liabilities and equity - us$ · one of the largest mfis in the country. the organization lenders....

October 2009

CONTACTS

MicroFinanza Rating srl Corso Sempione, 65 20149 Milan – Italy Tel: +39-02-3656.5019 [email protected] www.microfinanzarating.com

VF AzerCredit 13, Kaverochkin St.

Baku, Azerbaijan Tel: +994 (12) 4189417

[email protected] www.azercredit.az

VF AzerCredit – Azerbaijan

Final Rating BBB

Outlook: Stable

Third Rating Previous rating as of June 2007: BBB- by MicroFinanza Rating

Validity 1 year if no relevant changes in operations or within the operation context will happen.

Vision Fund AzerCredit LLC offers micro-lending services to people who are unable to access financial services provided by conventional banking system. After having obtained the license from the National Bank of Azerbaijan in 2003, AzerCredit transformed from the World Vision program to a limited liability company in 2004. Currently, the institution ownership is in the process of changing from World Vision International to Vision Fund International (VFI), a subsidiary of World Vision International. Through a network of 6 branches and 12 satellite offices, AzerCredit outreach counts more than 30,000 active clients, mainly focused on agricultural/livestock business. AzerCredit’s outstanding portfolio as of September 2009 is worth around US$ 20 M, positioning the institution as one of the largest MFIs in the country. The organization counts on a good network of international microfinance lenders. The expected new law for non-banking financial institutions should support AzerCredit to increase the equity.

Legal Form LLC

Inception year 1996 (World Vision Microfinance

program) – 2004 (MFI LLC)

Reg. & Supervision No

Shareholders 100% World Vision International

Area of intervention Rural, semi urban and urban

Credit methodology Individual and group lending

Portfolio quality Evolution

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

Dec07 Dec08 Sep09

0.0%

0.1%

0.1%

0.2%

0.2%

0.3%

0.3%

0.4%

0.4%

Gross outstanding portfolio PAR 30

Write-off ratio Restructured portfolio

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

Dec07 Dec08 Sep09

Liabilities and Equity - US$

Equity Short term liabilities

Long term liabilities Other liabilities

AzerCredit – Azerbaijan – October 2009

MicroFinanza Rating 2

Rating Rationale Vision Fund AzerCredit is characterized by sound and improving performance results despite the global economic turmoil and the general slowing down of the microfinance operations in the country. The institution has managed to further expand the clients’ base and maintain a respectable portfolio growth pattern (even though decreasing) thus enhancing its franchise value. AzerCredit demonstrates good capacity to deal with multiple foreign commercial investors and has reached a quite high financial leverage, whose pressure has however been alleviated, on the one hand, by issuance of subordinated debt and, on the other, by a more conservative planned growth if compared to that of the previous years. The institution relies on good governance with regular support from World Vision/Vision Fund, which is its sole funder. On the other hand, the top management is exposed to some supervision risk due to the involvement of the Deputy Director in multiple functions (the process of responsibilities delegation is on-going) and a part-time CEO. This risk might also be worsened by a poor internal control system which is not fully effective due to the just recently established internal auditor department (internal auditor has just been hired after a vacuum of almost a year ) and to policies and procedures which are still undergoing consolidation (i.e. audit manual and fraud prevention policy). Other areas for improvement are related to financial risk management, which at the moment highly relies on CREDO (MFI based in Georgia affiliated to World Vision/Vision Fund) practices and financial manager. Concurrently, the lack of regular and systematic internal and external training policies, is limiting the professional growth of middle management and credit staff.



AzerCredit’s HQs: Baku

Strengths Opportunities

- Good geographic coverage in the main economically active areas in the country;

- Good support from the Founder; - Strong and successful relationship with many

stakeholders (donors, investors, etc.) - Consolidated financial products.

- The new law for NBFI will help to define the ownership structure and possibly to increase the shares capital;

- Adoption of the new MIS; - Focus on capacity building, as the institution

already covers an important market share; - New financial products such as social loans

(educational, housing products).



Benchmarking

All figures of peer groups are referred to the MicroBanking Bulletin (MBB) database updated as of December 2008. AzerCredit ratios indicated here do not fully correspond to the ratios presented in the report as they are calculated according to the MBB methodology

1.

Key points

- AzerCredit portfolio size is bigger than the other peer groups, except from one involving the biggest

MFIs in ECA. - Depth of outreach is higher than the other peer groups, reflecting the social mission of AzerCredit and

the capacity to reach the low income population. - Despite the financial crisis which hits the MFIs performances, PAR 30 is below than most of the peer

groups. - Portfolio yield is higher than the other peer groups along with higher interest rates charged (including

commission fees). - Productivity per staff and per loan officers are above than all peer groups. - Notwithstanding efficiency is lower than the other peer groups, AzerCredit’s profitability is above the

values indicated by the other peer groups. Such a profitability level is supported by a quite high financial leverage, which is higher than the other peer groups.

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).



Table of contents 1. External Environment and AzerCredit positioning ..................................................... 6

Institutional background .............................................................................................................. 6 Political and Macroeconomic context .......................................................................................... 6 Microfinance sector ..................................................................................................................... 7 Regulation and supervision ......................................................................................................... 7 AzerCredit market positioning ..................................................................................................... 8

2. Governance and operational structure ...................................................................... 10 Ownership and Governance ...................................................................................................... 10 Organisation and structure ........................................................................................................ 11 Human Resources .................................................................................................................... 12 Risk Management, Internal control and Internal Audit ............................................................... 13 Accounting and external audit ................................................................................................... 13 Management Information System .............................................................................................. 14

3. Lending and savings operations ................................................................................ 15 4. Assets structure and quality ....................................................................................... 18

Assets structure ........................................................................................................................ 18 Portfolio structure ...................................................................................................................... 18 Loan portfolio quality ................................................................................................................. 20

5. Financial structure and ALM ....................................................................................... 22 Liabilities and equity structure ................................................................................................... 22 Assets and Liabilities Management ........................................................................................... 23

6. Financial and operational results ............................................................................... 26 7. Strategic objectives and financial needs ................................................................... 28

General guidelines for future evolution ...................................................................................... 28 Financial projections ................................................................................................................. 28 Financial needs ......................................................................................................................... 29

8. Details of the risk factors ............................................................................................ 30

Annex 1 - Financial statements ...................................................................................... 32 Annex 2 - Financial statements’ adjustments ............................................................... 34 Annex 3 - Financial ratios ............................................................................................... 35 Annex 4 - Definitions ....................................................................................................... 36 Annex 5 - Guidelines of reporting and accounting ....................................................... 37 Annex 6 - Rating Scale .................................................................................................... 39

