WUXI, China/HONG KONG, March 21 (Reuters) - The local government in Suntech Power Holdings Co Ltd's home town is seeking to bail out the Chinese solar panel maker to avoid an embarrassing corporate collapse, a person with knowledge of the matter told Reuters on Thursday.
One proposal under consideration is allowing Wuxi Guolian, the local government's investment arm, to take over Suntech's Wuxi business through a restructuring, and test a bankruptcy law introduced in 2007.
"Production has to continue," said the source in the city of Wuxi, where Suntech's headquarters are located. "The Wuxi government is still seeking to bail out Suntech in one form or another. It has no intention to let it collapse as, if that happens, it would damage its reputation."
A Wuxi government spokesman said he had no information on the matter. But the spokesman added: "If there is any news regarding the restructuring, it will be released through Wuxi Guolian."
What happens to Suntech and to the offshore holders of its debt will be an important test of how China deals with foreign investors.
Suntech defaulted on $541 million of its U.S. listed bonds due on Friday, triggering cross-defaults on loans from International Finance Corp (IFC) and Chinese lenders.
At the end of March 2012, Suntech had total debt of $2.2 billion - including loans from China Development Bank, and a $50 million convertible loan from the IFC, the private sector arm of the World Bank.
Nine banks, including Industrial and Commercial Bank of China , Agricultural Bank of China and Bank of China had outstanding loans of 7.1 billion yuan ($1.1 billion) to Suntech at the end of February, according to state news agency Xinhua.
Eight Chinese banks that have lent money to Suntech want the company's main unit, Wuxi Suntech Power Holdings Co Ltd, declared insolvent.
The Wuxi government has been a big promoter and supporter of the company, which in its heyday was a $16 billion symbol of China's green technology ambitions.
Spurred by government incentives and credit, China's solar manufacturing industry grew rapidly to become the world's largest in just a few years. But even as hundreds of factories popped up across China, European nations began to curb generous solar incentives, leading to a massive global oversupply of panels that has crippled the industry.
At Suntech's big solar panel factory in Wuxi, 120 km (75 miles) west of Shanghai, employees reported for work as usual on a chilly morning on Thursday.
The company's headquarters office is nearby, with one side of its facade entirely made up of solar panels that supply 85 percent of the energy it uses.
Asked whether he was aware of the news that lenders were pushing for bankruptcy of Wuxi Suntech, one Suntech employee taking a smoking break at the factory gate said, "No I don't know. Actually I don't read newspapers."
The man, who declined to give his name, snuffed out his cigarette and headed into the factory.
China has a history of bailing out companies on the brink of failure, and investors had assumed Suntech would be no exception. But the move by domestic creditors on Wednesday introduced some doubt. Where foreign creditors stand is also uncertain.
"We think Beijing has sent a message to all the Chinese solar companies - improve your balance sheets or you could go this way," said Nitin Kumar, a Singapore-based Nomura analyst.
Suntech's complicated business structure adds another element of uncertainty. The company's shares are listed on the New York Stock Exchange, but it is registered in the Cayman Islands and its assets are in China.
China passed a new bankruptcy law in 2007 that is rarely tested because local officials generally mediate between creditors behind closed doors. Beijing has used the law cautiously, fearing the failure of large companies and widespread layoffs could lead to social unrest.
Suntech employs around 20,000 people worldwide, with about half of that number in Wuxi, Chinese media and the company's web site say.
The main question is whether any bailout is forthcoming and how it will affect foreign investors holding Suntech's bonds.
"Obviously if the U.S. convertible bond holders are not paid back and they are not even part of the restructuring deals, then it does raise questions about investor rights," said Kumar.
While the insolvency proceedings have not hit the domestic bond market, they may become a factor over time, another analyst said.
"Most investors think it's an offshore bond, so it's not a problem for the onshore market," said Ethan Mou, China credit strategist at Bank of America-Merrill Lynch in Hong Kong.
"But going forward, (onshore) investors will take note of the government's stance towards this default. It takes time, but I think the market will digest the significance behind this default and realize that the implicit backstop of local governments may not appear every time."
Analysts say the widespread assumption of an implicit government guarantee against default prevents China's onshore yuan bond market from pricing risk effectively. A comparison of yields on bonds from companies that have issued both onshore and offshore shows that companies considered risky, high-yield plays offshore trade at much tighter spreads onshore.
Foreign debt holders are however in a more difficult situation.
"Offshore debt holders are on shaky legal ground (their claims are to a piece of paper in the Caymans, whereas STP's operating assets are effectively all in China)," said Charles Yonts at CLSA in Hong Kong.
"And even if not, they would have the rather daunting task of fighting to the front of the queue of Chinese creditors in China. Good luck with that."