HONG KONG (S&P Global Ratings) Jan. 20, 2022--China's policies restricting developers' use of presales is an increasingly hot topic, given the importance of the funds to repay debt. Investors are scrutinizing these rules to understand each developer's solvency. S&P Global Ratings believes these requirements are inconsistent and create confusion among investors about the true liquidity of rated firms. We also view the easing of escrow requirements as essential to restoring liquidity to Chinese property firms, at least to the ones with healthier fundamentals.
"China's uneven application of presale rules and the efforts of some developers to sidestep them will be key to entities' capacity to repay maturing bonds this year," said S&P Global Ratings credit analyst Ricky Tsang.
China has longstanding rules on the escrowing of funds from the presale of homes, but developers' compliance to the measures has been patchy. This came to a head in the second half of 2021 when China Evergrande Group (unrated) ran into financial distress. This prompted concern among government officials about whether the entity would be able to deliver hundreds of thousands of presold residences.
The government has since been more rigorously enforcing its escrow rules, trapping these funds and pushing many developers to the edge of default. Bond investors are reluctant to give money to issuers in these strained circumstances, particularly as they don't know when and how these rules may be applied. As this has also impaired developers' ability to deliver homes to their buyers, things appear to quickly have come full circle. Reuters and other media reported on Jan. 19, 2021, that the government was thinking of easing the rules to help developers meet debt obligations, and get back to building.
The potential relaxation of the supervision of escrow accounts shows the government is taking steps to ease liquidity strains in the sector.
PRESALES ARE RESTRICTED FOR A REASON
We nevertheless expect officials will continue to tighten compliance to the escrow rules. Local media have reported that some developers have evaded the supervision of presale funds. This has caught the attention of regulators, particularly the Ministry of Housing and Urban-Rural Development, which wants to see a more even adherence to the rules.
Part of the problem is that, while the ministry has established clear direction on the provisioning of presale funds in escrow accounts, the measures are not applied evenly across the country. Instead, the regulation is set at the local government level. As such, supervision of the rules is inconsistent. This makes it hard for investors to anticipate their impact.
We see a pattern of local authorities setting the standard for implementing escrow requirements. When a number of large developers got into financial trouble in the second half of last year, some local governments independently tightened their rules. In November 2021, Beijing increased the amount of presales to be held in escrow by 45%, to no less than Chinese renminbi (RMB) 5,000 per square meter.
Dozens of other cities--including Tianjin and Chongqing--rolled out stricter escrow account supervision measures, according to press reports. Regulators also set limits on the use of presale funds according to construction progress and by considering developers' credit quality. This adds a layer of subjectivity that bond investors may find difficult to anticipate.
INCONSISTENT APPROACH ON SUPERVISION
There is also a city-tier dimension to the rules. In general, tier-one and tier-two cities require that developers put just 10%-25% of presales into escrow. This ratio is higher in tier-three and tier-four cities, at 30%-40%. Developers with exposure to higher-tier cities should have more flexibility to move the cash at the project level back to headquarters for use for matters such as debt repayment.
Some distressed developers say cash balances are restricted even when their funds at the project level have already fulfilled local requirements. Banks can still stop developers from upstreaming the funds in the projects if they believe the developer is illiquid. Most of these banks have lent to these companies.
Banks' ability to block the movement of funds adds complication and unpredictability to a developer's ability to use cash from presales. The onshore subsidiary of Shimao Group Holdings Ltd. declared that only about 23% (RMB16.1 billion) of its total cash was unrestricted and accessible as of Nov. 30, 2021. The balance (RMB52.9 billion) was trapped in escrow. These funds exceeded the escrow requirements set by local governments.
DEVELOPERS NEED CASH TO COMPLETE PROJECTS
With the sector in a downturn, with developers recording much weaker presales, and with developers having used much of their funds for repayment, we believe about 70% of the sector's cash balance will be needed for housing delivery. By this estimate, we anticipate that 15 rated developers will not be able to fulfill their housing delivery obligations with existing funds. Ten out of these 15 developers are rated in the single 'B' or 'CCC' categories.
This assumes regulators keep sufficient presale funds in escrow to ensure all presold homes are delivered. This leaves only about 30% of entities' cash balance available to service debt. As such, we believe entities will need to sell assets or raise equity to ensure all debts are repaid on time.
Editor: Jasper Moiseiwitsch
This report does not constitute a rating action.
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| Primary Credit Analyst: | Ricky Tsang, Hong Kong (852) 2533-3575; ricky.tsang@spglobal.com |
| Secondary Contacts: | Matthew Chow, CFA, Hong Kong + 852 2532 8046; matthew.chow@spglobal.com |
| Lawrence Lu, CFA, Hong Kong + 85225333517; lawrence.lu@spglobal.com | |
| Christopher Lee, Hong Kong + 852 2533 3562; christopher.k.lee@spglobal.com | |
| Research Assistants: | Venus Lau, Hong Kong |
| Harshil Doshi, Mumbai |
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