AzerCredit – Azerbaijan – October 2009 Chapter 1


1. External Environment and AzerCredit positioning

Institutional background Vision Fund AzerCredit LLC, was originally established in 1996 as a World Vision International program, offering micro-lending to people who are unable to access financial services provided by conventional banking system. After being registered as a non-bank financial institution in 2002 and obtaining a license from the National Bank of Azerbaijan in 2003, AzerCredit transformed from the World Vision program to a limited liability company in 2004. Currently, the institution – which is 100% owned by World Vision International – is in the process of registering the ownership under Vision Fund International (VFI), a subsidiary of World Vision International. AzerCredit’s offers individual and group loans in rural and urban areas with a focus on the agricultural/livestock sectors. Through a network of 6 branches and 12 satellite offices, AzerCredit outreach counts more than 30,000 active clients. AzerCredit’s outstanding portfolio as of September 2009 is worth around US$ 20 M, positioning the institution as one of the largest MFIs in the country. The organization has reached a good level of visibility between the international microfinance stakeholders, attracting several commercial loans. The upcoming endorsement of the new law for non-banking financial institutions should support AzerCredit to define the ownership and potentially create the base for increasing the paid-in capital. Political and Macroeconomic context The President Ilham Aliyev has been re-confirmed for his second mandate during the last election held in October 2008. Moreover, he looked set to cement his grip on power even further when a move to lift the two-term limit on the president was approved in a referendum in March 2009, paving the way for a possible third term. The political situation is generally stable despite the existing tensions between Armenia and Azerbaijan over the Nagorno-Karabakh region (a ceasefire has been stipulated in 1994). The recent conflicts in Georgia along with the claims for independence by Ossetia have somehow increased the concerns of Azerbaijan government in reference with the risk of a secession of the Nagorno-Karabakh region. Azerbaijan has been experiencing repercussions from the global economic turmoil through continuing weaker oil prices and declining foreign and private domestic investment. GDP growth fell to 3.6% year on year in the first half of 2009 as growth in industrial output declined to 1.0% and fixed capital investment contracted by 7.1%. During the third quarter of 2009, signs of economic recovery are emerging as the annual GDP reached 5 per cent, reflecting a recovery in oil prices and an improved global economic outlook. Although this is a relatively strong growth performance regionally or even globally, it reflects a marked slow-down when compared with growth rates of over 20 per cent annually during the past three years. EIU has revised real GDP growth estimate for 2009 to 9.1% and growth forecast for 2010 to 9.5%, improving the original expectations.



Inflation has relevantly slowed due to lower demand and the annual inflation rate was negative from May, reaching 3% y-o-y in September 2009 compared with the yearly average of 20% at the end of 2008. Deflation pressures have been slightly compensated by higher public expenditure for salaries and pensions. With a weaker economic expansion now expected, full-year average inflation is expected to stand at 1.7% for 2009 (according to EIU, while ADB pointed out an average inflation equal to 4% at the end of 2009); for 2010 the projection is equal to 6.6%. Lower foreign exchange inflows following the large decline in exports have put pressure on the currency. The National Bank of Azerbaijan has so far supported the currency and lost about 19 per cent of its foreign exchange reserves during the first three months of 2009. Consequently, the exchange rate has remained relatively stable and reserves have gradually increased again since March 2009. Manat stability is confirmed by EIU projections which forecast a stable exchange rate against US$ at 0.80 for 2010. Microfinance sector Overall the microfinance sector includes 96 non-bank credit organizations. As of September 2009 the AMFA (Azerbaijan Microfinance Association) includes 31 microfinance institutions and 8 out of which are represented by downscaling commercial banks and 23 non-bank credit organizations. As of March 2008 the total outstanding portfolio, total micro-credit portfolio of the financial institutions belonging to AMFA network is worth more than US$ 382 M, with almost a total of 275,000 clients. These figures, compared to the data as of December 2005 – total portfolio of USD 73M and 70,000 active clients - demonstrate strong growth in outreach and scale of the sector and increasing competition. The leading actor - with an outstanding portfolio worth US$ 141m remains the former Microfinance Bank of Azerbaijan (MFBA), now called AccessBank. Other main players are FINCA (the first one in terms of number of clients – 81,000 as of July 2009), Credagro (ACDIVOCA) and Agrarcredit. Although the target market remains different for certain aspects, competition with commercial banks is rapidly increasing. Among the main banks offering microcredit services there are the Parabank, TuranBank, AzerDemiryolBank OJSC and Bank Respublika. Lastly, the role of the 30 credit unions operating in the country is limited both in terms of total number of clients and active portfolio. The microfinance sector, including AzerCredit does not currently participate in the Credit Bureau (set up by the National Bank of Azerbaijan in 2005), which is mainly including those financial institutions whose lending operations are concentrated in Baku. The Credit Bureau (credit register) still presents inefficiencies and limited involvement of financial institutions, and given the increasing competition, this could represent a risk for potential clients’ over-indebtedness. Banks’ loan portfolios have been shrinking month on month since the beginning of 2009, although a reversal has been seen since June. Microfinance institutions generally are following the same pattern, with an overall increase in the liquidity. Concurrently, non-performing portfolio slightly worsened. Regulation and supervision No considerable changes have occurred in the legal framework since the last rating (June 2007). The draft of Microfinance Law submitted by the National Bank to the Parliament is still under discussion, and the approval expected for 2009 has not come yet. According to the current regulation, all MFIs have to be legally registered as limited liability companies (LLC) and are required to pay profit taxes since 2005. Thanks to their social orientation, MFIs were exempted by decree from paying social taxes. However, the social fund since beginning 2009 started to claim back social taxes from commercial institutions. AzerCredit like other MFIs is now under court process and it has to pay social taxes for the previous years (since the transformation into a commercial entity). The transformation into commercial entities still presents



controversial for what concerns the donated equity originally injected and their related returns which should remain in Azerbaijan according to the civil law. Microfinance Institutions are not allowed to collect savings, unless they transform into banks. Supervision is carried out by the National Bank through reports (financial statements and portfolio classification) which MFIs are asked to submit quarterly. AzerCredit market positioning AzerCredit operates in both rural and urban areas through both individual and group lending methodology. The institution counts with a quite spread network, including 6 branches and 12 satellite offices. By the end of 2009, a new branch will be established converting a satellite office. The institution offers business loans (mainly for livestock and trade purposes) and household loan (consumer loans for entrepreneurs). AzerCredit faces growing competition not only from MFIs typically targeting the same market segment, but also from banks, downscaling lending activities to low-medium end market. As far as micro and small business credits, FINCA Azerbaijan represents the biggest competitor, with a relevant brand recognition and larger network coverage. As for rural areas, Normicro and Viator are the main competitors, together with Findev in Minghecevir area. CredAgro, which is very active in rural lending, overlaps with AzerCredit repeated clients, who need bigger loan size.

Main competitors - MFIs

Institution

Gross

Portfolio

(US$)

N. of sale

points

Lending

methodology

Loan size

(US$)

Loan

maturityInterest rate

AzerCredit $19,913,540 18Group &

Individual $100-$10,000 3-30 months

2.0% - 3.5%

declining, flat

Finca

Azerbaijan$59,453,160 54

Group &


2.0% - 3.7%

declining

Normicro $7,653,659 11Group &

Individual $200-$10,000 4-20 months 3.0% declining

Viator $5,745,758 5Group &


2.75% - 3.0%

declining

On the other hand, increasing competition from downscaling banks pose some concerns especially as those banks are able to offer more favourable conditions in terms of lower interest rates and longer maturity. Accessbank, which is the main microfinance provider in the country, Bank Respublika, Texnikabank, NBC Bank, and Parabank are the most visible and recognized competitors, which are also active members of AMFA.

