Dr. Kendall Mau's MICROFINANCE TRAVELS

Kiva Investor Money Really Reaches Borrowers

There's so much chatter because of David Roodman's article about Kiva investor money being used to fund other peoples' loans.  100% transparency is declared to be missing.  Not a very accurate portrayal.  Some part of his analysis of the Kiva loan funding process is missing here and causing much confusion.  I think it's Step 8 as I list below the process of what happens at Prisma Microfinance:

1.  A potential borrower applies for a loan.

2.  The application is underwritten by one of our loan officers.

3.  If the loan is approved, Prisma funds it within the week to keep our customer service humming.

4.  At the same time we make the decision to use our own loan capital or Kiva investor dollars to fund the loan.

5. If we decide it's a good loan that will attract potential Kiva investors, we start the cycle for Kiva funding - depending on the time of the month it could take one to four weeks.

6.  We upfront the money to the borrower using our own loan capital.  We will replace that money on our books with Kiva funds when we settle our accounts with Kiva at the end of each month.

7.  Settling our accounts with Kiva means the difference between what we owe them for monthly loan repayments by our clients and what Kiva owes us for new loans issued which we upfronted.   Some months we may sell more new loans than what we have to repay.  Kiva sends us money.  Other months, we sell less new loans than what we owe for repayments.  In that case, Prisma sends money to Kiva.

8.  NOTE:  this next step or explanation is what's missing from the article and causing all the negative discussion.  Kiva's updated loan module software is very exacting.  It ties the exact amount of funds settled at the end of each month to each specific new loan.  This keeps the MFI honest - we have to keep track of the original funding and the monthly repayments, loan-by-loan.  Kiva investors' funds are really booked directly to the borrower's loan as advertised!!!!  Many people joining the discussion don't get involved with this level of accounting detail and consequently make statements that are well intentioned, but not very accurate.

9.  One has to get over the fact that if you invest $25.00 by sending Kiva 25 one dollar bills to put towards a specific loan, those 25 bills don't somehow mysteriously fly across the US and land in Africa or South America and are given directly to the borrower.  It doesn't happen that way in real life and during the global money transfer of funds.

Scam the Underwriter

I recently received an e-mail from a Kiva investor who wanted to know what was happening with a group loan in which he and his group had invested.  I immediately checked the repayment history and noted that the loan was indeed very delinquent.  I sent an e-mail down to Honduras to see what had gone wrong with the loan and our underwriting.

What they told me:  a man and 2 women, all 3 street vendors, professing to be very old friends applied for a group loan.  Our loan officer made a visit to their homes and neighborhood to verify the existence of their inventory and discover how the loan would help to increase inventory.  Once the paperwork was completed, the loan officer recommended the approval of the loan.

For the first 2 months payments were made on time and then stopped.  Our loan officers went out to their homes to collect and discovered that it had all been a scam.  The man had set up the scam by convincing the 2 ladies to help him out by pretending to be hard working street vendors.  He then borrowed merchandise to display at each person's home to fool the loan officer.  He spent the money on personal expenses and is now insolvent.  We will continue to pursue payment of the loan, but the chances of collecting get slimmer by the day.

I ordered the division to refund the outstanding balance of the loan (from our reserves) to all Kiva investors.  This was not a case where a business failed.  It was outright theft, abet quite well planned.  Our GM says this is not something uncommon, but we try our best to avoid becoming a victim.  However, every once in awhile, we get taken.  

UC Berkeley Presentation

For the last 4 years, I've had the unique opportunity to be a guest speaker at one of Sean Foote's micro-finance classes at the Haas School of Business at the University of California, Berkeley. Last year, the class was telecast to 10 other universities.  This year it grew to 35 universities and about 1,000 students.

I'm called upon to give the students a micro-view of the financial guidelines one needs to follow when managing a micro-finance institution overseas.  This year I spoke about financial management tools that focus their efforts on:  1) managing from the balance sheet and not the profit and loss statement; 2) knowing the financial parameters imposed by CAMEL evaluation guidelines; and 3)  incorporating my new Product Pricing Model.

The Product Pricing Model was of particular interest as it will help future MFI managers peg the interest rates at which products and services should be priced.  Currently, many MFIs call around to other MFIs to see what they are charging, consult with other MFIs in their association or league, or after the fact, calculate the operating expenses of the organization and divide by the total loan portfolio to derive an interest rate.  I just wanted to give the students a simple and easily used financial model upon which to have a basis for product interest rate decisions. 

