asia credit outlook 2012 bumpy silk road

PLEASE REFER TO THE LAST PAGE FOR ANALYST CERTIFICATION(S) AND IMPORTANT DISCLOSURES

RESEARCH January 2012

ASIA CREDIT OUTLOOK 2012

BUMPY SILK ROAD

Barclays Capital | Asia Credit Outlook 2012

6 January 2012 1

FOREWORD

For most of 2011, the performance of Asia credit was driven by global macro events – much in the spirit of the theme of last year’s Asia Credit Outlook, Asia versus the World. While we don’t expect that general theme to change materially in 2012, we do believe developments in China will play a bigger role in market performance. Hence, this year’s Bumpy Silk Road.

A number of factors will influence Asia credit. Regional dynamics remain supportive – in terms of strong investor interest and flows into Asia, expectations of moderating USD bond supply, and benign sovereign financial and funding profiles. However, this backdrop is countered by several well-flagged global risks: pressures around European sovereigns and banks, moderating global growth – the eurozone is expected to enter a recession – and uncertainty about the US economic and political backdrop. Additionally, we believe developments in China have the potential to create a further, potentially significant, drag on Asia credit in 2012. While our base case is for a soft landing in China, a sharper-than-expected slowdown (our current forecast is for 2012 GDP growth of 8.1%), and its commensurate knock-on to fundamentals, growth and sentiment, is a key risk.

We expect Asia credit to adequately compensate for the higher volatility versus US and European credit. However, as the credit cycle turns, bottom-up credit analysis will become all the more important. In this publication, we include our Asia strategic market overview, together with sector outlooks and updated views and recommendations for all 118 corporates, banks and sovereigns in our coverage universe. We hope that you will find this publication useful in navigating the year ahead and would welcome your feedback.

Jon Scoffin

Head of Research, Asia-Pacific and Head of Credit Research


6 January 2012 2

TABLE OF CONTENTS

ASIA-PACIFIC CREDIT STRATEGY Asia Credit Strategy ................................................................................................................................... 4 Summary recommendations – Financial Institutions ......................................................................23 Summary recommendations – Corporates ........................................................................................24

SOVEREIGNS Sovereigns..................................................................................................................................................26 Issuer profiles ............................................................................................................................................29

ASIA-PACIFIC FINANCIAL INSTITUTIONS Non-Japan Asia Banks .............................................................................................................................34 Australia Banks .........................................................................................................................................36 Summary table of views on non-Japan Asia Banks ..........................................................................38 Issuer profiles ............................................................................................................................................40

ASIA-PACIFIC HIGH GRADE CORPORATES High Grade Diversified Industrials ........................................................................................................70 High Grade Resources.............................................................................................................................72 High Grade Telecoms and Utilities .......................................................................................................74 Issuer profiles ............................................................................................................................................77

ASIA-PACIFIC HIGH YIELD CORPORATES High Yield Chinese Real Estate ..............................................................................................................88 High Yield Diversified Industrials – North Asia ..................................................................................91 High Yield Diversified Industrials – South Asia ..................................................................................93 High Yield Indonesian Coal ....................................................................................................................97 High Yield Resources............................................................................................................................ 101 High Yield Telecom............................................................................................................................... 103 Issuer profiles ......................................................................................................................................... 106

ASIA-PACIFIC CONVERTIBLE BONDS Asia-Pacific convertible bonds ........................................................................................................... 126 Performance projections for 2012 .................................................................................................... 127 Positioning for 2012 ............................................................................................................................. 129 Key themes for 2012 ............................................................................................................................ 130 Net supply outlook for 2012............................................................................................................... 134 Review of 2011 ...................................................................................................................................... 137 CBInsight ................................................................................................................................................. 146

ISSUER INDEX 149


6 January 2012 3

ASIA-PACIFIC CREDIT STRATEGY


6 January 2012 4

ASIA CREDIT STRATEGY

Bumpy ‘Silk Road’ A combination of global macro events and Asia-specific concerns are likely to result in

a volatile 2012. Under our base case scenario, we look for high grade credit to post excess returns of 400-450bp in 2012. For high yield credit (corporates and sovereigns), we look for 9-10% total returns, with high yield corporates forecast to return 13-15%. The higher projected returns versus other regions are adequate compensation for higher volatility of Asian credit, in our view.

As with most risk assets, the European sovereign debt crisis and the effects of European bank deleveraging are likely to be central to the performance of Asian credit, at least in the first half of 2012. We believe the extent to which China’s growth slows will be the single most important Asia-specific factor, given the large proportion of China-related issuers.

We expect inflows into Asian credit to remain supportive, with new regions and investor segments entering the market. The continued growth of local-currency corporate bond markets will provide borrowers with more avenues for funding, helping technicals in the USD market.

We forecast 2012 gross supply of USD-denominated bonds from Asian issuers of USD50-55bn. Net supply is expected to be in line with 2011’s USD30-35bn.

With the exception of Indonesian coal companies, we expect high yield corporates’ credit metrics to deteriorate. The operating outlook for Chinese corporates is likely to be challenging in 2012. For financials, we expect asset quality to deteriorate, credit costs to rise and earnings to moderate. In particular, we expect the credit profiles of Indian and Hong Kong banks to come under pressure. Lastly, for sovereigns, the backdrop of weak global growth and a deteriorating external funding environment will highlight vulnerabilities and test reforms/mechanisms put in place to mitigate external risks.

Krishna Hegde, CFA +65 6308 2979

[email protected]

Avanti Save +65 6308 3116

[email protected]

Figure 1: Performance of global credit indices (normalised to end-December 2010)

70

90

110

130

150

170

190

210

230

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11

US HY US Credit Pan Euro HY EM Asia USD Credit Global EM - Sovereigns

Source: Barclays Capital


6 January 2012 5

Figure 2: Summary of 2012 Asian credit views

Comments

Spread outlook Excess returns of 400-450bp for high grade

Asian HY (sovereigns and corporates) to post total returns of 9-10%; high yield corporates to post total returns of 13-15%

Global themes Worries about European sovereign debt are set to persist into 2012

Deleveraging by European banks and its second-order effects are likely to have a number of implications for Asian credit – including European banks selling assets, which would create a headwind for risk asset prices in Asia; and reduced participation by European banks in the Asian syndicated loan market

Local themes Developments in China have the potential to be a significant drag on Asian credit in 2012. Our economists forecast 2012 GDP growth of 8.1%. Two key risks to their view are: 1) further deterioration in the European crisis and/or a deep recession in Europe; and 2) a disorderly correction in domestic housing market

The outlook for China and global growth expectations will play an important role for emerging Asia economies

We believe the theme of corporate issuance in local-currency bond markets is likely to gather momentum in 2012, driven by growing demand for diversification by currency and geography

Demand outlook High grade corporates and financials: Commercial banks' appetite for high grade corporate bonds is likely to diminish on tightening USD liquidity, higher secondary supply of loan assets (as European banks deleverage and dispose assets) and increased loan/deposit ratios

High yield corporates: Expect growing allocations from Japanese and Taiwanese accounts. At least four new retail Japanese funds dedicated to Asian high yield were set up in 2011, with the current aggregate AUM amounting to c.2% of the Asian high yield corporate universe

Supply outlook Gross supply of USD-denominated bonds from Asian issuers of USD50-55bn. Net supply is expected to be in line with 2011’s USD30-35bn

Look for increased activity in the local-currency bond markets

Sector positioning

Overweight: High grade resources, Korean policy banks, HY tyre manufacturers, Indonesian coal companies

Underweight: Hong Kong property companies, Hong Kong LT2 bullets, HY China industrials, HY petrochemicals and shipping, HY telcos


Positioning and forecasts Sector positioning

In high yield, we recommend being cautious on segments that are geared to Chinese construction but are not pricing in adequate stress – for example, Chinese HY industrials and smaller property developers. We recommend taking China exposure through some of the larger, mass-market developers. In high grade, we prefer Korean quasi-sovereigns and recommend a less-than-benchmark exposure to Chinese state-owned enterprises (SOEs). Among banks, we prefer the Korean policy banks.

We also recommend using high grade sovereign CDS to set up hedges. We prefer to buy China 5y CDS versus Korea 5y CDS if the spread differential exceeds 15bp. In high grade, we prefer to express hedges by shorting tight-spread Hong Kong property developers such as Sun Hung Kai (we recommend shorting the ’20s). Given relatively tight spreads for Asian sovereign credit and its resilience in times of market stress, we recommend Asian credit investors start 2012 with an overall market weight position on high yield sovereigns.

Curve positioning

Within the Chinese property sector, our preference remains to position at the front end of the curve (’14s/’15s). Most curves are flat and therefore do not offer compensation for adding duration (except the Yanlord curve which is steep and offers value at the long end). For Indonesia coal, the Bumi Resources and Indika Energy curves are inverted; therefore, we see better value at the front end.

Cautious on segments geared to Chinese construction

Recommend exposure via larger,

mass-market developers

Buy China 5y CDS versus Korea 5y CDS as a portfolio hedge if

spread differential exceeds 15bp

In the China property sector, we prefer the front end (’14/’15s)


6 January 2012 6

High grade corporate curves are generally steep (with the exception of CNOOC) compared with US credit curves. However, we are cautious about adding duration and believe technicals are weak for long-dated bonds in this segment. We prefer the belly of the curve (10y).

Given that a number of convertible bonds are puttable in 2012 and are traded as busted securities, we believe this asset class offers attractive relative value opportunities. For instance, the Vedanta CBs puttable in 2013 and 2014 offer yields to put of 16% and 14%, respectively; by comparison, the 2014 bonds yield 9.5%.

Figure 3: Relative value between convertible bonds and conventional bonds (%, YTP/M)

YLLG '14

SHUION '15

RCOMIN '12

NWDEVL '14

KERPRO '12

HIDILI '15

FUFENG '15

ELTYIJ '15

AGILE '16

VEDLN '16

VEDLN '17

VEDLN 6.75% '16VEDLN 8.75% '14

HIDILI 8.625% '15

FUFENG 7.625% '16

YLLG 10.625% '18YLLG 9.5% '17

AGILE 8.875% '17AGILE 10% '16

0

5

10

15

20

25

30

35

40

45

50

0 1 2 3 4 5 6 7

Converts Bonds

Avg life


Figure 4: Trade recommendations

High Grade Corporates

Buy Beijing Enterprises ’21s

Buy Reliance Industries ’20s

Sell Posco ’21s

High Yield Corporates

Buy Bumi Resources ’16s

Buy Evergrande ’15s

Buy Gajah Tunggal ’14s

Sell Bakrie Telecom ’15s

Financials

Buy Bank of East Asia 6.375% ’22c17s and sell Bank of East Asia 6.125% ’20s

Buy 5y CDS on Bank of China and sell 5y CDS on ICICI

Buy 5y sub CDS on DBS and sell 5y sub CDS on UOB

Buy 5y CDS on NAB and sell 5y CDS on CBA/WBC


Return forecasts

The binary nature of the European sovereign crisis makes it extremely challenging to forecast potential returns. As a result, we take a cue from our US colleagues (see Global Credit Outlook 2012, 2 December 2011) and offer views based on different scenarios for Europe.

Prefer the 10y point in high grade corporate curves

Convertibles trading to put dates offer attractive relative value

opportunities

We forecast 2012 total returns of 9-10% for high yield and excess returns 4.0-4.5% for high grade

https://live.barcap.com/go/publications/content?contentPubID=FC1771080�



6 January 2012 7

Base Case: European sovereigns return to a stable path. China growth slows in a controlled manner, in line with our expectations (2012 GDP growth of 8.1%). In such a scenario, we look for sovereign and bank spreads to compress from current levels. The effect of European bank deleveraging could result in corporates coming under more pressure, and in our view, there is risk of one or two defaults among small Chinese property companies with bonds outstanding.

Downside Case: The situation in Europe deteriorates. Growth in China surprises negatively, with policy intervention unable to slow the pace of the slowdown. Spreads on sovereigns in Asia widen slightly from current levels, but spreads on financials widen significantly owing to asset quality concerns. Credit conditions tighten across the region. Chinese property companies and industrials would likely see defaults, with a mid-sized developer defaulting in addition to smaller developers.

In our base case scenario, we look for high grade to post excess returns of 400-450bp in 2012. For high yield (corporates and sovereigns), we look for 9-10% total returns, with the high yield corporates forecast to return 13-15%.

Figure 5: 2012 excess and total returns forecast across asset classes and regions

2011 2012 forecasts

Excess return Total return Excess return Total return

Asia IG -2.9% 4.9% 4-4.5% 4-4.5%

US IG -3.2% 8.3% 4.50% 4.25%

EUR IG -3.1% 3.2% 4.50% 5.50%

Asia HY -8.1% 3.3% 9-10% 9-10%

- Asia HY ex-sovereigns -11.9% -3.9% 13-15% 13-15%

US HY -2.4% 4.9% 5-7% 5-7%

EUR HY -8.8% -2.4% (2)-0% (1)-1%


Themes for 2012

European sovereign crisis lingers Worries about European sovereign debt are set to persist into 2012. Focus will remain on peripheral Europe’s access to funding markets and the progress made by governments, especially in Italy and Spain, to implement austerity measures. With the ECB steadfast in refusing to be Europe’s lender of last resort and alternative mechanisms (EFSF leverage/IMF involvement at a larger scale) some way away from implementation, a near-term resolution to the sovereign crisis appears unlikely.

We believe the near-term outcome in Europe remains binary. Serious fiscal reform plus continued ECB buying could be a catalyst for stable, and eventually lower, yields. Lower yields, in turn, could lead to reduced volatility. That is our base case. However, it is also possible that these efforts fail, and the financial markets collapse before new forms of support can be delivered. In that case, we would expect severe repricing across risky assets globally, with Europe bearing the brunt.

With austerity measures making their presence felt and PMI prints declining, growth forecasts for EM Asia are being pared and factoring in a recession in Europe. The concerns about growth that were restricted to peripheral European countries now encompass the entire eurozone, a possibility that has significant negative implications for export-dependent Asian economies.

Near-term outlook in Europe remains binary


6 January 2012 8

European bank deleveraging intensifies As a result of the European debt crisis and their large exposure to stressed sovereigns, European banks are under pressure to raise capital ratios ahead of a June 2012 deadline. Our equity analysts estimate that European banks could cut their balance sheets by a total of EUR0.5-3.0trn. In the aggregate, about one-third of European banks’ balance sheets is deployed outside Europe. Some banks have already been explicit about their intentions to significantly reduce risk-weighted assets – especially in non-core markets – as they return their focus to their core markets. In Asia, we expect European banks to reduce trade finance, project finance and corporate lending via loans. It is also important to note that European banks face much higher funding costs in the unsecured market – a dynamic that is also likely to encourage deleveraging.

In our view, deleveraging by European banks and its second-order effects are likely to have a number of implications for Asian credit:

1. In the corporate lending space, our analysis shows that European banks have been very active in the syndicated loan market. Although some smaller banks in Europe did not have the capability to originate loans, their low cost of funding enabled them to participate in the syndicated market (Figure 6 and Figure 7). We expect loan pricing to reflect the change in market dynamics, with some European banks decreasing exposure to the loan markets. For loans that mature in the next few months, especially USD loans, and in the market for fresh borrowing, we believe the cost differential between loans and bonds will push borrowers towards bonds. We highlight that c.USD30bn of syndicated loans to Hong Kong corporates falls due between 2012 and mid-2013, and we estimate that European banks accounted for at least 17-20% of that amount. Notably, Hong Kong developer IFC sought to refinance a loan in December and found that prices are being reset higher and available loan sizes have shrunk.

Figure 6: Composition of the Asia ex-Japan syndicated loan market by currency

Figure 7: Market share of banks for syndicated loans in various currencies

CNY8%

TWD10%

HKD10%INR

19%

USD36%

SGD6%

GBP1%

KRW5%

EUR2%

Other3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

EUR GBP USD HKD SGD

Asia Banks European banks US Banks Others

Note: All outstanding syndicated loans with size USD 250mm or higher. Source: Dealogic, Barclays Capital

Note: All outstanding syndicated loans with size USD 250mm or higher. Source: Dealogic, Barclays Capital

2. Loan growth outpaced deposit growth in Asia throughout 2011, resulting in rising loan-to-deposit ratios. Most banks have reported that loan demand (especially USD loans) has been robust, creating the potential for tighter USD liquidity in many systems. Hong Kong is already experiencing tight liquidity, driven by strong loan demand from Chinese and Hong Kong corporates, and slower HKD and USD deposit growth. We expect this trend to

Expect European banks to reduce trade finance, project

finance and corporate lending via loans


6 January 2012 9

intensify into 2012 (Figure 8). As domestic liquidity becomes constrained and loan spreads increase (driven by European banks deleveraging), Asian banks are likely to be less supportive of corporate bond issuance and could become sellers. This dynamic will be negative for high grade bond issuers (see the “Demand drivers” section below).

3. Deleveraging is likely to result in European banks selling assets, which would create a headwind for risk asset prices in Asia.

US uncertainty persists S&P’s downgrade of US sovereign ratings in August 2011 and the failure of the Super Committee to reach an agreement on deficit reduction underscore the challenges faced by US policymakers in achieving political consensus on public finances. Our US economics research team believes policy-induced uncertainty will dominate for the better part of 2012, a presidential election year. Our economists forecast 2012 growth will average 2.5%. Their forecasts assume unemployment benefits and the payroll-tax holiday will be extended for the full year. If these measures are not extended, our economists think growth will be trimmed by about 1.0pp in 1Q and 0.5pp in 2Q. Overall, developments in the US are likely to be a source of volatility for Asian credit.

China slows further Developments in China have the potential to create a significant drag on Asian credit in 2012. Our Global Macro Survey, conducted in mid-November, found that less than 6% of respondents believe a sharp slowdown in China will be a key theme for markets in 2012. This indicates to us that positioning is tilted toward a benign outcome.

Our China economists expect growth to bottom out in 1Q12, before picking up over the remainder of 2012. They forecast 2012 GDP growth of 8.1%. Two key risks to their view are: 1) further deterioration in the European crisis and/or a deep recession in Europe; and 2) a disorderly correction in domestic housing market.

The trajectory of property prices will be an important driver of 2012 growth. We expect a correction of 10-30%. Recent comments from developers indicate price cutting (at least 10-15%) has begun, and land auctions have failed or received muted participation. Such a weakening in asset prices could quickly spill over and affect many sectors – construction, capital goods, metals/construction consumables, local governments and banks.

Figure 8: Loan-to-deposit ratios for Asian banking systems

20%30%40%50%60%70%80%90%

100%110%

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2006 2007 2008 2009 2010 2011

110%

115%

120%

125%

130%

135%

140%

Malaysia Thailand IndiaIndonesia HK (HKD) HK (Foreign ccy)Korea (RHS)

Source: Central banks, CEIC, Bloomberg

Developments in US are likely to be a source of volatility for Asia

credit

Developments in China have the potential to be a significant drag

on Asian credit in 2012

Trajectory of property prices will be an important driver of Chinese growth in 2012



6 January 2012 10

Rest of Asia – depending on external cues The outlook for emerging Asia in 2012 is not straightforward. Policymakers will look to balance moderating growth and potential inflationary pressures driven by food prices. The outlook for China and global growth expectations will play an important role. Weaker export demand, especially from Europe, is already evident in 3Q data. Taiwan, Singapore, the Philippines and Malaysia are most exposed to global (ex-China) demand dynamics. Commodity prices are likely to be another source of risk. Malaysia, Vietnam and Indonesia are relatively more exposed to commodity price fluctuations, while India and Korea stand to benefit from any correction in commodity prices. Finally, external funding markets and offshore portfolio flows remain at risk from developments in Europe (sovereigns/banks). Indonesia, Sri Lanka and Malaysia are most vulnerable to shifts in flows. Our economists believe the ability of India and Sri Lanka to provide fiscal stimulus is limited, owing to large fiscal deficits and high public debt.

Fund inflows from new regions to continue We believe the structural shift towards EM assets will continue into 2012. As seen in September 2011 when inflows reversed, the importance of flows and their implications for prices is significant. Amid the ongoing focus on sovereign debt and deficit levels, Asian countries look all the more attractive. Without being pressured by the market, they have been disciplined about keeping fiscal metrics strong. And the market response to their discipline is evident in spread levels, with double-B Asian sovereigns trading inside of AA/AAA European sovereigns.

In addition to inflows from Europe and the US, Japan stands out as a potential source of significant flows. In 2H11, Japanese retail funds targeting Asian credit attracted AUM of USD850mn. We expect a similar asset allocation dynamic in the institutional market. In addition, we see the possibility of further dedicated flows from other channels: Taiwanese insurance firms investing in CNH corporate bonds; Thai and Japanese asset managers raising India-dedicated funds. Overall, we look for inflows to remain supportive of Asian credit.

Local-currency markets grow faster Local-currency corporate bond markets (eg, CNH, INR) have gained the scale to attract standalone mandates from investors globally. Gross issuance in the CNH market was c.USD26bn in 2011. The amount of INR corporate bonds that foreign investors can purchase increased throughout last year and now stands at USD45bn (versus USD20bn at the start of 2011). Between the CNH and INR markets, the amount of corporate bonds that global investors could access last year was greater than the gross issuance in the USD markets in Asia ex-Japan. We believe the theme of corporate issuance in local-currency bond markets is likely to gather momentum in 2012, driven by growing demand for currency and geographical diversification.

From an issuer perspective, the ability to diversify the investor base is a positive. For the USD bond market, local-currency corporate bond markets help keep supply technicals in check. So, overall, the development is a positive for USD credit markets.

Demand drivers Asia credit has benefited from structural EM flows and growing allocations from Japanese and Taiwanese accounts. Based on Bloomberg data we estimate that at least four new retail Japanese funds dedicated to Asian high yield have been set up in 2011, with the current

In 2H11, Japanese retail funds targeting Asian credit attracted

AUM of USD850mn

We see the possibility of further dedicated flows from other

channels: Taiwanese insurance firms investing in CNH

corporate bonds; Thai and Japanese asset managers

raising India-dedicated funds

Between the CNH and INR markets, the amount of

corporate bonds that global investors could access in 2011

exceeded gross USD issuance in Asia ex-Japan


6 January 2012 11

aggregate AUM amounting to c.2% of Asian high yield corporate universe. In 2012, we are looking at some changes in the demand backdrop for Asian credit between segments.

1. High grade corporates and financials: Figure 9 shows that commercial banks account for 15-25% of demand for high grade gross supply. Their appetite for high grade corporate bonds is likely to diminish with tightening USD liquidity, higher secondary supply of loan assets (as European banks deleverage and dispose assets) and increased loan/deposit ratios.

2. High yield corporates: Asian high yield corporates have benefited from strong support from private banks and sustained interest from institutional investors. We estimate that since May 2011, at least four new retail Japanese mandates dedicated to Asian high yield have been set up. We do not expect this trend to change; therefore, relative value comparisons between US and European high yield are likely to be more of a focus. Asian high yield has underperformed US high yield and outperformed core European high yield. We believe such dislocations could weigh on the attractiveness of Asian high yield as investors compare and contrast valuations, recovery assumptions and institutional strength in Asia and core Europe. Furthermore, the removal of EM corporate credits from some benchmark indexes could also be a drag on demand for Asian credit.

2012 supply – Expect lower gross supply as local markets grow We forecast 2012 gross supply of USD-denominated bonds from Asian issuers of USD50-55bn. Net supply is expected to be inline with 2011’s USD30-35bn. Over the next few pages, we discuss the themes and drivers of issuance in 2012.

Banking system liquidity not expected to ease dramatically Loan growth has outpaced deposit growth in Asia throughout 2011, resulting in rising loan-to-deposit ratios. Most banks have reported that loan demand (especially USD loans) has been robust, creating potential for tighter USD liquidity in many systems. Hong Kong is already experiencing tight liquidity, driven by strong loan demand from Chinese and Hong Kong corporates, and slower HKD and USD deposit growth. We expect this trend to intensify into 2012. Similarly, credit conditions in China are unlikely to see broad-based loosening, and our base case is that easing will remain selective and directed towards

Figure 9: Commercial banks’ purchases of Asian high grade bonds – new issues

0%

5%

10%

15%

20%

25%

30%

35%

CN KR HK IN TH MY SG

Corporate Quasi sovereign Financial institution

Note: Based on primary market distribution. Source: Barclays Capital

Banking system liquidity is expected to remain tight


6 January 2012 12

specific sectors/segments. Notably loan-to-deposit ratios have ticked up in Indonesia, mainly driven by foreign-currency loan demand.

European bank deleveraging resulting in incremental loan-to-bond shift Funding costs for European banks have increased dramatically in recent months, as pressure on their capital levels has intensified due to their exposure to peripheral sovereigns. This trend has been compounded by the EBA requirement to boost capital levels by June 2012. In their 3Q earnings reports, many European banks announced plans to significantly reduce risk-weighted assets – especially in their non-domestic books.

Our analysis shows that banks from Europe were very active in the corporate syndicated loan market. While some of the smaller banks in Europe did not have the capability to originate loans, their cost of funding enabled them to participate in the syndicated market.

We expect loan pricing to reflect the change in market dynamics, with some European banks decreasing exposure to the loan markets. For loans that mature in the next few months, especially USD loans, and in the market for fresh borrowing, we believe the relative the cost-differential between the loans and bonds will push borrowers towards bonds.

We expect Asian and Japanese banks to increase their presence as European banks deleverage. Some Asian and Japanese banks may need wholesale funding as they look to gain share. As a second-order effect, large corporates in the region that previously relied on bank funding for trade finance could decide to finance those activities in-house – by accessing the bond market.

Local-currency corporate bond markets an attractive alternative Local-currency corporate bond markets (eg, CNH, INR) have gained the scale to attract standalone mandates from investors globally. 2011 gross issuance in the CNH market was c.USD26bn. The amount of INR corporate bonds that foreign investors can purchase has been increased throughout last year and now stands at USD45bn (versus USD20bn at the start of 2011). Between the CNH and INR markets, the amount of corporate bonds that foreign investors could access this year is greater than the gross issuance in the USD markets in Asia ex-Japan.

Furthermore, given demand for local-currency instruments (from retail investors and, increasingly, institutions) borrowers have begun looking at local-currency markets outside their home countries as an alternative source of funding. For instance Henderson Land (domiciled in Hong Kong) issued a SGD corporate bond, IDBI Bank (India) issued “dim sum” bonds and Korean banks have accessed THB and MYR bond markets.

We believe the theme of corporate issuance in local-currency bond markets is likely to intensify in 2012, driven by growing demand for diversification by currency and geography. Large Asian corporates and banks are the most likely candidates to consider refinancing or issuing new debt in local markets. Smaller and lesser-known corporates, especially from China, that cannot access the USD bond market also are likely to be maiden issuers in the CNH market.

Debt-funded acquisitions We expect Asian corporates to remain acquisitive in 2012. This trend is most likely to be seen among oil and gas companies, Chinese state-owned enterprises, and Korean and Indian corporates. These companies are likely to consider tapping offshore bond markets to fund large foreign acquisitions, especially given our expectation of tighter liquidity in loan markets and the need for sizes and tenors that may not be available in onshore bond markets.

For USD loans maturing in next few months, the relative cost

differential between loans and bonds will push borrowers

towards bond markets

Borrowers have begun looking at local-currency markets outside

their home countries as an alternative source of funding


6 January 2012 13

Furthermore, given the decline in equity prices, offshore M&A activity by Asian corporates is likely to increase, as these companies generally are cash rich or have access to funding, and have indicated plans/intentions to expand their footprint.

We also expect Asian banks to opportunistically seek acquisitions, and they may look to finance transactions in the bond market.

Redemptions in bonds and loans Asian issuers have USD17-20bn of bonds maturing in 2012. Given low all-in yields in 2010 and early 2011 most issuers pre-funded upcoming maturities (eg, ENN Energy tendered for its 2012s and issued a 10y bond). The bulk of the redemptions is now concentrated between 2014 and 2015 (Figure 10). Nearly half the redemptions coming due in 2012 is from Asian financials and is dominated by Korean banks’ senior and subordinated bonds.

Dealogic data indicate that European banks have been significant participants in Asian loan markets. As these banks deleverage, their participation in those markets will decline, which means borrowers with maturing loans may need to secure alternative funding sources. Approximately USD25-30bn of USD-denominated loans is due in 2012, and we estimate that European banks acted as bookrunner or lead arranger for at least 25% of that amount. If 50% of the large loans made by European banks are refinanced in the bond market, USD2-4bn of funding will need to be sourced from the other markets.

Figure 10: Asian issuers redemption profile (USD bn)

-60

-40

-20

0

20

40

60

80

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

F/E

2013

E

2014

E

2015

E

2016

E

Gross Supply Redemption Net Supply


Forecasts by Segment High yield corporates

Gross supply from high yield issuers (especially from China) grew rapidly in 2010 and 1H11. In 2012, we expect issuance to moderate. We forecast gross supply of USD9-11bn from high yield corporates. Although issuance from Chinese corporates has been muted in recent months, we expect it to pick up this year. Given property sales trends, developers’ liquidity positions are expected to deteriorate in 2012, creating the need to raise cash – even at a higher cost. We expect Chinese corporates to issue USD4-6bn this year (compared with USD9.3bn in 2011).

Offshore M&A activity by Asian corporates is likely to increase

given the decline in equity prices

The bulk of the redemptions is now concentrated between 2014

and 2015

We forecast gross supply of USD9-11bn from high yield

corporates


6 January 2012 14

The drivers for HY issuance are:

1. Refinancing/pre-funding – The amount of bonds eligible for redemption is low. The bulk of the maturities is in 2014 and 2015 (Figure 11). In China, although selective monetary easing is underway, we expect credit conditions to remain tight, at least early in the year. Therefore, Chinese developers and industrials with maturities (conventional and convertible bonds) are likely to look for alternative sources of raising funds, especially as trust financing is curtailed. We believe the bond market, especially the CNH market, is likely to be a source of funding for many corporates. Among Indonesian borrowers, we expect corporates to refinance expensive loans and extend debt maturity via USD bonds (eg, Bumi Resources said it plans to prepay a CIC loan that has an internal rate of return of 19%).

2. Expansion, growth, /M&A – High yield corporates such as Vedanta are expected to be acquisitive and fund their purchases with debt. For instance Vedanta plans to refinance loans used to fund the purchase Cairn India, and Borneo Lumbung is likely to be a maiden issuer as it seeks to refinance a USD1bn loan taken to buy a 23% stake in Bumi Plc.

Figure 11: Redemption profile for Asian corporates (USD bn)

-30

-25

-20

-15

-10

-5

0

2012 2013 2014 2015 2016

IG HY/NR


High grade corporates

We look for high grade corporates to issue USD20-25bn in 2012. Korean quasi-sovereigns will be issuers to refinance or to pre-fund maturities, or finance capital spending. The oil and gas sector is likely to tap the bond market opportunistically to fund acquisitions and expansion. Overall, high grade issuance will be sensitive to system-level liquidity. We look for supply from Chinese corporates (especially SOEs) to account for USD3-6bn. Traditionally, large corporates have been able to obtain loans (onshore and offshore) on attractive terms and issue in the onshore market. Given the changes to loan markets stemming from tight liquidity and European bank deleveraging, we expect large corporates to turn to the bond markets. Hong Kong- and Singapore-based corporates are likely to find direct funding in the bond markets more attractive than in the loan markets.

The need for raising funds will arise from:

1. Refinancing/pre-funding – The amount of bonds eligible for redemption is low. As is the case with high yield corporates, the bulk of the maturities is in 2014 and 2015 (Figure 11). We expect refinancing and pre-funding to be dominated by Korea and Malaysian quasi-sovereigns (eg, Petronas has USD2bn maturing in 2012).

We look for high grade corporates to issue USD20-25bn

in 2012


6 January 2012 15

2. Expansion, growth, M&A – The oil and gas sector, in particular, is likely to be active in M&A, and we believe some acquisitions could be funded by debt. CNOOC, CNPC and Reliance Industries are borrowers that have indicated they could make acquisitions (see Asia Credit Alpha, 11 November 2011).

3. Banking system liquidity – We believe that as liquidity tightens in the region and as European banks continue to deleverage, several large corporates may find it more cost effective to issue bonds than loans. Given our expectations for the loan market, we believe the rollover from loan to bonds is likely to be higher in 2012 than previously. We note that among Chinese borrowers, SOEs have been active the Hong Kong loan market. As liquidity conditions tighten in Hong Kong, these corporates are likely to be issuers of bonds.

Financials

We expect Asian banks to be active issuers in 2012. We forecast gross supply of USD15-17bn from Asian banks (USD4-6bn from Indian banks, USD4-6bn from Korean banks). We also expect banks from Hong Kong, Singapore and China to opportunistically tap the senior bond markets. Hong Kong and Singaporean banks have subordinated debt coming due in 2012. We expect subordinated debt issuance to account for USD2-3bn of total gross supply. Incremental clarity on Basel III from local regulators could be a source of upside risk to our estimates. The need to raise funds will arise from:

1. Refinancing/pre-funding – We estimate USD10bn of USD debt issued by Asian banks is due in 2012 and 2013 (Figure 12). Korean banks, such as Shinhan, Hana, Kookmin, Export-Import bank of Korea and National Agricultural Cooperative Federation have senior bonds maturing, and Hana, Busan and NACF have subordinated debt callable in 2012. Although we expect most of the maturities to be refinanced in the USD market, Korean banks also have issued in Asian local currencies. Among Indian banks, only ICICI has senior bonds maturing this year (USD2.5bn). The bank will look to refinance these bonds, in our view. Hong Kong, Singaporean and Malaysian banks have subordinated debt callable in 2012. We expect gross supply of subordinated debt of USD2-3bn, compared with more than USD4bn coming due in 2012 and 2013 (Figure 13). We believe the Hong Kong banks will refinance in the USD market, Singapore banks will consider issuing in the USD or SGD market and Malaysian banks are more likely to refinance onshore.

2. Expansion/growth/M&A – We believe Asian banks will be opportunistic about acquisitions. The banks have the flexibility to tap local markets to fund transactions. We expect Indian banks to continue to expand their overseas branch networks and lending operations. This is likely to be a source of maiden issuance. We note that two potential new borrowers have completed/planned investor meetings in 2011, according to Bloomberg – UCO Bank and Allahabad Bank.

3. Asset-liability tenor matching – We expect Chinese state-owned banks, and Malaysian (CIMB, RHB and Maybank, according to Bloomberg) and Thai banks to be opportunistic issuers of USD bonds. Furthermore, Hong Kong banks are candidates for senior bond supply as Hong Kong liquidity remains tight.

4. Regulatory requirements – We look for banks in the region to issue more senior bonds as they focus on achieving Basel III net stable funding ratios.

We forecast gross supply of USD15-17bn from Asian banks



6 January 2012 16

Sovereigns

We look for Indonesia to be the biggest issuer, with about USD4bn of issuance split between straight USD bonds, USD sukuks and samurai bonds. During 2011, the Philippines made significant progress in its policy of shifting more of its debt into local currency. We expect issuance by the country primarily to maintain a liquid benchmark curve, and on a net basis, we would not be surprised if issuance was minimal. Furthermore, the Philippines has indicated that the sovereign will issue bonds to on-lend proceeds to PSALM. Sri Lanka will likely continue to be an issuer, with proceeds use of applied to maturing debt and to pay down obligations to the IMF. The high grade sovereigns in the region – Korea, Thailand and Malaysia – are likely to be more opportunistic in tapping the market.

Fundamental outlook

Corporates In Figure 14 and Figure 15 we discuss our fundamental outlook for Asian corporates. In general, with the exception of Indonesian coal companies, we expect high yield corporates’ credit metrics to deteriorate.

For Chinese property developers, the trend of declining property prices and lower transaction volumes is gathering momentum. We expect the government to continue to keep a tight lid on the sector, and any policy changes that could boost price expectations are unlikely. Hence, we expect smaller, unlisted developers to face increased pressure, which could lead to some consolidation in the industry.

For Chinese high yield industrials, the impact of China’s efforts to slow its economy was apparent in 2H11. To sustain product demand, corporates reported elevated levels of trade receivables in 1H11 and are also accepting bank acceptance notes with maturities of 3-6m in lieu of payments from customers. This has created a drag on cash flow. We see limited scope for improvement in 1H12. Overall, we expect credit quality to deteriorate in 2012.

In contrast, we see stable to improving credit profiles for Indonesian coal producers in 2012 on stronger cash flow and likely lower debt. Most companies are expected to maintain adequate to strong liquidity positions.

Indonesia and Philippines likely to be issuers

Figure 12: Financials redemption profile – senior debt Figure 13: Financials redemption profile – sub debt

USD bn

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

2012 2013 2014 2015

SK IN MJ CH

TA SG MA PH

TH HK

USD bn

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

2012 2013 2014 2015

SK IN MJ CH TA

SG MA PH TH HK

Source: Barclays Capital Source: Barclays Capital

Expect smaller, unlisted developers to face increased

pressure, which could lead to some consolidation in the

industry


6 January 2012 17

Fundamentals for investment grade corporates in aggregate are expected to remain stable in 2012, given their large asset bases and strong/adequate liquidity positions. Sectors such as Hong Kong property developers and Chinese SOEs will be the source of concern.

The Hong Kong property sector as a whole faces significant headwinds due to expected slowdowns in both China and Hong Kong. We see three sources of risk for this segment – declining property prices and increased land supply; weakness in retail sales, especially from mainland buyers; and refinancing risk that could lead to increased funding costs. This is driven by large refinancing needs in 2012-13, especially in the syndicated loan market, and deleveraging by European banks is leading to a smaller pool of providers of funds.

Figure 14: Fundamentals for high yield corporates

Funda-mentals

Gross new issue

Event risk

Valua- tions

Recommended positioning Positives Key Concerns

Chinese Real Estate

Negative Neutral to Up

Low Neutral Prefer larger/ mass-market developers versus smaller developers

We believe large, diversified developers focused on lower-tier markets will see better sales and retain adequate liquidity in the short term.

Deteriorating operating outlook. We expect the smaller, unlisted developers to face increased pressure, which could lead to some consolidation in the industry.

Diversified Industrials (South Asia)

Negative Low Low Negative Underweight We have a positive view of Gajah Tunggal’s near-term credit outlook. The near-completion of its plant expansion should allow for higher tyre production and lower capex in 2012.

Berlian Laju Tanker faces near-term liquidity risk. Chandra Asri could face an increasingly challenging operating environment in 2012, given the global macroeconomic uncertainty

Diversified Industrials (North Asia)

Negative Low High Negative Underweight We think the sector’s outlook for 2H12 is biased to the downside due to macroeconomic uncertainties. We expect credit quality to deteriorate. Reflecting tight liquidity conditions, Chinese corporates reported elevated levels of trade receivables in 1H11.

Indonesian Coal

Positive Up High Positive Overweight We see improved credit profiles for the Indonesian coal producers in 2012 on stronger cash flow and likely lower debt. At end-3Q11, Adaro, Berau and Indika had cash balances that were at least double their short-term debt. We think they should be able to maintain robust liquidity levels, as free cash flow should be flat to positive.

Companies have expressed an intention to acquire coal assets. Depending on the size of any acquisition and the financing method, such deals could weaken liquidity positions and credit profiles.

Resources Negative Neutral High Neutral Market Weight Fundamentals for the Chinese coking coal market remain relatively healthy, as we expect the supply deficit in China to persist in 2012.

Credit profiles may weaken, as we expect the significant capex plans of both CITIC Resources and MIE Holdings to result in free cash flow remaining negative. Although Vedanta’s credit profile is weaker following Cairn India acquisition, it remains resilient.

TMT and Utilities

Stable Neutral Neutral Neutral Market Weight We believe the near-term credit outlook for Cikarang and Star Energy is stable.

Bakrie Telcom’s liquidity position. Star Energy, faces some uncertainty related to the construction delays of its Unit 3 power plant.

Note: To view Barclays Capital’s fundamental ratings on the issues listed in this table, please go to Barclays Capital Live. Source: Barclays Capital

Hong Kong property sector as a whole faces significant

headwinds


6 January 2012 18

Figure 15: Fundamentals for high grade corporates

Funda-mentals

Gross new issue

Event risk

Valua- tions

Recommended positioning Positives Key concerns

Chinese high grade real estate

Stable Neutral Low Neutral Market Weight State-owned developers benefit from access to local and international capital markets at competitive pricing, partly as a result of their state-owned status. Diversified business models to help them weather the headwinds facing the sector.

Deteriorating operating outlook

Diversified Industrials

Stable Up (oppor-tunistic)

Low Neutral We expect Hong Kong conglomerates (Hutchison Whampoa and Swire Pacific) to remain resilient to the expected economic slowdown due to the diversified and low-risk nature of their core businesses.

Steel sector to remain under pressure, as weak underlying demand and sentiment have already started to weigh on steel prices.

Hong Kong Property

Negative Up High Negative

Cautious on Hong Kong property companies and Korea steel makers; Market Weight rest of the sector Prudent financial management,

stable credit profiles and recurring income from investment property.

Declining transaction volumes, higher mortgage rates, reduced loan-to-value (LTV) ratios for residential mortgages and increased land supply are expected to create headwinds for this sector. We do not expect headline risk to fade soon and do not see any near-term positive credit catalysts for this sector.

Resources Stable Up High Positive Overweight Supportive crude oil prices. Integrated and E&P operators to remain acquisitive. Cautious on refining margins and weak petrochemical spreads.

Telecoms Stable Neutral High Neutral Market Weight Robust operating cash flows and stable credit metrics, supported by strong business profiles.

Expansion in non-core businesses; potential shareholder-friendly activity.

Utilities Negative Neutral Low Neutral Market Weight Despite deteriorating standalone credit metrics and some negative credit outlook revisions by rating agencies, in Malaysia and Korea we expect sovereign links to remain supportive of the utilities’ current ratings.

Elevated fuel prices mean the operating margins of Korean and Malaysian utilities, which do not benefit from automatic cost pass-through mechanisms, will remain under pressure. Geopolitical risk on the Korean peninsula will cast a shadow. With large capex programmes and less-than-robust operating cash flow, we expect debt issuance from the utilities to continue over the near to medium term.

Note: To view Barclays Capital’s fundamental ratings on the issuers listed in this table, please go to Barclays Capital Live. Source: Barclays Capital

Ratings outlook

After more positive rating actions in 2010, the number of corporate downgrades outnumbered upgrades in 2011. Corporate ratings and outlook downgrades were concentrated in the Chinese high yield segment.

In Figure 17 we identify possible upgrade and downgrade candidates among corporates we cover. In addition we expect negative outlook changes for: 1) Tenaga (by Moody’s), if the gas shortage persists through 2012; and 2) POSCO (by S&P and Moody’s), on further deterioration in earnings leading to higher leverage ratios. For Noble Group, we expect CW

Trajectory of ratings will be biased downward, especially for

high yield corporates


6 January 2012 19

Negative to revert to Negative outlook at S&P and no ratings downgrade. We expect Moody’s to change Evergrande’s outlook to Stable from Negative.

Going into 2012, we believe the trajectory of ratings will be biased downward, especially for high yield corporates.

Asian credit did not have any defaults in 2011, a fact we attribute to the limited number of credits traded in the market. China Forestry undertook a voluntary restructuring. Sino-Forest missed an interest payment on its convertible debt in December 2011, but the company is in discussions with bondholders to avoid a default.

Although we expect defaults to rise next year, the number will depend on the extent of the slowdown in China. The sectors facing potential stress include shipping, Chinese industrials and Chinese property. Beyond issuers that are already trading at distressed levels, identifying default candidates will remain challenging because even in such sectors as Chinese real estate, companies continue to have access to alternative funding sources.

Figure 16: S&P ratings action for Asian credit

911

46

17 18

31

42

10

24

8

1417

29

11

23

11 11

28

10

0

5

10

15

20

25

30

35

40

45

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Downgrade Upgrade

Source: S&P Ratings, Barclays Capital

Figure 17: Expected rating actions for Asian corporates

Issuer Ratings view

Downgrade High Grade SK Telecom (S&P, Moody's) – upon completion of the acquisition of the 20% stake in Hynix.

Upgrade Gajah Tunggal (Moody's) – on an improving credit profile. Expect lower capex as the company is close to completing its plant

expansion. Hynix All agencies have placed their ratings on review for upgrade following the SKT stake acquisition. Indosat (S&P) – completion of its tower sale and subsequent deleveraging may result in positive outlook change. Downgrade Bakrie Telecom (Fitch) – net debt/EBITDAR trigger was exceeded in 2010, but the agency remains hopeful for an imminent

improvement. BLT (S&P) – on refinancing risk in 2012. Chandra Asri (S&P) – deterioration in credit metrics and weakening of liquidity position. China Oriental (Moody's) – will likely exceed debt/EBITDA trigger by end of 2011.

High Yield

Pacnet (Moody's) – not likely to meet negative rating trigger of USD80mn EBITDA in 2011; (Fitch) – will likely fall below FFO/interest trigger in 2Q12.



6 January 2012 20

Figure 18: Fundamentals for financials

Funda-mentals

Gross new issue

Event risk

Valua- tions

Recommended positioning Positives Key concerns

Hong Kong

Negative Up Neutral Negative Asset quality concerns and potential for issuance are a headwind for Hong Kong banks.

India Negative Up Capital raising for SBI

Negative Stay cautious on Indian bank senior debt, given asset quality concerns and expected issuance.

Korea Stable Up High Stable Korean banks have bolstered their capital position over the past two years, and we expect this trend to continue. During 2012, we look for the banks to access funding markets in a variety of different currencies. In aggregate, the measures being taken are likely to result in an improved, stable funding and are a positive.

Further cleanup of the balance sheet should add to credit costs. Overall, net profits are likely to be lower.

Malaysia Stable Neutral to Up

High Stable

Singapore Stable Neutral to Up

Neutral Stable Singaporean banks remain fundamentally strong, but valuations are not compelling.

Thailand Stable Neutral to up

Stable Stable

Overall Market Weight. Cautious on HK LT2 bullets and Indian banks. In subordinated debt, Korean bank LT2s are pricing in minimal extension risk and are unattractive.


Financials We expect asset quality to deteriorate, credit costs to rise and earnings to moderate. In particular, we expect the credit profiles of Indian and Hong Kong banks to come under pressure. In Figure 18 we discuss our expectation for the credit fundamentals by banking system.

Ratings outlook

Among financials, Moody’s has recently downgraded its outlook on the Indian bank sector’s ratings to Negative. On average, weaker capital ratios and increased asset quality pressures could be a source of ratings pressure for Indian banks.

Sovereigns Weak global growth and a deteriorating external funding environment will highlight Asian sovereigns’ vulnerabilities. Across sovereigns, vulnerabilities vary and include factors such as dependence on external funding, lack of deep and developed local capital markets, export dependence on China and Europe, exposure to commodity prices and related subsidy regimes, and the ability policymakers to respond. This backdrop is likely to test the reforms put in place to mitigate external risks. We expect credit ratings to remain broadly stable and do not expect widespread deterioration in credit fundamentals. In Figure 19 we discuss outlook for the Asian high yield sovereigns.

Asset quality to deteriorate, credit costs to rise and earnings

to moderate

Weak global growth and a deteriorating external funding

environment will highlight Asian sovereigns’ vulnerabilities


6 January 2012 21

Figure 19: Fundamentals for sovereigns

Funda-mentals

Gross new issue

Valua-tions Ratings Outlook Positives Key concerns

Indonesia Stable to improving

Up Positive Expect Moody’s to change outlook to Positive. Investment grade rating from two of the three agencies in 2H12.

While debt ratios and external liquidity ratios have deteriorated slightly, they are in line with or better than peers in the rating category.

Infrastructure deficiencies and inadequate institutional strength weigh on credit quality. Sources of risk for Indonesia credit stem from a sharp reversal of portfolio flows and potential political uncertainty (elections in 2014). Vulnerable to deterioration in external funding environment and lower commodity prices.

Philippines Stable Up Neutral Expect outlook to be changed to Positive.

Successful implementation and execution of RATS/RATES programmes in 2011 has increased tax collection revenue. External liability management has improved debt profile. Political front remains stable for now as President Aquino continues to enjoy popular support.

Progress on public/private partnerships and government capex has been slow. Uncertainties on political front could stall reform process. Expect export sector to come under pressure on global growth concerns.

Sri Lanka Stable with risk of deterioration from external factors

Up Neutral No change. Growth remains robust. Revenue reforms carried out successfully.

Trade links to Europe are a source of risk. Vulnerable to deterioration in external funding environment. Most recent data (December 2011) show foreign reserves at USD6bn, down from USD8bn in August 2011.

Vietnam Negative Low Negative No change. Banking system poses a contingent debt risk. Policy uncertainty.


CNH Market – food for thought Regulatory changes continue to spur market development “Dim sum” bonds, which are RMB-denominated bonds issued in Hong Kong, remain the dominant RMB asset class in Hong Kong. Issuance of these bonds has risen significantly since 2010, but remains well short of the growth in offshore RMB deposits. Strict regulations related to bond issuance and the remittance of proceeds are the main bottlenecks. That said, policymakers have shown an intention to liberalise access to this market for onshore borrowers, albeit gradually. Measures that permit Hong Kong entities to make direct RMB investments into China are also spurring dim sum bond issuance, with the Baosteel transaction being the first to utilise the recent changes.

Growth in the sector has been rapid – we estimate new issuance of CNY165bn (USD26bn) in 2011, compared with a total market size of CNY209bn as at the end 2011. This rapid growth is likely to continue, in our view, driven by expectations of CNY appreciation and the lack of attractive alternative offshore RMB investments. CNH bonds have also become an attractive asset for investors looking to diversify their currency risk.


6 January 2012 22

Expect CNH corporate bond issuance to remain high We expect CNH corporate bond issuance to remain robust for the following reasons.

1. Chinese policymakers’ desire to continue the internationalisation of the CNY. We expect policy to continue to encourage onshore borrowers to use the CNH market as a means of diversifying funding sources and deepening the market.

2. Credit conditions are likely to remain tight in China even as monetary easing gets underway.

3. The dim sum bond market offers a unique low-cost funding source.

4. As the investor base expands, bond indentures and structures are likely to continue to evolve and include stricter covenants.

A key risk to this market would come from a reversal in expectations of CNY appreciation, most likely stemming from any sharper-than-expected slowdown in growth in China. So, an extended period during which the CNY does not appreciate against the USD, such as mid-2008 to mid-2010, would create a headwind for the market.

We expect the CNY to face continued depreciation pressures in the coming months. Capital outflows, together with a narrower trade surplus (USD14.5bn in November and USD17bn in October, and YTD surplus down 18% y/y; we forecast a trade deficit in 1Q12) and slower FDI (USD8.8bn in November, down 10% y/y, and USD8.3bn in October) given a slowing global economy and weaker investor sentiment, are likely to reduce appreciation expectations and reinforce depreciation expectations. For now, our economists maintain their forecast of modest 2-3% CNY appreciation against the USD over the next 12 months.

We discuss our views on the CNH market in detail in CNH Market Primer: Food for thought, 8 November 2011.

Key risk to this market would come from a reversal in

expectations of CNY appreciation

For now, our economists

maintain their forecast of modest 2-3% CNY appreciation

against the USD over the next 12 months

Figure 20: CNH issuance --- issuer profile

Figure 21: CNH issuance --- tenors

Financials48%

Sovereign/Quasi16%

Corporates35%

Supranationals

1%

<1y8%

1-3y38%

3-5y40%

>10y2%

5-10y12%

Source: CMU, Barclays Capital Source: CMU, Barclays Capital



6 January 2012 23

SUMMARY RECOMMENDATIONS – FINANCIAL INSTITUTIONS

Overweight Market Weight Underweight

Export-Import Bank of Korea AmBank (M) Bhd Australia & New Zealand Banking

Kasikornbank Bank of Baroda Axis Bank

Korea Development Bank CIMB Bank Bangkok Bank

DBS Bank Bank of China HK

Export-Import Bank of China Bank of East Asia

Export-Import Bank of India Bank of India

Hana Bank Canara Bank

ICICI Bank CITIC Bank International

Kookmin Bank Commonwealth Bank of Australia

Korea Exchange Bank Dah Sing Bank

Krung Thai Bank Fubon Bank (Hong Kong)

Macquarie Group Hyundai Capital Services Inc

National Agricultural Cooperative Federation IDBI Bank

Oversea-Chinese Banking Corp Industrial Bank of Korea

Public Bank Bhd National Australia Bank

Shinhan Bank Westpac Banking Corp

State Bank of India

United Overseas Bank

Wing Hang Bank

Woori Bank

Note: Shaded areas denote change of rating or initiation of coverage. Source: Barclays Capital


6 January 2012 24

SUMMARY RECOMMENDATIONS – CORPORATES

Sector Overweight Market Weight Underweight

High Grade China Resources Land China Overseas Land & Investment ENN Energy Holdings (Xinao)

Corporates Korea Hydro & Nuclear Power (KHNP) CNOOC Hongkong Land Holdings

Reliance Industries GS-Caltex Corp Korea Gas Corporation (KOGAS)

Henderson Land Noble Group

Hutchison Whampoa Petroliam Nasional (Petronas)

Hyundai Motor POSCO

Korea Electric Power Corp SK Telecom

Korea Land and Housing Corp Sun Hung Kai Properties

Korea National Oil (KOROIL) Tenaga Nasional

Korean gencos

PCCW

PTT Exploration & Production

PTT Global Chemical

PTT pcl

SK Broadband

Swire Pacific

Telekom Malaysia

The Wharf (Holdings)

Woodside Petroleum

High Yield Berau Coal Agile Property Adaro Indonesia

Corporates Bumi Resources Central China Real Estate Bakrie Telecom

Country Garden ('15s, '17s and '18s) China Oriental Group ('15s) Berlian Laju Tanker

Evergrande Real Estate Cikarang Listrindo Chandra Asri

Fufeng Group CITIC Resources Holdings China Oriental Group ('17s)

Gajah Tunggal Country Garden ('14s) Glorious Property

Kaisa Franshion Properties Hopson Development

Pacnet Indika Energy ('16s) Hynix Semiconductor

Yanlord Land ('18s) KWG Property Indika Energy ('18s)

Longfor Properties Indosat

MIE Holdings Road King

MNC Sky Vision STATS ChipPAC ('16s)

Shimao Property Holdings Vedanta Resources ('14s)

Star Energy

STATS ChipPAC ('15s)

Vedanta Resources ('16s, '18s and '21s) Yanlord Land ('17s)

Note: Shaded areas denote change of rating or initiation of coverage. Source: Barclays Capital


6 January 2012 25

SOVEREIGNS


6 January 2012 26

SOVEREIGNS

Stirred, not shaken

Positioning Indonesia to outperform EM sovereigns: We recommend long-dated Indonesian sovereign bonds such as the INDON ’38s. We expect the sovereign to achieve IG rating from two out of three agencies in 2H 12, an event that should create incremental demand from IG-benchmarked investors. We see value in front-end bonds, but we acknowledge that liquidity is thin and execution can be challenging.

