Extended Annual Review Report

Project Number: 47930-001 Investment Number: 7402 Loan Number: 3103

October 2019

Senior Loan TenGer Financial Group / XacLeasing LLC Supporting Leasing Finance (Mongolia)

This is an abbreviated version of the document, which excludes information that is subject to exceptions to disclosure set forth in ADB’s Access to Information Policy.

CURRENCY EQUIVALENTS Currency Unit – togrog (MNT)

At Appraisal At Project

Completion 30 July 2019

$0.0004 MNT2,666

31 October 2013 MNT1.00 – $0.0006

$1.00 – MNT1,638

ABBREVIATIONS ADB – Asian Development Bank DMF – design and monitoring framework IFC – International Finance Corporation MSMEs – micro, small, and medium-sized enterprises SEMS – social and environmental management system TenGer – TenGer Financial Group LLC XacLeasing – XacLeasing LLC

NOTES In this report, “$” refers to United States dollars.

Vice-President Diwakar Gupta, Private Sector Operations and Public–Private

Partnerships Director General Michael Barrow, Private Sector Operations Department (PSOD)

Senior Advisor/ Officer-in-Charge

Craig Roberts, Private Sector Operations Department; Portfolio Management Division

Team leader Team members

Manohari Gunawardhena, Investment Specialist, PSOD Cecilia De Castro, Safeguards Officer (Environment), PSOD Debby Anne Francisco, Project Analyst, PSOD Siela Teng-Almocera, Social Development Officer (Safeguards), PSOD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgment as to the legal or other status of any territory or area.

CONTENTS

BASIC DATA i

EXECUTIVE SUMMARY ii

I. THE PROJECT 1

A. Project Background 1 B. Key Project Features 2 C. Progress Highlights 2

II. EVALUATION 3

A. Project Rationale and Objectives 3 B. Development Results 3 C. ADB’s Additionality 8 D. ADB Investment Profitability 9 E. ADB’s Work Quality 9 F. Overall Evaluation 10

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 10

A. Issues and Lessons 10 B. Recommended Follow-Up Actions 11

i

BASIC DATA

Senior Loan: TenGer Financial Group for Leasing Finance (Loan No. 3103 – Mongolia)

Key Project Data

As per ADB Loan Documents ($ million)

Actual

($ million)

Total project cost:

ADB Loan 10.0 10.0 Total investment:

Committed 10.0 10.0 Disbursed 7.0 7.0 Outstanding 0 0

Supplementary cofinancing

Key Dates Expected Actual

Concept clearance approval Board approval Loan agreement Loan effectiveness First disbursement Loan maturity

2013 2013 2014 2014 2014

27 June 2019

2 September 2013 12 December 2013

27 June 2014 27 June 2014

21 August 2014 27 June 2019

Project Administration and Monitoring Number of Missions a

No. of Person- Days

Concept clearance … … Due diligence mission 1 8 Private sector credit committee meeting … … Board approval … … Project administration 2 4 XARR 1 3 … = data not available, ADB = Asian Development Bank, XARR = extended annual review report. a Missions undertaken for the three financial institutions participating in the program.

EXECUTIVE SUMMARY In December 2013, the Board of Directors of the Asian Development Bank (ADB) approved senior unsecured loans of $30 million to XacBank LLC and $10 million to TenGer Financial Group LLC (TenGer), a leading financial services group in Mongolia. The loan to TenGer Financial Group was for onlending to XacLeasing LLC. Both XacBank and XacLeasing were wholly owned subsidiaries of TenGer. The loans were to provide support to micro, small, and medium-sized enterprises and leasing finance in Mongolia. This extended annual review report covers the loan of $7 million (only $7 million was disbursed out of $10 million) to TenGer Financial Group LLC. Micro and small businesses make up 98% of all enterprises in Mongolia but only 10% of them had regular access to bank finance. Bank loans were of shorter maturity and smaller than borrowers’ needs. Leasing was an appropriate source of finance for enterprises unable to meet the collateral and documentation requirements of banks. XacLeasing was established in 2007 and had grown steadily. Several international financial institutions and social impact investment funds had shareholdings in XacLeasing’s parent, TenGer. XacLeasing adopted a more cautious approach in response to the economic slowdown of 2015–2016 in Mongolia and did not draw $3 million out of the $10 million ADB loan. It weathered the slowdown relatively well as a result of its cautious strategy, strong underwriting culture, and the intrinsic protection offered by lease contracts. The project’s development results are rated satisfactory, based on satisfactory performance across all four development impact dimensions: (i) contribution to private sector development and ADB strategic development objectives; (ii) business success; (iii) economic performance; and (iv) environmental, social, health, and safety aspects. Contribution to private sector and ADB strategic development objectives is rated satisfactory. XacLeasing significantly expanded its lease portfolio, from $13.4 million (based on the original exchange rate at the time of disbursement) in 2013 to $40.9 million as of the end of 2018, and is expected to reach the target of $50.0 million before the target date of the end of 2019. It achieved the portfolio growth despite disbursement of only 70% of the approved loan amount. However, the number of lessees was only 734 as of the end of 2018 from 350 in 2013, and it is not expected that the target of 1,500 set for 2019 will be reached. While this is a significant shortfall, there are several explanatory factors, mostly external, including the sharp contraction in growth in the Mongolian economy in 2015–2016, the slowdown in mining investment, the cancelation of the undrawn balance of $3 million, and the depreciation of the togrog. Business success is rated satisfactory. XacLeasing’s lease portfolio grew at a compound annual growth rate of 38.8% during 2014–2018 in togrog terms, indicating the company’s ability to grow despite challenges posed by the weak operating environment. The key financial indicators have been performing positively with strong capital, adequate liquidity, and excellent asset quality. Economic performance of the project is rated satisfactory. The strong business performance has been achieved without reliance on market distortions such as subsidies or protection. The project supported more widespread use of leasing as a relatively new financing technique in Mongolia that is well-suited to companies without sufficient collateral, leading to improved access to finance across a wide range of sectors. The environmental, social, health, and safety performance of XacLeasing is rated satisfactory. The loan was categorized as financial intermediary treated as C for impacts on environment,

