Fed's Duke Reiterates Need for Bank Lending

The Federal Reserve continues to browbeat, coerce and even appear to beg bankers to resume offering credit and unfreezing credit lines for businesses and consumers alike.

Fed Governor Elizabeth Duke, in a speech to a group of bankers gathered at a June 30 Ohio Department of Commerce event, reemphasized the need for financial institutions to start lending more frequently than in past, recession-fraught years. She did, however, stress that such credit should be extended to "worthy borrowers" in a manner that is more prudent than the easy-money economic boom years around the middle of last decade.

"In no way do we want to return to the world where people could buy a house with no money down and no documentation," said Duke. "But where prudent loans can be made, we want to do everything we can to make sure those deals are struck. It's best for the banks, it's best for the borrower and it's best for our economy as a whole."

Duke, who promised the Fed would continue to support opening up credit availability post-recession, also focused the following passage specifically on the situation of small businesses:

"Data that would indicate underlying borrower demand is much harder to find for small businesses than it is for consumers. Nonetheless, a number of indicators suggest that demand for credit by small businesses is down. Over the past two years, the National Federation of Independent Business (NFIB) monthly economic trends survey has consistently found that the problem reported as being most important by the largest number of small businesses was poor sales. The NFIB survey also shows that, despite a slight improvement in the last couple of months, the percentages of firms planning capital expenditures, increasing inventories, or finding it a good time to expand facilities are still very low by historical standards. These findings suggest that some potential borrowers are likely on the sidelines waiting for a good reason to expand or build inventories.

Despite these indicators of reduced demand, we continue to hear about difficulties experienced by small businesses in obtaining credit. The number of complaints we hear is supported by data from the NFIB's May survey indicating that the percentage of small businesses reporting tighter credit conditions than three months earlier was at levels comparable with its peaks of the early 1990s. Moreover, as reported in the NFIB's 2009 Credit Access Poll, among small businesses that attempted to borrow in 2009, only 50% got all or most of the credit they wanted. An earlier NFIB poll found that, during the period from 2003 to 2006, 61% of firms attempting to borrow got all of the credit they wanted and another 28% got most of the credit they wanted. This suggests that credit conditions for small businesses today remain tight, especially compared with the 2003-2006 period.

Of course, some of the difficulty that small businesses are currently experiencing in obtaining credit reflects their weakened economic condition. Although the May NFIB survey shows an improvement in actual sales, they remain below pre-recession levels. Furthermore, commercial real estate values have declined almost 40% during the downturn, and many small businesses rely on real estate as a source of capital or as collateral for other loans. The NFIB reports that as of the end of 2009, 95% of small business owners owned personal, commercial, or investment real estate; 21% used proceeds from mortgages to finance business activities; and 11% used real estate as collateral for loans. It is likely that most small business owners have seen a decline in the value of real estate owned, and many may have at least one property on which they owe more than the property's value.

To better understand what is happening in the area of lending to small businesses, the Federal Reserve System is holding more than 40 meetings across the country to gather information that will help the Fed and others craft responses to the immediate as well as longer-term needs of small businesses. In May, for example, the Federal Reserve Bank of Cleveland hosted five small business roundtable discussions in the region--one each in Columbus, Toledo, Cleveland, Cincinnati, and Pittsburgh--and a workshop on venture capital as part of this series of meetings. These meetings have brought together people with a wide range of backgrounds, including those from banks, community development financial institutions, bank exam teams, federal and local government, and small business trade groups..."

Click here for the Duke's full speech.

Brian Shappell, NACM staff writer

SOX Survives SCOTUS Ruling in Free Enterprise Fund v. Public Company Accounting Oversight Board

Today, on the final day of its October 2009 Term, the U.S. Supreme Court, led by Chief Justice John Roberts, amended the Sarbanes-Oxley Act (SOX) while leaving this legislation primarily intact. Based on a 5-4 decision, the Securities and Exchange Commission (SEC) will now be able to remove a member of the Public Company Accounting Oversight Board (PCAOB), which was created by SOX to oversee and investigate accounting firms that audit public companies, at will rather than for cause.

According to Chief Justice Roberts, PCAOB’s original structure violated the Constitutional separation of powers principle. “The president cannot take care that the laws be faithfully executed if he cannot oversee the faithfulness of the officers who execute them,” Chief Justice Roberts wrote.

