China Gets 1st Onshore Bond Default as Chaori Doesn’t Pay

China’s onshore bond market experienced its first default as a solar-cell maker failed to pay full interest on its bonds, signaling the government will back off its practice of bailing out companies with bad debt.

Shanghai Chaori Solar Energy Science & Technology Co. is trying to sell some of its overseas plants to raise money to repay the debt, Vice President Liu Tielong said in an interview yesterday at the company’s Shanghai headquarters. The company said March 4 it would only be able to pay 4 million yuan ($653,000) of an 89.8 million yuan coupon due yesterday.

The number of Chinese companies whose debt is double their equity has surged since the global financial crisis, suggesting this first onshore bond default won’t be the nation’s last. Publicly traded non-financial companies with debt-to-equity ratios exceeding 200 percent have jumped 57 percent since 2007. Chaori Solar may become China’s own “Bear Stearns moment,” prompting investors to reassess credit risks as they did after the U.S. securities firm was rescued in 2008, according to Bank of America Corp.

“There will be more defaults in China’s onshore bond market,” said Qiu Xinhong, a bond fund manager in Guangzhou at Golden Eagle Asset Management Co., which oversees 13.9 billion yuan in assets. “The next default will be likely to happen in overcapacity industries, such as steel, nonferrous metals and coal. Bond investors will shun private companies with heavy debt burdens because they’re the most at risk.”

Chaori Yields

The yield on Chaori Solar’s bonds due 2017 was at 22 percent before trade was halted on July 8, exchange data show. 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 data compiled by Bloomberg. The notes were downgraded to CCC from BBB+ by Pengyuan Credit Rating Co. in May.

Chaori’s default, which occurred during the annual session of China’s legislature, sent a signal that the government is more willing to tolerate such failures as it seeks to give market forces a more decisive role in the economy. China should set up a system for bonds to default, Liu Mingkang, former chairman of the China Banking Regulator Commission, said yesterday.

“Whenever a default becomes possible, there’s always either the government or a bank stepping in to coordinate a debt restructuring,” Liu said in remarks to a session of the Chinese People’s Political Consultative Conference in Beijing. “There still isn’t a normal, market-oriented bond default system, distorting the financial market’s risk allocation functions.”

Wake-Up Call

A default would be a “wake-up call” and advance the growth of China’s bond market, Moody’s Investors Service said in a report e-mailed yesterday. It would also “signal regulators’ higher tolerance for corporate bond defaults amid financial market reforms, which is in line with the current central administration’s shift to adopt more market-oriented policies,” Moody’s said.

Some “zombie” companies in China with cash shortages will fail as authorities end overly loose monetary policy, Xia Bin, an adviser to the State Council and former central bank board member, said on Feb. 10.

Total debt of publicly traded non-financial companies in China and Hong Kong has surged to $1.98 trillion from $607 billion at the end of 2007, according to data compiled by Bloomberg. A total of 63 have debt-to-equity ratios exceeding 400 percent, compared with the average of 73 percent. Renewable energy, materials, household appliances and software companies dominate the rankings.

Solar Farms

Chaori Solar ran into trouble because it expanded into building solar farms to produce power rather than just manufacturing panels, which is much cheaper, Wang Xiaoting, a Beijing-based analyst at Bloomberg New Energy Finance said yesterday by phone. Most surviving solar companies have become more cautious about expansion, she said.

According to the 2012 prospectus for Chaori Solar’s notes, China Guangfa Bank Co.’s Shanghai branch and China Citic Bank Corp.’s Suzhou branch agreed to extend 800 million yuan in loans to Chaori Solar if the company faces a temporary cash squeeze. Chaori Solar also has $100 million of insurance against trade receivables to help meet repayments, according to the sale document.

Bond Manager

The prospectus also says investors in the notes can ask the entrusted bond manager, China Securities Co., to force Chaori Solar to make payments, and participate in any reorganization or insolvency proceedings. Chaori Solar must explain its situation in writing to the entrusted bond manager if it can’t make interest payments and if the default lasts longer than 30 days.

“We may see other bonds default this year,” said Li Ning, a bond analyst in Shanghai at Haitong Securities Co., the nation’s second-biggest brokerage. “If it’s a default by a financial institution, it may turn into an extreme situation somewhat like the collapse of Lehman Brothers.”

Calls to officials at China Citic Bank in Suzhou weren’t answered yesterday. Calls to China Guangfa Bank’s Shanghai branch after office hours also weren’t answered. Liu said the company is in talks with both banks about liquidity assistance.

Not Guaranteed

Citic Bank won’t help Chaori Solar make any interest payment on its bonds because they weren’t guaranteed, the 21st Century Business Herald reported March 6 on its website, citing an unidentified person from the lender. An earlier liquidity support agreement between the bank and the company can’t be interpreted as a bond guarantee, the report said.

“This will likely be the first of many defaults, although I don’t think it’s going to cause a cascading effect,” said Brian Coulton, a global emerging-market strategist in London at Legal & General Investment Management, which manages some 450 billion pounds ($753 billion) globally. “Short term, we’re likely to see higher bond yields, but in the long term this will create a better market for pricing credit risk.”

The yield on five-year AA- notes rose eight basis points to 7.77 percent on March 5, the most in almost four months, and ended the week at 7.82 percent. Ratings of AA- or below in China are equivalent to non-investment grades globally, according to Haitong.

Borrowing Costs

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 similar-maturity government securities widened to 363 basis points yesterday from near a three-month low of 349 on March 4 before Chaori Solar’s first statement.

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.

Companies in China have postponed or delayed at least 6.6 billion yuan of bond sales over the past four days, according to data collected from ChinaBond, China Money and Shanghai Clearing House websites.

Four issuers pulled domestic notes sales on the Chaori Solar news. Suining Chuanzhong Economic Technology Development Co. will delay a 1 billion yuan offering due to “serious fluctuations in the bond market,” it said on ChinaBond’s website March 5. Taizhou Kouan Shipbuilding Co., Xining Special Steel Group and Qunsheng Group Co. also scrapped offerings for similar reasons.

Default Risks

People’s Bank of China adviser Chen Yulu said yesterday that default risks for trust products in the country are under control and aren’t systemic, the official Xinhua News Agency reported.

“This is the first default in a relatively new bond market with limited spillover effects,” Hans Stoter, the chief investment officer at ING Investment Management Co., said in an interview in Singapore yesterday. “It’s an important test to see the workout process and what losses will be incurred by domestic investors. We’re watching with great interest.”

— With assistance by Judy Chen, and David Yong

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