MARKET CALL Capital Markets Research

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1 September 2012 The MARKET CALL Capital Markets Research FMIC and UA&P Capital Markets Research Macroeconomy 2 Fixed-Income Securities 9 Equity Markets 15 Recent Economic Indicators 20 Contributors 22

2 Macroeconomy PH Economy Still Looking Good! 2 Despite the effects of continued recession in the Eurozone and slowdown in the US, Philippine Gross Domestic Product (GDP) expanded by 5.9% in Q2. With agriculture performing poorly and the country s copper smelter being closed, GDP growth fell to the lower end of our expectations of 6-7%. The strong peso was similarly a drag. Economic headwinds remain heavy due to higher inflation arising from crude oil prices and lack of resolution of the Eurozone woes. While the economy's growth may seem to ease, the outlook for H2 remains positive considering that Meralco electricity sales in July remained elevated particularly for the industrial sector. The acceleration of National Government (NG) spending and easier monetary policy, however, should further support the growth rates within our forecast. 5.9% GDP Growth in Q2, 6.1% in H1 H growth averaged 6.1% from H of 4.5%. On a quarterly basis, Q growth of 5.9% was slightly slower than the revised 6.3% growth in Q On the supply side, the three major production sectors had less than vibrant performances. Agriculture decelerated by 0.3%, Industry by 0.7% and Services by 0.5% points. On the demand side, current Government Spending grew 5.9% but posed the biggest drag. It eased sharply by 150 basis points (bps). Export growth decelerated slightly, while Capital Formation and Household Consumption Expenditure improved significantly. Gross National Income (GNI) also accelerated to 5.6% from the revised 5.1% in Q1. A slower peso appreciation relative to Q1 levels improved Net Primary Income from 1.7% to 4.5% since Overseas Filipino Workers' (OFW) remittances are lodged in this account. The production side for Q2 showed that Agriculture (incl. Forestry & Fisheries, or AFF), Industry and Services sectors were growing more slowly than in Q1. On a year-on-year (y-o-y) basis, AFF grew by 0.7% from 1% and Services by 7.6% from 8.1% in Q1. Meanwhile, Industry decelerated to 4.6% from 5.2%. Consecutive quarters of easing growth in Fisheries since Q has dragged down the AFF sector but the Agriculture industry alone improved and contributed to a 1.5% (y-o-y) expansion. Palay production gained by 10.1% but the huge decline in the Sugar industry (-42.5%) and Forestry products (-13.4%) took a heavy toll on the Agriculture sector. The sluggish performance of Industry was due to a 7.3% decline in Mining and Quarrying (MQ) output. This was primarily due to a 68% plunge in gold production (at least, that part is usually sold to the Bangko Sentral ng Pilipinas) and slightly lower crude oil output from the Nido wells. In addition, Manufacturing (MFG) output slowed to a 4% growth pace from 6% in Q1 despite the fact that 15 out of 22 key manufacturing industries were positive. Furthermore, Electricity, Gas, and Water Supply (EGW) slowed to 6.2% from 8.5%. Other slowdowns included Petroleum and other Fuel Products which slumped by 20.5% while Basic Metals plunged 42.7%. The peso appreciation made importation of finished petroleum products more advantageous for both refiners and independent players resulting in lower domestic production. Repairs in the Pasar copper smelting facility due to a Q1 fire that gutted a part of its manufacturing process made its absence felt in the large fall in Basic Metals. Meanwhile, Construction grew to 10% from 3.6% in Q1 and -24.2% in Q This was mainly due to continued rapid growth in infrastructure development such that Public Construction was up by 45.7% which diffused the 2.6% slide in Private Construction. Services Sector growth eased to 7.6% from 8.1% in Q1. Real Estate, Renting and Business Activities (RERBA) contributed positively and grew by 8.5% from 7.9% while Public Administration and Defense (PAD) accelerated to a rise of 2.1% from 1.5% last Q1. Ironically, all other Services subsectors decelerated slightly compared to Q1. Financial Intermediation and Other Services posted the slowest growth rates as bank lending slowed down beginning in Q1 and trading gains vanished with interest rates inching up in Q2.