We expect the front and belly of the Indonesian curve to continue to trade at a premium to the Philippines, partly due to onshore demand for the latter’s bonds. However, we expect the yield on longer-dated Indonesian bonds to compress gradually towards the levels of Philippines paper. In 2012, we expect Indonesian sovereign credit to outperform other EM sovereigns.

Indonesia sovereign eligible for Barclays Capital Global Aggregate index on another IG rating If Indonesia receives another investment grade rating, the sovereign's USD bonds will automatically qualify for inclusion in the Barclays Capital Global Aggregate Index, but not for the US Aggregate index, under current rules. We expect the sovereign to receive a second IG rating in H2 12, which would pave the way for its inclusion in the Barclays Global Aggregate index.

Eligible for Barclays Capital Global Aggregate Index

We estimate that c.USD1.5trn in funds are benchmarked to the Barclays Capital Global Aggregate Index and USD2.6trn to the US Aggregate Index. Inclusion in the Global Aggregate Index should provide some positive technicals for Indonesian sovereign bonds, at least initially, based on incremental buying of USD200-400mn by passive investors (our estimate assuming 20-40% of AUM benchmarked is passively managed).

Not eligible for Barclays Capital US Aggregate Index

One of the criteria for inclusion in the Barclays Capital US Aggregate index is that the bonds have to be SEC-registered securities or SEC Rule 144A securities with Registration Rights. Indonesia's existing bonds do not meet this condition. Provided the sovereign files relevant information with the SEC, it should be able to issue new bonds that are SEC registered and therefore qualify for the US Aggregate Index. See Indonesia sovereign eligible for Barclays Capital Global Aggregate index on another IG rating, 16 December 2011 for full details.

Philippines – defensive holding: We like the belly of the curve given our expectation that onshore demand will remain robust. As such, we recommend being neutral on the liquid points (such as the PHILIP ’21s) on the curve and would look to add when new issues are launched. The recently issued PHILIP ’37s provide an opportunity to pick up yield along the curve. Overall, we view the Philippines as a defensive holding.

Avanti Save +65 6308 3116

[email protected]

Prakriti Sofat +65 6308 3201

[email protected]


[email protected]




6 January 2012 27

Philippine banks have reported steady declines in deposits in their foreign-currency deposit units (FCDUs), while peso deposits have been rising. However, in USD terms (using PHP/USD), FCDU amounts have risen (up 4.3% y/y as at June 2011). At the same time, the Philippines’ net outstanding amount of USD-denominated bonds has shrunk by more than 4% y/y, driven by liability management exercises such as the buyback conducted in 2011. This implies that the demand dynamics from onshore banks will remain robust, especially for the front and belly of the curve. We believe this dynamic lends further support to our view of the Philippines as a defensive holding.

Portfolio hedge: We continue to recommend using high grade sovereign CDS to hedge Asia credit portfolios. We like buying protection on China and funding via Korea at spread differentials wider than 15bp. We have a positive view on Korea sovereign credit, driven by the country’s improved external position – progress has been made to reduce external vulnerability and mitigate roll-over risk on foreign currency borrowing. Based on DTCC reported data, net notionals outstanding for China (USD9.3bn from USD4.7bn at end 2010) has risen the most in 2011 among Asian sovereigns. This provides technical support for our view that China CDS spread may come under pressure.

Macro outlook Exposure to European banks not a macro concern

In aggregate, Asia has much lower exposure to European banks (Figure 22) than other emerging market regions. We believe an orderly deleveraging by European banks (and potentially US banks) would not cause a significant disruption to lending or real activity in Asia, as we would expect strong local and regional banks from Singapore, Australia and Japan to step in (see Asian Banks: European bank deleveraging in Asia, 23 November 2011). Moreover, most Asian governments have strong buffers in the form of low budget deficits (except India and Sri Lanka) and large FX reserves (except Sri Lanka and Vietnam), against a backdrop of healthy current account surpluses (except India, Vietnam and Sri Lanka) and net positive international investment positions (except Korea, Indonesia and India). In short, we believe Asian policymakers would be able to backstop sudden outflows, if needed. We have also seen an increase in swap lines agreements between Asian central banks that could quickly be activated to deploy the region’s massive reserves and mitigate the impact of outflows associated with bank deleveraging.

Figure 22: Claims of foreign banks on Asian countries Figure 23: Share of exports by destination

0

5

10

15

20

25

30

TW MY KR IN PH TH VN ID LK CN

% o

f GD

P

FR GE UK US EU Periphery EU Others

0%

25%

50%

75%

100%

CN IN ID KR MY PH SL TH VNEurope US Asia Others

Note: Consolidated Banking Statistics – national banks, domestic and foreign subsidiaries exposure. Source: BIS article 9D Q2 2011, Barclays Capital

Note: As at June 2011. Source: CEIC, Barclays Capital

Orderly deleveraging by European banks should not

create significant stress in Asia



6 January 2012 28

Weak global growth to weigh on Asian exports

Europe and the US remain important export markets for Asia – taking on average 30% of the region’s exports (Figure 23). Within Asia, the most exposed to European growth from the export channel are Sri Lanka, China, India and Vietnam. Based on our sensitivity analysis Singapore, Malaysia, Korea and Taiwan are the most susceptible to slowing US growth.

Watching Chinese growth

The importance of China as an export destination has steadily increased. Within the region, Hong Kong, Taiwan and Korea have the largest share of exports to China. Indonesia’s reliance on China has risen, both through direct exports and via China’s influence on global commodity markets (65% of Indonesia’s exports are commodities).

Deteriorating external environment poses risk to portfolio flows and credit spreads

Indonesia and Malaysia are susceptible to swings in portfolio flows. Sri Lanka is vulnerable to the external funding environment because of upcoming foreign currency maturities. Among the high yield sovereigns, we think the Philippines is the best positioned for this scenario.

Figure 24: External vulnerability indicators (% of GDP)

-60%

-40%

-20%

0%

20%

40%

60%

80%

CN TH MY IN KR PH VN LK ID

S/T external debt Bond (foreign holding)Equity (foreign holding) Net FDIC/A surplus FXRNet

Note: Short term external debt data is as at Q1 11 from World Bank. Foreign holdings of local bonds are not available for China and Vietnam. Foreign equity holdings data is not available for Sri Lanka and Vietnam. Source: CEIC, BIS, Barclays Capital

Exposed to global growth

China’s increasing importance as a trading partner

Risk of reversal in portfolio flows


6 January 2012 29

ISSUER PROFILES

Republic of Indonesia

Weights Commentary

Overweight

We have a positive view on the Indonesian sovereign (BB+ Pos/Ba1 Stb/BBB- Stb) and expect its bonds to outperform other EM sovereigns in 2012. Fitch recently upgraded Indonesia’s ratings to investment grade. We expect the sovereign to receive another IG rating in 2H 12, which would automatically qualify its bonds for the Barclays Capital Global Aggregate. Assuming benchmark buying by passive investors, this could create incremental demand of USD200-400mn (c.2% of outstanding bonds). External position: Despite higher FX reserves (December 2011: USD110bn) and prudential measures to deter “hot” money inflows since the global financial crisis, the financial system remains vulnerable to risk sentiment given heavy offshore holdings of local-currency bonds and in the equity market. The economy is also highly leveraged to commodity prices (65% of exports). In addition private sector foreign borrowing has been rising (on average 14% y/y in 2011). Structural: On the structural reform side, the creation of the OJK (Financial Services Authority) and recent passage of the Land Acquisition Bill further underpin the sovereign’s positive ratings trajectory. A slew of recent corruption scandals are concerning and appear to have had an impact on the president’s popularity, which continues to fall. Although we do not expect political instability, these developments could dampen the reform agenda in the near term. Towards the latter part of 2012, we believe the political focus will shift towards potential candidates for the presidential election in 2014, as President Yudhoyono is not allowed to run for a third term. Supply outlook: We believe the government will look to tap the USD bond market early this year. The head of the MoF’s Debt Management Office has indicated that the sovereign will issue USD4bn in foreign currency bonds in 2012. This will include conventional dollar bonds, c.USD1bn of dollar sukuks and, we estimate, USD500-700mn of samurai bonds. Issuance in 2012 will likely be in the long end (10y and/or 30y) as the sovereign has expressed an intention to develop a full yield curve. The policy bias remains strongly towards avoiding any bunching up of maturities. In addition to sovereign issues, we expect USD1.0-1.5bn of issuance from quasi sovereigns, Pertamina and PLN. Both have large capex plans, and Pertamina also has a total of USD900mn of syndicated loans coming due in mid 2012. Valuations: We are comfortable with the sovereign’s overall credit profile and expect its bonds to outperform the EM sovereign index in 2012. We prefer the long-dated part of the curve (such as INDON ’38s). We also see value in the 10y point at 60-70bp over the Philippines. Although front-end bonds are cheap (INDON ’14s/’15s/’16s/’17s), we acknowledge that the lack of liquidity makes it difficult to execute. We expect the primary market to offer opportunities to add to holdings in 2012. Finally, we recommend adding exposure via quasi-sovereigns, such as PLNIJ at a spread of more than 130-140bp over the sovereign.


6 January 2012 30

Republic of Philippines

Weights Commentary

Underweight

The Philippines sovereign (BB Pos/Ba2 Stb/BB+ Stb) remains a defensive investment within Asia, in our view. We believe its bond spreads reflect the strong external position and improved debt management. But progress on structural reforms is required to boost the economy’s growth prospects. External position: The Philippines remains vulnerable to slowing global growth as it has a relatively high exposure to demand in developed markets and a lack of diversification in its export base. Low-value-added electronics, such as assembly and testing, comprise 70% of the country’s exports. Recent growth prints already show a drag from net exports. However, the turnaround in US ISM new orders offers some encouraging signs. Remittances remain a key pillar of support for the economy. The Aquino Administration has made impressive progress on the sovereign’s debt dynamics. We expect to see further progress as the sovereign continues to diversify funding instruments (such as GPNs, RTBs), lengthen duration and reduce its reliance on foreign currency financing. Fiscal position: Government underspending has been a drag on growth. PPP projects have been very slow to start – the first PPP project was only approved in December 2011. We expect government capex to rise as project details have now been delineated in the budget. But a risk is that spending remains constrained given corruption-related fears. Progress on structural reforms is important for the medium term. President Aquino promised no tax increases in the first 12-18 months of his term. As we draw close to the end of that timeline, the focus remains on his ability to pass and implement structural reforms that boost revenues. Successful passage of ‘sin’ tax legislation under discussion in parliament, we think, would be a clear positive for the sovereign credit profile given the structural boost to government revenue (approval expected by mid 2012). In the meantime, we would look for evidence that the momentum in administrative reforms related to revenue collection does not fade in the coming year. Other: On the policy front, the President’s focus is increasingly shifting towards an anti-corruption platform (as evidenced by recent action against ex-president Arroyo). However, there is a risk that political developments/clashes involving the previous president distract the government from much-needed reforms. In the near term, the Philippines could enjoy a period of increased political stability given President Aquino’s strong mandate. But the government’s popularity appears mainly tied to the personality of the President, who can serve only one term (expires in 2016), which creates the risk of discontinuity. Supply outlook: The government plans gross overseas debt sales of USD2.25bn for 2012, compared with USD2.75bn realised in 2011 – the latter in line with our expectations and against planned issuance of USD3.25bn. The government’s bias remains to reduce its reliance on foreign currency borrowing, which, to us, suggests the potential for further GPN issues in 2012. However, given attractive costs for dollar financing combined with the government’s desire to maintain a presence in the market, we believe supply is likely to be balanced between USD bonds and GPNs. Furthermore, the Philippines has indicated it will issue bonds (balanced between offshore and local) and on-lend the proceeds to the Power Sector Assets And Liabilities Management Corp (PSALM) to refinance some of its PHP85bn (c.USD1.9bn) debt maturing in 2012. Following USD1.5bn of issuance recently, we expect the sovereign to issue additional USD0.5-1.0bn during the rest of the year, either via gross supply or during liability management exercises. Valuations: We like the belly of the curve given our expectation that onshore demand will remain robust. As such, we recommend being neutral on the liquid points (such as PHILIP 21s) on the curve and look to add when new issues are launched. The recently issued PHILIP ’37s provide an opportunity to pick up yield along the curve. Overall, we view the Philippines as a defensive holding.


6 January 2012 31

Democratic Republic of Sri Lanka

Weights Commentary

Neutral

We have turned neutral on Sri Lanka (B+ Pos/B1 Pos/BB- Stb). We think the best of the credit story is behind us and do not expect the sovereign’s bonds to provide alpha for a sovereign portfolio. External position: The expropriation bill, although a one-time exercise according to the government, could be a source of concern for foreign investors regarding property rights. Near term, we think the bill’s passage may dampen FDI and domestic investment sentiment. Sri Lanka’s balance of payments position remains vulnerable to swings in commodity prices. Slowing global trade also poses downside risks to transhipment activity and exports (30-40% go to Europe). Overall, we expect the 2011 BoP to be in deficit and recent commentary from the central bank indicates that FX reserves declined to USD6bn by end-2011, in line with our view (implying an import cover of four months). The latest reserve prints indicate that the foreign reserve position deteriorated significantly in Nov/Dec, in contrast with other countries in the region. It is also worth noting that a significant portion of the country’s FX reserves comprise borrowed funds (eurobonds, IMF disbursements and foreign holdings of treasuries). The central bank governor has indicated plans to negotiate a follow-up surveillance programme with IMF. We think this move is intended to bolster confidence among investors. Supply outlook: The government’s 2012 budget assumes LKR175.3bn (c.USD1.5bn) of foreign financing (LKR55bn (c.USD0.5bn) is the foreign commercial component). We forecast the sovereign to issue at least USD1bn in 2012, with the proceeds used to repay maturing debt and obligations to the IMF. We estimate that USD1.7bn of repayments are due in 2012 (including interest and principal on bonds, loans and IMF dues, which start in April 2012). Valuations: We are more cautious on Sri Lanka and recommend a neutral position in the near term. Sri Lankan sovereign bonds are subject to gap risk because they are not very liquid. Along the curve, we like the SRILAN ’21s. Recent data support our view that the external position remains vulnerable.

Socialist Republic of Vietnam

Weights Commentary

Underweight

We recommend an underweight position in Vietnam sovereign (BB- Neg/B1 Neg/B+ Stb) bonds, a view driven by a combination of the macro backdrop and valuations. External position: Vietnam is not well positioned against a backdrop of weak global growth. The economy is vulnerable via trade links and commodity prices. We maintain our view that structural flows will more than cover the trade deficit; however, limited onshore confidence in the VND implies that these flows will not be fully reflected in foreign reserves, in our view. According to Le Xuan Nghia, an advisor to the Prime Minister, FX reserves were equivalent to about 7.5 weeks of import cover as of October 2011 – roughly USD15bn vs USD12bn at end-2010. Contingent liability: Contingent banking sector liabilities also weigh on the Vietnam credit outlook. Tight credit conditions against a backdrop of slowing growth have meant bank asset quality has deteriorated. System-wide, the NPL ratio rose to 3.3% in November from 2% at end-2010. Recent press reports have noted government plans to restructure and strengthen the banking system. The World Bank is expected to support this programme, according to recent press reports. While we think a successful implementation of banking system reforms would be positive for the credit, the current lack of transparency weighs on fundamentals. Furthermore, resolution of Vinashin’s debt restructuring remains a headwind in the near term. Policy: The policy focus remains to macro stability for the time being. But we believe it is gradually shifting towards promoting growth, as reflected by the 1% depreciation of the official VND rate in October and recent comments from the State Bank of Vietnam (SBV). Selective easing is underway, with the SBV encouraging banks to lower lending rates to SMEs and the export sector. In our view, the key risk for Vietnam is that the central bank eases too much, too early (a repeat of 2010). Our economists’ base case is for interest rate cuts of 200bp in Q1 and 100bp in Q2. Supply outlook: We do not expect Vietnam to tap the USD bond market in 2012. The unresolved status of the Vinashin restructuring continues to weigh on investor sentiment. Foreign currency borrowing will most likely be via official development assistance (ODA) or multilateral/bilateral loans. Valuations: We believe current spreads on Vietnam’s sovereign bonds do not provide sufficient compensation for their volatility or limited liquidity. Furthermore, we expect headwinds in the near term – including a potential shift in policy towards growth, despite continued high inflation; contingent liabilities in the banking system; and FX depreciation. We recommend being underweight Vietnam. The unofficial VND/USD rate trades at a premium of 1% to the official rate. In the near term, we see a risk that the premium may increase given the rollover risk on USD loans. This may lead to widening of Vietnam sovereign CDS. The government’s bias, in our view, is to gradually depreciate the VND to support exports; we forecast 5% depreciation in 2012.


6 January 2012 32

Republic of Korea

Commentary

N/A We have a positive view on Korea sovereign (A Stb/A1 Stb/A+ Pos) credit driven by sound and improved external position. External position: Total external borrowing remains high, making the country vulnerable to any sharp deterioration in the external funding environment (Sep 2011: gross short-term external debt was USD139bn; banks account for 74% of the total). However, since 2008 progress has been made to reduce the external vulnerability and mitigate roll-over risk of foreign currency borrowing – regulatory measures to buffer against adverse external changes (eg, encouraging banks to term out foreign currency debt). For these efforts, we believe the sovereign deserves some credit. Geopolitical risks: Following the death of North Korean leader, Kim Jong Il in mid-December, the focus is on the durability of that country’s new administration. Our base case is that ahead of the 100th anniversary of Kim II Sung’s birth, the transition of leadership to Kim Jong Un will be orderly and the status quo maintained. Valuations: We recommend selling Korea sovereign CDS versus China at a spread differential of more than 15bp as a portfolio hedge. Among cash bonds, as discussed in the banks section, we would express a positive view on Korea via the policy banks for the yield pick up offered over the sovereign.

Federation of Malaysia

Commentary

N/A Malaysia (A-/A3/A- all Stb) has a strong external liquidity position, but the sovereign is vulnerable to fluctuations in global commodity/energy prices given its dependence on oil-related revenues. Our economists expect elections in March 2012. While we do not foresee any disruption around the elections, sovereign CDS pricing may come under pressure on headlines. Valuations: We expect Malaysian sovereign bonds (sukuks, ie, excluding the KNBZMK ‘16s) to benefit from onshore demand, especially given the lack of liquid dollar bond issues by Malaysian corporates. The sovereign bonds also benefit from strong demand from the Middle East. The KNBZMK ‘16s, on the other hand, should benefit from wider offshore demand as they are included in the EMBI Index and offer a higher spread compared with Petronas bonds (which are also in the index). Generally we like the KNBZMK ‘16s at more than 20-25bp above the MALAYS ‘16s. Sukuk demand: Islamic banks/funds/Takaful companies can only buy Sharia-compliant assets or hold cash, ie, they cannot hold conventional bonds or treasuries. Deposit growth has outpaced loan growth in the Middle East over the past three years. Loan growth dropped from an average of 30% pa in the pre-2008 period to less than 9% in the past three years. Also, in the GCC countries demand deposits make up 20-50% of total deposits. This means most banks have significant short-term maturity mismatches between assets and liabilities, hence, they maintain a high proportion of liquid instruments on their balance sheets. In short, demand for sukuks is driven by the strong liquidity of Islamic banks, the relatively scarcity of sukuk supply and limited availability of alternative Islamic investment products.

Kingdom of Thailand

Commentary

N/A Macro fundamentals for Thailand (BBB+/Baa1/BBB all Stb) are intact and growth is expected to pick up, supported by flooding relief and reconstruction efforts. The political situation appears to be stable, with the government’s focus on countering the effects of the recent floods on growth and economic activity. However, news regarding ex-premier Thaksin, including visits to countries in the region and re-issue of a Thai passport, could create a risk of political instability. Valuations: As a tail risk hedge for Thailand, we recommend buying protection at levels tighter than 30bp to Malaysia. Our base case is that political situation will remain stable, at least until Q2.

Note: Where indicated, ‘weights’ refer to our EM Local Bond Portfolio. See The Emerging Markets Quarterly, page 19, 6 December 2011.



6 January 2012 33

ASIA-PACIFIC FINANCIAL INSTITUTIONS


6 January 2012 34

NON-JAPAN ASIA BANKS

Position defensively in 2012 Sector positioning

While our base case scenario is still for Asian banks to call their bank capital instruments at first call date, we believe these instruments should price in a higher probability of non-call following the stream of liability management exercises conducted by the European banks. With increased market scrutiny of back-end coupons and the potential for market convention to increasingly move towards calls based on economic rather than reputational basis, we see little scope for outperformance and have a Market Weight stance on Asian bank capital.

Underweight Hong Kong banks’ sub debt as we expect the bonds to underperform on supply and concerns about the Chinese economy. Although we are cautious on this segment, we would not recommend shorting bonds as some of them trade special in repo.

In the senior bond space, we prefer the Korean policy banks to commercial banks due to the expected supply pipeline of the latter. We continue to recommend a cautious stance on Indian banks given an expected deterioration in asset quality and concerns about the Indian economy.

Trade recommendations

Buy 5y CDS on Bank of China, sell 5y CDS on ICICI

Buy 5y sub CDS on DBS, sell 5y sub CDS on UOB

Buy BNKEA 6.375% ‘22c17 versus sell BNKEA 6.125% ‘20

Tougher road ahead in 2012 Asset quality to come under pressure across the region

We expect non-performing loans to creep up across the region, as a result of the moderation in economic growth. In particular, we believe export-oriented borrowers may face greater stresses given weakness in external demand. Idiosyncratic issues such as the impact of the recent floods in Thailand and power sector problems in India could further add to NPLs. Consequently, credit costs are likely to increase, albeit from the current low levels (excepting India where credit costs were already a drag on earnings in 2011).

Tight liquidity conditions to remain

Liquidity conditions have generally tightened across Asian banking systems, as reflected in the rise in loan-to-deposit ratios. While we expect loan growth to moderate in 2012, we do not believe liquidity will ease significantly due to the offsetting factors of European bank deleveraging and selective (rather than broad-based) loosening in credit conditions in China. Banks’ margins, however, could see a slight reprieve from the pressures of the past couple of years as loans are repriced higher.

Earnings momentum to moderate

In our view, banks’ earnings are likely to moderate due to the slowdown in loan growth and rise in credit costs. Moreover, continued volatility in capital markets could weigh on trading and investment income.


[email protected]

Lyris Koh +65 6308 3595

[email protected]

Nicholas Yap +65 6308 3180

[email protected]


6 January 2012 35

Supply will remain robust, especially from Korean commercial banks

We expect the supply pipeline to remain healthy, with Korean commercial banks likely to be among the first banks in Asia to issue bonds once the markets reopen in 2012. Indeed, we believe recent events in North Korea have provided increased impetus for Korean banks to secure USD funding early this year. We also expect Indian banks (ICICI in particular) to tap the senior bond markets if spreads stabilise at tighter levels. However, given the poor market sentiment towards Indian banks, we think maiden issuance is less likely this year. In our view, Hong Kong and Singaporean banks are also likely to be opportunistic issuers given elevated USD loan-to-deposit ratios.

Figure 25: Loan-to-deposit ratios have increased

Figure 26: Gross NPL ratios

70%

75%

80%

85%

90%

95%

100%

105%

110%

Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

HK SG TH

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

TH MY IN KR SG AU CN HK

Note: HK LDR is for HKD loans and deposits. SG LDR is for DBU. Source: Central banks, Barclays Capital

Note: Latest available data used. Source: Banks, Central banks, Banking regulators, Barclays Capital


6 January 2012 36

AUSTRALIA BANKS

Underweight the big four Australian banks Sector positioning

Underweight, negative on senior debt, positive on bank capital: Our Underweight credit ratings on the big four banks reflect the tight valuations of their senior bonds relative to their benchmarks and our expectations of increased pressure on asset quality due to the subdued economic outlook. In the bank capital space however, we believe there is scope for the Australian banks to outperform. In our view, the probability of non-calls from the Australian banks is lower compared with the European banks given the former’s stronger fundamentals as well as their concerns about knock-on impact of non-calls on their cost of senior funding.

Trade recommendations

Buy 5y CDS on NAB, sell 5y CDS on CBA/WBC

Multiple headwinds in 2012 Given the subdued prospects for credit growth and potential pressure on margins from higher wholesale funding costs, we expect the banks to focus on containing (if not reducing) operating expenses. Credit costs could also increase, as the Australian banks’ loan portfolios are not immune to the challenging economic environment – delinquencies in banks’ mortgage and business portfolios are likely to pick up, in our view. That said, considering the banks’ healthy provisioning and capital levels, we believe they are well-positioned to weather a rise in NPLs.

European deleveraging offers opportunities for Australian banks We believe the Australian banks are well-placed to benefit from European bank deleveraging. In particular, we believe that ANZ will be able to accelerate the execution of its super-regional strategy and gain market share in syndicated lending and trade finance. The bank already has a local presence in key markets in Asia (eg, branches in India and China, RMB cross-border trade approval in Hong Kong) and the physical infrastructure, we believe, to take advantage of this likely regional financial sector shake-up. For CBA, its experience in areas such as


[email protected]

Lyris Koh +65 6308 3595

[email protected]

Nicholas Yap +65 6308 3180

[email protected]

Figure 27: Deposit growth outpacing loan growth Figure 28: Big four banks’ debt maturities (AUD bn)

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

y/y loan growth y/y deposit growth

0

5

10

15

20

25

30

35

ANZ CBA NAB Westpac

FY12 FY13

Source: RBA Source: Banks, Barclays Capital


6 January 2012 37

infrastructure lending and asset (aircraft) finance mean it is well placed to capitalise on the retreat of European banks to augment weak growth in its domestic market.

On the liabilities side, we note that the Australian banks have benefited from the concerns of US money market funds (MMFs) about the European sovereign debt crisis – US MMFs have reduced exposures to European banks and increased it to Australian banks.

Covered bond issuance a positive We expect the big four Australian banks to issue about USD25-30bn of covered bonds in 2012. In addition to diversifying their sources of funding, covered bond issuance also provides a positive technical driver by reducing the supply of senior unsecured bonds. Indeed, coupled with subdued credit growth, we think the Australian banks could repay some of their foreign borrowings. We estimate that the big four banks have about AUD98bn of debt maturing in FY12.


6 January 2012 38

SUMMARY TABLE OF VIEWS ON NON-JAPAN ASIA BANKS

Earnings Liquidity/Funding Capital Asset quality Valuations

Australia Given the subdued outlook for credit growth and potential pressure on margins from higher wholesale funding costs, we expect the banks to focus on containing (if not reducing) operating expenses. Credit costs could also increase as the Australian banks’ loan portfolios are not immune to the challenging economic environment

Increased allocation by US money market funds to Australian banks as a result of the European sovereign debt crisis has provided cheap short-dated funding. With the launch of covered bonds, a new funding channel has opened. Consequently, we expect senior unsecured bond issuance from the big four banks to decline in FY12.

APRA has accelerated the deadline for meeting the minimum 7% CET1 CAR including the capital conservation buffer to 1 January 2016 (from January 2019 under Basel III). But we still expect the banks to be able to meet these requirements comfortably.

We believe delinquencies will experience a slight pickup as a result of the subdued economic environment.

We have Underweight ratings on the big four Australian banks, reflecting the tight valuations of their senior bonds relative to their benchmarks and our expectations of increased pressure on asset quality due to the subdued economic outlook.

China – Banking system liquidity is expected to remain tight as monetary policy loosening is likely to be selective.

Capital positions have generally strengthened following equity raisings. But the market remains concerned about the potential need for further capital raising given asset quality concerns.

Gross NPL ratios are still low but concerns regarding property and LGFP exposures remain, especially following news reports of LGFPs deferring some loan repayments.

–

Hong Kong Earnings expected to be lacklustre due to moderation in loan growth and uptick in credit costs. Margin pressure may be partly alleviated by rise in Hibor and upward repricing of loans.

Notwithstanding the slowdown in RMB deposit growth, we expect liquidity to remain tight due to monetary policy settings in China and European bank deleveraging.

Capital positions expected to remain stable. We expect banks to be conscious of the need to conserve capital to meet Basel III guidelines. HKMA is likely to release its Basel III guidelines in January 2012.

Gross impaired loans are likely to increase slightly as economic growth in China and Hong Kong moderates.

Underweight Hong Kong banks’ sub debt. But we do not recommend shorting the bonds due to the high cost of borrowing.

India Earnings to remain pressured by credit costs. The decline in demand for loans due to high interest rates and the uncertain regulatory environment will also weigh on earnings.

Liquidity conditions to remain tight. We expect benchmark issuers such as SBI and ICICI to tap the USD bond market when spreads tighten.

Capital injections from the Indian government in 2012 will boost the capital positions of state-owned banks. However, we expect banks’ capital positions to weaken again due to asset quality declines, weaker earnings and double-digit loan growth.

We expect asset quality to continue to deteriorate as high interest rates pressure borrowers’ repayment abilities, although RBI easing should reduce pressure on this front, albeit with a lag. Gross NPLs, however, could continue to trend higher due to idiosyncratic stresses in various parts of loan portfolios (eg, power and aviation).

We recommend a cautious stance on Indian banks’ senior bonds as spreads could widen on continued concerns about asset quality and the Indian economy. However, given the wide differential in carry between Indian banks and the EM Asia USD HG Credit Index, we believe Market Weight ratings on SBI, ICICI and BOB are justified.


6 January 2012 39

Earnings Liquidity/Funding Capital Asset quality Valuations

Korea We look for pre-provision profit to be stable. In 2012, we see limited scope for one-off gains from stake sales. Further cleanup of balance sheets should add to credit costs. Overall, net profits are likely to be lower.

During the next 3-6 months, Korean banks are likely to continue securing committed lines and putting in place bond issuance plans as a way to offset USD funding pressures. Over 2012, we look for these banks to access funding markets in a variety of different currencies. Overall, we view the measures being taken as positive.

Korean banks have bolstered their capital positions over the past two years. We expect this to continue, especially given the nudges in this area from regulators. We see a small but growing risk of capital depleting M&A activities.

Project finance (PF) loans are now a smaller percentage of loan portfolios and credit costs from this area should decrease. Given the high level of consumer indebtedness in Korea, we believe household loan delinquencies are likely to rise and need monitoring. Finally, with global and regional growth flagging, there is risk of SME NPLs rising.

We have Overweight ratings on KDB and EIBKOR and Market Weight ratings on the Korean commercial banks. Given the expected supply from the Korean commercial banks, we do not see much scope for outperformance over the next six months.

Malaysia Earnings growth to ease in 2012 due to slower loan growth and continued intense competition. Over the medium-term, Malaysian banks will likely have to consolidate or look to overseas expansion to boost earnings growth.

We expect Malaysian banks to opportunistically tap the USD senior bond market.

Banks’ capital positions likely to remain stable.

NPLs are likely to creep up in 2012 as a result of subdued global economic growth.

We have revised our ratings on CIMBB and AmBank to Market Weight from Overweight to reflect our view that their Tier 1s are less attractive following the stream of liability management exercises conducted by the European banks.

Singapore Earnings to moderate as loan growth slows and credit costs register an uptick in 2012. Over the medium term, we expect the banks to redouble their efforts to grow their overseas business to boost earnings.

Loan-to-deposit ratios have increased as loan growth outstripped deposit growth. In particular, USD liquidity has tightened significantly and we expect banks to be opportunistic USD senior bond issuers this year.

Capital positions to remain solid although the strong loan growth over the past year has resulted in a decline in capital ratios. Singaporean banks will be able to meet the MAS revised capital adequacy guidelines with organic capital generation, in our view.

We expect NPLs to register a slight increase as a result of the economic slowdown in Singapore. Our economists expect GDP growth to slow from 5.2% in 2011 to 3.0% in 2012.

We are Market Weight the Singaporean banks.

Thailand We expect earnings to come under some pressure due to higher operating expenses related to restoration of networks as well as a rise in credit costs. An expected rebound in loan growth due to reconstruction efforts could support net interest income.

Liquidity has tightened as reflected in the increase in system loan-to-deposit ratio to c.108% at end September 2011 from c.98% a year earlier. We expect tightened guidelines on the issuance of bills of exchange to increase competition for deposits.

Capital positions to remain stable.

Gross NPLs expected to increase due to the impact of recent flooding. However, ‘economic’ NPLs are likely to be higher than reported NPLs due to regulatory forbearance.

Upside on BBLTB bonds look limited given current tight spreads and potential political risk.


6 January 2012 40

ISSUER PROFILES

AmBank (M) Bhd (AmBank) Lyris Koh

Rating Rationale

Market Weight

AmBank (Baa2 Stb/BBB+ Stb/BBB Stb) is a wholly owned subsidiary of AMMB Holdings Bhd (AHB), which in turn is c.14.2% owned by EPF and c.23.8% owned by ANZ. Since its strategic partnership with ANZ began in mid-2007, AmBank’s fundamentals have improved, with both its asset quality and funding profile showing clear signs of progress. That said, the bank’s overall credit profile still remains slightly weaker than its peers. Also, although AmBank’s plans to rebalance its loan portfolio towards variable-rate loans and increase the proportion of corporate loans should be positive for its credit profile, we expect it to take time for the bank to see the benefits of this strategy. Partnership with ANZ: There was speculation early last year that ANZ would increase its stake in AHB after Malaysian Prime Minister Najib Razak said he would consider allowing ANZ to raise its stake in AHB to 49% if the central bank approved. We would view such a move as positive for AmBank’s credit profile, as the likelihood of support from higher-rated ANZ would rise if its stake in AHB increased. We note that Malaysia’s Financial Sector Blueprint 2011-2020 contains a recommendation to “accord more flexible foreign equity participation in financial institutions”. Earnings: Trends in AmBank’s earnings were generally muted in 2QFY12. The key surprise was the doubling in credit costs (c.15% of 2QFY12 pre-provision profit). Notably, AHB downgraded its profit growth target for FY12 to 10-12% from 14-16% to reflect its expectations for a weaker 2HFY12. We view AmBank’s more conservative lending stance as a prudent strategy given the uncertain global environment – the bank’s loan portfolio is broadly flat year-to-date. We also view positively AmBank’s focus on risk-adjusted returns and its decision not to compete aggressively in segments where it views the pricing as uneconomic (eg, mortgages). Funding: Due to its finance company background, AmBank’s funding profile is slightly weaker than its peers, with a greater reliance on wholesale funding. The bank’s gross loan-to-deposit ratio increased to c.98% at end-September 2011 as deposits fell q/q. The bank said the decrease in deposits was a deliberate strategy as it focuses on increasing its low-cost deposits. While AmBank has made some progress in this regard, its low-cost deposit ratio remains low, at c.12.7%. Asset quality: New impaired loans rose in 2QFY12, but the bank said asset quality remains sound and the increase was largely due to a legacy loan. Despite the rise in new NPLs, gross NPLs declined q/q due to a jump in write-offs. In our view, NPLs may creep up as economic growth moderates, although we believe the bank is generally well placed to weather a cyclical decline in asset quality. Capital: We estimate that AmBank’s core Tier 1 CAR improved to c.7.8% at end-September 2011. Valuations: Although some level of extension risk likely has been factored into current valuations, we think the risk/reward profile on the AMMMK 6.77% perp ’16s have become less compelling, especially following the liability management exercises conducted by European banks. Therefore, we lower our rating on AmBank to Market Weight from Overweight.


6 January 2012 41

Australia and New Zealand Banking Corp (ANZ) Krishna Hegde

Rating Rationale

Underweight

ANZ (Aa2 Stb/AA- Stb/AA- Pos) has been making steady progress with its super-regional strategy – it aims to source 25-30% of its group profit from APEA (Asia-Pacific/Europe/Americas) by 2017 – and has made good progress in building a local presence in key regional markets (eg, branches in India and approval for RMB cross-border trade in Hong Kong). Coupled with strong capital levels, we believe ANZ is in the pole position relative to its peers to benefit from European banks deleveraging in Asia. That said, we retain our Underweight rating on the bank, given that its senior bonds continue to trade materially tight of benchmarks, limiting the scope for outperformance. Asset quality: New impaired assets declined in FY11 (-24% h/h and -21% y/y), notably in the institutional portfolio. However, impaired mortgages increased as the bank tightened collection practices. The bank’s collective provision for credit-risk-weighted assets declined 9bp h/h, to 1.28%, largely due to the rise in risk-weighted assets. ANZ released collective provisions for natural disasters but increased its collective provisions for uncertainty in the global markets, leaving management overlay broadly stable on a y/y basis. For its mortgage book, 90+ day delinquencies fell h/h in 2H FY11, and 30+ day delinquencies were down 50bp. While we expect delinquencies to pick up slightly in FY12 as the 2008-09 vintages season, we believe ANZ is well positioned to absorb an increase in credit costs. Funding: In line with its big four Australian bank peers, ANZ has taken steps to expand its deposit base and decrease its reliance on wholesale funding – FY11 customer deposits as a proportion of total funding was c.61% versus c.58% in FY10. The bank also benefits from an increased allocation from US money market funds following heightened concerns about the European crisis. New covered bond legislation has opened up another avenue for funding. For FY11, term debt issuance including pre-funding amounted to c.AUD18bn, with an additional AUD1.34bn of hybrid capital raised. The hybrid capital raised is Basel III compliant and was mainly sold to retail investors. Management expects FY12 funding targets to be similar to FY11, and stated that the bank has seen huge inflows of short-term funds, of which it intends to tender out and use to fund trade finance. Earnings: ANZ reported FY11 net income of AUD5.36bn (up 19% y/y), but this fell short of the Bloomberg consensus of AUD5.47bn. Earnings were hurt by increased costs and lacklustre trading revenue (especially in 2HFY11) as a result of volatile market conditions – which was in line with its peers – as the bank decided to adopt a “risk-off” approach. The net interest margin excluding global markets increased 6.7bp y/y to 2.81%, reflecting loan repricing and mix changes. Management expects margins to stabilise and looks for strong volume growth from the Institutional and APEA divisions as ANZ capitalises on growth opportunities presented by European banks deleveraging. Capital position: ANZ’s capital position improved, with its FY11 Tier 1 CAR rising 43bp h/h and 84bp y/y to 10.94%, the highest among its big four bank peers. Under APRA’s proposed Basel III rules, the bank estimates that its common equity ratio would have been c.7.5% at FY11. We believe ANZ prefers to hold more capital to support its super-regional expansion strategy and is well positioned for potential balance sheet expansion given its solid capital levels. Valuations: Despite being in the sweet spot to benefit from European bank deleveraging and its generally sound fundamentals, ANZ’s senior bonds continue to trade tight to their benchmarks. While average spreads on senior bonds of US banks and Asia ex-Japan banks have widened c.171bp and c.117bp, respectively, since 1 August 2011, the ANZ 3.25% ’16s have widened only c.87bp over the same period. At those levels, the potential for ANZ’s bonds to outperform is limited, in our view.


6 January 2012 42

Axis Bank (Axis) Lyris Koh

Rating Rationale

Underweight

Axis Bank (Baa2 Stb/BBB- Stb/BBB- Stb) is the third-largest private-sector bank in India. However, the government has an indirect stake in the bank, largely via state-owned UTI Asset Management (c.23.6%) and Life Insurance Corporation of India (c.9.5%). The bank has grown rapidly: its assets have increased at a CAGR of c.31% over the past four years. The bank’s total nonconsolidated assets were c.USD47bn at end-September 2011. Axis has a leading market position in debt syndication and underwriting, and has obtained in-principle approval from the Reserve Bank of India to acquire the investment banking and equities business of Enam Securities. The bank recently said it intends to grow the proportion of its retail loans to c.30% from 21%. Earnings: Axis’ profitability metrics are generally strong – 1HFY12 return on assets was c.1.57% while return on equity was c.19.5%. The c.50bp q/q expansion in margins over 2QFY12 was a positive surprise, but given that management maintained its FY12 NIM guidance of c.3.25-3.50%, we think margins may narrow from the c.3.8% recorded in 2Q. Reflecting the challenges facing the sector’s asset quality, Axis’s credit costs more than doubled over 2QFY12 and accounted for c.18% of pre-provision profit. Funding: Axis’s low-cost deposit ratio was healthy at c.42% at end September 2011. However, we estimate that retail term deposits account for only about c.36% of total term deposits, indicating a dependence on bulk deposits. Since end-2009, Axis’s international assets have more than doubled to USD5.2bn. We believe Axis will need to tap either the USD bond or loan markets if it intends to continue to grow its international book at the same pace. Furthermore, with the incorporation of a UK subsidiary, we think there is scope for issuance from the new entity as well. Asset Quality: At c.1.2%, Axis’s gross NPL ratio appears low compared with its peers (ICICI: c.4.1%). However, on an absolute basis, the bank’s gross NPLs have increased consistently and the rate of new NPL formation picked up in 2QFY12. New NPLs were c.INR5bn in 2Q versus c.INR3bn in 1Q. There was also a jump in the amount of loans restructured in 2QFY12 due to the microfinance sector. Given its above-average growth over the past few years, there is a potential for Axis’s NPLs to increase as its loan book seasons. Moreover, the bank’s relatively sizeable exposure to the power sector could add to NPLs over the medium term considering the problems facing that sector. At end-September 2011, lending to the power sector accounted for c.9% of the bank’s total loans. Capital: Axis’s Tier 1 CAR has been on a declining trend over the past year and was c.9.3% at end-2QFY12 versus c.10.7% a year earlier. We also note that risk-weighted assets have grown faster than total assets. We view the decline in Axis’s capital position as a concerning trend given its ambitions to grow faster than the industry. Indeed, Fitch said that “Continued rapid growth and/or deterioration in asset quality that is not matched by higher levels of capital may lead to negative rating action”. Valuations: We affirm our Underweight rating on Axis Bank and think its bonds trade tight to state-owned Indian banks.

Bangkok Bank (BBL) Lyris Koh

Rating Rationale

Underweight

BBL (Baa1 Stb/BBB+ Stb/BBB+ Stb) is the largest bank in Thailand, with total assets of THB2015bn (USD64bn), c.21% of system-wide deposits and 18% of system-wide loans at end-September 2011. BBL has the largest international presence among Thai banks, with foreign loans accounting for 17% of total loans. The bank operates in Malaysia and China via its wholly owned subsidiaries Bangkok Bank Berhad and Bangkok Bank (China). Recent media reports suggest that BBL intends to expand in Malaysia and open four more branches in the country by 2016. Earnings: BBL’s earnings were robust during 9M11, with net profit rising c.13% y/y on healthy earnings and lower credit costs. However, we expect earnings to moderate over 4Q11 and in 1H12 as operating expenses and credit costs rise due to the impact of the floods. We believe loan growth slowed in 4Q11 and is likely to slow further in 1Q12 before rebounding. The contribution to earnings from its equity stakes in insurance companies is also likely to dip, in our view. Funding: Loan growth has outpaced deposit growth in Thailand, and consequently, liquidity has tightened. Given that the system-wide gross loan-to-deposit ratio was c.108% at end-September 2011, we view positively BBL’s ability to maintain its LDR in the 90% range. The bank’s low-cost deposit ratio was also a healthy c.48% at end June 2011. Asset quality: We expect the floods in Thailand to temporarily reverse the positive trends in asset quality seen over the past few years. BBL said that it expects its NPL ratio to rise to 3.5% in 1Q12 from c.2.8% at end 3Q11. Given that BBL’s loans are mostly to large corporates, which should be more able to weather the financial impact of the floods, we believe the bank is better placed than its peers to cope with stresses in its portfolio. Furthermore, BBL’s healthy c.184% coverage ratio should help to reduce the impact on earnings from a rise in NPLs, in our view. Capital: BBL’s capital position is robust, with a Tier 1 CAR of c.13.2%, and we expect it to be able to comfortably meet the higher Basel III capital requirements. Valuations: We continue to view BBL’s bonds as rich and maintain our Underweight rating on the bank. Political risk remains the key potential spread driver in our view.


6 January 2012 43

Bank of Baroda (BOB) Lyris Koh

Rating Rationale

Market Weight

Bank of Baroda (Baa2 Stb/NR/BBB- Stb) is c.57% owned by the Indian government and had total nonconsolidated assets of c.USD73bn at end-September 2011. We have long viewed BOB’s fundamentals more positively than the other Indian banks, given its slightly better credit metrics and steadier performance over the past year. However, the bank is not immune to macro headwinds, and its 2Q FY12 results showed mixed trends. We are also a bit more cautious about the bank’s strategy of growing faster than the industry given the challenging operating environment. Management changes are also in store in 2012, as CEO M.D. Mallya will be retiring. Earnings: BOB’s 2QFY12 net profit beat consensus, largely due to improved margins. The bank’s NIM increased c.20bp q/q, to c.3.1%, and the gain was attributed to both increases in the bank’s lending rates and loan-mix effects. The higher-yielding SME segment accounted for c.18% of BOB’s total domestic credit, up from c.16% a year earlier. Despite the q/q rise in the bank’s credit costs, its coverage ratio declined for a second consecutive quarter to c.67% – a trend we have been monitoring closely. Funding: BOB has significant overseas operations – international assets accounted for c.27% of total assets at end-September 2011. In particular, we note that loan growth in 2QFY12 was largely driven by overseas lending; the domestic loan book was stable q/q. Despite its international presence, the bank has not been a frequent issuer in the USD-bond markets, and we attribute this in part to the bank’s healthy overseas deposit franchise. Asset quality: BOB’s asset quality has held up better than its peers, and its gross NPL ratio was relatively low at c.1.4% at end-September 2011. However, absolute gross NPLs have increased over the past year, and, significantly, the restructured loans have picked up. Since April 2008, the bank has restructured about INR78bn of loans, or c.3% of total loans. Also, we think the increase in the proportion of BOB’s SME loans could weigh on asset quality over the longer term. As with its peers, BOB faces the risk of rising NPLs from its power sector exposure (c.5.8% of total loans at end-March 2011). Also, according to media reports, BOB has about INR35bn of aviation exposure (c.1.4% of total loans). While the restructuring of Air India’s debt is unlikely to result in a rise in NPLs due to regulatory forbearance, BOB’s credit costs could increase due to the required provisioning on the loans. Capital: BOB’s Tier 1 CAR is adequate, at c.9.7%. The bank expects to receive a INR7.75bn equity injection from the government, which we estimate will raise its T1 CAR by about c.32bp. Valuations: We maintain our Market Weight rating on BOB, given the large difference in carry between its bonds and the EM Asia USD High Grade Credit Index.

Bank of China (BOC) Krishna Hegde

Rating Rationale

Not Rated

BOC (A1 Stb/A Stb/A Stb) is the fourth-largest commercial bank in China and is c.67.55% owned by the Chinese government via Central Huijin Investment Ltd. It had total assets of USD1.8trn at end-September 2011. As a legacy of its foreign exchange bank roots, BOC has the widest overseas presence among Chinese commercial banks. As at end-June 2011, foreign loans accounted for c.19% of its total loan portfolio. Earnings: In line with our economists’ forecast of a soft landing in China (2012 GDP growth of 8.1%), we expect BOC’s earnings growth to moderate. Credit costs will also rise in our view, although the extent of the increase will likely be dependent on potential regulatory forbearance measures. Funding: BOC has a weaker domestic deposit franchise than its peers, and its CNY loan-to-deposit ratio at end September 2011 was c.72%. BOC’s deposits decreased c.1.5% q/q in 3Q11; consequently loan growth was a relatively modest c.0.5% q/q. Given the 75% regulatory cap on loan-to-deposit ratio, we expect BOC’s deposit growth to limit loan growth. Also, with its FX loan-to-deposit ratio at c.106% (c.101% a year earlier), we believe BOC could tap the USD senior bond market in 2012. Asset quality: BOC’s asset quality was stable, with its impaired loan ratio broadly unchanged q/q at c.1%. The bank’s coverage ratio improved slightly to c.220% at end 3Q11. The bank’s total exposure to European debt securities was CNY97bn (c.0.8% of total assets), with c.96% of this related to UK, Germany, Netherlands, France and Switzerland. The bank also disclosed that it held CNY454mn of Italian debt securities, but said it owned no Portuguese, Irish, Greek or Spanish debt at end-September 2011. Capital: BOC’s Tier 1 CAR fell c.9bp q/q, to c.9.9%, at end September 2011 due to dividend payments and slower earnings growth. With its inclusion in the list of global systemically important financial institutions (SIFI), BOC’s minimum capital requirements likely will include a SIFI buffer of 1.0-2.5% of risk-weighted assets.


6 January 2012 44

Bank of China (Hong Kong) (BOCHK) Lyris Koh

Rating Rationale

Underweight

BOCHK (Aa3 Stb/A+ Stb/A Stb) is the second-largest banking group in Hong Kong (total assets of USD228bn) and one of the three note-issuing banks. It is also the sole RMB clearing bank in the territory. BOCHK is wholly owned by BOC Hong Kong (Holdings) Limited, which is in turn c.66% owned by Bank of China. We believe the likelihood of support for BOCHK from the Hong Kong government and Bank of China is very high given its systemic and strategic importance. Earnings: BOC Hong Kong (Holding)’s 3Q11 normalised pre-provision profit slipped c.0.7% q/q to HKD4.9bn. The decline appears to be due to mark-to-market losses on securities investments in its insurance businesses, as well as higher operating expenses. The net interest margin on its non-RMB business narrowed slightly during the quarter, likely reflecting the intense deposit competition. Going into 2012, we believe the outlook for BOCHK’s earnings is clouded by a likely slowdown in loan growth and potential MTM losses or impairments on securities if markets remain volatile. Furthermore, we think credit costs could rise from the current extremely low levels. Funding: Reflecting the tight liquidity in Hong Kong, BOC Hong Kong (Holding)’s deposits declined slightly over 3Q11 even as its loans to customers increased. The bank’s HKD loan-to-deposit ratio rose to c.75% at end-June 2011 from c.68% at end-December 2009. Its USD loan-to-deposit ratio (including other accounts) increased c.18pp y/y, to c.104%. Given the tight liquidity situation, we were not surprised by the bank’s decision to tap the USD-bond market in October 2011. Asset quality: BOCHK’s NPL ratio was a very low c.0.1%, with NPL coverage of 3.5x at end-June 2011. We expect its NPL ratio to rise gradually, in line with our expectation of a global economic slowdown and a soft landing in China. Over the longer term, the bank’s asset quality will be increasingly dependent on China in our opinion – BOCHK’s loans to mainland China have increased to c.22% of total loans from 7% at end-June 2007. Fitch has said that it “believes that future risks [for BOCHK] relate to excessive growth, in particular in China”. Management disclosed that about 50% of BOC HK Holdings’ investment securities exposure is to the US and Europe. About 90% of the bank’s European exposure was attributable to the UK, Germany, the Netherlands and France. The bank also said it had about HKD1bn of exposure to Irish and Italian financial institutions at end-June 2011 (c.0.86% of total equity), but the Irish debt has since matured. Capital: BOCHK migrated to the Foundation Internal Ratings-Based (FIRB) approach for calculating its credit risk-weighted assets during 1H11. Its credit risk-weighted assets decreased c.13% h/h, contributing to an improvement in its Tier 1 CAR to c.12.9% from c.11.3% at end-December 2010. We expect BOCHK’s capital ratios to improve gradually as it migrates its remaining risk-weighted assets to FIRB and as the capital floor adjustment is removed over the next few years. The bank said that more than 85% of its risk-weighted assets are calculated on the FIRB approach. We view positively the bank’s decision not to pay a special dividend despite the improvement in its capital ratios. Valuations: We revise our rating on BOCHK to Underweight from Market Weight to reflect our view that the bonds could underperform on concerns about China’s economy and supply from Hong Kong banks. Furthermore, at current valuations, we think the BCHINA ’16s are rich relative to the senior bonds of other Asian banks.


6 January 2012 45

Bank of East Asia (BEA) Lyris Koh

Rating Rationale

Underweight

BEA (A2 Stb/A Stb/NR) is the largest independent Hong Kong bank, with total assets of HKD599bn (USD77bn). The bank’s main shareholders are the Li family, Criteria Caixa and Guoco.

Earnings: In our view, BEA’s 2Q11 results reflected mixed trends. Headline 1H11 net profit of HKD2.7bn exceeded Bloomberg consensus of HKD2.08bn, but the beat was partly driven by volatile, non-core items, such as gains on sales of fixed assets, trading income and valuation gains on investment properties. The bottom line was also flattered by writebacks of bad debts at its overseas operations. BEA’s margin was stable at 1.73% due to the increase in BEA China’s margin to 2.45%. A continued decline in BEA’s low-cost deposits could pressure margins (1H11 low-cost deposit ratio of 29% versus 34% at 2H10). BEA’s cost-to-income ratio tends to be higher than its peers due to its ongoing investment in China, and although it fell to c.57% over 1H11 from c.64% six months earlier, we do not expect further significant improvement.

Funding: We believe BEA’s HKD liquidity has tightened in line with its peers, although the need to comply with CBRC’s required loan-to-deposit ratio of 75% resulted in a decline in the group’s loan-to-deposit ratio to c.68%. We also note that the bank has increased its issuance of certificates of deposits – total CDs outstanding more than doubled h/h to c.HKD12bn. Given the current tight liquidity situation, increased focus on stable sources of funding and potential lending opportunities on the withdrawal of European banks as they deleverage, we believe that BEA may seek to issue USD senior bonds in 2012.

Asset quality: Our main concern regarding BEA’s asset quality is the ability of its relatively unseasoned China loan portfolio to hold up as it goes through a full economic cycle. Net new China-related loans over the past four years accounted for c.63% of the bank’s total China loan portfolio, which accounted for c.40% of total loans at end-June 2011. Furthermore, we estimate that BEA’s overall property-related portfolio accounts for c.43% of total loans and could be a source of potential NPLs, given the soft outlook for the property sectors in Hong Kong and China. BEA has been reducing its exposure to Europe, and as at end 1H11, claims on Western Europe were c.4% of total assets.

Capital: Our key concern with BEA is the weakening in its capital position. Its Tier 1 CAR declined c.90bp y/y in 2Q11, to c.9.4% – one of the lowest among the Hong Kong banks under our coverage. Moreover, unlike most Hong Kong banks we cover, BEA’s Tier 1 capital does not consist solely of common equity. Assuming BEA grows its risk-weighted assets and capital at rates similar to the past year, we estimate that its Tier 1 CAR will fall to about 9% by end-2011. We note that Moody’s said “persistent strong loan and asset growth outweighing capital generation, leading to Tier-1 capitalization below 9%” could lead to a ratings downgrade. Following the issuance of USD500mn of Tier 2 bonds in October 2011, we believe there is an increased likelihood of the bank exercising the call option on the sterling BNKEA 6.125% perp ’12 s. We also think the bank could look to refinance its upcoming USD600mn LT2 callable in June 2012.

Valuations: We affirm our Underweight rating on BNKEA. Given the bank’s relatively high exposure to China and the property sector, we believe valuations of BNKEA’s bonds will be affected to a greater extent than peers by negative sentiment towards the Chinese economy. Potential supply (as highlighted above) could also weigh on spreads, in our view.


