ANALYSIS: Is microfinance investment on decline in Latin America?

Microfinance Focus, Feb 4, 2010: While microfinance institutions in Latin America are recovering as the general economic climate stabilizes, demand from MFIs for debt from external sources such as microfinance funds will remain subdued in the first half of 2010. And when growth returns, it is unlikely to be at the pace the industry has enjoyed previously.

In terms of investment, Latin America is a microfinance investment powerhouse. Second largest by percentage of global microfinance investment, the region has a long association with microfinance dating back to 1973 when Accion first experimented with microcredit lending. As result, the region boosts several highly-developed microfinance markets, such as Bolivia, Peru and Ecuador, that are well integrated within the mainstream financial sector.

“An advantage of LAC over other regions is that a relatively large group of MFIs have matured relatively rapidly into professionally-led institutions and in various LAC countries special microfinance regulation has been set up which in general has benefited the development of microfinance institutions in those countries”, explained Rita de Boer, Fund Manager at Triodos Investment Management. The Global Microscope 2009, an index by  Economist Intelligence Unit ranking countries and regions according to the attractiveness of their business environment for microfinance, LAC ranked first overall, and second in the investment climate and institutional development categories. Latin American countries also dominated the top 10 list, with Peru and Bolivia taking out the first and second places respectively.

The microfinance markets in Peru and Bolivia, along with Ecuador and Nicaragua, are some of the most competitive microfinance markets in the world. Not only is there a high degree of competition amongst regulated MFIs in the form of non-banking financial institutions, but also credit union and cooperatives and even commercial bank offer products catering to low-income groups. As Rita de Boer explained, this provides a wide range of highly professional, investment worthy microfinance institutions. However, as the market becomes increasingly saturated its prospects for growth are slowing and the industry is entering a consolidation phase. This means that the region has had to compete with fast-growing and increasingly sophisticated markets in other regions.

Microfinance investors – reconsidering Latin America?

According to the latest data available, MIV assets continued to grow in 2008 according to CGAP (see table below), albeit at slower a slow rate compared to previous year, and is projected to have grown at a similar rate in 2009.

MIV portfolio allocation to Latin America & Caribbean.

*
Year     Total Global Assets     Portfolio allocation LAC     % of global
2006     $2 billion                       $700 million                                 35%
2007     $5.4 billion                   $1.73 billion                                  32%
2008     $6.6 billion                   $1.91 billion                                   29%
2009     $8.5 billion*                 $2.21 billion**                              26%**

Source: CGAP MIV Survey.

* 2009 figure is a CGAP projection based upon estimates of participating MIVs.

** These figures are the author’s estimates based upon the continuing of past trends.

Interestingly, CGAP data indicates that since 2006 portfolio allocations to LAC have declined by 3% per year. Rita de Boer argues this is not due to the declining attractiveness of the region. Referring to decreased allocation to LAC in Triodos microfinance funds, she argues that this reflects the growing maturity of other markets: “Global funds aim to diversify investments in the various regions. As Latin America was the first region with ample opportunities the relative weight of the Latin America investments was higher but with increasing opportunities elsewhere the relative weight shifted.” Beneficiaries of this shift, according to CGAP data, are South Asia (SA), and Europe and Central Asia (ECA). These regions boast faster growing microfinance markets, such as India, and improving regulatory environments.

The limited publicly fund information available does not provide a clear suggestion as to whether this trend has continued or not in 2009. The Dexia Microfinance Fund (DMCF), managed by BlueOrchard, followed the trend, with portfolio allocation to Latin America decreasing from 33% in January 2009 to 25% in December. In contrast, however, the allocation of the ResponsAbility Global Microfinance Fund (rAGMF) increased significantly, from 37.4% to 42% over the same period.

However, broken down to the subregional level, both funds display a clear downscaling in commitments to the Central America and Caribbean (CAC). rAGMF’s commitments to the area decreased by 26% in 2009, from 14.4% to 10.6%. Similarly, the DMCF’s allocations to CAC fell by 43%, from 8.7% to 5%.

This does not necessarily indicate a general pull-out from the sector, but it could suggest that investors are re-considering allocations to the area. A reason may be the economic and political vulnerabilities the economic recession has highlighted.

