INCENTIVE SYSTEM AND ITS EFFECT ON CULTURAL AND BEHAVIORAL CHANGE IN THE MICROFINANCE INSTITUTION.

Transcription

1 INCENTIVE SYSTEM AND ITS EFFECT ON CULTURAL AND BEHAVIORAL CHANGE IN THE MICROFINANCE INSTITUTION. BY: MEHMAN TATLIYEV COO/FINCA JORDAN ABA Stonier Graduate School of Banking Capstone Project

2 TABLE OF CONTENTS TITLE PAGE EXECUTIVE SUMMARY 3 BACKGROUND INFO 4-9 STRATEGY/IMPLEMENTATION 9-15 FINANCIAL IMPACT NON-FINANCIAL IMPACT CONCLUSION 29 BIBLIOGRAPHY 30 APPENDIXES

3 I. EXECUTIVE SUMMARY FINCA JORDAN along with other Finca subsidiaries is reconsidering the sales staff compensation system and moving from mixture of fixed/variable compensation system to 100% fixed salary reward structure. The current incentive system is pretty much self administered program where numbers regulate the staff behavior. Sometime sales teams aren t encouraged to sell the way you need them to sell -- that is, to sell products and services strategically, in order to meet business goals. But instead they inevitably fall back on their own goals to guide them in the sales process. For instance, their only goal may be to close the deal as quickly as possible, often at the expense of gross margins and customer satisfaction. Another side effect of this approach is mission creep in the form of a shift in focus of credit officers towards wealthier clients in order to increase their incentives. We have also seen scenarios where credit officers offer a lower loan amount than the customer requested. This is done to mitigate a potential negative effect of a large loan on their portfolio at risk ratio. By making these decisions (knowingly or unknowingly) we actually make things worse. When client needs a certain amount to finance his business, i.e. to purchase a fixed asset and we offer less than needed amount it creates all sorts of issues for the customer such as, being forced to tap into their own capital to find the missing amount, look for another lender, etc. Either way, we are not doing any good for customer or for ourselves. Without bonus system, managers will have to spend more time on setting right goals and using correct metrics to manage staff performance. FINCA JORDAN will need to ensure that managers have time to manage their staff, provide ongoing coaching, feedback and reinforcement throughout the performance cycle to keep LOs motivated and on track. A review of policies and procedures will need to be conducted in order to ensure that Branch Managers and Credit Supervisors have adequate time to spend with their direct reports. It is our strong belief that in the long run the move from incentive based compensation structure to a fixed/merit based one will improve the quality of customer service which will inevitably translate in increased efficiency and growth in revenues. But we do not have illusions that along the way we will have to overcome some serious bumps and hurdles as all of our staff are used to one type of compensation and there is a potential fear that the new system may not work. 3

4 II. BACKGROUND INFO Please see map of Jordan with all the branch locations of FINCA JORDAN in the APPENDIX # 1. FINCA provides financial services to the world's lowest-income entrepreneurs so they can create jobs, build assets and improve their standard of living. We are an anti-poverty organization whose work is aimed at creating employment, raising family incomes, and reducing poverty worldwide. We offer small loans and other products to those turned down by traditional banks, believing that even the poor have a right to financial services. With these loans, families can invest in, and build their own small businesses and their income-earning capacity. At Finca the staff and primarily sales staff is compensated by combination of fixed salaries, incentives and bonuses. The portion of fixed pay is sometimes 50 70% and the bonuses constitute the rest of the compensation. The high value of variable compensation which most of the time depends on number of disbursement, number of active clients and portfolio at risk, often leads to low quality of loan analysis, bad collection practices and high client dropout rate. The goal of the project is to address this very important issue, dissect the current methodology and offer a practical solution where it is possible to have a 100% fixed pay offset by well established and implemented performance management system. Desired outcome of the project is to: Increase product and service sales Boost loyalty to our product line Capture market share Increase product adoption Launch new products Reduce sales cost Drive participation in training activities Manage multiple contests or campaigns 4

5 Organize by territory, team or organization Establish a customer service oriented culture Focus on relationship based lending rather than quick sales Avoid bad collection practices FINCA International was founded by John Hatch in 1984 and is a leading global microfinance organization. The organization has grown to 21 wholly owned subsidiaries throughout the world. The parent company is currently registered as a 401c entity in the US with subsidiaries registered, under varying structures depending on local regulations, in the countries where they operate. At the moment FINCA International has more than $800 million total assets, 1.6 million clients, $760 million outstanding loans, and over 7,500 employees. John Hatch worked in Bolivia in the early 1980s on US government funded rural development projects. Through his work, Hatch was involved with rural peasants who received low and unstable incomes. Many of the peasants displayed ingenuity and a strong work ethic. However, they remained in poverty from generation to generation. Hatch identified the circle of poverty and the fact that many rural poor remain impoverished due to limited access to finance. The lack of liquidity and buying power makes many peasants the victims of landlords and suppliers. John Hatch noted that many rural working poor are economically active and have the capacity to repay loan principal and interest. Hatch understood that one obstacle for rural poor to access finance and affordable working capital was an absence of collateral. Hatch developed and implemented a lending mechanism targeted at the rural poor. Small loans were provided to clients within groups using group guarantee and without physical collateral. The whole group was responsible for making sure that every loan within the group was repaid. The reputation and credit rating of each group member were at risk and no group member could get another loan until the entire group loan amount was repaid. John Hatch rolled out the new credit system and founded FINCA. FINCA began operating in the Eurasia region in the 1990s and 2000s in countries like Azerbaijan, Georgia, Kyrgyzstan, and Russia. Because of the larger loan amounts and competition, the level of professionalism in the FINCA Eurasia region set the pace for the rest of the organization. 5

