Confidential

Restructuring and Collection of Non-Performing Loans

How EY can help

Content
Page
Section 1 Section 2 Current issues in the Ukrainian banking sector Importance of NPL management and EY services 1. Disposal of an NPL portfolio to a third party 2. Repossession of collateral 3. Work with the banks borrowers to restructure and collect loans 4. Enhancement of the credit risk function Appendix Selected credentials 3 7 10 12 13 15 16

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Section 1

Current issues in the Ukrainian banking sector

Ref. DPD10905

Introduction

In January-October 2009 Ukrainian banks booked losses of USD 2.2 billion in statutory reporting. This was mainly caused by an increase in provisions due to the deterioration of the banks loan portfolios. A significant portion of loans issued by Ukrainian banks in recent years was denominated in foreign currencies, such as Euros and US dollars (USD). In the last quarter of 2008, the Ukrainian Hryvnia (UAH) depreciated in value and as a result, the lending burden for customers has significantly increased. Combined with deteriorating economic conditions, default rates have risen sharply and this trend is forecasted to continue. Credit ratings for most Ukrainian banks have been lowered and lenders face significant default risk. The National Bank of Ukraine (NBU) intervention has been widespread, including providing funds and introduction of temporary administration. The NBUs actions were aimed to protect depositors and to safeguard the banking sector against systemic risk, rather than to protect creditors. Ukrainian banks started to implement loan portfolio restructuring programs, including change of lending terms (period, interest rate, repayment schedule etc.), disposal of non-performing loans, enforcement of collateral. The restructuring of non-performing loans if done incorrectly may lead to deferring the actual losses in view of the deterioration of the portfolio quality. It is important not only to get rid of the toxic assets on the banks balance sheet, but also to enhance the credit function in order to avoid the rapid deterioration of the loan portfolio in the future. The key goal in the short term is to buy time through stabilising the bank, while capturing value in the long term addressing the loan portfolio quality. Ernst & Young has significant experience working with large banking syndicates, with governments and regulators as well as with the banks borrowers across Europe.

We also have significant experience in performing due diligence of loan books and business plans, including modelling different scenarios and performing stress tests of business plans.

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Current Issues in the Ukrainian Banking Sector

Liquidity

New lending has started to recover Interbank funding is very limited and expensive Rapid withdrawal of deposits by clients, low renewal rate International borrowings are not available Stickiness of deposits Higher share of demand vs. savings accounts Limited number of interested investors or lenders willing to provide funding M&A process is not active yet

Government and social liability

Introduction of temporary administration and curators to the banks Restructuring and redundancies Bankruptcies People lost trust in the banking system, but have no alternative for investments Stricter regulatory requirements for currency position and credit risk Stricter obligatory reserves maintenance requirements Introduced limitations on banking expenses Regulatory waivers / concessions are now available via arrangements with the NBU (e.g, loan restructuring could be a reason for a 6 months waiver on compliance with regulatory ratios) The NBU plans to restructure refinancing agreements with distressed banks (e.g. prolongations, lower interest rates) Plans to create state-owned bad bank

Capital and funding

Asset valuation and credit toxicity

Illiquid markets create valuation difficulties (securities, real estate etc) Diminished credibility of ratings agencies Increased counterparty risk NPL rate is growing (according to market experts the real rate is up to 30%)

Regulation and risk management

Solvency and regulatory capital

Pressure on regulatory capital due to declines in asset values and impairments Hryvnia devaluation impacts regulatory capital

Captive banks and nonbanking activity

Captive banks servicing interests of industrial borrowers are still in place Lack of stability affected asset management and insurance subsidiaries

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Share of NPL loans in portfolios of Ukrainian banks

Loan portfolio currency breakdown at August 2009
Corporate in UAH Retail in Foreign Currency 26% 36%

Share of NPL in the loan portfolio

6.8 7 6 5 % 4 3 2

3.8

3.7 2.1 2.3 1.9

Retail in UAH 10%

Corporate in Foreign Currency 28%

1 0 2004 2005 2006 2007 2008 Aug.09

Source: NBU

Source: NBU

According to the NBU, in September 2009 the share of NPL was 6.8%. However, according to market experts the real share of NPLs, including restructured loans, could be as high as 30%. While the regulatory statutory rules allow banks to avoid disclosing the real NPL figures, the IFRS financial statements will show a weaker financial position due to the deterioration of the loan portfolios in 2009. Foreign currency denominated loans represented 54% of the total commercial banks loan portfolios. Even moderate currency devaluation may further impair borrowers ability to pay their debts on schedule.

