OMRO Romania. Previous rating: A- March 2006

Transcription

1 August 2008 OMRO Romania Final Rating BBB- Third rating Validity: 1 year if no relevant changes in operations or within the operation context will happen. The final rating grade does not consider the political and economic context. Previous rating: A- March 2006 Originating from the local NGO IZVOR, Opportunity Microcredit Romania (OMRO), member of the Opportunity International (OI) Network, was re-registered as a Non-Bank Financial Institution under the regulation of the Central Bank in March OMRO has its headquarters in Târgu Mureş and operates through a network of 9 branches by providing a highly diversified credit offer to the MSME sector in order to support its development in the urban and rural areas of Romania. OMRO is currently undergoing a decentralization process with the implementation of a middle management system, the standardization of a branch model and the enhancement of credit risk management in view of the transformation into a bank. In the last years OMRO has been financing its growth with commercial liabilities. Moreover the institution relies on a solid ownership base having Opportunity International and OikoCredit among its major shareholders. Non-Bank Financial Legal Form Institution Year of inception 1995 Network of reference Opportunity International Area of intervention Urban and rural Credit methodology Individual 20,000,000 18,000,000 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 - Liabilities and equity - EUR Dec06 Dec07 Jun08 Equity Short term liabilities Long term liabilities Other liabilities Evolution of credit portfolio 20,000,000 18,000,000 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 0 Dec06 Dec07 Jun08 7% 6% 5% 4% 3% 2% 1% 0% Gross outstanding portfolio PAR 30 Write-off ratio Restructured portfolio MicroFinanza Rating srl Corso Sempione, Milan Italy Tel: info@microfinanzarating.com CONTACTS Opportunity Microcredit Romania (OMRO) Str. Tineretului, 2 RO Tg. Mures - Romania Tel/Fax: certzinger@opportunity.ro

2 OMRO Romania August 2008 Strengths Solid ownership structure and good governance Banking-experienced CEO Good operational efficiency Well-diversified product offer Steady loan portfolio growth Opportunities Rural and agricultural market Participation to banking credit bureau Transformation into a bank MicroFinanza Rating 2

3 OMRO Romania August 2008 Branches of OMRO 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% -20% Growth Dec06 Dec07 Jun08 Active gross portfolio Total assets Active clients (number) Funding liabilities Personnel Equity The financial crisis in the international markets has not been taken into account in the present rating report which has been written within September Final opinion The exceptional exchange rate losses and the increase of provisioning and funding costs strongly impacted on the results achieved by the institution for 2007 and first semester of Profitability is negative and sustainability is at risk, also due to a decreasing trend of the portfolio yield. Moreover the institution results exposed to currency and interest rate risk. As of June 2008, the debt to equity is worth 3.8, that is still an acceptable level given the solid ownership base. The process of institutional transformation into a bank has already started and an overall consolidation of the structure and operations is greatly required. Improvements are needed at the management team level and BoD competence in local banking. The increasing competition, both on final clients and staff, is then an additional challenge to face with. Nevertheless, OMRO, steadily growing over time, relies on a banking-experienced CEO, good governance and well-diversified product offer. MicroFinanza Rating 3

4 OMRO Romania August 2008 Relevant changes respect to the previous rating AREA Relevant changes and comments Trend External Environment Competition is increasing, especially due to the aggressiveness of ProCredit Bank and to the presence of other commercial banks to some extent downscaling operations and penetrating the microfinance market through both consumer and productive lending. The booming of consumer lending is pressuring OMRO to go deeper into rural areas looking for unsaturated markets, while its strategy is to increase portfolio segmentation through the reduction of the average disbursed loan amount on the one side and the development of SME products on the other side. Banks are sturdily competing also in HR resources as LOs of MFIs are good potential staff for the opening of new bank branches. Given increasing competition in the microfinance market, the absence of an efficient credit bureau brings about a risk of over-indebtedness. Nevertheless, from 2009 OMRO should participate to the banking credit bureau. Moreover the registration under the special register results in a stricter supervision by the CBR, affecting OMRO's performance and operations. Slightly negative Governance, management and operations Since the last rating the structure of the BoD significantly changed and improved both in terms of mixed composition between locals and international and higher independency from the management. As of today the CEO is still sitting in the BoD with full voting right, but this is considered to be crucial given the transition phase towards bank transformation that will occur in the coming year. Nevertheless the BoD still lacks local banking expertise and needs to be strengthened especially as far as concerns the local part. The two Committees existing within the BoD - the Risk Management Committee and the Audit Committee are not yet functioning. The ownership structure has been further strengthened in the last year thanks to the conversion of the OikoCredit loan in equity. As a consequence the three major shareholders are now IZVOR, the local NGO, Opportunity International and OikoCredit. In view of the bank transformation which is expected for , OMRO started a reorganization of its structure, focussing on the consolidation of top and middle management and of operations. A new position has been created, namely the Credit Risk Manager even if the same is still vacant. New branch managers have been positioned in 5 out of 9 branches with the aim of pushing decentralization and strengthening operation at field level. Continuous efforts are spent for the development of new products and for the overall consolidation of OMRO s image in the market. A strong drive in the implementations of all these changes has come from the new CEO, who succeeded Csaba Kalman after his death. HR function has been upgraded to management level and is now more structured. The HR department now counts on 2 people and some interns thus guaranteeing a better management of all HR issues. Moreover OMRO received also the support of OI for the development of sound HR policies. This is expected to solve the high turnover rate suffered in the last year that affected the overall operations of the institution. Salaries appear to be still faintly competitive given the strong role paid by banks in attracting field staff while the development of formal career paths and training plan are still missing. As far as internal control is concerned OMRO is planning to hire a dedicated internal auditor in the short run. Nonetheless for the moment internal audit is performed on the one side by the branch inspector who focuses more on operational checks and on the other side by the external audit company, since 2008 in charge of full audit session and paying bigger attention to operations. Important improvements occurred in the IT department, finally upgraded to management level. A complete review and replacement of hardware has been conducted as well as a full formalization of policies and procedures. A new upgrade of emerge is due to be bought in fall 2008 while the IT Manager is now in charge of seeking for a more adequate accounting software. Given the future bank transformation many efforts still need to be spent on the development of the MIS. Slightly Positive MicroFinanza Rating 4

5 OMRO Romania August 2008 Financial products and asset quality Although concrete results are not visible yet OMRO is gradually changing its portfolio structure, aiming at having shorter and smaller loans which will also help to push up portfolio yield. New products are being developed by the Business Development Manager in order to retain clients and remain competitive in the market. Moreover the institution is working on the strengthening of the lending methodology with the introduction of a credit scoring for the assessment of client s repayment capacity and on the overall strengthening of the analysis. Drop-out ratio has significantly decreased compared to the previous rating report, resulting 12% as of June Although the last customer survey conducted by OI in September 2007 revealed that the main reason for desertion is the loan maturity, OMRO is currently trying to reduce the overall maturity of portfolio, in order to improve its profitability. Compared to the last rating visit, OMRO portfolio quality deteriorated. PAR30 jumped from 1.9% as of December 2006 to 6.3% as of June Certainly a part of delinquencies for the year 2008 is due to the change in the write off policy. Indeed, starting from July 2007, OMRO must comply with a new regulation of the NBR with regards to write offs of loans deemed losses. The new practice does not allow to write off loans after 180 days of delay but requires to undergo the full execution process and liquidate the collateral and only later on if any principal remains unpaid, it allows the write off. Slightly negative Financial structure and ALM Financial and operational results Strategic objectives and future evolutions Liquidity registered on average during the last year 10%, a slightly higher level than needed due to an excess in inflow of funds during the second semester of Nonetheless liquidity management improved thanks to the use of daily cash flow reports. Even if the Risk Management Committee is not yet effectively functioning the overall risk management framework has improved compared to the last rating. An ALCO is not yet in place at OMRO, though it may be necessary given the dimension and the complexity of OMRO s assets and liabilities management. The institution is exposed to currency and interest rate risk but the management is aware of this and is taking adequate measure to mitigate such risks. Undoubtedly OMRO suffered a big loss of exchange rate due to its exposure in Euro, worth more than EUR 280,000 in 2007 and more than EUR 312,000 for the period July 2007 June The exceptional exchange rate loss, the increase of provisioning cost and the upward trend of inflation and funding cost strongly impacted on the results achieved by the institution for the year 2007 and for the first semester of The performances of the institution, especially in terms of profitability and sustainability, dropped in the last year and a half. ROE and ROA fell down to -16.7% and -3.1% for the period July 2007 June The same negative path has been followed by OSS and FSS which turned under the threshold of 100%. On the other side the operating expense ratio registered a positive trend. The decrease of portfolio yield down to 25% together with the rise of provisioning and financial costs eliminate the operational margin (the sum of operating, financial and provisioning costs is 25.2%). The institution is undoubtedly aware of this situation and is taking measures to control it. At first it completed the Activity Based Costing (ABC) exercise in order to review the overall lending products and analyze for each product its sustainability. On the other hand steps for the shortening of the loan term have already been taken and this will also contribute to increase profitability. Overall OMRO is planning to increase portfolio yield by 2% and so recover at least a part of its profitability. Since the last rating OMRO has been working on the gradual move towards the bank transformation. Currently the institution relies on two Business Planning documents: one specifically dedicated to the bank transformation and one as the operating one, to be followed and used by the Management to strive OMRO operations. The Business Planning activity in the last year followed a more participative approach involving also field staff. As for the Business Planning document there are two sets of financial projections available. Some informal scenarios and sensitivity analyses have also been carried out. The backbone of the strategy is the consolidation of OMRO s operations, the strengthening of the institutional image thanks to the improvements of the branch models and equipments, the consolidation of the branch networks and overall branch operations (with its increased decentralization), the continuous development of products and reinforcement of the credit methodology introducing the use of a credit scoring and the increase of productivity and efficiency. All at the same OMRO is considering the opportunity of opening an Eastern Management Office in Bucharest that should lead the expansion in the south-east part of the country. Negative Negative Positive MicroFinanza Rating 5

