* Chaori Solar will make interest payment on time -chairman
* Zero-tolerance policy for default continues
* Local govt persuades banks to forebear on overdue loans
* Moral hazard hampers China’s bond market development
By Gabriel Wildau and Sharon Xu
SHANGHAI, Jan 23 (Reuters) - A Chinese solar firm which nearly produced the country’s first domestic bond default will complete an interest payment on schedule after a local government intervened on its behalf.
Investors say the latest instance of a government riding to the rescue of a troubled Chinese firm has led to moral hazard and inefficient credit allocation.
The government of Shanghai’s Fengxian district persuaded Shanghai Chaori Solar Energy Science and Technology Co.’s banks to defer claims for overdue loans worth 380 million yuan ($61 million), the company’s chairman, Ni Kailu, told creditors at a meeting on Wednesday.
Ni said that the deferral period of three to six months will enable the company to use its own cash to make a 90 million yuan interest payment due on March 11.
In previous near-defaults, local governments had stepped in directly to arrange bailout funding. But as in past cases, the deal flouts legal notions of debt seniority by allowing one group of creditors - bondholders - to get paid in full, even as a pre-existing default remains un-cured.
Agricultural Bank of China is Chaori’s largest creditor bank, Ni said, with overdue loans worth 270 million yuan.
A spokesman with the Fengxian district government, who declined to give her name, said she wasn’t aware of negotiations with Chaori involving the government. AgBank couldn’t be reached for comment.
Chinese bond issuance has exploded in recent years and is an increasingly attractive alternative to bank loans for Chinese firms. But analysts say the market does not effectively price in risk because investors assume the government will never allow a default.
This assumption appears well-founded. In April 2012, a local government in Shandong province stepped in to prevent a bond default by a state-owned textile company, Shandong Helon .
In July, a local government in Jiangxi province announced it would use taxpayer funds to repay the trust loans of LDK Solar , a U.S.-listed solar equipment manufacturer.
Many market watchers had believed that the government would allow Chaori Solar to serve as a long-awaited lesson in credit risk and a test of the country’s little-used bankruptcy laws.
Unlike Helon, Chaori was not state-owned, nor was it a leader in its sector. Its location in prosperous Shanghai also meant that it was not viewed as integral to the local economy.
“It seemed like it could be a perfect test case for the first default,” said a Chinese bond trader at a European bank in Shanghai.
China’s solar industry has been battered over the last year by severe overcapacity in photovoltaic cell manufacturing, the cut-off of solar subsidies in major European markets, and trade complaints filed by both the EU and U.S.
Last week Chaori warned of a net loss for 2012 of up to 1.1 billion yuan, following a loss in 2011. Two straight years of net losses would put the company at risk of de-listing.
Fears over its finances ratcheted up after the company’s shares were suspended on Dec. 20.
Ni traveled to the U.S. and Italy in late December, prompting rumours that he had absconded with company funds. He returned early this month, but a few days later the company’s credit rating was downgraded from AA to AA-. ($1 = 6.2198 Chinese yuan) (Additional reporting by Chen Yixin; Editing by Kim Coghill and Jeremy Laurence)