Central America bears the brunt of the recession

A consensus that emerged from a recent Microfinance Focus survey of investment managers in the region was that, on the whole, demand for funds from MFIs has dropped significantly. This has been due to slower growth in MFI loan portfolios, as MFIs becoming more cautious in client selection and have accumulated extra cash on their balances to guard against increased defaults. “Although it’s hard to generalize, overall we have seen a build-up of cash on the balance sheets of our partner MFIs. In fact…  we have received a few prepayments this year, with two coming from MFIs in Latin America”, explained Ayesha Wagle, Senior Vice President at MicroCredit Enterprises. Even Rita be Boer, Triodos Investment Management, has indicated that Triodos microfinance funds have also received some loan prepayments.

Lower portfolio growth means that there is less MFI demand for debt. Considering that capital inflows into region have increased, this suggests that over-liquidity could be a problem. This would be contrary to the concern that MFIs in the region were face a funding shortage as a result of reduced availability for debt from local commercial banks and other sources. To address this perceived shortage the International Finance Corporation and KfW launched a the global $500 million Microfinance Enhancement Facility (MEF) in February 2009.

Also, the Overseas Pacific Investment Corporation (OPIC) and Inter-American Development Bank (IDB) announced in April the creation of a specialised vehicle for Latin America, the $156-250 million Microfinance Growth Facility (MGF). On announcing the facility’s launch, President Obama said “This fund will provide stable medium and longer-term sources of finance to microfinance institutions to help rebuild their capacity to lend during this difficult period”.

While opinions were mixed, the general consensus to emerge from Microfinance Focus‘ recent investor survey was that over-liquidity is primarily the problem in Latin America. “The downturn has seriously affected the demand for funds. Especially in Central America and Mexico the demand has slowed down drastically. Most markets show an excessive liquidity,” said Eeclo Mol, Regional Manager for Latin America at Triple Jump.

However this may not necessarily necessarily the case across the board. John Bishop, CEO of Envest, points out that demand from many smaller MFIs has not decreased, but their options for accessing funding has. Certainly, development finance institutions (DFIs) and international financial institutions (IFIs) target large, commercially-orientated MFIs and microbanks. However this is also an important segment for investment funds. While DFIs and IFIs regularly collaborate — for example BlueOrchard was chosen to manage the MGF and co-manages the MEF with ResponsAbility and Crynao Management, and Accion International is a major investor in the MGF — there are also reports that they are providing competition for investment funds. “The competition between funds is increasing with over-liquidity still in the market.

The multilateral facilities mentioned play an important role in this, as the facilities are abundant and relatively cheap,” argues Eelco Mol. Furthermore, he believes that local lenders have become more, rather then less, active. “We also see more internal supply, including governments funds and commercial banks. This is especially the case in Bolivia, Peru, Colombia” he added.

All fund managers who participated in the survey agreed that MFI demand for debt in CAC has been hit harder compared to the Andean countries. This reflects the greater impact the economic downturn has had on the region, due to closer economic links with the US, upon which it is dependent for export revenue and remittances. Both have declined significantly due to the recession, restricting the flow of external income into communities, leading to an increase in defaults and Portfolio at Risk (PAR), according to investor feedback. As the latest data from MIX shows, in 2008 Central America and Caribbean already had higher rates of PAR and write-off ratio compared to South America.

MFI Portfolio Risk Indicators

Indicator                          LAC                   South America     Central America and Caribbean
PAR                                     4.2%                  3.4%                             6.1%
Write-off ratio                2.3%                   2.1%                             2.9%

Source: Microfinance Information eXchange (MIX) Regional Benchmarks LAC 2008 (Central America and Caribbean values are averaged values from Mexico, Central America and Caribbean categories).

Nicaragua has been the biggest, and most publicised, casualty of the downturn. Prior to the crisis the country was considered one of the most attractive countries for microfinance investment not only in Latin America but in the world, supported by enabling legislation and a solid financial system. While also grappling with the fallout from the recession in the US, the country also had to contend with falling beef prices, with the cattle industry an important source of income for many rural communities, particularly in the north. Political unrest during 2009 also caused a sharp in both investment and donor contributions, intensifying the the country’s economic problems. This led to a fall in repayment rates, and was both encouraged and compounded by the rise of the “No Pago” movement in mid 2008 in northern Nicaragua. Demanding a moratorium on repayment of debts, the movement gained momentum throughout 2009.

