Monday, March 22, 2021

How big is the Greensill problem at Credit Suisse?

The franchise of Swiss Banks has historically been access to large numbers of seriously high net worth individuals and stuffing them full of "product".

The "product" is both third party and internal, but the internal stuff is where the profits are, but also where the conflicts of interest are.

And it is where the scandals are too. 

But it is a model that Credit Suisse has embraced. Famously Credit Suisse embraced the "One Bank" model on the basis that the private banking clients benefit from expertise over the whole bank. And at its best that is true.

And Credit Suisse have truly embraced it. 

When CS won Risk Magazine's Private Bank of the Year award in Asia last year they highlighted it. To quote:

In bringing value to local markets, Credit Suisse has another advantage, too: its ‘One Bank’ approach, in which the investment banking desk and the wealth management desk collaborate to a far greater extent than many other organisations. 

“Our success is defined by the degree of our collaboration,” says Cavalli. “And if you are a client, you feel this because you have the entire orchestration of the capability of the bank coming around you. This helps us to be early in identifying a client’s needs – when they are just starting their journey as an entrepreneur, and need structures for monetising illiquid assets – to when they are more established, and start having cash and liquid assets to manage.”

Embracing the synergies between the various divisions is what Credit Suisse is all about.

Until now.

Until Greensill.

To quote a Bloomberg article that had me falling off my chair:

Credit Suisse CEO Thomas Gottstein signaled he’d consider further separating the asset-management unit from the rest of the bank after the Greensill Capital collapse, as he steps up efforts to limit the reputational damage from the supply-chain finance scandal.

Making asset management an independent entity is “potentially part of the plan,” Gottstein said in a Bloomberg Television interview, days after the bank replaced the head of the business and removed it from direct oversight of the wealth management unit. “Having a holding company around that could be something we are pursuing,” he said, adding that the Greensill affair for Credit Suisse is primarily an asset-management problem.

Get this: over Greensill, a seemingly irrelevant trade finance firm, Thomas Gottstein will dismantle the classic model of Swiss Private Banking at Credit Suisse.

Like really.

If this were a billion dollar issue it is obvious what Credit Suisse would do. It would sign the check and move on. And blame previous management.

For this to the rational course of action (or even an action that warrants considering) the Greensill problem must be big. Really big. Like huge.

So let's have a proper disclosure. And start provisioning - because at this point Credit Suisse are talking down the issue (telling us Greensill is but a scratch) but simultaneously deciding to destroy their own business model to excise the cancer.

Like wow.


PS. Credit Suisse One Bank strategy is real. There are two problems with One Bank done with the consistency of Credit Suisse and they both apply to Greensill.

a). Every division assumes that the appropriate due diligence on Greensill (or any other client) was done elsewhere, with the effect that proper diligence never happens and

b). Every division of the "One Bank" will be implicated.

Thomas Gottstein, "One Bank" means you own this problem. Now it is time to be straight with us and your clients.


Friday, March 12, 2021

Greensill - who is holding the bag - part two

 Insurance Australia Group reacted to my last  post by stating that they carried no net risk. It was all reinsured to Tokio Marine (the big Japanese insurer).

Here is their statement in full:

In response to market enquiries relating to Greensill exposure, IAG clarifies it has no net insurance exposure to trade credit policies including those sold through BCC to Greensill entities.  

IAG sold its 50% interest in BCC on 9 April 2019 to Tokio Marine Management (Australasia) Pty Ltd with the result of eliminating net exposure to trade credit insurance.

BCC is an underwriting agency that was authorised to underwrite trade credit insurance on IAG’s behalf through Insurance Australia Limited (IAL), one of IAG’s two licensed insurance subsidiaries in Australia. 

As part of a transition arrangement after the April sale of BCC, new policies were underwritten by IAL from the date of sale up to 30 June 2019 and Tokio Marine & Nichido Fire Insurance Co. Ltd  (Tokio Marine) retained the risk for these polices, net of reinsurance.

In addition to extensive reinsurance placed by IAG, as part of the sale IAG entered into agreements with Tokio Marine for it to hold any remaining exposure to trade credit insurance written by BCC through IAL.

IAG thus say they have no "net exposure".

The summary of this press release is that Insurance Australia Group were once taking risks (on Greensill) that could kill them but they do not take them any more and any risk they have they have passed off to Tokio.

Teenagers (especially teenage boys) take risks that could kill them. Then usually they stop and they are okay. Sounds familiar. 

