Chinese bond defaults test govt appetite for market discipline

Two Chinese corporate bonds headed towards what may prove to be precedent-setting default this week, in the latest test of Beijing's willingness to confront moral hazard in the financial system.

While Beijing has repeatedly spoken of its desire to let market forces prevail and to allow companies and investments to fail it has proved less willing to deliver - fearing the fallout and impact on stability from hoardes of disgruntled investors.

Thus investors have been shielded from the handful of technical defaults and late coupon payments that have occurred in the past year, through the intervention of either government or state-backed white knights.

Economists say the widespread assumption that even high-yield debt enjoys an implicit government guarantee has distorted capital allocation by enabling fixed-income investors to effectively ignore company fundamentals,

With a slowing economy leading to a rise in bad debt, analysts warn that a zero-tolerance policy towards default is not sustainable.

Shenzhen-listed Cloud Live Technology Group, which operates restaurants selling spicy Hunan dishes amongst other regional cuisines, said in a filing late Thursday that it was "sparing no effort" to raise the cash necessary to make Rmb402m in principal and interest payments due next month but had so far raised less than a third of that amount.

The company issued Rmb480m in bonds on the Shenzhen stock exchange in 2012, a portion of which can be redeemed next week. If the company fails to meet its obligations, it would mark the first principal default in China's domestic bond market.

Chaori Solar defaulted on an interest payment last year, but investors were eventually bailed out in an arrangement that appeared to favour retail over institutional creditors who ought to have enjoyed seniority.

Separately this week, financial magazine Caixin reported that a local government-owned financing vehicle in the famous ghost city of Ordos, in Inner Mongolia, was unwilling to honor a guarantee it provided to Rmb200m in bonds sold by a highway construction company in 2013.

Ordos-based Sunry Group, which builds roads and bridges for local governments, lacked funds to honor redemption obligations on bonds issued by a subsidiary that are due on April 18, the magazine reported.

The bonds carry a guarantee from Erdos Dongsheng City Construction Development Investment Group, a financing platform that the Ordos government-like thousands of Chinese localities around China over the last decade-established in order to skirt a ban on direct borrowing by local governments.

The magazine quoted an unnamed Dongsheng Construction official as saying his company also lacked the cash flow and was urging bond investors to roll over the bonds for another year

Ordos rose to prominence in recent years as a mining boom coal boom created an explosion of wealth. But over-building and the collapse of coal prices subsequently left the city practically deserted and local government finances devastated.

Sunry Group and Dongsheng Construction declined to comment.

China's securities regulator launched a junk bond market in 2012, officially called small and medium-sized enterprise private-placement bonds. The bonds can only be issued via private placement to qualified investors but subsequently trade on the stock exchange.

A construction material manufacturer in eastern Jiangsu province last year became the first junk bond issuer to default, but a guarantor eventually repaid investors.

Additional reporting by Ma Nan

Twitter: @gabewildau

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