Credit Managers' Index Could Close 2016 with Cheerful Rebound

Credit managers appear to have rediscovered a spirit of confidence, according to preliminary data in the latest NACM Credit Managers’ Index (CMI), which will be released Friday morning at www.nacm.org. Pre-election jitters and a lack of clarity that inspired some of the previous months’ volatility may be fading.

Expect the December CMI to show an increase over recent months’ performances. Part of this is because of preliminary data that found manufacturing faring better than expected against formidable headwinds (e.g., the strengthening U.S. dollar and rising Federal Reserve rates). In addition, early signs that an improved (but not record-breaking) holiday sales season versus 2015 activity means that retailers that were previously approaching trouble “will be alive to fight another day.” said Chris Kuehl, Ph.D. That should drive overall improvements to filings for bankruptcies category, which was the only unfavorable factors category within expansion territory (above 50) in November’s disappointing CMI results.

Notable improvements to credit applications are expected in December as well, but it is important to juxtapose them with rejections of credit applications. If the two categories are improving simultaneously, that’s a great sign and will help set the table for a strong start to 2017, Kuehl said.

- Brian Shappell, CBF, CICP, managing editor


For a complete breakdown of the manufacturing and service sector data and graphics, view the December 2016 report on Friday morning by clicking here. CMI archives may also be viewed on NACM’s website.

GDP Growth Likely to End Year on Quiet Note

With consumer spending disappointing in November and durable goods orders soft, GDP growth is expected to end on a quiet note for the year, according to Wells Fargo Securities in a recent economic report. Inflation pressures eased somewhat in December. Based on updated third-quarter GDP data and other indicators, Wells Fargo expects real GDP to expand at a 1.3% annualized rate in the fourth quarter of this year.

Activity in manufacturing is poised to improve in coming years. The factory sector is set to start the new year in expansion territory, a contrast from a year ago, when it was contracting. It should be helped by recovery in the energy sector and improvement in global economic growth, though headwinds may remain from the strong U.S. dollar. Nonmanufacturers are on firmer ground after a rocky 2016.

Durable goods orders fell 4.6% in November due to a drop in civilian aircraft orders. Excluding aircraft and other transportation, new orders rose .5%. Equipment investment may increase in the coming months, due to the fourth-quarter rise of .9% for orders of core capital goods. Current quarter data, however, indicates another soft quarter for equipment investment. Core capital goods shipments remain nearly flat.

Nominal personal spending rose slightly, but, after adjusting for inflation, real spending was up only .1% in each of the last two months. A challenge for consumers is that inflation has picked up while income growth remains slow. Higher prices, however, have not dramatically affected consumer sentiment, Wells Fargo said. Consumer confidence enjoyed a postelection bounce and sits at a post-recession high, which bodes well for economic growth prospects in the 2017.

– Adam Fusco, editorial associate

Federal Reserve Study Indicates Strong Trends in Card Use

From 2012 to 2015, use of credit and debit cards for payments increased, accounting for more than two-thirds of all noncash payments in the United States, according to a Federal Reserve study. The data includes prepaid and nonprepaid cards.

The number of domestic core noncash payments totaled an estimated 144 billion, up 5.3% annually from 2012, said the 2016 Federal Reserve Payments Study, which presents 2015 payments data. The total value of the transactions increased 3.4% to nearly $178 trillion over the same period.

Other findings include:
  • Card payments were led by nonprepaid debit card payments, which grew by 12.4 billion, while credit card payments grew by 6.9 billion.
  • Remote card payments, sometimes referred to as card-not-present payments, accounted for 19% of card payments in 2015.
  • General-purpose card payments initiated with a chip-based card increased substantially from 2012, with growth of 230% per year, but this represented only about 2% of total in-person general-purpose card payments in 2015, during the industry effort to introduce chip card technology.
  • General-purpose card fraud attributed to counterfeiting held a greater share of total card fraud in the U.S. in 2015 compared to countries where the chip technology was more completely adopted. 
  • The number of Automated Clearing House payments is estimated to have grown to 23.5 billion in 2015. 
  • Check payments decreased at a rate of 4.4% annually from 2012 to 2015.

Some survey data will be collected on an annual basis rather than every three years, beginning in 2017, to enhance the value of the study, said Mary Kepler, senior vice president of the Federal Reserve Bank of Atlanta, which sponsored the study.

“The data collected for the 2016 study was substantially expanded,” Kepler said. “This reflects an increased desire within the payments industry for additional fraud-related information. Payment industry participation drives the quality of the study’s results. The Federal Reserve appreciates the industry’s response in 2016 and looks forward to working with selected participants for the annual data collection getting underway in the first quarter of 2017.”

– Adam Fusco, editorial associate

Liquidity Stress Index Points to Declining Default Rate, Moody’s Says

The Liquidity Stress Index (LSI) from Moody’s Investors Service will finish the year in a drop, signaling a moderation in defaults among speculative-grade companies for the coming year, the ratings agency said in its recent SGL Monitor.

“The past year has been choppy for speculative-grade liquidity, with weakness in the commodity sector pushing the LSI to a six-year high in the first quarter and contributing to a jump in defaults,” said Moody’s Senior Vice President John Puchalla. “But since then, the index has trended more favorably, falling below its historical average of 6.8% in October, a milestone related to the gradual letup of challenges in the oil and gas sector and continued good market access for most speculative-grade borrowers.”

The LSI falls when corporate liquidity appears to improve and rises when it appears to weaken. It reached 6% in mid-December. Puchalla said that the sharp drop in the oil and gas sector LSI to 17.1% from a high of 31.6% in March indicates the easing of liquidity and default pressures for the sector in 2017. Balance sheets and investment capacity have improved through asset sales and new financing.

Challenges exist, even in light of expected U.S. economic growth in 2017. Vulnerabilities may lie in the dependence on the market for liquidity and the weak rating distribution of speculative-grade borrowers, but such challenges appear manageable, according to the ratings agency, who expects the U.S. speculative-grade default rate, currently at 5.6%, to reach about 4% by the end of 2017.