Rapid grow of credit activity

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Weak risk management

Unsecured loans

Growth of NPL

Section 1

Importance of NPL management and EY services

Ref. DPD10905

Importance of NPL management

Definition of NPLs: A loan is non-performing when payments of interest and principal are past due by 90 days or more, or at least 90 days of interest payments have been capitalized, refinanced or delayed by an agreement, or payments are less than 90 days overdue, but there are other good reasons to doubt that payments will be made in full. (Source: IMF) Main benefits of NPL management:
Reduction of

Regular banking business Managing Loan Book

Managing Collateral Book

NPLs improve the financial position of the bank through releasing provisions. bank remains concentrated on its core business rather than on disposal of collateral. negative effects of rolling over bad loans

The

Valuation of the collateral Potential repossession/ realization of the collateral Collateral management processes review Distressed Assets Management and Restructuring

NPL and DA identification

Mitigation of

Streamlining Operations

Loan portfolio review Sale of the NPL portfolio Taxation issues

Release

of NPL from the banks balance sheet allows the bank to recapitalize and to provide new loans to creditworthy borrowers and as a result stimulate the flow of money into the economy.

Third party

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In distress

Avoidance

of perceptions that the bank allows deadbeat borrowers to extend repayment terms while good borrowers are still working diligently to repay their loan.

Borrowers focus Short-term cash flow preparation/review Independent Business Review Taxation issues

Banks focus

Pre distress

Portfolio Valuation Advisory in Risk & credit management Loan portfolio analysis

EY proposed services to manage NPLs

1. Disposal of the NPL portfolio to a third party: sell-side advice 2. Repossession of collateral: analysis of collateral; valuation of collateral; tax and legal advice on repossession procedures; analysis of impact of the repossession on the financial and regulatory ratios of the bank and its tax position; evaluation of alternatives for further usage of collateral 3. Work with the banks troubled borrowers: A. Independent business review of the borrowers financial standing B. Analysis of the borrowers cash flow forecast and working capital C. Assistance in preparation of business plan/forecast (modelling) D. Identification of cost saving opportunities to free-up cash and improve financial standing E. Formulation of loan restructuring advice

NPL management

4. Enhancement of the credit risk function

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1. NPL Sell Side Financial Advisory Services Key steps

Selling a loan portfolio to third parties seems to be a simple solution. However, to avoid potential pitfalls we will assist you through the whole cycle of selling the loan portfolio from the development of the transaction strategy, portfolio structuring and valuation to investor identification, due diligence facilitation and transaction closure.

Planning

Due diligence

Stratification/ Loan pooling

Oversee the compilation of the multiple stratifications on the loan portfolio in order to reflect the most positive characteristics of the portfolio based on different stratification results. Present creative pooling strategies derived from sophisticated stratifications. Aim at maximizing portfolio recovery by identifying best marketable subportfolios. Consider industry, size, location, type of loan, borrower relations, and other information derived from stratification to present balanced pools and encourage competitive bidding.

Portfolio valuation

Assist to define objectives and approaches prior to transaction commencement. Establish, define and coordinate the roles, tasks and responsibilities of all service providers engaged by the bank. Develop the Transaction Timeline.

Coordinate and supervise the compilation and organization of all relevant documents from the banks loan files. Preparation of comprehensive Investor Review File (IRF). Review the loan files to ensure that they meet International Standards and Investors expectations.

Coordinate with bank advisors in collecting the most relevant and complete information that will ensure the maximum value of the portfolio. Identify opportunities for value enhancement, e.g. market research, statutory registers search, public published information, etc. Assess the reasonability of the valuation assessment and set realistic expectations for the bank. Compare the recovery value between various resolution approaches and suggest the most suitable portfolio resolution strategy to the bank. Utilize EYs advantage and rich experience in real estate and corporate valuation.

Finalize assets portfolio and develop data gathering techniques.

