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Micro-Finance Rating - Risk Assessment

*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

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

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.

(revision of rating grade based on a desk analysis).

Urban Poverty Alleviation Program of NRSP – Risk Assessment Report

Category wise rating

Category Rating grade1

A Governance aspects β+

B Managerial factors α−

C Financial performance α−

Overall 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.

Key Programme Strengths

Governance, experience and strategy

Management and operations Financial

1 Long years of experience in

microfinance 2 Good second line of

leadership 3 Good expansion strategy 4 Strong credit culture

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

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.

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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

11,551

204

3

~57

(63 excluding management trainees)

* of the National Rural Support Programme

Microfinance programme: Operational highlights

Outstanding borrowings of MFI

(PkRs, US$)

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

72,744,569

271,634,069

~9,121

804,840

1,247,761

4,659,246

~156

Key financial ratios

Portfolio at risk (>=60 days)

Current repayment rate

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 2003. 2. ‘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 2003. 3. 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 PAR60 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.

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UPAP – financial overview

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Portfolio at risk (>=60 days): 31 December 2003

Operating expense ratio: 1 January -31 December 2003

Note: 1. nupper-end = 10 ndatabase = 125; Database updated as on 30 June 2003. 2. 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.

Income and expense distribution: 1 January -31 December 2003

Debt and equity composition: 31 December 2003

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U P A P U p p er-en d M F Is O v erall database

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ExpenseIncom e

* Other operating expenses include travel, depreciation and administrative expenses

Asset composition: 31 December 2003

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C ash

2.4%

O ther current assets2.0%

N et loans outstanding

91.1%

N et fixed

assets4.6%

** Concessional debt is borrowing+comp.savings taken at < Bank PLR +50 basis points, & voluntary savings taken at < bank deposit rates

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Liability & net worth composition: 31 December 2003

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S T debt59%

Networth39%

Other long term liabilities

1%

Other current liabilities

1%

1


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 1991. 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 1996. 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:

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Organisational Structure of UPAP/NRSP For its opbeginningsalaries oNRSP. Fcommercsources a

Source of f

Grant: UNDGrant: For Loan: from NLoan: First Total

CEO, NRSP

Manager, Faisalabad Manager, Rawalpindi Manager, Karachi

S

District Coordination, Audit and Monitoring Cell

Programme Manager, UPAP

GM, NRSP

Chairman and Board of Directors

Finance & Credit Section

erations, UPAP is largely dependent on the funds received from NRSP. At the of its operations UPAP received a grant of PakRs10,000,000. It also receives the

f its staff and other operational support including fund support for on-lending from or the last one year, it has been using a line of credit from the First Women Bank (a ial bank in Pakistan) through NRSP. Funds received by the UPAP from different re summarised in the table below

unds Cumulative grants till 31 Dec 2003 (PkRs)

Outstanding loans on 31 Dec 2003 (PkRs)

Rate(s) of interest

P through NRSP 10,000,000 Operations from NRSP 33,928,357

RSP for on-lending 22,430,716 6% Women Bank 14,491,462 6%

43,928,357 36,922,178

Area Manager

Settlement Office Settlement Office ettlement Office

Area Manager Area Manager

Senior Area Manager

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The flow of funds to and from the UPAP is shown in the following diagram:

@20% pa at Rawalpindi @30% pa at other places @ 6% per annum

UPAP

NRSP (operational grant & funds for on-lending)

First Women Bank (Funds for on-lending)

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

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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


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

-

2

4

6

8

10

12

14

1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04*

No o

f acc

ount

s, '0

00

-

20

40

60

80

100

120

140

Amou

nt d

isbu

rsed

, m R

s

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


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 drop-outs 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

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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 back-ups 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 20th 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 top-down system in which annual settlement office targets are set by the branches. These are

11


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 2003. 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

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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 PAR60 was 0.3% as on 31 December 2003. 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 0.02. 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 2003. 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 2003. 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 2002. 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

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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

0

50

100

150

200

250

300

350

400

450

500

Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08

Mill

ions

20%

25%

30%

35%

40%

45%

Loans outstanding Risk weighted capital adequacy ratio

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 2003. 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, 2003-04. 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

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Strengths Weaknesses

Governance and Strategy

Long years of experience in microfinance Good second line of leadership Good expansion strategy Strong credit culture

Governance & Strategy

Low involvement of policymakers in the operation Low concentration in the area of

operation

Managerial

Professionally trained, committed and stable managerial cadre Very well developed MIS Good tracking system for overdues Well developed financial planning and

control systems

Managerial Low staff productivity – possibly higher

than necessary level of appraisal and utilisation checks

Financial

Excellent repayment rate and portfolio quality Productive deployment of assets in the loan

portfolio Comfortable position on capital adequacy

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.

