A couple of months ago, I learned from a paper by Daniel Rozas that microcredit portfolios are like sand castles. A microcredit portfolio, understand, is a collection of disbursed microloans, usually carried on the books of a microfinance institution (MFI) and viewed as an asset since it entitles the MFI to principal and interest payments from borrowers.
Daniel studied cases in which an MFI had gone bankrupt (more precisley, into liquidation) and the managers had tried to salvage financial value by transferring the MFI's portfolio to another MFI. It turns out that while credit officers can build up magnificent loan portfolios with much manual effort---visiting clients weekly, cajoling them for repayment, promising new loans in return for steady repayment of old ones, building trust---if you try to pick microcredit portfolios up and move them, they disintegrate. Trust on both sides break down. The receiving MFI and its loan officers don't know which borrowers are more or less reliable, and so may hesitate to lend more than token amounts at first. Absent the surety of access to future loans, clients are less inclined to repay current ones. It may also seem quite strange to them to, in effect, repay Citibank for money they borrowed from Chase Manhattan:
For property to be considered an asset, it must generally retain value irrespective of its owner. However, in rare cases, assets have value only when associated with a given entity. Like David Beckham’s foot, such assets can generate cashflow to their owners, but they cannot be independently transferred or sold....
Microcredit appears to be just this type of asset. A microcredit portfolio is so closely associated with the MFI which created it, that it is in fact very difficult to realize its value without the MFI’s organization. The natural consequence of this relationship is that to an outside party, the value of a microcredit portfolio becomes largely dependent on the default risk of the MFI itself.
Today MicrofinanceFocus has an analysis by Daniel and Vinod Kothari that drives home the implications for securitization in microfinance. Securitizations occur when lenders, having disbursed (originated) loans, sell them to investors in exchange for fresh capital, which the lenders can use to make more loans. That of course is how the mortgage market works in the U.S. and other countries. A key idea here is that the borrower can be more reliable than the lender. For example, I got my mortgage from Flagstar Bank in 2003. If that bank collapses tomorrow, my mortgage (whoever owns it) will not lose value because I am still a good risk.
Rozas and Kathari argue that microcredit cannot work that way. If an Indian MFI disintegrates, so probably will the loans it has made, even if they have formally been sold off to someone else. Therefore, securitized microloans probably do not deserve better credit ratings than the companies selling them:
...we see that in India, where no microfinance credit bureau exists, CRISIL is issuing AAA ratings to microfinance securities where the MFI is rated as low as BBB-- (one level above junk). Unfortunately, this would not be the first time that a rating agency assigns a AAA to assets it apparently doesn’t understand. For all the comparisons made between microfinance and subprime, this may be the one that actually fits.
This is a complex subject, which I have not mastered. Any thoughtful dissents?