Global 'Zombie Companies' Proliferate Amid Excess Liquidity... Warning Signs of Corporate Credit Deterioration

As Governments Worldwide Unleash Stimulus Measures... Increase in Debt- and Low-Interest-Dependent Failing Companies
Speculative-Grade Corporate Bond Issuance Hits $322 Billion This Year... Concerns Over Deteriorating Financial Market Asset Quality

[Image source=AP Yonhap News]

[Asia Economy Reporter Jeong Hyunjin] The outbreak of the novel coronavirus disease (COVID-19) has unleashed massive liquidity into the market, leading to a proliferation of 'zombie' companies surviving on debt. As the corporate economy has sharply contracted, governments and central banks have implemented aggressive stimulus measures such as quantitative easing, resulting in a surge of companies accustomed to low-interest costs. Concerns are growing that this will not only deteriorate the asset quality of financial markets but also become a structural problem that hampers long-term economic recovery.

According to the Bank for International Settlements (BIS) on the 16th, a recent report revealed that the volume of new bonds issued by investment-grade companies worldwide reached $1.7 trillion (approximately 2,006 trillion KRW) by mid-August this year, while new corporate bonds issued by speculative-grade (high-yield) companies amounted to $322 billion. This significantly exceeds last year's combined corporate bond issuance of $1.3 trillion for both investment-grade and speculative-grade companies.

BIS pointed out that "with the net leverage ratio (total debt relative to equity) continuing to rise to an all-time high, corporate capital structures are increasingly relying on debt and low interest rates." It added, "Bankruptcy rates are projected to rise to between 20% and 40% depending on the expected GDP growth rates of -4.5% to -11.0% across countries this year." However, it explained, "Despite the continuous increase in the number of low-profitability companies, i.e., zombie companies, even before the COVID-19 pandemic, most economies have seen fewer corporate bankruptcies this year compared to the previous five years, thanks to various public support measures."

The increase in corporate bond issuance is also raising the proportion of zombie companies with poor profitability. Major foreign media cited the Rothold 3000 Universe Index, which is conceptually similar to the Russell 3000 Index that tracks the top 3,000 U.S. listed companies by market capitalization, reporting that the share of zombie companies unable to pay interest for at least three years rose from 8% at the end of 2008 to 13% last year. By proportion, the number of zombie companies increased from 240 in 2008 to 390 last year, growing by an average of 15 companies annually. This indicates a rise in distressed companies among the top market capitalization firms.

The problem is that the number of such companies is likely to increase further due to the COVID-19 crisis. Since March, as concerns over liquidity shortages in the global economy intensified, major central banks including the U.S. Federal Reserve (Fed) lowered benchmark interest rates to near zero and injected funds into the bond market by directly purchasing corporate bonds. While the aim was to ease corporate operations, it also created optimal conditions for zombie companies to survive.

This trend is also evident in changes to corporate credit ratings. According to credit rating agency S&P, the impact of COVID-19 led to a significant downgrade of U.S. corporate credit ratings in the first and second quarters of this year, increasing the proportion of speculative-grade companies. In July, the share of companies rated B- or below, classified as speculative grade, reached 40% of all companies, marking an all-time high. Based on the negative outlook for the corporate economy, credit ratings have deteriorated, and corporate bonds issued by these companies have rapidly increased.