UPDATE 2-China brokerage Guosen unit denies report it defaulted on dim sum yuan bond

(Adds comment, detail)

HONG KONG/SHANGHAI, March 31 (Reuters) - A unit of China’s Guosen Securities, one of the country’s largest brokerages, denied a Financial Times report it had defaulted on a Hong Kong-traded yuan bond and said the keepwell deed supporting the bond continued to be in effect.

In a notice to the Hong Kong Stock Exchange the brokerage said: “The Issuer is confident that it will be able to fully comply with its payment obligations in respect of the bonds.”

It added that the bond’s trustees, the Bank of New York Mellon, Hong Kong Branch, had issued a notice to bondholders on Thursday stating that no event of default under the bonds had occurred.

Earlier, a report in the Financial Times triggered a fall in Guosen’s “dim sum” bonds due 2017, with bids falling to 98 cents on the dollar from 99.5.

The newspaper said, citing a document from the trustee of the bond, a technical default had taken place because a keepwell deed associated with the Guosen bond “is not in full force and effect, which constitutes an Event of Default”.

A keepwell deed is a financial tool that borrowers use to enhance their credit worthiness, but they lack the legal strength of a guarantee.

“Guosen is one of the bigger onshore securities houses in China with a strong cash balance and they are highly unlikely to default given it is just a technical breach,” said Penny Chen, fund manager with Manulife Asset Management.

“Given the strategic importance of the guarantor to the parent, we believe Guosen Securities (onshore) will try its best to ensure the guarantor’s (offshore) liquidity to service its outstanding bond and compliance to the bond’s terms and conditions.”

A default would be the first debt breach by a state-owned enterprise in the offshore bond market in nearly two decades, the FT report said.

Guosen Securities’ shares ended the day 0.49 percent higher. Its bonds were trading flat after the morning’s fall, reflecting a lack of panic amongst investors.

“It is a technical issue rather than a real deterioration in credit quality,” said Nomura analyst William Mak.

Defaults have accelerated in 2015 among onshore Chinese firms, mainly in ailing heavy industrial sectors including steel and cement.

The knock-on effect has been felt by the financial sector largely through a rise in non-performing loans (NPLs).

Chinese banks’ NPLs have ballooned to a 10-year high of 1.27 trillion yuan, or 1.67 percent of the all loans outstanding at the end of last year, according to data from the China Banking Regulatory Commission. (Reporting by Umesh Desai in HONG KONG and Samuel Shen in SHANGHAI; Editing by Kim Coghill, Robert Birsel)