Financial Stability

The estimated failure rates for all sectors were almost unchanged in 2003 compared to 2002 which may reflect the ability of Danish companies to adjust their costs to the weak economic environment.

The households have become more exposed to rising interest rates and declining income, as indebtedness has risen more than income and the households' indebtedness at adjustable interest rates accounts for a larger share. However, the households' ability to meet payments has improved as a result of the low interest rates. Seen in a Nordic perspective, Danish households' indebtedness over income is high due to e.g. a higher ratio of housing wealth to income in Denmark than in the other Nordic countries.

The corporate sector and the households have benefited from the low level of interest rates but are at the same time sensitive to rising interest rates.

Corporate sector

Since mid-2002, the number of compulsory liquidations in the Danish corporate sector has stabilised at a higher level than in the period 1997-2001, cf. Chart 16. Despite almost zero growth in 2003 the number of compulsory liquidations is largely unchanged compared to 2002. It is assessed that Danish companies have been able to adjust their costs.

Incidence of compulsory liquidation in the corporate sector, 1995-2004	Chart 16

Note: The Chart shows monthly observations for the number of compulsory liquidations calculated as a 12-month moving average. The IT and telecom sector cannot be shown as a separate sector. The sectoral breakdown in the Chart is not identical to that in the analyses later in the chapter, which are based on KOB (KOB was previously known as the Danish Business Information Bureau).
Source: Statistics Denmark.

Development in the companies' key figures
In 2003, the average return on assets for the Danish corporate sector was almost unchanged from 2002. This overall picture of the earnings capacity conceals significant differences in and between the individual sectors. The average return on assets in the building and construction sector and in the sector for transport, etc. decreased during 2003, whereas it continues to increase in the IT and telecom sector as well as in trade, hotels and restaurants. Chart 17 shows the 10 per cent least profitable companies in each sector. The trend is unchanged from previous years.

Return on assets for the 10 per cent least profitable companies in various sectors, 1995-2003	Chart 17

Note: The return on assets is defined as the primary operating result as a ratio of total assets. 2003 comprises accounts presented in 2003, and accounts presented in the 3rd or 4th quarters of 2002 for companies that have not yet registered their accounts for 2003. Total comprises all public and private limited liability companies, i.e. the sectors stated as well as public and private limited liability companies with the sector code "unknown" which often indicates new companies.
Source: KOB.

Generally, the companies' ability to resist losses, measured as the average solvency, was reduced in 2003 over 2002. However, the solvency ratio for the 10 per cent least solvent companies in each sector has been almost unchanged, cf. Chart 18. The IT and telecom sector and trade, hotels and restaurants still stand out as the solvency of more than one out of 10 companies in these sectors was negative in 2003.

Solvency of the 10 per cent least solvent companies in various sectors, 1995-2003	Chart 18

Note: Solvency is defined as equity capital as a ratio of total liabilities. 2003 comprises accounts presented in 2003, and accounts presented in the 3rd or 4th quarters of 2002 for companies that have not yet registered their accounts for 2003. Total comprises all public and private limited liability companies, i.e. the sectors stated as well as public and private limited liability companies with the sector code "unknown" which often indicates new companies.
Source: KOB.

Estimated failure rates by sector
Financial stability 2003 introduced a failure-rate model estimated on the basis of Danish public and private limited liability companies' annual accounts collectively. Failure-rate models are now estimated by sector, cf. Box 11. In general, the sector models and the overall model in Financial stability 2003 indicate the same pattern. The IT and telecom sector still accounts for the highest estimated failure rate, cf. Chart 19 illustrating the estimated failure rates for the 10 per cent weakest companies in each sector. The ranking of other sectors has changed but the sectors manufacturing and business service, etc. still account for the lowest estimated failure rates.

Failure-rate model¹

Box 11

Based on a company's accounts Danmarks Nationalbank's failure-rate model can be used to estimate the probability of the company failing within the next few years. The estimated failure rate can be seen as a weighted index of key figures, etc. The model is estimated in the period 1995-99 and thus does not cover a full economic cycle. This may affect the level of estimated failure rates.

