Funding Microfinance:

An Analysis of Emerging
Financial Models

A Review for the Indian Banks’ Association

August 11, 2005
 Agenda
 Introductions
 Project Overview
 Conclusions
 Recommendations
 Financial Models
 Remittance Securitization
 CDFI Financial Model
 US Mortgage Securitization Model
 Review of Recommendations
 Introductions
International Executive MBA
Georgetown University McDonough School of
Business

Kent Bonham
Celeste Diaz Ferraro
John Gray
Brian Saal
Virginia McMullan
Javier Varela
Dr. Reena Aggarwal, Advisor
 Project Overview

 Research began by analyzing the U.S. mortgage

market and U.S. CDFI system to identify factors
relevant to success in capital generation for
microfinance
 After assessing weaknesses in transferring these
models to India, the Georgetown team chose to
also investigate remittances as a capital
generation model that has greater short-term
opportunity for success in India
Conclusions
 Conclusions
Remittances
 Trend toward increased efficiency, competition
and developing technology.

 Large market potential.

 Attractive conduit for cross-selling other financial

products.

 Securitization of remittance flows is a viable and

attractive mechanism for generating capital for
microfinance.
 Conclusions
U.S. CDFIs
 Without strong government pressure on banks as
well as significant incentives for investment,
CDFIs would cease to be attractive or, in some
cases, profitable investment vehicles.

 Even with significant government assistance,

CDFIs in the US took 10 years to reach today’s
operating standards.

 CDFI experts indicate that the timeframe for

industry maturity is approximately 20+ years,
even with significant government and banking
industry support.
 Conclusions
U.S. Mortgage Market
 The U.S. secondary mortgage market works due
to several factors:
 The extremely large market size provides
instant liquidity and provides significant for
large institutional investors
 Investor community has strong familiarity with
this asset class and perception of risk has been
erased over time
 Perception by financial community of implied
government guarantee
 Recommendations
Offer remittances through top-tier MFIs.
 “Top-tier” defined by MFIs who have either
obtained a credit rating from CGAP or have
demonstrated investment-worthy accounting
practices, management competency and
operational transparency.
 Cross-sell remittances with other financial products to
grow customer base.
 Securitize remittances, building on previous
pioneering works of ICICI in India.
 Use future remittance cash flows as collateral for
microfinance loans.

 Jointly lobby for Fannie/Freddie-style government

incentives.
 Jointly lobby for CDFI-style government incentives.
 Remittances

Expanding Microfinance
Through New Product Offerings
While Increasing Capital Through
Securitization
 Remittances
Global Market Trends

 Shift from informal to formal, professional

 Consolidation and partnerships
 Competitive environment
 Greater segmentation
 Proliferation and increasing levels of technology
 Securitization
 Stability of Remittance Flows
 Remittances
Demonstrated Long-Term
Stability

IMF Balance of Payments Statistics for Developing

Countries
 The Indian Remittance
Market
 Background
$126B worldwide, over $25B to South Asia
(2004)
 India largest in the world for remittance
receipts
 Stability of remittance flows
 Diaspora in U.S., migrant workers in
Middle East
 Large number of domestic migrant
workers
 The Indian Remittance
Market
Background

 MTOs such as Western Union

 Informal channels - hundi
 Current Bank products
 Post Offices
 Remittances
Potential for Microfinance

 Leverage existing relationships with MFIs

 Cross-sell additional product offerings
 Package
 Savings
 Potential to reach more customers
 Increase MFI credit ratings
 Domestic remittances
 Remittances
Ecuador Case Study

 Banco Solidario alliances with Spanish savings

banks
 Remittance services complement other products
 Credit
 Savings accounts - part of remittances can be
“blocked off” for future purchases or to service
existing loans
 Remittances
Haiti Case Study

 Microfinance NGO Fonkoze offering a range of

services including savings, microloans, currency
exchange
 Agreement with City National Bank of New Jersey
(CNB)
 Remittances through Fonkoze account at CNB –
transferred to Haitian bank
 Successes – cross-selling other services,
increasing volume of microloans
 Remittances
Additional Global MFI Case
Studies

 MFIs are providing savings and micro credit based

on remittances in Bulgaria, Serbia, El Salvador,
Ukraine, and Bosnia

 Use remittances to leverage more funds in the

commercial markets to finance lending operations
 Remittances
Global Securitization

 Ongoing access to funding, new investor base

 Leverage remittance flows to productive purposes

through financial intermediation of banks

 Include top tier MFIs, geographical diversity

 Remittance
Securitization
Turkey Case Study
 AKBank TAS - structured finance deal of US $400
million by securitizing its foreign currency
denominated present and future remittances.
Followed by additional advances

 Recently Ambac financial group provided

financial guarantee insurance and its AAA rating
to $350M in notes backed by AkBank’s offshore
remittances
 Remittance

