Risks to Australia’s Sovereign Credit Rating Include China Slowdown, Commodity Price Fall

Australia is set to see its gross public debt ratio peak in 2018 and the fiscal surplus to come into balance by 2021, reinforcing Fitch Ratings improving outlook for the sovereign and its 'AAA'/Stable rating.

Still, Fitch analysts expect Australia’s deficit to shrink at a slower pace than forecast in the Mid-Year Economic and Fiscal Outlook, mostly thanks to their subdued forecasts for real GDP growth and commodity prices. “The economy should be supported by buoyant employment growth, the fading drag from mining investment and improved non-mining investment prospects,” analysts said.

“However, weak wage growth will weigh on household consumption, while slowing growth in China is likely to constrain commodity price rises and Australia's export growth.”

The government has downgraded its growth forecast for fiscal 2018 to 2.50% from 2.75%, while it expects growth to rise again in fiscal 2019 to 3% and remain at that level until fiscal 2022.

The nation’s economy and fiscal performance face risks from negative global economic developments, especially a slowdown in China or a drop in commodity prices, Fitch said. “Risks might also stem from a faster-than-expected rise in U.S. interest rates, which could lift borrowing costs and pressure domestic liquidity conditions, given the banking system's reliance on international wholesale funding. High household debt levels could make the economy especially sensitive to rising rates,” analysts said.

Australia’s buffer against economic shocks has deteriorated over the last decade, while debt ratios have grown—in 2007, the government’s gross debt was less than 10% of GDP, while it’s likely to reach 42% next year, Fitch said.

– Nicholas Stern, managing editor

Bank of Israel Ponders Digital Currency

The Bank of Israel is considering adopting a digital currency as a way to create a faster payments system and reduce the amount of cash in the economy, according to a recent report in Reuters, which cited an unnamed central bank source.

While no decision has been made yet, the source told Reuters that the government was ready to legislate or include the matter in its 2019 budget and economic package if the central bank provided its’ final approval.

Such a currency would presumably be safe, centralized and follow anti-money laundering laws, the source told Reuters, thus distinguishing it from a cryptocurrency like Bitcoin, which is decentralized.

“Central banks around the world are examining (the use of digital currencies) so we should as well,” the Israeli source told Reuters.

In Israel, the underground economy is estimated at nearly a quarter of national output, and the nation has been looking at ways to address the issue for years, Reuters said. The Bank of Israel last month asked for proposals to create an infrastructure to support immediate payments in the country, like ones that are used in Britain and Sweden.

– Nicholas Stern, managing editor

Regulatory Headwinds Could Bring Risks to Clearing Houses, Central Counterparties

The potential fallout from a hard Brexit, and growing exposure to clearing houses and central counterparties (CCPs) may soon bring added regulatory oversight and scrutiny to the sector, according to a new report from Fitch Ratings.

Overall, Fitch’s outlook for the sector remains positive thanks to CCPs liquidity levels, robust risk management and, so far, supportive regulatory environment. Generally, large global clearing houses have profited from a supportive regulatory environment that’s allowed for participants to centrally clear transactions, rather than do so in an over-the-counter fashion on a bilateral basis, Fitch analysts said. That in turn has led to a steady increase of market participants’ exposures to CCPs. The Commodity Futures Trading Commission (CFTC) recently showed through regulatory stress tests that the world’s largest CCPs have adequate liquidity resources to complete their settlements at the end of the day should a severe market stress occur.

"Regulatory stress tests are an important and standardized measure of CCPs' resilience, but the tests incorporate the use of committed credit lines that could be extended by commercial banks, which may be also CCPs' largest clearing members," said Evgeny Konovalov, director in Fitch's Financial Institutions group.

CCPs ‘skin in the game,’ or the amount of allocated capital resources are still relatively small in the world’s largest organizations—bringing more to the party would be a positive for CCP’s risk profiles, and serve to maintain margin and counterparty standards in a growingly competitive environment, Fitch said.

“An area to watch in 2018 will be the implementation of MIFID II/MIFIR requirements for open and non-discriminatory access to trading venues and CCPs,” analysts said. “These provisions may pose a challenge to national CCPs' currently well-entrenched franchises and lead to a re-distribution of clearing volumes to the larger international CCPs.”

A hard Brexit scenario could inspire EU regulators to demand direct oversight over the clearing of euro derivatives, which would bring complications to cross-border supervision of CCPs, Fitch said.

– Nicholas Stern, managing editor

Take Heed: The EU’s New Private Data Regulation May Impact Your American Business

The European Union’s General Data Protection Regulation (GDPR), one of the world’s most stringent personal data protection laws on the books, will have implications for companies in the U.S. and elsewhere.

Passed in the EU parliament in April 2016, the steep fines—up to 4% of global revenue or €20 million, whichever is greater—that can be levied for violating its precepts go into effect May 28, 2018.

Essentially, the GDPR marks a significant shift in how companies treat the data of EU citizens, requiring organizations to clearly understand what information they have about private individuals, who has access to the information, where the data resides and how it is used; and then take steps to protect that private-user data, known as Personally Identifiable Information (PII), according to an article in eWeek.

PII can include credit card numbers, Social Security numbers, birthdays and home addresses—all of which are collected online and in the course of ordinary business operations, eWeek said.

The GDPR includes a “right to be forgotten,” a 72-hour data breach reporting period, and strong ‘opt-in’ consumer consent requirements, among other provisions. “Any U.S. company that has a web presence (and who doesn’t?) and markets their products over the web will have some homework to do,” a Forbes article said. Article 3 of the GDPR says that if your company collects personal data or behavioral information from someone in an EU country when the data is collected, your company is subject to the requirements of the GDPR, the article noted.

Also, a financial transaction doesn’t have to take place for the law to be effective. PII collected for a marketing survey, for instance, is protected under the regulation. Note that a business would have to specifically target a data subject in an EU country—generic marketing isn’t protected, Forbes said. So if the marketing is in the language of the EU country and there are references to EU users and customers, a webpage would be considered targeted marketing and the GDPR would apply.

U.S.-based hospitality, travel, software services and e-commerce firms are going to need to look closely at the regulation and how it will apply to them, Forbes warned. Also, any U.S. company that’s singled out a market in an EU country and has local web content will need to pay attention. Sound like you?

– Nicholas Stern, managing editor

Inventories’ Influence on GDP Growth in Recent Expansion Likely to Recede

Inventories have never been as much of a factor in GDP growth during expansions over the last 35 years as they have been in the current cycle, but that influence is waning.

Inventories boosted GDP growth by 0.8 percentage points in the most recent quarter, according to a special report by Wells Fargo. “The combination of the most-tepid growth backdrop in the post-WWII era, the unique changes in the energy sector (both technological and price swings) as well as a continued evolution in inventory management have all played a role in elevating the importance of inventories in this cycle,” wrote report authors Tim Quinlan, senior economist, Sara House, economist, and Shannon Seery, economic analyst. But now in its late stage, the expansion will likely be driven by other factors returning to more normal, long-term rates.

Dating back to the 1980s, the contribution of inventories as a share of the overall growth rate—especially in a slow GDP growth environment—is equivalent to 45% of GDP growth; much higher than the 27% to 34% seen in prior expansions, the Wells analysts said.

Looking toward the end of 2018, Wells expects modest inventory building with quarterly jumps from $40 billion to $50 billion. “Our base-case scenario is informed by our prior study of late-cycle inventory dynamics which suggests a slowing in the pace of inventory investment.”

During this cycle, inventory swings in the energy sector have been an important driver. Crude inventories boosted by shale supplies began growing in 2014. By the first quarter of 2015, inventories from energy—as reflected in government data for the mining, utilities and the construction sectors—boosted topline GDP by 1.5 percentage points. Energy sector inventories began to slow and then decline over the past three quarters, while inventories of manufactured and wholesale petroleum products after adjusting for inflation were 7% higher, year-over-year, in the third quarter, compared to the 25% annual gain seen in the final quarter of 2016.

Meanwhile, nonfarm business inventories also jumped to the largest annual gain on record in 2015, driven in part by slowing sales, the Wells analysts said. That inventory-to-sales ratio began to decrease in mid-2016, however, and has since dropped to its lowest level in nearly two years as businesses cut back on inventory investment. Still, elevated inventory levels in some industries, such as metals, machinery, chemicals and energy products, suggest a reduction in the pace of inventory building in the near term.

Retail inventories relative to sales have been at more healthy levels in recent years, hitting a 20-year low in the third quarter, Wells said.

But in the coming year, stronger growth is expected to bring businesses to add to inventories. “The pace is not expected to be as jaw-dropping as earlier in the expansion when businesses got out over their skis then subsequently had to dial back their inventory building. The relative importance of inventories as a growth driver should recede as broader growth picks up, the volatility in the energy sector fades a bit and as businesses appear to be taking a more deliberate approach to stockpiling.”

– Nicholas Stern, managing editor

China’s New Carbon Emissions Plan Could Hit Profitability of Higher Emitters

China’s plan to create a national carbon emissions trading platform will probably hit the profitability of coal-dependent power producers with high emission rates over the long term due to increasing emission costs and lower power generation.