3 Macroeconomy The third quarter started strong as Meralco electricity sales posted resilient growth of 8.9%. 3 Government Final Consumption (GFC) spending binge slowed to 5.9% from 20.9% in Q1 pulling down much of the economy from the demand or expenditure side. Nevertheless, relative to Q2 2011, stronger Consumer Spending and Capital Formation together with better exports data were recorded in the quarter. Household Final Consumption (HFC) grew by 5.7% and was higher than Q1 s revised downward figure of 5.1% while Capital Formation had a significant reversal from -25.4% to a 2.3% uptick. Faster paces in both Construction and Durable Equipment spending which expanded by 9.2% and 8.7% respectively, raised Fixed Capital growth from 3.9% to 8.5%. The external sector netted an export surplus, which was up by 103.5% (y-o-y) compared to a net deficit in Q1. Hefty peso appreciation and continued weak global demand bore down on the Exports sector decelerating to an 8.3% growth from 10.9% in Q1. Fortunately, export growth was even larger than the 4.4% uptick in Imports as Imports of Services surged to 13.2% from 9.3% in Q1. On a seasonally adjusted basis, GDP decelerated significantly to 0.2% from 3% in Q1. Industry declined to -2.4% from 3.8% while Services slowed to 1.5% from 2.6%, but an acceleration in Household Final Consumption Expenditure (HFCE) to 1.4% from 0.9% made up for the decline. Slower growth was largely accounted for by the significant peso appreciation as it cut into Exports and Overseas Filipino Workers (OFWs) remittances and heavily affected domestic spending. Despite the slowdown, the 5.9% growth was in the upper end of the government's target range and is still considered strong. It placed the country at third in terms of growth rate within the region after China and Indonesia. For Q3, a further weakening is expected. The National Statistics Coordination Board s (NSCB) Leading Economic Indicator (LEI) showed a slight reversal of the uptrend that started in Q Nonetheless, further expansionary fiscal policy can counter this reversal. Meanwhile, banks should be able to increase their pace of lending as they adjust to the lower reserve requirements that took effect on April 6, Continued strong domestic consumption and further NG spending as well as improved bank lending performance will counter exports deceleration, dampened by weak global demand. These factors keep us optimistic that GDP growth in Q3 as well as for the whole year would settle at 5.5-6%. Figure 1 - Gross Domestic Product Growth (Year-on-Year) 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Q Q2 Q3 Q4 Q Q2 Q3 Q4 Q Source: National Statistical Coordination Board (NSCB) 6.3% Q2 Q3 Q4 Q % 8.9% Uptick in July Meralco Sales The third quarter started strong as Meralco electricity sales posted resilient growth of 8.9% in July which is the seventh month above 8% in The July pace was faster than 8.3% in June and far better than 1.3% a year ago. For the H1, enhanced economic activities can be inferred from the 9.7% growth y-o-y in Meralco sales which was a significant improvement from the -1.1% decline in Meanwhile,the National Statistics Office s (NSO) Monthly Integrated Survey for Selected Industries (MISSI) reported a 4.4% Volume of Production Index acceleration in June from the downward revised -4.1% in May. For H1, VoPI grew by 4.5% which was lower than the 6.9% growth in the same period last year. The slowdown can be attributed to the weak production in the Industrial and Mining & Oil major sectors in May and June. Electricity sales to the Industrial sector accelerated to 18.7% from a 16.2% growth. Commercial sector s electricity sales turned around to a 5.5% upswing compared to a -6.3% Q2

4 Macroeconomy Top gainers posted exceptional growth especially in Footwear and Apparel (+82.5%), followed by Transport Equipment (+49.7%), Furniture and Fixtures (+40.2%) and Wood and Wood Products (+36.6%). 4 in June indicative of a more active consumer market. Electricity sales to Residential customers were relatively flat at 4.3% with cooler climate in the rainy season. VoPI in June showed a tepid performance. Out of 20 industries being monitored, only 12 showed a rise in output. Top gainers posted exceptional growth especially in Footwear and Apparel (+82.5%), followed by Transport Equipment (+49.7%), Furniture and Fixtures (+40.2%) and Wood and Wood Products (+36.6%). Meanwhile, main losers were Petroleum Products (-45.3%), Basic Metals (-32.5%), Publishing and Printing (-25.8%) and Miscellaneous Manufactures (-20%). While July economic activity showed healthy gains, the record rainfall in August which flooded Metro Manila, Central Luzon and Calabarzon will likely weaken sales up to September. Figure 2 - Meralco Sales & Volume of Production Index Growth Rate (Year-on-Year) Meralco Sales % Δ (Left Axis) VoPI - Total Manufacturing % Δ (Right Axis) Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Sources: Meralco, National Statistics Office (NSO) Inflation Accelerated to 3.2% in July Headline inflation rate in July was 3.2% year-on-year (y-o-y). It was faster than June s 2.8% but slower than 4.9% in the same month a year ago. This was mainly due to bigger jumps in food and oil product prices as well as in 7 out of the 10 other commodity groups. Core inflation also accelerated registering 4.1%, notably higher than 3.7% in June. Heavy-weighted indices, like Food & Non-Alcoholic Beverages (FNB) and Housing, Water, Electricity, Gas and Other Fuels (HWEGF) were major contributors to the uptick in inflation rate. Moreover, World Bank (WB) Major Price Indices of Global Commodities showed that global food prices were up by 10% and energy index was also up in July. Tension between Iran and Western countries fuelled speculation on the supply of global crude oil, reversing the downward trend seen since May. Electricity rates also moved due to higher spot prices at the Wholesale Elecricity Spot Market (WESM) in June. On a monthly (m-o-m) basis, inflation eased to 0.3% in July from 0.5% in June. Out of the 11 commodity group indices, only Education decelerated from the revised 4.4% in June to 0% in July, while 5 were unchanged. The other 5 indices climbed slightly which were Health (0.3% to 0.4%), Transport (-0.9% to -0.4%), Communication (0% to 0.1%), Recreation and Culture (0.3% to 0.4%), and Restaurants and Miscelleneous Goods and Services (0.2% to 0.3%). Food, Beverages, Clothing, Power, and Furnishing, Household Equipment and Routine Maintenance of the House indices were unchanged. On an annual (y-o-y) basis, the 3.2% rate in July was largely due to the 5% acceleration of the HWEGF index against 4.1% in June as prices of electricity and liquid petroleum gas (LPG) increased. The Dubai Fateh crude oil had an uptick of 5.3% to $99.22 per barrel. Furnishing, Household Equipment and Routine Maintenance of the House (FHERMH) index posted the second highest price increase from 3.7% to 4.1%. Acceleration in other commodity groups registered a mild pace of 0.2 to 0.3 percentage points. Meanwhile, Transport index decelerated from 1.3% to 0.7% as consecutive cuts in gasoline prices continued up to early July. Clothing & Footwear, Health, and Education indices also registered minimal slowdowns. The following table shows the y-o-y data with the year-todate (YTD) computation.

