Presentation on theme: "Value Maximization of Non-Performing Loans"— Presentation transcript:
1Value Maximization of Non-Performing Loans (NPL) and Distressed Assets – Pakistan’sExperience (October 1999 – October 2003)Salman Ali Shaikh
2The composition and the inherent characteristics vary significantly between countries.Key variations include which economic segments (e.g., manufacturing,real estate, etc.) are most impacted, geographic concentrations, theregulatory environment, labour and employment sensitivities, etc.The measurement of success (in terms of value maximization) can onlybe done after the above factors have been carefully studied.The traditional yardstick of quantifying how many cents to each $ havebeen recovered is much too narrow, if your canvas is the whole countryand its socio-economic framework.A national NPL reduction strategy entails being able to answer 3 verybasic questions: -Where are we??- Where do we want to be??- How do we get there??
3High NPL is certainly a problem for the economy and the financial sector, but it also has up-side potential.With creative handling, national planner’s can change the shape ofthe future (post-NPL) economy.Not all distressed assets are worth reviving. It is important to makea well-reasoned judgement (sector by sector) on the issue of “sicknessworthy of revival”.
4Where Are We?? – Pakistan’s NPL Profile At the time of independence (1947), the country did not have anindustrial base.It was an agrarian/commodity producing economy with a ruralpopulation of over 75%.The process of industrialization started in the late 1959’s, andwent through 3 distinct phases: -Import substitution phase (up to 1980):emphasis on infrastructure, fertilizers, petroleum/energy, etc.Export oriented phase ( ): growth of the textileindustry with a five-fold increase in spinning and weavingcapacity. Similar growth in down-stream industries – e.g.,knitwear, garments, home textiles and man made fibres.Consumer led phase (1995 onwards): major expansion inautomobiles, consumer durables cement, food processingand telecommunications.With a few exceptions, most of the industrial base is relatively modern.
5The main features of the NPL map are as follows: - Concentrated in the large-scale manufacturing sector. Key concentrationsin textiles, sugar, cement, food processing and the public sector. SMEsector not impacted owing to a culture of debt aversion.Concentrated in the public sector banks and financial institutions. Private(and foreign) banks not impacted. In the public sector banks, much of theNPL was avoidable, as the country has had relatively high economic growththroughout (except for a dip in the 1990’s). Major chunk of industry has alsoenjoyed protection against foreign competition.Culture of “zero equity” projects. Started in the 1980’s and 1990’s throughcollusive lending, poor corporate governance and a bureaucratic regulatorysystem. Kick-back’s (received overseas from machinery suppliers) oftenexceeded the paid-up capital of the company. High leverage became the norm.In the 1990’s many of these companies could not withstand even a minoreconomic downturn.
6Dilettante entrepreneurs Dilettante entrepreneurs. The 1980’s and 1990’s saw the emergence of newentrants from all walks of life into industry – e.g., agriculturists, bankers,bureaucrats, military seniors and even judges. Questionable ability tosuccessfully run an industrial project. These influential individuals(“the protected species”) constitute a major hurdle for meaningfulreform in the area of NPL.Chronic over-capacity/lack of competitive advantage. Caused by the “herd”(emulative) instinct and promoted by the kickback culture. Several largesegments impacted – e.g., cement and food processing. In the latter thereare 51 fruit juice companies and 41 dairy plants – I guess they did not knowabout branding as a marketing concept!!! In some industries (e.g., sugar -owing to low sucrose in the local sugarcane), there is perpetual sickness.Directed lending. Political patronage in the public sector. Senior managementhandpicked by politicians and military commanders – key qualification wasthe absence of professional competence. These “favours” were repaid inkind – i.e., by approving sub-standard project financing loans.
7Where Do We Want to Be?? And How Do We Get There?? Value Maximization: The Basic Imperatives and the CoreIngredientsThe configuration of the country’s NPL not only determines thechoice of tools, but also highlights desirable policy choices anddesired outcomes. In our case, an NPL reduction strategy(involving value maximization) should have the following features: -Fast-track implementation. Distressed assets (well over 75%) wereconcentrated in manufacturing companies (with modern equipment).Avoidance of closures was a key issue – once a plant closes down therecan be rapid degeneration, leading to a higher cost of rehabilitation. Banks(and bankers) who moved fast (in decision-making terms) were able to extractvalues ranging from P (Principal) + 25% to P + 50% in the late 1990’s.