6 OMRO Romania August 2008 Benchmarking All figures of peer groups are referred to the MicroBanking Bulletin (MBB) database updated as of December OMRO financial ratios indicated here do not fully correspond to the ratios presented in the report as they are calculated according to the MicroBanking Bullettin (MBB) methodology 1. Key issue of the benchmarking The benchmarking clearly highlights the relatively poor performance of OMRO in terms of profitability (AROE equal to -17.1%) and portfolio quality (PAR30 is equal to 6.3%), with both ratios being lower than the peer groups. In terms of efficiency OMRO presents the best performance registering an operating expense ratio equal to 10.2% for the periodjul07-jun08, whereas productivity levels, although improved compared to the last rating, are still below the benchmarking. With regard to portfolio yield, OMRO is more or less in line with the other MFIs despite the worsening trend observed over the years; the same is true for debt/equity ratio which stands at 3.3, being at sound levels. The transformation into a bank will further reduce the ratio in the short run. 1 The MBB adjusts the financial data to produce a common treatment for the effect of: a) inflation, b)subsidies, and c)loan loss provisioning and write-off (see MBB, Appendix I: Notes to Adjustments and Statistical Issues). MicroFinanza Rating 6

7 TABLE OF CONTENTS 1. External Environment and OMRO positioning... 8 Institutional background... 8 Context... 8 Regulation and Supervision Microfinance Industry OMRO market positioning Governance and operational structure Ownership and Governance Organisation and Structure System of internal control and internal audit Accounting and external audit Information technology and MIS Lending operations Financial products Lending procedures Collaterals and accessibility Assets structure and quality Assets structure Portfolio structure Loan portfolio quality Financial structure and ALM Liabilities and equity structure Assets and Liabilities Management Financial and operational results Strategic objectives and financial needs Financial needs Details of the risk factors and final opinion Annex 1 - Financial statements Annex 2 - Financial statement adjustments Annex 3 - Financial ratios Annex 4 - Definitions Annex 5 - Guidelines of reporting and accounting Annex 6 - Rating Scale... 43

8 OMRO Romania August 2008 Chapter 1 1. External Environment and OMRO positioning Institutional background Generated from the microfinance organization IZVOR, Opportunity Microcredit Romania (OMRO) was initially incorporated as a limited liability company in 2000, while in 2005 it became a jointstock company following the enforcement of the new microfinance law, which has been later enhanced by the Ordinance 28/2006 for incorporation and operation of the non-banking financial institutions. During 2007 OMRO was registered in the General Registry of the Non-Bank Financial Institutions held by the Central Bank in view of being included in the Special Registry, which implies a more thorough regulation from the NBR. Its ownership structure is composed of 3 main shareholders: the NGO IZVOR, Opportunity International and Oikocredit, holding together almost 90% of total shares. OMRO has its headquarters in Târgu Mureş and operates through a network of 9 branches by providing a highly-diversified credit offer to the MSME sector in order to support its development in the urban and rural areas of Romania. During the last years and especially with the entrance of the new CEO 2 OMRO started a renovation of its activities, pushing for an increased decentralization of operations through the implementation of a strong middle management system, the standardization of a branch model and the enhancement of credit risk management. Since 2007, on the basis of a feasibility study prepared in , OMRO s BoD has approved to move towards bank transformation, which is expected to be completed by OMRO is a member of the Opportunity International (OI) Network. Context Sovereign risk 3 Over the last 5 years, after a long period of economic crises related to the collapse of the soviet system, Romania has experienced a Romania Foreign currency Short term Long term Domestic currency Long term Rating Outlook MOODY'S n.a. Baa3 Baa3 Stable S&P A-3 BBB- BBB Negative Fitch F3 BBB BBB+ Negative strong economic growth. Thanks to the macroeconomic policies, which the Government adopted starting from the year 2000, the main economic indicators improved significantly finally leading the country to join the European Union in January In 2007, the Romanian economy continued to expand strongly, with estimated growth of 6 % following on from 7.9 % growth in High economic growth is still driven by strong domestic demand from several sources, mainly consumption but increasingly from investment. Prospects for further growth in 2008 and beyond remain favourable but the economy is not immune to a global downturn, and further structural and institutional reforms must be implemented for the economy to achieve its full potential in the long-term. Forecasts for 2008 indicate a 6% growth, fuelled by a rapid increase of government spending (in view of the 2008 local and parliamentary elections) and a fast-growing level of wages. Real GDP growth is expected to slow to 5% in 2009 as fiscal and income policies are tightened following the elections 4. 2 The new CEO joined OMRO after the death of the former CEO. 3 Scales used: MOODY'S: Long term - AAA, AA1, AA2, AA3, A1, A2, A3, Baa1, Baa2, Baa3 (Investment grade), Ba1, Ba2, Ba3, B1, B2, B3, Caa, Ca, C (Speculative grade); Short term - Prime-1, Prime-2, Prime-3 (Investment grade); Not Prime (Speculative grade); S&P: Long term - AAA, AA, A, BBB (Investment Grade); BB, B, CCC, CC (Speculative grade); SD (Selective Default); D (Default) - Rating from AA to CCC may be modified by a + or -; Short term - A-1(+), A- 2, A-3 (Investment Grade); B, C (Speculative Grade); SD (Selective Default); D (Default) Fitch: Long term - AAA, AA, A, BBB (Investment Grade); BB, B, CCC, CC, C (Speculative grade); DDD, DD, D (Default) - Rating from AA to CCC may be modified by a + or -; Short term: F1, F2, F3 (Investment grade); B, C (Speculative grade); D (Default). 4 Economist Intelligence Unit forecasts, Romania Report, April MicroFinanza Rating 8

9 OMRO Romania August 2008 Chapter 1 After averaging 4.8% in 2007, consumer price inflation is forecast to rise to 7.5% in 2008, partly because price increases that occurred in the second half of 2007 will boost price levels in the first half of 2008 compared with the year-earlier period, with year-on-year inflation likely to exceed 8% throughout the first half year. In addition, the government has been running budget deficits for the past two years, mainly through substantial spending increases in the last two months of each year. The government has committed to keep the deficit below 3 per cent of GDP, but there is a danger that this target will be missed as election-related pressures on the government to increase spending build up. A high degree of uncertainty is attached to the development of the exchange rate; after a rapid nominal appreciation of the domestic currency in 2005 the Leu appreciated sharply against both the euro and the US dollar until early July 2007, but depreciated by 19% against the euro between early July 2007 and end-january 2008, partly as a result of global financial market turmoil and partly owing to growing worries about Romania s macroeconomic fundamentals 5. The leu steadied and even strengthened a little in February, following the 1- percentage point increase in the monetary policy rate. The leu levelled out after a sharp fall in early March and did not rise following the March 26th increase in the interest rate. However, if the recent problems in international financial markets were to intensify, leading to a pronounced turn away from emerging-market assets, this could put further downward pressure on the leu and result in a significant exchangerate correction. The annual consolidated budget deficit could exceed 3% of GDP in 2008, despite the March budget revision, as forthcoming local and parliamentary elections see government spending rise steeply. Lax fiscal and wages policies will fuel domestic demand, but Leu depreciation should help to contain the current-account deficit at around 15% of GDP in Conflicts between the prime minister and the president, as well as between the ruling National Liberal Party (NLP) and the opposition Democratic Liberal Party (DLP), will underpin continued political discord. The minority government will remain under pressure to make policy concessions to the Social Democratic Party (SDP) on which it relies for a parliamentary majority with negative macroeconomic consequences. Additional structural reforms are crucial for building a competitive market economy capable of withstanding the pressures of EU integration. Moreover, poverty persists in the country, with over 15 percent of the population living below the poverty line. Two-thirds of Romania's poor live in rural areas despite the country's substantial potential in agriculture, forestry, and fisheries. Following Romania s EU membership, large amounts of subsidies (EUR 8 billion) are expected to flow into the Romanian agricultural sector in the next years. The NBFIs could be engaged, starting from year 2010, into the subsidies delivery mechanism. 5 Ibid. MicroFinanza Rating 9

