Khula Enterprise Ltd Corporate Strategy and Quarterly Performance Report up to 30 June 30 2010

Meeting report

Khula Enterprise Ltd (Khula) Corporate Strategy 2010-2013
Mr Z Ntuli (ANC) was elected as Acting Chairperson until the Committee Chairperson, Ms Coleman, was able to attend.

Mr Mkhululi Mazibuko, Chief Operations Officer, Khula Enterprise Ltd, said the organisation’s mandate was to facilitate funding for small businesses, by operating as a wholesale financial institution, partnering with retail financial intermediaries (RFIs). The RFIs would then make funds available to small and medium enterprises (SMEs).

Khula Enterprise Ltd (Khula) faced the same challenges as other development finance institutions (DFIs). Their long-term objective was to be financially sustainable, although this meant striving only to break even, so that maximum funding could be provided for Small and Medium Enterprises (SMEs). Khula had focused its development efforts in line with Government policy, seeking to make an impact in the areas of job creation, black economic empowerment (BEE), rural development and the empowerment of women.

Mr Mazibuko said Khula was filling the gap that existed between the micro and small financers, on the one hand, and, the medium to large institutions - mainly banks – on the other. Khula targeted black-owned and owner-managed formal SMEs, offering financial support for businesses requiring between R10 000 and R3 million, with special emphasis on the under-served market needing loans of less than R250 000.

Khula had a two-fold focus over the next three years . Its main thrust was to introduce Khula Direct as a retail operation offering finance directly to SMEs who were otherwise unable to attract funding. This was meant to address the limitations of the wholesale model, which channelled funds through other credit providers. The off-take by these partners had declined dramatically in recent years. Its other focus was to re-engineer the wholesale model, to enable it to support the retail model, and to grow Khula’s outreach and impact.

Mr Mazibuko outlined that Khula’s products and activities covered business loans, credit indemnities, joint ventures, funds for loans, mentorship programmes and property. Operations had had to be scaled down, owing to limited funding. It was therefore a priority for Khula to find ways of recapitalising itself, either inside or outside of government. Other avenues of strategic importance were staff development, the need to reduction of operating costs, increased awareness of the Khula brand in the small business target market, and the establishment of a research unit to gain insight into how the management of SMEs could be improved.

He also said some of Khula’s wholesale products needed to be reviewed, as they had been in existence since establishment of Khula in 1996. Service delivery could be improved through using regional offices. Apart from monitoring the number of businesses that it helped, Khula would also evaluate the impact of its interventions. There were also plans to position Khula as a fund manager for SME development. In the past, it had entrusted this function to third parties in the past, but now wanted to bring it “in house.”

Three financing programmes were envisaged. The SME Niche Finance Programme would involve partnering with institutions that provided niche-SME financing products, such as in the field of minerals and beneficiation. The Rural and Community Development Programme would aim at developing and promoting sustainable SMEs, particularly in the rural, agricultural and agri-processing sector, as well as in tourism. The Supply Chain Finance Programme would focus on partnering with large corporations and government departments, to provide funding for SMEs who had been awarded contracts.

Khula Direct planned to start lending in the next financial year, and the National Treasury had already been approached for funding for Phase One. In the past year, Khula had asked for around R1 billion to fund its existing operations. It had received only R120 million, which had impacted on its ability to deliver on its programmes, resulting in a decline in the level of approvals and disbursements. It had therefore engaged with organisations such as the Public Investment Corporation (PIC) and the Industrial Development Corporation (IDC), as well as with government, to try to raise funds to finance its operations. In the light of reduced funding, Khula also intended improving operational efficiencies through cost reduction measures, reducing “red tape” through decentralisation, and improving turnaround times.

Mr Mazibuko said that although research centres and academic institutions had conducted extensive research on SMEs, their work was fragmented and there was no ownership of SME policy formulation. Khula wanted to fulfil this role, so that it could influence the policy formulation of government.

Mr Mazibuko drew attention to the huge drop in Khula’s Credit Indemnity Scheme, owing to stricter lending criteria adopted by banks during the recession. An example was ABSA bank, whose transactions had fallen from 335 in 2005, to only five last year, with similar trends also in the other major banks. In 2007, Khula had written around R200 million worth of transactions. This had dropped to less than R50 million in the past year. The product would be reviewed and offered outside the current banking system; a method that worked in other countries, and there was no reason why it should not also work in South Africa. Previous borrowers who had benefited from the scheme would be encouraged to make use of it again.

