ACCESS TO FINANCE AND INVESTMENT ACTION PLAN

ACCESS TO FINANCE AND INVESTMENT ACTION PLAN

MARCH 2009

This report was produced by Chemonics International under Contract No. AID-112-C-08-00002 for review by the United States Agency for International Development. It was prepared by PSCEP consultants Richard Currie (access to debt) and Roberto Toso (access to private equity), with input from Dan Cruz-DePaula, PSCEP COP. Its contents express the views of the author and not necessarily those of USAID.

PSCEP – Access to Finance Action Plan

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TABLE OF CONTENTS

Executive Summary 2

Financial Sector Overview 8

Bank Selection 20

Equity Investment 30

Action Plans 35

APPENDICES

A. Banks’ Total Assets and Market Share 49

B. PSCEP Sector Assessment 51

TABLES

Table 1: Summary Bank Lending 27

Table 2: Key Financial Data for Select Partner Banks 29

Table 3: Timeline of Key Components for Bank SME Lending Program 36

Table 6: Trade Finance Implementation Plan 39

Table 4: Summary of Equity Activities, Time Line, and Planning Chart 45


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SECTION I

Executive Summary

The USAID Private Sector Competitiveness Enhancement Program (PSCEP) is a $6.6 million, three-year program financed by the United States Agency for International Development (USAID) and the people of the United States, designed to promote the competitiveness of select sectors of the non-oil economy in Azerbaijan. Access to debt financing and equity investments are major barriers to increasing the growth of SMEs, exports, competitiveness, trade, and new jobs, especially outside of Baku. There is a consensus among donors that perceived risk, excessive collateral requirements, and a limited range of financial products further exacerbate this problem. Many SMEs also have limited experience and success in obtaining the appropriate financing they need to grow their companies because of their weak and inadequate financial statements, poor internal financial management, and their continued reliance on a cash-based business environment, as well as their reluctance to operate within the banking and legal system for tax liability reasons and confidentiality concerns. A. Access to Debt Financing

The commercial banking sector needs to increase access to SME finance, as well as introduce new lending products such as innovative trade finance products and services, which can immediately meet the short-term financing needs of these enterprises. The USAID Financial Sector Stability Program (FSSP) is addressing many banking system constraints. It currently works with The National Bank of Azerbaijan (NBA) on banking supervision and with the following five commercial banks1: Azerdemiryol Bank (ADB), Mugan Bank, Royal Bank, Atra Bank, and NBC Bank. These five banks are presently receiving extensive technical assistance and training on the credit issues related to SME lending, risk management, IT/MIS, deposit mobilization, and marketing of financial products in order to improve and enhance their credit skills and knowledge. Nonetheless, institution-building is a long-term effort. All banks still have weaknesses in credit assessment, particularly cash flow analysis. The introduction of innovative loan products has also been constrained by a risk-adverse banking culture in Azerbaijan. The majority of banks still rely almost exclusively on collateral-based and relationship-based lending. There are several important issues that continue to plague the banking sector including: the current international financial crisis and its related liquidity constraints; lack of technical skills or institutional capacity to develop new loan products; the weak legal environment, such as the difficulty in enforcing court judgments against delinquent borrowers; and the urgent need to establish a credit registry. Revisions in the civil code that would allow for the assignment of accounts receivable, inventory, and cash flow along with personal and corporate guarantees need to be introduced in order to allow the banks to extend short-term trade finance loans, which use soft assets as collateral.

In Year One, the USAID/PSCEP program will work with an initial group of banks to increase SME financing and to design, develop, and implement two new and innovative trade finance products: purchase order finance and accounts receivable financing. USAID/PSCEP will also work to enhance Azerbaijan’s limited use of leasing. On the debt side, USAID/PSCEP will

1 The NBA will soon be renamed the Central Bank of Azerbaijan. This report will continue to utilize its current name.


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also build on the efforts of the FSSP project to enhance sustainable SME lending. As described in the equity section below, PSCEP will also work with the investment companies such as Azerbaijan Investment Company (AIC), Caspian International Investment Company (CIIC), Kuwait-Azerbaijan Investment Company (KAIC) to introduce mezzanine or subordinated-debt financing, as a new financial instrument. On a pilot basis, PSCEP will design and tailor the two above-mentioned trade finance products to each respective partner bank’s credit policies and corporate risk culture for maximum and rapid integration. For long-term sustainability, the team assumes that these trade finance products will become institutionalized–first within the partner banks, then throughout the banking system and within the majority of commercial banks through competition and marketing–thereby improving the access to finance for many more SMEs in Azerbaijan. These new trade finance products will also create opportunities for innovation in the banking sector and bring more transparency into the banking system. As part of this Action Plan formulation, PSCEP developed procedures to pre-screen the over 40 banks that constitute the local financial system. Through these procedures, PSCEP narrowed the selection process and interviewed the most qualified and receptive banks for inclusion into the SME lending program. Above all, the process focused on selecting a core group for an initial SME lending pilot program that offered the best chances of success in a difficult institutional and macroeconomic environment and built on the USAID/FSSP program. This process involved initially meeting with USAID/FSSP, representatives from the European Bank for Reconstruction and Development (EBRD), International Finance Corporation (IFC), Asian Development Bank (ADB), and German Azerbaijan Fund (GAF) to garner their views and input about the “best and most progressive” banks, as well as their views on the challenges and obstacles in the current banking environment that may affect implementation of the PSCEP access to finance project. There are currently 46 banks, of which PSCEP identified 12 banks to interview at length. These 12 banks also included the five banks currently participating in the USAID/FSSP project. In these bank meetings, PSCEP described the general framework of how the SME lending program will be implemented within their bank and the benefits to be derived. PSCEP made in-depth inquiries about each bank’s respective loan portfolio for quality, diversification, concentrations, etc. to determine if that bank would be an ideal candidate with which to partner. PSCEP emphasized that trade finance loans are essentially unsecured and the bank’s credit risk culture, corporate strategy, credit policies, senior management buy-in, and support of the SME lending program would be both crucial and essential for successful implementation of the program. The team used the following criteria in the selection and recommendation of the banks for participation in Year One pilot program:

1. Management buy-in: receptivity, enthusiasm and support for the SME lending program 2. Bank’s penetration in the market, particularly its branch network 3. Bank’s total assets: loan portfolio quality and corporate/SME client base 4. Knowledge and experience in cash flow credit analysis 5. Long-term corporate strategy and marketing plans 6. Bank’s credit risk culture and risk parameters 7. Easy and rapid integration of pilot trade finance products 8. Experienced and well-trained credit staff


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Based on the results and discussions with the 12 banks, the team (Richard Currie, Roberto Toso, and Ramal Jafarov), in consultation with USAID, recommends the following six banks to participate in the initial roll-out:

1. Mugan Bank

2. Rabita Bank

3. Bank of Baku

4. Royal Bank

5. Azerdemiryol Bank

6. Bank of Azerbaijan

Three of these banks (Mugan, Royal, and Azerdemiryol) are receiving USAID assistance under the FSSP program. Section III of this action plan provides an in-depth discussion of why the team, in consultation with USAID, considered these the banks most likely to generate quick results, including key metrics of the six selected banks, as listed above.

Based on our recent experience implementing pilot trade finance (TF) programs in other regional countries: Armenia, Moldova, and the Balkans, we strongly recommended PSCEP focus its initial effort on a limited number of banks to allow for the time to properly introduce, integrate and institutionalize these TF products into the banks before extending the program to the next group of banks. It is important to note that in strategic terms, a high level of success among a limited number of banks is much more important than a combination of success and not-so-successful efforts among a broader group. The team believes working with six banks initially is the best approach by which to provide each partner bank with the level of attention needed to implement the program and to make adjustments during the SME lending program to ensure the successful integration of the new loan products. A1. Benchmarks – New Trade Finance Products and Measurable Loan Results

The most important quantitative measure and benchmark for each bank will be its commitment and agreement to expand SME financing, including dedicating approximately 5,000,000 AZN from its loan funds for the SME lending program in Year One (the exact amount will have to be negotiated with each bank). Each partner bank will also commit to approve an agreed upon number of pilot trade finance loans from this allocation of funds, as well as show a willingness to innovate and enhance SME funding. These criteria are detailed in the Memorandum of Understanding (MOU) that each partner bank will sign with PSCEP. We have selected this amount based on our experience in other countries. The amount is sufficiently meaningful, reasonable for each partner bank at a time when many banks are suspending their lending operations, and also achievable in the Azerbaijani lending environment. It is important to highlight that at a very uncertain financial time, we are asking banks to significantly increase their risks through unsecured trade finance loans. In terms of timing, there has perhaps not been a worse environment for this task. On the other hand, PSCEP aims to convince banks that a crisis also brings opportunities. Once the pilot loans demonstrate they


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can be repaid at minimal risk to the bank, it will become easier for PSCEP to request these partner banks increase their funding allocations in Years Two and Three of the program. Another important point is that the overall commitment made in terms of loans (up to 30 million AZN total across the six banks) is not so crucial, in terms of ultimate impact. The key will be demonstrating that these products are profitable for the banks and clients, at which point overall lending will increase by many multiples. The partner banks will submit a monthly Trade Finance Loan and SME Tracker that will highlight the major trade finance loan terms and SME finance conditions, along with other key loan information, including: how the trade finance loan increased sales, supported exports, increased revenues, as well as the distribution of loans to male and female-owned companies. As noted above, PSCEP’s work in enhancing SME lending will not be limited to new trade finance products. On a continual basis, PSCEP will work with partner banks to promote increased lending to SMEs through additional sources such as leasing and documentary lending. PSCEP will also work with partner banks to help them more effectively utilize the credit lines available from the EBRD and the IFC.

A2. Methodology and Pilot Trade Finance Implementation Plan

The methodology and pilot trade finance implementation plan for the six partner banks will be as follows:

• Awareness-raising and training about the TF products for senior management and key credit staff;

• Assistance in reviewing and modifying, as needed, credit policies and procedures;

• Support in reviewing and modifying, as needed, trade finance loan agreements;

• Training for credit officers;

• Assistance in reviewing and processing initial trade finance loans, as part of the SME lending program;

• Support in promoting trade finance products to bank branches; and

• Assistance in developing and producing a preliminary marketing plan and materials, if appropriate.

PSCEP’s debt and equity access to finance components will also explore joint financing opportunities, particularly with an emphasis on the PSCEP-supported SMEs in the various value chains, which should prove ripe for co-financing, subordinated/mezzanine financing, and trade finance/equity investments. Moreover, PSCEP’s finance specialists, together with value chain specialists and the chief of party, will play a key role in promoting loan and equity packages for project targeted firms. This process has already begun. The implementation plan proposed herein is aggressive, especially in the current turbulent international and domestic financial/economic environment, which is likely to get worse before it gets better. By way of regional experience in implementing pilot trade finance programs in Kosovo, it took 18 months from introduction to when the first bank made the first TF loan. In Armenia, this took 2 years and in Moldova, which has the more sophisticated banking system of these countries, it took 8 months. We aim to cut this time by half. Is this possible or achievable? We believe so. But there will undoubtedly be challenges and we will constantly reassess the strategy and approach. We remain confident, however, that the commercial


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banking component will serve to increase access to finance for targeted PSCEP sectors and firms, as well as others beyond the scope of the project. B. Access to Equity Investments

In addition to access to debt financing, another critical channel through which PSCEP will promote growth, improve competitiveness and aggregate economic performance will be through the mobilization of equity financing to dynamic economic sectors and SMEs. New investments in plant, equipment and infrastructure and the corresponding new technologies and management disciplines that new investments bring are badly needed as many companies date from Soviet era where equipment and technologies have already been written off. Many companies therefore require sizeable investments that cannot easily be financed through debt alone. A relatively new and unknown source of capital in Azerbaijan is private equity, represented by the AIC, CIIC and the KAIC (in formation). So far, only AIC has closed transactions. It completed six minority investments worth approximately US$60 million and is evaluating another six opportunities. The industries where AIC closed transactions are in cement production, poultry, oil terminals, salt production, and dairy products. AIC is required by its charter to be minority strategic investors, participating with no more than 25 percent in the capital of a given company. CIIC may take majority positions up to 75 percent of a company, although at this time its “sweet spot” is also as a minority shareholder. In the case of AIC, excluded sectors for investments are the financial sector and up-stream oil and gas activities. In the case of the CIIC, which follows Islamic banking principles, excluded sectors are pork, alcohol, and investments in financial companies. Minimum investment requirements, industry sector limits and diversification criteria are also specified in the investment policies of both funds. Since private equity investments typically do not pay dividends, returns are derived from capital gains obtained upon exit. While a private sale to another company or a management buy-out can be attractive and effective exit options for equity investors, the preferred exit vehicle (if available) is often an initial public offering (IPO). In the current context of Azerbaijan with an under-developed and illiquid stock market, management of private equity funds faces major challenges of creating viable exit solutions. Mandated by their respective charters, both AIC and CIIC, include specific put option formulas and rights of first refusal clauses in the corresponding shareholders agreements. These formulas represent an exit alternative but they are mostly driven by legal principles rather than by value-maximizing principles. The Action Plan for the period February 2009 - January 2010 to promote equity investments in Azerbaijan will be executed in full partnership with the AIC and the CIIC, building on the extremely positive relationship that PSCEP has already established with these institutions. Both look to PSCEP for strategic and operational guidance, a significant program accomplishment in the program’s first semester of operations. The Action Plan is the result of an institutional review by PSCEP of the strengths and weakness of AIC and CIIC performed in conjunction with both entities. On this basis, PSCEP will provide technical assistance that will be carried out in four technical subject matter modules:

1. Transactions support and deal flow generation; 2. New financial product development and solutions;


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3. Business process support and capacity building; 4. Public awareness enhancement.

