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New Virus, Unprecedented Risks For China's Developers

The COVID-19 outbreak and China's staunch containment measures have left the country's property sector exposed to risks not seen before. S&P Global Ratings estimates that nearly a third of the Chinese developers we rate could breach or skirt downgrade triggers under a prolonged-outbreak scenario. Even in our more benign stress test, nearly a quarter of sector players could face ratings or outlook pressure. This does not include some very weak players we have identified as facing imminent liquidity strain.

Residential property sales will likely remain dismal for the coming weeks, with sales centers shut or empty. Volume sales plummeted by 95% year-on-year in 88 cities during the first week after China's Lunar New Year, according to China Real Estate Information Corp. Meanwhile, malls are void of shoppers and the operators have had to offer rent-free periods to struggling tenants.

The outbreak has occurred in the winter months, a relatively slow period for property activity. The longer this crisis lasts, the less recoverable this disruption will be. We stress test sales, spending, and financial hits to 66 rated Chinese property companies under two scenarios (aligned with our macroeconomics view of when the outbreak might peak) in this report.

Chart 1


Baseline Scenario: Contracted Sales Forecasts Cut By 15%

Should the outbreak peak in March, property sales centers should reopen selectively and operations could adjust bringing gradual improvements through May. We would then expect China's property sales volumes to return to normal by midyear, with a mild rebound toward year-end (see chart 2). Under this hypothetical scenario, it is also more likely that national sales performance will be similar to our expectation of 5%-10% decline against 2019, which we consider probable at this point.

Based on this hypothetical trajectory, we cut our 2020 contracted sales forecasts for rated developers by 15% across the board against our original estimates.

In turn, developers will cut spending. Given that most developers budget land expenditure is based on contracted sales, we assume full-year land acquisitions would be 20% lower than our original estimates for 2020, with the cuts occurring in the first half when liquidity is needed most. That said, developers with insufficient land banks will have less room to cut spending. Concurrently, we assume full-year construction expenditure to be 10% lower due to delivery deadlines allowing less flexibility for cuts.

The assumptions do not include additional measures developers could take such as boosting sales (e.g. promotions and discounts) or more drastic spending cuts, whether in terms of land and construction or getting more extensions on financing. Also, it excludes potential moves by policymakers to ease liquidity and restrictions on homebuyers at the same time.

More-Severe Scenario: Sales Plunge Similar To 2008

Under a more stressed scenario, with the outbreak peaking in April, monthly sales might not start to normalize until July. The overall rebound could be pushed to the fourth quarter. In our view, this harsher case (see chart 2) is comparable to the most severe downturn in 'China's property sector, which saw a 19% decline in national residential sales in 2008 during the global financial crisis.

Under this scenario, we assume land expenditure to be 30% lower than our original estimates. The relatively inelastic construction spending would be 10% lower.

Table 1

Scenario Analysis For Developers And Landlords
Scenario 1 (baseline) Scenario 2 (more severe)
Synopsis Outbreak peaks in March, sales and business activities to normalize by June, mild rebound through to year end Outbreak peaking in April, sales and business activities to normalize in July, mild rebound around the last quarter
Contracted sales 15% below our original forecast 20% below original forecast
Land expenditure 20% cut from our estimated annual budget 30% cut from our estimated annual budget
Construction expenditure 10% lower than our original forecast 10% lower than our original forecast
Others Cash collection rate, funding costs, and other parameters remain the same Cash collection rate, funding costs, and other parameters remain the same
Rent Concession At least one month* At least two months§
Mall capex Dec capex rolls over to 2021 Nov & Dec capex rolls over to 2021
Rental reversion for 2020 5% drop on all maturing tenancies 5% drop on all maturing tenancies
Note: These two scenarios are performed on 66 rated Chinese property companies. *In our model, we use (a) the landlord's announced rental-concession period or (b) if they have not announced, we assumed 1 month of rental concession period. §In our model, we use (a) the landlord’s announced rental concession period + 1 month or (b) if they have not announced, we assumed 2 months of rental-concession period. Capex--capital expenditure. Source: S&P Global Ratings.

Chart 2


Some Companies Wouldn't Survive The Liquidity Strains

Liquidity will be hit first, under both scenarios, as sales proceeds are the largest and most important funding source for China's developers. We anticipate that several rated developers would face crippling liquidity issues. Our ratings already reflect such risks: almost all of these companies are in 'C' categories, and all are on negative outlooks (see charts 3 and 4). Their ability to meet obligations would depend on whether they can execute timely refinancing plans despite business disruptions.

