Kaisa and Others Hope for a Miracle but Learn that Magic Does Not Exist

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Kaisa Developments

The recent financial crisis of Kaisa Group Holdings Ltd. (“Kaisa”), a large-scale Chinese1 property developer listed on the Hong Kong Stock Exchange (“SEHK”), continues to be in the headlines. The developer has seen its cash flow quickly evaporate while debts have soared after the Shenzhen Government imposed a sales ban on its projects in early December 2014. Kaisa is also reportedly under investigation amid China’s anti-graft crackdown. In February 2015, Sunac China Holdings Limited (“Sunac China”), a Tianjin-headquartered luxury property developer listed on the SEHK, had agreed to acquire Kaisa’s equity interests in, and the shareholders’ loans to, four prime property projects in Shanghai and a 49.25% stake in Kaisa, subject to certain conditions, including the restructuring of debt and removal of the sales ban. To comply with these conditions, since February 2015 Kaisa has been negotiating its debt restructuring plans with offshore2 and onshore lenders as well as the terms of refinancing its loans with HSBC and ICBC. However, no definite agreement has been reached yet. For more details on the Kaisa–Sunac China transaction, Kaisa’s offshore debt restructuring plan and prior developments in the PRC property market, see our article “Half-Pie or No Pie? News for Kaisa’s Offshore Creditors”.

“If creditors do not cooperate, the deal will not go through and we will surely give up,” said Sunac China’s chairman. “The possibility [of a successful deal] is diminishing as Kaisa is now in a much worse situation than we expected,” he added. Kaisa had US$2.5 billion in offshore debt and US$7.6 billion in domestic debt at the end of 2014.3 Standard & Poor’s has downgraded Kaisa’s long-term credit rating to “D” from “SD”.4

Kaisa said that, as of April 7, 2015, a total of 70 applications in relation to the preservation of assets under onshore loans have been filed by creditors against it with the relevant PRC courts. Of those, the courts have made 28 rulings, totaling approximately RMB 14.8 billion (equivalent to5 approximately US$2.4 billion). Kaisa said it intended to resolve the civil rulings through amicable negotiations.6 Sunac China, meanwhile, had been trying to delay the legal cases which would push Kaisa to the brink of liquidation once they start.7 “Every project is used as collateral to multiple banks – 24 in one extreme case. So 24 banks have applied to freeze the same project,” Sunac China’s chairman said.8

On March 31, 2015, Kaisa announced that it will delay the publication of its 2014 annual results. The reason for the delay, according to Kaisa, is that its “auditors require more time to ascertain the cash flow position and carry out additional work in order to finalize the audit of the consolidated financial statements of Kaisa as a result of Kaisa’s latest situation including the liquidity position”.9 Kaisa’s board decided not to publish its 2014 unaudited management accounts, as it is expected that there would be significant adjustments, and the accounts do not truly and fairly reflect the financial performance and position of Kaisa. Trading in Kaisa’s shares has been suspended since March 31, 2015 and will remain suspended until the publication of its 2014 annual results.10

In early April 2015, authorities in Shenzhen started to lift their unprecedented sales ban imposed on Kaisa’s projects about four months before. Kaisa announced that the blockage on most of its unsold units in the completed and uncompleted projects has been released. However, some units remain subject to freezing orders imposed by local courts in the PRC and, therefore, are still not saleable.11 Neither the government nor the developer has explained the latest change, just as they have never said why the restriction was imposed.12 This, however, does not make a difference to offshore creditors, as they still have no access to Kaisa’s assets, inferior to onshore creditors, as noted by Standard & Poor’s analyst.13

In early April 2015, Kaisa also obtained a two-year RMB 1.4 billion (equivalent to approximately US$0.2 billion) loan from Shenzhen Fund Resources Investment, a wholly-owned subsidiary of Funde Sino Life Insurance Company Limited, Kaisa’s second-largest shareholder, to finance a land site in Shenzhen it bought in 2014.14

Kwok Ying Shing, who resigned as Kaisa’s executive director and the chairman of its board on December 31, 2014, returned to the post on April 13, 2015. Kwok Ying Shing, together with his two brothers, are Kaisa’s controlling shareholders.15

The aforementioned news on removal of the sales restriction, access to a new loan and Kwok Ying Shing’s return were received by the market as positive, but only in the short term. “Going forward, concerns about debt stress will arise again. The market is reading [the news] as the Kwok family getting on well with the local government again. Who knows?” one expert said. “More legal actions will be taken [if Kaisa misses the deadline for payment of interest on its offshore bonds again] and Sunac [China] will officially walk away if they want and give up,” he added.16

