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RUSSIAN FEDERATION Selected Issues

Author(s):
International Monetary Fund
Published Date:
October 2005
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III. Corporate Sector in Russia: Capital Structures and Vulnerabilities66

A. Introduction

1. This paper analyzes balance sheet developments in the Russian non-financial corporate sector, with the objective of bringing out the key “stylized facts” and assessing potential vulnerabilities associated with the level and composition of external finance.67 Given the lack of diversified sources of funding, emerging market corporates often have to rely heavily on foreign currency and short-term debt instruments, which exposes them to exchange rate, interest rate, and debt rollover risks and may ultimately increase the likelihood of bankruptcy (credit risk). This paper also attempts to assess the sensitivity of the Russian international capital market participants to a number of adverse shocks affecting the availability and/or the cost of external funding, including sharp increases in interest and exchange rates, and a decline in the rollover ratio of short-term debt.

2. The focus on the nonfinancial corporate sector is motivated by the following developments:

  • Domestic banks, many of which remain weak and undercapitalized, continued to increase their exposure to the corporate sector either through direct lending or participation in the fast-growing domestic corporate bond market.68 Encouragingly, the share of nonperforming loans in total gross loans has so far remained broadly stable.

  • After re-gaining access to international capital markets around 2000, Russian firms significantly increased their foreign currency liabilities, albeit from a relatively low base. The external debt of the nonfinancial corporate sector reached $74 billion by the end of 2004, compared with $55 billion at end-2003.69

Domestic Bank Credit to Enterprises and Non-banking Financial Institutions

(In percent of GDP)

Citation: 2005, 379; 10.5089/9781451833140.002.A003

Source: CBR.

Domestic Bond Market in Russia: Amounts Outstanding

(In billions of U.S. dollars)

Source: MICEX and Cbonds.

Gross International Debt Issuance by the Russian Nonfinancial Sector Firms

(In billions U.S. dollars)

Source: Dealogic.

3. The structure of the paper is as follows. Section B discusses the key structural features of the Russian nonfinancial corporate sector, including production and market concentration, ownership structure and financing sources. Section C identifies the main stylized facts with regard to balance sheet developments of the large nonfinancial firms in Russia between 2000 and 2003, based on the sample of around 200 companies. The analysis focuses on the key balance sheet and profitability indicators, including leverage ratios, maturity and currency composition of debt, liquidity, profitability and credit risk indicators. Section D presents the results of solvency and liquidity stress tests for a subset of firms that have been active participants in the international debt markets since 2000. The main conclusions are presented in Section E.

B. Key Structural Features

Sectoral composition and concentration

4. The common belief that industry continues to play a dominant role in the Russian economy, though challenged by official statistics, appears to be robust. According to Rosstat, the production of goods accounted for only 40 percent of GDP in 2003, while 60 percent of GDP was attributed to the production of services. This appears to be inconsistent with the fact that revenues from the oil and gas sector alone stood at roughly 20 percent of GDP. The key to this puzzle is in the widespread use of “transfer pricing.” According to analysts, a large part of the profits and value added generated in the industrial sector is shifted to the trade sector in order to minimize taxes, thereby, “inflating” the proportion of services in GDP. Controlling for transfer pricing, the actual contribution of industry to GDP is estimated to have been over 50 percent (World Bank, 2004). Furthermore, based on consolidated accounting data for the 400 largest companies in Russia, the leading Russian rating agency Expert RA estimates that the share of industry in total sales exceeded 70 percent in 2003 (Expert RA, 2004).70

5. Production and market concentration in Russia are fairly high, especially in the natural resource sector. The level of production concentration at the enterprise level in Russia’s industry was always high, for historical reasons. However, because most enterprises were privatized as single firms, the average size of a (single-enterprise) Russian firm in the early 1990s was smaller than an average size of a (multiplant) firm in other countries (World Bank, 2004). Over the past ten years, however, horizontal and vertical integration intensified, leading, in some cases, to the creation and expansion of large financial-industrial groups. As a result, market concentration rose as well, most notably in the natural resource sector.

Ownership, control and corporate governance

6. Ownership and control in the Russian industry are highly concentrated as well. A recent survey of a representative sample of about 1000 Russian industrial enterprises suggests that the average management’s stake in a company is around 19 percent, the average stake of the single largest outside owner is 24 percent, and that of the largest blockholder is 40 percent (Guriev and others, 2003). Another study that looks at a sample of large industrial firms (which account for 62 percent of total industrial output) finds that the largest blockholder controls, on average, about 80 percent of the firm (Guriev and Rachinsky, 2004). This survey finding implies that control in Russia’s industry is even more concentrated than ownership.

7. The widely held view that the largest private owners (the so-called oligarchs) have significant control over the Russian economy is supported by empirical evidence (Guriev and Rachinsky, 2004). In particular, the authors find that the 23 largest private owners control at least 36–38 percent of output and employment of the firms in their sample, which, in turn, account for roughly two-thirds of total industrial output.71 Most of the companies controlled by oligarchs operate in the natural resource and energy sectors. In addition, most industries controlled by the largest private owners tend to have concentrated (monopolistic or oligopolistic) market structure.