Compared to the failure-rate model presented in Financial stability 2003, minor adjustments have been made. The model is now estimated independently for each sector while the previous model did not consider sector variations. The explanatory variables have been adjusted slightly.

Variables
The models still include nine explanatory variables, i.e. five quantitative variables and four dummy variables. The sign in parenthesis indicates the influence on the estimated failure rate.

Reduction of the capital base (+). The dummy variable is set at 1 if the company repeats the deficit for the year, whereby the company's equity capital falls below the required capital.
Size (-). Logarithm for total assets.
Solvency (-). Equity capital as a ratio of total assets.
Auditors' comment (+). The dummy variable is set at 1 if the auditors' comment in the accounts is critical.
Form of ownership (+). The dummy variable equals 1 if the company is a private limited liability company.
The company's return on assets adjusted for sector (-). The company's return on assets relative to the median return for the sector.
Age (+). The dummy variable equals 1 if the company is less than 5 years old.
Reduced liquidity (+). The short-term debt as a ratio of the primary operating result.
Debt ratio (+). Short-term debt as a ratio of total assets.

Sector models
Independent sector models provide for structural differences between the sectors. This is reflected in the varying significance of the individual variables in the specific sector models. The IT and telecom sector differs considerably as the return on assets adjusted for sector and solvency is not significant in this sector model. One explanation may be that the investors in the IT and telecom sector in the estimated period 1995-99 had supernormal expectations of future earnings.

Estimated failure rates
The distribution of estimated failure rates in the general model indicates when probability of failure is relatively high or low, cf. the Chart below. 50 per cent of the active companies have an estimated failure rate below 1.2 per cent, while 50 per cent of the companies subject to failure have a failure rate below 5.3 per cent.

¹For a more detailed review of the failure-rate model see Morten Lykke, Kenneth Juhl Pedersen and Heidi Mølgaard Vinther, A Failure-Rate Model for the Danish Corporate Sector, Danmarks Nationalbank's working paper series no. 16.

Distribution of companies' estimated failure rates

Note: The value "1" on the x-axis indicates that the companies within this range have an estimated failure rate of above 0 and below or equal to 1 per cent. ">20" indicates all estimated failure rates above 20 per cent. The estimated failure rate for companies subject to compulsory liquidation is based on the latest accounts before compulsory liquidation.
Source: Own calculations.

Estimated failure rates of the 10 per cent weakest companies, 1995-2003	Chart 19

Note: The Chart shows the 90th percentile. 2003 comprises accounts presented in 2003, and accounts presented in the 3rd or 4th quarters of 2002 for the companies that have not yet registered their accounts for 2003.
Source: Own calculations.

The estimated failure rates of the weakest companies were generally unchanged in 2003 over 2002, cf. Chart 19.

The dispersion of estimated failure rates can be used as an indication of the uncertainty concerning lending to the corporate sector. The higher the dispersion the greater the uncertainty. The dispersion of estimated failure rates stabilised in several sectors in 2003 after a rising trend for several years, cf. Chart 20.

Dispersion of estimated failure rates, 1995-2003	Chart 20

Note: The dispersion is measured in terms of the standard deviation. 2003 comprises accounts presented in 2003, and accounts presented in the 3rd or 4th quarters of 2002 for companies that have not yet registered their accounts for 2003.
Source: Own calculations.

The development of the estimated failure rate in the years prior to compulsory liquidation shows that the estimated failure rate changes considerably only in the last years before compulsory liquidation, cf. Chart 21. The same tendency applies to the key figures return on assets and solvency.

Estimated failure rate, return on assets and solvency for companies subject to failure in the period prior to failure, median	Chart 21

Source: Own calculations.

