Past experience stands Asia-Pacific in good stead for 2010

Default rates are expected to decline this year and the number of negative outlooks will continue to trend lower, but certain sectors are still vulnerable, Standard & Poor's says.

Standard & Poor's Rating Services sees a brighter economic and credit outlook for Asia-Pacific in 2010, albeit not without some smudges. In 2009, we downgraded entities in the region at four times the rate of upgrades. Our negative outlooks hit a peak at a third of ratings in April 2009, but have since steadily eased down to a quarter of ratings by end-2009. We expect this trend will continue through 2010 as resurgent economies, stronger domestic markets, and lower interest rates point to better times ahead and ameliorate some credit-quality pressures.

That said, some sectors are still vulnerable and risks to economic recovery remain (although most seem well managed). An important regional challenge will be to ensure exit strategies are timed carefully. As most government policies shift from crisis management to ongoing recovery management, expansionary programs will likely moderate, official interest rates will rise, and fiscal stimuli will be wound back to avoid asset-price inflation. This will increase funding costs for the corporate, infrastructure, and financial sectors, and run the risk of stalling the recovery if poorly executed.

We also note that loan portfolios will experience a rise in non-performing loans in 2010 (a lag from the economic slowdown), but they should be manageable within current-year earnings. The contingent liability of the financial system is declining as the region recovers, and higher deficits incurred to fund fiscal stimulus packages are staying within ratings tolerances.

Funding and liquidity management will remain a critical focus, with many Asia-Pacific entities facing substantial debt-refinancing tasks. We expect corporate, infrastructure, and financial entities to remain risk averse and pursue only moderate growth, with the possible exception of China. Funding profiles have shortened for many issuers after significant capital raisings in 2009 to meet immediate funding requirements and to de-leverage aggressive balance sheets. We believe that funding initiatives will focus on rolling over debt and lengthening maturity profiles. And we will see significant corporate refinancing when many term-debt programs mature in 2010, at a time when government guarantees to support banking-sector funding programs are being wound back. The banking sector will need to manage capital adequacy associated with strong asset growth and market perceptions.

Not all sectors will recover quickly in a market that will remain fragile for a few months yet. In particular, export-related industries such as manufactured goods will likely be slow to regain full health; the current subdued demand for some export goods will be compounded by foreign-exchange and interest-rate movements. Access to funding remains selective, with speculative-grade entities likely to feel constraints. Real estate investment, transport-related industries, and nonbank finance are sectors likely to remain challenged through 2010. Lastly, the pace and sustainability of global recovery remains a risk for Asian export markets targeting the US and European consumer sectors.

So what does this mean for the region's credit ratings? Taking a closer look at the portfolio shows a general positive trend emerging for 2010, although some sectors will face more challenges than others and lower-rated (speculative-grade) entities will remain inherently vulnerable to stress. Also, those in industries that are subject to slower recovery are likely to feel pressured for a while longer. Reflecting this, 43% of speculative-grade credits are on an outlook other than stable, versus a stable-outlook rate of 73% for the entire rating portfolio.

Taking a brief look at where we've come from, eight of our rated Asia-Pacific sovereigns saw negative GDP growth in 2009 and this contributed to the overall credit portfolio recording a negative bias. Defaults rose to 1.9%, the highest level since the Asian crisis in the late 1990s. Weaker entities were more profoundly troubled by the harsh operating conditions in 2009; about 20% of Asia-Pacific issuers rated below 'BBB-' accounted for 53% of rating actions last year.

In 2009, 14% of corporate and infrastructure rating actions were downgrades. Financial institutions, on the other hand, were less exposed to asset bubbles and volatile securitised assets than were their global peers and recorded a more modest downgrade rate of 8%. Mostly affected by parent-group actions and asset-quality issues, the Asia-Pacific insurance sector also had 8% downward actions. Post-Asian crisis structural reforms by the region's sovereigns in the past decade supported domestic banking systems and afforded some governments better flexibility to withstand the global slowdown. Only 7% of rating actions on sovereigns and international public finance entities were downgrades.

While defaults climbed in 2009, the default rate was still lower than in the US and Europe and also lower than during the Asian crisis. The defaults were also well spread across eight countries in the region, although concentrated in entities rated in the 'BB' category or below one year prior to default. Sectors affected included transportation, telecommunications, non-bank financing, manufacturing, and consumer discretionary. We anticipate default rates will decline in 2010, but defaults do tend to lag recovery and, for some, the turnaround may have come too late. Our base-case estimate is that default rates will decline in 2010 to around the 2008 level of about 1.2% of the rating pool.

In 2010, the economic rebound across Asia-Pacific will affect sectors differently. We expect that the construction and building materials sector -- while experiencing weakness -- will benefit from the infrastructure and housing investments that have been part of the governments' fiscal stimulus packages. We also anticipate that the improved outlook will encourage restocking and capital expenditure, which were measured in 2009. We believe that challenges will remain in the real estate sector and export- and transport-related industries and that these will likely be the slowest to recover, given the overall global economic outlook.

The outlook for financial institutions continues to be difficult but manageable. This reflects the lag effect of the slowdown on asset quality, and loan portfolios specifically. While credit losses will constrain earnings, we expect the banking sector to remain profitable in 2010 as it focuses on restoring or preserving balance-sheet strength. The banks will explore further capital-raising initiatives after they are freed from government funding and liquidity safety nets.

In structured finance, collateralised debt obligations represented the bulk of structured finance downgrades and defaults in 2009, and the outlook for these remains negative for the next 12 months (although the magnitude of negative transitions should decrease). Conversely, regional assets in securitisations (auto loans, consumer receivables, and residential mortgage-backed securities) have proved resilient. Given their relatively minor deterioration in 2009, we project that Asia-Pacific securitisation transactions in 2010 will continue to perform within expectations, and rating revisions will be limited -- some will be upward as portfolios season and senior tranches are paid down. Some transactions will, however, remain sensitive to the corporate credit recovery and the ensuing refinancing conditions. New issuance volumes are expected to remain subdued in 2010.

On balance, however -- and after a tough year -- Asia-Pacific credit dynamics do appear to be brightening in 2010. Will this positive trend prove sustainable? We believe so, but the answer lies in how well market participants and governments can carefully polish off any smudges in liquidity profiles, asset-price bubbles, inflation, and the timing of policy tightening. We'll also be looking to the US and Europe for signs of a sustainable rebound in those parts, but the job of fortifying Asia-Pacific against future shocks remains a regional responsibility.
The author of this article, Ian Thompson, is a senior credit officer for Asia-Pacific at Standard & Poor's.

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