The agency’s Covenant Stress Index reached 3.9% in November, down from 4.3% in October, an indication that speculative-grade companies remain at low risk of violating their debt covenants, Moody’s said.

– Adam Fusco, editorial associate

Ongoing Economic Problems in South Africa Pose Great Risks for Agrofood, Automotive Sectors

As Coface expressed concerns about South Africa’s economic performance going into 2017, the credit insurer believes the agrofood and automotive sectors pose major risks.

South Africa’s agrofood sector is among the most developed in Sub-Saharan Africa, is one of the country’s largest manufacturing segments and provides jobs for about 30% of the country’s workforce, analysts with Coface noted. Despite relatively stable demand, “…the deteriorating macroeconomic outlook and uncertainties surrounding economic policies, which are increasingly damaging consumer and business confidence,” place agrofood as a “very high risk.” Reduced investments, poor infrastructure and a weakening of local currency against the U.S. dollar present more added risks to the troubled sector.

Meanwhile, South Africa’s automotive sector is facing a poor economic outlook, high inflation and increasing interest rates, Coface said. “These factors are negatively impacting purchasing power and dragging down domestic sales,” analysts wrote. “New vehicle sales could also suffer from fears over the stability of the labor market and the constant threat of strikes.” A falling rand may also affect production costs that producers are likely to add on to final prices.

– Nicholas Stern, editorial associate

UAE Court System Still Needs to Develop Interpretations, Precedents for New Bankruptcy Law, Fitch Says

As the United Arab Emirates’ (UAE) new bankruptcy law is due to become effective at the end of the year, Fitch Ratings analysts believe courts’ interpretation of the law and how to handle bankruptcy proceedings will be key to its success.

The new law will apply to all companies established under the UAE’s commercial companies’ law, while companies established in the UAE’s free zones are not included because they have their own insolvency and bankruptcy laws.

“Existing UAE law defines how a court can declare a company bankrupt, appoint a trustee, realize assets and settle debts,” noted Bashar Al Natoor, global head of Islamic finance, and Mark Brown, senior analyst, both of the ratings firm. “But there has been no legal provision for the rehabilitation of distressed companies through creditor agreement, and the regime is largely untested.”

To date, debt restructurings in the UAE have been informal arrangements outside of the court system, in part because creditors see local courts as lacking the expertise to quickly and efficiently deal with these matters, analysts said. “When economically significant entities have experienced financial difficulties, the government has intervened, for example by introducing bespoke legislation when Dubai World rescheduled debt repayments in 2009,” Fitch said. “This has left some issues, such as whether courts can annul certain transactions by a borrower in the run-up to a declaration of bankruptcy, unclear.”

Moreover, it could take time for UAE courts to interpret and implement the new bankruptcy law—it is part of the reason why Fitch has yet to change its assessment of the UAE as a Group D jurisdiction in terms of assigning recovery ratings to debt instruments, the firm said. “Group D countries are generally jurisdictions where either the legal regime is less supportive of creditor rights, or the pursuit of a claim is highly likely to be hindered, for example by delays in bringing a claim to court, unpredictable judgments, or inconsistency in following due process.”

– Nicholas Stern, editorial associate

U.S. High-Yield Default Rate Set for 3% in 2017

The U.S. high-yield default rate is expected to finish 2017 at 3%, according to a new report from Fitch Ratings. U.S. energy defaults, after driving the rate in 2016 and currently at an 18.8% November trailing 12-month rate (TTM), also are predicted to reach 3% next year. Default volume for U.S. energy totals $39 billion so far this year.

U.S. defaults in 2017 will reach $36 billion, Fitch expects, an improvement compared to the $59 billion year-to-date, with no specific sector forecasted to propel the rate, as energy and metals/mining did this year.

The U.S. retail sector default rate is expected to climb to 9% from its current 1% TTM. Challenges driving some retailers into default include online competition, an increase in discounters, and a shift in consumer spending toward travel and entertainment. The retail sector carries a 4% weighting in the U.S. Fitch Default Index, so an increase in defaults would not significantly raise the U.S. rate.

Fitch expects health care/pharmaceuticals and utilities/power/gas combined to reach $5 billion in defaults next year. The two sectors experienced their first defaults of 2106 in December when 21st Century Oncology did not make its interest payment and Illinois Power Generating Co. filed for bankruptcy.

Radio broadcaster iHeart Communications, with almost $10 billion in bonds outstanding, represents the largest U.S. name on Fitch’s Bonds of Concern list. If a default should occur, the size of the debt would shift the default rate by .7%.

A total of $3.4 billion in defaults has already been recorded for December, more than the past two months combined. The current TTM U.S. default rate is 4.7%, up from 4.6% in November, Fitch said.

– Adam Fusco, editorial associate

S. Korea’s Strong Political Institutions, GDP Growth to Keep Sovereign Rating Stable

Political uncertainty in South Korea surrounding the impeachment of President Park Geun-hye will probably delay investment and disrupt consumer confidence, but Fitch Ratings analysts don’t expect to the turmoil to negatively impact the nation’s sovereign rating or overall economic activity.

The ratings firm affirmed Korea’s “AA-“ rating with a stable outlook in March and expects GDP growth of 2.5% to 3.0% in 2017 and 2018, which is higher than the 1.6% median rate for countries rated “AA-."

While the country decides whether to uphold Park’s impeachment, Fitch analysts see an opening for a presidential election to find Park’s replacement ahead of the December 2017 date that was originally scheduled.

Corporate restructuring passed in the nation’s 2017 budget is expected to weigh on GDP growth in the short term, but is likely to lead to a more productive allocation of resources over the long term, Fitch said. “The credit profile would be affected if the political situation were to develop in such a way that leads us to reassess governance standards,” Fitch analysts said. “It is possible that the strong public reaction to this scandal might eventually lead to weaker links between the state and the corporate sector, and a structural improvement in governance. However, changes in business culture are unlikely to happen quickly and require government support beyond the presidential election.”

– Nicholas Stern, editorial associate

Federal Reserve to Up Fed Funds Rate

For the first time this year, the Federal Reserve plans to raise interest rates 25 basis points to between ½% to ¾%, driven by a strengthening labor market and expanding economic activity since mid-year, according to a Fed press release.