8. Interestingly, higher ownership concentration is associated with better corporate governance and higher investment, although the latter holds true only if the largest blockholder’s stake in the company does not exceed 50 percent (Guriev and others, 2003).72 However, the variation in the level of corporate governance across industrial firms is substantial, with many medium and smaller-sized firms reportedly still unfamiliar with, or unaware of, the Code of Corporate Governance (Guriev and others, 2003).

Financing sources

9. The relative underdevelopment of the domestic financial systemand the lingering weaknesses in the banking sectorlimit the external funding sources available to local firms. Despite a pickup in commercial bank lending, only a small part of total fixed investment in Russia is financed through bank credits (around 5.3 percent in 2003). The primary users of bank credit are large and medium-sized firms, while the vast majority of smaller firms continue to rely on internal funds. For instance, the 2003 survey of a representative sample of industrial firms revealed that only 21 percent of them had used bank credit to finance investment in the previous year (Guriev and others, 2003).

10. The issuance of securities (stocks and bonds) in the domestic capital market has not yet become a significant source of funding for most Russian firms. Even though turnover in corporate stocks (83 percent of the total) and bonds (17 percent of the total) doubled in 2003 from 2002, reaching $113 billion, the number of issuers remains limited (less than 170 firms). Most of the firms listed on the exchanges in Moscow and St. Petersburg are from the energy and utilities sectors (see figure below). In addition, most traded shares are fairly illiquid, with the “free float” rarely exceeding 10 percent of the total number of shares outstanding. The benchmark Russian Trading System (RTS) index (50 firms) is highly concentrated, with four names accounting for 65 percent of the total index capitalization.

11. An increase in the issuance of international debt by the nonfinancial corporate sector during 2000-04raised risk exposures to exchange and interest rates. Given the relatively low level of financial intermediation in Russia, many domestic firms can finance large-scale investment projects only if they are able to raise funds abroad. Following the 1998 sovereign default, Russian firms were effectively shut out of the international capital markets. Foreign debt issuance resumed in earnest only in 2000, with gross issuance by nonfinancial firms quickly outpacing that of financial and public sector entities. The bulk of international debt issuance was in the form of syndicated loans, mainly for trade financing (see figure). Unlike Eurobonds issued by the Russian companies, which are predominantly dollar-denominated fixed-rate obligations, syndicated loans are typically floating rate instruments, with interest payments tied to the London interbank offered rate (LIBOR). This raises concerns that some issuers may have increased their exposure to (foreign) interest rate risk, in addition to exchange rate risk.

Turnover in the Russian Domestic Market for Shares and Bonds: Sectoral Composition

Source: Expert RA (2004)

Gross Issuance of Syndicated Loans by the Russian Nonfinancial Sector: by Loan Purpose

(In millions of U.S. dollars)

Source: Dealogic.

International Bonds and Syndicated Loans Outstanding: by Remaining Maturity, end-2004

(In millions of U.S. dollars)

Source: Dealogic; and staff estimates.

12. A significant part of outstanding foreign debt obligations (mainly syndicated loans) matures in 2005. This, in principle, could be used as an opportunity to swap at least part of the maturing floating-rate obligations into fixed-rate instruments. However, most refinancing operations have so far been done through the syndicated loan market as well (e.g., in 2004, two firms issued close to $3 billion in loans for the purposes of debt refinancing or debt repayment).73

C. Balance Sheet and Profitability Indicators

13. This section aims at identifying the key stylized facts with regard to balance sheet developments of the large nonfinancial firms in Russia between 2000 and 2003. The data set used in the analysis contains about 200 companies, many of which are also included in the Expert RA top 200 list and, therefore, clearly fall into the category of “big business.” Since these firms are the main users of external funds, the focus on big business is consistent with the objective of the paper, which is to analyze changes in the capital structures of Russian nonfinancial firms and associated (potential) vulnerabilities. The main characteristics used to analyze cross-sectional differences in the firms’ financial ratios include sector, size, participation in the local corporate bond market, and participation in the international debt market.

14. The sample includes publicly traded and nontraded firmsfrom a broad cross-section of industries grouped into six sectors: basic materials, energy, manufacturing, communications, utilities, and consumer goods.74 The balance sheet and income statement information for two fiscal years, 2000 and 2003, is pooled from two sources: CapitalLogica and Bloomberg.75 For most companies in the sample, financial statements are based on the Russian accounting standards (RAS); for some firms, only unconsolidated statements are available. For those companies that prepare financial statements in accordance with the international accounting standards (U.S. generally accepted accounting principles (GAAP) or international accounting standards (IAS)), the latter are used in the analysis instead of the RAS-based statements.

Leverage

15. Debt-to-equity ratios indicate that large nonfinancial firms in Russia have become more leveraged. The average debt-to-equity ratio (D/E ratio) of the firms in the sample, which is a commonly used measure of leverage, rose to 71 percent in 2003 from 34 percent in 2000 (Table 1). The distribution of leverage shifted to the right: the share of firms with leverage of more than 100 percent doubled, while the share of firms employing very little leverage shrunk proportionately. Firms in the basic materials and communications sectors remained among the least leveraged. In contrast, the average D/E ratio in the energy, consumer and manufacturing sectors increased two-to-threefold between 2000 and 2003 (Appendix II, Figure 1). The average D/E ratio of the local bond market participants more than doubled between 2000 and 2003, while that of nonparticipants increased only modestly (Appendix II, Figure 1). Interestingly, the most leveraged companies seem to be at the extremes of the size distribution.

