March 17, 2022

	I. Your Trade Exposure to Russia May Be Greater Than You Think
	II. Construction Outlook Predicts Continued Inflation and Steep Material Prices

	III. Credit Professionals Speak Out About Challenges from the Russia-Ukraine Crisis
	IV. New Precedent Set by Indiana Supreme Court Favors Suppliers

On the surface, the Russia-Ukraine conflict may seem distant and unlikely to impact your company here in the United States. But at a closer look, the implications of the war expand far beyond the Russian and Ukrainian borders—making increased due diligence non-negotiable.

According to a recent eNews poll, 26% of respondents have heightened due diligence in response to the Russia-Ukraine conflict and the severe sanctions that quickly followed. Many Russian banks were stopped from using SWIFT, the U.S. banned oil imports from Russia and blocked technology exports to the country, to name a few.

“We have stopped shipping to our German distributors that sell into Russia because of the sanctions on the end users,” said one NACM member, who also has customers in Russia. “Know your customers and make sure you know where your product is being used.”

A relatively low number of U.S. companies actually do business directly with Russia, whether that be importing or exporting. “When we think of U.S. exposure, these two markets are relatively small in terms of our exports,” said economist, Shannon Seery, in a Wells Fargo video, Economic Insights: Some Implications of the Russia-Ukraine Conflict. “About $2 billion of our exports go to Ukraine and about $6 billion go to Russia, which is fairly small in terms of our $24 trillion economy.”

However, if you dig deeper into your customers’ supply chain, you may find that you have been indirectly selling into Russia or to a company owned by a sanctioned Russian oligarch. The same goes for products your company imports. “We are performing more in-depth due diligence on our primary suppliers and their suppliers in an effort to proactively identify risks,” another NACM member said. “[We are] using in-depth surveys and focused communication to root out areas of concern.”

As product moves up the supply chain to your company, it can become unclear from where the raw materials originated. Tier 3 suppliers form the foundation of the supply chain; they provide materials in their raw form or nearly raw form to Tier 1 or Tier 2 companies. Tier 2 companies produce parts from materials supplied by Tier 3 and then provide those parts to Tier 1 companies for direct use of the finished product.

More than 190,000 firms in the U.S. have Russian or Ukrainian suppliers at Tier 3 of the supply chain, according to a report from Interos. “The proportion of U.S. and European supply chains that include Tier 1 Russian or Ukrainian suppliers is relatively low. This increases substantially when incorporating indirect relationships with suppliers at Tier 2 and Tier 3.”

That is why credit professionals need to pay greater attention to detail when evaluating customers as long as this conflict lasts. One way to do this is by dedicating at least one team member to thoroughly look at any connections your customer may have to Russia, Ukraine or Belarus. “We have a small compliance team that now looks at end users,” a credit professional said. “I also use weekly newsletters from various sources to stay abreast of the world news.”

Even if sanctions are lifted and the conflict is resolved, you may find that heightened due diligence needs to become a permanent part of how you do business going forward. “The challenge for managers is to be ready not just for fallout from the Russia conflict, but to develop a sound, responsible strategy for the next country that breaks international order and launches into conflict,” reads an article from the Harvard Business Review. “Recognizing where that may be, and perhaps even acting before it has reached the point of no return, can mean the difference between being lauded as a socially responsible firm and risking a total write-off.”

Supply-chain disruptions and labor shortages have led to significant increases in inflation and prices in the construction industry. And more disruptions may be on the horizon due to the conflict between Russia and the Ukraine, said Amy Crews Cutts, Ph.D., CBE, NACM economist, during the NACM webinar, U.S. Construction Outlook: Workforce Worries, Project Prospects, Supply Snags.

“From June 2020 through August of last year, nonresidential construction employment really stalled,” said Ken Simonson, chief economist for the Associated General Contractors of America. “In the last four months of the year and the first two months of this year, it has really been catching up. It has grown faster than total nonfarm and residential construction in the past six months.” However, industry growth would be stronger if contractors could find more qualified workers, he added.

