Wednesday, January 28, 2009

Corporate wipe-out and homeowners

Figures released by ICC Information today show that 21% of trading companies in Ireland have a ‘Negative Net Worth’. In other words, their balance sheet liabilities exceed the value of their assets. Net worth is composed primarily of all the money that has been invested since company inception, as well as retained earnings for the duration of its operation.

“A total of 28,513 trading companies in Ireland have a negative net worth according to their latest filed accounts. Not surprisingly the largest number of these were in the ‘Construction’ sector with 17.2%. However, in terms of actual monetary value ‘Leasing and Renting’ were top with a total negative net worth of over €7 billion.”

This is a scary sign of corporate debt overload, but it is also a sign of the unsustainable nature of many business models, especially those that emerged in 2003-2007 period of construction boom, based on cheap credit, over-supply of liquidity and overly optimistic valuations of demand.

This goes to the heart of debate about credit supply to Irish corporates.

Majority of these companies should not be rescued by cheaper fresh lending, as their businesses are no longer sustainable in the environment of much slower growth.

However, there is a second argument to be made against increasing the pressure on the banks to lend. Currently, some 140,000 households are in negative equity – with the value of their mortgages exceeding the value of their homes. Factoring in the down payments, stamp duty and closing costs, I would estimate that some 180,000 Irish households are actually in the negative equity territory, implying an insolvency risk rate of ca 9% for homeowners.

Large scale corporate bailouts and credit extensions will inevitably come at the expense of consumers and homeowners. Will this drive homeowners insolvency rates to 21% on par with the corporates? Imagine the number of financially bankrupt families in excess of 315,000…
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