Asia Credit Sector Specialists Citigroup Sales and Trading

December 15, 2011

Asian Credit Outlook 2012
Wake-Up Call from the West
For specific trade ideas associated with this sector review, please contact: Asian Credit Overall - umar.manzoor@citi.com Banks – dana.kulik@citi.com Investment-Grade Corporates – george.fong@citi.com; umar.manzoor@citi.com High-Yield China – jenny.z.zeng@citi.com High-Yield Indonesia – umar.manzoor@citi.com

Themes
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Headwinds from Europe will intensify Beyond the Europe question, growth is an issue In Asia, Chinese property the biggest “risk from within”: a hard landing We expect policy to be effective: timing the cycle a central theme Conditions will deteriorate further before policy action is initiated Asian credit spreads are cheap to fundamentals Asian corporates offer value versus the US in high-grade, while banks offer little value versus DM peers Supply pipeline will shift to Greater China high-grade and banks

Recommendations
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Stay in high-grade quasi-sovereign power and energy credits for now Within IG, avoid real estate, autos, steel, as well as banks in India and China Avoid distressed and short-dated illiquids except in most-own sectors Tactical shift into high-yield over next six months Within high-yield, thermal coal is a must-own and power is defensive Within China high-yield, prefer cement, selective in property, avoid forestry, pipes and steel sectors

Citigroup Global Markets Asia Limited

Fixed Income Credit Analysis • Credit Sector Specialists

December 15, 2011

Asian Credit Outlook 2012

Contents
Asian Credit Outlook 2012 ............................................................................................................................4 Wake Up Call from the West....................................................................................................................... 4 Asia: Landing the Blimp ............................................................................................................................... 4 Putting it all together: Outlook and Investment Strategy ........................................................................ 5 Fundamentals................................................................................................................................................ 7 Binary risk against a backdrop of declining growth........................................................................... 7 Polarization over China: a shock from within?................................................................................... 8 Banking system: liquidity and asset quality........................................................................................ 9 Corporate earnings and leverage ...................................................................................................... 10 Ratings and default risk: how cheap are we relative to fundamentals?....................................... 10 Technical Picture ........................................................................................................................................ 11 How contagious is Europe’s cold?..................................................................................................... 11 Opportunity of the decade: Issuers will make concessions ........................................................... 12 Logjam in the pipeline? ....................................................................................................................... 12 Banks ................................................................................................................................................................14 At the Mercy of their Global Peers ........................................................................................................... 14 Asian bank themes for 2012: .................................................................................................................... 15 Theme #1: Global trends to be the main driver of Asian bank bond performance ........................... 16 Theme #2: Disequilibrium between supply and demand dynamics.................................................... 19 Theme #3: The paradigm shift – a change in prevailing market practices ........................................ 21 Theme #4: Fundamentals to remain stable with a bias towards deterioration.................................. 23 Investment-Grade Corporates....................................................................................................................27 Investment Strategy.................................................................................................................................... 27 Leverage and Fundamentals .................................................................................................................... 27 Country-level analysis: high-grade looks in good shape................................................................ 27 Leverage versus margins.................................................................................................................... 28 Market structure and technicals................................................................................................................ 29 Chinese quasi-sovereigns join the fray............................................................................................. 29 Record year of high-grade corporate issuance lies ahead ............................................................ 29 Valuations .................................................................................................................................................... 31 Relative value within Asia: spot the difference ................................................................................ 31 Credit Curves in Asia ........................................................................................................................... 31 Finding value: comparison with US investment-grade ................................................................... 32 Focus on Fundamentals: Hong Kong Property approaches the tipping point................................... 33 Macro fundamentals: tied to China.................................................................................................... 33 Tipping point in Hong Kong property? .............................................................................................. 33 Supply-side mechanics: policy risk for developers ......................................................................... 35 Demand-side mechanics: the role of Chinese buyers.................................................................... 36 High-Yield – China.........................................................................................................................................38 Overview ...................................................................................................................................................... 38 Supply forecast ..................................................................................................................................... 38 Chinese Property – Variation .................................................................................................................... 38

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December 15, 2011

Asian Credit Outlook 2012

Chapter 1: A long and cold winter...................................................................................................... 39 Chapter 2: If winter comes, can spring be far behind?................................................................... 42 Chapter 3: Battle for survival: heralding of a new world order? .................................................... 43 China industrials.......................................................................................................................................... 44 Fundamentals remain acceptable...................................................................................................... 44 Corporate governance: textbook versus reality ............................................................................... 46 High-Yield – Indonesia .................................................................................................................................47 Market Performance and Investment Strategy....................................................................................... 47 Growth trajectory barely dented ............................................................................................................... 47 Supply: Another lean year ahead ............................................................................................................. 48 Liquidity and Fundamentals ...................................................................................................................... 49

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Fixed Income Credit Analysis • Credit Sector Specialists

December 15, 2011

Asian Credit Outlook 2012

Asian Credit Outlook 2012
Wake Up Call from the West
From early ‘2009 to early ‘2011, markets were in an unrelenting rebound with only the occasional stinging reminder of the paralyzing catastrophe that had occurred a year earlier. In ‘2011, the message received was that ‘2008 really happened: it was not a dream, and there is no silver- bullet in the firing chamber. Complacent markets were battered as growth expectations in the developed world went into free-fall and Europe’s plans to defer its leverage crisis backfired spectacularly. No doubt there are many lessons yet to be learnt, but when all is said and done the following three will surely appear on the list: (1) Quantitative easing is not an effective remedy for a choking case of leverage, only a temporary anesthetic, (2) Without a properly-functioning transmission of credit into the economy the diversion of excess liquidity into financial assets and commodities will turn the anesthetic rather poisonous, in the absence of wage growth or job creation, and (3) austerity does not work, since it weakens repayment capacity and is not a substitute for structural reforms that will take years to implement effectively. Yet these seem precisely the sorts of policy prescriptions that are now being reinforced in Europe. Further, the undercurrent of resentment both in the core (against fiscal transfers) and in the periphery’s “beneficiaries” (against austerity) is an existential threat to the union which so far has been reflected in social outcry and a rightward shift in the political landscape. Our economists’ and strategists’ base case does not include a disorderly set of defaults and break-up of the Euro-zone, but the risk of these events occurring can no longer be ignored. With Europe taking centre stage, it is difficult to feel optimistic about prospects in the first half of next year except perhaps to the extent that fixed income will benefit from the rate environment. Markets were far too late to price in the extent to which national politics, and not collective action, would drive the sequence of events in Europe as our Global Macro and Credit Strategy teams had warned at the beginning of the year. With the scale of the problem now better-dimensioned and a greater sense of urgency among policy-makers, one might expect tail risk in funding markets to diminish. Focusing on this narrow aspect risks missing the greater picture, since beyond the binary question of whether Europe can avoid a meltdown, what emerges is a grim picture of developed-world growth. The ramifications for Asia will probably become clearer in the months ahead, but the massive downward swing in ‘2012 growth projections during the course of this year shows the genuine academic challenges in anticipating the growth implications of one of the broadest-based slowdowns we have encountered. Put simply, this downward set of adjustments has already wiped almost US$700bn off G3 economic growth expectations for ‘2012 since the beginning of this year and may not be at the point of reversal quite yet.

Asia: Landing the Blimp
This leaves Asian credit in a precarious position since Asia-ex-Japan’s fundamentals, while substantially better than the developed world, do have their own vulnerabilities. First, the good news: sovereign fundamentals and fiscal flexibility are strong, external vulnerability is lower than in 2008, banking sector leverage is manageable with credit penetration still low in many countries, and corporate credit is fairly solid throughout high-grade and even in most of high-yield barring some very real shareholder issues. The bad news is the more sanguine growth outlook for Asia is contingent on assumptions about China’s ability to avoid a hard landing. Can China manage the transition to a lower-growth trajectory at a time when policy flexibility is limited on the monetary front by simmering inflationary pressures? According to our economists, the larger risks to China’s economy come from within, with the largest by far being that of a retrenchment in property investment. This is central to

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December 15, 2011

Asian Credit Outlook 2012

outlook for Asian corporate credit, since unless a freefall in property prices is avoided, China’s ability to avoid a hard landing will be compromised and this will have implications across Asia. Not only is property over one-quarter of GDP, it is also a principal store of personal wealth (accounting for 65%), and is intertwined both with asset quality in the banking system and local government revenues. So the key question is as property prices decline more sharply, will the government’s inevitable policy response (presumably in removing the home purchase restrictions among other property-specific measures) actually stimulate transaction volume? Could we go into a freefall scenario of cataclysmic proportions? We think not. Essentially, we continue to believe that given nominal wage growth is expected by our economists to average nearly 12% over the next two years amid lack of alternative investment channels, property will remain a principal store of value for the foreseeable future. This will be buttressed by longer-term end-user and upgrader demand from urbanization trends that still have further to run. Seeing rental yields of close to 1% is a concern further out but without a liberalization of cross-border investment channels or reversal of the savings rate, its difficult to see how this on its own can crater the property sector. The former would require a substantial reinforcement of vulnerabilities in the banking system as a prerequisite, and the latter won’t happen until the population has aged past a tipping that is some way off.

Putting it all together: Outlook and Investment Strategy
We think ‘2012 will be another year of macro/beta dominating credit/alpha. While we will seek to trade momentum in benchmark names from week to week, our medium-term view from here on Asian credit spreads is negative. We have retraced much of the mid-year widening in vulnerable sectors such as banks and private sector cyclical and high-yield corporates. Where we go from here depends firstly on the evolving fate of the European Union and broader developed market growth story, and secondly on China-specific risks. If Europe is in for twelve months of weak commitments and even weaker growth, this may be a pathetic outcome but as long as tail risk in the financial system is contained this will be more or less in line with consensus. China on the other hand has created such polarization in investor sentiment that its fate should emerge as an equally significant driver at the margin. If it resolves its real estate issues this may restore confidence to China’s growth trajectory. What this means for spreads is we first go wider as Europe’s sovereign and banking crisis intensifies further and alarm bells in China’s property market begin to sound louder. As policy action is taken in China and begins to take effect, markets will recover provided that tail risk in Europe is contained. We are definitely wide to fundamentals and actual default risk, which means we will revisit these levels later in the year. The correct strategy is to lurk in high-grade for now, watch markets potentially weaken over the next 3-6 months, and then shift tactically into seemingly vulnerable high-yield and illiquid sectors. If past years are any guide, our full-year prognosis may well be telescoped into the six-months ahead. In terms of US$-supply, we are expecting ‘2012 to come in at US$59.1bn across sovereigns, banks and corporates, but with a higher concentration of high-grade (68% including banks) versus high-yield (19%) because of (1) heavy refinancing requirements in the banking sector, (2) further issuance out of Greater China from Chinese quasi-sovereigns and refinancing from syndicated loan markets in Hong Kong, and (3) constraints in high-yield in the early part of the year. This compares with US$60.8bn in ‘2011 (55% banks and high-grade, 30% high-yield and 15% sovereigns). We recommend core positioning in defensive high-grade sectors with good secondary market liquidity such as Korean and Chinese quasi-sovereigns. Given that funds flow will eventually follow the tilting of the global economy in Asia’s favour and cash positions are high, we don’t see supply pipeline in these fundamentally strong sectors as a huge technical concern. Private-sector corporates, especially

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Fixed Income Credit Analysis • Credit Sector Specialists

and expect this tactical shift to occur some time in the second quarter. There is also a decent chance that liquidity pressure from the sizeable maturities in the syndicated loan markets (from which European banks will be withdrawing) will create a greater fear factor in high-yield and illiquids than in investment-grade. and our estimates suggest fundamentals have only deteriorated slightly in ‘2011. We recognize that investment strategy will need to more short-term in nature. but relative value trading must not be allowed to obscure inconsistencies in overall market valuations. The key pitfalls to avoid would include getting drawn in by short-term improvements in technicals as the macroeconomic backdrop goes through its usual oscillations. automotive and real estate sectors. If that happens. will struggle as they offer limited value versus quasi-sovereigns. Citigroup Global Markets Asia Limited 6 Fixed Income Credit Analysis • Credit Sector Specialists . Investment-grade corporates are also well-positioned from a liquidity standpoint. 2011 Asian Credit Outlook 2012 those in the steel. The rest of high-yield looks in good shape given involvement of fiscally robust sovereigns in the power sector. high-yielding or illiquid carry trades with refinancing risk should be avoided given technical risks to the downside. this is (again) not going to be a year for relative value trades. Finally. In short. We will increase risk positioning at that stage.December 15. crossborder recovery expectations and track record in the context of this year’s tumultuous reversal of fortunes in the newly emerged Chinese industrial space. we expect the bar to be raised with respect to shareholder risk. We are negative on banks given the global industry backdrop and downside risks in China. Another potential drag could come from Indian banks. the rest of Asian corporate fundamentals will follow. which are grappling with a challenging environment amid slowing growth and structurally high inflation. We also think short-dated. this will confirm that a hard landing is to be avoided. unless the industry fundamentals are so compelling that the possibility of funding availability drying up is remote. Once we have observed not only a policy response but an earlystage stabilization in transaction volumes within Chinese property. subject to developments in Europe. and natural resources credits that are in better shape than ever. we think opportunities will come further out given near-term deterioration in Chinese property sector fundamentals and recommend remaining light or restricting positioning to must-own sectors such as Indonesian coal. In high-yield.

6. core inflation will remain sticky. This potentially makes Chinese property credit a much more of a leading indicator of regional credit performance than it has been before.December 15. India and Indonesia. Hong Kong and Taiwan are relatively more exposed to external demand. and its capacity to do so is partially constrained by limitations on policy flexibility and the risk of a domestic shock that could emanate from property sector investment.3% (fr. Furthermore. policy flexibility may be much more constrained in response to a growth shock this time around. The central point is that with the output gap either positive or modestly negative in the more vulnerable economies. Evolution of ‘2012F GDP growth for major AXJ* economies  Figure 1. while the consensus is already very wide with regards developed-world weakness. Figure 2. While Singapore. domestic factors are expected to be a larger factor in China. but appear relatively healthy from the perspectives of system-wide leverage. central to this prognosis is an assumption that China is able to anchor the region by avoiding a hard landing. and well below 100% across much of South and South-East Asia. Growth: As for growth. the significant reduction in G3 growth expectations through most of ‘2011 could well reverberate through the early part of next year. while fiscal policy support will partially cushion collateral damage in China. While a hard landing is not our base case. This concern appears manageable given the capacity for fiscal policy flexibility 1 See “Asia Macro and Strategy Outlook”.  Leverage: Sovereign leverage is generally below 45% debt/GDP across most economies. the outlook on commodity prices and capital flows is uncertain and most policy rates (or their proxies) are historically low both on a nominal and real basis. including China. Evolution of ‘2012F GDP growth for US. suggesting Asia’s growth trajectory may remain in flux. domestic pressures in China will probably be as dominant a driver of Asian credit performance as developed-world factors. Johanna Chua & AP Economics Team. all of which indicates that there is limited room for easing. Overall. Banking system leverage is also manageable with credit penetration at or below 120% everywhere except in Hong Kong. even after including local-government debt. our economists are expecting slower growth with divergent trends within the region. CIRA – 29 November 2011 Citigroup Global Markets Asia Limited 7 Fixed Income Credit Analysis • Credit Sector Specialists . Korea. 2011 Asian Credit Outlook 2012 Fundamentals Binary risk against a backdrop of declining growth On the surface. Note: Indonesia: 6. Europe & Japan 4% 3% 2% 1% 0% -1% -2% '2012F Real GDP Growth % 10% US Euro Area Japan 8% 6% 4% 2% 0% '2012F Real GDP Growth China India HK Korea Month of '2011 in which forecasts were made Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Month of '2011 in which forecasts were made Source: CIRA Source: CIRA *Asia ex-Japan. However. since the outlook for China is still a source of polarized views. despite the fact the external vulnerability has improved. external vulnerability and growth trajectory. Asian economic fundamentals are expected by our economists1 to weaken going into ‘2012. Philippines and Thailand. Malaysia.5% as of Jan-11)  Inflation & Policy Flexibility: As our economists point out.

