ACCION

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Securitization of Microfinance Credits the Next
Frontier?
Rahul Desai VP, Financial Markets
Services ACCION International October 2007
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What is Securitization?

• Securitization is a process in which assets
  (typically loans or receivables) are transferred
  from the originator to a special purpose vehicle
  (SPV), often in the form of a trust.
• The SPV is bankruptcy-remote, which means that
  its assets will not be consolidated with those of
  the originator in case the latter goes bankrupt.
  This kind of transfer is called a true sale.
• The SPV issues bonds for which the loans or
  receivables serve as collateral These bonds are
  sold to institutional investors through an
  intermediary investment bank. The proceeds of the
  bonds are paid to the originator.
• In order to achieve the desired credit ratings on
  the bonds, credit enhancement can be provided by
  a variety of internal and external mechanisms
  (e.g. subordination, overcollateralization,
  financial guarantees).
• The trust would enter into an agreement with the
  issuer to collect payments and administer the
  trust assets for a specified servicing fee. This
  income is used to pay interest and principal on
  the notes and any guarantee premium.

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Securitization Transaction Diagram
Stage 1 - Issuance
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Securitization Transaction Diagram
Stage 2 - Operation
Financial Guarantor
Premium
P I
P I
SPV (Trust)
Institutional Investors
Originator (Financial Institution)
Servicing Fee Excess Spread
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Brief History of Securitization

• The first securitization took place in 1970 when
  the Government National Mortgage Association, a
  US government entity, issued securities using
  government guaranteed residential mortgages as
  collateral. In the late 1970s two
  quasi-government agencies, Fannie Mae and Freddie
  Mac, began to securitize conventional mortgage
  loans originated by banks and other financial
  institutions.
• Later, financial institutions began to securitize
  their own mortgages using credit enhancement
  techniques. The U.S. mortgage securitization
  market is now comparable in size and liquidity to
  the U.S. Treasury market.
• As the market became more comfortable with
  securitization, financial institutions began to
  securitize other kinds of assets commercial
  mortgages, trade receivables, auto loans and
  leases, student loans and credit cards.
• Securitization has now spread to Europe, Asia and
  Latin America.

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Securitization in Latin America

• Securitization has been growing rapidly as a
  capital raising instrument in Latin America in
  recent years, with more than 400 transactions
  issued in local markets in 2006, totaling
  approximately US16 billion.
• Approximately 20 of these were real estate
  related transactions (residential mortgages,
  commercial mortgages or residential construction
  loans), 30 was traditional ABS including
  consumer credits, auto loans, trade receivables,
  credit card receivables and bank loans, and 12
  future flow transactions.
• The largest domestic markets in 2006 were Mexico
  (US6.5 billion), followed by Brazil (US5.3
  billion), Argentina (2.4 billion) and Colombia
  (US1.1 billion). The dominant categories were
  residential mortgages in Mexico, auto loans in
  Brazil and consumer loans in Argentina.
• Different Latin American countries employ
  different SPVs for securitization - trust-like
  fideicomisos (Argentina, Mexico, Colombia, Peru)
  the FIDC, which is a kind of investment fund
  (Brazil) and the patrimonio separado (Chile), a
  special securitization company.
• Source Fitch Ratings

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Typical Mexican RMBS Structure
Hipotecaria Su Casita RMBS Nov 2006
Assets
Liabilities
100
100
Low Income Residential Mortgages
85.1 11.5
- mx AAA Senior Bonds
- mx A rated Mezzanine Bonds
- Unrated Residual Certificates (3.4)¹
¹ Initial level 1 building up to 3.4 through
capture of excess spread
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Characteristics of Assets that can be Securitized

• While new asset classes continue to emerge, the
  basic principles to assess whether an asset can
  be securitized remain constant.
• Known loss rates based on historical information
  on default and recovery rates
• Predictable cash flow based on historical
  experience
• Realizable value of underlying collateral
• Diversification of assets in the pool (borrowers,
  geographical regions, industry)
• Supporting information systems infrastructure to
  provide data and track performance

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Benefits of Securitization to Issuer

