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MORIS GROUP Law Firm
Bank Crisis in Ukraine — the Time to Invest
“When written in Chinese, the word ‘crisis’
is composed of two characters. One represents danger
and the other represents opportunity”, — John F. Kennedy
This article is about the state of affairs in the domain of distressed bank assets, some risks for business and opportunities for investors.
Statistics of Liquidation of Banks
In 2014-2016, 90 banks were adjudicated insolvent in Ukraine. 89 banks currently undergo liquidation procedures. In addition, one bank (JSC Astra Bank) was sold to an investor, 100% of the capital of another bank (JSC CB Privatbank) was taken by the state, and on the basis of Terra Bank JSC and PJSC Omega Bank, so-called transitional banks were established, working even now, namely, JSC Crystalbank and JSC RWS Bank. In 2018, DGF liquidated the first four banks: PJSC Derzhzembank, JSC Erde Bank, JSC Bank Tavrika, JSC ‘Classicbank. Since the maximum term of a bank’s liquidation is limited by the law and is 5 years, in 2019-2021 we will see mass closure of banks, meaning total sale of bank assets and maximum discounts.
Structure of Bank Assets
As of October 2018, the balance-sheet value of assets managed by the Deposit Guarantee Fund (DGF) exceeded UAH 500 billion. In that, over 80%, or more than UAH 400 billion, fell on debts under credit agreements. For evident reasons, the most liquid assets are credits granted to individuals, whose share in the DGF management is close to 20% of all assets, making slightly more than UAH 100 billion. That said, 85% of credits to individuals were issued in foreign currency. Some 60% of all credits to individuals are backed with mortgage. Almost 80% of those are concentrated in the three biggest banks: JSC Delta Bank, PJSC CB Nadra, JSC Bank Finance and Credit.
Sale of Assets
Currently, the main buyers of distressed bank assets are banks, financial companies, debt recovery companies and borrowers as such. Although formally, debtors are barred from participation in auctions where their debts are sold, it is no secret that this is a mass phenomenon, practiced by them via third parties.
In the spring of 2016, the Deposit Guarantee Fund lifted restrictions on the range of persons entitled to buy claims under credit agreements, since until recently, only banks and other financial institutions have enjoyed such opportunity. Hence, now, any person may buy credits in line with the DGF regulatory framework. This issue is disputable, especially in the light of a ruling of the Grand Chamber of the Supreme Court passed in the fall of 2018, which we will dwell upon later.
The procedure of sale of bank assets proper has undergone deep changes since the beginning of the bank collapse, evolving from classic “hammer” auctions to sales only via the electronic platform of ProZorro.Sale State Company. By the way, in February, 2018, it obtained the International Anticorruption Award from C5 Accelerate and the US Institute of Peace at the “Shield in the Cloud Innovation Challenge” contest. The only exception is presented by assets pledged to the National Bank of Ukraine, for the sale of which, the DGF employed subsidiaries of US-based DebtX and FFN.
Speaking of the types of auctions, DGF currently uses for sale of assets classic English auctions with prices growing (English Forward), and Dutch auctions, starting from the highest price, declining during the day to the pre-set minimum threshold, usually coming to 20% of the initial price. The main advantage of the Dutch auctions lies in their speed, since the asset price goes down within one day, rather than a few months, as the case is for English Forward auctions. For this reason, DGF sells all credit obligations at Dutch auctions.
Nevertheless, even this approach does not formally solve the problem of sale of the huge body of assets in conditions of limited liquidation terms, mentioned above. For this reason, all credit obligations not sold at individual auctions under the Dutch model are pooled in pools of assets. Noteworthy, the minimum pool price can be 2.5% or 0.8% of the total indebtedness for credits to individuals or corporate credits, respectively. This indeed may be termed a real sale. That said, the circle of probable buyers of such pools is significantly narrowing, since their price is measured in tens of millions, hundreds of millions, sometimes — billions of hryvnias. The ROI of such business often exceeds 100%. It will be very difficult for the domestic market to absorb such a volume of assets, which opens up huge opportunities for foreign investors.
