Asia-Pacific Credit Outlook 1Q 2014: Dark Clouds, Silver Linings

Primary Credit Analyst: Terry E Chan, CFA, Melbourne (61) 3-9631-2174; terry.chan@standardandpoors.com Secondary Contacts: Vera Chaplin, Melbourne (61) 3-9631-2058; vera.chaplin@standardandpoors.com Anna Hughes, Melbourne (61) 3-9631-2010; anna.hughes@standardandpoors.com Naoko Nemoto, Tokyo (81) 3-4550-8720; naoko.nemoto@standardandpoors.com KimEng Tan, Singapore (65) 6239-6350; kimeng.tan@standardandpoors.com Michael J Vine, Melbourne (61) 3-9631-2102; michael.vine@standardandpoors.com

Table Of Contents
Steady GDP Growth Not Quite The Panacea Darker For Some, Brighter For Others Overall, We're Most Negative On Mining Related Research

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(Editor's Note: This article is a companion piece to "Credit Conditions: Largely Stable In Asia-Pacific, With A Dash Of Negative And A Focus On China's Financial Sector Risks" published March 26, 2014. The article discusses the credit outlooks for issuer sectors in first quarter 2014.) The credit outlook for Asia-Pacific issuers is on average slightly more negative than it was three months ago. Driven primarily by a less favourable commodities market, the percentage of issuer ratings on net negative outlook or CreditWatch with negative implications increased to 16% in February 2014 from 14% in November 2013.Yet amid the dark clouds, there are some silver linings. Softer economic prospects and skittish financial markets make for a difficult environment for Asia-Pacific issuers in 2014. However, the risks from China's lower economic growth and the impact of the U.S. Federal Reserve's tapering of asset purchases ("QE", or quantitative easing) did subside in the last calendar quarter. Sectors that are most affected are those grappling with lower economic growth and, in some cases, cyclical downturns. These sectors are the building materials, metals and mining, chemicals, financial institutions, and capital goods. Other sectors facing strain include utilities, public finance, retail, telecommunications, and transportation--sectors subject to cyclical behaviours. Somewhat better placed are gaming and entertainment, project finance, insurance, high technology, transportation infrastructure, and real estate development. Best positioned--although some still with some slight negative bias--are issuers in consumer products, diversified, real estate investment trusts (REIT), oil and gas, and automobile original equipment manufacturers and suppliers. For government ratings, the negative outlooks on the sovereign ratings on India and Japan have a knock-on effect on the ratings on public finance entities there. On the other hand, some sectors in Asia-Pacific displayed reduced negative bias over the past year. The most improved sector is automotive original equipment manufacturer and suppliers, which had a net positive ratings bias in February 2014. Other sectors in which the negativity has eased, albeit still being at high levels, include building materials, real estate development, consumer products, and capital goods. Conversely, the negative bias of the project finance, telecommunications, and utilities sectors has worsened. (We should qualify that the sample size for each rated is statistically small which could lead to swings in net ratings bias from quarter to quarter). OVERVIEW Softer economic prospects, partly China-driven, and skittish financial markets make for a difficult environment for Asia-Pacific issuers in 2014. About 16% of issuer ratings are on net negative outlook or CreditWatch with negative implications. Sectors that are most affected are grappling with lower economic growth and, in some cases, cyclical downturns. These are the building materials, metals and mining, chemicals, financial institutions and capital goods. On the other hand, some sectors improved on their negative bias over the past year. Led by automotive original equipment manufacturer and suppliers, these sectors include building materials, real estate development, consumer products, and capital goods. However, we note that building materials and capital goods still have relatively high net negative bias.

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Steady GDP Growth Not Quite The Panacea

While we expect the region's GDP growth to improve marginally from 2013 to about 5.4% for both 2014 and 2015 (see chart 1), the dark cloud around this silver lining is that such a level would still be below the trend rate of earlier years. This trajectory of lower regional growth will continue to stress issuer credit ratings. Indeed, our pool of issuer ratings showed a higher net negative ratings bias of 16% at February 2014 from 14% at November 2013 (see table 1). We rate 1,071 issuers and 1,741 structured finance securities in Asia-Pacific at February 2014, and calculate the net negative bias as a percentage of ratings on negative outlook or CreditWatch negative less those ratings on positive outlook or CreditWatch positive.
Chart 1

Table 1

Net Ratings Bias Of Asia-Pacific Issuers By Sector, Feb. 2013-Feb. 2014

Net positive/ (negative) bias Feb. 2013 Auto OEM and suppliers Building materials (25) (50) Aug. 2013 (12) (43) Nov. 2013 0 (38) Feb. 2014 13 (33) At Feb. 2014 No. of entities Notional average rating 15 13 BBB BB+

