Survey Shows Small- and Mid-Size Firms Had Reduced Revenue Expectations

As expectations by small- and mid-size firms declined a bit in the third quarter from the second quarter, so has those companies’ demand for capital, according to a new Private Capital Access Index survey by the Pepperdine Graziadio School of Business and Management.

The survey, conducted in partnership with Dun & Bradstreet, was of 1,176 people in companies with less than $5 million and between $5 million and $100 million in annual revenue.

Firms surveyed with revenue below $5 million saw their annual revenue expectations drop to 9.3% in the third quarter from 10.6% in the prior quarter, while those with between $5 million and $100 million saw a similar decline in expectations.

Meanwhile, the survey found 22% of all firms expected slower trade account payments than they did in the prior quarter, while between 65% and 67% said payment periods would stay the same. Thirty percent of respondents said slowing payments have reduced their ability to grow, with the impact being more widely felt among smaller firms. Eight percent said they’ve had to reduce staff due to slower payments.

Six percent of survey respondents also said they had relied on a trade credit provider for credit in the last quarter, while more respondents (18%) said they borrowed from a large bank or community bank (13%).

– Nicholas Stern, managing editor

Fitch: Western Europe Sovereign Ratings Driven by Public Debt, Politics

Public debt, economic outlook and politics are the three key drivers of sovereign ratings in Western Europe, according to a new report from Fitch Ratings that presents a country-by-country look at sovereign credit trends in the region.

Positive rating actions have outnumbered negative ones since April of this year. There have been three upgrades (Greece, Iceland and Malta) and two downgrades (Italy and San Marino). Fifteen of the 22 rated sovereigns in Western Europe have stable outlooks while six (Andorra, Cyprus, Greece, Iceland, Portugal and Spain) have positive outlooks. The only country with a negative outlook is the United Kingdom, a reflection of the political and economic uncertainty from the break with the EU, though Fitch points out that its rating is not based on a specific outcome of the negotiations.

The key driver among Western Europe sovereign ratings is public finances. The most frequently cited rating sensitivity across the European Union sovereigns that Fitch rates is the trend in the ratio between public debt and GDP. Improvement in macroeconomic performance in the eurozone is expected to support public finances. “We assess fiscal developments through the cycle,” Fitch analysts said, “meaning that structural improvements in fiscal metrics are more likely to lead to positive rating actions.” A change to positive outlooks for Spain and Portugal are due to headline fiscal deficit reduction and improvement in structural balances that should lead to reduced government debt and improvement in external metrics.

Political challenges remain in the region. Populist and eurosceptic parties are not a spent force, Fitch said, and next year’s Italian elections could see euroscepticism regaining prominence. A continuance of tension between the Catalan and Spanish governments could lead to downside risk to Spain’s strong growth performance.

– Adam Fusco, associate editor

A Look at European Banking, Retail, Telecom and Media Sectors

In Europe’s rated banking sector, higher regulatory and restructuring costs have cut into savings achieved from large-scale branch and employee head count reductions, according to a new Moody’s Investors Service report.

"European banks are facing continued revenue erosion and we expect the sector to remain under pressure to find cost savings," said Nick Hill, a managing director at Moody's Investors Service. "So far, however, head count and branch reductions have not led to significant economies."

Rated European banks have cut branches by 18% since 2010, while total costs grew at a compound annual rate of 1.2% from 2010 to 2016. Higher administrative expenses, likely due to additional regulatory costs and higher legal, compliance and outsourcing costs are the primary culprit, Moody’s said. Meanwhile, profitability at European and U.K. banks has fallen since the financial crisis as return and tangible equity has measured in the single digits since 2007.

“The challenge of reducing costs is unlikely to diminish for European banks, despite the region's economic recovery, as interest margin pressures continue,” Moody’s said. “The pace of consolidation has accelerated, but the relationship between scale and efficiency is low, suggesting that banks will need to look internally to achieve further savings.”

European Retail
The retail sector’s prospects look bright in Europe thanks to overall revenue and earnings growth into 2018, Moody’s said in a separate report. "A rosier economic outlook for the majority of countries in Europe will offset fierce competition in many segments of the region's retail sector, underpinning median revenue and earnings growth of 3.0% and 4.1%, respectively, and supporting the stable outlook on the sector into 2018," said Vincent Gusdorf, vice president and senior analyst at Moody's.

At 3.1% for 2018, retailers’ growth prospects in the U.K. are not as strong as they are for those on the continent, mainly due to the effects of Brexit, Moody’s said.

Telecom and Media
Increased competition is likely to hamper growth for firms in the telecommunications and media sectors, especially for cable operators, Moody’s said in another report. Still, the above-average quality of the CLO-held issuers in the sector will help to offset this drag, analysts said.

"Debt issuers in the telecommunication and media, broadcast and subscription industries sector have better credit quality than the average CLO-held issuer in European CLO 2.0s we rate," says Javier Hevia Portocarrero, vice president and senior credit officer at Moody's. "Our 12-month default forecast is 0.7% for the combined European TMBS sectors, compared with 1.3% for all speculative-grade issuers, and our outlooks for the sectors are stable."

– Nicholas Stern, managing editor

Some U.S. Homebuilders Still Struggle during Housing Recovery

Though the housing market has been recovering for six years, some homebuilders are still struggling from high leverage and a heavy debt burden. Though operating conditions are more favorable, some have yet to bounce back.

According to a new report from Fitch Ratings, Havnanian Enterprises (HOV) and Beazer Homes USA (BZH) carried heavy debt into the downturn. Cash flow has been held back by high interest rates, and leverage is still at an elevated level. BZH has a chance to catch up to its peers if the housing market remains healthy, but HOV’s capital structure is untenable, the ratings agency said. HOV can avoid default if housing stays robust for several more years and if it can refinance near-term debt. It recently refinanced debt due in 2018 and 2019, though substantial debt will still mature in the next few years. BZH reduced its total debt by nearly $200 million since fiscal 2015 and plans to pay down another $100 million through fiscal 2018.

The operating models and growth strategies of homebuilders are focused on land purchases and development spending, Fitch said. Both HOV and BZH have recently curtailed land and development spending to concentrate on debt reduction, but lower land spending has led to a reduction in community count, lower net orders and a reduction in home deliveries.

Fitch expects the housing market recovery to continue through at least 2018, though rising costs for land, labor and materials will weigh on profits. Favorable demographics and continuing economic growth should offset inflation and a possible rise in interest rates. First-time buyers are expected to continue to represent a higher portion of housing purchases. Some lessening in affordability has occurred, however, as the upcycle in housing has matured, Fitch said.

– Adam Fusco, associate editor

Fewer Companies on Lower Corporate Ratings List Points to Declining Default Rate

There were fewer firms on Moody’s Lower Corporate Ratings List and earning its B3 Negative designation in the third quarter, pointing to a declining default rate in the year going forward.

The Lower Corporate Ratings List dropped 5% from the second quarter and is 26% smaller than its all-time high of 291 issuers, according to a new report from Moody’s Investors Service. "In the third quarter of 2017, most of the issuers that left our list of lower-rated companies did so due to rating withdrawals for reasons other than default," said Moody's Associate Analyst Julia Chursin. "Notably, the number of rating actions related to defaults among B3 Negative and Lower rated companies was the lowest we have seen so far this year."

The portion of energy and mining sectors’ shares of the B3 Negative and Lower list have dropped since commodity prices have stabilized, while the oil and gas sector’s share has dropped the most, though these companies still make up more than a fifth of the list, Chursin said. The consumer and business services sector has the next highest portion at 14%, followed by retail and apparel at 11%.

A majority of Moody’s indicators still point to easing credit and default risk for speculative-grade companies. Its’ Liquidity Stress Indicator dropped to 3.0% at the end of September from 3.5% at the end of June. Borrowers generally have good liquidity and access to favorable financing conditions, and Moody’s anticipates that the one-year U.S. speculative-grade default rate will drop to 2.3% in September next year, from 3.3% now.

Still, there are reasons to remain watchful. "Despite supportive credit conditions and accommodating markets, speculative-grade corporate family ratings continue to migrate lower and are now concentrated in the B2 and B3 rating buckets," Chursin said. "Event risk remains a concern for companies with weak balance sheets, particularly as interest rates rise."

– Nicholas Stern, managing editor

Fitch: Countries Can Rebound From Ratings Downgrades

A ratings downgrade is not the last straw for some sovereigns, however, it is not an easy recovery for some. Fitch Ratings reviewed 37 sovereign rating crises over the last 20 years and found it takes “an average [of] two years to reach the ratings trough and [they] have a high likelihood of suffering further downgrades.”

The analyzed sovereigns had at least three ratings downgrades within three years, and the average downgrade was nearly six levels. The most affected country was Greece, which saw its first downgrade in 2009. It had a total of 14, while Korea and Cyprus each saw 12 downgrades. Seven countries hit rock bottom, or the trough, in the year of the first downgrade. San Marino had the longest cycle from 2009 to 2017.

Despite the major setbacks, countries can recuperate. All sovereigns that saw the crisis start before 2008 have recovered at least one rating, and 10 have fully recovered. Korea had the strongest rebound within 10 years of the crisis, recovering all but one ratings notch. In addition, Uruguay and Russia have had improved ratings.

Roughly two-thirds of the sovereigns to see a ratings downgrade since 2007 have had at least one upgrade. Iceland, Latvia and Cyprus have been among the top performers. Iceland, Greece, Spain, Portugal and Cyprus are also expected to have further upgrades since they are on Positive Outlook.

-Michael Miller, editorial associate

Small Business Optimism Takes a Dive in September

Led by a severe drop in sales expectations across the country, the Index of Small Business Optimism from the National Federation of Independent Business (NFIB) slid from 105.3 to 103 in September.

“The temptation is to blame the decline on the hurricanes in Texas and Florida, but that is not consistent with our data,” said NFIB President and CEO Juanita Duggan. “Small business owners across the country were measurably less enthusiastic last month.”

The number of small business owners who expected better sales fell 12 points for the month, while the number of owners who think it is a good time to expand dropped 10 points. Readings for expected better business conditions and capital expenditure plans also decreased in September.

