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Is Another Credit Bubble About to Burst? In Microfinancing of All Places

August 21st, 2009 | No Comments | Posted in Private Equity, Venture Capital

The bursting of the credit bubble in 2008 was one of the major drivers of our current recession.  One would think private equity would learn that sometimes too much of a good thing is a bad thing after all.  A recent article by the Wall Street Journal’s Ketaki Gohkale describes how the world of microfinancing is experiencing a bubble that is about to burst.

As Gohkale notes in his article:

“A credit crisis is brewing in “microfinance,” the business of making the tiniest loans in the world.

Microlending fights poverty by helping poor people finance small businesses — snack stalls, fruit trees, milk-producing buffaloes — in slums and other places where it’s tough to get a normal loan. But what began as a social experiment to aid the world’s poorest has also shown it can turn a profit.

That has attracted private-equity funds and other foreign investors, who’ve poured billions of dollars over the past few years into microfinance world-wide.

The result: Today in India, some poor neighborhoods are being “carpet-bombed” with loans, says Rajalaxmi Kamath, a researcher at the Indian Institute of Management Bangalore who studies the issue. In India, microloans outstanding grew 72% in the year ended March 31, 2008, totaling $1.24 billion, according to Sa-Dhan, an industry association in New Delhi.

“We fear a bubble,” says Jacques Grivel of the Luxembourg-based Finethic, a $100 million investment fund that focuses on Latin America, Eastern Europe and Asia, though it has no exposure to India. “Too much money is chasing too few good candidates.

Of the 54 private-equity deals (totaling $1.19 billion) in India’s banking and finance sector in the past 18 months, microfinance accounted for 16 deals worth at least $245 million, according to Venture Intelligence, a Chennai-based private-equity research service.

International private-equity funds started taking notice of Indian microfinance in March 2007. That’s when Sequoia Capital, a venture-capital firm in Silicon Valley, participated in a $11.5 million share offering by SKS Microfinance Ltd. of Hyderabad, India, one of the world’s largest microlenders.

“SKS showed the industry how to tap private equity to scale up,” said Arun Natarajan of Venture Intelligence.

Numerous deals followed with investors including Boston-based Sandstone Capital, San Francisco-based Valiant Capital, and SVB India Capital Partners, an affiliate of Silicon Valley Bank.

As of last December, there were over 100 microfinance-investment funds globally with total estimated assets under management of $6.5 billion, according to the Consultative Group to Assist the Poor, or CGAP, a research institute hosted at the World Bank.”

As VentureBeat’s Anthony Ha recently noted in a post entitled Report: Private equity funds sitting on $400B of uninvested capital there is as much as $400 billion of un-invested private equity in the market today.  Check out the chart from Anthony’s post below which shows that the private equity overhang (money raised versus money invested) is at a five year all time high:

private-equity-overhang

Souce:pitchbook.com

While there certainly is a dearth of solid investment opportunities today, one would think that private equity could find somewhere else to put their money. 

Some observers blame a fundamental shift in the microfinance business for feeding the problem. Traditionally, microlenders were nonprofits focused on community service. In recent years, however, many of the larger microlending firms have registered with the Indian central bank as a type of for-profit finance company. That places them under greater regulatory scrutiny, but also gives them wider access to funding.

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