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