PSCEP’s Financial Value Chain Specialist (FVCS) with experience in Azerbaijan’s financial sector will be responsible for implementing these plans, together with the chief of party; and will manage the day-to-day working relationship with AIC and CIIC. PSCEP will provide technical assistance on a cost-sharing basis with AIC and CIIC, as well as the soon to be created Kuwait-Azerbaijan Investment Company (KAIC). The specifics of cost-sharing will be defined on a case-by-case basis.

Year One objectives for equity are:

1. Thirteen (13) transactions for approximately US$80 million analyzed by AIC and CIIC

with technical assistance from PSCEP.

2. From the thirteen (13) above-mentioned transactions, seven (7) transactions supported by PSCEP result in actual investments by AIC and/or CIIC (including debt financing and/or structured solutions of debt and equity) for no less than US$40-45 million.2

3. Four (4) product innovations and/or transaction-based financial (structured) solutions

completed.

4. AIC’s Investment Management and Performance Monitoring Department established with the contribution of PSCEP’s technical assistance.

5. “Private Equity Investment Analyst” certification training program delivered by

PSCEP.

6. Four regional and one national conference supported by PSCEP. 7. Ongoing assistance to AIC in promoting and educating the business community on

equity financing.

2 PSCEP has a first year target of US$50 million. This includes equity and debt financing, and investments made internally by companies PSCEP assists, as well as join ventures.


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SECTION II

Financial Sector Overview A. Overview

If a stronger banking and financial system can support and finance existing SMEs, encourage the entry of new SMEs, promote growth, and innovation, then a more developed banking and financial system in Azerbaijan will improve aggregate economic performance and the overall improvement of Azerbaijan’s economy.

Despite recent improvements and the ongoing technical assistance and training that is currently provided by a number of banking-related projects, especially by USAID/FSSP, SMEs and agricultural-related companies in Azerbaijan still have difficulties in accessing financing, particularly short-term working capital financing. Likewise, banks and other financial institutions have yet to fully capitalize on new market opportunities, especially outside of Baku. SMEs and micro-SMEs (MSMEs) have limited success in obtaining the financing they need to grow their companies; they are also faced with excessive collateral requirements and a limited range of financial products. Most of the commercial banks do not offer a full range of loan products, offering primarily overdraft facilities and term loans with maturities up to 24 months and sometimes 36 months. Due to the lack of long-term funds except for the on-line credit facilities, most banks cannot provide term loans maturing beyond three years. Nevertheless, some of the more sophisticated banks acknowledged that they match loan structure with loan purpose to the best extent possible. At the same time, the banks are not creative or aggressive in developing new loan products that meet the financing needs of their customers. The majority of bank loans are secured using immovable and movable assets as collateral with loan-to-collateral values of 150 percent. Interest rates, while market competitive, are fairly uniform throughout all banks, ranging usually from 18 to around 28 percent, and sometimes up to 30 percent. Difficulties in obtaining financing have been further exacerbated as a result of the current turbulence in the global economy, where many Azerbaijani banks have slowed down or temporarily suspended all lending to new clients.

The size and market share of the 46 commercial banks in Azerbaijan range from the International Bank of Azerbaijan (state-owned), which has a 43 percent market share and is the largest single bank, to the bottom 30 commercial banks, which each have a market share of 1 percent or less. The remaining 14 commercial banks that constitute the “middle tier” have market shares ranging from 2 to 6 percent. (See Appendix A: Banks Total Assets and Market Share of the 46 Commercial Banks)

There are 142 credit institutions, including 96 non-banking credit organizations (77 credit unions and 18 credit organizations funded by international humanitarian organizations), and 46 licensed commercial banks in Azerbaijan. Commercial bank finance is the traditional source of finance for larger firms. According to a recent Moody’s report, the Azerbaijani banking system is highly concentrated at the top, with the six largest banks controlling approximately 70 percent of the system's total assets. But the system remains relatively fragmented at the bottom, with other 40 banks accounting for the remaining market share. Government-owned banks have historically dominated the sector and the concentration of state ownership is still high. Privatizations have left the country with just one government-owned bank, although it is the dominant bank in the system: The International Bank of Azerbaijan. Foreign banking presence (primarily investments in local banks) is still modest but hopefully will increase in the near


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future as interest from foreign banks wishing to purchase stakes in local banks grows as macroeconomic stability and opportunities offered by Azerbaijani markets develops.

The National Bank of Azerbaijan (NBA) performs regulatory and controlling functions. As regulator, the NBA adopted a risk-based supervision model and is following the Basel I foundations, while it implements Basel II preparatory procedures. Modern trends in transactional lending suggest that improvements in information availability (for example, through the development of credit registries) and technological advances in analysis of this improved data (for example, through the use of automated credit appraisal) are likely to improve financing opportunities for SMEs. Azerbaijan is currently expanding the coverage and improving the collection and dissemination of credit information through its credit information registry. Relaxation of collateral regulations is also being implemented, allowing movable assets as acceptable collateral to secure loans.

Relationship lending (which relies on personal interaction between borrower and lender and is based on an understanding of the borrower’s business and not just on collateral or mechanical credit scoring systems) remains important in Azerbaijan for larger firms with established commercial bank relationships, which in most cases are part of the same holding company, and for micro-enterprises that are closely linked to microfinance institutions. Because relationship lending is costly for the lender, it requires either high spreads or large volumes to be viable. If the customer’s creditworthiness is hard to evaluate, there may be no alternative to relationship lending. Indeed, limited access to credit in Azerbaijan may be attributable to the reluctance of existing intermediaries to do relationship lending on a small scale. Difficulties in accessing finance have been exacerbated as a result of the current global financial crisis. Domestic banks in Azerbaijan are finding it increasingly difficult to borrow internationally. Also, as a result of the high rate of inflation (officially more than 20 percent per year as end of 2008) and low public trust in commercial banks, mobilization of local deposits constitutes a challenge. As a result, commercial banks are severely restricting lending in the domestic market despite recent economic measures aimed at freeing bank liquidity in the banking system. Many businesses (mainly MSMEs) have limited experience (or success) in getting the financing they need to grow their companies. B. Credit, Legal Regulatory and Collateral Issues

The meetings with the banks and other financial institutions revealed that the types of loan products offered to clients were similar throughout the majority of the banks. Except for the donor-funded on-lending facilities (approximately ten banks have access to these facilities), which allow for longer maturities of up to three to five years, and more generous repayment terms with some creativity in loan structure (grace periods, etc.); all the commercial banks essentially offer the same loan product: maximum two years (in rare cases three years), with immovable and movable assets as collateral, very little unsecured lending and interest rates that are market competitive, ranging from 18 – 30 percent maximum. Cash flow analysis and an understanding of cash flow and its implications for repayment of a loan ranges from good to almost non-existent at the banks. According to the USAID/FSSP consultants, the majority of the banks over-rely on the perceived strength of collateral as the source of repayment, whether or not there is a legitimate and real market value in the event of a distressed sale. The concept of cash flow and “Cash is King” is still sorely lacking. This opinion was expressed very clearly by the USAID/FSSP team during our meetings on their assessments to date of the credit skills and knowledge of the banks in their program. In


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addition, PSCEP held extensive discussions with the USAID/FSSP consultants on various credit-related topics, the quality of their banks’ loan portfolios, the quality and depth of bank management, corporate governance, MIT systems, etc. USAID/FSSP’s input was invaluable in helping PSCEP focus on key issues within the banks interviewed. The banks with on-lending facilities have certainly benefited from the technical assistance and training that is provided concurrently with the on-lending lines of credit. Some banks have also received technical assistance from consultants and other in-house advisors, from which they have also clearly benefited. But, in banks dominated and controlled by a single major shareholder or where the top two to three members of management make all final decisions, these banks appear the weakest in credit skills, knowledge and attitude. These banks are the very small banks that control no more than 1 percent of market share. The Azerbaijan Bank Training Center, which is a self-supporting bank training center, offers a comprehensive schedule of credit courses taught by both trained and experienced Azeri bankers, as well as foreign bank consultants. The technical assistance and training offered in conjunction with the on-lending SME facilities, the donor-funded banks and financial sector projects and the Banking Institute are collectively and over the long term providing much needed credit training to help improve the quality and skills of credit officers and bring them up to best banking practices and standards. PSCEP met with USAID/TIRSP project and had an extensive meeting regarding the current banking law, civil code, legal system and the enforceability of judgments; areas in which TIRSP has been working. According to USAID/TIRSP and again confirmed by the USAID/FSSP, the banking law places no restrictions on collateral values or the kinds of assets banks may accept as collateral other than that the bank must follow and adhere to its own credit policies and procedures. NBA examiners do not place any value or even suggest a “market value” when reviewing loans that use “soft assets” as collateral. Approximately 99 percent of all commercial loans, however, use hard assets as collateral (immovable property: machines, equipment, land, buildings, household items, cars and vehicles, jewelry, etc.). There is no real functioning credit registry at present for immovable assets such as apartments, but real estate can be registered at the local regional office of the State Registry and this provides some modicum of comfort to the banks. In addition, the civil code does have language for movable property, which could strengthen the position of the banks when seeking a judgment. Some of the banks extend “unsecured” short-term loans utilizing overdraft facilities, but again only to their very best clients. Another very critical issue that hinders banks in using soft assets (bills of exchange, assignment of cash flows, purchase orders, supplier contracts, accounts receivable and inventory, personal and corporate guarantees, etc.) as collateral is that there is also no credit registry for accounts receivable and inventory and thus, the banks cannot take formal liens against these assets. A borrower can sign an Assignment of Accounts Receivable and Inventory Agreement, however, this is more of a “moral hazard” protection and basically a “gentleman’s agreement” that the borrower will not dispose of the collateral. In the worst case scenario, the bank may get a court judgment against the borrower and the soft asset collateral, but the judgment is unenforceable. Again according to the USAID/TIRSP project, the lack of an adequate legal framework is one of the key obstacles that currently prohibit the banks from taking the following soft assets as collateral. If a bank does take any of the above listed assets as collateral and the loan is not repaid, then the bank has no means of enforcing against these assets since the legal system and civil code do not yet recognize these as valid collateral instruments. Bills of Exchange, which


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are a very common piece of collateral for purchase order finance (POF) and other trade finance loans, also called “Weksel” in Azerbaijan, can be taken as collateral but they constitute possession rather than legal title. According to USAID/TIRSP, it is possible for the banks to take an “Assignment of Cash Flows,” whereby the buyer of goods pay directly to a lockbox or segregated and blocked account at the bank in favor of the borrowing company, but it is not clear if and how many banks are utilizing this procedure. The civil code recognizes and allows banks to take personal and corporate guarantees for SME loans, but these guarantees also cannot be enforced through court process and procedures. As a result, all of these constraints will affect the successful implementation of the pilot trade finance efforts. For example, it cannot yet be determined if any of the partner banks have the risk capacity or desire to approve a POF loans that relies almost exclusively on the purchase order and the company’s cash flow as the sole pieces of collateral. This same concern applies to the approval of an accounts receivable loan where the singular collateral is accounts receivable that cannot be legally assigned, registered or enforced against in the worst case scenario. The mitigating factors, however, are that the partner banks will initially only offer these specialized trade finance products to their current best SME and corporate clients. This will help to minimize the risks associated with making an unsecured loan since the bank should already have a history of loans with the client along with an in-depth knowledge of the borrower’s cash flow and repayment history. USAID/TIRSP consultants indicated that one of the most important NBA regulatory issues is the legal lending limits that the NBA has established for the banks; the NBA seeks to ensure the commercial banks do not exceed their respective lending limits based on capital requirements. The NBA is also less concerned about the kinds of loan products the banks offer and collateral that the banks take. Banks can make unsecured loans, based on their own credit policies and risk management, and the NBA defines unsecured loans as a “loan for which either no collateral has been provided for, or if so, it has no market value, or where, regardless of value, it has not been properly registered or notarized.” This language is critical and supportive for PSCEP’s pilot trade finance effort because trade finance products are usually treated and classified as unsecured loans due to the nature of the soft assets taken as collateral. The current banking regulations date from 2003 with some recent amendments dating from August 2008. The NBA will promulgate revised banking regulations starting sometime in March 2009. For fully secured loans, the NBA states very clearly “that an asset pledged as collateral must be in the amount equal to 150 percent of its minimum market value.” At present, there is an approximately 67 percent loan-to-assets ratio among all the banks, so the balance of bank funds seems to be invested in government securities or other short-term liquid instruments. Although some of the banks expressed the urgent need for additional funding, primarily long-term funding, it also seems the bank system is more liquid than they want to acknowledge. The banks may fall prey to the risk of making bad loans as a result of the pressure to increase assets or to accommodate their “relationship-related” banking clients. Most funding, except for the on-lending facilities, is dependent on deposits, which are short term. Banks engage in “relationship” banking more heavily than usual. Most SMEs do not use the banks because they lack sufficient collateral of the quality and type required by the banks, and the absence of trust between SMEs and the banks. Consequently, many SMEs rely on outside funding sources. According to USAID/FSSP, a major bank concern though is the lack of transparency in the SMEs’ financial statements and the weakness or complete absence of general accounting principles or even basic financial management skills. Most SMEs function outside the banking system because they do now want to report


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sales or revenues, thus requiring them to pay higher taxes on reported net income. Also, SMEs do not want to register invoices or sales orders, again for tax purposes. Thus, the cash economy dominates. Based on the information gleaned from the bank interviews, only about 10 percent of SMEs operate within the banking system. There are approximately 300,000 registered SMEs, including physical persons, with about 170,000 SMEs functioning as operating, viable and ongoing entities. About 35 percent of all commercial bank loans are trade related, but this is trading of finished goods. A small number of Azerbaijani SMEs are classic manufacturing or producing companies, and the total value of exports is still relatively small given the country’s potential. PSCEP recognizes there is a long list of challenges, obstacles and constraints that will have an effect on the successful implementation of the SME lending program. It is not within PSCEP’s scope of work to address the legislative gaps and weaknesses in the banking system. The USAID/TIRSP project may over time work to address and resolve some of the issues within the legal system, and PSCEP intends to work closely with USAID/TIRSP to address and resolve any financial sector legal constraints. While it will be difficult to implement the pilot trade finance program under an accelerated timeline, it is hoped that the initial group of six partner banks will have the vision and long-term corporate growth strategy to understand the value of introducing these loans. C. Major Sector Assistance Programs and Instruments

