Finance

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

What's the limit to the patience of global investors with shifting goalposts in China? That test may be about to happen. Last Thursday, developer Guangzhou R&F asked creditors to remove several clauses from the documents of its dollar bonds which restrict the company's ability to take on more debt.

Nothing special about that. Covenant waivers such as this have become common among Chinese bond issuers. Last year, at least 15 companies asked foreign debt investors to loosen restrictions on their notes, most of the time making way for them to add liabilities to their balance sheets. That was more than double the number in 2014.

Changing the Rules
The number of companies asking for changes to bond documents doubled last year
Source: Bloomberg

A few things about the R&F consent solicitation, however, have bondholders grinding their teeth this time around. The Guangzhou-based homebuilder isn't only asking investors to allow it to take on more debt, it's also requesting that they turn a blind eye to a potential technical default. According to Standard & Poor's and Fitch Ratings,  the company needs a waiver after breaching its fixed-charge coverage ratio, which requires operational earnings equivalent to at least three times the amount of interest and recurring payments it makes every year.

It's not the first time a Chinese developer has asked investors to change the rules when they're about to break or have even broken them. In January 2014, Evergrande Real Estate Group asked for similar changes to allow it to take on more debt. After that, the company's borrowings increased more than 70 percent and it was downgraded twice. This year, Evergrande changed the rules on its debt contracts once more.

Climbing Debt
Developer Evergrande's debt has grown 70 percent and the company has been downgraded twice since it first asked investors to loosen bond restrictions in January 2014
Sources: Bloomberg; company filings

Guangzhou R&F added a twist to the practice, though. Even as earnings dropped below the required coverage level, the developer announced it was paying a record dividend. Normally, when a company isn't able to meet a fixed-charge coverage covenant, it is not only in technical default but is also barred from paying dividends. You can imagine how bondholders felt to be told that the company was increasing rewards to shareholders while failing to meet the standards imposed by debt contracts.

Evergrande's 2014 change opened the door for the slew of subsequent consent solicitations, all of which had a similar structure. If investors allow Guangzhou R&F to get away with breaching covenants and increasing its debt limits while still paying a record dividend, they can expect many other Chinese companies to follow. It's up to global bondholders to draw the line.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net