China Evergrande Group is in technical default after missing a US$82.5m bond coupon payment that was due by December 6, the end of a 30-day grace period.
The failed payment marks the company's first offshore default on a public bond, and will trigger cross-default provisions on around US$19bn of international bonds.
That will be the largest offshore bond default from an Asian issuer. Evergrande, once China's top property developer, has more than 1,300 real estate projects and around US$300bn in liabilities.
Evergrande's missed payment was confirmed by a source close to the bondholders, as well as Fitch. The ratings agency on December 9 downgraded Evergrande and its subsidiaries, Hengda Real Estate Group and Tianji Holding, to RD (restricted default), from C, following the non-payment. Fitch affirmed the senior unsecured ratings of bonds issued by Evergrande and its subsidiaries at C, with a recovery rating of RR6. Historically, RR6 securities only recover up to 10% of their principal and related interest following a default.
The next steps for Evergrande are unclear as the company is yet to make an official statement about its missed payment. The company did not immediately respond to a request for comment.
Evergrande said in a filing on December 3 that it may not be able to fulfil its pledge to guarantee payment on US$260m of debt, and it planned to restructure its offshore debt. The Guangdong provincial government summoned Evergrande's chairman Hui Ka Yan and sent a working group to the company to "oversee risk management, strengthen internal controls and maintain normal operations".
On December 6, the day the coupon payment was due, Evergrande said it had set up a risk management committee that includes officials from state-owned entities which "will play an important role in mitigating and eliminating the future risks of the group".
Market participants have been left to speculate about how the government will control the Evergrande implosion, and if bondholders have any hope of curtailing losses.
"I'm not sure what a ‘risk management committee’ is but my guess is that this is a unique case given the size [of the debt], and the central and provincial government is asking Evergrande to proactively manage the fallout and not have a messy default," said a portfolio manager, who does not hold Evergrande bonds. "I don’t really think it will work."
One syndicate banker reckoned the lack of investor noise around the default is a sign that Evergrande is already in negotiations with its bondholders. The company is likely to make a formal announcement after it has finalised more details, she said.
A Hong Kong-based lawyer said a slower announcement is likely better for bondholders as it provides more time for Evergrande to assess its assets, in particular its more opaque onshore holdings, to better tackle its debt.
“I would expect that the company comes forward with a proposal to the offshore guys [bondholders] that includes all of the offshore bonds in one go.” said the lawyer. “I’m personally struggling to see them formulate this proposal in the near term because they don’t know yet what is going on onshore, how much they can keep control over the completion of ongoing projects” or how much they will sell or dispose of these projects.
Government intervention
While helping bondholders is not the government's priority, official involvement in Evergrande's restructuring may reap benefits for them.
A bailout of Evergrande seems unlikely, but the Chinese government is keen to keep mainland property buyers happy. To avoid more protests from angry investors, the government will likely want to ensure that Evergrande's property projects are completed, said the syndicate banker.
The lawyer agreed, adding that the success of Evergrande's onshore projects could benefit bondholders.
“The government ultimately has limited love for the offshore bondholders,” said the lawyer. “That said, I’m not necessarily of the view that the government is out there with a mission to inflict pain on the offshore bondholders. For them it’s a bit of an afterthought.”
Andrew Sheng, a distinguished fellow at the Asia Global Institute of University of Hong Kong, said Evergrande has systemic implications on the housing market, given its size, "so it would not be surprising that if the largest liabilities of the borrower is to housebuyers, then the contractual obligations of the company would need to be taken into consideration".
A Greater China DCM head from a European bank said it is clear that creditors closer to the assets will get paid first. "All other bonds have similar terms, you can't say if the government's priority is to ensure project completion and delivery, it is putting bondholders at a disadvantage."
A person close to Evergrande said the company intends to follow international market standards and principles in dealing with its restructuring, and aims to "formulate and implement a viable restructuring plan" of its offshore debt for the benefit of all stakeholders.
Offshore bondholders will be structurally and contractually subordinated to those onshore with operational and financial exposure when Evergrande undergoes restructuring. Its US dollar bonds were trading at mid-10s to mid-20s handle, reflecting the expected recovery ratio by the market.
China is yet to voice a clear shift in policy with regards to the embattled property sector, but there have been signs that its tone is softening.
The People's Bank of China and China Banking and Insurance Regulatory Commission has reassured the market, saying that any risks from Evergrande's problem to the broader property sector can be contained.
In addition, PBoC on December 6 cut the bank reserve ratio requirement by 50bp, a move widely viewed as a signal of policy easing. The message sent out from the Politburo, the ruling Communist Party's top decision-making body, also fuelled speculation that the government might adopt a more dovish approach towards property companies.
"We've seen more step-in this time, with different government departments coming out to calm the market," said a DCM head from a Chinese investment bank. "Stability is the main concern and the government's priority is to ensure project completion and delivery to homebuyers. The ultimate outcome of the restructuring, however, is hard to say. What we can do is just wait and see."
The DCM head said the intervention in the Evergrande case is because of its size; for smaller players, the government will just let them default and go bankrupt, unless it increases instability.
Kaisa defaults
Evergrande's default was followed by Kaisa Group Holdings, which failed to pay its US$400m 6.50% senior notes due December 7 after bondholders rejected a proposal to extend the maturity, according to a source close to the situation. There is no grace period for the bond repayment, and the missed payment will trigger a cross-default on other notes.
Kaisa has about US$12bn of offshore debt.
Like Evergrande, Kaisa is yet to make an official announcement about the missed payment. The company did not immediately respond to a request for comment.
Fitch on December 9 also cut Kaisa's issuer rating to RD from C. The ratings agency affirmed the senior unsecured ratings of Kaisa's bonds at C with a recovery rating of RR4.
Given the size of Evergrande and Kaisa, in terms of their property projects and debt, both visible and invisible intervention from the authorities is expected during any restructuring process to limit contagion risk, said market participants. But ultimately the default of both companies has been long expected, and the market was ready for their fall.
"The market has already anticipated the default of Evergrande and Kaisa, reflected in both the stock and bond prices," said the European bank's Greater China DCM head. "I don't think the defaults in themselves this week have much impact on the market."