C1. USAID/FSSP - Financial Sector Stability Program (FSSP)

C1a. Commercial Banking Component

The USAID/FSSP currently works with the following five commercial banks: Azerdemiryol Bank, Mugan Bank, Royal Bank, Atra Bank and NBC Bank. These five banks are presently receiving extensive technical assistance and training on various topics related to SME lending, risk management, IT/MIS, deposit mobilization and marketing of financial products in order to improve and enhance their credit skills and knowledge with SME companies. Azerdemiryol is the only bank not receiving technical assistance on the IT/MIS component because the bank is currently installing new and sophisticated software (SAP). A description of FSSP’s work by component follows: Lending

Based on international best practices, each of the five banks receives technical assistance and training to ultimately improve the quality of and increase the number of loans to SMEs. The technical assistance begins by consultants first reviewing each bank’s existing credit policies and procedures, then recommending the necessary changes to incorporate best banking practices and standards, and then conducting training for the loan officers in order to teach them best practices and methodologies for banking, along with the requisite credit analysis tools. This technical assistance is done via workshops, formal classroom instruction and on-the-job training with loan officers. In conjunction, the USAID/FSSP project is also making the necessary changes to the organizational structure of the credit departments. The technical assistance and training is ongoing with differing levels of progress by banks, as to be expected. But, it is reasonable to conclude that as a result of USAID/FSSP efforts, that in the long term, these five banks will have more sophisticated systems in place and better trained


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loan officers. These improvements and enhancements by USAID/FSSP will contribute immensely in the long term to the success of PSCEP’s SME lending program. In addition, USAID/FSSP’s efforts will lay the foundation for the introduction of well-designed and better monitored lending products and services. Risk Management

Azerbaijani banks are very weak in risk management and many banks have little to no understanding or knowledge of risk management. Many banks do not even have an institutionalized Risk Management Department. The USAID/FSSP project is focusing on improving risk management to mitigate the credit risks and to ensure and maintain the quality of their loan portfolios. USAID/FSSP ensures that the design and delivery of risk management policies and procedures is based on banking best practices. The staff of the Risk Management Departments in each of the five banks is given applicable and concrete tools on how to mitigate and manage the risks, both real and perceived, at their respective bank. IT/MIS

Banks have software programs to manage the daily operations of their bank. But, many of them do not have sophisticated and integrated MIS reports; often many MIS reports are developed manually and, as a result, many reports are unsophisticated, prone to errors and are labor intensive. USAID/FSSP has introduced four types of MIS reports that are automatically generated for loan monitoring. This provides management will real time reports in order to make prompt and effective risk-related decisions. Currently, three out of the four USAID/FSSP partner banks (excluding Azerdemiryol) have already finished the design and implementation of the MIS reports. It is expected the four participating banks will begin to utilize these reports. These four MIS loan reports will create opportunities to control growth, ensure quality and manage risk. These MIS reports will also have a significant role in guaranteeing the quality of and mitigating the credit risks associated with PSCEP’s trade finance loan products. Deposit Mobilization/Marketing

One of the main problems the banks face is the lack of adequate financial resources. This gap is further exacerbated by the current turbulence in the global economy. USAID/FSSP is also focusing efforts to significantly increase the local deposit base of the banks through the development of new deposit products to meet the demands of the local market, and by offering attractive and competitive market rates. Over the next several months, it is expected these partner banks will offer newly-designed deposit products that will meet market demands. Increasing the local deposit base of the banks will directly support and contribute to PSCEP’s goal to offer new and innovative short-term trade finance products to SME companies. The ongoing financial crisis and worldwide credit crunch has increased interest among participating banks in this activity. C2. USAID/Trade and Investment Reform Support Project (TIRSP)

USAID has also undertaken an important project that is reviewing and making significant revisions and changes to commercial banking regulations through the USAID/TIRSP Project, including the current banking law, civil code, legal system and the enforceability of judgments. The analysis and work undertaken by TIRSP and confirmed by the USAID/FSSP project, has indicated that banking law places no restrictions on collateral values or the kinds of assets


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banks may accept as collateral, other than requiring banks to follow and adhere to their own credit policies and procedures when making loans on a secured or unsecured basis. (See Section B on “Credit, Legal Regulatory and Collateral Issues,” for more details.).

C3. British Petroleum

British Petroleum (BP) and its co-ventures are currently funding a Suppliers Funding Facility or SFF (essentially a rediscount program) aimed at supporting the provision of sources of funding for SMEs and MSMEs in Azerbaijan. The SFF is designed to give Azerbaijan's local oil and gas industry supplier and service enterprises greater access to transparent sources of financing. Access Bank (formerly Microfinance Bank of Azerbaijan (MFBA)) recently issued its first SFF to the local Azerbaijani company, Azmetco, which specializes in installing meter services. It is the first enterprise to receive a SFF loan under the BP/IFC Supplier Linkage Program. Resources for the SFF are provided by BP, the IFC, and Access Bank. Loans to local suppliers are backed in large part by the local companies’ contracts with BP and its partners. The project is in line with BP and its partners’ target to double their total spending with locally-owned companies by 2010, raising it to over US$500 million year. Local companies eligible to receive SFF loans are selected through competitive pre-qualifications by BP, then are passed through Access Bank’s credit appraisal, and receive final credit approval from the SFF Credit Committee, which comprises representatives of the three parties involved. This pilot project is being implemented through an IFC grant agreement to Access Bank and a total loan capital of US$316,000. BP provides US$140,000 on behalf of its partners, IFC provides US$140,000 (of which US$20,000 is for technical development and appraisal of the pilot phase), and the remaining US$56,000 is invested by Access Bank. In 2007, BP through its Regional Development Initiative also signed a US$1 million grant agreement with the IFC to support access to finance for MSME in Azerbaijan’s western regions. C4. European Bank for Reconstruction and Development (EBRD)

EBRD has four programs aimed at facilitating the access to finance for SMEs in Azerbaijan: an SME on-lending program with nine commercial banks, a trade facilitation program, a program for non-bank entities to access remote rural areas through microfinance institutions, and a co-financing program for “larger SME’s” through four commercial banks. EBRD and BP launched a contribution agreement aimed at creating transparent and effective access to commercial finance for local businesses including SMEs and MSMEs. Under this agreement, BP and its co-ventures contribute US$5.25 million and EBRD co-finances operations in an amount at least matching the contribution of BP and its co-ventures. It is a three-year program that started in the fourth quarter of 2006 and is used to provide loans and technical assistance to local businesses and enterprises. The program is implemented by EBRD through separate agreements with a number of local financial institutions. The vehicles for implementation consist of on-lending and technical cooperation funds to well-established, commercial non-bank microfinance institutions and commercial banks. The selection of both types of institutions and eligible local small and medium size enterprises (SMEs) is made by using EBRD’s and local financing institutions’ criteria.


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C5. German Azerbaijan Fund (GAF)

The GAF/KFW facility is playing an important role in SME lending. This on-lending facility is working with eight commercial banks, providing credit lines as well as technical assistance to selected MSMEs. D. Trade Finance Loan Products

The following trade finance loan products will be proposed and introduced in PSCEP’s pilot during the three-year timeframe. A brief description is provided as follows:

• Purchase Order Finance

• Pre-Export Financing

• Accounts Receivable Financing

• Warehouse Receipt Financing

• Factoring

• Leasing

D1. Purchase Order Finance

Purchase Order Finance (POF) is a transaction specific form of short-term working capital, which is used to pay job specific vendors and other costs associated with completing production and making delivery of a purchase order. It is a highly targeted form of trade financing, which allows an SME to fill a purchase order. When designed and implemented properly, POF loans can increase sales and revenues, can generate new employment, impose credit discipline on the SME, make the SME eventually more “bankable,” and provide excellent returns and profitability to the bank. POF loans are attractive to SMEs for the following reasons:

• Obtain the financing needed to increase sales

• Lower collateral requirements

• Short repayment terms

• Increase sales and revenues

• Generate new employment

• Lower total interest costs, because the company only borrows for the time period of the transaction; SMEs can then use the savings to further grow

• Develop credit discipline and establish a proven lending history; companies become more “bankable”

• Increased competition in the banking system improves loan terms and conditions. D2. Pre-Export Financing

Pre-Export Financing (PEF) is often very similar to POF, but it is specifically tailored and designed for export orders. PEF is structured and analyzed in exactly the same manner as POF loans, but PEF requires additional export-related documentation.


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D3. Accounts Receivable Financing

Accounts Receivable Financing (ARF) is another type of short-term working capital trade finance loan. In the context of value chain financing, ARF is usually the type of short-term trade financing banks usually introduce following POF loans. ARF is used when an SME, due to the nature of its business (low value added, high volume), is under-capitalized and has a permanent short-term working capital finance need. ARF is typically provided to traders, wholesalers, retail, distributors, processors, producers and SMEs that maintain large inventories and consistently generate sizable accounts receivable. In some cases, banks may offer ARF as interim financing that extends from several months (short-term financing) to several years (revolving line of credit). D4. Leasing

Another important financial instrument, especially for the agricultural sector, is leasing, which has expanded rapidly in Azerbaijan in recent years. Much of the work in this area has been to introduce producers and agribusinesses to leasing basics, which is a necessary first step.

Only financial leases are currently offered in Azerbaijan, primarily by Unileasing along with the leasing subsidiaries of several banks. PSCEP will focus on the development of operational leases, which are currently not developed in Azerbaijan due to the 18 percent VAT charges. The Action Plan allocates resources for a leasing consultant to come to Azerbaijan in September/October 2009 to assess the leasing market and to develop an implementation plan, if feasible. D5. Factoring

Factoring is not currently developed in Azerbaijan but is being explored by the IFC and BP. Factoring is a type of supplier financing in which firms sell their creditworthy accounts receivable at a discount to a financial intermediary (generally equal to interest plus service fees) and receives immediate cash. The advantage of factoring is that it is not a loan and there are no additional liabilities on the company’s balance sheet, but it does provide immediate working capital financing. In addition, factoring is often done “without recourse” in that the financial intermediary that purchases the receivables assumes the credit risk for the buyer’s ability to pay. Factoring can be a powerful tool in providing financing to high-risk suppliers with a lack of market information. Factoring’s key virtue is that its underwriting is based on the risk of the receivables (i.e., the buyer) rather than the risk of the supplier. Therefore, factoring is particularly well-suited for financing receivables from large foreign firms (i.e., BP) whose receivables are the obligations of buyers who are more creditworthy than the sellers themselves.

Some of the key advantages of Factoring are:

• Improved cash flow, increased liquidity, enhanced profits and strengthened overall financial condition of the SME

• With an improved cash flow, the SME may be able to take advantage of trade discounts that were previously unavailable

• SMEs can remain competitive in their markets by granting more liberal credit terms when required and without retarding their cash flow


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• Money and time can be applied to more productive functions rather than on credit and collection activities

Factoring is the riskiest type of trade financing and the development and introduction of factoring into the PSCEP program will be explored in Year Two of the project, only after the successful integration of the POF and ARF. D6. Warehouse Receipt Financing

Warehouse receipt financing is a another type of short-term trade financing in which the bank advances funds against inventory goods stored in a warehouse that have been assigned to the bank through warehouse receipts. Warehouse receipts give the bank title to the inventory goods until they have been sold and the proceeds collected. The borrowing company usually arranges for the storage of goods in an independently controlled warehouse, which issues warehouse receipts for the goods deposited. The warehouse receipt is a title document and possession is evidence of ownership of the goods. E. Experience of Trade Financing in Other Countries

Trade finance products and leasing have been introduced and implemented successfully in other countries, which share economic characteristics, constraints or challenges that are similar to Azerbaijan, such as countries in the Balkans and the Caucasus. Technical assistance and training to banks and other financial institutions to introduce POF, ARF, leasing and other types of trade finance products has been provided in Armenia, Moldova and two Balkan countries: Macedonia and Kosovo. In Armenia, under a USAID-funded project, 51 new trade finance loans were approved totaling over US$4.3million. In addition, trade finance workshops and business-to-business meetings between banks and MSMEs were organized to facilitate the introduction of trade financing in Armenia. In Moldova, again under a USAID-funded project, 29 new trade finance loans were approved totaling almost US$4.5 million. In Moldova, approximately US$1 million in new leases, both financial and operational, have also been extended. In Macedonia, trade financing was introduced under a USAID-funded project, which transformed into a self-sustaining Macedonian-registered commercial finance company and to date has approved over US$13 million in POF and ARF trade finance loans. Trade Financing is just now being introduced in Kosovo to jump start economic growth in that newly independent country. The design and implementation of POF and other short-term trade finance products as described above under USAID assistance has helped to increase the revenues and profits of the companies, on average, by approximately 25 percent and over 500 percent on a year-to-year basis, generated new employment on a permanent and sustainable basis, and last, supported over US$50 million in new exports. F. Capital Markets Development

Formal exchange offerings are not an effective mechanism for companies to raise funds in Azerbaijan. In fact, most companies do not rely on exchange financing or even on public offerings. A January 2009 preliminary capital markets assessment prepared by USAID, concluded that based upon 240 trading days in the Baku Stock Exchange (BSE) during 2008, the number of secondary market transactions in corporate securities (stocks and bonds) on the BSE averaged less than nine transactions per day. Of the 2.785 billion AZN in non-repo


