Earnings Growth Contributes to Stable Health Care Outlook

Stable fundamental business conditions for the next year-and-a-half are expected for global pharmaceuticals, U.S. medical products and devices, and U.S. for-profit hospitals, Moody’s Investors Service said in a new report. The ratings agency expects EBITDA (earnings before interest, taxes, depreciation and amortization) growth for each sector.

"Global demand for health care products and services will continue to rise," said Moody's Senior Vice President Michael Levesque; “however, rising health care spending creates budgetary pressures, driving ongoing cost-containment efforts. Payers will increasingly focus on cost effectiveness and value, and employers and insurers will place greater cost sharing on patients."

New product launches should drive incremental growth in the global pharmaceutical sector. Branded pharmaceutical prices are expected to rise at a slower pace in the United States, while the agency forecasts single-digit price declines in Europe and Japan.

Earnings growth from 2.5% to 3% in the U.S. for-profit hospital sector lead to Moody’s stable outlook, though high deductibles and copayments will increase the collection burden for health care providers. Rising bad debt expenses will weigh on EBITDA margins.

"Rising costs, including higher wages and pharmaceutical prices, will limit ability to improve margins given the slow pace of revenue growth," said Moody's Senior Vice President Dean Diaz.

Moody’s stable outlook for U.S. medical products and devices, with an estimated EBITDA increase from 3% to 3.5%, reflects solid growth from the release of new products, particularly in cardiology and orthopedics. Medical device manufacturers, however, may experience increasing pricing pressure with the shift toward value-based reimbursement for health care providers, Moody’s said.

– Adam Fusco, editorial associate

Supreme Court Hears Bankruptcy Case That Could Impact Structured Settlements

WASHINGTON—The U.S. Supreme Court heard oral arguments Wednesday on a case vital to the interests of trade creditors in bankruptcy cases, the ultimate ruling for which could potentially have wide-ranging effects on the rules governing litigation settlements in commercial bankruptcies.

The case, Casimir Czyzewski, et al. v. Jevic Holding Corp., et al., addresses the question of whether a bankruptcy court can authorize a distribution of settlement proceeds that violates the priority scheme in the Bankruptcy Code, despite the objection of priority creditors whose rights are impaired by the proposed distribution.

If the Court rules against the Third Circuit Court of Appeals and the United States Bankruptcy Court for the District of Delaware’s affirmation of a structured settlement in the case, it could be detrimental to unsecured creditors or those suppliers or vendors with 503(b)(9) claims, said Bruce Nathan, Esq., of Lowenstein, Sandler LLP of New York. A ruling to uphold the lower courts’ decisions would at least afford unsecured creditors in administratively insolvent cases the ability to hold on to some form of payment.

Czyzewski’s side argued that Congress made categorical judgments about the priority of distribution of estate assets to unsecured creditors in all bankruptcy cases. “No provision of the Code permits a court to circumvent those judgments via settlement, ‘structured dismissal,’ or any other mechanism outside a confirmed plan,” they said.

Jevic’s side argued that there’s nothing in the Bankruptcy Code that subjects settlements (as opposed to reorganization plans) to the absolute priority rule and that the circuit court conflict in the case is “illusory.” “There is not a single reported decision from any circuit holding that any provision of the Bankruptcy Code extends the absolute priority rule to settlements,” Jevic’s attorneys argued in briefs to the Supreme Court.

– Nicholas Stern, editorial associate

For more of NACM staff’s onsite coverage from Supreme Court arguments in the Czyzewski v. Jevic case, read this week’s edition of NACM eNews (available late Thursday afternoon by clicking here).

Outlook for North American Corporates Stable

The outlook for North American corporates in 2017 is stable, according to Moody’s Investors Service in a new report on the sector. Factors reflected in the ratings agency’s forecast include modest economic growth and downside risk, as well as ample system liquidity and accessible financial markets.

“Our stable outlook for North American corporates next year reflects an overall accommodative credit environment, with an easing corporate default rate,” Senior Vice President Bill Wolfe said. “But it also belies uncertainties and risks, with credit conditions influenced by a constantly adjusting global economic environment.”

