News and announcements

05 oktober 2016

A new era may dawn for NPL management


Hungary follows the best international practices in reducing the volume of non-performing bank loans. This was revealed by the EBRD funded EY study presented by László Haás, director of the Restructuring and Debt Financing division of Ernst & Young Advisory Ltd.

The Central Bank of Hungary expects that by the end of 2017 the ratio of non-performing corporate loans (NPLs) of the banking sector may drop to the “peacetime” level, i.e. below 5% if MARK succeeds in cleaning up the project loan portfolios too. With this in mind, isn’t it too late to think about how to solve the problem?

The rate of corporate NPLs is still very high. The cleaning process shows good progress, but this is not a one-off phenomenon, and the issue is expected to remain topical even after the crisis is over. There will always be non-performing loans and companies with financial problems, and there is plenty of room for improving the management of these loans, even on the basis of the practical experience gathered in the past few years.

What are the problem points where the banks follow incorrect practices in handling their non-performing corporate loans?

If a company faces a presumably long-term financial problem, it has two options: it will either pull through and continue its operations as a viable company, or it will ultimately cease to exist. In the first option the classic tool is the bankruptcy proceeding, while in the latter it is the enforcement proceeding and liquidation. However, bankruptcy proceedings are expensive and painful, it is best to avoid them. On the other hand, out-of-court restructuring is a completely voluntary form of cooperation. Its success depends on what agreement the bank and the company in financial difficulty can reach. This solution is much faster and more flexible than the bankruptcy proceeding, and involves much fewer risks to the impairment of goodwill and business. However, these benefits can only be realised if the participants can predict the reactions of the other party. The biggest weakness of the current practice is the lack of predictability and trust essential for cooperation. For the time being 80% of non-performing corporate loans are linked to 10% of companies, i.e. this is a relatively concentrated issue.

Who should do what in the framework of this novel cooperation?

Out-of-court restructuring works efficiently if a company contacts its bank immediately upon experiencing financial hardship. This is what we call preliminary stage. Today a lot of customers fear that the bank would immediately want to collect its outstanding debts despite the company’s liquidity problems, decrease the credit limit and require further securities. For this reason a lot of companies do not, or hardly get to the point where they can start restructuring negotiations with their banks. It is at this stage when the bank must decide whether it will cooperate with the company or act against it in order to reduce losses to the minimum. As a former CEO and head of the loan committee of BNP Paribas I am well aware of the dilemma. The bank can properly benefit from out-of-court restructuring if it can predict the reactions of the other banks too. For example, it does not have to fear that while it is cooperating with the company, the other banks will enforce their claims right away. We propose a standard framework which can offset this lack of trust, make the reactions of the stakeholders predictable, and can ensure smooth cooperation. This in turn can considerably increase the number of viable companies in Hungary.

What concrete progressive ideas and proposals are formulated in the study? What does the process look like?

After getting to know the financial problems of a company a bank meeting can be convened right away to make an educated decision about the possible restructuring of the affected company. On the other hand, the debtor shall immediately start to explore the problem through the involvement of adequate financial and legal consultants, and shall work out a plan to rectify its financial standing. If the analyses of the first stage show that there is some chance for restructuring, a formal agreement (a so called standstill agreement) is signed, in which it is agreed that for a certain period of time and under certain terms and conditions the banks will not initiate the liquidation of the company, they will not require more securities, they will not enforce the existing collateral, and will not take liquid assets away either. At this stage many companies are in need of bridging loans, and an agreement must be reached about the terms and conditions pertaining to the extension of such loans. The next step is about the approval of the restructuring plan, which has to be prepared jointly, with the involvement of consultants to ensure adequate quality and content. This step is followed by implementation, which again needs to be carried out in accordance with Hungarian law, similarly to the preliminary phase.

Is there an international best practice that Hungary can take over as is, or do we need to hand-pick the best elements from here and there?

The issue goes back to the 1970s, to the so called London Approach, issued by the Bank of England as a brief guide. It was developed into a practice in Asia later on, in the wake of the Asian Crisis, and was then reimported to Europe during the credit crisis. The relationship between banks and companies in a dire financial state was standardised by developed frameworks across Western Europe, including the Vienna Initiative in Austria. Hungary should combine the best elements of these systems.

To what extent does your work cover the rules of bankruptcy, enforcement and liquidation proceedings? Do you provide legislators with recommendations in this respect?

Our latest study, funded by EBRD, specifically focuses on out-of-court proceedings. However, this study was preceded by a study prepared jointly by EBRD, EY and White and Case back in 2015, exactly about the entire insolvency framework, i.e. bankruptcy, enforcement and liquidation proceedings, and discussed the required changes to these proceedings. The new study only cites the former one; out-of-court restructuring is only one of the many options available for the banks. If bankruptcy or enforcement acts function well, they may serve as a serious alternative or supplement to out-of-court restructuring.

The Central Bank of Hungary has also dealt with this issue. To what extent do you cooperate with them? Is it expected to publish a recommendation on the handling of corporate loans similarly to the mortgage recommendation it issued in March?

Discussions are under way among regulators, the Hungarian Banking Association and other stakeholders about out-of-court options, since no matter what guidance is adopted, it must be based on consensus. Out-of-court proceedings are based on voluntary cooperation rather than legal regulations, and we aim to keep it like this. If a non-mandatory recommendation is issued by the Central Bank, it will certainly have a significant effect on the domestic practice.