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turnover at the BSE in 2008, corporate securities trading volume comprised only 240 million AZN, or 8.7 percent. The transaction volume sustaining the business operations of BSE and its related institutions and firms is composed predominantly of trades in Treasury Bills and NBA notes. Nonetheless, even the comparatively greater government securities trading volume is insufficient to achieve liquidity in the government securities market or a reliable government securities yield-curve as a benchmark for developing a corporate bond market. According to the USAID assessment, the NBA is the largest issuer of government securities, which is part of its liquidity management and sterilization programs. The Ministry of Finance is a smaller issuer of government securities, however, with no regular or reliable program for issuances. Both institutions predominantly issue securities with one-month maturities. The primary issuances from both institutions exclusively trade, clear and settle on the Baku Stock Exchange. Approximately 60 percent of trading in the Ministry of Finance issued Treasury Bills is attributable to foreign investors. The USAID assessment also mentions that corporate securities traded on the stock exchange are equal to less than one-half of one-percent of Azerbaijan’s GDP. According to market participants, the BSE does not serve as price discovery mechanism or a meeting place for buyers or sellers. In fact, neither price discovery or price signaling occurs in the corporate securities market, because current market regulations do not require reporting actual trade prices. Many core objectives and principles of the International Organization of Securities Commissions (IOSCO) relevant to securities regulations are not in place in Azerbaijan. A broad range of policy and regulatory interventions aimed at improving market organization and operational infrastructure; with particular emphasis in the area of corporate transparency and governance are needed. Some of the 35 companies whose shares are listed on the BSE raised fresh capital in 2008 through securities transactions that cleared through the BSE. Ninety percent of those listed companies that raised additional capital through exchange-related transactions were financial sector businesses – over 75 percent of these issuances of corporate equity and debt were for the benefit of the domestic banks. Insurance and leasing companies accounted for about 15 percent of new intermediation through the issuance of securities. According to the USAID assessment, the issuance of stocks or bonds to raise capital for listed companies in Azerbaijan is achieved through a process that is consistent with private placements. This is not an uncommon practice. International experience shows that in developed and emerging countries owners of most companies raise funds first from family, friends and trading partners, and then use their own equity for later additional financing. In recognition of this pattern, some developed markets have built a legal mechanism that permits companies to go beyond their limited circle in seeking funding, but does not entail the time or expense of making a public offering. The so-called private placement can be very useful for encouraging growth and for addressing the incentives, preferences and market structure issues that are characteristic of primary market growth in many emerging markets. USAID’s assessment explains that in Azerbaijan the legislative framework supporting private placements is permitted under the civil code through a transaction termed ‘addressed sale,’ but that process is still under-developed and undefined. The process of financial intermediation outside the BSE needs to be completely overhauled to better facilitate the financial growth of enterprises. Private placements in Azerbaijan can be successfully developed as a valuable source of fresh capital and as an alternative and complement to the still incipient stock market. However, private placements will only flourish


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in an environment of clear regulatory "safe harbors," under which both issuers and investors can operate with confidence. A relatively new source of capital in Azerbaijan is private equity, represented by the AIC, CIIC and KAIC (in formation). These private equity companies were established with the purpose of bringing sorely needed investments in plant and equipment, as well as new technologies and modern management practices to existing and emerging companies in Azerbaijan. As of March 2009, only AIC has closed equity transactions. It completed six minority investments for approximately US$60 million and is evaluating another six opportunities. The industries where AIC closed transactions are in cement production, poultry, oil terminal, salt production and dairy products. Dictated by its charter, AIC is a minority investor, investing no more than 20-25 percent in a company. CIIC may become a majority investor but, in practice, prefers minority investments. In the case of AIC, excluded sectors for investments are the financial sector and up-stream oil and gas activities. Minimum investment requirements and industry sector limits and diversification criteria are also specified in the investment policies of both funds. The emerging private equity industry in the country is a promising new source of financing and if professionally developed can become a significant engine for economic growth and innovation. PSCEP’s consultants met with AIC and CIIC and conducted a preliminary institutional review of their strengths and weaknesses with respect to organizational structure, internal procedures and technical skills of their core staff. The review revealed that both entities are in their infancy and are in need of sustained and focused technical assistance to improve their capacity to identify, analyze, monitor and manage equity investments, as well as to create deals and structure adequate financing.


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SECTION III

Bank Selection

A. General Approach

The PSCEP team developed a process to identify the best qualified and receptive banks to be considered for inclusion into the SME lending program. This process initially involved meeting with USAID/FSSP, representatives from the EBRD, the IFC, ADB and the GAF to garner their views and input about the “best and most progressive” banks, as well as their views about the challenges and opportunities in the current banking environment. There are 46 banks in Azerbaijan, of which the team then short-listed 12 banks to interview at length, to finally select six. The selection process incorporated five banks in the current USAID/FSSP, and the team decided on the remaining eight banks based on PSCEP’s preliminary assessment of the “best qualified.” The preliminary assessment of these eight short-listed banks revealed they had total assets ranging from 180 million AZN to 387 million AZN and market shares ranging from 2 to 4 percent. Based on this preliminary judgment, PSCEP determined they would be the most qualified to interview for possible participation in the SME lending program (See the table in Appendix A on Banks’ Total Assets and Market Share). These eight banks also have agricultural-related and SME on-lending programs that are financed through their own internally-generated funding sources (primarily deposits), as well as various donors, including the EBRD, the IFC, GAF, the State Fund for Entrepreneurial Support, etc. This lent further support and credence to their potential for introducing the new trade finance loan products.

Almost all of the 12 banks short-listed and interviewed acknowledged they are taking a very cautious and prudent approach to lending during 2009, whether the loan proposals are from current or new clients. These banks also indicated they are more likely approve a new loan to a very good existing client, but would be much more cautious reviewing a loan proposal from a new client. With banks seemingly now in retreat, this is likely to affect PSCEP’s ability to rapidly implement the SME lending program. The obvious solution, which has been discussed and agreed upon with the banks, is to introduce the pilot trade finance loan products first to the bank’s current best corporate and SME clients. Following a review of the results of the SME lending program, PSCEP then will suggest the banks extend the SME lending program bank-wide to its other branches. Eventually, the banks could offer the trade finance products as a newly-offered loan product to all clients under a comprehensive and well-designed marketing effort. Although lending has slowed down considerably, the banks interviewed and especially those selected, expressed interest and believe there is sufficient demand and market for this SME lending program because they are more comfortable allocating funds to the short-term maturities of trade finance loans.

B. Commercial Banks Short-listed and Interviewed

Royal Bank

Royal Bank (RB) is one of five banks in the USAID/FSSP. RB senior management was very supportive and enthusiastic during the introductory meeting about the SME lending program. RB is primarily a retail/consumer bank with limited but growing exposure to MSMEs. RB has expanded aggressively through the franchising of branches which seem to operate semi-


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autonomously and independently of the main office. Most loans are under 5,000 AZN. SME loans are mostly to construction companies and agriculture-related companies. RB does not lend to dairy or poultry, but does lend to food processors and producers. RB provides letter of credit (L/Cs) and letter of grants (L/Gs) and wants to further develop its trade finance department.

In meetings with management, RB indicated it needs further technical assistance for L/Cs and L/Gs and assistance in lending in general. To date, RB credit staff does not undertake its own credit analysis and relies almost exclusively on an insurance collection (NOT insurance guarantee), which is provided to each borrower by a related insurance company. For example, if a loan is not repaid after 90 days, then the insurance company collects the loan and pays RB. The insurance company assumes all credit and collection risks; in this sense, RB is more of a loan processor, than a bank. For a variety of reasons, RB is looking to change this business model and become a more traditional bank. The USAID/FSSP team is implementing a comprehensive training and technical assistance program that should reap improvements and results over the long term in improving the credit skills of the loan officers. This program will be expanded in April-May 2009.

PSCEP wishes to take advantage of the significant eagerness and good will from its management team to participate in the program and expand its operations. For this reason, it

will be one of the six banks incorporated into the SME lending effort.

Mugan Bank

Mugan Bank (MB) is also one of the banks in the USAID/FSSP. MB is more Baku-centric with 24 branches in Baku and six in rural areas. The bank’s loan portfolio is about 70 million AZN and of this about 80 percent is SME and MSME focused. MB lends to all sectors of the economy, including manufacturing, health, agriculture, dairy, poultry, etc. MB provides working capital loans, loans to purchase fixed assets with maturities up to 18 months and term loans with maturities up to three years. But, MB emphasized they structure the loan to the purpose and thus can be creative in accommodating a client’s financing needs. MB provides L/Cs and L/Gs under a US$ 2 million EBRD line of credit.

MB is one of six banks selected for the SME lending program. MB was selected based on senior management’s very supportive buy-in and response to the SME lending program. More importantly, MB management indicated the bank needs these types of short-term loan products, strongly believes they will meet the short-term working capital needs of their SME clients, and the SME lending program could be quickly and seamlessly integrated within the bank, resulting in fairly rapid results and success. MB has been implementing MSME lending program using EBRD and GAF funds and achieved good results having a good SME client base. Last and significantly, MB has the short-term financial resources to allocate to these pilot loans.

Azerdemiryol Bank

Azerdemiryol Bank (AB), is also one of the USAID/FSSP banks, and is one of the 10 largest banks in Azerbaijan. AB’s loan portfolio is 170 million AZN, of which 60 percent is MSME and SMEs. AB approves business or corporate loans ranging from US$10 million to US$1 million, but the average size business loan from the banks’ own funds is around US$50 million. AB participates in the State Fund for Entrepreneurial Support with US$14 million in


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funding for loans to agriculture, food processors, and farmers. AB only provides L/Cs and L/Gs to poultry and potato farmers for the purchase of grains and chickens. Rural companies and credit officers, particularly in the branches are weak in general banking knowledge and skills, according to management. AB has had mixed results, more negative than positive, with their trade finance on-lending program and the bank has only approved about 25 percent of all trade finance loan requests submitted. This again is due to weak to poor credit skills and knowledge, as well as the weakness of the loan proposals, according to senior management. Nevertheless, the USAID/FSSP has an aggressive in-bank credit training program that is well underway and should reap very positive results and improvements in the credit skills of the loan officers.

With the generous on-lending facilities, management buy-in and an on-going credit

training program, AB was invited to participate in the PSCEP SME lending program.

Their participation in the program is an excellent complement to their existing work with

USAID/FSSP.

Bank of Baku

Bank of Baku (BB) is clearly one of the better managed and more credit-worthy banks, with better skilled, trained and experienced credit officers. Moreover, senior management is implementing more transparency, corporate governance and classic banking models and corporate culture that will foster accountability. BB is the largest retail bank and also has one of the largest SME loan portfolios; SME lending is about 30 percent of their 135 million AZN total portfolio. BB lends to the construction sector, agriculture, manufacturing, and trade and services. The EBRD has on-lending facilities for L/Cs, L/Gs, export financing and the ADB provides on-lending for documentary collections. BB offers only financial leasing, not operating leases.

BB is one of six banks that invited to participate in the SME lending program based on

the following positive indicators. BB management indicated it needs short-term loan products, and ideally short-term trade finance products. The bank’s credit analysis approach concentrates on cash flow and the financial condition and strength of the borrower, and less on the loan purpose. Therefore, BB tailors the loan structure to accommodate the clients financing needs. BB management also said the bank has excess liquidity, so funding is not a problem, however, the excess or available liquidity and funding is only available to their best current clients at this time due to the global economic crisis.

Bank of Azerbaijan

Bank of Azerbaijan (BoA) has a loan portfolio of 80 million AZN, of which 60 percent is corporate. Corporate lending, however, in Azerbaijani banks seems to be defined more as traditional SME and MSME lending, with very few genuine “corporate-size” clients. In the near future, BoA plans to implement new credit policies for SMEs and micro lending. BoA indicated it lends to all key economic sectors: trading, light manufacturing, food processing, transportation, construction, etc. The bank did say, however, it is not pro-active in marketing. The bank issues L/Cs, advance payment and performance bonds related to construction. The bank indicated it would eventually like to further develop domestic factoring.

BoA management was also extremely supportive of PSCEP’s SME lending program and indicated these recommended loan products could be rapidly designed and introduced within


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BoA, thereby achieving immediate impact. Given its dynamism and its apparent

commitment to significantly increase SME lending, BoA has been included among the

partner banks.

Rabita Bank

Rabita Bank (RB) has a loan portfolio of 67 million AZN: 50 percent of its portfolio is SMEs, about 15 percent is devoted to corporate, and the remaining 35 percent to retail. RB management indicated their market is SMEs and lends to most economic sectors, except trading which is only on a limited basis. The bank defines SMEs as a company with annual sales turnover of 1 million AZN and with 300 or fewer employees. RB lends to agricultural-related companies, including farmers. The bank offers trade finance, but only L/Cs and L/Gs at this time. Most loans have a maximum term of two years, but RB will make some loans with five-year maturities for their very best clients. RB currently receives technical assistance from the EBRD and the IFC.

Due to the following key factors, RB has been invited to participate in the PSCEP SME

lending program. RB management was very receptive to participating in the program and stated that their SME clients could immediately benefit from these new loan products. In addition, RB lends to all key economic sectors, particularly to PSCEP clusters. As a result, RB’s participation has the great potential to introduce new trade finance loan products and also offer them to companies in PSCEP’s selected sectors, further impacting the project’s results.

NBC Bank

NBC Bank also participates in USAID/FSSP and is receiving significant technical assistance and training. NBC Bank issues L/Cs and L/Gs, most of which are guaranteed through a Raiffeisen Bank guarantee fund. Most of the bank’s loans are overdraft facilities for retail/consumer clients and the bank has a very small exposure to MSME and SME companies. NBC Bank is essentially an auto finance loan company. The bank does not lend to agriculture, dairy or poultry, but does lend to food processing and cold storage companies. The credit skills of their loan officers, according to bank management and the USAID/FSSP team, need improvement. NBC indicated it would like further training in L/Cs and L/Gs.

Atra Bank

Atra Bank (ATB) also participates in the USAID/FSSP, which specifically focuses on credit analysis training. At this time, ATB appears to be more focused on consumer loans, rather than SME lending. In fact, ATB interprets SME lending in its bank as loans to individuals or retail clients, which is about 65 percent of their loan portfolio. The bank would like to see good SME clients, but only new ones. ATB has allocated about 6 million AZN or 30 percent of the loan portfolio to agricultural lending using the recourses of State Fund of Entrepreneurs Support. ATB has poorly trained credit staff (the FSSP training began recently and is on-going). PSCEP will review progress of the FSSP work in late summer and determine if at that time the bank is ready to be a partner in the program.