Figure 1.Altman’s Z-score

Sources: CapitalLogica, Bloomberg and Staff Estimates

Figure 1.Total Debt in Percent of Equity (Cross-Section Means)

Table 1.The Distribution of Leverage (D/E) 1/(In percent)
2003
0<D/E<5050<D/E<100D/E>100ALL
Mean177327871
Median137123629
Maximum4894586586
Minimum0521190
Standard deviation1513142114
Share of firms631918100
2000
0<D/E<5050<D/E<100D/E>100ALL
Mean127220634
Median86914810
Maximum4894518518
Minimum0521030
Standard deviation131512968
Share of firms78129100
Sources: CapitalLogica; Bloomberg; and staff estimates.

D/E is defined as total debt (sum of short-term and long-term borrowing) divided by the book value of shareholders’ equity; reported D/E ratios of less than 0 (negative equity) or greater than 1,000 were not used in computations

Sources: CapitalLogica; Bloomberg; and staff estimates.

D/E is defined as total debt (sum of short-term and long-term borrowing) divided by the book value of shareholders’ equity; reported D/E ratios of less than 0 (negative equity) or greater than 1,000 were not used in computations

16. Also, comparison of the median leverage ratios across developed and emerging-market countries suggests that large industrial firms in Russia in 2003 were not as “underleveraged” as they had been in 2000 (Appendix II, Table 1).76 In fact, several emerging-market countries (e.g., in Central and Eastern Europe) have much lower medianleverage ratios than Russia. However, for those firms that are exposed to debt-rollover risk(because of a high proportion of short-term debt) or to exchange rate risk (because of a largeshare of unhedged foreign currency debt), it may be desirable to maintain relatively low D/E ratios. The next subsection takes a closer look at debt structures.

Debt structures and liquidity indicators

17. On average, debt structures of the firms in the sample appear to have improved, which decreased their vulnerability to debt-rollover risk. The average proportions of short-term debt and bank credit in total debt of the firms in the sample fell, while the average proportion of foreign debt in total debt (based on the sample of issuers) increased only modestly (Table 2). The improvement in the maturity structure of corporate debt, while evident across all sectors, is particularly striking in the consumer goods sector, where the average share of short-term debt fell from around 80 percent in 2000 to only 44 percent in 2003 (Appendix II, Figure 2). The decline in the firms’ reliance on bank credit can be seen across almost all sectors as well and appears to have been driven by the substitution of bank loans for bonds.77 This is evident from the fact that the average share of bank credit of local bond market participants fell from 74 percent in 2000 to less than 50 percent in 2003, while the average share of bank credit of nonparticipants in the local bond market rose slightly (Appendix II, Figure 3).

Figure 2.Short-term Debt in Percent of Total Debt (Cross-Section Means)

Figure 3.Bank Credit in Percent of Total Debt (Cross-Section Means)

Table 2.Debt Structure and Liquidity Indicators(In percent; unless indicated otherwise)
20002003
MeanMedianMeanMedian
Leverage and debt structure
Debt/equity ratio34107129
Short-term debt/total debt69895755
Bank credit/total debt67865962
Foreign exchange debt/total debt 1/35273638
Ruble bonds/total debt 2/N.A.N.A.3929
Liquidity
Current ratio167123193156
Quick ratio12591150118
Interest coverage ratio (times)2011157
Sources: CapitalLogica; Bloomberg; Dealogic; www.cbonds.ru; and staff estimates.

Foreign exchange debt refers to the outstanding stock of Eurobonds and syndicated loans; the Foreign exchange debt/total debt ratios are based on the sample of international debt market participants.

Ruble bonds refer to the outstanding stock of ruble corporate bonds (not including veksels); the ratios are based on the sample of corporate bond issuers (see www.cbonds.ru).

Sources: CapitalLogica; Bloomberg; Dealogic; www.cbonds.ru; and staff estimates.

Foreign exchange debt refers to the outstanding stock of Eurobonds and syndicated loans; the Foreign exchange debt/total debt ratios are based on the sample of international debt market participants.

Ruble bonds refer to the outstanding stock of ruble corporate bonds (not including veksels); the ratios are based on the sample of corporate bond issuers (see www.cbonds.ru).

18. The liquidity ratios (“current” and “quick” ratios) of firms in the sample are at comfortable levels.78 The average current ratio increased from 167 percent in 2000 to 193 percent in 2003, while the quick ratio increased from 125 percent to 150 percent over the same period; however, the variation in liquidity ratios across firms was fairly high. Nevertheless, the positive and statistically significant correlation between liquidity ratios and the proportion of short-term debt in total debt suggests that firms facing higher debt-rollover risk generally try to maintain higher liquidity ratios.

19. Another indication that liquidity is at comfortable level is that the averageinterest coverage ratio of the firms in the sample is fairly high,79possibly because around 60 percent of them continue to maintain fairly low D/E ratios (less than 50 percent). More generally, liquidity indicators of Russian firms compare favorably with those of other emerging-market companies (Appendix I, Table 1).

