accounts receivable, drafts, bills of exchange, acceptances, or notes arising out of commercial transactions. Thrift banks also provide short-term working capital and medium- and long-term financing for businesses engaged in agriculture, services, industry, housing, and other financial and allied services for its chosen market and constituencies, especially for small and medium-sized enterprises and individuals. As of 31 March 2005, there were 83 thrift banks. Rural banks are organized primarily to make credit available and readily accessible in the rural areas on reasonable terms. Loans and advances extended by rural banks are primarily for the purpose of meeting the normal credit needs of farmers and fishermen, as well as the normal credit needs of cooperatives and merchants. As of 31 March 2005, there were 757 rural banks. Specialized government banks are organized to serve a particular purpose. The existing specialized banks are the Development Bank of the Philippines (‘‘DBP’’), Land Bank of the Philippines (‘‘LBP’’), and AI-Amanah Islamic Investment Bank of the Philippines (‘‘AAIIB’’). DBP was organized primarily to provide banking services catering to the medium- and longterm needs of agricultural and industrial enterprises, particularly in rural areas and preferably for small- and medium-sized enterprises. LBP primarily provides financial support in all phases of the Philippines’ agrarian reform program. In addition to their special functions, DBP and LBP are allowed to operate as universal banks. AAIIB was organized to promote and accelerate the socio-economic development of the Autonomous Region of Muslim Mindanao through banking, financing, and investment operations and to establish and participate in agricultural, commercial, and industrial ventures based on Islamic banking principles and rulings. During the past decade, the Philippine banking industry has been marked by 2 major trends: the liberalization of the industry and mergers and consolidation. 74 Foreign bank entry was liberalized in 1994, enabling foreign banks to invest in up to 60.00% of the voting stock of an existing bank or a new banking subsidiary, or to establish branches with full banking authority. This led to the establishment of 10 new foreign bank branches in 1995. The General Banking Law of 2000 further liberalized the industry by providing that the Monetary Board may authorize foreign banks to acquire up to 100.00% of the voting stock of one domestic bank. Under the General Banking Law, any foreign bank, which prior to the effectiveness of the said law availed itself of the privilege to acquire up to 60.00% of the voting stock of a domestic bank, may further acquire voting shares of such bank to the extent necessary for it to own 100.00% of the bank. As of 30 June 2003, there were 14 foreign banks with branches and 5 foreign banks with subsidiaries in the Philippines, accounting for 13.80% of the total resources of the Philippine banking system. The BSP has also been encouraging mergers and consolidations in the banking industry, seeing this as a means to create stronger and more globally competitive banking institutions. To encourage this trend, the BSP offers various incentives to merging or consolidating banks. Based on BSP data, since the new package of incentives took effect in September 1998, there have been 27 mergers, acquisitions, or consolidations of banks. However, while recent mergers increased market concentrations, BSP studies showed that they were not enough to pose a threat to the overall competition levels since market share remained relatively well dispersed among the remaining players. The following tables set out a comparison, based on published statements of condition, of the 10 leading banks in the Philippines as of 30 September 2005, and the 5 leading savings banks in the Philippines in terms of assets, customer loans, deposits, capital, and ROE as of 30 September 2005. Table 30. Comparative Summary of Top 10 Banks (As of 30 September 2005) In Php millions, except in branches No of Branches Metropolitan Bank and Trust Co Bank of the Philippine Islands Equitable-PCIBank Land Bank of the Philippines Philippine National Bank Citibank NA Banco de Oro Development Bank of the Phils Rizal Commercial Banking Corp China Banking Corp Rank in terms of Assets Total Assets Rank in terms of Loans Total Loans 562 1 478,388 1 214,219 538 408 2 3 388,448 312,067 2 3 158,511 118,889 323 324 6 180 4 5 6 7 296,056 220,246 209,356 202,123 4 9 5 6 107,257 54,031 76,964 72,767 77 8 187,750 7 72,202 178 141 9 10 160,272 132,142 8 10 56,005 48,730 Source: Published Statement of Condition 75 Table 31. Comparative Summary of Top 10 Banks (As of 30 September 2005) Rank in terms of Deposits In Php millions, except in ROE ROE Metropolitan Bank and Trust Co Bank of the Philippine Islands Equitable-PCIBank Land Bank of the Philippines Philippine National Bank Citibank NA Banco de Oro Development Bank of the Phils Rizal Commercial Banking Corp China Banking Corp 8.70% 16.70% 5.40% 12.80% 2.60% 33.70% 11.80% 14.90% 5.30% 15.70% Total Deposits 1 2 4 3 5 7 6 16 9 10 355,341 299,831 201,805 230,960 165,254 143,649 144,640 49,909 101,275 99,497 Rank in terms of Capital 2 1 3 4 5 14 8 6 11 7 Total Capital 49,989 56,002 42,529 22,763 22,356 7,647 18,779 21,890 13,863 21,002 Source: Published Statement of Condition Note: Data provided above are consolidated amounts with the exception of Citibank and LBP for which such numbers are presented on a non-consolidated basis. Table 32. Comparative Summary of Top 5 Thrift Banks, in terms of Assets 20-Dec-04 In Php Millions Rank BPI-Family Bank Philippine Savings Bank Planters Devt Bank RCBC Savings Asiatrust 1 2 3 4 5 30-Sep-05 Amount 63,685 46,016 32,100 31,645 12,300 Rank 1 2 3 4 5 Amount Growth Rate Rank 73,483 53,236 35,854 32,167 13,052 2 1 3 5 4 % 15.40% 15.70% 11.70% 1.70% 6.10% Source: Published Statement of Condition Table 33. Comparative Summary of Top 5 Thrift Banks, in terms of Loans 20-Dec-04 In Php Millions Rank BPI-Family Bank Philippine Savings Bank RCBC Savings Planters Devt Bank Equitable Savings 1 2 3 4 — 30-Sep-05 Amount 42,150 23,560 18,703 16,046 5,797 Rank 1 2 3 4 5 Amount 45,594 26,800 19,027 17,838 7,178 Growth Rate Rank 4 2 5 3 1 % 8.20% 13.80% 1.70% 11.20% 23.80% Source: Published Statement of Condition Table 34. Comparative Summary of Top 5 Thrift Banks, in terms of Deposits 20-Dec-04 In Php Millions Rank BPI-Family Bank Philippine Savings Bank RCBC Savings Planters Devt Bank Asiatrust 1 2 3 4 5 30-Sep-05 Amount 49,685 40,065 27,981 20,014 9,185 Source: Published Statement of Condition 76 Rank 1 2 3 4 5 Amount 63,004 46,807 27,963 23,416 9,497 Growth Rate Rank 1 3 5 2 4 % 26.80% 16.80% -0.10% 17.00% 3.40% Table 35. Comparative Summary of Top 5 Thrift Banks, in terms of Capital 20-Dec-04 In Php Millions Rank BPI-Family Bank Philippine Savings Bank ManilaBank Planters Devt Bank RCBC Savings 1 2 3 4 5 30-Sep-05 Amount 6,145 4,748 3,969 2,858 2,366 Rank 1 2 3 4 5 Amount 6,952 5,015 3,442 3,172 2,982 Growth Rate Rank 2 4 5 3 1 % 13.10% 5.60% -13.30% 11.00% 26.00% Source: Published Statement of Condition Table 36. Comparative Summary of Top 5 Thrift Banks, in terms ROE 20-Dec-04 In Php Millions Rank Asiatrust Equitable Savings Philam Savings Philippine Savings Bank BPI-Family Bank — 3 — 4 1 30-Sep-05 Amount 3.40% 13.50% 8.70% 12.90% 16.10% Rank 1 2 3 4 5 Amount 22.40% 21.50% 15.40% 14.20% 13.50% Growth Rate Rank 1 3 2 4 5 % 558.80% 59.30% 77.00% 10.00% -16.20% Source: Published Statement of Condition Competition The Bank faces competition from both domestic and foreign banks, in part as a result of the liberalization of the banking industry by the Government. Since 1994, a number of foreign banks that have greater financial resources than the Bank have been granted licenses to operate in the Philippines. Such foreign banks have generally focused their operations on the larger corporations and selected consumer finance products, such as credit cards. The foreign banks have not only increased competition in the corporate market, but have as a result caused more domestic banks to focus on the commercial middle-market, placing pressure on margins in both markets. In the domestic market prior to 2000, many banks expanded their networks in order to tap low-cost retail deposits following the relaxation of restrictions on branch banking. As a result, the Philippine banking market is relatively fragmented by comparison with other Asian countries, with the top 10 banks accounting for approximately 72.05% of total assets of commercial banks as of 27 June 2005. Since September 1998, the BSP has been encouraging consolidation among banks in order to strengthen the Philippine banking system. Consolidation is expected to result in greater competition, as a smaller group of ‘top tier’ banks compete for business. In addition, certain factors arising from the economic downturn are expected to result in greater competition and therefore exert downward pressure on margins. From 2000 to 2002, banks instituted more restrictive lending policies as they focused on asset quality and tried to reduce their exposure to non-performing loans, increasing liquidity. As the Philippine economy recovers from the economic downturn, and banks begin to apply such liquidity in the lending market, greater competition for corporate, commercial, and consumer loans may arise. The Bank is ranked 2nd among the country’s thrift banks in terms of assets as of 30 September 2005. 77 BANKING REGULATION AND SUPERVISION The following is a general discussion of the Philippine Banking Regulation and Supervision. It is based on the laws, regulations, and administrative rulings in force as at the date of this Offering Circular and is subject to any changes in law occurring after such date, which changes can be made on a retroactive basis. It does not purport to be a comprehensive description of all of the laws, regulations, and administrative rulings of the Philippine banking industry. The New Central Banking Act of 1993 (Republic Act No. 7653) and the General Banking Law of 2000 (the ‘‘General Banking Law’’) (Republic Act No. 8791) vest the Monetary Board of the BSP with the power to regulate and supervise financial intermediaries in the Philippines. Financial intermediaries include banking institutions such as universal banks, commercial banks, savings banks, mortgage banks, development banks, rural banks, stock savings and loan associations, as well as branches and agencies of foreign banks in the Philippines. Entities performing quasi-banking functions, trust companies, non-stock savings and loan associations, and other non-deposit accepting entities, while not considered banking institutions, are also subject to regulation by the Monetary Board. The BSP’s Manual of Regulations for Banks (the ‘‘Manual’’) is the principal source of rules and regulations to be complied with and observed by banks in the Philippines. The Manual contains regulations applicable to universal banks, commercial banks, savings banks, rural banks, and non-bank financial intermediaries performing quasi-banking functions. These regulations include those relating to the organization, management and administration, deposit and borrowing operations, loans, investments and special financing programs, and trust and other fiduciary functions of the relevant financial intermediary. Supplementing the Manual are rules and regulations promulgated in various circulars, memoranda, letters, and other directives issued by the Monetary Board. The Manual and other BSP rules and regulations are principally implemented by the Supervision and Examination Sector (the ‘‘SES’’) of the BSP. The SES is responsible for ensuring the observance of applicable laws and rules and regulations by banking institutions operating in the Philippines (including Government credit institutions, their subsidiaries and affiliates, non-bank financial intermediaries, and subsidiaries and affiliates of non-bank financial intermediaries performing quasi-banking functions). Permitted activities A thrift bank (‘‘TB’’), as defined in Thrift Bank Act of 1995 (Republic Act No. 7906), is composed of: (i) savings and mortgage banks; (ii) stock savings and loan associations, and (iii) private development banks. In addition to the powers provided in other laws, a TB may perform any or all of the following services: (i) grant loans, whether secured or unsecured; (ii) invest in readily marketable securities, (iii) extend credit facilities , (iv) act as correspondent for other financial institutions, (v) purchase, hold and convey real estate, (vi) engage in trust, quasi-banking functions and money market operations, (vii) act as collection agent for government entities, (viii) act as official depository of national agencies and of municipal, city or provincial funds in the municipality, city or province, (ix) issue mortgage and chattel mortgage certificates, (x) accept foreign currency deposits; (xi) issue domestic letters of credit and accept savings and time deposits; (xii) invest in the equity of allied undertakings. Financial allied undertakings include leasing companies, banks, investment houses, financial companies, credit card companies, and financial institutions catering to small- and mediumscale industries, including venture capital companies, companies engaged in stock brokerage, securities dealership and brokerage, and foreign exchange dealership/brokerage. Nonfinancial allied undertakings include warehousing companies, storage companies, safety deposit box companies, management of mutual funds, companies providing computer services, insurance agencies/brokerage, companies engaged in home building and home 78 development, companies providing drying and/or milling facilities for agricultural crops such as rice and corn, and service bureaus organized to perform for and on behalf of banks and nonbank financial institutions the services allowed to be outsourced. The total equity investments of a thrift bank in all enterprises are not permitted to exceed 25.00% of its net worth. A thrift bank is not allowed to invest in an enterprise engaged in nonallied or non-related activities. The Bank has only one equity investment in a financial services company and is in compliance with this limit. Banking regulation and supervision regulations The Manual and various BSP regulations impose the following restrictions on commercial, universal, and savings banks: Minimum capitalization Thrift banks with a head office in Metro Manila are required to have capital accounts of at least Php400.00 million while thrift banks with head offices outside Metro Manila are only required to have capitalization of at least Php64.00 million. For purposes of these requirements, the Manual provides that capital shall be unimpaired capital and surplus, combined capital accounts, and net worth, and shall refer to the combined total of the unimpaired capital (including paid-in surplus), earned surplus, and undivided profits, net of: (a) such unbooked valuation reserves and other capital adjustments as may be required by the BSP; (b) total outstanding unsecured credit accommodations, both direct and indirect, to DOSRI; (c) deferred income tax; (d) appraisal increment reserve (revaluation reserve) as a result of appreciation or increase in the book value of bank assets; (e) equity investment of a bank in another bank or enterprise (foreign or domestic) if the other bank or enterprise has a reciprocal equity investment in the investing bank, although if such bank or enterprise has reciprocal equity investment in the investing bank, the lower figure of the investment of the bank or the reciprocal investment of the other bank or enterprise should be used; and (f) in the case of rural banks, the Government counterpart equity, except those arising from conversion of arrears under the BSP rehabilitation program. Capital adequacy requirements In July 2001, the Philippines adopted the capital adequacy framework of the Basel Committee on Banking Supervision. The Manual provides that the net worth of a bank must not, as a general rule, be less than an amount equal to 10.00% of its risk assets. This general rate applies to the Bank. Under the Manual, net worth is synonymous with capital as defined above. Risk assets are the total assets of the bank less assets such as (a) cash on hand; (b) amount due from the BSP; (c) evidence of indebtedness issued by the Republic of the Philippines and the BSP or fully guaranteed by the Republic of the Philippines; (d) loans to the extent covered by hold-outs on, or assignment of, deposits/deposit substitutes maintained with a lending bank in the Philippines; (e) loans or acceptances under letters of credit to the extent covered by margin deposits; (f) bank premises net of depreciation; (g) furniture, fixtures, and equipment, net of depreciation; (h) balances maintained with any bank designated by the Monetary Board for clearing checks drawn on banks located in places not serviced by the BSP clearing offices; (i) amounts due from foreign banks representing normal working balances in the currencies eligible as part of the international reserve (and not maintained in the form of savings, time or fixed deposits), but not to exceed 30.00% of outstanding regular sight letters of credit; (j) portions of special time deposit loans covered by Industrial Guarantee and Loan Fund (IGLF) guarantee; (k) real estate mortgage loans insured by the Home Guaranty Corporation (HGC) to the extent of the amount of the insurance or the outstanding loan, whichever is lower; (l) loans to the extent secured by assets in item (c); (m) loans to the extent guaranteed by the Philippine Export and Foreign Loan Guarantee Corporation which are not past due; (n) deferred income tax; (o) the portion of the peso loans covered by guarantees of international/regional institutions where the Philippine Government is a member/shareholder such as IFC and ADB; (p) outstanding balance of deposit accounts of thrift banks with commercial banks/expanded commercial banks for clearing purposes; and 79 (q) loans of exporters to the extent guaranteed by the Guarantee Fund for Small and Medium Enterprises and by the Small Business Guarantee and Finance Corporation which are not past due. On 11 November 2002, the BSP announced that it had approved higher limits for the amount of lower and total tier 2 capital that may form part of the qualifying capital of Philippine banks. It announced that it had raised the limits prescribed in its Circular No. 280 dated 29 March 2001 from (i) in the case of lower tier 2 capital, 25.00% to 50.00% of tier 1 capital, and (ii) in the case of total tier 2 capital, 50.00% to 100.00% of tier 1 capital. Pursuant to Monetary Board Resolution No. 150 dated 30 January 2003, the BSP issued guidelines for the issuance of unsecured subordinated debt (‘‘USD’’) eligible as tier 2 capital on 17 February 2003, which regulate the private and public issuance of USD. Reserve requirements Under the New Central Bank Act, the BSP requires banks to maintain cash reserves and liquid assets in proportion to deposits in prescribed ratios. If a bank fails to meet this reserve during a particular week on an average basis, it must pay a penalty to the BSP on the amount of any deficiency. Thrift banks (including the Bank) are required to maintain regular reserves of 6.00% for demand and savings deposits, Negotiable Order of Withdrawal accounts, time deposits and, deposit substitutes. Regular reserve at the rate of 5.00% is required for bonds, mortgage and chattel mortgage certificates and 0% for interbank call loans. In addition to the foregoing regular reserve requirements, banks are required to set up liquidity reserves against Peso demand, savings, and time deposits and deposit substitute liabilities equivalent to 2.00%. Loan limit to a single borrower Under the General Banking Law, the total liabilities of any person, company, corporation, or firm to a commercial banking corporation and to a savings bank for money borrowed shall at no time exceed 25.00% of the net worth of such bank (or 30.00% of the net worth of the bank in the event that certain types and levels of security are provided). Pursuant to the General Banking Law, the Bank’s loans are subject to this single borrower’s limit. The basis for determining compliance with a single borrower’s limit is the total credit commitment of the bank to or on behalf of the borrower, which includes outstanding loans and other credit accommodations, deferred letters of credit less margin deposits and guarantees. Except as provided in the Manual, total credit commitment is determined on a credit risk-weighed basis consistent with existing regulations. Among the loans excluded from determining the loan limit are: (i) loans secured by obligations of the BSP or of the Republic of the Philippines; (ii) loans fully guaranteed by the Republic of the Philippines as to payment of principal and interest; (iii) loans to the extent covered by hold-out on or assignment of deposits maintained in the lending bank and held in the Philippines; (iv) loans and acceptances under letters of credit to the extent covered by margin deposits; (v) and other loans or credits which the Monetary Board may from time to time specify as non-risk assets. Trust regulation The Manual contains the regulations governing the grant of authority to and the management, administration, and conduct of trust, other fiduciary business, and investment management activities of trust corporations and financial institutions allowed by law to perform such operations. Trust corporations, banks, and investment houses may engage in trust and other fiduciary business after complying with the requirements imposed by the Manual. Thrift Banks applying for authority to perform trust and other fiduciary business must have a minimum capital account of Php650.00 million or such amounts as may be required by the Monetary 80 Board in the future. Furthermore, the requirements provided under the Manual should be complied with. The Bank may, under its Articles of Incorporation, accept and manage trust funds and properties and carry on the business of a trust corporation. Foreign currency deposit system A foreign currency deposit unit (‘‘FCDU’’) is a unit of a local bank or of a local branch of a foreign bank authorized by the BSP to engage in foreign currency-denominated transactions. Thrift banks with a net worth or combined capital accounts of at least Php650.00 million if located in Metro Manila or Php150.00 million if located outside Metro Manila, subject to prior Monetary Board approval, may be authorized to operate an FCDU. In general, FCDUs of such banks may, in any acceptable foreign currency, (a) accept deposits and trust accounts from residents and non-residents (without prior BSP approval); (b) deposit, on short-term maturity, with foreign banks abroad, offshore banking units, and other FCDUs; (c) invest in foreign currency-denominated debt instruments, which are of short-term maturity and are readily marketable; (d) grant short-term foreign currency loans as may be allowed by BSP regulations; (e) borrow on short-term maturity from other FCDUs, foreign banks abroad, and offshore banking units subject to existing rules on foreign borrowings; and (f) engage in foreign currency to foreign currency swaps with the BSP, offshore banking units, and FCDUs. However, FCDUs of thrift banks may only carry on these activities on a short-term basis. FCDUs are required to maintain a 100.00% cover for their foreign currency liabilities. For purposes of complying with this requirement, the principal offices in the Philippines of the authorized banks and all its branches located therein shall be considered as a single unit. The foreign currency cover shall consist of (i) foreign currency deposits with the BSP; (ii) short term foreign currency loans authorized by the BSP; (iii) investments in foreign currencydenominated debt instruments which are of short-term maturities and are readily marketable; (iv) foreign currency notes and coins on hand; (v) foreign currency swaps; (vi) foreign currency interest receivables; and (vii) such other assets as may be determined by the Monetary Board as eligible cover. FCDUs of thrift banks shall maintain the foreign currency cover in the same currency as that of the corresponding foreign currency deposit liability. Under the Republic Act No. 9294 which took effect on 21 May 2004, income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with non-residents, off-shore banking units in the Philippines and local commercial banks including branches of foreign banks that may be authorized by the BSP to transact business with foreign currency deposit system, is exempt from all taxes, except net income from such transactions as may be specified by the Secretary of Finance, upon recommendation by the Monetary Board to be subject to the regular income tax payable by banks. However, interest income from foreign currency loans granted by such depository banks under the said expanded system to residents other than the offshore banking units in the Philippines or other depository banks under the expanded system shall be subject to a 10.00% final tax. Lending policies, secured and unsecured lending Banks are generally required to ascertain the purpose of a proposed loan. The purpose of the loan shall be clearly stated in the application and in the contract between the bank and the borrower and the proceeds of the loan are to be used for that purpose only. Prior to lending on an unsecured basis, a bank must investigate the borrower’s financial condition and ability to service the debt and must obtain certain documentation from the borrower, such as financial statements duly certified by an independent Certified Public Accountant and tax returns. Any unsecured lending should be only for a time period essential for completion of the operations to be financed. In general, loans against real estate security shall not exceed 70.00% of the appraised value of the respective real estate security plus 70.00% of the appraised value of insured improvements, and such loans shall not be made unless title to the real estate is in the mortgagor. Loans and other credit accommodations on the security of chattels and intangible properties shall not exceed 75.00% of the appraised value of the security and such loans and other credit accommodations may be made to the title-holder of 81 the unencumbered chattels and intangible properties or his assignees. Loans for homebuilding and subdivision development for low and middle-income families against real estate security and housing loans defined as loans granted for the purpose of constructing, improving or acquiring a residential property which is rented or is occupied by the borrower may be granted up to 80.00% of the appraised value of the real estate security. Priority lending requirements BSP regulations currently provide that banks should set aside an amount equivalent to 25.00% of their loanable funds for loans to the agricultural sector, with 10.00% of such funds being made available exclusively to agrarian reform beneficiaries. By virtue of Rep. Act No. 7721, however, loans extended to finance educational institutions, cooperatives, hospitals and other medical services, socialized or low-cost housing, and to local government units without national government guarantee, will be considered as compliance to the agricultural-agrarian loans required under Pres. Decree No. 717, as amended. Loanable funds are defined to include the net increase in a bank’s funds from 1975. However, a bank may temporarily meet all or a portion of its agrarian reform and agriculture lending requirements by investing in certain government securities under certain conditions. BSP regulations also provide that until August 2007, banks are required to set aside a certain percentage of their total loan portfolio equal to at least 6.00% of the total loan portfolio for small enterprises and 2.00% for medium-sized enterprises, based on their balance sheet as at the previous quarter for lending to such enterprises. Investments in government securities will not satisfy such obligation. With the enactment of Barangay Micro Business Enterprises (BMBE’s) Act or R.A. 9178 on 13 November 2002, private banking and other financial institutions are encouraged to lend to BMBEs. Among the incentives of the law is that all loans granted to BMBEs shall be considered as part of the alternative compliance to the rules on reservations of funds for the agricultural sectors and small and medium-sized enterprise. Qualifications of directors and officers Under the Manual, bank directors and officers must meet certain minimum qualifications. For instance, directors must be at least 25 years old and have a college degree or at least 5 years’ business experience and must have attended a special seminar for the board of directors conducted or accredited by the BSP, while officers must be at least 21 years old, and have a college degree or at least 5 years’ experience in banking or trust operations or related activities. Certain persons are disqualified from acting as bank directors, including but not limited to (a) persons who have been convicted by final judgment of the courts for offenses involving dishonesty or breach of trust, violation of banking laws, moral turpitude or have been judicially declared insolvent, spendthrift, or incapacitated to contract; (b) persons who have been removed from office by the Monetary Board; (c) persons who refuse to disclose business interests to the appropriate supervising and examining department of the BSP when required for the proper implementation of a provision of law or of a circular, memorandum or rule or regulation of the BSP; (d) resident directors who have been absent for more than half of directors’ meetings and those who failed to attend the special seminar for board of directors required by the BSP; (e) persons who are delinquent in their obligations or have been found to have committed irregularities or to have conducted business in an unlawful, unsafe or unsound manner as determined by the Monetary Board in any institution supervised by the BSP; (f) persons who have been found to have willfully refused to comply with applicable banking laws or regulations; and (g) persons who have been dismissed for cause from any institution under the supervision of the BSP. When the ground for disqualification ceases to exist, the director or officer concerned may subsequently become a director or officer of an institution regulated by the BSP only upon approval of the Governor of the BSP. In addition, except as permitted by the Monetary Board, directors or officers of banks are also generally prohibited from simultaneously serving as directors or officers of other banks or non-bank financial intermediaries. 