UPDATE 3-Second private Chinese firm defaults on bond - report

Tue Apr 1, 2014 6:08am EDT

(Adds details about company, context on government policy)

SHANGHAI, April 1 (Reuters) - A small construction materials company failed to pay interest on 180 million yuan ($29 million) of bonds, a national newspaper said on Tuesday, marking China's second default on a domestic bond in a matter of weeks.

The latest default news underlines fears of rising credit risks in China, partly fuelled by signs that the economy is slowing down, especially the real estate sector, a key driver of growth.

Xuzhou Zhongsen Tonghao New Board Co Ltd missed an interest payment due March 28 on high-yield bonds issued last year , the 21st Century Business Herald reported. With a coupon rate of 10 percent, according to Thomson Reuters data, the interest payment would be worth 18 million yuan.

A default by Xuzhou Zhongsen would be the first in China's high-yield bond market, which was launched in June 2012 in a bid to expand financing channels for small, private firms.

It comes after Shanghai Chaori Solar Energy Science and Technology Co Ltd missed an interest payment on a yuan bond last month, becoming China's first-ever domestic bond default.

Chaori's default was seen as a landmark for Chinese markets, turning on its head a long-held assumption that even high-yielding debt carried an implicit state guarantee.

Following Chaori's default, Premier Li Keqiang warned that China's economy faced "severe challenges" and that further defaults would be "hard to avoid," signalling the government has become more reluctant to step in to support failing companies.

Semiconductor, software, and commodities firms are among the most at risk for default, a Reuters analysis of more than 2,600 Chinese companies showed.

Market reaction to the latest default news was muted. The Shanghai Composite Index closed 0.7 percent higher on Tuesday.

A comparable corporate bond from Heilongjiang Beidahuang Agricultural Group Corp, also due to mature in 2015 and carrying a relatively low AA rating, changed hands at a yield of 6.1 percent on Tuesday, unchanged from Monday.

Still, shares in Shandong Molong Petroleum Machinery Co Ltd dropped as much as 8.9 percent on Tuesday after the company reported a full-year loss for 2013.

Molong is due to pay a coupon on June 7 on 500 million yuan in bonds issued last June. The bonds offered a yield of 15 percent on Tuesday, up from 6.7 percent in late February. The company told Reuters earlier this month that rising yields are unrelated to its ability to repay debts.

Xuzhou Zhongsen is an affiliate of Zhongsen Tonghao Group Co, whose businesses include construction materials, real estate and logistics. The company, based in east China's prosperous but highly indebted Jiangsu province, makes synthetic wood-like materials used in ceilings, floors and panelling. It couldn't be reached for comment.

Prices for steel, copper and other basic materials have fallen in recent months as the real estate market and broader economy have slowed.

Xuzhou Zhongsen's bonds were guaranteed by Sino-Capital Guaranty Trust Co Ltd, but it declined to pay out, arguing that the guarantee had been issued by one of its local branch offices without head-office approval, the newspaper said, quoting an unnamed source.

Sino-Capital had sufficient funds to honour the guarantee, the 21st Century Business Herald said.

Beijing's tougher debt stance comes after leaders said they would allow market forces to play a greater role in the economy and to move away from the breakneck growth that was fuelled at times by wasteful investment. By forcing markets to price risk more accurately, they hope to cut back on poor investment decisions.

The trick for policymakers is to prod markets in the right direction without undermining confidence in the financial system following a massive buildup of debt since the global financial crisis. China's overall debt-to-GDP reached 221 percent at end-2103, according to Standard Chartered estimates. Corporate debt accounts for the majority of that total.

Highlighting the difficult financing conditions facing small, private firms, Xuzhou Zhongsen has also resorted to high-interest borrowing from China's shadow banking sector to raise funds.

In July 2012, China Jingu International Trust Co Ltd sold an investment product worth 1 billion yuan to wealthy investors based on a loan to the company. The product offered a yield of 9.5 to 10.5 percent and paid off on schedule when it matured in September 2013.

Xuzhou Zhongsen's bonds were still priced at a discount of less than 2 percent to par value on Tuesday, Thomson Reuters data showed, which likely indicates the bonds are not regularly traded, with no transactions in recent days or weeks that would reflect the market's latest assessment of their value. (Reporting by Gabriel Wildau; Additional reporting by Xu Yong and Shanghai Newsroom; Editing by Mark Bendeich and Neil Fullick)

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