PPP Program to Boost Argentine Infrastructure Investment

Infrastructure investment in Argentina has dwindled in recent years, but a new public-private partnership (PPP) program might give the country a much-needed boost over the next four years.

The PPP program will feature a $26 billion investment beginning this year through 2022 for roads, energy and mining, communications, water, sanitation and housing, Moody’s Investors Service reported on March 15. Bank debt and bond issuance in the country will fund investments, which Moody’s said remain low among domestic investors. Argentina saw $88 billion in total assets under management (AUM) by the end of 2017; however, only 6% went toward infrastructure.

“The PPP efforts will help boost the country’s low investment rates and will do so in a way that limits the program’s fiscal impact,” Moody’s said. The program was developed by analyzing PPP programs elsewhere in Latin America, such as Peru.

Government certificates, called TPIs, will fund construction, with limited risk exposure for more investors, Moody’s Vice President and Senior Analyst Daniela Cuan said in the report.

In FCIB’s December 2017 Credit and Collections survey for Argentina, 94% of respondents said they did not extend credit to customers. This was a drastic increased compared to the April 2017 survey, when only about 30% reported the same thing. One respondent said that anyone who plans to conduct business in Argentina should closely monitor the country’s “ever-changing government restrictions and monetary policy.”

Issues with extending credit showed problems with payment, such as postdated checks, wire transfer delays, incorrect invoices as well as customers only paying once they’ve been paid.

-Andrew Michaels, editorial associate

Rewritten Financial Reform Law Would Ease U.S. Small Bank Lending

The 2010 Dodd-Frank financial reform law giving the U.S. government regulation over the financial industry is headed toward a rewrite that would ease tight restrictions on small banks and community lenders. Following the U.S. Senate’s vote to approve the revised bill on March 14, the legislation is making its way to the U.S. House of Representatives.

According to a recent Reuters report, small banks and community lenders would see benefits from the rewritten bill, unlike large U.S. banks, including raising their risk threshold from $50 billion to $250 billion that would normally lead to “stricter oversight.” The report also said that banks with less than $10 billion in assets won’t have to worry about the ban on proprietary trading.

The original bill, enacted after the 2007-2009 global financial crisis, was criticized by Republicans for its effect on banks’ lending abilities, Reuters said, but applauded by Democrats for its “critical protections for consumers and taxpayers.” If passed in the House, the bill would go back for another vote in the Senate

“There’s no guarantee that a modified bill would be able to pass the Senate. That’s a real danger,” Paul Merski, executive vice president with the Independent Community Bankers of America, said in the Reuters report. Merski supports the bill.

-Andrew Michaels, editorial associate

Reverse Factoring Accounting Errors Led to Carillion Collapse

Although reverse factoring is becoming an increasingly popular supply-chain finance option around the globe, proper accounting procedures should be in place throughout the process—an arrangement that fell short and may have caused the demise of U.K. construction giant Carillion, which collapsed in January.

According to an article in Supply Chain Management Review, reverse factoring occurs when a supplier sells discounted invoices to a bank and pays them at a later date. Meanwhile, suppliers are getting paid earlier. In the case of Carillion, Moody’s Investors Service reported on March 13 that the construction and services group lacked “explicit disclosure” in its agreement with suppliers and banks.

“Carillion’s approach to its reverse factoring arrangement had two key shortcomings: the scale of the liability to banks was not evident from the balance sheet, and a key source of cash generated by the business was not clear from the cash flow statement,” said Moody’s Vice President and Senior Credit Officer Trevor Pijper, who also authored the report, in a press release.

The reverse factoring agreement began in 2013, with the banks owed about 498 million pounds (more than $695 million), outside of the balance sheet’s disclosed 148 million pounds (more than $206 million) in bank loans and overdrafts. Moody’s reported that the larger amount was shared with “other creditors” and “excluded from borrowings.”

Carillion also didn’t disclose bridging finance from its banks as part of its cash flow, which would have contributed nearly 100% of its cash generated.

-Andrew Michaels, editorial associate

Steel, Aluminum Import Tariffs Should Have ‘Limited’ Impact on Sector

With U.S. government plans in motion to impose tariffs on steel and aluminum imports, industries in the sector are left wondering what potential risks might be coming their way in regards to future business operations. A direct impact on the nation’s steel and aluminum producers will most likely be “limited,” said Fitch Ratings; however, retaliation from other countries could restrict global growth.

President Donald Trump brought attention to these tariffs earlier this month when he shared plans to impose them on 25% of steel imports and 10% of aluminum imports. About 0.3% of U.S. GDP is from iron, steel and aluminum imports, Fitch reported. More reports have already surfaced that the European Union is planning to retaliate with tariffs of their own if the U.S. tariffs pass.

As many political and business figures react negatively to the news, international law firm Foley & Lardner LLP reported on March 5 that steel and aluminum companies were pleased with the proposed tariffs. The report cited comments from the American Iron and Steel Institute, which said the tariffs will “combat an import ‘surge’ in 2017 and large amounts of worldwide excess steel capacity.”

“If the tariffs are successful in reducing the overall level of imports,” Fitch added, “they should result in higher domestic production volumes, capacity utilization and prices, supporting profit margins from 2018 onward.”

Any risks will only grow if countries take “protectionist measures,” Fitch said.

-Andrew Michaels, editorial associate

2018: Another Good Year for U.S. Insolvencies

The global economy is set for a change of pace this year, according to a new insolvency forecast from credit insurer Atradius. 2018 will be the ninth straight year of insolvency declines at 3%. This is due in part to economic growth and low interest rates, but “downside risks are rising as the period of easy money is coming to an end, especially in the [United States].”

The U.S. economy is poised for a nearly 3% increase this year, according to Atradius, and corporate bankruptcies dropped 4% in 2017. Business confidence has been spurred by the recent tax reform and regulatory rollbacks. This will “stimulate higher corporate investment and business activity, which in turn should further lower insolvencies.”

However, there are still risks to this prediction, which include tightening trade policies. Despite the positive outlook, there are a few industries that are dealing with heightened insolvencies. Bankruptcy filings increased in the oil and gas sector, and insolvencies reached a six-year high in the retail industry. The latter is potentially due to consumers migrating to online shopping.

Of the countries surveyed by Atradius, Greece showed the best outlook at -12%, while the United Kingdom was the only country to have its insolvency outlook increase at 4%.

-Michael Miller, managing editor

U.S. Protectionist Policies Could Hurt Global Trade

There is a potential slump in global trade on the horizon, according to the latest Intelligence Unit from The Economist (EIU). There is a moderate probability (21%-30%) that U.S. protectionism will have a very high impact (2% or more) on the global annual gross domestic product (GDP) in the next two years.

A strong global trade growth is expected this year and next despite the possible risks from U.S. policies, noted the EIU. The report cited two major developments that would be catalysts: an American withdrawal from the North American Free Trade Agreement (NAFTA) and a trade war with China.

The U.S., Mexico and Canada have gone through multiple rounds of negotiating during the past several months. Meanwhile, the U.S. has already imposed tariffs on solar cells and washing machine imports from China. On Feb. 27, the Commerce Department announced its findings for antidumping duty (AD) and countervailing duty (CVD) investigations on aluminum foil from China. The U.S. International Trade Commission still needs to review the determinations before the AD and CVD are finalized by Commerce.

U.S. protectionist policies and prolonged stock market falls were the top two global risks, according to the report. South China Sea territorial disputes and countries withdrawing from the eurozone were also among the top 10 risks.

-Michael Miller, managing editor

Asia-Pacific High-Yield Nonfinancial Companies to See Low Default Rate by End 2018

A low default rate awaits high-yield nonfinancial companies in Asia Pacific by the end of this year, which Moody’s Investors Service reported will fall in line with the global trend.

