Khula Direct

1. Khula Direct Parliamentary Portfolio Committee on Economic Development Setlakalane Molepo (MD) 22 July 2010

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

3. Khula’s new board members Reappointed Mr I Tayob Ms N Matyumza Mr N Greenhill Mr S Molepo (MD) 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) Contents

4. Summary - Khula Direct the Retail Business • Purpose of Khula Direct • Objectives of Khula Direct • Outcomes of Khula Direct Contents

5. 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 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

6. Purpose of Khula Direct Khula Enterprise Finance’s business Wholesale Lending 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

7. Long-term CAPITAL MARKETS INVESTMENT BANKS DEVELOPMENT FINANCE INSTITUTIONS TERM Medium- term MORTGAGE PROVIDERS COMMERCIAL BANKS MICRO-FINANCE INSTITUTIONS CONSUMPTION LENDERS Short-term STOKVELS, BURIAL SOCIETIES MONEY-LENDERS Micro Small Medium Large TRANSACTION SIZE Position of Institutions Long Source: Roussos and Ferrandi (2008) TERM Medium GAP Short Micro Small Medium Large TRANSACTION SIZE The GAP is apparent in the SME space Objectives of Khula Direct

8. Geographic distribution of Khula offices Current regional offices (11) New branch offices (30 – 40) New SOHO offices (40 – 60) There appears to be a high demand, and, surprisingly, a high supply of finance, but they are poorly matched Objectives of Khula Direct

9. Demographic Profile Khula Direct will accommodate a broad risk profile addressing underserviced segments • Women • Youth • Peri-urban and rural • Environmentally friendly projects Objectives of Khula Direct

10. Amount lent Micro-financiers Banks VC and PE investors 525,000* informal businesses need less than R50,000 R50,000 – R100 – R15,000 110,000* formal businesses need less than R250,000 Khula Direct will aim at the R50,000 to R500,000 range Objectives of Khula Direct * FinMark Trust report 2009

11. 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 Objectives of Khula Direct There appears to be a high demand, and, surprisingly, a high supply of finance, but they are poorly matched

12. Perceived high risk of applicants • No experience in running a business • No assets • Live far from major town • No contracts from customers • No cash to contribute to business • Don’t know the industry Bad credit record Khula Direct will assess the risk, and adjust the product to suit the level of risk Khula Direct will have a much higher risk appetite than commercial financiers Objectives of Khula Direct

13. 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

14. 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 The overriding outcome is a reduction in poverty Summary - Khula Direct

15. 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 Contents Progress since March

16. 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)

17. 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 AardtSmit, 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

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

19. Progress in relevant key strategic priorities (cont.) Progress to date

20. Product Design • 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

21. Distribution Channel Head Office - Regional Office - Branch Office - Field Office 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 Roles performed 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 • 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 Customer-facing staff will be out in the field Khula Direct to be accessible within 50km of most people, either atown office or via partners Progress to date

22. Head Office 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 Distribution Channel

23. Regional Offices 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

24. Field Staff 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

25. Risk Management Process All performed in-house

26. 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 decreases Progress to date

27. 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

28. Proposed Portfolio – Regional Variation 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

29. Capital Requirement How Much • When • For What 1,1bn R500m Rands 600m R350m 250m R250m 1 2 3 Years Contents

30. Next Steps Phases 2 & 3 Phase 1 Build Detail Design • Processes • Policies • Blueprint • Secure funding • Credit scorecard • Convert regional offices • Set up first branches • Hire field staff • Build IT system • Organisation redesign • Capacitate head office • Acquisitions and Take-overs, e.g. Seda, Samaf, RFIs, etc • National expansion • Review model • Open first branches • Appoint key strategic partners • Launch SME development campaign • Test model

31. Thank You www.khula.org.za 08600 KHULA (54852)