Microfinance for Bankers and Investors

1. Microfinance for Bankers and Investors

2. Summary • What Has Changed? • Debt Deals • Bank Loans

3. Bank Loans • As a measure of how far bank lending to MFIs has come, in 2007, Mibanco, a Peruvian bank specializing in microfinance (and onetime Bridge Fund guarantee recipient),

4. Bank Loans • raised money through an oversubscribed syndicated loan organized by Wachovia Bank and the International Finance Corporation (IFC), in which 10 major international banks provided $40 million in medium-term funding.

5. Bank Loans • While IFC presence helped give the syndication greater stature, there was no guarantee.

6. Bonds • In countries with active capital markets, the most appropriate providers of debt for microfinance are local investors. The domestic markets are ideal because they provide local currency, and the investors are familiar with local markets.

7. Bonds • In many countries, MFI bonds represent an attractive opportunity for local investors who have few options.

8. Bonds • Nevertheless, local capital markets were very wary of MFI bond issues at first, and so they required credit enhancements like guarantees or overcollateralization.

9. Bonds • Prior to its international loan syndication, in 2002, Mibancoissued $5.7 million in two-year bonds backed by a 50 percent guarantee from USAID10 and then a second bond with a similar guarantee from the Andean Development Corporation (CAF).

10. Bonds • Even with the enhancements, the first bond issues were small and carried a high interest rate. What may be surprising is how quickly the markets accepted the new institution after initial trials.

11. Bonds • Building on these experiences, in 2007, Mibanco offered a five-year bond for $10 million with an A rating on the Peruvian scale—and without a guarantee.

12. Bonds • Despite the lack of a guarantee, the interest rate on this issue fell from the 12 percent Mibanco paid on the first bonds to just over 6 percent.

13. Bonds • FinancieraCompartamos, the precursor to CompartamosBanco, issued five bonds from 2002 to 2005, placing a total of $68 million with increasingly favorable conditions.12 All of these bond issues were underpinned by strong ratings (MXA) from Standard & Poor’s and Fitch.

14. Bonds • In the 2004 offering, Citigroup/Banamex placed $44 million of peso-denominated five-year bonds. Part of the deepening story for Compartamos was a shift in the nature of buyers of the bonds.

15. Bonds • The initial bonds had been bought by high-net-worth individuals willing to take a risk. It was only after Compartamos had a track record in the market that institutional investors began to participate.

16. Bonds • It is important to note that both the Compartamos and Mibanco bonds were bought mainly by commercial investors (socially oriented investors being relatively scarce in Latin America).

17. Bonds • Bond issues have also taken place in Colombia, with Women’s World Banking Colombia in Cali demonstrating that even a well-run NGO can, with proper support and structure, approach the markets.

18. Bonds • Outside Latin America there have been few MFI bond issues, in part because of less active local bond markets.

19. Bonds • So what about more bonds? Local bond issues will probably become more common as mainstream ratings of MFIs bolster investor confidence and successful examples accumulate—provided, of course, that local markets have liquidity to place.

20. Collateralized Debt and Collateralized Loan Obligations • Collateralized debt obligations (CDOs), and a variation called collateralized loan obligations (CLOs), pool fixed-income assets and loans from a diversified portfolio of microfinance institutions and countries, and enable economies of scale and funding diversification.

21. Collateralized Debt and Collateralized Loan Obligations • Dexia, a Franco-Belgian bank, and BlueOrchard, an asset management company, created the first CDO for microfinance, the Dexia Microfinance Fund, in 1998. Investors included retail and private banking clients, institutional investors, and funds of funds.

22. Collateralized Debt and Collateralized Loan Obligations • The structure (which in 2007 managed $170 million) featured a commercial rate of return and redemption rights and was backed by a guarantee from the Overseas Private Investment Company.

23. Collateralized Debt and Collateralized Loan Obligations • Because of its legal structure, the Dexia Fund can only offer short-term maturities, limiting its attractiveness to both MFIs and investors.