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Table 1

Net Ratings Bias Of Asia-Pacific Issuers By Sector, Feb. 2013-Feb. 2014 (cont.)
Capital goods Chemicals Consumer products Diversified Gaming, media and entertainment Healthcare Metals and mining Oil and gas Project finance Real estate developer, other Real estate investment coy., trusts Retail Technology Telecommunications Transportation - cyclical Transportation infrastructure Utilities Total Corporate Financial Institutions Insurance Public finance Sovereign Total issuers (10) (16) (21) (20) NI NI NI (15) (14) (20) (10) NI NI (14) (36) (29) (23) (12) (8) 0 (34) (11) 8 (25) (2) (20) (12) (7) (11) (19) (32) (4) (11) (8) 0 (33) (11) 0 (7) 0 (17) (19) (10) (13) (20) (39) (7) (4) 0 (25) (26) (8) (13) (4) 0 (20) 0 3 (10) (5) (22) (11) (22) (9) (25) (12) (14) (22) (37) (8) (7) (15) (33) (32) (6) (11) (7) (7) (20) (9) (20) (19) (8) (22) (15) (23) (10) (21) (12) (16) 18 19 26 28 13 3 37 36 9 68 56 15 35 30 21 24 73 539 260 179 68 25 1,071 BBBBBBBBBBBB+ BB BBB BB BBBBBB+ BB ABBB BBB BBB+ BBB ABBB+ BBB AA+ AABBB+ BBB+

NI--Not included in table then. OEM--Original equipment manufacturer. Source: Standard & Poor's.

Among issuer types, the financial institution sector has highest net negative bias, at 23% in February 2014, slightly up on the 22% at November 2013 and 21% at February 2013 (see table 1). The high net negative bias level is partly explained by the circumstances underpinning the negative outlooks on the sovereign ratings on India and Japan, which have a flow-on effect on bank ratings in those countries. The uptick in the level can partly be explained by the slight deterioration in the quality of banks' asset books as the regional economic growth slows. The next highest net negative bias is in the public finance sector, at 21%, although this level is down from 25% at November 2013. As noted earlier, the high level is partly due to the effect of the negative outlooks on the sovereign ratings on India and Japan. The net negative bias for corporates is 15%, up from 11% at November 2013 but slightly down from 16% at February 2013. Sovereigns are at 12%, which is flat to November 2013; and insurance, at 10%, is slightly up from its 9% at November 2013. Such biases are expected to persist over the near term despite some signs of stabilization in regional economic growth.

Darker For Some, Brighter For Others

Drilling down into corporates, we find that the industry sectors have shown different net negative ratings bias trends over the past 12 months. The most improved sector is automotive original equipment manufacturers and suppliers,

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which had a net positive ratings bias of 13% in February 2014, in a stark reversal of the net negative ratings bias of 25% at February 2013. The positive trend is led by the Hyundai group of Korea. Sectors where the negativity has eased include building materials (to 33% from 50%), consumer products (8% from 23%), and capital goods (22% from 36%). Conversely, the negative bias of some sectors has worsened. These include project finance (net negative 11% from net positive 8%), telecommunications (20% from 7%), and utilities (22% from 10%). (While healthcare has a high net negative bias, its sample of three issuers indicates no meaningful conclusion.) Elaborating on the trends for sectors:

Automakers And Components

Contact: Sangyun Han We believe Japanese automakers should continue to benefit from the improved operating environment in 2014. Automakers should also benefit from a weaker yen. In our view, a correction in the yen has not only lifted carmakers' profits but has also helped recover their competitive positions in the global vehicle markets, where these manufacturers will deal with the same variable market conditions which we describe above. In China, Japanese automakers' sales had recovered in 2013 after a backlash over a territorial dispute between the nations cut Japanese automakers' sales there significantly from September 2012. Still, we see a potential risk that the issue may strike Japanese carmakers again. Currently, we assume strong performance in North America and Southeast Asia will likely contribute to solid earnings and allow Japanese automakers to maintain their recovery. Additional risk factors that Japanese automakers face, in our view, include intense competition in the global auto industry and exposure to currency fluctuations. While the Japanese automakers we rate will likely maintain their profitability at current improved levels, their results could vary given their different geographic exposures.

