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Chinese Developers' Record Profits Are Matched With Record Debt

Hong Kong, Sep. 06 2018 — Debt continued to mount for Chinese developers in the first half of 2018, though the pressure on balance sheets was partially offset by record earnings. Still, leverage is rising for many players in the sector. This indicates that developers are still jockeying for market dominance rather than retreating amid toughening regulatory and funding conditions, S&P Global Ratings said today.

"Most Chinese developers are still increasing leverage to chase growth and market share, in part because tightening also presents more opportunities for industry consolidation," said S&P Global Ratings analyst Matthew Chow.

In our view, overall debt will increase over the next 12 months, as developers borrow to accelerate land acquisitions. Despite strong cash earnings, about 40%-50% of our rated developers have higher debt-to-EBITDA ratios compared with levels at end-2017.

Better-funded companies see the tighter funding environment as an opportunity to seize market share. Meanwhile, in some cases even weaker players faced with deteriorating leverage and liquidity continue to expand.

Land prices have cooled somewhat, given property austerity measures and a crackdown on alternative "shadow banking" financing methods favored by many developers. Land parcels, for example, are no longer selling at significant premiums over the opening price in auctions.

In addition, some traditional sources of funding such as project loans and some trust financing are still available, albeit at a higher cost, to finance growing construction expenditures. Many rated developers have built up substantial cash balances and solid contracted sales, offering a reprieve to tough condition and help in funding outlays.

"We believe stronger Chinese developers can manage rising debt levels without an impact on credit profiles," said Mr. Chow. "This is because further borrowings should not cause leverage to expand markedly, given strong revenue growth and robust margins."

The average gross margin for rated developers expanded to 33% in the first half of 2018, from about 30% in 2017. Gross margins increased by more than 200 basis points for nearly 50% of our rated portfolio. Only 15% showed a deterioration. That said, higher profitability may not be sustainable beyond the next 12 months, in light of price restrictions in higher-tier cities.

Despite tough market conditions, liquidity profiles mostly remained stable in the first half of the year, with average cash to short-term debt coverage remaining around 1.2x. However, we expect liquidity risks to rise significantly for some weak players.

Further Credit Divergence is Likely

We see tail risks for weaker players attempting to expand despite smaller cash balances and weak cash generation capability. These developers tend to rely heavily on alternative financing such as short-term entrusted loans and asset management plans, thus they face acute refinancing risk.

Liquidity and refinancing risk drove recent negative rating actions and outlook revisions for some weaker players. We downgraded China South City Holdings Ltd. to 'B-' from 'B' (B-/Stable/--), and Yida China Holdings Ltd. to 'B-' from 'B' (B-/Negative/--). We revised the outlooks on Xinyuan Real Estate Co. Ltd. (B/Negative/--), and Fantasia Holdings Group Co. Ltd. (B/Negative/--) to negative from stable.

In a further sign of credit divergence, some developers have improved their debt leverage, in part by paying down debt rather than further expanding. Roughly 15%-20% of rated developers managed to lower their debt-to-EBITDA ratios in the first half, compared with end-2017 figures.

We recently revised our outlook on Ronshine China Holdings Ltd. (B/Stable/--) to stable from negative, and raised our rating from 'B' to 'B+' on China Evergrande Group (B+/Positive/--). Both companies have reduced gross debt. Moreover, they choose to apply cash earnings toward repaying alternative financing and adopt more moderate growth targets.

"While Chinese authorities have selectively eased liquidity to stimulate growth, we don't anticipate a material benefit to the riskiest developers," said S&P Global Ratings credit analyst Christopher Yip.

Refinancing demand will continue to climb as maturities, for both domestic and offshore bonds, will rise. "Effective maturities" (including put option dates) on domestic bonds will hit Chinese renminbi (RMB) 150 billion (US$22 billion) in the second half of 2018 and RMB250 billion (US$37 billion) in full-year 2019. Meanwhile, offshore bonds amount to US$6 billion (RMB40.8 billion) in the second half of 2018 and US$11 billion (RMB75 billion) and in 2019. As such, liquidity improvements will be dependent on market conditions and developers' proactive financial planning.

Weakness in the Chinese currency is another headwind for developers with U.S.-dollar borrowings. However, we expect the impact to be manageable, given the renminbi has still not fallen beyond levels seen at its recent December 2016 low against the U.S. dollar. Moreover, we believe developers have generally reduced the proportion of offshore debt in their capital structures, lessening the impact on their offshore debt servicing ability.