A “zombie” company is a business that is unable to generate enough earnings to support its interest expenses. In 2021, under the Federal Reserve’s definition of zombie companies, about 9% of publicly listed entities were estimated to fit into this category. However, when strictly using an interest coverage ratio of less than one, we found that about 40% of publicly listed U.S. companies are zombies.
The proliferation of zombie companies started with low interest rates, and as the Fed hikes rates, we are already beginning to see the highest-risk companies falter. It is a global problem, as well, with 31% of the roughly 30,000 non-financial domestic and foreign public companies fitting into zombie status.
A Global Economic Depression
Low interest rate regimes by central banks have led public companies to borrow more than ever and consequently, 31% of all companies now have an interest coverage ratio of less than one, defined by calculating TTM EBIT relative to interest expenses. As zombie corporations struggle to service their debt, many will compete on the prices of their products and services to sustain revenue over cash flow breakeven. Corporations facing off with zombie firms will then suffer, as they will compete to meet the lowered prices of zombies. This dynamic is especially problematic today as nonfinancial corporate debt in absolute terms and relative to global GDP is the highest in recorded history.
Credit, supply chain, and other risk professionals must evaluate the financial risk of public corporations, not private companies because they are the largest borrowers. Figure 3 of the Federal Reserve’s research shows that the frequency of zombies is 2-3x more likely to occur in public companies than in private companies. Public companies borrow more than private companies do as they have audited financials and stock market capitalizations that offer an equity cushion to support the raising of debt capital. However, an economic downturn would eliminate that lever for many public companies if their shares start to trade below book value. According to CreditRiskMonitor CEO, Jerry Flum, the next economic downturn will deliver substantial pain to counterparties of highly leveraged public companies:
“The next financial hurricane in terms of dollars lost will be at public corporations, not private ones, which will surely go out of business -- but they will owe much, much fewer dollars than the public ones."
Now that inflation has become entrenched in the global economy, central banks are collectively raising interest rates to battle said inflation. Central banks, however, have been reluctant to raise rates because of the concern over triggering an economic depression. Historically, the Federal Reserve has not been so nervous about one- or two-point rate hikes, but from the current historically low levels, even small absolute rate changes will be massive given the size of corporate debt balances.
At the end of 2021, the Federal Reserve estimates that total U.S. nonfinancial corporate loans totaled approximately $7.66 trillion, most of which have variable rate coupons. Bonds add another $6.65 trillion. That is a total of $14.3 trillion in debt! In terms of near-term maturities, more than $1 trillion in bonds, loans, and credit facilities will refinance at higher rates over the course of 2022 and 2023. With so many public companies on proverbial life support, higher interest rates would effectively lead to a massive wave of bankruptcy filings and an economic recession, if not an outright depression.
Evaluating Zombie Companies
We analyzed over 30,000 public companies globally with different financial statement ratios to gauge stability. Similar to the U.S., the share of zombie corporations is equally worrisome where 31% have an interest coverage ratio (ICR) under one and about 34% have an ICR under 1.5x. In the chart below, we found the following statistics:
| Zombie Analysis | % of All Companies |
| Interest Coverage <1 | 30.96% |
| Interest Coverage <1.5 | 34.03% |
| Short-term Debt >50% | 39.98% |
| Short-term Debt >25% | 58.90% |
| Working Capital Deficit* | 17.61% |
| High Debt to Tangible Net Worth** | 28.29% |
*Working capital deficit is defined as total current liabilities being greater than total current assets, which can be indicative of liquidity problems.
**High debt to tangible net worth is defined by a factor greater than one.
The CreditRiskMonitor FRISK® score funnels the riskiest zombie companies into scores of "5" or below, on the "1" (highest risk)-to-"10" (lowest risk) score, which we call the "red zone”, indicating above-average bankruptcy risk relative to the public company long-term average. In the table below, 22.9% of all accounts payable globally sourced from red zone companies. In an economic downturn, some FRISK® scores in the blue zone would fall into the red zone, which would increase the total share of high-risk accounts payable to as much as 36.9% and 52.4% if FRISK® scores of “6” and “7,” respectively, dropped into the red zone.
| FRISK® score | Accounts Payable $* | % of Total | Short Term Debt/Total | Median TTM ICR |
| 10 | $952,444,339 | 17.60% | 40% | 53.5 |
| 9 | $1,292,776,111 | 23.90% | 30% | 17.7 |
| 8 | $336,493,396 | 6.20% | 31% | 9.4 |
| 7 | $831,914,498 | 15.40% | 40% | 6.0 |
| 6 | $754,742,751 | 14.00% | 43% | 2.7 |
| 5 | $623,050,178 | 11.50% | 40% | 0.8 |
| 4 | $273,379,550 | 5.10% | 40% | -0.5 |
| 3 | $219,107,597 | 4.10% | 42% | -1.4 |
| 2 | $106,963,249 | 2.00% | 47% | -3.0 |
| 1 | $16,499,525 | 0.30% | 31% | -2.9 |
| Total | $5,407,371,193 | 100.00% | 49% | 4.2 |
*All accounts payable figures were converted into US dollars ($) and are measured in thousands.
The median high-risk company has an interest coverage ratio beneath one, and in the event of a downturn, many such companies would default and file bankruptcy. It is also important to recognize the second and third orders' effects of bankruptcy. Many of these high-risk companies are customers and suppliers of other companies, so bankruptcies will likely have a domino effect. Some zombies represent a high proportion of cash flow for certain counterparties and their troubles could easily trigger additional defaults and bankruptcies.
In short, risk professionals must stay ahead of the next bankruptcy wave for several reasons:
- Nonfinancial corporate debt is the highest in recorded history
- 31% of all public companies have become zombies
- Higher interest rates are pressuring zombie firms
- Zombies will compete on price to retain market share, impacting other companies
- A downturn would affect at least 22.9%, and perhaps up to 50%, of accounts payable worldwide
Bottom Line
The media and financial institutions, including the Federal Reserve, underreport the proliferation of zombie firms, a frightening reality you must not ignore. Risk professionals have two choices: either continue business as usual or proactively identify zombie counterparties. With the swelling risk of another global recession, companies must reduce risk exposure to minimize future dollars lost. Professionals can begin with the daily-updated FRISK® score and ensure they are doing business with financially healthy counterparties. Contact CreditRiskMonitor to learn how you can use the FRISK® score and other CreditRiskMonitor report features to protect your company from bankruptcy-prone zombies.