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Chaori Default Shifts Chinese Bonds Landscape

NEW YORK (The Deal) -- China witnessed its first domestic bond default Friday when solar equipment maker Shanghai Chaori Solar Energy Science & Technology failed to make a full payment on an 89.8 million renminbi ($15 million) coupon.

The default, though small, is significant as it is the first time China's state-backed lenders have failed to backstop the onshore bonds of one the country's many heavily indebted, listed businesses.

"Over the past few years, municipal governments and banks in China have stepped in to help distressed companies meet their bond payment obligations," noted Moody's Investors Service Ivan Chung on Friday. "These bailouts have led some investors to overlook the fundamental credit risks in bonds."

Loss-making Chaori said on Thursday that it planned to pay about Rmb4 million ($654,000) of the Rmb89.8 million coupon on a Rmb1 billion bond due in 2017. The company blamed an inability to raise new funds for its failure to pay the full bond coupon.

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The default comes just over a year after Chaori narrowly avoided default when a Shanghai local government convinced the solar company's bank to extend the terms on overdue bank loans.

The default will raise the importance of Chinese companies' risk profiles, introduce more accurate pricing of company debts and encourage more efficient capital allocation by the bond markets, according to Chung.

China's onshore bond market lacks many of the safeguards that western markets take for granted, including bond covenants, while bondholder-recovery mechanisms are untested. Despite those deficiencies Chinese corporate bonds have proven a popular investment, largely because of the perception that they were underwritten by the state. China's corporate debt market was worth $12 trillion at the end of 2013 and could reach $13.8 trillion in 2014, leapfrogging the U.S. as the world's largest debt market, said Standard & Poor's.

The default could be the first of many among small and midsized Chinese companies, according to some analysts, who predict the Chinese government will allow defaults in sectors with significant overcapacity, such as solar panel producers and steel manufacturers.

Chaori bonds are rated CCC. They have been suspended since July after the company posted its second consecutive yearly loss.

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