Forecast Cloudy for 2018 U.S. Manufacturing Outlook

Month-over-month results for January’s factory output in the U.S. are causing some uncertainty among the nation’s economists regarding the manufacturing outlook for 2018.

While the Federal Reserve predicted a 0.3% gain in U.S. manufacturing growth for January over December, a recent Reuters report said overall industrial production actually fell one-tenth of a percent, which was linked to a 1% decline in mining output. A small increase in output was originally predicted by the Fed in December—an expectation that was revised to show no gain.

Production in the aerospace, plastics and food industries were among the impacted sectors last month, Reuters said.

“The industrial sector has received support over the last year from a strengthening global economy,” Reuters reported. “Capacity utilization, a measure of how fully industries are deploying their resources, fell to 77.5%.”

Gains in manufacturing output, however, have showed promising results in primary metals, computers and motor vehicles, the report explained, with a modest rise since August 2017.

—Andrew Michaels, editorial associate 

Moody’s Predicts Stable Outlook for U.S. Steel Industry

A stable outlook is predicted for the U.S. steel industry in 2018 following last year’s demand growth, which Moody’s Investors Service described as “stronger than in many years.”

According to the Institute of Supply Management’s Purchasing Managers’ Index (PMI), Moody’s reported, the average rating in 2017 was about 57.5—readings above 50 indicate expansion. In the January 2018 reading alone, the PMI nearly reached 60. Moody’s Senior Vice President Carol Cowan said in a Feb. 22 report that demand growth in the country’s steel industry should spark stronger prices as well as capacity utilization levels.

Results similar to those in 2017 are expected in 2018 over the next year, year and a half, Moody’s reported.

“We expect 2018 capacity utilization to be 70% to 75% and hot-rolled prices to average between $650 to $700 per ton,” Cowan said in the report.

Moody’s said the U.S. tax legislation might also aid steel consumers by contributing to manufacturing and capital spending investment growth.

—Andrew Michaels, editorial associate

New Bankruptcy Law Coming to Saudi Arabia

A new bankruptcy law in Saudi Arabia will help companies in need of debt restructuring. The legislation was approved earlier this month, according to Reuters. It is not known when the bankruptcy law will become effective, however. This comes just weeks after Egypt passed a new bankruptcy law.

Official details of the new plan have not been released, but the draft consisted of 231 articles in 17 chapters, noted Reuters. The news outlet also stated debt restructuring approval would take at least two-thirds of creditors signing off on the deal.

The new law was adopted in part due to the global financial crisis nearly 10 years ago that left creditors without payments. Ahmad Hamad Algosaibi and Brothers (AHAB) and Saad Group defaulted during the crisis, and creditors and banks are owed roughly $22 billion. Two-thirds of AHAB creditors have approved a debt restructuring proposal, said Reuters.

The new law will have “structural reforms to further facilitate a dynamic business environment that encourages participation—a critical variable in further developing the entrepreneurial ecosystem, investments, and so much more,” said Saudi Arabia spokesperson Fatimah S. Baeshen on Twitter.

-Michael Miller, managing editor

Leveraged Finance Issuance Reaches Record High in January

Despite the year-over-year increase in January’s leveraged finance issue in Europe, Middle East and Africa (EMEA), Moody’s Investors Service predicts the rising stock market volatility will bring numbers back down in February.

Leveraged finance issuance was recorded at a record high for the month of January, which Moody’s reported was thanks to new issuers coming into the market. The January 2018 volume reached nearly $22.5 billion, up $3 billion from the prior year. High-yield bond volume was also up $1 billion year-over-year in January.

Moody’s Associate Managing Director Peter Firth said in the Feb. 20 report that January issuers were encouraged by the stable market and willing to take on “riskier investments.”

“Issuance could slow somewhat in February as equity market volatility may spill over into leveraged finance issuance activity,” Firth explained in the report. “Transactions could be delayed or postponed and we expect the high-yield bond market to remain more susceptible compared to leveraged loans.”

Rising interest rates and tightening monetary policies in the U.S., U.K. and Europe also remain risks, Moody’s said.

