eNews January 4, 2018

Corporate Bankruptcies, Debt Levels to Pose Ongoing Risks

The number of publicly traded companies filing for bankruptcy fell in 2017, even as the total assets going into Chapters 7 and 11 filings rose.

According to a report in Bankrupt Company News adapted from New Generation Research’s The Turnaround Letter, there were 70 bankruptcies of publicly listed companies in 2017, down from 99 the year prior. The total assets in Ch. 7 and 11 cases rose slightly to nearly $107 billion last year, from $104 billion in 2016. “This may have been skewed somewhat by the fact that some of the largest 2017 filers arguably were financial services companies … but the numbers nonetheless reflect a continued high level of filings by large companies,” the Bankrupt Company News said. The assets going into bankruptcy are, however, more than a third lower than the total in 2009.

The energy and mining sectors still saw a lot of Ch. 11 activity in 2017, but bankruptcy activities in these industries were less active—of the 10 largest Ch. 11 filings, four involved energy or mining firms, compared to eight of the 10 largest filings in 2016. “Looking ahead, we expect corporate bankruptcy activity to remain at a high level for at least the next few years,” the Bankrupt Company News reported.

The Kamakura Troubled Company index ended December at 8.89%, up 1.19% from the prior month, indicating declining credit quality. Overall, default probabilities declined to the 73rd percentile of historic credit quality as measured since 1990. Seven of the top-ten-riskiest-rated firms are in the U.S., while one each are located in Australia, the U.K. and Singapore. The Kamakura 10-year cumulative default rate for all rated companies worldwide is still above the 13.33% experienced in September 2008.

“Three of the riskiest global companies are either retailers themselves or are tied to consumer brands. Risks to the retail sector have surpassed levels reached during the Great Recession,” said Martin Zorn, president and COO for Kamakura Corporation. “The issues are more complex than brick-and-mortar versus e-commerce. While some physical stores are barely hanging on, others have adapted and are thriving in the online world.” Retail real estate is another risk factor credit managers need to focus on, Zorn said.

Highly leveraged corporate debt is another big risk factor this year. Approximately $1.5 trillion in lower quality corporate debt is due over the next five years, and some portion of that figure will likely need to be restructured, possibly through a Ch. 11 filling.

According to a recent report by Wells Fargo, developing economies have experienced a notable uptick—from just over 60% debt-to-GDP in 2008 to 104.1% in the second quarter of 2017—in leverage in the nonfinancial corporate sector, with much of that leverage occurring in China.

The International Monetary Fund found in December that corporate debt in China has reached 165% of GDP, leading to a slowdown of productivity growth and pressures on asset quality, potentially helping to fuel a major financial stability risk to the global economy.

– Nicholas Stern, managing editor

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Kentucky Supreme Court Ruling a Reminder to Track Change Order Amounts

The Kentucky Supreme Court recently decided that a project owner had precluded steel subcontractors from recovering payment for extra-contractual work amounting to more than $400,000 under a “pay-if-paid” contract clause.

The American Subcontractors Association (ASA) filed an amicus brief on July 18, 2016, in Superior Steel, Inc. and Ben Hur Construction Company, Inc. vs. the Ascent at Roebling’s Bridge, LLC, Corporex Development & Construction Management, LLC, Dugan & Meyers Construction Company and Westchester Fire Insurance Company. The ASA asked the Kentucky Supreme Court to overturn an appeals court’s ruling that essentially allowed the owner to benefit from valuable extra-contractual work provided by the subs without payment.

In its December ruling, the Court agreed with the ASA concerning the “unjust enrichment,” noting, “[A]ny recipient of a substantial benefit in the form of authorized extra work should not be surprised that payment will be due, eventually…,” an ASA press release on the ruling stated.

The Court also ruled that the issue of whether the pay-if-paid clause in the contract should be enforced is better left to the state legislature to decide, ASA said. “While there are valid reasons for disfavoring ‘pay-if-paid’ provisions, any prohibition against this type of contract clause should come from the legislature rather than this Court,” the ruling stated.

The Kentucky case serves as a reminder for subcontractors and materials suppliers to keep track of the original job contract and the stated dollar amount for the account, and make sure change orders to the original contract are signed, said Connie Baker, CBA, director of operations for NACM’s Secured Transaction Services (STS).

Subs and suppliers should also note that in certain states, such as California and Arizona, they should send another preliminary notice for private construction jobs if the change order exceeds, by a specified threshold, the dollar amount of the original contract, Baker said. For instance, in California, according to STS’s Lien Navigator, if the amount stated on the preliminary notice is going to be exceeded by greater than 10%, a new preliminary notice including only amounts in excess of the original stated amount should be sent to all parties. This will not prevent recovery of the full amount with one claim. In Arizona, construction creditors should re-notify within 20 days of the receivable balance exceeding 120%—or 20% more than the original—of the dollar amount documented in the original notice. Trade creditors can set up an alert within their systems to notify them when the original dollar value of the account has been surpassed and a renotice needs to be issued, said Chris Ring, of STS.

Construction creditors should also consider working closely with their sales team members to account for potential price fluctuations for materials throughout the course of a job within the purchase order, Ring advised. Prices for materials like structural steel, for example, can increase, sometimes substantially, over months or more. That price increase may ultimately wind up being pushed down to subs and suppliers if no language exists in the purchase order to account for market price, Ring said.