6 Queen Rania of Jordan joined the FINCA International Board of Directors in Many organizations had regional offices in Jordan during the mid 2000s. Jordan s stability, proximity to Iraq and other hot spots, and large number of qualified English speaking professionals made the Hashemite Kingdom a natural fit when FINCA established the GME regional hub in the country in FINCA prefers to have lending operations in the same country as regional hubs in order for high level visiting staff, investors, and donors to meet with micro-loan clients. The initial feasibility study for Jordan was written in 2006 and had the recommendation to not begin operations in the country at that time citing the following reasons:(a) well capitalized and entrenched competition and (b) smallto mid-sized market making attaining profitability and scaling up operations difficult. A second feasibility study was commissioned in 2007 and the recommendation to begin operations was positive. FINCA Jordan was founded in October 2007 and disbursed its first loan in November of that year. The company experienced liquidity problems from the start because start-up capital was only $70,000. However, FINCA was able to exploit a niche in the market. As of today the Jordan affiliate has more than $11 million total assets, 16,800 clients, $10.5 million outstanding loans, and 115 employees. In addition, the Jordan subsidiary achieved its first year of profitability in 2011 with $157,366 accumulated profit. FINCA Jordan has 8 branches. The fact that FINCA Jordan s portfolio yield is 39% would imply that the microfinance segment in Jordan is lacking completion. However, USAID spent large sums in microfinance in the 1990s in Jordan and established a number of microfinance institutions (MFIs). Two USAID MFIs (Tamweelcom and Microfund for Women) have over $10 million in equity each and large client numbers; Tamweelcom with 70,00 clients and Microfund for Women with 65,000 clients reported in QI The Middle East regional microfinance association Sanabel estimates the number of eligible microfinance borrowers in Jordan at 377,857. At year end 2012, the microfinance sector in Jordan had 203,579 clients. This constitutes a 53.9% market penetration rate in Jordan, which is the highest in the Middle East region. FINCA Jordan adapted strategies and tactics necessary to survive in the early years. The company experimented with a number of different products aimed at 6

7 market niches including Islamic group and individual loans, youth start up loans, along with traditional commercial group and individual loans. The incentive system in Finca Jordan is built on the base of rewarding on the performance. The rewarding of the credit employee is direct connected to the growth of the portfolio. In the first day after the preparation period or after receiving the portfolio, each credit officer will be eligible for the incentive as an Increase to his salary, and it comes in two parts: Please see the incentive system currently used by Finca Jordan in Appendix # 2: The described in APPENDIX # 2 incentive system is pretty much a self administered program where numbers regulate the staff behavior. Sometime sales teams aren t encouraged to sell the way you need them to sell -- that is, to sell products and services strategically, in order to meet business goals. But instead they inevitably fall back on their own goals to guide them in the sales process. For instance, their only goal may be to close the deal as quickly as possible, often at the expense of gross margins and customer satisfaction. Overall this kind of system has high effect upon overall financial performance, portfolio size (number of clients and value of portfolio), portfolio at risk, and staff motivation. However, there is relatively little perceived effect on improving client satisfaction, staff turnover and staff loyalty. It also leads to diversion away from the target population. The strong emphasis on portfolio at risk PAR- and its overall impact on the incentive system (sort of punitive measure) play a significant role in negative collection practices. We have yet to find a solution to eliminating this problem without sacrificing a portfolio quality. Another side effect of this approach is mission creep in the form of a shift in focus of credit officers towards wealthier clients in order to increase their incentives. We have also seen scenarios where credit officers offer a lower loan amount than the customer requested. This is done to mitigate a potential negative effect of a large loan on their portfolio at risk ratio. By making these decisions (knowingly or unknowingly) we actually make things worse. When client needs a certain amount to finance his business, 7

8 i.e. to purchase a fixed asset and we offer less than needed amount it creates all sorts of issues for the customer such as, being forced to tap into their own capital to find the missing amount, look for another lender, etc. Either way, we are not doing any good for customer or for ourselves. Box 1: Types of Staff Incentive Schemes There are many kinds of staff incentive schemes in use around the world. The following are some of the most common: Individual monetary schemes: Staff can receive a monetary reward at the end of determined periods based upon their individual performance. Team based monetary schemes: Team members regularly receive monetary rewards which are determined by the performance of the whole team. Branch monetary based: Branch staff members can regularly receive monetary rewards, based upon the performance of the branch. ESOPs (Employee Stock Ownership Programs): Employees compensation is tied to the share price of the organization. This is either through direct ownership in shares of the company, or indirectly, through another mechanism such as a trust funds that invests in the company. Gain sharing: Under gain sharing plans, employees are entitled to a certain bonus depending on improvements in the performance of the institution. Profit sharing: Employees receive a certain percentage of the annual (or semi-annual) profit. The profit pool allocated to the employees is then distributed equally between all staff members, or according to some form of allocation criteria (base salary, individual performance, etc.) Monetary tournaments/competitions: Based upon certain criteria, individuals or teams are ranked relative to each other and monetary rewards are given to staff who achieves the highest ranks. Non-monetary tournaments/competitions: Individuals or teams are ranked relative to each other and nonmonetary rewards (e.g. publication of their names in newsletters) are given to staff members who achieve the highest ranks, based upon certain criteria. 8