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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 14,491,462 247,717 Advance from NRSP 32,430,716 554,371

Total short term debt 46,922,178 802,089 Total current liabilities 47,579,675 813,328

Long term liabilities Deferred Liabilities 612,804 10,475

Total long term liabilities 612,804 10,475 Net worth Donated equity from NRSP 33,928,357 579,972 Grant from UNDP 10,000,000 170,940 Retained net surplus/(deficit) (9,971,155) (170,447) Current net surplus/(deficit) (3,062,822) (52,356)

Total net worth 30,894,379 528,109 Total Liabilities and Net Worth 79,086,858 1,351,912

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Income Statement – for the year ending 31 December 2003

Income PkRs PkRs US$ US$ Interest and fees on loans 11,224,838 191,878 Excess Recovery & other fees 1,202,112 20,548

Total income 12,426,950 212,426

Financial costs Interest on borrowings 2,205,159 37,695

Gross financial margin 10,221,791 174,731 Provision for loan losses 276,095 4,720

Net financial margin 9,945,696 170,012 Operating expenses Salaries 7,682,166 131,319 Travel 338,486 5,786 Depreciation 674,607 11,532 Administrative/office expenses 4,313,259 73,731 Total Operating expenses 13,008,518 222,368 Net Surplus/Deficit -3,062,822 -52,356

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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 (PAR60) 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%).

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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 70,000 100,000 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

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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 72,744 111,303 179,795 231,728 309,895 443,653 Loan loss reserve -727 -1,113 -1,798 -2,317 -3,099 -4,437 Net loans outstanding 72,017 110,190 177,997 229,411 306,796 439,216 Net fixed assets 3,638 3,454 4,909 6,218 7,396 8,456

Total Assets 79,087 117,573 190,996 246,670 325,803 460,730 Liabilities and Net Worth External borrowings 46,922 77,620 134,358 176,250 240,000 351,250 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 -3,063 133 9,015 13,594 15,176 23,450 Net worth 30,894 38,528 55,042 68,637 83,813 107,263 Total Liabilities and Net Worth 79,087 117,573 190,996 246,670 325,803 460,730

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 72,254 100,087 Cost Financial 2,205 3,961 6,586 9,327 12,548 17,906 Loan loss provision 276 386 685 519 782 1,338 Depreciation 675 384 545 691 822 940 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 -3,063 133 9,015 13,594 15,176 23,450

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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 47,500 102,500 125,000 177,500 262,500 Repayments from members 143,222 225,201 323,616 424,206 585,807 Grants 7,500 7,500 0 0 0 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 221,009 376,575 509,853 682,937 957,735 Outflows Disbursement 181,781 293,693 375,550 502,373 719,565 Repayments to lenders 16,803 45,762 83,108 113,750 151,250 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 218,786 370,360 500,876 673,597 947,175 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%

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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).

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M-CRIL’s Microfinance Rating Symbols

M-CRIL Grade

Description

α+++ alpha triple plus

Highest safety, excellent systems most highly recommended

α++ alpha double plus

Highest safety, very good systems most highly recommended

α+ alpha single plus

Very high safety, good systems highly recommended

α alpha

High safety, good systems highly recommended

α− alpha minus

Reasonable safety, good systems recommended

β+ beta plus

Reasonable safety, reasonable systems recommended, needs monitoring

β beta

Moderate safety, moderate systems acceptable, needs improvement to

handle large volumes β− beta minus

Significant risk, poor to moderate systems acceptable only after improvement

γ+ gamma plus

Substantial risk, poor systems needs considerable improvement

γ gamma

Highest risk, poor systems not worth considering

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