Fitch Ratings has downgraded the Chinese homebuilder Central China Real Estate Limited's (CCRE) Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B' from 'B+', and the senior unsecured rating and the ratings on CCRE's outstanding US dollar senior notes to 'B' from 'B+' with Recovery Rating of 'RR4'.

Fitch has also put all the ratings on Rating Watch Negative (RWN).

The downgrade reflects CCRE's tight liquidity and weak contracted sales in 1H22. Fitch believes that CCRE is likely to repay the USD500 million bonds due in August 2022 using proceeds from recent asset disposals and cash from operations. The RWN is due to uncertainties about the repayment of the US dollar bonds and completion of the proposed equity transaction.

Key Rating Drivers

Tight Liquidity: Fitch expects CCRE's liquidity position to remain tight on weak contracted sales in 1H22. Its unrestricted cash of CNY5.9 billion as of end-2021 appears sufficient to cover the USD500 million offshore bonds due in August 2022 and CNY1.2 billion trust loans maturing in 2022. The company has not provided its latest cash balance to Fitch, as it is in the process of an interim review.

Proposed Share and CB Sale: Fitch expects the equity stake sale by the CCRE chairman to Henan Railway Construction & Investment Group Co., Ltd. to be completed soon, although timing uncertainties remain. CCRE announced on June 1 the proposed sale of a 29% equity stake from its chairman to a Henan Railway Construction wholly owned subsidiary.

The share sale consideration of HKD688 million will be provided to CCRE as a shareholder loan. CCRE will also issue HKD708 million convertible bonds (CB) at 5% a year maturing in 24 months (which may be extended for another 12 months), with a conversion price of not higher than HKD1.20, to the same entity. CCRE said on 30 June that the negotiation and due diligence were at an advance stage.

Weak Contracted Sales: Fitch expects CCRE's full-year contracted sales to drop by 30% to around CNY42 billion in 2022, a similar decline to our expectation for China's overall property market. CCRE's contracted sales in 1H22 fell by 55% yoy to CNY14 billion, broadly in line with the sector.

Leading Position in Henan: Fitch believes CCRE's concentration in Henan may enable the company to obtain some support from the Henan government. CCRE has maintained a leading market position in Henan with a market share of about 7% for heavy asset sales in 2021. It has been developing residential properties almost entirely in Henan for nearly 30 years, and had 230 projects in Henan at end 2021.

Adequate Land Bank: CCRE's attributable land bank of around 38.6 million square metres with estimated sales value of CNY200 billion can sustain its sales for three to four years, taking into account there are some large projects that may take time to churn.

Guarantees to Related Parties: CCRE provided a CNY500 million financial guarantee to Henan Hongdao for a five-year bank loan, which has been included in our leverage calculation. Henan Hongdao is owned by CCRE's chairman and largest shareholder, and Henan Hongdao's subsidiary is a supplier to CCRE. An increase in related-party transactions and financial guarantees would cause Fitch to consider negative rating action.

Derivation Summary

The downgrade of CCRE's ratings to 'B' reflects its weak sales in 1H22 and limited financial flexibility. The RWN reflects our uncertainties on its repayment of the USD500 million offshore bonds in August 2022, and the completion of the proposed equity transaction.

CCRE has stronger business profile and better liquidity than China South City Holdings Limited (CSC, B-/Negative). CSC's attributable contracted sales is about CNY10 billion a year, compared with CCRE's about CNY30 billion a year. CSC completed the equity sale with Shenzhen SEZ Construction and Development Group Co Ltd in May 2022, with has improved its onshore funding access. Fitch also expects CCRE's funding access to improve after the completion of its equity transaction.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Total contracted sales of CNY40 billion-60 billion a year in 2022-2024;

Cash collection rate at 80-90% in 2022-2024;

Gross profit margin of about 15% in 2022-2024;

Annual land acquisition budget to be about 10%-30% of contracted sales proceeds in 2022-2024.

Recovery Rating Assumptions:

Liquidation Approach

The liquidation estimate reflects Fitch's view of the value of balance-sheet assets that can be realised in a sale or liquidation process conducted during bankruptcy or insolvency proceedings and distributed to creditors.

Advance rate of 80%, applied to accounts receivable. This treatment is in line with our recovery rating criteria.

Advance rate of 57% applied to the book value of self-owned investment properties. The portfolio has an average rental yield of 3%, which is reasonable. The implied rental yield on the liquidation value for the investment-property portfolio would improve to 6%, which will be considered acceptable in a secondary market transaction.

Advance rate of 50%, applied to property, plant and equipment, which mainly consists of buildings, the value of which is insignificant.

Advance rate of 62%, applied to net property inventory. The inventory mainly consists of completed properties held for sales, and properties under development (PUD), prepayments for land acquisitions. Different advance rates were applied to these different inventory categories to derived the blended advance rates for net inventory.

Advance rate of 70% to completed properties held for sale. Completed commodity housing units are closer to readily marketable inventory. The company has historically a gross margin for development property of around 15%. The company also adopts a fast churn strategy, so its book value of inventory should be close to the market value. Therefore, a higher advance rate of 70% (against the typical 50% mentioned in the criteria for inventory) was applied.

Advance rate of 50% to PUD and prepayment for development projects. Unlike completed projects, PUD are more difficult to sell. These assets are also in various stages of completion. A 50% advance rate was applied. The PUD balance - before applying the advance rate - is net of margin adjusted customer deposits.

Advance rate of 90% to deposits for land acquisitions. In a similar way to completed commodity housing units, land held for development is closer to readily marketable inventory. The company has been the leading developer in Henan and has good relationship with the Henan government. We believe that the company may be able to resell the land bank to the government, if needed. Therefore, we considered a higher advance rate than the typical 50% mentioned in the criteria.

Advance rate of 50%, applied to joint-venture (JV) net assets. JV assets typically include a combination of completed units, PUD and land bank. A 50% advance rate was applied in line with the baseline advance rate for inventories.

The allocation of value in the liability waterfall results in a Recovery Rating corresponding to 'RR4' for the offshore senior notes.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The RWN would be removed if the negative sensitivities are avoided, in particular:

Timely repayment of the offshore bonds due in August 2022;

Completion of the proposed equity transaction resulting in an improved liquidity and capital structure.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Failure to repay the offshore bonds due in August 2022;

Prolonged delay of the proposed equity transaction;

Deterioration in liquidity, funding access or sales proceeds.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Tight Liquidity: CCRE had unrestricted cash of CNY5.9 billion (excluding restricted cash of CNY2.7 billion) as of end-December 2021, while it had short-term debt of CNY3.8 billion. Fitch expects the company to repay the USD500 million maturity due on 8 August 2022, mainly using proceeds from operational cash and asset disposals.

Issuer Profile

CCRE, established in 1992, is a leading property developer in Henan province, focusing on developing residential properties, with about 7% market share in Henan for its heavy asset business.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

RATING ACTIONS

Entity / Debt

Rating

Recovery

Prior

Central China Real Estate Limited

LT IDR

B

Downgrade

B+

senior unsecured

LT

B

Downgrade

RR4

B+

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VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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