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Khula Direct

Parliamentary Portfolio Committee on Economic Development

Setlakalane Molepo (MD)22 July 2010

   

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Contents

• Introduction to the new Khula board• Summary – Khula Direct, the retail business• Progress to date• Capital requirements• Next steps

   

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Khula’s new board members

New

Mr M Kekana (Chairperson)

Ms S Rensburg (Deputy Chairperson)

Mr M Ferreira

Mr V Twala

Mr D Jackson

Dr Z Lees

Mr N Swana

Ms D Thabede

Mr M Mohoto (representative of the dti)

Reappointed

Mr I Tayob

Ms N Matyumza

Mr N Greenhill

Mr S Molepo (MD)

Contents

   

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Summary - Khula Direct the Retail Business

• Purpose of Khula Direct

• Objectives of Khula Direct

• Outcomes of Khula Direct

Contents

Objectives of Khula Direct

• Address the GAP in the market

• Institutional

• Geographic

• Demographic profile

• Amount lent

• Address problems faced by SMEs (mostly lack of access to finance)

• Address perceived high risk of applicants

• Address low level of non-financial support

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As a flagship DFI investing in the SME space, Khula has to fill the gap where the market has failed or does not exist

Summary - Khula Direct

Purpose of Khula Direct

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Khula Enterprise Finance’s business

WholesaleLending via other credit

providers

and supporting SMEs

Retail (Khula Direct)

Direct lending to SME market

Addressing the limitations of the wholesale model

• Credit Guarantees (Banks)

• Loans (RFIs)

• Joint Ventures/Funds

• 3rd Party Managed Funds (LREF)

• Term Loans

• Credit Lines

• Contract Financing

• Etc.

• Mentorship

• Property

Purpose of Khula Direct is to provide finance directly to viable small and medium enterprises (SMEs) that cannot otherwise

attract funding Summary - Khula Direct

   

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Position of Institutions

Source: Roussos and Ferrandi (2008)

Long-term

Short-term

TERM

Micro Medium Large Small

MONEY-LENDERS

STOKVELS, BURIAL SOCIETIES

CONSUMPTION LENDERS

MICRO-FINANCE INSTITUTIONSCOMMERCIAL BANKSCOMMERCIAL BANKS

MORTGAGE PROVIDERSMORTGAGE PROVIDERS

DEVELOPMENT FINANCE INSTITUTIONS

DEVELOPMENT FINANCE INSTITUTIONS

INVESTMENT BANKSINVESTMENT BANKS

CAPITAL MARKETSCAPITAL MARKETS

TRANSACTION SIZE

Medium- term

GAP

Long

Medium

Short

TERM

TRANSACTION SIZEMicro Small Medium Large

The GAP is apparent in the SME space

Objectives of Khula Direct

   

There appears to be a high demand, and, surprisingly, a high supply of finance, but they are poorly matched

Objectives of Khula Direct

Geographic distribution of Khula offices

Current regional offices (11)

New branch offices (30 – 40)

New SOHO offices (40 – 60)

Demographic Profile

Khula Direct will accommodate a broad risk profile addressing underserviced segments

•Women

•Youth

•Peri-urban and rural

•Environmentally friendly projects

9Objectives of Khula Direct

Amount lent

Micro-financiers Banks VC and PE investors

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* FinMark Trust report 2009

R100 – R15,000 R50,000 – 525,000* informal

businesses need less than R50,000

110,000* formal businesses need less than R250,000

Khula Direct will aim at the R50,000 to R500,000

range

Objectives of Khula Direct

   

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Problems experienced by SMEs

Supply-side Deficiencies (lenders)

Demand-side Deficiencies (borrowers)

• Rigid credit scoring policies• Rigid collateral requirements• Reluctance to provide small loans• Rigid repayment schedules• Development finance institutions

acting like banks• Lack of understanding of cultural

differences on the part of commercial banks

• Poor report-back to applicants on loan refusals

• Poor communication of services offered

• Lack of differentiation of products and approach to clients

• Restrictions placed on lending by the National Credit Act

• Lack of understanding of how to approach financial institutions to apply for a loan

