Microfinance - the Next Asset Bubble
Portland, United States, September, 10 2007 -
As many Wall Street businesses become involved, some wonder if microfinance will crumble under the pressure of capitalism.
Microfinance has grown at a sharp clip in recent years, making headlines in major business publications around the world and even spawning its own celebrity: Muhammad Yunus, winner of the Nobel Peace Prize in October 2006 for his work with Grameen Bank of Bangladesh. Large amounts of capital are flowing to the sector as major banks like Morgan Stanley, Citigroup, and Barclays Bank, among others, prove that investing in microfinance is not a charitable activity anymore. In addition to the involvement of banks and other large companies, microfinance is flooded with funding from a new breed of philanthro-capitalists such as Bill Gates, Warren Buffett, and e-Bay founder Pierre Omidyar. Overall, the microfinance sector can expect to see a sixfold increase in foreign funding over the next several years.
Despite the increasing amount of investment in microfinance, most of these dollars are chasing the same mature and commercially sustainable microfinance institutions that provide a predictable return. An example of this is the wildly successful initial public offering of Mexico's Banco Compartamos, which took place in April 2007. In ten years Compartamos went from a financially self-sufficient NGO to a bank with five successful bond offerings in the market, all rated investment grade by Standard and Poor's and Fitch Ratings.
The Compartamos initial public offering was a victory for those who argue that making a business case for microfinance is the most efficient way to expand and scale-up. The recent announcement of the MicroAccess Trust 2007 by MicroVest Capital Management and Lehman Brothers is another such victory-and further evidence of the profitability of microfinance. The MicroAccess Trust 2007 is a USD 39 million collateralized loan obligation financing 10 microfinance institutions in 8 countries. It is the first such issuance for Microvest and for Lehman Brothers, who arranged the trust.
The recent success of Compartamos and Microvest demonstrates that commercial capital now provides an important source of funding for microfinance. As the handful of investment banks and large companies active in the sector establish the business potential of microfinance, others will want their piece of the profit from this emerging asset class. Standard & Poor's notes that the USD 15 billion-plus in microloans that are currently on the books pales next to the potential of some USD 150 billion in lending. With a large amount of capital chasing a limited amount of quality assets, microfinance could be the next asset bubble. The Compartamos offering looks a lot like the beginning of such a bubble. The initial public offering was 13 times oversubscribed, meaning that the demand to purchase shares far exceeded the number of shares being offered. Only one month later, the bank's share price had been bid up 48 percent from the original offer price.
This rapid rise and fall of new asset classes is a constant in financial markets: oil in the 1970s, technology stocks in the late 1990s, real estate in the early 2000s, and now the subprime lending market. All of these boom and bust cycles are characterized by too much capital chasing too few assets (or too few assets of quality), and a severe misunderstanding of the risk involved. A recent front page Wall Street Journal article discussed how Wall Street ignored risks in the subprime lending market while providing important capital to fuel the market's expansion and eventual collapse. In "How Wall Street Stoked the Mortgage Mess: Lehman and Others Transformed the Market for Riskiest Borrowers" (June 27, 2007), critics allege that Wall Street threw so much money at the market that lenders had a growing incentive to push through shaky loans and mislead borrowers. The story goes that Lehman Brothers sent a vice president to visit a mortgage company in California as it considered an entrance into the lucrative business of making subprime home loans to consumers with less-than-stellar credit. Although Lehman recognized the company as a "financial sweat shop" specializing in "high pressure sales for people who are in a weak state", they lent them roughly USD 500 million and helped sell more than USD 700 million in bonds backed by customers' loans. The company later collapsed, as did dozens of similar lenders.
Could the next generation of microfinance institutions fall victim, like so many subprime lenders, to the flood of Wall Street capital? If most of the capital invested in microfinance is already chasing a small percentage of "top tier" microfinance institutions, then new capital from Wall Street will be directed at less mature organizations that are not prepared for large scale commercial investments. These organizations will crumble under the pressure to be profitable. To avoid a microfinance meltdown Wall Street must proceed with more due diligence and caution than it did when diving into subprime mortgage lending. If not, microfinance will end up on the front page of the Wall Street Journal, but this time not due to a Nobel Prize.