Sector Review:

Lower-Rated Chinese Real Estate Developers Remain Vulnerable To Market Shifts

Beijing Contact: Laura C Li, CFA, Beijing (86) 10-6569-2930; laura.li@standardandpoors.com Secondary Contact: Bei Fu, Hong Kong (852) 2533-3512; bei.fu@standardandpoors.com

Table Of Contents
Pricing Flexibility And Profitability Are The Key Determinants Of Business Performance Execution Is Less Consistent For Developers In The Lower-Rated Category Liquidity Hinges On Capital Expenditure Using Asset Disposals To Dodge Default Overall, Ratings Should Stay Stable With Some Room For Divergence Related Criteria And Research

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Sector Review:

Lower-Rated Chinese Real Estate Developers Remain Vulnerable To Market Shifts

Half of the 38 Chinese real estate developers that Standard & Poor's Ratings Services rates fall between the 'B+' to 'CCC' rating categories, lower than our average industry risk assessment for the sector. The lower ratings on most of these companies reflect their "weak" or "vulnerable" business risk profiles and their "aggressive" or "highly leveraged" financial risk profiles (see table 1).
Table 1

Lower-Rated Chinese Developers--Rating Profile

Long-Term Corporate Credit Rating Kaisa Group Holdings Ltd. CIFI Holdings (Group) Co. Ltd. Yuzhou Properties Co. Ltd. China South City Holdings Ltd. Lai Fung Holdings Ltd. Xinyuan Real Estate Co. Ltd. China SCE Property Holdings Ltd. Greentown China Holdings Ltd. Powerlong Real Estate Holdings Ltd. Mingfa Group (International) Co. Ltd. Shanghai Industrial Urban Development Group Ltd. Golden Wheel Tiandi Holdings Co. Ltd. Glorious Property Holdings Ltd. Zhong An Real Estate Ltd. SPG Land Holdings Ltd. Hopson Development Holdings Ltd. Shanghai Zendai Property Ltd. China Properties Group Ltd. Coastal Greenland Ltd. Renhe Commercial Holdings Co. Ltd. B+ B+ B+ B+ B+ B+ B+ B B B B B B B BBBBBCCC Outlook/CreditWatch Stable Stable Stable Stable Stable Stable Negative Positive Stable Stable Stable Stable Negative Negative Watch Positive Stable Stable Stable Negative Negative Business risk profile Weak Weak Weak Weak Weak Weak Weak Weak Weak Weak Weak Vulnerable Weak Vulnerable Weak Weak Vulnerable Vulnerable Vulnerable Vulnerable Financial risk profile Aggressive Aggressive Aggressive Aggressive Aggressive Aggressive Aggressive Highly leveraged Highly leveraged Highly leveraged Highly leveraged Aggressive Highly leveraged Highly leveraged Highly leveraged Highly leveraged Highly leveraged Highly leveraged Highly leveraged Highly leveraged

The business risk profile frequently is a rating constraint, particularly for companies that are small and have geographic concentration. Nevertheless, certain large companies fall in the lower category because of their financial risk profiles, often due to liquidity and near-term refinancing risks. An example is Hopson Development Holdings Ltd., which, despite its large scale, falls in the lower rating category because the company's highly leveraged financial risk profile and liquidity position constrain the overall rating.

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Sector Review: Lower-Rated Chinese Real Estate Developers Remain Vulnerable To Market Shifts

Overview The credit profiles of lower-rated Chinese real estate developers remain constrained, and the prospects for upgrade for most are limited over the next 12 months. Such entities face the risks of replenishing land at high costs, continued uncertain execution, and limited liquidity buffers. They also remain vulnerable to sudden shifts in market conditions. Nevertheless, we expect the credit quality of property developers in the 'B' and 'CCC' rating categories to be relatively stable in the next 12 months because they have reduced exposure to high-risk trust loans and refinanced offshore bonds.

