Micamericas

Apr 16, 2008

The Compartamos IPO: Pushing the Envelope on Doing Well by Doing Good

By Lucy Conger

The crowning achievement of commercial microfinance to date—the Initial Public Offering (IPO) in April of Mexican microfinance bank Compartamos—is not simply a success story. The most lucrative share sale in microfinance history also raised some fundamental questions about the mission of microcredit, the commercial microfinance model and the next generation of good practices for this growing industry.

The facts: on April 19, 2007, Compartamos sold just under 30% of its shares on the Mexican stock exchange for US$468 million. The offering was 13 times oversubscribed, and more than 5,900 institutional and retail investors in Mexico, Europe, South America and the United States bought the stock. The Compartamos IPO was the sixth such public offering in microfinance, and the one that provided the highest return to investors. ACCION International, the umbrella organization that partners with Compartamos, netted US$134 million with the sale of a 10% stake in the bank, half of the ACCION holding.

The sale allowed the original investors in Compartamos to reap a return of about 100% per year compounded over eight years, because the value of shares bought between 1998 and 2000 rose from US$6 million to US$126 million in December 2006, driven by the bank’s very high profits, according to a report by the Consultative Group to Assist the Poor (CGAP). The price paid to the existing shareholders who divested shares was 13 times the book value of the shares, ACCION reports.

The stunning success of the operation has sparked a heated debate about interest rates and the use of profits in microfinance as well as challenges about the use of donated money to enrich private investors and the balance that must be maintained between social and commercial objectives in microlending.

María Otero, president of ACCION International, a network of 35 micro-finance institutions that was an investor in Compartamos, defends the sale, citing the impact it may have on expanding financial services for poor clients. “I consider (those) resources the result of 25 years of work in Latin America, and we can invest the funds in Africa and grow the work in Africa faster, at a high quality level,” says Otero.

ACCION International will use the profit from the sale to expand microfinance operations outside Latin America, focusing on West Africa for expansion on that continent and investing in equity stakes in microfinance institutions (MFIs) in China, India and the Middle East/North Africa region. In addition, some of the funds will be spent to improve training in MFI management.

Mohammed Yunnus, Nobel prize-winner for his pioneering work with microcredit, had harsh words for the share sale. “When you are maximizing your profit, you are not looking at whether poor people are getting out of poverty,” he told a reporter for the Public Broadcasting System. He criticized Compartamos interest rates, which are in the range of 100%, saying that the only justification for rates that high is the profit motive.

The Compartamos IPO certainly puts microfinance institutions on the map, not only as sustainable organizations but as money-makers. The returns to be gained will light up the eyes of investors in the increasing numbers of funds specializing in microfinance equity. “The IPO improves the image of microfinance, and since there is a demand and few opportunities for investment in the shares of MFIs, the market will gradually regulate prices,” says Fernando Lucano, general manager of Cyrano Management, a specialized fund manager based in Peru.

Others are more skeptical about the impact of the IPO on investment. “Compartamos sets expectations too high but demonstrates that people should be able to get good returns,” says Sam Moss, president of Gray Matters Capital, an Atlanta-based -private equity fund that promotes microfinance infrastructure and services.

A host of microfinance specialists and ACCION International staff believe the price paid for Compartamos shares reached such a high level because of special circumstances in the Mexican market. “In Mexico, all the stars were aligned,” says Otero. She cites the favorable outlook for the Mexican economy, the lack of other IPOs on the Mexican securities exchange, the high profits and strong portfolio performance of Compartamos and the enormous growth of the bank’s client base, increasing by as many as 100,000 borrowers per year.

Compartamos also benefited from a characteristic particular to the Mexican banking system in general: high charges for client services and a lack of competition. “The IPO got such a high price because spreads are too high in Mexico due to the lack of competition,” observes Donald Terry, president of the IDB’s Multilateral Investment Fund (MIF). The IDB’s new scorecard on the business environment for microfinance, the Microscope, rated Mexico low for its level of competition, ranking it ninth among 14 Latin American and Caribbean countries.

There also was a severe scarcity of competing securities on the Mexican securities exchange, since only one other IPO had come to market in Mexico before the Compartamos placement, and in 2006 only three new issues were placed on the Mexican securities exchange.

The IPO process was set in motion when ACCION International, a leading shareholder, decided to cash out a portion of its initial US$1 million investment made in 2000. The World Bank’s private sector arm, the International Finance Corporation (IFC), the third largest shareholder, decided to join in the IPO “to contribute to the volume recommended by the investment banker and realize some of the gains in the investment,” says Manuel Reyes-Retana, IFC investment officer in the Mexico City office.

The bank Credit Suisse First Boston (CSFB) was hired as lead manager of the IPO on the international markets. After testing the waters in 54 meetings with bankers, the underwriter received an unusually high response: interest from 90% of potential investors. CSFB then determined the price for the offering of 30% of Compartamos shares should be US$1.56 billion. Banamex was lead manager for the portion of the IPO sold on the Mexican stock market.

The driver of Compartamos’s high profits—and its appeal to investors—was the high interest rates charged to clients. The interest yield (when adding in a 13% value-added tax) was about 86%, and the rate paid by borrowers was close to 100% in 2005, according to CGAP. From 2000 to 2006, Compartamos achieved an average return on equity of a hefty 52% per year.

