Financial Pacific: Sovereign bond issuer update (third party), december 15.2010


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Financial Pacific: Sovereign bond issuer update (third party), december 15.2010

  1. 1. Michael Bolliger, analyst, UBS AG Kilian Reber, analyst, UBS AGWealth Management Research 15 December 2010Emerging market bondsSovereign Bond Issuer Update Chile spreads vs. EMBI GlobalWe provide our analysis on selected sovereign debt issuers in emergingmarkets, including Brazil, Bulgaria, Chile, Indonesia, Malaysia, Peru, the 1000Philippines, Poland, Russia, South Africa and Venezuela. 800This is an excerpt of a report that was originally published outside of the US 600on 10 December 2010. This excerpt has been customized for US distribution. 400BrazilRating (Moodys / S&P): Baa3 / BBB- 200Since October 2010, Brazilian sovereign bonds underperformed our reference 0index, JP Morgan’s Emerging Market Bond Index (EMBI) Global. Reassessing 04 05 06 07 08 09 10the valuation of these bonds, we find that they are now fairly priced onaverage. However, we note that some bonds still look slightly expensive. Thus, Chile EMBI Globalwhile we think the shorter maturity bonds and the quasi-sovereign bonds Source: J.P. Morgan, UBS WMR, as of 10 December 2010 (EMBI = JP Morgan’s(from the governments development bank) are fairly priced, we would still Emerging Market Bond Index Global)advise investors to take profits on the sovereign bonds with longer maturities.BulgariaRating (Moodys / S&P): Baa3 / BBBSince August 2010, Bulgarian sovereign bonds saw a good favored by thecountrys solid fundamentals, with some of the lowest debt and deficit levels(targeted at 18% and 2.5%, respectively) worldwide. Given that Bulgariacurrently only has two sovereign bonds on the market, we see no attractivebond opportunities at current valuations.ChileRating (Moodys / S&P): Aa3 / A+Chilean sovereign bonds sold off quite a bit during the recent period ofheightened risk aversion. We think Chilean sovereign bonds are attractivefor investors who are looking for a moderate pick up in yields withoutcompromising their risk exposure.This report has been prepared by UBS AG.Please see important disclaimers and disclosures that begin on page 7.
  2. 2. UBS Wealth Management Research 15 December 2010Emerging market bondsIn June, the country received an Aa3 rating from Moodys. This upgrade was Malaysia spreads vs. EMBI Globalfully warranted, in our view, as Chile enjoys very strong fundamentals (amongothers, its public debt to GDP ratio is 7%, roughly 13 times lower than that 1000of the US, according to Fitch). 800Indonesia 600Rating (Moodys / S&P): Ba2 / BBThe Indonesian economy is on a strong growth path and, at 6%, the coun- 400try will likely be one of the fastest growing in the region. Even though the 200Indonesian sovereign is not Investment Grade, it has some of the regionshealthiest public balance sheets. However, it is precisely these solid funda- 0mentals which have made Indonesian assets relatively expensive compared 04 05 06 07 08 09 10to its peers. We recommend invested readers to take advantage of the good Malaysia EMBI Globalrun and to take profits. Source: J.P. Morgan, UBS WMR, as of 10 December 2010MalaysiaRating (Moodys / S&P): A3 / A-Malaysias economy has seen a sharp recovery in 2010 expanding 7% as perour estimate, with private consumption and investment as key drivers. Thismakes Malaysia one of the fastest growing economies – not only in the re-gion, but also worldwide. While we see a slowdown in growth for 2011,Malaysias fundamentals should remain solid. We expect Malaysias debt-to-Gross Domestic Product (GDP)ratio to reach 53.6% in 2011, which is higherthan the average in the region. Nonetheless, we expect Malaysia, which car-ries an A rating and a stable outlook, to remain in a comfortable position toservice its debt. Foreign exchange reserves of nearly USD 100bn and privati-zation plans should provide a sufficient buffer and help to lower the fiscaldeficit going forward. At current valuation levels, we believe Malaysian bondscan still offer some pickup, while they add stability to a portfolio due to theirhigh rating.PeruRating (Moodys / S&P): Baa3 / BBB-Since September 2010, Peruvian sovereign bonds underperformed our refer-ence index, the EMBI Global. Reassessing the valuation of these bonds, wefind that they are now more or