9 Merit pay scheme: Based upon scheduled performance appraisals, staff can increase their regular salary. At Finca Jordan we will focus on Merit Pay Scheme with potentially supplemental Branch Monetary Based system. At the forefront of this system, there will be a leading metric called Customer Experience Index. The latter will help us to concentrate on right behavior which will inevitably translate into increased revenues. III. STRATEGY/IMPLEMENTATION FINCA JORDAN along with other Finca subsidiaries is reconsidering the sales staff compensation system and moving from mixture of fixed/variable compensation system to 100% fixed salary reward structure. At Finca the staff and primarily sales staff is compensated by combination of fixed salaries, incentives and bonuses. The portion of fixed pay is sometimes 50 70% and the bonuses constitute the rest of the compensation. The high value of variable compensation which most of the time depends on number of disbursement, number of active clients and portfolio at risk, often leads to low quality of loan analysis, bad collection practices and high client dropout rate. The project is to address this very important issue, dissect the current methodology and offer a practical solution where it is possible to have a 100% fixed pay offset by well established and implemented performance management system. The price tag for this undertaking is currently being calculated and at this point it is hard to provide even the approximate cost. The desired outcome behind this change is to set different type of behavior amongst the sale staff where the focus is on the customers rather than on quick sales. Where staff targets the right customer segment with appropriate products and services with a real value proposition that helps their businesses and establishes a relationship based lending business. The current incentive system is a so called self managing compensation scheme where Credit Officer s behavior is administered by rigid targets, i.e. number of monthly disbursements, portfolio growth, etc. The compensation plan is also very inflexible when it comes to calculation of Portfolio at Risk (PAR) ratio. Which in return stimulates unhealthy and unproductive collection methodology that punishes both, well paying 9

10 customers who happen to be late for objective reasons as well punishes Credit Officers for not pressuring the customers to collect the particular repayment amount. Choosing the right sales incentives to motivate a team can be challenging. On the one hand, they need to be exciting enough to motivate a sales force to change their behavior, or at least point it in a certain direction. On the other hand, they also need to fit within an organization s budget and not cost so much that they cancel out the benefit of holding a sales contest in the first place. At this point, the latter is very important for FINCA Jordan as the institution is struggling with sustainability. The challenge is how to choreograph sales incentive programs that will produce the right types of behavior. Sales people react differently to various forms of incentives and are motivated in various ways. To pull off an award winning performance, we as managers should produce sales incentive programs that work in harmony with both long term and short term needs of the business as well as the institutional values and socially driven mission. The compensation plan design is most successful when everyone involved has an open mind and is willing to take a step back and think about the strategy of the company and the sales process. The understanding of both the product and the sales process are critical to determining the appropriate compensation arrangement. Is the product a commodity? A product similar to the competition is more difficult to sell and may require a more aggressive sales compensation plan. How fast does the company need to grow? If there is intense pressure for rapid growth, the company may need more representatives and a more aggressive compensation structure. How about the lead-time and time required to make a sale? Sales compensation should reflect the level of difficulty to close a sale, the skills required to sell a product and the profitability or margin involved. We need to address the following questions relative to sales compensation and sales incentives: 1. Do we have the right individuals for the job? 2. What is the relationship between sales and marketing? 3. What is the right value proposition between the compensation paid to sales professionals and the revenue they generate for the organization? 4. What are the right competitive benchmarks for the sales force? 10

11 5. How do we establish attainable goals? 6. How do we balance plan simplicity with plan sophistication? 7. What elements of plan design impact attraction, retention and motivation more effectively than others? Each of these questions is challenging and must be addressed in evaluating the effectiveness of existing sales compensation and sales incentive plans, as well as in redesign efforts. These are some of the key issues that we are facing at the moment with our existing compensation system and which are contributing to some of the negative behavior described above and causing our institution to lose sales: Participants do not understand how their plan works and what the company expects from them. The management talks about the importance of a company-wide focus on new business, but it is not reflected as an opportunity in the incentive compensation plan. Our institution has a higher than average turnover among sales reps, and the current sales reps are also thinking of joining the ranks of the departed due to better opportunities elsewhere. The bottom line is that we can't copy a plan that works for another company. It is essential that our plan be based on a thorough and accurate analysis of the institution's financial structure. Otherwise switching to salaries (fixed pay only) can be tremendously risky. The first thing we need to do is understand the difference between our fixed and variable expenses. Variable costs are tied to revenue if we don't make any money, we don't have those expenses. But whether or not we bring in any money, we still have to cover our fixed expenses. So we need to keep fixed costs as low as possible. 11

12 The problem with salaries is that they take the largest expense for most microfinance institutions and moving it from a variable expense to a fixed expense will drastically increases the risk of doing business. If sales fall, the institution can fall into the red very quickly. The best way to lower the risk of offering salaries to make sure the payment plan is based on a solid analysis of our company's financials and the first issue we need to consider is our breakeven point. What we need is something we the world wide experts call the "Optimal Fully Productive Equivalent". That means that newer sales staff or other low producers are counted as partial sales staff rather than whole sales staff. So at a branch where we have 16 sales staff working, we may end up with an optimal fully productive equivalent of 13 1/4 agents. Then we add up all our fixed expenses, including salaries, to get a total expense figure. Then we add in profit as an expense. Adding a reasonable profit typically about 12-15% into fixed expenses is the most effective way to make sure the institution is profitable. Now we divide our fixed expenses (with profit) by your optimal fully productive equivalent number of agents. That's our breakeven point the amount of money each sales staff needs to bring in to cover the expense of having him or her work for the institution. After that breakeven point is reached, all we need to cover is our variable expenses. Without commissions, those are typically small. So after the sales staff contribution to fixed expenses is paid, we can afford to set up a bonus structure that lets each sales staff keep everything he or she brings in, less variable expenses. When we use this method for setting up commission plans, it doesn't matter what payment plan the Credit Officer (sales staff) is on. If sales associates want to be on salary, they can be. Large bonuses will be available after they have covered their share of the institutions fixed expenses. These bonuses will be available to be shared amongst the best performing branch employees. 12

