Download IFC Russia Capitalization Fund

IFC Russian Banking Sector
NPL Management: Russia and International
Experience
November 2009
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IFC and the Financial Crisis
• Introduction and Background
• Response
Creating Opportunities
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Creating Opportunities
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Three Main Themes for
2010
• NPL and Distressed Asset Solutions
• Bank Capitalization
• Climate Change / Energy Efficiency
• Ongoing business: SME Lending, Trade Finance
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IFC and the Financial Crisis
IFC is committed to help emerging and frontier countries face the
challenges of a global financial crisis of unprecedented proportions
IFC’S CORE COMPETENCY
IFC’S COMMITTED EQUITY PORTFOLIO
Based on fair value as of June 30, 2009
• IFC’s core business is equity
investments in the financial sector
• These investments are supported by
complementary business lines:
• Europe and Central Asia (“ECA”):
targeted lending facilities (SME and
Energy Efficiency), trade finance
support
• Joint IFI Action Plan: supporting
financial sector throughout ECA
• Advisory Services: complementary
work to improve risk and creating
opportunities (e.g. Energy Efficiency
lending)
1%
Financial Sector
16%
Agribusiness
PE/VC Funds
5%
FINANCAL
8%
45%
Manufacturing &
Services
Health & Education
SECTOR
Infrastructure
2%
IT
Oil, Gas & Mining
9%
Sub-National Finance
10%
4%
IFC has a global exposure to the banking sector
(more than 45% of IFC’s equity portfolio) and
aims to play an active part in stabilizing
vulnerable financial systems during this crisis
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Joint IFI Action Plan
IFC, World Bank, MIGA, EBRD, EIB: Joint Plan to Stabilize Banks in
CEE
Up to Euro 25 billion in joint commitments
•European bank losses yet to be recognized in excess of €250 bln (EU-12) plus anticipated
capital needs of EU banking groups in CEE/CIS of over €100 bln
•IMF/WB: Initial Financial Sector
Programs Agreed
•EBRD and EIB: Senior debt,
liquidity support
•IFC: Trade Lines/ liquidity
support
•IMF/WB: Financial Sector
Programs fine-tuned; monitored
•EBRD and EIB: Continued longterm debt
•MIGA: Guarantees for within-group
lending, capital markets
•IFC: Focus on Equity-based
packages, with trade.
•RAPID IMPLEMENTATION
• IMF/WB Support, Liquidity
Interventions & Trade
•IMF/WB: Financial Sector Programs
fully disbursed
•EIB: Continued long-term debt
FINANCAL
•MIGA: Guarantees for within-group
lending,SECTOR
capital markets
•EBRD and IFC: Equity and Debt
negotiations closed
•ALL: Distressed Asset Programs
• MODERATE IMPLEMENTATION
• LAST STAGE IMPLEMENTATION
• Financial Sector
Stabilization
• IFI Capital support;
Distressed assets
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Russia Macro Background:
A Dangerous Neighbourhood
• Crisis centred on Central and Eastern Europe
 Significant structural / current account ‘imbalances’
• Roughly: Russia / China export (dollar returns)
• CEE / Southern Europe consumes
• Mundell’s Impossible Trinity: impossible to have simultaneously i) an open
economy, ii) fixed exchange rates, and iii) independent monetary policy
 From China to the United Kingdom, few countries with free floats
• Arguably only: Ukraine, U.K., Poland, Czech, Hungary, non-Euro
Scandinavia, Turkey
 Many countries with limited fiscal capacity, no ‘counter-cyclical’ policy
feasible
• Russia a major exception
 Changes likely…
• Waiting for / hoping for “Immaculate Recovery”
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Russian Banking Sector: Crisis Situation
• Russian government capital / liquidity support to banking sector has been
massive – and successful

Real risk of banking sector “collapse” averted and avoided…
• However, banking sector / real economy problems not yet resolved



NPLs and distressed assets stabilizing at high level
Extent of problems in “restructured” loans not clear, but likely high
Credit deterioration will continue to put pressure on bank balance sheets, as writedowns
and loan loss provisions rise over the next few years
Bank Profitability
Loan Portfolio Deterioration
NPLs:Gross Loans
Provisions:NPLs
ROA
ROE
8.0%
180.0%
3.5%
30.0%
7.0%
160.0%
3.0%
140.0%
25.0%
6.0%
120.0%
5.0%
4.0%
3.0%
2.5%
100.0%
2.0%
80.0%
1.5%
60.0%
20.0%
15.0%
10.0%
1.0%
2.0%
40.0%
1.0%
20.0%
0.5%
5.0%
0.0%
0.0%
0.0%
0.0%
2003
2004
2005
2006
Source: October 2009 IMF Global Financial Stability Report
2007
2008
2009
2003
2004
2005
2006
2007
2008
2009
Source: October 2009 IMF Global Financial Stability Report
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Russian Banking Sector: Issues
• “Paradox of thrift” – real economy and bank solvency will not improve
until growth resumes – which will require substantial additional capital –
because of this many sectors are underserved
• Regional banks: significant deposit-takers and intermediaries on local
markets, many with minimum efficient scale