5 Macroeconomy Total July NG expenditures maintained double-digit growth at 21.8%, the highest for the current year. 5 Inflation Year-on-Year Growth Rates Jul Jun YTD All items 3.2% 2.8% 3.0% Food and Non-Alcoholic Beverages 2.3% 2.1% 2.0% Alcoholic Beverages and Tobacco 4.9% 4.8% 4.9% Clothing and Footwear 5.0% 5.2% 4.5% Housing, Water, Electricity, Gas, and Other Fuels 5.0% 4.1% 4.7% Furnishing, Household Equipment and Routine Maintenance of the House 4.1% 3.7% 3.0% Health 3.2% 3.3% 3.1% Transport 0.7% 1.3% 2.9% Communication 0.2% 0.1% -0.1% Recreation and Culture 2.7% 2.4% 2.5% Education 4.4% 4.7% 4.7% Restaurants and Miscellaneous Goods and Services Source: National Statistics Office (NSO) 3.5% 3.4% 3.3% The year-to-date inflation registered exactly on the low end of the target range of Bangko Sentral ng Pilipinas (BSP) at 3%. This makes economic conditions to be conducive towards a positive growth momentum. Although inflation will have a weather-related acceleration bias in August and part of September due to the southwest monsoon, we foresee a reversal by October when the rains let up. Figure 3 -Inflation Rates Annualized ( ) Seasonally Adjusted vs. Year-on-Year 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% Monthly S.A. Inflation Annualized Year-on-Year Inflation Rate Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Enhanced Fiscal Expenditure in July The NG further boosted spending In July as total expenditures accelerated to a 21.8% growth from 17.8% in June. Despite 15.3% growth in revenues from June s 15.1%, July deficit rose to P39.2 B to reach a cumulative seven-month deficit of P73.7 B. Nevertheless, this is still way below the full-year program of P279.1 B. The Bureau of Internal Revenue (BIR) tax collection growth eased to 13.2% from 21.6%, while the Bureau of Customs (BoC) accelerated to 14.6% from 7.6%. Non-Tax Revenue also contributed much as it posted double-digit growth of 32.9% from a poor -6.6% last June. Despite the sustained revenue performance, tax collection was seen off its program as the BIR fell 2.6% shy from its H1 target while BoC was 14.2% short. To address this, the BIR mentioned that the Sin Tax reform was beneficial as it can provide additional P154 B revenue. The said reform and other plans to enhance tax collection are needed for the NG to sustain its contribution to the economic expansion. The double-digit NG expenditures growth in July was due to the surge in Interest Payments to 24.5% from 13.9% last June. In absolute terms these reached an all-time monthly high of P51.2 B likely due to coupon payments on ROPs which are usually made in January and July. Excluding interest payments, expenditure expanded by 20.6%. However, NG cut allotments to Local Government Units (LGUs) by 0.2%. Net financing in July was practically all from domestic sources to the tune of P37.7 B while foreign sources provided only P0.4 B. The bias is for domestic financing considering low domestic interest rates and tremendous liquidity in the funds market. The monthly deficit for the rest of the year should be P25-35 B, which means that full-year deficit is not likely to exceed P240 B, allowing for a primary surplus of some P100 B or 0.9% of GDP. This together with favorable interest rates and growth close to 6% would make it possible for the debt-to-gdp ratio to fall to 48%+ range which would be the first time in more than 30 years should it materialize. Source: National Statistics Office (NSO)

6 Macroeconomy 6 Money growth (M1, M2, and M3) in June showed a slight increase in liquidity. M1 climbed to 8.5% from 8% while M2 and M3 both grew at a slower pace to 7.9% from 9% and 9.1%, respectively. Figure 4 - NG Revenue Performace Growth Rates Year-on-Year of BoC and BIR 35.00% 30.00% 25.00% 20.00% 15.00% Tax Revenue BIR BOC of both Net Foreign Asset (NFA) and Net Domestic Asset (NDA) brought RM slightly higher in June. NFA decelerated to 7.7% from 11.6% while NDA eased to 3.2% from 9.6%. There appeared to be less need to mop up liquidity since the build-up of gross international reserves (GIR) was also milder. BSP s twin moves to allow more money growth would likely have a bigger effect on lending and economic growth in H % 5.00% Figure 5 -M2 and M3 Money Supply Growth Rates (Year-on-Year) 0.00% -5.00% % % Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul % 30.0% 25.0% 20.0% M2 M3 M1 Source: Bureau of the Treasury (BTr) Stable Money Growth Seen in June Money growth (M1, M2, and M3) in June showed a slight increase in liquidity. M1 climbed to 8.5% from 8% while M2 and M3 both grew at a slower pace to 7.9% from 9% and 9.1%, respectively. This was the effect of the first interest rate cut. However, these changes brought money multiplier lower to 3.64 than 3.68 in May. Implicitly, bank lending was not extensive. Special Deposit Accounts (SDAs) in June was P1.57 Tr which is lower than the P1.63 Tr in May but was 13.1% higher than a year ago. However, SDAs have reached P1.79 Tr in August based on partial data released by Bangko Sentral ng Pilipinas (BSP). Banks seem to have difficulty finding a suitable channel for their excess liquidity from the 3% reduction of the reserve requirements on April 6, The Monetary Board (MB) of BSP followed up with further easing and cut key policy rates for the third time this year on July 26 by 25 bps. This brought overnight borrowing rate or the Reverse Repurchase (RRP) facility down to 3.75% and overnight lending rate or Repurchase (RP) to 5.75%. Special Deposit Accounts (SDAs) rate was also cut from % to %. BSP's infusion of money into the financial system showed stable growth as Reserve Money (RM) grew 15.4%, a notch higher than 15.3% in May. The unequal slowdown 15.0% 10.0% 5.0% 0.0% Jun 07 Jun 08 Jun 09 Jun 10 Jun 11 Jun % -10.0% Source: Bangko Sentral ng Pilipinas (BSP) Exports Expansion Slows to 4.2% in June After a rapid acceleration of 19.7% in May, June exports eased to 4.2% growth. It was -9.3% growth a year ago. The 14.6% decline in Electronic Products shipments, which accounted for 43.8% of total exports, was the main reason for the slowdown. Nevertheless, exports in Q2 continue to be resilient considering the weak global demand (see article on GDP). For the annual (y-o-y) growth basis, out of the top ten Philippine export products only three were losers, while others were gainers mostly with double-digit pace. The main product gainers were Metal Components (+152.9%); Ignition Wiring Set and Other Wiring Sets Used in Vehicles, Aircrafts and Ships (+89.1%); Coconut Oil (+53.8%); Tuna (+24.1%) as well as Pineapple and Pineapple Products. Meanwhile, main losers were Electronic Products (-14.6%),