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involuntary resettlement, and indigenous peoples under ADB's Safeguard Policy Statement (2009). XacLeasing’s vehicle and equipment lease transactions using ADB funds had minimal or no adverse environmental impacts, involuntary physical or economic displacement, or impacts on ethnic minorities. Additionality of the project is rated satisfactory. The long-term ADB loan provided a more stable financing base with reduced maturity mismatch. XacLeasing relies on borrowings for funding, and the majority of lenders offer shorter-term loans for smaller amounts. The ADB loan also helped raise the profile of the company and attract other international lenders; XacLeasing has more than 10 international lenders as of May 2019. The combination of loans to both XacLeasing and its sister organization XacBank was also a unique feature of the ADB project, enabling it to achieve a broad impact on access to finance in Mongolia. ADB’s investment profitability is rated satisfactory. Pricing was in line with ADB policies. The cancelation of $3 million led to a smaller loan amount but appraisal and supervision expenses were partly shared with the concurrent $30 million loan to XacBank. An amendment to the facility agreement in June 2016, whereby XacLeasing guaranteed the full amount of TenGer’s obligations to ADB, led to a further reduction in risk for ADB. ADB’s work quality for screening, appraisal, and structuring of the project is rated satisfactory. The selection of XacLeasing was based on a thorough analysis of market conditions in Mongolia. However, the target set in the design and monitoring framework with regard to the baseline number of leases was an overestimation, although it was justifiable in view of the past growth trajectory of the client. The number of projected lessees was justified based on the expected average ticket size for leases. However, XacLeasing was not able to achieve the number of lessees because of market size and conditions and the cyclical nature of the Mongolian economy. This required a strategy change on the part of XacLeasing to focus on bigger ticket leases. ADB’s work quality for monitoring and supervision is rated satisfactory. ADB kept itself informed of project progress, maintained close contact with the client, and regularly received financial and monitoring reports. In addition, ADB was able to disburse the second tranche under challenging economic and operating conditions in Mongolia. The development monitoring indicators were closely monitored, where ADB noticed a challenge in meeting the target in the number of lessees. However, XacLeasing more than doubled the number of lessees within 5 years while all other indicators were met successfully. ADB’s overall work quality is rated satisfactory, as appraisal and monitoring quality were generally good even though some of the targets in the design and monitoring framework were overestimated based on the performance of XacLeasing at the time and growth projections. ADB’s senior unsecured loan project with TenGer Financial Group is rated successful overall. A lesson learned is that outcome targets should carefully consider the business strategy and past growth of the borrower, the size and expected growth of the market, and overall economic conditions. Extrapolating or anticipating high growth rates many years into the future is often idealistic in economies that are prone to cyclical fluctuations, even though clients’ projections may be optimistic. In addition, ADB should make efforts to provide loans in local currencies in economies with volatile exchange rates.