In January, the construction industry noted a record number of job openings—approximately 384,000, Simonson said. This represents a 27% increase in openings since January 2021. Furthermore, only 259,000 construction workers were hired January 2022—a 15% decrease from a year ago.

“Twenty-nine states have added workers beyond where they were in February of 2020, yet 21 states still lag,” Simonson said. “Louisiana, Wyoming and New York have all experienced over a 10% decline in construction employment from February 2020 to December 2021.”

An increase in construction worker wages is another factor affecting the industry. Wages for employees performing site work went up 6% from February 2021 to February 2022, the highest increase in 40 years, Simonson said.

“Contractors will have to pay even more to keep workers on,” Simonson said. “They are having trouble finding candidates, so they have to pay more overtime to current workers.”

A prominent topic of conversation is how inflation may affect the construction industry. Inflation becomes an issue when we are continuously spending more for the same items, Cutts said.

Supply-chain disruptions have led to producers being unable to get parts or to ship parts, she continued. One commodity that has affected multiple industries is oil. Crude oil is up 57%, and gasoline is up 25% from the beginning of this year. Commodities are up 40% since the beginning of 2020; processed goods are up 30%; and intermediate goods—or unfinished goods that go into the production of other items—are up 10%.

“We are up 1100% on the costs for shipping a container from China or Southeast Asia to the North American West Coast,” Cutts said.”Shipping to the East Coast from the same region is up 600%; and from Europe, we are up 400%.”

In addition, unfavorable differences between input prices and bid prices exist. Input prices are the costs for materials that go into producing a project, while bid prices are what someone pays for the finished project itself. From September 2020 to January 2022, input prices rose from 1.8% above the expected amount to 20.3%, and bid prices went from 1.8% to 16.5%. This means that bid prices are not covering the cost of input materials.

This forces contractors to absorb price differences, Simonson said. Input prices increased because they are reliant on costs for individual materials and price changes that may occur to the market for these materials. From April 2020 to January 2022, the following products experienced massive increases in prices:

• Steel mill products (136%)
• Lumber and plywood (89%)
• Copper and brass mill (70%)

The peak of material costs outweighing bid prices has more than doubled, Simonson said. “The entire construction industry is affected by this—especially subcontractors whose purchases may be more concentrated in high priced material items.”

Overall, it will cost a lot more for firms to do business, Cutts added. Prices for materials may rise even further due to sanctions being placed on Russian businesses, which could reduce the availability of certain commodities. “For example, steel products have spiked because Russia produces a lot of nickel. The price increases are due to companies fearing what might happen next week, so they are scrambling to buy as many materials as they can.”

The war could temporarily halt commercial projects, Simonson added. Expect more drastic changes in the March Producer Price Index report when post-war data come out.

The verdict is mixed on how exactly the crisis in Ukraine is impacting business credit. According to a recent eNews poll, nearly half (47%) of respondents are not seeing an immediate effect from the conflict. But the other half are experiencing everything from cost escalations (47%) to supply disruptions/shortages (26%) and additional sanctions (21%).  

You don’t need to have a large Russian customer base to be impacted. One NACM member has less than 2% of sales in Russia. However, the widespread increase in fuel prices “will mean higher transportation costs domestically and abroad,” she said. “We have reallocated the products from the Russian backlog to other customers’ backlog in different parts of the world.”

Some credit professionals have expressed uncertainty about outstanding payments from Russian customers or customers who sell into Russia. “We are not sure about the money owed from our German distributors [who sell into Russia] as of yet because the balance owed is still within the current window,” one creditor said.

According to FCIB’s most recent International Credit & Collections Survey, the most common reasons for payment delays from Russian customers include billing disputes, unwillingness to pay and cash flow issues. Now as Ukraine and Russia enter a third week of war, payment may be near impossible. Several Russian banks are cut off from SWIFT payments network and banks may not be able to pay in anything other than the ruble.

“Payments in currencies other than RUB require approval from the bank, which can only be granted when all required documentation is provided and is matching the order,” one Credit and Collections survey respondent wrote.