Sep-2011  External Vulnerability: Korea and Indonesia remain relatively more vulnerable within the region.e. FX Reserve coverage of short-term debt by remaining maturity 8. A related concern in ‘2008 was the scale of Korea’s contingent liabilities at the quasi-sovereign leverage.0 - FX Reserve Coverage (x) China Source: International Montery Fund. de-levering of the banking system. CIRA – 29 November 2011 Citigroup Global Markets Asia Limited 8 Fixed Income Credit Analysis • Credit Sector Specialists . and may need to hike deposit rates gradually (we expect 25bps in 2012F) to address financial stability risks from persistently negative real deposit rates”2.0 4. “China cannot cut rates. 2 See “Asia Macro and Strategy Outlook”. Note that our economists believe that. an aggressive tightening in liquidity created stress in the SME sector.8% of GDP in 2010 including an 18% indirect contribution through investment. and the scale of off balance-sheet lending was larger than anyone had anticipated. World Economic Outlook. Polarization over China: a shock from within? While a divergence of views over Chinese property has been a common theme over the last few years. Sep-2011 Phil Twn India Thai Mal Indon Kor Source: International Montery Fund.December 15. These “sector-specific” concerns in the property sector are doubling up as the most significant risk at a macroeconomic level given : 1) Contribution: its sizeable contribution to the economy: estimated by our economists at 25. given the above debt stock and concern that tight liquidity conditions are causing an acceleration in defaults in small and medium-sized corporates. 2011 Asian Credit Outlook 2012 particularly in China.7trn or 27% of GDP as of end2010. which it emerged has an estimated debt stock (i. Figure 3. local government debt) of Rmb10. particularly if European bank deleveraging has significant capital flow implications. 3) Asset Quality: its potential impact on asset quality in the banking system. However.0 6. In addition. Local government debt figures emerged and created concern about asset quality in the banking system. and from the perspective of refinancing risk in public markets we see limited public bond maturities out of the sector in ‘2012. World Economic Outlook.0 2. where policy flexibility has been hamstrung by structurally high inflation against a backdrop of slowing growth. Johanna Chua & AP Economics Team. Output Gap in Asian Economic Blocks Figure 4. in Korea’s case. slowing transaction volumes in the property sector and evidence of liquidity stress in the vast ocean of small-scale property developers has intensified sector-specific concerns. 2) Local Governments: its linkages into local government revenue generation. the magnitude of vulnerability has reduced on account of stronger FX reserve coverage and. taking aggregate sovereign debt/GDP to over 40%. this year we saw a significant polarization in views at a macroeconomic level. Where we do see vulnerability and rating pressure is in India.

Citigroup Global Markets Asia Limited 9 Fixed Income Credit Analysis • Credit Sector Specialists . system leverage) ratios in the region and yet is growing at the fastest pace. China stands out in Figure 6 below. Overall. a key factor to watch will be whether fiscal stimulus again exacerbates concern about capital allocation imbalances that will backfire in the medium-term. which account for 65% of personal wealth. our economists note that China has greater vulnerability to a domestic shock than an external shock next year. and on asset quality given the rapid expansion of credit in recent years. 2011 Asian Credit Outlook 2012 With all this to worry about onshore and limited room for monetary easing. Note that several banking systems have been upgraded due to higher sovereign support assumptions (at S&P) and this will probably support ratings across the region even in the face of some slippage in fundamentals. it does underline the risks emanating from that sector. starting with an easing of home-purchase restrictions. In the property sector specifically (and therefore at the macroeconomic level as well). Certainly the factors needed to reverse its role as an key investment channel are not expect to materialize anytime soon. namely 1) a liberalization of crossborder investment channels or 2) a drawdown in aggregate savings due to demographic factors.December 15. where sovereign fundamentals look vulnerable and liquidity and asset quality stress in the banking system looks a major challenge from an operational standpoint. liquidity metrics across Asian banking systems have weakened but are mostly at 70%-85% in terms of loan-to-deposit ratios (“LDR’s”). However. and thus we remain cognizant of second-order effects in the Chinese corporate sector as well. which shows that it has among the higher credit penetration (i. we doubt property investments. Secondly. While this does not take account of holdings of real estate and other household/financial assets. urbanization and upgrading demand is a long-term driver of demand that essentially provides the baseload. The Chinese banking system will also remain a key focus for the reasons highlighted in the preceding section. it remains our house view that China avoids a hard landing by way of fiscal stimulus and propertyspecific policy relaxation.e. we are not taking the doomsday view as we do believe a relaxation in property-specific measures will be effective in stimulating demand. That is really the key question here.and off-balance sheet creating the potential for meaningful deterioration in asset quality. either through the banking system (as we have already observed) or through the channeling of investment into unproductive assets. will be supplanted as a principal store of value anytime soon. we aren’t expecting major deterioration in fundamentals except in India. On the fiscal side though. Banking system: liquidity and asset quality We expect Asian bank fundamentals to deteriorate in ‘2012 given pressures on domestic liquidity as funding requirements are diverted from offshore to local markets. with rapid credit growth both on. The resultant regulatory constraints will continue to manifest themselves in declining credit availability to the corporate sector. Having said that. Firstly. Korea remains above 100% but regulators are addressing this vulnerability through policy-directed shrinkage of LDR’s. with the exception of countries with downside risks at the sovereign level (India and China).

In high-yield. shown for Moody’s) appears to confirm that the pace of deterioration in fundamentals is not a major cause for concern at this stage. and negative in forestry names. Citigroup Global Markets Asia Limited 10 Fixed Income Credit Analysis • Credit Sector Specialists . Thus we believe that spreads appear definitely cheap to fundamentals. Property developers are under greater liquidity stress. credit penetration 120% 100% 80% 60% 3Q11 12% '11F GDP % yoy 1x credit multiplier Credit Penetration 8% SG TW 126% 144% 28% 128% CN 131% 2x HK ID 31% 50% IN 5x 276% 120% 40% 20% 0% KOR THA SIN IDN TWN MAL IND CHN HK Source: CEIC. Chinese high-yield issuers are also in acceptable financial condition. the market appears to be implying between an 8% and 12% rate of default in the high-yield sector. Hong Kong and China. but given the bond issuer universe contains the largest and best-capitalized developers in the broader industry. there is greater divergence in credit trends. As for the industrial names. where natural resource credits maintain robust cashflow coverage metrics and power sector names are supported by a sovereign on an upgrade trajectory. Based on our crude estimate of the market-implied 1-year default rate based on both a 40% and 60% rate of recovery. we have analyzed the aggregated financial metrics of the bond issuer universe across the three key markets: Korea. CIRA. 2011 Asian Credit Outlook 2012 Figure 5. Asian Banking System Liquidity: Loans/Deposits by Country Figure 6. Moody’s projection of an Asian high-yield default rate of under 2% in ‘2012 for Asia appears lower than current market levels imply. fundamentals appear strongest in Indonesia. although we are relatively more negative on the Hong Kong fundamentals given the concentration of property developers and trading companies. Credit quality across high-grade issuers appears relatively stable. with liquidity positions enhanced by large-scale capital raising in early ‘2010. What’s more. but are being constrained by macro and technical factors (next section). we aren’t expecting major issues fundamentally. Citi 4% TH 78% MY PH KR Loan Growth % yoy 0% PHL 0% Source: CEIC. CIRA. Citi 10% 20% 30% Corporate earnings and leverage In investment-grade. plastic pipes and steel/materials Ratings and default risk: how cheap are we relative to fundamentals? The distribution of rating actions below (Figure 7.December 15. Asian Banking Systems: Credit multipliers vs. neutral in coking coal. with our views being most positive in cement.

using (Credit Spread bps) = (1 – Recovery Rate %) x probability of default % See “Half The World – Global Implications of European Bank Deleveraging”. European banks will likely withdraw from US$denominated corporate and investment banking activities. with total claims on the non-bank private sector estimated at close to 100% and 45% of GDP respectively (see Figure 9). often with five or more lenders. versus German and French banks for example. 3 4 Using a simplified methodology to estimate implied 1-year default rates. Citi. However. since the total syndicated loan stock with European bank participation is not excessive either in relation to regional banking systems. *excludes Japan Source: Moody’s Investor Service. note that European lenders’ share of these syndicated transactions is not 100%. and these banks are not expected to delever their balance sheets. Citi. totaling nearly US$159bn (or US$256bn including other currencies). with room as well for regional banks notwithstanding modest liquidity pressures. With non-UK banks accounting for less than a fifth of foreign bank claims to Asia our equity analysts expect Japanese and Australian banks to step into gaps left by the withdrawal of European banks’ lending capacity. We also agree with our equity analyst remarks about potential opportunities for competitors. Figure 10 shows the figures. or to Japanese or Australian banks should they intend to take up the slack. *’11/’12 is Moody’s forecast Technical Picture How contagious is Europe’s cold? According to our equity research division4. Asian High-Yield: Market-implied3 versus actual default rates* 20 10 0 -10 -20 -30 -40 -50 Positive Number of Actions 30% 20% 10% LTM AXJ HY Default % w/ Moody's forecast JACI HY spread-implied 1Y default % recovery of: 60% 40% Net Negative 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 0% Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: Moody’s Investor Service. – 11 November 2011 Citigroup Global Markets Asia Limited 11 Fixed Income Credit Analysis • Credit Sector Specialists . Ronit Ghose. since there may be some variation in the extent of liquidity retrenchment from Swiss banks. suggesting upside risk to our estimates particularly in high-grade markets such as Singapore.December 15. JPMorgan. We have also attempted to estimate the total stock of US$-denominated syndicated loans to Asian corporates with any level of European participation (defined as excluding the UK). Hong Kong and Korea. Hong Kong and Singapore feature prominently in the list of countries most exposed to a potential pullback in European bank lending. Asia* Rating Actions Distribution: Moody’s Investor Service Figure 8. and often with the European lenders in the minority. their analysis also shows that UK banks dominate Europe’s claims in Asia. we may not see uniform deleveraging across all European banks. In addition. 2011 Asian Credit Outlook 2012 Figure 7. However. Ignacio Moreno et al. since the majority of these transactions are club deals. of which US$27bn is maturing next year. These figures are very large in the context of our issuance estimates for this year.

We expect that continued market Citigroup Global Markets Asia Limited 12 Fixed Income Credit Analysis • Credit Sector Specialists .0 Yield (%.8bn in ‘2011.5 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Source: JPMorgan. Bloomberg Source: JPMorgan. The potential for high-grade issuers to make new issue concessions without significantly impacting funding costs may constrain secondary market performance and exacerbate volatility. This represented a decline of 13. European bank claims on Asian non-bank private sector Figure 10.0bn at the beginning of the year but with significant underestimation of high-yield supply made up for less-than-expected issuance in the banks and sovereign space. we expect issuers to take advantage of intermittent periods of market stability in the early months of the year.6% for the high-yield segment). Bloomberg Logjam in the pipeline? Issuance reached US$60.5 4 Jan-06 Spread (bps. As shown in Figure 11. JACI Index Weighted Average Yield (%) and Spread (bps) Figure 12.0 4. 2011 Asian Credit Outlook 2012 Figure 9. consistent with our forecast of US$61. Figure 11. while spreads may not necessarily be any lower than they were pre-crisis. Citi Opportunity of the decade: Issuers will make concessions Against a developed-markets backdrop that is likely to sustain elevated levels of volatility.December 15. with the sharpest overall decline coming in the banks space (down 34. Treasury yields have brought absolute yields in Asian high-grade to their lowest levels in some time. LHS) Daily FY Avg 600 500 400 300 200 4. which accounted for only 25. record low U. JACI Index Weighted Average Duration (Years) 12 11 10 9 8 7 6 5 % bps 900 800 700 5. RHS) Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 100 3.3% yoy in overall issuance. and this could well reverse the inversion of the 5s10s Asian credit curve as supply in the 10-year sector increases to meet long-term demand from regional real-money.5 Years 5. We also expect the trend towards longer-dated issuance to continue (see Figure 12). Volatility clearly kept investors on the sidelines in the second half of the year. Estimate of syndicated loans to Asian corporates with European bank participation (excluding UK banks) 100% 75% 50% 25% 0% % of GDP 80 60 40 20 - US$ bn All Currencies US$-denominated due beyond '2012 US$-denominated due in '2012 CN ID IN KR TW MY SG HK HK SG KR CN Other ID TH IN TW Source: CIRA Source: Loanconnector.9% of full-year issuance (and just 6.S.7% yoy).

2bn).8bn in Korea and US$3. accounted for about one-third of the US$21.7% yoy to US$59. for banks. The other major sector will be Hong Kong.December 15. Bouts of favourable technicals do open the door to higher-risk sectors.1%). Bloomberg. Banks will find ‘2012 tricky given the heavy US$17.2bn in India). IG Corp and HY Corp Source: Dealogic. domestics & corporate FRN’s Note: Bank sub-debts and capital securities shown by initial call date Citigroup Global Markets Asia Limited 13 Fixed Income Credit Analysis • Credit Sector Specialists . Asian US$. Chinese industrials. which we expect will struggle given increased focus on structural and cross-border subordination concerns given the series of defaults in the newly-emerged Chinese industrial space. The hurdle for similar issuers with a limited track record has been raised considerably. Citi. declining overall by 2.0bn) will be a major factor and we suspect the transactions will be sizeable.4bn in Chinese highyield issuance over the last two years. there will be less refinancing issuance from major high-yield quasi-sovereigns. which we estimate at around US$6bn based on available data. or more accurately non-property issuers.  In high-grade.1bn). privates. Figure 13. This incorporates some front-loading of ‘2013 maturities and refinancing demand from syndicated loans maturing in ‘2012. In fact. Citi. In addition. *excl. On the corporate side. we expect next year to see the highest level of US$-bond maturities until ‘2016 as shown below in Figure 14.2bn in refinancing requirements (US$8. The majority of this decline is coming from high-yield (US$11. but even if this opportunity arises we think the bad memories of ‘2011 may take longer than usual to fade away. as that year’s issuance was completely dominated by banks (accounting for 59. Chinese quasi-sovereigns (US$10.bonds: maturity profile* 80 60 40 20 - US$ bn 51 6 70 17 60 US$ bn HY 61 18 18 59 11 23 40 35 8 4 13 9 32 6 3 4 19 4 21 IG 20 11 2 3 1 14 10 24 20 18 8 FI 16 9 8 Sov 0 12 13 14 15 16 17 18 19 20 21 22+ '06 '07 '08 '09 '10 '11* '12F Source: Dealogic.0bn.5bn in bank issuance. we expect US$23.1bn (see Figure 13). Asian US$-issuance with ‘2012 Forecast Figure 14.0bn in corporate and US$17. *Figure for ‘2011 are YTD as of 11-Dec. therefore our gross issuance estimate for ‘2012 anticipates a marked shift towards investment-grade. overall refinancing requirements seem unusually low at sub-US$10bn this year. This appears to be a function of very low high-grade corporate issuance back in 2007 (just US$3. Stack chart in order (from bottom): Sovereigns. Banks. 2011 Asian Credit Outlook 2012 volatility against a weakening growth backdrop will prevent a repeat of the unfettered deployment into high-yield that we saw in early 2010.0bn from US$18. which we estimate at US$8. Bloomberg.

