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Not so grand: Evergrande’s bizarre bond return

China Property (resized 230)
By Morgan Davis
06 Nov 2018

Evergrande’s $1.8bn bond at the end of October sent ripples through Asia’s bond market. It also set a dangerous precedent for a market that is already accused of letting standards slip.

Chinese bond issuers are often in the headlines for the wrong reasons, but it’s usually debut or infrequent borrowers that appear to be abandoning market standards. On October 30, it was a frequent issuer with around $10bn of bonds outstanding, according to bankers. Evergrande, a Chinese property company, sold a $1.8bn bond — but the chairman bought more than half of it.

Much like the frequently seen Chinese high yield bond deals that are sold in what are essentially club trades, Evergrande’s transaction had little actual bookbuilding. The company’s chairman and founder Hui Ka Yan bought $1bn of the transaction both directly and through a company related to him, split across two of the deal’s three tranches. That left just $800m for outside orders.

Bookbuilding appeared limited even when leaving aside the chairman’s huge order. The issuer launched its 2020, 2022 and 2023 notes at final price guidance of 11%, 13% and 13.75%, respectively. That gave investors a generous premium, but it was rumoured that a portion of the $800m was picked up by friends and family as well.

High yield issuers should expect to pay a decent concession to get deals done in this market, but Evergrande was unusually generous. Each of the new notes came at a premium of more than 100bp to Evergrande’s curve. The two year bond, for instance, had a 1.8% yield pickup, according to CreditSights. With that pricing, the deal’s effect on the market was immediate. Evergrande’s existing notes, which were already among the worst trading bonds in Asia the week before, fell 1.6 to 2.3 points the day the trade was announced. On October 31, the day after the pricing, the company’s existing curve was down between one and three points.

How exactly should one interpret a deal that appeared to ignore all market convention?

There are some positives. Chairman Hui said his purchase of the bonds is a demonstration of his faith the company. Some investors told GlobalCapitalAsia they agreed. After all, not many company chairmen would so quickly and willingly funnel $1bn of their own money into their business.

Besides, some bankers argue, isn’t the practice of chairmen buying large chunks of a trade already common in the equity market? Perhaps, but the debt and equity markets are very different animals.

A chairman is typically a major equity holder in a company, so when participating in an equity deal, a chairman’s interests are more closely aligned with other shareholders. (His desire for a cheap equity price during bookbuilding is unlikely to overshadow his urge to protect the large amount of shares he already owns.)

In contrast, a chairman buying bonds issued by his own company is a conflict of interest. The investor wants the best yield he can get. The chairman wants the lowest funding cost. Whether or not you think Evergrande’s yield was a fair one, the precedent it sets should hardly be welcomed.

This is not the first time Evergrande has raised eyebrows. In June 2017, Evergrande sold a massive six tranche deal, as part of an exchange and new money offer, for more than $6.6bn. The sheer onslaught of the paper in the market, coupled with a similarly huge deal from Kaisa Group around the same time, overwhelmed high yield investors, and created problems for other borrowers in the weeks that followed.

The company clearly offers juicy returns to its bankers, but it also risks damaging their reputations. The latest transaction was led by China Citic Bank International, CEB International and Credit Suisse, along with bookrunners Haitong International and UBS. CEB International was, however, added to the transaction during bookbuilding.

Both Credit Suisse and Haitong have been on five of Evergrande’s eight outstanding dollar bond deals, and Citic has been on three.

The Evergrande trade should raise red flags for high yield property investors. The market backdrop has created difficulties for high yield issuers in recent weeks, and companies are no doubt beginning to get desperate for funds. Small companies will not be able to replicate Hui’s support of Evergrande, but they may similarly disregard market norms to secure trades.

It is not uncommon to see Chinese trades sold to Chinese investors that have little price sensitivity, making it questionable just how much actual bookbuilding happened. But if China wants its bond market to mature and attract international investors it must conform to accepted standards and stop relying on easy money. Sometimes it’s not worth selling a deal at any cost.

By Morgan Davis
06 Nov 2018