Debt & Restructuring KYIV
By Pavlo Maherovsky, London Business School MBA 2018
The London Business School Private Equity & Venture Capital Club had the privilege to participate in the WJ Global Group Debt & Restructuring Forum in Kyiv. The event was dedicated to the Ukrainian non-performing loan (NPL) investment opportunity.
Over 40 expert speakers, including regulators, international and local law firms, institutional investors, banks, restructuring advisors and loan servicing firms shared their insights with more than 120 enthusiastic participants. With early investors achieving IRRs in excess of 50% and a stock of over $40 billion Ukrainian NPLs waiting to be sold, the excitement of this opportunity was palpable at the conference.
The Forum came at a critical time for the Ukrainian economy. The country has endured two major financial shocks in recent years – the 2009 global financial crisis and continued Russian aggression since 2014. Although Ukraine’s
macro environment has now stabilised, the economy remains vulnerable without the support of the IMF, against a backdrop of rising interest rates, large external debt obligations, and looming elections.
With support from international organisations, regulators have achieved some admirable financial sector reforms over the past three years. These include closing insolvent banks and improving regulatory standards. A framework for selling NPLs has also been established and there is full government support to offload these “problem loans” to investors.
But why should governments be interested in lowering the volume of NPLs on banks’ balance sheets?
Simply put, NPLs prevent banks from doing what they are supposed to do – financing the real economy.
NPLs are high-risk assets that do not generate interest revenues, yet require funding at market rates and require banks to hold additional capital. Banks with high NPLs are perceived to be riskier institutions. This can lead to lower credit ratings, lower valuations, and higher funding costs, leaving banks vulnerable to external shocks. Additionally, servicing NPLs can be expensive and takes up staff resources. So overall, a high volume of NPLs on a bank’s balance sheet diminishes bank performance and lowers the availability of loans to individuals and companies.
In the aftermath of the Great Financial Crisis, the volume of NPLs on banks’ balance sheets surged. Banks in the UK and Western Europe started offloading NPLs and non-core assets, supported by favorable policies aimed at speeding up recovery in the banking sector. The sale of these assets at prices significantly below par created numerous investment opportunities for specialist funds.
However, as Western European economies recovered and bank balance sheets were cleaned, it became increasingly difficult for funds to find attractive investment opportunities. Unlike banks in Western Europe, banks in Southern and Eastern Europe have been slow to clean up their balance sheets, and many distressed debt investors are now focussing on NPLs in these regions. The abundance of NPLs in Ukraine and the support of the local regulator to create a secondary market for NPL sales has made the Ukrainian opportunity a hot topic of debate amongst investors.
However, even for investors comfortable with emerging markets risk, Ukraine is considered a high-risk market, with a volatile economy and limited protection for creditors. But, as we heard first-hand at the Debt & Restructuring Forum, Ukraine also offers an incredible opportunity to generate alpha for those investors willing to take the risk.
In such a challenging market, it is especially important to have local partners who know the market well. The knowledge of the local market was a key theme at the Forum, with expert opinions from local law firms and debt servicing companies that have years of experience working on the ground in Ukraine.
Above all, international investors require a stable and reliable enforcement framework when considering a market. Significant achievements have been made on this front in Ukraine over the past 3 years, including judicial reform and a restructuring law that incorporates LMA standards on debt restructuring. The expert speakers at the Forum did a great job of summarising the key reform achievements, which are often overlooked by Western observers.
Representatives of Ukraine’s Deposit Guarantee Fund (DGF) spoke about how they have been working to create a functional NPL market in Ukraine, taking best practices from around the world. The $19 billion nominal assets of insolvent banks held by the GDF are now starting to come to market.
All assets are sold through Ukraine’s online ProZorro platform, which is easy to access for international investors, created in recent years to fight corruption and bring transparency to public procurement. Dutch auctions are used, where the price starts at a maximum and comes down until a sale is made, a format that is optimal for selling illiquid assets.
A tremendous amount of work has been done to lay the foundations of a functioning market for NPLs in Ukraine. Secondary transactions have been picking up, but there is still a lot of room to go.
With many individual portfolio NPLs set to be sold over the coming 18 months, timing is critical for achieving the best risk-adjusted returns. Judging by the excitement of the participants and the interest in this market, next year’s edition of the Kyiv Debt & Restructuring Forum promises to be a sell-out.