the index has retraced 22% of October’s wide levels to finish the year around 166bp wider. fundamentals in select countries. Asian bank spreads remained rich relative to US and European peers throughout the year.375% 2015 BBLTB 3.625% SBIIN 4.Beg Dec . despite this spread widening.750% 2016 SHNHAN 4. and 4) fundamentals to remain stable with a bias towards deterioration. with Citi’s ABBI Financials index widening up to 211bp.250% 2016 2020 BNKEA 6. Asian Banks – Spread Retracement Analysis 500 Instrument Indicies Asia iTraxx Europe Senior Financials Europe Sub Financials Citi ABBI Financials Cash Bonds (Bid I-spread) INDKOR 4. bp) Figure 16. Yieldbook. 2011 Source: Citi. 2011 Citigroup Global Markets Asia Limited 14 Fixed Income Credit Analysis • Credit Sector Specialists . Additionally. and our European economist expects the European sovereign and banking crisis to intensify even further in 2012.550% 2020 2020 CINDBK 6.December 15. while domestic fundamentals are stable reflected by current ratings and spreads.250% 2015 WOORIB 6.875% KDB 3. 2011 Asian Credit Outlook 2012 Banks At the Mercy of their Global Peers Given the fragile state of the global banking system with European sovereign and banking system problems at the forefront of concern. Asian bank themes for 2012 include: 1) global trends to be the main driver of Asian bank bond performance. such as India and China.625% 2017 WOORIB 5.208% 2037 CITNAT 3. Asian Banks – ABBI Financials Index (OAS. Given that the European banking crisis is expected to intensify further coupled with fundamental deterioration in select Asian banking systems and a sizeable new issue pipeline.a change in prevailing market practices. However. Figure 15. 2) disequilibrium between supply and demand dynamics.% Retracement Dec Beg Aug Beg Oct 197 267 477 435 193 267 265 247 594 255 368 269 283 325 475 245 404 420 384 456 469 192 182 256 398 327 130 151 119 241 196 180 251 267 224 234 188 250 176 125 150 237 163 216 205 218 206 208 141 157 191 261 208 54 (69) (37) (73) (44) (131) (170) (170) (138) (140) (108) (139) (92) (52) (60) (91) (60) (76) (65) (57) (29) (16) (90) (88) (87) (101) (70) (10) 46% 31% 30% 22% 73% 68% 64% 62% 60% 58% 56% 52% 41% 40% 38% 37% 35% 32% 26% 14% 8% 63% 56% 46% 39% 34% 19% 450 400 166bp wider yoy 350 300 250 200 3-Jan 3-Mar 3-May 3-Jul 3-Sep 3-Nov Source: Citi.000% 2016 ICICI 5.125% 2020 DAHSIN 6. Asian banks will not decouple and are at the mercy of their global peers.500% 2017 ICBCAS 5. As of December 5. 3) the paradigm shift . As of December 5. we remain cautious on Asian bank spreads through at least 1H12.375% 2015 WOORIB 4.125% 2020 BCHINA 5. will continue to deteriorate. the probability of these scenarios materializing is no longer nil. Bloomberg. while single name cash bonds and CDS have retracted around 40-45%. Asian bank spreads widened along with the global banking sector in 2H11 as European concerns escalated.750% 2020 CDS (5-year) Shinhan KDB Bank of China ICICI SBI DBS (sub) Beg Aug 115 185 309 283 144 186 168 161 500 175 257 185 210 235 328 142 264 280 223 279 277 140 113 152 238 189 86 Beg Oct 266 304 550 479 324 437 435 385 734 363 507 361 335 385 565 305 480 485 441 485 485 281 270 343 499 397 140 Beg Beg Oct .500% 2015 ICICI 5.875% 2021 NACF 3. Citi’s base case is that there will not be a disorderly default of a European sovereign and it is unlikely that there will be a breakup of the Euro Area. Currently. However.

including loss-absorbing Tier2s. New-style securities in the US$ market. Therefore. Most of the issuance will be out of Korea and in the form of 5 and 10-year senior bonds with a few capital security issuances. 2) the global economic outlook remains challenging particularly for the US and Europe. if at all. Bloomberg. and 3) the technical landscape . Figure 17. Mid Z-spread. Asian banks began to see some fundamental deterioration during 2011. are more likely to come in the later part of 2H12. Given that Asian banks have US$17. 2011  Disequilibrium between supply and demand dynamics: Asian banks issued US$15. However. as well as Asian countries such as China and India. and exchanging old-style capital securities instead of calling them on the initial call date is starting to become prevailing market practice.9bn in 2010 and US$14. and we believe that this trend will continue in 2012 in light of a challenging global macro outlook. As of December 6. will experience downward rating pressure. While most banks will maintain their current ratings. Asian banks. we expect that some countries.5bn in 2011 versus US$23. senior bonds can face losses. it is critical that investors are aware of where they are on the new capital structure and how much they should be paid for this risk. Citigroup Global Markets Asia Limited 15 Fixed Income Credit Analysis • Credit Sector Specialists . such as India.  The paradigm shift . which are supported by strong government and group support. However. particularly in India. Asian Banks – Global 5-year senior cash bond relative value (Rating vs. Moody’s. we expect 2012 issuance to be US$17-18bn. 2011 Asian Credit Outlook 2012 Asian bank themes for 2012:  Global trends to be the main driver of Asian bank bond performance: Asian banks trade rich relative to global peers and will not decouple.2bn of debt maturing in 2012. We do not expect European exchange offers to negatively impact Asian capital securities in 2012. which is reflected by Asian bank spreads and ratings.a change in prevailing market practices: We are currently living in a new world where covered bonds are the new senior bonds.4bn in 2009. may eventually adopt these market practices. and European balance sheet retrenchment will create funding problems in Asia. The three main global banking system trends that will impact Asian banks include: 1) bank funding stress will remain high. Tier2s are the new Tier1s. and we expect all Asian banks to call their capital securities next year. bp) 900 Mid Z-Spread (bp) 800 700 600 SOCGEN 16 500 400 300 200 100 RABOBK 15 ACAFP 15 LLOYDS 16 BNP 16 INTNED 16 BACR 16 BCHINA 16 CBAAU 16 NAB 16 HSBC 16 BNS 16 JPM 16 SUMIBK 16 Aa3/AAA3/AUBS 17 RBS 16 DANBNK 16 NOMURA 16 HLBKMK 16 SCBTB 16 SANTAN 16 MS 16 BAC 16 MQGAU 17 AXSBIN 16 ICICI 16 BOBIN 16 SBIIN 15 ISPIM 15 CS 16 GS 16 SHNHAN 16 WOORIB 16 STANLN 16 KDB 17 WFC 16 Source: Citi.  Fundamentals to remain stable with a bias towards deterioration: Asian bank fundamentals remain solid relative to global peers.December 15. S&P.balance sheet retrenchment will also impact primary and secondary markets.

1. we believe funding stress will continue throughout 2012 and will put pressure on the global banking system. On the other hand.0 0.5 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Euribor . the BIS highlighted that “Asia-Pacific is the emerging market region most vulnerable to sudden capital withdrawals through the banking system. In Singapore. Indian banks do not have any significant exposures.5 2. Bank funding stress is high as the Euribor – OIS 3 month spread.December 15.1bn of assets in the UK. is currently around 1% and is on the rise. Bloomberg. the measure of interbank funding versus the risk-free rate. 2) the share of cross-border lending in total foreign lending. consolidated European banking claims or European bank claims on the non-bank private sector (as a % of GDP) is the highest in Hong Kong. However. both DBS and UOB have around S$2.1bn of EU exposure with no exposure to the peripherals. Citi’s European economist is forecasting the EU sovereign debt and banking crisis to further intensity in 2012. Bank funding stress will remain high. however. including HSBC and Standard Chartered. the BIS analyzes four main areas including: 1) short-term international claims relative to total international lending measures. Asian banks will be negatively impacted by European balance sheet deleveraging. Asian banks have limited direct exposure to Europe. European claims account for less than 6% of total assets in Hong Kong and less than 1% of total assets in China and Korea. Asian Banks – Euribor-OIS and Libor-OIS Spreads (%) 4.5 1. BIS. In the recent BIS Quarterly Review.0 2. Western European banks account for 49% of global banking assets. European banks deploy about one-third of their balance-sheets outside of Europe. this is somewhat mitigated by the fact that the majority of European exposure comes from UK banks. and European balance sheet retrenchment will create funding problems in Asia. particularly to countries of concern. as well as Asian countries such as China and India. According to the BIS. Data represents the consolidated EU & US bank foreign claims On the positive side. while French and German banks make up the majority of the remainder. therefore.” To come to this conclusion. and 3) the technical landscape – European balance sheet retrenchment will also impact primary and secondary markets.OIS Libor .0 % 3.0 1. Figure 18.OIS Figure 19. followed by Singapore and Malaysia. and European balance sheet retrenchment will create funding problems in Asia. therefore. Asian Banks – European and US Foreign Claims 400 Total EU Bank Exposure (US$bn) 350 300 250 200 150 100 50 PH TH ID MY IN SG KR CH HK Total US Bank Exposure (US$bn) Total EU Expsoure (as a % of 2011F GDP) Total US Exposure (as a % of 2011F GDP) 120% 100% 80% 60% 40% 20% 0% 140% 160% Source: Citi. 2) the global economic outlook remains challenging particularly for the US and Europe. 3) the proportion of cross-border claims held in the form of tradable debt Citigroup Global Markets Asia Limited 16 Fixed Income Credit Analysis • Credit Sector Specialists . and select European banks are pulling out of non-core markets. and only ICICI has $5. As of December 10. 2011 Source: Citi.5 3. 2011 Asian Credit Outlook 2012 Theme #1: Global trends to be the main driver of Asian bank bond performance The three main global banking system trends that will impact Asian banks include: 1) bank funding stress will remain high.

requiring more substantial ECB involvement to prevent multiple sovereign defaults. China is also a critical factor within Asia and while Citi’s economist forecasts FY12 GDP of 8. could translate into liquidity and asset quality problems. Asian Banks – Nationality of EU banking claims 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% PH SG ID KR IN CH TW TH MY HK Figure 21.3% SG TW CH IN TH PH MY HK ID KR Source: BIS. This challenging economic outlook will weigh on Asian bank earnings. A pull back in this market would negatively impact Asian credit as it would translate into lower credit availability. Additionally. Figure 20. Citi believes EU GDP will contract to 1. and potentially put pressure on asset quality.0% 3.4%. Asian Banks – GDP Growth and Forecasts (%. yoy) 2012E (%. CIRA 2. select regional Asian banks may be able to fill the void and gain market share on the back of this deleveraging.2% in 2012 and drop to 1. Asia-Pacific appears the region most exposed to sudden withdrawals since 63% of all international claims have a maturity of less than one year and cross-border claims represent 52% of all foreign lending to the area.December 15. trade with these countries will inevitably slow first leading to lower bank profitability. European banks have been active in the syndicated loan market particularly in shipping and trade finance as well as general corporate lending. In Hong Kong. The global economic outlook remains challenging particularly for the US and Europe. CEIC.7% 6. pressure on growth.0% 3. a sharper than expected decline is a major risk. Hong Kong trade activity remains skewed towards China.0% 4. the IMF estimated that financial and trade spill over effects from a crisis in Europe. Using the IMF’s Global Integrated Monetary and Fiscal model. yoy) 2011E (%. In addition. CIRA Source: Citi. On the back of the bleak growth outlook. and 4) foreign bank participation rate. However. Citigroup Global Markets Asia Limited 17 Fixed Income Credit Analysis • Credit Sector Specialists . particularly since Hong Kong and Singapore banks have been active in this lending segment. could put downward pressure on Hong Kong causing GDP to decline 4-4½ percentage points and Hong Kong to fall back into a recession.0% 5. US-dollar trade finance lending is an area of concern.0% 3.0% 4. yoy) 16% 14% 12% 10% 8% 6% 4% 2% 0% UK Banks French Banks German Banks Swiss Banks Dutch Banks Other EU Banks 2010 (%. Citi’s European economist is expecting the European crisis to intensify further.4% 7. as well as Asian countries such as China and India. Points three and four are less of a concern in Asia. yoy) 8. While intra-Asian trade is not as much of a concern. US and Japan. Europe. however.0% in 2013. foreign currency loans now make up over one-half of overall credit growth. which has driven up funding costs and FC LDRs. 2011 Asian Credit Outlook 2012 securities. pressure on the Asian banks to step-up and fill the void.5% 3.

and temporarily spiked before returning back around 10%. given the yield pick-up investors were receiving at that time for moving into Asia. CIRA Source: IMF 3. Global investors have historically played a critical role in Asian bank primary markets. Citigroup Global Markets Asia Limited 18 Fixed Income Credit Analysis • Credit Sector Specialists . European participation: In 2007. a weak US$. However. However. b. the US-dollar is appreciating. 2011 Asian Credit Outlook 2012 Figure 22. we believe that US allocations as a percentage of the total deal size are higher than US investors indicated interest as a percentage of the total order book. The foreign capital inflow into Asia back in 2008 was caused by quantitative easing. Emerging markets were adversely affected in August and September 2011. Overall. c. it will be tougher to attract international capital into Asia. from our findings. and Asian BOP surpluses will decline. the participation rate is already very low at this stage. CEIC. according to the BIS. Asian investors have been filling the void. Additionally. Our primary issuance findings include: a.December 15. looking at participation of questionable European banks. European investors were allocated around 20-30% of Asian bank deals. Asian Banks – Contribution to HK Bank Credit Growth (%. In light of the European situation. Asian investor allocations were just under 30% in 2007. with investors withdrawing US$25bn from EM funds. European allocations subsequently declined to under 10% in 2010. We’ve analyzed Citi led global benchmark 5 and 5½ year fixed rate senior bond deals issued from 20072011 out of well-known credits including the Korean policy and commercial banks and Indian banks such as SBI and ICICI. now that risk aversion has heightened. However. but eliminates one-off factors that would cause investors to participate more or less than usual. Asian participation: While US investors have been pulling back from these deals. US participation: Back in 2007. Also. we expect participation to remain low at around 10% or even lower. we believe that Asian investors interest in deals marginally exceeds current allocations. Asian Banks – HK Bank LC and FC Trade Finance Lending 225 HK$bn 205 185 165 145 125 105 85 65 45 25 Jan07 HK Trade Finance (HK$) HK Trade Finance (Fore ign Curre ncy) Figure 23. as Asian bond yields became less attractive relative to global peers. These stringent parameters only allow for a small data sample. however. there is an incentive for banks to give larger allocations to strong US accounts. and in turn. yoy) Jul07 Jan08 Jul08 Jan09 Jul09 Jan10 Jul10 Jan11 Jul11 Source: Citi. The technical landscape – European balance sheet retrenchment will also impact primary and secondary markets. US allocations subsequently declined to around 30%. allocations increased to 60-70% in 2011. US investors were the main participants in these Asian bank deals with allocations peaking around 60%.

global investors are unlikely to meaningfully buy Asian bank bonds in the secondary market in the near-term. equity investors were particularly interested in Tier1 capital securities that were offering equity like returns in the credit space. Asian banks issued US$15. Overall. Over time we’ve seen the main holders of Asian bank benchmark bonds switch hands from US investors back into Asia. the new issue supply pipeline remains large. US bank bonds trade wider than similar-rated Asian peers. which are in better fundamental shape. 2) Asian investors will continue to participate. Asian Banks – Asia vs. European investors are comfortable holding covered and senior bonds of high-quality European banks. albeit still stressed.9bn in 2010 and US$14. Asian Banks – European participation in new Asian bank deals 35% ASIA ALLOCATION 70% 30% 60% 25% 50% EUROPE ALLOCATION US ALLOCATION 40% 20% 15% 30% 10% 20% European banks (% of total deal) 5% 10% 0% Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 0% Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Source: Citi. US and European investors are sticking with their core markets. In the secondary market. During the GFC. since yields are at least somewhat compensating investors for taking banking system risk. In 2011. global credit investors are retreating back to their home markets especially when its more economical to do so. post the GFC. According to our equity colleagues.5bn vs US$23. US investors are happy sticking with their own banks. d. but has also increased in the secondary market. Around 61% of issuance came in the first half. Note: The sample includes 5 & 5½ year senior RegS/144A fixed rated bonds. Asian bank bonds have previously benefited from equity participation. 2011 Asian Credit Outlook 2012 Figure 24. it is unlikely that we will find support from these cross-over players this time around. a. Therefore. If equity investors are crossing over into credit at all. while capital markets periodically shut in 2H11. credit.December 15. b. and is expected to remain low or decrease even further. and 3) European interest is already low. not Asian. but participation is already at all time highs and it is uncertain if Asian investors have the capacity to participate further. they are putting their funds into US. Therefore. who is going to fill the void if global investors retreat from Asia? Our secondary market findings include: Asian investor participation in Asian bank deals has not only increased in primary deals. Theme #2: Disequilibrium between supply and demand dynamics While demand for Asian bank bonds is a concern. As a result.4bn in 2009. there is little equity interest in credit given the relatively lacklustre yields. Conclusion: From our analysis we’ve concluded that: 1) US investor participation is declining and is unlikely to increase at this time. Therefore the question remains. US allocation in new Asian bank deals 80% Figure 25. Since problems are closer to home. Korea was the most Citigroup Global Markets Asia Limited 19 Fixed Income Credit Analysis • Credit Sector Specialists .