“The drop off was consistent around the country regardless of region, and it’s likely that members in Florida and Texas were underrepresented in this survey because of the obvious disruptions,” said NFIB Chief Economist Bill Dunkelberg. “The adjusted average employment change per firm dipped to -0.17, which is a significant drop in hiring activity.”

Six of the 10 components of the index dropped in September. The reading for inventory plans bucked the trend, gaining five points as business owners anticipate a strong fourth quarter, the NFIB said. Two percent of business owners recorded that their borrowing needs were not satisfied, a decrease of one point. Thirty-three percent said that all their credit needs were met while 51% said they were not interested in a loan.

“The Index remains very high by historical standards,” Dunkelberg said. “Small business owners still expect policy changes from Washington on health care and taxes, and while they don’t know what those changes will look like, they expect them to be an improvement. But the frothy expectations they’ve had in the previous few months clearly slipped in September.”

– Adam Fusco, associate editor

Credit Market to Hit $1 Trillion in Managed Assets by 2020

The global private credit market, which manages $600 billion is assets, is set to reach the $1 trillion mark by 2020 with its current rate of growth, according to research by the Alternative Credit Council (ACC), the private credit affiliate of the Alternative Investment Management Association (AIMA).

“Private credit has become a permanent feature of the lending landscape and we forecast that the industry will break the $1 trillion ceiling by the end of the decade,” said AIMA CEO Jack Inglis. “Performance across the industry continues to be strong relative to many other asset classes. This has attracted fundraising, as investors hope to capture continued outperformance in the future. The industry continues to deliver flexible deals suited to borrowers’ needs and the success of the sector to date is fueling its expansion into new markets.”

Small- and medium-size businesses (SMEs) dominate the lending market, the ACC said in a recent release. About one-third of total committed capital is being lent to SMEs and the mid-market. The share of lending is about 22% for large businesses. The research suggests that private credit managers are required to be more flexible as covenant and coupon terms have shifted more favorably to the borrower. Focusing on lending standards and robust risk analysis is the most resource-intensive activity among 85% of private credit managers, according to a survey accompanying the research. One-third of the industry’s total assets is available capital, known as “dry powder.” It is at its lowest level in several years. During the period from 2000 to 2008, it was often close to 50%, the ACC said.

Most private credit activity continues to take place in the United States, but managers are looking for new growth opportunities in other markets. Beyond the U.S. and U.K., credit managers mentioned Germany, France and Canada as countries with significant opportunities for lending growth, the ACC said.

– Adam Fusco, associate editor

Chinese Banks Improve Funding Profiles following Regulatory Tightening

A more stable macroeconomic environment, improvement in funding profiles and regulatory tightening that curtailed Chinese banks’ reliance on market funding has led to improved results for the first six months of the year. Still, lower net interest margins have pressured their profitability.

"The banks' H1 2017 performance demonstrates that regulatory measures implemented since January this year have been successful in containing financial risks and unwinding some shadow banking and interbank activities," said Nicholas Zhu, a Moody's vice president and senior analyst in a new report.

"These positive outcomes will likely continue under the current regulatory environment—a credit positive for the banks, because such a situation would relieve the strain on their capital and funding positions, although at the expense of profitability.”

Banks that have relied on market funds to support their asset expansions are likely to see lower profitability, Moody’s analysts said.

The 16 banks that Moody’s analyzed in the report account for more than 70% of total assets for Chinese commercial banks. Their average asset growth slowed to 4.4% during the first half of the year, due partly to general declines in their investment in loans and receivables. Loan growth was also sluggish, with mortgage loans under stress thanks to tightened macro-prudential measures on property transactions.

– Nicholas Stern, managing editor

Large Banks Pile into Blockchain Trading Platform Project

Large, multinational banks are partnering together to build a new global trade finance platform using blockchain technology.

According to a report in Global Trade Review (GTR), Commerzbank, Bank of Montreal, Erste Group and CaixaBank are joining a project underway by UBS and IBM dubbed Batavia in an expansion of a proof of concept that IBM and UBS launched at Sibos in 2016 and have completed successfully.

The global platform is designed so that organizations can build multiparty, cross-border trading networks, GTR said. “It will give participants in a trade transaction a shared, immutable record, which will improve transparency and efficiency, minimize the risk of errors and dispute, as well as drive more trade business.”

The technology is designed to track shipment progress, facilitate financing for all types of trade regardless of how they’re transported and offer access to smart contracts, which allow payments to automatically be released as steps in the contracts are completed, GTR said.

The project is already underway and the pilot transactions with customers are slated for next year, with future project timelines to be set then.

A key factor of the project is creating connections between the smart contracts and the Internet of Things sensors that can feed data, such as the location of a shipment, into the contract, GTR said.

– Nicholas Stern, managing editor

SWIFT Survey Reveals Treasurer Wish List


Real-time tracking is at the top of a wish list among corporate treasurers when dealing with cross-border payments. In a recent survey conducted by EuroFinance and financial messaging provider SWIFT, pressing issues confronting corporate treasurers include the lack of payments traceability and confirmation of credit, the need for visibility on bank fees, and inconsistencies between amount sent and amount received.

Titled The Future of Payments: A Corporate Treasury Perspective and revealed at the EuroFinance International Conference in Barcelona, the survey collected the opinions of 300 treasury professionals from around the world in 18 different industries. A majority of treasurers, 64%, named real-time tracking as the enhancement they most sought, followed by increased consistency between bank payment processes and better visibility for banking fees, SWIFT said in a recent release.

“Corporates expect greater transparency in cross-border payments,” said Wim Raymaekers, head of banking market and SWIFT global payments innovation (gpi) at SWIFT. “They want to know what is happening with the payment and when it has been credited on the beneficiary’s account. Until now, this has not been the case. This survey confirms the relevance of SWIFT gpi, because of its ability to address these key pain points.”

Other findings include concerns surrounding alternative payment providers for cross-border payments, citing problems with scalability, security, regulatory oversight and standardization. Forty-two percent of treasurers seek instant payments for their transactions. In regards to choosing a bank partner for cross-border payments, 86% of respondents mentioned the need for efficient payment processes and better customer support. Competitive pricing and extended global coverage were listed as other desired criteria. Innovation for its own sake was a low priority; rather, innovation put to use to confront fundamental concerns and needs was desired more, according to SWIFT.

“SWIFT is continuously engaging with corporates in order to understand their priorities and challenges,” said Marc Delbaere, head of corporates and supply chain at SWIFT. “The recently launched SWIFT gpi service addresses many of the main topics cited by treasurers, in particular, real-time payments tracking. This is the ideal foundation to make international payments more efficient for corporates and we are working very closely with banks and corporates to fully embed SWIFT gpi into their core processes.”

– Adam Fusco, associate editor

As China’s Economy Matures, Neighbors Are Poised to Grow Low-End Manufacturing

As China’s economy rises and matures, the manufacturing juggernaut will continue to cede low-end manufacturing opportunities to Asia’s emerging markets best poised to take advantage of the situation.

“The countries best-placed to take advantage over the next few decades will be those offering workable business environments and relative macroeconomic and political stability to complement low wages, strong demographics and geographical advantages,” according to a new report by Fitch Ratings.

In China, a variety of factors over the past decade, including higher wages and land costs, as well as real exchange-rate appreciation, have made other nations like Bangladesh, Indonesia and Vietnam more competitive for cheaper manufacturing. The average Chinese manufacturing wage is now higher than other Asian neighbors, and finding inexpensive labor going forward will be a challenge amidst the nation’s high urbanization rates and a working age population set to shrink by 0.4% each year on average through 2035, Fitch said.

China’s global share of exports of clothing, footwear and furniture is still nearly 40%, up from 34% in 2010, but probably peaked in 2014 and appears to be on the decline, with Chinese exports of these types of goods decreasing 10% in 2016, Fitch analysts said.

Meanwhile, Bangladesh and Vietnam’s global portion of these types of manufactured goods rose to 8% in 2015 from 3% in 2010, Fitch said. Bangladesh has a firmly ensconced ready-made garments sector, while Vietnam is well-positioned to grow its basic electronics manufacturing sector, analysts said.

Still, political instability and business-environment deficiencies already prevent some of China’s neighbors, such as Pakistan and Myanmar, from taking full advantage of manufacturing opportunities in the region, Fitch said.

– Nicholas Stern, managing editor

Kamakura: Corporate Credit Quality Improves in September

Kamakura Corporation’s troubled company index ended September with a decrease of 0.16% from the month prior. That was a decrease of 0.07% from Aug. 31. At September’s 7.77%, the index reflects the percentage of companies that have a default probability of more than 1%. An increase in the index indicates a reduction in credit quality while a decrease indicates an improvement in credit quality.

Among the 10 riskiest rated firms in September, six were from the United States, two from Great Britain, and one each from Australia and Singapore. During the month, there were seven defaults among the companies in the index.

“Credit markets continue to be stable with benign short-term indicators,” said Martin Zorn, president and chief operating officer for Kamakura. “The Kamakura expected cumulative default rate continues to point to significant warning signs in the five-to-seven-year horizon which should not be ignored.”

The riskiest rated firm, with a one-year Kamakura default percentage of 20.31%, up 10.7% during the past month, was Boart Longyear Ltd., a mineral exploration company. It is undergoing a restructuring supervised by the New South Wales Court of Appeal.

“The large jump in the default probability for Boart Longyear Ltd. seemed notable as an example of liquidity risks and restructuring risks that transcend the banking book, given the increase in lending by alternative asset managers,” Zorn said. “With the introduction of IFRS9 and later CECL, we believe that we will see more liquidity provided by alternative sources and this is an instructive study of how future restructurings may evolve.”

The Kamakura troubled company index measures the percentage of firms that have an annualized one-month default risk over 1% among a group of 39,000 public firms in 68 countries. Kamakura uses a large historical database with more than 2.2 million observations to produce a forward-looking statistical estimate of default risk 10 years into the future, with the troubled company index focusing on the short term.