Mr Mazibuko gave numerous examples of Khula partnering with both public and sector funds, which had helped to create 2 790 new jobs, focussing mainly on black entrepreneurs, many of whom were women.

In future, because of the limited funds available, Khula would act as a fund manager. It would get involved with the private sector so that it could manage funds on its behalf.

Khula had taken over Business Partners’ property portfolio in 2001, and this was being used to house SMEs. The properties were valued at R129,8 million at the time of takeover, and were now worth R192 million.

Mr Mazibuko concluded that Khula was gearing itself to implement a Khula Direct model, to re-position the wholesale model, and to recapitalise the organisation in order to generate the kind of impact it wanted to achieve.

Discussion
Co-Chairperson Ntuli and Mr N Singh (IFP) wanted to know why ABSA’s involvement in the Credit Indemnity Scheme had fallen so sharply.

Mr Mazibuko said it had become evident during the recession that the major banks had all reviewed their books, and had scaled down their financing of SMEs. Since the economy had shown signs of recovery, there had been a small increase in activity.

Co-Chairperson Ntuli asked if Khula’s priority was to be a fund manager, or to introduce Khula Direct.

Mr Mazibuko replied that Khula had been set up as a wholesale operation for the past 14 years. In order to enter the retail market meant it would be necessary to reposition Khula. However, it needed to manage its existing book, so it could not just walk away from the wholesale business. Khula intended to start direct lending slowly at first, but retail would probably overtake wholesale within three to five years. Khula had also set up a number of funds, using its own money along with that sourced from partners in the private sector. Third parties were managing these funds on Khula’s behalf, so in future there would be a wholesale model where Khula would partner with niche players in the SME market. Khula would provide funding to major financial institutions to support an investment in SME projects, and would manage the funds on their behalf, in return for a fee. This was directly contrary to the current situation, where the financial institutions charged Khula a fee for managing a fund.

Co-Chairperson Ntuli asked for details of Khula’s involvement with the Foundation for African Business and Consumer Services (FABCOS).

Mr Mazibuko said Khula had set up a R100 million fund with FABCOS (with Khula providing R70 million, and FABCOS R30 million), which was largely dedicated to small entrepreneurs in the townships. The take-up was already very good.

Mr Singh suggested there might be a conflict of interests between Khula dealing directly with the community, and Khula dealing indirectly through RFIs. He asked whether, looking at the vision and mission, Khula now believed that it had become the development finance partner of first choice for SMEs, or whether there were alternatives. He also asked if Khula was succeeding in its mission.

Mr Mazibuko said that in the financing of small business, the only two comparable organisations were Khula and Business Partners. Khula’s impact could be seen through its disbursement of R2,5 billion since inception and creation of 25 000 jobs. These figures could have been even higher if it had been able to lend directly. He felt Khula had made a contribution in terms of SME development, and could do even better in the future.

Mr Singh said it was important for Khula to have discussions with SAMAF, because there were so many different lending organisations that communities would not know whom to approach. He suggested there should be one umbrella body, to eliminate confusion.

Mr Mazibuko said this issue had been raised by the Minister, and he agreed that the proposal made sense. He added, however, that this required a political decision.

Mr Singh asked how Khula monitored RFIs for their BEE compliance and alignment with government policy.

Mr Mazibuko said it was a Khula requirement that whenever it partnered with an RFI, the latter must have at least Level 4 BEE compliance. While this helped Khula to comply with the needs of the country, it limited the number of partners available to Khula, because of the large white component in the financial sector.

Ms H Line (ANC) said that although the Northern Cape was rich in land, water and mineral resources, Khula did not seem to be doing much in that area.

Mr Mazibuko said there was one RFI based in Bloemfontein to service both the Free State and Northern Cape. Khula also had a relationship with Business Partners, and had encouraged them to invest in a couple of ventures in the area. He conceded that this might not be enough. He said all the provinces outside of Gauteng, KwaZulu Natal and the Western Cape were under-served, and programmes were needed to address the problems in these regions.

Dr P Rabie (DA) commented that leveraged funding for Khula was long overdue.

Mr Mazibuko said Khula did not have the ability to borrow outside of government sources, and was last capitalised in 2006. This was why it was focussing on becoming a fund manager, using its funds as leverage for raising money from the private sector.