6 January 2012 46

Bank of India (BOI) Lyris Koh

Rating Rationale

Underweight

Bank of India (Baa2 Stb/BBB- Stb/NR) is c.66% owned by the government and had total nonconsolidated assets of c.USD66bn at end-September 2011. We have long been concerned about BOI’s asset quality, and trends seen over 2QFY12 have only reinforced our caution on the issuer. Earnings: BOI’s 2QFY12 net profit of INR4.9bn missed consensus of INR5.83bn by an extremely wide margin due to a sharp jump in its credit costs. Although the market expected 2Q credit costs to rise, they more than doubled – an indication of stresses in its loan book, in our view. 2Q credit costs accounted for c.53% of BOI’s pre-provision profit and more than offset the growth in pre-provision profit. One of the few positives in BOI’s 2Q results was the c.33bp improvement in its NIM, which was supported by a rise in the bank’s loan and investment yields. Funding: BOI’s low-cost deposit ratio is a healthy c.32% although it remains lower than such peers as State Bank of India and Axis Bank. BOI’s international loans grew at a robust c.10% q/q, partly due to INR depreciation, while its domestic loans declined c.2% q/q. Asset quality: Even after excluding slippages due to BOI’s migration to system-based recognition of NPLs, new NPLs picked up q/q. About 15% of the slippage during the quarter was from the bank’s restructured accounts, taking total NPLs as a percentage of restructured accounts to c.24%. We note that BOI was aggressive in writing off NPLs over 2QFY12 – the bank wrote off c.INR16bn of NPLs compared with c.INR1.5bn a quarter earlier. We believe this partly contributed to the decline in the bank’s specific coverage ratio to c.35% at end-2QFY12 from c.54% at end-1QFY12. Nonetheless, we view the decline in BOI’s coverage ratio as a worrying trend that raises the risk of a spike in credit costs if asset quality takes another sharp leg down. Capital: BOI’s Tier1 CAR improved to c.8.7% q/q at end-September 2011 due to a combination of internal capital generation and a move to lower risk-weighted assets. The bank said its risk-weighted assets declined sequentially due to a change in the mix of its investments towards lower-risk products. Given the bank’s asset quality problems, as well as likely double-digit growth in FY13, we believe the bank’s capital needs to be increased. BOI told the Bombay Stock Exchange that it intends to issue up to 40mn shares to the government via a preferential issue at an appropriate time. At current market prices, we estimate that this would increase BOI’s Tier 1 CAR by about 53bp. Valuations: There is no change to our Underweight rating on BOI. We expect broader, sector-wide concerns, instead of BOI-specific issues, to remain the key driver of BOI’s spreads in 2012.

Canara Bank (CBK) Lyris Koh

Rating Rationale

Underweight

Canara Bank (Baa2 Stb/NR/BBB- Stb) is c.68% owned by the government and is the sixth-largest bank in India. Total nonconsolidated assets were c.USD67bn at end September 2011. Earnings: Trends in Canara’s 2QFY12 earnings are generally similar to those seen across the sector: credit costs weighed on net profit, but margins improved as the rise in loan yields outweigh the increase in deposit costs. Canara’s coverage ratio is very low at c.18%. While this is partly due to Canara’s relatively aggressive write-off policy, we believe a higher provisioning level would be prudent, especially considering the asset quality challenges facing the sector. Funding: As with most Indian banks, Canara’s funding profile benefits from a stable deposit base, and its gross loan-to-deposit ratio was a healthy c.70% at end-2QFY12. However, its low-cost deposit ratio (c.27%) is weaker than the other major state-owned banks. As Canara has fewer international assets than banks such as BOB and BOI, we believe its USD funding needs are lower. Asset quality: Canara’s gross NPL ratio has increased due to its migration to system-based recognition of NPLs and the deterioration in underlying asset quality. Excluding the slippage due to system-based NPL recognition, 2QFY12 new NPLs fell c.14% q/q. However, given the uncertain economic backdrop, we do not believe that Canara’s gross NPL ratio has peaked. Over the medium term, we believe the infrastructure segment could add to its NPLs. Infrastructure loans accounted for about c.17% of the bank’s total loans at end-2QFY12. The infrastructure portfolio also presents concentration risks, as the power sector accounts for 55% of total infrastructure loans. Adding to our concerns, the bank also disclosed that loans to the troubled state electricity boards accounted for c.6% of its total loans. Capital: Canara’s capital position strengthened following its c.INR20bn qualified institutional placement in 2011. At c.9.9%, Canara’s Tier 1 CAR is stronger than most of the other state-owned Indian banks under our coverage. In our view, Canara’s relatively healthy capital position places it in a better position than its peers to weather the stresses in its loan portfolio. That said, as with the other Indian banks, we expect Canara’s double-digit loan growth to pressure its capital position over the medium term. Valuations: We revise our rating on Canara to Underweight from Market Weight. In our view, Moody’s is likely to lower Canara’s standalone rating to Ba1 from Baa3 if its asset quality deteriorates significantly. We note that BOB’s standalone rating is currently Ba1, although its gross NPL ratio and Tier 1 capital ratio are similar to Canara’s.


6 January 2012 47

CIMB Bank (CIMBB) Lyris Koh

Rating Rationale

Market Weight

CIMBB (A3 Stb/A- Stb/BBB+ Stb) is wholly owned by CIMB Group Holdings (CIMBGH), which in turn is c.29% owned by Khazanah and c.13% owned by EPF. Given its indirect government ownership and systemic importance as the key operating subsidiary of the second-largest banking group in Malaysia, we believe there is a very high likelihood of government support, if needed. The fate of CIMBGH’s c.96%-owned Indonesian operation, CIMB Niaga, was thrown into doubt following news that Indonesia may cap foreign ownership of domestic banks. Although Indonesia’s decision may not affect CIMBB directly, we think this development should be monitored, given the potential changes in the group’s strategy if it has to reduce its stake in a profitable and growing market. CIMB Niaga contributed c.30% of CIMBGH’s 9M11 profit before tax. M&A: CIMBGH has clearly shown that it is open to inorganic expansion with its attempt to acquire RHB Capital. Although the purchase fell through due to the high price set by Abu Dhabi Commercial Bank’s sale of its 25% stake in RHB Capital to Aabar Investments, we do not rule out further acquisitions. In our view, given the maturity of the Malaysian banking sector, pressure for consolidation will likely intensify. Earnings: CIMBB’s 3Q11 earnings trends were relatively subdued with core revenues declining c.2% q/q. Notably, credit costs increased sequentially, but accounted for only c.10% of 3Q11 pre-provision profit. As with AmBank, CIMBGH cut its guidance and said that achieving its targeted 2011 return on equity of 17% would be difficult. Funding: CIMBB’s funding profile is stable, with a gross loan-to-deposit ratio of c.80% at end-3Q11. The bank’s consumer banking strategy has also shown signs of progress, with the percentage of retail deposits increasing to c.35% from c.27% at end-2008. We note that CIMBB has set up a USD1bn MTN programme and could be a potential USD-bond issuer, especially if it decides to purchase assets that may be sold by European banks. Asset quality: CIMBB’s asset quality weakened slightly over 3Q11. The bank’s absolute gross NPLs increased c.4% q/q, although its gross NPL ratio was stable due to a denominator effect. We believe NPLs may have reached a cyclical low and could increase in line with the more subdued outlook for economic growth in 2012. We note that CIMBB’s asset quality has historically been weaker than its peers due to legacy loans from previous mergers and acquisitions. Capital: CIMBB’s capital position is healthy, with a core Tier 1 CAR of c.11.9% at end-September 2011. In our view, as the main operating subsidiary of CIMBGH, there is a possibility that CIMBB will be required to upstream dividends to provide capital for the group’s other operating subsidiaries – for instance, fast-growing CIMB Niaga. Valuations: We lower our rating on CIMBB to Market Weight from Overweight to reflect our view that the bonds are less likely to outperform, given the changes seen in Europe where exercise of call options is increasingly based on economic incentives.


6 January 2012 48

CITIC Bank International (CINDBK) Lyris Koh

Rating Rationale

Underweight

CINDBK (Baa2 Stb/NR/BBB Stb) is an unlisted, medium-sized Hong Kong Bank, wholly owned by CITIC International Financial Holdings (CIFH), which in turn is c.70% owned by China CITIC Bank, and c.30% owned by Spain’s BBVA. CIFH was privatised in November 2008 to enable CINDBK to “become CITIC’s exclusive vehicle to develop commercial banking business in Hong Kong and serve as an international commercial banking platform for new business expansion for CITIC in Asia”. Parental support: In our view, there is an extremely high likelihood of parental support, which was demonstrated most recently when CIFH agreed to assume CDS losses arising from CINDBK’s Farmington exposure. That said, with BBVA reviewing its portfolios to meet the EBA’s required 9% core Tier 1 CAR by June 2012, we think there is a chance that it could reduce its stake in CIFH. Although we would view a divestment by BBVA as slightly credit negative for CINDBK, we do not believe the agencies would take negative actions on the bank’s ratings as a result. Earnings: CINDBK’s 1H11 net profit doubled h/h to c.HKD948mn on improved net interest income, increased trading profits, the writeback of impairment losses and gains from the Lehman minibond writeback. Excluding the one-off gains from the Lehman minibond writeback, we estimate pre-provision profit increased c.7% h/h. Contrary to our expectation, the bank’s net interest margin improved to c.1.23% from c.1.07% six months earlier. Heading into 2012, we believe earnings growth will slow as economic growth moderates. Furthermore, we believe credit costs are likely to increase from current extremely low levels. Funding: CINDBK’s gross loan-to-deposit ratio increased to c.83% from c.77% a year earlier. Notably, the bank’s reliance on certificates of deposits also increased, and CDs now account for c.7% of total liabilities, up from c.4% at end-June 2010. Also, Fitch recently highlighted that CINDBK has funded its new USD loans mainly with CDs and therefore would need to “maintain a reasonable share of readily marketable assets as investor confidence, market volatility and a perceived weakening of China CITIC’s and/or CBI’s credit profile could quickly impair liquidity”. Asset quality: CINDBK’s gross impaired loan ratio has improved but remains higher than its peers, at c.1.3%. We also note that provisioning risk exists, given that the bank’s coverage ratio was only c.50% at end-June 2011. With c.24% of its loan portfolio related to mainland China, CINDBK’s asset quality is dependent on China’s economic growth. If China’s economy experiences a hard landing (not our base case), CINDBK’s impaired loans could climb. Moreover, we are also cautious on the relatively high property exposure within the bank’s mainland China portfolio. Claims on Western Europe accounted for c.11% of CINDBK’s total assets at end-June 2011. Notably, the bank’s claims on French, Spanish and UK financial institutions increased in 1H11. Capital: CINDBK’s end-June 2011Tier 1 CAR was healthy, at c.11.9%. CINDBK has USD500mn of Tier 2 bonds callable in 2012 and could seek to refinance these bonds. Given that the coupon on the CINDBK 9.125% perp ’12s converts to 3m Libor +501bp, which is wider than the CINDBK ’20s, we think there is a high likelihood of the bank calling the bonds at first call date. Valuation: While the overhang due to CINDBK’s CDS exposure has been resolved, we expect macro headwinds to continue to weigh on performance. Therefore, our Underweight rating on CINDBK is unchanged.


6 January 2012 49

Commonwealth Bank of Australia (CBA) Krishna Hegde

Rating Rationale

Underweight

CBA (Aa2 Stb/AA- Stb/AA Stb) is our preferred pick among the big four Australian banks given its stronger credit fundamentals, and we recommend adding exposure to CBA relative to the other big four Australian banks. That said, the bank is exposed to the same risks as its peers (asset quality concerns stemming from mortgage delinquencies, and uncertainty in the US, Europe and China weighing on the Australian economy). Furthermore, with already tight valuations, the scope for outperformance of CBA’s senior bonds is limited. In our view, a key theme to monitor in FY12 is any potential change in strategy, in particular, an increased focus on overseas expansion following the appointment of Ian Narev as CEO. Asset quality: In 1Q FY12, CBA’s asset quality improved further in terms of impaired assets, portfolio ratings and consumer arrears. Total overlay provisions remained stable during the quarter, with the bank retaining economic overlays given the continued macro uncertainty. CBA’s collective provisions increased slightly over 1Q FY12 (+AUD7mn q/q), but its collective provision as a percentage of credit-risk-weighted assets decreased slightly (-3bp q/q and -18bp h/h to 1.20%) as a result of strong CRWA growth, particularly in the Institutional Banking division. In our view, credit costs in the business and mortgage portfolios could rise given the challenging economic environment, but should remain manageable relative to operating earnings. Funding: Along with its big four bank peers, CBA has improved its funding profile by expanding its deposit base (1Q FY12 customer deposits as a proportion of total funding: c.60% versus FY10: c.58%) and benefits from increased allocations from US money market funds owing to heightened concerns about Europe. Furthermore, CBA’s Australian household deposits (considered “stickier”) as a proportion of total Australian deposits is the highest among its peers at 43% (big four banks average: 37%) as of October 2011. That said, wholesale funding costs have risen, particularly at the short end, with basis risk playing a large role in the increase. Earnings: CBA’s cash earnings increased 9.4% y/y, to c.AUD1.75bn, in 1Q FY12. In line with its peers, trading income was hurt by volatile market conditions and was c.AUD60mn below the long-term average for the quarter (the bank disclosed that its long-term average trading income is AUD300-350mn per half). Expenses grew due to salary increases and strategic investments, leading management to implement measures to slow the growth in costs. Management guided for the net interest margin to come under pressure due to elevated wholesale funding costs. Capital position: In 1Q FY12, CBA’s Tier 1 CAR declined 16bp q/q to 9.85%, due to increases in credit-risk-weighted assets and interest rate risk in the banking book. Management attributed the rise in RWA to growth in corporate lending (largely at the Institutional Banking division), an increase in liquid assets (up AUD8bn q/q to AUD109bn) and foreign exchange effects. That said, with capital ratios that compare favourably with its peers (behind only ANZ), we believe CBA has a healthy capital position. Valuations: While average spreads on senior bonds of US banks and Asia ex-Japan banks have widened c.171bp and c.117bp since 1 August 2011, the CBAAU 3.25% ‘16s have widened c.91bp over the same period. Therefore, we remain Underweight on CBA on valuation grounds.


6 January 2012 50

Dah Sing Bank (DSB) Lyris Koh

Rating Rationale

Underweight

Dah Sing Bank (A3 Stb/NR/A- Stb) is wholly owned by Dah Sing Banking Group (DSBG), which in turn is c.74% owned by Dah Sing Financial. The ultimate shareholders of DSB include the Wong family and Bank of Tokyo Mitsubishi. DSB operates outside of Hong Kong through its wholly owned subsidiaries, Banco Comercial de Macau and Dah Sing Bank (China). It also has a 20% stake in Bank of Chongqing (BoCQ). Like other small Hong Kong banks (its assets were c.USD18bn at end-June 2011), the key challenge facing DSB is to improve profitability in the intensely competitive market. Earnings: DSB’s 1H11 earnings were generally soft. Pre-provision profit declined c.5% h/h as operating expenses rose faster than revenue. In particular, net interest income was largely flat h/h, as the decline in NIM to c.1.5% offset the benefits of healthy loan growth (c.12% h/h). Notably, credit costs increased in 1H11 and accounted for c.16% of pre-provision profit. In our view, DSB’s credit costs are unlikely to decline, as we believe the bank will raise its collective provisions owing to the uncertainties facing the global economy. Contributions from BoCQ have also become increasingly important for DSB’s bottom line, accounting for c.25% of DSB’s 1H11 pre-tax profit. Asset quality: Concerns about DSB’s asset quality have emerged after the spike in impaired loans during 1H11. The bank’s impaired loans more than doubled h/h, raising its gross impaired-loan ratio to c.0.5% from 0.25% at end-December 2010. Most of the increase in impaired loans was due to mainland-related loans, and given their weak performance, we think DSB’s China portfolio needs monitoring, especially given its c.80% h/h growth in 1H11. Mainland-related loans accounted for c.8% of DSB’s total loans at end-June 2011, up from c.5% six months earlier. Given that DSB’s corporate customers are mainly SMEs, we think its asset quality may also be more vulnerable than its peers as economic growth moderates. Capital: DSB’s Tier 1 CAR increased to c.10.4% in 1H11 largely due to the injection of equity raised by its parent at end-2010. Excluding the benefits from the capital injection, DSB’s T1 CAR would have declined h/h. In our view, regulatory capital pressures could emerge if DSB is required to participate in BoCQ’s future capital raising. DSB has USD150mn of Tier 2 bonds callable in August 2012, and subject to HKMA Basel III guidelines, the bank could be an issuer of sub debt in 2012. Valuations: Our Underweight rating on Dah Sing Bank reflects our overall cautious view of the Hong Kong bank sector. In our opinion, negative headlines surrounding the Hong Kong economy and property sector could weigh on sentiment and, hence, the spreads of the Hong Kong banks. Moreover, we are concerned that the surprising rise in impaired loans over 1H11 is a sign that the bank’s asset quality cycle has peaked.


6 January 2012 51

DBS Bank Ltd (DBS) Lyris Koh

Rating Rationale

Market Weight

DBS’s (Aa1 Stb/AA- Stb/AA- Stb) credit profile is strengthened by its systemic importance as the largest bank in Singapore and its indirect government ownership via Temasek Holdings’ c.27% stake. DBS has ambitions to be a pan-Asian bank and targets a revenue mix of 40:30:30 from Singapore, Greater China and South and Southeast Asia by 2015. Therefore, we believe DBS may opportunistically look to acquire Asian assets if they become available due to European banks shrinking their balance sheets – indeed, we think that European bank deleveraging will enable DBS to accelerate its business diversification plans. Earnings: The earnings outlook in 2012 is relatively lacklustre due to headwinds from the low interest rate environment, slowing loan growth and possible continued market volatility, which could weigh on trading income. In our view, deposit growth is likely to be a constraint on loan growth in 2012. In particular, mortgage growth is likely to be sluggish following the recent introduction of an additional Buyer’s Stamp Duty by the Singaporean government. Credit costs could also rise from the extremely low levels currently (9M11 specific allowance was only 8bp to average loans). Funding: DBS’s loan growth has outpaced deposit growth over the past couple of years, resulting in a rise in the group’s loan-to-deposit ratio (LDR) to c.86% from c.73% two years earlier. Notably, USD loans have been a key driver of loan growth, and USD liquidity has consequently tightened (USD LDR of c.171% at end-September 2011). In our view, DBS has less headroom to fund its USD loans from surplus SGD liquidity, and we expect the bank to be an opportunistic USD-senior bond issuer in 2012. DBS upgraded its USD10bn Debt Issuance Programme to a USD15bn global MTN programme in October, allowing the bank to tap US investor demand. The bank also established a USD5bn US commercial paper programme in December 2011. We note that the bank’s short-term debt increased to SGD6.2bn at end-September 2011 from c.SGD957mn a quarter earlier. Asset quality: DBS’s end-3Q11 gross NPL ratio was relatively low, at c.1.3%, but we expect NPLs to increase in 2012 as economic growth slows across the region. The bank disclosed that trade accounted for c.50% of its China loan portfolio, manufacturing for 12% and building/construction for c.10%. DBS also said that its China manufacturing loans are 54% collateralized by cash and property. NPL coverage for the China portfolio is also extremely healthy at 262%. DBS also disclosed that its exposure to European government and banks’ in its available-for-sale portfolio amounted to just c.0.7% of total assets (SGD2.4bn). Furthermore, its European exposure is largely to Germany, the UK and the Netherlands. Capital: DBS’s capital position was healthy, with a core Tier 1 CAR of c.10.7% at end-September 2011, although it declined c.80bp q/q due to the growth in risk-weighted assets. With USD2bn of Tier 2 bonds callable in May 2012, we think DBS could refinance the bonds. We expect any Tier 2 bonds issued to be Basel III-compliant following the Monetary Authority of Singapore’s release of its proposed Basel III guidelines in December 2011. Valuations: We maintain our Market Weight rating on DBS. In our view, there are few catalysts for the bonds to outperform over the next six months given the headwinds facing the Singaporean economy. Moreover, as mentioned above, we believe the bank is a potential USD bond issuer. While the back-end coupons on the DBSSP 5.125% ’17c12s and the DBSSP 5% ’19c14s are tight relative to levels at which the bank could issue a 5y senior bond, our base case is still for DBS to call these bonds at first call date, given reputational concerns.

Export-Import Bank of China (CHEXIM) Krishna Hegde

Rating Rationale

Market Weight

CHEXIM (Aa3 Pos/AA- Stb/A+ Stb) is a quasi-sovereign Chinese policy bank tasked with supporting the nation’s international trade. It is wholly owned by the Chinese government via the Ministry of Finance (MoF). Government support: We believe CHEXIM enjoys a high probability of government support given its important policy role. Its close relationship is reflected in its sovereign-linked credit rating. The bank receives liquidity support from the People’s Bank of China (PBoC) and compensation from the MoF for losses incurred in providing policy loans below its cost of funding. Furthermore, it has vice-ministerial status and reports directly to the State Council. Margins: Given that it is policy- rather than profit-driven, CHEXIM’s NIM has historically been very low, largely because of the low yield on its loans and its relatively high funding cost via bond issuance. Liquidity: CHEXIM relies primarily on bond issuance for funding – bonds accounted for c.66.8% of its total liabilities at end-2010. Given that almost all of its bonds are denominated in CNY (c.96%), we believe CHEXIM is unlikely to face funding issues. This is bolstered by the fact that it plays an important policy role, as noted above. Valuations: Our Market Weight rating is predicated on the fact that although CHEXIM’s standalone credit profile is weak, it will continue to enjoy a high level of government support. Despite speculation about its possible commercialisation, we do not believe there will be a material change in the level of support provided to CHEXIM by the Chinese government.


6 January 2012 52

Export-Import Bank of India (EXIM) Lyris Koh

Rating Rationale

Market Weight

EXIM (Baa3 Stb/BBB- Stb/BBB- Stb) is wholly owned by the Indian government and is tasked with promoting and financing India’s foreign trade. Government support: Government ownership cannot fall below 100%, as the Export-Import Bank of India Act requires the capital of EXIM to be wholly subscribed by the Indian government. Given its role as a key policy institution, we believe there is a clear likelihood of support from the government, if needed. We note that EXIM’s credit ratings are linked to the sovereign. Government support for EXIM is demonstrated by regular capital infusions – the government injected INR3bn into the bank in FY11. That said, we note that EXIM’s Tier 1 CAR declined to c.15.1% at end-March 2011 from c.16.9% a year earlier. Standalone: Overall, EXIM’s relatively healthy capital position and low operating costs are balanced against its reliance on wholesale funding and sensitivity to the economic cycle, given its exposure to the export sector. EXIM’s loan portfolio is almost evenly split between the INR and foreign currencies, with foreign-currency loans accounting for 47% of the total portfolio at end FY11. During FY11, EXIM raised long-term foreign-currency funding of about USD1.38bn from the offshore market. In particular, for the first time the bank sold bonds in the Swiss market, raising CHF175mn. It also raised USD150mn via a syndicated loan, mainly from Taiwanese banks. Valuations: Although we believe continued concerns about the Indian economy may lead to further widening, we believe the wide spreads on EXIM’s bonds relative to the EM Asia USD High Grade Credit Index warrant our Market Weight rating on the bank.

Export-Import Bank of Korea (KEXIM) Krishna Hegde

Rating Rationale

Overweight

KEXIM (A1 Stb/A Stb/A+ Pos) is a quasi-sovereign Korean policy bank tasked with providing export credit and guarantee programs for Korean enterprises conducting business overseas. It is effectively 100% owned by the government, which holds a 62.7% direct stake, an 18.6% indirect stake through Korea Finance Corporation (KoFC) and an 18.7% indirect stake through the Bank of Korea (BoK). There are currently no plans to privatise KEXIM. Government support: We believe KEXIM enjoys an extremely high probability of government support given its policy role of facilitating trade. KEXIM has the explicit support of the Korean government under Article 37 of the KEXIM Act, which states that the government is legally mandated to cover any losses the bank may incur in excess of its capital reserves. “Failure to support” under the provisions of Article 37 is considered an event of default (EoD). Similarly, if the government no longer controls KEXIM directly or indirectly, it is also considered an EoD. Under an EoD, KEXIM would be required to repay outstanding bonds. Asset quality: Rapid loan growth over the past few years and a greater concentration on the stressed sectors of shipbuilding and construction in the loan book has resulted in deterioration in KEXIM’s asset quality. We note that although KEXIM’s gross NPL ratio remained relatively low, at c.0.71%, at end-September 2011, the bank’s “precautionary and below” loan ratio was relatively high at c.6.5% at end-1Q11. However, we expect NPA figures to show signs of improvement in 2012 as the bank has the option to offload NPAs to “bad banks”, including Korea Asset Management Corporation (KAMCO) and United Asset Management Corporation (UAMCO). Funding and liquidity: KEXIM is not a deposit-taking institution and relies solely on the wholesale market, in particular the foreign-currency wholesale market, to fund its operations. Foreign-currency borrowing and debentures amounted to 84.4% of total borrowing at September 2011. As such, the lender is highly vulnerable to dislocations in global financial markets. This weakness is mitigated to a large extent by its institutional importance to the Korean economy and the government’s explicit support mechanisms, as noted above. A recent article in the local media reported that the bank had successfully secured USD10bn of foreign funding year to date, of which USD6.7bn was non-USD-denominated. Capital position: KoFC injected KRW1trn in 2Q11, and the bank’s Tier 1 CAR improved to c.10.83% at end-June 2011. However, we note that the bank’s T1 CAR slipped to c.9.75% at end-September 2011. We also note that the government has injected capital into KEXIM almost every year for the past decade. Valuations: We raise our rating on KEXIM to Overweight from Market Weight to reflect the increased attractiveness of its bonds, given the rise in spread differential with the Korea sovereign. Key risks for the sovereign (and by extension, the bank) include any negative headlines related to North Korea. However, our base case scenario is for a smooth leadership transition following the death of Kim Jong Il.


6 January 2012 53

Fubon Bank (Hong Kong) (FBHK) Lyris Koh

Rating Rationale

Underweight

FBHK (NR/ BBB+ Stb /NR) is a wholly owned subsidiary of Taiwan-based Fubon Financial Holding (FFH). FBHK was privatised by its parent in early 2011 and delisted from the Hong Kong Stock Exchange. In our view, FBHK’s operating profitability is likely to remain challenged by its small size – total assets of c.USD7.9bn at end-June 2011 – given the intensely competitive Hong Kong market. Parental support: Despite its modest contribution to FFH’s net profit (c.4% for 1H11), we expect FFH to provide FBHK with a high level of support. FBHK is strategically important to FFH because it holds a c.20% stake in mainland-based Xiamen Bank. The growing importance of Xiamen Bank is reflected in its rising contribution to FBHK’s pretax profit (1H11: c.21% versus 1H10: c.7%). Overall, we think the privatisation of FBHK underscores FFH’s commitment to FBHK and believe that the main benefit of the privatisation will be the increased ease with which FFH will be able to provide capital to FBHK, given the absence of minority interests. Earnings: FBHK’s 1H11 results highlighted the challenging operating environment facing the bank. Core revenues declined c.16% h/h as margins fell c.29bp, to c.1.12%.The bank attributed the narrower margin to the steady depletion of its high-yielding hire-purchase portfolio, the rise in the cost of deposits and the drag from its low-yielding Hibor-based mortgage loans. In our opinion, the outlook for FBHK’s earnings in 2012 is unlikely to improve given macro uncertainties. And as highlighted above, we believe the bank’s small size hampers its efforts to grow its local franchise. Funding: In our view, a small bank like FBHK faces greater difficulties in growing its deposit base amid intense competition for deposits relative to a larger bank, such as Bank of China (Hong Kong). In fact, FBHK’s deposits declined c.2% h/h while its gross loans increased c.10% h/h at end June 2011. Consequently, the bank’s gross loan-to-deposit ratio increased to c.71% from c.63% six months earlier. We believe FBHK’s loan growth will likely be constrained by its deposit growth. Asset quality: FBHK’s impaired-loan ratio declined to c.0.5% at end-1H11 from c.0.66% at end-2010. We believe the bank’s impaired loans could inch up in line with the challenging economic environment. However, given FBHK’s more restrained growth relative to its peers over the past couple of years, we think its asset quality could hold up slightly better. Capital: FBHK’s Tier 1 CAR declined c.47bp h/h to c.9.5%. Given that it subscribed to Xiamen Bank’s rights issue during 2H11, we think FBHK’s regulatory capital ratios could have been further pressured. Valuations: Given the macro headwinds facing the Hong Kong economy, we see little scope for outperformance and maintain our Underweight rating on FBHK.


6 January 2012 54

Hana Bank (Hana) Krishna Hegde

Rating Rationale

Market Weight The Hana-KEB merger appears to have reached a conclusion. Following the Financial Service Commission’s (FSC) order to Lone Star Funds to sell its stake in KEB, Hana (A1 Stb/A Stb/A- Stb) and the Texas-based buyout fund reached a sale agreement in early December. Lone Star agreed to sell its 51.02% stake in KEB to Hana for KRW3.916trn (KRW11,900 per share), an 11% discount from the previously agreed price. The transaction is currently awaiting approval from the FSC. We believe the merger is credit positive for Hana, given that the combined entity will be one of the largest and more diversified financial groups in Korea, with greater systemic importance. However, we note that Hana Financial Group has indicated that it has no plans to merge KEB with Hana Bank. Asset quality: Hank Bank’s asset quality continued to improve in 3Q FY11, with its NPL ratio declining 7bp q/q, to 1.15%, and the NPL coverage ratio increasing c.5.0pp, to 123.1%. We note that Hana’s NPL ratio is the lowest among its commercial bank peers. Total overall delinquencies were roughly stable q/q, although both SME and household delinquencies inched higher (+7bp, to 0.94%, and +9bp, to 0.45%, respectively). Although regulators believe SMEs will have a tough 2012, we remain comforted given that delinquencies are still well below their long-term average. Although the uptick in household delinquencies was expected given the high level of consumer indebtedness in Korea, we believe this segment requires close monitoring. Funding and liquidity: The aggressive growth in Hana’s loan book during 3Q FY11 was offset by strong growth in deposits, leaving the gross loan-to-deposit (LTD) ratio only slightly higher q/q at 112.9%. Hana’s foreign-currency (primarily USD) liquidity position remains relatively healthy, with a 3Q FY11 foreign-currency LTD ratio of 160%. In addition, Hana secured a USD200mn committed line from a Japanese financial firm. However, the bank does have two USD-denominated bank capital instruments outstanding that are due for call before the end of 2012 – USD500mn of lower Tier 2 bonds and USD200mn of Tier 1 bonds. We continue to expect Hana to ultimately call these bonds. In addition, Hana has USD1bn of government-guaranteed bonds maturing in April 2012. Earnings: Hana Bank’s 3Q FY11 net income declined 62% q/q to KRW179.6bn, driven by the lack of one-off gains (2Q earnings were boosted by the sale of its stake in Hyundai Engineering & Construction), a one-off charge related to the bank’s early retirement program, and foreign currency translation losses. Specifically, the employee early retirement program led to a one-time before-tax KRW86.7bn payout to 404 retirees. The NIM declined in 3Q due to an increase in funding costs, but management guided for it to improve from 4Q as the bank tightens its pricing strategies. Capital position: Hana Bank’s capital adequacy deteriorated slightly in 3Q FY11, with the Tier 1 CAR falling 14bp q/q, to 10.27%. We note that Hana’s Tier 1 CAR is the lowest among its commercial bank peers. Valuations: With increased clarity on the KEB acquisition and an improving fundamental credit profile, we are turning more constructive on Hana. However, given the expected heavy supply pipeline from the Korean commercial banks and, in particular, Hana’s heavy refinancing needs (see above), we do not see much scope for outperformance for Hana’s bonds over the next six months, and we maintain our Market Weight rating on the bank.

Hyundai Capital Services Inc (HCS) Krishna Hegde

Rating Rationale

Underweight Hyundai Capital’s (Baa2 Stb/BBB+ Stb/BBB Pos) credit profile benefits from its key shareholders – GE Capital Corporation (43%) and Hyundai Motor Company (57%). Earnings: In 3Q11, HCS’s post-provision income increased 9.5% y/y. Bad debt expenses increased sharply, and the delinquency rate rose to 2.1% from 1.9 in 2Q11 and 1.6% in 2010. However, the higher bad debt expenses helped push up reserves to 124.4% of FSS guidance (versus 110.5% in 2Q11). Funding: Over the course of 2011, HCS has been able to meet the funding goals that were identified earlier in the year. In 3Q11, HCS’s long-term funding proportion rose to 66.5% from 63.5% at the end of 2010, ahead of its 2011 target to improve long-term funding to 65%. Bond issues in USD, CHF and MYR pushed the proportion of bond funding to 73.4% from 67.5% and cut commercial paper funding to 3.5% (below the target of 5%) from 8.5%. We are not concerned about HCS’s dependence on wholesale borrowing because it has demonstrated the ability to access new funding even in periods of market stress. We also view the diversification across currencies as a positive development. Asset quality: HCS’s exposure to personal loans increased 20bp q/q, to 8.7%, at the end of 3Q11. While that is lower than the 9.3% at end of 1Q, we are concerned about the trend given the high level of household debt in Korea. The 30+ delinquency rate resumed its increasing trend (+20bp q/q). We expect continued asset quality stress in coming months. Valuations: HCS bonds still trade inside the large commercial banks that are rated single-A. In contrast to the large Korean commercial banks, we do not consider HCS as systemically important and view its concentrated household exposure (across auto loans, personal loans and mortgages) negatively. Ultimately, we expect HCS bonds to trade wide of the commercial banks, as has been the case historically, hence our Underweight rating on the issuer.


6 January 2012 55

ICICI Bank (ICICI) Lyris Koh

Rating Rationale

Market Weight

ICICI (Baa2 Stb/BBB- Stb/BBB- Stb) is India’s second-largest commercial bank and its largest private sector bank, with total nonconsolidated assets of c.USD83bn at end-September 2011. While the rating agencies view the likelihood of extraordinary support for the bank as high, ICICI’s foreign-currency senior debt ratings currently do not benefit from system support uplift. Earnings: The decline in ICICI’s credit costs has been the key driver of the improvement in net profit over the past year. While the bank guided for full-year credit costs to be similar to the run rate seen in 1HFY12, we think credit costs face upside risks given the challenging operating environment. The bank also guided for FY12 NIM to remain stable at 2.6%, with international margins improving to 120bp by end FY12. Funding: ICICI has improved the composition of its deposits – its low-cost deposit ratio climbed to c.42% from c.25% four years earlier. However, due to its sizeable international operations, ICICI remains reliant on wholesale funding. This is reflected in its higher global loan-to-deposit ratio (LDR) of c.99% compared with its domestic LDR of c.72%. We estimate that ICICI has about USD3.1bn of bonds maturing in 2012. Asset quality: ICICI’s asset quality has stabilised over the past year, and we believe the stresses related to its unsecured personal loan portfolio have largely been resolved. Personal loans now account for c.0.5% of ICICI’s total loans compared with c.4% at end-March 2009. That said, we believe asset quality risks have risen again, given the strong loan growth in segments that we view as riskier. In particular, ICICI’s commercial real estate exposure increased c.86% y/y and accounted for c.11% of total loans at end-March 2011. Like many of its peers, ICICI has expanded its infrastructure exposure (c.34% y/y), and in our view, this sector could be a source of NPLs over the medium term. The bank disclosed that its loans to the power sector (including undisbursed commitments and non-fund facilities) accounted for c.7% of its total exposure at end 2QFY12. Capital: ICICI’s capital position remains a key strength, although its Tier 1 CAR slipped to c.13.1% at end-September 2011 from c.13.8% at end-September 2010. With ICICI shifting its strategy to pursuing growth from the policy of conserving its balance sheet during FY09-10, we expect some erosion in its capital position. The bank disclosed that it is in discussions with the Canadian regulators to repatriate some capital from its Canadian subsidiary. If the discussions are successful, we expect ICICI’s nonconsolidated capital ratios to benefit from the repatriation of capital. Valuations: Although ICICI has said that it has sufficient maturing foreign-currency assets to repay maturing foreign-currency debt, we expect the bank to tap the USD senior bond market. However, given the increased volatility in markets due to the European sovereign debt crisis, we believe it may be difficult for ICICI to refinance the entire amount of maturing debt at tight spread levels. Given that it also faces increased risks to asset quality (highlighted above) and macro headwinds, we revise our rating on ICICI to Market Weight from Overweight.


6 January 2012 56

IDBI Bank Ltd (IDBI) Lyris Koh

Rating Rationale

Underweight

Established as a development finance institution (DFI) in 1964, IDBI (Baa3 Stb/BBB- Stb/BBB- Stb) was converted into a commercial bank in 2004. It is the eighth-largest bank in India, with total non-consolidated assets of USD47bn at end-September 2011, and the government holds a c.65% stake. Due to its legacy as a DFI, the bank’s funding profile and margins are weaker than other large Indian banks. It also has a higher concentration of loans to the infrastructure sector, which adds to concerns about the bank’s asset quality, given the recent problems in the power and aviation sectors. That said, the bank’s credit profile has generally improved, as reflected in Fitch’s upgrade of the bank’s Individual Rating to C/D from D in September 2011. Earnings: IDBI targets below-industry-average loan growth of c.15% in order to improve its margins and increase its low-cost deposit ratio. Given, in addition, likely rising credit costs, we expect IDBI’s earnings to be muted over the remainder of FY12. We note that the bank’s coverage ratio (excluding technical write-offs) declined to c.37% at end-2QFY12. Assuming IDBI raises the coverage ratio to its desired 45% level, we estimate that the bank would have to increase provisions by c.INR3bn (c.30% of 2QFY12 pre-provision profit). Funding: IDBI has been working to raise its low-cost deposit ratio (eg, cutting fees on its current and savings accounts), but despite some gains, at c.19%, the ratio remains lower than most of its peers. Its reliance on bulk deposits also weighs on IDBI’s margins. We note that IDBI was the first Indian bank to tap the CNH market, issuing CNY650mn of 3y bonds at a yield of 4.5%. Asset quality: Like its peers, IDBI has seen its gross NPLs rise. Although its gross NPL ratio of c.2.5% at end-September 2011 does not appear out of line with other Indian banks, we believe the level of economically nonperforming loans is higher. Furthermore, due to its development finance roots, IDBI has a relatively high exposure to infrastructure. The bank’s outstanding infrastructure loans (including non-fund-based) accounted for c.36% of its loans. Of this, about 14% of IDBI’s total loans are to the power sector, although it has no exposure to the troubled state electricity boards. According to media reports, IDBI also has about INR35bn of loans to the aviation sector (c.2.2% of total loans). We do not expect IDBI’s loans to Air India to become nonperforming, based on the airline’s restructuring plans. However, we believe the associated credit costs are likely to weigh on the bank’s earnings. Capital: IDBI’s Tier 1 CAR was c.8.2% at end-2QFY12. Although the bank said it would be comfortable with its capital position even if its T1 CAR fell to 7%, we believe a higher level of capital would be, prudent given the concentration risks as well as potential stresses in IDBI’s loan portfolio. In our view, the bank recognises the need to shore up its core capital – it announced a proposal to convert INR21.3bn of Tier 1 bonds issued to the government into equity, subject to regulatory and statutory requirements. We also note that IDBI has announced to the stock exchange that the government is actively considering its request for capital support and intends to inject capital into the bank, subject to the necessary approvals. Valuations: Given its high exposure to the infrastructure sector, we expect IDBI to face more pressure than its peers from the troubles in the power and aviation sectors, and is more likely to underperform if negative headlines intensify. There is no change to our Underweight rating on IDBI.


6 January 2012 57

Industrial Bank of Korea (IBK) Krishna Hegde

Rating Rationale

Underweight

IBK (A1 Stb/A Stb/A+ Pos) is a quasi-sovereign financial institution whose charter is to provide financing to small- and medium-sized enterprises (SMEs). The Korean government has a direct ownership stake of 68.9% and indirect stakes of 1.9% through Korea Finance Corporation (KoFC) and 1.6% through Export-Import Bank of Korea. While the local media has reported that the government plans to privatise IBK, we believe this is unlikely to materialise in the near term, given the parliamentary and presidential elections in 2012, and the greater priority placed by the government on privatising Woori Finance Holdings. Government support: We believe IBK enjoys a high probability of government support given its role in supporting SMEs. IBK has the support of the Korean government under Article 43 of the IBK Act, which states that the government is legally mandated to cover any losses that the bank may incur in excess of its capital reserves. Additionally, the government has proven its commitment to support IBK with capital injections from 2008 to 2010. That said, the government could withdraw its support for IBK if the lender is fully privatised, although such a move could be politically challenging, in our view. Asset quality: IBK’s 3Q FY11 NPL ratio remained flat q/q at 1.76%, but its NPL coverage ratio dipped slightly (-1.6pp q/q, to 124.7%). The bank’s NPL ratio compares favourably with the average of its policy bank peers. Notably, total delinquencies ticked up in 3Q (+8bp q/q to 0.90%), particularly in the lease and rental (+76bp q/q, to 3.06%), and construction segments (+52bp, to 1.46%), and this trend bears further monitoring. Funding and liquidity: IBK continues to rely primarily on the wholesale markets for funding, which we view as a potential weakness. That said, we do not expect IBK to face funding/liquidity pressures, given investors’ confidence in continued governmental support, as well as its relatively small wholesale foreign-currency exposure (3Q FY11: 6.6% of total liabilities). Margins: Although its net interest margin moderated in 3Q FY11 (-3bp q/q to 2.63%) due to a rise in funding costs, IBK continues to enjoy the largest NIM among the Korean policy banks, given its focus on lending to the SME segment (3Q FY11 SME loans as a proportion of total loans: 77%). Capital position: IBK’s 3Q FY11 Tier 1 CAR declined slightly (-3bp q/q, to 8.94%). Capital has come under pressure over the past couple of years due to an increase in loans, but was shored up by injections from the government (amounting to KRW1.3trn) from 2008 to 2010. In our view, IBK’s capital levels should be improved, especially considering that SMEs will come under greater stress as economic growth moderates. Valuations: We continue to view IBK bonds as rich (spreads almost flat relative to benchmarks), and we believe there is potential for underperformance on privatisation headlines. Among the policy banks, we prefer KDB and KEXIM to IBK, considering the bonds trade relatively close to each other, and KDB/KEXIM’s bonds do not face headline risk related to possible privatisation.

Kasikornbank (KBANK) Lyris Koh

Rating Rationale

Overweight

Kasikornbank (Baa1 Stb/BBB+ Stb/BBB+ Stb) is the third-largest bank in Thailand, with total assets of USD57bn compared with USD64bn at Bangkok Bank. KBANK has a strong franchise in SME lending, which accounted for about 36% of its total loans as at end-September 2011. S&P recently upgraded KBANK’s issuer rating under its revised methodology and the bank is now rated the same as BBL. In our view, there is an extremely high likelihood of government support for KBANK, if required, given its systemic importance. Earnings: We expect KBANK’s earnings momentum to slow for a couple of quarters due to the floods before picking up again. KBANK targets relatively robust loan growth of 9-11% in 2012 under its base case forecast of 4.3% GDP growth in Thailand. It also expects to maintain its margins at 3.4-3.5%. KBANK’s margins tend to be higher than its peers due to its larger proportion of higher-yielding SME loans. Despite the bank’s optimistic outlook for revenue growth, we expect credit costs to increase as NPLs rise. Funding: At c.96%, KBANK’s gross loan-to-deposit ratio is elevated, although it is lower than the system-wide average of c.108%. The bank’s low-cost deposit ratio is a healthy c.60% Asset quality: KBANK estimates that its NPLs could increase by up to 0.5% of total loans due to the floods. The associated credit costs of such an increase would be manageable relative to pre-provision profit, in our view. Moreover, KBANK’s relatively healthy coverage ratio of c.128% should help to reduce the impact on earnings. Capital: KBANK’s capital position is adequate, with a Tier 1 CAR of c.10.3%. KBANK does not expect the implementation of Basel III to have a significant impact on its capital ratios. Valuations: We revise our rating on KBANK to Overweight from Market Weight to reflect our view that the KBANK 8.25% ’16s offer attractive carry, especially given the bullet nature of the bonds.


6 January 2012 58

Kookmin Bank (Kookmin) Krishna Hegde

Rating Rationale

Market Weight

Since chairman Euh Yoon-Dae took the helm in mid-2010, Kookmin Bank (A1 Stb/A Stb/A Stb), the key banking subsidiary of KB Financial Group, has cleaned up its balance sheet and improved its profitability. We expect this trend to continue, given the relatively more conservative strategy of Kookmin’s management. Asset quality: Kookmin’s asset quality deteriorated slightly in 3Q FY11. Its NPL ratio increased 4bp q/q, to 1.88%, and the NPL coverage ratio declined 3.9pp, to 120.0%, reversing the improvement in 2Q. Management attributed this to the lower level of sales and write-offs of bad loans – Kookmin wrote-off KRW442.2bn of bad loans (without any sales) in 3Q, compared with KRW816.7bn of NPLs sold and written off during 2Q – and expects higher levels of sales and write-offs in the future. The total delinquency ratio remained roughly stable q/q at 1.09%, with household delinquencies improving 6bp q/q to 0.90%. Notably, SME delinquencies ticked up q/q (+21bp q/q to 1.60%). Although SME delinquencies are not currently a cause for concern, they bear further monitoring. Funding and liquidity: As Korea’s largest bank, Kookmin benefits from a strong and stable domestic deposit franchise, and we view this as one of its key strengths. We also believe the bank’s muted loan growth in 3Q FY11 (+1.9% q/q) is positive from a credit perspective. In anticipation of foreign currency funding pressures, the bank pre-emptively secured a USD100mn committed line with an overseas financial firm and is looking to expand the size of committed lines with other foreign financial firms. At 174% as of 3Q FY11, Kookmin’s foreign-currency (primarily USD) LTD ratio is the highest among its commercial bank peers, although it is well below the levels that prevailed just before and during the 2008 global financial crisis. Earnings: Kookmin Bank’s 3Q FY11 net profit declined 63.2% q/q to KRW316bn, due to the absence of one-off gains (2Q profits benefited from sale of its stake of Hyundai Engineering & Construction). Core earnings remained healthy, with net interest income increasing 3.2% q/q and expenses declining 4.4% q/q. Management guided for expenses to rise in 4Q, but stated that the cumulative level for the year should not surpass KRW4trn. Indeed, Kookmin guided for its cost-to-income ratio to remain in the mid-40% range. Although the NIM was roughly flat q/q (3Q FY11: 2.40%) as the rise in funding costs offset the increase in asset yields, management is optimistic that it will improve – its stated objective is to maintain a net interest margin of c.3% over the long term. Capital position: Kookmin’s capital adequacy improved in 3Q FY11, partly due to its disposition of treasury stock. Its Tier 1 CAR increased 62bp q/q, to 11.32%, and its core Tier 1 CAR rose 63bp, to 10.83%, although this was slightly below the average of its commercial bank peers. Valuations: There is no change to our Market Weight rating on Kookmin. Although we believe the outlook for its fundamentals is stable in 2012, we think supply could drive spreads wider and recommend that investors add exposure via the primary rather than the secondary market.


6 January 2012 59

Korea Development Bank (KDB) Krishna Hegde

Rating Rationale

Overweight KDB (A1 Neg/A Neg/A+ Pos) is a policy bank that provides long-term financing for projects with the goal of facilitating economic growth and development in Korea. KDB is wholly owned by KDB Financial Group, which in turn is effectively 100% owned by the government (a 9.7% direct stake and 90.3% indirect stake through the Korea Finance Corporation (KoFC)). The government plans to privatise KDB, with the initial sale of shares on or before May 2014. Government support: We believe KDB enjoys a high probability of government support given its policy role. KDB has the explicit support of the Korean government under Article 44 of the KDB Act, which states that the government is legally mandated to maintain the solvency of KDB, provided the government’s stake remains greater than 50%. Under Article 18-2(1), when KDB Financial Group is privatised, the government will guarantee the bank’s outstanding medium- and long-term foreign-currency debt (with a maturity of greater than 1y) until it matures, assuming this amount is within the limit authorised by the National Assembly. Furthermore, under Article 18-2(3), the government could also guarantee the repayment of new long-term issuance that occurs after the initial stake sale, provided the government’s stake remains greater than 50%. Asset quality: KDB’s asset quality deteriorated slightly in 3Q FY11, with its NPL ratio increasing 3bp q/q to 2.36%. Delinquencies ticked up, increasing c.19bp q/q to 0.85%. We believe the bank’s asset quality is weaker than its policy bank peers, given its relatively greater (and concentrated) exposure to corporates undergoing restructuring (such as Kumho Tire in 2010) and SMEs with weaker credit profiles. Although we believe the impact of a global economic slowdown in 2012 on KDB’s borrowers requires monitoring, we believe a rise in NPLs is unlikely to affect spreads of KDB’s outstanding bonds. Funding and liquidity: KDB depends to a large extent on the wholesale market to fund its lending activities (3Q11: c.64% of total liabilities) and is especially vulnerable to dislocations in the global financial markets. In line with its stated objective of diversifying its funding sources, the bank has significantly increased its deposit base (c.42.5% increase YTD). Furthermore, we remain comforted by the high level of government support KDB enjoys, given its policy role. Capital position: KDB’s Tier 1 CAR declined c.1.54pp q/q, to c.14.58%, at end-3Q11. However, its capital position remains stronger than most policy banks. We view KDB’s capital position as a key credit strength, especially given our expectation that the bank may pursue M&A to prepare for its privatisation. We note that Fitch has said that “an acquisition or any action for privatization could trigger a rating action”. Valuations: We maintain our Overweight rating on KDB given the strong support mechanism for bondholders, even after privatisation. As mentioned above, its outstanding medium- to long-term foreign-currency debt will receive an explicit government guarantee at the time of the government’s initial stake sale. When it is eventually privatised, we expect spreads on KDB’s outstanding bonds to compress towards the sovereign.


6 January 2012 60

Korea Exchange Bank (KEB) Krishna Hegde

Rating Rationale

Market Weight

We believe that KEB’s (A2 Pos/BBB+ CW Pos/A- Stb) sale to Hana Financial Group (still pending approval) will likely be credit positive for KEB. The deal will remove significant uncertainty regarding KEB’s future, and given that the combined entity will be one of the largest and more diversified financial groups in Korea, it will increase its systemic importance. Hana has said it plans to keep the two banks as separate entities, but integrate certain operations, such as business development, for cost efficiencies. KEB’s ratings have been placed on Positive Outlook by Moody’s and CreditWatch Positive by S&P pending completion of the acquisition. KEB-Hana merger: After a five-year legal dispute, the Seoul High Court ruled that Lone Star Funds, a US buyout fund that is KEB’s majority owner, was guilty of stock price manipulation during the merger of KEB and its credit card unit in 2003, reversing a decision issued three years earlier that cleared Lone Star of any wrongdoing. Following the high court’s decision, the Financial Services Commission (FSC) ordered Lone Star to sell its stake in KEB within six months (before 18 May 2012). In early December 2011, Lone Star Funds agreed to sell its 51.02% stake in KEB to Hana for KRW3.916trn, or KRW11,900 per share, an 11% discount from the previously agreed price. The transaction is currently awaiting approval from the FSC. Asset quality: Although KEB’s gross NPL ratio declined c.7bp q/q to c.1.29%, we note that the decline was largely due to a denominator effect, as absolute NPLs increased 1% q/q. The total delinquency ratio was roughly flat q/q, at 0.68%, but again, the result was driven by the denominator effect. Total delinquent loans increased c.7.9% q/q. SME delinquencies were roughly flat q/q at 1.35%, but large-corporate delinquencies from increased 13bp q/q, to 0.25%, although this is low compared with the historical average. Funding and liquidity: Strong loan growth, driven by increased demand and the impact of KRW depreciation, outpaced deposit growth in 3Q FY11. Given KEB’s traditional role of providing trade finance and foreign exchange services, the bank has a relatively higher exposure to foreign-currency funding. However, the bank’s relatively sizeable foreign-currency deposits partially mitigate its foreign-currency liquidity/funding risks – foreign-currency deposits/foreign-currency loans was c.67% at end-3Q11. Earnings: KEB reported 3Q FY11 net income of KRW117bn, a 63.4% y/y decline, as provisions increased 71.3%. Management attributed the increase in provisions to growth in total credit and deterioration in some real estate loans. Net income declined significantly q/q, but this can be attributed to a lack of one-off gains (it sold its stake Hyundai Engineering & Construction in 2Q11). However, we note that core earnings also have come under pressure, with core revenues declining c.11% q/q. Unsurprisingly, non-interest income declined due to lower trading income. Its NIM declined 9bp q/q to 2.63%, with margins in both the KRW and foreign-currency businesses declining q/q, The bank attributed the decline in its KRW margin to increased funding costs and said the decrease in its foreign-currency margin was due to KRW depreciation and a stronger growth in lower-margin foreign-currency assets. Capital position: KEB’s Tier 1 CAR declined 30bp q/q and 97bp y/y, to 11.61%. The sequential decline was largely due to the c.7.1% q/q growth in its credit-risk-weighted assets. Valuations: With the Hana-KEB saga nearly resolved, some of the uncertainty surrounding KEB has been removed, a credit-positive development for the bank, in our view. However, as KEB bonds already trade inside of Hana’s, we do not see much scope for further tightening. We remain Market Weight on KEB.

Krung Thai Bank Public Company Limited (KTB) Lyris Koh

Rating Rationale

Market Weight

KTB (Baa1 Neg/BBB Stb/BBB Stb) is the second-largest bank in Thailand and is c.55% owned by the government via the Financial Institutions Development Fund. KTB’s credit profile is weaker than its peers, and this is reflected in its lower ratings from S&P and Fitch. Not surprisingly given its state-ownership, loans to the government and related enterprises account for a chunky c.15% of total loans. Earnings: We expect KTB’s earnings to come under pressure in 2012. Management expects loan growth to slow to 6-8%, and margins may come under pressure as loans reprice lower. Also, KTB may face a rise in credit costs relative to peers (see below for details). Funding: KTB’s gross loan-to-deposit ratio has increased and stood at c.104% at end September 2011. We are cautious about the increasingly tight liquidity and note that KTB has funded its loan growth with bills of exchange, which have increased c.53% since end-2010. The Bank of Thailand has expressed its concerns about the strong system-wide growth in bills of exchange and indicated that it may subject these instruments to the same reserve requirements and insurance premiums as deposits. On a more positive note, KTB has a strong deposit franchise, with government employees and state enterprises accounting for a significant percentage of its deposits. Asset quality: KTB’s asset quality is weaker than its peers due to legacy loans, but its gross NPL ratio has improved significantly over the past few years. As at end-September 2011, KTB’s gross NPL ratio was c.4.4%, down from c.5.3% at end-2010. We expect KTB’s asset quality to come under pressure over the coming quarters due to the floods in Thailand. Considering KTB’s relatively low coverage ratio of c.57%, the rise in NPLs is likely to put greater pressure on KTB’s earnings relative to BBL and KBANK in our view. Capital: The bank’s reported Tier 1 CAR was c.9.1% at end-September 2011. Valuations: At current levels, the KTB 7.378% perp ’16s are pricing in a relatively significant amount of extension risk in our view. However, we maintain our Market Weight rating on the bonds, given that the back-end coupon is only slightly wider than the BBLTB ’20s.