– Adam Fusco, associate editor

Manufacturing Sector Sees Solid Gains in September

Manufacturing activity ramped up in September as the ISM manufacturing index reached a cycle high. And while some gains can be attributed to increased activity following hurricanes Harvey and Irma, the data suggest underlying strength in the sector, according to an analysis by Wells Fargo Chief Economist John Silvia and Wells Economist Sarah House.

September’s ISM index increased to 60.8, while supplier deliveries posted the largest gain, increasing 7.3 points to 64.4. Bottlenecks from the Gulf area storms have grown beyond the chemicals industry to include the paper products and food, beverage and tobacco sectors. “That said, supplier deliveries have been lengthening over the year, consistent with improving manufacturing activity,” the Wells analysts said.

The production index had its fourth consecutive month of above-60 readings in September, while new orders jumped also, suggesting strength should continue for at least the next couple of months, Wells said.

Manufacturers have also been adding to inventories to meet the growing demand. “Although much of the ‘hard’ data on inventories has yet to become available, the ISM signals the strongest quarter of inventory building at the nation’s factories in more than two years,” Silvia and House said. “Moreover, the buildup appears intentional, as customer inventories were reported too low for a third consecutive month.”

Input costs are also rising thanks to the recent storms.

Manufacturing payrolls have gained by an average of 17,100 jobs per month so far this year, while the ISM employment index points to continued strength for September, Wells said. “We look for the factory sector to add to payroll growth in Friday’s employment report, but note that hiring disruptions due to the recent hurricanes generate the potential for readings that may not be indicative of the underlying trend in factory hiring.”

– Nicholas Stern, managing editor

NACM’s Credit Managers’ Index Reaches High Point for 2017

With the September combined score of NACM’s Credit Managers’ Index reaching its best level so far in 2017, it may be that the gains seen in August have established themselves into a positive pattern.

“The hope is that this may be the start of a nice little trend for the end of the year,” said NACM Economist Chris Kuehl, Ph.D.

The September index’s combined score came in at 56.5, an increase of more than a point from August. Most of the progress came from the favorable factors, whose combined score reached 63.5, the highest since April. Though there was some weakness remaining in the unfavorable factors, most of them are in expansion territory in the 50s.

Among the favorable factors, the sales reading is at its best level of the year, while the most volatile category, dollar collections, returned to the 60s this month. The reading for amount of credit extended stayed roughly the same. “There is still evidence that most of the credit is being issued to some of the larger companies,” Kuehl said.

The unfavorable categories—which include accounts placed for collection, disputes and filings for bankruptcies—remain close to the contraction zone (below 50), but all except one are above 50, and all are trending positive.

The performance in the manufacturing sector has been more positive than expected in the country as a whole. “Much of this can be attributed to a boost in export over the last few months,” Kuehl said. Favorable factors for manufacturing are all in the 60s.

Improvement in the service sector was more robust than in manufacturing in September, though its categories can be more volatile. The overall score for the sector was 57.1, a significant rise from August’s 55.1.

“Once more, there may be some expectation of stability and a trend toward the positive,” Kuehl said. “The favorable factors are improving, but the unfavorable numbers are still lagging badly.”

– Adam Fusco, associate editor

Click here for a complete breakdown of the manufacturing and service sector data and graphics. CMI archives may also be viewed here.

Cyber Insurance Policy Growth Not Necessarily Tied to Improving Insurer Credit Profiles

The hacking of Equifax’s extensive data on an estimated 143 million Americans is just the latest headline grabber in the growing and dangerous world of cybercrime. It may not surprise many that the cyber insurance sector has seen rapid growth recently, as global stand-alone cyber coverage is estimated at between $2.5 billion and $3.5 billion annually.

And according to a new report from Fitch Ratings, more active cyber regulation in the U.S. is a prime factor behind the estimated 90% of global cyber premium that originates here.

Despite the growth in the market, the ratings agency expects cyber insurance businesses to be ratings neutral for most highly rated insurers with sound underwriting policies, especially as these insurance lines make up a modest percentage of their overall volume and risk exposure. But the policies also present unique challenges to insurers based on the relatively new and difficult-to-quantify nature of cyberattacks.

“Insurers that lack cyber underwriting expertise, poorly manage their risk accumulations or fail to recognize loss potential from ‘silent’ cyber exposure in their traditional commercial insurance products could face pressure on earnings, capital or even ratings, if large loss scenarios emerge as the market expands,” Fitch analysts said. “Unduly large cyber risk aggregations of specific insurers may not become evident until after a large or catastrophic cyber event.”

Geographical diversification of risks also doesn’t play much into risk exposure with cyber threats as it does for other insurance lines, thanks to the interconnected nature of the internet, Fitch said. Also, risk concentrations can be more correlated to factors like exposure to a specific electric payment processor or firewall system, rather than a specific industry or geography.

Further, a lack of standardized policy language and terms can lead to significant differences among policies that can frustrate policy holders, analysts said.

Fitch predicts that developing cyber regulation in Europe, such as the General Data Protection Regulation set for implementation in May 2018, and other locales will likely increase demand for cyber insurance policies.

– Nicholas Stern, managing editor

Asian Development Survey Suggests Fintech, Digitization Still Not Significantly Impacting Trade Finance Gap

Banks and companies in the trade finance sector are increasingly using digital solutions to address companies’ significant and unmet financing needs. Yet the global trade finance gap—estimated at $1.5 trillion, with approximately 40% originating in Asia and the Pacific—persists in a stable state, with emerging economies and small- and mid-size enterprises (SME) bearing the brunt of financing shortfalls.

More than half of the 1,336 firms surveyed by the Asian Development Bank (ADB) in its recent Trade Finance Gaps, Growth, and Jobs Survey said they didn’t look for any alternative sources of financing when a transaction was rejected. The survey found that approximately 36% of rejected trade finance transactions were considered viable, but were rejected because of low profitability (15%) or the need for additional client information or collateral (21%). “These types of rejections, however, may be fundable by other financial institutions such as fintech firms which have different requirements,” the report’s authors concluded. Close to a third of rejections were due to Know Your Customer (KYC) concerns: “ … anecdotal evidence suggests that in most cases banks were not willing to expend the cost and effort to conduct KYC, particularly for potential SME clients that would not generate much profit.”

As fintech and digitization remain a focus of a potential solution for SME financing needs, data continue to show “ … few firms are familiar with fintech solutions to finance, and digitization of trade finance processes in banks are not reducing rejection rates for SMEs,” the ADB report found. About a fifth of firms surveyed said they used digital finance platforms, with peer-to-peer lending remaining the most-used platform.

And while 66% of the 515 banks surveyed by ADB reported that digitization is expected to enhance their ability to assess SME risk, and about 70% of firms said they expect technology platforms to reduce trade finance gaps, rejection rates of SMEs remain high. “The data challenge the assumptions that cost reductions alone will automatically reduce market gaps, particularly for SMEs. Indeed, there is no evidence to suggest this is happening.”

The report’s authors suggest that digitization and fintech “ … must be used to make due diligence on credit risk, performance risk and KYC more efficient, cost-effective and reliable.”

– Nicholas Stern, managing editor

Business Volume Rises in Equipment and Leasing Sector

In the equipment finance sector, new business volume rose 1% year-over-year in August, according to the Monthly Leasing and Finance Index from the Equipment Leasing and Finance Association (ELFA). The index takes economic data from 25 companies representing the $1 trillion equipment finance sector. Year to date, cumulative new business volume rose 6% compared to 2016.

Credit approvals were down slightly from July, totaling 75.3%. Head count for equipment finance companies was up 17% year-over-year, though this was mostly due to acquisition activity at one of the reporting companies. Receivables over 30 days were 1.5%, an increase from 1.4% in July and 1.3% in the same period last year.

A separate index, the Equipment Leasing and Finance Foundation’s Monthly Confidence Index, registered 63.7 for September, down from 64.4 in August.

“After a relatively strong second quarter in which growth in the overall economy is in the 3-percent range, end-of-summer equipment financing volume also is on solid footing,” said ELFA President and CEO Ralph Petta in a release. “U.S. business owners appear optimistic about the health of the economy, providing impetus for them to grow their businesses. … With low unemployment, healthy consumer spending, and equities and fixed-income markets at historic highs, the economy is in good shape. This bodes well for continued investment in equipment by businesses, both large and small.”

“The equipment leasing and finance industry continues to support capital formation in the U.S. with a 5.5-percent uptick in new business volume through eight months of 2017 compared to eight months of 2016,” said Robert Neagle, president and general manager, Merchant Finance Division, Ascentium Capital LLC, in the release. “As has been the pattern throughout the past couple of years, the expectation is for a stronger third quarter end.  While there was a slight move up in delinquency in August, asset quality continues hovering in a fairly consistent range month-to-month. The summer is over and so is any seasonal leveling of new business volume.”

– Adam Fusco, associate editor

China Could Soon See Defaults on Certain Types of Public Bonds

Despite China’s 2014 Budget Law that stated local government financing vehicles (LGFVs) would no longer be recognized as public sector liabilities eligible for government support, no LGFV has defaulted on its publicly traded debt.

That situation is likely to soon change, according to Fitch Ratings in a new report, and could trigger a re-pricing of the market, analysts said. “However, widespread LGFV defaults remain a tail risk, given that the authorities continue to rely on local government investment—supported by LGFVs—to hit economic growth targets and have a broad spectrum of policy tools to limit default contagion.”

The Chinese government has tried to separate LGFVs from public-sector balance sheets as part of a larger effort to contain risks associated with the growth in municipal contingent liabilities, Fitch said. Debt ceilings and debt swaps have been used to convert LGFV obligations into explicit local government debt, but LGFV debt continues to rise strongly. Since the 2014 Budget Law, investors haven’t much changed their view of the likelihood of default for these bonds given the narrow spreads on LGFV securities, as “ … there remains a conflict between these stated central government policies and implicit support of LGFVs in practice at the local level,” Fitch said.

Fitch estimates approximately 5.4% of GDP in LGFV bonds issued domestically since 2015 remain outstanding, with pockets of excessive risk taking and debt hiding likely a part of the mix. Analysts predict that Chinese authorities might soon allow selected defaults on LGFVs that come under stress, particularly lower-tiered ones that consist of property with urban development.