SOX and its PCAOB are not yet out of the woods though. The pending financial reform package in Congress includes a measure to exempt small businesses from the scope of SOX’s Section 404 (internal control mandates). Stay tuned to NACM’s Credit Real-Time blog, eNews and other publications for the latest developments concerning SOX and the PCAOB.

BREAKING: Fed Keeps Hands Off, Leaves Rate Untouched

As predicted, the Federal Reserve's Federal Open Market Committee (FOMC) today left the target range for the federal funds rate at 0-0.25%.

"The Committee...continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period," said the FOMC in a statement. "Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time."

Nine of the 10 FOMC members voted in favor of maintaining the current rate. The lone dissenting vote was cast by Thomas Hoenig, who believes that the low rate is no longer necessary and could "lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability."

Other remaining risks cited by the FOMC were weak investment in nonresidential structures, depressed housing starts and contracting bank lending in recent months.
A full copy of the FOMC statement can be found here.

Jacob Barron, NACM staff writer

China Moves On Currency Ahead of G20 Meeting, Stops Short of Revaluation

The yuan (RMB) surged today following the People's Bank of China's (PBOC's) announcement this weekend that it would greater flexibility in its currency's exchange rate.

On Saturday the PBOC announced that it would allow the yuan to appreciate, ending the unofficial two-year peg to the dollar that was fiercely criticized for giving China an unfair advantage in international markets. The move came just ahead of the Group of 20 (G20) meeting scheduled to take place this weekend in Toronto. Observers will be closely watching the yuan this week however, to make sure that the currency actually does move and that China's announcement of increased flexibility was not merely a hollow gesture.

The first indications today were positive, as the yuan rose by 0.45% to 6.7969 per dollar after the PBOC set the daily reference point for trading.

A stronger yuan is expected to benefit U.S. exporters by making them more competitive in the still-booming Chinese market. China's domestic economy also stands to benefit from greater currency flexibility, as noted in a statement by Managing Director of the International Monetary Fund (IMF), Dominique Strauss-Kahn. "The People's Bank of China announcement to increase exchange rate flexibility and return to the managed floating exchange rate regime in place prior to the global financial crisis is a very welcomed development," he said. "A stronger RMB is in line with findings of the G-20 Mutual Assessment Process, to be presented in Toronto next week, and will help increase Chinese household income and provide the incentives necessary to reorient investment toward industries that serve the Chinese consumer."

While China's announcement was welcome in markets across the globe, it is expected to do little to calm harshly critical American lawmakers, who were hoping for a full on revaluation of the currency. According to the PBOC, the Chinese government avoided such a move in the interest of stability. "The reform this time does not involve a one-off exchange rate revaluation," said a PBOC spokesperson. "The objective is to stabilize the RMB exchange rate basically around an adaptive and equilibrium level, and in the meantime, improve China´s Balance of Payments (BOP) situation, and achieve economic and financial stability."

Jacob Barron, NACM staff writer

Fed Chairman Unveils Report on 'Appropriate Responses' to Financial Crisis

(June 16 Speech by Federal Reserve Chairman Ben Bernanke)

The Squam Lake Report is a valuable contribution to the ongoing analysis of the causes of the financial crisis and the appropriate policy responses...I think we all agree on the key questions facing financial regulators: How do we strengthen the financial system and its oversight so as to minimize the risk of a replay of the recent financial crisis? And should a crisis occur, how can we limit its economic costs?

The report identifies two core principles that should be among those that guide us in answering these questions. First, financial policymakers and supervisors must consider more than the safety and soundness of individual financial institutions, as important as that is; they should also consider factors, including interactions of institutions and markets, that can affect the stability of the financial system as a whole. In the jargon of economists and regulators, supervisors need a macroprudential as well as a microprudential perspective.

The second core principle put forth in the report is that the stakeholders in financial firms--including shareholders, managers, creditors, and counterparties--must bear the costs of excessive risk-taking or poor business decisions, not the public. The perception that some institutions are "too big to fail"--and its implication that, for those firms, profits are privatized but losses are socialized--must be ended.

The Federal Reserve strongly agrees with both of these principles, and both have been important in shaping our views on regulatory reform. We also broadly agree with the narrative of the crisis offered in the report, which discusses, among other things, the role of subprime lending in the housing boom and bust; the structural weaknesses in the shadow banking system, including insufficient transparency and investor overreliance on rating agencies; inadequate risk management by many financial institutions; and a flawed regulatory framework that allowed some large financial firms to escape strong consolidated supervision and gave no regulator the mandate or powers needed to effectively evaluate and respond to risks to the financial system as a whole. Weaknesses in both the private sector and the public sector, in the framework for regulation, and in supervisory execution all contributed to the crisis. The crisis in turn led to a severe tightening of credit, a collapse in confidence, and a sharp global economic downturn.