Communicate our understanding of investors preferences and concerns to the bank based on our past experience and initial contact with investors.

Oversee the compilation of the stratifications on the portfolio and Executive Summary with all key borrower, loan, guarantor and collateral attributes to be included in the IRF.
Ensure that any issues identified during the due diligence process are adequately addressed and feedback is provided to the bank to mitigate any adverse investor pricing affects.

Create option pools for single assets.

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NPL Sell Side Financial Advisory Services Key steps (contd)

Go-to-Market strategy
Develop divestment strategies and deal structures, which are tailored to the portfolio characteristics, investors preferences, accounting, tax and regulatory issues that could impact the pricing and the financial and compliance considerations for the bank. Assist the bank in liaising with the regulators with regard to the transaction structure in order to obtain necessary endorsements and approvals. Consider and advise the bank on the possible accounting, tax and regulatory implications across different geographical jurisdictions based on the adoption of the specific transaction structure.

Preparation of transaction documentation

Bid process

Transaction closing
The process of closing an NPL sale which typically includes many hundreds or thousands of loans requires experience, judgment and an understanding of the timing of complex events and approvals.

Assist the bank in the preparation of high quality marketing documents and portfolio analysis for the purpose of presenting to investors. Preparation of primary transaction documents such as Investors Expression of Interest, Qualification Statement and Confidential Agreement (QSCA), Confidential Information Memorandum (CIM), Bid Documents, Loan Sale & Purchase Agreement (LSPA) and/or Joint Venture Agreement, Servicing Agreement. Assist the bank in addressing and answering investors questions.

Distribute detailed due diligence information package including Investor Review Files and electronic database to investors. Issue bid invitation letter, distribute draft Loan Sale & Purchase Agreement and allow comments from qualified bidders prior to stated date. Work with the bank to establish the appropriate transaction cutoff date. Distribute bid materials, including submission forms, procedures and deposit payment requirement.

Ensure that ownership of the assets sold are properly transferred. Ensure that bank secrecy and data protection law issues are addressed. Share our previous experience with the bank in closing the transaction.

Draft and implement standards for bid acceptance and assessment to ensure transparency and compliance with International Best Practices.
Design bid evaluation form. Design evaluation process to ensure efficiency and accuracy. Ensure timely announcement and award to the winning bidder (or bidders).

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2. Collateral repossession advisory services

Issue/ open questions Ernst & Young's approach
Stratification of the collateral by type of collateral, type of borrower and quality of the loans secured by the collateral Valuation of the collateral and assessment of the collateral marketability Analysis of legal constraints imposed on the collateral and availability for repossession and further disposal/leasing Assessment of the legal and tax cost derived from the repossession

Analysis of collateral

Selection of the collateral repossession option

Elaboration of collateral repossession options Analysis of the advantages and disadvantages of each option Analysis of the impact of the collateral transfer on the regulatory ratios and the banks financial and tax position Comment on how the purpose of the collateral is used (i.e. usage in operating activity, nonoperating or investment, lease, disposal) may impact the banks regulatory ratios and tax position; recommendations on how to address the issues Advise on strategies for the repossessed collateral disposal Sell-side support during the sale of the entity (if ownership title was repossessed): sell-side due diligence, search for potential buyer(s), negotiation support, valuation, deal structuring Advise the bank on different options of dealing with the difference between the collateral value and the amount of debt Analysis and comments on advantages and disadvantages of each option

Identification of possible further use of collateral

Repayment of the unsecured debt

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3. Work with troubled borrowers to understand the financial situation and advise on collection/restructuring options
EY will support you with a team of specialists that will work at the borrowers site and provide you with an understanding of the borrowers financial position. The work will include analysis of the current financial position and management projections as a basis for formulation of the restructuring and strategic options.