6 January 2012 61

Macquarie Group Ltd Krishna Hegde

Rating Rationale

Market Weight

Macquarie Group Limited (MGL, A2 CW Neg/BBB Stb/A Stb) bonds have come under pressure in recent months. Although MGL has bolstered its balance sheet over the past two years and the earnings stream has an increased contribution from more stable businesses (eg, asset management), the credit continues to trade with a high beta to the market. We do not expect the market beta to change. Given the significant management changes that are underway, we could see further changes to the business model in coming months. Earnings: MGL’s 1H12 (ended Sep 2011) net income fell 24% h/h due to weaker market conditions. Given management’s outlook provided in late October and market conditions in the last months of this year, we expect FY12 income to be significantly lower than in FY11. Balance sheet funding: MGL’s balance sheet continues to be strong, with the proportion of cash and liquid assets far outstripping short-term paper and debt maturing in less than one year. The proportion of MGL’s consolidated balance sheet that can be attributed to the banking subsidiary continued to increase y/y. The refinancing of the group-level senior credit facility is a positive. Deposits also continue to rise, and we view the growing deposit base as a credit positive since it helps diversify the funding base. However, a recent media report suggested that MGL may be considering the sale of its banking division. In our view, a sale of the division might be perceived as a short-term negative, as it would mean that MGL is again more dependent on wholesale funding. However, we think the ultimate impact of the sale on MGL would depend on the price at which the division is sold. Asset quality: Macquarie’s asset quality remained stable with impaired assets declining q/q in 1Q12 and 2Q12. Macquarie has AUD5.6bn of equity investments. Current valuations are likely to be higher than end-September 2011 levels, and there is potential for some gains if valuations do not deteriorate. Capital: As at 30 September 2011, MGL had capital of AUD12.4bn, 39% in excess of its minimum regulatory capital requirement. The Macquarie Banking Group Tier 1 capital ratio was also comfortable, at 12.5%, with a core Tier 1 ratio of 11.2%. Valuations: Its bonds’ recent underperformance versus the large Australian commercial banks reflects the lack of market comfort with the volatility in earnings, in our view. Despite their wider spreads, we await more clarity with regard to any further changes in the business model and retain our Market Weight rating.

Malayan Banking Bhd (Maybank) Lyris Koh

Rating Rationale

Not rated

Maybank (A3 Stb/A- Stb/A- Stb) is the largest bank in Malaysia, with total assets of MYR431bn (USD135bn) at end-September 2011. The Malaysian government indirectly owns a majority stake in the bank via the Employees Provident Fund Board (c.11%), Permodalan Nasional Berhad (c.5%) and Skim Amanah Saham Bumiputera (c.47%). Maybank established a USD2bn multi-currency MTN programme last year. BII: In our view, a decision by the Indonesian government to cap foreign ownership in Indonesian banks could likely prompt a change in strategy at Maybank. We believe the potential loss of Bank Internasional Indonesia (BII) as an earnings driver could cause Maybank to pursue other, potentially more aggressive, avenues of growth. M&A: We remain cautious about Maybank’s appetite for M&A. In addition to its purchase of Kim Eng Holdings last year, Maybank also attempted to acquire RHB Capital although the deal ultimately fell through. We note that Maybank has said that it targets a 40% contribution from its international business to pre-tax profit by 2015, raising the possibility of an overseas acquisition at some point. Maybank’s international operations contributed about 23% of its 1QFY11 pre-tax profit, with Singapore the largest international contributor, at c.14%. Funding: Maybank’s gross loan-to-deposit ratio was relatively high at c.93% at end-September 2011. In our view, this is partly due to the extremely strong loan growth at the bank’s overseas operations. Loans at the bank’s Singaporean operations grew c.37% y/y, and BII’s loans grew c.22%. We note that the LDR for its Singapore operations was c.97% versus c.86% at its Malaysian operations and c.91% at BII. Earnings: We expect Maybank to report decent earnings over the coming year, supported by healthy, but slower, loan growth and relatively stable margins. However, we believe credit costs are likely to increase, although from a relatively low base (c.15bp). The bank’s credit costs increased over 1QFY11 largely due to a rise in specific provisions. Asset quality: Maybank’s gross NPL ratio was generally stable q/q, at c.3.2%, although absolute NPLs increased slightly. We believe the rise was largely due to asset quality troubles at WOM Finance, BII’s motorcycle financing arm. WOM Finance’s gross NPL ratio jumped to c.3.41% at end-September 2011 from c.2.7% a quarter earlier. According to Maybank, its exposure to European securities was about MYR2.2bn (c.0.5% of total assets), with MYR1.1bn to the UK. Capital: Maybank’s Tier 1 CAR fell 1pp, to c.10.2%, during 1QFY11 due to growth in its risk-weighted assets and capital consumption related to the acquisition of Kim Eng. Although the bank’s capital position remains comfortable, we would be concerned if it deteriorates substantially due to further acquisitions. We note that Moody’s has commented that “Maybank has had a track record of allowing its capital ratios to deteriorate when it makes acquisitions, only to strengthen them later”.


6 January 2012 62

National Agricultural Cooperative Federation (NACF) Krishna Hegde

Rating Rationale

Market Weight NACF (A1 Neg/A Stb/A Pos) is a Korean policy bank tasked with providing financial services to agricultural cooperatives and farmers in Korea. NACF is fully owned by its 1,177 member cooperatives. Restructuring: In mid-March 2011, the National Assembly approved a revision to the Agricultural Co-operative Law. Under this plan, NACF’s unprofitable nonbank operations would be separated from its banking operations by March 2012. As yet, no details have been provided on what entity will service the outstanding foreign-currency bonds, although we think it is highly likely that they will be kept within the banking unit. According to media reports, NACF initially sought KRW6.0trn from the government to facilitate the reorganisation, but the government offered to provide only KRW 4.0trn – KRW3.0trn to be raised through borrowing or bond issuance, on which the government will service the interest, and a KRW1.0trn investment from the Korea Finance Corporation (KoFC). Local media reports speculated that regulators might push the reorganisation deadline back by five years to 2017 given the impasse. Government support: Given its policy mandate to provide loans to Korea’s politically significant farming sector, we believe NACF enjoys a high probability of government support even though the government has no direct ownership of the bank. After its reorganisation, we believe NACF will continue to enjoy implicit government support. We note, however, that unlike the other three policy banks (KDB, KEXIM and IBK), the Agricultural Co-operative Law does not contain any explicit language of government support. Support is instead predicated on the systemic importance of NACF, which holds c.13% of total banking system deposits as of September 2011. Asset quality: NACF’s asset quality has improved. Its 3Q FY11 NPL ratio of 2.08% was down from a peak of 2.96% in 3Q FY10. The rise in NPAs during 2010 was mainly the result of the rapid growth of its loan book in previous years and its relatively large project finance (PF) exposure. At end-March 2011, NACF’s real estate PF loans accounted for c.5.1% of total loans, and that portfolio’s NPL ratio was c.22.4%. We believe there is scope for further improvement through sales of construction-related NPAs to state-run “bad banks”, such as Korea Asset Management Corporation (KAMCO) and the United Asset Management Corporation (UAMCO). Funding and liquidity: With a healthy deposit base (3Q FY11: c.70.4% of total liabilities) that includes a high level of low-cost savings deposits (3Q FY11: 70.3% of total deposits), NACF’s funding profile is sound. During the global financial crisis, liquidity came under pressure, but was helped by government support measures. We believe the government will continue to provide liquidity support, if needed. Capital position: NACF’s capital position has improved over time (3Q FY11 Tier 1 CAR: 12.73% versus FY10: 12.22%). However, we believe its capital ratios are flattered by the method of computation – its capital ratios are calculated after allocating most of NACF’s capital to its banking unit). Valuations: We revise our rating on NACF to Market Weight from Overweight to reflect our view that the bonds are less likely to outperform owing to the uncertainties related to the government’s capital injection. Moreover, we think USD bond supply from NACF could increase following its restructuring.


6 January 2012 63

National Australia Bank (NAB) Krishna Hegde

Rating Rationale

Underweight

We remain Underweight on NAB (Aa2 Stb/AA- Stb/AA Stb), given that it is more sensitive to the Australian economy owing to its relatively large exposure to business lending, which historically experiences a higher loss rate. In addition, we see the potential for some deterioration in asset quality from playing catch-up in mortgage loans and growing its share of that market. These headwinds, coupled with already tight valuations, limit the potential for NAB’s bonds to outperform during the next six months, in our view. Asset quality: Gross impaired assets increased over FY11, largely owing to the continued migration to impaired status of commercial property exposures in the Business Banking and UK Banking divisions. Management expects impaired assets to remain elevated and sticky, but its does not expect a sustained uptrend. Given NAB’s aggressive expansion of its share of the mortgage market by competing on price, we expect a slight pick-up in mortgage delinquencies, despite the fact that according to the bank’s disclosures, the 2008 and 2009 vintages are performing better than earlier vintages. Collective provisions declined AUD84m q/q to AUD3,398, and collective provisions as a percentage of credit-risk-weighted assets declined 4bp q/q to 1.10%. Funding and liquidity: NAB has taken steps to improve its funding profile. In line with its Australian peers, NAB has enjoyed an increased allocation from US money market funds, owing to a flight to quality driven by heightened concerns about the European sovereign debt situation. At 31%, NAB’s Australian household deposits (considered “stickier”) as a proportion of total Australian deposits is the lowest among its peers (big four average: 37%) as of October 2011, although we believe this is not a cause for significant concern. The bank’s gross loan-to-deposit ratio improved (-4.9pp h/h to 124.1%). Management stated that its term funding requirement for FY12 is c.AUD23bn, largely to refinance term debt maturing in FY13. Earnings: NAB reported a FY11 cash profit of AUD5.46bn (+19.2% y/y), meeting Bloomberg consensus of AUD5.45bn. Core earnings trends were generally positive (2H FY11 net interest income increased 7.7% h/h to AUD6.79bn), with management attributing the weaker non-interest income to volatile market conditions. Although the group’s net interest margin increased 5bp h/h, to 2.28% (half-yearly basis), management guided for pressure on margins, citing as potential drags such factors as rising wholesale funding costs, competition for assets and deposits, and the move to improve the mix of liquid assets. Capital position: NAB’s capital position improved in FY11, with Tier 1 CAR up 51bp h/h and 79bp y/y, to 9.70%. Part of the strong improvement in the bank’s capital ratios is due to its continued efforts to optimise its risk-weighted assets by improving its models. Under APRA’s proposed Basel III rules, the bank estimates that its common equity ratio would have been about c.7.1% at FY11. This is lower than its big four bank peers, but is partly attributable to a greater proportion of its risk-weighted assets being calculated using the Standardized approach. Overall, we are comfortable with NAB’s capital levels. Valuations: Our Underweight rating on NAB reflects asset quality headwinds that stem from its aggressive mortgage book growth, as well as tight valuations. Since 1 August 2011, the NAB 3% ’16s have widened c.79bp, compared with average widening in senior bond spreads of c.171bp for US banks and c.117bp for Asia ex-Japan banks. At current spread levels, we believe the potential for NAB’s bonds to outperform is limited.

Oversea-Chinese Banking Corp Ltd (OCBC) Lyris Koh

Rating Rationale

Market Weight

OCBC (Aa1 Stb/AA- Stb/AA- Stb) has a very high likelihood of support from the government, if needed, given its systemic importance as one of Singapore’s three domestic banks. OCBC’s total assets were SGD267bn at end-September 2011 compared with SGD339bn at DBS. Earnings: OCBC’s 3Q11 net profit of SGD513mn missed market expectations largely due to trading losses and weak income at its insurance subsidiary. However, core earnings were still healthy – net interest income increased c.6% q/q, supported by strong loan growth (c.27% y/y) and relatively stable margins. Credit costs were low, accounting for just c.6% of 3Q11 pre-provision profit. Funding: OCBC’s loan growth has outpaced its deposit growth; consequently, its gross loan-to-deposit ratio was elevated, at c.89%, at end 3Q11. In particular, the bank’s USD LDR jumped to c.166% from c.101% a year earlier. Given the rising USD funding gap, we expect OCBC to opportunistically tap the USD bond market in 2012. We note that OCBC’s issuance of commercial paper has increased, with c.SGD5bn outstanding at end-September 2011 versus c.SGD2.8bn a quarter earlier. Asset quality: OCBC’s gross NPL ratio was a low c.0.7% at end-3Q11, and the bank registered a broad-based decline in its NPLs across various industries. That said, we are cautious on the outlook for asset quality given the headwinds from slowing economic growth. Capital: OCBC’s capital position is sound, with a core Tier 1 CAR of c.11.2%. The bank has said that it will be able to meet the Monetary Authority of Singapore’s revised capital adequacy requirements through organic capital generation. In particular, the bank said that it will not need to cut dividends or change its strategic plans to meet the higher requirements. Valuations: We revise our rating on OCBC to Market Weight from Overweight. While we think the OCBCSP 3.75% ’22c17s are attractive at current levels, we do not see much scope for outperformance given increased market scrutiny of back-end coupons following the liability-management exercises conducted by European banks.


6 January 2012 64

Public Bank Bhd (PBK) Lyris Koh

Rating Rationale

Market Weight

Public Bank (A3 Stb/A- Stb/NR) is the third-largest banking group in Malaysia and was founded by banker Tan Sri Dato’ Sri Dr. Teh Hong Piow. It has total assets of c.MYR240bn (USD75bn) and c.16% of the domestic loan market. PBK has a strong domestic retail franchise, evidenced by the fact that its retail operations accounted for about c.58% of its pre-tax profit and loans to individuals accounted for c.63% of total loans. Earnings: PBK reported a respectable set of 3Q11 results, with net profit increasing c.2% q/q on improved net interest income and declining credit costs. At c.29.6%, PBK’s cost-to-income ratio is much lower than its peers. However, we expect the bank’s earnings momentum to slow in 2012 as loan growth moderates and competition remains intense. Funding: We have previously flagged the increase in PBK’s gross loan-to-deposit ratio as a trend to monitor. Although the bank’s LDR was relatively stable in 3Q11, it remained elevated, at c.89%. In our view, if PBK intends to continue to grow its loan portfolio at similar rates, deposit growth needs to keep up. Therefore, we see a risk that PBK aggressively hikes deposit rates, putting pressure on its margins. Asset quality: PBK’s asset quality has always stood out as among the strongest of the Malaysian banks under our coverage. At end-3Q11, the bank’s gross NPL ratio was c.0.9% and its coverage ratio a healthy 178.1%. However, the bank is not immune to slower economic growth, and we believe credit costs could rise from current low levels. Indeed, PBK’s new NPLs picked up slightly during 3Q11. Capital: We remain concerned about PBK’s capital position as its core Tier 1 CAR of c.7% just meets Basel III’s minimum requirement. If Bank Negara Malaysia accelerates the timeline for meeting the Basel III capital requirements, we believe PBK may have to reduce its dividend payout ratio or raise equity. We note that PBK has reduced its dividend payout ratio since 2008. Valuations: There is no change to our Market Weight rating on PBK. Given the relatively low back-end coupon of the bank’s bonds, we see little scope for outperformance over the next six months.

Shinhan Bank (SHB) Krishna Hegde

Rating Rationale

Market Weight We believe Shinhan Bank (A1 Stb/A Stb/A Stb) is one of the stronger Korean commercial banks in terms of fundamentals, and the broad improvement in credit metrics in its latest earnings release (3Q FY11) reinforces our constructive view on the lender. We believe that the bank’s bid to acquire Tomato Savings Bank will not have a material impact on its fundamental credit profile given the deal’s relatively small size. Shinhan has also been looking at offshore acquisitions, with the Korea Economic Daily reporting that Shinhan had agreed to buy an Indonesian bank. Asset quality: Shinhan’s asset quality improved slightly in 3Q FY11, with its NPL ratio decreasing 4bp q/q to 1.24% and its NPL coverage ratio increasing 2pp q/q to 143%. We note that Shinhan’s NPL ratio compares favourably with its commercial bank peers (second-lowest after Hana) and it has the highest NPL coverage ratio. Its total delinquency ratio for KRW loans (not including loans in the trust account) fell 8bp q/q to 0.69%, with both retail (-10bp q/q, to 0.47%) and SME (-13bp, to 1.08%) delinquencies improving. Funding and liquidity: Shinhan’s funding profile also improved in 3Q FY11, with deposit growth (+5.9% q/q) outstripping gross loan growth (+1.6% q/q), pushing the gross LTD ratio including CDs down 4.3pp q/q, to 102.7%. While Shinhan’s foreign-currency LTD ratio is relatively high (3Q FY11: 152%), we note that this is well below the levels that prevailed during the 2008 global financial crisis. We note that Shinhan has USD700mn of USD-denominated bonds maturing in 2012. Earnings: Shinhan reported 3Q FY11 earnings of KRW458bn, down 41.7% q/q and 13.9% y/y. Although pre-provision profit fell c.37% q/q, largely due to the absence of one-off gains (ie, the sale of Hyundai Engineering & Construction in 2Q), core earnings improved, as net interest income increased (+2.6% q/q) and operating expenses declined (-9.2% q/q). Credit costs declined 24.1% q/q, partly due to provision writebacks stemming from a debt-equity swap with a company undergoing restructuring. Shinhan’s NIM declined 3bp q/q to 2.24%, with management guiding for further pressure on the NIM in 4Q as the bank’s cost of funding continues to increase. Capital position: With a Tier 1 CAR of 12.98% at 3Q FY11 (+3bp q/q and -20bp y/y), Shinhan Bank’s capital position continues to be the strongest among the commercial banks and is one of Shinhan’s key strengths. Valuations: There is no change to our Market Weight rating on Shinhan Bank. Although we believe the outlook for its fundamentals in 2012 is benign, we think supply could drive spreads wider, especially considering the bank’s refinancing needs.


6 January 2012 65

State Bank of India (SBI) Lyris Koh

Rating Rationale

Market Weight

State Bank of India (Baa2 Stb/BBB- Stb/BBB- Stb) is the largest bank in India, with total consolidated assets of USD311bn at end-March 2011. At end-June 2011, the bank had a c.16% share of India’s deposit market. The bank is c.59% owned by the government, and we believe there is a high likelihood of government support, if needed. The SBI Act has been amended to lower the minimum required government shareholding to 51% from 55%. Earnings: In our view, credit costs will continue to be the key driver of SBI’s net profits in 2012. We expect credit costs will remain a drag on the bank’s bottom line as borrowers’ ability to repay is being hurt by high interest rates. Rate cuts by the RBI could alleviate some of this pressure, although we expect any relief to be reflected in credit costs only with a lag. On the bright side, a key positive earnings surprise from SBI has been the resilience of its margins. The bank upgraded its FY12 NIM forecast to 3.65% from its original 3.5% target when its margins for 2QFY12 came in at a healthy c.3.8%. Funding: With European banks deleveraging and selling Asia loan portfolios, we would not be surprised if SBI opportunistically acquired assets. Coupled with the potential for some companies to seek refinancing for their foreign currency convertible bonds, we believe SBI will tap the USD-senior bond market when spreads stabilise at tighter levels. Asset quality: SBI’s asset quality has deteriorated over the past few years. The bank’s gross NPL ratio increased to c.4.2% at end-2QFY12 from c.3% at end September 2009, and the rate of new NPL formation has picked up. SBI’s slippages in 2QFY12 were c.INR80bn versus c.INR62bn a quarter earlier and c.INR44bn in 2QFY11. The decline in asset quality was broad based, although c.16% of the 2Q slippage was due to a few accounts in the agro-based sector. The bank’s aviation and infrastructure exposures also pose potential risks to asset quality. Infrastructure loans accounted for c.9% of SBI’s total loans at end-September 2011. According to news reports, the bank said that it has about INR14bn of exposure to Kingfisher Airlines. We estimate that SBI’s gross NPL ratio would increase c.17bp if this exposure becomes nonperforming. Given the challenges facing India’s economy, we expect the negative trend in asset quality to persist in 2012. Capital: The long, drawn-out saga regarding SBI’s capital injection from the government appears to be reaching a resolution, with the local media reporting that SBI has received a commitment from the government for a INR60bn capital injection. We estimate that the capital injection will raise SBI’s Tier 1 CAR by about 70bp to c.8.7%. In addition to the capital injection, SBI’s capital ratios are also likely to benefit from its capital efficiency initiatives. For example, the bank said that by utilising export credit guarantee programs, it would be able to lower its risk weights. Valuations: We raise our rating on SBI to Market Weight from Underweight even though we think spreads on its bonds could leak wider on continued concerns about the fundamental pressures facing Indian banks. Given the current large carry differential between SBI’s bonds and the EM Asia USD High Grade Credit Index, SBI’s bonds would have to widen significantly for SBI to underperform.

United Overseas Bank (UOB) Lyris Koh

Rating Rationale

Market Weight

UOB (Aa1 Stb/AA- Stb/AA- Stb) has a very high likelihood of support from the government if needed, given its systemic importance as one of Singapore’s three domestic banks. UOB’s total assets were SGD231bn at end-September 2011, compared with DBS’s SGD339bn. UOB was founded by the Wee family, which still holds substantial stake in the bank. Earnings: UOB’s 3Q11 earnings missed consensus largely due to weaker trading and investment income and increased operating expenses. Although net interest income was stable q/q, we believe it will remain under pressure as loan growth slows amid the continued low interest rate environment. The bank has said that it intends to protect its margins through growth in higher-margin countries such as Indonesia. However, we believe this strategy will take time to bear fruit, and the bank’s NIM could decline from the c.1.9% reported in 3Q11. Moreover, UOB said margins for its international businesses were also under pressure in 3Q11 – eg, its margin in Indonesia declined c.40bp q/q to c.5% due to competition. Credit costs could also rise from the current low levels, in our opinion. Funding: Like its Singaporean peers, UOB’s loan-to-deposit ratio (c.89%) has risen. However, the bank has been more conservative in growing its USD loan portfolio; therefore, its USD loan-to-deposit ratio is lower than its competitors. However, we believe UOB is a potential USD-bond issuer as it seeks to secure stable sources of USD funding. In a trend also seen at DBS, UOB’s short-term debt increased sharply in Q3, rising to c.SGD4.1bn from c.SGD2.7bn a quarter earlier. Asset quality: Although UOB’s gross NPL ratio remained relatively low at c.1.5%, its absolute gross NPLs increased c.9% q/q. The increase in NPLs was driven largely by the transport/storage sector, where the NPL ratio was c.7.4% at end-September 2011. Given the continued uncertainty in the economic outlook, we think gross NPLs could increase in 2012. Furthermore, NPLs in UOB’s Thai portfolio could rise due to the floods. However, the impact on earnings is likely to be minimal, as the bank said that it set aside SGD500mn of collective provisions for its Thai portfolio a few years ago but has not utilised it to date. UOB also disclosed that at end-September 2011, its exposure to European debt in its AFS portfolio was c.SGD2.1bn, or c.0.91% of total assets and c.9% of equity. Given the rout in global markets over the quarter, UOB recorded a SGD492mn fair value loss on its AFS portfolio in 3Q11. Capital: We believe UOB’s capital position is sound, with a core Tier 1 CAR of c.12.3% at end-3Q11, although it decreased c.37bp q/q. The bank said previously that it expects its overseas expansion to consume capital and to put some pressure on its capital ratios. We also note that the bank discontinued its scrip dividend scheme in 2Q11, citing greater clarity on capital requirements following MAS announcements. Valuations: There is no change to our Market Weight rating on UOB.


6 January 2012 66

Westpac Banking Corp (WBC) Krishna Hegde

Rating Rationale

Underweight

We remain Underweight on Westpac (Aa2 Stb/AA- Stb/AA Stb) given tight valuations and our expectation of a pick-up in credit costs. We think delinquencies from the mortgage (specifically the 2008 and 2009 vintages) and business portfolios could rise given the subdued economic outlook. Asset quality: Westpac’s asset quality showed signs of improvement, with stressed exposures as a percentage of total committed exposures at 2.48%, down 37bp h/h and 72bp y/y. The bank has more exposure to Australian mortgage lending (at October 2011, its Australian housing loans as a percentage of total Australian gross loans and acceptances was 74% versus the big four bank average of 65%), and coupled with strong mortgage loan growth during 2008-09, it is vulnerable to a weakening Australian housing market. While the bank’s mortgage book performed better than expected in 2H FY11, management expects delinquencies to tick up again as the mortgage book seasons. Funding and liquidity: Along with its big four Australian bank peers, Westpac has taken steps to improve its funding profile, albeit modestly: FY11 deposits accounted for 56% of total funding versus 55% in FY10. At 40%, Westpac has a relatively higher proportion of total deposits from relatively “stickier” household deposits (big four Australian bank average: 37%). Management stated that the c.AUD25bn raised in FY11 has mostly covered FY12 maturities (c.AUD27bn), and added that with c.AUD103bn of liquid assets (mostly in the form of cash, government and semi-government paper), Westpac would not have to tap the wholesale markets in FY12, assuming adverse market conditions persist. In addition, the ability to issue covered bonds adds diversity to Westpac’s possible funding sources. Earnings: Westpac reported FY11 net income of AUD6.99bn, but the increase of 10% y/y, from AUD6.35bn in FY10, was short of the Bloomberg consensus estimate of AUD7.07bn. However, cash earnings of AUD6.3bn were in line with market expectations. Strength in the retail and wealth divisions was offset by weakness in markets and treasury income – in line with peers – as a result of volatile trading conditions. Expenses were higher in 2H FY11 than in 1H FY11 due to one-off items and investments, which were weighted more heavily toward 2H. The group’s net interest margin improved modestly, rising 2bp h/h to 2.23%. Capital position: Westpac’s capital position improved in FY11, with Tier 1 CAR up 15bp h/h and 59bp y/y to 9.68%. Under APRA’s proposed Basel III rules, the bank estimates that its common equity ratio would have been c.7.4%. Valuations: Since 1 August 2011, a basket of Westpac ’15s senior bonds has widened only c.94bp compared with average widening in senior bond spreads of c.171bp for US banks and c.117bp for Asia ex-Japan banks. In our view, the Westpac bonds do not offer sufficient carry to compensate investors for potential deterioration in the bank’s asset quality or heightened economic risks.

Wing Hang Bank (WHB) Lyris Koh

Rating Rationale

Market Weight

Wing Hang Bank (A2 Stb/NR/A- Stb) is a mid-sized Hong Kong bank with total assets of HKD177bn (c.USD23bn) at end-June 2011. The bank’s major shareholders are the Fung family and the Bank of New York Mellon. Like most Hong Kong banks, WHB has expanded overseas to support its earnings growth. It operates in China and Macau via its wholly owned subsidiaries Wing Hang Bank (China) and Banco Weng Hang, respectively. These two subsidiaries accounted for about c.33% of the bank’s 1H11 profit before tax. Earnings: WHB’s 1H11 net profit of HKD1.2bn exceeded consensus largely due to one-off items, including a HKD381mn gain on the disposal and revaluation of fixed assets, and a writeback on the Lehman minibonds. Core operating trends were softer, with its NIM declining c.6bp h/h, to c.1.71%, owing to a “decrease in interest income from treasury operation, pressure from mortgage repricing and an increase in the cost of deposits”. As a smaller Hong Kong bank, we expect WHB to face greater margin pressure than its larger peers. At about 92%, its HKD LDR was elevated at end-June 2011, although it was broadly stable h/h. The bank’s credit costs were minimal in 1H11, but we believe that level is unsustainable and expect credit costs to rise gradually over 2012. Asset quality: WHB’s asset quality remained sound over 1H11, in our view, with its gross impaired loans down c.10% h/h. However, we think the bank’s coverage ratio – c.77% at end 1H11 – could be improved. We also note that impaired mainland-related loans increased c.42% h/h, albeit from a low base of HKD14mn at end-December 2010. Also, as with the other Hong Kong banks, we expect asset quality risks to increase as WHB’s exposure to China grows – mainland-related loans accounted for c.11% of total loans at end 1H11 versus c.6% at end 1H09. Capital: The bank’s capital position is adequate, with a Tier 1 CAR of c.10.3%. The bank raised its regulatory reserves by HKD258mn h/h and guided for further increase in 2H11. Valuations: We maintain our rating on WHB at Market Weight as we see little scope for the bonds to outperform given the macro headwinds. Moreover, we note that WHB’s bonds are extremely illiquid.


6 January 2012 67

Woori Bank Krishna Hegde

Rating Rationale

Market Weight Woori Bank (A1 Stb/A- Stb/A- Stb) is the main banking subsidiary of Woori Financial Group. Plans to privatise the group, revived in mid-2011, proved unsuccessful, with the Public Fund Oversight Committee suspending the sale after only one of three potential bidders – MBK Partners – submitted a letter of intent before the deadline. Furthermore, we do not expect the Korean government to make another attempt at privatisation ahead of the parliamentary and presidential elections in 2012. However, the government remains determined to privatise Woori, and recent news articles have reported that policymakers are preparing to resume the process in the first half of 2012. Asset quality: Woori’s asset quality continued to improve, as the bank cleans up its balance sheet. Its gross NPL ratio fell 17bp q/q, to 2.25%, and the NPL coverage ratio rose 4.5pp q/q, to 103.5%. Notably, the KRW SME delinquency ratio ticked up 80bp q/q, to 2.02% – a relatively high level historically – with the increase coming primarily from the real estate lease/business services segment. However, we note that the jump in the SME delinquency ratio is partly attributable to the sharp decline in sales and write-offs of delinquent loans during 3Q11. Given its relatively higher proportion of SME borrowers, we believe Woori’s asset quality may be more vulnerable than its peers to slowing economic growth. Funding and liquidity: Although Woori enjoys a stable deposit base, it retains exposure to foreign-currency funding. The bank’s foreign-currency LTD ratio is relatively high, at 148% as of 3Q FY11, but we note that this is well below the levels that prevailed during the 2008 global financial crisis. Like other Korean commercial banks, Woori has taken steps to shore up its liquidity: it secured a USD1bn committed line, with an intention to double it to USD2bn. Earnings: Woori Financial Group reported 3Q FY11 net income of KRW520bn, up 8.3% y/y. As expected, Woori Bank’s headline profit declined q/q due to the absence of the one-off gain (ie, the sale of stake in Hyundai Engineering & Construction in 2Q). That said, core earnings showed signs of improvement, with a 4.0% q/q increase in net interest income, declining operating expenses (-10.5% q/q) and a substantial decrease in credit costs (-55.8% q/q). The bank’s net interest margin improved 5bp q/q, to 2.50%. Capital position: Woori Bank’s capital position remained robust in 3Q FY11, with Tier 1 CAR increasing 34bp q/q, to 11.81%, which compares favourably with its commercial bank peers. Valuations: Woori’s credit metrics have improved and are now more in line with its Korean commercial bank peers. However, given the potential for its asset quality to weaken as a result of slowing economic growth, as well as possible supply from Korean commercial banks, we maintain our Market Weight rating on the bank.


6 January 2012 68

This page is intentionally left blank


6 January 2012 69

ASIA-PACIFIC HIGH GRADE CORPORATES


6 January 2012 70

HIGH GRADE DIVERSIFIED INDUSTRIALS

Weighed down by slowing growth Key recommendations

Underweight Posco (A3/A Both Neg): We have a cautious view on the company’s near-term outlook and we expect operating margins to remain under pressure as a result of weak steel prices and high raw materials costs. We see further near-term downside risk for both steel pricing and volumes. Capex remains elevated despite recent plans to reduce such spending in 2012 to KRW6trn from the originally proposed KRW7.3trn.

Market Weight Hutchison Whampoa (A3 Neg/A- Stb): We expect Hutch’s credit profile to remain stable in 2012 due to the diversified and stable nature of its business portfolio. One area of concern is Europe; however, we think the impact of any slowdown in Europe will be partially mitigated by the diversified nature of its assets. Although Europe accounts for 45% of Hutch’s assets and 40% of its revenues, it generates only 25% of group EBITDA, split between Ports (3%), Retail (5%), CKI (7%) and 3 Group (10%). We also expect earnings growth from subsidiaries CKI and Husky Energy to offset some of the weaknesses in Hutch’s more cyclical businesses.

Korean steel (Posco) – Rising global and domestic headwinds point to a bumpy ride ahead. Overall, we expect credit quality to come under pressure as global economic momentum continues to slow. Globally, weak underlying demand and sentiment have already started to impact steel prices. On the Korean domestic front, key industries such as autos, home appliances and shipbuilding are expected to reduce steel consumption in 2H11 and 1H12, causing domestic production to exceed consumption. We expect operating margins to remain under pressure as prices of key raw materials such as iron ore and metallurgical coal stay elevated relative to steel prices despite declining from recent peaks.

Hong Kong property companies – Headwinds, but downside mitigated by prudent financial management: The sector as a whole faces headwinds from expected economic slowdowns in both China and Hong Kong. Our economics team is expecting China to experience a soft landing, with growth slowing to around 8% in 2012. Under this scenario,

Timothy Tay, CFA +65 6308 2192

[email protected]

Figure 29: Global steel prices: Increasing headwinds from weak underlying demand

Figure 30: Higher elevated iron ore and metallurgical coal prices mean operating margins continue to be squeezed

200

400

600

800

1,000

1,200

1,400

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

N.Europe domestic ex-worksN.America FOB Midwest

China domestic Shanghai

0

50

100

150

200

250

300

350

1Q10 2Q10 3Q10 1Q11 2Q11 3Q110

2

4

6

8

10

12

14

16

18

20

Operating margin (%) - RHSCoal ($/t)Iron ore ($/t)

Source: CEIC Source: Company reports, Barclays Capital


6 January 2012 71

the team also expects Hong Kong’s economic growth to slow to 3.1% in 2012 from 4.8% in 2011. We see residential property developers as being impacted the most, followed by commercial property (office) investors and retail property investors.

Despite the subdued economic outlook, we believe the sector’s credit fundamentals are sound, with strong capitalisation and financial flexibility. All the issuers under our coverage have substantial liquidity, which bolsters their credit profiles. We estimate that Henderson Land and Sun Hung Kai have committed loan facilities in excess of HKD30bn. For our coverage universe, we expect the companies that generate significant cash flow from investment properties to weather the downturn better than those with heavy pipelines of residential developmental projects in both Hong Kong and China. We expect rental reversions to remain positive for both the office and retail segments as current spot rents, while trending weaker, are still 20-30% higher compared with 2008/2009.

Notwithstanding our view that credit fundamentals remain sound, we recommend an underweight stance on the sector given our expectation that negative industry headlines and the absence of any near-term positive catalysts will weigh on bond valuations. Our recommended strategy is to remain invested in wider-spread names, such as Henderson Land (Market Weight) and Wharf (Market Weight), and gradually reduce exposure to the tighter-spread names. Our Underweight ratings on both Sun Hung Kai Properties and Hongkong Land reflect the tight valuations of single A rated Hong Kong property companies versus BBB and unrated issuers such as Wharf and Henderson Land.

Hong Kong conglomerates – Better positioned to weather any storms: We expect Hong Kong conglomerates (Hutchison Whampoa and Swire Pacific) to remain resilient during the expected economic slowdown due to the diversified and low-risk nature of their core businesses. 2011 operating performances of these companies have been strong, lifted by higher earnings contributions from key businesses despite the difficult macro and operating environment. Liquidity remains strong and access to multiple sources of funding open. Similar to 2011, we expect bond issuances in 2012 to be opportunistic, mainly to refinance upcoming maturities and to diversify funding sources

Figure 31: Relative value of HK property companies

Figure 32: Hong Kong property market – Cycle turning

HKLAND '25

HENLND '19

SUNHUN '20

WHARF '17

SUNHUN '16SUNHUN '17

HKLAND '142

3

4

5

6

7

0 3 6 9 12 15Maturity

YT

W

50

70

90

110

130

150

170

190

210

230

1999 2001 2003 2005 2007 2009 2011

Retail Rental IndexOffice Rental IndexHK Retail SalesResidential Price Index (Grade A)

Source: Barclays Capital Source: CEIC


6 January 2012 72

HIGH GRADE RESOURCES

Constructive outlook for upstream producers; event risk manageable Key recommendations

Overweight Reliance Industries (Baa2/BBB, Both Pos): We expect the credit profile of Reliance to remain stable after the sale of the 30% stake in the 21 KGD6 wells to BP for a consideration of USD7.2bn. The sale should likely offset some of the near-term risk of decreased production output from the gas wells. We also do not expect Reliance’s financial profile to be impacted materially by the depreciation of the rupee.

Market Weight CNOOC (Aa3/AA-, Both Stbl): We continue to view the CNOOC ‘21s as a core position in our coverage universe, given the company’s strong financial and operating profiles compared to other Asian oil and gas companies. Absent any large acquisitions, we believe CNOOC does not require external debt as it is generating sufficient cash flows to fund its planned capex requirements. We think the company has adequate ratings headroom in the event of a moderately sized debt-funded acquisition.

Elevated but manageable event risk: We expect most E&P operators under our coverage to be acquisitive in 2012 given their aggressive targets for increased production and replacement of reserves. The risk of debt-financed acquisitions is, however, mitigated by the strong credit profiles of companies in the sector as well as a focus on acquiring assets rather than oil and gas companies outright due to rising competition and difficulties in obtaining regulatory approvals from governments. A recent example of a transaction that was scuttled for these reasons was the proposed Bridas (50/50% JV between CNOOC and Bridas Energy) acquisition of a 60% equity interest in Pan American Energy from BP. From a credit perspective, acquisitions of unconventional assets would likely be less detrimental to the credit profile of an acquirer, due to the significantly lower capital outlay and the reduced funding required. Our review of transactions over the past two years suggests that, with the exception of a few larger transactions, the majority were generally for less than USD3bn, and most involved the purchase of unconventional assets outside of the Asia-Pacific region.

Supportive crude prices: We believe credit metrics for the E&P sector will remain stable as a result of elevated commodity prices. We forecast Brent and WTI prices to average USD115 and USD110 in 2012. Our commodities team also believes potential downside to oil prices will not be as severe as during the 2008-09 cycle, and sees support at the USD90 level even in the event of a severe economic downturn. E&P operators are natural beneficiaries of high oil prices, so we expect earnings to remain underpinned. However, for operators with formula-based (PTTEP) or government-controlled (Petronas for gas output) selling prices, earnings growth may be less well supported.

Cautious on refining margins: We expect incremental refining capacity additions to exert downward pressure on refining margins in 2012 despite continued demand for refined products from emerging economies. Thus, we believe refining margins most likely peaked in 2011, as we do not expect the one-off factors that caused supply tightness in Asia to be repeated. While capacity utilisation rates of refiners in Asia were strong in 2011, with most averaging above 80%, we think the risks are on the downside in the event of a slowdown in emerging Asia due to the impact of the European sovereign crisis. Despite the headwinds from incremental supply and the potential for weakened demand, we think current supply and demand fundamentals are more constructive compared to the 2008/2009 period.


[email protected]

Rom Yudhanahas +65 6308 3804

[email protected]


6 January 2012 73

Absent a major slowdown in regional economies, we do not expect refining margins to test the levels reached during the 2008-09 global financial crisis period.

Figure 33: Reuters Singapore Dubai crack spread (USD/bbl)

Figure 34: Refining capacity additions (mmbpd)

0

2

4

6

8

10

12

Jan-06

Nov-06

Sep-07

Jul-08

May-09

Mar-10

Jan-11

Nov-11

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2011 2012 2013 2014 2015

Asia Rest of World

Source: Reuters, Barclays Capital Source: Barclays Capital

Continued weak petrochemical spreads: We believe petrochemical spreads are likely to remain under pressure in the near term as a result of elevated feedstock prices and weakening domestic demand in countries such as China and Thailand. The demand for chemical products in China has already been impacted by the tightening of domestic monetary policies as 2011 demand for chemical products was only up 2% compared with 6.7% in 2010. We also expect ethylene capacity expansions of c.4,200 mtpa in 2012 in the Middle East and Asia to exert further downward pressure on spreads.

Figure 35: Ethylene-naphtha spread (USD/ton)

0

100

200

300

400

500

600

700

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

Source: Bloomberg, Barclays Capital


6 January 2012 74

HIGH GRADE TELECOMS AND UTILITIES

Stability amid uncertainty Key recommendations

Overweight Korea Hydro & Nuclear Power Co: KHNP benefits from a strong support from the Korean government and has the strongest credit profile among the Korean quasi-sovereigns. As a predominantly nuclear operator, it also has the lowest generation cost per unit and is not exposed to carbon fuel prices like other thermal gencos. This will support the company’s earnings and credit profile in the event of volatile energy prices, in our view.

Underweight SK Telecom: SKT’s credit ratings are under review for possible downgrade by all three rating agencies, following its acquisition of a 21% stake in chipmaker Hynix Semiconductor which we expect to be partly debt-funded considering its size. We think a one-notch downgrade in the next 3-6 months is likely given SKT’s weakened credit metrics and increased business risk profile following the acquisition.

Market Weight Telekom Malaysia: TelMal has strong cash flow generation capacity, underpinned by its dominant position in the fixed-line and broadband market in Malaysia. In addition, we expect the company’s capex to slow down, as it is close to meeting its high-speed broadband roll-out target.

Korean quasi-sovereigns Potential new supply to fund capex programmes. We expect capital expenditure of the Korean quasi-sovereigns to remain high in 2012, given their large investment plans. These government-driven capex programmes range from expanding generation capacity and distribution networks at home and overseas (KEPCO and the gencos) to acquiring overseas assets (Korea Gas and Korea National Oil). In terms of capex guidance, KEPCO said it would spend KRW16-19trn annually on a consolidated basis during 2012-15, Korea Gas will spend KRW1.2trn on pipeline network in 2012 and up to KRW5.8trn on overseas E&P assets over 2011-12, Korea National Oil Corp (KNOC) plans to spend about USD4bn on overseas oil and gas assets, and KHNP is expected to spend close to KRW5trn in 2012 on new facilities. Given their large capex targets, we believe the Korean quasi-sovereigns, especially those with USD funding requirements (including KEPCO, KHNP, KOGAS, and KNOC) will continue to actively tap the offshore market to meet its funding needs.

Government support remains strong. While we expect the stand-alone credit profile of the Korean quasi-sovereigns to deteriorate in the medium term as a result of its large capex programmes, we believe the strong government support will continue to sustain the companies’ credit ratings. As seen in October, Moody’s downgraded the stand-alone credit rating of Korea Gas and KEPCO following the weakening of their credit metrics, but simultaneously factored in a higher degree of government support and thereby kept their credit ratings unchanged. Financial support from the Korean government to the quasi-sovereigns includes tax exemption for overseas investments, tax credits, equity injection, special loans and loss subsidies.

Utilities Commodity prices weigh on profitability. We expect input costs to remain high for the power and gas utilities in 2012. Our commodity team’s forecast for Newcastle coal price for 2012 is USD120/t, compared with an average of USD125/t for 2011. Similarly, regional gas price, which is referenced to crude oil price, is also expected to stay elevated (our 2012 price forecast for Brent crude is USD115/bbl). As witnessed in the past year, high input prices were


[email protected]

Rom Yudhanahas +65 6308 3804

[email protected]


6 January 2012 75

the reason for poor operating performance among the Korean and Malaysian utilities as they do not benefit from automatic cost pass-through mechanisms. In our view, the situation is unlikely to change significantly in the near term, given high fuel costs and the government’s motivation to contain inflation, especially with elections looming in both countries.

Implementation of cost pass-through remains uncertain. The implementation of cost past-through tariff system for KEPCO, which was initially set for July 2011, has already been delayed without a definite timeframe. Korea Gas’ fuel cost pass-through tariff system, though in place, has been facing frequent suspensions by the Korean government. In Malaysia, electricity tariffs adjustment is also subject to the government approval. Furthermore, tariffs hikes over the past year have not been sufficient to meet the increase in generation costs. We expect tariff adjustments to continue to be done on an ad-hoc basis and the increase insufficient given the government’s agenda. The absent of an automatic cost pass-through mechanism as well as a consistent implementation of such system will thus remain credit negative for the utilities.

Telecoms Search for growth a cause of concern: We think efforts to enhance revenue growth are the key risk for this relatively stable sector. We expect the telcos operating in mature markets to focus their investments on fast-growing segments such as media, content and ICT businesses. Although we do not expect the amount of investments to be substantial given the nature of these businesses, we expect these non-core areas to contribute little to overall revenue in the near term while the inherent volatility of these businesses could jeopardise the companies’ overall credit profiles.

Capex high but discretionary. Companies under our coverage have guided for largely stable capex, most of which will be utilised for capacity enhancement rather than coverage expansion. As such, even though capex remains high in absolute terms, we believe it is somewhat discretionary and should stabilise in terms of percentage of revenue going forward. One exception is Telekom Malaysia, which is building out its High Speed Broad Band (HSBB) network. Nonetheless, we expect TelMal’s HSBB investment to moderate from 2012 after the heavy spending of the past three years.

Figure 36: Korean quasi-sovereigns

Figure 37: KEPCO’s earnings vs revenue

0%

20%

40%

60%

80%

100%

KHNPKNOC

KEPCO

HIGHWYKOGAS

KOLAHO

0x

1x

2x

3x

4x

5x

6x

7x

Gross debt/capital EBITDA/interest

-1,500

-1,000

-500

0

500

1,000

1,500

2,000

2,500

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

70

75

80

85

90

95

100EBITDA, KRW bnRevenue, KRW/kWh (RHS)

Note: Credit metrics as of FY2010. Source: Company data, Barclays Capital Note: Non-consolidated. Source: Company data, Barclays Capital


6 January 2012 76

Competition remains high in Korea: The rise in the popularity of smartphones, which are now used by more than 20mn subscribers in Korea from just 7.2mn at end-2010, and the consequent surge in data usage have intensified competition among the Korean telcos. The competition to obtain the best bandwidth resulted in a record bidding price at the latest spectrum auction in September. We think the need for ongoing investment in new technologies, marketing activities and handset subsidies, as well as the Korean government’s inclination to control mobile tariffs will continue to weigh on the profitability of the Korean telcos.

Figure 38: Generation costs by fuel type

Figure 39: Telcos capex (USD mn)

45%29%

9%31%

40%40%

6%

0%

25%

50%

75%

100%

KEPCO Tenaga

Natural gas Oil and distillate Coal Nuclear

0

500

1,000

1,500

2,000

2,500

2008 2009 2010 2011E 2012E

Telekom Malaysia PCCW SK Telecom

Note: 1H11 for KEPCO and 2H FY11 for Tenaga. Source: Company data, Barclays Capital

Source: Company data, Barclays Capital


6 January 2012 77

ISSUER PROFILES

China Overseas Land and Investment Ltd (COLI) Christina Chiow

Rating Rationale

Market Weight

Credit view: Amid ongoing policy tightening, we expect large, established developers such as COLI (Baa2/BBB both Stb) to benefit at the expense of smaller players. COLI’s nationwide exposure and demonstrated prudence in preserving credit quality while pursuing growth provide a buffer against a material deterioration in its credit profile. Contracted sales performance has been strong, with sales of HKD81.6bn in 11M 11, more than its full-year target of HKD80bn. We expect debt/EBITDA and debt/capital to remain robust in 2011, at c.2.5x and 40% respectively, and look for interest cover to remain above 10x. Cash holdings of more than HKD18bn amount to more than 10% of total assets at June 2011 and appear ample against short-term debt of HKD13.2bn (includes amounts due to related entities). Additionally, leveraging its long operating track record and healthy financials, COLI has continued to enjoy a high level of financial flexibility in the equity, loan, and bond markets. Valuation: At a spread of more than 400bp to Treasuries, we view the valuation of COLI’s 2016 bonds as attractive for a state-owned company with a stable credit profile. However, we expect sector headwinds to take precedence in the near term, preventing significant spread tightening. Hence, we maintain our Market Weight on COLI.

China Resources Land Ltd (CRL) Christina Chiow

Rating Rationale

Overweight

Credit view: The outlook for China Resources Land (CRL, Baa2/BBB both Stb) remains stable, in our view. Execution to date has been better than expected, with the company more focused on asset turnover. It made good progress in its sales in 2011, achieving CNY30.1bn in 11M11 against its full-year target of CNY30bn. In addition, its 1.5mn sqm of investment properties have continued to enjoy robust rental growth. Up to 11M 11, rental income grew 57% y/y to HKD2.5bn. CRL is one of the few Chinese developers under our coverage that has a sizeable and quality investment property portfolio. CRL reported a dip in 1H operating earnings due to lower GFA booked. But based on the company’s targeted delivery of c2.2mn sqm in 2011, we expect 2H 11 revenue to surge to HKD24bn (1H 11: HKD7.7bn). We expect credit metrics to recover in 2011, with debt/EBITDA of c. 4.5x and debt/capital of below 50%. China Resources Holdings’ asset injection into CRL in 3Q 11, which was largely funded by equity, also helps support a stabilization in CRL’s capital structure and indicates the strong relationship CRL has with CRH, a state-owned enterprise. Offsetting these developments is the company’s growth appetite, which has resulted in a significant increase in debt from HKD37.8bn at end-December 2010 to HKD55bn at end-June 2011. CRL's liquidity looks adequate. At June 2011, CRL had cash of HKD18.7bn against short-term debt of HKD16.0bn. It raised USD250mn (HKD1.95bn) of USD bonds in July 2011 and went on to achieve better-than-contracted sales in 2H 11. Valuation: At T+ more than 400bp, we think current valuations are compelling for a Baa2/BBB state-owned developer. Unlike COLI and Franshion whose bonds are longer-dated, we believe this bond offers the best risk/reward among the three state-owned Chinese developers as it has a shorter tenor (2016s). We have an Overweight rating on CRL.

CNOOC Ltd Timothy Tay

Rating Rationale

Market Weight Credit view: We view the outlook for CNOOC Ltd’s (Aa3, AA- both Stb) credit profile as stable. We expect credit metrics to remain stable on a y/y basis despite a higher level of gross debt, as higher EBITDA supported by higher realized oil price and production levels effectively offsets higher gross debt levels. Absent a debt-funded acquisition, the company does not require external debt as it currently generates sufficient cash flow to fund its capital expenditure requirements. Credit metrics for CNOOC are currently the strongest within the Asian Oil & Gas sector with net debt/LTM EBITDA of -0.2x, LTM EBITDA/interest of 135.2x and LTM FFO/interest coverage of 130.6x. Liquidity is also strong – the company has c.CNY50bn of cash. We think the company also has adequate ratings acquisition headroom in the event of a debt-funded acquisition. Our analysis has shown only a slight deterioration in credit metrics, with debt/EBITDA increasing by 0.3x-0.6x in the event of a US$5– 10bn debt-funded acquisition. Valuation: We expect the bonds to perform in line with the index due to the company’s strong and defensive credit profile. The performance of the 4.25% ’21 and 5.75% ’41 bonds is, however, likely constrained by the longer dated nature of its tenor. We note that longer dated bonds have underperformed shorter and intermediate maturity bonds in this volatile environment as investors prefer shorter dated bonds with lower interest rate sensitivities. The increased duration of longer tenor bonds has amplified their volatility on an excess return basis. We think the 4.25% ’21 bonds are fairly valued at CT10+185 and the 5.75% ’41 bonds are rich at CT30+190. We view the spread between the 10-30 year curve at 5bp as tight and expect fair value to be about 20-30bp. Our recommended strategy is to stay invested in the front and intermediated part of the curve as a core position and continue to monitor the long end for tactical opportunities to add risk during periods of extreme underperformance.


6 January 2012 78

ENN Energy Holdings Ltd (Xinao Gas) Timothy Tay

Rating Rationale

Underweight Credit view: We have a negative view of ENN’s (Baa3/BBB-, Both CW Neg) credit profile as a result of its plan to acquire China Gas. We think the impact on ENN’s credit profile will largely depend on whether the general offer is accepted, on the final size of the acquisition (51%-75% of China Gas), and lastly on the financing structure of the deal. In our base case scenario, we expect the company to successfully acquire the requisite stakes at a higher price than the initial offered price of HKD3.50 a share and to fund that with a combination of debt/equity and cash. This would likely result in higher leverage and a deterioration in credit metrics and lead to a one-notch downgrade of the company by the rating agencies. The timeline for the transaction is 3-6 months. At this point, China Gas’s board has said publicly that the offer undervalues the company. We are not surprised by the initial reaction and we expect China Gas to demand a premium higher than the 25% that was offered by ENN. We think ENN’s bonds will remain volatile as a result of the uncertainties mentioned above. Valuation: We think the 6%’21s will trade in a range of 500-600bp due to the uncertainty over the acquisition of China Gas. If the deal does close, we would expect the bonds to trade in a 600-700bp range (8.0-9.0%), in line with or slightly behind other strong Ba1/BB+ HY issuers such as CITPAC, as we think the increased leverage could lead to a ratings downgrade.

GS Caltex Timothy Tay

Rating Rationale

Market Weight

Credit view: We view GS Caltex’s (GSC, Baa2/BBB both Stb) near-term operating outlook as stable. For 2012, we expect both revenues and operating income to be flat to 2011 as we believe refining margins have likely peaked in 2011, thus limiting further improvement in the company’s credit profile. We expect refining margins to be USD7–8/bbl. We expect incremental refining capacity additions in Asia to exert downward pressuring on refining margins in 2012, despite continued robust demand from emerging economies. While the capacity utilisation rates in Asia were strong during 2011, with most averaging above 80%, we think the risks are tilted to the downside in the event of a slowdown in emerging Asia due to the impact of the European sovereign debt crisis. For 2011, the bonds have outperformed the EM Asia IG Index by 250-500bp on an excess returns basis. For 2012 we expect the bonds to perform in line with the index. Valuation: At CT5+320 for the 6% ’16s, we think the valuations are fair for a mid-BBB refining company with an improving credit profile.

Henderson Land Timothy Tay

Rating Rationale

Market Weight

Credit view: We remain cautious on Henderson Land’s (NR) credit profile for 2012 given the company’s exposure to residential property, which accounted for 61% of 2010 operating profit, compared with 54% for Kerry Properties, 46% for Sun Hung Kai Properties and 12.5% for Wharf Holdings. The continued HKD liquidity squeeze, which is leading to higher-than-expected mortgage rates (mortgage rates are expected to rise another 175bp in 2012 according to BarCap Equity Research), is expected to weigh on home buying sentiment and property transaction volumes. Henderson Land has a sizeable pre-sale schedule in Hong Kong during 2012-13, with more than 2mn sq ft each year (2011: 1.8mn sq ft). Furthermore, while its contribution from China remains small (16% of 2010 revenue), Henderson Land’s exposure to the mainland property market is the highest among high grade Hong Kong issuers under our coverage, with a land bank of 150.4mn sq ft in China. The Chinese property market has tightened. Major Chinese cities have implemented restrictions that forbid local households from owning more than two units. Partly offsetting the uncertain operating environment is Henderson Land’s recurring income from investment properties and dividends of HKD2.2bn from strategic investments, such as Hong Kong & China Gas. Rental income is expected to stay flat in 2012. Despite declines in spot rentals, we still expect some meaningful positive rental reversion for Henderson Land’s commercial properties. We expect rentals for retail properties (which account for c.50% of the company’s investment property) to remain robust. Meanwhile, recently completed investment properties in China, such as Centro and Henderson Metropolitan in Shanghai, will also add to rental income. Net rental income covered 2.3x of gross interest. Liquidity is strong; as of 1H11 the company had HKD33.25bn of unsecured committed credit facilities and HKD17.8bn of cash versus HKD19.6bn of short term liabilities. Valuation: At current levels of CT10+385, we think the Henderson Land 5.5% ’19s are fairly valued relative to peers in the BBB- to BBB category, and we expect them to perform in line with the EM Asia USD IG Corporate Index, given that there likely will be few positive catalysts to cause spreads to tighten. The bonds are not rated by the agencies, which in our view limits the buyer base and demand for the ’19s.


