Will climbing interest rates bring down the zombie companies?

Businessman Looking At Prospect Of Higher Interest Rates
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One fund manager says he is expecting the worst when it comes to business failures. What do others think about today’s business climate and its risks? Christian Annesley reports.

Many experts out there agree this much: interest rates look poised to rise sooner rather than later, and inflation is climbing ahead of wage growth. So are these the conditions that point to a real and growing risk that thousands of companies will go soon go under, as some are claiming?

It’s a question that was brought into sharp focus this week by a warning made by a top fund manager – and reported by the Daily Telegraph.

Eoin Murray is head of investment at Hermes Investment Management and cautioned that, just like animals in captivity, “companies incubated on the milk of QE and low rates may no longer exhibit the natural behaviours needed for success in the wild of a stimulus-free market.”

Murray added that, as companies start to go down, many investors, too, will be badly burned because they have failed to put in place covenants that limit companies’ debts and protect savers.

“Unfortunately [...] the elasticity of unreality has a snapping point,” said Murray. “QE and ultra-low rates have insulated many companies, and unwary investors, from the dangers that normally lurk; they are now treading a dangerous path.

“As interest rates begin to meaningfully rise, companies that have been able to borrow cheaply and roll over debt will be exposed. These are the zombie firms that in a normal rate cycle would no longer exist. [But] eventually, the natural order must prevail.”

Bank of England

So how does Murray’s warning square with the actions and comments of the Bank of England?

Andy Haldane, chief economist at the Bank of England, has said he expects to vote for a rate rise later this year. But the message from the BoE’s Monetary Policy Committee with regard to rate rises is hardly clear-cut.

What does the industry group for insolvency and restructuring practitioners, R3, think?

Earlier this month R3 warned that one in 25 UK businesses would be unable to repay dates if interest rates were to rise by even by a small amount – that’s 79,000 businesses, which is four times the number of notionally exposed businesses when compared with research from September 2016.

Andrew Tate, spokesperson for R3, said: “This is the first increase in the number of businesses worried they would be unable to cope with an interest rate rise since 2014, and it coincides with a period of slower than expected growth and a small rise in corporate insolvency numbers.”

However, Tate believes that it’s not just interest rates that will decide the fate of companies, with lots of other variables in the mix.

“The sharp fall in the pound has made things difficult for importers, while a rising National Living Wage and the roll-out of pensions auto-enrolment have added to businesses’ running costs,” he noted.

“Only paying the interest on debts is not necessarily a sign that a business is in distress, remember. It may be that a company is taking advantage of low rates to invest in its operations or assets. But only repaying the interest is a common characteristic of a ‘zombie business’ – a business only able to keep going because of an ultra-low cost of borrowing and with little chance of survival.”

‘No bloodbath’

Graham Down, an experienced insolvency practitioner with Burton Sweet Corporate Recovery, is another who says it’s important to keep things in perspective.

“I don’t see a bloodbath, even if rates do rise,” Down told AccountingWEB. “My own take on it is that, while interest rates will go up – they must – it won’t happen soon, and businesses failures won’t rise too steeply.

“Having said that, there may be an increase in insolvencies for reasons other than interest rates. That’s because there is uncertainty in the market. A lot of investment decisions are being held back as a result and consumer spending is also likely to tighten.”

And Down added that, while some companies are struggling, there is also plenty to report that’s good in the UK economy.

“One more thing to remember is this: some kind of shake-out that sees weaker businesses go to the wall isn’t all bad; when it happens it frees up the banks to lend more easily to innovative and stronger start-ups. Company closures and company formations are a natural part of the business cycle. So long as the things don’t get too extreme, it shouldn’t be a cause for alarm.”

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29th Jun 2017 13:54

The short answer is maybe a few, providing the rise is not more than 1%.

The long answer is worthy of a thesis. Don't forget that higher interest rates should strengthen the pound, helping importers, hurting exporters and maybe reducing high street prices and/or increasing some retailers profits.

If inflation is outstripping wage rises, putting up interest rates should reduce inflation, but will reduce most peoples disposable incomes as their mortgage/rent costs rise.

And let's not forget businesses which go bust even when the economy is booming because they are selling the wrong products or are the sort that if given a 'Golden Goose' would forget to feed it!

Throw in the wildcard that is Brexit

Thanks (1)