NewBank Microfinance: Microcredit in the Ukraine

1. NewBank Microfinance:Microcredit in the Ukraine Fuqua School of Business Duke University Holly Dice, Andrew Khoo, Sara Kirchoff, Robert M. Little & Hartaj SIngh Emerging Markets Corporate Finance

2. Agenda • Scenario • What is Microfinance? • Characteristics of Microfinance Loans • Overview of Ukraine • Business Plan • Key Takeaways • Conclusion Emerging Markets Corporate Finance

3. 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 Emerging Markets Corporate Finance

4. 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 Emerging Markets Corporate Finance

5. 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: <5% • Labor and resource intensive to administer and monitor • Dependent upon social pressures for loan repayment • Aggressive penalty structures Emerging Markets Corporate Finance

6. 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/US$1) • Prime lending rate: 42% • Major industries: coal, electric power, metals, machinery & equipment, agriculture • Moody’s Credit Rating: Caa1 Emerging Markets Corporate Finance

7. 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 Emerging Markets Corporate Finance

8. 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 Emerging Markets Corporate Finance

9. 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 Emerging Markets Corporate Finance

10. 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 Emerging Markets Corporate Finance

11. 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% Emerging Markets Corporate Finance

12. 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 Emerging Markets Corporate Finance

13. 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 Emerging Markets Corporate Finance

14. Risks - Ukraine • Political instability • Economic environment • Currency exposure • Regulatory environment • Expropriation Emerging Markets Corporate Finance

15. Cost of Equity Calculations Emerging Markets Corporate Finance

16. Interest Rate Calculations • Ukraine Commercial (lower bound) – 50% • Ukraine Informal Moneylenders (upper bound) – unknown? • Microcredit Summit recommended rate: 35% to 51% for Asia Emerging Markets Corporate Finance

17. 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 Emerging Markets Corporate Finance

18. Key Takeaways • Risk assessment • Microfinance • Ukraine • Calculation of cost of capital and interest rates • Trade-offs between financial and socio-economic returns Emerging Markets Corporate Finance

19. Potential Development Bank Funds Emerging Markets Corporate Finance

20. Profile of Similar Banks Emerging Markets Corporate Finance

21. 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% = Emerging Markets Corporate Finance