Keep Well agreements or deeds were all the rage during the recent bull run in Asian bond markets between September 2012 and May 2013. Several companies in China used these agreements when issuing new bonds during this period. Good holding agreement or deed is a type of credit enhancement for bonds. This is issued in lieu of warranty and is weaker than a warranty. Credit enhancement reduces the risk associated with the bonds and therefore lowers the cost of financing.
When the bonds are issued and guaranteed by non-operating offshore entities or operating entities with weak assets and cash flows, the bonds offer a low degree of protection to investors. In such cases, a special structure called a maintenance agreement is used along with the share purchase commitment. These agreements basically state that the onshore asset-rich parent/operating entity (which is of better credit quality) will ensure that the bond issuer/guarantor maintains a minimum capital and adequate resources to service debt obligations. We need to understand the need to issue bonds with such a structure. Bond warrants require approval from regulatory authorities in China, while deeds of maintenance do not. Therefore, this structure facilitates access to offshore markets by Chinese companies (which cannot directly issue or guarantee offshore notes) through their offshore subsidiaries.
Another important aspect to examine is whether this link structure is strong enough. The two agreements indicate the parent’s willingness to financially support the issuer/guarantor of the bonds. However, the risks cannot be undermined since there is no pre-structured, legally tested to understand the results in case of default.
Let us consider the example of China Vanke to better understand this structure. China Vanke Co., one of China’s largest real estate developers, issued its first offshore bond in 2013 with a deed-support structure. The notes due 2018 were issued by Bestgain Real Estate Ltd, a BVI entity, and were guaranteed by Vanke Real Estate (HK). The bonds were backed by a deed of maintenance and a deed of commitment to purchase shares from China Vanke, the onshore listed company. China Vanke needed the approval of Chinese regulatory authorities to guarantee these bonds. Therefore, he opted for this type of bonus structure. The maintenance agreement stated that China Vanke would ensure that i) the issuer Bestgain maintained a minimum capital, and ii) the issuer and the guarantor maintained adequate resources to meet the debt obligations. Failure to do so would constitute an event of default and the bond trustee could go to Hong Kong court to require China Vanke to pay the debt. The share purchase agreement provided that China Vanke would purchase an equity interest in a subsidiary so that the issuer and guarantor would obtain the necessary resources to meet the obligations of the bonds.
This structure has been used by some high-yield issuers in the real estate sector such as Beijing Capital Land and Gemdale Properties. The various bond structures provide investment opportunities for investors. However, investors should consult financial advisors to better understand the complexity and risks involved in the various bond issuance structures.