8Avoidance of “cosmetic” tools Avoidance of “cosmetic” tools. Traditional methods of debt re-schedulingcause much harm. The company returns to NPL status every 3-4 years anda myth (that all NPL can be recovered) is perpetuated. There was an urgent needto devise a methodology for determining the “sustainable debt level” (throughforensic accounting) of projects. With write offs becoming an offence under themilitary’s accountability law, bankers played it safe and the use of “cosmetic”tools continued.Change of management as a value maximization tool. The poor quality ofsponsors/management was the main reason for the asset becoming distressedin the first place. Value maximization required a change of management.This can only be done if the larger players (i.e., banks and or AMC’s) have thecapability to keep the company running till the new management can beinducted.
9Creating a (national) scale of priorities Creating a (national) scale of priorities. Loan loss reserves were low andoften created by “cosmetic” tools (major re-capitalization of public sectorbanks). In this scenario, prioritising industrial segments should be a keypriority. Priority segments (e.g., textiles), which have the capability tojump-start the national economy, should get a larger share in terms ofresource allocation (e.g., write offs based on sustainable debt calculations).Conversely, the early demise of segments that are perpetually sick (e.g.,sugar) should be encouraged through denial of resources.Clarity and consistency is required in terms of regulatory signals to themarket. Both banks and borrowers watch these carefully. Regulators shoulddevise and implement strategy and not waste time in seeking consensus-basedsolutions. In Pakistan, we have wasted the better part of a decade by doingthe latter.The need for capacity building. The NPL crisis highlighted the absence ofskills in several areas of expertise and specialization – e.g., professionalreceivers, auctioneers, administrators, forensic accountants, evaluatorsand asset tracing specialists.
10Value Maximization: Challenge and Response The period under review saw several challenges – e.g., growing NPL, loweconomic growth, and decline in fixed investment, increases in militaryexpenditures, etc.How well did the country’s planners and the regulatory system respond tothese challenges??In October 1999 the military seized power. The first law passed was theNational Accountability Ordinance leading to the creation of the NAB(National Accountability Bureau).Concept was that NPL is recoverable in full.Assumption was that if a company is making a loss then an amountequivalent in cash has to be somewhere (e.g., under a mattress) - i.e.,a genuine business loss is a fiction.A 30-day deadline (for defaulting borrowers) to settle with banks wasannounced.
11In November 1999, the first batch of industrialists were arrested and subjected to inhumane treatment.NPL did not go down – it went up. The economy went into a tailspin andfresh investment stopped.Bankers (potential NAB targets) stopped making decisions in “sensitive”areas (debt restructuring and write offs).And yet this (Sheriff of Nottingham) approach to NPL reduction throughcoercive means was allowed to continue for over a year.The country’s economy slowed down considerably causing fresh NPLflows to the existing stock. This can be clearly seen in the chart given below.$ 3.4 billion (December 31, 1998)$ 3.9 billion (December 31, 1999)$ 4.9 billion (December 31, 2000)$ 5.4 billion (December 31, 2001)$ 5.1 billion (December 31, 2002)$ 4.9 billion (June 30, 2003)
12NPL peaked in 2001 – at peak it was over 25% of total loans. To disguise this growth, the regulators started reporting “net NPL” and notthe total figure.Net NPL is Gross NPL minus provisions held and minus NPL transferredto CIRC.CIRC (Corporate and Industrial Restructuring Corporation) is a public sectorasset management company (AMC).Another data integrity problem is the existence of 2 separate regulatorsin the financial system.The State Bank of Pakistan (SBP) regulates the banking system andpublishes NPL data regularly.The Security and Exchange Commission (SECP) regulates the NBFI’s(non-bank financial institutions – e.g., leasing companies, investmentbanks, etc.). SECP does not publish NPL data.It is estimated that the correct NPL figure for the financial system as awhole is around $ 1 billion higher than the reported figures.
