July 3, 2014
This monthâ€™s Credit Managersâ€™ Index (CMI) reading from the National Association of Credit Management (NACM) was 56.1â€”barely higher than it was in April, but falling well below Mayâ€™s 56.8. The readings had been closing in on 60 (57.1 in November and 57.3 in January) and are still firmly in positive territory, but are just not trending in the preferred direction. The services sector took the brunt of the impact, and the manufacturing sector did not budge for the second month in a row.
After the readings last month, it was thought that the CMI would show continued progress, but the manufacturing sector was flat and the service sector experienced a very sharp declineâ€”enough to drag the index down. â€śThe drop was unexpected, which has suddenly become a common refrain as some other data releases are starting to show similar trends,â€ť said NACM Economist Chris Kuehl, PhD. The economy is clearly not out of the woods just yet, and the latest revision of first quarter GDP came as a shock. â€śIt now appears that the economy contracted by far more than originally reported,â€ť Kuehl said. â€śAdd to this the latest data on durable goods and there is something amiss. Consumer confidence numbers have recovered to levels not seen since the start of the recession, but that renewed level of enthusiasm has not been enough to pull the economy forward, or so it would seem.â€ť
The damage was greater in the unfavorable categories, although the favorable factors saw some decline as well. The combined index of favorable factors deteriorated slightly from 62.7 to 62.4, but that is still firmly in the 60 range. The biggest drop was in sales, which went from a several-yearsâ€™ high of 65.6 to 63.9. That is still a reading higher than at any point since November, but after the surge last month, it was hoped the trend would accelerate. Dollar collections dropped out of the 60s, from 61.2 to 59.3, and amount of credit extended also slipped, from 65 to 64.8, but stayed very close to the record highs of late. New credit applications improved and that could be good or bad news. It is now over 60 for the first time since the recession, sitting at 61.5 after 58.9 last month. â€śThe problem is that there were more rejections of credit applications as well,â€ť Kuehl said. â€śWhen there are more applicants and more rejections, it is a signal that more companies in financial distress are seeking credit in the hopes that somebody will help them survive.â€ť
The real shifts seem to be taking place in the unfavorable factors, suggesting a certain amount of economic and financial distress. The unfavorable factor index slipped by almost a full point, from 52.8 to 52, but the bigger news was the change in some of the individual factors. Rejections of credit applications shifted from 52.7 to 52, suggesting the existence of more desperate applicants. Accounts placed for collection also shifted a little, from 53.8 to 52.5â€”a sign that more creditors are falling too far behind to ignore, sparking more collection activity. Disputes slipped under 50 again to 49.5 after being at 50.2 in May. â€śThis is an area of worry for a few months now and is another signal of some financial distress as companies try to change the terms of their arrangements using whatever leverage they can,â€ť Kuehl said. There was also a major dip in dollar amount beyond terms as it slipped below 50 for the first time since December. It is now at 49.6 after being at 51.5 last month. Dollar amount of customer deductions also dipped under 50 for the first time in over two years to 49.4, a full point down from May. Filings for bankruptcies actually improved and is as robust as it has been in some time. The reading this month is 58.9 compared to 58.4 last month. â€śIt will be interesting to see if this reading gets worse in future months as these other categories are now trending badly,â€ť Kuehl said.
For a full breakdown of the manufacturing and service sector data and graphics, view the complete June 2014 report at http://web.nacm.org/CMI/PDF/CMIcurrent.pdf. CMI archives may also be viewed on NACMâ€™s website at http://web.nacm.org/cmi/cmi.asp.
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The Bank for International Settlements (BIS) recently released its 84th Annual Report, complete with research on the so-called financial cycle that doubled as a warning on China and other emerging market economies' (EMEs') continued growth.
BIS notes that there is no consensus definition of the financial cycle, but that the broad concept "encapsulates joint fluctuations in a wide set of financial variables including both quantities and prices." Their research suggests that credit aggregates and property prices, which serve as proxies for leverage and available collateral, respectively, are particularly important in determining where in the financial cycle a particular market might currently be. "Rapid increases in credit, particularly mortgage credit, drive up property prices, which in turn increase collateral values and thus the amount of credit the private sector can obtain," the report noted. "It is this mutually reinforcing interaction between financing constraints and perceptions of value and risks that has historically caused the most serious macroeconomic dislocations."
BIS' research indicates that private sector debt as a percentage of GDP and measures of national property price gains are the surest way to track the financial cycle. By these metrics, alarms should be sounding in China. "The historical record shows that credit-to-GDP gaps (the difference between the credit-to-GDP ratio and its long-term trend) above 10 percentage points have usually been followed by serious banking strains within three years," the report said. China's credit-to-GDP gap currently sits at 23.6 points above its long-run norm, higher than any country the BIS measured, making the nation's economy extremely susceptible to certain shifts in monetary policy and economic activity.
Another indicator where China is in critical condition is its debt service ratio (DSR), which measures the share of income used to service debt. China's DSR is currently running 9.4 percentage points higher than its long-run average, also the highest of any country analyzed by the BIS research. If interest rates were to increase by 250 basis points, which BIS noted is typical of a tightening episode, the figure jumps to 12.2. "Taken at face value, [the DSRs] suggest that borrowers in China are currently especially vulnerable," the report said.
China's strong private sector credit growth, which created its ballooning credit-to-GDP ratio, has been primarily driven by non-banks, BIS noted, meaning many investors and trade creditors could be vulnerable to the risks that lie ahead as too-high private sector indebtedness becomes too expensive as well.
Read the full report here.
- Jacob Barron, CICP, NACM staff writer
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Argentina continues to be a headline stealer of late, and not just because of the deep run of its soccer team at the 2014 World Cup. The South American nation is spiraling downward from a credit-ratings perspective with little hope of recovery.