Shortly after this good news, Kaisa’s public float fell to approximately 20.81%, below the minimum SEHK requirement of 25%. Kaisa said its financial advisor on the debt restructuring will assist Kaisa in assessing various options.17

On April 20, 2015, Kaisa announced that it failed to make the interest payment of US$16.1 million due on March 18, 2015 on its US$250 million 12.875% senior notes due 2017 and the interest payment of US$35.5 million due on March 19, 2015 on its US$550 million 8.875% senior notes due 2018 within the grace period of 30 days after the said due dates. Kaisa said it is focusing on the release of its 2014 audited financial results, following which it will continue trying to reach a consensus on the restructuring of its outstanding debts and hopes to enter into standstill agreements with offshore debt holders soon.18 Kaisa, therefore, became the first Chinese property giant to default on its offshore bonds and China’s third debt defaulter after the solar panel manufacturer Shanghai Chaori Solar Energy Science & Technology19 and the internet firm Cloud Live Technology Group.20 As China’s economy slows down and the Central Government shows a new tolerance to allow isolated corporate defaults, bond defaults are expected to increase.21

Developments in the PRC Property Market

The PRC property market is under a record high destocking pressure.22 According to the data from domestically listed property firms, their destocking period was now close to historical highs set in 2008 and 2011, when the property market was also in a downward cycle. In 2008, some developers that are now among the industry’s top players were just a few months away from going bankrupt. But the Central Government’s multitrillion-yuan stimulus package saved them when it was introduced in the wake of the global financial crisis.23 An industry downturn and the anti-graft crackdown have already pushed developers to the verge of bankruptcy. Others worrying about their own mortality are keeping more cash in hand, extending debt maturities and cutting land acquisition budgets.

An economic slowdown and a raft of cooling measures have focused investor attention on the high levels of debt that developers took on to build projects that were not sold. China’s property sales in the first two months of 2015 recorded the largest decrease over the past three years amid a housing supply glut and slower property investment.24

Evergrande Real Estate Group Limited (“Evergrande”), China’s fourth-largest, and one of the most indebted, property developers listed on the SEHK, has cut leverage on its balance sheet over the past two years to a third by classifying some of it as equity, according to analysts’ calculations based on its public filings. Evergrande is seeking an additional funding to expand, and a lower proportion of debt to equity makes it easier and less costly for it to borrow. In Evergrande’s 2014 earnings report, published on March 30, 2014, its net debt-to-equity ratio was 85.9%. If perpetuals were classified as debt, that figure jumps to 292%, according to Barclays. The developer also increased fair value gains on some of its properties, according to the filings.25

The accounting treatments, even though legal, can effectively mask the amount of debt a company actually holds and in Evergrande’s case, they may obscure how highly leveraged it is, analysts say. Excessive leverage is not a problem as long as the developer manages debt payments and credit markets remain liquid, but analysts say it has a small margin of error if markets dry up or lose momentum or if it runs into liquidity issues. “Evergrande needs to rely on short-term loans such as bank and trust lending to refinance when the short-term debt matures. This is risky capital management because banks loosen and tighten lending from time to time and it’s unpredictable,” said Moody’s Investors Service.26

Evergrande reported that its gross debt rose 43% to around RMB 156.0 billion (equivalent to approximately US$25.1 billion) at the end of 2014, and concerns about its leverage have led to speculative-grade ratings from Moody’s and Fitch. Independent financial analysts CreditSights, which classifies perpetuals as debt, says Evergrande’s 2014 debt was 11.7 times earnings before interest, taxes, depreciation and amortization (EBITDA), meaning it would take 11.7 years to repay based on its current cash flow. Among developers, Evergrande has been particularly hard hit with most of its projects in less developed cities, where home prices have had some of the biggest drops. It has also borrowed heavily to diversify into food, energy and sports: it finances the Guangzhou Evergrande Taobao soccer club along with e-commerce giant Alibaba.27

Some developers, however, like Sunac China, see opportunities in the current market situation and a chance to expand via acquisitions. As its chairman said, “There will still be more merger and acquisition opportunities in the future as economic growth slows and some highly leveraged companies [land in trouble].28

