LDK Solar bond swap a sign that more defaults may be on the way

The seventh grace period for unpaid interest on LDK Solar bond issue turns attention to the increasing prospect of domestic bond defaults

PUBLISHED : Saturday, 15 February, 2014, 1:47am
UPDATED : Saturday, 15 February, 2014, 4:36am

The mainland green energy firm LDK Solar yesterday announced a two-week extension for repayment of interest on a US$280 million bond. It was the seventh such grace period investors granted the issuer and it relates to unpaid interest that came due in August last year.

An investor in the bond, which matures at the end of the month, said the company was close to implementing a restructuring that would see investors exchanging the bond for shares and a convertible bond.

Investors have been asked to accept shares valued at a 47 per cent premium to its February 13 close. The convertible bond, representing 91 per cent of the value of the package, pays about half the interest of the bond it replaces, and investors will not get a cash coupon, but "payment in kind", or the equivalent value in new bonds.

In the first year, the bond will only be profitably convertible into shares if the LDK share price hits US$20, a remarkable 1,851 per cent conversion premium.

LDK is attracting attention in the market because the issuer also has 500 million yuan (HK$635 million) of notes in the domestic market that mature in December and investors are concerned about the issuer's ability to repay.

While no issuer has ever defaulted on a domestic bond, thanks to government-led interventions, many analysts and investors are expecting this year to be the year of the domestic default.

The problem is exacerbated by the fact that 2014 will see a tripling in the volume of domestic bonds due compared to the previous year, with US$173 billion of bonds maturing this year, according to Thomson Reuters.

Mainland authorities debated during the November third plenum about the need for the market to play a "decisive role", which many market watchers have interpreted as a need for investors to take losses on bad investments.

"We have seen the People's Bank of China allow the money market rates to rise substantially over the past years … this is one way for the weaker credit to emerge to the surface [by defaulting]," said Stephen Chang, head of Asian fixed income at JP Morgan Asset Management.

"September and November will be heavy months for redemptions [for corporate bonds]. If the PBOC keeps rates at these levels ... I don't expect all these to be refinanced."

Already investors are bracing for technical defaults on wealth management products issued by China's trust sector.

A 289 million yuan wealth management product linked to Shanxi Liansheng Energy passed its February 7 maturity date without paying investors, technically a default. China Construction Bank sold the high-yield instrument issued by Jilin Province Trust.

Six Chinese trust firms have lent more than five billion yuan to the coal mining company, state media reported on Friday, raising the prospect of further defaults in China's shadow banking system.

Institutional investors see the prospect of defaults as positive. While some will take losses, this should translate into higher returns for riskier instruments.

Individual investors will also have to start using professional services, such as managed funds, instead of relying exclusively on wealth management products.

"China is moving towards a more market driven economy, and we expect to see some defaults in the future as defaults are normal for any mature credit market," said Raymond Gui, head of yuan strategy for Income Partners, a fund house.

Chang expects the government will gradually introduce investors to the concept of default.