• Lack of business training• Highly competitive and undiversified

markets• Lack of record keeping• Inability to present formal business

plans• Poor credit ratings• Lack of collateral/security for loans• Limited capital base and ability to grow

capital• Misconceptions about the risk analysis

process

There appears to be a high demand, and, surprisingly, a high supply of finance, but they are poorly matched

Objectives of Khula Direct

   

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Perceived high risk of applicants

No cash to contribute to

business

Khula Direct will have a much higher risk appetite than commercial financiers

Objectives of Khula Direct

No assetsLive far from major town

No experience in running a

business

No contracts from

customersDon’t know the industry

Khula Direct will assess the risk, and adjust the product to suit the level of risk

Bad credit record

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Non-Financial Support

Khula will support clients through:

• Business support

– Mentors– Consultants

• Training

• Workshops

– Networking in industry or in region– Education and information sharing

• Research

The support won’t be free, but it will be subsidised

Objectives of Khula Direct

Outcomes of Khula Direct

• Number of sustainable SMEs (no. of deals)

• Number of SMEs in perceived high risk category

– No or low levels of security

– No or little contribution into business

– Start-ups

• Number of jobs created (total, women, youth, disabled)

• Contribution to under-serviced regions (peri-urban, rural)

• Sustainability of retail lending business

– Bad debts and impairments

– Profitability

– Size of reserves to absorb economic shocks

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The overriding outcome is a reduction in poverty

Summary - Khula Direct

Progress to date

• Cabinet gave approval to extend the Khula mandate, to include direct lending, on 3 December 2008

• Project so far has accomplished:

• local and international research conducted, study visits (USA, Mexico, Brazil, Taiwan, Malaysia)

• products designed

• distribution channel designed

• stakeholders engaged

• risk model built – used to adjust pricing and product parameters

• credit management framework designed

• customer relationship management process designed

• new organisation designed

• budget and business plan finalised

• board oversight committee in effect

• applications for funding in progress (National Treasury, IDC, PIC)

• Currently in detail design phase – creating blue-print of procedures, policies, job descriptions and technical specifications for building operational environment

15Contents Progress since March

   

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Lessons learnt – not to be repeated

• Don’t provide free/cheap finance (local provincial DFIs)• Don’t provide capital holidays, especially for contract finance

(international and local counterparts)• Avoid complicated collection and lengthy legal processes (FinMark

Trust)• Avoid using other organisations to sell your product (Khula -

government needs to be seen as being active in the market, also international counterparts - avoid brand and loyalty confusion)

• Don’t use inferior IT systems (local RFIs and provincial DFIs)• Do not purchase systems without fully understanding requirements

(local Banks and provincial DFIs)• Don’t go to market with insufficient capital (local RFIs)• Don’t centralise customer-facing staff (trend in local DFIs is to build

branch infrastructure, international counterparts – all recommend extensive rural penetration)

   

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Lessons learnt – to be employed

• Build strong relationship with clients (Grameen Bank, failure in Banks’ relative anonymity, international counterparts)

• Hunt for deals, as opposed to walk-ins (local private equity firms, international counterparts)

• Rapid turnaround for smaller repetitive applications, e.g. contract finance (Mexico)

• Price for risk (international counterparts)

• Use simple products (FinMark Trust, van Aardt Smit, international counterparts)

• Use flexible approach to credit scoring (FinMark Trust, USAID)

• Consider flexible collection tolerance (local RFIs)

• Use competent “banking” staff (international counterparts)

• Extensive financial education/literacy (USAID)

Progress to date

Progress in relevant key strategic priorities (as presented in March)

Strategic Priorities Strategic Initiatives

Re-engineering operations to ensure maintenance of existing commitments and effective support to Khula Direct

Agencies to provide field staff services. – no suitable agency identified, now using employeesSystemise retail processes, incl. IT systems – in detail designGear up Regional Offices to manage field operations – being planned

Direct lending that focuses on specific sectors – completed, as per business model

Consolidate well performing current RFIs whilst gradually phasing out the non-performing ones. – strategy approved by board, about to be implemented

Re-alignment of human capital intervention to ensure maintenance of existing commitments and effective support to Khula Direct

Re-align company structure to meet the demands of Khula Direct – planned, in process

Skills audit & training of staff personnel to ensure that their skill s are relevant to the new business model – in process

Recruitment and retention of key and relevant staff that meet the requirements of the new model. – using top down approach, seeking executive staff at present

Progress in relevant key strategic priorities (cont.)

