Dr. Kendall Mau's MICROFINANCE TRAVELS

Regional Growth Hits a Brick Wall

The hot news in Central America is the closing of the largest micro-finance bank (BanEx) in Nicaragua.  The owners/investors did not inject the $32.0M of new capital needed to save the bank.  That's a large sum, but doesn't tell the whole story.  They did manage to pay off all their depositors.  However, when you liquidate a bank that's highly leveraged - lots of big loans from outside sources to supply the funds for the bank's loan portfolio - there may not be sufficient recovery or payback of outstanding client loans to pay off creditors in the end.  With delinquency running higher than 40%, rumors have mentioned around $100.0M in ultimate losses.  Ouch!!!

That micro-finance bank and maybe 2 others have the goal of expanding regionally because no one country in the region is supposedly large enough to support the desired high growth rate envisioned by the Board of Directors and outside investors.  BanEx was just starting its expansion strategy, beginning in Honduras, which has now fizzled.  A medium-size micro-finance bank in El Salvador wishes to do the same, but so far has only managed to acquire one entity in Mexico.  The surprising thing is the same investors found in BanEx financially back the other entities wishing to expand throughout Central America.  The largest Honduran MFI is crippled and up for sale.  It will be very interesting if said regional expansion strategy continues or abruptly comes to a halt for the remaining players.

I'm of the mind that politics had a lot to do with the liquidation of BanEx, but have no proof nor expertise to carry the argument.  Capitalist funds making money off the backs of the poor do not resonate as well as socialist funds supplied to help alleviate poverty.  

Guest and Invitation

We had a surprising guest and an unexpected invitation this month.

Annie, a graduate student in Canada spent a few days with us to observe and learn about micro-credit.  She was especially taken with the solar projects in Danli and Choluteca and how the recipients' lives have changed.  It's also great to show visitors how much we focus our efforts on helping the micro and small entrepreneurs.  It's a constant battle.  As an organization grows larger and eventually becomes regulated, there is serious attention paid by auditors and examiners to operating expenses.  One of the highest expense categories is personnel costs.  Having too many loan officers necessary to service small loans is not productive nor efficient.  In a larger organization with more funds, you can grant loans of $2,000 and above.  In a small micro-credit organization granting loans of $200 to $400, you can see that it would take 5 to 10 loans to equal only one in a larger outfit.  That's why some of the larger MFIs have left the field of micro-credit.

Thanks to organizations such as www.kiva.org and all its investors' support of micro-loans, we can continue to service this segment of society.  Without this help, we as an organization with limited resources would be hard pressed to continue our work.  Thank you, thank you.

Picture:  Susan Velasquez, Annie, President Lobo, Orbelina Valeriano, and Lucy Escoto

Well, on another note, Wednesday brought us a surprising invitation.  The President of Honduras, Porfirio Lobo Sosa, spent an hour with Orbelina Valeriano (Prisma President and GM of Prisma Honduras), Lucy Escoto (Office Administrator), and Susan Velasquez (Branch Supervisor), talking about micro-finance and the obstacles faced during the last few years and in the future.  In particular, they discussed the lack of credit facilities for small MFIs as the current banks and government funding affiliates are still channeling most funds towards the large MFIs.

Final Note:  Annie turned out to be the daughter of the President.  A complete surprise to us when she arrived at our office with her own security detail.  Not a problem - she was welcomed with open arms.

Jobs, Jobs, Jobs

It occurred to me that I haven't spoken about another aspect of microfinance that really helps the community.  Employment or Jobs!  Our company in Honduras offers 30 people full time employment with full benefits.  We help many clients to start businesses, but we also provide steady jobs which pay in the 50% to 75% quadrants of local market rates.

During my last visit the end of May 2010, I spoke with several happy employees who had recently received promotions after finishing their studies at local technical schools and universities.  Our cleaning person and our receptionist graduated in bookkeeping and both now work as Loan Processors.  The junior accountant just graduated from the university and assumes the position of Head Accountant.  Awhile back, the GM's secretary was promoted to Branch Supervisor and our best Branch Supervisor just became our company-wide Loan Manager.