Table 1.Key Financial Ratios (Median Values): Cross-Country Comparisons 1/
Operating income marginReturn on assetsDebt/equity ratio
COUNTRY200020012002200320002001200220032000200120022003
Emerging Market Countries
ARGENTINA6.46.72.08.32.61.6−3.74.863.768.962.644.3
BRAZIL10.79.68.910.46.47.57.57.451.857.361.667.6
CHILE9.610.811.411.25.44.44.75.440.538.134.433.9
CHINA7.66.58.07.14.93.84.33.948.053.348.657.1
COLOMBIA14.911.316.729.32.94.36.54.57.916.117.415.5
CZECH REPUBLIC3.32.63.08.34.54.44.52.716.810.510.117.9
HUNGARY4.93.42.04.47.75.35.35.228.018.716.023.7
INDIA10.79.98.69.58.27.96.97.461.556.753.460.1
INDONESIA9.86.74.24.71.83.95.54.136.829.537.145.6
KOREA (SOUTH)6.25.35.55.44.53.94.73.960.863.056.236.2
MALAYSIA6.84.95.26.12.62.42.73.331.729.931.931.6
MEXICO9.66.48.27.66.74.93.54.145.045.645.050.2
PHILIPPINES4.44.04.05.31.20.70.81.528.616.515.817.8
POLAND1.90.21.52.65.43.42.94.021.015.622.027.3
RUSSIA13.09.05.24.910.029.0
SOUTH AFRICA6.75.35.95.28.97.67.67.828.328.129.625.0
TAIWAN Province of China5.83.76.05.84.32.63.95.052.051.646.547.9
THAILAND5.05.45.88.65.15.56.47.654.847.837.829.1
TURKEY7.711.88.42.713.119.012.97.744.452.129.822.9
Developed Countries
FRANCE5.04.13.64.15.14.13.12.749.355.752.562.3
GERMANY0.4-0.4-0.81.93.41.90.91.823.631.535.431.5
HONG KONG SAR2.92.01.12.03.32.31.42.419.621.116.218.0
JAPAN3.74.03.03.61.71.61.31.756.553.851.249.2
SINGAPORE6.03.33.24.13.72.02.53.934.932.329.827.6
UNITED KINGDOM5.63.83.13.65.42.91.62.524.023.824.319.9
UNITED STATES1.70.31.82.61.40.81.01.414.810.710.610.1
Short-Term debt/total debtCurrent ratioQuick ratio
COUNTRY200020012002200320002001200220032000200120022003
Emerging Market Countries
ARGENTINA46.156.458.845.81.01.01.21.20.70.60.80.6
BRAZIL46.646.951.848.11.21.11.11.30.90.80.80.9
CHILE46.544.247.034.41.41.41.41.40.90.91.01.0
CHINA89.687.691.189.61.31.31.21.20.90.90.80.7
COLOMBIA33.139.157.032.32.32.31.92.11.51.41.11.3
CZECH REPUBLIC47.863.252.132.51.11.01.10.60.70.60.72.3
HUNGARY50.071.767.050.91.51.41.31.20.90.80.71.1
INDIA32.434.133.534.81.51.51.41.30.90.90.80.7
INDONESIA66.068.059.445.71.31.31.51.70.70.70.80.7
KOREA (SOUTH)58.460.663.469.81.31.31.31.50.80.90.91.0
MALAYSIA82.277.975.975.11.41.41.51.60.91.01.01.1
MEXICO37.732.625.228.41.41.21.41.50.80.80.91.0
PHILIPPINES56.762.646.644.81.21.21.41.40.70.90.81.0
POLAND55.154.462.150.71.31.21.21.30.90.90.80.9
RUSSIA89.055.01.21.60.91.2
SOUTH AFRICA52.553.650.849.51.41.41.41.41.00.91.00.9
TAIWAN Province of China68.961.060.255.21.51.51.61.60.90.91.01.1
THAILAND71.960.661.265.81.21.41.41.40.70.80.80.8
TURKEY78.580.678.475.71.41.41.41.71.00.90.91.4
Developed Countries
FRANCE47.946.646.040.71.41.41.31.31.01.01.01.0
GERMANY53.848.045.939.11.91.71.71.91.21.01.01.2
HONG KONG SAR77.977.574.775.01.61.71.81.81.21.31.41.4
JAPAN60.661.862.761.71.41.31.41.41.01.01.01.0
SINGAPORE65.967.563.464.31.51.51.61.61.11.01.11.2
UNITED KINGDOM43.644.042.436.61.41.41.31.30.90.90.90.9
UNITED STATES29.728.825.422.01.81.61.61.71.11.01.01.1
Sources: Worldscope; and staff estimates (for Russia).

Nonfinancial firms only. All ratios are in percent, except current ratio and quick ratio.

Sources: Worldscope; and staff estimates (for Russia).

Nonfinancial firms only. All ratios are in percent, except current ratio and quick ratio.