Dealogic. Asian Banks – Bank capital callable in 2012 Country Amt Out  (US$m) 200 GBP300 500 300 500 1. Dealogic. Dealogic.2bn dollarbonds maturing next year due to the large amount of 5-year senior bonds and capital securities with 5-year calls issued back in 2007. Bloomberg. therefore.5bn due to lower US$ funding costs compared to the domestic market. Asian Banks – Asian US$ Issuance and Forecast (US$bn) 80 Asian bank US$ issuance (US$bn) 70 Total Asian US$ issuance (US$bn) Bank issuance (as a % of total issuance) 70% 80% Figure 27. We expect US$7-8bn from Korea since Korea has US$8. Asian banks have US$17. and sizeable refinancing needs for ICICI. Figure 26.380 Type LT2 UT2 LT2 LT2 (FRN) LT2 LT2 (FRN) LT2 UT2 LT2 LT2 (FRN) LT2 LT2 LT2 LT2 Tier1 Call Date 14‐Mar‐12 21‐Mar‐12 12‐Apr‐12 25‐Apr‐12 26‐Apr‐12 16‐May‐12 16‐May‐12 31‐May‐12 20‐Jun‐12 22‐Jun‐12 6‐Jul‐12 18‐Aug‐12 30‐Oct‐12 12‐Dec‐12 17‐Dec‐12 Country KR HK KR MY KR SG SG HK MY HK HK HK KR HK KR 18 16 14 12 10 8 6 4 2 2012 2014 2016 2018 2020 2022 2024 2026 2028 BUSAN BNKEA HANABK MAYMK NACF DBS DBS CINDBK PBKMK BNKEA HANSEN DAHSIN BUSAN CINDBK HANABK Total Source: Citi. Bloomberg We expect 2012 Asian bank issuance to be US$17-18bn. Hong Kong/Chinese bank issuance is expected to be around US$3bn as the banks will continue issuing senior bonds and/or LT2s and potentially re-tap recent deals. Bloomberg South Korea Philippines Malaysia Hong Kong/ Source: Citi. Thailand and Malaysia. while Hong Kong/China issuance declined to 13% from 24% and SE Asian issuance declined to 7% from 14%. it may be challenging to price new deals. 2011 Asian Credit Outlook 2012 active with issuance constituting 52% of total issuance compared to 39% last year given that stronger Korean banks were able to price deals in fragile markets and the FSC required banks to secure proper funding in advance. Figure 28. Asian Banks – Asian US$ Debt Maturity Profile (US$bn) 20 Figure 29. Issuance could be larger. but Indian banks are price sensitive and fundamentals are deteriorating. Bloomberg Citigroup Global Markets Asia Limited 20 Fixed Income Credit Analysis • Credit Sector Specialists .500 500 250 400 600 300 150 250 250 200 6.December 15. Southeast Asian issuance will come back with bond issues from countries including Singapore. Asian Banks – Asian 2011 US$ Issuance By Country (%) 13% 2% 3% 2% 28% 60 50 40 30 60% 50% 40% 30% 20 10 2005 2006 2007 2008 2009 2010 2011 2012 20% 10% 0% 52% India Thailand Source: Citi.8bn maturing next year. raising funds for offshore lending. Indian bank issuance will be US$4-4. Deals under US$100m were excluded Source: Citi. Dealogic. Indian bank issuance increased to 28% from 23% with multiple inaugural issues.

Given this change. we expect the technicals to eventually unwind. Last year banks priced only US$1bn of Tier2s. Bank of India and ICBC all issued 10-year senior bonds. and Bank of East Asia received special HKMA approval to issue a LT2 with a call and coupon reset after 5½ years. therefore. the 10-year sector continues to trade rich relative to the short-end of the curve. Given the shortage of longer duration bonds and the regional demand for this paper. Future call decisions will be made based on economic reasons for both newly-issued and currently outstanding instruments. KOFC. Bloomberg. Asian issuers do not seem too keen on issuing covered bonds at this time. banks will continue to consider issuing older-style Tier2s even though they start amortizing in 2013. However. Asian banks have also been considering US$ loss-absorbing LT2s for some time now. however. As of December 6. Additionally. as new issuance continues to materialize. issuance in this sector will be limited. these exchange offers are signaling that banks have changed their call strategy. Tier2s are the new Tier1s. investors must be aware of where they are on the new capital structure and how much they should be paid for this risk. 2011 Asian Credit Outlook 2012 Most of the issuance will be 5 or 5½ year senior bonds.9bn of US$ securities with effective maturity dates in 2012. the funding costs have not made sense. Asian Banks – Cash bond curve (Modified Duration. and exchanging old-style capital securities is starting to become the prevailing market practice. bp) 500 Mid I-Spread (bp) SBIIN 14 ICICI 16 BOIIN 15 AXSBIN 16 IOBIN 16 SNDBIN 16 CANARA 16 BOBIN 16 ICICI 20 BOIIN 21 UNBKIN 16 SBIIN 15 400 300 200 HANABK 17 HANABK 16 NACF 16 SCBTB 16 NACF 17 HANABK 15 KDB 17 BBLTB 15 EIBKOR 15 KDB 16 CITNAT 17 HLBKMK 16 KDB 15 EIBKOR 15 INDKOR 16 SHNHAN 16 INDKOR 15 BCHINA 16 ICBC 21 KOFCOR 21 EIBKOR 21 DBSSP 15 Modified Duration 5 6 7 8 100 2 3 4 Source: Citi. KEXIM. however.December 15. banks are taking advantage of weak market conditions for economic benefit. Theme #3: The paradigm shift – a change in prevailing market practices We are currently living in a new world where covered bonds are the new senior bonds. These new exchange offers out of Europe are monumental because they are being done by strong national champion banks for both regulatory and economic reasons at the expense of bondholders. Nonetheless. and ICICI Bank has been exploring this option after IDBI Bank’s inaugural issue in the CNH market. therefore. In 2011. since it has over US$1bn of Tier2s callable in 2012. Citigroup Global Markets Asia Limited 21 Fixed Income Credit Analysis • Credit Sector Specialists . Figure 30. Select Asian banks will likely follow ICBC Asia’s lead and issue loss absorbing Tier2s in the CNH space given the attractive funding cost from the issuer’s perspective. senior bonds can face losses. however. 2011 Capital security issuance will be limited. more banks will consider issuing 10-year bonds given the attractive funding cost. Issuance in this sector is more likely to come in the later part of 2012. S&P. Asian banks have around US$5. Woori’s US$500m bullet LT2 replaced half of its US$1bn LT2 that was called in 2011. Some regulators have been promoting the use of covered bonds instead of senior bonds. versus Mid I-spread. Moody’s. We also expect nonChinese Asian banks to issue senior bonds in the CNH space. years. if at all.

2) the dollar prices are around par or higher. However. Figure 31. they continue to make progress towards adopting Basel III. presenting little economic benefit to tender. We believe that Basel III’s capital requirements and amortization schedule will still go into effect in 2013.December 15. Hong Kong banks were the most active in issuing bullet LT2s back in 2010. Asian banks have already unsuccessfully attempted to follow Europe’s lead. European banks are tendering bullet Tier2s. Surprisingly China already released a Basel III draft for public consultation and Singapore has announced capital requirements more onerous than Basel III. it is expensive to replace these securities and Asian banks like to maintain high capital ratios. Citi Citigroup Global Markets Asia Limited 22 Fixed Income Credit Analysis • Credit Sector Specialists . 2) Asian banks are well capitalized with high core Tier1 ratios. while select Thai banks such as Bangkok Bank and Kasikornbank also have bullet LT2s outstanding. respectively. Indian banks are the most likely candidates to adopt European market practices. since Indian banks tend to push the boundaries and funding costs are cheaper in the US$ market than in the local markets. Select investors are questioning if Basel III will go into effect as planned. and at some point. Asian banks are unlikely to tender their bullet bonds in 2012 since: 1) most of these bonds still receive significant capital qualification. As long as prevailing market practices continue to evolve in Europe. Asian Banks – Progress in adopting Basel III Basel II Australia China Hong Kong India Indonesia Korea Singapore UK 4 4 4 4 3 4 4 4 4 4 4 Basel 2. On the other hand. Due to Basel III’s amortization schedule. and 6) Asian investors are not ready to accept these types of practices as witnessed by ICICI Bank UK's unsuccessful exchange offer this year and Woori Bank’s LT2 non-call following Deutsche Bank’s infamous LT2 non-call. Asian banks may eventually adopt these practices. While Asian banks have been slow to act. and 3) given fragile markets. Nevertheless. these attempts may become successful. which subsequently caused problems for the bank. We expect to hear from other Asian regulators in 2012. 2011 Asian Credit Outlook 2012 We do not expect these practices to negatively impact Asian bank capital in 2012. 5) Asian banks are not looking at exchange offers at this time. Citi Source: BIS. The main reasons for calling include: 1) most Asian banks have a small amount of capital securities outstanding. 4) there is little economic incentive to exchange. which includes both Bank of East Asia and DBS which have US$1-2bn callable.5 3 4 2 4 1 2 3&4 2 1&2 4 3 Basel III 1 2 1 1 1 1 1 2 1 2 1 100% 60% 40% US EU Japan Key: 20% 1 draft regulation not published 2 draft regulation published 3 final rule published 4 final rule in force 0% 2011 2013 2014 2015 2016 2017 2018 2019 2020 2021 2020 Source: BIS. and recent headlines suggest that highly rated corporates may now be eligible for the bank’s liquidity portfolios. 3) Asia is adopting Basel III at a slower pace. Asian Banks – 10-year bullet LT2 Amortization Schedule 120% Contribution to Tier2 capital (%) Current amortization schedule Basel III amortization schedule 80% Figure 32. other parts of Basel III including liquidity requirements may get pushed back and/or amended. Asian banks will explore options along the same lines. banks may tender these LT2s at some point in the future before maturity.

Our economist forecasts lower GDP growth in Asia. our economist expects rates to stabilize with select easing measures in certain countries.Negative Negative KR bbb Wath Pos Stable KR bbb Stable Stable KR bbb+ Stable Stable KR bbb Stable Stable KR bbb Stable Stable TH bbb Stable Stable TH New Previous BICRA BICRA 5 6 5 6 2 2 2 2 5 6 5 6 5 6 5 6 5 6 5 6 5 6 5 6 4 4 2 2 2 2 2 2 3 4 3 4 3 4 3 4 3 4 3 4 3 4 3 4 5 6 5 6 Source: Citi. Given lower growth. These factors coupled with higher credit costs on the back of asset quality deterioration will all weigh on bank earnings. Asian Banks – S&P Bank Rating Changes of Major Asia-Pacific Banks Organization BOC ICBC BOCHK BNKEA AXSBIN BOIIN ICICI IDBI IOBIN SBIIN SNDBIN UNDKBIN Maybank DBS OCBC UOB Hana IBK Kookmin KDB KEB NACF Shinhan Woori BBLTB SCBTB Moody's Rating A1 A1 Aa3 A2 Baa2 Baa2 Baa2 Baa3 Baa3 Baa2 Baa2 Baa2 A3 Aa1 Aa1 Aa1 A1 A1 A1 A1 A1 A1 A1 A1 Baa1 Baa1 Moody's BFSR D D+ C+ CCD+ CDD D+ D+ D+ C B B B CD+ CD CD+ CCCC- Moody's BCA Ba2 Ba1 A2 Baa2 Baa2 Ba1 Baa2 Ba3 Ba2 Baa3 Ba1 Ba1 A3 Aa3 Aa3 Aa3 Baa1 Baa3 Baa1 Ba2 Baa2 Ba1 Baa1 Baa2 Baa2 Baa2 Moody's New S&P Previous Outlook Rating Rating Stable A AStable A A Stable A+ AStable A AStable BBBBBBStable BBBBBBStable BBBBBBStable BBBBBBStable BBBBBBStable BBBBBBStable BBBBBBStable BBBBBBStable AAStable AAAAStable AAA+ Stable AAA+ Stable A AStable A A Stable A A Stable A A Positive BBB+ BBB+ Stable A A Stable A AStable AAStable BBB+ BBB+ Stable BBB+ BBB+ New New S&P Previous SACP Outlook Outlook Country bbbStable Stable CN bbb Stable Stable CN a Stable Positive HK bbb+ Stable Stable HK bbbStable Stable IN bbbStable Stable IN bbb Stable Stable IN bb+ Stable Stable IN bb+ Stable Stable IN bbb Stable Stable IN bb+ Stable Stable IN bbbStable Stable IN aStable Stable MY a Stable Stable SG a Stable Stable SG aStable Stable SG bbb+ Stable Stable KR bbb Stable Stable KR aStable Stable KR bbb.December 15. Figure 33. However. continued strong government support. Moody’s. which we believe will continue in 2012 and may cause downward rating and spread pressure in 2012. fundamentals have started to deteriorate. Citigroup Global Markets Asia Limited 23 Fixed Income Credit Analysis • Credit Sector Specialists . as most Asian bank ratings remained unchanged or were upgraded one notch due to stable fundamentals. which is reflected by most Asian bank ratings holding a stable outlook and Asian bank spreads trading rich relative to DM peers. These policy rate cuts could be negative for net-interest margins as it puts pressure on asset yields. yellow denotes unchanged rating. light green denotes a one notch upgrade. Asia’s rating outperformance during S&P’s methodology revision emphasizes Asia’s relative strength. but more importantly. will cause lower loan growth in the mid-single digits to the high-teens. We believe that current Asian bank spreads and ratings reflect their credit profiles. which in turn. bright green denotes a two notch upgrade Fundamentals will continue to see pockets of stress in 2012 on the back of a challenging global macro outlook. On the other hand. S&P. global peers have experienced multiple rating downgrades from both Moody’s and S&P throughout the year. 2011 Asian Credit Outlook 2012 Theme #4: Fundamentals to remain stable with a bias towards deterioration Fundamentals remain solid.

2% 13. therefore. the top risks for the Chinese banking system include: 1) the impact of sharp credit expansion on banks’ asset quality. CEIC Loan growth outpaced deposit growth in all Asian countries during 2011 aside from Korea.0% 15% 13. particularly in countries such as Hong Kong.0% 21.4% 19.7% 8.0% 5% 7. China is heading into a soft patch in 2012.6% 13. yoy) 25. Asian Banks – 3Q11 Loan versus Deposit Growth (%.9% 20% 16. CEIC Source: Citi.7% 19.2% 0% CH HK IN ID KR MY PH SG TW TH CH IN ID SK MY PH TW TH Source: Citi.2% 25% 21. Figure 36. where local regulation required banks to reduce their local currency LDRs. CIRA. Asian Banks – Rates and 2012 Rate Forecasts 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 1Q FY 10 2Q FY 10 3Q FY 10 4Q FY 10 1Q FY 11 2Q FY 11 3Q FY 1 4Q 1 FY 11 E 1Q FY 12 E 2Q FY 12 E 3Q FY 12 E 4Q FY 12 E Figure 35.4% 17. Asian Banks – Loan-to-deposit ratio (%) 120% Figure 37. CEIC Source: IMF We are negative on Chinese and Hong Kong banks. We expect LDRs to continue increasing in 2012 as domestic liquidity remains tight and international liquidity is withdrawn from the system.7% 8. the RRR was cut for the first time in three years signaling that China is starting an easing policy cycle. 2) the rise of off-balance sheet exposures and lending outside the formal banking sector. CIRA. due to the expected deterioration of the banks’ fundamentals and uncertainty of off-balance sheet lending practices in China. Given these concerns.6% 17. yoy) 3Q11 Deposit growth (%.7% 10% 8.9% 6.December 15. According to the IMF.8% 12. CIRA.8% 7. yoy) 30% 3Q11 Loan growth (%. 3) the relatively high level of real estate prices. 2011 Asian Credit Outlook 2012 Figure 34. Strong loan demand combined with a tapering off of deposit growth led to an increase in LDRs. Hong Kong’s increased external banking claims to China is a main source of Citigroup Global Markets Asia Limited 24 Fixed Income Credit Analysis • Credit Sector Specialists . Asian Banks – Hong Kong Loan-to-Deposit Ratios (%) 3QFY10 1QFY11 100% 4QFY10 2QFY11 3QFY11 80% 60% 40% 20% CH HK IN ID KR MY PH SG TW TH Source: Citi.1% 24.4% 13. and 4) the increase in imbalances due to the current economic growth pattern.

