Credit Managers Cringe
July 3, 2006,
The roundhouse combination of rising oil prices and rising interest rates is starting to rattle the nation's corporate credit managers — who track how well companies are paying their bills — and a recent canvass shows they're increasingly concerned about a slowdown in the economy.
The credit index tracks both the manufacturing and service sectors of the economy, and each fell back unexpectedly sharply: the manufacturing sector by 4.9%, and the service sector by 4.1%.
“Only twice in over four years has the combined index fallen more, and all 10 of the components in the combined index fell. The size and breadth of the decline suggests a definitive, structural change that outstrips any random month-to-month change,” said Dan North, chief economist with credit insurer Euler Hermes ACI.
“Despite strength in recent government releases, it is likely that the combination of rising oil prices and interest rates continues to quietly erode the strength of the economy in the background,” said North.
The Federal Reserve appears poised to ratchet up interest rates further, and “in the meantime, crude oil continues to hover at near record prices, which also puts a significant drag on the economy.”
Scoping out the manufacturing sector, North said nine of the 10 index components fell, but six still remain above the 50% mark, indicating expansion. But the other four — rejection of credit applications, disputes, amount beyond terms, and customer deductions — he said, “suggest cash flow problems among customers.”
Turning to the service sector, all 10 components of the index fell, but only three were beneath the 50% mark, including two in common with the manufacturing sector: amounts beyond terms and customer deductions. “Combined with the deterioration in collections, a pattern of cash-flow problems emerges in the service sector as well, but overall growth remains positive.”
Looking at the combined index for both sectors on a year-over-year basis, the May 2006 reading is down 0.8% from the prior-year level. The decrease was widespread, with declines in seven of the 10 key metrics that credit managers watch. Manufacturing fared worse than service, with eight components falling, compared with five for the service sector.
North said, “A decline in bankruptcy was the only bright spot in both sectors, most likely as a result of bankruptcies falling off dramatically after a surge in activity caused by the change in bankruptcy law last October.”
The credit index measures 10 key components each month, both positive and negative. Positive factors are sales, new credit applications, dollar collections and the amount of credit extended. Negative factors are rejection of credit applications, accounts placed for collections, disputes, dollar amount of receivables beyond terms, dollar amount of customer deductions, and filings for bankruptcies.