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On 20 April 2007, Banco Compartamos, a very prominant microfinance institution in Mexico, held an IPO.  Shareholders sold 30% of their existing stockholdings, resulting in a record amount of profit-taking.

This has prompted a long discussion in the microfinance community.  Following are several message postings made by Chuck Waterfield and Howard Brady to the MicrofinancePractice (MFP) discussion group on YahooGroups.  These postings started a discussion which currently continues.

You can subscribe to this MFP discussion group by sending an email to microfinancepractice-subscribe@yahoogroups.com  Once subscribed, you can review the log of all postings at:

http://finance.groups.yahoo.com/group/MicrofinancePractice

Understanding Effective Interest Rates ("APR")

NEW!  This is new information I posted on 7 April, explaining how the cost of microfinance loans is generally much higher than what is stated.  I apply the logic to Compartamos' product pricing, but the information presented is valid for understanding how most of microfinance operates.  Click here to view this sheet.

Understanding the IPO history

I have posted some of my analysis of the issues.  These are thoughts I've had for months (even years).  I've been sharing them with individuals, and now feel I might as well just share them publicly.  Click here to read them.

PDF File for download

You can download Jonathan Lewis' paper on the IPO here:  What Would Leland Standford Do?

CGAP Paper on the IPO

This is the most substantive document on the IPO.  You can download it from the top of the list on this sheet: 

http://www.cgap.org/portal/site/CGAP/menuitem.caff1eaa3364200167808010591010a0/

 

MFP – 23 April 2007, posted by Chuck Waterfield

Something very important for us to reflect on.

Personally, I’m stunned by this.  I’ve seen this in the works for years now, but still stunned that it has really happened.  Compartamos, working in Mexico, has created a very large operation.  They work currently with 600,000 clients.  They have kept their interest rates at over 100% for many years (effective interest rate is currently 105%, as stated on their own website).  This is startlingly high to people inside of microfinance as well as outside of microfinance. 

They have gotten very profitable.  For the last six years, they have generated an ROE of over 50%.  “Invest $100,000 and make $50,000 in return after one year…”  You can see their financials at www.themix.org.  As they reached profitability, their interest rates did not come down.  They continued to keep them high and generate high profits.  Last year they made $57 million in profits.

I’ve watched them over the years. I have worked in their offices, but that has been some years ago.

Friday they went “public”.  The board and key staff members have become multi-millionaires (valued in US dollars).  They hold a considerable number of shares.  30% of the total Compartamos shares were sold on the market starting Friday.    Details are in the Reuters news article below.

This is a non-profit institution started with grants.  They got the first grant ever awarded by CGAP… $1M in 1997.  They have gotten support from numerous donors and networks.  They now are generating extremely high profits that now, as a publicly held institution, go to their share-holding board and staff and to their shareholders.

Is this the future of microfinance?  Is this where some other MFIs have already gone, and where other MFIs are hoping to go?  Is this the “solution to poverty”?   Do the “benefits” of this market-based approach outweigh any potential costs of such intentional and blatant moves that will inevitably draw the attention of the public?  Will these actions cause at least some people concern about how the “deeds” of microfinance more-and-more appear to contradict the “words” we say?  Will microfinance become the home of the profit-maximizing investors instead of the area that donors and non-profits use to effect beneficial economic and social change?

Please read the following article from Reuters.  Think carefully about this subject.  I strongly believe it is the most important current issue in microfinance.  I believe it has been for years (as anyone who has attended my courses knows).  I think it is time we stop avoiding this issue.  I think we need to openly discuss this.   I don’t believe it is necessary to “pick on Compartamos.”  I think we should be looking at the bigger “philosophical” picture, of where microfinance is going.   I think this is an essential issue for us to clarify.  The world now knows about microfinance.  The world will soon know about the “complexities” of microfinance.  What will you say when people start to ask you about these issues?

I look forward to your comments.

Chuck Waterfield

Reuters news article, 20 April 2007 

By Noel Randewich

REUTERS

12:03 p.m. April 20, 2007

MEXICO CITY – Shares of small Mexican bank Compartamos, which specializes in lending to mom-and-pop businesses, surged as much as 34 percent in their $407 million stock market debut Friday.

Owners of Banco Compartamos, which means ”let's share” in Spanish, sold about 30 percent of the bank, spokeswoman Luisa del Castillo told Reuters.

