Dr. Kendall Mau's MICROFINANCE TRAVELS

Jobs, Jobs, Jobs

Our General Manager in Honduras, Orbelina Valeriano, and her husband just spent Thanksgiving 2011 at my home in the San Francisco Bay Area.  What a fun and loving couple.   A pleasure to host them.

Orbelina said that over the last few months she had heard from 3 former interns that they were able to find good positions in the international development field.  Two came via Kiva and spent several months working in our Honduras office.  A third intern from the University of Maryland just spent the summer with us.  Hopefully our internships, now added to their resumes, were of big help to them.  We really teach them how to interview loan applicants, underwrite loans, and collections - all valuable skills.  They get to work with actual clients in the field. 

We also recognize that we have 25 full time employees.  We pay them decent industry wages and comply with all government mandated benefits.  In addition, we provide enhanced medical insurance for all our employees.  They seem to be be a very happy group as our competitors continually try to entice them with juicy job offers.  That they chose to stay with us is testimony and complement to Orbelina's great personnel management administration.

We're really looking forward to 2012 when we have some truly exciting news to announce with enhanced products and services for our clients and employees.

Stronger Balance Sheet, but Still Broke

Our GM, Orbelina Valeriano, is in Executive Management Training at INCAE (originally Harvard-related) in Managua, Nicaragua.  Her class has been doing some case studies.  This week it concerned the failure of some well known MFI's in the region despite showing improvement in balance sheet equity.

One financial transaction that is not usually highlighted is moving loans from the Liability Section of the Balance Sheet to Equity.  Here's how it could happen.  The institution borrows $1.0M from a foreign fund or similar with a 5-year payback.  At the end of 5 years, the debt should be repaid, or if there is not enough cash, the company and the lender may opt to covert the debt to equity in the company.  Instantly your $1.0M debt obligation on the liability side of the balance sheet becomes an increase of $1.0M in equity.

No new cash has entered the company to be used productively in operations.  However, your balance sheet shows more equity and mostly will continue to attract other lenders who are looking for good potential borrowers  The original lender didn't get back his/her funds, but there is always the possibility that the new shares will have more value in the future.  You don't have to write-down or claim a defaulted loan right away and book a big lost on your P&L.

This is what happened with a big MFI in Central America.  However, the scheme didn't last long as auditors finally caught on to what happened.  The original investors were really leary of putting more money into a bad situation and opted to try this type of financial transaction.  The odd thing about it - it's not illegal.  Just be aware.

Trying to Measure Poverty Alleviation

There's been a lot of chatter about measuring poverty alleviation.  I'm often asked if Prisma is contributing to poverty alleviation through its micro-credit loans.  I've given a lot of thought to how a subject that has so many parts (financial, educational, social, physical living conditions, market interest rates, and so forth) can be neatly packaged and scored in a simple rating scale.

I sat down with my staff in Honduras to decide how we as a small micro-credit institution could approach the measurement of poverty alleviation.  Articles I've read and many one-on-one discussions with other practitioners often left me a little bewildered and asking myself how any of the great claims about the success of poverty alleviation could be proved.

I went back to my academic roots.  It felt more like a setup for a doctoral dissertation,...... and we did eventually come to the conclusion that YES, we as a micro-credit organization do help about 60-70% of our clients rise above the poverty level.

Here's how we approached the question.  THE HYPOTHESIS:  the success of poverty alleviation measurement (the dependent variable) is based upon the interplay of various independent variables such as good financial underwriting statistics, education levels, physical living conditions, size of families, family health, urban or rural, market interest rates, and so forth.

My staff and I had to decide which of the various independent variables we would control or had major impact over.  It became obvious that we had control over financial underwriting statistics and little else.  Sad to say, we had no power nor control over the rest of the independent variables.  We as a small financial institution could be active in country associations to advocate fair banking laws, foreign aid, better schools, electricity, etc.  However, our impact as an organization would be indirect and relatively minor.  A very humbling realization.

With that reality in mind, we attacked financial underwriting.  We came up with the following:

1.  Our underwriting is based upon a DEBT-TO-INCOME RATIO calculation.  We comb through a client's monthly expenses and divide it by monthly income.  We set up 3 major categories.

2.  Those with debt-to-income ratios of 90% or higher fell into the absolute poverty category. Hardly any margin of extra money over monthly expenses.  Any little emergency or unforeseen expense would completely devastate these borrowers.  Our loans for simple businesses such as food production to sell on the streets, used clothing, ambulatory sale of other cheap products - would produce the only income for the borrower and his/her family.  What little money is made goes to feed the family and perhaps a little leftover for education.  These clients represent about 20-25% of our clients.  Poverty alleviation rarely touches this category of clients.  We do our part to grant them loans because the government and private industry do not.

