UKRAINE - World Bank



UKRAINE

Second Export Development Project (EDP2) – Implementation Support Review

Based on formal meetings March 29 – April 4, 2012 and subsequent discussions

Aide-Memoire

1. A World Bank team comprising Mr. Marius Vismantas (Project Team Leader), Ms. Angela Prigozhina, Ms. Nataliya Lutsenko, Ms. Irina Babich, and Ms. Irina Shmeliova conducted statutory consultations on the implementation of EDP2 in the period of March 29 – April 4, 2012. Additional discussions between the team and the Borrower were also conducted prior and after the indicated period.

2. The team met with representatives of the State Export-Import Bank of Ukraine (the Borrower; UEB), Ministry of Finance, and the Participating banks (PBs). The topics discussed during the visit and covered in this AM include: (i) utilization plans for the Project; (ii) PBs’ and UEB’s compliance with project eligibility criteria; (iii) institutional development component; (iv) financial management and procurement arrangements; (v) BEs performance and specifics of DSCR methodology calculation in certain circumstances; and (vi) preparations for disbursement of Additional Financing for EDP2.

3. In summary, the rate of EDP2 implementation has improved strongly from 2010-2011 and remains satisfactory. In the period from late 2009 to mid-2011 ten new sub-projects were approved by UEB as both UEB and the PBs coped with the effects of the crisis and reduced their lending activities substantially. The commitment and disbursement goals set in previous Aide-Memoire were being not fully met. In mid-2011, however, the Bank team agreed with UEB on a number of steps aimed at substantially accelerating the credit line utilization in the coming months. Since then, throughout late 2011 and early 2012, disbursements under the EDP2 were robust, making it the best disbursing project in the World Bank’s Ukraine project portfolio. So far in FY12 (July 2011-June 2012), US$22.3 million were disbursed, making the disbursement rate of 92% for the fiscal year. In total, as of May 2012 the EDP2 has disbursed around US$153 million, in effect completing disbursement of the original EDP2 amount (US$154.5 million).

Current implementation status of Credit Line Facility (Component A)

4. Nearly 100% of the original EDP2 credit line amount (US$150 million) have been committed and disbursed by now. As can be seen in Table 1, thirty five sub-loans have been approved for an amount totaling US$142.7 million (see complete list of sub-loans in Annex 1). Total disbursements on the same date stood at US$ 138.8 million (excluding Special Account allocation).

5. Most of the new activity over the reporting period is due to the direct lending by UEB and active participation of Credit Dnepr Bank and Megabank. Ten new sub-projects and additional financing to one existing project totaling US$22.5 million have been approved since late March 2010, bringing UEB’s total commitment under EDP2 to US$53.5 million (largest among PBs) and increasing commitment of Credit Dnepr Bank and Megabank up to US$20 million and US$24.5 million respectively. Only these three PBs have been able to continue disbursement over the supervision period, with the rest of the banks suspended due to failure to comply with eligibility criteria (see more details below). At the same time, in April 2010, UEB has decreased the subsidiary loan allocations for Kreditprombank to match its actual disbursement under EDP2, since it is unlikely that this bank will comply with eligibility criteria in the foreseeable future.

Table 1 EDP 2 Line of Credit Summary

|# |PB name |Date of Original SLA |SLA amount, |# of Subprojects |Amount Committed to |Disbursed to |