10 OMRO Romania August 2008 Chapter 1 Regulation and Supervision After 10 years of legal vacuum and thanks to the lobbying activities of the World Bank, USAID and the Microfinance Coalition 6, the Romanian Parliament adopted in July 2005 a law (n.240/2005) regarding Micro Financing Commercial Companies (MFCCs). All MFCCs have to transform into a Joint Stock Commercial Company with a wider base of shareholders. The main provisions introduced by the law can be summarized as follow: - MFCCs are not allowed to accept deposits or other repayable funds from the general public; - EUR 200,000 minimum capital requirement; - maximum loan size worth EUR 25,000 and maximum loan maturity of 60 months; - microfinance companies are not allowed to issue consumer loans; - provisions are deductible for microfinance companies; In January 2006 a second law regulating Non-Bank Financial Institutions (NBFIs) was issued, requiring MFIs to re-register under this form and to submit to the National Bank of Romania s supervisory authority. The National Bank has been designing specific prudential norms and monitoring activities for the microfinance sector, bringing MFIs supervision closer to the one applied to banks. According to the NBFIs law (2006), the main changes are the following ones: - EUR 200,000 minimum capital requirement; here, the National Bank of Romania is entitled to set differentiated levels of minimum share capital in terms of the type of activity of the non-bank financial institutions; - There are no limitations on the minimum or maximum loan size/loan maturity; - NBFIs may perform more lending activities than MFCCs. Such activities include consumer credits, mortgage credits, factoring, discount, financial leasing, pledging via pawnshops, etc. Worth mentioning is that MFIs can choose to register under two different options: (i) the general register for MFIs with total assets of less than RON 50 million and an outstanding loan portfolio of less than 50% of total assets; (ii) a special register which allows for higher total assets and a higher loan/total asset ratio but which will result in special supervision by the BNR. Consequently, many NBFI are opting to transform into a bank as Ordinance no. 28 implies much of regulation applied to banks: In general, the overall legal framework has been supportive for the growth of the microfinance sector and the increase in the offer of different and new products; at the same time, it has helped to improve consumer protection and transparency of operations by requiring the submission to interested parties of all the necessary information regarding offered terms and conditions. Microfinance Industry Microfinance demand is very strong in Romania: a study of EBRD estimates the aggregate demand over EUR 500m, leaving a large uncovered demand for microfinance providers. The sources of funds and support available are mainly international, with EBRD and the EU playing a primary role. Moreover, OMRO estimates at least 100,000 micro and SME businesses and 93,400 sustainable small farms operating in Romania, out of which approximately 35-40,000 micro-loan clients are being served by bank and non-bank MFIs. The microfinance supply is mainly driven by Non Bank Financial Institutions (NBFIs) and banks. Though the interest shown by banks in the microfinance sector is still limited, it is gradually increasing with already some overlaps with the NBFIs market starting to appear (e.g. Sogebank is opening up info point-branches promoting its products in the rural areas while traditional commercial banks such as Banka Transylvania and Raiffeisen among others are increasingly lending to small entrepreneurs). Moreover, ProCredit bank, a specialized microfinance bank, is 6 The Microfinance Coalition is one of the components of the Enterprise Development and Strengthening Program, financed by the United Stated Agency for International Development (USAID), designed to improve the legal and regulatory environment for microfinance institutions, creating the conditions for the growth of a healthy microfinance industry in Romania. MicroFinanza Rating 10

11 OMRO Romania August 2008 Chapter 1 playing a leading role in the delivery of micro and small loans. Apart from banks 7, there are currently 21 microfinance institutions, registered or in the process of registering under the NBFIs law 8. Overall, the microfinance sector is growing rapidly in Romania: the NBFIs operating in the field of microfinance (NBFIs MFIs) registered a total increase in their loan portfolio and in the number of active borrowers respectively worth 50% and 25% in Even if still limited, especially in rural areas, the level of competition is growing alongside with the growth of the sector. Indeed, rural areas of Romania are characterized by a very limited access to financial services, due to a lower credit culture, higher risk and higher delivery costs. Moreover, the lending technology that is applied to clients living in urban centres cannot be easily replicated in rural areas, requiring therefore specific adaptation. Individual lending is more commonly applied than group methodology. Among the main NBFIs/ MFIs it is worth mentioning OMRO, CAPA Finance, Express Finance, LAM PLC, FAER, and ROMCOM, with a consolidated portfolio of over EUR 40 M and about 12,000 active borrowers as of June There are three Credit Bureaus in Romania to date: one including 25 commercial banks (mainly retail banks) and two established by the National Bank of Romania (NBR). NBFIs are required to participate to a NBR Credit Bureau and to join a register of financial institutions 9. Regardless the provision contained into the new Law, which allows MFIs to join the banking Credit Bureau, the access to it and the overall exchange of information even informally - is basically nonexistent. Concerns about the risk of over-indebtedness are further amplified when considering the increasing competition coming from banks and the massive use of consumer lending that characterized the past few years. A part from the Microfinance Coalition, an entity funded by the World Bank and USAID, which has been built up only for legal lobbying, there is no formal MFI s Association. This in turn causes negative consequences in terms of loss of opportunities to further develop: external training, access to technical assistance, and exchange of best practices and experiences. OMRO market positioning As one of the largest MFIs in Romania, OMRO concentrates its activity within the historical region of Transylvania, through a network of 9 branches, operating in 8 out of the 41 counties of Romania and is increasingly expanding into new areas in order to enhance its national coverage. The institution provides a well diversified range of credit products to registered businesses, mainly addressing urban micro-enterprises and SMEs, which operate in the trade, production and services sectors. The credit amounts range from EUR 110 to around EUR 41,000, with an average disbursed loan size equal to EUR 4,408. As there exists in Romania a significant degree of unmet demand, there is still room for OMRO for further growth especially into rural areas, where the institution is gradually entering with 2 agro loan products. In terms of competition, OMRO is not at the moment suffering from significant competitive pressures, albeit downscaling banks, such as Raiffeisen Bank, Banca Transilvania, the Romanian Commercial Bank (BCR) and Banca Romaneasca are increasingly focussing on the SME market, targeting the middle and top end of the micro-loan segment, while ProCredit Bank, specialized in microfinance, represents OMRO s main competitor, maintaining its focus on the lower end of the micro-business market and presenting a competitive collateral policy. On the other hand, BRD Groupe Société Générale is competing with OMRO on larger clients. As far as non-banking microfinance institutions are concerned, there is not a main competitor only the three largest MFIs have a multi-regional coverage rather different ones according to the areas of operations and typology of product offered which overlap with those of OMRO. Their 7 Many commercial banks are implementing SME lending programs mainly funded by EBRD. 8 The only exception is represented by the NGO CDE (Foundation). 9 Common register for MFIs with total assets<us$ 17.4M and loan portfolio<us$ 8.7M and a special register for larger MFIs. MicroFinanza Rating 11

12 OMRO Romania August 2008 Chapter 1 impact on OMRO is quite small, given their limited dimension in terms of outstanding portfolio and number of transactions. In general, OMRO is enhancing its market positioning thanks to improved marketing and expansion strategies which are based on the upgrade of loan products and downscaling operations to serve smaller firms and individual clients in order to match better the niche identified as potential market. To this purpose, the institution relies on the following competitive advantages: Diversification of loan products Client-friendly approach and closeness to the client Simple and flexible procedures in accordance to client s needs Quick disbursement process Financing start-up businesses On the other hand, the main competitive disadvantages are the following ones: Lower maximum loan amount and shorter terms compared to banks Higher cost of the credit compared to banks and other MFIs Regarding the risk of over-indebtedness which has been driven by the increasing share of consumer lending promoted by banks, worth mentioning is that from 2009 OMRO should participate to the banking credit bureau. MicroFinanza Rating 12

13 OMRO Romania August 2008 Chapter 2 2. Governance and operational structure Ownership and Governance Created in 2001 by OI and IZVOR, a local NGO, in June 2005 OMRO became a Joint Stock Company increasing its shareholders and share capital. In June 2007 OMRO acquired the status of a Non-Bank Financial Institution. As of June 2008, OMRO ownership structure is composed of three main shareholders which are the mother NGO IZVOR, Opportunity International and OikoCredit 10, respectively with 36%, 31%, and 22% of the shares. Minor shareholders are private investors from the USA, Ireland and the UK. OMRO recently started the process of bank transformation with the support of a team of consultants regularly visiting the institution and closely monitoring its development. OMRO is governed by a Board of Directors elected by the General Assembly of the Shareholders, to whom they are accountable. BoD s meetings take place on a quarterly basis and decisions are taken by majority of votes. The CEO has voting power which may raise conflicts of interest. The BoD is composed of 7 members, presenting a good balance between local and international representatives (4 local vs. 3 international). Despite the different professional profiles (e.g. marketing, financial and legal) which contribute to addressing strategic issues and operational items from several points of view, it is worth mentioning that BoD members lack local banking expertise, which may constitute a significant deficiency in view of bank transformation. Currently, the composition of the Board has further strengthened thanks to the involvement of a new member with an audit professional profile. In the coming periods OMRO will work on the strengthening of the overall governance structure and functioning involving in the Board a wider number of members (most probably including an EBRD and EFSE representative). 10 In March 2008 Oikocredit increased its share, converting the debt of EUR 300,000 into capital. MicroFinanza Rating 13

