The Washington PostDemocracy Dies in Darkness

Here’s one more economic problem the government’s response to the virus has unleashed: Zombie firms

Troubling rise in number of U.S. companies that can’t make enough profit to cover debt payments

John Lee, a general manager at Oasis Petroleum, is shown walking along the top of a new oil production facility in the Permian Basin of Texas in 2018. (Nick Oxford/Reuters)

Even as it drilled in some of the nation’s richest oil and gas basins, Oasis Petroleum came up dry on the bottom line, failing for five straight years to make enough money to cover its annual borrowing costs.

In 2019, a dozen years after it began exploring shale formations in Montana, North Dakota and West Texas, Oasis reported $154 million in operating income -- well short of the $176 million it owed in interest on its debt. On Wall Street, the Houston-based company’s shares, which traded above $56 in 2014, have spent most of this year hovering around $1.

Oasis is what economists call a “zombie company” -- largely abandoned by investors and able to stay in business only by tapping banks or bond investors for more credit. The Federal Reserve’s efforts to fight the impact of the coronavirus upon the economy may be inadvertently making it possible for a growing number of companies to remain in this twilight state. And as the walking dead of the corporate world multiply, some analysts worry they are draining the life from the healthy parts of the economy.

Fears of corporate debt bomb grow as coronavirus outbreak worsens

Nearly one in every five publicly traded U.S. companies is a zombie, according to data compiled by Deutsche Bank Securities. That figure has doubled since 2013 and is up dramatically from the late 1990s, when there were almost no half-dead companies staggering across the landscape.

Years of ultralow interest rates intended to stimulate the economy after each of three 21st-century recessions created the conditions for zombies to proliferate, according to economists. Since the pandemic sideswiped the U.S. economy in March, the Federal Reserve has again lowered borrowing costs to near zero and further eased credit conditions by purchasing corporate bonds.

The Fed’s actions have drawn widespread support as an antidote to the pandemic-inspired economic collapse. Making it easier for companies to obtain financing should prevent countless business failures and millions of additional job losses, economists said. But that short-term success may breed long-term weakness, sapping productivity, investment and the economy’s competitive fire once the crisis passes.

“We’re not saying that the Fed shouldn’t have acted. But there are side effects of aggressively intervening,” said Torsten Slok, chief economist for Deutsche Bank Securities.

Fed chair warns of long, painful downturn if Congress does not provide more economic relief

One prominent zombie -- retailer JC Penney -- recently toppled into bankruptcy. Another struggling firm, AMC Theatres, which did not earn enough to cover its interest payments in the first quarter and two of the past three years, may be about to follow. The world’s largest theater chain warned investors earlier this month that it may be unable to obtain sufficient financing to ride out the pandemic.

Like a recuperating hospital patient relying on painkillers, the economy needs cheap credit to recover. But used for too long, low interest rates act like a narcotic, leaving the economy craving easy money and unable to thrive without it.

From 2009 through 2019, the U.S. economy grew more than twice as fast as either the Eurozone or Japan, according to the International Monetary Fund. The risk now, some economists say, is that the cure for the current recession will backfire and lead to a future of anemic growth like that experienced by these other advanced economies.

The effective Fed funds rate -- the central bank’s benchmark lending rate -- has not been above 2.5 percent in 12 years. And with the economy struggling amid the highest unemployment since the 1930s, rates are expected to remain depressed for years.

The Fed also is easing credit conditions by supporting $750 billion in corporate bond issuance and backing an additional $600 billion in lending to small and midsized businesses.

This prolonged period of easy money may lock the economy into a vicious cycle, some economists said.

Weak growth prompts the central bank to cut interest rates, which allows zombies to multiply. A growing number of zombified companies further erodes the economy’s strength, leaving central bankers reluctant to raise rates from their zombie-friendly levels. And the cycle repeats, keeping failing firms alive and interfering with the emergence of more productive competitors.

“Almost no one would say let firms go bankrupt left, right and center. That’s not reasonable,” said Viral Acharya, former deputy governor of India’s central bank. “But society needs a reallocation of resources to other sectors.”

After the 2008 financial crisis, the Fed kept rates near zero for seven years, then raised them in tiny increments until 2019, only to start cutting them again. With May’s 13.3 percent unemployment rate suggesting a long recovery lies ahead, Federal Reserve Chair Jerome H. Powell earlier this month said the central bank is “not even thinking about thinking about raising rates.”

That means more years of near-free money, an additional surge in business borrowing and thus more fuel for zombies. Nonfinancial business debt grew in the first quarter by almost 19 percent, the biggest percentage jump in at least 40 years, according to the Federal Reserve. Businesses took on more than $3 trillion in new debt in the first three months of 2020, almost 10 times as much as in the previous three months.

All that borrowed money was needed to replace revenue lost when the pandemic forced most factories, workplaces and retail outlets to close for several weeks. Without the borrowing surge, millions more Americans would have joined the 21 million workers currently idle. But at more than $16.8 trillion, business debt tops 78 percent of the economy.

