Mutual funds: a new source of financing for MFIs

IFMR Capital has completed landmark securitisation of a pool of JLG loans originated by the MFI Equitas, with a combination of several investors including a mutual fund (ICICI Prudential) and bank treasuries (Axis Bank and Dhanalakshmi Bank). ICICI Prudential took a majority of the deal size for inclusion in its short-term debt funds, marking the advent of mutual funds (MFs) as investors in micro finance securities. This transaction paves the way for other MFs to invest in micro finance securities.

Micro finance can become an attractive asset class for MFs as:

• MFs generally have a mandate for high quality assets. With a delinquency rate of less than 2% (industry-wide), MFI loans are superior to other asset classes like vehicle loans, credit card receivables and small-ticket personal loans. Moreover, investment-grade and above ratings of tranches of MFI loans provide extra comfort to MFs
• In view of a new SEBI directive, MFs have to hold three-months maturity papers in liquid schemes. The short tenure of MFI loans (about a year) has opened up an opportunity for them. Top-rated senior tranches of MFI securitisation can be structured to mature in three months, to match liabilities with assets.
• At present, MFs are getting fairly low returns on bank CDs. SBI is currently offering 6% return on CDs, which is expected to drop further to 5.5% because of excess liquidity in the financial system. MFI securities offer a better opportunity because their P1+/AAA-rated paper can give a 150-200 basis point spread over CDs. However, as more MFs participate, this spread is expected to come down.

For MFIs, the transaction initiated by IFMR Capital opens a whole range of possibilities:

• MF investment in MFI securities can lead to a significant reduction in overall cost of funding to MFIs. MFIs will be able to access debt funding at much cheaper rates, and much more efficiently, reliably and quickly. This will create a level playing field for MFIs, irrespective of size and vintage, where the only variable that will determine access to capital markets will be the underlying quality of the MFI and its assets.
• MF investment potentially offers a fundamentally new direction away from complete dependence on priority sector guidelines, to spur financing for MFIs. This also makes it possible to seek financing outside of the narrow January to March window that is typically active for priority sector requirements.
• MF investment makes it possible for MFIs to access low-cost funds without collecting deposits — offering a very good way out both for them as well as for their customers. In some countries MFIs do collect deposits, which allow them to access low-cost funds.
• Once MFI securities are listed on the stock exchange, their appeal will be considerably enhanced, even for a broader investor group.

MF investment also presents a way to harness the power of capital markets to exercise continuous “oversight” on the large numbers of local financial institutions (LFIs) that are needed to make universal financial inclusion a reality. LFIs are an important step in this direction; while they are involved in origination of services, part of the risk is held by specialised aggregators like mutual funds.

Read more about the landmark transaction.