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68 Sanjay Sinha
Annex: Ratings Directly Financed by Donors/MFIs
Country MFI Rating financed by .. Purpose
Bangladesh Ashrai SDC Novib
BURO Tangail DFID SDC
loan fund & operating cost: Deter-mination of investment in loan fund and operating cost subsidy
creation of special purpose funds
Shakti Foundation SDC provision of guarantee
Cambodia
India
Indonesia
CEB, EMT TPC
RGVN – Orissa 8 MFIs
ASA Trust DCCB Bidar SHARE Spandana Shepherd
BASIX SEWA Bank
3 BPRs
MPDF CGAP
Hivos
FWWB-USAID CGAP
Ford Foundation SEWA Bank
USAID
Asia Foundation
fund raising
financing loan fund and operating cost cross-verification
benchmarking and fund raising
fund raising benchmarking
demonstrate utility of rating to banks
Ganesha Found’n Hivos loan fund and operating cost Pokmas Mandiri
Ysn Mitra Usaha
Bina Swadaya
Kazakhstan Kazakhstan City Loan Fund
Cordaid
Hivos
loan fund and operating cost, fund raising
(1) loan fund and operating cost
(2) graduation to commercial funding
Myanmar Grameen Trust UNDP loan fund and operating cost GRET
PACT
Nirdhan Utthan Bk CECI-CIDA NSSC
RRN VYCCU
Pakistan Urban Poverty CGAP Alleviation Project
benchmarking, demonstrate utility of rating to banks
benchmarking
Philippines ARDCI CGAP CRBBI
NWTF TSKI
benchmarking fund raising
Sri Lanka
Timor-Leste
SEEDS CGAP Moris Rasik Hivos
Institute for ADB Microfinance TL
benchmarking
loan fund and operating cost
benchmarking
CHAPTER 4:
MFI Equity: An Investment Opportunity for the Broader Public?
Kylie A. Charlton
Vice President – Capital Markets, Unitus
Introduction
Microfinance institutions (MFIs) provide financial products to the economically active poor (EAP), a market segment underserved by mainstream financial institu-tions. Traditionally, credit in the form of livelihood (or business) loans has been the focus for MFIs. In recent years some MFIs have extended their product offer-ing to include savings accounts, home improvement loans, education loans and a range of insurance products.
Having the EAP as their target market, MFIs have been largely confined to governments and international donors for funding. MFIs have been unable to ac-cess the broad range of funding available to mainstream financial institutions from the debt and equity capital markets. Despite this limitation microfinance has proven to be an important, financially sustainable, even profitable instrument for economic development when sufficient capital is available in combination with sound business practices. However, continued dependence on capital from gov-ernment and donor sources will prevent the microfinance industry from closing a supply-demand gap estimated at 420 million people and an annual demand for capital of between $2.5 billion to $5.0 billion1 (de Sousa Shields and Frankiewicz 2004). The ability of MFIs to attract large amounts of new capital on a commer-cially sustainable basis, without an erosion of their original development goals, is critical to the future growth and success of the microfinance industry.
This chapter explores one aspect of the capital dilemma faced by the microfi-nance industry: the role of equity investment from the broader public. Equity is the cornerstone on which regulated, for-profit MFIs can build sustainable liability structures to support growth. Many parallels can be drawn between the investment opportunity presented by equity in early stage or “second generation” MFIs and private equity, or more precisely venture capital. Microfinance investment funds
1 All figures are in US dollars unless otherwise stated.
70 Kylie A. Charlton
(MFIFs) focused on equity investment in second generation MFIs present a poten-tially attractive investment opportunity not dissimilar to that of emerging market venture capital funds. The corollary is that such MFIFs appeal to niche investors. The challenges faced by MFIFs across the investment lifecycle in part mirror those of emerging market private equity funds, but are in some respects unique. Despite these challenges, MFIFs are increasingly taking ownership in MFIs around the world, providing clear evidence of a continuing evolution of microfi-nance away from philanthropy towards a sustainable commercial industry.
Role of MFI Equity
Portfolio growth and increasing the number of clients served depend on an MFI’s ability to generate retained earnings and attract external capital. Since the mid-1990s, internal capital sources have expanded beyond the traditional charitable grants or subsidised debt. Many MFIs are beginning to seek commercial debt and private equity. This transition reflects two changes. First, the microfinance indus-try recognises that retained earnings and traditional funding sources cannot satisfy the long-term funding requirements of MFIs. Second, the well-publicised success of a number of MFIs that have transformed from not-for-profit organisations to regulated, for-profit financial institutions is changing investors’ perception of microfinance from that of charity to a profitable commercial venture.
