Road Open for Transportation Growth

Though changes in trade and fiscal policies are on the horizon, healthy growth is expected in the U.S. transportation sector, according to Fitch Ratings’ U.S. Transportation Trends special report.

Leading the way for overall growth in airport passenger traffic are international hub airports, with passenger enplanements rising 3.5% in 2016. “Growth in passenger enplanements, however, is and will continue to soften as carriers scale back on service additions,” said Seth Lehman, senior director at Fitch. The ratings agency predicts growth from 2.5% to 3 % in 2017.

Growth in ports is expected to match GDP. Upward movement in the second half of 2016 was led by ports on the West Coast, with 1.8% growth year-over-year, while East Coast ports grew 3.4% in the same time period, though only posted a 0.4% rise last year compared to 2015. “Shifting trade agreements or renegotiated tariffs may affect import/export volumes, though the full effects of these changes will likely extend beyond 2017,” said Director Emma Griffith.

Moderate economic and population growth in the Southeast and Southwest should contribute to high traffic performance for toll roads in those regions. “Toll road revenues are positioned to grow faster than traffic as many authorities implement policies of inflationary toll increases,” said Director Tanya Langman.

Fitch has established a new metric called “Peak Recovery,” outlined in the report, which supplements the ratings agency’s peak-to-trough metric and demonstrates how the 2016 performance for each credit compares to its prerecession peak volume.

– Adam Fusco, associate editor

European Steel Outlook Improves

The steel industry in Europe is rebounding, and producers are expected to have increased profits during the next 12 months, said Moody’s Investors Service. The ratings agency also changed the European steel sector outlook from negative to stable. The change in rating is due to the “expectations for the fundamental business conditions in the industry over the next 12 to 18 months,” Moody’s analysts said.

Steel prices and industrial output in the European Union is expected to improve in the next year, but there could be a slight decline in prices in the “second half of this year because of a retreat in the cost of raw materials and seasonality,” said Hubert Allemani, a senior analyst and vice president with Moody’s. "Steel prices have remained at three-year highs since the strong rebound in the first quarter of 2016, alleviating concerns about how long the recovery would last."

Steel making is expected to be supported by demand from car manufacturers and the construction industry, which is Europe’s largest steel-using sector. Imported steel will still have an effect on European steel makers. “[China has] far too much capacity and will be trying to unload as much as they can on the U.S. and Europe,” said NACM Economist Chris Kuehl, Ph.D. The expected demand growth will be less than 2%, according to Moody’s.

Better prices between steel makers and their clients from a year ago are expected to help results for the first half of this year. “Together with improved consumer confidence, manufacturing in the eurozone has gained momentum and the strengthening of industrial activity should support demand for steel,” Moody’s said.

– Michael Miller, editorial associate

New Jersey Construction Subcontractors: Look Before You Lien!

The U.S. Court of Appeals for the Third Circuit’s recent decision in Linear Electric Company Inc. vs. Cooper Electric Supply Co. and Samson Electrical Supply Co. Inc. significantly increases risk for New Jersey construction subcontractors seeking to collect on claims for materials sold or services provided to construction contractors that file bankruptcy prior to paying for those materials or services.

Generally, under New Jersey’s construction lien law, when a supplier sells materials on credit to a contractor who then incorporates those materials into property located in New Jersey that is owned by a third party, the supplier can file a lien which “attaches” to the owner’s property for the amount the contractor owes the supplier for those materials. The supplier can then directly recover from the property owner on its claim for unpaid supplies—but only in an amount equal to the account receivable owed to the contractor by the owner. In other words, the supplier can collect the debt the owner owes to the contractor to satisfy its own account with the contractor. Given this statutory framework, suppliers selling materials on credit outside the bankruptcy context have a significant added source of recovery, knowing their accounts are secured by construction liens on the property of the owner (who does not want its property subject to liens).

Under bankruptcy law, when a contractor files bankruptcy, there arises an automatic stay which protects the contractor/debtor from any actions by creditors to collect a debt, including the creation or enforcement of liens “against” property of the debtor. Prior to the Third Circuit’s decision in Linear Electric, it was not clear whether the filing of a construction lien under New Jersey’s construction lien law after a contractor filed for bankruptcy constituted a violation of the automatic stay. Since the construction lien “attaches” to the property of the owner—not the property of the contractor—there is a reasonable argument that the filing of the lien would not violate the automatic stay, because such property is not property of the contractor’s estate.