The pandemic shutdowns did not start until the final weeks of the first quarter. So corporate debt is likely to swell even more sharply in the period that ends June 30, Paul Ashworth, chief U.S. economist for Capital Economics, told clients in a recent note.

“A near-unprecedented surge” in corporate bond issuance “could weigh on the recovery if firms’ existing debts makes them more reluctant to boost investment in the coming years,” he added.

The epic economic collapse that began in March brought numerous corporate borrowers closer to zombie status, particularly in the retail and energy sectors. The number of corporations that S&P Global rated “CCC” or lower -- a sign of unsustainable finances -- reached an all-time high of 256 on May 31, according to Gregg Lemos-Stein, S&P Global’s head of research for corporate ratings.

That is nearly twice as many as at the peak of the 2008-09 crisis.

Not every loss-making company is a zombie. Amazon, the online retail behemoth, famously lost money for several years before breaking into the black. (Jeff Bezos, Amazon’s chief executive, owns The Washington Post.) And Elon Musk’s Tesla has yet to post an annual profit, though investors remain enthusiastic.

While there is no formal definition of the term, companies that fail to book sufficient profits, or operating income, to cover their annual debt costs for three straight years are generally considered zombies, economists said.

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The phenomenon was first detected in Japan following the collapse of its 1990s-era bubble economy. Rather than recognize losses on their books, Japanese banks kept lending money to failing companies, which left the economy stagnant for years.

Japan’s economic malaise ultimately spread to Europe and now threatens to engulf the $21 trillion U.S. economy.

In recent years, economists at the Organization for Economic Co-operation and Development, the Bank of International Settlements and the Bank of Japan all have raised concerns about zombies. In 2003, Eric Rosengren, president of the Federal Reserve Bank of Boston, co-authored one of the earliest studies of lending by Japanese banks to zombie firms.

Industries populated by greater numbers of zombies experience lower investment and employment growth, according to a 2018 study by the BIS, a central bank group in Basel, Switzerland. The OECD one year earlier concluded that zombies stifled labor productivity throughout the economy.

The extraordinary central bank action that has kept credit unusually inexpensive for so long has prevented market forces from weeding out failure and rewarding success, these economists said. Zombies make it harder for new companies to enter a market and for existing, more productive companies to grow.

By this logic, the 609 people who work for Oasis Petroleum and the hundreds of millions of dollars available on its credit line might be put to more productive use elsewhere in the economy.

The company did not respond to an emailed request for comment.

Still, some are skeptical. Even though zombies are more numerous today, U.S. companies can easily raise money from bank loans or bond investors and there are tens of millions of jobless workers available for hire.

“No viable company is starved for cash -- not one,” said Joseph Gagnon, a former Federal Reserve economist now at the Peterson Institute for International Economics. “They’re not holding anyone back.”

Plus, keeping financially ailing firms alive beats the alternative of soaring bankruptcies and additional joblessness. And zombie companies will die a natural death once the economy recovers, pushing borrowing costs and workers’ wages higher, he added.

That may happen when the economy eventually recovers and interest rates rise. But in the aftermath of the 2008 crisis, the Fed was only able to raise interest rates about halfway back to their precrisis level before being forced to cut them again. And the number of zombies continued to rise.

So policymakers should not wait to act, said Acharya, an economics professor at New York University’s Stern School of Business.

For now, interest rate increases are a non-starter given the economy’s profound weakness. But the Fed should require banks to beef up their reserves against potential losses by halting dividend payments, he said.

“You have to ensure that banks have enough capital on the balance sheet that you can afford to let these firms go bankrupt,” Acharya said. “It’s not about what’s happening right now. It’s whether you have created resilience in the financial sector to deal with what is a plausibly weak outlook.”

At Oasis Petroleum, meanwhile, executives hope to ride out the recession. With oil prices down 40 percent, the company has halted drilling, cut capital expenditures in half and slowed output in a desperate bid to conserve cash, executives said last month on an earnings call.

But one way or another, its zombie days might be drawing to a close. In April, the energy company’s lenders cut its available credit line from $1.3 billion to $625 million with a further reduction to $600 million scheduled next month.

In its latest earnings filing, Oasis Petroleum formally acknowledged “substantial doubt” about its ability to survive and said as soon as this fall it will be unable to comply with the terms of its credit line.

If it can’t meet those terms, Oasis would be forced to default on its debt or to engage in a fire sale of assets to pay off what it owes.

Coronavirus: What you need to know

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New covid variant: The XBB.1.5 variant is a highly transmissible descendant of omicron that is now estimated to cause about half of new infections in the country. We answered some frequently asked questions about the bivalent booster shots.

Guidance: CDC guidelines have been confusing — if you get covid, here’s how to tell when you’re no longer contagious. We’ve also created a guide to help you decide when to keep wearing face coverings.

Where do things stand? See the latest coronavirus numbers in the U.S. and across the world. In the U.S., pandemic trends have shifted and now White people are more likely to die from covid than Black people. Nearly nine out of 10 covid deaths are people over the age 65.

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