Microfinance Institution Life Cycle Case Study

Transcription

1 Publication Series Microfinance Institution Life Cycle Case Study Financiera Edyficar, Peru Kathleen Dischner, Treetops Capital Mike Gabriel, Grameen Foundation April

3 About Grameen Foundation Grameen Foundation is a global non-profit organization that combines microfinance, technology, and innovation to empower the world s poorest people to escape poverty. Its global microfinance network and technology initiatives reach an estimated 45 million people in 28 countries across Asia, Africa, the Americas, and, through Grameen-Jameel Pan-Arab Microfinance, Ltd., the Arab world. Based in Washington, D.C., Grameen Foundation was founded in 1997 by Alex Counts, who began his work in microfinance with 2006 Nobel Peace Prize Laureate Dr. Muhammad Yunus, the founder of Grameen Bank. Dr. Yunus is a founding and current member of Grameen Foundation s board of directors. For more information on Grameen Foundation, please visit Acknowledgments We would like to thank Financiera Edyficar s Senior Management team for their openness and generosity in the development of this case study. Specifically Guillermo Fajardo, President and Chairman of the Board, Ana María Zegarra, Chief Executive Officer, Luis Guerra, Chief Financial and Admistration Officer and Mariela Ramirez, Treasurer provided invaluable insights into the challenges and successes that they have faced which will serve as invaluable lessons for other microfinance institutions focused on providing financial services to the world s poor. April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved ii

5 Table of Contents Introduction 2 Edyficar - Early Stage ( ) 3 Edyficar - Growth Stage A ( ) 3 Benefits of Transformation 4 Why is Foreign Debt Attractive to MFIs? 5 Edyficar - Growth Stage B ( ) 5 Consequences: Foreign Exchange Risk and Increased Leverage 6 What are the Risks of Foreign Debt? 7 Edyficar - Facing Competition & Consolidation in the Peruvian Market 8 Edyficar s Profile 8 The Competitive and Regulatory Environment in Peru 8 Edyficar - Mature Stage ( Present) 9 Shift Towards Local Currency Funding and the Call for Equity 12 Funding Sources: Issuing Bonds on Local Capital Markets 12 Local Currency Loans and Growth Guarantees 13 Equity Strengthening: The Search for New Investors 14 Evaluation: Edyficar s Successes and Challenges 15 Financial Strategy and Impact 15 Social Performance Management 16 Implications and Reflections of Edyficar s Transformation into a Financiera 16 Advantages and Challenges of Mobilizing Deposits 17 Edyficar s Current Financial Strategy & Vision for the Future 17 Competition and Consolidation Continues in the Peruvian Market 17 Looking Ahead Discussion Questions 20 Appendix Appendix 1: Edyficar s Leverage 23 Appendix 2: Edyficar s Key Indicators as of December 31, Appendix 3: Evolution of Shareholder Base 24 Appendix 4: Client and Portfolio Growth 24 Appendix 5: Financial Indicators 25 Appendix 6: Evolution of Funding Sources 25 Appendix 7: Sources of Currency Funding 26 Bibliography 27 April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved IV

7 Teaching Note: Purpose of this Case Study The rapid growth and increased dynamism the microfinance industry has experienced in recent years has created many new financing opportunities and challenges for microfinance institutions (MFIs). Commercialization, securitization, initial public offerings, mergers, bond issuances, and the growing interest in microfinance on the part of both commercial and socially responsible investors have transformed the playing field. However, while a broad range of legal structures and financing sources allow MFIs greater growth potential and funding diversification, they also make decisions about capital structure more complex. In 2007, CGAP and Grameen Foundation conducted a survey of MFI managers to better understand MFI capital structure decision-making processes in the face of these expanding financing options. The results showed that while the top priority for MFI managers was to obtain the lowest cost of funding, many were not accurately weighing the various funding options or assessing the true all-in costs, which often results in inappropriate leveraging or excessive foreign exchange risk. To explore in greater depth an MFI s capital structure and financial decision-making processes, this case study will analyze Financiera Edyficar (Edyficar) which has experienced two transformations over the last decade as well as intense competition in the Peruvian microfinance market. Specifically, this study will highlight the challenges and successes faced by Edyficar s management in creating an appropriate capital structure in each stage of its lifecycle development. It will analyze the various types of funding available to Edyficar as it grew from an NGO to an EDPYME (a regulated, non-deposit taking financial institution) to a Financiera (a financial institution with deposit-taking capacity), and the internal and external factors that influenced the evolution of management s financial strategy and vision. The Peruvian microfinance market is one of the most dynamic, well-developed in the world, and could possibly be viewed as a glimpse into the future of other microfinance markets. While the evolution of a particular country s microfinance sector largely depends on the structure of its financial system and regulatory environment (as well as many other factors), some of the trends, challenges, and opportunities brought on by the intense competition in Peru may very well be repeated in other microfinance markets as they become more competitive. Teaching Note: Audience This case study is intended for both academics and practitioners who are interested in how an MFI s financial decision-making process is influenced by the regulatory and competitive environment, its legal structure and its lifecycle stage of development. It is also an informative guide for MFIs on some of the financing challenges, opportunities, and trade-offs faced during the process of transformation and continued expansion. Included is a list of discussion topics and questions at the end of this study designed to help readers evaluate and analyze the various stages of Edyficar s growth and the decisions made by Edyficar s management team.. CGAP and Grameen Foundation. MFI Capital Structure Decision Making: A Call for Greater Awareness. August April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved 1