I. THE PROJECT

A. Project Background

1. In December 2013, the Board of Directors of the Asian Development Bank (ADB) approved senior unsecured loans of $30 million to XacBank and $10 million to TenGer Financial Group LLC (TenGer), a leading financial services group in Mongolia. The loan to TenGer was for onlending to XacLeasing. Both XacBank and XacLeasing are wholly owned subsidiaries of TenGer. The loans were to provide support to micro, small, and medium-sized enterprises (MSMEs) and leasing finance in Mongolia.1 This extended annual review report covers the loan of $10 million to TenGer for XacLeasing. The loan to XacBank is covered in a separate extended annual review report,2 which was reviewed in an extended validation report in October 2018.3

2. Development of MSMEs is considered critical for the Mongolian economy. MSMEs make up 98% of all enterprises in Mongolia, and three-quarters of these are microenterprises.4 According to a World Bank survey, more than 30% of MSMEs in Mongolia perceive access to finance as the single largest constraint on their operations.5 Only about 10% of the around 37,000 Mongolian MSMEs regularly access finance through banks. Another World Bank study noted that when finance is available to MSMEs, loan terms tend to be characterized by high interest rates, short maturities, and smaller amounts than needed to fulfill the needs of the borrowers.6 Lenders also typically require immovable assets as collateral, excluding potential borrowers who have insufficient or no immovable assets. 3. The Government of Mongolia focused on MSME development as a key plank of its strategy to boost employment and growth. ADB met with several financial intermediaries to identify candidates with the interest and ability to serve this market segment. TenGer’s main shareholders were Mongolyn Alt Corporation (20%), the International Finance Corporation (IFC) (19%), Orix Corporation (16%), the European Bank for Reconstruction and Development (12%), Ronoc (10%), Equity Investment Trust (10%), Mercy Corps (8%), and Triodos Bank (4%).7 Orix Corporation, a Japanese financial services group with global operations and expertise in leasing, became a shareholder in 2013. TenGer had a strong commitment to social and environmental goals along with commercial objectives and adopted the “People, Planet and Profit” slogan as its guiding principle. 4. XacLeasing was established in 2007 by TenGer as a wholly owned subsidiary. Its main purpose was to provide equipment leases to small businesses and finance leases for passenger vehicles to consumers. XacLeasing grew steadily after its inception in 2007 and reached a leasing volume of about $13 million and market share of about 14% in 2013. It was consistently profitable with a return on equity of over 10% in 2012. XacLeasing received technical assistance from IFC to improve risk management and corporate governance and was due to receive strategic support

1 Mongolia's small and medium-sized enterprise law defines these enterprises by sector: industry—maximum of 199

employees and maximum turnover of MNT1.5 billion; trade—maximum of 149 employees and maximum turnover of MNT1.5 billion; and services—maximum of 49 employees and maximum turnover of MNT1 billion.

2 ADB. 2017. Extended Annual Review Report: Senior Loan to XacBank. Manila. 3 ADB. 2018. Validation Report. Mongolia: Supporting Micro, Small, and Medium-Sized Enterprises (XB). Manila. The

report rated the project unsuccessful, mainly because it did not meet the main targets defined in the report and recommendation of the President.

4 ADB. 2013. Report and Recommendation of the President to the Board of Directors: Senior Loan to TenGer Financial Group / XacLeasing LLC Supporting Leasing Finance (Mongolia). Manila.

5 The World Bank Enterprise Surveys. 2012. http://www.enterprisesurveys.org/. 6 World Bank. 2012. Financial Sector Assessment: Mongolia. Washington, DC. 7 The remaining small shareholders were Mongolian individuals and the Mongolian Rotary Club.

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from Orix Corporation for the expansion of its leasing operations. XacLeasing needed long-term financing to support its expansion and reduce the mismatch between its predominantly short-term funding and longer-term leases.

B. Key Project Features

1. An ADB senior unsecured loan of $10 million to TenGer for onlending to XacLeasing was signed on 27 June 2014. The loan had a maturity of 5 years and grace period of 2 years. Disbursements took place on 21 August 2014 and 27 June 2016. While the ADB loan was structurally subordinated to the creditors of XacLeasing, an amendment to the facility agreement was signed in June 2016 whereby XacLeasing guaranteed the full amount of TenGer’s obligation to ADB. The disbursement was structured so that XacLeasing would achieve a targeted growth level in its lease portfolio to avail itself of the full $10 million.

2. As the Mongolian economy went through a sharp slowdown in 2015–2016 (para. 9), part of the ADB funds were no longer needed as XacLeasing adopted a more cautious approach adapted to the revised growth scenario. TenGer thus drew only $7 million of the original $10 million loan amount, and the $3 million balance was canceled upon expiration of the facility’s availability period. 3. The ADB loan was to support a substantial increase in XacLeasing’s activities, including raising the number of customers from 350 in 2013 to 1,100 by the end of 2017 and 1,500 by the end of 2019; growing the lease portfolio from $15 million8 in 2013 to $50 million by the end of 2019; and maintaining satisfactory financial indicators, including a nonperforming lease ratio of less than 5% and any applicable capital adequacy requirements. XacLeasing was also expected to make special efforts to reach female borrowers. 4. No technical assistance was provided by ADB in connection with this project as XacLeasing had already received advisory assistance on risk management and corporate governance from IFC and was to receive further support from Orix Corporation in connection with the Orix investment in TenGer. XacLeasing staff also had full access to the training programs conducted by XacBank.

