Zombies win again

Even higher rates can't kill them

Author

Tim Vollans
January 30, 2024 • Estimated Reading Time: 5 minutes

âš¡ The Spark
Zombies win again

Even higher rates can't kill the zombie companies

There’s a popular theory that higher interest rates are a good thing.

Good because a higher cost of capital will force better productivity.

Good because it will cleanse the system of those weak, unproductive companies.

Darwin’s theory of evolution in action.

Schumpeter called it ‘creative destruction’.

One problem. They’re just theories.

Joachim Klement hammers this point home in his latest note:

The Fed may extend the life of zombies

See, according to IMF researchers, reality doesn’t match the theory…

Think about the saying that if you owe the bank a million dollars, you are in trouble, but if you owe the bank a billion dollars, the bank is in trouble.

Zombie companies tend to be the customers that owe banks a billion dollars rather than a million. When interest rates rise, they will go to their lenders and tell them that they can’t pay their loans anymore.

What is a bank to do in such a situation? It can decide to call in the loan and let the zombie firm default on the loan in which case the loan will end up as nonperforming and a loss for the bank.

Or, it can decide to refinance the loan for the zombie firm and maybe even provide an even bigger loan facility to make sure the firm can survive and the existing loans don’t go bad.

Ironically, what banks seem to do is throw good money after bad in order to prevent bad loans from piling up on their balance sheet. 

They tend to roll over loans to zombie firms to a higher degree than loans to healthy firms.

Ooof. Myth BUSTED.

The other problem with the zombie perspective?

Companies are dynamic…

They don’t always stay zombies.

A couple of years back, we gently critiqued this opinion piece:

Greene’s argument was essentially that companies like Chesapeake should be left to die, because they hadn’t generated positive free cash flow in a decade.

Chesapeake went on to restructure, emerge from bankruptcy and become immensely profitable as US production rose to meet global energy demands.

Megan Greene went on to join the Bank of England’s monetary policy committee in 2023…

🧠 The Big Brain
Shiny New Toys

Great. What’s the trade?

You may have heard about the QRA over these past few months.

It’s an acronym for a very boring event. The US Treasury announces how much they will borrow for the next quarter.

You still there? Or did you die of boredom?

Usually, only bond traders care.

Then one day, about six months ago, it caught everyone off guard, impacting markets across the board and quickly became the markets’ shiny new toy.

Does it still matter…?

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💡 The Lightbulb
We were first and we don’t care anymore

Evergrande back in the headlines again

Long time readers will remember our work on the Chinese property market, especially Evergrande.

We were right, and timely.

The Chinese property boom ended, developers plunged into the red, and now Evergrande’s been hit with a liquidation order.

People are talking about this now as if it’s brand new. It’s not. The story’s old, the market impact is nil, and China will spend years dealing with the fallout.

The world’s moved on. So have we.

Just never forget that we were first:

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Replying to @user7990130875101

We even have the medal to show for it…