– Nicholas Stern, managing editor

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Prices in Oil and Gas Likely to Stay Stable, Despite Production Cuts, Geo-Political Uncertainty

Despite the extension of OPEC-led production cuts through the end of 2018, oil prices are expected to stay in the $60 to $80-per-barrel range. Prices that drift higher will lead to supply growth as countries reduce their compliance with production quotas and U.S. shale production continues its upward trend. U.S. natural gas abundance is also likely to stick around this year, even as demand rises, according to a recent credit trends report for the energy sector from Moody’s Investors Service.

"Political unrest in the Middle East, alongside assumptions of OPEC extending its agreement to cut production, helped to bolster oil prices in late 2017," said Terry Marshall, a Moody's senior vice president. "Yet even with these factors offering a boost, prices will likely remain range-bound, and possibly volatile, on a combination of increasing U.S. shale production, reduced but still significant global supplies and potential noncompliance with agreed production cuts—especially if demand growth is more tepid."

North American exploration and production (E&P) companies are going to focus on increasing returns after a period of strong capital investment in 2017, though enhanced capital discipline will reduce growth after 2018. “E&P companies will be aiming for profitable growth within existing oil acreage and cash flow, with improvement favoring companies with the greatest exposure to the best acreage and producers in the Permian Basin leading the way,” Moody’s analysts said.

Global oilfield services companies are set to continue in 2018 their recovery from low oil prices, but trade creditors should watch for vulnerable companies in the sector, Moody’s said. Firms may better utilize their equipment, and that should help with pricing, but the current oversupply will mean that supply and demand will match more closely only later in the year. “Oilfield services companies will face ongoing pressures from customers, reactivation and upgrade expenses, and higher labor costs,” analysts said.

As long as they don’t take on more debt, midstream firms should see enhanced credit quality from eliminating incentive distribution rights, retention of more cash and a more simplified corporate structure, Moody’s said.

Expect more mergers and acquisitions in 2018, especially between larger companies across the oil and gas sector, analysts predicted. Also, independent E&P firms will be especially attractive to larger independents and integrated oil companies.

Stormy Outlook for Coal

The coal sector saw a relatively stable year in 2017 after years of downturn, but troubled times may return for coal in 2018, according to a recent article by Taylor Kuykendall of S&P Global Market Intelligence. Risk factors for the sector include ongoing coal plant retirements that squeeze domestic demand, increasing natural gas capacity luring away customers and broader capital constraints. The industry used nearly six times the leverage loan volume in the first quarter of 2017 compared to all of 2016, but new capital availability is still lacking, S&P reported. The vast majority of equity holders in coal companies are still underwater on their positions.

Also, large producers have stated they plan to return cash to their investors, which can be problematic for future investments in a capital-intensive industry, Kuykendall said.

– Nicholas Stern, managing editor

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Eurozone Growth Starts Off Strong in 2018

A promising year lies ahead for eurozone factory growth in 2018 as its Purchasing Managers’ Index (PMI) is expected to maintain last year’s healthy performance, according to IHS Markit.

The eurozone’s two largest economies in Germany and France exceeded expectations. At the end of 2017, the 19-country bloc saw an increase in gross domestic product (GDP), which IHS Markit predicts will continue growing this year.

Reuters reported the manufacturing PMI for the eurozone reached a 20-year high in December at 60.6. This year, IHS Markit forecasts that growth is expected to continue in the eurozone; attributing growth to decreases in unemployment, the euro’s rise above $1.20 and its contributions toward exports, and beneficial policies.

NACM Economist Chris Kuehl, Ph.D., described the PMI numbers as “shockingly good” and its best reading since the start of the euro regime. Kuehl said the soaring numbers are thanks to resurgence in France and Germany’s ongoing expansion.

“This is a record level and caps the growth that had been seen in the latter part of 2017,” Kuehl said. “If this is indeed a harbinger of things to come, the 2018 numbers are going to be very promising —good news that will spread beyond the borders of the eurozone.”

Although threats to the eurozone include nonperforming loans in Italy and Spain, Kuehl said the eurozone’s progress “outweighs” those concerns.

While growth slowed in Italy, Britain’s negotiation to potentially withdraw from the European Union increases the likelihood of impact on the eurozone. Data from Reuters indicates an abrupt halt in growth in Britain, following increases since 2014.

U.K. Economist Samuel Tombs, of Pantheon Macroeconomics, said it will be “hard to sustain” growth in Britain moving into 2018 as the U.K. PMI reached a performance low last recorded in June 2008.

“British manufacturers … are failing to make the most of the rebound in global trade,” Tombs said.

In the U.S., IHS Markit predicts a slower but steady upswing this year.

The U.S. Institute for Supply Management released data on Jan. 3 that showed an increase in the U.S. manufacturing index from 58.2 to 59.7 from November to December of last year. IHS Markit reports booming economies and increasing employment are expected to boost consumer spending, capital expenditures and housing in the U.S.

“We expect continuing expansion in the U.S. and emerging markets to offset plateauing in the eurozone and Japan,” said IHS Markit Chief Economist Nariman Behravesh. “While economic risks remain, most are low-level threats to the overall picture for 2018.”

IHS Markit also predicts interest rates in the U.S. to rise at least three times this year. The recent passing of the tax cut bill along with economic growth and unemployment could very well lead to additional rate increases.

– Andrew Michaels, editorial associate

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