7 Macroeconomy Remittances in June could have been better if peso had not appreciated drastically. In June, average peso-dollar exchange rate was P42.8/$ which was stronger compared to May. 7 Gold (-11.4%) and Articles of Apparel and Clothing Accessories (-7.1%). On the larger basket of traded goods, total Agro-Based Products rose 11.9% while manufactured products climbed by 5.6%. On the other hand, Petroleum Products declined by 78.6%. Based on export performance by country recorded by NSO last June, Japan was still the primary exports destination as it accounted for 16.4% of total exports. United States of America (USA) followed with a 15.6% share while China reclaimed its rank as third with 12.4%. Other top export destinations were Singapore, Hong Kong, Germany, South Korea, Taiwan, Thailand, and Netherlands. East Asian countries, excluding Japan, accounted for 46.1% share of total exports but this was 5.4% lower than same month a year ago. Figure 6 - Monthly Exports Growth Rates (Year-on-Year) 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% Jan '09, -40.6% Jun '12 4.2% Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Source: National Statistics Office (NSO) For H1, exports growth reached 7.7%, which was off from the 10% annual target this year. Recently, an issue regarding Chinese Yuan as a possible international currency hogged the limelight. Bangko Sentral ng Pilipinas (BSP) stated that such move will be helpful for the export sector as it can lower foreign exchange risk. For the next few months, we expect better export performance particularly starting September as we expect the US economy to expand a bit faster than the 1.7% reported for Q2. This is because housing permits and starts have shown a definite upward trend while house prices have bottomed. Additionally, more election-related spending should provide an additional boost to the US economy. Remittances Grew by 4.2% in June After the consistent above 5% remittances growth from January to May, growth rate in June eased to 4.2%. It, nonetheless, registered the highest value of $1.8 B since Support for education expenditures heavily contributed to the upsurge of June s remittances aside from the historical basis that June s month always registers high remittances. Compared to H1 a year ago, remittances had a 5.1% expansion ($10.13 B from $9.64 B). Overseas Filipino Workers (OFWs) remittances performance was seen as robust despite the rampant geopolitical turmoil, particularly in Syria, and debt crisis among many host countries in the west. Remittances in June could have been better if the peso had not appreciated drastically. In June, average pesodollar exchange rate was P42.8/$ which was stronger compared to May and 2.5% less than P43.9/$ than June Average June forex would convert remittances to P79.5 B. However, if average peso-dollar exchange rate were at par with June 2011, remittances could have hit its highest peso value since Despite the slight decline in annual growth, OFW remittances in June were still strong. For July, however, we expect relatively lower performance as the peso appreciated to as much as P41/$. This costless source of stimulus for the economy will be missing or only felt minutely unlike in 2009 when the peso depreciation fostered a slightly positive GDP growth. Peso Finally Depreciates in August August saw a reversal of the drastic appreciation of peso in July as average peso-dollar exchange rate reached P42/$. The appreciation of the peso in July was due to massive increase in hot money inflow as risk aversion due to the lingering Eurozone debt crisis. In addition, the US economy was seen improving in July along with resilient OFW remittances performance.

8 Macroeconomy While there may be a slight deceleration of growth in Q3 primarily due to the impact of August floods and weak global economic outlook, we remain optimistic about H2. 8 The upsurge of hot money inflow in July affected the peso-dollar exchange rate to fluctuate at a fast pace with an appreciation bias. Hot money inflows came from the US, Australia, Netherlands, Japan, and United Kingdom. According to BSP, the increase was approximately four times greater even just for the first five months this year which amounted to $1.1 B from $278 M a year ago. Pesodollar exchange rates started to gradually depreciate when the Monetary Board (MB) of BSP modified the SDA rate and key policy rates in late July. From an average of P41/$, it gradually settled to P42/$ in August. The BSP noticed that volatile capital flows affected the movement of exchange rate while posing a possible inflation threat. To address this, measures were drawn to limit the volume of SDA (for non-residents) and Non- Deliverable Forwards (NDF) as these two had reached levels indicative of speculation. Figure 7 -Daily Peso-Dollar Exchange Rate Peso/Dollar Exchange Rate 200-Day Moving Average Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Source: Bangko Sentral ng Pilipinas (BSP) 30-Day Moving Average Looking at the graph, the 200-day Moving Average (MA) shows a slight appreciation bias for the longer-term. However, with actual rates moving up above the 30-day MA, there appears to be a depreciation bias in the shorter term. The intended effect of curtailing speculative hot money inflows through the previous BSP moves would take a little to materialize so that the 30-day MA approaches or goes beyond the 200-day MA. BSP officials have said they still have other tools to use should the need arise but cannot afford to wait too long. Outlook We expect a sharp deceleration of economic activity in August but a recovery in September. With NG able to spend more on infrastructures and operating expenses and a slight uptick in the U.S., the slowdown in Q3 will be minor. Meanwhile, Q4 recovery will be robust given election spending in the US and the beginnings of one in the Philippines. While inflation speeds up in August to early September, we do not expect it to exceed 4% for the rest of the year. Crude oil will tend to flatten or ease slightly and food supplies should normalize by end-september based on the experience of Typhoon Ondoy in 2009, which was admittedly worse than the August monsoon rains and floods. Monetary policy will remain on hold until inflation returns to the 3.2% to 3.7% range. But we still expect further easing once food prices normalize. Better export upticks will have to wait for Q4 when the US and East Asian economies are expected to speed up again in response to Q3 fiscal and monetary stimuli. The same may be said broadly with respect to OFW remittances. The exchange rate will be volatile as sentiment swings with the ups-and-downs in the Eurozone as well as the dimming or brightening of outlook in the US and China. Forecasts Rates Aug Sep Oct Nov Inflation (y-o-y %) day T-Bill (%) Peso-Dollar (P/$) year (%) Source: Authors Estimates

