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The Looming Corporate Debt Bubble

The Looming Corporate Debt Bubble

As we exit the COVID-19 pandemic, the economy appears to be aggressively recovering, fueled by pent-up consumer demand, low interest rates and cash from government stimulus programs. First quarter GDP grew at 6.4%. The Biden Administration just announced a $6 trillion budget, and currently negotiating with Congress for an infrastructure bill which will add another $1 – $2 trillion into the economy over the next several years. While largely positive, this combination has raised concerns about inflation as the prices of commodities, residential real estate, and basic food staples, transportation and travel are increasing. The Consumer Price Index rose 4.2% in April, the largest increase in twelve years.

Due to historically low interest rates, investors seeking higher yields are pouring cash into equities, real estate and alternative investments, such as cryptocurrencies, raising asset bubble concerns. The S&P 500 trailing twelve months (TTM) PE ratio is 31.36 vs. the thirty year average – 23.32. The median existing home price in April was $314,600, 19% year over year increase. Even with recent correction the crypto-currency market is now roughly $1.5 trillion, up nearly 600% from a year ago.

Less widely discussed however is the increased debt levels that corporations have taken on over the last ten years.

According to the Federal Reserve and Securities Industry and Financial Markets Association, large U.S. companies now face the highest levels of debt on record – more than $10.5 trillion. This figure doesn’t include small and middle market company debt estimated to be an additional $5 trillion.

Nonfinancial Corporate Business; Debt Securities

Source:  Federal Reserve Economic Data| FRED| Federal Reserve Bank of St. Louis 

While the coronavirus pandemic contributed to increased borrowing levels (nonfinancial corporate debt outstanding has grown by $1 trillion in two years), because of historically low interest rates, companies have been increasingly accessing cash through the debt markets since 2008 economic crisis.

 

Ten-year treasury yield:

10 Year Treasury Bond Yield

Source: Federal Reserve of the United States

Low interest rates have encouraged companies to borrow, but instead of funding business investment, in many cases the money was used for share buybacks to bolster share prices. According to JPMorgan Chase (Harvard Business Review, Why Stock Buybacks Are Dangerous for the Economy, Jan 2020) roughly 30% of stock buybacks in 2016 & 2017 were funded by corporate bonds. The International Monetary Funds’s Global Financial Stability Report, issued in October 2019 highlights “debt-funded payouts” as a form of financial risk-taking by U.S companies that “can considerably weaken a firm’s credit quality”. The authors conclude that “when companies do these buybacks, they deprive themselves of the liquidity that might help them cope when sales and profits decline in an economic downturn.”

This has left many companies with less flexibility to weather interest rate increases, or an economic contraction.

Non-financial corporate debt now stands at 40% of GDP:

Corporate Debt as % of GDPSource: Informa Financial Intelligence

 

Non-Financial Companies with Long-Term debt:

Nonfinancial Companies' Long-Term Debt

Source: “HowMuch.net, a financial literacy website”

The economic growth forecast for the second quarter and remainder of 2021 are positive. For federal budgeting purposes, the Congressional Budget Office forecasts 2021 real GDP growth rate at 5.6%. The highest since 1984 when the GDP annual growth was 7.24%.

Given the increased liquidity and consumer demand, the Federal Reserve will have the difficult task of managing interest rates to reign in inflationary pressures. Higher interest rates could have the dual impact of increased debt service levels and slowing the economy, both of which would negatively impact a highly leverage business.

As the saying goes “Everything thing is fine, until it’s not”. Companies will have to continue to diligently monitor credit even as the economy improves. Trade credit insurance and “Put” option contracts are two tools to assist financial executives evaluate credit risk and protect their balance sheet.

Credit Insurance

Trade credit insurance can be an integral part of a comprehensive credit evaluation and risk management strategy. Credit insurance protects the seller from buyer nonpayment due to insolvency or slow-pay. Credit insurers maintain extensive credit databases and actively capture, update and monitor debtor credit information. They often provide early notification if a debtor’s credit quality deteriorates, or financial performance declines. This information helps credit management professionals determine if, or how much, credit can safely be extended to a buyer.