One of our best branch supervisors graduated from the university in education and left the company for a teaching position.  However, we are glad to have given her full time employment to pay for her tuition and books as she worked her way through teacher's college these past 4 years. 

A Staggering Loss

I received an e-mail from Orbelina, GM of Prisma Honduras, this morning.  An article had appeared in the local Honduran newspaper covering the woes of the largest MFI in Central America.  The company lost about $26.0M for the fiscal year ending June 30, 2010.  Hard to even contemplate that an MFI established to help small entrepreneurs could get that far off base.  Very few MFIs have even a tenth of that amount in assets.

After the auditors analyzed the loan portfolio and the high delinquency rate, they established an assessment of $32.5M in new capital to bring the MFI's financials up to par.  This amount was in addition to the $10.0M in new money that had been assessed 6 months before.  At this point, no one knows if the investors will meet this demand or choose instead of walk away.

It got me thinking again.  Why do we need such big MFIs?  The usual reasons:  1) the larger you are the better chances that you won't fail; 2)  you can attract more private money with a big and going operation; 3) you can reach more people with better services and products; 4) the MFI will be converted to bank status and become regulated for the safety of all concerned; and 5) it's great for the egos of the board and general managers - size does matter.

On the other hand, it's hard to achieve the above:  1) in unstable political climates; 2) low population density countries where you have to pursue regional growth strategies to keep growing; 3) unforeseen world recessions; 4) regulations that force you to cut expenses to the bone forcing the MFI to let go of small loans under $500 and go after larger loans; 5) international investors seeking annual ROEs of 20% to30%: and 6) larger loans, larger write-offs when they go bad.  I'm sure there are a lot more pros and cons.  Please add to the list. 

Solar Energy on the Map

I just got back from a quick trip to Honduras and Nicaragua.  We have an exciting solar project in Honduras that was launched last year.  We have financed over 135 projects in villages surrounding Choluteca and San Lorenzo in the South West part of Honduras on the West Coast.  Electricity has yet to reach these areas.

The solar systems which are locally produced cost between $550 and $1,400 dollars depending upon power.  The little systems can run 3 lights and a small black and white TV.  The large systems can handle 5 lights, color TV, radios, and electric fans.  Various parties, including Prisma make it easy for villagers to purchase the systems.  Financing is as follows:

• The Interamerican Development Bank in conjunction with the Government of Honduras pay 30% of the initial cost of the system. They have also publicized the project with presentations in the villages and towns surrounding Choluteca and San Lorenzo.
• The villager puts down 10%.
• Prisma finances the remaining 60% over one to two year.

 

Some of the benefits the villagers find:

• Children can do some studying at night.
• Parents can do some work at night - for example, mending fishing nets and hand sewing.
• No longer have to use candles, kerosene lamps, nor the extra hot Coleman lanterns which generate lots of heat and pollute the air.
• Huge family gatherings when football season arrives.

 

The program is now moving into the Danli area.  I believe we have listed about 8 of these projects on Kiva during the last year. 

Scott's Summer of Microfinance

Download Scott Honduras

 

This is an article from the Smith Business School at the University of Maryland, College Park, MD.  Scott was our first undergraduate summer intern in Honduras in 2009.  He had a great experience as he relates in the article.  Enjoy.

We're offering the same internship opportunity for 2010.

Something to Hide - Repo 105 or 108

April 2010 is almost gone and I haven't posted!  Been busy filing taxes for various companies and partnerships.  However, the Lehman Brother's non-transparent use of Repo 105 has been in the news lately.  I was wondering if any MFI in our industry has used this same technique to enhance its current published financial numbers.  Repo 105 allows a company to temporarily transfer a big chunk of its bad assets - delinquent and potential write-off loans - off the books.  During the temporary period, about one year, the company can publish its financial statistics showing a good P&L and Balance Sheet.  Potential investors and creditors only see the good if not aware of the use of Repo 105.