Your potential needs

Ernst & Young's approach

Review the borrowers historical track record and use this as a basis to challenge the business plan, forecasts, projections and underlying assumptions Analyze the borrowers position within its market, customer perception, supplier/customer relations, competitive and regulatory environment Independently test the borrowers business Model for internal consistency, logic integrity and mathematical accuracy Independently test that the key assumptions and input data have been properly input into the Model Define and agree key sensitivity factors, which should be included in the Model Preparation of the business Model (if necessary) Evaluate cash flow forecasts and their accuracy, potential upsides and vulnerabilities Identify headroom/ peak funding requirements Understand cash management and control procedures and capital expenditure plans Understand key assumptions underlying management projected cash flows, potential risks, drivers, discretionary spend and comment on creditor stretch

Outcome/benefits
Provide comfort on adequacy of the business plan/model Provide a shared perspective on business prospects Identification of underperforming business units Provide comfort on the technical and logical functionality of the Model Ensure that the borrower built a consistent and robust sensitivity analysis into the Model Comment on the further development of the Model

Business review

Model review

Liquidity management review

Provide comfort that the borrower has sufficient liquidity to continue operating in the immediate term Provide a base level of information from which to perform the business review Improved cash management and control processes providing clearer cash visibility and planning

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Ernst & Young will support you with further restructuring assistance
Your potential needs Ernst & Young's approach
Analyze working capital position and historical trends Diagnose improvement opportunities in accounts receivable, accounts payable and inventory Co-development with management of action plan, reporting templates and monitoring tools for implementation of opportunities identified Knowledge transfer of improvement opportunities and best practice through training workshops Review all or key parts of borrower operations to understand inefficiencies and managements action plans Review all or key parts of borrower operations, identify operational specific issues, and highlight areas for improvement based on past experience

Outcome/benefits
Implementation of sustainable and continuous improvements in borrowers working capital Rapid cash release of excess working capital through optimization of inventory and improved management of receivables and payables

Working capital improvement

Operational due diligence

Recommendations for improvements to borrowers operations and comfort on implementation strategy Understanding of causes of operational inefficiencies and recommendations for addressing them Provide view on long term sustainability of the borrowers operations

Restructuring advice

Formulation, assessment and discussion of the options for restructuring of the borrower existing debt Modeling of the options available to illustrate and compare

Analyse restructuring options available and recommend the most suitable for the bank Provide our recommendations on the implementation steps and other considerations

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4. Enhancement of the credit risk function of the Bank

We can help you to enhance the banks credit risk strategies, processes and methodology.

Our range of services includes:

Strategies
Advise on planning and implementation of an effective loan portfolio management function. Analysis of the product structure and quality of the loan portfolio in order to identify key grey and weak areas in the loan cycle. Advise on lending strategy improvement taking into account specifics and peculiarities of the bank. Analysis of the credit processes to ensure that the processes are aligned with the general credit risk strategies implemented by the bank and in line with the best practices. Based on our analysis we identify weaknesses in the processes of granting loans and monitoring loans. Assistance in development of appropriate or validation of existing grading/scoring system in order to understand if it meets regulatory/mother bank/best practise requirements. Co-development of risk and quality assessment system based on deep analysis of the loan portfolio. Advise on redesigning and improvement of loan issue and monitoring, collateral management processes.

Processes

Methodology and Reporting

We can develop risk policies and procedures for the control and management of risk. We can also help to refine internal and external reporting to provide assurance of the accuracy and robustness of internal risk measurement systems. This also includes drafting credit risk and performance reports customized for specific management requirements. Development of risk and quality assessment system.

We can provide you with specialists from our team to help you address the temporary work load due to higher levels of nonperforming loans. The role of the outsourced specialist, as well as the level and responsibilities is subject for further discussion .
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Appendix Selected credentials

Ref. DPD10905

Selected Credentials in Financial Sector in Ukraine (Transaction Support and Tax Advisory)
This announcement appears as a matter of record only. This announcement appears as a matter of record only. This announcement appears as a matter of record only. This announcement appears as a matter of record only. This announcement appears as a matter of record only.

3 Ukrainian Banks out of Top-20

Diagnostic study on requirement of NBU, IMF and World Bank (tier 2) Ernst & Young performed financial and risk advisory services Ukraine

5 Ukrainian Banks out of Top-20

Diagnostic study on requirement of NBU, IMF and World Bank (tier 1) Ernst & Young performed financial and risk advisory services Ukraine

One of the Top-5 Ukrainian banks

Ernst & Young performed analysis and evaluation of financial and tax impact of different options for disposal of mortgage loan portfolio

Parex Banka
Contemplated acquisition of a small size bank in Ukraine

Ukrainian financial and industrial borrower

Merger of three Ukrainian banks

Ukraine 2008 Ukraine February 2009 - ongoing

Ukraine 2007-2008
Ernst & Young performed financial and tax due diligence

February 2009

2008 - 2009

Ernst & Young performed financial and tax due diligence

This announcement appears as a matter of record only.