“Put” Option contract

If a debtor is uninsurable (debt is rated CCC+ or lower), a Put option contract might be available. Put option contracts are non-cancelable and protect the seller if the debtor files for bankruptcy during the contract term. The contract terms are generally based on debtor credit quality, tenor and amount. Put option contracts have been limited to debtors with publicly traded debt. However, with recent changes in the Put option market, they can now be written on private debtors as well if financials are available.

Since 2004, Securitas Global Risk Solutions has helped clients develop credit and political risk solutions. As independent trade credit and political risk specialists, we are focused on developing comprehensive solutions that meet the needs of our clients. Please feel free to call us with any questions, or if we can be of any assistance.

Notes:

William Lazonick, Mustafa Erdem Sakinc, and Matt Hopkins. “Why Stock Buybacks Are Dangerous for the Economy.” Harvard Business Review, Jan 7, 2020, pages 2-3

HowMuch.net. a financial literacy website

Federal Reserve Bank of St. Louis

Congressional Budget Office, Nonpartisan Analysis for the U.S. Congress

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Securitas Global Risk Solutions, LLC. Launches Securitas India

Securitas Global Risk Solutions, LLC. Launches Securitas India

New Venture to Address Growing Demand in India for Specialized Real Property Title Solutions 

July 8, 2021 – Securitas Global Risk Solutions, LLC, (“Securitas”) a specialty credit and political risk insurance brokerage based in Wayne, Pennsylvania announces the launch of Securitas Global, LLC (“Securitas India”), a new corporate initiative to offer land title solutions, cross border investment protection, and land portfolio management specifically for the Indian market. Expanding on Securitas’ long-standing record of helping clients manage their credit and political risk needs locally and internationally, Securitas India furthers the mission by providing title and political risk solutions for a range of Indian and international clients including: 

    • International and local developers 
    • Mortgage lenders in India 
    • Insurers and international re-insurers 
    • Private equity funds and foreign direct investment 
    • Development Finance Institutions (DFI) and Export Credit Agencies (ECA)

Why Securitas India?  With nearly 10 million people in India migrating to cities each year, India’s current land titling system does not support the surging growth.  This is an impediment to new investment, and lacks consistency, transparency and security. India’s backlog of land disputes has put many major infrastructure projects on hold and stifled the country’s economic potential.  A recent article in Bloomberg notes that the Indian government is working to reform the land titling system through a model bill that will guarantee the accuracy of land titles, require states to computerize land records, and establish tribunals to resolve the backlog of land disputes within three years.  Land titling reform carries the potential for an investment boom and considerable job growth.   

“India’s real estate market is set to grow by nearly $800 billion this decade. There is a clear need for the quality risk and titling services Securitas India can provide to facilitate investment and business certainty in India.”

-Shekar Narasimhan, Co-Founder 

Securitas India

As land transactions increase in the coming years, Securitas India will provide solutions to support the dynamic real estate sector via tailored insurance products, project monitoring and transaction management. Our expertise and client specific solutions will increase investor confidence and de-risk all aspects of the real estate finance and development continuum. Our team of professionals in the United States and India, brings over 100 years of experience in title surety, risk cover and real estate transaction monitoring and management.

Securitas India will be assisted in its efforts by Trimble Inc., a leading technology solutions provider of global positioning, modeling, connectivity, data analytics and land solutions.   

Securitas India and Trimble Partner

 For more information or to set up a consultation, contact Securitas at 484.595.0100 or at https://www.securitasglobal.com/contact-us/ 

About Securitas 

Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients worldwide develop credit and political risk transfer solutions that provides value on numerous levels.  As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring complete understanding of policy wording and delivering excellent responsive service. 

About Trimble 

Trimble is transforming the way the world works by delivering products and services that connect the physical and digital worlds. Core technologies in positioning, modeling, connectivity and data analytics enable customers to improve productivity, quality, safety and sustainability. From purpose-built products to enterprise lifecycle solutions, Trimble software, hardware and services are transforming industries such as agriculture, automotive, construction, geospatial and transportation. For more information about Trimble (NASDAQ: TRMB), visit:  www.trimble.com. 