| | | |US$ million |approved |sub-projects, US$ |subprojects, US$ |

| | | | | |million |million |

|1 |OJS CB “Nadra” |March 14, 2007 |4.5  |3 |4.5 |4.5 |

|2 |JSC “Kreditprombank” |February 26, 2007 |15.2 |2 |17.1 |17.1 |

|3 |OJSC “Ukrgasbank” |July 09, 2007 |23.4  |5 |23.1 |23.1 |

|4 |OJSC “Megabank” |July 06, 2007 |24.5  |9 |24.5 |24.5 |

|5 |Credit Dnipro Bank |August 6, 2008 |20.0  |3 |20.0 |20.0 |

|6 |JSC “Ukreximbank” |May 29, 2009[1] |53.5 |13 |53.5 |49.6 |

| |Total |- |142.7 |35 |142.7 |138.8 |

Source: UEB, Data as of May 30, 2012

6. The team discussed with UEB the performance of the existing sub-loan portfolio. According to the information presented by PBs, all sub-borrowers continue to service their debt obligations, with the exception of sub-projects by Bank Nadra (no data). Some enterprises (Sacura I, Nibulon) have had problems with meeting the original export targets, or faced implementation delays in investment sub-projects, or required clarifications on the DSCR calculation methodology. Having considered the reasons of this incompliance and discussing Sub-loan performance plan with entities’ management each were granted with one-time waiver. The mission team reiterated its position that UEB, together with the PB in question and (if necessary) enterprise itself, needs to discuss such situations on a case-by-case basis, and inform the WB if changes are necessary. In several cases the export projections and investment schedules have already been adjusted, while in other cases the PB in question agreed to modify the original sub-loan amount or hand-over the unfinished sub-project to UEB.

7. The team commends UEB for accelerating the earlier agreed measures towards the utilization of the credit line component during the past 6-9 months. Improvements in the general situation in the economy resulted in more export-oriented enterprises benefiting from EDP2 financing, especially since other sources of longer term funding have remained limited. UEB’s experience of the past 1-2 years suggests that companies in food and food-processing sector are particularly promising since they were relatively less affected by the recession and hence are more capable to take on additional debt obligations. In addition, the machine building sector is also considered ripe for renewed exporting activity.

8. Effort should be made to continue the wholesale lending through qualified commercial banks. While the original EDP2 credit line component amount is by now exhausted, under the EDP2 AF there is US$105 million (70% of the total AF amount of US$150 million) allocated for wholesale lending by UEB through Participating Banks (PBs). The two banks currently participating in the Project have already expressed their interest in new allocations under the AF. In addition, UEB has initiated the selection process for additional PBs. During the past 18 months, as agreed with the Bank, expressions of interest were solicited from Groups 1 & 2 banks with solid financial standing. Two banks had expressed preliminary interest in EDP2 resources in 2010-2012 but so far no agreements have been concluded with them. More recently, two other banks came forward to discuss with UEB and the Bank team their participation in the Project’s Additional Financing (AF) stage. The team recommends that UEB assesses the compliance of these banks with EDP2 AF eligibility criteria based on the forthcoming 2011 UAS and IFRS-based audits and moves to negotiate the terms of Subsidiary Loan Agreements. The search and negotiations with the new potential PBs should be done in parallel with discussing the possibility for increasing existing credit ceilings under the EDP2 for the PBs which are already borrowers under EDP2 and meet all the project’s eligibility criteria.

9. Changes to Ukrainian legislation in October 2011 restricted lending in foreign currency to households and non-exporting enterprises. Therefore, extension of new FX loans to the limited group of eligible Ukrainian sub-borrowers became more competitive. On the other hand, in light of the deleveraging process, in particular by foreign bank subsidiaries in Ukraine and their efforts to diversify their sources of funding within Ukraine, the interest for long-term EDP2 AF resources may potentially increase from the banking system, including from banks with foreign ownership.

10. Going forward, the Bank team recommends that UEB considers possible participation of other banks in the Project, especially smaller Ukrainian banks. The experience to date shows that regional banks with domestic capital are more likely to show sustained interest in the project than larger banks. These banks are also well positioned to reach out to smaller prospective exporters with limited access to finance, i.e., the target group where EDP2 can have the largest developmental impact. To this effect, the Bank suggests that UEB undertakes a systematic review of Ukrainian banks in Group 2 and 3, seeking out institutions with sound financing indicators and transparent ownership structure which can potentially join the EDP2 program.

