Archive for: Xavier Reille

By market standards, the SKS IPO is a great success. Institutional investors have over-subscribed their allocations by 13 times, and the company’s valuation of USD 1.5 billion came in at the top end of the offer band price. 

This sky high valuation represents 6.7 times the company’s post issue book value, and about 40 times the company’s fiscal year 2010 earnings.

Such multiples are not in line with market peers. In emerging markets, banks are valued at 3 times the book value, while finance institutions serving low-income customers are trading at 2.6 times the book value. The SKS valuation is even higher – by a margin — than Compartamos’s valuation in its landmark 2007 IPO. At listing, Compartamos was valued at 27 times the company’s historical earnings although its 2006 return on equity (ROE) at 55% was more than double the ROE of SKS today. 

Earning prospects at SKS are attractive, but on their own don’t justify such a high valuation. On the positive side, SKS still has a lot of room for growth. It has ambitious plans including offering new financial products, distributing goods and services beyond microfinance at the bottom of the pyramid, and transforming into a universal bank. But there are clouds on the horizon. Portfolio yield might stagnate as increased competition and political scrutiny put pressure on interest rates. The cost of risk will likely go up in the absence of a well-functioning credit bureau. Transaction costs for group lending will also increase as SKS focuses its growth on underserved, harder-to-reach clients and states.

So what might explain the unrealistically high valuation? This “irrational exuberance” in the SKS IPO price is probably due in part to excess capital flow. It reflects strong institutional investor interest in microfinance combined with the dearth of publicly-traded microfinance securities. Investors are seeking more exposure to emerging markets and to alternative assets. They are eager to buy into the microfinance story and with only two pure microfinance institutions listed, prices are getting ahead of fundamentals.

One of my concerns is that investors buying at such a high level may pressure management to increase profitability, at the expense of clients’ interests and long-term company sustainability. There is indeed a risk that a focus on short-term profit and quarterly earnings might overshadow—if not clash—with the social mission of SKS. True, this did not happen in the Compartamos case (the company did not become more “commercial” after its IPO) but there is still a risk.

What does appear likely is that someone is going to lose as, over time, the SKS valuation should come in line with global standards. Will it be the latecomer investors who bought too high? Or will it be clients as the institution prioritizes profit maximization? And what about possible broader ripple effects? Unmet expectations might make it harder for other MFIs to go gain the confidence of the public markets.

Xavier Reille

Syria recently introduced new legislation allowing for the establishment of “social financial banking institutions” such as finance companies or banks to offer a range of financial services, including deposits. So it was a great place for CGAP to host this year’s Microfinance Policy Forum for the Arab world in collaboration with Sanabel Network (the microfinance network of the Arab countries). The Forum is a unique opportunity for officials from central banks and government ministries from across the Arab world to exchange experiences and knowledge with peers. Dr. Adib Mayaleh, governor of the Central Bank of Syria, made opening remarks in which he presented the recent legislation.

Arab microfinance is diverse. Although the region as a whole has grown at about the same rate as global microfinance since 2006, individual country experiences have varied greatly. Morocco, Egypt, and Jordan have exhibited strong growth while other countries have seen very little growth and some countries (such as Algeria) have almost no microfinance sector at all.

Though many countries in the region have relatively developed financial sectors, this development has not translated into increased financial inclusion. “In MENA, there are fewer loan accounts, accounts (except Sub-Saharan Africa) and branches (except East Asia and Sub-Saharan Africa) per population than any other region of the world and only an estimated 15% of microfinance demand is being met, ” said Mohammed Khaled, MENA regional representative at CGAP.

Clearly, there is much to be done. Microfinance in MENA is limited in scale, products, and capacity and very few MFIs offer financial services beyond basic credit. Investors are discouraged by a predominantly NGO-based model and by the lack of regulatory and supervisory clarity. Government-owned institutions such as state banks, development and employment funds, savings banks, and post offices continue to be primary providers of both credit and non-credit services for low-income households in the region.

