Urban Poverty Alleviation Program (UPAP) of NRSP Islamabad, Pakistan

Transcription

1 Micro-Finance Rating - Risk Assessment Urban Poverty Alleviation Program (UPAP) of NRSP Islamabad, Pakistan Rating grade α alpha minus Assessment: Recommended High safety, good systems Visit dates: 2-8 March, 2004 Operational head: Mr Masood Gill Maximum validity of rating*: till March 2005 Rating UPAP s performance on managerial and financial parameters is good, but is moderate on governance and strategy issues. Within the last three years, the organisation has grown very fast and yet has been able to maintain very good portfolio quality in a completely new market. However, low staff productivity coupled with the lack of full involvement of the board could affect its prospects in the future. With a growing portfolio and increasing size of operations, it is imperative that these two issues are addressed urgently. In M-CRIL s view, on account of its institutional mandate and culture, overall good performance, a commendable approach to sustainability and self-reliance as well as its growth plans, UPAP has tremendous potential to become one of the leading MFIs in South Asia. With action to address the key weaknesses, as pointed out in this report, its performance is likely to improve in the future. A rating update after one year is suggested to ascertain changes in the performance of the institution. This rating is valid, subject to no other significant changes in the organisational structure and external operating environment. for Micro-Credit Ratings International Ltd Sanjay Sinha, Managing Director *Validity This rating is valid till the next loan proposal made by the MFI to any financial institution or till any other significant change in the structure of the loan programme or in its external environment. A rating update (comprehensive repeat rating) is recommended whenever such changes take place or at the end of one year from the date of the initial assessment, whichever is earlier. Any substantial additional information that becomes available could also result in a rating update or a rating review (revision of rating grade based on a desk analysis). Liability The rating assigned is a professional opinion of the assessors and M-CRIL does not guarantee the information and cannot accept any legal responsibility for actions arising out of the recommendations made.

2 Category wise rating Category Rating grade 1 A Governance aspects β+ B Managerial factors C Financial performance Overall α α α Key Risk Factors 1 2 Limited involvement of the board: UPAP is being run as a programme of the National Rural Support Programme (NRSP) of Pakistan. Notwithstanding its strong current operational and credit performance, the indications are that the involvement of the board of NRSP in the affairs of UPAP is limited. All policy and strategic initiatives are taken by the Programme Manager of UPAP in consultation with the CEO and Chairman of NRSP. As the organisation grows and attains a critical volume of operation, it would need the collective expertise and professional acumen of a separate specialist board to become a major microfinance service provider and become a major Asian MFI. Low staff productivity: With a total of 204 staff UPAP has only 11,551 borrowers. This translates into a staff productivity of around 60 clients per staff member. The M-CRIL database puts the staff productivity of the Top10 MFIs in its database at 139 clients per staff member. Even the mature branch of Rawalpindi has a staff productivity of just 90 clients which is very low considering the urban operations of the programme. This low staff productivity has delayed solvency and slowed the growth of the organisation and may become a bigger problem if it is not resolved in time. Governance, experience and strategy 1 Long years of experience in microfinance 2 Good second line of leadership 3 Good expansion strategy 4 Strong credit culture Key Programme Strengths Management and operations 1 Professionally trained, committed and stable managerial cadre 2 Very well developed MIS 3 Good tracking system for overdues 4 Well developed financial planning and control systems Financial 1 Excellent repayment rate and portfolio quality 2 Productive deployment of assets in the loan portfolio 3 Comfortable position on capital adequacy 1 M-CRIL s grading sheet is attached at the end of the report. 2

3 Organisational Profile Legal form* Years of m-f Number of Operation Active borrowers Staff Branches Active borrowers/ Staff member A programme of a limited liability company 7.5 years 11, ~57 (63 excluding management trainees) * of the National Rural Support Programme Outstanding borrowings of MFI (PkRs, US$) Portfolio at risk (>=60 days) Microfinance programme: Operational highlights Loan portfolio of MFI (PkRs, US$) Cumulative loans disbursed by MFI (PkRs, US$) Average loan size from MFI to borrowers (PkRs, US$) 46,922,178 72,744, ,634,069 ~9, ,840 1,247,761 4,659,246 ~156 Current repayment rate Key financial ratios Risk weighted capital adequacy ratio Weighted average cost of funds Yield to APR ratio 0.3% 99.9% 40.6% 7.5% 87.2% Yield on portfolio Other income to average portfolio Financial cost ratio Loan loss provisioning ratio Operating expense ratio 19.3% 2.1% 3.8% 0.5% 22.4% Total income to average total assets Total expenses to average total assets Return on average total assets Operational Self Sufficiency Financial Self Sufficiency 19.5% 24.3% -4.8% 80.2% 75.7% Notes 1. All figures are estimated for the organisation s microfinance programme as on 31 December Members refer to the women who participate in the group meetings coordinated by UPAP, unless otherwise noted. The number of members in UPAP s programme was 18,062 on 31 December Other income includes income that the organisation receives as membership fee and excess recovery resulting from collections in multiples of PkRs10 per member per instalment. 4. Loan provisioning has been made for the current year as well as for the whole portfolio even though the UPAP and NRSP financial statements do not provide for this. 5. The provisioning for loan losses has been done on the basis of the quality of the portfolio of the organisation. 6. The ratio of repayment rate and PAR 60 has been calculated from the MIS reports generated by UPAP. Accuracy of data generated by the MIS has been verified by the rating team through an audit of the systems of UPAP. 3

