NPLs Are Growing, But It Is Not a Disaster, or How Businesses Repay Loans during the War

According to the National Bank of Ukraine, the non-performing assets in the banking sector (NPLs) exceeded 30% after eight months of the year 2022. The distressed corporate debt amounted to almost 36% or 4 percentage points higher than at the start of the war. However, new loans do not affect the distressed debt value in the banking sector because hardly any new loans are being granted. On the other hand, loan portfolios of some banks do grow because of preferential lending programs, such as 5–7–9. In fact, the National Bank presents restructured loans as new loans in its statistics. Andrii Volkov, Investohills Group’s founder and managing partner, explained Mind what is going on with the distressed debt in banks.

The NPL situation in banks is uneven. Financial institutions that have diversified their portfolios, granted loans to different sectors and been meticulous about the collateral value have much fewer distressed debt issues. However, banks with ailing risk management and lending policies have to deal with an NPL level much higher than the market average.

By the way, the NPL level in the banking sector would be much higher if judged according to the pre-war standards and criteria. The borrowers that fail to meet the loan repayment schedule and seek restructuring would have been categorized as NPLs. However, both banks and the NBU treat the debt under loans somewhat differently under the current circumstances and do not consider serviced loans to be distressed (yet).

What does the structure of loan portfolios look like? Speaking of the structure of the loan portfolio of banks, we can identify three segments.

The first segment includes loans to companies in active combat areas or occupied territories. Such borrowers do not repay loans, and they cannot be restructured. This debt has become bad for banks and needs to be written off

The second segment includes loans that are serviced well enough. The most solvent borrowers currently include retailers, agricultural producers (helped a lot by exports reinvigorated after the opening of seaports), and the energy sector. These businesses are active, and they earn some money. Even the domestic metals sector keeps operating profitably despite the considerable physical loss of production facilities.

The third segment includes loans granted to borrowers facing difficulties that still try to repay their debt to banks and seek compromise with creditors. Again, there are companies from almost all sectors in this category. However, those from sectors of real estate development, the food industry, machine building, and services have been hit hardest.

What kind of policies do banks pursue? We have to do justice to banks: They do not treat their borrowers aggressively. They do not make them repay their loans at any price; they do not repossess the pledged assets. Most banks, private and state-owned alike, agree to restructure without any problem.

Deferring principal repayments is the most widespread option. The situation is a bit more complicated with changes to interest rates. However, if a debtor is unable to pay interest, the bank may accept a reduced rate or interest capitalization. I am certain that banks will keep supporting such borrowers as much as possible.

However, credit risk remains among the major risks for the banking sector. The NBU reiterated it several times; according to its estimates, about 20% of borrowers can default by the end of the year 2022.

Their forecast is absolutely adequate because 75 to 80% of companies keep paying interest on the loans. It is the part of the economy that keeps operating and which is really alive.

What will happen to business loans? Many companies have already exhausted their financial reserves or are about to do so. The winter will become a real test for the business. The NPL can snowball in the case of an issue with the energy supply (for instance, due to damage to critical infrastructure) and logistics disruption.

Under this scenario, a critical accumulation of distressed debt will occur by spring 2023, and much more than 20% of the borrowers can go bankrupt. The companies with assets damaged by hostilities or remaining in occupied territories risk being the first to default. They are the key candidates for contributing to the NPL statistics.

However, if the war becomes less intense soon and the international community keeps supporting Ukraine, businesses will be able to service their debt. According to most forecasts, the war’s active phase will fade after winter. It means that the quality of the banks’ loan portfolio will improve by the summer of 2023, while the percentage of NPLs will start decreasing.