On the other hand, the platform will in the long term probably grow the profitability of renewable energy producers and coal-dependent power products with low emission rates thanks to higher power generation and carbon credit revenue, said Moody’s Investors Service in a new report. “The new platform will have no immediate impact on the ratings and outlooks of power producers rated by Moody's because any meaningful effects will likely come in 2020 or after when the platform becomes fully functional,” Moody’s analysts said. “But power producers may increase future capital expenditures if the government sets higher emission reduction targets, which will accordingly raise their leverage.”

According to China’s National Development and Reform Commission (NDRC), announced Dec. 19, the trading platform will be set up in Shanghai and Hubei provinces. The NDRC has a three-stage development plan, including a Pilot Run Stage that will take a year of testing. There’s no set time limit for the Perfection Stage to bring the platform up to required standards. No emission targets have been set so far.

The plan will begin with the power sector, Moody’s said. Producers with more than 26,000 tons of annual carbon emissions will be subject to the plan’s requirements, including approximately 1,700 entities with total emissions of over three billion tons and amounting to roughly 30% of China’s total emissions in 2016. More sectors are anticipated to be added to the plan later. Power producers with lower emission rates will be eligible to generate more power or sell surplus emissions permits for added revenue.

The national platform will complement the development of the Green Power Certificate program, Moody’s said. “In the longer run, Moody's expects the plan will encourage power producers to adjust power generation mix to optimize profitability based on prevailing emission levels of their coal-fired generation units. This will lead to lower carbon emissions for the entire sector.” The ratings firms also anticipates trading among coal-dependent power producers will likely be more active than it will between renewable energy producers and coal-dependent power producers due to the relatively large demand and supply of carbon quota.

– Nicholas Stern, managing editor

Tax Bill’s Limitation in Interest Expense Deductibility Greatly Impacts Highly Leveraged Firms

The impact of the limitation in the deductibility of interest expense in the reconciled U.S. tax bill will be more severe for highly leveraged firms, according to a new report by Fitch Ratings.

The change in net income under the reconciled bill, which will be voted on likely later this week, should be neutral to slightly positive for issuers with leverage 5.0 times or below, analysts said. The bill would limit the deduction of interest to 30% of EBITDA until 2021, after which the limitation of deduction would apply to 30% of EBIT. The non-deductible portion of interest expense can be carried forward for five years, and would reduce the effects for issuers with growing EBITDA or who are reducing debt, Fitch said.

Fitch estimates, based on a sample of 575 leveraged loan and high-yield issuers, that 37% of issuers will lose a portion of their interest deductions under the EBITDA definition. Also, 27% would be unable to deduct 20% or more of their interest and 10% would be unable to deduct 50% or more.

If EBIT is at 30%, there’s a bigger hit with the limitation of interest deduction, Fitch said. Without that depreciation buffer, 64% of the Fitch sample would lose a portion of their interest deduction, while more than half would be unable to deduct 20% or more of their interest and 40% would be unable to deduct half or more.

“We believe the limitation on interest expense deduction is unlikely to have a significant effect on debt issuance (speculative grade and investment grade), both from a supply and demand viewpoint,” Fitch analysts said. “Demand for corporate debt, including leveraged finance products, will likely remain robust as investors continue to seek yield on their investments. This will provide attractive markets for issuers. Even with the limitation, the cost of debt (before any tax benefit) is typically well below the cost of equity and the limited corporate tax deduction on interest expense will provide an offset.”

– Nicholas Stern, managing editor

Multi-Million Dollar Business Email Compromise Scam Targeted Suppliers, Vendors


A Nigerian man has pleaded guilty to U.S. prosecutors for defrauding more than $25 million from companies that were convinced through business emails to send payments via large wire transfers to accounts in China.

According to the report in The Guardian and Reuters, District Judge Paul Crotty in Manhattan sentenced David Chukwuneke Adindu to three years and five months in prison for taking part in the business email compromise scam. Adindu had impersonated executives or vendors of companies, and directed employees of those companies to make large wire transfers. Prosecutors said he’d resided in Guangzhou, China and Lagos, Nigeria, while working with others to carry out the frauds from 2014 to 2016.

Among the fraudsters’ targets was an unnamed New York investment firm, where in June 2015 an employee received an email claiming to be from an investment adviser at another firm asking for a $25,200 wire transfer. The employee later discovered the email was phony and didn’t send a second requested transfer request for $75,100, The Guardian said.

Other scams were carried out by exchanging information regarding bank and email accounts, and scripts for requesting wire transfers, reported SC Cybercrime. According to the International Business Times, Adindu sent phishing emails to companies, including in the U.S., by impersonating supervisors or third-party vendors linked to the company.

– Nicholas Stern, managing editor

A Tale of Two Retail Sectors: Risks in Europe vs. the U.S.

Parts of the retail sector are at risk both in the U.S. and in Europe, but different forces are affecting the credit profiles of firms at home and across the pond. The market penetration of e-commerce models great (Amazon) and small, as well as the level of overcapacity in store networks are important factors that distinguish these risks, according to a new report by Fitch Ratings.

In Europe, the retail sector has the most at-risk issuers (rated 'b-*'/Negative or below), but there have been fewer defaults than in the U.S. and the ratings agency expects credit profiles there to stabilize next year.

Established, brick-and-mortar retailers in the U.S. are being dogged by increased competition from other specialty, off-price retailers like TJX and Ross Stores, while fast-fashion, online competitors and significant physical retail space overcapacity are having their impact as well, Fitch said. Store sales density for these incumbents is dropping, and profit margins are drooping as they invest more in online features and increasing price markdowns. “These trends are mitigated by cost-cutting and store closures,” Fitch analysts said. “In contrast, consumption patterns and online retail sales penetration vary widely across Europe and shopping space per capita across the continent is much lower than in the U.S.”

European retailers like Inditex and H&M have more room to expand and suffer only marginal hits on profit, Fitch said. Still, Amazon and other online retailers such as Zalando, ASOS or Shop Direct are knocking at the door and present longer-term threats to store-based retailers in Europe.

“The more successful European non-food retailers tend to have a well-developed omni-channel platform with a smaller physical footprint than their more traditional peers, benefiting from agile supply chains allowing them to stay responsive to fast-changing consumer preferences,” analysts said.

In the European food retail sector, Fitch believes companies are operating with 15% to 20% more space than they require; retailers are addressing the issue by closing stores or sub-letting space.
Despite the pressures they face, the credit profiles of European retailers should mostly stabilize in 2018 as they adjust business models and extend debt-maturity profiles, analysts said.

– Nicholas Stern, managing editor

Many Companies Not Prepared for the Risk Brought by the EU’s New Customer Data Rule

The European Union’s (EU) General Data Protection Regulation (GDPR) will give European customers the ability to control all of the personal data businesses store and process about them. Many companies, however, will not be prepared to meet the requirements when the GDPR takes effect in May 2018, leaving them exposed to potentially millions in fines.

The GDPR will give European customers the power to control all data collected about them, from name, address and phone number to purchasing history, web browsing activity, and real-time location. Companies loaded down with legacy enterprise systems housed in various silos can’t adequately track how and where they store this information; many are working to redo their IT infrastructure to prepare for the impending GDPR inquiries. Gartner predicts that by the end of 2018, more than half of the companies affected by the GDPR will not be in full compliance.

That will be key because according to a new global study of 7,000 customers across the EU by software firm Pegasystems Inc., 82% of European consumers plan on using their rights under the regulation to view, limit or erase the information businesses collect on them. Customer awareness is still fairly low, but among those who do know something about the GDPR, 90% want direct control over how companies use their data, and 89% want to see the data companies store about them.

Survey participants ranked the ability to see what data is collected and stored about them as the most important aspect of the GDPR (47%), while 22% want the ability to erase such data. Ninety-three percent of respondents said they would erase their personal data if they weren’t comfortable with how they thought companies used it.

By country, 90% of respondents from Italy said they planned on enforcing their GDPR rights, while 89% of those from Spain, 86% from France and 74% from the U.K. said they would do so.

– Nicholas Stern, managing editor

Negative-Yielding Debt Has Sticking Power, Despite Growth in Eurozone, U.S.

The world’s supply of negative-yielding sovereign debt is still at elevated levels, even though the European Central Bank (ECB) plans to cut monthly asset purchases in an environment of eurozone economic gains.

As of Dec. 4, 2017, there was $9.7 trillion of negative-yielding sovereign debt outstanding, up from $9.5 trillion on May 31, 2017 and $9.3 trillion a year ago, said Fitch Ratings in a new report. Analysts anticipate 2.3% and 2.2% GDP growth in the area in 2017 and 2018, respectively, while growth this year has exceeded their forecasts. The gains have spurred ECB officials to plan a slowdown of asset purchases to €30 billion per month beginning in January. “However, these changes have not led to materially higher yields on government debt for short- or long-term maturities in the eurozone,” Fitch said.

Total negative-yielding debt in Europe has increased over the last six months to a year, with much of the growth being attributable to the appreciation of the euro relative to the U.S. dollar, the ratings agency said. Yields in Japan and Europe are mostly flat, or marginally lower in aggregate, compared to six months and a year ago.

The continued monetary easing by the ECB is probably having an impact on global financial markets. “ECB net purchases of public-sector debt securities have been roughly 3.5 times the volume of net issuance on average in 2016 and 2017, forcing holders of eurozone debt to purchase other assets, such as U.S. treasury securities. While long-term yields in the U.S. remain low, they remain well above core eurozone yields that are near their 2017 lows,” Fitch analysts said. Meanwhile, on Dec. 4, the spread between U.S. and German 10-year government bond yields was just over 200bps.

