Monday, September 10, 2012

10/9/2012: Corporate debt iceberg


Another topic, much ignored by the Irish media and the Government and covered by the IMF in today's releases is the corporate debt.

The chart below shows the extent of debt overhang in Ireland:

Here's what IMF has to say on that (emphasis mine):
"Despite an overall decline in corporate debt, an increasing number of firms are facing difficulties covering interest payments on debt. Interest coverage ratios [ratio of earnings before interest and taxes (EBIT) to interest expenses] have declined, with the interest coverage for the median firm having decreased from 6.9 in 2002 to 0.8 in 2009, and with an increasing number of firms not generating sufficient income to cover interest payments on outstanding debt. ... Moreover, the interest coverage is markedly lower for SMEs, with a median of 0.8 compared to 1.9 for large firms. The decline in firm profitability associated with depressed demand is playing an important role in the reduction in interest coverage ratio. This suggests that financing constraints are particularly important among SMEs and in property-related sectors."

In other words, whatever supply of credit is doing, demand for credit is severely constrained by deterioration in firms' financial sustainability.

Although "Leverage for the median firm (which is a small firm) has fallen to 46 percent of equity, with the usage of bank debt showing a similar decline. The data also indicate that trade credit and other non-debt liabilities play an important role in the financing of SMEs, together with internal financing from retained earnings." Although leverage overall has dropped, debt affordability has fallen off the cliff:

Why? "The decline in firm profitability associated with depressed demand is playing an important role in the reduction in interest coverage ratio. This suggests that financing constraints are particularly important among SMEs and in property-related sectors."


So what can be done? Here's the list of IMF outlined options:


"Credit guarantees or subsidies on SME loans can in principle stimulate SME financing. ... Until recently, Ireland was one of the few OECD countries without some form of loan guarantee scheme. ...However, the international experience with SME lending schemes is mixed. ...Moreover, the historical experience shows that credit guarantee schemes can only be effective when there are competent, financially sound banks, with adequate staff to effectively screen and monitor SME loans. ...

Government support for SMEs will need to be complemented with progress in improving the operational capacity of banks to work out loans. The restructuring of SMEs on a case-by-case basis is resource intensive yet important to ensure that where a viable core business exists, that it has the possibility to invest and grow, and contribute to broader economic recovery.

Considering the number of SMEs, it would not be appropriate to rely principally on court-based bankruptcy procedures. Rather, banks will need to build their capacity to design and implement work outs though out-of-court workout processes. Drawing on international expertise may well be needed to help major banks build capacity in this area.

The government could also explore ways to facilitate the securitization of SME loans. However, liquidity premia currently demanded by market participants even on senior
tranches, plus the inability of the Irish government to offer substantial credit enhancements
on such securitizations given the low sovereign credit rating, imply that, at least for the
moment, the market for securitization of SME loans is limited."

So, in other words: NOTHING can be done on the scale required. We are boxed into the corner with SMEs debt overhang too. All state resources and economy's resources wasted on rescuing the banks bondholdres, folks. No powder left for the rest of the economy. Sit tight and pray for a miracle.



Aside: An interesting observation via the IMF concerning the links between the negative equity and property values and firms formation: "With depressed home prices it has become more difficult to finance a new firm using home equity, which has hampered job creation."


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