Companies' borrowing
Danish companies' borrowing from domestic credit institutions increased by 5 per cent in 2003 following very weak growth in borrowing in 2002. The historically low interest rates in the 1st half of 2003 in particular resulted in growing interest in mortgage-credit loans. Danish mortgage-credit institutes' corporate lending thus increased by almost 10 per cent in 2003.

The distribution by sector of lending by banking institutions and mortgage-credit institutes shows that business service accounts for the largest share, cf. Chart 22. In 2003, this sector also showed the highest solvency (measured as the sector's median solvency) and the lowest estimated failure rate.

Banking institutions' and mortgage-credit institutes' corporate lending by sector, end-2003	Chart 22

Note: Lending is calculated as lending by sector as a ratio of total corporate lending by banking institutions and mortgage-credit institutes, respectively. The calculation is based on the institutions reporting in full to the MFI balance-sheet statistics. The IT and telecom sector cannot be shown as a separate sector.
Source: Danmarks Nationalbank.

The banking institutions' losses as a ratio of loans and guarantees to the corporate sector decreased in 2003 compared to 2002. However, the loss ratios for the trade, hotels and restaurants sector and for the transport and agriculture sectors increased, cf. Chart 23.

Sector breakdown of the banking institutions' loss ratio, 2000-03	Chart 23

Note: The Chart shows the banking institutions' losses in a number of sectors as a ratio of loans and guarantees to the individual sector. The development in provisions is not taken into account. The "Total" item covers total losses on corporate exposures. IT and telecom cannot be shown as a separate sector. The Danish Financial Supervisory Authority's figures for 2003 are preliminary.
Source: The Danish Financial Supervisory Authority.

Interest-rate sensitivity
The companies have benefited from the present low interest rates. In 2003 the average interest rate for banking institutions' outstanding corporate loans was 5.4 per cent.

In the 10 per cent of the companies with the highest interest expenditure relative to total assets, interest expenditure as a ratio of total assets accounts for approximately 25 per cent. The approximately 6,000 companies in question have a deficit of just over kr. 0.5 million on average. An increase in interest expenditure by 25 per cent implies an increase from 70 per cent to 77 per cent in the share of companies with a deficit, cf. Chart 24. The average deficit increases to just over kr. 0.8 million.

Effect of an increase in interest expenditure in the 10 per cent of companies with the highest interest expenditure as a ratio of total assets, 2003	Chart 24

Note: 2003 comprises accounts presented in 2003, and accounts presented in the 3rd or 4th quarters of 2002 for companies that have not yet registered their accounts for 2003.
Source: Own calculations.

Agriculture

Lending by banking institutions and mortgage-credit institutes to the agricultural sector accounts for approximately 20 per cent of total domestic corporate lending, of which the mortgage-credit institutes' share exceeds 80 per cent. The small institutions account for the relatively largest share of the banking institutions' lending to the agricultural sector.

Development in earnings and capital
Agriculture's accounts for 2003 will not be available until the autumn of 2004.

In 2002 agriculture's earnings fell considerably after two very good years. The agricultural sector's operating result decreased by kr. 253,000 to kr. 111,000 per full-time farm, primarily as a result of lower pork and grain prices. The Danish Agricultural Advisory Centre expects a further decrease in the agricultural sector's operating result in 2003 and a slight improvement in 2004.

Despite the lower operating result, investments continue to be significant. An important explanation of the high investment level is the agricultural sector's structural adjustment towards larger farms. The high investment level combined with the low operating result led to a significant financing requirement in 2002. Investments generated from operations accounted for only 27 per cent of the total financing requirement, the lowest level in 10 years.

The agricultural sector's net interest expenditure increased further in 2002 to more than 80 per cent of the operating result before interest, which is in line with the level in 1998 and 1999, the last years also with low pork prices.

Despite the declining interest rates in recent years interest expenditure has risen, reflecting the agricultural sector's growing debt. The debt-to-assets ratio rose to 57 per cent in 2002 – the highest level in 7 years, cf. Chart 25.

