56601 OCCASIONAL PAPER All Eyes on Asset Quality: Microfinance Global Valuation Survey 2010 his report is the result of a partnership between and Central Asia were particularly hard hit, large T CGAP and J.P. Morgan. CGAP is solely areas in South America and South Asia have responsible for the printing and the distribution of witnessed little or no impact. At the same time, a this Occasional Paper. CGAP is not affiliated with few countries (Nicaragua, Bosnia and Herzegovina, J.P. Morgan. Our objective is to provide benchmarks and Morocco) have experienced severe delinquency for valuation of microfinance equity, both private crises but for reasons not directly related to the and publicly listed, drawing on two data sets: a global downturn. sample of 200 private equity transactions between 2005 and 2009 (compared to 144 transactions in Against this backdrop, and to our surprise, last year's edition of the report), which represents microfinance equity valuations globally have the largest such data set gathered to date, and continued to rise. MFIs in the private equity market data on eight publicly traded low-income financial traded at a median of 2.1x book value--a 62 institutions (LIFIs).1 percent increase since 2007 that reflects sustained demand for microfinance equity. The sector also The past year held many challenges for continued to attract a larger pool of capital, with microfinance: not since the Asian crisis of the late Blue Orchard, Microvest, and Developing World 1990s has the sector faced a more difficult economic Markets all establishing new microfinance equity environment. Yet despite these conditions, most funds in 2009, while public investors significantly microfinance institutions (MFIs) proved to be up increased their commitments to microfinance. to the challenge. India in particular has been showing unusually high Beginning in January 2009, MFI portfolio valuations, with large MFIs trading at nearly 6x delinquency levels began to deteriorate rapidly, their book value, or nearly 3x the global median. with loans past due over 30 days (portfolio at risk While the recent impressive growth of Indian MFIs [PAR30]) jumping from a median of 2.2 percent to is expected to continue, in our view their current 4.7 percent during the first five months of 2009, and future earnings expectations do not justify while profitability dropped from a median return on such high multiples. equity (ROE) of nearly 18 percent at year-end 2008 to 6 percent by May 2009.2 However, since June Globally, the microfinance private equity market is 2009 delinquency has moderated and profitability still young and lacking in performance benchmarks. levels have come back to stabilize at 4 percent However, our statistical analysis of private for PAR30 and 10 percent for ROE, respectively. transactions shows that age, income growth, and Most MFIs continue to maintain solid reserve and asset quality are significant drivers of valuations. capitalization levels, with equity ratios unchanged from the 18­20 percent range established over the Publicly traded LIFIs, regarded as the listed vehicles past two years. most comparable to MFIs, have outperformed No. 16 emerging market banks--as measured by the MSCI March 2010 The effects of the downturn were also far from Emerging Markets Banks Index--by 79 percent For CGAP: Xavier Reille, uniform. While Central America, Eastern Europe, since September 2008. As of December 2009, they Christoph Kneiding, and Daniel Rozas; 1 Because there are few publicly listed MFIs, we consider a group of eight listed financial institutions targeting lower-income individuals and note for J.P. Morgan: Nick that their business models are very diverse. O'Donohoe and 2 Numbers based on the Sym50. Refer to the section on data sources that begins on p.5 for more details on this data set. Frederic Rozeira de Mariz 2 had already rebounded to precrisis levels and are continue to expand their client reach, though at a back at their historical peak. Our sample of eight slower rate and with improved risk management. LIFIs did not experience a significant deterioration Equity valuation will continue to attract the interest in the asset quality of their microcredit portfolios and of both public and commercial investors, while are continuing to expand in their respective markets. local banks are likely to step up their strategic However, LIFIs still trade at a discount of 13­23 acquisition of MFIs. In addition, the potential percent compared to emerging market banks. initial public offering (IPO) in 2010 of SKS--the largest MFI in India--should be a key milestone Outlook for 2010 and set the stage for future IPOs in the sector. Despite current market uncertainties, we believe While the effects of high delinquency will continue the medium-term outlook for equity investments to be felt, most MFIs around the world will likely in microfinance will remain positive. Table 1: Private Transactions Historical P/E Historical P/BV Year Unweighted Average Median Unweighted Average Median 2005 9.1 7.9 1.6 1.7 2006 8.6 7.4 1.5 1.3 2007 9.9 7.2 2.0 1.3 2008 10.0 7.9 2.5 2.0 2009 12.9 13.0 2.7 2.1 Source: CGAP. P/E = price-to-earnings ratio; P/BV = price-to-book-value ratio. Table 2: Valuation Summary: Comparing Our Index with Traditional Banks P/E P/BV ROE EPS CAGR 010E 11E 010E 11E 010E 11E 09­11E LIFI Index 12.4 9.9 2.6 2.2 21% 24% 29% Africa 10.9 8.3 1.8 1.7 15% 18% 0% Developed Asia Pacific 22.4 19.2 3.5 3.0 15% 16% 20% Emerging Asia Pacific 13.4 10.9 3.1 2.3 21% 23% 25% Developed Europe 12.0 8.5 0.5 0.5 9% 11% 27% Emerging Europe 10.7 6.5 1.7 1.5 17% 22% 72% Latin America 14.2 10.2 2.7 2.0 20% 20% 17% Market Cap. Weighted Averages for Banks Covered by J.P. Morgan 16.2 13.2 3.0 2.4 18% 20% 28% Source: Bloomberg, company data, J.P. Morgan estimates. ADTV = average daily trading volume for the past three months. Prices as of 23 February, 2010. Notes for the LIFI Index: We used Bloomberg consensus estimates and J.P. Morgan estimates for the individual stocks composing the LIFI Index. The LIFI Index is a market capitalization-weighted index, with the weight of BRI reduced to a fourth because its microfinance portfolio represents only about 25% of its total loan book. Refer to Table 11 for more details. Notes for Global Emerging Markets Banks: We show market capitalization-weighted averages of banks covered by J.P. Morgan analysts, representing a sample of more than 150 banks across global markets. P/E = price-to-earnings ratio; P/BV = price-to-book-value ratio; ROE = return on equity; EPS CAGR = earnings per share compound annual growth rate. 3 Introduction Table 3: Our Sample Represents the Largest Available Data Set to Date The upheaval that hit mainstream financial markets Transactions Transactions and the reverberations that continue to be felt Year (#) (US$mn) across the globe from the resulting economic crisis 2005 28 105.9 impacted MFIs and their clients. The early stages 2006 37 19.9 of the downturn saw MFIs experience significant 2007 37 60.3 liquidity shortages, but as the capital markets recovered, concerns turned from funding to asset 2008 64 146.8 quality. 2009 30 185.9 NA 4 3.3 Rising delinquencies were paralleled by an equally Total 200 -- strong decline in profitability, and although Source: CGAP. NA: dates not available. a minority of MFIs found themselves in serious distress, most have settled at levels that are high by historical standards but not alarming from the Next, we examine trends in valuation benchmarks perspective of losses. for microfinance private equity transactions and analyze the key drivers behind these valuations. Amid the turmoil, the still-nascent microfinance This section also delves into the recent growth in equity market continues to be active, with 42 transaction volume and valuation multiples in India, transactions reported between September which had a particularly active market in 2009. 2008 and September 2009. The vast majority of equity transactions are still in the form of private Finally, we seek to place the microfinance equity placements, with only two pure microfinance IPOs market within the context of the broader equity to date (Compartamos Banco and Equity Bank) market, using comparisons with publicly listed LIFIs and another expected in India in 2010 (SKS). in developing countries. Microfinance has been attracting interest from a growing pool of investors over the last few years, Table 4: Eight Institutions in the LIFI Index with both development finance institutions (DFIs) and private investors boosting their commitment First Cash Financial US/Mexico to the asset class despite the absence of reliable Compartamos Mexico market benchmarks on microfinance equity Financiera Independencia Mexico performance. Banco Panamericano Brazil IPF Mexico/Eastern Europe Responding to this knowledge gap, this Occasional BRI Indonesia Paper aims to shed new light on equity valuation Danamon Indonesia trends in microfinance, which must necessarily African Bank South Africa begin with a detailed examination of how MFIs Source: J.P. Morgan. We indicate the region in which the institution have coped during the recent economic crisis. has the largest presence. Accordingly, the first part of the paper is devoted to MFI asset quality and its impact on microfinance profitability. 4 Box 1: Methodology and Sources Our analysis is based on two original samples: (1) a transactions from 2005 to September 2009 (for a list private transaction data set encompassing 200 equity of contributors see Appendix III). acquisitions involving 86 MFIs and (2) a sample of eight LIFIs. Our sample covers 200 transactions that occurred between January 2005 and September 2009 with an LIFIs are publicly traded commercial institutions that aggregate value close to US$520 million, including 42 provide financial services to customers who overlap transactions collected after the Lehman bankruptcy on significantly with those of MFIs--the low-income 15 September 2008. This is the most comprehensive population in emerging markets. However, in many data set on private equity placements in microfinance cases LIFIs do not necessarily have an explicit social to date. agenda, and their loan portfolios tend to feature more consumer loans than microenterprise ones. For CGAP followed strict procedures to ensure full the sample of LIFIs used here, J.P. Morgan analysts confidentiality of the data reported. These included identified eight LIFIs with a broad microfinance focus. confidentiality agreements with all survey participants Although these institutions present a different risk and and restricted access policies to the database. Only return profile, they nevertheless provide interesting four CGAP staff members, authorized by CGAP's valuation comparables for traditional MFIs. CEO, had access to the underlying data. CGAP was responsible for quality control of the data and Data on private equity transactions were collected by preliminary analysis. Only aggregated benchmarks CGAP in a strictly confidential survey conducted in based on at least five data points were shared with