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China Bear Stearns Moment Seen by BofA in Solar Default

By Justina Lee
March 06, 2014 12:10 PM EST 19 Comments
People visit the stand of Shanghai Chaori Solar Energy Science and Technology Co., Ltd. during an exhibition in Beijing in 2012. Shanghai Chaori Solar Energy Science & Technology Co., a maker of solar cells, said yesterday it may not be able to make an 89.8 million yuan ($14.7 million) interest payment in full by the March 7 deadline.
Source: Imaginechina via AP Images
People visit the stand of Shanghai Chaori Solar Energy Science and Technology Co., Ltd. during an exhibition in Beijing in 2012. Shanghai Chaori Solar Energy Science & Technology Co., a maker of solar cells, said yesterday it may not be able to make an 89.8 million yuan ($14.7 million) interest payment in full by the March 7 deadline.

(Corrects to say Bear Stearns funds sought bankruptcy in 2007 in the third paragraph.)

The growing risk of default by Shanghai Chaori Solar Energy Science & Technology Co. may become China’s “Bear Stearns moment,” prompting investors to reassess credit risks as they did after the U.S. securities firm was rescued in 2008, according to Bank of America Corp.

“We doubt that the financial system in China will experience a liquidity crunch immediately because of this default but we think the chain reaction will probably start,” Hong Kong-based strategists David Cui, Tracy Tian and Katherine Tai wrote in a note yesterday. During the U.S. financial crisis, it took a year “to reach the Lehman stage” when investors began to panic and shadow banking froze, the strategists added.

The maker of solar cells said March 4 it may not be able to make an 89.8 million yuan ($14.7 million) interest payment in full by the deadline tomorrow. As the subprime mortgage market began to collapse in 2007, two Bear Stearns Co. hedge funds that owned the debt sought bankruptcy protection in the beginnings of the credit crisis. The troubled bank was sold to JPMorgan Chase & Co. in March of 2008 in a deal facilitated by the U.S. Federal Reserve. Six months later, Lehman Brothers Holdings Inc. collapsed in the biggest bankruptcy in U.S. history.

Chaori’s potential failure to pay investors would mark the first bond default in Asia’s largest economy, highlighting the strain in China’s $4.2 trillion bond market after a trust product issued by China Credit Trust Co. was bailed out in January. There haven’t been any defaults in China’s publicly traded domestic debt market since the central bank started regulating it in 1997, according to Moody’s Investors Service.

Soros, Gross

China’s corporate bond market totaled 8.7 trillion yuan at the end of January, compared with 800 billion yuan at the end of 2007, Bank of America estimates.

Billionaire investors George Soros and Bill Gross have drawn parallels this year between the situation in China now and that in the U.S. in the run-up to the 2008 financial crisis. Borrowing costs for China’s high-yield debt issuers may jump 200 basis points, or 2 percentage points, following a default by Chaori, according to Yang Kun, a Shanghai-based bond analyst at Guotai Junan Securities Co.

Two companies postponed domestic bond sales after Chaori warned of its possible default. Suining Chuanzhong Economic Technology Development Co. said yesterday it will delay a planned 1 billion yuan offering due to “serious fluctuations in the bond market following Chaori Solar’s statement,” while Taizhou Kouan Shipbuilding Co. said it will put off a 300 million yuan sale because of “big fluctuations in the market.”

Yield Jump

The average yield on five-year AA- notes in China jumped 8 basis points to 7.77 yesterday, the biggest increase in almost four months, ChinaBond data show. Ratings of AA- or below are equivalent to non-investment grades globally, according to Haitong Securities Co., the nation’s second-biggest brokerage.

The average yield on junk corporate dollar debt surged to a record 22.66 percent in December 2008 following the collapse of Lehman, more than double the 9.68 percent at the start of that year, according to the BofA Merrill Lynch High Yield Index.

The yuan strengthened 0.24 percent to 6.1282 per dollar in Shanghai yesterday, the biggest gain since December 2012. It advanced 0.22 percent to 6.1146 as of 11:48 a.m. today.

Bailout ‘Unlikely’

A bailout of Chaori “looks unlikely,” though the systemic risk to financial markets from such an event will be small, Chang Jian, chief China economist at Barclays Plc in Hong Kong, wrote in a note yesterday. More “selective defaults” are expected this year and the industries most at risk include energy, shipbuilding, steel, cement and property, she wrote, adding that local government financing vehicles are also vulnerable.

There is no need to panic about a bond default by Chaori because it only reflects normal volatility in the bond market, former PBOC adviser Li Daokui was cited as saying in a China Securities Journal report today. A local government debt default would be more of a concern because there would be a larger impact, Li said. Chaori Solar will “try to keep the losses of bondholders to a minimum,” it said March 4, adding that directors’ salaries will be cut or delayed and capital expenditure projects will be suspended.

Chaori’s default “will most likely be because the government wants to teach the market a lesson and address the implicit guarantee moral hazard issue,” the Bank of America strategists wrote, noting that the local government and the underwriter have sufficient funds for a bailout.

China’s policy makers are seeking to rein in credit expansion while defending this year’s economic growth target of 7.5 percent, announced yesterday. Shadow banking in China, which includes trusts and wealth-management products sold by lenders, is more closely linked to the real economy than in Western countries, Finance Minister Lou Jiwei said in a Feb. 22 interview in Sydney.

To contact the reporter on this story: Justina Lee in Taipei at jlee1489@bloomberg.net

To contact the editor responsible for this story: James Regan at jregan19@bloomberg.net

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