4 UPAP financial overview Portfolio at risk (>=60 days): 31 December 2003 Operating expense ratio: 1 January -31 December % 40% 10% 5% 0% U PA P U pper-end M FIs O veralldatabase 30% 20% 10% 0% U P A P U p p er-en d M F Is O v erall database Note: 1. n upper-end = 10 n database = 125; Database updated as on 30 June Outliers and rated MFI/NGOs with no direct lending have been removed for analysis. 3. The upper-end MFIs and overall database ratios represent simple averages for their respective samples. 4. The performance of either the Upper-end MFIs or all MFIs (overall database), do not necessarily reflect M-CRIL s rating standards. 30% 20% 10% 0% Income and expense distribution: 1 January -31 December 2003 % o f av erage p o rtfo lio Incom e Expense In terest in co m e O ther incom e In terest exp en se Provisions Salaries O ther operating exp en ses* R s m illio n s Debt and equity composition: 31 December Debt Equity C oncessionaldebt** C om m ercialdebt Cumulative surp lus/deficit D onated equity & grants * Other operating expenses include travel, depreciation and administrative expenses ** Concessional debt is borrowing+comp.savings taken at < Bank PLR +50 basis points, & voluntary savings taken at < bank deposit rates Asset composition: 31 December 2003 Liability & net worth composition: 31 December 2003 N e t fixed Cash O ther assets 2.4% current 4.6% assets 2.0% Networth 39% Other long 1 term liabilities S T debt 1% 59% Other current N et loans liabilities o u tsta n d ing 1% 91.1% 4

5 1 Organisational background The National Rural Support Programme (NRSP) was established as a non-profit organization and registered under Section 42 of the Companies Ordinance 1984 of Pakistan in November It was set up with the idea of fostering a countrywide network of community organisations at the village level. Apart from catering to the socio-economic needs of its rural clients, NRSP was also interested in serving the urban poor. Following a request from the Finance Ministry of the Government of Pakistan to initiate a microfinance programme in the slums of big cities of Pakistan, NRSP started its Urban Poverty Alleviation Programme (UPAP). The objective of the programme was to develop an indigenous model to improve the quality of life of low-income people in the urban areas of Pakistan. The programme was specifically aimed at enhancing credit flow to women in urban areas so as to improve their access to self-employment opportunities. In order to attain the above objectives UPAP started its microfinance programme in the slums of Rawalpindi in June UPAP currently functions as one of the projects of NRSP and the board of NRSP is the apex decision-making body of the organisation. NRSP has a 23 member board consisting of development professionals, government officers, banking professionals, a journalist and a doctor. Mr Shoaib Sultan Khan, a professional with many years of experience in rural development and an international reputation, is the Chairman of the Board. The Board of NRSP meets once in six months to take decisions on issues of policy and strategy. 2 Microfinance operations 2.1 Background of microfinance operations Since June 1996 when it started its microfinance programme in the slums of Rawalpindi, UPAP has expanded its operations to the urban and suburban areas of Rawalpindi-Islamabad, Faisalabad and Karachi. At the time of the rating visit, in March 2004, UPAP was operating in major parts of all these cities with district (branch) offices at Rawalpindi, Faisalabad and Karachi and a total of 48 settlement offices. Its outreach has extended to 17,636 borrowers (over 18,062 members) since inception. The programme is led by the Programme Manager (PM), who is an employee of NRSP. Other staff, however, are employed by UPAP and are not engaged with NRSP operationally. UPAP has a staff strength of 204 including the PM. The head office at Islamabad has a very thin structure with two assistant level staff who double as systems and accounts auditors, one driver and one caretaker apart from the PM. The staff structure at the district offices, is more elaborate and consists of a District Manager, a finance and credit section comprising of Accounts Manager, Senior Area Manager, Deputy Senior Area Manager and Area Managers. Each of the Area Managers monitors three settlement offices and is responsible for each of the settlement offices on a rotation basis. Each of the settlement offices has three workers who are based locally and are responsible for the day-to-day operations of the organisation. The organisational structure of the UPAP is depicted in the diagram below: 5

6 Organisational Structure of UPAP/NRSP Chairman and Board of Directors CEO, NRSP GM, NRSP Programme Manager, UPAP District Coordination, Audit and Monitoring Cell Manager, Faisalabad Manager, Rawalpindi Manager, Karachi Finance & Credit Section Senior Area Manager Area Manager Area Manager Area Manager Settlement Office Settlement Office Settlement Office For its operations, UPAP is largely dependent on the funds received from NRSP. At the beginning of its operations UPAP received a grant of PakRs10,000,000. It also receives the salaries of its staff and other operational support including fund support for on-lending from NRSP. For the last one year, it has been using a line of credit from the First Women Bank (a commercial bank in Pakistan) through NRSP. Funds received by the UPAP from different sources are summarised in the table below Source of funds Cumulative grants till 31 Dec 2003 (PkRs) Grant: UNDP through NRSP 10,000,000 Grant: For Operations from NRSP 33,928,357 Outstanding loans on 31 Dec 2003 (PkRs) Rate(s) of interest Loan: from NRSP for on-lending 22,430,716 6% Loan: First Women Bank 14,491,462 6% Total 43,928,357 36,922,178 6

