Beware Zombie Companies in Your Loan Portfolio

January 9th, 2014

As the doom and gloom of the financial crisis begins to subside for consumers, banks continue to live their own personal nightmares, bracing themselves against the onslaught of regulatory scrutiny and record-high fines.

BY: BRANDON DANIELS

Bank CEOs wake up every morning wondering what issues continue to lurk within the depths of the economy.  With financial markets invariably in a transition state, the most definitive thing we can say is that different markets are going to be impacted in unpredictable ways.

Another thing I can say with certainty: the amount of debt out there at current interest rates is unsustainable. Furthermore, as the global economy improves, monetary policy is going to tighten.

This nightmare could begin to get even scarier.

Cue the entrance of zombie companies, businesses that can sustain themselves on low interest rates alone and are able to pay back minimum interest payments but are in no position to repay the actual debt itself.

Zombie companies, especially prevalent in the hospitality and retail industries, have survived on the loose monetary policy of the past few years, designed to help at-risk businesses stay afloat and keep people employed in the wake of the financial crisis.

In the U.S., the resurgence of covenant-lite leveraged loans has the Federal Reserve worried. In 2013, the volume of leveraged loans – usually rated subprime and often handed out to indebted companies to refinance their debt – exceeded pre-crisis levels.

According to R3, a U.K.-based insolvency association, there are over 100,000 zombie companies—employing at least half a million people—lurking in the U.K.

Couple these two developments with an inevitable drop in consumer spending as interest rates rise, and the industry has got a problem brewing.

So what’s to be done? How should banks deal with a bubble that has yet to burst?

First, banks need to begin scrutinizing their debt portfolio and conducting data analysis to figure out which companies pose the most risk. Sector and jurisdictional analyses are in order, and models need to be built to assess financial viability and buoyancy at different levels of increase in interest rates.

Banks need to divide customers into different groups. Which sectors are prone to this lapse in debt? Who are their at-risk customers? Who has officially entered zombie territory?

The immediate impulse may be to proactively “pop the bubble” and take extraordinary measures to reclaim at-risk capital from those on the razor’s edge. Considering the current regulatory environment, however, that may be the wrong thing to do – and it could be seen as pushing clients into insolvency.

A balanced approach, however, is essential to keeping capital safe.

Banks should develop programs to coach their customers through what is bound to be a difficult time. Work with clients to more closely monitor and track debt. Devise mutually satisfactory and proactive ways to restructure debt. Invest in debt and capital management programs to help counsel customers back to health and to strong capital positions. Bring them to a point where default is not the default.

And, if default does occur, try to be the first to capture your debt, not the last. Implement a rigorous but fair process to ensure minimal damage to customers and clients.

Like in any zombie apocalypse, players need to keep resources safe and sound and stored in the right place. Banks are going to need to move quickly to transfer capital to high areas of growth.

Banks need to ask themselves: Which sectors are going to see high growth? What analyses are needed to figure out which enterprises are worth injecting capital into?

In short: have a debt recovery plan so that you’re not the last claimant in a line of debtors. This is one zombie party you can’t afford to be late to.

Brandon Daniels is the president of Clutch Group, a global provider of litigation, investigation, compliance and other legal services for Fortune 500 companies.