82 Loans to DOSRI The existing rules on loans to DOSRIs have 3 ceilings, namely, (a) individual ceiling; (b) aggregate ceiling; and (iii) ceiling on unsecured loans. The individual ceiling is the total allowable outstanding direct credit accommodations to each DOSRI which should be an amount equivalent to his unencumbered deposits in the lending bank and the book value of his paid-in capital contribution in the bank. The unsecured credit accommodation or loan, however, should not exceed 30.00% of the DOSRI’s total loans. The ceiling on unsecured loans, on the other hand, means that at least 70.00% of a DOSRI’s credit accommodations must be secured. In the aggregate, loans to DOSRI generally should not exceed 100.00% of the Bank’s combined capital accounts or 15.00% of the total loan portfolio of the bank, whichever is lower. Again, the ceiling on unsecured loans shall apply. Valuation reserves for probable losses against loans As a general rule, banking regulations define past due accounts of a bank as referring to all accounts in a Bank’s loan portfolio, all receivable components of trading account securities, and other receivables that are not paid at maturity. In the case of loans or receivables payable in installments, banking regulations consider the total outstanding obligation past due in accordance with the following schedule: Table 33. Schedule of Past Due Recognition Minimum Number of Installments in Arrears Mode of Payment Monthly Quarterly Semi-annually Annually 3 1 1 1 However, when the total amount of arrears reaches 20.00% of the total outstanding balance of the loan or receivable, the total outstanding balance of the loan or receivable is considered past due notwithstanding the number of installments in arrear. BSP regulations allow loans and advances to be written off as bad debts only if they have been past due for 6 months or more, and can be justified to be uncollectible. The board of directors of a bank has the discretion as to the frequency of write-off, so long as these are made against provisions for probable losses or against current operations. The prior approval of the Monetary Board of the BSP is required to write off loans to DOSRI, and for individual loan accounts involving Php100,000.00 or more the prior approval of the appropriate SES of the BSP is needed. On 26 January 2003, the Special Purpose Vehicle Act (the SPV Act) came into force. The SPV Act provides the legal framework for the creation of private management companies that will acquire non-performing loans, real estate, and other assets from financial institutions in order to help these financial institutions liquidate their non-performing loans and assets and thus provide new funds for new lending to support economic growth. Congress passed on 19 March 2003 the SPV Act’s implementing rules and regulations, which came into force on 12 April 2003. 83 Guidelines on general reserves Under existing BSP regulations, a general provision for loan losses shall also be set up as follows: (i) 5.00% of the outstanding balance of unclassified restructured loans less the outstanding balance of restructured loans that are considered non-risk under existing laws and regulations; and (ii) 1.00% of the outstanding balance of unclassified loans other than restructured loans less loans that are considered non-risk under existing laws and regulations. Restrictions on branch opening Under the Thrift Banks Act, thrift banks have unrestricted branching right within the region, free from any assessment or surcharges required in setting-up a branch, but under coordination with the BSP. In line with this, the Manual provides various minimum capitalization requirements for branches of thrift banks, depending on the location of the branch, ranging from a minimum of Php0.00 for branches of thrift banks to be located in 5th and 6th class municipalities to a minimum of Php10,000,000.00 for the same to be located in the National Capital Region, provided that in no case shall the capitalization of the bank be less than the minimum capitalization required for banks. A bank must first comply with this minimum capital requirement in order to be given authority to establish more branches. Only universal/commercial and thrift banks may establish branches on a nationwide basis. Once approved, a branch may be opened within 6 months from the date of approval (extendible for another 6 month period upon the presentation of justification). However, there has been, since 19 September 1999, a BSP moratorium on the granting of licenses for the establishment of new branches subject to certain exceptions. Anti-money laundering law The Anti-Money Laundering Act was passed on 29 September 2001 and was amended on 23 March 2003. Under its provisions, as amended, certain financial intermediaries, including banks, offshore banking units, quasi-banks, trust entities, non-stock savings and loan associations, all other institutions including their subsidiaries and affiliates supervised and/ or regulated by the BSP, and insurance companies and/or institutions regulated by the Insurance Commission, are required to submit a ‘‘covered’’ transaction report involving a single transaction in cash or other equivalent monetary instruments in excess of Php500,000.00 within one banking day. These institutions are also required to submit a ‘‘suspicious’’ transaction report if there is reasonable ground to believe that any amounts processed are the proceeds of moneylaundering activities. These transactions are reported to the Anti-Money Laundering Council (the ‘‘AMLC’’) of the BSP within 5 banking days of discovery of that transaction by the covered institution. The Court of Appeals, upon application by the AMLC, has the authority to order any accounts which it suspects are being used for money laundering to be frozen. Institutions that are subject to the Anti-Money Laundering Act are also required to establish and record the identities of their clients based on official documents. In addition, all records of transactions are required to be maintained and stored for 5 years from the date of a transaction. Records of closed accounts must also be kept for 5 years after their closure. 84 PHILIPPINE TAXATION The following is a general description of certain Philippine tax aspects of the Notes. It is based on the laws, regulations, and administrative rulings in force as at the date of this Offering Circular and is subject to any changes in law occurring after such date, which changes can be made on a retroactive basis. It does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a decision to purchase, own, or dispose of the Notes. Prospective purchasers should consult their tax advisors as to the laws of other applicable jurisdictions and the specific tax consequences of acquiring, holding, and disposing of the Notes. As used in this section, the term ‘‘resident alien’’ refers to an individual whose residence is within the Philippines but who is not a citizen of the Philippines; a ‘‘non-resident alien’’ is an individual whose residence is not within the Philippines and who is not a citizen of the Philippines; a non-resident alien who is actually within the Philippines for an aggregate period of more than 180 days during any calendar year is considered a ‘‘non-resident alien doing business in the Philippines’’; otherwise, such non-resident alien who is actually within the Philippines for an aggregate period of 180 days or less during any calendar year is considered a ‘‘non-resident alien not doing business in the Philippines.’’ A ‘‘resident foreign corporation’’ is a foreign corporation engaged in trade or business within the Philippines; and a ‘‘non-resident foreign corporation’’ is a foreign corporation not engaged in trade or business within the Philippines. The term ‘‘foreign’’ when applied to a corporation means a corporation which is not domestic while the term ‘‘domestic’’ when applied to a corporation means a corporation created or organized in the Philippines or under its laws. Taxation of Interest The Philippine National Internal Revenue Code of 1997 (the ‘‘Tax Code’’) provides that interest on interest-bearing obligations of Philippine residents are Philippine-sourced income subject to Philippine income tax. Generally, a final withholding tax at the rate of 20.00% is imposed upon the amount of interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes. Thus, interest income on the Notes shall be subject to a final withholding tax of 20.00% or such rate as may be provided by law or regulation, which shall be withheld at source. Interest income received by non-resident individuals not engaged in trade or business in the Philippines shall be subject to a final withholding tax of 25.00%. Interest income received by non-resident foreign corporations shall be subject to a final withholding tax of 35.00%. The tax shall be for the account of the affected holder. The foregoing rates are subject to further reduction by any applicable tax treaty. However, under the Tax Code, interest income from long-term deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments with a maturity period of not less than 5 years, the form of which shall be prescribed by the BSP and issued by banks only (not by non-bank financial intermediaries and finance companies) to individuals in denominations of P10,000.00 and other denominations as may be prescribed by the BSP, is exempt from income tax. Provided that, should the holder pre-terminate the deposit or investment before the 5th year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the long-term deposit or investment certificate based on the remaining maturity thereof: 4 years to less than 5 years — 5.00%; 3 years to less than 4 years — 12.00%; and Less than 3 years — 20.00%. Thus, all payments of principal and interest in respect of individual Noteholders who are (i) Philippine citizens; (ii) resident aliens; and (iii) non-resident aliens engaged in trade or business within the Philippines, shall be made free and clear of, and without withholding or deduction for, any taxes, duties, assessments, or governmental charges of whatever nature imposed, levies, collected, withhold, or assessed by or within the Philippines or any authority therein or thereof having the power to tax, unless such withholding or deduction is required by 85 law. In such event, the Bank shall pay such additional amount as will result in the receipt by such Noteholders of such amounts as would have been received by them had no such withholding or deduction been required. In accordance with Clause D(7)(e) of the BSP Rules, negotiations/transfers from one Noteholder to another do not constitute pre-termination. Documentary Stamp Taxes Philippine law imposes a documentary stamp tax on all bonds, loan agreements, and promissory notes at the rate of Php1.00 on every Php200.00 or fractional part of the face value of such securities. The Bank has undertaken to pay the Philippine documentary stamp taxes on the issuance of the Notes. No documentary stamp tax will be due on a subsequent sale or disposition of the Notes. Taxation on Sale or Other Disposition of Notes A holder will recognize gains or losses upon the sale or other disposition (including a redemption at maturity) of a Note in an amount equal to the difference between the amount realized from such disposition and the value of such holder’s interest in the Note. Under the Tax Code, any gain realized from the sale, exchange, or retirement of bonds, debentures, and other certificates of indebtedness with an original maturity date of more than five years (as measured from the date of issuance of such bonds, debentures, or other certificates of indebtedness) is exempt from income tax. Since the Notes have a maturity of more than 5 years from the date of issuance, any gains realized by a holder from the sale of the Notes will be exempt from Philippine income tax. As mentioned above, under Philippine law, interest income on deposit substitutes received by Filipino citizens and resident aliens is subject to a final withholding tax of 20.00%, which shall be withheld at source. Interest income received by non-resident individuals not engaged in trade or business in the Philippines shall be subject to a final withholding tax of 25.00%. Interest income received by non-resident foreign corporations shall be subject to final withholding tax of 35.00%. The said tax shall be for the account of the affected Noteholder, and shall be withheld at source. The foregoing rates may be subject to further reduction by any applicable treaty. Transfer of the Notes between persons of different tax status shall be made effective only on an Interest Payment Date (the ‘‘Transfer Date’’). Any change in tax status shall be recorded only upon submission of: (x) written notification of the transfer from the transferor; and (y) a sworn statement of the tax status of the transferee claiming tax exemption/ preferential tax treatment and other Tax Exempt/Tax Treaty Documents from such transferee, to the Issuer, through the Registry. Such change in tax status shall take effect beginning on the 1st day of the Interest Period subsequent to the Transfer Date; provided that notification is made and sufficient Tax Exempt/ Treaty Documents are sent to the Issuer, through the Registry no later than 5 Banking Days prior to the record date of such Interest Period, otherwise, the Registry shall be entitled to presume, without liability to the Issuer, that the relevant Noteholder/Transferee is not taxexempt or does not enjoy preferential tax treatment. In such case, the change in tax status arising from the transfer between a taxable and a tax-exempt individual shall take effect starting from the Interest Period of the relevant record date on or before which a written notification and submission of the Tax Exempt/Tax Treaty Documents are made which should be no later than 5 Banking Days prior to the relevant record date. In determining and recording such tax status, the Registry shall exercise such judgment and care, under the circumstances then prevailing that individuals of prudence, discretion and intelligence and familiar with such matters exercise in the management of their own affairs. 86 If tax status claimed is ‘‘exempt’’ or ‘‘reduced tax treaty rates’’, the Noteholder shall submit: (iv) Certified true copy of the original tax exemption certificate, ruling or opinion issued by the Bureau of Internal Revenue on file with the Noteholder as certified by its duly authorized officer; (v) With respect to tax treaty relief, proofs to support applicability of reduced treaty rates, consularized proof of tax domicile issued by the relevant tax authority of the Noteholder and original or SEC-certified true copy of the SEC confirmation that the relevant entity is not doing business in the Philippines; (vi) Original of the duly notarized undertaking, in the prescribed form, declaring and warranting its tax exempt status or entitlement to reduced tax treaty rates, undertaking to immediately notify the Issuer and the Registry and Paying Agent of any suspension or revocation of its tax exempt status or treaty privileges and agreeing to indemnify and hold the Issuer and the Registry and Paying Agent free and harmless against any claims, actions, suits, and liabilities resulting from the non-withholding or reduced withholding of the required tax; and (iv) Such other documentary requirements as may be required under the applicable regulations of the relevant taxing or other authorities which, for purposes of claiming tax treaty withholding rate benefits, shall include evidence of the applicability of a tax treaty and consularized proof of the Noteholder’s legal domicile in the relevant treaty state. Gross Receipts Tax/Value Added Tax The sale or transfer of the Notes in the Philippines by dealers in securities will be subject to VAT at the rate of 10.00% of the gross income. However, R.A. 9337 provides that the President may, at any time after January 1, 2006 and upon the recommendation of the Secretary of Finance, raise the rate of VAT, to 12.00% after any of the conditions provided by law has been satisfied. Pursuant to R.A. 9337, a gross receipts tax is imposed on the gross receipts derived by financial institutions for all financial or non-financial services or combinations thereof performed by financial institutions within the Philippines. For net trading gains derived from debt securities, derivatives and other financial instruments, gross receipt tax at the rate of 7.00% is imposed under the Tax Code. Estate and Donor’s Tax The transfer of Notes as part of the estate of a deceased foreign individual to his heirs, whether or not such individual was resident in the Philippines at the time of his death, will be subject to a state tax which is levied on the net estate of the deceased at progressive rates ranging from 5.00% to 20.00% if the value of the net estate exceeds Php200,000.00. A holder of such Notes will be subject to donor’s tax upon the donation of the Notes to strangers at a flat rate of 30.00% of the net gifts. A stranger is defined as any person who is not a brother, sister (whether by whole- or half-blood), spouse, ancestor and lineal descendant or relative by consanguinity in the collateral line within the 4th degree of relationship to the Noteholder. A donation to a non-stranger will be subject to a donor’s tax at progressive rates ranging from 2.00% to 15.00% based on net gifts made during the calendar year in excess of Php100,000.00. The estate tax as well as the donor’s tax in respect of the Notes shall not be collected (i) if the deceased at the time of death or the donor at the time of the donation was a citizen and resident of a foreign country which at the time of his death or donation did not impose a transfer tax of any character in respect of intangible personal property of citizens of the Philippines not residing in that foreign country or (ii) if the laws of the foreign country of which the deceased or the donor was a citizen and resident at the time of his death or donation allows a similar exemption from transfer or death taxes of every character or description in respect of intangible personal property owned by citizens of the Philippines not residing in that foreign country. 87 PROCEDURE The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information found elsewhere in this Offering Circular and the Agreements regarding the issuance, maintenance, servicing, trading, and settlement of the Notes. Prospective investors should read this entire Offering Circular and the Agreements fully and carefully. In case of any inconsistency between this summary and the more detailed information in this Offering Circular or the Agreements, then the more detailed portions and/or the Agreements, as the case may be, shall at all times prevail. Offering Period Procedure Pursuant to the Underwriting Agreement, Selling Agency Agreement, Registry and Paying Agency Agreement, and Trust Agreement (the ‘‘Agreements’’) entered into by the Issuer with the relevant counterparties, the Notes shall be offered for sale through the Lead Manager and Selling Agents and, to a limited extent, through the Issuer (collectively, the ‘‘Selling Agents’’). The Notes will be offered to any person of legal age, regardless of nationality or residency, or any corporation, association, partnership, trust account, fund or entity, regardless of place of incorporation or domicile. The following constitutes a summary of the procedure to be adopted among the parties and the Investors and is qualified in its entirety by, and should be read in conjunction with, the more detailed information found elsewhere in this Offering Circular and the Agreements. Prior to the Offer Period The Issuer shall enter into the Registry and Paying Agency Agreement with the Registry (Development Bank of the Philippines — Trust Services Department), the Trust Agreement with the Public Trustee (Development Bank of the Philippines — Trust Services Department), and the Selling Agency Agreement with the Selling Agents (ING Bank N.V., Manila Branch, Multinational Investment Bancorporation, and itself). The Offer Period During the relevant Offer Period, the Issuer, the Lead Manager, and other Selling Agents shall solicit subscriptions to the Notes. Interested investors (the ‘‘Applicants’’) will be required to execute an Application to Purchase (the ‘‘Applications’’) in 3 copies and return the completed Applications to their respective Selling Agents. Each of the Selling Agents shall then provide a receiving copy of the completed Applications to the Investor. There shall be no limitation on the number of Notes that an Applicant may apply for. Completed Applications shall be accompanied by check payments made out to the order of ‘‘PSBank Notes Offering’’ or appropriate debit instructions or other instructions acceptable to the Lead Manager and the relevant Selling Agent, as the case may be, and must cover the entire purchase price (the ‘‘Purchase Price’’). Each Selling Agent shall determine its own settlement procedure for its Applicants. The Selling Agent shall hold the Purchase Price received from their respective Applicants as deposit for the account of PSBank Notes Offering (the ‘‘Deposit’’). A Schedule of Applications (the ‘‘Schedule’’) summarizing the details on the Applicants and corresponding subscriptions made shall then be separately prepared by each of the Selling Agents at the end of the Offer Period, and together with one copy each of the completed Applications, be sent to the Lead Manager for consolidation. Allocation Period On the 1st Banking Day after the end of the Offer Period, the Lead Manager shall summarize the Schedule received from each of the Selling Agents as well as its own Schedule. Based on the total Applications received, the Lead Manager shall agree with the Issuer on the total 88 issue size of the Notes. If the corresponding Notes are insufficient to satisfy all Applications, the Lead Manager shall proceed with the manner of allocation and/or rejection of the Applications, including the scaling down of allocations, and prepare an allocation report (the ‘‘Allocation Report’’). The Lead Manager shall advise the Issuer and the Selling Agents of their respective sub-allocations for the Notes based on their respective Schedule. Each of the Selling Agents shall implement the allocation in accordance with the sub-allocation. Each of the Selling Agents shall establish its own policies and procedures regarding allocations of the Notes for its respective Applicants. A schedule of purchase advice (the ‘‘Schedule of Purchase Advice’’) summarizing the details regarding the investors and corresponding allocations made shall be prepared by each of the Selling Agents and delivered to the Lead Manager. No later than the Issue Date, each of the Selling Agents shall forward to the Lead Manager the total of the Purchase Price for all accepted Applications received by them via Real Time Gross Settlement (‘‘RTGS’’) or other means acceptable to the Lead Manager, and make available to its corresponding Applicants any refunds that may be due them. Payments made by Applicants whose Applications were rejected or scaled down shall be returned to them, in full (in case of a rejection) or in a proportionate sum (in case of a scale down), but in both instances shall carry no interest whatsoever. The amounts received by the Lead Manager shall be placed in escrow for the account of ‘‘PSBank Notes Offering’’, if applicable, or in a depository account with a Trust Department to be identified by the Lead Manager and the Issuer. Issue Date Based on the Consolidated Schedule of Purchase Advice, the Issuer shall issue the Notes, at the Offer Price, to the corresponding investors through the Public Trustee. Upon mere acceptance by the Selling Agents, on behalf of the Issuer, of all or part of the offer contained in an Application through the application of all or so much of the Deposit as payment and the sending by the Selling Agent to the Applicant (with a copy furnished to the Registry) of the proper Purchase Advice (the ‘‘Purchase Advice’’), the Applicant shall ipso facto be deemed a purchaser of the Notes covered by the accepted Application and the relevant Application shall be deemed a purchase agreement with respect to the accepted Application, fully binding the parties to the transaction under the stipulations of the Notes hereof and other related documents. On Issue Date, the Lead Manager shall release the net proceeds to the Issuer, which shall then distribute the proceeds of the Notes to the proper parties in accordance with the relevant Agreements. The Registry shall receive, through the Lead Manager, all completed Applications to Purchase from the Selling Agents and shall be responsible for processing such applications for purposes of preparing the Registry Book and shall issue and distribute the relevant Registry Confirmations to the investors. Interest and Principal Payment Procedure The Registry shall provide the Issuer with a report on the relevant Noteholders entitled to the payment of interest and/or principal, the total gross amounts falling due as interest due to each Noteholder, the tax status of each Noteholder for the relevant Interest Period, the relevant tax, if any, to be withheld by the Registry on behalf of the Issuer on the income of such Noteholder or the amount of grossing up required, as applicable; and such other information relevant for the purposes. Upon receipt of the report, the Issuer shall promptly transfer funds via RTGS to the Registry. 