Final Microcredit Report.docx

Evaluating Agricultural Microcredit Lending within Asociacin Mangle:An Assessment of Product Cost Structure and BudgetingMolly Hubbard, Sarah Kotb and Morgan RoggeTeam El Salvador 8: January 2014

Series Editor: Adele Negro, Program DirectorPhoto credit: Sarah Kotb

Acknowledgements We would like to express our gratitude to all who helped and supported us throughout this project. We would like to thank all of those involved in the planning, organization, and execution of this project, as well as all of the community members who participated in the interviews we conducted. The time, interest, openness, and attention to detail by all of those we interviewed allowed us to gather valuable data that would not have been obtained if not for the time and consideration of these producers. We would also like to extend a special thanks to Juan Luna, Amilcar Cruz, and Jos Maria Argueta for sharing their knowledge and for connecting us with local communities and all of those whom we interviewed: Humberto Rosa, Carlos Quintana, Antonio Amaya, Porfirio Belloso, Leonidas Monteagudo, Santiago Rajo, Carmen Argueta, Luis Ramos, Ricardo Antonio Olivo, Miguel Angel Bonillas, Antonio Rivera Rivera, Victor Giovani Lopez, Elmer Alfred Chavez Diaz, Francisco Daniel Alvonso Acevedo, and Walter Alexander Daz. Their efforts to provide information and transportation were invaluable in making this project a reality. We are very grateful for the support and accommodation of the entire Coordinadora staff, as well as of our host families, who were also extremely accommodating and ensured that our stay was comfortable and filled with delicious food. Last, but certainly not least, we would like to thank the rest of Team El Salvador 8 and Adele Negro for their unwavering support throughout the project.

Executive Summary

January 2014 marks the eighth year of Team Montereys collaboration with the NGO Asociacin Mangle and its grassroots organization La Coordinadora on a number of community development projects deemed to be of high importance to furthering the organizations social mission.

Between January 7th and January 24th, the Microcredit Team worked on the ground in El Salvador to examine Asociacin Mangles current agricultural microfinance program and elaborate a document of best practices for loan administration, as well as a preliminary cost structure for a lending program. As a result of this dual objective, the following report is divided into two distinct parts. Part I describes best practices for microcredit lending in the black bean program and includes recommendations for achieving these, while Part II accounts for the cost of the black bean program with the use of a preliminary income statement and activity cost structure. The Team focused particularly on the black bean and hybrid corn production programs, due to the guaranteed markets within these sectors, as well as to the promise of continued funding for these programs. In order to produce the best practices manual and create the income statement and cost structures, the Microcredit Team started with a literature review of best practices regarding agricultural microfinance and budgeting before arriving in El Salvador. In country, the team conducted interviews with both the producers receiving loans and the loan administration team of Asociacin Mangle. The interviews aimed to assess where Mangles program currently stands in terms of upholding its social mission in support of the producers and the community of the Bajo Lempa, as well as the financial and administrative sustainability of the program for the future. This final report reveals that, for the most part, Asociacin Mangle is successfully addressing its social mission by providing good support to producers. However, the programs future ability to fulfill this social mission is threatened by its lack of financially sustainable business practices. Low interest rates, lack of coverage of administrative and indirect costs, and few consequences for defaulters indicate that the design of the program must be improved to ensure financial viability.

PART I: BEST PRACTICES AND POLICIES FOR AGRICULTURAL MICROCREDIT LENDING1.0 Introduction As a community-based sustainable development organization, Asociacin Mangle has been involved in agricultural microfinance for many years, working to support producers for whom self-financed production is unrealistic, and access to traditional credit is limited. This microcredit program currently has six lines of credit within the agricultural sector, financed primarily through an annual loan portfolio of $150,000. Under these lines of credit, Asociacin Mangle provides small loans to producers, ranging in size from several hundred dollars to several thousand. A share of each loan is apportioned in the form of any inputs necessary for a cycle of production (seed, fertilizer, pesticides, etc.), purchased in bulk by the organization below market value, while the remainder of the credit is given to borrowers in the form of a check to cover labor and machinery costs. This report examines the credit line for the production of black beans, as well as the costs associated with the production of hybrid corn (see Background for further details).

Within the black bean program, members of Team El Salvador 8 were asked to investigate loan administration practices and produce an operational manual of policies and procedures for the successful administration and use of microcredit loans. This manual is based primarily on a literature review of best practices and policies for microcredit institutions with similar characteristics, operating in comparable environments. In addition to the literature review, we conducted interviews with loan administrators, agronomists, and producers to assess current lending practices in comparison with best practices. Based on this information, we have made recommendations to improve the lending practices and policies of Mangle and move toward best practices.

We examine best practices from both the social lens and the programmatic sustainability lens, the former with a greater focus on improving the quality of services rendered to borrowers; the latter with a greater focus on building profits for the lending institution. As such, in the following report, best practices have been separated into two categories: Maintaining Mangles Social Mission and Ensuring Programmatic Sustainability. Each of these sections contains subsections in which the best practice is defined, the policies and practices as they currently exist are evaluated, and the associated recommendations to approach best practices are laid out. While this report is based on primary research on production within the black bean and hybrid corn programs, it was designed to ensure that the majority of practices and recommendations could be applied to future lines of credit. This is particularly pertinent as Mangle redesigns the organizational structure of its microcredit system as a new institution called Xinachtli.

Mangles envisions Xinachtli, which means seed in, Nahuat, the indigenous language of El Salvador, as a new arm of the association, separated from its mother organization but under the same system of governance. This institution would manage all the lines of credit currently administered by Mangle, with the objective of eventually becoming a for-profit microfinance organization. Therefore, the primary purpose of this report is to help strengthen the administrative system of Mangles microcredit program under Xinachtli, in order to improve its programmatic sustainability and ensure adequate profit margins for both Xinachtli and associated producers. Simultaneously, this report seeks to ensure that Xinachtli can remain committed to the social mission of Mangle, and to its priority of supporting the needs and livelihoods of community members. 1.1 Background This year Team El Salvador 8 was asked to investigate two programs within the Granos Bsicos (basic grains) sector, specifically those of hybrid corn and black beans. While the black bean program follows a traditional agricultural microfinance model, distributing small loans to producers during each production cycle, the hybrid corn production program is no longer considered part of the microfinance system (as we explain below). The production programs for black beans and hybrid corn are unique among those in Mangles system for a variety of reasons.

The governments hybrid corn seed program contracts out the production of hybrid corn seed to local producers, who then sell their product back to the government for distribution to Salvadoran families. The distribution of hybrid seed packets to families is meant to ensure that small-scale growers have the greatest chance at success when cultivating corn for family consumption. The production of the seed for these packets, therefore, is of great importance to the government, both to ensure adequate sustenance for the low-income rural population, and to reduce reliance on foreign agricultural biotechnology corporations such as Monsanto.

However, a recent change in national regulation, with the goal of maintaining greater control of seed quality during corn production, now prevents small farmers in Mangles microcredit program from producing hybrid corn seed. Instead, Mangle holds a government contract to produce the corn seed internally for sale back to the government. Under this contract, Mangle, with the help of agricultural experts and government consultants, is in charge of the entire production process, from land preparation to processing and packaging the seed. Mangle manages two parcels of land for production of hybrid seed, totaling 22 manzanas, approximately 54 acres. While the production of corn seed is labor and resource-intensive, it is attractive because the sale of the seed back to the government is guaranteed, as long as the seed meets quality requirements. The production of the seed, including initial inputs, is financed primarily with loans from ALBA (Alianza Bolivariana para los Pueblos de Nuestra Amrica), a Central and South American trade organization.

Black beans, on the other hand, have not been produced in the Lower Lempa region in the past. Rather, small farmers grow several varieties of red beans. However, under an agreement with ALBA, Mangle is supporting local producers in their efforts to grow this crop for guaranteed sale on the Venezuelan market. As in the hybrid corn seed production program, the guaranteed sale of any black bean production output adds to the appeal of growing this unproven crop. Under the agreement with ALBA, Mangle receives a loan from the trade organization to finance production efforts using microcredit loans. In its first year, Venezuela will purchase all black beans produced at a price of $39/quintal ($39/220 pounds), and this value will increase accordingly if the Venezuelan market price for black beans increases. In the case of a price increase, ALBA will meet the market price, and transfer the additional funds to Mangle for distribution back to producers.

