NewBank Microfinance: Microcredit in the Ukraine Fuqua School of Business Duke University Holly Dice, Andrew Khoo, Sara Kirchoff, Robert M. Little & Hartaj SIngh January 13, 2019 Emerging Markets Corporate Finance

Emerging Markets Corporate Finance Agenda Scenario What is Microfinance? Characteristics of Microfinance Loans Overview of Ukraine Business Plan Key Takeaways Conclusion Emerging Markets Corporate Finance January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

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 January 13, 2019

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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

Emerging Markets Corporate Finance Risks - Ukraine Political instability Economic environment Currency exposure Regulatory environment Expropriation Emerging Markets Corporate Finance January 13, 2019

Cost of Equity Calculations Emerging Markets Corporate Finance January 13, 2019

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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019

Potential Development Bank Funds Emerging Markets Corporate Finance January 13, 2019

Profile of Similar Banks Emerging Markets Corporate Finance January 13, 2019

Emerging Markets Corporate Finance 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 January 13, 2019