Zombie Firms Face Slow Death in US as Era of Easy Credit Ends – ValueWalk Premium

Zombie Firms Face Slow Death in US as Era of Easy Credit Ends

They are creations of easy credit, beneficiaries of central bank largesse. And now that the era of unconventional monetary policy is over, they’re facing a challenge like never before.

They are America’s corporate zombies, companies that aren’t earning enough to cover their interest expenses, let alone turn a profit. From meme-stock favorite AMC Entertainment Holdings Inc. to household names such as American Airlines Group Inc. and Carnival Corp., their ranks have swelled in recent years, comprising roughly a fifth of the country’s 3,000 largest publicly-traded companies and accounting for about $900 billion of debt.

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Now, some say, their time may be running short.

Firms that could once count on virtually unfettered access to the bond and loan markets to stay afloat are being turned away as investors girding for a recession close the spigot to all but the most creditworthy issuers. The fortunate few that can still find willing lenders face significantly higher borrowing costs as the Federal Reserve raises interest rates to tame inflation of more than 8%. With surging input costs poised to eat away at earnings, it’s left a broad swath of corporate America with little margin for error.

The end result could be a prolonged stretch of bankruptcies unlike any in recent memory.

“When interest rates are at or close to zero, it’s very easy to get credit, and under those circumstances, the difference between a good company and a bad company is narrow,” said Komal Sri-Kumar, president of Sri-Kumar Global Strategies and former chief global strategist of TCW Group. “It’s only when the tide runs out that you figure out who is swimming naked.”

Of course, there have been any number of moments over the past decade when zombie firms have appeared on the cusp of a reckoning, only for markets to be tossed a last-minute lifeline. But industry watchers note that what makes this time different is the presence of rampant inflation, which will limit the ability of policy makers to ride to the rescue at the 11th hour.

That’s not to say that a wave of defaults is imminent. The Fed’s unprecedented efforts to bolster liquidity following the onset of the pandemic allowed zombie companies to raise hundreds of billions of dollars of debt financing that could last months, even years.

Yet as the central bank works to quickly unwind the stimulus, the effects on credit markets are already plain to see.

Junk-rated companies, those ranked below BBB- by S&P Global Ratings and Baa3 by Moody’s Investors Service, have borrowed just $56 billion in the bond market this year, a more than 75% decline from a year ago.

In fact, issuance in May of just $2.2 billion is set to be the slowest for the month in data going back to 2002.

“If rates had not been so low, many of them would have gone under” already, said Viral Acharya, a professor at New York University’s Stern School of Business and former deputy governor of the Reserve Bank of India. “Unless we have another full-blown financial crisis, I don’t think the Fed’s capacity to bail out is necessarily that high. Especially when they are explicitly saying they want to reduce demand. How is that consistent with keeping these firms alive?”

Read the full article here by , Advisor Perspectives.

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