Ukraine’s economy is stabilising, with international reserves reaching an 11-year-high of $37.3bn, falling inflation, GDP growth and new life in the domestic bond market. The trend bodes well for Ukraine’s recovery process, when it must attract investments and contribute 25% of reconstruction funds, according to the Minister of Reconstruction of Ukraine, Oleksandr Kubrakov.

Kubrakov added that half of the reconstruction’s financing should be covered by the seized assets from the Russian Federation, and partners will fund another 25% through various mechanisms.

Getting Ukraine Inc. back into business is going to be crucial for its recovery effort and the banking sector will play a key role.

Ukraine’s GDP grew by 2.5% in the first quarter of 2023 which was reflected in Ukraine’s soaring banking sector. After an uncertain year following the invasion of Ukraine by Russia last February, the banking sector stabilised in the second half of the year and was reporting very strong profits in the first quarter of this year. (chart)

Solvent banks earned UAH34bn ($926mn) in net profit in Q1 2023, a far cry from the UAH153mn in losses during the same period last year, Oschadbank’s CEO Sergii Naumov told bne IntelliNews in an exclusive interview.

The state-owned bank, Ukraine’s second most profitable, earned UAH2.09bn ($56mn) in net profit during Q1 2023, an 8.5 times increase compared to the same period last year.

“The main factors behind the sector's profitability are an increase in bank revenues and relatively low levels of additional provisioning,” Naumov said.

The majority of Ukraine’s bankers have a positive outlook for the sector, according to a survey conducted by the National Bank of Ukraine (NBU) in May. The majority of top managers in banks and non-bank financial institutions have reported an improvement in the state of the financial sector over the past six months, according to the NBU. This marks a significant shift from the previous survey conducted in November 2022, where only 3% of respondents expressed optimism. The survey also revealed that the percentage of respondents expecting a deterioration in the financial sector in the next six months has decreased significantly, from 51% to just 3%.

With the economy holding up, Ukrainian businesses are expecting things to improve from here. The NBU reported that the index of expectations of business activity reached 50.5 points in May. Oleksandr Kubrakov, the Minister of Reconstruction, believes that businesses will return to the pre-war level once logistics are restored and there are no issues with electricity supply.

It was a different story towards the end of last year, when Russia began targeting Ukraine’s energy infrastructure in October 2022, resulting in widespread blackouts throughout autumn and winter. As a consequence, the government struggled to sell large volume domestic bonds and increased yields to 19.5% on hryvnia securities in November, signalling that the government was struggling for cash.

But Ukraine has overcome the energy crisis, and as the number of blackouts falls away bond yields have come down again. Military bonds issued in May 2023 offered an annual interest rate of 18.5% in hryvnias, 4.85% in dollars and 3.85% in euros.

Last month, the Ministry of Finance borrowed more from the domestic debt market than what was required to cover bond payments, exceeding them by UAH16.427bn. As a result, the positive balance for the period of January to May of this year reached UAH77.458bn ($2.1bn) – a significant shot in the  arm for the cash-strapped country.

The Ukrainian government has raised UAH500bn ($13.6bn) through bond auctions since the start of the full-scale war, with the majority of securities held by banks, followed by Ukrainian citizens and businesses. More companies are now issuing bonds, such as the leading logistics company Nova Poshta, which recently issued UAH800mn interest-bearing unsecured series D bonds.

The vast majority of bonds are held by domestic investors, with non-residents only making up about 3% of Ukraine’s government bonds, Naumov noted. Currently, under the NBU’s regulatory policy on the withdrawal of foreign investment in government bonds, foreign investors will only be allowed to withdraw interest on the OVDPs state treasury bills received after April 1, 2023. “No new placements are taking place – only existing investments are being reinvested,” he said.

The volume of coupon payments to foreign investors in the period from April 1 to the end of 2023 will amount to about $120mn. Although this amount may increase in case of additional purchases, it is not anticipated to put significant pressure on Ukraine’s international reserves.

However, there are concerns over non-performing-loans (NPLs), which have been a thorn in the side of Ukraine’s banks. Problem loans grew by UAH87bn to UAH432bn ($11.71bn) last year, surging to 38% of the banking sector on January 1, 2023, up from 30% the year prior. (chart)

NPLs have been the bane of Ukraine’s banking sector since the 2008 global credit crisis and the share of NPLs on Ukrainian banks loan book remains high. The worst offender is the now state-owned PrivatBank, where a whopping 64% of its loans are non-performing, but that has more to do with its former owner oligarch Ihor Kolomoisky siphoning off billions of dollars in fake loans than the mismanagement of the bank. The bank was nationalised in 2016 when fully 99% of its loans were believed to be fake, according to an audit by the NBU, but since then the new management has managed to steadily reduce the bad debt.

Stripping PrivatBank out of the statistics and the level of NPLs in the rest of the state-owned banks is much better: 53% of the loans are non-performing. The sector wide NPL average was 39% in May for the whole sector. However, as part of the banking sector clean up carried out by a series of professional NBU governors, well over 90% of these debts have been provisioned for and the nominally high level of NPLs in the sector does not pose a danger to the system’s stability.

Nevertheless, the outbreak of war has seen a sharp uptick in NPLs, although more recently the growth has plateaued out. The concern is, according to NBU estimates, that by the end of the war the share of overdue loans could reach 60%, which will result in banks losing their profits and may lead to a wave of bankruptcies.

As NPLs has been a long-standing problem of Ukraine’s banking system, the managers know what to do. To combat the problem, Oschadbank, which recorded UAH65.9bn ($1.8bn) worth of NPLs in December 2022, has an ongoing dialogue with debtors, offering loan repayment holidays to allow clients to adapt to the new business environment and gradually resume payments to the bank.

“If the debtor is willing to co-operate, we also apply voluntary debt settlement instruments- restructuring (currently short-term), voluntary sale of collateral, etc,” Naumov said.

Oschadbank has also taken measures against non-cooperative clients, in some cases repossessing items put up as collateral. Last year, the bank sold repossessed property with a book value of UAH405mn. In one notable case, a grain elevator in Dnipropetrovsk Oblast was sold for UAH108.5mn.

“Oschadbank has traditionally taken a very conservative approach to NPL provisioning and fully complies with all applicable regulations,” Naumov stated.