1. NPL resolution in Ukraine: what does the global experience suggest ? Marius Vismantas Country Sector Coordinator, Financial and Private Sector Development Ukraine, Belarus & Moldova This presentation is based on a subject matter presentation developed by the World Bank Group staff. The views expressed in this presentation do not constitute an official position of the World Bank Group on the issues of discussed herein 1

2. 2 Presentation I.Asset Resolution Prerequisites II.Asset Resolution Process & Tools III.Global Lessons Learned

3. 3 I. Prerequisites for Effective Asset Resolution

4. 4 Asset Resolution (Repayment) involves both Asset Rehabilitation Asset Disposition enhancing borrowers’ repayment capacity through loan modification (financial engineering) or corporate restructuring (changes to debt, equity, management, and operations) sale of asset (debt or collateral) to a third party

5. 5 Effective Asset Resolution requires... Credit culture within banks - finance only viable projects –Then you won’t have to fix what is not broken Strong repayment ethic amongst borrowers - use credit wisely and feel obligation/duty to repay –Balm to banks’ ears – but that is why character and integrity of a borrower are such important credit decision criteria

6. Effective Asset Resolution requires... Effective Regulation and Supervision - encourage enforce prudent lending and encourage enforce timely loss recognition Legal framework for creditor rights and insolvency, including mediation process - provide incentives for consensual debt resolution, rehabilitation of viable businesses and liquidation of non-viable entities –Populist debtor protection makes the entire process unstable 6

7. 7 …But, Loss Recognition is an absolute prerequisite Loss recognition –makes explicit the losses in distressed assets –apportions losses amongst borrowers, lenders, and taxpayers –results in wealth transfer Requires Political Will

8. Who pays for the NPLs? –Bank owners – for poor credit policies –Bank creditors – for inadequate risk assessment of banks –Borrowers – for careless borrowing –Taxpayers – for having too much money and not knowing what to do with it all… in fact they pay for a possibility to see quick recovery led by NPL resolution 8

9. 9 II. Asset Resolution Process and Tools

10. 10 Is the borrower viable? Viable Asset resolution Step 1 – Identify Viable/Non-Viable Borrowers Non- viable GUIDING PRINCIPLE Maximize recovery via rehabilitation of viable borrowers Avoid “investment” in time and money in non viable businesses Borrower is expected to generate sufficient cash flow to repay some level of debt Only source of repayment from liquidation of collateral or business

11. 11 Viable Modified terms/Access to new financing Formal reorganization Monitor, re- classify as appropriate Restructure Non- performing Modify terms and monitor performance Performing Mediation Merger Debt-Equity Swap Single lender – cooperative borrower Multiple lenders – willingness to restructure Multiple non cooperative lenders Legal and Insolvency framework How to? Out-of-Court workout process (Mediation) Corporate Restructuring Fund (Fresh Money) Asset resolution Step 2: Dealing with viable borrowers GUIDING PRINCIPLE Preserve value by restructuring Preserve “going concern” Provide fresh working capital Sale of part of business/non- viable assets Replacement Management Reduce costs (labour) Bank Workout Departments Train banks and businesses to use tools

12. 12 Non- viable Sell Note Voluntary Settlement Legal enforcement mechanisms Cash Collateral Liquidate Foreclose collateral Sell Private Buyer/AMC Public AMC Cash Asset resolution Step 3 – Resolving non-viable businesses Private Buyer/AMC Public AMC Sell Private Buyer/AMC Public AMC Personal bankruptcy framework Private AMCs Legal and Insolvency framework GUIDING PRINCIPLE Maximize recovery through asset disposition Timely process to preserve value Identify suspicious transactions and refer to legal authorities

13. 13 Asset Resolution Entities Bank Workout Departments Asset Management Companies –Public or Private Bad Banks/Special Purpose Vehicles –Independent WO Dept., subsidiary of bank, or independent institution

14. 14 Bank Workout Departments Work Best When Problems are manageable in relation to size of bank Strong governance within bank Strong supervision and regulation Staffed with resolution professionals Separate operating and approval procedures including continuous monitoring and collateral valuation Adequate funding

15. 15 Private AMC’s Shareholders/taxpayers need protection from “asset stripping” and other fraudulent activities Consumers need protection from unwarranted collection practices Regulation requiring –Minimum standards for governance, accountability, and transparency –Full disclosure of ownership –Prohibition on purchasing related party assets –Minimum requirements for outsourcing contracts –Establish consumer protection standards

16. 16 Public AMCs Key Considerations Goals and mission - clearly defined up-front Governance structure - 3 principles: Independence Transparency Accountability Operational set-up - critical to ensure achievement of goals Legal/judicial framework: few key issues: Transfer of ownership/priority; Indemnity of AMC staff; Corporate insolvency regime; Special powers Political support of National AMC Need to address simultaneously financial sector resolution and corporate sector restructuring Key elements need to be addressed up- front to ensure effectiveness and results Key elements need to be addressed up- front to ensure effectiveness and results Set up time: between 6-18 months Set up time: between 6-18 months

17. 17 Additional Tools Corporate Restructuring Fund Legal and institutional insolvency frameworks Mediation - Out of Court Workout Procedures Asset Sales –Outright or maintain limited interest –Partnerships/joint ventures/SPV’s Securitization –Requires CASH FLOW

18. 18 Legal & Institutional Frameworks for Insolvency generally lack: Effective/Efficient Enforcement mechanisms Consumer insolvency framework Rehabilitation regime Transparency High levels of expertise of judges, practioners and other users

19. 19 III. Global Lessons Learned

20. 20 Lessons Learned Losses ought to be, should be, must be recognized upfront Limit role of government –Leadership role (political will) in developing public consensus for program and establishing framework –Step back to allow the private sector to negotiate solutions

21. 21 Lessons Learned Corporate restructuring is a process not an event –Likely to take 4-5 years to complete with more than one round of restructuring –Inability of both sides to face losses leads to cosmetic restructuring –True operational restructuring takes place only when apparent initial restructuring was not enough

22. 22 Lessons Learned No one correct approach –Tailor to particular needs and circumstance –Mix/Match strategies to goals –Consistency more important than perfection –keys to recovery are incentives for restructuring and the legal system for recovery

23. 23 Lessons Learned Narrow mandate of public AMC and focus on GOVERNANCE from beginning AMC should be separate from bank regulator/supervisor Active involvement of supervisor needed to force losses and encourage restructuring

24. 24 Concluding thoughts - for discussion Stock or flow solution? Who should pay for the NPLs in Ukraine? How big is the social cost? Does it always have to be a direct unrecoverable cost? Would banks be better off providing temporary capital to NPL workout managers – in-house or outside? Is shared effort/aligned motivation of those affected a key to avoiding painful valuation? Sharing downside and upside Protect the taxpayer! Public AMC likely the worst of options in an environment of poor political consensus and weak governance culture – hardly any value added to the taxpayers.