SVMN: MicroRate, Damian von Stauffenberg (April 11, 2007)

The April 11, 2007 meeting of the Silicon Valley Microfinance Network featured Damian von Stauffenberg from MicroRate, a rating agency that specializes in microfinance institutions. I ended up missing the first half of the talk, but was interested in what he had to say. After much cheerleading from the press, and the increased attention from Yunus and Grameen's Nobel award, von Stauffenberg sounded a note of caution. There have been some microfinance critics that oppose microfinance on it its own terms (that it doesn't do enough or works only in conjunction with other programs, works only for certain groups, unfairly profits from poverty, etc.) but von Stauffenberg's take was different: not that it didn't work for the borrowers, but that there was greater risk for the lenders than we were currently acknowledging.

Calling the industry's 40% annual growth a limit, given the institutional capacity, he said "We're in the seventh year of seven fat years." He quickly added that he wasn't necessarily predicting a crash next year, as timing any market is nearly impossible. This recent period of financial growth and stability has permitted nearly everyone in the market to do well. "Economic cycles haven't ended," he warned. When conditions change, those weaker performers or those that have overreached will run into difficulty. "We will see failures. It's only a question of how large and how soon."

His talk wasn't all doom and gloom. "We ain't seen nothing yet. The demand is so huge that even if we dream wild dreams, we will exceed them." Only the private sector can satisfy the demand for capital. There is a risk, he felt, that public (international financial companies) money could be "crowding out" private funding. Public money does have a role, but it's not in funding the established, successful MFI's that could be attracting private money. Too often, he said, the public money wins the deal by offering sweeteners, like technical assistance grants that the successful MFI's don't really need. Instead, the public money should be helping establish more MFI's as successful ones, ready for private money. They should be making the "5-hour journey" to the out of the way places that haven't yet made it on to the private money's map.

He talked a bit about the key cost components of the MFI's:

1. Operating costs
   
2. Cost of Capital
   
3. Loan loss provision
   

With relatively little flexibility in #2 or #3, and downward pressure on market interest rates (due to competition and regulation) MFI's are struggling with reducing costs, which causes them to move upmarket, into small business loans (at the $1,200-1,500 range). This is actually a different market, where the businesses have fixed assets and fixed costs, and therefore less flexibility, so are at greater risk for non-payment when hard times hit.

He talked a bit about the methodology that MicroRate uses to evaluate MFI's, looking at factors like:

• microfinance operations, including their methodology
  
• portfolio quality
  
• management and operations
  
• governance and strategic positioning
  
• Financial Position
  

He noted that the "optimal repayment rate" varied from country to country, where a top-performing institution in Columbia might have 1-2% of its portfolio at risk (30 days or more late) while in Peru, 5-6% would still be seen as OK.

He talked about some coming trends and risks. As a result of more competition among MFI's, credit is more widely available, and some borrowers have become over-indebted. Without a credit bureau and strong identification systems, it's difficult to prevent borrowers using one loan to pay off another. (Indeed, he even related an anecdote where a similar scheme was run in collusion with the branch level MFI officials to try to maintain "healthy" portfolio-at-risk metrics in tough economic times.) A second risk he mentioned was that of MFI's overreaching. He noted that the leverage trend is clearly up, which gives the organizations less leeway in operations. Third, populist politics and the desire of politicians to be seen as protective of the poor sometimes induces them to impose rate caps that make it uneconomic to provide microcredit. (Though he also noted that in Latin America especially, where those laws are on the books, they are routinely ignored.) Finally, he noted that economic conditions (political stability, high liquidity, low inflation) can't continue forever. For lenders, especially the Microfinance Investment Vehicles (MIV's), he rattled off another set of risks: an oversupply of foreign funding (between 2005 and 2006, the level of funding from these MIV's roughly doubled from $1B to $2B.); lack of transparency, benchmarks, and independent performance evaluation. The returns that are offered, he said, really don't match the risk incurred (until those factors are mitigated.)