From the Fed: “Job gains have been solid in recent months and the unemployment rate has declined. Household spending has been rising moderately but business fixed investment has remained soft. Inflation has increased since earlier this year but is still below the Committee's 2% longer-run objective, partly reflecting earlier declines in energy prices and in prices of nonenergy imports. Market-based measures of inflation compensation have moved up considerably but still are low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

“The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. Inflation is expected to rise to 2% over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook appear roughly balanced.

“In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2% inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2%, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”

Outlook Positive for Global Aerospace and Defense Sector

The outlook for the global aerospace and defense sector is positive, with deliveries of large commercial aircraft expected to grow, Moody’s Investors Service said in a new report. Defense spending, after a multiyear downturn, is also set to increase.

“The long-running commercial aerospace supercycle has a bit more room to run, and defense is now picking up,” said Moody’s Senior Vice President Russell Solomon. “Aircraft manufacturer order books remain near all-time highs despite a slowdown in new orders, rising deferrals/cancellations and modestly lower aircraft retirement rates—all as expected.”

Solomon added that deliveries of large commercial airplanes, which have 120 seats or more, will likely grow from 6% to 8% next year due to demand from developing markets. Over the long term, however, supply chain risk remains, as original equipment manufacturers push for cost reductions and pursue an increase in production rates for single-aisle jets and the latest widebodies.

“In 2017, airlines will continue to benefit from steady passenger demand, relatively stable GDP rates and still-cheap jet fuel, all of which are broadly supportive of the coming production ramp,” Solomon said.

Defense spending is expected to rise from 3% to 5%, with the sector’s operating profit to grow from 4% to 6% globally in 2017. Growth prospects are good in the U.S., with expected bipartisan support for increases in defense spending and relief from budget caps. Rising security concerns and geopolitical risk should support the industry globally, according to Moody’s. Higher defense spending may come from countries that increasingly need to defend their own borders if U.S. support for allies is reduced. Heightened tensions related to such potential withdrawals, however, may also lead to reduction in purchases of U.S.-made equipment and services.

In an increasingly political environment, cost control will remain important, Moody’s said. Merger and acquisition activity is expected to continue.

– Adam Fusco, editorial associate

Improved Commodities Sector Will Boost Canadian Firms’ Shift to High-Yield Debt Market in 2017

A boost from the commodities sector, refinancing requirements, and heightened mergers and acquisitions activity will prompt Canadian businesses in 2017 to turn to the high-yield debt market at an increased pace.

"After a significant slowdown in 2016, we expect speculative-grade debt issuance by Canadian companies to increase towards levels of about US$30 billion, up from US$22 billion through November 2016," said Ed Sustar, a Moody's Investors Service senior vice president.
So far this year, the Canadian speculative-grade bond sector saw only 16 new deals compared to 27 the year prior, with the majority of these transactions taking place in U.S. dollars, Sustar noted.

“Moody's attributed the decline to a dearth of new deals from the country's energy and mining sectors, both of which were hindered by the drop-off in commodity prices,” he said.
Still, domestic market bond issuance for the five speculative-grade Canadian companies reached CA$910 million year-to-date, up from the two deals the year prior that totaled CA$625 million Moody’s said. As about CA$5 billion of Canadian-dollar high-yield bonds issued in the last six years need to be refinanced, Moody’s expects speculative-grade issuance to increase over the next two years.

“The median EBITDA interest coverage for Canadian speculative-grade companies has tapered off to an historic low of 2.5x as of September 2016, while median debt/EBITDA has improved slightly, to 5.1x, from an historic high in 2015 of 5.2x,” Moody’s said.

Further, Moody’s expects the Canadian default rate to decline over the next year and come more in line with the long-term average of about five defaults per year, Sustar said. “In addition, the speculative-grade liquidity profile of Canadian companies will improve over the next 12 to 18 months with higher refinancing activity and stronger cash flow generation.”

– Nicholas Stern, editorial associate

Tide for U.S. Steel Turns as Near-Term Outlook Goes Positive

The outlook for the U.S. steel industry for the next year and a half just flipped from negative to stable, and Moody’s Investors Service attributes rising prices, improved capacity utilization and falling imports as the main factors leading the charge.

Since reaching their nadir in October at roughly $470 per ton, hot-rolled coil prices have risen four times to $600 per ton. "We anticipate 2017 will continue to build on this year's advances and our price sensitivities range from $550/ton to $600/ton," said Moody's Senior Vice President Carol Cowan.

Along with rising prices, capacity utilization has also been on a steady march to improvement, reaching 68.9% for the week ending Dec. 3 and just below the 75% stable outlook trigger Moody’s has set. Still, the ratings agency expects capacity utilization to climb to a range between 70% and 74% in 2017.

And there’s been more good news for the sector: U.S. steelmakers have benefited from fewer steel imports as several anti-dumping trade cases concluded in the favor of the U.S. sector, Moody’s said. Year-over-year in October, steel imports dropped 19% to 27.5 million tons, while finished steel imports fell 19.8% to 22 million tons.

– Nicholas Stern, editorial associate

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

China’s Rebalancing Act Sees Limited Progress

While China has made advances in rebalancing its investment-driven economy to one that is consumption-driven, that progress is limited and risks are increasing, according to credit insurer Atradius.

Investments and exports have driven the Chinese economy for decades. As the second-largest economy in the world, China had maintained GDP growth of 10% per year for nearly 30 years. The country’s growth policy was supported by large numbers of workers moving from rural areas to the cities, with only modest increases in wages. Its export policy was supported by the undervalued renminbi. China’s economy remains highly reliant on investments, which have become increasingly credit-driven.

Future growth is not sustainable under this model. The Chinese leadership has sought a transition whereby consumption becomes the driver for growth. In 2013, the Third Plenum meeting of the Central Committee proposed reforms that included an increased role of the market in the allocation of resources, as well as plans to liberalize exchange and interest rates.

