Fitch Ratings today launches the Fitch Fundamentals Index (FFI) to track changes in the strength ofthe U.S. economy by monitoring the shifting credit fundamentals for key economic attributes. TheFFI is based on Fitch’s proprietary data and complements credit ratings, but is not tied to any rating including the U.S. sovereign rating.
‘The FFI shows the fundamental drivers of the U.S. economy treading water right now,’ said Jeremy Carter, Fitch Ratings Managing Director. ‘If the political stalemate in Washington continues, or even escalates, we would expect to see a weakening of some of the fundamentals at year end.’
The U.S. FFI fell into the neutral zone (zero) in third-quarter 2013 (3Q’13) from slightly positive (+2) in 2Q’13 as the strengthening in consumer credit tailed off and the banking system score turned negative. The 10 credit fundamental indicators that make up the index are now equally balanced with three positive trends, three negative trends and four neutral, on a quarter-over-quarter basis.
The FFI tracks the changes in credit fundamentals across key sectors of the U.S. economy over the prior quarter and preceding 12 months. The current index does not incorporate the impact of the uncertainty regarding raising the debt ceiling.
The trend in potential drivers or constraints on economic growth or decline is indicated by the relative strength or weakness of the FFI, ranging from +10 to -10. The FFI’s components include mortgage and credit card performance, corporate defaults, high-yield recoveries, ratings outlooks,
EBITDA and CapEx forecasts, banks, the CDS outlook, and transportation trend. Released quarterly, the FFI relies primarily on proprietary Fitch-sourced data. The FFI shows significant correlation to the broader economy. The index fell sharply in 2005 before troughing towards the end of 2008, two quarters before GDP reached its nadir, then rose sharply before peaking in early 2010. The FFI has since leveled off, consistent with an economy recovering relatively slowly from the downturn than in past cycles. The FFI generally has a coincident relationship with the broader economy, although there is evidence that the index may have led the economy to some degree, at least in the recent past.
‘We are continually looking for ways to leverage the vast amounts of data generated in our daily ratings and research activities to help market participants. With over 1,300 analysts in 49 offices, there are unique opportunities for Fitch to connect developing trends in tangible and quantitative ways, beyond the ratings themselves,’ said John Olert, Fitch Ratings Chief Credit Officer. ‘The FFI continues Fitch’s efforts to complement the strong work done on the company and transaction level with how broader trends may aid or detract from current expectations. Providing a fundamental, holistic gauge of how underlying credit fundamentals for key sectors are interacting to influence broader activity seems a natural fit for Fitch given our breadth and depth across sectors, products, and regions.’
Residential Mortgage Improvement Slows
The FFI residential mortgage component score fell to +5 in 3Q’13 from +10 in 2Q’13, where it had been since 2Q’12. The FFI score reflects a slowdown in the reduction of U.S. prime residential mortgage delinquencies due to higher borrowing costs, which cut into home price affordability. Longer term, Federal efforts to reduce involvement in the mortgage market may further exacerbate the recent upward trend in interest rates, highlighting a new risk to mortgage credit quality strengthening. Year-over-year, the housing recovery has driven a 9.7% decline in Fitch’s measure of prime residential mortgages and the proportion of delinquent loans has dropped to 2009 levels. A sustained improvement in home prices is expected, which translates into continued mortgage performance improvement.
Banks Face Vast Operating Challenges Despite Solid Liquidity and Capital Improvement
The FFI banking component score fell to -5 in 3Q’13 from +5 in 2Q’13. The FFI was at zero in 3Q’12. The ten point swing quarter-over-quarter was driven by a slowdown in the rate of bank fundamentals improvement as a result of lingering post-financial crisis operating and asset quality challenges. High regulatory and litigation costs, weak loan demand and rising interest rates have driven net interest margins lower. Higher interest rates resulted in a steep drop off in mortgage refinancing volume and a shock to banks’ bond portfolios and an aggregate unrealized loss position. Steady earnings growth and monetary stimulus have built stronger capital and liquidity positions. The slow recovery of the labor market has supported better loan loss metrics, particularly in auto loans, credit cards, and commercial and industrial loans.
Corporate EBITDA Benefits From Modest Cash Flow Outlook Improvement
The FFI corporate EBITDA component score remained steady at zero from 2Q’13 to 3Q’13. The same component was at -5 in 3Q’12. The stable zero score reflects generally tepid demand and meager hiring and investment, highlighting little opportunity for accelerated earnings and cash flow growth. The year-over-year drop points to managements’ preference to sideline expansion plans because of slow growth. Corporate forecast EBITDA is expected to increase by 3% year-over-year, reflecting slow consumer and industrial demand growth and still-sluggish global-macro fundamentals. Near-term risks to cash flow are limited with margins healthy and liquidity strong. Further cost-cutting and operating efficiencies will be less effective in boosting margins going forward, with expense reduction unable to offset secular forces pressuring EBITDA, most notably in retail. CapEx plans remain constrained, with aggregate CapEx expected to decline modestly in 2014.