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Funding Microfinance: An Analysis of Emerging Financial Models A Review for the Indian Banks’ Association 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 Peru Case Study Banco de Crédito del Perú (BCP) raised $100 million in 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 Characteristics CDFIs are categorized by 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 1CDFI Data Project, FY 2003 Publication Regulatory Environment Catalyst for CDFI Growth 1994 creation of CDFI Fund Initial $382 million allocation 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 Objectives Surveyed some of the U.S.’ largest commercial investors in CDFIs 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 Relationship Investor Strategies Market development Technical assistance and community education programs 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 but does not completely offset expenditures CDFI-Investor Relationship Investor Strategies Financial Return 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 for Future Investment Commercial investors still evaluating the long-term profitability of CDFIs 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 Lessons Learned It’s taken 10 years (1995-2005) of government assistance and concerted commercial 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 (Again) 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. 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 incentives.
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