In Linear Electric, however, the Third Circuit, affirming decisions of the Bankruptcy Court and the United States District Court, held just the opposite. The Third Circuit held that the act of perfecting a construction lien after a contractor’s bankruptcy filing violated the automatic stay. The court emphasized that although the liens “attached” to the real property of a non-debtor owner, the recovery by the supplier on account of the construction lien is, as a practical matter, from the accounts receivable owed to the contractor by the owner. The court concluded, therefore, that the lien was “against” property of the contractor (the accounts receivable) and the act of filing the lien violated the automatic stay and was void. In short, the court determined that although a construction lien under New Jersey law attaches to the property of the owner, it is also “against” property of the contractor within the meaning of the Bankruptcy Code. 

The Third Circuit’s decision restricts the ability of suppliers who provide goods or services to projects in New Jersey to secure their accounts with construction liens after their contractor has filed bankruptcy.  On the flip side, it provides contractors who file bankruptcy with the ability to collect accounts receivable owed by the project owner (to the extent the owner does not otherwise have valid defenses) and improves the prospects that the contractor can reorganize its financial affairs. While suppliers could formerly seek solace in the exact argument advanced by the suppliers in Linear Electric, the Third Circuit’s decision confirms that the concept of property of the bankruptcy estate is, indeed, a far-reaching one, providing the utmost protection to the debtor’s estate. In light of this decision, suppliers to construction contractors in New Jersey should consider taking the following steps to reduce their risk:
 
(i) Reduce accounts receivable turnover ratio by adopting more conservative policies on credit extension;

(ii) closely monitor the creditworthiness of contractors to avoid unexpected bankruptcy issues and, particularly, so that a construction lien can be obtained and perfected prior to bankruptcy; and

(iii) if choosing to deal with a contractor whose financial situation is questionable, request adequate assurance of payment for the services or materials provided.

– Paul Kizel, Esq., is a partner and Nicole Fulfree, Esq., is an associate at Lowenstein Sandler LLP’s Bankruptcy, Financial Reorganization & Creditors’ Rights Department. Lowenstein Sandler represents the Official Committee of Unsecured Creditors in the Linear Electric Co. Inc. Chapter 11 case.

Global Outlooks See Strong Indications of Growth

With 20 key economic variables covering 20 major countries, the latest 20/20 Vision chart pack from Fitch Ratings reveals a major trend in the resilience of the recovery in the eurozone. The report plots high-frequency macroeconomic data and includes readings on PMI balances, credit growth and labor market performance.

“The eurozone saw one of the most impressive improvements in PMI balances amongst the advanced countries in the second half of 2016 and recent readings have corroborated this trend,” said Brian Coulton, chief economist at Fitch. “The steady rise in credit growth to the private sector is also suggesting that ECB QE [European Central Bank quantitative easing] may have started to gain some traction on the economy, while a pickup in exports partly reflects the stabilization in emerging markets.”

A key component of the persistent expansion in the area, as indicated in the ratings agency’s March Global Economic Outlook and subsequent data releases, has been improving labor market conditions. Consumer confidence has been helped by ongoing job growth. Nominal wage inflation has enjoyed a small uptick, though still below the ECB’s inflation target, Fitch said.

Data from China has been better than expected, with an increase in industrial production not seen since late 2014. Data is mixed from the United States and United Kingdom, with soft nonfarm payrolls in the U.S. and weakening retail sales growth in the U.K., Fitch said.

Trade is leading the growth seen globally, according to Wells Fargo. The bank’s recent Global Review said that the global economy is on the right path. Though China is not contributing what it once did at the start of this century, its first quarter GDP indicates an economy growing slightly more than market expectation. Strong performance by Chinese trade in March and improvement in international reserves are encouraging signs of global growth, according to Wells Fargo.

Low but positive growth is expected this year in troubled Brazil. The country’s monthly economic activity index in February was the strongest in nearly three years. Data from the U.K. indicates that the economy decelerated in the first quarter of this year, but real GDP growth has held up better than expected since last June’s Brexit referendum, Wells Fargo said.

– Adam Fusco, associate editor

Recovery in Central and Eastern Europe Fueling Local Telecom Earnings Rise

A regional recovery underway in Central and Eastern Europe is boosting household spending and consumer confidence that will allow telecom providers to outpace their Western European counterparts in credit quality and revenue and earnings growth into 2018.

"Strong regional economic recovery is fueling household demand for telecoms services, such as smartphones and mobile data, driving revenue and earnings growth, improving credit quality and attracting M&A interest,” said Alejandro Núñez, vice president and senior analyst at Moody's Investors Service. “The pace of these improvements will eventually slow, but will continue for at least the next 18 months."

