Financing the Microfinanciers, How MFIs are sourcing capital -- joint BlueOrchard-UnitusEquityFund presentation 2009.03.19

Financing the Microfinancers How MFIs are Sourcing Capital Ann Miles Mar. 19, 2009

Financing the Microfinanciers How MFIs are Sourcing Capital Maya Chorengel Managing Director, Elevar Equity

Latent Microfinance Demand Total Investment Current supply Potential demand 100% = ~$17B Domestic Investment: ~$13B (vs. Foreign Investment: ~$4B)

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Source: McKinsey’s “Optimizing Capital Supply in Support of Microfinance Industry Growth” presented October 2006. Study drew upon 2004 data.

Commercially-oriented capital - has clearly stated financial objectives, but is largely funded by private donors, development agencies, and other such actors in the microfinance industry.

Development capital – aims to make capital available to MFIs through sustainable mechanisms to support their development and their growth without necessarily achieving financial return.

What are MIVs and how is the MIV market organized today?

MIVs provide fixed income and equity investments to MFIs. There are more than 90 MIVS in operation, many created in the last five years. These MIVs are managed by investment managers such as BlueOrchard, BBVA, Calvert Social Investment Foundation, Credit Suisse, Deutsche Bank, Developing World Markets, Microvest and Oikocredit.

CGAP, the Consultative Group to Assist the Poorest, classifies MIVs into the following peer groups:

Registered Fixed Income Mutual funds: generally subjected to standard compliance regulations (Luxembourg, the Netherlands and the U.S.); open through share subscriptions

Commercial Fixed Income Investment funds: generally closed limited partnership funds

Structured Finance Vehicles (active and passive): closed special purpose vehicles (ex. CLOs)

Blended Value funds: foundations and limited liability companies

Holding Companies of MFIs: invest only in MFI partners

Private Equity funds: closed limited partnership funds

Total assets under management in MIVs increased from $3 billion in 2006 to $5.5 billion in 2007. More than 75% of these assets are invested in microfinance. The remaining 25% are invested in cash, cash equivalents and small and medium enterprise institutions.

Please see CGAP MIV Benchmarking Report 2008

What are MIVs and how is the MIV market organized today?

CGAP’s MIV Benchmarking Report 2008 reported on 58 MIVs representing 86% of assets under management as of December 2007.

82% of MIVs are in Western Europe jurisdiction while 12% are in North America.

The top 5 MIVs reporting to CGAP accounted for 52% of total MIV assets under management, while two regions- Eastern Europe and Central Asia (ECA) and Latin America and the Carribean (LAC) received 76% of all MIV investments.

MIVs were primarily invested in fixed income instruments (77% of MIV portfolio) but equity investments (21% of MIV portfolio) were increasing. The remaining 2% is invested in cash and cash equivalents.

Investments are concentrated in large sustainable MFIs. The average top five investment exposures represented 43% of the MIV portfolio.

The average net return for fixed income instruments was 6.3% in USD or close to money market rates. The returns for Private Equity funds were 12.5% (gross IRR for 2002/2003 vintage years).

Please see CGAP MIV Benchmarking Report 2008

DATA: The numbers are still small

As of December 2007 assets under management for MIVs totaled $5.5 billion with approximately $850 million of assets invested in equity*

Average size of equity investment in December 2007 sample: $3 million for mutual funds and $1.2 million for actively managed structured finance vehicles

As of December 2008, there were 24 specialized microfinance equity funds with total assets of $1.5 billion**

December 2008 study tracked 144 equity transactions between 2005 and 2008 with a total equity value of $297 million and average transaction size of $2.1 million

* From CGAP September 2008 Report “CGAP 2008 MIV Survey Main Findings”

** From CGAP / JP Morgan February 2009 Report “Shedding Light on Microfinance Equity Valuation: Past and Present”

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Significant regulation required Little to no regulation required Level of Financial Integrati o n Equity Capital Markets Debt Capital Markets Deposits Donor or Concessionary Funding

Gradual process which is highly dependent on local factors and an MFI’s legal structure

Private Equity Commercial Loans

When are MFIs ready for Equity: Blue Orchard Slide Take 2 2 Table prepared by Unitus, Inc.

What Environments Best Fit Commercial Equity? 2

Regulatory environment - and political and economic environments - supports equity investments and shareholder rights

MFIs must be constituted as for-profit entities

MFI management teams must be “culturally ready” to accept investors

Implications for governance and board representation

Implications for transparency

MFI business plans must address creation of shareholder value in addition to other goals

MFI must address investor need for liquidity

Different Types of Equity Investors

Multilateral Institutions – DEVELOPMENT

Institutional development objectives guide investment targets and criteria

Invest larger dollar amounts in fewer transactions

Balance development objectives with financial performance

Reputation for being “bureaucratic” / “procedure oriented”

Social Investors – SOCIAL MISSION

Invest equity capital to support growth and outreach of MFI

Concerned with mission of MFI

More concerned with social return than financial return

Commercial Investors (passive and active) – IRR

Concerned with financial return and eventual liquidity

“ Active” investors are more “muscular” in terms of board representation and exercising shareholder rights to preserve and augment company value

Portfolio investors or backers of management teams

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Commercial Loans- Local Banks

Local banks play an important role in financing MFIs.

Indian banks have financed MFIs to achieve their priority sector lending targets; generally they secure their loans with a pledge of MFI loan receivables.

MFIs are able to access local currency funding.

Microfinance networks have helped to promote local bank financing by extending loan guarantees that provide first loss protection for the bank; ACCION and Grameen Foundation USA run successful ‘growth guarantee’ programs for their MFIs.

In times of diminishing liquidity, however, local bank facilities can be the first to dry up or to become more expensive (for ex. Bosnia).

The Role of Deposits in Financing Microfinance

MFI must have appropriate regulatory structure to mobilize savings.

Banks, credit unions and rural banks can mobilize savings; NGOs and NBFIs generally cannot.

According to the MicroBanking Bulletin, rural banks had the highest deposits to total asset ratio at 68% followed by credit unions, 58%, and banks, 35.6%.

In Africa and LAC, the deposit to loan ratio is > 50%, for the large and financially self-sufficient MFIs (number of borrowers > 30,000 and FSS is > 100%). This represents 109 MFIs in the MBB database and almost half of all FSS MFis (231).

Liquidity analysis of sight and time deposits is critical.

The Development of Debt Capital Markets for Microfinance

MFIs have issued bonds in their local markets with partial guarantee support from one of the development banks; there have been private placements, too.

Securitization has been done locally in Bangladesh and India.

Structured finance transactions (CLOs) have been done on a

global basis.

Challenges in the Current Environment 2

Supply of “equity investment ready” MFIs

Supply of equity, especially “responsible” equity capital

Equity capital markets

Valuation

Pre-crisis valuations of 1.3x – 1.9x book (historical) and 7.2x – 7.9x earnings (historical) will settle at what

To what extent was the rise in valuations in 2008 a demand/supply issue rather than an intrinsic value issue. Will there be down rounds and how will they be managed?