More than 80 percent of the offer was placed in New York, with the rest on Mexico's stock exchange, according to a company release.

Mexican shares of Compartamos jumped as high as 53.53 pesos after the company priced the offer at 40 pesos per share. In afternoon trading the stock eased back slightly to 52 pesos.

Compartamos said it sold 111,572,532 shares, with an over allotment provision of 16,735,880 shares. It was unclear whether banks managing the offer exercised the over allotment, worth about $61 million.

Compartamos, with profits of around $57 million last year, has just over 600,000 clients in rural and semi-urban regions of Mexico.

“We have clients who work in food, clothing, shoes and crafts,” Castillo said. “They're people with anything from a super-small business up to a corner store.”

Despite lending to customers with little credit history or collateral, Compartamos has kept past-due loans below 1 percent of its portfolio.

“The offer received a lot of demand from institutional and retail investors,” said one banker associated with the offer. ”This is a one-of-a-kind story in the market today, which is why there is so much interest.”

Last year, Bangladeshi economics professor Muhammad Yunus received the Nobel Peace Prize for pioneering microlending as a way to create self-employment and escape poverty.

The World Bank's International Finance Corporation, which backs private companies with an eye toward eliminating poverty in developing markets, is the third-largest shareholder in Compartamos.

Mexico's government gave Compartamos a banking license last year, prior to which it had operated as a specialized lending firm.

Mexico's mostly foreign big banks, led by Citigroup and BBVA, focus on a small but growing middle class, although they are beginning to design consumer products for lower-income clients.

The big banks' branches are absent from many rural areas in Mexico, where one in two people live on less than $5 a day.

 

MFP – 1 May 2007, posted by Chuck Waterfield

Dear colleagues,

I started this discussion a week ago and have very closely followed all of your comments and questions.  I’ve not posted any messages since last Wednesday because I was invited to be in some dialogue with Compartamos over these recent events.  Hopefully, some of that content will be publicly distributed soon.

There has been a lot of discussion about ACCION the past few days.  It is important for me to stress here that I’m not advocating that we be should be suspicious or distrustful of ACCION in their role in the Compartamos IPO.  Many of us in the field know ACCION well, fully respect their abilities, they have our highest trust. My sole interest in this is to promote dialogue and discussion over the implications for microfinance.  As I stated a week ago, I still strongly believe this is the most important issue currently in microfinance.  I believe the implications of this event will extend far beyond Mexico, and have influence on the entire microfinance industry.  That is why I am promoting dialogue and discussion.

Last week I sent a message on MFP encouraging ACCION to participate in the discussion. Possibly for legal reasons, they did not do so until Friday night.  The notice on the ACCION website was posted and we were notified by ACCION’s Vice President of Communications. 

I’ve been doing some research of publicly available information over the past week.  I wanted to share, in one place, some of the facts that demonstrate rather conclusively that this is a milestone in microfinance, whether you applaud or are made anxious by the Compartamos IPO.

1.       As stated by ACCION in their announcement, Compartamos did a public offering of 30% of its equity.  This was also stated in the Reuters news article (included below in this email).  The ACCION announcement is at:  http://www.accion.org/media_noteworthy.asp_Q_N_E_344

2.       ACCION states in their announcement that they owned 18.5% of the shares, and sold approximately half of their holding in the IPO.

3.       Doing the simple math from the Reuter’s article (or by checking other public information on the IPO), you can see that the IPO raised US$407,000,000.   111,000,000 shares were sold (stated as 30% of the total), and that gives a calculated average price of US$3.66 per share.  I don’t know what the initial price was, but the share price quickly rose to about US$4.75 and stabilized there.

4.       Thus, Compartamos is now a publicly held corporation with on the order of 366,000,000 shares, based on the data in Reuters.  

5.       The current market value of those 366,000,000 shares, at US$4.75/share, is US$1,700,000,000 (US$1.7 billion).  For reference purposes, Compartamos reported total equity on 31 Dec 06 of US$125M, and most of this equity has been reinvested profits over the past seven or so years.  (You can see ten years of Compartamos’ financial history at http://www.mixmarket.org/en/demand/demand.show.profile.asp?token=&ett=237)

6.       ACCION states that they sold approximately 50% of their shares, or 9% of the total shares.  That results in a cash inflow, using the US$3.66 per share average price calculated from the Reuters article, of US$120 million.  The actual cash inflow may be somewhat lower, or possibly higher, than this figure.