Turan Bank

Turan Bank (TB) has also participated in numerous USAID- and other donor-funded programs. Its loan portfolio is about 55 percent retail and 45 percent corporate. Between the two


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divisions, 15 percent is attributed to SME loans. TB has five on-lending facilities: three are IFAD-funded for agricultural-related loans. These three lines total about US$7 million. There is also a US$1 million line from the Islamic Development Corporation for SMEs. Last, there are two lines for trade finance (L/Cs and L/Gs) totaling about US$3 million from BSP Switzerland and Zirat Bank of Turkey, which also includes technical support and training.

Azerbaijan Bank Training Centre is working with this bank and provides TA to necessary areas. Taking account current capacity of bank it’s too early to launch PSCEP’s SME lending program. There still number of gaps related to experience and skills of credit staff, risk management, monitoring and administration of loan portfolio.

Bank Respublika

Bank Respublika (BR) is the 7th largest bank in Azerbaijan and has a 25 percent equity investment from the German Development Fund (KfW). The loan portfolio is divided between retail and SME clients. BR has three on-lending lines with 52 million AZN of capital devoted to trade finance activities financed by the IFC, Sumitomo Bank, and Commerz Bank. The EBRD in 2008 rated BR as the “best bank” in Azerbaijan for trade finance. The bank also has a syndicated loan facility with the EBRD for SME lending in the amount of US$24 million, which includes technical assistance and training. The bank defines loans up to 10,000 AZN as micro and loans from 10,000 – 100,000 AZN as SME. BR lends to all sectors of the economy except construction and transportation. BR also has a leasing subsidiary and offers both financial and operating leases. According to BR management, BR is second only to the Bank of Azerbaijan in trade financing. BR has a co-financing facility with the EBRD in the amount of US$5 million for loans to the agricultural sector.

Given its involvement with the EBRD at this time, BR did not express much interest in joining the SME lending effort with its own funds. We believe that when success is demonstrated by the program, BR could expand TF lending significantly, either through PSCEP or its own.

Azergaz Bank

Azergaz Bank (AGB) was voted the “most active” bank by the EBRD for the last two years, meaning AGB was the most innovative, creative but conservative among the commercial banks in Azerbaijan. AGB has a very active trade finance department and issues L/Cs and L/Gs. But most of them have been given to select clients with long-established relations with the bank. AGB offers the lowest deposit rates, but has a very large deposit base and funding due to its reputation and financial stability in the market. AGB is very interested in the trade finance program and has even offered to make its in-bank training center available for all credit officers from the partner banks that will participate in the program.

As mentioned above, this bank is very conservative and adoption of any new product may take long time. Accordingly, they do not seem like a good fit for the program. Like Bank Respublika, they may well become a key player in SME lending when success is demonstrated by more innovative banks in the program.

Access Bank

Access Bank is 100 percent foreign-owned and was originally established as a micro-finance lender. Management said they operate very similar to Pro Credit Bank, which is another major


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micro-finance financial institution. Loans typically are up to US$5 million and are classified as business loans, but these loans are actually micro-finance loans to traders and “mom-and-pop” type stores and businesses. Access Bank does offer L/Cs and L/Gs on a limited basis and indicated it needs more training in this area, but would prefer to participate in a one-month type internship in the trade finance department at a foreign bank. Access Bank did not express interest in traditional trade finance loan products at this time.

C. Other Financial Institutions Interviewed

In addition to the banks discussed above, there are many other financial institutions, including banks, donors, and non-bank financial institutions (NBFIs), providing direct lending in the form of short- to medium-term loans. In addition, these financial institutions provide on-lending facilities along with technical assistance and training to commercial banks to support and sustain trade finance; specific sector lending, such as to agriculture and dairy; and micro lending to promote economic growth and sustainability. Along with the 46 commercial banks, there are 2 foreign banks: KocBank (a joint venture with Turkey and Italy) and the National Bank of Iran, 2 credit unions, 12 micro-finance institutions, 7 multilateral and international institutions, 4 leasing companies, 8 leasing offices, and other financial organizations and social organizations providing lending and technical assistance. The best and most comprehensive resource for further information (loan facilities, terms and conditions) about these financial institutions and what they offer can be found in the USAID-funded “The Complete Guide to Financing in Azerbaijan, 3rd Edition.”

FINCA

FINCA, a social development NBFI, focuses almost exclusively on micro lending, primarily in rural areas and to traders. FINCA does not lend to manufacturing or producer SMEs. At present, due to the global economic crisis and their own scarce resources, FINCA has scaled back lending and wants to maintain and preserve its current portfolio of good clients and not add new clients. Outside of Baku, FINCA has imposed a cap of US$5 million on all new loans to current clients. FINCA may lend very selectively and rarely now up to US$50 million for SMEs in and around Baku, but they said that this is highly unlikely. PSCEP and FINCA briefly discussed future “co-financing opportunities and synergies” once the SME access to finance project is implemented.

CredAgro

CredAgro (ACDI-VOCA) provides loans for agriculture and rural businesses. Its loan portfolio is around 42 million AZN with a majority of loans to companies registered as “physical persons.” Loan amounts range from US$500 to US$30 million with a repayment period of 36 months. Interest rates are competitive at 18 to 28 percent and collateral requirements follow the NBA regulations of a minimum of 150 percent of the loan amount. CreditAgro management said the lack of an NBFI law is an obstacle for further improvements to the banking system. CreditAgro only offers financial leases. Although CreditAgro assists and supports the agricultural sector, it is not a likely partner for PSCEP’s SME lending program.

Unileasing

Currently, there are 12 leasing companies in Azerbaijan, but only four are actually issuing leases, and Unileasing appears to be the major player. The other eight leasing companies are


26

leasing “offices” which have not generated any significant new lease contracts and seem to focus mainly on marketing. Leasing started in 2003 in Azerbaijan and, at present, only financial leases are available in Azerbaijan. No leasing company is offering operational leasing due to the VAT tax of 18 percent, which is applicable for all operational leases and is therefore too expensive to pass on to the clients at this time. In addition, the lack of a secondary market in order to sell the machines and equipment at the expiration of an operational lease is a further barrier. Unileasing, however, is considering the establishment of an operational leasing subsidiary. Unileasing has five offices and the company focuses on the rural areas almost exclusively because they believe rural growth rates are 2-3 times higher than in Baku. These offices opened via grant assistance with amount US$63,000 given by former USAID/ABAD project. Unileasing would like to add several more rural branches to further develop its leases, but readily acknowledged they need technical assistance and training in all areas of branch management, as well as in the design and development of new lease products for agriculture and rural areas. Unileasing would like to focus on food processing companies (for example, to lease warehouses), trade and services (to lease real estate), distributors, and agriculture (to lease tractors and other farm equipment). The PSCEP team discussed the possibility in providing some leasing technical assistance and training to Unileasing in the future with the PSCEP lease consultant.

Table 1 below highlights the key terms and conditions for loans to MSMEs, SMEs, and agriculture-related sectors that are funded from both the banks’ own resources and on-lending facilities:


27

TABLE 1: SUMMARY BANK LENDING

COMMERCIAL

BANKS

PURPOSE LOAN

AMOUNTS (MINIMUM TO

MAXIMUM IN

MANAT, EUROS

AND USD)

SECTORS AND

MARKETS

INTEREST

RATE

PROCESSING

& ADMIN-

ISTRATION

FEES

TERM COLLATERAL REPAY-

MENT

PERIOD

Bank of Azerbaijan Business loans 100m – 500m AZN Trade, manufacturing, and food processing

18 – 28% 24 months Immovable property and fixed assets

12 – 24 months

Bank Respublika: 3

SME credit lines:

SME Line 1 5m – 500m AZN Trade, manufacture, rural economy

7% 60 months Immovable property and fixed assets

18 – 60 months

SME Line 2 2m – 200m USD Production, services, trade, rural economy

15 – 28% 12 months Immovable property, fixed and current assets

up to 12 months

GAF/KfW SME line 3 1m – 100m Euros Manufacture, trade and services, rural economy

18 – 28% 36 months Immovable property, fixed and current assets

36 months

Azerdemiroyl Bank Trade and Import Credits, trade and services Micro and small credits

50m – 1mm USD Wholesale and retail 18 -25% 3 – 12 months, renewable up to 24 months

Immovable and movable assets

3 – 12 months

Micro and small credits 200 – 50m USD Entrepreneurial development 22 – 30% 24 months Immovable and movable assets

6 – 24 months

Azerigaz Bank Business expansion 1m – 1.8m USD SMEs 25% 1% 24 months Immovable and movable assets

24 months

EBRD SME credit line 50m – 400m USD Production, trade, services, working capital

20% 1%, 6 month grace period

36 months Immovable and movable assets

36 months

GAF SME credit line 2 1m – 60m USD Production, trade, services, working capital

26% 1%, 6 month grace period

24 months Immovable and movable assets

24 months

Access Bank Microfinance Up to 5m AZN Micro-lending 18 – 26% 1% 24 months Immovable assets 24 months

Bank of Baku GAF/SME credit line 10m – 120m USD Trade, production, services and agriculture

22 – 24% 6 months grace period 24 months Immovable and movable assets

24 months

EBRD/SME credit line 2 50m – 250m USD Trade, production and agriculture

18% minimum Grace period 48 months Immovable assets and vehicles

48 months


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TABLE 1 CONTINUED: SUMMARY BANK LENDING

COMMERCIAL

BANKS

PURPOSE LOAN

AMOUNTS (MINIMUM TO

MAXIMUM IN

MANAT, EUROS

AND USD)

SECTORS AND

MARKETS

INTEREST

RATE

PROCESSING

& ADMIN-

ISTRATION

FEES

TERM COLLATERAL REPAY-

MENT

PERIOD

Royal Bank Retail 5m AZN Production, trade and services 18 – 30% 3- 4% insurance guarantee fee

6- 12 months

Insurance coverage and guarantees

24 months

Agriculture 500m AZN Agriculture 18 – 24% 60 months Immovable assets 60 months

Mugan Bank Short-term Loans 6m – 140m USD Production, services and trade 18 – 36% 12 months Immovable and movable assets

Up to 12 months

Rabita Bank: 3 types

of loan facilities

Commercial Loans 10m – 500m AZN Trade and commerce 20 – 30% 1% 24 months Immovable assets and vehicles

12 – 24 months

Development of agricultural areas and ag. processing

50m – 300m AZN Agriculture 7 – 18% Processing fee 12 – 48 months

Immovable assets and equipment

12 – 48 months

Working capital, purchase of equipment

25m – 500m AZN Production and processing 18 – 24% 1% 24 months Immovable assets and equipment, jewelry

24 months

Turan Bank Commercial Loans Based on contract and business plan in AZN and USD

Exports and imports 18 – 30% 1% Based on contract

1.5x loan amount Based on business plan

SMEs Development Up to 500m AZN SMEs 7% 1% 18 – 60 months

1.5x loan amount 18 – 60 months

NBC Bank Business loans and import contracts

5m – 50m AZN Construction, services and agriculture

20 – 26% Insurance fee 36 months Immovable and movable assets

up to 36 months

Atra Bank Cropping, animal husbandry, purchase of mills

Loan size on a case-by-case basis

Agriculture 7 – 18% 60 months Immovable and movable assets

3 – 60 months

Purchase raw materials, commodities

Loan size on a case-by-case basis

Industrial, trade and services 7 – 30% 60 months Immovable and movable assets

3 – 60 months


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D. Trade Finance Program Selection Process

The team used the following criteria in the selection and recommendation of the six banks:

1. Management buy-in: receptivity, enthusiasm and support for the trade finance program

2. Bank’s penetration in the market, particularly its branch network 3. Bank’s total assets, loan portfolio quality and corporate/SME client base 4. Experience in agricultural lending 5. Long-term corporate strategy and marketing plans 6. Bank’s credit risk culture and risk parameters 7. Easy and rapid integration of trade finance products 8. Experienced and relatively well-trained credit staff

Based on the results and discussions with the 12 banks, the team recommends the following six banks to participate in the initial roll-out:

1. Mugan Bank

2. Rabita Bank

3. Bank of Baku

4. Royal Bank

5. Azerdemiryol Bank

6. Bank of Azerbaijan

Table 2 below highlights the key financial data for the selected partner banks:

TABLE 2 – Key Financial Data for Selected Partner Banks (AZN)

Azerdemiryol

Bank of

Azerbaijan

Rabita

Bank

Bank of

Baku Bank

Royal Bank MuganBank

Total Assets 106,150,031 94,425,000 180,000,000 211,000,000 146,000,000 100,746,000

Total Outstanding

Loan Portfolio 90,873,832 68,018,000 133,000,000 162,000,000 81,000,000 66,400,000

15,000,000

Micro Loans 353,817 1,110,000 13,000,000 <100,000 4,500,000 26,281,000

9,000,000

SME loans 20,144,586 35,289,000 39,400,000 >100,000<300,000 N/A 26,152,000

Corporate Loans 45,936,870 10,653,000 40,000,000 80,000,000 11,000,000 13,967,000

LG-5 230,000

TF loans 28,552,082 2,893,000 3,500,000 25,000,000 LC-425 000 2,000,000

SME share in TF

loan portfolio 1,683,230 2,893,000 3,500,000 18,000,000 N/A N/A

Number of

Branches 18 19 14 29 30 25

Branches in

regions 5 13 4 17 8 5

No. of branches to

be opened in

regions,2009, 2010 20 4 6 6 12 2


30

SECTION IV

Equity Investment A. Assessment of Azerbaijan’s private equity funds

A1. Azerbaijan Investement Company (AIC)

