China Sees First Onshore Company Default, Raising Concerns About ‘Bear Stearns’ Moment

Shanghai Chaori Solar Energy Science & Technology failed to pay the full interest on debt issued in China’s onshore bond market, the first default since 1997. The Shenzhen-listed company had earlier said that it could pay only RMB4 million of the RMB89.8 million in interest payment due on the bonds on March 7.
“This will likely be the first of many defaults, although I don’t think it’s going to cause a cascading effect in the bond market,” Brian Coulton, a global emerging-market strategist in London at Legal & General Investment Management, told Bloomberg. “Short term, we’re likely to see higher bond yields but in the long term, this will create a better market for pricing credit risk.”
But earlier in the week, Bank of America Merrill Lynch warned in a report that a default by Shanghai Chaori, particularly on the principal, may bring China to its "Bear Stearns stage," referring to the troubled US investment bank that had to be sold to JPMorgan Chase in 2008. Later that year, the much larger Lehman Brothers went bankrupt, precipitating the global financial crisis.
Similarly in China, said the Bank of America report, the markets may start to "seriously re-assess subprime debt risk." It took about a year after Bear Stearns for markets in the US to panic and for the shadow banking to freeze. Because the Chinese market is less transparent, however, "we assess that it may take less time in China," concludes the report.
But Moody’s Investor Service, in a report issued shortly before Shanghai Chaori confirmed it would default, stressed the positive. “Credit risk would play a more important role in pricing, thereby making the bond market more efficient in the allocation of capital,” it predicts.
“A default would also highlight the importance of more sophisticated credit analysis and would likely galvanize investors and regulators to pursue reforms such as the introduction of covenants, and better disclosures and governance,” Moody’s argued. “All of these developments would help China’s onshore bond market become more risk-based over time.”
In the near term, however, more bad news and volatility may hit the Chinese onshore market. “The softening economy in China and tight onshore credit market mean that some onshore bond issuers, such as financially weak private corporations in cyclical sectors with overcapacity, that hav bonds coming due in 204 will be more exposed to refinancing risk,” said Moody’s.
On its own, the Shanghai Chaori default is unlikely to have much of an impact on the balance sheet of China’s banks and lenders in the shadow banking system. The danger lies in defaults by much larger conglomerates.

If too many of them are forced to renege on their borrowings and the situation is not managed prudently, the Lehman Brothers scenario may play out in China – potentially causing serious damage to the economy, the financial system and other businesses, as happened in the United States.  




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