African lenders need new, innovative solutions to the menace of bad loans

Wednesday August 16 2017

Customers are served at a bank. PHOTO | FILE

Customers are served at a bank. PHOTO | FILE 

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The success of any lender is in the ability to source affordable finance, lend and satisfactorily collect with minimal defaults. Failure to compete that cycle means the lender will be left with a stockpile of non-performing loans. This is arguably the biggest headache to any financial institution.

Kenya’s national carrier owes commercial banks about $219 million. They will be offered a stake to replace Dutch airline KLM that has ceded its shareholding. The 11 banks are expected to offer $174 million in new credit to Kenya Airways to reverse its loss-making streak and dwindling fortunes.

A special general meeting on August 7 approved what some pundits may find an unconventional strategy in solving the problem of bad loans. Through a special purpose vehicle, the banks will jointly own 35.7 per cent of the company.

The KQ bailout plan follows another government-led intervention to avert a possible collapse of retailer Nakumatt Holdings. A meeting of a group of lenders owed by the distressed supermarket chain was recently convened by the Ministry of Trade to encourage them to work out an alternative, less painful strategy to recover their debts.

Of interest here is the extent to which stakeholders, banks and companies are going to deal with the headache of non-performing loans, whose burden has become complex and requires multifarious strategies and solutions.

Straitjacket route

The straitjacket foreclosure route may not be the best modern day solution.

Let’s face it, lenders grant loans hoping that, all things constant, the borrower will repay as per the loan agreement. But there are many factors that come into play between the time the loan is granted and when it is repaid.

Financial institutions usually carry out an in-depth credit analysis and due diligence on all potential borrowers. But no credit risk model in the world is able to project how a loan will perform in the future.

External factors, such as changes in the macroeconomic environment, for example interest rates, inflation and currency exchange rates, are hard to predict and can have a catastrophic impact on projects and businesses, which in turn impact the capacity and ability to service loans.

According to the Central Bank of Kenya, the ratio of gross non-performing loans to gross loans was 9.7 per cent in March 2017. These have substantially increased since October 2015, partly due to the placement of three banks under receivership and CBK’s aggressive clean-up and stringent regulatory oversight.

A report on the status of NPLs in the European Union released in March paints a similar picture. According to the report, the financial crisis of 2008 and the subsequent economic shocks left some European countries with high levels of NPLs. But, due to the stringent recovery efforts, the gross carrying amount of NPLs in the banking sector at the end of 2016 amounted to €990.4 billion ($1.2 trillion), or 6.7 per cent of the bloc’s GDP.

Exit routes

The reasons for NPLs are borrower-related, lender-related and country-specific. For example, lax credit risk analysis and high-risk appetite by lenders could result in nonperforming assets. Other factors include weak monitoring systems, regulatory environment, legal and judicial frameworks.

In Africa, the lack of well-developed secondary markets for nonperforming loans makes it hard for financial institutions to offload these distressed assets. In developed markets, it is easier to package NPLs into special purpose vehicles and sell them in a secondary market. Without such an exit routes, lenders find it hard to remove bad loans from their books.

As long as the management and the shareholders are convinced and have set aside sufficient capital buffers, sale of assets in the distressed debt markets may be the only panacea in some cases.

The only the undoing of this strategy is that the assets would have to be sold at a good discount to be appetising to the potential investors.

The bottom-line: With the challenging distressed assets market, lenders must devise innovative strategies to deal with NPLs. Agile lenders will have to be a step ahead. That is the reason alternative initiatives for restructuring debt, such as debt for equity or asset swaps may be considered.

But this must never be misconstrued to imply that such swaps are an end unto themselves. They are largely short-term measures that must be backed up with solid rudiments and clear exit strategies.

A lender could consider such an arrangement as an out-of-court or voluntary foreclosure process, but ensure there is a concise exit plan. If an asset is swapped for debt, the lender must set a clear plan on how to sell off the asset within shortest time.

Equity swaps need thorough due diligence. It should be clear how the lender would influence decisions in such outfits and how to exit after the turnaround period. Would it be through an initial public offering, for instance?

China has done tremendous work in setting up structures for debt-for-equity swaps. Its central bank has prepared regulations for commercial banks while swapping bad loans for equity in such firms.

There is a need to raise awareness on the financial stability implications of poor credit restructuring, insolvency and debt recovery systems. To sort out the huge pile of NPLs, the concerned authorities must seek to improve the predictability of insolvency and debt recovery regimes and incentivise out-of-court restructuring, including debt-for-asset/equity swaps.

Macharia Kihuro is a financial risk analyst working with a pan-African financial institution; [email protected]