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Italian clothing maker and retailer Stefanel SpA became famous for its knitted coats and cardigans. Many economists, investors and bankers know Stefanel as something starkly different: a zombie company. It has posted an annual loss for nine of the last 10 years and restructured its bank debt at least six times, including several grace periods when Stefanel only had to pay interest on what it owed.
After booming during Italy’s post-World War II expansion, Stefanel and its lumbering factories were overwhelmed by Spanish fast-fashion giant Zara and then battered by the economic slowdown that hit Italy in 2008.
Stefanel is still alive but staggering. So are hundreds of other chronically unprofitable, highly indebted companies being kept afloat with new infusions from lenders and shareholders, especially in Southern Europe.
The zombification of the corporate sector and banks is a risk for future living standards
Economists and central bankers say zombies undercut prices charged by healthier competitors, create artificial barriers to entry and prevent the flushing out of weak companies and bad loans that typically happens after downturns.
Now that the European economy is in growth mode, those zombies and their related debt problems could become a drag on the entire continent.
“The zombification of the corporate sector and banks [is] a risk for future living standards,” Klaas Knot, a European Central Bank governor and the head of the Dutch central bank, said in an interview.
The Bank for International Settlements, the Basel-based central bank for central banks, defines a zombie as any firm which is at least 10 years old, publicly traded and has interest expenses that exceed the company’s earnings before interest and taxes. Other organizations use different criteria.
About 10% of the companies in six eurozone countries, including France, Germany, Italy and Spain are zombies, according to the central bank’s latest data. The percentage is up sharply from 5.5% in 2007.
In Italy and Spain, the percentage of zombie companies has tripled since 2007, the Organization for Economic Cooperation and Development estimated in January. Italy’s zombies employed about 10% of all workers and gobbled up nearly 20% of all the capital invested in 2013, the latest year for which figures are available.
In some ways, zombie firms are an unintended side effect of years of easy money from the ECB, which rolled out aggressive stimulus policies, including negative interest rates, to support lending and growth. Those policies have been sharply criticized in some richer eurozone countries for making it easier for banks to keep struggling corporate borrowers alive.
It also ties up bank capital that could have been funneled elsewhere, including nearly €10 billion ($11.65 billion) in Italy and Spain from 2008 to 2013, according to the OECD. The misallocation of capital in those two countries “is higher today than at any point in time before the crisis,” ECB executive board member Benoît Coeuré said in June.
The ECB said in late October it would extend its giant bond-buying program through next September, likely pushing back the date of any interest-rate increase until at least 2019.
A small group of central-bank officials opposed the decision, including Jens Weidmann, president of Germany’s Bundesbank.
In a speech in September, Mr. Weidmann cited an academic study that concluded a bond-buying program by the ECB in 2012 had helped stabilize banks in southern Europe and boost lending but resulted in more loans to weak companies by the same banks. There was no positive impact on employment or investment, the study found.
“Some of these zombie companies are getting financed at [interest rates of] 2% because banks are trying to throw good money after bad,” said Basil Karatzas, a shipping-industry consultant in New York. The shipping industry has been pummeled by an oversupply of ships funded with cheap debt.
Economists say zombie firms are partly to blame for Europe’s productivity decline in recent years. Cement production in Italy peaked at 47 million tons in 2007 and has since fallen about 60%.
Yet there were 24 cement producers in Italy at the end of last year, down from 29 in 2007, according to the Italian Cement Association trade group.
Many Italian cement companies are limping along with help from “financial doping,” said Francesco Caltagirone Jr. , chief executive of Cementir Holding SpA, one of the country’s largest cement makers.
German shipping company Norddeutsche Vermoegen Holding GmbH & Co. KG suffered total losses of $1.1 billion from 2010 to 2015. Its debt quadrupled to more than $2 billion, or almost nine times revenue, from 2007 to 2010. The company hasn’t reported annual results for 2016.
In 2016, Norddeutsche Vermoegen got a half-billion euros in debt relief from HSH Nordbank, a German bank that was until recently the world’s largest lender to the shipping industry.
According to the shipping company’s financial statements, Norddeutsche Vermoegen made a profit due to “loan forgiveness by the bank.” Norddeutsche Vermoegen and HSH Nordbank declined to comment.
The loss is likely to hit people who live in the German states of Hamburg and Schleswig-Holstein, which own about 90% of the HSH Nordbank. That would be “bitter for local taxpayers,” said Michael Kruse, an opposition lawmaker in Hamburg’s state parliament.
In Germany, the five biggest ship lenders had about $26 billion of distressed ship-related loans at the end of 2016, according to Moody’s. The total was equal to 37% of all shipping loans by the same banks, up from 28% in 2015. Moody’s said the banks needed to set aside more for potential loan losses. Few banks disputed that finding.