summer 2009. Four DFIs, 13 microfinance investment J.P. Morgan. These aggregated data are available on vehicles (MIVs), and 14 MFIs provided data on their CGAP's Web site, www.cgap.org. J.P. Morgan had no access to the underlying database. Box 2: Microfinance Equity Market MFIs have built an impressive track record in asset consists of 21 specialized microfinance funds with an quality, and their financial performance has been equity focus or holding companies of microfinance documented by Microfinance Information Exchange banks.b These funds grew rapidly in 2008 despite the (MIX)--the reference database for microfinance global crisis. Their equity investments in MFIs have performance--since 1995. As of year-end 2008, there jumped from US$670 million to US$1.1 billion in were 357 banks and nonbank financial institutions 2008.c (NBFIs) reporting to MIX with an aggregate equity base of roughly US$6.2 billion. Eighty-five percent of Leading pension funds, such as TIAA CREF in the equity investments are concentrated in the largest 100 United States and ABP and PGGM in Europe, are MFIs. Eastern Europe and Latin America account for making asset allocations in specialized microfinance almost two-thirds of microfinance equity. In 2008, the equity funds as part of their socially responsible global MFI equity base increased more than US$1.6 investment (SRI) strategies. Their commitments to billion.a the sector, estimated at US$700 million, are growing rapidly. Finally, large private equity firms, such as On the funding side, DFIs such as IFC, KfW, and EBRD Sequoia and Legatum, have made equity investments have stepped up their commitment to the sector as a in select microfinance markets such as India (The response to the economic crisis. Their microfinance Economic Times 2007). We estimate that the total equity portfolios were valued at US$761 million as amount invested by these private institutions is in of December 2008. The second group of investors excess of US$400 million. a MIX panel data for 2007 and 2008. b CGAP MIV survey 2009; the number includes MIVs with an equity portfolio greater than US$10 million, as well as US$600 million from Procredit holding. c Based on CGAP MIV survey 2008 and CGAP estimates for growth projection in 2008. 5 Asset Quality Concerns Though a majority of MFIs felt the impact of the global economic slump, it did not affect all of them The microfinance sector earned its reputation as equally. Most MFIs saw their delinquencies rise a countercyclical industry in the wake of the Asian sharply in the first half of 2009, with a parallel slide financial crisis of the late 1990s, displaying relative in profitability. However, there were significant resilience during the tumult of that period and in deviations from this general trend: some MFIs with the years following. This reputation was burnished pre-existing vulnerabilities, such as uncontrolled by a series of studies that included a review of growth, poor credit methodology, and weak the performance of Bank Rakyat Indonesia during internal controls, found themselves dealing with the height of the Asian crisis (Patten et al. 2001) crisis-level situations and heavy losses. At the same and econometric analyses of MFI performance time, MFIs in a number of microfinance markets, during the six to eight years that followed (Krauss including India and Bolivia, showed no significant and Walter 2008 and Gonzalez 2007). Events of signs of deterioration. the last 12 months have led some to question this reputation as MFI asset quality and profit The rise in delinquency is notable for both its performance deteriorated amid the global breadth and pace, having taken place during the economic slump. first five months of the year. Data since June 2009 Box 3: Data Sources on Asset Quality The lack of available data poses a challenge when America, Eastern Europe, and Central Asia but with analyzing asset quality. If we use the Lehman no MFI data from South Asia and Africa. Nevertheless, bankruptcy as the symbolic beginning of the financial though it may reflect only a subset of the broader crisis (15 September 2008), its impact was not yet microfinance market, we believe Sym50 is fairly reflected in the widely used industry database representative of the types of MFIs that normally maintained by MIX, which compiles only end-of-year receive investments from commercial sources, since data, which are subject to a reporting time lag. Thus, these regions feature well-established microfinance although MIX provides a comprehensive data set of markets with low barriers to foreign investment. 1,500 institutions, only December 2008 data, which do Moreover, Sym50 is heavily weighted toward equity not reflect current market conditions, were available investment targets--banks and NBFIs--that comprise for our analysis. 75 percent of this data set. As a result, we rely extensively on data provided It seems reasonable to assume that when year- by Swiss microfinance investment intermediary end 2009 numbers are compiled for the broader Symbiotics, which collects detailed monthly reports benchmarks, the asset deterioration in the focus of 50 MFIs (Sym50). This data set has significant regions predicted by Sym50 will be reflected in MIX differences with MIX, yet we believe their similarities year-end figures. Figure B3.1 shows a comparison of are sufficient to rely on the more current reporting of Sym50, with different segments of MIX benchmarks, Sym50 as a predictor for year-end 2009 numbers that some reweighted to reflect the former's geographic will become available from MIX later this year. distribution. Although the two data sets share a strong similarity in PAR trends and absolute levels, One important difference is the definition of PAR30: MIX benchmarks for NBFIs and banks, when adjusted while MIX combines both past due and restructured for the geographic weightings described above, align loans in the numerator, Sym50 includes only the former. especially closely to Sym50. The two numbers are thus only partially comparable, though restructured loans are significantly lower and However, South and Southeast Asia have consistently thus only moderately affect the comparisons. shown delinquency rates below the global benchmarks since year-end 2006, and we expect this divergence to Sym50 also has a notably different geographic be evident in 2009 MIX data as well. distribution from MIX, with a heavy focus on South (Box continues on next page) 6 Box 3 (continued) Figure B3.1: Median PAR30* of Sym50 Aligns with MIX Benchmarks 5 MIX Benchmarks (all) MIX Benchmark NBFIs & Banks (wgt for Sym50) Sym50 4 MIX Benchmark South & SE Asia Percent 3 2 1 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Source: Sym50, data through November 2009; MIX benchmarks, data through December 2008. *The definitions of PAR30 differ between Sym50 and MIX, as described below. Asset Quality Measures principal of loans that have been restructured or rescheduled. Asset quality measures provide a view of loan portfolio quality and dictate loss provisioning levels at financial Restructured/Rescheduled/Reprogrammed Loans. institutions. The definitions below reflect different Loans for which the payment schedule, the interest aspects of asset quality. rate, and/or the outstanding principal amounts has or have been renegotiated with the borrower. Portfolio at Risk. PAR is the value of all loans outstanding that have one or more payments of Write-Offs. Write-offs are loans that are deemed interest or principal past due by more than a specified unrecoverable and written off the balance sheet. From number of days (e.g., PAR30 = loans past due > 30 an accounting standpoint, a write-off reduces the loan days). The reported amount includes the balance of book on the assets side and loan-loss reserves on the unpaid principal, expressed as a percentage of gross liabilities side. If reserves are not sufficient to cover for loan portfolio, that is, including all current, delinquent, the loss in loans, equity is impaired. Write-offs can be and renegotiated loans, but excluding write-offs. This expressed in absolute terms and as a percentage of is the definition used in Sym50. Note that the MIX outstanding gross loans. definition of PAR adds to the numerator the unpaid suggest that the rapid decline in asset quality has Unprecedented Drop in Asset Quality largely stabilized. Absent a relapse and a further in 2009 downturn in asset quality, we believe the sector as a whole will emerge from the storm generally At the onset of the crisis, most of the concern intact. Partly as a result of conservative loss reserve about MFIs related to the continued availability practices before the crisis, most MFIs appear to of funding, but MFIs quickly eased their growth have sufficient provisions to absorb write-offs, rates, which, along with the public commitment which we expect to continue to increase through of a number of leading investors to maintain their early 2010, but then moderate and possibly reverse support for the sector, helped avoid many potential in the second half of the year. liquidity problems. As a result, the concerns of 7 Figure 1: Steep Asset Quality Decline in First Half 2009 (median PAR) 5 4 PAR 30 PAR 80 3 Percent 2 1 0 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Source: Sym50, data through November 2009. many investors and practitioners turned from Although similar crises have hit individual countries funding to the deteriorating asset quality seen in in the past, such as Bolivia in the late 1990s, this a number of MFIs. is the first time the world has seen such a large simultaneous drop in the asset quality of a large Rapid declines in asset quality sample of globally distributed MFIs. Moreover, Starting in January 2009, delinquency levels began besides the pace of deterioration, we should a rapid climb, with half of the component MFIs of note that the actual level of delinquency is also Sym50 reporting PAR30 of 4.7 percent or higher historically high for the sector. According to in May 2009, up from 2.2 percent at the beginning MIX benchmarks, the highest sectorwide PAR30 of the year (Figure 1). Even adjusting for some achieved in the last five years on record was slight seasonal variation, this was an increase of 3.2 percent in 2003, while for the focus regions over two percentage points--a doubling of PAR30 represented by Sym50--Eastern Europe and within just five months. The start of a similar Central Asia--the rate has been far lower, having increase is becoming apparent in PAR180--a remained at or below 1.2 percent until 2008. lagging indicator that is more indicative of ultimate losses. This delinquency trend in the Sym50 has Such levels of delinquency directly impact been confirmed by informal conversations with profitability, especially for those MFIs that are other commercial MIVs and is reflected in other used to seeing far lower numbers.3 That said, sources--the 2009 Banana Skins survey of industry while current delinquency levels for any given participants put credit risk as the number one MFI are a source of