6 January 2012 79

Hongkong Land Holdings Ltd (HKL) Timothy Tay

Rating Rationale

Underweight

Credit view: Our outlook for HKL’s (A3/A- both Stb) credit is stable despite headwinds in the HK commercial property market. Despite an expected 10-15% decline in rents in 2012, we still expect positive rental reversions as average expected rentals of HKD90-HKD100psf are still higher than rents expiring (c.HKD80 in 2012). We believe low vacancies and low near-term supply of grade A commercial property in Hong Kong should be supportive for commercial rents, especially in Central. On the residential side, we expect earnings contribution from this segment to be lower in 2012, due to the lack of significant residential completions. At June 2011, FFO/gross debt was 23% (2010: 24%), EBITDA interest cover was 7.1x (2010: 7.3x) and gross debt/EBITDA was 4.0x (2010: 4.2x). We expect FFO/gross debt to remain above 20% in 2011. Liquidity is adequate – at June 2011, the company had cash of USD771mn, against short-term debt of USD661mn. In November 2011, the company signed revolving credit and term loan facilities for a total of c.USD860mn with eight banks, further improving its liquidity. Material debt-funded investments and shareholder-friendly activity are our key concerns, although HKL's track record in managing expansion and its financial profile provide us some comfort. Our Underweight recommendation reflects the long duration of its bond and its vulnerability to higher interest rates in the current environment, as well as the absence of major positive catalysts for outperformance. Valuation: At CT10+280 we view the 4.5% ’25s as rich, given the issue’s relatively longer tenure and lack of liquidity. We believe the bonds should trade at a discount to A- rated peers.

Hutchison Whampoa Ltd (Hutch) Timothy Tay

Rating Rationale

Market Weight

Credit view: We expect Hutch’s (A3 Neg/A- Stb) credit profile to remain stable in 2012 due to the diversified and stable nature of its business portfolio. Earnings growth will be driven mainly by higher contributions from both Husky Energy and Cheung Kong Infrastructure (CKI). Higher production levels and realised oil and gas prices are expected to lift Husky’s earnings. Likewise for CKI, we expect earnings to be lifted by increased contribution from newly acquired assets. Hutch’s core businesses of ports, property, hotel and retail are likely to remain stable despite increasing headwinds for economic growth in the regions where they operate. Europe is a concern; our economists expect GDP growth in Europe of -0.2% in 2012, down from 1.6% in 2011. We think the impact of a slowdown in Europe will be partially mitigated by the diverse and stable nature of Hutch’s assets. Although Europe accounts for 45% of Hutch’s assets and 40% of its revenues, it only accounts for 25% of its total EBITDA, further broken down into Ports (3%), Retail (5%), CKI (7%) and 3 Group (10%). We expect 3 Group's operating performance to continue to improve barring adverse market or regulatory developments, albeit at a slower pace due to rising customer acquisition and retention costs. In particular, HTAL's profitability is likely to recover as management has adopted a plan to turn the business around. As of 1H11, Hutch’s credit metrics strengthened on lower debt, which declined 16% h/h to HKD219bn. Net debt/net capitalisation declined to 21.9% from 26.8%, in line with S&P's expectation of less than 25% over the next two years. Nonetheless, Hutch’s credit metrics remain modest for its rating, and we do not believe Moody’s will revise its outlook to Stable from Negative in the near term. Debt/EBITDA improved to 6.2x. Liquidity remains adequate with liquid assets of HKD104bn and cash of HKD82.9bn. Major investments or acquisitions may constrain its deleveraging process, but we think Hutch’s financial flexibility remains high. We also believe that Hutch is committed to its A3/A- ratings, having raised USD3bn via perpetual securities to bolster its capital structure in late 2010. We note that Hutch has a USD3.1bn bond due in February 2013, which we think it may opportunistically seek to refinance in 2012. Valuation: : We view current valuations for Hutch as fair, as technicals are supportive owing to the firm’s track record of prudent financial management in times of stress. Both the 5.75% ’19s and the 7.625% ’19s are quoted at CT10+195.

Hyundai Motor Co Ltd (HMC) Timothy Tay

Rating Rationale

Market Weight Credit view: HMC’s (Baa2/BBB both Stb) strong operating performance is driving the improvement in its credit profile. Global sales have increased 11.7% y/y to 3.0mn units in 3Q11. The sales gain was driven by growth across all markets, especially in China (+12% y/y) and the US (+20.2% y/y). We believe HMC’s performance reflects its 1) improved product mix, 2) wide geographic reach (particularly in emerging markets), 3) stronger foothold in overseas markets, 4) improving efficiency, and 5) rising awareness of the brand and its quality. Furthermore, we believe capital investments have passed their peak and expect the company to generate positive free cash flow on a consolidated basis. However, despite being on Positive Outlook at two of the three credit rating agencies, we do not expect a positive ratings action in the near term. Given the competitive and cyclical nature of the auto industry, we believe the rating agencies would upgrade HMC only after it has shown a more consistent record of profitability and competitive product development. Risks to HMC's earnings in FY12 include the impact of a stronger KRW (Barclays Capital 6m forecast is 1075 KRW/USD), a slowdown in the global economy, and increased competition from the Japanese automakers. Liquidity remains adequate, with liquid assets of KRW15.2trn as of 3Q11 versus KRW16.8trn of short-term debt. Valuation: We view current levels for HYNMTR as fair relative to some of the Korean industrial issuers, such as POHANG, due to strong technical support from US-based investors. The HYNMTR 3.75% ’16s are quoted at CT5+295 and the 4.0% ’17s are quoted at CT5+330.


6 January 2012 80

Korea Electric Power Corp (KEPCO) Timothy Tay/Rom Yudhanahas

Rating Rationale

Market Weight

Credit view: We maintain our negative outlook on Korea Electric Power Corp (KEPCO, A1/A both Stb) in 2012, based on its inability to pass though generation costs amid elevated fuel prices and a large capex program. Despite a series of tariff adjustments in 2011, KEPCO’s fuel cost recovery remains inadequate, with the cost coverage ratio after the latest hike in August at just 90.3%. With fuel prices expected to stay elevated, the lack of a transparent and automatic cost-pass-through mechanism will continue to weigh on KEPCO’s credit profile. Furthermore, KEPCO’s plan to increase its reserve margin to 14% (1H11: 5.5%), prompted by a series of blackouts during the summer months, is expected to require KRW15-16trn of capex annually until 2014. With cash and equivalent of KRW1.9trn and short-term debt of KRW7trn at end-June 2011 and estimated annual operating cash flow of KRW6trn, KEPCO will likely need external funding to fund the majority of its capex. As such, we expect the company’s credit profile to continue to weaken over the next 2-3 years, unless a tariff regime that allows sufficient return on investments is implemented. Offsetting this concern, however, is the company’s strong access to both domestic and foreign funding, as well as strong support from the Korean government. Valuation: In our view, the KORELE ’14s (CT2+265) and KORELE ’15s (CT2+235) are fairly valued compared to its utility peers and other Korean gencos.

Korea Gas Corp Timothy Tay/Rom Yudhanahas

Rating Rationale

Underweight

Credit view: As with KEPCO, we have a negative outlook on Korea Gas Corp (KOGAS; A1 Neg/A Stb) in 2012 due to the uncertainty surrounding its tariff system and its large investment plan. The loss of KRW358bn reported in 3Q11, a result of the Korean government’s suspension of tariff adjustment during the period, and an insufficient 5.3% tariff hike in Oct ’11, served to highlight the company’s earnings vulnerability to gas prices and government intervention. Furthermore, we expect the company’s capex to be large in 2012. KOGAS said it would spend KRW1.2trn to expand its gas facilities and pipeline network, and more on overseas E&P projects in 2012. Although the exact amount allocated for upstream investments is unclear, we believe this could be substantial given that the company targets increasing its self-sufficiency rate to 25% (2012: 10%) and earnings from overseas projects to 60% by 2017 (2012: 40%). The company’s liquidity is weak, with KRW475bn of cash and short-term investments compared to KRW2.4trn of short-term debt at end-2Q11. However, we believe it has adequate access to external funding to make up for the shortfall. The company also enjoys government support in the form of special loans with repayment hinged on the success of its exploration, tax exemption and tax credit for overseas investments. Valuation: Compared to other Korean quasi-sovereigns, we think the current spread on KORGAS ’14s (CT2+265) and the KORGAS ’20s (CT10+255) are tight and do not fairly compensate investors for the company’s weaker credit profile and execution risks related to its E&P business.

Korea Land and Housing Corp Timothy Tay

Rating Rationale

Market Weight

Credit view: We expect Korea Land and Housing Corp’s (KOLAHO, A1/A both Stb) standalone credit profit to remain weak and believe the company will remain dependent on financial support from the government. Investors’ concerns about the company’s high debt and weak credit metrics prompted the Korean government to step in with measures to reassure investors of its support. Specifically, the government will 1) purchase bonds issued by KOLAHO, 2) allow private participation in state projects, 3) help the company sell land and other assets to raise capital, 4) cover losses from its development business, and 5) extend the repayment period for debts owed to the National Housing Fund to 30 years, from 20 years. In addition, KOLAHO will reduce its annual spending, including capex, to KRW30trn, from KRW46trn. We view these measures as evidence that the government will provide extraordinary support to KOLAHO in any distress situation. At end-2010, we estimate KOLAHO had gross debt/EBITDA of 138x, EBITDA/interest cover of 0.2x and gross debt/capital at 80%. Liquidity at end-2010 was weak, with KRW4.4trn cash against KRW10.6trn short-term debt. While its high leverage may limit its ability to borrow offshore, KOLAHO’s access to domestic funding and government financial support remains strong. Valuation: We view the KOLAHO 5.75% ’14s (CT2+275) and 4.875% ’14s (CT2+275) as fairly valued relative to other Korean quasi-sovereigns, given the company’s weaker credit profile.


6 January 2012 81

Korea National Oil Corp Timothy Tay

Rating Rationale

Market Weight

Credit view: Korea National Oil Corp’s (KNOC, A1/A both Stb) credit outlook will continue to be driven by its appetite for growth and the additional debt required to finance it. Capex, excluding potential acquisitions, is expected to be KRW4-5trn for the next two years, according to the company, which likely will be funded in part by a KRW1trn annual equity contribution from the government. In February 2011, KNOC paid USD1.55bn (KRW1.7trn) for a minority stake in Anadarko Petroleum’s Maverick Basin shale oil field and another USD515mn (KRW557bn) for a 95% stake in Kazakhstan’s Altius, which has total reserves of 57mn bbl. We expect to company to focus on acquiring standalone oil and gas assets rather than companies. To mitigate operational risk, the company also will seek to form JVs to operate some of these assets. Further acquisitions will be required to raise its daily production to its targeted 300,000bpd by 2012/2013. As a result, KNOC’s credit metrics are likely to deteriorate, although this is offset partially by elevated oil and gas prices and higher production levels. We also expect sovereign support to remain strong, given its strategic role and full government ownership. Excluding SAER debt, the company reported LTM 1H11 EBITDA/interest cover of 7.1x, gross debt/EBITDA of 5.4x, gross debt/capital of 49.3%. For FY12, we expect another USD1.5-2.0bn of incremental foreign debt issuance from KNOC, according to the company’s guidance. As of end-June 2011, reserves were 1,340 mmboe, production was c.217,000 bpd. Liquidity as of the end of 1H11 was KRW1.63trn versus short term debt of KRW1.9trn; while this is weak, in our view, it is offset by KNOC’s strong access to both domestic and international funding sources. Valuation: We view the current levels for the bonds as fair. The KOROIL 4% ‘16s are quoted at CT5+250 and the 2.875% ’15s at CT5+230.

Korean gencos Timothy Tay/Rom Yudhanahas

Rating Rationale

Overweight

KHNP

Market Weight

KEWSPO

KOWEPO

KOSPO

KOSEPW

KOMIPO

Credit view: We maintain a constructive outlook on the six Korean gencos, which include Korea Hydro and Nuclear Power (KHNP) and five thermal gencos – KEWSPO, KOWEPO, KOSPO, KOSEPW and KOMIPO (all A1/A both Stb). Despite high fuel prices, we expect the thermal gencos to maintain their robust standalone credit profile, as a cost-based pool system allows the gencos to largely pass on fuel cost increases to parent KEPCO. Among the six gencos, we prefer KHNP for its low fuel cost structure, which supports its strong margins and cash flows. KHNP plans to add seven nuclear plants to its current fleet of 21 by 2017, in line with the government’s aim to increase nuclear power’s share in the nation’s electricity supply mix. As such, we expect KHNP capex to be high – around KRW5.5-6trn a year – and its leverage to rise over the next few years. We also expect leverage of other gencos similarly to rise to fund capacity expansion. Nonetheless, we believe the gencos will maintain their sound credit profile, supported by higher sales and robust cash flows. At end-2010, the thermal gencos reported an aggregate EBITDA/interest cover of 9.9x (2009: 7.0x), gross debt/EBITDA of 2.3x (2009: 2.8x) and gross debt/capital of 39% (2009: 43%). KHNP reported consolidated 1Q11 EBITDA/interest cover of 4.9x, annualised gross debt/EBITDA of 1.7x and gross debt/capital of 22.3%. Liquidity at the gencos is generally weak but this is mitigated by their ample excess to external funding, in our view. Valuation: All the gencos’ bonds trade broadly in line with each other and with those issued by KEPCO. Among the gencos, we continue to see more value in the KHNP ’21s (CT10+275) and KOSEP ’17s (CT5+270) although we think the performance of the bonds will likely be capped by the prospect of new supplies.


6 January 2012 82

Noble Group Christina Chiow

Rating Rationale

Underweight

Credit view: We view the near-term growth outlook for commodity and related companies as challenging, given heightened concerns about global economic growth. In the case of Noble Group (Baa3 Neg/BBB- CW Neg), this outlook is exacerbated by its low margin trading business model, which leaves little room for error. The weaker–than-expected 3Q 11 results led to a further deterioration in Noble’s credit metrics, which were already close to downward rating triggers after the completion of two sugar mill acquisitions in 2Q 11. At the same time, we also note there has been a series of management changes. The latest relates to the resignation of its CEO in November 2011 (a new CEO has yet to be announced). At September 2011, based on S&P’s credit metrics, adjusted debt/capitalisation was 51% and FFO/adjusted debt 13%, both breaching S&P’s rating thresholds of 45% or lower and 20% or more respectively. However, we view Noble's balance sheet strength, debt profile and commitment to investment grade ratings as partly mitigating these challenges. We believe the proposed merger of its 64.5%-owned subsidiary, Gloucester Coal, with Yancoal Australia and the proposed capital return of AUD420mn to Noble Group will provide some financial flexibility to the company and underline its commitment to maintaining investment grade ratings (see Noble Group – Gloucester developments: a step in the right direction for Noble Group, 27 December 2011). However, both rating agencies said that recent developments with Gloucester Coal had no rating impact on Noble Group, given limited visibility over its underlying profitability and cash flows. Liquidity is sufficient, in our view. At September 2011, Noble had cash of USD1.8bn and undrawn committed facilities of USD4bn against short-term debt of USD1.1bn. Furthermore, the company also had readily marketable inventories of USD3.2bn. Valuation: We view the recent developments around Gloucester Coal as credit positive for Noble Group (Baa3 Neg/BBB- CW Neg). However, given the estimated timing and the fact that 4Q11 results will be announced in the interim, we believe it is prudent to maintain our Underweight rating on the bond complex and await further news flow. Nevertheless, we believe the current valuation is pricing in asymmetric risk/reward to the downside, especially in light of the proposed Gloucester Coal transaction.

PCCW Ltd Timothy Tay/Rom Yudhanahas

Rating Rationale

Market Weight

Credit view: We expect PCCW’s (Baa2/BBB both Stb) credit profile to be stable following the successful spin-off of its telecommunication businesses into a business trust in November, which also led the rating agencies to remove it from negative rating review status. The company plans to use HKD7.8bn of the net proceeds to pay down debt, which should lower its debt/EBITDA to 3.5x-3.7x from 4.7x in 1H11, based on our estimate. However, we expect further deleveraging to be limited as the company said it would distribute all of its excess cash flows as dividends to the trust. Any improvement in credit metrics will thus be driven mainly by EBITDA growth. We expect PCCW’s operating outlook to be stable, with earnings growth in a low-single digit range in 2012. The company’s operating performance is supported by its strong market position and enhanced by its status as the only quad-play operator in Hong Kong. However, growth in fixed line revenue should be largely stagnant given the high penetration rate, and earnings growth will mostly come from its TV & content and mobile businesses, in our view. Valuation: Our Market Weight recommendation on PCCW’s bonds is based on the company’s stable credit profile post-deleveraging. In our view, the defensive nature of PCCW’s business should support the performance of its bonds in an expected volatile market in 2012.

Petroliam Nasional Bhd (Petronas) Timothy Tay

Rating Rationale

Underweight

Credit view: Like other oil and gas corporates, we expect Petronas’s (A1/A- both Stb) credit metrics to remain robust. For 2Q12 (ended September 2011), the company reported EBITDA/gross interest cover of 37.2x, gross debt/EBITDA of 0.4x and gross debt/capital of 15%. Liquidity remains strong, with cash balances exceeding debt by MYR53bn at the end of September 2011. For 2012, we expect elevated energy prices to continue to fuel earnings growth. That said, free cash flow may be negative as a result of its large ongoing capex and dividends to its shareholders. In June 2011, Petronas revised its five year capex projections to MYR300bn from MYR250bn, as it seeks to expand exploration and production into deepwater and unconventional assets in a bid to replace its maturing assets. This marks a change in strategy, as it had previously focused on improving recovery rates at its domestic assets. We think any large acquisition that has a material impact on its financial and liquidity profile would prompt the rating agencies to reassess their ratings, although this is not our base-case scenario. The company will continue to pay a dividend of MYR30bn to the Malaysian government for FY12, after which it has indicated that it may switch to a dividend payout ratio of 30%. We estimate dividend payments of MYR15-17bn in FY13 based on the 30% payout ratio. In May, the government announced an increase in price for gas supplied by Petronas to the power and industrial sectors. We view the increase in the natural gas price as constructive for the company, as it effectively reduces subsidies and improves its operating cash flow. Valuation: We view current levels for Petronas bonds as tight relative to other single-A rated Asian oil and gas issuers. The PETMK 5.25% ’19s are quoted at CT10+148 and the 7.625% ’22s at CT10+185, which is 15-40bp tighter than the higher rated Aa3/AA- CNOOC 21s.


6 January 2012 83

POSCO Timothy Tay

Rating Rationale

Underweight

Credit view: We have a cautious view on POSCO’s (A3 /A- Both Neg) outlook for FY12 and we expect operating margins to remain under pressure as a result of weak steel prices and high raw material costs. We see further near-term downside risk for both steel pricing and volumes. A planned reduction in capex will help mitigate some risk from deteriorating credit metrics, although we still expect the company to report negative free cash flow in FY12. Capex is likely to remain elevated as POSCO continues to execute its strategy of securing raw materials through acquisitions of strategic stakes in raw materials producers globally and by expanding production outside of Korea. On the Korean domestic front, key industries such as autos, home appliances and shipbuilding are expected to reduce steel consumption in 2H11 and 1H12, causing domestic production to exceed consumption. Overall, we expect credit quality to come under pressure as the global economic momentum continues to slow. LTM 3Q11 total debt/EBITDA of 3.4x was weaker than the FY10 ratio of 2.3x. Liquidity of KRW8.3trn (3Q11) is weak relative to its short-term debt of KRW12.6trn (3Q11). We note that all three rating agencies have recently put POSCO’s outlook on negative and are likely to put ratings pressure on the company if its leverage ratio stays above 3.0x. Valuation: We view the POSCO 5.25% ’21s (CT10+285) as rich relative to other Korean corporate and quasi-sovereign issues such as the KORELE (KHNP) 4.75% ‘21s which trade at CT10+275.

PTT Global Chemical Company Timothy Tay/Rom Yudhanahas

Rating Rationale

Market Weight

Credit view: We have a constructive outlook on PTTGC’s (Baa2/BBB both Stb) credit profile in 2012, supported by healthy earnings growth and a strong balance sheet post-merger. In our view, petrochemical spreads should bottom out by end-2011 although the risk of severe economic downturn could result in the spreads remaining depressed in 2012. Nonetheless, PTTGC’s use of lower-priced gas as feedstock (as opposed to naphtha) gives the company a cost advantage over its regional peers. The company’s refinery mix is also biased toward middle distillates, demand for which is expected to be more robust than that of gasoline and other refined products. This should in turn provide some support for PTTGC’s utilization rate and refining margin in 2012. Additionally, management expects synergy arising from the merger to add USD80-154mn (c.THB2.4-4.6bn) annually to the company’s EBITDA. On a pro-forma basis, 1H11 EBITDA/gross interest was 11.0x, gross debt/EBITDA (annualised) was 2.1x and debt/capital was 36% at end-June ’11. Liquidity was robust with THB28.9bn of cash against THB16.1bn of short-term debt. PTTGC’s investment plan is not yet finalised as the integration process is still underway. However, we estimate capex to be less than THB30bn (excluding M&A) based on PTT group’s guidance and believe it should be comfortably funded with operating cash flows. Valuation: The PTTGC ’15s (previously PTTCH) are quoted at CT2+352 (Z+290), and the PTTGC ’12s (previously PTTAR) at CT2+290 (Z+230). We view these bonds as cheap compared to other PTT affiliates such as PTTEPT ’15 (Baa1/BBB+; CT2+290) and PTTTB ’14 (Baa1/BBB+; CT2+290), as well as to RILIN ’20 (CT10+405, Z+370).

PTT Exploration & Production Public Company Limited Timothy Tay/Rom Yudhanahas

Rating Rationale

Market Weight

Credit view: We have a constructive outlook for PTTEP’s (Baa1/BBB+ both Stb) credit profile in 2012. We expect revenue growth to be in the mid-teens, driven by supportive oil and gas prices and increased output. Despite slightly missing its 2011 production target due to Thailand’s flood crisis in 2H11, the company expects production volume to increase by 10% in 2012, based on planned contributions from new fields – Montara (expected early ’12), Bongkot South (expected early ’12) and Vietnam 16-1 (started Aug ’11). For 2012, the company has guided for capex of THB71bn, most of which is to be spent on the development of existing fields. Based on our expectation of approximately THB100bn of operating cash flows in 2012, we believe PTTEP will be able to fund its capex with internal resources. Moreover, we do not expect the company to engage in any large debt-funded acquisitions in 2012. The company said it would focus on value-accretive projects during the volatile market and is committed to maintaining its current credit ratings. With stable debt, we expect PTTEP’s debt leverage gradually to decline on improved earnings. The company’s liquidity is adequate, with THB40bn of cash compared to THB32bn of short-term debt at end-3Q11. Valuation: We think the PTTEPT ’15s (CT2+290) and the PTTEPT ’21s (CT10+300) are fairly valued compared to other Asian HG Oil & Gas issues.


6 January 2012 84

PTT Public Company Limited Timothy Tay/Rom Yudhanahas

Rating Rationale

Market Weight

Credit view: We expect PTT pcl’s (Baa1/BBB+ both Stb) credit profile to be broadly stable in 2012. The company’s NGV business (6% of revenue) will benefit from the floating of retail prices in 2012. According to the government’s direction, NGV prices will rise by THB0.50/kg each month from January to December, ending the year at THB14.5/kg compared to the current THB8.5/kg. We expect gas sales volume to recover in 1Q12 on a pick-up in domestic demand after a decline due to the flood in 2H11. Contributions from subsidiaries are expected to be robust, driven by higher oil and gas output at PTTEP and new refining capacity at its refining subsidiaries (Thai Oil and IRPC). The group has a substantial capex program in 2012-2016, with capex estimated at THB200bn next year. The amount comprises THB94bn at PTT and its wholly-owned subsidiaries, THB71bn at PTTEP, and the balance coming from other units. We expect this to be partially funded with debt. The company recently announced that it planned to sell THB20bn of bonds in January 2012 and another THB20bn later in the year. PTT’s liquidity looks adequate, with THB97bn of cash compared to THB92bn of short-term debt at end-3Q11. Valuation: While we think the PTTTB ’14s (CT2+290, Z+240) are fairly valued compared to the PTTEPT ’15s (CT2+290, Z+225), the PTTTB ’35s (CT30+255, Z+293) look rich.

Reliance Industries Ltd Timothy Tay

Rating Rationale

Overweight

Credit View: We view Reliance Industries (RIL, Baa2/BBB, both Pos) as having a high BBB credit profile, with 1H12 total debt/EBITDA of 1.8x, net debt/EBITDA of 0.3x and EBITDA/interest expense of 11.8x. Liquidity is strong, with cash of INR615bn as of end-September, versus estimated short-term debt of INR150bn. We view the recently completed sale of the 30% stake in the 21 oil and gas blocks to BP for USD7.2bn as credit positive and more than sufficient to offset the risk of further weaknesses in the E&P segment due to lower-than-expected production. BP is likely to bring much needed deep water drilling expertise to the KG-D6 block, as Reliance attempts to halt the decline in production. For the refining segment, we expect gross refining margins to decline to the USD7.00–9.00 range after having peaked in the USD10–11.50 range in 2011. We expect incremental refining capacity additions in 2012 in Asia to weigh on refining margins. In terms of refined product crack spreads, the strength in middle distillates is expected to offset weaknesses in light distillates. Refinery operating rates are also likely to remain above 100% for balance of the year. For the chemical segment, we expect petrochemical spreads to remain soft. An ongoing supply deficit in India will support RIL’s petrochemical spreads, as more than 70% of its petrochemical revenues are derived domestically. A key risk to the credit is the possibility of large-scale M&A – E&P operators remain acquisitive, and we think RIL could seek to add to its energy portfolio if the opportunity arose. Valuation: We view the RIL ’20s and 40’s bonds as cheap relative to Asian peers. We believe the current valuations do not take into account the improvement in RIL’s balance sheet as a result of the sale of the stake in the 21 gas assets to BP. We note that the RIL 10-30s curve is relatively steep at 40-50bp.

SK Telecom Timothy Tay/Rom Yudhanahas

Rating Rationale

Underweight

Credit view: Our credit outlook for SK Telecom (SKT; A2 Rvw for downgrade/A CW Neg) is negative, driven by the expectation of increased business and financial risk profiles following the company’s KRW3.4trn acquisition of a 20% stake in Hynix Semiconductor in November 2011. Based on its cash balance of KRW1.8trn, short-term debt of KRW1.8trn, and estimated full-year operating cash flow of KRW4.5-5trn, we estimate the company will have to borrow around KRW2trn to fund the acquisition. The increased leverage, coupled with heightened business risk profile from the exposure to the more cyclical semiconductor industry, would likely warrant a one-notch downgrade by the rating agencies, in our view. We are cautious on Hynix’s operating outlook and expect a recovery in its DRAM price only after 2Q12. Moreover, the profitability of SKT’s telecommunication business remains constrained by intense competition in the domestic market. 9M11 EBITDA margin of 29% reflects a continued decline from prior years, and rapid growth in smart phones usage is expected to keep marketing expenses and capacity-related investments at a high level. As such, we expect SKT’s consolidated credit metrics to be under pressure in 2012. Valuation: At CT30+190, we think the SKM ’27s are rich and offer insufficient compensation for SKT’s higher business risk profile following its acquisition of Hynix. Moreover, its long tenor and high cash price will likely further constrain the bonds’ performance in this volatile market, in our view.


6 January 2012 85

Sun Hung Kai Properties Limited (SHKP) Timothy Tay

Rating Rationale

Underweight

Credit view: We expect SHKP’s (A1/A+ both Stb) credit profile to remain stable in 2012 as it continues to benefit from its well-balanced property investment and development business, despite likely higher volatility in the residential property market. The company is likely to receive higher rental contributions from its Hong Kong investment portfolio due to positive rental reversions and incremental rental contributions from new properties. Additionally, SKHP’s rental income from its mainland investment portfolio is expected to grow substantially in the medium term. With Shanghai IFC and ICC, SHKP’s investment properties in China will increase to 12.1mn sq ft from 5.5mn sq ft in December 2010, and the company estimates gross rental income from Shanghai IFC and Shanghai ICC will reach HKD2bn pa when completed. Rental income from China was HKD797mn in FY11. The contribution from property development is likely to be lower in FY12 on lower completions in Hong Kong and because the contribution from property development in China remains small (9.8% of revenue and 6.6% of segment profits). SHK’s credit profile and liquidity remained stable over the past 12 months. The credit metrics remain strong for its ratings. At June 2011, debt/capital was 16.2% (June 2010: 14.5%), EBITDA interest cover 16.5x (17.0x) and debt/LTM EBITDA 2.8x (3.1x). Liquidity is adequate; at June 2011, the company had cash of HKD7.9bn, compared with short-term debt of HKD9.7bn and capital commitments of HKD5.2bn. Nonetheless, we believe the company has strong financial flexibility, ample committed banking facilities (not disclosed, but we believe they are in excess of HKD30bn) and annual FFO that averaged HKD13bn over the past five years. Net rental income covered 7.6x gross interest expenses. Valuation: We view the SUNHUN 4% ’20s as rich relative to Hong Kong peers, despite a robust balance sheet and credit profile. We see the bonds as unlikely to outperform in the near term owing to headwinds facing the Hong Kong property sector. The SUNHUN 4% ’20s, quoted at CT10+245, currently trade the tightest among Hong Kong property developers.

Swire Pacific Limited Timothy Tay

Rating Rationale

Market Weight

Credit view: Our lookout for Swire Pacific (A3/A- both Stb) is stable for 2012, underpinned by its diversified business mix and stable cash flow from its large investment properties. Cash flow from investment properties is expected to remain stable despite headwinds in the overall property market. Weakness in the Hong Kong office property segment as a result of declining rents in its grade A office portfolio is likely to be offset by continued strength in the Hong Kong retail property segment. The increase in Swire’s investment property to 20.3mn sq.ft in 2011 from 16.7mn sq.ft in 2010 should also translate into higher rental revenues in 2012. This increase was driven mainly by the completion of 4.8mn sq.ft of investment properties in China. We view the sale of Festival Walk for HKD18.80bn in 3Q11 as credit positive, as a large portion of the proceeds is expected to be used to fund its capex, thereby reducing the need for incremental debt financing. Furthermore, we expect capex to decline by almost half to HKD4bn in 2012 from HKD10bn in 2011 as a result of the completion of investment properties in China in 2011. We expect profit contribution from Cathay Pacific will likely weaken for 2012 as a result of elevated fuel cost and weaker demand for aviation services. Liquidity was adequate as of end-June 2011, when the company reported HKD4.5bn of cash and HKD18.3bn undrawn committed facilities, compared with HKD11.5bn of short-term debt. Valuation: We view the SWIRE 5.5% ’19s, quoted at CT10+215, as fair relative to HUWHY. The technicals are supportive of the bonds, owing to the recent sale of its Festival Walk shopping centre complex.

Telekom Malaysia Bhd Timothy Tay/Rom Yudhanahas

Rating Rationale

Market Weight

Credit view: We expect Telekom Malaysia’s credit profile (TM; A3 Stb/A- Stb) to improve gradually in 2012 on moderating high-speed broadband (HSBB) investments. The growth in HSBB service has been favourable, with subscriber numbers hitting the year-end target of 200,000 in October. We expect higher ARPU from HSBB customers (>MYR180 per month vs. MYR78 per month for regular broadband) to compensate for the decline in voice revenue and the migration from lower-priced service, leading to low-single digit revenue growth in 2012. We estimate capex to decline to around MYR2bn in 2012 as TM is close to reaching its HSBB deployment target of 1.3mn premises, and expect this to be comfortably funded with operating cash flows. TM’s liquidity position is also strong, with MYR3.3bn of cash against only MYR6mn of short-term debt at end-3Q12. As such, we believe there is a high likelihood that the company will distribute excess cash as a special dividend. Valuation: At CT10+220, we think the TELMAL ’25s seem rich relative to TNBMK ’25 (CT10+290; Baa1 Stb/BBB+ Neg) despite the more stable cash flows and higher credit rating of the former. However, we note that the TELMAL ’25s have proved relatively resilient in the volatile market conditions of 2011 and could work for defensive-minded investors given the uncertain outlook.


6 January 2012 86

Tenaga Nasional Bhd Timothy Tay/Rom Yudhanahas

Rating Rationale

Underweight

Credit view: We have a cautious outlook on Tenaga Nasional’s (TNB; Baa1 Stb/BBB+ Neg) credit profile in 2012, on uncertainty surrounding its gas supply. TNB’s operating expenses increased substantially in 2H FY11 (Feb-Aug) after a 20% decline in gas supply from Petronas, which the company said incurred an additional MYR300mn per month in fuel costs. While the gas supply shortage may improve in coming months, we do not expect a full recovery until Petronas’ new LNG terminal is completed in Jul ’12. Therefore, we expect TNB’s cash flows and credit metrics to weaken over the next 6-9 months. Although a sharing of costs incurred by the gas curtailment between TNB, Petronas and the Malaysian government has been suggested, the amount and the timing of payment are not yet finalized. Nevertheless, we believe the company has enough financial headroom to withstand a prolonged curtailment. It had MRY4bn of cash at end-Aug ’11 and raised MYR4.85bn from issuance of sukuk bonds in Nov ’11. We expect these to cover MYR1.7bn of upcoming debt maturities, MYR4.5-5bn of capex, and other working capital needs until the gas supply is fully restored. Even if this is not the case, we believe the company has adequate access to bank borrowings and expect the Malaysian government would step in before any distress situation arises. Valuation: We think the TNBMK ’15s (CT2+290) and the TNBMK ’25s (CT10+290) are tight compared to bonds issued by KEPCO and the Korean gencos, considering their weaker credit ratings.

The Wharf (Holdings) Limited Timothy Tay

Rating Rationale

Market Weight

Credit view: We expect Wharf’s (NR) credit profile to remain broadly stable. Strong recurring income should support potentially higher debt incurred to fund its large capital commitments (c.HKD 11.5bn in 2012). It also raised HKD10bn through a rights issue in 1Q11, which was more than 6x oversubscribed. Income from property investments and logistics accounted for over 89% (HKD8.3bn) of Wharf’s 2010 operating profit, and we expect this to remain relatively stable in 2012, owing to its strong market position and favourable retail sales growth outlook. In particular we expect Wharf’s retail properties to continue to outperform the rest of the Hong Kong market, given the dominance of its retail portfolio. In 1H11, the company’s Harbour City and Times Square recorded strong growth in operating profit (+13% and +10%, respectively) and together accounted for over 8.3% of total Hong Kong retail sales. Although the contribution from China property investment and development to the group’s operating profit is still small (c.16% in 2010), Wharf has been intensifying its focus on the sector. Credit metrics were weaker at June 2011 – debt/LTM EBITDA increased to 5.6x (2010: 4.6x), while EBITDA interest cover declined to 7.3x (2010: 8.3x) owing to increased borrowings. Wharf’s financial flexibility and liquidity remain strong. At end June 2011, it had HKD19.9bn of cash and HKD23bn of undrawn committed facilities, against HKD7.9bn of short-term debt. Its capital commitments stood at HKD91.1bn, including HKD15.2bn of land costs to be paid between 2011 and 2013. Valuation: We view the current levels for Wharf as fair, given the headwinds facing the Hong Kong property sector. The WHARF 6.125% ’17s are quoted at CT5+380.

Woodside Petroleum Ltd Timothy Tay

Rating Rationale

Market Weight

Credit view: We remain cautious on Woodside (Baa1 CW Neg/BBB+ Neg) in the near term, given the risk around the completion date for the Pluto Foundation Project despite the end-March 2012 guidance from the company, although we note that the commissioning milestones on the project are being achieved to date. On capital spending, we expect the company to exercise increased prudence on growth projects (Pluto expansion, Browse and Sunrise), with a renewed focus on the underlying economics of the projects. This was articulated by new CEO Peter Coleman during the recent 1H11earnings call, who assured investors that he would maintain a disciplined approach to investing. For FY12, we expect higher revenues and earnings driven mainly by higher production levels. The FY12 production guidance of 73–81 mmboe comprises 56–60 mmboe for the underlying business and 17–21 mmboe for Pluto Train 1. Capex guidance of USD2.3bn for FY12 is 45% is lower than FY11, largely due to the completion of the Pluto LNG Foundation Project in FY12. We expect the company to generate free cash flow in FY12, resulting in improved credit metrics. As of 1H11 total debt was USD4,961mn (up 1% h/h). EBITDAX/gross interest was 13.3x (FY10: 13.3x) and debt/EBITDA 1.5x (FY10: 1.5x). FFO/debt was 48% (up 8% h/h). The company expects FFO/debt to remain above 35% for the remainder of the Pluto Foundation development phase. Liquidity remains adequate. At the end of 1H11, the company had USD607mn of cash compared with USD467mn of short-term debt. Total liquidity including cash and undrawn credit lines was USD2.9bn. Valuation: We view its bonds as fairly priced at current levels, reflecting the company’s Negative Outlook at all three agencies.


6 January 2012 87

ASIA-PACIFIC HIGH YIELD CORPORATES


6 January 2012 88

HIGH YIELD CHINESE REAL ESTATE

No reprieve in sight Key recommendations

Overweight Evergrande ’15s (B2 Neg/BB- Stb): Compared with the bonds of other large developers, the yield on the Evergrande ’15s appears attractive for investors with a high risk appetite, in our view. Despite the negative industry outlook, we believe Evergrande’s steady progress in sales and moderation in land acquisitions will help to stabilise its credit profile. We expect fairly stable metrics with debt/EBITDA of 3.5-4.0x (LTM Jun 11: 3.3x) and EBITDA gross interest cover of 4.0-4.5x (LTM Jun 11: 5x) for 2011. We estimate Evergrande had more than CNY10bn of unrestricted cash at end December 11.

Overweight Cogard ’15s/’17s (Ba3/BB- both Stb): We recommend that investors with moderate risk appetite who want to stay involved in high yield Chinese real estate Overweight the Country Garden ’15s/’17s, the better yielding bonds in the Cogard complex. The company exercises prudent financial management, and given its position as a mass market developer, its sales have been less affected by current market-cooling measures. We believe debt/EBITDA was stable at c.3x at end-December 2011.

Market Weight developers with concentration risks, such as Agile (’16s/’17s); Underweight small developers, such as Road King (’14s/’15s), and those with refinancing needs, such as Glorious (’15s) and Hopson (’16s).

Neutral on sector positioning: Our Market Weight stance on the sector reflects the challenging operating conditions in the near term, although we believe valuations have largely priced in the risks to the larger developers. We expect the smaller, unlisted developers to face increased pressure, which should lead to some industry consolidation. Given their experience in 2008, most developers are now more sensitive to the operating backdrop – they have slowed land acquisitions and are looking to preserve cash. Although liquidity is tight in some cases, it generally remains manageable for the sector, in our view.

Figure 40: Chinese real estate – Widest spreads, OAS (bp)

Figure 41: Liquidity – Tighter for small developers (CNY bn)

400

900

1,400

1,900

2,400

2,900

Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11

Philippines corporates

Chinese non-property

Chinese property

Indonesian corporates

-40

-20

0

20

40

60

Large developers Medium/smalldevelopers

Overall

Dec-08 Dec-09 Dec-10 Jun-11

Source: Barclays Capital Calculated as cash minus short-term debt. Based on a sample of 19 Chinese real estate companies with USD bonds. Source: Company data, Barclays Capital

Christina Chiow +65 6308 3214

[email protected]


6 January 2012 89

Deteriorating operating outlook: The trend of declining property prices is becoming more noticeable. Of the 70 cities surveyed by China’s National Bureau of Statistics, the number reporting m/m house price declines increased to 49 in November, from 34 in October and 17 in September. Developers resisted cutting prices up to July and August, but reductions have become more aggressive in recent months, as inventories build owing to aggressive land acquisitions in 2010. Property prices are very sentiment driven, and given that sentiment is weakening (see Figure 43 – the real estate index fell below 100 for the first time in November 2011 since July 2009), we expect the correction in prices to continue.

Figure 42: Price declines becoming more widespread

Figure 43: Sentiment is weakening

0

10

20

30

40

50

60

Jan-

11

Feb-

11

Mar

-11

Apr

-11

May

-11

Jun-

11

Jul-

11

Aug

-11

Sep-

11

Oct

-11

Nov

-11

Cities with m/m price declines (out of 70 cities)

90

94

98

102

106

110

2004 2005 2006 2007 2008 2009 2010 2011

Real estate climate index

Source: National Bureau of Statistics The index describes the present situation and future trend of the real estate market in China using eight different indices to reflect three factors: land, finance and demand. A reading over 100 indicates the real estate market is improving. A reading below 100 indicates the market is worsening. Source: CEIC, National Bureau of Statistics

No relaxation of tightening stance, at least in 1H12: We believe the government will likely tolerate property price declines of 10-20%. A PBoC monetary policy committee argued that price falls should not exceed 15%, as declines of more than 10% would cause larger social problems than a rise of 30%. In Shanghai, developers are required to notify the government if they want to cut prices more than 20%. Since the impact of policies on property prices is just beginning to show, we see little chance that the measures will be relaxed in the near-term. Our economists believe policies may be adjusted if the average price decline approaches 20% (see China: Beyond the miracle – Part 3 – Bubble deflation, Chinese style, 8 November 2011).

Diverging trends among developers: Large, diversified developers and developers focused on lower-tier markets have outperformed in terms of sales and have been gaining market share at the expense of smaller firms. The government’s cooling measures have had a more significant impact on the balance sheets and credit metrics of smaller developers. Overall, we expect Chinese developers’ credit metrics to weaken, although this trend will be partially offset by the impact from lagged booking of revenue from sales made in 2010. The sector’s credit ratings outlook is negative, with 18 of the 29 rated developers having at least a Negative outlook from either Moody’s or S&P. Currently, none of the developer has a Positive outlook from the rating agencies.

http://my.barcapint.com/PRC/servlets/dv.search?contentPubID=FC1763970�


6 January 2012 90

Figure 44: Large developers gaining at the expense of smaller developers – contracted sales (CNY bn)

Figure 45: Weakening credit metrics obvious at smaller developers – EBITDA gross interest cover

79%77%

75%

73%

21%23%

25%

27%

0

50

100

150

200

250

300

350

400

2008 2009 2010 9M 11

Large developers Medium/small developers

0x

1x

2x

3x

4x

5x

6x

7x

Large developers Medium/smalldevelopers

Overall

Dec 08 Dec 09 Dec 10 Jun 11

Based on a sample of 19 Chinese real estate companies with USD bonds. Source: Company data, Barclays Capital

Based on a sample of 19 Chinese real estate companies with USD bonds. Source: Company data, Barclays Capital

Watch test cases in 2012: As shown in Figure 47, several Chinese developers have offshore bonds due/puttable in 2012. Among the larger-sized bonds (more than USD100mn) maturing, we believe Hopson could face refinancing challenges, given its lacklustre sales, tight liquidity and high leverage. We believe China Overseas Land, Yanlord Land, Franshion Properties and Road King should face less refinancing pressure due to a combination of their liquidity, credit quality, ownership, track records and access to offshore syndicated loans in most cases. Further down in Figure 47, Shanghai Zendai announced that it will sell its interest in a project on Shanghai’s Bund for CNY2.96bn in cash. If the deal is completed, Shanghai Zendai will receive the money in several instalments, with most scheduled to be received in 1H12. This should help fund Shanghai Zendai trust loans of HKD1.1bn due in April 2012 and the USD139mn bond that matures in June 2012. Based on the disclosure by Shenzhen Investment Ltd, a Chinese developer that is 43% owned by Shenzhen’s city government, it held USD50mn of Coastal Greenland’s maturing bonds, which could reduce the amount Coastal Greenland needs to refinance. Given that capital markets are basically closed to property developers (no bonds issued in 2H11), the sector’s funding options are limited, and it remains to be seen how the weaker companies will refinance their debt due in 2012.

Figure 46: Offshore bonds due/puttable in 2012

Base currency

amount USD

equivalent Coupon Maturity/ Put date

Hopson ’12 (fixed) USD350mn USD350mn 8.125% 09-Nov-12

China Overseas Land ’12 (fixed) USD300mn USD300mn 5.75% 13-Jul-12

Yanlord ’14p12 (CB) SGD375mn USD291mn 5.85% 13-Jul-12

Franshion ’12 (fixed) CNY1,000mn USD158mn 4.22% 28-Apr-12

Road King ’12 (FRN) USD149mn USD149mn FRN 14-May-12

Shanghai Zendai ’12 (fixed) USD139mn USD139mn 10% 06-Jun-12

Coastal Greenland ’12 (fixed) USD132mn USD132mn 12% 08-Nov-12

Central China ’14p12 (CB) HKD765mn USD98mn 4.90% 31-Aug-12

SRE ’14p12 (CB) CNY447mn USD71mn 6% 23-Jul-12

Greentown ’12 (CB) CNY180mn USD28mn 0% 18-May-12

Source: Bloomberg, company data, Barclays Capital


6 January 2012 91

HIGH YIELD DIVERSIFIED INDUSTRIALS – NORTH ASIA

Credit and macro conditions to weigh on earnings Key recommendations Overweight Fufeng ’16s: We believe Fufeng’s gross margins bottomed in 3Q11 and that

earnings will improve from 4Q11. The price of corn has fallen 8% since September as China’s corn harvest commenced, providing some cost relief. Fufeng also was able to raise selling prices by 2.5% in October. Coupled with higher volumes from the company’s new production capacity, we expect Fufeng to report broadly stable 2H11 earnings, with improvements likely in 2012.

China Oriental – Market Weight ’15s, Underweight ’17s: The prices of these bonds have dropped 6-7pts since the company guided for a poor 4Q11 in November. We remain cautious on the credit given the likelihood of weak performance in 1Q12, which could extend into 2Q12. We also believe the company’s ratings are vulnerable to negative action by Moody's once its 2H11 results are released.

Weak 2H11-1H12 expected: The impact of China’s efforts to slow its economy was apparent in 2H11. Cement prices have been falling since mid-June 2011, with no signs of abating (Figure 48). Construction sector demand eased following the introduction of property tightening measures and delays in infrastructure projects in 1H11. Similarly, heavy equipment manufacturer Lonking (Not covered) reported a 17% y/y fall in July-October wheel loader sales volumes. Its November sales volume was significantly higher (+50% y/y), although the company believes the increase was due to the payment of sales commissions in December instead of January owing to the early timing of the Chinese New Year holidays in 2012. China Oriental (’15s: MW, ’17s: UW) itself has guided for a weak 4Q11. Although China’s 50bp RRR cut in early December signalled a loosening of credit conditions, we believe the impact will be modest and will only be felt in 2Q12 at the earliest. In addition, our economists expect investment’s contribution to China’s GDP growth to fall from 4.9pp to 4.3pp in 2012. Ongoing global macro uncertainties will also weigh on China’s, and hence the Chinese corporates’, growth outlook in 2012. Barclays Capital projects China’s 2012 GDP growth at 8.1%, with downside risk in the event of a further deterioration in the European crisis and/or a deeper recession in Europe or a disorderly correction in the domestic housing market. Not surprisingly, we have a cautious credit outlook on Chinese industrials and we expect credit quality to deteriorate in 2012.

Jit Ming Tan, CFA +65 6308 3210

[email protected]

Figure 47: Chinese industrials’ mid-YTWs Figure 48: China cement prices (CNY/tonne)

CHOGRP '15

TEXTEX '16

WESCHI '16

CNAUTO '16

MPEL '18

HYVANL '16

CITPAC perp

FUFENG '16

SHASHU '16

LONKING '16 FOSUNI '16

MIEHOL '16 LIANSU '16

7%

9%

11%

13%

15%

17%

19%

21%

3.6 3.8 4.0 4.2 4.4 4.6Years to worst

250

300

350

400

450

500

Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11

China average Shaanxi Shandong

Note: As at 4 January 2012. Source: Barclays Capital Source: Chinacement.net, Barclays Capital


6 January 2012 92

Eyes on liquidity conditions: Reflecting China’s tight liquidity conditions, Chinese corporates reported elevated levels of trade receivables in 1H11. They have also been accepting bank acceptance notes with 3-6 months maturity in lieu of payments from customers to sustain product demand. China Oriental disclosed its bankers’ notes receivables rose from CNY4.2bn in June 2011 to more than CNY5bn by October 2011. Fufeng also started accepting bankers’ notes from some customers in 2H11 and has noted that trade receivables have risen. These notes present minimal credit risk, as they are guaranteed by the issuing banks and can be discounted prior to maturity, if necessary. Nonetheless, they are a drag on corporate cash flow. Coupled with the expected weak operating conditions, we expect currently robust liquidity profiles (Figure 49) to deteriorate in 2012. However, we think most of the Chinese corporates we cover will retain adequate liquidity in 2012 in the absence of significant M&A activities. Outside China, Hynix’s (’17s: Underweight) weak liquidity profile should improve significantly if its KRW2.3trn equity offering to SK Telecom succeeds. STATS ChipPAC’s (’15s: MW, ’16s: UW) liquidity profile looks strong, with a September 2011 cash balance of USD212mn and short-term debt of USD30mn; we expect it to remain robust in 2012.

Technology weakness to persist through 1Q12: We expect the tech sector to remain subdued through 1Q12 due to weak PC demand and potential supply-chain disruptions due to floods in Thailand. In 2012, we expect DRAM production adjustments to reduce oversupply, although muted demand will likely cap earnings improvements at Hynix. We think it will report operating losses through 2Q12 before a modest recovery in 2H12. For STATS ChipPAC, the temporary closure of its Thailand plant will weigh on earnings in 4Q11 and possibly 1Q12. Recovery prospects for the technology industry are likely stronger after 1Q12 as supply-chain concerns fade and new smartphones and tablets drive a pick-up in demand.

Low supply risk in 2012: We expect issuance to moderate from the elevated levels achieved in 1H11. The amount of USD bonds maturing in 2012 is low – only China Lumena’s (Not covered) USD250mn and Titan Petrochemical’s (Not covered) USD106mn bonds are due in 2012. Hynix’s USD500mn 2017 bonds are callable in 2012, although it is currently priced to worst in 2015. Current issuers also have minimal pre-funding needs given low redemption levels in 2013. Instead, we think USD issuance is more likely to come from maiden issuers looking for alternative funding to domestic debt markets. For these companies, we think the CNH market is one alternative source of funding.

Figure 49: Robust 1H11 liquidity likely to deteriorate(CNY mn)

Figure 50: DRAM and NAND prices remain weak(USD)

0

1,000

2,000

3,000

4,000

5,000

CHOGRP

CNAUTO

FUFENG

LIANSU

LONKIN

SHASHU

TEXTEX

WESCHI

Cash ST debt

0

1

2

3

4

5

6

7

Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12

DDR3 2Gb DDR3 1Gb

NAND 32Gb NAND 16Gb

Source: Company data, Barclays Capital Source: DRAMeXchange, Bloomberg, Barclays Capital


6 January 2012 93

HIGH YIELD DIVERSIFIED INDUSTRIALS – SOUTH ASIA

Cautious industry fundamentals Key recommendations

Overweight the Gajah Tunggal ’14s: We see Gajah as an improving credit. Lower rubber prices should support a higher operating margin in the near term. With reduced capex requirements in 2012, we also expect an increase in Gajah’s free cash flow. The company’s credit metrics are robust for its B/B3 ratings, in our view, which raises the likelihood of an upgrade in the near term. Additionally, we expect the step-up in the coupon to 8% from 6% in mid-2012 to support tightening in the bond’s yield.

Underweight the Berlian Laju Tanker ’14s: The company faces significant refinancing risk in the near term. It had short-term debt of USD460mn versus cash of USD195mn at end-3Q11. Unlike in the past, the company’s ability to refinance this debt is increasingly challenged, given its high debt leverage, low unencumbered assets and weak equity performance. Furthermore, we see a risk of weaker earnings in the near term on lower shipping demand and high bunker prices. Although the yield on the ’14s is high, we believe the price could see further downside if the company is unable cover its cash shortfall.

Underweight the Chandra Asri ’15s: Chandra Asri is likely to face earnings pressure in the near term. A tight ethylene-naphtha spread as a result of high oil prices will hurt the company’s profit margin. A slowdown in the global economy is likely to curb demand, which could result in further cash burn for Chandra Asri. In the near term, we expect its weaker credit profile to lead to a Negative outlook, if not one-notch ratings downgrade.

Overall, we have an Underweight stance on the South Asian diversified industrial sector. A slowdown in global economic growth is likely to hurt cyclical industries (petrochemicals, ports and shipping). While the credit outlook for the property, retail and utility sectors is more constructive, we see bond valuations as only fair, at best, relative to Asian HY peers. Our only top pick among the diversified industrial credits is the Gajah Tunggal ’14s. This reflects the likely improvement in the company’s credit profile, the bonds’ high yield and the scheduled increase in coupon rate in the near term.

Erly Witoyo +65 6308 3011

[email protected]

Figure 51: South Asian HY diversified industrials compared

ICTSI '19

LPKRIJ '15

SMPM '14 SMPM '13

SMCPM '16 EDCPM '21

STAREN '15c13

GJTLIJ '14c10 BRPTIJ '15c13

CIKLIS '15c13 SMPM '17

2%

4%

6%

8%

10%

12%

14%

0 1 2 3 4 5 6 7 8 9 10

Avg life (yrs)

YTW



6 January 2012 94

Petrochemicals: We believe the operating outlook for the Indonesian HY petrochemical sector is negative. High oil prices will squeeze profit margins, given that Indonesian producers mainly use naphtha as their feedstock. Our commodities research team expects Brent and WTI prices to average USD115/bbl and USD110/bbl, respectively, in 2012. In addition, we think slower global economic growth could weigh on demand, putting the producers in a weak bargaining position. Chandra Asri’s profit margin has declined over the past few quarters and has contributed to the company’s significant cash burn.

Ports and shipping: We are cautious about these cyclical sectors given the uncertainty in the global economy. We see downside risks for ports on a potential slowdown in international trade. For ICTSI, we think this risk will be partially mitigated by contributions from new ports that are expected to begin operations in 2012. We are also slightly negative on the chemical tanker segment. Weaker petrochemical demand could put pressure on shipping rates, and higher bunker prices should continue to squeeze operating margin in the near term. Offsetting these risks, we see improving supply fundamentals in the sector – vessel overcapacity has declined on reduced ship orders and high scrapping rates over the past few years.