11. In the meantime, UEB itself remains well placed to continue the utilization of project proceeds through a direct lending instrument. Under the EDP2 AF, UEB has an allocation of US$45 million (30% of the total AF) for direct lending to its exporting clients. Based on its relatively strong financial position and generous capital support from the Government of Ukraine, UEB is planning to continuously increase lending to real sector over the course of 2012-2014. The UEB management assured the Bank team that UEB is capable to allocate the direct lending component of the EDP2 AF proceeds to concrete sub-projects during the Project’s extended lifetime. Special internal staff incentive systems have been put in place to encourage usage of the EDP2 funding resource in UEB. At the time of the team visit UEB was looking at a few prospective sub-projects totaling around US$36.2 million.

Implementation Arrangements

12. The internal UEB Project implementation arrangements remain fully satisfactory. Since March 2010, UEB maintains a special department responsible for administration of multiple credit lines provided by WB, EBRD and other developmental partners. The department has inherited most of the qualified personnel who had worked for EDP2 PIU in the past, and additional staff has been added. Separate units for Export Development and Energy Efficiency operate within the department. These arrangements are consistent with earlier recommendations by the WB team, and continue to ensure that that UEB’s institutional capacity for EDP2 implementation remains strong.

Assessment of the financial compliance of PBs

13. Following the Bank’s earlier recommendations, UEB closely monitored the financial performance all PBs under the program and remained conservative in selecting new eligible PBs. As was recommended during April 2010 and June 2011 visits, UEB reduced the EDP 2 SLA allocations for three banks (Nadra Bank, Ukrgasbank and Kreditprombank) to the actual disbursement amount and increased allocations for Credit Dnipro and Megabank.

14. Banks’ financials under IFRS were not available for the time of the visit of the Bank’s team. Therefore, the Bank has reviewed PBs compliance under UAS based on the PBs annual UAS audited financial statements and the respective letters from the banks’ management and NBU. The Bank will be in the position to confirm PBs compliance with EDP 2 eligibility criteria only upon receipt of PBs’ IFRS audited financial statements and auditors’ confirmation letters for compliance with EDP2 IFRS based eligibility criteria. Most of the PBs expect having their year-end 2011 financial statements prepared in line with IFRS and audited according to ISA by the middle or end of May 2012. The same applies for the auditors and management confirmation letters.

|Table 2 EDP 2 Participating Banks - Key Financial Indicators 2011/2010 according to UAS |

|Banks |Assets, |% change |Loans, |% change |Share capital, |% change |Financial result, |

| |UAH bln | |UAH bn | |UAH bn | |UAH bn |

| |2011 |2010 |

| |IFRS |UAS |IFRS |UAS |

|PREQUALIFICATION CRITERIA |

|Asset Size (millionUAH) |min 500 |

|Paid-in statutory capital (million EUR) |min 10 |

|Annual financial statements according to IFRS together with the independent auditor’s |X | |X | |

|report for at least 2 years | | | | |

|Share of loans to exporters / total loan portfolio (%) |min 10 |

| Period of the PB consecutive operation (years) |min 3 |

|NBU confirmation of PB’s compliance with Ukrainian legislation and eligibility criteria| |X | |X |

|under UAS | | | | |

|ELIGIBILITY CRITERIA |

|Capital adequacy ratio CAR (%) |10 |10 |10 |10 |

|Single Insider Lending Exposure (%)* | max 5 |

|Aggregate Insider Lending (%)* |max 30 |

|Single Exposure (%) |max 25 |

|Total Large Exposures (%) |max 800 |

|Total Foreign Exchange Position** |max 35% |

|long open currency position (%) |30 |5 |5 |

|short open currency position (%) |5 |10 |10 |

|Liquidity Ratio*** |min 25% | |

| | | |

|Quick ratio (%) | |min 20 |min 20 |

|Current ratio (%) | |min 40 |min 40 |

|Short-term ratio (%) | |min 60 |min 60 |

|CERTIFICATION LETTERS & AUDIT REPORTS |

|NBU confirmation of PB’s compliance with EDP 2 Eligibility Criteria calculated under | |X | |X |

|UAS | | | | |

|NBU confirmation of PB’s compliance with and all the NBU prudential requirements during| |X | |X |

|the last 6 months | | | | |

|NBU confirmation of PB’s compliance with NBU loan classification and loan loss | |X | |X |

|provisioning requirements | | | | |

|PB’s management certification of PB’s compliance with IFRS and UAS eligibility criteria|X |X |X |X |

|Auditor’s certification of PB’s compliance with EDP 2 IFRS eligibility criteria |X | |X | |

|Audited financial statements for the last 2 years |X |X |X |X |

* For the purposes of the EDP 2 eligibility criteria under IFRS, calculation of a insider/related party single or total lending exposure ratios for the state owned banks or banks with state participation includes loans, guarantees and securities to the state and state owned companies.