The ratings firm anticipates several telecoms in the region will see an average of 3.5% revenue growth this year and next, based on the sector’s being a less-mature market than in Western Europe as regards service penetration, pricing and usage. “CEE telecom markets have had more scope to expand their networks and increase the penetration of new services such as 4G mobile and Internet Protocol television (IPTV) services,” Moody’s analysts said. Prices in Central and Eastern Europe also lag behind those in Western Europe—from 44% in mobile voice revenue per minute to 14% in mobile data.

This growth potential is fueling M&A interest among foreign buyers, particularly in Poland, Moody’s said. “This trend will continue most likely in the form of in-market cable-to-mobile deals or foreign firms acquiring or merging with CEE operators.”

Earnings volatility for the sector is also likely to decrease as many telecom companies in the region have lowered foreign exchange risk over the past year by refinancing euro and U.S. dollar bonds with local-currency-denominated bank loans, analysts said.

– Nicholas Stern, senior editor

Clearing, Settlement Services Highly Vulnerable as Cyberattacks Threaten Financial Institutions

Cyberattacks against financial institutions have become an increasingly important risk factor, and institutions that provide trade execution, clearing and settlement services are more vulnerable to attacks aiming for system disruption because of their interconnectivity with the financial system.

“Cyber risk is a growing threat that can adversely affect credit ratings as attacks can compromise customer data and disrupt websites, with detrimental financial or operational consequences for individual issuers and financial systems,” said Fitch Ratings analysts in a recent report. “Related reputational damage may weaken business and access to funding and capital markets.”

In the U.S., the chair of the Securities and Exchange Commission has said cyber-security poses the biggest risk to the financial system. Under the European Union’s General Data Protection Regulation, which takes effect in May next year, banks can face fines of up to 4% of their global turnover for security breaches; any organization that uses data from EU citizens has to comply with the rule. Fitch sees that some organizations, like The International Organization of Securities Commission’s Committee on Payments and Market Infrastructures, are seeking more coordination at the international level to combat the issue. The European Central Bank reports that the average lag until a breach is detected was 146 days in 2016, a drop from 205 days in 2014.

“As information is shared across firms, cyber risk detection and response plans could improve, but coordination does not ensure that risks can be fully contained,” Fitch notes.

The use of cyberinsurance to mitigate some of the damage from cyberattacks is on the rise, reaching about $1 billion in premiums in 2015 and expected to continue growing, though protection against reputational damage is more difficult to protect against, Fitch says.

– Nicholas Stern, senior editor

SWIFT Addresses Allegations of Service Bureau Hacking

SWIFT, the financial messaging service, has said in a press release that there is no indication that its network or core services have been compromised amid allegations that two services bureaus may have been targeted to gain unauthorized access to bank customers’ data.

As reported by Reuters, a hacking group calling itself the Shadow Brokers recently released allegations that service bureaus in the Middle East and Latin America may have been compromised by third parties. The allegations date back several years. Service bureaus are third-party providers that operate a connection to SWIFT for firms that wish to outsource their day-to-day operation of the SWIFT connection. In its release, SWIFT said that it is in close contact with the service bureaus in question to ensure that they are implementing appropriate preventive measures.

SWIFT recommends that customers pay close attention to their own security and keep in mind security issues when choosing a service bureau or other third-party provider. The effects of any vulnerabilities can be mitigated by immediately installing security updates and patches. SWIFT is working through its Customer Security Programme to provide tools and guidance about security to its customers and will keep customers updated through its Security Notification Service.

SWIFT said that there has been no impact on its infrastructure or data and that there is no evidence to suggest that unauthorized access has occurred to its network or messaging services.

Service bureaus must register under SWIFT’s Shared Infrastructure Programme (SIP), which outlines the legal, financial and operational requirements with which services bureaus must comply. The SIP should not be considered a substitute for customers to perform their own security checks and due diligence, the messaging service noted.

– Adam Fusco, associate editor

Small Fabricators and Manufacturers Optimistic about Future in New Survey

Many small- to medium-size job shops surveyed for the latest Fabricators and Manufacturers Association’s Forming and Fabricating Job Shop Consumption Report have an optimistic outlook lately and believe some significant impediments to business progress may be removed and that some of the stimulating efforts will bear fruit.

A whopping 61.9% of those surveyed see improving conditions for the coming quarter and another 34.3% expect things to be about as they are now. Only 3.7% expect things to get worse. This is the most confident the sector has been in a while.