Stripping Power from the Feds

Now we hear that the Democrats are trying to strip the Federal Reserve Bank of its regulatory powers over US banks.  At first glance, the general reaction is - are they nuts?  How can you strip a central bank of its regulatory authority? 

What most of us don't realize is that our quasi-central bank (the Federal Reserve Bank) is very unique.  Unlike most central banks around the world where governments own and control them, our Federal Reserve Bank is actually owned by individual banks chartered by the Federal Reserve.  Congress gives it certain regulatory authority which make it appear like a central bank.  We have 3 kinds of chartered banks in the US - Federal Reserve Chartered, Office of the Treasury Chartered, and State Chartered.

Kind of like having the prisoners manning their own prison.  On second thought, it might not be such a bad ideal to have a 3rd party hands-off regulatory body doing the regulating.

Healthcare Considerations

Well it got through the house.  Only 3 more giant steps to confront.  I applaud the march towards universal healthcare for all US citizens.  It basically comes down to:  should healthcare be excluded from the arena of money making?  Is it a basic service to be offered to all citizens that should not be subject to huge profits?

In Honduras and Nicaragua, Prisma contributes its share to maintain basic healthcare for all our employees - this is done through social security premiums.  In addition, we buy extra private healthcare insurance for all employees - an added expense, but something we don't even hesitate not doing.

In the US, I fall into the worst medical insurance category because I'm 63 years old.  I now pay $758/month for a high $1,500-deductible policy.  I couldn't qualify for a regular medical insurance policy because of pre-existing considerations.  The last resort was to enter California's forced insurance plan which has no pre-existing exclusions, but you pay extremely high premiums.

By the time the new healthcare initiative gets established, I'll be on medicare.  I only hope that others in my current age group can also stagger over the line while those just entering the  60-65 age group can benefit from the new legislation.

KPMau Product Pricing Model for Small MFIs (with Delinquency)

Over the years, I have often been asked how MFIs price or set their interest rates for various loan products.  I have developed a basic pricing model for MFIs with less than $5.0M in assets with the caveat that there are many variations to the formula depending upon local conditions and investor requirements.  I am fully aware that in my 25+ year-MFI career, I have never met another MFI manager who approaches pricing in this manner and expect a lot of push back.  However, my financial training and work experience have led to this basic model.

((TE+ROA) - (F&M-Invest)) / (TLP - Del) = INTEREST RATE

 

1. TE = Total Annual Expenses = Ideal 15% of Total Assets,

2. ROA = Return-on-Assets = Ideal 10% of Total Assets,

3. F&M = Fees and Misc = Ideal 3% of Total Assets,

4.Invest = Investment Income if any

5. TLP = Total Loan Portfolio = Ideal 90% of Total Assets,

6. Del = Delinquency = Ideal < 5% of TLP

5.  INTEREST RATE = Overall Interest Rate to be charged for Products.

 

ASSUMPTIONS:

1. 15% of Total Assets = the ideal theoretical annual operating expenses for a small MFI based on CAMEL evaluation criteria.

2. 10% of Total Assets = recommended Return-on-Assets (ROA) before taxes for the MFI.

3.  3% of Total Assets = Fees and Misc Income.  This should be kept to a minimum.

4.  Investment Income usually occurs when too much cash is sitting around and not being placed in productive loans.  Extra funds are invested in bank CDs, savings account interest, and some conservative investments.

5. 90% of Total Assets = the ideal size of the outstanding loan portfolio with the remaining 7% of assets in cash and 3% in fixed assets.

6. Delinquency of up to 5% of total loan portfolio is allowable with CAMEL and its variations.  Remember that loans that are delinquency temporarily produce no interest revenue - more like dead assets.

 

EXAMPLE:

An MFI with $1,000,000 in Assets

1. Total Expenses would be $150,000,

2. ROA would be $100,000.

3. F&M would be $30,000.

4.  Invest will be zero.

5. Total Loan Portfolio would be $900,000,

6. Delinquency $45,000.

5. $220,000 divided by $855,000 = 25.7% rounded to around 26.0%.

Your product(s) should be returning around 26.0% per year.

SOME VARIATIONS:

1. Many MFIs have very high expenses because of inefficiencies.  It is not uncommon to see 25% to 30% of Assets.  In this case our example of a $1,000,000-MFI would have at least $250,000 in expenses.

2. Equity investors are now seeking 20% returns on equity (sometimes ROA) over a consistent 5-year basis.  This will then up your ROA by 5% to 10% or an extra $50,000 to $100,000.