Securitization
Banco de Crédito del Perú (BCP) raised $100 million in
Peru Case Study
January 2001 with its first-ever bond backed by securitized
electronic transfer payment instructions. ING Baring's Latin
America was the organizer of the Banco de Crédito
transaction
 BCP was first bank to introduce electronic transfers as a
new asset class for future-flow securitizations.
 The bank receives annually close to $3 billion in electronic
transfers
 BCP arranged with its five major correspondent banks – JP
Morgan, Citibank, Bank of New York, Bank of America and
Standard Chartered to flow securitization through a special
purpose vehicle
 ING structured the deal as a sale of BCP's existing and
future rights to the dollar payments, so the receivables are
no longer owned by BCP but transferred to the SPVfor the
benefit of the certificate holders.
 MBIA guaranteed the timely payment of interest as well as
payment of the principal on maturity.
 Community
Development Financial
Institutions
 CDFI Profile
 Community Development Financial Institutions
are private sector financial institutions that solicit
capital from public and private sources and
channel it via their various services into specific
underserved communities
 Financial resources are provided through:
 Provision of financial services, loans, and
investments
 Offering training and technical assistance
services
 Promoting development efforts that enable
individuals and communities to effectively use
credit and capital
 CDFI Profile
 CDFIs are categorized byCharacteristics
services offered and
lending portfolio focus. Common categories
include home loans, consumer credit, enterprise
funding.
 Loans are far and away the tool most used by
CDFIs, with 98% of all financial outstanding, or
$8.3 billion.1

$217,113
$272,061
$300,000

$250,000

$200,000
2002
$59,268

$150,000
$40,030

$40,379
2003
$36,338
$100,000
$4,998
$4,510

$50,000

$-
Banks Credit Loan Funds Venture
Unions Capital

CDFI Data Project, FY 2003 Publication

1
 Regulatory
 Environment
1994 creation of CDFI Fund
 Initial $382Catalyst for CDFI
million allocation Growth
over 4 year
period
 Paid out over $700 million to date
 $55 million slated for FY 2006

 1995 revision of Community Reinvestment Act

(CRA)
 Government subjects lenders to evaluation
under CRA
 Up to 5% of deposits must be allocated to
community development initiatives for
maximum compliance
 Rating impacts bank’s abilities to accept
deposits
 CDFI investments qualify as CRA activity
 CDFI Profile
Operational Model

Banks
CDFI Borrowers
Private Investors

US Government
(Tax Incentives)

 CDFIs act effectively as an intermediary

 The flow of capital is predominantly loans
 This model relies on government incentives for
success
 Regulatory
Environment
Federal Incentives for
Banks
 Bank Enterprise Award (BEA)
 Monetary award given directly to banks to
offset investments in CDFIs

 New Markets Tax Credit (NMTC)

 Credit given against Federal income taxes
initiated in 2000
 Totals 39% of the cost of the investment and is
claimed over a seven-year credit allowance
period
 CDFI-Investor
Relationship
Motivation for Bank
Investment
 Gain access to intermediary with stronger
expertise
 Technical support for customers
 Lower administrative and marketing costs
 Reduce bank portfolio and operational risk
 Enter new markets
 New target audiences
 New geographic markets
 Product or loan type offerings
 CDFI-Investor
Relationship
Three Primary Investor
 Surveyed some of the U.S.’ largest commercial
investors in CDFIs Objectives
 Banks: Bank of America, Wells Fargo Bank,
Citibank
 CDE funds managers: Community
Reinvestment Fund, Calvert Funds

 Commercial investors tend to have three common

goals
 Compliance with Community Reinvestment Act
 Market return on investment
 New market development
 CDFI-Investor
Relationship
Three Primary Investor
Objectives
 Community Reinvestment Act Compliance
 Banks must invest in all communities where
they have presence or accept deposits
 Banks are limited by human and capital
resources
 CDFIs can reach multiple areas more
efficiently, helping banks achieve maximum
ratings while covering broad geographic areas
 CDFI-Investor
Relationship
Three Primary Investor
Objectives
 Market Returns on Investment
 Banks must commit 5% of deposits to CRA
investments
 Many development activities are unprofitable
and often classified as charitable or marketing
efforts
 CDFIs, particularly New Markets Tax Credit
investments, can be profit generators and
meet or exceed standard commercial
investment parameters
 CDFI-Investor
Relationship
Three Primary Investor
Objectives

 New Market Development

 Working through CDFIs provides banks an
opportunity to instill brand awareness and
loyalty among new customers
 Long-term capacity building grows the overall
market by creating new customers in
underserved areas
 CDFI-Investor
 Market development

Relationship
Technical assistance and community education
programs Investor Strategies
 Homeownership and financial responsibility courses,
small business outreach, etc.
 Management and technological exposure to CDFI
similar to training for MFIs
 Typically viewed as charitable or marketing efforts
(cost centers)

