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 Last month, Shanghai Chaori Solar Energy Science and Technology (Chaori)
<002506.SZ>, defaulted when it missed an interest payment on a bond,
and this week a newspaper reported a small construction materials
company had also defaulted on an interest payment.
The central bank and government have both indicated in recent weeks
that they are prepared to tolerate some failures as they reform
financial markets.
Chen Dongming, chief credit officer at China Lianhe Credit Rating,
which has global rating agency Fitch as a shareholder, said Chaori
was not a harbinger of larger defaults that posed a systemic risk.
Roughly 90 percent of publicly issued bonds are issued by large or
mid-size state-owned enterprises which are still likely to get
government assistance, Chen said.
"Their likelihood of getting bank capital or government support is
still a lot higher than for a private enterprise," he said.
NO INCENTIVE
Until now, it had been widely assumed that even high-yielding debt
carried an implicit state guarantee so there was little incentive
for investors to demand ratings that reflected creditworthiness.
For example, Chaori narrowly avoided a bond default in January 2013
after a Shanghai district government persuaded banks to defer claims
for overdue loans.
"A lot of local investors were not looking at ratings agencies'
reports, but were just looking at the yield, thought that no company
would ever default in China, and looked at who distributed the
bonds," said Geoffroy Wallier, the managing partner of OrfiCapital,
a Hong Kong-based asset management firm that invests in offshore
Chinese corporate bonds.
Any fallout from Chaori's default is expected to be seen most in the
ratings of smaller private firms, as investors become more aware of
the need to price in risk.
"Chaori's default is a warning," Guan Jianzhong, CEO of Dagong
Global Credit Rating Co, which did not rate Chaori, told Reuters.
"We'll draw lessons from it, and improve our ratings system and
standards."
Chaori's default is having an impact in the secondary market. Yields
on AA- five-year medium-term notes have shot up more than 50 basis
points, while yields on safer AA and AAA medium-term notes have
remained steady.
But exactly how it will change the broader industry is not clear,
particularly as investors and rating agencies still expect favorable
treatment for state-backed firms.
RATING MAINTAINED
When Chaori filed a bond prospectus in March 2012, Pengyuan Ratings
said its "current orders are comparatively full, and future business
has definite surety."
Indeed, Chaori had only days earlier forecast its 2011 profits at
83.5 million yuan. But, after the bond sale opened, its annual
report revealed a loss of 54.8 million yuan.
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Still, in June 2012, Pengyuan re-rated Chaori and its bond AA, while
acknowledging the company's "profits have fallen substantially, debt
has grown substantially, and liability pressure has enlarged."
On its website, Pengyuan defines AA as "very strong ability to repay
debt, low vulnerability to foreseeable events, very low risk of
default."
Pengyuan eventually downgraded Chaori three times in five months,
ending at the CCC rating in May 2013.
Pengyuan declined to comment when contacted by Reuters.
PLEASE THE ISSUER
Around half a dozen rating firms dominate the Chinese market, and a
debt issuer only needs a rating from one agency. Most agencies don't
publish detailed methodologies, which leaves investors with little
to judge the quality of the ratings.
"We are a bit worried that local agencies want to please the
issuer," Wallier of OrfiCapital said.
This is not an issue just in China — in the aftermath of the 2008
global financial crisis, major international credit rating agencies
have been accused by investors, regulators and politicians of
inflating the ratings of risky mortgage-backed and structured
securities in a bid to win new business.
Fitch and the other two leading global credit rating agencies,
Moody's Investors Service and Standard & Poor's, aren't licensed to
rate onshore debt in China, although each has a relationship with a
local firm.
Ivan Chung, chief credit officer in Hong Kong for Moody's, which has
a minority stake in China Chengxin International Credit Rating, said
a weakness in the Chinese market was that debt subordination and
creditor priority were generally not reflected in ratings.
"If you continue to be inaccurate or cannot meet the expectations of
investors, your market position will progressively weaken," Chung
said.
Guan, the CEO at Dagong, was confident of avoiding that fate.
"Our methodologies are constantly changing," he said.
"Dagong isn't going to have a problem like Chaori."
(Additional reporting by Pete Sweeney; editing by John Mair)
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