3.  Those clients who fall into the 80-70% of debt-to-income ratio where someone in the family probably has a regular income be it from farming, government job, or low wage job in the private sector.  The family now wants to mount a little grocery store in its garage, sell food items, etc. to supplement income.  These clients represent 30-35% of our clients.  They are pulling themselves above subsistence level living by mounting a small business that will add to their overall earnings.  Yes, we are helping this category of clients rise above poverty.

4.  Clients who have debt-to-income ratios of 70% or less.  They already have small businesses and need lines-of-credit for maintenance or expansion.  They have at least a 30% margin of income and don't live on the poverty line.  They are still poor, but really moving beyond poverty.  They represent about 30-35% of our clients.

5.  We have another category of clients who borrow to improve their living conditions, mainly solar electricity where the national electrical grid does not reach.  They are usually small merchants who need the electricity for their businesses, and clients who have enough income to support loans for solar installations that will improve their daily living conditions.  We do not include this category in poverty alleviation statics.

In summary, we can say that we are helping between 60 and 70% of our clients rise above poverty levels while 20-25% remain so poor that all we are able to do is help put food on the table.  This is our DIRECT IMPACT.

As to the INDIRECT IMPACT, we are active on the board of directors of our MFI country association, dedicate many volunteer hours, and strongly advocate better education, social services, etc.  However, we do not declare any miracles of poverty alleviation from this category of activity.

     

Speaking with the Next Generation

Two weeks ago, I spent an evening with about 30 SEAM members (students for engagement and activism in micro-finance) at Stanford University, Palo Alto, CA.  We got down to the realities of the current micro-finance scene.  The failure of several large MFIs and what contributed to their downfalls.  We followed that with how to run a smaller MFI, serve customers' needs, and still produce good and reasonable net income and return for investors.  I call it the $1.0M model.

Lastly, we discussed how to break into the micro-finance industry.  The attendees really appreciated the discussion as most of their speakers extol the wonders of micro-finance, but never address the current situation after the recession.

Last night, I returned to UC Berkeley to have the same discussion with about 30 students in a DECAL (democratic education at CAL.)  It was a very fast-paced talk as we only had 50 minutes to cover everything that I spoke about in 90 minutes at Stanford University.

It occurred to me that as I contemplate full retirement and approach 65, we really have a need to train the next generation of managers as we step off the stage.  There is much work to be done and speaking to these students is just a very small step toward the goal.

Currently we have a new intern in Honduras who just graduated from Tufts University.  Diana Baide will be spending 3 months with us in the position of Junior Loan Officer.  When she completes her internship, she'll be followed by a graduate student in Public Policy from the University of Maryland, Adrian Carroll.  Hopefully another graduate student from UC Berkeley's Goldman School of Public Policy will join him. 

HAPPY NEW YEAR 2011

I spent the last week of December 2010, in Honduras.  What a great week, filled with financial triumphs and visits to great clients.

• We ended 2010 in the black and recorded a phenomenally low delinquency level of less than 2.0% for our total loan portfolio.  Competitors are running at the 15.0+% level.
• We welcomed a new Prisma friend, Kevin Brinkman of Colorado, who explored the latest techniques for debt financing with us.  Thank you Kevin for spending a week with us getting to know the company and its clients.
• We visited 6 solar electricity projects which we financed 1.5 hours up in the hills surrounding Danli, Honduras.  It was incredible to visit adobe homes and little grocery stores with electricity.  They are located so far away from the government electricity grid that the possibility of electricity was only an unfulfilled dream.  Now they have enough power for 3 to 12 light bulbs, a TV, and a radio.
• We visited a dozen clients in San Lorenzo and Choluteca, Honduras.  Little businesses - restaurants, grocery stores, t-shirt printing, charcoal sellers, and tortilla makers/sellers.  All of the businesses making enough money to put food on the table for the family and to educate the children.
• A new intern, a recent graduate of Tufts University will be spending about 3 months with us.  Diana Baide - welcome to the Prisma Honduras family.
• I met our most recent past intern who came by to see her old friends and to meet me.  I was honored.  Thanks Annie for dropping by.
• The staff in our main office threw a BBQ for me.  Thanks Marilu, Susan, Vicky, Roberto, Carlos, Orbelina, Doris, Annie, and many more for the tasty food and company.  It was much appreciated.
• Even our Nicaragua problem child seems to have righted itself although we still have a few more legal steps to get through before we can declare a win. 

Grameen Bank Controversy

Well here we are in December and not all is well in the Micro-finance world, especially in East Asia.  Lots of Internet chatter about the negative happenings in India and the SKS IPO.  Now comes a charge from a Norwegian documentary that Dr. Yunus moved $100+millions from the Grameen Bank to another organization called Grameen Kalyan 12 years ago.

