Microfinance Focus, August 19, 2011: Since the onset of the Andhra Pradesh crisis that hit the Indian microfinance sector late last year, a number of microfinance institutions took the securitization route to access debt capital.

SKS Microfinance securitized a loan worth Rs 500 million comprising 65, 438 contracts with YES Bank. The portfolio was rated as PR1+ (SO) Highest Safety by rating agency CARE. Bangalore based NBFC-MFI, Ujjivan Financial Services raised Rs 173 million through a securitisation transaction in May. Tamil Nadu based Grama Vidyal also raised Rs 268 million through securitization.

Dr. Kshama Fernandes, Chief Risk Officer, IFMR Capital, in her recently authored a paper titled “A structured finance approach to microfinance” says that the use of the structured finance approach has enabled microfinance institutions to raise the much needed liquidity during times when most regular funders stayed away from the sector due to risk considerations.

According to Dr. Fernandes, the structured finance approach has given MFIs access to a new class of debt investors, thereby reducing over-dependence on traditional sources of funds and enabling risk transfer over a larger gamut of financial institutions.

Microfinance institutions have traditionally been relying on banks and development financial institutions (DFIs) for funding. This funding however is extremely sensitive to external risks. Post Andhra Pradesh crisis, banks ceased fresh lending to MFIs in the state which brought the industry to a near standstill.

The paper points out a new class of investors comprising of NBFCs, mutual funds, bank treasuries and private wealth have emerged, enabling MFIs in India to diversify their sources of capital. These securitisation transactions have shown very high collection efficiencies. Several of the rated securities have been upgraded during the life of the transaction.

Microfinance securitisation provides the same benefits that conventional structured finance products provide. For the originator of the microfinance assets, the advantages of securitisation include relief in regulatory and economic capital, diversification of the investor base, access to new (and potentially cheaper) sources of funding based on asset risk rather than corporate risk and portfolio management.

Rating analysis and market based pricing also create credit history that may enable the originator to raise future capital at market-linked rates. For investors buying into structured securities gives access to a diversified portfolio with a return profile that matches their risk appetite.

High repayment rates, low volatility of returns, low prepayment, granularity of loans and low correlation with other asset classes make microfinance an interesting asset class for securitisation.

The success and sustainability of the structured finance approach in the microfinance sector depends on the high-quality origination of loans, appropriate incentives for all parties to a transaction and continuous monitoring of the portfolio and originator. Transparency and adequate disclosures ensure that market players act responsibly and the best originators are recognised.

Finally, a strong regulatory framework that promotes innovation while ensuring transparent reporting, sufficient accounting mechanisms, prudent exposure limits and effective risk management is critical. Past experience has shown that the importance of this cannot be overestimated, the paper says.

IFMR Capital is an NBFC headquartered at Chennai, India. IFMR Capital provides efficient and reliable access to debt capital markets for institutions that impact low income households. IFMR Capital has facilitated more than Rs. 1000 crore of funding to high quality MFIs through securitization, loans to originate products and NCDs.

Since March 2009, IFMR Capital has structured, arranged and co-invested in 35 microloan securitisation transaction in India. Till date IFMR Capital has completed six multi-originator transactions and has established microfinance as a mainstream asset class.