Sri Lankan corporates, which piled up heavy bank borrowings leading up to the balance of payment crisis in 2016, will have a tough time going forward as the borrowing costs will eat a bigger slice of their operating profits, weakening their debt servicing capacity as the interest rates are on the rise.
Most Sri Lankan corporates gobbled up an insurmountable amount of debt during the period when the interest rates were kept artificially low by the money printing Central Bank, during the 2014-2016 period.
The companies, which obviously thought that debt is cheaper than equity and less of a hassle than printing prospectuses and often meeting stringent set of regulatory requirements, went for easy bank loans for their expansion projects and bigger acquisitions.
The banks, which were also hungry for yields and were competing with each other in lending moneys, offered attractive rates to the corporates with little homework on their borrowing capacity and existing leverage.
Both parties forgot that the party wouldn’t last long when the economy eventually slows down.
Now what wasn’t thought at the time is unfolding fast as many corporates have reported hefty borrowings costs in their income statements while banks have reported multi-year high non-performing loans.
Sri Lanka’s corporate performance is anyway under pressure amid slowdown in demand due to poor consumer and investment sentiments.
The banking sector non-performing loans ratio touched 3.3 percent in June, up from 2.75 percent in December 2017, the highest reported in three years.
Moody’s Investors Service releasing its most recent outlook on the banking sector this week said corporate debt serviceability had already weakened and expected the situation to worsen going forward with spill-over effects to be visible in banks’ non-performing loans.
“Corporates’ debt serviceability will be weakened by higher interest rates,” Moody’s said.
According to Moody’s data, around 40 percent of the Sri Lankan corporates are expected to have debt interest coverage ratio (ICR) of less than two under a stressed scenario.
ICR measures the ability of a company to meet its interest payments. ICR is a fitting measure to gauge a firm’s or a nation’s debt affordability than the leverage ratio.
ICR is the same concept explained by the Sri Lankan business tycoon Dhammika Perera last week at a much-talked about Fireside Chat to say that the amount of debt is never a concern if one has the income to service the interest payments.
However, Moody’s cautioned that if corporate debt serviceability weakens in a stressed scenario, the banking sector asset quality could become further deteriorated, if the banks are exposed to these corporate loans significantly.
“Loan concentration, a structural feature of the banking system, will add volatility to asset quality,” Moody’s said.