Funding Microfinance: An Analysis of Emerging Financial Models

1
Funding MicrofinanceAn Analysis of Emerging
Financial Models

• A Review for the Indian Banks Association

2
Agenda

• Introductions
• Project Overview
• Conclusions
• Recommendations
• Financial Models
• Remittance Securitization
• CDFI Financial Model
• US Mortgage Securitization Model
• Review of Recommendations

3
Introductions

• International Executive MBA
• Georgetown University McDonough School of
  Business
• Kent Bonham
• Celeste Diaz Ferraro
• John Gray
• Brian Saal
• Virginia McMullan
• Javier Varela
• Dr. Reena Aggarwal, Advisor

4
Project Overview

• Research began by analyzing the U.S. mortgage
  market and U.S. CDFI system to identify factors
  relevant to success in capital generation for
  microfinance
• After assessing weaknesses in transferring these
  models to India, the Georgetown team chose to
  also investigate remittances as a capital
  generation model that has greater short-term
  opportunity for success in India

5
Conclusions
6
ConclusionsRemittances

• Trend toward increased efficiency, competition
  and developing technology.
• Large market potential.
• Attractive conduit for cross-selling other
  financial products.
• Securitization of remittance flows is a viable
  and attractive mechanism for generating capital
  for microfinance.

7
Conclusions U.S. CDFIs

• Without strong government pressure on banks as
  well as significant incentives for investment,
  CDFIs would cease to be attractive or, in some
  cases, profitable investment vehicles.
• Even with significant government assistance,
  CDFIs in the US took 10 years to reach todays
  operating standards.
• CDFI experts indicate that the timeframe for
  industry maturity is approximately 20 years,
  even with significant government and banking
  industry support.

8
Conclusions U.S. Mortgage Market

• The U.S. secondary mortgage market works due to
  several factors
• The extremely large market size provides instant
  liquidity and provides significant for large
  institutional investors
• Investor community has strong familiarity with
  this asset class and perception of risk has been
  erased over time
• Perception by financial community of implied
  government guarantee

9
Recommendations

• Offer remittances through top-tier MFIs.
• Top-tier defined by MFIs who have either
  obtained a credit rating from CGAP or have
  demonstrated investment-worthy accounting
  practices, management competency and operational
  transparency.
• Cross-sell remittances with other financial
  products to grow customer base.
• Securitize remittances, building on previous
  pioneering works of ICICI in India.
• Use future remittance cash flows as collateral
  for microfinance loans.
• Jointly lobby for Fannie/Freddie-style government
  incentives.
• Jointly lobby for CDFI-style government
  incentives.

10
Remittances

• Expanding Microfinance
• Through New Product Offerings
• While Increasing Capital Through Securitization

11
Remittances Global Market Trends

• Shift from informal to formal, professional
• Consolidation and partnerships
• Competitive environment
• Greater segmentation
• Proliferation and increasing levels of technology
• Securitization
• Stability of Remittance Flows

12
Remittances Demonstrated Long-Term Stability

• IMF Balance of Payments Statistics for Developing
  Countries

13
The Indian Remittance MarketBackground

• 126B worldwide, over 25B to South Asia (2004)
• India largest in the world for remittance
  receipts
• Stability of remittance flows
• Diaspora in U.S., migrant workers in Middle East
• Large number of domestic migrant workers

14
The Indian Remittance MarketBackground

• MTOs such as Western Union
• Informal channels - hundi
• Current Bank products
• Post Offices

15
Remittances Potential for Microfinance

• Leverage existing relationships with MFIs
• Cross-sell additional product offerings
• Package
• Savings
• Potential to reach more customers
• Increase MFI credit ratings
• Domestic remittances

16
Remittances Ecuador Case Study

• Banco Solidario alliances with Spanish savings
  banks
• Remittance services complement other products
• Credit
• Savings accounts - part of remittances can be
  blocked off for future purchases or to service
  existing loans

17
Remittances Haiti Case Study

• Microfinance NGO Fonkoze offering a range of
  services including savings, microloans, currency
  exchange
• Agreement with City National Bank of New Jersey
  (CNB)
• Remittances through Fonkoze account at CNB
  transferred to Haitian bank
• Successes cross-selling other services,
  increasing volume of microloans

18
Remittances Additional Global MFI Case Studies

• MFIs are providing savings and micro credit based
  on remittances in Bulgaria, Serbia, El Salvador,
  Ukraine, and Bosnia
• Use remittances to leverage more funds in the
  commercial markets to finance lending operations

19
Remittances Global Securitization

• Ongoing access to funding, new investor base
• Leverage remittance flows to productive purposes
  through financial intermediation of banks
• Include top tier MFIs, geographical diversity

20
Remittance Securitization Turkey Case Study

• AKBank TAS - structured finance deal of US 400
  million by securitizing its foreign currency
  denominated present and future remittances.
  Followed by additional advances
• Recently Ambac financial group provided
  financial guarantee insurance and its AAA rating
  to 350M in notes backed by AkBanks offshore
  remittances