Main competitors - Banks

InstitutionN. of sale

points

Lending

methodologyLoan size (US$) Loan maturity Interest rate

AzerCredit 18Group &

Individual

$100-$10,000 (micro,

small)3-30 months (micro, small) 2.0% - 3.5%

Accessbank 23 Individual $100-$2,000,000

(micro, small, medium)

max. 36 months (micro),

max. 60 months (small,

medium)

2.5%-3.0% (micro),

2.0%-2.5% (small),

1.5%-2,25% (medium)

Bank

Respublika33

Group &

Individual

$100-$10,000 (micro);

$10,000-$50,000

(MSE); $ 50,000-$

500,000 (SME); $

500,000-$6,000,000

(big)

3-36 months (micro), 6-60

months (MSE), 12-60

months (SME), 12-84

months (big)

0.6%-3.0% (micro),

0.6%-2.5% (MSE),

0.6%-2.3% (SME, big)

Texnikabank 39 Individual

$100-$1,200 (micro),

$120,000-$1,200,000

(big)

1-60 months 0.6%-3.0%

AzerCredit, through its marketing department, recently has aligned all branches with a common brand line. Franchise value is increasing, especially in the area surrounding Ganja.



Nevertheless, front-office operations become of critical importance (especially in the biggest branches) in order to compete with more structured banks. The Marketing department is aware of such a situation and is planning to introduce the position o customer relationship officer in the largest branches. In the main urban and per-urban areas (e.g. Ganja, Minghecevir, ec.) growing competition is accompanied also by a certain risk of over indebtedness. Nevertheless, some rural areas particularly in Southern regions present unmet credit needs. The main competitive advantages of AzerCredit are:

• Expedient loan processing compare to medium-size MFIs; • Good partnerships with village councils; • Well-known institution on the local market; • Competitive commission fees;

As far as main competitive disadvantages are concerned, AzerCredit presents:

• Limited product offer for what concerns consumer loans (education, health, etc.); • Higher interest rates compared to downscaling banks; • Shorter maturity compared to downscaling banks.



2. Governance and operational structure

Ownership and Governance Vision Fund AzerCredit (hereinafter AzerCredit) is a limited liability company, wholly owned by the sole founder World Vision International (WVI), since 20042. Recently WVI transferred the shares to Vision Fund, a subsidiary organization of WVI. The change of founder ownership of AzerCredit is still in the process and most likely will be completed along with the entrance in force of the law of non-banking institution in Azerbaijan (expected by the beginning of 2010). The new law will also likely clarify the shareholder rights over the portion of donated equity originally injected in the humanitarian-relief program, which cannot be transferred out of the country.

Since the last rating visit the institution’s governance structure has undergone some changes.

The number of members in the Supervisory Council increased and is adequately composed of local and foreign members (7 members in total), who have good financial and economic knowledge and expertise, without neglecting a particular focus on social issues. One of new appointed members has legal background.

2 In 2004 AzerCredit successfully transformed from a relief program to a commercial entity with World Vision

International becoming the sole shareholder.



The SC recently has supported the top management to identify the new internal auditor. Besides, the SC has elaborated policies for an audit sub-committed within the SC, which however is not effective yet. Internal audit still represents a crucial area for AzerCredit as for the whole 2009, the institution did not count on an internal auditor.

Nevertheless, regular meetings (on a quarterly basis) and effectively support and guidance from the SC have partly compensated the lack of audits and daily independent supervision on AzerCredit’s activities.

Top management and SC enjoy a good level of communication and regular reports are provided by the CEO and the top management to the SC’s members. Progressive reports submitted by the top management constitute also the base for a constant evaluation of executive management, even though a formal appraisal has not been introduced yet.

Although the top management relies only on a part-time CEO3, responsibilities and commitment are well shared between the CEO himself and her deputy. Nevertheless, the part-time CEO considering an organizational structure more sophisticated (compared to the previous years) and a still young internal department somehow exposes the top management to potential weaknesses in terms of supervision and overall management.

At the moment, the deputy CEO represents a key person risk, while financial and operational department have been only recently strengthened. The process of functions delegations is still somehow in the process and the top management is aware of such a situation, planning for 2010 an intensification of the HR trainings (see human resources paragraph). Organisation and structure AzerCredit operates through a network of 6 Branches and 12 Sub-branches, allowing for a good geographical coverage of the main economically key areas in the country. During the last two years AzerCredit intensified its presence over the territory opening new sub-branches, which enable the institution to gradually scaling up. The institution’s expansion approach counts on a gradual upgrading of sub-branches and by the end year one sub-office should be transformed into a branch. Besides, AzerCredit will continue the expansion through the opening of two new sub-branches and consolidating the operations in Ganja Branch (which is the biggest one) setting up a second office in the city.

3 The new CEO has been appointed in March 2009 and she is currently also CEO of CREDO Georgia, a microfinance

institution affiliated to Vision Fund International.



This would ease the front-office operations, which at the moment result to be somehow affected by a the role of loan officers who often have to deal with a great number of clients at the branch premises potentially slowing the flow of information. Within this perspective, the marketing department is aware of such a situation and is planning to introduce a customer relationship officer in the biggest branches in order to optimize the workload of loan officers and the accessibility of clients to the financial services. As mentioned in the previous paragraph, the deputy CEO (i.e. COO) is gradually delegating part of his more operative responsibilities to the new operational mangers (out of whom, the responsible for the north region has been recently appointed). This would indeed mitigating the key person risk in his person and improve the internal control of the institution, defining clear accountability levels between the top management and the field staff. As far as the financial side is concerned, the institution still does not include a formal ALCO, even though main financial issues are discussed between the top management and the Financial Director, who is developing skills in financial risk management (see next paragraph). An important support is granted by the financial risk manager of CREDO Georgia, who regularly provide with ad hoc financial risk management reports AzerCredit top management. While the company is still in the process of defining autonomous departments at HQ level, decentralization on credit decisions is well defined (see chapter 3). Branches are treated as cost centres and regular meetings are taken between branch managers and HQ as well as through the Regional Operational Managers. The branch structure at field level is adequately set up and facilitates a participatory approach in the definition of the annual budget exercise. Concurrently, the staff allocation ratio (46.1% as of September 2009) is explained by the fact that some branches directly deal with the cash both in terms of loan disbursements and repayments. Human Resources As of September 2009, AzerCredit’s human resource is composed of 204 staff, 94 of whom are loan officers. The institution presents a staff generally committed to the institution’s goals and objectives, with a middle management in the process of strengthening its capabilities in terms of guidance and leadership in the different departments. As mentioned in the previous paragraph, this will reinforce the whole structure, especially in reference with the COO. HR management represents one of the main area to be addressed in the short term as a carrier development growth for the employee within the company has not been formalized yet. Specifically, internal training modules and in-depth training assessment needs have not been carried out so far and a first training plan is expected to be compiled in 2010. A basic mapping on the training needs is included in the current yearly staff appraisal process, which constitutes the base for selecting external trainings. However, only part of the staff can benefit from external trainings from international providers, without a systematic internal training mechanism in place. Staff appraisal is regularly undertaken at the end of the year, including a mutual evaluation between staff and direct supervisors. The new HR Manager, appointed in May 2009, is in charge now (with the HR department) to revise the appraisal formats in order to adequately include in the evaluation process new positions, such as Regional Managers.



