Is NIT’s social impact fund a MFI/MFB bailout fund?
Investments in illiquid instruments of an insolvent sector are classified as MEDIUM risk by SECP 🤷♂️
I wrote this over the phone so apologies for typos and grammatical mistakes.
I came across this advertisement in the newspaper of NIT launching Pakistan’s first social impact fund.
Over the last few years, there has been an increase in fund managers launching ESG themed funds in the West. It is the extension of Socially Responsible Investment (SRI) movement. ESG investing is propelled in the West by the climate change movement. The millennials that are studying at Ivy League universities or working with large Silicon Valley companies are asking that the endowment money or the retirement funds be invested responsibly. For those who have been following this space, this is similar to the late 80’s movement at universities to divest from investment in apartheid era South Africa
Dartmouth Trustees to Divest South African Investments
Dartmouth College will sell off $11.5 million worth of investments in companies doing business in South Africa by the end of the year, the Board of Trustees announced Monday.
The Ivy League school, which has been a hot spot in the debate in this country over South Africa’s apartheid policies, will also refrain from such investments in the future, the board said in a statement.
Dartmouth’s investments in companies doing business in South Africa have declined from $63 million, or 15 percent of its endowment, to $11.5 million, or less than 2 percent, the board said.
After the announcement, Heetan Kalan, a sophomore who heads the International Student Association on campus, said, ″I’m speechless. It’s a great victory.″
It was black and white when it came to investment in South Africa: divest all investments in South Africa. Thw ESG criteria is fuzzier. Most of the investors and fund managers rely on ESG ratings assigned by indexing providers or rating companies. Bloomberg Businessweek wrote a great investigative piece on it. I highly recommend you read it in full.
MSCI, the largest ESG rating company, doesn’t even try to measure the impact of a corporation on the world. It’s all about whether the world might mess with the bottom line.
A Bloomberg Intelligence analysis earlier this year showed that BlackRock’s ESG Aware holds a portfolio that closely tracks both the S&P 500 and BlackRock’s own top-selling S&P 500 fund, with two notable exceptions: The ESG fund has a “sustainable” label thanks to MSCI, and it’s more heavily weighted in 12 fossil fuel stocks than the actual S&P 500. Asked for comment, BlackRock said that the fund is not designed to offer investors the top ESG-scoring companies and that it shouldn’t be compared to the S&P 500.
One other critical difference between the two BlackRock funds: Fees for ESG Aware are five times those for the S&P 500 fund. The ESG fund, now holding $24.8 billion, has grown by about $1 billion a month.
…In MSCI’s system, companies are measured not against universal standards but against their industry peers. And the starting proposition is that an average company in each peer group is worthy of a BBB rating. MSCI doesn’t use the term “investment grade,” but that’s what BBB has meant for decades on Wall Street. By default, an average fossil fuel producer, utility company, automaker, used-car dealer, bank, retailer, chemical manufacturer, or arms maker earns that grade from MSCI. When a peer group swings, or MSCI changes its methodologies, companies can get upgraded for doing nothing other than staying the same. Businessweek found half of the 155 companies that got upgrades did so in significant part because of changes to the way MSCI calculated scores, not because of any change in the companies’ behavior.
…Even sophisticated investors can be forgiven for not knowing what’s going on inside the ratings used to build their ESG funds. MSCI’s detailed rating reports are available only to its financial-industry clients. The sellers of ESG funds don’t add much clarity. On the main page of its website for individual investors, BlackRock advertises iShares ESG Aware MSCI USA as offering exposure to “U.S. stocks with favorable environmental, social, and governance (ESG) practices.” It doesn’t tell anyone what “favorable practices” actually means.
Regardless of the challenges, it is understandable that Western companies and fund managers are responding to the demand for ESG investments. There is no such movement in Pakistan. While individual Pakistani companies can go for ESG rating to attract foreign investors or foreign funds as they value ESG ratings, there appears to be no demand from Pakistani retail and institutional investors (I presume they are the target investors) for a fund with an ESG tilt. I tweeted the following:
The responses were enlightening
As per NIT website, the fund allocation will be
Cash and Cash equivalents: Min: 25%, Max: 100%
Govt Securities (PIBs/Tbills etc): Min: NA, Max: 30%
Rated TFCs/CPs/others of MFIs/MFBs: Upto 70%
Green Bonds/Social Impact Bonds of other Financial Institutions Upto 30% . Mininum Investment Grade - BBB
The third bullet point is the key. The fund will be directed towards high yield deposits and other instruments of micro finance institutions/banks which are illiquid. I don’t know what is SECP’s criteria but investing in illiquid securities of a sector which is insolvent shouldn’t be categorized as “MEDIUM” risk.