13 Incentive Plan Design Process Evaluate business economic value drivers Current plan effectivene ss assessment Pay strategy/pl an design Payout modelling Plan administrat ion/effectiv eness monitoring Evaluate Business Economic Value Drivers Every sales force is impacted by the marketing strategy and how senior management communicates it. The sales force is also directly impacted by how the business is organized, how it is managed and by its unique value drivers. Relative to value drivers, does the company have the best product, best price, best delivery, and best market coverage or does it rely heavily on the business relationships maintained by the sales force? Relative to business operations and culture, how realistic are management s sales goals and marketing strategy? Is there enough inside sales support and investment in promotion and marketing? Do sales people feel they have the freedom to adjust their approach to various situations, or are they required to use the same strategy for every customer? Who will do this? FINCA International HR team, FINCA Jordan marketing and operations departments. COO will oversee the progress When will it be done? By March 15, 2014 Analyze Current Plan Effectiveness - Is the current incentive plan working as well as management would like? It could be that there is significant turnover in the sales force. Perhaps the commission or salary structure is creating problems. Who will do this? FINCA International HR team, FINCA Jordan finance team and operations departments. CFO and COO will oversee the progress 13

14 When will it be done? By March 15, 2014 Determine Pay Strategy What is the current pay strategy? Are there unique industry characteristics that require sales people with special technical skills? i.e. agricultural loan specialist, small business advisors, etc. Sales compensation will be designed so that it is planned and predictable. External industry competitiveness will be consideration in plan design. The pay strategy and incentive plan will reflect the individual s impact on the completion of the sale. The compensation program will reward strong performers, identify poor performers who require improvement and help recruit top talent from other organizations. Pay modeling will be done to make sure the plan works under a variety of economic scenarios. One of the key issues however, is the goal setting process. Goals will support the organization s strategy and will be understood and agreed to by top management and both sales and marketing management. The most common goals used are sales revenue, gross profit and number of loans sold. The branch incentive will include metrics like Customer Experience Index. Other goals will include acquiring new customers as well as maintaining existing customer relationships. Here are some other goals that will be considered: Product mix (selling a certain amount of specific products in a given territory). Cross-selling different products to existing customers Territory market share Who will do this? FINCA International HR team, FINCA Jordan finance team and operations departments. CFO and COO will oversee the progress When will it be done? By April 15, 2014 Payout Modeling What is the payout under various situations: below budget, at budget and above budget? Is the plan capped or uncapped? Does the salary rate increase after the company reaches various performance levels? Payout modeling is intended to ward off the effects of unintended consequences. Who will do this? FINCA International HR team, FINCA Jordan finance team and operations departments. CEO, CFO and COO will oversee the progress 14

15 When will it be done? By June 01, 2014 Administrative Guidelines and Communication This plan documents will clearly state the managers responsible for approving any changes to the plan. Many plans fail because of poor communication, not poor plan design. One salesperson summarized plan communication this way: If I can t easily explain it to my spouse, it is too complicated. If we do not understand how the plan works, how can you expect it to work? Management will take the time to meet with the sales force to explain the sales compensation plan and answer any questions that are asked. Who will do this? FINCA International HR team, FINCA Jordan finance team and operations departments. CEO, CFO and COO will oversee the progress When will it be done? Regularly Conclusion FINCA Jordan will develop a plan to fit our business needs. This step-by-step design process is intended to help us develop a sound program while keeping in mind the many intricacies that must be addressed along the way. Sales incentives help drive sales and sales drive business value. Developing new business, retaining existing customers and producing growth when prices increases are limited is challenging work. The sales incentive plan will be reviewed regularly to make sure it is supporting the strategy of the organization. The support of top management will be critical, both in how the plan supports management s specific business objectives, and by the amount of time management spends communicating the program to the sales force. The sales force will provide input, but will not control the design process. The Management will determine what is best for the overall business, not just for the sales force. There needs to be a rigorous modeling of various performance scenarios to make sure the program does not produce any windfalls or shortfalls that could cause unwanted turnover or embarrassing situations. 15

16 IV. FINANCIAL IMPACT On one hand it is relatively easy to calculate the costs associated with moving from variable compensation to a fixed one, but on the other had it is hard to see all the indirect costs such as one of the biggest fears, losing high performing Credit Officers due to an earning cap. Since this change will primarily involve sales staff, the whole impact calculation will revolve around those numbers. At the moment FINCA JORDAN has 70 Credit Officers who are engaged in sales activities. The average base salary for a Credit Officer is JD 400 per months. Depending on portfolio size and monthly sales, the incentive may vary from JD 100 to JD 400 per months. So, a Credit Officer who has 250 customers and manages a portfolio of JD 200,000 can earn around JD 700 per month. It should also be mentioned that the salary survey amongst the competing micro finance institutions conducted by human resources has revealed that our base salary is one of the best in the market, but in terms of overall compensation (base + incentives) we are below the market average. Therefore it s important to have a competitive fixed pay structure in order not to shock the system by losing best performing sales staff. One of the biggest challenges of moving from variable to 100% fixed compensation is paying competitive fixed salaries and in a way incurring high fixed costs with the aim of increasing efficiency in the long run. To put it all in prospective let s take a look at FINCA JORDAN s current financial structure vs the projected one after launching of fixed compensation plan. Fixed costs could potentially increase by 30-40% for employees with 1 year of service or more. This increase in fixed cost will need to be sustainable. Below you will find a proposed payment structure for various Credit Officer levels with their respective criteria: 16

