Thursday, August 2, 2012

One in twelve UK companies are 'stuck in debt trap'

The Telegraph reports that according to R3, the insolvency trade body, one in twelve UK companies are 'zombie businesses' that are servicing their debt, but cannot grow.

There is no reason to believe that similar figures do not exist in both the EU and US.

R3, the insolvency trade body, warned that 8pc of businesses are stuck in corporate limbo, only able to pay the interest on their debts, but not reduce the debt itself. 
The group, which based the figure on its latest “business distress index” survey, said this could equate to as many as 146,000 zombie companies in the UK. 
Its quarterly research also found that 8pc of businesses said they would be unable to service their debts if interest rates rose. 
Lee Manning, R3’s president, said: “The implication here is that these businesses have been 'running on empty’ for quite some time now and with no reserves left in the tank, they may not be able to carry on for much longer. 
Please re-read the highlighted text.

As regular readers know, policymakers and financial regulators have been pursuing the Japanese model for handling a bank solvency crisis.  Under the Japanese model, bank book capital is protected at all costs.

This means that policies like regulatory forbearance are adopted and rather than recognize their losses, banks engage in extend and pretend on loans to 'zombie borrowers'.

Here is the evidence of how extensive this extend and pretend practice is.
“The danger for businesses that are teetering on the edge is that any change of circumstances, such as a rise in interest rates, the loss of a major customer, or suppliers upping their prices, will mean that they will not be able to hang on any longer.” 
The real problem is that these companies currently exist solely to pay interest.  As a result, they engage in different behavior than would a company that is trying to generate earnings for its equity holders.

In addition, since they are kept alive in interest paying mode, the assets that they control cannot be redistributed so that they can be used to support economic growth.
The retail and construction sectors were most likely to have zombie businesses, the research found.

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