Buy and hold fixed-income investors in medium- and long-term sovereign debt are being challenged in this low-rate environment. Foreign investment has likely contributed to a rapidly flattening yield curve in the U.S. as the Fed continues to raise the Funds rate slowly. Demand from investors has put downward pressure on U.S. yields, with the 10-year treasury remaining mostly flat in recent months.

“Meanwhile, yields on shorter-term securities have risen rapidly, bringing the spread between benchmark 2-year and 10-year U.S. treasury securities to 57bps on Dec. 4, the tightest since before the financial crisis,” Fitch said. “This is despite the fact that U.S. GDP growth has exhibited strong momentum and outperformance in 2017, similar to the eurozone.”

– Nicholas Stern, managing editor

Small Business Optimism Surges in November, Signaling Growth in ‘18

Small Business Optimism climbed to its highest level in 34 years in November, buoyed by the prospects of significant tax cuts. The National Federation of Independent Business (NFIB) Index of Small Business Optimism increased 3.7 points on the month to 107.5, and reached the second highest mark in its’ 44-year history.

Eight of the 10 index components improved in November, with the lion’s share of the gains going to a 16-point jump in Expected Business Conditions and a 13-point rise in Sales Expectations.

“The improvement in small business confidence is meaningful and suggests employment growth and business fixed investment should maintain strong momentum going into the New Year,” said Wells Fargo senior economist Mark Vitner. “The improvement in Small Business Optimism suggests tax reform may provide a more meaningful boost to economic growth in 2018.”

Small business owners have consistently highlighted taxes and regulation as their most important barriers to success—a recent political climate focused on reducing the impact of existing regulations and scaling back the adoption of new regulations, has boosted small business confidence, Vitner explained. Tax reform on the edge of passage only boosts such confidence.

Some owners said they believe now is a good time to expand; 27% of those in the November survey said as much, marking a four-point gain from October, the Wells economist said. Stated plans to increase employment also rose, by six points in November. “While hiring plans rose, actual hiring moderated. Thirteen percent of firms reported hiring workers, while 10 percent said they reduced employment,” Vitner said.

Finding qualified workers seems to be a problem for employers, as 52% reported they either hired to tried to hire workers in November, but 44% said they found few or no qualified candidates. The hiring problem has been more acute in the construction and manufacturing sectors.

– Nicholas Stern, managing editor

Asian Liquidity Stress Indicator Improves in November

Moody’s Investors Services’ Asian Liquidity Stress Indicator (LSI) decreased in November, a sign of improvement in speculative-grade liquidity.

"The Asian LSI improved in November to 26.4% [from 27.6% the prior month], largely due to the addition of new issuers, but remains weaker than the long-term average of 23.1%," said Brian Grieser, a Moody's vice president and senior credit officer. "The momentum in high-yield issuance continued in November, with rated issuance totaling $1.9 billion in the month, raising year-to-date issuance to a record $33.9 billion."

The number of rated high-yield companies with Moody’s weakest speculative-grade liquidity score (SGL-4) decreased to 39 from 40, while the total number of rated high-yield companies increased to 148 from 145.

For North Asian high-yield companies, the liquidity stress sub-indicator decreased to 27.8% in November from 28% in October, Moody’s said. The Chinese sub-indicator stayed stable at 28.7% from 28.9%, while the Chinese high-yield industrials subsector decreased to 40% from 43.2%, with new ratings assignments during November being the deciding factor.

In South and Southeast Asian high-yield companies, the liquidity stress sub-indicator decreased to 23.5% in November from 26.9% the month prior.

– Nicholas Stern, managing editor

Tax Reform to Help Tech Companies

The planned tax reform is a credit positive for the U.S. technology sector and will give tech companies additional financial flexibility, said Fitch Ratings. Much of the repatriated cash will go to shareholders rather than toward debt reduction or acquisitions, which could be credit negative in the short term, added the credit ratings agency.

Fitch predicts the tax rate reduction will cause tech companies to send cash overseas mainly for shareholder returns. It also expects offshore cash will not increase acquisition activity or leave cash on balance sheets.

Two of the largest cash piles—Oracle and Microsoft—will see their supplemental adjusted net leverage ratios “converge but decline over time as greater access to cash flow enables management to achieve target shareholder returns while reducing gross leverage to levels more appropriate for ratings.” Tech debt issuance will decline over the long term since most of the recent debt increases were to support shareholder returns.

Meanwhile, Moody’s Investors Services said the tax reform could be negative for states. State tax revenue will grow 2% to 3% over the next 12 to 18 months, but new tax regulations are an unknown, according to Moody’s. “The federal policy environment is becoming increasingly credit negative for states since many potential changes would affect state finances and challenge states as they plan future budgets.” Additional federal changes to Medicaid and the North American Free Trade Agreement could also have a negative impact at the state level.

-Michael Miller, editorial associate

Oil and Gas Production Will Remain Strong, with Supply Dampening Prices

A steady stream of oil and natural gas production should serve to aid the energy industry in its slow recovery, though excess supply is likely to tamp down price increases in 2018, according to a new report by Moody’s Investors Service.

"Prolonged oversupply will constrain oil prices in the next one to two years, though OPEC-led production cuts have now stabilized around price-supportive levels," said Steve Wood, Moody's managing director for oil and gas. "We expect prices to remain within the $40 to $60 per barrel band through 2019, assuming continued compliance with global production targets."

For natural gas, large reserves are expected to start yielding returns for many producers at $3.00/MMBtu as demand increases, Wood said. Storage levels are improving and U.S. production is anticipated to grow again in 2018 after the plateau seen this year.

The ratings agency’s outlook for the integrated oil and gas sub-sector over the next year to year-and-a-half is stable, while EBITDA should grow by approximately 5%, despite constrained investment conditions. Positive free cash flow could entice major European companies to reinstate cash dividends.

The outlook for the exploration and production sector remains positive, with EBITDA expected to grow more than 10% in 2018, as higher capital spending helps ramp up production volumes, according to Moody’s.

The midstream outlook is also positive, with EBITDA estimates for 2018 between 8% and 10%. Capital spending and production in the sector will increase, Moody’s reported. Potential headwinds include state and local regulations.

The refining and marketing sector of the industry has a stable outlook. EBITDA should grow 5% to 7% next year, as strong distillery demands are likely and should help ease high inventory levels, Moody’s said.

– Nicholas Stern, managing editor

Overcapacity Discipline Is Key to Maintaining Growth in Global Shipping

Ongoing overcapacity in the global shipping industry is among the factors keeping Fitch Ratings analysts from changing their negative outlook on the sector.

Container and bulk shipping are showing positive signals of growth, but the staying power of this trend remains cloudy “due to limited adherence to capacity discipline in the sector,” Fitch analysts said in a new report. Supply and demand dynamics are likely to support container, bulk and liquefied natural gas (LNG) shipping rates, but tanker rates could stall.

“The tanker shipping segment is the most exposed following a glut of new vessel deliveries in 2017,” Fitch said. “We expect demand for tankers to grow by around 4% in 2018, helped by rising global oil consumption, higher U.S. exports and declining oil inventories. But this would still only broadly match the expected growth in tanker supply. Rates therefore may not fall further, but a sustained increase is unlikely.”

Rates for container shipping have been raised this year, but again, overcapacity threatens continuation of the trend, which has fluctuated historically, analysts said. The ratings agency expects supply to grow by more than 5.5% in 2018, backed by stable capacity discipline and potential consolidation in the sector over the medium term.

A recent recovery in the rates for dry bulk shipping could also be transient, but Fitch believes demand will outpace the growth in vessel supply next year. “The market balance will be helped by the low level of new vessel orders for the last three years. China will remain the key driver for dry bulk commodities imports and trade, and the sector is therefore particularly sensitive to Chinese GDP growth, which we expect to be 6.4% in 2018,” Fitch said.

– Nicholas Stern, managing editor

Moderate Policy, Funding Capacity to Aid APAC Power Sector Transition to Renewables

The outlook from Moody’s Investors Service for the power sector in the Asia-Pacific (APAC) region through 2018 is stable, but as regional governments begin to tackle carbon transition risks, business conditions across the region will begin to diverge.

"The key factors supporting our stable outlook for the power sector in APAC are the steady market structures or consistency of returns in the region," said Mic Kang, a Moody's vice president and senior analyst. "Growing demand for electricity will help most Moody's-rated power companies with dominant or stable market positions maintain adequate dispatch volumes, despite challenges from renewables. As for the higher environmental costs associated with carbon transition policies, such costs will remain manageable, because of the gradual implementation of initiatives, cost pass-through and/or compensation through subsidies."

Carbon transition policies will become an important driver of business conditions in APAC, as each country’s target emissions level and the deadline to reach it will affect its exposure to carbon transition risks, Moody’s said. China’s thermal power generators are likely to face the biggest issues in the region while the sector faces overcapacity as it moves rapidly into renewables.

