World markets have been volatile in the wake of the global financial crisis, but investors showed nearly unshakeable faith in the microfinance sector during 2009, driving equity valuations higher even as asset quality and profitability at microfinance institutions (MFIs) deteriorated.
A new report by CGAP and investment bank, JP Morgan, shows that MFI equity valuations continued to rise across all regions last year, with MFIs in the private equity market trading at a median of 2.1 times their book value â€“ a 62 per cent increase since 2007.
â€œThereâ€™s no doubt the crisis did have an impact on MFIs, and a significant one, so the strength in equity valuations is a surprise,â€ says CGAPâ€™s Xavier Reille, a co-author of the report.
Although most investors have focused on microfinance blue chips with strong management, good asset quality, and diversified funding structure, Reille cautions that some valuations â€“ particularly in the Indian market â€“ might be outstripping fundamentals.Indian MFIs comprised 30% of all microfinance equity transactions in the 2009 CGAP dataset, and their equity valuations are trading at six times book value â€“ three times the global median.
Interest in the Indian microfinance equity market â€“ and the broader MFI market â€“ will likely intensify further in 2010 with the impending initial public offering by the countryâ€™s largest microfinance institution, SKS.
The relative youth of the microfinance equity market means there are few established performance benchmarks, making assessments difficult.
However, the CGAP/JP Morgan report is bridging this gap by drawing on the analysis of 200 private equity transactions between 2005 and 2009 and trading information on eight publicly-listed low-income financial institutions to assess the strong performance of the microfinance equity market.
Judging by the performance of publicly-traded low-income financial institutions, the most comparable listed vehicles to MFIs, investors are bullish on emerging market financial institutions serving low-income populations.
These stocks have strongly outperformed emerging market banks (as measured by the MSCI Emerging Markets Bank Index) and by the end of 2009, had rebounded to pre-crisis levels or new historical peaks.
Despite the strength in equity valuations, the microfinance sector is undoubtedly feeling the impact of the crisis more severely than at any time since the depths of the Asian financial crisis in the mid-nineties.
The CGAP/JP Morgan report shows that portfolio quality began to deteriorate rapidly after January 2009, with past due loans over 30 days jumping to a median of 4.7 per cent from 2.2 per cent over the first five months of 2009, although it has moderated since then and so far remained stable.
The effects of the downtown were far from uniform however, with MFIs in South Asia and South America showing few signs of impact, while others in Central America, Eastern Europe, and Central Asia were more affected.However, most MFIs have been well-positioned to sustain the downturn and their equity base remains strong at nearly 20 per cent of total assets.