• Efficient Means of Funding
• Lower cost funding relative to traditional debt
  alternatives because underlying assets may have
  higher credit quality than originator.
• AAA tranche can usually be structured through
  credit enhancement
• Risk Reduction
• Allows for transfer of credit, interest rate and
  prepayment risk in portfolio to investors?
• Generates risk-free fee income from continued
  servicing of assets
• Provides match funding for the assets
• Benefits to Financial Statements
• Transfer of assets off balance sheet lowers
  leverage and enhances borrowing capacity
• Frees up capital for future portfolio growth
• Improves financial ratios (ROA, ROE)
• ? Originator may retain top portion of risk in
  securitization

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Constraints to Securitization of Microfinance
Credits

• Given the issues most MFIs face with respect to
  funding, securitization could be to their great
  benefit but has been very challenging for the
  following reasons
• Transaction Size. Securitization, particularly
  the first time, can be very expensive for MFIs
  and involves paying legal, accounting, rating
  agency, registration and placement fees. To
  justify the costs and reap the benefits of a
  securitization program, MFIs must generate
  sufficiently large portfolios to securitize on a
  regular basis.
• Investor Reporting. As originator and servicer of
  the loans, MFIs must compile detailed
  descriptions and payment statistics on the loans,
  both at issuance and afterwards. This often
  requires an investment in MIS systems.
• Correlation between Originator and Credit
  Performance. Performance of microfinance loans
  depends on high levels of close interaction
  between the borrowers and officers of the
  originating/servicing institution. As such, it
  is almost impossible to separate the risk of the
  loans from the risk of the institution. Despite
  credit enhancement, rating agencies will give
  bonds backed by microfinance credits only a 2-3
  notch upgrade above the institutions own rating,
  limiting the benefit in terms of lower funding
  cost.

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The BRAC transaction appears to constitute a real
breakthrough.

• BRAC is largest MFI NGO in the world serving 5
  million mostly women members in Bangladesh.
  Average loan per borrower is 165
• In 2006, BRAC successfully initiated a
  securitization program that will provide it with
  US180 million of financing over 6 years.
• This was the first local currency AAA-rated
  microcredit securitization in the world, with the
  national scale rating provided by the Credit
  Rating Agency of Bangladesh.
• The bonds were 150 collateralized by micro-loans
  but there was no other credit enhancement.
• The investors in the first issuance of 15
  million were FMO directly, Citibank Bangladesh
  with a guarantee from FMO and Citibank itself
  along with two local banks. Citigroup arranged
  the transaction.
• BRAC achieved reduced funding costs vis-à-vis its
  alternatives.
• How was this possible?
• BRACs portfolio is of sufficient size to absorb
  transaction costs
• The initial pool was selected with sophisticated
  software that seeks to replicate the
  characteristics of the overall portfolio
• BRAC is a superior servicer with daily
  reconciliations of collections, but what about a
  back-up servicer?

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Whereas the ProCredit Bulgaria Transaction is
more questionable

• In May 2006, ProCredit Bank Bulgaria (PCB)
  securitized 47.8 million of its Euro-denominated
  loan portfolio The initial pool consists of 1,286
  loans, and the average loan size is 15,000.
• Credit enhancement for the Note consisted of a
  subordinated loan equal to 5.05 that was
  purchased by ProCredit Holding (PCH). PCH also
  provided a guarantee facility to cover certain
  risks up to 6.6 of the Note balance.
• Fitch rated the Note BBB on the international
  scale, which is two notches above the rating for
  the bank itself (BB). The European Investment
  Fund and Kfw provided additional guarantees to
  further enhance the credit rating.
• The Note was bought by a conduit administered by
  Deutsche Bank, which also arranged the
  transaction.
• PCB acts as servicer of the collateral but upon a
  downgrade of PCB, the bank is obliged to
  establish a hot backup servicer.
• Are these really microfinance credits or SME
  loans?
• With DB as arranger and buyer and the heavy
  credit enhancement is this really a guaranteed
  loan rather than a securitization?

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What Has to Happen for Securitization of
Microfinance Credits to Take Off?

• Larger institutions with larger portfolios to
  securitize or combination of portfolios of
  similar institutions
• Better MIS systems for portfolio tracking and
  monitoring
• Establishment of consistent underwriting
  standards and collection procedures
• Development of standardized servicing contracts
• Availability of high quality back-up servicers
• Better understanding of product by rating
  agencies and institutional investors
• Most likely places in Latin America for
  microfinance securitization to happen? Bolivia
  or Peru.
• ?Proposed by Sharon Stieber, innovations/winter
  and spring 2007

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THANK YOU !