Corporate debt ratios Should we be worried? - Credit Agricole [PDF]

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Jul 12, 2017 - 39.2. 114.2. 270.4. MSBs. 96.6. 65.3. 143.7. 290.1. Large corporates. 111.8. 92.6. 164.0. 286.9. SMEs < 250 employees. MSBs > 250 and ...
An occasional publication – No. 17/186 – July 12, 2017

FRANCE – Corporate debt ratios Should we be worried?  The debt ratio of non-financial companies (NFCs), defined as the ratio of debt (Credits and debt securities) to value-added, has grown significantly since 2006 to reach a record high of close to 135% at the beginning of 2017. At first sight, this development seems worrying.  Nevertheless, other measures, such as net debt ratio or the debt-to-equity ratio (ratios linked to corporate accounting) provide a more reassuring image, with less pronounced evolution and a stabilisation in recent years.  The high level of the debt ratio and its continuous increase are explained by the structural financing gap occurring each year and more recently by the very advantageous financing conditions. In the coming years, long-term rates should rise gradually and profits should keep recovering (higher growth, new tax cuts). The second point could limit the increase in the debt ratio. However, the first point is a greater cause for concerns. It would limit the propensity to scale issue new debt at a low cost but it would also increase the interest payments for companies.  However, it is mostly the dynamic of the indebtedness of the large companies that explains the progression of the global debt ratio and that can be worrying and suggests to be cautious. The ratio of indebtedness of large corporates has indeed been driven mostly by the issuance of debt securities witch were available mostly to large corporates. The debt ratio of these is very high and keeps growing whatever the type of ratio used. This greater recourse to debt is used, beyond their funding requirements, for financial investment: share buy backs and participations, etc. and particularly for foreign direct investments (taking equity interest in foreign companies), which involves risks in case of a market downturn. However, the debt ratio of SMEs is

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more contained and tends to stabilize, or even to go down slightly.

A marked rise in debt ratios The debt ratio of non-financial companies (NFCs) is defined as the ratio between their debt and their value-added (VA). On the Bank of France’s definition, NFC debt is equal to:  Loans granted to resident NFCs by resident financial institutions  + Bonds issued by resident NFCs  + Short-term negotiable debt securities issued by resident NFCs. This measure does not include inter-company loans (customer and supplier receivables), nor intra-group loans, nor those granted by non-residents to resident NFCs. It has been observed that this ratio has seen a steady, fairly marked rise since 2006. It stood at 134.2% of value-added in Q1 2017, compared with 94% at the start of 2006. The rise in debt ratios is very marked in respect of debt securities (bonds and short-term negotiable debt securities). Total outstandings to value-added has doubled in eleven years, rising from 28.6% in Q1 2006 to 53.2% in Q1 2017. Conversely bank debt (loans/AV) has seen a more modest long-term increase, rising from 65.5% in 2006 to 81% in early 2017 and has been virtually unchanged in recent years.

France – Corporate debt ratios Should we be worried?

Olivier ELUÈRE

Ludovic MARTIN

[email protected]

[email protected]

Evolution of indebtedness of NFC

Non-financial company debt ratios

%

25

130

yoy, %

20

120

15

110

10

100

5

90

0

80

-5

70

-10 04 05 06 07 08 09 10 11 12 13 14 15 16 17

60 96

98

00

02

04

06

08

10

Loans and securities/VA Source : Bank of france, Crédit Agricole SA

12

14

16

Credit

Loans/VA

The rise can secondly be explained, in the recent past, by very favourable financial conditions. The costs of funding on the markets have become extremely low, ranging from 0.6% to 0.9% between mid-2016 and April 2017, as has the cost of credit, although to a lesser extent (between 1.4% and 1.7%). Total outstandings of securities issued by NFCs, which is a highly volatile figure, have accelerated sharply in recent months, by 11% in the twelve months to March this year, and by 9.4% in the year to April, while lending has risen at a more reasonable rate of 5.4% over twelve months. Firms have substantially increased their debt levels, and especially their securities issuance, due to the very low cost of funding, strong investor demand, ECB securities purchases (as part of its Quantitative Easing programme), and the spectre of higher bond rates.

Total debt

Source : Bank of France, Crédit Agricole SA

How may we explain this steady increase in NFC debt? It can be put down, first off, to persistent NFC funding requirements. The funding requirement is the difference between retained earnings (after-tax profit, interest, dividends) and investment and inventory expenditures. Since 1990, this balance has been negative every year except in 1996-1999. Due to low growth and the high level of taxes and levies, the free cash flow generated by firms is insufficient to cover investment and inventory expenditures. The recent support measures (CICE, Responsibility Pact) have only allowed for a limited decrease in this financial gap. This has been leading to a constant recourse to debt and a steady rise in outstanding debt and the debt ratio.

Debt securities

Cost of indebtedness of NFC 6

%

5 4 3 2 1 0 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Total debt Credit Debt securities

Source : Banque of France, Crédit Agricole S.A.