** For EDP 2 FX position under is calculated based on the then-current NBU requirements; EDP 2 AF FX position is calculated based on the renewed NBU requirements and is subject to further change if NBU requirements change;

***EDP 2 AF liquidity ratio under UAS

16. Based on the information provided to the Bank, three banks (UEB, Megabank and Credit Dnipro bank) reported full compliance with UAS based EDP 2 eligibility criteria and the NBU prudential requirements. This is confirmed by the banks’ end 2011 UAS based audited financial statements and the confirmation letters issued by the management of these PBs and the NBU banking supervision officials. The information on PBs compliance with EDP 2 AF eligibility criteria calculated according to UAS has not been provided, however, based on the information reviewed during the visit, these three banks also meet UAS based EDP 2 AF criteria. Compliance of these three banks under IFRS will be confirmed upon receipt of the respective IFRS based audited financial statements and the confirmation letters from the auditors and the management of banks.

Table 4 PBs compliance with EDP 2 Eligibility Criteria under IFRS and UAS, 2011

|Banks |Eligibility Criteria Compliance |Recommended Action |

| |UAS |IFRS | |

|Ukreximbank |compliant |2011 information is not available. | Continued compliance with EDP2 criteria |

| | |As of mid 2011, UEB non-compliance | |

| | |with 3 ratios – waiver was granted| |

|Credit Dnepr Bank |compliant |2011 information is not available |Review IFRS audited financial statements and confirmation letters (from |

| | |yet. 2010 - compliant |the auditors and management) to confirm compliance and bank’s |

| | | |eligibility under EPD 2 and EDP 2 AF |

|Megabank |compliant |Information is not available yet. |Review IFRS audited financial statements and confirmation letters (from |

| | |2010 – non-compliance with |the auditors and management) to confirm compliance and bank’s |

| | |liquidity ratio; waiver was granted|eligibility under EPD 2 and EDP 2 AF. |

|Kreditprombank |non-compliant |Information is not available yet. |Continued close monitoring of financial performance of the bank; no |

| | |2010 - non-compliant (CAR) |renewal of disbursements under EDP2 AF until full compliance with EDP 2 |

| | | |eligibility criteria |

|Ukrgasbank |non-compliant |2011 information is not available |Continued close monitoring of financial performance of the bank; no |

| | |yet. 2010 - non-compliant |renewal of disbursements under EDP2 AF until full compliance with EDP 2 |

| | | |eligibility criteria |

|Nadra Bank |non-compliant | non-compliant |Nadra Bank has repaid overdue interest accrued by UEB in Augsut 2011, |

| | | |but the principal amount under SLA is not repaid. Discussions on loan |

| | | |restructuring under SLA have been stalled since 2009 despite Nadra |

| | | |Bank’s change of ownership. |

17. The other three banks which have SLAs with UEB under EDP 2, namely Nadra bank, Ukrgasbank, and Kreditprombank, continue to be not fully compliant based on the end-2011 results. While the IFRS data is not available yet, the Bank has reviewed and confirmed these PBs’ non-compliance with UAS requirements, specifically (details are provided below):

• Bank Nadra continues having the most severe project’s eligibility criteria and SLA non-compliance problems. The Bank is found non-compliant both under UAS and IFRS eligibility criteria;

• Ukrgasbank – is non compliant with two criteria under UAS; its compliance under IFRS could not be confirmed during the Bank’s team visit due to absence of data;

• Kreditprombank – reported negative end 2011 financial result under UAS. Its compliance under IFRS could not be confirmed during the Bank’s team visit due to absence of data