21
Remittance Securitization Peru Case Study

• Banco de Crédito del Perú (BCP) raised 100
  million in January 2001 with its first-ever bond
  backed by securitized electronic transfer payment
  instructions. ING Baring's Latin America was the
  organizer of the Banco de Crédito transaction
• BCP was first bank to introduce electronic
  transfers as a new asset class for future-flow
  securitizations.
• The bank receives annually close to 3 billion in
  electronic transfers
• BCP arranged with its five major correspondent
  banks JP Morgan, Citibank, Bank of New York,
  Bank of America and Standard Chartered to flow
  securitization through a special purpose vehicle
• ING structured the deal as a sale of BCP's
  existing and future rights to the dollar
  payments, so the receivables are no longer owned
  by BCP but transferred to the SPVfor the benefit
  of the certificate holders.
• MBIA guaranteed the timely payment of interest as
  well as payment of the principal on maturity.

22
Community Development Financial Institutions
23
CDFI Profile

• Community Development Financial Institutions are
  private sector financial institutions that
  solicit capital from public and private sources
  and channel it via their various services into
  specific underserved communities
• Financial resources are provided through
• Provision of financial services, loans, and
  investments
• Offering training and technical assistance
  services
• Promoting development efforts that enable
  individuals and communities to effectively use
  credit and capital

24
CDFI ProfileCharacteristics

• CDFIs are categorized by services offered and
  lending portfolio focus. Common categories
  include home loans, consumer credit, enterprise
  funding.
• Loans are far and away the tool most used by
  CDFIs, with 98 of all financial outstanding, or
  8.3 billion.1

1CDFI Data Project, FY 2003 Publication
25
Regulatory Environment Catalyst for CDFI Growth

• 1994 creation of CDFI Fund
• Initial 382 million allocation over 4 year
  period
• Paid out over 700 million to date
• 55 million slated for FY 2006
• 1995 revision of Community Reinvestment Act (CRA)
• Government subjects lenders to evaluation under
  CRA
• Up to 5 of deposits must be allocated to
  community development initiatives for maximum
  compliance
• Rating impacts banks abilities to accept
  deposits
• CDFI investments qualify as CRA activity

26
CDFI Profile Operational Model

• CDFIs act effectively as an intermediary
• The flow of capital is predominantly loans
• This model relies on government incentives for
  success

27
Regulatory Environment Federal Incentives for
Banks

• Bank Enterprise Award (BEA)
• Monetary award given directly to banks to offset
  investments in CDFIs
• New Markets Tax Credit (NMTC)
• Credit given against Federal income taxes
  initiated in 2000
• Totals 39 of the cost of the investment and is
  claimed over a seven-year credit allowance period

28
CDFI-Investor RelationshipMotivation for Bank
Investment

• Gain access to intermediary with stronger
  expertise
• Technical support for customers
• Lower administrative and marketing costs
• Reduce bank portfolio and operational risk
• Enter new markets
• New target audiences
• New geographic markets
• Product or loan type offerings

29
CDFI-Investor RelationshipThree Primary Investor
Objectives

• Surveyed some of the U.S. largest commercial
  investors in CDFIs
• Banks Bank of America, Wells Fargo Bank,
  Citibank
• CDE funds managers Community Reinvestment Fund,
  Calvert Funds
• Commercial investors tend to have three common
  goals
• Compliance with Community Reinvestment Act
• Market return on investment
• New market development

30
CDFI-Investor Relationship Three Primary
Investor Objectives

• Community Reinvestment Act Compliance
• Banks must invest in all communities where they
  have presence or accept deposits
• Banks are limited by human and capital resources
• CDFIs can reach multiple areas more efficiently,
  helping banks achieve maximum ratings while
  covering broad geographic areas

31
CDFI-Investor Relationship Three Primary
Investor Objectives

• Market Returns on Investment
• Banks must commit 5 of deposits to CRA
  investments
• Many development activities are unprofitable and
  often classified as charitable or marketing
  efforts
• CDFIs, particularly New Markets Tax Credit
  investments, can be profit generators and meet or
  exceed standard commercial investment parameters

32
CDFI-Investor Relationship Three Primary
Investor Objectives

• New Market Development
• Working through CDFIs provides banks an
  opportunity to instill brand awareness and
  loyalty among new customers
• Long-term capacity building grows the overall
  market by creating new customers in underserved
  areas

33
CDFI-Investor RelationshipInvestor Strategies

• Market development
• Technical assistance and community education
  programs
• Homeownership and financial responsibility
  courses, small business outreach, etc.
• Management and technological exposure to CDFI
  similar to training for MFIs
• Typically viewed as charitable or marketing
  efforts (cost centers)
• Direct investment in local CDFIs (Bank Enterprise
  Award grants)
• Factors in selecting CDFIs comparable to
  screening MFIs
• Management ratings
• Efficiency and market returns
• Target audience and customers (loan and funding
  types)
• BEA award reduces losses on marketing investments
  but does not completely offset expenditures