17 FINCA Jordan Credit Officer Levels Level Criteria Credit Officer Trainee - Starting Base Salary is 450 JD. - Once the CO Trainee handles a current portfolio or starts to build their own portfolio, they will be eligible for Credit Officer Compensation. - Training Passed: Basic Training to COs (CODP Trainings); eg. Orientation, Code of Conduct, Marketing Skills, Customer Service, Financial Analysis. - CO trainee should pass exam at the end of the probation period with a score of >70%. - Recommendation from Branch Manager and approval from HR Manager and COO Level 1 Credit Officer ( to Graduate from Level One to Level Two, the following criteria should be met ) Level 2 Credit Officer ( to Graduate from Level Two to Level Three, the following criteria should be met - Salary range of level 1 is JD Minimum 12 months in Level 1 including probation period. - No Written Warning(s) in the last six months. - Minimum Number of active clients = 225 ( or 125 for Individual COs). - Minimum Average Monthly Evaluation for the last 6 months = Max Average PAR (portfolio at risk ratio) over one day (the last reading for the month) for the last 6 months is less than 2 %. - Training Passed: Time Management, Communication Skills. - Recommendation from Branch Manager and approval from COO and HR Manager. - Salary range of level 2 is JD Minimum 6 months in Level 2 - No Written Warning(s) in the last six months. - Minimum Number of active clients = 350 (or 175 for Individual COs). - Minimum Average Monthly Evaluation for the last 6 months = Max Average PAR over one day (the last reading of the month) for the last 6 months is less than 1%. - Training Passed: Credit Committee Training, Financial Analysis for SME and a refresher, Coaching Training. - Recommendation from Branch Manager and 17

18 approval from COO and HR Manager. Level 3 Credit Officer - Salary range of level 3 is JD 900-1,100 JD. - All criteria of level 2 should be achieved. Also, each CO in Level Three must have coached 1 CO trainee to successfully pass the probation period and move to Level One or has been assigned for the Credit Supervisor position for a period of time. - Recommendation from Branch Manager and approval from COO and HR Manager. Notes : - The Credit Officer must achieve the criteria of each level to move to the next level. - No maximum duration is guaranteed in each level. - Only Credit Officers in Level 3 can be promoted to Credit Supervisors. However, Management Board can make exceptional decisions for promotions based on business needs. - Coaching for COs Trainees is only done by COs in Level 3. If no Credit Officer in Level 3 is available, then COs from lower levels should do the coaching. - In absence of Credit Supervisor, the Branch Manager can give his/her responsibilities to ONLY Level 3 COs with prior COO approval. If no Credit Officer in Level 3 is available, then COs from lower levels should take the responsibility. - Levels will be reviewed semi annually. - Upon review, COs levels may increase or decrease based on the criteria met in the time of the review. However, COs may skip levels going up, while going down in the levels will be for one level at a time. - If the Credit Officer has not met all the criteria for his/her current level, he/she is able to stay at the current level for one review period only. However, Credit Officer's level who have not met all the criteria for their level for two consecutive periods can be decreased one level according to management discretion. - The written warnings that are considered in reviewing levels are those of non performance type. As mentioned earlier, at the moment FINCA JORDAN has 70 Credit Officers who are engaged in sales activities. In the next 2 years, we are planning on adding additional 30 new Credit Officers. Below you will find the income statement projection for FINCA JORDAN until year It s projected that the cost of sales staff salaries to be at around 38% of total operating costs. The operations team will introduce some innovations, i.e. automated 18

19 approvals, decentralization of certain functions in order to reduce operational costs in order to offset increase in salary expenses. See attachment in Excel spreadsheet for income statement details. Jordan UDT_FINAL_ xlsx INCOME STATEMENT Operating Revenue Financial Revenue from Loan Portfolio 5,523,875 6,607,774 7,466,538 Interest income from Loans 5,289,884 6,316,543 7,126,434 Loan Fees/Commissions 233, , ,104 Less Client Rebates Financial Income on Investments Bank Interest income Income on financial investments Interest income on intercompany investments Penalties & Fines 83, , ,389 Income on Money Transfers Client insurance income Other operating revenue TOTAL OPERATING REVENUE 5,607,021 6,743,682 7,647,927 Expenses FINANCIAL EXPENSES 1,863,960 2,143,188 2,335,118 Financial Expense on Funding Liabilities 1,555,409 1,832,643 1,973,167 Interest and Fees paid on Clients Deposits on Collateral Deposits on Savings Accounts on Time Deposits on Other Voluntary Savings Interest and Fees paid on Borrowings 1,555,409 1,832,643 1,973,167 on Intercompany Sub-debt on External Sub-debt on Intercompany Notes Payble on External Notes Payable 1,555,409 1,832,643 1,973,167 Impairment Losses on Loans 308, , ,951 Impairment Charge 308, , ,951 less Recoveries OPERATING EXPENSES 3,684,890 4,400,605 4,942,421 Salaries 2,379,559 2,748,713 3,013,868 Salaries Head Office 752, , ,299 Salaries Branch 1,433,898 1,648,982 1,835,630 19