About Trimble Land Administration 

Trimble’s Land Administration solutions automate and integrate land registries, cadastral mapping, and the permitting and licensing of land for surveyors, governments, and businesses worldwide. Through the integration of a broad portfolio of technologies with workflow management tools, and consulting services, Trimble provides a fully configurable, scalable solution to help drive the efficient administration of land and its associated transactions, rights, and agreements. 

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    Vodafone Arbitration Victory a Reminder to Consider Political Risk

    Vodafone Arbitration Victory a Reminder to Consider Political Risk

    In a recent, little-publicized international arbitration decision, an intergovernmental dispute resolution body ruled on September 20, 2020 that Netherlands-based Vodafone was not liable for an estimated $2.2 billion tax bill demanded by the Government of India and that India had violated the “fair and equitable” treatment provisions under a 1995 bilateral investment treaty between India and the Netherlands. The case, titled Vodafone International Holdings BV v. The Republic of India was initiated in 2014 before the Permanent Court of Arbitration (PCA), an international body based in The Hague.

    The long story of the case underscores the importance of understanding political risk for those doing business overseas.  Country-specific efforts to balance investment promotion with the need to generate tax revenue can lead to legal changes that can either unlock opportunities or increase risks for investors.  Additionally, the case shows how bilateral trade and investment treaties (BITs) create legal mechanisms that can be utilized to adjudicate disputes such as the one between Vodafone and India.

    In this instance, India’s attempts to capture revenue from international investment transactions led it to pass legislation allowing transactions to be taxed retroactively, leading to drawn-out legal disputes with Vodafone and other companies.  Beginning in 2007, Indian tax authorities had unsuccessfully sound to levy taxes on Vodafone after its roughly $11 billion purchase of the Indian mobile phone company Hutchison Essar Limited (HEL).  After legal appeals by Vodafone, India’s Supreme Court held in January 2012 that Vodafone’s acquisition of HEL was not liable for taxes under India’s Income Tax Act of 1961.

    Retrospective Legislation

    In response to the Supreme Court decision, the Indian parliament passed the Finance Act of 2012, which amended the Tax Act of 1961 and gave its government authority to retroactively tax past transactions.  With a new law in force, India again sought to levy the tax fee against Vodafone plus interest and penalties totaling roughly $3.79 billion.

    Citing the 1995 bilateral trade and investment treaty between India and the Netherlands, Vodafone invoked the treaty’s arbitration provisions in April 2014, bringing the case before the PCA.  Some six years later, under the authority granted to it by the India-Netherlands BIT,  the PCA ruled in favor of Vodafone, ordering India to stop seeking tax payments from Vodafone and pay Vodafone over $4 million in legal fees.  The Vodafone case is one of three cases before the PCA in the wake of India’s retroactive attempts to collect tax under the Finance Act of 2012.

    Arbitration Case Definition

    Arbitration – the hearing and determining of a dispute or the settling of differences between parties by a person or persons chosen or agreed to by them.

    Political Risk and Remedies

    It remains to be seen how the PCA’s decision will be enforced.  Just before the PCA ruling, India’s Supreme Court had ruled against Vodafone, upholding the India’s efforts to collect revenue under the 2012 Finance Act.  These extensive and costly proceedings highlight just some of the potential difficulties that companies face when doing business overseas in countries where shifting political priorities can put investments or agreements at risk.  Solid political risk analysis, trusted legal counsel, and political risk insurance are all tools companies need to navigate global trade and investment.

    Bilateral trade and investment treaties (called BITs), such as that between the Netherlands and India in 1995, are important legal instruments to understand and utilize.  BITs include agreed upon language to protect investments and encourage fair and transparent legal treatment of transactions and contracts.

    In addition, BITs often create procedures, such as international arbitration, for disputes that cannot be settled in domestic courts.

    U.S. Department of Commerce’s International Trade Administration (ITA) maintains a list of BITs between the U.S. and other countries.

    Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients across the United States develop credit and political risk transfer solutions that provides value on several levels.  As a specialty independent trade credit and political risk insurance broker, Securitas is focused on developing comprehensive solutions that meet the needs of their clients, ensures complete understanding of policy wording and delivers responsive excellent customer service.