concern, the more pertinent concern (Lascelles 2009). issue is that, at the country-level, the situation 3 An increase in PAR30 does not necessarily signal an MFI's demise. Based on preliminary analysis of MIX data from 2003 to 2008, a random MFI of over US$1 million in assets had a 1­5% chance of failing during a three-year period. An MFI that reported PAR30 >5% had a 6­10% chance of failure, while one with PAR30 >10% would fail 10­15% of the time. 8 witnessed in the first semester of 2009 is and average figures in Figure 3 suggest that unknown territory for most young microfinance while short-term delinquency (expressed through markets.4 PAR30) is relatively evenly distributed around the median, reprogrammed loans are heavily weighted Deterioration is not uniform toward a minority of particularly distressed MFIs, Looked at more closely, the Sym50 index appears with the rest reporting only minimal levels of to reflect two different yet complementary stories. reprogramming. This supports the hypothesis On the one hand, there is significant broad-based that most MFIs are dealing with elevated but decline in MFI portfolio performance from January still controllable delinquency levels. At the same to June 2009. However, there is also significant time, a minority of MFIs are in distress and are country-level variation at both ends of the spectrum taking remedial action, including extensive loan (Figure 2). rescheduling, to get out of their predicament. Indeed, while increased rescheduling can While most MFIs have experienced significant sometimes signal MFIs attempting to artificially asset deterioration, MFIs in countries such as reduce PAR, the technique has proven to be an Bolivia, Egypt, Kosovo, and most of India are important instrument for distressed MFIs during demonstrating little change in asset quality and previous crises.6 profitability. The differences are apparent at the regional level as well, with South America relatively Is the worst over? stable while Eastern Europe and Central Asia have Recent trends in portfolio performance point to seen extensive asset quality declines. a possible bottoming out of the downturn. Since May 2009, when the global PAR30 delinquency The situation is particularly difficult in three rate peaked at 4.7 percent, asset quality has countries--Nicaragua, Morocco, and Bosnia and actually moderated slightly, having settled at Herzegovina--where most MFIs have been dealing around 4 percent through the three months with large-scale borrower delinquencies. While starting in September (Figure 1). The lagging there may be a couple of possible explanations for indicator PAR180 is still climbing and is likely to this, our initial hypothesis is that in these countries peak in early 2010. The situation has stabilized the economic crisis hit a sector that had already at historically high rates of delinquency, with an been weakened by factors such as unhealthy inevitable impact on profitability. competition, overstretched MFI capacity, and loss of credit discipline. In these cases, the economic Rapid, But Limited, Decline in downturn was not the causative factor, though it Profitability was a critical aggravating variable, turning already ailing markets into full-blown crises.5 If there is a surprise on the returns side, it is that profitability has not been affected more. In fact, Such MFI- and country-level differences are also Figure 4 shows profitability, already in slow decline evident in how MFIs have been using restructured since early 2007, becoming particularly rapid in loans. The levels of divergence between median December 2008. While the early part of this decline 4 This applies to most markets, though according to MIX benchmarks for African and Central American/Caribbean NBFI MFIs, these levels are common and would not be considered elevated. 5 See Chen, Rasmussen, and Reille (2010). 6 At the height of the Bolivian crisis in 1999, BancoSol reported 7% PAR30 while additionally rescheduling some 7% of its portfolio. The tactic was potentially risky as it could have undermined its borrowers' repayment incentive (Rhyne 2001). 9 Figure 2: Deterioration Is Not Uniform (median PAR30) 14 12 Nicaragua 10 Bosnia Sym50 8 Percent Bolivia 6 4 2 0 Dec. 07 Jun. 08 Dec. 08 Jun. 09 Dec. 09 Source: Sym50, data through November 2009, ASOFIN (Bolivia), CGAP for Bosnia and Nicaragua. Figure 3: Distribution of Delinquent Loans Has Not Changed, whereas Reprogramming Rates Have Increased among Distressed MFIs 6 1.60 PAR 30­average (L) 5 PAR 30­median (L) Reprogrammed­average (R) 1.20 Reprogrammed­median (R) 4 Percent 3 0.80 Percent 2 0.40 1 0 0.00 Dec. 06 Dec. 07 Dec. 08 Dec. 09 Source: Sym50, data through November 2009. in 2008 may have been precipitated by other the rapid rise in delinquencies (Figure 5) and the causes, such as higher funding costs or foreign consequent increased loss provisioning taken by exchange losses (Littlefield and Kneiding 2009), the MFIs. This pattern is consistent for both return the steep drop seen early in 2009 closely parallels on assets (ROA) and ROE. 10 Figure 4: Rapid Decline in Median Profitability (ROA) in First Half of 2009 5 ROA 4 3-month moving average 3 Percent 2 1 0 Dec-06 Dec-07 Dec-08 Dec-09 Source: Sym50, data through November 2009. Figure 5: Drop in Median Profitability (ROE) Mirrors Increase in PAR 30 6 20 4 Percent Percent 10 2 ROE (L) PAR30 (R) 0 0 Dec-06 Dec-07 Dec-08 Dec-09 Source: Sym50, data through November 2009. Since hitting bottom in mid-2009, profitability has MFI Capital Is Still Relatively Safe rebounded slightly, with ROE settling at around 10 percent--about half the level recorded over When the crisis hit, most MFIs were able to maintain the two preceding years. However, in the short their capital base largely because of the relatively term, the high delinquency rate will likely keep high loss reserves they had maintained prior to profitability depressed until asset quality returns 2009. But reserves are diminishing significantly: to historical levels. as with ROA, the median coverage ratio of PAR30 11 had already been in decline prior to the crisis, Since then, loss reserves have rebounded in line having fallen by 11 percent between January with the moderation in PAR, but still at significantly 2007 and November 2008 (Figure 6). But the pace lower levels from before, settling at around 110 quickened in 2009: even after controlling for the percent of PAR30. Despite this softening, with the December cyclical bump, some 15 percent of current levels of delinquency, existing loss reserves loss reserves were exhausted during the first two should be fully sufficient for most MFIs to cover months of the year--exactly when the rapid rise in eventual losses without having to impair their delinquency was taking place and profitability was equity (Figure 7).7 Moreover, solvency is generally falling fastest. Thus, prior policies in management not a concern as most MFIs remain very well of loan-loss reserves helped cushion the drop in capitalized, with median equity levels not having profitability in 2009. Figure 6: Median Reserves Have Declined ... 160 5 150 4 140 Percent 3 Percent 130 2 120 Risk Coverage (L) 1 110 PAR > 30 (R) 100 0 Dec-06 Dec-07 Dec-08 Dec-09 Source: Sym50, data through November 2009. Figure 7: ... But Median Reserve and Equity Buffers Are Intact 30 Equity/Assets Loan Loss Reserve PAR > 30 Days 20 Percent 10 0 Dec-06 Dec-07 Dec-08 Dec-09 Source: Sym50, data through November 2009. 7 An unpublished study by Adrian Gonzalez (MIX 2009) suggests that about 25% of loans delinquent over 30 days end up as write-offs the following year. 12 deviated from the nearly static range of 18­20 for others are being quickly developed in countries percent of total assets established in mid-2007. such as India. However, while these capitalization levels should Meanwhile, despite the difficult backdrop, give confidence, they would not necessarily apply commercial and public investors have to all MFIs. Some countries are also generally more demonstrated their continuing commitment exposed than others, with India, for example, to the sector, providing fresh equity and much having a particularly low equity cushion and high needed technical assistance packages to MFIs as financial leverage. well as organizing the restructuring of particularly distressed ones, such as Banex in Nicaragua and While a second dip in delinquency levels is Normicro in Azerbaijan. still possible and MFIs with already high PAR remain vulnerable, we see a number of positive The current focus of MFIs on resolving their asset developments. Affected MFIs have been quick quality issues along with the commitment on the to react to the crisis, slowing their growth and part of investors to tackle problems instead of tightening their credit policies. To improve risk cutting losses and pulling out makes us optimistic management and prevent over-indebtedness, credit about the sector's medium-term outlook. The bureaus are in the process of being established in watershed events of the past year may have Morocco and Bosnia and Herzegovina, while plans caught the sector unawares, but it has proved to be largely up to the challenge. 13 Valuation of Private Equity on the valuation of MFIs. Although the data set Transactions--MFIs is limited in size and might not be representative of each country situation, our analysis provides It is natural to expect the significant deterioration insights on market benchmarks and valuation in both asset quality and profitability at MFIs to drivers in the private market. A detailed overview be reflected in the valuation of MFI equity and of this analysis is presented in Appendix II. transactions. Remarkably, this is not the case, and indeed in some markets, most notably India, Valuations Continued Rising in 2009 there are signs of equity valuations outstripping Despite Adverse Economic Conditions fundamental benchmarks. Our 2009 report predicted lower valuations for Accordingly, this section looks at equity valuations private transactions for the year, moving toward of MFI shares traded on the private market in 1x historical book value. We were concerned light of three questions: What are the trends in about the impact of the global crisis on MFIs microfinance valuation in the private market in the and expected equity write-downs on the back of context of the global crisis? What are the significant rising past due loans and foreign exchange losses. valuation drivers for investors and MFIs? Are MFI This deterioration did in fact occur: both asset valuations in India showing signs of "irrational quality and profitability saw large declines across exuberance"? Our analysis is based on a sample the board in 2009, though some markets suffered of 200 private equity transactions that occurred more than others, as highlighted in the first part of between 2005 and 2009, including 42 transactions this paper. But, to our surprise, valuations continue after September 2008. to rise. We conducted a statistical analysis of the data Historical and forward book multiples continued set and explored the influence of eight variables their upward trend in 2009 (see tables 6 and 7). Table 5: Number and Value of Transactions, by Year 2005 2006 2007 2008 2009 NR Total Transactions (#) 28 37 37 64 30 4 200 Transactions (US$mn) 105.9 19.9 60.3 146.8 185.9 3.3 -- Source: CGAP. 2009 includes the purchase of Edyficar by Banco del Credito de Peru for US$96mn, announced on 7 September 2009. NR = Not reported. Table 6: Upward Trend in Valuations Confirmed in 2009 Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median 2005 9.1 7.9 1.6 1.7 2006 8.6 7.4 1.5 1.3 2007 9.9 7.2 2.0 1.3 2008 10.0 7.9 2.5 2.0 2009 12.9 13.0 2.7 2.1 Source: CGAP. P/E = price-to-earnings ratio; P/BV = price-to-book-value ratio. 