The current universe of MFIs structured as regulated, for-profit institutions is limited. A study commissioned by the Council of Microfinance Equity Funds2 identified a total of 124 regulated, for-profit MFIs in the developing world, inclu-
Table 1. Regulated, for-profit MFIs in the developing world
Regions No. of MFIs No. of MFIs Total Assets Gross Loans Number of Total Equity Identified Providing (USD (USD Clients (USD
Sufficient millions) millions) millions) Information
Latin America & Caribbean 47
Eastern Europe
& NIS 25
Asia 24
Africa & the 28 Middle East
TOTAL 124
35 1,032.4
21 874.5 17 248.7 19 335.9
92 $2,490.8
826.7
377.3 130.2 214.4
$1,548.6
965,668 159.5
145,988 82.7 1,077,808 47.8 706,839 76.7
2,896,303 $362.6
Source: Kaddaras and Rhyne (2005)
2 The Council for Microfinance Equity Funds is a group of 19 private equity funds with joint social and financial missions that invest in MFIs (www.cmef.org).
MFI Equity: An Investment Opportunity for the Broader Public? 71
ding nine government-controlled institutions (Kaddaras and Rhyne 2005). A signifi-cant increase in this number is expected as three trends accelerate: (1) “upgrading” or transforming not-for-profit MFIs into regulated, for-profit financial institutions, (2) “downscaling” or the entry of mainstream financial institutions into microfi-nance services, and (3) “greenfielding” or founding new MFIs as regulated, for-profit financial institutions.
Equity is the critical cornerstone for regulated, for-profit financial institutions. Equity is required to meet the minimum capital requirements set by the local cen-tral bank. Moreover, equity provides the capacity to: (1) leverage an institution’s balance sheet through debt, mezzanine debt and quasi-equity instruments; and (2) mobilise local savings. Together, equity, debt and savings deposits form the essen-tial components of a sustainable liability structure that over time can be fully inte-grated into international and local capital markets and substantially increase MFIs’ access to capital and thus their ability to expand outreach to target clients. Diversi-fication across these funding sources will lower MFIs’ cost of funds.
Equity’s expansionary role is as important as its role in corporate governance. Equity entails ownership: shareholders’ active presence at the board level influ-ences the strategic direction and ultimate performance of an MFI.
Second Generation MFIs: A Subset of Private Equity?
“Private equity” denotes investment in illiquid, unregistered securities of firms. It describes all venture, buyout and mezzanine investing. This chapter focuses prin-cipally on venture capital and the many parallels it has with investment opportuni-ties presented by second generation MFIs. “Private equity” and “venture capital” are used interchangeably.
Venture capital bridges the gap between the sources of funds for innovation (chiefly corporations, government bodies, an entrepreneur’s friends and family or “angel investors”) and lower-cost sources of capital available to going concerns. Venture capital funds typically:
• Invest in high-growth industries at the middle of the classic industry S-curve when companies begin to commercialise their innovations;
• Support rapid growth in portfolio companies (that is, companies represented in an investor’s portfolio) by dedicating funding to building these companies’ infrastructure in ways that drive and sustain growth;
• Provide equity finance and also add value through active participation in the management of portfolio companies;
• Seek some control over portfolio companies by, for example, taking an equity stake large enough to buy a board seat or to reserve the right to replace management;
72 Kylie A. Charlton
• Realise returns for investors through exit mechanisms such as a trade sale, management buy-back or initial public offering; and
• Thrive when invested in illiquid, difficult-to-value firms in environments with substantial uncertainties and information asymmetries.
Successful private equity transactions occur when market inefficiencies are identi-fied and exploited. This can mean searching for sectors lacking capital, investing in misperceived or out-of-favour industries and asset classes, identifying companies with significant franchise value, barriers to entry and other competitive advantages, or taking advantage of government or tax policies that skew the risk/return trade-off decidedly in favour of investors.
The microfinance industry is characterised by factors that would typically at-tract private equity. First, as noted above, microfinance is estimated to have a substantial supply-demand gap and an annual demand for capital of between $2.5 billion to $5.0 billion. Second, there is a wide misperception that microfinance is nothing more than a philanthropic endeavour. Few in the global investing commu-nity are aware that some MFIs have attained self-sufficiency and are profitable, providing strong returns on assets and on equity, while performing better than commercial banks operating in the same market (Tucker and Miles 2004). Third, favourable regulatory changes in many countries are creating environments that promote microfinance.
Start-Up Early Stage Growth Later Stage Mature
•Friends & Family •Grants
—Bilateral and Multilateral Financial Institutions —Philanthropists
•International Financial Institutions •Private Public Partnerships
—Procredit
Subsidized Debt
•Nascent Debt Capital Markets —Compartamos Bonds —Blue Orchard CLO
•Nascent Public Equity Markets —BRI
Local Commercial Debt
Micro Finance Investment Funds (MFIFs)
Size
MFI Lifecycle
Sources of Traditional Corporate Financing
•R & D Budgets —Corporate —Government —University
•Friends & Family •Angel Investors
VENTURE CAPITAL •Mezzanine Debt •Buyout
Time
•Buyout
•Public Capital Markets —Debt
—Equity
Start-Up Early Stage Growth Later Stage Mature
Fig. 1. Comparative typology of financing sources
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