This announcement appears as a matter of record only.

This announcement appears as a matter of record only.

This announcement appears as a matter of record only. This announcement appears as a matter of record only.

Several Top-20 Ukrainian banks

Ernst & Young provided taxation advice on the Ukrainian tax and currency control implications of selling the nonperforming loan portfolio to a third party (distressed debt investor) Ukraine, 2008

Ukrainian investment bank

Considered setting up a debt collection borrower to purchase distressed loan portfolios Ernst & Young advised the investor on the taxation implications of the proposed business Ukraine August 2008

Large Ukrainian business borrower

Wanted to establish a tax efficient structure for its real estate assets Ernst & Young provided taxation advice on possible options and opportunities Ukraine, April 2008

Mid-size Ukrainian bank

On request of a private equity fund Ernst & Young performed financial, operational and IT due diligence of consumer lending function.

Top-20 Ukrainian bank

On request of a private equity fund Ernst & Young performed financial, operational and IT due diligence of mortgage lending function. The due diligence was a preparatory stage for the securitization of the loan portfolio. Ukraine June 2007

Followed by monthly evaluation of the loan portfolio quality

Ukraine August 2006

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Selected Credentials in Financial Sector in Ukraine (Tax and Legal Advisory / Financial Risk Management Advisory)
This announcement appears as a matter of record only. This announcement appears as a matter of record only. This announcement appears as a matter of record only. This announcement appears as a matter of record only.

One of the Top-5 Ukrainian bank

Ernst & Young provided a number of taxation advices in relation to distressed debt management

Ukrainian collection borrower

Ernst & Young provided taxation advice on the tax aspects of acquiring nonperforming loan portfolios from Ukrainian banks

Several Top-10 Ukrainian leasing companies

Ernst & Young provided a number of tax advices in relation to management of nonperforming leasing portfolios

Leading European receivables management borrower

Ernst & Young provided full tax and legal support to the borrower in connection with setting up its Ukrainian operations on the markets of debt collection services and acquisition of distressed loan portfolios from Ukrainian banks Ukraine, Sep 2008 Feb 2009

Ukraine, Jul 2008 Feb 2009

Ukraine, November 2008

Ukraine, Sep Dec 2008

This announcement appears as a matter of record only.

This announcement appears as a matter of record only.

This announcement appears as a matter of record only.

This announcement appears as a matter of record only.

Ukrainian subsidiary of international bank

Ernst&Young helps to define and structure cost reduction program
Ongoing

CJSC "BANK NRB"

Raiffeisen Bank Aval

considered a number of options and steps related to doubtful and bad debt management Ernst & Young provided taxation advisory services 2008 2009

OJCS Kreditprombank

Creation of the 5-year development program (including loan and client strategy) and short-term action plan (18 months).

Building the system of credit risk management according EBRD program

Ukraine

Ukraine

Ukraine

Ukraine

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Selected Restructuring Credentials

This announcement appears as a matter of record only. This announcement appears as a matter of record only. This announcement appears as a matter of record only. This announcement appears as a matter of record only.

Private Equity Firm and Portfolio borrower

RBC

Ukrainian Steel Manufacturer

International Bank

Short term cash flow forecasting, business review and evaluation analysis supporting debt restructuring negotiations In Process

Short term cash flow forecasting, business review supporting debt restructuring negotiations

Review of short term cash flow forecasts and business review at request of international lending consortium

Ernst & Young provided restructuring services and performed review of the cash flow forecasts

In Process Russia Ukraine Ukraine

Russia

This announcement appears as a matter of record only.

This announcement appears as a matter of record only.

This announcement appears as a matter of record only.

Global Industrial borrower

Pharmaceutical Wholesaler

European Tyre Manufacturer

100 day cash flow and working capital improvement plan

Cash flow and working capital improvement plan

Short term cash review forecasting, business review

Russia

Russia

Russia

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Ref. DPD10905