9 Fixed Income Securities Yields Drop After BSP Rate Cut in End-July 9 As inflation edged up to a six-month high of 3.2% in July (from 2.8% in June), yields continued to slide due to consistent robust macroeconomic fundamentals and high liquidity in the market. Even as inflation was higher than expected, it remained close to the lower end of the target range and justifies the 25 bps rate cut by the BSP on July 26. The National Government (NG) released a proposed P2 Tr budget for 2013, 9.9% higher than the P1.8 Tr laid out for The NG projects a higher tax take from a reform of sin taxes and tax incentives rationalization to be enacted by Congress this year, and the deficit is expected to be lower at P241 B from P279 B in Apart from the two tax reform measures for 2012, Budget Secretary Florencio Abad said the Aquino administration will not press for new taxes in 2013, but will focus on improving tax collection efficiency instead. Primary Market: Strong Demand Sends Yields Lower August auctions resulted in yields softening further following the BSP policy rate cut on July 26 and high market liquidity. The rate cut in July was in line with the US Federal Reserve s decision to stand by for possible further stimulus. A return to nearly 3x oversubscription, albeit higher earlier in the month, paved the way for the slide of yields. The 91-day and 182-day yields softened in the August 6 auction. The 91-day resulted in a 30.5 bps drop from the previous auction to 1.495%. Oversubscribed 5.77x, the yield was pushed down close to its level in the first T-bill auction for the year. It was a similar result for the 4.24x oversubscribed 182-day paper with rates falling 32.2 bps from the previous issue to 1.795%. In contrast, the 364- day was partially awarded with its yield climbing 14.3 bps to 2.422%. The 364-day saw lower demand compared to the shorter-tenors and was oversubscribed 1.37x. Consistent sound fundamentals attracted investors to the 25-year T-bond resulting in tenders exceeding the offer 2.92x. Coupon rate fell to a record low of 5.75% in the August 14 auction. Yield fell to 5.731%, representing a deep plunge of 92.5 bps from its previous issue in December 6, Heavy rain and floods moved the regular auction to August 22. In spite of signs of inflation quickening due to food supply disruptions following the inclement weather, appetite for both the 91-day and 182-day remained strong and yields continued their downward trend. The 2.82x oversubscribed 91-day fetched 1.452%, 4.3 bps lower than the yield in August 6. The 2.10x oversubscribed 182-day was partially awarded to keep the rate close to the prevailing rate in the secondary market resulting in a 1.671% yield. Meanwhile, demand for the 364-day improved and was 1.69x oversubscribed pushing the yield down 29.7 bps to 2.125%. August 28 auction for the 7-year T-bond had a similar 4.75% coupon as the July 17 auction. Strong demand prevailed with the offer oversubscribed 2.74x and the yield easing 3.3 bps to 4.662%. Fiscal prudence went side by side with the successful auctions for this month. Total debt issue was 68% of the Q3 cap of P108 B as the government opted for partial awards in some auctions to keep the rates from rising. Meanwhile, H1 borrowing was up 30.2% from last year at P1.76 Tr, with the borrowing mix tilted towards domestic sources. The ratio of domestic to foreign debt was approximately As of end-july, the fiscal deficit was P73.73 B, a figure way below the programmed P279.1 B ceiling for the year. Nevertheless, the BIR and BoC fell short of their H1 target collections by P3.7 B and P23.75 B, respectively. The Department of Finance (DOF) is planning an RTB sale in October and a bond exchange in November to manage average length of the government s debt stock.

10 Fixed Income Securities For most of the month, the government yield curve had a slightly steepening bias with the front end of the curve easing slightly. 10 Date T-Bond / T-Bill Offer (Php B) T-Bonds and T-Bills Auction Results Terndered (Php B) Awarded (Php B) Tendered Offered Average Yield Change bps 6-Aug 91-day day day Aug 25-year Aug 91-day day day Aug 7-year Totals All Auctions Source: Bureau of the Treasury (BTr) Secondary Market: A Quiet Month Mixed results came in across a largely unchanged FXTN curve as the 7-43, 5-67 and remained unchanged, while the declined 12.5 bps while the had a small uptick of 0.5 bps and the climbed 9.75 bps. This reflected hesitancy on the part of investors after higher inflation rates were reported and expectations for these to rise following the severe floods heightened. For most of the month, the government yield curve had a slightly steepening bias with the front end of the curve easing slightly. Figure 9 - GS Yield Spreads (using PDST-R2) 7 6 Figure 8 - FXTN Yields May 29-Jun Jul 29-Aug Source: First Metro Investment Corp. (FMIC) Jul 30 - Aug 3 Aug 6 - Aug 10 Aug 13 - Aug 17 Aug 20 - Aug 24 Aug 27 - Aug 31 3M 5Y 10Y 20Y 25Y Source: Philippine Dealing and Exchange Corp. (PDEx) Average weekly traded volume of GS in August was P41.04 B which was about 73% lower year-on-year (y-o-y) as players searched for direction. It was also a large drop from last month s average of P B as devastating floods early in the month and the long weekends reduced