—Andrew Michaels, editorial associate

Infrastructure Plan Could Be Great for Private Bonds, but Lags in Overall Funding

A recent Fitch Ratings report finds that one highlight of the Trump administration’s infrastructure proposal would be that it could expand private activity bond (PAB) usage and speed the approval process, which would be credit positive for infrastructure projects.

“However, the proposal's effects on overall infrastructure development will be small as the proposal lags the need in the U.S.,” the report concludes. “In addition, there are political risks to implementation with uncertainties including legislative support and potential opposition from states.”

Under the plan, PABs would be applicable to a wider range of infrastructure projects and would also increase the amount of PABs that could be issued by raising state volume caps, Fitch said. This expansion would offer a wider set of funding options and could enhance private investment in infrastructure, thus potentially benefiting the country’s aging infrastructure. “It is Fitch's view that the current range of funding options is too narrow.”

Environmental permitting timeframes would also be reduced by putting the agency with the most expertise in the lead and giving it a coordinating role, analysts said. Faster projects would bolster project credit, assuming legal exposures aren’t increased.

The proposal includes $200 billion in federal funding over 10 years, with $50 billion in block grants going directly to state governors for rural infrastructure, $10 billion for federal office building infrastructure and $20 billion to expand existing federal loan programs and PABs. The funding amounts are underwhelming. As an example, the Gateway Program to expand the train connection between New Jersey and New York City is a $12.9 billion project alone.

The plan also doesn’t address the ailing Highway Trust Fund, the primary source of existing federal support for infrastructure, which the Congressional Budget Office estimates will run dry in two years.
“Providing funding from state tax revenues could be challenging for some state and local governments as many have already raised revenues in recent years to fund infrastructure investments and general revenue growth has been slow,” Fitch said.

– Nicholas Stern, managing editor

Business Inventories Increased More than Anticipated in December

Economists and the U.S. Department of Commerce were pleasantly surprised by the results for business inventories at the end of last year, which Reuters reported increased “more than expected” between November and December 2017.

According to a Reuters report on Feb. 14, business inventories rose nearly half a percent, 0.1% higher than economists originally predicted. Gains in stocks at manufacturers and wholesalers were believed to have contributed to the slight bump—similar to results seen in November.

“The government estimated [in January] that inventory investment subtracted a 0.67 percentage point from GDP growth in the fourth quarter,” the report stated. “The economy grew at a 2.6% annualized growth pace in the final three months of 2017.”

Retail and manufacturing inventories as well as wholesalers rose in December; however, motor vehicle inventories fell twice as much as the prior month. Reuters said December business sales also increased, albeit, slower than in November, and it takes about 1.3 months for businesses to clear their shelves.

—Andrew Michaels, editorial associate

Crack Down on Shadow Banking in China to Impact Supply of Credit to Real Economy

The impact of stricter regulations in China is impacting its shadow banking sector, including slowing the aggregate growth of entrusted loans, trust loans and undiscounted bankers’ acceptances, according to a new Moody’s Investors Service report. Financial flows to the nation’s social financing will be reduced this year as a result.

"What started as a regulatory crackdown on some previously fast-growing shadow banking segments—such as the banks' wealth management products and nonbank financial institutions' asset management plans—has spread to other major core shadow banking components," said Michael Taylor, a Moody's managing director and chief credit officer for Asia Pacific. "The effect of intensified regulation is no longer limited to de-risking the financial sector, but is now beginning to impact the supply of credit to the real economy."

During 2017, Moody’s figures that shadow banking assets increased at a 10th of the amount of the previous year, expanding by $173 billion versus $1.77 trillion in 2016. "Shadow banking activity also declined as a percentage of GDP for the first time since 2012, falling to 79.3% at the end of 2017, compared to the peak of 86.7% at the end of 2016," said George Xu, a Moody's analyst.

Declines in the banks’ wealth management products, and nonbank financial institutions’ asset management plans—the focus of the Chinese authorities coordinated regulatory actions since the second half of 2016—drove the decline, Xu said.

More recent regulatory actions have focused on core shadow banking activities, which have been a growing source of credit supply to the real economy in 2017. "These measures will likely reduce the supply of credit to more marginal borrowers, who are most dependent on shadow finance," said Xu. "Consequently, refinancing risks are increasing for some sectors, such as property developers, local government financial vehicles, and companies from overcapacity and polluting industries."