8 Introduction In Peru, one of the most competitive microfinance markets in the world, microentrepreneurs today can choose from a variety of financial institutions and have the leverage to demand higher quality products and services. However, Ana María Zegarra Leyva, the CEO of Financiera Edyficar, a regulated financial institution, remembers ten years ago when there were long queues of microentrepreneurs hoping to secure a microcredit loan from Edyficar, but there was not enough funding to meet demand. Today, Edyficar s main challenge in expanding operations is no longer access to sustainable sources of funding, but rather how to continue diversification of funding sources and improve client services in an increasingly competitive environment. Edyficar was incorporated in 1997 by CARE Peru and began operations as an EDPYME (Entities of Development for the Small and Micro-business) in 1998 out of the realization that it could not access the financing required to significantly scale up operations as an NGO. Edyficar assumed the assets of CARE s microcredit programs that began in 1985 in Peru, and spun off as its own financially regulated entity, with CARE Peru as its main shareholder. Ana María also worked for CARE before Edyficar was created, and witnessed the obstacles the organization faced in financing the growth of its microcredit operations under a non-profit structure. As Ana María prepared her notes for the upcoming Board meeting, where Edyficar s long-term vision and strategy would be evaluated in light of recent developments, she reflected on some of the challenges and successes it faced in creating an appropriate capital structure during its various phases of growth over the last ten years, and the financing challenges and decisions that lay ahead as Edyficar began a new chapter in its evolution as a Financiera (a deposit-taking financial institution). In many ways, Ana María considered Edyficar a pioneer in the Peruvian microfinance market because of its innovative financing approaches which opened doors for other MFIs. Its unique conception as an EDPYME in 1998 has been modeled by many of CARE s other microcredit programs. Its acquisition of another MFI in 2006 started a trend of consolidation in the Peruvian microfinance market. And, it was the first EDPYME to issue bonds in the local capital markets and transform into a Financiera. As Ana María saw it, there were three main financing strategies adopted by Edyficar over the last decade. These strategies were shaped not only by Edyficar s size, legal structure, and lifecycle stage of development, but were also strongly influenced by the regulatory and competitive environment in Peru, as well as the realities of the financing opportunities and challenges that presented themselves at the time. Edyficar Early Stage ( ) Since the 1970s, after a devastating earthquake hit Peru, CARE International has been involved in various social projects throughout the country. From 1985 to 1997, CARE coordinated two large programs that included microcredit services and complementary technical and business support services. Until 1997, these programs were supported primarily by donations and government funding from USAID, the Dutch government and European Union Development Grameen Foundation USA. All Rights Reserved Microfinance Institution Life Cycle Case Study: Financiera Edyficar April 2009

9 Fund CARE s three principal donors. However, over the course of the years, the management running these programs began to observe that CARE s non-profit structure did not permit the organization to access the funding required to scale up and give continuity to its microcredit operations. This realization first began during a FONCODES 2 reunion in FONCODES provided 500,000 Peruvian soles (roughly US$150,000) to CARE Peru s microcredit programs, with the condition that profits had to be reinvested in the loan portfolio and could not be used for operational purposes. At the same time, CARE learned that there would also be a reduction in Official Development Assistance funds managed by the Peruvian government. To reach the masses of financially under-served in Peru, CARE was determined to ramp up its microcredit programs. It first attempted to secure greater funding for its microcredit programs through lines of credit from local banks. However, banks were not familiar with the risk characteristics of microfinance, and those that believed it was a viable business wanted to make loans directly to CARE s clients. As a result, Edyficar was not able to secure credit lines from local commercial banks. Edyficar Growth Stage A ( ) In 1994, the Peruvian Banking Superintendent established a new, non-deposit taking regulated financial entity called an EDPYME. The Superintendent created this new entity to formalize and regulate the microfinance sector, which at the time comprised many non-profit organizations. CARE s management saw this development as an opportunity to institutionalize and provide sustainability to its microcredit programs. Then, in 1998, as the Peruvian economy entered into recession and financial crisis, a new law was passed that turned this idea into a more pressing consideration. The Superintendent passed a regulation that required all NGOs providing microcredit services to pay a general sales tax on all interest generated from microcredit 3. With its growth constrained as an NGO, CARE decided it could better realize its outreach ambitions by formalizing its operations. As an EDPYME, Edyficar would be required to demonstrate a higher level of transparency and commitment to best practices which would facilitate greater access to the funding sources needed to expand its operations, and broaden the scope of the financial products and services offered beyond purely microcredit for small entrepreneurs. 4 With 2.3 million soles (US$700,000) in donations and government funding and more than 7,000 clients, CARE transferred its assets in 1997, which included the loan portfolio and certain fixed assets, to Edyficar in return for majority shares in the new EDPYME. CARE created a Board of Directors that included three employees of Edyficar: Ana María Zegarra Leyva, Jorge Guillermo Fajardo Torres, and Nancy Balbina Goyburo Reeves. As its principal shareholder, CARE would maintain control of its operational activities and ensure that its social mission was being fulfilled. 2. FONCODES (Fondo de Cooperación para el Desarrollo Social) is a Peruvian government organization that was set up to fund social development programs including microfinance.. EDPYMEs are exempt from the general sales tax on interest income generated from microcredit due to their regulated status. EDPYMEs, however, are still subject to income tax, which NGOs are exempt from.. At the time Edyficar was considering transformation into an EDPYME, NGOs were only allowed to provide microloans to small entrepreneurs. EDPYMEs were allowed to offer microloans, mortgage loans, issue letters of credit and create special trusts in order to segregate funding from government sources targeting priority sectors. April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved

10 Edyficar had a social, as well as a financial mission, which was to: Facilitate sustainable development by providing financial services to men and women entrepreneurs with small and microenterprises, contributing to the improvement of their lives. This aspect of its social mission the provision of a range of financial services to clients would become an integral part of Edyficar s strategy for years to come. Benefits of Transformation While a new regulation provided the impetus for CARE to spin off its microfinance operations into a regulated financial entity, management also saw the benefits that transformation would bring. The principal motivations for transformation* of MFIs include the ability to: Provide a broader range of products and services to clients, including mortgage loans. Improve and increase access to commercial and government funding because of greater transparency and commitment to best practices. Ensure growth and sustainability Improve transparency and governance Gain legitimacy Enable employees, clients, etc. to become owners * However, in dynamic, competitive microfinance markets such as Peru s, the reasons MFIs choose to transform - or not transform - may not be so clear-cut. Refer to the Reflections section at the end of this study. While Ana María realized that Edyficar faced no immediate financing challenges during the transformation because its financial reserves exceeded the minimum capital requirement of 824,680 soles (approximately US$238,000 at the time), it would soon face some constraints. A recession and financial crisis in Peru between 1998 and 2001 made it difficult for Edyficar to diversify its funding base and access commercial sources of financing in its early years. During this period, Peru experienced increasing unemployment and an average annual GDP growth of only 1.7%. In 1998, CARE gave Edyficar a short-term loan, denominated in US dollars, of US$207,000 (at 5% per annum), and a year later provided another loan, also denominated in US dollars, of US$911,000 (at 10% per annum). However, apart from CARE, Edyficar s only stable source of funding came from COFIDE 5, a second-tier, government-owned financial institution. Approximately 71% of Edyficar s external funding in 1998 came from COFIDE, growing from 500,000 soles to 6 million soles by Despite slow growth in the Peruvian financial sector and a lack of funding amounts, Edyficar s client base grew from 7,244 clients in 1998 to 20,975 in 2001, and it experienced strong average portfolio growth of 67% per year. Edyficar still had not managed to diversify its funding base: 74% of its liabilities in 2001 still came from public funding through COFIDE, with an additional 19% coming from CARE.. COFIDE (Corporación Financiero de Desarrollo) is a state-owned development bank in Peru Grameen Foundation USA. All Rights Reserved Microfinance Institution Life Cycle Case Study: Financiera Edyficar April 2009

11 As government institutions such as COFIDE could provide only limited amounts of funding, the main challenge Edyficar s management faced during its first few years as an EDPYME was diversifying its financing base and reducing its dependence on public funds. This realization coincided with a trend that was developing in the microfinance market at the time the movement away from subsidized donor and government funding towards diversification through international private capital. International investors were beginning to see microfinance as an attractive investment, with its low default rates and double bottom-line returns, and the number and size of international lenders and microfinance investment funds began to grow rapidly. Edyficar capitalized on this trend and adopted a new financing strategy characterized by diversification through loans from international institutions, with a gradual evolution towards commercial sources of capital 6. Edyficar s management viewed this strategy as a way to gradually increase access to the local currency funding that would allow it to ramp up growth. In addition, having this seal of recognition from international investors could enable Edyficar to negotiate better funding terms from other commercial sources in the future. Why is Foreign Debt Attractive to MFIs? Foreign debt is usually attractive to MFIs, as it often appears cheaper, may have longer tenures, and may require less collateral as compared to local debt. This is because foreign funders are often more familiar with MFI risk, and/or because their social motivation leads them to accept below-market returns. Local banks often require more collateral or some type of security from MFIs, which MFIs are sometimes unable or unwilling to give up. A partnership with an international lender can also provide an MFI with a stamp of recognition which it can use to leverage better local funding terms. Foreign investors are also perceived to have a greater potential for strategic guidance, alignment with social mission, political neutrality and technical expertise. Source: CGAP and Grameen Foundation, 2007 Edyficar - Growth Stage B ( ) Ana María and her team took the first step toward securing international funding for Edyficar when it received two ratings in 2001 one local and one international. While EDPYMEs were not obligated to be rated, Edyficar s management believed that being benchmarked against other microfinance institutions would facilitate access to international capital. Edyficar first received a rating of C (on a scale of A to E) by the local firm Class Ratings, followed by a C (on a scale of A through E) by Apoyo & Asociados, a local firm associated with Fitch ratings. The latter rating appealed to institutional investors. 7 In 2001, the Latin American Challenge Investment Fund (LACIF) became the first international microfinance fund to invest debt in Edyficar, followed by Triodos.. USAID. Transitions to Private Capital: Case Studies from the Liabilities Side of the Balance Sheet. July USAID, p 15. April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved 5

