The 56% non-performing loan (NPL) ratio of the total countrywide loan book, together with an overall volume of close to USD 20 billion, make the Ukrainian NPL market deserving of an in-depth investigation from institutional investors as well as workout companies. Most of Ukraine’s NPL volume is concentrated within the corporate sector, which accounts for more than 80% of overall NPL volume. It is highly covered with underlying assets, making it particularly interesting for workout.
The Ukrainian government, the country’s National Bank, and supranational institutions all share a priority interest in the cleanup of this NPL portfolio, as it creates congestion in the credit system and slows down new loan issuing and economic growth. The dynamics in the sector will be high for the coming two to three years due to the ongoing restructuring of the banking sector. As a result, the rewards will also be high for successful players. This is a game of “Double or Quit”, be it through the acquisition of important individual corporate debt positions or entire NPL portfolios from big lenders.
The Ukrainian economy can be characterized by comparatively high political risk and political interference, as well as high inflation and lending rates and a chronic equity shortage. For this reason, NPL ratios are high and can be acquired at attractive prices. The prudent investor will prioritize NPL investments along the following criteria: debts show no or little political exposure, underlying cash flows are export oriented or are USD/EUR linked (e.g. rental income based on currency-based contracts). Underlying assets, or companies in case of an appropriation, should be sellable to international buyers. Meanwhile, the time horizon for realization should not be longer than one to two years. Accordingly, the following sectors look promising: IT, Food and Agriculture, Real Estate (standing assets), Logistics, and Light Industrial Production.
The NPL business is sometimes like a real-life Western movie, and this is especially true in Ukraine. It is exciting, not for the faint-hearted, and sometimes dirty. The human factor can add enormous complexity with greed, misplaced morality, chicken runs, compliance frameworks, criminal behavior and personal egos all taking their toll. Based on experience on all fronts of the spectrum in Ukraine, I have a number of lessons from successful NPL cases to share with lenders, investors and debtors.
Begin with a Realistic Endgame
All successful investments start by thinking through the endgame. This will also mean the readiness of the investor to work out a debt, repossess assets, re-structure or upgrade assets, operate or sell assets. Be careful on the timing side: factors such as non-liquid markets for certain assets, challenges to the enforceability of claims, the need to upgrade assets, and time delays from courts and authorities can all often prolong planned investment horizons in Ukraine.
Real Value and Underlying Assets
As the investor needs to be prepared to take over and operate or sell assets, it is critical during due diligence to understand the true value of the underlying assets of NPLs. In Ukraine, this also means understanding the true physical state of the assets and clarifying who is in control of assets and cash flows.
Focus on Negotiations
Always prioritize open and transparent negotiations, ideally moderated by a neutral party. This has proven to be the most efficient and fastest way towards conflict resolution. Prepare your negotiations by finding and using local allies and by building personal pressure on your debtors. Assume in principle a non-payment attitude and be bold and strong. Sometimes both parties have to get bloody noses before a real negotiation process can start. Sometimes it never happens. In these cases, the winner will collect the whole lot, but often the value is then already negligible.
Beware of Compliance Restrictions
Debtors might fight back with legal, half-legal and sometimes criminal means to avoid payment. Legal and commercial loopholes sometimes allow for unprecedented situations. In case the reporting, legal or compliance regulatory frames do not allow for a solution, this part of the NPL investment should be rapidly divested or out-structured.
Avoid Moral Hazard and Bloated Egos
We have observed that lenders and investors lean towards punishing debtors for not being willing to pay back debt or to deny them a profitable debt restructuring. Debtors are prone to overestimating their own power and often driven by personal ego and pride. Better results are possible by focusing on win-win deals and face-saving solutions while forgetting morale or justice and staying unemotional.
Watch Out for Poison Pills
Some Ukrainian debtors are masters of deflection techniques. Be prepared for poison pills in your loan portfolio in the form of blurred property rights, complex corporate structures, side tracking and counter-attacks, out-structuring of key assets, abuse of authority and relationship networks.
Bad debt deals can be highly rewarding, especially in highly volatile economies like Ukraine. Investors and debtors who are ready to invest in the appropriate planning, be disciplined in their execution, and ready to test unchartered waters, will be in line for the extra yields on offer in this market. The current market situation features a high volume of NPL, important market players who have to reduce their NPL positions, an improved regulatory framework and a positive economic outlook as well as increased integration into European Union markets. These factors will lead to an increase in the value of NPLs and their underlying assets. This makes Ukraine a very interesting market for financial investors, supranational lenders, and organizations who are ready to work out loans or loan portfolios.