Strategic Priorities Strategic Initiatives

Seeking commitment/buy-in from key stakeholders (overarching)

Seeking Khula Board; the EDD support + parliamentary presentation – board on board, EDD supportive, National Treasury supportive, parliamentary presentation in progress

Ensuring Core knowledge in Risk and Credit Management

Acquire expertise – currently seeking CRO and credit analystsEducation – in process of researching service providersConferences – MFI summit in May, others to come in Aug and Sep

Ensuring appropriate research

Research Hub – commissioned, to come on stream later in 2010RFI & bank visits - completedPrior knowledge – docs/consultants – researched, completedExternal input – absorbing in current detailed design phaseResearch to feed into policy formulation – in process.

Progress to date

Product Design

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• Products are designed to meet the SME financing needs

• Using risk management to adjust the details – but products remain generic:– Term Loans

– Short term facilities

• Grow product range and reach over time, in line with government’s priorities:

– Industry-specific products / programmes like Malaysia’s “Green Industries” priority responded to by CGC

– Demographic-specific products/programmes

Emphasis on simplicity, ease of understanding

Progress to date

Distribution Channel

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Head Office - Regional Office - Branch Office - Field Office

Customer-facing staff will be out in the field

Progress to date

Roles performed

• Define products• Define risk model• Manage portfolio• Set policies and procedures• Centralise:– Marketing– Financial management– Credit Decisions– IT system– Intelligence and Knowledge Management– Document storage– Collection process• Call-centre

Khula Direct to be accessible within 50km of most people, either atown office or via partners

Roles performed

• Manage the field staff (via SLAs)• Process applications all the way to

submission for approval• Perform verification/due diligence• Copy, file and store documents relating to the

application• Inform customer of progress• Ensure customer signs legal documents• Ensure money is disbursed to customer• Monitor customer periodically• Visit customer regularly• Manage business support to customer• Follow up on arrear amounts – collect, if

necessary• Gather market intelligence• Liaise with strategic local partners

Roles performed

• Market Khula Direct on a 1-on-1 basis• Gather market intelligence• Gather KYC information about customers and

potential deals• Aid customer in understanding Khula Direct• Assist customer in completing application forms• Aid regional office in gather all necessary

documents from customer• Submit applications to regional office• Aid customer in completion of CPs• Liaise between customer and regional office• Aid regional office in monitoring customer,

including visits• Identify business support needs, and monitor

implementation on behalf of regional office

Head Office

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Roles performed

• Define products

• Define risk model

• Manage portfolio

• Set policies and procedures

• Centralise:

– Marketing

– Financial management

– Credit Decisions

– IT system

– Intelligence and Knowledge Management

– Document storage

– Collection process

• Call-centreDistribution Channel

Regional Offices

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Roles performed

• Manage the field staff (via SLAs)

• Process applications all the way to submission for approval

• Perform verification/due diligence

• Copy, file and store documents relating to the application

• Inform customer of progress

• Ensure customer signs legal documents

• Ensure money is disbursed to customer

• Monitor customer periodically

• Visit customer regularly

• Manage business support to customer

• Follow up on arrear amounts – collect, if necessary

• Gather market intelligence

• Liaise with strategic local partners

More authority will be delegated over time

Distribution Channel

Field Staff

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Roles performed

• Market Khula Direct on a 1-on-1 basis

• Gather market intelligence

• Gather Know Your Customer (KYC) information about customers and potential deals