14 OMRO Romania August 2008 Chapter 2 The communication flow between the CEO and the Chairman of the BoD is satisfactory, permitting to timely discuss urgent issues and assuring the constant monitoring of the performance of the management. Nevertheless, formal evaluation of the top management is not in place. Although established in 2006 the 2 committees within the BoD - the Risk Management Committee and the Audit Committee - are still scarcely effective. Their functioning is still quite feeble and no clear policies and procedures exist for these Committees. The CEO is currently working on the development of a more adequate functioning of both Committees which will most probably gather all BoD members. Noteworthy is the fact that the existence of these 2 Committees satisfies the CBR requirement for bank transformation. Organisation and Structure OMRO is based in Târgu Mureş and concentrates its areas of operation in the north-western part of Romania and plans to further extend its branch network beyond the boundaries of traditional Transylvania, most likely towards North-West, South, South East and North East of the country in order to widen its national coverage through the opening of additional 4 branch agencies foreseen by end of Along with geographic expansion leading to the future establishment of 2 regional centres (one located in the Eastern part of the country and the other one in the Western part), the institution is undergoing a decentralization process, which pursues the development and strengthening of the senior and middle management structure and procedures. To this purpose, OMRO is correspondently investing in the standardization of a branch model 12 and in upgrading existing infrastructure, which suit banking standards, in order to contribute to the creation of a strong brand name and corporate image. All these efforts are part of the bank transformation process and aim at preparing the institution for the new legal status and type of business. Nevertheless, the organizational restructuring and strengthening has still to be completed. The senior management team needs to be consolidated in terms of expertise and management functions while some key positions are still vacant, such as the Credit Risk Manager, the Director of Operations 13 and Administrative Manager. At General Assembly the moment, the credit risk department is functioning Board of Directors under the leadership of the Business Development Manager and the CEO. On the other hand, the middle management team, which was non-existent during previous years, is not complete yet, as 4 branches are still operating without branch manager. In fact, not all existing agencies have been upgraded to the branch model whereas the standard is automatically applied for the new agencies. Finance department Audit committee IT department HR department Business development department Risk management committee Credit risk department Administrative department With regard to the level of decentralization, operations are still deeply centralized as most of credit decisions, financial statements and liquidity management are carried out in the HQ. At the CEO Branches Internal auditor 11 New offices in Bucharest, Piatra Neamt, Craiova and Timisoara are planned to be opened. 12 The branch model presents the following structure: 1 branch manager, 3 loan officers, 1 loan officer assistant, 1 cashier, after bank transformation. 13 This position is directly linked to the bank transformation process and is critical in this transitional phase, as it deals with branch staff and communication flow between branches and HQ. MicroFinanza Rating 14

15 OMRO Romania August 2008 Chapter 2 moment, branches are not treated as cost centres, being just responsible for the management of their own portfolio and participation in expenses. Credit decisions present three levels of approval according to the loan amount, involving the CEO for loans bigger than RON 100,000 (EUR 27,461). For budget and planning, OMRO has recently introduced a bottom up approach, according to which all field staff is directly involved in the disbursement plan and budget monitoring. In general, OMRO enjoys a good communication flow, while the follow-up and monitoring of consistent implementation of decisions are assured by regular field visits by the management and routinely by the CEO, to also obtain feedbacks from the staff. Since 2007, OMRO counts on a Business development department, which mainly deals with marketing and product development. It is in charge of elaborating and managing information coming from the field in order to monitor clients satisfaction, strengthen OMRO positioning and image on the market, track competition and develop products. From marketing point of view, it is in the process of developing networks in each operational area with the purpose of establishing contacts based on win-win solutions between dealers and potential clients. The approach is to rely also on external persons, who collaborate with OMRO on a voluntary basis. Human Resources As of June 2008, OMRO counts on 52 staff members, out of whom 26 are loan officers presenting an adequate staff allocation ratio (50% as of June 2008), which is expected to decrease along with the recruitment of new back office staff required by the future bank status. The close bank transformation calls for a more specialized staff and OMRO is currently focussing on the substantial upgrade of existing staff and significant hiring of new staff with some banking experience at all levels. In this regard, the senior management team needs to be further strengthened, as it does not present banking expertise and does not count on a solid managerial experience; nevertheless, its commitment to the institution is highly ensured by the fact that most senior managers are coming from internal promotion. On the other hand, concerning the recruitment of new staff, year 2008 is characterized by a significant increase in number of staff members, which is expected to double by year end (reaching 85 employers). Nevertheless, in case of middle management and management positions, the institution is facing difficulties in the recruitment of qualified staff with adequate profiles. This is mainly linked to increasing competition on human resources coming from banks, the disadvantageous location of the Headquarters, which is not based in the capital city, and the absence of potential internal staff that could be upgraded. The delay in covering critical positions is affecting the management of daily operations, resulting in a still weak organizational structure. Staff turnover rate stands at a warning level of 25% for the period July 07 June 08 and has steadily increased since 2006, reflecting the increasing competitive environment and consequent low capacity of OMRO to retain staff. The main losses occurred among LOs, who went to the competition affecting overall portfolio quality. To minimize the staff turnover risk OMRO is currently working on the consolidation of a solid corporate image. Nevertheless, a formal succession plan for some executive positions is not in place yet. The HR department has been recently established, with the HR officer being upgraded to managerial position in April She is currently in charge of strengthening the recruitment and selection process and providing orientation and induction 14 to new staff. In view of bank transformation and along with institutional growth, overall profile 14 Induction is the first stage of training for all new staff and provided in a two-week course in the headquarters. MicroFinanza Rating 15

16 OMRO Romania August 2008 Chapter 2 requirements have become more demanding, while hiring procedures have been improved in order to ensure a better screening. Staff appraisal is carried out annually and is based on an Opportunity International format. The purpose is to define training needs and develop potential career paths, although these are still not in place and a training plan for 2008 is currently missing. Nevertheless, increasing efforts have been directed to improve overall training opportunities, which are mainly organized into sessions provided to specific categories of staff members. Both in-house and external trainings are provided to all levels of the organization. The increasing staff turnover and competitive environment have pushed OMRO to revise salary levels. Initially OMRO analyzed the compensation survey conducted by Pricewaterhouse 15, which however had little relevance due to the difficulty in matching and comparing banking positions to OMRO s structure. Nevertheless OMRO designed a new salary scale, adjusted for inflation, in order to increase satisfaction among staff. The incentive scheme changed in August 2008 and is substantially based on 2 parameters: portfolio quality and outstanding portfolio, while previously the focus was on the number of loans disbursed. In general, OMRO is aware of the critical role played by the HR management function in this transitional phase and is in the process of formalizing HR policies and procedures, with the aim of strengthening its organizational structure and staff retention capacity. System of internal control and internal audit The organizational and operational restructuring process which OMRO has been undergoing during the last years, has brought about a correspondent strengthening of the internal control system. Credit policies and procedures have been improved thanks to a major focus on the business analysis and new procedures for loan approval, while operational standardization among branches is on-going throughout the establishment of a middle management system. In the last year and a half OMRO reviewed the organization of internal control and currently relies on two layers of control: on the one side it counts on a branch inspector in charge of operational audit especially for what concerns compliance with policies and procedures; on the other side it outsourced the service to an external audit company - Evalex SA for the complete audit of the company. Nevertheless OMRO s strategy is to internalize the audit function as soon as possible, certainly before transforming into a bank. For 2008 the Audit Plan includes different audits on cash, tangible and intangible assets, cost of personnel, loans and other assets, liabilities and operating expenses. Branches are visited at least once during a year and results are provided quarterly to the BoD. A further check at operational level is performed by the branch inspector - assistant of the Credit Risk department - who performs branch inspections lasting 1 to 2 days. On a systematic basis 5-10% of loan disbursed are checked, but no visits to clients are performed. On the other hand, particular attention is paid to collateral evaluations and delinquent clients. As Credit Risk manager position is still vacant, the assistant reports directly to the CEO. Considering the future geographical expansion, the ongoing decentralization and the expected cash handling due to bank transformation, the internal audit function needs to be strengthened and performed on a more frequent basis. In addition to this OMRO reports monthly financial information and quarterly activities to OI and is monitored to identify areas of concern and risk. Moreover, beginning from current year it receives the visit from the National Bank of Romania on a yearly basis, finalized to check overall compliance with national regulations. Accounting and external audit For the last 3 years OMRO has appointed KPMG Romania as an external auditor. OMRO prepares its financial statements in accordance with the Romanian accounting legislation and 15 The survey was conducted on 14 banking institutions. Nevertheless, positions were not matching with those of OMRO and therefore it was not possible to compare salary levels and make correspondent adjustments. 16 A member of the Financial Auditors Chamber in Romania MicroFinanza Rating 16

