How to deal with NPLs.
A Global Approach to Recovery / Workouts.
Esteban Buljevich
International Finance Corporation
Pastoriza Eviner Cangueiro Ruiz Buljevich
Abogados
I. How to deal with
Non-Performing Loans
II. A Global Approach to
Recovery / Work-outs
How to deal with
Non-Performing Loans
(NPLs)
Non-Performing Loans
Substandard, doubtful and loss loans represent
the so-called NPLs.
standard loans
full payment is expected
watch loans
substandard loans
concern as to payment
chances
payment is in doubt
doubtful loans
payment is improbable
loss loans
payment virtually
uncollectible
Non-Performing Loans
When has a loan gone bad?
Majority consent on the following conditions:
• principal or interest has been due and unpaid for 90 days or more;
and
• interest payments equal to 90 day interest or more have been
capitalized, refinanced or rolled over.
The Basel Committee on Banking Supervision has set a
standard definition for “past due loans” specifying that more
than 90 days have passed since the last payment
Causes of NPLs
• Credit relaxation and insufficient regulation.
• Holders of trouble or bad loans spread the NPL’s risk by making bad-loan
provisions or taking out credit insurance.
• Sudden economic changes that lead to loss of confidence and ultimately a
financial crisis.
• Rising interests rates.
• Borrower friendly regulations and overoptimistic
creditworthiness during booming economies.
assessment
of
Both endogenous (such as the parties and their circumstances)
and exogenous (such as economic, social, political, legal and
fiscal circumstances) causes affect the ability of a borrower to
comply with its obligations.
Why do financial institutions have to deal with
NPLs?
• NPLs tend to generate economic, financial and fiscal costs to
financial institutions, especially when left unresolved.
• NPLs are inefficient, costly and risky.
• NPLs deteriorate the financial institutions’ financial statements,
which may lead to institutions’ failures.
• Provisions or write offs must be made in the financial instutions’
balance sheets to cover for potential losses, affecting its profitability.
Why do financial institutions have to deal with
NPLs?
• NPLs not only affect the solvency and liquidity of the holder but also
the whole market’s.
• Large, unresolved NPL portfolios result in catastrophic micro and
macroeconomic effects.
• Costly recovery and enforcement procedures.
A financial system contaminated with NPLs is a
system where consumers and inverstors are
suspicious and lacking in confidence.
Credit Risk Management
In any financial institution, the NPLs problem is closely
related to the issue of credit risk management.
Upstream
Risk
Relates to
Capital. Expected
losses must be
covered
Downstream Risk
Relates to the mitigation of
capital loss. Requires
effective regulatory
framework in order to
implement successful
procedures for dealing with
distressed assets.
Smart Solutions for NPL Resolution
NPL resolution starts here
•
NPL containment oriented credit approval policies.
• Sharp Monitoring systems
• Keen decision making skills amongst their working
groups and qualified personnel in specialized tasks .
• Provisioning
• Well thought NPL resolution strategy
Obstacles to Efficient NPL Management in
Developing Countries’ Banks and
Financial Institutions
• Cultural issues negatively affecting management and working
habits
• Lack of problem solving skills
• Weak IT systems affecting monitoring and data collection
processes
• Lack of information and experience on efficient resolution
methods
NPLs Resolution Methods
Two approaches to NPLs Resolution:
Portfolio
Asset by Asset
True Sale
Workouts
Synthetic
Transactions
True Sale
Foreclosure / Winding – Up Processes
Securitization
NPLs Resolution Methods
Portfolio Approach – True Sale and Synthetic Transactions
• Nowadays, the most common instruments for NPL
resolution are true sales, synthetic transactions and joint
ventures.
• The decision to opt for either a true sale or a synthetic
transaction depends on, among other things, whether the
bank’s prefers the NPL portfolio to remain on its balance
sheet or not.
NPLs Resolution Methods
Portfolio Approach – True Sale
• True Sale erases NPL portfolio from the financial
institution’s balance sheet since the whole loan is
transferred to the purchaser, unlike the synthetic
transactions by which only the credit riskm is transferred.
•The servicing of the loan may be assumed by the
purchaser, by the financial institution, or by another
company.
•The difference between the purchase price and the
ultimate recovery price constitutes the purchaser’s profit.