89 On each Payment Date, the Call Option Date, or the Maturity Date (as the case may be), the Registry shall handle any and all payments to the relevant Noteholders in accordance with the instructions on the Purchase Advice, either through direct debit of their accounts, through the Noteholders’ Selling Agent or Market Maker via RTGS, or through Managers’ Checks, as may be appropriate. 90 SUMMARY OF SIGNIFICANT DIFFERENCES BETWEEN INTERNATIONAL FINANCIAL REPORTING STANDARDS AND PHILIPPINE GENERALLY ACCEPTED ACCOUNTING PRINCIPLES To keep pace with the accounting development, the Philippine Accounting Standards Council (ASC) decided in 1997 to move totally towards the adoption of International Financial Reporting Standards (IFRS). The ASC has since issued a number of IFRS-based accounting standards. Prior to 2004, there were 23 IFRS-based standards, which had been adopted locally. In 2004, 3 new IFRS-based standards were adopted, while several others took effect on January 1, 2005, including improvements introduced in 2003 to the previously adopted standards. The ASC has re-named the new standards ‘‘Philippine Accounting Standards (PAS)’’ and ‘‘Philippine Financial Reporting Standards (PFRS)’’ (collectively, Philippine GAAP) to correspond with the adopted IASs and IFRSs of the International Accounting Standards Board. Philippine GAAP differ with IAS/IFRS in certain aspects. The financial statements included in the Offering Circular were prepared in accordance with Philippine GAAP existing as of December 31, 2004 (i.e. do not include the new and revised accounting standards which became effective starting January 1, 2005). The following analysis is a general comparison of IFRS and Philippine GAAP existing as of December 31, 2004. Reference should be made to the relevant IAS/IFRS and Philippine pronouncements for more detailed information when applying the individual accounting standards. The differences between Philippine GAAP and IAS/IFRS have not been quantified nor has a reconciliation of Philippine GAAP to IAS/IFRS been undertaken. If the Bank had undertaken any such quantification or reconciliation, it may have become aware of other potential significant accounting and disclosure differences which are not identified below. No attempt has been made to identify future differences between Philippine GAAP and IAS/ IFRS as the result of prescribed changes in accounting standards. Regulatory bodies that promulgate Philippine GAAP and IAS/IFRS have significant projects ongoing that could affect the accuracy of the following analysis in the future. In addition, no attempt has been made to identify future differences between Philippine GAAP and IAS/IFRS that may affect the financial statements as a result of transactions or events that may occur in the future. Financial Instruments: Recognition and Measurement There is no specific Philippine GAAP Standard which requires recognition of all financial assets and financial liabilities, including all derivatives. Under IAS, all financial assets and financial liabilities should be recognized on the balance sheet, including all derivatives. Such assets and liabilities should be measured initially at cost, which is the fair value of the consideration given or received to acquire the financial asset or liability. Subsequent to the initial recognition, all financial assets, including derivatives that are assets, shall be re-measured to fair values except for the following, which shall be subject to review for impairment: . loans and receivables, which shall be measured at amortized cost using the effective interest method; . held-to-maturity investments, which shall be measured at amortized cost using the effective interest method; and . investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured and derivatives that are linked to and must be settled by delivery of such unquoted equity instruments, which shall be measured at cost. 91 All derivative transactions, both stand-alone and bifurcated embedded derivatives, will have to be carried at fair value directly through earnings except when these are designated and qualify for hedge accounting. An entity must formally document, designate, and assess the effectiveness of derivative transactions that receive hedge accounting treatment. Financial Instruments: Disclosure and Presentations There is no specific Philippine GAAP Standard which covers presentation and disclosure requirements. IAS requires a discussion of management’s policies for controlling the risk associated with financial instruments, including policies regarding hedging of risk exposures, avoidance of undue concentrations of risk and collateralization to mitigate credit risks, which provides a valuable additional perspective that is independent of specific instruments outstanding at a particular time. IAS also requires disclosure of the fair value of each class of financial asset and liability. Investment Properties Philippine GAAP requires investments in real estate and income producing properties to be carried at cost and depreciated as appropriate in the same manner as other properties. Under Philippine GAAP, assets acquired in settlement of receivables are stated at the total outstanding exposure at the time of foreclosure or bid price, whichever is lower, less allowance for probable losses and impairment in value, if any. Nonrefundable taxes such as capital gains tax and documentary stamp tax that were paid are capitalized provided that the adjusted value of the foreclosed asset does not exceed net realizable values. Security, maintenance and other foreclosure-related expenses are charged to operations as incurred. Allowance for probable losses is set up based on BSP provisioning requirements and for any anticipated significant shortfalls from the recorded values based on appraisal reports and current negotiations and programs to dispose of these properties to other interested parties. Upon adoption of IAS 40, Investment Property, these acquired assets shall be accounted for as investment properties at fair value at the time of acquisition and subsequently carried at either their fair values or their costs. Changes in fair value shall be recognized in the statements of income. Loans and Allowance for Probable Loan Losses Under Philippine GAAP, the allowance for loan losses is the estimated amount of losses in a bank’s loan portfolio and is established through charges against operation. The allowance should be determined after a qualitative review of the collectibility of loans based on the net realizable value of the collateral, credit history, industry trends, the borrowers’ financial abilities, financial responsibility of guarantors and other factors. Loans are to be written off when they are deemed uncollectible. Any amounts set aside in respect of general banking risks, including future losses and other unforeseeable risks or contingencies, are included in the determination of the net profit or loss for the period. Industry practice in the Philippines is to also follow BSP rules with regard to computing loan loss provisions. IAS provides that loans originated by an enterprise which are excluded from fair valuation and that have fixed maturity should be measured at amortized cost using the effective interest rate method. Loans that do not have a fixed maturity should be measured at cost. Loans should be subjected to review for impairment. Where it is probable that the bank will not be able to collect all amounts due under a loan, comprised of principal and interest, IAS provides that the amount of the resulting loss is the difference between the asset’s carrying amount and the present value of expected future cash flows discounted at the current effective interest rate determined under the loan contract. If 92 such loan is collateralized and foreclosure is probable, then the holder measures impairment based on the fair value of the collateral. If, in subsequent period, the amount of the impairment or bad debt loss decreases and the decrease can be objectively related to an event occurring after the write-down, IAS provides that the write-down of the financial asset should be reversed either directly or by adjusting an allowance account. The amount of reversal should be included in the net profit or loss for the period. Once a loan has been written down to its estimated recoverable amount, IAS provides that interest income should be recognized based on the rate of interest that was used to discount the future cash flows for the purpose of measuring the recoverable amount. Additionally, after initially recognizing an impairment loss, the bank should review the asset for further improvements at subsequent financial reporting dates. IAS provides that provision for general banking risks should be separately disclosed as appropriations of retained earnings. To the extent that such provision for general banking risks is reduced, such amount of reduction should be recognized as an increase in retained earnings and are not included in the determination of net profit or loss for the relevant period. Disclosure in the Financial Statements of Banks and Similar Financial Institutions Philippine GAAP does not require banks to disclose the maturities of assets and liabilities and concentrations of assets and liabilities and off-balance sheet items. Current disclosure is made to comply with the regulatory accounting policies through BSP Circular 212 which requires that such information be disclosed in the same manner that IAS 30 requires such disclosure. IAS requires banks to disclose an analysis of their assets and liabilities classified into relevant maturity groupings based on their remaining period at the balance sheet date up to their respective maturity dates. Other Matters When resolving questions relating to subjects not specifically covered by Philippine SEC rulings and Philippine GAAP, pronouncements of the International Accounting Standards Board and other authoritative accounting bodies are generally referred to for guidance, but are not mandatory. 93 The following is the list of IAS with differences with Philippine GAAP as of January 1, 2005. IAS Modification of IAS for the purpose of PAS/PFRS IAS 1 Presentation of Financial Statements For purposes of financial reporting in the Philippines, reference shall be made to PFRS, in lieu of IFRS in the following paragraphs in IAS 1 : IAS 1.2; IAS 1.13; IAS 1.14 and IAS 1.105 (a). In the Philippines, the common practice is to present in the balance sheet current assets before non-current assets; current liabilities before non-current liabilities; and equity accounts after liabilities (equivalent to IAS 1.IG2). IAS 19 Employee Benefits For Philippine financial reporting purposes, the transition provision includes the alternative treatment of recognizing the transitional liability on a straight line basis over up to 5 years. PAS 19 is applicable to benefits provided (a) under formal or informal plans, (b) under legislative requirements and (c) by those informal practices that give rise to a constructive obligation. In the Philippines, these would include employee benefits provided for under legislative requirements such as (a) social security contributions paid by an employer and (b) employee benefits provided under Republic Act 7641, Retirement Pay Law, which provides for the payment of defined employee retirement benefits to qualifying employees if an entity has no retirement plan or agreement providing retirement benefits for its employees. IAS 31 Interests In Joint Ventures For Philippine financial reporting purposes, reference to PFRS is added to paragraph 2(c)(iv) of IAS 31, as follows: 2. IAS 39 Financial Instruments: Recognition and Measurement A venturer with an interest in a jointly controlled entity is exempted from proportionate consolidation (IAS 31.30) and equity method (IAS 31.38) when it meets the following conditions: a) .... b) .... c) all of the following apply: (i) .... (ii) .... (iii) .... (iv) the ultimate or any intermediate parent of the venturer produces consolidated financial statements available for public use that comply with Philippine Financial Reporting Standards or International Financial Reporting Standards. Transition and Initial Recognition of Financial Assets and Financial Liabilities. The amendment provides transitional relief from retrospective application of the ‘day 1’ gain and loss recognition requirements by allowing entities to adopt a transition option that is easier to implement than that in the previous version of PAS 39. It gives entities a choice of applying the ‘day 1’ gain or loss recognition requirements in PAS 39 : (a) retrospectively (as currently required by PAS 39); (b) prospectively to transactions entered into after 25 October 2002; or (c) prospectively to transactions entered into after 01 January 2004. Effective date: Annual periods beginning on or after 01 January 2005 94 INDEX TO FINANCIAL STATEMENTS REPORT OF INDEPENDENT AUDITORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-2 AUDITED FINANCIAL STATEMENTS Statements of Condition as at 31 December 2004 and 2003 . . . . . . . . . . . . . . . . . . . . . . . F-3 Statements of Income for the years ended 31 December 2004, 2003 and 2002 . . . F-4 Statements of Changes in Capital Funds for the years ended 31 December 2004, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-5 Statements of Cash Flows for the years ended 31 December 2004, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6 Notes to the Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-8 UNAUDITED INTERIM FINANCIAL STATEMENTS Statements of Condition as at 30 September 2005 and 2004 . . . . . . . . . . . . . . . . . . . . . . F-32 Statements of Income for the periods ended 30 September 2005 and 2004 . . . . . . . F-33 Statements of Changes in Capital Funds for the periods ended 30 September 2005 and 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-34 Statements of Cash Flows for the periods ended 30 September 2005 and 2004 . . F-35 Notes to Unaudited Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-37 F-1 REPORT OF INDEPENDENT AUDITORS The Stockholders and the Board of Directors Philippine Savings Bank PSBank Center, 777 Paseo de Roxas corner Sedeño St. Makati City We have audited the accompanying statements of condition of Philippine Savings Bank as of December 31, 2004 and 2003, and the related statements of income, changes in capital funds and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the Philippines. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Philippine Savings Bank as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the Philippines. Renato J. Galve Partner CPA Certificate No. 37759 SEC Accreditation No. 0081-A Tax Identification No. 102-087-055 PTR No. 9404006, January 3, 2005, Makati City March 15, 2005 F-2 PHILIPPINE SAVINGS BANK STATEMENTS OF CONDITION December 31 2004 RESOURCES Cash and Other Cash Items (Note 10) Due from Bangko Sentral ng Pilipinas (Notes 10 and 13) Due from Other Banks (Notes 13 and 21) Interbank Loans Receivable (Notes 13 and 21) Trading Account Securities — at market (Notes 4 and 13) Available-for-Sale Securities — at market (Notes 4 and 13) Investments in Bonds and Other Debt Instruments — net (Notes 4, 10, 13 and 18) Receivables from Customers — net (Notes 5, 13, 21 and 25) Bank Premises, Furniture and Equipment — net (Note 6) Real and Other Properties Owned or Acquired — net (Notes 7 and 25) Deferred Tax Assets (Note 17) Other Resources — net (Note 8) 2003 (As restated — Note 2) P = 750,408,617 P = 759,540,596 1,958,275,032 885,962,808 200,000,000 1,651,912,913 837,287,402 — 71,869,207 2,725,192 2,081,332,979 — 11,188,618,814 6,278,262,138 23,649,151,935 19,651,187,233 1,539,244,694 1,503,691,336 1,734,525,166 285,693,333 1,443,589,670 1,667,809,868 159,663,673 1,091,981,542 P = 45,788,672,255 P = 33,604,061,893 P = 2,071,542,212 24,247,860,215 13,926,182,294 P = 715,857,646 20,716,617,281 6,340,214,702 40,245,584,721 — 211,541,049 27,772,689,629 656,206,699 135,778,875 388,262,862 691,848,865 295,326,030 851,877,173 41,537,237,497 29,711,878,406 1,795,015,200 693,554,524 388,111,384 1,393,354,548 1,795,015,200 693,554,524 339,556,076 1,064,057,687 LIABILITIES AND CAPITAL FUNDS Liabilities Deposit Liabilities (Notes 10, 13 and 21) Demand Savings Time Bills Payable (Notes 11, 13 and 21) Cashier’s and Gift Checks (Note 13) Accrued Taxes, Interest and Other Expenses (Note 13) Other Liabilities (Note 12) Capital Funds (Note 19) Common stock Capital paid in excess of par value Surplus reserves (Notes 2 and 18) Surplus (Notes 2 and 18) Unrealized loss on available-for-sale securities (Note 4) See accompanying Notes to Financial Statements. F-3 (18,600,898) — 4,251,434,758 3,892,183,487 P = 45,788,672,255 P = 33,604,061,893 PHILIPPINE SAVINGS BANK STATEMENTS OF INCOME Years Ended December 31 2003 2002 (As restated — Note 2) 2004 INTEREST INCOME ON Receivables from customers (Notes 5 and 21) Investment securities (Note 4) Deposits with other banks (Note 21) Interbank loans receivable (Note 21) INTEREST EXPENSE ON Deposit liabilities (Notes 10 and 21) Bills payable (Notes 11 and 21) NET INTEREST INCOME BEFORE PROVISION FOR PROBABLE LOSSES PROVISION FOR PROBABLE LOSSES (Note 9) NET INTEREST INCOME AFTER PROVISION FOR PROBABLE LOSSES OTHER INCOME Service charges, penalties, fees and commissions Profit from assets sold (Note 7) Trading and securities gain — net Miscellaneous (Note 14) OTHER EXPENSES Compensation and fringe benefits (Note 22) Taxes and licenses (Note 17) Occupancy and equipment-related expenses (Note 15) Depreciation and amortization (Note 6) Security, messengerial and janitorial services Amortization of intangible assets (Note 8) Miscellaneous (Note 16) P = 2,779,165,110 850,223,688 44,818,999 33,336,391 P = 2,164,088,626 490,646,263 42,032,136 28,051,851 P = 1,798,424,772 430,353,931 35,983,676 56,969,232 3,707,544,188 2,724,818,876 2,321,731,611 1,737,422,306 8,997,457 1,186,956,173 9,788,728 909,708,779 2,298,081 1,746,419,763 1,196,744,901 912,006,860 1,961,124,425 1,528,073,975 1,409,724,751 120,900,000 127,136,284 31,446,032 1,840,224,425 1,400,937,691 1,378,278,719 381,597,929 88,476,861 81,758,557 93,603,339 258,354,701 7,608,585 201,767,608 82,970,700 212,953,563 7,930,840 177,704,333 24,132,016 645,436,686 550,701,594 422,720,752 778,912,625 226,099,705 686,643,256 13,014,802 621,331,466 110,619,456 202,886,226 178,824,029 164,573,185 142,735,104 142,426,926 108,127,730 109,026,783 82,118,000 91,028,690 47,861,572 494,707,279 38,207,053 406,808,281 30,099,484 400,019,226 2,038,318,219 1,534,099,681 1,503,652,978 INCOME BEFORE INCOME TAX 447,342,892 417,539,604 297,346,493 PROVISION FOR (BENEFIT FROM) INCOME TAX (Note 17) (38,210,189) (53,707,286) 17,614,665 NET INCOME P = 485,553,081 P = 471,246,890 P = 279,731,828 P = 2.71 P = 2.63 P = 1.56 Earnings Per Share (Note 20) See accompanying Notes to Financial Statements. F-4 PHILIPPINE SAVINGS BANK STATEMENTS OF CHANGES IN CAPITAL FUNDS Years Ended December 31 2004 COMMON STOCK — P = 10 par value Authorized — 425,000,000 shares Issued — 179,501,520 shares 2003 2002 (As restated) P = 1,795,015,200 P = 1,795,015,200 P = 1,795,015,200 CAPITAL PAID IN EXCESS OF PAR VALUE 693,554,524 693,554,524 693,554,524 SURPLUS RESERVES (Note 18) Balance at beginning of year Transfer from surplus 339,556,076 48,555,308 299,235,910 40,320,166 269,032,670 30,203,240 Balance at end of year 388,111,384 339,556,076 299,235,910 1,416,638,208 1,340,959,148 1,071,452,552 SURPLUS Balance at beginning of year, as previously reported Effect of adoption of new standards on accounting for: Income tax (Note 2) Leases (Note 2) (317,220,037) (35,360,484) (395,387,621) (25,238,132) (382,485,839) (18,161,906) Balance at beginning of year, as restated Net income Transfer to surplus reserves (Note 18) Cash dividends (Note 19) 1,064,057,687 485,553,081 (48,555,308) (107,700,912) 920,333,395 471,246,890 (40,320,166) (287,202,432) 670,804,807 279,731,828 (30,203,240) — Balance at end of year 1,393,354,548 1,064,057,687 920,333,395 UNREALIZED LOSS ON AVAILABLEFOR-SALE SECURITIES (Note 4) Balance at beginning of year Unrealized loss during the year — (18,600,898) — — — — Balance at end of year (18,600,898) — — P = 3,892,183,487 P = 3,708,139,029 P = 4,251,434,758 See accompanying Notes to Financial Statements. F-5 PHILIPPINE SAVINGS BANK STATEMENTS OF CASH FLOWS Years Ended December 31 2004 CASH FLOWS FROM OPERATING ACTIVITIES Income before income tax Adjustments to reconcile income before income tax to net cash generated from operations: Depreciation and amortization (Note 6) Provision for probable losses (Note 9) Profit from assets sold (Note 7) Amortization of intangible assets (Note 8) Unrealized trading loss (gain) on trading account securities (Note 4) Changes in operating resources and liabilities: Decrease (increase) in amounts of: Trading account securities Receivables from customers Other resources Increase (decrease) in amounts of: Deposit liabilities Cashier’s and gift checks Accrued taxes and other expenses Other liabilities P = 447,342,892 2003 2002 (As restated) P = 417,539,604 P = 297,346,493 178,824,029 120,900,000 (88,476,861) 142,735,104 127,136,284 (7,608,585) 108,127,730 31,446,032 (7,930,840) 47,861,572 38,207,053 30,099,484 (38,682) (196,448) (69,550,000) (4,130,566,831) (399,469,701) 9,088,512 (3,892,971,507) (501,089,455) (10,897,206) (2,749,810,111) (74,540,163) 12,472,895,092 75,762,174 88,653,428 (16,686,552) 5,443,303,358 (18,880,155) 62,273,213 225,280,842 5,771,243,858 58,447,328 72,457,091 162,921,219 Net cash generated from operations Income taxes paid 8,727,895,227 (83,536,067) 2,044,975,586 (50,576,509) 3,688,714,467 (63,816,891) Net cash provided by operating activities 8,644,359,160 1,994,399,077 3,624,897,576 — — CASH FLOWS FROM INVESTING ACTIVITIES Purchases of available-for-sale securities Purchases of investments in bonds and other debt instruments Acquisitions of bank premises, furniture and equipment (Note 6) Disposal of bank premises, furniture and equipment 405,985 (2,099,933,877) (4,876,892,983) (1,759,390,616) (2,235,791,912) (216,192,392) (213,061,504) (1,073,532,174) 1,815,005 10,323,958 74,332,905 Net cash used in investing activities (7,191,204,247) (1,962,128,162) (3,234,991,181) CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid (Note 19) Net proceeds from (payment of) bills payable (251,042,668) (106,907,815) (178,799,190) (656,206,699) (143,793,301) 697,192,000 Net cash provided by (used in) financing activities (907,249,367) (250,701,116) 518,392,810 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 545,905,546 (218,430,201) 908,299,205 (Forward) F-6 Years Ended December 31 2004 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR Cash and other cash items Due from Bangko Sentral ng Pilipinas Due from other banks Interbank loans receivable CASH AND CASH EQUIVALENTS AT END OF YEAR Cash and other cash items Due from Bangko Sentral ng Pilipinas Due from other banks Interbank loans receivable 2003 2002 (As restated) P = 759,540,596 1,651,912,913 837,287,402 — P = 532,832,207 811,896,670 1,622,442,235 500,000,000 P = 438,434,642 240,995,530 799,441,735 1,080,000,000 3,248,740,911 3,467,171,112 2,558,871,907 750,408,617 1,958,275,032 885,962,808 200,000,000 759,540,596 1,651,912,913 837,287,402 — 532,832,207 811,896,670 1,622,442,235 500,000,000 P = 3,794,646,457 P = 3,248,740,911 P = 3,467,171,112 See accompanying Notes to Financial Statements. F-7 PHILIPPINE SAVINGS BANK NOTES TO FINANCIAL STATEMENTS 1. Corporate Information Philippine Savings Bank (the Bank) was incorporated in the Philippines on June 30, 1959 primarily to engage in savings and mortgage banking. The Bank’s shares are listed in the Philippine Stock Exchange. The Bank offers a wide range of products and services such as deposit products, loans, treasury and trust functions that cater mainly to the retail and consumer market. On September 6, 1991, the Bank was authorized to perform trust functions. As of December 31, 2004 and 2003, the Bank had 139 and 110 branches, respectively, and 1,584 and 1,433 employees, respectively. As of December 31, 2004, the Bank is seventy-four percent (74%) owned by Metropolitan Bank & Trust Company (Metrobank). The Bank’s principal place of business is located at PSBank Center, 777 Paseo de Roxas corner Sedeño St., Makati City. 2. Summary of Significant Accounting Policies Basis of Financial Statement Preparation The Bank’s financial statements have been prepared in accordance with the accounting principles generally accepted in the Philippines (Philippine GAAP) for the banking industry. Use of Estimates in the Preparation of the Financial Statements The preparation of the financial statements in accordance with Philippine GAAP requires the Bank to make estimates and assumptions that affect the reported amounts of resources, liabilities, income and expenses, and disclosure of contingent resources and contingent liabilities. Future events may occur which will cause the assumptions used in arriving at the estimates to change. The effect of any change in estimates will be reflected in the financial statements when they become reasonably determinable. Changes in Accounting Policies On January 