Until relatively recently the view from investors was that the ‘Beijing Put’ would always prevail in China’s financial markets, meaning that the government wouldn’t let large corporates fail (for our explantion of the Beijing Put see WiC226).
That older certainty is long gone, however. Creditworthiness has deteriorated in China, with bond defaults expected to hit record highs for the third consecutive year. Major firms once deemed too big to fail – such as Huarong and HNA – have filed for bankruptcy restructurings and investors are now contemplating the prospect of the largest Chinese corporate failure since GITIC in the 1990s – should China Evergrande implode under the weight of total liabilities of more than $300 billion.
Warnings have been sounded that “China’s Lehman moment” is looming, although others have suggested that the US government-led rescue of AIG might be a better parallel.
More specific comparisons lie closer to home, perhaps. Amid the frenzied speculation on Evergrande’s future, we take a closer look at other restructuring in China, wondering whether one of these scenarios might play out if Evergrande finally succumbs to bankruptcy proceedings.
Bailout or not: China Huarong
Earlier this year Huarong, the state-controlled asset management company, was the firm getting more of the attention in the financial press. Its former chairman Lai Xiaomin was executed in February for soliciting Rmb1.8 billion ($279 million) of bribes, while 54 other Huarong executives were disciplined.
As things turned out, the financial clean up at Huarong had only just begun. Shares in the state-owned enterprise (SOE) have been suspended since March in Hong Kong, following its failure to publish its 2020 financial report on time. The price of its bonds nosedived as concerns grew over the financial health of what is the largest of the Chinese ‘bad banks’ – Huarong had about Rmb1.7 trillion worth of assets by the end of 2019.
Worse, the company warned in early August that its 2020 net loss could top Rmb100 billion. But creditors then got some respite a few days later when Huarong said in another circular that it had signed a “framework agreement” to bring in a group of financial SOEs including Citic Group and China Life Insurance as strategic investors.
Details of the deal are still pending but some reports have put the size of the rescue at about Rmb50 billion (about 50% more than current market value of Huarong’s shares).
Huarong was one of four bad banks created to mop up the more toxic assets of the big four state lenders ahead of their stock market listings around 15 years ago. Nevertheless Huarong is not being put through a “debt restructuring”, a spokesperson has been telling local media outlets. That might be accurate from a purely technical point of view perhaps, but its shareholders are still staring at some unpleasant losses, depending on how its shares are priced in the recapitalisation plan. When details are disclosed, investors will be looking closely to gauge more broadly what it says about Chinese lenders’ asset quality.
Restructuring on good terms: China Minsheng Investment
China Minsheng Investment (CMI) is a private-sector investment firm founded by a similar group of entrepreneurs to those who laid the foundations for China Minsheng Bank. CMI was created in 2014, a landmark year for the Chinese bond market after a flurry of defaults that shattered the complacency surrounding the ‘Beijing Put’ (especially in the solar power sector, see WiC229). At the time, CMI was being billed as a private-sector asset manager to complement China Minsheng Bank’s core business. This saw it invest in the lender’s more promising clients, while also cleaning up some of the poorer performing loans on the bank’s books (see WiC237).
It took less than five years for CMI to amass debt of more than Rmb230 billion and blunder into a liquidity crisis of its own. The investment firm defaulted on a flurry of bond and interest repayments starting in early 2019. It has since gone into a debt restructuring process which is ongoing today.
The process involves renegotiation of repayment terms with creditors largely without government involvement. CMI and its creditors appear to have stayed on good terms during the process, with creditors deciding against triggering a bankruptcy restructuring through the courts (more on this later). Repayment deadlines have been postponed – in exchange for these delays being agreed CMI’s management proactively offloaded assets. Salaries for senior executives were cut significantly in a further gesture of goodwill to bondholders.
CMI was mired in debt trouble mainly because of its involvement in sectors plagued by overcapacity, such as solar panels. But the prospects for realising more value from some of these assets now looks rosier, because China’s commitment to achieving carbon neutrality by 2060 has buoyed sentiment in these industries. China Securities Journal reported last month that CMI is on the verge of unveiling a final restructuring proposal, following the appointment of a new president in August.
When creditors bring proceedings to court: Qinghai Salt Lake and QPIG
China’s insolvency laws have been revamped on a number of occasions since 2014, allowing creditors to try to force a resolution through the courts.
