Canadian Firms Facing More Default Risk Heading into 2017

For the first time in six years, the default risk associated with Canadian companies in December as tracked by Kamakura Corp.’s monthly Troubled Company Index amounted to 30% of the 10 riskiest companies.

Canadian firms previously tracked through Kamakura's index, which analyzes default probability exceeding 1% among 38,000 public firms in 68 countries, remained relatively unscathed, with only 8% at that risk level, said Martin Zorn, president and COO for Kamakura Corp. Despite companies in the energy sector showing recent improvement and easing default pressures, more Canadian companies than usual are at risk. “Something tells me the malaise is deeper than just natural resources,” Zorn said.

The overall December 2016 Troubled Company Index increased 0.44% to 9.65%, indicating that corporate default probability rose from the previous month. The index’s data do suggest, however, a marked decline in volatility—especially in the energy sector—compared to prior months. And the index declined 1.08% for the calendar year, demonstrating an overall improvement in credit quality.

Among the 10 riskiest firms in December, five were from the United States and two from the United Kingdom. Houston, TX’s Vanguard Natural Resources again remained the riskiest firm, with a one-year Kamakura Default Probability of 37.20%.

Other trends in 2016 point to rising regional bank stock prices well above their 2007 highs, the first positive year for the Brazilian stock market in the last six years and bets against short-term volatility working well in 2016, Zorn said.

– Nicholas Stern, editorial associate


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Improved Picture for North American Metals and Mining

The prospects for increased commodities prices and construction workers’ wages are as high as they’ve been in years at the onset of 2017. That’s not a problem for credit managers … as long as they’re working in advance to update credit profiles and review terms accordingly.

A better outlook for Chinese demand, supply rationalization, cost-cutting steps and balance sheet repair has served to improve asset and equity valuations in the North American metals and mining sector in 2016, according to a recent Fitch Ratings report.

More free cash flow generation in the sector has relieved the pressure to sell off assets, raise equity or cut dividends, the report noted. Fitch analysts Monica Bonar, senior director of corporate, and Gregory Fodell, associate director of corporate, said reflation pressures should moderate in the near term and supply discipline should hold for most mined commodities. “Furthermore, domestic steel is benefiting from trade curbs and infrastructure spending prospects.”

“At the end of the day, we’re pretty optimistic things will improve from last year,” said Kenny Wine, CCE, director of credit-South/East, for metals processor and distributor Joseph T Ryerson & Son, Inc. of Little Rock, AR. Credit professionals in this industry often see a run-up in purchases from customers prior to price increases in metals like carbon or stainless steel. Typically, if credit managers in Wine’s company know commodity prices will rise in a coming year, they also know they’re going to have issues with customers and balances. The credit department then works proactively to update credit profiles, particularly for customers already at their credit limits, and attempts to requalify them at a higher amount that the raise will engender.

Distinguishing between customers who are seeking to build up inventory ahead of a price increase and those approaching bankruptcy is a key task for any credit team in this sector, Wine said.

For suppliers and other construction contractors, construction input prices were up for the year by 0.5% as of November 2016, while only three key inputs—plumbing fixtures and fittings, nonferrous wire and cable, and tar roofing and siding products—have fallen, according to Associated Builders and Contractors (ABC). “With wage pressures building, contractors will need to be extremely careful in bidding on projects, particularly large ones,” said ABC Chief Economist Anirban Basu. “Construction cost increases are likely to prove more profound than what has been experienced in recent years, and contractors should consider that while negotiating their contractual commitments.”


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Be Aware of Not Only Opportunity but Risk with Event-Based Customers

The latest bankruptcy court developments this week in the case of a professional auto race that never happened should serve as (another) wake-up call to material suppliers and service providers operating in accordance with a special event. The rush to chase opportunity for new revenue streams can often leave suppliers and providers open to significant risk.

U.S. Bankruptcy Court Judge Joan Feeney ordered a freeze on the assets of Boston Grand Prix organizer John Casey amid allegations of reckless personal use of funds. The IndyCar series race through a makeshift course along the streets of Boston was supposed to take place in 2016, but was cancelled a few months in advance and moved to a permanent racing site in New York state. This was, however, not before many spectators had purchased tickets, suppliers had sold items to customers on terms and service providers performed work. The $11 million bankruptcy case appears far from a conclusion, to the chagrin of these stakeholders.

Perhaps the risk involved should have been predictable within the credit industry given that the City of Baltimore ran an event with the same concept from 2011 to 2013. None of the outings were profitable, and extensive payment delays were reported by local contractors, subcontractors and suppliers.

