Some time ago, the Bank of Latvia published its annual Report on the availability of financing, in which it calculated both the number of potentially creditworthy companies - 25,000 - and the potential amount of financing - EUR 2 billion. An impressive sum that will supposedly give the Latvian economy a much-needed boost.
These conclusions of the Bank of Latvia have given us pause for thought. Therefore, together with analysts from SEB banka, we have analysed the data available to us on the financial performance of Latvian companies to understand whether and where such credit potential lies and why it has not been exploited so far. This analysis, together with daily observations in the bank both here in Latvia and with colleagues in Lithuania and Estonia, has led to an interesting overview of the Latvian business environment and lending, which I would like to share with you in this article.
How many creditworthy companies are there in Latvia?
Nearly 109,000 companies (excluding holding companies and the finance sector companies) have submitted their annual financial statements for 2022, which can be regarded as economically active companies and which we have analysed in more detail in this report.
Of the total number of companies, 40%, i.e. 43,000 companies, have an annual turnover of less than EUR 50,000. While these companies can pay the Latvian average wage per employee plus taxes, their ability to borrow and repay loans is limited. Nearly 29,000 companies have negative equity, which means that their liabilities exceed their assets and they cannot borrow any more funds.
In order to borrow and repay debt, it is not sufficient to have a certain turnover and equity of more than zero - the company must also be able to generate regular free income in order to repay the loans and maintain an appropriate equity/debt ratio. Let us assume that the criterion for a creditworthy company is an EBITDA (or earnings before interest, taxes, depreciation and amortisation) of at least EUR 10 thousand (average of the last 3 years), which would allow a loan of up to EUR 30 thousand. Almost 11,000 companies do not fulfil this criterion. A further 3,000 companies have equity ratios of less than 30%, reflecting a high level of debt and limiting their borrowing capacity.
21.000 companies fulfil the basic financial criteria and only a quarter of them, i.e. 4,500, have already received a loan from a commercial bank. However, it should be noted here that around 8,000 companies in Latvia have received bank loans - 4,500 companies that fulfil the minimum financial criteria and a further 3,500 that are in a relatively weaker financial position. This leaves almost 17,000 companies with seemingly good financing potential, but which are unwilling or unable to take out a loan. A closer examination of the data on company size and economic sectors allowed us to identify commonalities.
Where to look for additional funding potential?
When comparing credit intensity by sector, the most active sector is agriculture and forestry - more than half. There is also a high proportion of financed companies in the capital-intensive sectors of energy and various utilities, where state and municipal companies are well represented, but the total number of companies in these sectors is relatively low.
Loans are least utilised by companies in the services sector, which rarely receive bank financing regardless of their size. The special characteristics of the sector must be taken into account here: small long-term investments are usually required and there is a relatively fast cash flow, which reduces the demand for loans.
Among the traditionally capital-intensive sectors with a large number of companies and employees, the construction sector stands out, in which 84% of companies, including large companies, are not creditworthy. Around 1,600 companies with a balance sheet total of more than EUR 1 billion and a turnover of close to EUR 2 billion. It is likely that the high level of shadow economy activity (34.5%, according to A. Sauka from SSE Riga) is a contributing factor to the weak lending situation. Numerous scandals and lawsuits involving major contracts, as well as violations of competition law, may damage the reputation of the sector and discourage lenders from investing in it.
Across all sectors, weak lending is prevalent among companies with a turnover of less than EUR 1 million. Also, the majority of creditworthy companies are located here - 15.5 thousand or 73%. There are many challenges - local business models that limit growth, insufficient profitability for investments, shadow economy, tax arrears, etc. But there are also many promising companies with good results and high growth potential, but little appetite to take risks to grow. The investment and lending potential of this segment of companies has certainly not yet been exhausted.
And how much funding potential is there?
In order to estimate the untapped financing potential, we have calculated the most actively financed sector in Latvia - agriculture and forestry, where about half of all companies have received bank financing. Assuming that exactly half of the creditworthy companies in all sectors were financed with the same intensity, around 6,000 additional companies could be financed - about twice as many as today. However, most of the unfinanced companies are relatively small and the amount of financing would not increase as quickly - it would be around EUR 1.5 billion.
Of course, this is a very theoretical calculation, so we have also looked at credit intensity from a productivity perspective, i.e. we have weighed the amount of credit in each sector against the value added generated by that sector and compared it with the rest of the Baltic countries.
Interestingly, the credit intensity in the Baltic states is similar in most sectors, and compared to Lithuania we even lend more here and there, but in one sector we differ significantly. The property sector is financed to 125% of gross value added in Estonia, 72% in Lithuania and only 47% in Latvia. If this sector were financed with a similar intensity as in Estonia, the credit portfolio of Latvian banks would be almost 3 billion higher. The development of new real estate in Latvia has been up to twice as slow as in neighbouring countries in recent years, while the unorganised construction sector and the lower purchasing power of the population have led investors to look more to Tallinn and Vilnius. We are also lagging behind with the implementation of energy efficiency projects in buildings, especially in Riga.
Conversely, comparing the Baltic countries with an economy like Germany, it is interesting to note that Germany has an overall credit intensity of 53% (Latvia 19%), and in sectors such as agriculture, real estate and energy, the credit intensity even exceeds the annual value added by the sector.
Loans are an important source of capital financing for corporate development, but they are only one of many sources. It is also possible to achieve a company's growth goals through equity, venture capital, institutional investment funds, capital raised on the stock exchange or through mergers.
Ints Krasts
Member of the Board at SEB
