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Ratings agencies take a harsher view of China's private debt

Moody's cut its credit outlook on more than 60 Chinese companies, including Bank of China, to "negative" from "stable" in February. (Photo by Takaki Kashiwabara)

HONG KONG   If Moody's downgrade of China's sovereign debt outlook was a slap in the face for Beijing, a wave of corporate rating cuts is only adding to the humiliation. 

     Sluggish demand and high leverage are casting doubt on the creditworthiness of top Chinese companies. "It's clearly a negative trend now," said Clara Lau, Moody's senior vice president for credit policy. "The trend has accelerated since the fourth quarter," she said, adding multinotch downgrades cannot be ruled out.

     In the first two months of 2016 alone, Moody's Investors Service estimates the number of negative rating actions taken on Chinese companies exceeded last year's total, at 42. China accounted for nearly half the number in Asia. Negative actions include cuts in outlook and credit rating, as well as the placement of companies on downgrade watch lists.

     Moody's cut China's sovereign debt outlook to "negative" from "stable" on March 1, just days before the National People's Congress convened to approve the country's next five-year economic plan. The agency subsequently lowered its credit outlook for 38 Chinese state-owned enterprises and 25 financial companies, excluding insurers, to "negative" from "stable." Among them are China Mobile, carmaker Dongfeng Motor Group, China National Nuclear Power, China Communications Construction and Shanghai Electric Group. China's four largest state-owned banks are also on the list.

     It cited rising debt and uncertainty over the government's ability to make economic reforms as key reasons for the decision.

     Moody's rates China's government debt at Aa3, in line with Standard & Poor's Financial Services' AA-, but one notch higher than Fitch Ratings' A+ rating.

DARKER DAYS AHEAD   Chinese officials have been muted in their response so far. On March 12, Shang Fulin, chairman of the China Banking Regulatory Commission, told reporters the recent downgrades of China and its financial institutions stemmed from a "misjudgment" of its banking sector. 

     Private-sector analysts see it differently. "Moody's has only just caught up to the market," wrote Aidan Yao, senior emerging Asia economist at AXA Investment Managers. "Concerns about China's debt metrics, capital outflows, reserve depletion and policy uncertainty were the major causes of market routs over the past 12 months."

     S&P, too, sees a similar trend. As of the end of February, about 15% of its rated portfolio of 243 greater China companies either have "negative" outlooks or are on downgrade watch lists. The company expects that figure to rise to 18% for the first quarter.

     The gap between the number of upgrades and downgrades is also widening. S&P made seven more downgrades than upgrades in 2014; last year, the difference was 18.

     "The deterioration of credit quality has been the worst since the global financial crisis in 2008," said Christopher Lee, S&P's managing director of corporate ratings for greater China. "Since this year, we have seen more than 10 downgrades but no more than five upgrades."

     Not surprisingly, sectors suffering from overcapacity, notably construction and resources, are more likely to be downgraded as China shifts from an investment-led economy toward a consumption-driven one. In February, S&P took negative rating actions against five mining and minerals companies, including Baoshan Iron & Steel. This followed downgrades of seven energy companies, such as state-owned CNOOC and China Petroleum & Chemical, or Sinopec.

NO PLACE LIKE HOMES   Consumer sectors such as retail remain under pressure as well.

     Two rating agencies earlier cut the long-term credit rating of Dalian Wanda Commercial Properties, a Hong Kong-listed company controlled by China's richest man, Wang Jianlin, on expectations that its aggressive expansion plans are unsustainable in the face of falling sales. Both S&P and Fitch downgraded Wanda from BBB+ to BBB, two notches above junk. Later, Moody's, which rates Wanda at an equivalent Baa2 at present, announced it will cut its outlook to "negative" from "stable."

     China's bricks-and-mortar retailers are still grappling with a slowing economy and growing competition from e-commerce players such as Alibaba Group Holding and "It would be a double whammy for mall developers to have too much capital spending amid a property downturn," said S&P's Lee.

     The broader property sector is, however, showing signs of stabilization. It is one of the few sectors in which more companies have positive outlooks than negative ones, according to Fitch.

     "It's a reflection of the polarization of views we've been seeing for three to four years. The stronger will get stronger, the weaker will get weaker," said Su Aik Lim, senior director at Fitch, which has cut credit ratings for a number of smaller developers since January.

     China's housing market has seen an uneven recovery, with big cities such as Beijing and Shanghai showing price increases due to the government's credit loosening efforts. In February, taxes on some property transactions were slashed and down-payment requirements for first- and second-time buyers were further eased. But smaller cities are still plagued by a glut of homes.

    Overall, Fitch is slightly more optimistic than its peers. The rating agency has given 6% of its portfolio of companies "positive" outlooks as of March 4, a rise from 2% last year. Those with negative outlooks account for 10% of its portfolio, compared with last year's 12%. "While we might still expect to see more negative outlooks than positive outlooks, I would say we are slightly closer to the bottom of the cycle," said Lim. "So it's not all bad news."

     Even so, analysts warn of risks from indebted Chinese state-run companies, whose credit profiles are linked to the country's sovereign ratings. Fitch and S&P have so far held their outlooks steady on China's sovereign debt. "If we ignore the impact of sovereign rating on Chinese companies, who knows, we might see more negative outlooks than last year," Lim said.

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