Restructuring vs. sale of collateral: the experience of the Gulliver case

Why doesn't Oschadbank sell the Gulliver shopping center, which is a collateral for a bad loan?

Recently, the media have often mentioned Viktor Polishchuk, the ultimate beneficiary of the company that owns the Gulliver office center in the center of the capital.

This borrower received a loan from state-owned banks for the construction of this office and shopping center back in 2006 (by the way, the company that received the loan had other owners at the time of obtaining the loan).

The accusations against the person involved in the articles are varied, and their analysis is not the subject of this column. The state-owned banks, which, according to the media, set this borrower an abnormally low rate during the restructuring process, are also being criticized.

These authors also write that the management of the state-owned banks simply turned a blind eye to the borrower's almost year-long default on its financial obligations after the full-scale invasion began and did not apply any penalties, although they had the tools to do so. These are the points that I think are worth commenting on.

As I have already mentioned, the loan was issued in 2006, and it was almost entirely received in foreign currency. This was the key problem with this loan. The situation of this debtor is no different from thousands and thousands of other bad debts in banks in the US, Europe and around the world, which issued risky loans despite the possible economic risks of the real estate market. 

In the naughtiest, everyone took out such loans – both companies and individuals. Currency stability, as it was believed at the time, would last for a long time, and real estate would constantly grow in value. Two false assumptions that led to disaster.

The crises of 2008 and 2014 dealt an irreparable blow to businesses that had foreign currency loans. In addition to a significant increase in mandatory payments in terms of hryvnia, demand fell, so as people became poorer.

How financial restructuring works during martial law

Half of banks' loan portfolios became non-performing loans, and there were a huge number of bankruptcies. At the same time, the legislator actually froze the issue for individuals for a long time (by prohibiting the forced alienation of their residential real estate and then allowing partial forgiveness of such debts).

Businesses and banks were offered to solve problems with the help of the law on financial restructuring.

After the 2014 crisis, when the debt increased many times over due to the devaluation of the hryvnia, the debtor was unable to fulfill the terms of the agreement in full. The problems were exacerbated during the pandemic, as stores and offices were operating in a limited mode at the time.

The loan was restructured in 2020 (as mentioned in journalistic investigations) in accordance with the Law on Financial Restructuring.

I would like to remind you that this law was drafted at the initiative of the IMF, with input from the EBRD and the World Bank, and was based on the best international practices. It was developed specifically to mitigate the requirements for debtors (in terms of interest rates, loan repayment terms, even partial debt forgiveness, etc.) in connection with financial difficulties. 

To ensure that the restructuring process is not abused, the law provides for special safeguards. One of them is the participation of third-party independent experts in the restructuring process. In this case, world-renowned companies such as Rothschild, KPMG, and others were involved.

The new interest rates and loan term were not taken "from the ceiling" – they were the subject of careful calculations. They were based on the cash flow of the business (existing and projected). The experts also determined how much of this flow the borrower can use to service the debt, as the premises of the shopping and office center need to be maintained in working order, and this is an expense.

The term and interest rates are interdependent – the logic is that these parameters should not kill the business, but enable it to continue operating and repay all debt. The main goal is to maximize economic benefits for the lending banks in these difficult conditions.

The new post-restructuring loan rate (3.68%) mentioned in the media is not abnormally low (as some media outlets reported), but the highest possible rate given the incredible amount of debt, which is approximately three times the market value of the building pledged as collateral for the loan as of 2020.

The same applies to the new term of the agreement, as it was simply unrealistic to pay off the entire debt in a shorter period of time. All of this was confirmed by the calculations and conclusions of the aforementioned international experts.

By the way, Rothschild even offered the creditors to consider a scenario of debt forgiveness in accordance with Western practices, as the amount of debt was so disproportionate to the business opportunities of the shopping and office center. However, the lending banks did not agree to this.  

In the course of the restructuring, the contractual framework was brought in line with the requirements of the current legislation, which strengthened the banks' position, and, as already mentioned in the media, a personal guarantee of the beneficiary was issued under Ukrainian law and English law (with a provision for dispute resolution in the London Court of Arbitration).

