PAPER WRAP-UP: BRAC Micro-Credit Securitization Series I: Lessons from the World’s First Micro-Credit Backed Security (MCBS), by Ray Rahman & Saif Shah Mohammed

Written by Ray Rahman and Saif Shah Mohammed of MF Analytics Ltd., a US financial services house focused on microfinance and small-and-medium enterprise (SME) that participated in the world’s first microfinance securitization, released March 2007 by MF Analytics, 22 pages, available at: http://www.microfinancegateway.com/redirect.php?mode=link&id=45785

Background & Risks

In August 2006, the world’s first securitization of micro-credit receivables, known as BRAC Micro Credit Securitization Series I, was secured. It signaled the birth of the Micro-Credit Backed Security (MCBS), a new instrument seen as a source of funding for microfinance institutions (MFIs) and designed to be relatively safe for investors. The project partnered MF Analytics with BRAC (Building Resources Across Communities), Bangladesh’s largest non-governmental organization (NGO), which operates an MFI and programs for healthcare, education, and social advocacy.

At the time, BRAC could use a new channel for financing, as traditional channels were looking less appealing. Donor funding was volatile, lending from the country’s central public-private microfinance partnership would have unpalatably required that BRAC lower its interest rates, and syndication financing was too expensive. Securitization would allow for a more efficient balance sheet, improve BRAC’s asset/liability management, reduce leverage, increase BRAC’s investor base, and allow for a higher rating of the security than of BRAC itself. Indeed, when it was finalized, the security received Bangladesh’s first-ever AAA rating, from an affiliate of Moody’s Investors Service.

The road to securitization, though, required patience amid regulatory foot-dragging. Both the central bank of Bangladesh and the U.S. Securities and Exchange Commission (SEC) were periodically unresponsive, sometimes wavering, and highly demanding of information or structural changes before final approval came down in June 2006.

MF Analytics, which carried out data analysis and structured the transaction, also had to face numerous issues before proceeding with the BRAC securitization. Because the organization is spread vastly across an underdeveloped country, the transmission of data involves a time lag between local offices and the head office, data often become missing or unusable, the availability of historical data is inconsistent, collection dates are not constant, and a uniform definition of loan default is difficult to apply. In quantifying risks, then, MF Analytics decided to focus on two variables: borrower location and activity type (i.e., loan age and size). Also taken into consideration was the risk of loan prepayments, which could affect the regular inflow of cash down the line.

Security Structure

The security was eventually structured as such: BRAC would be the Originator and Servicer. The Investors would be FMO of the Netherlands, Citibank of the U.S., and two local banks – Pubali Bank and the City Bank. The transaction would be equivalent to USD 180 million and would be divided into 12 equal tranches issued over six years. The Originator would sell USD 15 million in micro-credit receivables on a monthly basis and additional receivables as collateral to the special-purpose vehicle (SPV). The SPV would in turn issue one-year certificates or bonds in the amount of USD 15 million, backed by the receivables and collateral, to the Investors. Importantly, credit enhancements – including overcollateralization of pools, conditional pool replenishment, and the excision of risky loans – would help mitigate risk.

Conclusion

After six payment dates on the first tranche had passed, the paper revisited the transaction to assess performance. It found that during that time, delinquency rates never deviated alarmingly from normal, even though minor political turmoil occurred at one point. The SPV remained awash in liquidity; much of this was attributed to overcollatoralization and, to a lesser extent, other credit enhancements that kept the cash flowing.

Looking forward, it appears there are a few lessons to learn. First, an important risk to consider in the future is that of the Servicer going out of business, which would require a new entity to enforce collections from borrowers. Second, future structurings will depend on improving borrower risk profiles. A fuller understanding of borrower histories would better inform the structuring of securities, and this information could also be shared with other MFIs so they could launch their own securitizations. Third, MFIs should work to minimize time lag and information disconnects between local offices and the head office by integrating new technologies (e.g., the Internet and mobile phones). This can lower risk for investors and improve MFIs’ cash flow management practices. Finally, the securitization process at BRAC has shown another incidental benefit: such a process of inspection and requisite forthrightness by the organization involved increases its transparency and accountability.

By Stephen Son

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