Joana has experience both as practitioner and researcher in the microfinance sector. Among other topics, she has conducted research on client overindebtdness and impact evaluation methodologies in microfinance with field work in the Dominican Republic, Pakistan, Zimbabwe, and Ecuador. She started her career in 2005 as a credit officer at an NGO in Portugal, and co-edited the 2019 book, “Emerging Challenges and Innovations in Microfinance and Financial Inclusion.”
Joana holds a doctorate in economics and finance from the University of Portsmouth, and a master’s in microfinance from the Université Libre de Bruxelles, Belgium.

Financial Inclusion Specialist, European Microfinance Platform (e-MFP)

Joana Afonso

Daniel Rozas

Brief

Past crises have taught the microfinance sector a lot about weathering storms, and microfinance institutions (MFIs) are once again facing challenging times. This case study is part of a series that CFI, in partnership with the European Microfinance Platform (e-MFP) and the Mastercard Center for Inclusive Growth, is publishing to revisit tales of tough times and resiliency in five markets — <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-viator-azerbaijan/" target="_blank" rel="noopener noreferrer">Azerbaijan</a>, Bosnia and Herzegovina, <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-spandana/" target="_blank" rel="noopener noreferrer">India</a>, Nicaragua and <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-vitas-palestine/" target="_blank" rel="noopener noreferrer">Palestine</a> — and discuss how MFIs, with the help of their investors and other stakeholders, emerged and thrived. The lessons learned from these cases will be compiled and examined in a forthcoming report, Weathering the Storm II, a follow-up to the first edition published in the aftermath of the global financial crisis a decade ago. The hope is that these lessons will be applicable to not only the COVID-19 response, but to future crisis responses as well.

During the final months of 2008, as the world was entering what would be the worst economic crisis of the past half-century, Senad Sinanović, CEO of Partner Microcredit Foundation in Bosnia and Herzegovina, was contemplating the future.

A year earlier, he and his staff had celebrated Partner’s 20th anniversary. Partner was founded following the tragic war that marked the breakup of Yugoslavia, which had itself been assembled from the ashes of the Austro-Hungarian Empire 90 years earlier. It was in the country’s capital, Sarajevo, that WWI began, with the assassination of the Archduke Franz Ferdinand. On his frequent work visits to Sarajevo, Sinanović sometimes passed by the plaque marking the site of the “shot heard round the world,” along the way stepping on the Sarajevo Roses — red-painted shell marks on the pavement, remnants of the Bosnian war of the 1990s. In that corner of the world, history can seem omnipresent.

But it wasn’t history that was on Sinanović’s mind. He was worried about how the financial crisis would impact his clients, his institution, and the broader microfinance sector in the country. The path ahead concerned him greatly. The situation was unfolding against a backdrop of high liquidity in the sector. A strong period of growth of the main MFIs during the second half of the 2000s, as well as a new regulatory framework for microcredit, contributed to the high confidence of donors and funders, who responded by pouring large amounts of funding into the market.

In 2008, the tiny country of Bosnia and Herzegovina, with a population of 3.7 million, was the second biggest destination worldwide, behind Peru, for <a href="https://www.cgap.org/sites/default/files/CGAP-Focus-Note-Foreign-Capital-Investment-in-Microfinance-Reassessing-Financial-and-Social-Returns-May-2011.pdf" target="_blank" rel="noopener noreferrer">foreign capital investment</a> in the microfinance sector. In that market, Partner was (and still is) one of its leading MFIs, with the third largest by gross loan portfolio at about 181 million convertible marks (abbreviated KM), or about USD$106 million, and the second largest in number of active borrowers, at 63,500.

High liquidity may be a blessing during growth periods, but it quickly becomes a curse when loan demand contracts and all that cash sits in a bank, yielding no income. The deep recession in Bosnia brought about by the global financial crisis strongly affected the micro and small enterprises in the country, resulting in less appetite for investment, and thus for the business loans provided by the microcredit sector.
<blockquote>High liquidity may be a blessing during growth periods, but it quickly becomes a curse when loan demand contracts and cash sits in a bank, yielding no income.</blockquote>
Those same challenges also lowered clients’ ability to repay their existing loans. In a context of intense competition between MFIs and widespread multiple borrowing — which was difficult to trace since the use of credit bureau data was still incipient — this predictably resulted in severe loan delinquency problems and credit losses across all MFIs. The poor lending standards of several MFIs also undermined the sector’s reputation, further legitimizing non-repayment of loans even beyond what might have been expected from the economic downturn alone.
<h2>Dealing With High Liquidity</h2>
Partner had, by the end of 2008, a total debt of 156 million KM, broken down into 10 outstanding short-term loans with local banks and 23 long-term loans from foreign social and development investors. While the overwhelming majority of these were market-rate loans, Partner also had subsidized loans, including a 6 million euro loan from a bilateral public funder.

