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

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

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

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

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

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

– Nicholas Stern, managing editor

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

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

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

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

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

– Adam Fusco, associate editor

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

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

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

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

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

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

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

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

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

– Nicholas Stern, managing editor

Some U.S. Homebuilders Still Struggle during Housing Recovery

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

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

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

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

– Adam Fusco, associate editor

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

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

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

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

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

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

– Nicholas Stern, managing editor

Fitch: Countries Can Rebound From Ratings Downgrades

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

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

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

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

-Michael Miller, editorial associate

Small Business Optimism Takes a Dive in September

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

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

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

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

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

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

– Adam Fusco, associate editor

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

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

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

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

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

– Adam Fusco, associate editor

Chinese Banks Improve Funding Profiles following Regulatory Tightening

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

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

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

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

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

– Nicholas Stern, managing editor

Large Banks Pile into Blockchain Trading Platform Project

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

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

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

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

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

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

– Nicholas Stern, managing editor

SWIFT Survey Reveals Treasurer Wish List


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

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

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

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

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

– Adam Fusco, associate editor

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

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

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

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

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

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

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

– Nicholas Stern, managing editor

Kamakura: Corporate Credit Quality Improves in September

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

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

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

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

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

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

– Adam Fusco, associate editor

Manufacturing Sector Sees Solid Gains in September

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

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

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

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

Input costs are also rising thanks to the recent storms.

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

– Nicholas Stern, managing editor