Higher debt level at Asian firms raises concern

Stress tests show some may be vulnerable if rates rise or earnings fall: MAS review

Singapore's banking system remains resilient even in the face of external uncertainties, says MAS, as banks here have strong capital and liquidity buffers. Even so, the regulator cautions that continued vigilance is needed in areas such as credit und
Singapore's banking system remains resilient even in the face of external uncertainties, says MAS, as banks here have strong capital and liquidity buffers. Even so, the regulator cautions that continued vigilance is needed in areas such as credit underwriting. It also notes the importance of managing foreign currency risks and developing liquid contingency plans. PHOTO: LIM YAOHUI FOR THE STRAITS TIMES

Asian firms, already weighed down by weaker earnings, are also facing volatile currency movements and a softening economic outlook, raising concerns that some might not be able to meet debt payments when interest rates start rising.

The Monetary Authority of Singapore (MAS) noted in its latest Financial Stability Review that Asian firms took on more debt in the period of low interest rates and strong capital flows into Asia that followed the financial crisis of 2008.

Corporate debt as a proportion of gross domestic product (GDP), a key measure of corporate debt holding, has risen across the board in Asia.

In Singapore, in 2010, corporate debt came in lower than GDP, but last year, it amounted to 145 per cent of GDP.

"Higher corporate leverage is not necessarily undesirable, especially if the debt raised was used for productive investments or capital-intensive restructuring," MAS said.

"However, the higher debt burden increases the risk of debt repayment difficulties when interest rates normalise or firms' revenue projections are not met."

Indeed, MAS stress tests of more than 19,000 corporate balance sheets across the region found that they had become weaker and more sensitive to a rise in interest rates and earnings shocks, compared with the situation in the period just before the 2008 financial crisis.

However, the tests also found that Asian corporate balance sheets are less vulnerable now than during the Asian financial crisis of 1997 and that Asian firms in general have relatively high stress thresholds.

The tests suggest that most could withstand interest rate and earnings shocks, MAS said.

Larger companies, in particular, have ample financial buffers that should help cushion them against the impact of any volatile movements in foreign currencies, the regulator added. "Significant corporate distress remains a low-probability scenario in most of Asia," it said.

Even so, firms that have significantly high levels of debt "could be vulnerable if interest rates rise or earnings weaken further", MAS noted, adding that there is a concentration of debt in some commodity- and property-related firms.

Companies with foreign currency exposure could also face increased risks from foreign currency mismatches should volatility in the currency market persist, it said.

For example, a firm that incurs costs in Singapore dollars, but earns revenues in ringgit, could see its bottom line drop sharply if the Malaysian currency continues to weaken.

In addition, MAS flagged the risk of contagion - the health of the corporate sector as a whole has an impact on banks' asset quality and financial stability.

"Across Asia, corporates still rely heavily on banks for external financing, although bond financing has also increased," it said.

"Corporate loans make up the majority of bank loan exposures. Asian banks would be exposed to higher asset-quality risks when corporate balance sheets weaken."

Higher provisioning and non- performing loans (NPLs) could translate into weaker earnings for banks, while a rise in corporate- sector risks could trigger corporate bond sell-offs and trading losses, MAS said.

Credit Suisse economist Michael Wan said a rise in NPLs is inevitable, but should be manageable for the region's banks.

"Credit has risen a lot, but it is nowhere near levels during the Asian financial crisis and, especially across Asean, we have seen the credit cycle turn already. Credit growth has already moderated," he said. "There will be a slow grinding moderation and a pretty manageable rise in NPLs."

The regulator noted that Singapore's banking system remains resilient amid the uncertain external environment. Banks here have strong capital and liquidity buffers to withstand severe shocks, although "continued vigilance is warranted", it said. "Banks should continue to maintain prudent credit underwriting standards, monitor portfolio vulnerabilities and ensure adequate provisioning," it said.

"Banks should also manage foreign currency risks prudently and develop liquidity contingency plans."

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A version of this article appeared in the print edition of The Straits Times on November 28, 2015, with the headline Higher debt level at Asian firms raises concern. Subscribe