In general, the HR Department is currently working also in aligning HR policies with Azeri standards as for national labor normative. Besides, at global level of Vision Fund Network, general procedures for all processes are being developed, including HR procedures which then will be updated and tailored to AzerCredit needs. Salary level is on average in line with the main competitors even though the middle management remuneration is perceived slightly lowered compared to other financial institutions (especially big MFIs and downscaling banks). Credit Staff receives regularly bonuses based on qualitative and quantitative performances, calculated at branch level. For support staff, a semi-annual bonus is granted according to the performance of the Branch Manager (and in general of the branch). The perception of lower salaries is one of the reason of the important staff turnover registered in 2008 (15%) with the desertion of some managers preferring banks rather than AzerCredit. During the period October 2008 – September 2009, staff turnover stands at 9%, mainly corresponding to support staff which left AzerCredit for education and family reasons. Risk Management, Internal control and Internal Audit Risk Management at AzerCredit is spearheaded by the SC and top management, with a support of the Financial Risk Manager working for CREDO Georgia specifically for what concerns the financial risk management (at the moment the institution does not have an ALCO). A general supervision is addressed to financial risk tolerances set up by the founder at regional level. However, no specific Risk Management Committee, reporting directly to or including SC representation, is yet developed to monitor risk tolerance, limit and alert levels set by the SC for a more comprehensive risk management. AzerCredit’s internal control system is characterized by a good control environment between the staff at field and HQ level. Approval functions and accountability are well identified at field level, while the middle management (i.e. CFO and Regional Managers) is in the process of being reinforced as main reference for the operations and financial management of the company. The organization’s policies and procedures is an area for improvement as updates are not regularly included in the credit procedures and some aspects (such as HR and financial management) need to be developed. However, at the moment Vision Fund International at global level is carrying out a revision of policies and procedures as a whole. Nowadays, deficiencies in the formalization might hamper the internal auditor ex-post checks. MIS is in the development phase and by the next year the institution should be endowed with a new system, which is under testing in other Vision Fund partner institutions. At the moment, standardized and automatic reports are somewhat not adequately compiled at field level, preventing Regional Managers to have a quick supervision on the operations. AzerCredit loan disbursements and repayments are allowed both via cash and via bank, with cash limits at branch and sub-branch levels adequately set up. Since August 2009 a new Internal Auditor was appointed, filling a position, which has been vacant for whole 2009. An assistant Internal Auditor is planned to be hired by end of 2009. Currently, the Internal Auditor is working out procedures, audit plan for 2010 and adapting tools for starting his activities in 2010. Within the SC, an Internal Audit Committee has been foreseen, even though as of now it is not fully active. At the moment, an Internal Audit Manual including fraud prevention policy is missing. In general, Internal Audit function represents a crucial area during 2010, requiring systematic support from the SC.

Accounting and external audit During 2006-2008 the financial statements of AzerCredit have been audited by local audit companies (TID Audit – 2006, RR & VAM International – 2007, Kapital Karden – 2008). The



auditors in general expressed unqualified opinion for each audited year, however, with some comments, particularly for 2006 (regarding usage of different methods to recognize the interest income and concerning different year-end total amounts for revenue). Overall, the institution’s accounting policy is accurate and is in compliance with IFRS. Management Information System AzerCredit IT department consists of 3 persons, IT Manager, IT Specialist and MIS Manager adequately responding to the daily needs. The institution is endowed with E-merge as for the loan tracking system (LTS) and SunSystem for what concerns the accounting system. The two systems are not integrated, while portfolio information are imported through a specific module in the accounting system whose operations are fully centralized at HQ level. E-merge is installed in all the 6 branches and partly in the other sub-branches (4 sub-branches are working in excel spreadsheet). E-merge presents some drawbacks, especially related to the fact that it does not allow to see the lending history, it prevents the possibility to easily access information in a certain period in the past and, overall, the reporting is quite limited at branch level. Specifically, reports are generated through excel extracting consolidated data from SunSystem. Back up system at head office is adequate, with the main server safely located in the head office. Back ups at branch level (for accounting and general operations) is not regularly carried out, following specific policies. Password policy for what concerns the E-merge system is adequate. In 2010, a new MIS (Global One) will be installed along with the general change in the MIS of Vision Fund partners decided in 2009. Currently, the institution is awaiting from the founder specific timeframe for the parameterization, installation and testing phases.



3. Lending and savings operations Lending products AzerCredit mainly operates in the rural areas providing credits through group and individual lending methodology. Overall, the institution offers micro and small loans in urban areas, while micro loans in rural areas. Credits can be offered either in local (AZN) or foreign currency (US$). However, since March 2009, these loans are fully disbursed in US$ in order to reduce the exposure of the currency risk. Besides, AzerCredit has recently launched a new product aiming at supporting households for purchasing utilities or other consumer goods. The main difference from the typical consumer lending based on salaries is that such a kind of credit is based on a cash-flow analysis of clients’ business. Household credits are disbursed only in AZN. Household loans can be offered as parallel loans to the micro/small loans (according to internal data provided, 15-20% of household loans are parallel). Terms and conditions of lending products offered by the institution are described in the table below. In 2009, stricter conditions in terms of loan size have been adopted along with the economic turmoil. Maximum loan size was decreased from US$ 10,000 down to US$ 5,000. In addition, for new clients loans can amount up to US$ 3,000, while for repeated clients, US$ 4,000. In rural areas, agricultural loans have been subjected to a more prudential approach as repeated clients and new clients can respectively obtain a maximum of US$ 3,000 and US$ 2,000.

Recently, AzerCredit entered in partnership with Village Associations, which support branches in gathering clients and applications in areas far from the field offices. This facility contributes to gain some efficiency in serving those areas not covered yet through an outlet. Group lending – which count 20% of total portfolio – is generally granted to groups composed of 5-6 members, for which solidarity guarantee is required, while physical collateral is not regularly registered. Overall, loan products include a certain level of flexibility, especially in reference with decreasing interest rates along with an increase in the loan size (for loans bigger than US$ 5,000 monthly i.r. charged stands at 2.5%, while for loans below than US$ 2,500, 3.5%). Alongside a strong competition in Minghecivir area from International Bank of Azerbaijan, lower interest rates are granted upon clients’ assessment on cash-flow and collateral. In Minghecivir branch, AzerCredit developed a specific matrix-scoring attributing certain interest rates according to clients’ features. The institution is now working out a scoring system more comprehensive. Overall, AzerCredit enjoys a satisfactory product diversification, albeit social loans for specific consumption purposes could represent another niche to be investigated. Within this perspective, the marketing activity represents a good resource for the institution, with several initiatives already launched such as a brand common line designed for all branches.

