Chinese developers have been the talk of the town this year as their sales and share prices surged, and even the major rating agencies are starting to pay attention. Investors in the companies’ dollar bonds should rein in their enthusiasm, though.

Moody’s Investors Service now expects real estate firms’ credit metrics to improve over the next 12 to 18 months, while Fitch Ratings last week upgraded Country Garden Holdings Co. to investment grade.

Bouncing Back

China’s real estate developers have been avid dollar bond issuers this year. But curiously, S&P Global Ratings lowered Country Garden’s dollar bonds to BB- this week, a rung below its score on the company itself. In July, S&P lifted its outlook on the developer to positive, usually a prelude to an upgrade.

Prompting the downgrade is S&P’s concern that offshore bond investors may not be able to recover much in the way of assets in the event of a default.

Recall the Kaisa Group Holdings Ltd. fiasco in 2015? Kaisa’s 10.25 percent 2020 bond traded as low as 32 cents on the dollar, even though the Shenzhen-based property company had no shortage of juicy assets. Offshore bondholders couldn’t get hold of these because they were frozen by local courts in the mainland.

Chinese developers usually have an offshore parent holding company, but day-to-day operations are run by their onshore subsidiaries, which hold the land bank and development projects. Without guarantees from the operating units, offshore dollar bonds are thus “subordinated:” Investors have rights to cash flows from the subsidiaries in the form of coupon payments, but in a credit event they have no direct claim over the assets.

Take Country Garden. S&P noted that as of the end of 2016, the developer had 36 billion yuan ($5.4 billion) in secured debt and 62 billion yuan in unsecured debt issued or guaranteed by the parent, and 64 billion yuan in unsecured debt issued by or guaranteed by its operating subsidiaries. That means investors in Country Garden’s $8.8 billion of dollar bonds have to wait in line in the event of a bankruptcy until the onshore subsidiaries clear their debts. That lower rating for Country Garden’s dollar bonds “reflects the significant subordination of these senior unsecured debts,” according to S&P.

Moreover, how much debt the operating subsidies have accrued isn’t always clear. As land prices in China rise, developers are increasingly entering into joint ventures to reduce investment risks and financial burdens. But these off-balance-sheet ventures can churn out unexpected bills.

Greenland Hong Kong Holdings Ltd., China’s fourth-largest developer by sales, said in August that one of its joint ventures in the northeast province of Liaoning had 457.5 million yuan of overdue loans. A government-related local entity had declined to pay its share, potentially leaving Greenland to hold the baby. Even though the Shanghai-based company isn’t obligated to pay, it may be compelled by the need to prevent reputation and contagion risks.

According to S&P, more than a quarter of the Chinese developers it covers have “significant exposure” to joint ventures. Over the past year, Country Garden almost doubled its investments in the vehicles to more than 9 billion yuan. Some borrowings at its ventures, which have a total carrying value of 428 billion yuan, are secured and guaranteed by the developer, according to its first-half filings.

As offshore investors gobble up developers’ dollar bonds, let’s not forget there may be a lot of skeletons in the closet. Developers may end up on the hook for more than their share of debt — and dollar bondholders will be last in line.