With a rising number of so-called zombie companies limiting domestic productivity in the UK, Director, Sinead McIntosh takes a dive into the corporate debt underworld...
Anatomy 101: the zombie company
A "zombie company" is, as the name would suggest, a company that is not alive and thriving, nor is it resting peacefully in death. In real terms, it's a company that can just about keep the lights on and wages paid. It is in no position to repay its debts and is likely to be in receipt of bailouts to keep afloat; a zombie company is essentially on corporate life support. Even a slight ripple in their microeconomic circumstances would spell the end to trading.
Yet, according to analysis from KPMG UK, these zombie firms are limiting domestic productivity growth and threaten to exacerbate future economic downturns, with up to 14% of private UK companies showing zombie-like symptoms.
Proliferation of the zombie army
For some time now, we've all been hearing that the credit cycle correction is overdue; insolvency practitioners and advisors are ramping up their practices and the restructuring community is awaiting a deluge of corporate work. However, the current reality is that the flood gates have not yet opened and the global economic outlook would appear to reinforce rather than release those gates.
Interest rates have been at sustained low levels for over a decade with no sign of significant change. Not only does that mean that debt repayments are and will remain low, but it helps support the corporate approach of kicking the proverbial can down the road, pretending that everything is fine and that they will pull themselves back from the brink.
Post global financial crisis, many banks have engaged in forbearance or zombie lending whereby they offer repayment holidays, evergreening and other credit extensions to the struggling corporates. Whilst this benefits the company by giving them a window for possible financial recovery, the motivation of the banks is as you would expect, primarily selfish. Foreclosing on a loan would require the bank to take the loss as a liability on their balance sheet, thereby impacting their capital adequacy ratio with potentially significant regulatory repercussions. There looks to be no easing of regulatory oversight on bank balance sheets, so from this aspect at least, we don't expect to see any change to covenant enforcement.
The burden of the undead
While interest rates and lender leniency can extend the life of the zombie or even give it a lifeline to convert it back into a profit making enterprise, these economic forces can have a very different effect on the wider economy. By perpetuating the life of a zombie, you are locking up talent and market share that could be better employed by companies that are more profitable. Their subsequent growth would drive productivity, recruitment and investment; benefitting the wider economy.
Is the end near for the zombie population?
For the foreseeable future, the zombie population looks set to grow, fuelled by the combination of expected low, long-term interest rates and the pressure of capital adequacy ratio regulations on banks. However, it will not continue indefinitely. Any slight economic shock or changes to fiscal policy as a result of the UK general election in December could push a lot of British zombie firms into restructuring or administration, and that's all without mentioning Brexit.
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