The Ranks of Corporate Zombies Are Growing: Credit Weekly
The tally of “zombie companies” in the US that aren’t earning enough to cover their interest expenses stands at the highest since early 2022.
(Bloomberg) — As Halloween monsters of all stripes flood neighborhoods in search of candy and parties this weekend, credit markets are seeing the resurgence of a different type of zombie.
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The tally of “zombie companies” in the US that aren’t earning enough to cover their interest expenses stands at the highest since early 2022, with almost 100 gaining the designation in October. The main reason: Companies that gorged on debt at near-zero interest rates in the pandemic era have since been hurt by tariffs and higher funding costs.
The odds of getting much relief on either front aren’t improving, with the US signing trade deals that lock in some of the higher tariffs and the Federal Reserve signaling that it might not continue to cut rates at its December meeting. Zombies will have to take steps to fix their balance sheets, such as boosting earnings or arranging costly new financing, or potentially face default.
It won’t be easy. “Even if the Fed were continuing with cuts, the borrowing costs for small companies, zombie companies, are still multiples higher than historic averages,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “A lot of these companies were barely scraping by at zero rates.”
Many of the companies that slid into zombie status in October were in health care and biotech. The sector has been under pressure amid soaring costs and shrinking federal subsidies. Other types of companies with exposure to tariffs were added to the list, too. And many of the companies have been on the list for some time.
Among the corporate zombies in the US were film producer Lionsgate Studios Corp.; the firm owns the rights to popular film franchises including John Wick, The Hunger Games and Twilight. Other signs of potential distress are embedded in bond prices. Tronox Holdings Plc, a chemical company, raised funds from the bond market earlier this year to refinance its revolvers; its new notes have fallen by about 9 cents on the dollar since pricing.
Some of Altice USA’s CSC Holdings 2029 bonds that debuted only last year have been quoted below 80 cents, yielding close to 20%. The company “likely requires a strategic or financial maneuver” to address a “massive maturity wall in 2027,” according to a note from Bloomberg Intelligence.
Spokespeople for Lionsgate and Tronox declined to comment. A representative for Altice USA didn’t respond to a request for comment.
LBO Legacies
Some companies are in trouble because they’re carrying heavy debts tied to leveraged buyouts that made more sense years ago. “These balance sheets were structured when rates were low, and they don’t necessarily work when rates are high,” said David Rosenberg, head of liquid performing credit at Oaktree Capital Management.
To be clear, the designation isn’t necessarily a death sentence — unlike the walking dead on the silver screen, these zombies can come back to life. Companies can cut costs, sell off pieces of themselves, issue equity or renegotiate their debts.
Corporate zombies are businesses whose operating income is less than their interest expenses. A related measure — the interest coverage ratio — compares earnings before interest, tax, depreciation and amortization with interest payments.
If the coverage ratio falls below one, it signals to lenders that a company isn’t earning enough to carry its debt. In some cases, this can violate terms of a zombie’s loans or bonds. In the most severe scenarios, a creditor can impose even more costly terms or demand immediate repayment.
Eroding Coverage
“It worries me when I see interest coverage below one,” said Shannon Ward, a fixed-income portfolio manager at Capital Group. Companies that borrowed in the high-yield market or loan market “likely used adjusted Ebitda, which tends to be more optimistic,” and in some cases, their growth and cost projections just haven’t panned out, she said.
Getting new financing could be an uphill battle. S&P Global Ratings has already lowered its earnings forecasts for speculative-grade corporate issuers for this year and the next, according to a report published in October. Homebuilders, oil and gas producers, and chemical companies all had their earnings projections cut.
“Then there’s a third problem: maturities. How companies are going to address that will be an interesting question,” Ward said.
Some companies have all but conceded they can’t answer it unless they get a break from lenders. Other zombies are still lurking, according to Carolyn Alford, partner with the law firm King & Spalding.
