Zombie companies – real danger or just scaremongering?
Published: Friday, Apr 12th 2024, 10:20
Updated At: Saturday, Apr 13th 2024, 01:58
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Companies around the world are struggling with the rise in interest rates. For some, they are even threatening their existence. Experts believe that these so-called zombie companies are a threat to the global economy. Others disagree.
"The return of the zombies", "Walking Dead on the financial market" - what sounds like bad horror films are in fact studies and articles about companies that are in financial difficulties and are barely able to conduct their normal business.
The term became particularly widespread during the coronavirus pandemic, when many companies had to pause their business and could only continue to exist thanks to state aid.
A company is often defined as a zombie if it has an interest coverage ratio (ICR) of less than 1 for three consecutive years. Or in short: the profit from ongoing operations is not sufficient to cover the necessary interest payments.
Debts have to be refinanced again and again. And this can become a problem in times of rising or higher interest rates. Especially if the central banks do not start cutting interest rates as quickly as hoped. Just last week, the regional central bank president of Minneapolis, Neel Kashkari, spooked the markets with his assessment that an interest rate cut may not be necessary in the USA this year.
Inflation data also tends to cast doubt on early cuts. This is not a particularly rosy outlook for companies due to refinance in the summer.
Not only private companies affected
At present, it is mainly smaller, privately owned companies that are affected by zombie status. However, the French-speaking Swiss bank Mirabaud recently stated in an analysis that almost 13% of S&P 1500 companies, for example, could also be classified as the "living dead". In Switzerland, the latest data from the FSO shows that bankruptcies are continuing to rise. Almost 15,500 companies went bankrupt in 2023 - a record. And for the first time since the time series began in 2008, insolvencies increased for three consecutive years.
The increase in zombie companies is a problem: it rewards the unproductive and burdens the productive companies, according to the Mirabaud study. This is because companies with lower returns are always able to refinance their debts, as banks do not want to increase their loan default rates. This resulted in a lack of resources and growth companies with high productivity had difficulty accessing credit.
The OECD has also shown in studies that the rise of zombie companies is linked to weak productivity growth. Accordingly, it is disadvantageous for economies to keep such companies alive. The weakness of some countries after the Covid-19 pandemic can be explained, at least in part, by the fact that some chronically weak companies have still not left the market.
Zombies fear higher interest rates
What the stake is in classic horror films, a rise in interest rates is for zombie companies. This can trigger a series of problems, explains Mirabaud. Firstly, higher interest rates reduce general demand in an economy, which leads to lower revenues for companies and less cash to service their debts.
Added to this are the more difficult and more expensive financing conditions. Companies that are already unable to cover their interest burden at low interest rates are now falling even further into arrears. Banks also have less incentive to lend money to zombies as there are better and safer alternatives. Accordingly, higher interest rates drive more zombies into bankruptcy and push more healthy companies into zombie status. This can lead to dwindling confidence in the capital markets and a domino effect begins.
VP Bank chief economist Thomas Gitzel also sees the risks. However, he believes that we are not currently facing a major wave of bankruptcies. Because even if the US Federal Reserve or the ECB do not lower their interest rates as quickly as hoped, there will not be a major wave of refinancing until 2026 in the US, for example.
"In Switzerland, interest rates have not risen significantly anyway. In addition, a study by the International Monetary Fund (IMF) shows that Germany and Switzerland, for example, have one of the lowest densities of zombie companies - both among private and listed companies," says Gitzel.
Mirabaud goes one step further, as states could also be described as zombies. Namely, if they are unable to balance their budgets or take on debt more easily in order to finance their economic policy. Just like a company, the state wastes resources that could actually be used for productive purposes. This can be observed in some European countries that are not experiencing growth.
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