Fall of the zombies? Why corporate failures could surge in 2024

Debt-laden companies across Europe, Middle East and Africa face a $500 billion refinancing scramble in the first half of 2024, a challenge that could kill off many "zombie" businesses even though an expected peak in rates could bring some relief.

Businesses facing rising debt costs after years of low rates will have to compete to secure enough cash in the biggest corporate refinancing rush seen for years, just as banks rein in risk ahead of stricter capital rules.

Analysis by restructuring consultancy Alvarez & Marsal (A&M), shared with Reuters, shows the value of company loans and bonds maturing in the six-month period is higher than any other equivalent period between now and the end of 2025.

A crunch is looming, finance industry experts said, with many weaker, smaller businesses seeking new private loans and public debt deals just as government borrowing costs - which influence loan rates - are soaring globally.

Failure to secure the cash they need at rates they can afford, could lead to insolvencies and layoffs.

"Interest rate rises are becoming more and more of an issue for companies, particularly those zombie businesses that have been holding on with a sustained period of low interest rates but just barely able to service their debt," said Julie Palmer, partner at UK restructuring firm Begbies Traynor.

"I think we're now starting to finally see the fall of some of the zombies," she added.

The term "zombie" is broadly used in a business context to refer to companies relying on support from governments, lenders and investors to stay afloat.

This can include restructuring loan repayments, offering reduced rates or other more relaxed terms and can help banks avoid loan write-offs.

Signs of distress are already showing. The latest official data from Britain's Office of National Statistics put corporate insolvencies in England and Wales at 2,308 in August, up 19% on the previous year.

Reuters Graphics

Begbies Traynor's quarterly Red Flag Report on corporate distress, covering the April-June period, found that 438,702 businesses across the UK were in "significant" distress, up 8.5% on a year earlier.

British discount retailer Wilko fell into administration this summer, leading to thousands of job cuts.

France's sixth largest retailer Casino has just finalised a debt restructuring to avert bankruptcy.

"Central banks are taking a breather but aren't ready to say rate hikes are over," Nicola Marinelli, assistant professor of finance at Regent's University, told Reuters. "Banks and private equity shops have waited to see if the tide turned but higher rates don't allow hiding anymore."

Default scenario

The Bank of England has urged lenders not to underestimate the risk of corporate loan defaults and to avoid relying on models that measure risk across entire sectors rather than individual borrowers, after England and Wales had the highest number of company insolvencies since 2009 in the second quarter.

One major bank is referring 100 small businesses a month to its restructuring team, up tenfold from 18 months ago, Paul Kirkbright, a managing director in A&M's restructuring practice, said. He declined to name the bank.

One senior banker told Reuters their bank has plans to redeploy hundreds of staff to support distressed business customers if high funding costs and flagging consumer demand push more companies to the brink.

But so far business borrowers have shown few material signs of stress, two senior banking sources told Reuters.

This resilience is partly due to liquidity pumped into the economy during the pandemic but banks' year-end asset quality reviews - which measure a loan's underlying strength - will be key, Kirkbright said.

Bank of England data showed gross lending in the first half of 2023 was 12% lower than the previous six-month period. Trade body UK Finance described demand to borrow among smaller firms as "muted" in its Q2 Business Finance Review on Sept. 13.

But the refinancing task cannot be put off indefinitely.

"Our insolvency colleagues are already busy in the smaller end of the market, and that's where it always starts," Kirkbright said, adding that A&M's U.S. restructuring team had also seen a significant influx - a leading indicator for Europe.

Eva Shang, co-founder and CEO of Legalist, a U.S.-based hedge fund that offers debtor-in-possession (DIP) financing to companies in Chapter 11 bankruptcy, told Reuters her firm had received more than 300 applications for funding since January, mostly from Main Street businesses in distress due to rising interest rates and the end of COVID stimulus.

Tougher capital rules for banks that come in from 2025 are expected to constrain appetite to support companies in need of fresh funding, industry experts said.

Katie Murray, CFO at NatWest Group  told a conference last month that her bank had concerns about how Basel III capital rules might impact small business lending.

Some lenders have tightened credit terms and even offloaded some smaller business customers entirely as they review the profitability of those relationships, said Naresh Aggarwal, policy director of the Association of Corporate Treasurers. He pointed to construction and retail sectors where he felt strains were most acute.

Ravi Anand, managing director of specialist lender ThinCats, said firms without large asset bases were struggling to access all but the most vanilla, loan-to-value based finance from mainstream banks, with loans based on core profit much harder to come by.

"[The leveraged loan market] is always cyclical, some banks are in and suddenly they are out," Anand said. "These loans require much extra work to assess constantly moving cash flows and in this kind of environment," he said.

Companies in need of cash are also likely to tap private equity firms, which are also becoming more discerning about the companies they support.

Any large corporate failures are likely to have a "contamination effect", said Tim Metzgen, an A&M managing director.

"It feels like a tight rope walker – they may well get to the end, but there are actually some pretty strong headwinds that could topple the person over."