Compared to a default rate of more than 4% in 2017, a Feb. 26 Moody’s report stated that the rate is expected to drop to just under 2% before the end of 2018, according to its Credit Transition Model (CTM). The three contributing factors to this anticipated low default rate include major central banks normalizing monetary policies, steady liquidity as well as ongoing intraregional financial flows and domestic bond markets.

“Our expectation of a low default rate also reflects generally stable global funding and liquidity conditions, despite global monetary conditions having started to normalize and expectations of a moderate slowdown in China’s growth rate,” Moody’s Group Credit Officer Clara Lau said in the report. “Moreover, expected default risk across all the sectors of our rated portfolio will be low, as continued accommodative monetary policies and intraregional financial flows support debt servicing.”

Asia Pacific could still encounter risks of a higher default rate in connection to increased trade protectionism with the U.S. and geopolitical tensions escalating with North Korea. Global liquidity appears stable, however, Moody’s reported that tightening liquidity could cause financial market volatility.

Moody’s CTM also indicated that global default rates should drop about 1% year-over-year, while landing around 2% and 1% in the U.S. and Europe, respectively.

—Andrew Michaels, editorial associate

Forecast Cloudy for 2018 U.S. Manufacturing Outlook

Month-over-month results for January’s factory output in the U.S. are causing some uncertainty among the nation’s economists regarding the manufacturing outlook for 2018.

While the Federal Reserve predicted a 0.3% gain in U.S. manufacturing growth for January over December, a recent Reuters report said overall industrial production actually fell one-tenth of a percent, which was linked to a 1% decline in mining output. A small increase in output was originally predicted by the Fed in December—an expectation that was revised to show no gain.

Production in the aerospace, plastics and food industries were among the impacted sectors last month, Reuters said.

“The industrial sector has received support over the last year from a strengthening global economy,” Reuters reported. “Capacity utilization, a measure of how fully industries are deploying their resources, fell to 77.5%.”

Gains in manufacturing output, however, have showed promising results in primary metals, computers and motor vehicles, the report explained, with a modest rise since August 2017.

—Andrew Michaels, editorial associate 

Moody’s Predicts Stable Outlook for U.S. Steel Industry

A stable outlook is predicted for the U.S. steel industry in 2018 following last year’s demand growth, which Moody’s Investors Service described as “stronger than in many years.”

According to the Institute of Supply Management’s Purchasing Managers’ Index (PMI), Moody’s reported, the average rating in 2017 was about 57.5—readings above 50 indicate expansion. In the January 2018 reading alone, the PMI nearly reached 60. Moody’s Senior Vice President Carol Cowan said in a Feb. 22 report that demand growth in the country’s steel industry should spark stronger prices as well as capacity utilization levels.

Results similar to those in 2017 are expected in 2018 over the next year, year and a half, Moody’s reported.

“We expect 2018 capacity utilization to be 70% to 75% and hot-rolled prices to average between $650 to $700 per ton,” Cowan said in the report.

Moody’s said the U.S. tax legislation might also aid steel consumers by contributing to manufacturing and capital spending investment growth.

—Andrew Michaels, editorial associate

New Bankruptcy Law Coming to Saudi Arabia

A new bankruptcy law in Saudi Arabia will help companies in need of debt restructuring. The legislation was approved earlier this month, according to Reuters. It is not known when the bankruptcy law will become effective, however. This comes just weeks after Egypt passed a new bankruptcy law.

Official details of the new plan have not been released, but the draft consisted of 231 articles in 17 chapters, noted Reuters. The news outlet also stated debt restructuring approval would take at least two-thirds of creditors signing off on the deal.

The new law was adopted in part due to the global financial crisis nearly 10 years ago that left creditors without payments. Ahmad Hamad Algosaibi and Brothers (AHAB) and Saad Group defaulted during the crisis, and creditors and banks are owed roughly $22 billion. Two-thirds of AHAB creditors have approved a debt restructuring proposal, said Reuters.

The new law will have “structural reforms to further facilitate a dynamic business environment that encourages participation—a critical variable in further developing the entrepreneurial ecosystem, investments, and so much more,” said Saudi Arabia spokesperson Fatimah S. Baeshen on Twitter.

-Michael Miller, managing editor

Leveraged Finance Issuance Reaches Record High in January

Despite the year-over-year increase in January’s leveraged finance issue in Europe, Middle East and Africa (EMEA), Moody’s Investors Service predicts the rising stock market volatility will bring numbers back down in February.

Leveraged finance issuance was recorded at a record high for the month of January, which Moody’s reported was thanks to new issuers coming into the market. The January 2018 volume reached nearly $22.5 billion, up $3 billion from the prior year. High-yield bond volume was also up $1 billion year-over-year in January.

Moody’s Associate Managing Director Peter Firth said in the Feb. 20 report that January issuers were encouraged by the stable market and willing to take on “riskier investments.”

“Issuance could slow somewhat in February as equity market volatility may spill over into leveraged finance issuance activity,” Firth explained in the report. “Transactions could be delayed or postponed and we expect the high-yield bond market to remain more susceptible compared to leveraged loans.”

Rising interest rates and tightening monetary policies in the U.S., U.K. and Europe also remain risks, Moody’s said.

—Andrew Michaels, editorial associate

Infrastructure Plan Could Be Great for Private Bonds, but Lags in Overall Funding

A recent Fitch Ratings report finds that one highlight of the Trump administration’s infrastructure proposal would be that it could expand private activity bond (PAB) usage and speed the approval process, which would be credit positive for infrastructure projects.

“However, the proposal's effects on overall infrastructure development will be small as the proposal lags the need in the U.S.,” the report concludes. “In addition, there are political risks to implementation with uncertainties including legislative support and potential opposition from states.”

Under the plan, PABs would be applicable to a wider range of infrastructure projects and would also increase the amount of PABs that could be issued by raising state volume caps, Fitch said. This expansion would offer a wider set of funding options and could enhance private investment in infrastructure, thus potentially benefiting the country’s aging infrastructure. “It is Fitch's view that the current range of funding options is too narrow.”

Environmental permitting timeframes would also be reduced by putting the agency with the most expertise in the lead and giving it a coordinating role, analysts said. Faster projects would bolster project credit, assuming legal exposures aren’t increased.

The proposal includes $200 billion in federal funding over 10 years, with $50 billion in block grants going directly to state governors for rural infrastructure, $10 billion for federal office building infrastructure and $20 billion to expand existing federal loan programs and PABs. The funding amounts are underwhelming. As an example, the Gateway Program to expand the train connection between New Jersey and New York City is a $12.9 billion project alone.

The plan also doesn’t address the ailing Highway Trust Fund, the primary source of existing federal support for infrastructure, which the Congressional Budget Office estimates will run dry in two years.
“Providing funding from state tax revenues could be challenging for some state and local governments as many have already raised revenues in recent years to fund infrastructure investments and general revenue growth has been slow,” Fitch said.

– Nicholas Stern, managing editor

Business Inventories Increased More than Anticipated in December

Economists and the U.S. Department of Commerce were pleasantly surprised by the results for business inventories at the end of last year, which Reuters reported increased “more than expected” between November and December 2017.

According to a Reuters report on Feb. 14, business inventories rose nearly half a percent, 0.1% higher than economists originally predicted. Gains in stocks at manufacturers and wholesalers were believed to have contributed to the slight bump—similar to results seen in November.

“The government estimated [in January] that inventory investment subtracted a 0.67 percentage point from GDP growth in the fourth quarter,” the report stated. “The economy grew at a 2.6% annualized growth pace in the final three months of 2017.”

Retail and manufacturing inventories as well as wholesalers rose in December; however, motor vehicle inventories fell twice as much as the prior month. Reuters said December business sales also increased, albeit, slower than in November, and it takes about 1.3 months for businesses to clear their shelves.