Lending procedures The AzerCredit International lending process is characterized by a rather efficient disbursement process which takes an average of 2-3 days for repeated clients and 3-5 days (max. 1 week) for new clients.

The client repayment capacity analysis is satisfactorily carried out and modulated according to loan size. For credit less than US$ 700, the analysis is quite rapid and based on general



information on the clients’ assets. For loans bigger than US$ 700, the analysis is more in-depth, including 1 month business analysis and a determined ratio for the maximum repayment capacity over the monthly business net income. Cash-flow for all the lifespan of the credit is not included, which might be a good input for bigger loans (more than US$ 5,000). The approval process is adequately decentralized at field level and in general, all loans under US$ 5,000 can be approved by the branch Credit Committee, consisting of at least 3 members (2 Credit Officers and 1 Branch Manager). The loan amounts higher than USD 5,000 need approval of the Regional Manager and COO. Currently, following the introduction of stricter measures along with the global financial crisis, loan amount greater than limits fixed should be submitted to the COO approval. Loan disbursement and collection are undertaken through bank or via cash in the field offices. Client monitoring undertaken after disbursement can be deemed acceptable and relied mainly on periodical visits by loan officers and random visit by branch managers and, nowadays regional managers. Follow up on late loans is acceptable and based on close monitoring of delinquent clients. After 1 month of unsatisfactory recovery process the legal department of the head office gets involved. Late payments are charged with 1% penalty for every late day (on the monthly amount due). Loans can be rescheduled in extraordinary cases, even though so far no restructuring facilities was granted..Early repayment is allowed with a termination penalty.

Collaterals and accessibility Group loans are backed by group solidarity guarantee. Golden jewellery can be used as an additional guarantee. Individual loans are backed by various types of collaterals, including personal guarantee, gold (jewellery), home assets, livestock and real estate - even if livestock and real estate are not commonly considered. The minimum value of the collateral should be not less than 100% of the principal loan amount plus interest. For household loan, the collateral is the purchased item itself. Collateral is modulated according to the loan size. For loans less than US$ 1750, home assets are registered as collateral, while for bigger loans a minimum of 60% of the collateral should be represented by gold.

AzerCredit – Azerbaijan - October 2009 Chapter 4


4. Assets structure and quality

Assets structure As of September 2009, AzerCredit’s net portfolio over total assets is equal to 74% indicating a fair level of concentration into the core business. Over the period October 2008 – September 2009, on average, net portfolio represented 86% on total assets, showing a good level of assets productivity. As of September 2009, liquid assets stand at high values (22%) following a trend started since July 2009 triggered by several factors. Firstly, a decline in the credit demand along with the global financial crisis has slowed down the growth pace of the institution, especially in midst 2009. Secondly, there was an inflow of resources in that period not expected as some funds from Vision Fund were expected to be confirmed earlier generating in August-September 2009 an excess of liquidity. Thirdly, the substantial high liquidity is also explained by the fact that AzerCredit has a contentious with the social fund which required the institution to pay social fund taxes for the past three years. Finally, a liquidity management not sophisticated has in a certain degree prevented the company to timely react to liquidity oscillations. Currently, AzerCredit is planning to place in short time deposit excesses of liquidity. AzerCredit’s fixed assets represent 2% of total assets as most of the properties are not owned by the company. Portfolio structure As of September 2009, AzerCredit total outstanding portfolio is worth around US$ 20 M., mainly allocated through individual lending methodology, while group loans represent 20% of total portfolio.

22%

74%

2%1%

1%

Assets composition - September 2009

Cash and Banks Net Portfolio Net Fixed Assets

Accrued interest Other Assets



AzerCredit has registered a slow down of portfolio growth during the last period of analysis along with the worldwide economic turmoil which hits the credit demand. On the other hand, as of September 2009, number of active borrowers grown by 72% compared to the same period of the

previous year, denoting a positive trend even though the credit demand has been negatively affected. Such a positive trend can be also seen in the average disbursed loan size which decreased from US$ 1,105 down to US$ 995. The bulk of portfolio is concentrated in the amount disbursed

category between US$ 500 and US$ 2,000. The increase in the number of clients has slightly lowered the average loan size as the institution for the first cycles maintain a prudential risk profile towards new clients. As a result of, the institution is characterized by high outreach with an average disbursed loan size on per capita GDP equal to 120% as for the last period of analysis. Concurrently, AzerCredit’s client drop-out ratio4 has been ranging between 30% and 24% registered during the last period analysed. The improving and fair trend reflects the capacity of the institution to retain clients offering them favourable conditions along the loan cycles. Client retention is monitored by the Marketing department, even though systematic or regular exit questionnaire are still not provided in order to investigate reasons behind clients desertion. On the other hand, the Marketing department conducted a clients satisfaction survey, which denoted that the majority of clients involved have a rather high appreciation of AzerCredit products and delivery loans approach. The loan portfolio breakdown by term shows a rather fair division of loans disbursed with a maturity within the year and loans offered with a longer maturity. This reflects also AzerCredit’s clientele profile which is, on the one hand, constantly fuelled by new clients along with the network expansion and on the other hand by consolidated and upgraded borrowers. At September 2009, only 4.1% of the portfolio had a maturity of less than 6 months.

4 Calculated with the ACCION formula as follows: (number of active clients at the beginning of the period + number of

new (first time) clients entering during the period - number of active clients at the end of the period) / (number of active clients at the beginning of the period).



As far as the portfolio breakdown by sector is concerned, AzerCredit presents a quite significant concentration in the agriculture portfolio (at September 2009, it stands at almost 49%) which, by its intrinsic nature, is exposed by exogenous factors (weather conditions) and market constraint (accessibility). Trade is the second sector targeted by the institution with a portfolio share equal to 32% as of September 2009. So far, the institution has not set up any exposure ceiling for the different sector.

Overall, the portfolio breakdown by branch shows that Ganja is the biggest branch as well as considering the 3 sub-branches (i.e. Shamkir, Gazakh and Goy-Gol) controlled by it (25.4% as od September 2009). Hence, AzerCredit decided to split Ganja Branch in two offices in order to optimize loan procedures. Moreover, Shamkit sub-branch likely will be converted in a full-fledged branch. Loan portfolio quality As of September 2009, AzerCredit presents a good portfolio quality with PAR30 standing at 0.4%.

Portfolio quality has been rather stable over the last years, registering a slight worsening especially since June 2009. However, the downward trend is kept below 1% and the institution has introduced some measures to reduce the potential impacts of the financial crisis effects in the real economy.



