Evaluation Team

This summary report was prepared by Nicholas Burke, Independent Consultant, under the overall guidance of Mohamed Manai, Manager of the Projects and Programs Evaluation Division at the Operations Evaluation Department (OPEV) of the African Development Bank. The Evaluation Team comprised Grace Kyokunda, Chief Evaluation Officer, Hadizatou Sidikou, Principal Evaluation Officer and Clément Bansé and Emmanuel Kouassi Kouadio who provided research assistance.

Wrap Up video of the evaluation from Hadizatou Sidikou, Principal Evaluation Officer

 

Objective

This report reviews the performance of the Bank in relation to its private sector (non-sovereign) operations. It is based on the Bank’s portfolio of 137 investments that were approved by the Board between 2006 and 2011, and which account for a total approved investment volume of UA 3.9 billion, of which UA 3.5 billion is committed.

Main Findings

• Through the selection and financing of the projects it supports, the Bank has generally achieved good alignment of its operations with the private sector strategy. Its presence as a finance partner has a signal effect on other investors and lenders, such that in addition to its own contribution of UA 3.9 billion, these projects have succeeded in mobilizing a further UA 20 billion of financial support. The Bank has originated 54 per cent of its approvals in low-income countries, evidence of its critical role in catalysing private sector investment in  conomies that attract only a relatively small share of regional FDI and private capital flows.

• The Bank has adopted industry best practices for measuring and managing risk in its private sector portfolio. It has remained within defined exposure limits, and within a target range for the portfolio’s weighted average risk rating. Under its new pricing framework, loan margins and fee structures are now more closely aligned with the underlying credit risk of transactions. The May 2010 General Capital Increase has created more headroom for the Bank to expand its investment operations in pursuit of the private sector strategy.

• The Bank has increased to 80 the number of staff dedicated to private sector operations. They exhibit skills across the sectors and functional disciplines that are central to the strategy. Implementation of the decentralization roadmap will provide more resources in the field to help the Bank originate, transact and superviseinvestments more efficiently and enhance client responsiveness.

• Compared to its peers, the Bank has used a relatively narrow range of instruments to support private sector development; predominantly senior loans, lines of credit and equity   investments. At the project level, greater use of guarantees, local currency and trade finance, and other innovative financing products could help meet the needs of more clients. Technical assistance at the project or macro level is also under-utilized by the Bank yet could help relieve market, regulatory and policy constraints to private sector investment.

• Although the Bank aims to increase its reach to micro and small enterprises by channelling its funding through financial intermediaries, there is insufficient evidence that these target groups are actually the beneficiaries of sub-loans. More generally, the Bank has inadequate systems for monitoring and reporting the development effects at the project level. In part, this is due to a lack of client knowledge or capacity to collect and provide relevant data to the Bank, but it also stems from a lack of internal focus on these areas during supervision.

• The Bank has been unsuccessful in sourcing new investment opportunities on the ground, relying instead on approaches from prospective or existing clients, or on referrals from other multilateral or commercial banks and investors. In converting pipeline projects into approved investment operations, the Bank falls well short of its peers in the time it requires and the efficiency of its processes. The Bank is also hindered by a repeated failure to budget adequately for its operational requirements.

• The Bank’s loan portfolio is still relatively young and its profit contribution is not yet evident. The Bank’s non-performing assets show an increase and are now at 2.51%. While this is reasonable, it is important to note that more than half the portfolio is less than 2 years old and still in the grace period. Thus it is hard to determine the direction of the non-performing portfolio for the future. As a comparator, the level of non-performing assets at the IFC which holds a mature portfolio is 4.7%. There is also evidence to suggest that the Bank is overpricing or under-pricing loans relative to its peers. The under-pricing occurs in the high risk category and requires particular attention. Finally, during the period under review, the Bank has yet to realize any capital gains from its equity portfolio, which is currently yielding negative returns overall.

Main Lessons

• A good knowledge of the business environment in RMCs should lead the Bank to better diversify private sector operations (PSO ), which has remained essentially focused on investment activity rather than on extensive market reforms : The majority of bank competition to private companies is in the form of direct loans, lines of privileged loans, direct equity , participation in private equity investments , and very little in the form of other facilities or instruments such as guarantees , trade facilities and technical assistance (TA )

• The private sector projects supported by the Bank have contributed in various and diverse ways to development whose effectiveness could be greatly improved through the use of technical assistance by the Bank in areas such as project design and studies feasibility, market knowledge, the reform of corporate governance and public -private partnerships.

• To cope with the expansion of private sector operations, the bank has significantly increased the number of staff assigned to Private Sector Department (OPSM), which department must continue to have multidisciplinary human resources and skills required for its mission. The implementation of the roadmap for decentralization must provide more resources on the ground to help the Bank to assemble, process and oversee its investments more efficiently and improve its responsiveness vis-à- vis customers .