—Andrew Michaels, editorial associate

Crack Down on Shadow Banking in China to Impact Supply of Credit to Real Economy

The impact of stricter regulations in China is impacting its shadow banking sector, including slowing the aggregate growth of entrusted loans, trust loans and undiscounted bankers’ acceptances, according to a new Moody’s Investors Service report. Financial flows to the nation’s social financing will be reduced this year as a result.

"What started as a regulatory crackdown on some previously fast-growing shadow banking segments—such as the banks' wealth management products and nonbank financial institutions' asset management plans—has spread to other major core shadow banking components," said Michael Taylor, a Moody's managing director and chief credit officer for Asia Pacific. "The effect of intensified regulation is no longer limited to de-risking the financial sector, but is now beginning to impact the supply of credit to the real economy."

During 2017, Moody’s figures that shadow banking assets increased at a 10th of the amount of the previous year, expanding by $173 billion versus $1.77 trillion in 2016. "Shadow banking activity also declined as a percentage of GDP for the first time since 2012, falling to 79.3% at the end of 2017, compared to the peak of 86.7% at the end of 2016," said George Xu, a Moody's analyst.

Declines in the banks’ wealth management products, and nonbank financial institutions’ asset management plans—the focus of the Chinese authorities coordinated regulatory actions since the second half of 2016—drove the decline, Xu said.

More recent regulatory actions have focused on core shadow banking activities, which have been a growing source of credit supply to the real economy in 2017. "These measures will likely reduce the supply of credit to more marginal borrowers, who are most dependent on shadow finance," said Xu. "Consequently, refinancing risks are increasing for some sectors, such as property developers, local government financial vehicles, and companies from overcapacity and polluting industries."

Liquidity conditions will continue to tighten for Chinese financial institutions, especially for smaller banks and nonbank financial institutions, Moody’s said. The People’s Bank of China has thus expanded direct lending to the banks with an increasing use of medium-term liquidity facilities.

Smaller property developers and local government financing vehicles may now be turning to the offshore market for funding, the ratings agency said.

– Nicholas Stern, managing editor

Less Volatility Expected for Banking Ratings in 2018

A shift in global bank ratings at the end of last year indicates less volatility in 2018, as Fitch Ratings reports stable outlooks are at their highest mark in recent years.

According to a Fitch report on Feb. 9, the share of positive outlooks nearly doubled year-over-year, despite being outweighed by negative outlooks toward the end of 2017. Upgrades and downgrades remained around the same levels, data showed, while the share of negative outlooks became stable after rating downgrades.

Thanks to revisions, Europe is on balance positive, Fitch said; however, emerging markets in the Middle East, Africa and the Americas are balance negative.

“We changed 65 bank Issuer Default Ratings in 2H17, down from a record high of 92 in 1H17,” Fitch said. “… Upgrades were concentrated in Europe, where the economic recovery is improving banks’ operating environments, while most downgrades were in emerging markets … mostly driven by sovereign downgrades.”

Qatar experienced the most downgrades (nine) in 2H17, the report said.

—Andrew Michaels, editorial associate

Increased M&A in European Pharma to Hit Credit Metrics of Large Firms

Europe’s six-largest pharmaceutical companies will face increased credit quality risks from mergers and acquisitions this year, while any benefits to operating performance are also likely to take a hit, according to a new report by Moody’s Investors Service.

These firms include: GlaxoSmithKline, AstraZeneca, Roche Holding, Novartis and Novo Nordisk. "While the 2018 guidance from the larger European pharma companies is modestly more upbeat than for 2017, this is unlikely to translate into any major improvement in credit quality, mainly because of the impact of recent M&A transactions and the risk of possible future deals," said Knut Slatten, vice president and senior analyst at Moody's.

Moody’s cites as an example Novartis’s $3.9 billion debt-funded acquisition of Advanced Accelerator Applications, which will surpass the company’s 2018 free cash flow and is likely to dampen any recovery of its credit metrics as a result.

Sanofi’s acquisitions of Bioverativ and Ablynx for more than 13 billion euros will see its Moody’s adjusted debt/EBITDA increase to about 2.8x from 2.1x at the end of 2017, depending on how much debt is raised for the two purchases, analysts said. Also, GSK may have to pay Novartis GBP8.6 billion for their common consumer health joint venture.

European pharmaceuticals are also anticipating in 2018 regulatory decisions or important data readouts on drugs “that will be important cornerstones in driving revenue growth over the next 2-3 years,” Moody’s said. “However, this year the focus will be more on line extensions of already approved drugs rather than on approvals of new, high-profile drugs as was the case last year.”

– Nicholas Stern, managing editor

Improved Earnings Doesn’t Mean Corporate Debt is out of the Woods

Corporate debt levels will remain an issue in 2018, according to S&P Global Ratings analysts, despite corporations seeing relief in their earnings and cash flow, some of which is thanks to the recent U.S. tax bill.

In a 2018 study of 13,000 corporate issuers, analysts reported that although corporate earnings have improved and default rates are currently low, the steep corporate indebtedness brings risk of lower asset prices and liquidity reversals. The debt-to-earnings ratio improved slightly from 2016 to 2017, but was still higher than the numbers that were recorded in the past decade.

Last month’s market volatility brought about a weak U.S. dollar, the report said, and when combined with rising commodity prices and improving economic growth, a snowball effect may follow, beginning with inflation and then a repricing in risk assets and spike in higher interest rates.

“High corporate debt levels have increased the sensitivity of borrowers to elevated financing costs,” S&P Global’s Head of Analytics and Research in Asia-Pacific Terry Chan said in a Feb. 5 Barron’s article. “Removing the easy money punch bowl could trigger the next default cycle.”

However, Moody’s Investors Services reported a more positive outlook for corporations. Analyst Julia Chursin said in a report that more corporate ratings improved than companies defaulted; therefore, the default rate for high-yield bonds could continue to fall.

—Andrew Michaels, editorial associate

Cyber Insurance ‘Profitable,’ but Could Be Credit Negative for Insurers

Cyber security studies confirmed a significant increase in data breaches last year and, now, property/casualty (P&C) insurers are scouring for ways to protect their policyholders in the likelihood cyber attacks occur in 2018. But according to Fitch Ratings, cyber insurance could be credit negative for insurers in the demanding market.

The Equifax breach and Wannacry and NotPetya ransomware attacks are among the more severe cyber attacks that occurred in 2017. With the number of U.S. data breaches increasing nearly 45% last year, as reported by the Identity Theft Resource Center and Cyber Scout, insurers are continually challenged when it comes to underwriting and actuarially pricing these exposures.

“Newer market entrants may be more vulnerable to underpricing risks and exposures to large future losses as they may lack the unique underwriting and claims expertise needed for cyber insurance,” Fitch reported on Feb. 7.

Although described by Fitch as a “profitable niche,” cyber insurance demand is expected to remain strong this year, fueled by companies’ concerns as well as increased government regulations. As statutory financial data becomes available in the coming months, Fitch plans to update its report on cyber insurance 2017 market share and performance.

—Andrew Michaels, editorial associate

Asian Liquidity Stress Indicator Improves Again in January

Moody’s Investors Service’s Asian Liquidity Stress Indicator (Asian LSI) improved for the third consecutive month to 24.7% in January—its lowest level since July 2015—from 26.2% in December 2017. The Asian LSI measures the percentage of high-yield companies with Moody’s weakest speculative-grade liquidity score of SGL-4 as a proportion of high-yield corporate family ratings. It increases when speculative-grade liquidity deteriorates.

The number of rated high-yield companies with the weakest speculative-grade scores fell to 38 in January from 39 the month prior, while the total number of high-yield companies increased to 154 from 149 over the same timeframe, Moody’s said.

"The reading for January 2018 fell to the lowest level since July 2015, and is below its trailing 12-month average of 26.5%, benefitting from strong refinancing activity over the past 12 months" said Moody's Vice President and Senior Credit Officer Brian Grieser.