1, 2004, the following new accounting standards became effective and were adopted by the Bank: . Statement of Financial Accounting Standards (SFAS) 12/International Accounting Standard (IAS) 12, Income Taxes, requires deferred income taxes to be determined using the balance sheet liability method. The adoption of this accounting standard resulted in a retroactive downward adjustment to surplus as of December 31, 2003, 2002 and 2001 amounting to P = 317.2 million, P = 395.4 million and P = 382.5 million, respectively. Net income increased by P 78.2 million in 2003 and decreased by = P 12.9 million in 2002. = . SFAS 17/IAS 17, Leases, prescribes the accounting policies and disclosures applicable to finance and operating leases. The adoption of the standard resulted in the recognition of lease payments under operating leases on a straight-line basis. Previously, all leases under operating lease are recognized in the statements of income on the basis of the terms of the lease agreement. The adoption of this accounting standard resulted in a retroactive downward adjustment to surplus as of December 31, 2003, 2002 and 2001 amounting to P = 35.4 million, P = 25.2 million and P 18.2 million, respectively. Net income decreased by P 10.1 million in 2003 and P = = = 7.1 million in 2002. Additional disclosures required by the new standards were included in the financial statements, where applicable. F-8 New accounting standards based on IAS and International Financial Standards, referred to as Philippine Accounting Standards (PAS) and Financial Reporting Standards (PFRS), respectively, will become effective in Bank will adopt the following new accounting standards that are relevant to its effective January 1, 2005 : . Reporting Philippine 2005. The operations PAS 19, Employee Benefits, provides for the accounting for long-term and other employee benefits. The standard requires the projected unit credit cost method in determining the retirement benefits of the employees and a change in the manner of computing benefit expense relating to past service cost and actuarial gains and losses. It requires the Bank to determine the present value of defined benefit obligations and the fair value of any plan assets with sufficient regularity that the amounts recognized in the financial statements do not differ materially from the amounts that would be determined at the statement of condition date. Upon adoption of the standard in 2005, the difference between the present value of the obligation and the fair value of the plan assets will be included in the statements of condition and will be charged against surplus (see Note 22). . PAS 21, The Effects of Changes in Foreign Exchange Rates, provides restrictive conditions for the capitalization of foreign exchange losses. The standard also addresses the accounting for transactions in foreign currency and translating the financial statements of foreign operations that are included in those of the reporting enterprise by consolidation, proportionate consolidation and equity method. The adoption of this standard will have no impact on the financial statements. . PAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, provides for the required disclosure and presentation in respect of the accounts of banks and similar financial institutions. It also provides that provision for general banking risks is treated as appropriation of surplus and should not be included in the determination of net income for the period. The Bank is in the process of determining the effect of this standard in the context of the need to reallocate the general reserve to cover any increase in specific loan reserves required under PAS 39 (see discussion on PAS 39 below). . PAS 32, Financial Instruments: Disclosure and Presentation, covers the disclosure and presentation of all financial instruments. The standard requires more comprehensive disclosures about the Bank’s financial instruments, whether recognized or unrecognized in the financial statements. New disclosure requirements include terms and conditions of financial instruments used by the Bank, types of risks associated with both recognized and unrecognized financial instruments (market risk, price risk, credit risk, liquidity risk, and cash flow risk), fair value information of both recognized and unrecognized financial assets and financial liabilities, and the Bank’s financial risk management policies and objectives. The standard also requires financial instruments to be classified as liabilities or equity in accordance with its substance and not its legal form. . PAS 39, Financial Instruments: Recognition and Measurement, establishes the accounting and reporting standards for recognizing and measuring information about the Bank’s financial assets and financial liabilities. The standard requires a financial asset or financial liability to be recognized initially at fair value. Subsequent to initial recognition, the Bank should continue to measure financial assets at their fair values, except for loans and receivables and held-to-maturity investments, which are measured at cost or amortized cost using the effective interest rate method. Financial liabilities are subsequently measured at cost or amortized cost, except for liabilities classified as ‘‘at fair value through profit and loss’’ and derivatives, which are subsequently measured at fair value. F-9 PAS 39 also covers the accounting for derivative instruments. The standard has expanded the definition of a derivative instrument to include derivatives (derivativelike provisions) embedded in non-derivative contracts. Under the standard, every derivative instrument is recorded in the statements of condition as either an asset or liability measured at its fair value. Derivatives that are not hedges are adjusted to fair value through income. If a derivative is designated and qualifies as a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in capital funds until the hedged item is recognized in income. The Bank must formally document, designate, and assess the effectiveness of derivative transactions that receive hedge accounting treatment. The Bank has established a task force that will implement the provisions of PAS 32 and PAS 39 and assess the implications of these standards on the Bank’s financial statements. To date, the Bank has not yet determined the impact of these standards on the financial statements due to the following: . The Bank is still in the process of updating its system, processes and policies which will incorporate the requirements of PAS 32 and 39. . The Bangko Sentral ng Pilipinas (BSP), through BSP Monetary Board (MB) Resolution No. 1869 dated December 23, 2004, has given the banks and financial institutions until December 31, 2005 to ready their infrastructures to be PAS 32 and 39 compliant. Interim reports that will be submitted to the BSP for 2005 need not be in compliance with the provisions of the said standards. With respect to account classification and related measurement, the Bank has already submitted to the BSP the reclassification of its trading and investment securities portfolio. The Bank does not expect any further material impact on the classification of financial assets and liabilities. The Bank is currently adopting the effective interest rate method in amortizing unearned discount related to loans. Therefore, the effect of the adoption of PAS 39 in so far as the amortization of unearned discount on loans is concerned will not be material. With regard to the adoption of effective interest rate method in measuring amortized cost for investments in bonds and other debt instruments (IBODI) and available-for-sale securities (ASS), the effect has not yet been quantified since the existing systems of the Bank have not yet been reconfigured to adopt effective interest rate method of amortization. Due to the volume of transactions, it is impracticable to compute for the financial impact manually. The Bank will report the financial implications as soon as the information becomes available. PAS 39 requires that in the absence of quoted market rates, the discounted cash flow method will be used in determining whether an asset is impaired. The Bank will adopt the net flow rate method for consumer loans and discounted cashflows method for corporate accounts in determining asset impairment. The effect of adopting this provision may be material for impaired loans and other receivables. Currently, the adequacy of allowance for probable losses on loans and other receivables is determined based on management criteria and BSP requirements. The existing systems of the Bank have not yet been programmed to adopt the discounted cash flow method. Due to the volume of transactions, it is impracticable to compute for the financial impact manually. The Bank will report the financial implications as soon as the information becomes available. . PAS 40, Investment Property, prescribes the accounting treatment for investment property and related disclosure requirements. This standard permits the Bank to choose either the fair value model or cost model in accounting for investment property. Fair value model requires an investment property to be measured at fair value with fair value changes recognized directly in the statements of income. Cost model requires that an investment property should be measured at depreciated cost F-10 less any accumulated impairment losses. The Bank is still in the process of identifying real and other properties owned or acquired (ROPOA) accounts that will be accounted for under PAS 40 and PFRS 5 (see significant provisions of PFRS 5 below), and which valuation model to be used under PAS 40. Regardless of valuation model (either cost or fair value), the adoption of PAS 40 may result in a material adjustment of prior years’ financial statements. The Bank has not yet quantified the implication of PAS 40 since the system that will support the accounting for ROPOA under PAS 40 has not yet been established. Due to the volume of transactions, it is impracticable to compute for the financial impact manually. The Bank will report the financial implications of PAS 40 as soon as the information becomes available. . PFRS 2, Share-Based Payments, will result in a charge to net income for the cost of share options granted. Currently, the Bank has no transaction involving share-based payments but will comply with the requirements of this standard in respect of future transactions. . PFRS 3, Business Combination, which will result in the cessation of the amortization of goodwill and a requirement for an annual test for goodwill impairment. Any resulting negative goodwill from a business combination after performing reassessment will be credited to income. Moreover, pooling of interests in accounting for business combination will no longer be permitted. The effect of adopting this standard will not result in retroactive adjustment of prior years’ financial statements but will affect prospective financial statements as a result of nonamortization of goodwill. . PFRS 5, Non-current Assets Held for Sale and Discontinued Operations, specifies the accounting for assets held for sale and the presentation and disclosure of discontinued operations. It requires assets that meet the criteria to be classified as held for sale to be measured at the lower of carrying amount and fair value less costs to sell, and the depreciation on such assets to cease. Furthermore, assets that meet the criteria to be classified as held for sale should be presented separately on the face of the statements of condition and the results of discontinued operations to be presented separately in the statements of income. Pending the identification of the ROPOA accounts to be accounted for under PFRS 5, as discussed under PAS 40 above, the effect of adoption of PFRS 5 with respect to the assets to be accounted for under this standard will not be material to the financial statements. The Bank will also adopt in 2005 the following revised standards: . PAS 1, Presentation of Financial Statements, provides a framework within which an entity assesses how to present fairly the effects of transactions and other events; provides the base criteria for classifying liabilities as current or non-current; prohibits the presentation of income from operating activities and extraordinary items as separate line items in statements of income; and specifies the disclosures about key sources of estimation uncertainty and judgments that management has made in the process of applying the entity’s accounting policies. It also requires changes in the presentation of minority interest in the statements of condition and statements of income. . PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, removes the concept of fundamental error and the allowed alternative to retrospective application of voluntary changes in accounting policies and retrospective restatement to correct prior period errors. It defines material omission or misstatements, and describes how to apply the concept of materiality when applying accounting policies and correcting errors. . PAS 10, Events After the Balance Sheet Date, provides a limited clarification of the accounting for dividends declared after the statement of condition date. F-11 . PAS 16, Property, Plant and Equipment, provides additional guidance clarification on recognition and measurement of items of property, plant equipment. It also provides that each part of an item of property, plant equipment with a cost that is significant in relation to the total cost of the item be depreciated separately. and and and shall . PAS 17, Leases, provides a limited revision to clarify the classification of a lease of land and buildings and prohibits expensing of initial direct costs in the financial statements of lessors. . PAS 24, Related Party Disclosures, provides additional guidance and clarity in the scope of the standard, the definitions and the disclosures for related parties. It also requires disclosure of the compensation of key management personnel by benefit type. . PAS 27, Consolidated and Separate Financial Statements, reduces alternatives in accounting for subsidiaries in consolidated financial statements and in accounting for investments in the separate financial statements of a parent, venturer or investor. Investments in subsidiaries will be accounted for either at cost or in accordance with PAS 39 in the separate financial statements. Equity method of accounting will no longer be allowed in the separate financial statements. This standard also requires strict compliance with adoption of uniform accounting policies and requires the parent to make appropriate adjustments to the subsidiary’s financial statements to conform them to the parent’s accounting policies for reporting like transactions and other events in similar circumstances. . PAS 28, Investments in Associates, reduces alternatives in accounting for associates in consolidated financial statements and in accounting for investments in the separate financial statements of an investor. Investments in associates will be accounted for either at cost or in accordance with PAS 39 in the separate financial statements. Equity method of accounting will no longer be allowed in the separate financial statements. This standard also requires strict compliance with adoption of uniform accounting policies and requires the investor to make appropriate adjustments to the associate’s financial statements to conform them to the investor’s accounting policies for reporting like transactions and other events in similar circumstances. . PAS 31, Interests in Joint Ventures, reduces the alternatives in accounting for interests in joint ventures in consolidated financial statements and in accounting for investments in the separate financial statements of a venturer. Interests in joint ventures will be accounted for either at cost or in accordance with PAS 39 in the separate financial statements. Equity method of accounting will no longer be allowed in the separate financial statements. The Bank does not expect significant changes in the accounting policies when it adopts the applicable revised standards in 2005. Additional disclosures required by the applicable revised standards will be included, where applicable. Cash and Cash Equivalents Cash and cash equivalents include cash and other cash items, amounts due from BSP and other banks and interbank loans receivable that are convertible to known amount of cash with original maturities of three months or less from dates of placements and that are subject to insignificant risk of changes in value. Trading Account Securities (TAS) TAS, which consist of government and private debt securities, are purchased and held principally with the intention of selling them in the near term and are carried at fair market value. Realized and unrealized gains and losses on these instruments are recognized in Trading and Securities Gain — Net in the statements of income. Quoted market prices, when available, are used to determine the fair value of trading F-12 instruments. If quoted market prices are not available, fair market value is determined using the discounted cash flows or using quoted prices of instruments with similar characteristics. When a security is transferred to TAS, the unrealized holding gain or loss at the date of transfer is recognized in the statements of income immediately. Available-for-Sale Securities Securities are classified as ASS when purchased and held indefinitely, i.e., neither held to maturity nor for trading purposes, where the Bank anticipates to sell in response to liquidity requirements or in anticipation of changes in interest rates or other factors. ASS are carried at fair market value and any unrealized gains or losses are reported as a separate component of capital funds unless unrealized losses represent impairment losses in which case such amounts are charged against income. When a debt security transferred into ASS from IBODI, the unrealized holding gain or loss at the date of the transfer shall be excluded from reported earnings and reported as a separate component of capital funds until realized. Investments in Bonds and Other Debt Instruments IBODI are government and private debt securities where the Bank has the positive intent and ability to hold to maturity and are carried at amortized cost on a straight-line basis. An allowance is set up for any substantial and presumably permanent decline in the aggregate carrying value of the investments. Under current BSP regulations, IBODI shall not exceed 50% of adjusted statutory net worth plus 40% of total deposit liabilities. Receivables from Customers and Allowance for Probable Losses Receivables from customers are stated at the outstanding principal balance reduced by unearned discounts and allowance for probable losses. Under current BSP regulations, nonaccruing receivables are those that have been defined as past due and items under litigation, or those for which, in the opinion of management, collection of interest or principal is doubtful. Receivables are not reclassified as accruing until interest and principal payments are brought current or the receivables are restructured in accordance with existing BSP regulations, and future payments appear assured. The allowance for probable losses on loans represents management’s estimate of probable losses inherent in the portfolio, after consideration of prevailing and anticipated economic conditions, prior loss experience, estimated recoverable values based on fair market values of underlying collateral, prospects of supports from any financially responsible guarantor, subsequent collections including, as appropriate, estimated cash flows and on evaluations made by the BSP. The BSP observes certain criteria and guidelines based largely on the classification of loans in establishing specific loan loss reserves. Allowance on other risk assets is maintained at a level considered adequate to provide for potential uncollectibility of other risk assets. Management evaluates the level of this allowance based on the factors that affect the collectibility of the accounts. A review of age and status of these accounts, designed to identify accounts to be provided with allowance, is made by the management on a continuing basis. The allowance for probable losses is established through provisions for probable losses charged against current operations. Receivables are written off against the allowance for probable losses when management believes that the collectibility of the principal is unlikely. Bank Premises, Furniture and Equipment Bank premises, furniture and equipment are stated at cost less accumulated depreciation (except for leasehold improvements which is carried net of amortization) and any impairment in value. The initial cost of bank premises, furniture and equipment consists of its purchase price, including taxes and any directly attributable costs of bringing the F-13 asset to its working condition and location for its intended use. Expenditures incurred after the bank premises, furniture and equipment have been put into operation, such as repairs and maintenance are normally charged against operations in the year in which the costs are incurred. In situations where it can be clearly demonstrated that the expenditures have resulted in an increase in the future economic benefits expected to be obtained from the use of an item of bank premises, furniture and equipment beyond its originally assessed standard of performance, the expenditures are capitalized as additional cost of bank premises, furniture and equipment. When assets are retired or otherwise disposed of, the cost, and the related accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is reflected as income or loss in the statements of income. Depreciation is determined using the straight-line method over the estimated useful life of the respective assets. Leasehold improvements are amortized over the shorter of the estimated average useful life of the improvements of five years or the terms of the related leases. The annual depreciation rates follow: Building Furniture, fixtures and equipment Leasehold improvements 4% 20% 20% or the term of the lease, whichever is shorter The useful life and the depreciation and amortization method are reviewed periodically to ensure that the period and the method of depreciation and amortization are consistent with the expected pattern of economic benefits from items of bank premises, furniture and equipment. The carrying values of bank premises, furniture and equipment are reviewed for impairment when events or changes in circumstances indicate that the carrying values may not be recoverable. If any such indication exists and where the carrying values exceed the estimated recoverable amounts, an impairment loss is recognized in the statements of income (see accounting policy on Impairment of Assets). Impairment of Assets An assessment is made at each statement of condition date if there is any indication of impairment of any asset, or if there is any indication that an impairment loss previously recognized for an asset in prior years may no longer exist or may have decreased. If any such indication exists, the asset’s recoverable amount is estimated at the higher of the asset’s value in use or its net selling price. An impairment loss is recognized by a charge against current operations for the excess of the carrying amount of an asset over its recoverable amount. An impairment loss is charged against operations in the year in which it arises. A previously recognized impairment loss is reversed by a credit to current operations to the extent that it does not restate the asset to a carrying amount in excess of what would have been determined (net of any accumulated depreciation) had no impairment loss been recognized for the asset in prior years. Real and Other Properties Owned or Acquired Resources acquired in settlement receivables are stated at the total outstanding exposure at the time of acquisition or bid price, whichever is lower, less allowance for probable losses and impairment in value, if any. Nonrefundable taxes such as capital gains tax and documentary stamp tax which were paid by the Bank are capitalized, provided that the adjusted value of the foreclosed asset does not exceed net realizable value. Security, maintenance and other foreclosure-related expenses are charged against operations as incurred. Allowance for probable losses is set up based on BSP F-14 provisioning requirements and for any anticipated significant shortfalls from the recorded values based on appraisal reports and current negotiations and programs to dispose of these properties to other interested parties. Intangible Assets Intangible assets include goodwill, software costs and license fees. Intangible assets acquired separately from a business are capitalized at cost. Intangible assets acquired as part of an acquisition of a business are capitalized separately from goodwill if the fair value can be measured reliably on initial recognition, subject to the constraint that, unless the asset has a readily ascertainable market value, the fair value is limited to an amount that does not create or increase any negative goodwill arising on the acquisition. Software costs and license fees are being amortized over a period of five years on a straight-line basis. Intangible assets are carried net of amortization and any impairment in value. Goodwill which arises from the purchase of branch offices from the Parent Company, is being amortized over a period of five years from the date of purchase. The carrying values of intangible assets are reviewed for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable. Income Taxes Deferred income tax is provided, using the balance sheet liability method, on all temporary differences at the statement of condition date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred income tax liabilities are recognized for all taxable temporary differences. Deferred income tax assets are recognized for all deductible temporary differences, carryforward of unused tax credits from excess minimum corporate income tax (MCIT) over the regular corporate income tax and unused net operating loss carryover (NOLCO), to the extent that it is probable that taxable profit will be available against which the deductible temporary differences and carryforward of unused MCIT and unused NOLCO can be utilized. Deferred income tax, however, is not recognized when it arises from the initial recognition of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting profit nor taxable profit or loss. The carrying amount of deferred income tax assets is reviewed at each statement of condition date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred income tax asset to be utilized. Deferred income tax assets and liabilities are measured at the tax rates that are applicable to the year when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the statement of condition date. Revenue Recognition Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Bank and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognized: Interest Income Unearned discount is recognized as income over the terms