China Evergrande liquidation: ‘thin payout’ likely for offshore creditors as legal drama plays out, S&P says

China Evergrande liquidation: ‘thin payout’ likely for offshore creditors as legal drama plays out, S&P says

An agreement struck in 2021 to mutually recognise liquidation orders in mainland China and Hong Kong may not apply to China Evergrande Group, according to a S&P Global Ratings report on Wednesday.

The liquidation order is difficult to implement because most of Evergrande’s assets are not in the three mainland China cities – Shanghai, Xiamen and Shenzhen -covered under the pilot programme, according to the report.

The agreement – the Mainland-Hong Kong Cooperation Mechanism – was struck in May 2021 for mutual recognition and assistance in insolvency proceedings between the courts in the three mainland cities and Hong Kong.

“The liquidation is a milestone for China’s biggest corporate defaulter with US$337 billion in liabilities,” said Esther Liu, credit analyst at S&P Global Ratings. “But much of this story is yet to be told. The bulk of the issuer’s assets and liabilities are in mainland China, outside the purview of the Hong Kong court.”



A vanishing fairyland dream: how China Evergrande rose, then crashed

A vanishing fairyland dream: how China Evergrande rose, then crashed

Adding to the pain, Evergrande’s offshore creditors will only be paid after the onshore creditors, as they rank lower in the repayment pecking order when the assets are liquidated, the report said.

Evergrande, one of the world’s most indebted property developers, was ordered to wind up by a Hong Kong court on Monday, after it failed to reach a consensus with creditors on a “concrete restructuring proposal” following years of discussions. The court appointed Eddie Middleton and Tiffany Wong Wing-sze, managing directors of the consulting firm Alvarez & Marsal, as provisional liquidators for the developer.

Why offshore creditors will remain nervous about Evergrande liquidation

The court’s liquidation order triggered an implosion in the shares and bonds of Evergrande and its affiliates, further diminishing the value of its recoverable assets.

Meanwhile, Fengtao (Shanghai) Property Company, an indirect subsidiary of Evergrande that was set up in 2016, will be put up for auction on Thursday, according to local media Guandian.

The Shanghai No 3 Intermediate People’s Court accepted the company’s bankruptcy liquidation case in May last year, the report said. Dues owed to Fengtao amounting to some 11.48 billion yuan (US$1.6 billion) will be auctioned, it added.

S&P said it expected the winding-up to highlight the arduous task of liquidating a large company, and reset expectations about recovery rates on defaulted Chinese speculative-grade bonds in the offshore market.

There is substantial legal and execution risk when trying to extract value from the onshore entities, the report said.

A research report by Natixis on Wednesday noted that more Chinese developers could possibly end up in the same situation as Evergrande, as a precedent was set.

Natixis said the dilemma for offshore creditors is that the enforcement of the ruling will be carried out in a different jurisdiction, and those developments may affect foreign investors’ perspective.

The liquidation order comes at a tricky time when China’s capital flows through direct and portfolio investment face more pressure, according to the report. “Such risk-averse sentiment can be amplified with the lower repayment priority for offshore bondholders, confirming our prediction in October 2021, and the potential losses for shareholders.”

Markets see a silver lining for China property in Evergrande’s liquidation order

Evergrande has more than 1,200 projects at different stages of progress, ranging from near completion to under construction, according to its 2022 annual report.

It would be difficult for offshore creditors to take control of Evergrande’s mainland assets, especially considering the priority to deliver 1.6 million pre-sold homes, according to a Citi report on Wednesday.

The offshore liquidator has to deal with each entity and its own set of managers, shareholders and onshore creditors in their respective legal jurisdictions.

“We assume offshore bondholders will get a few cents on the dollar once the liquidation plays out,” said Chang Li, S&P Global Ratings’ China companies specialist.

“They will likely have to wait years even for this thin payout.”



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