'Fail-Safe' Bond Default Shakes Chinese Bond Market

NEW YORK (TheStreet) -- A corporate bond market that raised $77 billion for Chinese companies in 2013 is losing its innocence after a struggling solar panel manufacturer warned of a pending interest payment default.

A few ETFs cater to the Chinese bond market, including PowerShares Chinese Yuan Dim Sum Bond (DSUM) and Market Vectors Renminbi Bond ETF (CHLC). Both have been treading water, pretty much breaking even over the past year and YTD.

Chaori Solar Energy is shaking up this market. Chaori is expected to become the first corporate bond issuer to stiff investors on the Chinese market, which has been an increasingly important fund-raising tool for the nation's small and mid-sized companies ever since bank credit tightened after the 2008 global financial crisis.

A Chaori notice posted by the Shenzhen Stock Exchange, where trading in the company's shares was suspended Tuesday, March 4, said it could pay only 4 million yuan toward 89.8 million yuan in interest on its bonds due Friday, March 7.

Investors -- apparently including some foreign institutions -- were expecting their share of the interest on the 1 billion yuan in five-year bonds they bought in March 2012.

The default warning marked a turning point for the nation's bond trade, according to a China Merchants Securities research report. Until now, bonds and most credit products in China have been touted as nearly fail-safe thanks to a tradition of outright or indirect bailouts by the government and state-owned banks.

"This means that the myth of the indomitable payment in China has been smashed," the report declared. "The significance of this event, no matter how you look at it, cannot be overstated."

Bond defaults are likely to become more common, the report said, raising corporate financing costs to cover credit risks.

The government, through an ongoing economic reform campaign, last year signaled its intent to start foregoing bailouts and let the market shape the credit sector. But in January, a last-minute bailout for a teetering 3 billion yuan China Credit Trust wealth product sold to 700 retail investors raised questions about the government's sincerity.

Apparently it's different this time. China Central Depository & Clearing, the government agency that oversees the bond market, said Wednesday that "the Chaori event" had sparked "significantly" higher bond market yields on government treasury, policy bank and corporate bonds.

Government agencies and policy banks issue most of the country's bonds. Of the 5.6 trillion yuan in bonds sold last year, the clearing house said, those issued by companies raised only 475 billion yuan, or $77 billion.  

Chaori's notice, without naming bond holders, said it had drawn up a two-tier system for partial compensation. One tier was for Chinese investors, while the other was designed for foreign investors who bought bonds through the government's Qualified Foreign Institutional Investor and Renminbi Qualified Foreign Institutional Investor programs.

"Now that credit risks have been completely exposed," the China Merchants report said, "institutional investors, retail investors... and rating agencies must face up to the problems and revaluate credit risk."

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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