In China, about 45% of GDP is devoted to fixed capital investment, a level well above neighboring East Asian countries. Overinvestment and excess capacity in the construction sector and industries such as steel and cement have contributed to a leveling off of China’s productivity. Investment-driven growth has also impeded the growth of personal consumption. The share of household consumption in GDP reached 35.5% in 2010, a low that has increased only slightly since then. (In the U.S., the consumption share is 68.8%.) Chinese authorities believe that if they can grow private consumption, it will foster employment growth and reverse income inequality.

Progress has been made. The size of the industry sector has declined over the past few years, while the services sector has grown, favoring a consumption-driven economy. China’s trade balance has declined, and steps have been taken in opening up the capital account and lifting the peg of the renminbi. Consumption rates are kept down, however, by high savings rates. Chinese families are forced to save large amounts of disposable income due to the lack of developed health care and a pension system. They must self-insure.

After the financial crisis of 2008, consumption and investments were equal partners in GDP growth, with consumption pulling forward in 2011. But the share of total investments in GDP remains high at 45%. While consumption increasingly drives growth, its share in GDP has not risen extensively since its low in 2010.

Further steps toward rebalancing are necessary, according to Atradius. The risk lies in China’s high growth rate, rather than its total debt. The debt problem can be alleviated if the savings rate goes down, if social welfare is extended in order to reduce the necessity of households to save as a precautionary measure. Overcapacity issues in the coal and steel industries have been addressed, but a more comprehensive and centrally led approach is needed, the credit insurer said.

– Adam Fusco, editorial associate

Rebounding Commodities Expected to Keep Asian Nonfinancial Corporate Sector Stable in 2017


Analysts at Moody’s Investors Service anticipate that recovering commodity prices, sound macroeconomic conditions and market liquidity likely will keep Asian nonfinancial corporate credit quality in stable territory in 2017.

"We expect growth in global and regional economies to stabilize in 2017, which will mitigate the risk of any material deterioration in the credit quality of rated Asian corporates," said Gary Lau, a managing director in Moody's Corporate Finance Group. "That said, we expect a continued trend of modest negative-biased rating actions in 2017, mainly because of still-high financial leverage for many companies and company-specific reasons," adds Lau.

Moderate earnings growth should help improve corporate leverage next year, though it should remain high, Moody’s predicts. Monetary easing, bank funding and “strong onshore markets” should redound positively for adequate domestic liquidity. "On the other hand, capital flows will likely remain volatile due to prolonged uncertainty over potential U.S. rate hikes,” said Laura Acres, a managing director in Moody's Corporate Finance Group. “Asia-bound portfolio flows continue to decline, and a continuation of this trend could weaken Asian currencies and fuel further credit market volatility." Protectionist policies in advanced economies also place trade-reliant nations and exporters in the region at risk.

Companies in India should see the strongest profit growth in 2017, boosted by capacity add-ons and higher commodity prices, while China’s expected 6.2% GDP growth and market liquidity may support moderate revenue and cash flow growth, though the country’s substantial investment needs could further heighten financial leverage, Moody’s analysts predict.

Moody’s outlook by industry is stable for China’s property developers, as it is for the Asian marketing, telecommunications and power sectors, analysts said. The outlook for Asian steel is negative, however, as the ratings firms anticipates declining production and low profitability will weaken earnings in the sector.

– Nicholas Stern, editorial associate

Lower Liquidity Stress Index Reflects Strength in Credit Market

Moody’s Liquidity Stress Index lowered to 6.2% in the middle of November, down from 6.6% at the end of October. This is the seventh consecutive month the index, which falls when corporate liquidity appears to improve, showed improvement and indicates ongoing strength in the credit markets, according to the latest SGL Monitor report from Moody’s Investors Service.

“The LSI’s improving trajectory is the result of a confluence of factors, including healthy credit market access, which has helped speculative-grade companies enhance investment funding capacity and proactively manage their balance sheet needs, including refinancing upcoming maturities,” said Moody’s Senior Vice President John Puchalla. “The index has also benefited as the level of rating activity in the energy sector continues to moderate, following a large number of rating actions in late 2015 and early 2016.”

Speculative-grade companies may be benefitting from an environment of ongoing low interest rates, however, rather than improved fundamentals. Risks remain, Puchalla said.

Downgrades of speculative-grade liquidity ratings outnumbered upgrades by seven to three so far in November and were dispersed across industries. The ratings moves did not affect energy companies. The downgrades came about from operational and other issues specific to those companies.

Speculative-grade companies remain at low risk of violating their debt covenants, Moody’s said, as indicated by the rating agency’s Covenant Stress Index, which enjoyed a sixth straight monthly decline, landing at 4.3% in October from 4.4% in September.

– Adam Fusco, editorial associate

Venue Reform Likely a ‘NonStarter’ in 115th U.S. Congress

Overshadowed on Election Day was that fact that, with the Republican Party maintaining of the majority in both houses of the U.S. Congress, committees responsible for potential changes to the U.S. Bankruptcy Reform will be essentially unchanged. This renders venue reform a virtual impossibility in 2017.

“Targeted, surgical, noncontroversial” federal bankruptcy changes appear very much in play, according to NACM Lobbyist Jim Wise, co-founder of Pace LLC in Washington, D.C. The areas of preferences and 503(b)(9) are the most likely to change to the benefit of unsecured creditors in the likelihood that such legislation catches on.

Grand-scale code changes, however, should also not be expected. The appetite to “crack open a complicated Bankruptcy Code” or take on something controversial is simply not apparent, Wise says. Among the more controversial changes would be limitations to venue shopping on the part of debtors in Chapter 11 cases. NACM recommended in its most recent Legislative Brief that Congress "require the debtor to file in the jurisdiction of its primary place of business or its principal assets within 180 days of a bankruptcy filing,” as it would allow more access to cases by businesses, employees and local vendors who are owed money, as well as have the case administered by a court that is familiar with the company and its operations.

