Via Wolf Street

“Zombie firms,” kept alive by low interest rates, account for up to 14% of UK companies.  

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

The number of companies in the UK going into administration — which is when a licensed insolvency “administrator” is appointed to manage a company’s affairs, business, and property for the benefit of the creditors — jumped by 21.8% in Q1 2019 to 451, the highest quarterly level in five years (although the number of administrations is still much lower than during and after the Financial Crisis).

In Q1, the number of small businesses going into liquidation rose 5.1% compared to the same period a year ago, to 4,187. Liquidations also rose  6.3% from the fourth quarter of 2018, according to The UK Insolvency Service.

“Both the total number of new company insolvencies as well as underlying total insolvencies have reached their highest levels since 2014,” said Mike Cherry, chairman of the Federation for Small Businesses. “These latest figures show the immense strain that small businesses are currently under with rising employment costs and unfair business rates as well as significant uncertainty as a result of the Brexit process.”

The number of companies classed as being in “critical distress,” often a precursor to insolvency, surged 17% in the first quarter from a year earlier, to 484,000 mostly small and medium-sized businesses, according to data compiled by financial adviser Begbies Traynor Group Plc. These businesses in “critical distress” now account for about 14% of all active businesses in the UK.

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“Many U.K. businesses are currently in limbo and deferring major investment decisions,” Julie Palmer, a partner at Begbies Traynor, said in the report. “This, combined with consumers holding back on big ticket purchases, has resulted in increasing significant distress across many sectors.”

This number chimes with the findings of a new report by Big Four accountancy firm KPMG that warns that as many as 14% of all UK companies could be classified as “zombie firms”, whose symptoms include static or falling turnover, persistently low profitability, squeezed margins, limited cash, high leverage levels, and a chronic inability to invest for the future.

The highest concentration of zombie companies is in the energy sector, where 23% are under sustained financial strain, the automotive sector, with 17%, and in utilities, with 15%.

Growing ranks of struggling firms that are being kept alive by persistently low interest rates have created a drag on UK productivity, which continues to under perform compared to other G7 economies, KPMG said. Productivity is around 20% lower than what it would have been if it had continued at pre-financial crisis levels, according to the Office for Budget Responsibility (OBR).

In terms of small-business insolvencies, construction, administration, and retail were the sectors hardest hit. The construction sector, which is notoriously beset with late payments, has the highest level of insolvencies, up 0.6% in 2018.

Late payment of suppliers and subcontractors is a widespread problem in the UK. Perversely, the worst offenders are often large companies that claim to comply with official payment codes. For instance, Carillion, the outsourcing behemoth that went bankrupt in January 2018, taking hundreds of suppliers with it, was fully signed up to the government’s prompt payment code, despite the fact it was making suppliers wait 120 days or more to get paid.

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In April five large companies — BHP Billiton, DHL, GKN Plc, John Sisk & Son and tea maker Twining — were removed from the government’s Prompt Payment Code (PPC) for failing to honor a pledge to pay 95% of all supplier invoices within 60 days. Another 12 (Balfour Beatty, Costain, Engie Services, Interserve Construction, Kellogg Brown & Root, Laing O’Rourke, Persimmon Homes, Atos IT Services, British Sugar UK, Rolls-Royce, SSE and Vodafone) were suspended, rather than expelled, because they promised to change their late payment practices.

The government has threatened to punish companies that fail to comply with the PPC by preventing them from bidding for government contracts. Whether it actually follows through on the threat is yet to be seen.

There are also signs that the recent slowdown in the UK’s manufacturing sector may be spreading to the country’s all-important services sector, Palmer at Begbies Traynor says. In other words, if the British government and parliament don’t get their act together in the next few months and find a way of reaching some degree of consensus on Brexit, the U.K. may face a broader economic slowdown.

The EU’s decision, largely at Westminster’s behest, to extend the Brexit deadline until Oct. 31, rather than providing much-needed clarity, has produced yet more confusion and uncertainty. “The politics of Brexit have become more protracted and, as a result, the side-effects of Brexit on the UK economy have intensified,” arch-remainer Goldman Sachs said in a note to clients last week titled ‘Brexit — Withdrawal Symptoms’.

Right now, small businesses need all the help they can get as Brexit uncertainty and other problems take their toll on business and consumer confidence. But instead of that, a whole new problem could be about to emerge if the government carries through on plans to move tax debts up the pecking order for recoveries when companies go bust, above debts owed to suppliers, consumers, pension schemes and employees, as well as common types of lending debts. As insolvency practitioners are warning, that could have the effect of restricting lending to small companies. And that is the last thing the UK’s struggling small businesses need right now. By Don Quijones.

February was bad for London’s housing market. And the weakness is now spreading out from London. Read…  London Home Prices Had Biggest Monthly Drop Since Lehman

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