14 Table 7: Breakdown, by Region: Historical Price-to-Book-Value in Asia Increases by 50% in 2009 Median Historical P/E Median Historical P/BV 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 Africa 5.6 6.2 17.1 13.2 NA 0.9 1.2 1.6 1.8 NA Asia NA NA NA 6.9 NA 1.7 2.0 5.1 2.9 5.0 ECA 9.3 8.6 13.8 9.4 14.5 1.8 1.3 1.0 2.1 2.2 LAC NA 6.7 5.6 7.8 NA 1.4 1.2 1.1 1.2 1.3 Source: CGAP. NA = fewer than five transactions. P/E = price-to-earnings ratio; P/BV = price-to-book-value ratio; ECA = Eastern Europe and Central Asia; LAC = Latin America and Caribbean. Price-to-earnings multiples increased significantly given the severity of the economic crisis in this and reached their peak of 13x in 2009. Median region, but it is important to acknowledge that price-to-book multiples increased to 2.1x in 2009 transactions reported in our sample represent versus 2.0x in 2008. high-quality MFIs that have shown impressive resilience to the economic downturn. Not enough Multiples are increasing across all regions transactions were reported in the Africa region to The regional breakdown of valuations (Table 7) produce reliable benchmarks for 2009. shows that in 2009 investors paid significantly more across all regions compared to the 2005­ Forward multiples remained significantly below 2008 period. With valuations at 5x book value, historical multiples in 2009, reflecting a positive Asia8 commands the highest multiples, followed outlook on MFI earnings prospects (figures 8 and by Eastern Europe and Central Asia and by Latin 9). In our view, investors still expect high earnings America and the Caribbean. The upward trend growth in 2010 notwithstanding the difficult market in Eastern Europe and Central Asia is surprising environment. Figure 8: Price-to-Book Multiples Figure 9: Price-to-Earnings Multiples Increasing Increasing 2.1 13.0 2.0 10.8 10.4 1.7 1.7 1.4 Historical 8.7 Historical 1.3 1.3 1.3 7.9 7.9 8.0 Multiples 7.4 7.2 Multiples 1.1 1.0 (Medians) 5.8 (Medians) 0.9 0.9 5.2 4.3 Expected Expected Multiples Multiples (Medians) (Medians) 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 w/out w/out India India Source: CGAP. Source: CGAP. 8 Valuations in Asia have an upward bias, due almost exclusively to transactions in India, which account for more than 80% of all Asian transactions in our 2009 sample. 15 Figure 10: Expected Price-to-Earnings Multiples (Median): Asia on the Fast Track 14 12 Earnings multiples (median) 10 8 ECA 6 Latin America 4 Asia 2 0 2005 2006 2007 2008 2009 Source: CGAP. In fact, except for Latin America in 2009, none Despite the global meltdown, foreign investors of the regions has experienced a noteworthy continued to step up their investment in year-on-year drop in expected price-to-earnings microfinance. Specialized microfinance funds multiples since the inception of this survey (Figure increased their equity portfolio by 54 percent, up to 10). While multiples in Latin America have been US$1.1 trillion in 2008. Several new funds, including oscillating around a median value of 5, Asia has the Blue Orchard Fund and the Developing World outpaced all other regions with a compound Markets Equity Fund, were launched in the first annual growth rate of 60 percent, taking it from quarter of 2009. the lowest median valuation in 2005 to a head-on- head competition with Eastern Europe and Central In addition, local banks took advantage of the crisis Asia for the top of the valuation table by 2009.9 to make some strategic MFI acquisitions. Several These variations among regions and across the flagship transactions have been reported publicly, years are characteristics of a young asset class including the purchase of Edyficar by Banco de lacking market reference and investor consensus Crédito del Perú, Banco Solidario by Bank Uno on valuation. in Ecuador, Opportunity Bank Montenegro by Austrian Erste Steiermaerkische Bank, and Finsol Investors Increased Their Allocation to by Financiera Independencia in Mexico. Thus, the Microfinance in 2009 and Focused on combined new capital of banks and commercial MFIs with Good Asset Quality investors flowing into a narrow equity market of more than 400 institutions as well as few sales from The microfinance private equity market remained existing investors boosted MFI pricing upward. active despite the virtual shutdown of capital markets following the fall of Lehman Brothers: 42 Another reason for the continued rise in equity transactions, with a total value of US$205 microfinance valuations is the relatively strong million, have been reported to CGAP. asset quality indicators for MFIs receiving equity 9 Africa had to be dropped from this graph because the yearly number of transactions was too low to be presented. 16 Figure 11: Lower Asset Quality Negatively Affects Expected Price-to-Earnings Size of bubbles: Total MFI assets in 2008 14 12 India Median Expected P/E (2004­09) 10 8 Mongolia Tajikistan 6 Bolivia Peru 4 Cambodia Uganda Nicaragua 2 0 ­1 0 1 2 3 4 5 Median PAR30 (2004­09) (%) Source: CGAP. capital. The average MFI PAR30 2008 for the 2009 correlation between PAR30 and expected price- transactions reported to CGAP is 2.6 percent to-earnings multiples, controlling for a variety of versus a MIX average of 3.1 percent.10 Good asset factors, including geographic location, profitability, quality appears to be a precondition for attracting and transaction value. equity investments. Asset Quality, Net Income Growth, and Indeed, most transactions reported to CGAP after Age of the MFI Drive Valuations September 2008 occurred in resilient markets with good portfolio quality, such as India. Our data Profitability does not seem to drive set shows no transactions in the three worst hit valuations markets--Nicaragua, Bosnia and Herzegovina, In mature private equity markets, book value and Morocco--and very few transactions involving multiples are positively correlated to return on distressed MFIs. equity. Figure 12 presents the current price-to- book-value multiples of 150 banks across the world Our analysis indicates that higher delinquency covered by J.P. Morgan against the expected (expressed as PAR30) exacted a hefty discount average ROE for 2009­2010. ROE appears to on valuation multiples. Our regression model drive price-to-book-value multiples, with a strong (see Appendix II) shows a significant negative correlation coefficient of 70 percent. 10 MIX 2008 MFI benchmarks. 17 Figure 12: Regression of Return on Equity and Price-to-Book Multiples for 150 Banks across Global Markets 8.0x 7.0x Compartamos Current Price-to-Book Multiple Indian MFIs 6.0x 5.0x 4.0x 3.0x 2.0x 1.0x 0.0x 0 5 10 15 20 25 30 35 40 ROE (2010­11) (%) Source: J.P. Morgan estimates, Bloomberg. Prices as of 23 February, 2010. We used current price-to-book-value multiples and average return on equity for 2010 and 2011, as forecast by J.P. Morgan analysts. We note that correlation reaches 69%, with a y-intercept at ­0.1 and a slope of 13.2. Table 8: Matrix of Equivalence Theoretical ROE P/BV 0% ­0.1x 5% 0.6x 10% 1.2x 14% 1.8x 15% 1.9x 20% 2.6x 25% 3.2x 30% 3.9x 35% 4.5x 40% 5.2x 45% 5.9x 50% 6.5x 55% 7.2x 60% 7.9x Source: J.P. Morgan estimates, using the relation between return on equity (ROE) and price-to-book-value (P/BV) multiples, as described in Figure 12. We highlight the lines corresponding to an ROE of 14% and a P/BV multiple of 5.9x, as those are the figures corresponding to the Indian microfinance market. 18 However, this relationship does not hold true in measures, indicating again a lack of consensus on our sample of MFIs. Plotting price-to-book-value MFI valuations (see Appendix II for details on the and profitability as done in Table 9 and Figure regression model). 13 shows no relationship between these two Table 9: No Significant Correlation between Price-to-Book Value (P/BV) and Profitability (ROE) Unweighted Average Median P/BV ROE (%) P/BV ROE (%) Bolivia 1.1 21.1 1.1 19.3 Cambodia 2.1 26.7 1.9 28.5 Ghana 2.3 8.3 2.0 13.2 India 5.4 14.2 5.9 16.1 Mongolia 1.9 19.6 2.1 18.7 Nicaragua 1.7 26.2 1.3 29.1 Peru 1.3 20.5 1.2 21.0 Tajikistan 1.4 ­3.2 1.4 3.3 Uganda 1.5 12.1 0.9 11.5 Africa 1.9 1.5 1.6 8.1 Asia 3.4 9.1 2.5 15.9 ECA 1.9 15.6 1.8 19.1 LAC 1.5 21.6 1.3 20.0 Source: CGAP. Figure 13: No Significant Correlation between Price-to-Book Value (P/BV) and Profitability (ROE) Size of bubbles: Total MFI assets in 2008 7 6 India Median Historical P/BV (2004­09) 5 4 3 Mongolia Ghana Cambodia 2 Bolivia Tajikistan Peru Nicaragua 1 Uganda 0 0 5 10 15 20 25 30 35 Median ROE (2004­09) (%) Source: CGAP. Median numbers are shown in this chart. There is no relationship between ROE and P/BV in the case of MFIs, suggesting an immature market. In mature markets, the P/BV multiple paid for a financial institution depends on the profitability of the institution as measured by its ROE. 19 MFIs in Eastern Europe and Africa are trading at Net income growth is a key driver of the same level of 1.9x price-to-book-value while valuation the average ROE for Africa MFIs is 1.5 percent and Price-to-earnings multiples are positively correlated 15.6 percent for Eastern Europe MFIs. Investors do with income growth as demonstrated in Table 10 not appear to put too much weight on current ROE and Figure 14. Investors assign a clear premium to but are looking at other factors, such as growth in earnings growth prospects. However, this analysis earnings and market size. does not take into account the effect of equity dilution on valuation. Table 10: Growth Prospects Exert Significant Influence on Pricing Unweighted Average Median P/E Income Growth (%) P/E Income Growth (%) Bolivia 6.3 28.3 6.6 33.5 Cambodia 6.8 41.9 4.7 26.4 India 23.5 82.3 26.7 121.9 Mongolia 11.4 42.7 11.3 28.0 Nicaragua 6.7 19.5 5.0 20.3 Peru 9.1 73.1 6.8 30.1 Tajikistan 17.9 96.8 13.8 89.0 Uganda 8.1 ­6.1 6.0 22.0 Africa 11.7 17.9 11.6 22.3 Asia 9.2 55.8 4.8 52.5 ECA 11.8 47.2 10.5 31.0 LAC 8.3 54.2 6.9 25.5 Source: CGAP. P/E = price-to-earnings ratio. Figure 14: Growth Prospects Exert Significant Influence on Pricing Size of bubbles: Total MFI assets in 2008 35 30 India Median Historical P/E (2004­09) 25 20 15 Mongolia Tajikistan 10 Peru Bolivia Uganda 5 Nicaragua Cambodia 0 0 20 40 60 80 100 120 140 160 Net Income Growth (2004­09) Source: CGAP. Median numbers are shown in this chart. P/E = price-to earnings ratio. 