The credit worthiness of China’s property sector has been unclear judging from the actions of the international rating agencies. Fitch Ratings upgraded Country Garden to investment grade the week before and Moody’s Investors Service has come out to say that it now expects real estate firms’ credit metrics to improve over the next 12 to 18 months. On the flip side, S&P Global Ratings lowered Country Garden’s US dollar bonds to ‘BB-‘ last week, a notch below the issuer ratings of ‘BB’. Strangely, S&P had previously in July, lifted the real estate developer’s outlook to positive, usually a prelude to an upgrade.
The rating agency’s concern is that offshore bond investors may not be able to recover much in the way of assets if Chinese developers were to default, as these usually have an offshore parent holding company, whereas onshore operating subsidiaries hold land bank and development projects. Offshore dollar bond investors are thus structurally subordinated and have no direct claim on issuers’ assets in the case of a default. This problem is compounded by the fact that the level of debt held by the operating subsidies is not always transparent as developers are often engaged in off-balance sheet joint ventures. Demand for Chinese property bonds remain strong, but investors just need to keep in mind that they might be last in line when trouble comes.