Still, the survey found capacity utilization is on the low side, just short of 70%, which indicates slack in the system, though when looking at the anticipated capacity, there is a general sense that companies will be adding to it. That may mean more slack in the short term, but should mean less in the way of shortages and bottlenecks later. But generally, the survey respondents are staying connected to their capital equipment strategies as 57.4% indicate that nothing has altered their plans and they intend to buy what they had intended to buy. About 18% have delayed their original plans by a quarter or two and 24.6% have set their plans on the back burner indefinitely. There is tremendous variability between sectors, however. Those feeding into the agricultural community are seeing very low demand while medical manufacturing thrives. Automotive and aerospace are not as vibrant as they have been.

In the manufacturing community, the level of real confidence is reflected in data such as new orders. The survey this month shows that 44.7% of the respondents are reporting more in the way of new orders and another 41% are reporting that this activity has been stable. Only a little over 14% of the responses indicated a decline in new orders. That suggests that there is more expansion in the manufacturing sector overall and that it is expected to expand further into the year.

Hiring has also seen progress and stability, but there are some factors to take into consideration that affect these numbers and have for some time. The survey reports that over 27% expect to do additional hiring while just over 68% are staying right where they are as far as hiring is concerned. That means that only 4.5% of the respondents plan to reduce their workforce. This is as low a level as has been seen in the last few years. The wrinkle in all this is that most of the manufacturers are struggling to find qualified people to hire. The pipeline as far as talent is empty. Companies really have no alternative but to poach one another’s employees, which generally means that labor costs will rise steadily as companies try to lure the people they want and need.

Beyond hiring, the next biggest expense is raw material costs. Here, the key factors are generally the price of steel and aluminum. The survey reports that the vast majority of respondents see prices for both metals coming up. In general, the commodities suppliers have been trying to adjust to reduced demand over the last few years—they have limited output as a means to hike prices. The tactic has worked pretty well and the hope is that more production can be spurred when and if there is a boost in overall demand.

The cost of transportation and logistics has also been a factor when it comes to overall expenses, but there hasn’t been all that much movement. The percentage of respondents that report more logistics costs is 29.3% and most have indicated that these costs have been stable—over 70%. Not one respondent reported that these costs are going down. Rail costs have been more stable than trucking costs and there has been some reduction in the costs of ocean cargo due to the overcapacity issue facing maritime shipping. There is also a great deal of regionalism in logistics, in part due to the fluctuating costs of fuel and overall operating expenses. Just as with manufacturing, there has been a shortage of manpower in transportation. It is estimated trucking companies are short some 80,000 drivers this year alone.

– Chris Kuehl, Ph.D., NACM economist

Leveraged U.S. Corporates May Face Challenges from Rising Rates

Rising interest rates may translate into downside risk for some U.S. corporate sectors. The credit profiles of U.S. corporates are generally insulated from rising rates, but lower-rated issuers are more vulnerable, according to a new report from Fitch Ratings.

The ratings agency does not see significant interest rate risk across speculative-grade credit profiles, even in a severe stress scenario, but a rising rate environment may limit the margin of error available to corporates that are undergoing material acquisition or in the midst of adjusting their business models. This is particularly true for those that are highly leveraged. Poor execution of cost-saving programs and key initiatives, for example, may hamper a cash flow profile that is already weak if coupled with rising rates. Negative rating actions may result.

The retail sector, with high floating-rate debt exposure, is vulnerable to interest rate risk if the benefits of a growing economy are offset by secular challenges, Fitch said. Diversified manufacturing, which likewise has high floating-rate exposure, could see improved demand, though external factors such as an increase in trade restrictions could weigh on costs and hamper growth. Sectors with low floating-rate exposure like telecom face their own challenges from a competitive environment.

The stable outlook for U.S. corporates for this year supports the view that rates rise in response to increasing inflation during an economic recovery, Fitch said. Since companies have been proactively managing maturity profiles, modest rate increases, without an increase in spreads, would not impact interest rate expense in the near term. Investment-grade corporates are less vulnerable to rising rates. Fitch estimates that its portfolio of speculative-grade corporates has an average of 52% of floating-rate debt compared to 15% for investment grade.

– Adam Fusco, associate editor

China’s GDP Climbs in First Quarter with Strong Housing, Construction Sectors

Chinese GDP for the first quarter beat economists’ consensus forecast, buoyed by the nation’s secondary industry comprised of mining, manufacturing, construction and utilities production.
GDP in China grew 6.9% in the first quarter of the year, continuing a slight upward trend over the last three quarters, according to an analysis by Wells Fargo’s Jay Bryson, global economist, and E. Harry Pershing, economic analyst.

The country’s secondary industry climbed 6.4% year-over-year, following 6.1% the prior quarter, and accounts for about 40% of the value added in the Chinese economy, the analysts said. The nation’s primary industry, including the agriculture, forestry and fishing sectors, slowed to 3.0% in the first quarter from 3.3% the prior quarter. Growth in China’s service sector also decreased slightly to 7.7% from 7.8% the prior quarter.

