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Illustration by Perry Tse

Zombie apocalypse: 1 in 5 Hong Kong-listed companies not earning enough to pay the soaring interest on their debts

  • 462 Hong Kong-listed companies qualify as ‘zombies’, and 266 have been in these dire straits for three years running
  • Overextended on funding they got at historically low rates in recent years, they must find white knights, sell assets or risk bankruptcy
Higher interest rates will weigh on Hong Kong’s mortgage borrowers and corporate debtors, as the costs of servicing their debt soar with the key interest rate at a 14-year high.

Some corporate borrowers in particular face a perilous fate. Unable to generate enough cash to pay the interest on their loans, let alone the principal, these firms find themselves branded “zombie” companies.

Last year, 462 of Hong Kong’s 2,500 listed companies fell into the category, with an Ebit-to-interest-expense (earnings before interest and tax) ratio of less than 1, based on Bloomberg’s data.

This horde of the walking dead, each with at least 10 years of operating history, tripled in number from a decade ago and multiplied during the pandemic, from 319 in 2019 to 396 in 2020. Among them, 266 companies have been in dire straits for three years running – a necessary time period for true zombiehood, according to the OECD.

In the past many zombie companies could shamble on indefinitely, refinancing their debt at historically low interest rates, receiving cash injections from white knights, or getting support from governments that wish to avoid the mess their collapse would entail. However, the current interest-rate situation makes it likely that more of these living-dead firms will succumb, according to analysts.

“The rise of the zombie companies since the Covid-19 pandemic is a global phenomenon,” said Natixis CIB’s senior economist Gary Ng, whose research found that the undead throng grew 18 per cent last year to 597 out of 15,000 listed companies worldwide, after a 37 per cent increase in 2020. “It means the risk of zombie companies going bankrupt has increased all over the world.”

As many as 149 China-based companies listed in Hong Kong, Shanghai, Shenzhen and New York have earned less than the interest on their debt for three straight years from 2019 through 2021, according to Natixis’ data. That number is up from 102 in 2020, and has tripled from 49 in 2019, before the pandemic broke out.

A view of Victoria Harbour from the waterfront in Tsim Sha Tsui in Hong Kong on June 15, 2022. The city’s base interest rate rose to a 14-year high following an increase by the US Federal Reserve on Thursday. Photo: SCMP / Sam Tsang

China ranks second in the world in terms of its 2021 zombie population; the US had 171 zombies and Asia excluding China had 134.

Use of the term zombie dates back to when Japan’s asset bubbles collapsed in the 1990s. One of the most famous zombies of all, the unprofitable electronics firm Sharp, was kept alive on loans and bailed out by banks in 2012, only to lose US$8 billion over the next two years. The company that launched the world’s first commercial camera phone in 1997 was taken over in 2016 by Foxconn, the Taiwan-based assembler of the Apple iPhone.

The current environment makes lengthy sagas such as Sharp’s less likely.

US Fed, with third straight rate rise, signals further aggressive moves

“With the global policy rates adjustment having further room to go and the multiple shocks facing the global economy, zombie companies are feeling the heat,” said Jerome Jean Haegeli, group chief economist of Swiss Re.

The pandemic has conspired with an era of readily accessible funding – at historically low rates until recently – to not only increase the population of zombies but also to make these distressed firms even more vulnerable now that the monetary tables have turned, according to Etienne Ranwez, a senior manager at Sia Partners in Hong Kong.

“Revenues of many companies in Hong Kong and China, just like in most regions globally, were already under pressure with Covid,” he said. “As funding was cheap, these companies have loaded on more debt than usual. Hence, we could indeed expect an increase in bankruptcies.”

This will be true more so in liberal and developing economies than in developed economies with more government intervention, he added.

Many governments offered pandemic relief that helped to sustain some zombies through the last three years. But those sources of sustenance are drying up.

As are cheap loans, after the US Federal Reserve increased interest rates five times this year, including turning the dial up by 75 basis points on Thursday while also signalling further aggressive moves.

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Making life even tougher for zombie companies, borrowing costs in the bond markets are also rising.

“Investors would be more risk-averse and selective in bond markets, meaning the funding costs for high-yield issuers will climb, or some may not even be able to refinance,” said Natixis CIB’s Ng.

In China, the zero-Covid policy has eaten into the revenue of many companies at the same time that a Beijing crackdown has created a credit crunch among real-estate developers. The property sector has been in a tailspin since late 2020 when the People’s Bank of China (PBOC) enforced its so-called three red lines, which imposed borrowing thresholds on developers.
Embattled China Evergrande Group faces possible liquidation after it received a winding-up petition from a creditor in June for failing to pay US$110 million. The petition will be heard by the High Court of Hong Kong on November 28.

In the US, defaults on leveraged loans reached US$6 billion in August, Haegeli said.

“This is still very low, but it is the highest since October 2020 when the pandemic shutdown hit the US economy,” he said. “Europe is much more vulnerable to the energy crisis and stagflationary shock overall.”