CEIC We are negative on Indian banks due to the challenging operating environment which will adversely impact capital. While the banking sector’s direct exposure to the real estate sector is moderate. and the banks do not provide sufficient provisions and capital for off-balance sheet lending. around 20% of total banking system’s loans. tightening liquidity. Asian Banks – Indian Bank Asset Quality 800 NPLs . Figure 38. are the sectors under the most pressure. Capital ratios have been deteriorating and are weaker than global peers.Private Sector Banks NPL grow th . but it could undermine monetary policy effectiveness in a severe scenario.PSB (%. but these stresses will manifest themselves first as liquidity stress. The decline in China’s NPL ratio from 8. the majority which is real estate. Also the increasing shift of risks off-balance sheet. Given this deterioration.6%. which provides some support. Due to regulatory forbearance. 2011 Asian Credit Outlook 2012 concern along with exposure to the property market. including wealth management products. since they still dominate financial intermediation on behalf of the government.1% in 2010 was the result of rapid credit expansion and an NPL carve-out from one of the major banks. real estate and local government loans which constitute around 45% of gross loans.Private Sector Banks (%. Not only is this exposure not transparent. a global slowdown and trade finance lending. this rapid credit growth raises the risk of asset quality deterioration since credit may be directed to less productive investments and the Chinese banks have limited ability to apply prudent risk management. We expect the government will at least recapitalize the major public sector banks. There will be an increase in restructured loans and computed based NPL recognition increasing NPLs declared.PSB 700 600 500 40% 400 20% 300 200 100 0 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 100% NPLs . Therefore. asset quality and profitability. According to Moody's stress test. the indirect exposure is much higher as 30-45% of total loans are backed by collateral. and the main areas of concern include SME. core Tier1 ratios would decline to 5.9% in 2005 to 1.5%. yoy) 80% 60% 0% -20% -40% Source: IMF Source: Citi. Retail loans may be negatively impacted due to recent monetary tightening. which distorts fundamental credit ratios. However. Asian Banks – HK Banks external claims (% of total) Figure 39. in a highly adverse scenario with system gross NPLs increasing to 12%. core Tier1 ratios would be relatively unchanged at 9. however. augment the banks’ credit risk exposure. We expect that NPLs will increase going forward which will impair the banks’ profitability and capital positions. provisions will remain elevated which will hurt profitability along with an expected decline in net-interest-margins and treasury income. both power and airlines. Asset quality is expected to deteriorate in 2012 driven by high interest rates and slowing economic growth. asset quality stresses may not necessarily come through in the NPL figures. SMEs and utilities. etc.December 15. yoy) NPL grow th . Citigroup Global Markets Asia Limited 25 Fixed Income Credit Analysis • Credit Sector Specialists . in an adverse scenario with system NPLs increasing to 7% from the current mid-5% level. real estate exposure will continue to be at the forefront of concern.

While not our base case. Korean banks do get funding from European banks that may come under stress. Indian bank issuer ratings may benefit from up to 3 notches of government support. If this happens. the household cooling measured implement by the regulators in 2011 should help ease some of these concerns. have room for their BFSRs to be downgraded while maintaining issuer ratings. a large portion of their problematic assets have already been taken care of. and the major Korean banks secured around US$2. there is a risk that Moody’s downgrades the Indian sovereign rating in 2012.December 15. but potential issuer rating downgrades. S&P Source: BOK. However. Indian banks will face downward rating pressure in 2012. Overall. In a worst case scenario situation. Asian Banks – Korea External Debt Analysis 80% External Debt (as a percentage of GDP) 70% ST External Debt (as a percentage of international reserves) 60% 50% 40% 30% 20% 2005 2006 2007 2008 2009 2010 2011F 2012F Source: Citi. Korean banks spent the past few years cleaning up loans to concerning sectors including project finance. particularly the policy banks. given that the banking system is currently stable and better positioned compared to 4Q08. The property sector needs to be monitored carefully as select retail loans may come under pressure. shipping and shipbuilding sectors. While issuance will remain high. We are more constructive on Korea. CIRA Ratings will come under pressure – BFSR downgrades first. and the commercial banks have larger refinancing needs in 2012 than usual. External debt as a percentage of GDP is expected to be 34% in FY12. and most Indian banks. while depressed margins and deteriorating asset quality is largely behind us. 2011 Asian Credit Outlook 2012 Figure 40. Moody’s is likely to downgrade the BFSR ratings of Indian banks on the back of fundamental deterioration. Indian bank issuer ratings would be subsequently downgraded. the quasi-sovereigns are strongly supported by the government. this is a main area of concern. Therefore. Moody’s. while the banks might continue to some pressure in the SMEs segment. short-term external debt as a percentage of internal reserves is around 45% in FY11 and FY12E. aside from IDBI Bank and Central Bank of India. Loan growth will continue to be muted and the banks are focusing on increasing deposits to bring down LDRs. LDRs have declined. asset quality problems in the project finance segment are largely behind us. We prefer quasi-sovereigns to the commercial banks since the quasi-sovereign bonds offer better value. similar to SBI’s BFSR downgrade in 2011. The focus is on deleveraging and decelerating.4bn of committed credit lines and tapped international capital markets. Citigroup Global Markets Asia Limited 26 Fixed Income Credit Analysis • Credit Sector Specialists . Asian Banks – Indian bank ratings and support uplift by Moody’s Banks Public Sector Banks State Bank of India Punjab National Bank Bank of Baroda Bank of India Canara Bank IDBI Bank Union Bank of India Central Bank of India Indian Overseas Bank Syndicate Bank Oriental Bank of Comm Private Sector Banks ICICI Bank HDFC Bank Axis Bank Yes Bank Baa2 Baa2 Baa2 Baa3 Stable Stable Stable Stable CCCD+ Baa2 Baa2 Baa2 Ba1 0 0 0 1 BBBBBBBBBNR Baa2 Baa2 Baa2 Baa2 Baa2 Baa3 Baa2 Baa3 Baa3 Baa2 Baa2 Stable Stable Stable Stable Stable Stable Stable Stable Stable Stable Negative D+ D+ D+ D+ D+ DD+ DD D+ D+ Baa3 Baa3 Ba1 Ba1 Baa3 Ba3 Ba1 Ba3 Ba2 Ba1 Ba1 1 1 2 2 1 3 2 3 2 2 2 BBBNR BBBBBBBBBBBBBBBNR BBBBBBNR Moody's Rating Outlook BFSR BCA Notch Uplift S&P Rating Figure 41. we believe that the banks would be able to secure liquidity from the government or central bank as well as issue government guaranteed bonds similar to the financial crisis. We prefer Korean quasi-sovereign banks. However. liquidity is sufficient over the next few months. However. and the banks no longer have structural or product problems such as KIKOs or future shipping options that were problematic in 2008. Given that both household debt to GDP and disposable income remains elevated and the majority of mortgage loans are floating rate interest only instruments.

1% of total. We recommend positioning in defensive quasi-sovereign power and oil & gas credits and taking advantage of new issue opportunities to stay defensive in advance of a tactical shift down the credit curve later in the year. Hong Kong and Korean sectors. the range of A-rated credits is much broader than other rating buckets within Asian high-grade. This is supported by our analysis of relative value within Asia. however this is made up for higher quasi-sovereign participation in the Korean bond market. Given the cash that is being kept out of the Asian game by the macro volatility. Asian Investment-Grade: Spread Performance of Asia’s ABBI versus the US BIG Corporate Index 400 300 200 100 bps ABBI IG Corp [Rating A-. A-rated credits appear to offer poorest value versus the US (as they trade flat). since that sector is dominated by quasi-sovereign issuers in fundamentally strong industries.0bn according to our estimates for ‘2012. we have calculated aggregated ratios for listed US$-bond issuers across the Chinese. should outperform high-yield in the early part of the year as the more defensive play. we think that higher-rated issuers in fundamentally sound sectors such as power and oil & gas will be well received by a jittery market with few alternatives. Figure 42. Citi Leverage and Fundamentals Country-level analysis: high-grade looks in good shape In the below charts.5 years). and despite a sizeable pipeline of US$23. Duration 6. In addition.5 versus 6. Bloomberg. Note that we have excluded unlisted quasi-sovereign and Citigroup Global Markets Asia Limited 27 Fixed Income Credit Analysis • Credit Sector Specialists . offer less compelling value given the importance of earnings stability this year. Credit quality appears to be on average better in Hong Kong than Korea.7y] 0 Jan-10 Jul-10 Jan-11 Jul-11 Source: Yieldbook. We also compared valuations with the US.December 15. and we think there are still defensive opportunities in the quasi-sovereign power sector therein. Duration 4. which suggests that private sector credits in real estate and cyclical industries such as automotives and steel. 2011 Asian Credit Outlook 2012 Investment-Grade Corporates Investment Strategy Investment-grade credit is looking in good shape fundamentally. however this is deceptive as Asian A-rated credits are on average 2 years shorter in effective duration than the single-A tranche of the US high-grade corporate index (4. given it constitutes the largest component of Asian high-grade corporate credit at 58.7y] US BIG Corp [Rating A-. We would target these names for longer-term value. which show that the AA-rated sector is the most attractive. China’s fundamentals are strongest. due to the presence of high-rated quasi-sovereigns in the Chinese oil and gas sector.

This is because credit quality is on average better in Hong Kong than in Korea. which contributed 58% of sales and have unusually low margins by high-grade standards. which is dominated by corporates with a weakening industry backdrop (steel and automotives account for 51% of the EBITDA of our sample set). Aggregated Corporate Ratios: China* 15 12 9 6 3 - EBITDA/Int 50% 40% 10 8 6 4 2 FY10 1H11 15% 12% 9% 6% 3% 0% 10 8 6 4 2 FY10 9M11 15% 12% 9% 6% 3% 0% EBITDA % RHS 30% 20% Debt/ EBITDA FY10 9M11 10% 0% Source: Bloomberg. the credit metrics are all over the place. Citi. for quasi-sovereigns. excludes unlisted corporates/quasi-sovereigns Leverage versus margins The below charts plot leverage as measured by net debt/EBITDA against EBITDA margins. indicating lower profitability relative to the Hong Kong corporates. In Korea. Hong Kong metrics are skewed by trading businesses. thanks to a 43% contribution to EBITDA from the property sector.December 15. This is an interesting contrast to the previous analysis that appears to show that on an aggregated basis.  China understandably has the strongest ratios. indicating lower leverage. In China. The metrics nevertheless show that the pace of deterioration in profitability is modest and leverage is slightly lower as of 1H11 than during FY10. but profitability is still relatively stable. the credit metrics appear to be generally of lower quality than in Hong Kong. *Ratios are aggregated for all listed US$-bond issuers.e. Aggregated Corporate Ratios: HK* Figure 45. 2011 Asian Credit Outlook 2012 private-sector issuers given the lack of quarterly disclosure and. i. This makes sense. Hong Kong’s metrics are generally weaker than Korea’s. given the contribution of government-owned (but HK-listed) bond issuers in the oil & gas space. which is heavily skewed in favour of quasisovereigns. Citigroup Global Markets Asia Limited 28 Fixed Income Credit Analysis • Credit Sector Specialists . Figure 44. since the distribution of corporates appears to be generally lower in the chart. where credit ratings are among the highest across all of high-grade.. there is a noticeable decline in interest coverage as leverage crept up slightly. but with a critical mass further to the left. but is skewed by the presence of higher-levered trading companies which have belowaverage margins. There seem to be clear differences between the three sectors that appear to be a function of the level of quasi-sovereign involvement in the credit space. the dependency on sovereign credit-worthiness. given the higher participation of quasi-sovereign issuers. since Korea’s corporates have less dependency on financial metrics to drive credit quality. In Korea. Aggregated Corporate Ratios: Korea*   Figure 43.

Bloomberg.3bn in deals of which just under half (43.00 Source: Loanconnector. printed US$5. This was made up for by robust issuance out of the China (US$8.4bn. New Issue Breakdown by Country: 2005-2011 25 US$ bn 20 15 10 5 0 2005 China Singapore 2006 2007 Hong Kong South Korea 2008 2009 India Others 2010 2011 Malaysia Figure 49. This environment should favour high-rated issuers in Asia with quasi-sovereign linkages or solid industry positioning.0bn. largely driven by a sharp decline from Hong Kong to just US$1.8%) came from the quasi-sovereign sector. Figure 48.8bn. Bloomberg.00 6.December 15. The other major issuance market. Citi Record year of high-grade corporate issuance lies ahead We expect a 29.00 Net Debt/ EBITDA (x) EBITDA Margin % Korea HK China HKL 10. Net Debt/EBITDA versus EBITDA Margin %: By Issuer 70 60 50 CNOOC 40 30 20 10 (2) HKCG CLP PCCW SHK CHIBEI HenLnd Zijin KT CRP Swire SKBB NWD Kerry HynMtr Hutch KEPCO BeiEnt Posco KOGAS HSteel SKI Lotte MCC Kia LiFng Net Debt/ EBITDA (x) Noble 2 4 6 8 10 12 CHIOLI EBITDA Margin % Figure 47.00 12. Citi Source: Dealogic.9bn). Maturity Profile of US$-bonds outstanding 70 60 50 40 30 20 10 (2.3% yoy to US$17. after printing US$8. South Korea.00) 2. Asian Investment-Grade: Country Breakdown Others Sing India Hong Kong Malaysia China South Korea Source: Dealogic. primarily from oil & gas.6bn in ‘2010 and US$7. Citi Market structure and technicals Chinese quasi-sovereigns join the fray This year’s total investment-grade issuance of US$17. municipal government and other state-owned issuers. 2011 Asian Credit Outlook 2012 Figure 46. We did not see repeat of last year’s aggressive issuance by heavyweight conglomerates and property issuers. Citi Source: Dealogic.00 8.8bn represented a decline of 16. and since we expect cash Citigroup Global Markets Asia Limited 29 Fixed Income Credit Analysis • Credit Sector Specialists .00 4. Bloomberg. based on: (1) Jittery Markets: We expect high-yield issuance to remain out of favour in the early part of the year given macro factors and weak technicals.1bn in ‘2009.0% yoy increase in high-grade corporate issuance to US$23.

with some incremental buffer to account for refinancing demand from syndicated loan markets as European banks pull out. we believe this will provide a relatively defensive way of deploying into the market while avoiding the potential volatility of high-yield.6% yoy) in potential supply. refinancing requirements seem unusually low at sub-US$5bn this year.1bn).0bbn (+493. Bloomberg. (3) Hong Kong: refinancing early: This will be the other major sector. The reason we have assumed such a large increase is to do with pre-funding of the US$5. there is a lull in refinancing requirement which will pick up going into the ‘2013-2016 period before going quiet again in ‘2017/’2018. Figure 50. As shown below (Figure 50).1%). Our detailed investigation revealed that this appears to be a function of very low high-grade corporate issuance back in 2007 (just US$3. as that year’s issuance was completely dominated by banks (accounting for 59. Citi Citigroup Global Markets Asia Limited 30 Fixed Income Credit Analysis • Credit Sector Specialists . We expect the Chinese high-grade corporates that tap the market to have extremely robust market position in their respective industries.0% yoy). Hong Kong has the largest share of US$denominated syndicated loans maturing in ‘2012 that have European bank participation (defined as excluding UK banks). What about refinancing requirements in the public bond markets? As shown in Figure 51. strong sovereign linkage. accounting for about US$8. or be in sectors that are globally favoured.0bn in new supply out of China (+12. Citi Source: Dealogic. such as oil & gas and maybe even power. At first glance it appears that this is too low and can’t possibly be right. We estimate this at about US$6bn but suspect the real figure could be larger than this.6bn in refinancing requirements from ‘2013. 2011 Asian Credit Outlook 2012 positions to be high going into next year. (2) China’s cash-hungry corporates: We believe China will continue to be a major factor and are projecting a further increase to US$10.December 15. Thus five years on. Maturity Profile of US$-bonds outstanding 80 60 40 20 - US$ bn All Currencies US$-denominated due beyond '2012 US$-denominated due in '2012 25 20 15 10 5 0 US$ bn HK SG KR CN Other ID TH IN TW 12 13 14 15 16 17 18 19 20 21 22+ Source: Loanconnector. Syndicated Loan maturities with European Bank Participation (excludes UK Banks) Figure 51.

which are generally private-sector names. Korean credits also appear to be in a tight spread range. the range of ratings is fairly wide. we expect Hong Kong to underperform fundamentally. Figure 52. show a much broader distribution of spread and duration profile. has a much less developed credit curve. 2011 Asian Credit Outlook 2012 Valuations Relative value within Asia: spot the difference The below Figure 52 shows the distribution of Asian high-grade credits from the three key sectors: Korea. Asia’s credit curves look anything but normal. and this is probably due to the high concentration of shorter-dated paper from the quasi-sovereigns. and thus we would expect the 10-year sector to become larger and potentially reverse the current inversion of the credit curve. and are exposed to the cyclical property sector. due to the different levels of quasi-sovereign issuers within the nebulous infrastructure of the state. This reflects the fact that despite being a sector of largely quasi-sovereign issuers. Hong Kong and China. Hong Kong credits. Korean credits tend to be shorter in duration on average. reflecting both the presence of quasi-sovereigns. As shown at the 7-8-year point on the duration curve. but credit spreads effectively inverted beyond 10-years due to limited supply against heavy demand from regional real money investors. Citigroup Global Markets Asia Limited 31 Fixed Income Credit Analysis • Credit Sector Specialists . and the fact that private sector corporates are trading too tight as a sector. Companies. Citi Credit Curves in Asia As shown below. being the newest of the three sectors to gain critical mass. the credits appear to be spread out vertically across a wide range of spread points. treasury curve). Chinese corporates. but suspect the lower-rated names are probably trading too wide relative to the level of sovereign support they would likely receive in the event of distress.S. we recommend sticking to the higher-rated issuers. We expect the credit curve to normalize going forward given issuers should be looking to price in the 10year segment given the limited additional funding cost on account of the curve inversion (which offsets the positive slope of the 5s10s U. Here. Relative Value within Asian high-grade 600 500 400 300 200 100 0 0 Z-spread (bps) Hong Kong China Korea Modified Duration (years) 2 4 6 8 10 12 Source: Bloomberg. Given Hong Kong credits are trading largely in line with Korean credits. This will clearly get lengthened out in the coming years.December 15. This reveals some interesting patterns.

