By Annie Brown, Assistant Editor, Microfinance Focus, May 8, 2011: This year the International Association of Microfinance Investors (IAMFI) released a paper entitled Charting the Course: Best Practices and Tools for Voluntary Debt Restructurings in Microfinance for public distribution. Charting the Course seeks to promote best practices for the workout among co-creditors of MFI debt. The study was sponsored by Morgan Stanley – an IAMFI board member – and focused on lessons learned from difficult times. IAMFI’s research equips micro-creditors with the tools and practices they need to grow while avoiding bankruptcy in order reach the more than three billion people living on less than U.S. $2.50 per day.

Executive Director at IAMFI Joan Trant and Vice President of Global Sustainable Finance at Morgan Stanley Bryan Wagner were kind enough to speak with Microfinance Focus over-the-phone and answer some questions about debt restructuring and the value of Charting the Course to the microfinance industry. As our phone interview began, Trant and Wagner introduced themselves and their organization's respective roles in the research process.

IAMFI is a non-profit research group as well as “a global membership organization dedicated to helping current and potential commercially oriented microfinance investors achieve their financial and social goals,” Trant explained.  Eligible members include financial institutions, foundations, asset managers and service providers who are interested in market-driven microfinance investment to list only a few examples. Members benefit from IAMFI's objective research, educational events, and facilitation services.

Although IAMFI is forming a 501(c) (3) public charity “to spearhead a comprehensive research program focused on building industry infrastructure, to increase the sustainability of microfinance,” the 2011 paper on debt restructuring, Charting the Course, would have been impossible without financial support from Morgan Stanley.

In order to avoid financial crisis in the microfinance sector, a relatively new industry built on human need, IAMFI enlisted the support of researchers, investors, industry leaders, and understandably, one of the oldest financial service providers in the United States. Charting the Course interested Morgan Stanley’s socially conscious investors. “This report is a response to strong interest from our clients to understand the impact of the global financial crisis on the microfinance sector as well as the ways in which the microfinance community is collaborating to address any financial difficulties,” said Bryan Wagner representing Morgan Stanley’s Global Financial Group. 

The Global Financial Group at Morgan Stanley focuses on sustainability and economic opportunity. It “leverages Morgan Stanley’s capital markets expertise to support business models that generate commercial, social and/or environmental returns,” Wagner said.

When the financial crisis occurred in 2008, many microfinance experts believed that the industry would have difficulty repaying their debts. IAMFI wanted to provide the industry with best practices in debt restructuring in order to “strengthen the commercial attractiveness and social impact of the industry,” reads the introduction to Charting the Course.

IAMFI and Morgan Stanley worked together to convene the IAMFI Microfinance Lenders Working Group (IMFLWG) in order to find out more about MFI defaults and create an orderly process to work through restructuring. Trant explained, “The IMFLWG’s activities over the course of 2010 culminated in the paper, Charting the Course: Best Practices and Tools for Voluntary Debt Restructurings in Microfinance.”

The study, which was released in February of 2011, claims that although sixteen MFIs were engaged in or recently completed restructuring, the industry as a whole has emerged from the financial crisis stronger than ever. The report states, “The global financial crisis has made microfinance a better industry by offering proactive and corrective measures that will facilitate orderly debt workouts, help viable MFIs continue to serve the socioeconomically excluded in a financially responsible manner and lessen risks to microfinance investment.” Even though the industry was not loosing investors (in 2009 U.S. investors allocated over $1 billion to the microfinance industry) IAMFI’s study found that defaults were occurring more frequently due to fast-paced growth without effective business strategies. Causes of defaults include “faulty business strategy, weak management, and poor governance,” Trant continued, “these can cause overlending to clients, among other strategic errors.”

Some of the most significant findings in this paper came from the experiences of Microfinance Investment Intermediaries (MIIs) who successfully completed a workout process. The paper lists out changes made during the process such as improvements to the areas of due diligence, loan documentation, staff composition and loan provisioning. In interviews with (MIIs) there was consensus that open communication, transparency, and leadership of the MFI were all necessary in a successful workout.

