Transcript Funding Microfinance in India through Securitization

Funding Microfinance:
An Analysis of Emerging Financial Models
A Review for the Indian Banks’ Association
Agenda
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Introductions
Project Overview
Conclusions
Recommendations
Financial Models
 Remittance Securitization
 CDFI Financial Model
 US Mortgage Securitization Model
Review of Recommendations
Introductions
International Executive MBA
Georgetown University McDonough School of Business
Kent Bonham
Celeste Diaz Ferraro
John Gray
Brian Saal
Virginia McMullan
Javier Varela
Dr. Reena Aggarwal, Advisor
Project Overview
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Research began by analyzing the U.S. mortgage market and U.S.
CDFI system to identify factors relevant to success in capital
generation for microfinance
After assessing weaknesses in transferring these models to India,
the Georgetown team chose to also investigate remittances as a
capital generation model that has greater short-term opportunity for
success in India
Conclusions
Conclusions
Remittances
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Trend toward increased efficiency, competition and developing
technology.
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Large market potential.
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Attractive conduit for cross-selling other financial products.
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Securitization of remittance flows is a viable and attractive
mechanism for generating capital for microfinance.
Conclusions
U.S. CDFIs
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Without strong government pressure on banks as well as significant
incentives for investment, CDFIs would cease to be attractive or, in
some cases, profitable investment vehicles.
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Even with significant government assistance, CDFIs in the US took
10 years to reach today’s operating standards.

CDFI experts indicate that the timeframe for industry maturity is
approximately 20+ years, even with significant government and
banking industry support.
Conclusions
U.S. Mortgage Market

