The Economy

Are Private Companies Gearing Up to Borrow?

Private companies are less likely to default on debt, according to new data, making them well-positioned to secure loans for expansion.
Marielle SegarraMay 30, 2013

Private companies in the United States may be in a good position to borrow. They are less likely to default, on average, than they were last year, according to data from financial-information company Sageworks, making them more creditworthy. The average probability of default among thousands of privately held companies that Sageworks tracks fell from 5.1 percent to 4.1 percent in the twelve months ending April 2013.

“The decrease in the probability of default could be attributed to lessons learned during the recession,” says Libby Bierman, analyst at Sageworks. “But companies may also be trying to position themselves so that they’re more appealing to bankers or other creditors that are going to make them loans.”

The private companies tracked by Sageworks have become less likely to default because they are less highly leveraged than they were a year ago. Sageworks found that companies’ average debt ratio (total liabilities to total assets) fell from 75.7 percent to 71.4 percent year-over-year, and debt-to-equity fell from 3.2 percent to 2.9 percent. Private companies’ debt-to-EBITDA also dropped, partly fueled by earnings growth.

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Interest coverage at private companies also improved, increasing from 9.5 percent to 11.2 percent, suggesting that liabilities may have decreased, according to Sageworks. The interest coverage ratio is “a good measure to use as a proxy for how readily a private company could pay off interest expenses,” Bierman says.

So is the deleveraging a result of economic and regulatory uncertainty and general risk-aversion, or something else?

While private companies clean up their balance sheets, large businesses are adding more debt. According to data provided by S&P Capital IQ, companies in the S&P 500 index increased their debt-to-EBITDA ratio by 20.3 percent on average over the last 12 months. Debt-to-equity likewise increased, by 21 percent on average, and the average debt ratio jumped by 2.8 percent. That suggests rising, not falling, confidence in the economy.

Whatever the cause, private companies are poised for growth, and they have plenty of sources of debt to tap. “I would assume that because there are [investment] opportunities, these businesses are going to be looking to expand,” Bierman says.

Bill Hampel, chief economist at the Credit Union National Association, a trade group, says small businesses in particular might be ready for more aggressive investment.

Although the outlook for the growth of small business credit is mixed, Hempel says, “I would suspect that given the improved economic conditions and given how bad economic conditions have been over the last five years, more businesses are going to want to take advantage of opportunities to expand, rather than use improved cash flows to [further] reduce debt.”

“They’ve essentially been battening down the hatches for five years,” Hampel says. “A business would be more likely to want to take opportunities to expand now, having had to avoid them for much of the last five years.”

If private companies are going to borrow, it appears to be the right time. Most small businesses say they are getting credit if they want it. In the May 2013 National Federation of Independent Business Small Business Optimism Index, only six percent of business owners said that their credit needs were not met. Just two percent said financing was their top business problem, and 31 percent reported borrowing regularly.

Notably, the business owners surveyed did not expect credit conditions to ease further: the seasonally adjusted optimism index level for expected credit conditions dropped by two points from March.

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