Where did the $100+millions go?  Why was it done? and did he really steal that amount of money for his own use?  I'm not qualified to opine on the 3rd question.  However, I would like to add my 2 cents to the first two questions.

The Grameen Bank had received donor funds to support housing loans.  Someone or several people in the organization was/were worried that the money once used would not be fully reused for the same purpose.  To assure an on-going regard for the original purpose of the funds, a second organization called Grameen Kalyan was formed.  The funds where transferred out of the Grameen Bank and into the new Grameen Kalyan.  Grameen Kalyan would then make a non-interest loan to the Grameen Bank for the same amount.  This would obligate the Grameen Bank to pay back the funds and the funds would be preserved for housing loans.  Furthermore, if the money had been received in the form of a donation, it would be reported in the equity section of the balance sheet and subject to the free use or allocation by the board and management.  Moved to Grameen Kalyan, the Grameen Bank's equity would have been reduced, but the funds' purpose would have been maintained.

In the industry, we would call Grameen Kalyan a level 2 lender.  Usually cooperatives and MFIs overseas apply to private banks or government development banks for big loan (2nd tier or level) which would then be used to lend to their individual borrowers (1st tier or level.)  This is a frequent transaction for institutions needing funds.  In the case of the Grameen Bank, it already had the funds.  WHO ADVISED the Grameen Board to take such action?  Apparently it was their CPAs or Chartered Accountants who devised the strategy.  Did they have weak management or no faith in the management that the funds could not be used correctly without having to go through such an elaborate scheme?  Was it really safer?  It might have been politically necessary to keep transparency in transactions and on the books.  However, tier 1 borrowers can also default on loans granted by tier 2 insitutions.

Assuming the best intentions, it appears that the move was a good political move to maintain integrity within the Grameen Bank.  It was probably to guard against embezzlements, co-mingling of funds, and incorrect usage of funds within the organization by board members and management.  If Grameen Kalyan was completely controlled by Dr. Yunus and honest board members, they could assure integrity of the funds.

In the end, you can find a full explanation from Grameen as to what happened - this should be the end of the controversy.  Find the explanation at:  http://bit.ly/gJA9sd

Searching for Alternate Growth Strategies in Central America

I just got back from a month in France.  Still suffering from a bit of jet lag, I spoke at Sean Foote's Microfinance Seminar at the Haas School of Business, University California, Berkeley.  It's a wonder I didn't fall asleep while talking.

At any rate, I gave a rundown on the operating environment in Central America where Prisma Microfinance has operations in Honduras and Nicaragua.  The last 2 years have been very hard on the microfinance industry.  Our icons, the 2 largest MFIs in Honduras and Nicaragua ran into trouble.  The former was put up for sale while the later was liquidated. They both followed the Tier 1 model of fast and big growth with lots of foreign loan capital debt.  Too big to fail - where have we heard that before?  You need to be the biggest to be strong and survive.  The recession and some not so great strategic decisions by the board and management proved otherwise.  In addition, the largest German MFI just sold off its $75.0M small loan portfolio in El Salvador to a local MFI - what's up with this?  Too hard to continue serving the poor?

What we saw:

• Extremely high overhead costs.  Over 30% of total assets when a 10% or under amount is recommended by CAMEL.
• High amounts of agriculture loans (almost 40% of total loan portfolio) with low liquidity to support the lack of inward cash flows during the life of the loans as full repayment would come only after the harvest season and sale of the product.....and you don't even know if they will be delinquent by the time the end of the loan period occurs.  You may have been asleep at the wheel for 18 months!!!
• High delinquency reaching almost 40% of the loan portfolio.  These are non-productive loans as no income is derived from them when the borrowers are not paying.
• Pushing loans in the > $2000 range.  Moving upscale and leaving behind the small borrowers in the under $500-range.
• Low population countries needing cross boarder strategies to accomplish aggressive growth strategies.  Not enough good customers/borrowers.  So far no large MFI has been able to do successful cross boarder expansion.  There is only one Credit Union from El Salvador which is taking a slow, cautious approach in Honduras on the Pacific coast.  Just because you all speak Spanish doesn't mean that it will be easy to do cross-boarder growth.  There are lots of cultural and political differences that exist which cause obstacles and conflicts. 
• Weak management and board.  How could the board let the situation get so out of hand that the largest MFI in Nicaragua had to be liquidated?  Were they asleep, getting the wrong financial information, or just not up to par about asking the right questions?
• Political unrest.  A coup in Honduras, the socialists in Nicaragua.  Not easy environments in which to operate.

As a small but profitable MFI, Prisma looks to the future and wonders if pursuing the Tier 1 strategy the best way to go in a low population arena.  An alternative would be for a company to create several small, but very profitable MFIs and join them together in a privately owned network.  Less need for high-powered financially sophisticated management on the ground and continue to serve your very poor and poor clients needing loans of < $500.  Playing the high financial sophistication game with offshore holding and shell companies may just be a little too much for MFIs designed to exclusively serve the very poor.

