More liquidations of Chinese developers are expected after the liquidation of China Evergrande Group in Hong Kong's High Court. The liquidation of the world’s most indebted property developer has set a benchmark for future liquidations and will raise the cost of offshore financing by Chinese developers, according to market experts.
The Hong Kong-listed firm, once the biggest Chinese property developer by revenue, defaulted in December 2021.
Other Chinese companies with assets in China, including the developers Logan Group and Kaisa Group, are also facing winding-up demands in Hong Kong courts, and more are expected in the coming months, said Marco Metzler, a German entrepreneur, said on his Linkedin account on January 30.
The liquidation of Evergrande is credit negative for the broader property sector of Greater China, as it will weaken already-fragile investor and market sentiment, said a Moody’s report on January 30. “It reinforces our view that the Chinese government will choose to resolve such debt issues via commercial channels rather than bail out companies. It also increases the possibility of more cases of liquidation of distressed developers in the future.”
Rationale
Justice Linda Chan ordered the liquidation of Evergrande at the Hong Kong High Court on January 29.
Evergrande has not demonstrated any useful purpose for the court to adjourn the petition to wind it up, said Justice Chan. “There is no restructuring proposal, let alone a viable proposal which has the support of the requisite majorities of the creditors. To the contrary, it seems to me that the interests of the creditors will be better protected if the company is wound up by the court, so that independent liquidators can take control over the company, secure and preserve its assets and review and formulate a restructuring proposal if they consider that such course is appropriate.”
“This has the additional advantage of putting the company out of the control of [founding chairman] Hui, which had hitherto been one of the regulatory hurdles preventing the company from issuing new debt instruments or new shares,” she added.
In September 2023, Hui Ka Yan, the founding chairman of Evergrande, was detained by Chinese authorities on suspicion of having committed crimes, FinanceAsia reported on October 3, 2023.
The offshore bonds issued by Evergrande and its subsidiary, Scenery Journey, total $19.5 billion, according to Justice Chan’s judgement. Evergrande’s main subsidiary, Hengda Real Estate Group, has issued onshore corporate bonds in mainland China totaling Rmb53.5 billion ($8 billion), according to Chan.
“It is indisputable that the company is grossly insolvent and is unable to pay its debts,” said Justice Chan.
According to Evergrande’s 2023 interim report, as at June 30, 2023, the company had total assets of Rmb1.74 trillion, less than its total liabilities of Rmb2.38 trillion ($335 billion).
“We find that in-court cash recovery rates average 2.8% in offshore default cases involving Chinese developers. The recovery rate on onshore defaults for the same issuer type is 8.3%. We fully expect a similar gap in recovery rates to play out in the Evergrande liquidation,” said an S&P Global report on January 31.
"We assume offshore bondholders (of Evergrande) will get a few cents on the dollar once the liquidation plays out. Moreover, they will likely yet have to wait years even for this thin payout," said Chang Li, S&P Global Ratings' China corporates specialist.
"Evergrande's offshore liquidation will set a benchmark for other workouts involving other defaulted Chinese property firms. If recovered values are low, as we expect, it will set a significant reference point," said S&P Global ratings credit analyst Esther Liu.
Asset recovery
In the wake of Evergrande’s liquidation, Chinese companies will find it more expensive and harder to raise overseas financing, Alicia Garcia-Herrero, the chief Apac economist at Natixis, told FA.
Potential investors in the foreign bonds of Chinese companies will fear that these companies may not have access to their assets in mainland China should they default, Garcia-Herrero explained.
The bulk of Evergrande’s assets and liabilities are in mainland China, outside the purview of the Hong Kong court, said Liu.
“My predictions for the next weeks are that the liquidator Alvarez & Marsal will not be able to get hold of the assets in mainland China and will discover that the best assets have been sold in a fire sale to selected creditors,” said Metzler.
Evergrande needs to deliver hundreds of thousands of presold homes to its customers in mainland China, said the S&P report. Chinese authorities have prioritised this target and won't likely let a liquidation stall project construction, the report added. The liquidated company can only get repaid by extracting cash flow from the onshore entities in mainland China, the S&P report explained.
“In another complication, an agreement struck in 2021 to mutually recognise liquidation orders between mainland China and Hong Kong may not apply to Evergrande. Most of its assets are not in the three mainland China pilot cities (Shanghai, Xiamen, and Shenzhen). Moreover, the offshore parent -- as a shareholder--will only be paid after the onshore creditors in terms of repayment ranking when liquidating the onshore entities,” the S&P report said.
There is substantial legal and execution risk when trying to extract value from the onshore entities, the S&P report warned. Evergrande has 1,200-plus project companies, the S&P report pointed out. “The likely upshot of all this is a low recovery rate for those holding Evergrande's offshore debt: the dollar bond investors.”
Evergrande’s liquidation in Hong Kong is the way the Western system operates, whereas the Chinese system seems to keep zombie companies alive because of non-financial considerations, a Singapore businesswoman who declined to be named told FA.
China / HK
Coincidentally, on the same date as the judgment on Evergrande’s liquidation, a new law came into force in Hong Kong permitting certain judgments in the city to be enforced in mainland China and vice versa, Basil Hwang, managing partner and founder of Hauzen, a Hong Kong law firm, told FA.
While the new legislation does not currently include insolvency judgments, a 2021 agreement between the Chinese Supreme People’s Court and the Hong Kong Justice Secretary allows courts in the mainland cities of Shanghai, Xiamen and Shenzhen to assist Hong Kong insolvency proceedings, Hwang said. This 2021 agreement could be helpful in Evergrande’s case as the company was formerly headquartered in Shenzhen, he added. Evergrande’s headquarters is presently in Guangzhou, the capital of Guangdong province.
"The liquidation of Evergrande by a Hong Kong court marks the symbolic end to property's dominance of the Chinese economy. It ensures a cleaner break from the issues dragging on growth, allowing policymakers to focus on revitalising the economy in 2024,” Diana Choyleva, the chief economist and founder of Enodo Economics, a UK macroeconomic and political consultancy, told FA.
“With Beijing having repeatedly blocked Evergrande’s proposed restructuring plans, the outcome appears to have the central government’s tacit approval. Moreover, it is necessary in the broader context of rectifying the imbalances within China's property sector,” Choyleva said.
“In the short-term, the decision may worsen home-buyer and investor sentiment, as long-held hopes for a bailout finally disappear. But with a conclusion to the almost three-year long saga now on the horizon, Beijing can focus on introducing new policies to stabilise the Chinese property market,” she added.
