Key Takeaways
- More distressed Chinese developers could use an equity element to resolve defaulted offshore bonds, following a recent deal for Fortune Land.
- Ringfencing assets or equity swaps could help developers win creditors' support for longer repayment terms--indeed, extensions will still likely comprise the bulk of workout deals.
- Haircut risk will remain high even for deals that technically restructure all principal and interest.
- In the Fortune Land case, the equity is illiquid shares of unlisted assets, making it harder to be valued and disposed of at the price expected by investors.
A recent debt workout could become a benchmark for China's troubled property developers. The deal between China Fortune Land Development Co. Ltd. and its offshore creditors involves equity exposure as part of the resolution. S&P Global Ratings believes more distressed developers may consider debt-to-equity elements as they seek to restructure their obligations.
That said, this won't necessarily open the the floodgates on workouts. China property developers have defaulted on well over US$30 billion in offshore bonds in 2022, and further delays on repayment could ensue. Many developers will seek to extend payment schedules--buying time to wait for the physical market to recover.
Ultimately, the health of China's property market remains the key to resolving stalled debt. We expect an "L" shape recovery, with sales stabilizing in the second half of 2023 but not taking off with any great vigor.
A Step Forward In Resolving China's Defaulted Offshore Bonds
The deal by Fortune Land (unrated) is one more option for distressed borrowers in China's real estate sector. This is the first time in many years that a Chinese offshore developer has included a debt-to-equity swap in their restructuring proposal.
It is also a case of progress made in cleaning up property sector debt in China. After the offshore transaction is completed, Fortune Land's restructured debt will exceed Chinese renminbi 170 billion (US$24.7 billion)--about 80% of the company's total debts under the restructuring arrangement.
The developer's proposal to resolve $4.96 billion of offshore bonds was approved by the High Court in London on Jan. 24, 2023. The restructuring has been conducted by way of a U.K. scheme of arrangement, and is binding on all of the offshore bondholders. Besides an option to swap debt into equity interests in an onshore business portfolio, the deal stretches repayment schedule to eight years for some portion of principal (see charts 1-2).
Chart 1
Chart 2
Swaps Can Restore Capital Structure; Valuing The Equity Is Tricky
An equity element offers a way to restore developers' capital structure, by not further heightening already steep leverage. In the Fortune Land case, the equity is not listed, which makes it harder to value; nonetheless, it did offer an alternative that may have helped deal completion. Fortune Land added the equity component to its original plan, aiming to attract creditors that may not be satisfied with the maturity extension as long as eight years.
The restructuring plan includes convertible bond (new bond 2, see chart 2) that can be swapped into either shares of a Cayman trust that wholly owns a British Virgin Islands (BVI) special purpose vehicle or directly into the shares of the SPV. The SPV will indirectly hold shares in an onshore business portfolio whose assets include onshore property management, industrial park operations, among other.
Creditors have the option of receiving $1.33 worth of shares for every $1 of principal. It remains uncertain how many investors will opt to convert their new bonds to equity, given the difficulty of valuing the underlying portfolio.
A deal structure that worked for offshore investors
Debt-to-equity swaps are not unusual in debt restructuring for China corporates, but this approach can be trickier for offshore debt obligations, given ownership of onshore assets can be subject to regulatory requirements for offshore investors (see "fter A Massive SOE Default, China Rethinks Resolutions," published on RatingsDirect on July 18, 2021).
Fortune Land has provided a viable way to facilitate an equity component that gives offshore creditors access to onshore assets. This could pave the way for other distressed developers to take similar steps; i.e., to offer swaps to convert debts into shares in offshore listed entities or onshore assets.
Payment extensions will likely continue to center most resolution proposals
Some types of debt-to-equity swaps could substantially dilute the interest of the existing shareholders, preventing them from becoming a main solution for debt workouts. In some cases, this solution would cause the founder or key shareholder to lose control of the company. Creditors would also worry about the willingness of owners to turn around the companies if they have limited exposure to the upside.
Swaps are more likely to be employed as a supplementary option to maturity extension--which will continue to be the primary solution. An equity element can help developers win creditors' support for longer bond extensions; such maturity extensions are increasingly facing creditor resistance, mainly because of inadequate compensation (see "China's Defaulted Developers Hope For The Best, Prepare For The Worst," Jan. 10, 2023).
Why Did Investors Take This Deal?
In our view, investors likely won't get their money back unless China's underlying property market recovers. This deal offers exposure to that recovery. Elements include:
- The equity components offer the potential for earlier returns--in short, it's a better option than waiting eight years for recovery.
- As unlisted assets, valuations and resales prospects are murky. Still, this deal will be a template, given the tough conditions.
- The value collection from the property trust unit is mainly dependent on recovery in the underlying property market.
- A cash payment by end-2023 is another sweetener--though this will only occur if Fortune Land can actually obtain a price this year to make the sale worthwhile.
- We note the equity swap approach will test rules and regulations. That said, we believe the company would strive to facilitate equity exposures should investors exercise their debt-for-equity rights.
Recovery Will Ultimately Depend On China's Underlying Property Market
Haircut risk remains for Fortune Land's offshore creditors. Final recovery could falter if the property market recovers slower than expected, or the company fails to turn around its business operation amid a further polarized market condition, then the restructure.
This same issue looms over all of China's defaulted property debt. Ultimately, debt workouts will hinge on whether distressed developers can stabilize their operations and homebuyers feel safe enough to come back to the market.
A revival in the fundamentals is not a given, though the country's reopening and sector support will help. (See "Credit FAQ: China Property Is On The Cusp Of A Recovery," Jan. 11, 2023.)
Related Research
- China Debt Restructurings: Five Cents On The Dollar Or 50?, Feb. 28, 2023
- Credit FAQ: China Property Is On The Cusp Of A Recovery, Jan. 11, 2023
- China's Defaulted Developers Hope For The Best, Prepare For The Worst, Jan. 10, 2023
- China Property Is Heading For A Transformation, And Maybe A Turnaround, Nov. 21, 2022
- Credit FAQ: China's Defaulted Developers Are Running Out Of Time To Exchange And Extend, July 17, 2022.
- China's Surging Defaults Test Courts And Bond Recovery, May 5, 2022
- After A Massive SOE Default, China Rethinks Resolutions, July 18, 2021
This report does not constitute a rating action.
| Primary Credit Analyst: | Esther Liu, Hong Kong + 852 2533 3556; esther.liu@spglobal.com |
| Secondary Contacts: | Christopher Lee, Hong Kong + 852 2533 3562; christopher.k.lee@spglobal.com |
| Lawrence Lu, CFA, Hong Kong + 85225333517; lawrence.lu@spglobal.com | |
| China Country Specialist: | Chang Li, Beijing + 86 10 6569 2705; chang.li@spglobal.com |
| Research Assistants: | Claire Sun, Hong Kong |
| Jenny Chan, Hong Kong |
No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.