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    Upcoming LVMH, Tiffany & Co. Legal Battle Shines a Light on Political Risk

    Upcoming LVMH, Tiffany & Co. Legal Battle Shines a Light on Political Risk

    LVMH Legal Case

    A dispute between luxury goods brands Moët Hennessy Louis Vuitton (LVMH) and Tiffany & Co. (Tiffany) highlights the continued political volatility of the global economy as companies and their home countries try to recover from the coronavirus downturn.  In November 2019, LVMH reached an agreement to buy US-based Tiffany in a deal said to be worth $16.6 billion.  The acquisition is set to be the biggest ever in the luxury goods market and would have added yet another iconic brand name to the LVMH conglomerate, which includes Christian Dior, Givenchy, and Dom Perignon champagne, along with dozens of brands across various sub-sectors of luxury goods.

    Yet on September 9, nine months into the deal and two months before an agreed-upon November 24, 2020 deadline to complete the sale, Paris-based LVMH announced that it was backing out of the deal, asserting that Tiffany had been mismanaged during the pandemic and its poor performance in 2020 constituted a material adverse event.  LVMH then added a political wrinkle to the story, noting that it had received a letter from French Foreign Minister Jean-Yves Le Drian requesting that it back out of the deal.  The letter is said to have referenced anticipated trade tension between France and the United States in response to French efforts to tax technology companies, including industry giants like Google and Amazon.  According to LVMH, the French minister’s letter constitutes a “valid, legally-binding order.”

    Tiffany quickly contested LVMH’s moves, filing suit against LVMH in the Chancery Court of Delaware, which has jurisdiction over the international deal, and demanding that the deal be completed at its agreed upon price of $135 per share.  The case has been fast-tracked for a January 2021 trial.  Some industry watchers note that LVMH CEO Bernard Arnault, the wealthiest man in France, is simply unwilling to pay a pre-pandemic price for a company that has seen major losses due to the pandemic and only has only recently reported improved numbers.  While the entire luxury goods sector has seen tremendous losses in 2020, larger companies like LVMH, with a more diverse range of products and capacity to shift to e-commerce, have been better able to adapt to the pandemic than have firms with greater dependence on retail outlets, tourism, or Chinese demand.

    It remains to be seen whether LVMH’s attempts to scrap the deal will hold up under legal scrutiny, particularly its attempt to claim legally binding pressure from the French government.  The brewing legal fight shows how the coronavirus pandemic has rattled economic relationships and highlights a trade environment that can be easily strained, even among long-time allies with considerable two-way trade like France and the United States.  As the global economy works its way out of the pandemic and companies consider new operating models and markets, the need for an adequate political risk assessment is evident

    Understanding Political Risk

    Political risk insurance protects cross boarder investments, trade, permanent/mobile assets and contracts against various perils such as political violence, currency inconvertibility, foreign government intervention, expropriation, confiscation, nationalization, forced abandonment. 

     The COVID-19 pandemic has accelerated a tendency toward economic nationalism and protectionism in the current trade and investment environment.  The LVMH/Tiffany case shows an example of how governments may seek to influence trade and investment deals to benefit domestic companies, or as part of a broader political strategy

     As the LVHM/Tiffany gets litigated in the Chancery Court of Delaware watch to see if the demise of the transaction meets the following definition of an insured peril on a political risk policy:

    “an act or a decision on the part of the government of the Buyer’s country, the Insured’s

    Country or any other country specifically named in the Declarations, which prevents the

    performance of the Commercial Contract.”

    Political risks can drastically impact a company’s investment in a host country.  Foreign government intervention or political violence can render a company unable to operate or withdraw their capital from a host country. Yet, as the global economy slowly recovers from the depths of the pandemic downturn, exporters will need to be aware that as new opportunities are created overseas, a proper assessment of both credit risk and political risk, and consideration of political risk insurance is prudent. 

    See Securitas’ Guide to Political Risk Insurance or contact Securitas to learn more.

    Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients across the United States develop credit and political risk transfer solutions that provides value on several levels.  As a specialty independent trade credit and political risk insurance broker, Securitas is focused on developing comprehensive solutions that meet the needs of their clients, ensures complete understanding of policy wording and delivers responsive excellent customer service.

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    Pandemic Invokes Force Majeure

    Pandemic Invokes Force Majeure

    In mid-February, during the height of the Coronavirus crisis in China, the China Council for the Promotion of...