It is important to note that the technical expert employed by Mangle for the black bean program, Porfirio Belloso, also provides technical support to producers within two other community development organizations, OIKOS and COMUS. Asociacin Mangle lends a portion of the capital borrowed from ALBA to these organizations at the same interest rate; these organizations in turn are responsible for disbursing and managing individual loans to producers, and ensuring that Mangle receives repayment.1.2 Methodology Prior to Team El Salvadors arrival in the Bajo Lempa, the Microcredit Team conducted preliminary research of literature and submitted a project proposal to the board of Asociacin Mangle for review. While still in the United States, the had an initial discussion regarding the merits of this proposal via Skype with the teams board liaisons, Jos Amilcar Cruz, the Production Program representative, and Juan Luna, Mangles chief agronomist and Production Program Coordinator. After arriving in country, the team met with Juan Luna and Amilcar Cruz in person to finalize the project proposal. In this meeting the methodologies and deliverables of the project were more clearly laid out, and a work schedule for the weeks that followed was created. Throughout the three weeks in country, between January 7, 2014 and January 24, 2014, the Microcredit Team conducted both qualitative and quantitative research, using three main methodologies: a series of semi-structured interviews, the review of documents related to the distribution and repayment of loans, and direct observation at both Mangle offices and producer sites in order to further understand practices, policies, and attitudes. With the help of Juan Luna, Jos Maria Argueta Pineda (the main liaison between Mangle and El Salvador 8), and Porfirio Belloso, Mangles extension agent, interviews were scheduled with the board of directors, loan administrators, accountants, technical assistants, and producers (see Appendix 2). In the days before the first interview, the team developed a series of interview questions: 54 questions (Appendix 1a) were created for the loan administrators, 41 questions (Appendix 1b) for the technical assistants, and 38 questions (Appendix 1c, Appendix 1d) for the producers. These questions were aimed at gathering both qualitative and quantitative data from each of these groups regarding their experiences within the microcredit program. The open-ended interview questions were developed in order to obtain in-depth, unbiased responses with respect to some of the impacts of the microcredit system that had not previously been considered or that were incidental effects or externalities. The team opted for semi-structured interviews in order to allow the interviewees to answer the questions freely and foster an open conversation regarding their experiences. In all, the team conducted interviews with two accountants, nine producers, two agronomists, and four administrators. In addition to the research on relevant literature regarding microcredit programs and best practices associated with them, the Microcredit team was able to procure important loan documents with the help of Humberto Rosa, a loan administrator and accountant at Mangle, including a sample contract, a letter of exchange, a copy of the Rules and Regulations for Microcredit Lending in Agriculture (Reglamento de Crdito Agropecuario), and a ledger of the black bean loans administered to date.

1.3 Project Scope The research conducted for the purpose of producing this operating manual examines the agricultural microcredit program provided by Asocacin Mangle in the area of the Bajo Lempa, El Salvador. The manual covers the basic grains sector and is based upon fieldwork regarding the hybrid corn and the black bean program. However, more emphasis has been given to the black bean program, due to both its novelty and its different nature from that of the hybrid corn program, where producers work under Mangle instead of receiving microcredit loans for production. During the time of the fieldwork and as of the writing of this report, the first harvest cycle for black beans has not yet been completed. This has imposed many limitations on the research process. Specific numbers for earnings and repayment rates could not be examined and only projected ideas with respect to profit margins could be requested. All the producers involved in the research have received loans from Asociacin Mangle, but none from its partner organizations, OIKOS or COMUS, as they operate in different regions of El Salvador. The interviews conducted with loan administrators have also been limited to personnel working within Asociacin Mangle.

1.4 Interview Summaries 1.4.1 Technical ExpertsPorfirio Belloso:The interview with Porfirio Belloso, a technical expert for Mangles black bean program, took place on the land Mangle leases for hybrid corn production. Porfirio clearly laid out his role from start to finish of the production cycle. As the extension agent for the black bean program, Porfirio works with 200 producers farming on nearly 180 manzanas of land; of these producers, 50 are members of Mangles microfinance program, 100 produce under OIKOS, and 50 produce under COMUS. Porfirio explained that he is extremely busy with all of these producers and that he tries to visit them every fifteen days, if possible, and often consults with producers over the phone. As an agricultural expert, Porfirio explained that he does not have much involvement with the administration of loans, and that meetings more often occur between the head of the production sector, Amilcar Cruz, and Mangles Board of Directors. Porfirio stated that he thinks the greatest challenge for the production of beans is the transition from conventional to organic agricultural practices, as well as the risk of natural phenomena, including disease, drought, flooding, and other changes in weather affecting production. When asked for recommendations to improve the efficiency of the microcredit program, Porfirio expressed a desire for increased contact between accountants and technical experts; the creation of a separate sector within Mangle for the micro-lending program would be beneficial.

Leonidas Monteagudo: The interview with agronomist Leonidas Monteagudo took place at Mangles offices in San Nicolas on January 13, 2014. Leonidas works as Mangles technical expert, specializing in the hybrid corn program. Leonidas was extremely clear in his description of the various costs associated with each phase of production for the hybrid corn microcredit program. These costs include, but are not limited to: preparing the soil; finding water sources; sowing the land; installing and operating irrigation systems when necessary; applying fertilizers, insecticides and herbicides; cross-fertilizing the male and female reproductive plants; harvesting the crop; selecting quality seeds; and transporting, processing, and packaging the seeds. In the summer months the total cost per manzana is approximately $3,000, and during the winter it is approximately $1,500, due to differences in the moisture of the soil. As a technical expert, Leonidass role requires him to visit the producers frequently in order to assess the suitability of the land, check for plant infections, monitor the plants development, explain the technical aspects of production to workers and producers, and monitor how these recommendations are followed. With the recent changes in policy, Mangle can no longer disburse micro loans for the production of hybrid corn, but rather must itself cultivate the corn. Mangle is currently cultivating 22 manzanas of land for the hybrid corn seeds. Antonio Amaya produces twelve of these manzanas, and another producer known as Johnny produces ten. In previous years, when Mangle did disburse micro loans to individual producers to farm hybrid corn seeds, there were approximately 25 corn seed producers under its management.

1.4.2 Loan AdministratorsHumberto Rosa and Carlos Quintana: The interview with the loan administrators and Mangle accountants Humberto Rosa (Chepe) and Carlos Quintana took place at Mangles offices in San Nicolas on January 7, 2014. Throughout the interview it became clear that, although these two accountants work with the microcredit program, it is not their only responsibility within Mangle. Furthermore, the two accountants explained that they do not participate extensively in the full process of administering loans, but rather handle paperwork, such as contracts, and disburse checks. The accountants explained that none of the administrative costs required for the processing of the loans are internalized and, further, that Mangles Board of Directors decides the interest rate without the participation of the accountants. The accountants explained that a fee for administrative costs is not currently being assessed because it would raise the costs to producers significantly, which would not be in keeping with Mangles social mission. When asked how long, in terms of hours, it took to administer a loan; the accountants were unable to say. They explained that they were unsure how much time they spend on any one loan because they are often interrupted and asked to start a new task or project, and because they are involved in so many different aspects of Mangles accounting. Both accountants expressed concern with this method and commented on the lack of organization and the inefficiency this causes. The accountants explained that they would like to have more clear communication with the Board of Directors, and more personnel to assist them; however, they admitted that this was not possible because Mangle does not currently have sufficient funds to hire more employees.

1.4.3 Black Bean ProducersVictor Giovanni Lopez Bontle, Elmer Alfredo Chavez Diaz, Fransisco Daniel Alfonso Acevedo, Walter Alexander Diaz, Ricardo Antonio Olivo, Miguel Angel Bonillas, Antonio Rivera Rivera, and Santiago Rajo:Eight black bean producers were interviewed for the purpose of analyzing Mangles lending service. Seven of these were interviewed in the area of Salinas del Potrero: Victor Giovanni Lopez Bontle, Elmer Alfredo Chavez Diaz, Fransisco Daniel Alfonso Acevedo, Walter Alexander Diaz, Ricardo Antonio Olivo, Miguel Angel Bonillas. Santiago Rajo was interviewed in the community of El Mono.

All eight producers currently receive loans from Mangle. This is the first time that three of these producers have worked with Mangle. All eight producers learned about the black bean program by attending information sessions with Porfirio Belloso and the Production Program Director, Juan Luna.

