China Is Headed For Its First Domestic Bond Default — And Here's Why That's A Good Thing

China Is Headed For Its First Domestic Bond Default — And Here's Why That's A Good Thing
Mamta Badkar
 

Chinese solar company, Shanghai Chaori Solar Energy Science and Technology Company, announced that it can not pay interests in the amount of 89.8 million yuan (approx $14.6 million) on its 11 Chaori bond, that are due on March 7.
 
 
Instead, the company said it can only pay bondholders 4 million yuan.
 
The 11 Chaori bond was first issued in March 2012 with a coupon of 8.98%, with annual interest due on March 7 every year. But the solar company became another victim of China's excess capacity problem.

The first signs of trouble began to emerge in January 2013 when the company nearly became the first domestic company to have a bond default.

At the time though Shanghai’s Fengxian district stepped in and asked Chaori’s banks to defer claims in the amount of 380 million. And to top it off there were reports that the Chairman had taken off with the company money.

The new announcement makes Chaori the first default of an onshore bond, Bank of America's Ting Lu writes in a note to clients.

A silver-lining
But the bond default might actually be a good thing. "A normal economy needs defaults to better price bonds and other debt products," writes Ting.
We have previously pointed out that this can actually help investors have more information to better price risk.

"If you talk to anyone in China, if you talk to them about the prospect of a financial crisis, the first thing out of their mouths will be that the government will never let that happen," Patrick Chovanec at Silvercrest Asset Management told Business Insider in January. "And until you shake that belief you won't have efficient allocation of resources."
"At some point the financial system does have to turn the corner, where there's real risk and there's real pricing of risk," Chovanec added Ting also say investors needn't be anxious for other reasons.
 
"Defaults of some debt products are not on a similar scale to a collapse of a major financial institution. As we think corporate bonds and incoming trust loan defaults will not lead to a credit crunch, and we are reasonably confident with our 7.6% GDP growth forecast for this year."

That being said, the news has caused corporate bonds to fall, and is "a negative for riskier debt products," writes Ting.

With China's corporate bond market sitting at 8.7 trillion yuan outstanding, up from 800 billion yuan at the end of 2007, Beijing needs to step up the game on its bankruptcy law.
Societe Generale's Wei Yao has previously warned that as local governments struggle with their own financial needs and burdens they could let go of troubled corporates and that stress will emerge in bond markets and trust products.
As Beijing moves to curb local government debt, clean up its financial market, and push through reforms, Ting warns that we should expect bond and trust loan defaults to rise "significantly" this year.
 
 
Read more: http://www.businessinsider.com/china-to-see-first-onshore-bond-default-2014-3#ixzz2v5sT42NM

China's government bond situation is potentially even worse, although the central government has thus far kept a lid on it. Having ultimate control of everything does have some advantages I guess.