Microfinance Area Feeling Credit Heat:
Microfinance institutions expanding, but some are tweaking strategies due to stale CDO and CLO markets

A $130 loan from a microfinance lender enabled Fatouma Dijbril Issifou to buy vegetables in bulk, and then resell them at a higher price in her hometown in the West African nation of Benin. The $2 she now makes on a bushel of carrots has changed her family's life.

The subprime mortgage crisis is a world away from entrepreneurs like Issifou but it has hurt some sources of funding for lenders who, for example, relied on the sale of collateralized loan obligations (CLOs). At the same time, though, the microfinance industry hopes the crisis won't affect their lending too much.

"Microfinance institutions (MFIs) have been growing quickly despite the international liquidity crunch and credit spread increases," says Brad Swanson, partner at Developing World Markets, speaking at a conference "Microfinance Cracking the Capital Markets III" sponsored by Credit Suisse and ACCION, a microfinance lender, last week.

Microloan borrowers are not tied closely to international markets. However, if there is a prolonged downturn, it will eventually hurt MFIs, warns Swanson, whose company, a fund manager and investment bank, uses the capital markets to help find money for sustainable development. MFIs are "not uniquely shielded and can't continue to operate that way if the US goes into a recession," he says.

The microfinance industry provides financial services to innovative entrepreneurs in developing regions, such as Africa and Latin America, that otherwise would not be able to receive access to the mainstream financial services market. The market is gaining traction thanks to international financial institutions (IFIs) and microfinance investment vehicles. Typically, microfinance investment vehicles (MIVs) have under $20 million in assets under management, with the average totaling $1 million. There are now over 80 microfinance investment vehicles with over $3 billion in assets under management. The level reached $2 billion in 2006.

Between 2004 and 2006, foreign capital investment, both debt and equity, more than tripled to $4 billion, according to Consultative Group to Assist the Poor (CGAP).

The latest investors eyeing MFIs include private equity investors that focus on emerging markets. Blackstone Group, Carlyle Group and Sequoia Capital are among the PE heavyweights to back the MFIs with investments of between $20 million and $40 million.

Andrew Pospielovsky, chief executive officer at Bank of Azerbaijan, a microfinance bank, revealed at the conference last week that he has been affected by the subprime crisis.

Some collateralized debt obligations (CDOs) issued by microfinance funds have been cancelled or delayed. While others have been successful, "we are now trying to keep a thick pipeline of deals," says Pospielovsky. Additionally, the bank is diversifying its funding base, deposits and increasing capital, he says.

That said, he believes "MFIs are developing as an attractive asset class for investors seeking good returns, clear risk structure and double bottom line returns."

Morgan Stanley, meanwhile, has shifted its microfinance efforts in the wake of the credit crunch. The bank has a dedicated microfinance team of 12 employees based in London and New York to provide services for depositors, IPOs and corporate advisory.

When Morgan Stanley first started in the market in 2006, the business was focused on arranging CLOs that, by providing five-year loans, "seemed to be creating an incredibly useful product for microfinance," says Ian Callaghan, head of the microfinance institutions group at Morgan Stanley, who was not a speaker at the conference. "The typical loan period that MFI's were seeing was up to 18 months that resulted in MFIs dealing with a dozen or more banks to meet their needs," says Callaghan.

In 2006, Morgan Stanley issued BlueOrchard Loans for development, the first microfinance-backed CLO transaction arranged by a Wall Street investment bank. The $99.6 million deal funded 21 MFIs in 13 countries.

However, CLO deals have been more difficult to complete due to challenging market conditions resulting from the subprime crisis. So, Morgan Stanley's group has since shifted its focus and is looking to create new products with some initiatives set to launch later this year, says Callaghan who declined to elaborate on the initiatives.

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