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A Big Trader of Evergrande Bonds Braces for More Wild Swings

Rebecca Choong Wilkins
·5 min read

(Bloomberg) -- After a month of near-constant drama surrounding China Evergrande Group, a sense of uneasy calm has descended on Asia’s biggest issuer of junk bonds.

Michel Lowy says it’s unlikely to last.

The distressed bond veteran and co-founder of SC Lowy is anticipating a rocky end to the year as Evergrande tries to come to grips with the biggest debt pile among real estate companies worldwide. Lowy has a particularly keen interest in the developer: His firm is an active dealer of its dollar notes, trading nearly $200 million worth during just a few days as prices tumbled around the end of September.

Evergrande’s bonds have since recouped some of their losses after the company took steps to avoid a liquidity crunch, but long-term doubts about its financial strength remain.

“This is not something that will be either sorted out soon or something that will default tomorrow,” said Lowy, a former Deutsche Bank AG executive whose eponymous firm provides banking, broker dealer and asset management services with a focus on distressed and high-yield debt. “We should expect quite a bit of volatility going forward.”

In an interview with Bloomberg, Lowy shared his views on Evergrande, the Chinese property industry and the broader high-yield market. Evergrande, which raised $2.2 billion over the weekend by selling a stake in a Chinese investment holding company, didn’t respond to emailed questions.

Evergrande’s dollar bond due 2025 rose about 1 cent on the dollar to 74.7 cents Monday, the highest in nearly three weeks, Bloomberg-compiled prices show. Shares gained 1% in Hong Kong.

Share Sale Surprise

“This has been the story of Evergrande, having major liquidity walls and finding ways to address them. That’s been the story of the group for the last ten to fifteen years. To be honest, I was more surprised at their inability to raise the $1 billion of equity.

Read more: Evergrande Deal Misses Target After Founder Cut Out Rich Friends

“It’s a good thing to raise half a billion dollars and to have an extra half billion dollars of liquidity but it concerns me they weren’t able to raise the amount they were targeting; historically they’ve had very good support. So is that an indication the tide is changing? Possibly.”

Industry Repercussions

“Recent events at Evergrande haven’t fundamentally changed the way I view default risk in the property sector. What did change my view was the announcement by the Chinese government that they’re starting to put measures in place to limit the ability of the most levered borrowers to increase their leverage. That signaled the party may be over for some of those borrowers. And, certainly, at that time we were surprised the market didn’t really move on the news.

Read more: What China’s Three Red Lines Mean for Property Firms

“The recent volatility highlights again that many Chinese developers are very levered and highly dependent on support from financial institutions, government and markets to be able to avoid complex debt restructurings. It also raises the question as to whether one is compensated for the risks taken considering binary outcomes. We are certainly becoming more careful about the developers that have excess debt.”

Trading Volatility

“We increased our exposure together with multiple clients around the dip at the time and, while we buy and sell constantly as a broker dealer, we certainly had more buying interest.

“Now the flows are more two sided, the bonds are yielding 17% or 18% so it’s still extremely wide and a pretty rich yield for a very large corporate that some are deeming too big to fail. Most other China property bonds, even in the single B space, are around the 10% mark. When the prices leveled off, we had a bigger holding than prior to the volatility.

“We trade in 30 to 40 different issuers a day and we were certainly trading actively and providing liquidity during the period of volatility. During those few days, there were a couple of issuers like Kaisa and Sunac that were in focus but 80% of activity was centered around Evergrande.”

Binary Outcome

“It’s a really tough one to handicap and it’s a totally binary outcome. If Evergrande does default and it goes through a massive restructuring, the recovery time for investors will be long.

Read more: Evergrande’s Buyback May Not Ease Concerns on Share Sales

“Around 75 cents for the 2025 bond is a fair price. Fair price all depends on the news flow, but based on what we know, if it was back into the 80s, it would be overpriced and if it was in the 60s it would be interesting again.”

Trouble Ahead

“There’s been a long rally since March where, besides the specific volatility on large issuers like Evergrande or Vedanta, every month the market has been going up and there’s been a lot of inflows into high yield funds.

“I would think that between the specific risk we’ve seen on large issuers in the last few weeks, the U.S. elections, the fact lockdowns may be coming back which would slow down the economy, all that will probably pave the way for a fairly rocky market going into year-end. And especially after a rally that has lasted for almost six months.”

(Updates market moves in seventh paragraph.)

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