The Squam Lake Recommendations
What, then, is to be done? The Squam Lake Report provides a substantial set of recommendations. Among these are the adoption of a more systemic approach to the supervision and regulation of financial firms and markets; enhanced capital and liquidity regulation for financial firms, particularly for systemically important institutions; improved information collection by regulators and, where possible, the public release of such information; development of a resolution regime that would allow the authorities to manage the failure of a systemically important financial firm in an orderly manner while imposing losses on shareholders and creditors; and significant strengthening of the financial infrastructure, particularly for derivatives contracts. The Federal Reserve has supported legislative changes in all of these areas, and, where possible under current law, has initiated changes along these lines within its own operations. In the remainder of my remarks I will elaborate briefly on these recommendations, with particular attention to how they are currently helping shape regulatory reform and the Fed's own regulatory and supervisory activities...

For the full speech and specific suggestions for action, visit http://www.federalreserve.gov/newsevents/speech/bernanke20100616a.htm.

Fight Over SOX Rages Ahead of Supreme Court Ruling

While the Supreme Court could rule on the constitutionality of the Sarbanes-Oxley Act (SOX) before the end of this month, the debate over the Act's merits has continued unabated.

According to the Competitive Enterprise Institute (CEI), which is serving as co-counsel in Free Enterprise Fund v. Public Company Accounting Oversight Board (PCAOB), SOX has had such negative effects as permanently reducing the number of companies going public and negatively affecting job creation and economic growth. "The sheer size of companies going public has increased, in large part because a company needs to be pretty big to afford the accounting costs that have shot up fourfold as a result of SOX, according to a summary of research in the Sarbanes-Oxley Compliance Journal," said the CEI in a recent memo.

Citing a study in Business Week, the CEI also noted that the median market cap for a company doing an Initial Public Offering (IPO) was $52 million in the mid-1990s. "Today, it has shot up $227 million. Google had a $1 billion market cap when it went public of 2004. And Facebook still hasn't gone public, despite having an estimated market cap of nearly $10 billion," they added. "By contrast, in 1981, Home Depot went public with just four stores. Home Depot co-founder Bernie Marcus told Investor's Business Daily that his firm could never have gone public and raised money for growth had SOX been in effect."

"This illustrates the devastating effect of the law in holding back present and future economic growth," said the memo.

In Free Enterprise Fund, the plaintiffs have argued that the PCAOB's existence violates the Constitution's Appointments and Separation of Powers Clauses, which require that important federal officials be appointed by either the president or by Cabinet heads. The PCAOB's members are picked collectively by commissioners at the Securities and Exchange Commission (SEC).

SOX also faces a simultaneous challenge from Congress, as lawmakers continue to hammer out a deal on financial reform that could include an exemption from the Act for small businesses. A group of SOX advocates, namely the Center for Audit Quality (CAQ), the CFA Institute and the Council of Institutional Investors, recently sent a letter to Congress urging them to maintain SOX's integrity and application to the nation's smaller firms. "We ask that you exclude from the final bill an amendment in the House Act that would permanently exempt public companies with less than $75 million in market capitalization from compliance with Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX)," said the letter. "Section 404(b) requires an independent audit of a public company's assessment of its internal controls over financial reporting (ICFR). We dispute the notion that investors in smaller public companies do not deserve the same financial reporting safeguards as investors of large public companies."

"Like you, our organizations recognize the positive impact small businesses have on the economy and job creation," they added. "However, we cannot support actions, no matter how well intentioned, that threaten investor confidence and the stability of the U.S. capital markets."

Stay tuned to NACM's eNews and Credit Real-Time Blog for any updates.

Jacob Barron, NACM staff writer

MGM Mirage Sidestepping GC to Make Nice with Subcontractors

As a battle between the owner and general contractor of the $8.5 billion CityCenter development in Las Vegas continues to percolate, it appears subcontractors will be able to largely avoid the western-style standoff and, perhaps, some financial woes.
MGM Resorts International (MGM), whose board and shareholders on June 15 approved a change in its name from MGM Mirage effective immediately, told subcontractors on CityCenter that it will pay all legitimate claims of money owed to them for work on the Las Vegas Strip project, NACM has been told by sources with MGM and multiple subcontractor organizations present at the meeting.

