Cloud Live bond default tests market credulity

China's second public corporate bond default hasn't spooked investors. Instead, some appear willing to bet on a White Knight riding in again to save the day.
After seeing an earlier bond default averted, investors have come to see light at the end of every potential bond default in China
After seeing an earlier bond default averted, investors have come to see light at the end of every potential bond default in China

The market's reaction so far to Cloud Live Technology Group’s missed bond repayment shows onshore credit market needs a real default to break investors’s belief in the Chinese state's implicit guarantees.

Cloud Live said in a statement on Tuesday it was short Rmb241 million ($39 million) needed to repay a Rmb402 million bond issued three years ago.

The company, a Shenzhen-listed restaurant chain with plans to shift focus to information technology, has the distinction of being the onshore debt market’s second default on a public corporate bond after Shanghai Chaori Solar missed an interest payment of Rmb89.8 million on its bond in March last year.

But unlike Chaori’s default, which led to some market concerns and triggered investor lawsuits, news of Cloud Live didn’t arouse much fear in the market.

In reaction, high-yield corporate bonds of the same vintage have barely changed. On average, yields on CC-rated notes slipped on Tuesday to 52.2987% from last Friday’s 52.2991% while on BB-rated bonds they eased to 19.1622% from 19.1626%, according to China Bond, the website of China's bond depository and clearing corporation. That's hardly setting the heather on fire.

Trading in Cloud Live bonds was suspended on April 2 and local rating company Pengyuan cut the company's rating to CC from BB on April 4.

More surprisingly, the company’s stock price rose 9.95% on the day news of the default broke, gaining a further 3.6% to Rmb8.7 on Wednesday.

White Knight

A-share market fever only partly explains this seemingly perverse reaction. That's because equity investors now buying into Cloud Live believe strategic investors will eventually come in and help to restructure the company.

“Investors [are betting] on the potential growth after the company’s restructure,” a fund manager based in Shenzhen told FinanceAsia. “Their confidence comes from Chaori’s case.”

With Chaori, Beijing put market stabilisation first and state-owned enterprises saved the day, instead of allowing market forces to play a greater role in the economy, as policymakers had promised. 

Chaori is not an isolated case. Debt investors on the Chinese mainland have dodged defaults in numerous other scenarios, including bonds, trusts, and wealth management products, in private or public markets. In each case, the authorities directly, or through SOEs and other entities, have stepped in and bailed out investors.

“It’s not good once investors get used to it [bail outs],” said Li Ning, a credit analyst at Haitong Securities. An actual default will help correct credit misallocation and help investors to grow more aware of the potential risks, Li said.

The central government, for its part, continues to signal a tolerance for defaults. Premier Li Keqiang, speaking at the close of the National People’s Congress on March 15, said government can tolerate individual cases of financial risk.

Cloud Live recorded a net loss of Rmb60 million in the first quarter and it has posted an annual net loss of more than Rmb560 million in both 2013 and 2014. GF Securities is the trustee of the troubled bond.

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