Evergrande favours domestic investors as default looms

Offshore bondholders last in line behind households, suppliers, local creditors

Caption courtesy by Nikkei Asia

By guest author Narayaynan Somasujndaram, Nikkei Asia regional finance editor.

China Evergrande has announced that it will make interest payments on domestically issued bonds, even as the property developer teeters on the brink of a dollar debt default, deepening suspicions among offshore investors that they will be last in line for repayment.

Hengda, Evergrande’s primary unit on the mainland, said in a statement late Friday that it will pay coupons worth 121.8 million yuan (USD 19 million) on its October 2025 bond, which comes due Tuesday. That contrasts with the company’s failure to meet three rounds of bond interest payments in the offshore market totalling USD 277 million since late September. The official deadline for the company to be declared in default comes this week.

“Earlier this year, fearing a situation similar to what we are seeing now, we began selling out our dollar bond exposure to Evergrande,” said a portfolio manager at a global fund. “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.”

The fund manager declined to be named, citing the fund’s policy of not commenting on individual companies.

While Evergrande’s approach to dealing with the biggest crisis in its two decades of existence may not be shocking to offshore investors, it has spurred them to band together and form a creditors committee to protect their rights. Evergrande has a little over USD 20 billion in outstanding offshore bonds, representing 6.7% of its total balance sheet liabilities of USD 300 billion.

The apparent prioritization of local bondholders over their offshore peers has made “some upset,” said Travis Lundy, an analyst at Quiddity Advisors, which publishes on the SmartKarma platform. He argues, however, that payments to onshore bondholders should be seen as a positive sign.

“The two issuers are separate. Bondholders of Evergrande have access to 60% of the residual equity of Hengda, not to funds which pay bondholders,” he said referring to the developer’s stake in the unit. “Bondholders should, if anything, be happy that Hengda is paying its coupons, which means that Hengda’s shareholders are still alive.”

Evergrande, which has already missed payments to banks, retail creditors and suppliers, leading to the suspension of more than half its 800 ongoing projects on the mainland, has so far maintained silence on its dollar bond liabilities and refused to meaningfully engage with creditors.

Evergrande is trying to sell assets, such as its stake in its electric vehicle unit, a property management subsidiary and its Hong Kong headquarters, to raise funds. However, some of these initiatives have run into hurdles, with REDD Intelligence saying Tuesday that a plan to sell a majority stake in Evergrande Property Services to rival Hopson Development has been suspended. Reuters reported last week that the sale of the developer’s Hong Kong offices had also fallen through.

The company’s shares, which have been suspended since the beginning of October, have lost four-fifths of their value this year and its offshore bonds are quoting at around 20 cents on the dollar, indicating investors are certain that a default or a restructuring is on the horizon.

Evergrande’s creditors, by order of repayment, are households, which have contributed 54% of the developer’s funding by prepaying for homes; suppliers, who make up 43% of the company’s liabilities; followed by retail creditors who provided funds through wealth-management products; banks; and finally bondholders, according to analysts.

“All in all, Evergrande has many stakeholders and creditors, but not all are equal,” said Alicia Garcia Herrero, chief economist for the Asia-Pacific at Natixis. “Offshore bondholders seem to be the last in the queue.”

Besides the government’s focus on safeguarding households and suppliers to prevent a financial panic, offshore holders have legal hurdles to overcome: Under Chinese rules, mainland companies can guarantee their units’ offshore debt only after they complete a registration and approval process.

To get around this requirement, some companies raise debt through an offshore vehicle, with the mainland business issuing so-called keepwell deeds — an undertaking to bondholders that the parent will ensure the offshore vehicle’s solvency. However, the structure does not guarantee repayment.

Evergrande began using this structure about four years ago, according to its bond offering prospectus.

Chinese courts have broad discretion over whether to enforce a keep well agreement, based on the public interest.

Evergrande faces a further USD 573 million in bond coupon payments this year and USD 7.7 billion in bond redemptions next year.

Some offshore bondholders have engaged law firms and advisers to protect their interests. Law firm Kirkland & Ellis, and investment bank Moelis, on behalf of investors holding USD 5 billion of Evergrande debt, say they have reached out to the developer seeking information on the company’s financial situation and assurances that offshore assets will not be sold off while negotiations to reclaim the bond coupons are ongoing.

Contact with Evergrande was initiated before the first missed bond interest payment, but the advisers have had no “meaningful contact” as yet, they said in a call with bondholders this month.

“What we don’t want is to have a situation where so-called offshore assets are being monetiSed in some way, and the value of those assets being leaked to other parties, whether that be onshore or elsewhere,” Neil McDonald, a restructuring partner at Kirkland & Ellis, said during the call.