Hosting Diplomacy Council Visitors

I've been a volunteer host for the US Diplomacy Council (now managed by the International Institute of Education on the West Coast) for the last 15 years.  About 2 times per year, volunteer hosts are asked to invite visiting mid-career visitors from foreign countries (trips sponsored by the US State Department) to their homes for dinner, good conversation, and friendship.  The guests visit businesses and universities in their fields and in several states of the country.  Over the years I've hosted guests from Central Asia, Latin America, the Far East, Africa, and last night, Lebanon and South Korea - Drs Kim and Sadek, both PhDs in economics.  Their group of 18 were from about 16 countries and interested in entrepreneurship in emerging economies.

We had a glorious meal and learned so much from our visitors.  I was very surprised to hear that one feasible economic integration method being bandied about for a possible future coming together of South and North Koreas is micro-finance.  With North Koreans having no recent history of entrepreneurship, micro-finance could be a mechanism for introducing the population to small business creation - restaurants, beauty and barber shops, bicycle and motorcycle repair shops, clothing stores, food shops, and so forth.  Of course I told Dr Kim to sign me up if he needed any help with such an exciting undertaking.

Dr. Sadek had not worked with micro-finance in his country.  I told him that I had invested in several micro-credit loans in Lebanon via Kiva (www.kiva.org). 

Regional Growth Hits a Brick Wall

The hot news in Central America is the closing of the largest micro-finance bank (BanEx) in Nicaragua.  The owners/investors did not inject the $32.0M of new capital needed to save the bank.  That's a large sum, but doesn't tell the whole story.  They did manage to pay off all their depositors.  However, when you liquidate a bank that's highly leveraged - lots of big loans from outside sources to supply the funds for the bank's loan portfolio - there may not be sufficient recovery or payback of outstanding client loans to pay off creditors in the end.  With delinquency running higher than 40%, rumors have mentioned around $100.0M in ultimate losses.  Ouch!!!

That micro-finance bank and maybe 2 others have the goal of expanding regionally because no one country in the region is supposedly large enough to support the desired high growth rate envisioned by the Board of Directors and outside investors.  BanEx was just starting its expansion strategy, beginning in Honduras, which has now fizzled.  A medium-size micro-finance bank in El Salvador wishes to do the same, but so far has only managed to acquire one entity in Mexico.  The surprising thing is the same investors found in BanEx financially back the other entities wishing to expand throughout Central America.  The largest Honduran MFI is crippled and up for sale.  It will be very interesting if said regional expansion strategy continues or abruptly comes to a halt for the remaining players.

I'm of the mind that politics had a lot to do with the liquidation of BanEx, but have no proof nor expertise to carry the argument.  Capitalist funds making money off the backs of the poor do not resonate as well as socialist funds supplied to help alleviate poverty.  

Guest and Invitation

We had a surprising guest and an unexpected invitation this month.

Annie, a graduate student in Canada spent a few days with us to observe and learn about micro-credit.  She was especially taken with the solar projects in Danli and Choluteca and how the recipients' lives have changed.  It's also great to show visitors how much we focus our efforts on helping the micro and small entrepreneurs.  It's a constant battle.  As an organization grows larger and eventually becomes regulated, there is serious attention paid by auditors and examiners to operating expenses.  One of the highest expense categories is personnel costs.  Having too many loan officers necessary to service small loans is not productive nor efficient.  In a larger organization with more funds, you can grant loans of $2,000 and above.  In a small micro-credit organization granting loans of $200 to $400, you can see that it would take 5 to 10 loans to equal only one in a larger outfit.  That's why some of the larger MFIs have left the field of micro-credit.

Thanks to organizations such as www.kiva.org and all its investors' support of micro-loans, we can continue to service this segment of society.  Without this help, we as an organization with limited resources would be hard pressed to continue our work.  Thank you, thank you.

Picture:  Susan Velasquez, Annie, President Lobo, Orbelina Valeriano, and Lucy Escoto

Well, on another note, Wednesday brought us a surprising invitation.  The President of Honduras, Porfirio Lobo Sosa, spent an hour with Orbelina Valeriano (Prisma President and GM of Prisma Honduras), Lucy Escoto (Office Administrator), and Susan Velasquez (Branch Supervisor), talking about micro-finance and the obstacles faced during the last few years and in the future.  In particular, they discussed the lack of credit facilities for small MFIs as the current banks and government funding affiliates are still channeling most funds towards the large MFIs.

Final Note:  Annie turned out to be the daughter of the President.  A complete surprise to us when she arrived at our office with her own security detail.  Not a problem - she was welcomed with open arms.