20 Premium for younger MFIs living below $1.50 a day, while the combined MFI Investors pay higher multiples for younger MFIs. and self-help group (SHG) market serves only an Our regression analysis (see Appendix II) shows estimated 67 million borrowers today (Srinivasan that this trend is broad-based and stable across 2009).11 Thus India's still unmet demand for earnings and book multiples. It is important to microfinance remains the highest in the world. note that this analysis is already controlling for size of the institution, which is highly positively Moreover, Indian MFIs are some of the best correlated to valuations. Investors appear to place performers of the sector. From 2003 to 2008, they a premium on an institution's growth potential. have enjoyed the world's highest growth rate in Younger MFIs tend to grow faster than their more both assets and net income (over 100 percent established counterparts. Moreover, new and per year on each metric over the last five years). more commercially oriented MFIs tend to have They have maintained excellent asset quality (2008 professional management and more aggressive median PAR30 at 0.36 percent versus 2.98 percent growth models. globally for NBFIs) and a low-cost model, with a median efficiency ratio of 11 percent compared To summarize, asset quality, net income growth, to 19.8 percent for NBFIs globally.12 Large Indian and age of the MFIs are the main drivers of price as NBFIs also have excellent management teams and demonstrated by our statistical analysis. However, sound systems, according to CRISIL Ratings (2009). we recognize that other drivers of valuation should The Indian market is significantly concentrated, be taken into account by investors, such as the size and this trend is growing: the top five MFIs already of the transaction, the country where the MFI is account for 61 percent of total clients and are located, its legal status, current profitability, cost leveraging their scale and capital market access structure, financial leverage, and funding base. to grow at 2.5 times the rate of the next 10 MFIs (M-CRIL 2009). The Case of India: High Valuations in a Dynamic Market But current valuation levels are cause for concern India has been a major market for private equity In 2009, Indian MFIs have been sold on the private transactions this year, accounting for over 30 equity market at a median of 5.9x book value versus percent of the transactions in our sample. Even 2.1x globally. In our view, such high valuations of more surprisingly, microfinance appears to be the Indian MFIs are difficult to justify: dominant target for private equity in India, with MFIs having comprised 40 percent of all private 1. Current profitability is a moderate 14 equity transactions in the country during the past percent and relies on high leverage. Our two years (Bhadra 2009). Perhaps this should not be analysis of the relationship between price-to- unexpected, given the high growth rates of Indian book and ROE suggests that, to justify the MFIs and the still very large market potential. current valuations, the average ROE of Indian MFIs should stand around 45 percent (Table India has great potential for microfinance 8). However, microfinance NBFIs in India India presents the single largest microfinance are generating a median ROE of only 14.4 market in the world, with over 600 million people percent,13,14 with the largest five institutions 11 Note that the 67 million clients reported include significant double-counting of multiple borrowers, so the number of potential clients with no access to microfinance is even higher than these number imply. 12 MIX benchmarks 2008 adjusted data (http://mixmarket.org/mfi/benchmarks). 13 MIX benchmarks 2008 unadjusted data. 14 A high level of ROE would in fact allow the bank to grow its book value per share at a high pace, which would naturally decrease the price-to-book-value multiple over time. This is the case of Compartamos, which enjoyed a very high average ROE of 43% in 2009. Its current price-to-book multiple of 6.7x is therefore prone to decrease as the bank grows its book value by 32% over the next three years, according to J.P. Morgan estimates. 21 showing substantially higher numbers. profitability to decline in the near term as Moreover, this ROE is already significantly MFIs expand into less penetrated areas, inflated by increased leverage--the top given the relatively higher operating cost 50 Indian MFIs have a leverage ratio (debt- such expansion incurs. At the same time, we to-equity) of 7.2x (CRISIL Ratings 2009), in believe margins will begin to shrink in the contrast to the global MIX average of 3.3x more competitive markets in the south. for NBFIs. 5. Overvaluation is driven by excess capital 2. Investors should not pay for growth per flows, in our view. India garnered 35 percent se. There still is a huge underserved market of microfinance private equity investments in in India, and MFIs have grown dramatically 2008 and 25 percent in 2009.15 A significant over the last few years to service it. However, share of these flows comes from investors growth in market share or in the number of whose objective is to realize profits by floating clients does not necessarily translate into or otherwise exiting their investments in a growth in earnings or solid profitability, as relatively short time frame. In many cases in measured by ROE. the past (such as during the dot com bubble in 3. Low delinquency levels may not be the 1990s), this type of capital has produced sustainable. Indian MFIs have maintained overvaluation of equity prices in the short excellent portfolio quality so far, but we term and disappointment in the long term. question whether the low level of loan losses is sustainable. In particular, we are concerned Although our analysis suggests a market by the signs of overheating in some Indian dominated by high-valuation transactions, we states, such as Andhra Pradesh and Karnataka, recognize that our data set is limited and may not as well as the decline in credit origination be representative of all MFI equity deals in India.16 standards reported by CRISIL. However, partly A number of domestic microfinance investors, in recognition of these issues, leading Indian such as SIDBI, are active in the equity market, and MFIs have recently begun concerted efforts we believe they are investing at lower valuations. to develop industry standards, such as setting Moreover, there are still attractive social investment combined maximum debt limits for multiple opportunities in India in small and medium-size borrowers and developing a credit bureau to MFIs in underserved regions, although their capital facilitate information sharing (Microcapital absorption capacity is limited due the growing Monitor 2009). If implemented effectively, market dominance of the larger players. these measures should significantly reduce the risk of credit bubbles in Indian microfinance. Developments in India should be watched by 4. Microfinance penetration is high in select all microfinance investors. Given India's market regions. MFIs are heavily concentrated in presence, its potential impact could be felt across the southern states, with relatively little the entire microfinance sector. presence in other regions. We expect overall 15 CGAP equity valuation database. 16 Of the 21 Indian transactions in our data set, only four deals were valued below 4x book value, whereas seven were over 6x book value, and six were so high (above 10x book value) as to be deemed outliers for the purposes of our analysis. 22 Valuation of Public Transactions-- and (2) two emblematic LIFIs, namely Mexico's Low-Income Finance Institutions Compartamos and Bank Rakyat Indonesia (BRI). The private market for MFI equity transactions Nonperforming loan (NPL) ratios have having shown remarkable resilience in the face of increased since the beginning of the crisis deteriorating asset quality and profitability, one but remain below historical levels needs also to examine the broader context of Asset quality deteriorated across product lines the publicly listed market for guidance on future both in Mexico and Indonesia. The Mexican Central trends. As the pool of listed MFIs is extremely Bank reported that the NPL ratio of Mexican banks limited, this means comparing to other, similar, increased to 3.0 percent at the end of September institutions. 2009 from 2.1 percent in June 2008 and appears to have stabilized around that level.17 Similarly, In this section we look at valuation trends for LIFIs the NPL ratio at Compartamos, defined as loans in the public markets. LIFIs may not necessarily past due over 90 days to total loans, increased to share the double-bottom-line business model of 2.3 percent in September 2009 from 1.4 percent most MFIs, but they operate in the same markets, in June 2008. providing financial services (consumer and microenterprise loans, payments, and insurance) In the case of Indonesian banks, the Central Bank to lower income segments of the population. As of Indonesia reported an increase of 80 basis such, they offer interesting comparables to MFIs. points in the NPL ratio18 between September 2008 We have identified eight such institutions. and the peak in loan delinquencies in May 2009, when the NPL ratio reached 4.9 percent. The NPL In this section we examine answers to the following ratio has decreased since then and reached 4.3 questions about asset quality and stock price percent in September 2009. At BRI, the NPL ratio, performance of LIFIs in the context of the global defined as loans that are overdue by 91 days or crisis: more, increased to 3.9 percent in September 2009 from 3.4 percent in June 2008. · How did LIFIs' asset quality evolve in the recent past and is their capital well covered? The increase in NPLs for regulated banks in these · How did the LIFI Index, first introduced in last two countries is mild and far short of the fears year's report, perform in the context of the analysts expressed when the crisis started to unfold. financial crisis? And the publicly listed MFIs, Compartamos and · How did the LIFI Index compare with BRI, were only moderately affected by the crisis. mainstream banks? The group lending loan portfolio of Compartamos resisted particularly well: its NPL ratio increased Asset Quality Deteriorated During only from 0.4 percent in September 2007 to 0.7 the Crisis percent in September 2009.19 Similarly, the BRI microcredit portfolio exhibits the same resilience We used two distinct data sets: (1) data for the seen in previous crises, with its NPL ratio increasing banking systems of Indonesia and Mexico, which from 1.2 percent at the end of 2007 to only 1.7 are two of the largest microfinance markets, percent in September 2009. 17 The Mexican Central Bank compiles data for Mexican banks and reports the data quarterly. As a result, it does not incorporate data for NBFIs (such as Financiera Independencia) and NGOs. The Central Bank of Mexico defines NPLs as loans past due over 90 days. 18 The Central Bank of Indonesia defines NPLs as loans that are past due 91 days or more. 19 Group lending represented 74% of the bank's total loan portfolio as of September 2009. The rest of the portfolio consisted of additional loans, individual loans, and home renovation loans. 