12 Over the next several years, the level of funding secured by international funds became increasingly favorable with larger amounts and longer tenors. In 2004, Edyficar was able to secure three long-term loans: a US$1.5 million loan from the Belgian Investment Company for Developing Countries, a US$3 million credit line from Blue Orchard Microfinance, and US$3 million in senior debt from the International Finance Corporation. 8 While interest rates on these loans were slightly higher than those from government institutions (8.5%-10.5% compared to 6.5%-8%), management viewed these international loans as a way to enhance Edyficar s reputation and facilitate future access to capital markets. However, despite the new focus on securing international loans, COFIDE remained Edyficar s main source of funding during this period, as it provided a reliable, inexpensive source of flexible funding in local currency. In terms of equity financing, Edyficar also took on a new shareholder in Microvest, a private microfinance investment fund owned partially by CARE, purchased shares from CARE as well as provided Edyficar with a US$1 million convertible subordinated loan, which it converted into Class A voting shares of 8.5% (Appendix 3). Consequences: Foreign Exchange Risk and Increased Leverage While Edyficar s financing strategy of diversification through loans from international institutions during this period was relatively successful, it carried some undesirable costs and consequences. It was able to diversify its funding base and reduce its percentage of debt from public institutions from 65% in 2001 to 44% by 2005, but the majority of its debt was still concentrated in three institutions: COFIDE, FONCODES, and Blue Orchard. 9 More alarmingly, Edyficar s financing strategy resulted not only in increased leverage, but currency mismatch of its assets and liabilities, exposing it to foreign exchange risk and the cost of exchange rate coverage. By December 2005, 48% of Edyficar s liabilities were denominated in foreign currency (either US dollars or Euros), while only 27% of its loan portfolio was in dollars. This currency mismatch carried with it significant foreign currency risk that could adversely impact earnings that is, if the Peruvian sol were to depreciate against the dollar, Edyficar would in essence have to pay more in soles to meet its dollar-denominated liabilities. In addition, during this period Edyficar s leverage ratio 10 increased from 3 in 2000 to 5.2 in December (Appendix 1) According to the Mix Market, the benchmark ratio (the median of 150 Latin American MFIs) remained at 3 throughout this period. By its nature, excessive leverage could hinder Edyficar s ability to access future capital. Thus, increasing its equity base would become critical for Edyficar to continue accessing debt on favorable terms. During its first several years of operations, Edyficar did not pursue loans from local commercial banks due to their comparatively unattractive rates and terms. As these banks were relatively unfamiliar with the risk characteristics of EDPYMES, they often required higher interest rates and 100% security through cash deposits on loans. Instead, Edyficar s management chose to. USAID, p 13.. USAID, p Measured as Total Debt/Liabilities Grameen Foundation USA. All Rights Reserved Microfinance Institution Life Cycle Case Study: Financiera Edyficar April 2009

13 bypass commercial banks and seek loans from international investors, in essence trading-off local currency loans for lower costs of funding. However, the pressing need to manage liquidity risk and reduce foreign debt made them change course and approach the local commercial banks, despite their seemingly higher interest rates and guarantee requirements. In 2003, Edyficar began receiving loans from local commercial banks that were secured by borrowing from international institutions in foreign currency (e.g. U.S. dollars or Euros) and placing that loan on deposit with a local commercial bank as a guarantee for a loan in the local currency equivalent. These loans were called back-to-back loans and provided close to a 100% guarantee, depending on prevailing exchange rates, for the local commercial bank. By 2007, more than a third of Edyficar s debt was secured by either a pledge of its loan portfolio or by dollar deposits it had borrowed internationally (in the course of structuring back-to-back loans). While these loans have helped Edyficar reduce its foreign currency exposure, they also carried the adverse consequences of increasing Edyficar s borrowing costs and artificially raising its debt-to-equity ratio (as both the local and foreign loan appeared as liabilities). Adjusting for these back-to-back loans, Edyficar s debt-to-equity ratio would drop from 5.1, to 4.2 as of July 31, Edyficar s overall cost of foreign exchange rate coverage was estimated to be between 5.20% and 6.55%. 11 Due to these new risks and the high costs of back-to-back loans, Edyficar s management adjusted their financing strategy to address these adverse developments. The solution called for greater access to domestic sources of funding and the need for new equity investors, which would mitigate their foreign exchange risk and decrease leverage while further diversifying their funding base. While this plan seemed to address Edyficar s specific capital structure challenges, another challenge emerged during this period which demanded a reevaluation of Edyficar s overall strategy and positioning increasing competition in the Peruvian microfinance market. 12 What are the Risks of Foreign Debt? As MFIs tend to lend in local currency, borrowing in foreign currency without proper hedging leads to currency mismatch and exposes MFI s earnings to the risk of exchange rate fluctuation. Depreciation of local currency results in higher costs of servicing foreign currency debt and thus has a negative impact on earnings. Other risk factors of foreign debt include: country risk volatility, local banking system reserve requirements on international loans and tax implications. The growing competition among international microfinance investors, as well as the insistence on the part of MFIs on local currency debt, has resulted in the creation of new techniques employed by international investors to offer MFIs local currency funding. Some solutions have included hedging foreign exchange risk through swaps, forwards, futures, and options, as well as establishing partnerships with global financial institutions to provide foreignexchange risk hedging capabilities. Source: Women s World Banking (WWB). From Dollar to Dinar: The Rise of Local Currency Lending and Hedging in Microfinance. 2007, p USAID, p Women s World Banking (WWB). From Dollar to Dinar: The Rise of Local Currency Lending and Hedging in Microfinance. 2007, p 23. April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved

14 Edyficar: Facing Competition & Consolidation in the Peruvian Market Edyficar s Profile By the end of 2006, Edyficar was the largest non-deposit taking microfinance institution in Peru, with 49 offices in major cities and a staff of over 500. Its main product was individual loans to small and microenterprises, which accounted for approximately 90% of its loans. Edyficar s average loan size was much smaller compared to most MFIs in Peru (US$857), because it targeted a relatively poorer segment of the microfinance market and also because its competitors have a higher mix of consumer loans. Until 2004, Edyficar offered only one microcredit product. However, since providing financial services to its clients is as an important aspect of Edyficar s social mission, in 2005, its management began increasing the scope of products offered. Specialized loan packages were created for different uses and by 2006, Edyficar began offering consumer loans (roughly 6% of total loans), home-improvement loans (3% - 4% of total loans), and commercial loans (1%). In 2007, Edyficar began negotiations with an insurance company, Positiva, so that it could act as a broker to offer microinsurance products including business insurance and life insurance for one sol per month. For a detailed view of Edyficar s key performance indicators as compared to the Peruvian and Latin American medians of 2007, refer to Appendix 2. The Competitive and Regulatory Environment in Peru When Edyficar first started operations as an EDPYME, the demand for microfinance services in Peru far exceeded supply. However, over the last decade, a favorable regulatory framework has encouraged the entry of many different players, and the microfinance market in Peru quickly became one of the most dynamic and competitive in the world. As of 2008, the microenterprise sector in Peru was estimated to comprise 45% of Peru s GDP and employ 84% of the working age population of Peru. 13 The Banking Superintendent has played a major role in carving out Peru s competitive environment. In contrast to most other microfinance markets in the world, the majority of the institutions providing microfinance services in Peru are regulated financial entities. This is largely a result of regulations passed by the Superintendent that have encouraged the formalization of the sector. Apart from the commercial banks and specialized microfinance banks, there are 39 regulated, non-bank financial institutions which provide microfinance services in Peru (including 13 municipal banks, 12 rural savings banks and 14 EDPYMES), as compared to only 20 NGOs. While urban and semi-urban areas are becoming increasingly competitive and are even considered to be saturated, rural areas in Peru still remain largely underserved. 13. Consorcio de Organizaciones Privadas de Promoción al Desarrollo de la Micro y Pequeña Empresa (COPEME). < Accessed July 15, Grameen Foundation USA. All Rights Reserved Microfinance Institution Life Cycle Case Study: Financiera Edyficar April 2009

15 The Caja Municipales and Caja Rurales (the Municipal Banks and Rural Savings Banks) have increasingly become major players in Peru s microfinance market. The Cajas are governmentowned, regulated financial entities which are permitted to mobilize deposits from the public and largely provide financial services to small and micro enterprises. While Cajas were traditionally not allowed to service clients outside of their municipality, a regulation passed by the Superintendent in 1998 permitted them to expand operations into cities where no other Caja had jurisdiction, which resulted in increased competition in urban areas. Non-governmental MFIs were also another significant source of competition. A decade ago, Edyficar s growth was constrained as an NGO because there were no financing opportunities. Today, with significant interest in microfinance on the part of international investors, NGOs have access to a wide range of funding sources in Peru, and on increasingly competitive terms (refer to Reflections section at the end of this study). After observing the rapid growth and profitability of the microfinance sector, the large commercial banks also entered the microfinance market in Peru in Their advantages included not only a larger branch network and equity base, but also the ability to offer lower interest rates to microentrepreneurs (approximately 25% versus 35% offered by most MFIs). Banks could also recruit loans officers (and their clients) by offering them higher salaries. In addition to the NGOs, Cajas, commercial banks and other EDPYMES, intense competition also came from fully regulated commercial banks specializing in microfinance. These included Banco de Trabajo and Mibanco, Edyficar s main competitor. Teaching Note Mibanco s principal advantage is its sheer size and ability to offer savings products to clients. However, a survey conducted by a reputable market-based research firm in Lima indicated that the majority of Edyficar s clients found it to be competitive with Mibanco in terms of prices and loan approval times. Moreover, 62% of these clients reported that Edyficar was the first institution to provide them with a loan and management reports an annual client retention rate of over 80%. These findings highlight one of Edyficar s key competitive advantages in Lima the strong bond it shares with its clients. Edyficar Mature Stage (2008-Present) From management s perspective, intense competition in the microfinance market has been Edyficar s greatest challenge in their attempt to reach more clients. Two innovative approaches were employed by Edyficar in 2006 to secure new markets and expand operations. In 2006, Edyficar acquired Crear Cusco, a small MFI with a portfolio of US$2.3 million. This was viewed as a pioneering transaction and the start of a new trend of consolidation in the Peruvian microfinance market. However, while the acquisition of Crear Cusco helped Edyficar gain a foothold in a new market, there were many hidden and unexpected costs. Looking back, Edyficar s management believes it would have been cheaper to open branches and build from April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved 9