Sector reforms in most APAC countries are suggesting only modest changes to the way companies operate through 2018, which should help reduce the associated risks with liberalization policies, analysts said. Meanwhile, the power companies will see greater funding diversity that will allow them to expand capacity and develop renewables. “Given their large investment needs, a multi-pronged approach that combines bank loans with institutional debt capital will help boost private sector debt capacity.” Moody's says that “while corporate-type debt will remain dominant through 2018, debt funding across APAC will gradually include more project bonds.”

– Nicholas Stern, managing editor

Despite Recent Downshift, Long-Term Chinese Overseas Corporate Acquisitions to Remain

Chinese corporates’ foreign investments are likely to grow over the long term, despite a dramatic drop in such investments during the first nine months of 2017. That’s because Chinese authorities are likely to support overseas acquisitions of companies looking for advanced technology and strategic assets and to create jobs that enhance the country’s Belt and Road Initiative, according to a recent report by Fitch Ratings.

Year-over-year, Chinese corporate outbound activity dropped by 42% in the first three quarters of the year, thanks to the government’s tightened approval process related to its desire to limit capital outflows since the end of 2016. Overseas mergers and acquisitions in property, hospitality, and sports and entertainment saw a drop of nearly 70%.

Some of these restrictions on investments are likely to continue into 2018, while increased scrutiny from overseas regulators and regulatory uncertainty in the U.S. pose added headwinds to Chinese investments overseas, analysts said.

Still, many Chinese companies are at an early stage in terms of the interest in expanding overseas investments, while the Belt and Road Initiative is expected to continue interest in overseas M&A activity, Fitch said. Indeed, investments related to this initiative have increased in 2017.

Analysts at the ratings firm also believe Chinese overseas M&A will shift from energy and commodities to consumption-driven sectors like health care, consumer goods and high-end manufacturing. “It was notable that five out of China's top 10 overseas acquisitions in 2016 were in the computer and software and manufacturing sectors, and none was in the mining sector,” Fitch said.
 “Private companies have overtaken state-owned enterprises (SOEs) in overseas M&A transaction value, while appetite is switching away from resource-rich markets such as Australia, Canada, South America and Africa, in favor of the U.S., Europe and developed Asian economies.”

– Nicholas Stern, managing editor

Corporates to Continue Piling Cash

Corporate cash piles in the U.S. will continue to grow as the year ends. Company liquidity will increase roughly 5% to $1.9 trillion at the end of 2017, according to a recent report from Moody’s Investors Service.

Nearly half of corporate cash piles in the U.S. will be held by the technology sector. In fact, the top five cash holders—Apple, Microsoft, Alphabet (Google), Cisco Systems and Oracle—all come from the tech sector. The five companies will hold 35% of the total nonfinancial cash piles this year. Apple alone will have almost 15% ($285 billion) of the total corporate cash pile.

The increase in tech cash piles is due to the sector’s strong cash flow, according to Moody’s Senior Vice President Richard Lane. Offshore cash piles of U.S. nonfinancial corporates will also increase this year. U.S. firms aren’t the only companies focusing on cash.

Several weeks ago, Samsung named a new CFO to manage nearly $70 billion in cash. The electronics company has increased its cash pile 8% in three months. In Japan, over half of the listed companies reached all-time highs in retained earnings, said Nikkei Asian Review. Two of the world’s top automakers led the way. Toyota had more than $160 billion in retained earnings, while Honda was a distant second with over $62 billion in retained earnings. “Critics point to restraint on wage increases and dividends as another factor letting corporate cash pile up,” said Nikkei.

– Michael Miller, editorial associate

Australian Government Mandates Quicker Payment to Small Businesses on Infrastructure Projects

The Australian government plans to cut payment times for small businesses on public contracts by up to a third as it attempts to encourage small business competitiveness in infrastructure projects, according to a recent report in the Brisbane Times.

The changes, suggested by the Australian Small Business and Family Enterprise Ombudsman, will impact more than 6,800 businesses that have been hampered by month-long payment times for work on government contracts, the publication reports. As of last week, the Australian government will have to pay invoices for contracts worth up to $1 million within 20 days.

According to a 2016 Dun & Bradstreet report cited by the Brisbane Times, contractors for businesses with 500 or more employees saw average payment delays of 18 days beyond 30-day terms. The ombudsman said up to half of all small businesses had more than $20,000 owed to them.

"Adverse payment terms between businesses can have a negative impact on competitiveness, increase the cost of doing business and place significant stress on owners," Federal Small Business Minister Michael McCormack was quoted as saying in the report.

Small firms in Australia with a turnover of up to $50 million per year will also benefit from recent tax cuts—from 30% to 25%—that will be phased in by 2027, the Brisbane Times reported.

– Nicholas Stern, managing editor

Climate Change to Be an Increasing Credit Factor

The increasing effects of climate change are expected to incur an economic impact on U.S. state and local governments, according to a new report from Moody’s Investors Service. Climbing global temperatures and rising sea levels will be a negative credit factor for those without sufficient adaptation and mitigation strategies, the ratings agency said.

“While we anticipate states and municipalities will adopt mitigation strategies for these events, costs to employ them could also become an ongoing credit challenge,” said Michael Wertz, a Moody’s vice president. “Our analysis of economic strength and diversity, access to liquidity and levers to raise additional revenue are also key to our assessment of climate risks, as is evaluating asset management and governance.”

Moody’s credit analysis takes into account the effects of climate change when analysts believe that a meaningful credit impact is highly likely and will not be mitigated by issuer actions, even if it is years in the future. The report makes a distinction between climate trends, which are shifts in climate that take place over decades, and climate shock, which includes extreme weather events such as natural disasters and floods that are made worse by climate change. Extreme weather patterns can create economic challenges from smaller crop yields, infrastructure damage and higher energy demands.

“U.S. issuer resilience to extreme climate events is enhanced by a variety of local, state and federal tools to improve immediate response and long-term recovery from climate shocks,” Wertz said.

The ability of local government to mitigate credit impacts can be affected by the availability of state and federal resources. Municipalities can benefit from disaster aid provided by the Federal Emergency Management Agency to assist in economic recovery. The preparedness and planning of municipalities is weighed with the impact of climate risks when Moody’s analyzes credit ratings. Analysts for municipalities that have higher exposure to climate risk also focus on current and future mitigation steps and how those steps affect the issuer’s overall profile, Moody’s said.

– Adam Fusco, associate editor

Japanese Corporate Earnings Stable in 2018 on Global Economic Growth

A combination of moderate global economic growth and solid domestic demand will support Japanese corporate earnings in 2018 and produce stable outlooks for most sectors in the country.

"We project 2018 GDP growth of 3.2 % for the G20 economies and 1.1% for Japan, while rated Japanese companies' EBITDA will grow 1% to 3%," said Mihoko Manabe, a Moody's associate managing director, in a new report. “The recovery in commodity prices will support the earnings of trading companies, and the oil and gas and mining sectors, but higher raw material costs may pressure margins for autos. At the same time, for Japanese corporates overall, a cautious stance towards financial management and investments will lead to a modest fall in leverage, supporting credit quality and ratings," Manabe said.

Moody’s analysts expect ongoing monetary and fiscal accommodation to boost domestic demand in the coming year. Meanwhile, electric vehicles will provide potential earnings bumps to the manufacturing and service sectors. Still, Moody’s outlook for the Japanese auto sector is negative on low unit sales predictions for 2018. Maturing technologies already in use will make way for newer technologies and propel companies to restructure and look for new investments. Telecoms, steel, shipping, utilities, trading companies, electronics, oil and gas, pharmaceuticals and real estate all have stable outlooks.

Downside risks for the Japanese economy include lower-than-anticipated global economic growth that could weaken demand for exports, a strengthening yen, geopolitical risks and protectionist policies in advanced economies, analysts said.

– Nicholas Stern, managing editor

Brexit Already Starting to Impact U.K. Corporates

The fallout from Brexit is starting to weigh on U.K. corporates, particularly those that are more leveraged and have other significant operating issues. “Any broader impact on corporate sectors remains dependent on post-Brexit trade terms and the amount of time companies have to prepare for change,” Fitch Ratings analysts said in a new report.

Last month, Monarch Airlines collapsed, thanks in part to the pound’s drop, which pushed up dollar denominated costs. That in turn ramped up pressures from low cost carriers, Fitch said. More recently, easyJet had an adverse currency impact as well. Still, “…We believe the key credit risk for airlines is the potential loss of access to the single aviation market, which allows an airline in an EU member state to operate anywhere in the EU. Access is vital for [low cost carriers’] point-to-point business models and certainty will be needed well before the planned Brexit date of March 2019 because flights are open for booking months in advance.” Carriers’ offices being opened up in Europe won’t help resolve the uncertain issue of flights between the U.K. and Europe.

Meanwhile, food prices are taking off at the fastest rate since 2013, and more World Trade Organization tariffs imposed in the situation of a hard Brexit would exacerbate the problem, especially if the pound continues to depreciate, Fitch said.

Staffing costs may rise if uncertainty around Brexit causes EU nationals to leave ahead of a resolution, analysts said. Nursing shortages have already popped up at Four Seasons Health Care, which reported a rise in staff costs recently attributed to a Brexit-related shortage of nurses.