That’s what happened to Qinghai Salt Lake (QSL) when it defaulted. The world’s biggest potash producer was already on a shortlist to be thrown off the Shenzhen bourse after consecutive years of lossmaking. But in a market circular published in August 2019, it said it had begun a court-ordered bankruptcy restructuring process after a creditor filed a lawsuit over Rmb4.4 million in overdue payments. It warned that liquidation – the worst case scenario – beckoned if creditors couldn’t agree on a restructuring proposal.
The perception that QSL hadn’t made serious efforts to respond to creditor concerns – at the time it was reporting Rmb70 billion in assets including Rmb700 million in cash – enraged its creditors, fuelling speculation that its biggest shareholders in the Qinghai provincial government were prioritising the interests of shareholders (including itself) over debt holders.
But the court proceedings seem to have prompted an effort to balance the conflicting interests of the various parties. The potash maker reached a deal with most of its creditors, who agreed to swap Rmb33 billion of debt into QSL’s equity. They might end up better-off in the long run: QSL’s shares started trading again in August and have tripled since then.
However, the long-held expectation that local governments would bail out SOEs under their control was all but shattered by another credit event in Qinghai shortly after the QSL debacle.
Enter Qinghai Provincial Investment Group (QPIG), which until 2013 was a pure-play local government financing vehicle (or LGFV, see WiC48 for our earliest mention of these uniquely Chinese entities). In subsequent years it brought in investment from sister SOEs in Qinghai.
After defaulting on a couple of US dollar bonds in early 2020, QPIG proposed a debt restructuring that required bondholders to take a 60% haircut. Bondholders said no. Hoping to make their discontent more widely known, some creditors even protested in Hong Kong’s Central business district. Before long QPIG was also brought to court by creditors.
News website Jiemian reported last month that QPIG is close to agreeing its own restructuring plan with debt holders, which is likely to be anchored by a strategic investment from the influential State Power Investment Corporation.
Restructuring, then liquidation: a fate awaiting HNA Group?
The detention by Chinese police of HNA’s chairman Chen Feng and CEO Tang Xiaodong last week added another twist to the drama of an aviation conglomerate already under court administration.
The duo’s detention, confirmed via HNA’s WeChat account, came a week after the company held a second meeting with creditors on restructuring proposals.
Several thousand creditors have filed claims worth at least Rmb350 billion (HNA was initially taken to court in February). In this case, the local government in Hainan has also stepped in, setting up a working group to oversee the debt restructuring process. In a bid to move things forward the commodity firm Liaoning Fangda was approved as the new controlling shareholder of HNA’s ‘crown jewel’ aviation businesses, including its flagship asset Hainan Airlines (see WiC556).
In a WeChat post, the head of the rescue team claimed the restructuring effort was in its “last sprint” this month. Executives would do their best to communicate with the interested parties even if it meant they were “scolded and beaten up” by furious investors, he dramatically promised.
That sounded to some like a warning that the settlement that’s going to be offered to creditors may not be that alluring. Caixin Weekly has reported that HNA is proposing that Hainan Airlines and 10 other units will repay Rmb161 billion of the Rmb400 billion being sought by creditors. The repayment will comprise a one-time cash payment of no more than Rmb100,000, with a third of the outstanding amount met through a swap into the airline’s shares.
According to Caixin, creditors will vote on the proposal on October 20. If they veto the plan, the aviation group could then go into bankruptcy liquidation.
Buying time: the case of Kaisa
Real estate firm Kaisa came close to collapse in late 2014 when news broke that the Shenzhen government had taken control of some of its projects, freezing payments from homebuyers on presold contracts. The inference was clear: the local authorities were protecting the interest of homebuyers in the event the developer went under.
Kaisa’s chairman Kwok Ying-shing resigned in December 2014 amid speculation that he was caught up in an anti-corruption investigation and Kaisa became the first Chinese property firm to default on its offshore dollar bonds a month later. The company was quick, however, to agree to a debt restructuring proposal in February 2015, announcing that Shanghai-based rival Sunac had agreed to acquire a 49% stake from the Kwok family for about $585 million.
The change in shareholding control would see Sunac become a white knight and assume Kaisa’s debts. Nevertheless, the precondition was that Kaisa talk its creditors into accepting the terms of the rescue. At the time Kaisa proposed that both onshore and offshore bondholders should be repaid their principal at an extended maturity, although interest payments would be substantially cut And while onshore bondholders largely agreed to adopt the plan, offshore creditors weren’t happy with the terms, given they were holding notes with longer maturities and higher interest rates.