In fact, during the last period of analysis AzerCredit has generally lowered the maximum exposure from US$ 10,000 to US$ 5,000 as for loan disbursed. Besides, as mentioned in the chapter 3, maximum amount for the first credit has been reduced. The good performances of portfolio quality have been confirmed also for the last quarter of 2009 as PAR30 is 0,4% as at 31 December 2009. The different portfolio breakdowns illustrated above do not show particular levels of concentration Even though the agricultural sector represents a quite relevant portfolio share, the institution owns a rather good level of specialization, considering that since the very beginning AzerCredit deal with the livestock sector. On the other hand, bigger loans are exposed to higher risks triggered not only by borrowers cash flow difficulties (during 2009), but also by a credit analysis not significantly sophisticated (i.e. month cash flow not included) for such a kind of loans size. Other credits in default are concentrated in one of the new sub-branch (i.e. Gazakh). 60% of the portfolio at risk falls in the aging category 1-60 days, while the “oldest” category (more than 180 days) registers a slight worsening from 16% at December 2008 to 28% as of September 2009, denoting progressive difficulties in bad loans recovering. Loan loss provision ratio registered a brisk drop from December 2008 as external auditors have adjusted the loan loss reserve recorded by the institution. AzerCredit loan loss provisioning policy reflects the reccomended one from the Central Bank for the Credit Unions (see annex 5). Loan loss reserve coverage of impaired loans (over 30 days) as of September 2009 stands at 105%, which adequately cover the risk of loan losses.



5. Financial structure and ALM As of September 2009, AzerCredit financial structure is mainly composed of liabilities, received from different international lenders, which have relevantly boosted the financial leverage of the company. AzerCredit is characterized by a substantial high debt to equity ratio standing at 5.25 as of September 2009, considerably increased compared to December 2007 (3.4). On the other hand, equity during the last year has not received injections from the founder, while the capital build-up has been based by capitalization of retained earnings. Concurrently, the institution has already dealt with international lenders to receive subordinated debts, which loosening the

institution indebtedness within a regulatory and financial risk management perspective.

Liabilities and equity structure As of September 2009, total funding liabilities of AzerCredit are worth US$ 22.4 M, marking a relevant pattern of growth compared to December 2008 (+81%). In terms of maturity structure, most of funding liabilities, 74%, are long term loans received from international social and commercial lenders. Since the last rating (March 2007), AzerCredit has notably increased the spectrum of sources of funding, dealing with 13 different lenders as of September 2009. The institution has indeed gained a good level of visibility attracting loans almost exclusively characterized by commercial terms6. AzerCredit has started borrowing in local currency, even though loans nominated in hard currency still represents 90% of total funding liabilities. Liabilities composition does not show particular risk of concentration, with an average concentration of 8% per lender. Symbiotics and Vision Fund, and Impulse, respectively with 21% and 14% have the biggest portion within the debt composition. However, 76% of Symbiotics loans will expire only in 2011-2012, with the entire loans to be repaid at maturity. The maturity structure of AzerCredit’s funding liabilities has consistently favoured long term debt, with 74% of total funding liabilities as of September 2009, which is improved from the 60% registered in December 2008. In terms of long terms loans, the institution has been able to attract its first subordinated debts which constitute 8% of total liabilities (see annex 5).

5 Considering the subordinated debts as equity (II Tier Capital), the debt equity ratio stands at 3.46 as of September

2009 6 Only 2% of total liabilities are characterized by concessional terms (see annex 5 for details).

-

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

Dec07 Dec08 Sep09

Liabilities and Equity - US$

Equity Short term liabilities

Long term liabilities Other liabilities

Liabilities composition - September 2009

21%

74%

5%

Short term loans Long term loans

Other short term liabilities



While this positively affects the leveraging rooms of the company, the cost of fund ratio has increased reaching 9.5% as of September 2009 (from 8.9% in 2008 and 8.4% in 2007). Besides, the global financial crisis has also triggered a slight increase in the passive interest rates in the first half of 2009. Most of the liabilities are bearing commercial rates, while only 2% are characterized by concessional rate (loans received from World Vision International and UMCOR). 7% of liabilities (i.e. 2 loans from EBRD) are based on floating interest rate not affecting therefore the evolution of the net interest margin. As of September 2009, AzerCredit’s total equity amounts to US$ 4.3 M. 36% of equity is represented by grants received from World Vision International especially at the beginning of AzerCredit operations. According to recent disposals from the Azeri Law, the donated equity and the related economic returns must remain within the equity Azercredit and not sold outside the country. During 2009, a loan from World Vision International (amounting to US$ 315,000) was in the process of being converted into equity, but at the end the operation was suspended for fiscal reasons. Retained earnings represent a significant portion of AzerCredit’s equity and the main factor of capitalization for AzerCredit. The expected law for non-banking financial institutions will certainly pose the base for better defining the ownership structure and possibly to increase the paid in capital. In the short term, Vision Fund intends to maintain the control over the institution capital. Assets and Liabilities Management AzerCredit presents a still fragmented assets and liabilities management (ALM) system, with no ALCO supervision in place. ALM is spearheaded by the Deputy COO and the Financial Manager who reports directly to Chief Finance Officer. A relevant support is given by the Risk Manager of CREDO Georgia, the parent organization. He provides regular reports on analysis of main financial risks and performance trends, including maturity GAP analysis, FX position, interest rate spread on a monthly basis. Nevertheless, the Financial department of AzerCredit is still in the process of integrating all the tools elaborated by the Financial Risk Manager based in Georgia. As mentioned in the chapter 2, the institution is aware of such a situation and it intends to foster specific trainings towards this aspects in the next year. At the moment therefore, tolerance limits and specific policies are more discussed at Top Management and Board level, without a full risk management approach in place. Monthly cash flow projections are carried out by the Financial department involving every branch. Liquidity registered low-peak levels in September 2008, while generally liquid assets stand at values above 5%. In 2009, liquid asset have experienced high values starting from the second

Equity - September 2009

0.1%

36.0%

37.3%

26.5%

Paid-in capital from shareholders Donated equity

Net income, previous years Net income, current year

Liquid Assets Evolution

0%

5%

10%

15%

20%

25%

Dec

embe

r 06

Mar

ch 0

7

June

07

Septe

mbe

r 07

Dec

embe

r 07

Mar

ch 0

8

June

08

Septe

mbe

r 08

Dec

embe

r 08

Mar

ch 0

9

June

09

Septe

mbe

r 09



semester along with a diminishing of the credit demand in the country. In February 2009, AzerCredit registered low levels of liquid assets (1.9%) when in concomitance with the economic downturn, international investors stopped lending for a while. Besides, uncertainties in renewing part of Vision Fund loans (which were closely to expire in June 20097) force AzerCredit to attract a short term loan from CREDO Georgia (in March 2009, US$ 200,000 at 11% interest rate), which has the possibility to obtain overdraft from the Central Bank in Georgia. Notwithstanding back-up liquidity facility provided by the partner organization in Georgia, for AzerCredit becomes of critical importance enhances the liquidity management tools. As of now, high liquidity levels are however explained by the fact that AzerCredit is in the court process for clarifying an open issue about social taxes not paid since 2004. Most likely AzerCredit should pay US$ 1 M in two years. Furthermore, the institution is assessing opportunities to place excess of liquidity in short term deposits. Overall, AzerCredit needs to formalize policies and limits for the cash management, which nowadays relies on informal practices. AzerCredit’s liquidity contingency plan has not specifically set out or approved by the BoD. AzerCredit’s maturity structure is characterized by 77% of the outstanding portfolio with short term maturity, showing a rather stable trend on prior periods. At the same time, more than 50% of the outstanding portfolio ages between 0-180 days. With over 70% of funding liabilities being long term, all aging categories, thus, register positive net positions and AzerCredit does not experience maturity gap risk (except from the later aging category). AzerCredit maintains fixed active interest rates on client loans, which coupled with a liabilities structure with only 7% of liabilities bearing floating interest rates, means that the institution does not suffer from any significant negative interest rate gap8, in terms of contractual interest re-pricing. On the other hand, AzerCredit shows an high cumulative gap which reflects a mismatching in terms of contractual maturity re-pricing. Within this perspective, the institution is relatively exposed to interest rate risk related to possible competitive pressures which would trigger a reduction in active interest rates with a consequent squeezing of the financial spread. In fact, the cumulative gap up to 90 days represents around the 39% over earning assets, denoting a certain degree of assets exposure along