NPLs Resolution Methods
Portfolio Approach – Synthetic Transactions
• Only
the credit risks are transferred while the loans
remain on the bank’s or financial institution’s balance
sheet.
• There are no asset transfer issues (i.e. loan transfer
consents) nor their associated costs.
• Risk
involved in derivative transactions is greater than the
risk of a true sale transaction.
• Regulatory issues to consider
NPLs Resolution Methods
Portfolio Approach – Securitization of NPLs
• One of the newest methods of dealing with pools of
NPLs is through securitization, either by way of a true
sale or a synthetic transaction.
• Requires the development of a secondary market for
distressed loan portfolios.
• Provides immediate liquidity to the originator who sells
the NPLs or transfers their credit risk.
• Positive impact on the economy as a whole.
NPLs Resolution Methods
Portfolio Approach – Securitization of NPLs
• Better ratings for the originator through the mitigation
and transfer of risks.
• accelerates NPL resolution process.
• Reduces the originators’ operational costs.
• Provides for a wide range of investment opportunities
through “tranching” and a greater number of investors.
NPLs Resolution Methods
Portfolio Approach – Securitization of NPLs
On the downside:
• Returns may not be enough to cover the standard costs
of securitization and problems relating to information may
rise.
• Lack of adequate legal framework may be an obstacle.
• Credit risk attached to dealing with NPLs.
• Secondary market is not fully developed yet.
Some Examples of NPL
Securitizations
• Korea Asset Management Corportion - KAMCO.
• Huarong Transaction in 2003.
• International and Commercial Bank of China
Transaction in 2004.
• Bluebonnet Finance Transaction.
Structure of a common NPL
Securitization Deal
True Sale of
NPLs by the
originator
Servicer in charge of
collecting receivables
SPV or Issuer buys or
receives in trust the NPLs
(along with a collateral
and/or enforcement rights)
from originator and issues
the securities
Transfer of NPL
credit risk through
Synthetic
Transactions
Investors acquire securities issued by the SPV or
Issuer
NPL Resolution
Joint ventures and other resolution structures
• Strategic Alliances, Joint Ventures, Partnerships and
Outsourced Management Programs.
•Most common specialized structure is the joint venture.
Common Joint Venture Structure
Investors (loan financing or equity investment)
SPV (i.e Asset Management Company)
SPV + Company A
Joint Venture
Company A to
acquire NPLs or
interests in them
from originator
Originator
(holder of NPLs)
SPV + Company B
Joint Venture to
create a servicing
company to manage
and resolve NPLs
bought by the Joint
Venture Company A
Advantages of Joint Venture Structures
• Tailor
made solutions for NPL resolution.
• Specialized knowledge and know-how on NPL
management and/or recovery and/or winding up
processes.
• Transparency and reputation of the entities involved
provide for markets’ trust.
• Local and International institutional support.
What Lies Ahead
• The number of NPLs is likely to increase due to
credit deterioration, thus creating new opportunities for
investors.
• Structures finance is currently viewed as a risky
matter, raising concern and mistrust.
• Nevertheless, an exponential increase in NPLs may
generate profitable business opportunities in both
short and medium terms.
A Global Approach to
Recovery / Work-outs
Financial Distress and
Recovery
Level of Distress
Low/ Moderate
Refinancing (Out-of-Court)
High
Refinancing/Restructuring (Out-of- Court or Prepack)
Very High
Judicial Restructuring/Settlement/Long-term Standstill
Maximum
Judicial or Voluntary Liquidation or Settlement
The Traditional Approach
Borrower´s Viability and
Collateral Analysis Matrix
Viability as a Going- Concern
vs.
Collateral / Liquidation
Analysis
The Traditional Approach
Traditional Matrix
+
Long-Term Work-out
(+V / -C)
False Alarm / Refinancing /
Restructuring
(+V / +C)
Delayed Liquidation
(-V / -C)
Liquidation
(-V / +C)
-
+
Adequacy of Collateral
+V : Positive Viability
-V : Negative Viability
+C : Positive Collateral Coverage -C : Negative Collateral Coverage
The New Global Approach
New Restated Matrix
Character and
Good/Bad
Faith
+
Negotiate a
Long-Term Work-out or an
Orderly Liquidation—Long
Standstill may occur
(Good Faith Character)
Negotiate a Refinancing or
Restructuring
(Fair Burden Sharing
Issues???)