20. While the number of Russian firms participating in international capital markets increased between 2000 and 2003, their average ratios of short-term and foreign currency debt-to-total debt remained broadly unchanged, with the average D/E ratio below 100 percent and the average foreign debt-to-total debt ratio below 40 percent (Table 3).80 This is consistent with anecdotal evidence suggesting that many Russian firms used their access to international capital markets mainly to extend maturities and/or reduce debt-service costs.81

Table 3.Debt Structure of the International Debt Issuers 1/(In percent; average ratios)
2003
All issuersRegular issuers 2/New issuersD/E >100D/E <100Oil & Gas Sector
Total debt/book equity824210118435114
Short-term debt/total debt405135473733
Foreign exchange debt/total debt364333284034
2000
All issuersRegular issuers 2/D/E >100D/E <100Oil & Gas Sector
Total debt/book equity981356943026
Short-term debt/total debt4946255251
Foreign exchange debt/total debt352433816
Sources: Bloomberg; Dealogic; and staff estimates.

Foreign exchange debt refers to the outstanding stock of Eurobonds and syndicated loans.

Regular issuers include firms that had outstanding foreign exchange debt both in 2000 and 2003.

New issuers did not have outstanding foreign exchange debt in 2000.

Sources: Bloomberg; Dealogic; and staff estimates.

Foreign exchange debt refers to the outstanding stock of Eurobonds and syndicated loans.

Regular issuers include firms that had outstanding foreign exchange debt both in 2000 and 2003.

New issuers did not have outstanding foreign exchange debt in 2000.

21. Although average share of foreign currency debt-in-total debt of “regular issuers”increased and appears to have been higher than that of “new issuers,”regular issuers do not necessarily face higher exchange rate risk exposure. This is because most of the regular issuers are oil and gas companies, which generate foreign currency earnings and, therefore, are naturally hedged against foreign currency risk. In addition, more leveraged firms seem to have smaller shares of foreign currency debt than less leveraged firms.

Operating performance and profitability

22. The operating performance of firms in the sample appears to have deteriorated between 2000 and 2003. A comparison of several performance indicators (gross profit margin, operating income margin, and net income margin) for 2000 and 2003 suggests that companies across almost all sectors experienced a significant squeeze in profit margins (Table 4).82 For firms in the nontradables sector, the squeeze in profit margins can be attributed to the rising costs of domestic inputs and increased competitive pressures from imports because of real exchange rate appreciation. However, in the case of the energy sector, these explanations are less plausible, since the decline in all performance indicators was particularly dramatic (50–60 percent) during the period when output and exports continued to expand on the back of rising oil prices. It is, therefore, more likely that at least some of the balance sheet performance deterioration can be attributed to the increased incidence of transfer pricing.

Table 4.Operating Performance(In percent)
20002003
MeanMedianMeanMedian
Gross profit margin
All firms17151310
Basic materials20191412
Energy31301614
Manufacturing111688
Communications27232928
Utilities9997
Consumer goods1310119
Operating income margin
All firms1513129
Basic materials18151513
Energy26271516
Manufacturing1515610
Communications22262423
Utilities6877
Consumer goods119107
Net income margin
All firms9653
Basic materials111086
Energy192087
Manufacturing7622
Communications14161110
Utilities2221
Consumer goods4264
Sources: CapitalLogica; Bloomberg; and staff estimates.
Sources: CapitalLogica; Bloomberg; and staff estimates.

23. The profitability indicators (return on assets (ROA) and return on equity (ROE)) show a deterioration as well (Table 5). The 2003 average ROA was higher only in the utilities and consumer goods sector, while the 2003 average ROE exceeded the 2000 level only in the communications sector. Compared with other emerging-market companies, Russian firms seem to have been average performers, based on the median ROAs, and better-than-average performers, based on their operating margins.

Table 5.Profitability(In percent)
20002003
MeanMedianMeanMedian
Return on Assets (ROA)
All firms9.05.26.04.9
Basic materials13.911.810.18.8
Energy19.318.56.67.1
Manufacturing7.54.84.45.1
Communications10.38.98.67.3
Utilities1.21.21.41.5
Consumer goods7.26.77.76.7
Return on Equity (ROE)
All firms17.810.98.84.6
Basic materials27.829.216.514.5
Energy36.531.012.211.6
Manufacturing16.910.71.63.9
Communications12.911.213.411.3
Utilities1.21.80.70.8
Consumer goods20.122.913.66.7
Sources: CapitalLogica; Bloomberg; and staff estimates
Sources: CapitalLogica; Bloomberg; and staff estimates

Bankruptcy risk

24. The risk of bankruptcy (default) is typically estimated using one of two methods: the traditional financial ratios analysis and the contingent claims approach. The financial ratios approach consists of calculating several key financial indicators that can then be drawn together in one score, which provides a snapshot of the firm’s financial health, as for instance, in the case of the Altman’s Z-score.83 The contingent claims approach uses the well-known Black-Scholes-Merton (BSM) option-pricing methodology for computing the probability of default using historical prices of the firm’s traded shares and book values of debt.84

25. The financial ratios approach suggests that the overall financial health of the firms in the sample was broadly stable between 2000 and 2003. Based on the average and median Z-scores, the basic materials, utilities, and consumer goods sectors showed some improvement, while the manufacturing, energy, and communications sectors experienced some deterioration (Appendix II, Figure 1). In the cases where Z-scores increased, the improvement was achieved because the decline in profitability indicators was offset by the increase in the working capital-to-total assets ratio. The latter is consistent with the improvement in liquidity indicators discussed above.85

26. The reduction in default probabilities computed using the BSM approach was more uniform across sectors than the improvement in Z-scores. This decline was mainly driven by the sharp rise in share prices and/or decline in share price volatility, and only in a few cases—by the decline in the debt-to-market value ratios. Appendix II, Figure 5 presents the probabilities of default, computed for a subset of publicly traded firms, which had sufficiently liquid shares (or ADRs) traded throughout 1998–2004.86 Consistent with the Z-scores, the probabilities of default of manufacturing firms appear to be higher than those of the firms in the energy or utilities sectors. For almost all firms in the energy sector, the current level of default probabilities is significantly lower than that of two–three years ago. The only “special case” is Yukos, whose probability of default rose rapidly during the second half of 2004 ahead of its default on a $1 billion syndicated loan on December 27, 2004.

