Industry Insight

Date March 2018

Approximate net recovery on cost


Current trends

  • March 2018 import levies of 25% on steel and 10% on aluminum cause distress across the manufacturing and consumer industries
  • As a result of tariffs on steel imports from non-exempt countries, borrowers may face unexpected cost increases that could compress margins
  • Scrap steel prices increased approximately 22% for the 12-month period ended February 2018
  • After nine months of expansion, China’s steel Purchasing Managers’ Index ("PMI") decreased 1.4 points to 49.5 in February 2018 over January, indicating a potential market contraction






25% tariff on steel and 10% on aluminum imports

Canada, Mexico, Argentina, Brazil, South Korea, Australia, and the European Union are initially exempted
Higher margins for domestic producers and importers from exempted countries
  • Increased cash for CAPEX, R&D, debt repayment or distributions
Economic advantage for domestic production
  • Increase in domestic production using existing capacity
  • Unclear if producers will invest in new capacity
  • Supply chain disruption if supply sources are switched by customers
Ripple effect of higher input prices on downstream products
  • Lower margins or higher prices (if can be passed through) for downstream products
  • Potentially reduced cash for CAPEX, R&D, debt repayment or distributions, though raw material component is relatively small for many products
Concentrated impact on some states
  • Texas, California, Illinois, Michigan, Louisiana, and Pennsylvania account for 50% of steel/aluminum imports
Retaliatory actions by other countries
  • As yet unclear, at a minimum creates uncertainty
Tariff creates uncertainty across the supply chain:
The Trump administration has imposed a 25 percent tariff on all steel imports and a 10 percent tariff on all U.S. aluminum imports, with the exception of North American Free Trade Agreement (“NAFTA”) partners Canada and Mexico.  Initial exemptions have also been extended for the European Union, Australia, Brazil, South Korea, and Argentina.  The tariffs became effective on March 23, 2018.  Canada is the leading supplier of imported steel and aluminum to the United States, accounting for 16 percent of imported steel and 41 percent of imported aluminum, according to CNBC.  Authority for the tariffs comes from a seldom-used law from the 1960s, the Trade Expansion Act of 1962, that was designed to protect domestic industries deemed vital to national defense.  Section 232 of the Act gives the U.S. president authority to place restrictions on the importation of vital materials if such imports “threaten to impair the national security.”  The majority of the impact of the tariff on U.S. aluminum imports will be felt in the physical market; however, the majority of the industry believes that eventually there will be a significant impact on exchange prices as well.  

Both the steel and aluminum industries have been under heavy pressure from imports for some time.  In recommending tariffs or quotas, the U.S. Department of Commerce noted that employment in the domestic steel industry has decreased by 35 percent in the past two decades, while the aluminum industry lost almost 60 percent of its jobs between 2013 and 2016.  Texas, which is the number one state for steel and aluminum imports, is particularly fearful of the prospect of a trade war brought on by the recent action.  The Dallas News notes that a much greater share of Texans work in the energy sector and other industries that rely upon steel and aluminum than in those that actually produce the metals, which carries broader implications for the economic impact.  In short, the globalized economies of Texas and many other states could be susceptible to any retaliation from abroad.

Steel sales shape global market: American steelmakers have warned the U.S. government that there is a global overcapacity crisis in the steel market, describing cheap imports from China and other countries with state-supported industries as a threat to national security.  At the same time, American steel producers have seen a boost in the last year from trade cases, including U.S. Steel, which is expecting to turn a profit in 2017 for the first time since 2014.

Texas legislation that became effective September 1, 2017, known as the “Buy American” bill requires state infrastructure projects to purchase both iron and steel material from American suppliers, as long as the cost doesn’t exceed the price of imported material by 20 percent.  This law is expected to provide a significant boost to both Texas and domestic steel and iron production facilities.  However, there is also concern that the law could harm the Texas-Canada 
trade relationship, which represented more than $12 billion in 2016, although Canada purchases more steel from Texas than it sells.  

In December 2017, Governor Cuomo of New York signed a similar bill that requires the Metropolitan Transit Authority (“MTA”) and other state agencies to “Buy American,” but only for certain projects.  The bill, which will take effect in April 2018, is a watered-down version of a previous bill Cuomo put forth that would cover most state purchases over $100 thousand.

Certifications important: In order to achieve maximum value for inventory collateral, each item must have current and up-to-date material certifications from the appropriate vendor.  The documentation specifies all relevant certifications including grade; alloy, ASTM, SAE, or UNS specifications; size; mill of origin; heat number and other information that would be required by a potential buyer.  Without these certifications, the value of the inventory would be lower as fewer customers would purchase the material, and in essence the inventory would become secondary-grade material.  Lenders should ensure that record keeping related to certifications is being maintained and audit this paper trail in the same fashion that proof of deliveries are checked for accounts receivable.

Inventory costing and mark-to-market reserves: When a company’s inventory contains commodity-type items, like steel, which are subject to frequent price fluctuations, it is imperative to understand the company’s inventory costing methodology.  A standard cost approach includes updating inventory costs periodically and, depending on the frequency of the update, can result in the company’s reported cost varying from the market in an inflationary or deflationary environment.  A rolling weighted cost approach utilizes an average weighted cost for each purchased item that equates to a rolling perpetual average.  This methodology is useful for commodity-type items as a company’s reported cost will remain closer in line with the market, although costs will still trail market prices by a set period.  Given the volatility in the steel market, lenders should be aware of the target company’s costing methods and should consider incorporating a mark-to-market or lower-of-cost-or-market reserve.  A mark-to-market reserve account will adjust the cost basis to market and ensure that an advance rate based on a percentage of cost remains relevant even in a volatile market.

Impact of import tariffs on NOLV: For domestic and exempt nations’ producers, the NOLV impact will be positive, as these steel products will not be subject to the tariffs.  This will result in lower cost product from the U.S. and exempt nations, as compared to imports that will be subject to the new tariffs. Consequently, companies with inventory purchased from non-exempt nations will see a negative impact on NOLV, as the cost of bringing the product into the U.S. will increase by 25 percent as a result of the tariffs, in addition to any additional market-driven price changes.

Number 1 Heavy Melt Steel market prices as of March 2018 are up 21 percent compared to February of 2017, and up 22 percent compared to November of 2017.  These increases will lead to positive NOLV trends, as inventory purchased at market price levels in November and December 2017 and January 2018 are benefiting from higher market prices.  Inversely, if market prices were to decrease, inventory from non-tariff exempt nations would be doubly hit, first by the additional tariff amount, and then by the variance between the purchased market price and the new market price.  Aluminum market pricing has seen similar trends when compared to steel, as market prices in February 2018 were roughly 8 percent higher than February 2017.