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After A Massive SOE Default, China Rethinks Resolutions

The Peking University Founder Group (PUFG) has sped through a restructuring, underscoring the Chinese government's desire for efficient, market-based default resolutions. S&P Global Ratings believes the deal's speediness and the high recovery rate will increase market acceptance of court-led workouts, but that the process may put offshore bondholders at a disadvantage compared with onshore creditors.

The restructuring of the diversified conglomerate should preserve much of the value of PUFG, which was behind the country's biggest U.S. dollar bond default in two decades. The plan separates the most viable part of its businesses into a "Newco" (New Founder Group). The remaining, unsustainable portion of the business will be put into a trust. The court approved this plan on June 28, 2021.

Creditors can partially recover their claims through the sale of New Founder Group shares, the sale of other retained assets to strategic investors, or from the liquidation of the trust (see chart 1).

Chart 1

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The restructuring proposes to repay secured creditors in full. Unsecured creditors may also be repaid in full, up to Chinese renminbi (RMB) 1 million for each claim. For unsecured debt exceeding RMB1 million, the proposal includes three options: a one-time cash payment, a cash payment plus shares, or a cash payment plus new debt (see table 1). PUFG has about RMB250 billion in debt.

How To Reach A Resolution In Just 574 Days

PUFG's restructuring went smoothly. It took 574 days to get the court's approval on the reorganization, from the date when the default occurred (in December 2019). This was less than the 679-day average seen for in-court restructurings in China, based on our statistics (see "China Paves Way For Better Default Resolution Systems," published July 27, 2020 on RatingsDirect). This was efficient, especially considering it unfolded after the pandemic started in 2020, and given it was a complex case involving four main subsidiaries.

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Other high-profile defaults by state-owned enterprises were not followed by such a transparent and efficient restructuring. For example, Baoding Tianwei Group defaulted in April 2015, and it took the court till April 2020 to approve its restructuring. Qinghai Provincial Investment Group defaulted in January 2020, and only submitted a restructuring plan 1-1/2 years later, on June 19, 2021.

PUFG's efficient workout owes much to the powerful entities overseeing the plan. The administrator was stacked with official bodies including the People's Bank of China, the Ministry of Education, the China Banking and Insurance Regulatory Commission, and the Beijing municipal government. The administrator had the credibility to get creditors to quickly support a complicated restructuring.

A consortium comprising Zhuhai Huafa Group Co. Ltd., Ping An Life Insurance Co. of China Ltd., and Shenzhen Tefa Group will maintain New Founder Group as a going concern. The consortium is expected to invest RMB53.7 billion to RMB73.3 billion (US$8.3 billion to US$11 billion) to repay PUFG's creditors. They acquired 73%-100% of the shares of New Founder Group and other assets. The consortium will take over the five main sustainable businesses. This is better than selling these businesses separately, which would be time consuming.

Chart 3

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Reaching For A Higher Recovery Rate

The cash recovery rate of PUFG's unsecured debt is at least 31.43%, according to the restructuring plan. This compares positively to the average recovery of 23.7% seen in in-court restructurings. This is based on our review of nearly 50 defaulters going through in-court restructurings.

Recovery rates vary greatly depending on many factors, including asset quality, the complexity of the group structure and equity ownership, the strategic investor's financial strength, and turnaround capability.

Regulators and the courts are adhering to a "one entity, one solution" resolution policy. This means each plan will be designed to fit the restructuring problem at hand, and will be difficult to replicate.

PUFG has developed five main businesses in the past 30 years, including IT, healthcare, property, finance, and commodities. The main businesses are still viable, which helped the group attract strategic investors.

PUFG's legacy businesses such as finance and property have good margins or have valuable lands that are easy to sell. Other businesses, such as IT and healthcare are in line with the government's economic-planning goals, and thus have high growth potential (see chart 4).

Chart 4

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Offshore Investors May Still Be At A Disadvantage

The case is a setback for investors in PUFG's offshore bonds. The biggest blow lay in the administrator's rejection of keepwell claims on PUFG.

A keepwell deed is a statement of commitment made by the onshore parent company in support of the offshore issuer. Under most keepwells, the parent ensures the issuing subsidiary remains solvent, and has sufficient liquidity to service the interest and repay the principal of the bonds (see "Peking University Ruling Raises Refinancing Risk On US$93 Billion Of Keepwell Bonds," Sept. 2, 2020.)

