Is Kaisa About to Be ‘Municipalised’ by Shenzhen?

The default and distress of Kaisa Group Holdings, a drama that has transfixed the region’s financial markets since the Chinese real estate developer defaulted on a loan to HSBC nearly one month ago, might be headed towards a resolution as the Shenzhen government is said to be pushing other property developers to take over shares in the troubled firm.

While it remains unclear what type of transaction the authorities in the southern Chinese megacity are working towards, market reports indicate that officials in Shenzhen have fixed on the twin objectives of not allowing the Hong Kong-listed developer to collapse, while at the same time ensuring that the company’s former chairman and his associates do not profit further from their alleged association with former Shenzhen officials currently under investigation for corruption.

Kaisa’s crisis was triggered by the government’s shutdown of sales at four of the company’s projects in Shenzhen during December. At the end of the month Kaisa defaulted on a loan from HSBC, and there have been multiple failures by the company to meets its obligations to creditors since then.

Bailing Out Kaisa Through Asset Sales or Share Transfers

According to reports in Reuters and The Wall Street Journal, Kaisa has been discussing with investors, including China Vanke and Shenzhen Overseas Chinese Town – a local state-owned developer – to sell off Kaisa assets and raise badly needed cash.

However, a similar transaction involving sale of a Kaisa property in Shanghai to Vanke was abandoned earlier this month, reportedly due to resistance from the Shenzhen government, which objected to attempts at assets disposals that gave the impression of a fire sale.

An account in Bloomberg indicates that the local authorities are holding discussion about transferring shares in the company as a way to bail out the distressed developer, although it also said that the government prefers that any such share sales not be done at a discount.

How such a transaction would happen following Kaisa’s default on the HSBC loan (which was later waived) and its subsequent failure to make an interest payment on a $500 million bond, was not made clear.

The company’s inability or unwillingness to pay its obligations was further underlined to investors on January 21st, when an unnamed third party took over Kaisa’s liability and covered a payment on a trust product due that day. The trust loan had been arranged through Shenzhen-based insurance and finance giant Ping An, which is assumed to have been the white knight in this case.

Kaisa Needs to Beat a February 9th Deadline

Kaisa, and apparently the Shenzhen government, are under pressure to revive the failing company before the one month grace period on its bond payment default expires on February 9th. Failure to meet that deadline could trigger defaults on other company debts and make the developer the first Chinese real estate firm to default on its overseas debts. Multiple local creditors have already succeeded in having Kaisa’s accounts frozen in Shenzhen, Hangzhou and Dalian.

Kaisa’s struggles have already driven down its bond prices as low as 32 cents on the dollar earlier this month, and have resulted in Chinese developers, who raised $4.9 billion on regional bond markets in January 2014, being completely shut out by investors this month.

While China has made noises about its unwillingness to bail out failing companies in recent years, in December last year it still compensated bond holder after Chaori Solar became the first company to default on the country’s domestic bond market during March.

Speaking at the World Economic Forum in Davos last week, Chinese Premier Li Keqiang sought to reassure the world of China’s stability. “The Chinese government is capable of ensuring that no regional or systematic financial risks will happen in the country,” Li pointed out.

Shenzhen Government Pursuing Twin Objectives

While Chinese authorities are notoriously shy of controversy and instability, Xi Jinping’s administration has made rooting out corruption and the removal of factions one of the primary themes of its first term in office. And right now, Guangdong officials – and in Kaisa’s case, the companies and individuals who profited through relationships with these officials – appear to be targets of the current campaign.

The highlight of the anti-corruption campaign in Guangdong happened when Guangzhou party secretary Wan Qingliang was removed from office and put under investigation for corruption last year. And much of that corruption was related to real estate deals.

Kaisa, is said to formerly have enjoyed a close relationship with a much lower level official, Jiang Zunyu, the former head of Shenzhen’s Longgang district. Jiang later became the Secretary of the Shenzhen Municipal Politics and Law Commission before he was charged with corruption in October.

Two of Kaisa’s frozen projects are located in Longgang district, and local reports link Kaisa’s former leaders with Jiang. Former Kaisa chairman Kwok Ying-shing abruptly sold 11 percent of the company to Shenzhen state-owned insurer SinoLife in early December and also resigned from his posts with the developer last month.

As part of its drive to root out corrupt officials and punish property developers who colluded with the officials to obtain land, the Shenzhen government’s goal is likely seeking to ensure that Kwok and his associates do not profit further from their ill-obtained assets, without causing the collapse of a well-known developer and and with it public confidence in the city’s real estate market.

Whether this concern for confidence extends to offshore bond markets is not clear.

How a Kaisa Bailout May Work

While there have been no public announcements or confirmed reports regarding outside investment in Kaisa, market discussions indicate that the most likely rescue plan is a sale of shares in the company to another developer.

China Vanke and Shenzhen Overseas Town (both Shenzhen-based) have been reported as potential partners for the government in a bailout scheme, and trading in shares of Shenzhen Overseas Town were halted on Thursday pending an unspecified market announcement.

If the Shenzhen government does arrange a forced marriage between another developer and Kaisa, it could then presumably remove the sales freeze on the company’s projects and eliminate the root cause of the developer’s financial distress. The transfer of a stake in Kaisa to another developer would presumably involve a significant divestment by Kwok.

Given the administration’s perceived interest in cutting off Kaisa from Kwok and his family, and its reported unwillingness to have Kaisa sold at a discount, its unclear how the effective windfall to Kwok would be handled in such a scenario.

While rumours in late November and early December hinted that Kwok had been detained by the authorities, he has since been seen in public, and no charges have been filed against the property magnate.

Prospects for Kaisa to Pay Its Obligations

Should the Shenzhen government succeed in orchestrating a deal within the next two weeks that prevents any further disruption of the city’s real estate markets while preventing any further ill-gotten profits by Kwok and his family, it’s possible that Kaisa could meet its February 9th bond payment deadline and effectively erase its default.

Such a deal may mean that Kaisa will exist as a subsidiary of another developer (if it were to be acquired by Vanke) or that a new Shenzhen-based developer be formed out of what would amount to a merger of Shenzhen Overseas Town and Kaisa.

After troubled developer Agile Property was able to renegotiate its loans last October even with its chairman in custody, it would seem unwise to doubt the resiliency of China’s property developers.

However, overseas investors in Chinese developer bonds should keep in mind that they are last in line for repayment in this situation and Kaisa has already retained counsel to help it restructure its debt obligations.