less fairly priced.PhilippinesRating (Moodys / S&P): Ba3 / BBThe Philippine economy gained momentum for the third consecutive quar-ter, albeit at a slower pace, while inflation has begun to trend higher now.While we see no major issues with the countrys economic performance, thesovereigns apparent unwillingness to cut spending makes the credit less at-tractive compared to its peers, in our view. The Philippines debt-to-GDP ratiois one of the highest in Southeast Asia at 52.2% as per our 2011 forecastand the budget deficit, targeted at 3.9% of GDP, is at risk of rising further,particularly as tax revenue in recent months have been below expectations.Concerns about tax revenues collection and rising inflation recently led tothe failure of a bond auction in early December. Compared to other BB rat-ed emerging market bonds, we believe that Philippine sovereign bonds arerelatively expensively valued. Emerging market bonds - 2
  3. 3. UBS Wealth Management Research 15 December 2010Emerging market bondsPoland Poland spreads vs. EMBI GlobalRating (Moodys / S&P): A2 / A-Polands third quarter GDP data surprised on the upside with a 4.2% expan- 1000sion compared to last year – some of the highest growth numbers in Cen- 800tral and Eastern Europe. While growth will likely slow down somewhat incoming months, and we expect interest rates to be increased within the next 600few months, Poland should still be one of the fastest growing economies inthe region. Even though we expect Polands deficit to stay relatively high at 4006.3% of GDP in 2011, the countrys relatively moderate debt-to-GDP ratio of 200around 54% next year, should leave it in a comfortable position to service itsdebt. Polish sovereign bonds have taken a hit recently, along with the Euro- 0zone, which is why current valuation levels make them attractive instruments 04 05 06 07 08 09 10at the more conservative side of the spectrum of emerging market bonds. We Poland EMBI Globalnote, however, that going forward the relatively high deficit level will leavePoland slightly more vulnerable to drops in investor risk appetite. Source: J.P. Morgan, UBS WMR, as of 10 December 2010RussiaRating (Moodys / S&P): Baa1 / BBB Russia spreads vs. EMBI GlobalLatest economic data show that the Russian economy is returning to morerobust growth after the recent weakening phase due to the severe drought 1000during the summer months. Going forward, we expect a renewed pick-upin economic growth to moderate levels, on supportive domestic consump- 800tion but subdued external demand, particularly from the Eurozone. The main 600factor to watch for Russia is inflation which is edging up again, as well asthe central banks monetary policy reaction which should be geared towards 400tightening. Nonetheless, Russias debt-to-GDP ratio is much lower than thatof most countries around the globe, expected at 8.5% as per our 2011 fore- 200cast. While this years initial budget deficit target was set to 6.8% of GDP, we 0expect it to come in much lower, at around 5% due to stable, relatively high 04 05 06 07 08 09 10oil prices. Russian sovereign bonds thus remain relatively solid and are attrac- Russia EMBI Globaltively priced compared to its BBB-rated peers. Investors need to be aware,however, that Russian sovereign bonds tend to be more volatile than other Source: J.P. Morgan, UBS WMR, as of 10 December 2010BBB-rated sovereigns. We would become more cautious if the oil price wereto start trending weaker for a sustained period of time.South AfricaRating (Moodys / S&P): A3 / BBB+South Africas economy continues its moderate recovery with a higher-than-expected November Purchasing Managers Index, indicating that manufactur-ing output should expand moderately. However, structural unemployment, alikely widening of the current account deficit and the risk of subdued foreigninvestment flows will likely challenge South Africa. We expect South Africasgrowth to lag behind its emerging markets peers, while inflation should re-main moderate over the next 12 months. Considering current bond valua-tions, South African sovereign bonds trade at a premium to its peers. Givenour economic outlook, we think this premium is not justified. In our view,these less attractive valuations are not in a reasonable relation to the limitedupward potential in the months ahead. Emerging market bonds - 3