Argentina missed a bond payment deadline, related to a previous restructuring of sovereign debt, on June 30 of over $500 million (USD). The country recently tried to renegotiate with creditors, including US hedge fund management groups, but to no avail. It also suffered a legal setback when a US judge ruled that some payments to other bondholders were, in fact, illegal. With the likelihood of an amicable resolution fading, Standard & Poorâ€™s placed Argentinaâ€™s already low long- and short-term foreign currency sovereign credit ratings into negative watch territory. S&P characterized the chances of Argentina fixing its payment issues within a designated grace period as a 50-50 proposition, at best. The nationâ€™s foreign currency credit ratings will almost certainly be downgraded significantly if delinquent interest on the bonds in question is not paid, S&P said, and Argentina will be placed in â€śselective default.â€ť
Kevin Hebner, â€Žsenior FX Strategist at JPMorgan, said, while serving as an instructor at the inaugural year of NACM's Graduate School of Credit and Financial Management International (GSCFMI), that Argentina has become a red hot topic in international business and finance recently, more so even than volatile matters in the Middle East and Eastern Europe. â€śThe number one question we are asked is how to get money out of Argentina,â€ť Hebner said. â€śThereâ€™s no reason to believe things will get better.â€ť
Meanwhile, in Puerto Rico, there isnâ€™t nearly the same level of concern. However, a recent change in insolvency law involving public corporations and government has landed it on ratings agenciesâ€™ radars, but for all the wrong reasons. The new law will allow public corporations to defer or reduce payments on debts with greater ease. Moodyâ€™s, which downgraded several categories of Puerto Rican debt July 1, sees this as a significant issue:
â€śPuerto Ricoâ€™s new law marks the end of the commonwealthâ€™s long history of taking actions needed to support its debt. It signals a depleted capacity for revenue increases and austerity measures and a new preference for shifting financial pressures to creditors, which, in our view, has implications for all of Puerto Ricoâ€™s debt.â€ť
- Brian Shappell, CBA, CICP, NACM staff writer
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Missouri will have a new retainage statute starting in August, signed into law by Governor Jay Nixon last month as SCS SB 529. Under current law, contractors in Missouri must pay subcontractors and suppliers when they receive payment on a public project, less any retention, not exceeding 10% of the value. SB 529 lowers that retention threshold to 5%. It also provides that a public owner may retain up to 10% if the contractor is not required to obtain a surety bond on the project, which is to say if the value of the project is $50,000 or less. The new statute also provides that if a public owner determines that certain aspects of a public project are not substantially or satisfactorily completed, the owner must provide a written explanation within 14 calendar days to the contractor, which must then inform any subcontractor or supplier that might be held responsible. Failing to provide this notice means the public body must pay at least 98% of the retainage within 30 calendar days.
Elsewhere, in Colorado, upon the June 6 signature by Governor John Hickenlooper, HB 14-1387 entered into force, instituting a number of different construction law reforms particularly focused on updating the state's laws on purchasing and maintaining public real property. The bill cleans up some inconsistencies in the existing statute and establishes procedures for a number of different bookkeeping, budgeting and certifying purposes, but additionally also raises the threshold at which prime contractors on public construction projects must provide payment and performance bonds from $100,000 to $150,000.
Finally in Ohio, new amendments to the state's public-private partnership (P3) authority approved by Governor John Kasich last month have left subcontractor and materials supplier advocates disappointed. The changes, which enter into effect on September 14, require that prime contractors provide both performance and payment bonds on P3 projects, but also allow the state's P3 director to specify the amount of the bonds, meaning that entities further down the ladder of supply might not be covered, depending on the specified size of the bond. The amendments also stipulate that building and construction materials used in P3s are exempt from Ohio's sales and use tax.
Learn more about how your company can stay up to date with changes in construction law at NACM's Secured Transaction Services.
- Jacob Barron, CICP, NACM staff writer
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The most recent Mortgage Bankers Association's (MBA's) Quarterly Databook was the latest in a long line of studies to blame poor growth conditions on the â€śpolar vortexâ€ť weather situation from early in 2014. Still, MBA seemed to indicate there were plenty of reasons to remain optimistic, at least on the commercial side of things.
MBA noted that commercial and multifamily Q1 2014 construction originations have maintained the pace found in the first quarter of 2013, while anticipating a boost later this year. In addition, office vacancy rates continue to fall nationally, albeit slowly. Loans involving commercial construction continued dramatic improvement, with loan delinquencies at a very low level. MBA was also positive on the likelihood of better economic growth in late 2014, far surpassing the first quarter.
This weekâ€™s release comes on the heels of somewhat divided news about residential real estate activity. The S&P/Case-Shiller Home Price Indices (10-City and 20-City Composites) each showed annual gains above 10%. While seemingly good news that growth is still in play in the long-battered segment, it remains well off the pace of price growth from the last year. On a monthly basis, there were also significantly lower returns in previously rebounding markets like Los Angeles, Las Vegas, Phoenix and Miami. On the flip side, Boston and San Francisco have each been showing some impressive, newfound strength of late.
Analysts with S&P Dow Jones, authors of the monthly study, said there is reason to believe further gains are on the way. They listed factors such as expected economic improvement, especially within labor markets, and expectations that the Federal Reserve will continue to keep rates low through mid-2015 among reasons to believe in a continued housing bounce-back during the second half of the year. That is, at least until the Fed eventually does the inevitable, and raises interest rates. That very well could be a game changer, whenever the decision comes.
- Brian Shappell, CBA, CICP, NACM staff writer
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Corporate Director of Credit at MRC Global in Charleston, WV
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