From afar, China Evergrande Group had all the makings of a deadly distressed debt trade: $19 billion in defaulted offshore bonds; $242 billion in assets; and a government that seemed determined to shore up the country’s faltering real estate market. So American and European hedge funds took on debt, imagining big payouts to boost their returns.
Instead, what they received over the course of the next two years was a harsh lesson in the dangers of attempting to negotiate with the Communist Party. The talks are now dead: Evergrande has been ordered liquidated by a Hong Kong court and the bonds are almost worthless, trading on secondary markets at just 1 cent on the dollar.
In the wake of the Jan. 29 liquidation order, the largest in Chinese history, key players on both sides of the negotiations paint a Kafkaesque picture of endless micromanagement by unnamed government officials that was communicated to investors via of a numbing message. labyrinth of channels, only to be interrupted by gaps in dialogue that last for months. The latest of those breaches came – to the surprise of creditors – after the court’s ruling in December gave the two sides one last chance to reach an agreement.
Bloomberg spoke to more than a dozen people with direct knowledge of the talks for this story. All requested anonymity because they were not authorized to comment publicly on private conversations.
While global money managers have long known that the Chinese government exerts influence over corporate affairs in ways uncommon in the developed world, Evergrande was nonetheless a first-hand education for many of them in the extent to which The authorities will intervene for political interests. and economic convenience.
They say the 1 cent per dollar price of the bonds sends a warning to investors as other Chinese companies, including Country Garden Holdings Co., follow Evergrande toward default amid an economic crisis that officials have struggled to overcome. sort out. And the country’s disdain for foreign creditors almost certainly means that more of them will be sold for pieces.
“Investors probably didn’t fully appreciate the risk of government intervention,” said David Knutson, president of The Credit Roundtable, an investor organization that works to respond to corporate actions adverse to bondholders. “Spreading losses between domestic creditors and foreign creditors will be a political issue.”
Of course, it’s more than just Beijing’s involvement that caused Evergrande bonds to tank.
The deep decline in the country’s housing market, a $7 trillion stock market crash and a lukewarm political response are weighing on broader sentiment. The fact that most of the company’s assets are already seized or located not in Hong Kong but in mainland China (potentially out of reach of bondholders including Davidson Kempner Capital Management, King Street Capital Management and Contrarian Capital Management), has also contributed to rock- lower recovery expectations.
Representatives for Davidson Kempner and King Street declined to comment, while Contrarian Capital did not respond to requests for comment.
Among the litany of complaints raised by those close to the negotiations, almost all pointed to a lack of clarity about who was making decisions in favor of Evergrande.
Shortly after the company’s 2021 default, a risk management committee dominated by officials from Evergrande’s home province of Guangdong, partly made up of company executives and state-affiliated debt managers, was formed to guide reform. . Provincial authorities also said that year they would send a task force to strengthen Evergrande’s internal controls and management.
During the course of negotiations, Evergrande representatives sometimes referred to “Guangzhou” (the capital of Guangdong province) as responsible for vetting virtually all key decisions, but creditors were unclear as to which combination of entities or individuals were referring to.
Investors and advisors regretted not being fully aware of whose interests were prioritized in the negotiations, nor what levels of government they were dealing with.
The secretive but omnipresent group never interacted directly with those involved in talks about offshore debt, people familiar with the matter said. Their opinions were relayed to the company’s financial advisors, China International Capital Corp. and Bank of China International Holdings, who would then pass information to bondholders through an intricate communications network composed of lawyers and advisors both in Hong Kong like on the continent. said the people.
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The group could and did veto creditors’ proposals with minimal explanation, the people added.
For example, it resisted an initial offer that would have given offshore creditors access to future revenue streams generated by Evergrande’s onshore projects. Instead, that cash was to be preserved to ensure the execution of the company’s other projects, the people said. That reasoning was not communicated to investors, who were only told that the terms were not acceptable, they added.
Representatives from Evergrande, CICC, BOCI and the Guangdong government did not respond to requests for comment.
Still, early last year, Evergrande and its creditors appeared close to reaching an agreement to overhaul the company’s offshore debt load. Its $4.7 billion bonds due in 2025 rose as much as 11 cents.
But a series of setbacks, including weaker-than-expected property sales, backlash from regulators and the arrest of Evergrande’s billionaire chairman Hui Ka Yan, ultimately torpedoed the deal, further fueling frustration and causing a significant rift in the conversations, the people said.
In early December, when a Hong Kong court gave Evergrande one last chance to reach a settlement, company representatives were largely silent. More than a month passed before they finally contacted the offshore creditor group again, via email.
When they did, their proposal surprised bondholders. Not only did he do little to strengthen his offer, he crossed a number of red lines that the creditor group believed were clearly established, people with knowledge of the situation said.
A key point was the claims of a group of creditors identified as class C, which is made up of some state banks, according to the people.
While Evergrande eventually agreed to give creditors controlling equity stakes in two foreign-listed units (a commitment it previously refused to make), the plan would have put the claims of foreign bondholders and debt in power. of the banks on an equal footing, reducing the pie for international investors, said several people familiar with the matter. Offshore bondholders found the plan particularly objectionable because Class C creditors also have access to local assets for which they have little recourse.
A counteroffer was quickly made and the company submitted another proposal on January 29, just hours before the last scheduled liquidation hearing.
Even so, progress was limited. While before the hearing, the creditor group was willing to give the company more time to reach a deal, it did not ask for another adjournment or seek a liquidation order, the people said.
In the end, the judge handling the case, frustrated by the lack of progress on the agreement, ordered the liquidation of the company.
‘Serious setback’
An Evergrande adviser said that while they are relieved that the negotiations are over, the way they ended made them feel like they had wasted two years of their life. It is a feeling shared by many.
Alvarez & Marsal’s court-ordered liquidators now begin the process of seizing and distributing the developer’s 1.74 trillion yuan ($242 billion) in assets, more than 90% of which are located in mainland China. However, with Hong Kong insolvency proceedings having limited recognition in China, creditors face an uphill battle to recover losses.
“Authorities are unlikely to allow offshore claimants to secure valuable onshore assets while effectively insolvent developers struggle to meet politically fraught domestic obligations,” said Brock Silvers, managing director at private equity firm Kaiyuan Capital. “This is a serious setback for China’s still-developing credit markets and can only exacerbate declining market sentiment as foreign capital increasingly seeks lower-risk outlets.”