  4. 4. UBS Wealth Management Research 15 December 2010Emerging market bondsVenezuelaRating (Moodys / S&P): B2 / BB-Even after the issuance of USD 3 billion by the Republic of Venezuela, thePetróleos de Venezuela (PdVSA), the countrys nationalized oil company isissuing between USD 500 million and USD 1 billion of new debt monthlyto fund the demand in the controlled parallel exchange market. While thehigher oil price supported Venezuelan sovereign bonds in recent weeks, themedium term outlook remains shaky, at best. First, with an estimated USD12 billion of new debt issuance per year at a cost of up to 12.75% per an-num, the countrys external vulnerability is likely to deteriorate. Second, thedomestic situation in Venezuela remains very challenging. Emerging market bonds - 4
  5. 5. UBS Wealth Management Research 15 December 2010Emerging market bondsOverview of emerging market sovereign ratings and spreadsThe graph below shows the relationship between emerging market sovereign Sovereign bond issuer recommendationsissuer ratings and the spreads of their USD-denominated bonds. The horizon- The return outlook that is assigned to a country istal axis represents the issuers credit rating, for which we use the average based on fundamental analysis (e.g., external solven-rating from Moodys and S&P. The vertical axis shows the spreads, i.e., the cy ratios, indebtedness, GDP growth, prospects for re-difference in yield between the emerging market bonds and US Treasuries. form-related legislation and political events), techni-As can be seen from the graph, on average, the weaker the issuers credit cal analysis (e.g., new debt issuance and/or liabilityrating, the higher the spread. We use a regression model to approximate the management offerings) and on Wealth Managementrelationship between credit ratings and spreads. The solid line represents the Research’s (WMR) expectations for changes in theestimation result. The vertical distance provides a first indication of whether country spread over US treasuries over a 12-month pe-a sovereign issuer is rather expensive (issuers are below the curve) or rather riod. This analysis is compared with the benchmark in-cheap (issuers are above the curve). dex (comprising country bonds in JP Morgan’s Emerg- ing Market Bond Index Global).Relative value USD emerging market debtSpreads over US Treasuries relative to issuer rating 1200 Venezuela 1000 Ecuador Basis points over US Treasuries 800 Pakistan 600 Argentina Ukraine Serbia 400 Hungary Ghana Russia Kazakhstan Sri Lanka South Africa Bulgaria Vietnam Gabon 200 Egypt Indonesia Poland Brazil China Philippines Mexico Peru Turkey Chile Malaysia Colombia 0 AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+Source: J.P. Morgan, Bloomberg, UBS WMR, 10 December 2010. The horizontal axis represents the average rating of Moodys and S&P. For an explanation of what these credit ratings mean in terms ofdefault probabilities (i.e., the risk that investors will not get their money back if they buy the bond of a particular sovereign), please see the appendix. Emerging market bonds - 5
  6. 6. UBS Wealth Management Research 15 December 2010Emerging market bonds Rating Agencies Credit Ratings S&P Moody# s Fitch / IBCA Definition AAA Aaa AAA Issuers have exceptionally strong credit quality. AAA is the best credit quality. AA+ Aa1 AA+ Investment Grade AA Aa2 AA Issuers have very strong credit quality. AA- Aa3 AA- A+ A1 A+ A A2 A Issuers have high credit quality. A- A3 A- BBB+ Baa1 BBB+ Issuers have adequate credit quality. This is the lowest Investment Grade BBB Baa2 BBB category. BBB- Baa3 BBB- BB+ Ba1 BB+ Issuers have weak credit quality. This is the highest Speculative Grade BB Ba2 BB category. BB- Ba3 BB- B+ B1 B+ B B2 B Issuers have very weak credit quality. Non-Investment Grade B- B3 B- CCC+ Caa1 CCC+ Issuers have extremely weak credit quality. CCC Caa2 CCC CCC- Caa3 CCC- CC CC+ C Ca CC Issuers have very high risk of default. CC- Obligor failed to make payment on one or more of its financial D C DDD commitments. This is the lowest quality of the Speculative Grade category.Investors should be aware that Emerging Market assets are subject to, amongst others, potential risks linked to currency volatility, abruptchanges in the cost of capital and the economic growth outlook, as well as regulatory and socio-political risk, interest rate risk andhigher credit risk. Assets can sometimes be very illiquid and