London real estate, exposed to the potential loss of financial jobs, is another area that could be negatively impacted by Brexit. The British auto industry—especially for low-margin, high-volume manufacturers—could also come to raise costs for automobiles depending on how trade terms are worked out in Brexit. “Non-tariff barriers could be an equally big challenge to just-in-time manufacturing models if Brexit leads to frequent customs delays,” Fitch analysts said. “This is already delaying investment decisions and in the long term could move more auto manufacturing and associated supply chains out of the U.K.”

– Nicholas Stern, managing editor

New Business Volume Rises in October

New business volume in October rose 2% year-over-year from that in October of last year, though it was down 3% month-to-month from that in September. According to the Equipment Leasing and Finance Association’s (ELFA) Monthly Leasing and Finance Index, which covers economic activity from 25 companies who represent a portion of the $1 trillion equipment finance sector, cumulative new business volume was up 4% compared to 2016, year to date.

“Equipment finance originations continue to grow, albeit slowly, as some sluggish market verticals show signs of rebounding,” said ELFA President and CEO Ralph Petta in a release. “This trend, coupled with buoyed confidence in overall economic conditions, paves the way for a very healthy end-of-year bump.”

Credit approvals clocked in at 74.6% for October, up from 74% in September. Head count for equipment finance companies was up 17.1% year-over-year, though this is attributable mostly to one company in the survey. Participants in the index include Bank of America Merrill Lynch, BB&T Bank, CIT, Hitachi Credit America, M&T Bank, Merchants Bank Equipment Finance, TD Equipment Finance, Volvo Financial Services and Wells Fargo Equipment Finance.

Receivables over 30 days were 1.4%, the same as in September and unchanged from the same time frame last year. Charge-offs were 0.41%, only a slight rise from the previous month. The separate Equipment Leasing & Finance Foundation’s Monthly Confidence Index registered 67 in November, up from 63.7 in October.

“Business confidence is very strong and building, despite the relatively flat growth of originations,” said David C. Mirsky, CEO of Pacific Rim Capital, in the release. “This is because lessors are feeling mounting strength in the overall economy, evidenced by increasing requests for quotations and new orders being placed by lessees in every market segment.”

The hurricanes that occurred earlier in the year have had an effect on the economy, as shown by recent numbers from the “index of indices.” “The Conference Board’s index of leading economic indicators rose slightly more than expected as the economy shrugged off the impact of the hurricanes,” said NACM Economist Chris Kuehl, Ph.D. “It wasn’t so much that the storm damage was ignored—more that the storm aftermath took over as far as the economy is concerned. The initial damage was not quite as severe as had been expected (at least at a national level), but the reconstruction has been swift and has boosted several areas of the economy. The expectation had been a 0.9% boost; the actual improvement was 1.2%, to a total of 130.4.”

– Adam Fusco, associate editor

Cov-Lite Loans Pose Greater Risks as Leveraged Finance Activity Nearly Reaches Post-Crisis High

Corporate creditors should take note that the covenant-lite loans that are predominating in the North American leveraged loans sector provide new risks that could jeopardize lenders’ ability to repay.

Cov-lite loans accounted for approximately 77% of the leveraged loans that Moody’s Investors Service has analyzed since the beginning of 2016; this figure is up from 25% a decade ago. Vanishing maintenance covenants and those covenants providing leveraging, lien and structural protections may not prohibit borrowers from taking certain actions that could harm their ability to pay the loans back, Moody’s said.

"Strikingly, the covenant packages are weakest in lower-rated cov-lite loans," said Derek Gluckman, a Moody's vice president and senior covenant officer. “Cov-lite's domination of the leveraged loan market is now well established. But cov-lite loans are more risky for investors, with the absence of maintenance covenants depriving them of early warnings of distress, periodic oversight and the opportunity to secure a place at the head of the line when enforcing their rights."

Libor spreads are also tightening on these cov-lite loans, the analysts warn. “The expectation of receiving some premium for taking on increased risk remains challenged by extraordinary demand in the loan market,” Moody’s analysts said. “Analysts at the rating agency have observed a compounding of default and structural risks in the lower-rated cov-lite loan space where the weakest covenant packages are found, but noted offsetting compensation is not so clearly evidenced when looking at spreads.”

Meanwhile, in a separate report, Moody’s analysts note that high-yield bond issuance increased to its highest monthly level this year, while overall leveraged finance volumes have reached a post-crisis high.

High-yield bond volumes reached $21.7 billion in October, up from $5.7 billion in September as well as the prior October’s $4.3 billion, Moody’s said. "While larger transactions contributed to the exceptionally large high-yield bond issuance, October's volumes also benefited from the high number of issuers, including first-time issuers, accessing the market. Increased activity in the cable and telecom sectors also boosted loan volumes," said Peter Firth, an associate managing director at Moody's.

Leveraged finance activity so far this year has nearly reached the post-crisis record of $240 billion in 2014.

– Nicholas Stern, managing editor

Business Confidence Hits Three-Year High

More than a third of companies forecast growth, indicating a high degree of confidence in the U.S. private sector, according to IHS Markit’s latest Business Outlook report. Favorable business conditions and new product developments are reasons for the positive sentiment. Expectations regarding future output were also buoyed by strong client demand and larger customer bases. Potential threats to growth include supply chain pressures and changes in government regulations.

“The latest data on industrial production has been as impressive as it has been in several years, and the most interesting aspect of this recovery is that it has come despite the impact of the hurricanes,” said NACM Economist Chris Kuehl, Ph.D. “The drivers for the manufacturing boost have been manifesting all year and continue to pick up speed. The export sector is as strong as it has been since the recession because the economies of Europe and Japan have been on the rebound and they are both important markets for the U.S. The weaker dollar has been a big contributor as well.”

“Optimism among private sector firms is the highest since June 2014 for both output and new orders,” said Sian Jones, economist at IHS Markit. “Moreover, confidence is reflected across both manufacturers and service providers. In line with greater confidence, business revenues are forecast to rise at the quickest pace since mid-2014. Similarly, expectations around profits are the strongest since February 2014. Expenditure on capital investment, however, is predicted to soften from the previous survey period, but remained in line with recent trends.”

Optimism is also high in regards to increasing staffing levels among goods producers for the coming year. Confidence in hiring is at its highest in three years. Service providers also foresee a pickup in job hiring plans. Workforce numbers in the U.S. are expected to grow at a faster pace than the global average.

Supplier shortages and higher raw materials prices will weigh on the cost burdens of private sector firms over the coming year, though companies expect just a mild rise in input prices compared to the global average, IHS Markit said.

– Adam Fusco, associate editor

Some U.S. States Will Lose More than Others under NAFTA Renegotiation

As President Trump’s administration takes more of a hard line on trade, it may be time for an evaluation of the effects changes in policy may have, and in detail. In a recent report, Fitch Ratings assesses the impact of changes to or withdrawal from the North American Free Trade Agreement (NAFTA) on individual states and the role they play in trade with Canada and Mexico. Though it seems the administration is willing to renegotiate the trade pact rather than withdraw from it altogether, the ratings agency looked at data in light of minor changes to NAFTA that could result in prolonged negotiations as well as major disruptions in trade that could occur from a complete withdrawal.

North Dakota is at the top of the list among states in terms of its export exposure to Canada, according to a ranking of U.S. states’ 2016 import and export trade volume with Canada and Mexico from the U.S. Census Bureau. A total of 82% of North Dakota’s exports were sent to Canada in 2016. New Mexico is No. 1 by volume of exported goods shipped to Mexico, with the Mexican domestic market the destination for 43% of that state’s exports, Fitch said.

The states with the largest export exposures to Canada, after New Mexico, are Maine, Montana, Michigan, Vermont, Ohio, Missouri, South Dakota and Indiana. Major export industries include farm products, energy (i.e., oil and natural gas), machine parts and automotive products.

Eleven U.S. states send 30% or more of their exports to Canada, including those above, and 24 others depend on Canada for at least 20% of their exports. Imports of industrial and consumer goods in these states are heavily weighted toward Canada. A withdrawal from NAFTA would greatly increase import tariffs, imposing substantial costs to U.S. importers and consumers, Fitch said.

Mexico took in 40% of Texas’ exports by product value in 2016, and the Mexican domestic market was the recipient of 38% of Arizona’s and 15% of California’s exports. Due to the complex supply chain in the automotive industry that started in 1993, when NAFTA was signed, Michigan is a big component in U.S./Mexico trade. Twenty-two percent of Michigan’s exports by value, mostly automotive and heavy machine components, were destined for Mexico in 2016. Other states with important exporting relationships with Mexico include South Dakota, Nebraska, Iowa, Kansas and Missouri.

Michigan is in a unique position if NAFTA’s terms change drastically, due to its proximity to Canada and prominent role in the automotive industry. Sixty-five percent of the state’s exports went to Canada and Mexico, resulting in 7.4% of its Gross State Product in 2016.

– Adam Fusco, associate editor

U.S. Steel Sector Has Stable Outlook

The U.S. steel and metals sector is stable overall, according to the latest Market Monitor from credit insurer Atradius. The demand for U.S. steel is expected to increase by roughly 3% in 2017 and 2018, following a nearly 5% decline in 2016.

“While the overall financial and credit conditions are generally stable, steel/metals companies still must be financially very viable in order to obtain their preferred lending terms and interest rates,” said Atradius. Since the second half of last year, steel prices have rebounded. There was a profit margin deterioration in 2015 and the first half of 2016 due to the lower cost of imported steel and a drop in demand from the oil and gas sector.

