First China Onshore Default Looms as Chaori to Miss Payment

Shanghai Chaori Solar Energy Science & Technology Co. said it may not be able to make an 89.8 million yuan ($14.6 million) interest payment in full on March 7, in what would be the first default of an onshore bond.

The maker of energy cells to convert sunlight into power, plans to pay 4 million yuan to bondholders, the company said in a statement to the Shenzhen stock exchange yesterday. The stock has dropped 41 percent over the past 12 months to 2.59 yuan a share before trading was halted on Feb. 19.

A default would highlight strain in China’s $4.2 trillion bond market after a trust product issued by China Credit Trust Co. was bailed out in January. China’s renewable energy industry faces a record $7.7 billion in bonds maturing this year, testing the resolve of Premier Li Keqiang who needs to allow industry consolidation to slow a buildup of debt in the economy estimated by a state think tank to the equivalent of 215 percent of gross domestic product.

“This is the first onshore default,” said Yang Kun, a Shanghai-based bond analyst at Guotai Junan Securities Co. “It shows regulators’ attitude toward defaults has changed and they’re silently permitting defaults. Risk appetite will slump substantially.”

Protest Planned

There haven’t been any defaults in China’s publicly traded domestic debt market since the central bank started regulating it in 1997, according to Moody’s Investors Service. Guosen Securities Co. estimates Chinese non-financial companies’ debt ratios reached 93 percent last year, while the average in Asia hasn’t surpassed 70 percent in the last 10 years, according to a report released on Dec. 2.

“They’re going to miss the coupon payment,” said Ivan Chung, a Moody’s senior credit officer in Hong Kong. “If the underwriters or the authorities don’t come out with a bailout plan, it’s as good as the first default in China’s public bond market.”

Some Chaori Solar bondholders plan to complain to the Shanghai Fengxian local government later today and “express their anger” at its not aiding the company, the 21st Century Business Herald reported on its website.

Chaori Solar “will try to figure out when money will arrive as soon as possible” and “try to keep the losses of bondholders to a minimum,” according to yesterday’s stock exchange filing. Directors’ salaries will be cut or delayed and capital expenditure projects will be suspended, it said.

‘Good Thing’

Chaori Solar sold 1 billion yuan of five-year notes in March 2012 with a variable annual coupon, starting at 8.98 percent, according to Bloomberg data. Bondholders have the right to sell the bonds back to the company at par in March 2015. The notes were priced at 76.2 percent of face value yesterday, according to ChinaBond valuations.

A default may be China’s “Bear Stearns moment,” prompting investors to reassess credit risks as they did after the U.S. lender was bailed out in 2008, according to Bank of America Merrill Lynch.

“We doubt the financial system in China will experience a liquidity crunch immediately because of this default but we think the chain reaction will probably start,” Bank of America strategists David Cui, Tracy Tian and Katherine Tai wrote in a note, adding that during the global financial crisis it took a year to “to reach the Lehman stage” when investors began to panic and shadow banking froze.

Healthier Market

The bank’s head of greater China economics in Hong Kong, Lu Ting, said in a separate report a default would help ensure better market pricing and a healthier bond market. China’s corporate bond market totaled 8.7 trillion yuan at the end of January compared with 800 billion yuan at the end of 2007, according to Bank of America estimates.

That Chaori Solar would default on its debt was “to some extent expected given the financial stresses the company had been under for several years,” according to Nomura Holdings Inc. Hong Kong-based economist Zhang Zhiwei. “The immediate repercussions in the bond market may not be systemic.”

Fitch Ratings Ltd. said a default would be “positive for the market in the long term as it will instill greater discipline to price credit risk more effectively.”

Industries with overcapacity such as solar, steel and shipbuilding are struggling under the weight of higher borrowing costs. The premium of five-year AA bonds over top-rated notes widened to 148 basis points on Feb. 12, the most since April 2012, before narrowing to 141 yesterday.

Guotai Junan’s Yang said yields on speculative-grade notes may rise 200 basis points once investors realize there may be more defaults in the pipeline.

‘Declare War’

LDK Solar Co. has already defaulted on its overseas debt, while Suntech Power Holdings Co. filed for bankruptcy protection in U.S. courts. Bond maturities will start to slow next year, with an average of $2.3 billion falling due in the coming five years.

Shanghai-based Chaori Solar’s announcement came on the eve of the annual session of China’s National People’s Congress, the country’s legislature. Li told the NPC today the government will “declare war” on pollution and address debt risks.

Renewable energy firms issued $8.1 billion of debt in 2013 and a record $9.6 billion in 2012, data compiled by Bloomberg show. Chaori Solar reported a net loss of 1.33 billion yuan for 2013, its third straight annual earnings deficit. It avoided a default last year around the same time.

Bank Loans

Solar-cell prices have begun to recover after falling 70 percent since 2010 as an industrywide expansion of capacity exceeded demand. The average spot price of polysilicon, which is used in solar cells, climbed 25 percent in the past year to $20.69 per kilogram on Feb. 24, according to Bloomberg New Energy Finance.

Just three to five “leading” solar companies will remain in China by 2017 and account for 80 percent of the market, Trina Solar Ltd. Chairman Jifan Gao said in a January interview. Trina Solar, which returned to profitability in the third quarter, bought a majority stake in solar-cell producer Hongyuan PV Science and Technology earlier this year.

It’s become harder for unprofitable companies to obtain bank loans for interest payments because of stricter risk management policies at lenders, according to Xu Hanfei, a Shanghai-based analyst at Guotai Junan. Chaori’s debt-to-asset ratio was 90.1 percent at the end of the third quarter, according to a company financial report released Oct. 27.

“In the short term investors will be risk averse, after all, it’s an actual default,” said Zhang Yingjie, a Beijing-based deputy general manager in the research department of Moody’s China joint venture, China Chengxin International Credit Rating Co. “But in the long term, investors will see that returns also reflect risks, which will benefit the development of the market.”