liquidity conditions can abruptly worsen.WMR generally recommends onlythose securities it believes have been registered under Federal U.S. registration rules (Section 12 of the Securities Exchange Act of 1934)and individual State registration rules (commonly known as "Blue Sky" laws).Prospective investors should be aware that to the extentpermitted under US law, WMR may from time to time recommend bonds that are not registered under US or State securities laws.These bonds may be issued in jurisdictions where the level of required disclosures to be made by issuers is not as frequent or completeas that required by US laws.For more background on emerging markets generally, see the WMR Education Notes, "Emerging Market Bonds: Understanding Emerg-ing Market Bonds," 12 August 2009 and "Emerging Markets Bonds: Understanding Sovereign Risk," 17 December 2009.Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns with the highest creditratings (in the investment grade band). Such an approach should decrease the risk that an investor could end up holding bonds onwhich the sovereign has defaulted. Sub-investment grade bonds are recommended only for clients with a higher risk tolerance andwho seek to hold higher yielding bonds for shorter periods only. Emerging market bonds - 6
  7. 7. UBS Wealth Management Research 15 December 2010Emerging market bondsAppendixGlobal DisclaimerWealth Management Research is published by Wealth Management & Swiss Bank and Wealth Management Americas, Business Divisions of UBS AG (UBS) or an affiliatethereof. In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buyor sell any investment or other specific product. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially differentresults. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to allinvestors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty,express or implied, is made as to its accuracy or completeness (other than disclosures relating to UBS and its affiliates). All information and opinions as well as any pricesindicated are current as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by otherbusiness areas or divisions of UBS as a result of using different assumptions and/or criteria. At any time UBS AG and other companies in the UBS group (or employees thereof)may have a long or short position, or deal as principal or agent, in relevant securities or provide advisory or other services to the issuer of relevant securities or to a companyconnected with an issuer. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying therisk to which you are exposed may be difficult to quantify. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, intoother areas, units, divisions or affiliates of UBS. Futures and options trading is considered risky. Past performance of an investment is no guarantee for its future performance.Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changesin FX rates may have an adverse effect on the price, value or income of an investment. We are of necessity unable to take into account the particular investment objectives,financial situation and needs of our individual clients and we would recommend that you take financial and/or tax advice as to the implications (including tax) of investingin any of the products mentioned herein. This document may not be reproduced or copies circulated without prior authority of UBS or a subsidiary of UBS. UBS expresslyprohibits the distribution and transfer of this document to third parties for any reason. UBS will not be liable for any claims or lawsuits from any third parties arising from theuse or distribution of this document. This report is for distribution only under such circumstances as may be permitted by applicable law.Australia: Distributed by UBS Wealth Management Australia Ltd (Holder of Australian Financial Services Licence No. 231127), Chifley Tower, 2 Chifley Square, Sydney, NewSouth Wales, NSW 2000. Austria: This publication is not intended to constitute a public offer or a comparable solicitation under Austrian law and will only be used undercircumstances which will not be equivalent to a public offering of securities in Austria. The document may only be used by the direct recipient of this information and mayunder no circumstances be passed on to any other investor. Bahamas: This publication is distributed to private clients of UBS (Bahamas) Ltd and is not intended