C. Progress Highlights

5. XacLeasing’s progress after the receipt of ADB’s loan happened amid a sharp economic

slowdown in Mongolia. The Mongolian economy slowed sharply in 2015–2016, with real gross

domestic product growth declining from an average of about 12.0% in 2012–2013 to 2.4% in 2015

and 1.2% in 2016. This was mainly because of slower growth in the People’s Republic of China,

lower commodity prices for Mongolia’s main exports (in particular coal and copper), and a decline

in mining investment caused by policy and regulatory uncertainty. The slower growth led to a

substantial slowdown in finance sector credit and a rise in the nonperforming loans across the

banking industry. The Mongolian currency depreciated by about one-third, from around $1 =

MNT1,850 at the end of 2014 to around $1 = MNT2,450 at the end of 2016.

8 The $15 million baseline was an estimate given to the deal team during processing of the report and recommendation

of the President as of November 2013. The actual 2013 portfolio was MNT22.1 billion in local currency or $13.4 million equivalent using historical rates.

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6. XacLeasing’s lease portfolio continued to grow in local currency terms, from MNT38.2

billion in June 2015 to MNT41.7 billion as of 31 December 2016, while the number of lessees

increased from 441 to 611. Because of the depreciation of the togrog, however, the total lease

portfolio declined in dollar terms over the same period, from $19.2 million to $16.7 million.9

Profitability remained positive and capitalization adequate. The liquidity position of XacLeasing

tightened, though it is supported by credit lines from XacBank and intrinsic support from TenGer.

The ADB loan also assisted the liquidity situation and enabled XacLeasing to attract other lenders.

XacLeasing weathered the slowdown relatively well, though the rate of growth was slower than

expected at the time of project approval.

7. The economy recovered in 2017 and has grown strongly since then. Growth reached 5.3%

in 2017 and 6.9% in 2018. Investments in mining as well as recovery in commodity prices have

provided a strong boost to the economy. Mongolia also entered an International Monetary Fund

program with an extended fund facility of $425 million, approved in May 2017, supporting fiscal

consolidation and aiming to lay the foundation for sustainable and inclusive growth in the future.10

II. EVALUATION

A. Project Rationale and Objectives

8. The project aimed to improve access to finance, and thereby investment and growth, of MSMEs in Mongolia. The objectives were in line with priorities of the ADB country partnership strategy for Mongolia in targeting private sector development, financial deepening, and MSME growth.11 ADB also conducted an independent evaluation of its assistance to the finance sector in 2008, which recommended that future nonsovereign operations consider providing longer-term loans to meet the needs of MSMEs and supporting the development of nonbank and capital market sectors.12 The project was also fully consistent with ADB’s Strategy 2020 in targeting strengthening of key financial intermediaries and promoting inclusive finance.13 9. Leasing was an appropriate financial instrument for Mongolia as it serves the needs of enterprises that have sound business plans but cannot meet the collateral and documentation requirements of banks. XacLeasing was a specialized leasing company that belonged to a reputable and successful financial services group. It needed long-term funding to expand its business and reduce the mismatch between its predominantly short-term funds and longer-term leases.

B. Development Results

10. The project’s development results are rated satisfactory overall.

1. Contribution to Private Sector Development and ADB Strategic Objectives

9 According to development effectiveness monitoring report figures supplied by XacLeasing, which take account of

exchange rates prevailing at the time of reporting. 10 The program was supported by many multilateral and bilateral donors, including the World Bank and ADB, for a total

financing package of $5.5 billion. 11 ADB. 2012. Country Partnership Strategy: Mongolia: 2012–2016. Manila. 12 ADB. 2008. Evaluation Paper on the Financial Sector in Mongolia. Manila. 13 ADB. 2008. Strategy 2020: The Long-Term Strategic Framework of the Asian Development Bank. Manila.

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11. Contribution to private sector development and ADB strategic objectives is rated satisfactory. XacLeasing significantly expanded its lease portfolio, from $13.25 million (based on historical exchange rates) in 2013 to $40.90 million as of the end of 2018. With the continued growth in the Mongolian economy and XacLeasing’s portfolio,14 XacLeasing is expected to reach the target of $50 million before the end of 2019.15 This achievement is all the more remarkable as the togrog depreciated from around $1 = MNT1,400 to $1 = MNT2,600 during this period, and the Mongolian economy underwent a sharp slowdown in 2015–2016. 12. On the other hand, there were only lessees 734 as of the end of December 2018, below the target of 1,100 set for 2017. The number is not expected to be close to the target of 1,500 lessees set for the end of 2019. This evaluation estimates that it does not detract from the significant contribution to private sector development and access to finance for MSMEs made by the project, though it is observed that there is an overestimation of the number of lessees based on ticket size expectations and the baseline portfolio because of an exchange rate depreciation from 2012 to 2013. While this represents a significant shortfall, there are a number of explanatory factors, as outlined in the following list:

(i) XacLeasing more than doubled the number of lessees, from 350 in 2013 to 734 in 2018, although it missed the target of 1,500 borrowers. However, the leasing portfolio more than quadrupled in local currency terms from MNT22.1 billion in 2013 to MNT108.1 billion in 2018. The main reason for not meeting the targeted number of borrowers despite meeting portfolio targets is the ticket size per borrower having increased from 2013 to 2019 by 133%.

