Asian credit: Down but not out

Widening spreads and continued volatility are set to give way to better performance, says Calyon.
Asian credit markets will outperform in the second half of 2008 as investors put their subprime fears to one side and return to the markets with a greater appetite for risk.

Presenting their outlook for Asia in 2008, strategists at Calyon said that most of the bad news left in the system should come out during the next six months and that Asian credits in particular stand to benefit, thanks to the region's stronger economic fundamentals and greater credit quality.

"Credit is still a dirty word," says Dilip Parameswaran, head of Asia credit research. "Clearly there is still a sense of crisis and we think this will last to the end of the first half, but Asian balance sheets are healthy, the M&A pressure has been lower and the banks have a lot of money. When you put all these things together Asian credit looks much better."

Before that can happen, investors want to be sure that there are no more subprime surprises in the pipeline. That is still some way off. According to Calyon, banks have reported $130 billion of subprime-related losses so far and the next round of results announcements is expected to reveal even more problems related to structured investment vehicles and leveraged buyout debts.

The bad news doesn't end there. The big monoline bond insurers are expected to be downgraded in the next few months and Moody's is forecasting that credit defaults will rise from 1% in November 2007 to 4.5% by the end of 2008.

All of this spells trouble for the first half of the year, says Parameswaran. Spreads will widen across the board, by perhaps as much as 100bp on the region's high-yield sovereign credits, and volatility will continue to be high. But once the bad news is out in the open it should provide investors with far greater clarity on the extent of banking losses, which in turn will allow the hard work of fixing things to start in earnest. That spells good news for the second half.

It is also possible that things are not quite as bad as they seem anyway. Even if defaults spike as Moody's predicts, they are still at relatively low levels and the much sharper spike in credit spreads suggests that the worst case is already being reflected in prices.

When investors do come back to the market they might find that Asian credits represent a good bet. Asian borrowers have a greater share of positive ratings outlooks than any other region and spreads on some credits offer good value.

Asian investment-grade corporates look to offer particularly good value, says Parameswaran, because they have widened substantially compared to US credits. "High-yield corporates are at 112bp over, but they have always been at about 100bp, so we don't see that as a good opportunity," he says. Translating this into Asian portfolio recommendations, Parameswaran likes sovereigns, telecoms, utilities and Hong Kong credits.

Among the high-yield sovereigns he expects Indonesia to outperform the Philippines and Vietnam, and Korea to outperform Malaysia among the investment-grade sovereigns. Telecoms credits are expected to do well because they are relatively insulated from the subprime mess and have good cash flow. Parameswaran picks out Hutchison, Telekom Malaysia, Korea Telecom and PCCW. Needless to say, two of these are also Hong Kong credits, which are set to benefit from rising property yields û rents are forecast to rise by as much as 20% in 2008. Finally, utilities make a good defensive play, particularly during the volatile first half of the year.

Underperformers could include Chinese property, energy and any credits exposed to the global consumer sector.
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