Dr Rabie suggested that Khula should publicise some of its success stories, indicating where it had helped small companies to succeed.

Mr Mazibuko said the aim of the project was to profile some of the success stories. He cited Stoned Cherry as an example, as well as an advertising agency and a lady operating in the construction industry in KwaZulu Natal. He said if the story were told by the beneficiary, it would be more credible than if it were told by the institution.

Dr Rabie expressed concern at the proposal that Khula should have its own research unit, as the Department of Economic Affairs and the universities conducted this type of research. He warned that there was a need to be wary of “empire building.”

Mr Mazibuko agreed that research was taking place, but it was fragmented. Khula wanted a round table discussion with all these institutions to establish what had come out of the research, so that this research could be applied to its operations and be used to influence government policy. The objective was not to initiate new research, but rather to co-ordinate research that had already been done.

Khula Quarterly Performance Report to end June 2010
Mr Mazibuko then gave a brief review of Khula’s performance for the quarter ending on 30 June 2010. During this period there were two main changes within the entity. The first was the appointment of a new board, and the second related to the new reporting structures. This meant that during the period, the institution was realigning its strategies, as the board had a new mandate, plan and vision.

At the start of the quarter, Khula had R185 million of commitments to RFIs, of which R14 million had been disbursed. A total of R15 million had been disbursed from the fund, while credit indemnities of R9 million had been approved, and R4 million disbursed.

Projects in the pipeline involved the State Enterprises Procurement Programme, where Khula engaged with organisations such as the Post Office and Eskom to secure contracts for SMEs.

He said that Khula had established a relationship with the Institute of Business Advisers, as it needed to create a capacity for developing and sourcing new businesses, and for monitoring these investments. Khula had 471 business advisers located in the various provinces, as part of its outreach strategy, and the plan was for them to source transactions on Khula’s behalf and then handle the monitoring.

He concluded by saying that the level of approvals had been lower than expected, but this was largely due to the current review and refinement of its products to bring them into line with government objectives.

Discussion
Mr Singh said the presentation had indicated that reliance on intermediaries to get Khula’s products to its end market created problems, with only 7,5% of funds being disbursed in the first quarter. He asked what happened to unused funds.

Mr Mazibuko said Khula had long-term commitments, and funds were disbursed in tranches. Each time a disbursement was made, the performance of the fund was evaluated against objectives, and if it had not delivered what was expected, Khula had the right to withhold the allocation and use it to fund other opportunities.

Mr Singh asked for more information about the UTHO Fund.

Mr Mazibuko said this was an initiative that Khula was considering, in partnership with the IDC, to co-fund a programme aimed at emerging contractors involved in the building of houses, bridges, roads and other infrastructure projects.

Mr S Ngonyama (COPE) asked for more information on Khula’s involvement in the State-Owned Enterprise procurement programmes.

Mr Mazibuko said many opportunities were available to emerging contractors. Portions of large contracts were allocated to sub-contractors, many of whom had the skills to do the job, but lacked the finance. It was this gap that Khula could fill. He urged that the country should avoid situations such as the World Cup building, where most of the work was done by overseas contractors.

Mr Ngonyama asked what was meant by getting rid of the “cradle to grave” approach in dealing with RFIs.

Mr Mazibuko explained that traditionally, the loan officer was in charge of the transaction right from the time the deal was originated until Khula exited from it. There needed to be a separation of functions, to ensure that a conflict of interest did not arise by the originator using his role as monitor to “protect” the transaction he had approved.

South African Microfinance Apex Fund (SAMAF): Strategic Plan 2010-2013
Mr Kumaran Naidoo, Acting Chief Executive Officer, South African Microfinance Apex Fund (SAMAF), said that the organisation (SAMAF) operated in a unique environment, and its functions were somewhat different to those of Khula.

SAMAF’s mandate was to support the establishment of sustainable micro-finance institutions dealing with the enterprising poor, as well as those already established. The grants and loans made available were intended to service the poorest of the poor. SAMAF was aiming to establish a network of sustainable micro-financial institutions which could broaden and deepen access to affordable financial services by the enterprising poor.

SAMAF’s mission was to provide developmental financial and non-financial services to financial intermediaries, by providing capital to micro-financial institutions with proven potential, including stokvels and burial societies, as these included a savings component. A huge challenge was to develop human capital in this segment. It also aimed to develop valuable partnerships between business, government and the community.

