Chaori bond

Chinese default landmark looms

Chaori Solar said it would not make a March 7 interest payment, signalling China's first default. Some are calling it the country's Bear Stearns moment.

China is finally set for its first-ever bond default after a spate of recent near-misses. Now begins the start of the market's long-overdue reassessment of the country's credit risks.

Shanghai Chaori Solar Energy Science and Technology said late Tuesday that could not pay all of the Rmb89.8 million ($14.5 million) interest due March 7 on the Rmb1 billion 5-year bond it issued in 2011 and listed in Shenzhen.

Chaori said it was only able to pay Rmb4 million, potentially signalling a default - China's first onshore bond default.

To an extent, this landmark credit event has been coming.

In January, a financial trust product issued by China Credit Trust totaling Rmb3 billion was rescued by strategic investors at the last minute. The deal attracted much media attention at the time and flagged China's growing debt risks as the country's economic growth slowed.

Chemical fibre company Shandong Hailong in 2012 also narrowly avoided default on its Rmb400 million short-term bond after an injection of capital from local government and banks.

"The market conditions have changed. Nowadays the government is inclined to let market forces be the decisive role in capital markets and correct credit misallocation,” said Ivan Chung, vice president with Moody’s Investors Service. “If the issuer is a privately-owned company from an industry that has limited impact on the real economy, the government will probably allow its bond to default.”

News of the looming Chaori default nonetheless drew a mixed response from analysts, even inside the same bank, as some drew parallels with the US subprime mortgage crisis and others emphasised the long-term benefits to the Chinese economy from better risk-pricing.

"If a default indeed occurs (especially on principal), we believe that the market will have reached the Bear Stearns stage (when the market started to seriously re-assess subprime debt risk)," said equity strategists led by David Cui at Bank of America Merrill Lynch in Hong Kong.

"We doubt that the financial system in China will experience a liquidity crunch immediately because of this default but we think the chain reaction will probably start," they said in a research note. "In the US, it took about a year to reach the Lehman stage when the market panicked and the shadow banking sector froze. We assess that it may take less time in China as the market here is less transparent."

But other economists and analysts welcomed the shift towards more market-orientated risk pricing.

There's "no need to worry," said Lu Ting, BoA-Merrill Lynch's China economist, because "defaults of some debt products are not on a similar scale to a collapse of a major financial institution."

Spread widening

That was echoed in the onshore debt market where credit yields were largely flat, having moved up slightly in early trade, according to a bonds salesperson in Shenzhen.

But with onshore investors like to grow more aware of the potential risks as a result of Chaori's troubles, it was likely that pressure would build in the long-term, he said.

Ting took the view that onshore credit spreads would likely widen to the detriment of riskier debt products -- a view some market participants looked ready to act upon.

“We are planning to sell some highly-risky assets (debts) and buy in safer notes like government bonds or policy banks’ bonds,” said one Beijing-based bond trader.

Chung of Moody's added that a default by Chaori, by presenting investors with a situation they had not faced before, would help the onshore market to improve its practises. 

Robin Cheng, an analyst covering the solar sector and also with BoA-Merrill Lynch, said the Chinese government had been signalling since 2012 that it would stop funding unprofitable players with limited cost-competitiveness and that it wanted greater consolidation in the sector.

Chaori, which has been struggling due to overcapacity in the solar panel industry, expects to make a loss of Rmb1.05 billion to Rmb1.45 billion in 2013 after posting losses in the previous two years. Domestic rating company Pengyuan in May slashed the company's debt rating to CCC from BBB+ (and before that from AA).

Chaori and its 2011 bond’s underwriter China Securities did not return enquiry emails or calls from FinanceAsia.

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