It’s better that China Vanke defaults now

Shuli Ren, Bloomberg

Companies thrive and fail, and this is the natural evolution of business cycles. What’s unnatural, however, is a zombie firm that erodes investors’ interests over time.

Shenzhen-based China Vanke Co. failed to obtain enough support for a plan to delay paying a 2 billion yuan ($283 million) bond due Monday, therefore setting the stage for a potential default. The real estate developer must repay the note within five business days, or come to some separate agreement to push back the deadline. Vanke has since sweetened the deal by offering to pay 60 million yuan interest by Dec. 22.

While shocking, a default is not the worst outcome for creditors. If Vanke was allowed to continue business as usual, there might not be any assets left for bondholders when the inevitable reckoning comes.

State-owned Shenzhen Metro Group Co., Vanke’s largest shareholder with a 27% stake, has made it very clear that land-grabbing is in the cards. In early November, it demanded Vanke retroactively pledge collateral for existing unsecured shareholder loans worth 20 billion yuan.

By late November, Vanke had pledged its entire stake in property management firm Onewo Inc., arguably its most valuable and liquid asset, to its largest stakeholder. We only got a glimpse of the behind-the-scenes because, as a publicly-listed company, Onewo disclosed this material information to the Hong Kong Stock Exchange.

Meanwhile, the remaining asset pool is getting smaller. As of June, the company held only 51 billion yuan of unpledged investment properties. On the other side of the equation, it had about 99 billion of unsecured loans and 44 billion yuan corporate bonds outstanding, in addition to Shenzhen Metro’s shareholder loans, which the state-owned enterprise now demands collateral for.

In other words, even in the event of an immediate liquidation, Vanke’s creditors will be fighting in an ugly hunger game. Any delays, and their recovery rate will be even more dismal.

This perhaps explains why Vanke’s onshore bondholders overwhelmingly rejected the company’s proposal to extend repayments. About 85% of the 2-billion-yuan notes were held by banks, which have been increasingly wary of uncollateralized lending. As of June, secured lending accounted for over 60% of bank loans, versus only around 10% two years ago.

Plus, those hoping for a last-minute state-sponsored bailout must have realized it wouldn’t happen. The fact that Vanke has failed to garner support from its onshore creditors is a sign that the Chinese government doesn’t even remotely consider the developer as too-big-to-fail. There’s been no window guidance from regulators asking the bond-holding banks to extend and pretend that all is well, thereby kicking the can down the road.

Earlier in the year, bond investors developed a blind faith in Vanke, believing somehow that a series of unsecured shareholder loans from Shenzhen Metro constituted an unofficial bailout, even though the SOE never consolidated the builder into its books. It’s time to confront the cruel realty: Shenzhen Metro is not your friend. It’s time to wind up Vanke now, before everything gets taken away.

Courtesy Bloomberg/Shuli Ren