24. Collateralized Debt and Collateralized Loan Obligations • BlueOrchard and Developing World Markets, an emerging markets fund management and consulting company, addressed this shortcoming when they created BlueOrchard Microfinance Securities I (BOMSI), which raised $87 million in two tranches in 2004 and 2005.

25. Collateralized Debt and Collateralized Loan Obligations • This CDO financed 14 MFIs in nine emerging markets with seven-year loans at fixed rates. Blue Orchard’s next deal, BOLD, in 2006, was a CLO (that is, backed by loan assets as collateral rather than MFIs).

26. Collateralized Debt and Collateralized Loan Obligations • It raised $99 million for 21 MFIs in 13 countries and was followed in 2007 by BOLD 2, together with Morgan Stanley, which securitized $110 million in loans with a rating by Standard & Poor’s.

27. Collateralized Debt and Collateralized Loan Obligations • Behind each such deal is a proud arranger. Ian Callaghan, who led the deal for Morgan Stanley, attributed much of the success of BOLD 2 to the rating. He says it opened doors to a much wider audience of investors.

28. Collateralized Debt and Collateralized Loan Obligations • AsadMahmood, managing director, Global Social Investment Funds of Deutsche Bank, was equally proud of the Global Commercial Microfinance Consortium he spearheaded in 2005.

29. Collateralized Debt and Collateralized Loan Obligations • The consortium included Merrill Lynch, Munich Re, and Axa, along with the international development agencies of the United Kingdom, the United States, and France.

30. Collateralized Debt and Collateralized Loan Obligations • Ten of the 14 institutional investors in the consortium had no previous involvement with microfinance. One of the features that structured finance deals such as this make possible is the precise application of credit enhancements only where they are most needed.

31. Collateralized Debt and Collateralized Loan Obligations • In this case a DFID grant supported the equity and a partial USAID guarantee supported the first tranche of debt. Investors were stratified according to risk appetite. High-net-worth individuals and development agencies took the riskier equity and subordinated debt tranches.

32. Collateralized Debt and Collateralized Loan Obligations • More risk-averse institutional investors held the senior debt tranche, with risk lowered not only by its senior status but also by a 40 percent U.S. government guarantee.

33. Collateralized Debt and Collateralized Loan Obligations • The fund raised $81 million, which was almost completely placed within the first year in 40 MFIs in 21 countries.

34. Collateralized Debt and Collateralized Loan Obligations • There are obstacles, to be sure. Investors prefer CDOs in euros or dollars, which puts foreign exchange risk on MFIs, though the Deutsche Bank Consortium was notable in that the MFIs received local currency.

35. Collateralized Debt and Collateralized Loan Obligations • The lack of investor-quality data on MFIs hinders arranging CDOs. The biggest issue, however, is perhaps the limited number of large MFIs in the world, with the consequence that many investors are chasing the same ones, leading to an oversupply of financing.

36. Collateralized Debt and Collateralized Loan Obligations • It is unfortunate for microfinance that structured finance instruments like CDOs are perceived as risky in the public mind, in light of the role of mortgage- backed CDOs in the financial-sector crisis of 2008.

37. Collateralized Debt and Collateralized Loan Obligations • With the onset of the crisis, the rate of new CDOs to finance microfinance fell to a standstill. CDOs are very good—maybe too good—at bringing investors into sectors that are either riskier or less familiar than blue-chip companies or conforming mortgages.

38. Collateralized Debt and Collateralized Loan Obligations • But there is no reason to panic about microfinance CDOs. These obligations are backed by the creditworthiness of individual MFIs, most of which are regulated financial institutions.

39. Collateralized Debt and Collateralized Loan Obligations • They lack the speculative element inherent in mortgages that rely on house prices to retain their value. Moreover, they are geographically well-diversified since they include organizations in various countries and regions.

40. Collateralized Debt and Collateralized Loan Obligations • Nevertheless, the subprime mortgage experience provides a warning against overconfidence in microfinance (or any) popular investment vehicles.

41. Summary • Bonds • Collateralized Debt and Collateralized Loan Obligations