First State-owned Corporate Bond Default

Meanwhile, Baoding Tianwei Group Co., China’s state-owned power-transformer maker, has failed to make a scheduled RMB 85.5 million (equivalent to approximately US$ 13.8 million) interest payment due on April 20, 2015 on its RMB 1.5 billion onshore bonds issued in April 2011 and became China’s first state-owned company to default on an onshore bond. Although it is early days and it is still unclear whether the payment will be made, commentators are predicting it may be the start of more defaults in China as a result of the economic slowdown.29

1   “China” or the “PRC” in this article refers to the People’s Republic of China, excluding Hong Kong, Macau and Taiwan.
2   “Offshore” in this article refers to the jurisdiction outside of the PRC, and “onshore”, accordingly, refers to the jurisdiction of the PRC.
3   “Kaisa’s woes persist despite removal of Shenzhen sales ban” by Langi Chiang, South China Morning Post, April 7, 2015.
4   “China’s Kaisa will die soon if creditors ‘do not cooperate,’ Sunac warns” by Langi Chiang, South China Morning Post, March 24, 2015.
5   All exchange rates in this article are as of April 27, 2015.
6   Kaisa Group Holdings Ltd. “Recent Developments of the Company” dated April 9, 2015: http://www.hkex.com.hk/eng/csm/ShowNews.asp?mkt=hk&FileName=http://www.hkexnews.hk/listedco/listconews/sehk/2015/0409/LTN20150409051.pdf 
7   See footnote 4.
8   See footnote 4.
9   Kaisa Group Holdings Ltd. “Delay in Publication of the 2014 Annual Results Announcement Postponement of Board Meeting and Suspension of Trading” dated March 31, 2015: http://www.hkex.com.hk/eng/csm/ShowNews.asp?mkt=hk&FileName=http://www.hkexnews.hk/listedco/listconews/sehk/2015/0331/LTN20150331215.PDF
10  See footnote 9.
11  See footnote 6.
12  See footnotes 3 and 6.
13  See footnote 3.
14  Kaisa Group Holdings Ltd. “Major and Connected Transaction – Provision of Financial Assistance” dated April 9, 2015: http://www.hkex.com.hk/eng/csm/ShowNews.asp?mkt=hk&FileName=http://www.hkexnews.hk/listedco/listconews/sehk/2015/0409/LTN20150409971.pdf
15  Kaisa Group Holdings Ltd. “Change of Board Composition” dated April 13, 2015: http://www.hkex.com.hk/eng/csm/ShowNews.asp?mkt=hk&FileName=http://www.hkexnews.hk/listedco/listconews/sehk/2015/0413/LTN20150413003.pdf
16  “Former Kaisa chief Kwok Ying-shing returns as chairman” by Sandy Li, South China Morning Post, April 13, 2015.
17  Kaisa Group Holdings Ltd. “Update on the Status of the Public Float of the Company” dated April 16, 2015:
http://www.hkex.com.hk/eng/csm/ShowNews.asp?mkt=hk&FileName=http://www.hkexnews.hk/listedco/listconews/sehk/2015/0416/LTN20150416003.pdf
18  Kaisa Group Holdings Ltd. “Recent Developments” dated April 20, 2015:
http://www.hkex.com.hk/eng/csm/ShowNews.asp?mkt=hk&FileName=http://www.hkexnews.hk/listedco/listconews/sehk/2015/0420/LTN201504201152.pdf
19  In March 2014, Shanghai Chaori Solar Energy Science & Technology became the first PRC-listed company to default on an onshore bond. A Bank of America Merrill Lynch report warned that this default could mark China’s “Bear Stearns moment”, a reference to the U.S. firm that failed in 2008 and ignited the global financial crisis. See “Shanghai Chaori Solar Energy defaults on bond issue” by Jasper Moiseiwitsch, Langi Chiang and Agencies, March 8, 2014.
20  In early April 2015, Cloud Live Technology Group became the second PRC-listed company’s onshore bond default. See “Cloud Live Technology in second China onshore bond default” by Eric Ng, Don Weinland and Bloomberg, South China Morning Post, April 7, 2015.
21  See footnote 20.
22  “China’s record high property inventories seen as an opportunity by some players” by Langi Chiang, South China Morning Post, April 1, 2015.
23  See footnote 22.
24  “China’s Evergrande Group classifies debt as equity, cuts leverage” by Reuters, South China Morning Post, April 13, 2015.
25  See footnote 24.
26  See footnote 24.
27  See footnote 24.
28  See footnote 22.
29  “China sees first bond default by state firm with Tianwei” by Bloomberg, April 21, 2015.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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