A couple days ago IFMR Capital and Equitas completed the first rated micro loan-backed securitisation in India (and maybe around the world). How does a securitisation differ from the typical loan-portfolio buyout? Both can help banks fulfill priority sector lending requirements, but securities can be traded on the market while banks are fixed in when they buyout loan portfolios, which could mean securities would be more valuable. This securitisation bundles Rs. 157 million (~USD 3.1 million) worth of Equitas' micro loans into one security. As the fiscal year ends in India at the end of March, I am curious how much this security will go for as banks scramble to meet priority sector lending requirements.
The Reserve Bank of India’s (RBI) priority sector requirements stipulate that 13.5% of domestic banks’ net credit must go directly toward agricultural purposes. Banks that fail to meet this target are required to deposit the shortfall with NABARD for which they receive below-market rates of interests (typically 3.5% to 6% depending on the size of the shortfall). Rural micro loans often can qualify as direct agricultural loans. Also, there are RBI weaker sector lending requirements that include poorer urban borrowers, that combined with the 13.5% direct agricultural lending requirements, total 40% of domestic banks' net credit. RBI now says they will enforce this 40% weaker lending requirement in 2009. WIth this 40% now being enforced, microfinance loan portfolio buyouts (and now securities) should be bought up quickly before the end of the fiscal year.
To help explain the differences between loan portfolio buyouts and securitisations, I include some detail below, which I mainly borrow from an investment climate summary written by my colleague Doug Johnson (and used in the 2009 State of the Microfinance Sector report):
Loan Portfolio Buyouts
A portfolio buy-out occurs when a bank (or other agent) purchases the rights to the future payment stream from a set of loans granted by the MFI. Notionally, there is little difference between an MFI receiving an up-front term loan or a delayed payment from a portfolio buyout other than the timing of the transfer from the bank to the MFI. In practice however, buyouts allow banks to more easily create a portfolio of loans which qualify under the RBI’s priority sector requirements for direct agricultural lending.
MFIs typically can only sell off loans financed by accumulated earnings or equity, not term loans from banks, in a portfolio buyout. (This is because the payment stream from those micro-loans is already hypothecated to the bank which granted the term loan.)
Securitisation
Securitisations are often confused with portfolio buyouts but is in fact quite different. Securitisation in microfinance generally refers to a transaction in which microfinance loans held by a bank (either as a result of the bank extending a term loan to the MFI, lending via the partnership model, or purchasing the loans via a portfolio buy-out) are bundled into a special purpose vehicle to create a security (usually bonds) which is then traded on international capital markets. From the perspective of the MFI, whether or not a portfolio of loans it has sold to a bank is securitised matters little. (The only substantive difference from the MFI’s perspective is that the bank may be willing to pay more to the MFI for the portfolio of loans if it anticipates receiving a high price for them via securitisation.)
Will be interesting to see how well this IFMR Capital -Equitas security sells on the market. Would be great to hear others thoughts . . .
8 comments:
A few notes:
1. The Equitas securitisation does not consist of one security. It consists of many securities, known as “pass-through-certificates” (PTCs), divided into two tranches. The senior tranche of PTCs, rated AA and equal to 80% of the portfolio, will be purchased by an institutional investor, while the junior tranche, rated BBB and equal to 20% of the portfolio, will be held by IFMR Capital. The junior tranche is completely subordinated to the senior tranche.
2. From an MFI’s perspective, there’s an important difference between securitisation and portfolio buy-outs. While portfolio buy-outs can be conducted only by banks, securitised micro-loans can be purchased by banks as well as by other institutional investors, such as mutual funds. Existing lenders will also be able to take larger exposures as they now have the tools to evaluate risk of loan pools and risk-manage exposures on their balance sheets. Moreover, IFMR Capital as a mezzanine investor in the BBB-rated securities will improve the overall credit appetite for such assets. Thus the market for securitised micro-loans is much larger than the market for portfolio buy-outs, and this can ultimately lower MFIs' cost of funding. Via rated securitisations, microfinance can now become an “asset on its own merit.”
3. A high-quality MFI can also lower its cost of funding by signalling its quality via the rating that a securitisation carries.
4. Securitisation and bonds are two different financing structures. Micro-loan-backed securities represent claims on the repayment cash flows from a specific pool of loans, while bonds represent claims on the organization that issues the bonds.
While this is a positive development for the sector, I am wondering how much commercial sense this made for the MFI in question (already one of the 'star performers' as far as the Indian Microfinance space is concerned).
Moreso, with the amazing amount of credit enhancement for the buyer/cost for MFI (11.7% cash collateral+ 20% protection for the junior most tranche which was subscribed to by IFMR Capital itself + excess interest trapped in SPV).
It would be particularly useful to look at this transaction from the commercials point of view, especially since one of the advantages of securitization often quoted by Microfinance experts as 'reducing the cost of borrowing' (besides the other obvious one being capital relief). Case in point is the securitization transaction done by BRAC long back, with high levels of credit enhancement (50% over collat. and additional guarantees) which leaves one to wonder if such a transaction is infact replicable.
While the level of credit enhancement for the Equitas securitisation is relatively high, it’s premature to compare securitisation with other sources of funding for MFIs. Because micro loans represent a new asset class and thus lack a track record, rating agencies are conservative, hence the large amount of credit enhancement. As more micro loan securitisations are done, and these securities build a track record, the level of credit enhancement is expected to decrease. And as confidence in the asset class builds, demand from investors will grow, which will also lower MFIs’ cost of funding.
All of that aside, even with the relatively high level of credit enhancement for the Equitas securitisation, the price was still competitive with other sources of funding for the MFI.
Here is a link to the official press release:
http://www.ifmrtrust.co.in/downloads/20090309_IFMR_Capital_press_release.pdf
This is the first of many transactions that we expect to do at IFMR Capital. This one was important to build rating agency confidence and familiarity with the asset class. We want to clearly focus on multi-originator securitisations next aimed at the small and new MFI segment where the debt access is most impaired.
We also expect the market for BBB rated securities backed by pools of micro loans to take off. The subtle but significant difference between the BBB tranche and cash collateral is that this is a financial security and is freely transfereable. As the track record of this new asset class develops, we expect other investors to find value in these securities and deepen the market for mezz funding.
The scheme is no new in the developing world. E.g., Compartamos (Mexico) has securitized portions of its (microfinance) operations since they transited legally and administratively from MFI to bank.
http://54pesos.org/
Are you planning to make information public on the sales of the security? Would be great to know how this has been greeted by the market
Information regarding this transaction can be found on the websites of IFMR Trust http://www.ifmrtrust.co.in/announcements/ifmr_capital.php and CRISIL http://www.crisil.com/Ratings/RatingList/RatingDocs/equitas-microfin_09mar09.htm. The senior tranche of securities was purchased by Yes Bank http://www.yesbank.in/releasedisp.php?pid=275.
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