The Corporate Sector and the Households
On overall terms, the Danish corporate sector showed stable development in 2002, even though economic growth was still subdued. However, the overall picture conceals differences between and within sectors.
Danmarks Nationalbank has estimated a model of the probability that companies will fail. The results of the model indicate that the failure rate has increased slightly.
In view of the low level of interest rates the households augmented their debt burden, even though there was no increase in the interest burden. The households' indebtedness has increased in line with the expansion of housing wealth. The households are well-consolidated, but the greater indebtedness makes them more vulnerable to declining incomes, rising interest rates and falling house prices.
Corporate sector
Corporate profits were almost unchanged in 2002 over 2001. However, the weakest companies in all sectors experienced a tightening. One result is that in August 2002 the number of compulsory liquidations had reached the highest level for seven years, cf. Chart 19.
The banking institutions' lending and losses on corporate exposures
The banking institutions' domestic lending to the corporate sector increased by 1.1 per cent in 2002. At an aggregate level, the banks in category 1 reduced their corporate lending, while the banks in category 2 increased their credit expansion. The breakdown in Chart 20 shows that business service, etc., trade, hotels and restaurants, as well as manufacturing, are the three most important sectors for the banking institutions in terms of lending.
The banking institutions' total losses as a ratio of loans and guarantees decreased marginally from 2001 to 2002. This applied to all sectors apart from manufacturing and building and construction, for which the loss ratio increased, cf. Chart 21.
For manufacturing, as well as trade, hotels and restaurants, which are both sectors accounting for a large share of the banking institutions' total lending, the loss ratio in 2002 exceeded the average.
Development in the companies' key figures
The average return on assets in 2002 was at the level of 2001. The average return on assets increased in the IT and telecom sectors, as well as in trade, hotels and restaurants. The improvement in the IT and telecom sector can be explained by the large number of companies with a sound business basis and increasing earnings, despite the sector's problems relating to the IT bubble. In addition, the very weakest companies no longer exist.
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Box 4
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A new Financial Statements Act entered into force on 1 January 2002. The conceptual framework of annual accounts is now focused on balance sheet rather than results. The prudential principle has been abandoned in favour of a more topical view of the company's value. In the annual accounts the balance sheet must therefore include more assets, which are to be calculated at fair value instead of acquisition cost. This development accords with international accounting standards. The amendments to the Financial Statements Act relate primarily to the company's balance sheet, while the profit and loss account is affected by the ongoing value adjustments to the balance-sheet items, cf. the Table. |
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| Selected accounting items subject to new accounting practice under the amended financial statements act | |||||||||||||||||||||||||||||||||
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| Note: The table describes the main principles. There may be exceptions within the individual items. | |||||||||||||||||||||||||||||||||
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Intangible assets, including goodwill, must be entered to the company's balance sheet subject to annual systematic amortisation over the expected economic life of the asset. Goodwill previously written off immediately against equity capital must now be included in the balance sheet and written off over the expected useful life of the asset. In future, leased assets are entered to the balance sheet and treated as acquired assets. All other things being equal, the balance sheet will be expanded, and thiswill affect the calculation of key financial ratios. Certain financial items previously entered at acquisition cost must now be stated at fair value or amortised cost. This may lead to greater fluctuation than before in the value of the financial items. |
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For the 10 per cent of the companies in each sector with the weakest earnings the trend for the past year is almost flat, cf. Chart 22.
The companies' average solvency has deteriorated slightly from 2001. For most sectors, the solvency ratio for the 10 per cent least solvent companies is between 0 and 4 per cent in 2002, cf. Chart 23. In the IT and telecom sector, and in trade, hotels and restaurants, the solvency of more than one out of 10 companies is still negative.
Model for quantification of probable failure rates by sector[1]
Danmarks Nationalbank has developed an account-based model for Danish public and private limited liability companies in order to quantify a company's probable failure rate within the next few years[2]. A banking institution's credit risk associated with lending to a company can be expressed as the probability of that company defaulting on its financial obligations, whereby the bank incurs a loss. However, this probability cannot be calculated on the basis of the available data due to insufficient information on failure to repay debt. Therefore company failures are used instead.
The calculations are based on key financial ratios to illustrate the company's earnings, solvency and liquidity, as well as information on the company's age, size, etc. Aggregation of the failure rates of the individual companies within each sector indicates the overall failure rate for the sector. The model is described in further detail in Box 6.