(ii) The Mongolian economy underwent a significant slowdown in 2015–2016, with growth declining from 12% to less than 2%. While this is not unexpected in a cyclical, resource-dependent economy like Mongolia and was mentioned as a risk factor in the design and monitoring framework (DMF), it should have been more explicitly factored into performance targets.

(iii) The slowdown in mining investment resulted in declining demand for related extraction, processing, and transport equipment. At the same time, difficult weather conditions, including severe droughts and harsh winters, affected the agriculture sector, resulting in reduced demand for agricultural machinery.

(iv) Because of the contraction in growth, $3 million out of the approved $10 million loan was not drawn down by TenGer and had to be cancelled. The expected impact of the project should be viewed in light of the smaller scale of the ADB loan.

(v) The depreciation of the togrog resulted in an increase in the price of imported vehicles and equipment. This led to an increase in average ticket sizes and made purchases less affordable for many customers. XacLeasing responded to these pressures by focusing on high-quality MSME customers who could afford the relatively larger lease amounts required. This decision was a departure from the strategy at the time of structuring the DMF and so also impacted the achievement of DMF targets.

13. While market demand was affected by the above factors, competition in the leasing market intensified as the leasing product became more widely known and better accepted in Mongolia apart from loans, prompting banks with broader outreach and lower cost of funds than XacLeasing to move into the market. XacLeasing adjusted its strategy in response to these changes in macroeconomic and market conditions. These changes are considered well-advised and

14 XacLeasing expects growth of around 30% in 2019. 15 XacLeasing’s gross lease portfolio was $47 million based on unaudited 31 March 2019 financial statements.

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contributed to the strong operational and financial performance of XacLeasing. The changes were as follows:

(i) Focus on high-quality equipment, with reliable supplies of spare parts and repair

services. (ii) Focus less on the manufacturing sector because of the difficulties in competing

against products made in the People’s Republic of China. (iii) Emphasize speedy approvals and limited documentation requirements as a core

competitive advantage of XacLeasing. (iv) Focus on vendor networks as key marketing channels, combined with more

selective choice of vendors. The number of partner vendors was reduced from over 300 in 2013 to about 35 as of 30 April 2019, resulting in closer partnerships and higher-quality leases.

(v) In addition to vendors, rely on the XacBank network as the second most important source of customer referrals.

14. Some of the targets set in the DMF, in particular the number of lessees, was an overestimation and should have been more carefully vetted:

(i) The report and recommendation of the President notes that XacLeasing had adopted a conservative approach in its early years, leading to slow portfolio growth with sound profitability. An increase from 350 to 1,500 lessees in 6 years, corresponding to a compound annual growth rate of 27.5%, seems an overly ambitious target under these circumstances.

(ii) The Mongolian economy is heavily dependent on mining and is therefore known to be prone to cyclical fluctuations. This risk was recognized in the DMF and should be taken into consideration when assessing the results achieved against the targets.

(iii) The targets also do not appear to have been based on a proper market analysis. XacLeasing estimates that it currently has a 26.7% share of the leasing market; hence reaching 1,500 instead of 734 clients, assuming similar size leases, would imply a market share of more than 50.0% for XacLeasing. Given the competition from banks and specialized and captive leasing companies, this is not an achievable target.

15. XacLeasing achieved an increase in female and rural customers during the project period.16 The number of female customers rose from 84 in 2013 to 188 as of the end of December 2018. Over the same period, the number of customers in rural areas increased from 48 to 256. The share of rural customers in leasing volume rose to more than 50%, reflecting mainly the rise in mining and related industries. 16. The average tenor of XacLeasing leases also increased steadily, from 38.7 months in 2014 to 46.1 months as of 31 March 2019. The reduction in maturity mismatch and resultant ability to provide longer-term leases, adapted to the cash flows of customers, was an important rationale for the ADB loan. 17. In summary, XacLeasing achieved a substantial expansion of its leasing activities for MSMEs, in terms of both volume and number, under difficult macroeconomic and market conditions while maintaining sound financial indicators. XacLeasing also achieved increases in

16 These achievements and increasing the average tenor of leases were beyond the scope of the targets originally set

in the design and monitoring framework for XacLeasing. As per the report and recommendation of the President, female and rural targets were set only for XacBank, however the facility agreement signed with XacLeasing used the same template of DMF reporting as XacBank which required female and rural customers.

