>Global Bank Rating Trends Q109 (Fitch Ratings)

Introduction
This publication continues the series dating from the beginning of 2006, and presents data for the four quarters up to and including Q109. Data from Q105 are included in earlier publications. New charts showing the distribution across rating categories are also included in this publication.

Global Overview
Significant economic pressures continue, particularly in some emerging markets, although the crisis conditions following the bankruptcy of Lehman Brothers on 15 September 2008 have abated. This is partly due to the liquidity and capital support from the governments and the acquisitions of weaker banks by stronger banks. In addition to their willingness, the ability of sovereigns to continue to support their banking systems has received increased focus recently. Fitch Ratings forecasts that the real economies of many developed economies will contract significantly in 2009. Fitch also forecasts world GDP will decline by 2.7% this year, although growth in the BRICs (Brazil, Russia, India and China) is expected to remain positive at 3.2%.

Elsewhere in emerging markets, there has been increased attention on banking operations in eastern Europe, and several eastern European countries have received IMF assistance.
Negative rating actions in Q109 remained high, although the number was lower than the peak in Q408. Fitch took 188 negative rating actions in Q109, compared with 266 in Q408. The reduction was mainly caused by less negative rating actions in emerging markets in Q109, while negative rating actions in developed markets remained high. In contrast, there were no positive actions in emerging markets and only a small number of positive actions in developed markets in Q109. This resulted in the worst ratio of negative to positive actions since the series began in Q105 (−12.5).

There is also substantial negativity in the Outlooks assigned to banks’ Long‐Term Issuer Default Ratings (IDRs) globally in Q109. The number of global Negative Outlooks has exceeded the number of Positive Outlooks since end‐Q208. The global ratio of Negative to Positive Outlooks deteriorated significantly, to −16.2 at end‐ Q109 from −9.6 at end‐Q408 (see Chart 1). By end‐Q109, the ratio stood at −11.3 in developed markets (end‐Q408: −6.2) and −24.0 in emerging markets (end‐Q408: −15.0). Significant differences remain among regions in both developed and emerging markets. In developed markets, this ratio varied from −3.7 in the developed Americas to −25.0 in developed Europe. In emerging markets, the ratio at end‐Q109 ranged from −2.4 in the emerging Americas to −75.0 in emerging Europe.

The percentage of Fitch’s global bank ratings universe with Stable Outlooks continued to decline moderately (see Table 1). However, the majority of ratings (66.1%) had Stable Outlooks at
end‐Q109. Most of the remaining banks had Negative Outlooks at end‐Q109 (24.1%). In addition, 1.5% of bank ratings were on Positive Outlook.

The negativity in Fitch’s bank ratings suggests the negative trend will continue. This is somewhat mitigated by Fitch’s view on sovereign support within the banking sector (see “Updated Support Rating Floors for Major Banks in High‐Grade Sovereigns”, dated 9 April 2009). Fitch’s Support Rating Floors in many developed markets remain at relatively high levels and therefore limit downgrades in Long‐ Term IDRs.

Trends in Rating Outlooks and Watches

Developed Markets
Although 68.6% of bank ratings in developed markets still had Stable Outlooks at end‐Q109, the proportion of Negative Outlooks increased to 19.5% (end‐Q408: 16.6%). There was an increase in Negative Outlooks in developed Asia during Q109. However, the largest numbers of Negative Outlooks at end‐Q109 were in developed Europe (50) and the developed Americas (22), with no change in the number from end‐Q408. The ratios of Negative to Positive Outlooks have deteriorated significantly in the developed markets overall and particularly in developed Europe and developed Asia (see Chart 2). In addition, there were 38 Negative Watches in developed markets at end‐ Q109.

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>Hedge Fund Monitor (MERRILL LYNCH)

HFs short 10-year T-note to levels not seen since April ‘05

Large Specs buy gold, 2Y-Ts; sell NDX, oil, US$ and 10Y-Ts
Note: Commitment of Traders data reflects positions as of last’s Tues close
Equities: Large specs decreased their net long position in the S&P 500 futures last week while also continuing to pullback on their crowded longs in the NDX. In recent weeks readings in the NDX reached their highest levels since Oct 07- when the NDX subsequently fell 6.7% 1month on. Large specs also added to their shorts in the Russell 2000. HFs are still a source of liquidity for the markets but less so with a potential buying power of ~$9b, consisting of $6b in the SPX and $3b in the R2000.
Metals: Large specs marginally added to their gold longs last week, while aggressively buying silver. Additionally they modestly added to their net shorts in copper.
Energy: HFs sold crude oil last week to go net short, while adding to their deep short position in natural gas. Additionally, they marginally increased their longs in heating oil and moved sharply back into a crowded long in gasoline.
Forex: Large specs covered the Euro last week, while modestly selling the USD. They also added to their net shorts in the Yen.
Interest Rates: HFs increased their longs in the 2-Yr Ts, while increasing their significant shorts in the 10-Yr Ts. They also added to their shorts in the 30-Yr T-Bonds.

M/N and L/S hedge funds’ market exposure continue to improve
Our models indicate both M/N and L/S funds’ market exposure continuing to improve after falling rapidly in late March and early April; both still remain underweight equities though (pp 3-4). It is potentially bullish for equities if HFs, with substantial cash on the sidelines and facing significantly lower outflows in Q2, return to the markets. M/N HFs were big losers in April because of their sharp drop in beta during much of the current rally (for reference see Hedge Fund Monitor, 13 April 2009). We also note a significant shift by M/N and L/S funds towards Low quality from High. Low quality has significantly outperformed in this rally, but that may be changing.

