Four Tips for MFIs To Impress Investors
The due diligence process can be hard on MFIs. Substantial management time and resources are often required, investors' questions can appear mysterious and intrusive, and unwelcome light may be shed on shortcomings in governance and procedures. Plus, there is the pressure of knowing that the final outcome will directly impact MFIs’ cost of capital. However, simple changes to how MFIs provide information can make the process much easier and lead to better results. Being well-prepared for due diligence is especially important when portfolios at risk (PARs) are rising and liquidity is constrained, the case for many MFIs now during the COVID-19 pandemic.
As due diligence analysts, we have observed over years of practice that the quality of disclosure has a direct impact on the length of time it takes to turn around a due diligence, and ultimately on an institution’s cost of capital. In this blog post, we would like to share some of our experiences and offer four tips for MFIs to improve the due diligence experience.
A tale of two MFIs
One of our most difficult due diligence assessments was for “MFI A” in a South Asian city, commissioned by an investor with a tight timeline. To our dismay, before departure we discovered that the MFI had provided incomplete and disjointed information. The financial reporting was muddled. Complicating matters further, MFI A’s funding model was somewhat unusual, and we needed to have it explained to us. As a result, we started the due diligence with only cursory knowledge of the MFI’s business model, its most basic key performance indicators (KPIs), market environment, underwriting procedures and governance.
Unfortunately, it did not improve once we got there. Meetings lacked focus and dwelt on minutiae. Management seemed irritated by having to give time-consuming explanations of basic facts. Because of poor coordination among the executive team, the CEO’s stated strategy diverged from that of the CFO and CIO. After our visit, we had to bother management with follow-up questions because there wasn’t a dedicated person to field queries.
Due to all of these issues, the final due diligence report included a mention to the client’s risk officer that information disclosure was below par. The Investment Committee took note and offered the MFI less attractive investment terms.
“MFI B,” in a Southeast Asian city, was a different story. Before the due diligence, MFI B gave us access to a logically constructed and easily navigable data room (a secure website where all relevant confidential information about the MFI is placed for access by lenders). They delivered numbers well ahead of the due diligence, in a format aligned with best practice.
Best of all, MFI B compiled an information memorandum summarizing everything we needed to know, in a format similar to that of the report we would give to the investment committee. We arrived well-briefed and were thus able to focus on key questions, probing management’s assertions and assumptions. The few follow-ups we had were handled by a specially assigned manager. In our final report, we were able to inform our client’s risk officer that MFI B’s disclosure and responsiveness were excellent. The Investment Committee approved a loan facility to MFI B under favorable conditions.
Tips for MFIs to streamline the due diligence process
Having conducted hundreds of MFI due diligence assessments across emerging markets, we’ve seen that disclosure issues are present in larger and smaller MFIs alike. The good news is that we believe due diligence turnaround times can be trimmed relatively easily. Here are our suggestions for MFIs to make this process much easier for everyone:
1. Be prepared. The key to a smooth due diligence is thorough prior preparation. As a first step, we advise MFIs to maintain, on an ongoing basis, a "live" information memorandum - a report that is regularly updated and can be issued, for instance, when covenant reports are sent out or before board meetings. Such a memorandum should provide a running commentary on the operating situation of the MFI, and could immediately be passed to funding partners for due diligence. In addition to a description of the MFI’s business model, this document should include:
- The MFI’s KPIs (e.g. capital adequacy, liquidity schedule, PAR, loan metrics).
- A succinct commentary on the drivers behind these metrics, including developments in the MFI’s market and its sector positioning.
- A clear breakdown of underwriting, collection, antifraud and internal audit procedures.
- Governance data including executive and director bios.
All of this information should be set out in a format similar to that of the reports due diligence analysts will eventually produce, or in PowerPoint.
2. Appoint a due diligence liaison. MFIs should assign a competent manager from the finance department to liaise with due diligence analysts and centralize all information demands throughout the deal process. The manager should anticipate topical questions and proactively volunteer answers, for instance in relation to COVID-19. This person should ensure that the due diligence consultants are well-briefed enough to be able to engage effectively with the executive team.
3. Organize your virtual data room. MFIs should think carefully about the quality of their data rooms, making them intuitively navigable and hosting content aligned with industry best practice. The data room should give the capital provider a clear presentation of procedure manuals, anti-money-laundering (AML) and other policies, audit and asset and liability management committee (ALCO) minutes, business continuity plans and industry data.
4. Deliver a coherent narrative. Everyone the due diligence analysts talk to should agree on what the MFI’s strategy is. While this sounds simple, sometimes managers in the same company can contradict each other about basic aspects of overall direction. A clear and consistent strategic and operational message needs to be conveyed to potential investors. To make sure managers are all on the same page, we recommend arranging a short training session and internal coordination ahead of the due diligence.
These measures should not be difficult to undertake, and any associated expenses would be offset by reduced senior executive time spent on due diligence and lower capital costs. Implementing each of these recommendations will make the process much easier and allow the due diligence analysts to present the MFIs’ investment cases to decision-makers more quickly. A more efficient and organized due diligence process, in turn, can ultimately lower MFIs’ cost of funds and bolster their goodwill with investors – especially helpful at a time when capital is scarce.