<img class="alignleft wp-image-41167" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2021/01/Chart-debt-in-KM-4.png" alt="bar graph debt" width="700" height="389" />Some of the loans had just been disbursed when the crisis began to unfold, leading to a situation where Partner was sitting on a pile of money that it could not lend out, and thus could not generate income, even as the interest due on the loans continued to accrue.

To limit interest losses, especially on its more recent and expensive loans, Sinanović tried to give the money back, asking to prepay the loans ahead of schedule. However, this was not welcomed by all investors, and some needed to be persuaded to accept the money and terminate the contracts without penalties. This process included a meeting in April 2009 with lenders at the Microfinance Centre (MFC) conference in Belgrade, organized by a group of Bosnian MFIs, including Partner. Facing the reluctance of some investors to accept early loan prepayment, one of the Bosnian CEOs questioned if their behavior was consistent with social investing, which helped change investors’ minds. During the period of crisis, and in the following years, Partner’s short- and long-term debt fell significantly. By the end of 2011, its total debt was down 61 percent from its peak in 2008.
<h2>Getting Ahead of Events</h2>
While reducing excess liquidity solved a part of Partner’s problems, the MFI was still facing strong, serious challenges in its loan portfolio and the consequences of escalating credit and market risks.

<img class="alignright size-full wp-image-41142" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2021/01/Chart-glp-delinquency-partner.png" alt="graph" width="600" height="320" />During 2009 and 2010, Partner’s portfolio contracted by nearly 50 percent off its 2008 peak, and while it has been recovering steadily since then, as of 2019, its portfolio remains 25 percent smaller than it was over a decade ago, at 137 million KM ($78 million).

<img class="alignright size-full wp-image-41191" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2021/01/Chart-write-offs-partner-V2.png" alt="chart" width="600" height="266" />Beginning in 2008, delinquency levels grew rapidly, peaking at 11.5 percent in 2010. Partner also took an aggressive approach to writing off loans it saw as non-recoverable. Between 2009 and 2011, the MFI wrote off 11.4 percent of its 2008 gross loan portfolio (GLP). While high, these credit losses were modest in the context of the Bosnian microfinance crisis. Three of Partner’s major competitors experienced cumulative write-offs of 25 percent or more of their peak 2008 portfolio (according to the authors' calculation using <a href="https://databank.worldbank.org/source/mix-market" target="_blank" rel="noopener noreferrer">MIX Market</a> data).

Nonetheless, Partner’s portfolio quality was worrying, and during the early months of the crisis, Sinanović knew already that Partner would breach many of its debt covenants with its lenders. Together with Partner’s board of directors, Sinanović decided to get ahead of events and provide lenders all the information available on the context of the crisis, the reputation issues affecting the sector, and the exact situation of the MFI. For this, Sinanović and his staff prepared a detailed, 13-page memorandum outlining the impact of the crisis on Partner, its clients, and the Bosnian microfinance market, as well as Partner’s response up to that point and planned next steps. The memo also included extensive monthly data and ratios pertaining to Partner’s portfolio and financial situation. This document was sent to all 17 creditors in April 2009, when the crisis was still in its early phase.
<blockquote class="pullquote--left">Sinanović and his staff prepared a detailed, 13-page memorandum outlining the impact of the crisis.</blockquote>
In this way, Partner’s transparency helped gain lenders’ confidence and, at the same time, effectively created the reporting template for all individual creditors. This early transparency helped Partner avoid being flooded with multiple and diverse requests for information by lenders and gave Sinanović and his team the space to focus on containing repayment problems in its portfolio.

Midway through the crisis, after extensive conversations with like-minded MFIs in the country and with support of outside stakeholders, Partner went further. In 2010, together with two other MFIs, EKI and Mi-Bospo, Partner created U-Plusu. This non-profit financial management advisory center aimed to tackle client over-indebtedness and improve the public image of the institution and the sector by providing financial education and mediation services between clients and financial institutions, especially in cases of multiple borrowing.

