Variance Newand Old Methods 20090316 T1717

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  • 1. FX Risk Sharing January 16, 2009
  • 2. Executive Summary
    • Kiva loans come with “foreign exchange” risk to the microfinance institution
    • Kiva Partners are not able to prepare for potential foreign exchange losses
    • As a result of foreign exchange risk, and the attendant uncertainty and costs, some of Kiva’s MFIs are restricting how much they are raising on Kiva
      • Furthermore, some MFIs are unwilling to work with Kiva until we incorporate some form of foreign exchange risk sharing
    • Possible Solution:
      • Share the burden of currency-related losses between the MFI and the lender, thereby:
        • Enhancing transparency by making the implicit foreign exchange risk currently borne by Kiva Lenders an explicit risk
        • Improving the value proposition for MFI partners by reducing their risk of default arising from a large local currency devaluation
    • A theoretical analysis of MFI balance sheets highlights the significant harm that occurs when applying moderate US Dollar leverage and suffering a local currency depreciation of greater than 20%
    • An analysis using historical currency data demonstrates that Kiva lenders are effectively shielded from losses at a 10% threshold using 5-years of data, and at a 20% threshold using 2008 data alone
    • We propose a threshold of [ ]%
  • 3. Scope of the Problem for Kiva Kiva Partnership Countries: Maximum 4-month USD Depreciation during 2008 Kiva Partnership Countries: Annual 2008 Historical Volatility Source: OANDA.com Risk aversion due to the US economic crisis has caused emerging market currencies to devalue relative to the US Dollar over the last twelve months. The crisis has also increased volatility in those markets.
  • 4. Five Historical Currency Crises Investor confidence in a country can decline suddenly and rapidly, as the chart below shows. A currency threshold for MFIs would be of extreme importance in these scenarios. Source: OANDA.com -73% -72% -57% -46% -43%
  • 5. The Threshold Explained A threshold works by sharing the FX losses between the MFI and the lender. We adopt the currency convention that a depreciation is in terms of the USD value of 1 unit of local currency (LCU). In other words, if today 1 LCU buys 1 USD, and tomorrow it buys 0.50 USD, then the currency has depreciated 50%.
  • 6. Effect of a Devaluation on an MFI Balance Sheet
    • We analyze the impact of a devaluation on the net worth of an MFI as a function of leverage (debt to equity) and the extent of a devaluation
    • Assumes the following
      • Full TFR of 30% Kiva USD loans used
      • MFI has no other foreign currency debt
  • 7. Historical Impact Analysis
    • In order to assess the lender impact of a currency risk sharing agreement, we collected historical currency data for our partner countries and back-tested our threshold levels in order to see how many lenders would be affected by a risk-sharing agreement and to see how severely they might be affected
    • The analysis was constructed as follows:
      • 5-years of currency data collected for our partner countries
      • $1,200 constant loan size assumed
      • Loans are made each day, and paid back in monthly installments over a 12 month term (so as to maximize the utility of the available currency data)
      • Currency losses are calculated for each installment then summed over the course of the loan (i.e. a payback of $1,180 to the lender implies a 10% loss to the lender)
      • Losses are passed on to lenders above the specified currency thresholds and are non-cumulative (in other words, FX gains do not compensate lenders for FX losses)
    • This results in 53,070 data points. Several countries were excluded from the analysis due to a lack of quality 5-year data – Afghanistan, Azerbaijan, Benin, Bosnia and Herzegovina, Cameroon, Cote D'Ivoire, Iraq, Mali, Moldova, Sudan, Tajikistan, Togo
    • A 2008 analysis was also prepared in order to gauge the threshold effect under a semi-crisis year for field partner currencies
      • Term payments were calculated on a rolling basis (such that a loan issued on Dec. 1 would have a 1-month term)
  • 8. 5-yr Historical Data: Number of Lenders Source: OANDA.com An unweighted analysis showing the number of lenders affected by losses under increasing threshold levels. As the threshold increases, the MFI bears more of the FX loss, and fewer lenders are affected.
  • 9. 5-yr Historical Data: Weighted by Kiva’s Loan Portfolio
    • Key takeaway is that over the past five years, few lenders would have taken currency losses under any threshold
    • A 10% threshold caps most losses at under 2%, while 20% threshold effectively eliminates all risk to Kiva lenders
    • Consideration: for most of the past five years, the USD has been appreciating, so this may not be indicative of future results
    Source: OANDA.com The weighted analysis uses the distribution of Kiva’s current loan portfolio by country to weigh the number of lenders affected by the size of Kiva’s exposure to each country.
  • 10. 1-yr Historical Data: Number of Lenders Source: OANDA.com In 2008 a greater percentage of lenders were affected by losses due to the depreciation of many emerging market currencies, which occurred in the second half of the year.
  • 11. 1-yr Historical Data: Weighted by Kiva’s Loan Portfolio
    • If 2009 is similar to 2008, we can expect further damage to MFI balance sheets
    • A 15% threshold effectively eliminates losses greater than 5%, while a 20% threshold caps maximum losses at 5%
    Source: OANDA.com Although fewer lenders were effected in the weighted analysis, the losses are nonetheless significant.
  • 12. www.kiva.org Loans that Change Lives