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leases for female and rural customers and an increase in average lease terms. It is set to meet key targets in the DMF, except the target for the number of leases. This may be viewed as reflecting on the quality of project appraisal but should not detract from the substantial development impact achieved by the project.

2. Economic Performance

18. Economic performance is rated satisfactory. The strong business performance has been achieved without reliance on significant market distortions. The finance sector in Mongolia is generally market driven and suitably regulated. The economy is open to trade, and sectors supported by XacLeasing–in particular mining, transport, trade, and agriculture—are subject to import and/or domestic competition. The economic sustainability of XacLeasing is, therefore, expected to mirror its financial success. 19. The project supported more widespread use of leasing as a relatively new financing technique in Mongolia. Leasing is particularly well-suited to the needs of MSMEs, which lack fixed assets as collateral and have insufficient financial records and business plans to access bank loans. The focus on assets with high resale value enables XacLeasing to approve leases with minimal time and documentation requirements, thereby making financing available when it is needed by clients. This has led to improved access to finance for MSMEs across a wide range of sectors.

20. The increase in leases for female customers and in rural areas further contributes to economic activity as it makes financing available to more deprived groups. The lengthening of average tenors also makes financing better adapted to client needs, and therefore supports larger and better investment plans. 21. XacLeasing also introduced new practices and products, including (i) use of biometrics for customer identification, resulting in more efficient processes and reduced risks; (ii) introduction of fair value leases, where the lessee has the option to continue the lease at the renewal rate or buy the asset at its fair market value at the end of the initial lease term; and (iii) digitization of lease approvals and processing, though this has only just begun. These practices contribute to more efficient operations and enhanced customer service by XacLeasing, and some of them are likely to be followed by other market participants. 22. While passenger vehicles remain a core market segment, XacLeasing achieved significant growth in commercial vehicles and equipment, accounting for 68% of its total business. XacLeasing’s portfolio is also broadly diversified across sectors, meeting the needs of the key mining, transport, trade, and services industries. The evaluation team met with several customers of XacLeasing who emphasized the high quality of service, in particular speed of approval and low bureaucratic requirements, and the contribution to their business development.

3. Environment, Social, Health, and Safety Performance

23. The environmental, social, health, and safety performance of XacLeasing is rated satisfactory. The loan was categorized as financial intermediary treated as C (FI-C) for impacts on environment, involuntary resettlement, and indigenous peoples under ADB's Safeguard Policy

Statement (2009).17 Due diligence at the time of loan processing found that XacLeasing’s social

17 During project processing the loan was initially categorized as FI but the signed facility agreement excluded

subprojects categorized A and B for impacts on environment, involuntary resettlement, and indigenous peoples.

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and environmental management system (SEMS) has been integrated in the lease application, appraisal, and management process since 2011. The SEMS provided the policies and procedures for ensuring compliance with applicable national and local environmental, occupational health, and safety requirements and labor laws and in identifying and managing potential minimal social, environmental, health, and safety concerns from its leasing operations. 24. XacLeasing’s vehicle and equipment lease transactions using ADB funds had minimal or no adverse environmental impacts, involuntary physical or economic displacement, or impacts on ethnic minorities. No lessees have business activities which appear on XacLeasing’s list of excluded activities, which is aligned with ADB's prohibited investment activities list. Lease contracts included a representation on lessees’ compliance with applicable Mongolian environmental, health, and safety requirements. Based on XacLeasing’s records, there are no lessees who do not comply with applicable Mongolian environmental, health, and safety requirements, and no complaints on environmental and social aspects were made against any of XacLeasing’s vehicle and equipment lease transactions. XacLeasing has a dedicated environmental and social manager coordinating and monitoring the implementation of the SEMS. XacLeasing regularly reports its environmental and social performance to ADB. 25. XacLeasing ensures that its operations as well as its clients’ business activities comply with national labor laws, rules, and regulations as well as adhere to international core labor standards. It excludes clients engaged in child and forced labor. Evaluation of lease applications includes assessment of working conditions, health and sanitation, and labor issues involving clients’ business activities. XacLeasing is an equal opportunity employer and maintains a level of 50% female employment in its workforce. The employee turnover rate is less than 10%, and from 2014 to 2018 only seven new positions were filled, which includes one female relationship officer and one female support person.

26. The project is classified as having some gender elements.18 XacLeasing maintains a sex-disaggregated database of the lease portfolio. From 2013 to 2018, it achieved a 124% increase in the number of female customers who are micro, small, and medium-sized entrepreneurs and are mostly engaged in the services and trade sectors. To widen its reach to female customers, XacLeasing will launch a campaign program that will feature leading women in Mongolia in business, the arts, politics, and sports, and will conduct training seminars on women’s empowerment and leadership. These campaign events will also be a venue for XacLeasing to introduce and promote various products and services.