“There is more distress in the market than participants will admit,” Alford said.
WATCH: This week’s guests are TCW Fixed Income Generalist Portfolio Manager Bryan Whalen, Societe Generale Americas Head of Research Subadra Rajappa, Pinebridge Investments Global Head of Credit and Fixed Income Steven Oh, and AllianceBernstein Director of Credit William Smith.TCW Fixed Income Generalist Portfolio Manager Bryan Whalen, Societe Generale Americas Head of Research Subadra Rajappa, Pinebridge Investments Global Head of Credit and Fixed Income Steven Oh and AllianceBernstein Director of Credit William Smith.
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Week In Review
Meta Platforms Inc. sold $30 billion of US high-grade corporate bonds, the biggest such offering of the year, after the company received record orders for the debt.
HSBC Holdings Plc said it’s reviewing its exposure to smaller banks and hedge funds that have large private credit businesses, as the market comes under scrutiny after the collapses of First Brands Group and Tricolor Holdings.
A joint venture between Norinchukin Bank and Mitsui & Co. is booking an ¥18.9 billion ($122 million) allowance for unpaid debts stemming from the First Brands bankruptcy.
Seven classes of notes from four deals by auto lender First Help Financial are at risk of being downgraded by Kroll Bond Ratings Agency after losses mounted in collateral portfolios.
Investors in Adler Pelzer Holding GmbH’s bonds are freezing out short sellers seeking to profit from their decline, driving up the price of the auto-parts maker’s notes.
Top executives across Wall Street dismissed fears of a brewing credit crisis — even as some of the industry’s biggest names set aside hundreds of millions more to cover potential losses.
Goldman Sachs Group Inc. Chief Executive Officer David Solomon said he doesn’t see any systemic risk looming in the credit market.
Veteran dealmaker Paul Taubman echoed those remarks in a separate interview, while acknowledging there are always “idiosyncratic risks” lurking.
UBS Group AG Chief Executive Officer Sergio Ermotti defended his bank against criticism over the exposure to First Brands, saying investors were aware that they were engaged in higher-risk strategies.
For Ares Management Corp. executives, the recent losses in credit markets actually make private credit look good, while presenting an opportunity to snag more deals.
BlackRock Inc. and other creditors are grappling with the fallout from loans made to two telecom companies — Broadband Telecom and Bridgevoice — that the firms are now accusing of fraud.
Healthcare services firm Sevita shelved a $2.5 billion leveraged loan sale — the latest multibillion-dollar deal pulled as investors ramp up their scrutiny of borrowers.
Adidas AG priced the year’s tightest five-year euro corporate bond, highlighting the continued solid investor demand that’s allowing companies to lock in cheap funding.
Credit traders are buying protection against Oracle Corp. defaulting on its debt, a trend that Morgan Stanley sees continuing in the near term as the tech giant pours billions into artificial intelligence.
Deutsche Bank AG’s US distressed trading desk netted about $200 million in profit during the three months ending Sep. 30, according to a person with knowledge of the matter, part of a trading boom that helped drive record third-quarter gains for the German bank.
On the Move
BlackRock Inc.’s head of US capital markets Jackie Krese has left the company after four years. She joined in 2021 after 16 years at Credit Suisse, where she was most recently group head of Americas debt capital markets solutions.
BNP Paribas hired Mike Curry as managing director, senior loan salesperson. He previously worked at Jefferies for about 12 years, most recently as a managing director in a similar role.
Former Citigroup Inc. banker Jake Atcheson has joined Natixis SA to head up its European insurance debt capital markets.
Neuberger Berman hired Mizuho Bank Ltd.’s Yasuyuki Fujita as a managing director and head of Japan private debt investment, as alternative asset managers ramp up their operations in the country.
Avenue Capital Group LLC’s Manish Srivastava joined Jain Global LLC as head of Asia Pacific credit, adding to a string of personnel changes at the hedge fund.
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