[Financial Stability Status] The Proportion of Corporate Loans with High Default Risk Exceeds 10%

Financial Institution Loans Held by Risky Companies at 10.4%
Companies with Repayment Risk Also Near 40% Level

[Asia Economy Reporter Kim Eun-byeol] Due to the spread of COVID-19, corporate profitability has declined and debt has increased, resulting in the proportion of corporate loans held by companies with a high risk of default exceeding 10%. Loans that have relatively lower default risk but require careful management have also surpassed 40% of total corporate loans. In particular, companies in severely impacted sectors such as aviation, accommodation and food services, and shipbuilding are bearing significant risks, raising concerns that if the COVID-19 recovery is slower than expected or government financial support is discontinued, the number of high-risk companies could increase substantially.

According to the "Financial Stability Report (March 2021)" released by the Bank of Korea on the 25th, companies classified as "repayment risk companies" (hereafter referred to as risk companies)?those failing to meet all criteria for interest coverage ratio, debt repayment ratio, and debt ratio?accounted for 6.9% as of the end of last year. The proportion of financial institution loans (risk loans) held by these risk companies rose to 10.4%, continuing an upward trend. The Bank of Korea surveyed 2,175 companies to assess corporate debt repayment risks.

The risk companies classified by the Bank of Korea can be interpreted as companies with a high likelihood of default. According to the report, an analysis of financial indicator patterns over the seven years preceding actual defaults among companies that defaulted between 2007 and 2019 revealed that these companies exhibited all of the following phenomena 2 to 5 years before default: an interest coverage ratio below 1, a debt repayment ratio exceeding 5 times, and a debt ratio exceeding 200%.

Although companies failing to meet all three criteria are not necessarily at the point of default, those requiring caution in repayment risk management (companies failing to meet two or more criteria, hereafter referred to as caution companies) accounted for nearly 40%. The analysis showed that the proportion of caution companies was 36.8%, and the proportion of financial institution loans held by caution companies (hereafter referred to as caution loans) was 40.9%, both increasing compared to the previous year. While corporate loans have increased significantly, about 40% of these are classified as loans requiring careful attention.

By industry, the proportion of risk companies was high in aviation (71.4%), shipping (25.0%), and accommodation and food services (22.2%) due to travel contraction and sluggish face-to-face services. In the aviation industry, this means that 7 out of 10 companies have a high risk of default. The proportion of risk loans was higher in sectors with large loan sizes per company, such as machinery and equipment and shipbuilding.

Although the proportion of risk companies is not very large at present, the Bank of Korea noted that recovery speeds vary by industry this year and interest rates may normalize, potentially increasing interest burdens. If industries with slower recovery also face higher interest burdens, their financial indicators could deteriorate, leading to classification as risk companies.

For example, under a basic scenario where corporate sales growth reaches 7.2% this year and overall corporate performance recovers to pre-COVID-19 levels, the proportion of risk companies would decrease significantly from 6.9% last year to 5.3% this year, and the risk loan ratio would drop from 10.4% to 5.2% during the same period. However, if the government normalizes financial support measures or interest costs return to pre-COVID-19 levels due to rising interest rates, the proportion of risk companies could be 5.7%, and the risk loan ratio could also reach 5.7%, even with COVID-19 recovery. In a pessimistic scenario where COVID-19 prolongs and poor performance continues while interest rates normalize, the proportion of risk companies could rise to 8.5%, and the risk loan ratio could increase to 16.7%.

A Bank of Korea official stated, "If average interest costs rise to pre-COVID-19 levels due to normalization of financial support measures and interest rate increases, companies currently in sound financial condition could be classified as risk companies. Care must be taken to prevent credit risks in vulnerable sectors from emerging all at once when financial support measures are discontinued."

Meanwhile, the average interest coverage ratio of companies assessing their ability to pay interest last year was 4.4 times, slightly improving as loan interest rates declined. However, excluding the electronics sector, which saw significant performance improvement during COVID-19, the interest coverage ratio dropped sharply to 3.1 times. The debt repayment ratio (debt/EBITDA), indicating principal repayment ability, averaged 3.0 times, slightly worsening compared to the previous year due to increased borrowing. Excluding the electronics sector, the debt repayment ratio also worsened significantly, rising to 4.2 times. The debt ratio (debt/equity), indicating reliance on borrowed capital, averaged 79.0%, continuing an upward (worsening) trend since 2018. Amid increasing corporate debt burdens in 2020 and declining profitability, overall corporate debt repayment ability deteriorated considerably.

The Bank of Korea views that while government financial support is reducing corporate debt repayment burdens, the proportion of companies with weak repayment ability is increasing, widening disparities among companies. The proportion of companies with an interest coverage ratio below 1, meaning they cannot even cover interest expenses with operating profit, grew from 36.1% in 2019 to 40.7% last year.

This content was produced with the assistance of AI translation services.