Sunac eventually scrapped the takeover bid. Nevertheless the Sunac proposal bought precious time for Kaisa to respond to the worst of its liquidity crisis and show signs of turning around its core property development business. In 2017 trading in its Hong Kong-listed shares was resumed, following a 724-day hiatus.
In another sign of its recovery, Kaisa was back in the offshore bond market again early last month with a $300 million issuance that carried a 10.5% coupon on a 2022 maturity.
What is the latest on the Evergrande situation?
Similar to Kaisa’s situation, Evergrande has assets to trade, including its land bank, its commercial property portfolio, and one of the country’s biggest property management businesses. But the problem is that it doesn’t have the time to liquidate these assets at the best possible prices.
In a memo to employees ahead of the traditional Mid-Autumn Festival last week, Evergrande’s founder Xu Jiayin (often referred to in the international media by his Cantonese name of Hui Ka-yan) promised that his cash-strapped firm could soon “walk out of its darkest moment”. Plenty of commentators take a more pessimistic view. The Wall Street Journal noted that Evergrande faced another $45 million of interest payments this Wednesday, after skipping $83.5 million in coupon payments due on its bonds last week.
Its football franchise Guangzhou FC (formerly known as Guangzhou Evergrande) also announced this week that its contract with Italian coach Fabio Cannavaro has been terminated “after a friendly negotiation”.
The bigger signal of rapidly diminishing confidence in Evergrande’s prospects has come from Joseph Lau, a Hong Kong tycoon who has been a long-time financial backer of Evergrande and a card-playing buddy of Xu’s. Lau’s firm Chinese Estates announced last week that it was offloading all of its 5.7% stake in Evergrande at an expected loss of $1.4 billion.
This week Evergrande itself raised Rmb10 billion – or around $1.5 billion – by selling a 20% stake in Shenjing Bank to Shenyang Shengjing Finance Investment Group, which is owned by local authorities. Significantly that was Evergrande’s first major asset disposal.
And what are the lessons for Evergrande from the other cases?
There are strands of each of the other credit crises in Evergrande’s predicament. For instance, Huarong comes closest in terms of scale or systemic risk, while Kaisa shares some of the same dynamics, given its shared heritage as a real estate developer.
The experiences of HNA and QPIG point to white knight solutions, while CMI’s survival highlights the importance of holding assets in key industries (for Evergrande that might turn out to be electric vehicles) and assuaging creditors with asset disposals.
Weeks ago there was talk that a white knight might step in to buy assets (and time) for Evergrande to find a wider solution to its own debt crisis. But the chances have receded that such a scenario might play out. One of the investors being touted, Country Garden, walked away, turning instead to Evergrande’s struggling counterpart Guangzhou R&F by acquiring its property management operator for Rmb10 billion.
Even an equity investment, similar to Sunac’s proposed role in Kaisa’s turnaround, will hinge on a friendly restructuring agreement between Evergrande and its bondholders. That is going to be difficult to pull off across such a tangled web of assets and liabilities – the firm has nearly 800 projects located in hundreds of cities. The mood seems just as likely to turn hostile, with the dispute going to court.
A state bailout is unlikely too, many analysts believe. Evergrande is a poster child for the kind of behaviour that regulators have tried to counter in their wider deleveraging campaign in the property sector. A wholesale bailout would also send a confusing message at a time when China has promised a market-oriented approach to its bond market, where it wants to attract more foreign investment through scheme like its cross-border Bond Connect.
That doesn’t imply that the government won’t play a major role in resolving the situation, similar to the way that the Qinghai and Hainan governments have tried to respond to the conflicting interests of different stakeholders (expect homebuyers and suppliers to get the most sympathetic hearing in Evergrande’s case, analysts say). Global investors will be watching closely for whether they get the same treatment as onshore creditors too.
Three weeks from now HNA’s bondholder vote will offer another signal on Evergrande’s future. But it’s telling that, despite a number of ‘credit events’ in China since 2014, investors are yet to see a bankruptcy process ending with a major liquidation.
Of course, a final aspect of the Evergrande crisis unlike the other situations we’ve mentioned is its global profile. To use the Donald Rumsfeld expression this is another of those ‘known unknowns’, with indications last week of the potential for an Evergrande collapse to have a financial impact in stock markets outside China. The world is watching this crisis unfold a lot more closely than the others…
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