China’s quirky little bubble-makers | FT Alphaville

China’s quirky little bubble-makers

They are in the middle of a rather large bubble. They are feeling the pinch of tightened bank lending.

They are Chinese property developers.

And it would generally be very nice to find out how their cashflow and credit factors work. Accordingly, some eye-catching bits from a Fitch Ratings report on Wednesday on how it rates the developers:

Low Market Transparency

The ratings of Chinese property companies are likely to be capped at the lower end of the ‘BBB’ category — given the lack of co-ordinated disclosure (whether from independent agents or co-ordinated by the central authority) on market dynamics such as supply and demand; vacancy rates; and sufficient disclosure to engender open-market evidence verifying valuations to the standards seen in developed markets. Furthermore, China’s central authorities are often intervening in the domestic market — successfully or not — to affect investment factors in order to bring the situation in line with their policy intentions…

Reliance on Debt

Property development generates inherently volatile cash flows. Chinese property developers, unlike many integrated property companies in developed markets, generate the vast majority of their revenues and cash flows from residential property development activities, and receive only marginal income from investment property portfolios…

There’s another point here in how property developers use debt, Fitch adds. Under Chinese law, they can’t use bank loans to buy land (even if regulators’ need for constant reminders of this law’s existence suggest it may not have complete sway in the market).

Of course, as credit is being tightened in any case, legitimate bank loans for other bits of property developers’ outlays (and any illicit ones which financed land acquisition) will dry up. Consequently, we’d ask what now happens to continued land acquisition, and whether revenue from presales (since projects themselves are taking a while to complete) will be enough.

Questions for another time, perhaps. Back to Fitch on another point:

Industry Fragmentation

A significant number of property developers are small regional players with only a single project, or a limited number of projects, due to low barriers to entry. Large players with a dominant market share on a national scale are scarce. To the extent that data is available to measure this, Chinese property companies tend to have a market share of only 2%‐3% in a given region. Hence, the Chinese developers are considered as “price-takers” overall. Given the highly fragmented nature of China’s property sector, the downside bias of property cycles is manifested mostly by weaker and smaller players falling foul of the above sector risk factors…

All of which is highly useful in itself.

And lastly, a point to note for those who have seen property developers issuing bonds in offshore markets (whether dollar or offshore renminbi) to replace the drying up of new bank loans:

Structural Subordination Risk

Bond issuers within the Chinese property development sector are generally holding companies incorporated outside China (usually in Cayman Islands or British Virgin Islands) and listed in Hong Kong with no substantial operations. They conduct their operations through their Chinese onshore subsidiaries.

The dollar-denominated bonds are not guaranteed by any current or future onshore subsidiaries due to restrictions by Chinese law. As a result, offshore creditors are structurally subordinated to the onshore ones. As onshore project loans increase, the offshore bondholders will become more structurally subordinate…

Outlook stable on the sector for now, Fitch says.

Related links:
Meanwhile, in Chinese gyms – FT Alphaville
Dim sum bonds are the new Euroyen bonds – FT Alphaville