Chinese property developers' overall sales performance has recovered so far in 2013, in our opinion, leading to healthier liquidity positions compared with those 12 months ago. We also attribute part of the improvement in liquidity to a pervading mood of fear among issuers, particularly since the last downturn. Such negative sentiment prompted many lower-rated companies to significantly cut back their capital expenditure to stay afloat. We expect the trend of downgrades across all rating categories to subside over the next six to 12 months. This is because China's property market is likely to remain stable and financing conditions should be fair during this time, although they are likely to be less favorable than in early 2013. We envisage that rating actions will likely reflect company-specific developments such as liquidity/refinancing risk, sales execution, and debt-funded expansion. For example, we could lower ratings if we believe the issuer faces immediate refinancing risk, as we did for Renhe Commercial Holdings Co. Ltd. earlier this year (see table 2).
Table 2

Lower-Rated Chinese Developers--Rating Actions*

To China Properties Group Ltd. China SCE Property Holdings Ltd. CIFI Holdings (Group) Co. Ltd. Coastal Greenland Ltd. Coastal Greenland Ltd. Glorious Property Holdings Ltd. B-/Stable/-B+/Negative/-B+/Stable/-B-/Negative/-CCC+/Negative/-B/Negative/-From --B+/Stable/---CCC+/Negative/-B-/Negative/-B+/Negative/---CCC+/Watch Pos/-CCC+/Negative/-B-/Negative/-B/Negative/-B-/Negative/-B-/Watch Neg/-B/Watch Neg/-B+/Negative/-B+/Negative/-B+/Stable/-Date May 23, 2013 Oct. 31, 2012 Feb. 15, 2013 Nov. 8, 2012 Feb. 20, 2012 April 3, 2012 April 12, 2013 Dec. 19, 2012 June 11, 2012 April 26, 2012 Jan. 20, 2012 April 26, 2013 Sept. 24, 2012 May 31, 2012 April 3, 2012 March 11, 2013 March 20, 2012

Golden Wheel Tiandi Holdings Co. Ltd. B/Stable/-Greentown China Holdings Ltd. Greentown China Holdings Ltd. Greentown China Holdings Ltd. Greentown China Holdings Ltd. Hopson Development Holdings Ltd. Hopson Development Holdings Ltd. Hopson Development Holdings Ltd. Hopson Development Holdings Ltd. Kaisa Group Holdings Ltd. Kaisa Group Holdings Ltd. B/Positive/-CCC+/Watch Pos/-CCC+/Negative/-B-/Negative/-B-/Stable/-B-/Negative/-B-/Watch Neg/-B/Watch Neg/-B+/Stable/-B+/Negative/--

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Sector Review: Lower-Rated Chinese Real Estate Developers Remain Vulnerable To Market Shifts

Table 2

Lower-Rated Chinese Developers--Rating Actions* (cont.)

Lai Fung Holdings Ltd. Mingfa Group (International) Co. Ltd. Powerlong Real Estate Holdings Ltd. Powerlong Real Estate Holdings Ltd. Powerlong Real Estate Holdings Ltd. Renhe Commercial Holdings Co. Ltd. Renhe Commercial Holdings Co. Ltd. Renhe Commercial Holdings Co. Ltd. Renhe Commercial Holdings Co. Ltd. Shanghai Zendai Property Ltd. SPG Land (Holdings) Ltd. SPG Land (Holdings) Ltd. SPG Land (Holdings) Ltd. Xinyuan Real Estate Co. Ltd. Yuzhou Properties Co. Ltd. Yuzhou Properties Co. Ltd. Zhong An Real Estate Ltd. *Since 2012. B+/Stable/-B/Stable/-B/Stable/-B/Negative/-B/Watch Neg/-CCC/Negative/-B-/Negative/-B/Watch Neg/-B+/Negative/-B-/Stable/-B-/Watch Pos/-B-/Negative/-B/Negative/-B+/Stable/-B+/Stable/-B+/Negative/-B/Negative/-B+/Negative/---B/Negative/-B/Watch Neg/-B+/Negative/-B-/Negative/-B/Watch Neg/-B+/Negative/-BB-/Watch Neg/-B-/Negative/-B-/Negative/-B/Negative/-B+/Watch Neg/---B+/Negative/-B+/Stable/-B+/Negative/-March 8, 2013 Jan. 23, 2013 Jan. 15, 2013 April 27, 2012 March 27, 2012 April 5, 2013 July 4, 2012 March 28, 2012 March 15, 2012 June 7, 2012 May 9, 2013 July 10, 2012 Jan. 16, 2012 April 17, 2013 Sept. 13, 2012 Feb. 22, 2012 Feb. 28, 2012

