Published as part of the Financial Stability Review, May 2022.
By the end of 2021, the aggregate profitability and indebtedness of non-financial corporations (NFCs) in the euro area had returned to pre-pandemic levels. While overall gross debt to gross value added remains elevated at around 160%, net debt has returned to pre-pandemic levels of around 100% of gross value added as companies have reserves of increased precautionary cash under favorable financing conditions. However, these aggregate developments were mainly driven by large companies, while the net debt position of small companies increased as they used credit to offset cash losses that were not covered by the support measures. public authorities. In addition, many companies are now facing widespread increases in input prices due to rising energy prices and supply chain disruptions. Against this background, this box uses firm-level balance sheet data for around 91,000 euro area non-financial corporations to identify vulnerable firms based on Altman’s Z-score, a measure of corporate risk. insolvency that uses five balance sheet and income statement ratios and their common importance., ,  It then matches bank and sovereign exposures to account for related risks associated with the sovereign-bank-corporate nexus.
Although business revenues have deteriorated sharply during the COVID-19 pandemic, policy support measures have helped keep bankruptcies remarkably subdued. The economic effects of the pandemic have weakened corporate balance sheets, particularly in the services sector. At the same time, companies in the technology sectors and many consumer goods sectors have also benefited (Table A, panel a). Falling income seems to have been the main factor in the deterioration of financial health. Firm-level data also suggests that firms with higher levels of leverage experienced a greater deterioration in their financial health (Table A, panel b), and firms classified as weak had relatively higher debt, lower profits, and lower revenues than firms classified as healthy. Compared to the general decline in revenue, profits and margins remained relatively resilient. This is partly due to government support measures.
Rising liabilities, lower cash levels and modest earnings continue to pose a risk for a subset of businesses. Translating Altman Z scores into implied corporate credit ratings, the share of companies that would be rated CCC or lower increased from 7.5% in 2019 to over 9% in 2020, consistent with the relatively benign downgrades among rated companies. Overall, however, the share of vulnerable companies (those with an Altman Z score below 1.81 or an implied credit rating below BBB-) has increased from 36% before the pandemic to 42% at the end of 2020. Overall, more companies migrated to a lower implied rating than to a higher implied rating. Additionally, incoming quarterly financial results suggest that a significant share of businesses had not fully recovered by mid-2021. This reflected weakness in the tourism, entertainment and aviation sectors, while large listed companies in the technology and industrial sectors benefited from strong demand and improved their cash position.
The financial health of small businesses, highly indebted businesses and companies in the service sector has been hit harder by the pandemic, due to lower incomes
Vulnerable companies are clustered in countries with high levels of sovereign debt, higher non-performing loan ratios and closer ties between banks and national sovereigns. Eurozone countries with higher levels of sovereign debt also have higher shares of weaker companies (Table B, panel a). For these countries, median Altman Z-scores also remain significantly below pre-pandemic levels. In addition, contagion vulnerabilities exist in several countries due to a closer nexus between the state, businesses and banks. These countries tend to have higher shares of vulnerable firms, and banks hold larger credit exposures to the national sovereign state; at the same time, the sovereign provided significant loan guarantees, in particular for loans to companies in vulnerable sectors (Table Bpanel b).
Corporate vulnerabilities are concentrated in countries with high sovereign debt and weaker banks
Weaker firms and firms with lower pricing power are more vulnerable to supply chain disruptions and rising input prices. Indices measuring input prices for euro area producers rose sharply in 2021 and the first months of 2022, driven by rising energy costs and bottlenecks in the economy. ‘offer. Additionally, some key inputs posted double-digit price increases. The sharp increase in prices and input costs will likely put pressure on profit margins, especially for companies that have weaker pricing power and cannot easily pass on price increases. This could create short-term cash flow problems and compromise medium-term debt sustainability and investment capacity. Vulnerabilities are concentrated in firms at the intersection of lower pricing power and those with higher production energy intensity and lower Altman Z-scores (Table Bpanel c).
Overall, business vulnerabilities remain and correlate to pandemic exposures and fallout from the Russian war in Ukraine. Overall, the corporate sector has weathered the shock of the pandemic, as evidenced by the recovery in profits. However, the Eurozone has a large cohort of vulnerable small businesses that are still recovering from the pandemic and are now facing additional cost pressures due to the sharp rise in input prices seen in recent months. At the current stage, financing conditions remain in their favour, but they could deteriorate rapidly if the economy slows down and lenders reassess the risks associated with certain business models. Moreover, uncertainty will reduce investment and contribute to clouding growth prospects in the future.