18. Out of six BPs, three banks (UEB, Credit Dnipro and Megabank) remained active under EDP 2 and continued to disburse under the credit line since the time of the previous Bank’s missions in April 2010 and June 2011. Ukrgasbank and Kreditprombank continued to timely service the credit line and fees to UEB, however new disbursements for these PBs have been frozen and credit limits reduced. Nadra Bank has stopped servicing the credit line in early 2009 and didn’t provide required reporting to UEB. In the second half of 2011, after Nadra Bank has changed the owner[2], it repaid the interest accrued on UEB loan to Nadra Bank under EDP 2. However, no more progress was achieved. Some Nadra Bank’s reporting to UEB has been renewed.

Assessment of the financial compliance of Ukrexim Bank

19. Based on bank’s 2011 reporting under UAS and as confirmed by the NBU, UEB continues to comply with all NBU prudential requirements and UAS EDP2 eligibility criteria. UEB reported UAH 88 million of net profit in 2011 under UAS. Auditor’s and management’s confirmation of UEB compliance with EDP2 eligibility criteria under IFRS was not available at the time of the mission, and will be reviewed by the team once available. Based on July 1, 2011 and end 2010 IFRS data, UEB reported non-compliance with three EDP 2 eligibility criteria, namely single insider lending, aggregated insider lending and single exposure. Upon consideration of the rationale for the incompliance, one-time wavers were given by the Bank. The non-compliance resulted from the IFRS treatment of state-owned enterprises and the sovereign (as the issuer of treasury securities) as related parties to UEB which is fully owned by the state. The Bank continues to strongly urge UEB and the Ukrainian authorities to limit concentration of credit exposures to the state or state-controlled companies that may negatively affect financial soundness and prudential ratios of UEB. The Bank team would like to continue receiving quarterly summary of UEB risk exposures in order to be able to monitor the situation.

20. UEB needs to strive to bring its performance into full compliance with EDP 2 AF eligibility criteria in the future. In the past several years the Bank has granted UEB with temporary waivers (the most recent one in May 2012), with the understanding of the challenging economic situation in the country in the aftermath of the crisis and the crucial role of UEB in Ukraine’s economic recovery. The Ukraine’s economy is now gradually recovering after 2008 shock, and UEB sees increasing demand for lending from private clients and PBs to enable diversification of its lending exposures and improved risk profile. UEB should be in a position to gradually bring its performance into full compliance with provisions of EDP Loan Agreement. The Bank therefore will continue to monitor the situation and expects that UEB would perform necessary steps to bring to compliance, in timely manner, respective IFRS-based eligibility criteria where UEB has been non-compliant.

Table 5 UEB compliance with EDP 2 eligibility criteria under UAS and IFRS, 2010-2011

|UKREXIMBANK |Benchmarks |IFRS |UAS |

|Eligibility Criteria |IFRS |UAS |2011 |1-Jul-11 |2010 |2011 |1-Jul-11 |2010 |

|Single Insider Lending Exposure (%) |max 5 |max 5 |n/a |13.21 |16.46 |0.7 |2.16 |0.72 |

|Total Foreign Exchange Position |max 30 |max 15 |n/a |10.19 |7.1725 | | |  |

|short open currency position (%) |max 10 |max 10 (5) |n/a |0 |0.0025 |4.0173 |0 |0.0053 |

|Liquidity Ratio |min 25 | |n/a |31.44 |27.74 | | |  |

|Quick ratio (%) | |min 20 | | | |70.51 |101.83 |93.09 |

|Current ratio (%) | |min 40 | | | |49.00 |99.32 |83.26 |

|Short-term ratio (%) | |min 60 | | | |86.62 |96.82 |103.01 |

|CERTIFICATION LETTERS & AUDIT REPORTS |  |  |  |  |

|NBU confirmation of PB’s compliance with and all the NBU prudential requirements | |yes |yes |yes |

|during the last 6 months and a positive year end result | | | | |

|NBU confirmation of PB’s compliance with NBU loan classification and loan loss | |yes |yes |yes |

|provisioning requirements | | | | |

|PB’s management certification of PB’s compliance with IFRS and UAS eligibility |n/a |yes* |yes* |yes |yes |yes |

|criteria | | | | | | |

|Auditor’s certification of PB’s compliance with EDP 2 IFRS eligibility criteria |n/a |yes* |yes* |yes |yes |yes |

|Audited financial statements |n/a |yes |yes |yes |yes |yes |

|*Non-compliance was reported; UEB asked for the Bank's waiver. |

Institutional Development of UEB (Component B)