Tyres: The significant decline in rubber prices (see Figure 53) should support higher 2012 profit margins for tyre producers, especially after they raised product prices in 2011. We expect Indonesia’s tyre demand to remain robust in the near term, driven by our expectation of continued strong economic expansion in the country (6.2% in 2012) and the rapid growth in vehicle sales over the past three years. Economic uncertainty in key export markets – the US and Europe – poses some concern for overseas sales. However, we believe the impact on Gajah will be limited, as the demand for low-cost tyres is generally more inelastic in times of economic stress. We also believe Gajah has some room to increase exports to other markets to mitigate possibly lower demand from US and European customers.

Utilities: We see a stable credit profile for the independent power producers in Indonesia and the Philippines in 2012. Most benefit from take-or-pay contracts with state-owned utilities, which allow for cost adjustments. Although some of these utilities sell a portion of their power at the spot price, we think persistent power shortages in Indonesia and the Philippines will ensure there is demand for their electricity. Apart from operating risks, our key concern with the IPPs relates to expansion. Most are likely to boost their capacity in the near term to meet the growing demand from customers or to diversify their business. We think this risk is highest for Energy Development Corp. (EDC) and Star Energy. EDC is

Figure 52: Tight ethylene-naphtha spread is likely to continue into 2012 (USD/tonne)

300

500

700

900

1,100

1,300

1,500

Jan-09 Jan-10 Jan-11

Naphtha (cif Japan) Ethylene (fob Japan)



6 January 2012 95

moving into renewable energy and entering new electricity markets (Chile and Peru). Star Energy may need to take on additional debt if it proceeds with its original plan to build a 127MW geothermal plant.

Liquidity update: The liquidity position of most issuers in this sector is strong (see Figure 54). The only exception is Berlian Laju Tanker, which faces significant maturing debt in 2012. Combined with its committed capex and operating needs, we expect a cash shortage in the near term. Unlike in the past, we think BLT could find it challenging to refinance its short-term debt owing to its weak credit profile and deteriorating financial flexibility. We are also increasingly concerned about Chandra Asri’s currently strong liquidity position. Although it had cash of USD60mn at end-3Q11, its liquidity could be depleted rapidly if earnings do not improve. The company burned USD66mn of cash in 3Q11 on reduced operating cash flow and higher capex. The recent signing of a USD150mn credit facility (for capex) should provide a decent liquidity buffer as the company goes through the industry downturn.

Figure 53: Tyres – Falling rubber price should boost profit margins in the near-term

10%

12%

14%

16%

18%

20%

22%

24%

26%

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-110

100

200

300

400

500

600

700

800Thai RSS3 rubber (RHS; USD cents/kg)US WTI oil (RHS; USD/bbl)Gajah's gross margin

Source: Bloomberg, Company data, Barclays Capital

Figure 54: Strong liquidity position except for BLT

0

150

300

450

600

750

900

BLT ChandraAsri

Cikarang EDC ICTSI LippoKarawaci

SMInvestment

ST debt Cash and equivalents

Note: As at 30 September 2011. Source: Company data, Barclays Capital


6 January 2012 96

Near-term rating changes: Among the issuers in our coverage universe, we expect upward rating revisions for Gajah Tunggal and downward rating revisions for Berlian Laju Tanker and Chandra Asri. Based on Gajah Tunggal’s debt/EBITDA of 2.6x and EBITDA/interest of 4x in LTM-3Q11, we view the company as a high-B/low-BB credit. We expect Gajah’s credit metrics to improve in the near term. BLT’s B- rating from S&P is likely to come under pressure, given the company’s refinancing risk. Our expectation of deterioration in Chandra Asri’s earnings and credit metrics should also result in a negative ratings action.

Figure 55: Credit metrics (LTM to 3Q11)

0x

2x

4x

6x

8x

10x

12x

14x

BLT ChandraAsri

Cikarang EDC ICTSI LippoKarawaci

SMInvestment

0x

1x

2x

3x

4x

5x

Debt/EBITDA EBITDA/interest (RHS)



6 January 2012 97

HIGH YIELD INDONESIAN COAL

On solid ground Key recommendations

Overweight Bumi Resources ’16s and ’17s: The current yield provides an attractive risk-return trade-off, in our view. While the company faces a high level of debt refinancing in 2012, we view the default risk as low given its strong financial flexibility. Apart from the refinancing of short-term debt, we expect an improvement in credit profile from higher earnings as the company is targeting a 14% rise in production. Management is also taking steps to deleverage and lower the company’s financing costs. It intends to achieve this by using proceeds from asset sales for debt repayment and to refinance the second tranche of its high-cost CIC loan in 2H12.

Overweight Berau Coal ’15s: Among Asian HY coal credits, Berau has some of the strongest credit metrics and liquidity position, in our view. Its bonds also have a creditor-friendly structure. Despite these favourable factors, the yield on the Berau ’15s continues to trade relatively wide compared with its peers. We expect further deleveraging in the near term as free cash flow is likely to remain positive. This should support tightening in the yield. Given the high coupon of 12.5%, we believe the Berau ’15s also offer attractive carry.

We are Overweight on the Indonesian coal sector. This reflects robust industry fundamentals and our expectation of likely improvements in the issuer credit profiles in the near term. Despite the high cash price for most bonds, we think technicals will remain supportive in the near term given limited new supply. In addition, we believe the relatively stable operating profile and predictable cash flows of Indonesian coal companies will continue to appeal to credit investors.

Figure 56: Indonesian coal credits vs US peers

CLOUD PEAK '19

PEABODY '16

INDIKA '16INDIKA '18

BUMI '17BUMI '16

BERAU '15

ADARO '19

4

5

6

7

8

9

10

11

12

2 3 4 5 6 7Avg life (yrs)

YTW

(%

)

US HY coal Indonesia Coal

PEABODY '18


Strong industry fundamentals: We remain bullish on the near-term fundamentals for thermal coal in Asia. Robust demand dynamics should support high thermal coal prices over the near to medium term. We expect increased usage of coal for power generation in large Asian countries (China, India, and Indonesia), as they require cheap electricity to sustain their rapid economic growth. Supply increases in the region, on the other hand, are likely to be limited by infrastructure bottlenecks and weather-related issues. Barclays Capital


[email protected]


6 January 2012 98

forecasts an average Newcastle coal price of USD115-120/tonne in 2012 compared with the average of USD121/tonne in 2011.

Figure 57: Coal industry fundamental should remain robust in 2012

18

-5

8

-18

-24 -25-20

-30

-20

-10

0

10

20

2006 2007 2008 2009 2010 2011F 2012F20

40

60

80

100

120

140

Global coal trade balance (mn tonnes; LHS) Newcastle coal price (USD/tonne; RHS)

Source: McCloskeys, Ecowin, Barclays Capital

Earnings growth: Higher coal production in 2012 is likely to more than offset our expectation for some deterioration in average selling prices. The Indonesian coal producers are targeting 10-15% growth in production this year. We view this as feasible given the relatively simple open-pit mining operations of these companies. The key risk to production is potentially adverse weather conditions. In 2010, heavy rain in Kalimantan resulted in coal production falling well below the producers’ targets. In the near term, we think production growth is likely to be highest for Bumi Resources, which expects to complete the construction of a new conveyor belt in 1Q12. This project should significantly improve the efficiency of coal transportation at one of its Kaltim Prima Coal mines.

Figure 58: Higher coal production expected in 2012

0

10

20

30

40

50

60

70

80

Adaro Berau Bumi Resources Kideco*

mn

tonn

es

2010 2011F 2012F

Note: * Kideco is a 46% associate of Indika. Source: Company data, Barclays Capital

Improving credits… : Expected higher earnings and positive free cash flow should support stronger credit profiles for most issuers in 2012, in our view (see Figure 59). Excluding acquisitions, we expect Indonesian coal producers to generate positive free cash flow, a trend aided by their use of mining contractors to ease capex burdens. This should support lower debt levels at Berau, Bumi Resources and Indika. Adaro will likely see some deterioration in its


6 January 2012 99

credit metrics, in our view, reflecting a likely increase in debt to fund recent acquisitions and upcoming expansion.

Figure 59: Indonesian coal producers – deleveraging in 2012

0x

1x

2x

3x

4x

5x

Adaro Berau Bumi Indika*

9M11 (annualised) 2012E

Note: Indika’s EBITDA is adjusted to include dividends from associate companies. Source: Company data, Barclays Capital

… though expansion poses risk: Potential asset acquisitions by these issuers, however, could lead to weaker credit profiles. Adaro and Indika still appear keen to purchase energy-related assets to integrate their businesses, according to management. We believe the risk is lower for Berau and Bumi, as both companies are focusing on organic growth. For these two companies, we also believe that any large acquisitions would more likely be undertaken at the parent level (Bumi Plc) as part of the group’s efforts to diversify its business profile.

Liquidity: Based on our estimates, Adaro, Berau and Indika have robust liquidity positions with cash and equivalents at least twice their short-term debt levels. Bumi Resources faces some refinancing risk, as it has close to USD800mn of debt maturing in 2012; at end-3Q11, its cash and equivalents amounted to only USD327mn. But given the company’s financial flexibility, we believe the risk of a default in the near term is low. It has strong banking relationships, access to the debt and equity capital markets, and non-core assets that it can sell to raise cash if necessary. It also intends to use part of the proceeds of a loan repayment from Bukit Mutiara for its own debt repayment needs in 2012. Overall, we expect the liquidity positions of the Indonesian coal producers to strengthen in the near term, in part aided by positive free cash flows.


6 January 2012 100

Regulatory uncertainties. Potential regulatory changes in the sector create some operating uncertainties for the producers. Adaro, Berau, Bumi and Kideco appear partly protected from this risk by their mining contracts, which state that the companies are exempt from any new taxes, duties, rentals and royalties that are not included in their original contracts. While there have been past instances of coal producers benefiting from such exemptions as per their contract terms, we do not believe these safeguards should be considered watertight given the possibility for legal challenges in Indonesia.

We list below the potential key regulatory changes that could take place in the near to medium term.

1. Export tax. It was recently reported by Reuters that the Indonesian government may introduce a tax on coal exports in 2012. The government’s stated purpose for the new tax is to incentivise coal producers to develop their downstream businesses. As mentioned above, if such a law was passed, we think most of the companies we cover would be exempted given the terms of their existing mining contracts.

2. Export ban. The Indonesian government is also considering a ban on the export of low-ranked coal from 2014. The law is still in the preliminary stage and we see a low likelihood of it being approved. Depending on the heat value threshold for such a law, this could have a material impact on coal sales by Indonesian producers. In turn, this would affect royalty and tax payments to the government. Moreover, domestic coal production is more than sufficient to meet domestic demand.

3. Domestic Market Obligation (DMO). The DMO requires a certain percentage of coal production to be sold within Indonesia. Currently, this is 25%, which is being met by Adaro, Berau, Bumi and Kideco. There is a risk that the rate could be raised in future as the DMO is revised annually. However, we do not see this as being a significant risk for the coal producers, as the profit margin for domestic and export sales should be largely similar. If required, we think the coal producers could increase the production of easily-mined, low-ranked coal to meet a higher DMO rate.

Figure 60: Indonesian coal producers – liquidity positions (USD mn; as at end-3Q11)

0

100

200

300

400

500

600

Adaro Berau Bumi Indika

ST debt Cash and equivalents



6 January 2012 101

HIGH YIELD RESOURCES

Relative resilience Key recommendations

Underweight Vedanta ’14s: The recent underperformance of this bond suggests that the deterioration in the company’s credit profile caused by the Cairn India acquisition has largely been priced in. However, we see more downside risk due to weak technicals: Vedanta has USD2.1bn of convertible bonds that are puttable a few months before and after the ’14s mature that offer significantly higher yields. Also, the ’14s have the highest cash price Among Vedanta’s outstanding bonds.

Market Weight MIE Holdings ’16s (NR/B+/B both Stb): The company’s operating profile will likely remain stable in 2012, although liquidity could deteriorate due to capex resulting in negative free operating cash flow. While we think this could prompt S&P to reassess its rating, we believe the probability of a downgrade is low, as MIE has the flexibility to delay capex. We view the MIEHOL ’16s as fairly valued compared with its Chinese industrial peers but cheap relative to other emerging market independent E&P operators. That said, the high correlation of the bond with the broader Asian high yield market suggests to us that its performance will continue to closely track its Asian peers.

Base metals: Barclays Capital’s commodities research team views the base metals market as at a precipice. Even so, we are still relatively constructive on the sector’s fundamentals and view downside risk as limited. Our base case scenario is for higher average aluminium, copper and zinc prices in 2012 compared with 2011 (see Figure 62), although we are cognisant of the potential downside should the global macro picture deteriorate. Among the three metals, we think copper has the most favourable fundamentals, as we expect tightness in supply to continue in the near term. Aluminium and zinc are less promising, with production surpluses expected to persist in 2012. For a more detailed view on the base metals market, please see Metals Magnifier: Precipice, 23 November 2011.

Oil and gas: Our commodity analysts remain constructive on oil, with an average Brent forecast of USD115/bbl for 2012 (+3% y/y). Global crude oil output growth prospects are limited by sluggish non-OPEC trends and a lack of spare OPEC capacity. At the same time, OECD inventories are a long way below five-year average levels. Global oil demand is projected


[email protected]


[email protected]

Figure 61: Asian HY resources (YTW) Figure 62: We remain constructive on base metal prices

OLAMSP '20

WINSWY '16

HIDILI '15 LUMENA '14

CITIC '14

MIEHOL '16 VEDLN '21 VEDLN '18

VEDLN '16VEDLN '14

4%

6%

8%

10%

12%

14%

16%

18%

0 2 4 6 8 10Years to worst

1,000

1,300

1,600

1,900

2,200

2,500

2,800

1Q10 3Q10 1Q11 3Q11 1Q12F 3Q12F3,000

4,500

6,000

7,500

9,000

10,500

12,000

Aluminium Zinc Copper (RHS)

Forecast

Note: As at 4 January 2012. Source: Barclays Capital Note: USD/tonne. Source: Bloomberg, Barclays Capital



6 January 2012 102

to grow 1.27 mb/d under our base scenario. Should 2012 global GDP growth be lower than our base forecast of 3.6%, we expect global oil demand growth to average 0.7 mb/d in a mild slowdown, 0.4 mb/d in a moderate slowdown and -0.75 mn/d in a sharp contraction. Overall, we expect price stability to be supportive of earnings for the upstream oil and gas credits we cover, with higher production volumes, stable selling prices but rising lifting costs.

Credit profiles and ratings trajectory: We expect credit metrics for the Chinese E&P operators, CITIC Resources (Market Weight) and MIE Holdings (Market Weight) to weaken due to continued elevated capex, and these companies to report negative free cash flow as a result. But we expect ratings to remain stable. S&P had indicated that MIE’s ratings could come under pressure if its free operating cash flow turned negative. We think the company has sufficient flexibility in the timing of its investment to avoid triggering any action by S&P. As such, we view the probability of a rating downgrade as low.

Vedanta’s credit metrics are likely to improve following the acquisition of Cairn India due to the latter’s strong cash flow generation and low debt leverage. However, we believe the company’s overall credit profile has deteriorated given the increased debt held at the parent level, Vedanta Plc. Almost all of the group’s cash and cash flow generation takes place in the subsidiaries. This raises our concern about the parent’s ability to service its higher debt load, the majority of which will mature in the next few years. While we would not overly-stress this as an issue at the current time, we think there could be increasing pressure on Vedanta’s ratings if the commodity markets weaken more than expected or if the company is unable to increase cash distribution from subsidiaries.

Adequate liquidity for Chinese credits; refinancing pressure for Vedanta: Chinese E&P operators raised significant sums in 2011 and are well positioned to fund their 2012 investment plans and debt repayments. CITIC Resources raised HKD2.5bn through an equity issue and another HKD6.2bn from selling its interests in Macarthur Coal. For MIE Holdings, we think proceeds from its USD400mn bond issue should fund most, if not all, of its CNY2.5bn capex plans for 2012, although we believe it would be prudent for the company to obtain some additional funding to maintain some cash buffer. In any case, the company has no short-term debt and retains flexibility in the timing of its capex.

Vedanta’s liquidity position looks robust on a consolidated basis, given its cash and equivalents of USD5.9bn and short-term debt of USD3.7bn as at 30 September 2011. However, at the holding company level there is a significant debt (USD9bn as at 30 September 2011) and cash (USD178mn) mismatch. About USD1bn of this holdco debt will mature in FY13. Nonetheless, we think the risk here is mitigated by the company’s strong financial flexibility. We think it has various options to raise new funds from its strong banking relationships, to its good access to equity and debt markets, and ability to sell non-core assets. Moreover, we expect a significant dividend contribution from Cairn India in the near term on an expected increase in the subsidiary’s free cash flow.

Supply risk: Given Vedanta’s large and lumpy debt maturity profile over the next few years, we think it is likely to consider issuing new bonds for refinancing, if market conditions allow. Other than Vedanta, the other companies under our coverage have no immediate funding needs. However, we would not be surprised if Asian resource companies sought to issue new bonds in 2012. The ongoing deleveraging by European banks, especially outside their core markets, could push Asian corporates to the debt capital market for funding. We think investors would be amenable to funding Asian resource companies, given the sector’s constructive operating and credit outlooks.


6 January 2012 103

HIGH YIELD TELECOM

Idiosyncratic risks weigh on sector’s stable fundamentals Key recommendations

Underweight Bakrie Telecom ’15s (NR/B Stb): Concerns about the company’s liquidity are weighing on the bond’s price. Following weak 2Q11 and 3Q11 results, BTEL’s aggregate cash and short-term investment balance fell to IDR428bn in September 2011, while short-term debt rose to IDR1.9trn. Although BTEL has raised tariffs and reduced capex to improve its liquidity, we are sceptical that these measures fully address its upcoming funding needs.

Overweight Pacnet ’15s (B1/NR/BB+): The company’s operating outlook is weak, with low- to mid-single-digit growth in 2012 revenue and EBITDA expected. At the same time, we believe the agencies will downgrade its ratings on account of expected poor 2011 results. That said, the ’15s offer one of the best security packages in the Asian high yield universe, as they are secured by operating assets. Based on our estimate of the asset replacement value and past industry transactions, we believe the potential recovery in a distressed scenario is high.

Telecom Stable wireless voice market: While still intense, competition in Indonesia’s cellular market appeared to stabilise in 2011, with the Big 3 operators reporting flat or rising blended ARPUs (Figure 61). We expect a similar dynamic in 2012 as the operators move away from aggressive price-based competition towards more rational and sustainable models. This likely reflects the country’s maturing wireless voice market as q/q growth in the cellular subscriber base slows to low- to mid-single-digit levels, while voice revenue y/y growth slows to low-single-digit levels. Indeed, voice competition has moderated to such an extent that Bakrie Telecom was able to double on-net tariffs in September 2011. The company acknowledged that there was a reduction in voice traffic following the tariff increase, but said revenues rose nonetheless.


[email protected]


[email protected]

Figure 63: Indonesia’s blended mobile ARPU (IDR ’000)

Figure 64: Indonesia’s wireless capex (IDR trn)

0

10

20

30

40

50

Telkomsel Indosat XL Axiata BakrieTelecom

1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11

0

2

4

6

8

10

12

14

16

18

2007 2008 2009 2010 2011E 2012E0

5

10

15

20

25

30

35

40

45

Telkomsel Indosat XL AxiataBakrie Telecom Total (RHS)

Source: Company data, Barclays Capital Source: Company data, Barclays Capital


6 January 2012 104

Data remains a source of growth: We believe growth in data revenue will remain strong and will support mid-single-digit overall revenue growth for the sector. XL Axiata reported that 9M11 data and VAS (value-added services) revenue rose 50% y/y. Data, excluding SMS, represented 22% of its 9M11 revenues, up from 16% in 9M10. Telkomsel reported that mobile broadband subscriptions grew 39% y/y in 3Q11. Bakrie Telecom, which started offering data services in 3Q10, has attracted 246,000 subscribers. Its data ARPU was IDR60,000/month, approximately three times its blended ARPU. In the undersea cable sector, Pacnet (’15s: Overweight) indicated that traffic growth remains strong while ASP erosion has moderated. The company disclosed that it is targeting 10% EBITDA growth in 2012. We are somewhat sceptical and project 4% EBITDA growth.

Capex likely unchanged: The biggest Indonesian wireless operators have guided that capex will be broadly unchanged in 2012 (Figure 62). Investments will be geared towards improving network quality in order to cope with the rapid growth of the data business. Steps to reduce future capex are also being undertaken – Indosat (’20s: Underweight) and XL Axiata (not covered) are negotiating sales of their tower assets. We believe this sets the stage for tower-sharing arrangements, which should reduce the operators’ future capex needs. Outside Indonesia, we estimate that Pacnet will spend USD80mn on capex in 2012, broadly unchanged from 2011 levels.

Credit profile to improve at Indosat, weaken at Pacnet and Bakrie Telecom: Overall, we expect Indosat and its Big 3 peers to register stable to improving credit profiles. We estimate that these companies will be free cash flow positive in 2011 and 2012. Based on our flat capex and mid-single digit revenue and EBITDA growth projections for 2012, we expect credit metrics to improve. Outside of the Big 3, we think Bakrie Telecom’s credit profile will continue to deteriorate due to its still-large capex plans, poor operating performance and weak liquidity position. The company’s plans to reduce capex and raise tariffs will likely have a positive, but insufficient, impact on its credit and liquidity profiles, in our opinion. We project negative free cash flow of USD30mn for Pacnet in 2012, which we think it can fund with available credit lines. Its liquidity will also deteriorate but will remain sufficient, in our view. The revenue contribution from its new data landing station (DLS) in Hong Kong, completed at end-2011, should boost its top line growth. However, we have not assumed any incremental earnings from this new business in our 2012 projections.

Pay-TV Robust growth outlook: The low penetration rate of pay-TV in Indonesia suggests room for significant growth in the industry. Only around 5% of TV households subscribe to pay-TV services. This is significantly lower compared with India, Vietnam and the Philippines – countries with lower per capital income levels than Indonesia. This low penetration rate and rising personal income in Indonesia has supported average subscriber growth of more than 30% over the past five years. We expect this growth trend to continue in the near term given our forecast for robust economic growth in Indonesia and the industry’s initiatives to reduce pay-TV piracy.


6 January 2012 105

Figure 65: Low pay-TV penetration rate in Indonesia

Figure 66: MSV has a dominant market position (9M11)

0%

20%

40%

60%

80%

100%

India

MalaysiaChina

Vietnam

Philippines

Thailand

Indonesia

Pay-TV penetration rate TV penetration rate

TelkomVision

15%

Indovision(MSV)48%

Top TV (MSV)18%

First Media13%

Aora3% Okevision

3%

Source: Media Partners Asia, Barclays Capital Source: Company data, Barclays Capital

Improving profitability: The pay-TV providers should see an improvement in their profitability in line with a higher number of subscribers. Program costs, the largest expense for providers, are largely fixed. This, along with the increase in premium offerings (eg, high-definition programs) from industry players should more than make up for the normally declining trend in ARPU, in our view. In 9M11, MSV’s EBITDA margin rose to 42% from 36% in 2010.

Intensifying competition. While the market is currently dominated by MNC Sky Vision (MSV), we expect competition within the sector to escalate as incumbents and new entrants fight for position in this fast-growing market. We think TelkomVision and First Media present the biggest threats to MSV given their strong sponsors and ability to provide bundled services. TelkomVision is majority owned by PT Telekomunikasi Indonesia, Indonesia’s largest telecommunications provider. First Media is controlled by the Lippo Group, one of the largest conglomerates in Indonesia. One advantage MSV has over these competitors is that it provides services through satellite transmission, which enables it to expand at a faster rate as it can target a wider geographic area. Further, we believe its first-mover advantage, economies of scale and comprehensive content portfolio provide some buffer against the threat of a significant deterioration in its market share.

MNC Sky Vision’s strong operating outlook hurt by weak liquidity. We expect an improvement in MSV’s credit metrics in the near term mainly on stronger earnings. This will be driven by robust subscriber growth and improved profitability. The company expects its number of subscribers to grow to around 1.4mn at end-2012 from 1mn at end-9M11. We estimate such an improvement would improve EBITDA margin to around 45% from 42% in 9M11. The company may take on more debt to finance its budgeted capex of IDR500bn (USD55mn). However, we expect the preferred funding source to be an IPO. In the near term, the company’s tight liquidity position will remain a key focus, and until adequately addressed, limit any improvement in its credit profile, in our view.


6 January 2012 106

ISSUER PROFILES

Adaro Indonesia Erly Witoyo

Rating Coupon Description Maturity Principal (USD mn) Ratings (Moody’s/S&P/Fitch)

Underweight 7.625% Snr unsecured 22 Oct 19c14 800 Ba1/--/BB+

Rationale

Credit view: Adaro’s increasingly aggressive asset acquisitions raise concern on its credit profile, although we expect a limited impact in the near term. So far, most acquisitions have been relatively small – the purchase of greenfield coal assets and an equity stake in a power station. While Adaro has partly funded these with debt, we think its credit metrics remain adequate for its high-BB ratings. For 9M11, annualised debt/EBITDA was 1.5x and EBITDA/interest was 11.1x. Fitch and Moody’s consider debt/EBITDA of above 2x as one of their rating downgrade triggers. The company’s credit profile could deteriorate in the near term as it takes on more debt-funded acquisitions, although we believe management is committed in maintaining its high-BB ratings. We forecast relatively stable cash flow in 2012. A planned increase in coal production to 51-53mt in 2012 from around 46mt in 2011 should mitigate a slight decline in selling prices. The profit margin is expected to be slightly lower as most of the increased production is likely to come from the lower-ranked Wara coal. Liquidity position: Strong – at end-3Q11, Adaro had cash of USD619mn compared with short-term debt of USD140mn. Its liquidity position is further strengthened by over USD850mn of undrawn, committed credit facilities. Management budgets capex of approximately USD600mn for 2012, which we believe can be largely funded through operating cash flow. Increased asset purchases, however, could require external financing. Valuation: Our Underweight recommendation on the Adaro ’19s largely reflects their tight valuation. The bonds are among the lowest-yielding Asian HY corporate paper. Despite strong technicals, we see limited upside and expect the bonds to underperform the Barclays Capital Asian HY corporate index over the next six months.

Agile Property Holdings Ltd Christina Chiow


Market Weight 10.00% Snr unsecured 14 Nov 16c13 300 Ba2/BB/--

Market Weight 8.875% Snr unsecured 28 Apr 17c14 650 Ba2/BB/--

Rationale

Credit view: We maintain our stable view on Agile. This reflects its low leverage, flexible growth strategy and sufficient liquidity. At June 2011, debt/LTM EBITDA was 2.1x and LTM EBITDA interest cover 6.7x. We expect these ratios to have weakened marginally to c.2.5x and 5.5x respectively, by end-2011, due to higher debt. Agile did not acquire any land in 2H 11. For 2011, it spent CNY1.5bn on land acquisitions, well under its budgeted CNY2-3bn for the year. Other than Yunnan, management says the company will be cautious on land acquisitions in the near-term. A negative factor is that Agile has concentration risk from a large project in Hainan. The “holiday” nature of this project could make sales vulnerable to an economic slowdown and continued tightening in the sector. Hainan Clearwater Bay contributed contracted sales of c.CNY7bn in 2011, underperforming the company’s expectation of over CNY9bn. Based on the company’s expected property delivery of 2.2mn sqm in 2011, we think it should report full year recognised revenue growth of 19% y/y to CNY24bn. We expect full year gross profit margin to have normalised towards 45-50%, from 52% in 1H 11, which was helped by an increased contribution from higher-priced projects. Liquidity: Agile has a good liquidity buffer, although sales of CNY28bn in 11M 11 were running significantly below its full-year CNY37bn target. At June 2011, Agile had unrestricted cash of CNY5bn, against CNY5.9bn of short-term debt. At December 2011, we estimate Agile had c.CNY6bn in cash. Major obligations in 2012 include trust loans due of CNY2.6bn and our estimate of construction capex of CNY12-15bn. We believe these can be met by internal resources such as cash and contracted sales proceeds in 2012. The company does not have any land premiums outstanding. Valuation: Agile remains one of the strongest credits among high yield Chinese developers, as reflected by its credit metrics and bonds being among the tightest. We view the bonds as fairly priced. Our preference is for the mass-market developers which we think should better perform in the current market. Between the Agile ‘16s and ‘17s, we prefer the 17s given the yield pickup of c.40bp for a five-month maturity difference.


6 January 2012 107

Alliance Global Group Inc. (AGI) Christina Chiow


Not Rated 6.5% Snr unsecured 18 Aug 17 500 Not rated

Rationale

Credit view: 9M 11 operating results were strong, with EBITDA growth of 63% y/y and net income growth of 84% y/y. The gains were driven by strong growth in its real estate (which includes subsidiary Megaworld, joint venture Travellers International) and food and beverage businesses, as well as the consolidation of various subsidiaries such as Global-Estate Resorts Inc. (GERI, formerly Fil-Estate Land Inc.), Suntrust Properties and Empire East Landholdings. We expect the strong momentum to continue into 2012, supported by its diverse range of interests including Megaworld (real estate), Travellers/GERI (tourism) and food and beverage (distilled spirits). Megaworld reported a 36% y/y increase in net income in 9M 11, driven by strong residential sales and BPO office rental, which surpassed the performance for full year 2010. Traveller’s net income reached PHP4.2bn in 9M 11, and was on track to meet the company’s projection of c.PHP6bn for 2011, on higher traffic and expansion. Nevertheless, AGI has aggressive plans to expand its real estate and tourism businesses, which will likely entail a rise in capital expenditure. Together with other AGI subsidiaries, GERI will invest PHP20bn in two integrated tourism estate projects in Boracay Newcoast and Twin Lakes at Tagaytay. At the same time, Travellers International intends to spend an estimated USD1.1bn on a second integrated tourism resort (Resorts World Bayshore). We expect the company to have some financial flexibility to fund these plans, given its net cash position and relatively low financial leverage of 26% (debt/capital). Liquidity: AGI's liquidity is robust, with net cash of PHP8.5bn at end-September 2011. Its cash flow generation also remains strong, with FFO amounting to PHP10bn for LTM September 2011, covering 24% of debt. Valuation: In comparison with other Philippines corporate bonds, current valuations look attractive for what we think is a stable credit story.

Bakrie Telecom Jit Ming Tan


Underweight 11.5% Snr unsecured 5 Jul 15c13 380 --/B/B

Rationale

Credit view: We have a negative view of BTEL’s credit profile. The company reported weak 3Q11 results, with EBITDA falling 21% q/q and 24% y/y on lower voice traffic despite the expected surge in usage during the Lebaran holidays. BTEL has since doubled its on-net tariff to boost earnings. 4Q11 earnings should rise as a result, although we are not convinced that the higher profits will be sustainable. We expect subscriber levels and traffic to decline as a result of the tariff increase, potentially offsetting most of the positive impact on revenue. As a result, we do not expect a material improvement in BTEL’s credit metrics, which are already weak for its ratings. BTEL’s 3Q11 EBITDA barely covered interest expenses, with a ratio of only 1.2x. Gross debt/LTM EBITDA was 5.7x, and gross debt/capital was 58%. Although rating pressure exists, we do not think the agencies will act immediately, but will wait to consider the extent of improvement in BTEL’s 4Q11 earnings before making their assessment. Liquidity: BTEL's near-term liquidity position remains weak and, we think, is unsustainable. The aggregate cash and short-term investment balance was IDR428bn compared with short-term debt of IDR1.9trn at end-September. Uncertainty about its ability to repay a IDR650bn bond maturing in September 2012 weighs on its credit profile. We think BTEL will struggle to improve its liquidity position through ongoing operations – it recorded negative LTM free cash flow of IDR882bn in 3Q11. Instead, we believe BTEL will require external funding to repay maturing debt. While it should be able to access some bank funding under normal circumstances, continued economic uncertainties could weigh on the ability or willingness of banks to lend the company additional funds. Partly mitigating the liquidity concerns is the fact that vendor payables accounted for IDR812bn of its near-term maturities, and BTEL may have some flexibility in delaying payments to its vendors, if necessary. Valuation: Although its YTW of almost 30% appears to compensate investors for the company's weak credit profile, our Underweight rating reflects our view that caution is warranted, at least until the near-term liquidity concerns are addressed. The company’s challenging operating profile is also a concern. Although BTEL has increased tariffs to improve its profitability, we are not sure the improvements are sustainable.


6 January 2012 108

Berau Coal Erly Witoyo


Overweight 12.50% Snr secured 8 July 15c13 450 B1/BB-/--

Rationale

Credit view: We maintain our positive near-term outlook on Berau’s credit profile. Its credit metrics should improve slightly in the near term on lower debt and higher cash flow. Rising free cash flow in 2012 should also strengthen the company’s liquidity position. Berau targets an increase in coal production to 23mt in 2012 from the planned 20mt in 2011. Partly offsetting this, the company forecasts a slight decline in its average selling price in 2012. Berau’s credit metrics are currently in line with a high-BB rating, in our view. Its annualised debt/EBITDA improved to 1.4x in 9M11 from 2.5x in FY10, while EBITDA/interest rose to 5.3x from 4.5x. Given an expected lower debt level (from loan amortisation), we expect these metrics to further strengthen in the near term. However, we think the likelihood of a rating upgrade in the next 6-12 months is low. This reflects the agencies’ concerns over Berau’s relatively small size and the lack of clarity about its strategy and financial policies under the new ownership (Bumi Plc). The second point is somewhat of a two-edged sword for Berau, in our view. The new ownership has resulted in Berau changing its auditors to PricewaterhouseCoopers from Mazars, a relatively small auditing firm. Furthermore, we think Bumi’s UK listing imposes higher corporate governance oversight on Berau. On the other hand, negative headlines about the parent related to debt acceleration on Bakrie-related loans were partly to blame for its bonds’ volatile performance at end-2011. Following the repayment of these loans, we expect less parent-level noise in the near term. Liquidity position: Strong – as at 30 September 2011, the company had cash and equivalents of USD463mn compared with short-term debt of USD60mn. Its liquidity position should strengthen in the near term, as we expect the company to be free cash flow positive. The company has budgeted capex of USD150mn for 2012; we project operating cash flow of over USD250mn for the year. Valuation: We see value in the Berau ’15s. We think the current yield is attractive for the credit risk. Among Indonesian coal producers, Berau has some of the strongest credit metrics, and the 2015 bonds have the strongest structure. Moreover, the bonds provide attractive carry given the high coupon.

Berlian Laju Tanker Erly Witoyo


Underweight 7.50% Snr unsecured 15 May 14c12 400 --/CCC/CC

Rationale

Credit view: Near-term debt refinancing remains a key concern for BLT. We estimate the company has approximately USD387mn of debt maturing in 2012. Its cash balance at end-3Q11 was only USD195mn with USD50mn earmarked for committed capex in 2012. Although the company has shown a consistent ability to refinance debt in the past, we think its ability to raise financing in the near term will be increasingly difficult. Its financial flexibility is now much weaker due to its high leverage (above 10x), low unencumbered assets and poor share price performance. Of the total debt maturing next year, about USD180mn is unsecured convertible bonds and IDR bonds. Unlike bank loans, the maturity on these debts is not easily extendable and will require the company to raise financing in the capital market. The negative market sentiment on the shipping market could further weaken BLT’s ability to refinance debt, especially after several shipping companies faced bankruptcy in 2011. Exacerbating the sector risk, we have yet to see easing in bunker prices, which remain close to historical highs. This could hurt BLT’s earnings in the near term, especially if tanker rates fall. Liquidity position: Weak – the company had cash and equivalents of USD195mn at end-3Q11 compared with short-term debt of USD460mn, including the likely put on its USD49mn 2015 convertible bonds in February 2012. Also, the company has committed capex of USD50mn for the delivery of three LPG tankers, which should result in a negative free cash flow for the year. Valuation: We see few catalysts that could spark tightening of the USD bonds until the company addresses its near-term refinancing concerns. We believe there could be increased downside in the near term as we see a low likelihood of the company successfully refinancing all of its short-term debts.


6 January 2012 109

Bumi Resources Erly Witoyo


Overweight 12.00% Snr secured 10 Nov 16c13 300 Ba3/BB/--

Overweight 10.75% Snr secured 6 Oct 17c14 700 Ba3/BB/--

Rationale

Credit view: We have a positive near-term credit outlook on Bumi Resources. Management seems determined to lower the company’s debt leverage and/or reduce its financing costs. The company has demonstrated this by refinancing USD600mn of a high-cost loan (19% IRR) from China Investment Corp with cheaper bank loans. It intends to prepay the second tranche of this loan (USD600mn) at end-2012. The company’s plan to deleverage faced some challenges in 2011, largely due to the postponed sale of a majority stake in subsidiary Bumi Resources Minerals to parent Bumi Plc. Management is now keen to sell a partial stake in the subsidiary to third parties to raise cash for debt repayment. Moreover, the company has committed to utilise USD230mn of its short-term investments with Recapital and USD125mn of its debt repayment from Bukit Mutiara for debt repayment in 2012. We expect Bumi’s cash flow to be slightly higher in 2012. The company intends to raise its coal production to 75mt from the targeted 65mt in 2011, although this could be partly offset by slightly lower selling prices. Based on our forecast, Bumi’s debt/EBITDA should to decline to around 2.5x in 2012 from 3.4x in LTM3Q11, and EBITDA/interest should increase to around 3x from 2.2x. The key risks for the company in the near term are weather-related issues and a delay in the completion of its new conveyor belt at Kaltim Prima Coal (expected in 1Q12), which would result in a lower-than-expected coal production for the year. Liquidity position: Weak – the company had cash and equivalents of USD327mn versus short-term debt of USD274mn at end-3Q11. Post-3Q, Bumi signed USD600mn of 1y bridging loans from several banks to refinance high-cost loans from China Investment Corp, and repaid USD125mn of its UBS loan. We are confident in Bumi’s ability to refinance close to USD800mn of debt maturing in 2012 given its relatively robust financial flexibility. It has strong banking relationships, access to equity and bond markets and several non-core assets that it could sell to raise cash. As mentioned above, Bumi intends to use USD355mn of proceeds from short-term investments and the repayment of a loan to a related party to pay down its debt. Valuation: The Bumi ’16s and ’17s trade at a significant discount to Indonesian coal peers. We think this partly reflects the company’s high debt refinancing requirement in the near term. We expect the bonds’ spreads to tighten as Bumi refinances its short-term debt and takes further steps to deleverage and lower financing costs. Of the two bonds, we prefer the ’16s to the ’17s given their higher yield and the shorter maturity.

Central China Real Estate (CCRE) Christina Chiow


Market Weight 12.25% Snr unsecured 20 Oct 15c13 300 B1/B+/--

Rationale

Credit view: In our view, CCRE’s stable credit profile reflects its focus in Henan province (where it has increased its market share from 3.6% to 5%) and prudent growth strategy. Other than Zhengzhou, cities in Henan are not subject to home purchase restrictions as they are predominantly end-user driven markets. Hence, the province reported healthy transaction volume growth of 18.9% y/y to 41.2mn sqm in 10M 11 and price growth of 22% to CNY3,616/sqm. As a result, CCRE was one of the few property companies we cover to achieve its 2011 sales target before year-end. Furthermore, unlike many other high yield Chinese real estate developers, CCRE has shown a willingness to tap the equity market, undertaking a HKD718mn rights issue in 2Q 11. We believe management is relatively prudent in its overall approach. This is despite the company’s growth ambitions and increasing debt amid a tightening macro environment. With strong contracted sales growth in recent years (2010: 53% y/y, 2011: 44% y/y), we expect credit metrics to remain relatively stable with debt/EBITDA of c.3.5x (LTM Jun 11: 2.9x) and EBITDA interest cover of 3.5x (LTM Jun 11: 3.7x) at the end of 2011, as these sales are recognised. Liquidity: CCRE has a good liquidity buffer, driven by better-than-expected sales in 2011. At June 2011, CCRE had unrestricted cash of CNY3.5bn, against short-term debt of CNY2.2bn. At December 2011, we estimate the company had at least c.CNY2.5bn in cash. Major obligations in 2012 include HKD765mn of convertible bonds puttable in August 2012 and construction capex of CNY5-6bn (our estimate). It does not have any land premiums outstanding. We expect the company to be able to use operating cash flow to fund a large part of the expected outgoings in 2012. Valuation: We like the stability that CCRE’s focus on Henan province provides, but believe the 2015 bond’s yield already reflects this – it is the tightest among single-B rated developers. We see limited risk of significant downside, given a core investor following and having Capitaland as the second largest shareholder with a 27% stake. We maintain Market Weight on the bond.


6 January 2012 110

Chandra Asri Erly Witoyo


Underweight 12.875% Snr secured 10 Feb 15c13 223* B2/B+/--

Rationale

Credit view: We are cautious on Chandra Asri’s near-term outlook. A slowdown in the global economy is likely to hurt demand for petrochemicals. Furthermore, we expect oil prices to remain relatively high, which should result in petrochemical margins remaining tight over the next few quarters. This is likely to hurt Chandra Asri’s profitability as was the case in 3Q11, when the operating margin fell to 1% from 4% in 2Q11 and 9% in 1Q11. Given its budgeted capex of USD92mn in 2012, we expect the company to remain free cash flow negative in the near term. The recent signing of a USD150mn syndicated loan to fund part of its capex addresses concerns about its declining cash balance. However, with lower earnings and cash flow expected, the higher debt will weaken the company’s credit metrics, and may put pressure on its ratings. Including the new loan, we estimate pro forma annualised debt/EBITDA of 3.5x in 9M11. Siam Cement’s purchase of a 30% stake in the company is positive for Chandra Asri, in our view. Siam Cement brings operating expertise, given its diversified petrochemical operations, and significantly larger size. Given its relatively strong financial profile, it is possible that Siam Cement would provide some financial support to Chandra Asri in times of financial distress. Liquidity position: Adequate – the company had cash and equivalents of USD60mn and no short-term debt at end-3Q11. However, we believe weak petrochemical markets could result in a rapid cash burn by the company, as seen in 3Q11 when cash balance fell by USD66mn. We expect elevated negative free cash flow in 4Q11 as the company undertook a 35-day turnaround maintenance during the quarter for its ethylene and polyethylene facilities. The recent signing of a USD150mn syndicated loan for capex, however, should help reduce liquidity pressure in the near term. Valuation: We see downside risk for the bonds as Chandra Asri’s credit profile is likely to weaken in the near term. Continued uncertainty in the global economy is likely to weigh on sentiment toward the petrochemical sector. * Outstanding amount as at 5 January 2012.

China Oriental Group Co Ltd Jit Ming Tan


Market Weight 8.00% Snr unsecured 18 Aug 15 550 Ba1/--/BB+

Underweight 7.00% Snr unsecured 17 Nov 17c14 300 Ba1/--/BB+

Rationale

Credit view: We currently have a negative view of China Oriental’s credit fundamentals, given our expectation that tight credit conditions and customer de-stocking will weigh significantly on 2H11 steel demand in China. We expect the company to record minimal earnings in 4Q11, and we forecast 2011 EBITDA of CNY3.16bn, compared with the company’s earlier target of CNY3.6-4.0bn. As a result, we believe China Oriental will not be able to strengthen its gross debt/EBITDA ratio below the 2.0-2.5x range to avoid a downgrade by Moody’s when it releases its 2H11 results. Instead, we expect China Oriental to report stable gross debt/EBITDA of 2.5x and gross debt/capital of 45%, and weaker EBITDA/interest cover of 2.9x. Although the Chinese banks’ 25% m/m new loan growth in October 2011 could signal a loosening of credit conditions, we believe the impact of any easing will only be felt in 2Q12 at the earliest, and we expect 1H12 outlook will remain poor. Liquidity: We expect China Oriental’s liquidity profile to remain robust. At end-June 2011, the company reported CNY2.0bn of cash, CNY4.2bn of bank acceptance notes and c.CNY4.5bn of unutilised banking facilities, compared with CNY2.1bn of short-term debt. China Oriental indicated that in 2H11, it focused on conserving cash and kept capex at a minimal level. We expect its cash balance to fall marginally and its bankers’ notes to increase significantly at end-2011. Funding for M&A remains a concern, although we do not expect any material acquisitions in the near-term. Valuation: Yields on the CHOGRP ’15s are currently flat to other BB-rated Chinese industrials, which we believe fairly reflects near-term operating concerns and its rating vulnerability. Our Underweight rating on the CHOGRP ’17s reflects its tighter yield compared with the shorter-dated bond.


6 January 2012 111

Cikarang Listrindo Erly Witoyo


Market Weight 9.250% Snr unsecured 29 Jan 15c13 300 Ba2/BB-/--

Rationale

Credit view: We are constructive on Cikarang’s near-term credit profile as we expect stronger cash flow on higher electricity sales. Furthermore, we see a low need for debt in the next 12 months, given the company’s ample reserve capacity and strong liquidity position. Barclays Capital’s forecast that Indonesia’s GDP will expand 6.2% in 2012 suggests that electricity demand growth should remain robust in the near term. Historically, growth in electricity consumption has exceeded overall economic growth. Sales in 2012 also should benefit from the full-year contribution of the company’s new 125MW power plant, which was completed at end-1Q11. Most of the output from the new plant is taken by state-owned utility PLN under a take-or-pay contract. Cikarang’s credit metrics are robust for its Ba2/BB- ratings. Annualised debt/EBITDA was 2.4x and EBITDA/interest was 4.6x in 9M11. Assuming the company does not undertake any significant debt-funded expansion, we think these metrics should improve in the near term. The need for the company to continue expanding its facilities to meet customers’ demand poses a key credit risk. However, we believe future expansions may be funded largely through internal resources given Cikarang’s improving cash flow and the relatively low investment cost of a gas-fired power plant. Liquidity position: Strong – Cikarang had cash of USD124mn at end-3Q11 and no short-term debt. We expect the company’s liquidity position to strengthen in the near term, given that it will likely be free cash flow positive. We expect committed capex of less than USD25mn in 2012, comprising the retention payment for the 125MW power plant completed in 1Q11, partial payment for the completion of a peaking unit in 1Q12 and maintenance capex of around USD7mn. Valuation: In our opinion, the Cikarang ’15s are fairly priced at current levels. We believe the bonds are among the most defensive in the Asian HY space, a reflection of the company’s stable business and predictable cash flow. The Cikarang ’15s may not offer significant upside, but given the current volatile market conditions, it may be safer to stay in defensive names.

CITIC Resources Holdings Ltd Jit Ming Tan


Market Weight 6.75% Snr unsecured 15 May 14 1000 Ba3/BB/--

Rationale

Credit view: We expect higher crude production in 2012 on the ramp-up at its Yuedong oilfield and steady production at its Kazakhstan fields. Oil prices should remain stable – our commodity analysts expect Brent to average USD115/bbl in 2012 (2011E: USD112/bbl). As such, we expect crude oil revenue to grow at the same pace as volume growth, with a smaller increase in earnings due to rising operating costs. Contributions from other businesses should be fairly minimal following the sale of stakes in its manganese and coal businesses, as well as likely weak operating conditions for its aluminium smelting and commodity trading operations. Capex will remain elevated – we estimate CITIC Resources will spend CNY1.0-1.5bn in 2H11 and CNY2.5bn in 2012. The company has sufficient internal funds from its equity offering and Macarthur Coal stake disposal to finance its capex, but it remain free cash flow negative in 2012. Gross credit metrics are likely to benefit from the higher earnings, although net metrics are likely to remain stable due to its investments. At end-June 2011, EBITDA/gross interest was 2.7x, gross debt/LTM EBITDA was 6.6x, while gross debt/capital was 47%. Liquidity: Liquidity is strong, with end-June 2011 cash of CNY5.3bn following its rights issuance. The company received another HKD6.2bn from the disposal of its stake in Macarthur Coal in November 2011, and 2H11-2012 operating cash flow should contribute another CNY1.5bn. It has more than sufficient funds to repay CNY1.9bn of short-term debt and capex, which is estimated of CNY3.5-4.0bn for 2H11-2012. Valuation: The CITIC ’14s are the richest Chinese high yield bond and among the richest in the Asian HY market, despite its mid- to low-BB rating. That said, the bond benefits from strong technical support and hold up relatively well in a defensive environment. Indeed, the CITIC ’14s have historically outperformed the Asian HY index during periods of risk aversion.


6 January 2012 112

Country Garden Holdings (Cogard) Christina Chiow


Market Weight 11.75% Snr unsecured 10 Sep 14 375 Ba3/BB-/--

Overweight 10.50% Snr unsecured 11 Aug 15 400 Ba3/BB-/--

Overweight 11.25% Snr unsecured 22 Apr 17 c14 550 Ba3/BB-/--

Overweight 11.125% Snr unsecured 23 Feb 18 c15 900 Ba3/BB-/--

Rationale

Credit view: We expect Country Garden’s credit fundamentals to remain stable in 2012. Given its position as a mass-market developer offering affordable average selling prices in lower tier cities, we think it is less vulnerable to regulatory measures. The company achieved steady contracted sales of CNY39.4bn in 11M 11, tracking its full year target of CNY43bn. Based on the company’s delivery target of 5.9mn sqm in 2011, this likely implies delivery of c.3mn sqm and revenue of CNY17bn in 2H 11, taking full-year revenue growth to 27% y/y. Gross margins are likely to stay in the low 30% area in 2011 and 2012. We expect credit metrics such as debt/EBITDA to be stable at c.3x (LTM Jun 11: 3.4x) and interest cover of c.4.5x (LTM Jun 11: 4.7x) as at end-December 2011. The company recently formed a joint venture to potentially invest in real estate projects in Selangor (Malaysia). This was a surprise as this is Country Garden’s first investment outside China. The company is still conducting due diligence on the land it is interested in and has yet to finalise a price. Moody’s expects the committed investment to be small. Liquidity: Liquidity looks adequate. At September 2011, the company had c.CNY9.8bn of unrestricted cash and cash for construction (June 2011: CNY10.1bn). Outstanding land premiums amounted to c.CNY5.5bn, of which CNY4.5bn was payable in 4Q 11. Going into 2012, we expect the company to generate sufficient operating cash flow to cover its operating expenses, construction costs and land premiums outstanding of CNY1bn. Valuation: Our ratings on Cogard’s bonds reflect our comfort with the company’s business model and execution. Technicals also seem strong for this credit, given its mass-market position, track record of prudent financial management and the large issue sizes of the bonds. The slope of the yield curve between the 14s and 15s is steep, at more than 100bp. Hence, we rate the 14s as Market Weight and the 15s as Overweight given the latter’s better value and potential for outperformance. Similarly, we also have Overweight ratings on the longer-dated 17s and 18s for the yield pick-up, although we think the sweet spot is in the Cogard 15s.

Energy Development Corp. Erly Witoyo


Not rated 6.50% Snr unsecured 20 Jan 21 300 Not rated

Rationale

Credit update: We are positive on the near-term operating outlook for Energy Development Corp (EDC). The recommissioning of its 150MW BacMan plant in late-2011 should contribute to earnings growth. The plant accounts for approximately 13% of the company’s total generating capacity and its shutdown was largely responsible for the 15% y/y decline in 9M11 EBITDA. We continue to view EDC as a mid-BB credit based on annualised 9M11 debt/EBITDA of 3.9x and EBITDA/interest of 3.0x. The company has stable, predictable cash flow, given that close to 90% of its power is sold under long-term off-take contracts. While we expect higher capex in the near term, we believe it can be largely covered through internal resources. To expand generating capacity to 1,500MW from the current 1,130MW, management plans to spend about USD1bn (PHP44bn) over the next five years. In comparison, it has generated annual operating cash flow of over PHP10bn in the past three years. The aggressive expansion plan could entail significant execution risk, as it involves diversifying into new sectors and markets. The company is currently developing a wind power project. In November, it announced the acquisition of 70% stake in a company that engages in geothermal projects in Chile and Peru. It also has plans to acquire geothermal concessions in Indonesia. Liquidity position: Strong – the company had cash and equivalents of PHP12.7bn compared with short-term debt of PHP2.1bn at end-3Q11. Its debt maturities over the next few years are manageable, in our view – its next large repayment is in 2015 when PHP8.5bn of notes mature. Valuation: We view the EDC ’21s as fairly valued compared with Philippine corporate peers. Although we are relatively constructive on the credit, we see limited upside for the bonds based on the yield.


6 January 2012 113

Evergrande Real Estate Group Christina Chiow


Overweight 13.00% Snr unsecured 27 Jan 15 1,350 B2/BB-/BB

Rationale

Credit view: We expect Evergrande’s credit profile to gradually improve as it continues to achieve good sales progress and has slowed its acquisition of new land. Evergrande was one of the few developers we cover to exceed its 2011 sales target by more than 10%. Given the company’s enlarged scale and still affordable prices in lower tier cities, we expect it to experience steady sales growth in 2012. At the same time, Evergrande has kept to its cautious land acquisition strategy; in 2H 11, it only acquired a single piece of land with a GFA of 1mn sqm in Hefei for c.CNY500mn after buying 48.97mn sqm in 1H 11. Assuming its slower pace of land acquisitions continues, we believe this will stabilise credit metrics and lead to a rating outlook reversal to Stable by Moody’s in 2012. Moody’s current Negative Outlook is due to Evergrande’s debt-funded expansion amid a tightening environment in China. We estimate debt/EBITDA of c.3.5-4.0x (LTM Jun 11: 3.3x) and EBITDA interest cover of at least 4x (LTM Jun 11: 5.0x) as at end-2011. Offsetting these positives is Evergrande’s rapid land acquisitions in the past, which have resulted in significant land premiums outstanding, large capex requirements and high debt levels. These render it sensitive to changes in contracted sales. Liquidity: Evergrande’s liquidity looks adequate, despite the high amount of land premiums outstanding. At June 2011, Evergrande had unrestricted cash of CNY16.9bn. We estimate that after paying land premiums of more than CNY10bn in 2H 11, by end-December it still had unrestricted cash in excess of CNY10bn. Furthermore, another CNY7.6bn of restricted cash (as at June 2011) can be used for construction costs. Major spending commitments in 2012 include scheduled land premiums of CNY17.6bn, another CNY5bn of land premiums we think have been pushed forward from 2011, construction costs of CNY35bn and other costs of CNY15bn. Assuming no contracted sales growth in 2012, ie, sales of CNY80bn, then funding for these costs can still largely be met through cash and operating cash flows. Valuation: We believe size matters in a tough operating environment. As one of the largest Chinese developers focused on the lower tier cities, Evergrande looks better placed than most other developers, which should support outperformance of its bonds, in our view. Further, valuation is extremely wide compared to peers of similar size. We maintain our Overweight on the ‘15s. But we note that technicals for this bond are not particularly strong, given the large issue size and the availability of alternative securities in the CNH bond and equity markets.

