* No last-minute rescue seen for Chaori to avoid bond
* First-ever default would force re-assessment of credit
* More defaults expected after explosion of corp debt
* Markets calm, but investors may shun risky debt
By Gabriel Wildau
SHANGHAI, March 7 China's first domestic bond
default looked set to occur as expected on Friday as there was
no sign of a last-minute bailout for solar equipment producer
Chaori Solar, an event seen as a landmark for market discipline
in the world's second-largest economy.
The loss-making Shanghai Chaori Solar Energy Science and
Technology Co Ltd warned this week 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
After a series of near misses in recent years, in which
local governments stepped in at the last minute to rescue local
champions, analysts say the precedent-setting default is likely
to force a re-pricing of credit risk in a market that long
assumed even high-yielding debt carried an implicit state
"The Chaori default goes to show the government will begin
to let the market decide the fate of weak borrowers. This test
case indicates the government is addressing the moral hazard
issue," said Christopher Lee, managing director of corporate
ratings for Greater China at Standard & Poor's in Hong Kong.
"Incidence of defaults will likely be incremental but
controlled," he said, nominating metals and mining, shipbuilding
and materials as the key sectors with high default risks.
Chaori did not answer calls seeking comment on Friday. But
no further statements are expected, as the company's exchange
filing late on Tuesday met the requirement that bond issuers
notify investors two days in advance about payment arrangements.
Markets were stoic ahead of the expected default. The
benchmark seven-day bond repurchase rate was
little changed at 2.45 percent at mid-morning, its lowest since
2012. That weighted-average rate had briefly spiked on Wednesday
after Chaori announced it would default, but has since plunged.
The Shanghai Composite Index was down less than 1
percent since Tuesday's close.
"A default would likely make investors recalibrate their
risk-return consideration for onshore bonds," Ivan Chung, senior
credit officer at Moody's Investor Services in Hong Kong, said
in a note.
"Credit risk would play a more important role in pricing,
thereby making the bond market more efficient in the allocation
Chaori narrowly avoided a bond default in January 2013 after
a Shanghai district government persuaded banks to defer claims
for overdue loans.
This time around, the 21st Century Business Herald reported
on Thursday that Chaori had financing lined up that would have
enabled it to meet the interest payment, but the plan fell
through at the last minute.
"This default was totally unexpected. We already had an
interest payment plan in place. But because the counterparty
suddenly changed his mind on the morning of March 4th, we had no
choice but to default," the paper quoted an unnamed senior
company executive as saying.
Nevertheless, a reassessment of credit risk in the world's
second-largest economy appears to be underway. Three low-rated
companies announced postponements to planned bond sales on
Thursday, citing deteriorating market conditions due to Chaori.
In the near term, analysts predict that demand for riskier
credit will fall.
"We suggest investors avoid buying low-rating bonds issued
by private firms in near term due to worsening liquidity and
potential default risks," Wang Ming, partner at Yaozhi Asset
Management Co in Shanghai, wrote in a note on Wednesday.
"We think first credit bond default will change trading
patterns of China fixed-income market and the treasuries and
(treasury futures) markets are likely to be more active as a
result," Wang wrote.
Such an adjustment appears well-justified, as analysts
expect more defaults on loans, bonds and shadow-bank credit this
year. Local governments and firms in industries suffering from
overcapacity are the focus of concern.
Last month, a high-yield investment product issued by Jilin
Province Trust Co Ltd and backed by high-interest loans to a
struggling coal producer failed to repay investors on maturity.
Ratings agency Standard & Poor's estimates overall debt in
China reached 213 percent of GDP last year, up sharply from 140
percent in 2007. Corporate debt comprises the bulk of this
China's domestic bond market was worth 9.3 trillion yuan
($1.5 trillion) at the end of 2013. The overall bond market, at
29.7 trillion yuan, is the world's third-largest after the
United States and Japan.
Also on Friday, media reported the Shanghai government had
approved the launch of a bad-loan bank to buy bad assets from
local banks and other financial institutions. China Business
News said a source close to the bank said the first purchase may
be of troubled loans to Chaori.
(Additional reporting by Umesh Desai in HONG KONG; Editing by