For four years, it has been hunting season in Ukraine. The hunter is the National Bank of Ukraine. And the country’s failing, undercapitalized, and often corrupt banks are the big game.
Ukraine agreed to clean up its corrupt banking sector in 2014 as one of the conditions for International Monetary Fund loans. Since then, it has declared more than 90 banks insolvent and confiscated their assets.
The state Deposit Guarantee Fund, which received the assets, paid out Hr 90 billion ($3.4 billion) to the banks’ depositors, a direct loss of state funds. But rampant bank fraud and insider lending have cost Ukrainian taxpayers more than $20 billion in the past decade.
Now DGF is working to sell off the assets to recover money for the state. But a lack of due diligence is leading to a worrying result: some of the assets are being sold to parties related to the debtors.
And that may be acceptable to the fund.
“Our core task is to maximize the recovery for the sale of the asset,” says Svitlana Rekrut, a deputy managing director of Deposit Guarantee Fund. “We do not care that much who is the buyer.”
Going Dutch
Why should the state agency responsible for liquidating the assets of insolvent banks not care if problem borrowers are purchasing their own debt? For some, the answer lies at the intersection of bureaucratic purview and capacity, economic priorities and the market for so-called distressed assets.
(Others have called it corruption. Last month, one of DGF’s liquidators was arrested for taking a $5 million bribe, and the fund’s director, Kostyantyn Vorushylyn, has previously worked for companies belonging to President Petro Poroshenko. He denies any conflict of interest.)
Of DGF’s portfolio, 80 percent of the assets are loans and 10 percent are real estate. The rest include furniture and securities with little value.
Officially, the total assets are worth roughly Hr 500 billion ($19 billion). But their true, independently assessed value is closer to $100 billion ($3.8 billion). Ultimately, however, the market sets the real price.
Since 2017, DGF has used both Ukraine’s ProZorro public procurement system and over 50 online trading platforms to ensure transparency and fairness in the sales.
The assets are sold using a Dutch auction system. An item is initially offered for its full official price. Over the course of the auction, the price drops. At any point, a participant can stop the value from dropping. Then, the system launches a standard English auction, where subsequent bids raise the price.
By law, DGF must liquidate each bank within five years, and time is quickly running out for many of them.
Meanwhile, Dutch auctions only enjoy a success rate of 3.5 percent, according to Yuriy Fedoriv, who leads the financial restructuring practice at KPMG in Ukraine, which has worked with DGF to liquidate assets.
Assets that fail to find a buyer can be auctioned off in bulk. “The last step is that they can sell all bulk assets for Hr 1,” or roughly four U.S. cents, Fedoriv says.
Deposit Guarantee Fund Deputy Managing Director Svitlana Rekrut says the state agency’s top priority is recovering funds, even if that means selling bank assets to insiders. (Kostyantyn Chernichkin)
Ticket to war
In theory, any individual or company can take part in the auction, provided they aren’t the debtor or previous owner of the asset. In practice, however, business journalist Ivan Palchevskyi has found three concrete categories of auction participants that are common.
The first category consists of so-called “professional market participants” — financial and collector firms that invest in non-performing loans. The second consists of auction participants who simply view certain assets as good investments.
But the third is comprised of companies with ties to the borrowers themselves. In analyzing the top 15 largest purchases at auction, Palchevskyi found that three of the buyers were related parties.
DGF’s Rekrut openly admits that some buyers are likely related. But no one knows their exact number.
“Usually, we hear only rumors from the market about who bought that asset or why he bought it,” she says.
But Fedoriv suggests that most of the buyers are related parties. There are two reasons for this, he says.
First, DGF does not do its own vendor due diligence, but instead provides auction participants with access to documentation for the assets. The due diligence is left up to them.
Formally, there is an obligation in the ProZorro documentation that the owners of the debt are not eligible to apply. But responsibility for enforcement lies with the online trading platforms used for the auctions. Those platforms do investigate this, but only on a superficial level, Fedoriv says.
The second issue is the market. “There are not many active players who buy these debts,” Fedoriv said. “This is the problem.”
This issue is not lost on DGF. Rekrut stresses that the sale of liquidated bank assets is creating a new market for non-performing loans, an investment opportunity that previously barely existed in Ukraine.
At the same time, there are institutional obstacles to investing. By and large, the assets DGF received are not strong. It is not uncommon for the bank’s owners to have plundered the best assets before losing control of the bank. DGF can still include these assets on the bank’s balance sheet, but enforcing this decision is challenging.
For these reasons, she describes purchasing distressed assets as “buying a ticket to war.” The new owner must somehow force the borrower to pay the loan or go to court and foreclose on the collateral, which often is not particularly valuable. This is a long and arduous process in the Ukrainian legal framework.
As a result, related parties usually are the ones willing to pay a higher price for distressed assets.
“Why? Because if somebody else wants to buy the asset, [they] should include the price of the possible war with the borrower,” Rekrut told the Kyiv Post. By contrast, a related party does not incur that cost.
This makes related parties potentially attractive to DGF.
DGF borrowed the Hr 90 billion it paid to depositors from the Finance Ministry and the central bank. It is paying up to 12 percent interest annually — the market rate — and must repay the loans by 2032. So far it has returned Hr 22 billion ($834 million) to the bank and Hr 4.4 billion ($166.8 million) as interest to the Finance Ministry.
Transparent but uncompetitive?
Few believe that DGF’s approach is perfect. Fedoriv stresses that, despite the liquidation drive’s flaws, Prozorro makes the auctions transparent and fair. And Rekrut emphasizes that legal restrictions limit DGF’s options. Unlike a private entity, it cannot restructure loans in order to get repayment.
But Alexander Pochkun, managing partner at Baker Tilly Ukraine, sees a problem in how DGF liquidates banks.
He has no inherent objection to borrowers buying their own debt, comparing that to loan restructuring. It is simply a way to get as much return as possible from the non-performing loan, he says.
Rather, Pochkun worries that the auctions, though technically open and fair, are, in fact, not competitive. While DGF provides documentation for the asset, this is not enough. A potential buyer cannot know, for example, whether there are 10 ongoing court cases over the object in question, he says.
“Often you get this situation where the potential buyer…doesn’t want any connection to the asset because he cannot know all the risks,” Pochkun told the Kyiv Post. “So only the [previous] owner can lay claim to it.”
He suggests more vender due diligence must be carried out on the assets. This is not simply a matter of competitiveness, but also about recovering money.
“If we want to sell it expensive, we need to invest in the cost of that object,” Pochkun says. “We need to create conditions in which others will consider buying it.”
No cooperation
But DGF is busy fighting other battles. Rekrut stresses that a lack of cooperation between state bodies hinders its effort to recover money.
The fund has submitted over 4,000 claims against unreliable borrowers, but only 10 to 15 are currently in court. The vast majority die in the Prosecutor General’s office.
In some cases, the borrower has a working business and should be capable of making payments, suggesting that not repaying is a strategic move, Rekrut says. DGF cannot force the borrower’s hand without the help of other state agencies.
As a result, it recovers what it can. And selling to related parties is better than nothing.
This may have “some moral hazard,” says Rekrut, but “at the end of bank liquidation, all the losses will be claimed by the [bank’s] shareholders.”