Indebtedness of full-time farms, 1990-2002	Chart 25

Note: The operating results of full-time farms include mixed farms.
Source: Danish Research Institute of Food Economics.

The agricultural sector's expected weak earnings in 2003, which are expected to improve only gradually in 2004, together with the growing debt indicate that the situation of the weakest members of the sector is tightening.

Households

In 2003, the households' indebtedness increased more than their disposable income, but their ability to meet payments improved, due to the low interest rates.

The number of enforced sales of owner-occupied homes is still low, and the arrears ratio of the mortgage-credit institutes is historically low. The development at the beginning of 2004 shows no signs of change. Since 1998 the number of RKI registrations has been rising, however, without reaching the peak of 1993. In 2003, the number of RKI registrations stabilised around 330,000.

The banking institutions and mortgage-credit institutes may solely register a debtor with RKI based on a decision by a third party, typically a court order, which is why some time may pass between the time of non-performance and the time of registration. Financing companies, on the other hand, may register a default on the basis of a simple debtor's declaration^[1]. Thus, the time of registration might be closer to the actual cyclical situation for financing companies than for banking institutions and mortgage-credit institutes. The development in RKI registrations for financing companies, cf. Chart 26, thus supports the presumption of a slight improvement in the financially weakest households' current ability to meet payments. However, in general the average amount per registration increased throughout 2003.

Registrations of late payments from credit providers and all creditors, 2002-04, index	Chart 26

Note: As per February 2004 the banking institutions and the mortgage-credit institutes, and the financing companies have made 58,567 and 64,159 registrations, respectively. This is equivalent to 18 and 19 per cent of the total number of RKI registrations, respectively. The Chart shows registrations for both the households and the corporate sector. The households account for approximately 97 per cent of the total registrations. The average number of registrations per person is 2.
Source: RKI Kredit Information.

Households' borrowing
In recent years, the households have used the rising house prices to raise mortgage-credit loans to the detriment of borrowing from the banking institutions. In 2003, borrowing by the households from the banking institutions increased again.

The households' interest payments decreased in 2003 as a result of the low level of interest rates and a shift towards loans with a shorter fixed-interest period. As of 1 October 2003 it became possible to obtain mortgage-credit loans with deferred amortisation for up to 10 years. In the 4th quarter of 2003 and 1st quarter of 2004 deferred-amortisation loans for owner-occupied homes and summer cottages were granted for an amount of kr. 86 billion in total or 55 per cent of gross new lending. The mortgage-credit institutes' lending to households has grown by more than the average increase in house prices^[2] since 2001, indicating a higher loan-to-value ratio for owner-occupied housing. A description of the development in owner-occupied housing prices in Denmark is available in The Development in Cash Prices of Owner-Occupied Housing, Danmarks Nationalbank, Monetary Review, 1st Quarter, 2004.

Danish households' indebtedness seen in a Nordic perspective
Seen in a Nordic perspective, Danish households have the highest indebtedness relative to disposable income^[3], cf. Chart 27. Thus, the Danish households appear more vulnerable to e.g. social events, such as unemployment and divorce, than the households in the other Nordic countries.

The households' debt burden in the nordic countries, 1995-2003	Chart 27

Note: The debt burden is defined as the households' debt to credit institutions as a ratio of disposable income.
Source: Finlands Bank, Norges Bank, Sveriges Riksbank, Eurostat, Ministry of Finance and Danmarks Nationalbank.

The tax deductibility of interest payments does not as such explain the higher indebtedness in Denmark, as the interest deductibility is almost identical in the Nordic countries. The higher indebtedness of Danish households can be attributed to other factors. For instance, Danish households' interest burden^[4] is not proportionally higher than in the other Nordic countries, cf. Chart 28.

The households' interest burden in the nordic countries,1995-2003	Chart 28

Note: The interest burden is defined as net interest expenditure after tax as a ratio of disposable income.
Source: Finlands Bank, Norges Bank, Sveriges Riksbank, Eurostat, Ministry of Finance and Danmarks Nationalbank.