16 scratch rather than to acquire Crear Cusco. While consolidation in the Peruvian market is becoming increasingly necessary and likely to continue in the short and medium term, Edyficar s management estimates it would need a minimum portfolio of US$18 million to do another merger. While many MFIs are moving into rural markets, Edyficar is focusing more on its urban clients and building a dense network of smaller offices. To facilitate this expansion, in 2006, Edyficar formed an alliance with Banco de la Nación, a state-owned development bank with a broad branch network. Under this alliance, for a modest fee, Banco de la Nación provides Edyficar with a line of credit to fund microfinance loans through its existing branches. This has allowed Edyficar to expand its outreach without paying large start up and operational costs. Through this partnership, Edyficar has been able to increase its gross loan portfolio by US$3.5 million (out of a total portfolio of US$96 million) and expand operations to 17 offices as of July 31, Teaching Note - Competition: Advantages and Consequences from Client Perspective Intense competition has provided many advantages to microentreprenueurs in Peru. One favorable development is that competition has caused microfinance providers to significantly lower interest rates over the last several years. In 2000, rates were over 50%, and by 2007, they had dropped to around 35%; many believe rates will continue to steadily decline. Competition has also provided microentrepreneurs with greater and closer access to a variety of institutions, as well as the leverage to demand more and better products and services. In the face of competition, MFIs of all sizes and legal structures are struggling to expand outreach and improve efficiency to offset declining spreads on profit margins. In order to retain and attract more clients, MFIs such as Edyficar have been broadening the scope of products and services they offer. As a result, clients receive more flexible products in a more efficient manner, and often with fewer guarantees. Despite these benefits, intense competition can also bring grave consequences. There is a serious concern in Peru that competition will lead to over-indebtedness among microfinance clients, and in many urban areas, it already has. Over-indebtedness often results when clients take out additional loans, often from different institutions, to make their original loan payment a vicious cycle that surely does not result in the improvement of livelihoods. In Peru, over-indebtedness in urban areas seems to be caused by a combination of two factors: the entry of consumer credit institutions and increased competition as a result of the Cajas and banks entering urban markets. Specifically, intense competition can often cause institutions to grant larger loans to clients, which microentrepreneurs often use for consumption purposes. If payments cannot be made because business operations have not grown enough to cover the costs of these consumer credit loans or additional consumption, then clients are forced to take out additional loans to avoid default. And with many institutions competing to provide microfinance services, it is often not hard to obtain multiple loans. In 2005, management articulated a new five-year vision for Edyficar. It had successfully scaledup operations as an EDPYME and now aimed to be one of the top five microfinance institutions in Peru; at the time it was the eighth largest institution. Another aspect of Edyficar s vision was to be an MFI that contributes to a reduction in the costs of microcredit products Grameen Foundation USA. All Rights Reserved Microfinance Institution Life Cycle Case Study: Financiera Edyficar April 2009