From these interviews, as well as case studies, legal, financial and statistical research, Charting the Course developed ten best practices for debt restructuring including using local legal counsel, immediate responses to material breaches, and ensuring that the preservation of the MFI is an ongoing concern. In addition to best practices, the IMFLWG developed four industry tools located at the end of the paper. “Those tools are largely geared towards creditors, but they also help the MFIs by describing the restructuring process,” Trant added.

One of the lessons from voluntary debt restructurings presented in the paper is, “social intent matters, but fiduciary responsibility comes first.” As Trant told Microfinance Focus, “this specific report acknowledges the reality that defaults happen...the microfinance industry should not be taken by surprise, so that it may continue to serve its target populations.”

Trant explained that the paper's findings are equally important for commercial and non-profit lenders. The study found that when debt restructuring occurred in non-profit MFIs it presented a larger challenge to creditors, because of the “absence of shareholders to recapitalize the institution.” The for-profit model, according to this study, may be a less risky option for larger MFIs, because of the difficulty that nonprofits have in raising capital; “they don’t have shareholders that can commit fresh capital in a crisis,” Trant added. However, since the microcredit-related suicides in the Indian state of Andhra Pradesh criticism surrounding commercialization has become more common.

For Morgan Stanley, this research presented a chance to give back to the financial community. “A study like this was the perfect opportunity for us to support timely research that explored the extent to which microfinance was impacted by the financial crisis,” said Wager. 

Debt restructuring is a complicated process that, if done correctly, allows microfinance institutions (MFIs) to avoid bankruptcy and continue operations. The microfinance industry needs to understand the global reality of debt restructuring in order to remain viable during a time of economic uncertainty. Additionally, debt restructuring is in the best interests of employees and stockholders, because it preserves jobs and investments.

However, the best interests of employees and stockholders became an issue in the  U.S. financial crisis, during which Charting the Course’s primary sponsor, Morgan Stanley, went from an investment bank to a bank holding company, and as a result underwent stringent federal regulations on the amount of debt they could take on. Corporate investment in social issues like microfinance is a poignant show of cooperation and a crucial part of modern humanitarianism. Even so, as sponsors of IAMFI’s research Morgan Stanley’s recent history is an important consideration.

The microfinance industry is similar to the commercial banking industry in many ways, but Charting the Course makes clear that it is also very different. Trant said that the research process evaluated “common practices in the commercial banking world and adapt[ed] them to the unique characteristics of microfinance.” Liquidation of an MFI will have a negative impact on communities already marginalized by commercial banks. Similarly, if a faulty MFI is able to continue financially due to successful restructuring but continues to have problems on the humanitarian side of its operations, it will cyclically hurt people who this industry aims to help. If applied correctly, IAMFI's research can help improve both the social and financial abilities of MFIs.

When asked who the ultimate beneficiaries of this research are, both Wagner and Trant agreed that the goal of restructuring is to improve the quality of life for borrowers. Charting the Course provides best practices for debt restructuring in order to keep viable MFIs going and “to make sure that creditors [do] not take actions that...jeopardize the MFI, because our ultimate clients are the entrepreneurs we seek to serve,” Trant said.

Backed by Morgan Stanley, IAMFI was able to generate new research that will help MFIs improve internal processes as well as make debt restructuring a more feasible option for failing microfinance organizations. Trant would like to see Charting the Course circulated “among entire organizations, shareholders and lenders,” she continued, “It is a blueprint for what we need to work on as an industry to develop better skills and processes.”

Charting The Course is available to read and print on the IAMFI website. If used in the best interests of the working-poor, debt restructuring can help struggling MFIs continue to provide impoverished people with the capital they need to survive and perhaps escape poverty. As Trant told Microfinance Focus, “our hope is that the industry is as prepared as possible.”