Building Materials
Contact: Huma Shi We expect the credit outlook for the Asia-Pacific building materials sector to be stable to slightly negative in 2014, depending on consumer sentiment, government stimulus packages, and continuation of relatively low interest rates. The overcapacity in the largest markets, including China and India, is likely to depress operating performance in a number of the region's economies in 2014, with potentially diverging trends in revenue growth and margins on a country-by-country basis, until stronger demand, especially for public works, puts the idle functions back to work. The packaging sector, which largely caters to the food, beverage, pharmaceuticals, and tobacco industries, is likely to remain steady. Forest products remain vulnerable to potential demand for timber building materials and paper products.

Capital Goods
Contact: Abhishek Dangra We consider the credit outlook for the Asia-Pacific capital goods sector to be somewhat negative in 2014. We keep the view of divergent development. Namely smaller, weaker players are likely to trigger negative rating actions because of their greater sensitivity to economic slowdowns or policy changes; major companies, however, have deep pockets to endure a lengthy downturn. Also, we pay more attention to Chinese players: companies on China have been struggling with stiff competition and slow demand since 2011, because of the country's economic rebalancing away from

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investment in fixed assets.

Chemicals
Contact: Brenda Wardlaw Despite a high net negative ratings bias for rated issuers in this sector, we regard the chemicals outlook as largely stable in 2014. The high net negative ratings bias is less to do with the industry conditions and more because of company-specific factors. The majority of chemical products are intermediate products or raw materials rather than final products. There is some potential for upside in product spreads and capacity expansion in petrochemicals sector.

Consumer Products
Contact: Xavier Jean Overall, we don't predict a change in the trend of the stable-to-negative outlooks in the next 12 months for consumer product manufacturers in Asia-Pacific. The business conditions trend should stay "satisfactory" and there should be "no change" in business outlooks and financial trends. This is based on Standard & Poor's Ratings Services' expectation of fast-rising consumption by the region's middle-class population.

Diversified
Contact: Christopher Lee The business outlook for diversified is somewhat weaker for 2012 versus 2013. Expect modest to moderate revenue growth, constrained by subpar growth in the U.S. and China but offset by subdued cost pressures in response to the modest recovery in commodity prices. Interest rates are rising, albeit from a low base, which will impact profitability somewhat. Profitability is likely to be stable-to-weaker versus the previous year, reflecting lower revenue growth but partially offset by lower cost. The financial outlook also is somewhat weaker for 2014. There's a diverging trend between Japanese general trading companies and the other Asian conglomerates such as Cheung Kong Infrastructure, Hutchison Whampoa, Swire Pacific, and Fosun. The financial ratios for the general trading companies (GTCs) are improving due to a strong recovery in its non-resource business and relatively more restrained investment appetite. We expect some deterioration in leverage and cash flows for these aggressive acquirers. Weak economic recovery and deleveraging by corporates and financial investors in developed markets present acquisition opportunities for Asian-based conglomerates Rating trends are stable, as we expect the deterioration in financial metrics to be modest. Most conglomerates issuers' outlooks are stable, with these huge companies benefiting from diversified business portfolios comprising strong cash-flow-generation businesses in infrastructure, utilities, and consumer. A small number of issuer ratings are under pressure, such as those for Citic Pacific and Fosun due to the poor outlook for the mining business and increasing leverage due to aggressive acquisitions.

Financial Institutions
Contact: Naoko Nemoto Finance companies have the same risks as the large banks, but they also have less resilient funding conditions than

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them. Hence, they are more susceptible to a market reaction to any U.S. policy change. Large banks are seeing worsening asset quality, triggered by slow economic growth. A China hard landing is a key threat, because of the close linkage between the economy and banks' asset quality. Capital outflows and interest rate hikes could pressure the payment abilities of borrowers and impair banks' asset quality. Gains and sharp declines of property prices could pose risks in many counties. Regional banks face structural weakness, such as stagnant local economy and high reliance on region's economy are key risks, in addition to the same risks standing in front of the large banks.

Gaming
Contact: Joe Poon We expect growth in gaming revenues in the key Macau gaming market to moderate to the 5%-10% range in 2014, given the market is cycling off a higher base and 2013 was a particularly strong result, benefitting from the release of pent up demand after the Chinese change of government in late 2012. Longer term drivers (such as the growing Chinese middle class, improving infrastructure, and so on) also support a continuing robust growth outlook in Macau. Across the rest of Asia-Pacific, we expect market growth to track broadly in line with GDP in Australia, Singapore and Malaysia, boosted slightly in some markets by recent investment in VIP capacity.