for distributionto persons designated as a Bahamian citizen or resident under the Bahamas Exchange Control Regulations. Canada: In Canada, this publication is distributed to clients of UBSWealth Management Canada by UBS Investment Management Canada Inc.. Dubai: Research is issued by UBS AG Dubai Branch within the DIFC, is intended for professionalclients only and is not for onward distribution within the United Arab Emirates. France: This publication is distributed by UBS (France) S.A., French "société anonyme" withshare capital of € 125.726.944, 69, boulevard Haussmann F-75008 Paris, R.C.S. Paris B 421 255 670, to its clients and prospects. UBS (France) S.A. is a provider of investmentservices duly authorized according to the terms of the "Code Monétaire et Financier", regulated by French banking and financial authorities as the "Banque de France"and the "Autorité des Marchés Financiers". Germany: The issuer under German Law is UBS Deutschland AG, Bockenheimer Landstrasse 2-4, 60306 Frankfurt am Main.UBS Deutschland AG is authorized and regulated by the "Bundesanstalt für Finanzdienstleistungsaufsicht". Hong Kong: This publication is distributed to clients of UBS AGHong Kong Branch by UBS AG Hong Kong Branch, a licensed bank under the Hong Kong Banking Ordinance and a registered institution under the Securities and FuturesOrdinance. Indonesia: This research or publication is not intended and not prepared for purposes of public offering of securities under the Indonesian Capital Market Lawand its implementing regulations. Securities mentioned in this material have not been, and will not be, registered under the Indonesian Capital Market Law and Regulations.Italy: This publication is distributed to the clients of UBS (Italia) S.p.A., via del vecchio politecnico 3, Milano, an Italian bank duly authorized by Bank of Italy to the provisionof financial services and supervised by "Consob" and Bank of Italy. Jersey: UBS AG, Jersey Branch, is regulated and authorized by the Jersey Financial Services Commissionfor the conduct of banking, funds and investment business. Luxembourg: This publication is not intended to constitute a public offer under Luxembourg law, but mightbe made available for information purposes to clients of UBS (Luxembourg) S.A., a regulated bank under the supervision of the "Commission de Surveillance du SecteurFinancier" (CSSF), to which this publication has not been submitted for approval. Singapore: Please contact UBS AG Singapore branch, an exempt financial adviser underthe Singapore Financial Advisers Act (Cap. 110) and a wholesale bank licensed under the Singapore Banking Act (Cap. 19) regulated by the Monetary Authority of Singapore,in respect of any matters arising from, or in connection with, the analysis or report. Spain: This publication is distributed to clients of UBS Bank, S.A. by UBS Bank, S.A., abank registered with the Bank of Spain. UAE: This research report is not intended to constitute an offer, sale or delivery of shares or other securities under the laws of theUnited Arab Emirates (UAE). The contents of this report have not been and will not be approved by any authority in the United Arab Emirates including the UAE Central Bankor Dubai Financial Authorities, the Emirates Securities and Commodities Authority, the Dubai Financial Market, the Abu Dhabi Securities market or any other UAE exchange.UK: Approved by UBS AG, authorized and regulated in the UK by the Financial Services Authority. A member of the London Stock Exchange. This publication is distributed toprivate clients of UBS London in the UK. Where products or services are provided from outside the UK, they will not be covered by the UK regulatory regime or the FinancialServices Compensation Scheme. USA: Distributed to US persons by UBS Financial Services Inc., a subsidiary of UBS AG. UBS Securities LLC is a subsidiary of UBS AG and anaffiliate of UBS Financial Services Inc. UBS Financial Services Inc. accepts responsibility for the content of a report prepared by a non-US affiliate when it distributes reportsto US persons. All transactions by a US person in the securities mentioned in this report should be effected through a US-registered broker dealer affiliated with UBS, andnot through a non-US affiliate.Version as per January 2010.© UBS 2010.The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved. Emerging market bonds - 7