20 Bonuses/Incentives Social security funds expenses 192, , ,938 Benefits 191, , ,639 Employee benefits and insurance 98, , ,989 Allowances 93, , ,650 Transportation and per diem (In Country) Travel and per diem (International) 49,365 51,834 54,425 Professional services 78,346 89,350 93,112 Consultants 6,683 14,104 14,104 Audit 22,533 23,660 24,843 Legal expenses 19,464 20,437 21,459 IT service fees 20,258 21,271 22,334 Other professional services 9,408 9,878 10,372 Rent 141, , ,544 Utilities 45,629 50,192 57,720 Security Vehicle operating cost 9,817 10,307 10,823 Vehicle Fuel 6,770 7,109 7,464 Vehicle maintenance/repairs 2,116 2,221 2,333 Vehicle insurance ,026 Office supplies/equipment 62,593 65,723 69,009 Training expenses 56,417 59,238 62,200 Maintenance/repair expense 13,022 13,673 14,356 Marketing/Advertising 70,522 98, ,939 Subsidiary Royalty Fees to FMH 0 108, ,354 Subsidiary MSA Fees to FMH 183, , ,302 Subsidary MSSA Fees to FINCA Network Support BV (SSC) 35,439 93, ,854 Depreciation and amortization expense 105, , ,863 Fixed-asset depreciation expense 97, , ,182 Intangible asset amortization expense 8,226 14, ,681 Communications 54,322 57,038 59,889 Phone/mobile expenses 15,956 16,754 17,591 Internet/network expenses 13,428 14,099 14,804 Postage & delivery 24,938 26,185 27,494 Employee recruitment/relocation 2,821 3,103 3,413 Taxes other than Profit Tax 50,758 53,296 55,961 Insurance 70,520 77,572 85,330 Printing & Stationery 37,582 39,461 41,434 Meetings, Conferences, Meals & Entertainment 20,310 21,326 22,392 License/Memberships 16,925 17,772 18,660 Bank charges 8,463 8,886 9,330 Miscellaneous TOTAL OPERATING EXPENSES 5,548,850 6,543,793 7,277,539 Net Operating Margin (pre fx, taxes and non-op rev/exp) 58, , ,388 Profit tax 37,518 60,935 90,452 Net Operating Margin (post tax, pre fx & non-op rev/exp) 20, , ,936 20

21 Foreign exchange gain/loss (8,463) (10,155) (12,186) Unrealised gain Unrealised loss Realised gain Realised loss (8,463) (10,155) (12,186) Net income and forex gain or losses on swaps and back-to-back loans) Net Operating Margin (pre non-op rev / exp) 12, , ,750 Net Non-operating Income/Expenses 114,024 63,747 0 Non-operating Revenue 114,024 63,747 0 Grants 114,024 63,747 0 Received via FI 114,024 63,747 0 Received directly from donors Donations Received via FI Received directly from donors Other Non-operating income Non-operating Expenses Net income 126, , ,750 OUTREACH I. BORROWERS Total Active Borrowers 22,127 26,475 31,535 Growth # 3,505 4,348 5,061 Growth % 19% 20% 19% Active Village Banking Borrowers 0 Growth # Growth % na na na Active Small Group Loan Borrowers 15,795 18,164 20,889 Growth # 1,478 2,369 2,725 Growth % 10% 15% 15% Active Individual Borrowers 6,332 8,311 10,647 Growth # 2,027 1,978 2,336 Growth % 47% 31% 28% Active Other Borrowers (Including Staff Loans) Growth # Growth % na na na II. GROSS LOAN PORTFOLIO Total Loan Portfolio, USD 17,711,519 21,119,215 24,227,964 Portfolio Growth # 5,349,945 3,407,696 3,108,749 Portfolio Growth % 43% 19% 15% Village Banking Group Loan Portfolio, USD Group LP Growth # Group LP Growth % na na na Small Group Loan Portfolio, USD 10,577,439 12,164,055 13,988,663 Group LP Growth # 2,788,163 1,586,616 1,824,608 Group LP Growth % 36% 15% 15% Ind. Loan Portfolio, USD 7,134,080 8,955,161 10,239,301 21

22 Ind.Bus. LP Growth # 2,561,783 1,821,080 1,284,140 Ind.Bus. LP Growth % 56% 26% 14% Other Loan Portfolio, USD (Including Staff Loans) Other LP Growth # Other LP Growth % na na na GLP Check with BS (should be zero) III. PORTFOLIO DISTRIBUTION % in Village Banking Group Loans 0.0% 0.0% 0.0% % in Small Group Loans 59.7% 57.6% 57.7% % in Individual Loan 40.3% 42.4% 42.3% % in Other Loans (Including Staff Loans) 0.0% 0.0% 0.0% V. MONEY TRANSFERS Total Money Transfers Number of transactions Average transaction size na na na VI. TOTAL STAFF Loan Officers Supervisors Tellers Customer Care Staff Other Field / Branch Staff 0 HO Staff VII. TOTAL LOAN OFFICERS Village Banking Group Loan Officers Small Group Loan Officers Individual Loan Officers Other Loan Officers (Including Staff Loans) VIII. TOTAL SERVICE OUTLETS / POINTS OF SERVICE Branches Sub-Branches / Agencies POS/Kiosks Sales Centers Other Locations (Room) PERFORMANCE INDICATORS I.PROFITABILITY NOM (before taxes, fx and non-operating revenue) 58, , ,388 NOM (after tax before fx and before non-operating revenue) 20, ,954 NOM (after tax after fx and before non-operating revenue) 12, ,799 Net Income 126, , ,750 RoA (net income / average assets) 0.7% 0.9% 1.0% RoE (net income / average equity) 3.2% 3.7% 3.7% 22