“Strength in the secondary sector can partially be attributed to a rebound in overall investment spending, which increased 9.2% in March—its highest year-over-year rate of growth since May of last year,” the analysts said. Meanwhile, investment in the Chinese housing sector has similarly grown—by 8.9% in February. “The turnaround in housing investment has seemed to provide a boost to the construction sector, which is contained in the secondary industry. Although we do not expect housing investment growth rates to return to the 30% rates we witnessed during 2010–2011, continued government support for lending should buoy investment in the sector and for the foreseeable future.”

Also, China’s foreign exchange reserve woes, which saw reserves decline from nearly $4 trillion in mid-2014 to about $3 trillion today, have eased somewhat after modest increases in February and March, Wells said.

– Nicholas Stern, senior editor

Asian High-Yield Bond Issuance More than Doubles in Q1 2017

Asian high-yield bond issuance is at its highest level in four years. This has paved the way for “stronger liquidity profiles and manageable levels of refinancing risk,” according to Moody’s Investors Service. The first quarter of 2017 was more than double the last quarter of 2016, said the ratings agency.

There were 26 deals totaling $10 billion during the first quarter of this year, which is the highest level of issuance since the first quarter of 2013, when it was at more than $12 billion, said Annalisa DiChiara, a Moody's vice president and senior credit officer, in a news release. This was “driven by investor tolerance for lower credit quality and active refinancing by issuers," she added.

Refinancing risk will stay at a manageable level, “and the market is well positioned to absorb upcoming maturities which total [$127 billion] in rated and unrated bonds from now through to 2021," DiChiara said. The fourth quarter 2016 issuance was at $4.5 billion, and “50% of the [$10 billion] issued in Q1 2017 was rated at B3—a record amount of issuance at this level,” said the release.

The Asian nonfinancial high-yield corporate default rate will also stay low, according to Moody’s, at around 3% this year, while “most Asian high-yield corporates currently show good or adequate liquidity.”As of the last day of March, Moody’s covered 123 Asian companies in its high-yield portfolio with nearly $67 billion of rated debt outstanding.

The March Asian Liquidity Stress Index was at its lowest since September 2015, but the long-term average of the index shows “the ongoing weakness in liquidity for many issuers in Asia,” said Moody’s.

– Michael Miller, editorial associate

U.S. AAA Rating Affirmed by Fitch

With its financing flexibility and its prominence as having the most liquid capital markets in the world, the United States has earned an affirmation of its AAA rating and stable outlook from Fitch Ratings.

According to Fitch, the U.S. economy is one of the most productive and dynamic and is supported by strong institutions and a favorable business climate. The U.S. is the issuer of the world’s preeminent reserve currency, which accounts for nearly two-thirds of global reserves.

Uncertainty remains, however, over the short-term fiscal and borrowing outlook, but Fitch expects tax cuts to lead to a loosening in fiscal policy. The U.S. government debt burden is a relative credit weakness in comparison to other AAA-rated sovereigns, Fitch said. A tax reform proposal may lead to an increase in deficits over a 10-year time span, though the plan would aim at boosting investment and growth. Tax cuts are not likely to lead to a lasting boost in growth, however, Fitch believes.

The ratings agency has revised its real GDP growth forecast for the U.S. to 2.3% for next year and 2.6% for 2018. Trade protectionism and checks on immigration would be negative for growth in the medium term. Fitch expects the Federal Reserve to continue to raise interest rates, with two more 25 basis point increases in 2017 and four in 2018, with no major effects on credit growth.

Fitch does not anticipate any developments that would lead to a downgrade in the stable outlook for the United States. Developments that may lead to negative rating action, however, include 1) a significant increase in government deficits and the debt-to-GDP ratio, and 2) a deterioration in the credibility of economy policy or a shock that affects the U.S. dollar’s role as the foremost global currency.

– Adam Fusco, associate editor

New Chinese Bond-Tightening Rules Should Ease System Risks

A recent announcement by Chinese regulators to tighten the rules surrounding the use of corporate bonds as collateral should help reduce systemic risks, but it is also a credit negative for onshore issuers and borrowers. The rule changes effectively reduce the pool of bonds eligible to serve as collateral for repurchase agreements or repos, which should curb the growth in system-wide leverage that the rapid development of the repo market has helped engender, according to a new Moody’s Investors Service report.