In January, 15 bond deals worth $4.8 billion closed, making up the largest monthly issuance of Moody’s-rated high-yield bond debt in Asia since June 2017, the ratings agency said. "But the Asian LSI remains slightly above the indicator's long-term average of 23.1%, showing that weak liquidity remains an issue for some companies in Asia," said Grieser.

– Nicholas Stern, managing editor

Companies Could Spend Accumulated Cash Soon, Survey Finds

If all goes well, U.S. businesses may be set to deploy some of their cash piles on capital expenditures, wage increases, dividends and buyback and mergers and acquisitions, according to a recent report from the Association for Financial Professionals (AFP).

The organization saw companies accumulating cash and short-term investment holdings at a lesser pace in the last quarter of 2017. AFP contends this could be a sign that companies are ready to spend.

“A strong domestic and global economy, and the most significant change to the United States tax code in more than 30 years, are the likeliest explanations,” AFP said in a statement.
In a quarterly survey, AFP said respondents expected to deploy a minimal amount of cash during the first three months of the year.

Thirty-seven percent of respondents said their firms held larger cash and short-term investment balances at the end of the fourth quarter for 2017 than they did the prior quarter, while 22% said they reduced cash holdings in the prior three months, AFP said. Also, 24% anticipate expanding cash and short-term investment balances over the next three months, while 25% plan to reduce these balances.

“Treasury and finance leaders are still analyzing the new tax bill and are not ready to commit to aggressive spending, but many are weighing plans to deploy cash,” said Jim Kaitz, president and CEO of the AFP. “Given the new era of corporate taxation, not to mention a healthy economy and increasing wage pressure due to a shallow labor pool, it would come as no surprise.”

– Nicholas Stern, managing editor

Liquidity-Stress Indicator Remains Low, Despite Rising in January

Despite economic growth and healthy credit markets in the U.S., the January 2018 results from Moody’s Investors Service’s Liquidity-Stress Indicator (LSI) show a potentially weakened corporate liquidity after increasing for the first time in a year.

The indicator, which generally falls when corporate liquidity improves and rises when it weakens, recorded a 0.2% increase from December 2017 to January 2018. The LSI’s last increase was in January 2017, Moody’s reported, while hitting an all-time low of 2.5% this past December.

“We expect the LSI to inch higher this year amid monetary tightening, tax law changes affecting interest deductibility and less room for improvement in commodity liquidity,” Moody's Senior Vice President. John Puchalla said in a press release on Feb. 2. “Nevertheless, good speculative-grade liquidity (SGL) should keep a lid on defaults, with the U.S. spec-grade default rate also forecast to decline.”

Moody’s SGL ratings saw four downgrades, including two energy companies, an oil services provider as well as an electric production firm, Puchalla said in the report. Three upgrades were also recorded.

—Andrew Michaels, editorial associate

As U.S. Hotel Market Peaks, Loan Transfers to Special Services Increases

After four years of warning signs that pointed to a peaking U.S. hotel market, Fitch Ratings’ prediction is coming to fruition as more hotel properties in the country’s top metropolitan markets transfer loans to special services in the midst of facing pressures from oversupply.

An increasing number of hotel properties transferred to special servicing in the past two years, making up the largest percentage of commercial mortgage-backed securities loans since 2010 (CMBS 2.0). On Jan. 29, Fitch reported that just over $690 million in hotel loans were in special servicing by the end of 2017. For the most part, however, the hotel loans engaged with special servicing have smaller balances at an average of about $15 million.

Oversupply is also an issue within the hotel market, with the supply of rooms under construction exceeding 20% of the number of rooms currently available. This is becoming especially prominent in areas such as Dallas, Denver, Houston, Miami, Nashville, New York and Seattle.

“We expect revenues across the broader U.S. market to grow through the end of 2018, albeit slowly, and the impact on CMBS to be limited this year,” Fitch reported.

—Andrew Michaels, editorial associate

China’s Debt-for-Equity Swap Framework Provides Companies Time, Turnaround Plans Still Needed

China’s debt-for-equity swap framework provides near-term liquidity relief to Chinese corporates that need it, offering much-needed time to restore their business and credit profiles.

Still, these debt-for-equity swaps need to be combined with well-planned and closely monitored turnaround plans to allow companies to improve cash flow and recapitalize in order to avoid simply delaying default risk, according to a new report by Moody’s Investors Service. The report included an assessment of the debt-for-equity swap framework begun in October 2016. The Chinese State Council announced at its inception that the framework is designed to deleverage China’s corporate sector by expanding the number of parties eligible to execute such swaps and widens their funding channels.

"Furthermore, some swapped obligations remain as contingent liabilities in the system, and, in many cases, indebted corporations have to commit to buy back the equities created from the swap transactions after a fixed period; thus these equities are potentially more like fixed-income investments," said Clara Lau, a Moody's senior vice president.

Also, uncertainty remains as to who will finally eat the losses if the company fails to turn around, Moody’s said. "Execution entities—which can establish private equity funds and raise funds from third-party investors, such as wealth management products (WMPs), to invest in the debt-for-equity swaps—and their parent banks may need to bear the potential losses of these funds if exit strategies for the concerned companies do not materialize, as investors generally expect the banks to protect the principal and returns of WMPs," said David Yin, a Moody's vice president and senior analyst.

The swaps also bring risks for the banks, as, for example, it’s not clear if execution entities and their parent banks need to book their minority stakes in debt-for-equity swap investment funds on their balance sheets, or if they have to consolidate the funds in their entirety, including the stakes owned by third-party investors. "In the latter case, pressure on the funding profiles, capital adequacy and earnings stability of the parent banks will be material compared to the former case," said Yin.

The effects on corporates will vary, Moody’s said, depending on the structures of the transactions, and swap arrangements that are used to repay bank debt rather than fund new projects. Most of the affected companies are likely to use the funds to repay their outstanding debt in full, analysts said.

– Nicholas Stern, managing editor

U.K. Insolvency Levels Hit Four-Year High in 2017, Credit Insurance Should Be Considered

Insolvency numbers in the United Kingdom (U.K.) were recorded just shy of 17,250 in 2017, reaching the highest levels in the past four years. According to the Association of British Insurers (ABI), this 4.2% rise from 2016 should make trade credit insurance that much more appealing to businesses, insurers and brokers.

In an Insurance Times article on Jan. 29, ABI Assistant Director, Head of Property, Commercial and Specialist Lines Mark Shepherd said that in the U.K., there were more than 300 business insolvencies every week in 2017. Insolvencies in 2016 reached about 16,550, while there were approximately 17,680 insolvencies in 2013.

“One insolvency can risk a domino effect to hundreds of firms in the supply chain,” Shepherd said in the article; an occurrence, for example, that is clearly demonstrated in the wake of Carillion construction’s liquidation in the U.K.

2018 was barely underway before Carillion collapsed, creating a ripple effect in the European engineering and construction sector. Although trade credit insurers are expected to pay impacted firms about 31 million pounds, news reports concluded that significant losses will still weigh on suppliers and contractors.

A “second wave” of insolvencies is imminent in this case, added Credit Risk Solution’s Mike Clark, also the chair of Biba’s Trade Risk Focus Group. However, all hope isn’t lost as other major contractors swoop in to help prevent further losses, he said. But if credit insurance wasn’t on your mind before, it should be now.

“Those companies who invested in cover had access to industry specialists who offered guidance on the credit risks involved in selling goods and services to Carillion,” Clark told Insurance Times. “Significant claims will be paid, but many suppliers took heed and managed exposures accordingly.”

—Andrew Michaels, editorial associate

Indian Demonetization Highlighted a Significant Liquidity Risk

Moody’s Investors Service recently looked into the types of transactions by country that pose the greatest liquidity risk. Their findings? Indian structure finance transactions, particularly as highlighted during the demonetization process.

