CITIC Ltd. And CITIC Group Corp. Downgraded To #BBB+#; Outlooks Stable

Stocks and Financial Services Press Releases Thursday September 28, 2017 16:12
HONG KONG--28 Sep--S&P Global Ratings

HONG KONG (S&P Global Ratings) Sept. 28, 2017--S&P Global Ratings lowered its long-term corporate credit rating on CITIC Ltd. and CITIC Group Corp. to 'BBB+' from 'A-'. At the same time, we affirmed the 'A-2' short-term corporate credit rating on CITIC Group. CITIC Ltd. is an operating subsidiary of CITIC Group, a China-based operating holding company.

Concurrently, we lowered the issue level rating on both entities' senior unsecured notes to 'BBB+' from 'A-'.

We lowered the ratings following our revision on Sept. 22, 2017, of the economic risk score under our Banking Industry Country Risk Assessment on China. We believe the heighted credit risk in China reduced CITIC Bank's capital buffer. As CITIC Bank drives the majority of profit contribution, this increased the relative credit risk of CITIC Group and CITIC Ltd.

We lowered our assessment of CITIC Bank's capitalization to weak from moderate because we believe that the risk-adjusted capital ratio is likely to stay below 5% over the next 12-24 months. With the worsened economic risk score, we applied higher risk weight to the bank's exposure, which is mostly in China, in deriving our risk-weighted assets.

Rapid domestic credit expansion through regular and shadow banking has pushed up China's debt leverage over the past few years, and we expect it to increase further. The country's ratio of nonfinancial and nonpublic debt to GDP is very high relative to the country's GDP per capita. According to our calculation, China's private sector debt-to-GDP ratio was 162.5% at end-2016, presenting challenges for all financial institutions operating in China.

In our view, the elevated debt leverage and risk overhang from a possible property price correction subject China's banking industry to heightened credit risks in the economy, and outweigh potential benefits from the country's economic resilience.

CITIC Ltd. underpins the credit profile of CITIC Group, which is essentially a holding company with limited operations. CITIC Ltd. contributes 99% of the group's total assets and liabilities, and has overlapping management and governance structures. We expect the group to maintain its 58.1% interest in CITIC Ltd. and that CITIC Ltd. will remain a core subsidiary of the group.

CITIC Ltd.'s stand-alone credit profile (SACP) is primarily driven by its banking business due to its profit contributions. We apply a weight of 70% for the bank business' SACP and 30% for the corporate business' SACP to arrive at a combined SACP of 'bb' for CITIC Ltd. The weighting reflects our view that CITIC Ltd. would continue to expand its operating scale and increase its earnings contribution from the corporate business.

We believe the corporate business will focus on managing its business risk and enhancing the operating efficiency over the coming 12 months. We expect the corporate business to increase its exposure to consumer, retail, environmental, agricultural, and healthcare-related businesses mainly through investment and acquisitions. We see some progress for such transformation. CITIC Ltd. completed its acquisition of McDonald's franchises in China and Hong Kong in early August. Additionally, CITIC Ltd. sold its residential property business to China Overseas Land and Investment Ltd.

In our view, this business transformation may bring medium- to long-term benefits to CITIC Ltd., given their higher cash flow and earnings visibility. Additionally, these businesses tend to be counter-cyclical and less sensitive to macroeconomic environment. However, the transition is likely to be slow because the company is fairly cautious and selective in business expansion. The existing resource and manufacturing business still accounts for over 55% of total nonfinancial services revenue.

We expect the profitability of CITIC Ltd.'s corporate business will be largely stable in the coming 24 months, supported by a more diversified business portfolio. We estimate its EBITDA margin to be fairly stable at 13%-15% in the coming 24 months, in line with 2016 levels.

We see a very high likelihood that the Chinese central government will provide sufficient and timely extraordinary support to CITIC Group in the event of financial distress. The extraordinary support to CITIC Ltd. is likely to pass down through CITIC Group when needed. Therefore, the rating is four notches higher than the company's SACP. Our view of extraordinary government support is based on the following factors: Very strong link to the central government. The Ministry of Finance owns 100% of CITIC Group, which in turns own 58.1% of CITIC Ltd. We expect CITIC Group's ownership in CITIC Ltd. to be at least 50%. CITIC Ltd. has a history of receiving extraordinary government support. We see a close link between the company and the government as the latter continues to appoint CITIC Group's senior management and directly oversee their strategy, financial management, and operations. Very important role to the central government. CITIC Group benefits from its legacy role as a leading company heeding the government's reform initiatives. It continues to play this role after its recent restructuring, including in safeguarding national natural resource security, representing the Chinese government in overseas engineering and construction, restructuring of loss-making state-owned enterprises, and the whole group listing. It is also one of the key players in the domestic banking sector. CITIC Group is directly supervised by the Ministry of Finance. We expect the role to the government may diminish somewhat as the group expands into competitive businesses and as reform initiatives that aim to improve state owned enterprises' competitiveness progress. Nevertheless, we expect the extraordinary government support to remain unchanged.The stable outlook is based on our expectation that CITIC Bank's credit quality will remain near the current level and that the key credit measures of CITIC's corporate arm aren't likely to fluctuate meaningfully over the next two years.

We could lower the ratings if CITIC Bank's credit quality deteriorates to a level below the industry average with little prospect of improvement. This could be indicated by a faster deterioration than the industry average for the problem loan ratio (defined as sum of nonperforming loans and special mention loans to total loans ratio) or credit loss metrics, such as ratios of credit provisions or net charge-offs to total loans.

We could also lower the rating if CITIC's corporate arm's adjusted EBITDA interest coverage is below 2x over an extended period of time. This could result from aggressive debt-financed acquisitions and a significant deterioration in existing and newly acquired businesses. Separately, we could also lower the rating if we believe the likelihood of extraordinary support from the Chinese central government to CITIC Ltd diminishes. An indicator of that could be the government reducing its shareholding in CITIC Ltd. to substantially below 50% or is CITIC Ltd.'s quasi-policy role reduces meaningfully.

We could raise the rating on CITIC Ltd. if CITIC Bank improves its capitalization, leading to our expected risk-adjusted capital ratio to be sustainably above 5% or if CITIC Ltd. significantly reduces adjusted debt leverage in its corporate business without compromising growth and profitability.

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