11 Fixed Income Securities Yields declined in the first week following the cut in policy rate to 3.75% on July 26 and the maturity of P25 B worth of RTBs on August the number of trading days. Yields declined in the first week following the cut in policy rate to 3.75% on July 26 and the maturity of P25 B worth of RTBs on August 1. Figure 10 - Weekly Trade Volume (in Billion Pesos) YTD (Aug 31) = P41.04 B 2011 YTD (Sep 2) = P B Ayala Land Inc. (ALI) had the highest turnover in July at P1.29 B. Newly listed SM Investments Corporation (SMIC) started strong with P M worth of traded papers. Power Sector Assets and Liabilities Management (PSALM) maintained consistent demand with P M despite a sharp fall of about 88% from June. Meanwhile San Miguel Corporation (SMC) traded P M and Ayala Corporation (AC) had a turnover worth P86.9 M. Figure 12 - Corporate Trading (in Million Pesos) 1,400 1,200 May 2012 June 2012 July Jul 30-Aug 3 Aug 6-Aug 10 Aug 15-Aug 17 Aug 20-Aug 24 Aug 27-Aug 31 1, Source: Bureau of the Treasury (BTr) Corporate Bonds: Less Trading with Slow Issuances July traded volume in corporate papers fell 28.5% versus June levels. Nevertheless, it was a 203.4% increase from year ago levels as investors took in positions ahead of the July 26 policy rate cut. Figure 11 - Total Corporate Trade Volume (in Million Pesos) PSALM SMC AC ALI SMIC Source: Philippine Dealing and Exchange Corp. (PDEx) Planned Corporate Issuance On August 23, the Monetary Board of the BSP approved East West Bank s planned issuance of long-term negotiable certificates of deposit (LTNCD) worth up to P5 B to be issued within a year. The interest rate will be set according to the prevailing market rates when they issue in Q4 or next year. Minimum placement is P50,000 and increases by increments of P10,000 while the tenor can range from 5-years and one-day to 5-years and 6-months from issue. Funds raised will be used for lending and improve their liability structure May June July Source: Philippine Dealing and Exchange Corp. (PDEx)

12 Fixed Income Securities The peso remains strong despite BSP s recent efforts to stymie hot money inflows. 12 ROPs: Yield Curve Moves Down, More at Short-end Positive US economic data held back the Federal Reserve Board from pushing through with QE3. They, nevertheless, indicated that they were keeping their options open resulting in the dollar slightly strengthening across the board, including the peso. Additionally, SDAs levels climbed to P1.76 Tr in July indicating that the 1/32 bps cut was insufficient to discourage the use of the facility. The peso remains strong despite BSP s recent efforts to stymie hot money inflows. Its foreign exchange operations enabled the country s gross international reserves (GIR) to exceed its full-year target. The GIR reached $79.35B by end of July, which is $1 B above the year-end target. Despite investors seeing ROPs to be expensive, the yield curve barely moved. Yields for the ROPs14 eased by bps while ROPs16 declined by 5.87 bps. Yields on the ROPs19 gained 3.52 bps while that of the ROPs32 hardly moved. Figure 13 - ROPs Source: Bloomberg 31-May Jul Jun Aug ROPS14 ROPS16 ROPS19 ROPS32 ASEAN+1: PH Bucks Slight Upward Yield Curve Movement in the Region US: On a month-to-date (MTD) basis, yields across the curve increased slightly on the back of improved economic data. The 1-year had an uptick of 1.02 bps while the 2-year went up 4.26 bps. The 5-year climbed 8.22 bps while the 10-year benchmark gained the most by bps. Tame inflation of 1.4% (y-o-y) in July spurred speculation of another stimulus. However, the Federal Reserve has held off from another round of quantitative easing but has kept it an open option due to worries on unemployment which has remained stuck above 8%. PRC: Yields gained even as inflation slowdown to a 30-month low at 1.8%. Yields for the 1-year papers were up 35 bps MTD while the 2-year increased by 45 bps MTD. The 5-year had a slightly smaller rise of 31 bps MTD while the 10-year had an uptick of 10 bps MTD. The economy appears to be headed for a soft landing with a 3-year low of 7.6% Q2 GDP growth. Demand for Chinese government bonds continue to be strong due to six consecutive quarter of easing growth. Latest economic data showed the August Purchasing Managers Index (PMI) slumping to 49.2, a slight contraction from July levels. Nevertheless, strong domestic demand and sectoral performance in retail sales which were up 13.7% y-o-y and industrial output which increased by 9.5% y-o-y continue to support the economy. Moreover, H1 registered a $68.91 B trade surplus which was 53.4% higher than year ago levels Indonesia: Yields moved upwards the most in the region as investors reduced their holdings due to speculation over a widening trade deficit. This sent the 1-year yields to climb 58.5 bps MTD while 2-year increased by 49.3 bps MTD. Yields for the 5-year was up 53.9 bps MTD and the 10- year gained 58.6 bps MTD. Q2 GDP growth came in better than expected at 6.4% while July inflation accelerated to 4.56%. Inflation is expected to be higher in August following Ramadan and Eid al-fitr celebrations in the world s largest Muslim population. The rupiah continued to show weakness as the trade deficit widened for a third consecutive month to a 5-year high of $1.32 B in June, which brought Q2 trade deficit to $2.29 B. In addition, current account deficit registered at $6.9 B for Q2 (around 3.1% of GDP). This prompted the Bank of Indonesia (BI) to relax regulation on hedging foreign exchange transactions in support of the currency. The BI raised the standing deposit facility rate by 25 bps to 4% to mop up excess rupiah in the system while the standing lending facility remained at 6.75%. In addition, concerns have been raised regarding the widening budget deficit estimated to reach 2.3% of GDP this year. This led the government to plan issuances of Samurai sukuk bonds worth $750 M in early September and US-currency sukuk bonds amounting to $1 B in late October.