“We would expect a re-pricing of LGFV bonds due to better risk discrimination by creditors and an accelerated replacement of the opaque LGFV mechanism with a genuine municipal bond and loan market,” analysts said. “It is also likely that market liquidity might dry up for some LGFVs, at least temporarily, which could cause problems for some issuers—particularly those that have issued debt with short maturities and are therefore exposed to refinancing risk. Access to foreign borrowing may also become more limited or expensive for some LGFVs.”

Still, the government is in a position to prevent systemic defaults, including the last-ditch use of a fiscal solution, Fitch said.

– Nicholas Stern, managing editor

Core Permian Basin Counties Mark Hot Spot for Improving Credit Quality

Oil and natural gas companies with operations mostly located in the core of the booming Permian Basin are poised to see their credit quality improve, while those operating at its fringes should see less of a bump, according to a new report from Moody’s Investors Service.

"E&P companies including Pioneer Natural Resources, Diamondback, Energen, RSP Permian and Parsley Energy all have high acreage concentrations in core counties with outsized Permian exposure, leaving them well positioned to prosper," said Moody's assistant vice president Paresh Chari.

Other firms with operations on the Permian fringes, such as Anadarko Petroleum, Chevron and Occidental Petroleum, would not likely see their credit quality improve just because of their development there, said Moody’s analysts. Legacy Reserves and EP Energy operate in the fringe areas but have moderate exposure, while Approach Resources mostly holds acreage in mainly fringe counties, leaving its credit quality vulnerable—weak well performance or unexpected declines in production being the primary cause, Moody’s said.

Moody’s sees recent acquisitions highlighting the Permian Basin’s booming counties for E&P activity. “Producers have spent almost $27 billion in the past year, targeting mainly the Martin, Glasscock, Howard and Reagan counties in the Midland Basin, and Reeves, Pecos and Ward counties in the Delaware Basin,” analysts said. “Rig counts also help demonstrate which counties are core to the Permian, with most rigs situated in the westward Delaware and eastward Midland basins. At mid-2017, oil production in those basins had risen to about 2.5 million bpd, with another 500,000 boe/d of growth expected by 2018.”

– Nicholas Stern, managing editor

Aircraft Lessors See Strong Outlook in Medium Term

Strong air travel growth, aircraft leasing, potentially rising lease yields and accommodative funding markets point to favorable industry conditions for aircraft leasing company credit profiles for the rest of the year.

Air traffic growth has stayed strong and, twinned with low oil prices over the last couple of years, has translated into a positive sector outlook for both airlines and aircraft leasing firms in recent years, according to a recent report by Fitch Ratings. Through July, revenue passenger kilometers were up 7.7% on the year, the highest rate since 2011 and above the average of 5.5%. Low oil prices have led aided airline profitability.

Aircraft lessors have seen low repossession activity and high utilization rates as more people choose to lease aircraft over ownership—about 40% of the global aircraft fleet was under an operating lease as of 2016, approximately double the rate 20 years prior, Fitch analysts said.

“Fitch believes that some of these favorable industry dynamics will moderate over the medium term,” the ratings agency said. “For example, air traffic growth is not likely to be sustainable at current levels and should decelerate. There are also some indications that aircraft demand may be beginning to slow, which could suggest that aircraft deliveries from the major producers could peak. That said, lower demand should not meaningfully affect aircraft lessors given already-high utilization rates.”

Aircraft lessor asset impairments have been low, reaching an average of 0.5% from 2012 to the second quarter of 2017, mostly through the resilience of the appraised value of some aircraft.

– Nicholas Stern, managing editor

Auto Industry on the Fast Track

The fast-changing automobile sector is set to exceed 100 million in annual sales in 2019, with China and India boosting worldwide sales growth this year and next, according to a new economic outlook on the industry from credit insurer Euler Hermes. The report assessed the auto industry in China, France, Germany, India, Italy, Japan, the U.K. and the United States, focusing on sales, electric cars, profitability and innovation.

The debt burden of manufacturers is lower than before the financial crisis, with the exception of those in the U.S. and Italy. Liquidity and capital expenditures remain stable, Euler Hermes said. Profitability is strong across the sector, with an average EBIT margin of 6% in 2016, up from its 5.5% level in 2015.

“The report identified three levers for innovation: R&D expenditure, patentable technology and external growth,” said Maxime Lemerle, head of sector research at Euler Hermes. “Traditional manufacturers in Germany, Japan and the U.S. lead the first two categories, while China and India exhibit aggressive growth.”

The number of electric vehicles could exceed 3 million worldwide in 2017. China, France, Germany, the U.K. and the U.S. are market leaders for battery-powered cars. China and the U.S. are expected to represent two-thirds of global electric vehicle sales by year end.

China is expected to be at the forefront of sales growth, with India in second place, which will offset declines in sales in the U.S. and U.K.

“New vehicle registrations are expected to grow globally 2.1% this year, as Europe is on the mend and manufacturers worldwide are making cars ‘cool’ again,” said Ludovic Subran, chief economist at Euler Hermes. “However, this is only half the growth of 2016, as new registrations in the U.S. and U.K. decline while used-car sales boom, and as China stopped tax breaks for car sales earlier this year.”

– Adam Fusco, associate editor

Toys ‘R’ Us Files for Chapter 11 Bankruptcy

Late yesterday, major retailer Toys ‘R’ Us announced that it and certain of its U.S. subsidiaries and its Canadian subsidiary filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the Eastern District of Virginia in Richmond. The filing excludes the company’s operations outside of the U.S. and Canada, which includes about 255 stores in Asia. The company’s approximately 1,600 Toys ‘R’ Us and Babies ‘R’ Us stores around the world, the majority of which are profitable, will continue to operate as usual, the company said in a press release.

“Today marks the dawn of a new era at Toys ‘R’ Us, where we expect that the financial constraints that have held us back will be addressed in a lasting and effective way,” said Dave Brandon, chairman and chief executive officer, in the release. “Together with our investors, our objective is to work with our debtholders and other creditors to restructure the $5 billion of long-term debt on our balance sheet, which will provide us with greater financial flexibility to invest in our business, continue to improve the customer experience in our physical stores and online, and strengthen our competitive position in an increasingly challenging and rapidly changing retail marketplace worldwide.”

Toys ‘R’ Us has struggled amid the rise of discounters such as Wal-Mart and Target, and especially Amazon.com, the Wall Street Journal reported.  Most Toys ‘R’ Us stores are expected to be open during the holidays, and the company will use $3 billion in bankruptcy financing to continue to finance its operations, the Journal said. More than 20 retailers, including RadioShack and Payless Shoe Source, have filed for bankruptcy this year.

With assets of $6.9 billion, this marks the second-largest retail bankruptcy after Kmart, Reuters reported. Toys ‘R’ Us is the second-largest toy seller in the United States behind Amazon, the news agency added.

– Adam Fusco, associate editor

Asia-Pacific Economies to Gain from Global Demand, Structural Reforms

Global demand has helped steady Asia-Pacific’s economies that are so reliant on trade, but sovereign profiles will remain strongest where the export surge mixes with structural reforms and investments in infrastructure, according to a new Moody’s Investors Service report.

China and Japan have been contributing to the global uptick in trade and supporting regional demand, Moody’s analysts said. Moody’s has raised its GDP forecasts for Asia-Pacific economies, and should external demand and robust domestic conditions form to sustain business investment, the ratings agency expects the medium-term growth outlook will remain positive.

“The acceleration in growth in Hong Kong (Aa2 stable) and Malaysia (A3 stable) looks to be more broad-based than in other trade-dependent economies, reflecting in part the strength of public infrastructure spending,” Moody’s said. “In the event that solid external demand persists and ongoing government infrastructure spending supports a further wave of investment by private businesses, that could mean that growth there slows less in 2018 than we currently expect.”

Countries like Thailand that don’t benefit as much from accelerating global demand may have to rely more on additional fiscal stimulus to support their economies, analysts said. “Trends in gross fixed capital formation have differed markedly among the region's trade-dependent economies, suggesting that some businesses have started to invest in new or replacement equipment and facilities, while others are still using existing idle capacity to meet increased demand.”

The positive effects on the economy following India (Baa3 positive) and Indonesia’s (Baa3 positive) efforts to attract more foreign direct investment, as well as steps they’re taking to improve business conditions, will be boosted in a stronger global macroeconomic environment. “Similarly, the global up-cycle will amplify improvements in business operating conditions in Vietnam (B1 positive) that have already attracted investment and helped production move up the manufacturing value chain,” Moody’s said.

– Nicholas Stern, managing editor

Interest Payment Due Date Risks Rise in U.S. High-Yield Default Rate

Today marks a deadline for several U.S. high-yield companies to make interest payments, otherwise the default rate would move above the current 1.8% mark, according to Fitch Ratings.

The companies include two large retailers. Claire’s Stores and Nine West Holdings are on Fitch’s Bonds of Concern list, which means a high probability of default within the next year. Claire’s CEO indicated during a recent earnings call that the payment would be made. Same-store sales trends for the company have been positive for the first half of the year, but declining U.S. mall traffic and rough macroeconomic conditions in Europe weigh on the top line. Liquidity remains tight but adequate to fund this year’s holiday season, Fitch said.

The interest payment for exploration and production company EXCO Resources is more in doubt. The termination of its asset sale resulted in its bid price declining about 35 points in recent weeks, the ratings agency said.

“The September sector trailing 12-month [TTM] high-yield rate is at 2.1%, with less than $1 billion of defaults,” said Eric Rosenthal, Fitch’s senior director of leveraged finance.

In August, for the second consecutive month, the TTM U.S. high-yield default rate remained below 2%. Only $1 billion in high-yield bond defaults were registered during that period. Ongoing stress in the retail sector as well as a pending filing from iHeartCommunications may result in the rate rising to just below 3% by the end of the year. After oil-drilling contractor Seadrill filed for bankruptcy on Sept. 12, the Yankee index’s default rate rose to 3.3%. Fitch expects the Yankee default rate to end the year near 4%.