Relative value – Asia’s ABBI vs US’ BIG index 2 Yield to Maturity Differential (Asia . 2011 Asian Credit Outlook 2012 Figure 53. A-rated corporates make up 58. the pickup is greatest in the AAA and AA-rated space. however this is where the majority of Asian investment-grade corporate bonds are. The BBBrated sector does not come off as particularly attractive when compared with the pickup available in AAA/AA rated credits. The A-rated sector appears to offer the poorest value relative to the US. Citi Finding value: comparison with US investment-grade As far as relative value against the United States is concerned. which has an average ABBI rating of A-.December 15. however it is nevertheless positive. while the AA-pickup clearly reflects the underperformance of Chinese AA-rated oil & gas quasi-sovereigns. which have been punished by the broader negativity on China. The AAA-pickup is not too relevant given the lack of AAA-bonds in Asia. Credit curves in Asian high-grade 350 300 Z-spread (bps) GS Caltex Posco 250 CNPC 200 Kepco 150 100 50 0 2 4 6 8 10 Modified Duration (years) 12 14 16 Petronas Hutch Source: Bloomberg. Citi Citigroup Global Markets Asia Limited 32 Fixed Income Credit Analysis • Credit Sector Specialists . Figure 54.1% of the ABBI high-grade corporate index. Clearly there is value here.US) (%) 1 AAA BBB AA A 0 -1 Jan-10 Jul-10 Jan-11 Jul-11 Source: Yieldbook.

We expect downside risk in ‘2012. On the positive side. Hong Kong’s open economy. We Citigroup Global Markets Asia Limited 33 Fixed Income Credit Analysis • Credit Sector Specialists .75% and 4. Tipping point in Hong Kong property? The Hong Kong properties market has been a responsive indicator to the economic landscape. Very low debt levels. usually with a six month lag.5% for 2012. Hong Kong has one of the healthiest fiscal balance sheets in the world.December 15. while trade linkages are also extremely strong. thus the pickup to single-A is much more substantial even though A-rated credits trade across the two regions. Figure 55. Relative Value by Ratings Distribution: Asia ABBI 6 5 4 3 2 1 0 Jan-10 Yield to Maturity (%) BBB A AA BBB A AA Jul-10 Jan-11 Jul-11 Jul-10 Jan-11 Jul-11 Source: Yieldbook. This is more conservative than IMF’s forecast of 5. Beijing have only experienced one. a halving of growth in China would put Hong Kong into a “sustained downturn with close to zero growth for the next two years”. lack of independent monetary system due to the currency peg.5% earlier in the year in light of lower merchandise exports and the wealth destruction effect due to the Europe crisis. Chinese buyers have contributed to substantial retail and property demand. According to IMF’s latest report. its economy will be highly susceptible to shocks in external demand led by the Europe crisis.0% for 2011 and 3. The pickup to BBB-rated credit is more substantial in Asia. London. Citi Focus on Fundamentals: Hong Kong Property approaches the tipping point Macro fundamentals: tied to China Citi’s economists revised Hong Kong’s GDP forecast to 5. The first thing that is immediately obvious is that the AA-rated credits in the US trade much tighter than in Asia. the property cycle in Hong Kong is shorter than that in other cities.6% and 4. down from 5. thus again AA-credit comes out looking best here (constitutes just 8% of Asian bonds though). Relative Value by Ratings Distribution: US BIG 6 Yield to Maturity (%) 5 4 3 2 1 0 Jan-10 Figure 56. trade financing and the funding channels (discussed in the Banks section above). 2011 Asian Credit Outlook 2012 The below charts compare the pickup for moving down the credit curve in US credit (represented by the US BIG index) versus the similar pickup in Asia (represented by the Asia ABBI index). Our economists forecast government debt/GDP at 2% for 2012. Historically.0% respectively. The transmission mechanism will be through external trade. cultural demand for home ownership and low-tax system have contributed to the frequency and severity of property cycles. A key risk at the macro level is Hong Kong’s linkage with China’s economy. Since 1994. Citi Source: Yieldbook. coupled with sizeable fiscal reserves and a robust and well-managed banking system are key strengths. and Hong Kong’s sovereign upgrades in 4Q10 were linked to China’s ratings. Hong Kong has experienced four significant downturns while New York. As Hong Kong operates under an open economy without an independent monetary system.

including the government’s commitment to increasing land supply. from Oct-97. accelerated pre-sales of primary properties and 4Q land auction/tenders missing estimates.1bn) for 3Q11. is at its highest level since 2Q09. Negative equity cases rose to 1.6% from the peak at Jun-11 which had nearly reached the preAsian-crisis peak of 102. capital raising activities by developers. down 2. Hong Kong Land Registry Tipping point? The weekly transaction volume of Hong Kong’s top 35 housing estates has dropped to around 100 units recently. weak property turnover in the secondary market. Mixed signals tending towards downside risk Several indicators suggest consolidation in property prices.13. and cut prices by 10-15% below Citigroup Global Markets Asia Limited 34 Fixed Income Credit Analysis • Credit Sector Specialists . “Pre-sale rush” an indicator of downtrend? With a pipeline of 834 units from seven projects. which was denied by Donald Tsang a day later. wealth effects from volatility in global equities. Policy risk will be a major source of volatility since Chief Executive Donald Tsang reintroduced the Home Ownership Scheme (having rejected it a year earlier). whereas rental income should hold up well. We are comfortable with credit risk of Hong Kong developers.675 unit transactions for HK$27. and another 5. matching the 2008 crisis level. 2011 Asian Credit Outlook 2012 expect the retail and office retail segments to outperform that of residential. Total property transaction rebounded slightly from a 32month low of 5. we expect new policies to be introduced. This reflects less willingness to lend on the part of banks in a low margin business. We believe a sharper downtrend in property prices will need to be in full evidence before the “government’s put” comes into play.5% of total outstanding value of mortgage loans. The latest Centa-City Leading Index was 98. Financial secretary John Tsang mentioned the possibility of policy easing in early December. Developers have brought pre-sale marketing forward by a month in some cases.653 (HK$4. Hong Kong Property: Monthly Transaction Volume and Prices 25000 Monthly Transaction Volume (units) 20000 15000 10000 5000 0 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 HK Property Transaction Volume (LHS) HK Property Prices (RHS) 7000 6000 5000 HK$/sqf 4000 3000 2000 1000 0 Source: Centaline. We believe property issuers with high proportion of rental income will outperform. skewed to the downside. With the change of office in July-12.5bn in the month of October. HIBOR-linked home mortgages registered a substantial decline from >90% of new mortgages in 4Q10-1Q11 to 46% over the last 6 months. the bar has been set rather high given the downside risk to prices. Figure 57.December 15.93.6% drop of property prices. following a mere 2. A 10-15% drop in residential property prices would not surprise us. but believe the foundations of a downtrend have already been laid and will weigh on credit metrics in the year ahead. While still low at 0.211 units from nine properties already in the primary market.

Together with a 2.6-year low in residential property transaction volume. in order to stimulate demand. As the wealth gap persists in Hong Kong and new properties are sold as luxury flats regardless of size. which we believe are relatively low in the immediate term. 2011 Asian Credit Outlook 2012 initial estimates in others. What concerns us most is not the developers’ actual liquidity requirements. One concern we have is that the government’s launches of land auctions are evenly spaced out and hence are irrespective of market conditions. It is interesting to observe that issuance increased qoq. HK Chief Executive Donald Tsang announced the government’s continued commitment to increase supply of residential units. we are concerned about ongoing private units land supply and policy risk in the medium term. 5. we believe this is a clear indicator of weak markets ahead. Citi Pre-emptive fund-raising? Hong Kong property companies raised raised US$1. Hong Kong Property: Primary Market Project Developer ASP(HK$/sqf) Units Sold 1 2 3 4 5 6 7 8 9 La Splendeur Marinella The Wings One Mayfair The Warren Festival City III Providence Bay One Wanchai The Altitude Cheung Kong/Nan Fung/MTRC K Wah/Sino Land/Nan Fung SHK Sino Land Wing Tai Properties Cheung Kong Sino Land/Nan Fung/K Wah/Wing Tai Chinese Estates Holdings Kerry Properties/Peterson 5000-6000 19000-20000 8000-13000 17000-19000 ~20000 8000-10000 15000-20000 18000-20000 19000 1168 411 1028 120 103 1536 482 237 126 5211 1078 290 925 86 41 250 156 13 14 2853 Source: Companies.000 respectively. A target was set to supply approximately 20.December 15. Eligibility for PRH and HOS is available to a 3-person income below HK$16. We are more concerned about what this implies about developers’ expectations about the market outlook and future access to funding channels. a rough price estimate for a 500 sq ft unit is around HK$2mn. Figure 58. The unit price is lower than most new property prices in the market which is usually above HK$3mn. government-initiated land sales coupled with the Application List system is designed to ensure a smooth pipeline of land supply for development according to the policy address.000 private units. North Point Oil Street and Shatin Site 56A. The last three land auctions. we believe impact to private property sales from PRH supply is nonexistent and that from HOS is minor. the market is highly segmented. peaking in 4Q11 amid turbulent financial markets and in spite of relatively benign immediate funding needs.2bn in bonds (across all currencies) and US$158 in equity (at a deep discount) in 4Q11.000 and household income below HK$30. Hence. Given that it is difficult for large-scale developers to miss the opportunity to bid for Citigroup Global Markets Asia Limited 35 Fixed Income Credit Analysis • Credit Sector Specialists . given the timing of fund-raising in such difficult markets and with no apparent funding or investment requirements. Supply risk in the property market For private units. However.000 public rental housing (“PRH”) units per year. Supply-side mechanics: policy risk for developers In the latest policy address announced in October.000 home ownership scheme (“HOS”) units and 15. For HOS units. namely those of the Nam Cheong site. for which pre-sales will not start until 2014/2015. were concluded at levels below initial market estimates.

there were only 5 cases of speculative resale transactions up to Nov-11. Investors should be watchful in how this plays out in the medium-term.. some of these transactions were sold at a loss on top of the additional stamp duty. reclamation and peripheral land use.000 per year according to a 10-year average household formation rate of 1. with risk to the downside. With the implementation of additional stamp duty for property resale within 2 years of purchase starting Nov 2010. Figure 59. 2011 Asian Credit Outlook 2012 landmark sites such as West Rail Nam Cheong.December 15. growth of households through marriages and population growth should amount to 31.Additional Stamp Duty for resale 3/8/2011 6/10/2011 Set maximum flat sizes in new land supply Tightening Mortgage . and 3) purchase of holiday homes. According to our equity colleagues. we see greater policy uncertainty in the medium-term to the property price trajectory.LTV Ratio (Tightening first started in Oct 09) 10/12/2011 10/12/2011 10/12/2011 10/12/2011 Resumption of Home Ownership Scheme (HOS) .32% p. Chinese individuals continue to be net buyers of HK properties due to 1) channeling of excess liquidity into investment vehicles. Both potential candidates for the ‘2012 Chief Executive election. we are concerned with the increasingly swift execution of strict policy measures such as Special Stamp Duty and the quick policy reversal from affirming no HOS supply to fully resuming HOS housing within a year.Government subsidized housing Increase supply of Public Rental Housing (PRH) Refine "My home purchase Scheme" Reinforce land supply Banning the sale of property to a sub-purchaser before the legal completion of the original sale Subsidizing purchase of government housing with up to 50% of rents paid prior to purchase Investing in properties ceases to be an option for investment immigration into Hong Kong Additional Stamp Duty for short term property investors Property resold within 6 months has to pay a 15% stamp duty on value of transaction Property resold within 6-12 months has to pay a 10% stamp duty on value of transaction Property resold within 12-24 months has to pay a 5% stamp duty on value of transaction Restrict sizes of newly built units Maximum loan value from banks is restricted 50% max. On the other hand. are proposing housing policy measures above and beyond what is already in place. 50% of the purchase notional for Citigroup Global Markets Asia Limited 36 Fixed Income Credit Analysis • Credit Sector Specialists . Selected property measures implemented in Hong Kong Date Policy Details 8/13/2010 10/13/2010 10/13/2010 11/19/2010 Restrict all confirmor transactions in new primary projects "My home purchase Scheme" Banned property investment option for Capital Investment Immigration Scheme Reducing secondary market churn . 2) home purchase for babies born in HK. CY Leung and Henry Tang. Policy risk With regards policy risk. Citi Demand-side mechanics: the role of Chinese buyers We see housing demand originating from a) organic growth of households and b) Chinese purchases after speculative demand ebbs.a.2mn Additional 10% for mortgage applicants whose principle income is not from HK 50% for all non-residential properties Maximum LTV ratio for mortgage is 40% of borrower's net worth Providing 17000 units of HOS housing starting 2016-2017 for families with household income less than HK$30000/mth Providing 75000 units for the next five years for families with income less than HK$8740/mth (1 person family) Purchase price look-back option for rental buyers Supplying 20000 units to private developers every year on average along with 15000 PRH Source: Hong Kong Government. LTV for homes of HK$10mn above 60% for flats valued between HK$7-10mn 70% for those below HK$7mn capped at HK$4. If the government adopts interventions which are less laissez-faire (restricting purchase) in favor of more laissez-faire policies (increasing supply) following developments in China. Interestingly. the former favors a strict control over unit growth while the latter. In 3Q11. there is a risk that developers acquire too much land too early in the current property down-cycle.

Thirdly.5% (12. price cuts and potential policy loosening could keep capital onshore and ease the demand for HK properties. Citigroup Global Markets Asia Limited 37 Fixed Income Credit Analysis • Credit Sector Specialists .5% will be sustained. registering a net take-up of 9. one at Wong Tai Sin and five at Kowloon Town. In the latest quarter there was one case at Olympic city.0% sold).5m to HK$4. some of which involved Chinese buyers. property prices historically have a 6-month lag to equity performance. Other than one-off cases. we see an increased correlation between equities and property demand. Secondly. While we do not see a change in long-term demand from Chinese buyers for Hong Kong properties due to structural migration. we take caution in the lagged effect to follow. Amidst the recent equity market weakness since August. Hong Kong has seen purchase rescission cases for luxury flats. This translates to roughly 9.1m.000 units in demand per year. 2011 Asian Credit Outlook 2012 primary properties in 3Q11 came from Chinese buyers (Oriental Daily. Hong Kong properties have been serving as an investment channel for Chinese savings given purchase restrictions in the property market in China.December 15. the spike in applications before the window of opportunity closed for investment immigration through property purchase last October would translate to demand up to 3Q11.5% bought and 3. We do not have a precise estimate for the drop in transaction volume but we doubt that the net take-up of 9. which represents a 12-month deadline within which transactions must be completed. With the Chinese property sector facing an extremely challenging outlook. Centaline). we are cautious of the shortterm risks. With a gradual sell-off in global indices. up from a 4-year average of 5-6%. Demand risk from China Firstly. with buyers forsaking deposits ranging from HK$2.

with issuance picking up in the second half. while we believe a big pipeline has been built up after a dead 2H11. it has less sector concentration. Despite higher historical default rates. to put a figure to it. land purchases and bank lending to developers. the upside-downside on property bonds at the current level looks less favorable for investors. Another relevant factor is the rapidly expanding CNH market. for the first half of 2012. should market normalize. We see greater likelihood of downward pressure in the direction of the 2008 lows than of positive catalysts materializing. which will absorb part of the supply requirements of the sector. a shorter track record and inferior asset coverage ratios. Chinese industrials appear to be a lower-beta sector and have always been trading at a premium to property sector credits. as we assume the market will remain closed at least in the first quarter. issuers are hesitant to print at current levels unless they are desperate for funding. as the global macro and property sector outlook are not necessarily any better than in 2008. despite a significant selloff from issuance levels. In addition. Citigroup Global Markets Asia Limited 38 Fixed Income Credit Analysis • Credit Sector Specialists . we doubt there will be any appetite for high-yield in the near term. It is likely that property bonds will take another leg lower in 2012 before any sustainable rebound. Technicals will remain weak for Chinese property as the sector continues to be heavily exposed to negative headlines. Therefore. While non-property issuance is even more opportunistic. weaker corporate governance. is relatively easier for investors to differentiate and provides muchneeded diversification in the China high-yield space. potential issuance will also weigh on technicals once the market normalizes. Under current market conditions. supply. With a year-end rally. in reality property bonds will probably continue to trade at a discount for a prolonged period. we see a set of variations on the theme that property remains one of the most important sectors for Chinese economy. we continue to play on the defensive side by focusing on BB names while picking up only a couple of high-quality B names to enhance return. Meanwhile. Chinese Property – Variation Chinese property bonds were down as much as 30pt from the highs of the year. Supply forecast Supply will be contingent on market conditions. with the fall beginning on the back of tightening measures on all possible aspects: demand. 2011 Asian Credit Outlook 2012 High-Yield – China Overview Technicals rule the market. we estimate close to US$7bn in supply.December 15. In 2012 and going forward. While we tend to argue Chinese property bonds should theoretically trade through industrial names based on default probability and recovery prospects. Therefore.