7 Late May 2009, Vision Fund renewed such loans.

8 AzerCredit is asset sensitive for all aging categories up to one year.

Net position (US$) / Total Equity

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

Dec

-08

Jan-

09

Feb-0

9

Mar

-09

Apr-0

9

May

-09

Jun-

09

Jul-0

9

Aug-0

9

Sep-0

9



with falling interest rates. In terms of currency risk, AzerCredit presents, as of September 2009, a long position in US$ equal to 4% of the total equity. Informal limits have been set up within Top Management and Board stating a margin of +/- 25% of net position in hard currency over total equity. As shown in the graph, AzerCredit’s equity was significantly exposed to potential effects of FX fluctuations (i.e. depreciation of AZN). Starting from March 2009, the institution started to disburse loans in US$ in order to mitigate the currency risk reaching in September 2009 a long net position. As of now, all loans are disbursed in hard currency, except from household loans. Currently, 74% of total portfolio is nominated in US$, while AzerCredit has not set up ceilings or limits on portfolio concentration by currency. Although, the local currency is rather stable (and EIU projections for 2010 are confirming such a stability), the institution is however partially transferring part of the FX risk to the clients. AzerCredit’s most successful hedging mechanism to date was to disburse in hard currency, and other mechanisms (i.e. back to back, swaps, etc.) have still not been successfully explored by the institution. Such hedging mechanisms result still costly and difficult to access in the local banks. So far, the institution has managed to attract two loans in local currency, which can indeed represent a good option to mitigate the exposure on credit risk and at the same time alleviating the impact of foreign currency risk.



6. Financial and operational results The analysis is based on audited financial statements for 2006, 2007 and 2008, while for the last period of analysis (October 2008 – September 2009) internal FSs (January 08 – September 08; January 09 – September 09) have been used. AzerCredit shows good and improving levels of profitability and sustainability, in terms of non-adjusted and adjusted ratios during the last two years. For the period October 2008 – September 2009, ROE is equal to 31.8%, after having registered 28% in 2008 and 15% in 2007. The upward trend of ROE has been triggered initially by a increase in the financial leverage (especially in 2008) and, then, by a steady consolidation of the portfolio yield and the operating expenses ratio. ROA dynamics follow a slight increase in 2008 (5.5% versus 4.4% IN 2007) for then maintaining the same value in the period October 2008 – September 2009. In fact, during the last period of analysis the institution has registered high level of liquid assets impacting on the assets productivity. OSS also registers a slight increment in the lasts period of analysis, confirming good levels since 2007 (119.6% at December 2007 and 125.5% at September 2009). Regarding the adjusted results, indicators have also been impacted by adjustments for inflation, especially in 2007 and 2009 when the average consumer prices index registered high levels (15-16%). During the last period of analysis a deflationary pressure has pushed down consumer prices, positively affecting the trends of adjusted results. AROE passes from -4.6% over the period January – December 2007 to 24% over the period of January – December 2009. AROA increases from -1% in 2007 to 4.3% for 2009. Similarly, FSS has increased to 120.6% at the end of 2008 from 100.6% registered at the end of 2007. Over the period of analysis, the cost of structure has remain unchanged. Given a double effect of a slight decrease of operating expenses and an increase of financial expenses. The operating expenses ratio drops from 26.4% in 2007 to 24.7% in the last period of analysis. On the other hand, the institution has however margin for improving its efficiency, which is lower than the average registered in the peer group of institutions characterized by the same portfolio size category in ECA region (see benchmarking section). Moreover, efficiency does not still benefit

Profitability and Sustainability

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Dec07 Dec08 Oct08 - Sep09

80.0%

90.0%

100.0%

110.0%

120.0%

130.0%

140.0%

ROE (L) AROE (L) ROA (L) AROA (L)OSS (R) FSS (R)

Costs and Revenues structure (on average gross

portfolio)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

Jan07-Dec07 Jan08-Dec08 Oct08-Sept09

Operating expenses Finacial expenses

Loan loss provision exp. Financial revenues



from important economies of scale alongside a downward trend of the average loan disbursed size (from US$ 1,100 in December 2008 to US$ 995 in September 2009). Productivity levels in terms of number of borrowers increased from 225 in 2007 to 329 at September 2009. Loan officer productivity levels show indeed good levels taking into consideration the increasing share of the individual lending methodology over the portfolio structure. However, productivity trends are uneven between loan officers, with some of them dealing with more than 450 borrowers. Concurrently, the staff allocation ratio however is improving even though the institution is handling cash operations in most of the branches, requiring therefore a back-office staff quite structured. Notwithstanding, the implementation of the existing MIS and, in the future, the adoption of a new on-line MIS will somehow loosen the back-office structure. As mentioned before, the improvement of the operating expense ratio has been counterbalanced by an increase in the financial expenses. The funding expense ratio has grown from 6.4% as of December 2007 to 8.8% as of September 2009, along with an increase in the cost of funds (see chapter 5). The excellent portfolio quality has notably contributed to keep the provision expense ratio standing at less than 1% in the last 3 years. On the other side, the portfolio yield is slightly increasing in the last period of analysis (from 39.3% in 2007 to 41.2% in at September 2009). Interest rates have not been changed during the last years, but since they are modulated according to loan amount, during the last period the institution has tried to limit the disbursement of high amounts.

Overall, AzerCredit shows positive and stable sustainability and profitability performances, with rather good margin respect to the costs (around 8 percentage pints on the average outstanding portfolio). However, streamlining of the operations and information flow, adoption of a new MIS and enhancing the role of the financial department especially towards financial risk management and cost reduction analysis remain areas to be addressed in order to consolidate the existing trends. This becomes important especially in view of the compulsory payment of social taxes for the past years, which will burden the cost structure of AzerCredit.