Values and integrity were of particular importance in the financial market, and all stakeholders needed to be dealt with in an honest and ethical manner. While SAMAF was accountable for its decisions and actions, it should be recognised that it was acting in a high-risk environment, and that it would make losses from time to time. However, these losses should be seen as an investment in human development, and were probably better than social grants.

SAMAF offered three main products and services – financial, technical support and Financial Sector Cooperative (FSC) supervision. It provided loans up to a maximum of R10 million to financial intermediaries (FIs), who in turn could provide loans of up to R10 000 to their clients. This R10 000 limit was too low, as the cost of providing such a small loan was disproportionate to the benefits. Capacity building took the form of loans and grants, as well as technical support in the areas of policy development and training. SAMAF was also mandated to regulate and supervise all FSCs in the country.

The performance objectives were aligned to the Economic Development Department (EDD) policies covering improved support for FIs, outreach to rural areas, youth employment, effective reporting mechanisms, research, red tape eliminations and cost reduction.

Mr Naidoo said that R36 million had been set aside to provide financial support to FIs for on-lending. This seemed a small amount, but should be seen in the context of the past four years, during which R46 million had been disbursed. There needed to be a more intensified effort from SAMAF, as the poor were clearly not satisfied with what was being provided.

He repeated his proposal that the maximum loan threshold be raised from R10 000 to R50 000, but added that after discussions with Khula, an increase to R100 000 was considered appropriate.

The projected three-year performance targets showed modest increases in the loan book – from R36 million to R40,6 million, but it was hoped that SAMAF’s intensified efforts would result in a more substantial increase.

An analysis of the loan allocation targets showed that 75% were aimed at entrepreneurs, 15% at housing and 10% at education. A further breakdown showed 70% aimed at rural areas, and 30% at peri-urban areas. Women were to be the main beneficiaries (80%), while the balance was split between youth and disabled people. These projections had been made mainly on the basis of past performance. Provinces such as North West, Northern Cape, Free State and KwaZulu Natal were lagging behind, and a new focus needed to be adopted to improve the situation.

Mr Naidoo said SAMAF wanted to tap into the social responsibility programmes of banks and accounting firms, so that they could assist in capacity building in the micro-financing sector. Another key target was to improve awareness of the organisation, initially through brochures and later in broadcast media.

SAMAF intended to reduce turnaround times for handling client complaints from five to two days, and to improve the loan approval and disbursement process turnaround time. Equally important, because small businesses were involved, was the need to cut creditor payment times from 30 to 15 days.

There was a critical skills shortage in the sector which needed to be addressed. An internship and youth learnership programme within SAMAF involved small numbers, and it was the organisation’s intention to deploy graduates from the community to FIs, and link them up with accounting institutions where they could get their training at the same time.

He said SAMAF’s first quarter performance had not been as good as expected, but the number of borrowers had increased substantially to 11 434, and the annual target of 17 025, which had been based on past history, would be surpassed.

The review showed that while the 30-day target time for paying creditors had already been reduced to 20 days, the target of 91 days to approve loan applications had not been met. The turnaround time of 125 days was attributed to poor quality of funding proposals, which required further investigation and re-presentation. This figure would improve substantially in the second quarter.

Mr Naidoo outlined the challenges facing SAMAF, which included that the level of skills, leadership and accountability at senior levels within the organisation left much to be desired. Five of the nine provinces were not performing well, and if the very clear targets which had been set for the next three months were not met, appropriate action would be necessary. Interventions were being put in place to deal with the lack of skills within the micro-finance sector. SAMAF had spent a lot of time over the past four years developing institutional mechanisms. Some of them had become very cumbersome and were not developmental in nature, and would have to be refined.

Discussion
Mr Ntuli asked what the difference was between Khula and SAMAF

Mr Naidoo said SAMAF gave institutional and capacity-building support to intermediaries in order to make them sustainable. Khula, on the other hand, used these intermediaries for on-lending. SAMAF was limited to micro-finance, while Khula operated in the small to medium sector. If SAMAF were absorbed into Khula, the specific focus of catering to the poorest of the poor would be lost.

Mr Ngonyama asked whether SAMAF was similar to two banks in Bangladesh – BRAC, which had a big capacity-building component, or Grameen, which was more of a financier. It seemed to him the emphasis at SAMAF was more commercial than developmental.

Mr Naidoo said SAMAF was a mixture since it provided both funding and technical support for capacity building.