I have already written a post on how Telenor Microfinance Bank is already kaput. The entire microfinance sector, in my opinion, with the exception of one or two entities is insolvent. With the increasing inflation, devaluation and multiple crises facing the country, there is a possibility that when all this will over, those one or two standing that are solvent right now will also go belly up.
As per the financial statements as of December 31, 2021, the total capital of UMB is Rs.7.4 billion. As per the notes to financial statements, due to the relief provided by SBP to dampen the effect of Covid-19 on the financial standing of MFI/MFBs, Rs. 8.2 billion loans are restructured/deferred against which no provisions are made. Provisions against such loans can erode one-half to three-quarter of the capital of UMB if not completely wipe it off.
The financial statements of other MFIs/MFBs aren’t any better.
In February 2022, Bank of Punjab signed an agreement to provide Rs. 5 billion to U Microfinance Bank(UMB).
U Microfinance Bank Signs an Agreement with The Bank of Punjab for Kamyab Pakistan Program
BOP will provide U Bank with an interest-free Term Finance Facility under the KPP framework compliant Low-Cost Housing Program, amounting to PKR 5 Billion, to promote housing finance in the country.
This new initiative not only strengthens the bond between both institutions and opens up more avenues for collaboration, but also ties in with the Government’s agenda for providing access to housing credit to the excluded part of Pakistan.
A commercial bank is providing an interest free loan to an insolvent micro-finance institution. This isn’t a commercial transaction. It’s a bailout.
In my earlier post, I had written
Kamyab Pakistan Program : Too Cute By Half
The entire [Kamyab Pakistan] program stands on the assumption that the 8% subsidy that the GoP is providing is sufficient to cover the operating expense of MFI. As per PMFN, the operating expense ratio of MFIs is in the range of 20%.
I dislike the usurious rate that MFIs charge to low-income borrowers and have my doubts about poverty eradication or upliftment, if any, that MFIs achieve but discussion of that is beyond the scope of this post. If MFI's operating expense is 20% and their usual cost of funds is ~10%+, MFIs need to charge above 30% to make money. That is the reason MFI's charge the usurious rate of 36%+ to low-income borrowers.
The cost of fund of MFIs at the time was 10% when the policy rate was around 7.25% and T-bills were in the same range. Now T-bills are offering 15%+.
Commercial banks are offering 10.75% on their saving accounts.
Both T-bills and commercial bank saving accounts are liquid instruments. If MFIs are to attract deposits or debts at market terms, their cost of funds will have to increase significantly above 10.8%. Consequently, they will have to charge higher rates to their borrowers ie if it was minimum 36% earlier, it should be at least 45% now. I don’t know much about microfinance but I believe such loans won’t have high repayment probability in the current challenging environment.
No wonder, Bank of Punjab is offering interest free loans to UMB for Kamyab Pakistan Program (KPP) which will allow UMB to earn KIBOR+4% on low cost housing loans while charging borrowers 5%.
Under Kamyab Pakistan Program, GoP will be providing K+0.5% to BoP and a 50% loan loss guarantee. BoP is earning 15.5% on this loan, paid by GoP and 50% loss is covered by GoP.
KIBOR is around 15% today. This arrangement is allowing UMB to earn 19% on zero cost funds. A bailout!! UMB has to cover credit and operational costs from it but providing borrowers a loan at 5% shouldn’t carry as much risk as a 45% loan.
Thus, while it may appear from the press releases that it’s BoP that’s bailing out UMB, it’s actually taxpayers ie GoP and the cost of bailout is:
14% (difference between K+4% that UMB earns and 5% charged to borrower, and
50% loan loss guarantee provided to BoP by GoP.
Usually, it’s multilateral financial institutions or international development finance institutions that seed such funds to achieve Sustainable Development Goals (SDGs). However, here the seed investors are government owned Bank of Punjab (BOP) and National Bank of Pakistan (NBP).
Thus, it appears, this fund is created to bailout the micro finance sector. On the plus side, instead of taxpayers unwillingly on the hook when the government directs NIT etc. to invest in PSX, this time investors will be willingly parting from their savings under the garb of Socially Impactful investing in illiquid instruments of a sector that is insolvent but is classified by SECP as “MEDIUM” risk.
On a side note, PSX is trading at attractive valuations right now. This would have been a great time to launch a PSX bailout fund. (This is not an investment advice. Talk to your investment advisor before making an investment).
Josh’s