Europe’s ‘Zombie’ Borrowers Besieged by Spread of Coronavirus
Europe’s ‘Zombie’ Borrowers Besieged by Spread of Coronavirus
(Bloomberg) --
Europe’s so-called ‘zombies’ -- heavily indebted and poorly performing companies that have staggered on for years feasting on cheap credit -- may have finally met their match in the coronavirus.
Years of low interest rates and favorable financial conditions have helped firms with overlevered balance sheets stay out of serious trouble, their path smoothed by loose documentation that doesn’t usually impose limits on how much debt they can carry.
Now, borrowers on the lowest rungs of the sub-investment grade universe could find themselves vulnerable to a drop in consumer spending and supply chain disruption that finally triggers a debt restructuring. That could fuel losses to investors after a long benign spell for defaults.
“If a company is already teetering -- even if it’s not directly impacted by the virus and profits fall just a little -- that might be sufficient for highly leveraged borrowers to draw down their revolving credit lines as a source of liquidity,” said Jeanine Arnold, Associate Managing Director at Moody’s Investors Service.
That, she says, could result in borrowers breaching rules set by lenders on how much debt they are allowed to carry, while “weaker liquidity can also mean that a company can fail to pay interest.”
Rising Risk
European default risk is highest in transport, telecoms and cyclicals and industrials, while in the U.S. it’s concentrated on energy, telecom, and transport with potential spillovers to retail and industrials, according to UBS strategists including Stephen Caprio and Matthew Mish.
“A severe virus with persistently high reinfection rates could engineer a rise in defaults, above our 5% estimate in U.S. high-yield and 3.25% for EU high-yield; this is not ruled out,” they wrote in a report published March 2.
A quick and sustained recovery is more likely in production-related sectors where there is supply chain disruption and the demand could be satisfied in three to six months, according to Paul Watters, head of corporate research for Europe at S&P Global Ratings. “In other sectors, particularly related to consumer discretionary purchases, such as travel, leisure and education, one would expect that it could take longer for confidence to return to allow business as usual.”
Looking for Help
For companies under pressure from their debt burden, central bank action such as rate cuts may ease borrowing costs but will do little to restore consumer and business confidence in the near term.
While both the European Central Bank and the Bank of England have vowed to take action where appropriate, both have less room for manouevre and it remains an open question how much monetary policy can mitigate the effects of the epidemic. The U.S. Federal Reserve’s emergency rate cut has had mixed results so far.
“Central banks can’t necessarily help the top line,” Arnold said. “The levers they do have may help with lenders being able to provide short term financing, but central banks can’t get people to go into restaurants. On the contrary, governments may say to stay indoors.”
China has allowed more financially incurable borrowers, including two prominent state-run companies and a commercial arm of a top university, to go under in recent months. But it has also demonstrated its customary fixation with economic and social stability by rescuing more strategically important companies such as the heavily-indebted conglomerate HNA Group Co.
In Europe and the U.S., the jury’s still out.
“We’ll see defaults rise but for companies that were already limping over the line,” Martin Horne, head of global public fixed income at Barings. “The virus will accelerate the process, it will be a natural market clear-out.”
--With assistance from Laura Benitez.
To contact the reporters on this story: Irene García Pérez in London at igarciaperez@bloomberg.net;Ruth McGavin in London at rmcgavin1@bloomberg.net
To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Bruce Douglas
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