Thursday, Cloud Live Technology Group disclosed it did not have sufficient funds to make a bond payment due April 7. The Shenzhen-listed company, which had sold 18 Hunan-style restaurants in December to go into cloud computing, stated it had raised 161.4 million yuan, far short of the 402 million yuan owed this week. The expected default could be the first failure to repay bond principal in the history of the People’s Republic of China.
Or it could be another fake failure. There have been two bond defaults, both last year. Shanghai Chaori Solar Energy Science & Technology Co. did not pay a coupon last March, but local government officials arranged a complex bailout involving nine new investors and two guarantors. The rescue package, assembled by cadres apparently concerned about social unrest, put small holders in front of institutional ones, which should have received priority. Bond investors received payment on December 22.
Also in March, Xuzhou Zhongsen Tonghao New Board Co. failed to pay interest. A guarantor eventually made good the skipped payment.
Especially with the state-led Chaori Solar rescue, Chinese leaders have reinforced the notion of moral hazard in a market where investors have been chasing yield without regard for creditworthiness. Beijing has, for the most part, taken the risk out of investing.
And that brings us back to Cloud Live. Its expected default on Tuesday will be historic if officials do not mount a rescue.
Beijing just might stand aside. For one thing, the company is small enough so that its failure should not have much effect on China’s market. And anyone holding onto Cloud Live’s bonds after the bizarre change in business and after the now ex-chairman left the country under a cloud of suspicion—the China Securities Regulatory Commission has urged him to return to China—deserves to lose money. The company’s warning on March 4 that it faced “big uncertainties” in repaying bondholders this month was, as a practical matter, superfluous.
Furthermore, there is are hints Beijing is getting ready to permit defaults. On Tuesday, for instance, the State Council announced a deposit insurance plan will go into effect in May. The scheme is said to be a prelude to the liberalization of interest rates, but it also is a way to allow weak banks to fail without depositors rioting.
It is not entirely clear, however, that Cloud Live will be permitted to die. The bond market, for instance, hardly reacted to the company’s Thursday announcement of the impending default, suggesting that investors believe there will be a government-orchestrated rescue.
Moreover, central leaders have important reasons to support the bond market, now seen as the mechanism to alleviate what could be China’s most pressing economic problem, the big debts indirectly incurred by local governments. Beijing announced a plan last month to permit lower-tier governments to swap 1 trillion yuan of high-interest debt for either municipal or provincial bonds. Anhui province announced such a conversion plan yesterday.
Chinese technocrats are even willing to commit funds under control of the central government to the debt-for-bonds scheme. On April 1, the State Council said the nation’s social security fund would be permitted to put money into local government bonds.
A bond default, even of such an obscure issuer like Cloud Live, could set back such a plan.
Beijing, after all, knows there are many Cloud Lives. For example, a subsidiary of Sunry Group, based in the now-famous ghost city of Ordos in Inner Mongolia, looks like it will default on April 18. An official of the Erdos Dongsheng City Construction Development Investment Group, a local government financing vehicle, said it did not have funds to honor a guarantee on the Sunry bonds.
Everyone knows that, at some point, Beijing has to permit an issuer to fail. “It’s necessary to allow a real default in China’s bond market,” said Zhang Yingjie of China Chengxin International Credit Rating, affiliated with Moody’s, to Bloomberg. “More bailouts may lead to systemic risk.”
Could the failure of Cloud Live cause a country-wide failure? That’s improbable, to say the least.
State media, however, is obviously worried. Xinhua News Agency on Friday carried the comments of an analyst who discussed whether Cloud Live could trigger China’s “Bear Stearns moment.”
Follow me on Twitter @GordonGChang and on Forbes. And find much more here.
