Fitch Ratings has downgraded China SCE Group Holdings Limited's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B-' from 'B+'.
The Outlook is Negative. Fitch has also downgraded China SCE's senior unsecured rating and the ratings on the outstanding US dollar senior unsecured notes to 'B-' from 'B+' with the Recovery Rating remaining at 'RR4'.
The downgrade reflects a reduction in China SCE's financial flexibility amid the Chinese homebuilding sector's challenging operating and financing environment. Fitch believes a narrowing in funding access and a decline in sales coupled with working capital commitments is putting pressure on the company's cash generation and liquidity buffer.
The Negative Outlook reflects rising uncertainty on China SCE's ability to address capital market maturities in 1H23, including USD500 million senior notes due in April 2023. We believe that China SCE's plans to raise funds via new secure borrowings and assets disposals are subject to execution risk, given volatile market conditions.
Key Rating Drivers
Tight Liquidity: China SCE's available cash decreased to CNY14.5 billion in 1H22 from CNY15.7 billion in 2021. The liquidity ratio - measured by available cash/short-term debt (including ABS) - was 0.9x at end-1H22. Fitch noted that the consolidated cash balance at end-1H22 included CNY2.9 billion in available cash at its 60%-owned property management arm, SCE Intelligent Commercial Management, and cash balances at various project companies. We believe there could be uncertainty on whether China SCE can upstream subsidiaries' cash for the holding company's debt repayments.
Concentrated Short-Term Maturities: China SCE has large capital market maturities in 2H22 and 1H23, including a CNY2 billion onshore bond puttable in October 2022, CNY1.28 billion receivable ABS due in December 2022, USD500 million notes due in April 2023, and certain offshore bank loans with scheduled amortisations. Fitch believes that China SCE's capital market access could remain restricted in the medium term. It will have to rely on internal cash generation, as well as funding from new onshore secured borrowings and/or asset disposals to address debt repayment needs in 1H23.
Improving Operating Cash Flow: China SCE's operating cash flow should improve in 2H22, as we forecast a significant reduction in cash outflows after the repayment of its supply chain ABS and lower construction expenditure, based on a gradual decline in construction activities and slower pace of capex on investment properties. We also expect a reduction in project profit distribution to minority shareholders, which peaked in 1H22. China SCE repaid CNY3.4 billion supply chain ABS in 1H22 and the remaining outstanding balance of CNY490 million was also repaid in August 2022.
Weak Contracted Sales: China SCE's total contracted sales declined by 45% yoy in 8M22 to CNY41 billion. We expect its full-year contracted sales to decline by 43% to around CNY60 billion. Fitch may consider further negative rating action should the company's monthly contracted sales decline by more than expected, jeopardising cash generation.
Stable Onshore Bank Financing: China SCE's onshore bank financing appears intact in 1H22 with the raising of CNY4.7 billion additional bank loans during the period, based on Fitch's estimation. We believe the company has sufficient unencumbered property assets to help raise additional secured loans, which will be a key financing source for debt repayments in 1H23 besides internal cash generation. The company has said it is working with banks on new secured loans against investment-property assets, mainly shopping malls opened in the past two years. Still, we think this is subject to execution risk.
Asset Disposals, Execution Risk: China SCE has long-term rental apartments valued around CNY2 billion in operation that are fully owned by the company. It is disposing some of these assets to financial partners to help fund debt repayments, according the company. However, the timely completion of the disposals is subject to execution risk.
Derivation Summary
China SCE's ratings are constrained by its tight liquidity amid weak contracted sales and increasing uncertainty on upcoming capital-market maturities.
China SCE faces a higher amount of capital market debt in the rest of 2022 than Central China Real Estate Limited (CCRE, B/Negative), which repaid its offshore notes in August and has no remaining capital market debt due within the year. We also think CCRE may benefit from improving onshore funding access after a Henan stare-owned enterprise became one of its major shareholders.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
Total contracted sales to decrease by 43% in 2022, on our expectation of 37% sales drop in September-December 2022. Contracted sales to increase by 2% in 2023, given a low base in 2022;
Consolidated cash collection rate at 90% in 2022 and 2023 (2021: 98%);
Property development gross profit margin of about 19% in 2022-2025 (2021: 20%);
Minimal land acquisitions as the company prioritises debt repayment.
KEY RECOVERY RATING ASSUMPTIONS
Our recovery analysis assumes that China SCE would be liquidated in a bankruptcy because it is essentially an asset-trading company. The nature of homebuilding means the liquidation-value approach will almost always result in a much higher value than the going-concern approach.
We have assumed a 10% administrative claim in line with criteria
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%, raised from 70%, applied to account receivables. This treatment is in line with our Recovery Rating criteria.
Advance rate of 58% applied to net property inventory. China SCE's inventory consists mainly of completed properties held for sale, properties under development (PUD) as well as deposits and prepayments for land acquisition. Different advance rates were applied to these different inventory categories to derive the blended advance rates for net inventory.
Advance rate of 70% applied to completed properties held for sale. Completed commodity housing units are closer to readily marketable inventory. China SCE has historically a gross margin of around 20%, which justifies a higher advance rate than our criteria.
Advance rate of 55% applied to PUD, which are more difficult to sell than completed projects and are at various stages of completion. The PUD balance - prior to applying the advance rate - is net of margin-adjusted customer deposits.
Advance rate of 90% applied to deposits and prepayments for land acquisition. Similar to completed commodity housing units, land held for development is closer to readily marketable inventory. China SCE's land is mostly located in Tier 2 and 3 cities in the Yangtze River Delta and West Taiwan Strait.
Advance rate of 50%, lowered from 60%, applied to property, plant and equipment, which consist mainly of buildings with insignificant value.
Advance rate of 30% applied to investment properties. China SCE's investment-property portfolio consists mainly of shopping malls and long-term rental apartments. The portfolio has an average rental yield of 1.5%, which is below the industry average.
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.
Advance rate of 0% applied to excess cash, after netting the amount of note payables and trade payables (construction fee and retention payables). We do not assume available cash in excess of outstanding trade payables would be available for other debt-servicing purposes and therefore the advance rate for excess cash is 0%.
The allocation of value in the liability waterfall results in a Recovery Rating corresponding to 'RR3' for the senior unsecured offshore bonds. However, the Recovery Rating for senior unsecured debt is capped at 'RR4', under Fitch's Country-Specific Treatment of Recovery Ratings Criteria. China falls into Group D of creditor friendliness, and Recovery Ratings of instruments from issuers with assets in this group are subject to a cap of 'RR4'.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
The Outlook will be revised to Stable if the negative sensitivities are not met.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Deterioration in liquidity or funding access to address debt maturities for the rest of 2022 and 1H23;
Further deterioration in contracted sales or cash collection.
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
Squeezed Liquidity: China SCE's unrestricted cash fell to CNY14.5 billion in 1H22 from CNY15.7 billion in 2021, while its liquidity ratio (available cash/short-term debt including ABS) was largely unchanged at 0.9x. It has large capital-market debt and trust loan maturities in the rest of 2022, including a CNY2 billion onshore bond puttable in October 2022. We believe China SCE will have to rely on internal cash to cover debt repayment needs for the remainder of 2022, which is likely to weaken its liquidity buffer.
Issuer Profile
China SCE is one of China's 50 largest property developers. It had a land bank with total gross floor area of 36.6 million square metres as of June 2022. The company has operations in major economic zones, including Fujian province, the Yangtze River Delta, the Bohai Rim and Central Western China.
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
CHINA SCE GROUP HOLDINGS LIMITED 