7.       ACCION still holds 9% of the total shares, and at the current market price of US$4.75 per share, that represents a market value of some US$150 million. ACCION’s announcement did state that they made a “significant return” and states they intend to use that return for the expansion of microfinance. 

8.       ACCION’s investment in Compartamos was made by ACCION’s Gateway Fund, which is a registered, for-profit LLC (Limited Liability Corporation).  You can read a very brief description of the Gateway Fund at: http://www.accion.org/services_financing.asp

9.       The ACCION Gateway Fund has, in 2006, published that their investment in Compartamos was US$1M.  One can infer that this is a US$1M investment that has yielded a return that appears in the range of US$270M.

10.   Though clearly a “for-profit” entity, the actual ownership structure of the Gateway Fund is not clear.  ACCION’s announcement would seem to imply that ACCION-the-non-profit wholly owns the Gateway Fund, and therefore the shares (sold and retained) in Compartamos.  Still, as I understand it, this very large amount of money that is not being directly held inside of a non-profit.

11.    Gateway Fund held 18% of the pre-IPO shares, and a significant portion of the other 82% of the pre-IPO shares (32%) are also held outside of non-profit status.  This is public information accessible via other sources

It is the ramifications of these last two points that I think we need to recognize and consider.  We have previously been discussing the high interest rates and the very high profitability of Compartamos, not only this past week, but for years.  As an industry, we have discussed at great length the issues of commercial capital, profit and interest rates, etc, for many years.  We have seen numerous transformations to for-profit MFI, but in most cases the for-profit MFI is principally owned by the non-profit parent MFI.  I’ve not seen, on the order of this magnitude, such a large amount of money raised, and I’ve not seen such a large amount going into private and/or “for-profit” control.

The fundamental issues are not about the Compartamos IPO per se, but about the implications for the *future* of microfinance.  Some see this IPO as “greatly expanding opportunities for the poor to access financial services,”  persuasively demonstrating that consistently high profit margins can potentially attract large amounts of money into microfinance, and not just from social investors but from the entire spectrum of the market.  But others have said they see this with concern, as “profit-maximizing” behavior that takes advantage of the poor. 

My perspective is that for two decades we have been struggling to find the acceptable breadth of that middle section of the non-profit/for-profit continuum that some of us call “socially-responsible business”. My concern is that we may now be shifting to a phase in which the microfinance industry becomes something of a mini “internet boom”.  If profit-maximizing businesses are drawn in by what we have demonstrated is possible, we can soon see the microfinance industry routinely criticized for charging very high interest rates to the very poor, making higher profits than most other industries, and then – instead of reinvesting that profit to expand services to the poor – those profits start to be directed to private corporations and individuals.   And many MFIs were created initially with public funding, adding a new dimension and complexity to the issue of IPO-generated wealth.

My goal in starting this discussion and in writing this email is to encourage us to enter into serious discussions about these issues.  What are the ramifications and implications for the poor?  What are the ramifications and implications for government regulation of microfinance? What are the long-term ramifications and implications for the microfinance industry as a whole?  

These are not simple questions.  There are myriad complexities. 

Chuck Waterfield

MFP – 11 June 2007, posted by Chuck Waterfield

All, 

You’ve been following this for two months on MFP.  You will have seen the announcement last week by ACCION of their webinar conference scheduled for June 27.  I encourage you to sign up for that.

CGAP has been working for some weeks on a Focus Note documenting the IPO and some of the key issues related to that IPO.  (In full disclosure, I confess that I have been in frequent communication with CGAP on this issue since the IPO took place.  I was invited to participate in a CGAP-moderated debate with Compartamos the week after the IPO.  The final results of the debate were then blocked by ACCION in their role as one of the principal shareholders.  CGAP then chose to document the IPO in a CGAP Focus Note, and I reviewed drafts of this document.)

