Posted by Rewan Tremethick on October 31st, 2016.
While you might not see them on a hit AMC show any time soon, there’s a type of zombie that has been terrorising economists for the past few years; the zombie company. This isn’t a company run by reanimated corpses, but a company barely able to survive in the current economy.
Following the UK’s decision to Brexit following the EU referendum, the zombie horde could become even larger.
So what are zombie companies, why are they a concern and can you dress up as one for Halloween?
Many zombie tales begin with an apocalyptic event. The story of zombie companies is no different. In late 2008/early 2009, the financial markets crashed as a long chain of risky investments collapsed and forced institutions across the world into bankruptcy.
Since the financial crash, central banks have been trying to combat the weakened economy using monetary policy tools, like cutting interest rates. This encourages banks to lend out more money and, because rates are so low, more businesses and people can afford to borrow as they can meet the repayments.
The problem is that this means there are now a lot of companies operating in the economy who haven’t got enough money once they’ve made their loan repayments to invest in the kinds of things that would boost their business; such as equipment, staff, or new premises. They aren’t even repaying the capital amount on their loans, just the interest.
Mark Thomas wrote a book about it called The Zombie Economy. He explained to the BBC that;
‘A zombie company is one which is generating just about enough cash to service its debt, so the bank is not obliged to pull the plug on the loan. The company can limp along, it can survive, but it hasn’t got enough money to invest.’
Banks let these companies survive because they are paying the interest on their loans, so the banks are making some money from them. Also, if they were to toughen up and refuse to help the company meet its costs, the company would collapse, the loan would go bad and the bank would take a hit.
The result of the UK’s EU referendum could complicate matters further.
Zombie companies thrive off low interest rates and cheap credit. In response to the UK’s vote for Brexit during the EU referendum, the Bank of England (BoE) recently cut interest rates to the lowest in 322 years; the entire lifetime of the BoE. At 0.25%, banks can borrow from the central bank for almost nothing, encouraging them to make more loans. The BoE even created a £100 billion ‘term funding scheme’ designed to encourage banks to lend more money by helping them deal with the profit squeeze from low rates.
This could mean that struggling zombie companies are given a lifeline thanks to the loose post-Brexit monetary stimulus measures. More businesses will be able to afford to borrow and, with banks encouraged to give out cash, they are now more likely to find credit. The Bank of England’s quantitative easing programme could also exacerbate the situation. Since shortly after the EU referendum, the BoE has been buying government assets from the banks that hold them, encouraging those banks to invest in corporations instead. This means there is more money for zombie companies to latch onto at the expense of businesses with strong growth potential.
On the other hand, many economists believe that the economy will weaken after Brexit. A lot of businesses could be hit by the changed trading relationship between the UK and the EU, while others could suffer as uncertain consumers hold back on purchases. If this is true, only the strong will survive. Brexit may actually turn out to be the ‘silver bullet’ needed to deal with the zombie company problem, although how many other businesses will become casualties thanks to the potential Brexit weakening remains to be seen.
What’s the problem if people have jobs and the company is ticking along? Well, there are two key issues.
Stephen King has written about zombie companies. No, not that one. Stephen King, the Senior Economic Adviser for HSBC, who explains that cheap funding meant companies;
‘… could happily employ people who might otherwise have lost their jobs. Capital markets were thus no longer able easily to perform their central function, namely the efficient allocation of capital. Too much capital stayed in bloated and inefficient companies leaving too little to support the growth of smaller, more dynamic, enterprises.’
Considering many economists have warned the Brexit could see a drop-off in foreign investment, there could be fewer funding sources available to companies; viable businesses may collapse due to the lack of capital while weaker companies stagger onwards.
While focussing on Japan, a paper by Ricardo Caballero, Takeo Hoshi and Anil Kashyap sums up the problem zombie companies pose worldwide when it states;
‘The congestion created by the zombies reduces the profits for healthy firms, which discourages their entry and investment…Zombie-dominated industries exhibit more depressed job creation and destruction, and lower productivity.’
The second problem is that these companies are creating a barrier to raising interest rates.
If the Bank of England was to raise interest rates once the initial Brexit volatility has subsided, these zombie companies would be unable to afford their repayments. Lots of people would lose their jobs, which would put extra strain upon the government’s welfare budget. If there are still around 70,000 zombie companies in the country and if they all employed 10 people that would increase the unemployment rate in the UK by almost 50%. Currently 4.9% of the population, or 1.66 million people, are unemployed.
That would severely impact upon tax revenues – Managing Director of IGF Invoice Finance Tracy Ewen notes;
‘As nearly half of public turnover is derived from our SMEs, it is little wonder that the government wants to do everything it can to kick-start these SME zombie companies and avoid risking tens of thousands of job losses.’
These aren’t just scare-stories. There are plenty of reasons to believe that these vulnerable firms could go out of business at any moment. Speaking before the Brexit vote, Executive Chairman of restructuring firm Begbies Traynor, Ric Traynor explained;
‘Struggling businesses should not expect any respite in 2016, with the UK economy facing greater headwinds this year from slow global growth, lower levels of business investment and the highest levels of consumer debt seen for five years. Meanwhile the looming EU referendum, potential interest rate rises and additional cost pressures, including the introduction of the new national living wage in April, give cause to yet more uncertainty for UK businesses over the coming months.’
The most brutal way to tackle the zombie company problem is to simply force them to ‘adapt or die’. This can be done in the UK by either the Bank of England (BoE) raising interest rates or by banks refusing to support companies with underperforming loans.
Combating the cost of insolvency is a softer way to help zombie companies out of business. For many companies, insolvency is too expensive, meaning they have no choice but to carry on operating. According to business recovery professionals R3, the majority of insolvency practitioners work in small or medium-sized firms and are likely to charge between £100 and £300 per hour, while IPs in larger firms could charge up to £800 per hour.
If the cost of insolvency continues to fall, many of the zombie companies in the UK may have an affordable way out of business.
Some of the solution to the problem of zombie companies lies with the companies themselves. Tracy Ewen advises that there are several ways companies can adjust their business practices to free up cash and kick-start growth. Her tips include cutting operating costs, investing in staff training to improve their skills and focussing on retaining existing customers rather than hunting for new ones. There are even specialist restructuring firms that can help a zombie company streamline its operations and trim its running costs.
Lifeless, hard to kill and here in large numbers – the UK has a zombie problem. The number of zombie companies in the UK has fallen dramatically from 145,000 in 2012, but will this trend continue? Considering how Brexit has, or could, change the face of the UK economy, there is a chance the horde could grow stronger and become a serious threat again.
But even if the zombie companies in the UK melt away without trouble, beaten back by the tighter conditions of post-Brexit Britain, those operating abroad are still a concern. After all, how relaxed would you feel if someone told you zombies were occupying Europe?
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