(Good Faith Character)
Litigate (Threaten) to Settle for
Cash or Liquidation—Long
Standstill is not an option
(Bad Faith Character)
Litigate (Threaten) to Force a
Bloody Restructuring (Fair
Burden Sharing), a Cash
Settlement or a Collateral
Liquidation
(Bad Faith Character)
+
Adequacy of Collateral and
Viability
The New Global Approach
(cont.)
Negotiate to Restructure ...
assumes good faith character and goodwill in the negotiation
process
generally, the interest and expectations of the distressed debtor
and creditors are mostly aligned: solve the problem as fast as
reasonably possible in a sustainable, equitable way
assumes a viable, sustainable concern
may or may not present fair burden sharing issues
A rescheduling or restructuring is the likely outcome
a friendly, voluntary liquidation may be an option if there is no
viable going concern
“...assumes both the ability and willigness to pay by
distressed debtor...”
The New Global Approach (cont.)
Litigate to Settle ...
assumes bad faith, gross-negligence, fraud, the lack of
willingness to pay or engage or the like
assumes that a sufficient standstill period has brought no
solution to the distress
assumes that creditor has grounds to pursue litigation or
foreclosure of collateral
benchmark: reasonable grounds to litigate or more than
reasonable grounds to litigate
“...assumes lack of willigness to pay or engage...take
creditors for a ride”
The New Global Approach (cont.)
Litigate to Settle ...
does not require the actual filing of litigation or
foreclosure—a meaningful threat of filing of well prepared
litigation or foreclosure papers is oftentimes enough
main objective is to reverse the logic and show a
recalcitrant borrower or sponsor that creditor can indeed
litigate or foreclose
a cash settlement (either with the sponsor or out of a
judgment or foreclosure) or a involuntary bankruptcy or
liquidation is the likely outcome
The New Global Approach
A Short Summary
Afford a “performing client” in financial trouble a sufficient standstill period
to wait-and-see and undertake a good faith work-out: negotiate to
restructure approach
If more than two years after the inception of the financial distress have
passed, most good faith clients should have restructured or be about to
restructure their debts
After two years of financial trouble, non-performing clients generally do
not improve—on the contrary, they became dead horse clients: litigate to
settle approach
“...when a client gets used not to paying for a
long while, it is tough to find a restructuring
solution”
The Global Recovery Process—
Process—Stages
Timeline of Events
1
2
3
4
5
6
7
8
9
10
11
12 13
Restructuring
egotiation
Dealing with Creditors
Post-Closing
Formulation
of
Attacks
Matters
Soliciting
BP / Business
Dealing with Initial
Acceptance of
Valuation
Reactions
Restructuring
Plan
Stand-Still Period
Operations
Consultation with creditors
during
Financial Distress
Restructuring
Selection of Professionals
Period
Creation of
Closing
Steering
Committe
Global Recovery Solutions
“...creditors should be ready to use multiple creative
solutions for overcoming a financial distress...”
1. Debt- for- debt rescheduling
2. Debt- for- equity restructuring; Recapitalization
3. Debt-for-quasi equity instruments
4. Explicit haircuts
5. Payments in kind and synthetic instruments
6. Down payments at par or with a discount/tenders
7. Granting of new collateral
Global Recovery Solutions
8. Sale of Assets
9. Interest Rate Relief
10. Spin-off and divestitures
11. Operating Restructuring and Rationalization
12. Leverage New Money Facilities
13. Corporate Governance
14. Settlement or Contributions from Sponsors
Key WorkWork-out Principles
o Pari-Passu Treatment
- Secured vs. unsecured lenders
- Short-term vs. Long-term lenders
- Trade lenders and multilaterals vs. other creditors
- Self-liquidating lenders
- Shareholders’ loans
o Fair Burden Sharing (According to ranking and seniority, including shareholders)—
Approach to Shareholders’ fair sharing of the burden
– fair burden sharing and political events
– fair burden sharing and systemic crisis
– cash contribution
– equity dilution
– sponsor support
“...Principles and pragmatism are equally important for
creditors when pursuing distressed work-outs...”
