Last-minute bailout saves firm from default

A construction firm in northwest China's Shanxi Province narrowly avoided what could have been the first default in China's interbank bond market, after local authorities and the company repaid principal and interest due on Wednesday.

Sources close to the bond's underwriters said enough funds were available to cover the principal and interest of the one-year commercial paper, totaling 429.2 million yuan (69.15 million U.S. dollars).

The privately held Huatong Group claimed in a statement issued on July 16 that it faced "uncertainties" paying back the principal and interest of its 400 million yuan note.

The possibility of a default emerged after the company's board chairman Wang Guorui was stripped of his membership from the local political advisory body on July 10 for allegedly breaking the law.

The one-year note, recently revised down by domestic rating agencies to B from A-1, was due with an annual interest rate of 7.3 percent.

In early March, Shanghai Chaori Solar Energy Science & Technology failed to cover 89.8 million yuan in interest payments, making it the first onshore bond default and caused a minor panic among investors.

Authorities have signaled since late last year that it would tolerate defaults as long as such incidents do not bring systemic risks to the country's financial systems.

Companies have long relied on local government and state-backed lenders for last minute bailouts to help meet their obligations when they run into liquidity problems.

Such bailouts have been criticized for causing distortions in the market and preventing investors from getting a clear look at the risks they are exposed to.

Unlike Chaori, whose bond is traded at the Shenzhen exchange, Huatong's note is traded in the interbank market, which according to Standard Chartered, accounts for 93 percent of outstanding bonds issued in the onshore market.

Investors appeared unfazed by the impending default. The size of Huatong's debt is relatively small and traded in the interbank market among institutional investors. Even if the default had materialized, it would have had limited impact on institutions that hold the bond.

Analysts say Huatong has sound operating fundamentals but has difficulties getting its account receivables paid and converting its stock assets into cash. Most of the projects the company is involved in are construction of infrastructures for local governments.

Rating agency China Credit Rating Co., Ltd said that even if Huatong could not have paid back the principal and interest on time, given its low leverage, the company could have met its obligation at a later date.

The possibility of default underscored the risk stemming from the company's over-reliance on its actual controller, Wang Guorui, who holds the single largest stake of the firm, at 60.25 percent, the rating agency added.

"This is an isolated case and will have limited impact in the interbank bond market," said Qin Xinfeng, a trader with Qingdao Rural Commercial Bank, which participates in interbank trade but does not hold the short-term bill issued by Huatong.

"But private companies with low credit ratings will come under greater pressure in the future while bonds issued by state-owned firms and local financing vehicles will grow more favorable among investors given the implicit guarantee from government," Qin said.

China's onshore bond market is the world's third largest, after the United States and Japan. As of the end of last year, outstanding bonds stood at 29.6 trillion yuan and some 9 trillion yuan worth of bonds were issued that year, according to Standard Chartered.