Value Maximization of Non-Performing Loans
(NPL) and Distressed Assets – Pakistan’s
Experience (October 1999 – October 2003)
Salman Ali Shaikh
The composition and the inherent characteristics vary significantly
Key variations include which economic segments (e.g., manufacturing,
real estate, etc.) are most impacted, geographic concentrations, the
regulatory environment, labour and employment sensitivities, etc.
The measurement of success (in terms of value maximization) can only
be done after the above factors have been carefully studied.
The traditional yardstick of quantifying how many cents to each $ have
been recovered is much too narrow, if your canvas is the whole country
and its socio-economic framework.
A national NPL reduction strategy entails being able to answer 3 very
basic questions: -
-Where are we??
- Where do we want to be??
- How do we get there??
High 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 of
the future (post-NPL) economy.
Not all distressed assets are worth reviving. It is important to make
a well-reasoned judgement (sector by sector) on the issue of “sickness
worthy of revival”.
Where Are We?? – Pakistan’s NPL Profile
At the time of independence (1947), the country did not have an
It was an agrarian/commodity producing economy with a rural
population of over 75%.
The process of industrialization started in the late 1959’s, and
went through 3 distinct phases: -
-Import substitution phase (up to 1980):
emphasis on infrastructure, fertilizers, petroleum/energy, etc.
-Export oriented phase (1980-1995): growth of the textile
industry with a five-fold increase in spinning and weaving
capacity. Similar growth in down-stream industries – e.g.,
knitwear, garments, home textiles and man made fibres.
-Consumer led phase (1995 onwards): major expansion in
automobiles, consumer durables cement, food processing
With a few exceptions, most of the industrial base is relatively modern.
The main features of the NPL map are as follows: -
Concentrated in the large-scale manufacturing sector. Key concentrations
in textiles, sugar, cement, food processing and the public sector. SME
sector 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 the
NPL was avoidable, as the country has had relatively high economic growth
throughout (except for a dip in the 1990’s). Major chunk of industry has also
enjoyed protection against foreign competition.
Culture of “zero equity” projects. Started in the 1980’s and 1990’s through
collusive lending, poor corporate governance and a bureaucratic regulatory
system. Kick-back’s (received overseas from machinery suppliers) often
exceeded 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 minor
Dilettante entrepreneurs. The 1980’s and 1990’s saw the emergence of new
entrants from all walks of life into industry – e.g., agriculturists, bankers,
bureaucrats, military seniors and even judges. Questionable ability to
successfully run an industrial project. These influential individuals
(“the protected species”) constitute a major hurdle for meaningful
reform 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 large
segments impacted – e.g., cement and food processing. In the latter there
are 51 fruit juice companies and 41 dairy plants – I guess they did not know
about 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 management
handpicked by politicians and military commanders – key qualification was
the absence of professional competence. These “favours” were repaid in
kind – i.e., by approving sub-standard project financing loans.
Where Do We Want to Be?? And How Do We Get There??
Value Maximization: The Basic Imperatives and the Core
The configuration of the country’s NPL not only determines the
choice of tools, but also highlights desirable policy choices and
desired outcomes. In our case, an NPL reduction strategy
(involving value maximization) should have the following features: -
Fast-track implementation. Distressed assets (well over 75%) were
concentrated in manufacturing companies (with modern equipment).
Avoidance of closures was a key issue – once a plant closes down there
can be rapid degeneration, leading to a higher cost of rehabilitation. Banks
(and bankers) who moved fast (in decision-making terms) were able to extract
values ranging from P (Principal) + 25% to P + 50% in the late 1990’s.
