Download Firm Vulnerability

Debt & Firm Vulnerability
Jack Glen
IFC
March 2004
Why Do Firms Get into Trouble?
Poor Management
 Technological Innovation
 Market Competition
 Demand Declines

Business Cycle
 Crisis

Problem: Fixed Debt Service

FX Denominated Debt
• Mismatched Revenues/Expenses
• FX Impact on Demand

Short-Maturity Debt
• Inability to Roll-over
• Interest rate volatility

Demand Declines
• Interest Coverage
How to Measure Leverage?

Aggregate Measures
External Debt Ratios
 Consumer Debt Component


Firm-Level Measures
Accurate, but what to Count?
 Reveals Distribution of Exposure
 Ability to Service Debt Varies

Excess Leverage?
Domestic Bank Credit
Percentage of GDP
140
120
100
80
1995
1997
2001
60
40
20
0
East Asia and
Pacific
Europe and
Central Asia
Latin America and
Caribbean
Excess Leverage?
Spot the Emerging Market Country
Median, Total Liabilities/Total Assets
0.8
0.7
0.6
0.5
Ireland
Malaysia
0.4
0.3
0.2
0.1
0
1994
1995
1996
1997
1998
1999
2000
2001
Declining East Asian Debt Levels
Total Liabilities/Total Assets, Median
0.75
0.70
0.65
Korea
Thailand
Netherlands
0.60
0.55
0.50
0.45
0.40
1995 1996 1997
1998 1999 2000 2001
Korea: Total Liabilities/Total Assets
% of Companies
35%
30%
25%
20%
15%
10%
5%
0%
TL/TA %
10
0
M
or
e
90
80
70
60
50
40
30
20
10
2000
1995
Short-term Debt Vulnerability?
Current Liabilities
Percentage of Total Liabilities
80
70
60
50
1995
40
1997
30
2001
20
10
0
East Asia
Latin America
Europe and Central
Asia
Too Much Short-Term Debt?
Median Current Liabilities/Total Assets
OECD, Low Middle & Upper Middle Income Countries
0.36
0.34
0.32
0.30
LMI
UMI
OECD
0.28
0.26
0.24
0.22
0.20
1994 1995 1996 1997 1998 1999 2000 2001
Too Much Short-Term Debt?
Spot the Emerging Market Country
Median, Total Current Liabilities/Total Assets
0.45
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
Argentina
Japan
1994 1995 1996 1997 1998 1999 2000 2001
Excess External Leverage?
Corporate foreign debt
Percentage of GDP
35
30
25
20
Latin America and
the Caribbean
Europe and
Central Asia
15
10
5
East Asia
and Pacific
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Private Flows to Emerging Markets
$ Billions
200
FDI
150
Portfolio
100
Debt
50
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
0
-50
East Asian Corporate Borrowers
LT Debt/Total Debt,
Firms with FX Debt & with no FX Debt
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Allayanis, Brown & Klapper (2003)
No FX Debt
FX Debt
How Does Foreign Debt Impact Results?
Allayanis, Brown & Klapper (2003)
Foreign debt no worse than local debt for
stock prices & interest coverage
 FX debt is used because it is longer tenor
 FX debt is used most when FX sales are
available

Cash Flow and Interest Coverage
Glen (2004)

Cash Flow Volatility
Business Cycle
 Currency Depreciation
 Interest Rate Increases

ICR=EBITDA/Interest Expense
 What is impact of these factors on
ICR?

The Data
Osiris
 41 Countries
 1994-2001
 Manufacturing



7 Sectors
44,424 Firm Years
Interest Coverage Ratio
.04
0
.02
Density
.06
.08
All Countries & Firms, EBITDA/Interest Expense, 2000
-50
-40
-30
-20
-10
0
ICR
10
20
30
40
50
Interest Collection Rate
.15
.1
0
.05
Density
.2
.25
Brazil, All Firms (149), 2000
0
5
10
ICR
15
Thailand
Interest Coverage Ratio (Median),
GDP Growth (%) & Interest Rates (%)
20
15
10
ICR
GDP
Int Rate
5
0
-5
-10
-15
1994 1995 1996 1997 1998 1999 2000 2001
The Findings

Significant Business Cycle Effect
•

–1 Δ ICR
Significant Sector Differences
•

-5% ΔGDP
General Manufacturing Hit Hardest
Significant Interest & Inflation
Effects
•
Both Negative & Economically Large
Developed and Emerging Markets
Better fit for Emerging Markets
 GDP impact same
 DM sensitive to Inflation
 EM sensitive to Interest Rates

Impact of a 5% Decline in GDP
.04
0
.02
Density
.06
.08
All Countries & Firms, EBITDA/Interest Expense, 2000
-50
-40
-30
-20
-10
0
ICR
10
20
30
40
50
Turnover & Margins
EBITDA
EBITDA
Sales

x
TotalAssets
Sales
TotalAssets
Returns correlated with Business
Cycle
 Margin Effects Hard to Discern
 Turnover Effects Strongly Negative

Conclusions
Debt Service a major source of
Vulnerability
 Business Cycle Impacts Significant
 Measuring Vulnerability

Product Market Volatility
 Sensitivity to Business Cycle
 Does Market Structure Permit a
Management Response?
