Sold out. What will happen to the market of problem debts in Ukraine without the “legacy of bank fall”

How the market for distressed assets was formed in Ukraine, can it be considered full-price and what is waiting for it in the future

In July 2019, the National Bank of Ukraine published a remarkable study on the factors that affected the unprecedented increase in the share of non-working loans in Ukrainian banks in the period after 2014.

The results are impressive: the war in the Donbas, the occupation of Crimea and the economic crisis caused by these events (including the breakdown of business ties with Russia) provoked only a third of defaults among borrowers of Ukrainian banks.

The rest decided not to pay their debts for other – much more subjective – reasons. However, this medal has a positive side: these loans can still be returned to life, since we are often talking about living businesses. They continue to work and bring money to their owners, but for some reason the latter do not pay on loans.

It is on this assumption that a new, unusual and specific industry appears in any system affected by a major crisis – the market of distressed assets.

In Ukraine, too, there is one. It sells debts with a nominal value of half a trillion hryvnias, or buys hundreds of professional financial companies that specialize in the return of problematic and even bad debts.

How was this system formed, can it be considered a full-fledged market and what is waiting for it in the future? asked representatives of three key institutions to tell us about the Ukrainian NPL market: the Individual Deposit Guarantee Fund, the NBU and Prozorro.Sales.

The Prozorro.Sale revolution and the laws that did not exist. How the Ukrainian NPLs market began

First Deputy Director of Prozorro.Sale Darina Marchak (formerly a journalist specializing in state finances) is at the epicenter of one of the main economic reforms since independence – the creation of the Prozorro.Sale system.

In 2017, by analogy with public procurement, in the Prozorro.Sale paradigm, assets of bankrupt banks that were managed by the Deposit Guarantee Fund began to be sold. According to the Fund’s own statistics, 95% of borrowers transferred to the NPL category almost immediately after their lender was declared bankrupt.

The current director of the DGF, Svitlana Recruit, was already part of its top management at that time (Konstantin Vorushylin was the head). Under her leadership, the Fund tested first English and then Dutch auctions with lower prices, experimented with pooling assets into multibillion-dollar pools and invited large trading platforms from the USA and Europe to Ukraine.

The National Bank also took part in this process, which acted as a collateral lender for refinancing loans of many bankrupt banks. After the division of the functions of the National Financial Services Committee between the NBU and the National Securities Commission, the National Bank became the key regulator of the problem debt market.

As of mid-2021, the DGF held almost all of its “own” assets through Prozorro.Sale. The system has become a kind of watershed between the “Wild West”, as described by the participants of the Fund sale market in 2014-16, and the emergence of a civilized NPLs market in Ukraine.

How it happened and what the market was like before – Darina Marchak, Svitlana Recruit and Alexey Onishchenko (NBU) tell.

With the help of Prozorro.Sale, we have eliminated the monopoly on the sale of assets. It generated frequent “controlled sales” when a particular asset was actually given to a known buyer. It was simple, because each individual platform through which the asset was sold had all the information about the lot, potential buyers, and price offers.

So it was until Prozorro.Sale appeared – an integrator between all the main sites that operate in Ukraine. It does not matter through whom the lot is placed and with whom the buyer works. Anyone can buy an asset, no one can prevent specific companies from participating in the auction. How many of them there will be and who they are – no one knows until the end of the auction.

You can refuse to register a participant, but he will go to another exchange. If one site wants to close the bidding information, it will appear in dozens of other places. This is a very strong anti-corruption measure – it excludes the possibility of an agreement, because the number of auction participants, who they are, are unknown before the auction itself begins – but as soon as it starts, everyone can watch its progress online, and after the auction ends, all information about all participants, about the buyer, instantly becomes public.

These changes have become the foundation of trust in the system. Thanks to this, market participants understand that it is possible to compete fairly on it. And this in turn leads to an increase in prices.

Our mission sounds like this – “building markets and trust”. This is important, because the main thing is that this transparency helps everyone: both the state, which can see what is happening with its property, and business, which understands which assets and at what prices are being sold at the moment on the one hand and the demand for them on the other.

There was no NPL market in Ukraine in 2014-16, there were no clear rules that the market could be sure of.

This is important because businesses need to plan their financial flows. At the first stages of market development, sales were chaotic, it was simply impossible to predict anything.

But the formation of a normal market was inevitable – the principle played when a large offer appears in some unfilled niche, sooner or later capital also comes there.

Of course, a certain period of adaptation has passed. But now we can say for sure that these are no longer primitive operations like buying out their own debt, but a structured segment on which people have learned how to do business.

There was no NPL market in Ukraine in 2014-16, there were no clear rules that the market could be sure of.

This is important because businesses need to plan their financial flows. At the first stages of market development, sales were chaotic, it was simply impossible to predict anything.

But the formation of a normal market was inevitable – the principle played when a large offer appears in some unfilled niche, sooner or later capital also comes there.

Of course, a certain period of adaptation has passed. But now we can say for sure that these are no longer primitive operations like buying out their own debt, but a structured segment on which people have learned how to do business.

NBU Press Service

The main part of the NPLs market is the operations of the Guarantee Fund for the sale of distressed debt. Commercial banks conducted relatively few transactions on the sale of NPLs after the crisis of 2014-16.

This can be associated with more successful claim work, as well as the restructuring of borrowers’ debts. Private banks have practically closed the issue with NPLs with the exception of foreign currency mortgages.

The most liquid loans were sold at Dutch auctions for a little more than 20% of the debt.