23 II. LP YIELD Yield on Gross Loan Portfolio 36.4% 34.0% 32.9% Yield on Village Banking Group Loans 0% 0% 0% Yield on Small Group Loans 39.3% 37.0% 35.9% Yield on Individual Loans 31.7% 29.8% 28.9% Yield on Other (Including Staff Loans) 0% 0% 0% III. OPERATING EFFICIENCY Operating Expense / Avg. Assets (Operating Expenses excluding financial costs and impairment charges) 21% 20% 19% Operating Expense / Avg. Loans (Operating Expenses excluding financial costs and impairment charges) 24% 23% 22% OSS (Operating Revenues / Operating Expenses) 101% 103% 105% IV. OTHER EFFICIENCY METRICS OLP / Loan Officer 215, , ,264 OLP / Staff Member 112, , ,015 Loan Officers to Total Staff 52% 51% 52% Opex/Borrower (Operating Expenses excluding financial costs and impairment charges) Opex/Staff Member (Operating Expenses excluding financial costs and impairment charges) 23,880 26,020 25,105 V. LOAN OFFICER CASELOAD Village Banking Group Loan Caseload #DIV/0! #DIV/0! #DIV/0! Small Group Loan Caseload Individual Loan Caseload #DIV/0! #DIV/0! #DIV/0! Other Loan Caseload (Including Staff Loans) #DIV/0! #DIV/0! #DIV/0! VI. DISBURSEMENTS AND AVERAGE LOAN SIZE Amt of Disbursements - Overall (USD) 22,142,588 36,581,811 45,594,201 Amt of Disbursements - Village Banking Group Loans Amt of Disbursements - Small Group Loans 13,291,206 16,519,140 20,588,838 Amt of Disbursements - Individual Loans 8,851,382 20,062,671 25,005,363 Amt of Disbursements - Other (Including Staff Loans) Amt Disbursed YTD 22,142,588 36,581,811 45,594,201 No. of Disbursements - Total 23,339 29,445 34,952 No. of Disbursements - Village Banking Group Loans No. of Disbursements - Small Group Loans 17,154 19,925 23,652 No. of Disbursements - Individual Loans 6,185 9,520 11,300 No. of Disbursements - Other (Including Staff Loans) No. Disbursed YTD 23,339 29,445 34,952 23

24 Avg Loan Size Disbursed - Overall (USD) 949 1,242 1,304 Avg Loan Size Disbursed - Village Banking Group Loans #DIV/0! #DIV/0! #DIV Avg Loan Size Disbursed - Small Group Loans Avg Loan Size Disbursed - Individual Loans 1,431 2,107 2,213 Avg Loan Size Disbursed - Other (Including Staff Loans) #DIV/0! #DIV/0! #DIV YTD Avg Loan Size Disbursed - Total 949 1,242 1,304 Average Loan Size Outstanding - Overall (USD) Average Loan Size Outstanding - Village Banking Group Loans #DIV/0! #DIV/0! #DIV Average Loan Size Outstanding - Small Group Loans Average Loan Size Outstanding - Individual Loans 1,127 1, Average Loan Size Outstanding - Other (Including Staff Loans) #DIV/0! #DIV/0! #DIV VII. PAR Total % PAR > 1 Day 1.52% 1.52% 1.52% % Village Banking Group Loan PAR > 1 Day 0.00% 0.00% 0.00% % Small Group Loan PAR > 1 Day 1.15% 1.15% 1.15% % Individual Loan PAR > 1 Day 2.06% 2.06% 2.06% % Other Loan PAR > 1 Day (Including Staff Loans) 0.00% 0.00% 0.00% Total % PAR > 30 Days 1.35% 1.35% 1.35% % Village Banking Group Loan PAR > 30 Days 0.00% 0.00% 0.00% % Small Group Loan PAR > 30 Days 1.00% 1.00% 1.00% % Individual Loan PAR > 30 Days 1.86% 1.86% 1.86% % Other Loan PAR > 30 Days (Including Staff Loans) 0.00% 0.00% 0.00% VIII. Other Ratios Equity / Assets 21.6% 25.2% 30.4% Unrestricted Cash / Assets 9.3% 5.0% 5.0% Cash / Assets 9.3% 5.0% 5.0% IX. % of Opex Salaries 65% 62% 61% Salaries Head Office 20% 20% 19% Salaries Branch 38% 37% 37% Bonuses/Incentives Social security funds expenses 5% 5% 5% Benefits 5% 5% 5% Employee benefits and insurance 3% 3% 3% Allowances 3% 2% 2% Transportation and per diem (In Country) 0% 0% 0% Travel and per diem (International) 1% 1% 1% Professional services 2% 2% 2% Consultants 0% 0% 0% Audit 1% 1% 1% Legal expenses 1% 0% 0% IT service fees 1% 0% 0% Other professional services 0% 0% 0% 24

25 Rent 4% 4% 4% Utilities 1% 1% 1% Security 0.0% 0.0% 0.0% Vehicle operating cost 0.3% 0.2% 0.2% Vehicle Fuel 0.2% 0.2% 0.2% Vehicle maintenance/repairs 0.1% 0.1% 0.0% Vehicle insurance 0.0% 0.0% 0.0% Office supplies/equipment 1.7% 1.5% 1.4% Training expenses 1.5% 1.3% 1.3% Maintenance/repair expense 0.4% 0.3% 0.3% Marketing/Advertising 1.9% 2.2% 2.6% Subsidiary Royalty and MSA Fees 0.0% 2.5% 2.5% Depreciation and amortization expense 2.9% 3.5% 5.9% Fixed-asset depreciation expense 2.6% 3.2% 3.0% Intangible asset amortization expense 0.2% 0.3% 2.9% Communications 1.5% 1.3% 1.2% Phone/mobile expenses 0.4% 0.4% 0.4% Internet/network expenses 0.4% 0.3% 0.3% Postage & delivery 0.7% 0.6% 0.6% Employee recruitment/relocation 0.1% 0.1% 0.1% Taxes other than Profit Tax 1.4% 1.2% 1.1% Insurance 1.9% 1.8% 1.7% Printing & Stationery 1.0% 0.9% 0.8% Meetings, Conferences, Meals & Entertainment 0.6% 0.5% 0.5% License/Memberships 0.5% 0.4% 0.4% Bank charges 0.2% 0.2% 0.2% Miscellaneous 0.0% 0.0% 0.0% 25