of the receivables using the effective interest rate method. Interest income on nondiscounted receivables is recognized based on the accrual method of accounting, except in the case of nonaccruing receivables. Interest income on nonaccruing receivables are recognized only to the extent of the cash collections received. F-15 Interest on interest-bearing placements and securities are recognized as the interest accrues, taking into account the effective yield on the asset. Loan Fees and Service Charges Loan commitment fees are recognized as earned over the terms of the credit lines granted to each borrower. Loan syndication fees are recognized upon completion of all syndication activities and where the Bank does not have further obligations to perform under the syndication agreement. Service charges and penalties are recognized only upon collection. Leases Operating lease payments are recognized as an expense in the statements of income on a straight-line basis over the lease term. Retirement Cost The Bank determines retirement cost under the projected unit credit method. Under this method, the current service cost is the present value of retirement benefits payable in the future with respect to services rendered in the current period. The accrued actuarial liability is the present value of benefits payable in the future with respect to services rendered to date. Unfunded past service costs, experience adjustments and any actuarial gains or losses are amortized over the expected average remaining working life of the employees. Retirement cost includes current service cost, amortization of past service costs, interest on unfunded accrued retirement liability, experience adjustments and actuarial gain or losses, if any. Foreign Exchange Transactions and Translations Foreign currency-denominated assets and liabilities are translated to Philippine pesos using the Philippine Dealing System weighted average rates (PDSWAR) prevailing at the end of the year. Income and expense items are translated at PDSWAR prevailing at transaction dates. Exchange differences arising from reporting monetary items at rates different from those at which they where previously recorded, as well as foreign exchange gains or losses arising from foreign currency are credited to or charged against operations in the year in which the rates change. Provisions and Contingencies Provisions are recognized when an obligation (legal or constructive) is incurred as a result of a past event and where it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. If the effect of the time value of money is material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessment of the time value of money and, where appropriate, the risks specific to the liability. Where discounting is used, the increase in the provision due to the passage of time is recognized as an interest expense. Contingent liabilities are not recognized but are disclosed in the financial statements unless the possibility of an outflow of resources embodying economic benefits is remote. Contingent assets are not recognized but are disclosed in the financial statements when an inflow of economic benefits is probable. Earnings Per Share Basic earnings per share is computed based on the weighted average number of common shares outstanding, after giving retroactive effect to stock dividends declared, stock rights exercised and stock splits made during the year. Subsequent Events Post-year-end events that provide additional information about the Bank’s position at the statement of condition date (adjusting events) are reflected in the financial statements. Post-year-end events that are not adjusting events are disclosed in the notes to the financial statements when material. F-16 3. Segment Information The Bank’s operating businesses are organized and managed separately according to the nature of services provided and the different markets served with segments representing strategic business unit. The Bank’s business segments are as follows: Consumer Banking — principally handling individual customers’ deposits, and providing consumer-type loans, overdrafts and fund transfer facilities; Corporate Banking — principally handling loans and other credit facilities, and deposit and current accounts for corporate and institutional customers; and Treasury — principally providing money market, trading and treasury services, as well as the managing of the Bank’s funding operations by use of treasury bills, government securities and placements and acceptances with other banks, through treasury. These segments are the bases on which the Bank reports its primary segment information. Other operations of the Bank comprise the operations and financial control groups. Transactions between segments are conducted at estimated market rates on an arm’s length basis. Primary segment information (by business segment) for the years ended December 31, 2004, 2003 and 2002 follows (in thousands): 2004 Consumer Banking Results of Operations Net interest income Noninterest income Total revenue Noninterest expense P = 1,400,493 411,052 P = 545,483 149,237 Treasury P = 15,148 85,148 Total P = 1,961,124 645,437 694,720 (585,836) 100,296 (12,095) 250,258 — 108,884 — 88,201 — P = 250,258 P = 108,884 P = 88,201 P = 485,553 Statement of Condition Total resources P = 19,384,677 P = 11,151,650 P = 14,966,652 P = 45,502,979 Total liabilities P = 17,243,166 P = 9,617,713 P = 14,676,358 P = 41,537,237 Other Segment Information Capital expenditures P = 173,083 P = 42,303 P = 806 P = 216,192 Depreciation and amortization P = 143,166 P = 34,991 P = 667 P = 178,824 Income before income tax Benefit from income tax Net income 1,811,545 (1,561,287) Corporate Banking F-17 2,606,561 (2,159,218) 447,343 (38,210) 2003 (As restated — Note 2) Consumer Banking Results of Operations Net interest income Noninterest income Total revenue Noninterest expense Income before income tax Benefit from income tax Net income P = 991,034 235,569 1,226,603 (1,078,442) Corporate Banking P = 524,656 112,925 637,581 (575,393) Treasury P = 12,384 202,208 214,592 (7,401) 148,161 — 62,188 — 207,191 — P = 148,161 P = 62,188 P = 207,191 Total P = 1,528,074 550,702 2,078,776 (1,661,236) 417,540 (53,707) P = 471,247 Statement of Condition Total resources P = 14,905,205 P = 10,714,795 P = 7,824,398 P = 33,444,398 Total liabilities P = 13,019,937 P = 8,894,540 P = 7,797,401 P = 29,711,878 Other Segment Information Capital expenditures P = 166,654 P = 45,681 P = 727 P = 213,062 Depreciation and amortization P = 111,646 P = 30,602 P = 487 P = 142,735 2002 (As restated — Note 2) Results of Operations Net interest income Noninterest income Total revenue Noninterest expense Income before income tax Provision for income tax Net income Consumer Banking Corporate Banking Treasury P = 1,007,056 159,209 P = 435,923 84,782 P = (33,254) 178,730 1,166,265 (1,061,557) 520,705 (449,270) 145,476 (24,272) Total P = 1,409,725 422,721 1,832,446 (1,535,099) 104,708 — 71,435 — 121,204 — 297,347 17,615 P = 104,708 P = 71,435 P = 121,204 P = 279,732 Statement of Condition Total resources P = 9,412,629 P = 10,372,268 P = 7,837,246 P = 27,622,143 Total liabilities P = 7,552,072 P = 8,609,856 P = 7,799,380 P = 23,961,308 Other Segment Information Capital expenditures P = 839,705 P = 230,167 P = 3,660 P = 1,073,532 Depreciation and amortization P = 84,576 P = 23,183 P = 369 P = 108,128 Total resources do not include deferred tax assets amounting to P = 285.7 million, P = 159.7 million and P 47.3 million as of December 31, 2004, 2003 and 2002. = 4. Trading and Investments Securities TAS includes unrealized loss of P = 0.41 million in 2004 and unrealized gain of P = 0.04 million and P 0.20 million in 2003 and 2002, respectively. = As of December 31, 2004, ASS is carried net of accumulated unrealized loss of P = 18.6 million. F-18 IBODI account consists of: 2004 2003 Government bonds (Note 18) BSP Treasury bills Private bonds Treasury notes P = 8,550,758,849 522,759,822 395,610,552 1,781,636,449 P = 4,550,689,848 491,899,969 395,610,552 935,672,320 Less allowance for probable losses (Note 9) 11,250,765,672 62,146,858 6,373,872,689 95,610,551 P = 11,188,618,814 P = 6,278,262,138 As of December 31, 2004 and 2003, the market values of IBODI follow: 2004 Government bonds (Note 18) BSP Treasury bills Private bonds Treasury notes 2003 P = 8,497,610,816 555,737,087 397,114,107 1,755,933,540 P = 4,524,959,426 474,589,678 408,693,558 1,078,332,322 P = 11,206,395,550 P = 6,486,574,984 Peso-denominated IBODI bear nominal annual interest rates ranging from 10.00% to 18.25% in 2004 and 4.57% to 18.25% in 2003, while foreign currency-denominated IBODI bear nominal annual interest rates ranging from 8.25% to 9.38% in 2004 and 4.22% to 9.00% in 2003. 5. Receivables from Customers This account consists of: 2004 Loans and discounts Bills purchased (Note 12) P = 26,074,259,049 141,555,213 26,215,814,262 (1,704,379,681) (862,282,646) Unearned discounts Allowance for probable losses (Note 9) P = 23,649,151,935 2003 P = 21,614,607,706 88,854,894 21,703,462,600 (1,388,854,925) (663,420,442) P = 19,651,187,233 As of December 31, 2003, loans amounting to P = 8.3 million were rediscounted with the BSP (see Note 11). There were no rediscounted loans as of December 31, 2004. Restructured loans as of December 31, 2004 and 2003 amounted to P = 1,021.6 million and P 1,235.8 million, respectively. = As of December 31, 2004 and 2003, 48.45% and 71.23% of the total receivables were subject to periodic interest repricing, respectively. Remaining receivables earned annual fixed interest rates which averaged 20.10% in 2004 and 15.15% in 2003. F-19 The breakdown of receivables from customers as to secured and unsecured and as to type of security follows: 2004 Secured by: Real estate Chattel Deposit hold-out Securities Others Unsecured % 2003 % P = 10,025,526,936 8,732,888,798 443,804,158 — 880,693,861 38.24 33.31 1.69 — 3.36 P = 9,098,078,954 6,800,538,204 379,350,716 951,500,000 166,666,668 41.92 31.33 1.75 4.38 0.77 20,082,913,753 6,132,900,509 76.60 23.40 17,396,134,542 4,307,328,058 80.15 19.85 P = 26,215,814,262 100.00 P = 21,703,462,600 100.00 As of December 31, 2004 and 2003, nonaccruing loans follow: 2004 Secured Unsecured 2003 P = 978,841,674 598,446,102 P = 1,062,624,031 243,767,843 P = 1,577,287,776 P = 1,306,391,874 Current banking regulations allow banks with no unbooked valuation reserves and capital adjustments to exclude from nonperforming classification loans classified as Loss in the latest examination of the BSP which are fully covered by allowance for probable losses, provided that interest on said receivables shall not be accrued. As of December 31, 2004 and 2003, the nonperforming loans (NPLs) of the Bank not fully covered by allowance for probable losses follow: 2004 Total NPLs NPLs fully covered by allowance for probable losses 2003 P = 1,496,068,950 P = 1,147,326,557 (325,638,000) P = 1,170,430,950 (325,638,000) P = 821,688,557 As of December 31, 2004 and 2003, the loan concentration as to economic activity follows: 2004 Other community, social and personal activities Real estate Wholesale and retail trade Agriculture Banks, insurance and other financial institutions Public utilities Manufacturing Services Mining and quarrying Others % 2003 % P = 10,939,562,400 5,390,445,643 4,705,249,748 1,590,303,623 41.73 20.56 17.95 6.07 P = 8,077,150,470 5,095,970,391 6,704,316,641 1,199,927,217 37.22 23.48 30.89 5.53 1,170,544,244 1,103,986,789 853,510,742 254,458,247 16,193,234 191,559,592 4.47 4.21 3.25 0.97 0.06 0.73 5,103,846 200,294,662 100,180,610 200,838,050 1,100,000 118,580,713 0.02 0.92 0.46 0.93 0.00 0.55 P = 26,215,814,262 100.00 P = 21,703,462,600 100.00 Thrift banks are not covered by the loan concentration limit of 30% as prescribed by BSP. F-20 6. Bank Premises, Furniture and Equipment The composition and movements in the bank premises, furniture and equipment account follow: 2004 Land Cost Balance at beginning of year Acquisitions Disposals/others Balance at end of year Accumulated Depreciation Balance at beginning of year Depreciation Disposals Balance at end of year Net Book Value Building P = 75,549,955 — (1,800,000) P = 1,261,795,460 5,076,714 — 73,749,955 1,266,872,174 — — — 171,230,823 50,442,531 — Furniture, Fixtures and Equipment Leasehold Improvements 2003 P = 652,582,029 133,217,483 (21,539,514) P = 109,097,699 77,898,195 (38,924,376) P = 2,099,025,143 216,192,392 (62,263,890) P = 1,922,476,798 213,061,504 (36,513,159) 764,259,998 148,071,518 2,252,953,645 2,099,025,143 424,102,984 89,457,122 (21,524,509) — — — 595,333,807 139,899,653 (21,524,509) 478,787,904 119,100,374 (2,554,471) — 221,673,354 492,035,597 — 713,708,951 595,333,807 P = 73,749,955 P = 1,045,198,820 P = 272,224,401 P = 148,071,518 P = 1,539,244,694 P = 1,503,691,336 Depreciation and amortization amounted to P = 178.8 million in 2003 and P 108.1 million in 2002 (includes amortization of = amounting to P 38.9 million in 2004, P 23.6 million in 2003 and = = 7. Total 2004, P = 142.7 million in leasehold improvements P = 17.1 million in 2002). Real and Other Properties Owned or Acquired This account consists of: 2004 ROPOA (Note 25) Less allowance for probable losses (Note 9) 2003 P = 1,815,221,138 80,695,972 P = 1,861,516,446 193,706,578 P = 1,734,525,166 P = 1,667,809,868 Net gains from sale of ROPOA amounted to P = 88.5 million in 2004, P = 7.6 million in 2003 and P = 7.9 million in 2002 are presented as Profit from Assets Sold in the statements of income. F-21 8. Other Resources This account consists of: 2003 (As restated) 2004 Accrued interest receivable (Note 13) Sales contract receivable (Note 13) Accounts receivable (Notes 13 and 21) Intangible assets — net Foreign currency notes and coins on hand Other investments — at cost (Note 13) Returned checks and other cash items Prepaid expenses Sundry debits Miscellaneous P = 642,390,192 386,512,812 251,133,965 95,357,606 60,057,711 51,492,562 37,019,258 26,534,929 23,947,877 89,032,339 P = 431,490,058 234,281,472 170,558,455 110,322,826 43,827,814 61,202,466 54,487,796 17,124,917 25,823,288 94,239,936 Less allowance for probable losses (Note 9) 1,663,479,251 219,889,581 1,243,359,028 151,377,486 P = 1,443,589,670 P = 1,091,981,542 Sales contract receivable earned interest rate ranging from 10.40% to 11.62% in 2004 and 5.19% to 10.95% in 2003. The composition and movements of intangible assets follow: 2004 Software Cost 9. Goodwill License Fees Balance at beginning of year Additions Amortization P = 56,197,821 14,146,352 (23,819,905) P = 48,058,338 5,500,000 (23,600,000) Balance at end of year P = 46,524,268 P = 29,958,338 Total 2003 P = 6,066,667 P = 110,322,826 P = 106,188,994 13,250,000 32,896,352 42,340,885 (441,667) (47,861,572) (38,207,053) P = 18,875,000 P = 95,357,606 P = 110,322,826 Allowance for Probable Losses Changes in the allowance for probable losses are as follows: Balance at beginning of year: IBODI Receivables from customers ROPOA Other resources 2004 2003 P = 95,610,551 663,420,442 193,706,578 151,377,486 P =— 839,017,613 34,346,605 142,594,939 1,104,115,057 120,900,000 — Provisions charged against operations Accounts charged off Balance at end of year: IBODI (Note 4) Receivables from customers (Note 5) ROPOA (Note 7) Other resources (Note 8) F-22 1,015,959,157 127,136,284 (38,980,384) P = 62,146,858 862,282,646 80,695,972 219,889,581 P = 95,610,551 663,420,442 193,706,578 151,377,486 P = 1,225,015,057 P = 1,104,115,057 With the foregoing level of allowance for probable losses, management believes that the Bank has sufficient level of allowance to take care of any losses that the Bank may incur from the noncollection or nonrealization of its receivables from customers and other risk assets. 10. Deposit Liabilities Available reserves as of December 31, 2004 and 2003 follow: 2004 Cash Due from BSP IBODI 2003 P = 921,908,075 1,959,139,050 593,082,063 P = 756,239,176 1,609,348,655 462,982,286 P = 3,474,129,188 P = 2,828,570,117 Under existing BSP regulations, non-FCDU deposit liabilities are subject to liquidity reserve equivalent to 2% and statutory reserve of 6%. As of December 31, 2004 and 2003, the Bank was in compliance with such regulation. As of December 31, 2004 and 2003, 71.06% and 63.16% of the deposit liabilities were subject to periodic interest repricing, respectively. Remaining deposits earned annual fixed interest rate which averaged 4.75% in 2004 and 5.02% in 2003. 11. Bills Payable In 2003, this account consists of: 2003 Interbank call loans Rediscounted loans (see Note 5) P = 650,000,000 6,206,699 P = 656,206,699 Interbank call loans were subject to annual fixed interest rates ranging from 6.87% to 7.50%. Rediscounted loans were subject to annual fixed interest rate of 4.17%. 12. Other Liabilities This account consists of: 2004 Accounts payable (Note 13) Bills purchased-contra (Note 13) Other credits (Note 13) Dividends payable (Notes 13 and 19) Withholding taxes payable (Note 13) Sundry credits Miscellaneous 2003 P = 300,239,138 137,067,612 80,616,882 37,655,191 35,888,285 25,261,370 75,120,387 P = 376,699,700 88,854,894 38,013,452 180,996,947 25,709,341 43,301,905 98,300,934 P = 691,848,865 P = 851,877,173 Accounts payable includes payable to suppliers and service providers and payments for principal, interest and other charges received from customers in advance. F-23 13. Maturity Profile of Financial Resources and Financial Liabilities The following tables present the financial resources and financial liabilities by contractual maturity and settlement dates as of December 31, 2004 and 2003 : 2004 Financial Resources Due from BSP 2003 Due Within Due Beyond One Year One Year Total Due Within Due Beyond One Year One Year Total P = 1,958,275,032 P =— P = 1,958,275,032 P = 1,651,912,913 P =— P = 1,651,912,913 Due from other banks 885,962,808 — 885,962,808 837,287,402 — 837,287,402 Interbank loans receivable 200,000,000 — 200,000,000 — — — 38,425,084 33,444,123 71,869,207 45,312 2,679,880 2,725,192 TAS Available-for-sale securities IBODI (Note 4) 86,075,104 1,995,257,875 2,081,332,979 — — — 783,415,804 10,467,349,868 11,250,765,672 1,447,037,352 4,926,835,337 6,373,872,689 P = 6,605,702,345 P = 19,610,111,917 P = 26,215,814,262 P = 14,607,913,752 P = 7,095,548,848 P = 21,703,462,600 431,490,058 Receivables from customers (Note 5) Other resources (Note 8): Accrued interest receivable 393,927,264 248,462,928 642,390,192 431,002,058 488,000 5,812,626 380,700,186 386,512,812 43,883,573 190,397,899 234,281,472 150,652,367 100,481,598 251,133,965 142,887,039 27,671,416 170,558,455 292,562 51,200,000 51,492,562 61,202,466 — 61,202,466 P = 11,108,540,996 P = 32,887,008,495 P = 43,995,559,491 P = 19,223,171,867 P = 12,243,621,380 P = 31,466,793,247 Sales contract receivable Accounts receivable Other investments 2003 2004 Financial Liabilities (As restated) Due Within Due Beyond One Year One Year Total Due Within Due Beyond One Year One Year Total Deposit liabilities Demand P = 2,071,542,212 P =— P = 2,071,542,212 P = 715,857,646 P =— P = 715,857,646 Savings 24,247,860,215 — 24,247,860,215 20,716,617,281 — 20,716,617,281 Time 10,151,591,998 3,774,590,296 13,926,182,294 4,221,383,102 2,118,831,600 6,340,214,702 36,470,994,425 3,774,590,296 40,245,584,721 25,653,858,029 2,118,831,600 27,772,689,629 Bills payable (Note 11) — — — 656,206,699 — 656,206,699 211,541,049 — 211,541,049 135,778,875 — 135,778,875 388,262,862 — 388,262,862 295,326,030 — 295,326,030 Accounts payable 300,239,138 — 300,239,138 368,484,827 8,214,873 376,699,700 Bills purchased — contra 137,067,612 — 137,067,612 88,854,894 — 88,854,894 Other credits 80,616,882 — 80,616,882 38,013,452 — 38,013,452 Dividends payable 37,655,191 — 37,655,191 180,996,947 — 180,996,947 Withholding taxes payable 35,888,285 — 35,888,285 25,709,341 — 25,709,341 P = 37,662,265,444 P = 3,774,590,296 P = 41,436,855,740 P = 27,443,229,094 P = 2,127,046,473 P = 29,570,275,567 Cashier’s and gift checks Accrued taxes, interest and other expenses Other liabilities (Note 12): 14. Miscellaneous Income This account consists of: 2004 Rent (Note 15) Foreign exchange gain — net Recovery from accounts written-off Income from trust operations Others 2003 2002 (As restated) P = 28,750,156 3,389,699 3,353,957 2,777,556 55,331,971 P = 41,966,730 440,338 2,990,015 3,437,890 34,135,727 P = 8,749,843 1,025,727 4,582,613 3,087,100 6,686,733 P = 93,603,339 P = 82,970,700 P = 24,132,016 Miscellaneous income — others in 2004 include long outstanding accounts payable which were recognized in income amounting to P = 21.2 million. F-24 15. Leases The Bank leases the premises occupied by its branches for periods ranging from 1 to 20 years renewable under certain terms and conditions. Various lease contracts include escalation clauses, most of which bear an annual rent increase of 10%. Rentals charged against operations under these lease contracts amounting to P = 151.2 million in 2004 and P = 118.1 million (as restated) in 2003 and P = 105.3 million (as restated) in 2002 are shown under Occupancy and Equipment-related Expenses in the statements of income. Future minimum rentals payable under non-cancelable operating leases are as follows: 2004 Within one year After one year but not more than five years After more than five years 2003 P = 155,315,801 450,445,351 299,329,676 P = 152,421,782 520,486,658 384,604,170 P = 905,090,828 P = 1,057,512,610 The Bank entered into commercial property leases on its surplus office. These noncancelable leases have remaining non-cancelable lease terms of between 1 and 5 years. As of December 31, 2004, there is no contingent rental income. Rent income of the Bank related to these property leases amounted to P = 24.8 million in 2004, P = 38.6 million in 2003 and P 6.1 million in 2002. = Future minimum rentals receivable under non-cancelable operating leases are as follows: 2004 Within one year After one year but not more than five years 2003 P = 2,471,969 902,888 P = 3,644,987 3,227,875 P = 3,374,857 P = 6,872,862 16. Miscellaneous Expenses This account consists of: 2004 Insurance Information technology Litigation Communications Advertising Transportation and traveling Management and professional fees Repairs and maintenance Commissions Stationery and supplies Fines, penalties and other charges Supervision and examination fees Rewards and incentives Entertainment, amusement and recreation (Note 17) Membership fees and dues Banking fees Others 2003 2002 P = 73,832,356 57,446,158 53,897,276 48,624,609 36,064,500 31,269,973 30,499,955 24,692,224 23,289,567 22,707,055 17,734,078 11,262,046 8,450,149 P = 58,600,452 35,964,478 73,686,478 35,417,403 47,377,610 28,669,025 14,056,124 19,973,872 11,839,537 20,242,399 4,505,691 12,144,000 4,202,066 P = 66,056,657 37,652,920 28,850,077 30,476,031 66,825,657 42,131,761 14,406,201 22,324,118 7,838,705 20,891,273 3,160,483 11,310,957 5,218,197 4,293,736 4,126,093 2,083,353 44,434,151 15,235,744 3,247,858 1,036,004 20,609,540 21,977,981 5,393,147 1,413,163 14,091,898 P = 494,707,279 P = 406,808,281 P = 400,019,226 F-25 Insurance expense includes premiums paid to the Philippine Deposit Insurance Corporation amounting to P = 61.5 million in 2004, P = 56.4 million in 2003 and P = 43.9 million in 2002. 17. Income and Other Taxes Under Philippine tax laws, the Bank is subject to percentage and other taxes (presented as Taxes and Licenses in the statements of income) as well as income taxes. Percentage and other taxes paid consist principally of gross receipts tax (GRT) and documentary stamps taxes. Effective January 1, 2003, the Bank was subject to the value-added tax instead of GRT. However, Republic Act No. 9238 reimposed GRT on the Bank effective January 1, 2004. Income taxes include corporate income tax, discussed below, and final tax paid at the rate of 20%, which represents final withholding tax on gross interest income from government securities, deposits, and other deposit substitutes. Under current tax regulations, the corporate income tax rate is 32%. Interest allowed as a deductible expense is reduced by an amount equivalent to 38% of interest income subjected to final tax. An MCIT of 2% of modified gross income is computed and compared with the regular income tax. Any excess of the MCIT over the regular income tax is deferred and can be used as a tax credit against future income tax liability for the next three years. In addition, the NOLCO is allowed as a deduction from taxable income in the next three years from inception. Provision for income tax consists of: 2003 2002 (As restated) 2004 Current: Final tax MCIT P = 65,222,797 22,596,674 P = 39,069,947 19,582,859 Deferred 87,819,471 (126,029,660) 58,652,806 (112,360,092) P = (38,210,189) P = (53,707,286) P = 46,878,281 18,039,966 64,918,247 (47,303,582) P = 17,614,665 Recognized deferred tax assets consist of: 2004 Temporary differences on: Allowance for probable losses NOLCO Accrued rent Carryforward benefits of MCIT F-26 2003 (As restated) P = 148,260,423 73,246,084 22,007,293 42,179,533 P = 115,055,311 8,385,275 16,640,228 19,582,859 P = 285,693,333 P = 159,663,673 Unrecognized deferred tax assets consist of: 2003 (As restated) 2004 Temporary differences on: Allowance for probable losses Unamortized past service costs NOLCO Unrealized loss on foreclosures Carryforward benefits of MCIT P = 243,744,396 33,744,904 24,661,808 1,155,872 18,039,966 P = 238,291,507 34,374,596 25,312,156 1,231,812 18,039,966 P = 321,346,946 P = 317,250,037 Management believes that it is not probable that these temporary differences, unused tax credits and tax losses will be realized in the future. Details of the Bank’s NOLCO follow: Inception Year Amount Expired Balance Expiry Year 2001 2002 2003 2004 P = 2,032,338 77,068,149 26,203,985 202,690,028 P = 2,032,338 — — — P =— 77,068,149 26,203,985 202,690,028 P = 307,994,500 P = 2,032,338 P = 305,962,162 2004 2005 2006 2007 Details of the Bank’s MCIT follow: Inception Year Amount Expired Balance Expiry Year 2001 2002 2003 2004 P = 13,244,538 18,039,966 19,582,859 22,596,674 P = 13,244,538 — — — P =— 18,039,966 19,582,859 22,596,674 P = 73,464,037 P = 13,244,538 P = 60,219,499 2004 2005 2006 2007 The reconciliation between the statutory income tax rate and effective income tax rate follows: 2004 2003 2002 (As restated) Statutory income tax rate Tax effect of: Tax-paid and tax-exempt income Expired NOLCO and MCIT Nondeductible expense Others 32.00% 32.00% (49.55) — 7.94 1.07 (40.07) 9.03 6.59 (20.41) Effective income tax rate (8.54%) (12.86%) 32.00% (43.79) — 10.96 6.75 5.92% Effective September 1, 2002, Revenue Regulations No. 10-2002 provides for the ceiling on the amount of entertainment, amusement and recreational (EAR) expense that can be claimed as a deduction against taxable income. Under the regulation, EAR expenses allowed as a deductible expense is limited to the actual EAR paid or incurred but not to exceed 1% of net revenue. 