Overall, payment delays and defaults have stabilized. Payments on average take from 30 to 45 days domestically and 60 to 90 internationally. Industry insolvencies are not expected to rise much this year and next year. “However, an increase in both payment delays and business failures in Puerto Rico and the area around Houston with its large oil industry cannot be ruled out,” said the market watch report. This is due to the recent hurricanes to make landfall.

The possibility of a major infrastructure plan “would certainly help the sector,” said Atradius. This was one of three strengths for the industry, along with lower insolvencies and a businesses’ stable financial situation. International trade wars and increasing competition were among the weaknesses.

Atradius also reviewed the steel industry in other countries, including China, Germany, the U.K. and India.

– Michael Miller, editorial associate

Small-Business Optimism Rises in October

Small-business owners expect higher sales and anticipate that now is a good time to expand, according to October’s Index of Small Business Optimism from the National Federation of Independent Business (NFIB). Four of the index’s components rose while five declined slightly, and one remained unchanged. The categories of expansion and sales expectations each climbed six points; the job openings category rose by five points. Overall, the index rose to 103.8 in October, up from 103 in the previous month.

“Owners became much more positive about the economic environment last month, which suggests a longer-run view,” said NFIB Chief Economist Bill Dunkelberg. “In the nearer term, they are more optimistic about real sales growth and improved business conditions through the end of the year.”

The labor market remains tight for small-business owners, which has been a trend the past year. Among owners, 59% reported that they tried to hire in October; 88% of them reported finding no or few candidates who were qualified. Construction firms are still trying to meet demand due to the recent hurricanes, with the result that hiring activity was particularly strong in Florida and Georgia.

Just 2% of small-business owners said that financing was their top business problem. Four percent reported that all of their borrowing needs were not met, a historical low. Twenty-nine percent said that their credit needs were met, a decrease of four points, and 53% said they were not interested in a loan, an increase of two points.

“Consumer sentiment surged based on optimism about jobs and incomes, an encouraging development as consumers account for 70 percent of GDP,” Dunkelberg said. “We expect a pickup in auto spending as people in Texas and Florida continue to replace cars that were damaged in hurricanes. We expect the same increase in home improvement spending, partly because of the hurricanes, but also because of the skyrocketing price of homes.”

– Adam Fusco, associate editor

China Looks to Expand Presence of International Aircraft Lessors

Thanks to a rise in the number of Chinese consumers able to spend more on travel, Chinese aircraft lessors are expanding rapidly and bringing added competition to the global marketplace that may further pressure the yields and margins of established companies.

China’s growth in air traffic has been a key driver of strong global demand for commercial aircraft, and in a recent report by Fitch Ratings analysts expect the rapid pace of this growth to continue, with revenue per passenger kilometer likely to increase to 10% per year over the next decade or so. So far this year, 42% of Chinese aircraft deliveries have been lessor-owned, up from 33% in 2012.
China’s Belt and Road initiative and Go Global strategies are also helping drive Chinese lessors pursuing international expansion, Fitch said. This expansion is also aided by airspace bottlenecks and a lack of airport capacity for domestic routes.

“Chinese-backed aircraft lessors are competing aggressively in the global market across the spectrum of future aircraft orders, new delivery transactions and the leasing of older aircraft,” Fitch said. “Chinese entrants may price risk differently from established players, given their growth priorities and generally shorter track record in aircraft leasing. Leasing subsidiaries of leading Chinese banks [are] also benefiting from their parents' funding and capital support, which may lower their funding costs and provide an advantage over standalone global competitors.”

Increasing competition in the worldwide market could pinch profitability and weaken underwriting standards for established international lessors, thus raising the risk of market shocks putting pressure on lessors’ ratings. “Several airlines have already been forced into bankruptcy this year, including Monarch of the U.K., Air Berlin and Alitalia. This illustrates the weak credit quality of some airlines even in a benign market environment, as well as the dangers for lessors of significant airline customer concentration,” analysts said.

– Nicholas Stern, managing editor

G20 Nations Issue Fewer Trade Restrictions in Recent Period

G20 economies have introduced fewer trade-restrictive measures since May than the prior period and many more trade-friendly measures, according to a new report from the World Trade Organization (WTO).

Nations within the trading block adopted 16 new trade-restrictive measures from May to October, including new or increased tariffs, export restrictions and local content measures; this was about half of the number of measures introduced from mid-October 2016 to May 2017, the WTO said. Meanwhile, G20 economies implemented 28 measures designed to facilitate trade from May to October.

“G20 members have shown restraint in implementing trade-restrictive measures, despite continuing economic uncertainties,” said WTO Director-General Roberto Azevedo in a press release. “This is positive news and it shows again that the global trading system is working. Nevertheless, the threat of protectionism remains and so I urge G20 countries to redouble their efforts to avoid implementing new trade restrictions and to reverse those measures that are currently in place.”

– Nicholas Stern, managing editor

Emerging Market Corporate Ratings Hindered by Commodities Downturn

Even though global economic growth is set to be the strongest since 2010, the corporate ratings of emerging markets (EM) will take time to catch up. According to a recent report from Fitch Ratings, the downturn in commodities has damaged balance sheets and the Brazilian recession is also a drag on international ratings, despite a likely 10% increase in revenues this year among emerging markets as a whole.

Though Fitch expects that eventually the positive economic atmosphere will shift the direction of its rating actions, it will not likely happen until next year. So far in 2017, EM corporate downgrades have outnumbered upgrades 60 to 45. Ratings outlooks and watches have also tended toward the negative, though less so compared to last year.

Global GDP is expected to increase by 3.1% in 2017 and 3.2% in 2018 from strong growth in the U.S. and robust performance in the eurozone, Fitch said. This will support demand of EM exports. The two years of economic contraction in Brazil, however, weighs on ratings, though a return to growth in that country is anticipated.

Commodity prices, with the exception of oil, have outperformed Fitch Ratings’ expectations. This, along with a weakening U.S. dollar, should contribute to conditions that will lead to expansion for EM corporates. The largest contributors to growth will be energy companies, Chinese domestic homebuilders, utilities, building materials firms and construction firms, Fitch said. Year-end leverage will decline in all regions except China, where a reduction is not expected until 2018.

– Adam Fusco, associate editor

Moody’s: 2018 Sovereign Creditworthiness Outlook Is Stable


Sovereign creditworthiness has a stable outlook for 2018, according to Moody’s Investors Service. The “healthy growth and synchronized global economic expansion of 2017 [is] likely to continue into 2018,” said the ratings agency in a release.

Moody’s rated 137 sovereigns in its most recent 2018 outlook. Nearly three-fourths of them have a stable outlook, while 10% have a positive outlook and 22 sovereigns have a negative one. There were 35 negative outlooks a year ago.

"The macroeconomic environment for sovereigns is more favorable than it was a year ago," said Moody’s Managing Director of Global Sovereigns Alastair Wilson. "Moody's expects global GDP growth in 2018 to remain over 3% in 2018, similar to 2017. That benign economic backdrop allows governments a longer window in which to carry out economic and fiscal reforms."

Despite a favorable global outlook, Moody’s cites several challenges that prevent “a greater improvement in global credit conditions,” according to the report. Among the issues are political uncertainty and social tensions. This problem can be seen in Brazil, South Africa and Turkey, noted Moody’s. “Overall, slow progress on reforms leaves many sovereigns more vulnerable to a deterioration in their credit profiles in the event of a shock.”

Public debt levels are also a cause for concern, but Moody’s predicts almost half of the sovereigns’ debt burdens will stay within one percent of current levels. "While benign economic conditions lower the risk posed by high debt levels, few sovereigns have much, if any, fiscal space to respond to shocks," explained Wilson. Heightened geopolitical risk is the third challenge listed by Moody’s, which could “potentially undermine the stable outlook for sovereign credit.” Among the specific challenges were U.S. protectionism, a potential military conflict in Korea and tensions in Spain.

– Michael Miller, editorial associate

Global Economic Growth Edges Higher in October

The global economy continued it steady progress as the final quarter of the year began. The J.P. Morgan Global All-Industry Output Index, produced by J.P. Morgan and IHS Markit, rose a fraction in October to 54. The headline index has signaled growth for the past 61 months.

“October saw rates of expansion in global economic activity and employment edge higher, despite new order growth ticking lower, suggesting that the global economy is maintaining its solid and steady growth path,” said David Hensley, director of global economic coordination at J.P. Morgan. “Signs that price inflation eased should provide some respite to firms and ensure cost pressures will not constrain growth in the months ahead.”

Activity increased in all six categories of the survey, indicating broad-based expansion. Consumer-facing sectors such as consumer goods and services were weaker than other industries, such as intermediate goods, investment goods, business services and financial services.

One of the best performing regions is the eurozone. Though the rate of expansion of its economic activity eased, it is one of the best registered during the past six-and-a-half years, IHS Markit said. Growth accelerated in France while it eased in Germany, Italy, Spain and Ireland.

New orders increased globally for the hundredth month in October, though the pace of expansion eased to a four-month low. Business optimism increased from new business intakes and still-rising outstanding business. Backlogs of work have been increasing for 15 months. Rates of inflation in input costs and output charges slowed in October, easing price pressures, IHS Markit said.