– Adam Fusco, associate editor

Reinsurers Exposed to Hurricanes Harvey and Irma to See Capital Strains

Re-insurers with disproportionate combined exposures to hurricanes Irma and Harvey could wind up seeing losses at levels that could strain capital and pressure their credit ratings, according to a new report by Fitch Ratings.

AIR Worldwide currently estimates insured losses from Hurricane Irma between $20 billion and $40 billion in Florida, with an extra $5 billion to $15 billion in the Caribbean, the ratings agency said. Insured losses from Hurricane Harvey range from $10 billion to as high as $30 billion, excluding losses to the National Flood Insurance Program.

“Fitch believes if losses ultimately reach this level, or higher, there may be select (re)insurers with concentrations across each locale that, added together, could adversely affect capital,” analysts said. “However, we believe such cases will not become evident until (re)insurers provide their own specific loss experience.”

Also, Fitch said its ratings coverage will not include small Florida specialist insurers with approximately 60% market share in Florida homeowners’ insurance, which will yield most losses to reinsurers. “Hurricane Irma will be the first notable test of these groups' underwriting policies, claims-handling capabilities, reinsurance programs, capital strength and overall risk management,” the ratings agency said.

– Nicholas Stern, managing editor

Global Speculative-Grade Default Rate Falls to Lowest Level in Nearly Two Years

In August, the global speculative-grade default rate fell below 3% for the first time since October 2015, according to a new report from Moody’s Investors Service. The rate fell 0.2% from its 3.1% level in July. The ratings agency anticipates that the rate will reach 2.3% in August 2018, down from a high of 4.8% two years previously, when commodity sectors drove the default rate to its highest level in seven years.

“This benign forecast is a function of a relatively low level of high-yield spread and stability in commodity prices,” said Moody’s Vice President and Credit Officer Sharon Ou.

Two speculative-grade companies defaulted last month: a U.S. retailer that completed a distressed exchange and a Singapore-based semiconductor assembly and test services provider that failed to make coupon payments, Moody’s said. The most vulnerable industries include media advertising, printing and publishing, durable consumer goods and retail.

For the United States alone, the speculative-grade default rate declined to 3.4% in August from 3.6% in July. In Europe, the rate fell to 2.6% from 2.8%.

– Adam Fusco, associate editor

Small-Business Optimism Heads for Record Levels

A surge in capital spending and high sales expectations have caused a streak of historically high performances dating back to November to continue in the Index of Small Business Optimism from the National Federation of Independent Business (NFIB). The percentage of small-business owners who plan to make capital expenditures in the near term is at its highest level since 2006.

“This is a sign of economic health that we’ve been expecting based on the soaring optimism that began last year,” said NFIB President and CEO Juanita Duggan. “Higher optimism resulted first in higher employment activity, and now we’re seeing more small-business owners making capital investments. Consumer demand is very strong, and the regulatory relief has been dramatic. Small-business owners still expect progress on tax reform and health care, and they will be watching closely.”

The index rose 0.1 points to 105.3. Five of the components of the index rose while five declined. Those planning capital outlays were highest among professional service firms (46%), followed by manufacturing (38%).

“Small firms are now making long-term investments in new machines, equipment, facilities, and technology,” said NFIB Chief Economist Bill Dunkelberg. “That’s a real sign of strength, and it will be interesting to see if the August result becomes a trend.”

Those expecting better sales in August increased by 5% to a net 27%, which matches the number of owners who believe factors are favorable for expansion.

“Consumer demand is driving optimism, and optimism is driving business activity,” Duggan said.

– Adam Fusco, associate editor

Energy Default Risk Sees Little Change after Harvey

While Hurricane Irma continues to devastate Florida, the economic costs of Hurricane Harvey, beyond the human toll, are starting to be evaluated for the states of Texas and Louisiana. The storm is likely to have little impact on the default risk of the North American energy sector, according to Moody’s Analytics’ Expected Default Frequency (EDF) probability of default metrics. The sector’s average one-year EDF fell by 0.06% from its level prior to Harvey’s landfall in August, indicating a lower level of default risk. Most energy subsectors participated in the decline, Moody’s said.

The hurricane caused an immediate drop of over three million barrels a day in refinery output, with smaller declines in the demand for petroleum products and crude oil production. The small change in energy sector risk goes hand in hand with Moody’s Analytics’ evaluation that the region’s economy should recover quickly and that the hurricane will have only a small effect on the national economy, though southeastern Texas and Louisiana house 21% of the United States’ refining capacity. Moody’s estimates that 45% of the refining capacity shut down by Harvey is already back on line.

Some refineries, however, suffered more severe damage than others and will be slower in restoring operations. Moody’s estimates that refinery profit margins will rise in the near term as a result, since the reduction in capacity gives leeway for the remaining companies to increase prices. Moody’s further estimates that the price of energy will be higher in the coming months because of a minimal decrease of demand for petroleum products and the shutdown, though temporary, of several offshore and shale oil and gas rigs. The higher energy prices will make it economical to resume drilling and production, with strong demand for rigs, the ratings agency said.

– Adam Fusco, associate editor

Global Economy Gathers Momentum

The global economy expanded at its fastest pace in nearly a year and a half in August, with improvement in both the manufacturing and service sectors and business optimism moving higher. The August J.P. Morgan Global All-Industry Output Index registered 53.9, up from 53.6 in July. This marks the 59th month in a row that the index posted above the 50 neutral mark.

“The August PMI [Purchasing Managers’ Index] signaled a broad and accelerated expansion of global economic output,” said David Hensley, director of global economic coordination at J.P. Morgan. “Overall growth was the quickest since April 2015, underpinned by expansions across the six main categories of manufacturing and services covered by the survey. With new order inflows strengthening, backlogs rising and jobs growth accelerating, the economy looks set to perform well in the coming months.”

Developed nations outperformed emerging markets. The euro area saw a solid gain in economic output, with faster growth in Germany and Ireland. Strong growth in manufacturing was offset by a more tepid increase in the service sector. Output growth in the United States was at its steepest since January. Some acceleration of growth was noted in Japan, while growth slowed to a 10-month low in Australia. Among the emerging nations, economic output accelerated in China and Russia but fell in India and Brazil.

An increase in the backlog of work and further job creation resulted from new business rising at its quickest in nearly three years, while the growth rate of employee numbers reached a 77-month record. Staffing levels rose in the U.S., eurozone, Japan, the U.K., India, Australia and Russia.

– Adam Fusco, associate editor

Corporate Debt Rises, Along with Lower Quality Bonds

Two decades ago, the size of the corporate bond market was approximately $3 trillion, with 20% of the market issued in the lowest level (Baa and BBB) of the investment-grade rating scale.

Now the corporate bond market is estimated at $5 trillion, with 49% of the market issued in the Baa and BBB categories, according to a recent report by Seeking Alpha. While the amount of debt has increased, low interest rates have boosted leverage and credit quality has declined. “The potential ramifications of this shift are enormous,” the article stated. “We are in the very late stages of the business cycle, where you want to own quality. Corporate spreads are tight to treasuries, offering nominal premiums for associated risks.”

Meanwhile, traders have been hedging their corporate bond investments by piling money into derivatives, as volumes in these instruments have increased 110% in the week ended Aug. 11, compared to the same time a year prior, a Bloomberg report noted. For most of 2017, derivatives activity was relatively muted. As of late, investors in corporate debt appear to want to mitigate the risks of potential hits to the broader economy, like hurricanes or geopolitical dust-ups.

– Nicholas Stern, managing editor

Kamakura: Corporate Credit Quality Stays Consistent in August

With just a slight increase from the month before, the Kamakura Corporation troubled company index ended August at 7.84%, reflecting the percentage of companies that have a default probability of more than 1%. An increase in the index indicates a reduction in credit quality while a decrease indicates an improvement in credit quality.

“Credit metrics continue to be stable and benign during August, with a decline in the number of observed defaults to a multimonth low,” said Martin Zorn, president and chief operating officer for Kamakura Corporation. “Overall government statistics show reductions in household debt burden, although U.S. credit card debt is near the peak levels reached in 2008. We continue to believe the biggest risk is the leveraged loan sector, once interest rates begin to rise.”

Among the 10 firms rated at most risk, seven were from the United States, two from Great Britain and one from Singapore. Two defaults occurred in the coverage group, the most prominent being Air Berlin. The riskiest rated firm is Ascena Retail Group, with a Kamakura default probability of 26.9%. For August, the percentage of companies with default probabilities between 1% and 5% was 6.5%; the percentage of those with default probabilities between 5% and 10% was .92%.

The Kamakura troubled company index measures the percentage of firms that have an annualized one-month default risk over 1% among a group of 39,000 public firms in 68 countries. Kamakura uses a large historical database with more than 2.2 million observations to produce a forward-looking statistical estimate of default risk 10 years into the future, with the troubled company index focusing on the short term.

– Adam Fusco, associate editor

Global Oilfield Services and Drilling Sector Set for Stable Period

Prospects for the global oilfield services and drilling sector (OFS) have turned the corner and now appear to have stabilized after a stretch of severe demand and price erosion.

"The stable outlook for the global OFS sector reflects our view that the worst is now behind us and we are in the early stages of a cyclical recovery," said Moody's analyst Sajjad Alam. "After a weak 2016, we expect industry earnings to grow 6% to 8% in 2017 and more substantially next year, given improved prospects for commodity prices and higher upstream spending."

In North America, exploration and production companies are expected to spend 25% to 30% more this year, while overall global upstream spending should grow by mid-single-digit percentages, leading to rising revenues, Alam said. But substantial cash flow growth won’t be seen until 2018, as global oil markets continue to slowly rebalance and OFS pricing only modestly improves, Moody’s said.

Also, some markets will continue to suffer further revenue and EBITDA declines, analysts said. “Many companies have to cover significant reactivation costs, rising labor costs and increasing working capital demands during the early phases of recovery,” Alam said. Demand is expected to grow mostly in U.S. and Canadian land markets, where activity contracted most significantly during the downturn. “Completion-related services will see the highest price appreciation, though cash flows will still grow only modestly this year.”

