Latvian companies in cross-section. Where does the unused lending potential lie?

These conclusions of the Bank of Latvia provoked reflection, therefore together with the analysts of “SEB banka” we looked at the data available to us on the financial creators of Latvian companies in order to understand if and where such lending potential is hidden and why it has not been used so far? This analysis combined with daily observations in the bank, both here in Latvia and also with colleagues in Lithuania and Estonia, allowed us to arrive at an interesting overview of both the Latvian business environment and lending, which I will share in this article.

How many loanable companies are there in Latvia?

Annual reports for the year 2022 have been submitted by less than 109 thousand companies (excluding holding companies and companies in the financial sector), which we can consider as economically active companies and which we looked at in more detail in this analysis.

Out of the total number of companies, 40% or 43 thousand companies’ annual turnover does not reach 50 thousand euros. Such companies are probably able to pay Latvia’s average salary for one employee, paying taxes as well, but their ability to receive and repay loans is very limited. Almost 29,000 more companies have negative equity, which shows that the existing liabilities exceed the value of the company’s assets, and here too there are no opportunities to take on new loans.

But in order to be able to take on and repay credit obligations, it is not enough to achieve a certain turnover and equity greater than zero – the company must also be able to generate regular free income to repay loans and ensure a proportionate ratio of equity and borrowed capital. Let’s assume that the criterion of a creditworthy company is EBITDA (or the company’s profit before interest payments, taxes and amortization deductions) of at least 10 thousand euros (on average over the last 3 years), which would allow you to receive a loan of up to 30 thousand euros. Another 11,000 companies do not meet this criterion. In addition, the share of equity capital of another 3 thousand companies does not reach 30%, which indicates an already high level of liabilities and limits the borrowing potential.

21 thousand companies meet the basic financial criteria and only a quarter of them, or 4.5 thousand, have already received loans from one of the commercial banks. It should be noted here that around 8,000 companies have received bank loans in Latvia – that is, 4,500 companies that meet minimum financial criteria, and another 3,500 companies whose financial position is relatively weaker. There are almost 17 thousand companies with apparently good financing potential, but they did not want or were unable to receive loans. Looking for connections, we looked in more detail at the data describing the size of the companies and the sectors of operation.

Where to look for additional financing potential?

Comparing the intensity of borrowing by sector, loans are most actively used in the agriculture and forestry sector – more than half. There is also a high share of financed companies in the energy and various utilities sectors, which are capital-intensive and where state and municipal corporations are widely represented, but the total number of companies in these sectors is relatively small.

The least credit is used by companies in the service sector, which rarely receive bank financing, regardless of their size. The specifics of the industry should be taken into account here – small long-term investments are most often required and there is a relatively fast circulation of money, which reduces the demand for loans.

From the traditionally capital-intensive industries with a large number of companies and employees, the construction industry should be singled out, where 84% of companies, including large companies, are uncredited. About 1,600 companies whose assets exceed a billion euros and turnover is almost 2 billion euros. Perhaps the weak lending is influenced by the high presence of the shadow economy (34.5%, A. Sauka, SSE Riga). Perhaps the industry’s reputation is damaged and creditors are deterred by countless scandals and legal proceedings in large procurements, as well as violations of the competition law.

A common feature in all sectors is weak crediting, especially in the segment of smaller companies with a turnover of up to 1 million euros. There are also the most companies here – 15.5 thousand or 73% of the number of creditworthy companies. There is no lack of challenges here – local business models that limit growth, insufficient profitability for investments, shadow economy, tax debts, etc. However, there are also many promising companies with good results and great growth potential, but little desire to take risks to grow. The investment and lending potential in this segment of companies is definitely not exhausted.

And how big is the financing potential?

In order to estimate the unused financing potential, we made a calculation, taking as an example the most actively financed sector in Latvia – agriculture and forestry, where approximately half of all companies received bank financing. Assuming that exactly half of credit-worthy companies in all sectors would be financed with equivalent intensity, approximately 6 thousand more companies could be financed in addition – approximately twice as many as at present. However, most of the unfinanced companies are relatively small and the amount of financing would not increase so rapidly – it would be around 1.5 billion euros.

Of course, this is a very theoretical calculation, so we looked at the intensity of lending also from the aspect of productivity, ie by evaluating the amount of loans issued in each sector against the added value created by the sector and comparing it with the other Baltic countries.

It is interesting that the intensity of lending in most sectors is similar in the Baltics and compared to Lithuania we even lend here and there more, but we differ significantly in one sector. The real estate sector in Estonia is financed in the amount of 125%, in Lithuania – 72%, while in Latvia it is only 47% of the gross added value of the sector. By financing only this sector with a similar intensity as in Estonia, the loan portfolio of Latvian banks would be almost 3 billion more. In recent years, the development of new real estate in Latvia has been up to two times slower than in its neighbors, the disorganized construction industry and lower purchasing power of the population have made investors look more often in the direction of Tallinn and Vilnius. We are also late with the implementation of building energy efficiency projects, especially in Riga.

On the other hand, comparing the Baltic countries with an economy like Germany, it is interesting to note that in Germany the total intensity of loans against the added value of the entire economy is 53% (in Latvia 19%), and in sectors such as agriculture, real estate and energy the intensity of loans even exceeds the industry annual added value.

Loans are important, but only one of many sources of capital financing for business development. Equity capital, venture capital and institutional investment funds, capital raised on the stock exchange or acquired in business merger transactions can also serve as a tool for achieving the company’s development goals.