(Bloomberg) — From afar, China Evergrande Group had all the makings of a killer distressed-debt trade: $19 billion in defaulted offshore bonds; $242 billion in assets; and a government that appeared determined to prop up the country’s faltering property market. So US and European hedge funds piled into the debt, envisioning big payouts to juice their returns.
What they got instead over the course of the next two years is a harsh lesson in the dangers of trying to bargain with the Communist Party. The talks are now dead — a Hong Kong court has ordered Evergrande’s liquidation, and the bonds are nearly worthless, trading in secondary markets at just 1 cent on the dollar.
In the aftermath of the Jan. 29 wind-up order, the biggest in China’s history, key players on both sides of the negotiations paint a Kafkaesque picture of endless micro-managing by unidentified government handlers that was communicated to investors through a mind-numbing maze of channels, only to then be interrupted by months-long gaps in dialogue. The last of those gaps came — to the shock of creditors — after the court’s December ruling giving the two sides one final chance to cut a deal.
Bloomberg spoke with more than a dozen people with direct knowledge of the talks for this story. All of them requested anonymity because they weren’t authorized to comment publicly about private conversations.
While global money managers have long known that the Chinese government exerts influence over corporate affairs in ways that are uncommon across the developed world, Evergrande was nonetheless a first-hand education for many of them in just how much authorities will intervene for the sake of political and economic expediency.
The 1-cent-on-the-dollar price on the bonds, they say, sends a warning to investors as other Chinese companies, including Country Garden Holdings Co., follow Evergrande into default amid an economic slump that officials have struggled to fix. And the country’s disregard for foreign creditors almost certainly means more of them will get sold for parts.
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“Investors probably did not fully appreciate the risk of state intervention,” said David Knutson, chair of The Credit Roundtable, an organization of investors that works to respond to corporate actions averse to bondholders. “Apportioning losses between domestic creditors and foreign creditors will be political.”
Of course, it’s more than just Beijing’s involvement that caused Evergrande’s bonds to crater.
The nation’s deepening property-market slump, a $7 trillion stock rout and a tepid policy response are all weighing on broader sentiment. The fact that the bulk of the company’s assets are either already seized or located not in Hong Kong but 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-bottom recovery expectations.
Representatives for Davidson Kempner and King Street declined to comment, while Contrarian Capital didn’t respond to requests seeking comment.
Among the litany of grievances raised by those close to the negotiations, almost all pointed to a lack of clarity over who was calling the shots for Evergrande.
Soon after the company’s 2021 default, a risk-management committee dominated by officials from Evergrande’s home province of Guangdong — in part made up of company executives and state-affiliated debt managers — was formed to guide the overhaul. Provincial authorities also said in that year that they would send a working group to strengthen internal controls and management of Evergrande.
Over the course of the negotiations, Evergrande representatives would sometimes refer to “Guangzhou” (the capital of Guangdong province) as responsible for vetting virtually all key decisions, yet it remained unclear to creditors which combination of entities or individuals they were alluding to.
Investors and advisers lamented not being fully aware of whose interests were being prioritized in negotiations, nor which layers of government they were dealing with.
The secretive yet omnipresent group never directly interacted with the those involved in offshore debt talks, said the people familiar. Their views were relayed to the company’s financial advisers China International Capital Corp. and Bank of China International Holdings, which would then pass information on to bondholders via a convoluted web of communications that consisted of lawyers and advisers both in Hong Kong and the mainland, the people said.
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The group could, and did, veto creditor proposals with minimal explanation, the people added.
In one example, it balked at an early offer that would’ve given offshore creditors access to the future income streams generated from Evergrande’s onshore projects. That cash instead was to be preserved for ensuring the delivery of other company projects, the people said. That reasoning wasn’t communicated to investors, who were only told the terms were not acceptable, they added.
Representatives for Evergrande, CICC, BOCI and the Guangdong government didn’t respond to requests seeking comment.
Still, early last year, Evergrande and its creditors were seemingly near an agreement to overhaul the company’s offshore debt load. Its $4.7 billion of dollar bonds due 2025 spiked as high as 11 cents.
But a series of setbacks, including weaker than expected property sales, push back from regulators and the detention of Evergrande billionaire chairman Hui Ka Yan, ultimately torpedoed a deal, fueling further frustration and leading to a significant breakdown in talks, the people said.
In early December, when a Hong Kong court gave Evergrande one last chance to strike a deal, the company’s representatives largely fell silent. Over a month went by before they finally contacted the offshore creditor group again — via email.
When they did, their proposal shocked bondholders. Not only did it do little to strengthen their offer, it crossed a number of red lines the creditor group thought were clearly laid out, people with knowledge of the situation said.
One key sticking point was the claims of a group of creditors identified as class C, which consists of some state-run banks, according to the people.
While Evergrande eventually agreed to give creditors controlling stakes in two offshore listed units’ equity — a compromise it previously refused to make, the plan would have put the foreign bondholder claims and the debt held by the banks on equal footing, shrinking the pie for the international investors, multiple people familiar said. Offshore bondholders deemed the plan particularly objectionable because class C creditors also have access to onshore assets that they have little recourse to.
A counteroffer was quickly made, and the company sent over another proposal on Jan. 29, just hours before the latest scheduled wind-up hearing.
Still, progress was scant. While heading into the hearing the creditor group was amenable to giving the company more time to work out an agreement, it neither asked for another adjournment or requested a wind-up order, the people said.
In the end, the judge overseeing the case, frustrated by the lack of progress on a deal, ordered the company’s liquidation.
‘Serious Setback’
One Evergrande adviser said that while he’s relieved the negotiations are over, how they ended has left him feeling like he wasted two years of his life. It’s a sentiment shared by many.
The company’s court-ordered liquidators from Alvarez & Marsal now begin the process of seizing and carving up the developer’s 1.74 trillion yuan ($242 billion) of assets. Yet given Hong Kong’s insolvency proceedings have limited recognition in China, creditors face an uphill battle recouping losses.
“Authorities are not likely to allow offshore claimants to secure valuable onshore assets while effectively insolvent developers struggle to meet politically tense onshore 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.”
–With assistance from Eliza Ronalds-Hannon, Erin Hudson, Dong Cao and Zheng Wu.
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