Venue reform has garnered support from some federal lawmakers as recently as this spring, notably from those representing Texas and Iowa. However, significant change to venue language would divert many cases (re: revenue) from the areas with the two busiest and experienced (also most debtor-friendly in the minds of creditors) bankruptcy courts in the country: Delaware and the Southern District of New York. Discussions between lobbyists and congressional staffers from these areas on the topic did not prove fruitful this year, and no lawmakers from these areas with previous and continuing Judiciary Committee assignments of note lost seats on Nov. 8.

- Brian Shappell, CBF, CICP managing editor

China Launches Answer to Dying TPP Pact

Perhaps the most profound policy change in the near future following President-Elect Donald Trump’s surprise victory is that trade pacts will be few and far between and existing ones may well be up for review.

The United States has used its market as leverage for years—trading access to domestic markets for favors that were arguably as geopolitical as they were economic at times. The Trans-Pacific Partnership (TPP) was supposedly aimed to isolate China while opening emerging Asia-Pacific markets. The idea was to blunt China’s influence in the region with a trade pact that pulled countries away from Beijing.

If ever there was a plan that backfired, it would be the TPP. Its slow death, capped off by Trump’s successful campaign, which included promises to shut down the deal that included 11 other nations and already faced much opposition even if Hillary Clinton had won as expected, gave China plenty of time to react. A version of a Chinese-led Regional Comprehensive Economic Partnership (or RCEP) that favors it and excludes the U.S. has appeared suddenly. A key difference is that China need not go through an approval process or much public debate to get it up-and-running. TPP members like Malaysia and Australia have already hinted at interested in joining onto the RCEP if the Trump victory completely derails the long discussed trade pact, as is expected.

- Chris Kuehl, Ph.D., NACM economist and co-founder of Armada Corporate Intelligence

Property Markets Are Sound, though Supply/Demand Imbalances Linger in Some Hotel Markets

Fundamentals in the U.S. property markets improved in the second quarter, while high levels of construction in four major hotel sector markets since 2014 have led to supply/demand imbalances, according to new Moody’s Investors Service analysis.

The rating agency said its Red-Yellow-Green scores for the major U.S. property markets, including the hotel, retail, multifamily and industrial sectors, increased slightly in the second quarter to Green 70 from Green 68 in the prior quarter. The Red-Yellow-Green scoring system uses Moody’s near-term outlook for new construction and absorption. Scores indicate which markets are most (Red) or least (Green) vulnerable to short-term declines in occupancy and rent, which are indicators of Commercial Mortgage-Backed Securities (CMBS) loan default risk.

"At the end of the second quarter, our scores were Green for all the major U.S. commercial property types except hotel and suburban office, whose 'Yellow' scores indicate these markets are somewhat more vulnerable to decreasing volume," said Moody's Director of Commercial Real Estate Research Tad Philipp. "Multifamily remains the highest-scoring sector, with New York and Seattle both seeing improvement, including the pace of construction dropping below 3% of existing inventory."

The central business district office segment dropped for the third consecutive quarter, despite Seattle’s 15-point gain, while the suburban office segment declined by 18 points as demand decreased and construction increased, Moody’s analysts said. The retail sector saw a one-point gain, realizing 13 consecutive quarters with a Green reading, as the vacancy rate dropped to 10.9% in the second quarter from 11.2% in the first quarter. The industrial composite score increased as vacancy rates dropped. The hotel composite score also improved four points on revenue per available room growth despite softening demand.

All is not well in all U.S. hotel markets, however, as high construction rates in New York, Houston, Miami and Dallas hotel markets since the end of 2014 have led to a declining Red-Yellow-Green score for the sector, which stood in upper Yellow territory by the end of the second quarter, Moody’s said. "The driving force behind the deterioration in the hotel sector's Red-Yellow-Green score is projected forward supply," Philipp said. "The sector has seen a significant expansion of construction activity, with its score starting to fall after supply exceeded the long-term national average of approximately 2.0% in the fourth quarter of 2014."

– Nicholas Stern, editorial associate

Egypt’s Currency Moves Show Promise, with Possible Inflation, Social Risks

Recent moves by the Central Bank of Egypt to devalue the Egyptian pound and the possibility it will float the currency will work to improve the nation’s sovereign credit profile (‘B’/Stable). But in a new report, Fitch Ratings believes these adjustments may be tempered by the social and political risks Egypt faces.

Egypt’s Central Bank also last week raised its policy rate by 300bp to tighten monetary conditions, while the currency has since dropped further following the Central Bank’s March 13% devaluation of the pound, wrote Toby Illes, director of sovereigns at the ratings agency, and Mark Brown, senior analyst. The Egyptian government has also reduced fuel subsidies. The moves will likely be viewed favorably by the International Monetary Fund (IMF) board and could pave the way for it to approve the $12 billion Extended Fund Facility announced in August.

“We expect the IMF board to approve the deal when it meets to discuss it on Friday, Nov. 11, and release the first tranche of funding,” Fitch analysts said. The ratings agency believes the IMF funding should support the central bank’s foreign reserves stock and potentially lead to international bond issuance.

“Over the medium term, the exchange rate shift should also support external rebalancing, raise portfolio inflows, and ease FX shortages, which have weighed on economic activity, including domestic manufacturing,” Illes said.

However, FX changes could still be risky in that they could increase inflation—already at 14.1%, year-over-year, in September—and lead to exacerbated social unrest, the analysts said. “The fiscal impact of devaluation is mixed. Public sector external debt is low as a percentage of total public debt, but the weaker currency will increase the size of the debt, and the interest rate rise will push up the interest payment bill yet further. The weaker currency will also put pressure on the government's import costs. But the increase in fuel prices and the likely approval of the IMF program will help control spending (although the IMF loans themselves will also add to debt),” they said.

– Nicholas Stern, editorial associate

Turmoil Greets Trump Win

Once again, the polls and the prognosticators got it wrong and, once again, the reaction has been turmoil. The financial markets were convinced that the election would be a narrow victory for democrat Hillary Clinton, but as the races in the battleground states went to republican Donald Trump, it became obvious that this was going to be an upset win for the latter.

At this point, there is very little known about what a Trump presidency will mean, as this was a campaign very light on talk of policy specifics. Markets expressed great concerns initially, but then stabilized for a time. Either way, it is going to take a while for everyone to digest a result that surprised most analysts.