7 The flow of funds to and from the UPAP is shown in the following diagram: NRSP (operational grant & funds for on-lending) First Women Bank (Funds for pa at Rawalpindi pa at other 6% per annum Clients The dotted lines indicate repayments from UPAP to the lending institution and from clients to UPAP. Though NRSP has been booking the funds being transferred for on-lending to UPAP as a loan and it has also been accruing interest on this fund UPAP has, so far, neither paid any interest nor repaid any of the funds provided for on-lending. 2.2 Microfinance policies Though the UPAP programme was initially meant to test the replicability of the Grameen Bank model of Bangladesh in the urban areas of Pakistan, UPAP has devised a different methodology of credit delivery over the last few years. Once the location of the target population is identified, the staff of UPAP visits each household in the location and introduces the programme to the women of the area. Women willing to avail the services of UPAP are then asked to form groups of three. However, there are some norms that need to be adhered to while forming such groups. The basic idea behind the formation of these groups is to ensure the joint liability of the loans to be provided to the women. Once the women come together to form groups, they are asked to start weekly savings of a mutually agreed amount. This amount is kept with one of the group members and is rotated among the members each week. The group members are not supposed to use the savings money. In order to ensure discipline, the field staff signs on each of the currency notes and checks the signature at the next visit to the group. In the meantime, the group members apply for loans and the appraisal of their applications starts during their third savings meeting. Each group must meet weekly for five consecutive weeks and the field worker of UPAP visits them during each of these meetings. Once the group completes its meetings in five weeks consecutively without violating any of the norms of UPAP it is considered trustworthy for credit absorption and the members savings are returned to them. Within a week of the first appraisal by the field worker, the area manager of the settlement office visits the group member to carry out another detailed appraisal of the loan application. UPAP has a very detailed and comprehensive format to carry out this exercise. This format checks a variety of aspects of the activity to be financed by the client with the loan and also her saving potential. It also determines the resource base of the client for this purpose. After the Area Manager s appraisal, it is the client s turn to visit the branch office and present herself to the district manager along with the head of the family (who is usually her husband). The District Manager interviews the client again and checks all the information in the application form and appraisal format. The Area Manager also interviews the other group members and 7

8 their agreement is sought to stand guarantee for each others loans and to sign (or put thumb impression) on the demand promissory notes. Once all these formalities are complete the client is required to pay the loan processing and application fee and is then given a cheque for the loan amount. She is also given a photo identity card by UPAP which she uses at the bank counter to encash the cheque. Savings UPAP does not collect savings from its clients but encourages them to save. As part of the enrolment to the programme, all members must save a mutually agreed amount (generally Rs250) every week. After the completion of five weeks this saving is returned to each of the members. Since the members themselves retain this money in rotation no interest is paid to anyone. Loan product UPAP has only one loan product. All the loans are meant to be used for productive purposes only. The first loan usually goes up to PkRs10,000 though those who do not possess National Identity Cards only get upto Rs9,000. The subsequent loan sizes may go up by a maximum of Rs5,000 with each of the cycles maximum loan size may go up to Rs30,000. UPAP charges interest at 20% per annum at Rawalpindi and Islamabad and 30% at Faisalabad and Karachi on the declining principal balance. A loan processing and application fee of 1% of the loan amount is also charged from the borrower. All the loans are supposed to be paid within twelve months with equal monthly principal instalments. The loan repayment period may go up in case the loan amount goes up. 3 Observations 3.1 Governance & strategy UPAP records a moderate performance on governance and strategy with a grade of β+. A very clear focus on microfinance coupled with clear strategic understanding of the issues and ability to handle competition are primarily responsible for this performance. However, a limited involvement of the apex body in the decision making of UPAP and the lack of a strong and institutional advisory mechanism for the chief executive of UPAP has limited its otherwise good performance on governance and strategy. Strategy for microfinance operations UPAP has a very sound and low risk strategy for taking up microfinance operations. It is operating in urban settlements where social collateral is regarded as less useful. It is, therefore, important to have a very sound growth and expansion strategy coupled with an adequate system for screening and monitoring borrowers. Over the last seven years of its existence, UPAP has successfully devised very sound systems to take on these challenges. A high degree of checks at every level of transaction ensures a low risk of default and misappropriation of funds. UPAP has also made an attempt to bring down its dependence on borrowed funds from NRSP. It has opened a line of credit with the First Women Bank (FWB) through NRSP (since UPAP is a project of NRSP and is not an independent legal entity) and most of the 8