Figure 5.Default Probabilities, December 2001-December 2004

D. Stress Testing

27. This section attempts to assess the sensitivity of the Russian corporate sector to a number of adverse shocks affecting the availability and/or cost of external funding. These shocks include sharp increases in (foreign) interest and exchange rates, and a decline in the rollover ratio of short-term debt. Using a sample of 23 companies87 that had outstanding foreign currency-denominated debt at the end of 2003, two types of tests were performed:

  • Solvency test. For each company, the loss from a shock or a combination of shocks was compared to its end-2003 accounting capital, with “technical insolvency” defined as a loss exceeding accounting capital.

  • Liquidity test. For each company, the loss from a shock or a combination of shocks was compared to the estimated cash flow (net profit) generated by the firm during 2004 (based on the firm’s preliminary assessments). A company was considered illiquid if the cash flow generated in 2004 was insufficient to cover the losses from the shocks, as well as the maturing debt obligations that it was assumed to have been unable to roll over.

28. Exchange rate shocks were calibrated using historical data, while interest rate shocks were based on the “reasonable ranges” approach. The exchange rate shock was modeled as a standard deviation of percent changes (annualized) of the monthly ruble-dollar exchange rate levels for the period 1999–2003. Interest rate shocks were modeled as 100–300 basis point increases in the U.S. LIBOR (three-month) rate, given that a large part of the outstanding foreign currency-denominated debt of the companies in the sample is in the form of syndicated loans, with the interest payments linked to the dollar LIBOR rate. The short-term debt rollover scenarios considered in this exercise included possible reductions in the rollover ratios of up to 20 percent.

29. The stress tests presented in Table 6 suggest that Russian firms should be able to withstand significant adverse developments in the exchange and interest rates, as long as the short-term debt rollover does not fall below 50 percent. Two firms (including Yukos), which account for about 10 percent of the total capital of all firms in the sample, were effectively illiquid even in the absence of any shocks, as these firms (tentatively) reported losses for the first nine months of 2004. The likelihood of a reduction in the rollover rate is difficult to assess without knowing the exact composition of the firms’ short-term debt. Such an event could be related to banking sector problems or to a sudden decline in the foreign creditors’ appetite for Russian bonds.

Table 6.Corporate Sector Stress Tests
Solvency TestsLiquidity Tests
Number

of Firms

technically

insolvent
Total

Accounting

Capital of

insolvent

firms

(in percent

of sample)
Total

Debt

of

insolvent

firms

(in percent

of sample)
Number

of Firms

illiquid

Total

Accounting

Capital of

illiquid

firms

(in percent

of sample)
Total

Debt

of

illiquid

firms

(in percent

of sample)
Exchange Rate Shock (1 STD)00031022
and Interest rate shock (100 bps)00041328
and Interest rate shock (300 bps)00041328
Exchange Rate Shock (2 STDs)00041328
and Interest rate shock (100 bps)00041328
and Interest rate shock (300 bps)00041328
Exchange Rate Shock (2 STDs) and
Interest rate shock (300 bps)
and rollover rate at 80 percent00051329
and rollover rate at 60 percent00051329
and rollover rate at 40 percent20.7767370
and rollover rate at 20 percent20.7777472
Sources: CapitalLogica; Bloomberg; Dealogic; and staff estimates.
Sources: CapitalLogica; Bloomberg; Dealogic; and staff estimates.

30. Stress tests also point to a high concentration of risk. Owing to the high production concentration in the Russian industry, the technical insolvency or illiquidity of a small number of firms could have significant implications for the sector or for the economy as a whole.

31. Vulnerabilities may have increased during 2004. For instance, given the relatively large amount of the foreign currency-denominated syndicated loans maturing in 2005 (see figure following paragraph 10), debt rollover risks may have increased. In addition, a big part of international debt issuance in 2004 was in the form of interest rate–sensitive instruments, which, combined with rising global interest rates, implies higher interest rate risk exposure. Therefore, it may be useful to conduct similar stress tests using the end-2004 data (whenever these data become available).

E. Conclusions

32. The Russian corporate sector is highly concentrated, with access to capital markets and bank financing available only to top-tier corporates, while the majority of medium-sized and small firms continue to rely primarily on internally generated funds. The relaxation of credit constraints for these firms, which is an important pre-condition for sustainable growth, remains a challenge.