Although financing conditions are fair as property developers continue to avail bank credit and offshore funding, albeit at higher costs, we believe refinancing risk could increase because of several reasons. Financially weaker developers might find it increasingly difficult to borrow from banks if credit growth slows in China as the government stems out excessive credit growth. They might also find it harder to borrow from the offshore debt market because of volatile market sentiment, flight of capital, and significantly higher funding costs. Also, companies could have large upcoming short-term debt maturities--bank loans or senior notes--while sales performance is poor. Additionally, they might find it hard to divest or sell assets to boost liquidity. Some developers could be vulnerable to refinancing pressure on their offshore convertible bonds or senior notes in the next two years, such as Mingfa Group (International) Co. Ltd. and Shanghai Industrial Urban Development Group Ltd. (SIUD). We believe the recent interbank rate hike in the Chinese banking system is a temporary phenomenon. Nevertheless, it highlights the risk of onshore credit conditions turning quickly and bank credit becoming more selective, leaving smaller and weaker developers with limited funding. A quick turn in the credit and financing conditions onshore and offshore could alter our view of the sector if credit tightening becomes prevalent in the second half of this year, although it is not our base-case assumption. Property development is capital intensive and developers' liquidity is sensitive to mortgage availability and funding from banks for construction. Although liquidity risk remains the top uncertainty for lower-rated Chinese developers, they do face other challenges as well, such as weaker competitive positions, profitability, and corporate governance compared with that of peers with a higher rating.

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Sector Review: Lower-Rated Chinese Real Estate Developers Remain Vulnerable To Market Shifts

Pricing Flexibility And Profitability Are The Key Determinants Of Business Performance
In our view, China's regional property developers generally have weaker pricing power compared with that of their larger national peers. This makes the regional entities vulnerable to competition and market shifts. Most of the developers that we rate in the 'B' category are regional players whose brand recognition and operating scale is far below that of national-level players. This disparity explains why developers rated 'BB' or higher often deliver relatively more stable and better profitability. One of the key determinants of profitability is land cost. Land prices have been rising and are much higher in first-tier cities, such as Beijing, Shanghai, Shenzhen, and Guangzhou, and in some second-tier cities, such as Hangzhou, Nanjing, and Tianjin. These are the cities in which national-level bidders with much stronger financial strength operate. Regional players usually face intense competition as well as financing pressure while acquiring land in these cities. Often, national players outbid regional entities. Rising land prices increase the risks for small developers, given that a large acquisition could significantly increase their financial leverage and project concentration. A similar-sized acquisition would have a smaller impact on the financial position of large developers. However, several smaller or regional players continue to acquire low-cost land by carving out a niche in the market. Kaisa Group Holdings Ltd. secured urban redevelopment projects at a reasonable land cost in Shenzhen and Guangdong by virtue of its proven urban redevelopment experience with the Shenzhen government. As a result, these projects have lower capital intensity and higher profit margins than other projects. China South City Holdings Ltd., a niche trade center developer and operator, has a much lower land cost than peers. This is because China South City's track record at CSC Shenzhen, one of the largest trade centers in China, enables the company to develop new projects in other cities with support and incentives from local governments. The local governments usually support trade center development to facilitate economic progress and improve tax revenues and employment. Another example is Powerlong Real Estate Holdings Ltd., which mainly develops urban complexes on the outskirts of second- and lower-tier cities and holds retail malls for rental income. The company has obtained government support to purchase land at a reasonable cost. As of end-2012, Powerlong owns 12 retail malls with gross floor area of 1.3 million square meters. The company generated Chinese renminbi 508 million rental and management income in 2012, higher than similarly-rated peers.

Execution Is Less Consistent For Developers In The Lower-Rated Category

We believe business strategy execution will be mixed for lower-rated developers if the market changes. In a downturn, smaller developers whose liquidity is under pressure are most likely to cut prices to promote property sales, leading to volatile profitability in the coming revenue recognition cycles. Liquidity could also come under pressure even if the developer does not lower prices but its execution remains weak, especially when the short-term debt maturities are significant. In our view, financial volatility will remain high for developers with a limited number of projects and weak execution,