First, Porfirio Belloso visits the producers who are requesting a loan in order to determine the size of the land, assess the producers ability to produce adequate yield, and determine whether the land was appropriate for the crop. After meeting with Porfirio, the producer, if deemed appropriate for the program, presents his ID and signs a contract. Based on the size and characteristics of the land, Porfirio determines the amount of inputs, including seed, fertilizers, and pesticides, that the producer requires for the cycle of production, and orders these from suppliers along with the inputs needed by all other producers in the program. Eight days later, the producers receive these inputs as well as a check for labor and land preparation costs. No other documentation is needed to receive the loan. The land cultivated by each farmer ranges from one half of a manzana to three manzanas, and four of the eight producers own their own land. Most of the producers would expect an average of 20-30 quintales of black beans per manzana in a good harvest. However, given the newness of the program, the real harvest is expected to be much lower (between 6-7 quintales). For every manzana of production, Mangle provides a loan with a total value of $600, including inputs and cash provided for labor and machinery. Before participating in the black bean program, half of the producers engaged in other agricultural activities with crops such as red beans and corn. Three out of the eight bean producers have previously received loans from Mangle within the basic grains sector, for corn or red bean production. Two other producers received loans for shrimp farming. Even while cultivating beans for the black bean program, however, the majority of these producers earn income from other activities to sustain their livelihoods. Three producers earn their current income from fishing, while three others cultivate other crops. If they were able to save part of their income, the majority of these producers indicated they would use the savings for investment purposes, such as acquiring more land or more animals. One producer expressed the need for a greater income in order to provide better nutrition and better health care for his family.

The producers responses varied when questioned about the interest rate they pay on their loans from Mangle. Four producers mentioned a 4% interest rate, while the other four claimed an interest rate of 6%. This discrepancy aside, most producers confirmed that Mangles loan terms are much easier than those of conventional banks, with no collateral requirements or processing fees. In addition, producers receive free technical assistance and more flexible repayment rates in case of harvest failure. For example, one producer mentioned that when a previous harvest failed because of a storm, a conventional bank, from which he had taken out a loan, failed to send any representatives to confirm that his harvest had been affected by the storm. The technical assistance provided by Mangle takes the form of regular visits or phone calls by Porfirio. As the technical expert, Porfirio consults with the producers individually and gives each one specific recommendation to help him achieve success, such as a table of exact dates to apply pesticides, and the quantity to apply. Porfirio is also available in case of emergencies, such as the appearance of a plant disease. There are many challenges facing the lending program, according to the producers. Infrastructural problems caused by winter floods, for example, discourage engagement in agriculture. Before the civil war, there were channels that directed the floodwater. During the war, however, they were not maintained, a situation that now compromises both agricultural and daily activities. There are also many health problems that result from storm flooding. Moreover, the roads are in disrepair and must be fixed to improve market access. Mangle could make a number of improvements to better serve producers, as recommended by the black bean farmers interviewed. For example, Mangle should attempt to improve farm infrastructure, either by providing small loans to producers for this purpose or by networking with other organizations such as ALBA with greater resources to deal with infrastructural problems. In particular, a better drainage system is desperately needed. Finally, several producers mentioned that the cost of renting land for cultivation can be high, and this cost should be taken into account when determining loan size.

1.5 Best Practices: Maintaining Mangles Social Mission

Although Mangle now hopes to expand its micro lending into a more lucrative (for-profit) financial institution, the following six best practices have been selected to ensure that Mangle continues to adhere to its social mission of providing an accessible lending service to local producers and improving their economic welfare. In addition to the definition of each best practice, the Microcredit Teams evaluation of Mangles performance in this regard will be set forth, followed by our recommendations, as laid out below.

1.5.1 Communication and TransparencyDefinition of Practice:According to Evers et. al (2000), the microfinance institution should facilitate clear communication and transparency between the client and personnel in terms of lending procedures, loan terms and options, as well as borrowers rights and responsibilities. This transparency is crucial to the success of any microfinance institution since it contributes to establishing trust between the community and the organization. It is then also noteworthy that transparency is key not only to Mangles social mission but also to its programmatic sustainability, an aspect easily threatened by the lack of trust. Furthermore, in line with Mangles objective to act in accordance with the double bottom line, Guntz (2011) presents client protection through transparency in interest rate pricing as imperative to supporting an organizations social mission.

Evaluation of Practice: UnsuccessfulThrough interviews with eight producers participating in the black bean program, we found a strong discrepancy between the clients understanding of the loan terms and the reality. Four out of the eight producers interviewed stated that the interest rate charged on their loan was 4%. The other four producers believed that their interest rate was 6%. Furthermore, the two accountants interviewed stated that the interest rate for these programs was 8%. According to the Mangle Board of Directors, which is the overseeing body of the organization, all those interviewed were incorrect: the interest rate on the black bean program is 7%. Communication and transparency both between the producers participating in the microcredit programs and with Mangle administrators was therefore found to be extremely lacking.

Recommendations:On the basis of this research, it is recommended that Mangle increase and improve engagement with producers to ensure that they fully understand the terms of their loans, and in turn their obligations to Mangle as participants in this program. It is further recommended that in all meetings and conversations between borrowers and Mangles personnel prior to the loan disbursal, the terms of the loan be reiterated and clarified until it is certain that all parties understand. This disparity in information is potentially detrimental to Mangles ability to support local communities. Strengthening organizational transparency and communication between producers and administration by confirming producer understanding of all loan terms, including interest rates, will ensure that Mangle comprehensively adheres to its social mission. Moreover, Mangles access to and influence on its constituent communities is largely supported by the trustworthy reputation that the organization has built steadily throughout its years of operation. Any misunderstanding that leads to borrowers suspecting an infringement of their rights is a potential threat to this trustworthiness and, ultimately, to Mangles social mission.

1.5.2 Financial Planning and Financial Follow-Through

Definition of Practice:Most of the existing literature on micro financing strongly points to the importance of ensuring long-term financial planning mechanisms for the loan recipients (IFAD 2006a, IFAD 2006b, Miller 2011, Waheed and Hamid 2002, and Brau and Woller 2004). This is dictated by the dangers inherent in developing dependency on the lending program. Both group savings plans through cooperatives and individual savings programs have the potential to reduce producer dependence on micro financing programs and spur long-term economic self-sufficiency. Savings plans take many forms: they can include, for example, a requirement that the beneficiary save 20% of the loan value and lend this amount along with an additional voluntary savings deposit to needy individuals at a low interest rate, thus generating profit while promoting future self-sufficiency (Karlan 2007). In addition, micro-lending institutions are now venturing even further, providing insurance and business education to their borrowers (Brau and Woller 2004). These additional offerings increase borrower understanding of policies and practices and, although at first this educational initiative often meets resistance, it has been found to be welcomed eventually, contributing to increased self-sufficiency, trust and transparency. In fact, the study by Brau and Woller (2004) confirms that the number of savers greatly exceeded the number of borrowers when both loans and savings plans were offered by microfinance institutions (MFIs). This being said, however, such initiatives are limited in their effectiveness by their costliness. Moreover, literature that proposes such initiatives does not consider the financial intricacies of agricultural lending.

Evaluation of Practice: UnsuccessfulThroughout this study, it was found that not one of the nine producers interviewed participated in a savings program. Furthermore, within this pilot year of the black bean program many of the producers did not expect to receive much, if any, income from their participation in the program.

Recommendations:In order to improve the financial planning and follow-through that Mangle provides to its producers, it is recommended that the creation of Xinatchli be accompanied by the requirement that producers participate in either group or individual savings programs associated with cooperative or individual lending programs respectively. In recognition of the fact that Mangle itself is not a financial institution, and therefore is not capable of managing these savings accounts on its own, it is recommended that Mangle partner with local banks in order to streamline this process. The implementation of these savings programs will enable both individual producers and cooperatives to reduce dependence on lending institutions, and, in turn, increase the efficiency of the lending institutions by eliminating the disparity between funds and target groups. Eventually, this efficiency will work to achieve Mangles social mission of improving the welfare of the community in Bajo Lempa.

1.5.3 Technical Assistance and Support

Definition of PracticeIn order to minimize credit risk, non-financial services, including training and technical assistance, are considered necessary practices in agricultural lending by a number of policy experts. (IFAD 2006, FARM 2007, Guntz 2011). According to IFAD (2006), direct technical support to producers from lending organizations can improve agricultural yield and product quality, which ensures better chances at the market and hence improves repayment rates.

Evaluation of Practice: SuccessfulThe study of Mangles procedures has revealed the execution of thorough technical assistance throughout the agricultural season. The support takes place in the form of regular monitoring visits by the extension agent, Perfirio Belloso, as well as additional support in the event of any unexpected problems such as the spread of a crop pest. In that regard, Mangle is approaching what would be considered best practices. Although technical follow-up is costly, it also provides security to the institution by helping to guarantee a minimum yield, and thereby ensuring repayment rates are sustainable.

