Rising controversy and heavy indebtedness saddling Avolon Holdings’ parent HNA Group threaten to erode the subsidiary’s own credit quality, two bondholders said. Chief among bondholder concerns – Avolon’s USD 1.25bn 5.5% unsecured notes were raised just seven months ago – is that a turbulent ownership group could take advantage of loose restricted payment covenants to upstream cash, the sources added.
Chinese conglomerate HNA has been on a USD 40bn international M&A spree of aerospace and tourism companies since 2011. It added global aircraft leasing company Avolon to its portfolio in 2015 for USD 2.6bn. Other recent HNA purchases include the USD 2.8bn acquisition of cargo handling services provider Swissport, and most recently in January the parent used Avolon as the vehicle through which it made a USD 10bn acquisition of CIT Group’s commercial aircraft leasing business.
To give an idea of the scale on which HNA operates, as of 30 November 2016 the parent company had raised an aggregate total of CNY 374.3bn (roughly USD 55.5bn) of outstanding debt, according to a Debtwire research report.
But capital market access could soon be a thing of the past for HNA. Over the past several weeks a string of news reports shed light on a murky ownership structure – so much so that HNA took the unprecedented step of releasing a list of its owners. But the attempt at transparency left investors with even more questions, particularly surrounding the revelation that largest stakeholders were two previously unknown charities that together hold 52% of the company.
“We knew nothing about these two charities, it’s the hidden aspect which makes you worried,” one of the buysiders said. “Disclosure is very far from what we are used to in the US.”
Raising suspicions further, one of the not-for-profit organizations, the New York-based Hainan Cihang Charity Foundation Inc, was only registered last December.
The confusion could have material consequences for US lenders to HNA’s overseas subsidiaries, highlighting the risks of investing in companies backed by secretive Chinese conglomerates.
At least three major US banks, BofA Merril Lynch, Citigroup and Morgan Stanley, indicated they will drastically scale back on deals with HNA amid concerns over its debt levels and ownership structure, according to a recent report from Bloomberg. The pull-back by US financial institutions was in part driven by difficulty meeting anti-money laundering Know Your Customer (KYC) requirements due to HNA’s opaque formation, the buysiders said.
On Tuesday, HNA walked away from a joint venture with the inflight content and connectivity provider Global Eagle Entertainment after failing to get approval for the deal from the Committee on Foreign Investment in the United States (CFIUS).
“If all the other US banks follow suit, HNA portfolio companies would lose access to financing,” one of the buysiders said.
Meanwhile the Chinese government also recently signaled it would be less supportive of the country’s massive conglomerates – such as HNA, Anbang Insurance Group, Dalian Wanda Group and Fosun International – entities that built global empires on cheap debt issued by state banks. HNA currently has a credit line with government controlled financial institutors worth USD 90bn, for example.
Beijing regulators fear that these so-called ‘Grey Rhinos’ have borrowed so much that it now poses a risk to the financial system, prompting fears that the government will move to rein in international deal-makers like HNA. On Monday (24 July) Bloomberg reported that three Chinese lenders have already decided to stop extending new loans to HNA. The next day CEO Xiangdong (Adam) Tan hit back at reports that international lenders were scaling down credit to the group, claiming instead that the company has strong relationships with US banks.
Despite the HNA uncertainty, secondary trading in Avolon’s capital structure has so far remained relatively unscathed from the budding concerns the parent may look to exploit its subsidiaries while it can. Avolon’s recently issued USD 1.25bn 5.5% senior unsecured notes due 2024 changed hands this morning at 102.875 for a 4.979% yield, down slightly from 103.375 and a 4.891% yield on Monday (24 July), according to MarketAxess. The borrower’s USD 1.75bn 5.25% senior unsecured notes due 2022 last traded at 103.625 to yield 4.439%, compared to 103.75 and a 4.413% yield on Monday.
“The Avolon bonds are holding firm for now, but they should be trading at some kind of yield premium,” one of the buysiders said.
House of cards
If HNA loses its implicit state backing, as well as access to the US capital markets, some buysiders fear that the company may look to extract cash from its better rated and lower levered subsidiaries – such as Avolon.
In January US investors took down a USD 8.5bn loan and bond package to finance Avolon’s USD 10bn purchase of CIT Group’s commercial aircraft leasing business. Both the secured and unsecured portions of the deal were heavily oversubscribed, despite flags raised by some prospective lenders about weak covenant protections.
HNA vehicle Bohai Capital Holding contributed USD 2.4bn equity to the deal, a cash investment that was itself debt-funded – adding another layer of risk to the capital structure, according to one of the buysiders.
“If HNA starts running into issues then they don’t have the cash that they said they do, it’s borrowed cash” one of the buysiders said. “You’re setting everything up on a deck of cards.”
Some participants in the January debt offering are now closely reading the bond indenture and loan credit agreement language to see what protections that have against a heavily-indebted parent in need of liquidity.
Avolon’s USD 3bn senior unsecured dual-tranche notes contain borrower-friendly investment grade covenant package giving the issuer unlimited ability to issue more unsecured debt, sell assets or make restricted payments – such as upstreaming cash to its parent or making intercompany loans.
“From a legal standpoint there is nothing stopping HNA upstreaming cash from Avolon,” one of the buysiders said.
The potential scenario calls to mind Brazilian meat-packing giant JBS SA, which earlier this year was caught up in a widespread political corruption scandal in its home country, noted one of the buysiders. In that situation, bonds issued by the company’s US subsidiary, JBS USA and its majority-owned Pilgrim’s Pride, zig-zagged in trading amid fears that those entities could be forced to help address liquidity shortfalls at the parent as it faced a BRL 10.3bn (USD 3.2bn) fine to settle corruption charges.
An important distinction in Avolon’s case however, is that the aircraft leasing company is protected by an additional layer of corporate governance in the form of an independent board of directors. While HNA chief Tan is a non-executive director on Avolon’s nine-person board, bondholders are hoping that the company’s four independent directors will help safeguard their interests.
“The board having a say is going to stop, at least in my opinion, HNA using Avolon as an ATM,” one of the buysiders said.
Avolon’s US lenders are unlikely to be comforted by the recent experience of fellow HNA-owned issuer Swissport. In May the company announced a technical default under its senior secured credit facility after revealing a previously undisclosed lien not permitted by its credit agreement.
The public filing remained vague over the precise cause of the covenant breach, stating only that Swissport became aware that its shares were used as security for a debt facility incurred by a subsidiary of HNA Group.
According to a source familiar with the transaction, HNA failed to disclose to lenders that it has taken out a loan as short-term financing to buy an aircraft. While the loan was repaid within nine days, the lack of disclosure concerned some creditors, the source familiar added.
“Creditors were not really impaired, however it was not the norm and they do not like the opaqueness of it,” the source said.
In a move that effectively cured the breach, Swissport this week refinanced its senior secured EUR 660m TLB with a EUR 460m TLB due 2022 together with EUR 200m of cash from sponsor HNA’s EUR 718m equity injection, which was made in April. The new term loan allocated yesterday (26 July) with a Euribor+ 375bps (no floor) coupon at par.
CLICK HERE to access the Debtwire research team’s primary deal sheet on Avolon’s last debt raise.
Avolon declined to comment. Swissport did not respond to requests for comment.