The Impact Alpha | April 12, 2018

The impact opportunity in the mispriced risk of lending to the underserved

David Bank
ImpactAlpha Editor

David Bank

ImpactAlpha, April 12 – Techies are used to making the impossible possible. Bankers, not so much.

But I’ve been struck by a common theme in many of the recent deals ImpactAlpha has rounded up in our Dealflow column, as well as in a bunch of conversations with financiers. Things that were impossible even a few years ago are now possible, and profitable.

That means that millions of small businesses and individuals in the US and around the world may finally get access to the kind of appropriate, affordable capital they need – to build a school, buy a rickshaw or motorcycle, light their homes, or start or grow a business.

We’re familiar with the impact of the falling cost of technology, from mobile phones to solar panels. The falling cost of capital may have even greater impact.

Information assets

Of course, the falling cost of capital is itself tech-enabled. But instead of collecting your personal information to sell you to advertisers, the new crop of financial innovators are using new sources of information to qualify you for an affordable loan.

“There are more information assets than ever before in human history, but lending is at its most abysmal state in 70 years,” Jacob Haar, a managing partner at Community Investment Management in San Francisco, told me over coffee recently. “The model has not caught up.”

>>MORE: Jacob Haar: Financing the financiers expanding small-business lending in America

That kind of gap is an opportunity, and hundreds of lenders have sprung up in the past five years to take advantage of the “mispriced risk” of making loans to historically underserved borrowers. Community Investment Management has a “picks and shovels” strategy, providing capital to the lenders to make loans, primarily to US borrowers, and keeping the actual debt as collateral. “These are creditworthy people. How do we get to ‘yes’? It’s that simple,” Haar says.

The drumbeat of recent deals tells the same story. Varthana, in Bangalore, raised $55 million to make loans to low-fee private schools in India. Veritas, in Chennai, secured $8.5 million in debt to expand its lending to small businesses, some of whom borrow as little as $75. Namaste, in Delhi, which this week raised $3.8 million, helps qualify small businesses for loans and then connects them with more than 30 institutional lenders.

And it’s not just in India. Peruvian startup Tienda Pago raised $7.5 million to lend to small retailers in Peru and Mexico. In Brazil, Moeda raised raised $20 million (through an initial coin offering) to improve lending to rural businesses. Visor, in Mexico, recently raised funds to improve small-business credit assessments.

Good returns, good economics

Bankers historically have not rushed to finance the receivables of customers without established credit histories. That’s starting to change. “As you prove there are good returns and good economics, you start to attract more commercial capital,” Bill Lenihan, the chief financial officer of Off-Grid Electric, told me. “The risk profile is lower, and cost of capital comes down.

The company, which operates in Tanzania and Rwanda, effectively finances its customers, most of whom have never set foot in a bank nor opened a bank account. The business of selling solar home systems in Africa is “wildly capital-intensive,” he says. “The cost of capital is a huge component, every bit as much as the cost of the product.”

>>MORE: Can businesses profitably serve the poorest of the poor?

M-Kopa, another pay-as-you-go solar provider, last fall secured $80 million in commercial debt, one of the largest debt facilities to date in the pay-as-you-go, off-grid energy market. The new facility is backed by M-KOPA’s customer receivables – regular mobile-money payments made for M-KOPA solar kits and other products. The $80 million includes a new $55 million local currency equivalent debt facility, led by Stanbic Bank Uganda, with additional financing from a range of development banks. It also includes $25 million in US dollar debt from responsAbility, Symbiotics, and Triodos Investment Management.

“There are exciting developments in areas no one thought we could finance profitably,” Gil Crawford, CEO of MicroVest told me. Microvest provides capital to lenders like Banco Solidario in Ecuador and Bina Artha in Indonesia. Solidario, which started as a foundation, is now a regulated, deposit-taking bank. Costs and interest rates have declined as the company and competition has grown.

The depth of private credit has historically been a leading indicator of development in particular markets – and in many markets, such provision has been terrible.

“You can’t build businesses on venture capital,” says Crawford. As MicroVest’s borrowers prove their reliability, MicroVest itself is able to secure capital on better terms, expanding its impact. “In inflation-adjusted return, we’ll continue to see the cost of capital get better as we get better at it,” he said.

The impossible, it turns out, just takes a bit longer.

(Editor’s note: This story was updated April 16 with new information from MicroVest.)