Drilling efficiency and well productivity improvements are expected to slow rig additions this year, as the U.S. rig count will likely settle around 1,000 rigs, Moody’s said. Rig counts in international land markets are also expected to slow through mid-2018.

For offshore projects, near-term prospects remain challenged as major deepwater/ultradeepwater development is unlikely to be green-lighted until oil prices rise above $60 per barrel, analysts said. “Revenues and backlogs for offshore drillers, equipment manufacturers and logistics companies will continue to decline as customers offer low-margin contracts, or avoid contracts altogether, while overcapacity in the offshore segment takes several years yet to clear.”

– Nicholas Stern, managing editor

Chinese Overseas Investment Guidelines Could Hamper International Deals

New Chinese guidelines on overseas investment are likely to concentrate risks and increase costs and the complexity of regulations for investment companies in the country.

Risks will grow because the new rules, issued by the State Council this month, will narrow the range of industries in which investment companies can invest overseas, according to a new report from Fitch Ratings. The longer and more complex process for approving deals could negatively impact profitability as well, though they could serve to moderate investment companies’ recent rapid overseas expansion.

The guidelines reflect the government’s worries about the pressure that overseas investment could put on the currency and the aggressive bidding on overseas assets by Chinese investment companies and insurance companies, Fitch analysts said. The guidelines are also designed to align overseas investment with the priorities of the “One Belt, One Road” initiative.

“ICs [investment companies] will face much greater regulatory scrutiny when investing in several overseas sectors, including real estate, hotels, entertainment and sports clubs, which investors had been expecting to benefit from demographic changes and economic rebalancing,” the report stated. “While ICs have invested in these sectors overseas, they generally have not done so in China, and the changes will therefore reduce diversification of ICs' investment portfolios in terms of sector, and weaken ICs' overall appetite for international investment.”

Analysts also believe the guidelines will make it more difficult for investment companies to raise foreign-currency funding overseas, as well as make it more time-consuming to get approval for any international mergers and acquisitions.

– Nicholas Stern, managing editor

China’s Downstream Natural Gas Distributors See Positives from Price Cut


A decrease in China’s benchmark city-gate natural gas prices is a positive for downstream gas distributors. This will “stimulate natural gas consumption and improve the earnings of the distributors,” according to Moody’s Investors Service.

“It is also a credit positive to the gas distributors, given the expected result of higher gas sales volumes,” said Moody’s Analyst Ralph Ng in a release. “The reduction in city-gate prices will encourage consumption because it lowers the overall production costs of nonresidential users, assuming a timely cost pass-through from the distributor to end-users,” Ng added.

Benchmark city-gate prices are “the regulated procurement costs of natural gas for downstream gas distributors in China,” according to the Moody’s release. Prices will be cut 4.6% to 8.7% on average by the National Development and Reform Commission. This is effective Sept. 1. The price drop will “enhance the competitiveness of natural gas against alternative fuel sources, and thereby increase gas consumption,” said Moody’s.

The downstream distributors will see an increase in gas sales volumes without an impact on the dollar margins of sales. Even with previous discounts to nonresidential customers, downstream distributors will earn more clearance and flexibility to adjust prices and maintain margins, said Moody’s.

The cuts will also “reduce the financial burden of corporates and promote the usage of natural gas as a major energy source,” said Moody’s.

– Michael Miller, editorial associate

New Hedge Accounting Standards from the FASB to Take Effect Next Year

The Financial Accounting Standards Board (FASB) recently issued a final Accounting Standards Update (ASU) that it says will improve and simplify accounting rules related to hedge accounting.

The new ASU is effective for public companies in 2019 and private companies in 2020, the FASB said in a press release. Early adoption is permitted. The new standard takes effect for fiscal years and interim periods within those fiscal years, after Dec. 15, 2018, for public companies. For private companies, the standards take effect for fiscal years after Dec. 15, 2019.

“Companies and investors alike have expressed overwhelming support for this long-awaited standard,” stated FASB Chairman Russell G. Golden. “Thanks to their input, the final ASU better aligns the accounting rules with a company’s risk management activities, better reflects the economic results of hedging in the financial statements and simplifies hedge accounting treatment.”
The new standard refines and expands hedge accounting for financial (interest rate) and commodity risks, and it provides more transparency around how economic results are presented, both on the face of financial statements and in the footnotes, the FASB said.

The FASB will host a free, one-hour webinar entitled IN FOCUS: FASB Accounting Standards Update on Hedging from 1 p.m. to 2 p.m., Eastern, on Sept. 25. More on the webinar can be found here.

– Nicholas Stern, Managing Editor

Global Credit Growth on Path to Stabilization

Though global credit growth remains at a record low since the financial crisis of 2008, it is likely to stabilize this year, following the slowdown it experienced in 2016. As a result, macro-prudential risk indicators show a reduction in vulnerability to systemic stress in the majority of markets, according to a new report from Fitch Ratings.

The expected stabilization is driven by the credit performance of emerging markets, such as the Middle East and Africa (MEA) and Latin America, which accounted for the reduction in global credit growth from 5.6% in 2015. According to Fitch, global median real credit growth will be 2.5% in 2017, in accord with the 2.8% registered for 2016. The ratings agency does not expect any markets to register credit growth over 15% this year. Roughly 40% of emerging markets and 60% of developed markets are forecast to record positive credit growth of up to 5%.

The slowdown in 2016 was due to a marked reduction in median credit growth of 2.9% in emerging markets, which was below the average of 8.4% from 2010 to 2015. Median credit growth slowed to 2.8% and 2.9% for the MEA and Latin American, respectively, while emerging markets in Europe recorded 1.3%. The highest credit growth was recorded among emerging markets in Asia, at 9.9%. Reflective of the economic recovery, developing markets experienced modest credit growth of 2% for the third consecutive year.

– Adam Fusco, associate editor

Texas Storm Roils Global Refined Gasoline Markets

Hurricane Harvey that has struck Texas is causing serious damage to the nation’s oil refining capacity and is set to impact national and global consumers of refined products like gasoline, pushing up prices as ports in the Gulf of Mexico close. Demand for U.S. crude could also take a hit and crude futures have already fallen.

Reuters reports that gasoline futures climbed to their highest level in more than two years with a 7% rise early today. Flooding from the storm has wiped out 11% of U.S. refining capacity, as a quarter of oil production in the country comes from the Gulf of Mexico. Ports that deliver products to Latin America and Asia remained closed Monday. According to the U.S. Bureau of Safety and Environmental Enforcement, approximately 22% of Gulf production was shut down Sunday afternoon.

Damages are estimated to require days to weeks to complete, as rains continue to cause damage to oil, gas, pipeline and chemical plants west of Houston, media reports estimate. Meanwhile, the U.S. government has yet to say whether it will release reserves of refined gas from the country’s Strategic Petroleum Reserve.

U.S. traders have been searching for oil product cargoes from North Asia, which is expected to provide more product if U.S. refineries stay closed for more than a week, Reuters reports.

– Nicholas Stern, managing editor

Equipment Finance Sector Enjoys Growth in July

In the $1 trillion equipment finance sector, overall new business volume for July rose 13% year-over-year from July 2016. In its survey of economic activity among 25 companies, the Equipment Leasing and Finance Association's (ELFA) Monthly Leasing and Finance Index also indicated volume was down 19% month-to-month from June. Cumulative new business volume was up 6% from 2016.

"The second half of the year gets off to a strong start, with double-digit, year-over-year growth,” said ELFA President and CEO Ralph Petta. “Business fundamentals appear solid, with low unemployment, continued low interest rates and an active equities market buoying the economy. With a number of difficult public policy decisions on the horizon, all eyes will be on Washington in the coming months to glean whether this benign economic condition continues."

Credit approvals totaled 76% in July, hardly changed from what it was in June. Headcount totals for equipment finance companies was up 15.3% year-over-year, mostly due to acquisition activity from one company in the survey. Receivables over 30 days were 1.4%, up slightly from the previous month. Charge-offs were 0.35%, down somewhat from June. The separate Equipment Leasing and Finance Foundation’s Monthly Confidence Index registered 64.4, up from 63.5 the prior two months.

"It is promising to see such a great start to Q3 for our industry,” said Michael Sweeney, senior vice president of vendor equipment finance originations at EverBank Commercial Finance Inc. “While we all know that a great month doesn't make a quarter, it is particularly gratifying to see that new business volume for our industry is up by 6% over 2016 through the first seven months. Portfolio performance continues to be a source of comfort despite a recent uptick in delinquencies, as indicated by a slight decrease in charge-offs as contrasted with the prior year and month. Stable credit approval rates and our continued strong confidence index indicate … that it is a great time to be in the equipment finance business."

– Adam Fusco, associate editor

U.S. Private Sector Growth Reaches Two-Year High While Policies May Weigh on Sovereign Rating

The fastest growth in overall business activity since May 2015 was signaled in August, according to the IHS Markit Flash U.S. Composite Purchasing Managers’ Index. Though manufacturing production growth slowed, a sharp increase in service sector activity drove the index higher.

“The U.S. economic growth story remained a tale of two sectors in August,” said Rob Dobson, director at IHS Markit. “The overall rate of expansion accelerated to a 27-month record, driven higher by strong and improved growth of business activity in the vast services economy. In contrast, the performance of manufacturing remained sluggish in comparison, with production volumes rising to the weakest extent in over a year.”

New business volumes grew at the quickest pace in a little more than two years while total new orders increased at a quicker pace in August. Input costs rose, with the rate of inflation reaching a four-month high.

In the service sector, strong economic conditions and improvement in demand drove the upturn, with a significant rise in new business received. In the manufacturing sector, weaker increases in output and new orders weighed on the modest rate of improvement. New business growth weakened in manufacturing and production volumes grew at the slowest rate for 14 months.

The main downside risk to growth remains exports, IHS Markit said. “Foreign goods orders fell—albeit only marginally—for the second month in a row, often blamed on the strength of the dollar. The domestic demand picture should hopefully remain relatively bright to offset such risks, however.”

