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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 between countries.

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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

  • between countries.
  • 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

industrial base.

  • 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
  • and telecommunications.
  • 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

economic downturn.


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”

tools continued.

  • 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 latter.

  • 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

expenditures, etc.

  • How well did the country’s planners and the regulatory system respond to

these challenges??

  • 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

to CIRC.

  • 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

Corporation (CIRC)

  • 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

On Terror!!!

  • Pakistan’s debts have been re-scheduled and most economic indicators are

quite positive.


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)