18. Trust Operations Securities and other resources held by the Bank in fiduciary or agency capacity for its customers are not included in the accompanying statements of condition since these are not resources of the Bank (see Note 23). F-27 In connection with the trust functions of the Bank, government securities with face value of P = 13.0 million and P = 16.0 million as of December 31, 2004 and 2003, respectively, are deposited with the BSP in compliance with trust regulations. Additionally, 10% of the Bank’s net profit realized by the Bank from its trust operations is appropriated to surplus reserve until such reserve for trust functions amounts to 20% of the Bank’s regulatory capital. 19. Capital Funds Details of the Bank’s dividend distribution follow: Dividends Date of declaration November 19, 2001 January 27, 2003 November 25, 2003 August 24, 2004 December 31, 2004 Per share P = 1.00 0.60 1.00 0.40 0.20 The determination of based on the amount to the BSP, which is differ from Philippine Total amount P = 179,501,520 107,700,912 179,501,520 71,800,608 35,900,304 Date of BSP approval Record date Payment date December 7, 2001 February 27, 2003 January 12, 2003 September 30, 2004 February 23, 2005 January 1, 2002 March 26, 2003 February 10, 2004 October 25, 2004 March 16, 2005 February 8, 2002 April 8, 2003 March 5, 2004 November 10, 2004 April 1, 2005 the Bank’s compliance with regulatory requirements and ratios is of the Bank’s ‘‘unimpaired capital’’ (regulatory networth) as reported determined on the basis of regulatory accounting practices which GAAP in some respects. Under Section 9 of the Thrift Banks Act, the combined capital accounts of each bank should not be less than an amount equal to ten percent (10%) of its risk assets. Risk assets consist of total assets after exclusion of cash on hand, due from BSP, loans covered by hold out or assignment of deposits, loans or acceptances under letters of credit to the extent covered by margin deposits and other non-risk items as determined by the MB. Under BSP Circular No. 360, effective July 1, 2003, the capital-to-risk assets ratio (CAR) is to be inclusive of a market risk change. Using this formula, the CAR of the Bank was 12.46% and 13.30% as of December 31, 2004 and 2003, respectively. 20. Earnings Per Share (EPS) The following table presents information used to calculate basic EPS: 2004 a. b. c. Net income Weighted average number of common shares EPS (a/b) 2003 2002 (As restated) P = 485,553,081 P = 471,246,890 P = 279,731,828 179,501,520 P = 2.71 179,501,520 P = 2.63 179,501,520 P = 1.56 As of December 31, 2004, 2003 and 2002, there were no shares of stock with dilutive effect on the basic EPS of the Bank. 21. Related Party Transactions In the ordinary course of business, the Bank has loans and other transactions with its affiliates, and with certain directors, officers, stockholders and related interests (DOSRI). Under the Bank’s policy, these loans and other transactions are made substantially on the same terms as with other individuals and businesses of comparable risks. The General Banking Law limits the amount of direct credit accommodations to DOSRI, 70% of which must be secured and should not exceed the total of their respective deposits F-28 and book value of their respective investments in the Bank. In the aggregate, loans to DOSRI generally should not exceed the lower of the Bank’s total capital funds or 15% of the Bank’s total loan portfolio. BSP Circular No. 423 dated March 15, 2004 amended the definition of DOSRI accounts. The following table shows information relating to the loans, other credit accommodations and guarantees classified as DOSRI accounts under regulations existing prior to said circular and new DOSRI loans, other credit accommodations granted under said circular as of December 31, 2004 and 2003 : 2004 Total outstanding DOSRI accounts Percent of DOSRI accounts granted under regulations existing prior to BSP Circular No. 423 to total loans Percent of new DOSRI accounts granted under BSP Circular No. 423 to total loans Percent of unsecured DOSRI accounts to total DOSRI accounts Percent of past due DOSRI accounts to total DOSRI accounts Percent of nonperforming DOSRI accounts to total DOSRI accounts 2003 P = 1,713,257,285 P = 1,966,205,048 6.49% 9.06% — — 25.34% 27.83% — — — — As of December 31, 2004, the Bank has no loans, other credit accommodations and guarantees, as well as availments of previously approved loans and committed credit lines not considered DOSRI accounts prior to the issuance of said circular but are allowed a transition period of two years from the effectivity of the said circular until said circular or said loan, other credit accommodations and guarantees become past due, or are extended, renewed or restructured, whichever comes later. Total interest income to these DOSRI loans amounted to P = 202.8 million, P = 204.4 million and P 264.3 million in 2004, 2003 and 2002, respectively. = Other significant transactions and outstanding balances of the Bank with Metrobank and its affiliates follow: 2004 Statement of condition accounts: Due from other banks — Metrobank Interbank loans receivable — Metrobank Accounts receivable — Metrobank (Note 8) Deposit liabilities Bills payable — First Metro Investment Corporation Statement of income accounts: Interest income on due from other banks and interbank loans receivable Interest expense on deposit liabilities Interest expense on bills payable 2003 P = 792,569,919 200,000,000 — 85,779,597 P = 783,639,782 — 6,754,120 303,807,426 — 450,000,000 46,479,135 1,111,094 8,779,781 22,566,986 3,655,912 8,155,778 The total assets of retirement fund of employees amounting to P = 97.1 million and P = 80.5 million as of December 31, 2004 and 2003, respectively, is being managed by the Bank’s trust department. F-29 22. Retirement Plan The Bank has a funded, noncontributory defined benefit plan covering substantially all of its employees. The benefits are based on years of service and final compensation. Total retirement expense which amounted to P = 60.0 million in 2004 and 2003, and P = 88.1 million in 2002, is included under Compensation and Fringe Benefits in the statements of income. Retirement expense in 2002 included retirement expense under the Bank’s early retirement program. Based on the actuarial valuation report dated October 31, 2004, the fair value of the plan assets amounted to P = 95.6 million. The unfunded actuarial liability of P = 79.2 million as of that date is amortized over the estimated average remaining working life of the employees. Other principal actuarial assumptions used to determine retirement benefits in such actuarial valuation were an investment earning rate of 10% per annum (p.a.), and salary increase of 10%, both compounded annually. The Bank’s annual contribution consists of payment covering the current service cost, interest on the unfunded actuarial accrued liability and the annual amortization of the unfunded accrued liability less the amortization of the actuarial gain (or loss) on the plan assets. Actuarial valuations are made at least every two years. 23. Commitments and Contingent Liabilities In the normal course of the Bank’s operations, there are various outstanding commitments and contingent liabilities such as guarantees and commitments to extend credit, which are not reflected in the accompanying financial statements. The Bank does not anticipate significant losses as a result of these transactions. The following is a summary of the Bank’s commitments and contingent liabilities at their equivalent peso contractual amounts: 2004 Trust department accounts (see Note 18) Late deposits/payments received Items held for safekeeping Outward bills for collection Others 2003 P = 579,772,207 100,987,844 1,219,625 474,768 1,843 P = 497,701,131 19,058,469 55,745 945,164 24,471 In addition, the Bank has received tax assessments from the Bureau of Internal Revenue on two banking industry issues. Management and tax counsels believe that they have a valid defense against such claims. Accordingly, no provision for probable losses has been provided. Several suits and claims relating to the Bank’s lending operations and labor-related cases remain unsettled. In the opinion of management, these suits and claims, if decided adversely, will not involve sums having a material effect on the financial statements. 24. Financial Performance The following basic ratios measure the financial performance of the Bank: 2003 (As restated — Note 2) 2004 Return on average equity Return on average assets Net interest margin on average earning assets F-30 11.85% 1.19 5.57 11.20% 1.47 5.84 25. Notes to Statements of Cash Flows The following is a summary of non-cash activities: 2004 Non-cash investing activity: Additions to ROPOA in settlement of loans P = 2,951,646 2003 P = 9,147,889 2002 P = 139,065,917 26. Approval for the Release of the Financial Statements The accompanying financial statements of the Bank were authorized for issue by the Bank’s board of directors on March 15, 2005. F-31 PHILIPPINE SAVINGS BANK UNAUDITED STATEMENTS OF CONDITION September 30 2005 RESOURCES Cash and Other Cash Items (Note 10) Due from Bangko Sentral ng Pilipinas (Notes 10 and 12) Due from Other Banks (Notes 12 and 20) Interbank Loans Receivable (Notes 12 and 20) Trading Account Securities, at market (Notes 4 and 12) Available for Sale Securities, at market (Notes 4, 10 and 12) Investment in Bonds and Other Debt Instruments — net (Notes 4, 10, 12 and 17) Receivables from Customers — net (Notes 5, 12 and 20) Bank Premises, Furniture and Equipment — net (Note 6) Real and Other Properties Owned or Acquired — net (Note 7) Deferred Tax Assets (Note 16) Other Resources — net (Note 8) LIABILITIES AND CAPITAL FUNDS Liabilities Deposit Liabilities (Notes 10, 12 and 20) Demand Savings Time Cashier’s and Gift Checks (Note 12) Accrued Taxes, Interest and Other Expenses (Note 12) Other Liabilities (Note 11) Capital Funds Common stock Capital paid in excess of par value Surplus reserves Surplus Unrealized gain on available-for-sale securities (Note 4) P = 467,117,281 P = 432,396,699 1,774,617,226 881,213,884 550,000,000 1,057,645,384 1,792,427,729 585,000,000 127,302,027 79,132,607 13,164,869,943 — 4,060,661,601 11,348,095,859 26,799,876,607 22,927,211,515 1,780,966,145 1,520,643,095 1,775,978,723 384,140,785 1,469,457,874 1,694,635,111 202,090,099 1,188,962,028 P = 53,236,202,096 P = 42,828,240,126 P = 5,468,625,707 10,221,021,535 31,117,573,691 P = 1,589,778,881 21,961,828,256 13,833,052,644 46,807,220,933 214,856,674 37,384,659,781 206,385,088 460,704,991 738,478,339 330,009,940 710,179,827 48,221,260,937 38,631,234,636 1,795,015,200 693,554,524 388,107,135 1,740,906,693 1,795,015,200 693,554,524 339,556,076 1,368,879,690 397,357,607 — 5,014,941,159 4,197,005,490 P = 53,236,202,096 P = 42,828,240,126 See accompanying Notes to Unaudited Financial Statements. F-32 2004 PHILIPPINE SAVINGS BANK UNAUDITED STATEMENTS OF INCOME Nine Months Ended September 30 2005 2004 P = 2,502,906,523 986,085,391 37,477,014 108,434,149 P = 2,007,257,710 578,944,766 34,428,852 27,982,467 3,634,903,077 2,648,613,795 1,601,651,812 424,247 1,234,073,867 7,942,700 1,602,076,059 1,242,016,567 NET INTEREST INCOME BEFORE PROVISION FOR PROBABLE LOSSES PROVISION FOR PROBABLE LOSSES (Note 9) 2,032,827,018 275,000,000 1,406,597,228 41,000,000 NET INTEREST INCOME AFTER PROVISION FOR PROBABLE LOSSES 1,757,827,018 1,365,597,228 294,185,633 52,791,903 140,931,866 47,536,522 275,845,715 68,577,266 63,377,376 72,704,741 535,445,924 480,505,098 666,239,411 227,499,342 592,257,509 162,566,927 191,152,215 134,670,479 87,372,068 32,188,091 531,935,193 148,216,412 93,057,298 82,891,033 39,825,489 404,034,787 1,871,056,799 1,522,849,455 422,216,143 323,252,871 INTEREST INCOME ON Receivables from customers (Note 20) Investment securities Deposits with other banks (Note 20) Interbank loans receivable (Note 20) INTEREST EXPENSE ON Deposit liabilities (Note 20) Bills payable (Note 20) OTHER INCOME Service charges, penalties, fees and commissions Profit from assets sold (Note 7) Trading and securities gain — net (Note 4) Miscellaneous (Note 13) OTHER EXPENSES Compensation and fringe benefits (Note 21) Taxes and licenses (Note 16) Occupancy and equipment-related expenses (Note 14) Depreciation and amortization (Note 6) Security, messengerial and janitorial services Amortization of intangible assets (Note 8) Miscellaneous (Note 15) INCOME BEFORE INCOME TAX PROVISION FOR (BENEFIT FROM) INCOME TAX (Note 16) NET INCOME (5,568,933) P = 304,822,003 P = 2.38 P = 1.70 Earnings per share (Note 19) See accompanying Notes to Unaudited Financial Statements. F-33 18,430,868 P = 427,785,076 PHILIPPINE SAVINGS BANK UNAUDITED STATEMENTS OF CHANGES IN CAPITAL FUNDS Nine Months Ended September 30 COMMON STOCK — P = 10 par value Authorized — 425,000,000 shares Issued — 179,501,520 shares CAPITAL PAID IN EXCESS OF PAR VALUE 2005 2004 P = 1,795,015,200 693,554,524 P = 1,795,015,200 693,554,524 SURPLUS RESERVES Balance at beginning of year Transfer from surplus (Note 17) 388,111,384 (4,249) 339,556,076 — Balance at end of year 388,107,135 339,556,076 1,393,354,548 1,416,638,208 SURPLUS Balance at beginning of year, as previously reported Effect of adoption of new standards on accounting for: Income tax Leases — — (317,220,037) (35,360,484) Balance at beginning of year, as restated Net income Transfer to surplus reserves (Note 17) Cash dividends (Note 18) Other Adjustment 1,393,354,548 427,785,076 4,249 (80,775,684) 538,504 1,064,057,687 304,822,003 Balance at end of year 1,740,906,693 1,368,879,690 UNREALIZED GAIN/ (LOSS) ON AVAILABLE-FORSALE SECURITIES (Note 4) Balance at beginning of year Unrealized loss during the year — 397,357,607 — — Balance at end of year 397,357,607 — P = 5,014,941,159 P = 4,197,005,490 See accompanying Notes to Unaudited Financial Statements. F-34 — — PHILIPPINE SAVINGS BANK UNAUDITED STATEMENTS OF CASH FLOWS Nine Months Ended September 30 CASH FLOWS FROM OPERATING ACTIVITIES Income before income tax Adjustments to reconcile income before income tax to net cash generated from operations: Depreciation and amortization (Note 6) Provision for probable losses (Note 9) Profit from assets sold (Note 7) Amortization of intangible assets (Note 8) Unrealized trading loss on trading account securities (Note 4) Changes in operating resources and liabilities: Increase in amounts of: Trading account securities Receivables from customers Other resources Increase in amounts of: Deposit liabilities Cashier’s and gift checks Accrued taxes and other expenses Other liabilities 2005 2004 P = 422,216,143 P = 323,252,871 134,670,479 275,000,000 (52,791,903) 32,188,091 93,419 93,057,298 41,000,000 (68,577,266) 39,825,489 2,332 (55,526,239) (3,414,386,326) (75,001,003) (76,407,415) (3,275,274,792) (138,515,678) 6,561,636,212 3,315,625 85,106,490 54,514,217 9,611,970,153 70,606,212 34,446,622 37,039,146 Net cash generated from operations Income taxes paid 3,971,035,205 (87,192,849) 6,692,424,972 (43,522,881) Net cash provided by operating activities 3,883,842,356 6,648,902,091 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of available-for-sale securities Purchases of investments in bonds and other debt instruments Net acquisitions of bank premises, furniture and equipment (Note 6) (10,667,578,459) 7,127,957,213 — (5,069,833,721) (377,797,253) (125,396,479) (3,917,418,499) (5,195,230,200) CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid (Note 18) Net payment of bills payable (88,121,923) — (178,736,291) (656,206,699) Net cash used in financing activities (88,121,923) (834,942,990) Net cash used in investing activities NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (Forward) F-35 (121,698,066) 618,728,901 Nine Months Ended September 30 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR Cash and other cash items Due from Bangko Sentral ng Pilipinas Due from other banks Interbank loans receivable CASH AND CASH EQUIVALENTS AT END OF YEAR Cash and other cash items Due from Bangko Sentral ng Pilipinas Due from other banks Interbank loans receivable 2005 2004 P = 750,408,617 1,958,275,032 885,962,808 200,000,000 P = 759,540,596 1,651,912,913 837,287,402 — 3,794,646,457 3,248,740,911 467,117,281 1,774,617,226 881,213,884 550,000,000 432,396,699 1,057,645,384 1,792,427,729 585,000,000 P = 3,672,948,391 3,867,469,812 See accompanying Notes to Unaudited Financial Statements. F-36 PHILIPPINE SAVINGS BANK NOTES TO UNAUDITED FINANCIAL STATEMENTS 1. Corporate Information Philippine Savings Bank (the Bank) was incorporated in the Philippines on June 30, 1959 primarily to engage in savings and mortgage banking. The Bank’s shares are listed in the Philippine Stock Exchange. The Bank offers a wide range of products and services such as deposit products, loans, treasury and trust functions that cater mainly to the retail and consumer market. On September 6, 1991, the Bank was authorized to perform trust functions. As of September 30, 2005 and 2004, the Bank had 150 and 122 branches, respectively, and 1,725 and 1,561 employees, respectively. As of September 30, 2005, the Bank is seventy-four percent (74%) owned by Metropolitan Bank & Trust Company (Metrobank). The Bank’s principal place of business is located at PSBank Center, 777 Paseo de Roxas corner Sedeno St., Makati City. 2. Summary of Significant Accounting Policies Basis of Financial Statement Preparation The Bank’s financial statements have been prepared in accordance with the accounting principles generally accepted in the Philippines (Philippine GAAP) for the banking industry in effect as of December 31, 2004. The financial statements are prepared under the historical cost convention as modified for the measurement at fair value of derivatives and investment securities other than Investments in Bonds and Other Debt Instruments (IBODI). The accompanying financial statements of the Bank reflect the accounts maintained in the Regular Banking Unit (RBU) and Foreign Currency Deposit Unit (FCDU). The financial statements individually prepared for these units are combined and inter-unit accounts are eliminated. The books of accounts of the RBU are maintained in Philippine pesos, while those of FCDU are maintained in their original currencies. For financial reporting purposes, FCDU accounts and foreign-currency denominated accounts in RBU are translated into their equivalents in Philippine pesos based on the Philippine Dealing System weighted average rate (PDSWAR) prevailing at the end of the year (for resources and liabilities) and at the average PDSWAR for the year (for income and expenses). Foreign exchange differentials arising from foreign currency transactions and restatements of foreign currency denominated resources and liabilities, except for past due receivables and nonmonetary assets, are credited to or charged against operations in the year in which the rates change. The preparation of the financial statements in accordance with Philippine GAAP requires the Bank to make estimates and assumptions that affect the reported amounts of resources, liabilities, income and expenses and disclosure of contingent resources and contingent liabilities. Future events may occur which will cause the assumptions used in arriving at the estimates to change. The effects of any change in estimates are reflected in the financial statements as they become reasonably determinable. Operating results for the nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for the full fiscal year. F-37 Changes in Accounting Policies New accounting standards based on International Accounting Standards and International Financial Reporting Standards referred to as Philippine Financial Reporting Standards (PFRS), respectively, became effective on January 1, 2005. The Bank will adopt the following new accounting standards that are relevant to its operations beginning with its annual audited financial statements for the year ending December 31, 2005 : . PAS 19, Employee Benefits, provides for the accounting for long-term and other employee benefits. The standard requires the projected unit credit method in determining the retirement benefits of the employees and a change in the manner of computing benefit expense relating to past service cost and actuarial gains and losses. It requires the Bank to determine the present value of defined benefit obligations and the fair value of any plan assets with sufficient regularity that the amounts recognized in the financial statements do not differ materially from the amounts that would be determined at the statement of condition date. Upon adoption of the standard, the difference between the present value of the obligation and the fair value of the plan assets will be included in the statements of condition and will be charged against surplus. . PAS 21, The Effects of Changes in Foreign Exchange Rates, prohibits the capitalization of foreign exchange losses. The standard also addresses the accounting for transactions in foreign currency and translating the financial statements of foreign operations that are included in those of the reporting enterprise by consolidation, proportionate consolidation and equity method. The adoption of this standard will have no material impact on the financial statements. . PAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, provides for the required disclosure and presentation in respect of the accounts of banks and similar financial institutions. It also provides that provision for general banking risks is treated as an appropriation of surplus and should not be included in the determination of net income for the period. The Bank is in the process of determining the effect of this standard in the context of the need to reallocate the general reserve to cover any increase in specific loan reserves required under PAS 39 (see discussion on PAS 39 below). . PAS 32, Financial Instruments: Disclosure and Presentation, covers the disclosure and presentation of all financial instruments. The standard requires more comprehensive disclosures about the Bank’s financial instruments, whether recognized or unrecognized in the financial statements. New disclosure requirements include terms and conditions of financial instruments used by the Bank, types of risks associated with both recognized and unrecognized financial instruments (market risk, price risk, credit risk, liquidity risk, and cash flow risk), fair value information of both recognized and unrecognized financial assets and financial liabilities, and the Bank’s financial risk management policies and objectives. The standard also requires financial instruments to be classified as liabilities or equity in accordance with its substance and not its legal form. . PAS 39, Financial Instruments: Recognition and Measurement, establishes the accounting and reporting standards for recognizing and measuring information about the Bank’s financial assets and financial liabilities. The standard requires a financial asset or financial liability to be recognized initially at fair value. Subsequent to initial recognition, the Bank should continue to measure financial assets at their fair values, except for loans and receivables and held-to-maturity investments, which are measured at cost or amortized cost using the effective interest rate method. Financial liabilities are subsequently measured at cost or amortized cost, except for liabilities classified as ‘‘at fair value through profit and loss’’ and derivatives, which are subsequently measured at fair value. F-38 PAS 39 also covers the accounting for derivative instruments. The standard has expanded the definition of a derivative instrument to include derivatives (derivativelike provisions) embedded in non-derivative contracts. Under the standard, every derivative instrument is recorded in the statement of condition as either an asset or liability measured at its fair value. Derivatives that are not hedged are adjusted to fair value through income. If a derivative is designated and qualifies as a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in capital funds until the hedged item is recognized in income. The Bank must formally document, designate, and assess the effectiveness of derivative transactions that receive hedge accounting treatment. The Bank has established a working committee that handles and monitors the implementation of the new and revised accounting standards, particularly PAS 32 and PAS 39. The implementation plan covers the following activities: 1. Review of all contracts and agreements outstanding as of January 1, 2005 and beyond with the aim of identifying any embedded derivatives for bifurcation and valuation; 2. Evaluation of the financial risks exposures relative to the adoption of the standards and formulation of appropriate risk management strategies; 3. Classification and measurement of financial assets and financial liabilities; 4. Review of PAS 39 implications on non-derivative financial assets and liabilities; and 5. Enhancement of existing processes and systems relating to valuation of financial instruments. The working committee has substantially completed the foregoing implementation activities and is now quantifying the financial impact of the adoption of PAS 39. The Bangko Sentral ng Pilipinas (BSP), through its Monetary Board (MB) Resolution No. 1869 dated December 23, 2004, has given the banks and financial institutions until December 31, 2005 to set up their infrastructures to be PAS 32 and 39 compliant. The Philippine Securities and Exchange Commission (SEC), through an advisory letter dated June 3, 2005, issued guidelines for the transition to PAS 39 of regulated companies. Interim reports that are required to be submitted to the BSP and SEC for 2005 need not be in compliance with the provisions of the said standards. With respect to account classification and related measurement, the Bank has already submitted to the BSP the reclassification of its trading and investment securities portfolio. The Bank does not expect any further material impact on the classification of financial assets and liabilities. The Bank is currently adopting the effective interest rate method in amortizing unearned discount related to loans. Therefore, the effect of the adoption of PAS 39 in so far as the amortization of unearned discount on loans is concerned will not be material. With regard to the adoption of effective interest rate method in measuring amortized cost for IBODI and Available-for-sale securities (ASS), the effect has not yet been quantified since the existing systems of the Bank have not yet been reconfigured to adopt the effective interest rate method of amortization. Due to the volume of transactions, it is impracticable to compute for the financial impact manually. The Bank will report the financial implications as soon as the information becomes available. F-39 PAS 39 requires that in the absence of quoted market rates, the discounted cash flow method will be used in determining whether an asset is impaired. The Bank will adopt the net flow rate method for consumer loans and discounted cashflows method for corporate accounts in determining asset impairment. The effect of adopting this provision will be material for impaired loans and other receivables. Currently, the adequacy of allowance for probable losses on loans and other receivables is determined based on management criteria and BSP requirements. The existing systems of the Bank have not yet been programmed to adopt the discounted cash flow method. Due to the volume of transactions, it