The source at MGM, still facing a $492 million mechanic's lien filed by Perini Building, said the pace of payments depends almost solely on how quickly the subs turn around documentation and/or billing materials and discredited media reports that such payments could be held up until November. The source alleged they are taking this route with struggling subs because Perini badly mishandled its own paperwork for billing to the tune of 300,000 haphazardly organized documents strewn about in dozens of bankers boxes.

Randy Clark, of Nevada-based Young Electric Sign Co. (YESCO), which worked on the CityCenter project, said subcontractors he knows appear somewhat relieved by the development, and that he has never seen a company take this kind of approach when a hefty mechanic's lien is involved. Clark noted that it appears MGM officials "are going to try to be good local corporate citizens."
Perini, which previously met with Nevada Gov. Jim Gibbons (R) without MGM and called for the corporation to pay the subcontractors despite the lien, were not invited to the subcontractors meeting and again did not respond to requests for comment from NACM. MGM Mirage has alleged the general contractor failed to even present MGM with a final bill before filing the record mechanic's lien and botched the construction of CityCenter's Harmon Hotel so badly that it needed to be reduced by more than 20 floors from its original design.

For its part, Perini alleged MGM abruptly stopped paying for work already completed earlier this year, made thousands of change orders on the project's design well after an agreed-upon deadline and is trying to buy time because of its financial struggles of late. Perini said nearly $400 million of its mechanic's lien filing represented what was owed to subcontractors.
Greg Powelson, director of NACM's Mechanic's Lien & Bond Services, called the ongoing spat "a mess" and said MGM and Perini were likely still in the first stages of an 18- to 24-month process. Like disputes with other massive Las Vegas projects such as Fontainebleau and the Venetian, the situation doesn't appear to be one that will be fully settled quickly.

Brian Shappell, NACM staff writer

Exports Dip Ups Trade Deficit to Early '09 Levels

(From U.S. Census Bureau):

Goods and Services


The U.S. Census Bureau and the U.S. Bureau of Economic Analysis, through the Department of Commerce, announced [June 10] that total April exports of $148.8 billion, and imports of $189.1 billion resulted in a goods and services deficit of $40.3 billion, up from $40.0 billion in March, revised. April exports were $1.0 billion less than March exports of $149.8 billion. April imports were $0.8 billion less than March imports of $189.9 billion.

In April, the goods deficit increased $0.1 billion from March to $52.5 billion, and the services surplus decreased $0.1 billion to $12.2 billion. Exports of goods decreased $1.1 billion to $104 billion, and imports of goods decreased $1 billion to $156.5 billion. Exports of services increased $0.1 billion to $44.8 billion, and imports of services increased $0.2 billion to $32.6 billion.

The goods and services deficit increased $11.8 billion from April 2009 to April 2010. Exports were up $24.7 billion, or 19.9 percent, and imports were up $36.5 billion, or 23.9 percent.

Goods (Census basis)

The March to April decrease in exports of goods reflected decreases in other goods ($0.8 billion); consumer goods ($0.7 billion); and foods, feeds, and beverages ($0.6 billion). Increases occurred in industrial supplies and materials ($0.6 billion) and automotive vehicles, parts and engines ($0.1 billion). Capital goods were virtually unchanged.

The March to April decrease in imports of goods reflected decreases in consumer goods ($1.7 billion); other goods ($0.5 billion); and automotive vehicles, parts, and engines ($0.2 billion). Increases occurred in capital goods ($1.4 billion) and industrial supplies and materials ($0.1 billion). Foods, feeds, and beverages were virtually unchanged.

The April 2009 to April 2010 increase in exports of goods reflected increases in industrial supplies and materials ($10.8 billion); capital goods ($4.9 billion); automotive vehicles, parts, and engines ($3.4 billion); consumer goods ($1.2 billion); other goods ($1.0 billion); and foods, feeds, and beverages ($0.3 billion).

The April 2009 to April 2010 increase in imports of goods reflected increases in industrial supplies and materials ($18.2 billion); automotive vehicles, parts, and engines ($6.9 billion); capital goods ($6.8 billion); consumer goods ($1.4 billion); and foods, feeds, and beverages ($0.7 billion). A decrease occurred in other goods ($0.1 billion).