Insurance
Contact: Michael Vine A moderate increase in interest rates in the region is improving investment return and reducing asset/liability mismatches for life insurers, but exposure to long-term low rates remains a risk. A wider key risk is the unexpected material economic slowdown in China and exposure to European economic stresses, which could have a negative spill-over effect on the life insurance sector's growth, and hence lower profitability. However, we still expect strong underlying regional growth for the life sector. Credit trends in the China life industry remain negative, reflecting dampened growth and capital constraints. Positive signs are emerging from 2013 results, but they are driven by single-premium products and future volumes, and profitability could suffer volatility from margin pressure and competition. Taiwan's life business conditions are somewhat weaker, reflecting the regulator's cooling on savings-type products, although earnings are generally improving. The continued softening of pricing for most property & casualty insurer markets in the region after the benign 2013 for natural catastrophe losses is expected to contribute to lower profitability in 2014. We also expect potential for greater earnings volatility, reflecting higher reinsurance retentions and exposures to un-modelled risks (although some insurers benefit from lower reinsurance rates and strong capacity). Among reinsurers, increased competition from global players and continued premium rate declines will pressure Asia-Pacific in 2014. The drop in pricing in the region, evidenced at the January 2014 renewal season, is likely to post some volatility in operating results over the coming year.

Metals & Mining

Contact: May Zhong Because we don't expect much recovery in metal prices in the next six months, this sector's earnings and cash flows see pressure. Mitigating this risk are the cost-reduction initiatives undertaken across the industry, regardless of

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whether the companies are big or small. Generally speaking, with the exception of some Chinese companies, we also expect this sector to continue its reduction of capital expenditure to conserve cash; growth projects also could be delayed.

Oil & Gas

Contact: Andrew Wong Our baseline forecast for oil prices in 2014 remains robust, broadly in line with the futures curves for the primary traded benchmarks, West Texas Intermediate (WTI) and Brent crude. Our current price deck assumption for WTI crude is US$90 per barrel in 2014, and our Brent crude price assumption is US$100 per barrel. We see a near-term continuation of the trends from recent years. Global oil supply growth is likely to remain low but positive. On the demand side, emerging markets continue to drive growth. China remains a key influence, as Standard & Poor's baseline forecast for China GDP growth is 7.4% in 2014. We also forecast India GDP growth of 6.0% this year. OECD demand is relatively weak but recovering overall.

Public Finance
Contact: Anna Hughes The primary macroeconomic risk to several of Asia-Pacific's local and regional governments (LRGs) relates to their ability to collect corporate, mining, employment, housing, and consumption taxes. LRGs reliant on property rates, such as those in New Zealand, Australia and Japan, are not as vulnerable to national GDP conditions as many other LRGs tend to be. In Australia, the main risks to LRGs relate to consumption, specifically for the state governments that rely on the goods and services tax to fund services; and transaction taxes associated with houses being bought and sold rather than sat upon. The risks for Australian states still revolve around the collection of both transaction and consumption taxes. In higher education, central government funding uncertainty is the biggest risk to the Australian university sector. There are few risks to local governments. In Japan, we expect the increase of the national sales tax will ease the credit risks of rated prefectures and cities. The national sales tax rate will be increased to 8% in April 2014 and to 10% in October 2015 from its current 5%. Both prefectures and cities will have a share of the revenues from the tax increase.

Real Estate Development

Contact: Bei Fu We expect to see slower growth in China and Indonesia, from a high base; flat sales in Hong Kong will be underpinned by lower selling prices, but will be offset by higher volumes. In China, credit conditions will be tighter for developers this year, but underlying demand will remain healthy. Chinese developers' credit outlooks are mixed, as some undertake aggressive debt-funded growth strategies while profit margins are trending down. Although we don't expect regulatory risk to further impact the Indonesian market, the property measures in Hong Kong will continue to compress demand and selling prices.

Real Estate Investment Trusts

Contact: Craig Parker While the sector has displayed a net negative bias over the past quarter, it was driven by some potential

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re-organisations of some REITs' asset ownership and capital structures. The high profile CreditWatch negatives on Westfield Group and Westfield Retail Trust are contributing to this negative bias. Overall, the outlook for Asia-Pacific REITs is likely to remain stable in the next 12 months, with business conditions "satisfactory" and "no change" expected in business outlook. The financial trends have reverted to a more stable position, reflecting softer rental conditions that are limiting the scope for debt-funded asset growth.

Retailing
Contact: Lillian Chiou The overall retail credit trend is turning negative. Business risk profiles remain challenging, with industry competition, threats from e-commence, and uncertainties from market consolidation all over the region. Financial risk profiles might deteriorate or recover at much slower pace, with slower sales growth, margin compression from price cuts, or more aggressive promotions, and lingering/new capex plans.

