This 13-page study thoroughly details Morgan Stanley’s internal rating methodology and approach to assessing credit risks. Morgan Stanley provides investment banking, securities, and investment management services. Developed by the firm’s microfinance-oriented business unit, the Microfinance Institutions Group (MFIG), the paper was written by Miguel Arvelo, Ju-Lie Bell, Christian Novak, Juliette Rose, and Shally Venugopal. One can find the article in the subscription-only International Corporate Governance issue of Morgan Stanley’s Journal of Corporate Finance or free of charge at the Microfinance Gateway.
The MFIG’s goal was for the firm to be able “to assess the risk of microfinance institutions [MFIs] relative to any other issuers through a global (foreign and local currency) scale rating.” In addition, the approach tries to address inherent, microfinance challenges such as country risk, data availability, and the minimal default history among MFIs. However, the authors also point out that their system was created for MFIs strictly dedicated to offering microfinance products and whose business models revolve around supplying microloans for microentrepreneurs’ businesses.
The paper also acknowledges drawing on microfinance rating methods by Standard & Poor’s (S&P) and specialized microfinance rating agencies PlaNet Finance, MicroRate, M-CRIL, and CRISIL. Research by multinational microfinance organizations, ACCION and the Consultative Group to Assist the Poor, as wells as emerging markets credit analysis processes also contributed to developing their methodology.
The paper lists 7 “rating factors”, which must be considered when analyzing the credit risks of MFIs. These factors are: loan portfolio; profitability, sustainability, and operating efficiency; management and strategy; systems and reporting; operating procedures and internal controls; asset-liability management; and growth potential. For a summary of these 7 factors, see Figure 1 on page 3 of the paper.
The MFIG weights these factors in the order listed above- i.e. the loan portfolio with its portfolio at risk over 30 days, write-offs, size, and loan loss reserves accounts has a 24 percent weight. The three variables of profitability, sustainability, and operating efficiency determine an MFI’s financial viability and thus have a 23 percent weight. Applying a 19 percent weight, the MFIG believes management’s decisions heavily influence an MFI’s success. At 11 percent, the MFIG analyses the systems and reporting via the quality of management information, accounting systems, data feed speed, reports, and distribution of findings.
On the lower end, internal controls and operating procedures allow MFIs to reach operation efficiency, avoid fraud, and create a history of transparency; therefore, the MFIG weights them at 10 percent. At 7 percent, asset and liability management help identify potential financial risks by examining leverage, exposure to foreign currency, and liquidity. Finally, given the beginning stages of many MFIs, their growth potential is given a weight of 6 percent. In evaluating growth potential, the MFIG considers the regulatory environment as wells potential client numbers and density.
The paper also highlights important but avoidable “missteps” to be considered in addition to their weighted, formulaic approach. The first is the consolidation of entities given the growth of some MFIs and the many accounting practices for such transitions. As touched on earlier, other microfinance products should be reviewed separately from the microloan portfolio, considering their credit approval process, their loan sizing methodology, and their portion of the total portfolio. From a client perspective, the paper also notes that small and medium enterprises are different businesses and thus should also be analyzed differently. Finally the disparity between group and individual lending will influence the due diligence required as well as the analysis of financial statements and projections.
MicroCapital has reviewed Morgan Stanley’s microfinance activities and wrote articles on its first structured finance deal, BOLD 2006-1. MicroCapital has also written articles on other microfinance rating methodologies, including S&P’s rating system which was used as a reference for Morgan Stanley’s.
by Jennifer Lee
Additional Resources:
Journal of Applied Corporate Finance: “Morgan Stanley’s Approach to Assessing Credit Risks in the Microfinance Industry”; by Miguel Arvelo, Ju-Lie Bell, Christian Novak, Juliette Rose, and Shally Venugopal; Vol. 20; Winter 2008.
Morgan Stanley: Home, 2007 10K, BOLD 2006, BOLD 2007, Credit Analysis Methodology
MicroCapital Story: “BlueOrchard Finance and Morgan Stanley Partner in $106 Million Landmark Financing Deal for Microfinance Investment”, July 12, 2006.
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