• Risks related to the profitability of the Bank's operations in the private sector exist. To minimize this risk, the Bank shall take all measures necessary to ensure compliance with the commitment set out in the private portfolio as a whole and separately for clients and individual sectors.

Main Recommendations

Recommendations to the Bank:

• Financial sector operations: Review its strategy, policies and procedures for financial sector investments, particularly intermediation through lines of credit: a. Develop specific investment guidelines that will allow to appraise the benefits and trade-offs of indirect wholesaling operations against direct interventions b. Develop specific guidelines in supporting MSMEs in order to ensure that financial intermediaries are held accountable for the deployment of Bank funds and that these funds have the best chance of reaching their intended beneficiaries (e.g. MSMEs) c. Ensure that financial institutions comply with environmental and social requirements, and adopt a more systematic approach to capacity building in client financial institutions to help them establish sound approval, credit risk management, portfolio management and supervision, audit and reporting standards;

• Instrument mix: Utilize a wider range of instruments including guarantees and trade finance.

• One Bank culture: Strengthen the One Bank approach to break silos and allow better synergies between the departments.

• Equity performance: Develop policy guidance for exit strategy and deal with underperforming funds, with policy directives for re-valuation and strengthen supervision procedures.

• Equity performance: Provide specialized officer training, place more detailed and more frequent reporting requirements on fund managers and recruit additional experienced investment officers and fund advisory board members.

• Equity portfolio growth: Be more selective in approving new equity investments, increase underwriting restrictions and reduce the overall rate of growth of new interventions.

• Equity portfolio growth: Create headroom for new investments by: a. Adopting an aggressive sales strategy for its active portfolio and devoting sufficient resources and staff towards monitoring the active portfolio, searching for viable exits and closing sales at the most opportune times; b. Placing greater emphasis on future exit options at the time of approval of new equity investments; c. Acknowledging that exits through initial public offerings (IPOs) are rarely possible, and not therefore a sufficient condition for approval; d. Incorporating options on sponsors wherever possible or making use of alternative instruments such as preferred shares or other quasi-equity or mezzanine products with an assured payback schedule.

• Monitoring and Evaluation: Introduce an appropriate monitoring and evaluation system to measure and report the development effectiveness and ensure that the Bank collects sufficient, credible results data throughout the life of a project or technical assistance operations;

• Monitoring and Evaluation: Address the apparent low level of client reporting on development results by reviewing the adequacy of the reporting template, incorporating the requirement to report in project legal agreements, and working with clients to educate them on data collection methods;

• Performance measurement: Introduce a highlight system based on scorecards at the departmental and individual level, which balance incentives for new approval volume

• Strategic, riskmanagement and capital adequacy imperatives: Adjust the private sector strategy in recognition of any constraints imposed by prudent portfolio risk management, to achieve a balance between core strategic objectives, strategic priorities, and risk management guidelines.

• Strategic, riskmanagement and capital adequacy imperatives: Monitor closely the overall capital adequacy, the effect of downgrades of regional member countries on callable capital, and the consequent headroom for further growth in private sector operations.

• Strategic, riskmanagement and capital adequacy imperatives: Take into account explicitly the projected impact on portfolio risk from increased exposure to LICs, fragile states and other high risk-rated priority group.

• Delegated approval authority: Consider delegating approval authority to levels below the Board by: a. Developing framework agreements for processing investments that fall below specified risk criteria; b. Clarifying the roles and responsibilities of staff for the credit approval process, and c. Considering introducing a position of Chief Credit Officer.

• High-risk operations Loan pricing: Investigate the reasons for apparent under-pricing in the category of high risk transactions and periodically review the pricing framework to ensure its effectiveness and alignment to the ongoing development of the Bank’s risk practices and standards (Economic Capital Framework, Enterprise Risk Management etc.)

• Loan security: Reinforce the systems and procedures for documenting, perfecting and monitoring the value of loan collateral, sponsor guarantees and other forms of security and strengthen financial systems in local markets by improving collateral protection and the enabling environment for SME lending.

• Workout capacity: Develop its work out capacity by developing comprehensive and clear policies, procedures and resources required to react quickly to deteriorating credit quality in investments, intervene with clients, sponsors and co-financiers, and where necessary instigate recovery measures to minimize financial loss for the Bank.

• Decentralization: Proceed with its decentralization strategy to place a critical mass of private sector staff in the field with a mandate to identify, originate and, where appropriate, approve new investment projects;

• Approval times: Review its approval procedures to identify where there is duplication or repetition of activity or where certain processes are not adding value to be informed by client surveys and feedback as to the main causes of dissatisfaction.

• Time-recording system - Management Information System: Upgrade its Management Information System (MIS) to provide centralized, onestop access to all relevant project and investment documentation and implement a time-recording system to track staff activities during project origination and supervision, in order to attribute transaction costs and administrative overhead to individual investments.

• Budget processes: Address current deficiencies in the budgeting process and in the skill levels of budget coordinators, to ensure that budgets for private sector operations are credible and sufficient