Evergreening is a deceptive banking practice where a lender provides a new Loan to a borrower who is on the brink of defaulting on an existing one. This new loan is used by the borrower to make payments on the old loan, creating the illusion that the original debt is being serviced on time. In essence, it’s a way for a bank to “kick the can down the road,” hiding a bad loan to avoid classifying it as a Non-Performing Asset (NPA). This practice temporarily makes the lender’s Balance Sheet look healthier than it actually is by masking the true Credit Quality of its loan portfolio. Think of it as painting over rust on a car; it looks fine for a while, but the underlying problem is only getting worse. This temporary fix prevents the bank from having to set aside capital as a Loan Loss Provision, artificially inflating its short-term profitability and misleading investors, Regulators, and Auditors.
The mechanics of evergreening are deceptively simple but lead to a dangerous cycle. It all starts when a borrower, be it a company or an individual, can't afford to pay the interest or Principal on their loan. Instead of acknowledging the default, the bank steps in with a solution that benefits its own books in the short term. It offers a fresh loan to the struggling borrower. The borrower then immediately uses the funds from this new loan to pay off the interest due on the old one. Voilà! From an accounting perspective, the original loan is now “current” and performing. The bank avoids taking a hit to its profits, and the borrower lives to fight another day. The problem, of course, is that the borrower’s underlying financial situation hasn't improved. In fact, it has worsened, as they now owe even more money. This process can be repeated, with the loan amount growing larger each time, until the borrower is so buried in debt that the charade can no longer be maintained.
Evergreening isn't just a bit of creative accounting; it's a practice that can have severe consequences for investors, the bank itself, and the wider economy.
The most immediate danger is that it completely distorts a bank's financial health. Investors who rely on Financial Statements to make decisions are flying blind, believing the bank is stable when, in reality, its foundation is cracking. The practice creates a ticking time bomb. When the evergreened loans eventually collapse—and they always do—the resulting losses are often catastrophic, far worse than if they had been dealt with properly from the start. Furthermore, evergreening props up financially unviable businesses, often referred to as Zombie Companies. These companies are kept on life support by an endless drip-feed of new credit, trapping capital that could have been invested in healthy, innovative businesses.
On a larger scale, widespread evergreening leads to a gross misallocation of capital. Money that should be fueling economic growth is instead used to paper over the cracks of failing enterprises. This can stifle competition, reduce productivity, and ultimately lead to a prolonged period of economic stagnation. It creates an unhealthy and fragile financial system where perceived stability is just an illusion.
For a practitioner of Value Investing, evergreening is one of the most serious red flags imaginable. The entire philosophy is built on a foundation of analyzing the true, intrinsic value of a business based on reliable financial data. Evergreening deliberately corrupts that data. It directly attacks the core principle of a Margin of Safety. An investor might think they are buying a bank's stock at a discount to its book value, but if that book value is inflated with worthless, evergreened loans, the margin of safety is a mirage. The risk is hidden, unquantifiable, and potentially devastating.
Detecting evergreening from the outside is notoriously difficult, as it's designed to be hidden. However, a diligent investor can look for clues and warning signs:
Ultimately, evergreening is a sign of poor management and a weak corporate culture. A Value Investor prizes honesty and transparency above all, and evergreening is the exact opposite.