Services

Services exports increased $0.1 billion from March to April. The increase was mostly accounted for by an increase in passenger fares. Changes in the other categories of services exports were small.

Services imports increased $0.2 billion from March to April. The increase was mostly accounted for by increases in other private services (which include items such as business, professional, and technical services, insurance services, and financial services) and passenger fares. Changes in the other categories of services imports were small.

Services exports increased $3.3 billion from April 2009 to April 2010. The largest increases were in other private services ($1.4 billion), royalties and license fees ($0.7 billion), and travel ($0.6 billion). Within other private services, the largest increase was in business, professional, and technical services.

Services imports increased $2.1 billion from April 2009 to April 2010. The largest increases were in other private services ($1.1 billion) and other transportation ($0.5 billion), which includes freight and port services. Within other private services, the largest increase was in business, professional, and technical services.

Goods and Services Moving Average

For the three months ending in April, exports of goods and services averaged $147.6 billion, while imports of goods and services averaged $187.8 billion, resulting in an average trade deficit of $40.2 billion. For the three months ending in March, the average trade deficit was $38.4 billion, reflecting average exports of $146.2 billion and average imports of $184.6 billion.

A-Rod Joins Credit Committee

New York Yankees slugger Alex Rodriguez is used to getting on base and used to getting on All-Star teams. But this month, Rodriguez entered new territory by getting on a creditors' committee as part of the bankruptcy proceedings of his former Major League Baseball team.

During recent teleconferences, coverage in the NACM blog and the latest Credit Congress event in Las Vegas, attorneys and industry experts have continually sang the praises of getting on a well-run creditors' committee. Consider this: even baseball's highest paid player recently fought to get on one. Rodriguez, whose current contract is worth nearly $300 million, was one of three people appointed to the creditors' committee involved with the Texas Rangers bankruptcy case. Rodriguez, who is still owed about $25 million in deferred compensation from a $250 million contract he signed with the Rangers in 2001, joins representatives from Vratsinas Construction Co. and architecture firm RTKL on the committee. The latter companies are suing Rangers owner Tom Hicks, who is also co-owner of the Liverpool (UK) Football Club, alleging they were not paid for their work on a failed construction venture adjacent to the site of the Rangers' home stadium.

Rangers ownership is trying to facilitate a quick bankruptcy reorganization so the team can be sold to a group of investors that includes Hall of Fame pitcher and former Rangers player Nolan Ryan.

Brian Shappell, NACM staff writer

Fed Beige Book Finds Modest Economic Improvement; Commercial Real Estate Weak

The Federal Reserve found economic conditions throughout the nation continuing to improve, albeit at a "modest" pace, according to the Beige Book report unveiled one day after Fed Chairman Ben Bernanke publicly tried to alleviate market concerns of a slowing of the rebound. However, there were few positive changes of note in the commercial real estate and financial industry segments.

Though U.S. businesses appeared to be spending more during the latest reporting period (mid-April to late May), commercial real estate activity remained generally weak but at least stable in many areas. Office, industrial and retail vacancies continue to increase in most districts, though areas including New York, Philadelphia, Dallas and San Francisco helped increase leasing activity through cutting rental rates. Most are not expecting any boom period in commercial construction any time soon.

Meanwhile, two-thirds of the Fed's 12 districts reported that commercial and industrial lending by banks remained weak on lessened credit demand and tougher standards for borrowing, in areas such as commercial real estate more than others.

District 1 -- Boston

Leasing rates throughout New England are at least flat or noticeably improved unlike much of the nation. However, sources said tenants who are aware of high vacancy rates and newfound bargaining power often are trying to strike significant deals. Debt default rates for commercial properties "remain significant," but there appears to be a lot of activity and new capital in the region. As such, the outlook is mixed and cautious.

District 2 -- New York

Commercial real estate activity appeared steadier than in previous months. Demand is being driven largely from legal firms as well as some business services companies. Even so, vacancies continued to increase. Additionally, credit terms tightened yet again during the most recent period even though delinquency rates, including where business credit is concerned, were stable.

District 3 -- Philadelphia

Fed contacts at regional banks noted business borrowing has increased. In addition, commercial real estate activity has either remained stable or increased, in part because of publicly funded projects, depending on the submarket. Commercial construction contractors, agents and suppliers, however, envision "no signs" of significant improvement for the industry sector in the near term.

