Banco Compartamos: Interest Rates, Profits, and an Initial Public Offering

June 15, 2007    

In April 2007, Mexican microfinance institution (MFI) Banco Compartamos made an initial public offering (IPO) of its stock. The original investors who created the company in 2000 sold off part of their shareholding to public investors at an astonishing profit. A new Focus Note, CGAP Reflections on the Compartamos Initial Public Offering, asks: are clients paying the price?

Big profits

The Compartamos IPO was 13 times oversubscribed, and the share price surged 22 percent in the first day of trading alone, even though the offering price was twelve times the book value of the company. The original investors received US$450 million for 30 percent of their shares, representing a rate of return on their original investment (about US$6 million) of 100 percent a year compounded over the eight year investment period. Most of these gains went to not-for-profit development agencies--a Mexican NGO, the International Finance Corporation, and ACCION International--but a third of the proceeds went into the pockets of private shareholders.

The biggest reason for the high sales price was that Compartamos had been generating very high profits (returns on equity above 50 percent a year), driven by very high interest charges to borrowers (about 86 percent a year).

Not surprisingly, the news raised a lot of eyebrows. Two concerns predominated in discussions among industry observers. Did the high interest rates place an unreasonable burden on Compartamos's borrowers, contrary to the social objectives of the company and its majority shareholders? And did the early donor grants that Compartamos received before it commercialized in 2000 wind up enriching private parties?

Using profits to expand outreach?

Given the cost of labor in Mexico and the tiny size of Compartamos loans, a high interest rate was inevitable. But how high? If Compartamos had charged 68 percent a year, it would have made a profit of about 15 percent on equity, which is average for Mexican banks. By charging clients about 86 percent, it generated profits that were over three times larger than the banking average. Compartamos justified this practice as a means to fund rapid growth of its outreach to poor women: the profits were re-invested in new branches and staff, so that by the time of the IPO Compartamos was serving almost 700,000 borrowers, making it one of the largest MFIs in Latin America. Was this a defensible strategy for an institution with a social objective--improving the welfare of present and future poor clients?

We at CGAP think that the answer depends on which stage of Compartamos's history one is discussing. Prior to 2000, Compartamos was a not-for-profit NGO. By law, it could make profits, but it had no owners. Any profits had to be used for the institution's social purpose, and could not be distributed to any private party. Thus, every additional percent of interest paid by current borrowers would go to benefit future clients, rather than escaping into the hands of private individuals. Also, during this period Compartamos probably did not have other practical options for funding such a rapid expansion of its services. Under those circumstances, we think that funding expansion with higher-than-usual profits could be defended, in light of Compartamos's announced objective of reaching one million poor Mexican women as quickly as possible.

But things changed after 2000, when Compartamos "commercialized"--that is, moved its operations into a for-profit company that sold its shares not only to pro-bono investors but also to a minority of private individuals. Once that happened, some of the profits generated by the high interest rates would go to private investors rather than future clients. More importantly, Compartamos had other ways to fund its growth after 2000. It could (and did) sell bonds in Mexico, and socially-motivated international investors had begun creating large funds to invest in the debt and equity of high-quality MFIs.

It seems to us at CGAP that after 2000 there was a direct conflict between the profits of private investors and the financial interests of Compartamos borrowers. We don't think that Compartamos and its pro-bono majority shareholders gave enough weight to the interests of the borrowers when setting its prices.

Public grants leaking into private pockets?

Before commercialization in 2000, Compartamos's operations were supported by direct or indirect grants of about US$6 million from private Mexicans and international public donors, including CGAP. True, these grants did fund the start-up of an operation that eventually produced big returns for private for-profit investors. But these private investors paid for their shares with their own money, at a price that represented a premium over the book value of the loan portfolio that the Compartamos NGO contributed to the new for-profit company. All the donor grants went to non-profit NGOs. Any shares purchased with those grants remained the property of the NGOs, and all profits accruing to those shares will remain in the NGOs, supporting their pro-bono work. We don't think there has been an inappropriate leakage of donor grants into private pockets.

Is the IPO good or bad for the microfinance industry?

The concern about interest rates and private enrichment has obscured some of the clear benefits of the IPO. The buyers of the shares were almost all truly commercial mainline investors, who represent a much larger long-term funding source for microfinance than the socially-motivated investors who are buying most MFI debt and equity at present. The huge success of the Compartamos IPO will no doubt make it easier for MFIs to raise mainline funding in the future, and help microfinance be regarded as a serious business by the financial systems of the countries where it operates.

While the Compartamos IPO may stimulate investors' interest in other MFIs, it may also have less fortunate results for some MFIs in Latin America and elsewhere. A number of countries are seeing a strong backlash against high microcredit rates from populist governments and politicians. This populist critique conveniently ignores the fact that rates for tiny loans have to be higher--sometimes much higher--than normal bank rates even when the MFIs are efficient and profits are reasonable. But the public example of Compartamos, where interest rates and profits look surprisingly high even to a fair-minded observer, seems likely to add fuel to the flames.

A time for reflection

We at CGAP ask ourselves whether we bear any responsibility for this situation. Our 1996 grant of US$2 million to the Compartamos NGO included no covenants about future interest rates or profit levels. Such covenants would probably have been inappropriate or impractical for a number of reasons, but in truth we never gave much consideration to the possibility that Compartamos would be charging such interest rates, and generating such profits, ten years later, after private investors had been brought into the picture. We thought the motivations of the early leaders, or at least eventual competition, would keep things in reasonable bounds. We still hope--indeed expect--that competition will reduce rates and profits in the sector, as discussed above. But it is taking a long time.

More generally, since our founding in 1995 CGAP has been vocal about the need for interest rates that are high enough to cover costs, but we have been less emphatic about the loss to clients when interest rates are driven by inefficiency or exorbitant profits. We never made concrete predictions about how quickly competition would fix these problems, but we were probably too optimistic on this score. The Compartamos IPO gives all of us an opportunity to take another look at these questions.