Loss Given Default Estimation using Transition Matrix (TM-LGD): A Case Study
What does it take to make a mutual fund invest in small MFIs? The one team that would be able to answer this question would be the IFMR Capital MOSEC team that has just concluded the second multi-originator microloan securitization. We talk to the IFMR Capital team to find out all about MOSEC, microloan securitization and what it means to the MFIs, and how the poor can benefit from it.
Consistent source of finance
Gaurav from the Origination team tells us “MFIs have difficulty in accessing the capital markets and traditionally bank lending has been seasonal. During the first quarter, many banks seldom lend to the priority sector, whereas in the third quarter, there is a spurt in lending. This lumpiness in availability of finance meant that MFIs had difficulty in planning their operations. We have just ensured MFIs can hope for a more consistent source of finance all through the year. MOSEC has given small MFIs access to reliable capital market finance even at the beginning of the year, and from a greater variety of investors.”
Gaurav has just got us interested and we ask him to explain more about MOSEC. “MOSEC is a Multi-Originator Securitization transaction where we combine portfolios of multiple small MFIs. We then design a unique structure and issue securities backed by the receivables from these portfolios” he explains. MOSEC I was executed in January for 4 MFIs and MOSEC II, recently concluded, had 3 MFIs. “We received the portfolios from the MFIs, analyzed them and put together a very unique structure through which an investor has invested in 76 percent of this portfolio. All this is done through a Special Purpose Vehicle called IFMR Capital MOSEC”. That definitely sounds quite complicated and difficult. Was it? “Yes and no”, says Gaurav, “It was not easy but it definitely was exciting for me.”
But the structuring must have been a lot of work? “It is”, says Hari Nathan, who worked on the structuring for both MOSEC I and II. “I learnt a lot during MOSEC I and that helped me for the second deal. It definitely was a steep learning curve for me – analyzing the portfolios and coming up with the right structure. I entered the financial inclusion space because I wanted to make a substantial contribution, but I come with a specific skill-set which I wanted to take advantage of. This deal made the best use of my technical skills and I am really happy to be a part of this team” he admits.
CRISIL rating adds credibility
“Our MFI partners are quite satisfied” smiles Bhagirath, also from Origination team. “This MOSEC has given them access to Rs. 339 million from the capital market and much more. Market transactions impart credibility to MFIs and the CRISIL rating adds value to their portfolio. Deals like this mean a lot to the small MFIs and I can say that with confidence because I have worked in both MFI and in credit rating. I know how difficult it is for a small MFI to get an MFI portfolio rated and raise funds. Initially they were a bit apprehensive about combining their portfolio with another MFI’s. We had to convince them a lot to make them understand that the risk would be limited to their portfolio, but the reduction in cost of funding they get makes it all worth it.”
This deal also means a lot to an aspiring finance professional like Dhiraj, who co-ordinated with the Chartered Accountants for the deal. He says “This Deal came just a month after our previous deal and thus, gave us insight about the operational constraints under which we are operating and considering the business plan of 10-12 such deals, it prepares us for automating the operational process so that it will be scalable and economical.”
Lower interest rates
We ask Kshama Fernandes, Head, Risk Management, if MOSEC II was a repeat of MOSEC I. “Yes and no”, she explains. “All three Mosec II MFIs were also a part of Mosec I. However, the Mosec II structure is very different in terms of weight of each MFI in the total pool as well as its geographic diversification. There has been a significant reduction in the amount of cash collateral that the MFIs had to put upfront. This translates into a lower cost of funds for the MFIs, which when passed down, results in the lowering of interest rates to the end borrower, the MFI’s clients. This is what we aim to achieve over the long run. ”
Didn’t we hear that MOSEC II was creating a history of sorts? “Yes” she replies. “This is the first time a mutual fund investor has subscribed directly to a primary microfinance multi originator issuance. The investor has purchased the entire amount of Series A1 PTC which is rated P1+. This is encouraging because it means that investors have started looking at microfinance-backed paper with underlying loans originated by small to medium sized MFIs, as a new asset class. Being uncorrelated to mainstream debt and equity markets, this could prove to be an interesting investment for mutual funds, not just from the return perspective, but also from the risk diversification perspective”.
Challenging task
Meenal Madhukar, Head, Investor Relations, shares her most challenging aspect of the deal. “Price discovery is a continuous challenge in every transaction. While the originators are eagerly looking for us to lower the cost of funding for them, the capital market investors demand a significant premium for investing not just in a new asset class, but in this case, in a brand new structure that happens to be a global first, a multi-originator securitization structure that has been tried just once before by IFMR Capital. Yet, for us at IFMR Capital, the battle is not just about bringing an alternate source of funds to the MFIs, it is also about ensuring that we get the best price for them. As a result, each transaction is a tightrope walk in trying to lower the premium demanded while at the same time convincing new investors of the inherent value of our transactions. Getting them to spend quality time in evaluating our small size transactions, and conforming to their last minute requirements add spice to the adventurous journey, which though not for the faint hearted, has been truly exciting and very rewarding as we have been able to create new benchmarks in almost every transaction, in terms of a lower pricing.”
Sucharita Mukherjee, CEO, IFMR Capital, attributed the successful completion of the deal to her team. She summed it up nicely when asked about her thoughts on the deal. “It is a total team effort and it is only right that the team answered all your questions”.
We just had one last question. “Are you guys going to celebrate now?” “Yes!” is the team’s reply. But we only know too well they will back soon to work on the next deal that is already lined up for execution.
How are the three MFIs reacting to this deal? What is the mood in their camp? Watch this space for more.
This is a great post. Keep up the good work.
Thank you Nachiket. We also plan to feature some serious discussions and bring together different stakeholders to voice their opinions in the blog.