Microfinance

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GLOBAL INVESTOR FOCUS Microfinance—30 Securitization of microloans Providing commercial funding for microfinance banks means developing a financial product that can attract mainstream investors. Refinancing microfinance banks by securitizing microloans has significant potential to generate numerous benefits for both investors and microfinance banks. Philipp Jung / University of St. Gallen Mike Imam / Credit Suisse 1 A special-purpose vehicle (SPV) is an instrument specifically designed for the respective transaction. It is not actively managed, but administered by a trustee that strictly follows the documented procedures. The securitization principle … The securitization of balance-sheet assets is one of the key innovations introduced by banks in recent years. In such transactions, illiquid assets (e.g., loans) can be converted into tradable capitalmarket products. For originators (owners) of such illiquid assets, securitization can be an instrument to tap capital markets for funding purposes – and to free-up regulatory capital as assets are transferred off balance sheet. The terms of the funding mainly depend on the quality of the assets to be securitized: i.e., on the expected losses. Generally, a portfolio of assets is transferred from the balance sheet of an originator (e.g., a bank) to a special-purpose vehicle (SPV) 1 . For refinancing and compensating the originator for the asset transfer, the SPV issues notes (asset-backed securities) to investors. The SPV repays interest and principal of the issued notes to the investors out of the cash flow of the acquired assets. These notes often include separate classes of different seniority, meaning that losses in excess of the most junior tranche are absorbed by the subsequent tranche and so on. Consequently, the most senior tranches bear only a relatively remote possibility of being affected by defaults in the underlying reference portfolio. … applied to microloans Microloans have a strong potential to be established as a new asset class for securitization transactions. In spite of the oftenabsent collateral for backing microloans, default rates have consistently been at low levels, and the excess spread is significant. Securitization of microloans refers to a transaction in which an SPV buys (parts of) the microloan portfolio of a microfinance bank. The microfinance bank will still act as servicing entity (i.e., the microloan borrower is not affected by the sale). All proceeds of this asset transfer to the SPV are paid to the microfinance bank, which also keeps an equity tranche (the so-called first loss piece) of the SPV. The first loss piece (FLP) provides incentives for efficient servicing of microloans, while allowing the microfinance bank to still participate in the revenues of the loan portfolio it has sold. This participation in the cash flow of the microloans is nonetheless subordinated to the payments to the investors in the SPV (interest and principal of investor notes). Due to this structure, investors are exposed only to limited credit risk, which is reflected by a corresponding rating of the respective investor note. Existing securitization transactions … This concept of securitization of microloans has not been seen in the market as such. However, in a somewhat revolutionary move, Blue Orchard structured a transaction that first applied the securitization principle to microfinance institutions. Several bonds issued by microfinance banks were repackaged and sold to capital markets. A similar structure was later also applied by Deutsche Bank Foundation’s Global Microfinance Consortium and others. This has marked the beginning of linking capital markets with microfinance banks. Noteworthy is, however, that such transactions do not represent securitization of microfinance banks’ assets (microloans), but of bonds issued by microfinance banks and held by an intermediary.
GLOBAL INVESTOR FOCUS Microfinance—31 … and how to further develop them The Swiss State Secretariat for Economic Affairs (SECO) is currently financing a feasibility study that is supported by Credit Suisse and other institutions such as the European Investment Fund (EIF) and MicroRate (a rating agency specialized in microfinance institutions). For the first time, this project aims at setting up a platform enabling securitization of the actual assets (microloans) of microfinance banks. The platform could provide a structure that mitigates the political risk through diversification and sophisticated insurance mechanisms, pools microloan portfolios of different originators, and provides standardized procedures and documentation. The transaction is structured to apply a direct securitization principle: meaning that individual microloans are directly securitized (and not a portfolio of bonds issued by a microfinance banks). The benefits of such an approach are potentially lower funding costs for microfinance banks (due to the asset isolation of the microloans), regulatory capital relief effects for microfinance banks and correspondingly increased loan volume, and direct integration of microfinance banks in global capital markets. In other words, mainstream investors are offered a structured product that is ultimately backed by microloans, but can be viewed as a conventional securitization transaction, in which the investor buys rated notes and is paid a corresponding spread – a private-sector approach that could strongly increase commercial refinancing for microfinance banks. Hence, an initial pilot transaction should be implemented at some time. æ Figure 1 Simplified structure of the concept Source: Credit Suisse, University of St. Gallen Asset side Capital market side Microfinance bank (asset seller) proceeds (funding) SPV (asset buyer) proceeds Investors microloan portfolio sale of microloans investor notes loan-servicing agreement cash flow generated by microloans
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Microfinance

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