Microfinance for Bankers and Investors

1. Microfinance for Bankers and Investors

2. Summary of the Last Lecture • Bonds • Collateralized Debt and Collateralized Loan Obligations

3. Securitization of Microfinance Portfolios • Securitization of microloans has been viewed as a kind of holy grail for microfinance. A true securitization accompanied by a secondary market could, some hope,

4. Securitization of Microfinance Portfolios • make investing in microcredit a function of end-borrower creditworthiness while at the same time allowing a wider range of investors to participate by creating liquidity for the securities.

5. Securitization of Microfinance Portfolios • The quest remains, as quests often do, elusive. There have been a number of steps, but no full-fledged securitization involving all the requisite elements:

6. Securitization of Microfinance Portfolios • (a) packaging of loans from multiple originators, (b) securities offered on the basis of the creditworthiness of the underlying assets alone (that is, without credit enhancement)

7. Securitization of Microfinance Portfolios • , (c) actual transfer of ownership of the original loans to buyers, and (d) resale and trading among investors.

8. Securitization of Microfinance Portfolios • The closest deal to a full securitization is that of BRAC in Bangladesh, the world’s largest national NGO with over 6 million active borrowers and assets of $619 million as of 2007.

9. Securitization of Microfinance Portfolios • In 2006, MF Analytics, a financial boutique based in Massachusetts, and Citigroup structured a true-sale securitization for BRAC. This deal, as a first of its kind, required enhancements, despite BRAC’s 32-year history, strong balance sheet, and expanding market.

10. Securitization of Microfinance Portfolios • The issue was 150 percent collateralized. As a result, the paper received a AAA rating from the Moody’s affiliated Credit Rating Agency of Bangladesh.

11. Securitization of Microfinance Portfolios • BRAC raised $180 million of inexpensive and long-term financing, made available over a term of six years.

12. Securitization of Microfinance Portfolios • Another true-sale portfolio securitization, for $60 million, was done for Pro- Credit Bulgaria, structured by Deutsche Bank and guaranteed by the European Investment Fund and KfWEntwicklungsbank in mid–2006.

13. Securitization of Microfinance Portfolios • For a few years it looked like the ICICI Bank partnership model in India would be a stepping-stone toward securitization. In that model, created in 2002,

14. Securitization of Microfinance Portfolios • ICICI directly loaned microfinance clients, using MFIs as loan originators and servicers, similar to mortgage originators in the United States.

15. Securitization of Microfinance Portfolios • By transferring ownership of loans directly to ICICI, rather than to the MFI, this model set the stage for the sale of loan assets to other investors.

16. Securitization of Microfinance Portfolios • Know-yourcustomer rules made it difficult for ICICI to continue developing this model, however, and the bank ended it in 2007.

17. Securitization of Microfinance Portfolios • Will securitization ever become standard in microfinance? Challenges remain to tempt financial innovators who want to experiment further using securitization to release capital constraints for MFIs,

18. Securitization of Microfinance Portfolios • widen the investor pool, and provide liquidity to investors. The small size, short duration (3 to 36 months), and variable prepayment rates of microloans make them relatively expensive to group.

19. Securitization of Microfinance Portfolios • Institutions need to pool thousands of microloans to create a security of minimum size. Variations in lending methodology from one MFI to another make it hard to create assets with a uniform and consistent risk profile.

20. Securitization of Microfinance Portfolios • Legal frameworks in many countries need reform in order to perfect the status of the sale and the buyer’s claim to the asset.

21. Securitization of Microfinance Portfolios • For all these reasons, most MFI quasi-securitizations, including the CDOs described above, involve pooled loans to MFIs rather than pooling the underlying loans to microentrepreneurs.

22. Securitization of Microfinance Portfolios • At the risk of being proved wrong by enterprising financial engineers, we believe there is little reason to expect a major shift toward securitization in microfinance anytime soon.

23. Equity Investments • Equity investing in microfinance is still mainly for the intrepid investor equipped to take on greater risk and responsibility. Since most MFIs are privately held, many equity investors also take on governance duties.

24. Equity Investments • Until recently the potential upside of microfinance equity investment did not justify the added risk and responsibility, unless the investor was seeking social as well as financial returns.

25. Equity Investments • Public-sector development banks and nonprofits held most MFI equity. These were the kind of investors who created ProFund, the first equity fund for microfinance, which operated from 1995 to 2005.

26. Equity Investments • Pro- Fund closed out with a 6.6 percent internal rate of return, and sponsors were pleased with the result. At the start, few people believed the ProFund concept would work at all.

27. Equity Investments • The IPO of CompartamosBanco in 2007 changed that picture in an instant. The social investors who scraped together $6 million to create FinancieraCompartamos in 2000

28. Equity Investments • (a time when private capital for microfinance was nearly nonexistent) earned a compound annual return of 100 percent in the IPO.

29. Equity Investments • Word of these high returns attracted many private investors toward microfinance. It is unlikely, however, that the Compartamos IPO returns will be duplicated.

30. Equity Investments • Today’s investor in microfinance equity should expect an attractive but not excessive return.

31. Equity Investments • The deepening story of microfinance equity begins in the mid–1990s with the public sector and philanthropists who created the first shareholder-owned MFIs,

32. Equity Investments • and moves forward to today with mainstream private players including Sequoia Capital, TIAA-CREF, and Credit Suisse. This kind of progression has been made possible by market-creating steps that provide prospective investors with more of what they need—

33. Equity Investments • information, confidence, a track record of returns, stability, scale, and liquidity (ease of exit). The result of these advances is that microfinance institutions are now given more credit in the marketplace for their past performance and future growth prospects, causing valuations to rise.

34. Equity Investments • During the decade when ProFund operated, from 1995 to 2005, most sales of microfinance equity were extremely quiet affairs priced at approximately book value.

35. Equity Investments • Such valuations represented a deep illiquidity discount because there were so few prospective buyers. Since 2005 there have been more buyers, and multiples increased substantially.

36. Equity Investments • Transactions such as the Compartamos and Equity Bank IPOs, with their multiples of several times book value, raised expectations about MFI valuations.

37. Equity Investments • Most past private trades of MFI equity have generally occurred between one and two times book value and feature price-earnings ratios between seven and eight.

38. Equity Investments • After the IPOs, more MFI valuations were trending up, until the slowdown in 2008. According to J.P. Morgan, even since 2008,

39. Equity Investments • valuations for MFIs are somewhat above the multiples associated with emerging market banks, in part “because of the higher resilience of their business to economic shocks.”

40. Equity Investments • The progression that has taken place involves the creation of market infrastructure, such as the Microfinance Information Exchange, the development of funds aimed primarily at socially responsible investors, and the involvement of rating agencies.

41. Equity Investments • But as everyone on Wall Street knows, the deals are what matter. We will look at several landmark deals with strong private commercial leadership, each representing a different model of investing.

42. Summary • Securitization of Microfinance Portfolios • Equity Investments