Moody’s Downgrades 3 China Developers in Real Estate Downturn

The combined pressures of higher debt and slowing sales for China’s real estate developers led a major ratings agency to downgrade the credit prospects of Fantasia Holdings, Guangzhou R&F, and Greentown China during the last month.

Moody’s Investor Services downgraded Fantasia Holdings Group Co Limited’s (B2 stable) corporate family rating by one notch in August owing to weak sales execution and revenue recognition and high leverage.

Moody’s also changed the outlooks on Guangzhou R&F’s Ba2 rating to negative and Greentown China Holdings Limited’s B1 rating to stable from positive.

In a statement, Moody’s indicated that, while it does not expect a catastrophic slide in the real estate sector, the credit rating agency did indicate that it expects downgrades in credit prospects will likely outstrip positive ones between now and the end of 2014, and gives the overall sector a negative outlook.

Revenue Outlook on the Rise

Despite the overall gloom, the ratings agency does expect revenues to bounce back soon in the sector.

Unfortunately, for China’s real estate firms these higher revenues are expected only to come at the price of lower prices and dropping revenues, according to a report issued this week by Moody’s Investor Service.

“Revenue recognition and EBITDA of rated Chinese property developers should rise during 2H 2014 compared to their 1H performances, as they deliver an increased number of housing projects, Moody’s Vice President Kaven Tsang commented in a company statement. The analyst went on to point out that, “Liquidity should increase along with higher contracted sales and faster cash collection.”

China’s Real Estate Developers Begin Offering Deeper Discounts

After disappointing financial performances for many developers in the first half of 2014, the industry expects an increasing number of new housing projects to be introduced for sale in the second half of the year. This surge of new supply in the face of tepid demand is forcing more frequent and deeper discounting.

Moody’s Tsang expects these discounts to bring down profit margins for many developers, while some companies are now borrowing more money to hedge against the risk of lower sales. “certain financial measures, primarily profitability and leverage, will likely be weaker for full-year 2014 compared to 2013,” Tsang noted in his analysis.

Moody’s expects ongoing weakness in developers’ profit margins this year, as property prices new project launches are likely to keep the pressure on housing prices.

Just last week, Socam Development, an affiliate of Shui On Land, cut prices by 30 percent at a housing project in Chengdu as it struggles to undercut competitors on price, in the search for buyers. Socam brought the price of new apartments in one of its projects down to RMB 7600 per square metre, after selling new homes in the compound for RMB 10,656 per square metre in December.

Developers in other markets, such as Hangzhou and Changzhou in eastern China have been offering even deeper discounts to boost sales.

Debt Sales Raising Leverage Among China Real Estate Companies

Moody’s said in the report that it expects leverage to stay elevated partly because some companies are raising debt – including onshore perpetual capital securities — to fund their land and construction payments. (The ratings agency treats such capital as debt although companies classify it as equity on their balance sheets).

Moody’s noted that the step-up of coupons on these debt instruments will raise the companies’ funding costs substantially if they cannot refinance, or repay the debt before the step-up takes place.

Evergrande and Guangzhou R&F Carry Biggest Debts

The higher levels of debt from perpetual capital securities, should be a concern for a number of developers, with Moody’s singling out Evergrande Real Estate Group Limited and Guangzhou R&F Properties as having the highest portion of debt from these securities, with their leverage increasing accordingly.

Many developers have been forced into taking on more debt as slow cash collection from contracted sales, and weak revenues from slow project deliveries have limited their ability to pay down their obligations.