Banks’ taste for ‘zombie’ companies feeds overcapacity

Last updated: May 3, 2013 12:06 am

Banks’ taste for ‘zombie’ companies feeds overcapacity

By Louise Lucas

Banks are slimming down, but they still have a hand in the cookie jar – literally, in the case of Canadian Imperial Bank of Commerce.

CIBC is part owner of Burton’s Biscuits, maker of Jammie Dodgers. Barclays, better known for paying jaw-busting bonuses, owns a slice of Soreen’s fruity malt bread, while JPMorgan Chase houses fish fingers alongside the London Whale.

Critics charge that these incongruous larders explain why Schumpeterian creative destruction has failed to curb overcapacity in Britain’s £75bn-turnover food and drink industry.

By seizing control of companies through debt-for-equity swaps, as Barclays did with Soreen manufacturer McCambridge in 2008, or rolling over loans to companies barely able to service their debts, critics say banks are supporting “zombie companies”. The continued existence of such companies allows retailers to pummel suppliers’ margins, critics charge.However, for the owners, “haircuts are better than decapitation,” says one veteran food industry executive with a shrug. These deals, he adds, allow private equity firms to protect their reputations, even if it comes at a cost.

Take Findus, owner of the Young’s seafood brand. Private equity firm Lion Capital bought the frozen fish finger maker for £1.1bn in 2008, just before credit markets evaporated and food inflation spiked. It breached banking covenants and – following a tussle for control with Triton Capital – refinanced with a debt-for-equity swap that reduced its holding to one-third and handed half the company to Highbridge Capital and JPMorgan Chase.

But these deals are not very sweet for rivals, such as cake-maker Finsbury Food Group, itself once highly leveraged and now again on the acquisition trail.

“In previous recessions banks allowed companies to go to the wall when they got into trouble,” says John Duffy, Finsbury Food’s chief executive. Now, banks are stepping in when “the best thing that could have happened is to close them down”.

However, closure is often not best for the banks, since the plants are generally cash-generative, says Will Hayller, partner at consultants OC&C. “So although capital has been spent to build capacity that won’t generate a return on the initial investment, that capital cost is sunk and they’d rather capture whatever cash a factory can generate as long as it is covering its operating costs.”

With margins compressed by elevated input costs and top-line growth dented by austerity, “the model is not bust, but a lot of these companies are only just paying interest and not paying down core debt,” an industry executive adds. “So the banks are saying: ‘What do we do? Let’s think of it as an option on the future and just roll over their debt’.”

Some argue that this was the predicament the 28 lenders to Premier Foods found themselves in when the then-biggest food producer in the UK was on the verge of breaching covenants in 2011.

The banks agreed fresh terms despite Premier’s growing debts, bloated pension deficit and minimal equity value. They were won over in part by the company’s planned asset disposals and strategy, penned by the then-new chief executive Mike Clarke, who quit 18 months later. They were also undeterred by the fact that by far the lion’s share of earnings was gobbled up by servicing debts and liabilities.

Indiscriminate debt rollovers proved irrational for the Japanese banks, which wrote the textbook on lending to “zombie companies” after the country’s economic bubble burst at the start of the 1990s and subsequently required a Y12.8tr government bailout.

While British food manufacturers are on an altogether more modest scale than Japan’s banks, chill winds are starting to whip through their factories too. Lending to the sector has fallen 37 per cent to £5.5bn from September 2007 to end-2012, according to Bank of England data. This is a bigger fall than most sectors, and in sharp contrast to the 42 per cent increase to machinery and transport manufacturing.

Some food executives also warn that the Basel III regulations, which are being phased in over the next five years, will recalibrate banks’ appetite for dicier loans.

By increasing the capital that has to be set aside against loans, “it is going to make debt a lot more expensive for SMEs,” says Kenneth Gray, consultant at Norton Rose, the legal firm.

“Given the huge amounts of extra capital some banks have to raise to maintain their current loan portfolios, their options are to do no more new business or to sell down some of their existing portfolios.”

That may still do little to erase capacity. Closing factories is an expensive business, says Robert Lawson, co-founder of Food Strategy Associates. “It’s capital intensive and time intensive and the track record inconclusive.” He estimates it could cost £30m to shutter a factory for £10m a year of savings.

Besides, there are always other financiers waiting in the wings. Barclays managed to sell McCambridge’s private label cake division last December – albeit for £23.5m, a few crumbs of what Britain’s self-styled biggest maker of fairy cakes was once worth.

The buyer? Private equity firm NBGI, the bulk of whose equity comes from National Bank of Greece.