Structured Finance
Contact: Vera Chaplin Asset-backed securities' is vulnerable to economic conditions, although there is some tolerance for potential mild downturn. Any downward rating migration of Australian asset-backed commercial paper (ABCP), driven by the financial strength ratings of lenders' mortgage insurance providers, might impact the ratings on the ABCP. The commercial mortgage-backed securities (CMBS) sector has seen improved asset trading and finance availability. The demand and supply dynamics are more balanced, and refinancing pressures have eased. Collateral liquidation in outstanding Japanese CMBS is mostly complete, and recovery estimates have stabilized. But we still expect downgrades for some Japanese securities that are currently vulnerable to non-payment from realizing losses of defaulted commercial real-estate loans. For Australia and New Zealand, any downward rating migration of residential mortgage-backed securities (RMBS), driven by the financial strength ratings of lenders' mortgage insurance providers, will impact the ratings on subordinated notes in prime RMBS. Otherwise, the ratings can withstand a mild downturn. Exposure of synthetic collateralized debt obligations (SCDO) to global credit conditions across various corporate and financial sectors remains, as the referenced obligors comprise corporate entities and financial institutions.

Technology
Contact: Raymond Hsu We consider the credit outlook for the Asia-Pacific technology sector to be largely stable in 2014. We expect the technology sector to grow around mid-single-digits in 2014. Strong sales in storage devices, tablets, and smartphones should outweigh the decline in PC-related sales. Also, such a shift in the market could result in divergent performance of the region's tech companies. The negative ratings bias for the region's tech sector is relatively low, and is largely comprised of Japanese players. Japan's tech companies continue to encounter stiff competition from emerging premium providers or mass producers such as Korean or Chinese companies. Still, such pressures may alleviate, with Japan's economy expanding faster, the Japanese yen depreciating, and benefits from its business structuring flowing through.

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Telecommunications
Contact: Paul Draffin Despite technological, regulatory, and competitive change, we view overall business conditions as remaining generally supportive of credit quality for telecommunications companies across the region. Although telecom operators are less sensitive to macroeconomic drivers than many other sectors are, we expect relatively supportive economic conditions to persist. Importantly, the balance sheets of telecom operators in Asia-Pacific remain relatively strong in a global context, which should facilitate investment in new mobile spectrum and networks, and allow investment in new revenues streams (cloud computing networks, etc.) to offset the ongoing structural decline of traditional fixed-line voice revenues.

Transportation Cyclical
Contact: Katsuyuki Nakai We consider the credit outlook for the Asia-Pacific transportation sector as being generally stable for 2014--under still weak business conditions. Our rated pool for Asia-Pacific transportation companies is dominated by the highly cyclical shipping subsector. Although we have seen steadiness for shipping rates at the tanker and dry bulk market recently, we expect "weak" business conditions to continue. Industry overcapacity globally and economic slowdowns in China lead us to believe that shipping companies are likely to face continued pressures and volatility. Mitigating factors are the stable bunker prices and shipping companies' improving disciplines, such as pricing/capacity control. The business condition for airlines remains weak, with continuing yield pressure, in our view. Yet, we see regional passenger demand growth, better cargo capacity control, and a more favourable cost level as supporting factors.

Transportation Infrastructure
Contact: Thomas Jacquot Growth remains primarily linked to state, national, and regional economic growth. Although those are showing some positive signs, there is always an inherent lag in the response. Some market-specific events are expected (such as tempering of competition for domestic airlines in Australia or an increase in consumer tax in Japan), but we view these as having overall a limited impact. Overall, the sector's outlook remains stable-to-slightly negative, subject to demand growth, trends in capital works, and approaches to debt usage.

Utilities
Contact: Parvathy Iyer Growth and performance remains stable; they are linked to economic conditions in each market. In Asia, fuel supply and prices are variable factors, offset by good demand, and these risks are adequately incorporated into our views. Evolving regulatory changes are a medium-to-long-term factor that may cause companies to adapt their operations. Acquisitions/spin offs are likely to occur as entities look to grow and expand outside of their local market.

Overall, We're Most Negative On Mining

We remain most concerned about the metals and mining sector, and would qualitatively regard the 12-month outlook for the sector as negative. Sectors for which we would regard the outlook as stable-to-negative include building

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materials, capital goods, chemicals, consumer products, real estate development, and retail. We would generally classify the other sectors in corporates, financial institutions, insurance, public finance and sovereign as having stable outlooks.

Related Research
Credit Conditions: Largely Stable In Asia-Pacific, With A Dash Of Negative And A Focus On China's Financial Sector Risks, March 26, 2014
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