17 OMRO Romania August 2008 Chapter 2 with the International Accounting Standards (IAS). For year 2006, OMRO received a qualified opinion from KPMG, which is expected to be renovated in 2007, as OMRO did not apply the IAS requirements concerning the recognition of upfront commission fees for loans and advances to customers. Indeed, under Romanian accounting standards, OMRO can no longer take loan associated commission fees directly into income. All fees must be amortized over the term of the loan. The difference between the cash method of reporting income and the amortized income will be reported on the Balance Sheet as deferred income Moreover, as of July 2007, OMRO must comply with a new regulation of the NBR with regards to write offs of loans deemed losses. The new practice does not allow to write off loans after 180 days of delay but requires to undergo the full execution process and liquidate the collateral and only later on if any principal remains unpaid, it allows the write off. Information technology and MIS In view of bank transformation and along with institutional growth, IT department has increasingly gained importance, being upgraded to take part in the decision making process of management team; in fact, since May 2008 the IT senior has been promoted to IT manager position. Besides one IT specialist and one internship student, OMRO plans to hire additional 2 staff members within current year (1 programmer and 1 hardware specialist). The strategy is to have 3/5% of IT staff over total employers. This means 4/5 people for As all Opportunity International affiliates OMRO runs the MIS E-Merge Advanced, a loan tracking system with integrated general ledger, savings module and reporting capability. Over the years the system has been successfully upgraded from the last version (G11) to a more powerful one (G13) with the support of OI network. A further upgrade to G15 is expected in fall The MIS, while customized to meet the needs of MFIs, is fully capable of managing normal commercial banking transactions. Based on the results of specialized IT audit from KPMG during 2005/2006, OMRO has recently improved IT infrastructure (3 new servers, hardware renewed, fire/doubled system) and the security system (user rights security module), while a new accounting system will be purchased within the end of year. All branches are connected to the HQ through VPN network and data are collected and consolidated on a daily basis (disbursements and quality of the portfolio, bank statements and invoices from the suppliers and service providers). Accounting is centralized and financial statements are produced monthly for management use. Reporting is also centralized and presents some rigidities when it comes to generate additional reports than originally designed (for example, monitoring drop-out loans and other historical data). This means that the quality of the reporting is improvable, given the operational and managerial needs of an institution of this size. For example, it can be worth to track parallel loans and start-ups separately due to their risky nature. Especially at branch level a deeper portfolio analysis (e.g. including restructured loans) should be realized within the framework of upgrading offices to fully-pledged branches through decentralization of information. During 2008 OMRO plans to implement Wide Area Network technology for having all of its offices on line with the head office and the MIS. The benefits of the use of the WAN will allow for improved sharing and access of information, decentralization of standard operations, improved internal controls and moreover the customer service and increased capacity of OMRO branches to process a large volume of clients. The security of the system is satisfactory, counting on the use of appropriate back-up and storage procedures are being in place. This involves both on-site and offsite storage, which are both maintained within fireproof and data-proof cabinets. The system is equipped with UPS to enable back-up and closure without loss of data. Further improvements of overall security is planned in the new building of OMRO, where the institution should probably move before the end of year. MicroFinanza Rating 17

18 OMRO Romania August 2008 Chapter 3 3. Lending operations Financial products OMRO offers lending services to start-ups and MSME businesses in urban and rural areas of Romania, with the aim of supporting the development of the sector and generating employment. In order to increase its client base and enhance its market positioning, OMRO has progressively diversified its credit offer counting with eleven products as of June 2008 which are tailored to the purpose of the loan. Terms and conditions vary depending on the product, repayment history of the client and loan cycle. Besides the two core services: the Commercial Loan and the Production Loan, financing respectively trade/service and production/investment, OMRO has recently launched two products directed to agricultural businesses, one for investment (AgroInvest Loan) and the other for working capital (AgroSeason Loan). At the same time the institution is pushing more on the disbursement of smaller loans with a shorter maturity and faster disbursement procedures (as for example the Credit Line Product, the Overnight and Bridge Loans). Moreover, it is worth mentioning that during 2006, the institution introduced a new credit facility designed for start-up companies with less than 6 months history, which has increasingly gained share over total portfolio (6.6% of total portfolio as of June 2008). As presented in the next table, OMRO s product range is well developed. Although some of the products do not really sell 17 the present classification of loans responds to the demand and to the competitive Romanian market. All loans are disbursed in local currency, applying both individual and group lending methodologies. Nevertheless, the share of total clients taking a group loan has significantly decreased during the last years until almost disappearing (0.02% of outstanding portfolio, as of June 2008). With regard to the cost of the credit, OMRO charges an upfront fee on the disbursed amount differentiated according to the cycle of the credit and financial product. OMRO does not charge interest rates for Overnight Loans thus upfront fees are considerably high for the short maturity of the loans. In future, OMRO is planning to further increase interest rates while reducing the amount of up-front fees, as reaction to the new regulation of the CBR. Indeed, the amortization of commission fees implies a reduction in the financial income, what may push also other financial institutions to increase interest rates. In general, however, OMRO remains one of the most expensive lenders in the market. Worth mentioning is that OMRO, with the financial support of the European Fund for Southeast Europe (EFSE), recently underwent a Cost Modeling Project 18 with the purpose, among others, to price interest rates according to break-even point analysis and identify inefficiencies in lending procedures. The results will help the institution to become more competitive in the market. In order to consolidate its market positioning in the SME sector and enlarge its client base, OMRO is constantly updating and designing new products. For current year different new products are expected to be introduced, namely Agro Tourism, Home Improvement, SME Loans, Loans for disadvantage people (e.g. women, minorities, disabled people) and small-amount loans named fast and easy. The Credit Manual has been updated in 2008 and comprehends a new branch policy. Within the policies, there is also a part of behavioral instructions for LOs. 17 In fact, with the exception of the core products and AgroInvest Loan, all other products stand for less than 8% individually. 18 The project was executed in seven weeks between March and April of 2008, by a team comprised by Perfect Point Partners SRL (PPP) consultants and OMRO staff. PPP is a consultant firm based in Bolivia. MicroFinanza Rating 18

19 OMRO Romania August 2008 Chapter 3 MicroFinanza Rating 19

20 OMRO Romania August 2008 Chapter 3 Lending procedures Along with increasing decentralization OMRO has strengthened and will further strengthen the lending process by enhancing business analysis and monitoring of delinquency. In the short run the institution is also planning to introduce a comprehensive credit scoring model to standardize and facilitate the analysis of all clients files in the branches. Thanks to the network-promoting activities of the Business Development department, the screening process will progressively rely on the involvement of local rural communities or cooperatives, ensuring a better selection of clients, especially in remote areas. The assessment of loan applications is adequate, while the repayment capacity is comprehensively assessed by LOs, who usually check the financial statements of the business, make cash flow analysis, by including family expenses and examine other relevant documents related to the assessment of the collateral etc. The extension of the analysis varies in accordance to risk of products and loan size. In general, OMRO uses 3 types of loan application forms: a form for agricultural loans; a short form for bridge loans and overnight loans which are for existing clients; and a standard form for all other products. On site visits are required for all kind of loans. Worth mentioning is that only formally registered businesses and agri-producers are eligible for OMRO s products. OMRO has no access yet to the NBR credit bureau what may represent a risk for the correct estimation of the level of exposure and indebtedness of clients. Starting from January 2007 OMRO counts on a credit scoring just for large loans, according to which clients are rated from A-E. The system does not consider historical data but relies on the LOs analysis of qualitative variables (business trend, management experience, business plan, market conditions, potential job creation) and a quantitative analysis of profitability and liquidity ratios. Compared to banks the time needed for loan disbursement represents a competitive advantage for OMRO, being a quite fast process: on average it can take from 1 day to 7 days. 7 days for mortgage loans, which require the registration of the collateral. OMRO does not directly disburse in cash so far loan disbursements are made via bank transfer. At the same time, repayments are directly made on OMRO account at the same banks. Monitoring and follow up of clients are satisfactory through periodic visits to the clients. OMRO has recently activated standardized procedures 19 to be followed which seem to be effective in maximizing loan recovery. Moreover, 2 staff persons have been hired at HQ level, who are entirely dedicated to the recovery of delinquent portfolio. Collaterals and accessibility Given that Ordinance no. 28 implies much of regulation applied to banks, including stricter BNR requirements on collateral, this may limit OMRO s capacity to increase the level of accessibility of its products. In general, OMRO s collateral policy is in line with competitors requests, although commercial banks take advantage of consumer lending, which can be provided without guarantors nor collateral up to EUR 5,000 and that seriously affects the microfinance market. The VTL required ranges from 130 to 200 % of the disbursed loan amount. Usually 130 % is taken for mortgage and cars and 200 % for equipment. Real estate mortgages are often used and taken for the majority of loans. Inventory pledges are not accepted while pledges of movable assets (equipment) and co-signers are used occasionally. Promissory notes are often used for Overnight loans. Collateral assessment is generally performed by the LO or the credit risk officer and the collateral registration is simple. Promissory notes can be liquidated within a day, while in case of pledged mobile goods, OMRO turns to state-commissioned legal executors who go to the client site to collect the pledged item. 19 After 41 days in arrears the LO hands over the case to a lawyer. The lawyer sends a letter to the client and if the client does not pay within 15 days the lawyer starts a legal procedure. MicroFinanza Rating 20