The IAG as stupid teenage boy now grown up meme is one that I could get behind. 

And I can't reasonably complain about it either. I was once a teenage boy and am familiar with the process of growing up.

The only problem with this statement is that Tokio Marine say they are not liable. There is an article in the Financial Times where Tokio do not think that these policies will impact them in any meaningful way.

The money quote though is this:

People with direct knowledge of Tokio Marine’s situation said the Greensill issue was dominating the attention of top management. They added that there was a working assumption that many of the questions being asked would ultimately be answered by expected litigation proceedings in Japan, Australia and possibly Germany.

Tokio Marine said it remained “ready to protect its interests in court as required”.

The highlighted section could be very nasty for Insurance Australia Group.

You could see a situation where the primary insurance is determined to be valid and Insurance Australia Group get a ten figure judgement against them. (After all the amount insured is many billions of dollars and the more we find out about Greensill the uglier it looks.)

Insurance Australia has to front the money, and they have a claim against Tokio. It may even be a valid claim, but Tokio may protect their "interests in court as required". That could be very ugly for Insurance Australia as they would be ten figures out of pocket until they win their claim against Tokio.

I am not sure how that would affect their regulatory capital situation. 

Whatever - methinks it is likely that IAG will (eventually) get out of much (probably all) of their BCC liability. I see little reason to doubt their statement that they have no net exposure - although they clearly have large, thinly disclosed gross exposure and some legal risk.

Credit Suisse

Credit Suisse according to the FT is still working on the assumption that the funds are insured. To quote:

A person briefed on Credit Suisse’s stance said the bank was “working under the hypothesis” that the insurance policies would pay out in the event of a default, as they had done in the case of NMC Health, the former FTSE company that collapsed last year. But they added: “This is one of the big questions outstanding.”

We are about a week into the speculation here, and as far as I can tell we still do not know who is holding the bag.

But my working hypothesis is that IAG will face large lawsuits with uncertain outcomes and where disasters are possible. The defining disaster being they are held liable on primary policies but the reinsurance policies somehow fail. The scale of legal risks however are large enough to threaten IAGs solvency.

But at the end of the day IAG will probably skate through, and meanwhile Credit Suisse will have to operate where they do not know whether the funds are insured or not - and will wind up having to take large provisions anyhow. 

So far the stock market thinks that this isn't quite as bad as it appears to me. But that is the difference between a bull market and a bear market. In a bull market nobody is carrying the risk and nobody gets marked down. In a bear market everyone is carrying the risk and everyone is marked down.


Monday, March 8, 2021

Greensill - who is holding the bag?

There has been much fabulous reporting in the lead-up to the collapse of Greensill, the eponymously named Australian domiciled but London headquartered supply chain financier. But if you want guidance start with anything by Duncan Mavin (from the Wall Street Journal) or Robert Smith sometimes with Olaf Storbeck (at the Financial Times).

The excellent work of these journalists is now on the front page above the fold. It is not everyday a globally significant financial institution fails, and it is rarer still that this collapse happens within a couple of percent of all time highs in markets.

There has been remarkably little coverage of where the losses (which will be enormous) will sit.

I do not know either. But I am a short-seller at heart and trying to work this out seems like a core task for me. 

I will start my speculations at home in Australia.

In late November 2020 I wrote a letter to the Australian Prudential Regulatory Authority (APRA) about the credit risk that Insurance Australia Group was taking on Greensill. Here is that letter (which given outcomes looks rather on point). 

This letter is slightly modified, correcting punctuation and having some redactions.

Greensill and Insurance Australia  Group 

First - you need to know what Greensill and Lex Greensill are.

Lex is a controversial and aggressive factoring/supply chain/trade finance financier. Possibly the most controversial one in the world.

He is an Australian - bought up on a farm near Bundaberg in Queensland - and the parent company is Australian domiciled and still has a Bundaberg address.

The enterprise however is vast - and - by far - the biggest company headquartered in Bundaberg. 

The official version piles on the humble origins.

The unofficial versions focus a little on the indulgences, the family jets etc. Though apparently (and according to one of the articles attached) he is selling the fleet of private jets (four of them) as he takes money from Softbank.


Greensill is controversial. They financed the fraudulent NMC Health. 

More publicly they were involved in the collapse of the GAM funds that was widely publicised.

In that case the fund manager Tim Hayward overloaded his fund with Greensill paper at valuations some considered questionable.

Since Hayward's fund collapsed there have needed to be new large-scale sources of finance.