21. The Borrower by now has fully utilized the US$3.375 million allocated to this Component for purchasing and installing hardware for improved centralized data warehouse. Some delays in implementation of this component were caused in 2010-2011 by the need to complete the reconstruction of premises where the hardware was installed. The team inspected the installation and commends the UEB project team for successfully implementing a complicated procurement task and installing the purchased equipment and software in the renovated facilities.

22. Centralized Data Warehouse System was successfully completed. It is an integrated infrastructure which delivers the access to corporate data and use of modern technology of managing databases and data warehouses for the collection, structuring, storage and processing of relevant information.

23. The Data Warehouse system JSC "UkrEximBank” is an open system with centralized capabilities to manage performance and scalability and has a wide range of functions and tools to connect and manage large amounts of data, their usage and protection. Also it provides data storage based on modern methods of information lifecycle management and unity of management and data storage processes, system configuration settings, monitor of its status, to ensure simple, secure and efficient work of users. The System provides guaranteed reliability and data integrity of application systems, which are important for the bank.

Status of financial management arrangements

24. The last full scope FM monitoring of the project was carried out in December 2011. The Financial Management arrangements, including accounting, reporting, budgeting, flow of funds, and staffing of UEB for implementation of the Project, were assessed as satisfactory to the Bank. Accounting and reporting functions are being properly carried out in the automated accounting and reporting system, strong system of internal controls is in place and staffing is adequate to project needs. No further recommendations were made based on the last FM supervision. FMRs have been submitted on time in 2011-2012. The auditors (Ernst and Young) have issued unqualified audit reports on both the project and entity financial statements for 2010, and all audit reports have been submitted before the deadline. No internal control weaknesses for implementation of the project have been noted by the auditors.

Status of procurement arrangements

25. A procurement post review was conducted on March 26, 2012. The objective of the post review was to check if the procurement by sub-borrowers was conducted in accordance with the agreed provisions of the legal agreement and applicable Guidelines. There were no issues identified and UEB should continue to follow current practices related to procurement and contract management. A more detailed account of the review is provided in Annex 3 to this Aide Memoire.

Additional Financing for EDP2

26. The EDP2 Additional Financing of US$150 million was approved by the Bank on August 25, 2012, signed on October 4, and the legal agreements became effective on January 31, 2012. The AF funds are ready to be disbursed. The UEB will start disbursements of the AF funds shortly, once the original EDP2 amount is fully exhausted (expected in July-August 2012). It is expedient that new SLAs with Participating Banks are signed as soon as possible so that the wholesale component of the AF can start to be disbursed in addition to direct lending by UEB.

27. Recommended Next Steps

• Joint agreement by end-September 2012 between WB and UEB on measures for bringing the full set of eligibility criteria applicable to UEB to full compliance;

• Signing of at least 2 new SLAs with existing and new Participating Banks before end of September 2012, and a total of 4 new SLAs before end-2012;

• Disbursements under the original EDP2 credit line component are fully completed by end-August 2012. At least US$15 million are committed / disbursed from the EDP2 Additional Financing credit line by end-2012;

• Implementation of the EDP2 Component B is fully completed by end-August 2012.

Annex 1. List of Current Sub-Projects

Attached in a separate file

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[1] Date of signing the amendment to the Loan Agreement to allow direct lending by UEB to sub-borrowers.

[2] On August 11, 2011 NBU has officially terminated the temporary administration in Nadra Bank by announcing the purchase of the bank by the DF Group. At the moment the new management of the bank was appointed.

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