Key WorkWork-out Principles
o Recovery Expectations according to Status or Seniority (Benchmarking for
any out-of-court restructuring)
o No Fraudulent Transfers or Discriminatory Preferences or Treatment
(Transparency is key)
o Pro-Rata Distribution of Payments (Equal access to available cash—the
bottom line of any restructuring)
- Rules for distribution of cash during standstill period
- Common interest rate vs. Contractual rates
- Cash tenders
“...Key work-out principles should be applied on a caseby-case basis—flexibility is key for a successful workout strategy...”
Key WorkWork-out Philosophies
The New Global Approach towards work-outs ...
o Always take a rigorous and aggressive approach towards any
work-out
- within the boundaries of creditors´ legal rights,
- taking into account creditor’s role as a good corporate
citizen,
- with a view to protecting a going-concern and maximizing
recovery,
- without hesitating to pursue legal remedies or foreclosure, if
need be, and
- always avoiding lender´ liability or institutional or reputation
risk issues, including with the government
Key WorkWork-out Philosophies
The New Global Approach towards work-outs ...
• Never
take a passive or indifferent role in a distress and
always strive to support clients and relationships unless fraud
or bad faith were present
• If possible, do not sell exposures and actively pursued
reschedulings and restructurings in a RUSH regardless of
provisions or write-off/down positions—TIME WORKS IN
YOUR FAVOR
• Always take a long-term view on recovery
Restructuring Mottos
o Break the mold (no more business as usual)—change the tone of the
relationship (but in moderate, discrete increments)
o Assess the character and business ethics of your borrower before determining
how to deal with a problem loan
o If good faith is present, support your client but never forget that your main
mission is recovery
o Never compromise with fraud, bad faith or gross negligence—if it has happened
once, it might and will happen again...litigation or foreclosure of collateral (or
threaten thereof) may the only viable option
“...non-performing clients should forget about VIP
treatment...”
Restructuring Mottos
o Always lead, never follow
o Be aggressive and determined—always take quick and decisive
actions
o Never show an indication of weakness, concern or anxiety
o Reinforce the authority of the team
“...Look like a bureaucrat, behave like a
banker—let them underestimate you...”
Restructuring Mottos
o Never threaten if you are not ready and capable of enforcing the threat;
credibility is key
o Always behave in a professional, serious, moderate and responsible manner
o Be firm and consistent but always avoid a vindictive behavior, an arrogant
conduct, extortion pressures or other unacceptable conducts
o Always focus on factual issues and not on people; disregard human-factor
issues and base your decisions on facts
“Don’t love them, don’t hate them, just focus on
recovery...”
Restructuring Mottos
o Be reasonable in determining what you will require a borrower to do—don’t ask
your borrower to deliver something beyond its capabilities
o Always seek real consideration; not mere promises
o Base your recovery expectations and strategy on an assessment of your status,
ranking, remedies and available recovery options
o If there is good faith, strive to pursue a going concern solution
o Once a recovery strategy is developed, follow it on a consistent basis but
consider your fall-back position (plan B)
“...Reverse the logic, you need to be a problem and
nuisance for your borrower; it should not work the other
way around...”
Restructuring Mottos
o Always seek sustainable debt reduction and recapitalization
o Always encourage a distressed borrower to distribute available, excess cash to
creditors
o When possible, seek capital infusion or credit enhancements from sponsors, other
constituents or cash from sale of non-essential assets
o Never grant a waiver without improving your position, if possible (and as long as
you don't violate pari-passu principles)
o Never permit collateral deterioration and always seek further collateral (again,
respecting pari-passu principles)
“...Cash, Collateral and Character are the three Cs of
restructurings...”
Restructuring Mottos
o Recovery means pursuing all available options—always pursue all obligors
simultaneously, including guarantors
o Use your loss provisions and write-offs as your best friends / you have nothing or
little to lose—they can lose their company
o REVERSE THE LOGIC: distressed debtors need to feel that they have a big
problem, not you—once again, look like an orthodox bureaucrat
o Never settle for less than what you would eventually obtain in a liquidation or
foreclosure of collateral
“Success in any recovery effort requires a
creative, patient, persistent, firm and sophisticated
attitude...”