Liquidators of PUFG's offshore subsidiaries alleged PUFG was in breach of the keepwell deed. This purports to support US$1.7 billion of the company's defaulted keepwell bonds, according to media reports. However, it is still uncertain whether this claim will be upheld by the Hong Kong courts or how the keepwell deeds will be enforced.

Table 1

Chinese Restructurings Are Complicated And Are Not Easily Standardized
Company First bond default date (including onshore and offshore debt) Date that court approved restructuring plan Details of onshore, in-court restructuring
Baoding Tianwei Group April 21, 2015 April 10, 2020 Restructuring details were not released. The company said the estimated recovery rate on the restructured, unsecured debt was 15.02%
Tewoo Group Dec. 12, 2019 Dec. 23, 2020 Creditors with unsecured debt of no more than RMB500,000 were fully repaid. For those holding debt exceeding RMB500,000, 68% of the claim will be subject to a 10-year extension with amortized payments; they will receive annual interest of 3.15%. The remaining 32% will be put in a trust product plan, backed by part of Tewoo's assets and managed by professionals
PUFG Dec. 2, 2019 June 28, 2021 Unsecured creditors holding up to RMB1 million in debt are repaid in full. For debt exceeding that amount, investors receive RMB20.32 for every RMB100 of debt, plus 1.11 shares valued at RMB12.88. Creditors can also choose to exit immediately with a one-time cash payment of RMB31.43 (per RMB100 of debt) or RMB20.32 cash plus RMB12.88 of New Founder Group debt
QPIG Jan. 10, 2020 N.A. N.A.
Unigroup Nov. 16, 2020 N.A. N.A.
N.A.--Not available. This means that the company has not submitted the restructuring plan, or the court has not approved the restructuring plan. PUFG--Peking University Founder Group. QPIG--Qinghai Provincial Investment Group Ltd. RMB--Chinese renminbi. Sources: S&P Global, local news.

The offshore bonds the PUFG administrator did recognize came with complications. Although the administrator gave creditors options, regulatory requirements narrow the choices open to offshore investors. This includes a requirement to register with the State Administration of Foreign Exchange to transfer cash to offshore bondholders, the need for offshore investors to get approval from regulators to own shares in the onshore entity, and the need for the New Founder Group to get approval to issue offshore debt.

The onshore bankruptcy administrator will also only accept the trustee's claims for all the offshore bonds as group. This means individual offshore investors cannot choose a particular option, according to press reports.

This reflects the lower bargaining power of the offshore investors in onshore, in-court restructurings. The outcome presented cross-border investors with fewer options than was offered to the onshore creditors.

Offshore investors could have more room for negotiation in an out-of-court debt settlement. An out-of-court settlement is always negotiated separately among investors. This means offshore investors can negotiate a different settlement to which the onshore investors agree.

Out-of-court restructurings are common in cases involving U.S.-dollar bond defaults. For example, Tewoo Group completed an exchange and tender offer for its four U.S.-dollar bonds in December 2019. The cash recovery ratio ranged from 36% to 66.73%. In comparison, Tewoo's onshore in-court debt restructuring was only approved by court in December 2020 (see table 1).

Market-Based Principles Are The Way Forward

PUFG's restructuring is the result of government efforts to use market-based mechanisms to resolve bond defaults. After record high defaults in the past two years, China regulators have sped up efforts to improve the mechanism for post-default resolutions. Debt restructuring has accounted for nearly three-quarters of the onshore resolved defaults, and about half of the restructurings are done in-court.

Issuers, creditors, and other stakeholders are becoming increasingly experienced in default resolutions. We expect court-led restructurings to become faster and more efficient, and may save investors from what had been years of legal limbo seen in other workouts.

Related Research

Editing: Jasper Moiseiwitsch

Digital Design: Halie Mennen

This report does not constitute a rating action.

China Country Specialist:Chang Li, Beijing + 86 10 6569 2705;
chang.li@spglobal.com
Secondary Contact:Boyang Gao, Beijing + 86 (010) 65692725;
boyang.gao@spglobal.com

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