NewBank Microfinance: Microcredit in the Ukraine

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NewBank MicrofinanceMicrocredit in the Ukraine

• Fuqua School of Business
• Duke University
• Holly Dice, Andrew Khoo, Sara Kirchoff, Robert M.
  Little Hartaj SIngh

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Agenda

• Scenario
• What is Microfinance?
• Characteristics of Microfinance Loans
• Overview of Ukraine
• Business Plan
• Key Takeaways
• Conclusion

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Scenario

• Ukrainian-American entrepreneur wants to give
  back to his native country by fostering small and
  family owned businesses
• Willing to provide 2.5MM in interest free loans
• Wants to verify feasibility and sustainability of
  a for-profit microfinance lending institution in
  the Ukraine

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What is Microfinance?

• Providing financial services to the poor and
  micro enterprises
• Currently 7,000 microfinance Institutions
  worldwide (2.5 billion).
• Individual and group-based lending
• Small size of loans makes it inefficient for
  commercial banks to target these markets
• Successfully pioneered by Grameen Bank in 1976

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Characteristics of Microfinance Loans

• Size 25 to 100,000
• Term 6 months to 2 years
• Collateral typically none
• High interest rates 25 to 51 in Asia
• Low default rates lt5
• Labor and resource intensive to administer and
  monitor
• Dependent upon social pressures for loan
  repayment
• Aggressive penalty structures

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Overview of Ukraine

• Declared independence from Soviet Union in August
  1991
• Population 49.8 million
• GDP 30.4 billion (610/capita)
• Inflation 28.5
• Currency Hryvnia (5.6 hryvnia/US1)
• Prime lending rate 42
• Major industries coal, electric power, metals,
  machinery equipment, agriculture
• Moodys Credit Rating Caa1

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Overview of Ukraine (cont.)

• Economy
• Post-independence GDP contraction
• Approximately 40 of pre-independence size
• First year of GDP growth (5.6) in 2000
• Shadow economy accounts for 60 of total economy
• Periods of hyperinflation in the early 1990s
• Economy expected to grow in 2001-2002

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Ukrainian Banking Sector

• Primarily finance state-run enterprises
• Suffers from problem loan rate of 20
• Loans of short maturities, usually 6 months
• Nominal interest rate is currently around 50
• Inadequate development of financial services
• Banks are information source for tax collectors
• Viewed as inefficient and lacking in small loans
  expertise

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Business Plan

• Utilize microcredit lending models to construct a
  sustainable for-profit microcredit bank in
  Ukraine
• Target business opportunities
• Below the high-end lending activities of the
  World Bank, EBRD and various for-profit
  multinational banks
• Above the low-end lending activities of Grameen
  Bank model in Bangladesh
• Loan sizes to range from 10,000 to 100,000

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Business Plan

• Initially set up 1 branch growing to 8 in year 5
• Loan advisors will handle 15-25 accounts
• Require groups of 5 or more to cross guarantee
  loans (assumed default rate of 10)
• Collateral depending on size of loan (10-20 in
  savings account)
• Interest rates 50
• Source of funding
• interest-free loan of 2.5MM for first 3 years
• staged equity financing totaling 6.5MM in years
  2-5
• approach capital markets or commercial sources

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Results of Model

• 5000 loans issued by 2010
• Total loan portfolio value in 2010 of approx.
  25MM
• Interest-free loan repaid by Year 5
• NPV 1.9MM
• CAGR 34

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Real Options

• Opportunity to expand into other financial
  services
• Ability to scale-back operations during periods
  of economic turmoil
• Option to provide larger loans (100K) to proven
  borrowers
• Value associated with proving the
  financial-viability of model to encourage
  establishment of other banks as conditions
  improve

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Risks - Firm Specific

• Funding
• Market demand for microfinance loans
• Competition
• Default rate and late payment of loans
• Lack of collateral
• Financial sustainability
• Improper management
• Recruitment of loan advisors

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Risks - Ukraine

• Political instability
• Economic environment
• Currency exposure
• Regulatory environment
• Expropriation

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Cost of Equity Calculations
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Interest Rate Calculations

• Ukraine Commercial (lower bound) 50
• Ukraine Informal Moneylenders (upper bound)
  unknown?
• Microcredit Summit recommended rate 35 to 51
  for Asia

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Conclusion

• Feasible at 29.4 Cost of Capital
• Anticipated financial return of 1.9MM
• Investment in this bank would be attractive to
• Development banks
• Companies with a long-term development stake

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Key Takeaways

• Risk assessment
• Microfinance
• Ukraine
• Calculation of cost of capital and interest rates
• Trade-offs between financial and socio-economic
  returns

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Potential Development Bank Funds
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Profile of Similar Banks
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Cost of Debt

• Debt Markets
• II Credit Rating 17.7
• Opacity use Russia as proxy (O-Factor 84, Tax
  Equiv 43, Op Risk Prem 1,225)
• Development Banks
• Worldbank 12 to 15 for Asian economies
• European Bank of Reconstruction and Development
  LIBOR 3