You will find two concise summaries of the document below, which I have clipped from their website.  You can download the entire paper from:

http://www.microfinancegateway.org/content/article/detail/41182

If that link doesn’t work, you will find the paper listed on:  http://www.microfinancegateway.org/

I do encourage you to study this paper carefully.  I still believe this is an absolutely critical issue for the microfinance industry to discuss.  We need dialogue, and we need to understand and process the history and potential implications for our work.   I’m pleased to see ACCION scheduling an opportunity for us to ask them about this event, but I feel that we need not wait three weeks for to discussion to begin.  Study the paper and let’s begin talking.

Chuck Waterfield

===========================================

Draft Focus Note Reflects on Compartamos as Case Study on Microfinance Interest Rates and Profits

Two months ago, shareholders in the Mexican MFI Compartamos had a hugely successful public equity offering. The remarkable success of the IPO and the gains produced by the sale were driven in part by Compartamos’ history of very high profits. These profits stem from interest rates that were a lot higher than was necessary to cover costs. These circumstances have provoked discussion and concern within the microfinance community and elsewhere. Some of this concern is justified and some is not, according to CGAP.

CGAP's analysis of the situation is now available as a draft Focus Note, CGAP Reflections on the Compartamos Initial Public Offering: A Case Study on Microfinance Interest Rates and Profits. Among the paper's conclusions:

bullet The most important issues have to do not with the IPO itself, but with Compartamos’ very high interest rates and profits since 2000.
bullet When Compartamos set up a for-profit company in 2000, pro-bono (NGO or IFI) organizations controlled the majority of the shares, but a third of the company was in the hands of private investors. Compartamos continued to fund its rapid growth by charging interest rates that were much higher than what was necessary to cover its costs. Roughly a third of the exceptional profits created by this policy accrued to private for-profit investors. It appears to us that there were alternative ways to fund growth without relying on such high charges to existing borrowers, and that using those alternatives would have been more consistent with the social objectives of the controlling shareholders.
bullet The aid money granted to Compartamos in its early years did not wind up in private pockets: those grants, and all the profits and capital gains accruing to the shares that were purchased with those grants, have remained in not-for-profit entities where they will be used for development purposes, not private gain.
bullet All of us who are involved in commercial transformation—that is, moving microfinance operations from not-for-profit to for-profit institutional forms—need to think more clearly and realistically about the consequences of the resulting changes in governance incentives.

MFP – 12 June 2007, posted by Howard Brady 

Colleagues,

First off, I want to encourage meaningful dialogue on the Compartamos IPO.
As moderator, I won’t restrict any comment on this issue nor do I want it to
appear that this is the definitive last word.  I’d be sad if my points
didn’t generate discussion.  I’d encourage those lurking in the wings who
may have a different, or similar, point of view to express it.  Expanding on
a point that I mention in its own discussion thread is totally appropriate.
I fear that I’ve been somewhat long-winded in my posting.

In general, I’m happy that microfinance is at this stage.  I got involved in
the industry 13 years ago (I guess I pre-date even CGAP) when there were
very few who understood the impact of interest rates and how to manage
interest rate policy.  From Mexico to Argentina I’ve saw a blind 3% flat per
month charged on microfinance loans.  Since then, lots has been written and
many understand the components of interest rates and what it means to charge
a sustainable rate of interest.  Bolivian MFIs now charge ˝ of what they had
changed.  It’s easy now to talk about portfolio at risk and Adjusted Return
on Assets and know that the majority of folks have heard these terms before
and can explain them.  As an industry, microfinance is much more
professional, commercial, and financially savvy than it was just a few years
ago.  And I think this is a good thing.  What we need to do is make sure
that we’re using this professional mindset to make good decisions. 

I also believe that equity holders should be compensated with ROE that is
greater than the cost of debt.  Equity holders assume more risk and should
have a higher return on their investment in terms of ROE.

A couple of observations:

1.       No additional money was raised through the IPO.  No additional
shares were sold.  The debt-to-equity ratio and amount of equity is the same
as it was prior to the IPO.  No additional cash came into Compartamos.

2.       The transaction can be thought of as just a swapping of ownership
of 30%(?) of the organization.  Think of it as a commonly owned apartment or
condo complex.  30% of the condo owners are new and have subdivided their
individual pieces into very small pieces.

3.       Previous ownership could have liquidated their shares in private
transactions to known owners.  They would have achieved a lower return, but
they could have controlled the nature of the owners.  If purchasers of the
shares of the IPO relied upon the offering document, they may expect a
future return similar to historical returns.  If Compartamos were to reduce
its interest rate now, it may find itself with threatened or actual suits
unless a reduction in interest rates was disclosed.