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    Pandemic Invokes Force Majeure

    Pandemic Invokes Force Majeure

    In mid-February, during the height of the Coronavirus crisis in China, the China Council for the Promotion of International Trade (CCPIT), a state-run organization, reported that it had issued over 1,600 “force majeure” certificates, in an effort to protect Chinese companies from legal issues related to non-compliance with their contractual obligations.  These certificates at the time covered a value of about $15.7 billion. By the first week of March, the number of Chinese force majeure declarations had risen to over 4,800 companies covering contracts worth $53.8 billon.

    What is a “Force Majeure” Declaration?

    When a company declares “force majeure,” it is invoking a clause, typically noted in its contract with its clients, that states that due to circumstances beyond its control, it is unable to fulfill the terms of the contract.

    Invoking the clause is an effort to typically delay or possibly be released from contractual obligations without legal or financial liability.  According to one legal definition: “Generally, force majeure refers to the occurrence of an extraordinary event beyond the reasonable control of a party and prevents that party from performing its obligations under a contract.”

    Force majeure clauses are common, but vary from industry to industry.  On a personal level, property owners may be familiar with mortgage contract language stating various natural disasters or “Acts of God” that can relieve the owner of contractual obligations.

    The oil and gas sector and other industries that utilize long-term supply contracts often have extensive force majeure clauses that also include human interventions such as government action, terrorism, war, and strikes that can cause a break in operations beyond the control of one of the parties to a contract.

    From industry to industry, and company to company, the details and specificity of force majeure clauses vary widely, and are being tested by the economic disruption wrought by the Coronavirus pandemic.  According to one source, “if you’ve seen one force majeure clause, you’ve seen one force majeure clause.”

    According to the World Bank, there is no template or standard wording for force majeure clauses or for the events that may or may not cause a force majeure declaration.

    While no template exists, global organizations are attempting to introduce some basic standards. For example, the International Chamber of Commerce (ICC) updated its model force majeure contract language only recently (it includes terms like “plague” and “epidemic”).

    While these efforts are useful in moving international business toward common terms and language, declarations of force majeure still remain subject to often dueling legal opinions and the decisions of specific courts and arbitrators.

    A Legal Burden

    According to one analysis, China’s above-noted attempt to offer companies blanket force majeure certificates are likely to be contested legally.  One reason noted is that the standard for a force majeure declaration may be different domestically in China than it is internationally – where many trade contracts are based on English common law, in which force majeure events are extensively enumerated and specific.

    Some contracts may not contain reference to public health events such as epidemics or pandemics.  Additionally, if challenged legally, the burden is on the company making the declaration to prove that the events were unforeseen, unavoidable, and left the company in an impossible situation with no alternatives to meet its contractual obligations.  Already, some companies have taken their Chinese counterparts to task, rejecting their force majeure claims and setting up legal battles.

    Seek Legal Advice

    To avoid costly legal conflict, companies will often seek out a workable solution to avoid a force majeure declaration. The need to work out the details of myriad contractual obligations is said to be one of the main reasons that the International Olympic Committee and organizers of the 2020 Tokyo Summer Olympics took a longer time than most other sports leagues and planners of sporting events to declare a postponement due to Coronavirus.

    The input of a trained legal advisor is invaluable when seeking to understand force majeure clauses and tailor contract language that is either specific or broad enough to account for a range of potential events – including public health crisis.

    Legal counsel can also help draft language that conforms with both the details of doing business in a specific industry and existing legal precedents concerning force majeure declarations.

    Get Proper Coverage

    In the current environment, there is considerable likelihood that companies will face a force majeure declaration from either a supplier or buyer, or may even have to contemplate making a such a declaration due to unforeseen and unavoidable circumstances of Covid-19.

    In addition to sound legal advice, companies need to have insurance coverage that meets a range of contingencies including force majeure.  The team at Securitas Global Risk Solutions has the necessary experience to discuss and advise clients on force majeure and trade credit insurance.  If you would like to discuss further, please contact Peter Seneca at 484-595-0100 or email him at pseneca@securitasglobal.com.

    Disclaimer: The text above is for informational purposes only, and does not constitute legal advice.  Seek the input of a legal practitioner for more detailed information and advice on contract language and force majeure declarations.

     

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