– Adam Fusco, associate editor

More Small Businesses Taking Credit/Debit Payments

Small business owners look like they’re embracing new technologies when it comes to the types of payments their businesses will accept, allowing more in-person credit and debit card payments using point-of-sale terminals.

According to the latest Wells Fargo/Gallup Small Business Index conducted in early October, 39% of business owners now accept credit or debit card payment, up from 31% in January 2016. Also, 33% accept credit or debit card payments via a mobile point-of-sale terminal, up from 20% in January 2016. Twelve percent of business owners said they accept digital wallet payments, compared to 5% in January 2016. Still, the top form of accepted payments, at 88%, is in-person cash or check, followed by a mailed check at 82%.

The survey found optimism is still high—at 103 in October from 106 in July, when it was the highest reading in a decade. Seventy-one percent of respondents said their financial situation was very or somewhat good in October. Businesses have been buttressed by steady revenues, healthy cash flow and a relative ease of obtaining credit.

Hiring and retaining quality staff members remains the top challenge of small business owners, according to Wells Fargo/Gallup. Sixteen percent of owners said hiring was their biggest issue, up from 13% during the prior quarter. Thirty-two percent of owners reported their plans to increase the number of jobs at their businesses next year, marking the second highest percentage in the 14-year history of the survey.

“Hiring the workers they need has clearly become a more pressing issue for small business owners,” said Mark Vitner, senior economist at Wells Fargo. “Labor markets have tightened around the country and many workers that had been employed part-time have moved on to full-time positions, making it particularly difficult to fill these positions right now.”

– Nicholas Stern, managing editor

BOE Rate Rise Points to Interest Rate Normalization

The Bank of England’s recent decision to increase U.K. interest rates by 25 basis points highlights the fact that shrinking output gaps and tighter labor markets are causing central banks to move toward interest rate normalization.

According to a report from Fitch Ratings, the Bank of England is looking to tighten policy slowly. The bank said Thursday that its Monetary Policy Committee voted seven to two to increase the bank rate to 0.5%, reversing the cut made last August following Brexit. The last rate hike was made in July 2007. The bank also left the stock of bonds purchased through so-called quantitative easing unchanged.

“We think another increase is unlikely in the next 12 months, given the impact of Brexit uncertainty on the outlook for investment,” Fitch analysts said. The ratings agency said the bank’s decision doesn’t change its U.K. growth forecasts, “…which see a net trade boost partially offsetting slower domestic demand this year, enabling real GDP to rise by 1.5%, before slowing to 1.3% next year. But it remains to be seen how firms and households adjust to a shift in the monetary policy stance after such a long period without a rate rise.”

The bank’s decision underscores how tighter labor market conditions, with U.K. unemployment at a 42-year low, as well as concerns about harmful supply-side affects from Brexit, have decreased the acceptability for higher-than-expected inflation. Inflation grew to 3% in September, in part, as a reaction to a weakening sterling.

“As output gaps close, central banks around the world are generally refocusing on policy normalization,” Fitch analysts concluded.

– Nicholas Stern, managing editor

Kamakura: Corporate Credit Quality Improves in October

The Kamakura Corporation’s troubled company index ended October with a decrease of 0.61% from the previous month, at 7.16%. A decrease in the index reflects improving credit quality. The index is the percentage of companies in Kamakura’s 39,000 public firm universe that have a default probability of more than 1%.

“Global economic news remains positive, with momentum building in many markets,” said Martin Zorn, president and chief operating officer for Kamakura. “While inflation remains muted, the Fed believes that the Phillips Curve holds and tighter labor markets will boost inflation in the months ahead. On the other hand, market expectations have not moved much. European economic data and sentiment remains positive and the markets have largely ignored the turmoil in Spain. These indicators all point toward increased interest rates ahead, with the possibility that rates may rise faster than market expectations.”

Volatility in the index remained low in October. At the end of the month, the percentage of companies with default probabilities between 1% and 5% was 6.02%, a decrease of 0.39% from September. At its current level, the index is at the 88th percentile of historical credit quality, with 100 being best, from January 1990 to the present. Of the 10 firms rated the riskiest, seven were from the United States and one each from Australia, Canada and Great Britain. The riskiest firm is Windstream Holdings, which has been on the troubled company list since 2014.

“In Asia, we see increases in China’s government bond yields accelerating,” Zorn continued. “This could be bad news for leveraged loans, zombie companies and low-income Americans who are leveraging to the max according to recently released data. Stress testing interest coverage protection on debt instruments should be a priority for portfolio managers in the current environment.”

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

Moody’s Sector Risk Roundup: European Auto Parts, Global Beverages, Brexit Ports

The European auto parts sector looks stable with a steady stream of global light-vehicle sales, while the global beverage industry’s outlook also remains stable, thanks to expected growth in brown spirits and craft beer sales, according to reports released today by Moody’s Investors Service. Meanwhile, a Brexit “no deal” could bring new risks to the U.K. port sector.

European Auto Parts
Moody’s expects 2017 organic revenue growth for the European auto parts sector to achieve approximately 4.5%, and then to slow to 3.5% in 2018. The growth will be driven by global light-vehicle sales. This year, vehicle sales should grow 1.3% and 1.5% in 2018, which is still a large drop from the 4.1% gain realized in 2016.

"European auto parts suppliers will continue generating revenue growth in excess of global light-vehicle sales as stricter carbon emissions enforcement, consumer demand for improved safety features and the development of autonomous driving technologies drive more content per vehicle and underpin the stable outlook on the sector," says Matthias Heck, vice president, senior analyst at Moody's.

EBITA should remain robust in 2017 at 4.5% to 5% and 3.5% to 4% in 2018, Moody’s said. Free cash flow generation among European auto suppliers will improve through 2018 as revenue growth slows and working capital levels improve. “However, capital expenditures and R&D spending will remain high in the sector, constraining free cash flow at about 2% of sales in 2017 and 2018, which is in line with the historical five-year average,” Moody’s analysts said.

Global Beverages
Premium brands and innovation are supporting higher prices in the sector, while portfolio mix will offset volume challenges in some categories, said Moody’s in a separate report. Also, large M&A transactions are likely to bring more efficiency to support operating growth. "We expect overall operating profit to grow 4% to 5% over the next one to two years, based on low single-digit sales growth," said Linda Montag, a Moody's senior vice president.

Some commodity cost inflation for beverage companies is also anticipated in the year ahead, Moody’s said. Brown spirits and premium beers are expected to drive growth in the sector, while carbonated beverages and mainstream beers will continue to challenge sales growth. Still, both of the latter categories have room to grow in emerging markets.

U.K. Ports
A “no deal” scenario regarding Brexit would complicate matters for the U.K. port sector, which currently sees frictionless, custom-free EU trade, another Moody’s report concluded. Chances of a “no deal” do remain substantial, though Moody’s predicts the U.K. and EU should find some agreement that maintains many of the current arrangements.

"While a Brexit 'no deal' presents a risk, the impact would vary depending on a port's diversification and traffic mix. For example, non-EU-reliant ports, like Felixstowe, and diversified port groups such as Associated British Ports, are less exposed than single ports that rely on EU traffic, like the Port of Dover," said Joanna Fic, vice president and senior credit officer at Moody's.

The “roll-on roll-off” ferry ports and the Channel Tunnel are the most exposed to a no-deal Brexit. Ferry ports such as Dover and Holyhead, as well as Groupe Eurotunnel SE, have little or no room to accommodate delays in the movement of passengers or trucks, Moody’s said.

Container ports would have a more mixed response to such pressures. A change in trade flows could benefit some ports, including on the east coast, as ports that rely on “feeder services” from the EU could be exposed to a shift in volume to larger ports if tariffs and customs became an issue.

Large and diversified ports are the most sheltered from a no-deal storm. Ports with available land, for instance, could develop port-centric activities such as warehousing to support just-in-time deliveries, Moody’s said. “However, this would require adjustments in the supply and logistics chain, a complex and uncertain process, and port companies would need to make investments without visibility on future volumes and returns,” analysts said.

– Nicholas Stern, managing editor

NACM’s October CMI Scores One for the Ghosts and Goblins

Creditors may find a few rocks mixed in with their candy corn and caramel apples this Halloween, as NACM’s Credit Managers’ Index declined for the month of October. The retreat should not come as a surprise, however, after the index reached its highest level in over two years last month. Good news reigned among the favorable factors, though the difference in performance with the unfavorable factors remains stark.

“The storms altered a lot of economic patterns,” said NACM Economist Chris Kuehl, Ph.D. “That has been seen in everything from volatile job numbers, changes in the rate of housing starts and even internal migration patterns for skilled workers. There are already signs of shifts as reconstruction gets thoroughly underway.”

The combined score for the index came in at 55.5, down one point from September. Among the favorable factors, sales declined but still maintained the second-best reading of the year. An indication of a greater demand for credit and a desire to grow and expand was to be found in the improved numbers for new credit applications.

Last month, almost all the unfavorable factors were in expansion territory; all but two fell into the contraction zone in October, though the overall reading leveled off at 50. Dollar amount beyond terms fell into contraction with a decline of three points. “The volatility that has characterized the CMI for the last several months has been largely attributed to the vagaries of the slow pay,” explained Kuehl. Filings for bankruptcies and rejections of credit applications also declined, but stayed in expansion territory. Accounts placed for collection slipped out of expansion into contraction; the reading for disputes did as well, with a fall of over four points.