• Aid customer in understanding requirements

• Assist customer in completing application forms

• Aid regional office in gather all necessary documents from customer

• Submit applications to regional office

• Aid customer in completion of Conditions Precedent (CPs)

• Liaise between customer and regional office

• Aid regional office in monitoring customer, including visits

• Identify business support needs, and monitor implementation on behalf of regional office

Field staff remuneration is performance based – motivating for quality deals and repayment of loans

Distribution Channel

Risk Management Process

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All performed in-house

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Risk Mitigation

• General entrepreneurial education - constant marketing message– improve attitude towards paying money back– specific training for entrepreneurs– sponsorship of/linkages with training opportunities outside of Khula

• Specific intervention for Khula entrepreneurs– access to information regarding trading environment

• Khula magazine

• research hub

• networking fora

– specific training for entrepreneurs– sponsorship of events/linkages with industry opportunities

• Mentoring– Increased intervention and support of customers in trouble

• Monitoring– Increased activity when customer approaches or is in arrears

• Risk-based pricing

• Call for additional security when behavioural scoring decreasesProgress to date

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Pricing

Input factors considered

• Cost of capital (nil)

• Risk (price rises as risk increases)

• Expected losses (price rises as collateral decreases)

• Stress scenarios (reserves built up over time)

• Discounts (can be considered, but increases prices)

• Operating costs

• Business Support (not included)

• Profit (enough to cover a nominal return on assets)

Progress to date

   

Proposed Portfolio – Regional Variation

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  GP WC KZN EC MP NW FS LP NC TOTAL

Size of market

credit line deals < R      50,000 23% 16% 15% 13% 8% 7% 7% 6% 5% 100%

credit line deals < R    250,000 35% 18% 12% 9% 6% 6% 6% 4% 4% 100%

term loan deals < R   250,000 30% 20% 11% 9% 7% 7% 7% 6% 3% 100%

term loan deals < R3,000,000 40% 25% 10% 7% 4% 4% 5% 3% 2% 100%

credit line deals < R      50,000    74 750    52 000    48 750     42 250     26 000    22 750      22 750    19 500    16 250  325 000

credit line deals < R    250,000    87 500    45 000    30 000     22 500     15 000    15 000      15 000    10 000    10 000  250 000

number of credit line deals 162 250 97 000 78 750 64 750 41 000 37 750 37 750 29 500 26 250 575 000

term loan deals < R   250,000    30 000    20 000   11 000      9 000      7 000      7 000       7 000       6 000      3 000  100 000

term loan deals < R3,000,000      4 000      2 500     1 000         700         400         400          500          300         200  10 000

number of term loan deals 34 000 22 500 12 000 9 700 7 400 7 400 7 500 6 300 3 200 110 000

Even though 48% of all SMEs are in Gauteng, we will only have 23% to 40% of our portfolio there as Gauteng is already relatively well serviced. With less than 1% of SMEs in NC we will have 2% to 5% of our portfolio there to stimulate economic growth

Outcomes

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Capital RequirementHow Much • When • For What

Deals in year 1 (example) 500 @ R250k ea = R125m 125 @ R1m ea = R125m

625 deals for R250m

Total funds required for Khula Direct:

•Investment (shareholder loan)

•Business support (grant)

R 1 100m

R 100mR 1 200m

Recapitalisation of Khula wholesale R 400m

Total Capital Required R 1,6 bn

Years

Rands

250m

600m

1,1bn

1 2 3

R250m

R350m

R500m

Contents

Next Steps

• Processes

• Policies

• Blueprint

• Secure funding

• Credit scorecard

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Detail Design Build Phase 1 Phases 2 & 3

• Convert regional offices

• Set up first branches

• Hire field staff

• Build IT system

• Organisation redesign

• Capacitate head office

• Open first branches

• Appoint key strategic partners

• Launch SME development campaign

• Test model

• Acquisitions and Take-overs, e.g. Seda, Samaf, RFIs, etc

• National expansion

• Review model

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Thank Youwww.khula.org.za

08600 KHULA (54852)