Updated: Apr 15
According to the Bank of International Settlements, 12% of all global companies and 16% of US companies are now considered "zombie firms." A moniker used to describe firms that are more than 10 years old and whose profits are lower than the interest payments on their debts, zombie firms that should have gone out of business years ago have been allowed to stay afloat due to low-interest rates and a huge appetite for leveraged loans. Another way to describe a zombie firm is a company with a less than average "q ratio" where the cost of replacing the assets of the firm is greater than its market cap.
While leveraged loans clearly have their place in benefiting the global economy, zombie companies are bad because they suck up resources, including financial resources, lower productivity and prolong the time that workers spend in jobs for companies going nowhere. Zombie firms are also indicative of weaknesses in the banking system. To avoid having to write off deteriorating firms from their balance sheets, weaker banks are incentivized to keep firms afloat putting a tremendous amount of debt at risk.
According to Janet Yellen, "I am worried about the systemic risks associated with these loans. There has been a huge deterioration in standards; covenants have been loosened in leveraged lending." Considering interest rates are on the rise, $1.6 trillion of leveraged loans will potentially have to be downgraded. This could trigger a massive sell-off.