CMI Dips, Even with U.S. Economy in Expansion Territory

Credit managers’ optimistic view of the economy in October turned out to be short-lived, according to the latest NACM’s Credit Managers’ Index (CMI). Talk of improving business conditions failed to materialize in the November CMI data in nearly all areas except sales, which typically benefits from the start of the holiday season.

The November CMI maintains its place within expansion territory at 52.9, but is more than a half-point off the impressive September and October totals. Among significant concerns are that rejections of credit applications surged since last month, and dollar amount beyond terms and bankruptcy filing activity deteriorated in the service sector, noted NACM Economist Chris Kuehl, Ph.D. Those two service subcategories saw their second-worst and worst declines of 2016. There is, however, reason to believe some of the negative movement will at least stabilize heading into 2017.

“Credit requests tend to flag a little at this time of year as retailers have already done most of their ordering,” Kuehl said.

Kuehl also believes credit managers should temper their cheer regarding November’s sales levels, which were the best of 2016 and showed the biggest one-month surge of the year. “The holidays can skew data,” he warned. “Consumers have been active, but focused exclusively on discounted items—lots of traffic, but low profits as these goods don’t carry the highest of margins.”

– Brian Shappell, CBF, CICP, managing editor


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Credit Managers Should Scan for Risk from Indemnity Clauses

Suppliers and other players in construction are increasingly encountering indemnity provisions within contracts. It has become more important than ever for credit managers to carefully examine such documents to limit any potential associated risk to their companies.

“The key for a credit manager is to recognize them and understand how to react,” said Sam Smith, regional finance manager-East, at Crescent Electric Supply Company in East Dubuque, IL.

Indemnity provisions are agreements in which one party agrees to protect and “hold harmless” another party from liability that arises from personal injury or property damage on the job, according to Don Gregory, the American Subcontractors Association’s (ASA) general counsel and partner with Columbus, OH-based firm Kegler, Brown, Hill & Ritter. These provisions can shift the risk of liability from a negligent party to an innocent one, and have been criticized as being unfair, he said.

Clauses that contain indemnity provisions can be difficult to spot, Smith said. For example, instead of including the term “indemnification clause,” the terms “hold harmless,” “indemnify” or “defend” may appear in a contract. Also, a clause can be buried in other contracts with which one’s company is linked. If there is language present that is similar to “This purchase order incorporates by reference all terms of subcontractor’s contract with the general contractor” or “All warranties in the general conditions are incorporated herein,” proceed with caution and request a copy of the contract for review. “Not only can you be tied to indemnification clauses, but also to terms such as liquidated damages, uncapped liability or even extended warranties,” he said.

An early defense for a credit manager is to redline any contract language as it may not even apply to one’s company, Smith said. Note that some states have anti-indemnification statutes, which provide that an indemnity provision in a construction contract that purports to indemnify and hold harmless a party from its own negligence is void as it’s against public policy and unenforceable, Gregory said. Regardless, try to limit the value of the indemnification to the value of your contract, Smith advised.

Another option is to ask vendors to agree to the indemnification clause, shifting the risk, often appropriately, to them, he said. It’s appropriate for a vendor to agree to the clause if, for instance, the indemnification clause revolves around guaranteed delivery dates.

It is important to remember that the value of the contract should not dictate the level of importance placed on reviewing its language, Smith said. If you agree to a $500 contract that contains an uncapped indemnification clause, for example, your organization might be subject to a $10,000 or higher claim.


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Exports from India Likely to Be Impaired by Government’s Demonetization

India’s Nov. 8 decision to withdraw large-denomination bank notes from circulation is affecting virtually all sectors of that country’s economy to one degree or another. The policy, which seeks to curb the use of untaxed or illegally obtained money, is resulting in disruption throughout the economy, according to a new report from Moody’s Investors Service.

“The sheer number of people impacted is huge,” said Past NACM Chairman Val Venable, CCE, director of credit for Ascend Performance Materials. “The government didn’t print enough new notes fast enough,” she added, referring to the requirement for people to exchange old notes for new.

In the near term, the effects on credit are low, but the long-range impact will be that Indian companies will have limited means to pay their employees, which will affect exports, Venable said. This will likely include textiles and low- to medium-end manufacturing. For those selling into the country, Venable is not seeing much impact, other than customers asking for extended terms. Inside the country, it will “cause more turmoil” than outside, she said, but if it continues, “it will definitely have an impact on exports.” Local suppliers transact a lot of business in cash. Low-wage workers are paid in cash, so factories, for example, will be detrimentally affected by the policy.

“Big businesses see it as a positive investment,” said Rohit Choudhary, vice president and director, India, at WorldBusiness Capital, Inc. “We see a positive outlook.” He added that businesses are keen on the policy taking place, as it will streamline a lot of processes, make payments easier and ensure transactions are coordinated.

The withdrawal of 500(INR) and 1,000(INR) notes, which represents about 86% of all notes in circulation, is expected to result in weaker consumption and GDP growth temporarily. Households and businesses will experience liquidity shortages, but increased formalization of economic and financial activity should broaden the tax base and expand usage of the financial system.

