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Rating Agencies Put Microlenders under the Microscope

By Lucy Conger and Tor Jansson

 

Microlenders may walk like banks and talk like banks, but do they act like banks? To answer that question, specialized assessment firms and conventional rating agencies are plowing through the books of microfinance institutions to analyze their credit risk, reserve levels and operating procedures. As a result, detailed reports and standard credit ratings are available that can reassure development institutions and commercial funds that lend to or invest in microfinance institutions. The rating reports can also offer a measure of comfort for savers in the leading microbanks that receive deposits.

MicroRate, a pioneering organization in the field of independent analysis of microlenders, specializes in preparing detailed examinations of microfinance institutions. “We provide information for sophisticated investors who are interested in knowing where the microfinance funding goes,” says Damian von Stauffenberg, director and founder of MicroRate. The information allows investors, creditors and donors to track the performance of the institutions they fund.

Capital markets are signaling a growing willingness to invest in microbanks. The pioneers in this venture include ProFund and the Latin American Challenge Investment Fund, backed by private investors as well as development banks, which buy shares or take stakes in microfinance institutions. For these and other private commercial investors, the conventional credit ratings prepared by the international rating agencies, such as Standard & Poor’s, Fitch-IBCA and Moody’s, are invaluable tools for assessing the risk of an investment object. Ratings hold out many promises for microfinance institutions. “Rating is a great instrument to be able to raise funds on better terms and leverage my portfolio better,” says Eduardo Bazoberry, president of FFP Prodem, a specialized Bolivian financial institution with about $25 million in loans to microentrepreneurs. A good credit rating will open up new alternatives for microfinance institutions seeking to get investors to expand their loan capital.

By applying ratings to microbanks, Peru leads Latin America in putting microfinance under the microscope of conventional financial analysis. In the last three years, Peru’s cajas municipales, city-sponsored savings and loan associations, began requesting ratings. “It implied opening our minds because it was another experience,” says Elke Braun, financial analyst for Apoyo y Asociados Internacional, a Lima rating agency that is a partner of the international firm Fitch-IBCA. Previously, Apoyo had rated only commercial banks.

Braun has had some pleasant surprises in her examination of microlenders. In the loan portfolios of the stronger cajas, Braun saw the ability of microlenders to continue making loans successfully even while riding out an economic crisis. This tricky balancing act is made possible by the resilience of the microentrepreneurs who take out the loans. “Microentrepreneurs are very flexible, so if their business goes broke they are already thinking up another one,” she says. Risk tends to be well spread over the cajas’ portfolios—they can typically boast of a diversified group of savers, numerous loans, low default rates and coverage with high loan loss provisions. Compared with commercial banks, “the cajas seem to hold quite well in terms of loan arrears,” she continues (see graph).

Compared with banks, the cajas and other microlenders typically have a more intimate and detailed knowledge of their borrowers. “With cajas, the relationship is broader—they analyze the balances , visit the business and the family, see the family’s income and expenses and their state of health,” Braun says. In short, the caja loan officers verify the holdings of their clients through on-site inspections, which offer a good idea of their ability to borrow.

Still, weaknesses are inherent in serving a clientele of often vulnerable micro and small businesses. The activity of the cajas municipales is highly cyclical, reflecting the rhythms of the microbusinesses they finance. In Cuzco, lending is driven by tourism; in the northern coastal state of Piura, credits rotate with the agricultural seasons; and everywhere, the Christmas holiday and local patron saints’ festivals cause a spike in defaults. Loan guarantees are inadequate because the collateral offered is often used electrical appliances worth nothing in the market. Even so, default rates remain very low in the microfinance industry compared with the nonperforming loans in commercial banks.

Another point of vulnerability for microfinance institutions lies in the instability of savings among microenterprise clients. Cajas accept savings deposits, and about 70 percent of short-term deposits are held in U.S. dollars. Fewer than half of the loans are made in hard currency. The potential currency risk in this mismatch is minimized because most deposits are held for less than 30 days, while loan repayment periods average between 12 and 18 months, Braun says.

Cajas also compete with other handicaps. The cajas do not have an extensive network of branch offices, so they are unable to achieve economies of scale, and their operating costs are higher than those of commercial banks. Also, the cajas spend too much to get lending capital, paying high interest rates to development institutions.

Beating down borrowing costs and becoming eligible to receive deposits are the leading incentives for seeking a rating. The ultimate goal for microfinance institutions—being able to tap the capital reserves of Peru’s pension funds, a huge potential source of investment—would require achieving the high rating of A. Still, securing a B rating (B+, B or B-) for two consecutive years entitles microfinance institutions to be qualified by the Superintendency of Banks to expand their range of products and compete on a more equal footing with commercial banks in lending and in receiving deposits.

So far, only five of the 35 formal microfinance institutions in Peru hold ratings. These include three cajas municipales and two commercial banks. However, seeking ratings is expected to become a growing trend that will eventually reach many of the cajas and the non-governmental credit organizations that have recently converted to regulated institutions.While ratings hold much promise for microfinance, the process of rating an institution is not an exact science. For example, when Mibanco, a commercial bank specializing in microfinance, was first rated, Apoyo gave it a C+, a classification that implies that more loan loss provisions are needed. So Mibanco Director and General Manager Manuel Montoya, following a practice common among sovereign debtors, sought a rating from a competing agency, Equilibrium, which awarded it a B. “I’m trying to see that the rating nomenclature for microfinance be different,” he says.

As microfinance evolves, rating will act as a check on excess risks in the loan portfolios of microbanks. For example, if the cajas of the provincial capitals of Arequipa and Piura realize their plans to launch lending in Lima, their staff will need additional training and procedures and their ratings—which are reviewed every six months—could suffer, Braun cautions.

Microfinance institutions will become a growing source of business for the rating agencies. “This is our future,” says Oscar Jasaui, general manager of PCR, Pacific Credit Rating, Peru, the ratings operation that covers Peru, Bolivia and Ecuador. He sees the business expanding beyond rating microfinance institutions. At the Inter-American Development Bank’s sponsored microfinance forum in Barcelona, Jasaui talked with representatives of other organizations to gather ideas for his new project to develop a methodology for rating microbusinesses. That would refine even further the knowledge of risk in the portfolios of microfinance institutions.



Graph:
Balance of loans more than 30 days past due
(as percentage of loan portfolio)

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