Zombies – they may remind you of the slow
walking mindless undead of many a horror film but the term is
increasingly cropping up in relation to thousands of companies.
Paul Wood discusses why this is.
The zombie walk
The origins of the credit crunch are well documented. In the
subsequent recession, as well as struggling with difficult market
conditions, businesses in the UK find it difficult to obtain credit
from traditional lending sources and many have therefore looked to
survive by other means. This often involves taking extended credit
from suppliers, entering into time-to-pay agreements with HMRC
and/or freezing or reducing payments of capital to banks and other
lenders.
Some businesses have accrued so much debt that they have little
prospect of ever being able to repay it. The directors of these
businesses continue working each day with no end to the misery in
sight as the recession continues to bite and the infection
continues to spread. It is not difficult to see how the zombie term
came about.
Spreading the zombie infection
Suppliers, reluctant to lose what may be a key customer, succumb
to the will of zombie companies and become increasingly exposed to
them so that eventually they cannot afford for their zombie clients
to fail. This cascades down the supplier chain, with each debtor in
turn deferring payments and causing many more companies to become
infected with the burden of the original zombie company's
debt.
Secured lenders have also been supporting these zombie
companies, so that they often cannot afford to enforce their
security when the zombie company is unable to pay. As the value of
the assets of these companies withers away and decomposes, secured
creditors are realising that the zombie companies have little or no
inherent value and that there is significant risk of default and
loss. While we expect that lenders have appropriately impaired
these loans in their own accounts, achieving an acceptable exit is
often far from easy.
Zombie death
Recent research by R3 suggests that this infection has spread to
around 146,000 companies and that 8% of businesses admit to only
being able to service the interest (not the principal) on their
debts. Given their debts, the loss of a significant customer, the
failure of a key supplier or even a modest increase in interest
rates would tip many of these businesses over the edge.
The whole UK economy now risks many years of depression as these
businesses continue to infect corporates and financial institutions
in the UK and abroad.
The only option left for many of these creditor companies is to
cut off the life blood of these zombie companies – namely
the extended credit. As in all previous recessions, a proportion of
these businesses need to fail to allow healthy businesses the space
to grow and pull the economy out of the doldrums. This recession is
no different. These zombie companies are tying up capital and
resource that could be put to better use elsewhere in the economy.
The fact that the infection has spread so virulently will make any
correction drastic in its effect; many businesses will go insolvent
with the loss of thousands of jobs.
However, strong healthy businesses will be left, with directors
that have taken appropriate steps to secure the long-term viability
of their companies. This is an extreme measure, which may be a
politically and socially difficult pill to swallow, but it is the
only way the UK economy can return to strong, sustained growth.
The big question is what will be the catalyst for this to
start?
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