Corporate finance: The high cost of cheap money
When companies are allowed to borrow aggressively at ultra-cheap rates, things can turn ugly fast when trouble strikes.
Debt-fuelled acquisitions can be hard to resist when there seems little prospect in sight of interest rates returning to anything approaching normal levels.
Claims that the 30-year bull run in the bond market ended in January when 10-year US Treasury yields shot up to 2.6% – a high not since for, oh, nine months – sound like the usual attention-seekers crying wolf.
There is no realistic prospect of rate rises in Europe any time soon.
It is perhaps surprising that the net result of this – artificially cheap debt – hasn’t wreaked more corporate havoc yet. However, turning amending and extending loans into extending and pretending that repayment is ever likely to happen will have consequences down the line.
New research published by Ryan Banerjee and Boris Hofmann at the Bank for International Settlements recently looked at zombie companies, which it defines as firms that are at least 10 years old, whose ebitda does not cover interest payments and which have low future growth potential.
Their research examined nearly 32,000 publicly quoted companies in 14 OECD countries since 1980. They reach the not entirely surprising conclusion that zombies are now more prevalent – after 10 years of monetary easing and ultra-low interest rates.
In 1987, the probability of a zombie firm remaining a zombie in the following year was 40%; by 2016 it had risen to 65%, according to their findings. This is what happens when investors chase assets and are willing to refinance almost anything at any price.
The recent travails at two highly acquisitive, debt-fuelled conglomerates have shown, however, that cheap debt can come at a high price for any corporate and its owners.
South African retailer Steinhoff International provided a spectacular case study in value destruction at the end of last year when its share price fell 62% in one day.