Abstract
Selected Issues
Corporate Leverage in the Philippines—a Concern?1
Using a novel firm-level dataset with detailed information on firms’ debt structure, this chapter shows that Philippine firms are highly leveraged by regional standards with relatively greater exposures to FX shocks, and their debt service capacity deteriorated somewhat during 2018, although still comparable to historical levels. The results from stress tests suggest that Philippine firms’ balance sheets have room to sustain large temporary shocks. Nevertheless, polices that promote domestic financial market development would help reduce exposures to exchange rate fluctuations.
A. Introduction
1. Nonfinancial corporate leverage in the Philippines has steadily increased since 2010. Low global interest rates and strong macroeconomic performance have contributed to a steady rise in nonfinancial corporate debt and leverage since the global financial crisis. While part of this trend reflects Philippine firms’ growing need to finance their productive investments, the higher indebtedness could also amplify the impacts of adverse macroeconomic shocks and possibly strain the bank balance sheets. Against some early signs of deteriorating credit quality, as indicated by the recent pickup in the nonperforming loan (NPL) ratio,2 this chapter documents Philippine firms’ leverage over the last five years and assesses their balance sheet vulnerability under illustrative stress scenarios.
Loans to Nonfinancial Corporate Sector 1/
(In percent of 4-quarter rolling sum of nominal GDP)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: Bangko Sentral ng Pilipinas.; Haver Analytics.; and IMF staff estimates.1/ From universal and commercial banks and excluding credit to “Financial and insurance.”Banking Sector Gross NPL Ratio
(In percent of gross loan portfolio)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: Bangko Central ng Pilipinas; Haver Analytics; and IMF staff estimates.2. The granular diagnosis of Philippines’ nonfinancial corporate sector vulnerability has been hampered by data gaps (IMF, 2018). For example, information on the currency composition of corporate debt is not readily available,3 preventing an accurate assessment of their balance sheet exposures to exchange rate risks. More generally, the lack of timely data on nonfinancial corporate balance sheets has constrained the BSP’s ability to identify and monitor emerging systemic risks and formulate targeted policy measures.
3. Philippine firms’ leverage and vulnerability are examined by using a novel firm-level dataset. The dataset is constructed from S&P’s Capital IQ database and comprises over 160 listed and nonlisted nonfinancial firms in the Philippines during 2014–2018. In contrast to other commercial databases, the Capital IQ database provides detailed balance sheet information on firms’ debt structure, including the currency of denomination and the type of debt instrument (for example, bonds or loans). The use of actual FX liability information, instead of estimates based on macro-level statistics, is a novel feature of the analysis in this paper. Appendix I provides further description of the dataset.
B. Nonfinancial Corporate Leverage in the Philippines
4. Philippine firms’ leverage ranks among the highest in the region after a sustained rise over the recent years. The median nonfinancial corporate leverage, measured by the total debt to total assets ratio, has increased by 2 percentage points in the Philippines since 2014. This trend is in clear contrast to most other major emerging market (EM) Asian economies, where nonfinancial firms have deleveraged their balance sheets over the same period. Consequently, the level of Philippine firms’ median leverage stands among the highest in the region as of end-2018. This assessment also holds with alternative measures of leverage. In terms of the net debt to earnings ratio, for example, Philippine firms have the highest median leverage in the sample at 265 percent.
Nonfinancial Corporate Leverage
(In percent of debt-to-assets ratio, median, 2018)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Source: S&P Capital IQ; and IM F staff estimate.Change in Nonfinancial Corporate Leverage, 2014–2018
(In percent of median debt-to-assets ratio)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.5. Corporate leverage is higher among larger firms and those in the utilities and mining/energy sectors. Firms are divided into quintile groups according to their asset size, in which “Medium” firms indicate those with the total asset size between the 40th and 60th quintile in the sample. Overall, “Medium” and larger firms are found to be more leveraged, with an average leverage ratio above 30 percent. On average, these firms are also more leveraged than their peers in other EM Asian economies. In terms of sectors, firms in utilities and mining/energy firms are the most leveraged, followed by manufacturing and real estate.4 Mining/energy is also the sector in which leverage increased the most over the last five years.
Nonfinancial Corporate Leverage: By Asset Size
(In percent of debt-to-assets ratio, average, 2018)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.Nonfinancial Corporate Leverage: By Sector
(In percent of debt-to-assets ratio, average, 2018)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.6. Firms with low or moderate initial leverage increased their leverage, whereas high-leverage firms deleveraged. This pattern is confirmed by comparing each firm’s cumulative change in leverage during 2014–2018 against their leverage level in 2014. The results show that most firms with an initial leverage ratio of 30 percent or below in 2014 increased their leverage over this period, whereas high-leverage firms generally reduced their leverage.
