Development Impact Evaluation Results
FMO's investment selection process is focused on optimizing sustainable growth and development impact – this we ensure using our own assessment tools. Our tools comprise three main components: the ex-ante Economic Development Impact Score (EDIS) system that assesses a business’s contribution to the local economy, the Development Impact Indicator (DII) that gauges the relationship between development impact and volume of new investment, and a set of development monitoring indicators (quantitative indicators, or QIs). To verify whether the anticipated (ex-ante) development impacts have been realized, we use our evaluation assessment tool to evaluate project development and investment outcomes of projects or client companies five years after contracting or on exit.
Business success is the most important driver for overall development outcomes. Clients must be profitable in order to be financially sustainable, which is necessary if they are to have lasting positive effects on the local economy and to improve on environmental and social issues. Our evaluation tool also assesses projects’ impact on the local economy and environment. Furthermore, we look at the role FMO played in the project: whether we were additional, whether we catalyzed commercial financiers and whether we added value to the client’s environmental, social, governance performance and business operations. We investigate the extent to which the various outcomes are interrelated, as well as factors leading to the success or failure of projects. This allows us to understand what we need to do more or less of in order to continue achieving our objectives. Please visit our website to learn more about our approach to development impact.
In 2007, commercial flows to our clients’ markets were at their boom. Liquidity increased such that FMO moved up the risk ladder and down the market, targeting deprived segments and mid-tier companies lacking access to commercial financing. We ensured our ‘additionality’ through higher numbers of investments in higher risk-segments and riskier products. At the end of 2007, FMO was able to enter into record levels of new commitment, reaching over €1 billion. The years following the economic boom in 2007 saw an economic crisis that affected emerging markets, particularly in Eastern Europe and Central Asia. Our clients in emerging markets saw the effect of the crisis as well, which manifested itself in a declining percentage of successful projects, from a business point of view.
Development Outcomes of Projects Financed from FMO Capital
For evaluation purposes, projects financed from FMO’s capital only include projects financed as FMO’s risk and do not include the projects guaranteed by the Government (FOM). The evaluation outcome of these guaranteed projects is included in the development outcomes of the Government funds.
The overall development outcome rating is the result of evaluating various dimensions and indicators of development outcome: the project’s business success (whether it was viable and profitable for its shareholders and financiers, and thus financially sustainable), its contribution to economic growth (including broader private sector development beyond the project company), and the environmental and social outcomes of project. Business success is strongly correlated with other development outcome indicators and, of course, with investment outcomes (in other words returns) for FMO. In 2012, we evaluated fifty percent of the projects that were contracted in pre-crisis 2007 and that have been in our portfolio during the last five years. Among the 2007 evaluated projects, 54% (2011: 67%) produced good (‘satisfactory’ or ‘excellent’) development outcome. Development outcomes for the remaining projects were below our evaluative benchmarks. Looking on a three-year moving average (to smooth out year-on-year variations), 61% were developmentally successful. Development outcomes have been under pressure during the last few years, mainly due to the direct and indirect effects of the global financial crisis. In particular in Eastern Europe, the business climate deteriorated sharply in 2008-2009. This deteriorating business climate has resulted in several projects where financial projections have not been met. Business-cycle-sensitive industries, such as car manufacturing, have been confronted with falling domestic and international demand, and a lot of financial institutions have reduced their loan portfolios as a consequence of deleveraging and declining credit demand. Although FMO clients in most cases reacted relatively well to the financial crisis – in some instances supported by FMO financing – the business projections at contracting of many projects in 2007 have not been met due to limited growth in sales and/or loan portfolio. This, in turn, led to ‘unsuccessful’ development outcome ratings based on our evaluative benchmark.
Investment Outcomes of Projects Financed from FMO Capital
Despite the crisis, FMO’s investment outcome success rates (based on approval year) for 2012 remained relatively stable at 77% (2011: 83%) when compared with last year - often reflecting FMO’s choice for loan products that generally come with a downside protection for investors. That is, an obligation on clients to repay loans. This has also been confirmed by the stable quality of FMO’s loan portfolio in the last few years. In addition to the crisis, weaker performance of our equity returns on investments made in 2006-2007 – the peak in emerging markets equity valuations – also contributed to slightly deteriorated investment outcomes. During the last five years, stock markets in emerging markets have been fairly volatile, with limited net returns that manifested as a drop in the percentage of successful projects from a business point of view, and consequently on development outcomes and returns to shareholders. An important point is that most of the projects approved in 2005-2007 are still in our portfolio; most evaluation assessment is based on interim market valuations (while most of them still have a positive outlook).
Correlation between Investment and Development Outcomes of Projects Financed from FMO Capital
The graph below shows the results of project evaluations on a three-year moving average (i.e. projects committed 2005-2007) for FMO projects: 57% (2011: 65%) realized a win-win outcome (simultaneously good development and investment outcomes) and 16% (2011: 13%) a lose-lose outcome. In other words, for 73% (2011: 78%) of projects FMO financed in this period, there was a direct correlation between development outcomes and FMO investment outcomes. There is hardly any trade-off between good development outcomes and FMO’s investment outcomes as long as clients are selected based on their potential for good contributions to development as well as on financial sustainability. In that case, projects which succeed in reaching their expected business objectives both contribute to development and are able to meet financial obligations to FMO.
The most remarkable difference between the previous year’s graph is the increase in the proportion of projects with poor development outcome in combination with good investment results. This is mainly due to clients who failed to fulfill their business projections but were still able to repay their loans. This was particularly noticeable in Eastern Europe.
We also noted an increase in the incidence of poor development outcomes combined with an adequate return on FMO’s investment. Among the evaluated projects, there were a few with poor business success and poor overall development outcomes that nevertheless managed to service (and even prepay) their loan obligations from additional capital injections, and equity investments where FMO’s return was rated as satisfactory.
Development and investment outcomes, Government funds
With regards to projects funded and guarantee by the Government, 53% and 64% of evaluated projects produced good development and investment outcomes, respectively. These figures are based on a 3-year moving average (committed 2005-2007) and assessed based on our evaluative benchmarks. In comparison to projects financed with FMO's own capital, those financed by Government funds have a higher incidence of failing. This is understandable given their higher risk levels. Those that are successful, however, produce very good development results much more frequently, whereas FMO projects are concentrated in the moderately successful categories.