Recommendations:In order to reduce the costs of providing technical assistance, Mangle should undertake an investigation of the costs and benefits of contracting out technical work to extension agents who have easier access to producers located in hard-to-reach areas. We also recommend that Mangle provide further training to producers so that they can monitor and assess the health of their crops, and effectively confront certain production problems on their own, in order to reduce the number of visits by the expert.

1.5.4 Suitability of Loans to Agricultural Needs

Definition of Practice:Agriculture is widely recognized as a risky area of investment, due to the vulnerability of repayment rates caused by a range of unknowns such as weather, pests, and disease. A 2006 International Fund for Agricultural Development (IFAD) Occasional Paper, in a series of 2006 IFAD case studies, and Miller (2011) discuss key factors of successful microfinance lending that are specific to the agricultural sector and address this vulnerability. These include a comprehensive consideration of household income to design a loan, the reliance on both character and technical assessments for lending; maintenance of a diversified risk portfolio; the provision of a complete package of inputs; and accommodating loan terms and conditions.

Evaluation of Practice: Partially Successful As part of the effort to help ensure the suitability of loans for agricultural needs, the five sub-practices mentioned in the previous paragraph were assessed. In interviews with loan administrators and producers, it was found that although Mangle was following four of these best practices--a diversified risk portfolio, the provision of a complete package of inputs, reliance on both character and technical-based assessments for loan applicants, and accommodating loan terms and conditions--it lacked one important practice: a comprehensive evaluation of household income to assess loan applicants.

Recommendations:In order to improve the suitability of Mangle loans to agricultural needs, we recommend that Mangle take into account the total income of an applicants household rather than the income as a result of production when considering repayment options, especially because many producers have multiple sources of income, including remittances, livestock and small businesses. Furthermore, while the suitability of the cultivated land and the producers technical capabilities are taken into consideration within the black bean and hybrid corn programs, in most lines of credit loans were found to be distributed on the basis of character recommendations alone, without taking into account technical experience or knowledge. Therefore, we recommend that Mangle require applicants in all credit lines to pass both technical and character-based assessments before being accepted to the loan program.

1.5.5 Promoting Access to MarketsDefinition of Practice:Facilitating access to markets for agricultural producers is a means by which microfinance institutions can work to maximize the success of agricultural lending efforts. Guaranteed market access ensures that producers can generate an income through the sale of their products, which in turn acts as a mechanism for improved repayment rates as well as improved livelihood for the farmer. Lending institutions must carefully consider the quality of the market, including such aspects as price volatility, seasonal demand, the prevalence of intermediary traders, and storage and processing channels. Carefully assessing the features of the market of each lending sector, and finding partners that can guarantee markets, mitigate market risks, and facilitate transportation, processing and storage should be key objectives of any microfinance institution (FARM, 2007). Evaluation of Practice: Partially Successful Within the black bean microfinance program, Mangle has successfully guaranteed market access for producers through its partnership with ALBA. Through this relationship bean producers are able to sell their full production of beans at $39/quintal, a price significantly higher than the open market price in both El Salvador and Venezuela. This relationship is unique, and not all production sectors within Mangles microcredit program have access to such assured markets. According to bean producers who received loans from Mangle prior to participating in the black bean program, low prices and the reliance on intermediaries, or coyotes, represented a significant impediment to the realization of full returns on their loans.Recommendations:We recommend that Mangle design a procedure for assessing the market strength of products within current and potential credit lines, based on a number of indicators such as those outlined above (price volatility, seasonal demand, intermediaries, transportation, processing, and storage channels). In addition, Mangle should work to establish and maintain strong portfolio quality and employ marketing tactics that attract further partnerships with institutions with the ability to offer guaranteed markets, secure processing, and distribution channels. In forging partnerships, Mangle should take into consideration the need to insulate its microcredit program from political interference; according to CGAP (2006), government intervention is one of the largest sources of risk in agricultural lending.

1.6 Best Practices: Ensuring Programmatic Sustainability

While the social mission motivates most of Mangles work, the sustainability of the organization, and in particular the sustainability of its microcredit program, cannot be ignored. Furthermore, programmatic sustainability is key to the long-term effectiveness of Mangles programs. Mangle must find a balance between providing strong, accessible lending services to the producer at present, and ensuring the availability of these services in the future. Many studies in fact show that one of the reasons why present access to microcredit is at times limited is the, lack of self-sustainability [Stiglitz (1990); Yunus (1999) and McNamara and Morse (1998)] (Waheed).1.6.1 Improvement of Repayment RatesDefinition of Practice:In order to ensure the sustainability of the lending program, improving repayment rates is crucial. The ability to increase the number of loans disbursed is largely dependent on the liquidity and availability of funds within the micro-financing institution. If its borrowers are not repaying the micro-lending institution, the institution will be unable to finance new loans into the future. If, as we have seen with Mangle and ALBA, a microfinance institution seeks outside sources for funding and cannot repay its creditors because of low repayment rates among its own borrowers, the institution faces a great deal of difficulty: the institution will be expected to adhere to any procedures agreed upon for unpaid loans or pay with funds devoted to other activities. Evaluation of Practice: UnsuccessfulMangle is currently suffering extremely low repayment rates of around 10%. These low rates represent the current unsustainable nature of the lending program. Many factors contribute to this alarming rate: character assessment of loan applicants is not accompanied by an assessment of individual financial capacity to repay the loan; no collateral requirements are imposed and repayment of loan is based on the success of the harvest. In case of harvest failure, the producer is given the option of being refinanced with no consideration of the potential repayment capacity through other sources of income. With low repayment rates, Mangle must finance the unpaid loans with funds previously devoted to other activities. This complicates the financial structure of Asociacin Mangle, and it limits the possibilities of pursuing other non-microcredit services offered by the organization. The creation of Xinachtli and thus the separation between Mangle and the micro lending program, continual refinancing from Mangle would not be necessary.Recommendations:To improve repayment rates, stricter requirements to obtain a loan, as well as stricter procedures in case of default are to be encouraged.

First of all, we recommend a more comprehensive financial assessment of a loan applicants ability to repay. The assessment should consider non-agricultural sources of income. Most agricultural producers have multiple sources of income due to the cyclical nature of agriculture that does not afford a constant income spread throughout the year (IFAD 2006). Five out of nine producers interviewed revealed other sources of income accounted for by the possession of livestock, fishing activity practiced by parents, or remittances from family members abroad. By recognizing the loan applicant as a member of an economic unit with many sources of income, Mangle can achieve a better assessment of repayment capacity. According to the IFAD report, successful agricultural lenders disseminate the clear message that repayment is not linked to the success of the crop.

Many studies also show that successful microfinance institutions have collateral requirements. Such requirements suitable for rural and agricultural lending do not rely on land or property but rather on combinations of personal guarantors and pledges on household and enterprise assets (including titled land and animals), (IFAD 2006). In order to proceed with this recommendation, we suggest a feasibility study to determine to what extent would the introduction of collateral requirements improve repayment rates without affecting access to loans.

In case of default, consequent procedures should be determined according to the circumstances and specific causes of the default. In most cases, including external environmental factors such as a flood, which contributes to the failure of the crop, other sources of income for the producer should be considered for repayment. Easier repayment options could be explored only in that light. Furthermore, in the case of intentional default, strict financial actions should be carried out. The successful experience with ProCredit Bank El Salvador supports the effectiveness of this policy, where annual nominal interest rates were charged on the unpaid loan principal, ranging between 12 and 27 per cent (Meyer). It is therefore recommended that similar practices be undertaken by Mangle. 1.6.2 Recovering Administrative CostsDefinition of Practice:According to the Russian Microfinance Project, interest rates need to be high enough to cover both operational and financial costs in order to have a financially viable institution. These interest rates include the direct and indirect costs involved in the processing, disbursal, and repayments of the microcredit loans. Individually tailored micro loans are far more labor intensive than traditional bank loans; in order to recover all of the administrative costs associated with loan processing and disbursal, interest rates must increase accordingly (Guntz, 2011). Evaluation of Practice: UnsuccessfulThe interviews conducted with Mangle administrators have revealed that the Board of Directors set the interest rate for loans within the black bean program at 7%. The rationale behind the rate is to cover the 6% interest rate on the loan Mangle receives from ALBA with the expectation of a profit margin of 1%. However, given that ALBA charges a loan processing fee, the profit margin is reduced to less than the expected 1% and even before all of the indirect costs of loan distribution were taken into consideration, this margin was found sometimes to be negative. Interviews with the accountants as well as the Board of Directors have revealed that no administrative costs, loan loss provisions, or transaction costs are taken into consideration when the interest rates for micro loans are determined. Capping the interest rate to a low 7% is, as explained by the Board of Directors, an attempt to uphold the social mission of Asociacin Mangle. However, the consistent losses inflicted by the low interest rates, combined with the low repayment rates, are seriously threatening the sustainability of the lending program and, in turn, Mangles ability to uphold its social mission of continued provision of such services in the future. According to Evers et al. (2000), as an institution increases the number of small loans it disburses, operational costs greatly increase as well. The relationship between Mangle and the two local organizations it partners with, OIKOS and COMUS, is another opportunity through which Mangle can recover administrative costs. OIKOS and COMUS each handle the administration of loans in their respective geographical areas; however, since Mangle transports inputs to its partner organizations it still bears the entire burden of costs related to transportation as well as the transaction costs from ALBA. Recommendations:In order for appropriate interest rates to be determined, we recommend hiring additional accountants with specifically agricultural experience, or, alternatively, training agronomists in accounting (IFAD 2006). This will help to bridge the gap between the financial and agricultural aspects of decision-making as it pertains to loan terms; it will also further ensure that loan terms are suitable for agricultural needs and, at the same time, sufficiently sound economically to ensure programmatic sustainability.