AIC was established by decree of the President of the Azerbaijan on March 30, 2006 and began its operations in early 2007. Its initial charter capital is 90 million AZN and its main objective consists of investing in the non-oil and financial sectors. AIC is 100 percent owned by the GOAJ through the Ministry of Economic Development. According to its charter, AIC can invest in companies through the acquisition of existing or newly issued shares but it aims at not exceeding 20 to 25 percent of the charter capital of a company. The term of investment is 5-7 years (exit period). According to a shareholders’ agreement or by decision of the general shareholders assembly, the investment company may or may not receive dividends. In terms of exit vehicle, a shareholders agreement establishes a right of “first refusal” and a put-option. Investment Strategy

During the interview with PSCEP staff, the company did not have a detailed written investment policy, strategy or yearly business plans. Also, there is no written and approved document that describes concrete and clear goals that the company intends to achieve and the steps or tactics how to achieve it. AIC staff operates on the basis of instructions emanating from senior of management who in turn answer to the Supervisory Board. Basic Organizational Structure

The company is controlled by a Supervisory Board appointed by the Ministry of Economic Development and has five members and a General Manager. The Supervisory Board is responsible for all key decisions including all investment approvals and essential management decisions. The General Manager is responsible for the day-to-day operations of the company. There is also a Deputy General Manager and five departments: Investor Relations, Legal Counsel and Monitoring, Economic Analysis, Financial Analysis and General Administration. No incentive compensation system exists and no staff performance evaluation is being conducted on a regular and formal basis. Sectors for Investment and Investment Process

Priorities were given to agriculture and targeted clients are processors and producer within that sector. In practice, AIC has invested in a broad number of non-oil sectors and does not appear to have a clear sector focus, other than its non-oil mandate. The company essentially has a reactive approach to business. In other words, the company is not looking pro-actively for investment opportunities or deal creation. The process is as follows:


31

a. A company or venture investor submits an application to AIC, which includes a description of the business concept.

b. The Financial and Economic Analysis Departments review the application and submits a concept note to the General Manager.

c. If the General Manager approves the concept, due diligence is initiated; including discussions about the business plan.

d. The Legal Counsel in conjunction with the Economic Analysis and Financial Analysis Departments prepares the investment documentation, thereby recommending the investment.

e. After getting the internal approval from the General Manager, the Legal Counsel prepares a shareholder’s agreement and all pertinent documents to be considered by the Supervisory Board for final approval.

PSCEP’s assessment found that the entire investment process takes between three months to one year to be completed, however, in the past it has not been followed. A more ad hoc process has been the norm. However, AIC staff also indicated that the company is determined to formalize the deal flow, approval process, and but require assistance from PSCEP to do so. Monitoring and Investment Management

There is a complete lack of monitoring activity. The Legal Counsel is currently responsible for this function but due to lack of experienced staff, they do not actually have effective monitoring mechanisms in place and only verify legal documents of the client. There is no activity in performance monitoring, management of investments, or responses to market changes. Marketing and Public Outreach Program

There is no marketing department and no marketing activity. A marketing plan has been developed, but not yet approved. The company participates in some business forums. They participated in the Guba Investment Conference with USAID/PSCEP in December 2008 and in the Sheki Investment Conference in March 2009. A further road show is planned for Ganja in July 2009. Technical Assistance

For several months, USAID provided a resident consultant funded by the USAID/FSSP and subsequently by USAID/TIRSP. The documents reviewed by the PSCEP team prepared by the previous consultants appeared to be pertinent and insightful, according to the AIC. PSCEP’s assessment confirmed that AIC’s staff appears more interested in “on the job” technical assistance, especially in deal flow and transaction analysis. Other areas include the establishment of an effective investment monitoring and management structure within AIC, a comprehensive training program for staff in all the stages of the investment process (from proactive deal origination, to deal execution) and sustained public outreach and marketing program.


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A2. Caspian International Investment Company (CIIC)

CIIC was founded in March 2008 by AIC and the Islamic Corporation for the Development of the Private Sector (ICDPS). At present the charter capital of CIIC constitutes 2,954,200 AZN. ICDPS constitutes 75 percent of charter capital and 25 percent pertains to AIC. CIIC intends to increase its capital to US$70 million in the near future. The company plans to invest in exiting companies through acquisition of existing or newly issued shares with a minimum of US$1 million and a maximum of US$15 million. CIIC aim is to not invest more than 20 to 25 percent of the total investment of a given project. The term of investment is 5-7 years and according to the shareholders agreement or decision of general assembly of shareholders, the investment company may or may not receive dividends. The company intends to sell its shares to existing shareholders at the end of investment (right of first refusal plus put-option). Investment Strategy

The company has neither a written strategy nor business plan. In other words, there is no written and approved document that describes concrete and clear goals for CIIC. Employees operate upon request and investment application of potential partners. Like AIC, CIIC’s strategy is passive. Organizational Structure

The company is controlled by the Supervisory Board with a heavy ICDPS presence. AIC has also a representative in the Supervisory Board. The company is managed by a General Manager. The Supervisory Board is also responsible for all important decisions and the General Manager is responsible for day-to-day operations. Staff

The company has one general manager, two deputies and five departments: Investments, Portfolio Management, Finance, Administrative and Business Development/Investor Relations. There are three senior employees: one General Manager, one Deputy General Manager, and the head of business development. There is one analyst in the investment department, and three employees in administration. Many of the positions are still vacant and the company is actively recruiting experienced staff.

Sectors for Investment

The company intends to invest in non-oil sectors of the economy. Priorities are given to agriculture and targeted clients are food processors and producers. CIIC is currently working on cold storage and cardboard production and assessing investment opportunities in these projects. The investment process is essential reactive and similar in its form to AIC’s. Under the investment from ICDPS, CIIC must follow Islamic Banking principles that restrict investments in areas of tobacco, alcohol and financial institutions. Marketing and Public Outreach There is no marketing department and no planned and explicit marketing activity. CIIC participates in selected business forums. It participated in a Middle East business


33

conference in Baku and was able to attract additional US$70 million in capital from investors. New capital registration is ongoing and the corresponding changes are being incorporated to its charter. The company also participated in the Guba Investment Conference with USAID/PSCEP in December 2008 and in the Sheki Investment Conference in March 2009. Technical Assistance

During the assessment, CIIC staff indicated their willingness to collaborate with PSCEP in transaction support (technical industry expertise to be provided by PSCEP) and deal origination. CIIC also indicated that institutional strengthening support will be provided by its main shareholder; the ICDPS. A3. Private Equity Exit Vehicle

Private equity investments typically do not pay dividends, and returns are derived from capital gains obtained upon exit. While a private sale to another company or a management buy-out can be an attractive and effective exit options for equity investors, the preferred exit vehicle (if available) is often an initial public offering or IPO. Therefore, in the current context of Azerbaijan with an under-developed and illiquid stock market, management of private equity funds faces major challenges of creating viable exit solutions. When evaluating a new investment opportunity, successful fund managers should rigorously assess the exit strategy before deciding whether to make the investment. Equally important is that equity fund managers be proactive in deal origination, rather than reactive. Successful deals should also fit the skill set and industry knowledge of the fund manager where it can offer creative ideas for enhancing the value of the investments. Therefore, when the deal is closed is when the real work to enhance the value of investments starts. Mandated by their respective charters, both AIC and CIIC, include specific put option formulas and rights of first refusal clauses in the corresponding shareholders agreements. These formulas represent an exit alternative, but they are mostly driven by legal rather than by value-maximizing principles. In this context and to facilitate exiting its investments, PSCEP in collaboration with AIC will explore the introduction of “mezzanine financing,” which is further discussed below in the Access to Equity Action Plan. PSCEP has already developed a concept paper for “mezzanine financing” and shared it with AIC, and is waiting for feedback. A4. Conclusions

As highlighted in this section, equity financing is a new concept in Azerbaijan; the stage of development of both the AIC and CIIC reflects this phenomena. Both are relatively nascent organizations at this stage. Although funded primarily with sovereign funds and public monies, CIIC appears more flexible and PSCEP needs to take advantage of their eagerness to aggressively move forward. As a public sector entity responding to the government, AIC presents a more interesting challenge. Nonetheless, AIC also represents a rich opportunity for PSCEP. Key technical staff look to the COP and PSCEP technical experts as key advisors and are eager to work and receive assistance from the


34

program. While there may be issues outside PSCEP’s control that could impact progress, the program should place considerable priorities on these relationships. Similarly, AIC’s likely investment in the Kuwait-Azerbaijan Investment Company (KAIC) will present an opportunity for PSCEP to also participate with a third important equity player.


35

SECTION V Action Plans

A. PSCEP Debt Financing Strategy and Year One Action Plan

USAID/PSCEP will work with the six partner banks to design, develop and implement new and innovative trade finance products to encourage and increase SME lending. The first two trade finance products that will be designed and integrated into the partner banks will be: Purchase Order Financing and Accounts Receivable Financing. Later in Year One and based on the successful and measurable results achieved with the first six partner banks, PSCEP will then invite the next group of partner banks into the program. In the long term, it is anticipated that these trade finance products will become institutionalized in the banking system and adopted by many more commercial banks, thereby improving better access to short-term working capital throughout the banking system for many more SMEs in Azerbaijan. The trade finance loan products will be tailored and designed to rapidly integrate into each partner banks on a pilot basis. PSCEP will also introduce mezzanine financing as a new product innovation that will facilitate private equity funds (mainly AIC) to exit investments in the current context of illiquid securities markets. Connected to the development of these new trade finance products will be the introduction and utilization of alternative forms of collateral, particularly soft assets (such as Bills of Exchange, Personal and Corporate Guarantees, the Assignment of Cash Flows, Accounts Receivable and Inventory), which can increase the borrowing opportunities for SMEs and MSMEs. This will be accomplished in coordination and in consultation with the USAID/TIRSP project. In addition, PSCEP will collaborate and coordinate with USAID/FSSP on credit training and monitoring to avoid duplication and to share and cooperate on a variety of credit related topics and concerns. The further development of leasing, particularly operational leases and leaseback products, which can be used for machines, equipment, land and buildings for SMEs, especially in the PSCEP sectors, will be explored. A leasing consultant is scheduled to visit in the fall to review and assess this effort. Table 3 provides a highlight of the key components of the SME lending program and the months in which they will be implemented.


36

Table 3: Timeline of Key Components for Bank SME lending program

Result

Area Result Measure M A M J J A S O N D J Status

Access

to

Finance

Draft MOU, Implementation

Plan, new Trade Finance Credit

Policies and Procedures and

POF/ARF Loan Agreements

X X

Done. MOUs

developed and

submitted to six

partner banks. Four

signed and rest of two

will sign by June 3.

Policies and

Procedures developed

and submitted to the

banks.

Pilot

Trade

Finance

efforts

Review bank’s loan agreements

and other supporting loan

documentation. Training needs

analysis and technical assistance

for development of POF and

ARF

X X

Done. SME lending

(especially TF

products) through

mentoring of loan

officer is big focus.

Trade finance technical

assistance and training

X

TA will be provided

beginning from June-

09.

Deliver trade finance

presentations to potential SME

customers and

Continue TA with bank credit

staff

X

TA will be delivered

after presentation of

products to the banks.

Assist banks to extend trade

finance loans

On going effort. Will work with

loan officer in actual loan

requests case by case

X X X X X X X

Explore leasing products and

develop an action plan to

enhance delivery

X X X X X

After trainings PSCEP

specialists will work

with loan officers on

actual lease requests

Design preliminary Marketing

Plan for bank’s trade finance

loan product and guide on

implementation.

X X X

Analyze next steps for expansion

X


37

A1. Benchmarks – New Trade Finance Products, SME Lending, and Measurable Loan Results

The PSCEP team will introduce, develop and implement two new trade finance products and one trade finance related product within the six partner banks in Year One. The implementation and final institutionalization of these three products should occur no later than July 2009. The three new products will be:

1. Purchase Order Financing 2. Accounts Receivable Financing 3. Leasing: Operational leases (tentatively scheduled)

In Year Two of the project, PSCEP plans to introduce the following three new trade finance products:

4. Invoice Discounting 5. Inventory Financing 6. Factoring

The most important quantitative measure and benchmark for PSCEP will be each bank’s commitment and agreement to allocate up to 5,000,000 AZN of bank funds for the SME lending program in Year One. In addition, each partner bank also agree to approve a certain number of trade finance loans from this initial allocation of funds, as well as to expand SME lending in other areas. A detailed MOU will be signed with each partner bank and USAID/PSCEP by June 5, 2009. The MOU outlines the roles and responsibilities between each partner bank and USAID/PSCEP, including the amount of the bank’s loan funds committed, target number of new trade finance loans, technical assistance and training to be provided, as well as other pertinent information. In addition to the implementation of new trade finance products, the six partner banks will also submit a monthly tracker on trade finance loans and other type of SME lending made under PSCEP assistance. The tracker will highlight every new trade finance/and other SME loan approved along with the major loan terms and conditions and other key supporting financial information, such as: the increase in sales, support to exports, increase in revenues, male/female-owned company, and other key data resulting from or relating to the trade finance loan. A2. Product Development and SME Support

The methodology and pilot trade finance implementation plan is described as follows:

• Awareness raising and training on TF products and SME lending for senior management and key credit staff

• Assistance reviewing and modifying, as needed, credit policies and procedures to develop new products and enhance SME lending

• Support in reviewing and modifying, as needed, trade finance loan agreements

• On-the-job training for credit officers in TF and best practices in SME lending

• Assistance reviewing and processing initial trade finance loans as part of the SME lending program

• Help in promoting trade finance products to bank branches


38

• Support in developing and producing a preliminary marketing plan and materials, if appropriate

PSCEP will analyze the needs of the partner banks to develop new products and will build a training and technical assistance plan that matches the needs of the six banks. PSCEP will also coordinate with USAID/FSSP to ensure consistency in the credit training and to build upon each project’s efforts in order to rapidly jump start the SME lending program. A3. Product Development and SME Support: Phase Two

To enable the necessary amount of hands-on and in-bank training and technical assistance, PSCEP will split its product development program into two phases. PSCEP will start with the first group of six banks to properly introduce, integrate and institutionalize these trade finance products into the banks before expanding the program to the next group of banks. PSCEP is confident that, assuming measurable results with the first six banks, we will be able to incorporate additional bank(s) in 2010. Table 4 below outlines the key activities and stakeholders for the trade finance pilot program. A4. Develop Collateral Instruments

An important issue for development or enhancement of any new product is its acceptance by the NBA. PSCEP will coordinate with the NBA through the USAID/TIRSP project, when necessary, to ensure that new product development, including alternative forms of collateral introduced to the market are in compliance with all NBA regulations, Azerbaijani civil code and the banking laws, and to ensure that new credit policies and regulations are adapted to incorporate the new trade finance products. PSCEP will work with each bank to ensure that appropriate credit policies and procedures are put in place at their banks for proper risk management. Development of new collateral instruments also can open opportunities for other lending products currently offered on the market. Currently, the majority of loans offered in Azerbaijan require hard asset collateral. Collateral instruments such as soft assets—Bills of Exchange, Personal and Corporate Guarantees and the Assignment of Cash Flow—which are “unsecured instruments” are used for trade finance loans. Their development and introduction into the Azerbaijani banking environment will require the assistance and guidance from USAID/TIRSP and USAID/FSSP, thus drawing on their collective knowledge and results achieved in their programs to date.