Therefore, the Private Sector Operations Department’s revised assessment concluded that the financial intermediary’s business activities would have minimal or no environmental impacts or risks and would be unlikely to generate involuntary resettlement impacts or impacts on indigenous peoples, so the project has been treated as a category C project. As such, it is in accordance with ADB’s Safeguard Policy Statement. Notwithstanding that, XacLeasing continued the use of its SEMS, which has been integrated in the lease applications, appraisal, and management since 2011. The SEMS provides the policies and procedures for ensuring compliance with applicable national and local environmental, occupational, health and safety requirements, and labor laws, and in identifying and managing potential minimal social, environmental, health, and safety concerns from its leasing operations.

18 ADB. 2012 Guidelines for Gender Mainstreaming Categories of ADB Projects. Manila.

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4. Business Success

27. The business success of XacLeasing is rated satisfactory based on an analysis of the borrowers’ business performance and prospects. 28. XacLeasing’s gross lease portfolio grew by 38.8% compound annual growth rate during 2014–2018 because of a faster underwriting process (compared to banks) and an overall increase in the demand for finance leases. XacLeasing operates as a separate legal entity from XacBank, a key advantage (because of more focused operations) over its leasing competitors operating only as business units within Khan Bank, the Trade and Development Bank, and Golomt Bank. XacLeasing has a diversified portfolio with top exposures being to the sectors of mining (22.9%), services (22.0%), and trading (22.0%) as of 2018. XacLeasing also began to offer operating leases (no transfer of ownership relating to a leased asset) in 2017 to have another income stream. In terms of asset class, the lease portfolio is divided into passenger vehicles (68.0%), commercial vehicles (29.5%), and others (2.5%). 29. XacLeasing’s capital has historically been strong and at high levels, especially during the slowdown in 2015–2016, because of selective lending. In 2017, as the economy picked up, XacLeasing began to grow its portfolio and started paying dividends, despite which XacLeasing was able to comply with financial covenants of ADB. Nonperforming loans increased during the slowdown in the economy, however XacLeasing was able to generate good financial metrics, evidenced in healthy returns during 2014–2018 with return on average equity at 17.5% or higher and return on average assets at 4.6% or higher. XacLeasing continues to rely on borrowings to fund its lease operations. Funding sources remained well-diversified with nine international lenders apart from ADB, and some social impact funds. Local banks such as Khan Bank and XacBank also provide short-term facilities. C. ADB’s Additionality

30. Additionality of the project is rated satisfactory. The long-term ADB loan improved the funding structure of XacLeasing, providing a more stable financing base with reduced maturity mismatch. As a leasing company, XacLeasing cannot raise deposits and must rely on institutional lenders for its funding needs. Most of these loans are short term and for relatively small amounts. The ADB loan enabled XacLeasing to pursue its growth strategy and raise average lease terms without damaging its maturity structure or liquidity position. ADB was able to disburse the second tranche of $3 million amid the weak economic and operating environment conditions in Mongolia with a clear assessment of the company’s requirements at the time. The remaining $3 million of the $10 million loan was ultimately left undrawn and had to be cancelled as XacLeasing’s growth rate had slowed considerably because of the deteriorating macroeconomic environment in Mongolia and resultant slowdown in leasing demand from 2015-2016. 31. Since XacLeasing was a small and unknown entity at the time, the ADB loan also helped raise the profile of the company and attract other international lenders. While the European Bank for Reconstruction and Development was the main lender prior to the ADB project, XacLeasing currently has over 10 international financial institution and microfinance investment vehicle lenders, and the latter account for a growing share of its funding.19 Despite this favorable development, ADB is still the second largest lender to XacLeasing, just behind Khan Bank, highlighting the importance of ADB to the borrower.

19 XacLeasing could of course access financing from its parent TenGer or sister organization XacBank, but these also

faced financing constraints and would put XacLeasing’s demands in competition with multiple other activities.

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32. The combination of loans to both XacBank and XacLeasing was also a unique feature of the ADB project, enabling it to have a broad impact on access to finance for MSMEs in Mongolia. The inclusion of XacLeasing allowed the project to meet the needs of MSMEs that might not have been eligible for bank financing.