9 growth of UPAP has been driven by these commercially sourced funds. While UPAP has developed its product delivery mechanism and operational strategies, its product development strategy is sub-optimal. A relatively high client drop-out (25-41% depending on definition) suggests the need to develop a product to suit the needs of second (and later) cycle microfinance clients in the urban areas of Pakistan. Though the pricing of the product has been done intelligently to cover all the operating costs and attain a quick breakeven, a high degree of risk aversion results in a lack of experimentation with products (especially increases in the loan size and high insistence on productive use) resulting in the high client drop out rate. Together with the NRSP, UPAP has been consciously trying to develop a strong second line of leadership. It has recently started a scheme of inducting young college graduates as management trainees, who undergo a six-month on job training at UPAP to select people for absorption by the organisation upon satisfactory completion of training. It is expected that some of these trainees would rise from within the organisation to take up the leadership role in future. Other senior staff of the organisation are also given opportunities to develop their management skills. UPAP has grown very fast over the past 3 years with an average annual growth rate in excess of 60% - see Figure 1. However, the increase in outreach and business volume has not brought any deterioration in programme quality despite the risk-oriented nature of its business. It has opened new branches at Faisalabad and Karachi and plans soon to open offices in other urban centres of Pakistan. However, though it is present in a large number of slums and localities of the 3 cities its client coverage within these settlements is relatively sparse. Since competition in the delivery of microfinance services in these clusters is low, there is substantial scope to intensify its coverage. Figure 1: Growth performance of UPAP No of accounts, ' Amount disbursed, m Rs * Unit Accounts Disbursement - * Annualised Since the UPAP is a programme of NRSP, the board of NRSP is the apex decision-making forum for the programme. The board of UPAP consists of a number of development professionals, banking professionals and government officers. Though the Chairman has 9

10 taken a very keen interest in the development of UPAP and is kept informed about it, the involvement of other members of the board in the operations of UPAP appears to be quite limited. Thus, all the important strategic decisions are taken by the Programme Manager and are discussed with the CEO of NRSP and the Chairman. Since UPAP s operations are gradually acquiring a very large volume it would benefit from the strategic advice of a separate board of experienced professionals in the future. Experience UPAP has been in operation for over seven years and has learnt a lot from its experience. Though it was meant initially to be a replication of the Grameen Bank in the urban areas of Pakistan, it modified its methodology to suit local conditions. However, the impact of experience seems to have been limited to some areas only, as the programme has neither grown as fast as many microfinance programmes in other countries nor does it appear to have exhausted the potential for microfinance in the urban clusters of Pakistan. 3.2 Managerial factors UPAP has recorded a good performance on managerial factors with a grade of α. A very good system of collecting and analysing management information, sound accounting practices, thorough internal controls and a committed set of management and field staff are responsible for this high rating grade. However, some inconsistency in maintaining accounting records (resulting from dual record keeping) and a moderate exposure of staff to other microfinance programmes limiting, thereby, their understanding of microfinance have reduced the score of UPAP on this segment. Human resource quality and management UPAP has very qualified, committed and professional managerial staff. The training and induction system for all staff members is systematic and thorough. The understanding of the staff of the various operational and procedural aspects is adequate. Commitment and motivation at all staff levels is high and there have been very few dropouts in the past year. UPAP also has a very good incentive system for its staff members. Though it sets performance targets for its employees there is still scope for making the system more objective and standardising it based on global norms. However, the relatively low productivity of the staff is a matter of concern. The current level of ~57 clients per staff member (63 if management trainees are excluded) is very low considering the urban nature of its operations. Even the mature branch of Rawalpindi has a staff productivity level of ~90 (though this improves to 101 clients per staff, if the productivity of management trainees is excluded). This is still very low considering the M-CRIL database s Top10 performers staff productivity level of ~139 clients per staff including rural programmes. This not only limits the expansion capacity of the programme, but also increases its operating expenses. Considering the high potential for growth in the urban areas of Pakistan, UPAP would do well to address the productivity issue. Though the reasons for the low staff productivity would be ascertained only after a full process audit by an independent agency, one possible reason could be that the checks being employed by the programme at different levels of appraisal and monitoring are not entirely necessary but yet consume a significant amount of 10

