China On The Verge Of First Corporate Bond Default Once More

While everyone was focusing on the threat of tumbling debt dominoes in China's shadow banking sector, a new threat has re-emerged: regular, plain vanilla corporate bankruptcies, in the country with the $12 trillion corporate bond market (these are official numbers - the unofficial, and accurate, one is certainly far higher). And while anywhere else in the world this would be a non-event, in China, where corporate - as well as shadow banking - bankruptcies are taboo, a default would immediately reprice the entire bond market lower and have adverse follow through consequences to all other financial products. This explains is why in the past two months, China was forced to bail out not one but two Trusts with exposure to the coal industry as we reported previously in great detail. However, the Chinese Default Protection Team will have its hands full as soon as Friday, March 7, which is when the interest on a bond issued by Shanghai Chaori Solar Energy Science & Technology a Chinese maker of solar cells, falls due. That payment, as of this moment, will not be made, following an announcement made late on Tuesday that it will not be able to repay the CNY89.8 million interest on a CNY1 billion bond issued on March 7th 2012.

FT reports [15]:

The company has until March 7th to repay the interest, charged at an annual 8.98 per cent, the company said in a statement. “Due to various uncontrollable factors, until now the company has only raised Rmb 4m to pay the interest,” it said in the statement.

Trading in the Chaori bond, given a CCC junk rating, was suspended last July because the company suffered two consecutive years of losses. The company had a further RMB1.37bn loss in 2013, according to the results it posted on the exchange.

Just pointing out the obvious here, but how bad must things be for the company to be on the verge of default not due to principal repayment but because two years after issuing a bond, it only has 4% in cash on hand for the intended coupon payment?

Furthermore, as noted previously, China has so far been able to kick the can on its defaults for nearly three decades. Which is why suddenly everyone is focusing on this tiny company: Chaori Solar’s default – if it transpires – would mark the first time a company has defaulted on publicly traded debt in China since the central bank began regulating the market in the late 1990s. Bloomberg adds, citing Liu Dongliang, Shenzhen-based senior analyst at China Merchants Bank, that such a default would be the "first of a string of further defaults in China.” FT continues:

Though the bond is relatively small, a default could deliver a sharp shock to risk management strategies in China vast corporate debt market, estimated by Standard&Poor’s to be $12tn in size at the end of 2013.

Any default could also slow down new issuance. A Thomson Reuters analysis of 945 listed medium and large non-financial firms showed total debt soared by more than 260 per cent, from Rmb1.82tn to Rmb4.74tn, between December 2008 and September 2013.

In January, a Chinese fund company avoided a high-profile default, reaching a last-minute agreement [16] to repay investors in a soured $500m high-yield investment trust, in a case that had sent tremors through global markets.

Then again, those who follow China's bond market will know that Chaori's failure to pay interest would not really be the true first Chinese corporate default: recall as we reported almost exactly a year ago [17]:

For the first time, a mainland Chinese company has defaulted on its bonds. SunTech Power Holdings has been clinging on by its teeth but after failing to repay $541mm of notes due on March 15th - and following four consecutive quarters of losses through the first quarter of 2012 and since then having failed to report quarterly earnings - owed to Chinese domestic lenders, the firm is restructuring. As Bloomberg reports, Chinese solar companies are struggling after taking on debt to expand supply, leading to a glut that forced down prices and squeezed profits - and most notably were unable to renegotiate its liabilities and obtain “additional flexibility” from creditors. This is highly unusual and perhaps is the beginning of a trend for Chinese firms.

So yes: a prior default, and one by a solar company no less. However, going back down memory lane again, ultimately Suntech had the same fate as all other insolvent corporations in China do - it got a post-facto bailout [18]:

Struggling Chinese solar panel maker Suntech Power Holdings Co Ltd is set for a $150 million local government bailout, a step towards tackling its $2.3 billion debt pile that is at odds with Beijing's effort to wean the sector off state support. The lifeline comes from the municipal government of Wuxi, an eastern city where Suntech's Chinese subsidiary is headquartered, and follows Shunfeng Photovoltaic International Ltd's signing of a preliminary deal to buy its bankrupt Chinese unit.

Curious why China's local government continues to balloon at an exponential pace, and has doubled in roughly two years to roughly CNY20 trillion [19](that's the real number - the official, made up one is CNY17.9 trillion or $3 trillion [20])? Because just like the Fed and ECB are the ultimate toxic bad banks in the US and Eurozone, respectively, in China all the bad debt ultimately disappears under the comfortable carpet of the broad "local government debt" umbrella. However, things like these must never be discussed in polite public conversation. Which is why despite what Guan Qingyou, an economist with Minsheng Securities said in his Weibo account that the "first default might not be a bad thing even that means more defaults might happen, because it is ultimately good for the market reform", the reality is that once the dam breaks, it may well be game over for a country that only knows one thing - how to kick the can ever further.

There are additional considerations: As the FT also notes, "given the squeeze on credit supply already seen in January this year, corporate debt defaults could further slow momentum in China’s fixed asset investments." In other words, the just announced 7.5% GDP target revealed ahead of the National People's Congress will be impossible to achieve, should China be unable to fund the Capex to build its burgeoning ghost cities, should rates spike.

Which is why this too default will ultimately be made to disappear.

And the next one, and the one after that, because "now" is never the right time to make the right, but difficult decision.

But how much longer can China avoid reality? Not much if one consider this just crossed headline on Bloomberg:

CHINA TO SHUT 50,000 COAL FURNACES THIS YEAR, LI SAYS

Recall coal is the industry that China's near-bankrupt Trusts have most of their exposure to [21].

And then there are our four favorite charts confirming the dire situation in China's credit market:

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For those who need a refresh course on why the Chinese situation is rapidly going from bad to worse, read these several most recent comprehensive articles on the topic:

Bank of America warns further that a more confident government means the start of defaults...

With amazing speed in consolidating power in 2013, a more confident President Xi Jinping and team are expected to push for a wide range of reforms. 2014 will be the year for China seriously cleans up mounting local government and corporate debts which have been rapidly accumulated since late 2008. We believe the chance of some bond and trust loan defaults will rise significantly in 2014, especially as the more confident government sees the need for some defaults to develop a more disciplined financial market