26 V. NON-FINANCIAL IMPACT FINCA International has made the strategic decision to change the compensation structure for Credit Officers [LO].A decision has been made to update the current compensation scheme and shift away from a monthly bonus model to a compensation program comprised primarily of base salary. Although the current compensation model rewards outreach/performance and portfolio quality/arrears, it also reinforces short term thinking/results, can be punitive in nature and encourages high risk behaviors and fraud. The objective of moving away from a monthly bonus structure is to align compensation more strategically with long term business objectives and to reinforce long term growth and stability. It is believed that a shift from a monthly bonus scheme to fair and adequate salary levels which are competitive with the market base and differentiated based on performance, will be more aligned with FINCA core values and achieve targeted business objectives. Over the last 2 years there have been steps to decrease the bonus component for LOs. In a majority of the subsidiaries bonuses have been reduced from 50% of total compensation to 30%. The initial concern that productivity and portfolio quality would be adversely impacted as a result was not realized. In some instances, an increase in performance was observed. Feedback from branch visits included that the lessening of pressure allowed for a more stable work place and better daily performance. A complete shift away from a monthly bonus plan is the next step in the process. Ensuring that the transition is smooth, managers are prepared and overall performance is maintained is the primary concern of FINCA JORDAN. Below are some items to consider prior to the shift. Communication strategy Compensation model for shift Enhanced performance management process and tools Decrease in performance Training to support the transition and challenges Talent Development focusing on emerging talent Recruiting practices Communication Strategy A communication strategy which describes the vision, supports the change and reinforces objectives is an important first step to the success of the transition. The communication plan will include the purpose and objectives for change, key messages important to convey, the timing of the change and expectations/support going forward. 26

27 Compensation-Model for Shift Financial model for shift The shift is transparent and understandable LOs are not disadvantaged Sustainable Future compensation scheme Branch Managers and Credit Supervisors. To increase LO acceptance, it is important that the method used (how the new salary was determined) for the shift is understandable and does not significantly disadvantage any individual LO. An additional consideration will be the compensation scheme going forward. With no bonus, FINCA JORDAN will have to consider an alternative compensation program such as annual or biannual salary review with merit increase and budget guidelines. With the current monthly bonus system, there is little link between pay and the performance evaluation. As a result, little importance is placed on the evaluation. Merit increases linked to the performance review and rating would address this issue and provide the criteria for salary increases. In case when there is a decline in performance, for instance more than 3 months in a row then an action plan and possible probation period will be enforced. Other forms of recognition around core values or excellence in customer experience will also be considered to reinforce desired behaviors and outcomes and reinforce cultural change. Once bonuses have been shifted to salaries, compensation will no longer fluctuate as closely with profitability. In a year where performance is not maintained, the increase in salary cost will impact profitability. There is also a risk of losing high performing employees who are motivated solely by increased incentives. Higher salaries will improve FINCA JORDAN s competitive position in the market place, attract a higher caliber of LO and potentially improve retention. Active and ongoing management of performance will become even more critical to success. Reinforcement and recognition of good behaviors and coaching on development needs will set the tone for a positive work environment interested in the success of every Credit Officer. 27

28 Long term performance targets (6 months) with shorter termed milestones coupled with a stable compensation scheme and ongoing coaching and reinforcing throughout the performance cycle, should allow LOs to focus on building their client base responsibly. Enhancing the goals set for each Credit Officer in their performance evaluation to include business critical behaviors as key performance indicators will be essential when pending changes are approved. Including business critical behaviors will help ensure that behaviors which FINCA JORDAN values as key to success are being communicated and developed. With no bonus system, managers will have to spend more time managing. FINCA JORDAN will need to ensure that managers have time to manage their staff, provide ongoing coaching, feedback and reinforcement throughout the performance cycle to keep LOs motivated and on track. A review of policies and procedures will need to be conducted in order to ensure that Branch Managers and Credit Supervisors have adequate time to spend with their direct reports. A potential decrease in individual performance should be addressed immediately and constructively by the management. A protocol for addressing poor performance should be in place and communicated for each employee (for example, performance improvement plan, written warning and final written warning). The immediate impact of a decrease in compensation to address a downturn in individual performance will no longer be available. Addressing performance issues in a timely manner and effectively and efficiently will be critical. During the transition a downturn in FINCA JORDAN performance could be solely attributed to employee performance and other factors such as change in competitive landscape, product offering could be overlooked. A thorough assessment should be conducted if an overall decrease is observed. In order to address this issue more efficiently FINCA JORDAN (for the first time in its history) hired a professional marketing/product research manager to provide us (management) with timely market intelligence in order to make effective changes to our products and services as well as delivery channels. A clearly identified credit career path with promotion criteria could also help keep LOs motivated. Increased accountability and authority could help keep LOs motivated and engaged. Identifying high potential emerging talent at the LO level could help retain top performers. Formalizing a program around emerging talent could support their development and keep them motivated. 28