President Vladimir Putin issued on March 5 a decree that allows Russian debtors to repay debt owed to certain foreign creditors with rubles at the official exchange rate of the Central Bank of Russia (which is likely to be lower than the market rate of exchange). As of March 8, the list included the United States, Canada, the European Union, the United Kingdom, Ukraine, Montenegro, Switzerland, Albania, Andorra, Iceland, Liechtenstein, Monaco, Norway, San Marino, North Macedonia, Japan, South Korea, Australia, Micronesia, New Zealand, Singapore and Taiwan.

And now Russia is facing a potential default. The country owes $117 million in interest on its U.S. dollar bonds, but paying in ruble would mean sovereign default, according to Fitch Ratings. “Russia addressing its debt obligations in rubles would prompt Fitch to downgrade the ratings on the bonds to a D if the coupon payments aren't made in U.S. dollars by the end of the grace period that runs through mid-April,” reads a Forbes article.

“This rating action considers i) the Presidential Decree of 5 March 2022, which could impose insurmountable barriers to issuers' ability to make timely payments on foreign- and local-currency debt to certain international creditors in their original currency,” Fitch says.

The Indiana Supreme Court on March 10 set a new precedent in favor of suppliers. Under this precedent, suppliers have lien rights in Indiana even in situations where they sell materials to another supplier so long as the materials were furnished for the erection of a building or structure.

“This ruling significantly expands the lien protections afforded to suppliers of Indiana construction projects,” said Joshua Casselman, of Rubin & Levin, P.C., who argued the case and an NACM Secured Transaction Services network attorney. “The Supreme Court overturned the trial court’s ruling in favor of the landowner, which was based on a long-standing judicially created rule that prohibited ‘suppliers to suppliers’ from being within the protection of Indiana’s mechanic’s lien statute.”

Facts of the Case

According to court documents, United States Steel Corp. contracted with Carbonyx, Inc. to design and build two facilities in Gary, Indiana. Carbonyx then contracted with Steven Pounds, which did business as Troll Supply, to fabricate steel for the project.

Service Steel Warehouse Co., L.P. sold steel for the project to Troll Supply and identified the project on its invoices. The fabrication involved significant labor—cutting, welding, drilling, painting and connecting thousands of pieces of steel to the exact specifications necessary for the project. Troll Supply did not perform any work at the project site, which would have been impossible. The fabricated steel ultimately ended up at the site.

Troll Supply did not pay all of its bills and ultimately owed Service Steel $452,825.03. Service Steel recorded a mechanic’s lien against the project site and sued U.S. Steel to foreclose on it. Both parties moved for summary judgment. U.S. Steel argued that because Troll Supply did not perform on-site work, it was a material supplier of fabricated steel, not a subcontractor. And that meant Service Steel, also a material supplier, could not have a lien. The trial court granted summary judgment for U.S. Steel on the mechanic’s lien claim. Although the court did not provide a basis for its ruling, the parties agreed it was based on the prohibition against supplier-to-supplier-based liens. Service Steel appealed the decision.

The Indiana Court of Appeals reversed the trial court’s decision because it found the fabricator was a subcontractor even if it did not perform on-site work, so Service Steel could have a lien. The Court defined a subcontractor “as one who performs a definite, substantial portion of the prime contract.” Under that test, “Troll Supply was a subcontractor, not a material supplier,” so the prohibition against supplier-to-supplier-based liens did not bar Service Steel’s lien.

After granting transfer, the Indiana Supreme Court also concluded that the trial court erred in granting U.S. Steel’s motion for summary judgment. The Court held that the long-standing judicially created rule in Indiana, which barred a supplier to another supplier from having a lien, conflicted with the plain language of Indiana’s mechanic’s lien statute. Under the statutory language, a supplier that furnishes “materials for the erection of a building, regardless of the recipient, can have a lien on that building and accompanying land.” Accordingly, the Supreme Court held that Service Steel can have a lien on U.S. Steel’s project site.