[Financial Report] Last Year’s Marginal Companies’ Borrowings Reach 50 Trillion Won... "If Defaults Increase, Soundness Will Deteriorate"

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As of last year, it was found that the financial institution borrowings of long-term persistent marginal firms in South Korea amounted to 50 trillion won. Although these companies show differences in soundness depending on their size and industry, most are experiencing deteriorations in liquidity, repayment ability, and stability while covering operating losses, raising concerns that they could increase the burden on the Korean economy and financial markets in the future.

According to the Financial Stability Report released by the Bank of Korea on the 26th, among the externally audited corporate firms last year, there were 903 long-term persistent marginal firms holding a total of 50 trillion won in financial institution borrowings. Marginal firms refer to companies that have been unable to cover total interest expenses with operating profits for three consecutive years. Long-term persistent marginal firms are those that have remained in such a marginal state for at least five years.

Long-term persistent marginal firms accounted for 3.6% of the 25,135 externally audited firms analyzed in 2022 and 23.1% of the 3,903 marginal firms. The borrowings held by these firms represent 5.1% of the total borrowings of all externally audited firms (986 trillion won) and 29.6% of the borrowings of marginal firms (168.7 trillion won), making them a significant portion.

On the 1st, container unloading work is being carried out at Busan Port Sinsundae Pier. [Image source=Yonhap News]

Among mid-sized companies, especially many long-term persistent marginal firms were identified. It was found that 4.0?4.3% of externally audited firms with assets between 100 billion and less than 1 trillion won are long-term persistent marginal firms, which is significantly higher than the 3.2?3.9% of small and medium enterprises with assets under 100 billion won or the 2.6% of large companies with assets over 1 trillion won.

By industry, the proportion of long-term persistent marginal firms was high in sectors requiring long-term investment such as real estate (6.1%) and transportation (6.8%), as well as in business support services (19.6%), which have relatively small operating scales.

The Bank of Korea analyzed that long-term persistent marginal firms have a high risk of insolvency, so the rate of recovery to normal firms is expected to be low. In fact, the insolvency risk of long-term persistent marginal firms is 5.67%, significantly exceeding that of externally audited firms (0.88%) and marginal firms (3.26%).

The Bank of Korea explained, "The longer the duration of a firm's vulnerable state, the lower the rate of recovery to normal firms after one year as the interest coverage ratio rises, and the higher the rate of remaining as a vulnerable firm."

The average asset and sales size of long-term persistent marginal firms are only 0.67 and 0.40 times those of normal firms, respectively, but their borrowings are 1.47 times and interest expenses 2.32 times larger.

These firms mainly use cash raised through financial activities to cover operating losses, resulting in poor key financial ratios such as profitability (operating profit margin -3.8%), liquidity (current ratio 62.7%), stability (debt ratio 686.5%), and repayment ability (interest coverage ratio -0.7 times).

In particular, their borrowing dependency reaches 50%, and the average interest rate on borrowings is 5.5%, which is higher than that of normal firms and marginal firms, indicating a high risk of insolvency.

The Bank of Korea pointed out, "If marginal firms persist without normalization for a long time, the supply of funds to more productive sectors shrinks, reducing the efficiency of credit allocation. In the event of domestic or external shocks, insolvency may increase centered on long-term persistent marginal firms, which could deteriorate the soundness of financial institutions."

It emphasized, "When deciding and implementing policies such as restructuring insolvent firms or providing financial support to vulnerable firms, it is necessary to comprehensively evaluate the recovery potential of firms by reviewing not only whether they are marginal firms but also their individual financial soundness, asset size, and industry characteristics."

On the 21st, containers were piled up at the Shinsundae Pier yard in Busan Port. [Image source=Yonhap News]