source:GURU CLUB
1·Think Tank: Whether there is any reference value for the standard deadlock rating of international rating agencies?
Recently, the real estate industry has ushered in a long-lasting hot market. In particular, a series of favourable news released on the policy side has greatly boosted market confidence. If the housing purchase policies in Guangzhou and Suzhou with high economic volume and being the first-tier cities have successively been strengthened and adjusted, they will become the heavyweight catalysts for market performance.
However, as the market fundamentals and valuation repair expectations continue to rise, international rating agencies have launched a new round of rating downgrades, including leading domestic real estate enterprises such as Country Garden, CIFI, Agile and Shimao, all of which are on the list of downgrades. International rating agencies have always taken a pessimistic view on the real estate industry. After Moody released its negative outlook report on China’s real estate industry in April, it is again pessimistic about the mainland real estate industry this time and believes that real estate sales will continue to decline in the next 6-12 months. Based on the fragile confidence of home buyers, real estate sales are not expected to recover strongly in the next 12 months.
However, it appears that the predictions of the rating agencies may not be realized. According to the report issued by Moody’s in April, it is believed that the real estate market in China will continue to experience tight capital and sluggish sales, and the contracted sales of commercial housing will continue to decrease by 10%-15% in 2022. However, data from the National Bureau of Statistics showed that from January to August, the cumulative year-on-year decline in the sales area and sales of commercial housing has narrowed. In particular, the sales area and sales of commercial housing increased by 5% and 4% month-on-month, respectively, reflecting the gradual achievement of the policy to stabilize the real estate market, thus accelerating recovery of the real estate market, which clearly deviates from the industry trend predicted by rating agencies.
At the same time, from the perspective of sector and individual share trends, the market’s response to these international credit rating agencies has been quite calm. In September, even though the rating agencies successively downgraded the rating of real estate enterprises and the overall market was sluggish, the domestic real estate sector bucked the trend and rose sharply for several consecutive days and becoming the main line of the market.
(Source: Futu Quotes)
Since last year, more and more real estate enterprises have voluntarily withdrawn from the credit ratings of international rating agencies such as S&P, Fitch and Moody’s. In May, Zhongliang withdrew from Moody’s credit rating; In July and August, KWG also voluntarily withdrew from S&P and Fitch’s credit ratings. In this regard, KWG said that the foreign rating agencies were pessimistic about the expectations of the real estate market in China and ignored the efforts of real estate enterprises to repay debts.
Although rating agencies gave criteria for consideration when lowering the ratings of real estate enterprises, EH Consulting pointed out that international rating agencies have deviated from the original intention of risk warning, and the overreaction following the crisis exacerbated the risk consequences. There is a precedent for rating agencies to “jump out” and escape immediately when encountering a crisis. In the subprime crisis in 2008 and the European debt crisis in 2009, international rating agencies raised concerns and disputes.
During the financial crisis in 2008, the three major rating agencies were involved in the expansion of the scale of subprime loans in the United States due to their prior incorrect credit endorsements.
On the eve of the crisis, the large-scale downgrades of subprime loans caused financial market volatility. The three major rating agencies were ultimately sued by the market or the government and were sentenced to high compensation. In the European debt crisis, the three major rating agencies lowered the sovereign credit ratings of the related countries and issued crisis warnings, which triggered market panic and pushed these countries into the debt market due to political factors. Actually, they were closely related to hedge funds of Wall Street, and even believed to be the political drive of the United States to fight for currency dominance and debt resources.
The interests behind the rating agencies were complex, losing the role of warning risks for a long time. It is not as simple as objective rating. As a result, we also need to be aware that the current actions of rating agencies to bet against real estate market of China, and even lowering the rating of high-quality real estate enterprises, are not a prediction, but more of a “hindsight”. In order to exempt responsibility, even the interest dispute behind whether it is linked to hedge funds has aroused imagination.
- Is it ‘true’ or ‘innocent’? The rating of LVGEM (China) was downgraded by Fitch on the 16th September
On September 16, Fitch announced the rating downgrade of LVGEM (China) from B-to CCC.
It can be seen from Fitch’s downgrade report that Fitch’s downgrade of LVGEM (China)’s rating was mainly due to three concerns. 1) Before the pre-sale of Phase I of the Baishizhou Project next year, the Company needed to settle the US$470 million bonds due in March 2023, with tight liquidity and high refinancing risk; 2) LVGEM (China) has RMB2.7 billion of unrestricted funds in its account, which is insufficient to cover RMB5.6 billion of debt due in May next year; 3) LVGEM (China) has a small sales scale and a relatively concentrated project distribution, which is difficult to survive during the market downturn.