“What doesn’t show up that well with this data is the stark difference between the readings for the favorable categories and the unfavorable,” concluded Kuehl. “The favorable numbers are consistently in the 60s and the unfavorable keep sinking into the 40s and the contraction zone.”

– Adam Fusco, associate editor

Risk Professionals Think Executives, Boards Less Concerned with Cyber Risk

Executives and boards of directors appear to risk-management professionals to be less concerned about cybersecurity risk this year compared to last, according to a survey of risk professionals by the Zurich Insurance Group Ltd. and Advisen Ltd.

The survey found 62% of risk professionals believe their boards of directors view cyber risk as a significant threat to their organizations, compared to 83% the prior year. Also, 60% of the 315 risk professionals polled said executive management views cyber risk as a significant threat compared to 85% in 2016.

“This could indicate board members have become more comfortable in their understanding of cyber exposures,” the Security and Cyber Risk Management survey report said. “Or, it could mean risk professionals are not up-to-date on the evolving nature of cyber risk and the possible magnitude of the losses.”

Just 53% of respondents knew of changes or upgrades made following well-known attacks in early 2017. “This could indicate that risk professionals are either less educated about the exposures, have concluded these exposures are less significant to their business, or are confident (or overconfident) in their cybersecurity controls,” said the survey report. “Or the reason could be that risk professionals are not fully aware that the nature of the cyber risk has been evolving beyond data security and toward interconnected risks, including business interruption due to malware and ransomware attacks.”

– Nicholas Stern, managing editor

New Developments Helping Trade Finance, Small Businesses

Two major world financial centers have joined together to promote financial technology (fintech) growth and innovation. The Monetary Authority of Singapore (MAS) and the Hong Kong Monetary Authority (HKMA) signed a cooperation agreement on fintech this week in Hong Kong.

The first initiative is a project based on distributed ledger technology (DLT) to help facilitate trade finance cross-border infrastructure. Additional details are expected to be announced in November, said separate releases from the monetary authorities.

Additionally, the agreement will include other fintech projects, referrals of innovative businesses, information sharing and the exchange of expertise. “Collaboration between the HKMA and MAS will create significant synergy for the development of fintech and more efficient fund flows between the two markets,” said HKMA Chief Executive Norman Chan.

HKMA partnered with banks HSBC and Standard Chartered to test DLT late last year. Using DLT or blockchain can help move trade finance along with faster and safer methods. “Letters of credit are one of the most widely used ways of reducing risk between importers and exporters, helping guarantee more than $2 trillion worth of transactions, but the process creates a long paper trail and is time-consuming,” said a Reuters article. This is where DLT and blockchain can step in to facilitate a transition toward a better trade finance experience.

Meanwhile, Intuit, the company behind TurboTax and QuickBooks, is building a better payment experience for small businesses. “QuickBooks now offers one-touch electronic invoicing, a seamless Gmail integration for the one billion who have Gmail accounts and a next-generation mobile card payments reader,” said a company release.

Roughly two-thirds of small businesses have invoices that go unpaid for more than two months. The reason behind this is the medium of the invoice—“outdated, manual methods.” Customers will now be able to create invoices electronically and “click a simple link to pay electronically, enabling the invoices to be paid two times faster.” The speed of payments is very important to small firms that are trying to stay in business. “Money is like oxygen for small businesses, but every day they struggle to get paid on time,” said Intuit Vice President of Payments Jimena Almendares in the release.

– Michael Miller, editorial associate

U.S. Composite PMI Shows Private Sector Growth at Nine-Month High

The fastest rise in manufacturing production and an increase in service sector output accompanied the IHS Markit U.S. Composite Purchasing Managers’ (PMI) Output Index for October. The latest reading, at 55.7, signaled the fastest upturn in private sector output since January, IHS Markit said.

“The U.S. economy seems to have made a strong start to the final quarter of 2017,” said Tim Moore, associate director at IHS Markit. “Resilient service sector growth and an encouraging rebound in manufacturing production combined to generate one of the sharpest rises in private sector output for two-and-a-half years during October.”

The growth of new business volumes moderated from a two-year peak in August. An increase in private sector employment was supported by the steepest rise in manufacturing payroll numbers since June 2015. The October data indicated the greatest pressure on manufacturing supply chains since 2014, due to disruption caused among suppliers after hurricanes Harvey and Irma.

“The main near-term concern for manufacturers is that national supply chain pressures remain the most widespread since those recorded after the heavy snowfall in early 2014,” Moore said. “In particular, survey respondents pointed to depleted inventories among suppliers, ongoing transport delays and sharply rising raw material prices during October.”

There were also positive numbers in export sales, with manufacturers recording the most marked increase in new work from abroad for 14 months, IHS Markit said. Average lead times among vendors, however, saw their greatest lengthening since the heavy snowfall in February 2014.

– Adam Fusco, associate editor

Credit Conditions throughout the World Are on the Upswing

Credit conditions for the various industry sectors that Moody’s Investors Service tracks are at their best condition since the Great Recession. A majority of industry sector outlooks covering the next 12 to 18 months are either stable or positive.

"Our assessment of solid credit conditions is bolstered by the median EBITDA growth forecast of Moody's global ISOs, which, as of September 30, had decisively increased to 4.3% after two quarters at 4.0%, and nearly three years at about 3.5%," said Bill Wolfe, a Moody's senior vice president. "Accordingly, the aggregate and these signals, along with those from other proprietary indicators, our macroeconomic assessment, and market parameters, prompted us to change our North American ISO to positive from stable."

Outside of North America, credit conditions are expanding as well in the Euro area, China and most emerging economies, as economic fundamentals appear in better shape than they have been at any time since the end of the last decade, Moody’s said. A large amount of room to grow in Europe and some emerging markets means the current rate of growth looks sustainable.

“Moderating monetary stimulus likewise indicates that credit conditions today are solid, and Moody's analysts anticipate global monetary policy to remain relatively accommodating, gradually normalizing as economic conditions improve. If managed or received poorly, however, reduced stimulus could threaten economic growth and credit conditions. The challenge, then, will be to change course without disrupting the financial markets, or transmitting any disruption to the real economy.”

– Nicholas Stern, managing editor

New Business Volume Rises for September

New business volume in September increased 12% month-to-month from August, according to the Equipment Leasing and Finance Association’s (ELFA) Monthly Leasing and Finance Index, which covers economic activity from 25 companies who represent a portion of the $1 trillion equipment finance sector. Overall new business volume clocked in at $8.7 billion, a 7% decrease year-over-year from that in September 2016. Cumulative new business volume was up by 4% compared to 2016, year to date.

Credit approvals decreased more than a point for the month, totaling 74%. Head count for equipment finance companies rose 16.5% year-over-year, mostly due to acquisition activity at one surveyed company. The separate Equipment Leasing & Finance Foundation’s Monthly Confidence Index for October is 63.7, unchanged from September, ELFA said.

Receivables over 30 days were 1.4%, a decrease from the 1.5% in August. Charge offs in September were 0.4%, down from 0.44% the previous month.

“Third quarter new business volume was steady, if not exceptional, despite the string of devastating weather events that plagued parts of the U.S. during the month of September,” said ELFA president and CEO Ralph Petta. “Positive cumulative year-to-date volume is indicative of healthy capex, which shows that business owners continue to choose financing as a means to acquire the equipment they need to run their operations. In addition, credit quality remains at historic lows. These metrics bode well for a solid end-of-year performance.”    

“Overall, September 2017 was a satisfactory month for commercial originations,” said William J. Clark, executive vice president of Univest Capital Inc. “Our municipal originations were above average for the month. We continue to see aggressive pricing in the market and loosening of credit standards, especially as it relates to ‘corp only’ approvals. It is becoming increasingly challenging; however, we are maintaining a superior net interest margin compared to our select peer group. It is part of a strategic plan to increase our average ticket and we are experiencing some success with that, especially in the municipal and golf/turf vertical markets. Additionally, we are seeing larger financing opportunities referred by our parent bank and affiliates.”

– Adam Fusco, associate editor

P3 Projects in China Rise at Steep Pace

Public-private partnerships (P3s) in China that are used to build up infrastructure, among other projects, have been increasing in number and investment value as more projects are set to be implemented this year, according to a new report by Moody’s Investors Service.

"Support from the central government has resulted in positive regulatory developments in China's Public-Private Partnership (PPP) framework, thereby enhancing the financing options available to PPP developers and investors," said Osbert Tang, a Moody's vice president and senior analyst. "And, regulations that increase transparency and improve investor protections are positive for the ongoing development of the PPP sector."

More long-term financing and improved regulatory transparency for Chinese P3 projects are likely to lure more private investors, Moody’s said.

P3 projects in China’s national database grew by 21.5% or $436.8 billion for the first six months of 2017, as 20% of the projects were in the implementation phase—the penultimate stage of such projects—at the end of June, compared to 17% at the same time of year in 2016, Moody’s said.
The total number of P3 projects in China at the end of June was 13,554, up 20% from the end of 2016. The total investment value of these projects was $2.47 trillion at the end of June, up 21.5% from the end of 2016.

– Nicholas Stern, managing editor

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