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Pandemic Progress Check: China Homebuilding

Contracted sales of Chinese property developers have largely recovered since the onset of the coronavirus pandemic. Nationwide monthly sales declined by up to 35% at the pandemic’s peak in February 2020 when the government ordered most sales offices to shut, but have since rebounded. Monthly sales growth turned positive in year-on-year terms since May 2020, and cumulative nationwide contracted sales up to September 2020 were 6% higher than in the same period in 2019.
A gradual recovery in contracted sales was the result of the pandemic being controlled in a timely manner, which led to resumption of construction and reopening of sales offices in March. In addition, January and February are traditionally quiet months for property sales and constructions as workers break for Chinese New Year. The percentage decrease in sales was significant at the height of the pandemic, while the drop in terms of absolute sales value was small.
Property developers have therefore focused on sales in 2H20, and Fitch Ratings expects nationwide sales in 2020 to be moderately higher than in 2019. Developers’ cash-collection rates have generally been better than in 2019, helped by some relaxation in buyers’ mortgage approvals.
Stable financial profile likely
Amid a less certain sales outlook, developers have preserved cash by slowing down land acquisitions and construction. Smaller developers with strong balance sheets have continued to acquire land to boost scale, without overstretching their balance sheets. 
Our rated homebuilders typically have two to four years of land bank life. Developers with a longer land bank life have more flexibility to control expenditure, and should see a faster deleveraging trend than those with a short land bank life. 
The Chinese government has introduced additional measures in the past few months to curb debt growth in the sector, which will also pressure some higher-leveraged developers to reduce leverage via asset disposals and/or a slowdown in land purchases. 
Overall, we expect to see homebuilders’ leverage (measured by net debt to adjusted inventory) to be largely flat in 2020.  Leverage for the sector has been relatively stable in 1H20 compared with 2019. 
Key moving pieces in 2020 - government policies to influence industry dynamics
Macroeconomic factors and government policies continued to drive demand in 2020. Larger developers with diversified land banks in key economic regions will continue to be able to benefit from stronger economic fundamentals, as well as being able to cushion against local asymmetric shocks.
Government policies remain an important driver. The government continues to discourage housing speculation and runaway housing prices. Fitch believes strict buying restrictions and price caps are likely to remain in place, especially in higher-tier cities where pent-up demand is still robust.
In addition, deleveraging for homebuilders is an increasingly important policy. Regulators have gradually introduced policies during the year to tighten funding. These include the “Three Red Lines” window guidance, which is designed to limit the amount of borrowings a developer can increase in the following year, depending on how many red lines have been breached. 
In addition, the quota for onshore bond issuance has been tightened to 85% of the amounts due, meaning the developer would need to use its own internal resources to repay the remaining maturity. The National Development and Reform Commission continues to stipulate that use of the proceeds from offshore bond issuance will be used to repay long-term offshore borrowings maturing within one year.
These policies mean that it is unlikely the fast expansion seen in the last few years will be repeated in the next few years, and developers will try to keep leverage stable or deleverage through a combination of faster sales churn – and they may lower selling prices to do so – and more conservative land acquisitions and investments. Industry consolidation will continue as developers with weaker financial profiles are likely to sell off projects to those with strong ones.
Regional divergence
Fitch’s assumptions for Chinese homebuilders do not incorporate a sporadic regional lockdown, as the impact of such lockdowns on most rated homebuilders is low. Many rated homebuilders have projects diversified across China, and such developers can simply push sales in other regions if a lockdown occurs in one region. Nevertheless, small developers with projects concentrated in one region could be heavily affected by a regional lockdown if it occurs.
There has been significant divergence in sales performance across different regions, with the Yangtze Delta Region and Greater Bay Area performing better than northern China/Greater Jingjinji Area. This continues to highlight the importance of geographical diversification for issuers in the sector. 
Flexibility over cash outflows
Chinese homebuilders are less vulnerable to a widespread resurgence of the pandemic compared with some other sectors. This is because they have significant flexibility over land acquisitions and construction spending, which are the largest cash outflow items, typically accounting for 60%-80% of sales proceeds. 
The main “fixed” cash outflow item is interest expenses, which range from below 5% of sales proceeds for investment-grade issuers up to ~20% for ‘B’ category issuers. Selling and administrative costs are usually well below 10% of sales proceeds. 
Liquidity and refinancing risks 
Liquidity and refinancing risks were the key drivers for negative rating actions so far in 2020. There were eight negative rating actions for China homebuilders, six of which were related to issues’ liquidity and refinancing risks.
Homebuilders that saw negative rating actions from heightened liquidity and refinancing risks are small homebuilders in the ‘B’ or ‘CCC’ categories, with concentrated land banks and concentrated funding channels. Fitch believes liquidity and refinancing risks are still higher for such small-scale homebuilders.
Several larger-scale homebuilders like China Evergrande Group (B+/Stable) and Guangzhou R&F Properties Co. Ltd. (B+/Negative) have debt or debt-like instruments that are puttable or maturing in the next six months. These homebuilders have better ability to repay or extend these instruments through cash flow from operations, asset disposals, conversion to equity, and capital market issuance. The inherent risks of not meeting the obligations exist until they are fully refinanced or extended.

For more insights, please visit the Fitch Ratings website here.

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