is impracticable to compute for the financial impact manually. The Bank will report the financial implications as soon as the information becomes available. As allowed by the SEC, the effect of adopting PAS 32 and PAS 39 will not result in a restatement of prior years’ financial statements. Any cumulative effect of adopting these standards, however, will be charged against surplus as of January 1, 2005. The disclosures required by these standards will be reflected in the 2005 annual audited financial statements, where applicable. . PAS 40, Investment Property, prescribes the accounting treatment for investment property and related disclosure requirements. This standard permits the Bank to choose either the fair value model or cost model in accounting for investment property. Fair value model requires an investment property to be measured at fair value with fair value changes recognized directly in the statements of income. Cost model requires that an investment property should be measured at depreciated cost less any accumulated impairment losses. The Bank is still in the process of identifying real and other properties owned or acquired (ROPOA) that will be accounted for under PAS 40 and PFRS 5 (see significant provisions of PFRS 5 below), and account for these assets using the cost model under PAS 40. The adoption of PAS 40 may result in a material adjustment of prior year’s financial statements. The Bank has not yet fully quantified the implications of PAS 40 since the system that will support the accounting for ROPOA under PAS 40 has not yet been established. Due to the volume of transactions, it is impracticable to compute for the financial impact manually. The Bank will report the financial implications of PAS 40 as soon as the information becomes available. . PFRS 2, Share-Based Payments, will result in a charge to net income for the cost of share options granted. Currently, the Bank has no transaction involving share-based payments but will comply with the requirements of this standard in respect of future transactions. . PFRS 3, Business Combination, which will result in the cessation of the amortization of goodwill and a requirement for an annual test for goodwill impairment. Any resulting negative goodwill after performing reassessment will be credited to income. Moreover, pooling of interests in accounting for business combination will no longer be permitted. The effect of adopting this standard will not result in retroactive adjustment of priors’ financial statements but will affect prospective financial statements as a result of non-amortization of goodwill. . PFRS 5, Non-current Assets Held for Sale and Discontinued Operations, specifies the accounting for assets held for sale and the presentation and disclosure of discontinued operations. It requires assets that meet the criteria to be classified as held for sale to be measured at the lower of carrying amount and fair value less costs to sell, and the depreciation on such assets to cease. Furthermore, assets that meet the criteria to be classified as held-for-sale should be presented separately on the face of the statements of condition and the results of discontinued operations to be presented separately in the statements of income. Pending the identification of the ROPOA to be accounted for under PFRS 5, as discussed under PAS 40 above, the effect of adoption of PFRS 5 with respect to the assets to be accounted for under this standard will not be material to the financial statements. F-40 The Bank will also adopt the following revised standards: . PAS 1, Presentation of Financial Statements, provides a framework within which an entity assesses how to present fairly the effects of transactions and other events; provides the base criteria for classifying liabilities as current or noncurrent; prohibits the presentation of income from operating activities and extraordinary items as separate line items in the statements of income; and specifies the disclosures about key sources of estimation uncertainty and judgments that management has made in the process of applying the entity’s accounting policies. It also requires changes in the presentation of minority interest in the statements of condition and statements of income. . PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, removes the concept of fundamental error and the allowed alternative to retrospective application of voluntary changes in accounting policies and retrospective restatement to correct prior period errors. It defines material omission or misstatements, and describes how to apply the concept of materiality when applying accounting policies and correcting errors. . PAS 10, Events After the Balance Sheet Date, provides a limited clarification of the accounting for dividends declared after the statement of condition date. . PAS 16, Property, Plant and Equipment, provides additional guidance clarification on recognition and measurement of items of property, plant equipment. It also provides that each part of an item of property, plant equipment with a cost that is significant in relation to the total cost of the item be depreciated separately. . PAS 17, Leases, provides a limited revision to clarify the classification of a lease of land and buildings and prohibits expensing of initial direct costs in the financial statements of lessors. . PAS 24, Related Party Disclosures, provides additional guidance and clarity in the scope of the standard, the definitions and the disclosures for related parties. It also requires disclosure of the compensation of key management personnel by benefit type. . PAS 33, Earnings Per Share, prescribes principles for the determination and presentation of earnings per share for entities with publicly traded shares, entities in the process of issuing ordinary shares to the public, and any entities that calculate and disclose earnings per share. The standard also provides additional guidance in computing earnings per share including the effects of mandatorily convertible instruments and contingently issuable shares, among others. . PAS 36, Impairment of Assets, establishes frequency of impairment testing for certain intangibles and provides additional guidance on the measurement of an asset’s value in use. . PAS 38, Intangible Assets, provides additional clarification on the definition and recognition of certain intangibles. Moreover, this revised accounting standard requires that an intangible asset with an indefinite useful life should not be amortized but will be tested for impairment by comparing its recoverable amount with its carrying amount annually and whenever there is an indication that the intangible asset may be impaired. and and and shall The Bank does not expect significant changes in the accounting policies when it adopts the applicable revised standards. Additional disclosures required by the applicable revised standards will be included, where applicable. F-41 Cash and Cash Equivalents Cash and cash equivalents include cash and other cash items, amounts due from BSP and other banks and interbank loans receivable that are convertible to known amount of cash with original maturities of three months or less from dates of placements and that are subject to insignificant risk of changes in value. Trading Account Securities (TAS) TAS, which consist of government and private debt securities, are purchased and held principally with the intention of selling them in the near term and are carried at fair market value. Realized and unrealized gains and losses on these instruments are recognized in Trading and Securities Gain — Net in the statements of income. Quoted market prices, when available, are used to determine the fair value of trading instruments. If quoted market prices are not available, fair market value is determined using the discounted cash flows or using quoted prices of instruments with similar characteristics. When a security is transferred to TAS, the unrealized holding gain or loss at the date of transfer is recognized in the statements of income immediately. Available-for-Sale Securities Securities are classified as ASS when purchased and held indefinitely, i.e., neither held to maturity nor for trading purposes, where the Bank anticipates to sell in response to liquidity requirements or in anticipation of changes in interest rates or other factors. ASS is carried at fair market value and any unrealized gains or losses are reported as a separate component of capital funds unless unrealized losses represent impairment losses in which case such amounts are charged against income. For a debt security transferred into ASS from IBODI, the unrealized holding gain or loss at the date of the transfer shall be excluded from reported earnings and reported as a separate component of capital funds until realized. Investments in Bonds and Other Debt Instruments IBODI are government and private debt securities where the Bank has the positive intent and ability to hold to maturity and are carried at amortized cost on a straight-line basis. An allowance is set up for any substantial and presumably permanent decline in the aggregate carrying value of the investments. Under current BSP regulations, IBODI shall not exceed 50% of adjusted statutory net worth plus 40% of total deposit liabilities. Receivables from Customers and Allowance for Probable Losses Receivables from customers are stated at the outstanding principal balance reduced by unearned discounts and allowance for probable losses. Under current BSP regulations, nonaccruing receivables are those that have been defined as past due and items under litigation, or those for which, in the opinion of management, collection of interest or principal is doubtful. Receivables are not reclassified as accruing until interest and principal payments are brought current or the receivables are restructured in accordance with existing BSP regulations, and future payments appear assured. The allowance for probable losses on loans, which includes both specific and general loan loss reserves, represents management’s estimate of probable losses inherent in the portfolio, after consideration of prevailing and anticipated economic conditions, prior loss experience, estimated recoverable values based on fair market values of underlying collateral, prospects of supports from any financially responsible guarantor, subsequent collections including, as appropriate, estimated cash flows and on evaluations made by the BSP. The BSP observes certain criteria and guidelines based largely on the classification of loans in establishing specific loan loss reserves. F-42 Allowance on other risk assets is maintained at a level considered adequate to provide for potential uncollectibility of other risk assets. Management evaluates the level of this allowance based on the factors that affect the collectibility of the accounts. A review of age and status of these accounts, designed to identify accounts to be provided with allowance, is made by the management on a continuing basis. The allowance for probable losses is established through provisions for probable losses charged to current operations. Receivables are written off against the allowance for probable losses when management believes that the collectibility of the principal is unlikely. As discussed in the changes in accounting policies, under PAS 39, the discounted cash flow method generally will be used in determining impairment provisions on loans. Moreover, as provided under PAS 30, general loan loss provisions will no longer be included in the determination of net income for the period. Bank Premises, Furniture and Equipment Bank premises, furniture and equipment are stated at cost less accumulated depreciation (except for leasehold improvements which is carried net of amortization) and any impairment in value. The initial cost of bank premises, furniture and equipment consists of its purchase price, including taxes and any directly attributable costs of bringing the asset to its working condition and location for its intended use. Expenditures incurred after the bank premises, furniture and equipment have been put into operation, such as repairs and maintenance are normally charged against operations in the year in which the costs are incurred. In situations where it can be clearly demonstrated that the expenditures have resulted in an increase in the future economic benefits expected to be obtained from the use of an item of bank premises, furniture and equipment beyond its originally assessed standard of performance, the expenditures are capitalized as additional cost of bank premises, furniture and equipment. When assets are retired or otherwise disposed of, the cost, and the related accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is reflected as income or loss in the statements of income. Depreciation is determined using the straight-line method over the estimated useful life of the respective assets. Leasehold improvements are amortized over the shorter of the estimated average useful life of the improvements of five years or the terms of the related leases. The annual depreciation rates follow: Building Furniture, fixtures and equipment Leasehold improvements 4% 20% 20% or the term of the lease, whichever is shorter The useful life and the depreciation and amortization method are reviewed periodically to ensure that the period and the method of depreciation and amortization are consistent with the expected pattern of economic benefits from items of bank premises, furniture and equipment. The carrying values of bank premises, furniture and equipment are reviewed for impairment when events or changes in circumstances indicate that the carrying values may not be recoverable. If any such indication exists and where the carrying values exceed the estimated recoverable amounts, an impairment loss is recognized in the statements of income (see accounting policy on Impairment of Assets). F-43 Impairment of Assets An assessment is made at each statement of condition date if there is any indication of impairment of any asset, or if there is any indication that an impairment loss previously recognized for an asset in prior years may no longer exist or may have decreased. If any such indication exists, the asset’s recoverable amount is estimated at the higher of the asset’s value in use or its net selling price. An impairment loss is recognized by a charge against current operations for the excess of the carrying amount of an asset over its recoverable amount. An impairment loss is charged to operations in the year in which it arises. A previously recognized impairment loss is reversed by a credit to current operations to the extent that it does not restate the asset to a carrying amount in excess of what would have been determine (net of any accumulated depreciation) had no impairment loss been recognized for the asset in prior years. Real and Other Properties Owned or Acquired Resources acquired in settlement receivables are stated at the total outstanding exposure at the time of acquisition or bid price, whichever is lower, less allowance for probable losses and impairment in value, if any. Nonrefundable taxes such as capital gains tax and documentary stamp tax which were paid by the Bank are capitalized, provided that the adjusted value of the foreclosed asset does not exceed net realizable value. Security, maintenance and other foreclosure-related expenses are charged to operations as incurred. Allowance for probable losses is set up based on BSP provisioning requirements and for any anticipated significant shortfalls from the recorded values based on appraisal reports and current negotiations and programs to dispose of these properties to other interested parties. As discussed in the changes in accounting policies, acquired assets should be carried at depreciated cost and any unnecessary impairment loss reserves should be reversed upon adoption of PAS 40 by December 31, 2005. Intangible Assets Intangible assets include goodwill, software costs and license fees. Intangible assets acquired separately from a business are capitalized at cost. Intangible assets acquired as part of an acquisition of a business are capitalized separately from goodwill if the fair value can be measured reliably on initial recognition, subject to the constraint that, unless the asset has a readily ascertainable market value, the fair value is limited to an amount that does not create or increase any negative goodwill arising on the acquisition. Software costs and license fees are being amortized over a period of five years on a straight-line basis. Intangible assets are carried net of amortization and any impairment in value. Goodwill which arises from the purchase of branch offices from the Parent Company is being amortized over a period of five years from the date of purchase. As discussed in the changes in accounting policies, goodwill will no longer be amortized but will be subject to an annual test for impairment. Goodwill amortizations recognized since January 1, 2005 will be reversed upon adoption of the new standard by December 31, 2005. The carrying values of intangible assets are reviewed for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable. Income Taxes Deferred income tax is provided, using the balance sheet liability method, on all temporary differences at the statement of condition date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred income tax liabilities are recognized for all taxable temporary differences. Deferred income tax assets are recognized for all deductible temporary differences, carryforward of unused tax credits from excess minimum corporate income tax (MCIT) F-44 over the regular corporate income tax and unused net operating loss carryover (NOLCO), to the extent that it is probable that taxable profit will be available against which the deductible temporary differences and carryforward of unused MCIT and unused NOLCO can be utilized. Deferred income tax, however, is not recognized when it arises from the initial recognition of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting profit nor taxable profit or loss. The carrying amount of deferred income tax assets is reviewed at each statement of condition date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred income tax asset to be utilized. Deferred income tax assets and liabilities are measured at the tax rates that are applicable to the year when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the statement of condition date. Revenue Recognition Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Bank and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognized: Interest Income Unearned discount is recognized as income over the terms of the receivables using the effective interest rate method. Interest income on nondiscounted receivables is recognized based on the accrual method of accounting, except in the case of nonaccruing receivables. Interest income on nonaccruing receivables are recognized only to the extent of the cash collections received. Interest on interest-bearing placements and securities are recognized as the interest accrues, taking into account the effective yield on the asset. Under the new standards, interest will be recognized on impaired loans as loss provisions are made by way of discounting estimated cash flow recoveries from such impaired loans. Loan Fees and Service Charges Loan commitment fees are recognized as earned over the terms of the credit lines granted to each borrower. Loan syndication fees are recognized upon completion of all syndication activities and where the Bank does not have further obligations to perform under the syndication agreement. Service charges and penalties are recognized only upon collection. Leases Operating lease payments are recognized as an expense in the statements of income on a straight-line basis over the lease term. Retirement Cost The Bank determines retirement cost under the projected unit credit cost method. Under this method, the current service cost is the present value of retirement benefits payable in the future with respect to services rendered in the current period. The accrued actuarial liability is the present value of benefits payable in the future with respect to services rendered to date. Unfunded past service cost, experience adjustments and any actuarial gains or losses are amortized over the expected average remaining working life of the employees. Retirement cost includes current service cost, amortization of past service costs, interest on unfunded accrued retirement liability, experience adjustments and actuarial gain or losses, if any. F-45 As discussed in the changes in accounting policies, the accrued actuarial liability, net of the fair value of the pension plan assets, shall be recognized as part of the Bank’s liabilities in the statement of condition by way of a retroactive adjustment to the Surplus account as of January 1, 2004 in accordance with PAS 19. Foreign Exchange Transactions and Translations Foreign currency-denominated assets and liabilities are translated to Philippine pesos using the Philippine Dealing System weighted average rates (PDSWAR) prevailing at the end of the year. Income and expense items are translated at PDSWAR prevailing at transaction dates. Exchange differences arising from reporting monetary items at rates different from those at which they where previously recorded, as well as foreign exchange gains or losses arising from foreign currency are credited to or charged against operations in the year in which the rates change. Provisions and Contingencies Provisions are recognized when an obligation (legal or constructive) is incurred as a result of a past event and where it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. If the effect of the time value of money is material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessment of the time value of money and, where appropriate, the risks specific to the liability. Where discounting is used, the increase in the provision due to the passage of time is recognized as an interest expense. Contingent liabilities are not recognized but are disclosed in the financial statements unless the possibility of an outflow of resources embodying economic benefits is remote. Contingent assets are not recognized but are disclosed in the financial statements when an inflow of economic benefits is probable. Earnings Per Share Basic earnings per share is computed based on the weighted average number of common shares outstanding, after giving retroactive effect to stock dividends declared, stock rights exercised and stock splits made during the year. Subsequent Events Post-year-end events that provide additional information about the Bank’s position at the statement of condition date (adjusting events) are reflected in the financial statements. Post-year-end events that are not adjusting events are disclosed in the notes to the financial statements when material. 3. Segment Information The Bank’s operating businesses are organized and managed separately according to the nature of services provided and the different markets served with segments representing strategic business unit. The Bank’s business segments are as follows: Consumer Banking — principally handling individual customers’ deposits, and providing consumer-type loans, overdrafts and fund transfer facilities; Corporate Banking — principally handling loans and other credit facilities, and deposit and current accounts for corporate and institutional customers; and Treasury — principally providing money market, trading and treasury services, as well as the managing of the Bank’s funding operations by use of treasury bills, government securities and placements and acceptances with other banks, through treasury. These segments are the bases on which the Bank reports its primary segment information. Other operations of the Bank comprise the operations and financial control groups. Transactions between segments are conducted at estimated market rates on an arm’s length basis. F-46 Primary segment information (by business segment) for the years ended September 30, 2005, and 2004 follows (in thousands): 2005 Consumer Banking Results of Operations Net interest income Noninterest income Total revenue Noninterest expense P = 1,379,394 292,843 Corporate Banking P = 522,231 109,114 Treasury P = 131,202 133,489 264,691 (26,911) Total P = 2,032,827 535,446 1,672,237 (1,538,722) 631,345 (580,424) 2,568,273 (2,146,057) Income before income tax Income tax provision/(benefit) 133,515 (36,005) 50,921 (34,228) 237,780 64,664 422,216 (5,569) Net income 169,520 85,149 173,116 427,785 Statement of Condition Total resources P = 22,849,860 P = 11,603,775 P = 18,398,426 P = 52,852,061 Total liabilities P = 20,121,374 P = 9,895,719 P = 18,204,168 P = 48,221,261 Other Segment Information Capital expenditures P = 296,947 P = 71,967 P = 1,419 P = 370,333 Depreciation and amortization P = 107,179 P = 26,960 P = 531 P = 134,670 2004 (As restated — Note 2) Consumer Banking Results of Operations Net interest income Noninterest income Total revenue Noninterest expense P = 994,530 303,311 P = 401,214 111,299 1,297,841 (1,140,082) 512,513 (413,925) 157,759 (10,278) 98,588 (6,867) Income before income tax Income tax provision/(benefit) Net income Corporate Banking P = 168,037 P = 105,455 Treasury P = 10,853 65,895 76,748 (9,842) Total P = 1,406,597 480,505 1,887,102 (1,563,849) 66,906 35,576 323,253 18,431 P = 31,330 P = 304,822 Statement of Condition Total resources P = 18,284,127 P = 10,933,567 P = 13,408,456 P = 42,626,150 Total liabilities P = 16,291,856 P = 9,258,611 P = 13,080,768 P = 38,631,235 Other Segment Information Capital expenditures P = 105,410 P = 42,303 P = 806 P = 148,519 Depreciation and amortization P = 57,399 P = 34,991 P = 667 P = 93,057 Total resources do not include deferred tax assets amounting to P = 384.1 million and P = 202.1 million as of September 30, 2005 and 2004. 4. Trading and Investment Securities TAS includes unrealized loss of P = 0.09 million in 2005 and P = 0.002 million in 2004. As of September 30, 2005, ASS is carried net of accumulated unrealized loss of P = 397.4 million. F-47 IBODI consists of the following: 2005 Government bonds (Note 18) BSP Treasury bills Private bonds Treasury notes P = 2,820,427,474 7,999,588 395,610,552 898,770,845 Less allowance for probable losses (Note 9) 4,122,808,459 (62,146,858) P = 4,060,661,601 2004 P = 9,931,711,120 562,539,383 395,610,552 506,040,080 11,395,901,135 (47,805,276) P = 11,348,095,859 As of September 30, 2005 and 2004, the aggregate market value of the IBODI amounted to P = 4.37 billion and P = 11.06 billion, respectively. Market values of IBODI follow: 2005 Government bonds (Note 18) BSP Treasury bills Private bonds Treasury notes 2004 P = 3,014,048,052 8,074,561 397,027,105 947,027,499 P = 9,631,438,690 554,049,471 377,380,482 499,119,412 P = 4,366,177,217 P = 11,061,988,055 As of September 30, 2005 and 2004, foreign-currency denominated trading and investment securities bear nominal annual interest rates ranging from 7.68% to 8.80% in 2005 and from 7.57% to 8.56% in 2004 and peso-denominated trading and investment securities bear nominal annual interest rates ranging from 7.46% to 12.40% in 2005 and from 8.82% to 12.11% in 2004. 