A majority of developers would be able to ride out the liquidity crunch under both scenarios, in our view. This mainly stems from their ability to control expenditures flexibly in response to falling sales. Cutting spending can buy them time, although not forever.

Chart 3


Chart 4


Many developers also have cash cushions from recent fundraisings. The record offshore debt issuance in January 2020 (and recently reignited) was also timely in helping developers to buffer up.

Table 2


Most Developers Steadfast In Event Of A One-Off Shock

Stifled sales for a few months should be a temporary shock that most rated developers can withstand. Our sensitivity analyses show that 24% of sector ratings and outlooks may come under pressure under our baseline scenario, and 32% under our more-severe scenario. This excludes the batch of companies, mentioned above and mostly in the 'C' categories, which face liquidity issues. Credit profiles will deteriorate mainly due to rising leverage starting immediately from lower sales and revenue, breaching downgrade triggers. That said, whether these companies will really come under rating pressure will depend on how they execute their sales, as well as cash flow and leverage management, which could be different from what the scenarios depict.

Almost half of the ratings under pressure comprise entities with negative outlooks. These companies generally have debt leverage that is already incommensurate with current rating levels, however with scope to reduce leverage. Disruptions to sales would make it harder to realize deleveraging plans (see table 3). This group of companies may have more imminent rating pressure.

Companies with thin rating buffers are also more vulnerable to extraordinary fallout in the sector, regardless of stable rating outlooks or adequate liquidity. They would only avoid negative actions under our stress tests if they are able to control debt and quickly resume sales after the landscape normalizes.

Selected names with positive rating outlooks could face similar issues in managing their leverage through crisis. The health emergency makes improvement plans less feasible. We could revise the outlooks to stable if our hypothetical scenarios play out (see table 3).

Our broad-brush stress test may point to vulnerability in the sector ratings, but a number of variables will swing the ultimate impact. Some developers have amassed or are working hard to boost their subscription sales through virtual or alternative channels. Their monthly contracted sales figures will demonstrate how much of these can be converted, along with other channels, into genuine cash inflow. This will become a leading indicator in our view.

Property companies' 2019 full-year results will be out in the next few weeks, and could also be better or worse than originally forecasted. This could also bolster or undermine how much they can weather this year. Paired with their expansion targets and expenditure budgets, now likely to be tweaked, will help us form a clearer forward-looking view.

Chart 5


Table 3

Developers On Positive Or Negative Outlooks More Sensitive To Stress Scenarios
Most such developers face outlook revision/downgrade pressure on both scenarios
Developer Issuer credit rating Outlook Scenario for outlook revision/downgrade pressure
Greenland Holding Group Co. Ltd. BB Positive Both scenarios
Yuzhou Properties Co. Ltd. BB- Negative Both
Jiangsu Zhongnan Construction Group Co. Ltd. B Positive Both
Zhenro Properties Group Ltd. B Positive Both
Jiayuan International Group Ltd. B Negative Severe scenario
Xinhu Zhongbao Co. Ltd. B Negative Severe scenario
Sunshine 100 China Holdings Ltd. CCC+ Negative Both
Yida China Holdings Ltd. CC Negative Both
Source: S&P Global Ratings.

Retail's Less Cash-Intensive Business Model Helps With Shocks

China's retail properties will inevitably be hit hard, given restrictions on movement in China and voluntary isolation amid infection fears. However, most of our developers with investment properties do not generate substantial turnover rent, i.e., their revenues are not based on a proportion of the tenants' sales, which can quickly evaporate. In addition, even rated developers with a stronger rental focus generate less than 10% of their EBITDA from rentals and this includes portfolios that are not directly affected.

For pure landlords with a retail focus, the impact is more direct. Any lease renewals due this year will be contracted at lower rates, and such negative rental reversions may linger for a longer period as tenants will likely struggle to recover from losses. These conditions apply to traditional mall landlords (e.g., Dalian Wanda Commercial Management Group Co. Ltd) as well as home decoration mall operators (e.g., Red Star Macalline Group Corp. Ltd. and Beijing Easyhome Investment Holding Group Co. Ltd.). Tenant contracts are generally renewed annually for home decoration malls, which exacerbates the impact for them.

However, the business model of landlords is less expenditure-heavy than other real-estate segments and have some ability to defer their expansion capex. This supports their cash flows. Moreover, contracts entitle landlords to receive income for full term of the lease plus deposits worth a few months of rent. That said, rental income will still be hurt if retail tenants fail to survive.

