Amid an economic downturn, the debt repayment ability of South Korean companies and business owners has got worse. One out of three firms is unable to generate enough operating profit to pay the interest on its loans. As small business owners are struggling due to weak domestic demand, they have to increase loans and, as a result, their loan default rate is rising.
In 2018, 32.1 percent of South Korean companies had an interest coverage ratio below one, up 2.4 percentage points from a year ago, according to a first-half financial stability report for 2019 released by the Bank of Korea (BOK) on June 20. It was the highest figure in eight years since 26.9 percent in 2010. The interest coverage ratio is calculated by dividing a company's operating profit by its interest expenses. In short, one in three companies could not make interest payments on its debt with its earnings.
In particular, 57.7 percent of lodging and food businesses had an interest coverage ratio below one. The interest coverage ratio of all businesses also stood at 5.9, down from 6.3 a year earlier.
The figure drops to 3.9, the lowest since 3.5 in 2015, when the electrical and electronics businesses, which enjoyed a boom last year, are excluded.
By size of firm, conglomerates saw their interest coverage ratio fall from 8 to 7.5. The figure showed a downward trend again, though it continued to rise for three years in a row since 2015. Small and mid-sized companies had an interest coverage ratio of 2.5, continuing to show a decline for second successive year after 2.9 in 2017. A BOK official said, “As the economic growth rate at home and abroad had been slowing down and the upstream industry had cut down its investment in facilities, small and mid-sized companies which supply intermediary goods were in a bigger shock.”
As business market conditions got worse, an increasing number of small business owners had more financial problems as well. More and more small business owners kept their business by taking out loans, leading to a rise in loan default rates. The loan balance of small business owners came to 624.30 trillion won (US$537.49 billion) as of the first quarter of 2019, up 12.10 trillion won (US$10.42 billion) from the end of the previous year. The figure increased by about12 trillion won (US$10.33 billion) in three months.
The BOK said, “There are growing concerns over loan soundness, with the loan default rate of individual businesses recently rising and the self-employed businesses sector remaining sluggish. In fact, the loan to income ratio (LTI) of small business owners increased from 220.4 percent in 2017 to 230.3 percent in 2018. Particularly, the wholesale and retail sector and the lodging and restaurant business had a considerable rise. The figure for the wholesale and retail sector increased from 239.4 percent in 2017 to 294.4 percent and the lodging and restaurant sector from 222.1 percent to 255.3 percent.
Accordingly, their loan default rate was on the rise. The loan default rate by individual businesses stood at 0.38 percent in the first half of 2019, up 0.06 percentage point from the previous quarter. It was the highest figure since 0.34 percent in the third quarter of 2016.
In addition, the BOK said the number of households at high risk increased in the second to fourth income quintiles. Households at high risk refer to those whose debt service ratio (DSR) and debt to asset ratio (DTA) exceed 40 percent and 100 percent, respectively. A BOK official said, “Households at high risk accounted for 2.7 percent of the total as of 2018, down 0.2 percentage point from a year ago. However, their proportion increased in the second to fourth income brackets. Moreover, the debt repayment capability of total households at high risk got worse than a year earlier.” The median value of the DSR for households at high risk rose from 70.6 to 76.6 and the DTA from 145.6 to 150.6.