Latin American Firms: Keeping Corporate Vulnerabilities in Check

IMF Blog, December 17, 2012

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Four years after the Lehman Brothers crisis, private companies in the largest and most financially integrated Latin American countries are doing relatively well, despite continuous bouts of global uncertainty.
The LA5 (Brazil, Chile, Colombia, Mexico, and Peru) have benefited from abundant external financing, strong domestic credit, and generally robust demand growth.
Favorable conditions have produced robust corporate profitability and valuation, reasonably contained debt ratios, and lower short-term maturity exposures than those observed in other emerging markets.
However, some vulnerabilities are starting to build up.

Nearly 15 years ago, the failure of large private firms unleashed a deep economic and financial crisis in Asia, despite strong prior economic fundamentals.
The Asian experience shows firms can act as a source or magnifier of adverse shocks.
Boom episodes can create corporate vulnerabilities: overvalued assets can lead firms to borrow too much based on inflated collateral, and abundant capital inflows can raise foreign currency exposures in unhedged firms.
These lessons motivate gauging the financial strength of the corporate sector in the LA5 given the uncertain global environment.

Assessing corporate-sector strength is difficult due to significant data gaps.
The study uses publicly-traded firm-level balance sheet data for large firms (publicly traded) as a proxy, since large firms tend to be “systemic.”
Indicators analyzed include debt burden, maturity exposure, liquidity, collateral, and profitability.

Evidence of rising vulnerabilities:
- A hike in leverage since the Lehman crisis, as measured by debt-asset and debt-sales ratios.
- Higher debt-sales ratios are especially stark for the wholesale trade and the transport and utilities sectors.
- Debt-asset ratios have risen as well, but remain at more manageable levels.
Profitability has been moderating nearly across the board.
Liquidity and collateral buffers have been moderating (declining).
Maturity composition of debt has improved markedly across sectors, with reductions in short-term maturity exposures.
At the country level:
- Debt-sales ratios in Brazil, Chile, and Colombia have lingered around the 100 percent mark.
- Debt-asset ratios have trended up since 2008, though at more reasonable levels.
- Across-the-board reductions in short-term maturity exposures.
- In most countries, firms have kept their liquidity buffers but are reducing holdings of collateral.
- Profitability has declined in Brazil and Chile, but picked up significantly in Colombia, Mexico, and Peru.
Scenario on sudden stop:
- If financing were to dry up sharply—making debt rollover difficult—the share of firms in the sample at risk of not being able to repay their debt on time would be equal or greater today than it was in 2007.

Greater availability of bank credit lessens corporate vulnerability.
A rapid increase in borrowing from abroad can raise vulnerability.
The probability that firms will be unable to generate enough cash flow to repay their debts increases when the currency depreciates.
Exchange rate flexibility reduces this currency-depreciation vulnerability by inducing firms to hedge and avoid excessive exchange rate bets.

Macroprudential tools can mitigate risks from abundant capital inflows to the corporate sector:
- Measures targeted to moderate borrowing in foreign currency (for example, through prudent loan-value ratios).
- Measures geared toward boosting provisions, capital buffers, and liquidity requirements in the domestic financial system.
These tools can help ensure credit markets remain resilient to sharp reversals in external funding and continue to provide domestic credit during global stress.
Increasing the availability of data on the assets and liabilities of firms is critical to monitor risks and adapt policies and regulations in a timely manner.

María González-Miranda, December 17, 2012

Nonfinancial Firms in Latin America: A Source of Vulnerability?
- Nonfinancial Firms in Latin America: A Source of Vulnerability? (Markdown version)
- Nonfinancial Firms in Latin America: A Source of Vulnerability? (PDF)