Asia-Pacific issuers set for a positive 2011, but challenges lurk

Ian Thompson, Standard & Poor's chief credit officer for Asia-Pacific, discusses Asia’s credit outlook for 2011.

Resilient economic conditions, strong domestic demand and a generally favourable regional operating environment translate to a robust credit outlook for Asia Pacific in 2011, according to a recent publication released by Standard & Poor’s Ratings Services.

But policymakers and officials must be alert to the challenges facing the region and ensure these risks do not impair economic growth and credit dynamics. Standard & Poor’s chief credit officer for Asia Pacific, Ian Thompson, shares his views on the outlook for the region’s sovereigns, corporates and debt markets, and identifies potential risks on the horizon.

Your economic outlook for the region indicates you think that economic growth will remain robust this year, although moderate from the strong levels seen in 2010. What are your views on the trends facing sovereign ratings in the Asia-Pacific region?
Asia-Pacific sovereigns continue to outperform most other regions in terms of growth and creditworthiness trends. With few exceptions, we expect to see the largely stable credit trend continue over the next three-to-five years, and in some cases we expect a degree of upward momentum in sovereign credit quality. We have a stable outlook on 17 of the 22 countries we rate around the region. Economic growth and favourable comparisons with other parts of the world notwithstanding, Asia-Pacific policymakers can’t be complacent, in our estimation. The intertwined challenges of strong capital inflows and rising inflationary pressures bring with them important credit risks. The right policy mix is important and the risk of wrong moves is rising as the task of balancing the region’s growth prospects against the multitude of downside risks becomes more complex.

Despite some challenges, including the still-soft US and European markets and currency challenges, Asia’s corporate sector is showing signs of continuing improvement in 2011. Looking ahead, what can we expect for the region’s corporate issuers?
The region’s corporate sectors should also continue to benefit from strong domestic demand, with consumer spending, capital expenditure, and infrastructure investment, along with high levels of regional trade underpinning our view. We expect exports from the region to remain competitive on a global front, although there will be some challenges. But not all sectors are so well placed, with the transportation, media/entertainment, steel and the downstream oil and gas sectors likely to face challenges throughout 2011. While we expect most regional governments will look to tighten monetary policy in 2011, interest rates are likely to remain low in real terms. The generally favourable regional operating environment should support increased activity, but higher costs for raw materials and commodities, along with tight labour markets in some sectors, could constrain production and profit margins.

What is your corporate credit outlook for Japan after the tragic earthquake and tsunami, and the following situation with the nuclear power facilities? Is there any pressure to downgrade corporate ratings in Japan?
Insurance is obviously a sector likely to be impacted by the events in Japan. We have revised the outlook for the sector to negative as we expect the earthquake and tsunami to be an expensive insured event — in fact one of the largest in recent times. If the expected losses exceed current market estimates, this could potentially erode capital basis of insurance companies and that may result in downward rating pressure. At this stage, we believe for the domestic Japanese market, losses are likely to have a very negative effect on this year’s earnings and perhaps have a capital impact of up to 10%. Global reinsurance is actively used in Japan and we believe the global reinsurance community will be able to withstand this event as they are very well capitalised and have liquid balance sheets. We see these events in Japan as mostly having earning impact on the sector.

As for other Japanese corporates, we believe the impact of the earthquake and tsunami is unlikely to have a major ratings impact on the entities that we rate, with exception of Tokyo Electric Power Co (the operator of the Fukushima nuclear power facility), which we have recently lowered to A+ and the rating remains on CreditWatch negative. We also note that the corporate sector is likely to be beset with power outages and continuing disruptions. But overall we believe the negative impact will be manageable and within current ratings of the Japanese corporate portfolio.

The performance of the region’s banking sector has been relatively strong since the global financial crisis. How do you see the performance of issuers in that sector over the coming year?
The outlook for the banking and insurance sectors remain stable, in our view. For the most part, the region’s banks are well structured, with satisfactory capital resources. Banks and insurers are likely to benefit from resilient domestic economies and moderate credit costs for 2011. Regulatory reforms, including Basel III for banks and Solvency II for insurers, are unlikely to have a material impact on the region’s financial institutions, in our view. But we will continue to monitor factors including monetary policy and the potential for asset bubbles across the region as we assess credit risk. Higher inflation and the potential for tighter monetary policy from Asia’s central banks could dent the payment ability of some borrowers and put pressure on banks’ asset quality and earnings, in our view.

As Asia’s population continues to expand and the region’s prosperity grows, the spotlight on the region’s infrastructure is intensifying. What are the key issues that you will be watching in the infrastructure space in the year ahead as you consider the credit outlook?
After some volatility in financial markets over recent years, we note that Asia Pacific’s infrastructure sector is now back on firmer ground. This largely reflects continuing economic activity across the region with rising demand for, and investment in, a range of infrastructure sectors and improving stability in both credit and financial market conditions. There are credit-related risks that we are monitoring closely across the region’s infrastructure space, including how companies manage not only their refinancing and liquidity needs but also financial headroom against their financial policies and debt covenants.

We’ve seen increasing signs of life in select areas of structured finance in the region since the global financial crisis. What is your view of the likely trends in structured finance in 2011?
Mirroring strong local economic conditions and the banking sector’s low credit costs in 2010, the performance of regional assets underlying securitised pools has been robust over the course of the financial crisis, and we expect that to continue throughout 2011. Delinquency and default rates have largely tracked historical norms, with the exception of Japanese commercial real estate. We expect asset quality to remain sound for residential mortgage-backed securities and asset-backed securities, and stabilise for commercial mortgage-backed securities, where refinancing may continue to be an issue for some transactions.

Funding and liquidity remain a key focus for the region’s issuers as we move through 2011. What is your view of the dynamics for the region’s capital markets, and what do you identify as the major risks facing markets?
While liquid capital markets benefited Asian credits in 2010, we note that many Asia-Pacific entities have substantial debt-refinancing tasks ahead. Based on our estimates, Asia-Pacific issuers have more than $1.5 trillion in refinancing due in 2011 and a total of $4 trillion over the next three years. As a consequence, funding and liquidity management will continue to be a critical focus in 2011, in our view. Issues that may affect the liquidity of funding markets include nervous global funding markets. On the positive side though, we acknowledge growing domestic debt markets and we note that government funding of deficits has not crowded out the corporate and financial services sectors.

Overall, you are relatively upbeat about the prospects for issuers around the region, while flagging inflation among the potential problem areas. Is there anything else that could challenge the outlook?
While the overall outlook for Asia’s credit in 2011 is positive, we note there are several residual risks that require careful management and appropriate policy responses if the region’s economic growth and credit dynamics are to remain healthy. These risks include the potential for asset bubbles, fuelled by excess liquidity, strong capital inflows and low interest rates. We’ve also called out inflationary pressures stemming from high liquidity, rising commodity and food prices, and skilled labour shortages as a potential risk to the region’s economic health. Sustained higher input costs could pressure margins and potentially the competitiveness of the region’s corporate sector, in our view. We’re also keeping close watch on geopolitical tensions and will continue to assess whether they have the potential to disrupt trade flows and contribute to commodity-price volatility. Presuming policymakers juggle all that successfully, 2011 should be another good year for debt issuers and credit in Asia Pacific, in our view.

To access full analysis of Standard & Poor’s Asia-Pacific credit outlook, please click here.

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