Chinese Retail Firms Face Pressure

The Chinese retail sector is facing weak but improving credit conditions, while most other non-financial corporates in a variety of sectors are experiencing stable conditions, according to a new Moody’s Investors Service report.

"A challenging operating environment and merger and acquisition activity have pressured the credit profiles of Chinese retail companies, but revenue and margins are stabilizing thanks to improved product and service offerings and upgraded shopping environments," said Lina Choi, a Moody's vice president and senior credit officer.

Chinese internet and technology companies are expected to see slow, stable revenue growth this year boosted by consumer demand and increased monetization, analysts said. Meanwhile, the automakers and auto services companies will also experience slow and steady growth, thanks to reduced vehicle purchase tax incentives.

Utilities companies are expected to stay stable this year thanks to the current regulatory framework.

Domestic and overseas infrastructure investment, in addition to a large order backlog for existing property projects, should increase the revenue growth of Chinese construction and engineering firms this year, Moody’s said. “The credit profiles of rated developers should improve in 2017, despite slowing sales growth from tighter government controls,” Moody’s analysts said. “The major developers will continue to increase their market share, supported by their strong branding and execution abilities, solid financial profiles and continued access to funding.”

– Nicholas Stern, senior editor

Growth Strengthens in European Emerging Market Overview

Strengthening growth, diverging fiscal policy trends and political risk are themes in a recent report from Fitch Ratings that provides an overview of sovereign credit trends in European emerging markets.

The European Commission is forecasting a deterioration in the structural balance for most countries in the region, Fitch said. Output gaps remain negative, though wage rates are being pressured by strengthening growth. Commodity prices have contributed to an increase in inflation in the first quarter of 2017. Growth in central and eastern Europe is supported by distribution of European Union funds and by increasing strength of trade from western European countries. Easy monetary conditions and lowering unemployment, along with an increase in tourism, have helped domestic demand.

Political risks appear to be contained, Fitch said, in the face of recent changes to ruling factions in Bulgaria and Croatia, a new Romanian government and elections in the Czech Republic. A recovery in Russia continues, with domestic demand responding to confidence in the economic policy.

Turkey has recovered from a coup attempt, with growth reaching 5% year-over-year in the first quarter of 2017, supported by a stimulus effort by the government. “Billions have been poured into the economy to stabilize the political and economic situation and it has worked—at least for now,” said NACM Economist Chris Kuehl, Ph.D. “The issue now is whether the country has the ability to keep this up. The majority of analysts assert that it will not be able to. The country has been financing this surge of spending with debt (and expensive debt at that) given that investors are still not convinced the government is that stable. The only hope is that consumers and the business community have enough impact to boost government revenues. Most assert that there is just too much debt to handle and that it only stands to get worse.”

Fitch has taken three ratings actions in the region this year. Bulgaria was changed from Stable to Positive and Croatia was moved from Negative to Stable. Turkey was downgraded due to political developments affecting economic performance and the slowing economy weighing on banks, among other reasons.

– Adam Fusco, associate editor

IMF: U.S., U.K. Economy Growth Downgraded


The global economy will remain unchanged the rest of this year and into 2018, according to the July World Economic Outlook Update from the International Monetary Fund (IMF). Despite the stability across the globe, the U.S. and U.K. will grow weaker than previously expected.

“The recovery in global growth that we projected in April is on a firmer footing; there is now no question mark over the world economy’s gain in momentum,” said IMF Chief Economist Maurice Obstfeld in an IMF blog. The July update further cemented the projected global growth at 3.5% this year and 3.6% next year. China, Japan and the eurozone saw revised upward growth.

The IMF revised the U.S. growth forecasts to 2.1% in 2017 and 2018. The reason for this is due to “the weak growth outturn in the first quarter of the year; the major factor behind the growth revision, especially for 2018, is the assumption that fiscal policy will be less expansionary than previously assumed,” said the update. Even with the downgrade, “U.S. growth should remain above its longer-run potential growth rate,” added Obstfeld. The impact of Brexit on the U.K. is still unknown.

In China, “higher growth is coming at the cost of continuing rapid credit expansion and the resulting financial stability risks,” Obstfeld said. Also among emerging and developing economies, India is forecasted to grow in 2017 and 2018. Canada saw the biggest growth prediction in 2017 compared to the April projection. Meanwhile, Sub-Saharan Africa is expected to have some of the largest growth in 2017 and 2018 compared to last year.

“Despite the current improved outlook, longer-term growth forecasts remain subdued compared with historical levels, and tepid longer-term growth also carries risks,” said Obstfeld.

– Michael Miller, editorial associate

Retail High-Yield Default Rate Rises While Overall Rate Declines

Despite a drop in the overall high-yield default rate since the end of June, the U.S. retail trailing 12-month (TTM) high-yield default rate rose, following apparel retailer J.Crew’s $566 million distressed debt exchange (DDE). Large retailers such as Claire’s Stores, Sears and Nine West Holdings have a high likelihood of default before the end of the year, according to a new report from Fitch Ratings.