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Sector Review: Lower-Rated Chinese Real Estate Developers Remain Vulnerable To Market Shifts

such as China Properties Group Ltd., Coastal Greenland Ltd., and Renhe. This is because property sales are lumpy and profitability fluctuates based on different revenue contributing projects each year. In most cases, smaller developers tend to have less product and geographical diversification. Geographically, some developers are diversifying too fast, making such execution a problem due to lagging management and control capability (e.g., Coastal Greenland and SPG Land Holdings Ltd.). Conversely, some are so concentrated that they could become vulnerable to local market conditions and regulatory changes. Examples include Golden Wheel Tiandi Holdings Co. Ltd., Xinyuan Real Estate Co. Ltd., Zhong An Real Estate Ltd., and China SCE Property Holdings Ltd., which are all highly concentrated in a single city. In our view, purchase restrictions are likely to remain effective in first-tier and most second-tier cities for the next 12 months at least. Most companies in the lower rating range have limited recurring income and interest coverage, and a short track record of developing and managing commercial properties. We also believe that the companies' capability of retaining tenants and maintaining quality of commercial property assets is untested. Certain developers follow a strategy of holding a part of their properties for growing recurring income. This strategy requires higher capital expenditure that leads to higher leverage and lower liquidity at times. For those developers that have meaningful investment property holdings, such as Powerlong and Mingfa, we expect recurring income to grow. But rental interest coverage will remain limited due to a low rental base and fast-growing interest expenses to support building of commercial properties.

Liquidity Hinges On Capital Expenditure

In our view, liquidity buffer for most issuers in the lower-rated category is limited because they need to constantly replenish their small land banks (usually less than 10 million square meters gross floor area). Moreover, land prices have been rising. Issuers' weak financial position further exacerbates their liquidity buffer because any significant land acquisition could put pressure on their financial position. Large developers, such as Greentown and Hopson, are exceptions, given that they have much bigger land reserves that are adequate for development over the next 10 to 20 years. But they face the challenges that their large construction needs, high interest expenses, and lumpy short-term debt maturities pose. In addition, most of the developers rated 'B' or lower have limited financial flexibility. They usually rely on domestic banks and trust financing to support business expansion. Besides land bank replenishment, large short-term debt maturities and construction commitments could also lead to liquidity crises when sales performance is significantly below expectation. This typically happens following a change in market sentiment from overt optimism, when developers expand aggressively through substantial land acquisitions and new construction. The situation could be even worse if companies lack consistent financial management, which is the case for most lower-rated developers.

Using Asset Disposals To Dodge Default

In our opinion, property developers--even lower-rated ones--turn to asset disposal as a last resort to boost liquidity during their most difficult period. Disposable assets include equity interest in property projects, usually those with undeveloped land banks, self-owned investment properties, and financial assets. Under liquidity stress during the past

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Sector Review: Lower-Rated Chinese Real Estate Developers Remain Vulnerable To Market Shifts

market downturn, a few developers, such as SPG Land and SIUD, were acquired as subsidiaries by financially stronger peers. Asset disposals can affect companies in many ways. The cash inflow from the disposal provides liquidity support in the short term, but some negative repercussions are also possible: Some previously consolidated projects become unconsolidated, and their status is not fully reflected in the developers' financial statements following the disposal. An example is Greentown's asset disposal to Sunac China Holdings Ltd. in 2012. Asset disposal would shrink the land bank, the most important asset of property developers, which may lead to possibly higher spending to replenish land reserves. The disposal proceeds may not be available in a timely manner. Selling investment property could be harder than selling land parcels, and it could also lead to lower recurring income. Not all companies can dispose assets during a liquidity crisis as the case of Renhe illustrates. Renhe does not have land use rights on its underground malls, and this prevents the company from selling assets or obtaining bank financing.

Overall, Ratings Should Stay Stable With Some Room For Divergence
The rating trend for most lower-rated developers is likely to be stable over the next 12 months, even though most of these companies are still vulnerable to market changes. This is because we revised our industry outlook for China's real estate sector to stable from negative earlier this year. Also, the sector's overall liquidity and refinancing risk have improved compared with that a year ago. Potential candidates for an upgrade could be those companies whose financial performance, including liquidity, displays a remarkable improvement and whose business risk profile is not a rating constraint. These companies usually have a good market position, an abundant land reserve, and better diversification than similarly-rated peers. Upgrade potential also exists for those lower-rated developers that have merged with or acquired peers with much stronger credit profiles. Examples include SIUD, Greentown, and SPG Land. We expect the business and financial risk profiles of these developers to improve because of support from their new large shareholders. Support could include potential asset injections, better financial flexibility, more prudent financial management, and greater assistance on boosting sales and margin. There could be further downward pressure on companies with a negative outlook that do not show signs of sales recovery and have difficulty obtaining other liquidity support as needed. In contrast, smaller companies, especially those constrained by their business risk profile have limited upside potential in the next 12 months.

Related Criteria And Research

Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

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Sector Review: Lower-Rated Chinese Real Estate Developers Remain Vulnerable To Market Shifts 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008

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