Distressed Debt for Peanuts, or Why State-owned Banks Will Have to Sell NPLs at an 85 to 95% Discount
Who Will Be the First to Try to Get Rid of Bad Loans
In the last six months, state-owned banks have been actively offering for sale claims for distressed and bad loans. In November 2022, Oschadbank announced in Setam an auction to sell UAH 1.8 billion of the debt of ESU, the company that owns almost 93% of Ukrtelekom’s shares. In January 2023, Ukrgasbank offered nine NPL lots to the tune of UAH 683 million at ProZorro.Sales. In mid-April, Ukreximbank offered for sale its claim to the unfinished Sky Towers building complex in the center of Kyiv; it secured a UAH 5.95 billion line of credit granted to the Office Construction Agency. Andriy Volkov, Investohills Group’s founder and managing partner, explained in his exclusive column for Mind the reasons for such determination among banks, telling whether they will be able to clean up their loan portfolios.
Why Right Now?
It has long been necessary for the state-owned banks to clean up their NPLs. They do have a significant amount of distressed debts. According to the NBU, PrivatBank, Oschadbank, Ukrgasbank, and Ukreximbank held an aggregate non-performing loan portfolio of UAH 324 billion as of March 1, 2023. It amounts to about 75% of the whole problem debt in the banking system.
They should have started working out this debt five years ago. It is even more important because the IMF and other donors made it a goal for the Cabinet of Ministers to clean up the banking sector, including placing the balance sheets of state-owned banks on a sound footing, back after the 2014–2015 crisis.
In 2020, the Financial Stability Council (comprising governors of the National Bank, the Ministry of Finance, the Deposit Guarantee Fund, and the National Securities and Stock Market Commission) approved the state-owned banks’ plans to reduce their NPLs by UAH 305 billion over three years by selling their debt and writing off loans that are 100% provisioned.
However, the time frame for implementing decisions in state-owned banks is really long. That process became even longer due to the COVID-19 pandemic, followed by the war. There were also some doubts about what type of NPL clean-up effort to opt for: whether one should establish a bad bank that would become a new corrupt gravy train and offload all the distressed assets there or task the DGF with dealing with everything. As a result, they decided to have the banks sell the distressed debt themselves from their balance sheets.
What Kind of Distressed Loans Are Offered for Sale?
The NPLs offered for sale by state-owned banks belong to one of the following two groups:
- absolutely “empty” debt with nothing to collect in principle. They can be offered at discounts ranging from 95 to 99%;
- high-quality loans with enough liquid collateral. In such cases, even 100% of the debt amount is recoverable. Ukreximbank’s UAH 95 million loan to the LAZ Lviv Bus Plant is an encouraging example.
What Are the Sources of the Value?
The eventual discount depends on the specific debtor, the collateral quality, and the presence of independent buyers on the market. For example, in the pre-war market of 2020–2021, one could have expected average discounts on loans offered for sale by state-owned banks at a level of 60 to 70 percent on average. However, demand is going to be the core price driver now. And the demand is abysmally low today.
The war in Ukraine has affected prices offered under risk-prone agreements. Systemic players fled the market. For instance, Investohills Group has been one of the largest independent (i. e., unrelated to debtors) NPL buyers for the last few years. We bought out over UAH 100 billion of such loans.
Currently, we have no plans to absorb the state-owned banks’ debts. It is difficult even to suggest who is going to buy them in large volumes other than the debtors themselves. Even before the war, there were only a couple of foreign entities on the market, and they preferred to work together with a local market player only. We can forget about them now. Thus, if there is no genuine competition and if only debtors themselves or random outsiders are to buy out the debt, the discount will average 85 to 95 percent.
Which Factors Make Sales Harder?
Another issue is that not all loans can be sold. They include, for example, the portfolio owned by PrivatBank, which holds 67.5% of the distressed debt of Ukraine’s entire banking sector. However, when dealing with corporate NPLs, the bank cannot offer large cases supported with liquid collateral and real business.
According to the NBU’s statements, loans granted to insider companies account for 95% of PrivatBank’s NPL portfolio. These debts are relatively concentrated, while their quality and collateral liquidity are poor. In practical terms, they cannot be sold in principle, other than for less than one percent of their par value, and only to entities related to the bank’s former shareholders.
While PrivatBank’s NPL portfolio contracted by about UAH 82 billion to UAH 178 billion since 2020, it did not mean that the distressed debt had been settled or sold. Instead, the debts were essentially written off (UAH 66 billion, mainly in Q4 2020).
Importantly, the NPL portfolio is growing by accumulating debts of the “dead businesses,” such as enterprises destroyed by hostilities and companies with assets under the occupation. The current situation gives rise to additional problems for state-owned banks because they are and have been the major creditors of Ukraine’s corporations.
What to Expect?
A scenario for reviving such a business can be considered in the future. However, in this case, the NPLs need to be bought either by the debtor or by a genuine investor. Reviving the business calls for collecting the debt to clean up the asset anyway. The bankruptcy is initiated. Usually, collateral and other property are bought out by a new legal entity. The new owner takes over the business, and the old debtor is liquidated. But for this mechanism to operate, an investor should be willing to finance not only the debt redemption but also the costs of collection and resumption of operations. It is hardly possible in the war reality.
My forecast is that the state-owned banks will offer more than UAH 100 billion of debt before the end of 2023. How much they can sell will depend on the banks’ willingness to bring the price to a level acceptable for buyers during the bidding process. They would have to offer discounts in excess of 80% of the par value and hold Dutch auctions (with the price reduction). Otherwise, they would only be able to sell isolated lots. If the state-owned banks dared to discount the debt, they could sell 50 to 70% of the portfolio this year, with the rest to follow after they drop prices further.
They will likely write off a major portion of distressed loans. It is to be expected from PrivatBank first of all because its major debtors are in the course of the bankruptcy procedure or about to enter it. It will affect the NPL level in their balance sheets substantially because a liquidator, who wants to get at least some money, would be selling collateral instead of the bank. So, collateral properties will be offered for peanuts.
Interestingly, the Government and the NBU are still discussing whether to sell distressed assets during the war or wait for it to end and try to sell at a higher price. The NBU seems to be against selling them, while the Cabinet of Ministers is generally in favor. However, the discussion is ongoing, so the process can become suspended soon, with new assets not offered for sale and without reducing the price charged for the assets currently offered for sale to a level acceptable to a buyer.