Debt rating companies say Chinese builder bonds are at risk of downgrades to junk, after borrowing heavily to buy land as prices surged.
S&P Global Ratings has a negative outlook on two of the four real-estate companies it ranks at the lowest investment grade and says they are increasingly exposed to a correction in the property market.
Moody’s Investors Service has a negative outlook on four of the five developers with a similar ranking.
The Bloomberg Default-Risk model shows only 37 of China’s 107 listed borrowers in the industry with a market capitalisation of over $1bn merit an investment grade.
“The key risk for bondholders at the moment is land prices, which are going up too fast due to higher competition,” said Cindy Huang, a Hong Kong-based analyst at S&P, which highlighted the risk of so-called fallen angels losing their investment grade in a June 19 report. “This could lead to profit margin compression and higher leverage.”
China’s property boom has already seen developers’ ratio of liabilities to total equity double since 2008, while 31% of them have earnings before interest, tax, depreciation and amortisation lower than interest expenses, a Natixis analysis of China’s 3,000 biggest listed companies showed.
Real estate companies are now stretching their balance sheets to buy more land at higher prices just as housing-market growth tapers off.
Sino-Ocean Group Holdings and Poly Real Estate Group Co are both rated investment grade with a negative outlook by Moody’s as well as S&P. Bloomberg’s model, which tracks metrics including share performance, liabilities and cash flow, signals they have characteristics common with issuers on the borderline between investment grade and junk.
The gauge doesn’t make assumptions about shareholder support, regulations or future earnings as a debt rating would.
There is a 0.67% probability Sino-Ocean Group will miss payments in the next 12 months, according to the model. The probability for Poly Real Estate is 0.56%. As at the end of 2015, Sino-Ocean Group’s net debt to EBITDA rose to 5.5 times from 2.9 times three years prior, Bloomberg-compiled data show.
The investor relations department at Sino-Ocean Group declined to comment, while Poly Real Estate didn’t immediately respond to a e-mails seeking comment.
Sunac China Holdings Chairman Sun Hongbin said land prices are high and the trend isn’t sustainable, according to a Caixin report.
The Tianjin-based builder has suspended its applications to buy land nationwide temporarily, complaining that high prices have prevented it from obtaining land in first- tier cities.
While there is no official data on land sale prices in China, the central government released a commentary last month saying regional authorities need to curb speculation.
Offers for two plots of land in Suzhou, 30 minutes by train from Shanghai, exceeded regulatory ceilings, triggering the cancellation of the auction, according to the city’s land bureau.
There are signs the market is cooling. Moody’s wrote in a June 27 report that it sees nationwide home sales growing in single digits in the 12 months ended May 2017, down from 32% in the previous period, amid “selective regulatory tightening in higher-tier cities.” The pace of price growth in Shenzhen and Shanghai moderated in May, it said.
Chinese developers’ operating income only covers 1.9 times their interest expense, down from 5 times five years ago, data compiled by Bloomberg show.
“The key risks for Chinese developers are rising leverage as many of them have raised debt for land acquisition and to support their fast growth plan, as well as pressure on profit margin due to increasing land prices,” said Kaven Tsang, an analyst at Moody’s in Hong Kong.
Dollar property bonds have rallied in the past five months, helped by a lack of issuance. Yields on Chinese US currency high-yield bonds, almost three quarters of which are issued by developers, dropped 157 basis points since Feb. 1 to 7.64%, not too far from the record low of 7.13% in 2005, Bank of America Merrill Lynch indexes show.
Raymond Chia, Singapore-based head of credit research for Asia excluding Japan at Schroder Investment Management Ltd, said that dollar bond yields have been pushed down by onshore fundraising that led to a scarcity of debt offshore. Exceptions allowed under dollar-note covenants permit additional borrowing, he noted.
“Given the various funding channels available, leverage at Chinese developers should be monitored,” he said.