The 2009 Policy Forum in Beirut attracted 23 regulators from 11 Arab countries and was the first such gathering of Arab regulators on financial inclusion. This year, the Forum attracted 25 regulators representing all countries of the MENA region as well as observers from AFI, USAID, IFC, KfW, GTZ, World Bank, and UNDP.

Mrs. Shamshad Akhtar, World Bank Vice President for the MENA region delivered the keynote address, a call to action for government policymakers. While a number of steps are already being taken by some regulators in the region, she said, there is much more government can do to promote financial inclusion including improving financial infrastructure, and providing low cost access through mobile phones and ATMs:

“We need to set our sights higher than a well-regulated and sound financial sector that reaches only a minority of people and firms. We should aim for well-regulated and sound financial sectors that reach a majority.”

The event featured discussions of the wide array of regulatory challenges confronting regulators of the region including:

(i) The advantages and risks of the deposit-taking model: In Egypt deposit-taking services are not allowed, whereas Syria allows MFIs to offer savings services, as Nisreen Karkotly, Head of Research Department at the Central Bank of Syria, pointed out because “deposit-taking institutions are recognized to be more resilient to crisis than non-deposit taking ones as customer savings represent a stable and reliable source of funding.”

(ii) The transformation of NGO-MFIs into commercial institutions: Fouad Abdelmoumni, former Director of Al Amana and member of CGAP Executive Committee, urged MFIs to consider the advantages of transforming from non-profit NGOs into commercial entities: “By transforming, Arab MFIs could access commercial funding and a legal charter to provide a broad range of services helping them achieve their outreach objective on a sustainable basis.”

(iii) Risk management in times of crisis: My colleague Xavier Reille, Lead Microfinance Specialist at CGAP emphasized the shift in microfinance risks that operated between 2008 and 2009: from staffing and capital availability in 2008, to credit risks and macro-economic trends in 2009. He also presented a fictional case study to help microfinance regulators react in uncertain environments, as the microfinance sector is facing uncontrolled growth in several MENA countries.

(iv) The potential for mobile banking and other forms of branchless banking to increase financial inclusion: in an interactive session, Michael Tarazi presented the various existing models of branchless banking with examples from Brazil, Kenya, and other countries.

Some themes that emerged from the discussions were:

• The huge potential of branchless banking to provide low cost access to people,
• The need for a nuanced approach to regulation,
• Better financial infrastructure and support mechanisms,
• A collaborative approach to bringing in the various financial inclusion stakeholders within governments,
• More collaboration with regulators within and outside the region possibly through
• Engagement with the Association for Financial Access (AFI).

A couple of interesting nuggets from the Global Investment Congress in New York last week: first, as my colleagues Xavier Reille and Jasmina Glisovic-Mezieres have highlighted in a recent Web article, microfinance investment vehicles are currently over-liquid. It’s quite a reversal from just a year ago, when in the context of the spreading financial crisis, the concern was lack of liquidity. Today instead the issue for the funds is placing money. Indeed, responsAbility just  announced that it has temporarily suspended new subscriptions to its Global Microfinance Fund in order to reduce the share of liquid assets from 30 percent to 10 percent of the fund volume. (The plea from the microfinance networks was to reach down to Tier II and Tier III MFIs, but as Ann Miles of BlueOrchard pointed out, that’s easier said than done: “We’d love to go deeper in the market and invest in Tier IIs and Tier IIIs,” she said, “But as fund managers wearing our fiduciary hat, we can’t do that. We need investors who are prepared to take more risks…”)

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Lately, I’ve noticed several versions of the statement, “Although much is made of MFIs becoming subsidy independent, few of them have reached this goal.”  I find it pretty hard to square such statements with the evidence.

Among roughly 1300 MFIs reporting to the MIX for 2006, about 565 showed a positive return on assets. Let’s assume that some of these aren’t really sustainable, either because their results are incorrectly reported or because adequate adjustments weren’t made for subsidies they received.  That still leaves hundreds of sustainable MFIs. Read the rest of this page »