November 6, 2008

A Global Ratings Methodology For Microfinance Institutions May Help The Industry
Primary Credit Analyst: Jane Eddy, New York (1) 212-438-7996; jane_eddy@standardandpoors.com Contributor: Nelun Wijeyeratne, Microfinance Project Manager 1 (212) 438-3615; nelun_wijeyeratne@standardandpoors.com

Table Of Contents
MFI Ratings Methodology Developed And Refined The Pilot Program Seeks To Promote Transparency And Disclosure Of MFIs The Liquidity Crunch Might Lead To A Stronger Microfinance Industry Note

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A Global Ratings Methodology For Microfinance Institutions May Help The Industry
Interest in the microfinance industry has soared as participants gain a better understanding of the potential for microfinance institutions (MFI) to alter lives and economies. The primary business of these organizations is providing small loans and financial services to low income and/or financially underserved clients. The rapid expansion of MFIs, and the ongoing interest of mainstream investors--even in the current financial crisis--confirm our belief that microfinance is on the path to becoming an emerging market asset class. To achieve this potential, in our opinion, the industry must continue to widen and mobilize the investor base, especially given the current market turmoil, while expanding the universe of effective and sustainable MFIs. As a key first step to meet this challenge, industry constituents have recognized the need to create globally accepted metrics. These metrics could have the potential to provide investors with transparent and globally acceptable standards for credit analysis and performance evaluations, as well as enable comparisons of microfinance investment opportunities within and across borders and with other types of investment opportunities. In our view, the current financial crisis has made the need for transparency and industry benchmarks even more relevant to the microfinance sector as it faces new challenges.

MFI Ratings Methodology Developed And Refined

In response to the need for globally accepted and standardized analytical tools, Standard & Poor's Ratings Services is taking steps to develop ratings criteria for MFIs. In June 2007, a report outlining the recommendations for a comprehensive MFI ratings methodology addressing the analytical needs of investors was published by Standard & Poor's. A working group composed of experts in the microfinance industry and Standard & Poor's analysts developed the report. After publishing the report, we reviewed our relevant criteria in a variety of areas, including financial institutions, health care, non-traditional public finance, affordable housing, and universities, to further refine our thoughts on our own draft rating criteria for MFIs. We did this review to ascertain similarities between these types of entities and the microfinance industry, particularly in relation to the impact that ownership structure (not-for-profit versus for-profit) and mission execution have on operating and financial performance. We believe the review resulted in a more nuanced approach that reflects the specialized nature of MFIs and their operations. While we incorporated unique features of the MFI model into the evaluation process, the draft criteria include all standard indicators of creditworthiness for financial institutions: Economic and industry risk; Market position and diversification; Management and strategy; Ownership and governance; Financial reporting; Operational, enterprise, credit, and market risk management; Earnings and profitability; Funding/liquidity; and

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A Global Ratings Methodology For Microfinance Institutions May Help The Industry Capitalization. We are validating the robustness of these criteria through a pilot program. Once the ratings are complete, our analysts will present the revised criteria to our Analytics Policy Board for approval, a required step before the publication of any Standard & Poor's criteria. This approval is part of our standard internal procedures and independent review process to finalize any new credit ratings criteria. Once we finalize our microfinance rating criteria, we will publish and disseminate it. We expect to complete this work by mid-2009. Currently, we follow our financial institutions criteria to rate MFIs.

The Pilot Program Seeks To Promote Transparency And Disclosure Of MFIs

The Inter-American Development Bank's Multilateral Investment Fund is collaborating with Standard & Poor's to support the issuance of global credit ratings through a pilot program for 10 MFIs in the Latin American and Caribbean region. The overall objectives of the program are to promote the development of transparency and disclosure through global ratings and benchmarks. When we selected the 10 MFIs for this pilot project, our aim was to gather as broad a group as possible. As part of the selection process, we reviewed the Championship League 2007 MIX Latin America & Caribbean 100 tables published by the Microfinance Information Exchange. (MIX is a business information provider dedicated to strengthening the microfinance sector, and participated in the MFI working group.) We also consulted a variety of other industry sources. To provide a diverse group of MFIs, the selection criteria included diversification by geography, portfolio size, type of institution (for example, banks, non-bank financial institutions, and not-for-profits), and major microfinance networks as well as unaffiliated entities.

The Liquidity Crunch Might Lead To A Stronger Microfinance Industry

To better understand and respond to the needs of the industry, and to solicit feedback on the credit ratings approach, we conducted an extensive series of more than 60 meetings and interviews with industry participants. We included representatives from MFIs, major investments banks, microfinance investment funds (both equity and debt), the largest microfinance networks, microfinance industry associations, and a specialized rating agency. Investors in particular were interested in global ratings, which are familiar to them. And emerging market investors are growing more comfortable with the speculative-grade ratings on microfinance institutions. The industry experts we interviewed raised a series of concerns about the impact of current market and economic conditions on MFIs. The current liquidity crunch is definitely curtailing the growth of the loan portfolios of these institutions. Although most stakeholders in the industry voiced the view that there is still a significant need for risk capital to flow to these institutions, they consider this period of dampened growth as a positive. They believe that the slower growth scenario will lead MFIs to improve their operating discipline, and ensure that their infrastructure (enterprise risk management systems, internal controls, management capabilities, and so on) is better equipped to handle any anticipated future pickup in expansion. Some of the other concerns they expressed included the greater need for local MFI debt and equity offerings, especially during this time of restrained global funding activity, to avoid unhedged foreign currency exposures. The transformation of non-profit MFIs to regulated financial entities continues to raise concerns about mission drift, as reflected in the paper published by Women's World Banking titled, "Focus Note: Stemming the Tide of Mission Drift: Microfinance Transformations and the Double Bottom

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A Global Ratings Methodology For Microfinance Institutions May Help The Industry

Line." In our view, the evolution and performance of the microfinance industry over the past 30 years has been impressive. However, this success brings with it a myriad of challenges. Discussions with industry leaders show that significant risks exist, including management quality and staffing of MFIs, as well as their governance, technological expertise, and ability to effectively manage growth while maintaining a commitment to their original mission. As many MFIs continue to transform from not-for-profit entities to for-profit banks, these risks may be exacerbated. Effectively managing and mitigating them will be instrumental to expanding the industry. Therefore, the impetus to attract global capital needs to be tempered by prudent codes of conduct and globally recognized standards. We're continuing to expand our role in the global microfinance market by contributing to the development of globally recognized standards. Most recently, we have provided global ratings in Latin America, Eastern Europe, and Asia, and continue to receive inquiries for ratings in the Latin American and Caribbean and other regions. Our transaction pipeline includes a number of requests for ratings on microfinance securitizations. Many of the transactions are delayed, however, pending improved market conditions. If they are completed, we believe that these transactions will go a long way toward developing primary and secondary markets for the microfinance sector.

Note
"Microfinance: Taking Root In The Global Capital Markets," published by Standard & Poor's in June 2007, contains the complete results of the Microfinance Rating Methodology Working Group. Two major portions are available on RatingsDirect. See: "Report Of The Microfinance Rating Methodology Working Group" and "MFI Rating Methodology," both published on June 19, 2007.
Additional Contact: Andrea M Esposito, New York (1) 212-438-6520; andrea_esposito@standardandpoors.com

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