Liquidity conditions will continue to tighten for Chinese financial institutions, especially for smaller banks and nonbank financial institutions, Moody’s said. The People’s Bank of China has thus expanded direct lending to the banks with an increasing use of medium-term liquidity facilities.

Smaller property developers and local government financing vehicles may now be turning to the offshore market for funding, the ratings agency said.

– Nicholas Stern, managing editor

Less Volatility Expected for Banking Ratings in 2018

A shift in global bank ratings at the end of last year indicates less volatility in 2018, as Fitch Ratings reports stable outlooks are at their highest mark in recent years.

According to a Fitch report on Feb. 9, the share of positive outlooks nearly doubled year-over-year, despite being outweighed by negative outlooks toward the end of 2017. Upgrades and downgrades remained around the same levels, data showed, while the share of negative outlooks became stable after rating downgrades.

Thanks to revisions, Europe is on balance positive, Fitch said; however, emerging markets in the Middle East, Africa and the Americas are balance negative.

“We changed 65 bank Issuer Default Ratings in 2H17, down from a record high of 92 in 1H17,” Fitch said. “… Upgrades were concentrated in Europe, where the economic recovery is improving banks’ operating environments, while most downgrades were in emerging markets … mostly driven by sovereign downgrades.”

Qatar experienced the most downgrades (nine) in 2H17, the report said.

—Andrew Michaels, editorial associate

Increased M&A in European Pharma to Hit Credit Metrics of Large Firms

Europe’s six-largest pharmaceutical companies will face increased credit quality risks from mergers and acquisitions this year, while any benefits to operating performance are also likely to take a hit, according to a new report by Moody’s Investors Service.

These firms include: GlaxoSmithKline, AstraZeneca, Roche Holding, Novartis and Novo Nordisk. "While the 2018 guidance from the larger European pharma companies is modestly more upbeat than for 2017, this is unlikely to translate into any major improvement in credit quality, mainly because of the impact of recent M&A transactions and the risk of possible future deals," said Knut Slatten, vice president and senior analyst at Moody's.

Moody’s cites as an example Novartis’s $3.9 billion debt-funded acquisition of Advanced Accelerator Applications, which will surpass the company’s 2018 free cash flow and is likely to dampen any recovery of its credit metrics as a result.

Sanofi’s acquisitions of Bioverativ and Ablynx for more than 13 billion euros will see its Moody’s adjusted debt/EBITDA increase to about 2.8x from 2.1x at the end of 2017, depending on how much debt is raised for the two purchases, analysts said. Also, GSK may have to pay Novartis GBP8.6 billion for their common consumer health joint venture.

European pharmaceuticals are also anticipating in 2018 regulatory decisions or important data readouts on drugs “that will be important cornerstones in driving revenue growth over the next 2-3 years,” Moody’s said. “However, this year the focus will be more on line extensions of already approved drugs rather than on approvals of new, high-profile drugs as was the case last year.”

– Nicholas Stern, managing editor

Improved Earnings Doesn’t Mean Corporate Debt is out of the Woods

Corporate debt levels will remain an issue in 2018, according to S&P Global Ratings analysts, despite corporations seeing relief in their earnings and cash flow, some of which is thanks to the recent U.S. tax bill.

In a 2018 study of 13,000 corporate issuers, analysts reported that although corporate earnings have improved and default rates are currently low, the steep corporate indebtedness brings risk of lower asset prices and liquidity reversals. The debt-to-earnings ratio improved slightly from 2016 to 2017, but was still higher than the numbers that were recorded in the past decade.

Last month’s market volatility brought about a weak U.S. dollar, the report said, and when combined with rising commodity prices and improving economic growth, a snowball effect may follow, beginning with inflation and then a repricing in risk assets and spike in higher interest rates.

“High corporate debt levels have increased the sensitivity of borrowers to elevated financing costs,” S&P Global’s Head of Analytics and Research in Asia-Pacific Terry Chan said in a Feb. 5 Barron’s article. “Removing the easy money punch bowl could trigger the next default cycle.”

However, Moody’s Investors Services reported a more positive outlook for corporations. Analyst Julia Chursin said in a report that more corporate ratings improved than companies defaulted; therefore, the default rate for high-yield bonds could continue to fall.

—Andrew Michaels, editorial associate