17 Considering the intense competition in the microfinance market, this new vision was ambitious. To be successful, Edyficar would need to continue scaling up operations, find cost-effective ways to reach untapped markets, and continue to attract and retain clients. To differentiate itself from its competitors, Edyficar s management asked: What is important to clients? Internal research and surveys showed that what Edyficar s target client base valued most was speed, flexibility and cost, followed by the quality of client services and range of products. Since Edyficar could not lower rates and was already considered one of the most efficient MFIs in providing loans, management believed that improving its client service would be the most strategic way to differentiate itself from competitors. Edyficar s management decided that offering savings products was both in line with its larger social mission and crucial to its continued long-term growth. Since its main competitors, Mibanco and the Cajas, already offered savings, it was critical that Edyficar also offer these services to retain and attract new clients. But while the majority of these institutions deposits came from wealthier clients, Edyficar wanted to also offer savings to microentrepreneurs. In order to do so, Edyficar had two options: transform into a Financiera (a regulated, deposittaking financial institution) or merge with another institution that already offered savings. The latter would have been the easier alternative in terms of acquiring deposit management knowhow, and would have saved Edyficar a substantial amount of time and hassle in implementing new systems and processes. However, after having experienced firsthand the operational difficulties and costs that a merger entailed, Edyficar s management decided against this option. Given its vision of becoming one of the top five MFIs in Peru by 2010, and the need to continue diversifying both its product offerings and funding base in the face of competition, the decision was clear Edyficar should transform into a Financiera. As a Financiera, Edyficar would be able to offer savings products to clients, as well as other products and services which it could not offer as an EDPYME, such as credit cards, leasing and factoring. 14 The decision to become a Financiera supported Edyficar s new financing strategy on several levels. First, it would provide greater access to the capital markets and local currency funding, as it would be able to issue bonds and certificates of deposits without needing special permission from the securities regulator (in order to issue bonds) and the banking superintendent (in order to take deposits from its clients and the general public). Second, its new status as a Financiera gave it a higher level of prestige in the eyes of the local banks, and would likely facilitate access to cheaper, more attractive funding terms in the future. Third, Edyficar would be able to employ hedging techniques such as swaps and forwards to manage its foreign exchange risk, which it was unauthorized to do as an EDPYME. Finally, the ability to mobilize deposits would provide Edyficar with an additional source of local currency funding, and further diversify its funding base. However, given the high cost of deposit management and the time required to implement the proper systems and processes, Edyficar s management did not expect savings to be a significant source of funding in the short to medium term. By 2010, they estimated that deposits would 14. Factoring is a form of financing through which a financial institution purchases receivables at a discount (e.g. invoices) from a client rather than extending a loan. April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved 11

18 only compromise approximately 8% to 10% of Edyficar s liabilities. In comparison at MiBanco and the Cajas, savings as a percent of total liabilities averaged approximately 54% and 74%, respectively. Teaching note - The Superintendent s Role in Edyficar s Transformation into a Financiera The Superintendent has significantly influenced the development of Peru s microfinance sector and has shaped its competitive environment over the course of the years. By encouraging the formalization of the sector, that office has been able to pass regulations that dictate which institutions are allowed certain capacities, who can compete where, and the necessary requirements for transformation. For example, it created the new legal structure of EDPYMEs to be able to bring non-profit microfinance operations into the regulated sphere so that it could more closely monitor the sector. It also decided that EDPYMEs could not mobilize deposits without passing certain requirements, but allowed Rural Savings Banks (which were considered weak institutions) to be able to do so. At first, the Superintendent passed a regulation that said that EDPYMEs that received a rating of B- or better could provide savings products. However, no EDPYME received the minimum rating from the Superintendent until it changed the law again to say that any EDPYME that would like to mobilize deposits could do so, as long as it received official approval. Instead of granting special permission for Edyficar to offer certain financial services as an EDPYME, however, it required it to transform into a Financiera. Edyficar thus became the first EDPYME to receive approval from the Superintendent to mobilize deposits, as well as the first Financiera to participate largely in microfinance activities. Transformation for Edyficar was a three-step process, which included initial approval from the Superintendent, final approval and an operating license, and implementation of new systems and processes. Shift Towards Local Currency Funding and the Call for Equity Edyficar s new financial strategy and shift away from foreign debt was in full effect by While becoming a Financiera would help Edyficar access stable sources of local funding in the long-term, in the short to medium term, it would need to tap into the capital markets and find innovative ways of accessing funding in local currency to reduce exchange risk and further diversify its funding base. Funding Sources: Issuing bonds on local capital markets To carry out this strategy, Edyficar s management again decided to bypass local commercial banks and, instead, issue bonds in the Peruvian capital market. Issuing bonds would not only increase access to domestic funding, but it would also help Edyficar establish a solid credit history with the local capital market, allowing it to negotiate better funding terms in the future. In addition, as institutional investors have higher risk tolerances and lower transaction costs than commercial banks, raising capital through a bond issuance would provide Edyficar with a less expensive source of local financing (commercial banks often charge high risk premiums) USAID, p Grameen Foundation USA. All Rights Reserved Microfinance Institution Life Cycle Case Study: Financiera Edyficar April 2009