“The new rules are aimed at controlling leverage in China's financial markets and should therefore reduce systemic risks,” said Nino Siu, a Moody's vice president and senior analyst. “And, by restricting the use of collateral to high-quality bonds, the new rules reduce the likelihood that defaults on lower-rated bonds could bring about a rapid contraction in the supply of credit, in the event that they cause lenders to reassess the risks of collateralized lending.”

On April 7, the China Securities Depository and Clearing Corporation Limited (CSDC) announced that, starting April 8, only newly issued corporate bonds with onshore issuer ratings/bond ratings of AA/AAA, AA+/AAA and AAA/AAA can be used as collateral in a repurchase agreement. Bonds issued or announced with a prospectus on or before April 7 are not affected by the new rules.

This change should enhance the regulation of the credit risks in the repo market that has more than doubled since March 2015 to about $3.25 billion by the end of this March, analysts said. About 34% of all corporate bonds in the onshore exchange-traded market in China are AAA-rated by onshore rating agencies. That means borrowing on the remaining lower-tier bonds available in the onshore market will become more difficult. Also, more borrowers tend to look for non-AAA-rated bonds at the short end of the duration curve. “The loss of repo eligibility for non-AAA-rated bonds will therefore boost the liquidity premium of such corporate bonds and result in a wider yield differentiation between AAA and non-AAA-rated bonds, raising funding costs for lower-rated issuers,” Moody’s said.

– Nicholas Stern, senior editor

Small Business Owners Remain Optimistic

A surge in small business optimism that started last November was continued in March, according to the National Federation of Independent Business’ (NFIB) Small Business Optimism Index. Though the index slipped slightly, it still posted a strong reading, with gains in actual earnings, capital expenditure plans and job-creation plans. Sales expectations, however, dropped eight points, signaling that the index could be moderating.

“Small business owners remain optimistic about the future of the economy and the direction of consumer confidence,” said NFIB President and CEO Juanita Duggan. “We are encouraged by signs that optimism is translating into economic activity, such as capital investment and job creation.”

The Uncertainty Index, which is a subset of data on how small business owners foresee the near term, saw a significant increase, the NFIB said. It reached its second-highest reading in the survey’s history in March. Most of the March data was collected before Congress failed to pass a bill repealing and replacing the Affordable Care Act, NFIB noted, adding that the optimism of the past five months was in part due to small business owners’ expectations of a reversal in some government policies. Duggan said that the index’s April data, due in May, will better indicate how owners are processing events in Washington.

“By historical standards, this is an excellent performance, with most of the components of the index holding their gains,” said NFIB Chief Economist Bill Dunkelberg. “The increases in capital expenditure plans and actual earnings are signs of a healthier economy, and we expect job creation to pick up in future months.”

Small business owners are having a hard time satisfactorily filling open positions, however, which will be a headwind to job growth, the NFIB said. The reports correlate with hard data on a tightening labor market and a gradual pickup in wage growth, Wells Fargo noted.

– Adam Fusco, associate editor

Supreme Court Summarily Vacates Fifth Circuit Decision Upholding Texas Surcharge Prohibition

On March 29, 2017, the United States Supreme Court issued its long-awaited decision in Expressions Hair Design, et al. v. Schneiderman, holding that New York’s prohibition against surcharging credit card transactions is a regulation of commercial speech and remanding the case to the Second Circuit Court of Appeals for further consideration as such.

On Monday, April 3, 2017, the Supreme Court ruled on petitions for certiorari in the two other surcharge-related cases that were pending before it.

In Rowell, et al. v. Pettijohn, a group of merchants sought review of a decision by the Fifth Circuit Court of Appeals, which, like the Second Circuit in Expressions, held in early 2016 that the Texas surcharge ban is a constitutionally permissible regulation of pricing.  On Monday, the Supreme Court granted the merchants’ petition, summarily (i.e., immediately and with no further briefing or argument by the parties) vacated the Fifth Circuit’s decision and remanded the case back to the Fifth Circuit for further consideration in light of the Supreme Court’s holding in Expressions.

In Bondi v. Dana’s Railroad Supply, et al., the Florida attorney general sought review of a decision by the Eleventh Circuit Court of Appeals, which held in late 2015 that Florida’s surcharge ban is a facially unconstitutional regulation of merchants’ speech.  The Supreme Court denied the state’s petition for a writ of certiorari, leaving the Eleventh Circuit’s ruling intact.  As a result, the Florida surcharge ban has effectively been overturned in its entirety.

