The position facing many Ukrainian businesses and their bankers is extremely challenging: an economy in recession, external sanctions and a lack of liquidity in the system. This is com-pounded by major currency devaluation, with many businesses having at least some of their borrowing in USD whilst their revenues are in the national hryvnia currency (UAH). This set of circumstances is not necessarily the fault of the Ukrainian businesses or the banks that lend to them. However, it remains increasingly clear that macroeconomic and geopolitical factors are conspiring to create a perfect storm.

How to survive in the perfect stormThe tried and tested route to survive such eco-nomic turmoil is a combination of financial and operational restructuring whereby businesses cut costs, focus on day-to-day liquidity and cash flow management, and seek to restructure their borrowings. This requires the right steps. Firstly, the owners and CEOs of businesses need to resize in order to meet the economic realities they face. This often requires deep cost cutting and a realistic assessment of the time it will take to recover lost revenues. Businesses are almost always overly optimistic and don’t cut costs quickly or deeply enough, and then fore-cast an unrealistically short timeline for sales to recover. Once they have established a more stable and realistic re-sized business model, owners and managers then need to seek a con-sensual deal with the banks and other institu-tions that lend to them.

Threats to achieving consensusMy discussions suggest there are some real threats which could prevent companies and banks from ‘doing the right thing’ to sur-

vive the current economic turmoil. Most of all there appears suspicion, by at least some banks, that the owners of Ukrainian businesses will not seek a win-win consen-sual outcome. Suspicions include not rein-troducing to the business some of the mon-ey made by the owners in the good times (or worse, money removed since the trou-bles began) which might be held outside Ukraine. Some owners are also suspected of forcing businesses into bankruptcy and buying back the businesses assets through connected parties at knock down prices, or of failing to declare the real financial posi-tion of their businesses to the banks. Some CEOs also suspect that the banks are seek-ing to recover their lending in full from the businesses at “their time of most need,” leaving them strapped for cash and facing bankruptcy. Alongside these threats to Ukrainian busi-ness survival are two other factors which oc-cur in all restructurings across the globe: the provision of new money (cash) and the ‘value break’ in the business. Often the business needs new money to survive, and in some cases, to pay for the required operational restructuring. Owners want the banks to put this money in, but banks often want the own-ers to. The answer is normally a combination of the two options, with owners supporting their business with new cash injections while bankers provide liquidity by agreeing to the prolongation of loans. It is a two-way street. If businesses, like many in Ukraine, have expanded rapidly, they may find that in do-ing so they have raised significant levels of debt, making them highly leveraged. With economic hardship comes a reduction in the value of the company. In a highly leveraged company, the real value of the company to-

day may well be at a figure that leaves the equity ‘out of the money’ or ‘underwater.’ The ‘value break’ (the point at which the current value of the assets no longer covers the total amount owed to creditors and in-vested by owners) may not be sufficient to fully cover any bondholders, or maybe even just to cover the senior debt. This means there would be no value for the owners on any sale of the company. Therefore there is no immediate incentive for the owners to support their business. Such a situation requires a realistic assessment of the posi-tion. The owners and the debt holders must reach a compromise. The debt holders need the owners, who are operationally involved in the business, to continue and to provide the ‘new money’ injection, whilst the own-ers need the debt holders to continue to support their businesses so they can regain, over time, their equity value. There may need to be a debt-to-equity swap if the val-ue is truly breaking in the debt, but the debt holders must be careful to compromise as the owners active in the management and their management will need sufficient in-centive to motivate them to work hard for the businesses into the future.

The impact of failed restructuring If there is no compromise between owners and banks on these two ‘standard’ restruc-turing factors, both sides will normally lose a great deal and the business will generally go into bankruptcy. In central and eastern Europe, bankruptcy regimes are generally immature and slow, with high levels of bu-reaucracy and legal process. In many cases, control remains too much in the hands of the owners and the management. This can make the bankruptcy option very unattractive to the banks and to others who are owed money. In Ukraine there is a deep distrust of credi-tors in the bankruptcy procedure and a lack of fair dealing, with owners able to buy back assets at knockdown prices. It is worthwhile mentioning that the World Bank’s recent Do-ing Business 2015 report ranked Ukraine 142nd in the world in the Resolving Insolven-cies category.The lack of a reliable bankruptcy regime,

Weathering the economic stormUkraine must demonstrate that it can manage its commercial system in order to attract investment

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Macroeconomic and geopolitical factors are conspiring to create a

perfect storm

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whether arising either from poor governance and process or sometimes from alleged fraud against the creditors by business owners, is a major barrier to another important restruc-turing opportunity: the buying and selling of non-performing loan portfolios by banks. If a Ukrainian bank wants to sell a portfolio of cus-tomer loans that are ‘non-performing’, typical-ly to another financial institution, the value of that portfolio is determined by the reliability as a ‘backstop’ of the Ukrainian bankruptcy re-gime. If there is no reliable means of enforce-ment of creditors’ rights, this means a poor price for the sale of loan portfolios, or worse, non-performing loans become impossible to sell. Currently the interest in Ukrainian non-performing loans is poor.

Need for leadershipOwners of Ukrainian businesses may see the lack of a reliable bankruptcy procedure

and an illiquid non-performing loan market in Ukraine as an opportunity to obtain a great deal on restructuring their business-es against banks and bondholders. Even worse, they may see this as an opportunity to take advantage of their creditors by re-buying the assets through bankruptcy at knockdown prices. This would be a big mistake. Foreign Direct Investors and major financial institutions, including foreign-owned banks, are watch-ing closely how the restructuring of the Ukrainian economy proceeds over the com-ing months. In particular they will watch how the new government leads on this is-sue. If either restructuring or bankruptcy processes are abused, some may get rich (or not as poor) in the short-term, but in the medium- to long-term, lenders and investors will shun Ukraine. Strong leadership is needed from the gov-

ernment to ensure responsible behaviour by the owners (which include some of the newly elected MPs who will need to set the example for others). Responsible behav-iour must also be ensured from the banks themselves, and the courts charged with overseeing bankruptcies. This is essential, not only for Ukraine to survive the current crisis, but in order to show the world that Ukraine can manage its commercial sys-tem in a responsible way that will attract and retain foreign investment and make the most of its significant fu-ture economic op-portunities.

About the author: Stephen Oldfield is a PwC partner in Central and Eastern Europe and a specialist in busi-ness recovery and restructuring who recently met the CEOs and CFOs of some large Ukrainian businesses and senior officers from Ukrainian private and state-owned banks and international banks based in Ukraine.

March 2015