Despite the serious impact from the crisis, with credit losses accompanied by steep drops in lending and profitability (ROE decreased from 24 percent in 2008 to -5 percent in 2009), Partner managed to keep the situation under control throughout, and its solvency was never at risk. In fact, despite the large provisions and eventual write-offs, Partner’s equity only slightly decreased during the crisis period (from 43 million KM to 41 million KM).
<blockquote>Partner's solvency was never at risk and its equity only decreased slightly.</blockquote>
Partner’s ability to weather the storm was closely linked to a process of foresight and preparation led by Sinanović and the MFI’s directors. It started with swift adaptation to a significant decrease in loan demand, both in terms of credit offer and operational structure, and an aggressive strategy regarding write-offs, while getting rid of excessive liquidity and being proactive and transparent in its communications with creditors. All this helped Partner ready itself for what would be a sustainable — albeit smaller — future.

What are some dos and don’ts and key success factors that the microfinance sector can learn from the Partner case? CFI’s forthcoming report, Weathering the Storm II, will draw on lessons from Partner and cases from microfinance institutions in four other markets: <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-viator-azerbaijan/" target="_blank" rel="noopener noreferrer">Azerbaijan</a>, <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-spandana/" target="_blank" rel="noopener noreferrer">India</a>, <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-vitas-palestine/" target="_blank" rel="noopener noreferrer">Palestine</a> and Nicaragua. See also the <a href="https://centerforfinancialinclusion.org/weathering-the-storm-hazards-beacons-and-life-rafts-lessons-in-microfinance-crisis-survival-from-those-who-have-been-there/">original Weathering the Storm</a> report from 2011.

Weathering the Storm II: A Case Study of Partner

Past crises have taught the microfinance sector a lot about weathering storms. Microfinance institutions (MFIs) are once again facing challenging times. This case study is part of a series that CFI, in partnership with the European Microfinance Platform (e-MFP) and the Mastercard Center for Inclusive Growth, is publishing to (re)visit tales of tough times and resiliency in five markets – Azerbaijan, <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-partner/" target="_blank" rel="noopener noreferrer">Bosnia and Herzegovina</a>, <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-spandana/" target="_blank" rel="noopener noreferrer">India</a>, Nicaragua and <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-vitas-palestine/" target="_blank" rel="noopener noreferrer">Palestine</a> – and discuss how MFIs, with the help of their investors and other stakeholders, emerged and thrived. The lessons learned from these cases will be compiled and examined in a forthcoming report, Weathering the Storm II, a follow up to the <a href="https://centerforfinancialinclusion.org/weathering-the-storm-hazards-beacons-and-life-rafts-lessons-in-microfinance-crisis-survival-from-those-who-have-been-there/" target="_blank" rel="noopener noreferrer">first edition</a> published in the aftermath of the global financial crisis a decade ago. The hope is that these lessons will be applicable to not only the COVID-19 response, but to future crisis responses as well.

Aynur Aliyeva began 2015 in limbo and facing uncertainty. Her CEO had just left Azerbaijan and gone back to the Philippines, thousands of miles away, having been denied a renewed work visa a few months earlier. As his deputy at the Azerbaijani microfinance company Viator, Aliyeva stepped in, working feverishly with lawyers and government authorities to bring the CEO back. Unbeknownst to her, a far greater challenge loomed just ahead.

On February 21st of that year, the Azerbaijani currency, the manat, lost 25 percent of its value — all in a single day. For a country whose currency had been steady since at least 2000, even during the height of the global financial crisis in 2008-09, such a devaluation was a major shock. It capped a year of severe economic pressures, with falling oil prices over the past year having already been felt in every corner of the petroleum-driven economy. Even with that, the devaluation was something new entirely — “snow in the middle of summer,” thought Aliyeva.

These pressures were bearing down on Viator. Like other MFIs in the country, much of Viator’s portfolio was lent out in USD-denominated loans, and most of its debt was likewise in dollars. Now its borrowers — few of whom actually earned USD incomes — were facing large payment shocks, on top of already being affected by the slowing economy. Viator was entering an existential crisis. Meanwhile, Aliyeva spent those initial few months navigating between a remote CEO, concerned investors and staff, and a loan portfolio that was fast deteriorating.

<img class="wp-image-40041 alignright" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/10/Table-1-v2-1-1024x620.png" alt="" width="400" height="242" />In April 2015, Aliyeva was finally appointed CEO. With that uncertainty resolved, Viator embarked on a crisis response. Its first step was to change its lending policy; until then, Viator had been lending between a third and half of its loans in USD. With the devaluation, it began to sharply curtail this practice, bringing USD disbursements down to zero by the end of the year. That was just in time, because on December 21st, the manat was suddenly devalued again, this time by another 32 percent. With these two devaluations, the manat had lost half of its value — and the decline would continue through 2016 into 2017.