19 Edyficar became the first EDPYME to issue bonds in the Peruvian capital market. As issuing bonds was not expressly permitted by EDPYMES, Edyficar needed special approval from the Superintendent which was granted after going through a series of intense negotiations. The fact that Edyficar was about to transform into a Financiera facilitated the approval process, but it was not a prerequisite. In fact, the Superintendent modified the law to allow EDPYMES to be able to issue bonds, thus opening the door for other EDPYMES to do the same in the future. Before being permitted to do so, Edyficar also had to comply with certain standards to attract institutional investors. For one, these investors often demanded a rating of AA ; however, Edyficar had only obtained a bond rating of A by Apoyo. In order to improve its rating, the IFC offered to provide Edyficar with a 30% guarantee on the bond issuance. Other requirements mandated by the market were that Edyficar maintain a leverage ratio of less than 7, a portfolio at 30-day risk (PAR) of less than 5%, and three months cash available to finance operations. Edyficar planned to issue a total of US$50 million in bonds over six years, starting in the fall of 2007, however, the final amount was actually $55 million due to overwhelming demand. Each issuance was to be US$10-$15 million and have a tenor of 1 to 4 years; however, becoming a Financiera would eventually allow Edyficar to expand this to ten years. Edyficar s first issuance totaled $25 million ($5 million higher than initial amount due to high demand) in local currency in December of 2007, of which $20 million was invested by Municipal Funds (which represent a US$8 billion market in Peru). The success of the first issuance attracted another important investor, the AFPs (Peru s pension fund administrators), a US$30 billion market. The AFP invested $6 million of the total $30 million raised in local currency in the second issuance. This was an important step for Edyficar, as these investors are purely commercial, which demonstrated its strong financial performance and ability to generate solid returns. In order to issue more bonds in the future and raise significant amounts of capital in general, Edyficar s management has realized the importance of credibility and transparency. Edyficar s strong business plans have earned it a five-diamond rating on the Mix Market, the highest rating, as well as a transparency award from CGAP. In addition, the rating of C Edyficar received in 2001 from Apoyo & Asociados, was raised to a B- by 2006, and management expects it will be raised again to a B by the end of This rating is for organizations with a good capacity to service its debt on the terms agreed, but that are susceptible to slight deterioration due to changes in the organization, the industry or the economy. Local Currency Loans and Growth Guarantees While Edyficar had not been successful in obtaining loans from local banks on favorable terms, management realized that it needed to access loans from commercial banks (on favorable terms) to significantly increase and diversify its sources of local currency funding. At the Global Microcredit Summit in November 2006, Edyficar s management learned of an attractive alternative to providing banks with 100% guarantees Grameen Foundation s Growth Guarantees. Grameen Foundation provided a US$2 million first-loss guarantee to a Peruvian bank, Continental, to leverage a US$4 million local currency loan to Edyficar. Edyficar used the proceeds of the loan for on-lending and, as a condition of this guarantee, Grameen Foundation required Edyficar s debt-to-equity ratio to not exceed 7, and its PAR not to exceed 5%. April 2009 Microfinance Institution Life Cycle Case Study: Financiera Edyficar 2009 Grameen Foundation USA. All Rights Reserved 13

20 While these terms are more favorable to Edyficar (compared to the 100% guarantees previously required by local banks), 50% guarantees are still considered relatively high, given the recent success Edyficar has experienced in the local capital markets. In the past, these high guarantees could be attributed to a general unfamiliarity of the risk characteristics of microfinance. However, the commercial banks in Peru entered the microfinance sector several years ago, after several years of observing its success and profitability. Thus, it would be expected that these banks would relax restrictions on loans to EDPYMES such as Edyficar. However, there are reasons to believe it may not be in the interest of local banks to do so. For one, these banks are now competing in the same sector, and lending to MFIs such as Edyficar would potentially take away business as well as increase the bank s overall exposure to the microfinance sector. Also, some of these banks may have ambitions to either acquire some of these MFIs at some point, or conduct a merger between them, such as BBVA has done (refer to last section). Luckily for Edyficar and other MFIs, in recent years, access to local currency funding has become more abundant through means other than commercial banks. International investors have realized importance of local currency funding, hence microfinance funds have found innovative ways of lending to MFIs in local currency. These developments allowed Edyficar to access local currency loans from commercial investment funds such as Blue Orchard and Triodos in Equity Strengthening: The Search for New Investors Another of Edyficar s main financing goals between 2006 and 2010 was to strengthen its equity base, which will allow it to better access a variety of debt sources. Edyficar s capital adequacy ratio leverage ratio of 19% (as of June 2008) is acceptable for a large, regulated MFI, and well above Peru s minimum of 8% (in accordance with the Basel standards). However, as most investors, as well as the Superintendent, recommend a ratio of no less than 11%, this does not provide Edyficar with much room to continue financing through the liabilities side of its balance sheet. From management s perspective, obtaining equity will be critical to maintaining a solid capital base from which to leverage further growth. Furthermore, as CARE plans on gradually decreasing its equity stake to 51% by 2010, attracting new equity investors will be critical to continued growth. Edyficar s goal is to raise US$3-$5 million in equity between 2008 and 2009, either through an additional shareholder or subordinated debt (which, for bank regulatory purposes, is classified under equity as Tier II capital). 16 Since its inception, CARE Peru has remained Edyficar s principal shareholder, with a 77% stake as of March 2008, and 83% control of Class A voting shares (refer to Appendix 3 for a detailed breakdown of the evolution of Edyficar s shareholder structure). Because of its commitment to Edyficar s social mission, over time, CARE has capitalized almost all of its profits, which has permitted Edyficar to maintain a lower leverage ratio and high growth levels. Thus, for almost a decade, Edyficar reinvested close to 100% of its profits back into the company to expand operations. 16. Tier I capital is the core measure of a bank s financial strength, from a regulator s viewpoint, and consists of equity, preferred stock, and retained earning. Tier II capital includes undisclosed reserves, revaluation reserves, general provisions, hybrid instruments and subordinated term debt Grameen Foundation USA. All Rights Reserved Microfinance Institution Life Cycle Case Study: Financiera Edyficar April 2009