Keep well agreements or deeds were in vogue during the recent bull run of the Asian bond markets between Sep 2012 and May 2013. Several companies from China used these agreements when they came out with new bond issuance during this period. Keep well agreement or deed is a type of credit enhancement for the bonds. This is issued in place of guarantee and is weaker than a guarantee. Credit enhancement reduces the risk associated with the bonds and hence reduces the cost of funding.
When bonds are issued and guaranteed by offshore non-operating entities or operating entities with weak assets and cash flows, the bonds offer low degree of protection to investors. In such cases, a special structure called keep well agreement is used in tandem with equity purchase undertaking. These agreements basically state that the onshore asset-rich parent company/ operating entity (which is of better credit quality) will ensure that the bond issuer/guarantor will maintain minimum equity and adequate resources to service debt obligations. We need to understand the necessity of issuing bonds with such a structure. Bond guarantees require approval of regulatory authorities in China, while keep well deeds do not need it. Hence, this structure facilitates the access of offshore markets by Chinese companies (that can’t directly issue or guarantee offshore notes) via their offshore subsidiaries.
Another important aspect to examine is whether this bond structure is strong enough. The two agreements indicate the parent company’s willingness to financially support the issuer/guarantor of the bonds. However, risks cannot be undermined given that there is no precedent – the structure has not been tested legally to understand the results in case of a default.
Let us consider the example of China Vanke to better understand this structure. China Vanke Co., one of the largest property developers in China, issued its first offshore bond in 2013 with a keep well deed structure. The 2018 maturity bonds were issued by Bestgain Real Estate Ltd, a BVI entity, and were guaranteed by Vanke Real Estate (HK). The bonds were supported by a keep well deed and a deed of equity interest purchase undertaking by China Vanke, the onshore listed company. China Vanke needed approval of the Chinese regulatory authorities to guarantee these bonds. Hence, it went in for this type of bond structure. The keep well agreement stated that China Vanke would ensure that i) issuer Bestgain would maintain minimum equity, and ii) issuer and guarantor would maintain adequate resources to service the debt obligations. Else, it would constitute an event of default and the bond trustee could approach the Hong Kong court to require China Vanke to service the debt. The equity purchase undertaking stated that China Vanke would buy equity stake in some subsidiary such that issuer and guarantor get resources required to service the bond obligations.
This structure has been used by some high yield issuers from property sector such as Beijing Capital Land and Gemdale Properties. The various bond structures provide investment opportunities to investors. However, investors should consult financial advisors in order to better understand the complexity and risks involved with various bond issuance structures.