The U.S. secondary mortgage market works due to several factors:
 The extremely large market size provides instant liquidity and
provides significant for large institutional investors
 Investor community has strong familiarity with this asset class
and perception of risk has been erased over time
 Perception by financial community of implied government
guarantee
Recommendations
Offer remittances through top-tier MFIs.
 “Top-tier” defined by MFIs who have either obtained a credit rating from
CGAP or have demonstrated investment-worthy accounting practices,
management competency and operational transparency.
 Cross-sell remittances with other financial products to grow customer base.
 Securitize remittances, building on previous pioneering works of ICICI in
India.
 Use future remittance cash flows as collateral for microfinance loans.
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Jointly lobby for Fannie/Freddie-style government incentives.
 Jointly lobby for CDFI-style government incentives.
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Remittances
Expanding Microfinance
Through New Product Offerings
While Increasing Capital Through Securitization
Remittances
Global Market Trends
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Shift from informal to formal, professional
Consolidation and partnerships
Competitive environment
Greater segmentation
Proliferation and increasing levels of technology
Securitization
Stability of Remittance Flows
Remittances
Demonstrated Long-Term Stability
IMF Balance of Payments Statistics for Developing Countries
The Indian Remittance Market
Background
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$126B worldwide, over $25B to South Asia (2004)
India largest in the world for remittance receipts
Stability of remittance flows
Diaspora in U.S., migrant workers in Middle East
Large number of domestic migrant workers
The Indian Remittance Market
Background
MTOs such as Western Union
 Informal channels - hundi
 Current Bank products
 Post Offices
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Remittances
Potential for Microfinance
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Leverage existing relationships with MFIs
Cross-sell additional product offerings
 Package
 Savings
Potential to reach more customers
Increase MFI credit ratings
Domestic remittances
Remittances
Ecuador Case Study
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Banco Solidario alliances with Spanish savings banks
Remittance services complement other products
 Credit
 Savings accounts - part of remittances can be “blocked off” for
future purchases or to service existing loans
Remittances
Haiti Case Study
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Microfinance NGO Fonkoze offering a range of services including
savings, microloans, currency exchange
Agreement with City National Bank of New Jersey (CNB)
Remittances through Fonkoze account at CNB – transferred to
Haitian bank
Successes – cross-selling other services, increasing volume of
microloans
Remittances
Additional Global MFI Case Studies
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MFIs are providing savings and micro credit based on remittances in
Bulgaria, Serbia, El Salvador, Ukraine, and Bosnia
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Use remittances to leverage more funds in the commercial markets
to finance lending operations
Remittances
Global Securitization
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Ongoing access to funding, new investor base
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Leverage remittance flows to productive purposes through financial
intermediation of banks
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Include top tier MFIs, geographical diversity
Remittance Securitization
Turkey Case Study
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AKBank TAS - structured finance deal of US $400 million by
securitizing its foreign currency denominated present and future
remittances. Followed by additional advances
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Recently Ambac financial group provided financial guarantee
insurance and its AAA rating to $350M in notes backed by AkBank’s
offshore remittances
Remittance Securitization
Peru Case Study
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Banco de Crédito del Perú (BCP) raised $100 million in January 2001 with its firstever bond backed by securitized electronic transfer payment instructions. ING
Baring's Latin America was the organizer of the Banco de Crédito transaction
BCP was first bank to introduce electronic transfers as a new asset class for futureflow securitizations.
The bank receives annually close to $3 billion in electronic transfers
BCP arranged with its five major correspondent banks – JP Morgan, Citibank, Bank
of New York, Bank of America and Standard Chartered to flow securitization
through a special purpose vehicle
ING structured the deal as a sale of BCP's existing and future rights to the dollar
payments, so the receivables are no longer owned by BCP but transferred to the
SPVfor the benefit of the certificate holders.
MBIA guaranteed the timely payment of interest as well as payment of the principal
on maturity.
Community Development
Financial Institutions
CDFI Profile
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Community Development Financial Institutions are private sector
financial institutions that solicit capital from public and private
sources and channel it via their various services into specific
underserved communities
Financial resources are provided through:
 Provision of financial services, loans, and investments
 Offering training and technical assistance services
 Promoting development efforts that enable individuals and
communities to effectively use credit and capital
CDFI Profile
Characteristics
$250,000
$272,061
$217,113
$300,000
$200,000
$40,379
$36,338
$50,000
$4,998
$100,000
2002
$4,510
$150,000
$59,268
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CDFIs are categorized by services offered and lending portfolio
focus. Common categories include home loans, consumer credit,
enterprise funding.
Loans are far and away the tool most used by CDFIs, with 98% of all
financial outstanding, or $8.3 billion.1
$40,030
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2003
$Banks
Credit
Unions
1CDFI
Loan Funds
Data Project, FY 2003 Publication
Venture
Capital
Regulatory Environment
Catalyst for CDFI Growth
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1994 creation of CDFI Fund
 Initial $382 million allocation over 4 year period
 Paid out over $700 million to date
 $55 million slated for FY 2006
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1995 revision of Community Reinvestment Act (CRA)
 Government subjects lenders to evaluation under CRA
 Up to 5% of deposits must be allocated to community
development initiatives for maximum compliance
 Rating impacts bank’s abilities to accept deposits
 CDFI investments qualify as CRA activity
CDFI Profile
Operational Model
Banks
Private Investors
CDFI
Borrowers
US Government
(Tax Incentives)
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CDFIs act effectively as an intermediary
The flow of capital is predominantly loans
This model relies on government incentives for success
Regulatory Environment
Federal Incentives for Banks
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Bank Enterprise Award (BEA)
 Monetary award given directly to banks to offset investments in
CDFIs
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New Markets Tax Credit (NMTC)
 Credit given against Federal income taxes initiated in 2000
 Totals 39% of the cost of the investment and is claimed over a
seven-year credit allowance period
CDFI-Investor Relationship
Motivation for Bank Investment
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Gain access to intermediary with stronger expertise
 Technical support for customers
 Lower administrative and marketing costs
Reduce bank portfolio and operational risk
Enter new markets
 New target audiences
 New geographic markets
 Product or loan type offerings
CDFI-Investor Relationship
Three Primary Investor Objectives
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Surveyed some of the U.S.’ largest commercial investors in CDFIs
 Banks: Bank of America, Wells Fargo Bank, Citibank
 CDE funds managers: Community Reinvestment Fund, Calvert
Funds
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Commercial investors tend to have three common goals
 Compliance with Community Reinvestment Act
 Market return on investment
 New market development
CDFI-Investor Relationship
Three Primary Investor Objectives
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Community Reinvestment Act Compliance
 Banks must invest in all communities where they have presence
or accept deposits
 Banks are limited by human and capital resources
 CDFIs can reach multiple areas more efficiently, helping banks
achieve maximum ratings while covering broad geographic areas
CDFI-Investor Relationship
Three Primary Investor Objectives
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Market Returns on Investment
 Banks must commit 5% of deposits to CRA investments
 Many development activities are unprofitable and often classified
as charitable or marketing efforts
 CDFIs, particularly New Markets Tax Credit investments, can be
profit generators and meet or exceed standard commercial
investment parameters
CDFI-Investor Relationship
Three Primary Investor Objectives
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New Market Development
 Working through CDFIs provides banks an opportunity to instill
brand awareness and loyalty among new customers
 Long-term capacity building grows the overall market by creating
new customers in underserved areas
CDFI-Investor Relationship
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Market development
Investor Strategies
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Technical assistance and community education programs
 Homeownership and financial responsibility courses, small business
outreach, etc.
 Management and technological exposure to CDFI similar to training for
MFIs
 Typically viewed as charitable or marketing efforts (cost centers)
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Direct investment in local CDFIs (Bank Enterprise Award grants)
 Factors in selecting CDFIs comparable to screening MFIs
 Management ratings
 Efficiency and market returns
 Target audience and customers (loan and funding types)
 BEA award reduces losses on marketing investments but does not
completely offset expenditures
CDFI-Investor Relationship
Investor Strategies
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Financial Return
 NMTC investments provide banks with commercial rates of return
 Minimize risk and reduce administrative expenses
 Banks utilize same assessment tools and processes to
evaluate CDFIs as commercial investments
 Banks can dictate CDFIs underwriting guidelines
 Banks do shoulder greater risk in NMTC than other tax
programs
CDFI-Investor Relationship
Bank of America case study
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Bank of America background
 U.S.’ largest bank and largest CDFI investor
 CDFI investments make up 10% of all Bank of America’s community
development budget
 Currently have $350mm invested in NMTC with a commitment for another
$256 million in 4th round (2005)
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Risk assessment and return on investment requirements
 BoA applies similar risk and return evaluation processes to both commercial
and NMTC investments
 Commercial vs. NMTC repayment rates: 98.1% vs 97.8
 Commercial vs. NMTC ROI: 8-10% vs. 7-8% + 5% tax credit (total 12-13%)
 Additional risk assigned internally to CDFI investments (generally 2-3%
additional cost of capital), not by demonstrated market performance
CDFI-Investor Relationship
Evaluation for Future Investment
Commercial investors still evaluating the long-term profitability of
CDFIs
 CDFI Data Project launched by government in 2004, initial results in
2005. Standardized data collection for all CDFIs to enable more
transparent evaluation of performance.
 Horizon for assessment of commercial return on investment
 Banks have 3-4 years initial data on NMTC investments, will need
3-4 additional to gauge overall return on investment.
 It will take an additional 8-10 years of data to conclusively
evaluate CDFIs as reliable investment vehicles.
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CDFI-Investor Relationship
Lessons Learned
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It’s taken 10 years (1995-2005) of government assistance and
concerted commercial investment for CDFIs to gain acceptance as
investment vehicles.
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Without continued strong government pressure on banks as well as
significant incentives for investment, CDFIs would cease to be
attractive or, in some cases, profitable investment vehicles.