7. Strategic objectives and financial needs General guidelines for future evolution AzerCredit strategic and future financial/operational evolutions are disclosed in the Business Plan 2006-2010, which nowadays is in the process of being re-compiled for the upcoming 5 years. At the moment, the institution has set up a working group for elaborating and developing the main areas within the Business Plan. In November 2009, each department worked out a narrative strategic plan in order to improve and consolidate the related team. The main areas in the upcoming Business Plan will focus more on capacity building with the aim to create autonomous departments. HR department is a priority in order to provide staff with regular training and foster a carrier development growth for each staff. Besides, efforts will focus on the Internal Auditor department to ensure a daily supervision as well as independently report to the SC. In general, HR and Internal Audit functions are areas to be reinforced to meet the objectives set out in the Business Plan 2006-2010. Furthermore, the implementation of the new MIS is an activity already in the agenda and it is expected to be finalized by the end of 2010. Finally, consolidation of the financial risk management within the Financial Department, which is expected to provide timely support to the top management as far as liquidity, credit and market risk, is concerned. In terms of market share and geographical coverage, AzerCredit for 2010 intends to expands in 2 new region (out of which 1 has been already explored through a market research). As far as portfolio growth is concerned, as mentioned before, the focus will be more devoted to capacity building, while portfolio size would not be characterized by a significant growth pace. Financial projections AzerCredit financial projections are internally drafted using Microfin. The projections have been updated in 2008 for the period 2009-2011. The table below summarizes the main indicators reported in AzerCredit financial projections:

AzerCredit’s portfolio growth is exceeding the expectation despite the financial crisis which did not relevantly affect the credit demand. In fact, such a growth level mainly derives from the new offices opened late 2008. This also explain the continuous expansion in terms of outreach with a good number of clients reached. As mentioned before, in the years to come the institution plans to generally maintain the same size with the same performances with a control of expenses. Portfolio yield is expected to decrease along with competitive pressures from the Azeri financial market.



Financial leverage is higher than expected as AzerCredit attracted funds not exploited yet. Financial needs AzerCredit’s financial needs for 2010 have been promptly identified and already somehow met, considering the level of liquidity, the capitalization of retained earnings and the negotiation already almost finalized with some international lending providers, such as Incofin, Oikocredit and Triple Jump. The institution will also face a contingency in terms of social taxes to be paid (US$ 1 M in two years).



8. Details of the risk factors According to our analysis, the main risk factors of AzerCredit are the following:

AzerCredit – Azerbaijan – October 2009 Annex 1


Annex 1 - Financial statements



Annex 2 - Financial statements’ adjustments The financial statements in Annex 1 are the result of standard reclassification. They are based on audited financial statements according to international standards for 2007 and 2008 years; internal financial statements for the period October 2008 – September 2009.

Financial statements have been then adjusted in order to make them comparable to financial reporting and performances of institutions using different accounting standards and operating in different environment and to evaluate the level of sustainability of the institution with market conditions. The main adjustments include:

adjustment for the accrued interest on delinquent loans > 90 days;

provisions are calculated with a standard formula9;

adjustments for inflation;

adjustment for the cost of loans at concessional rates.

The bulk of the adjustments for AzerCredit is related to inflation, which has significantly lowered its pressure during the last period of analysis, following the commodity prices drop. As the institutions nowadays deal with almost exclusively with commercial loans, no adjustments are needed. The cumulative effect of the adjustments reduces the net income in all the periods.

9 Provisions are calculated according to the following formula:

Portfolio: 1-30 days 10% Restructured loans 0-30 days 50% 31-60 days 30% > 1 day 100% 61-90 days 50% >90 days 100%



Annex 3 - Financial ratios



Annex 4 - Definitions

Description of the ratio Formula

Profitability

Return on equity (ROE) Net income before donations / Average equity

Adjusted return on equity (AROE) Adjusted net income before donations / Average equity

Return on assets (ROA) Net income before donations / Average assets

Adjusted return on assets (AROA) Adjusted net income before donations / Average assets

Operational self-sufficiency (OSS) (Financial revenue + Other operating revenue) / (Financial expenses + Loan loss provision expenses + Operating expenses).

Financial self-sufficiency (FSS) (Adjusted financial revenue + Other operating revenue) / (Adjusted financial expenses + Adjusted loan loss provision expenses + Adjusted operating expenses)

Profit margin Net operating income / operating revenue

Portfolio quality

Portfolio at Risk (PAR30) Portfolio at Risk > 30/ Gross outstanding portfolio

Provision expense ratio Loan loss provision expenses / Average gross portfolio

Loan loss reserve ratio Accumulated reserve / Gross portfolio

Risk coverage ratio (>30 days) Accumulated reserve / Portfolio at risk >30 days

Write-off ratio Write-off of loans / Average gross portfolio

Efficiency and productivity

Staff allocation ratio Loan officers / Total staff

Loan officer productivity – Borrowers Number of active borrowers / Number of loan officer

Loan officer productivity – Amount Gross portfolio / Number of loan officer

Staff productivity – Borrowers Number of active borrowers/ Number of staff

Staff productivity – Amount Gross portfolio / Number of staff

Operating expenses ratio Operating expenses / Average gross portfolio

Cost per borrower Operating expenses / Average number of borrowers

Administrative expenses ratio Administrative expenses / Average gross portfolio

Personnel expenses ratio Personnel expenses / Average gross portfolio

Financial management

Portfolio yield Interest income from portfolio / Average gross or net portfolio

Funding expense ratio Interests and fee expenses on funding liability / Average gross portfolio

Cost of funds ratio Interest expenses on funding liability / Period average funding liability

Current ratio Short term assets / Short term liability

Debt/Equity ratio Total liability / Equity

Capital adequacy ratio Total equity / Total assets

Outreach Average disbursed loan size Amount issued in the period / Number of issued loans

Average disbursed loan size on per-capita GDP Average disbursed loan size / Per-capita GDP

Other definitions:

Funding liability: Liability 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). Drop-out ratio: calculated as follows: (number of active clients at the beginning of the period + number of new (first time) clients entering during the period – clients written off during the period – number of active clients at the end of the period) / (number of active clients at the beginning of the period).



Annex 5 - Guidelines of reporting and accounting Financial statements Over the period of analysis (2006, 2007 and 2008) AzerCredit’s financial statements were audited by TID Audit – 2006, RR & VAM International – 2007, Kapital Karden – 2008. For the analysis of the period July 2008 – June 2009 the internal financial statements have been used.

Loan loss provision and write-offs Following suggestions of Central Bank of Azerbaijan related to the requirements of Credit Unions, AzerCredit uses a prudential provisioning policy, shown in the table aside. As for non-performing portfolio, Loan Loss Provision (LLP) is set up according to three different aging

categories according to the loan maturity at disbursement. On a monthly basis the LLP is calculated as: LLP = (LLR at the end of the period) – (LLR at the beginning of the period) + (amounts written off for the period). The amount of LLP for the period is included in the Income Statement as expenses. Late loans more than 180 days can be written off upon Top Management decison. Insider loans AzerCredit does not offer Insider loans.

Donations For the periods of analysis, AzerCredit has received donations from World Vision Azerbaijan program for covering operating expenses and from World Vision International for loan capital to a minor extent. Donations are recorded in the income statement

Details of funding liability As of September 2009, AzerCredit has following funding liabilities (see next page).



Annex 6 - Rating Scale

liabilities and equity - us$ · one of the largest mfis in the country. the organization lenders....

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