The financial crisis badly hurt global trade and shipping companies, some of which were unable to repay their loans. Yet there have been few bankruptcies by German shipping firms, said Max Johns, managing director of the German Shipowners’ Association.
That is another sign that banks are willing to keep weak companies alive. In addition, an investment structure known as Kommanditgesellschaft funds, commonly used to invest in German shipping assets, allows individual ships to go bankrupt without taking down the entire firm.
In May, the ECB said it would conduct on-site inspections at banks with exposure to ship-related lending to ensure that the banks are dealing with any nonperforming loans in that sector.
Some banks have said loan-loss reserves inherently reflect a bank’s judgment about how much the shipping industry will rebound and how much time struggling borrowers should get to recover.
If they pass new rules, credit to small businesses will be impossible
Italy’s economy has been in and out of recession for a decade. About 15% of loans and credit advances from large Italian banks are nonperforming, which means the borrower is at least 90 days behind on payments. In the eurozone, about 6% of loans are nonperforming, according to the ECB.
In the U.S., nonperforming loans peaked at 5% during the financial crisis and have since fallen below 2%, according to the World Bank.
Italian banks have set aside half of the value of their $407 billion in gross problem loans at the end of 2016, according to the country’s central bank. That means the banks would be hit with billions of euros in additional losses if they sell the loans. Many lenders would rather hold on to the shaky loans and hope for the best.
The ECB proposed last month requiring banks to set aside more cash to cover newly classified bad loans. The proposal was criticized by senior Italian officials, including former Prime Minister Matteo Renzi. “If they pass new rules, credit to small businesses will be impossible,” he wrote on Twitter.
Some banks in Italy have begun to tackle the problem, including by announcing plans to sell billions of dollars of bad loans within three years. Analysts at Morgan Stanley estimate it will take the country’s banks 10 years to reach the European average for nonperforming loans.
Banks restructured Stefanel’s debt even when the apparel maker’s financial problems worsened. The banks continued to collect interest, and some of the loans were repaid, but their decisions not to wipe the debt off their balance sheets meant the banks had less money for healthy firms.
Stefanel’s lenders included Banca Monte dei Paschi di Siena, where bad loans peaked at nearly $58 billion in 2016. The Italian government took over the bank earlier this year. The bank and Stefanel declined to comment.
As part of a new restructuring plan, two distressed-debt funds will get a 71% stake in Stefanel by year-end for about $13 million. Giuseppe Stefanel, the founder’s son and company’s largest shareholder, will wind up with a stake of about 16%, down from his previous 56%. Banks owed $125 million by Stefanel will see that decline to about $110 million.
Banks demanded that Mr. Stefanel give up control and step down as chief executive as a precondition for approving the turnaround plan, according to a person familiar with the matter. Mr. Stefanel will remain non-executive chairman and “have no control whatsoever,” the person said. Mr. Stefanel declined to comment.
The restructuring plan is a sliver of hope to residents of Ponte di Piave, the small town in northeastern Italy where Stefanel is based. “Everybody in Ponte has suffered, from the gas stations to mechanics, bars, restaurants and shops,” said Andrea Malisani, a cafe owner and former head of personnel for the company in the 1990s. “The backbone of this community’s economic and social life has been reduced to a tiny shell of itself.”
Efforts to change Europe’s insolvency laws and bankruptcy courts could eventually help flush out zombie firms, speed the resolution of banks’ nonperforming loans and put the money to better use, according to analysts. Despite attempts to establish chapter 11-style bankruptcy procedures in Europe, it lags behind the U.S. on efficiency of corporate restructuring and insolvency procedures.
Economists have warned that some recent efforts to encourage debt restructuring that would allow troubled European companies to return to health are instead contributing to the problem of too many zombies.
In Portugal, a program set up in 2012 by the government as part of the country’s bailout aimed to help heavily indebted companies reach agreements with creditors, avoid insolvency and free up money to invest and grow.
In practice, the revitalization program can discourage banks from pulling the plug on battered companies, said Antonio Samagaio, an accounting professor at ISEG-Lisbon School of Economics and Management. The reason: The program allows lenders to take fewer write-downs because debt that isn’t forgiven still is considered performing for accounting purposes.
Lisgráfica Impressão e Artes Gráficas SA, one of Portugal’s largest printers, entered the program in early 2013. Banks forgave 65% of the company’s debt and agreed to extend repayments. That helped Lisgráfica to keep most of its workers on the job.
Now, though, Lisgráfica is having trouble making its debt payments. The company’s revenue has been hurt by the advertising decline at newspaper and magazine clients. Lisgráfica’s losses are widening, and it got rid of 9% of its workforce last year.
Lisgráfica recently filed to take part in the program for troubled companies again. The company declined to comment.
Patricia Kowsmann contributed to this article.
Copyright The Wall Street Journal 2017