NPL resolution in Ukraine:what does the global experience

suggest?

Marius VismantasCountry Sector Coordinator, Financial and Private Sector

DevelopmentUkraine, Belarus & Moldova

This presentation is based on a subject matter presentation developed by the World Bank Group staff. The views expressed in this presentation do not constitute an official position of the World Bank Group on the issues of discussed herein 1

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Presentation

I. Asset Resolution Prerequisites II. Asset Resolution Process & Tools III. Global Lessons Learned

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I. Prerequisites for Effective Asset Resolution

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Asset Resolution (Repayment)involves both

• Asset Rehabilitation

• Asset Disposition

• enhancing borrowers’ repayment capacity through loan modification (financial engineering) or corporate restructuring (changes to debt, equity, management, and operations)

• sale of asset (debt or collateral) to a third party

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Effective Asset Resolution requires...

• Credit culture within banks - finance only viable projects– Then you won’t have to fix what is not broken

• Strong repayment ethic amongst borrowers - use credit wisely and feel obligation/duty to repay– Balm to banks’ ears – but that is why character and integrity of a

borrower are such important credit decision criteria

Effective Asset Resolution requires...

• Effective Regulation and Supervision - encourage enforce prudent lending and encourage enforce timely loss recognition

• Legal framework for creditor rights and insolvency, including mediation process - provide incentives for consensual debt resolution, rehabilitation of viable businesses and liquidation of non-viable entities– Populist debtor protection makes the entire process unstable

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…But, Loss Recognition is an absolute prerequisite

• Loss recognition– makes explicit the losses in distressed assets– apportions losses amongst borrowers,

lenders, and taxpayers– results in wealth transfer

• Requires Political Will

Who pays for the NPLs?– Bank owners – for poor credit policies– Bank creditors – for inadequate risk

assessment of banks– Borrowers – for careless borrowing– Taxpayers – for having too much money and

not knowing what to do with it all… in fact they pay for a possibility to see quick recovery led by NPL resolution

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II. Asset Resolution Process and Tools

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Is the borrower viable?

Viable

Asset resolutionStep 1 – Identify Viable/Non-Viable Borrowers

Non-viable

GUIDING PRINCIPLE

• Maximize recovery via rehabilitation of viable borrowers• Avoid “investment” in time and money in non viable businesses

• Borrower is expected to generate sufficient cash flow to repay some level of debt

• Only source of repayment from liquidation of collateral or business

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Viable

Modified terms/Access to new financing

Formal reorganization

Monitor, re-classify as appropriate

RestructureNon-performing

Modify terms and monitor performance

Performing

Mediation

Merger

Debt-Equity Swap

Single lender – cooperative borrower

Multiple lenders – willingness to restructure

Multiple non cooperative lenders

Legal and Insolvency framework

How to?

Out-of-Court workout process (Mediation)

Corporate Restructuring Fund (Fresh Money)

Asset resolutionStep 2: Dealing with viable borrowers

GUIDING PRINCIPLE

•Preserve value by restructuring•Preserve “going concern” •Provide fresh working capital

Sale of part of business/non-viable assets

Replacement ManagementReduce costs (labour)

Bank Workout Departments

Train banks and businesses to

use tools

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Non-viable

Sell Note

Voluntary Settlement

Legal enforcement mechanisms

Cash

Collateral

Liquidate

Foreclose collateral

Sell

Private Buyer/AMC

Public AMC

Cash

Asset resolutionStep 3 – Resolving non-viable businesses

Private Buyer/AMC

Public AMC

Sell

Private Buyer/AMC

Public AMC

Public AMC

Personal bankruptcy framework

Private AMCs

Legal and Insolvency framework

GUIDING PRINCIPLE

•Maximize recovery through asset disposition•Timely process to preserve value•Identify suspicious transactions and refer to legal authorities

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Asset Resolution Entities

• Bank Workout Departments• Asset Management Companies

– Public or Private• Bad Banks/Special Purpose Vehicles

– Independent WO Dept., subsidiary of bank, or independent institution

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Bank Workout DepartmentsWork Best When

• Problems are manageable in relation to size of bank

• Strong governance within bank• Strong supervision and regulation• Staffed with resolution professionals• Separate operating and approval procedures

including continuous monitoring and collateral valuation• Adequate funding

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Private AMC’s

• Shareholders/taxpayers need protection from “asset stripping” and other fraudulent activities

• Consumers need protection from unwarranted collection practices

• Regulation requiring– Minimum standards for governance, accountability, and

transparency – Full disclosure of ownership– Prohibition on purchasing related party assets– Minimum requirements for outsourcing contracts– Establish consumer protection standards

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Public AMCsKey Considerations

• Goals and mission - clearly defined up-front• Governance structure - 3 principles:

• Independence• Transparency• Accountability

• Operational set-up - critical to ensure achievement of goals

• Legal/judicial framework: few key issues:• Transfer of ownership/priority; • Indemnity of AMC staff;• Corporate insolvency regime; • Special powers

• Political support of National AMC• Need to address simultaneously financial sector

resolution and corporate sector restructuring

• Key elements need to be addressed up-front to ensure effectiveness and results

• Set up time: between 6-18 months

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Additional Tools• Corporate Restructuring Fund• Legal and institutional insolvency frameworks• Mediation - Out of Court Workout Procedures• Asset Sales

– Outright or maintain limited interest– Partnerships/joint ventures/SPV’s

• Securitization– Requires CASH FLOW

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Legal & Institutional Frameworks for Insolvency generally lack:

• Effective/Efficient Enforcement mechanisms

• Consumer insolvency framework• Rehabilitation regime• Transparency • High levels of expertise of judges,

practioners and other users

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III. Global Lessons Learned

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Lessons Learned

• Losses ought to be, should be, must be recognized upfront

• Limit role of government– Leadership role (political will) in developing

public consensus for program and establishing framework

– Step back to allow the private sector to negotiate solutions

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Lessons Learned• Corporate restructuring is a process not

an event– Likely to take 4-5 years to complete with more

than one round of restructuring– Inability of both sides to face losses leads to

cosmetic restructuring– True operational restructuring takes place

only when apparent initial restructuring was not enough

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Lessons Learned• No one correct approach

– Tailor to particular needs and circumstance– Mix/Match strategies to goals– Consistency more important than perfection– keys to recovery are incentives for

restructuring and the legal system for recovery

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Lessons Learned• Narrow mandate of public AMC and focus on

GOVERNANCE from beginning

• AMC should be separate from bank regulator/supervisor

• Active involvement of supervisor needed to force losses and encourage restructuring

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Concluding thoughts - for discussion• Stock or flow solution?

• Who should pay for the NPLs in Ukraine? How big is the social cost?

• Does it always have to be a direct unrecoverable cost? Would banks be better off providing temporary capital to NPL workout managers – in-house or outside?

• Is shared effort/aligned motivation of those affected a key to avoiding painful valuation? Sharing downside and upside

• Protect the taxpayer! Public AMC likely the worst of options in an environment of poor political consensus and weak governance culture – hardly any value added to the taxpayers.