On the surface, Fitch pointed out that the problem was indeed unscrupulous. After all, for companies such as LVGEM (China) with a market value of only HK $5 billion, the US$470 million debt (equivalent to approximately HK$3.7 billion) was really a difficulty that needs to be overcome through countless efforts. However, the problem lied in whether LVGEM (China) had found a reliable ladder.
With six months to go until March next year, LVGEM (China) has replied that two rounds of financing have been under negotiation with investors in the market, with a total financing scale of RMB3 billion to 6 billion. The two facilities were for the purpose of refinancing the offshore equity interests in the urban renewal project and onshore properties, respectively.
The urban renewal project with foreign equity that can support such a large financing scale of US$300million to 500 million is likely to be the Baishizhou Project, while domestic property is possibly Shenzhen NEO Building, whose LTV ranging from 20% to 30%, which can support a better refinancing scale. The Company said that at present, the two financing have been negotiated with appropriate investors to implement the details of the terms, which is expected to be completed by the end of the year with little uncertainty.
In terms of capital, Fitch focused on the low cash in account of LVGEM (China), and the short-term debt of RMB5.6 billion cannot be covered by RMB2.7 billion. In terms of finance, we often cannot simply apply the number of a point in time to the number that occurs over time. Fitch did not take into account the factors such as the additional cash flow brought by the subsequent new financing and sales collection of LVGEM (China), which was professionally challenged.
From the interim result disclosure of LVGEM (China), the saleable inventory value of properties project of the Company in the second half of the year amounted to approximately RMB7.9 billion, which could continuously supplement the own cash of the Company. In the long run, the pre-sale of Phase I of the Baishizhou Project will be officially commenced in the coming year, with an inventory value of approximately 10 billion in the first phase, which will also provide stronger support for the cash flow of the Company.
Fitch believed that the projects of the Company are few and concentrated, small in scale and high in operational risks. It is also representing that it does not truly review the different business models among real estate enterprises. Instead, it adopts the established thinking of fast turnover and the deadlock evaluation standard to “vote by foot”. It is believed that real estate enterprises will become difficult in the environment of deleveraging and capital contraction, and small real estate enterprises will be eliminated more easily.
However, the fact is that LVGEM (China) is not an enterprise with high turnover model. Instead, it invested time and energy to deeply develop the renewal projects, while getting high returns. The gross profit margin of LVGEM (China) has been kept at approximately 50%, representing a strong profitability as compared to the average gross profit margin of 19% in the industry. This robust business model enables the Company to ensure its sustainable growth to the greatest extent in the changing landscape of the industry.
Under the strict audit of the current four accounting firms, LVGEM (China) has become one of the few real estate enterprises, which continued to issue audit reports and result on time. It can be seen that Fitch didn’t take into account the efforts made by the real estate enterprises in the operation and lowered the credit rating of the real estate enterprises in the way of “presumption of guilt”. It showed that they worried about the future and hurried to absolve themselves from their obligation, while it is not the result from the deterioration of the fundamental aspects of the real estate enterprises.
In terms of the actual debt, the debt of LVGEM (China) has no off-balance sheet trust products with 80% from bank and other project loans, which are often secured by high-quality projects with high security. In addition, the bank loans for project development can also provide sufficient funds for the development of various projects. At the beginning of 2022, the Company’s short-term debts due within one year amounted to RMB9.8 billion, but within only eight months, it has completed 84% of debt rescheduling arrangements, reflecting the superiority of this bank-oriented debt structure.
Earlier, LVGEM (China) announced that the first tower of Phase I of the Baishizhou Project has been in full swing and the construction of the underground structure has been completed. It is understood that in the first half of the year, the Company paid the land premium for the presale land lot 08 of Phase I of the Baishizhou Project, and obtained the land use rights certificate successfully, which has satisfied the conditions of drawing the bank loans for project development. The formation of the banking syndicate of Baishizhou Project was in good progress, and the credit facility of RMB20.7 billion has also been approved. It is expected that the withdrawal will be realized in October. It is also worth noting that in the first half of this year, Vanke announced to invest in the Baishizhou Project at a consideration of RMB2.3 billion. With the increase in the number of leading real estate enterprises with strong state-owned background, it not only provided strong endorsement for the operation and credit of the Baishizhou Project, but also further improved the safety of Baishizhou Project and the entire company.
Although the rating of LVGEM (China) was lowered, in my opinion, it did not affect the normal operation of LVGEM (China). In contrast, from various actions of LVGEM (China), we can see that the Company has not only maintained good experience and resilience in the previous severe situation, but also the safety margin of the Company has been continuously improved with the recovery of the industry. As the industry enters the second half of the year, the Company’s unique development model demonstrates its anti-cyclical capabilities, which will also bring new development opportunities for the industry.
Related News