District 4 -- Cleveland

Those in commercial construction optimistically anticipate a small, mostly seasonal, increase in activity during the second half of 2010. Some automotive parts suppliers were encouraged by the ongoing increase in car sales through mid-May. Still, the overall market for business lending remained soft, and tight credit standards aren't expected to abate soon.

District 5 -- Richmond

Overall credit quality in the region was unchanged, save some reports of an uptick in 30-day delinquencies. New commercial construction, however, was "generally nonexistent." One contractor started a new project in the suburbs, believing businesses there are looking to move away from costly urban locations.

District 6 -- Atlanta

Commercial construction was well below the pace found in spring 2009 both from lack of demand and limited access to financing. Credit in the region, however, is readily available to borrowers that meet stringent requirements.

District 7 -- Chicago

Business loan demand firmed in this market more than almost any other in the nation, and credit conditions largely improved. Commercial activity is up for highway, education and health care projects. The condominium market continued to take a beating though.

District 8 -- St. Louis

Commercial real estate still has a long way to go in the district because the entire real estate downturn started in this region much later than the rest of the nation. As such, the district still is going through some correction pains, and a rebound isn't expected until well into 2011. On the positive side, business lending has increased, and credit standards have stopped tightening.

District 9 -- Minneapolis

Commercial construction is characterized as quite weak, and conditions could deteriorate further as spending on infrastructure construction is on the downswing. There is some hope in parts of Minnesota and Wisconsin for a bump in industrial construction.

District 10 -- Kansas City

Demand for commercial real estate construction loans actually increased in the district, and credit quality among businesses appeared to improve in recent weeks. Commercial real estate remained weak though discounting has slowed the rate of vacancy increases. Optimism abounds for a spike in leasing activity in the coming months.

District 11 -- Dallas

Signs of firming were reported for commercial real estate. Leases and property sales both increased amid price discounting. And there has been a return in some cases of bidding wars over prime commercial properties. Additionally, commercial lending activity appears to on the upswing despite ongoing tough credit standards.

District 12 -- San Francisco

Conditions continue to deteriorate in the district, as does loan demand from businesses. Those businesses that are looking for credit and products are doing so largely to replace outdated equipment and software that are crucial to their efficiency.

Brian Shappell, NACM staff writer

Credit Congress' 10: Communication Key in Creditor's Committees

A panel of top attorneys and credit/financial professionals led an illuminating Credit Congress session on Creditors' Committees. One of the top takeaways from the session was that ensuring communication among all members of the committee, especially with hired financial professionals as early in the process as possible, can be crucial for unsecured debtors to maximize their returns in reorganization.

Panelists William Lenhart, CPA, of BDO Seidman, and Bruce Nathan Esq., of Lowenstein Sandler PC both talked about the difficulty and lack of quality communication present in the unsuccessful Circuit City reorganization. "Years ago, they would have figured out a way to reorganize...They lost confidence and liquidated," Lenhart said.

Former NACM Chairman Val Venable, CCE, SABIC Innovative Plastics, suggested the first move of creditors is establishing its unofficial "Bill of Rights" that addresses issues such as conduct, frequency of meetings and who can call meetings, among other things. "They provide an understanding of what is expected from everyone, and they clearly articulate that so there are not big surprises. Everybody has to know everybody else's expectations for a successful reorganization."

Brian Shappell, NACM staff writer

BP Credit Rating Takes Hit

BP's struggles to stop the largest oil spill in U.S. history almost ensures that it will become intensely difficult for the company to prevent its credit rating, not to mention its image, from sinking for years to come. Still NACM's economic analyst believes the problem is relegated to just one company in the oil sector and other small industry sectors, meaning a massive national economic impact remains unlikely. That is unless a worst case scenario rears its head during hurricane season.

BP, which has continued to botch its efforts to stop the massive Gulf Coast leak more than a month after an explosion and failed cut-off started the growing mess, saw its credit rating dropped this week by all three major ratings agencies: Moody's Investment Services, Fitch Ratings and, following their counterparts' lead, Standard & Poor's. Despite the ratings agencies own ongoing credibility problems (see related story in NACM's June 8 eNews), the lower ratings could signal big problems for BP. The ratings agencies explained their respective decisions by noting concerns that include the potential for mounting cleanup and legal costs that could be long-term, the possibility of federally levied criminal charges or cease/desist orders that prevent future BP drilling and a lack of confidence in the company's ability to stop the leak.