Nonfinancial Corporate Leverage, 2014 versus 2018
(In percent of debt-to-assets ratio)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ: and IMF staff estimates7. A significant share of Philippine firms’ outstanding debt is denominated in foreign currencies. Philippine firms carried on average about 17 percent of their debt in foreign currencies as of end-2018, slightly lower than the 19 percent in 2014. The foreign currency debt was predominantly denominated in U.S. dollars (86.5 percent), followed by Japanese Yen (2.7 percent). In terms of the debt instrument, about 79.1 percent of the foreign currency debt was in the form of bank loans, followed by bonds and notes (13.6 percent) and other instruments (for example, capital lease). Furthermore, the foreign currency debt share was higher among larger firms and those in utilities, mining/energy, and manufacturing sectors. For some firms in mining and manufacturing, this could reflect the existence of natural hedges in the form of foreign currency income. In the absence of information on firms’ hedging, the next section presents an alternative approach to examine the balance sheet exposure to exchange rate risks.
Foreign Currency Nonfinancial Corporate Debt
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
8. The maturity structure appears favorable. As of end-2018, Philippine firms had on average about three thirds of their outstanding debt with a maturity of over one year, which is significantly higher than their regional peers. The quick ratio, defined as the ratio between liquid assets-to-liquid debt, is also comparable to that of other firms in the region. Together, these findings appear to indicate a relatively low exposure to liquidity risks for Philippine firms.
Share of Long-Term Debt
(In percent of total debt, remaining maturity, median)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.Liquid Assets to Liquid Debt Ratio 1/
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.1/ Liquid assets are the sum of cash and cash equivalent assets, marketable securities, and accounts receivable. Liquid debt denotes current liabilities.9. The rise in leverage was not accompanied by strong corporate performance. Philippine firms that increased their leverage during 2014–2018 did not significantly increase their investment with respect to assets over the same period while their profitability, measured by the return on assets, declined. These trends point to the possibility that the increase in leverage was driven more by supply of credit to nonfinancial firms, which averaged 16.8 percent over this period, rather than by demand.
Changes in Leverage and Investment: 2014–2018
(In percentage point)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.Changes in Leverage and Return on Assets: 2014–2018
(Percentage point change)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.C. How Vulnerable Are Philippine Firms’ Balance Sheets?
10. Philippine firms’ solvency is examined using the interest coverage ratio (ICR). The ratio, defined as the earnings before tax and interest expenses (EBIT) to interest expenses ratio, measures the firms’ capacity to service its debt payments out of its earnings. In this chapter, a firm’s debt service burden is considered as “high” if the firm’s ICR is lower than 2, which indicates that the firm uses over half of its earnings to service its debt.
11. Firms’ capacity to service their debt deteriorated in 2018, returning to the historical levels. About 41 percent of Philippine firms used more than one third of their EBIT to make interest payments, with 7 percent of them spending more than half of their EBIT on interests. Although Philippine firms’ earnings rose by 22 percent in 2018, the increase in market interest rates and exchange rate depreciation led to a 38 percent rise in interest payments from 2017.
Nonfinancial Corporate Debt by Interest Coverage Ratio
(In percent of total sample debt)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.12. As expected, more leveraged firms are facing higher debt service burden. Firms with leverage ratios above the median level have an average ICR ratio of 2.7, compared to 3.5 for those with below-median leverage. Furthermore, although larger firms tend to be more leveraged, many of them also have higher debt service capacity (as shown by the relative scarcity of large firms with ICR below 3), which is an important mitigating factor from a systemic stability perspective. Nonetheless, some of the largest firms in the sample used more than one third of their earnings for interest payments, which warrants caution.
Leverage and Interest Coverage Ratio
(In percent for leverage, in decimal for interest coverage ratio, 2018)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ,’ and IMF staff estimates.13. The debt service burden is relatively high among firms in utilities and mining and energy sectors. Among these sectors, mining and energy and utilities appear relatively more vulnerable, with 14 percent and 34 percent of each sector’s total debt held by firms facing high debt service burden (ICR<2), respectively. Nonetheless, the share of these sectors’ debt in the sample is relatively low (5 percent for mining and energy and 16 percent for utilities). Moreover, these sectors consist of a small set of large sample firms, which suggests that the low ICR could reflect firm-specific rather than sectoral performance.