Denial of certiorari in Dana’s means the Supreme Court will not have an opportunity to provide further guidance on the application of the commercial speech doctrine to credit card surcharge bans unless and until another case—possibly even Expressions or Rowell, depending upon the outcome in those cases on remand—comes up from the courts of appeals.  However, the Dana’s decision at least suggests that the Supreme Court is receptive to the Eleventh Circuit’s reasoning, and is a knockout punch for Florida merchants, whose surcharging fight is now over unless and until the Florida legislature decides to craft a new surcharge ban.

– Bruce Nathan, Esq., and Andrew Behlmann, Esq., of Lowenstein Sandler LLP

U.S. Unemployment at Its Lowest in 10 Years

The U.S. unemployment rate is at its lowest figure in nearly 10 years. The rate dropped to 4.5% in March from 4.7% in February, according to the latest release from the Bureau of Labor Statistics (BLS). The unemployment rate is also the lowest it has been since May 2007, when it was at 4.4%. The rate has been under 5% for 11 months straight. On a year-over-year basis, the unemployment rate was down half a percentage point.

Total nonfarm employment increased by 98,000 jobs in March after increasing by 435,000 jobs in January and February. There were an additional 6,000 construction jobs in March compared to 59,000 new jobs in February. This was the lowest increase in construction jobs in seven months, according to the Associated Press. This is likely in part to the warmer-than-normal weather in February across the country.

“Employment in construction has been trending up since late last summer, largely among specialty trade contractors and in residential building,” BLS said. Meanwhile, manufacturing and wholesale trade were among the other major industries with little or no change in March. Construction unemployment was down to 8.4% last month compared to 8.7% a year ago, and the number of unemployed workers was down 4,000.

As much as better-than-usual weather in February is to be credited for job gains, less-than-favorable weather was a factor for the swing and miss on growth in March. It was expected the economy would add 180,000 jobs with an unchanged unemployment rate, according to economists polled by Reuters. Economists surveyed by Bloomberg also expected an increase of 180,000 jobs.

– Michael Miller, editorial associate

Fitch’s Retail Loan Default Rate Climbs

Fitch Ratings has increased its U.S. retail trailing 12-month (TTM) loan default rate on the back of Payless ShoeSource’s bankruptcy filing on April 4. The ratings agency expects the rate to go much higher from continued challenges in the retail sector.

The loan default rate fell to 0% in March after reaching a level of 0.5% in February. Fitch expects the rate to hit 9% over the next 12 months, equaling about $6 billion in defaults, due to increased discounter and online penetration as well as a shift in consumer spending toward services and experiences. The vicissitudes of brand popularity are also a factor in the competitive retail environment that has seen negative cash flow, tight liquidity and unsustainable capital structures, according to Fitch.

Payless was on Fitch’s Loans of Concern list. Eight other retailers on the list with a significant risk of default include Sears Holding Corp., Gymboree Corp., Nine West Holdings Inc. and rue21 Inc.

Payless’ Chapter 11 filing was intended to facilitate a balance sheet debt restructuring and operational overhaul. It intends to emerge as a smaller concern. Liquidation sales are planned for 400 out of 4,400 underperforming stores that are pegged for permanent closure. To reduce debt by 50%, the company has entered a plan support agreement with parties that hold about two-thirds of its first-lien and second-lien debt.

– Adam Fusco, associate editor

Credit Quality for Public Firms Grew in March, but Watch for Longer-Term Default Risks

Overall corporate credit quality improved in March as the Kamakura Corporation’s troubled company index decreased from the prior month. The troubled company index was at 8.15% in March and at the 81st percentile of historical credit quality (with 100 being the best of all time) from January 1990 to the present.

The index reflects the percentage of the Kamakura 38,000 public firm universe that has a default probability over 1.00%. A rising index indicates declining credit quality and vice versa. The percentage of the firms tracked by the index with default probabilities between 1% and 5% decreased in March, as did the percentage of firms with default probabilities between 5% and 10% and those with default probabilities over 20%. Those companies with default probabilities between 10% and 20% were mostly flat for the month. Overall volatility in the numbers was low as well.

Trade creditors should continue to watch for signs of distress coming from troubled retailers, as the two tracked American defaults in March were discount retailers Gordman’s and HHGregg, Kamakura said. During March, there were 18 overall defaults tracked in the index, with four from Brazil, three from Russia and two each from Australia, Great Britain and the U.S. Among the 10 riskiest rated firms, five were from the U.S., two from Great Britain and one each from France, Greece and Spain. Walter Investment Management Group was the riskiest rated firm with a one-year default probability of 15.02%, up 6.54% from the prior month.