In 2016, therefore, we observed net recourse to debt of 84 billion euros, substantially higher than the 45 billion euro funding requirement. The corporate funding requirement is close to net recourse to debt (loans and market securities) and generally trends in a similar fashion (see graph), but they are not equal. The financial equilibrium of the corporate account is more complex, as it also includes equity issues and cash and equivalent in its sources of funding. NFCs: Funding requirement and lending and securities flows 10

(%)

5

0 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 Net lending and securities flows/VA Funding requirement/VA Source : INSEE, Bank of France, Crédit Agricole S A

No. 17/186 – July 2017

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France – Corporate debt ratios Should we be worried?

Olivier ELUÈRE

Ludovic MARTIN

[email protected]

[email protected]

This greater recourse to debt, and to debt securities in particular, can mainly be attributed to the large corporates, which have privileged access to the capital markets. It is used, over and above their funding requirements, for financial investment: purchase of shares, equity interests, shares in mutual funds, etc.). These financial investments include foreign direct investments (equity interests in foreign companies). This type of investment is major for these large corporates due to their size and international operations. In the 2016 financial statements of the Bank of France, we note a marked increase in the “share purchases” item, at 59 billion euros, compared with 46 billion in 2015. Firms have taken advantage of the very low interest rates to increase their financial investments. They have also bolstered their cash holdings (precautionary saving, a cushion to help them react rapidly to opportunities, etc.). The ratios by size of corporates and on ratios linked to corporate accounting are coming from the FIBEN database of the Bank of France. These figures are not directly comparable to the monthly data of the Bank of France quoted in the previous paragraphs. These concern all non-financial companies, while the FIBEN data are on a more restricted scope1. Moreover, the FIBEN data stop in 2015. Generally speaking debt levels among large corporates is far higher than those of SMEs and has increased markedly since 2006, while those of SMEs have been falling in recent years. Ratio of debt to value added % 170 150 130 110 90

of 2017 against 3.9% on average in 2015 and 4.2% in 2016. Outstanding credit used by size of corporate 15

yoy, %

10 5 0 -5 -10 -15 -20 12

13 MSBs

14 15 Large companies

16

17 SMEs

Source : Central of risks, Banque of France, Crédit Agricole S.A.

The rise in debt should be qualified Several factors argue in favour of putting this sharp rise in French corporate indebtedness into perspective. 1) The recent surge in corporate debt derives from the unprecedented ultra-low interest rate environment combined with very high financing requirements. These two factors should tend to reverse during the coming years. As interest rates gradually recover, this windfall effect will gradually fade. Moreover, in line with our growth forecasts, NFC value-added should remain on an uptrend. In addition, firms are likely to benefit from lower taxes and levies going forward. This should help to improve profit margins, reduce funding requirement levels for NFCs (by around 30 billion euros a year) and ultimately contain the increase in firms’ debt to value-added ratios. 2) The debt to equity ratio3 tends to show that French firms are still in relative control over their debt.

70 50 96

98

MSBs

00

02

04

06

Large corporates

08

10

12

SMEs

14 Total

Source : Bank of France, Fiben, Crédit Agricole S.A.

This increase in the debt ratio of large companies has most likely continued in the recent past. Debt securities issuance has been very dynamic in recent months. We can also observe in 2017 an acceleration in the outstanding bank credit (source Banque de France, “Centrale des risques”2. It went up 7% year on year on average during the first four month 1

In the FIBEN database, annual figures are calculated on a sample made of non-financial corporations of the private sector whose sales revenue is above 750.000 euros or whose indebtedness is below 380.000 euros.

No. 17/186 – July 2017

The ratio has seen fairly sharp variations, with a sharp increase between 1999 and 2002 (the period of the internet bubble) peaking at 99%, followed by a sharp fall between 2003 and 2007, with a low of 78% in 2007, since when it has been fairly stable. In 2015, the ratio was similar to that of 2008 (85%).

2

Credits above 25.000 euros, for non financial companies and individual entrepreneurs. 3 Equity = the total value of shares issued by the company plus total retained earnings.

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France – Corporate debt ratios Should we be worried?

Olivier ELUÈRE

Ludovic MARTIN

[email protected]

[email protected]

4) Corporate borrowing capacity (cash flow/ financial debt) has been improving since 2013. By size, the ratio has been improving for all company categories.

Debt to equity ratio

% 130 120

Corporate free cash flow levels have been picking up relative to their debt since 2013, whereas the opposite had been observed between 2007 and 2012. The change has been justified in particular by the recent improvement in NFC margins, which have reached high levels (31.7% in Q1 2017; 1.7 points above their 2013 level).

110 100 90 80 70 96

98

00

02

04

06

08

10

12

14

MSBs

Large corporates

SMEs

Total

Borrowing capacity

% 26 24

Source : Bank of France, Fiben, Crédit Agricole S.A.