"This higher liquidity risk occurs because most Indian transactions pay both interest and principal to investors on a predetermined periodic basis—known as timely payment—whereas in other countries, principal payments are typically only passed through to investors once they are received from the underlying borrowers," said Siddharth Lal, a Moody's analyst. "Furthermore, the characteristics of the underlying borrowers in certain Indian transactions—such as auto asset-backed securities (ABS)—accentuate the liquidity risk posed by such deals.”

In the ABS markets for instance, the earnings of borrowers tend to be volatile, as can the level of cash collections from borrowers, Moody’s said.

In fact, when cash flows to a transaction are briefly disrupted, cash reserves that support the related notes have to be used at a heightened pace to pay off principal to investors, even when it’s not received from the borrowers, analysts said.

But there exist several mitigating factors to this liquidity risk, such as cash reserve facilities that support rated notes and are fully funded at closing and don’t amortize over the transaction term, Moody’s said. These usually cover up to three months of principal and interest payments at closing, and the coverage grows as the notes amortize.

Excess spread, or the amount of interest collected from the portfolio that’s in excess of the aggregate amount of interest due on the notes, as well as other fees and expenses payable each month help mitigate liquidity risks.

During Indian demonetization, as in November 2016, the government withdrew all INR500 and INR1,000 notes from circulation—about 85% of all currency notes at that time, Moody’s said. “As a result, collections for the Indian auto ABS Moody's rated at the time dropped by an average of around 1.3%,” Moody’s analysts said. “The average utilization of cash reserves was less than 1%, while the maximum was 1.4%. However, if the drop in collections had been more severe and prolonged, it could have led to a significantly higher utilization.”

– Nicholas Stern, managing editor

Less than Half of Businesses Aware of GDPR as Deadline Closes In

Less than four months before the General Data Protection Regulation (GDPR) takes effect in the U.K., a recent government survey indicates that only 38% of businesses are aware of the upcoming data protection laws. GDPR will commence on May 25 and, according to ZDNet, “those who are found to misuse, exploit, lose, or otherwise mishandle personal data could potentially face huge fines.”

GDPR will allow European customers to control any personal data about their businesses’ storage and processes. The survey shows that the impending deadline isn’t giving companies enough time to prepare, despite government warnings. Little or no action could lead to fines of up to 4% of company turnover, ZDNet reported, with additional penalties if companies are hacked and attempt to hide it from their customers.

Gov.uk published the Cyber Security Breaches Survey 2018: Preparations for the New Data Protection Act on Jan. 24, which comprises data from telephone interviews over a three-month period in late-2017. The survey was commissioned by the Department for Digital, Culture, Media and Sport (DCMS) as part of the National Cyber Security Programme and includes responses from more than 1,500 businesses and nearly 570 charities.

The finance and insurance sectors have the most awareness of the coming legislation, according to the report; however, only one in four businesses in the construction sector is aware of GDPR.

“Among those aware of GDPR, just over a quarter of businesses and charities made changes to their operations in response to GDPR’s introduction,” the report states. “Among those making changes, just under half of businesses, and just over one-third of charities, said these changes included those to cyber security practices.”

The majority of businesses and charities that reported cyber and security changes said they were made by creating or updating policies, while others made changes by conducting additional staff training or communications, or by installing, changing or updating antivirus or antimalware software.

A wider survey, including more input from U.K. businesses and charities, is expected to be released in April prior to the start of the GDPR.

—Andrew Michaels, editorial associate

Argentina Keeps Positive Outlook, but Inflation, Reforms Will Be Tested

Economic reforms are well underway in Argentina since the country’s mid-term elections in October 2017, and are the basis for Fitch Ratings’ positive outlook and B rating. However, recent hikes to the official inflation targets and a large deficit have underscored ongoing policy tensions.

Since October, the country has passed a new tax bill that cuts corporate taxes, contains spending and changes the pension indexation formula to lower expenses, Fitch said. Capital market reforms are also in the works, as are “controversial” labor market and electoral reforms.

“This reform momentum is broadly positive for Argentina's credit profile,” analysts wrote. “It reflects improving executive governability vis-a-vis the congress and provincial governments. It could also support a stronger and more sustainable growth path after a decade of policy-related volatility.”

A large fiscal deficit, however, is still Argentina’s main credit weakness. In 2017, the primary fiscal deficit dropped to 3.9% of GDP from 4.3% in 2016. Still, the total fiscal deficit increased to 6.1% of GDP in 2017 from 5.9% thanks to interest charges.

Money supply growth remains high due to strong dollar inflows from public borrowing and ongoing central bank financing. Utility rate hikes are creating price pressures, credit growth is surging amidst weak financial markets and inflation reached 25% in 2017, above the government’s target of 12% to 17%.

“The subsequent jump in 2018 inflation expectations to around 18%—higher than the new target—highlights this risk and poses a challenging backdrop to upcoming wage negotiations,” Fitch said. “These will serve as a crucial test in the disinflation process.”

– Nicholas Stern, managing editor

Asian Credit Conditions Stable for 2018

Credit conditions in Asia will be steady this year due to regional and global economic growth, according to Moody’s Investors Service. A global trade recovery and broad-based accommodating monetary policies will also contribute to the stable outlook.

Moody’s prediction is based on several outlooks surrounding regional sovereigns and the banking and corporate sectors. Despite steady credit conditions, there are risks, such as “tighter financing conditions, the threat of increased trade protectionism and geopolitical tensions,” noted Moody’s.

Japan and India will see positive growth, while China will slow slightly. The Philippines and Vietnam will expand their economic performance and stand out among ASEAN countries. "For the first time since the Global Financial Crisis, we are seeing a synchronized expansion across all the major economies. … Asia will remain the fastest-growing economic region in the world, supported by a recovery in global trade and continued accommodative monetary policies by Asian central banks,” said Moody's Managing Director and Chief Credit Officer for Asia Pacific Michael Taylor in the release.

Moody’s has stable outlooks on 13 of the 16 banking systems in the region, while there are two systems with a positive outlook. Some of the risks that could compromise the credit condition outlook are the tariffs imposed by the U.S.—this will have an immediate impact of credit in the APAC region. "U.S. tariffs, if they signal rising protectionism, could hurt rated manufacturers, sovereigns,” noted a separate Moody’s report. Other risks include the tension in the Korean peninsula and South China Sea, but Moody’s doesn’t expect either to lead to conflict.

-Michael Miller, associate editor

Australia Set to Implement Real-Time Payment Platform

Australia is preparing to launch its real-time payments infrastructure—the New Payments Platform (NPP)—in early 2018 to support its growing digital economy.

According to an article on the Open.gov website, the NPP will support payments between business accounts and customers at different financial institutions in Australia by providing “fast, versatile, data-rich payments any time and any day.”

The plan was first announced in 2013 by the Australian Payments Clearing Association and began as an industry-wide collaborative program as industry participants called for payment innovations and an updated payments system for the country.

The NPP supports near real-time payments clearing and settlement, allowing residents to use their phone number, email address or an Australian Business Number (ABN) to facilitate transfer of funds through its PayID capability, Open.gov said. The NPP connects the participating financial institutions with the Reserve Bank of Australia’s (RBA) Fast Settlement Service, allowing for real-time settlement between participating institutions.

NPP says payments will be able to be made in real time, with close to immediate funds availability to the recipient; 24/7 availability that enables payments to be made and received even outside normal banking hours; data-enriched payments with more complete remittance information attached; and, simple addressing enabled by the PayID system using common identifiers.

