In a “normal” financial crisis, weak companies tend to go the wall, even if there is a lag between onset of a crisis and the date of expiration, because they become insolvent and run out of liquidity. In contrast, the economic consequences of the pandemic are anything but normal, and in some ways perverse.
First, some definitions. A “Corpse” is a company that is definitely defunct and whose carcass is being picked over. A zombie (made famous over the years by the Japanese) is a company that cannot properly service its debt in any realistic circumstance, because its business model is obsolescent, or its addressable market is inexorably declining, but manages to stagger on because of forbearance by its lenders and investors, none of whom is willing to administer the coup de grace. The pandemic has now created a third category, which we shall call Hibernators- companies which in normal circumstances would be perfectly viable, but have found themselves “side-swiped” by such things as lockdowns or travel restrictions- airlines, restaurants and (perhaps) gyms would be good examples of this last category.
What is really unusual is that in a period of economic carnage, as the FT recently pointed out in a couple of articles on the topic, in many countries the level of reported insolvencies and the like, has actually decreased significantly year-on-year, contrary to expectation and prior experience. For example, in Germany, Bundesbank estimates show insolvencies down 35% year-on-year as at September; while in France corporate bankruptcies are down 30%; whereas in the UK corporate insolvencies are down 42%.
The reasons behind this seem to be two-fold:
- Firstly, many governments have gone to great lengths to avoid a spate of insolvencies and so further job losses by providing a range of support measures to bolster corporate liquidity
- Secondly, both governments and regulators have either explicitly encouraged deferrals of requirements to file for bankruptcy, or “encouraged” banks to forbear in terms of requiring contractual payments or principal and interest.
This Faustian bargain is likely to be storing up trouble for the future- postponing, rather than preventing a day of reckoning for those companies whose business model, and so long term viability has been permanently harmed by the consequences of the pandemic. The difficulty, of course, lies in discerning between the likely Corpses and Zombies, and the Hibernators.
Yet, what has also been quite remarkable during the past 9 months or so is the ability of competent managements to adapt, re-invent, and re-order their businesses in order to survive and maintain the ability to prosper in the longer term. Whether Schumpeterian destruction will be one result remains to be seen, and there has to be concern that far too many Zombies will be allowed to continue to stalk economies, thus impeding recovery and efficiency.
Not surprisingly investors and advisors who specialize in the “distressed” elements of the economy are ready and waiting- and probably frustrated that the trajectory of available opportunities is not yet upward.
At Awbury, with our specialization in complex credit, economic and financial risks, an environment in which all may not be as it seems, presents some interesting opportunities, as well as causing us to re-assess constantly our assumptions about the characteristics of a sound risk. The past is not always prologue (to invert Shakespeare), and one must always be wary of making false assumptions and extrapolations based upon “past experience”.
The Awbury Team