It’s hard to outdo Beijing’s extravagant National People’s Congress, the annual meeting of parliament. But a small solar company that’s teetering on the edge of default might do just that on Friday.
The company, Shanghai Chaori Solar Energy Science and Technology, said in a statement to the Shenzhen Stock Exchange on Wednesday that it could pay a trifling US$653,462 (RMB4 million) on a US$14.54 million bond-interest payment due on Friday. As long as the local government in Fengxian, a district of Shanghai, doesn’t come to the rescue, China will witness its first onshore corporate default.
Such a development could crowd out the long policy statements China’s top leadership is delivering at the congress in Beijing this week. Ironically, China’s new administration was expected to focus on the risks associated with corporate and local government debt, among many other topics, at the meet.
Senior leaders no doubt would have preferred to discuss this on their own terms.
Chaori issued a five-year US$163 million bond in March 2011 but ran into financial problems in December 2012. The company made a full payment last year but trading of the bond was suspended in June. At that time both the banking and the securities regulators said they would help restructure it.
The bond’s underwriter, China Securities, has deep pockets. So does the jurisdiction it hails from. That makes a quick and quiet bailout all the more feasible and Wednesday’s announcement even more surprising. A Bank of America Merrill Lynch report called the potential default China’s “Bear Stearns moment,” that sudden realization that all might not be well with the assets that many are heavily invested in. The country’s “Lehman stage,” or severe panic in the markets, is still a way off, though Bank of America thinks “that it may take less time in China as the market here is less transparent.”
Chaori is part of a much larger ecosystem of corporate distress. Corporations in China this year will have to pay back more than US$425 billion in principal and interest. Refinancing the debt is growing increasingly expensive amid higher borrowing costs and rising interest rates on bonds.
“Unfortunately, most of the corporates with a negative credit outlook already have high debt-asset ratios and may also face the problem of overcapacity, which has negative effect on profit and solvency improving,” Zhang Yingjie, a senior researcher at Chinese rating agency CCXI, said earlier this year in an interview. The description fits Chaori well, given that it’s part of China’s glutted solar industry.
The reason why China Securities, a joint venture between Huijin Investments and the Beijing arm of the national state-asset regulator, isn’t jumping in and saving face during the congress event shows a major change in attitude toward how China will deal with emerging risk in corporate debt.
“Chaori’s expected default coincides with the annual National People’s Congress, a meeting of China’s political leadership. That the Chaori default has been allowed to emerge may signal a shift in the government’s stance towards a greater tolerance of outright corporate defaults,” Fitch Ratings said in a note on Wednesday.
Many retail investors bought the bond, Fitch noted, meaning that average Chinese people would lose money in a default, not just wealthy investor consortiums. The ownership of debt has been a sticky subject for Beijing, which is still nervous about letting the small guy take losses.
At the end of January, China Credit Trust was set to default on a US$500 million trust product due to mature. The government showed disinterest in bailing the company out, likely because the bust would not put the wealthy investors in the product out on the street. Still, before January 31, an unidentified buyer swooped in and bought the products, reinforcing an implicit government guarantee on the highly risky products and delivering a shot of morphine to the market with the hope of temporarily easing the pain. Suntech Solar defaulted on a US$541 million bond last year but that company was incorporated in the Cayman Islands and the investors were all offshore.
If Beijing allows the much-smaller Chaori to default on Friday, it’s removing that implicit guarantee and cutting off the supply of painkillers, at least to the smallest players that don’t pose any systemic risk.
This is what economists mean when they talk about short-term pain for long-term gain in China’s economic reforms. Corporate, trust or even small local-government defaults will hurt all involved but they will reduce risky lending practices and help prevent future – potentially bigger – defaults. In the corporate bond market, a default would better price risk into bonds.
The congress in the capital this week might be able to steal the show back from Chaori if the leaders come out with a strong message on what kind of financial pangs they are willing to tolerate.