Participating institutions include: the Australia and New Zealand Banking Group (ANZ), Australian Settlements Limited (ASL), Bendigo and Adelaide Bank, Citigroup, Commonwealth Bank of Australia, Cuscal, HSBC Bank Australia, Indue, ING Direct, Macquarie Bank, National Australia Bank (NAB), Reserve Bank of Australia (RBA), and Westpac Banking Corporation.

After its launch, the NPP is expected to reach about four in five accounts in Australia. The NPP’s base infrastructure is built by Fiserv and Swift, and adopts the ISO 20022 standard used for electronic data interchange between financial institutions or organizations able to move money and data.

– Nicholas Stern, managing editor

German Economy Sees ‘High Investor Confidence’ Continuing Through 2019

Germany will sustain some of its strong economic growth from 2017 over the next two years, as Moody’s Investors Services reports highly credible government policy and healthy public finances in the country.

Political uncertainty is not an issue in Germany, according to Moody’s analysts, who reported that the country’s economy will not be affected by the September 2017 parliamentary elections. Instead, near-term shocks are expected to be met with “high resilience” since Germany’s growth is broad-based and domestically driven.

In a Jan. 23 report, Moody’s said they expect a 2% growth in Germany’s economy in 2018, with a slight dip to 1.7% in 2019.

“Germany enjoys high levels of investor confidence, highlighted by its safe haven status in times of crisis and reflected in its low funding costs,” Moody’s Assistant Vice President Heiko Peters said in his report.

The country’s fiscal surplus also expanded to 1.2% of GDP in 2017—a 0.4% increase over the prior year. If Moody’s predication is accurate, fiscal surpluses will stay above 1% of GDP through 2019.
That isn’t to say there aren’t risks. Moody’s said that a downturn in the global business cycle could impact German companies as well as any increase in protectionism. Demographic trends are also believed to slow Germany’s growth in the medium to long term.

“Pressure could develop on Germany's creditworthiness if the country experienced a material and prolonged decline in the size and wealth of its economy, if it fails to address rising demographic pressures in the coming decades,” Moody’s said. “The rating could also come under pressure if government debt increases sharply and is unlikely to be reversed.”

—Andrew Michaels, editorial associate

Major U.K. Construction Firm Bankruptcy Highlights Importance of Contract Risks

The bankruptcy and liquidation of U.K. construction giant Carillion, and its impact on suppliers and other small businesses underscores the importance of contract risk management and maintaining margins for firms in the European engineering and construction sector.

According to a recent report by Fitch Ratings, the sector is mostly sub-investment grade, but the situation may be better for companies that are managed well and keep a close watch on their balance sheets.

Carillion went into liquidation last week with estimated debts at $2.4 billion due to cost overruns on several key projects. The company wrote off over $1.3 billion worth of receivables in 2017, which in part were due to construction delays, “but also suggest poor risk assessment regarding contract bidding,” Fitch analysts said. “With margins in the construction and services industries under pressure, strong contract discipline has become more important in recent years. In its absence, companies may find themselves bidding for new contracts to cover cash shortfalls on existing contracts.”

Assessing risk in the contract bidding phase, and monitoring them closely to watch for unexpected capital outflows due to cost increases are important factors in a viable risk management strategy, Fitch said.

As companies step in to replace Carillion on its projects, credit managers should watch for the replacement costs in play, how near completion the replacement projects are and how much money is already owed to sub-contractors, analysts said.

– Nicholas Stern, managing editor

Loan Covenant Quality Hits Record Low in North America in 2017

Investor protections in North America reached a record low on Moody’s Investors Service’s Loan Covenant Quality Indicator (LCQI), hitting 4.15 in the third quarter of 2017, a deterioration of .06 from the prior quarter.

The LCQI is updated on a quarterly basis and ranges from 1 (strongest investor protections) to 5 (weakest). The indicator reviews investor protection in the covenant packages of speculative-grade leveraged loans, which Moody’s analysts said will remain covenant-lite in the foreseeable future, despite the lack of financial maintenance covenants.

“Borrowers are making the most of a wide-open market,” said Moody’s Vice President Derek Gluckman. “As demand continues to outpace supply and pressure on covenant quality remains intense, it is hard to see what investors get in return for giving up covenants in these frothy market conditions.”

When repricing protections lapse, Moody’s reported borrowers are then refinancing at six-month intervals. The LCQI’s five-year historical average was recorded at 3.71 and reached its best in the third and fourth quarters of 2012 at 3.18.

—Andrew Michaels, editorial associate

China Tightens Regulations to Better Bank Transparency

The China Banking Regulatory Commission is cracking down its regulation of loopholes in the country’s financial sector, while giving authorities more leverage control in the process. According to a Jan. 18 Fitch Ratings report, the endeavor is believed to improve transparency in Chinese banks.

Notices from the commission were put in place to help banks better understand their total credit exposure as well as any potential risks that could impact Chinese banks’ viability ratings. Efforts to combat risky lending began in early 2017, Fitch said, which found evidence that interbank activity and entrusted investment exposure are contracting.

Although loan exposure to a single name will remain capped at 10% of Tier 1 capital, the latest proposals state the cap will extend to include non-loan credit, with single-name total credit exposure capped at 15% of Tier 1 capital. Fitch said single-group exposure will be capped at 20% of Tier 1 capital, with both single-name and single-group including counterparties that are controlled or economically dependent on the same group.

“There will also be a 15% cap on exposure to unidentified counterparties in structured products, which will force banks to adopt a look-through approach and identify the underlying assets and counterparties embedded in these products,” Fitch said. “Single-group limits will also apply to interbank exposures for the first time.”

Per Basel requirements, single-group limits will be capped at 100% of Tier 1 capital from June 2019, while a phased, three-year reduction will bring the cap to 25% by 2021. This grace period would give mid-tier banks the time necessary to fall in line with the interbank exposure rules. Global systemically important banks (G-SIBs) will then have their credit exposure to other G-SIBs capped at 15% of Tier 1 capital.

Another notice released by the commission focuses on entrusted loans and ensures that the proceeds are not used to purchase financial assets or extend loans in restricted sectors. Fitch said that outstanding entrusted loans increased by 6% last year, accounting for 8% of total social financing (TSF).

“Official TSF growth has not slowed notably and at 12% in 2017 is still running faster than nominal GDP growth, which means that the overall system deleveraging is still not happening,” Fitch reported. “Genuine deleveraging would hurt near-term economic growth and banks’ asset quality, but there are so far no signs of the effects.”

—Andrew Michaels, editorial associate

Economic Growth Leads to Stable Outlook for Central and Eastern Europe

Despite some structural and institutional challenges in Central and Eastern Europe (CEE), Moody’s Investors Service’s outlook for sovereign creditworthiness in the region is stable, based on solid economic growth.

"Dynamic household consumption, and a continued recovery in investment will continue to drive growth in the CEE region," says Daniela Re Fraschini, an associate vice president at Moody's and author of the report. "This will help to further narrow the CEE region's income gap with the remainder of the EU." Seven of the region’s eight sovereigns have a stable outlook.

Moody’s analysts anticipate growth rates in the region will continue to surpass EU and euro area averages this year, but will moderate to between 3% and 4% for most countries, in part due to gradual monetary tightening in some countries.

Fiscal policy should remain expansionary in 2018 for most of the region, but the ability to raise tax revenues will diminish for many countries as revenue growth slows along with economic growth, and interest costs rise due to normalizing monetary policies, Moody’s said. “In Moody's view, this will exert pressure on the countries with the least favorable fiscal position, like Romania (Baa3 stable) and Hungary (Baa3 stable), where structural deficits are set to widen further.”

Challenges to the region include demographic factors and labor shortages, which could limit future growth. “In addition, the rating agency says that a less predictable policy environment will constrain the credit profile of some sovereigns in the region,” analysts said. “In this context, policy unpredictability will remain relevant for Poland (A2 stable) where judicial reform could potentially erode the rule of law and dampen economic sentiment and [Foreign Direct Investment] FDI.”