While toplines at mall operators could decline, near-term liquidity issues are unlikely to emerge under either stress scenario (see table 1). This is because sector players typically don't have substantial short-term debt relative to their capital structures. They have also either made refinancing arrangements for upcoming offshore debt maturities or have none at all. Furthermore, they currently have sufficient buffers to sustain their credit profiles and absorb the impact of some negative rental reversions. In our view, their leverage level could return to close to previous levels from 2021 onwards if the virus is contained within our scenarios.

Rebound Is Still A Wildcard, Further Margin Compression Is At Hand

Once the virus is contained, we assume only a mild rebound for the last few months of 2020 of around 5%-10% year-on-year. The scale depends on the scenario.

If the virus is quickly and well contained, there could be upside given our belief that demand is being deferred rather than disappearing. The gradual revival of the land auction activity is also a sign of confidence on demand.

Policy support could also intensify the magnitude of recovery. Many local governments have promised or already outlined measures to help relieve liquidity strains, such as extensions on deadlines for land premiums or tax breaks (see table 4). Governments are also lifting restrictions on presales on buyers, however these can only be effective if normal operations and confidence are restored.

As such, the rating trends for property companies will also need to take into account a number of variables that are not covered in our stress scenarios. Moreover, individual performance, such as cash-flow management in crisis, can vary widely.

Table 4

Local Government Policies Give Developers More Breathing Space
City Accomodative policies announced since the health emergency in China
Shanghai Land premiums can be paid at later dates/by installments.
Extensions permitted for project construction/completion.
Financial institutions encouraged to provide credit support/lower borrowing costs to firms.
Extensions/reductions in contribution to social insurance/housing funds required by employers.
Corporate tax extensions/reductions.
Shenzhen Subsidies for property management firms in proportion to their area under management.
Subsidies for landlords who have offered rental-free periods.
Financial institutions encouraged to provide credit support/lower borrowing costs to firms.
Extension/reductions in contribution to social insurance/housing fund required by employers.
Corporate tax extensions/reductions.
Wuxi Loosening of pre-sale requirements. Homes can be eligible for pre-sale once 25% of the project's financing is obtained, rather than based on a certain threshold of project completion.
Land premium can be paid at later dates/by installments.
Extensions permitted for project construction/completion
Banks encouraged to offer grace periods for firms in distress due to the outbreak.
Subsidies for long-term rental apartment operators.
Qingdao Loosening of pre-sale requirements. Homes can be eligible for pre-sale once 25% of the project's financing is obtained, rather than based on a certain threshold of project completion.
Earlier release of pre-sale deposits to developers.
Land premium can be paid at later dates/by installments.
Financial institutions encouraged to provide credit support/lower borrowing costs to firms.
Extension/reductions in contribution to social insurance/housing fund required by employers.
Corporate tax extensions/reductions.
Scope of talent-attraction incentives (cheaper homes, fewer hukou restrictions) widened to include final-year undergraduate students.
Xiamen Land premium can be paid at later dates/by installments.
Extensions permitted for project construction/completion.
Pre-sale deposits can be withdrawn early with a guarantee from a bank or a listed parent company.
Tax reductions for landlords who have offered rental discounts.
Suzhou Loosening of pre-sale requirements on selected projects.
Land premium can be paid at later dates/by installments.
Extensions permitted for project construction/completion
Extension/reductions in contribution to social insurance/housing fund required by employers.
Tianjin Land premium can be paid at later dates/by installments.
Extensions permitted for project construction/completion.
Fnancial institutions encouraged to provide credit support/lower borrowing costs to firms.
Extension/reductions in contributions to social insurance/housing fund required by employers.
Corporate tax extensions/reductions.
Sources: Local government websites, S&P Global Ratings.

We also expect an increase in promotions and discounts, and cost hikes from delays and operational complexities. The sector's profitability has already been declining, due to climbing land costs and capped sales prices. The slide is now likely to be steeper and that could feed into leverage ratios. Delays in construction will likely push out delivery schedules and revenue recognition, adding to burdens on the sector.

This report does not constitute a rating action.

Primary Credit Analyst:Christopher Yip, Hong Kong (852) 2533-3593;
Secondary Contacts:Matthew Chow, CFA, Hong Kong (852) 2532-8046;
Edward Chan, CFA, Hong Kong + 852 2533 3539;
Research Assistants:Oscar Chung, Hong Kong
Coco Yim, Hong Kong

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