Repayment rates plummeted as a result, and several MFIs missed or had to reschedule repayments to debtors, including microfinance fund managers. Publicly available fund reports such as for rAGMF, DMCF and the Dual Return Fund indicate that provisions against loan-loses have been made been made at least since September, and have in some cases been cited for flat or negative fund performance. The Dual Return Fund in the November market commentary by Dr. Arman Vardanyan, while reaffirming the fund’s commitment to the country and working with affected investee MFIs, admitted that many international creditors were exiting Nicaragua by not re-lending. While there have been no reports of any full-scale pullouts by microfinance funds from Nicaragua, some funds have downscaled commitments. For example DMCF has reduced its commitments in Nicaragua from 5% in January 2009 to under 3% in December, while commitment levels for Incofin funds and the Dual Return Fund have remained stable. This makes two important suggestions. Firstly, there has not been a uniform response of investors to the crisis. Secondly, the Nicaraguan crisis cannot fully account for reduced allocations to Central America and Caribbean.

With the dust yet to settle on the no payment crisis, it remains to be seen when the crisis will be finally resolved. But there has been some positive outcomes from this, such as the strengthening of Nicaragua’s credit bureaus. But what will have a longer lasting impact will be the political response. The government threw its weight behind the movement early on, and proposals to tighten the regulation of MFIs has been reintroduced to the Nicaraguan congress. While the final details of this regulation are yet to emerge, it is likely to contain measures adopted recently in Ecuador, such as interest rate caps. If such regulations are introduced, it makes it less likely that investment levels will recover to pre-crisis levels, even if the economy recovers. This will make MFIs more dependent on local funding sources such as commercial banks, increasing their vulnerability to shock to shocks in the financial sector.

Agitation for regulatory change is not confined to Nicaragua, but across the entire region the picture is mixed. According to Eelco Mol, Regional Manager for Triple Jump, said these proposals would increase the cost of fundrasing and decrease MFI profit margins, are being considered in several countries in the region. The Mexican congress is currently debating special legislation for MFIs, “bancho de nicho”, which may be beneficial for microfinance investment in Mexico, added Mr Mol.

Beth Castleberry, from Global Partnerships, however argues that moves throughout the region to adopting legislation which would make MFIs more competitive, such the ability to accept deposits and improved loss provisioning requirements. The Microscope 2009 rankings by regulations also paint a mixed picture. Chile, Brazil and Argentina improved their regulation in 2009, while investment heavyweights Ecuador, Bolivia, Peru and Guatemala all lost points for making changes that weakened regulatory frameworks, such as heavier credit provision requirements or tougher criteria for becoming deposit-taking entities.

Economic stability has improved in the region, but there remains the potential for a popular backlash against microfinance. This would have serious consequences for investment in the region. “For certain countries the political environment may result in a movement for regulatory change, albeit that is likely to be in another form to Nicaragua”, argues Rita de Boer from Triodos Investment Management. “Should this happen, it would surely impact the overall investment in the region, as it would show that Nicaragua is not an isolated event.”

The outlook for 2010 – cautious optimism

With the worst of the global recession having passed, most economies in Latin America have stabilised and some have begun to recover. Dr Armand Vardanyan in the December market commentary for the Dual Return Fund believes that confidence is returning: “MFIs have started to make their 2010 projections and we expect to see the recovery in demand again during the first quarter of 2010.” However his tone remains cautious for the outlook for the year, arguing that MFIs will continue to largely focus on maintaining portfolio quality and strengthening risk management systems. While MFIs are likely to recover in-line with the general economy in 2010, demand from MFIs for debt is likely to remain muted in the first half of the year. Even when growth returns, it is unlikely that it will be at the dizzying pace it became accustomed to prior to the recession.

Recovery will be slower in Central America due to greater economic dependency on the US, whose economy is expected to remain to sluggish while recovering gradually throughout 2010. The regulatory regimes in th it Andean countries have proved themselves to be, on the whole, recession-proof, but movements towards tightening controls over regulated MFIs threatens to dent the robustness of sector and prolong its recovery.

The region will remain an important region for microfinance investors, as large investment-worthy  will always require refinancing. While investment in real terms will increase in-line with MIV growth globally, the percentage of LAC occupies in portfolios is likely to continue to decrease this year to around 26%, as investors take advantage of opportunities in the high-growth countries of ECA and South Asia, such as India.

That said, Brazil, an emerging economic powerhouse with the largest population in the region, has a very low-level of market penetration and presents huge prospects for future expansion. This has been recognised by Accion Intenational, who announced in November that they had received approval to establish a subsidiary in Brazil’s remote Amazonas province. When Financiera Independencia, one of Mexico’s leading MFIs, announced the takeover of Financiera Finsol, the group’s Brazilian subsidy was cited as strategic advantage, describing the country’s potential for expansion as “immense”. With the regulatory environment improving in 2009,  Brazil will be a country to watch in 2010.