First Pacific Company Limited Jit Ming Tan


Not Rated 7.375% Snr secured 24 Jul 17 300 Not rated

Not Rated 6.375% Snr secured 28 Sep 20 400 Not rated

Rationale

Credit view: We like First Pacific for its stable, utility-like businesses and revenue streams. In 1H11, its recurring earnings breakdown was: telecoms (44%), consumer staples (34%), infrastructure (14%) and natural resources (8%). 1H11 EBITDA rose 16% y/y, on stable telecom earnings, but improved contributions from its other businesses. Indeed, its infrastructure (MPIC) and natural resources (Philex) businesses reported significant increases in profitability that exceeded 50% y/y, albeit from a low base. Based on its continued positive free cash flow generation, we expect credit metrics to improve further. In 1H11, it reported EBITDA/interest cover of 4.8x, gross debt/EBITDA of 2.8x and gross debt/capital of 34%. While not rated by any of the agencies, based on international rating scales, we estimate that First Pacific could be viewed as a mid-BB credit, with low-BB ratings for its bonds due to structural subordination. Liquidity: Liquidity is robust, with an end-June cash balance of USD2.0bn against maturing debt of USD801mn. In 1H11, First Pacific generated USD416mn of operating cash flow and spent USD312mn on capex and dividends; we expect it to be similarly free cash flow positive in 2H11. Valuation: We continue to see value in the bonds within the context of the Philippines corporate bond universe. In addition to the company’s stable earnings, the bonds benefit from some protection from the structural subordination, given that they are secured by shares in MPIC (FIRPAC ’17s) and PLDT (FIRPAC ’20s). The bonds’ yields are flat to each other; we prefer the shorter-dated credit despite its higher cash price.


6 January 2012 114

Franshion Properties (China) Ltd Christina Chiow


Market Weight 6.75% Snr unsecured 15 Apr 21 500 Ba1/BB/BBB-

Rationale

Credit view: With good contracted sales in 2011 and more investment properties scheduled for completion in 2012 and beyond, we expect Franshion’s credit metrics to gradually recover from the weak levels recorded at the end of June 2011. Up to mid November 2011, Franshion had achieved contracted sales of CNY9.7-9.8bn, close to its full-year target of CNY10bn. The company’s investment properties will also increase with the opening of the Shanghai International Shipping Service Center in 2012 and a hotel in Lijiang in 2013. Further, a key credit overhang relating to the progress of its Changsha project has been removed, with the CNY2.67bn sale of some land in the project in 4Q 11, which was in line with its expectations. However, we believe recent positive developments may be somewhat offset by management’s view that the company needs to acquire more land and it has not ruled out M&A opportunities for the investment property business. Indeed, Franshion acquired two parcels of land in Chongqing and Beijing (through a joint venture with Sunac China) in December 2011 for CNY1.05bn and CNY3.07bn respectively. Liquidity: Franshion’s liquidity looks adequate. It had a higher than usual level of unrestricted cash of HKD13.6bn at the end of June 2011. In 2H 11, the company also achieved sales of CNY1.7bn from the second batch of units in the Beijing Jin Mao Palace project. We estimate Franshion had cash of c.HKD13bn at end-December 2011. The company has c.CNY4bn of land premiums payable in 2012. Depending on contracted sales and construction progress, we think Franshion may have to partly fund these payments through increased borrowing such as construction loans, which we think it has the ability to access. Valuation: We maintain our Market Weight on the Franshion 2021s. We believe the yields are attractive and sufficiently compensate investors for the company’s credit profile (including a balanced development/investment property business model and parental support). However, weak technicals and still aggressive growth are likely to prevent outperformance in the near term, especially as the bonds of other high-yield non-state owned developers are offering much wider yields. We prefer the shorter-dated bonds of state-owned CRL in this risk-averse environment.

Fufeng Group Limited Jit Ming Tan


Overweight 7.625% Snr unsecured 13 Apr 16c14 300 -/BB/BB

Rationale

Credit view: We remain constructive on Fufeng’s credit profile. We expect 2H11 revenues to grow 29% y/y on higher production volumes and a marginally higher ASP. We expect gross margins of 18.5%, weaker than the 21.7% achieved in 1H11. We believe margins fell to the mid-teens in 3Q11, although an 8-10% decline in corn prices since September should boost profitability in 4Q11. EBITDA is expected to flat h/h and y/y, although net credit metrics will likely deteriorate due to capital spending. Fufeng brought forward some 2012 outlays for its Northeastern Phase II plant, and we estimate 2H11 capex of CNY650mn. We expect the company to report EBITDA/interest cover of 6.1x, gross debt/EBITDA of 2.7x and gross debt/capital of 47% for 2011. Our outlook for 2012 is better – we project revenues will grow 21% and EBITDA 39%, on likely stable ASPs and input costs, but higher volumes. We expect 2012 gross margins to rise to 22.5% from cost efficiencies at its new plant. Fufeng has guided for significantly lower capex in 2012, which we estimate will be CNY500-700mn. Credit metrics are expected to improve as a result. In the absence of additional unannounced capex, we think Fufeng can record positive free cash flow in 2012. Liquidity: We expect liquidity is expected to weaken in 2H11 due to tight credit conditions in China and higher-than-expected capex. Fufeng indicated that some customers have asked the company to accept bankers’ acceptances in lieu of payment. We expect the trade and notes receivable balance to be materially higher as a result. We expect an end-2011 cash balance of CNY500-600mn, compared with short-term debt of CNY310mn in June 2011. Clearly, the company’s liquidity profile remains more than adequate. Valuation: The FUFENG ’16s marginally outperformed the EM Asia USD Corporate High Yield index over the past three and six months. We believe operating pressures have eased with the decline in corn prices, and we think the bond has scope for further outperformance in 2012.


6 January 2012 115

Gajah Tunggal Erly Witoyo


Overweight 6.00%* Snr unsecured 21 Jul 14c09 424** B3/B/--

Rationale

Credit view: We see Gajah as an improving credit. Its tyre plant expansion is nearly complete, which should result in a lower capex requirement and higher free cash flow. We believe the company’s operating environment remains constructive in the near term. Its profit margin should improve on lower rubber prices, and the 5-10% increase in selling prices implemented in 2011. In addition, tyre demand remains relatively robust, especially in Gajah’s domestic market. Indonesia’s strong economic outlook (our economists forecast GDP growth of 6.2% in 2012) and the robust growth in vehicle sales over the past few years should support demand for replacement tyres in the near term. Export demand could experience some weakness given the economic uncertainty in Europe and the US. However, we believe sales of lower-cost replacement tyres are normally more resilient in market downturns. Gajah’s credit metrics are strong for its B3/B ratings, in our view. Debt/LTM EBITDA was 2.6x in 3Q11 and LTM EBITDA/interest was 4.0x. These metrics are likely to improve in the near term on higher earnings and slightly lower debt. Given that we expect free cash flow to increase, we see a high likelihood of Moody’s raising its B3 rating on Gajah by one notch in the next six months. Liquidity position: Strong – at end-3Q11, the company had cash and equivalents of USD111mn compared with short-term debt of USD11mn, comprising the amortisation of the USD bonds. Capex in 2012 is estimated to be about USD20mn, most of which is for maintenance. We believe this can be covered through operating cash flow. Valuation: We believe the Gajah ’14s are one of the best values within the Asian HY sector, given their relatively high yield and low cash price. The improvement we expect in Gajah’s credit profile, which could drive a rating upgrade, and the step-up in the coupon to 8% in mid-2012 should support near-term tightening in the bond’s yield. Note: * The Gajah ’14s have a step up coupon – 5% in year 1 and 2, 6% in year 3, 8% in year 4, and 10.25% in year 5. ** Amount outstanding as at 5 January 2012.

Glorious Property Christina Chiow


Underweight 13.00% Snr unsecured 25 Oct 15c13 300 B3/B/--

Rationale

Credit view: We remain negative on Glorious Property, given its high debt leverage and tight liquidity. At June 2011, Glorious had short-term debt of CNY9.3bn against unrestricted cash of CNY2.2bn (CNY5.8bn including restricted cash). Although the company repaid the CNY2bn Shanghai Bay loan (which was due on 1 December 2011), we expect short-term debt to remain relatively high given the high level of GFA under construction and trust loans of CNY1.7bn outstanding. Due to an increase in debt in recent years, we expect debt/EBITDA to remain on the high side at c.5x and EBITDA/interest to be relatively weak at c.2x. Sales in 2011 were, however, better than expected, which we believe reflects the company’s increasing presence in lower-tier cities (in the Yangtze River Delta and northeast China). Glorious achieved contracted sales of CNY14bn in 2011, close to its target of CNY15bn. Liquidity: Despite Glorious nearly achieving its full-year contracted sales target in 2011, we believe its liquidity remains relatively tight. We estimate that it had cash of c.CNY3bn versus short-term debt of CNY6-7bn at the end of December. Besides being cautious on the land acquisition front, we expect the company to reduce new construction starts in 2012 to preserve cash. Valuation: Given our view of its leverage and tight liquidity position, we believe the Glorious ’15s will underperform the broader market and retain an Underweight rating on the bond. We believe there is limited appetite for single-B rated Chinese developers such as Glorious, given current risk aversion among investors to the sector.


6 January 2012 116

Guangzhou R&F Properties Co. Ltd Christina Chiow


Not Rated 10.875% Snr unsecured 29 Apr 16 150 Not rated

Rationale

Credit view: Despite lower than expected sales in 2011, we believe Guangzhou R&F has sufficient liquidity to weather the challenging operating environment. Further, Guangzhou R&F’s land acquisition policy is more conservative than its peers, which at times is undertaken on a joint-venture basis. The company saw notable improvements to its credit metrics in 1H 11 as higher earnings were recognised. Debt/LTM EBITDA was 2.8x and LTM EBITDA/gross interest cover was 6.3x, comparable to Agile and Longfor’s credit metrics. However, debt/capital and gearing (net/equity) remained high, which we believe reflects its limited ability to raise new capital as a company incorporated in China. Based on the company's estimate of full-year deliveries of 2.65mn sqm (1H 11: 723,600sqm) at an ASP of CNY9,000/sqm, 2H11 earnings could be even stronger than 1H. We estimate that debt/EBITDA could be c.4x and EBITDA/interest cover c.5 by the end of 2011 and remain stable in 2012. Liquidity: Liquidity looks good. In early October 2011, the company had unrestricted and restricted cash for construction of c.CNY11bn (June 2011: CNY12.4bn). We estimate it ended 2011 with cash of c.CNY10bn, which implies a strong buffer against outstanding land premiums of CNY1.7bn payable in 2012 and another CNY2bn for the Asian Games project (20% stake), which may be partly funded by the project’s sales proceeds. In 2011, the company made two land acquisitions, one in Guangzhou and one in Harbin. Valuation: We continue to see value in the Guangzhou R&F ’16s, as the bonds are an outlier among comparable peers. Part of this may be attributable to the small issue size and the lack of a credit agency rating. We think investors able to invest in unrated bonds are potentially well compensated by the above-average yield of the ’16s relative to similar bonds from the larger and established developers in China.

Hopson Development Holdings Limited Christina Chiow


Underweight 8.125% Snr unsecured 9 Nov 12c10 350 Caa1/B/--

Underweight 11.75% Snr unsecured 21 Jan 16c 14 300 Caa1/B/--

Rationale

Credit view: We remain negative on Hopson’s credit fundamentals. The company faces tight liquidity, due to its lacklustre contracted sales in 2010 and 2011, and a high level of short-term debt, including its USD350mn bonds due in November 2012. In 2010, Hopson achieved only CNY11bn in contracted sales versus its target of CNY20bn. It also underperformed in 2011, with sales of c.CNY1bn each month, below the rate needed to achieve its original full-year target of CNY14bn (revised to CNY12bn in September 2011). We believe this reflects the company’s focus on tier-one cities and high-end markets. Aggressive expansion has also increased debt, which stood at HKD33bn by June 2011, from HKD24bn at December 2010. Credit metrics are weak, with debt/LTM EBITDA of 6.8x and LTM EBITDA/interest cover of 2.8x at June 2011. We expect them to have remained elevated, with end-2011 levels of more than 6x for debt/EBITDA and 2-3x for EBITDA/interest cover. Liquidity: Liquidity is tight. At June 2011, Hopson had cash of HKD4.2bn against short-term debt (all bank and financial institution borrowings) of HKD10.1bn. It has c.HKD3bn of trust loans due in 2012 and a USD350mn (HKD2.7bn) bond due in November 2012. Alleviate the refinancing risk somewhat, in our view, is Hopson’s strong onshore banking relationships. At June 2011, Hopson had unutilised banking facilities of HKD33bn (uncommitted as is the usual practice in China). We think the company could also defer some commitments, if needed (as it did in 2008). Nevertheless, without clearly articulating a refinancing plan, we see this area as a risk in the current environment. Valuation: We maintain Underweight ratings on Hopson’s bonds. We see asymmetric risks as outweighing the relatively high yields on the bonds, even for the shorter-dated 2012s, until we get further clarity on its refinancing plans and contracted sales progress.

Hynix Semiconductor Jit Ming Tan


Underweight 7.875% Snr unsecured 27 Jun 17c12 500 B1/B+/BB-

Rationale

Credit view: Hynix has a positive credit trajectory due to its impending KRW2.3trn rights offering for SK Telecom’s acquisition of a 21% stake in the company. We estimate pro forma net debt/capital of 20% (3Q11: 38%), net debt/LTM EBITDA of 0.6x (3Q11: 1.2x) and EBITDA/net interest cover of 17x (3Q11: 11x) if its rights offering is successful. Improvement in gross credit metrics is also likely, as we expect the company apply part of the offering proceeds towards deleveraging. All three rating agencies have placed Hynix’s ratings on review for upgrade as a result. We are less constructive on its operating outlook. We think revenues will weaken through 1Q12 on soft demand and the continued decline in DRAM ASPs; we expect Hynix to report operating losses through 2Q12. Our equity analyst estimates that DRAM ASP is currently below the cash cost level for all DRAM makers, with the exception of Samsung Electronics. We believe prices will recover in 2H12, as PC makers ramp up production once the supply of hard disk drives normalises after the Thai floods. Overall, we expect full-year 2012 operating earnings to be broadly stable. Liquidity: The pending KRW2.3trn rights offering will provide a significant boost to Hynix’s cash holdings of KRW2.0trn at end-September 2011. Combined with estimated 2012 operating cash flow of KRW3.5trn, we think Hynix can easily fund its estimated capex of KRW3.4trn and repay short-term debt of KRW3.1trn. Valuation: Priced to call in June 2015, we think the positive credit trajectory is fully priced in and the HYUELE ’17s are rich for its high-B/low-BB rating especially given its weak near-term operating outlook.


6 January 2012 117

Indika Energy Erly Witoyo


Market Weight 9.75% Snr unsecured 5 Nov 16c13 230 B1/--/B+

Underweight 7.00% Snr unsecured 7 May 18c15 300 B1/--/B+

Rationale

Credit view: We are positive on Indika’s near-term credit outlook. A higher dividend payment from its coal associate, Kideco, should support stronger cash flow. Indika’s management estimates that Kideco’s coal production rose to 31mt in 2011 from 29mt in 2010, and its average selling price increased to USD66/ton from USD55/ton. Kideco posted a net profit of USD336mn in 9M11 compared with USD243mn a year earlier, which should allow higher distribution to shareholders in 2012. At the subsidiary level, new contracts and a full-year contribution from subsidiary Mitra Bahtera, which was acquired in April 2011, should strengthen Indika’s cash flow in 2012. Its mining and engineering subsidiaries faced operating difficulties in 2011, owing to delayed deliveries of mining equipment at Petrosea and the cancellation of a major project at Tripatra. The issues at Petrosea were resolved in 2H11, and a contract to build EPC production processing facilities for ExxonMobil should mitigate the cash flow losses from the cancelled project at Tripatra. Increased cash flow and lower debt should support stronger credit metrics for Indika. We forecast the company’s debt/EBITDA will fall to around 3x in 2012 from an annualised 4.3x in 9M11, and expect EBITDA/interest to rise to close to 4x from 3.2x. Potentially offsetting the improvement, we continue to see M&A as a key risk for Indika. The company seeks to acquire energy-related assets in order to strengthen its business integration. Liquidity position: Strong – at end-3Q11, the company had cash and equivalents of USD510mn compared with short-term debt of USD259mn. Part of the cash balance is earmarked for expansion and possible acquisitions. As such, it could decline significantly in a short period of time. The company’s plan to refloat at least 17% of the shares of subsidiary Petrosea in 1H12, if successful, would strengthen its liquidity position. Valuation: We believe the Indika ’16s are fairly valued given our expectation of an improvement in the company’s credit metrics in the near term. The ’18s, however, look rich given the tight yield to the ’16s. Among the Indonesian coal paper, we think Indika’s bonds have some of the weakest structures. They do not contain a guarantee from the issuer’s largest cash flow contributor, Kideco.

Indosat Tbk, PT Jit Ming Tan


Underweight 7.375% Snr unsecured 29 Jul 20c15 650 Ba1/BB/BBB-

Rationale

Credit view: Indosat’s credit profile will likely improve in 2012. We expect a stable operating outlook, with mid-single digit revenue and EBITDA growth. This likely will be supported by rational (but elevated) price competition in voice and a rising contribution from data services. We expect credit improvements based on likely positive 2012 free cash flow, with estimated operating cash flow of IDR8.0-8.5trn, capex of IDR6trn and dividend payments of IDR1.0trn. The company could raise another USD500mn (IDR4.5trn) from the potential sale and leaseback of 3,000 cellular towers to PT Tower Bersama, according to Bloomberg. The sale proceeds may be used to reduce its outstanding debt; however, we do not expect a corresponding decline in Indosat’s lease-adjusted debt once operating leases are taken into account. That said, we think S&P may reassess its Stable outlook in 2012 if Indosat’s credit profile improves and the company is able to maintain its debt/EBITDA ratio below 3x and improve its liquidity position. Indosat reported 3Q11 EBITDA/interest cover of 6.1x, gross debt/LTM EBITDA of 2.6x and gross debt/capital of 57%. Liquidity: End-September liquidity remained weak, with cash of IDR1.8trn versus short-term debt of IDR4.2trn and procurement payables of another IDR3.4trn. We believe a successful sale-and-leaseback transaction for its towers would significantly strengthen its liquidity profile. Our expectation that Indosat will be free cash flow positive in 2012 could provide room for further improvement. In our view, Indosat also has good access to external funding from banks and capital markets. Valuation: Priced to call in 2015, the ISATIJ ’20s are among the tightest bonds in the Asian HY universe and the global BB-rated wireless sector. Our Underweight recommendation reflects this dynamic. That said, we acknowledge the strong technicals supporting the ISATIJ ’20s due to the defensive nature of its business and its exposure to Indonesia's economy.


6 January 2012 118

International Container Terminal Services Inc. Erly Witoyo


Not rated 7.375% Snr unsecured 17 Mar 20 450mn Not rated

Rationale

Credit update: The slowdown in the global economy poses downside risks to ICTSI’s container yield and volume growth. However, we think this will be mitigated by contributions from new ports that will come online in 2012. These include the Subic New Container Terminal 2 (ICTSI signed a contract in Aug 11 to operate 100,000 TEUs annually), the 1.2mn-TEU Kattupalli terminal in India (scheduled to start commercial operations in Jan 12) and the first phase of TECPLATA port in Argentina (expected to add another 450,000 TEU in 2H12). Moreover, ICTSI’s cash flow should benefit from a government-approved tariff increase at its Manila International Container Terminal (6% in Oct 11 and a further 5% in the following six months). We view the company as a low-BB credit. Assuming a 50% debt treatment for the USD200mn perpetual notes, debt/LTM EBITDA was 4.0x at end-3Q11, and EBITDA/interest was 4.4x. We expect a slight improvement in these metrics in 2012 on a modest increase in earnings. Additional debt needs are low, in our view. Although we expect capex to remain high in 2012, we believe the company will be able to fund its investment through operating cash flow and its cash balance. The company has a relatively comfortable debt maturity profile – until the bond matures in 2020, ITCSI faces only USD165mn of debt repayments (loan and bond). Liquidity position: Strong – the company had cash and equivalents of USD473mn at end-3Q11, compared with short-term debt of USD66mn. Management has not yet finalised its 2012capex budget, but based on historical levels, we think its cash flow and cash balance can cover potential outlays in the near term. Valuation: Based on the current yield, we view the ICTPM ’20s as rich relative to Philippines corporate peers. Given the cyclical nature of its business, we think investor sentiment on the bonds could weaken on slowing global economic conditions.

Kaisa Property Group Christina Chiow


Overweight 13.5% Snr unsecured 28 Apr 15c13 650 B2/B/--

Rationale

Credit view: Kaisa’s credit profile has been negatively affected by its aggressive land acquisitions in 2010 and 1H 11, and high leverage. However, the company’s execution of a back-loaded launch schedule in lower-tier cities has proved successful, in our view. Moody’s changed Kaisa’s rating outlook to Negative in June 2011, citing lacklustre 5M 11 sales. We believe Moody’s could reverse this view in 2012 as the company achieved CNY13.5bn in contracted sales in 11M 11. According to Moody’s, the outlook could return to Stable if full-year contracted sales are above CNY10bn without pushing EBITDA margin below 20-25%, and if Kaisa maintains unrestricted cash above 10% of total assets. Based on the company’s property delivery target of 1.2mn sqm in 2011, we estimate GFA delivery of 900k sqm and revenue of CNY6.4bn in 2H 11, which would have pushed full-year revenue to CNY10bn (+31%). Nevertheless, we see limited scope for credit metrics to improve and expect leverage and interest cover to remain relatively weak at c.4.5x and c.3x respectively, given the increase in debt in 2011. Liquidity: Despite aggressive land acquisitions in 2010 and 8M 11, Kaisa’s liquidity was helped by strong contracted sales of CNY13.5bn in 11M 11 and the deferment of some land premiums from 2011 to 2012. It has c.CNY2.5bn of land premiums payable in 2012. Given Kaisa’s better–than-expected execution in lower tier cities and our estimate of c.CNY4bn cash as at the end of December, we believe the company has sufficient liquidity to meet its near-term obligations. Like many other developers, the company is also actively preserving cash by slowing acquisitions and construction activity. At the same time, management says it is talking to third parties for some projects as a means of bolstering its capital position and it has not ruled out the possibility of equity financing. Valuation: While cognisant of current risk aversion towards single-B rated developers and the bond’s seemingly weak technicals, we maintain our Overweight rating on the Kaisa 2015c13s. We view the company as a growing medium-sized developer that has had some success expanding into lower tier cities. This makes the current yield, at c.20%, attractive, in our view, and we expect the bond to outperform the HY Asia Corporate index.


6 January 2012 119

KWG Property Holding Ltd Christina Chiow


Market Weight 12.75% Snr unsecured 30 Mar 16c14 350 B1/B+/--

Market Weight 12.50% Snr unsecured 18 Aug 17c14 250 B1/B+/--

Rationale

Credit view: We expect KWG’s credit profile to remain stable and commensurate with a high single-B bond rating. After achieving significant growth in 1H11, with revenue rising 120% y/y and EBITDA by 163%, we think 2H 11 growth was more stable, reflecting property delivery of a similar value (c.CNY5bn). Assuming a moderate increase in debt, we estimate that at end-2011 debt/EBITDA had weakened moderately to 4.0-4.5x from 3.8x at June 2011 and EBITDA/interest cover to c.3.0-3.5x from 4.0x. Contracted sales in 2011 were somewhat disappointing, with the company achieving only CNY10.1bn by 11M 11 out of its full-year CNY15bn target. We believe this reflects KWG’s mid to high-end positioning and focus on Tier 1 and Tier 2 cities, which are most exposed to the raft of property purchase restrictions. Mitigating these negatives is KWG’s ample liquidity. Liquidity: KWG’s liquidity profile is one of the strongest among its peers, in our view. At June 2011, the company reported cash of CNY5bn. By the end of 2011, we estimate it had unrestricted cash of c.CNY4-5bn, which would comfortably cover outstanding land premiums of CNY1.5bn due in 2012. In 1H 11, KWG spent CNY3bn acquiring land but nothing in 2H 11. Valuation: We view valuations of its bonds as fair for their single-B bond ratings. Among the two bonds, we think the ’16s offer the better value. In the single B segment, we prefer the shorter-dated Kaisa 2015s for the higher yield, better business execution and sales exposure to lower tier cities.

Longfor Properties Christina Chiow


Market Weight 9.5% Snr unsecured 7 Apr 16c14 750 Ba3/BB/--

Rationale

Credit view: With ample liquidity, strong execution capability and robust credit metrics, we view Longfor’s overall credit quality as comparable with Agile (Ba2/BB). At June 2011, the company had an exceptionally high level of cash, CNY12.2bn, and achieved contracted sales of CNY35.7bn in 11M 11. Its strategy is also flexible, as shown by its willingness to cut prices aggressively to spark sales in select projects to improve asset churn. This helped it to keep contracted sales on track for its full year target of CNY40bn. To preserve liquidity, the company is slowing down the construction of investment properties that it intends to hold for sale while maintaining construction of properties for sale to improve asset and cash churn. However, Longfor was aggressive in acquiring land in 2H 11, spending c.CNY7bn. Nevertheless, we estimate that credit metrics such as debt/EBITDA and EBITDA/interest cover remained decent at below 3x (Jun 11: 3.1x) and above 6x (LTM Jun 11: 6.6x) at the end of 2011. Liquidity: Despite CNY7bn of land acquisitions in 2H 11, we think its liquidity remains robust. We estimate it had cash of at least CNY8bn as at end-December 2011. Valuation: The Longfor ’16s, which are trading inside the Agile ‘16s, are the tightest bonds in the Chinese high yield sector. Although we view the credit profile is stable, we see little room for further out-performance. We maintain our Market Weight on the bonds.

Manila Cavite Toll Road Erly Witoyo


Not rated 12.00% Snr secured 15 Sep 22* 160 Caa1/CCC+/--

Rationale

Credit update: Manila Cavite’s liquidity faces pressure in the near term, as traffic volume on its new toll road (R-1 Extension) has been significantly lower than forecast. Construction delays, an unexpected pipe-laying project and the redesign of an interchange are partly to blame for the low traffic (the last two also affected the traffic on the existing R-1 Expressway). Since it opened in May 2011, average daily traffic on the R-1 Extension has been 10,000-11,000 compared with an independent consultant’s forecast of 50,000/day for 2011. The lower-than-expected cash flow raises the risk of a default and the triggering of an early amortization event (EAE: issuer fails to maintain a quarterly debt service coverage ratio of at least 1.15x and the forward-looking DSCR falls below 1.25x). The project sponsor, however, seems committed to comply with bond covenants, and we believe it could continue to provide financial support to the project while traffic ramps up to the forecasted level. We understand the sponsor injected additional cash to the project in 2011 to avoid an EAE trigger. We note that the first few years are often the most challenging in toll-road project financing. Once traffic on the R-1 Extension exceeds the breakeven level, which we believe is around 30,000/day, debt servicing risk should be much lower. Assuming no other interruptions on the company’s toll roads, we believe traffic will reach the breakeven level by end-2012 or early-2013. Liquidity position: Weak – Manila Cavite Toll Road had USD24.9mn of cash deposited in its debt service reserve account as at 7 December 2011, which would cover less than one year of debt servicing assuming traffic on the R-1 Extension remains stagnant. Until traffic reaches breakeven, a cash injection from the project sponsor may be needed to ease near-term liquidity pressures and avoid an early amortisation event. Valuation: The bonds are likely to underperform in the near term in light of the company’s near-term liquidity pressure. We could see increased value on the bonds if there is evidence on the sponsor’s willingness to continually support the project through equity injections and on the successful ramping up in traffic volume to the breakeven rate of 30,000 vehicles per day by end-2012. Note: *The bonds are amortising, with the final maturity on 15 September 2022.


6 January 2012 120

MIE Holdings Jit Ming Tan


Market Weight 9.75% Snr unsecured 12 May 16c14 400 --/B+/B

Rationale

Credit view: Net credit metrics likely deteriorated in 2H11 following the Emir-Oil acquisition in September 2011, although this will be partly offset by c.10-15% increase in production volume from Emir-Oil in 4Q11. In 2012, we expect production volume to rise c.25% y/y due to a full-year contribution from Emir-Oil, with further upside if MIE successfully repairs Emir-Oil’s shut-in wells. Oil prices should remain stable – our commodity analysts expect Brent to average USD115/bbl in 2012 (2011E: USD112/bbl). MIE’s unit lifting cost will likely rise, although we do not expect a significant increase. Our higher production estimate supports stronger 2012 earnings and operating cash flows, which would partly fund its capex, estimated at CNY950mn in 2H11 and CNY1.5bn in 2012. Nonetheless, we expect the company to report negative free cash flow in 2012. This could result in negative action by S&P, although we think MIE will be able to avoid a downgrade. Overall, we have a broadly stable view of MIE’s credit profile in 2012. MIE reported 1H11 EBITDA/gross interest of 7.5x, gross debt/LTM EBITDA of 1.9x and gross debt/capital of 54%. Liquidity: MIE’s liquidity position is likely to deteriorate following its USD160mn (CNY1.0bn) acquisition of Emir-Oil in September, an estimated CNY2.5bn of capex in 2H11 and 2012 and an estimated CNY100mn of dividend payments in 2012. We expect MIE’s cash balance to decline from CNY1.9bn in June 2011 to CNY200-300mn in end-2012 in the absence of external funding. However, MIE does not have any short-term debt. As such, we do not expect its lower cash balance to result in liquidity problems. Valuation: We think the MIEHOL ’16s are fairly valued compared with other Chinese HY industrials. Although the bonds are cheap compared with other emerging market E&P credits, we do not expect the valuations to narrow due to a lack of technical support from global investors. We also do not see any operating or credit catalyst in the near-term that would reprice the bonds. Our Market Weight rating reflects this view.

MNC Sky Vision Erly Witoyo


Market Weight 12.75% Snr secured 16 Nov 15 165 B2/B/--

Rationale

Credit view: The Indonesian pay-TV sector’s attractive growth prospects bode well for MNC Sky Vision’s (MSV) credit profile. We expect the recent 20%-plus growth to continue, supported by the low penetration rate (c.5%) and consumers’ rising purchasing power. As Indonesia’s largest pay-TV provider (market share of close to 80%), MSV stands to benefit from the strong industry dynamics. The company forecasts its subscribers will increase to 1.4mn by end-2012 from about 1mn at end-3Q11. In addition, the company should post higher earnings on improved profitability – MSV expects its EBITDA margin to increase to 45% in 2012 from 42% in 9M11 and 36% in 2010, driven by lower program costs per subscriber. We believe this will support a near-term improvement in credit metrics, with debt/EBITDA falling to close to 2x from an annualised 2.4x in 9M11, and EBITDA/interest rising to 3.5x from 3.1x. The company has budgeted capex of IDR500bn (USD55mn) for 2012, although we believe if its plan for an IPO does not proceeds, capital spending is likely to be reduced. We note that in 2011, the company budgeted capex of IDR400bn, but had spent only IDR25bn through 9M11. Liquidity position: Weak – the company had cash of USD11mn at end-3Q11 compared with short-term debt of USD29mn. A significant portion of the short-term debt is letter-of-credit facilities used to fund purchases of set-top boxes from Samsung since early 2011. The purchases are payable in 12 months under the agreement with the vendor. The signing of a USD35mn letter of credit facility in December 2011 increased liquidity, although the use of the facility is restricted for trade financing. Given its limited financial flexibility, we think MSV needs to raise cash through an IPO to address its liquidity needs. The plan to sell shares in 2011 was postponed due to weak market conditions. Valuation: At the current yield, the MSV ’15s are among the highest-yielding Indonesian corporate bonds. We believe this sufficiently compensates investors for the company’s weak liquidity and small size. Assuming MSV can strengthen its cash balance, we expect the yield on the ’15s to tighten.


6 January 2012 121

Pacnet Limited Jit Ming Tan


Overweight 9.25% Snr secured 11 Sep 15c13 300 B1/NR/BB+

Rationale

Credit view: Pacnet’s weak 2Q11 results, partly due to one-off items, have weighed on the company’s credit metrics and ratings. Although earnings recovered in 3Q11, the company is unlikely to achieve the full-year EBITDA of USD80mn needed to avoid a Moody’s downgrade. We expect a downgrade by Fitch in 2012 unless earnings improve significantly. We are somewhat sceptical, and project 4% EBITDA growth in 2012. Traffic growth has been strong, although price declines have offset most of the volume growth. We expect this dynamic to persist in 2012. Capex will likely remain elevated at an estimated USD80mn in 2012, compared with our operating cash flow projection of USD53mn. Pacnet also expressed interest in acquiring operating assets, and Bloomberg reported its interest in Cable & Wireless’s (C&W) overseas assets. However, due to its tight leverage ratio, we believe Pacnet can only pursue acquisitions using significant equity funding or target assets that are EBITDA accretive in order to raise its debt capacity. Overall, we expect Pacnet’s credit metrics to deteriorate. In the absence of an M&A transaction or an equity injection, we estimate end-2012 EBITDA/gross interest cover of 2.4x, net debt/EBITDA of 3.5x and net debt/capital in excess of 100%. Liquidity: Pacnet has adequate liquidity, with an end-September cash balance of USD105mn and an estimated USD5mn of short-term debt. We estimate 2012 operating cash flow of USD53mn, which would be sufficient for maintenance-and-upgrading capex. Expansionary capex, estimated at USD30mn, will require external funding, in our view. Valuation: Valuations are weighed down by its weak earnings outlook, lack of visibility on the industry trends, and perceived lack of transparency due to its private status. We think its bonds are undervalued relative to industry peers and offer a better security package and corporate governance compared with similarly valued Asian high yield bonds. Asset valuations point to a high potential recovery in a distressed scenario, in our opinion.

Powerlong Real Estate Holdings Ltd Christina Chiow


Not Rated 13.75% Snr unsecured 16 Sep 15c13 200 B2/B/--

Rationale

Credit view: Powerlong is experiencing increasing leverage and tight liquidity. Debt, which more than doubled to CNY8.8bn in the one year ended June 2011 continues to rise; while sales and revenue have risen at a slower pace. Contracted sales disappointed by a wide margin in 2011 (CNY5.2bn in 11M 11 vs full-year target of CNY10bn), with rising debt likely as a result of the funding gap. In September 2011, HKD1bn of bonds were issued to China Life Trustees that were pledged by 30.2% (originally 19.7%) of the controlling shareholder’s stake in Powerlong. In light of its tight liquidity, the company’s share buybacks in December look somewhat aggressive, although so far it has only spent c.HKD17mn for this purpose. Liquidity: Despite the HKD1bn bond issue to China Life Trustees, Powerlong’s liquidity looks tight. At June 2011, Powerlong had cash of CNY1.3bn against short-term debt of CNY2.3bn and land premiums payable in 2H 11 of CNY2.6bn. In addition, reported sales of CNY2.9bn in July – November were below expectations. We think the company will have funded the gap with new debt, and maintained its unrestricted cash at similar levels as June 2011. Valuation: Although the 2015 bonds offer a high yield, we think they will underperform the bonds of peers such as Cenchi ‘15s, Evergrande ‘15s and Kaisa ‘15s,reflecting Powerlong’s tight liquidity situation and weaker than expected sales. Credit metrics are also likely to remain weak given an increase in debt.

Road King Infrastructure Ltd Christina Chiow


Underweight 7.625% Snr unsecured 14 May 14 c11 200 Ba3/BB-/BB-

Underweight 9.5% Snr unsecured 21 Sep 15 c13 350 --/BB-/BB-

Rationale

Credit view: Our credit view of Road King is negative. This reflects its position as a small developer with below-average execution. Road King's 1H11 results were disappointing, largely due to lower profitability at its property business. With contracted sales of CNY4.8bn in 11M 11, we think full-year sales fell short of its revised target of CNY6bn. We expect credit metrics to have weakened further in 2H 11 on increased debt, although the operating performance was likely modestly better than the first half due to a higher-priced product mix. We expect gross margins to remain generally low at c.30%. These are similar to the margins of Country Garden and Evergrande, although Road King lacks the scale of these two companies. Offsetting the weak property performance is Road King’s more stable toll road business, which we estimate on a cash contribution basis covered c.1x interest expense in 2011. Liquidity: Liquidity looks adequate. We believe the company has had some success in raising offshore loans to re-finance its USD149mn FRNs due May 2012. Moreover, for 2012 Road King does not have any land premiums outstanding. Valuation: In an uncertain operating environment, we expect the bonds of the smaller developers such as Road King to underperform their larger peers. We prefer the similarly rated Country Garden ’15s (Overweight, Ba3/BB- both Stb), as we view that company’s credit trajectory as stable, and the lower-rated Evergrande '15s (Overweight, B2 Neg/BB- Stb) for its improving credit profile and the yield pick-up.


6 January 2012 122

Shimao Property Holdings Limited Christina Chiow


Market Weight 8.00% Snr unsecured 1 Dec 16c11 350 B1/BB-/BB+

Market Weight 9.65% Snr unsecured 3 Aug 17c14 500 B1/BB-/BB+

Market Weight 11.00% Snr unsecured 8 Mar 18c15 350 B1/BB-/BB+

Rationale

Credit view: In our view, Shimao’s credit profile remains relatively weak. This is due to its aggressive growth appetite, which has weakened its credit metrics and makes its liquidity position vulnerable to contracted sales performance. As at end-2011, we estimate its debt/EBITDA remained high at c.5x (LTM Jun 11: 5.0x) while EBITDA/interest cover slipped to c.3x (LTM Jun 11: 3.2x). While weak for its ratings (S&P), we think credit metrics could stabilise in the near term as the company modifies its acquisition policies, slows down construction and de-leverages. After spending CNY20bn and CNY3.8bn acquiring land in 2010 and 1H 11 respectively, Shimao bought no land in 2H 11. Contracted sales were satisfactory. It achieved sales of CNY28.5bn in 11M11, though we think full-year sales likely fell short of its 2011 target of CNY36bn. Liquidity: Liquidity looks adequate. At June 2011, it had cash of CNY11.4bn against short-term debt of CNY8.1bn. We think Shimao maintained a similar cash level at end-December 2011. This compares against outstanding land premiums of c.CNY6bn payable in 2012. Shimao’s liquidity position is further supported by its banking relationships, which includes access to offshore syndicated loan facilities. Valuation: Post the 1H 11 results and Shimao’s stated strategy to de-leverage, its bonds performed relatively better than those of its property peers. But they still under-performed the overall high yield index due to broader investor concerns about the Chinese property sector. We expect the stabilisation in credit metrics to provide some support to Shimao’s bonds, although we do not think they will outperform the index given a lack of positive credit catalysts and the company’s split ratings.

SM Investments Erly Witoyo


Not rated 6.75% Snr unsecured 18 Jul 13* 274* Not rated

Not rated 6.00% Snr unsecured 22 Sep 14 379 Not rated

Not rated 5.50% Snr unsecured 13 Oct 17 400 Not rated

Rationale

Credit update: Although we are constructive on SM Investments Corp’s (SMIC) operating outlook, we believe the company’s aggressive expansion plans could limit improvement in its credit metrics in 2012. Management estimates capex of PHP56.8bn for 2012, compared with the budget of PHP43bn in 2011. We think the company will need to raise additional funding, part of which may be through debt, if it is to meet its 2012 capex target. We note its annual operating cash flow averaged PHP16bn during 2008-10. We expect robust earnings growth in 2012 to partly offset a possible increase in debt, however. The company’s various businesses should benefit from strong economic expansion in the Philippines (our analysts expect GDP growth of 4.2% in 2012, compared with 3.8% in 2011). Moreover, we expect an additional contribution from project completions in 2012, which include a 200-room hotel in Davao, a 150,000-sqm mall in China and a 102,704-sqm office tower in Manila. At end-3Q11, annualised debt/EBITDA fell to 4.5x from 5.3x in FY10, while gross interest cover rose to 3.5x from 3.3x. We do not think these credit metrics will improve significantly in the near term given a likely higher debt level. Liquidity position: Strong – At end-3Q11 SMIC had cash and equivalents of PHP38.6bn compared with short-term debt of PHP16.7bn. Although cash could decline owing to large investments, we believe the company has strong financial flexibility, given its position as one of the largest conglomerates in the Philippines, its ownership of two banks and its listing on the Philippines Stock Exchange. Valuation: We view the SMIC bonds as rich relative to other Philippine corporate paper. Among the SMIC bond complex, we see better value in the shorter-dated (2013/2014) bonds. Note: * Outstanding amount as at 5 January 2012.


6 January 2012 123

Star Energy Erly Witoyo


Market Weight 11.50% Snr secured 12 Feb 15c13 350 B2/--/B+

Rationale

Credit view: The direction in Star Energy’s credit profile will largely depend on the construction of its Unit 3 geothermal power plant. The company has not yet committed to the size of the new plant, although we believe it is leaning towards building a smaller facility than originally envisaged. If true, this should be credit-positive as it would reduce the financial burden for Star Energy and allow for faster completion. Management intends to announce the plan for Unit 3 in early-2012, after feasibility studies on the construction is completed. The company originally planned to build a 125MW plant that would have been completed at end-2013. Delays in obtaining exploration approvals, however, have pushed back construction, and the expected date of completion is now 4Q14. The original plan would have required the company to raise USD75-100mn of additional debt financing. The other option is for the construction of a smaller (60-70MW) power plant, which management believes can be financed internally. In addition, the smaller size and the use of excess steam from existing fields would allow the project to be completed sooner than 2H14. Owing to timing and financing constraints, as well as the continued uncertainty about obtaining drilling permits for new fields, we think the company will opt for a smaller plant. Apart from its expansion, Star Energy has a very stable business arising from its take-or-pay contract with PLN. We expect credit metrics to remain largely unchanged in the near term, with debt/EBITDA of about 5x and EBITDA/interest of 2x. If the company proceeds with its original plan for Unit 3 and takes on additional debt, we estimate debt leverage would rise to around 6x. Liquidity position: Strong – the company had cash of USD123mn at end-2Q11 with no short-term debt. We expect to see some weakening in Star Energy’s liquidity position in the near term as the company increases spending for the construction of Unit 3. Valuation: We think the bonds are fairly valued; although the yield is tight relative to other B-rated Asian corporates, we think this is justified by the company’s stable and predictable cash flow. We would be more positive on the bonds if the company commits to building a smaller Unit 3 power plant.

STATS ChipPAC Jit Ming Tan


Market Weight 7.50% Snr unsecured 12 Aug 15c13 600 Ba1/BB+/--

Underweight 5.375% Snr unsecured 31 Mar 16c14 200 Ba1/BB+/--

Rationale

Credit view: STATS ChipPAC guided for single-digit q/q decline in 4Q11 revenue and a lower EBITDA margin in the range of 20-25% (3Q11: 25%), reflecting the sluggish business environment, exacerbated by the production shutdown at its Thailand plant, which contributes 7% of revenues. We expect demand to remain weak through 1H12, with a potential recovery in 2H12, when the industry’s hard disk drive situation normalises – assuming the macro outlook also stabilises. On the other hand, continued economic headwinds would weigh on the company’s 2012 earnings. In such an environment, we expect the company to adopt a conservative financial policy by reducing capex and conserving cash, as it did in 1H09. Indeed, the company guided for 4Q11 capex of USD50-60mn, approximately 13-15% of revenue. In a normal environment, its capex/revenue ratio historically has been in the mid- to high-teens and falls into the low-teens in challenging markets. STATS’ credit metrics will likely deteriorate in a downturn, although it has a sufficient cushion to avoid negative rating actions. Credit metrics are firmly within the rating agencies’ mid-BB rating range, with a one-notch uplift to high-BB on expected parental support. The company reported 3Q11 EBITDA/gross interest of 7.4x, gross debt/LTM EBITDA of 1.9x and gross debt/capital of 44%. Liquidity: Its end-September 2011 cash balance was USD212mn, while short-term debt was only USD30mn. Historically, STATS has been disciplined in maintaining a healthy cash balance and minimal short-term debt. We expect this trend to continue in 2012. Valuation: Valuations are driven by technical factors, with the shorter-dated STATSP ’15s yielding more than the STATSP ’16s. The bonds are among the tightest in the Asia HY universe and are well-supported at current levels. We believe this reflects investors’ lower concerns about corporate governance at STATS, the use of global comps to value the bonds and the bonds’ large US investor base.


6 January 2012 124

Vedanta Resources Erly Witoyo


Underweight 8.75% Snr unsecured 15 Jan 14 500 Ba2/BB/BB

Market Weight 6.75% Snr unsecured 7 Jun 16 750 Ba2/BB/BB

Market Weight 9.50% Snr unsecured 18 Jul 18 750 Ba2/BB/BB

Market Weight 8.25% Snr unsecured 7 Jun 21 900 Ba2/BB/BB

Rationale

Credit view: The completion of the Cairn India acquisition has weakened Vedanta’s credit profile, in our view. There is now a significantly higher debt burden at the parent level, which will require the subsidiaries of Vedanta Plc. to upstream more cash to service debt. Moreover, the parent now faces lumpy debt maturities over the next few years. The near-term default risk, nonetheless, remains low, in our view. We expect dividends from Cairn to cover the cash shortfall resulting from the USD500-550mn of annual financing costs at Vedanta Plc. Cairn had free cash flow of approximately USD800mn in FY11. This should rise in the near term on higher oil production and lower capex. Parent debt maturities are USD2.5bn in FY13, USD3.2bn in FY14 and USD3.6bn in FY15. Although high, we are confident of the company’s ability to refinance these amounts, given its strong financial flexibility – it has strong banking relationships, significant unencumbered assets and access to the debt and equity markets. Moreover, the company still has time to consider its refinancing options. Its success in refinancing these debts, however, will depend in part on market conditions. The acquisition of Cairn will strengthen Vedanta’s operating diversity. We estimate about one-third of the company’s revenue will come from oil and gas going forward. Its credit metrics should also improve given Cairn’s strong earnings and low debt leverage. We estimate pro forma consolidated debt/EBITDA of 2.8x in 1HFY12 compared with 3.4x before the acquisition. These metrics could deteriorate slightly in the near term, as the company may need to raise new debt to fund its annual capex budget of USD2.5bn. We see the current volatility in commodity prices as a potential risk to the company’s credit profile. But our commodity research team remains relatively constructive on the fundamentals for oil and base metals in 2012 and expects average prices for these commodities to remain relatively stable relative to 2011 levels. Liquidity position: Weak – following the acquisition of Cairn India, we estimate a consolidated cash balance of USD6.6bn versus short-term debt of approximately USD2.5bn. However, less than USD200mn of cash is at the parent level compared with about USD1bn short-term debt. We expect the cash shortfall to be covered by increased dividend payments from subsidiaries and new debt. Valuation: Although we recognise the higher debt burden at the company, we think bond prices have largely factored in this development. Vedanta bonds are trading at a significant discount to their global HY metal and mining peers. We think the technicals on the ’14s are especially weak owing to the company’s USD2.1bn of convertible bonds, which are puttable a few months before and after the ’14s mature and offer higher yields. In the Vedanta complex, the ’14s have the highest cash price.

Yanlord Land Group Christina Chiow


Market Weight 9.5% Snr unsecured 4 May 2017 c14 300 Ba3/BB/NR

Overweight 10.625% Snr unsecured 29 Mar 2018 c15 400 Ba3/BB /NR

Rationale

Credit view: Yanlord’s high-end niche positioning and small scale are seen as negatives in the current difficult operating environment. Unlike the mass-market developers, Yanlord has less flexibility to cut prices given its small sales volume. As a result, contracted sales were lumpy in 11M 11 (CNY6.9bn), and still short of its revised target of CNY9bn (original: CNY11bn). Further, the company was more aggressive in acquisitions in 4Q, acquiring a piece of land in Zhuhai for CNY1.8bn and one in Shanghai for CNY1.7bn. In term of results, we expect Yanlord to report a better performance for 4Q 11, reflecting the booking of more property sales after two weak quarters. Nevertheless, we think debt/EBITDA remained high at c.5x (LTM Sep 11: 9.3x) at the end of 2011. Liquidity: Liquidity looks adequate. At end–September 2011, Yanlord had cash of CNY4.7bn against short-term debt of CNY2.3bn. After paying land premiums of c.CNY2bn in 4Q11 and other expenses, we estimate the company had cash of c.CNY3.5bn as at end–December 2011. Major expenses in 2012 include construction costs of c.CNY6bn and land premiums of CNY1.05bn. We think the company will be able to fund these costs through contracted sales and construction loans, which implies leverage is likely to remain high for its ratings. Valuation: The Yanlord bonds have underperformed owing, we think, to the company’s high-end niche positioning and small market position. In our view, current bond yields are pricing the credit as a weak BB, closer to Shimao than Agile. We believe Yanlord’s weak outlook is fully reflected in current yields, and we expect the 18s (Overweight), which offer c.80bp pick-up over the 17s, to outperform the Asia High Yield corporate index. We rate the 17s as Market Weight.


6 January 2012 125

ASIA-PACIFIC CONVERTIBLE BONDS


6 January 2012 126

ASIA-PACIFIC CONVERTIBLE BONDS

2012 Outlook – Cheapness, convexity, correlation Performance projections for 2012: A return to positive returns We project an 5.3% total return for Asia Pacific convertibles as a base case. This is driven

by our modestly constructive equities view plus a healthy contribution from income. However, this comes laced with sizeable macro risks.

The asymmetric risk-return profile of convertibles should appeal in these highly uncertain times. For 12m equity return scenarios of +/-25%, we project convertible returns of 6.8% and -1.8% in Asia Pacific.

Positioning for 2012: Asymmetry will continue to appeal In Asia Pacific, we recommend high yield busted convertibles with some allocation to

convex or short-dated names for a more defensive stance. EM currencies look set to continue to outperform. In terms of sectors, we prefer some of the larger Chinese developers, Taiwanese technology and select consumer/industrials.

Key themes for 2012: Cheapness, convexity and correlation Our analysis indicates that convertibles are now cheap on a volatility relative-value basis.

The market has cheapened over 2011 and now presents relative value not seen since the end of 2008. We introduce a rolling calendar collar strategy to hedge convertible returns and rich/cheapness, which are highly correlated with broad market index changes.

Net supply outlook for 2012: Loan to bond shift may bolster issuance We forecast $15.4bn of scheduled redemptions in Asia Pacific. Potential issuance

catalysts include the loan-to-bond financing shift and possible supply from Chinese issuers using the convertible market to fill the forecasted funding gap in the high yield market.

Review of 2011: Markets declined, valuations cheapened Our Asia Pacific convertibles index returned -3.0% to 2 December, compared with -7.4%

for HY credit, +3.9% for IG and -15.6% for equities.

Convertible-implied volatilities declined to 3.8pts below options in Asia Pacific. We do not expect a sharp rebound, given macro headwinds.

Major enhancements on CBInsight™, our convertibles website: a new exchangeable model, change-of-control analyser and improved custom query.

Convertibles Research

Heather Beattie, CFA [email protected]

+44 (0) 20 7773 5859 Barclays Capital, London

Luke Olsen

[email protected] +44 (0) 20 7773 8310

Barclays Capital, London

Angus Allison [email protected]

+44 (0) 20 7773 5379 Barclays Capital, London

This extract is an adapted version of an article originally

published in Convertible Outlook 2012 EMEA and Asia Pacific:

Cheapness, convexity, correlation on 15 December

2011. To view analyst certifications and other

important disclosures, please click on the hyperlink above.

https://live.barcap.com/keyword/CBINSIGHT�






6 January 2012 127

PERFORMANCE PROJECTIONS FOR 2012

Convertible return projections: Scenarios highlight convexity

Conclusions: Convertibles offer attractive convexity profiles Our base case 12m convertibles total return projection is 5.3% for Asia Pacific. This is

driven mainly by our modestly constructive equities view. However, this prognosis is laced with health warnings. Amid such heightened uncertainty, we favour convex products such as convertibles for their asymmetric risk-reward profiles.

We project Asia Pacific convertible 12m total returns of -1.8%, 1.5% and 6.8% in the scenarios of equity returns of -25%, 0% and 25% (Figure 67).

Hence, our analysis indicates that returns convexity is 2.0% in Asia Pacific. We define convexity as the differential: (up return – flat return) – (flat return – down return). The upside/downside participation ratio of convertible/equity returns is 0.27/0.07 in Asia Pacific, which is compelling, in our view.

We list the convertibles with the most convex potential return profiles according to this analysis in Figure 68. We identify 30 convertibles in Asia Pacific with a convexity differential greater than 3%. The average convexity differential of these “most convex” bonds is 5.6%.

Methodology and assumptions for performance projections We use forward theoretical valuations, including income impacts: We value all

convertibles now and in 12m time, for -25%, flat and +25% equity moves, including coupon income and optimal put exercises. We account for foregone dividends via a negative contribution of dividend yield x delta x parity.

Credit-equity relationship with “k-factor” of 0.5: Our model projections include credit spread widening/tightening when equities fall/rise according to a power relationship, with a sensitivity or “k-factor” of 0.5. This implies credit spreads would widen by 15.5% if equities fall 25% and credit spreads would tighten by 10.6% if equities rise 25%.

Figure 67: Projected potential convertible 12m total returns for +/-25% equity returns, Asia Pacific

-1.8%

1.5%

6.8%

-4%

-2%

0%

2%

4%

6%

8%

Equities -25% Equities flat Equities +25%



6 January 2012 128

Default rate at 3% for HY in Asia Pacific: We apply this only to the c.60% of non-IG quality bonds. Conservatively, we assume that defaults occur on the highest-yielding bonds.

We find that the impact of defaults accounts for -0.6% of the convertibles total return projections in the flat equity scenario in Asia Pacific.

No net richening or cheapening, or contributions from event risk. We assume no change in relative convertible valuations over the next 12m, or contributions from event risk, such as buybacks, tender/conversion offers or takeovers. This is very conservative, as relative-implied volatilities are more likely to rise than decline, in our view.