“Although the measures in the near term will pressure GDP growth and thereby government revenues, in the longer term they should boost tax revenues and translate into higher government capital expenditure and/or faster fiscal consolidation,” said Marie Diron, an associate managing director in Moody’s Sovereign Group.

Positive effects may not last, however, Fitch Ratings believes. The informal sector accounts for more than 20% of GDP in India and 80% of employment. Demonetization will move economic activity from the informal to the formal sector as more earnings are declared. But uncertainties are strong. Without new incentives to avoid cash transactions, the informal sector may go back to the way things were.



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Business Insolvencies Set to Increase for the Year

Despite steady though uneven economic growth predicted for the United States, an increase in bankruptcies is expected for 2016 after a decline in corporate insolvencies since 2010.

Business bankruptcies are expected to increase by about 3% this year, with insolvencies also affecting Canada and Mexico, according to credit insurer Atradius’ recent NAFTA Country Report. It bucks some projections by predicting a 1% decline in filings next year. The number of cases filed in federal courts declined by 8.3% year-on-year in 2015, by comparison.

“A good portion of the 2016 increase comes from the energy sector,” said Bruce Nathan, Esq., of Lowenstein Sandler LLP, though he believes such insolvencies are winding down due to oil price increases. Bankruptcies have been wide-ranging across the sector, including gas, pipeline and coal industries. The latter will likely continue to have issues because of damage the industry suffered from lower natural gas prices and years of stiff federal regulations and enforcement.

Retail is another problem, Nathan added. A large number of troubled U.S. retailers are at risk of filing for bankruptcy. “You’ll continue to see big retail bankruptcies going into next year,” he said. The health care industry also is an area of concern. More Chapter 11 filings are expected in the health sector if the Affordable Care Act is repealed, Nathan said.

A Federal Reserve interest rate increase could also threaten business solvency because long-distressed companies, which have been able to get by in a low interest rate environment, may be too marginal and unable survive when their debt needs to be refinanced at a higher cost.

Nathan disagrees with the Atradius prediction of a slight decrease in bankruptcies, though he acknowledges that the energy sector should stabilize. Atradius based some of its prediction on a real fixed investment recovery in 2017, with state and local governments predicted to turn around a long period of austerity.

In Canada, corporate insolvencies are also expected to increase. The country enjoyed double-digit decreases year-on-year from 2010 to 2012, with the rate of insolvency decline slowing down during the following three years. Low commodity prices and a difficult economic environment may cause an increase in business insolvencies, to a predicted 4% in 2016. Canada, as the fifth-largest producer of oil in the world, has endured a major decrease in investment due to lower oil prices.

In Mexico, an increase in currency volatility has already negatively affected the economy. Depreciation in the peso affects companies indebted in U.S. dollars or those dependent on imported goods. Cash flow is hampered if the higher producer prices cannot be passed on to customers. Some businesses have already started to delay payments. Rising interest rates could result in breach of covenants and default, according to Atradius.


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Economic Sector Risks Grow in Fourth Quarter into 2017

Eight of 12 economic sectors tracked by trade insurer Coface across the globe have been downgraded for the final quarter of 2016, and the negative trend is likely to continue into 2017 with weak global growth.

By region, North America saw the most sector downgrades in the fourth quarter, as increasing risks in the retail, textile/clothing, paper/wood and transport sectors surfaced, Coface analysts said. Western Europe’s agro/food and Central Europe’s construction and IT and communications sectors were also downgraded, as was the IT and communications sector in the Middle East. Central Europe’s transport sector was upgraded, however.

Coface didn’t issue any downgrades for sectors in Latin America or Asia—regions that have suffered from economic shocks over the past two years.

“The number of risky elections scheduled over the next 12 months in Europe could cause companies to delay their investment decisions,” potentially undermining a tepid recovery since 2014, the credit insurer said.

Insolvencies in Europe should decline for the most part, Coface said, with the notable exception of the U.K., where insolvencies could grow in 2017 by 8%, especially for “less well-structured” firms in the construction, metals, energy and textile/clothing sectors.

In North America, companies are experiencing an increase in insolvencies associated with lower-than-potential growth for the second year in a row, Coface noted. “Sectors linked to consumer spending (textile, clothing and retail in particular) are apparently experiencing increased risk. In the meantime, the continuation of low energy prices is likely to affect regions where the cost of nonconventional oil extraction and production remains high.”

A modest bump in nonrenewable commodity prices in 2017 probably won’t be enough to turn the tide for poorly diversified, commodity-dependent economies in the Middle East, sub-Saharan Africa and Latin America, Coface predicted. In the U.S., crude oil prices in the mid-50s could keep oil and coal players in the black, but an increase in well count could dampen rising prices and contribute to "limiting the adjustments in stocks seen in 2016.”

The IT sector has high growth potential, but rapid life cycles of IT companies create a high level of credit risk, Coface said. Telecom services, the primary contributor to the sector, are expecting to see zero growth in 2016, while analysts think “mobile peripherals” like phones, tablets and computers reached peak revenues at about $645 billion in 2015. Coface expects new smartphone shipments will decline in the first half of 2017 as large markets have been saturated with the devices.

The textiles/clothing sector is among the riskiest around the world as consumers purchase more products online and domestic demand softens in the U.S. and elsewhere.



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