The retail sector rate, which rose to 2.9% in mid-July from 1.8% at the end of June, may reach 9% if those three retailers file for bankruptcy, the ratings agency said. The forecast for the sector at year end, even if Sears and Claire’s do not file, is 5%. The overall high-yield default rate fell to 1.9% in mid-July from 2.2% at the end of June, as $4.7 billion rolled out of the TTM default universe.

“Even with energy prices languishing in the mid $40s, a likely iHeart bankruptcy and retail remaining the sector of concern, the broader default environment remains benign,” said Eric Rosenthal, senior director of leverage finance at Fitch.

DDEs are the leading cause of default on an issuer basis. A total of 146 DDEs have occurred since 2008, with about 40% of those experiencing a subsequent default within an average of 13 months.

The energy default rate reached its lowest point since August 2015. Fitch expects the 2017 sector rate to finish at 2.5% and believes the sector has passed the peak of the default cycle for high-yield energy bonds.

– Adam Fusco, associate editor

Stable and Positive Outlooks Predominate Global Industry Sectors

The global economy is gaining traction as stable and positive outlooks dominate Moody’s Investors Service’s distribution of industry sector outlooks and stable growth appears more likely. Moody’s 54 industry sector outlooks reflect the rating agency’s expectations for fundamental business conditions over the coming 12 to 18 months. Currently, 12 of those outlooks are positive, four are negative and the rest are stable.

"Business conditions currently indicate continuing, if hesitant, global economic growth," said Moody's Senior Vice President Bill Wolfe. "Even so, despite an uneven recovery and even with many commodities-based sectors only recently emerging from a prolonged supply-side adjustment, overall business conditions are strong enough to support reduced monetary stimulus—suggesting that conditions for nonfinancial companies may be near a difficult-to-improve-upon peak."

Consumer-based industries, including consumer durables, global consumer products, North American building materials and U.S. homebuilding, have bolstered growth since the Great Recession and particularly over the past three to five years, Moody’s reported. Still, flagging monetary stimulus puts strengths in this sector at risk.

In March, global integrated oil moved to a positive outlook from stable, while global oilfield services and drilling and North America and EMEA refining and marketing moved out of negative territory to stable. During the second quarter, the Latin American telecommunications’ outlook improved to stable from negative, as did the global shipping sector.

Risks increased in the global automotive sector, as the outlook switched to negative from stable in October 2016, while in the same month the European automotive parts suppliers sectors fell to stable from positive, Moody’s said.

In a separate report, Moody’s noted that, so far this year, only 14 global nonfinancial companies have fallen into speculative investment-grade territory; in 2016, 63 companies lost their investment-grade status, prompted in part by flagging commodity-linked industries and negative sovereign rating actions.

– Nicholas Stern, senior editor

Almost Half of GCC Businesses Not Ready for New Value-Added Tax

Nearly half of businesses polled in the Gulf Cooperation Council (GCC) nations—the United Arab Emirates, Bahrain, Saudi Arabia, Oman, Qatar and Kuwait—are unprepared for the implementation of value-added tax (VAT) on Jan. 1, 2018, according to a new survey by the Association of Chartered Certified Accountants (ACCA) and Thomson Reuters.

Of the more than 330 people from a variety of industries in the region who participated in the survey, 11% said they understand the impact VAT implementation will have on their businesses and have used this knowledge to draft a policy, consider compliance models and identify IT system gaps, the survey noted.

Further complicating the matter, aside from Saudi Arabia, each GCC member state has yet to issue its own VAT law and executive regulation that can potentially lead to different tax treatment between each country, said Pierre Arman, market development lead for tax and accounting at Thomson Reuters. “Every function will be impacted by VAT (it’s not just a finance issue) and therefore it is essential for organizations in the region to begin analyzing how VAT will impact their operations through careful planning with their chosen tax adviser,” he said. “Time is limited and a considerable amount of the VAT impact assessment analysis can be done without knowing the details of the final law, as most of the VAT treatment can be extrapolated from other jurisdictions around the world.”

The ACCA and Thomson Reuters included a few pointers for businesses to ensure they’re ready for the VAT:

-    Allocate a budget for VAT.
-    Seek out a tax advisor.
-    Identify potential IT system gaps for VAT implementation. Specifically, when reviewing your existing billing system, identify what VAT compliance data is available and what’s not available for VAT calculation and reporting.
-    Evaluate the VAT reporting model you’d like to apply and prepare for the appropriate operational decisions and their consequences.

– Nicholas Stern, senior editor

U.S. Transportation Sector on Healthy Path for Remainder of the Year

Despite uncertainly surrounding the U.S. administration’s policies concerning upcoming spending on infrastructure, the outlook for the U.S. transportation sector is expected to be healthy for the remainder of the year.

According to Fitch Ratings’ midyear outlook on the sector, large transportation companies will still need to borrow debt to serve ongoing infrastructure renewal needs and provide congestion relief. Low fuel prices, however, should keep travel costs affordable.

