Trouble brewing in the best microfinance sector on Earth?

by Hugh Sinclair

In October 2013 the rating agency Fitch downgraded Peru’s Grupo ACP to near junk status. The microfinance sector barely noticed, despite Grupo ACP being the main shareholder (60.7%) of one of the largest MFIs on Earth: MiBanco. ACP was struggling to service its own debts as dividend income from its main cash cow, MiBanco, had declined drastically. According to Semana Económica MiBanco had previously represented 80% of the group’s income.

Indeed, MiBanco was in trouble. In 2013 it lost 140.000 clients. The loan portfolio fell from $1.9 billion to $1.6 billion, while the number of outstanding loans fell by a third. A healthy profit margin of 12.6% in 2011 fell to a rather mediocre 2.2% a year later, and has continued this trajectory. 13% of the workforce was laid off. The bank wrote off 5% of its portfolio in both 2011 and 2012, yet delinquent portfolio remains stubbornly high (Par30 approaching 8%). In 2013 alone, MiBanco’s equity fell by 7%. The bank was fairly highly leveraged, so obtaining more debt capital was unlikely. Investors in Peru’s microfinance sector had been withdrawing since 2011, and BlueOrchard’s timely withdrawal from MiBanco just weeks before the downgrade was either extremely lucky or skilful. And yet the Economist Intelligence Unit insists, for the sixth year in a row, that Peru is the finest country globally for microfinance.

ACP has been selling off its microfinance family silver, beginning with BancoSol in Bolivia, but this was insufficient to service its own bonds (which were already in technical default). MiBanco thus had to be sold. Needless to say the disposal of both the BancoSol shares and those of MiBanco were described in a wonderfully positive light, without mention of the looming default at ACP.

Eventually CrediCorp, the holding company of Peru’s second largest bank, Edyficar, bought MiBanco for a song. In 2007 MiBanco was valued at 2.5x its book value. Edyficar paid a bargain 1.25x, or $179 million, and in the process came to dominate a fifth of Peru’s entire microfinance sector in a single day. According to Peru’s SemanaEconómica, the valuation of MiBanco had plunged 37% in the previous five years, destroying millions of dollars of worth for its shareholders – principally ACP, but also Triodos, Bamboo, Accion and the IFC.

What was the underlying cause? Firstly, ACP (and debatably MiBanco) were overly leveraged. Had they not borrowed so massively to grow at breakneck speeds (indebting the poor in the process), perhaps this fiasco could be been avoided, but the quest for ever-growing portfolios necessitates such recklessness. However, this phenomenon is not limited to MiBanco alone, and has resulted in a far more pernicious problem in Peru: over-indebtedness. Nowhere else on Earth is microfinance as abundant as in Peru. According to the MixMarket Peru’s currently boasts $11bn in outstanding microfinance loans, over 12% of the world’s supply. It is larger than the whole of South Asia combined, including India and Bangladesh. Mexico, Bolivia and Ecuador, well-established microfinance countries with a combined population of 5x that of Peru, have less loans, and over-indebtedness in even these countries is a concern. Indeed, chronic over-indebtedness is daily news in the Peruvian media – people are finally talking about the elephant in the room. Equifax recently announced that 14% of Peruvian microfinance client have 3 or more loans simultaneously – worryingly reminiscent of Nicaragua’s “no pago” crisis.

The regulator is in a tricky position. It desperately needs to avert a full-blown crisis of the sort seen in Morocco, Bolivia, Andhra Pradesh, Nicaragua, Pakistan etc. Many Peruvian MFIs also take deposits from the general public, and if fear enters the market and depositors withdraw their savings, this could precipitate precisely the nightmare the regulator wants to avoid. But doing nothing would be an equally hazardous course of action. Expect regulatory intervention shortly.

Cross-contamination is the main fear. Edyificar is adopting an intelligent strategy of writing-off a large proportion of MiBanco’s portfolio, but in doing so forces other MFIs to increase provisioning for those clients they hold in common with MiBanco. Meanwhile Edyficar has access to a lower cost of capital than most other MFIs, and an extensive branch network. Thus it can expand cheaply and offer lower-cost loans than its competitors. It is likely that some competitors will collapse, and early signs of this are already visible. This month, Grupo Divisa acquired 66% of the shares of Nuevo Vision at a suspiciously low price. Edyificar/MiBanco’s dominant position of 20% of the sector is likely to increase as other MFIs drop out of the game or are swallowed up in a wave of consolidations. Meanwhile, funding in other countries may suffer as investors grow weary of mounting over-indebtedness problems across the continent. Once bitten twice shy. MiBanco’s near collapse was a warning to the sector, albeit one kept relatively quiet.

However, a full-blown collapse in Peru of the style seen in other countries is not out of the question, and would be catastrophic for the global microfinance sector. Never before have we created a market this big, only to have to pick up the pieces afterwards. Crises tend to be brutal, sparked (but not caused) by some unforeseen event, unanticipated, and extremely expensive. At the peak of Nicaragua’s microfinance boom before the undignified collapse, its sector was approximately $400m, and this crisis cost a number of investment funds dearly. Peru’s sector is 25x larger.

Some, but not all, of the early warning signs of a possible collapse are visible: investors withdrawing, critical media coverage, over-indebtedness, the undignified downfall of a major player, rising delinquency, and some cripplingly high interest rates (233.48% is the highest I have discovered so far – Edpyme Inv. La Cruz). Hopefully the microfinance industry has learned from previous mistakes, and will act prudently and pro-actively to avoid a meltdown. For all the praise lavished on the regulator by the industry and the Economist, 2014 is likely to be the acid test. Will the regulator find that fine line of regulating enough to avert a crisis and calm the sector down, without creating panic and a mass exodus of investors and depositors alike? Only time will tell. The relative stability that returned to the sector after the fire-sale of MiBanco could well be the calm before the storm. The underlying problem of over-indebtedness remains.

Hugh Sinclair is the author of Confessions of  Microfinance Heretic

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