11 staff time and, thereby, affect productivity. Accounting and MIS UPAP has a good and partly integrated accounting system and MIS both at the branches and at the head office. With most of the accounting transactions being carried out at the branches, the vouchers are also generated at the branch offices. Branches prepare monthly trial balances, balance sheets and profit and loss accounts. The quality of the accounts at the branches is good with all the vouchers properly documented and authenticated. The branches are treated as profit centres and the financial statements, therefore, reflect all expenses including the cost of funds though there is no system of allocating head office overheads to the branches. UPAP has devised its norms to maintain a loan loss reserve based on the age of the overdue, even though it does not have any legal or regulatory requirement to do so. However, it does not have a norm for writing off old overdues and, as a result of this, some very old overdues continue to be part of the current portfolio of the programme. Daily collection reports prepared by the settlement office and the actual cash deposited by the field worker form the basic input for the MIS at the branch office. All loan-related information is entered into the MIS at the branch and the summary collection sheet is sent to the HO and the settlement office on a monthly basis. Additionally, monthly soft copy backups are sent to the HO. The software has well defined user access rights, and in-built internal checks to maintain policy compliance and reduce human errors. UPAP has developed an ORACLE based software for MIS with a part of accounting integrated. This software has been developed internally by a select group of staff after acquiring the required expertise. Being developed by practitioners, it is very well integrated with the business processes and activities and generates all the relevant reports for operations. Tracking system for overdues UPAP has a very good system for tracking overdues. A monthly collection sheet is provided to each of the settlement offices in the first week of every month. It has information on the amount falling due during the month with the dates for each of the clients. As the borrowers come to deposit their repayments, the name of the borrower is cancelled to indicate the repayment for the month. Borrowers also carry a repayment schedule where all the repayments from the borrowers are recorded with details of the amount being paid and the date of repayment. All the repayments are deposited at the branch office on a daily basis along with the triplicate of the receipt that has the name and unique identity code of the borrower. Since most of the loans fall due for repayment during the first fortnight of the month, the field staff aims to collect all the dues by the 20 th of each month. In case there has been a delay on the part of the borrower, the field staff start to follow up. The monthly report sent to the branch office from the settlement office has details of all such cases. The monthly due report for the subsequent month also carries these records. Financial planning and control systems UPAP has a very strong financial planning and control system. Financial planning is a topdown system in which annual settlement office targets are set by the branches. These are 11

12 based on the age of the settlement office, staff and current membership. The variance analysis of actual performance from targeted performance is carried out each month and the targets are reviewed accordingly during the monthly staff meeting. Cash planning starts at the branch wherein each month the BM sends the fund requirement statement for the next month to the HO. If required the HO transfers funds to the branch through the cash transfer on a fortnightly basis. In case there is not an adequate balance available with the HO, a request for funds is sent to the NRSP. It has a standard procedure to transfer funds for UPAP s requirement. At the Head Office, projections are made of cash inflows and outflows for each month. In addition, detailed long-term projections are made for projecting the future growth of the organisation. UPAP has a good internal control mechanism and a number of internal checks to detect and prevent accounting errors and misappropriation. It has a two-member internal audit team based at the head office reporting directly to the PM, that carries out monthly process and accounting audits at the branches. The team prepares a detailed audit plan with around 10 days at each branch. The audit is comprehensive and includes both financial and process compliance. The team prepares a report for the PM. However, this audit process is meant just for the district level branches. Another team at the branches carries out the auditing of settlement offices. The audits at the settlement offices are also carried out on a monthly basis, though the field staff does not know the dates of the audit. Here, the emphasis is divided equally between the process and record keeping. Again, a one member team submits the report to the District Manager. Corrective action is taken on the basis of the report. A system of control for fraud is maintained by the regular rotation of the settlement offices allotted to the Area Managers and field staff. However, so far there is no system of rotation of District Managers and Area Managers and field staff across branches. It is commendable that UPAP has not witnessed any major case of misappropriation or fraud despite having operations in urban areas. Quality of clients/member groups Visited borrowers showed very good performance on repayment of loans and overall discipline. Though there is no culture of group meetings over the period of the loan, they are fully aware of the joint group liability of the loans. In addition, awareness about the organisation s rules/norms is very high and members display a clear understanding of loan product, amounts, instalments and interest rates. This reflects the high degree of consistency in policies of the organisation and their effective and quick dissemination at the lowest level. Infrastructure UPAP has an infrastructure base of Rs 3.64 million ($63,000) as on 31 December This includes computer hardware and software, vehicles, furniture and fixture at branches and at the head office. All the branches and the settlement offices along with the head office operate from rented premises. The current level of infrastructure is adequate and is being employed effectively for the overall management of the microfinance programme. 3.3 Financial performance 12

13 The financial performance grade of UPAP is good with a rating grade of α. This results primarily from a strong focus on maintaining portfolio quality and continued high capital adequacy. A high operating expense ratio resulting from low staff efficiency and a negative return on assets limits the overall rating of the programme. Credit performance and asset quality UPAP has excellent credit performance. Its cumulative repayment rate is 99.9% and the PAR 60 was 0.3% as on 31 December This performance is praiseworthy considering the urban operations of the programme and a very high rate of growth in relatively new areas. This has been possible on account high levels of discipline at all levels of staff (especially field staff) and members and a zero tolerance policy towards overdues. UPAP s portfolio is reasonably well diversified with a standard deviation score of exposure on activities being less than The activities being taken up by the clients include animal husbandry, and a variety of trade, manufacturing and services. This occurs mainly because of the diversity of clients being targeted by UPAP. Though this may not be an urgent and immediate requirement, UPAP does not presently have an exposure norm in relation to different sectors and sub-sectors which may be prone to natural and economic cycles. Mobilisation of funds UPAP has long been dependent on the NRSP for different types of fund support. Initially, this was necessary considering the start-up nature of the programme and the lack of an established commercial funding system for micro-credit in Pakistan. However, this dependence has come down considerably over the last two years. The net increase in the credit funds from NRSP is only 0.5% as against a 61% increase in loan portfolio of the organisation during the year ending December Over the last two years, UPAP has obtained a line of credit from the First Women Bank (FWB), a commercial bank of Pakistan at a competitive cost. There has been a net increase of more than 86% in the borrowings from FWB during the year. Another private commercial bank of Pakistan has recently approached UPAP offering a competitive interest rate. With established credibility in the market and interest rates falling to very low levels, UPAP would probably be able to meet its fund requirements from other financial institutions in the future. Asset, liability and equity composition UPAP has utilised its assets well with about 91% deployed in loans as on 31 December The organisation has also been able to minimise idle funds with cash (in hand and bank) being as low as 2.3%, a small improvement over the already efficient level of 3.8% as on December Though no substantive comments can be made on the basis of this information, UPAP appears to have attained an even better efficiency level in terms of cash holding with respect to its assets in recent months. In terms of liabilities, UPAP has relied mainly on the external debt from FWB and funds from NRSP. The organisation has been able to maintain a very healthy capital adequacy ratio of more than 40% as its capital base increases year by year on account of operating cost support from NRSP. With the current trend of performance UPAP is likely to have a comfortable capital adequacy position in future, though this could come down in case NRSP decides to stop operational support once the whole programme attains solvency. According 13