21 OMRO Romania August 2008 Chapter 3 Pledged goods are sold via auction which has to be published for 15 days in advance. According to Romanian Law, OMRO has executive power on mortgage liquidation therefore avoiding the necessity to go to court for a decision. MicroFinanza Rating 21

22 OMRO Romania August 2008 Chapter 4 4. Assets structure and quality Assets structure As of June 2008, OMRO s net portfolio is equal to 86% of the total assets, which represents a fair concentration of resources in the core business, while the average figure for the last 2-3 years stands at a quite stable 85-87%. Liquidity (8.6% of total assets as of June 2008) registered on average during the last year 10%, a slightly higher level than needed. Minor components of assets are accrued interests (2%) net fixed assets (1%) and other assets (3%). Portfolio structure As of June 2008, OMRO s total outstanding portfolio is worth around EUR 18 millions and is concentrated in three main loan products: 41% is allocated in Commercial loans, showing a quite stable trend compared to previous periods, while the Production Loan dropped from 30% in 2006 to 19% as of June 08. On the other hand, the recently introduced Agroinvest Loan has gained an increasing share over total portfolio, reaching 10% during the last period. All other products stand for minor shares. Over the period of analysis OMRO has slowed down its portfolio growth passing from a rate of 154% in 2006 to 64% in 2007 and to 49% during the period Jul07-Jun08. Besides the effects of increasing competition, this is mainly due to the ongoing restructuring and strengthening process which focuses on the consolidation rather than on expansion. In general growth rates stand at sound levels for the last period of analysis, confirming OMRO s capacity to access new funding sources. The number of active clients and loans also registered a positive growth of around 33%. MicroFinanza Rating 22

23 OMRO Romania August 2008 Chapter 4 As far as average disbursed loan amount is concerned a gradual but constant upward trend can be observed for the last years. From EUR 3,869 of 2006 the amount disbursed has now increased to EUR 4,408, thus gradually diminishing its outreach in depth (as shown by the % on per capita GDP). Nevertheless, OMRO s strategy is to further diversify its loan portfolio through downscaling operations in order to serve smaller firms and individual clients, while consolidating its market position with the SME sector. Drop-out ratio has significantly decreased since 2006, passing from 56% in 2006 to 12% in the period Jul07-Jun08. The positive trend is the result of an on-going process of product development, which has focussed on gaining higher levels of flexibility in response to a wider range of clients financial needs. Moreover OMRO systematically monitors and calculates drop-out ratio applying the CGAP formula. In September 2007 Opportunity International conducted a customer survey and interviewed 300 clients of OMRO reporting that the first reason for insatisfaction is related to the term of the loan. This undoubtedly contrasts with the strategy of OMRO which aims at reducing the term of the loans; nevertheless it is worth noting that the institution took this decision analyzing current and expected performances and with the objective of protecting and improving its profitability. The current portfolio structure does not present a real risk of concentration in large loans, as only 21.5% of total portfolio is represented by loans bigger than EUR 19,001, which register a limited PAR30 of 3.5%. Indeed, the bulk of OMRO s portfolio is concentrated in loans ranging from EUR 2,801-EUR 11,000, which also present the highest weighted PAR30. In absolute terms, however, OMRO s riskiest category is given by loan amounts between EUR 11,001-19,000, whose PAR30 is equal to 8%. Moreover, attention should be paid also to smaller loans (less than EUR 2,800), mainly composed of parallel loans and start-ups, reflecting the relatively higher risk related to new businesses, which are more sensitive to the economic situation. The analysis of portfolio structure by branches highlights a good diversification of portfolio. Not MicroFinanza Rating 23

24 OMRO Romania August 2008 Chapter 4 surprisingly, the biggest branch in terms of outstanding portfolio and number of loans is Târgu Mureş, respectively with 21% and 24% over the total. Bistrita and Brasov branches follow just behind, reflecting the relatively higher years of operations compared to the other branches. With regard to portfolio quality, Cluj Napoca branch registers the worst performance, with a PAR30 equal to 23.3%, followed by Agentia Sibiu (PAR30 is 11.4%). Their weighted effect on the overall portfolio at risk is respectively of 1.6% and 1.2%. Both branches have suffered from high staff turn-over, partially driven by behavioural and productivity reasons in the case of some LOs, while other branch staff, among them the branch manager, left for the competition. The analysis of portfolio by sector highlights a concentration in trade, which reflects more or less the same percentage of Commercial loans. The same is true for production and agriculture; the last having significantly increased through the introduction and increasing demand of the agro loan products. Compared to previous years, the composition of the portfolio presents a shift from production towards services and agriculture, where services constitute the second biggest portfolio share, but also presents the highest PAR30 (9.9% as of June 2008). As an heritage from the past OMRO still relies on a long term portfolio: 51% of it is disbursed for more than 48 months while more than 80% has a maturity of more than 2 years. Nevertheless there is no specific risk concentration on this structure of portfolio and delinquencies are quite homogeneously divided into the different categories. Loan portfolio quality OMRO s portfolio quality presents a worsening trend, with PAR30 increasing from 1.9% as of December 2006 to 6.3% as of June Certainly a part of delinquencies for the year 2008 are due to the change in the write off policy. Despite of this however the trend of PAR 30 from January 2007 to June 2008 (as shown in the graph) follows a clear upward path. A complete analysis which includes also restructured loans and write offs confirms the statements above 70,000,000 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000 0 Jan07 Feb07 Mar07 Apr07 May07 Portfolio quality Jun07 Jul07 Aug07 Sep07 Oct07 Nov07 Dec07 Jan08 Feb08 Mar08 Apr08 May08 Jun08 Outstanding portfolio PAR 30 (amount) PAR 30 (%) MicroFinanza Rating 24 8% 7% 6% 5% 4% 3% 2% 1% 0%

25 OMRO Romania August 2008 Chapter 4 as restructured portfolio slightly increased to 0.2% while write offs are 0% for the period Jul07- Jun08. OMRO has identified the main causes of portfolio deterioration in a weak human resource management which has not been able to retain good staff and select adequate personnel, and in the lack of a consolidated middle management system functioning as an essential layer of control in the overall lending process. Moreover, the worsening of portfolio quality due to the loss of some LOs was further amplified by the low level of clients retention to the institution. In addition, worth mentioning is the significant role that also played the lack of a Credit Risk Manager. OMRO developed and put in place a strategy aimed at reducing PAR30 to 3.5% by year end. The strategy, as already mentioned, involves different measures, ranging from the on-going decentralization and strengthening process through trainings, recruitment of new staff, implementation of the Branch Model and customer service campaign to the hiring of dedicated staff for loan recovery and enhancement of business analysis. Positive results are already visible starting from June Along with the deterioration of portfolio quality the risk coverage ratio knew a negative trend till finally registering 88% over PAR30 as of June Nevertheless given that an important portion of the loan portfolio is backed by real mortgage, the risk coverage is adequate. MicroFinanza Rating 25

26 OMRO - Romania - August 2008 Chapter 5 5. Financial structure and ALM In the last year and a half OMRO strongly rooted its path toward a more commercial evolution what corresponds to the strategic objectives of the institution. As of June 2008 the financial leverage stands at 3.78 constantly and gradually increasing over the period of analysis (it was 2.11 in 2005, 2.35 in 2006 and 3.45 in 2007). Since the last rating OMRO has consolidated its capacity to attract foreign investments and has accessed also a subordinated loans in order to keep an adequate capital adequacy. Indeed as of June 2008 capital adequacy ratio stands at 20.9% which is to be considered a satisfactory level. Certainly to support future growth the institution needs to further capitalize. Liabilities and equity structure As of June 2008 OMRO total liabilities are worth more than EUR 15 ml, registering in the last year and a half an outstanding rise ( % in 2007 and +52.7% during the period July 2007 June 2008). 84% of them are long term commercial loans while 13% are due within less than one year. As of today the biggest investors are Symbiotics, EBRD and EFSE with OikoCredit following immediately after. Since the last rating OMRO demonstrated its capacity to attract a quite varied set of international investors, all of them bearing commercial conditions. At the same time the institution accessed for the first time in 2007 a subordinated loan agreement and this will allow to control the financial leverage and protect the capital adequacy. In the last year and a half equity grew at a quite slow pace due to the losses generated in year 2007 and in the first semester of As of June 2008 total equity is worth more than EUR 4 ml but presents a negative growth for the period July 2007 June 2008 (-6.5%). Almost half of the total equity is composed of paidin capital from shareholders while the other half is almost equally divided into retained earnings and quasi-capital. Quasi-capital which alone covers the 56% of the total outstanding liabilities are denominated in local currency, thus demonstrating the increased ability of the institution to negotiate with foreign investors. Nevertheless the 34% denominated in Euro generated in 2007 and in the first semester of 2008 a serious exchange rate loss 20. A residual 9.8% of liabilities is denominated in US$. The commercial nature of OMRO s liabilities is confirmed by the increasing share of loans that bear floating rates. Indeed, as of June 2008, 76.1% of total loans are linked to the BUBOR or to the EURIBOR / EUROSWAP. 20 Exchange rate loss represents 8.7% of total expenses in 2007 and 7.6%for the first semester of MicroFinanza Rating 26