Avoidance of “cosmetic” tools. Traditional methods of debt re-scheduling
cause much harm. The company returns to NPL status every 3-4 years and
a myth (that all NPL can be recovered) is perpetuated. There was an urgent need
to devise a methodology for determining the “sustainable debt level” (through
forensic accounting) of projects. With write offs becoming an offence under the
military’s accountability law, bankers played it safe and the use of “cosmetic”
Change of management as a value maximization tool. The poor quality of
sponsors/management was the main reason for the asset becoming distressed
in 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 the
capability to keep the company running till the new management can be
Creating a (national) scale of priorities. Loan loss reserves were low and
often created by “cosmetic” tools (major re-capitalization of public sector
banks). In this scenario, prioritising industrial segments should be a key
priority. Priority segments (e.g., textiles), which have the capability to
jump-start the national economy, should get a larger share in terms of
resource 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 the
market. Both banks and borrowers watch these carefully. Regulators should
devise and implement strategy and not waste time in seeking consensus-based
solutions. In Pakistan, we have wasted the better part of a decade by doing
The need for capacity building. The NPL crisis highlighted the absence of
skills in several areas of expertise and specialization – e.g., professional
receivers, auctioneers, administrators, forensic accountants, evaluators
and asset tracing specialists.
Value Maximization: Challenge and Response
The period under review saw several challenges – e.g., growing NPL, low
economic growth, and decline in fixed investment, increases in military
How well did the country’s planners and the regulatory system respond to
In October 1999 the military seized power. The first law passed was the
National 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 amount
equivalent 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 was
In 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 and
fresh 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 through
coercive means was allowed to continue for over a year.
The country’s economy slowed down considerably causing fresh NPL
flows 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)
NPL peaked in 2001 – at peak it was over 25% of total loans.
To disguise this growth, the regulators started reporting “net NPL” and not
the total figure.
Net NPL is Gross NPL minus provisions held and minus NPL transferred
CIRC (Corporate and Industrial Restructuring Corporation) is a public sector
asset management company (AMC).
Another data integrity problem is the existence of 2 separate regulators
in the financial system.
The State Bank of Pakistan (SBP) regulates the banking system and
publishes NPL data regularly.
The Security and Exchange Commission (SECP) regulates the NBFI’s
(non-bank financial institutions – e.g., leasing companies, investment
banks, etc.). SECP does not publish NPL data.
It is estimated that the correct NPL figure for the financial system as a
whole is around $ 1 billion higher than the reported figures.
What 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 old
NPL 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 – a
somewhat desperate manoeuvre.
A directive was issued to the banking system in October 2002 asking
make “aggressive” settlements with their defaulting borrowers at values
well below actual debt outstanding and/or the decreed amount through
recovery suits in the court.
Instead 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 2-3
years earlier) of NPL being inherently recoverable in full and that write offs
were 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 opting
for such settlements.
These benefits are out-weighed by several
negatives, which are as follows: -
• Heavy guzzler of provisions. A few years earlier, smart banks were settling
NPL at values approaching P (Principal) + 25% to P + 50%. Now, similar
assets are being settled at P – 75% to P – 25%. This scheme could eat up
nearly $ 1 billion of loan loss reserves. Some of the weaker banks may
require re-capitalization. Rather than maximize values (from distressed
assets) this scheme minimizes values.
• The mechanics of determining FSV. Evaluators determine FSV. Gives them
enormous power. There are several reported cases of major under-valuation
to make the settlement extra sweet for all concerned – except the hapless bank.
• This scheme protects all existing managements. It makes it almost impossible
to evict inefficient sponsors. Very unfortunate as many of these companies
will 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 are
causing havoc – making borrowers who repay regularly feel like and look
like idiots. Overall, retards the development of corporate good governance
and the improvement in financial disclosure standards.
Corporate and Industrial Restructuring
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 an
NPL 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).
The 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 CIRC
as 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 the
new corporate rehabilitation law (CRA).
The Beginning of the End or the End of the
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 War
Pakistan’s debts have been re-scheduled and most economic indicators are
This (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 help
to restore the balance between debtors and creditors rights and enhance
predictability in the legal process.
However, there has been little or no progress on long-term institutional
and capacity building issues.
Till than happens, no law (however, well conceived and drafted) can fulfil
its “design” potential.
Turning 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 everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
William Butler Yeats (1865-1939)