New foundations

Creditors’ approval of Sunac China Holdings’ workout plan provides some much-needed good news for the China property sector, but it won’t necessarily help break the impasse in restructuring talks at other developers.

Sunac won the green light from creditors to restructure around US$10bn in principal amount of its offshore bonds into new notes, convertible bonds and shares of its Hong Kong-listed property services firm. That multi-part solution hints at how complicated it will be for other developers to reach a compromise between giving creditors a reasonable amount of value and cutting debt in the capital structure.

When in 2015 Kaisa Group Holdings became the first Chinese property company to default offshore, the restructuring was reasonably painless. The market was still booming and the developer had only defaulted because it found a huge hole in its balance sheet caused by former employees’ apparently fraudulent transactions.

Creditors didn’t even have to accept a haircut on principal. They swapped their old paper for payment-in-kind notes with contingent value rights, giving them an implied recovery rate of 80 cents in the dollar, and saw the paper surge in the aftermarket. The company was soon flush with cash again and took out the restructured bonds with a tender and exchange offer within a year.

These days, terming out debt won’t be enough to keep companies alive and creditors won’t avoid a haircut. No one expects a recovery rate of 80 cents in the dollar; most creditors today would be happy with half that.

Debt-to-equity swaps used to carry a certain stigma in the Chinese market, until industrial park developer China Fortune Land Development in January became the first Chinese real estate company to use the mechanism in its US$5bn offshore workout.

It also came up with a way to make it easier for offshore creditors to receive exposure to onshore equity, by giving them new bonds that can be swapped for shares in a property trust and a special purpose vehicle holding its other businesses.

While China Fortune Land’s business is quite different to the residential property focus of most of China’s distressed developers, that restructuring helped pave the way for Sunac.

China Evergrande Group and Fantasia Holdings Group are also proposing to swap debt for equity, but after winning early support from bondholders their proposals have not yet crossed the finish line, with Evergrande’s creditor votes rescheduled to next month. Sunac’s success won’t necessarily make it more likely that other developers will reach agreement on similar terms.

The trouble is that there are so many property companies in distress – the default rate among Chinese developers’ bonds is over 50% – and each has a different corporate profile and set of circumstances. Creditors, who may be involved in talks with more than one company or simply hear about developments on the grapevine, could find out about a better deal being proposed by a rival developer and threaten to withdraw their support for the current plan unless it is sweetened.

The uncertain outlook for the property market also has an impact. Some creditors, considering whether to accept a haircut in exchange for potential equity upside, may be looking at the anaemic market and thinking that they are unlikely to see any share price gains. Developers may be inclined to stall and hope that the government unveils policies to support the property sector.

Companies also need to balance what they offer their offshore and onshore creditors, given that onshore creditors are in a much better bargaining position and closer to the assets.

In addition, objectives may differ even among offshore investors. A vulture fund that swooped on distressed bonds at five cents in the dollar will want to cash out its gains as soon as possible, while a buy-and-hold investor that bought the bonds at par may be reluctant to bite the bullet and crystallise its losses.

The sheer number of developers in dire financial straits and the continued struggles of the sector in the only area that really matters – selling properties – means that restructurings will rumble on for the next year or two.

The only way companies and creditors will really know whether Sunac’s workout is a template worth following is if it returns to profitability.