This is what I imagine would happen if an MFI uses Repo 105 or 108.:

 

• An MFI would sell its delinquent and ready-for-write-off loans to a shell company in another country.
• The shell company is funded by investors who are most likely also investors in the MFI through loans and/or equity, possibly a holding company.
• The sale money is used to lower liabilities - pay down loans from banks, investors, and so forth. This makes the MFI look good on the balance sheet and hides the level of delinquency and write-off potentials.
• The modified balance sheet is published at the end of the fiscal year.  The P&L also takes a smaller hit for provisions for possible loan losses - this non-cash expense is charged as part of the expenses and lowers the net income.  All the financial numbers will look good for one year as reported to the rating agencies. 
• The MFI then gets immediately to work. It borrows new money (hopefully it has enough credibility to land new loan money) to buy back the original loans sold to the shell company. The cost of such a transaction which is paid in Step 1 - Repo 105 is 5% of the total portfolio of loans sold while Repo 108 is 8%.
• The MFI essentially buys a year to fix the delinquency problem without the public knowing what's going on.
• I assume that if the one year is not enough time to rectify the problem, Repo 105 can be used again and again.

I'm sure there are other variations to the process I imagined above.  However, if you are a potential investor in an MFI, it would not be unreasonable to ask if said institution has any Repo 105s or 108s hidden in its financial portofolio.

Kiva Looking for More Honduras Partners

February/March 2010 has been "Honduras visiting time" for Kiva representatives.  We also have our third intern from Kiva for a few months.  I received an e-mail from Orbelina, President and GM of Prisma Honduras, telling me that she invited the Kiva reps to an association meeting to make a presentation about the wonders of Kiva partnership.

With the political turmoil the last 9 months and funding having disappeared, local MFIs have been struggling to find alternate funding sources to the traditional banks, government funding, and European funds.  They were excited to hear about Kiva and its program.  Of course, with a little competitive spirit entering the picture, they were also surprised to know that Prisma Honduras has been participating in the program for several years, enjoying all the benefits, and not letting them know about it.

Several local MFI managers have stopped by our offices to take a look at how the program works.  I suspect that the presentation will have been very fruitful for Kiva.

Speaking at UC Berkeley Haas School of Business

Last week I spoke to a class of about 25 undergraduate business students at the Haas School of Business at UC Berkeley.  Two main topics that we covered:  1) how to establish a for-profit private MFI; and 2) careers in the micro-finance industry.  We only had one hour to get through a lot of material.

We spent the first 30 minutes on the ins and outs of what it took to establish Prisma Microfinance in Central America - funding, human resources, legal, operations, loans, sales and marketing, delinquencies, defaults, and the high cost of delivering micro-credit. 

During the second half, we covered academic preparation in accounting, finance, foreign languages and marketing.  This was followed by areas of opportunities for internships, global micro-capital funds, and where jobs are posted.

It was fast, but rewarding to spend some time with bright young students and the chance to donate some time and expertise to my alma mater - UC Berkeley.  Go Bears!!!!  Thanks to Emily, Nikita, and Tiffany for the invitation.

After the class I walked over to the Bancroft Hotel across from the campus to attend a late reception and dinner for Ann Veneman, Director of UNICEF and former Secretary of Agriculture.  The event was sponsored by the Goldman School of Public Policy.

The Costs of Equity Investors

In the last post I wrote about the high cost of borrowing money for loan capital.  In this post, I'll cover the expectation of high returns of equity investors for private for-profit MFIs.

MFIs which are not allowed to accept client savings get their loan funds from two sources - borrowed money and equity investors.  Most borrowed money works in the form of lines-of-credit or interest only loans with the total return of principal at the end of the loan.  There are other variations.

The equity investor is different.  The investor takes shares in the MFI and invests money for the medium term.  The expectation is that the MFI will earn enough net income to show a ROE (Return-on-Equity) of 20.0% to 30.0%  per year over 5 years.  Another variation is that after 5 years, the MFI will go public or a buyer will be found who will pay the investor a return of 100.0% to 150.0% over his/her initial investment.

As you can see, the MFI is put under severe earnings pressure to cover the interest on borrowed money and/or make a high ROE for investors.  Another reason why it costs so much to deliver micro-credit services.