23 Figure 15: Compartamos NPL Ratio Figure 16: The NPL Ratio at Mexican Banks Increased from 1.4% in June 2008 (before Increased from 2.1% in June 2008 to 3.0% in the crisis) to 2.3% in September 2009 September 2009 2.5 3.5 3.0 2.0 2.5 Percent Percent 1.5 2.0 1.0 1.5 1.0 0.5 0.5 0.0 0.0 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Year Year Source: Company data. NPL ratio defined as loans past due 91 days Source: Banco de Mexico, data up to October 2009. or more. Data up to September 2009. Figure 17: BRI NPL Ratio Increased from Figure 18: The NPL Ratio at Indonesian 3.4% in June 2008 (before the crisis) to Banks Increased from 4.1% in June 2008 to 3.9% in September 2009 4.3% in September 2009 6.0 7.0 5.0 6.5 6.0 4.0 5.5 Percent Percent 3.0 5.0 2.0 4.5 4.0 1.0 3.5 0.0 3.0 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Source: Company data. NPL ratio defined as loans past due 91 days Source: Central Bank of Indonesia, CEIC. NPL ratio defined as loans or more. Data up to September 2009. past due 91 days or more. Data up to September 2009. The Strength of Bank Capital Varies by average of 3.0 percent in Mexico. Moreover, this Country ratio of 3.0 percent for Mexican banks is well below levels seen at the beginning of the decade (when Despite the recent spike in NPLs, the delinquency NPLs reached 15 percent), as shown in Figure rates of the two banking systems analyzed in 20. Similarly, the NPL ratio of Indonesian banks this section (Mexico and Indonesia) remained at decreased during the decade from 18.8 percent historically low levels. This is different from the at the end of 2000 to 4.3 percent in September results for MFIs in the first part of this paper, for 2009. which delinquency rates had reached historical highs. To assess the soundness of the two banking systems, we analyze their coverage ratios of past The NPL ratio of Compartamos at 2.3 percent in due loans (defined as loan-loss reserves to past September 2009 remains below the banking system due loans). The average coverage ratio for Mexico 24 Figure 19: Mexico: NPLs Went Down and Coverage Ratio Remains above 120% 250 15.0 NPL Ratio 12.5 Coverage Ratio 200 10.0 Percent Percent 150 7.5 5.0 100 2.5 0.0 50 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Source: Banco de Mexico, data up to October 2009. Figure 20: Indonesia: NPL Went Down and Coverage Ratio Reached 135% as of September 2009 250 15.0 NPL Ratio 230 Coverage Ratio 210 12.5 190 10.0 170 Percent Percent 150 7.5 130 5.0 110 90 2.5 70 0.0 50 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Source: CEIC, data up to September 2009. and Indonesia stood, respectively, at 131 percent September 2009, significantly above the average and 144 percent in September 2009, relatively coverage ratio of MFIs, as analyzed in the first part high levels by international standards. BRI and of this paper, which stood at around 115 percent Compartamos also enjoyed comfortable coverage at the end of 2009. ratios of more than 150 percent at the end of 25 Despite Stresses in Asset Quality, in the United States. It is a hybrid, short-term, Valuations of LIFIs Increased and fully collateralized consumer lender and a deep Outperformed Mainstream Banks' discount retailer of forfeited collateral. The bank had US$279 million in total assets as of September Definition of the LIFI Index 2009. It is listed on Nasdaq and sees trading The LIFI Index groups eight publicly listed volume averaging US$4.0 million daily. institutions, including banks and NBFIs, that provide financial services to the lower income Banco Panamericano is a regulated bank in Brazil demographic. It is a market cap-weighted index, that offers consumer lending. The bank had US$5.9 covering various geographies and business models. billion in total assets as of September 2009 and The index includes institutions based on four US$4.5 billion in total loans. Its loan portfolio breaks criteria: (1) the LIFI offers mostly financial services down into 55 percent auto loans, 24 percent credit and targets the lower income segments of the cards, and 13 percent payroll-deducted loans. The population; (2) it is publicly listed on an exchange; average loan size is US$4,000. The company is (3) financial information is easily available; and (4) listed on the Sao Paulo Stock Exchange (Bovespa) its stock has good daily liquidity. and has an average daily trading volume of US$2.8 million. The index includes banks that are not exclusively offering working capital loans to The LIFI Index outperformed mainstream microentrepreneurs, broadening the scope banks and is trading 1 percent below its to include consumer loans. The selected LIFIs peak in 2007 are BRI, Danamon, Compartamos, Financiera A review of the historical performance of the Independencia, African Bank, IPF, First Cash index shows strong performance against emerging Financial, and Panamericano. We note that two market banks and mainstream banks in global LIFIs, First Cash and Panamericano, have been markets. added to this year's edition of the index, in order to expand its scope. In Figure 21, we back-tested the index since November 2003 with the first set of four LIFIs First Cash Financial is the second largest pawn (African Bank, BRI, Danamon, and First Cash shop operator in Mexico and the third largest Financial). The index incorporates more LIFIs as they become listed: Compartamos (April 2007), IPF Table 11: Eight Institutions in the LIFI Index (July 2007), and Independencia and Panamericano (November 2007). Over the long run, the index First Cash Financial US/Mexico outperforms traditional banks by 714 percent, as Compartamos Mexico reflected by the MSCI Financials Index. Financiera Independencia Mexico Banco Panamericano Brazil The index has a base of 100 as of 10 November IPF Mexico/Eastern Europe 2003. Since the index peaked at 801 on 2 BRI Indonesia November 2007, it performed in line with the MSCI Danamon Indonesia World Financials Index until October 2008. It has African Bank South Africa since strongly bounced back and is now trading Source: J.P. Morgan. We indicate the region where the institution close to its peak. has the largest presence. 26 Figure 21: The LIFI Index Outperforms Banks in the Long Run 1,000 JPM LIFI Index MSCI World Financials MSCI EM Banks 800 600 LIFI Index 400 200 0 Nov-03 Aug-04 May-05 Feb-06 Nov-06 Aug-07 May-08 Feb-09 Nov-09 Source: Bloomberg, J.P. Morgan. Base = 100 as of 10 November 2003. The index at inception consisted of four institutions (BRI, Danamon, African Bank, and First Cash Financial) and included the other four MFIs (Compartamos, Financiera Independencia, Panamericano, and IPF) when they went public in 2007. Priced as of 23 February, 2010. Figure 22: The LIFI Index Is Trading 1% below Its Peak in December 2007 120 JPM LIFI Index MSCI World Financials MSCI EM Banks 100 80 LIFI Index 60 40 20 0 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Source: Bloomberg, J.P. Morgan. Base = 100 as of 10 November 2007. Priced as of 23 February, 2010. Figure 23 shows the relative performance of the the crisis, the LIFI Index outperformed the LIFI Index and MSCI World Financials Index since MSCI World Financials Index by 79 percent. the Lehman bankruptcy in September 2008. The The main contributors to the performance were LIFI Index bounced significantly above its pre- Compartamos and BRI, the most liquid stocks in September 2008 level, making up for the losses the index. of the past 14 months. Since the beginning of 27 Figure 23: LIFI Index Outperformed Global Banks by 79% since Lehman Bankruptcy (15 September 2008) 200 JPM LIFI Index MSCI World Financials MSCI EM Banks 150 LIFI Index 100 50 0 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Source: Bloomberg, J.P. Morgan. Base = 100 as of 15 September 2008. Priced as of 23 February, 2010. Despite the Outperformance, LIFI Index trading at a lower multiple, all other things being Still Trades at a Discount to Mainstream equal. This represents a discount of approximately Banks 23 percent for LIFIs versus mainstream banks. The LIFI Index trades at a 13­23 percent Moreover, the LIFI Index trades at a discount discount to mainstream banks to mainstream banks in terms of price-to-book The table below shows that the LIFI Index trades multiple, in spite of having a higher average ROE at a discount in terms of price-to-earnings multiple at 22 percent in 2010e­11e versus 19 percent for at 12.4x forward earnings, while mainstream mainstream banks. LIFIs trade at a discount of 13 banks trade at 16.2x forward earnings. However, percent compared to mainstream banks, with a earnings-per-share (EPS) growth is similar for price-to-book value multiple of 2.6x, versus 3.0x LIFIs and for mainstream banks at roughly 28­29 for mainstream banks. percent, on average, suggesting that LIFIs are 28 Table 12: Valuation Summary: Comparing Our Index with Traditional Banks P/E P/BV ROE EPS CAGR Country of Mkt. Cap ADTV Local Company Ticker Listing (US$ MM) (US$ MM) Price 10E 11E 10E 11E 10E 11E 09-11E African Bank ABL SJ S. Africa 3,155 12.8 2,420.0 8.5 6.2 1.5 1.4 18% 23% 32% Banco Panamericano BPNM4 BZ Brazil 1,456 2.8 10.9 10.6 8.7 1.5 1.3 17% 17% 37% BRI BBRI IJ Indonesia 9,858 10.9 7,450.0 10.6 8.9 2.8 2.4 28% 29% 23% Compartamos COMPARTO MM Mexico 2,151 3.1 65.0 15.3 12.6 5.1 3.9 38% 34% 20% Danamon BDMN IJ Indonesia 4,636 4.2 5,150.0 15.4 12.4 2.4 2.2 16% 19% 32% First Cash Financial FCFS US USA/Mexico 634 4.0 21.3 13.0 10.9 2.4 2.0 19% 18% 17% Fin. Independencia FINDEP* Mexico 637 0.2 11.5 14.2 9.6 3.3 2.5 26% 31% 34% IPF IPF LN UK 811 1.1 204.2 9.0 7.4 1.8 1.4 18% 19% 37% LIFI Index 12.4 9.9 2.6 2.2 21% 24% 29% 10E 11E 10E 11E 10E 11E 09-11E Africa 10.9 8.3 1.8 1.7 15% 18% 0% Developed Asia Pacific 22.4 19.2 3.5 3.0 15% 16% 20% Emerging Asia Pacific 13.4 10.9 3.1 2.3 21% 23% 25% Developed Europe 12.0 8.5 0.5 0.5 9% 11% 27% Emerging Europe 10.7 6.5 1.7 1.5 17% 22% 72% Latin America 14.2 10.2 2.7 2.0 20% 20% 17% Market Cap. Weighted 16.2 13.2 3.0 2.4 18% 20% 28% Averages for Banks Covered by J.P. Morgan Source: Bloomberg, company data, J.P. Morgan estimates. ADTV=average daily trading volume for the past three months. Prices as of 23 February, 2010. Notes for the LIFI Index: We use Bloomberg consensus estimates for all individual stocks mentioned in this table, except for First Cash Financial, for which we use J.P. Morgan estimates for book value per share. The LIFI Index is a market capitalization-weighted index, with the weight of BRI reduced to a fourth because its microfinance portfolio represents only about 25% of its total loan book. Notes for Global Emerging Markets Banks: We show market capitalization-weighted averages of banks covered by J.P. Morgan analysts, representing a sample of more than 150 banks across global markets. 