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China's developers face rising financing risks

Wary investors are increasing pressure on mainland property groups, according to S&P's Matthew Kong and Christopher Yip.

How do you see the impact of Kaisa's default on China’s property bond market?
Bond issues from Chinese property developers stagnated in January 2015 after Shenzhen-based property developer Kaisa Group almost defaulted on an offshore loan and missed a coupon payment for one of its bonds.

There was only one issue in January (from Sino-Ocean Land at US$1.2 billion), compared with bond issuance of US$5.55 billion and Rmb2.6 billion by 15 property developers in January 2014.

Even so, we expect the bond market to remain open for stronger property developers as investors flock to quality. We anticipate more bond issues in the coming months as unease stemming from the Kaisa event diminishes.

Earlier this month, Shimao Properties became the first Chinese property developer to launch a high-yield bond in 2015. This signals the reopening of the US-dollar bond markets to Chinese developers for speculative grades.

However, Chinese developers are likely to increasingly prefer onshore renminbi financing to offshore US dollar-denominated debt this year. That’s because offshore investors have turned more selective and real funding costs are higher due to the US dollar appreciation. Therefore, we expect US dollar bond issuance to slow.

In our view, investors are likely to be more selective on the issues from Chinese developers. At the same time, pricing may go up. We believe investor sentiment for the sector will remain cautious given the economic slowdown and high inventory levels. In particular, developers with weak liquidity and high refinancing needs in the next 12 months may face funding difficulties as financing sources steer toward more stable players.

Among the rated Chinese developers, which companies face heightened refinancing risks in 2015?
We believe refinancing risks should be manageable for most upcoming maturities. Despite tighter refinancing conditions, most Chinese developers have sufficient liquidity to manage their repayment needs.

These developers include Gemdale Corp, which has sufficient cash balances, and Country Garden Holdings, which has refinanced actively over the past year at significantly reduced costs.

We also believe Renhe Commercial Holdings has sufficient funds to repay its bond due 2015 after it raised about Rmb4.9 billion from a rights issuance and loan facilities.

In contrast, Glorious Property Holdings has heightened refinancing risks because of its weak sales performance and liquidity profile.

At the same time, companies with weak cash flow and high leverage could also face liquidity problems. China Properties Group and Hopson Development Holdings, for example, don't have offshore bonds maturing in 2015 but they have some reliance on trust financing.


The People's Bank of China recently cut its reserve requirement ratio (RRR). Do you expect more policy measures in 2015 to loosen financing conditions?

The recent RRR cut and the interest rate cut in November 2014 reaffirms Chinese policymakers' intention to spur credit growth by enhancing banks' lending capacity and lowering funding costs for companies amid slowing economic growth.

It is possible that we will continue to see more favorable policies from the Chinese government in an effort to stabilise the slowing economy in 2015, including further cuts to the RRR and interest rates. Such steps will release the pent-up demand in the market.

Despite the encouragement of the central bank, which has quickened the release of funds, mortgage growth continues to slow and is one of the factors affecting sales.

We expect a moderate improvement in mortgage availability in 2015 because of the loosening mortgage rules and enhanced lending capacity in banks as a result of a few cuts in the RRR and interest rates.

Financing is trending toward borrowers with better credit quality. While banks and the bond market continue to provide much-needed funding to fill the cashflow gap stemming from slower sales and higher development costs, they have been more selective than before.

What’s the outlook for China’s property sector over the next 12 months?

Oversupply continues to hamper prospects for the property sector and a strong rebound is unlikely over the next 12 months, in our view.

According to China's National Bureau of Statistics, nationwide inventory levels for residential stock rose by 25.6% year-on-year by the end of 2014. We believe the price correction has not run its full course.

Developers are likely to continue to cut prices amid high inventory levels, particularly in lower-tier cities. In our base case, we expect average selling prices on a national basis will either stay level or drop up to 5% in 2015.

However, demand is likely to stabilise in the next 12 months as the government continues to loosen policies amid a slowing Chinese economy.

The government's relaxation on home-purchase restrictions, mortgage rules and onshore funding should help developers maintain sales volumes in 2015.

We believe the positive effect on property sales could grow, especially in the second half. Overall, we forecast sales to perform in the same range for the year, compared with a 7.8% fall in 2014 and 27% growth in 2013.

We also expect the recovery to be uneven across the different regional markets in China. Top-tier cities should recover first, while lower-tier cities are likely to be still saddled with large inventories.

We expect a gradually improving inventory-to-sales ratio due to destocking efforts from developers. In our view, limited upside in pricing and rising land cost will squeeze margins, and net operating cash flow could be lower than our expectation.

How about the credit outlook for Chinese developers in 2015?
We expect Chinese developers' credit profiles to diverge further in the next 12 months. While the larger companies will continue to perform steadily and increase their market shares, the credit profiles of some smaller players may deteriorate amid slower market growth and tough funding options.

Market conditions in 2014 weakened the credit profiles of many property developers in China. Negative rating actions outnumbered positive actions in the second half of 2014 and in the early part of this year (see chart).

A few developers could face downward rating pressure owing to their weak sales, limited financing sources, and high funding cost. They are typically the smaller rated developers.

Nonetheless, we could also downgrade some large developers with aggressive expansion or acquisitions, even if their sales are high.

This is because the increase in capital expenditure or working capital may outpace the growth in sales, hence weighing on their already-stretched credit profiles.

The authors of this article are Matthew Kong, associate director of corporate ratings at Standard & Poor’s Ratings Services, and Christopher Yip, director of corporate ratings.

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