That interest rate is low, says Chuck Waterfield, president of MFI Solutions, a microfinance business software provider and former adviser to Compartamos. He puts the Compartamos interest rate on loans to the poor women borrowers at 105% when calculated as an Annual Percentage Rate, or APR. The APR is an interest rate equivalent that reflects the actual cost of a loan by adding up the interest rate and extra costs such as the credit application fee and other charges related to the loan, including its duration. “They were making money hand over fist by lending to poor rural women; they then cashed out and stuffed their pockets,” says Waterfield, a critic of the Compartamos lending practices.

The interest rates “were considerably higher than what the company needed to cover its costs,” argues a CGAP study. The devaluation and recession of 1995 caused Compartamos to raise its effective annual interest rate above 100%—as did many other banks in Mexico at the time. Later, when inflation came down, Compartamos decided to maintain high interest rates in order to generate income that would allow it to finance rapid growth.

Lowering rates is a challenge for MFIs, says Carlos Labarthe, codirector of Compartamos. “At microfinance institutions, the issue of costs is not related just to operating costs, it is also a function of the small size of loans,” he said at an ACCION-sponsored workshop in San Salvador. As a result, MFIs must achieve scale because “with more volume, we achieve economies.” Moreover, they must diversify products in order to include larger loans such as mortgages and use credit bureaus in order to save on costly credit checking procedures.

Compartamos achieved very high profits, with an average return on equity of 52% in this decade, reaching a peak of 55.2% in 2005. The Compartamos rates of return ranged from more than double to more than 10 times the profits earned by all other types of MFIs, according to MIX Market and MicroBanking Bulletin statistics. The ROE outperformed all Mexican MFIs and consumer lenders and dwarfed the median ROE for Mexican banks of about 15%.

Those profits were put to work to fuel high growth. Compartamos more than doubled its client base in four years, growing from 26,700 in 1996 to 64,000 in 2000, and went on to increase the number of borrowers 10-fold, topping 616,000 clients in 2005. The average growth in this decade was 46% per year. Reflecting on the Compartamos high profits/high growth strategy, ACCION president Otero asks rhetorically, “The question is, could you grow it any other way?”

Bankers with long experience operating the commercial model of microfinance have doubts about the Compartamos high-interest road to growth. “Those who bought Compartamos are seeking very high multiples, assuming the market in Mexico is going to continue for many years with very little competition,” says Stefan Queck, general manager of Banco ProCredit in El Salvador.

ProCredit shareholders seek a 15% annual return, which frees it from the pressure of maximizing profit and allows it to invest more money in training local staff, he says. Profit margins of 10-to-15% are widely considered market-rate profits and could be made an industry standard, argues MFI consultant Waterfield.

A counterargument is that the demonstration effect of the Compartamos IPO will generate competition by drawing more investors into microfinance. “The IPO has attracted other entrepreneurs and financiers to the market, hence fostering competition and therefore benefiting the clients,” comments Reyes-Retana of IFC.

The Compartamos interest rates are still controversial, even if they were used for expanding access to microcredit for poor rural residents. “Compartamos made many market participants see the poor majority as profitable; that vision would be positive if accompanied by lower interest rates,” says Yerom Castro, vice president of banking supervision and popular finances at Mexico’s banking supervisory agency, the Comisión Nacional Bancaria y de Valores (“National Banking and Securities Commission”).

The high interest rate embodies a host of problems that are widespread in the microfinance industry, says Waterfield. Compartamos and many other microlenders charge a flat interest rate throughout the duration of the loan even while the loan balance is being reduced, a practice that allows MFIs to quote a lower interest rate to borrowers who don’t realize the full amount they are being charged. “We don’t have truth in lending anywhere outside the developed world; we are working in microfinance,” says Waterfield.

Compartamos should create a mandate for improving the information available to microfinance clients. Consumer protection agencies are needed to demand that interest rates be made transparent to the public and advocate for other client-friendly controls on microfinance transactions. In addition, financial education services should be provided to help borrowers select the financial services that are most advantageous for them, say industry specialists.

For donors to microfinance institutions, the Compartamos IPO both sparks applause and raises alarms. As a financial success story, Compartamos overshot the wildest expectations of any donor agency—and poses new questions about the role of donors. Donors give grants for microfinance and place no rules on the use of the monies or, in case they are invested, on how the profits are to be used. Waterfield has a proposal for the use of profits: take a percent of the profit and dedicate it to setting up savings accounts for the poor women borrowers who contributed to the Compartamos profits.


Sources:

ACCION International. The Banco Compartamos Initial Public Offering. Insight series, No. 23. June 2007. www.accion.org

Consultative Group to Assist the Poor. “CGAP Reflections on the Compartamos Initial Public Offering: A Case Study on Microfinance Interest Rates and Profits.”

Mix Market and MicroBanking Bulletin. (Cited in CGAP “Reflections,” ibid.). No. 14.




2006 RETURN ON AVERAGE EQUITY:
COMPARTAMOS VS. MEXICAN MFIs AND CONSUMER LENDERS

Sources: MIX Market, Mexican Banking and Securities Commission (www.cnbv.gov.mx).
Note: Consumer lenders (top two bars) lend mainly to salaried workers.
MFIs (bottom six bars) lend mainly to unsalaried microentrepreneurs.

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