It is assumed that part of the Trump administration plan will be an aggressive attack on trade. Stocks that took the biggest hits were those that are engaged in exports. During the campaign, there were promises to eliminate existing trade deals, such as NAFTA (North American Free Trade Agreement). This leaves virtually no chance that newer proposals, like the Trans-Pacific Partnership, will ever see the light of day. There was also talk of establishing high tariffs on imported goods, especially those from China. If that materializes, it could impair U.S. businesses from many export opportunities.

The Trump win also could influence Federal Reserve interest rate decisions. The expectation was that rates would rise again in December, but now all bets are off. Given Trump’s likely appointments, the Fed may find itself preoccupied with its own survival and playing a reduced role as economic stimulator as a result.

As for Trump’s economic plans, they were largely assailed during summer analyses by economists as a path to recession in the U.S. and even for the global economy. Moody’s Analytics, for example, predicted it would shrink the domestic growth to 0.6% from 2%, although there would likely be a small reduction in unemployment along with it.

Traditionally, much that is said in any campaign is abandoned once the real governing starts—pragmatism takes over. But there has been little about this campaign that could be described as traditional. It remains to be seen how these issues really play out. How the new administration actually addresses trade will be the first signal.

The U.S. is as divided as it has been in generations, which can perhaps be said about most every nation in the world. There are many interpretations of this phenomenon, but at the heart of most of this has been the issue of change. Broadly speaking, the people who have been supporting the Trump vision do not like the changes that have taken place in the world. Those voters, often older, have seen their jobs go to robots and overseas workers and want the old system back. This split may be reaching its peak simply due to demographics. The Millennial population will be the dominant political force for the next 35 years, but they have only barely started to play a role. The eventual transition from one to the other, like it has been in parts of Europe, could be extremely ugly.

– Chris Kuehl, Ph.D., NACM economist

Moody’s Assesses Climate Risk for Sovereigns

Scientists may debate the implications of climate change, but weather events and trends in climate can affect not only the environment, but sovereign credit as well.

Moody’s Investors Service recently described how it incorporates climate risk in its credit analyses and ratings. In the new report Environmental Risks – Sovereigns: How Moody’s Assesses the Physical Effects of Climate Change on Sovereign Issuers, the agency outlined its key rating factors for climate events that, when taken together, have an impact on a country’s ability and willingness to repay its debts. These include economic, institutional and fiscal strength, as well as susceptibility to event risk.

Moody’s classifies climate risk under two categories: climate trends and climate shocks.

 Climate trends include such phenomena as global warming and ocean acidification. They span multiple decades and are less likely to have a discernible impact on credit, since a country will have time to either adapt to the change or take steps to lessen its effects. Due to its nature, however, a climate trend can result in irreversible conditions and can bring about long-term changes in economic and social spheres. They also increase the probability of climate shocks.

Climate shocks, though they are one-time events, can cause significant disruption to economic activity. These include droughts, floods, hurricanes and wildfires.

A country’s susceptibility to climate on its sovereign credit depends on its exposure and resilience to such events. Higher-rated sovereigns are better able to endure such shocks through their diversified economies and stronger infrastructure. They also can carry a higher debt burden at more affordable interest rates. A sovereign that is dependent on agriculture and possesses a weaker infrastructure and smaller fiscal capacity has greater susceptibility to the effects of climate.

– Adam Fusco, editorial associate

Hungary Sees Sovereign Bond Upgrade on Falling Debt, Improving Employment

A declining debt burden, structural economic improvements and a more resilient credit profile have led Moody’s Investors Service to recently upgrade Hungary’s long-term government bond ratings to Baa3 from Ba1, with a stable outlook.

“The stable outlook on Hungary's Baa3 rating reflects the balanced risks to the credit rating over the coming years,” noted Moody’s analysts, including Evan Wholmann, assistant vice president with the ratings agency. “Moody's expects the greater predictability in policy making seen in the last couple of years will be sustained, resulting in a more stable, growth-friendly policy environment in Hungary than in the past. At the same time — and while we expect some further improvements in the country's key fiscal and external metrics, in some areas such as the public sector debt burden — the country will continue to lag its Baa-rated peers.”

The Hungarian government has committed, through primary surpluses, resources to reducing its debt burden that should continue into the future, Moody’s analysts said, as they expect the debt-to-GDP ratio to decline to about 72% of GDP next year from a peak of around 81% in 2011. Also, the government’s debt has a lesser share in foreign currency, which helps increase Hungary’s resiliency in the face of foreign exchange rate shocks.

Also, Hungary’s economy should grow at a rate of 2% to 2.5% in coming years as it benefits from some of the largest fund inflows from the EU to Central and Eastern Europe over the next five years, Moody’s said. A public sector work program has driven up employment rates to 67.1% in the third quarter from about 55% in 2011.

The “bread basket” nation has also benefitted from a persistent current account surplus to the tune of some 3% of GDP over the past few years, compared to a 7% deficit in 2008, analysts said. “This reflects a robust and sustained improvement in the trade balance and gains in export product diversification,” Wholmann said. “Furthermore, Hungary no longer relies on external financing as its capital account benefits from the growing absorption of EU funds, such that the combined current and capital account surplus reached around 10% of GDP in the last quarter of 2015.”

– Nicholas Stern, editorial associate

September Trade Deficit Narrows on Civilian Aircraft Exports

The U.S. trade deficit in goods and services decreased in September by $4.1 billion to $36.4 billion, a 19-month low, fueled mostly by American firms’ ramped-up exports in services.

The deficit decline was larger than analysts predicted, even as exports have been buoyed in recent months by surges in soybean exports, noted Wells Fargo Global Economist Jay Bryson. A lackluster harvest in South America benefited American soybean producers earlier in the summer, though soybean exports have since declined by some $2 billion in September.

“Looking forward, we expect that net exports will again exert headwinds on overall GDP growth,” Bryson said. “The one-off surge in soybean exports will not be repeated in coming quarters, and growth in many of America’s major trading partners remains lackluster. On the other side of the ledger, continued modest growth in domestic demand likely will cause import growth to accelerate somewhat.”