33. The average leverage of firms in the sample has increased, though it does not appear to be excessive, while the share of short-term debt in total debt has declined. Liquidity indicators appear to be at comfortable levels. While the number of international capital market participants rose between 2000 and 2003, the average foreign currency debt-to-total debt ratio appears to have been stable. Many of the firms, which significantly increased their foreign exchange exposures between 2000 and 2003, were exporters from the natural resource sector. More recently, however, some nontradables sector firms (e.g., from the communications sector) have begun to tap into international debt markets as well, taking on unhedged and often interest rate–sensitive foreign exposures.

34. Theoverall financial health of firms in the sampleappears to have been broadly stable between 2000 and 2003. The basic materials, utilities and consumer goods sectors showed some improvement, and the manufacturing, energy and communications sectors experienced some deterioration. At the same time, the estimated default probabilities for a subset of publicly traded firms show a considerable reduction in credit risk.

35. One important caveat is related to the quality of financial statements. For the majority of firms in the sample, the only available accounting data are financial statements compiled in accordance with the Russian accounting standards (RAS); in some cases, information is reported on an unconsolidated basis. Recognizing this problem, the government is taking steps to improve financial accounting and reporting by nonfinancial firms. In 2004, the Duma considered (in the second reading) the draft of the new federal law On Consolidated Financial Reporting. Also, in July 2004, the ministry of finance adopted a new medium-term program aimed at improving the accounting framework and financial reporting in Russia.

36. The simple stress tests presented in the paper suggest that the balance sheets of foreign borrowers are relatively robust to a combination of adverse shocks affecting the availability and/or cost of external funding, but also point to a high concentration of risk. The tests indicate that the risk of liquidity difficulties could become significant (systemic) if, in addition to adverse shocks to the exchange rate and (foreign) interest rates, short-term debt rollover ratios were to fall below 50 percent.

37. Despite the relatively benign picture that emerges from the analysis of the end-2003 accounting data, some corporate sector vulnerabilities remain, and may have increased, during 2004. In particular, the issuance of interest rate–sensitive (gross) debt by Russian firms in the international capital markets has continued to rise, along with the increase in leverage. Going forward, other factors, such as an economic slowdown and/or a sharp decline in oil price, may affect the profitability and credit quality of Russian companies as well.

Definitions and Methodology

Definitions of financial ratios

Gross profit margin (GPM)=Ordinary IncomeNet Sales, where Ordinary income = net sales of goods, products, work, services (minus VAT, excise duties and similar obligatory payments)—cost of goods, products, work, services sold—selling & administrative Expenses;

Gross profit margin (GPM)=Ordinary IncomeNet Sales, where Operating Income (EBIT) = ordinary Income + other operating income, where non-operating gains include dividend and interest income, profits on sale of fixed assets/investments, foreign currency gains, share of associates’ net profits; nonoperating expenses include interest expenses, finance charges, borrowing costs, loss on sales of fixed assets/investments, foreign currency losses, and share of associates net losses.

Net profit margin (NPM)=Net IncomeNet Sales,, where Net Income is operating income adjusted for tax payments and extraordinary income/expenses.

Altman’s Z-score (Z) is computed using the methodology described in Altman (2000) for emerging market firms, namely Z = 3.25 + 6.56 (X1) + 3.26 (X2) + 6.72 (X3) + 1.05 (X4), where X1 = working capital/total assets; X2 = retained earnings/total assets, X3 = earnings before interest and taxes/total assets, and X4 = book value of equity/book value of total liabilities.

Probability of default computation methodology

The default probabilities presented in Appendix II, Figure 1 are computed using the methodology developed by CreditGrades (see http://www.creditgrades.com/)

The annualized probability of default at date t, for a maturity of T is: pt(T) = - 1/T ln(Xt(T)), where Xt(T) is defined as

and AT and d are defined as

where

N[.] is the cumulative normal distribution function;

St is the share price at time t;

σs is the annualized standard deviation of log returns, ln (St/St-1), calculated using historical daily time series with a 1000-day moving window;

D is the financial debt-per-share, where financial debt = (short-term borrowing + long-term borrowing + 0.5* (other short-term liabilities + other long-term liabilities);

T is the term to maturity, which is chosen to be T = 5;

L¯ is the mean global recovery rate, where L¯ = 0.5; and

λ is the percentage standard deviation of the global recovery rate L, where λ = 0.3.

Note: L¯ and λ are estimated using actual recovery data for approximately 300 nonfinancial U.S. firms that defaulted during 1987–97. The default probabilities computed for the sample of Russian firms do not appear to be sensitive to changes in these parameters. There is no history of corporate defaults in Russia.

Sample Description

The sample contains around 200 firms representing the following sectors:

  • basic materials(chemicals, forest products & paper, iron/steel and mining);

  • energy (oil & gas products, pipelines, coal);

  • manufacturing (building materials, electronic components/equipment, electronics, engineering/construction, hand/machine tools, machine construction, machinery, hardware, packaging and containers, shipbuilding, transportation);

  • communications(telecommunications);

  • utilities (electric); and

  • consumer goods (airlines, apparel/textiles, auto manufacturers, food service, retail).