13What should you do when things are not happening according to plan?? When in doubt,execute a U-turn.By the autumn of 2002, realization dawned that all is not well on the NPL front.Through NAB the draconian approach had been tried and it failed.By creating CIRC (the AMC) in 2000, it was hoped that the stock of oldNPL would be drastically reduced. CIRC had not delivered meaningful results.The informal loan workout process (through a national committee)was also a failure.The SBP executed a sharp U-turn in the NPL reduction strategy – asomewhat desperate manoeuvre.A directive was issued to the banking system in October 2002 askingmake “aggressive” settlements with their defaulting borrowers at valueswell below actual debt outstanding and/or the decreed amount throughrecovery suits in the court.
14Instead of using a balanced yardstick of sustainable debt (going concern valuation), this directive sets the settlement amount at the fire sale value(FSV) of the distressed asset.Conceptually, this is a very major U-turn from a stated position (only 2-3years earlier) of NPL being inherently recoverable in full and that write offswere not required.Needless to say, borrowers are going berserk with delight.This approach has some positive features.Firstly, it is expected that NPL of over $ 1.5 billion will be settled.Second, large haircuts will improve the balance sheets of borrowers optingfor such settlements.
15These benefits are out-weighed by several negatives, which are as follows: -Heavy guzzler of provisions. A few years earlier, smart banks were settlingNPL at values approaching P (Principal) + 25% to P + 50%. Now, similarassets are being settled at P – 75% to P – 25%. This scheme could eat upnearly $ 1 billion of loan loss reserves. Some of the weaker banks mayrequire re-capitalization. Rather than maximize values (from distressedassets) this scheme minimizes values.The mechanics of determining FSV. Evaluators determine FSV. Gives themenormous power. There are several reported cases of major under-valuationto make the settlement extra sweet for all concerned – except the hapless bank.
16This scheme protects all existing managements This scheme protects all existing managements. It makes it almost impossibleto evict inefficient sponsors. Very unfortunate as many of these companieswill return to NPL status within 5-6 years.Promotes a continuation of the default culture. The SBP had a similar(incentive) scheme 6 years ago. These periodic “amnesty” schemes arecausing havoc – making borrowers who repay regularly feel like and looklike idiots. Overall, retards the development of corporate good governanceand the improvement in financial disclosure standards.
17Corporate and Industrial Restructuring Corporation (CIRC) Discussed at FAIR II last year. Hence, this is just an up-date.CIRC was created in 2000 as a public sector AMC with a “sunset clause”.It was designed to complete its business and be wound up by September 2006.Banks have referred 722 cases (of distressed companies) to CIRC with anNPL of $ 2.1 billion.387 cases (with an NPL of $ 1.0 billion) were returned to the banks.Of the balance $ 1.1 billion, CIRC has settled NPL of $ 0.2 billion (around 4%of country’s NPL).
18The World Bank’s recent report on CIRC recommended major changes in order to improve its performance.Lack of any action by the government suggests that they are treating CIRCas a lost cause and will let it fade away during the next 2 years.We have incorporated enabling provisions for private sector AMC’s in thenew corporate rehabilitation law (CRA).
19The Beginning of the End or the End of the Beginning??? It has been 6 six years since NPL hit the national radar as a key issue.While there has been progress in many areas of financial sector reform,the handling of maximizing value from NPL remains seriously flawed.The battle against increasing NPL is finally being won thanks to the WarOn Terror!!!Pakistan’s debts have been re-scheduled and most economic indicators arequite positive.
20This (plus the recent amnesty scheme) is helping to reduce both stock and flow of NPL.The CRA (once enacted) should improve the legal environment – it will helpto restore the balance between debtors and creditors rights and enhancepredictability in the legal process.However, there has been little or no progress on long-term institutionaland capacity building issues.Till than happens, no law (however, well conceived and drafted) can fulfilits “design” potential.
21Turning and turning in the widening gyre The falcon cannot hear the falconer;Things fall apart; the centre cannot hold;Mere anarchy is loosed upon the world,The blood-dimmed tide is loosed, and everywhereThe ceremony of innocence is drowned;The best lack all conviction, while the worstAre full of passionate intensity.William Butler Yeats ( )