In addition, administrative expenses, inflation and depreciation, cost of loan losses, and costs of obtaining funds from other sources are all factors that should be taken into consideration when deciding an interest rate. It is recommended, therefore, that the Board of Directors set interest rates that accurately cover all costs associated with loan disbursal.

Finally, it is recommended that both the operational and transaction costs be shared among Mangle and all future partner organizations, including those with whom it currently works, i.e. OIKUS and COMUS.1.6.3 Improving Operational EfficiencyDefinition of Practice:The high interest rates associated with microfinance are due to high operational costs; therefore, operational costs are one of the greatest challenges for microfinance institutions. Those institutions that strive for financial self-sufficiency must fully cover their cost of operations, making efficiency a key objective (IFAD, 2006). If a microfinance institution is able to reduce operating costs by 5% without increasing default, losses, or any other expenses, it will be able to translate this savings into a 5% decrease in loan interest rates, or a 5% increase in profits, or any combination thereof, according to a bulletin report by the Microfinance Information Exchange (Gonzales 2007). (http://www.themix.org/sites/default/files/MBB%2015%20-%20Efficiency%20Drivers%20of%20MFIs.pdf) Operational sustainability, in which the institutions income covers operating expenses and the cost of obtaining funds, can be easily achieved by the organization and at a lower cost to the borrower, by improving internal procedures to maximize efficiency. These include a strict division of labor between different organizational activities, improved communication between organization levels, decentralized decision-making, and rigorous documentation processes for labor and other costs, which will help to identify and resolve deficiencies.Evaluation of Practices: UnsuccessfulA series of interviews with Mangle personnel including accountants and technical experts indicated significant problems in operational efficiency. Mangle accountants are involved in all of Mangles projects, and must divide their time between microcredit administration and other accounting activities. This overburdening of employees was found to result in high losses in efficiency. Interviews revealed that lack of communication and lack of equal access to information among Mangle personnel further contributed to operational inefficiencies. Crucial decision-making with regard to the microcredit program was found to take place among the Board of Directors alone, with little input from accountants or technical assistants. This top-down structure requires communications to flow through multiple channels to reach intended recipients, and efficiency is therefore further compromised. Finally, record-keeping and documentation of costs and time expenditure were found to be lacking; because personnel do not record labor costs for work within different projects, areas of improvement are difficult to identify. Although a manual of operational procedures for the disbursal of loans does exist, interviews revealed that this manual was not in fact used. Recommendations:In order to confront these issues, we recommend that Mangle use uniform accounting procedures, and divide accounting tasks by activity, allowing accountants to devote time to learning the nuances of loan administration within each of the sectors, thus improving labor efficiency. This will be especially important within the structure of Xinachtli.

It is further recommended that a more fluid structure of information sharing among Mangle personnel be created. This information sharing can take place through regular meetings with loan administrators, accountants, board members, and technical experts to ensure equal access to information and clear communication between parties. Moreover, it is recommended that all major decision-making with regard to the microcredit program include the input of accountants and technical experts, who have a greater familiarity with important aspects of the microfinance program and agricultural requirements respectively. In addition, within the day-to-day loan administration activities of Xinachtli, decision-making should be decentralized, so that bureaucratic efficiency losses are minimized.

Finally, it is recommended that Mangle institute clear documentation processes so that all of the costs associated with the microcredit program are clearly identified and recorded. First, Mangle accountants and technical experts should carefully record the labor time spent on lending to each client, categorized by activity, such as, processing loan contract, or regular production monitoring visit. This will facilitate future Human Resources studies and, at the same time, help make the identification of relative costs easier. Moreover, Mangles accounting personnel have expressed the need for an updated operating manual, which could increase future efficiency in removing administrative obstacles that have been previously encountered and documented.

1.7 Looking Forward

The best practices used in this evaluation can be applied to other sectors receiving agricultural micro loans, thus allowing Asociacin Mangle and future Team El Salvador project teams to refer to those best practices when designing new microcredit lines and evaluating existing lines. While some elements of best practices will change slightly between credit lines, for the most part best practices will be the same within the agricultural sector. In addition, the outcome of this project should offer some guidance when the policies and operational structure of the new Xinachtli microcredit institution are designed. We hope that future student delegations will assist in the implementation of these recommendations within Xinachtli and the evaluation of the institution post-implementation.

We also believe that a fully developed business plan would be highly valuable to the future success of Xinachtli. A business plan should incorporate not only best practices of loan administration but also the financial recommendations outlined in Part II of this report. However, it should be noted that this type of business plan would require a team of students or professionals with training in business development, market analysis, accounting and financial management, and may require a significant time commitment. Nevertheless, if the involvement of MBA students in future Team El Salvador delegations continues to increase, and if the work of students with Asociacin Mangle beyond the January delegations continues to be sustained, we believe that Team El Salvador can support Mangle staff in the development of a detailed business plan to achieve maximum success with Xinachtli.

PART II. MICROCREDIT PROGRAM COST STRUCTURE AND BUDGETING

2.0 Introduction

In addition to a series of best practices, this year Team El Salvador 8 was asked to produce an exploratory cost structure for production programs within Xinachtli, based on the costs incurred during the adminstration of the current black bean microlending program. While the following evaluation should be considered preliminary, an assessment of lending program costs is a necessary task to ensure the financial sustainability of microfinance operations. As a result of our data collection and analysis, the following report includes a number of findings and recommendations as well as several provisional financial spreadsheets based on current credit lines. These may help the organization better understand and manage the costs of its programs, and may additionally assist in the transition from the current lending program to the fuller-scale lending institution, Xinachtli. The provisional financial spreadsheets include a sample budgeting income statement (Table 1) based on the current black bean production program; a sample budgeting income statement for self-financed lending, for comparison (Table 2); a tentative activity- based cost structure (Table 3) based on the black bean program; and a tentative accounting of the costs of a single loan product under the black bean program (Table 4). We hope that these statements and the resulting findings can be extrapolated and used to improve the design of the oncoming Xinachtli program.

A tentative budgeting income statement, like the one produced in Table 1, should serve to ensure that each lending program undertaken by Xinachtli is economically feasible for the long-term sustainability of the lending institution by balancing the income from the program against its costs. Once the organization achieves financial independence, the income statement will appear as in Table 2. While the cost structure shown here (Table 3) is not complete, a fully elaborated cost structure would allow Mangle to assess the financial costs of each operational activity that forms part of the lending program, and attribute these costs to single loan products or credit lines. In its final form, a cost structure would enable Mangle to produce an accounting statement of a single loan product or line of credit (as in Table 4), making it easier to manage costs based on underlying lending activities. By using activity-based costing (ABC) to produce a cost structure, managers should be able to understand causes of different product costs and improve the efficiency of lending programs.

2.1 Methodology

During January 2014, we gathered information pertaining to the types of core activities that must be carried out to achieve success in an agricultural microfinancing program, as well as information regarding the current accounting structure of the program. This information is based on a review of documents, including lending records and any accounting of production costs and operating costs, as well as on semi-structured interviews with loan accountants and administrators, technical experts, and production program personnel. Our interviews with Mangle accountants, technicians, and production program coordinators (see Part I for interview summaries) allowed us to capture several loan administration costs that are not recorded or accounted for, although the costs captured may not be comprehensive.

In order to synthesize and analyze the data we gathered and draw conclusions, we attempted to follow the methodologies outlined in two guiding documents, the Microfinance Product Costing Tool produced by the Consultive Group to Assist the Poor (CGAP) and the World Bank Group, and Creating a Budget: A Self-study Guide for Microfinance Institutions by the Rural Finance Learning Center.