Housing wealth
In Denmark 53 per cent of the households live in owner-occupied homes, while the share in Finland, Norway and Sweden is 64 per cent, 77 per cent and 66 per cent, respectively. The housing wealth relative to the households' disposable income is, however, relatively large in Denmark, cf. Chart 29. Other things being equal, this supports a higher level of indebtedness as more collateral can be provided when borrowing.

Housing wealth as a ratio of the households' disposable income, end-2002	Chart 29

Source: Finlands Bank, Statistics Finland, Norges Bank, Sveriges Riksbank, Statistics Denmark and Danmarks Nationalbank.

In terms of debt to credit institutions in relation to the collateral to be provided, expressed as debt as a percentage of housing wealth, Danish households thus differ less from the other Nordic households, cf. Chart 30.

The households' debt to credit institutions as a ratio of housing wealth and disposable income, 2002-03	Chart 30

Note: Due to a slight time lag in the compilation of the calculated figures the results are not directly comparable in terms of time.
Source: Finlands Bank, Statistics Finland, Norges Bank, Statistics Norway, Sveriges Riksbank, Eurostat, Ministry of Finance, Statistics Denmark and Danmarks Nationalbank.

The macroeconomic environment
Expectations of continued stable macroeconomic development may affect the households' propensity to invest, leading to higher borrowing. Several macroeconomic variables have developed more steadily in Denmark than in other Nordic countries in the period from 1990, cf. Chart 31. See also Volatility in Inflation and Economic Activity in the Nordic Countries, Danmarks Nationalbank, Monetary Review, 4th Quarter 2003.

Dispersion of annual changes in macroeconomic variables, 1990-2003	Chart 31

Note: Real disposable income only covers the period 1990-2002.
Source: Statistics Finland, Statistics Norway, Statistics Sweden, Eurostat, OECD and Statistics Denmark.

Home financing
In Denmark fixed-rate convertible mortgage-credit loans with a maturity and an initial fixation period of 30 years are still the most common form of home financing. The Danish mortgage-credit system makes it possible for homeowners to borrow at market interest rates. In Finland and Norway housing is typically financed through the banking institution at an adjustable interest rate. In Sweden the households mostly raise housing loans in "bostadsinstitutter" (building societies) as serial loans that are typically amortised over 30-60 years. Home financing in the Nordic countries is outlined in Box 12.

Characteristics of home financing in the nordic countries

Box 12

	Finland	Norway	Sweden	Denmark
Home financing typically takes place	Bank	Bank	Building society	Mortgage-credit institute
Maturity, years	17-18	25	40-60	30
Fixed-rate loans, per cent	10	20	66*	64
Adjustable-rate loans, per cent	90	80	33	36**
Fixed-interest period, fixed rate		< 5 Years	5-10 Years, £ 5 Years	30 Years
Fixed-interest period, adjustable rate	£ 1 Year	< 1 Year	< 1 Year	1-3 Years
Maximum loan-to-value ratio in mortgage-credit institute	60		80	80
Note: * Half of the loans characterised as fixed-rate loans have an fixed-interest period of up to 5 years. The adjustable-rate loans are loans with a fixed-interest period of up to 10 years, but typically 1-3 years. Source:** Finlands Bank, Norges Bank, Sveriges Riksbank and Danmarks Nationalbank.

[1] If a company wishes to register a debtor with RKI, the company must have submitted three reminders in writing and in the last reminder warned the debtor of debt collection and RKI registration. The minimum amount is kr. 200, and there must be no dispute.

[2] Cash price index for one-family houses.

[3] The debt burden is defined as the households' debt to credit institutions as a percentage of disposable income. Disposable income here is income after tax and depreciation.

[4] The interest burden is defined as the households' net interest expenditure after tax as a ratio of disposable income.

The Corporate Sector and the Households

Corporate sector

Agriculture

Households