With liabilities of more than $300 billion, China’s Evergrande Group is the one of most indebted property developers in the world. Having failed to make payments on some of its debts, Evergrande is making offshore investors extremely nervous.
On Oct. 15, the company announced that it would pay interest payments on domestically-issued bonds worth 121.8 million yuan (US$19 million). Since late September, Evergrande has missed three rounds of payments worth US$277 million due on its offshore debts. As such, the announcement has increased skepticism among offshore investors that they are not prioritized when it comes to paying back company loans.
Evergrande has so far seen more than half of its 800 ongoing projects on the mainland suspended as it failed to settle debts with suppliers, banks, and retail creditors. The company has not had any meaningful interactions with creditors so far and is tight-lipped on its dollar bond liabilities.
According to analysts, Evergrande’s creditors by order of repayment priority are households who account for 54 percent of the company’s funding, suppliers who make up 43 percent of the firm’s liabilities, retail creditors, banks, and finally bondholders.
“Earlier this year, fearing a situation similar to what we are seeing now, we began selling out our dollar bond exposure to Evergrande… Our assumption has been vindicated. Offshore creditors have the least protection in the event of liquidation of Evergrande, and we assume bondholders will recover about 10% of their total dues,” a portfolio manager at a global fund told Nikkei Asia.
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Apart from the prioritization of suppliers and households, offshore investors face other legal challenges in making Evergrande accountable for the debt. In China, it is forbidden for mainland companies to guarantee offshore debts of their units until they complete a special registration and approval process.
To bypass this requirement when taking on debt, some companies set up offshore vehicles. The company then issued what are called “keepwell bonds,” which is basically a promise that ensures the solvency of the offshore vehicle.
However, keepwell bonds do not guarantee repayment of debts taken. The keepwell structure first emerged in 2012-2013. By 2020, around $100 billion, or over 16 percent of outstanding offshore bonds issued by Chinese companies made use of such structures.
Ensuring the company honors promises made in the keepwell bonds is a tough task. In one such case last year, court-appointed administrators had refused to recognize keepwell deeds issued by the company.
In an interview with Reuters, David Billington, restructuring partner at Cleary Gottlieb Steen & Hamilton LLP, said that offshore creditors might be better off avoiding attempting to enforce keepwell bonds. Instead, they could put the offshore issuer company into liquidation or other insolvency processes.
“Instead of giving a judgment requiring a payment directly to a bunch of foreign creditors, the Chinese court would just be upholding a promise that a mainland parent gave to its subsidiary, which it failed to perform on,” Billington said.
Meanwhile, the Evergrande situation is spilling over into the wider property market, with several Chinese developers finding it difficult to pay back loans. Many of them have been downgraded by credit rating agencies.
On Oct. 18, Fitch and Moody’s Investors Service cut the credit outlook or ratings of 18 Chinese developers. According to some analysts, the large-scale downgrades could mean that the era of blind property worship, as a means of stable investment, is nearing an end in China.
“As China is lowering the reliance of property and trying to let the air out of the housing bubble and deleverage, we will see defaults for sure and some developers may go bankrupt,” Li Yujia, senior economist with the Real Estate Assessment and Development Research Centre, a research arm of Shenzhen’s government, told the South China Morning Post (SCMP).