TEXT-Fitch Rates Franshion's Proposed Notes 'BBB-(EXP)'

(The following was released by the rating agency)

HONG KONG, October 19 (Fitch) Fitch Ratings has assigned property developer Franshion Properties (China) Limited's (Franshion, 'BBB-'/Stable) proposed senior unsecured USD notes an expected rating of 'BBB-(EXP)'.

The final rating of the proposed notes is contingent upon the receipt of documents conforming to information already received. The proceeds will be used to refinance outstanding debt, to fund capital expenditure, and for other general corporate purposes.

The bonds are rated at the same level as Franshion's rating to reflect Fitch's view that they represent direct, unconditional, unsubordinated and unsecured obligations of the company. Franshion's ratings continue to benefit from its status as an indirect state-owned Chinese property company.

This puts it at an advantage in government-led strategic projects, as illustrated by the prime location of both its investment properties and commercial developments, and helps provide strong access to domestic bank funding.

Despite the current unfavourable operating environment Franshion's contracted sales in H112 grew 4% y-o-y to HKD5.6bn, underlining the sustainability of its property development income. Revenue from the property leasing business grew 11% y-o-y, and the company is likely to achieve a further improvement in rental income through rent increases over the next 12 to 24 months as Fitch expects demand for office properties in China to remain strong.

Fitch also notes a slight increase in leverage as measured by net debt/inventory (inventory including development assets plus all long-term property assets) increased to 27% in H112 from 24% in 2011. This is largely due to an increase in net debt to HKD16bn from HKD13bn during the same period to fund new project development.

Interest expense grew faster than recurrent income during this period, which together with borrowings for the Changsha project, caused interest expense coverage to extend its downward trend. Fitch does not expect significant improvement in the coverage ratio over the next two years. Nevertheless, the Stable Outlook reflects Fitch's expectation that the company's sustainable earnings growth from its property development will mitigate its higher leverage and lower liquidity.

What could trigger a rating action?

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- rental and hotel EBITDA/gross interest expense ratio falling below 1.5x on a sustained basis. The ratio was around 1.1x at end-H112, but Fitch expects it to improve above 1.5x when most of its borrowings for the Changsha project have been repaid.

- a shift in strategy away from high-end commercial properties in prime locations and strategic projects through local government collaboration

- reduced ties with Sinochem Group, including a reduction in Sinochem Group's equity stake in Franshion to under 51%

- reduced access to onshore bank loans or inter-company funding support

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

-increasing the portfolio size of investment properties and hotels above CNY30bn in value, while maintaining rental and hotel EBITDA/gross interest expense above 2.5x