NACM Economic Analyst Chris Kuehl, Ph.D, of Armada Corporate Intelligence, said he believes most other oil companies won't be badly wounded by this situation. However, it is likely BP will become subject to rampant rumors of takeovers in the coming years and will be spending large amounts of effort cleaning up its mess while its competitors are moving into new, profitable areas. Kuehl said the oil drilling industry, even in the Gulf, is unlikely to be brought to a halt because the drilling areas are dependent on three major industries: oil, fishing and tourism. And BP's snafu has pretty much destroyed the latter two.

"But tourism and fishing still only bring in less than one-quarter of what oil brings in," said Kuehl, noting there are more than 4,000 rigs and accompanying jobs in the Gulf alone. "That's the economic reality of their world. If you take away oil, what are they going to have left?"

Kuehl also reiterated the general economy very likely won't be affected significantly by this disaster. He called it an emotional issue, mainly because of environmental degradation and media stories on struggling fisherman from the Gulf area, more than a real economic issue. Kuehl noted there have been oil spills occurring in Nigeria of this magnitude for 20 years that few discuss, or even know about. The true threat to the economy, long-shot as it is, would be a sort of perfect storm during 2010's hurricane season. Forecasts aren't calling for a particularly active, strong storm season in the spill's heavily impacted area - but anything can change.

"If you get a really badly placed storm that drives the oil over all the barriers and shifts prevailing winds in different directions [like toward the Texas coast or beyond the Florida peninsula], and the cleanup is truly catastrophic, the interdiction efforts will become overwhelmed," said Kuehl. "That could end up inundating cities and driving oil into farm country, where you'd see things affected like cotton and rice."

Brian Shappell, NACM staff writer

May 2010 Credit Managers' Index: Service Sector Under Stress

There has been a great deal of concern in the financial sector in the last month as the world reacts to the mounting threats from the "Greek disease." While it has been acknowledged that the crisis is disrupting the markets in Europe as well as the rest of the world, there has been relatively little impact on the rest of the global economy to this point. The data from May's Credit Managers' Index, issued by the National Association of Credit Management (NACM), seem to suggest that this turmoil is having an impact on the U.S. credit and business community-perhaps more than most people realize.

"Over the last few years the CMI has tended to be a harbinger of things to come as far as the overall economy is concerned as it presages the activity in the credit and financial communities," said Chris Kuehl, Ph.D., NACM economic advisor, who prepares the CMI report each month. The CMI dipped in 2008, three months before the rest of the economy started to react to the banking debacle that engulfed the U.S. and the rest of the world soon after. Now the CMI is dipping again-and dramatically-while at the same time the rest of the economic indicators have barely started to respond. "The sense among observers has been that the Greek crisis and its implications would soon have the same kind of impact on the credit environment that the sub-prime crisis had in 2008. Last month's data seems to bear this out."

Kuehl noted the growing signs of distress in credit circles in the last few weeks, the most obvious being the rise of the London Interbank Offered Rate (LIBOR) to a point not seen since July 2009. The LIBOR is the benchmark for banks making short-term loans to one another and often determines the rates that drive the rest of the economy, more so than the interest rates set by central banks. "A growing concern among bondholders, about the viability of the European economy, has caused some wild swings in both bonds and equities," said Kuehl. "The data from the CMI is both reflecting this and anticipating some more trouble in the future."

There has been deterioration in both the positive and negative factors across the board, although the service sector has been hit harder than manufacturing. Sales have slipped from 65.7 to 64.5 which is not a dramatic reduction, but comes after five months of steady increases. The level of dollar collections fell as well-from 62.1 to 59.7-as some business sectors struggled to keep pace with the nascent recovery. There was also a reduction in the level of credit as the financial system tightened again.

Some of the more urgent changes took place in the negative categories. The dollar amount of customer deductions fell from 55.7 to 51.8. There is a sense that accounts have become nervous again and have started to worry about their access to capital in the coming months as well as their ability to keep generating sufficient demand to maintain their growth expectations. "There is not the level of panic that existed in the months leading up to the credit meltdown, but there is far more concern about what is happening in the global markets than existed even a few weeks ago," said Kuehl. "The fact that the major concern is rooted in Europe is slightly better news than if it were motivated by another meltdown in the U.S., but it is entirely possible that the Greek disease will spread."

The full report, complete with tables and graphs, along with CMI archives may be viewed at http://web.nacm.org/cmi/cmi.asp.