39

TABLE 4: Trade Finance Implementation Plan

ACTIVITY MONTH COUNTERPART PSCEP INPUT PSCEP LOE

1. Draft and sign

Memorandum of

Understanding (MOU)

2. Design and approve

draft Implementation

Plan with partner

banks

3. Review partner

banks current credit

P&P and draft trade

finance P&P for

inclusion

April-09

1. Banks review and approve MOU and Implementation Plan 2. Bank’s management’s participation in the design, review, revision, and adoption of the new trade finance credit policies and procedures

1. Draft MOU 2. Implementation Plan 3. Translate relevant sections of banks’ credit P&P and PSCEP team drafts new trade finance credit P&P for integration into the banks’ existing policies and procedures 4. Analysis of necessary changes/additions to policies and procedures for adoption of trade finance loans

RC: draft MOU, Implementation Plan, review current credit P&P and draft new trade finance P&P 7 days in home country RJ: draft MOU, review and translate key sections of current credit P&P, review new trade finance P&P

1. Review bank’s loan

agreements and other

supporting loan

documentation

2. Training needs

analysis and technical

assistance for

development of POF

and ARF

3. Presentation of cash

flow lending and TF

work-shops with credit

staff on newly adopted

trade finance policies

and procedures

April-June 09

Banks’ management and legal department to address legal and regulatory issues and provide clarifications Banks credit staff to provide current loan product information:

• Terms and conditions

• Collateral Full commitment and dedication of bank management and credit staff

1. Draft trade finance Loan Agreements that conform to banks existing loan agreements and documents 2. Meet with credit officers to assess current credit skills 3. Establish institutional baseline to measure impact of trade finance SME lending program 4. PSCEP consultant and banks credit staff to jointly present new policies and procedures

RC: Draft trade finance loan agreements 3 days home country and 1 week in country RJ: Review draft loan agreements and assist with training needs assessment and establishment of baseline measures

Trade finance and

SME lending technical

assistance and training

conducted with banks’

credit staff

June 09

Banks commits credit officers to participate in the on-the-job training and technical assistance Review loan applications with banks’ credit officers for trade finance loans and training purposes Review Bank’s current loan portfolio and identify for trade finance loans and for training purposes

1. In-Bank technical assistance and training delivered to bank’s key branch and credit officers: 2. On-the-job review and analysis of potential trade finance clients, including PSCEP’s targeted clusters 3. Review loan applications with credit officers for trade finance loans and training purposes

RC: 1 week in country RJ: Assist in training sessions, review and follow-up review of bank’s loan portfolio and loan applications


40

TABLE 4 CONTINUED: Trade Finance Implementation Plan

ACTIVITY MONTH COUNTERPART PSCEP INPUT PSCEP LOE

1. Deliver trade

finance presentations

to potential SME

customers

2. Continue TA with

bank credit staff

June/July 09

Partner banks to identify key clients from loan portfolio for group presentations

Review and approve with bank staff on identifying SME clients

RC: 1 week in country RJ: Present TFP to cluster companies and assist in training bank staff

1. Assist banks to extend

trade finance loans July/August 09

Each bank extends at least 20 pilot trade finance loans to business enterprises Bank provides quantitative information on loans approved

Assist Bank to extend pilot trade finance loans. This effort will be ongoing throughout the project and each follow-up visit will devote time to this effort Further on-site review with credit officers of pilot trade finance loans Trade finance Loan Tracker provided

RC: 1 week in country RJ: Assist in analyzing TF loan proposals

Based on results to date,

explore adding three

more banks to the SME

lending program

October-09

PSCEP will review success and benchmarks achieved and invite three more banks to join the SME lending program

RC: 1 week in country RJ: Assist in meeting and selecting banks

Explore leasing products

and develop an action

plan

September – October 09

Partner banks and PSCEP to assess leasing opportunities and needs

PSCEP to invite Crimson leasing expert for assessment and technical assistance

Crimson Lease Expert/TBD: 2 weeks in country

Review and identification

of trade finance loans,

from PSCEP clusters

September-09

Bank credit officers meet and review potential PSCEP cluster clients

PSCEP’s clusters recommend minimum 4 potential clients from each cluster for trade financing at partner banks

RC: 1 week in country RJ: Present TF program to cluster companies

Design preliminary

Marketing Plan for

bank’s SME and trade

finance loan product

November – December 09

Bank’s Marketing Department to commit staff and resources to revise and refine current Marketing Plan to accommodate trade finance loans Bank launches trade finance Marketing Plan

Design and develop Marketing Plan/Brochure Coordinate with bank’s Marketing Department on new product development

RC: 1 week in country RJ: Work w/banks to develop marketing strategy

Analyze next steps to

expand trade finance

program: new products

and/or new banks

December – 09

Meet with partner banks to assess environment for introduction of two new trade finance products: Invoice Discounting and Factoring

PSCEP will review results achieved to date and look to add two new products in 2010: Invoice Discounting and Factoring

RC: 3 days in country

RJ: Assist in assessment


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B. PSCEP Equity Investment Strategy and Year One Action Plan

This section presents an Action Plan for PSCEP to promote equity investments in Azerbaijan through the AIC and the CIIC. Other funds in the process of creation with AIC participation such as the KAIC may also form part of this strategy later this year. The access to equity consultant worked closely with each institution. There is full agreement and coordination with these institutions; action plans have been prepared to increase the funds’ market presence and promote acceptance for equity as a viable source of financing. Furthermore, PSCEP will work to strengthen the institutional and deal generation capacities of these investment companies. The consultant also coordinated closely with the access to debt financing expert to ensure that PSCEP efforts were fully integrated across action plans for the financial sector.

PSCEP equity financing technical assistance actions plans for the period February 2009 - January 2010 will consist of four technical subject modules:

1. Transactions support and deal flow generation; 2. New financial product development and solutions; 3. Business process support and capacity building; and 4. Public awareness enhancement.

PSCEP’s Financial Value Chain Specialist (FVCS) will be responsible for implementing these plans and will manage the day-to-day working relationship with the staff of AIC and CIIC. PSCEP will provide technical assistance on a cost-sharing basis with AIC and CIIC. The specifics of cost-sharing will be defined on a case-by-case basis. B1. Deal flow generation and transactions support

PSCEP will play a key role in assisting the AIC and CIIC in deal flow generation and transaction support. There are already a number of immediate support requests for current transactions, which are likely to expand as PSCEP’s BDS program gets underway and the regional “road shows” are completed. Among those being considered to date:

a. A US$6.5 million investment in a cold storage company in Ganja (CIIC) for the

development of two new lines of production: a corrugated cardboard packaging production line and the establishment of greenhouses for year-round farming of specialty fruits and vegetables. PSCEP provided two consultants both in packaging and greenhouses. Those consultants reviewed business plans and made recommendations related to the technical side of analysis. CIIC still working on this proposal.

b. A US$14 million investment has already been executed to the second largest poultry farm and poultry distribution company in Azerbaijan by AIC. The objective of this investment is to expand the production of existing and new products. PSCEP is working with the company to assess additional investment needs as well as a buyout of a joint venture from a Turkish company. The consultant provided by PSCEP is working closely with this company, especially on business modeling to increase production and reduce expenses.


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c. As a result of the Sheki and Guba road show, PSCEP directed six potential investments to AIC and CIIC representing possible investments in excess of US$20 million. Currently, investment companies are reviewing proposals and PSCEP will provide technical assistance on selected investment proposals wherever needed. Road shows in Ganja and Lankaran later this year will likely triple the potential investment opportunities where PSCEP will support the AIC and CIIC.

To institutionalize deal flow procedures, PSCEP’s COP and FVCS will meet the first week of every month with AIC and CIIC separately to review and discuss the existing pipeline of both entities and also share and discuss PSCEP’s specific investment opportunities. The objective of these meetings (Deal Flow Workshops) is to agree on specific transactions support, technical assistance, or investment opportunities to be included in the AIC and CIIC pipeline under consideration. At present AIC has a pipeline of six potential investment projects (greenfield and existing companies in the aluminum sector, engine accumulators, KAIC (shareholder’s agreement signed), ship-building, urban transportation services and iodine production). In Year One, PSCEP will provide assistance (initial company profiles for AIC, technical due diligence, assisting in business plans for thirteen to fifteen (13-15) transactions for AIC and CIIC with a potential value of no less than US$80 million). In practice, to get to the estimated number of 13-15 transactions, PSCEP expects to review over 50 potential investments. At least seven to ten (7-10) will result in actual investments (including debt financing and structured solutions of debt and equity) for a value of US$40-45 million. B2. Deal New financial product development and solutions

B2a. Mezzanine or Subordinated Debt Financing

Taking into consideration AIC’s charter, PSCEP is working with AIC’s legal and analysis departments to innovate at least one financial product. PSCEP developed a concept paper about the feasibility of introducing “mezzanine financing” in AIC’s product offerings and discussed with AIC legal and analysis departments. Mezzanine financing is a hybrid product of debt and equity financing that is is typically used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time or in full. It is generally subordinated to debt provided by senior lenders such as banks and capital investment companies. Mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower. Mezzanine financing is advantageous because it is treated like equity on a company's balance sheet. Therefore, mezzanine financing is considered an excellent exit vehicle where an IPO is not viable. To attract mezzanine financing, a company usually must demonstrate a track record in the industry with an established reputation and product, a history of profitability and a viable expansion plan for the business (e.g. acquisitions). PSCEP is working with AIC management on this concept paper and in case of positive feedback, will begin translation of the mezzanine financing concept into an actual financial product offering.


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B2b. Financial packages or structured solutions

Financial packages, or structured solutions, refer to transaction based, ad-hoc financial solutions that combine debt and equity structured financing. The source for these solutions will be the “Deal Flow Workshops” with AIC and CIIC. The objective for the period will be to close at least three (3) solutions by October 2009. B3. Business Process Support and Capacity Building

B3a. Investment portfolio management and performance monitoring

For AIC, PSCEP will review existing proposals to establish the Investment Management and Performance Monitoring (IMMP) Department and propose an organizational and staffing structure, operations manual, job descriptions and competency requirements matrix and prepare a model template for the IMMP to monitor specific transactions. Three weeks in June-July 2009. B3b. Deal creation, investment analysis and performance monitoring, and measurement training

PSCEP will deliver a comprehensive training program for AIC, which will be open to CIIC and KAIC staff. The program will consist of a “Private Equity Investment Analyst” certification and its content will be developed and delivered in six, illustrative and self-contained progressive modules. The module structure allows for tailor-made subject-matter training based on input from the AIC to meet their needs. An investment training consultant will travel to Azerbaijan in June/July to assess specific training needs and define the modules. Modules I-III are brief overviews of equity investment principles. Modules IV-VI will provide the course’s principal components. Module I: Equity Investment Overview

- Understand the structure of an equity investment fund, the way it operates

and governs its portfolio companies - Origins, history and present state of the equity investment industry - Structure and institutional features of the global equity investment industry - Equity: when and when not to use it - Current international trends and emerging markets

Module II: Equity Investment Characteristics and Classifications

- Characteristics - Classifications - Best practices and case reviews

Module III: Equity Investors and Investing Issues

- Equity investors - Why invest in equity, and why a company would take on an equity

investment? - Other ways to invest : debt-equity hybrid products ( i.e. mezzanine

financing)


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Module IV: Creating and Measuring Value

- External climate and sources of investments - Creating value in invested companies - Introducing corporate governance principles and international accounting

standards in invested companies - How to measure performance and trends in performance. The importance of

the PMMP

Module V: Evaluating Investment Opportunities and Structuring Transactions

- Equity as an asset class - Deal origination, selection, screening, analysis and valuation - Structuring transactions and harvesting (alternative models of exit vehicles) - Concepts, techniques and instruments used in equity investment - Mechanics of deal selection, valuation and structuring techniques - Legal and financial aspects of buyout transactions and equity investments

Module VI: Performing Due Diligence

- Technical due diligence - Commercial and legal due diligence

September 2009: PSCEP will provide the services of a financial/equity investment training specialist for approximately one week to design a comprehensive, three-week training/certification program. Content-tailoring or program customization will be based on a training needs assessment performed in AIC by the training consultant. Table 5 below highlights major PSCEP actions in support of equity financing in Year One following the Action Plan. Given the practical and on-hands approach focused on transactions, it concentrates on actions for the next four months (March-July). We recommend that this Action list be reviewed each quarter, updated, and assistance targeted to immediate AIC, CIIC and KAIC requests. This is not, however, just a “targets of opportunity” strategy, although such targets should be aggressively pursued. We believe – and AIC and CIIC management concurs – that long-term institution building can best be accomplished by PSCEP playing a key role in routine transactions during the next year.