CDFI experts indicate that the timeframe for industry maturity is
approximately 20+ years, even with significant government and
banking industry support.
Fannie Mae / Freddie Mac and
the U.S. Mortgage Industry
Fannie Mae / Freddie Mac
US Mortgage Market
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Securitization of the US Mortgage Market
 Federal National Mortgage Association (FNMA or Fannie Mae)
created by US Government in 1938, authorized to purchase
federally insured mortgages
 Became self-sustaining private company in 1968, operating on
private capital
 Currently operates under congressional charter, focuses on
availability of funds for low to middle income families to purchase
homes
Fannie Mae / Freddie Mac
US Mortgage Market
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Purchase mortgages from primary lenders stabilizing the availability
of mortgage credit
Pool the mortgages and resell as securities
 Securities earn smaller but constant differential between the yield
on pooled mortgages and payout to investors
 Capital requirements are lower
Fannie Mae / Freddie Mac
US Government Regulations
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Fannie and Freddie benefit from arrangements with the Federal
Government
 Each has a line of credit with the US Treasury up to $2.25 billion
 The US Federal Reserve has the authority to buy their debt
 Potential to act as a “bail out”
 Exempt from state and local income taxes on profits
 Exempt from SEC securities regulation restrictions
Fannie Mae / Freddie Mac
Market Model
US Government
(Guarantor)
Investors
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Freddie Mac
Fannie Mae
Brokers and Banks
Borrowers
This model generates large amounts of capital and reduces risk
 Risk is distributed among many investors
Key elements: government guarantee, established credit systems,
large market size
Conclusions (Again)
Conclusions
Remittances
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Large market potential.
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Attractive conduit for cross-selling other financial products.

Securitization of remittance flows is a viable and attractive
mechanism for generating capital for microfinance.
Conclusions
U.S. CDFIs

Without strong government pressure on banks as well as significant
incentives for investment, CDFIs would cease to be attractive or, in
some cases, profitable investment vehicles.

Even with significant government assistance, CDFIs in the US took
10 years to reach today’s operating standards.

CDFI experts indicate that the timeframe for industry maturity is
approximately 20+ years, even with significant government and
banking industry support.
Conclusions
U.S. Mortgage Market

The U.S. secondary mortgage market works due to several factors:
 The extremely large market size provides instant liquidity and
provides significant for large institutional investors
 Investor community has strong familiarity with this asset class
and perception of risk has been erased over time
 Perception by financial community of implied government
guarantee
Recommendations (Again)
Offer remittances through top-tier MFIs.
 “Top-tier” defined by MFIs who have either obtained a credit rating
from CGAP or have demonstrated investment-worthy accounting
practices, management competency and operational transparency.
 Securitize remittances, building on previous pioneering works of
ICICI in India.
 Cross-sell remittances with other financial products.
 Use future remittance cash flows as collateral for microfinance loans.
 Jointly lobby for Fannie/Freddie-style government incentives.
 Jointly lobby for CDFI-style government incentives.
