COVID-19 and Microfinance: Managing Trouble with Restructuring

The COVID-19 pandemic, and measures in response to it, have hit investors, providers of microfinance and small and medium-size enterprise (SME) loans in developing and emerging markets, and the vulnerable people these providers serve, with unprecedented challenges. Relief and restructuring efforts continue. More innovation is needed. Exogenous events will occur with more frequency, including financial or currency crises, pandemics, climate change-related events like flooding, and earthquakes. What have investors learned from the current crisis? What can investors do to improve providers’ readiness for future crises?

COVID-19 restructurings to date

There has been a tremendous outpouring of goodwill from investors and investees alike during the pandemic. This is despite investors’ inability to travel to perform on-the-ground diligence, the strain that meeting virtually has placed on the trustful relationships needed to build consensus around financial restructurings and crisis responses, and the reality that people on all sides of the virtual negotiating table have faced unprecedented pressures.

Temporary measures, such as standstills and payment deferrals, were implemented early. Strenuous efforts are ongoing to amicably reach restructuring or rescheduling agreements that are fair to the providers of microfinance and SME loans (the investees) and their investors, and that support the survival of these investees. Many investees remain engaged in negotiations with international and local lenders and other stakeholders. However, historic and current portfolio performance data universally deemed reliable is scarce. Without an agreed base case, creating credible projections is challenging; parties struggle to gauge how much sacrifice is needed, whether upside potential exists and how burdens should be shared.

Investees and investors have little experience managing multiple extreme crises at once, particularly where a number of stakeholders with differing interests are involved. Trust can weaken or evaporate if investors doubt whether providers are being fully transparent. The existential question of whether providers are facing a liquidity issue or a solvency crisis haunts the parties. In some cases, borrowers have filed for local insolvency protection, which has slowed resolutions and increased costs and complexity.

Innovative approaches to restructuring have been deployed, though more traditional approaches to restructuring continue to be pursued. In many cases, stakeholders are frustrated with the amount of time the process is taking. We have not (yet?) seen cases where investors have simply walked away from a distressed project, even if the investee is in an insolvency proceeding. Especially when dealing with so many stressed cases, investors cannot justify complete write-downs to their investment committees and investors.

We have seen attempts by investees to sell their microfinance and SME loan portfolios, though it is a challenge to achieve credible valuations of portfolios and determine appropriate pricing. Some investees have been able to access additional debt or equity investments during the pandemic, but for distressed providers, this is particularly difficult. Approaches being explored include incentivizing principal payments with partial debt forgiveness, offering interest-free periods, and proposing conversions to subordinated debt, among others. However, the uncertainty of the data plagues all of the negotiations. The parties may need to take bold and pragmatic steps forward so the investees (and the investors) can get back to their primary businesses, rather than being mired in negotiations.

What have investors learned from these restructurings?

Here are some practical recommendations to consider that can help to move discussions forward more quickly:

• Share new tools and structures with those enmeshed in restructurings. COVID-19 has shown that past approaches to restructuring may not always be optimal, particularly in a global crisis. It has also revealed that investors and investees may not know of innovative solutions being employed by others. Finding ways to publicize alternatives could facilitate restructurings.
   
• Make technical assistance funds and resources on restructuring management skills accessible to investees. Lender groups frequently require investees to retain advisors to confirm data and assist with the design and implementation of restructurings. Investees resist due to cost (a legitimate concern) and fear of finger-pointing. Ensuring involvement of objective advisors with relevant skills vastly improves the likelihood of achieving viable restructuring plans, which, in turn, can preserve relationships between investors and investees.
   
• Bring all constituencies to the same table and share all relevant information. Negotiations rarely include both international and local lenders, the latter being a key source of new capital. When negotiations don’t include all relevant constituencies, negotiating a fair and universally accepted plan is tough. Investees may feel it is to their advantage to keep dealings with different lenders or lender groups separate. However, a viable plan is more likely to emerge if parties encourage an inclusive dialogue and promote transparency, including around issues such as the availability and terms of potential new debt or equity funding. Investors could help investees to implement strategies to encourage this kind of dialogue among interested parties and better manage relationships with multiple constituencies.

Taking what we’ve learned and improving readiness for future crises

This is an opportune moment to use what we have learned to enhance the process of making new investments, particularly if we want to contribute to the availability and sustainability of financial services for vulnerable populations. How can we increase the resilience of lower-tier microfinance and SME financial services providers in the face of exogenous events in the future? Here are three general sets of approaches that investors might want to consider when making and administering new investments to providers of microfinance and SME loans:

• When identifying operational, governance, staffing, management, business model and information technology opportunities and challenges, make sure to evaluate the issues through the lens of a potential crisis to highlight areas of possible weaknesses. Improvements and support in this context may include creating covenants and metrics, and if possible, providing funding for technical assistance so that investees are better prepared.
   
• At the inception of investment processes, emphasize the need for crisis management tools with investee teams. Investees need to focus on communication strategies for all stakeholders. Transparency is imperative to engender trust with stakeholders under all circumstances.
   
• Develop deeper relationships with other constituencies, including other investors (both international and local) and local governments and regulators. Confidentiality concerns need to be managed. Good relationships can contribute to amicable resolutions in challenging times.

Mary Rose Brusewitz is member-in-charge of the New York office of Clark Hill PLC and a founding member of the Impact Investing Legal Working Group. This post is part of the CGAP blog series, "Microfinance Solvency and COVID-19," which looks at key issues related to microfinance providers' solvency amid COVID-19 and explores ways forward for the sector.