Compound Interest, or How Businesses Repay Loans during the War
Which Sectors Find It Most Difficult to Manage Their Debt?
In April, the National Bank of Ukraine published data on distressed and non-performing loans (NPL) for the first two months of 2022. The NBU indicated that the percentage of such loans in the banking sector dropped by 3.4 percentage points to 26.6% by March 1. It happened due to the withdrawal of banks with the Russian capital from the market—International Reserve Bank (Sberbank’s former subsidiary) and Prominvestbank. As a result, the NBU decided to liquidate these banks and revoked their licenses. As a result, the NPL portfolio shrunk by more than UAH 46 billion.
However, these statistics ignore the impact of combat activities that have been taking place for more than two months. Over this period, the solvency of many borrowers deteriorated. Some businesses had to roll down or freeze their operations. Thus, the NPL situation can get much worse by summer.
Running on Fumes. Based on the NPL data as of March 1, 2022, the NPLs total UAH 305 billion. This figure comprises UAH 43 billion in distressed retail loans and UAH 262 billion in distressed corporate loans. Thus, loans to businesses account for 86% of NPLs.
It is easy to figure out that bankers are worried most about the solvency of their corporate borrowers. This is because businesses account for the lion’s share of the total loan portfolio, around 72%. This portfolio includes short-term loans (overdrafts, working capital loans) and investment loans for business development.
Loans have been granted to purchase fixed assets, machinery, special equipment, and real estate for 3–5 years or more. Accordingly, it will be a major headache for banks if corporate borrowers have difficulty repaying their loans on a mass scale.
However, businesses kept repaying loans even after the start of the military conflict as if because of momentum. “Most borrowers had no problems in March because the companies made provisions for the debt repayment in advance. It includes, for instance, the companies in the area of active combat,” Andrii Volkov, founder and managing partner of Investohills Group, says.
In April, the situation with the repayment of corporate loans changed greatly. It did not change for the better, but it does not present itself as threatening so far. Borrowers from active-combat areas stopped paying their debts completely. These are businesses and companies that stopped operating for understandable reasons. Their assets have been either fully destroyed or located in areas under the occupation. According to experts, there are not that many borrowers of this kind—about 10 to 20% of all business borrowers.
“About 80 to 90% of companies (except those seriously affected by the hostilities) keep meeting their liabilities to banks, although not fully. Usually, they pay only the interest, having suspended principal repayments. As a result, many borrowers seek restructuring, asking banks for a grace period or a review of amortization schedules,” Andrii Volkov says.
The Most Vulnerable. Currently, the loan repayment depends not so much on a sector as on the regional affiliation of a company and the location of its production facilities.
“The loan service depends on the business geography and sectors where the clients operated before the war. Borrowers in areas and regions, which are currently under temporary occupation, are in the worst condition. However, all other regions and sectors demonstrate positive debt repayment trends,” Tetiana Poplavska, Deputy Chair of the Management Board in charge of corporate business in Kredyt Dnipro Bank.
However, there are also high credit risk sectors. First of all, these are agroindustrial businesses. Yes, the sowing campaign is going on, but many agrarian companies face challenges with money. The blockade of seaports disrupted agricultural logistics. It prevents agricultural companies from entering into forward contracts, usually used to fund the sowing campaign, not to mention the potential curtailment of the grounds under crops by “several hundred thousand hectares” due to fighting in principle. A statement to this effect was made by Taras Vysotskyi, Deputy Minister of Agrarian Policy and Food.
The construction sector stopped operations completely. Despite the Government’s Napoleonic plans to rebuild the country, the residential and commercial construction remains frozen. Nevertheless, there is hope for some revival in this sector because the Government has already come up with plans to shelter displaced persons. The houses for this need to be built. Moreover, any transactions with real estate were blocked till late April. They were resumed in May in a limited format, however.
The manufacturing sector is in a difficult situation. Iron and steelworks, which are located mainly in Ukraine’s east, have been destroyed or rendered inoperable by their inability to obtain raw materials. Furthermore, the steel companies face major challenges with exports. Machine building companies face a stalemate. They used to supply products to CIS countries. They can’t do so now. They will need time to shift their focus to other markets. There is no guarantee, though, that this focus shift will succeed.
The fuel and energy sector was seriously affected by shelling that destroyed processing facilities and infrastructure and by disrupting logistics oriented on the Russian and Belarusian markets.
Threats also endanger the cargo transportation business, services, and even retail sectors—the latter is highly dependent on the agro-industrial sector and processing of agricultural products. As a result, many companies from these sectors will be unable not only to obtain loans on appropriate terms but also to repay “old” loans.
Rescheduling to the Rescue. “Quite a lot will depend on policies pursued by the National Bank and the Cabinet of Ministers and the support they’ll provide to the banking sector and economy in general—the liquidity facilities for banks, partial compensation of borrowers for the interest, provision of guarantees to banks, simplification of loan restructuring, governmental support to priority sectors of the economy,” Andrii Volkov believes.
According to the financial analyst Vasyl Nevmerzhytskyi, large-scale borrowers will face most difficulties when repaying loans. “These are companies with good liquidity, ROA, and profits. It is because their entire business depends on lenders, debtors, logistics, contractors, distribution networks, etc. Therefore, this crisis will affect them most,” Nevmerzhytskyi explains.
The situation gets more complicated for corporate borrowers also because the state of martial law does not entitle them to require banks to restructure their debt. Thus, it depends on the lender’s good will whether to accept the postponement of the loan repayment or revise its amortization schedule. Nevertheless, bankers reassure that they are always prepared for compromise when dealing with bona fide clients.
“Every business faces a different situation, and all decisions on each borrower are made on an individual basis,” Tetiana Poplavska says.
Borrowers with loans from state-owned banks have it somewhat easier. They are more willing to come to an agreement on debt restructuring. Unlike them, banks with private capital are not always that accommodating.
“State-owned banks usually support clients because the current stance of the Cabinet of Ministers and the Presidential Office is that the business should get any support possible. However, owners of many commercial banks instructed their management to require at least interest payments at any cost. However, it does not mean that commercial banks are not flexible or that they do not agree to discuss and seek restructuring options,” Nevmerzhytskyi explains.
According to the NBU, Ukrainian banks made a loss of UAH 160 million in the first quarter. It was caused by both reduced income of the banking sector and the need to make provisions for non-performing loans. It is another confirmation of the imminent increase in the NPL percentage in the banking sector. The only issue is the extent to which banks and the NBU will be able to control this process and whether at least a portion of the distressed loans will be repaid in the future.
It makes a big difference if a borrower cannot repay a loan due to temporary business issues or if the production facility has been physically destroyed in the course of combat operations and there is no one to repay the debt.