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