PAPER WRAP-UP: Microfinance Cracking the Capital Markets II

MicroCapital will review the conclusions from last year’s conference in preparation for the upcoming third annual Microfinance Cracking the Capital Markets conference in May, 2008. The conference was summarized in a 16-page publication written by Rekha Reddy and is part of ACCION’s InSight series, available here. The conference was hosted by ACCION International and sponsored by Credit Suisse. ACCION is a private, non-profit microfinance organization founded in 1961 that specializes in global micro-enterprise loans, business training, and other financial services.

Comprised of fund managers, emerging markets specialists, and intermediaries, the conference focused on microfinance investment growth, innovations in structured deals, and ways in which microfinance institutions (MFIs) need to develop to better integrate into capital markets.

Reviewing the state of microfinance investments, the paper highlighted an increased demand as the largest 100 MFIs grew their client base by 26 percent per year. However, some investors remarketd that investment flooding into microfinance is more than MFIs can absorb. In particular, Jean Philippe de Schrevel of Blue Orchard Microfinance Investment Managers stated he would be unable to place USD 100 million in debt due to the lack of ready MFIs.

Furthermore, some private investors felt that International Financial Institutions (IFIs) were crowding out private investors for deals with top MFIs, rather than making riskier investments to advance the sector. IFIs are typically private sector arms of public finance institutions. However, discussions regarding crowding-out were inconclusive, as the line between IFI and private investments is often blurred.

The paper also noted that savings from local depositors would likely be the largest source of capital. For the 100 largest MFIs according to MixMarket, savings was the first source of capital at 41 percent of all assets in 2005, whereas foreign capital provided 22 percent of funding. Yet, foreign capital investment did rise from USD 4 billion in 2006 from USD 1.6 billion in 2004, according to the Consultative Group to Assist the Poor (CGAP). Foreign capital derives from primarily two sources, IFIs and private microfinance funds known as Microfinance Investment Vehicles (MVIs).

Following this overview, the paper also detailed recent innovative structured finance deals, which applied of techniques commonly used in emerging markets. In particular, the paper summarized Blue Orchard’s 2006 collateralized debt obligation (BOLD-2006-1) which raised USD 99.1 million and brought mainstream investors, such as insurance companies and pension funds, into microfinance. Another deal was the creation of Global Commercial Microfinance Consortium mezzanine fund, which raised USD 80.6 million and allowed IFIs to take riskier positions, thereby encouraging private sector investment. Finally, the portfolio securitization of Bagladesh-based NGO BRAC raised USD 180 million, diversify its funding sources, reducing the assets held on its balance sheet, and saving the MFI 200 basis points over comparable bank funding.

With these new deals, investors must also identify and manage their risks. A panelist discussion identified six types of risks particular to microfinance and how to mitigate them. Risks were broken down into two categories, “controllable” and “uncontrollable”. Controllable risks included financial, operational, and market risks. Uncontrollable risks were regulatory, political, and foreign exchange risk. A study by two New York University professors also suggested that microfinance risks are countercyclical and can thus reduce portfolio volatility. As microfinance appears less correlated with macroeconomic indicators and other emerging asset classes, it could be an attractive diversification tool.

While recent microfinance structured deals have been limited to larger, more sophisticated MFIs, the paper also stressed the importance of financing smaller, newer MFIs which are often perceived as overly risky investments. To increase the number of MFIs that can receive commercial investment, conference participants recommended providing management training, using support from IFIs, using local presence, targeting funds for new MFIs, accelerating start-up operations, and connecting microfinance initiatives with health or environment efforts.

Clearly, significant challenges still need to be faced to build a mature microfinance market. In particular, mainstream investors will require frequent pricing information on investments, liquidity, and ease of access to information such as mainstream ratings. While microfinance has become a household name, investors will need to find ways to manage their risk as well as address the challenges above to truly crack the capital markets.

By Jennifer Lee

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