Lending in the new reality. How can businesses secure bank financing following the Russian attacks?

Serhii Chernikov, Deputy Chairman of the Management Board in charge of  corporate business at Oschadbank, explains the key aspects of lending in the new reality in a Forbes column.

Large-scale Russian attacks on Ukraine are creating new challenges for businesses in their dealings with banks. How can a business secure a loan when some of its assets have been destroyed? How can businesses convince banks that they are capable of servicing a new loan?

Just a month ago, the debate on lending to the Ukrainian economy was dominated by two opposing viewpoints. The pessimistic view was that high-quality lending in a country at war is impossible due to excessively high risks. The optimistic view was that banks have sufficient liquidity, so they simply need to channel money into the economy more quickly.

The latest wave of Russian attacks has changed the nature of this debate. Manufacturing, logistics centres, the retail sector, and fuel and energy infrastructure have all come under attack.

The full impact of the destruction has not yet been fully reflected in the statistics on lending and non-performing loans. For the time being, these figures mainly reflect the portfolio and lending decisions made prior to the latest wave of attacks.

However, it is already clear that the main issue has shifted: the question is no longer how to channel banks’ high liquidity into new investments, but how to maintain funding for viable companies that have already been affected by the risks of war.

Following the latest attacks, the range of projects whose risk a bank can reasonably absorb using its own capital has narrowed significantly. For a bank, this means two parallel challenges: retaining viable borrowers for whom the war risk has already materialised, and ensuring that funding for new projects is not halted.

Lending in the new reality

At Oschadbank, we are not yet seeing a systematic increase in non-performing loans. However, we are already recording the first instances of payment defaults among companies which, prior to the materialisation of the war risk, had a viable business model and were servicing their debt. The physical destruction of assets, the halt in production or disruptions to logistics have sharply reduced or brought their cash flow to a standstill. This is an early warning sign, whilst the consequences of the latest attacks will become apparent later in the systemic statistics.

The key issue now is not how much the volume of loans issued this year will increase. What is more important is whether borrowers will remain viable after the widespread destruction and whether they will be able to restore their cash flow.

Therefore, given the current circumstances, when it comes to lending or restructuring, the bank assesses three things:

• Future cash flow, not just past profits. The company must demonstrate how it will cope with a fall in revenue, currency devaluation, rising energy and logistics costs, contract delays or the loss of some of its assets. Historical financial statements provide a baseline, but the loan is repaid from future cash flow.
• Security structure, not just the cost of the risk. If the weak point is project completion, you need a sufficient equity contribution, a budget reserve and a robust contract with the contractor. If revenue depends on a single buyer, you need a long-term contract or greater diversification. Reserve accounts and covenants help to limit and control other risks.
• Signals of problems before defaults, not after. A problem loan does not begin on the day of default. It is preceded by a breached contract, rising trade receivables, falling capacity utilisation, loss of an asset or a change in logistics. Waiting for quarterly reports is no longer enough. Businesses must notify the bank of a problem as soon as it arises, and the bank must act before an operational failure turns into a formal default.

Another factor is the speed of decision-making. If the approval process takes half a year, the bank may end up approving a project that is no longer the one it originally analysed: the cost price, the market, logistics or contractual terms may have changed. A flawless decision regarding a project that no longer exists is not a sign of prudence, but of being too late.

“Peaceful” rules do not always work  

Historical financial statements remain important, but following the recent attacks, they provide an even poorer indication of a borrower’s future viability. A single strike can simultaneously destroy production facilities, stock levels, logistics routes and sources of future revenue. At the very same moment, the collateral on which the bank relied when making its decision may also lose its value.

Adding a few percentage points to the loan rate does not solve the problem either. It will not restore the destroyed production capacity, but will merely increase the strain on cash flow, which has already been hit hard. Therefore, the bank must not simply assign a higher price to the risk, but understand how the company will operate in the wake of the crisis.

For businesses, this means that profitability based on historical financial statements and liquid collateral are no longer sufficient. The bank assesses whether the company has a backup site or warehouse, alternative energy supplies and delivery routes, a diversified customer base, accessible insurance cover and a realistic recovery plan. The timeframe for resuming operations, shareholders’ own contributions and the key performance indicators used to assess the plan’s implementation are also becoming important factors.

For a practical banker, the critical distinction today lies not between “paying” and “not paying”, but between a temporary shock and a broken business model. If a company has retained its market, contracts and team, and has a realistic recovery plan involving the owner, rescheduling payments can preserve a viable business. If there is no new cash flow, restructuring merely postpones acknowledging the problem.

In early August, the NBU allowed banks, under certain conditions, not to recognise a borrower’s default in the event of short-term  -  up to one year -  restructuring, provided the financial difficulties are caused by the war. This creates scope for preventive restructuring, but only provided the business’s viability is confirmed and there is a realistic recovery plan.

This is not a risk amnesty. The bank must justify its forecast of future cash flows and the borrower’s ability to resume debt servicing.

War risk requires allocation

The bank’s task is not to avoid all risk, but to make a specific risk acceptable. However, following the latest wave of destruction, it has become particularly clear that a bank cannot bear the entire burden of war risk on its own.

Operational and commercial risks remain, first and foremost, the responsibility of the business. The bank assumes credit risk within limits that it is able to assess and cover with capital. Systemic and war risks require the involvement of the state, donors, international financial organisations and the insurance market.

An investment loan should therefore be combined with working capital financing, guarantees, trade finance and, where possible, insurance. Where necessary, other banks and international financial partners should be involved in the transaction. For a company, this means that it should approach the bank not only with a request for a loan amount, but also with a well-thought-out financial structure: sources of equity, available risk coverage, contingency plans and a clear allocation of responsibilities. In such a deal, the bank is not merely a cashier, but the  financial structure’s architect.