NPL resolution in Ukraine: what does the global experience suggest ?

1. NPL resolution in Ukraine:what does the global experience suggest? Marius Vismantas Country Sector Coordinator, Financial and Private Sector Development Ukraine, 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

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

3. I. Prerequisites for Effective Asset Resolution

4. 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 Asset Resolution (Repayment)involves both

5. 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

6. 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

7. …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

8. 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

9. II. Asset Resolution Process and Tools

10. Is the borrower viable? Asset resolution Step 1 – Identify Viable/Non-Viable Borrowers Viable • Borrower is expected to generate sufficient cash flow to repay some level of debt • GUIDING PRINCIPLE • Maximize recovery via rehabilitation of viable borrowers • Avoid “investment” in time and money in non viable businesses • Only source of repayment from liquidation of collateral or business Non-viable

11. Asset resolution Step 2: Dealing with viable borrowers Performing • GUIDING PRINCIPLE • Preserve value by restructuring • Preserve “going concern” • Provide fresh working capital Monitor, re-classify as appropriate BankWorkout Departments How to? Legal and Insolvency framework Viable Single lender – cooperative borrower Modify terms and monitor performance Out-of-Court workout process(Mediation) Multiple lenders – willingness to restructure Restructure Mediation Modified terms/Access to new financing Non-performing Corporate RestructuringFund (Fresh Money) Merger Debt-Equity Swap Replacement Management Train banks and businesses to use tools Reduce costs (labour) Formal reorganization Sale of part of business/non-viable assets Multiple non cooperative lenders

12. Asset resolution Step 3 – Resolving non-viable businesses • GUIDING PRINCIPLE • Maximize recovery through asset disposition • Timely process to preserve value • Identify suspicious transactions and refer to legal authorities Legal and Insolvency framework Cash Voluntary Settlement Private Buyer/AMC Public AMC Collateral Sell Public AMC Liquidate Cash Private AMCs Non-viable Legal enforcement mechanisms Private Buyer/AMC Foreclose collateral Sell Public AMC Personal bankruptcy framework Private Buyer/AMC Sell Note Public AMC

13. 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

14. 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

15. 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 Private AMC’s

16. 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

17. 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

18. 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

19. III. Global Lessons Learned

20. 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

21. 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

22. 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

23. 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

24. 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.