Some colleagues in CGAP (including myself) and at JP Morgan just published a report showing that private equity valuations for MFIs have varied widely over the past few years. Traditional value measures like price/book and price/earnings ratios depend very much on institutional features like income growth and asset quality, but also on where the MFI is located. For example, Indian MFIs are valued far above their peers from other countries, which has certainly to do with the large growth potential for microfinance in India, but also reflects the lack of reliable market benchmarks.

The financial crisis that has been ricocheting across the globe for several months now will almost certainly have an effect on these ratios. Valuations for private transaction will probably move toward a median of 1.0x book value in the next 12 months, mirroring the drop of approximately 50% in the valuation of traditional banks since September 2008. But the business fundamental of microfinance remains strong. Valuation should bounce back in 2010–2011 as economic conditions and credit markets improve. Larger institutions, especially those with diversified funding sources, such as retail deposits, are best positioned to manage the effects of economic and financial contraction. Valuations may change, but the long-term outlook for equity investment in microfinance is positive.

What can investors learn from all this? As everywhere else, microfinance has had its fair share of hype, and institutions have been overvalued in certain instances. Moving forward, investors should look out for MFIs with stable funding, high asset quality, and solid profitability. “Back to basics” is probably the best advice one can give in these turbulent times.