RHS Source: NBS. the focus should shift to how much worse the situation can get and when potentially the turning point may arrive.000 6.3 Average: 92. National Property Transaction Volume and ASP 200. 30.December 15.000 Ja n05 Ap r-0 5 Transaction Area .000 140. which should be neither surprising.000 80.000 120.000 100. Figure 61.2 High on Nov.000 '000 sqm 60.000 40. 8.000 4.000 RMB psm 2. Citi Price Chapter 1: A long and cold winter Missing 2011 sales targets has clearly become a reality for most developers.1 120 25 100 20 80 15 Price 60 10 40 5 YTM 0 Oct-10 Dec-10 Mar-11 May-09 Nov-09 Dec-08 Aug-09 Dec-11 7. 2011 Asian Credit Outlook 2012 Figure 60.0 Last: 86. 2008: 57. Citi Citigroup Global Markets Asia Limited 39 Fixed Income Credit Analysis • Credit Sector Specialists .000 3. nor a key focus.000 180.000 5. 2010: 106.LHS O O Average Selling Price .000 1.000 ct -0 7 Ja n08 Ap r-0 8 ct -0 8 Ja n09 ct -0 5 Ja n06 Ap r-0 6 ct -0 6 Ja n07 Ap r-0 7 Ap r-0 9 Ju l-0 9 O ct -0 9 Ja n10 Ap r-1 0 Ju l-1 0 O ct -1 0 Ja n11 Ju l-0 8 Ap r-1 1 Ju l-1 1 Ju l-0 5 Ju l-0 6 Ju l-0 7 ct -1 1 O O O 20 0 Feb-09 Jan-10 Jun-11 Jul-10 Sep-11 Apr-10 YTM Source: Yieldbook.000 160. ABBI China Property Index Historical Performance Low on Oct. Instead.000 20.

as they may not want to offend their old customers. Beijing Tongzhou was trading extremely expensive on speculation that the local government would relocate there.LHS Average Selling Price . Those dramatic cuts are only happening in certain projects or areas that were highly speculative due to specific reasons. However. We expect transaction volumes to bottom out first in tier 1 and key tier 2 cities. For example.December 15. hence making a rebound unsustainable. The huge jump in December sales witnessed every year will likely be maintained but to a much lesser extent. it is difficult to change prices.0 Ja 8 n0 Ju 9 l.0 Ja 9 n1 Ju 0 l. particularly with a high base in 2010. Resistance to price cuts can only lengthen the winter period. and (4) Developers are reluctant to cut ASPs on existing projects or new phases of existing projects. Shanghai 12% and Shenzhen 9%. There are reports of dramatic price cuts in certain cities. the eligible buying power in the market will be quickly absorbed by the early round of price promotions. 2012 won’t be the year of property-mania that 2009 was owing to the existence of HPR and tight mortgage policies. Hence. Realistically. while the rest are less willing to cut if limited demand has already been satisfied. Figure 62. as (1) the volume decline has been partially absorbed in second half of 2011 when policy tightening measures were intensified. we think developers can tolerate 10%15% real discount without a significant impact on net margin due to the offsetting Land Appreciation Tax (“LAT”) savings. Beijing Transaction Volume and ASP Figure 63. for those projects. the price corrections were also partially attributable to different sales mix. Overall. developers intend to offer promotions with all the flexibility on site. Bejing has seen a 10% ASP decline since August.0 Ja 5 n0 Ju 6 l. In comparison.LHS Average Selling Price .RHS Source: NBS. which to some extent should support transaction volume.RHS Transaction Area .0 Ja 6 n0 Ju 7 l. We expect further volume declines due to both seasonality and a high base in early 2011. (2) Home purchase restrictions (“HPR”) makes price cuts less effective given the decline in eligible purchasing power in the market. A few smart developers seized the first-mover advantage by offering competitive pricings on new launches before their competitors. While volumes will recover to some extent as prices fall. Shanghai Transaction Volume and ASP 3500 3000 2000 '000 sqm 1500 1000 500 0 -0 Ju 5 l. Certainly.1 Ja 0 n1 Ju 1 l. We believe the physical market in 4Q11 should see a low-teens year-on-year transaction volume decline. lower-tier cities may either start or continue to see downward pressure in both price and volume. This is not encouraging.0 Ja 8 n0 Ju 9 l.0 Ja 6 n0 Ju 7 l. Citi Citigroup Global Markets Asia Limited 40 Fixed Income Credit Analysis • Credit Sector Specialists .1 1 Ja n Transaction Area . (3) good-quality projects can still sell well even without price cuts or promotions. 2011 Asian Credit Outlook 2012 Our recent trip to China showed that there has not been official large-scale price cuts yet. 2011 still likely sees nationwide transaction volume up by a low-single-digit percentage owing to a good performance in the first half. Clearly suicidal price cuts are not the broader trend and should not become the trend.0 Ja 5 n0 Ju 6 l. we may not see the 20% nationwide yoy decline we saw in 2008. or else the game will be up for the entire sector.0 Ja 9 n1 Ju 0 l.1 1 Ja n 2500 25000 20000 15000 10000 5000 0 RMB 'mn 18000 16000 14000 12000 10000 8000 6000 4000 RMB psm 2500 '000 sqm 2000 1500 1000 500 0 -0 Ju 5 l. For example. Citi Source: NBS. This means actual average selling prices (“ASPs”) could be much lower than those recorded on the government’s website.1 Ja 0 n1 Ju 1 l. because (1) for projects that have already obtained sales permits.0 Ja 7 n08 Ju l. and (2) developers have started price cuts in 4Q. as developers start to cut prices more aggressively and earlier in tier 1 and key tier 2 cities than lower-tier cities.0 Ja 7 n0 Ju 8 l.

particularly at a time with high inflation and food prices. the government does not want a collapse of the sector either given its broader ramifications on the economy. which clearly is not what the government wants. 3m units each will be delivered in 2011 and 2012. In our view. 2011 Asian Credit Outlook 2012 Figure 64. Citi It’s a policy solo! Macro monetary environment may ease but administrative control on property will persist… Property sector control is more than just an economic issue.LHS Average Selling Price .0 Ja 8 n0 Ju 9 l.RHS Source: NBS.0 Ja 9 n1 Ju 0 l.1 1 Ja n Figure 65. It is the central government’s decision on how much the price should drop.RHS Transaction Area . Historically. Without a mature social housing system to complement private housing supply. particularly this time.0 Ja 6 n0 Ju 7 l. and the 2013 number depends on the availability on funding. … until … Clearly. Guangzhou Transaction Volume and ASP 1800 1600 1400 '000 sqm 1200 1000 800 600 400 200 0 -0 Ju 5 l.December 15. it is more Citigroup Global Markets Asia Limited 41 Fixed Income Credit Analysis • Credit Sector Specialists . Controlling the property sector has become the government’s tool. we probably will see a high chance of policy relaxation. According to the latest figures released by the Ministry of Housing and Urban-Rural Development (“MoHURD”). the government can leave the private-sector housing to follow market trends instead of using administrative measures to deliberately curb prices. to balance public opinions and ensure social stability.0 Ja 7 n0 Ju 8 l. the government/party may lose face and popularity. the government has no option but to use administrative measures to curb skyrocketing property prices to partially alleviate discontent from low-to-middle income consumers. if more than 80% see month-on month price corrections for consecutive six months with a cumulative year-on-year price correction of 10-15% on the index. of the 70 cities that NBS tracks. What we know from the recent high government officials’ publicity is that the October price correction recorded by the NBS remains insignificant and unsatisfactory. housing prices will likely see a retaliatory price rebound. While the number looks quite insignificant compared with normal housing. (2) the completion and launching schedule of social housing. Shenzhen Transaction Volume and ASP 20000 18000 16000 14000 RMBpsm 1200 1000 '000 sqm 800 29000 24000 19000 RMB psm 12000 10000 8000 6000 4000 2000 0 600 14000 400 200 0 Ja n0 Ju 5 lJa 05 n0 Ju 6 l-0 Ja 6 n0 Ju 7 l-0 Ja 7 n0 Ju 8 l-0 Ja 8 n0 Ju 9 l-0 Ja 9 n1 Ju 0 l-1 Ja 0 n1 Ju 1 l-1 1 9000 4000 Transaction Area . If the government were to relax measures aimed at cooling the market. China’s official target was to start construction of 10m units of social housing.1 Ja 0 n1 Ju 1 l. Without a satisfactory price correction.0 Ja 5 n0 Ju 6 l.LHS Average Selling Price . Social housing is essential to balance demand and supply in the property market and to avoid social unrest from unhappiness stemming from increasing income inequality and a lack of social safety-net for lower-income citizens. (1) ASP decline recorded by National Bureau of Statistics (NBS). Citi Source: NBS. it has always been a policy-driven sector. Relaxation of the restrictive policies depends on whether the government believes it has solid achievements to show its people. The property market has just started to see some effect from the tightening measures. Once social housing is ready.

On the supply side. HPR should not stay in place forever and will eventually be replaced by market-based long-term measures such as property tax. as it directly suppresses real demand and hence makes price cuts less effective. as the government has some grounds to gradually replace administrative measures by long-term market measures such as property tax. the sector is sitting on a seesaw rather than a slide. we see HPR as the killer. Citigroup Global Markets Asia Limited 42 Fixed Income Credit Analysis • Credit Sector Specialists . Apart from that. Some investors are concerned about the oversupply in the sector by looking at the gap between GFA under construction and GFA sold. The HPR have been proved to be the most effective way to cool down the sector so far in the history of China’s property sector. first of all. which is roughly 5 times. Figure 66. With increasing contribution to GDP and its broad ramification on the society. with three key source of demand: first home buyers on the back of urbanization and formation of new households in the cities. the property sector is simply too important to fail at the moment. We believe the property sector will remain central for a decent period of time. Looking behind the immediate term. However. 2011 Asian Credit Outlook 2012 like a gesture than anything else at this stage. upgraders and investment demand. Looking deeper into the cause of the tough situation. there are reports of low vacancy and ghost towns. (3) significant decline in new housing starts and real-estate investment that pressure the overall economy to the downside amid global macro weakness.8bn hectare. We can take a deeper look at the supply and demand dynamics. but it is not the end of the world. the sector has no way out. as the government has set the red mark for farmland of not less than 1. As discussed in the previous chapter.December 15. more comprehensive taxation and credit system and industrial consolidation. the sector will become healthier with structural problems gradually solved by social housing. Coupled with tight mortgage and banking loans controls. The demand side is quite simple. CIRA Too early to worry about oversupply. dawn will emerge from the darkest moment. which further tie the hands of the buyers and squeeze the developers’ liquidity. can spring be far behind? 2012 is definitely tough for developers. Chapter 2: If winter comes. From a mid-term perspective. supply won’t jump significantly given land supply constraints. once it is ready for the transition. GDP Contribution from China Property Sector Source: NBS.

As a matter of fact. if such a liberalization were to accelerate a decline in property prices for instance. Asset breakdown of personal wealth . 60% Real Estate. developers have maintained a better liquidity position. Even for names like with heightened liquidity concerns in the market. bond. oversupply is not a nationwide problem. we have already see developers slowing down construction. Asset breakdown of personal wealth . We have already heard in certain cities that lower-income groups are not willing to accept the social housing provided by the government for various reasons. While the government aims to offer 20m units next year to the market.December 15. The property sector is generally a safer sector than industrials in terms of default risk due to sector-specific features. bond. we see low probability of bankruptcy.China Others. 2011 Asian Credit Outlook 2012 Secondly. until either there are other better investment alternatives. given a lack of other investment alternatives. certain cities do have oversupply problems. In a sluggish market like this year and next. In relative terms. Chapter 3: Battle for survival: heralding of a new world order? Bankruptcy risks far-fetched for developers under our coverage. Citigroup Global Markets Asia Limited 43 Fixed Income Credit Analysis • Credit Sector Specialists . 15% Real Estate. And we believe the repayment of the ‘2012 bonds by developers will be a boost to market sentiments. Hence. 65% Source: World bank. the existing inventories can hardly be defined as true supply at the moment as properties are in a format of capital reservoir for Chinese people. Thirdly. as they still have assets on their balance sheet to liquidate. while some other cities have quite favorable dynamics. any liberalization of cross-border investment channels would likely first require a reform of the banking system. Citi Fourthly. As discussed earlier in “Polarization over China: Shock from Within?”. in the short run.US/EU Figure 68. 20% Insurance. Citi Source: World bank. the smaller property credits have a higher probability of going under this time. According to our equity analysts’ calculation. Hence. nor do we think this signals a sector meltdown due to oversupply. With local governments so dependent on land sales revenues. this time. compared with A-share-listed and private names.130 msm GFA of supply on a national basis. there will be an annual 800-850 msm GFA demand compared with 900-1. The holders won’t easily dump during market downturns. this would cause a ripple effect into the banking system which has local government debt amounting to 27% of GDP on its balance sheet. But again. All our developers have gone through the last market downturn and learnt to be relatively less aggressive. The listed developers under our coverage are actually the better-capitalized players in the industry. there is very low probability that developers under our coverage will go under. 25% Insurance. we still see their chance of survival as high. or the expectation on property appreciation is completely reversed. which isn’t likely especially in the light of the asset quality issues that came to light this year. how much of that can actually be calculated as “real” supply remains unclear. Hence. equity. social welfare housing: this may be a less straightforward issue. equity. developers can adjust construction rates under differring market conditions. 20% Others. We don’t think this is extremely unhealthy. given their vast liquid asset base and deep roots in the local society. Figure 67.

