Having been thoroughly embarrassed by their failings (and losses) in Archegos and Greensill, we suspect the public relations team at Credit Suisse (CS) were over the moon when they discovered that, not only was CS not exposed to the Evergrande debacle, they had actually sold well ahead of the crisis because “risk procedures worked.”
“Risk procedures actually worked then…[but] it was a warning signal about the kind of deals that were being brought in” by bankers and wealth managers in Asia, people involved told the FT.
Specifically, The FT reports that CS – once the top international underwriter of Evergrande bonds (over the past decade, CS helped arrange $4.6bn of dollar bonds for Evergrande, about 13% of the total) – sold down its entire exposure to the troubled Chinese property developer late last year, according to people familiar with the decision; and has not underwritten any debt for two years after becoming concerned about the developer’s financials.
Credit Suisse reassured investors and asset management clients this week that the bank’s funds held very little Evergrande debt and the overall institution had minimal exposure, having decided to sell down its residual exposures because “it didn’t like what it was seeing”, the people familiar with the matter said.
The red flags were reportedly there for a few years, and The FT reports one incident flagged to senior management was a proposed loan to the company’s chair, Hui Ka Yuan, in late 2018:
Evergrande had recently raised a $1.8bn bond to help pay a special dividend to investors.
Hui, then China’s third-richest man, had to put up $1bn of his own money to support the deal due to lack of demand, the Financial Times reported at the time.
Hui then approached Credit Suisse for a loan that would be used to purchase Evergrande securities, offering the bond as collateral.
When the transaction was submitted for review, risk managers criticised the structure for having characteristics of circular financing, people involved told the FT.
“The transaction was wrong financially and morally,” one of the people said.
“Also, Evergrande had the most fragile financials [among Chinese developers] and was clearly facing a liquidity crunch.”
We suspect a major sigh of relief was felt across the Credit Suisse C-Suite that avoided this landmine, but as The Wall Street Journal reports, Evergrande’s auditor, PricewaterhouseCoopers in Hong Kong, may not escape unharmed from this crisis.
The property developer’s auditor faces growing backlash that it gave the imploding firm a clean bill of health in an annual report issued this spring.
Despite Evergrande’s stock and bond prices plunging as the firm offered deep discounts to keep sales growing during the pandemic (and the government effectively warning that it had borrowed too much), PwC in HK signed off on the company’s 2020 financial statements without including a so-called going concern warning.
WSJ notes that concerns about the company’s financial health may not have been sufficient to trigger a going-concern notice in Evergrande’s 2020 annual report under U.S. and Hong Kong accounting rules.
The bar to issue one of these is high, and there are often bankruptcies or reorganizations that aren’t preceded by a going-concern statement, academics said.
“The auditor is not responsible for predicting future conditions or events,” the regulator says on its website.
It added that the absence of a going-concern warning “should not be viewed as providing assurance as to an entity’s ability to continue as a going concern.”
But in the company’s financial statement for the first six months of this year, Evergrande’s board of directors expressed concerns about the company’s ability to pay its short-term obligations and its ability to continue as a going concern. The report, which was unaudited, was one of the company’s first serious admissions of its financial problems.
So PwC has plenty of cover for its potential lack of diligence, but we suspect, when all is said and done and with Evergrande in default on its offshore bonds, numerous investors will be looking for someone to blame and the auditor may be high on that list.