– Nicholas Stern, managing editor

New Chinese Regulations to Limit P3 Investment

Infrastructure growth is expected to slow in China in 2018. Fitch Ratings predicts recent regulations on public-private partnerships (P3s or PPP) will cool down such projects. The new rules are designed to contain risks and increase transparency.

The new regulations are structured to encourage private capital for P3s since they restrict state-owned enterprises (SOEs) from being involved in P3s. Over half of PPP projects “were driven by SOEs in 2017,” said Fitch. Some such projects have already been stopped due to the new regulations, which were put in place late last year.

There is typically a small return on P3s, roughly between 5%-10%, noted Fitch. This will make it difficult for private investors to fill the shortfall left by the regulations. “SOEs can generally borrow at lower interest rates, and are therefore more willing to accept lower project returns.” The infrastructure investment slow down has already begun, with year-over-year fixed asset investment declining steadily since the beginning of 2017.

As a result of the new regulations, local governments may now need to fund more of their projects through on-balance-sheet borrowing since the regulations remove the option for off-balance-sheet financing. This will likely increase local government debt, but it will be at a slower pace compared to years past, explained Fitch. The initiatives may expose risky practices and cause disruption in the short term, but will ultimately increase overall transparency in local governments, concluded Fitch.

-Michael Miller, associate editor

Global Financial Conditions Looking to Remain Stable This Year

Risks to global financial conditions are not significant, economic growth will be robust and asset quality is expected to remain stable this year, leading to favorable bond issuance and credit for 2018.
Any fall in asset prices or fallout from withdrawn quantitative easing is also overestimated, said Moody’s Investors Service in a new report.

"Global financial market risks remain moderate, with little change in underlying pressures over the past six months," said Colin Ellis, Moody's managing director of credit strategy. "Our assessment remains broadly unchanged in the continued absence of significant macroeconomic, financial and political shocks."

Geopolitical risks stemming from the Korean peninsula and the Middle East are ever present, while substantial shifts in U.S. economic policy also remains as a potential risk to the generally stable global banking sector, Moody’s said.

“Moody's expects policy rates to peak at lower levels than seen in the pre-crisis period, which is consistent with long-term rates only partly unwinding past declines,” the report stated. “Some of the observed decline in benchmark long-term yields is likely to be permanent.”

Corporate bond yields are low, and in line with benchmark rates, while credit spreads for high-yield bonds are tighter, but not mismatched with Moody’s ratings for the high-yield issuers.

Globally, equity markets are relatively even-keeled, with the U.S. being an exception as price-earnings ratios look over-valued in some situations, analysts said.

"Based on our analysis, asset prices do not generally appear to be inflated on a global basis," Ellis said. "Furthermore, QE may not have blown big asset bubbles, and risks from falling asset prices as and when QE is withdrawn are overestimated."

– Nicholas Stern, managing editor

Same Day ACH Picks up Steam in 2017

Same Day ACH payments are on the rise, according to NACHA–the Electronic Payments Association. Same Day ACH debits and credits increased by 51% from November to December, said NACHA in a release this week. Such transactions totaled more than 15 million last month.

“Financial institutions, businesses and consumers are reaping the benefits of Same Day ACH,” said NACHA Chief Operating Officer Jane Larimer in the release. “Same Day ACH is now a reality for payroll, bill payment, business-to-business (B2B) payments, account transfers and many other applications.”

Last year, there were over 75 million Same Day ACH transactions valued at more than $87 billion. It was an average of over $1,160 per transaction. Debit transactions have only been available since September, but in just several months, there were more than 18 million Same Day ACH debits, totaling $14.5 billion. However, only 8% of the debits were B2B payments. B2B debit transactions were valued at $2.3 billion, or 16% of the total debit value.

Same Day ACH credits are a different story. A third of credit transactions—nearly 19 million—were B2B. Just under half of the credit volume, at more than $35 billion, was B2B.

“The rapid growth of Same Day ACH payments in 2017 sets the stage for an even stronger 2018, with the implementation of the third phase of Same Day ACH on March 16,” said NACHA. The third phase is designed to make payments even faster and make funds available sooner.

—Michael Miller associate editor

Creditworthiness in Latin American Could Be Impacted by Politics

Tension in Latin America’s political atmosphere this past year could send countries’ creditworthiness down a rocky path toward weakening growth and fiscal accounts. Although their already-low ratings address the economic, fiscal and financing challenges, Fitch Ratings said Jan. 10 that ongoing political debacles, such as reform delays and policy adjustments, aren’t making the outlook any brighter.

The economic impacts from certain political environments aren’t set in stone, Fitch said, but some countries, like Ecuador, have ideas of what’s to come regarding its fiscal future if the current status of governance remains as is. Fitch reported that the start of proceedings to impeachment Ecuador’s former vice president last month—due to bribe allegations—took the government’s focus away from boosting economic growth, necessary to reduce the surmounting fiscal deficits.

“The government debt burden will continue to rise rapidly and Ecuador will remain heavily reliant on external financing,” Fitch said. “The private sector is awaiting economic policy responses, undermining growth prospects, as much of the economic policy framework will depend on political developments in [the first quarter of 2018].”

Meanwhile, a delay in Costa Rica’s tax reforms could spell trouble as Fitch anticipates the central government deficit to widen in the coming year. The country’s rating fell in January 2017.

—Andrew Michaels, associate editor

Asian Liquidity Index for Speculative-Grade Companies Improved in December

Liquidity for high-yield companies in Asia in December improved from the prior month and year-over year, according to the latest Asian Liquidity Stress Indicator (Asian LSI) from Moody’s Investors Service.

The Asian LSI decreased to 26.2% in December 2017 from 26.4% in November, and 30.3% at the end of 2016, Moody’s said. The Asian LSI measures the percentage of high-yield companies with Moody’s weakest speculative-grade liquidity score of SGL-4 as a proportion of high-yield corporate family ratings. The indicator increases when speculative-grade liquidity deteriorates.

"Although Moody's Asian LSI reading remained above the long-term average of 23.1%, highlighting ongoing weakness in liquidity for many companies in Asia, the December figure also marks the strongest year-end reading since December 2014," says Brian Grieser, a Moody's vice president and senior credit officer.

The number of rated high-yield companies with Moody’s weakest speculative-grade liquidity score increased to 39 in 2017 from 37 in 2016, the ratings agency said. It was the fact that the total number of rated high-yield companies increased by 22% to 149 from 122 that led to the improvement in the index.

In December, rated high-yield issuance totaled $0.6 billion, raising year-to-date issuance to a record $34.5 billion, surpassing the previous $23.3 billion high reached in 2013, Moody’s said.

In China, the subsector’s index improved to 29.1% in December 2017 from 34.2% in 2016. Still, the high-yield property sector weakened to 23.4% from 20% in December 2016, Moody’s said.
The South and Southeast Asian LSI subsector decreased to 23.1% in December 2017 from 26.2% a year prior.

 – Nicholas Stern, managing editor

Small Business Optimism Highest on Record

Despite a slight drop off in December, small business confidence was at its highest ever in 2017. The Small Business Optimism Index from the National Federation of Independent Business (NFIB) dipped 2.6 points to 104.9 last month.

“2017 was the most remarkable year in the 45-year history of the NFIB Optimism Index,” said Juanita Duggan, NFIB president and CEO, in a release. The average monthly index level was 104.8, breaking the previous record of 104.6 set in 2004.

The strong optimism can be linked to politics. “With a massive tax cut this year, accompanied by significant regulatory relief, we expect very strong growth, millions more jobs, and higher pay for Americans,” said Duggan.

“Small business owners were waiting for better policies from Washington, suddenly they got them, and the engine of the economy roared back to life,” added NFIB Chief Economist Bill Dunkelberg.