14 to the projected business plan of UPAP (see annex), assuming that the operational support would cease to come after UPAP starts making a profit, its capital adequacy is likely to come down to less than 25% with an expected eight times increase in portfolio, as shown in Figure 2. However it would still be above 20%, well above internationally accepted norms on capital adequacy. Figure 2: Projected Capital Adequacy position vis-à-vis portfolio of UPAP % % Millions % 30% 25% 0 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Loans outstanding Risk weighted capital adequacy ratio 20% Profitability and Sustainability UPAP is yet to attain profitability and sustainability. It has a negative return on assets (- 4.8%) and its operational self-sufficiency is just 80.2% for Year The organisation has an Operating Expense Ratio of 22.4% for the year ending December 2003 relatively high in relation to its yield of 19.3%. This results from low staff productivity. In order to attain a faster solvency it would need to bring the OER down to less than 18% in line with microfinance best practice in the next couple of years. This is quite possible to attain, as demonstrated by its Rawalpindi branch, which had an OER of less than 12% for the first quarter of the current financial year, This is despite the staff productivity of even the Rawalpindi branch, 90 clients per staff, not being exemplary. Overall, UPAP needs to set higher and more productive targets for its staff to attain faster solvency. Going by the latest estimates, Faisalabad as well as Rawalpindi have now attained breakeven volumes and are likely to register positive returns during the current financial year (ending June 2004). The low Operational Self-Sufficiency at 80.2% also results in a relatively low Financial Self- Sufficiency of 76% compared to the M-CRIL Top10 benchmark of 109% and 97% respectively. 4 Conclusions 14

15 Strengths Governance and Strategy Long years of experience in microfinance Good second line of leadership Good expansion strategy Strong credit culture Managerial Professionally trained, committed and stable managerial cadre Very well developed MIS Good tracking system for overdues Well developed financial planning and control systems Financial Excellent repayment rate and portfolio quality Productive deployment of assets in the loan portfolio Comfortable position on capital adequacy Weaknesses Governance & Strategy Low involvement of policymakers in the operation Low concentration in the area of operation Managerial Low staff productivity possibly higher than necessary level of appraisal and utilisation checks Financial High operating expenses for a large Asian MFI Negative profitability 5 Creditworthiness UPAP has achieved a rating grade of alpha minus (α ). 3 In terms of creditworthiness this implies reasonable safety along with good systems. UPAP s performance on management and financial parameters is good, though its performance on governance and strategy would improve with a separate board and a more engaged policy making and oversight structure. UPAP s success in maintaining excellent credit performance, while at the same time growing at a good pace in a completely new and emerging market, is commendable. In M-CRIL s view, on account of its institutional mandate and culture, overall good performance, a commendable approach to sustainability and self-reliance as well as its growth plans, UPAP has a tremendous potential to become one of the leading MFIs in the South Asia. With an improvement in some of the areas of key weakness as pointed out in this report, UPAP would improve its rating performance in the future. 3 The Rating Grade given measures performance on the rigorous standards established by M-CRIL. The assessment uses an instrument designed specifically for the conditions and nature of MFIs operating in Asia and is comparable with other ratings done by M-CRIL in this region. 15

16 Financial statements for UPAP s microfinance operations Balance Sheet - as on 31 December 2003 Assets PkRs PkRs US$ US$ Current assets Cash in hand and bank 1,881,283 32,159 Advances 186,363 3,186 Security Deposit 170,000 2,906 Receivables 204,915 3,503 Prepayments 989,632 16,917 Loans outstanding Gross loans outstanding 72,744,452 1,243,495 (Loan loss reserve) (727,445) -12,435 Net loans outstanding 72,017,007 1,231,060 Total current assets 75,449,200 1,289,730 Long term assets Net property and equipment 3,637,658 62,182 Total long term assets 3,637,658 62,182 Total Assets 79,086,858 1,351,912 Liabilities and Networth Current liabilities Accrued provision and other liabilities 657,497 11,239 Short term debt First Women Bank 14,491, ,717 Advance from NRSP 32,430, ,371 Total short term debt 46,922, ,089 Total current liabilities 47,579, ,328 Long term liabilities Deferred Liabilities 612,804 10,475 Total long term liabilities 612,804 10,475 Net worth Donated equity from NRSP 33,928, ,972 Grant from UNDP 10,000, ,940 Retained net surplus/(deficit) (9,971,155) (170,447) Current net surplus/(deficit) (3,062,822) (52,356) Total net worth 30,894, ,109 Total Liabilities and Net Worth 79,086,858 1,351,912 16