29 Figure 24: Regression of ROE and Price-to-Book Multiples for Global Mainstream Banks. Correlation Reaches an Impressive 71% 7.0x 6.0x 5.0x Price-to-Book Multiple Global Banks Average 4.0x LIFI Index 3.0x 2.0x 1.0x 0.0x 0 5 10 15 20 25 30 35 40 ROE (2010­11) (%) Source: J.P. Morgan estimates, Bloomberg. Prices as of 23 February, 2010. Price-to-book multiples use the current price divided by 2010-end book value per share. The axis for ROE uses the average of ROE for those institutions for 2010e and 2011e. Figure 24 shows the correlation between ROEs ROE in 2009­10 of 22 percent. This suggests that and price-to-book multiples for approximately 130 the current valuation of the index is fair, while the banks around the world. The LIFI Index currently average valuation of global banks is above the trades at 2.6x 2010e book value, for an average trend line. 30 Conclusion NPLs and large numbers of restructured loans will have to be written off. This may require additional A little more than one year after the bankruptcy equity and significant restructuring. In a few cases, of Lehman Brothers, we are optimistic about the distress mergers, or even liquidations, are likely. ability of the microfinance industry to rebound from the impact of the financial crisis. Looking at private equity, we believe valuations will continue to be supported by a large pool of private At the outset of the crisis, late in 2008, the chief and public investors with a long-term commitment concern had been about a liquidity squeeze, with to the asset class. In the private market, most MFI fears that MFIs would be unable to roll over their transactions will continue to be in the range of debt. In large part, the sector avoided this fate, as 1.5x­2.5x book value, although some distressed the credit market serving MFIs recovered quickly, MFIs urgently seeking to raise equity will likely be and microfinance investors remained committed to valued at lower multiples. Asset quality and funding the asset class. However, the crisis exposed some structure as well as management and governance structural issues and operational weaknesses, and are likely to remain key concerns for investors. At credit risk has now become the top concern of the same time, we believe investors will need to investors and MFIs (Lascelles 2009). be more selective in their MFI investments than in the past. Some fast moving markets that had witnessed unrestrained growth in recent years, such as Microfinance IPOs should resume in the coming Nicaragua and Bosnia and Herzegovina, have been months. The expected 2010 IPO of SKS--the facing large-scale delinquency crises. And for the leading MFI in India--would be a milestone, first time in the sector's 30-year history, we have setting the stage for future IPOs in the sector. witnessed a concurrent and significant decline in Depending on the outcome, it is quite probable the asset quality of the majority of MFIs across the that the spotlight on the Indian microcredit sector globe, with a parallel impact on their profitability. will intensify, while triggering renewed discussion However, with a few significant exceptions, thus far around MFIs' profitability and social impact. MFIs have managed to weather this delinquency crisis reasonably well, reducing their growth, using The current environment may cause MFI valuations their surplus loan-loss provisions, and keeping their to be volatile in the near term, but we believe that capital intact. the medium-term outlook for equity investments in microfinance remains positive. For those with With the downturn having apparently bottomed a long-term commitment to microfinance--both out in the last months of 2009, most MFIs are financial and social--we believe 2009 will come to generally well positioned for 2010 and are likely be seen as an important transition period, with the to resume growth, though with greater awareness lessons and adjustments of the year helping the of risk management and more prudent growth microfinance industry to lay a foundation for more strategies. For a few vulnerable MFIs, however, solid and sustainable growth. 31 References Littlefield, Elizabeth, and Christoph Kneiding. 2009. "The Global Financial Crisis and Its Impact Bhadra, Sagar. 2009. "Microfinance sector losing on Microfinance." Focus Note 52. Washington, sheen due to high valuations." The Hindu Business D.C.: CGAP, February. Line, 18 August. M-CRIL. 2009. "M-CRIL Microfinance Analytics Chen, Greg, Stephen Rasmussen, and Xavier Reille. 2009." Gurgaon, India: M-CRIL. 2010. "Growth and Vulnerabilities in Microfinance." Focus Note 61. Washington, D.C.: CGAP. Microcapital Monitor. 2009. "Indian MFIs Agree to Voluntary Credit Code Enforced by Microfinance CRISIL Ratings. 2009. "India Top 50 Microfinance India Network (MFIN) and Take Equity Stake in Institutions." Mumbai: CRISIL Ratings, October. Credit Information Bureau." Microcapital Monitor, 29 December. http://www.microcapital.org/ Economic Times. 2007. "Blackstone, Carlyle eye microcapital-brief-indian-mfis-agree-to-voluntary- microfinance firms." The Economic Times, India, credit-code-enforced-by-microfinance-india- 12 October 2007. network-mfin-and-take-equity-stake-in-credit- information-bureau. Gonzalez, Adrian. 2007. "Resilience of Microfinance Institutions to National Macroeconomic Events: An Patten, Richard, et al. 2001. "Microfinance Success Econometric Analysis of MFI Asset Quality." MIX Amidst Macroeconomic Failure: The Experience Discussion Paper No. 1. Washington, D.C.: MIX, of Bank Rakyat Indonesia During the East Asian July. Crisis." World Development, Vol. 29, No. 6, pp. 1057­69. Krauss, Nicolas, and Ingo Walter. 2008. "Can Microfinance Reduce Portfolio Volatility?" N.Y.: Rhyne, Elisabeth. 2001. "Commercialization and New York University, 18 February. Crisis in Bolivian Microfinance." Washington, D.C.: Development Alternatives Inc. Lascelles, David. 2009. "Microfinance Banana Skins 2009: Confronting crisis and change." London: Srinivasan, N. 2009. "Microfinance India: State of Center for the Study of Financial Innovation. the Sector 2009." New Delhi: SAGE Publications. 32 Appendix I: Glossary Lower income financial institutions (LIFIs) are publicly traded commercial institutions that Asset quality in this context pertains to the quality operate in the same markets as MFIs and provide of the assets (loans) on a financial institution's financial services (consumer and microenterprise balance sheet, based on the likelihood that a given loans, payments, and insurance) to lower income loan will repay principal and interest on time. Low segments of the population generally similar to asset quality denotes that the institution must those targeted by microfinance. In many cases they make provisions for eventual losses. do not necessarily have an explicit social agenda; while they do have different risk/profitability Development finance institutions (DFIs) are profiles and their loan portfolios tend to feature the private sector arms of government-owned more consumer loans than microenterprise ones, bilateral agencies and multilateral institutions, such they nevertheless provide interesting comparables as the World Bank. DFIs have been established to MFIs. to provide investments and advisory services to build the private sector in developing countries. Microfinance institutions (MFIs) provide microloans They include multilateral organizations, such as the specifically for low-income borrowers who are International Finance Corporation (a subsidiary of typically self-employed or owners of tiny informal the World Bank), and bilateral financial institutions, businesses rather than salaried workers. The loan such as the German KfW (Kreditanstalt für size is small (on average US$3,000 in Europe and Wiederaufbau). Central Asia20 and less than US$1,000 elsewhere), and lenders rely on alternative lending techniques DFIs have been early investors in microfinance. that generally do not rely on conventional collateral. Most DFIs started financing microfinance in the Most of the 1,300 institutions that report to late 1990s, following the grant funding of donor MixMarket--the industry information exchange-- agencies since the 1970s. DFIs are bringing a have microenterprise lending as a core product commercial approach to the microfinance industry, but are increasingly offering other types of loans, providing quasi-commercial loans, equity, and such as mortgage loans and consumer loans for guarantees to MFIs. There were 16 DFIs active salaried workers and savings accounts. MFIs exist in microfinance in 2008. Their total microfinance in a variety of legal forms, from credit unions and portfolio is in excess of US$4.8 billion and NGOs to formal NBFIs and regulated banks. Many grew by 24 percent in 2008. Most of the DFIs' of them are increasingly moving away from donor investments are in fixed income (62 percent) and subsidies to leverage commercial capital (usually are concentrated in the largest MFIs. But DFIs' debt, deposits, and equity investments). Most equity investments are also on the rise and had MFIs see themselves as having a double bottom reached 16 percent, according to most current line, aiming for both profit and social impact. data, with 57 percent of all equity investments going to Europe and Central Asia. According to Microfinance investment vehicles (MIVs) are CGAP's 2009 Funder Survey, the top five DFIs-- specialized microfinance funds or investment KfW, EBRD, IFC, AECID, and FMO--account for vehicles intermediating capital between investors 74 percent of total DFI funding. and MFIs. There were 103 active MIVs in 2008 with total assets under management of US$6.6 20 "MicroBanking Bulletin average for 2007," www.mixmarket.org. 33 billion as of December 2008. MIVs comprise a specified number of days (e.g., PAR30 = loans diverse range of organizations in term of investor past due > 30 days). The reported amount includes base, instruments, and legal setup. The largest the balance of unpaid principal, expressed as a MIV group is fixed-income regulated mutual percentage of gross loan portfolio, that is, including funds with average assets of US$161 million. MIV all current, delinquent, and renegotiated loans but investments have quadrupled since 2005, and this excluding write-offs. This is the definition used in growth is set to continue. Individual investors were Sym50. Note that the MIX definition of PAR adds early backers and continue to provide one-third of to the numerator the unpaid principal of loans that the MIV capital. DFIs were also early subscribers have been restructured or rescheduled. and drove several MIV startups, such as the equity fund Profund. Today, institutional investors are Restructured/rescheduled/reprogrammed loans providing the mainstay of MIVs' funding with a are loans for which the payment schedule, the 42 percent share. MIVs are invested primarily in interest rate, and/or the outstanding principal fixed income (75 percent) in large MFIs in Eastern amounts has or have been renegotiated with the Europe and Latin America. But equity investments borrower. are growing rapidly (more than 47 percent in 2008) and passed the US$1 billion milestone in 2008. Sustainable and responsible investment (SRI) According to CGAP's 2009 MIV survey, the