China is close to reaching agreement with government on debt restructuring

China is close to reaching agreement with government on debt restructuring

The logo of China Evergrande is visible out at the China Evergrande Centre building in Hong Kong.

China Evergrande Group has agreed to settle interest payments on a debt-laden bond, while the central bank has injected cash into the banking system, cooling fears of imminent contagion from the debt-laden property developer.

In my opinion, it shows they are closer to reaching an agreement with the government as to how they should go about this managed restructuring.

Two Wealth Management products are for two reasons. Of course it's a grey area and we don't have visibility as to how big the risks could be in that sphere. More importantly it has translated into quite a bit of social unrest. We've seen protesters gather outside of Evergrande's headquarters over the past couple of months over unpaid income management products.

It signals in my opinion that they are closer to being in a position where they have an agreement on how they should manage the situation. We think there are two parts to this: One, the nature of investors and two, how far investors sit from the assets.

Assuming this situation goes the way of a debt restructuring we think the social investor nature of the wealth management products WMP will be prioritised for retail stability.

This is particularly notably as we understand that the media reported that WMP investors also consist of employees of the company. In our view, this would be despite the actual legal standing of WMPs. It is still unclear to us on the exact terms of such products for example: whether such products are outright guaranteed by Evergande development projects We did not find much disclosures about the WMP in the company's audited financials.

In regards to the bonds denominated in dollars, this is what offshore bondholders generally invest in dollar bonds which are issued from offshore entities that sit further away from the assets located in China and would be subordinated to lenders onshore. Being close to assets would mean lower bargaining power versus other lenders more close to assets, particularly lenders with direct claims on assets.

Aside from this, we would imagine many of the holders of the dollar is distributed by sophisticated investors, where matters at Evergrande have been well telegraphed for at least a few months now leading up to its current bout of liquidity stress. Wealth management products are marketed to retail investors, and there is likely political pressure on the company to ensure a fair settlement. On the other hand, professional investors in bond bonds are expected to have done their due diligence and therefore see no special treatment.

The priority of creditors in a restructure should not be impacted and will depend on legal clauses on bonds and wealth products. China's leadership is likely to be aware of the seriousness of the situation. The idea could be to break up Evergrande Group. Evergrande is already selling its good bits. In this way, the government is continuing on its already chosen path of breaking up monopoly structures in the real estate market as well.

We assume that the Chinese leadership will intervene, but attention will be paid to the exact form it takes. The authorities will try to bring the failure of Evergrande to break down other groups to keep liquidity in market. At the same time Beijing is likely to try to protect private property buyers who have already paid for their flats and are paying mortgage payments but are waiting for completion. The government is therefore likely to conclude the completion of real estate projects.

The sale to private companies has already failed. It is conceivable that interventions will be made through the central government of Guangdong instead of provincial government. The greatest damage would thus fall to the creditors.

A major impact would be a long and severe slump in property prices and sales. This must be averted. In the short term, China could deviate from its own course of cooling the real estate market through stricter lending. LONG CHEN, partner in the firm Plenum, an independent research platform, for independent research in Beijing.

Over the past three years, China has experienced numerous bankruptcies and corporate bankruptcies. The financial risks from Evergrande do not look much bigger than those in Baoshang Bank or HNA failures. Evergrande's dollar bond is trading at below 30 c so it is not a surprise that there is a default as of yet. The top job is to get the apartments built, and the government has multiple options to get that done. It is equally important to prevent a nationwide property collapse and that requires a shift of policies, which are often too hawkish at the moment.

Nobody is interested in bailing out Evergrande, but nobody wants to get involved in a crisis either. The moment Beijing falls, the easier it will be for Evergrande to ease political policy. To put it this way: it will be more like a 'whatever it takes' moment than a Lehman moment.