22

For the record, the ratio should be less than 100% in order to ensure that creditors are repaid in the event of bankruptcy. On average, firms therefore seem to be in control of their debt. By company size, since 2008, the ratio has been increasing for large corporates (+8 points, to 91%). Conversely, it has fallen sharply among SMEs (by 19 points, to 71%) and mid-sized businesses (by 8 points, to 82%). 3) The net ratio of corporate financial debt (net debt4/value-added) seems to have been fairly stable since 2008, falling 3% in 2008-2015. By company size over this period, it has risen for large corporates (by 3.5 points, to 55%), while it has fallen quite sharply for SMEs (down 17 points, to 25%) and mid-sized businesses (down 10 points, to 46%). The change can be explained by the growth of firms’ cash reserves. In times of economic uncertainty, an increase in cash holdings can provide firms with sufficient flexibility to react to investment opportunities as well as with precautionary savings should the business climate deteriorate.

18 16 14 12 96

98

00

MSBs

02

04

06

08

10

12

14

Large corporates

SMEs Total Source : Bank of France, Fiben, Crédit Agricole S.A.

5) In terms of creditworthiness, the ratio of doubtful loans among French companies is limited especially when compared with that of countries in the southern eurozone, and compared with the levels seen in the 1990s in France. The ratio of doubtful loans among companies is higher than in 2008, but has been more or less unchanged since 2013 at around 4%.

14%

Net financial debt ratio

% 110 100 90 80 70 60 50 40 30 20

20

Share of NPL for corporate (NPL gross amount/ gross outstanding credit)

12% 10% 8% 6% 4% 2% 0% 96

98

00

MSBs

02

04

06

08

10

12

14

96 98 00 02 04 06 08 10 12 Source : Banque of France, Crédit Agricole S.A.

14

16

Large corporates

SMEs Total Source : Banque de France, Fiben, Crédit Agricole S.A.

4

Net debt = gross debt minus certain financial assets held by NFCs such as deposits, short-term debt securities, and mutual fund units.

No. 17/186 – July 2017

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France – Corporate debt ratios Should we be worried?

Olivier ELUÈRE

Ludovic MARTIN

[email protected]

[email protected]

Vigilance on the interest rates and large corporates All these factors put the recent increase in French corporate debt into a clearer perspective. Interest rate levels, however, need to be watched. Firms are dependent on an environment characterised by falling rates, which have significantly lowered their cost of financing. The risk of a surge (even a gradual one) of interest rates would limit both the propensity to raise debt and the recently observed strong increase in financial investments. However, it would increase the financial burden for companies and therefore would lower their net profits and their ability to payback their debt. The major part of the corporate debt has been issued with variable rates (around 65%). According to the Bank of France, a 100 basis point increase in both the short term and long term rates would increase the financial burden of corporates by 5 billion within five years. It would cause the debt ratio to rise by 0.5 points.

Besides, the debt ratios of large companies are a cause for concern and incite to greater awareness. Indeed, its dynamic is mainly responsible for the global increase in the debt ratio. This ratio is very high and keeps growing whatever the type of debt ratio used. The threat of a sharp rise in rates could contribute to degrading some firms’ ability to repay. In addition, the ratios presented previously are averages that do not take into account the diversity of the corporate population under study. We cannot rule out the existence of a highly indebted sub-group of businesses, as shown by the table below, from the Bank of France’s December 2015 evaluation of risks to the French financial system.  Financial debts to equity ratio in 2014

(%)

average ratio

median

upper quartile

upper decile

SMEs

76.5

39.2

114.2

270.4

MSBs

96.6

65.3

143.7

290.1

Large corporates

111.8

92.6

164.0

286.9

SMEs < 250 employees

MSBs > 250 and < 5000 employees

Large corporates > 5000 employees Source: Bank of France, Fiben, Crédit Agricole S.A.

No. 17/186 – July 2017

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France – Corporate debt ratios Should we be worried?

Olivier ELUÈRE

Ludovic MARTIN

[email protected]

[email protected]

Crédit Agricole S.A. — Group Economic Research 12 place des Etats Unis – 92127 Montrouge Cedex Publication Manager: Isabelle Job-Bazille - Chief Editor: Armelle Sarda Information center: Dominique Petit - Statistics: Robin Mourier Sub-editor: Véronique Champion Contact: [email protected] Access and subscribe to our free online publications: Website: http://economic-research.credit-agricole.com iPad: Etudes ECO application available in App store platform Androïd: Etudes ECO application available in Google Play platform This publication reflects the opinion of Crédit Agricole S.A. on the date of publication, unless otherwise specified (in the case of outside contributors). Such opinion is subject to change without notice. This publication is provided for informational purposes only. The information and analyses contained herein are not to be construed as an offer to sell or as a solicitation whatsoever. Crédit Agricole S.A. and its affiliates shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising therefrom. Crédit Agricole does not warrant the accuracy or completeness of such opinions, nor of the sources of information upon which they are based, although such sources of information are considered reliable. Crédit Agricole S.A. or its affiliates therefore shall not be responsible in any manner for direct, indirect, special or consequential damages, however caused, arising from the disclosure or use of the information contained in this publication.

N°17/186 – July 2017

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