Nonfinancial Corporate Debt by Sector and ICR
(In percent of total debt for each sector, 2018)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.14. Using the accounting information on firms’ net FX valuation gains associated with their assets and liabilities, the sample is divided into two groups (see Appendix I for additional details). The first group (“Exposed”) consists of firms that reported net FX valuation loss when the exchange rate depreciated, on average, during the post-crisis period, which implies these firms tended to carry more unhedged foreign currency liabilities than assets. Similarly, the second group (“Hedged”) consists of firms that reported net average FX valuation gains from depreciation.
15. The results show that Philippine firms are relatively more exposed to exchange rate depreciation than other EM Asian firms. In 2018, about 84 percent of total sample debt was held by “Exposed” firms in the Philippines, which is higher than in other major EM economies in the region. This finding appears consistent with the larger average FX valuation loss incurred by Philippine firms in 2018 than Indonesian firms, although Indonesian firms held a higher share of their debt in foreign currencies and the peso depreciated less than the Indonesian rupiah in this period.
Balance Sheet Exposure to Exchange Rate Depreciation
(In percent of total debt, 2018)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.Net FX Valuation Gains/Loss
(In millions of U.S. dollar, average, 2018)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IG;and IMF staff estimates1/ Average of exchange rate depreciations from individual firms’ reporting periods.Illustrative Stress Tests
16. Philippine firms’ balance sheet vulnerability is tested with different stress scenarios. Using a framework similar to that of Jones and Karasulu (2006), shocks to different subcomponents of corporate earnings are applied to assess their impacts on Philippine firms’ debt service capacity. The subcomponents considered comprise interest expenses, net FX valuation loss, and operating income. The size of the shock to each component is set to match the change in the amount between 2007 and 2008 and between 2012 and 2013. These differentials are then applied to the benchmark levels in 2018 for each firm.5 Table 1 presents the average impacts on these components and EBIT under the two stress scenarios. In Scenario I, the only negative shock to firms’ EBIT is the exchange rate shock, which is set to generate an average increase in net FX loss of 182 percent from the 2018 level (equivalent to 0.4 percent of 2018 GDP). In Scenario II, operating income is assumed to decline by 3.9 percent, in addition to an average 156 percent increase in net FX loss. In both scenarios, interest expenses are assumed to decline slightly on average, consistent with Philippine firms’ experience during the global financial crisis and the Taper Tantrum episode.
Average Impact on Philippine Corporate Earnings
Average Impact on Philippine Corporate Earnings
| Operating Income | Net FX Loss | Interest Expense | EBIT | |||
|---|---|---|---|---|---|---|
| (Percentage change from 201S levels) | ||||||
| Scenario I (Taper Tantrum) | 1.5 | 132 | -5.2 | -6.1 | ||
| Scenario II (GFC) | -3.9 | 156 | -2.4 | -9.8 | ||
| Memorandum items: | (In millions of U.S. dollar) | |||||
| Average (201S) | 232.5 | 10.1 | 53.8 | 240.6 | ||
| Standard deviations (2009–2018) | ||||||
| Within firm | 131.7 | 27.4 | 34.9 | 136.3 | ||
| Between firm | 235.0 | 12.6 | 70.1 | 246.7 | ||
| Overall | 300.6 | 30.9 | 90.3 | 320.2 | ||
Average Impact on Philippine Corporate Earnings
| Operating Income | Net FX Loss | Interest Expense | EBIT | |||
|---|---|---|---|---|---|---|
| (Percentage change from 201S levels) | ||||||
| Scenario I (Taper Tantrum) | 1.5 | 132 | -5.2 | -6.1 | ||
| Scenario II (GFC) | -3.9 | 156 | -2.4 | -9.8 | ||
| Memorandum items: | (In millions of U.S. dollar) | |||||
| Average (201S) | 232.5 | 10.1 | 53.8 | 240.6 | ||
| Standard deviations (2009–2018) | ||||||
| Within firm | 131.7 | 27.4 | 34.9 | 136.3 | ||
| Between firm | 235.0 | 12.6 | 70.1 | 246.7 | ||
| Overall | 300.6 | 30.9 | 90.3 | 320.2 | ||
17. The stress scenarios differ markedly in terms of the impacts on the earnings distribution across firm sizes and sectors. In Scenario I, the negative earnings shock is largely concentrated among large firms, especially in utilities, whereas in Scenario II the shock is more evenly distributed. This difference in the distributional impacts reflects the nature of shocks in these scenarios. As Scenario I only features exchange rate shocks, the decline in EBIT is the largest among large firms and in utilities, consistent with the findings above that it is these groups of firms that tend to hold the highest shares of foreign currency-denominated debt.