Meanwhile, as deadlines approach for the U.S. Congress to reach agreement concerning government funding and the federal debt limit, Fitch Ratings warns that it may need to review the United States’ sovereign rating, with potentially negative implications, if the debt limit is not raised in a timely manner. “Prioritizing debt service payment over other obligations if the limit is not raised—if legally and technically feasible—may not be compatible with ‘AAA’ status,” analysts said. “In Fitch’s view, the economic impact of stopping other spending to prioritize debt repayment, and potential damage to investor confidence in the full faith and credit of the U.S., which enables its ‘AAA’ rating to tolerate such high public debt, would be negative for U.S. sovereign creditworthiness.”

Latest budget resolutions assume a 2.6% growth rate, Fitch said, which the ratings agency views as optimistic over the medium term. Fitch forecasts 2.6% growth for 2018, with a slowdown to 2.2% in 2019.

– Adam Fusco, associate editor

U.S. Gaming Companies Tread Risky Ground

Regional gaming companies in the United States run the risk of falling into a precarious financial situation and entering speculative-grade rating territory. Though they have the cash flow to improve their balance sheets, they hang on to large loads of debt, according to a new report from Moody’s Investors Service.

“The combined amount of debt held by regional gaming companies has barely budged over the past 18 months, contrary to our expectation that many would use free cash flow to repay debt in an effort to de-risk their balance sheets,” said Moody’s Senior Vice President Keith Foley.

The gaming industry carries high fixed costs. Many regional gaming companies are expected to carry debt-to-EBITDA (earnings before interest, tax, depreciation and amortization) ratios at or above five times through next year, Foley said. If a sudden drop in patronage were to occur, those companies who are highly leveraged could fall deeper in debt rather quickly. Though EBITDA will continue to increase, it may not grow at a pace that would improve leverage levels due to the few opportunities to reduce operating costs. Improvement in the debt-to-EBITDA ratio in the near term will likely be limited unless absolute debt is reduced.

Few incentives exist to deal with absolute debt, however. Free cash flow is positive, debt maturities are far in the future and chances to make acquisitions remain present. Those acquisitions have a positive effect on earnings and asset profiles, but they are also a financial burden that adds to the industry’s high financial risk, Moody’s said.

– Adam Fusco, associate editor

Expectations Fall for German, Eurozone Economies

A significant decrease in expectations has been registered for the German economy that also reflects on the eurozone as a whole. The Indicator of Economic Sentiment from the Centre for European Economic Research (ZEW) dropped a considerable amount in August, 7.5 points, to a level of 10. This is significantly below the long-term average of 23.8 points. The indicator for the current economic situation in Germany increased slightly, however, and now stands at 86.7 points.

“The significant decrease of the ZEW economic sentiment indicator reflects the high degree of nervousness over the future path of growth in Germany,” said Professor Achim Wambach, president of ZEW. “Both weaker-than-expected German exports as well as the widening scandal in the German automobile sector, in particular, have helped contribute to this situation. Overall, the economic outlook still remains relatively stable at a fairly high level.”

Expectations for eurozone growth are slightly lower than those for Germany. The indicator for financial market experts’ expectations for such growth dropped by 6.3 points in August. However, the indicator for the current economic situation in the eurozone has increased since November of 2016 and now stands at its highest level since January 2008. It rose 9.7 points higher in August, ZEW said.

Another index that has contributed to the view that the German and eurozone economies are slowing down is the Markit Manufacturing Purchasing Managers’ Index for July, Wells Fargo Securities said in a recent report. After hitting highs in June, indexes for both Germany and the eurozone dipped marginally in July. A further decline may solidify the view of a slowing-down economy in the region, Wells Fargo said.

– Adam Fusco, associate editor

Greece Upgraded, with Outlook Positive

In light of ongoing compliance with the conditions of the European Stability Mechanism (ESM) program, reduced political risk and sustained growth of GDP, Fitch Ratings has upgraded Greece’s rating to B- from CCC. The rating carries an outlook of positive.

The economy of Greece is undergoing a gradual recovery. Indicators signal growing economic activity, though ESM program delays weighed on confidence and private-sector payments in the first quarter. With rising consumer and business confidence, the European Commission economic sentiment indicators reached a two-year high in July. Fitch expects real GDP growth of 1.6% and 2.1% in 2017 and 2018, respectively. Domestic demand should be boosted by a decline in unemployment, continued clearance of government arrears and increasing investments.

The successful completion of the second review of the ESM program has reduced the risk of a fall in confidence or an increase of government arrears with the private sector. Fitch expects that the third review of the adjustment program will result in no increase of instability and that the Eurogroup will grant significant debt relief to the country next year.

In Fitch’s view, an important development is the Eurogroup’s plan to connect debt relief measures to actual growth outcomes after the program period. This should increase confidence that government debt is on a sustainable path. European partners appear to be changing focus from strict fiscal targets to the restoration of medium-term GDP growth, Fitch said.

– Adam Fusco, associate editor

First Insolvency Case under New Indian Bankruptcy Code Goes Forward

Aug. 18, 2017

India’s National Company Law Tribunal (NCLT) has approved the country’s first insolvency resolution order under the new Insolvency and Bankruptcy Code, 2016.

The plan for Synergies-Dooray Automotive Ltd., a company that manufactures alloy wheels, submitted its application to the NCLT January 23, according to a report in Money Control. The firm’s resolution plan was submitted within the code’s 180-day deadline.

The bankruptcy law passed Indian Parliament in May 2016 and went into effect in December, replacing the nest of rules and regulations formerly in place to tackle bad loans and nonperforming assets in the Indian economy. The total claim against Dooray from financial creditors, including three asset reconstruction companies, is roughly $15.2 million, according to a report in Livemint.com.

“There were three resolution plans out of which one was selected,” said Mamta Binani, the insolvency resolution professional for Synergies-Dooray and past president of Institute of Company Secretaries of India (ICSI), in the Livemint article. “The other two plans had good money in them, but the companies infusing capital were from a trading background. We went with the plan which had some manufacturing background to keep the company as a going concern. Putting in money is not the end of it. The selected plan also takes care of dues of operational creditors and the government, which is generally not the case when the liquidation value is zero. We are increasingly seeing that committee of creditors are conscious of the dues of operational creditors, as these are mostly small and medium enterprises, and if their dues do not get paid, then the companies can go under and overall hurt the economy.”

– Nicholas Stern, managing editor

Growth Accelerates in Eurozone

Growth is accelerating in the eurozone, reflecting the region’s broad cyclical recovery, though the pace of growth may slow next year, according to a new report from Fitch Ratings.

Factors that have supported growth include a reduction in political risk following the French elections, a rise in business confidence and improvement in export demand. Unemployment this June reached an eight-year low, which boosted consumer confidence. Policy support for the economy also has gained ground, with credit standards for loans to businesses easing this year.

Fitch raised its 2017 GDP growth forecast for the region to 2.0% from 1.7% in June. Growth is expected to slow to 1.8% in 2018. As the benefits in the drop in energy prices wear off, consumption demand is expected to decrease as well. In addition, negotiations surrounding Brexit and questions over U.S. trade policy create uncertainties over international trade.

Fitch expects growth potential in the medium term will be constrained for major economies by 2019 due to demographic and productivity trends, as well as a narrowing of output gaps. Near term, however, growth in the region should remain above the potential rates seen in recent quarters. Growth potential in advanced economies is expected to fall in the range of 1.25% to 1.75% over the next five years, Fitch said.

– Adam Fusco, associate editor

NAFTA Talks Begin in Washington

Reworking the North American Free Trade Agreement (NAFTA) has been a focus point of the Trump administration since last summer. Talks between the U.S., Canada and Mexico started in Washington today to discuss the nearly 25-year-old pact.

American officials want to continue with their protectionist views by removing dispute-resolution panels within NAFTA, said the Wall Street Journal. The panels are designed to sustain or overturn tariffs during conflicts. Both Canada and Mexico are in support of keeping the panels. These panels fall under Chapter 19 of NAFTA. If it is done away with, tariff disputes would then enter national courts or go before the World Trade Organization.

Rules of origin, especially in the automotive industry, is another topic set to be discussed, according to the Washington Post. Roughly two-thirds “of the total value of the components in a car have to come from within North America in order for that automotive to move across North American borders tax free,” said the Post.

Meanwhile, positive negotiations will not improve Mexico’s growth, according to Moody’s Investors Service. "NAFTA has not remedied Mexico's low growth, low productivity and low wages," said Madhavi Bokil, a Moody’s VP and senior analyst, in a release. “Successful NAFTA talks alone will not fix structural impediments to Mexico's growth,” he added.

Updating the rules of origin and the overall trade pact could both benefit Mexico and its economic reform efforts, said a press release from Fitch Ratings. “Changes to the treaty do not put Mexico's industrial sector at a disadvantage in the U.S. market,” said Fitch. “Trump’s protectionist turn could help Mexico further diversify its export destinations and reduce its overdependence on the U.S. for its foreign trade,” said a report from credit insurer Atradius.

U.S. and Mexican officials are looking to close the door on negotiations, with a new deal by early next year due to elections. The general election in Mexico is in July, while the U.S. has an election in November. All three sides are expected to meet in Mexico next month.

– Michael Miller, editorial associate

Chinese Internet Companies with Finance Operations May Suffer Weak Credit Quality

Chinese internet companies that conduct finance operations may be weakening their credit quality. Finance operations offer loans to consumers and merchants, distribute wealth management products and allow consumers to make purchases on a company’s platform. But if they are consolidated into the company’s financials, they are usually funded by debt, do not produce meaningful profits and lack a track record of borrowers making timely repayment of loans, according to a new report from Moody’s Investors Service.

“Loans to consumers and merchants and distribution of wealth management products—two of the primary services that finance operations provide—can also lead to contingent liabilities and potential capital calls for internet companies,” said Lina Choi, a Moody’s vice president and senior credit officer. “These risks will persist even after the finance operations are deconsolidated, although further removed from the core business. The loans and wealth management services will still be offered with the internet companies’ brand names, and the strategic relationship between the core and finance operations remains.”

