Since October 2021, the Chinese real estate sector has seen over US$50 billion worth of defaults due to market downturn, financing disruption and other external factors. This has pushed the rolling 12-month default rate of China high yield properties to more than 50 percent. So what happens before and after a default? Some of you who serve as financial advisors to debt holders and corporates may be familiar with the whole process, but let’s go through it from the view of a buy-side, and perhaps it will reveal interesting career prospects for some.
The market usually smells something before a corporate shows any sign of trouble, which is often reflected in the price of its securities (bonds, equities and even loans). While financial statements may show deterioration of the financial health of the company on a gradual basis, this wave of defaults is more abrupt and driven by external factors.
The negotiation process can be as quick as a few weeks or as long as a few years, and there could be multiple parties involved. Financial advisors are often hired by the company and debt holders during the negotiation and restructuring process, and accountants are hired to dig into the financial matters of the company to determine the financial basis to a deal and transaction. Obviously, financial advisors from both sides can come to very different conclusions as their respective duties to the parties are different. Financial advisors of the issuer, in working together with the issuer and its lawyers, will formulate a restructuring plan to the debt holders. Debt holders will usually be represented by a debt restructuring committee (or an ad hoc committee) to negotiate, block, and propose new terms in an event where the issuer’s proposed terms are bad or unfair. A Chinese property company that defaulted in 2014 is a recent example that went through the debt restructuring process. During the final stages of debt restructuring talks, while a deal was almost finalized with one ad hoc committee, another big ticket investor came forward with a better recovery plan to block the first plan. Debt holders obviously chose the better plan in the end.
The worst case scenario is when both parties cannot reach a deal (or that there is no sign of a breakthrough), debt holders may force or threaten the company to go through a liquidation process. Debt holders will usually ask the court to appoint a financial advisor to act in the capacity of a liquidator. The liquidator will go through a list of assets and assess debt rankings, and will subsequently sell assets and distribute the payments received to debt holders after fees. Many debt-laden Chinese developers have multiple projects in different provinces and cities, some are wholly-owned and some are joint ventures with other parties (who may have also defaulted). This would complicate the whole liquidation process. A major Chinese company defaulted on its debt obligation of more than US$4 billion in 1998. The whole liquidation process lasted close to 20 years. Debt holders (who by then were claim holders) did not receive their final distributions until 20 years from its collapse, and only then would equity holders receive any residual value. In an ideal world, neither equity nor debt holders want to go through the liquidation process as value is further eroded by time and fees. In the eyes of an equity holder, this process would only be accepted if they see the business as no longer viable even after a debt restructuring and want to refrain from further liabilities.
With the changing landscape in the market, it will be difficult for the sector and the Chinese real estate high yield market to return to its glory days. However, issuers and debt holders need to work on a deal acceptable by all parties. This is why debt restructuring financial advisory has emerged as a hot business right now, as is distressed debt investing. There are plenty of opportunities in both areas, and what has been shared here is only a tiny spectrum of the market and process.
About the webinar
The Institute’s Mainland Business Interest Group, and Property, Infrastructure and Construction Interest Group are jointly organizing the e-learning webinar on 27 June, titled “Debt restructuring of Chinese/Asian companies with offshore debt,” which will be presented from the buy-side’s perspective, and discuss what happens in a debt restructuring; how the market views the default and debt restructuring; and the future of this market for anyone who is interested in this avenue.
Alex Liu is Head of Fixed Income Research and Director, Taikang Asset Management (Hong Kong) Co. Ltd. Liu has over 15 years of experience in investment and research, and he possesses extensive experience in various fixed income products including loans trading, securitized products and principal protected notes. Currently, he is a CFA, AICPA member and a certified ESG analyst.