Market or not? What is going on and who is trading NPLs now

Is it possible to consider the NPL situation that has developed in Ukraine after the banking crisis of 2014-16 as a market for problem debts?

On the one hand, there are specialized players who compete according to a single set of rules and pay real money for assets. According to the NBU, in the first half of 2021, factoring contracts worth UAH 30.2 billion were concluded.

On the other hand, a frequent subject of criticism is the possibility for borrowers who intentionally did not service loans to buy back their own debts at a large discount.

On the third– the market may soon face a supply crisis: due to the virtually monopoly status of the Guarantee Fund as the sole seller of NPLs. This year, DGF is likely to complete the sale of its assets.

The market has been structured. There are players who buy only pools of assets, there are those who buy unsecured claims on loans (these are, as a rule, collectors), both collectors and financial companies specialize in mortgages, several large market participants specialize in debts of legal entities.

It’s a really complicated business. The assets that we sell are usually deeply distressed, the overdue periods can reach ten years, collateral often does not exist as such. Buyers have three ways: completion of the judicial history, settlement agreement and recovery of collateral.

The Guarantee Fund does not have the resources to participate in labor-intensive, lengthy and expensive court battles. And private players do. Especially when they understand what and how a particular debtor lives. For example, they can orient themselves and promptly seize the borrower’s property abroad. This is an additional motivation for the debtor to go to a meeting and, for example, agree to a settlement.

When we talk about what happens to the assets of the Guarantee Fund, in my opinion, it is the choice of each individual entrepreneur – what to do with the goods for which he paid.

Buyers are trying to get real money, this means very serious preparatory work. The requirement of transparency in this aspect, as for me, will interfere with business activities.

On the other hand, the task of the state is to transparently sell assets at a market price. Anyone can come to auctions in Prozorro.Sale. If we cut off the debtors themselves who want to redeem their debts, we cut off the most interested buyer. He is ready to pay the highest possible price for the market. Thus, the state loses a significant part of the money, and often the opportunity to sell a problematic asset in general.

Ukrainian legislation does not provide for such financial services as transactions with problem debts. Some of these transactions are factoring.

733 companies have a factoring license in Ukraine. In 2020, 45,000 transactions worth UAH 85 billion took place in this market, which is 46% more than in 2019. In the first half of 2021, 30,000 contracts worth UAH 30 billion have already been recorded.

It is difficult to estimate the exact share of transactions with problem debts, however, it is likely that we are talking about at least half of the specified volume.

The NBU is currently working on a concept for the development of trade finance in Ukraine (a component of the Financial Sector Development Strategy until 2025). It also provides for the reform of the factoring market, one of the goals of which is to separate trading factoring and operations with problem debts.

What’s next? Will state banks save the market of problem debts in Ukraine?

What will happen to the NPLs market in Ukraine when the Guarantee Fund completes a large sale of assets inherited in the fall of 2014-16? The first fiddle goes to state banks: at the beginning of the year, PrivatBank had about UAH 178 billion in NPLs, Ukreximbank – 57 billion, Oschadbank – about 52 billion.

Does the Ukrainian market have the capacity to process this mass of bad debts (a significant part of which is connected by politicians of different years, dummy companies and influential oligarchs)? And, most importantly, are state banks able to put them up for sale?

Another layer of questions is what other types of “bad” assets can be effectively sold, including through the Prozorro.Sale system.

Why is a civilized NPL market important for the economy?

NPLs are huge sums that freeze bank liquidity, the embassy needs to form reserves for bad loans, thus limiting lending. According to expert estimates, if state banks sold all their distressed assets, it would free up about UAH 30 billion of liquidity for them. This is money for the development of market niches, which each of the banks focuses on. For example, large-scale construction, energy efficiency programs, lending to SMEs.

Yes, state-owned banks have a problem with the sale of bad loans – their management is not sufficiently protected in terms of claims from law enforcement agencies due to the sale of assets at a reduced price: the authorities often interpret this as causing losses to the state. Therefore, for the time being, state-owned banks can only use English auctions for sale, which work on the principle of increasing the price, while the experience of the Guarantee Fund shows the effectiveness of the Dutch system – for a decrease.

What promising areas in terms of sales through Prozorro do we see?

Firstly, since October 2019, the income from auctions in bankruptcy cases amounts to UAH 2.4 billion, we have already seen more than 300 auction organizers and 1.5 thousand participants. The average difference between the starting price and the selling price is 47%. An important aspect in this sense is that sales have become much less contested in the courts. If earlier about a third of sales were challenged in court, now we are talking about isolated cases.

Other areas with the greatest potential are the sale of seized property and mortgage claims, land auctions, the market for wood processing rights.

Ukrainian banks in their three-year NPL strategies have planned the sale of portfolios with a total debt of UAH 39 billion.

Like the Ministry of Finance, the NBU has high hopes that banks will use the Dutch auction tool (Cabinet Resolution No. 281, adopted back in 2020, – Ed.) for loans with a delay of more than 36 months.

This regulation provides for a number of safeguards regarding the minimum sale and sale price of assets to related parties. At the same time, the NBU and the Ministry of Finance will monitor the practical application of these rules and, in case of abuse, will change the requirements for banks.

The peak of the market has already passed; it is unlikely that radically new players will appear on it. In addition, the profile of distressed assets of state-owned banks is not much different from ours – these are deeply distressed loans that need very serious study.

Nevertheless, it is very important for the market to maintain a rhythmic supply. There is capital on it. Therefore, it is important for state banks not to miss the moment when the market is organized and well capitalized. If they last another year, the money will go elsewhere.

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