Caution is still warranted, since negative momentum has been in place since mid-2011. Increasing uncertainty is likely to weaken credit conditions in North America next year. Factors influencing prices and terms include event-related risks amid G-20 countries in connection to uncertain policies, low and uneven economic growth in Europe, and an ongoing slowdown in China. The flow of credit, however, is expected to be supported by robust systemic liquidity and positive global growth.

Moody’s industry outlooks are mainly stable, with negative signals contained, though positive indicators are dependent on consumers and therefore fragile. The agency forecasts that U.S. GDP will grow 2.2% in 2017 and 2.1% the following year.

An atmosphere of expansionist monetary policies amid ample liquidity, though low-risk assets are scarce, is a factor in the availability of credit. Confidence and a stronger credit supply will depend on positive economic news, Moody’s said.

– Adam Fusco, editorial associate

China’s Banking Outlook Negative for 2017 with Slower Economic Growth Forecasted

The outlook for China’s banking system is negative for the next 12 to 18 months, as rated by Moody’s Investors Service, thanks to slower economic growth, increased corporate sector restructuring and elevated asset prices.

"Our baseline scenario assumes a further moderation in real GDP growth to 6.3% in 2017 from 6.7% in the first three quarters of 2016,” said Christine Kuo, a Moody's senior vice president. “In view of weaker demand for corporate loans and the Chinese authorities' stance to pursue corporate deleveraging, we expect credit growth to moderate as well."

"At the same time, we expect government support to remain strong for the major banks, reflecting the policy imperative of maintaining public confidence and systemic stability,” said Yulia Wan, a Moody's assistant vice president and analyst. “And, while we think that government support for smaller banks will become more selective following the implementation of the deposit insurance scheme, it will remain high for the larger regional banks."

The ratings agency also anticipates Chinese authorities will increase their efforts to slow the nation’s increasing level of corporate leverage over the next year and a half, which in turn could increase corporate default risk and loan restructurings in the near term.

Meanwhile, debt restructuring for distressed borrowers is likely to result in economic losses for creditors of various asset classes, including banks, Moody’s analysts said.

As liquidity conditions are likely to remain stable thanks to a supportive central bank, “we see limited room for further policy easing, given the policy focus shift towards deleveraging, containing risks from capital outflows, the steep rise in property prices and gradual increase in inflation,” analysts said. This situation could bring added risk to small- and mid-size banks that have grown reliant on wholesale funding to support longer-duration investments.

“Furthermore, profitability will be pressured as moderating economic growth, the adoption of a more conservative growth strategy by the major banks and the broad shift towards deleveraging constrain the banks' income prospects from lending,” Moody’s said. “Net interest income still accounted for around 70% of total revenue in the first three quarters of 2016.”

– Nicholas Stern, editorial associate

Corporate Liquidity Improves for the Seventh Consecutive Month in November

For the seventh month in a row Moody’s Liquidity-Stress Index (LSI) fell in November, indicating that corporate liquidity has improved. Yet while modest economic gains have served to reduce corporate liquidity difficulties, the majority of the index’s improvement has successful refinancing in a low-yield environment and default-related ratings withdrawals to thank.

The LSI, which rises when corporate liquidity weakens and falls when it strengthens, dropped to 6% in November from 6.6% in October, according to Senior Vice President John Puchalla. “Notably, the index's shift to its lowest level since September 2015 marks a significant retreat from the most recent peak of 10.3% in March 2016, and points to moderating default risk," he said.

The ratings firm’s forecast for the one-year U.S. spec-grade default rate is for it to fall even more next year to 4.1% by October 2017, Moody’s said.

Further, speculative-grade liquidity (SGL) ratings for 10 companies decreased in November, marking the end to a five-month trend that saw upgrades leading to downgrades, analysts said. “The impetus for the downgrades during the month—all by one notch—reflected a variety of reasons, including earnings pressure and maturities,” Puchalla said. The downgraded companies included firms from the health care, communications and manufacturing sectors.

– Nicholas Stern, associate editor

Market Rebalancing on the Horizon with OPEC Agreement

For the first time in nearly eight years, OPEC has agreed to cut oil production. This move, along with the potential of non-OPEC countries joining in the cut, should accelerate market rebalancing and increase the chances of a rapid oil price recovery, according to Fitch Ratings.