3.  During the recession delinquencies are climbing to alarming levels.  I've run across MFIs with 40% delinquencies.  Play with this percentage in the formula to give yourself a heart attack.

4. You can then imagine how high your interest rates for products have to be.

5. One cannot simply keep raising interest rates.  Expenses and ROA have to go down and loan volume has to be maintained.  It's truly an art to get all the parts working in harmony.

Please play around with various scenarios to see how you can use this model for setting the base interest rates for products.  Let me know if you come up with other variations or thoughts of how to improve the model.  Thanks much. 

The Indignity of it all

After speaking to Dr. David Gill's MBA Global Executive Program class on Saturday, I was thinking of the last time I faced the breaking point where the lack of ethics clashed with an extremely high indignity factor.

Last year, the company received an unsolicited investment/purchase inquiry from a large MFI in Central America.  I quickly caught a plane down from San Francisco to explore the offer.  I had Orbelina meet me as 2 heads are always better than one when doing a deal.

The President of the potential investor company/buyer was very charismatic and had done quite a few deals with smaller entities.  However, his knowledge of finance was scant at best which clashed with my left brain financial training.  He wanted to do the deal based on the force of his personality.  Once we set the talking points, we agreed to meet the following month in Honduras.

I flew down to Honduras the next month.  After touring our operations, the offer was made.  Orbelina and I instantly realized that the deal was not feasible as the financing was not first rate, too much leverage involved, and the investment was to build brick and mortar instead of increasing the loan portfolio to help more budding entrepreneurs.

When I reminded him that the offer did not follow the talking points that we had set the prior month he flew into a rage.  His response was that I being of Chinese background, I did not speak sufficient Spanish to understand the deal.  He ranted on for another half hour while his General Manager actually put his head on the conference table and tried to escape the embarrassment of the tirade by covering his face with both hands.  Our Loan Supervisor drove them to the airport an hour later and reported that the two fought the whole way.  Apparently, this tirade wasn't the first.

He then tried to get around me by trying to do the deal with another person in our company.  Needless to say, I let that offer die out ASAP.  A year later, he has come back asking to try to do the deal again with a better offer.  I turned the whole affair over to Orbelina who isn't thrilled about it.

Ethics for Overseas Companies

Before going off to my 45th high school reunion on Saturday, I was a guest speaker at my friend Dr. David Gill's class on Ethics in Business at St. Mary's College in Moraga, CA.  It was a 4-day seminar for the MBA Executive Global Program with 23 students (mid-level executives) studying together for 15 months.  Their companies are paying close to $70,000 per student to participate in the program.

My talk encompassed the point at which a company's culture manifests an overwhelming lack of ethics and personal indignity drive a senior executive to resign from a company.  In addition to examples from my earlier career in international business for a Fortune 200 company, there were discussions about ethical problems I've found working in the micro-credit/finance industry in Honduras and Nicaragua.

45th High School Reunion and Nicaragua

On Saturday night my high school class of 1964 had its 45th reunion.  Over 100 former classmates showed up for an excellent dinner-dance.  Not bad for a class of 450 students with almost 50 friends having left this world during the last few years.  I met many friends who are now retired and dedicating themselves to voluntary work.  Quite a few knew about Kiva and other NGOs.  Of course they were in awe of Prisma's relationship with Kiva.

Nicaragua:  I received an e-mail from a friend of mine who is President of one of the biggest MFIs in the country.  He tells me that the groups advocating "no-repayments of MFI loans" are being backed by the government.  His organization has experienced trouble in branch offices, including the kidnapping of employees.  The amount of default loans has skyrocketed.

Delta Phi Epsilon at UC Berkeley and other Subjects

Last night, I spoke to 30 members of the international business society - Delta Phi Epsilon.  They wanted to know about what it takes to establish a new MFI overseas - personnel needs, finding loan funds, granting loans, controlling delinquency and defaults, savings, and so forth.  I also gave them a rundown on how to find jobs in the industry when first starting out.  Not an easy task, but possible.

The lack of mainstream foreign language fluency (Russian, French, Spanish, Mandarin) seems to be an obstacle for many who want to enter the field.  However, it was a most enjoyable evening for me to spend some time with members of the next generation of social entrepreneurs.

It's official.  Orbelina Valeriano is now Prisma Microfinance, Inc.'s new President.  She has full responsibility for our Honduras Division and represents Prisma in all associational and legal affairs in Central America.  I have taken over as Chairman of the Board and CEO of Prisma Microfinance, Inc.