The resulting fear and uncertainty, combined with a major recession, destroyed trust and threw the entire financial sector into turmoil. Viator was a small fish, had no deposits, and certainly did not meet the too-big-to-fail test. Its primary shareholder was a Norwegian NGO that, while morally supportive, had little financial expertise and no access to additional capital. If Viator was to survive, it would have to do it on its own.

And survival was indeed at stake. Several of the country’s MFIs, far larger and more important than Viator, would not make it.

Aliyeva had never run an MFI in the midst of crisis, but that had its advantages, too — she carried no “founder’s syndrome” baggage; whatever mistakes were made previously were made by her predecessor. This allowed her to ignore the past and focus entirely on the present and the future.

<img class="wp-image-40055 alignleft" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/10/Table-2-v4-1024x660.png" alt="" width="600" height="387" />In the meantime, in Viator’s portfolio, things were going from bad to worse. By the end of 2015, 47 percent of its loans were overdue. A year later, that number had grown to 77 percent, comprising mostly loans that were by then more than 12 months behind. Faced with such numbers, most managers would panic.

Aliyeva did not panic. With many of the country’s financial institutions — banks and MFIs alike — hunkering down in the midst of crisis, Viator suddenly found a wide-open market. In the face of uncertainty and volatile cash flows, people still needed to borrow. And so Viator continued to lend. Indeed, no matter how bad things got during the long crisis period, Viator never stopped lending.

Having already switched to entirely local currency loans, Viator focused on the best clients and low-risk products. Chief among these was the jewelry loan, which allowed clients to monetize the gold received during weddings and other family events — a common cultural practice in Azerbaijan. With this secure and relatively liquid collateral, Viator could lend during the depths of the crisis, and still keep credit risk low.

Of course, this new lending was far below pre-crisis levels. Midway through 2016, monthly disbursements averaged AZN 0.6 million, or 70 percent lower than a year earlier. By mid-2017, this was cut again by half, down 83 percent from the level set two years before. These lower disbursements were accompanied by lower operating costs; in 2016 alone, operating expenses were halved, mainly through salary cuts and staff attrition, as well as layoffs that prioritized retention of the best-performing and most experienced staff.

<img class="aligncenter size-full wp-image-40044" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/10/Table-3-v2-e1604330128251.png" alt="" width="1200" height="438" />

Though shrinking, Viator was by no means closing its doors. Despite the greatly reduced levels, new disbursements proved crucial to its survival. By January 2017 — a year after the second devaluation that marked the full onset of the crisis — repayments from its new portfolio of jewelry-backed loans accounted for nearly two-thirds of Viator’s total cash inflows. Indeed, for nearly five years during the period 2015-2019, loan repayments were Viator’s sole source of cash inflows. That proved crucial not only for allowing Viator to continue disbursing new loans, but also to continue to repay its debt.

<img class="aligncenter wp-image-40045" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/10/Table-4-v2-1024x587.png" alt="" width="797" height="457" />

At the start of 2015, nearly all of Viator’s funding was in the form of debt from foreign social investment funds, mostly in foreign currency. Given the depth of the crisis, its investors were naturally worried. Many had also invested in other MFIs in Azerbaijan, not surprising considering that just before the crisis, the country was one of the five largest markets in the world for microfinance investment. Now these investors were faced with preserving capital and minimizing losses.

Complicating matters further, some investors had disbursed their investments as recently as February 2015, while others were already near the end of their loan maturities. With Viator in violation of multiple debt covenants, investors faced the same coordination problem that arises with nearly every crisis-stricken MFI: if all of them were to follow the loan covenants and accelerate their debts, they would be fighting for the meager leftovers of a liquidated entity. Not only would they face steep financial losses, they would also be abandoning an MFI that was one of the few institutions still providing loans to excluded rural households in Azerbaijan.

<img class="aligncenter size-large wp-image-40047" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/10/Table-5-v2-1-1024x350.png" alt="" width="1024" height="350" />

To nearly all investors, the answer was clear: the debt had to be restructured. Despite this, the negotiations among them proved challenging. Some of the investors had prior experience handling workouts, but for others, this was the first time. There were additional obstacles that some negotiators faced when needing to explain these inter-creditor discussions and tentative agreements to their own credit committees, some of which had limited experience investing in microfinance or even in emerging markets more generally. For one credit committee, the sole reference point for debt restructuring was a court-supervised process — a drawn-out and deeply uncertain option in the context of Azerbaijan. Educating them in these realities took time.

