When Evergrande Real Estate Group, a Chinese developer of luxury hotels and apartment complexes, sought to shore up its balance sheet, it packaged its debt into a series of notes that listed some of the proceeds as mandatory annual payments on a water connection to a hydropower plant in Hunan province.
But what the company failed to disclose to investors is that the utility company has, in fact, never charged the bond holders the annual fee and has never been required to levy it.
Instead, Evergrande said in documents filed Tuesday with China’s National Development and Reform Commission that the daily water fee it has been billed by the utility company for more than a decade has never been paid.
The obvious market advantage of the $80 million bond was that Evergrande would have an easy source of cash to cover the annual payments.
But Evergrande, after years of spectacular real estate deals that pushed the company and its controlling shareholder Baoneng Group into the red, has had difficulty selling any of its real estate. The company has been active in curtailing its overseas business and disposing of its assets.
An Evergrande spokesman and the lawyers for Baoneng and Evergrande declined to comment beyond the unassailable narrative of the bond contract.
But China’s Securities Regulatory Commission said it opened an investigation on Wednesday into Evergrande.
An Evergrande spokesman said in an email that Evergrande had been “fully communicating” with bond holders throughout the “pleasantly smooth process.”
In 2015, when Evergrande first issued the bonds, it said the annual payment would represent roughly 9 percent of the $333 million bond sum, and the annual utility fees it would have to pay should Evergrande fail to make those payments would only cost it about $6 million, the company said.
That year, Evergrande was spending $110 million a month, on average, on building its portfolio of projects, documents show.
To make good on the bond payment, Evergrande had to post almost $6 billion of cash to its parent and Baoneng in the last three years. This month, Evergrande said that Baoneng and Evergrande’s common shares were worth about $480 million combined, as its share price plummeted 66 percent in a single year.
Evergrande said the bond’s $80 million bond principal amount was secured with “ a long-term contractual entitlement of consolidated amounts in the amount of approximately RMB26.42 billion in payments of water rates” as long as Evergrande continued to pay them.
The bond’s language states that if Evergrande does not “pay” the annual payment, “Baoneng will receive the amount of approximately RMB26.42 billion on November 21, 2015, the first payment date.”
Evergrande also failed to mention that the bond is, in fact, convertible into shares in Baoneng, the pension fund of the government of Hunan, with a fixed percentage of the share value, and that its terms, like most convertible bonds, include protection against losses as a share price falls.
It also failed to tell investors that Evergrande executives had counted as key stakeholders Evergrande Chairman Guo Guangchang and his chief financial officer Wang Zhenyu.
Evergrande’s cash demands have gone so far that it took steps to prevent the payment of the bond obligations if it sold other assets or closed a property, according to documents. The payment was required from Nov. 21, 2016 to Nov. 21, 2018, documents say.
The bond also is understood to have legal protections that prevent it from being resold.