“Whenever we get involved in work like this or stadium projects, operationally, we slow down a lot, and rightfully so,” said Chris Ring of NACM’s Secured Transaction Services (STS). “These can be a mess.” Concerns may include the level of vetting for posted bonds, payment and bond laws of an area in question, whether the main players are public or private entities (or both) and how that can unearth vagaries in legal statutes, and so on.

“Because these types of projects are extremely convoluted, you have to put in due diligence in determining who the players involved are and their character [including how they have paid other people on past projects],” Ring said. “At the end of the day, it’s an underwriting practice. With these types of large projects you absolutely have to determine exactly what you’re getting into.”


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Indices Show Increasing Health for Factory, Service Sectors

The U.S. economy has a “clean slate” going into 2017, according to Wells Fargo’s latest weekly economic report.

An upward swing for the factory sector was the clear signal in the manufacturing index from the Institute for Supply Management (ISM), Wells Fargo noted. Activity in the services sector was also strong, with the ISM’s nonmanufacturing index holding solid for the past two months after wavering during the run-up to the U.S. presidential election.

Falling commodities prices, weak demand globally and the strong dollar impacting exports were prevailing conditions for manufacturers a year ago, but improvement came in the second half of 2016. Strength in new orders lent an encouraging sign for production in coming months. The new orders index was strong for service firms, contributing to optimistic business conditions for the start of the new year.

“The latest data from the ISM Service Sector PMI [Purchasing Managers’ Index] is solid, which is very good news for an economy that remains dependent on services,” said NACM Economist Chris Kuehl, Ph.D. “The bottom line is that this sector continues to be healthy.”

The ISM indices show increasing input price pressures. Orders of capital goods were up, an encouraging sign for capital expenditures in the near future, Wells Fargo reported. Capital goods shipments were flat in November after a decline in October, while new orders of durable goods ex-transportation were up in November.

The manufacturing sector increased employment in December, adding 17,000 new jobs, mostly from durable goods producers. The outlook on hiring, however, may not be so rosy.

“Right now, it appears that many of the largest manufacturers are preparing more layoffs than hiring binges,” Kuehl said. “The prime motivation is that finding people has been hard and they are turning towards robots and technology instead. There has been less desire to move operations offshore, but the rise of the machine is at hand and will continue to impact hiring.”


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Credit Outlook Stable for Asia Pacific, Negative for Sub-Saharan Africa

Varying credit factors have led to an overall stable outlook for the creditworthiness of sovereigns in the Asia Pacific region, according to new reports from Moody’s Investors Service. Those in Sub-Saharan Africa, meanwhile, continue to face challenges from political risk and subdued economic growth.

In the Asia Pacific, lackluster growth in global trade and capital outflows could affect the credit profiles of countries more dependent on external demand or financing. Ongoing reform efforts and changing political risks will determine credit outcomes in the new year, Moody’s predicted.

Still, GDP growth in the region is strong. Of the 24 sovereigns that Moody’s rates in Asia Pacific, 18 were stable, four were negative and two were positive, through Jan. 10. However, negative ratings actions outnumbered positive 10 to one. Causes were mixed, with 38% of the rated countries showing a decline in their fiscal strength and 42% an increase in event risk.

Capital inflows to emerging markets could taper abruptly as a result of increased U.S. interest rates and downside risks to global growth, Moody’s warned. Besides pressures from external trade and financing, sovereign credit trends will depend upon policy efforts of the governments themselves.

Political risk, subdued economic growth and the liquidity stress facing countries dependent on commodities contribute to Moody’s overall negative outlook for the creditworthiness of sovereigns in Sub-Saharan Africa.

“Sub-Saharan Africa’s economies will continue to face commodity-induced liquidity stress in 2017, with recurring fiscal deficits amid challenging financing conditions,” said Lucie Villa, a Moody’s vice president and senior analyst. “These will remain important credit constraints and underpin our negative outlook for Sub-Saharan Africa sovereigns overall.”

Moody’s downgraded a third of the region’s 19 rated countries in 2016 by an average of two notches. Five of the seven downgrades carry negative outlooks. The ratings agency said conditions that inspired those downgrades likely will persist throughout this year.

Fiscal consolidation plans are to be implemented in a majority of the 19 rated countries, which will have a positive effect in 2017; however, Moody’s expects these plans could be undermined by subdued growth, social demands, and potential shocks from weather or geopolitics.



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