Construction firm cites inability to make interest, principal payments

China appears to be heading for another domestic bond default after Huatong Road & Bridge Group Co, a Shanxi-based construction firm, said on Thursday it was not sure whether it would be able to pay interest or principal on a 400 million yuan ($64.5 million) one-year bond set to mature next Tuesday.

In a statement, the company blamed the payment uncertainties on an ongoing official investigation into its chief executive. A statement issued by the Shanxi Committee of the Chinese People's Political Consultative Conference said Wang Guorui, the company chairman, has been removed from his position on suspicion of law violations.

The note in question, with a coupon of 7.3 percent, has no guarantees. Huatong is supposed to pay back the principal amount of 400 million yuan and 29.2 million yuan as interest next Tuesday. China Guangfa Bank was the bond's lead underwriter.

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China Lianhe Credit Rating Co Ltd, on Thursday lowered Huatong's rating to BB+ from AA-, after Huatong made the announcement.

Huatong is operating at a profit at the moment. Public statements show that the company made a profit of 300 million yuan in 2013 and 65 million yuan in the first quarter of this year. The company is also believed to have ample liquidity, with 1.9 billion yuan of its 10.7 billion yuan total assets being in cash at the end of March.

Deng Haiqing, chief fixed-income analyst with CITIC Securities, said that a default by Huatong is "probable", but that would be a stand-alone incident as it was caused by an investigation against the company's chairman.

China Lianhe Credit Rating said in a statement that Huatong needs the authorization of Wang, who holds over 60 percent stake in the company, to move funds.

In March, Shanghai Chaori Solar Energy Science & Technology Co missed a coupon payment on its domestic bond, marking the first default in China's bond market. Rates in the bond market went through a correction following the default to price in higher risks. A default by Huatong might send bigger ripples as it would be the first to fail to pay both interest and principal, and would also be the first default in the interbank note market, the nation's biggest bond market.

China's corporate bond market has evolved quickly over the past decade to become the world's third biggest, behind only the United States and Japan. According to the Asian Development Bank, corporate bonds outstanding in China totaled 8.5 trillion yuan at the end of last year, up from 500 billion yuan at the end of 2005.

Defaults in China's bond market are rare, though there have been instances of Chinese companies defaulting in the international market.

Some experts feel that domestic bond defaults are a positive development for China, as it shows that the market is maturing.