34
CDFI-Investor RelationshipInvestor Strategies

• Financial Return
• NMTC investments provide banks with commercial
  rates of return
• Minimize risk and reduce administrative expenses
• Banks utilize same assessment tools and processes
  to evaluate CDFIs as commercial investments
• Banks can dictate CDFIs underwriting guidelines
• Banks do shoulder greater risk in NMTC than other
  tax programs

35
CDFI-Investor RelationshipBank of America case
study

• Bank of America background
• U.S. largest bank and largest CDFI investor
• CDFI investments make up 10 of all Bank of
  Americas community development budget
• Currently have 350mm invested in NMTC with a
  commitment for another 256 million in 4th round
  (2005)
• Risk assessment and return on investment
  requirements
• BoA applies similar risk and return evaluation
  processes to both commercial and NMTC investments
• Commercial vs. NMTC repayment rates 98.1 vs
  97.8
• Commercial vs. NMTC ROI 8-10 vs. 7-8 5 tax
  credit (total 12-13)
• Additional risk assigned internally to CDFI
  investments (generally 2-3 additional cost of
  capital), not by demonstrated market performance

36
CDFI-Investor RelationshipEvaluation for Future
Investment

• Commercial investors still evaluating the
  long-term profitability of CDFIs
• CDFI Data Project launched by government in 2004,
  initial results in 2005. Standardized data
  collection for all CDFIs to enable more
  transparent evaluation of performance.
• Horizon for assessment of commercial return on
  investment
• Banks have 3-4 years initial data on NMTC
  investments, will need 3-4 additional to gauge
  overall return on investment.
• It will take an additional 8-10 years of data to
  conclusively evaluate CDFIs as reliable
  investment vehicles.

37
CDFI-Investor RelationshipLessons Learned

• Its taken 10 years (1995-2005) of government
  assistance and concerted commercial investment
  for CDFIs to gain acceptance as investment
  vehicles.
• Without continued strong government pressure on
  banks as well as significant incentives for
  investment, CDFIs would cease to be attractive
  or, in some cases, profitable investment
  vehicles.
• CDFI experts indicate that the timeframe for
  industry maturity is approximately 20 years,
  even with significant government and banking
  industry support.

38
Fannie Mae / Freddie Mac and the U.S. Mortgage
Industry
39
Fannie Mae / Freddie Mac US Mortgage Market

• Securitization of the US Mortgage Market
• Federal National Mortgage Association (FNMA or
  Fannie Mae) created by US Government in 1938,
  authorized to purchase federally insured
  mortgages
• Became self-sustaining private company in 1968,
  operating on private capital
• Currently operates under congressional charter,
  focuses on availability of funds for low to
  middle income families to purchase homes

40
Fannie Mae / Freddie Mac US Mortgage Market

• Purchase mortgages from primary lenders
  stabilizing the availability of mortgage credit
• Pool the mortgages and resell as securities
• Securities earn smaller but constant differential
  between the yield on pooled mortgages and payout
  to investors
• Capital requirements are lower

41
Fannie Mae / Freddie Mac US Government
Regulations

• Fannie and Freddie benefit from arrangements with
  the Federal Government
• Each has a line of credit with the US Treasury up
  to 2.25 billion
• The US Federal Reserve has the authority to buy
  their debt
• Potential to act as a bail out
• Exempt from state and local income taxes on
  profits
• Exempt from SEC securities regulation
  restrictions

42
Fannie Mae / Freddie Mac Market Model
US Government (Guarantor)
Freddie Mac Fannie Mae
Investors
Brokers and Banks
Borrowers

• This model generates large amounts of capital and
  reduces risk
• Risk is distributed among many investors
• Key elements government guarantee, established
  credit systems, large market size

43
Conclusions (Again)
44
ConclusionsRemittances

• Large market potential.
• Attractive conduit for cross-selling other
  financial products.
• Securitization of remittance flows is a viable
  and attractive mechanism for generating capital
  for microfinance.

45
Conclusions U.S. CDFIs

• Without strong government pressure on banks as
  well as significant incentives for investment,
  CDFIs would cease to be attractive or, in some
  cases, profitable investment vehicles.
• Even with significant government assistance,
  CDFIs in the US took 10 years to reach todays
  operating standards.
• CDFI experts indicate that the timeframe for
  industry maturity is approximately 20 years,
  even with significant government and banking
  industry support.

46
Conclusions U.S. Mortgage Market

• The U.S. secondary mortgage market works due to
  several factors
• The extremely large market size provides instant
  liquidity and provides significant for large
  institutional investors
• Investor community has strong familiarity with
  this asset class and perception of risk has been
  erased over time
• Perception by financial community of implied
  government guarantee

47
Recommendations (Again)

• Offer remittances through top-tier MFIs.
• Top-tier defined by MFIs who have either
  obtained a credit rating from CGAP or have
  demonstrated investment-worthy accounting
  practices, management competency and operational
  transparency.
• Securitize remittances, building on previous
  pioneering works of ICICI in India.
• Cross-sell remittances with other financial
  products.
• Use future remittance cash flows as collateral
  for microfinance loans.
• Jointly lobby for Fannie/Freddie-style government
  incentives.
• Jointly lobby for CDFI-style government
  incentives.