4.       Anyone can follow the share price of Compartamos if they wish.
Here’s the link:  http://finance.yahoo.com/q/bc?s=COMPARTO.MX
<http://finance.yahoo.com/q/bc?s=COMPARTO.MX&t=3m> &t=3m

A couple of relevant points:

1.       The Mexican government’s policies help keep the interest rate high.
The value added tax of 15% plus income taxes of 11% = 26% of the 101% that
borrowers pay.  Governments should realize that their taxation policies of
the sector impact the poor by keeping microfinance interest rates high.
Taxation policies of foreign governments are not my specialty, I’ll admit.
Comments here are very welcome.

2.       The high interest rate restricts what activity a borrower can do.
If I’d like to farm a piece of land, but my 3 crops per year will only
return 20% each, then since 60% is less than 101%, I’d pay more in interest
than I’d earn in return.  Buying wholesale and selling retail generally has
sufficient margins to be able to generate sufficient returns to overcome
this “hurdle rate” as there are more inventory turns.  But as more and more
borrowers want to sell shoes, gum, or tomatoes, there will be downward
pressure on the price these merchants will receive.  I don’t think that
society will benefit if all farmers moved to the cities to buy and resell.

3.       I agree with Rich Rosenberg on page 21 that the development related
organizations that had ownership of Compartamos from 2000 to 2007 had the
opportunity and failed to reduce interest rates during that time frame.   I
sincerely hope that this transaction and experience at Compartamos
highlights the need of MFI board members with a social mission to look
carefully at the profits being generated by their controlled institutions
and conclude if excess profits are being generated.  I’d encourage them to
act TODAY on an interest rate policy that is fair for the client and fair
for the institution.

4.       I’m confused about the claim that interest rates were kept high to
expand growth.  Unless growth expenses were capitalized as an asset they
should have be included as expenses and would reduce the ROE.  It might be
that we’re talking about keeping a debt to equity ratio constant over a
period of rapid debt and loan portfolio growth.  If that’s the case I
understand.  However the less than 2 to 1 debt to equity ratio is extremely
conservative, in my opinion.

My ideas:

1.       I believe that when a NGO transforms into a for-profit, that the
organizing documents should state some sort of maximum net income / ROE
target that management is required to not exceed or else there’s an
automatic reduction in the interest rate.  It might be helpful to think of
it as a factor above that which debt holders receive.  For example if the
weighted average cost of debt is 12%, targeting ROE to 18%, or 1.5 times
WACD might make it clear that what some might consider “excess” profits will
be sacrificed back to the client.  Note that I’m not saying that exactly 1.5
is the correct number here but just a representative idea of what’s been
rolling around in my head.  Board members might have to think of ways of
rewarding increasing efficiency if an infinite profit possibility is taken
off of the table.

2.       I believe that creative ownership structures should be explored
that would benefit the clients/borrowers of MFIs as they make more profits.
In India, when a non-profit MFI converts to an NBFC, the “net assets” (or
retained earnings from the non-profit) is distributed to the
borrowers/clients and they in turn assign it to one or many “mutual benefit
trusts” which then purchases shares in the for-profit NBFC.  The MBT has its
own charter and set of governance rules.  When the value of the shares
increase, a structure that the clients of the MFI increases in value.  (I’m
unsure if the MBTs can distribute dividends if the MFI declares a dividend,
maybe someone in India could help me out here.)

3.       Perhaps the Credit Union structure should receive some additional
attention.  Credit Unions have been listed in the MBB since its inception
and have typically charged lower rates than what we’ve seen in other
non-profit and for-profit MFIs.  Caja Popular Mexicana has about the same
number of clients that Compartamos had in 2005, yet charged much less (a
nominal yield of 16%! [ok comparing apples to apples –someone correct me if
I’m wrong here—it might be CPM charges 40% and Compartamos charges 101%])
yet continued to grow.

I’m looking forward to the presentation from ACCION in a couple of weeks.  I
encourage others to listen and participate as well.  I expect many of my
doubts and questions to be cleared up.

I look forward to your responses.

Howard Brady, President and CEO
MFI Resources

This website is managed by Chuck Waterfield.  If you have any questions or comments about the website, please email waterfield@microfin.com