After Fitch Ratings downgraded China Evergrande and some of its subsidiaries to “Restricted Default” status on Thursday, there was for the first time, widespread acknowledgement of the Chinese property giant’s failure to meet its debt obligations.
“The downgrades reflect the non-payment of coupons due 6 November 2021 for Tianji’s USD645 million 13% bonds and USD590 million 13.75% bonds after the grace period lapsed on 6 December. The non-payment is consistent with an ‘RD’ rating, signifying the uncured expiry of any applicable grace period, cure period or default forbearance period following a payment default on a material financial obligation,” Fitch wrote.
This acknowledgement was a long time coming.
For months investors had been forced to rely on the validity of anonymous sources who claimed, via respected publications, that Evergrande had been making good on bond coupon payments at the very last minute – and staving off default.
It happened (maybe for the final time) last month when, at the expiration of a 30-day grace period on three missed bond coupon payments worth a total of US$148.2 million, anonymous sources were quoted by Reuters and Bloomberg claiming bondholders had received payments.
There was not any official confirmation from Evergrande or bondholders. This same playbook had been used as multiple debt payment deadlines passed during 2021.
But now, is the game up for China Evergrande? Has the can been kicked to end of the road?
The Fitch Ratings downgrade comes just days after S&P Global said “default looks inevitable for Evergrande” and in the coming days its expected the other “big 3” global ratings agency, Moodys, will also move on downgrading Evergrande.
What’s next for China Evergrande?
While Evergrande has officially been labelled a defaulter by one of the world’s most respected and most powerful ratings agencies, the company is yet to default in any offical legal sense.
From here, if Evergrande’s directors respect and acknowledge Fitch Ratings’ view, the next step would be for them to file for insolvency, which would see the company liquidated.
China Evergrande Group is headquartered in China, but incorporated in the Cayman Islands. So the process would be bound by Cayman Island Common Law.
Under Cayman Islands Common Law, company directors have a Fiduciary Duty which means they must act in good faith and in the best interests of the company.
This is what top global law firm Conyers says about the duty of directors of Cayman Islands incorporated companies which are insolvent or nearing insolvency:
“Directors do not owe a duty to creditors while the company is solvent. However, such a duty arises if the company is insolvent or near insolvency. When a company is nearing insolvency, the interests of the company become synonymous with the interests of its creditors. In other words, in such circumstances the interests of the shareholders are subordinated to the interests of the creditors and the directors have a duty to shift their focus to ensuring that any decision made is not necessarily in the company’s interest but must be in the interest of the creditors’ (as a general body).”
In short, if Evergrande’s directors do not believe there is a reasonable prospect that the company can avoid debt defaults and thus, insolvency, they must act to liquidate the company in order to return some capital to creditors.
On the other hand, creditors, emboldened by the Fitch downgrade may force legal action upon the company by initiating bankruptcy proceedings.
Should Evergrande be liquidated in the event of a formal default, some experts have predicted bondholders would be paid only around 5% of their claims. So the question is, do large creditors even want insolvency just yet if they too can continue to kick the can down the road?
To many observers though, Evergrande attempts to free up cash throughout 2021 have been seen as liquidation by stealth.
These efforts have involved selling private jets and mansions, along with the sale of subsidiaries.
The international bondholders forced to write-off billions
Despite there being no formal insolvency proceeding initiated by major bondholders or Evergrande itself, Dr Marco Metzler, an outspoken critic of Evergrande and the management its bonds has named five large global financial institutions that he says will be forced to write-off some $23 billion as a result of the Fitch downgrade.
“Companies like BlackRock, Ashmore Group, Allianz, HSBC or UBS own the most bonds,” says Metzler.
“It is also striking that although Chinese real estate giants have been in crisis for a long time, those funds bought additional securities even shortly before Evergrande’s insolvency. BlackRock’s portfolio (Asian High Yield Bond Fund), for example, saw a net addition of 31.3m shares in Evergrande bonds between January and August 2021. The fund holds 1% of its portfolio assets in Evergrande.
“Between January and July, HSBC increased its holdings in Evergrande bonds by a full 40%. The UBS Asian high-yield bond fund reduced its exposure to Evergrande by 0.09 percentage points, but the number of shares rose by 25% in May.
“And Allianz Dynamic Asian High Yield Bond also had a higher weighting of Evergrande of 2.56% at the end of July.”
December debt deadlines
The debt deadlines continue for Evergrande this month, with two key coupon payments due on December 28.
One of them is the Group’s largest offshore bond coupon payment of the year – a $204.8 million coupon on a 2025 bond.
The other is a $50.4 million coupon due on a 2023 bond. Both, totalling $255.2 million, have 30-day grace periods attached.
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