Also, during the restructuring, part of the loan was converted into hryvnia. Unfortunately, at that time, the banks' foreign currency position did not allow for a full conversion of the debt into the national currency, so currently approximately half of the debt is still denominated in foreign currency and the banks are unable to convert it due to the restrictions imposed by the regulations in force during the martial law period.

The terms of the restructuring were approved by the supervisory boards of the two state-owned banks, which were established as part of the corporate governance reform. Each supervisory board had a majority of independent directors, international financiers with an impeccable reputation.

The banks' decisions were approved by the Financial Stability Council's working group on non-performing loans, which includes senior officials from the NBU, various financial institutions, and international experts.

Representatives of law enforcement agencies also attended its meetings. The restructuring plan fully complied with the requirements of the aforementioned law in terms of rates, payment terms, etc.

Since the conclusion of the financial restructuring plan, the borrower has complied with the restructuring terms until early 2022. The outbreak of a full-scale war had a negative impact on all borrowers of all banks (from individuals to large corporate clients).

During this period, almost all Ukrainian banks provided their clients with loan repayment holidays, followed by a gradual process of resumption of loan servicing payments. The fact that the facility is located in the city center did not save it from a drop in revenue at the beginning of the large-scale war.

Revenues dropped 20 times, the office part was empty, and a grocery supermarket and a pharmacy were operating in the retail area. At the same time, the facility had to be maintained, i.e., expenses that exceeded revenues in the first months of the great war.

During martial law and for a 30-day period after its termination or cancellation in accordance with the law, all borrowers, both legal entities and individuals, are released from any liability for late debt service, including fines, penalties, inflationary losses, late loan repayment and/or interest payments.

In accordance with the regulations governing banks' handling of non-performing loans, the choice of a settlement instrument with any borrower should be made by comparing the net cash flows that a particular settlement instrument provides to the bank.

Accordingly, the bank should choose the strategy that provides the bank with the highest cash flow from the scenario. As in most such cases, a restructuring agreement is the best possible way out of a very bad situation.

This debtor did not have and does not have any privileges among the many problematic debtors, which, unfortunately, are still very numerous in state-owned banks (this is our legacy from past crises).

All economic calculations have shown and continue to show that debt enforcement instruments are two or three times less profitable for creditor banks. The process of collateral collection is lengthy, it usually leads to the cessation of all payments to the bank and has a negative impact on the business itself.

Demand for non-performing loans, especially large ones, is extremely low. In addition, the full-scale war has significantly reduced the value of real estate, and investors are taking into account military risks and economic prospects. So, if we sell collateral or a loan, we will at best be able to get only a quarter of the existing debt.

What is happening now and how do we see a way out of this situation? Along with the gradual resumption of business activity, the borrower has returned to debt servicing since last year in the economic logic of the restructuring agreement.

If there are no major shocks in the country, the borrower will be able to fully resume loan servicing from the beginning of next year. The recent news that the retail giant Inditex (Zara, Massimo Dutti boutiques, etc.) is returning to Ukraine adds to the optimism.

It is also expected that over the next three years, the debtor will be able to repay a portion of the debt that it was unable to pay at the initial stage of the war, when no one had time to visit shopping centers, and offices were closed. We are demanding the repayment of this part of the debt as well. The case is closely monitored by Oschadbank's Supervisory Board and is subject to supervision by the Financial Stability Council. 

If the regulator eventually abolishes the rule on the impossibility of converting debt from foreign currency to hryvnia and allows this tool at least for debtors in critical financial condition, it will be an important step towards the overall stabilization of the situation with the repayment of this and other similar foreign currency debts.

I would like to emphasize once again that both now and in the future, when making decisions on such complex cases, Oschad will always be guided solely by the interests of the state-owned bank, determined by economic feasibility. We are well aware that today the state treasury needs taxes and dividends from us as never before.

Original https://www.epravda.com.ua/columns/2024/05/3/713231/