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Debt & 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

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Debt & Firm Vulnerability

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  1. Debt & Firm Vulnerability Jack Glen IFC March 2004

  2. Why Do Firms Get into Trouble? • Poor Management • Technological Innovation • Market Competition • Demand Declines • Business Cycle • Crisis

  3. 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

  4. 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

  5. Excess Leverage? Domestic Bank Credit

  6. Excess Leverage?Spot the Emerging Market CountryMedian, Total Liabilities/Total Assets

  7. Declining East Asian Debt LevelsTotal Liabilities/Total Assets, Median

  8. Korea: Total Liabilities/Total Assets% of Companies

  9. Short-term Debt Vulnerability?

  10. Too Much Short-Term Debt?Median Current Liabilities/Total AssetsOECD, Low Middle & Upper Middle Income Countries

  11. Too Much Short-Term Debt?Spot the Emerging Market CountryMedian, Total Current Liabilities/Total Assets

  12. Excess External Leverage?

  13. Private Flows to Emerging Markets$ Billions

  14. East Asian Corporate BorrowersLT Debt/Total Debt,Firms with FX Debt & with no FX Debt Allayanis, Brown & Klapper (2003)

  15. 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

  16. Cash Flow and Interest CoverageGlen (2004) • Cash Flow Volatility • Business Cycle • Currency Depreciation • Interest Rate Increases • ICR=EBITDA/Interest Expense • What is impact of these factors on ICR?

  17. The Data • Osiris • 41 Countries • 1994-2001 • Manufacturing • 7 Sectors • 44,424 Firm Years

  18. Interest Coverage RatioAll Countries & Firms, EBITDA/Interest Expense, 2000

  19. Interest Collection RateBrazil, All Firms (149), 2000

  20. ThailandInterest Coverage Ratio (Median),GDP Growth (%) & Interest Rates (%)

  21. The Findings • Significant Business Cycle Effect • -5% ΔGDP –1 Δ ICR • Significant Sector Differences • General Manufacturing Hit Hardest • Significant Interest & Inflation Effects • Both Negative & Economically Large

  22. Developed and Emerging Markets • Better fit for Emerging Markets • GDP impact same • DM sensitive to Inflation • EM sensitive to Interest Rates

  23. Impact of a 5% Decline in GDPAll Countries & Firms, EBITDA/Interest Expense, 2000

  24. Turnover & Margins • Returns correlated with Business Cycle • Margin Effects Hard to Discern • Turnover Effects Strongly Negative

  25. 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?

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