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Box 5
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Data Non-financial holding companies are excluded. A holding company is characterised by partial or full ownership of other companies. As a general rule holding companies have no other activities. In addition, a number of large international groups have placed their holding companies in Denmark. Non-financial holding companies were previously included under business service, etc., so that only this sector is affected by the adjustment. For 2002, almost 3,000 non-financial holding companies are excluded. Companies with total assets of less than kr. 50,000 are excluded, i.e. approximately 1,300 companies were excluded in 2002. These companies are registered as active, but have no activities. Registration of accounts presented in 2002. The Danish Business Information Bureau collects annual accounts as they are registered at the Danish Commerce and Companies Agency. Not all annual accounts for 2002 are available for the analyses in Financial stability 2003. Against this background, observations for 2002 consist of accounts finalised in 2002 which are registered in the database, as well as accounts published in the 3rd and 4th quarters of 2001 for the companies that have not yet registered their accounts for 2002. The figures for 2002 are thus partial approximations and should be interpreted with caution. |
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| 1 See also Box 4 in Financial stability 2002, Danmarks Nationalbank. | |
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Box 6
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Danmarks Nationalbank has estimated a model to calculate individual failure rates on the basis of the companies' annual accounts. The individual failure rates are aggregated to sector level, to enable comparison across sectors. Data Variables
The model is also estimated over different periods, which has no significant effect on the results. |
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| 1 For a failed company, there is a certain time lag from the publication of accounts to the registration of failure. After almost 21 months half of the failed companies have received a public notification. It is thus difficult to specify the timing of failure. | |
Results from the model
Chart 24 shows the probable failure rate by sector for the 10 per cent of companies that are most exposed to failure.
According to the model, the IT and telecom sector accounts for the highest, and manufacturing for the lowest, probable failure rates viewed over the entire period. This is in line with previous analyses in Financial stability. Of the three sectors accounting for the largest share of the banking institutions' lending, trade, hotels and restaurants account for the highest failure rate.
The dispersion of failure rates has risen for all sectors in the last few years, cf. Chart 25. The increased dispersion indicates greater uncertainty concerning lending to the corporate sector.
The lowest dispersion and smallest failure rate are found in manufacturing. Against this background, manufacturing is the sector deemed to be least exposed in overall terms, according to the available accounts. On the other hand, manufacturing showed the highest loss ratio in 2002. Like manufacturing, building and construction has a low dispersion, but a somewhat higher failure rate.
It is examined whether the model's probable failure rate at sector level and the loss ratio for the banks vary together. If the co-variation is high, the development in the failure rate can be used as an indicator of the banks' future losses. The analysis shows that for all sectors there is a robustly positive co-variation between the failure rate and the banks' loss ratio one to two years ahead.
The banks' debt is concentrated in the companies with the lowest failure rates, cf. Chart 26. An analysis of the concentration of bank debt by sector gives a similar result.
Agriculture
Lending by banking institutions and mortgage-credit institutes to the agricultural sector accounts for 7.5 per cent of total domestic lending, of which the mortgage-credit institutes' share exceeded 80 per cent in 2002. Total lending to the agricultural sector rose by 7 per cent from 2001 to 2002. The small institutions account for the relatively largest share of the banking institutions' lending to the agricultural sector.
Agriculture's earnings and capital
The agricultural sector's operating result fluctuates strongly, and has been strongly influenced by pork prices in recent years, cf. Chart 27.
The operating result of pig producers has shown strong fluctuation, while the operating result of plant growers and dairy cattle producers has been relatively stable, although at a low level. According to the estimate of the Danish Agricultural Advisory Centre, the agricultural sector's operating result decreases in both 2002 and 2003, primarily due to lower pork prices.
The agricultural sector's net interest expenditure increased considerably in the period 1997-2001, despite the falling level of interest rates in recent years. The increase is attributable to the agricultural sector's growing debt. In the same period, the debt-to-assets ratio fell slightly to just over 50 per cent as a consequence of the continued increases in prices for farmland.
Expectations that earnings will decrease in 2003, together with a slightly rising trend for the number of compulsory liquidations, indicate that the situation of the weakest members of the sector is worsening.
The price of farmland
The agricultural sector's earnings and production conditions, as well as other conditions, influence demand for and the price of land. The price of farmland is determined by such factors as the return on cultivating the land, the environment-related requirements of land used for livestock production, including pig production, and various EU subsidy schemes, including subsidy per hectare. Other conditions specific to the agricultural sector include the location of the agricultural property, and the fact that land is a scarce resource. Finally, more general factors influence property prices overall, such as the general development in prices and wages, the level of interest rates, and inflation expectations.
Chart 28 shows the development since 1971 in the index of cash prices for agricultural properties exceeding 60 hectares, compared to the consumer-price index. Since there are no separate statistics for traded farmland, the index of cash prices for the largest agricultural properties is chosen as an estimate for the price of farmland. The housing element thus constitutes only a small proportion of the index.
When Denmark joined the EU at the beginning of the 1970s, land prices rose at a faster rate than inflation. The agricultural crisis around 1980 entailed a significant correction, whereby product prices were more than halved. Since 1994, land prices have again increased considerably, and in 2002 the price of the largest agricultural properties is kr. 100,000 per hectare[3].