SectorCodeFirms in the Sample

(in % of total)
Total Assets of Firms

in the Sample

(in % of total)
Fixed Assets of Firms in the Sample

in % of Fixed Assets of the Sector
Basic materialsS1211223.3
EnergyS2156198.1
ManufacturingS31633.9
CommunicationsS49656.1
UtilitiesS5261526.5
Consumer goodsS61444.4
Note: for the consumer sector, the comparison of the fixed asset size of the firms in the sample with the total fixed-asset size of the firms in the industry is based on three subsectors (apparel/textiles, food service, retail). Also, there are differences in the classification of some metallurgical and manufacturing firms in different sources.
Note: for the consumer sector, the comparison of the fixed asset size of the firms in the sample with the total fixed-asset size of the firms in the industry is based on three subsectors (apparel/textiles, food service, retail). Also, there are differences in the classification of some metallurgical and manufacturing firms in different sources.

Figure 4.Gross Profit Margin (Cross–Section Means)

References

    AltmanE.2000Predicting Financial Distress of Companies: Revisiting the Z–Score and Zeta® Models” available via the Internet: http://www.defaultrisk.com//

    ExpertRA2004Real Business in Russia” (in Russian) November 23–24 2004. (Moscow: Expert RA).

    GurievSergei.OlgaLazarevaAndreiRachinsky andSergeiTsukhlo2003.Corporate Governance in Russian Industry” Problems of Economic Transition Vol. 47July pp. 683

    GurievSergei andAndreiRachinsky2004.Ownership Concentration in Russian Industry” background paper for the World Bank’s Country Economic Memorandum for the Russian Federation. Available via the Internet: http://www.cefir.org/

    World Bank2005.From Transition to Development” A Country Economic Memorandum for the Russian Federation March 2005. Poverty Reduction and Economic Management Unit Europe and Central Asia Region Report Number 3230.–RU. Available via the Internet:http://web.worldbank.org/

Prepared By Anna Ilyina.

The term “external funds” here refers to “funds from outside sources.”

The total amount of outstanding ruble corporate bonds reached Rub 267 billion ($9.6 billion) at end-2004, increasing further to Rub 310 billion ($11 billion) during the first five months of 2005.

By end-2004, Russia’s corporate sector had become a small net debtor, in contrast to the sovereign, which had achieved a net creditor position.

Expert RA conducts annual surveys of the largest firms in Russia, receiving accounting information directly from participating firms. However, in many cases, the publicly available financial statements are based on unconsolidated accounting information and, therefore, are likely to differ from the ones provided to Expert RA.

Managers of large government-owned monopolies were not classified as oligarchs.

The effect of ownership concentration on governance has been found to be positive and statistically significant even when one controls for corporate governance (Guriev and others, 2003).

Gazprom ($2.2 billion, maturing in 2010) and Mobile TeleSystems ($600 million, maturing in 2007).

By comparison, the Worldscope database contains less than 30 publicly traded companies, most of which are from the energy sector.

The median D/E ratios in some mature market countries may seem too low because of the large proportion of small firms in the Worldscope sample. For example, in 2003, the median D/E ratios for the United Kingdom and the United States were 20 and 10 percent; meanwhile, the average D/E ratios were 43 and 48 percent and the weighted average D/E ratios, were 85 and 72 percent, respectively.

The latter has to be interpreted with some caution because not all firms in the sample reported their debt composition for 2003. However, if this is true (i.e., large industrial firms, on average, reduced the share of bank loans in total debt), it may also be the case that the recent expansion of the banks’ loan books was driven by lending to new clients who are possibly smaller in size and lower on the credit spectrum than the top 200 names.

The current ratio is the ratio of current assets to current liabilities. The quick ratio is a more conservative measure of liquidity, it is the ratio of current assets (net of inventories) to current liabilities. Both ratios should be comfortably above 100 percent. If that is not the case, i.e., if liquidity ratios are low, a company may not be able to reduce its current assets for cash in order to meet maturing obligations and, therefore, may be forced to roll over its debt to avoid insolvency.

The interest coverage ratio is the ratio of operating income to gross interest expense.

The ratios presented in Table 3 are based on a sample of 23 companies that had outstanding foreign currency bonds and/or syndicated loans at end-2000 or at end-2003.

The foreign currency debt estimates used in Table 3 are based on the firm-level data (provided by Dealogic) on the issuance of Eurobonds and syndicated loans in the international capital markets. These numbers represent the lower-bound estimates of the companies’ foreign currency debt stocks because they do not capture all possible foreign currency debt exposures; for example, they do not include foreign currency-denominated bilateral bank loans.

For detailed definitions, see Appendix I.

The Altman’s Z-score specification used in this paper was developed specifically for emerging market corporates (Altman, 2000). See Appendix I, for details.

The BSM method is based on the assumption that the equity value of a firm can be viewed as a European call option on the firm’s assets, with the debt value as a strike price. The “distance to default” can therefore be calculated using the standard option-pricing equations and interpreted as the number of standard deviations of asset growth by which the market value of assets exceeds its liabilities. For more details on computation methodology used in this paper, which is a variation of the BSM technique, see Appendix I.

Interestingly, some of the commonly used bankruptcy indicators in the traditional system of accounting and financial analysis in Russia are based on a comparison of the firms’ liquidity indicators with “normative” values.

The estimated default probabilities may have a downward bias, when free-float or secondary market liquidity and, therefore, equity price volatilities are too low.

Same sample as the one described in footnote 15. The total accounting capital and total debt of the firms in the sample are equivalent to 23 percent of GDP and 10 percent of GDP, respectively.

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