Half of the 10 components declined in December, while two grew and three were constant. Expected better business conditions and inventory plans were among those to decline. Actual sales saw a 14-point upward swing last month. Wells Fargo Securities expects businesses to expand following the tax reform.

The overarching issue of a labor shortage is still at the forefront for small businesses as it is in the construction industry. “There’s a critical shortage of qualified workers and it’s becoming a real cost driver for small businesses,” said Dunkelberg. Businesses are forced to raise wages to attract and keep workers, but that’s a positive for the economy, he concluded.

-Michael Miller, associate editor

Majority of Rated Chinese State-Owned Companies to See Reduced Leverage This Year

The Chinese government’s reform efforts are likely to help two-thirds of 53 Moody’s-rated Chinese state-owned enterprises (SOEs) realize lower-leverage levels this year versus 2016, according to a new report by Moody’s Investors Service. Debt/EBITDA, in particular, will fall.

“ … Reform measures underpin the continuing reduction in leverage levels,” the report’s authors said. “Specifically, the reforms related to SOEs, which aim to increase their efficiency and profitability, as well as supply-side reforms, which are targeted at lowering leverage and costs for Chinese corporates and removing excess capacity in certain industries. Both reform programs will increase EBITDA and curb debt growth.”

Moody’s senior vice president Kai Hu said the aggregate average debt/EBITDA for the 53 SOEs rated by the agency will fall to 5.4x this year from 5.5x in 2016 and 5.7x in 2015.

SOEs in the commodity sectors have stronger standalone credit quality that will help them weather future downturns in commodity prices, Moody’s said. “The 2016-17 recovery in such prices has boosted the EBITDA for SOEs in the metals and mining, oil and gas, and agriculture and food sectors. While Moody's price assumptions for commodities in 2018 are moderately lower than the average for 2017, the SOEs' cost savings, capital spending cuts and more conservative financial policies will enable them to continue deleveraging through 2018.”

Still, leverage will grow for a third of Moody’s related Chinese SOEs, with debt/EBITDA rising more than 0.5x for 12 rated firms at the end of the year versus the end of 2016. Seven of these firms are power and gas utilities that can’t pass on increased fuel prices to customers fast enough, show large planned capital expenses or both.

– Nicholas Stern, managing editor

Infrastructure Investment is ‘Credit Strong’ for China Railway Group

China Railway Group Limited (CRG), one of the largest construction companies globally, should see steadily increasing revenue through 2019 as the state-owned China Railway Corporation (CRC) makes its billion-dollar investment on railway infrastructure development in the coming year. CRC’s stable, financially backed plan supports CRG’s low investment-grade rating.

As operator of China’s railway systems, CRC announced plans on Jan. 2 to invest RMB823.8 billion for railway infrastructure development in 2018. Moody’s Investor Services reported that the country’s investment is slightly less than in the past two years, but noticeably higher than investments between 2011 and 2013.

The latest investment is “credit positive” for CRG, based in Beijing, which has about a 45% to 50% share in the country’s railway construction industry, according to Moody’s. About 35% of CRG’s total revenue of RMB666.4 billion was thanks to railway construction revenue, ending June 2017.
“CRG will be one of the main beneficiaries of the government’s plan to continue making large investments into the country’s railway network, given its strong position in the domestic railway construction industry,” said Chenyi Lu, a vice president and senior credit officer for Moody’s.

Although CRG’s revenue will continue growing in the next two years, Moody’s predicts a slight decline from the 7.5% increase in 2017 to 5% in 2018 and 4% in 2019. At the end of June 2017, CRG experienced a significant order backlog of RMB2.21 trillion in addition to ongoing expansion overseas.

The company’s plans to increase its investment in real estate development and in builder-operator-transfer (BOT) and public-private partnership (P3) projects will cause its debt levels to increase between today and 2019. In order to support expanded operations, Moody’s reported, capital spending will also increase, effectively raising the debt level.

–Andrew Michaels, editorial associate

‘Unsolicited Takeovers’ Make Up Significant Portion of M&A Activity in 2017

At a global level, mergers and acquisitions (M&A) heightened in 2017 with a recurring approach from nearly 80% of buyers who initiated company sales rather than go after companies that were for sale.

Michael Carr, Goldman Sachs Group’s global co-head of M&A, said the significant majority of buyers approached target companies in 2017 in an “unsolicited takeover,” according to CNBC. Preliminary Thomson Reuters data showed that M&A reached $3.54 trillion last year, falling just shy of the $3.59 trillion in 2016.

In 2017, M&A were recorded at the third-highest annual level since the financial crisis in 2008, and peaked in 2015 at $4.22 trillion. The steady outcome was credited to CEOs’ latest approach, which also included companies that refused to engage with interested buyers.

"Some of this is driven by buyers who believe they will not face competition,” Carr said, “which encourages them to aggressively pressure their targets confidentially with the implied threat that they will go public.”

Stephen Arcano, an M&A partner at law firm Skadden, Arps, Slate, Meagher & Flom, said buyers’ stock was frequently used in last year’s acquisitions.

"We are seeing a stock component becoming a bigger portion of the offers being made, perhaps because the deals are bigger and transformative, and acquirers are looking to offer targets additional upside in these transactions," Arcano said.

Buyout firms also used funds from investors in M&A through private equity, which rose 27% last year and reached $322.6 billion on a global scale. Following the passage in U.S. tax changes, CNBC reports that companies can allocate more cash to M&A.

The dealmaking tactic has reared its head over the past three years, with geopolitics having little impact on overall M&A, CNBC said.

Thomson Reuters data shows Europe and Asia-Pacific with an upswing of 16% and 11 %, respectively, bringing M&A in Europe to $856 billion and those in Asia-Pacific to $912 billion. Billion-dollar acquisitions in the U.S., such as CVS Health buying health insurer Aetna and Walt Disney buying Twenty-First Century Fox film and television businesses, could not prevent the year-on-year 16% decline in M&A to $1.4 trillion in 2017.

–Andrew Michaels, editorial associate

Majority of Small Businesses Surveyed Aren’t Following Cloud Storage Regulations

A majority of small U.S. businesses that store customer credit card data and banking information in the cloud do not follow data storage industry regulations.

More than 60% of 300 companies surveyed by business-to-business research firm Clutch fail to do so, according to a report in Information Management. In addition, 54% of surveyed companies don’t follow industry regulations regarding medical information storage in the cloud.

Businesses that store bank or health data information are required to follow the Payment Card Industry Data Security Standard (PCI DSS) and the Health Insurance Portability and Accountability Act (HIPAA), the article stated. Failing to adhere to these standards can result in millions of dollars in fines.

Still, these businesses were confident that the security steps they were taking were sufficient—60% use encryption, 58% train their employees on data security issues and 53% require two-factor authentication to protect their cloud storage, Information Management said.

– Nicholas Stern, managing editor

B2B Buyer Demographics Growing Younger, More Digitally Savvy

When it comes interacting with e-commerce businesses, a lot of the interaction from a more traditional credit department involves reaching out and responding to a buyer of the client, particularly as these newer firms move to automated accounts payable systems.

A buyer might be the quickest way to interact with a human customer when problems arise, say, with payment charge backs or deductions. And according to a recent article in Chief/Marketer, these business-to-business (B2B) buyers expect a vendor to know a lot about them from the beginning. Chief/Marketer cites a study by the marketing publication The Drum that shows 90% of B2B and consumer audiences in a survey said brand experiences that deliver stronger personal interactions are more compelling.

Further, B2B buyers are getting younger and more digitally savvy—the 18- to 34-year-old demographic of B2B buyer grew 70% from 2012 to 2014, the publication said. These buyers expect more of a digitally friendly experience with their vendors, from searching out questions about your firm and its workings online, to being able to interact with your website on mobile devices.

 – Nicholas Stern, managing editor