In September, capital goods exports surged with $1.4 billion in civilian aircraft trade, while consumer goods exports rose by $738 million, according to the Department of Commerce.

Imports meanwhile dropped by $2 billion as petroleum imports were mostly flat in September and imports of capital and consumer goods declined, Commerce said. “The decline in capital goods imports is consistent with the weakness in business fixed-investment spending in recent quarters,” Bryson said. “Given that personal consumption expenditures continue to grow, we view the $837 million decline in consumer goods imports in September as being somewhat of an aberration.”

– Nicholas Stern, editorial associate

U.K. May Face Downgrade if Trade Deal With EU Falls Short, Takes Too Long

Brexit has hampered the U.K.’s medium-term economic outlook, but Moody’s Investors Service believes the scale of Brexit’s damage to the U.K.’s growth prospects will depend on whether the trading relationship with the European Union (EU) remains similar to what it has been, as well as how long it will take to strike a new deal with the EU.

“We would downgrade the U.K.'s sovereign rating if the outcome of the negotiations with the EU was a loss of access to the Single Market, as this would materially damage its medium-term growth prospects," said Kathrin Muehlbronner, a Moody's senior vice president and co-author of a recent report on the topic. "A second trigger for a downgrade would be if we were to conclude that the credibility of the U.K.'s fiscal policy had been tarnished as a result of Brexit or other reasons." The U.K. government's Autumn Statement, which is slated for Nov. 23, will likely give significantly more clarity to this issue, Moody’s analysts said.

Moody’s current expectation is that the U.K. will eventually enter into some form of trade agreement with the EU, most likely in a series of accords that provide access to the EU market for goods with more limited access for services, especially financial services.

Analysts anticipate lengthy negotiations, however, with the government starting the exit process by as late as March 2017; even the two-year deadline set by the Lisbon Treaty may be too little time to finalize the process.

“But once negotiations start, the agency expects that the spirit in which they are handled by both sides will offer important insights into the likely outcome,” Moody’s said. Complex and challenging issues to be ironed out in the deal include global trade, immigration and regulation. “Given the magnitude and complexity of these decisions, the risk is material that some might damage the U.K.'s economic or fiscal strength.”

– Nicholas Stern, editorial associate

Asian Companies in Nonfinancial Industries See Negative Ratings Trend

Downgrades and negative ratings for Asian nonfinancial businesses are set to continue in the near term, with Chinese companies in the property development and transportation industries dragging down the overall outlook.

Some 40% of Asian firms rated by Moody’s Investors Service and 31% of Moody’s-rated companies in Japan had ratings with negative implications in the third quarter, said Clara Lau, a Moody's Investors Service group credit officer. On the other hand, firms with stable outlooks were at 53% and 64%, respectively, the lowest levels since the first quarter of 2014.

In the Asia Pacific region, ratings for nonfinancial corporates have been trending negative, with 26 negative ratings versus 15 positive rating actions during the third quarter of 2016.

"By region, China remained the major driver of the negative actions, accounting for 12 of the 26 actions during 3Q 2016," said Lau. "And, by industry, companies in the property development, REIT and transportation sectors each accounted for four negative actions."

Businesses in construction and engineering, and metals and mining, saw the most pressure in the third quarter, with about 65% of rate issuers in these sectors showing ratings with negative implications, Moody’s said.

An exception to the sector trend was seen in Australia, where ratings for companies stayed mostly stable, as the portion of ratings with stable outlooks rose to 78% in the third quarter from 75% at the end of the second quarter, Moody’s analysts said.

– Nicholas Stern, editorial associate

Hanjin Bankruptcy Exposes Potential Risk for U.S. Ports Through Terminal Operators

The bankruptcy of South Korea-based global carrier Hanjin has highlighted the potential risk that terminal operating companies, which are often set up as joint ventures between shipping counterparties or private equity firms, aren’t always remote from the financial status of their owners.

Take the example of Pier T at the Port of Long Beach, which is leased by a joint venture—dubbed Total Terminal International (TTI)—between Hanjin and Terminal Investment Limited (TIL), noted Rob Rowan, senior analyst with Fitch Ratings, in a new report. The port saw TTI’s structure as distinct from Hanjin and believed at the beginning that the shipping firm’s bankruptcy would not impact lease payments. But Hanjin’s ability to post its portion of the joint venture as collateral to obtain funding from Korean Air so that stranded cargo could be processed suggests “…that terminal [joint ventures] are not always remote from the financial situations of their owners,” Rowan said.

“While lease terms are often confidential, scrutiny of [joint venture] structures for lease and concession partners is warranted given ports' potential exposure to shipping counterparties, which are typically of lower credit quality than their port operator landlords in the U.S.,” he continued. “As mergers between some of the world's largest shippers increase and alliances morph to include different carriers with varying bases of operation, ports may be exposed to similar strategic shifts. Careful consideration of the costs and benefits of such concessions, as well as scrutiny of termination provisions, can provide protection as ports consider taking on these agreements.”

– Nicholas Stern, editorial associate

Latest Credit Managers’ Index Maintains Gains on Service Sector Surge

U.S. companies have plenty to be optimistic about in view of NACM’s Credit Managers’ Index (CMI) for October. Retailers gearing up for a better holiday shopping season, more credit applications coming from seemingly worthy customers and top clients asking for substantial levels of credit to buy machines and inventory are just some of the reasons.

Lingering concerns in other areas, however, leave the overall economic picture “jumbled” at least until the U.S. election passes, noted NACM Economist Chris Kuehl, Ph.D.

The latest CMI tracks well into expansion territory at 53.5, although it is slightly off from the September total that came from the biggest one-month improvement in 2016. It shows more strength than the summer months or last year’s holiday season. Much of the hope seems to be driven by a quicker-than-expected rebound by the service sector.

“The gains in the service side this month appear to be in retail, as there is some sense that consumers may be in the mood to spend again,” Kuehl said. “There was also some movement in construction, as there has been renewed strength in the residential category as well as minor growth in the commercial side.”