13 Fixed Income Securities The steepest yield curve in the region (Philippines) moved opposite the trend as most yields fell slightly due to strong demand and rate cut in July. 13 Malaysia: Upward movement along the curve was also the trend in Malaysia. On a MTD basis, 1-year yields had an uptick of 3.1 bps while the 2-year gained 4.1 bps. Meanwhile, slightly higher gains were seen for the 5-year and 10-year, both increasing by 11.2 bps. Q2 GDP growth also unexpectedly rose to 5.4% as domestic demand grew 8.9% along with all sectors except Agriculture which contracted by 4.7%. Additionally, more investments came in as it grew 26.1% versus the same period last year. The relatively stable Malaysian bonds have attracted investors who intended to buffer their portfolios from possible hard landings in China, US and the Eurozone. However, Malaysia s debt situation has been deteriorating as its debt-to-gdp ratio increased over the years to 51.8% as of end It is expected to worsen further due to fuel subsidies which drain the budget and limit fiscal flexibility as Q2 current account recorded a lower surplus of RM 9.6 B versus Q1 s RM 18.1 B. Nevertheless, Fitch Ratings affirmed the country s foreign currency issuer default rating of A- and local currency issuer default rating of A with stable outlooks. Thailand: Small mixed movements along the curve were observed as the 1-year fell 1 bp MTD and the 2-year decreased by 1.5 bps MTD, while the 5-year climbed slightly by 3.8 bps MTD, while the 10-year was up 9.7 bps. Strong demand for Thai financial assets strengthened the Baht amidst speculation of a rate cut. Meanwhile, inflation accelerated to 2.73% while Q2 GDP grew at a faster 4.2% than the 0.4% in Q1. Strong domestic demand with household consumption increasing by 5.3% and more investments, up 10.2% supported growth. However, factory output and exports still continue to feel the aftermath of the floods as electronics and auto factories relocate while demand from the US and China decline. Meanwhile, plans to cut policy rates are being considered as it remained unchanged for four consecutive meetings as debt-to-gdp ratio stands at 40% giving leeway for stimulus via infrastructure projects. In other news, the government faces a 400 B baht budget deficit and maturing debt obligations worth 206 B baht in October. Eighty billion baht worth of government bonds issues are in the works to finance them. Philippines: The steepest yield curve in the region moved opposite the trend as most yields fell slightly due to strong demand and rate cut in July. The 1-year decreased by bps MTD while the 2-year went down bps MTD and the 10-year fell 5 bps MTD. On the other hand, the 5-year gained with a negligible uptick of 0.51 bps. In addition, the country s 10-year to 2-year spread widened by 9 bps MTD to continue with the highest spread in the region. Figure 14 - ASEAN Market US PRC Indonesia Malaysia Thailand Philippines Source: Asian Development Bank (ADB) Spreads between 10-year and 2-year T-Bonds Country 2-year 10-year Projected Real 10-year 10 year to 2-year Spread (bps) Spread Change rate rate Inflation Rates yield Aug. 1, 2012 Aug. 30, 2012 (bps) Latest Policy Rate Real Policy Rate US PRC Indonesia Malaysia Thailand Philippines

14 Fixed Income Securities Market players have shown some tentativeness shortly after the good news because of supply concerns with NG s plan to issue RTBs followed by a bond exchange in Q4. 14 Outlook The bond market was buoyed by the good GDP numbers released just before the end of August. However, market players have shown some tentativeness shortly after the good news because of supply concerns with NG s plan to issue RTBs followed by a bond exchange in Q4. Although higher inflation is expected in August and September due to the floods and heavy rains that lowered available supply especially in Metro Manila, we think that based on the Typhoon Ondoy record, prices will normalize by end-september and so inflation rates should be at around 3.5% in the next three months. Because of this, yields across-the-board may have a slight upward bias in the coming month but they should return to their low levels in tandem with the inflation reports. At the same time, a slight steepening of the yield curve may be expected. To fund its higher deficits in H2, NG borrowings will also rise, although, these will likely be in peso-denominated debt. Corporate issues will also likely to speed up in Q4, as firms strive to fix new debt in lower yield instruments.

