For all the media ink spilled recently, you would think the ongoing fight in Hong Kong between severely-troubled Hong Kong-listed Chinese real estate developer Kaisa Group and its creditors was the biggest, nastiest, most portentous blood feud the capital markets have ever seen.
It’s none of that. It’s a reasonably small deal (US$2.5 billion in total Hong Kong bond debt that may prove worthless) involving a Chinese company of no great significance and a group of unnamed bond-holders who are screaming bloody murder about being asked to take a 50 percent haircut on the face value of the bonds. The creditors have brought in high-priced legal talent to argue their case, both in court and in the media.
Kaisa announced on April 20 that it had defaulted on US$51.6 million in interest payments on offshore bonds that were due in March. The company’s troubles began in November when Shenzhen authorities blocked sales of units in 11 Kaisa projects, apparently when its chairman, Kwok Ying Shing, got caught in the coils of President Xi Jinping’s corruption campaign, allegedly by acquiring land at concessionary prices.
There is nothing wrong with creditors fighting to get back all the money they loaned and interest they were promised. But what goes unspoken in this whole dispute is the core question of what in heaven’s name were bond investors thinking when they bought these bonds to begin with. Kaisa was if not a train wreck waiting to happen then clearly the kind of borrower that should be made to pay interest rates sufficiently high to compensate investors for the manifold risks. Instead, just the opposite occurred.
The six different Kaisa bond issues were sold without problem by Hong Kong-based global securities houses including Citigroup, Credit Suisse and UBS to some of the world’s most sophisticated investors including Fidelity and Blackrock by offering average interest rates of around 8 percent. If Kaisa were trying to raise loans on its home territory in China, rather than Hong Kong, there is likely no way anyone would have loaned such sums to them, with the conditions attached, for anything less than 12-15 percent a year, perhaps even higher. Kaisa’s Hong Kong bonds were mispriced at their offering.
It may strain mercy, therefore, to feel much sympathy for investors who lose money on this deal. Start with the fact Kaisa, headquartered like China First Capital in Shenzhen, is a PRC company that sought a stock market listing and issued debt in Hong Kong rather than at home. Not always but often this is itself a big red flag. Hong Kong’s stock exchange had laxer listing rules than those on the mainland. As a result, a significant number of PRC companies that would never get approval to IPO in China because of dodgy finances and laughable corporate governance managed to go public in Hong Kong. Kaisa looks like one of these. It has a corporate structure, which since 2009 has been basically illegal, that used to allow PRC companies to slip an offshore holding company at the top of its capital structure.