5. Loans and Receivables This account consists of: 2005 Loans and discounts Bills purchased P = 29,874,870,541 130,565,055 30,005,435,596 (2,055,080,021) (1,150,478,968) Unearned discounts Allowance for probable losses (Note 9) P = 26,799,876,607 2004 P = 25,275,992,807 107,512,954 25,383,505,761 (1,590,050,298) (866,243,948) P = 22,927,211,515 There were no rediscounted loans as of September 30, 2005 and September 30, 2004. Restructured loans as of September 30, 2005 and 2004 amounted to P = 772.1 million and P 869.8 million, respectively. = As of September 30, 2005 and 2004, 45.67% and 55.09% of the total receivables were subject to periodic interest repricing, respectively. Remaining receivables earned annual fixed interest rates which averaged 19.50% in 2005 and 20.1% in 2004. F-48 The breakdown of receivables from customers as to secured and unsecured and as to type of security follows: 2005 Secured by: Real estate Chattel Deposit hold-out Securities Others Unsecured % 2004 % P = 11,079,302,207 10,766,399,394 354,338,312 — 914,270,856 36.92 35.88 1.18 — 3.05 P = 9,620,201,986 8,147,420,390 502,235,880 — 1,493,022,663 37.90 32.10 1.98 — 5.88 23,114,310,769 6,891,124,827 77.03 22.97 19,762,880,919 5,620,624,842 77.86 22.14 P = 30,005,435,596 100.00 P = 25,383,505,761 100.00 As of September 30, 2005 and 2004, nonaccruing loans follow: 2005 Secured Unsecured 2004 P = 1,174,985,455 801,344,154 P = 814,080,972 428,864,082 P = 1,976,329,609 P = 1,242,945,054 Current banking regulations allow banks with no unbooked valuation reserves and capital adjustments to exclude from nonperforming classification loans classified as Loss in the latest examination of the BSP which are fully covered by allowance for probable losses, provided that interest on said receivables shall not be accrued. As of September 30, 2005 and 2004, the nonperformimg loans (NPLs) of the Bank not fully covered by allowance for probable losses follow: 2005 Total NPLs NPLs fully covered by allowance for probable losses 2004 P = 1,754,297,918 P = 1,384,285,216 (325,638,000) P = 1,428,659,918 (325,638,000) P = 1,058,647,216 As of September 30, 2005 and 2004, the loan concentration as to economic activity follows: 2005 Other community, social and personal activities Real estate Wholesale and retail trade Agriculture Banks, insurance and other financial institutions Public utilities Manufacturing Services Mining and quarrying Others % 2004 % P = 10,739,897,216 5,933,648,078 7,546,834,223 2,031,939,705 35.79 19.78 25.15 6.77 P = 7,655,366,106 5,212,442,191 7,274,727,111 1,469,637,051 30.16 20.54 28.66 5.79 621,336,682 1,663,365,989 948,698,972 323,073,299 16,237,422 180,404,010 2.07 5.55 3.16 1.08 0.05 0.60 1,351,278,852 1,214,633,564 779,394,859 234,492,543 10,242,163 181,291,321 5.32 4.79 3.07 0.92 0.04 0.71 P = 30,005,435,596 100.00 P = 25,383,505,761 100.00 Thrift banks are not covered by the loan concentration limit of 30% as prescribed by BSP. F-49 6. Bank Premises, Furniture and Equipment The composition and movements in the bank premises, furniture and equipment account follow: 2005 Land Cost Balance at beginning of year Acquisitions Disposals/others Balance at end of year Accumulated Depreciation Balance at beginning of year Depreciation Disposals Balance at end of year Net Book Value Furniture, Fixtures and Equipment Building P = 73,749,955 1,835,000 — 75,584,955 — — — Leasehold Improvements Total 2004 P = 1,266,872,174 245,025,394 (5,308,061) P = 764,259,998 78,186,586 (105,216,594) P = 148,071,518 45,286,331 (29,333,891) P = 2,252,953,645 370,333,311 (139,858,546) P = 2,099,025,143 148,519,034 (40,245,041) 1,506,589,507 737,229,990 164,023,958 2,483,428,410 2,207,299,136 221,673,354 40,351,524 (1,555,262) 492,035,597 64,985,064 (115,028,012) — — — 713,708,951 105,336,588 (116,583,274) 595,333,807 76,155,772 15,166,462 — 260,469,616 441,992,649 — 702,462,265 686,656,041 P = 75,584,955 P = 1,246,119,891 P = 295,237,341 P = 164,023,958 P = 1,780,966,145 P = 1,520,643,095 Depreciation and amortization amounted to P = 134.7 million in 2005 and P = 93.1 million in 2004 (includes amortization of leasehold improvements amounting to P = 29.3 million in 2005 and P 16.9 million in 2004). = 7. Real and Other Properties Owned or Acquired This account consists of: 2005 ROPOA Less allowance for probable losses (Note 9) 2004 P = 1,890,051,422 (114,072,699) P = 1,735,866,593 (41,231,482) P = 1,775,978,723 P = 1,694,635,111 Net gains from sale of ROPOA amounted to P = 52.8 million in 2005 and P = 68.6 million in 2004 are presented as Profit from assets sold in the statements of income. F-50 8. Other Resources This account consists of: 2005 2004 Accrued interest receivable (Note 12) Sales contract receivable (Note 12) Accounts receivable (Note 12) Intangible assets — net Foreign currency notes and coins on hand Other investments — at cost (Note 12) Returned checks and other cash items Prepaid expenses Sundry debits Miscellaneous P = 428,014,518 491,460,894 292,832,095 88,019,218 45,865,747 53,964,914 40,204,330 45,910,379 11,155,846 145,347,679 P = 312,245,090 402,014,139 206,811,691 93,516,784 49,574,494 105,399,258 48,083,284 42,644,276 10,884,865 107,622,498 Less allowance for probable losses (Note 9) 1,642,775,620 173,317,746 1,378,796,379 189,834,351 P = 1,469,457,874 P = 1,188,962,028 Sales contract receivable earned interest rate ranging from 8.65% to 10.68% in 2005 and 9.66% to 14.70% in 2004. The composition and movements of intangible assets follow: 2005 Software Cost 9. Goodwill License Fees Total 2004 Balance at beginning of year Additions/(Disposals) Amortization P = 46,524,268 15,944,030 (15,517,151) P = 29,958,338 (58,388) (11,212,500) P = 18,875,000 8,964,061 (5,458,440) P = 95,357,606 P = 110,322,826 24,849,703 23,019,447 (32,188,091) (39,825,489) Balance at end of year P = 46,951,147 P = 18,687,450 P = 22,380,621 P = 88,019,218 P = 93,516,784 Allowance for Probable Losses Changes in the allowance for probable losses follow: Balance at beginning of year: IBODI Receivables from customers ROPOA Other resources 2005 2004 P = 62,146,858 862,282,646 80,695,972 219,889,581 P = 95,610,551 663,420,442 193,706,578 151,377,486 1,225,015,057 1,104,115,057 Provisions for the year charged against operations Others 275,000,000 1,214 41,000,000 Balance at end of year: IBODI (Note 4) Receivables from customers (Note 5) ROPOA (Note 7) Other resources (Note 8) 62,146,858 1,150,478,968 114,072,699 173,317,746 47,805,276 866,243,948 41,231,482 189,834,351 P = 1,500,016,271 P = 1,145,115,057 F-51 With the foregoing level of allowance for probable losses, management believes that the Bank has sufficient level of allowance to take care of any losses that the Bank may incur from the noncollection or nonrealization of its receivables from customers and other risk assets. 10. Deposit Liabilities Available reserves as of September 30, 2005 and 2004 follow: 2005 Cash Due from BSP Available for sale securities-net IBODI 2004 P = 485,261,849 1,777,674,988 716,290,257 — P = 438,577,943 1,058,096,042 — 546,493,330 P = 2,979,227,094 P = 2,043,167,315 Under existing BSP regulations, non-FCDU deposit liabilities are subject to liquidity reserve equivalent to 2% and statutory reserve of 6%. As of September 30, 2005 and 2004, the Bank was in compliance with such regulation. As of September 30, 2005 and 2004, 62.11% and 72.46% of the deposit liabilities were subject to periodic interest repricing, respectively. Remaining deposits earned annual fixed interest rate, which averaged 5.95% in 2005 and 2004. 11. Other Liabilities This account consists of: 2005 Accounts payable (Note 12) Bills purchased-contra (Note 12) Other credits (Note 12) Unearned income Withholding taxes payable (Note 12) Dividends payable (Notes 12 and 18) Sundry credits Miscellaneous 2004 P = 333,224,155 130,565,055 87,815,616 56,906,850 41,549,157 28,952,641 6,362,492 53,102,373 P = 387,957,132 107,512,954 79,023,155 40,600,072 36,873,637 2,260,656 5,835,169 50,117,052 P = 738,478,339 P = 710,179,827 Accounts payable includes payable to suppliers and service providers and payments for principal, interest and other charges received from customers in advance. F-52 12. Maturity Profile of Financial Resources and Financial Liabilities The following tables present the financial resources and financial liabilities by contractual maturity and settlement dates as of September 30, 2005 and 2004 : 2005 Financial Resources Due from BSP 2004 Due Within Due Beyond One Year One Year Total Due Within Due Beyond One Year One Year Total P = 1,774,617,226 P =— P = 1,774,617,226 P = 1,057,645,384 P =— P = 1,057,645,384 Due from other banks 881,213,884 — 881,213,884 1,792,427,729 — 1,792,427,729 Interbank loans receivable 550,000,000 — 550,000,000 585,000,000 — 585,000,000 TAS 127,302,027 — 127,302,027 — 79,132,607 79,132,607 Available-for-sale securities 868,374,041 12,296,495,902 13,164,869,943 — — — IBODI (Note 4) 200,000,000 3,922,808,459 4,122,808,459 776,845,847 10,619,055,288 11,395,901,135 13,429,436,060 16,575,999,536 30,005,435,596 18,560,740,870 6,822,764,891 25,383,505,761 Loans and receivables (Note 5) Other resources (Note 8): Accrued interest receivable 100,218,225 327,796,293 428,014,518 312,245,090 — 312,245,090 2,247,389 489,213,505 491,460,894 336,332,213 65,681,926 402,014,139 266,957,838 25,874,257 292,832,095 206,811,691 — 206,811,691 28,964,914 25,000,000 53,964,914 105,399,258 — 105,399,258 P = 18,229,331,604 P = 33,663,187,952 P = 51,892,519,556 P = 23,733,448,082 P = 17,586,634,712 P = 41,320,082,794 Sales contract receivable Accounts receivable Other investments 2004 2005 Financial Liabilities (As restated) Due Within Due Beyond One Year One Year Total Due Within Due Beyond One Year One Year Total Deposit liabilities Demand P = 3,290,637,945 P = 2,177,987,762 P = 5,468,625,707 P = 1,589,778,881 P =— Savings 3,500,757,046 6,720,264,489 10,221,021,535 21,961,828,256 — 21,961,828,256 13,961,974,258 17,155,599,433 31,117,573,691 10,410,208,156 3,422,844,488 13,833,052,644 20,753,369,249 26,053,851,684 46,807,220,933 33,961,815,293 3,422,844,488 37,384,659,781 214,856,674 — 214,856,674 206,385,088 — 206,385,088 319,722,831 140,982,160 460,704,991 330,009,940 — 330,009,940 Accounts payable 322,774,450 10,449,705 333,224,155 375,790,832 12,166,300 387,957,132 Bills purchased — contra 130,565,055 — 130,565,055 107,512,954 — 107,512,954 — 87,815,616 87,815,616 — 79,023,155 79,023,155 Dividends payable 28,952,641 — 28,952,641 2,260,656 — 2,260,656 Withholding taxes payable 41,549,157 — 41,549,157 36,873,637 — 36,873,637 P = 21,811,790,057 P = 26,293,099,165 P = 48,104,889,222 P = 35,020,648,400 P = 3,514,033,943 P = 38,534,682,343 Time Cashier’s and gift checks P = 1,589,778,881 Accrued taxes, interest and other expenses Other liabilities (Note 11): Other credits 13. Miscellaneous Income This account consists of: Rent (Note 14) Foreign exchange gain — net Recovery from accounts written-off Income from trust operations Others F-53 2005 2004 P = 23,627,870 (7,442,909) 4,356,743 1,771,626 25,223,192 P = 20,690,397 2,518,128 2,158,845 2,089,084 45,248,287 P = 47,536,522 P = 72,704,741 14. Leases The Bank leases the premises occupied by its branches for periods ranging from 1 to 20 years renewable under certain terms and conditions. Various lease contracts include escalation clauses, most of which bear an annual rent increase of 10%. Rentals charged against operations under these lease contracts amounting to P = 137.4 million in 2005 and P = 110.5 in 2004 and are shown under Occupancy and equipment-related expenses in the statements of income. Future minimum rentals payable under non-cancelable operating leases are as follows: 2005 Within one year After one year but not more than five years After more than five years 2004 P = 156,799,529 536,026,808 224,628,729 P = 155,315,801 450,445,351 299,329,676 P = 917,455,066 P = 905,090,828 The Bank entered into commercial property leases on its surplus office. These noncancelable leases have remaining non-cancelable lease terms of between 1 and 5 years. As of September 30, 2005, there is no contingent rental income. Rent income of the Bank, as shown under Miscellaneous income related to these property leases amounted to P = 23.627 million in 2005 and P = 20.690 million in 2004. Future minimum rentals receivable under non-cancelable operating leases are as follows: 2005 Within one year After one year but not more than five years 2004 P = 26,359,398 2,085,326 P = 2,471,969 902,888 P = 28,444,724 P = 3,374,857 15. Miscellaneous Expenses This account consists of: Insurance Advertising Information technology Litigation Communications Transportation and traveling Management and professional fees Stationery and supplies Repairs and maintenance Supervision and examination fees Membership fees and dues Fines, penalties and other charges Entertainment, amusement and recreation (Note 16) Others 2005 2004 P = 87,394,647 79,492,237 67,398,558 54,947,608 42,977,485 28,248,089 28,081,293 27,239,295 22,250,419 13,614,000 4,594,550 4,226,583 P = 54,582,706 25,629,708 57,576,976 40,629,188 34,568,636 23,481,400 21,984,007 19,187,458 18,631,667 7,843,486 2,782,699 11,724,861 2,847,533 68,622,896 3,199,539 82,212,456 P = 531,935,193 P = 404,034,787 Insurance expense includes premiums paid to the Philippine Deposit Insurance Corporation amounting to P = 72.01 million in 2005 and P = 44.38 million in 2004. F-54 16. Income and Other Taxes Under Philippine tax laws, the Bank is subject to percentage and other taxes (presented as Taxes and Licenses in the statements of income) as well as income taxes. Percentage and other taxes paid consist principally of gross receipts tax (GRT) and documentary stamps taxes. Effective January 1, 2003, the Bank was subject to the value-added tax instead of GRT. However, Republic Act No. 9238 reimposed GRT on the Bank effective January 1, 2004. Income taxes include corporate income tax, discussed below, and final taxes paid at the rate of 20%, which is a final withholding tax on gross interest income from government securities, and other deposit substitutes. Effective November 1, 2005, the regular corporate income tax shall be 35% until January 1, 2009. Starting January 1, 2009, the regular corporate income tax rate shall be 30%. Current tax regulations also provide for the ceiling on the amount of entertainment, amusement and recreation (EAR) expense that can be claimed as a deduction against taxable income. Under the regulation, EAR expense allowed as a deductible expense for a service company is limited to the actual EAR paid or incurred but not to exceed 1% of net revenue. The regulations also provide for MCIT of 2% on modified gross income and allow a NOLCO. The MCIT and NOLCO may be applied against the Bank’s income tax liability and taxable income, respectively, over a three-year period from the year of inception. FCDU offshore income (income from non-residents) is tax-exempt while gross onshore income (income from residents) is subject to 10% income tax. In addition, interest income on deposit placements with other FCDUs and offshore banking units (OBUs) is taxed at 7.50%. Republic Act No. 9294, which became effective in May 2004, provides that the income derived by the FCDU from foreign currency transactions with non-residents, OBUs, local commercial banks including branches of foreign banks is tax-exempt while interest income on foreign currency loans from residents other than OBUs or other depository banks under the expanded system is subject to 10% income tax. Prior to 2005, the Bank’s FCDU transactions are being tax under the regular income tax rate. Provision for/ (benefit from) income tax consists of: Current: Final tax MCIT 2005 2004 P = 64,596,175 28,281,955 P = 43,760,169 17,096,691 92,878,130 (98,447,063) Deferred 60,856,860 (42,425,992) (P = 5,568,933) P = 18,430,868 2005 2004 Recognized deferred tax assets consist of: Temporary differences on: Allowance for probable losses Accrued rent NOLCO Carryforward benefits of MCIT F-55 P = 258,409,838 28,990,442 26,279,017 70,461,488 P = 120,359,747 20,665,527 24,385,275 36,679,550 P = 384,140,785 P = 202,090,099 Unrecognized deferred tax assets consist of: 2005 Temporary differences on: Allowance for probable losses Unamortized past service costs Unrealized loss on foreclosures NOLCO Carryforward benefits of MCIT 2004 P = 266,595,857 33,744,904 1,155,872 — 18,039,966 P = 359,645,459 34,374,595 1,155,872 73,522,617 18,039,966 P = 319,536,599 P = 486,738,509 Management believes that it is not probable that these temporary differences, unused tax credits and tax losses will be realized in the future. Details of the Bank’s NOLCO follow: Inception Year Amount Applied Balance 2002 2003 2004 P = 77,068,149 26,203,985 202,690,028 (P = 77,068,149) (26,203,985) (127,607,122) P =— — 75,082,906 P = 305,962,162 (P = 231,879,256) P = 75,082,906 Expiry Year 2005 2006 2007 Details of the Bank’s MCIT follow: Inception Year Amount Expired Balance 2002 2003 2004 2005 P = 18,039,966 19,582,859 22,596,674 28,281,955 P =— — — — P = 18,039,966 19,582,859 22,596,674 28,281,955 P = 88,501,454 P =— P = 88,501,454 Expiry Year 2005 2006 2007 2008 The reconciliation between the statutory income tax rate and effective income tax rate follows: 2005 2004 Statutory income tax rate Tax effect of: Tax-paid and tax-exempt income Nondeductible expense Others 32.00% 32.00% (13.01) 11.10 (31.40) (46.66) 22.91 (2.55) Effective income tax rate (1.31%) 5.70% 17. Trust Operations Securities and other resources held by the Bank in fiduciary or agency capacity for its customers are not included in the accompanying statements of condition since these are not resources of the Bank (see Note 22). In connection with the trust functions of the Bank, government securities with face value of P = 2.10 million and P = 970.66 million as of September 30, 2005 and 2004, respectively, are deposited with the BSP in compliance with trust regulations. Additionally, 10% of the Bank’s net profit realized by the Bank from its trust operations is appropriated to surplus reserve until such reserve for trust functions amounts to 20% of the Bank’s regulatory capital. F-56 18. Capital Funds Details of the Bank’s dividend distribution follow: Dividends Date of declaration November 19, 2001 January 27, 2003 November 25, 2003 August 24, 2004 December 31, 2004 March 16, 2005 April 28, 2005 Per share P = 1.00 0.60 1.00 0.40 0.20 0.15 0.15 The determination of based on the amount to the BSP, which is differ from Philippine Total amount P = 179,501,520 107,700,912 179,501,520 71,800,608 35,900,304 26,925,228 26,925,228 Date of BSP approval Record date Payment date December 7, 2001 February 27, 2003 January 12, 2004 September 30, 2004 February 23, 2005 April 15, 2005 June 14, 2005 January 1, 2002 March 26, 2003 February 10, 2004 October 25, 2004 March 16, 2005 May 12, 2005 July 8, 2005 February 8, 2002 April 8, 2003 March 5, 2004 November 10, 2004 April 1, 2005 May 26, 2005 July 22, 2005 the Bank’s compliance with regulatory requirements and ratios is of the Bank’s ‘‘unimpaired capital’’ (regulatory networth) as reported determined on the basis of regulatory accounting practices which GAAP in some respects. Under Section 9 of the Thrift Banks Act, the combined capital accounts of each bank should not be less than an amount equal to ten percent (10%) of its risk assets. Risk assets consist of total assets after exclusion of cash on hand, due from BSP, loans covered by hold out or assignment of deposits, loans or acceptances under letters of credit to the extent covered by margin deposits and other non-risk items as determined by the MB. Under BSP Circular No. 360, effective July 1, 2003, the capital-to-risk assets ratio (CAR) is to be inclusive of a market risk change. Using this formula, the CAR of the Bank was 13.54% and 14.41% as of September 30, 2005 and 2004, respectively. 19. Earnings Per Share (EPS) The following table presents information used to calculate basic EPS: 2005 a. b. c. Net income Weighted average number of common shares EPS (a/b) 2004 P = 427,785,076 P = 304,822,003 179,501,520 2.38 179,501,520 1.70 As of September 30, 2005 and 2004, there were no shares of stock with dilutive effect on the basic EPS of the Bank. 20. Related Party Transactions In the ordinary course of business, the Bank has loans and other transactions with its affiliates, and with certain directors, officers, stockholders and related interests (DOSRI). Under the Bank’s policy, these loans and other transactions are made substantially on the same terms as with other individuals and businesses of comparable risks. The General Banking Law limits the amount of direct credit accommodations to DOSRI, 70% of which must be secured and should not exceed the total of their respective deposits and book value of their respective investments in the Bank. In the aggregate, loans to DOSRI generally should not exceed the lower of the Bank’s total capital funds or 15% of the Bank’s total loan portfolio. BSP Circular No. 423 dated March 15, 2004 amended the definition of DOSRI accounts. F-57 The following table shows information relating to the loans, other credit accommodations and guarantees classified as DOSRI accounts under regulations existing prior to said circular and new DOSRI loans, other credit accommodations granted under said circular as of September 30, 2005 and 2004 : 2005 Total outstanding DOSRI accounts Percent of DOSRI accounts granted under regulations existing prior to BSP Circular No. 423 to total loans Percent of new DOSRI accounts granted under BSP Circular No. 423 to total loans Percent of unsecured DOSRI accounts to total DOSRI accounts Percent of past due DOSRI accounts to total DOSRI accounts Percent of nonperforming DOSRI accounts to total DOSRI accounts 2004 P = 977,097,789 P = 1,936,194,898 3.26% 7.72% — — 35.33% 24.67% — — — — As of September 30, 2005, the Bank has no loans, other credit accommodations and guarantees, as well as availments of previously approved loans and committed credit lines not considered DOSRI accounts prior to the issuance of said circular but are allowed a transition period of two years from the effectivity of the said circular until said circular or said loan, other credit accommodations and guarantees become past due, or are extended, renewed or restructured, whichever comes later. Total interest income to these DOSRI loans amounted to P = 140.7 million and P = 151.5 million in 2005 and 2004, respectively. Other significant transactions and outstanding balances of the Bank with Metrobank and its affiliates follow: 2005 Statement of condition accounts: Due from other banks — Metrobank Interbank loans receivable — Metrobank Deposit liabilities: First Metro Investment Corporation (FMIC) SMBC Metro Investment Corporation MBTC Technology, Inc., (MTI) Statement of income accounts: Interest income on due from other banks and interbank loans receivable Interest expense on deposit liabilities Interest expense on bills payable 2004 P = 574,612,097 — P = 1,705,266,062 200,000,000 85,779,597 3,490,462,202 98,664,181 40,334,428 — — — 5,519,344 — 181,539 46,479,135 1,111,094 8,779,781 The total assets of retirement fund of employees amounting to P = 127.75 million and P = 87.817 million as of September 30, 2005 and 2004, respectively, is being managed by the Bank’s trust department. 21. Retirement Plan The Bank has a funded, noncontributory defined benefit plan covering substantially all of its employees. The benefits are based on years of service and final compensation. Total retirement expense which amounted to P = 55.03 million in 2005 and P = 49.31 million in 2004, is included under Compensation and fringe benefits in the statements of income. F-58 Based on the actuarial valuation report dated October 31, 2004, the fair value of the plan assets amounted to P = 95.6 million. The unfunded actuarial liability of P = 79.2 million as of that date is amortized over the estimated average remaining working life of the employees. Other principal actuarial assumptions used to determine retirement benefits in such actuarial valuation were an investment earning rate of 10.00% per annum (p.a.), and salary increase of 10.00%, both compounded annually. The Bank’s annual contribution consists of payment covering the current service cost, interest on the unfunded actuarial accrued liability and the annual amortization of the unfunded accrued liability less the amortization of the actuarial gain (or loss) on the plan assets. Actuarial valuations are made at least every two years. 22. Commitments and Contingent Liabilities In the normal course of the Bank’s operations, there are various outstanding commitments and contingent liabilities such as guarantees and commitments to extend credit, which are not reflected in the accompanying financial statements. The Bank does not anticipate significant losses as a result of these transactions. The following is a summary of the Bank’s commitments and contingent liabilities at their equivalent peso contractual amounts: 2005 Trust department accounts (see Note 17) Late deposits/payments received Items held for safekeeping Outward bills for collection Others 2004 P = 398,143,090 119,311,421 76,920 242,382 25,465 P = 1,050,862,412 69,239,614 61,551 451,751 1,785 In addition, the Bank has received tax assessments from the Bureau of Internal Revenue on two banking industry issues. Management and tax counsels believe that they have a valid defense against such claims. Accordingly, no provision for probable losses has been provided. Several suits and claims relating to the Bank’s lending operations and labor-related cases remain unsettled. In the opinion of management, these suits and claims, if decided adversely, will not involve sums having a material effect on the financial statements. 23. Financial Performance The following basic ratios measure the financial performance of the Bank: 2005 Return on average equity Return on average assets Net interest margin on average earning assets 2004 12.07% 1.12 5.83 9.17% 1.07 5.59 24. Approval of the Release of the Financial Statements The accompanying financial statements were authorized for issue by the management on January 3, 2006. F-59 This page is intentionally left blank PARTIES TO THE ISSUE ISSUER Philippine Savings Bank PSBank Center 777 Paseo de Roxas corner Sedeno St., Makati City LEAD MANAGER, SELLING AGENT AND MARKET MAKER ING Bank N.V., MANILA BRANCH 21/F Tower One, Ayala Triangle Ayala Avenue, Makati City Multinational Investment Bancorporation SELLING AGENT and MARKET MAKER Philippine Savings Bank LIMITED SELLING AGENT REGISTRY AND PAYING AGENT Trust Services Department Development Bank of the Philippines DBP Bldg., Sen. Gil J. Puyat Ave Makati City PUBLIC TRUSTEE Trust Services Department Development Bank of the Philippines DBP Bldg., Sen. Gil J. Puyat Ave Makati City LEGAL ADVISERS To the Lead Manager Picazo Buyco Tan Fider and Santos 19/F, 18/F and 17/F Liberty Center 104 H.V. de la Costa St., Makati City EXTERNAL AUDITOR SyCip, Gorres, Velayo & Co. 6760 Ayala Ave., Makati City PHILIPPINE SAVINGS BANK Printed by ROMAN 10130-1
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