Implementation risks remain, however. OPEC’s adherence to the agreement may be in question, as well as the full cooperation of other participants, particularly Russia. Russia has already stated that it is prepared to cut production by up to 300 thousand barrels of oil per day (mbpd). OPEC has said that non-OPEC entities have agreed to cut by 600 mbpd. Combined with OPEC’s agreement to cut production by 1.2 million barrels per day, the total reduction would account for nearly 2% of global output.

Market oversupply could end just from OPEC’s commitment, with an expected decrease in OECD oil stocks throughout 2017. Fitch Ratings estimates that crude consumption may exceed production by 400 mbpd in the first quarter of next year, increasing to 1,300 mbpd by the fourth quarter of 2017 if the deal is extended past its initial six-month term. Without the deal, oil stocks would remain flat, which Fitch estimates are 300 million barrels above their five-year average.

There is no guarantee that OPEC members will agree to extend the deal. Another risk is that OPEC members will produce above their quotas. Unknown is how quickly the U.S. short-cycle crude production will react to higher oil prices.

Fitch has not changed its view on the long-term price of oil, for which its latest full-cycle cost estimate is $65 (USD).

– Adam Fusco, editorial associate

Look for More Defaults, Consolidations in Shipping Sector Next Year

Fitch Ratings is holding on to its negative outlook for the world’s shipping sector in 2017, due to subdued demand growth that is likely to worsen overcapacity, apply pressure on freight rates, and push more consolidations and defaults.

Tanker shipping will experience slightly less stress than dry bulk and container shipping, said Angelina Valavina, senior director of corporates, and Simon Kennedy, senior analyst at the ratings firm.

A lot of container shipping and tanker shipping firms had enough cash for short-term maturities at their most recent reporting date, but are reliant on uninterrupted access to bank funding to cover negative free cash flow, the analysts said.

“Therefore, the filing for receivership in August by Korea-based Hanjin Shipping, the seventh-largest container shipping company in the world, may have far-reaching ramifications,” Valavina and Kennedy said. “In particular, creditors' withdrawal of support may indicate a reassessment of the financing landscape, where secured bank funding for new vessels has remained relatively accessible even as market conditions have deteriorated.”

Fitch expects to see more mergers and acquisitions activity and defaults in the short- and medium-term, which will “…only restore equilibrium and boost freight rates if they prompt capacity reduction,” the ratings firm said. In the container shipping segment, Fitch foresees consolidation to affect companies in the entire sector, “…with smaller operators focusing on survival through increasing scale while market leaders such as Maersk Line defend their market position through M&A.”

Look for likely defaults among companies with weak liquidity and limited access to bank funding, Fitch said.

– Nicholas Stern, editorial associate

NACM’s Credit Managers’ Index Expands, but Data Shows Mixed Signals

The latest NACM Credit Managers’ Index (CMI) for November is mostly on track with prior months' readings, with post-election jitters sending some mixed signals of enthusiasm in some sectors and trepidation in others. Overall, the CMI score is slightly down at 52.9 from October’s reading of 53.5, but still remains in expansion territory (readings over 50).

“The data from the CMI this month reflects this shifting attitude, but there is an additional caveat to be aware of,” noted NACM Economist Chris Kuehl, Ph.D. “The response to the survey was less robust than it has been in past months. This creates some concern that readings might be skewed as compared with where they have been and might be in future months.”

An interesting dynamic to this month’s reading is found in comparing the favorable factors with the unfavorable ones, where overall favorable factors expanded beyond September’s highs, while unfavorable factors caused the most worry as they dipped below expansion territory to the lowest level so far this year, he said.

The approaching holidays have affected the retail sector as consumers have been active but targeting discounted items that bring in lower profits, Kuehl said. The manufacturing sector has been cautious as companies girded for major changes to the industry in the run-up to the election, no matter who won. The service sector stayed mostly consistent with previous months’ readings as sales increased, new credit applications fell and dollar collections improved. “The sense is that credit requests tend to flag a little this time of year as retailers have already done most of their ordering,” Kuehl explained. “Now, they will be more likely to spend to catch up with the credit they already have.”

Data for rejections of credit applications reflected a drop below the expansion level, while the dollar amount beyond terms category fell off and the accounts placed for collections category declined slightly, he said.