2.2 Limitations

It should be noted that members of the commercial microfinance team of Team El Salvador 8 are not explicitly trained in accounting, nor in budgeting methodologies specific to microfinance institutions. The financial spreadsheets and findings here are simplified models that may contain errors and are not intended to be comprehensive. Rather, they are meant to act a starting point to improve the understanding of product costs and to help guide future financial evaluations.

In addition, as our time in El Salvador was limited, we did not complete the costing exercise we began on the ground. While we did gather information on the types of activities necessary to operate a lending program, we were unable to gather reliable data on the staff time spent carrying out these various activities, nor the costs of each activity. We hope that future studies and costing exercises can help assign specific costs to lending activities. A full costing exercise would allow Asociacin Mangle to attribute these activities to final loan products, enabling administrators and production program personnel to determine the cost components of single loan products within production programs, including any hidden costs. Importantly, a full costing exercise would reveal inefficiencies that might hinder the growth and development of the microlending organization, and would enable lenders to better manage the costs of the program.

Finally, in order to elaborate the tentative budgeting income statement and assess the core activities of Mangles current lending programs, we relied heavily on information gathered from one to two representatives of microlending program departments (accounting, technical assistance/expertise, production program management) that were directly involved in the activities of the lending program. However, in order to gather reliable information that truly reflects the reality of the time and costs spent on lending activities, more personnel should be interviewed for future costing exercises.

2.3 Findings and Recommendations

2.3.1 Redesign the financial elements of microcredit loans to guarantee program viability.

In order to successfully budget for a microfinance lending activities under Xinachtli, it is necessary that Asociacin Mangle improve the design of its current microfinance system by restructuring the interest rate, the coverage of administrative expenses, and the accounting of loan loss provisions to reflect the true costs of lending. By improving these elements of the current income statement, Mangle can ensure that its microfinance program is financially viable. Here we outline the requirements for successful income budgeting as a microfinance organization, which are not employed in Mangles current microfinance operations:

I. Ensure that income is greater than expenses:In order to produce a positive net income for the lending program, the total financial income must exceed the sum of the costs of the program, including total financial costs, provision for loan losses, and total operating expenses (In Table 1, g > j + m + u). In other words, the interest rate on loans outstanding plus the loan fee or service charge on each outstanding loan must cover the costs of microlending activities, including financial and operational costs, and provisions for loan losses.

II. Account for loan loss provisions:Currently, Mangle does not account for loan loss provision expenses, even though agricultural lending tends to have a higher rate of loan loss than other lending activities. The loan loss provision expense is a non-cash expense used to create a loan loss reserve, and is calculated as a percentage of the value of the gross loan portfolio (a + b + c) that is at risk of default. Microlending institutions generally establish a loan loss provision expense equal to between 2 and 5% of the active loan portfolio (GDRC, 2014). The rate of loan loss provisions should be proportional to the level of credit risk the institution undertakes as a result of agricultural lending.

III. Eliminate double losses:Asociacin Mangle currently incurs double losses, as it pays a loan service fee on its ALBA debt without passing on this cost to borrowers, while simultaneously covering its own administrative expenses without transferring costs to borrowers. While ALBAs loan service fee should be internalized within the interest rate, Mangle should also consider levying a minor loan fee or service charge on each loan disbursed to help recover a portion of its own variable (per-transaction) administrative costs, including client assessment, paperwork, accounting, loan disbursement, and ongoing loan maintenance. Loan fees or service charges are small, one-time payments and are typically quantified either as a percentage of the principal, as a flat rate, or as a tiered flat rate based on loan size. Mangle should use cost allocation methods (see below) to assess average variable administrative expenses and determine a reasonable loan fee or service charge.

IV. Account for cost of debt and administrative expenses when determining interest rates:Loan interest rates should be determined based on an accounting of the expenses incurred throughout the lending process. In fact, according to CGAP (2002),

MFIs [Micro-Finance Institutions] must set interest rates that cover all administrative costs, plus the cost of capital (including inflation), loan losses, and a provision for increasing equity. Unless MFIs do so, they may only operate for a limited time; reach a limited number of clients; and will tend to be driven by donor or government goals, not client needs. Only sustainable MFIs can provide permanent access to financial services to [those] who need them.

An interest rate placed arbitrarily at 1% above the cost of funds will not provide adequate margins to recover loan losses and administration expenses, even if the microlending institution levies a loan fee or service charge (at a reasonable rate). The cost of funds should not be used as the sole baseline to determine interest rates; it is only one of several factors the institution must take into account, including administrative expenses, loan losses, the desired capitalization rate, and any investment income (see CGAP Occasional Paper, Microcredit Interest Rates (1996) for a full discussion of the microcredit interest rate formula). In addition to internalizing the costs of lending, the interest rate should also provide a small margin for the lending institution. Mangle should undertake a feasibility study to establish the size of the margin needed to sustain lending activities and maintain Xinachtlis financial viability, while also considering the ability of borrowers to pay higher interest rates.

Asociacin Mangles primary interest is the welfare of community members, and it is therefore highly concerned about the possibility of compromising its social mission by raising interest rates and levying service charges. Nevertheless, achieving financial viability within this program should take precedence at this time, as the organization will be unable to maintain the provision of services to local producers unless financially sustainable practices can be upheld. The general consensus among experts is that access to credit is of greater importance to poor rural borrowers than actual interest cost, to a reasonable degree, especially when compared to conventional or informal banking alternatives, total household costs, and other streams of income (CGAP, 2002).

2.3.2 Create a feasible timeline for financing Xinachtli to achieve financial independence

It is unrealistic to assume that the new microfinance institution, Xinachtli, will be self-financed within any upcoming period. Rather, it will likely take years of efficient operations to reach the point at which the new institution can consider itself financially independent. In order to ensure that such a time comes and to prepare for it accordingly, Mangle should work with financial experts to produce a timeline of financing for the institution, complete with projections of interest rates and financial income, financial and operational costs, and inflation. Mangle should carefully consider financing options and opportunities in the meantime, including partnerships with organizations such as ALBA, other development organizations, NGOs, and businesses, as well as donor (impact investment) funding, and even social enterprise funding for small businesses. See Tables 1 and 2 for a comparison of income statements between externally financed lending and self-financed lending.

2.3.3 Undertake an Activity-Based Costing (ABC) exercise

In order to understand the true costs of the lending program, Mangle should undertake activity-based costing, which would allow the organization to trace the costs of individual products back to the activities and departments in which they originate. Activity-based costing is meant to assign indirect, or shared costs to different products based on the activities that go into these products. Unlike traditional cost allocation methods, activity-based costing gives managers direct insight into why some products cost more than others by showing how and why costs are incurred. By isolating the causes of the different cost components of lending, this cost tracing methodology will reveal areas for improvement within the operations of the microfinance institution, which should lead to increased efficiency and reduced expenses.

We believe that activity-based costing will allow Mangle to best understand the sources of product costs, preparing the organization to design a lean and efficient operating structure for Xinachtli; however, this methodology can be time-intensive and requires the cooperation of personnel within all departments associated with microlending activities. During January 2014, Team El Salvador endeavored to ascertain the core activities undertaken during the distribution and management of a micro-loan in the black bean program, and to attribute these activities to individual personnel within Mangle (see Table 2). However, this should be considered a preliminary account of core activities and processes, not a finalized product.

Due to time constraints, Team El Salvador 8 was unable to complete the activity-based costing analysis, which would require determining how much time each individual spends on different activities and the resulting cost of those activities. Therefore, the next step for Mangle is to confirm the core lending activities and the personnel to whom they are attributed, then carefully gather data on time spent on each activity, using timesheets, in depth interviews, direct observations, or a combination of all three. Staff salaries and benefits should then be distributed to activities based on these time estimates. CGAP (2004) recommends that non-staff costs, such as transportation, supplies, and expenses, be distributed to activities in the same proportion as total staff time. However, these could alternatively be distributed based on direct use, although this method is more time consuming. Ultimately, the activity-based costing method will result in accurate accounting of individual loan products, as shown in Table 3.

Using activity-based costing methods, microcredit program administrators and managers will be able to determine how to eliminate unnecessary costs and operating inefficiencies, ensuring that inefficiencies are not passed on to borrowers, and clients pay the lowest possible cost for loan products. As stated by CGAP (2002),

Although microcredit interest rates can be legitimately high, inefficient operations can make them higher than necessary. As the microcredit market matures in a given country or region, donors and others should pay more attention to reducing operating costs to ensure the most efficient, competitive interest rates possible.