Ms D Tsotetsi (ANC) noted the remark that accountability, skills and leadership at senior levels had been identified as a challenge, and she wanted to know how appointments to these positions had been made.

Mr Naidoo said even though a performance management system was in place, too much latitude had been allowed, because the organisation was still being developed. The system was now applied more strictly, and staff were measured against clear standards.

Ms Nosipho Ngewu, Human Resources Executive, SAMAF, added that it was initially not known what skills would be required to run the organisation. As the organisational model was being refined, the competency gaps were being addressed.

Mr Singh asked whether the funds allocated for education were to assist students or student organisations.

Mr Naidoo said the funds were refundable loans to pay for individual student’s fees.

Mr Singh said the target of 91 days’ turnaround time for loan applications was still too long.

Mr Naidoo agreed, and said the organisation was working hard to reduce this to 30 days in most cases.

Dr Rabie welcomed the priority being given to women and young people in the rural areas, but asked what measures were adopted by SAMAF to reduce the risk involved in making money available to people in poor communities.

Mr Naidoo stressed that SAMAF was dealing with the poorest of the poor, and as government, it had to be accepted that any loss of money was still an investment in a learning process. It would be too costly to take out insurance cover.

Ms P Bhengu (ANC) referred to the low profits generated by businesses in the start-up phase, and asked what level of interest was charged, and at what stage a loan would become repayable.

Mr Naidoo said SAMAF was created to avoid a commercial emphasis until the FIs became banks in their own right. The FIs charged rates stipulated by the credit regulator, which he felt were far too high, so SAMAF wanted to engage with the intermediaries to see how the rates could be brought down. SAMAF’s rates were a low 4% to 6%, which was not cost effective, and, in any event, were passed on to the end user. SAMAF would look at the possibility of removing interest charged to intermediaries, particularly in the early stages of the loan.

Co-Chairperson Coleman said certain provinces were deemed to have performed well, but asked how this performance was measured.

Mr Naidoo said there was no yardstick in South Africa by which to measure performance, so the figures merely represented a comparison between provinces. A baseline needed to be established.

Co-Chairperson Coleman asked how SAMAF had arrived at the target figures for internships and learnerships over the next three years.

Mr Naidoo said the intention was to introduce a pilot programme this year, and the methodology for setting targets was based on this.

Co-Chairperson Coleman asked if SAMAF was following the required complaints process, and if it was capable of handling complaints in a single day.

Mr Naidoo said there were very few complaints, and they were mostly from the intermediaries. These were generally easy to handle, and there was an acknowledgement process in place, if this was needed.

Co-Chairperson Coleman complimented the organisation on its reduced timeframe for paying creditors, but asked how this had been achieved when there was a skills shortage.

Mr Naidoo said he was not at SAMAF when this had been achieved, but there was now a process in place to indicate, on a daily basis, the status of accounts that had come in. Payment was now being made in ten days.

Co-Chairperson Coleman asked what would be the financial impact of moving the minimum loan threshold from R10 000 to R50 000.

Mr Naidoo said that R46 million had been disbursed in the previous four years, so the increase in the threshold had been catered for in the R36 million allocated for this year.

Ms Coleman asked what process was used by SAMAF to clear bad debts.

Mr Naidoo said the required legal process was followed, and when the lawyers advised there was no chance of recovery, the amount was written off, although SAMAF still followed up to see if there was any chance that the funds could be recovered.

Ms Coleman said the FI retention level had been good, and asked how this had been achieved.

Mr Naidoo said he thought the wrong strategy had been used in the past. It was undesirable to start funding a FI, only to take legal action against it a few years later, resulting in its collapse. SAMAF wanted to “hold hands” with the FIs for five to ten years, so that they could become fully sustainable.

Ms Coleman said the poverty alleviation programme had failed, with rural banks and co-operatives dying out over time. She asked if SAMAF had learnt anything from this that might help it in the future.

Mr Naidoo said this touched on the issue of sustainability of FIs, and he felt that in the past they had been abandoned too soon. There was a need to “hold hands” for longer.

Mr Buhle Dlulane, Chief Operating Officer, SAMAF, gave a brief overview of the way in which the Grameen and BRAC banks in Bangladesh operated in relation to the South African situation. He also stressed the need to develop FIs so that they could assist in reducing the timeframe for approving funding applications.

Ms Ngewu said the lessons from the successful provinces would be replicated in the other provinces.

The meeting was adjourned.