D. ADB Investment Profitability

33. ADB’s investment profitability is rated satisfactory. The senior loan carried a spread in line with ADB policies and approved by the Office of Risk Management. The cancelation of $3 million led to a smaller loan amount, but appraisal and supervision expenses were partly shared with the concurrent $30 million loan to XacBank. These are relatively large loan amounts given the size of the Mongolian economy. 34. The amendment to the facility agreement signed in June 2016, whereby XacLeasing guaranteed the full amount of TenGer’s obligations to ADB, led to a further reduction in risk for ADB and, therefore, improvement in the risk–reward profile of the project. 35. TenGer is current on all fee, interest, and principal payments due on the ADB loan for XacLeasing. The final payment was received in June 2019. E. ADB’s Work Quality

36. ADB’s overall work quality is rated satisfactory based on its (i) screening, appraisal, and structuring of the project; and (ii) monitoring and supervision.

1. Screening, Appraisal, and Structuring of the Project

37. ADB’s work quality for screening, appraisal, and structuring of the project is rated satisfactory. The selection of XacLeasing along with XacBank as financial intermediaries was based on a thorough analysis of market conditions and opportunities in Mongolia and is considered sound. The addition of a leasing component for XacLeasing to the MSME finance project with XacBank was also well-advised as it allowed the project to widen its reach to companies without enough collateral or formal documentation. The DMF had numerous relevant indicators with baselines and targets which are development focused, pertinent to the project, and measurable. 38. The target set for the number of lessees in the DMF appears to be an overestimation in view of the past growth trajectory of the client, market size and conditions, and the cyclical nature of the Mongolian economy. While this did not prevent the project from achieving satisfactory development and financial outcomes, it resulted in a substantial shortfall in the target for the number of clients. This could have been avoided by moderating the growth expectation in the number of borrowers. Metrics such as lease ticket size and market share of XacLeasing in the leasing industry in Mongolia could have been included to measure the success of the project, which would vindicate the achievement of portfolio growth by the client. 39. In terms of structure, the routing of the loan through TenGer also resulted in a 10% corporate income tax being imposed, which could have been avoided with a direct loan to XacLeasing. However, given the better credit standing of TenGer at the time of loan approval, the channeling of the loan to XacLeasing through TenGer was an acceptable alternative. ADB was able to disburse the second tranche with an improved credit structure where XacLeasing, as the stronger company, was able to guarantee the borrower on record.

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2. Monitoring and Supervision

40. ADB’s work quality for monitoring and supervision is rated satisfactory. ADB kept itself informed of project progress and maintained close contact with the client. ADB regularly received financial and development monitoring reports and followed up diligently on missing data.20 The addition of a XacLeasing guarantee in 2016 reflected the inherent credit strength of XacLeasing, separately from TenGer, and appears to have been timely and justified. ADB was also able to amend the net nonperforming loan covenant in the list of financial covenants (from 15% to 12%) to assist in improving the asset quality of the bank. Although ADB noted that XacLeasing was challenged during the economic cycle during 2013–2018 in achieving DMF targets, apart from the number of lessees XacLeasing achieved all development indicators and also attained a creditable doubling of the number of lessees despite a strategy change.

F. Overall Evaluation

41. ADB’s senior unsecured loan project with TenGer is rated successful overall.

Evaluation of the Project

Indicator/Rating

Unsatisfactory

Less than Satisfactory

Satisfactory

Excellent

A. Development Results √ (i) Contribution to private sector

development and ADB strategic development objectives

√

(ii) Economic performance √

(iii) Environmental, social, health, and safety performance

√

(iv) Business success √ B. ADB Additionality √ C. ADB Investment Profitability √ D. ADB Work Quality (i) Screening, appraisal, and structuring √ (ii) Monitoring and supervision √

Overall Rating Successful

ADB = Asian Development Bank.

Source: ADB.

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

A. Issues and Lessons

42. DMF targets should consider the business strategy and past growth of the client, size, and expected growth of the market and overall economic conditions when thresholds are set. Extrapolating or anticipating high growth rates many years into the future is often idealistic, especially in economies that are prone to cyclical fluctuations. DMF targets should also be set in local currency to avoid measurement distortions which may arise because of significant currency depreciation.

20 In addition to quarterly unaudited and annual audited financial statements and compliance certificates, ADB received

seven semiannual progress reports on its development targets.

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43. Currency of the loan for a small company like XacLeasing is an important factor as the company’s business is in togrog. ADB should make efforts to give local currency loans or structure the loan where the foreign currency loan could be given to a financial institution with foreign currency flows in the TenGer, like XacBank, which in turn could then give a local currency loan, e.g., a togrog loan to XacLeasing.

B. Recommended Follow-Up Actions

44. If requested by potential clients that otherwise meet investment criteria, ADB should consider providing local currency financing at fixed interest rates in Mongolia. 45. In case further financing support to XacLeasing is considered, ADB may provide the loan directly to XacLeasing rather than routing it through TenGer. ADB could also consider adding technical assistance, e.g., to support the ongoing digitization of XacLeasing’s operations and/or to assess the scope for new products (such as operating leases or consumer finance leases).