* Chaori says can't make 89 mln yuan interest payment due
* Would be first-ever default in China's domestic bond
* Default positive for rational risk pricing in China -
* Chaori default unlikely to spark panic-driven chain
* Government seen likely to allow more defaults
(Adds market reaction, context, analyst quotes)
By Gabriel Wildau and Umesh Desai
SHANGHAI/HONG KONG, March 5 Loss-making Chinese
solar equipment producer Chaori Solar said it will
not be able to meet interest payments on bonds due on Friday in
what would be the country's first-ever domestic bond default,
and possibly the first of many.
The warning by Shanghai Chaori Solar Energy Science and
Technology Co Ltd highlights rising credit risk in China, where
a massive run-up in corporate debt since 2008 - and overcapacity
in sectors such as steel, coal and solar - have threatened the
solvency of many borrowers.
A precedent-setting default, however, could benefit the
economy in the long run by heralding the end of an era of
risk-free credit in China, where local governments have often
used public funds to rescue weak firms in order to prevent
financial and social instability.
"2014 will be the year China seriously cleans up mounting
local government and corporate debts," Lu Ting, China economist
for Bank of America-Merrill Lynch in Hong Kong, wrote in a note.
"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," he added.
In a stock market filing late on Tuesday, Chaori Solar said
it could only pay out less than five percent of the 89 million
yuan ($14.5 million) in interest due on 1 billion yuan worth of
bonds issued in 2012.
"As such, the company will not be able to fully pay the
interest on the 'Chaori-11 bond' in time on March 7," the
Investors took the news in their stride. The cost of buying
protection against a default by the Chinese government within
the next five years, which typically rises if
markets are fearful about credit risk, actually fell by 6 basis
points in morning trade.
The benchmark yield on five-year corporate bonds rated AA-
AA-M5Y=CFXS was flat at 7.27 percent, well below the record
high of 8.07 percent set on Dec. 30. AA- is the lowest rating at
which most companies are able to sell paper in China's domestic
"We judge the systemic risk to the overall bond and
financial markets from this potential default to be small,"
Barclays analysts wrote in a note to clients.
"The likelihood of a credit or a financial crisis, and its
overall macro and growth impact, is also small for now."
China's domestic bond market was worth 9.3 trillion yuan
($1.5 trillion) at the end of last year. The overall bond market
is the world's third largest after the United States and Japan.
NO WHITE KNIGHT
Chaori narrowly avoided a bond default in January 2013 after
a local government in Shanghai persuaded banks to defer claims
for overdue loans, which enabled the company to meet interest
This time, however, a last-minute rescue appears unlikely.
The Shenzhen stock exchange, where Chaori's bond trades,
requires issuers to notify investors two days in advance of
scheduled payments and Chaori's notice late on Tuesday indicates
it is already resigned to missing the deadline.
But the company also said it was working to secure the
necessary funds, leaving open the possibility the interest
payment may occur after a delay. The bond matures
in March 2017 and carries an interest rate of 8.98 percent.
Analysts say a default could help reduce the moral hazard
caused by the widespread assumption that corporate bonds,
regardless of the financial health of the issuer, enjoy an
implicit guarantee from the government and state banks.
"Onshore investors are now likely to sell higher risk bonds
and in the short term there will be a flight to quality," said
Moody's Hong Kong-based senior credit officer Ivan Chung.
"In the longer term it will change investor expectation of a
default. They will factor in more credit risk for pricing in
expected yields for bonds."
Chaori's default warning also coincides with the annual
meeting of China's political leadership, which could be a sign
of the government's commitment to clamp down on borrowing by
weak companies and wasteful investments, ratings agency Fitch
said in a note. China is trying to reduce its reliance on
investment for economic growth.
While domestic bond defaults are so far unprecedented,
Chinese markets were on edge last month when a high-yield
investment product issued by China Credit Trust Co Ltd warned it
may not pay out on maturity.
That product eventually paid out principal, though not
interest, after an unnamed white knight stepped in, but a few
days later, another high-yield product issued by Jilin Province
Trust failed to pay out on schedule.
Both trust products were based on loans to deeply indebted
Defaults on offshore bonds issued by Chinese firms have
occurred before. LDK Solar Co Ltd's missed several
interest payments on offshore U.S. dollar bonds last year.
China's solar industry has in recent years suffered from
severe overcapacity and falling prices for photovoltaic cells,
while the government has been embroiled in a trade war with the
United States and the European Union
Chaori on Friday reported a net loss of 1.33 billion yuan
for 2013, less than its loss of 1.68 billion yuan in 2012. But
the operating income fell by 60 percent in 2013, in a sign of
its ongoing struggles.
($1 = 6.15 Chinese yuan)
(Additional reporting by Kazunori Takada in SHANGHAI; Editing
by Miral Fahmy)