Nonffnancial Corporate Earnings Shock: By Asset Size
(Percent charge of group median EBIT from end-2018 levels)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.Nonfinancial Corporate Earnings Shock: By Sector
(Percent charge of group median EBIT from end-2018 levels)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ; and IMF staff estimates.18. The results indicate that Philippine firms’ balance sheets are sufficiently healthy to absorb large adverse shocks in the short term. Under Scenarios I and II, the share of total debt held by firms with ICR less than 2 would rise to 8.4 percent and 11.7 percent, respectively, from the benchmark level of 7.1 percent in 2018. Against the median level of 7.9 percent during 2009–2018, these levels appear to be manageable. Among the three types of shocks considered, a negative shock to firms’ operating income appears to have the largest impact on EBIT, followed by interest rate and exchange rate shocks.
Debt-at-Risk Under Stress Scenarios 1/
(In percent of total debt)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: S&P Capital IQ and IM F staff estimates.1/ Debt-at-risk is defined as the total amount of debt held by firms with ICR<2.19. The impacts on banks’ balance sheets appear to be manageable. Under the additional assumption that 10 percent of firms with ICR less than 2 default on their debt,6 the average gross NPL ratio among commercial and universal banks is expected to rise to 2.7 percent under Scenario I and 3 percent under Scenario II, against the end-May 2019 level of 2.2 percent. These NPL ratios are comparable to the levels observed in 2014. Considering the ample capital buffers of Philippine banks (above 15 percent of risk-weighted assets on average), however, the shocks appear to be manageable.
Banking Sector Gross NPL Ratio Under Stress Scenarios 1/
(In percent of gross loan portfolio, as of end-May 2019)
Citation: IMF Staff Country Reports 2020, 037; 10.5089/9781513529158.002.A005
Sources: Haver Analytics; S6iP Capital IQ; and IMF staff estimates.1/ For commercial and universal banks only. The estimates are based on the assumption that 10 percent of firms with ICR<2 default on their loans.20. These assessments, however, should be taken with caution. First, the test does not consider the vulnerability in the household sector, which could put additional pressures on banks’ balance sheets under stress scenarios. Second, given the higher average leverage ratio in 2018, the balance sheet impacts from negative macroeconomic shocks could be nonlinear, leading to disproportionately larger losses compared to past stress episodes. Finally, these tests do not assess the potential negative impacts on firms’ real activities, especially investment. Empirical studies find a robust negative relationship between leverage and investment (IMF, 2015), which should be considered when evaluating the broader macroeconomic vulnerability.
D. Policy Implications
21. Given the risks of slowing growth, active policies might be needed to limit a further increase in corporate leverage. Although the stress results show that Philippine firms’ balance sheets can sustain large short-term shocks, targeted macro-prudential measures could be considered to contain further increases in leverage in some sectors. Corporate insolvency regimes could also be strengthened pre-emptively to prepare for a potential increase in corporate failures in the future.
22. In the long run, polices that promote domestic financial market development would help reduce exposure to exchange rate fluctuations. Using a large international firm-level dataset spanning 21 major EM economies, including the Philippines, Kim (2019)7 finds evidence that firms in developed financial markets carry less unhedged dollar debt compared to those in less developed financial markets. Domestic financial market development could help reduce firms’ need to borrow externally in unhedged foreign currencies by allowing an easier access to hedging instruments.
Appendix I. Data Source
Firm-Level Dataset
This study uses a firm-level dataset constructed from the corporate balance sheet database provided by Capital IQ, S&P Global Market Intelligence.
One advantage of the Capital IQ database over other commercial databases such as Worldscope and Orbis is the availability of detailed information on firms’ outstanding debt held in their balance sheets. Its Debt Capital Structure database, in particular, provides information on the individual debt instruments held by each firm at a given point in time, including the principal amount due, the currency of denomination, and the type of instrument (for example, whether bank loans or bonds).
Information on debt instruments is collected from company financial reports filed to national regulatory agencies, typically available in the supplementary note accompanying the main financial statements. Compared with primary debt issuance databases, such as Dealogic and Thomson One, Capital IQ has the advantage of providing direct and comprehensive information on firms’ liability exposure to exchange rate risks.