Asociacin Mangle can follow the procedures established by CGAP in the Microfinance Costing Tool, available online in both English and Spanish at www.cgap.org/productcosting, to complete the activity based costing exercise.

2.4 Looking Forward

The accounting methods and tables used in this evaluation can be modified slightly and used in other lines of microcredit, and may be extrapolated for use under the new operational structure of Xinachtli. This would allow Mangle to preliminarily project different scenarios by looking at the financial outcomes of using different interest rates and loan fees, taking into account that the tables are not comprehensive and should be used only for guidance. While the assumptions and financial data used here may differ between lines of credit and may be significantly different under Xinachtli, the outcome of this project should nevertheless serve as an initial guideline for future financial evaluations of Asociacin Mangles microcredit program.

Finally, with the understanding that a full activity-based costing exercise will require significant time and effort, we recommend the involvement of a Team El Salvador student or student group to help undertake this task, ideally as soon as possible.

14

Table 1: Example of Budget Income Statement for Externally Financed Lending*CURRENT INCOME STATEMENTPRO FORMA INCOME BUDGETING UNDER XINACHTLI

CURRENT PROD. CYCLE**PROD. CYCLE 1PROD. CYCLE 2PROD. CYCLE 3AVERAGE

Loan Portfolio Outstanding: a. Current loans ($) b. Past due loans ($) c. Restructured loans ($)abc

Financial Income: d. Principal on loans ($) e. Interest on current, past due, and restructured loans ($) f. Loan fees/service charges ($)a+b+cd x (0.07)

0

g. Total Financial Incomed+e+f

Financial Costs: h. Debt principal ($) i. Interest on debt ($) j. Loan fees/service charges ($)(a+b+c)(h x (0.06))(h x (0.01))

k. Total Financial Costs ($)(h+i+j)

l. Gross Financial Margin ($)g+(k)

m. Provision for Loan Losses ($)(0)

n. Net Financial Margin ($)l+(m)

Operating Expenses: o. Salaries (admin/technician) ($) p. Transaction/Transportation costs($) q. Tech. expert visit expenses ($) r. Supplies (office/tech. expert) ($) s. Occupancy expense ($) t. Other ($)(o)(p)(q)

(r)(s)(t)

u. Total Operating Expenses ($)(o+p+q+r+s+t)

v. Net Income from Operations ($)n+(u)

*Note: This is a simplified model and does not intend to capture all of the costs of microfinancing activities.**Bracketed variables in red denote negative values

Table 1 Assumptions:

1. Accounting period is in production cycles rather than months or years2. Interest is simple, not compounded (for either loans disbursed or received), and paid in lump sum at the end of the loan cycle3. Principal is paid in a single payment at the end of the loan cycle 4. Total value of loans outstanding = total value of financing received (d = h). This may not necessarily be the case.5. In current period, interest rate on microcredit loans provided is 7%, 1% above the interest rate of loans received from ALBA, at 6% interest (see e; i: e = 1+i), based on information gathered from loan documents and interviews.6. In the current period, Mangle does not charge loan processing fees or service charges on loans provided (see f).7. In the current period, ALBA does charge loan fees and service charges on loans provided; however, data on the quantification of loan fees was not available to Team El Salvador members. Therefore, we assumed a 1% service fee charged on loans provided by ALBA (see j), based on the quantification of loan service fees by similar financing institutions.8. Mangle currently does not account for loan losses provision expenses.9. Operating Expenses is significantly simplified. For a more detailed accounting of operating expenses see Table 2, Activity-Based Costing (ABC): Attributing Indirect Costs to Black Bean Microcredit Lending and Table 3, ABC Accounting of Black Bean Microcredit Cost.

Table 2: Example of Budget Income Statement for Self- Financed Lending*PRO FORMA INCOME BUDGETING UNDER XINACHTLI

PROD. CYCLE 1**PROD. CYCLE 2PROD. CYCLE 3PROD. CYCLE 4AVERAGE

Loan Portfolio Outstanding: a. Current loans ($) b. Past due loans ($) c. Restructured loans ($)abc

Financial Income: d. Interest income on unused lending capital ($) e. Interest on current, past due, and restructured loans ($) f. Loan fees/service charges ($)d

(a+b+c) x r

(a+b+c) x sr

g. Total Financial Incomed+e+f

k. Total Financial Costs ($)(0)

l. Gross Financial Margin ($)g+(0)

m. Provision for Loan Losses ($)((a+b+c)*(0.025))

n. Net Financial Margin ($)l+(m)

Operating Expenses: o. Salaries (admin/technician) ($) p. Transaction/Transportation costs($) q. Tech. expert visit expenses ($) r. Supplies (office/tech. expert) ($) s. Occupancy expense ($) t. Other ($)(o)(p)(q)

(r)(s)(t)

u. Total Operating Expenses ($)(o+p+q+r+s+t)

v. Net Income from Operations ($)n+(u)

*Note: This is a simplified model and does not intend to capture all of the costs of microfinancing activities.**Bracketed variables in red denote negative values

Table 2 Assumptions:

1. Accounting period is in production cycles rather than months or years.2. Interest for loans dispersed is simple, not compounded and paid in lump sum at the end of the loan cycle.3. Principal is paid in a single payment at the end of the loan cycle. 4. In the future period, the interest rate (r) on microcredit loans provided (see e) will be carefully determined in order to cover the costs of the program, while also preserving the social benefits of the program to farmers. We assume that this interest rate will be greater than the 7% charged currently, but will likely be less than the average interest rate on microcredit loans in the region of Latin America, at 30% as of 2011 (Rosenberg, 2013). Therefore, 0.07 < r < 0.30.5. In the future period, we assumed a loan fee or service charge on loans disbursed by Mangle as a percentage of the loan principal (see f) rather than as a flat rate or tiered flat rate. For example, for a service charge rate (sr) of 1% of principal, sr = 0.01. 6. In the future period, we assumed a loan loss provision expense of 2.5% of active loan value (see m), as most microfinance institutions establish an expense of 2-5% active loans value.7. Operating Expenses is significantly simplified. For a more detailed accounting of operating expenses see Table 2, Activity-Based Costing (ABC): Attributing Indirect Costs to Black Bean Microcredit Lending and Table 3, ABC Accounting of Black Bean Microcredit Cost.

Table 3: Activity-Based Costing (ABC): Attributing Indirect Costs to Black Bean Microcredit Lending*

CORE PROCESS/ACTIVITYPRODUCTION PROGRAM DIRECTORTECHNICAL EXPERTACCOUNTANTOTHERTOTAL

Making Loans Meet with potential clients Assess client land and production capability Answer client questions/advise Accept loan application Review and approve loan application Assess input needs Create budget (presupuesto) for production inputs and preparation of land Order inputs from suppliers Perform general loan disbursement administration File paperwork/reporting and recording procedures Draw up contract Cut checksX

XXX

XXXXXXX

X

X

X

X

XX

Servicing Existing Loans Receive production inputs Process and redistribute production inputs Regular monitoring visits to production sites Extra client visits for production issues (pests, etc.) Account for visit expenses (fuel costs, supplies) Produce technical paperwork/production recommendations Track repayments and delinquencies Follow up with delinquent clients Perform general loan administration File paperwork/reporting and recording

X

X

XXXX

XX

X

XX

Sustaining Activities Meet with Junta Directiva/Production Program Coordinators to discuss lending program Maintain relationship with lenders (ALBA) Apply for new loans Pay off existing loans Perform general accounting and reporting Recruit and train staff Pay staff Maintain information technology (loan tracking software, etc.) Perform general administrationX

XX

X

X

X

XXX

XX

X

Total Costs

*Note: This is a simplified model and does not capture all of the activities of the microfinance institution. Asociacion Mangle should undertake a microfinance product costing exercise in order to determine the core processes and activities to evaluate, and to assign costs to each of these activities.

Table 4: ABC Accounting of Black Bean Microcredit Cost

LOAN 1LOAN 2 LOAN 3 LOAN NAVG.