average is a generic term covering ethical investments, return for private equity funds in microfinance is responsible investments, and sustainable 10.5 percent (average gross internal rate of return; investments that combine investors' financial the vintage years of the two MIVs in the sample are objectives with their concerns about environmental, 1999 and 2003). social, and governance (ESG) issues. SRI investors can use a broad range of investment strategies, Nonbank financial institutions (NBFIs) provide including ethical exclusion, negative screening, services similar to those of a bank but are licensed positive screening, and shareholder engagements. under a separate category. The separate license Institutional investors, such as pension funds may be due to lower capital requirements, to integrating ESG factors in their investment limitations on financial service offerings, or to decisions, are part of the broad SRI markets. supervision under a different state agency. In some According to the Eurosif SRI 2008 study, the broad countries this corresponds to a special category SRI market is estimated at 5 trillion, including created for MFIs. 2 trillion in the United States and 2.6 trillion in Europe. Nonperforming loans (NPLs) is a term used most often by banks to represent delinquency levels. Write-offs are loans that are deemed unrecoverable The specific definition of NPL is usually set by and written off the balance sheet. From an the local regulatory authority governing banking accounting standpoint, a write-off reduces the institutions and therefore varies extensively among loan book on the assets side and loan-loss reserves countries and regions. on the liabilities side. If reserves are not sufficient to cover for the loss in loans, equity is impaired. Portfolio at risk (PAR) is the value of all loans Write-offs can be expressed in absolute terms and outstanding that have one or more payments as a percentage of outstanding gross loans. of interest or principal past due by more than a 34 Appendix II: Methodology and equity. When analyzing the multiples in our sample, Data Sets for Private Transactions the following outliers were eliminated: (1) negative multiples, (2) price-to-book multiples above 10,21 The sample covers 200 transactions that occurred and (3) price-to-earnings multiples above 40. between January 2005 and September 2009, including 56 transactions collected between Transactions that involved multiple parties, which September 2008 and September 2009. The obviously had done the valuation jointly, are treated aggregate value of all transactions is slightly more as one single transaction. This avoids a potential than US$520 million. bias caused by including the same transaction information several times in the database. Transaction data were collected and processed by CGAP and communicated to J.P. Morgan in the The multiples we show are all post-money, that form of aggregates. This was done to preserve is, they are based on the number of shares and the confidentiality of the underlying data. The financial data of the MFI after transaction. This complete set of CGAP tables with aggregated shall not imply that post-money multiples are the data on valuation multiples is available on the industry standards. In fact, a sizable number of CGAP Web site (www.cgap.org). fund managers relies on premoney multiples for their decision making. Our aim is simply to make We analyze both historical multiples (historical the transaction data comparable. price-to-earnings and historical price-to-book- values, also called trailing multiples), and this When presenting this year's data set we cut it year extend our analysis to expected (forward) by calendar year, with 2009 comprising the first multiples. three quarters of the year. This year we are also including expected (forward) multiples to better We collected around 100 individual deals during illustrate investors' growth expectations. this survey cycle, of which only 56 were included in our sample. Transactions were dropped if This report presents aggregates only when at they were executed at nominal value so that no least five underlying observations per aggregate underlying valuation process could be assumed were available. Cases with fewer observations are or if they were part of loans being converted into marked with "NA" throughout the report. Table 13: Transaction Size Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample <$500k 8.7 7.2 1.7 1.4 73 $500k­$1m 9.4 7.4 1.7 1.4 36 $1m­$2m 7.8 4.8 1.6 1.3 31 >$2m 14.1 13.0 3.5 2.6 38 Source: CGAP. 21 This is a deviation from last year's method, which included price-to-book-values up to 20. We decided to lower the cut-off to create a more stable and reliable sample. Minor variations from the numbers in last year's report can be attributed to this rule. 35 Table 14: Market Capitalization Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample <$5m 9.3 6.6 1.8 1.6 71 $5m­$10m 10.0 7.6 1.6 1.3 35 $10m­$20m 8.1 6.9 1.7 1.3 38 >$20m 12.9 12.2 3.4 2.3 39 Source: CGAP. Table 15: Buyer Type Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample MIV 10.0 7.5 2.1 1.4 100 IFI 11.2 7.3 2.3 1.8 40 Other 8.9 7.9 1.9 1.8 34 Source: CGAP. Table 16: Scale--Number of Borrowers Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample Small 11.5 9.8 1.6 1.6 41 Medium 10.9 7.6 1.7 1.4 31 Large 9.1 7.5 2.4 1.8 89 Source: CGAP. Small=<10,000 borrowers, medium=10,000­30,000 borrowers, large=>30,000 borrowers. Table 17: Tier--Total Assets Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample Tier 1 9.7 7.8 2.6 2.1 49 Tier 2 10.2 7.9 2.0 1.5 59 Tier 3 9.9 6.6 1.7 1.5 56 Source: CGAP. Tier 1=Assets>100m US$, Tier 2=Assets 15­100m US$, Tier 3=Assets<15m US$. 36 Table 18: Age of the MFI Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample New 16.9 13.8 2.3 1.8 36 Young 11.2 7.6 2.1 1.7 41 Mature 9.0 7.4 2.0 1.4 84 Source: CGAP. New=0­6 years, young=6­10 years, mature=>10 years. Table 19: Efficiency Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample <10% 6.6 6.8 3.3 1.9 4 10%­20% 8.3 7.3 1.8 1.4 76 20%­30% 12.4 11.8 1.5 1.4 14 >30% 11.5 9.1 2.5 1.7 57 Source: CGAP. Operating Expense / Period Average Gross Loan Portfolio. Table 20: Asset Quality--PAR30 Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample <1% 9.8 7.9 2.4 1.8 68 1%­3% 9.4 6.9 2.0 1.4 52 >3% 10.3 7.8 1.7 1.4 40 Source: CGAP. Outstanding balance of loans (principal and interests) with at least one payment > 30 days overdue / Gross Loan Portfolio. Table 21: Financial Intermediation--Savings to Total Assets Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample No FI 9.8 7.3 2.0 1.4 68 Low FI 9.9 6.6 2.6 1.9 47 High FI 10.1 8.4 1.8 1.5 68 Source: CGAP. No FI = Voluntary Savings / Total Assets=0, medium FI = Voluntary Savings / Total Assets > 0 and <20%, high FI=Voluntary Savings / Total Assets>20%. 37 Table 22: Leverage--Debt to Equity Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample <3 12.8 10.5 2.1 1.7 38 3­6 9.7 7.6 1.9 1.4 59 >6 9.1 7.5 2.2 1.8 67 Source: CGAP. Total Liabilities / Total Equity. Table 23: Outreach--Average Loan Balance Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample <50% 10.7 7.3 2.6 1.7 57 50%­150% 9.1 7.9 2.0 1.7 51 >150% 10.3 8.1 1.6 1.4 56 Source: CGAP. Average Loan Balance per Borrower / Gross National Income per capita. Table 24: Outreach--Average Savings Balance Historical P/E Historical P/BV Unweighted Average Median Unweighted Average Median Sample <50% 11.3 7.3 2.9 2.3 31 50%­100% 9.0 8.9 1.6 1.4 42 >100% 8.2 5.6 1.5 1.3 28 Source: CGAP. Operating Expense / Period Average Gross Loan Portfolio. 38 Table 25: Regression Results Historical P/E Historical P/BV Debt/Equity no no Operating Expense Ratio (log) no no PAR30 no no NI Growth + + ROE - no Age - - Gross Loan Portfolio (log) + no Transaction Size + + R-squared 10.3% 19.6% Expected P/E Expected P/BV Debt/Equity no no Operating Expense Ratio (log) + + PAR30 - no NI Growth no no ROE - no Age - - Gross Loan Portfolio (log) + no Transaction Size + + R-squared 8.7% 16.3% Source: CGAP. Operating expense ratio is calculated as operating expenses divided by loans. All models are specified as (left-censored) tobit regressions and include regional dummies for Africa, Asia, and Europe and Central Asia (Latin American countries is the omitted category). Note: "+" indicates significant positive effect, "-" indicates significant negative effect, "no" indicates no significant effect. Some variables have been linearized (indicated by "log") for a better model fit. 39 Appendix III: List of Contributors CGAP is grateful for the contributions of the following organizations to its confidential private equity survey in 2009. · Aavishkaar Goodwell · Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden N.V. (FMO) · ACCION Microfinance Bank Limited · Norwegian Investment Fund for Developing · Advans Countries (Norfund) · Belgian Investment Company for Developing · Oikocredit Countries SA/NV (BIO) · Omidyar Tufts Microfinance Fund (OTMF) · Blue Orchard · Opportunity International · European Fund for Southeast Europe (EFSE) · Proparco · Incofin Investment Management · Solidarité Internationale pour le · India Financial Inclusion Fund (IFIF) Développement et l'Investissement (SIDI) · Kreditanstalt fuer Wiederaufbau (KfW) · Triodos Investment Management BV · Mecene Investment/Africap · XacBank · MicroVest II, LP No. 16 March 2010 Please share this Occasional Paper with your colleagues or request extra copies of this paper or others in this series. CGAP welcomes your comments on this paper. All CGAP publications are available on the CGAP Web site at www.cgap.org. CGAP 1818 H Street, NW MSN P3-300 Washington, DC 20433 USA Tel: 202-473-9594 Fax: 202-522-3744 Email: cgap@worldbank.org © CGAP, 2010 The authors of this Occasional Paper are Xavier Reille, Christoph Credit Bureaus; and Aditya Srinath, J.P. Morgan head of Equity Kneiding, Daniel Rozas, Nick O'Donohoe, and Frederic Rozeira de Research for Indonesia. Elisa Sitbon of CGAP provided excellent Mariz. Richard Rosenberg and Jeanette Thomas from CGAP provided research assistance. We would like to thank the investors and MFIs invaluable guidance throughout the research. The authors also would who contributed to CGAP's confidential equity valuation survey like to acknowledge the contributions of Christina Leijonhufvud, (see Appendix III for the full list of contributing institutions). We head of the Social Sector Finance team at J.P. Morgan, and Mia are also grateful to MIX and Symbiotics for their data and analytics Feldman of the Social Sector Finance team; Neil Gupte, J.P. Morgan on microfinance. The authors remain responsible for the opinions analyst of Asian Financials; David Lewis, J.P. Morgan analyst of expressed in this report and for any inaccuracies. The suggested citation for this Occasional Paper is as follows: Reille, Xavier, Christoph Kneiding, Daniel Rozas, Nick O'Donohoe, and Frederic Rozeira de Mariz. 2010. "All Eyes on Asset Quality: Microfinance Global Valuation Survey 2010." Occasional Paper 16. Washington, D.C.: CGAP, March.