 Direct investment in local CDFIs (Bank Enterprise Award

grants)
 Factors in selecting CDFIs comparable to screening
MFIs
 Management ratings
 Efficiency and market returns
 Target audience and customers (loan and funding
types)
 BEA award reduces losses on marketing investments
 CDFI-Investor
Relationship
 Financial Return Investor Strategies
 NMTC investments provide banks with
commercial rates of return
 Minimize risk and reduce administrative
expenses
 Banks utilize same assessment tools and
processes to evaluate CDFIs as commercial
investments
 Banks can dictate CDFIs underwriting
guidelines
 Banks do shoulder greater risk in NMTC than
other tax programs
 CDFI-Investor
Relationship

Bank of America case study
Bank of America background
 U.S.’ largest bank and largest CDFI investor
 CDFI investments make up 10% of all Bank of America’s
community development budget
 Currently have $350mm invested in NMTC with a
commitment for another $256 million in 4th round (2005)

 Risk assessment and return on investment requirements

 BoA applies similar risk and return evaluation processes
to both commercial and NMTC investments
 Commercial vs. NMTC repayment rates: 98.1% vs 97.8
 Commercial vs. NMTC ROI: 8-10% vs. 7-8% + 5% tax
credit (total 12-13%)
 Additional risk assigned internally to CDFI investments
(generally 2-3% additional cost of capital), not by
demonstrated market performance
 CDFI-Investor
Relationship
 Evaluation
Commercial investors forthe
still evaluating Future
long-
term profitability of CDFIs Investment
 CDFI Data Project launched by government in
2004, initial results in 2005. Standardized data
collection for all CDFIs to enable more
transparent evaluation of performance.
 Horizon for assessment of commercial return on
investment
 Banks have 3-4 years initial data on NMTC
investments, will need 3-4 additional to gauge
overall return on investment.
 It will take an additional 8-10 years of data to
conclusively evaluate CDFIs as reliable
investment vehicles.
 CDFI-Investor

Relationship
It’s taken 10 years (1995-2005) of government
Lessons
assistance and concerted commercialLearned
investment
for CDFIs to gain acceptance as investment
vehicles.

 Without continued strong government pressure

on banks as well as significant incentives for
investment, CDFIs would cease to be attractive
or, in some cases, profitable investment vehicles.

 CDFI experts indicate that the timeframe for

industry maturity is approximately 20+ years,
even with significant government and banking
industry support.
Fannie Mae / Freddie
Mac and
the U.S. Mortgage
Industry
 Fannie Mae / Freddie
Mac
US Mortgage Market
 Securitization of the US Mortgage Market
 Federal National Mortgage Association (FNMA
or Fannie Mae) created by US Government in
1938, authorized to purchase federally insured
mortgages
 Became self-sustaining private company in
1968, operating on private capital
 Currently operates under congressional
charter, focuses on availability of funds for low
to middle income families to purchase homes
 Fannie Mae / Freddie
Mac
US Mortgage Market

 Purchase mortgages from primary lenders

stabilizing the availability of mortgage credit
 Pool the mortgages and resell as securities
 Securities earn smaller but constant differential
between the yield on pooled mortgages and
payout to investors
 Capital requirements are lower
 Fannie Mae / Freddie
Mac
US Government Regulations
 Fannie and Freddie benefit from arrangements
with the Federal Government
 Each has a line of credit with the US Treasury
up to $2.25 billion
 The US Federal Reserve has the authority to
buy their debt
 Potential to act as a “bail out”
 Exempt from state and local income taxes on
profits
 Exempt from SEC securities regulation
restrictions
Fannie Mae / Freddie Mac

Market Model
US Government
(Guarantor)

Freddie Mac
Investors Brokers and Banks Borrowers
Fannie Mae

 This model generates large amounts of capital

and reduces risk
 Risk is distributed among many investors
 Key elements: government guarantee,
established credit systems, large market size
Conclusions (Again)
 Conclusions
Remittances

 Large market potential.

 Attractive conduit for cross-selling other financial

products.

 Securitization of remittance flows is a viable and

attractive mechanism for generating capital for
microfinance.
 Conclusions
U.S. CDFIs
 Without strong government pressure on banks as
well as significant incentives for investment,
CDFIs would cease to be attractive or, in some
cases, profitable investment vehicles.

 Even with significant government assistance,

CDFIs in the US took 10 years to reach today’s
operating standards.

 CDFI experts indicate that the timeframe for

industry maturity is approximately 20+ years,
even with significant government and banking
industry support.
 Conclusions
U.S. Mortgage Market
 The U.S. secondary mortgage market works due
to several factors:
 The extremely large market size provides
instant liquidity and provides significant for
large institutional investors
 Investor community has strong familiarity with
this asset class and perception of risk has been
erased over time
 Perception by financial community of implied
government guarantee
 Recommendations
 Offer remittances through top-tier MFIs.
 (Again)
“Top-tier” defined by MFIs who have either
obtained a credit rating from CGAP or have
demonstrated investment-worthy accounting
practices, management competency and
operational transparency.
 Securitize remittances, building on previous
pioneering works of ICICI in India.
 Cross-sell remittances with other financial
products.
 Use future remittance cash flows as collateral for
microfinance loans.
 Jointly lobby for Fannie/Freddie-style government
incentives.
 Jointly lobby for CDFI-style government