I was invited to attend the London conference on July 8th as a member of the board of the Microfinance Club of New York, courtesy of the organizers Hanson Wade. The sessions and subsequent discussions were very professional and highly information. The event drew 120 participants from European banks (Standard Chartered, a sponsor), microfinance investment funds (Blue Orchard), and MFIs from India and Africa. The speakers were all key microfinance practitioners.
Some highlights from the presentations:
- Gavin McLean from White & Case noted that the investor base in microfinance is growing due to the social investment sector and the familiarity with microfinance as an asset class is gaining momentum. He also noted that investors are turning away from overly complicated structured products and want less complex investment vehicles. Furthermore, there are changing regulations in the EU that will make it more attractive for investments. For example, there are new capital requirements where originator/sponsor of an instrument must retain 5% sake in the transaction, and securitizations will play an important part in microfinance where most deals are in the US $100 M - $150 M range.
- Nick O’Donohoe, Global Head of Research at JPMorgan noted that benchmarking is key to determining valuations; by knowing your subsector, it can drive a premium or a discount. MFIs have a double bottom line driven by both social and financial objectives and he is skeptical the approach can optimize a risk adjusted return. While the social impact can be measured, the double bottom line may cause higher cost structures while also attracting cheaper funding. IRRs for equity funds is 15-20%. In the emerging markets they are more typically 30-35%. So, there is a need to make a tradeoff. Higher lending rates charged by MFIs vs. traditional banks explains higher margins. The top 45 MFIs charge interest rates of 24.4% on average, (except Comportamos with 68.5%), while emerging markets are at 6.1%. Comparisons also noted, as follows: Operating costs: MFI banks=14%, EM banks= 10.9%. Leverage (equity to asset ratio): Top 45 MFIs=19.4%; EM banks=10.9%. Lower default rates of MFIs (due to frequent customer contact) results in better asset quality. Valuations are determined on price/book value and price/earnings ratios, transaction size (investors pay more for higher stake) and income growth. Projected 2009 valuations for EM banks average 18x earnings, as compared with LIFI’s 14x earnings. LIFIs have outperformed traditional banks: Since Sept. 2008, LIFI Index stands at 120 vs. 66 for traditional banks.
- Christian Speckhardt of responsAbility (Zurich) has US$800 million under management, mostly in MF debt and equity; invested in 200 MFIs globally. Cost of debt has not increased much, although credit margins have widened in the fall of 2008. FX volatility can have great impact on cost of debt if not hedged. Refinancing rates are expected to be low. Many MIVs are sitting on cash (20-25%), and there are still inflows into MIVs, and can invest in 350 MFIs at present. While there are some US$30 million in redemptions, some US$100 has flowed into the fund. He noted that if MIVs can be defined as asset class, then more money will flow in.
- Chuck Waterfield, CEO & Founder of Transparency noted that some activities are now blurring the line between moneylending and microfinance. Non-transparent pricing creates a money imperfection, impeding competition and consumer choice. Should a $100 that costs $200 to operate be made to a microfinance borrower? He cited the President Obama initiative that calls for simple, transparent and accurate information for borrowers/consumers.
- David Fitzherbert, MD of Grassroots Capital Management noted the firm invests strictly in MF equity with exit projections of at least 5-7 years. They are invested in 45 MFIs in 25 countries. To date, they have undertaken 13 exits with an average return of 30% (based on Grassroots’ calculations). Their IRR target is 25% at MFI level with exit valuations of 2.5 x book value. Basic IRR model is driven by growth rate and exit assumptions; and operating costs. Also, social performance is critical to Grassroots and they monitor social indicators (e.g. running water, construction materials of house, access to sanitation. Further noted that investors want to see measurable social returns.
Discussion: The MFI industry has a balance sheet of US$200 billion, which will grow. There will be more IPOs; commercial banks will start investing in MFIs (MIVs) as will other financial players. Reinsurance players are interested in MF, they are already selling insurance products. Nick noted that concern for investors is whether industry can grow and credit quality as well as political risk addressed to mitigate investor concerns. Xavier noted tat valuations have not gone down since the financial crisis started, but credit quality and incomes at MFIs are declining. There are pools of money which are interested in investing in MFIs. Valuations are still good in Tier 2 & Tier 3. While no dividends are paid, MFIs can generate cash in years 5-7; but they should re-invest in accordance with their social mission.
The conference also afforded good opportunities to speak with other participants, such as Brian Cox of MFX Solutions who noted that the firm has secured $13 million to manage global currency risk for the microfinance industry, using modern hedging instruments. I also spoke with Inci Yalman and Hande Yazman of Stand Chartered, which is actively supportive of microfinance, adding value to both investors and MFIs, especially given its reach in developing markets. Ms. Yalman and Yazman would like to connect with the MFCNY for possible future collaboration.
The organizers will be holding Microfinance for Institutional Investors conference in Washington DC on September 21-23, 2009.
Clara Lipson
Indepedent Consultant and Board Member, Microfinance Club of NY
Note: More information on conference available at: http://www.hansonwade.com/events/investments-in-microfinance/index.shtml
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