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Assessing Credit Risks in the Microfinance Industry June 06, 2008 By Miguel Arvelo, Ju-Lie Bell, Christian Novak, Juliette Rose | In 2007, Morgan Stanley arranged and placed its second securitization of loans to microfinance institutions (MFIs). Taking the form of a collateralized loan obligation, this issue—referred to as “BOLD 2007-1”—was the first rated securitization of loans to MFIs and succeeded in attracting 21 investors, almost twice the number that purchased the firm's similar but unrated transaction (“BOLD 2006-1”) a year earlier. Convinced of investor demand for microfinance investments, Morgan Stanley has developed its own origination platform to provide a capital markets contribution to the projected $2.5-5.0 billion of annual capital demand from MFIs. To support that platform, the firm's Microfinance Institutions Group developed an internal credit analysis and rating approach that allows us to assess the risk of microfinance institutions relative to any other issuers through a global (foreign and local currency) scale rating – an approach that is not currently prevalent in the microfinance industry. Our methodology addresses the specific challenges inherent in microfinance such as country risk, data availability and minimal default history among microfinance institutions. Importantly, the methodology draws upon the work of major pioneers in microfinance rating, including Standard and Poor's June 2007 report on assessing microfinance risks, as well as the analysis of specialized rating agencies like Planet Finance, MicroRate, M-CRIL and CRISIL. We have also incorporated research insights made available by important industry players like ACCION and the Consultative Group to Assist the Poor. Finally, our methodology builds on credit analysis processes used to assess established emerging markets financial institutions and companies, applying the team's extensive experience in emerging markets credit evaluation. This article describes the framework and credit risk assessment process we use to determine internal global scale ratings for microfinance institutions, including a detailed discussion of both conventional and specialized credit evaluation metrics. Our analysis has identified seven “rating factors” that are important to consider when assessing the credit risk of these institutions: (1) loan portfolio; (2) profitability, sustainability, and operating efficiency; (3) management and strategy; (4) systems and reporting; (5) operating procedures and internal controls; (6) asset-liability management; and (7) growth potential. To learn more about this and other articles in the most recent issue of the Journal of Applied Corporate Finance, click here. |