17 Income Statement for the year ending 31 December 2003 Income PkRs PkRs US$ US$ Interest and fees on loans 11,224, ,878 Excess Recovery & other fees 1,202,112 20,548 Total income 12,426, ,426 Financial costs Interest on borrowings 2,205,159 37,695 Gross financial margin 10,221, ,731 Provision for loan losses 276,095 4,720 Net financial margin 9,945, ,012 Operating expenses Salaries 7,682, ,319 Travel 338,486 5,786 Depreciation 674,607 11,532 Administrative/office expenses 4,313,259 73,731 Total Operating expenses 13,008, ,368 Net Surplus/Deficit -3,062,822-52,356 17

18 Notes to the financial statements 1. The Financial Statements have been estimated for the microfinance operations and represent an approximate picture only. This has involved appropriate modifications to the existing financial statements using data gathered and assumptions made during the rating exercise. Such modifications can result in differences between the income statement and balance sheet prepared by the organization itself and the statements presented above. 2. Income includes interest income, fees and earnings from other microfinance related services offered by the MFI rated. All loan portfolio related income is recognised only when it is actually received (cash basis). Grants allocated to the organisation s microfinance programme are treated as donated equity in the balance sheet (and not regarded as operational income). 3. Financial costs (interest on borrowings and savings, if any) and operating costs are calculated on an accrual basis. Loan loss provisioning expense and the corresponding balance sheet entry (loan loss reserve) has been computed based on the quality of the portfolio. Glossary 1. Cumulative repayment rate Ratio of cumulative principal recovered (net of pre-payments) to the cumulative principal due till the date of measurement. 2. Portfolio at risk (PAR 60 ) Ratio of the principal balance outstanding on all loans with overdues greater than or equal to 60 days to the total loans outstanding on a given date. 3. Yield on portfolio The interest income on loans divided by the average loan portfolio for the year. 4. Other income to average portfolio Total income other than from the interest on loans divided by average portfolio. 5. Financial cost ratio Total interest expense for the year divided by the average portfolio. 6. Loan loss provisioning ratio Total loan loss provisioning expense for the year divided by the average portfolio. 7. Operating expense ratio Ratio of salaries, travel, administrative costs and depreciation expenses to the average loan portfolio. 8. Average loan portfolio This represents the average loan outstanding for the year computed on a monthly basis. 9. Subsidy Dependence Index The Subsidy Dependence Index broadly measures the net subsidies received as a proportion of the income of the organisation. A higher ratio indicates that there is a higher level of dependence on subsidies. Subsidies can be in the form of grants and savings deposits/ borrowings at a rate lower than market rate. Computation of subsidies is done with respect to the market rate of interest. 10. Average total assets This represents the average total assets for the year calculated on an annual basis. 11. Operational Self-Sufficiency Ratio of total income to total costs for the year. 12. Financial Self-Sufficiency Ratio of total income to total adjusted expenses for the year. Adjustments have been made for subsidised cost of funds (w.r.t. market interest rate), equity (w.r.t. inflation) and in-kind donations. 13. Risk weighted capital adequacy ratio Ratio of networth to risk weighted assets (Risk weights: 100% for all assets except the following: fixed assets & interest bearing deposits: 50%; cash 0%). 18

19 Projected Cash Flows and Financial Statements for five years The following assumptions and projections - derived from the limited information available from the organisation on its future financial projections are tentative in nature. These should not be viewed in isolation nor be regarded as a basis for investing in the future - only the main risk rating report provides an opinion on investments. All assumptions are based on the data gathered during the rating exercise and the savings and credit methodology used by the organisation. 1 Basic Assumptions (see also Notes to Cash Flow Projections below) For the year ending: Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Members 19,023 30,000 45,000 55,000 70, ,000 Yield on average portfolio 19.3% 21.3% 25.5% 25.5% 25.5% 25.5% Cost of external funds 7.5% 5.9% 5.7% 5.7% 5.7% 5.7% Repayment rate from groups 99.9% 99.5% 99.5% 99.0% 99.0% 99.0% Loan loss reserve ratio 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% Number of active loanees/loan a/cs 12,171 19,500 31,500 38,500 49,000 70,000 Number of loans disbursed 19,135 30,915 37,555 47,845 68,530 Average loan size to borrowers 9,121 9,500 9,500 10,000 10,500 10,500 19