One crucial input into these negotiations was an assessment and recommendations from an external advisor, hired by Viator in early 2016 upon the recommendation of one of its investors. The advisor had extensive experience managing situations such as this, having worked at a crisis-stricken MFI in Bosnia and Herzegovina during its turnaround following the 2008 crash. Her report found that while Viator was deeply affected by the crisis, its operations were sound and it remained a viable institution that could survive the crisis. The report also contained a series of suggestions to Viator, especially aimed at strengthening collections on overdue loans — advice that Aliyeva readily adopted.

The consultant went further and invited several of Viator’s senior staff to her former MFI in Bosnia to directly observe the collections systems the MFI had instituted during its turnaround. This experience, along with training of Viator’s collections staff, were crucial factors into Viator’s crisis response.

The work this consultant did for Viator was not only important to the MFI; included with her report was a series of cash flow projections that showed the turnaround to be very much possible. These projections would prove a critical input for Viator’s investors.

Throughout this time, Viator’s transparency and openness with both the external advisor and with its investors played an important role in building trust. As it happens, several of the fund managers had also invested in another Azerbaijan MFI that took an approach that was diametrically opposite from Viator’s. Its unwillingness to communicate and share information made Viator’s openness even more notable in the investors’ eyes — and made them more willing to make the difficult decisions required for the workout.
<blockquote class="pullquote--left">Viator’s transparency and openness with both the external advisor and with its investors played an important role in building trust.</blockquote>
With the consultant’s report concluded in June 2016, negotiations among Viator’s creditors swung into high gear, and finally in August 2016, they signed an inter-creditor agreement that extended all loans, regardless of maturity. The agreement specified a single repayment schedule for all investors, who would be paid pro rata, but using a formula that gave some additional preference to debts with the earliest maturities. The agreement also fixed a discounted interest rate of 5 percent for all creditors. Over the course of the next two years, reflecting the depth of the crisis, this agreement would be amended twice more, adding further discounts to the interest rate.

During these negotiations, Aliyeva was adamant that rather than funneling all excess inflows from loan repayments back to its creditors, Viator should use a substantial portion of these cash flows in order to reinvest in new lending. For investors, this meant they would have to sacrifice some repayments in the short-term. It is here that the external consultant’s projections proved crucial, for they showed the value of reinvesting cash flows into new loan disbursements. Indeed, a number of Viator’s investors used these same projections as a benchmark to monitor Viator’s performance over the coming months.

<img class="alignright wp-image-40058" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2020/10/Table-6-v3-1-1024x713.png" alt="" width="550" height="383" />With its liquidity thus stabilized, Viator could focus on managing its solvency situation. Here, things were arguably even more challenging. It certainly helped that Viator entered the crisis well-capitalized, with equity comprising 40 percent of total assets at the end of 2014. Even so, that generous level of capital was not enough when 63 percent of its pre-crisis portfolio was six or more months delinquent by the end of 2016. One way that Viator handled this challenge was by adapting its provisioning practices. At the outset of the crisis in 2015, it provisioned generously (100 percent for all loans overdue by more than 90 days), in 2016-18 provisioning dropped to as low as 64 percent, even when nearly all overdue loans had by then exceeded 12 months.

The decision to change its provisioning rules helped conserve much needed equity, which by 2017 had eroded to just 13 percent of assets. Doing so bought crucial respite during the years that non-performing loans continuing to fester on its books. Finally, rescue arrived in 2019, four years after the onset of the crisis, when the Azerbaijani government implemented a rescue package for the microfinance sector. Through it, Viator received both a grant and a subsidized loan from the Central Bank of Azerbaijan that allowed it to cover a major portion of its losses. Only then did Viator once again fully provision for its delinquent portfolio. Almost exactly five years after the onset of the crisis in February 2015, Viator could finally close the last page on this difficult episode and truly look forward.

A few months later, it was facing COVID-19…

What are some dos and don’ts and key factors of success that the microfinance sector can learn from the Viator case? CFI’s forthcoming report, Weathering the Storm II, will draw on lessons from this case and cases from microfinance institutions in four other markets – <a href="https://centerforfinancialinclusion.org/weathering-the-storm-ii-a-case-study-of-partner/" target="_blank" rel="noopener noreferrer">Bosnia and Herzegovenia</a>, India, Palestine and Nicaragua. See also CFI's original <a href="https://centerforfinancialinclusion.org/weathering-the-storm-hazards-beacons-and-life-rafts-lessons-in-microfinance-crisis-survival-from-those-who-have-been-there/" target="_blank" rel="noopener noreferrer">Weathering the Storm</a> report from 2011.

Joana Afonso

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