Of the five rated Chinese internet companies, four have finance operations: e-commerce platform Alibaba, search engine Baidu, and online retailers JD.com and Vipshop Holdings Limited.

Risks are mitigated, however, due to strong liquidity and the synergies between each company’s core business and the finance operation. Alibaba, JD.com and Vipshop can generate higher transaction volumes and cash flow through the loans  that they provide to those who conduct business on their platforms. Data gathered on consumers and merchants assist in determining to whom loans are offered and how much.

Alibaba’s risk exposure is lower than the other three companies because its finance operation is an associate company rather than consolidated in its financials. Baidu has a large cash buffer against capital calls, and both Baidu and Alibaba have larger cash buffers than JD.com and Vipshop, Moody’s said.

– Adam Fusco, associate editor

Solar Power Projects Require Lower Debt-Service Ratio than Wind Projects

Solar power projects typically require a lower debt-service cover ratio to achieve investment-grade status compared to wind projects, according a recently released report from Fitch Ratings. Electricity production from solar projects analyzed across the U.S., Europe, the Middle East and Africa have tended to exceed initial independent estimates, while wind projects have more often underperformed against initial estimates.

Fitch analysts looked at data collected since 2010 for wind and 2011 for solar projects in terms of initial P50 forecasts, or the annual production level the project is expected to exceed 50% of the time. They found that 70% of annual observations across solar projects met or exceeded the original P50 levels, while approximately 75% of wind project observations were below the P50 level and 43% were significantly below.

“Wind project underperformance is due to three factors,” Fitch said. “The greater technical challenge in forecasting led to some initial overestimation of power production. Higher natural resource volatility has affected some projects, including unusually low wind in the Western U.S. last year. And some wind projects have also been hit by problems with equipment.”

Solar projects, meanwhile, have benefitted from better-than-anticipated solar irradiance and plant availability. “The track record of solar projects is shorter, but they clearly have lower operational risk, better generation performance and lower volatility than wind projects,” Fitch analysts said. “They are also more resilient to downside scenarios, as shown by stronger financial metrics under one-in-100-year generation assumptions.”

Fully contracted, fully amortizing solar photovoltaic projects achieve an investment-grade rating from Fitch after achieving a 1.2x debt-service coverage ratio threshold, while the ratio for wind power projects is 1.3x.

– Nicholas Stern, managing editor

Reforming NAFTA May Not Be Enough to Fix Mexico’s Growth

Though renegotiation of the North American Free Trade Agreement (NAFTA) is scheduled to begin next week, it may not solve the factors hampering Mexico’s growth. Wage and productivity gaps with the United States have widened since the agreement’s inception, according to a new report from Moody’s Investors Service.

“NAFTA has not remedied Mexico’s low growth, low productivity and low wages,” said Madhavi Bokil, vice president and senior analyst at Moody’s.

NAFTA has continued to boost Mexico’s export competitiveness through a shift toward more complex production and integration with the U.S. economy, but the liberalization of its economy with its growth model focused on exports and access to the U.S. market has not resulted in the anticipated growth rates. The income gap with the U.S. will widen over time if productivity does not improve, Moody’s said. The country’s low productivity and wage growth is connected to uneven regional growth opportunities and a high degree of informality in its economy. Reduction in regional disparity is one objective of the structural reforms agenda.

Changes to the agreement may be more reserved than radical, however. “The talks on what the future of NAFTA will look like have started and the position of the Mexican government has emerged,” said Chris Kuehl, Ph.D., economist to NACM. “In the beginning, it appeared that Mexico would be in a defensive position, but times have changed and the advantage seems to lie with Mexico to some degree. The government of Enrique Peńa Nieto has refused to bend on some of the high-profile issues pushed by Trump, while those U.S. interests that have benefited from NAFTA have become more focused and organized. The modifications are likely to be far less drastic than was originally assumed.”

– Adam Fusco, associate editor


Chinese Bankruptcies Continue Rising in 2017

Bankruptcies in China will continue to increase the remainder of the year, yet the total number does not compare to those of other large economies. China saw more than 5,600 insolvency cases in 2016 after 3,600 in 2015, said a report from Fitch Ratings.

There were 4,700 cases filed in the first half of 2017 alone. Cases are being resolved at a higher rate as well with just over 3,600 last year, which is up roughly 40% from 2015. This year, there have been more than 1,900 resolved cases.

The reason for the rise in bankruptcies is partially due to China becoming more accepting. China’s authorities “have made efforts to improve the insolvency framework,” said Fitch. Zombie enterprises, which are entities that rely on government support and state bank assistance to stay afloat, “are responsible for the most significant corporate inefficiencies and account for the bulk of overcapacity.”

To put China’s bankruptcies in perspective, France had more than 55,000 last year, while the U.S. had less than 25,000. As an alternative to outright bankruptcy, “authorities may continue to favor mergers of weak companies with stronger ones,” added the report.

Fitch believes “bankruptcies are likely to continue rising quickly over the next few years in light of rising policy attention and the tightening of credit conditions since late 2016.” Firms will also face slower growth due to the deceleration in credit growth, which can be seen in Fitch’s gross domestic product growth forecast for 2018.

– Michael Miller, editorial associate

Tech Sector Most Efficient at Turning EBITDA into Cash Flow

The technology sector of the U.S. economy grew its corporate cash position again in 2016, amassing nearly half of the total accumulated for nonfinancial companies, and is likely to add more to the pile this year.

The top five most cash-rich companies in the U.S.—Microsoft Corp., Google Inc., Cisco Systems Inc. and Oracle Corp.—kept $594 billion in cash in 2016, or 32% of the total U.S. nonfinancial corporate cash, according to a recent report by Moody’s Investors Service. "The concentration of cash among the most cash-rich U.S. companies continued to grow last year, as did the proportion held by the technology sector, which accounted for close to half of the total," said Richard Lane, Moody's senior vice president. "Despite strong returns of capital to shareholders, we expect, absent tax reform, the technology sector's cash concentration to grind even higher over the next year because of its strong cash flow generation."

The health care/pharmaceuticals, consumer products, energy, automotive and manufacturing sectors all trailed tech in terms of cash holdings, analysts said.

Aggregate cash relative to debt climbed 37% in 2016, up from 34% in 2015 and higher than the 35% average over the past decade, Moody’s said. Cash flow from nonfinancial corporate operations dropped nearly 6% in 2016 to $1.45 trillion. Also, spending on plants and equipment decreased 18% last year, with reduced energy sector spending leading the pack.

“Reflecting the decline in cash flow from operations that was more than offset by reduced capital expenditures, U.S. nonfinancial corporates generated a record $720 billion in discretionary cash flow in 2016, up 11% from 2015,” Moody’s said. “The technology sector has, on average, turned 72% of EBITDA into discretionary cash flow in the past 10 years, making it the most efficient sector in this regard.”

– Nicholas Stern, managing editor

Small Businesses Continue Optimism Streak

Optimism continues apace among small business owners, continuing a streak that started shortly after the U.S. presidential election. The Index of Small Business Optimism from the National Federation of Independent Business (NFIB) rose 1.6 points to 105.2 in July, with seven of the 10 components in the index posting a gain, two declining and one unchanged. Stronger consumer demand was apparently the key, which was a major contributor to growth in the second quarter of 2017, according to the NFIB.

“There’s nothing like more customers to make owners happy, and optimism held up, as did important measures of spending and hiring plans,” the NFIB said.

A seasonally adjusted net 19% of small business owners plan to create new jobs, an increase of four points, with higher levels not seen since December 1999. A full 60% reported hiring or trying to hire, though more than half said that they were finding few or no qualified applicants for their open positions. Finding qualified workers was a particular problem in construction and manufacturing.

"The number of owners trying to fill positions and create new jobs is very high," said Bill Dunkelberg, NFIB chief economist. "That's good news for workers, because they can command higher wages and better benefits. The bad news is that small business employers are finding it very hard to hire and keep their workers."

An unchanged 57% reported capital outlays, with spending on new equipment, vehicles, and improved or expanded facilities. Five percent acquired new buildings or land for expansion.

Among small business owners, 3% said that all their borrowing needs were not satisfied, which is a decrease of 1 point and a low reading, historically. About 31% reported that all credit needs were met and just over half said that they were not interested in a loan. Only 2% said that financing was their top business problem.

– Adam Fusco, associate editor

China’s Regulation of Its Shadow Banking Sector is Showing Some Results

Chinese authorities’ moves to dampen credit growth and liquidity conditions, as well as their efforts to regulate the nation’s shadow banking industry, appear to be having a modest effect in moderating the growth of wealth management.

"However, the authorities are also engaged in a delicate balance to ensure that tighter credit and liquidity conditions do not trigger financial instability," said Michael Taylor, a Moody's Investors Service managing director and chief credit officer for Asia Pacific, in a new report on the topic. "Tighter market liquidity is being partially offset by higher lending to the banking system by the People's Bank of China, while regulators are offering grace periods for the implementation of new policy guidelines.”

Borrowers are increasingly turning to formal bank lending, as well as lending by the relatively more highly regulated parts of the shadow banking sector, like trust companies, as regulation has tightened around shadow banking in general, analysts said. "The rotation of credit supply to these sources improves transparency and could increase the system's resilience in the face of unexpected shocks," said George Xu, a Moody's associate analyst. "However, it remains unclear whether credit from these sources will be sufficient to replace credit supplied by the shadow banking components that are now subject to closer regulatory scrutiny."

Refinancing risk is thus growing for borrowing businesses in China that have grown reliant on the shadow banking industry, including property developers, local government financing vehicles and state-owned enterprises in overcapacity industries, Moody’s said. The gap between overall credit growth in the Chinese shadow banking sector and the growth rate of nominal GDP has shortened in recent months. Also, the growth in credit assets like wealth management products has apparently slowed, thanks to regulation. “Moody's points out that the challenges associated with regulatory tightening are illustrated by a strong rebound in new negotiable certificates of deposit issuance and the increase in the banks' net claims on nonbank financial institutions, both indicators of continuing system interconnectedness,” the ratings agency said.

– Nicholas Stern, senior editor