Experience of “local” deposit runs
• Concentration of risks/assets in state-owned banks (incl bailed-out banks)
2,357,336
(9.0%)
Total Assets, Top 100 by Type of Ownership
Total Assets, Top 500 Banks
3,623,554
(13.9%)
6,475,163
(24.8%)
Sberbank
Top 5 Govt
2,357,336
(9.0%)
6,805,830
(26.0%)
3,067,635
(11.7%)
6,892,211
(26.4%)
Top 30
Top 100
15,038,349
(57.5%)
5,690,774
(21.8%)
Top 500
By type, of total Assets
Govt
Private
Foreign
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Bottom 400
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IFC Financial Markets: Crisis Response
• NPL / Distressed Assets
 No doubt that distressed assets / NPLs will continue to grow
• Peaking in 2010?
• “Peak” NPLs: a measure of nominal risk, not losses
– “Average temperature at the hospital” not a good indicator
• True NPLs: uncertain repayment profiles (“restructuring”)
– “Extend and pretend”
 “Bad bank” solution
• Recognise, resolve, rehabilitate >>> ‘good banks’ the goal
• How likely without government/regulatory leadership?
• IFC Approach
 Approach will differ by country
 No single ‘bad bank’, rather bad asset solutions
• NPL resolution most attractive when economy/lending start to grow
• BUT: this may be too late to maximise recoveries
 Investments in ‘bad debt infrastructure’ – asset management co.
 Investments in pools of assets / SPVs
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NPL Resolution: International Experience
• Two Primary Models for NPL Management: usually called “Swedish” and “Chinese” … plus
the “Zombie” solution

Goal is similar, difference is distributive: who takes the losses?
• “Swedish”: regulators require write-downs, investors contribute capital, bad assets spun off
into “bad banks”



Ultimate goal is good banks – ‘bad banks’ are run down quickly
Government may be ‘capital of last resort’ – if investors unwilling/unable
May require losses/write downs for lenders
• “Chinese” Solution



Government purchases bad assets at nominal, ‘bad bank’ assets sold at market price
Government is effectively re-capitalizing … may only work where banks are state-owned
N.B.: ‘Chinese’ not an accurate name – governments have been bailing out banks for
centuries
• Key Distinction: System-wide … or Bank-by-Bank?

May be driven by structure of banking sector, depth of crisis, extent of government
involvement
• “Zombie” Banks (The Japanese approach)?


Wait for banks to recover through earnings, no required write-down of assets
Problem: no incentive to become ‘good bank’, no/delayed economic recovery
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NPL Resolution: Comparisons to Russia
• In first phase of crisis, government response similar to those in other
countries with strong fiscal position:





Urgent and massive effort to avoid collapse of banking system
Massive liquidity support, government bail-outs / sanatsiya of failing banks
Government capital injections into ‘systemic’ banks
World-wide, government subsidies to banking sector not transparent
• “Hidden recapitalization”
Centralized ‘bad asset’ solution unlikely
• Second phase:





Extent of ‘second wave’ problems unclear
• Historically, NPL peak is a trailing indicator 12-18 months after peak of crisis
External factors (commodity prices) – to date – positive effect on economy
Government now focussing on lending to “real sector”
Availability of / priority for Bank Capitalization programs currently lower
• Capital needs still enormous, sources of capital undefined
Underlying belief / hope for “immaculate recovery” (непорочное экономическое
восстановление)
• Danger: NPLs decline in value over time
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•Equity is a residual of:
•“Bad Bank” – Transforming a Zombie Bank into a Good Bank
•Assets – Liabilities
•Problem is uncertainty of valuation of ‘bad’ assets
•May mean that existing bank is insolvent, or undercapitalized, or just subject
to market risk
•“Good” Assets
•If assets are of uncertain
value, “equity” – and hence
capital adequacy - are
unknown
•“Good” Assets
•Debt
Liabilities
•Debt Liabilities
•“Bad” or “Toxic”
Assets
Equity?)
•(
•“Bad” or
“Toxic” Assets
•Because of the potential shortfall, lack of market trust, resulting in:
•Either loss of funding (requiring disposal of assets) or simply much higher cost of
funding
•Equity?
•Regulatory sanctions may be applied if not fixed
•Bank needs to be cleaned of its toxic assets
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•Investors may purchase or require (in
addition to bad assets):
•“Bad” or
“Toxic” Assets
•Some good asssets
•New Cash
•Equity
•Warrants
•Some other debt
•Other deal elements can resolve
pricing differences
•Investors purchase ‘bad’
assets for cash, creating:
•Actual sale price will determine
need for new equity (if any)
•New equity can be raised
separately, contributed by
existing owners, or ‘granted’ to
investors in BB (for paying ‘over’
value of bad assets
•Good bank should have reduced
cost of funding
•Recovery over certain levels,
other arrangements possible
•“Good” bank
•But: will lower sale price of
assets
•Various hybrid combinations
possible, incl convertible debt,
warrants, etc
•New Cash
•“Good” Assets
•Debt Liabilities
•Debt Liabilities
•“Bad” bank (AMC)
•New debt?
•“Bad” or “Toxic” Assets
•“Good” Assets
•“Bad” or “Toxic” Assets
•Equity?
•Old Equity
•New Equity
•Equity
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Outright Sale
•Loans
•Bank
•Portfolio
•Sub-agreement (?)
•fees
•Fees
•Servicing
•Servicer
•AMC
•Agreement
•Funding
•Investors
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Lessons in Portfolio Selection
• There needs to be a selection process of NPLs to compose a
portfolio for disposal to make it attractive and valuable for the
buyer: try matching the buyer’s needs and preferences.
• This portfolio of loans needs to have to the extent possible:
 Diversification: e.g. industry, geography, type of borrower
(corporate/SME/retail/mortgages), type of collateral, foreign/local
currency denomination, etc.
 Granularity: not too very large nor too very small exposures
 Vintages: not too “old” loans
 Security: loans with some good collateral (some buyers prefer real estate)
• May need to group some more attractive assets (e.g. subperforming loans) with NPLs in order to dispose them all.
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What is the Buyer Looking for?
• Receive a satisfactory return on the assets (NPLs)---a function
of the price paid.
• Good servicing platform in place.
• Good data and historical performance on collections and
liquidation.
• Diversified portfolio of loans---sectors, geography, granularity,
types of collateral, currency denomination, types of assets.
• Buyer looks for asset risk and to avoid other risks---past
portfolio risk, reps & warranties, seller’s risk.
• If the NPL portfolio produces some cash flow then it is easier to
finance.
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Key Impediments for Transferring “Bad” Loans
• Inadequate data and information in loan files
• Banks want to transfer only “very bad” loans
• Inadequate provisions---low NPL coverage ratio
• Weak or mis-valued collateral
• High expectations about loan recovery
• High price expectations
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4. IFC’s Value Addition
• IFC’s Value Addition
• IFC’s Global Reach
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IFC’s Value Addition
• Seasoned investment team

Investment expertise and proven track record in equity investing in financial markets in
IFC client countries, including sourcing, negotiating, structuring, monitoring, and exiting
investments
• IFC’s track record (since inception)


All industries: over 1,800 equity investments
• Aggregate realized and unrealized real gross US dollar IRR of 23.1% and real value
to real cost ratio of 1.73 times
Financial services industry: over 490 equity investments
• Aggregate realized and unrealized real gross US dollar IRR of 27.9% and real value
to real cost ratio of 1.97 times
• IFC’s global expertise in the financial sector & local presence:




100 field offices in 81 countries
Hands-on approach
Ability and capacity to “applying global standards locally”
Strategic guidance to portfolio banks include, for example:
• Stabilizing operations
• Improving risk management and NPL resolution
• Re-initiating growth through MSME lending
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IFC Advisory Services: Global Knowledge Sharing
• IFC Advisory Services: Best in Class reputation in region
• IFC track record in Advisory in Russia/ECA:
• Russia Leasing Development, Primary Mortgage Market Development, Energy
Efficiency Finance, Banking Corporate Governance and Risk Advisory, Crisis Response
• Benefits to IFC client base … and throughout sector
• IFC AS model: direct engagements with broad client base
• Sharing knowledge throughout sector
• Russian banks want to be leaders by global standards
• Advisory Services supports global ambitions on local and regional markets
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IFC’s Global Reach
100+ country and regional offices worldwide
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IFC’s Local Knowledge
IFC’s global reach is complemented by its deep local knowledge.
•Active relationships with more than two dozen
banks and financial institutions
•10 GTFP issuing banks - 2.5X growth in
trade finance in FY2009, 2X FYTD (annualized)
•Milestone transactions
•First mortgage securitization
•Ruble bond issues (partial guarantees)
•Close to $1 billion in ruble financing
IFC Committed Balance - Russian Federation
Millions
•As of September 30, 2009 Russia represented
IFC’s second largest country exposure with a
committed balance of US$2,281 million.
3,000
2,718
2,500
2,238
1,938
2,000
1,432
1,500
1,179
1,000
500
2,244 2,281
762
357
233 279 231
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
•$500 mln syndication in 2008
• Over $1.8 billion in investments in FM
sector to date
•Investments in over six regional banks
• Current committed portfolio $876 million
• Financial sector approximately 40% of IFC
commitments outstanding
• Successful equity investments/exits:
Absolut Bank, Russian Standard Bank
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