(2) have ample development resources for the years to come. the majority of Chinese industrial names have ample liquidities to weather through ‘2012 despite mounting macro uncertainties. At the same time. property development has now become a highly capital-intensive business and is not as lucrative as before. from high-end to mass market and have high standard for quality regardless of products. liquidity an leverage are the two most important determinants. construction loans are much more strictly monitored. However. the key factors will be cyclicality of the industry. LAT and corporate income tax. that may not be sustainable in the medium-term. The rule of games have changed. particularly in certain big cities. which probably will see a bottoming-out of profitability as early as in Chinese New Year. transparency and a lack of track record. our bottom-up analysis on these non-property sectors makes us conservative on 1H12 as we see little near-term catalysts. in our view. developers have heavy tax burdens with business tax. which may take some time. thanks to the timely fund raising done in early ‘2011. We use cash on hand to ST debt as a proxy for liquidity and total debt/EBITDA for leverage. indirect/direct exposure to the property sector. there can be sector rotation opportunities as short-term performance may not correctly speak to the mid to long-term perspectives. structural subordination. As a matter of fact. we expect two factors to be the differentiating variables: liquidity and leverage. developers that are best positioned for the long term are those that (1) have a clear market strategy rather than being opportunistic and speculative. accounting standards/fraud. Citigroup Global Markets Asia Limited 44 Fixed Income Credit Analysis • Credit Sector Specialists . accounting for almost 50% of the total sales. China industrials Fundamentals remain acceptable China’s non-property sector have gained traction in 2011 and now accounts for 37% of total China issuance. Certainly.December 15. On the fundamental side. while short opportunities in the steel sector. not only are the barriers to entry much higher and stricter. Pick up the long-term winners. but we think for ‘2012. there are other fundamental indications. and (5) have strong balance sheet and disciplined financial management. Unlike many years ago. Developers have to pay large amounts to acquire a piece of land. limited geographic exposure and development resources will be eventually squeezed out of the market. Meanwhile. That’s why we need to differentiate and pick up the long-term winners. non-property sector issuance appears to be more opportunistic. In terms of macro vulnerability. We see long opportunities in cement and coal credits should the market sell off more on negative industry headlines such as price declines and margin squeeze. Hence. as questions will remain over whether there is a sustainable competitive advantage. The sector fell from well-loved to badly-beaten through the course of this year owing to outbursts of corporate governance issues in the forestry sector. (2) macro vulnerability. property price will be controlled by either administrative measures and/or marketbased measures to crack down on speculators. (4) have diversified geographic exposure or a dominant position in the regional home market with selective diversification. which heightened concerns over sponsor risk. With great industry diversity. sensitivity to China domestic economic slowdown and pricing power (or market share). During the consolidation period. from commercial to residential. In the foreseeable future. 2011 Asian Credit Outlook 2012 Nevertheless. We believe the performance of industrial bonds in 2012 largely relies on a top-down view of (1) fundamental and. we believe land prices and tax burdens will remain high for the sector. but consolidation will occur as developers with less financial flexibility. the presales cycles are lengthened. The good news is companies with vulnerability to both fundamental and macro variables are in the minority. exposure to exports. (3) are able to develop different products. managing a crisis will not necessarily ensure long-term survival.

we think the downside on coking coal prices is well supported by logistical bottlenecks which will not be resolved until 2014. Besides. RMB appreciation does gradually pick up and partially not bode well offset the export decline Higher than expected inventory. we expect coking coal prices to rebound in the latter half of 2012 along with our expectation of improvement on steel output. New VAT tax policy on Corn price stabilization and Leading players stay on the agriculture product processing ASP hikes partially alleviate peak of capex and hence FCF enterprises may roll out to a margin squeeze will maintain negative boarder industry base Falling PV prices may stimulate The sector will continue to report losses in 1Q12 at least. New resources tax in China hurts profitability Sales volume should fall due to weak seasonality.8% and supply growth of 4.December 15. demand. Coking coal prices will remain under pressure in the immediate quarter due to steel production cuts and high coke and coking coal inventory. More bankruptcies in this sector furhter drag down sentiments Textile Source: Citi Cotton price should find a support at Rmb19k/ton Demand from US/EU slows down further. Further macro economic downside Coking coal Logistic bottleneck will support Demand from steel sector ASP shrinks Closure of small mines and higher safety standard to cap supply Frequent accidents cause production disruption Steel Poor outlook for downstream Iron ore and coking coal prices ASP continues to fall and havor Construction of social housing industries such as auto. GM to decline further to burn inventory 2011 down significantly Improving credit environment Final products ASP will continue to fall due to lagging Domestic demand may effect. Despite short-term headwinds. Coking coal. Weakening demand. near-term headline risks remain. Weakening profitability in 1H12 due to high base Further sector consolidation Policy overhang on suspended infrastructure projects. Chinese Industrial Sectors: The lowdown Industry Positives Certainties Negatives Positives Uncertainties Negatives Cement Demand outpaces supply ASP should fall due to weak seasonality. Nevertheless. unfavorable seasonality and uncertain policies will produce negative headlines. despite production reactivation in Shanxi province. 2011 Asian Credit Outlook 2012 Figure 69. Volume growth from both organic and acquisitions should drive earnings. Citigroup Global Markets Asia Limited 45 Fixed Income Credit Analysis • Credit Sector Specialists . We see fiercer challenges in the first quarter of 2012. cement makers should be able to keep a flat profit-per-ton in 2012 on an annualized basis. we should see improvement in the demand/supply balance in 2012. Our equity analysts project demand growth of 5. and should benefit immediately from any fiscal stimulus should China go into a deeper economic slowdown. The prospect of lower Further inventory writedown on subsidies next year may drive demand in the last months of The pace of ASP decline slows falling ASPs. and have only started to retreat recently due to weakening crude steel output growth. Competition from other Asian countries Cement. ship coming down around bottom on weak PMI may speed up building. Cement remains our favorite industry in ‘2012. Hence. As a result. However. Better margins allure new players into the market China demand growth not enough to offset European decline.6%. machinery and etc Oil & Gas Better US economic data supports crude ASP Construction equipment MSG Solar Construction of social housing may speed up Further industry consolidation. the sector is least exposed to external markets. China’s coking coal prices remain relatively resilient on the back of supply constraints and logistical bottlenecks. Chinese players lack competitive advantage other than more favorable pricing Geopolitical tensions surrounding Iran and a possible disruption of exports Higher resources tax probably won't be offset by lower windfall tax FAI growth decelerates Corn price volatilities. Policy overhang on corn processing companies.

the plastic pipe sector and materials. or both.December 15. The sector seems to be caught in a catch-22: higher input prices erode margins while lower input prices typically coincide with a weak demand outlook. oversupply and homogeneity of production have hurt steel-makers’ P&L. Besides. In the next six months. capacity and willingness to service debt. while flat products will continue to suffer. (3) Listing in an irrelevant country with auditors signing in a different country to key business operations. Long products may outperform as construction should find a seasonal bottom after Chinese New Year. echoing weak PMI data. there exist some “China” factors. Citigroup Global Markets Asia Limited 46 Fixed Income Credit Analysis • Credit Sector Specialists . The fundamental reasons are relatively easier to predict while sponsor risk is hard to detect. Historical defaults in the China industrial space can be attributable to fundamental deterioration. sponsor/major shareholders’ intention to default. as well as potential recovery prospects once a company gets into trouble. Instead. Only if demand improves so much that steel-makers can pass through rising material costs. rely significantly on the major shareholders’ creditworthiness. operating with uncompleted licenses in certain industries and some “relationships” factors. (2) Simple business with extremely high profitability but no competitors. we think those aspects should be analyzed on an ad-hoc basis. it is difficult to differentiate China credits by sponsor risks. Corporate governance: textbook versus reality Valuing sponsor risk is not an easy task in China. would profitability improve. concentration of shareholdings. Given China’s vast geographic expanse and relatively short history of private businesses. which serve as red flags in more mature economies but can be quite common in China. such as short listing history. In this respect. Steel is our least-favored sector in 2012 within basic materials. as most privately-owned enterprises are under the key man’s control. So what are the practical “red flags” investors should watch out for a potential corporate governance issue or fraud from the very beginning? (1) Low-value add but extraordinarily high profit margins compared with peers. nor any easy way to check the sponsor’s background to form any firm opinion on creditworthiness at the shareholder level. Sluggish demand. (4) A very lucrative business that generates consistently negative free cashflow and unreasonably high capex. 2011 Asian Credit Outlook 2012 Steel. We are not saying investors should not be concerned about those aspects. Sponsor risk is crucial for China credits. there isn’t enough track record. In this context. we maintain our reservations on the forestry names. The subordination issue. (5) High relevance of major shareholders’ private business (6) The industry itself is opaque with little public information The six points above are clearly only a starting point. steel prices should consolidate and profitability may hit a trough on the back of restocking and a decline in iron ore and coking coal prices. an input margin squeeze.

Figure 70. Therefore. Indonesia is still appears to have already entered investment-grade territory on many metrics. we maintain that Indonesian credit is the best sector to be positioned in. with a more aggressive easing stance taken than anywhere else in Asia. a reduction of just 0. However. despite 75bp easing in policy rates and a fairly significant expansion in money supply. Helmi Arman and Brian Tan – 29 November 2011 Citigroup Global Markets Asia Limited 47 Fixed Income Credit Analysis • Credit Sector Specialists .3% in ‘2012. we prefer coal players as a must-own sector. Within Indonesia. and also see power-sector credits as a core holding as well. while banking system liquidity is acceptable at just over 80% in loans-to-deposits. Volatility ranges for Indonesian corporate on-the-run bonds 120 100 80 60 40 20 0 ADRO BRAU MNCS DAVO STAR BLTA GAJA TPIA BTEL ISAT LIPP CIKLI BUMI INDIK $-price Figure 71. with external debt/GDP estimated at 29.Indonesia Jan-10 Jul-10 Jan-11 Jul-11 Source: Bloomberg. Sovereign fundamentals remained robust and although the upgrade trajectory into investment-grade may be delayed slightly in to ‘2013. things seem to have worked out reasonably well.5% (‘2011E). Indonesian credit versus Asian high-yield 20 Yield % 15 ABBI HY Corporates 10 5 ABBI HY Corporates . Very limited issuance among private-sector corporates has substantially reduced duration in the sector (thus less volatility) and has also provided a strong technical base particularly in the natural resources credits. Even where risks were taken. it consistently outperforms the rest of the high-yield space (see Figure 71). 2011 Asian Credit Outlook 2012 High-Yield – Indonesia Market Performance and Investment Strategy Indonesian credit had a volatile year. We are recommending light positioning in high-yield given that even Indonesian credit sees large volatility during periods of market stress (see Figure 70). Leverage both at the sovereign level and in the banking system are extremely low. Leverage both at the sovereign level and within the banking system remains low.December 15. Shareholder risk is of course another critical factor to consider. Yieldbook Growth trajectory barely dented The large volatility in the global macro landscape has done little to dent Indonesia’s solid fundamentals. but was relatively better-behaved in comparison with its peers in Chinese high-yield. Inflation pressure has remained benign. within high-yield.5% and see inflation remaining a risk given the potential for energy subsidy reforms. although it is likely that the size of some of the issuers (and not their financial metrics) may prove to be constraints in terms of following the sovereign’s trajectory into investment-grade. Citi Source: Citi. Indonesia section. although we are expecting a modest reduction in growth from the ‘2011 figure of 6.2%-pt from forecasts made at the beginning of the year.1% and credit 5 See “Asia Macro and Strategy Outlook”. Corporate fundamentals and liquidity metrics look fine. according to our economist5. Growth remains strong projected at 6. running at 4.

0bn in ‘2012. of which about two-thirds will probably be paid down or defaulted upon (i. External debt to GDP Ratio Figure 73. since it is positioned at the lowest end of the volatility spectrum of the broader commodity space.5 - FX Reserve Coverage (x) 2005 Source: CIRA 2006 2007 2008 2009 2010 2011E 2012F Source: CIRA Supply: Another lean year ahead Availability of credit is adequate through the banking system. Citigroup Global Markets Asia Limited 48 Fixed Income Credit Analysis • Credit Sector Specialists . be they currency. representing 10 months of import cover (versus 8 months) and 1. On that front. Refinancing requirements in ‘2012 amount to about US$800m external bond markets. and agricultural commodities are also oriented towards relatively inelastic segments of food consumption. and the 2009 change in withholding tax legislation withdrawing eligibility of offshore special purpose vehicles from a 10% exemption. We are projecting US$2.9bn this year (of which US$2. figures as of 3Q11). As a result. FX reserves coverage of short-term debt by remaining maturity 50% 40% 30% 20% 10% 0% 2005 2006 2007 2008 2009 2010 2011E 2012F 2. While we understand there were also practical constraints related to archaic stock exchange regulations that are now being modified.0 1.5 1. external issuance out of the corporate sector has dried up.0 0.December 15. 2011 Asian Credit Outlook 2012 penetration is barely above 30% (although we presume some of this leverage is actually offshore the Singapore banking system which is at a still-manageable 126. making offshore bonds costlier. supply could again be abysmally low. Essentially. Indonesia’s concentration in commodities is a major advantage. whatever its metrics may look like.e.3x). In addition.3%. local government bond or external credit markets. in truth we do not expect this to have much of an impact.1bn as of 2011E (versus US$56. Indonesia will always be at risk of capital withdrawal from the region.8x coverage of short-term debt by remaining maturity (versus 1. external vulnerability looks much lower than it did in ‘2007. Figure 72. versus US$2. External vulnerability has always been the Achilles’ heel of Indonesian markets. All of which means that with no quasi-sovereign supply coming up for refinancing next year. Thermal coal plays into a very robust power demand theme in India and China. the flow of financial capital into Indonesia has only intensified over the last few years as investors sought sheltered investments in domestically-driven economies with low growth vulnerability.5 2. For what it’s worth though.9bn).5bn was from quasi-sovereigns). with FX reserves at US$117. since policy credibility take many years of consistency to establish even though things are on the right track. which as mentioned above is one of the most underleveraged in the region. will not come through to the bond market for refinancing).

This is why many will not benefit directly from the sovereign upgrade when it occurs in terms of rating action.0 2. the majority of corporate issuers are at or below 3x.9 2.December 15.0 0.5 ADRO Coal US$ bn Cash + EBITDA . Bloomberg.0 1. however aside from governance concerns another key constraint is the aggregate size of some of the issuers in terms of asset base and market capitalization. Figure 76.8 3. quasi-sovereign support remains a key element even for private-sector players. *BTEL and CIKL are based on 1H11 information In terms of leverage.5 1.Current Debt Cash + EBITDA Current Debt BRAU Coal ISAT Telecom BUMI Coal LPKR Property GJTL Tires CIKL* Power STAR Power TPIA Petro BTEL* Telecom BLTA Shipping Source: Citi.4 2. and is supported by cash balances in many cases. Citigroup Global Markets Asia Limited 49 Fixed Income Credit Analysis • Credit Sector Specialists . In the coal sector.0 0. Dealogic Liquidity and Fundamentals Based on chart below.0 1. the majority of issuers in the sector have annualized EBITDA that is sufficient to cover current debt. US$-bond issuance trends Figure 75. Dealogic Source: Citi.0 '06 3.5 2. Indonesian private-sector corporates: Cash & EBITDA (YTD annualized) versus Current Debt as of most recent reported financials 2. (2) rising energy intensity in China (hard landing or not) and India and (3) Indonesia’s dominant role as the largest supplier of thermal coal in the seaborne market.8 US$ bn 2. 2011 Asian Credit Outlook 2012 Figure 74. Bloomberg. we believe demand-supply fundamentals will remain tight due to (1) the frequent occurrence of supply disruptions in the global thermal coal trade.0 3.0 1.5 3.0 1.5 0. We are generally sanguine on the fundamentals of the Indonesian private-sector corporates given the majority of issuance is in the natural resources and power space. Bloomberg. mining and logistics costs such that EBITDA margins will expand further on a per-MT basis. Maturity profile of US$ corporate bonds outstanding 4.0 US$ bn 2.2 '07 '08 '09 '10 '11* '12F 12 13 14 15 16 17 18 19 20 21 22+ Source: Citi. is the key driver of yields in Indonesia except in very extreme cases. Many Indonesian corporates have financial metrics that could be considered at or above the BBB-range. In power. which correctly reflects the fact that shareholder risk and not financial risk. given the offtake agreements with the state-owned electric utility. We expect contract prices to continue to outpace inflation in extraction. Companies.

Net Debt/EBITDA versus EBITDA margin for Indonesian privatesector corporates 10 8 6 4 2 BLTA ADRO BRAU STAR BTEL GJTL TPIA LPKR BUMI INDY ISAT CIKL 100% 80% 60% EBITDA Margin % STAR ISAT CIKL ADRO GJTL Net Debt / EBITDA x 2.0 BUMI 40% BRAU 20% 0% - BTEL BLTA LPKR TPIA Ship Telco Pow Coal Coal Telco Tires Petro Pow Coal Prop Coal Source: Citi.0 10.December 15. Companies. Net Debt/EBITDA of Indonesian private-sector corporates Figure 78. Bloomberg Citigroup Global Markets Asia Limited 50 Fixed Income Credit Analysis • Credit Sector Specialists . 2011 Asian Credit Outlook 2012 Figure 77. Companies. Bloomberg Source: Citi.0 8.0 6.0 4.

z.December 15.fong@citi.zeng@citi.kulik@citi.com Jenny Zeng.com Hong Kong Hong Kong Hong Kong Citigroup Global Markets Asia Limited 51 Fixed Income Credit Analysis • Credit Sector Specialists .com Hong Kong George Fong (852) 2501-2562 george. 2011 Asian Credit Outlook 2012 Credit Sector Specialists Umar Manzoor. CFA (852) 2501-2355 umar.manzoor@citi. CFA (852) 2501-8314 jenny.com Dana Kulik (852) 2501-8227 dana.

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