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Table 5: Summary of Equity Activities, Timetable, and Planning Chart

ACTIVITY MONTH COUNTER-

PART

PSCEP INPUT- SOW PSCEP LOE

Draft mezzanine

financing concept

paper.

March-April 09

AIC Access to finance senior consultant ( Roberto Toso)

Two weeks No cost for PSCEP.

Review feasibility study

for establishing a

packaging

manufacturing facility

and draft technical

specifications for

procuring technology

and capital equipment

April-May 09 CIIC PSCEP will provide a technical expert in packaging and corrugated cardboard to critically review feasibility study and provide guidance on technical specifications

Two weeks in country

Review existing business

and investment plan in

poultry derivatives and

draft an IMMP

Ongoing effort

AIC PSCEP provided a technical expert (Tom Fattori) to work with AIC’s analysis department

Ongoing effort

Follow up on Sheki

Road show potential

investment for AIC and

CIIC

March-though end of 1st year

AIC, CIIC PSCEP staff to development company profiles.

Ongoing effort

Review feasibility study

for establishing

greenhouses and draft

technical specifications

for procuring

technology and capital

equipment

April-June 09 CIIC PCEP will provide a technical expert in greenhouses to critically review feasibility study and provide guidance on technical specifications

Three weeks in country

AIC’s legal and analysis

departments review

“mezzanine financing”

concept paper

July 09 AIC PCEP’s access to finance technical expert (Roberto Toso) engages in reviewing and discussing concept paper with AIC’s staff

Two weeks in HO-no cost for PSCEP

If AIC approves

mezzanine financing,

then “productivization”

of this instrument is

developed.

“Productivization” is the translation of a financial concept into a financial product.

September 09 AIC PSCEP’s consultant (Roberto Toso) will prepare “model contracts and templates” for mezzanine financing and will mentor AIC’s staff in first transaction if available

Two weeks in country ( end of September 09)


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TABLE 5 CONTINUED: Summary of Equity Activities, Timetable, and Planning Chart


PART


PSCEP COP assists AIC in investment pipeline and deal prioritization, followed by STTA

May-June AIC Dedicated time to analyzing AIC pipeline. Additional STTA provided to work on specific transactions

Ongoing effort for two months by COP, STTA for 2 months

AIC’s Ganja regional investor’s conference

9-Jul AIC PSCEP’s COP and USAID’s CTO make presentations at the conference

PSCEP sponsors and funds 50% of conference cost

Establishment of AIC’s Investment Management and Performance Monitoring Department, including templates for IMMP

Sept/Oct 09 AIC (CIIC and KAIC could benefit)

PSCEP will provide a senior organizational development expert with experience in private equity funds to review existing AIC’s plans and propose an organizational structure, job descriptions, manuals and templates for the department

Four weeks in country

AIC’s regional conference in Lankaran

9-Sep AIC PSCEP’s COP and USAID’s CTO make presentations at the conference

PSCEP sponsors and funds 50% of conference cost ( approximately $ 1,500)

PSCEP will select training experts to design program, customize and deliver it. One training and curriculum development

“Private Equity Financial Analyst” certification program. Design and customization preparatory stage

9-Sep AIC

Consultant will work with AIC (and CIIC) to design the program.

One week in country

AIC’s national investor’s conference in Baku

9-Oct AIC PSCEP’s COP and USAID’s CTO make presentations at the conference

PSCEP sponsors and funds 50% of conference cost

“Private Equity Financial Analyst” certification training program delivered

9-Sep AIC ( open invite to CIIC’s and Kuwait Investment House’s technical staff)

PSCEP will provide two trainers and training material.

Two trainers for 3 weeks in country


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TABLE 5 CONTINUED: Summary of Equity Activities, Timetable, and Planning Chart


PART


“Transaction support” for 9 transactions, one per month. Transaction support will be industry expertise and/or financial structuring expertise. Each transaction and specific technical assistance need will be defined and agreed upon in the monthly “ Deal Creation Workshops” to be held separately between PSCEP and AIC and CIIC.

May 09- January 10

AIC,CIIC PSCEP will provide one senior industry/and or financial structuring expert per transaction

One expert for two weeks in country per transaction. A total of 9 experts for a total of 18 weeks in country

B4. Benchmarks- Access to Equity Performance Indicators

1. Thirteen to fifteen (13-15) transactions for approximately US$80 million receiving PSCEP’s technical support. (AIC, CIIC and KAIC)

2. From the above transactions, seven to ten (7-10) transactions supported by PSCEP result in actual investments by AIC, CIIC and/or KAIC (including debt financing and/or structured solutions of debt and equity), approximately US$45-50 million in total value.

3. Four (4) product innovations and/or transaction based financial (structured)

solutions completed.

4. AIC’s Investment Management and Performance Monitoring Department established with the contribution of PSCEP’s technical assistance. End of August 2009.

5. “Private Equity Investment Analyst” certification training delivered by PSCEP.

End of September 2009.

6. Four regional and one national conference supported by PSCEP. Two regional conferences and one national conference will be held by the end of the first six months and two regional conferences will be held by the end of the period.


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C. Conclusion

USAID has correctly identified access to sustainable finance and investment as one of the key constraints to increase the competitiveness of Azerbaijan’s economy. We believe that the program described herein will have a meaningful sector and national level impact in addressing this constraint. As noted earlier, the program begins somewhere in the beginning or middle of the worse financial and economic crisis facing the world, and increasingly Azerbaijan. On the equity side, this represents a major opportunity. Many companies previously not inclined to give part of their ownership to access capital are now much more willing to do so. Nonetheless, creating the right structure and incentives are absolutely necessary to make transactions happen. In this sense, we do not see PSCEP simply “piggy backing” on a need for capital, but playing a key role in ensuring that transactions are adequately structured, and that the funds become sustainable by identifying solid opportunities. The debt component will be much more challenging. If the liquidity crisis worsens, banks that are now willing to provide unsecured loans may become unwilling to do so. It will take perseverance and at times patience to overcome these constraints. But this is also a case where challenges bring up opportunities and the PSCEP team needs to move aggressively to pursue them.


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APPENDIX A: BANKS’ TOTAL ASSETS AND MARKET SHARE

Dated: January 1, 2009; '000 AZN

BANK NAME ASSETS MARKET SHARE

1 The International Bank of Azerbaijan 4,369,751.30 42.53%

2 Bank Standart 619,085.40 6.03%

3 Kapital Bank 577,589.90 5.62%

4 Texnika Bank 450,099.50 4.38%

5 UNI Bank 417,563.30 4.06%

6 Xalq Bank 403,710.10 3.93%

7 Bank Respublika 387,874.50 3.78%

8 Nikoyl Bank 294,704.90 2.87%

9 Azərdəmiryol Bank 228,526.40 2.22%

10 Azəriqaz Bank 211,215.50 2.06%

11 AccessBank 198,862.80 1.94%

12 Paşa Bank 198,254.00 1.93%

13 Bank of Baku 183,885.90 1.79%

14 Yapi Kredi Azərbaycan Bank 173,627.90 1.69%

15 Ata Bank 155,177.30 1.51%

16 Bank of Azerbaijan 108,755.80 1.06%

17 Zamin Bank 102,201.80 0.99%

18 Royal Bank 101,926.30 0.99%

19 Muğan Bank 100,746.90 0.98%

20 Rabita Bank 94,424.80 0.92%

21 Turan Bank 83,533.10 0.81%

22 AzərSənayeBank 78,029.30 0.76%

23 Para Bank 65,552.40 0.64%

24 Əmrah Bank 62,397.00 0.61%

25 Azərnəqliyyat Bank 50,266.20 0.49%

26 Azər-Türk Bank 45,783.30 0.45%

27 Bank Avrasiya 45,171.00 0.44%

28 Birlik Bank 40,636.80 0.40%

29 NBC Bank 39,831.90 0.39%

30 Atra Bank 35,181.10 0.34%

31 United Credit Bank 32,350.70 0.31%

32 Qafqaz İnkişaf Bankı 32,337.90 0.31%

33 Kredo Bank 31,833.80 0.31%

34 Gəncə Bank 30,916.40 0.30%

35 Debüt Bank 29,435.10 0.29%

36 Deka Bank 27,358.90 0.27%

37 Günay Bank 27,161.80 0.26%


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APPENDIX A CONTINUED: BANKS’ TOTAL ASSETS AND MARKET SHARE

BANK NAME ASSETS MARKET SHARE

38 Azərbaycan Kredit Bankı 26,908.30 0.26%

39 Melli İran Bank 19,805.10 0.19%

40 Avro Bank 18,794.80 0.18%

41 Bank Silkvey 18,373.70 0.18%

42 Kövsər Bank 16,270.50 0.16%

43 AF Bank 14,610.00 0.14%

44 Naxçıvanbank 11,476.90 0.11%

45 Pakistan Milli Bankı 11,455.10 0.11%

Total 10,273,455.40 100%


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APPENDIX B: PSCEP SECTOR ASSESSMENT

According to the PSCEP sector specialist, the majority of food processing, producing, warehouse and cold storage companies still lack the access to finance, particularly for short-term working capital to finance a purchase order or a supplier order. It was stated that many of these companies could grow faster if they could obtain short-term financing. Many of these companies also lack an understanding of and the ability to access equity financing. In addition, the leasing companies are not particularly active in the rural areas and Unileasing (see notes on Unileasing above) has expressed a desire to start leasing in the rural areas. The food processing companies also do not understand how to properly market products for new buyers or to develop a well-defined business plan and marketing strategy. Often, these companies will first produce goods, then try to find buyers and develop a market. About less than 10 percent of these food processing companies have ISO and HAACP certification. Few companies do export food products to countries in the region, the EU and even the US.

The poultry and packaging sector specialists noted the companies in their sectors need financing first to import grains and feed and second to finance innovation and new technologies, such as production lines, etc. This sector is still assessing the exact financing needs of their companies. In addition to financing the import of grains and feed; meat, fruits and vegetable importers also need short-term financing on a regular, on-going basis. The sector specialist believes “Inventory Financing” could be a valuable short-term financing tool given that many of their companies maintain large inventories.

The PSCEP ICT sector specialist has met with over 20 different types of ICT-related companies, including hardware, software, vendors, etc. to better gauge the needs of this sector. The ICT sector at this stage plans to work with “assemblers,” software developers and broadband companies. Currently, IT retailers and wholesale dealers can obtain 45-day advance financing (supplier financing) from the vendors, but vendor financing is starting to dry up. These retailers and wholesalers do not rely on bank financing. The ICT sector also may link with British Petroleum to provide financing for services related to the oil industry, light manufacturing (protective clothing), software services, catering, etc.

The following is a synopsis of the major rural and agricultural-related financing that is currently provided by the banks:

1. Royal Bank does not lend to dairy or poultry, but does lend to food processors and producers.

2. Bank of Azerbaijan indicated it lends to all key economic sectors: trading, light manufacturing, food processing, transportation, construction, etc.

3. NBC Bank does not lend to agriculture, dairy or poultry, but does lend to food processing companies and cold storage companies.

4. Atra Bank has allocated about 6 million AZN or 30 percent of its loan portfolio to agricultural lending and finances meat and dairy production. Most of the resources have been received from State Fund for Entrepreneur Support. Atra Bank is not interested so much to allocate its own resources for agricultural lending.


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5. Bank Respublika has a co-financing facility with the EBRD in the amount of US$ 5 million for loans to the agricultural sector. GAF is starting a US$1.5 million rural credit line program with Bank Respublika to help develop the agricultural sector with the focus on assisting small farmers with loans up to 100,000 AZN.

6. Bank of Baku lends to the construction sector, agriculture, manufacturing, and trade and services. Bank of Baku has an EBRD on-lending facility for L/Cs, L/Gs, and export financing. The ADB also provides on-lending for documentary collections all geared to the agricultural sector.

7. Turan Bank has five on-lending facilities: three are IFAD-funded and geared toward agricultural-related loans; these three lines total about US$7 million. There is also a US$1 milllion line from the Islamic Development Corporation for SMEs also with a focus on agriculture-related companies.

8. Azerdemiryol Bank participates in the State Fund for Entrepreneur Support with up to US$14 million for lending to agriculture, food processors, and farmers. The bank also provides L/Cs and L/Gs to poultry and potato farmers for the purchase of grains and chickens.

9. AzergazBank lends to all economic sectors, including agriculture and food processing companies.

10. MuganBank lends to all sectors of the economy, including manufacturing, health, agriculture, dairy, poultry, farmers, etc.

11. Rabita Bank lends to agricultural-related companies, including farmers. 12. FINCA, a social development NBFI, focuses almost exclusively on micro lending,

primarily in rural areas. 13. CreditAgro (ACDI-VOCA) provides loans for agriculture and rural businesses.

It seems at this early stage of the project that companies throughout most of the PSCEP sectors could benefit from the short-term trade finance products that will be introduced under the access to finance project.

Unileasing has five offices and the company focuses on the rural areas almost exclusively because the rural growth rates are 2-3 times higher than in Baku. Unileasing would like to add several more rural branches. Unileasing would like to focus on food processing companies (for example, to lease warehouses), trade and services (to lease real estate), distributors, and agriculture (to lease tractors and other farm equipment).

It is acknowledged that rural SMEs and MSMEs and credit officers in many bank branches have weak banking knowledge and skills and that further technical assistance and training is needed for not only the rural credit staff but also to better educate the MSMEs and SMEs in the regions about better financial statements, accounting, fiscal management and cash flow and cash budgeting. Technical assistance and training would greatly assist both parties and improve not only the quality and financial reliability of the company’s loan proposal and supporting financial statements, but would also concurrently improve the credit analysis and due diligence of the branch credit officers in the rural areas. From a preliminary assessment, it appears the introduction of the SME lending program could immediately have a positive impact on providing short-term working capital financing for many companies in PSCEP sectors.

ACCESS TO FINANCE AND INVESTMENT ACTION PLAN

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