Analysis / Zombie firms in danger of strangling the economy, warn experts

Zombie firms in danger of strangling the economy, warn experts

Industry gurus claim unviable businesses are sucking up vital capital – but letting them fail could be worse.

The UK could struggle to “lance the boil” of unproductive, debt-addled companies without potentially sabotaging economic growth, an industry expert claims.

Liz Bingham, president of insolvency trade body R3, fears so-called zombie companies, defined as those who can only afford to pay the interest on their debts, are holding up the fledgling economic recovery but could cause more serious damage if they were allowed to fail.

“I think the biggest challenge presented by zombie companies is they are taking up capital that could be used and deployed in higher-growth businesses,” she says.

“What you would typically see in recovery times is that churn from bad business to high growth, but this time there’s a risk these companies are limping along and not going anywhere.

“It will come good in the end. But if you try and lance the boil, we are going to be facing an increase in unemployment and a flooding of the market of certain asset classes, which would depress [property] value. It’s a tricky situation to unwind.”

While many companies have gone bust in the fallout of the global financial crisis, a large number of zombie companies have struggled on thanks to a combination of historically low interest rates and creditor lenience.

Bingham says: “There are a number of unique factors in this recovery allowing zombies to survive. You have two of the major UK banks in effect owned and controlled by
the government, and while the government has priority to stimulate growth, it won’t be wanting to see its banks pulling the rug out from under customers.

“There’s also regulatory pressure on the banks around capital ratios, and they may feel it is easier at the moment to allow companies to limp on. You also have very low interest rates.”

Zombie pics 3

Business Secretary Vince Cable recently warned that the economy was still infested with zombies, which were at risk of collapsing as soon as interest rates came back up, leading to major economic damage.

In July, R3 calculated that there were 108,000 zombies in the UK. Although it noted this was fewer than the 146,000 around a year before, the number is still high.

Zombies could be here to stay, at least in the short term. Mark Carney, the new Bank of England governor, has so far remained firm in his plan to keep interest rates low until somewhere around late 2016 – the point at which he expects the unemployment rate to fall to 7 per cent – despite some believing they could come up sooner. And Carney has moved to dispel suspicions that he could act sooner if unemployment were to fall before 2016.

He recently told a crowd of business leaders in Nottingham: “Thinking unemployment will come down faster than the Bank expects isn’t enough to believe interest rates will soon.

“The 7 per cent threshold is a staging post to assess the economy. Nobody should assume that it’s a trigger for raising interest rates.”

Nick Winks, a turnaround specialist and partner at WayPoint Change, argues that because many zombies are property companies, their survival is likely to be based on how commercial property prices perform in future.

“Most of it is in commercial property,” he says. “Banks are being lenient with them in the hope that, in a few years, the value of their assets will rise and the bank will be able to recover more value.

“I would say commercial property prices rising is more important in helping those companies than interest rates staying low, because if the prices rise, rents for them will rise and those companies will have a higher income.”

But he fears commercial property prices are unlikely to rise in the short term. “I’m a bit sceptical that that’s going to happen soon,” he says. “There is inflation in house prices because there is always a high demand and we are not building enough to meet that, but very little of that affects the commercial property market.

“Commercial property is driven by the growth of business. There’s not huge evidence that what we’re seeing in the economy will turn into the sort of growth you need more property for.

“Most companies coming out of the recession can grow quite significantly without changing the amount of property they have already got. And you will have demand from start-ups, but I think that’s fairly limited.”

Liberal Democrats' spring conference

Winks argues that, if property prices fail to rise in the commercial sector, zombies could be in trouble when interest rates do go up.

“I think it will be a problem,” he says. “I’m not a doom-monger but I think there will be some failing businesses.”

With tentative signs that the economy could be improving, a swathe of failing businesses would be bad news. But one way or another, zombies will have to vanish.

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