– Nicholas Stern, editorial associate

Developing Economies Unlikely to See Prior Growth with More Capital Spending, Trade

Developing economies and the businesses operating within them, particularly those in industrial production and exports, will likely face in the foreseeable future an uphill battle to realize the growth rates they enjoyed in past decades, Wells Fargo predicts. That will be the case even if robust capital spending reignited trade on a global level, the bank’s analysts said in a new report.

Global trade volumes, along with industrial production, have been mostly flat on a year-over-year basis in the June through August period, but developing economies appear to have been more negatively affected during the current economic cycle, noted Jay Bryson, global economist, and E. Harry Pershing, economic analyst, both with Wells Fargo. This trend follows a previous decade that saw developing economies benefitting at the expense of advanced economies, in part, as companies off-shored their production facilities. Between 2011 and 2015, however, industrial production in the developing world was cut in half relative to prior years, while export volumes have slowed.

The banks’ analysts believe that developing nations are more dependent on foreign trade than advanced-economy nations, which would most likely benefit more from any acceleration in global capital spending that may appear on the horizon. “Specifically, spending in the rest of the world on capital goods accounts for 2.8% of value added in advanced economies, whereas the comparable ration in developing countries is 2.2%,” Bryson and Pershing said.

Likewise, international trade in raw materials and intermediate inputs is particularly important for developing nations; 9.2% of the value added that is generated in developing economies is accounted for by final domestic demand in foreign economies, compared to 4% in advanced economies, the Wells analysts said. “In short, it appears that the developing world is more dependent on the secular forces of globalization and its positive effect on global trade volumes than are advanced economies,” they said.

– Nicholas Stern, editorial associate

Illinois Appellate Court Affirms Decision to Dismiss Mechanic’s Lien Claim

A recent decision by the Appellate Court of Illinois, Second Judicial District, is likely bad news for suppliers and subcontractors in the state, as it may erode the mechanic’s lien act protections for work on commercial projects that involves property improvement subject to an easement and title retention agreement.

The ruling was a surprise to Connie Baker, CBA, director of operations for NACM’s Secured Transactions Services (STS). “It will add another layer of research for credit professionals to look over easement agreements and to know when something could be considered removable and, therefore, non-lienable,” she said.

The American Subcontractors Association’s (ASA) Subcontractors Legal Defense Fund filed a “friend of the court” brief in support of the unpaid subcontractor in this case. Eric Travers, a partner with the Columbus, OH, law firm of Kegler, Brown, Hill and Ritter, ASA’s general counsel, described the appellate court’s decision as “discouraging” and “at odds with the public policy of the Illinois Mechanic’s Lien Act,” noting that the rationale used by the court could “deprive untold numbers of subcontractors and suppliers on future projects of mechanic’s lien rights the Illinois legislature granted.”

The appellate court affirmed on Aug. 9 a summary dismissal of subcontractor’s mechanic’s lien claim in AUI Construction Group, LLC, vs. Louis J. Vaessen, et al. (For more details from NACM’s Secured Transaction Services on the case, click here.) According to court documents, AUI Construction Group entered into a cost-plus agreement with Postensa Wind Structures U.S., LLC, to build a 500-foot-tall wind power plant in 2011. A memorandum of the wind park easement agreement between the project owners and developers was recorded on Dec. 22, 2011.

After completing the work in mid-2012, AUI ultimately billed Postensa for more than $3 million. In late 2013, after Postensa filed for bankruptcy, an arbitrator awarded AUI $3.5 million, including attorney’s fees. In 2014, AUI filed a foreclosure complaint on a mechanic’s lien against the project’s owner, the estate of Louis and Carol Vaessen, asserting the estate’s property should be sold at public auction to satisfy its lien.

Earlier in the year, an Illinois circuit court summarily dismissed AUI’s lien claim, holding AUI’s 500-foot-tall wind power plant was removable, was not an improvement to real property under the state’s mechanic’s lien act and was a non-lienable trade fixture.

“As the intent of the parties is the most important factor in determining whether an item is a removable trade fixture or a permanent improvement, the easement agreement establishes that the tower was a trade fixture,” the appellate court said in its ruling.

– Nicholas Stern, editorial associate