Figure 68: Top 30 most convex convertibles in Asia Pacific, based on modelled potential returns for +/-25% equity moves

Name Price Parity Downside

Return Flat

Return Upside Return

Convexity differential: (up-flat) -

(flat-down)

Convexity ratio: (up-flat) / (flat-down)

Gamma (%)

Wilmar International 0% 2012 119.5 105.4 -3% -3% 8% 12% 1.3

Aeon 0% 2012 117.6 115.4 -17% -4% 20% 11% 1.9 1.2

Hongkong Land 2.75% 2012 116.1 117.9 -16% -2% 22% 11% 1.8 0.6

Unicharm 0% 2013 106.6 94.1 -6% -2% 12% 11% 3.8 1.6

Aeon 0.3% 2013 118.4 112.5 -15% -3% 17% 8% 1.7 1.0

Unicharm 0% 2015 108.9 94.1 -9% -1% 12% 6% 1.9 1.2

Anritsu Corporation 0% 2015 138.5 136.2 -19% -2% 21% 6% 1.4 0.6

Soho China 3.75% 2014 107.5 95.0 -7% 1% 15% 6% 1.8 1.0

Asahi Breweries 0% 2028 106.1 82.5 -4% -1% 9% 6% 2.7 1.4

San Miguel Corp 2% 2014 108.5 107.7 -11% 1% 18% 6% 1.5 0.9

Hitachi 0.1% 2014 136.4 134.1 -19% -4% 17% 5% 1.3 0.5

YTL Corp 1.875% 2015 97.6 82.1 -3% 0% 9% 5% 2.4 1.0

China Power Int 2.25% 2016 94.5 78.4 0% 4% 14% 5% 2.2 1.4

AREIT 1.6% 2017 98.4 82.9 -4% 0% 10% 5% 2.2 1.2

CPA 5.25% 2016 96.5 85.3 -2% 4% 15% 5% 1.8 1.2

KDDI 0% 2015 102.9 89.5 -8% -2% 10% 5% 1.8 1.0

Beijing Enterprises 2.25% 2014 113.9 95.2 -9% -1% 12% 5% 1.6 0.9

Orix 1% 2014 109.5 92.7 -10% -2% 11% 5% 1.5 0.8

SK Telecom 1.75% 2014 105.3 86.7 -7% -2% 8% 5% 1.8 0.8

GDH-Guangdong Investment 3.0% 2016 102.2 88.7 -7% 1% 13% 5% 1.6 0.9

CapitaMall Trust 2.125% 2014 96.4 77.3 0% 1% 7% 4% 3.6 1.2

CFS Retail Property Trust 5.75% 2016 96.5 75.2 3% 5% 11% 4% 2.8 1.2

China Unicom 0.75% 2015 114.1 101.9 -13% -2% 13% 4% 1.3 0.6

Sawai Pharma 0% 2015 107.4 84.2 -8% -2% 8% 4% 1.6 0.8

CapitaCommercial Trust 2.7% 2015 98.8 80.5 -5% 0% 9% 3% 1.6 0.9

Hynix 2.65% 2015 97.9 67.7 -2% 2% 8% 3% 2.0 0.9

Nippon Meat 0% 2014 101.0 72.2 -1% 0% 4% 3% 5.0 1.1

GOME Electrical 3% 2014 99.5 67.1 5% 5% 8% 3% 1.2

Western Areas 6.4% 2015 102.8 88.5 -5% 4% 16% 3% 1.3 0.7

Takashimaya 0% 2014 102.0 67.2 -1% 0% 3% 3% 5.9 1.1

Note: Based on prices and theoretical valuations as of 1 December 2011. Gamma(%) is the change in Delta(%) for a one-point parity move. Source: Barclays Capital


6 January 2012 129

POSITIONING FOR 2012

Convertible positioning recommendations

In Asia Pacific, we recommend the following positioning:

High-yield busted convertibles have potential to outperform.

Asia Pacific high yield convertibles have outperformed on a non-risk and risk-adjusted basis over the past 2.5 years but have underperformed 2011. Our strategists forecast 13-15% total returns for Asia HY corporate credit for 2012. Despite outperforming in 2011, we believe busted convertibles may continue to do so.

A note of caution.

To hedge more defensively, we would advocate some allocation to convex convertibles with some delta exposure together with short-dated cash rich convertibles and those providing some income.

Domestic currencies may perform better.

Our FX strategists are constructive on EM currencies relative to USD and believe Asia Pacific in particular may continue to outperform. 24% of our convertible universe offers exposure to currencies other than USD and JPY.

Real estate, technology and select consumer/industrials are our sector recommendations.

We believe most Taiwanese technology names are now at attractive levels in terms of yield while offering global exposure. We prefer some of the large mass-market Chinese real estate developers where price corrections etc are already fully priced in. Despite seeing downside risks to China GDP growth, at a forecast of 8% for 2012 we believe select consumer and industrial names provide growth opportunity plays.

Summary of convertible-related credit views

Figure 69: Summary of Barclays Capital Asia Pacific credit views

Overweight Market Weight Underweight

Bumi Resources Agile Property Berlian Laju Tanker

Fufeng China Overseas Land & Inv.* Hongkong Land*

Kaisa Wharf* Hynix Semiconductor

Yanlord Land (‘18s) Vedanta Resources (‘14s, ‘18s,

‘21s) Noble Group*

Yanlord Land (‘17s) POSCO*

SK Telecom*

Note: Recommendations are relative to the benchmark indices and are for cash bonds. *Indicates HG rating. Source: Barclays Capital


6 January 2012 130

KEY THEMES FOR 2012

Relative value: Even cheaper in implied volatility terms For Asia Pacific, our analysis shows that average convertible-implied volatilities – uncalibrated and calibrated – have declined by approximately 2.1 and 1.9 points, respectively, since the middle of September (Figure 70). Meanwhile, 12m at-the-money option-implied volatilities have ticked lower, by 0.7 points, while 100-day realised volatility has jumped 8.0 points as heightened market volatility impacts the metric. In our view, Asia Pacific convertibles have cheapened versus option-implied and 100-day volatilities since the middle of September. As of 2 December 2011, on average, versus 15 September 2011:

convertible-implied volatility is 24.0%, down by 2.1 volatility points;

credit-calibrated convertible-implied volatility is 27.5%, down by 1.9 pts;

12m at-the-money option-implied volatility is 31.3%, down by 0.7 pts;

100-day realised volatility is 42.2%, up by 8.0 pts;

999-day realised volatility is 46.6%, down by 1.3 pts; and

credit spreads are 350bp, wider by 45bp.

Thus, credit-calibrated convertible-implied volatilities are now 3.8 volatility points lower than option-implied volatilities, on average, as of 2 December. As of 15 September, they were 2.6 points lower and hence have cheapened by a further 1.2 points relatively.

Figure 70: Summary of volatility metrics (%) for Asia Pacific volatility sensitive convertibles

Uncalibrated CB IV Calibrated CB IV 12m ATM option IV 100-day volatility 999-day volatility

17 May 2010 (31 bonds)

Average 30.6 35.1 32.3 32.8 48.8

Median 30.0 35.9 32.2 32.2 47.3

30 June 2010 (32 bonds)

Average 26.4 31.3 35.4 34.4 51.3 Median 27.1 33.0 34.1 33.5 51.5 28 Sept 2010 (56 bonds) Average 27.7 32.0 31.6 33.1 51.8 Median 27.8 32.5 31.2 34.8 46.8 30 Nov 2010 (54 bonds) Average 29.2 33.6 31.3 30.3 48.7 Median 29.2 33.4 31.4 30.1 46.2 31 Mar 2011 (55 bonds) Average 30.6 34.1 30.7 32.6 48.3 Median 30.4 32.5 31.0 30.8 46.8 30 Jun 2011 (66 bonds) Average 27.7 31.1 29.9 33.6 47.1 Median 27.7 30.5 30.4 33.5 46.5 15 Sep 2011 (57 bonds) Average 26.1 29.4 32.0 34.2 47.9 Median 26.3 29.2 32.8 33.0 46.0 02 Dec 2011 (43 bonds) Average 24.0 27.5 31.3 42.2 46.6 Median 23.7 28.5 33.4 37.2 44.0

Note: “IV” denotes implied volatility. 100- and 999-day volatilities are for the underlying equity in the currency of the bond. Data as of close on 2 December 2011. Source: Bloomberg, Barclays Capital

Credit-calibrated convertible-implied volatilities are now 3.8

points lower than option-implied volatilities. In the middle of

September, they were 2.6 points lower


6 January 2012 131

Figure 71: Asia Pacific convertible-implied, option-implied and realised volatilities

26%

28%

30%32%

34%

36%

38%40%

42%

44%

Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11

Convertible implied (calibrated) Option implied (12m at-the-money)

Realised (100-day)


Convertible-specific volatility relative value Figure 72 shows convertible-implied, option-implied and realised volatilities for Asia Pacific convertibles as of 2 December 2011. Here, we list the most relatively undervalued and overvalued convertibles in calibrated implied-volatility terms:

Undervalued Asia Pacific convertibles in implied-volatility terms: Asia Cement – FENC ’16; UMC ’16; Posco – SK Telecom ’16; SK Telecom ’14; China Unicom ’15; COLI ’14; KDDI ’15; Orix ’14; and Asahi Glass ‘14.

Overvalued Asia Pacific convertibles in implied-volatility terms: Asahi Breweries ’28; Unicharm ’15; Unicharm ’13; and IHI ’16,

Figure 72: Uncalibrated and credit-calibrated convertible IV, 12m ATM option IV (where available), 100-day and 999-day realised volatility, for volatility-sensitive Asia Pacific convertibles – in order of ascending credit spread input (left to right)

0%10%20%30%40%50%60%70%80%

Seki

sui '

16N

idec

'15

A G

lass

'14

KDD

I '15

Uni

char

m '1

3U

nich

arm

'15

Nip

ro '1

5N

agoy

a '1

5Sa

wai

'15

As

Brew

'28

SK T

el '1

4IH

I '16

Kado

ka '1

4A

REI

T '1

7A

C-F

ENC

'16

Posc

o-SK

T '1

6YT

L '1

5C

CT

'15

C U

nico

m '1

5U

MC

'16

Ori

x '1

4Be

ij En

t '1

4C

apLa

nd 2

.875

% '1

6H

on H

ai '1

3W

ilmar

'12

CFS

'16

CO

LI '1

4 W

SA '1

4W

SA '1

5C

PA '1

6G

DH

-GI '

16D

aew

oo '1

4H

ynix

'15

Ola

m '1

6Ta

ta P

'14

Ch

Pow

'16

Nob

le '1

4So

ho C

'14

C A

gri '

15In

tim

e '1

3H

engd

eli '

15Bu

mi '

14G

OM

E 3%

'14

Uncalibrated CB IV Calibrated CB IV 12m ATM option IV 100d realised vol 999d realised vol

Note: Data as of close on 2 December 2011. Option IVs are 12m at-the-money. 100-day and 999-day realised volatility are in the bond currency. Source: Barclays Capital


6 January 2012 132

Risk return by profile and credit rating

For Asia Pacific, we find that high yield convertibles have significantly outperformed over the past 2.5 years, up by 42% versus 27% for the overall index. This outperformance was primarily due to stellar returns achieved in 2009 but even in a more normalised year like 2010, high yield bonds outperformed, up by 31% versus 17% for the overall index. High yield bonds also outperformed in terms of risk-adjusted returns with a Sharpe ratio of 2.4 versus 1.3 for the overall index in the June 2009 to November 2011 time period. However, in 2011 year to date, this has completely reversed, with the high yield sub index down by 7% versus -3% for the overall index. In terms of Sharpe ratio, the high yield sub index also underperformed, with a ratio of -0.6 versus -0.4 for the overall index. In 2011, investment grade convertibles have marginally outperformed, declining by 1% with the lowest Sharpe ratio of -0.1. Non-rated convertibles in both time periods have closely mirrored the overall index on both a returns and Sharpe ratio basis, unsurprisingly given non-rated bonds constitute 67% of the overall index.

Figure 73: APAC convertible performance by credit rating Figure 74: APAC convertible performance by credit rating 2011

100

110

120

130

140

150

160

170

Jun-09 Dec-09 Jun-10 Dec-10 Jun-11

Investment Grade Non-Invest GradeNon-Rated Composite

85

90

95

100

105

110

Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11

Investment Grade Non-Invest Grade

Non-Rated Composite

Note: Rebalanced to 100 as of 30 June 2009. Source: Barclays Capital Note: Rebalanced to 100 as of 31 December 2010. Source: Barclays Capital

Figure 75: APAC convertible performance by profile

Figure 76: APAC convertible performance by profile 2011

100

110

120

130

140

Jun-09 Dec-09 Jun-10 Dec-10 Jun-11

Typical Busted

Equity Sensitive Composite

8587899193959799

101103105

Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11

Typical BustedEquity Sensitive Composite

Note: Rebalanced to 100 as of 30 June 2009. Source: Barclays Capital Note: Rebalanced to 100 as of 31 December 2010. Source: Barclays Capital

Asia Pacific high yield convertibles have outperformed on a non-risk and risk-adjusted

basis over the past 2.5 years but have underperformed 2011 year

to date. Non-rated convertibles have closely mirrored the

overall index


6 January 2012 133

Our analysis shows less variety in performance by our Asia Pacific convertible profile sub indices. Over the past 2.5 years, we find that Equity-sensitive convertibles have underperformed with returns up by 18% versus 27% for the overall index. The Sharpe ratio for Equity-sensitive convertibles is the lowest versus the overall index (1.1) and Balanced (0.9) and Busted (0.8) convertibles at 0.7. In 2011 year to date, Equity-sensitive convertibles have underperformed, down by 8% versus -3% for the overall index. In terms of profile, the best performing has been busted; in line with the overall index in 2010 on a risk-adjusted basis and outperforming in 2011, up 0.9% with a Sharpe ratio of 0.2.

Figure 77: Asia Pacific returns and Sharpe ratios

2010 return % 2010 volatility % 2010 Sharpe

ratio 2011 return

% 2011

volatility % 2011 Sharpe ratio

Asia Pacific Composite index 17.2 6.2 2.8 -3.2 7.1 -0.4

IG CB sub index 22.2 9.1 2.4 -1.2 11.4 -0.1

HY CB sub index 31.4 9.0 3.5 -6.6 11.2 -0.6

Non-rated CB sub index 13.9 5.4 2.6 -3.5 6.0 -0.6

Balanced CB sub index 14.9 6.3 2.3 -3.9 7.2 -0.5

Busted CB sub index 15.4 5.9 2.6 0.9 5.6 0.2

Equity sensitive CB sub index 21.6 9.6 2.3 -8.4 14.2 -0.6

Note: For calculation of the ratios we assume a risk-free return of zero with 0% volatility. Source: Barclays Capital convertible indices

Equity-sensitive convertibles have underperformed historically

with Busted bonds outperforming in 2011


6 January 2012 134

NET SUPPLY OUTLOOK FOR 2012

Asia Pacific convertibles net supply and action dates 2011 realised issuance and redemptions

We calculate that in 2011, there was:

$12.7bn of issuance and $4.1bn of IG issuance;

$16.4bn of redemptions and $9.5bn of IG redemptions; and

$3.7bn of negative net supply and $5.4bn of negative IG net supply.

2012 redemption projection

Projecting ahead for 2012, we estimate that, all else equal, there could be:

$15.4bn of redemptions requiring $1.3bn of issuance per month for flat annual supply; and

$3.6bn of IG redemptions, requiring $0.3bn of issuance per month for flat IG annual supply.

Figure 78: 2011 issuance versus redemptions ($bn) Figure 79: 2011 IG issuance versus redemptions ($bn)

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

Jan Mar May Jul Sep Nov

Issuance Conversion Buyback Maturity Call Put

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0


Issuance Conversion Buyback Maturity Call Put

Note: December redemptions are scheduled according to current levels. Source: Barclays Capital

Note: December redemptions are scheduled according to current levels. Source: Barclays Capital

Figure 80: 2012 issuance versus redemptions ($bn) Figure 81: 2012 IG issuance versus redemptions ($bn)

-3.5-3.0-2.5-2.0-1.5-1.0-0.50.00.51.01.5


Issuance breakeven Maturity Call Put

-1.5

-1.0

-0.5

0.0

0.5



-1.5

-1.0

-0.5

0.0

0.5



Note: 2012 redemptions are scheduled according to current levels; 2012 issuance is average required for the full year to exhibit flat net supply. Source: Barclays Capital

Note: 2012 redemptions are scheduled according to current levels; 2012 Issuance is average required for the full year to exhibit flat net supply. Source: Barclays Capital


6 January 2012 135

Figure 82: Potential redemptions and key action dates for Q1 2012

Name Price Parity Red amt ($mn) Action date Action

Osung 4.0% 2016 91.0 71.7 07 Jan 12 Reset date

Era Constructions 0% 2012 137.5 81.4 60 10 Jan 12 Final conv.

Subex Azure 2% 2012 102.2 4.6 53 29 Jan 12 Final conv.

Far East Consortium 3.625% 2015 99.3 31.8 90 04 Feb 12 Put notice

San Miguel Corp 2% 2014 107.3 104.9 05 Feb 12 Reset date

Kerry Properties 0% 2012 116.3 50.9 353 08 Feb 12 Final conv.

Orchid Chemicals & Pharmas 0% 2012 130.2 41.1 114 18 Feb 12 Final conv.

Reliance Communications 0% 2012 120.6 10.0 1180 20 Feb 12 Final conv.

Toray 0% 2012 99.9 51.6 646 27 Feb 12 Final conv.

LG Uplus 5% 2012 100.0 80.6 300 28 Feb 12 Put notice

Mingfa 5.25% 2016 74.2 72.0 10 Mar 12 Reset date

Casio Computer 0% 2015 100.0 24.2 646 10 Mar 12 Put notice

SM Investments Corp 0% 2012 129.8 130.9 65 13 Mar 12 Final conv.

Daewoo 3.25% 2014 118.2 104.0 24 Mar 12 Reset date

Nagoya Railroad 0% 2012 99.8 69.5 126 29 Mar 12 Final conv.

Note: Prices as of 2 December 2011. Redemption amount is greater of parity and redemption price. Source: Barclays Capital

Market size: A modest pick-up in issuance could grow the market In Figure 83, we explore how the size of the Asia Pacific convertible markets may evolve between now and the end of 2014 under different issuance scenarios.

We use a lower bound of zero annual issuance, which is overly conservative, in our view. The upper bound equates to issuance as in 2007 (the highest in the past five years), but key secular trends – notably, the loan to bond financing shift – could justify this, in our view.

For 2012-14, we estimate a total of $57.2bn in scheduled redemptions in Asia Pacific, ie, maturities and puts, not accounting for any potential buybacks or tenders. 2013 has the greatest scheduled redemptions at $22.1bn followed by 2014 at $19.8bn with 2012 at $15.4bn.

Unsurprisingly, given the bumper issuance in 2007, particularly in India, maturing Indian FCCBs account for 38% of total redemptions in 2012.

Zero issuance could result in the Asia Pacific market shrinking from its current size of $71.7bn in market value to just $14.5bn by the end of 2014. We also examine what the market size would be with similar issuance to 2011 ($12.3bn) and at the 5y average ($15.5bn), the resulting market size would be $51.4bn and $60.8bn, respectively. Lastly a repeat of 2007 issuance ($29bn) would see the market grow to $101.5bn.

We see potential supply coming from the Chinese issuers among others. Over the last five years, Chinese HY straight bond issuance has grown from $2.3bn in 2007 to $9.3bn in 2011. Our credit strategists see a reversal in this trend in 2012 and forecast Chinese HY straight bond issuance of between $4bn and $6bn in 2012. We therefore see potential for the convertible bond market to fill the funding gap for Chinese issuers.


6 January 2012 136

Figure 83: Asia Pacific 2012 – 2014 forecast redemptions versus issuance scenarios

0123456789

10

Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q2 13 Q3 13 Q3 14 Q1 14 Q2 14 Q3 14 Q4 140

20

40

60

80

100

120

Quarterly redemptions Zero issuance Issuance same as 2011

Issuance same as 5y average Issuance same as 5y high (2007)



6 January 2012 137

REVIEW OF 2011

Performance across asset classes and regions For the year to 2 December 2011, Asia Pacific ex-Japan convertibles returned -6.7%, versus -13.7% for a broad measure of equities, the MSCI Asia Pacific ex-Japan index, -7.4% for HY credit (Barclays Capital EM Asia USD Credit Corporate HY index) and 3.9% for IG credit (Barclays Capital EM Asia USD Credit Corporate HG index).

Figure 84: Performance of Asia Pacific ex-Japan convertibles, credit and equity indices in 2011

70

75

80

85

90

95

100

105

110

31-Dec 28-Feb 30-Apr 30-Jun 31-Aug 31-Oct

Asia ex-Japan Convertibles EM Asia USD IG Corporate Credit

EM Asia USD HY Corporate Credit MSCI Asia Pacific ex-Japan

Note: Rebased to 100 at 1 January and measured until 2 December. Source: Bloomberg, Barclays Capital

For the year to 2 December 2011, Japan convertibles returned -2.0%, versus -15.5% for the Nikkei stock index and -3.9% for credit (Barclays Capital Asian-Pacific Japan Corporate index).

Figure 85: Performance of Japan convertibles, credit and equity indices in 2011

75

80

85

90

95

100

105

110

31-Dec 28-Feb 30-Apr 30-Jun 31-Aug 31-Oct

Japan Convertibles Japan Corporate Credit Nikkei

Note: Rebased to 100 at 1 January and measured until 2 December. Source: Bloomberg, Barclays Capital

Asia ex-Japan convertibles second only to IG credit


6 January 2012 138

Convertibles performance: Global perspective Japanese convertibles look set to finish 2011 on top with EMEA the laggard

Figure 86 highlights convertible performance from a global perspective. In 2011 as of 2 December, the Barclays Capital Japanese convertible index has the highest relative total return of -2.0%, followed by the US -5.2%, Asia ex-Japan -6.7% and EMEA -9.4%. Since the start of 2011, however, the Japanese yen has strengthened by 3.9% versus the US dollar. This suggests that in US dollar terms, the Japanese index (which is in ¥) would have outperformed (total return of 2.0% in US$ according to our Global Convertible index). On the same basis, the EMEA index total return in US$ would be -9.3% as there was little change in the USD/EUR FX rate in 2011.

In Q4 as of 2 December, US convertibles had outperformed Asia ex-Japan, EMEA and Japan (3.9%, 2.6%, 0.9% and 0.5%, respectively), having underperformed in Q3 (-13.7%, -10.1%, -11.5% and -3.1%, respectively).

The volatility of returns is greatest for the US convertible index (13.8%) and for EMEA convertibles (7.9%). The Asia ex-Japan returns volatility is 6.8%, and Japan is 7.0%. The relatively lower returns volatility of Asia ex-Japan convertibles stems partly from their relatively lower delta, at 22%, compared with average deltas of 25% for Japan, 36% for EMEA and 54% for the US.

Figure 86: Total returns of the Barclays Capital convertible composite indices: EMEA, Japan, Asia ex-Japan and the US in 2011

-15%

-10%

-5%

0%

5%

10%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

EMEA (165) Japan (48) Asia ex-Japan (118) US (569)

-5.2%

-6.7%

-9.4%

-2.0%

Note: EMEA index total returns are in EUR, Japan in JPY, Asia ex-Japan and US in USD. Numbers of index constituents are in parentheses. Source: Barclays Capital Indices

In 2011 the Japanese convertible index outperformed, while EMEA

underperformed

US outperformed in Q4 having underperformed in Q3


6 January 2012 139

Figure 87: Summary of Barclays Capital convertible composite indices

EMEA Japan Asia ex-Japan US

Total return -9.4% -2.0% -6.7% -5.2%

Volatility of returns (annualised) 7.9% 7.0% 6.8% 13.8%

Total return / volatility -1.2 -0.3 -1.0 -0.4

Index currency EUR JPY USD USD

FX rate vs. USD 0.7466 77.99 1 1

FX move vs. USD -0.1% -3.9% 0.0% 0.0%

Market value of index (bn) 64 2301 40 209

Market value (USD bn) 86 29 40 209

Delta of index (wtd avg) 36% 25% 22% 54%

Number of index constituents 165 48 118 569

Total return (Q4 to date) 0.9% 0.5% 2.6% 3.9%

Total return (Q3) -11.5% -3.1% -10.1% -13.7%

Total return (Q2) -1.6% -0.1% 0.1% -0.7%

Total return (Q1) 2.8% 0.7% 0.7% 4.4%

Note: Index data as at 2 December 2011. Source: Bloomberg, Barclays Capital

Rich/cheapness: Relative value similar to the end of 2008 The Asia Pacific ex-Japan convertible markets have cheapened over the course of the year and now present relative value not seen since the end of 2008. We explore the drivers for this in greater detail earlier in the report.

Figure 88: Rich/(Cheapness) of the Barclays Capital convertible composite indices

-5

-4

-3

-2

-1

0

1

2

Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11

Global EMEA APAC ex Jpn Global median

Note: More negative values in the lower part of the chart indicate increasing cheapness. Source: Barclays Capital


6 January 2012 140

Performance attribution: Equities the main driver Our analysis reveals that 0.7% of 2011 convertible index performance as of 2 December in Asia ex-Japan was unexplained by either equity or credit moves, as shown in Figure 89. As such, this quantifies equity-neutral and credit-neutral convertible cheapening/richening, in our view.

We make certain key assumptions for this analysis: (1) we use arithmetic averages of delta (for the parity impact) and rho (for the credit impact) at 31 December 2010 and 2 December 2011, to approximate the nonlinear/convex impact; (2) we weight the Barclays Capital credit index yield moves according to the market values of IG and HY within the convertible market at these dates, and for the non-rated subset, we apportion weight between IG and HY according to index-average credit spreads; (3) the yield changes in the Barclays Capital straight bond indices model the respective credit moves in convertibles; and (4) we assume that parity levels on index joiners and leavers are equal to the current parity level on average.

Figure 89: Performance attribution of convertible index performance in 2011, Asia ex-Japan

-8%

-6%

-4%

-2%

0%

2%

CB

Pari

ty

HY

cred

it

IG c

redi

t

Cou

pon

Une

xpla

ined


One reason why Asia ex-Japan appears to have cheapened less than EMEA is the sharp widening in the HY credit index selected for this analysis, namely the Barclays Capital EM Asia USD Corporate High Yield index. Its yield increased from 8.6% to 12.7%. Even after scaling using the rho of our Asian convertible index, this contributes much more to convertible performance than in EMEA.

Universe and new issuance profiles

Asia Pacific convertibles universe profile: Now more busted The Asia Pacific convertible bond market’s value is currently $71.7bn, relative to a

nominal value of $71.3bn. This represents a decline in market value of $1.1bn over the past three months. In Japan, this total only includes active names.

Thanks to KDDI’s jumbo issue at the end of November, Japan now accounts for approximately 42% of our Asia Pacific universe vs. 30% in Q3. In terms of profile, unsurprisingly given the sustained market volatility the proportion of typical bonds has decreased to 26% from 32% over the past three months. The percentage of Busted convertibles has risen from 37% to 51% y/y.


6 January 2012 141

Based on our estimates, the average YTM/P, delta and rho as at 2 December 2011 were 5.6%, 19% and 1.6, respectively. The average YTM/P has increased from 4.3%, and the average delta has decreased from 23%.

Asia Pacific convertibles new issues: $2bn short of 2010 Figure 97 displays 2011 issuance, and we note:

In 2011, there was $12.7bn of Asia Pacific issuance from 36 deals, $3.6bn in Japan and $9.1bn in Asia ex-Japan. This compares with $14.7bn in 2010, $3.3bn in Japan and $11.4bn in Asia ex-Japan. There were three new issues in Q4: a RMB790mn ($125mn) 5y convertible from United Laboratories; a jumbo ¥190bn ($2.4bn) from KDDI, which gave a much needed boost to 2011 issuance; and a SG$500mn exchangeable from Temasek into shares of Li & Fung.

In 2011, our analysis shows that $4.6bn of the new deals were investment grade rated, including the two deals with IG rated letters of credit (ie, BTS and Tatung). We calculate that 29% of issuance is repeat issuance. The weighted average size of new issues was $792mn ($360mn unweighted) with the yield at 1.2% and a conversion premium of 28%. Japan, Hong Kong and Taiwan issuers dominated with 28%, 27% and 19% of total

Figure 90: Asia Pacific universe market value by country

Figure 91: Asia Pacific universe market value by sector

Hong Kong20%

India9%

Japan42%

Korea5%

Other8%

Singapore10%

Taiwan6%

Food & Retail14%

Industrial18%

Mining, Oil & Gas

5%Real Estate

18%

Technology17%

Telecoms10%

Other18%

Source: Barclays Capital Source: Barclays Capital

Figure 92: Asia Pacific universe market value by rating

Figure 93: Asia Pacific universe market value by profile

High Yield7%

Investment Grade27%

Non Rated66%

Busted51%

Typical26%

Equity Sensitive &

ITM12%

Equity Sensitive &

OTM11%

Source: Bloomberg, Barclays Capital Source: Barclays Capital


6 January 2012 142

issuance by amount issued. The most prolific sectors were Telecoms (19%, represented solely by the KDDI new issue), Industrials (17%) and Real Estate (15%).

We had no new issues from Indonesia and Malaysia or from the Banking, Healthcare, Media and Public Sector sectors.

Figure 94: Asia Pacific monthly new issuance ($bn)

0

1

2

3

4

5

6

7

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec*0

2

4

6

8

10

12

14

16

2011 2010 2011 Cumulative (RHS) 2010 Cumulative (RHS)

Note: * month to date. Source: Barclays Capital

Figure 95: Asia Pacific annual new issuance ($bn)

9.9

21.7

29.0

12.29.1

14.712.7

0

5

10

15

20

25

30

35

2005 2006 2007 2008 2009 2010 2011 YTD



6 January 2012 143

Asia Pacific convertible bond new issue performance Our analysis shows that the average performance of the new issues in 2011, measured over the first week since being announced, was 0.9% on an outright basis, increasing to 1.2% on a delta-neutral basis. On a quarterly basis, this data is as follows: 2.3% and 2.2%, respectively, for Q1; 1.2% and 0.9%, respectively, for Q2; -1.0% and 0.2%, respectively, for Q3; and -1.9% and 2.6%, respectively, for Q4 (we note there has been only three new issues in Q4). In terms of cheapness, we calculate using our assumptions that the average cheapness in 2011 to date is 0.9%, compared with 0.3% in Q1, 0.9% in Q2, 1.3% in Q3 and 2.2% in Q4.

Figure 96: Asia Pacific convertible new issue performance (one week)

-8%-6%-4%-2%0%2%4%6%8%

Epis

tar

'16

BTS

'16

Asi

a C

emen

t-FE

NC

'16

Yam

ato

'16

IHI '

16

Cap

itaM

all '

14

Tatu

ng '1

4

Tsin

lien-

Tian

jin '1

6

Suzl

on '1

6

Agi

le '1

6

Shan

gri-

La '1

6

Chi

na H

uiyu

an '1

6

Chi

na P

ower

'16

TPK

'14

Min

gfa

'16

San

Mig

uel '

14

Wha

rf '1

4

UM

C '1

6

Asi

a C

emen

t '1

6

Hor

izon

Oil

'16

OSI

M '1

6

Lott

e Sh

oppi

ng '1

6 ($

)

Lott

e Sh

oppi

ng '1

6 (¥

)

Seki

sui H

ouse

'16

CFS

'16

GD

H-G

uang

dong

'16

Osu

ng '1

6

Han

jin '1

6

Sola

r A

pplie

d '1

6

Rad

iant

Opt

o '1

6

Taiw

an G

lass

'14

Posc

o-SK

T '1

6

Uni

ted

Labs

'16

KDD

I '15

Outright Delta-neutral Cheapness


Unsurprisingly given weak market sentiment, Q4 new

issues are cheapest of the year


6 January 2012 144

Figure 97: New convertible issuance in 2011

Senior unsecured issuer rating Issue rating

Date Issuer-underlying Country Ccy Coupon Maturity Yield Premium Size (mn) S&P Moody’s S&P Moody’s

07 Dec Temasek-Li & Fung Hong Kong SGD 0.00% 14 Dec 2013 0.00% 40.2% 500 AAA Aaa NR NR

28 Nov KDDI Japan JPY 0.00% 14 Dec 2015 -0.75% 10.0% 190,000 NR NR NR NR

07 Nov United Laboratories Hong Kong HKD 7.50% 14 Nov 16 7.50% 30.0% 817 NR NR NR NR

21 Sep REXlot Hong Kong RMB 6.00% 28 Sep 16 6.00% 20.0% 790 NR NR NR NR

04 Aug POSCO-SK Telecom Korea JPY 0.00% 18 Aug 2016 1.00% 32.0% 24,526 A A3 NR NR

22 Jul Taiwan Glass Taiwan USD 0.00% 28 Jul 2014 0.00% 26.0% 300 NR NR NR NR

14 Jul Radiant Opto Taiwan USD 0.00% 21 Jul 2016 0.00% 30.0% 100 NR NR NR NR

08 Jul Solar Applied Mat Taiwan USD 0.00% 22 Jul 2016 0.00% 28.0% 115 NR NR NR NR

07 Jul Hanjin Shipping Korea USD 4.00% 20 Jul 2016 4.00% 20.0% 150 NR NR NR NR

29 Jun Osung Korea USD 4.00% 07 Jul 2016 4.00% 20.0% 70 R NR NR

23 Jun GDH-Guangdong Inv Hong Kong USD 3.00% 21 Jul 2016 3.00% 30.0% 250 NR NR NR NR

21 Jun CFS Retail Property Australia AUD 5.75% 04 Jul 2016 5.75% 27.7% 300 A NR NR NR

16 Jun Sekisui House Japan JPY 0.00% 05 Jul 2016 -0.50% 31.6% 50,000 NR A3 NR NR

15 Jun Lotte Shopping Korea JPY 0.00% 05 Jul 2016 -0.25% 23.8% 32,500 NR A3 NR NR

15 Jun Lotte Shopping Korea USD 0.00% 05 Jul 2016 0.00% 23.8% 500 NR A3 NR NR

07 Jun OSIM Singapore SGD 2.75% 05 Jul 2016 2.75% 25.0% 120 NR NR NR NR

02 Jun Asia Cement Taiwan USD 0.00% 07 Jun 2016 0.30% 24.5% 173 NR NR NR NR

02 Jun Horizon Oil Australia USD 5.50% 17 Jun 2016 7.00% 29.0% 80 NR NR NR NR

17 May Wharf Holdings Hong Kong HKD 2.30% 07 Jun 2014 2.30% 65.0% 6,220 NR NR NR NR

17 May UMC Taiwan USD 0.00% 24 May 2016 -0.25% 29.0% 500 NR NR NR NR

18 Apr San Miguel Corp Philippines USD 2.00% 05 May 2014 2.00% 25.0% 600 BB- Ba3 NR NR

18 Apr Mingfa Hong Kong HKD 5.25% 23 May 2016 9.50% 20.0% 1,560 NR NR NR NR

13 Apr TPK Taiwan USD 0.00% 20 Apr 2014 0.00% 32.0% 400 NR NR NR NR

12 Apr China Power Hong Kong RMB 2.25% 17 May 2016 2.25% 25.0% 982 NR NR NR NR

08 Apr China Huiyuan Juice Hong Kong USD 4.00% 29 Apr 2016 5.00% 30.0% 150 NR NR NR NR

07 Apr Shangri-La Asia Hong Kong USD 0.00% 12 May 2016 2.25% 35.0% 500 NR NR NR NR

06 Apr Agile Property Hong Kong USD 4.00% 28 Apr 2016 4.00% 40.0% 500 BB Ba3 NR NR

04 Apr Suzlon India USD 5.00% 13 Apr 2016 6.50% 10.0% 175 NR NR NR NR

31 Mar Tsinlien - Tianjin Hong Kong CNY 1.25% 13 Apr 2016 1.25% 32.0% 1638 NR NR NR NR

22 Mar Tatung Taiwan USD 0.00% 25 Mar 2014 0.00% 20.0% 150 NR NR NR NR

11 Mar CapitaMall Trust Singapore SGD 2.13% 19 Apr 2014 2.13% 24.0% 350 NR A2 NR NR

11 Mar IHI Japan JPY 0.00% 29 Mar 2016 -0.50% 35.4% 23,000 NR NR NR NR

17 Feb Yamato Japan JPY 0.00% 07 Mar 2016 -0.50% 40.7% 20,000 NR NR NR NR

21 Jan Asia Cement-FENC Taiwan USD 0.00% 27 Jan 2016 0.00% 30.0% 375 NR NR NR NR

19 Jan BTS Thailand THB 1.00% 25 Jan 2016 1.00% 13.0% 10,000 NR NR NR NR

19 Jan Epistar Taiwan USD 0.00% 27 Jan 2016 0.00% 30.0% 280 NR NR NR NR

Note: Ratings at time of issue. Source: Bloomberg, Barclays Capital


6 January 2012 145

Convertible bond defaults: Surprisingly few Asia Pacific convertible defaults were conspicuous by their absence in 2011, as shown in Figure 98. Note, we only include actual defaults here, rather than offers to exchange, repurchase at a discount or restructure bonds.

Figure 98: Asia Pacific convertible bond defaults since 2000

Default date Name Currency Issue size (mn) Country

17 Jan 2000 Thai Petrochemical 3.5% 2003 USD 48 Thailand

26 Jul 2000 Land & General 4.5% 2004 USD 100 Malaysia

31 Oct 2000 Dong-AH Construction 1.25% 2004 USD 50 Korea

30 Apr 2001 APP Finance 3.5% 2003 USD 500 Indonesia

22 Jan 2002 Tanayong 3.5% 2004 USD 130 Thailand

28 Jan 2002 ADI Corp 1.5% 2003 USD 60 Taiwan

03 Jan 2009 Pyramid Saimira 1.75% 2012 USD 90 India

18 May 2009 Wockhardt 0% 2009 USD 110 India

16 Sep 2009 China Sun 0% 2011 USD 100 Singapore

18 Sep 2009 Cranes Software 2.5% 2011 USD 42 India

20 Oct 2009 Fu Ji 0% 2009 HKD 462 Hong Kong

20 Oct 2009 Fu Ji 0% 2010 CNY 1500 Hong Kong

02 Nov 2010 Celestial Nutrifoods 0% 2011 SGD 235 Singapore



6 January 2012 146

CBINSIGHT

CBInsight™: Where do we want to go next? We have provided three substantial enhancements to the tools on the Barclays Capital Live convertibles website, CBInsight™: a new, flexible exchangeable bond pricing model, a comprehensive change-of-control analysis tool, and an improved global custom query tool. We value feedback and intend to continue to develop our online convertibles offering in tandem with users’ needs: therefore, we would be grateful to hear what users would most like to see next or how we can improve the existing features.

New exchangeable bond model in bond pricer Quantify the nuances of exchangeable bonds.

Equity credit spread reflects the credit risk of the underlying entity.

Parity recovery rate reflects ring-fencing, zero if not ring-fenced, otherwise the percentage of prevailing parity that bondholders expect to recover in the event of an issuer default.

https://live.barcap.com/keyword/CBINSIGHT�


6 January 2012 147

Change-of-control analysis screen and bond analysis Screen for potential change-of-control opportunities.

Vary assumptions to identify additional value/risk within convertibles.

Drill down into individual bonds to compare value across the convertible and equity.

Custom query tool Access a selection of pre-defined searches.

Gain the ability to save and share custom queries.

Customise via a global and expanding set of analytics.


6 January 2012 148

This page is intentionally left blank


6 January 2012 149

ISSUER INDEX


6 January 2012 150

Sovereigns Republic of Indonesia 29 Republic of Korea 32 Republic of Philippines 30 Federation of Malaysia 32 Democratic Republic of Sri Lanka 31 Kingdom of Thailand 32 Socialist Republic of Vietnam 31

Corporates AmBank (M) Bhd (AmBank) 40 PCCW Ltd 82 Australia and New Zealand Banking Corp (ANZ) 41 Petroliam Nasional Bhd (Petronas) 82 Axis Bank (Axis) 42 POSCO 83 Bangkok Bank (BBL) 42 PTT Global Chemical Company 83 Bank of Baroda (BOB) 43 PTT Exploration & Production Public Company Limited 83 Bank of China (BOC) 43 PTT Public Company Limited 84 Bank of China (Hong Kong) (BOCHK) 44 Reliance Industries Ltd 84 Bank of East Asia (BEA) 45 SK Telecom 84 Bank of India (BOI) 46 Sun Hung Kai Properties Limited (SHKP) 85 Canara Bank (CBK) 46 Swire Pacific Limited 85 CIMB Bank (CIMBB) 47 Telekom Malaysia Bhd 85 CITIC Bank International (CINDBK) 48 Tenaga Nasional Bhd 86 Commonwealth Bank of Australia (CBA) 49 The Wharf (Holdings) Limited 86 Dah Sing Bank (DSB) 50 Woodside Petroleum Ltd 86 DBS Bank Ltd (DBS) 51 Adaro Indonesia 106 Export-Import Bank of China (CHEXIM) 51 Agile Property Holdings Ltd 106 Export-Import Bank of India (EXIM) 52 Alliance Global Group Inc. (AGI) 107 Export-Import Bank of Korea (KEXIM) 52 Bakrie Telecom 107 Fubon Bank (Hong Kong) (FBHK) 53 Berau Coal 108 Hana Bank (Hana) 54 Berlian Laju Tanker 108 Hyundai Capital Services Inc (HCS) 54 Bumi Resources 109 ICICI Bank (ICICI) 55 Central China Real Estate (CCRE) 109 IDBI Bank Ltd (IDBI) 56 Chandra Asri 110 Industrial Bank of Korea (IBK) 57 China Oriental Group Co Ltd 110 Kasikornbank (KBANK) 57 Cikarang Listrindo 111 Kookmin Bank (Kookmin) 58 CITIC Resources Holdings Ltd 111 Korea Development Bank (KDB) 59 Country Garden Holdings (Cogard) 112 Korea Exchange Bank (KEB) 60 Energy Development Corp. 112 Krung Thai Bank Public Company Limited (KTB) 60 Evergrande Real Estate Group 113 Macquarie Group Ltd 61 First Pacific Company Limited 113 Malayan Banking Bhd (Maybank) 61 Franshion Properties (China) Ltd 114 National Agricultural Cooperative Federation (NACF) 62 Fufeng Group Limited 114 National Australia Bank (NAB) 63 Gajah Tunggal 115 Oversea-Chinese Banking Corp Ltd (OCBC) 63 Glorious Property 115 Public Bank Bhd (PBK) 64 Guangzhou R&F Properties Co. Ltd 116 Shinhan Bank (SHB) 64 Hopson Development Holdings Limited 116 State Bank of India (SBI) 65 Hynix Semiconductor 116 United Overseas Bank (UOB) 65 Indika Energy 117 Westpac Banking Corp (WBC) 66 Indosat Tbk, PT 117 Wing Hang Bank (WHB) 66 International Container Terminal Services Inc. 118 Woori Bank 67 Kaisa Property Group 118 China Overseas Land and Investment Ltd (COLI) 77 KWG Property Holding Ltd 119 China Resources Land Ltd (CRL) 77 Longfor Properties 119 CNOOC Ltd 77 Manila Cavite Toll Road 119 ENN Energy Holdings Ltd (Xinao Gas) 78 MIE Holdings 120 GS Caltex 78 MNC Sky Vision 120 Henderson Land 78 Pacnet Limited 121 Hongkong Land Holdings Ltd (HKL) 79 Powerlong Real Estate Holdings Ltd 121 Hutchison Whampoa Ltd (Hutch) 79 Road King Infrastructure Ltd 121 Hyundai Motor Co Ltd (HMC) 79 Shimao Property Holdings Limited 122 Korea Electric Power Corp (KEPCO) 80 SM Investments 122 Korea Gas Corp 80 Star Energy 123 Korea Land and Housing Corp 80 STATS ChipPAC 123 Korea National Oil Corp 81 Vedanta Resources 124 Korean gencos 81 Yanlord Land Group 124 Noble Group 82


6 January 2012 151

ASIA CREDIT RESEARCH ANALYSTS

Barclays Capital Level 28, One Raffles Quay South Tower, Singapore 048583

Phone: +65 6308 3000 Fax: +65 6308 3206

Jon Scoffin Head of Research, Asia-Pacific and Head of Credit Research +65 6308 3217 [email protected]

Krishna Hegde, CFA Asia Credit Strategy and Senior Financial Institutions +65 6308 2979 [email protected]

Avanti Save Credit Strategy +65 6308 3116 [email protected]

Lyris Koh Financial Institutions +65 6308 3595 [email protected]

Erly Witoyo S.E. Asia High Yield Industrials and Resources +65 6308 3011 [email protected]

Christina Chiow, CFA Chinese Real Estate; High Grade Industrials +65 6308 3214 [email protected]

Jit Ming Tan, CFA N. Asia High Yield Industrials and Resources +65 6308 3210 [email protected]

Timothy Tay, CFA High Grade Industrials; Oil & Gas and Utilities +65 6308 2192 [email protected]

Rom Yudhanahas Associate +65 6308 3804 [email protected]

Nicholas Yap Associate +65 6308 3180 [email protected]

Akane Enatsu Japan Public Sector +81 3 4530 1629 [email protected]

CONVERTIBLE BOND RESEARCH ANALYSTS

Barclays Capital 5 The North Colonnade London E14 4BB

Luke Olsen +44 (0)20 7773 8310 [email protected] Barclays Capital, London

Heather Beattie, CFA +44 (0)20 7773 5859 [email protected] Barclays Capital, London

Angus Allison +44 (0)20 7773 5379 [email protected] Barclays Capital, London


6 January 2012 LAST PAGE

Analyst Certification(s) We, Christina Chiow, CFA, Krishna Hegde, CFA, Lyris Koh, Avanti Save, Jon Scoffin, Prakriti Sofat, Jit Ming Tan, CFA, Timothy Tay, CFA, Erly Witoyo, Nicholas Yap, Rom Yudhanahas, Prakriti Sofat, Heather Beattie, Luke Olsen and Angus Allison, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to http://publicresearch.barcap.com or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise. In order to access Barclays Capital's Statement regarding Research Dissemination Policies and Procedures, please refer to https://live.barcap.com/publiccp/RSR/nyfipubs/disclaimer/disclaimer-research-dissemination.html.



Explanation of the High Grade Sector Weighting System Overweight: Expected six-month excess return of the sector exceeds the six-month expected excess return of the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable. Market Weight: Expected six-month excess return of the sector is in line with the six-month expected excess return of the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable. Underweight: Expected six-month excess return of the sector is below the six-month expected excess return of the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index, as applicable. Explanation of the High Grade Research Rating System The High Grade Research rating system is based on the analyst's view of the expected excess returns over a six-month period of the issuer's index-eligible corporate debt securities to the Barclays Capital U.S. Credit Index, the Pan-European Credit Index or the EM Asia USD High Grade Credit Index, as applicable. Overweight: The analyst expects the issuer's index-eligible corporate bonds to provide positive excess returns relative to the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. Market Weight: The analyst expects the issuer's index-eligible corporate bonds to provide excess returns in line with the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. Underweight: The analyst expects the issuer's index-eligible corporate bonds to provide negative excess returns relative to the Barclays Capital U.S. Credit Index, the Pan-European Credit Index, or the EM Asia USD High Grade Credit Index over the next six months. Not Rated (NR): An issuer which has not been assigned a formal rating. Rating Suspended (RS): The rating has been suspended temporarily due to market events that make coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company. For Japan and Australia issuers, the ratings are relative to the Barclays Capital U.S. Credit Index or Pan-European Credit Index, as applicable. Explanation of the High Yield Sector Weighting System Overweight: Expected six-month total return of the sector exceeds the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Market Weight: Expected six-month total return of the sector is in line with the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Underweight: Expected six-month total return of the sector is below the six-month expected total return of the Barclays Capital U.S. High Yield 2% Issuer Capped Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Explanation of the High Yield Research Rating System The High Yield Research team employs a relative return based rating system that, depending on the company under analysis, may be applied to either some or all of the company's debt securities, bank loans, or other instruments. Please review the latest report on a company to ascertain the application of the rating system to that company. Overweight: The analyst expects the six-month total return of the rated debt security or instrument to exceed the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Market Weight: The analyst expects the six-month total return of the rated debt security or instrument to be in line with the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Underweight: The analyst expects the six-month total return of the rated debt security or instrument to be below the six-month expected total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable. Not Rated (NR): An issuer which has not been assigned a formal rating. Rating Suspended (RS): The rating has been suspended temporarily due to market events that make coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company.



This publication has been prepared by Barclays Capital, the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates as provided below. It is provided to our clients for information purposes only, and Barclays Capital makes no express or implied warranties, and expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with respect to any data included in this publication. Barclays Capital will not treat unauthorized recipients of this report as its clients. Prices shown are indicative and Barclays Capital is not offering to buy or sell or soliciting offers to buy or sell any financial instrument. Without limiting any of the foregoing and to the extent permitted by law, in no event shall Barclays Capital, nor any affiliate, nor any of their respective officers, directors, partners, or employees have any liability for (a) any special, punitive, indirect, or consequential damages; or (b) any lost profits, lost revenue, loss of anticipated savings or loss of opportunity or other financial loss, even if notified of the possibility of such damages, arising from any use of this publication or its contents. Other than disclosures relating to Barclays Capital, the information contained in this publication has been obtained from sources that Barclays Capital believes to be reliable, but Barclays Capital does not represent or warrant that it is accurate or complete. The views in this publication are those of Barclays Capital and are subject to change, and Barclays Capital has no obligation to update its opinions or the information in this publication. The analyst recommendations in this publication reflect solely and exclusively those of the author(s), and such opinions were prepared independently of any other interests, including those of Barclays Capital and/or its affiliates. This publication does not constitute personal investment advice or take into account the individual financial circumstances or objectives of the clients who receive it. The securities discussed herein may not be suitable for all investors. Barclays Capital recommends that investors independently evaluate each issuer, security or instrument discussed herein and consult any independent advisors they believe necessary. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information herein is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results. This communication is being made available in the UK and Europe primarily to persons who are investment professionals as that term is defined in Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion Order) 2005. It is directed at, and therefore should only be relied upon by, persons who have professional experience in matters relating to investments. The investments to which it relates are available only to such persons and will be entered into only with such persons. Barclays Capital is authorized and regulated by the Financial Services Authority ('FSA') and member of the London Stock Exchange. Barclays Capital Inc., U.S. registered broker/dealer and member of FINRA (www.finra.org), is distributing this material in the United States and, in connection therewith accepts responsibility for its contents. Any U.S. person wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Barclays Capital Inc. in the U.S. at 745 Seventh Avenue, New York, New York 10019. Non-U.S. persons should contact and execute transactions through a Barclays Bank PLC branch or affiliate in their home jurisdiction unless local regulations permit otherwise. This material is distributed in Canada by Barclays Capital Canada Inc., a registered investment dealer and member of IIROC (www.iiroc.ca). Subject to the conditions of this publication as set out above, Absa Capital, the Investment Banking Division of Absa Bank Limited, an authorised financial services provider (Registration No.: 1986/004794/06), is distributing this material in South Africa. Absa Bank Limited is regulated by the South African Reserve Bank. This publication is not, nor is it intended to be, advice as defined and/or contemplated in the (South African) Financial Advisory and Intermediary Services Act, 37 of 2002, or any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever. Any South African person or entity wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Absa Capital in South Africa, 15 Alice Lane, Sandton, Johannesburg, Gauteng 2196. Absa Capital is an affiliate of Barclays Capital. In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed to institutional investors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan with registered office of 6-10-1 Roppongi, Minato-ku, Tokyo 106-6131, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firm regulated by the Financial Services Agency of Japan. Registered Number: Kanto Zaimukyokucho (kinsho) No. 143. Barclays Bank PLC, Hong Kong Branch is distributing this material in Hong Kong as an authorised institution regulated by the Hong Kong Monetary Authority. Registered Office: 41/F, Cheung Kong Center, 2 Queen's Road Central, Hong Kong. This material is issued in Taiwan by Barclays Capital Securities Taiwan Limited. This material on securities not traded in Taiwan is not to be construed as 'recommendation' in Taiwan. Barclays Capital Securities Taiwan Limited does not accept orders from clients to trade in such securities. This material may not be distributed to the public media or used by the public media without prior written consent of Barclays Capital. This material is distributed in South Korea by Barclays Capital Securities Limited, Seoul Branch. All equity research material is distributed in India by Barclays Securities (India) Private Limited (SEBI Registration No: INB/INF 231292732 (NSE), INB/INF 011292738 (BSE), Registered Office: 208 | Ceejay House | Dr. Annie Besant Road | Shivsagar Estate | Worli | Mumbai - 400 018 | India, Phone: + 91 22 67196363). Other research reports are distributed in India by Barclays Bank PLC, India Branch. Barclays Bank PLC Frankfurt Branch distributes this material in Germany under the supervision of Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin). This material is distributed in Malaysia by Barclays Capital Markets Malaysia Sdn Bhd. This material is distributed in Brazil by Banco Barclays S.A. This material is distributed in Mexico by Barclays Bank Mexico, S.A. Barclays Bank PLC in the Dubai International Financial Centre (Registered No. 0060) is regulated by the Dubai Financial Services Authority (DFSA). Barclays Bank PLC-DIFC Branch, may only undertake the financial services activities that fall within the scope of its existing DFSA licence. Barclays Bank PLC in the UAE is regulated by the Central Bank of the UAE and is licensed to conduct business activities as a branch of a commercial bank incorporated outside the UAE in Dubai (Licence No.: 13/1844/2008, Registered Office: Building No. 6, Burj Dubai Business Hub, Sheikh Zayed Road, Dubai City) and Abu Dhabi (Licence No.: 13/952/2008, Registered Office: Al Jazira Towers, Hamdan Street, PO Box 2734, Abu Dhabi). Barclays Bank PLC in the Qatar Financial Centre (Registered No. 00018) is authorised by the Qatar Financial Centre Regulatory Authority (QFCRA). Barclays Bank PLC-QFC Branch may only undertake the regulated activities that fall within the scope of its existing QFCRA licence. Principal place of business in Qatar: Qatar Financial Centre, Office 1002, 10th Floor, QFC Tower, Diplomatic Area, West Bay, PO Box 15891, Doha, Qatar. This material is distributed in Dubai, the UAE and Qatar by Barclays Bank PLC. Related financial products or services are only available to Professional Clients as defined by the DFSA, and Business Customers as defined by the QFCRA.



This material is distributed in Saudi Arabia by Barclays Saudi Arabia ('BSA'). It is not the intention of the Publication to be used or deemed as recommendation, option or advice for any action (s) that may take place in future. Barclays Saudi Arabia is a Closed Joint Stock Company, (CMA License No. 09141-37). Registered office Al Faisaliah Tower | Level 18 | Riyadh 11311 | Kingdom of Saudi Arabia. Authorised and regulated by the Capital Market Authority, Commercial Registration Number: 1010283024. This material is distributed in Russia by OOO Barclays Capital, affiliated company of Barclays Bank PLC, registered and regulated in Russia by the FSFM. Broker License #177-11850-100000; Dealer License #177-11855-010000. Registered address in Russia: 125047 Moscow, 1st Tverskaya-Yamskaya str. 21. This material is distributed in Singapore by the Singapore branch of Barclays Bank PLC, a bank licensed in Singapore by the Monetary Authority of Singapore. For matters in connection with this report, recipients in Singapore may contact the Singapore branch of Barclays Bank PLC, whose registered address is One Raffles Quay Level 28, South Tower, Singapore 048583. Barclays Bank PLC, Australia Branch (ARBN 062 449 585, AFSL 246617) is distributing this material in Australia. It is directed at 'wholesale clients' as defined by Australian Corporations Act 2001. IRS Circular 230 Prepared Materials Disclaimer: Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should be construed to be tax advice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot be used, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matters addressed herein. Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor. Barclays Capital is not responsible for, and makes no warranties whatsoever as to, the content of any third-party web site accessed via a hyperlink in this publication and such information is not incorporated by reference. © Copyright Barclays Bank PLC (2012). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of Barclays Capital or any of its affiliates. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London, E14 5HP. Additional information regarding this publication will be furnished upon request.

asia credit outlook 2012 bumpy silk road

Documents