To The Moon

9 January 2024

Asian Fixed Income Team

Sector Outlooks

Financials and non-bank financials

Higher interest rates had a net positive impact on the banking sector in Asia through 2023. Banks were able to add pre-emptively to their coffers for non-performing assets and raise their capital buffer, while recording manageable unrealised losses on their portfolio of financial securities due to their strong banking franchise and limited reliance on financial securities for income. As the fundamentally strong financial institutions exude enduring strength and resilience, the divergence taking place within the sector is difficult to ignore. Amid a dynamic operating environment owing to macroeconomic headwinds and geopolitical risks, the main problems plaguing the sector—high household debt against Gross Domestic Product (GDP) and exposure to weak segments such as mainland China real estate—developed over an extended period. These problems cannot be solved overnight, and they have become recurring themes over the years.

Fundamentally strong banks include institutions from Singapore and the dominant players across Asia. We see limited room for further upside on the profitability front (specifically, on a year-on-year basis) given where we are at in the interest rate cycle, and our focus is on resilience. Having benefited from higher interest rates, these banks have accumulated large provisions and are well prepared to weather weaknesses in asset quality if the macroeconomic environment deteriorates. The strong funding profiles of these domestic retail banking-driven banks are the bedrocks of their defensive nature and provide stability to their fundamentals as there is a reduced need for these banks to compete for deposits. Substantial capital buffers have allowed these banks to pursue inorganic growth as well as buybacks of shares and capital instruments in 2023. Amid macroeconomic uncertainty and a high interest rate environment, loan growth is expected to remain subdued across the sector. As such, the differentiating factor among the strong banks may lie in their ability to generate fee income from segments such as wealth management.

Among the Thai banks, we have a more favourable view of institutions with relatively large proportions of corporate clients over those focused more on retail and Small and medium-sized enterprises (SME) banking due to the country’s high household debt relative to GDP. With a high interest rate, it is inevitable that concerns arise towards the debt servicing ability of borrowers and asset quality of banks’ loan books. That said, such risk continues to be moderated by the provision buffers the banks have set aside over the quarters.

Within South Korea’s financial sector, we see the bulk of the risk residing among the smaller players in the banking and non-bank financial institutions (namely, savings banks, community banks and securities firms). This is because their businesses are positioned to service the lower credit quality customers; in addition, to generate income, they rely more materially on higher risk business activities, such as those linked to the capital market, rather than mortgage lending. As such, we continue to differentiate among financial institutions and remain comfortable with the dominant players in South Korea that have consistently demonstrated fundamental strength.

For Hong Kong and Chinese banks, the key source of risk continues to revolve around real estate. A majority of the banks have manageable exposures in the double-digit percent handle, and loans specifically for property development account for an even smaller part of banks’ loan books. They also have adequate capitalisation, except for a handful of joint-stock banks. That said, we are yet to see a reprieve from credit deterioration within real estate. In addition, margin compression has been unique to the mainland Chinese banks, as policies have been introduced to guide interest rates and fees lower. Therefore, even though we remain comfortable with the major mainland Chinese banks, they appear less attractive compared to the past.

Elsewhere, improvements in asset quality lifted the fundamentals of Indian banks as loan books were cleaned up and as underwriting and risk management capabilities were enhanced. We continue to view Indonesian banks favourably as loan growth is supported by ample liquidity while the restructured loan situation continues to improve.

Overall, we believe that the banking sector is resilient. With strong capital, adequate loan loss buffers, robust liquidity and expectations of stable profitability, we retain our favourable view of banks, positively assessing the capital structure of large players with strong fundamentals as non-call risk is seen to be minimal for these issuers’ bonds while being watchful on asset quality.

For the non-bank financial intermediation sector, we see pockets of opportunities in the asset management companies in mainland China as we continue to observe timely acts of support for the sector. Lastly, we like insurance companies for their resilience in operations. We view securities firms with caution due to their strong correlation to their domestic capital market conditions.

Real estate

We are cautious on the real estate sector overall, given that the high interest rate and weakening macroeconomic environment could dampen property demand and prices for developers and landlords.

Through 2023, China’s government removed a series of tight property polices that were introduced during the property bull market period in order to stabilise the physical property market. While incremental marginal policy easing could continue to be rolled out at various city levels, we do not expect such policies to be sufficient for the overall sector. As such, physical property sales are expected to continue facing downward pressure, especially in lower tier cities amid a weak macro and employment environment. For the sector, access to funding remains tight and polarised. Coupled with tight escrow account control, new starts will likely remain low which will be a further drag on new home sales. Overall, we view the China property sector with caution. Within the sector, we prefer developers with state-owned backgrounds as we expect them to continue outperforming private firms in terms of contracted sales and funding access.

Outside mainland China, we expect the Hong Kong property market to face headwinds in 2024 amid oversupply, high interest rates and softening economic activities. However, we believe most Hong Kong developers and landlords within the dollar bond market will be able to withstand the near-term pressure of falling property demand and prices, supported by their low gearing ratio and historically prudent financial policies.

Over in Singapore, the residential property market held steady throughout 2023 despite the rising rates environment, held together by relatively tight supply. As key demand drivers from previous years fade, we turn more cautious on the sector with headwinds from the government’s cooling measures deterring foreign buyers, and softer rents and increasing public and private supply hitting the market. Within the S-REITs space, Singapore’s commercial real estate market has remained remarkably resilient, as positive rental reversions offset expanding cap rates, and as portfolio valuations held steady. We continue to be positive on the retail, hospitality and industrial & logistics sub-segments given continued tailwinds. We remain cautious on the office space sector amid a softening in broader demand as businesses strive to rein in costs.