27 OMRO - Romania - August 2008 Chapter 5 24% of equity is represented by the subordinated loan agreement signed with COOPEST due in Although retained earnings represent 26% of total equity (as of June 2008), the institution has registered negative results in year 2007 and in the first semester of The loss was still negligible in 2007, worth EUR 126,163 while it went up to more than EUR 500,000 during the first six months of Currently OMRO presents a limited ability to capitalized through retained earnings; however a further possible capitalization from Opportunity International may happen in the coming years, in order to allow the bank transformation. Indeed, as per Regulation for the granting of a license to conduct banking activity in the Republic of Romania the minimum capital requirement corresponds to EUR 10 ml. Capitalization strategy is directed to the opening to new shareholders, among them possible equity investors are EBRD, EFSE and OikoCredit. An important issue of new shares is due in 2008 even if there is not yet a shortlist of potential equity investors. Since 2005 OMRO has been distributing dividends to its shareholders worth 4% of the yearly net income. Assets and Liabilities Management Regardless of the formal existence of a Risk Management Committee within the Board, the real degree of analysis and monitoring of major operational and financial risks is still limited to the discussions held during BoD meetings. An ALCO is not yet in place at OMRO, though it may be necessary given the dimension and the complexity of OMRO s assets and liabilities management. Even if general policies about ALM exist at BoD level, they are not yet formalized and certainly need to be gathered in a Risk Management Manual (currently missing). As per its financial structure OMRO finds itself exposed to currency risk. Although more than half of the liabilities are denominated in local currency, the institution still relies on some important contracts in Euro and US$ amounting respectively to 34% of funding sources (in EUR) and 9.8% in US$. The significant depreciation of the RON against the Euro generated in the last periods relevant losses, although the institution had bought three options with Deutsche Bank. As of June 2008, the hedging coverage is worth almost EUR 3.7 ml. As of June 2008 the institution presents a net open position in Euro worth 60.1% of pure equity (without considering the subordinated loan) and 45.7% of equity plus subordinated loan. A minor open position exists also in US$ worth 6.7% of equity. The long term nature of liabilities, which have an average residual maturity of more than 3 years coupled with OMRO portfolio structure composed for roughly 60% by long term loans and having a weighted residual maturity of slightly more than 2 years shows that there is no significant maturity risk in the short run. Indeed a maturity mismatch exists only in the bracket 1 to 3 years and over 3 years. Over the years OMRO developed a wide experience in dealing with commercial liabilities. This, together with the continuous control paid to liquidity management thanks to daily cash flow analysis ensure the capacity to cover potential shortfalls. Liquid assets accounted on average almost 10% of total assets (during the last year) considering cash and banks. MicroFinanza Rating 27

28 OMRO - Romania - August 2008 Chapter 5 On the other hand the fact that 76% of liabilities bears floating interest rate while portfolio has fixed interest rate exposes the institution to a significant interest rate risk. As of December 2007 the institution had a negative gap in the bracket days and in the following one: 91 days to 1 year. The cumulative gap remains negative only in the bracket 91 days-1 year even if less relevant (1.5% of total assets) and this could negatively affect the financial margin in case of an increase of market interest rates. The Financial Manual has been recently updated and the institution counts with policies and tolerance levels for each financial risk. MicroFinanza Rating 28

29 OMRO Romania August 2008 Chapter 6 6. Financial and operational results The exceptional exchange rate loss, the increase cost of provisioning and the trend of inflation and funding cost strongly impacted on the results achieved by the institution for the year 2007 and for the first semester of The performances of the institution, especially in terms of profitability and sustainability, dropped in the last year and a half. After having registered positive and quite stable values for 2005 and 2006, in 2007 ROE and ROA fell down to 3.9% and 0.9% as of December 2007 and to % and -3.1% for the period July 2007 June Undoubtedly there is a series of causes of that important worsening trend of profitability, some of that linked to real movements of rates in the markets, other linked to CB regulations with regard to the amortization of commission fees and the change in the provisioning and write-off policy 21. Operational-self sufficiency followed the same path diminishing from 126.3% of 2006 to 105.7% of 2007 and turning to an insufficient level of 85.4% for the period July 2007 June It is worth mentioning that the newly applied amortization of up-front fee significantly impacted on the amount of revenues generated by the portfolio and this coupled with the increasing costs of provisioning significantly changed the composition of revenues and expenses. Adjusted ratios that reflect the impact of inflation, show the same negative trend and are all negative. For the period July 2007 June 2008 AROE and AROA stand at -17.1% e -4.2% dropping from -1.7% and -0.4% of year Financial self-sufficiency also lags behind the satisfactory level of 100% being 81.4% for the period July 2007 June 2008 (while it was 100% in 2007). OMRO successfully streamlined its efficiency over the period of analysis and this is reflected by the positive trend of operating expense ratio. The ratio followed a decreasing path and reached 10.2% for the period July 2007 June 2008 (it was 11.4% in 2007 and 15.8% in 2006). And this is confirmed also by the continuous decrease of the cost per borrower which stands now at EUR 642. On the opposite direction the funding expense ratio: for the period July 2007 June 2008 it stands at 9.6% increasing from the 8.9% of 2007 and the 8% of This is better explained by the rising trend of the cost of fund ratio which passed from 9.4% of 2006 to 10.5% of 2007 and 10.9% for the period July 2007 June Undoubtedly it is worth noting that financial expenses include not only the interest rate paid on borrowings but also the cost of the hedging used for some of OMRO s liabilities. As far as provisioning expense ratio is concerned the situation appears to be, at a first sight worrying, having the same ratio passing from 2.7% of 2007 to 5.3% for the period July 2007 June Nevertheless the main reason for this important rise has to be found in the change of 21 Details about the provisioning and write-off policy can be find in the Annex 5. MicroFinanza Rating 29

30 OMRO Romania August 2008 Chapter 6 provisioning and write off policy (implemented in July 2007). Indeed since mid-2007 the institution stopped its write offs and PAR consequently grew, thus resulting in a higher provisioning cost. As shown in the graph OMRO has been so far able to cover with its portfolio yield operating, financial and loan loss provision expenses. As explained above for the period July 2007 June 2008 the situation worsen and the decrease of portfolio yield down to 25% together with the rise of provisioning and financial costs eliminate all the margin (the sum of operating, financial and provisioning costs is 25.2%). Beside this, there is the impact of exchange rate losses worth 2.1% (over portfolio) which further contributes to the negative margin. The institution is undoubtedly aware of this situation and is taking measures to control it. At first it completed the Activity Based Costing (ABC) exercise in order to review the overall lending products and analyze for each product its sustainability. On the other hand steps for the shortening of the loan term have already been taken and this will also contribute to increase profitability. Overall OMRO is planning to increase portfolio yield by 2% and so recuperate at least a part of its profitability. In the last years indeed portfolio yield decreased sensibly (it was 26.2% in 2007 and 30.3% in 2006). As far as productivity is concerned loan officers and staff productivity in terms of number of clients stands respectively at 105 and 53 borrowers (for the period July 2007-June 2008), decreasing from the 145 and 57 of Nonetheless it is worth noting that OMRO increases the number of LOs, from 17 as of December 2007, to 26 as of June Indeed if analyzing branch productivity by amount a continuous increase has to be revealed. It stands at more than EUR 2 ml for the period July 2007 June 2008, increasing from EUR 1.9 ml as of dec-07 and EUR 1.2 ml as of dec-06. Similarly to other Romanian MFIs OMRO sustainability has been importantly affected by exchange rate fluctuations 22 and a high and volatile cost of funds (namely interest rate risk). Even if the expected rising trend of financial expenses and loan loss provision, together with a probable pressure on active interest rates in the medium term could further strain OMRO sustainability, it has to be noted that the institution already took some actions to overcome the situation. The yield on portfolio is expected to rise by 2% in the coming periods due to the shortening of loan term. 22 A high degree of uncertainty is attached to the development of the exchange rate (see also Chapter 1). MicroFinanza Rating 30