Macros sell the SPX, commodities; buy the NDX, US$, 10 Yr-Ts
Our models suggest Macro HFs added to their crowded net short in the S&P 500 last week, while buying the NDX. Additionally, they continued to buy the US$ index and modestly covered their shorts in the 10-Yr Ts, while selling commodities. We also estimate Macro HFs were flat the Emerging markets and bought the EAFE markets.

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>Lanco Infratech (ICICI Securities)

Steadyfast Growth....

As per our recent interaction with the management of Lanco, the execution of its power projects is continuing at a fast pace. We expect the company to start commercial operations of Amarkantak-I (300MW) in the next 1-2 months. Lanco’s operational capacity will rise to 2,000MW from 500MW in the next 15 months. Other projects expected to be commissioned are Kondapalli-II (October ’09; 366MW capacity), Amarkantak-II (November ’09, 300MW capacity), hydro projects (20MW capacity) and Udipi (April ’10; 600MW capacity). Also, the EPC segment will witness growth as power projects worth ~Rs100bn and 4,000MW capacity are expected to achieve financial closure in the next 12 months. The recently won 3,000MW power projects, Rajpura & Dhopave, and the Vizhinjam port project will provide additional impetus to orderflow. Given the visible growth in Lanco’s EPC orderbook, discounted valuations for the power portfolio and healthy execution of its power projects, we maintain BUY on Lanco with revised target price of Rs274/share from Rs206/share.

■ Liquidity concerns overdone. Lanco’s cash & cash equivalent and outstanding debt was at Rs10bn and Rs53bn respectively as of end Q3FY09. We believe this is adequate to fund the company’s capex. Cumulative capex for under-construction power projects of 4,000MW capacity was at Rs168bn, of which ~Rs65bn has already been expended, with an equity contribution of Rs22bn (34% of the total project cost). We expect Rs20-25bn equity requirement for projects under
construction over the next three years; this could be met by annual cashflows from the EPC business (~Rs4bn) and operational power plants (~Rs4-5bn). We believe that current reserves are sufficient to meet equity requirements of planned projects that are yet to achieve financial closure. Lanco’s foreign exchange risk from equipment purchase post the buyer’s credit utilisation breaks even at ~Rs49. The company’s real-estate portfolio is cashflow neutral; its residential segment has
advances of Rs3bn (2.5mn sqft sold of 4mn sqft) and equity contribution of Rs2.6bn, with ~Rs6bn debt outstanding. The company has slowed down the execution of the commercial portfolio and will await better environment to launch its projects.

■ Valuations. We raise our NAV estimates to Rs60bn or Rs274/share from Rs45bn or Rs206/share earlier. Based on FY09E, FY10E & FY11E EPS estimates, the stock is trading at P/E of 14.4x, 12.2x & 8.6x respectively. We expect earnings to remain stable as revenues from EPC division (50% contribution) are dependent on execution of internal power projects and earnings from power plants would steadily increase owing to commissioning of new projects. Lanco is trading at FY11E P/BV of 1.6x. Maintain BUY.

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>EDUCOMP SOLUTIONS (ICICI SECURITIES)

Educomp Solutions’ standalone revenues grew lower than expectations at 56% YoY and 27% QoQ to Rs1.84bn (I-Sec: Rs1.94bn). With higher admin costs, depreciation and interest, operating profits before taxes (OPBT) declined 9% QoQ to Rs500mn. OPBT margin declined 10.7ppts QoQ to 27.2% (I-Sec: 34.3%). PAT rose 73% to Rs545mn after Rs369mn write-back of forex loss on MTM of FCCBs (as per the option provided in amended AS11). The management has guided for Rs10-10.5bn FY10 consolidated revenues and Rs2.1-2.2bn PAT, implying 58-66% YoY growth, broadly in line with market expectations. With lower-than-expected Q4FY09 results and in line FY10 guidance, we expect the stock to be under pressure in the short term. Educomp’s diversified business model is less prone to slowdown with strong annuity-based cashflows providing high and sustainable growth visibility in the long term. We believe robust growth momentum will continue in Smart_Class and K-12 schools, which are the key growth drivers for the company, while ICT and other businesses/acquisitions would supplement the strong growth. The management expects better financial performance from subsidiaries/acquisitions in FY10. We expect 43% CAGR each in consolidated revenues and PAT over FY09-11E. Maintain BUY with Rs2,950 price target (at FY10E P/E of 26x).

■ Strong traction in Smart_Class, with 120% YoY revenue growth to Rs1.1bn in Q4FY09. Educomp added 258 schools to its Smart_Class portfolio, taking the total to 1,737 (surpassing its guidance of 1,700) and covering +1.98mn students. The management has guided for healthy Smart_Class school additions (to cover 2,800- 2,900 schools) in FY10. To ensure continued robust growth in Smart_Class, Educomp plans to: i) add 40 sales personnel to the existing 180, ii) increasingly provide hardware upfront to the schools, thereby reducing cashflow requirements, iii) improve logistic facilities and iv) outsource resource co-ordinators. We expect
strong 53% CAGR in Smart_Class revenues over FY09-11E.

■ K-12 initiatives on track. At present, Educomp has 14 operational schools with 14,000+ students. Admissions have started for six more schools and three schools would be added by June ’09. Educomp has visibility for 20 more schools in FY10. We expect 46% revenue CAGR from K-12 initiatives over FY09-11E.

■ ICT and other businesses/acquisitions. Educomp has guided to add 5,000 schools in ICT for FY10. Pre-school brand, Roots to Wings, is present in 169 centres, while Eurokids has more than 450 pre-schools; the management intends to have presence in >1,000 pre-schools in the next two years. Raffles Millennium International Institute is operational in Delhi and would also be started in Bangalore.

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