Principal Value of Loan Land Preparation/Cultivation (disbursed in the form of a check) Equipment and machinery costs Labor costs Production inputs (purchased by Mangle on behalf of client) Seed Fertilizer Insecticides Herbicides Foliar products

Total Loan Principal

Revenue from Loan Interest income (Total Loan Principal x Interest rate charged to producer) Loan service charges (Currently none)

Total Revenue from Loan

Financing Cost of Loan Interest cost of micro-loan (Amount of Total Loan Principal debt financed by ALBA x Cost of Debt) Debt fees paid for micro-loan ([Amount of Total Loan Principal debt financed by ALBA/total amount borrowed from ALBA] x Loan service charge by ALBA)

Total Financing Cost of Loan

Gross Financial Margin

Provision for Loan Loss (Loan value x loan loss provision %)

Net Financial Margin

Indirect Costs of Loan* Salaries of technical experts Salaries of accountants/administrators Transaction costs of inputs Technical expert visit expenses (fuel, supplies, etc.) Office supplies Occupancy expense Processing production output Transportation of production output to end client Transaction of sales profits back to producers

Total Indirect Costs of Loan

Net Income from Loan

* Should be attributed to single loan based on activity based costing (ABC) method, see Table 2.

3.0 Appendices

3.1 Appendix 1: References

The Consultive Group to Assist the Poor (CGAP) (2004). Microfinance Product Costing Tool. CGAP Technical Tools Series No. 6.

CGAP (2002). Helping to Improve Donor Effectiveness in Microfinance: Making Sense of Microfinance Interest Rates. CGAP Donor Brief No. 6.

CGAP (1996). Microfinance Interest Rates. CGAP Occasional Paper.

Global Development Research Center (GDRC). Loan Loss Reserve. Microcredit and Microfinance Glossary. Accessed January 2014 at .

Rosenberg, R. et al. (2013). Microcredit Interest Rates and their Determinants: 2004-2011. Access to Finance Forum: Reports by CGAP and Partners No. 7.

The Rural Finance Learning Center. Lesson 7: Creating a Budget. Self-Study Guide for Staff of Micro-Finance Institutions. Accessed January 2014 at .3.2 Appendix 2: Interview Questions3.2.1 Appendix 2a: Questions for Loan Administrators

Process:1. Please briefly describe your role at Mangle as it relates to the granos bsicos program (in particular, the production of hybrid corn internally by Mangle, and the production of back beans for ALBA)Por favor describan brevemente su papel en Mangle en relacin al programa de granos bsicos, en particular, al programa de produccin de maz hbrido y al programa de produccin de frijol negro para ALBA. Corn Production:2. How does the hybrid corn production program work? Please give a detailed step by step description beginning with the solicitation of the loan and the purchase of the seed. This will help us determine all of the direct and indirect costs associated with the program.Como funciona el programa de maz hbrido? Paso por paso describa por favor el proceso empezando con la solicitacin del prstamo y la compra de la semilla. Esto nos ayudar a determinar todos los costos, tanto directos como indirectos, asociados con el programa. 3. How/when is the purchasing price of the corn determined?Cmo y cundo se determina el precio de venta del maz al gobierno? 4. What are the terms of the loan from the National Bank?Qu son los trminos del prstamo del BFA? 5. To confirm, must Mangle purchase the hybrid seed, or is it provided by the government? If it must be purchased, at what price?Para confirmar, Mangle tiene que comprar la semilla al gobierno, o es donada? Si tiene que comprarla, a que precio? 6. What the interest rate of Mangles loan from the national bank? Qu es la tasa de inters del prstamo que le otorga a Mangle el BFA? 7. How does Mangle repay the loan to National Bank? Does it pay both interest and the principal payment after the harvest? Is there any type of loan processing fee?Cmo repaga Mangle el prstamo de BFA? Paga el inters y el capital al mismo tiempo al final de la cosecha, o hay algn otro tipo de modalidad para reembolsar el prstamo al BFA? 8. Is there a loan processing fee levied on Mangle by the National Bank?Hay algn tipo de cuota de procesamiento del prstamo que le impone BFA? 9. How do you document the costs associated with the hybrid corn program?Cmo documentan los costos asociados con el programa de maz hbrido? Por ejemplo, una hoja de datos computarizada? 10. May we see any documented costs of the hybrid corn program, both direct and indirect?Nos permitiran ver la documentacin de los costos, tanto directos como indirectos? ALBA:11. What are the terms of the loan from Alba?Qu son los trminos del prstamo de ALBA? 12. What the interest rate of Mangles loan from ALBA? Qu es la tasa de inters del prstamo que le otorga a Mangle ALBA? 13. How does Mangle repay the loan to Alba? Does it pay both interest and the principal payment after the harvest? Is there any type of loan processing fee?Cmo repaga Mangle el prstamo de ALBA? Paga el inters y el capital al mismo tiempo al final de la cosecha, o hay algn otro tipo de modalidad para reembolsar el prstamo a ALBA? 14. Is there a loan processing fee levied on Mangle by ALBA?Hay algn tipo de cuota de procesamiento del prstamo que le impone ALBA? 15. How did you find producers to participate in the ALBA program, or what was the process of application?Cmo se seleccionaron a los productores que participan en el programa de ALBA? O hubo un proceso de solicitud de parte de los productores?) Frijol Production: 16. Please describe in detail the administration of loans from start to finish. Please be as thorough and detailed as possible as this will help us to determine the costs of loan administration to Mangle.Por favor describa en detalle todo el proceso de administracin de los prstamos desde el principio hasta al fin. Por favor, que sea lo ms detallado posible, ya que esto nos ayudar a determinar los costos de administracin de prstamos para Mangle. 17. What lines of credit are currently in operation? Shrimp, cattle, etc.Qu lneas de crdito existen actualmente? Camarn, ganadera, etc. 18. What requirements must a producer meet in order to receive a loan for the production of beans?Qu requisitos debe satisfacer un productor para recibir un prstamo para la produccin de frijol negro? Por ejemplo, un buen record de reembolso de prstamos anteriores? 19. Who might be rejected/excluded from access to loans from Mangle?A quin se le podra negar un prstamo, y por qu? 20. What are the conditions of the loan? Qu son las condiciones que se imponen para el uso del prstamo? 21. What is done to ensure that these are followed? Qu se hace para asegurar que stas sean cumplidas? 22. Is there a contract between Mangle and each producer? If so can we see it?Existe un contrato entre Mangle y cada productor del frijol? Si lo hay, nos permiten verlo? 23. Are the needs of each producer assessed individually? If yes, what is the process of assessment of these needs? (Figure out relationship between land and resources)Son evaluadas las necesidades de cada productor individualmente? Si es as, que es el proceso de evaluar estas necesidades? 24. What are the components of the loan (in terms of both the inputs provided by Mangle, and the monetary loan given to producers? (ask about land and water if they dont come up)Cuales son los componentes del micro prstamo que otorga Mangle (por ejemplo insumos provedos por Mangle, prstamo de dinero, etc.)? 25. What is the average loan size to participants in the black bean program?Qu es el tamao promedio del prstamo dado a los participantes en el programa de frijol negro? 26. To confirm, is the seed provided to Mangle by ALBA, or must it be purchased?Para confirmar, ALBA le da la semilla a Mangle, o tiene que comprarla Mangle a ALBA? 27. How/when is the purchasing price of the beans determined?Cmo y cundo se determina el precio de venta del frijol negro a ALBA ? Producers:28. How many producers of frijol are currently receiving microcredit loans?Cuntos productores de frijol estn recibiendo prstamos de microcrdito ahora? 29. Do you foresee that number changing? For example, if Alba wanted to produce more beans next year?Se prev un cambio en este numero? Por ejemplo, en el caso de que la cosecha sea buena, y Alba quiera producir ms frijol el ao que viene. 30. How do you keep track of the loans and producer information?Cmo documentan la informacin sobre los productores y los prestamos que reciben? 31. How do you document the costs associated with the hybrid corn program?Cmo documentan los costos asociados con el programa de maz hbrido? Por ejemplo, una hoja de datos computarizada? 32. May we see any documented costs of the black bean program, both direct and indirect?Nos permitiran ver la documentacin de los costos, tanto directos como indirectos? 33. Do you have a software program to track loans, if so can we see it?Tienen para eso un programa de software? De ser as, lo podemos mirar? Communication:34. How often do you communicate with producers in the frijol program?Con que frecuencia se comunican los administradores con los productores en el sector del frijol? 35. How often do you meet with the producers in person?Con que frecuencia se renen con los productores en persona? Interest:36. What is the interest rate of loans to bean producers?Cul es la tasa de inters de los prstamos para los productores de frijol? 37. How is this interest rate determined?Cmo se determina la tasa de inters? 38. How is the interest compounded?Cmo est compuesto el inters? Repayment:39. What is the average repayment rate within the black bean program? How does this number compare to the average repayment rate in the microcredit program as a whole?Qu es la tasa de reembolso promedio en el programa del frijol negro? Cmo se compara este numero con el promedio del programa de microcrditos en otros sectores? 40. If the producers are unable to repay what do you do?Si los productores no pueden reembolsar el cr