Fed hawks push Chinese banks to pay off US$12 billion of perpetual debt

Cruise operator Genting Hong Kong, one of the zombie companies listed in Hong Kong, filed a winding-up petition in Bermuda in January after the bankruptcy of its shipyard in Germany triggered US$2.78 billion of debt – despite the fact that its major shareholder is Malaysian tycoon Lim Kok Thay.

The liquidation is the biggest casualty in Asia’s tourism in­­dustry as the Covid-19 pandemic con­tinues to wreak havoc on global travel.

Zombie companies can survive by selling profitable assets or business lines, or by finding white knights to inject new capital, said Derek Lai, vice-chair of Deloitte China.

For example, one well-known case Lai handled involved finding a rescuer for troubled broadcaster Asia Television (ATV).
ATV wallowed in losses and lived as a zombie for many years in the early 2010s. Eventually, it could not afford to pay its licence fee and staff costs, and it fell into provisional liquidation in February 2016. It went off the air two months later, ending 59 years of broadcasting.

Asian central banks locked in losing chess match with US Fed

Lai, the provisional liquidator for ATV, however, quickly found a white knight in Hong Kong-listed textile company Co-Prosperity Holdings, which offered US$64 million to buy 52.42 per cent of ATV in early 2017. One year later, Co-Prosperity renamed itself Asia Television Holdings and announced it would produce online entertainment.

“Many zombie companies can turn into normal companies by restructuring debt and finding new investors to support their business,” Lai told the Post. “Bankruptcies are not the only way out.”

Lai also helped the restructuring of Freeman Fintech in February 2020, by connecting the company with Adrian Cheng Chi-kong, the third generation executive of New World Development. Cheng injected new working capital at a time when the company had US$536 million in outstanding claims as of March 2021. The company resumed trading on November 1, 2021, escaping the fate of being delisted after a suspension of 18 months.
Chinese zombie companies may have better survival prospects than their US or European counterparts at the moment. While the US is raising interest rates, with Hong Kong and many Western markets following in lockstep, China surprised the market last month by cutting its two key interest rates.

China’s one-year loan prime rate (LPR) was reduced from 3.7 per cent to 3.65 per cent, the People’s Bank of China said on August 22, while the five-year LPR, which is the reference for mortgages, was cut from 4.45 per cent to 4.3 per cent.

Vacancy notices in Hong Kong’s Causeway Bay shopping district on 31 March 2016. Photo: Sam Tsang

“China is a totally different animal, as interest rates are kept low and banks are being asked to support companies,” said Alicia García Herrero, chief Asia-Pacific economist at Natixis CIB.

“Still, bond defaults are as high as in 2020 and 2021, and the ratio should increase after the party Congress and the consequences of a rapid economic deceleration are fully there.”

China has a huge amount of zombie companies, García Herrero said, and that is not going to change soon because China, like some Western governments, tends to prefer the survival of zombie companies to their collapse. Although letting zombies die could be more healthy for overall economic development, it can be politically costly, with knock-on effects on healthy companies, she said.

“If more zombie companies go bankrupt, bank non-performing loans will continue, so the problem is passed to the banks,” García Herrero said. “This is one more reason why governments continue to support zombie companies.”

The Hong Kong Monetary Authority (HKMA), the de facto central bank of the city, considers the credit risk facing the Hong Kong banking sector to be manageable, according to a spokesman.

The entrance to the Hong Kong Monetary Authority (HKMA) at International Financial Centre in Central in Hong Kong, pictured in June 2020. Photo: SCMP / Nora Tam

Based on the latest statistics, the asset quality of banks remains healthy, with an average classified loan ratio of 1.1 per cent at the end of June 2022.

“The HKMA has all along required banks to adopt prudent underwriting standards and carefully assess the financial strength and repayment ability of borrowers,” the spokesman said.

In mainland China, historical state intervention and a relatively lower level of transparency around financial data may have allowed zombie companies to become larger on average than in neighbouring countries, according to Sia Partners’ Ranwez.

However, Beijing’s support seems to have limits.

“More recently, the government seems increasingly reluctant to save non-performing companies such as the Evergrande Group, although probably less so in key strategic sectors like telecoms and even banking,” Ranwez said.

A photo taken on November 5, 2020, shows the US Federal Reserve in Washington, DC. Officials who attended the Fed’s policy meeting this week expect it to lift rates by at least another 1.25 percentage points by the end of 2022. Photo: Xinhua

Large companies can raise funds through new share placements or rights issues, but smaller firms may not be able to secure such funding, he said.

Another option is to look for salvation in a merger or acquisition by competitors or private-equity firms.

“Recessions and high-interest-rate environments will eventually ‘clean up’ the weaker participants in the economy,” Ranwez said.

“For the longer term, this will result in a stronger and healthier economic environment, where resources and capital are utilised by firms who are performing well and creating value, rather than by zombie companies that are unproductive and inefficient.”