15 Equity Markets Central Banks Try to Save the World Again 15 Right on cue with the Philippine equities market s seasonality, August was indeed a weak month. Heavy foreign selling and low value turnover were aggravated by the Morgan Stanley Capital International (MSCI) quarterly index review. Q2 earnings reports kept the market afloat. But as the earning season wound down, so did the support on stock prices. Not even the expectation of a surprise in Q2 Gross Domestic Product (GDP) was able to buoy the local market. For the month of September, we focus on three major themes as key drivers: first, the external risk events as central banks continue to try to save the world economy, an ongoing theme since the Lehman collapse; second, earnings results in Q2 were mostly in-line, but company earnings are yet to see a substantial upgrade; finally, much like August, September is usually a weak and low value turnover month for Philippine equities which is further aggravated by seemingly inexhaustible foreign selling. Outlook and Strategy Theme 1: Central Banks Try to Save the World Again In September, the spotlight would pan across the U.S. Federal Reserve (Fed), the European Central Bank (ECB), the German Constitutional Court, and People s Bank of China (PBoC). The ECB meets on September 6, 2012 and may cut policy rates by another 25 basis points (bps). They could also outline the details of its bond buying plan. However, the plan hinges on Germany s Constitutional Court ruling on the European Stability Mechanism (ESM) on September 12, Coincidentally, the Fed may announce another round of monetary stimulus the day after depending on the most recent economic data. They should have a clearer view after the August Employment Report due on September 7, Meanwhile, in Asia, latest manufacturing data point to weakening economies. Consequently, we may see the PBoC doing more to stimulate growth. Positive outcome from the Fed, the ECB, and Germany s Constitutional Court will be supportive of risky assets. Should their actions disappoint, the world will not end. They can always try again in Q4. Theme 2: The Need for Earnings Upgrade Second quarter earnings results were mostly in-line with expectations. Among PSEi components, four were above, four were below, and the rest were in-line with estimates. However, valuations wise, the market appears stretched. Both trailing and forward price-to-earnings ratios of MSCI Philippines and the PSEi have converged. Figure 15 - MSCI Philippines P/E Source: Bloomberg Market value has declined dragging down with it trailing P/Es. However, forward P/Es have yet to follow suit indicating limited upside price movements. Should we have a substantial upgrade in earnings, it would set the stage for a year-end rally. So far, we are seeing a mix of upgrades and downgrades.

16 Equity Markets September might be a month of weak stock prices and value might remain light given that the Ghost Month goes into the first half of the month. 16 Figure 16 - PSEi Trailing P/Es PSEi Q Net Income Scorecard (in Billion Pesos) H H % Chg YoY 2012E % of FYE Rating AC % % / AEV % % / AGI % % / ALI % % / AP % % / BDO % % / BEL % % - BPI % % / CEB % % - DMC % % / EDC % % / Source: Bloomberg Theme #3: Weak Seasonality to Persist Just like August, September might be a month of weak stock prices. We expect value turnover to remain light given that the Ghost Month goes into the first half of September. In August, the average daily value turnover was P5.2 B, a far cry from the six-month daily average of P7 B. Moreover, we think foreign selling will continue as the Philippine market may no longer carry a consensus overweight among international financial institutions. Figure 17 - MSCI Philippines Seasonality FGEN % % + GLO % % / GTCAP % % / ICT* % % / JFC % % - JGS % % / MBT % % + MEG % % / MER % % + MPI % % / MWC % % + PX % % - RLC % % / SCC % % / SM % % / SMC % % + SMDC % % / SMPH % % / TEL % % / URC** % % / VLL % % / * in USD ** reflects 9 months fiscal year results Note: (+) Above Expectations (-) Below Expectations (/) In line Source: Bloomberg and First Metro Securities Research

17 Equity Markets It is prudent to keep exposure light ahead of risk events expected to emerge this month. Clarity in Fed and ECB decisions would allow for increased risk exposure. 17 With these themes in mind, it is best to keep exposures light ahead of the risk events that we expect to emerge this month. Increasing exposure may start once we have clarity on when the Fed and ECB will act. We will likewise wait until forward earnings are substantially upgraded and when selling by foreign funds start showing signs of exhaustion. Regardless of these, one need not hesitate to accumulate if valuations go down to levels that become acceptable. Figure 18 - PSEi Seasonality Source: FMIC Investment Committee Sectoral Performance The Philippine bourse ended the month in the red, posting a decline of 2.10% against the previous month s close. The PSE index tumbled points, dragged down mainly by the Mining and Oil sector. In early and mid-august, the Philippine market traded sideways amid a dismal global growth outlook and shortened trading weeks, which prompted investors to scale down positions a couple of times. Towards the end of the month, market trend reversed as a result of window dressing and upbeat Q2 GDP growth expectations. Monthly Sectoral Performance 29-Jun-12 Source of Basic Data: PSE Quotation Reports 31-Jul-12 Sector Index % Change Index % Change PSEi 5, % 5, % Financial 1, % 1, % Industrial 7, % 7, % Holdings 4, % 4, % Property 1, % 1, % Services 1, % 1, % Mining and Oil 23, % 20, % The Financial sector s index went down by 2.29% as top companies posted declines in share prices. A big drop of 9% was seen in Metrobank s (MBT) share price as it failed to stay above or sustain its all-time high of P100 last month. BDO Unibank (BDO) also posted a decline despite the relatively positive report on their Q2 earnings. BDO recently raised P43.5 B in core capital through a 1:3 rights offer made early July This share sale was said to support the company s medium-term growth objectives and meet the Basel III capital requirements ahead of schedule. Moreover, the bank is keen on enhancing its ability to access longer-term funding for their re-lending projects, which includes infrastructure projects under the government s PPP program. BDO also plans to retire P10 B of Tier 2 in November 2012 using part of the additional capital raised from the 1:3 offer. On the other hand, share prices of Bank of the Philippine Islands (BPI) posted an increase in reported income due to considerable trading gains. BPI had seen its first half net income soar more than 50% from P6.2 B to P9.4 B primarily due to the increase in its non-interest income. Company Symbol 7/31/12 8/31/12 % Change Metrobank MBT % Banco de Oro BDO % Bank of the Philippine Islands BPI % Source of Basic Data: PSE Quotation Reports