Risks for Business
The external reasons for mass incurrence of bad debts include the effects of the global financial crisis, devaluation of the national currency, occupation of part of Ukraine’s territory, general decline of household incomes, loss of markets (for the corporate sector), etc. Due Diligence of the given assets presents an important element of identification of the internal reasons. Exactly this stage is critical for a decision on acquisition of a specific bank asset, as it makes it possible to assess the risks encountered by the investor in its future dealing with the specific borrowers. Meanwhile, I would like to dwell upon a few key obstacles encountered by creditors in Ukraine and lying mainly in the legal domain.
If we speak about credits granted to individuals on mortgage in foreign currency, since 2014, there has been a moratorium on recovery of immovable property of citizens granted as mortgage for such credits in Ukraine. The moratorium prohibits collection of immovable residential property, if it is the only property of the borrower/mortgager, and the area of such property does not exceed 140 sq.m for an apartment or 250 sq.m for a house.
Regarding legal entities, a big problem is posed by mass bankruptcy of such borrowers. The bankruptcy procedure under the existing rules is often misused by unscrupulous debtors, property (even pledged to a bank) is sold for a penny, which effectively rules out repayment of the debt to creditors.
A common problem on the side of the borrowers — individuals and legal entities alike — is presented by the misuse of the judicial system. For that, different juridical subterfuges are used, the most common of them being: claims for invalidation of credit and mortgage agreements on contrived pretexts, initiation of numerous lawsuits to delay consideration of the main case, attachment of pledged property, imposition of various bans on commitment of certain acts with pledged property by creditors and so on. Unscrupulous borrowers frequently resort to different alterations of the pledged property, which often bars its recovery.
I would like to specifically mention the ruling of the Grand Chamber of the Supreme Court, adopted on the 11th of September, 2018. In that ruling, the Court touched upon the criteria of distinction between agreements of factoring and assignment, thus upholding the opinion of lower courts, that the difference between the amount of the debt and the actual value of claims under a credit is a discount, i.e., a fee (financial benefit) obtained by the agent under a factoring agreement. Given that actually all bad debts of bankrupt banks are sold with a discount, and such assets are often bought by individuals or legal entities not holding a proper licence, this gives rise to the risk of invalidation of such agreements, which was actually the result of consideration of that case.
Actually all the described problems are addressed in the updated legislation on protection of creditor rights, the amendments to which have already been passed.
Concerning the moratorium on recovery of immovable property of individuals under credit agreements, on 10 October 2018, Parliament passed the Bankruptcy Code of Ukraine that cancelled the moratorium and introduced the institute of individual bankruptcy. Under the procedure, individual debtors may have their debts restructured to the amount of the market value of the pledged property. However, in case of violation of the conditions of restructuring, they will have to answer for their debts in full, including with the mortgaged immovable property, no longer protected by the moratorium.
The Code also introduced substantial changes to the procedure of bankruptcy of legal entities, in particular, the procedure of sale of the property of bankrupts, to be performed only in electronic format. As exemplified by the sale of assets of bankrupt banks, this is, beyond doubt, a significant improvement that must have a positive effect on sale of property at market prices and, respectively, let creditors return their funds.
The Code has been presented to the President of Ukraine and signed by him recently. It will enter into effect in October 2019.
On 4 February 2019, the Law of Ukraine On Introduction of Amendments to Some Legislative Acts of Ukraine Concerning Resumption of Crediting came into effect, to amend a number of Ukrainian regulatory acts defending the rights of creditors. They include the ability of financial institutions to register the title to the pledged property extrajuridically even in the presence of other encumbrance registered after the creation of the mortgage, application of mortgage to reconstructed and new property, preservation of security in its initial form even in case of an increase of the debtor’s liability, extended term of claims to the debtor’s successor, etc.
Finally, it should be mentioned that on 15 December 2017, new procedural legislation entered into effect in Ukraine, which defined abuse of procedural rights and specified the consequences and responsibility for commitment of such acts. Under effective legislation, a court may declare most actions taken by unscrupulous borrowers for intentional delay of litigation and creation of obstacles for exercise of creditor rights as abuse of procedural rights. As a result, procedural documents of an unscrupulous opponent may be left unattended, and in some cases, it may even be fined.
Summing up, it may be said that the sale of bank assets is about to reach its highest point, while new legislative provisions give creditors grounds for optimism. Nevertheless, investments in distressed assets, just as in any business, still involve a number of risks that can be diminished by a reliable partner possessing the infrastructure, the experience, and the reputation.