In the last days of the old regime – pre the 2008 credit crisis – bankers partied like rock stars. They binged without constraint and without discernment. It often seemed that all you needed to land a bank loan was a warmed-over business plan and a tie with a four-inch knot. The champagne flowed as free and fast as self-assessment mortgages.
There is a popular concern now that many of these companies have turned into "zombies".
They were never likely to succeed on their merits and now they are being kept in a kind of living death by banks which are desperate to hide the extent of their bad loans.
Instead of admitting the truth, closing the company, taking the hit and moving on, banks are pushing new loans onto these zombie companies, loans which allow the company to do no more than pay the interest on their already crushing debts.
This is bad business, certainly in the long-term, but it is also bad economics as resources are poured into hopeless causes, good money thrown after bad.
It would be far better, however embarrassing in the short-term, to euthanise the zombie companies and free up valuable capital that could be used to make loans to viable businesses and get the economy buzzing again.
The problem with assessing the depth of the problem is obvious – these transactions are purposefully hidden.
That is the whole point of them. They are meant to disguise the true level of bad loans. We can, though, do our best to piece together as much evidence as there is.
Let’s start with developed market banks – the most debauched were arguably in the UK and the US.
As investors, perhaps we should be expecting that there is still the need for a purging of balance sheets where swathes of unacknowledged bad debt still needs to be written down, with serious consequences for solvency and profitability.
In 2009, following a marriage so excruciating it made Katy Perry and Russell Brand seem idyllic, Lloyds Bank had a whopping £236bn of "non-core business", a euphemistic reference to bad loans and bad businesses. By 2012 it was down to a "mere" £98bn – a 60 per cent decline.
RBS, arguably the architects of their own ruin, have shrunk even further with an 85 per cent reduction from £258bn in 2009 to £40bn last year, a sum likely to be halved again in the next two years.
As a representative of the USA, let’s look at Citigroup. It went into the credit crunch with a CEO famously declaring, "as long as the music [of liquidity] is playing, you’ve got to get up and dance. We’re still dancing".
Citigroup had chopped its bloated non-core assets down from $650bn to $269bn by end 2011.
And it’s not just about getting rid of the dead wood – these businesses are starting to get serious about cost-cutting after years of unconstrained and unfocused expansion.
So if they’re now well on the way down the path to recovery – who’s still in rehab, who’s ready for discharge and who is still in denial?
Spanish banks are looking most like financial versions of Lindsay Lohan. The intentions seem to be good, if frequently having to be enforced by the courts, but under the surface there are still a host of unresolved issues.
With unemployment hitting 27 per cent in Spain and bad loans on a steady upward climb, the chances of another round of recapitalisation are rising – superficially Spain and Ireland’s property-driven boom and busts have a lot in common.
Ireland’s housing market fell 40 per cent while Spain’s has fallen 20 per cent to date – likewise, Irish bad loans are at 13 per cent and may peak at 16 per cent – compared with only 3.8 per cent so far acknowledged in Spain.
If Spain’s housing market gradually slides as far as Ireland’s, there could be another €24bn of capital needed – that’s nearly one and a half times the entire annual profit of the Spanish banking system.
Finally, Italian banks – in denial and with little room for manoeuvre. Bad loans are accelerating and provisions against delinquency are low by historical standards and low relative to other banking systems.
The reason is that profitability is just not high enough to allow more to be put aside. The model is already being stretched to the limit.
In the periphery of Europe is where zombie banks beget zombie companies, or worse still, where they kill off the good with the bad.
According to the Italian National Agency for New Technologies (ENEA), small- and medium-sized enterprises provide 81 per cent of employment and 72.4 per cent of added value in Italy.
These companies are wholly dependent on domestic banks for credit – and with that line of credit choked off by the slow fossilisation of the banks, business failures and unemployment rocket.
But what of the UK and the US? With the banks smaller, humbled, but better for it, are they really keeping alive zombie companies?
A useful exercise is to compare the profitability of UK and US companies in the years following the credit crisis to that of Japanese companies after the spectacular collapse of their property bubble in 1989, which is where "zombie-ism" notoriously began.
The comparison shows a surprisingly cheerful picture. UK and US company earnings and margins have improved despite the poor economic backdrop – far from being zombies, companies are reinventing themselves as super-fit survivors.
Engineering companies such as GKN went into the crisis with heavy overheads and the wrong client base.
Through a dramatic programme of self-improvement, the company has diversified its clients and restructured costs.
It has pushed up operating profits by 400 per cent since 2009, making double the cash-flow in 2011 than they had made in the previous 10 years put together. Add any pickup in global growth and that company is turbo-charged.
So US and UK companies are comfortably in various states of recovery.
Programmes like the Funding for Lending Scheme (FLS) in the UK and Home Affordable Refinance Program (HARP) in the US stop companies becoming too reclusive and make it easier for them to socialise again.
Together with impressive adaptation by businesses, there’s a future ahead.
For peripheral Europe, the picture is much darker and in some ways a little sadder. Here we see the problems of neglect.
Italy never had a spectacular boom. Nothing can be addressed in isolation, the heavily indebted sovereign cannot afford to underwrite bad loans, austerity measures crush growth, unemployment is rising and a fragmented industrial sector, mired in red tape, has few funding options.
Left unaddressed, that’s not the spectacular blow-up of Hollywood stars – it’s the environment that eventually creates the zombification of an entire country.
Christine Johnson manages the Old Mutual Corporate Bond and Old Mutual Monthly Income Bond funds. The views expressed here are her own.