A cautious growth trajectory is seen for public-private partnerships (P3s), as state and local governments explore P3 financial models. However, “there remains a scarcity of funding and a lack of understanding around the P3 structure, meaning most infrastructure needs will continue to be financed via more traditional means,” said Senior Director Scott Zuchorski.

Growth in passenger traffic at U.S. airports is expected to level off in the near term. “Large-hub airports are still the strongest performers in the aggregate, though smaller regional airports are now showing stronger performance as well,” said Senior Director Seth Lehman. Volume growth for U.S. ports should reflect that of GDP for the rest of 2017. However, “shipping company mergers, changing alliance structures and fluctuating freight rates will shift volumes, which could alter contractual protections for select ports,” said Director Emma Griffith.

Moderate growth is expected for toll roads for the remainder of the year. Stronger revenue growth is expected from inflationary toll increases. “Toll roads still face political risk, including federal funding uncertainty and state tolling opposition,” said Director Tanya Langman.

– Adam Fusco, associate editor

Business Volume Increased in the Equipment Finance Sector in 2016

The equipment finance sector saw business volume increase 2.5% in 2016, according to the recently released 2017 Survey of Equipment Finance Activity (SEFA). That marks the seventh consecutive year businesses increased spending on capital equipment. For small-ticket equipment transactions, new business volume grew 10.7% in 2016, according to a companion survey.

“The equipment finance industry continues a slow-growth trajectory, mirroring a fundamentally sound—if unspectacular—U.S. economy during the past several years,” said
Equipment Leasing and Finance Association (ELFA) President and CEO Ralph Petta. “Despite a slowly rising interest rate environment, leasing and finance companies are profitable entities, with generally healthy portfolios and sustainable levels of returns.”

The growth rate reported in the 2016 SEFA was down from 2015’s rate of 12.4%. In 2016, independents saw a 12% jump in new business volume and banks reported a 5% increase, while captives noted a 5.9% decrease. The middle ticket segment saw the largest increase in 2016.

According to the survey, the top five most-financed equipment types were transportation, IT and related technology services, agriculture, construction and office machines. The top five end-user industries representing the greatest portion of new business volume were services, industrial and manufacturing, agriculture, transportation and wholesale/retail.

Delinquencies increased in 2016, with 1.8% of receivables over 31 days past due compared to the prior year’s rate of 1.5%. Net full-year losses or charge-offs increased and remained at 0.29% of average receivables. Credit approvals increased a bit also, while the percentage of those approved applications being booked and funded fell overall.

– Nicholas Stern, senior editor

Fitch: Latin America’s Outlook is Negative

Latin America does not have a positive outlook after the first half of 2017. There were more negative than positive sovereign rating actions made by Fitch Ratings for the region in the first six months of the year, the agency said earlier this week.

Brazil, Chile, Ecuador and Mexico have negative outlooks, while Costa Rica and Suriname were downgraded one notch and two notches, respectively. El Salvador defaulted on local debt. No Latin American sovereigns are on a positive outlook in Fitch’s 2017 Mid-Year Sovereign Review and Outlook. The only positive move was Colombia, going from negative to stable due to a tax reform and “sharp falls in the current account deficit and inflation.”

“Sovereign credit pressures in the region generally stem from the challenging macroeconomic backdrop, the difficulty of fiscal consolidation, and sometimes volatile or polarized politics,” said Fitch. “All of these factors will see important developments in the second half of 2017 and 2018 as countries present their 2018 budgets and several elections take place.”

Some countries are doing their best to improve public debt. “Chile and Mexico are seeing benefits from earlier tax reforms, and Colombia and Uruguay have enacted tax increases in the past year,” added Fitch.

For a sovereign rating to change, the reasons may have to come from the citizens of the country. Fitch cites nine elections in the next year and a half as a key factor to a country’s rating. “Political deadlock was a major factor in our negative rating actions on Costa Rica and El Salvador, which have elections scheduled in [the first quarter of 2018],” said Fitch.

– Michael Miller, editorial associate

Weak Demand Cause for C&I Lending Slowdown


Weak demand may be the cause of a slowdown in growth for commercial and industrial (C&I) lending, rather than tighter credit, according to a report from Wells Fargo Securities. The pace of commercial and industrial lending at domestically chartered banks has slowed over the past year and is consistent with previous periods of economic weakness in 1990, 2001 and 2008. But the net percentage of banks that are tightening standards for such lending is easing, so other factors are at play.

A drop in the need to increase spending on business equipment is one reason. Firms are able to produce at the current pace of economic output. “The expected pace of final sales in the economy has come to reflect the steadiness of 2% economic growth over the last five years,” Wells Fargo said. Business equipment spending fell by 0.5% in 2016 after gaining 2.1% the year before.

Also, profit margins have declined. There is less incentive to add to capacity as a result. Finally, firms are able to exercise tighter control over inventories. “There is little need to borrow funds since both the real quantity of inventories has been low and little incentive exists to borrow in anticipation of higher inflation prices for inventories goods,” Wells Fargo said. “Inventories were a drag of 0.4% on growth in 2016 and are expected to add just 0.1% this year.”

– Adam Fusco, associate editor