The data downloaded from Capital IQ are cleaned following the usual procedures in the literature, including the following steps:
Drop all firm-year observations in which the difference between the sum of total liabilities and the equity and total assets is greater than US$10,000.
Drop all firm-year observations in which the amount of cash and cash equivalents and that of tangible assets are greater than the total assets, respectively.
Drop any firm with a negative value for total assets in any year.
Drop all firm-year observations in which the difference between the sum of due amounts for individual debt instruments (downloaded from the Debt Capital Structure database) and the total principal due outstanding (downloaded from the main financial statements database) is greater than US$100,000.
Drop all firm-year observations in which the outstanding debt denominated in individual currencies exceeds the total debt.
Furthermore, all firms that do not carry any outstanding debt are excluded from the sample. Restricting the sample to firms with debt allows this paper to focus solely on firms’ choice of funding currencies.
The final sample consists of a total of 164 firms over the period of 2014–2018 (160 listed and 4 non-listed). The total market capitalization of listed sample firms accounts for 77 percent of the Philippine Stock Exchange’s market capitalization (US$258 billion as of end-2018).
Balance Sheet Exposure to Exchange Rate Fluctuations
To examine the balance sheet vulnerability to exchange rate shocks, information on net FX translation gains in firms’ income statements is exploited. A firm’s standard income statement typically includes an accounting item on the firm’s net FX valuation gains on its assets and liabilities, reported as part of nonoperating income (also referred as “FX translation gains or loss” in accounting). This item reports the net gain or loss incurred to the firm due to the valuation changes in its foreign currency-denominated assets and liabilities as a result of the change in the exchange rate between two financial years.
To understand how this item would be affected by changes in the exchange rate, it is instructive to consider an actual example presented in San Miguel Corporation’s 2017 Annual Report, a large Philippine conglomerate with businesses in food and beverage, energy, and infrastructure. Table A.1 shows how the company’s earnings (before tax) would change due to a one-peso increase (that is, depreciation) against the U.S. dollar in 2018.
Net Valuation Effect on Income
(Assuming one-peso depreciation against U.S. dollar)
Net Valuation Effect on Income
(Assuming one-peso depreciation against U.S. dollar)
| Effect on income | |
|---|---|
| Assets | |
| Cash and cash equivalents | 2,031 |
| Trade and other receivables | 334 |
| Prepaid expenses and other current asset: | 8 |
| Noncurrent receivables | 30 |
| Sub-total | 2,403 |
| Liabilities | |
| Loans payable | -450 |
| Accounts payable and accrued expenses | -618 |
| Long-term debt | -4,016 |
| Finance lease liabilities | -785 |
| Other non-current liabilities | -16 |
| Sub-total | -5.885 |
| Net total | -3,482 |
Net Valuation Effect on Income
(Assuming one-peso depreciation against U.S. dollar)
| Effect on income | |
|---|---|
| Assets | |
| Cash and cash equivalents | 2,031 |
| Trade and other receivables | 334 |
| Prepaid expenses and other current asset: | 8 |
| Noncurrent receivables | 30 |
| Sub-total | 2,403 |
| Liabilities | |
| Loans payable | -450 |
| Accounts payable and accrued expenses | -618 |
| Long-term debt | -4,016 |
| Finance lease liabilities | -785 |
| Other non-current liabilities | -16 |
| Sub-total | -5.885 |
| Net total | -3,482 |
Under this scenario, the company expects to earn an additional income of P 2,403 from the revaluation of their foreign currency-denominated assets while losing P 5,885 due to their foreign currency-denominated liabilities. As a result, the net valuation loss is expected at P 3,482, implying that the company holds more unhedged foreign currency liabilities than assets. By contrast, if a company earns a net positive income due to currency depreciation, this would imply that the company holds more unhedged foreign currency assets than liabilities.
Prepared by Minsuk Kim (APD).
NPL ratios by sector are not publicly available.
Bangko Sentral ng Pilipinas, 2017 Financial Stability Report.
Real estate here also comprises construction.
For example, if a firm experienced a decline in the operating income amounting to P 10 million in 2008, this same amount is subtracted from the same firm’s operating income in 2018.
For comparison, Chow (2015) considers a stress scenario in which firms with ICRs less than 1.5 default with a probability of 15 percent.
Kim, Minsuk, 2019, “Financial Development, Exchange Rate Fluctuations, and Debt Dollarization: A Firm-Level Evidence,” IMF Working Paper No. 19/168.
