It’s Cleanup Time: What Banks Will Do to Get Rid of NPLs in 2023

A column by Andriy Volkov, Investohills Group’s founder and managing partner, for the Delo.ua portal.

Distressed debt in the banking sector keeps going up.  According to the NBU, the NPL percentage in the banks’ credit portfolios grew to 38.2% by February 1, 2023.  To put that into perspective, it was at 31.8% as of February 1, 2022.

Most toxic loans are concentrated in the corporate segment.  NPLs among the banks’ business loans exceeded 43.3%, which is close to UAH 364 billion, in February 2023.  The NPLs account for 32.4% of retail loans, or UAH 73 billion.  The toxic retail loans have doubled since February 2022.  The reason is that many Ukrainians lost their jobs and, as a result, became unable to repay the debt on time.  However, the monetary amount is not as high as the NPLs in the corporate portfolio.

In fact, the toxic-debt situation in the banking sector turned out to be worse than expected.  The root cause is clear: It is the war.  A significant part of territories where assets were located, or business was pursued is under occupation.  Many workshops, logistics centers, factories, and property complexes were destroyed or damaged.  However, business is not doing well in the territory under government control.  Ports are partly blocked; shelling is regular; prices for logistics and raw materials are growing, and there have been power outages since the fall of 2022.

While most enterprises have resumed their business in coordination with power grid operators, the situation does increase production costs and makes it difficult to repay loans.

Speaking of NPLs in various sectors of the economy, most bad debts are concentrated in retail trade (about UAH 96 billion), wholesale trade (UAH 51 billion), and real estate (UAH 35 billion).

How does the accumulation of distressed debt endanger banks?

  1. Financial institutions have to make provisions for the loan portfolio.  It puts pressure on their profits.  Over 2022, banks made provisions of almost UAH 119 billion.  As a result, the banking sector’s net profit went down by a factor of three to UAH 24.7 billion year on year, while over 20 banks made losses.
  2. Provisioning makes violating target ratios more likely and can result in yet another wave of bank failures.  Thus, many private banks are facing the need to increase equity.

In fact, the whole banking sector is facing the challenge of what to do next about the NPLs.

The situation is more or less clear with the borrowers that have not stopped their business completely because they can still repay at least something.  So, they can come up with something to settle accounts with the banks or negotiate restructuring (loan extension, debt write-down etc.).  However, it is much more difficult to deal with the NPLs with the production stopped or with assets destroyed or located in the occupied territory.  Even enforcement is not always helpful in these cases.

However, banks still have another tool in their arsenal – the sales of loan portfolios (claims under loans to third parties).  Despite martial law, the distressed debt sales in 2022 rose by UAH 400 million to UAH 3.97 billion versus 2021.  This increase occurred mainly in connection with the Deposit Guarantee Fund’s takeover of four banks.  They include Megabank and Sich Bank, as well as two non-failing Russian-owned banks, MR Bank (ex-Sberbank) and Prominvestbank (PIB).

In 2022, the DGF obtained UAH 4 billion out of its UAH 4.5 billion total proceeds from selling assets of these banks.  The remaining UAH 500 million comes mainly from sales of Arkada Bank’s assets, such as its head office sold by the DGF for UAH 351 million.

There will be more NPL sales in 2023.  They will be offered by not only private but also state-owned banks.  Attractive assets can come to the market together with unsold NPLs of Russian-owned banks under liquidation.  They include Office Construction Agency (Ukreximbank’s borrower), Velta Group (PIB’s debtor), Bohdan Motors (Ukreximbank), Altcom (PIB), Elektrovazhmash (MR Bank), Zoria-Mashproekt (Ukreximbank), and others.

The most important question is the discount at which these and other assets will be offered for sale.  When selling loan portfolios, the discount can be as high as 99% depending on the condition of the debtor’s business, the available collateral, and the property location (the closer to the combat zone, the lower the price).

However, the Russian-owned banks’ debts are relatively high-quality, so the discount should be pretty small.  Moreover, state-owned banks that started offering their NPLs for sale in late 2022 are also trying to keep the price up.  This is why the volume of trade in their assets is so small.

In any case, the distressed debt market is expected to be quite active during 2023.  However, the NPLs in the banking sector will also keep going up.  Unfortunately, the economic situation in the country can hardly be expected to improve.  By the end of 2023, the percentage of toxic loans in portfolios of solvent banks can go up to 48%, or UAH 400 billion.