31 OMRO Romania August 2008 Chapter 7 7. Strategic objectives and financial needs Finding itself in the first step towards the transformation into a bank, OMRO currently relies on two different planning documents. One specifically designed in view of the bank transformation but still as a draft. The second one as the operating one, to be followed and used by the Management to strive OMRO operations. The last one, the Business Plan has been developed in November 2007 with a participative approach that involved all staff including field staff. The Business Plan document appears quite complete and detailed with OMRO vision, an internal and external assessment, a SWOT analysis and the description of the strategy plus an Action Plan for the following steps to be implemented to achieve planned results. The backbone of the strategy is the consolidation of OMRO s operations and image, finally aiming at the bank transformation. Net portfolio is expected to reach almost EUR 60 ml by 2010, keeping its major share over total assets. A similar growth path is to be followed by liabilities which should account for more than EUR 50 ml by the end of The very important growth of portfolio (+91% in 2008 and + 61% in 2009) is then expected to slow down to 30% in Undoubtedly these figures will be constantly monitored and reviewed along with the completion of the process of transformation into a banking institute. In terms of Operational Plan the main objectives for 2008 are the strengthening of the institutional image thanks to the improvements of the branch models and equipments, the consolidation of the branch networks and overall branch operations (with its increased decentralization), the continuous development of products and reinforcement of the credit methodology introducing the use of a credit scoring and the increase of productivity and efficiency. All at the same OMRO is considering the opportunity of opening an Eastern Management Office in Bucharest that should lead the expansion in the south-east part of the country. As for the Business Planning document there are two sets of financial projections available. Usually the Financial Manager is in charge of developing projections and budget for the institution. Some informal scenarios and sensitivity analyses have also been carried out. The table below presents the main projected figures for the two following years: It is worth noting that after having registered negative results for the period July 2007 June 2008 OMRO is planning to reverse the trend and recover its profitability and sustainability. MicroFinanza Rating 31

32 OMRO Romania August 2008 Chapter 7 Financial needs OMRO expects to attract further 9 million Euro by the end of Signed agreements already exist with BlueOrchard and Citibank while negotiations are still ongoing with COOPEST and other actual funders. For what concerns the capitalization strategy OMRO is focussed on the generation of retained earnings. Moreover a further capitalization is expected with the contribution of Opportunity International, in order to allow a smooth transformation process. Under the banking status, the most probable equity structure will include Opportunity International, OikoCredit, EBRD and EFSE. Equity is open to other potential shareholders in the form of private equity funds or similar but the identification process has not yet been completed. MicroFinanza Rating 32

33 OMRO Romania August 2008 Chapter 8 8. Details of the risk factors and final opinion According to our analysis, the main risk factors of OMRO are the followings: MicroFinanza Rating 33

34 OMRO Romania August 2008 Chapter 8 MicroFinanza Rating 34

35 OMRO Romania August 2008 Annex 1 Annex 1 - Financial statements Microfinanza Rating 35

36 OMRO Romania August 2008 Annex 1 Microfinanza Rating 36

37 OMRO Romania August 2008 Annex 2 Annex 2 - Financial statement adjustments The financial statements in Annex 1 are the result of standard reclassification. The numbers are based on audited financial statements according to international standards and on the financial statement internally prepared by OMRO. Financial statements have been then adjusted to allow a comparison with other institutions which use a different logic of presentation of the information and to evaluate the level of sustainability of the institution with market conditions. The main adjustments normally are: adjustment for the accrued interest on delinquent loans elimination of subsidies (donations in kind 23 and soft loans 24 ) provisions are calculated with a standard formula 25 adjustments for inflation adjustments for write-off 26 The most relevant adjustment for OMRO is related to the inflation, as the institution does not include in its financial statements a reserve for inflation. The write-off adjustment represents the amount of loans past due more than 180 days which, according to the best standards in microfinance, should be written-off. As of June 2008, it accounts for EUR 272,277. Although this has been the practice of OMRO until July, the 1 st of 2007, the institution is now applying the new NBR regulation on write-off accounts. Nevertheless, the writeoff adjustment does not have a direct effect in terms of net income variation. 23 Donations in kind are valorized and added to operational expenses. 24 In the income statement it is registered the value of the difference between financial costs of the institutions and financial cost evaluated at the market rate. In particular, in the case of loans in local currency, it is considered 75% of the average lending rate in the national market (IFS Line 60P). In the case of loans denominated in foreign currencies (US$ and EUR), it is considered the average value of LIBOR 1 year plus 3%. 25 Provisions are calculated according to the following formula: Portfolio: 1-30 days 10% Restructured loans 0-30 days 50% days 30% > 30 days 100% days 50% >90 days 100% 26 Loans past due more than 180 days are written-off. Microfinanza Rating 37

38 OMRO Romania August 2008 Annex 3 Annex 3 - Financial ratios Microfinanza Rating 38

39 OMRO Romania August 2008 Annex 4 Annex 4 - Definitions Profitability Description of the ratio Return on equity (ROE) Adjusted return on equity (AROE) Return on assets (ROA) Adjusted return on assets (AROA) Operational self-sufficiency (OSS) Financial self-sufficiency (FSS) Profit margin Formula Net income before donations / Average equity Adjusted net income before donations / Average equity Net income before donations / Average assets Adjusted net income before donations / Average assets (Financial revenue + Other operating revenue) / (Financial expenses + Loan loss provision expenses + Operating expenses). (Adjusted financial revenue + Other operating revenue) / (Adjusted financial expenses + Adjusted loan loss provision expenses + Adjusted operating expenses) Net operating income / operating revenue Portfolio quality Efficiency and productivity Financial management Outreach Portfolio at Risk (PAR30) Provision expense ratio Loan loss reserve ratio Risk coverage ratio (>30 days) Write-off ratio Staff allocation ratio Loan officer productivity Borrowers Loan officer productivity Amount Staff productivity Borrowers Staff productivity Amount Operating expenses ratio Cost per borrower Administrative expenses ratio Personnel expenses ratio Portfolio Yield (gross portfolio) Cost of fund ratio Funding expense ratio Current ratio Debt/Equity ratio Capital adequacy ratio Average disbursed loan size Average disbursed loan size on per-capita GDP Portfolio at Risk > 30/ Outstanding gross portfolio Loan loss provision expenses / Average gross portfolio Accumulated reserve / Gross portfolio Accumulated reserve / Portfolio at risk >30 days Write-off of loans / Average gross portfolio Loan officers / Total staff Number of active borrowers / Number of loan officer Gross portfolio / Number of loan officer Number of active borrowers/ Number of staff Gross portfolio / Number of staff Operating expenses / Average gross portfolio Operating expenses / Number of borrowers Administrative expenses / Average gross portfolio Personnel expenses / Average gross portfolio Interest income from portfolio / Average gross or net portfolio Interest expenses on funding liabilities / Period average funding liabilities Interests and fee expenses on funding liabilities / Average gross portfolio Short term assets / Short term liabilities Liabilities / Equity Total equity / Total assets Amount issued in the period / Number of issued loans Average disbursed loan size / Per-capita GDP Other definitions: Funding liabilities: Liabilities that finance the loan portfolio and the cash investments necessary to manage the loan portfolio Operating expenses: Personnel expenses + Administrative expenses Recovery from write-off ratio: Income from write-off (payments received from loan already written-off) / Average gross portfolio Restructuring of delinquent loans: includes rescheduling loans (extending the term of the loan or relaxing the schedule of required payments) and refinancing loans (paying off a problem loan by issuing a new loan). Microfinanza Rating 39

40 OMRO Romania August 2008 Annex 5 Annex 5 - Guidelines of reporting and accounting Financial statements OMRO does not provide non-financial services; its financial statements (FS) only reflect the results of financial activities. Financial statements are audited by KPMG Romania according to IAS. Loan loss provision and write-off In July 2007 the National Bank of Romania enforced a new regulation regarding the loan loss provisioning policy, according to which loans that are 90 days past due must be provisioned at 100%, what previously was done with portfolio in arrears more than 120 days. Provision expenses are recorded in the income statement and the loan loss reserve is presented in the balance sheet as a negative asset item. At the same time, as of July 1, 2007, OMRO must comply with the new regulation regarding write off accounts. The new practice prevents writing off of loans at 180 days delinquent as has been practice by OMRO. Since then, loans at OMRO must go through execution, the collateral liquidated and then, if any principal remains unpaid, it may be written off. The process can take up to 3 years. Restructured loans Regarding restructured loans, the Credit Manual considers two procedures: reesalonare when the client presents a late payment and the restructuring just affects the current outstanding amount, and reactivare when all the loan amount is restructured. Each procedure requires a different type of commission. Insider loans Insider loans are mainly granted for LOs (amounting EUR 202,062); they have to be approved by the CEO and the BoD and are given at the local inter-bank interest rate. Donations During the last three years, OMRO did not receive any donation. Details of funding liabilities As of June 2008, OMRO presents the following liabilities. Microfinanza Rating 40

41 OMRO Romania August 2008 Annex 5 Microfinanza Rating 41

42 OMRO Romania August 2008 Annex 5 Microfinanza Rating 42

43 OMRO Romania August 2008 Annex 6 Annex 6 - Rating Scale Microfinanza Rating 43