Over the longer term, Kamakura analysis shows default rates dramatically expanding on the five- to seven-year time horizon, even for blue-chip firms. This expansion is particularly significant given new issuance of high-grade debt in the five- to seven-year window both in 2016 and 2017, said Martin Zorn, president and COO for Kamakura Corporation. Kamakura’s anticipated 10-year cumulative default rate among 2,577 rated firms is 13.44%, higher than the 13.33% rate expected in September 2008 when Lehman failed.

“One of the risk management lessons learned during my tenure at the Winston-Salem-based Wachovia was that excellent credit management was earned through portfolio management and the early identification of problems,” Zorn said. “The term structure of default is a critical tool in the early identification of potential future problems.”

– Nicholas Stern, senior editor

Kamakura Chairman and CEO Donald R. van Deventer, Ph. D., will speak about using big data and computer power to supplement careful credit analysis at NACM’s 121st annual Credit Congress & Expo in Dallas, TX, June 11-14.

Moody’s Database Reveals Insights into Corporate Debt Structure

Analysis of data from a database of debt instruments from Moody’s Investors Service may yield helpful insights ahead of the next economic downturn. The data reveals how default types change over time, how recoveries differ depending on the instrument’s position in a company’s debt structure and whether private-equity ownership influences recovery rates.

Moody’s Ultimate Recovery Database traces close to 5,500 debt instruments from more than 1,100 defaulted U.S. companies whose total liabilities recently exceeded $1 trillion, the ratings agency said in a new report. The database spans the years from 1987 to the end of 2016 and includes U.S. nonfinancial corporate borrowers, both rated and unrated by Moody’s, that had more than $50 million in debt at the time of default.

“Our database includes information gathered during the 2008–2009 recession and shows that it featured a higher percentage of distressed exchanges than did previous downturns,” said Moody’s Vice President David Keisman. “Distressed exchanges accounted for about 15% of defaults between 1987 and 2007, but that figure has since risen to almost 50%.”

The data reinforces the importance of a debt instrument’s position in a company’s capital structure and the amount of debt cushion beneath it, with a positive correlation between debt cushion and ultimate recovery rates, Moody’s said.

“Recoveries are also influenced by current default rates, but industry rarely matters,” said Moody’s Associate Analyst Julia Chursin. “Losses are exacerbated during default peaks and are less pronounced during more benign credit cycles. On the other hand, there is relatively little variation in firm-wide recovery rates among industries, and so no observable relationship between the recovery rates of asset-heavy and asset-light industries.”

Private-equity ownership affects the type of default and the recoveries on certain kinds of debt, but has little influence on firm-wide recovery rates. Higher losses for junior creditors result from the prevalence of distressed exchanges, prepacks and bank debt in the liability structures of private-equity defaulters, Moody’s said.

– Adam Fusco, editorial associate

Construction Spending at Nearly 11-Year High

Construction spending is on the rise according to the latest monthly release from the U.S. Census Bureau. February’s seasonally adjusted rate was at $1.19 trillion, up nearly 1% from the revised January estimate of $1.18 trillion. Construction spending is at its highest level since April 2006 after it had declined the previous two months. A spending rebound of 1.1% was expected, said economists polled by Reuters.

The data is collected through surveys in all 50 states and Washington, D.C. They gather information on four construction types: privately owned nonresidential construction, state and local construction, privately owned multifamily, and federal construction projects. It estimates the cost of labor and materials and contractor’s profits, among other items.

On a year-over-year basis for February and the first two months of 2017, total construction spending was up 3%. The latter works out to be a positive difference of nearly $5 billion. Meanwhile, private construction saw a spending increase of 0.8%, or about a $7 billion increase from January. Public construction spending saw a smaller rise of $1.6 billion in February. Educational and highway construction also increased from January to February.

Total private construction jumped nearly 7% from February 2016 to February 2017 while total public construction spending dropped 8% over the same time period. Residential construction spending moved upward more than 6%, but nonresidential spending only increased 1%. A main reason for the small increase was due to a nearly 30% drop in sewage and waste disposal spending and an almost 20% dip in conservation and development spending over the year time frame.

Within total public construction, power spending slipped more than 36% from February 2016 and over 11% from January 2017. Total nonresidential lodging, office and commercial spending each saw major breakthroughs from February 2016 despite little or no change from January 2017.

“The construction sector hasn't been on fire but continues to post passable numbers, and momentum may begin to build at least for the housing sector as permits for both single- and multifamily units are on the climb,” according to Econoday. “Construction spending is a good indicator for the economy’s momentum,” said the economic website.

Warmer weather in February helped construction start earlier this year, but late winter weather could cause a fallback in March, said Wells Fargo. Data for March will be released by the Census Bureau on May 1.

– Michael Miller, editorial associate