A price of kr. 100,000 per hectare makes great demands of the agricultural sector's earnings. Expectations of weak development in earnings, together with pressure on the agricultural sector's other framework conditions, may lead to downward pressure on farmland prices. All other things being equal, receding earnings and declining land prices mayreinforce the tendency within the agricultural sector towards larger and more profitable farms, particularly in pig production where it seems the greatest economies of scale can be obtained.
Households
Several indicators show that the households' ability to fulfil their payments is still robust. Recent years have seen firm increases in real disposable gross incomes. Unemployment is still low, even though it has increased a little.
The reports of late payment incidents to RKI may give an early warning of the households' future ability to meet payments. The RKI data indicates that, in overall terms, the households' financial situation has tightened a little. A more direct warning concerning homeowners' ability to meet payments can be obtained by considering the development in the arrears ratio of mortgage-credit loans, since repayment of housing loans must be assumed to be homeowners' highest-ranking debt commitment. The arrears ratio is at a very low level historically, and was almost unchanged throughout 2002, cf. Chart 29. One explanation for the increase in RKI registrations may be that non-homeowners' ability to meet payments has tightened a little.
The number of enforced property sales is still very low, although the number of enforced sales of one-family houses increased by 35 per cent in the period from 2000 to 2002, while the number of enforced sales of owner-occupied flats decreased by 15 per cent in that period.
The increase in house prices has diminished over the past year after several years of substantial growth. The most recent drop in interest rates has thus not fully impacted house prices. This may be explained by the weaker economic development and a dampening labour market.
So far it has not been possible to repay mortgage-credit loans for owner-occupied homes at a slower rate than an annuity loan is repaid. The government has proposed a bill which e.g. permits repayment-free loans for up to 10 years. Theoretically, this should not affect house prices, since changing a loan's repayment profile does not affect the real cost of owning a home. Repayments constitute savings and are not a housing cost. However, even if the new type of loan gains ground, it is uncertain whether it will stimulate house prices, which traditionally are fixed on the basis of the net instalments on the home, including repayments. If this is the case, the new type of loan will mainly be to the advantage of existing homeowners.
Borrowing by households
The banking institutions' lending to households accounts for approximately 1/3 of the banking institutions' total lending, while approximately 2/3 of the mortgage-credit institutes' total lending is extended to the households.
The banking institutions' lending to the households increased only moderately in 2002, while the lending of mortgage-credit institutes increased considerably, cf. Chart 30. Of the households' debt 18 per cent is extended by the banking institutions, and 82 per cent by the mortgage-credit institutes. Recent years' development in house prices has enabled homeowners to mortgage the equity in their homes. In conjunction with falling interest rates many homeowners have used this opportunity, e.g. to repay bank debt. Since the 2nd half of 2001 the growth in mortgage-credit lending has exceeded increases in house prices[4]. Given a constant supply of homes in the short term this may indicate a higher loan-to-value ratio.
Debt burden and ability to meet payments
The households' debt has grown more than their gross disposable income[5] in the period 1997-2001, i.e. the households' debt burden has increased[6]. In terms of the 10 per cent most indebted households in various income brackets, cf. Chart 31, all income brackets' debt burden has increased. The group of households with incomes above average are those most indebted. At the same time, this group has the largest proportion of 25-39 year-olds, of whom many must be assumed to be new entrants to the housing market. This may help to explain the high debt burden of this group. On average, non-homeowners have increased their debt burden more than homeowners, although from a relatively low level. All other things being equal, the higher debt burden makes the households more vulnerable to a decrease in income.
An expression of the households' ability to repay their debt is the interest burden, cf. Chart 32, i.e. interest expenditure as a ratio of gross disposable income. In overall terms, the interest burden has been reduced during the period for the 10 per cent most interest-burdened households in each income bracket, despite growing indebtedness.
[1] The work is based on e.g. Kenneth Juhl Pedersen, Regnskabsbaseret konkursmodel for danske virksomheder – teori og empiri (Accounts-Based Model for Failure Rates of Danish Companies – Theory and Empirical Evidence – in Danish), 2002, thesis for a master's degree in Economics, University of Copenhagen.
[2] The model assumes a failure rate to include the following events: The company is subject to compulsory liquidation or is being liquidated, the company has been dissolved/dissolved by the courts, or is subject to compulsory dissolution by the courts, the company is subject to a compulsory deed of arrangement with creditors or is subject to a compulsory scheme of arrangement with creditors.
[3] Customs and Tax, Property Sales, 1st half of 2002.
[4] The house price is the average cash price per square metre for one-family and row houses nationwide, cf. www.realkreditraadet.dk.
[5] The gross disposable income is defined as the households' income after tax, but before payment of interest expenditure.
[6] The debt burden is defined as total debt as a ratio of gross disposable income.