Oil & gas

We expect oil prices to remain elevated but volatile heading into 2024. A multitude of forces ranging from climate change, regional conflicts and macroeconomic cycles are creating significant concerns in the market that we see making oil prices volatile. The ongoing conflict in Ukraine, along with recent eruption of the Israel-Hamas war, could destabilise the Middle East and disrupt oil supply. On the demand side, the weakening business environment following the sharp increase in interest rates will likely begin to bite into overall consumption in 2024 and potentially curb demand for oil.

Asian upstream oil & gas companies are likely to continue benefitting from volatile but high oil prices. However, a volatile oil price environment may be a challenge for downstream oil refining companies as they manage feedstock prices and inventories. A softening demand outlook may also likely weigh on refining margins that adds an additional layer of complexity for refiners to manage. As for petrochemical companies, a combination of a weak macro environment coupled with industry capacity additions in the region could place downward pressure on margins. In summary, we see a mixed picture for companies along the value chain in this sector for 2024. Upstream companies could continue to do well in this environment, while downstream refining and petrochemical companies may face headwinds stemming from weakened profitability.

Consumer and entertainment

We expect the leisure and entertainment industry to continue performing well in 2024. Within the Macau gaming sector, the recovery momentum remains strong as the sector’s gross gaming revenue continues to reach new monthly highs. We expect the sector’s strong performance to continue into 2024, driven by strong visitations from mainland Chinese tourists into the territory. Such a trend would be a boost to casino concessionaires. Following the period of severe operational disruptions that battered their balance sheets during the pandemic lockdown, casino operators are now laser-focused on improving their balance sheet leverage and business cash flow generation. This is seen improving the credit profile of issuers within the sector. Capex commitments that were made as part of the concession renewal agreements made between the Macau government and the casino operators are expected to be spread across the new concession term and support the overall deleveraging profile of the sector. We have a positive view on the outlook of the Macau operators.

As for the broader consumer segment, we think consumers could become more cautious regarding their spendings going into 2024 as inflation starts to have negative impact on discretionary income. We believe that consumers are likely to save more, delaying purchases of big ticket items such as properties and cars and forgoing upgrades to their homes. And if they do splurge, they are more likely to do so on smaller ticket items and on experiences, such as domestic and regional travel or speciality dining. In general, we prefer consumer staple companies over consumer discretionary-related companies.

Technology

We see Asian technology firms’ credit fundamentals remaining relatively resilient in 2024. However, geopolitical tensions remain an overhanging risk for the sector.

Asian technology firms in the dollar bond market are generally industry leaders and have low balance sheet leverage. For hardware companies, there are increasing signs that demand may have bottomed for various sub-segments such as those related to personal computers, smartphones and memory chips. At the same time, domestic regulatory risks, which were a key concern in previous years, have declined significantly for Chinese technology firms.

At the same time, heightened geopolitical tensions continue to be a headwind for many Asian technology firms. We expect the direct impact of Washington's recent measures on Chinese technology firms, such as restrictions on some US investments into certain Chinese technologies and tightened access to artificial intelligence chips, to be limited and manageable for the sector. However, these geopolitical tensions remain a large overhang for Asia’s technology firms, given the risk of further escalations in the future, especially as the US heads into the 2024 presidential elections.

Utilities

We expect the credit profile of Asian utilities companies to be largely stable in 2024 as fuel prices continue to moderate. The peak out in coal prices is mainly due to China’s expansion of its domestic coal production and cheaper coal imports across the region. These have led to the profit recovery of most of the coal-fired power producers in 2023. These producers also benefitted from rising energy demand as various economies fully reopened after the pandemic. China’s new tariff policy takes effect on 1 January 2024; we believe that the new tariff regime will further reduce the current earnings volatility of China’s independent power producers. We also believe that the new tariff regime will help speed up their energy transition developments, which are viewed to be positive for the sector from a credit perspective.

The Asia-Pacific is witnessing a significant shift towards clean energy sources as both governments and corporations in the region increasingly prioritise their sustainability goals. We believe the demand for renewable power sources will continue to accelerate as industry regulators tighten carbon emission standards and implement and enforce carbon taxes across the region. In this space, we prefer companies that have clear transition pathways towards decarbonisation, backed by strong project sponsors and execution track records in addition to effective cost controls.

Transportation and infrastructure

We expect the Asian aviation sector to remain firmly on a recovery track in 2024 and head back towards pre-pandemic levels. The sector is expected to witness sustained growth thanks to increasing demand for air travel, especially with the return of tourists from China following the easing of travel restrictions there. We remain constructive over the sector given Asia's rising middle income segment, which is expected to continue driving tourism-related activities over the medium to longer term. We expect airport infrastructure operators and airlines issuers to benefit from the demand resurgence. In contrast, we see seaport operators experiencing slower growth amid heightened global geopolitical tensions and structural shifts taking place within the shipping industry which could slow trade activity. The slowdown in trade across several developed and emerging markets caused by softer demand conditions could further reduce cargo and container traffic volumes. That said, we believe that most of the seaport operators we track have strong financial profiles and adequate financial flexibility to control their growth capex if necessary. As such, we expect the credit profiles of most seaport operators to remain stable well into 2024.

* The forecast is not necessarily indicative of future performance

(1) Source: JP Morgan, Bloomberg, Dec 2023

(2) Source: JP Morgan, Bloomberg, Dec 2023

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