[Bank of Korea Financial Stability Report] "Operating income can't even cover interest"... 4 out of 10 vulnerable companies

Vulnerable Companies Account for 39.7%, Upward Trend Continues
Borrowing Costs Decreased, but Corporate Profitability Worsened

[Asia Economy Reporter Jang Sehee] Since the spread of COVID-19, four out of ten companies have been pushed into a critical situation where they cannot even cover interest expenses with operating profits.

According to the "2021 First Half Financial Stability Report" released by the Bank of Korea on the 22nd, an analysis of 1,276 large corporations and 1,244 small and medium enterprises in 2020 showed that the proportion of vulnerable companies with an interest coverage ratio below 1 was 39.7%, continuing an upward trend. In particular, the increase was centered on companies with operating losses, resulting in an interest coverage ratio below 0.

The interest coverage ratio is an indicator that measures the extent to which a company can cover interest expenses with operating profits. A ratio below 1 means it is difficult to cover interest with operating profits.

Looking at the proportion of vulnerable companies in major countries in 2020, Korea recorded 36.5% based on the number of companies, which was lower than the averages of major countries such as the United States (61.9%), Canada (72.6%), and the United Kingdom (49.1%). However, based on credit, Korea showed 30.7%, which was higher than the United States (27.4%) and the United Kingdom (23.9%).

The Bank of Korea cited the deterioration of corporate profitability as the background for the increase in vulnerable companies. In fact, the profitability of the bottom 25% declined from -1.5% in 2019 to -1.9% in 2020. The median and top 25% also recorded 1.9% and 5.6%, respectively, indicating a deterioration in profitability compared to the previous year.

The Bank of Korea analyzed vulnerable companies based on whether they ▲recover to normal companies ▲remain in a vulnerable state ▲convert to bankruptcy, and found that the vulnerable state of vulnerable companies tends to persist long-term.

In particular, as the duration of vulnerability lengthens, the rate of recovery to normal companies significantly decreases, while the rate of conversion to bankruptcy increases. For companies in their first year of vulnerability, the recovery rate to normal was 37.6%, whereas for companies in their eighth year, it was only 12.6%. Additionally, the bankruptcy conversion rate for first-year vulnerable companies was 4.1%, while for seventh-year companies, it was 13.6%.

It was pointed out that if the vulnerable state persists for more than four years, both short-term liquidity and long-term solvency deteriorate, resulting in simultaneous decreases in assets and equity. This could gradually lead to a contraction in corporate activities.

Since the global financial crisis, the median interest coverage ratio has shown a declining trend across all credit ratings except for the highest grade. In 2020, the median interest coverage ratio by credit rating was 5.9 times for normal and 0.4 times for caution.

The Bank of Korea stated, "To improve companies' ability to pay interest, a more fundamental and urgent task is to improve sales and operating profits through domestic and international demand recovery and strengthening corporate competitiveness," adding, "If financial support for companies is prolonged, it may delay corporate restructuring."

It also added, "After COVID-19, it is necessary to orderly normalize financial support measures by comprehensively considering the patterns of economic recovery and financial imbalance situations."