Kuehl believes credit managers also should be hopeful because the latest CMI data reflect that fewer companies are distressed and “are getting their credit affairs in better order.” Most unease or negativity in October’s data comes from the manufacturing side.

– Brian Shappell, CBF, CICP, managing editor

For a complete breakdown of the manufacturing and service sector data and graphics, view the October 2016 report by clicking here. CMI archives may also be viewed on NACM’s website.

Trading Strategies for Those Entering Into the Growing Chinese Marketplace

As China remains an economic hotspot in a stagnating world economy, companies everywhere remain interested in the possibility of trading into the country.

Aside from figuring out where to find accurate economic data about a country that keeps a close lid on how it obtains official information, foreign suppliers need to understand some of the practicalities of conducting business in China, note analysts with credit insurer Atradius in a new report about trading in China.

Atradius analysts provided the following list of factors to help inform commercial credit professionals attempting to mitigate and optimize rewards when selling into China. (See NACM’s eNews piece that lists more tips for trading into China.)

Understand Chinese business culture. Formality and respect for hierarchy are crucial in Chinese business matters, including the concept of “face,” which Atradius defines as a “…combination of actions and perceptions that can either help or hinder business relationships.” Bad or rude behavior during a meeting can serve to lose face, while having a CEO attend a fruitful business meeting can enhance it. Also, note that obtaining an appointment for a meeting, sometimes as much as a month or two in advance, is essential in China.

Protect intellectual property (IP). A reputation of producing pirated or fake goods is widespread in China, and despite efforts to protect IP in the country, companies will want to register copyright in the country. Copyright protections for written or published works last for 50 years from the author’s death. For commercial inventions, patents in China give protection for up to 20 years and are issued on a “first-to-file” basis. Trademarks are also protected on a first-to-file basis in China. “Apart from recording your registered IP rights, there are several ways that you can protect your IP,” Atradius analysts said. “Regular risk assessment checks, advice from local agents or others already trading in China, and IP-related clauses in your employment contracts can all help.”

Select the correct payment method. Atradius is seeing the possibility for a delay in payment in the durable goods, retail and E-commerce sectors, among others, so pick the payment method wisely. Chinese customers must have significant trust in order to accept a cash-in-advance situation. A letter of credit (LC), especially a Confirmed Irrevocable LC, provides security, though beware of some of the drawbacks. These include shifting the liability for payment to a customer’s bank and the fact that LCs can be expensive to arrange, particularly for low-dollar transactions. Open account terms will be attractive for your customers, but be wary of risks of delayed or renegotiated prices to overseas traders, particularly for perishable goods.

– Nicholas Stern, editorial associate

Department Stores Need to Find Right Mix of E-Commerce, Physical Space to Compete Online

U.S. department stores will have to figure out a way to improve inventory management and take other steps to compete in the face of customers’ growing preference for off-price retailers and online shopping options. Department stores could see a roughly 11% decline this year in aggregate operating income, predicted Moody’s Investors Service analysts.

"Consumers today have access to a broad array of goods at the most competitive prices, which has spurred retailers across the industry to accelerate their efforts to compete more effectively," said Moody's Vice President Christina Boni. "Department stores have been the hardest hit, with relatively slow supply chains their biggest Achilles' heel."

When consumer demand suddenly changes, department stores can pay the price with inventory backlogs, Boni added. Highlighting the stores’ supply chain issues is consumers’ unwillingness to pay full price for goods that have had bigger markdowns in order to clear merchandise. “Unlike department stores, the off-price incumbents continue to achieve impressive results thanks to their ability to purchase high volumes of disparate goods closer to the time they're likely to be purchased,” Boni said.

Also, some department stores, such as Nordstrom and Neiman Marcus, have been more successful at growing online sales than others by investing in technology platforms and fulfillment capabilities to increase e-commerce to between 20% and 25% of total sales, respectively, Moody’s said. Other regional players have been falling behind with less than 10% of total sales in e-commerce.

These challenges place a greater importance on maximizing the use of physical space; Moody’s believes having a brick-and-mortar location makes product pickup and returns more efficient, but predicts owners may have to shingle some locations or reduce size to maintain good results.

In the near term, department stores’ operating income should see about 4% growth next year as trimmed inventory places them in good position to take advantage of holiday season sales and better inventory management positions them to take advantage of improved margins, Moody’s said.

– Nicholas Stern, editorial associate

Corporate Liquidity for Speculative-Grade Firms in Better Shape During First Half of October

Corporate liquidity for U.S. speculative-grade companies as tracked by Moody’s Investors Service’s Liquidity-Stress Index (LSI) improved by mid-October from the end of September, benefitting in part from reduced volatility in the energy sector.

The LSI decreased to 6.8% from 7.1%, extending the index’s six-month decline from a recent peak of 10.3% in March, and matches its long-term average, Moody’s analysts said.

"The LSI is now sitting exactly at its long-term average, indicating that the liquidity pressures that fueled so much volatility in the energy sector are moderating," said John Puchalla, senior vice president at the ratings agency. "Even so, liquidity risks remain elevated among energy companies, with cash flows mismatching debt load at many firms that were largely capitalized before the oil price slump."

Also, U.S. speculative-grade firms are being aided by a favorable primary market to meet their liquidity needs. Meanwhile, “Investors' quest for yield rather than a meaningful improvement in corporate fundamentals is aiding market access, suggesting that liquidity could be vulnerable to sudden shifts in investor sentiment,” Puchalla said.

In the first half of October, Moody’s made no speculative-grade liquidity rating downgrades. It did make three upgrades, as upgrades are now close to overtaking downgrades for the fifth consecutive month, with companies benefitting from refinancing and liquidity gains that accompany distressed exchanges and asset sales, the ratings firm said.

Also of note, Moody’s Covenant Stress Index, which measures the extent to which speculative-grade companies are at risk of violating debt covenants, improved to 4.4% in September from 5.0% in August, carrying on a decrease from April’s peak of 7%, analysts said. Moody’s dropped five companies from the list of those firms with the weakest covenant quality score, and none were added to the list.

– Nicholas Stern, editorial associate