20 2 Projected balance sheets PkRs in thousands As on: Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Assets Cash balance 1,881 2,223 6,214 8,977 9,340 10,560 Other current assets 1,551 1,706 1,877 2,064 2,271 2,498 Loans outstanding 72, , , , , ,653 Loan loss reserve ,113-1,798-2,317-3,099-4,437 Net loans outstanding 72, , , , , ,216 Net fixed assets 3,638 3,454 4,909 6,218 7,396 8,456 Liabilities and Net Worth Total Assets 79, , , , , ,730 External borrowings 46,922 77, , , , ,250 Other liabilities 1,270 1,425 1,596 1,784 1,990 2,217 Donations and equity 43,928 51,428 58,928 58,928 58,928 58,928 Retained surplus/deficit -9,971-13,034-12,901-3,886 9,708 24,884 Current surplus/deficit -3, ,015 13,594 15,176 23,450 Net worth 30,894 38,528 55,042 68,637 83, ,263 Total Liabilities and Net Worth 79, , , , , ,730 3 Projected Income Statements PkRs in thousands For the year ending: Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Income Interest 11,225 19,583 37,167 52,543 69,155 96,213 Other income 1,202 1,322 1,983 2,479 3,099 3,874 Total Income 12,427 20,905 39,151 55,023 72, ,087 Cost Financial 2,205 3,961 6,586 9,327 12,548 17,906 Loan loss provision ,338 Depreciation Operating expenses (excl. depr.) 12,334 16,041 22,320 30,892 42,927 56,453 Total Cost 15,490 20,772 30,136 41,428 57,078 76,637 Surplus/Deficit -3, ,015 13,594 15,176 23,450 20

21 4 Projected Cash Flow Statements (PkRs in 000) For the year ending: Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Inflows Opening cash 1,881 2,223 6,214 8,977 9,340 External borrowings 47, , , , ,500 Repayments from members 143, , , , ,807 Grants 7,500 7, Interest income 19,583 37,167 52,543 69,155 96,213 Other income 1,322 1,983 2,479 3,099 3,874 Total Inflow 221, , , , ,735 Outflows Disbursement 181, , , , ,565 Repayments to lenders 16,803 45,762 83, , ,250 Operating expenses (excl. depr.) 16,041 22,320 30,892 42,927 56,453 Interest paid on borrowings 3,961 6,586 9,327 12,548 17,906 Fixed assets purchase 200 2,000 2,000 2,000 2,000 Total Outflow 218, , , , ,175 Net cash balance 2,223 6,214 8,977 9,340 10,560 5 Key projected performance ratios For the year ending: Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Operational self-sufficiency 80% 100.6% 129.9% 132.8% 126.6% 130.6% Return on average assets -4.8% 0.1% 5.8% 6.2% 5.3% 6.0% Operating expense ratio 22.4% 17.8% 15.7% 15.3% 16.2% 15.2% Average outstanding/borrower (PkRs) 5,977 5,708 5,708 6,019 6,324 6,338 Portfolio growth rate 61.2% 53.0% 61.5% 28.9% 33.7% 43.2% Risk weighted capital adequacy ratio 40.6% 34.4% 30.5% 29.5% 27.0% 24.2% 21

22 6 Notes to the projections 1. The Operating Expense Ratio is based on current levels and is projected based on changes in overall productivity and growth in staff, branches and portfolio. 2. Estimated external borrowings are subject strictly to performance based on the findings of this microfinance capacity assessment (credit rating). 3. Number of loans disbursed is approximately 95% of the loan accounts as it takes minimum five week for a new set of members to avail the loan funds from UPAP. The present high attrition rate of clients is another reason for the difference in the two numbers. 4. Average loan size to members increases marginally over the five years period. This is based on the present policy of the UPAP and it has been assumed that the growth would be driven more by inducting new clients than by repeating the old borrowers. 5. Interest income is taken as [yield on portfolio*average portfolio for the year]. Yield movements are projected to increase, as the portfolio from Rawalpindi-Islamabad office is likely to come down in the future as a proportion of total portfolio as new offices are opened at other urban centres of Pakistan. 6. Other income is the income that the organisation earns on membership fees, administrative charges, service charges and excess recovery from its clients. 7. Disbursements are taken as the [number of loans disbursed during the year*average loan size to borrowers]. 8. Estimates on growth in outreach and demand for loans from the organisation have been made based on current growth levels and future expansion potential and capacity. Increase in members is taken at rates between 20-40% per year. 9. Repayments to lenders is 50% per annum on the projected liability structure and the actual repayments due on the present outstanding debt. 10. Interest paid is taken as the [average cost of external funds * the average external borrowing liability figure]. 11. In the projections the net worth figure includes donated equity, retained and current surpluses (deficits). 22

23 M-CRIL s Microfinance Rating Symbols M-CRIL Grade α+++ alpha triple plus α++ alpha double plus α+ alpha single plus Description Highest safety, excellent systems most highly recommended Highest safety, very good systems most highly recommended Very high safety, good systems highly recommended alpha α High safety, good systems highly recommended α alpha minus β+ beta plus β beta β beta minus γ+ gamma plus γ gamma Reasonable safety, good systems recommended Reasonable safety, reasonable systems recommended, needs monitoring Moderate safety, moderate systems acceptable, needs improvement to handle large volumes Significant risk, poor to moderate systems acceptable only after improvement Substantial risk, poor systems needs considerable improvement Highest risk, poor systems not worth considering 23