A Chinese power-transformer maker became the country’s first state-owned company to default on an onshore bond, signaling the government’s willingness to let market forces decide an enterprise’s fate.

Baoding Tianwei Group Co., the unit of central government-owned China South Industries Group Corp., said it will fail to pay 85.5 million yuan ($13.8 million) of bond interest due Tuesday. Kaisa Group Holdings Ltd. became the first Chinese developer to default on its U.S. currency debt Monday.

Until now, only private-sector companies have defaulted in China’s domestic bond market even as state-owned enterprises have sold the vast majority of debt. Tianwei’s default highlights a shifting attitude toward financial risk, underscored by Premier Li Keqiang’s pledge to open a cooling economy to market forces and strip power from the government.

“It’s probably a start of more defaults in China,” said Qu Qing, a bond analyst at Huachuang Securities Co. in Beijing. “The economic slowdown has given a huge blow to some industries.”

‘Can’t Raise Enough’

Baoding Tianwei’s 1.5 billion yuan of 5.7 percent April 2016 notes have dropped 7.1 percent since March 31 to 85.3 percent of par as of Monday, set for the sharpest monthly decline since they were issued in 2011. The company will continue to raise payment funds via various means including asset disposal, according to today’s statement posted to Chinamoney.com.cn, the China Foreign Exchange Trade System website. The bonds’ rating is now B versus AA+ at issuance.

“Our company suffered huge losses in 2014 and the debt to asset ratio surged quickly,” Baoding Tianwei said in today’s statement. “Our company has lost financing ability and suffered from a capital shortage. We can’t raise enough money to repay interest, despite all the efforts we have made.”

Baoding Tianwei, based in China’s northern Hebei province, had a loss of 10.14 billion yuan in 2014, according to today’s statement. A statement from the company on April 3 showed that by the end of last year, Tianwei had some 1.86 billion yuan of overdue borrowings. Its 22.96 percent stake in listed firm Baoding Tianwei Baobian Electric Co. has been frozen by local courts because of its dispute with creditors, according to China Credit Rating Co.

Alternative Energy

Tianwei earlier this month flagged “huge losses” in its alternative energy business. The group, founded in 1995, mainly focuses on the manufacturing of power transformers, and, according to its website, exports to over 30 countries including the U.S., Pakistan, Iran and Malaysia.

The fight for survival in China’s solar and wind industries, where overcapacity has weighed on earnings, is escalating after President Xi Jinping said last year the nation should boost alternative-energy supply amid worsening smog. Solar-panel maker Suntech Power Holdings Co.’s securities were reduced to one cent after it defaulted on $541 million of bonds in 2013 while LDK Solar Co. defaulted on a dollar note in February last year.

Two privately held companies have defaulted in China’s onshore bond market to date — Cloud Live Technology Group Co. earlier this month and Shanghai Chaori Solar Energy Science & Technology Co. last year. Among outstanding notes issued by Chinese companies, 91 percent are from government-backed enterprises, while just 6 percent are sold by privately owned firms, according to data compiled by Haitong Securities Co.

Bondholder Meeting

“The government has probably played a role in Baoding Tianwei’s default,” Qu said. “It is expecting orderly defaults, which won’t cause any big problem. But when there are more defaults coming, who knows what will happen.”

China Construction Bank Corp., the notes’ lead underwriter, will convene a Tianwei bondholder meeting “as soon as possible,” according to a separate statement on Chinamoney.com.cn. The Beijing-based lender will discuss measures with relevant parties to protect investors’ rights and benefits.

Tianwei’s notes are traded on China’s interbank market, according to data compiled by Bloomberg. Most notes in China, more than 90 percent, are traded on the interbank market, where Chinese banks make up the majority of investors.

Asia’s biggest economy expanded at the weakest pace since 2009 last quarter, with output, investment and retail data pointing to a deepening slowdown, data released by the statistics bureau in Beijing on April 15 showed. On Sunday, the central bank cut the reserve-requirement ratio for banks by 1 percentage point, stepping up stimulus policies.

Corporate Debt

China’s corporate debt is the highest in the world, former central bank adviser Yu Yongding wrote in the official China Daily last week. Companies had $14.2 trillion in debt at the end of 2013, exceeding every other country including the U.S., which had $13.1 trillion in company obligations, Standard & Poor’s said in a June report.

Baoding Tianwei isn’t the first state-owned company to have run into financial trouble. China Erzhong Group Deyang Heavy Industries Co., government-owned maker of equipment used in steel manufacturing, had 7.26 billion yuan of overdue debt as of March 25, according to a March 27 company statement.

“We need to be aware the government won’t be able to protect all the state-owned companies,” Ivan Chung, an analyst at Moody’s Investors Service, said in a phone interview today. “For those that are not strategically important, they may receive less government support and encounter repayment difficulties when their fundamentals weaken.”

Chung said it’s important for authorities in China to “set a case so that upcoming defaults in the future have a model to refer to.” “It also helps the bond market to develop more healthily,” he said. “It will effectively break the moral hazard so that the market will properly price in risk.”

The yield premium of five-year AA- rated bonds over top-rated notes narrowed 4.5 basis points this year to 150 basis points as of April 17, according to data compiled by ChinaBond. The gap widened 11 basis points last week, the most this year, after Cloud Live’s default.

“If China’s credit environment doesn’t improve, more defaults will come,” said Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai. “If local governments’ bonds or their financing vehicles’ bonds default, that may cause a widespread increase in risk aversion.”

For Bloomberg Business, April 21 2015

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