The biggest of these is that Greensill bought control of a tiny (and failing) German bank, recapitalised it, took a huge pile of brokered deposits (by paying about 100-120bps over) and either bought Greensill receivables or pledged bank assets to get letter of credit capacity to support Greensill activities.

The annual report for the bank (alas in German) is attached. The bank assets are largely "insured" but we cannot tell who they are insured by.

What we can see is the Credit Suisse fund that has deep Greensill relations (and is also the subject of this excellent article in the WSJ -

I have attached a letter from the Credit Suisse Supply Chain Finance Fund. A good way to start would be to get EVERY letter and prospectus from this fund and any other Credit Suisse fund with a decent Greensill exposure.

The fund is USD5667 in size - as per this cut-and-paste.

Other than 10 percent US Treasury holding it is diversified as to the countries that the assets are from and the industries that they are in.

But it is not diversified as to the the source of these assets (Greensill, Greensill and Greensill as far as I can tell) or the source of the insurance on these assets.


It is 56.1 percent Insurance Australia Ltd as per the following.

Now that is USD3.18 billion in exposure - just through one fund. That is AUD4.4 billion.

That is just the Insurance Australia exposure I can find.

I am assured the bank assets are also largely insured - but I cannot find who the insurer is.

So you would think that this is a disclosable large exposure to a single controversial financier. But the only statement in the IAG annual report is as follows:

That is it. They say it is in run-off. They feel no need to disclose a multi-billion dollar exposure to a questionable credit/s.

The only problem is that no insurer (other than Tokio Marine) seems to insure for them any more and the amount insured is rising fast.

I think the insurance is written at a broker in Sydney:

This entity used to be owned by IAG and Tokio Marine - but IAG sold their bit to Tokio Marine. However the insured amounts keep going up (at least the bits I can find) even though IAG say the thing is in run-off.


I have some hypotheses. Either

a) An amount - at least 4.4 billion - but possibly much higher - is insured by IAG. Given the size (say 50 plus billion) and controversy of Greensill this is potentially a solvency risk for IAG.

b). Greensill is faking IAG insurance policies - and the amounts are not insured by IAG but Greensill says they are. In which case the German Bank (taking all those insured bonds) is facing solvency risk - and you should be talking to your German counterpart.

c). The Credit Suisse documents are fake. I think this unlikely but cannot dismiss it.

Either way it is one of the uglier situations I have seen lately.


APRA (and to the extent I talked to them the Australian Securities Commission) dealt with me professionally. I was originally not short any company mentioned, but I did not want to restrict my ability to trade. They asked me a few precise questions but gave me no indication as to whether they took these issues seriously or what they were thinking. I wanted no insight to their thoughts and they gave me none.

But Sarah Danckert in the Age has reported (quoting multiple sources) that APRA has been interested in the situation since November. So I  guess my letter had the desired effect although for all I know APRA may have already had the situation in-hand.

Anyway it is clear that IAG had a large and thinly disclosed Greensill risk.

The collapse of Greensill and the role of the insurers

Tom Braithwaite in the Financial Times (and others) have reported that the proximate cause of the collapse of Greensill was that these insurance policies were not renewed. This led to a chain of events whereby Credit Suisse funds stopped accepting Greensill assurances and BaFin (the German regulator) took over Greensill Bank.

The best bits of information however come from an Australian court case.

Late at night and in emergency sitting the Supreme Court of NSW (a first-instance court despite its title) heard an urgent after-hours application for an interlocutory mandatory injunction compelling insurer to issue a trade credit insurance policy. 

This was always a long shot. The policy terms require 180 days notice to terminate or the insurer might be forced to renew. 

The argument Greensill made to the court was that maybe 179 or 178 days of notice was given, not 180 days and that Insurance Australia Group should be forced to renew USD4.6 billion in credit insurance for which it had no reinsurance coverage.

Understandably at a last-ditch 7PM hearing a single judge wasn't prepared to bankrupt a major Australian insurer by forcing renewal.

You can find the judgement here.

Greensill duly collapsed as they told the Judge that it would.

That said, the question of whether Greensill can force renewal of those policies is still open and is still going to court. All the judge decided was that at short notice and on only an "arguable" case he wasn't going to issue a mandatory injunction. 

So there will be a court case to come. And the court case will reveal new details and make important decisions.

The alleged rogue underwriter and what is at stake?

Jenny Wiggins and Hans van Leeuwen in the Australian Financial Review tell a story about a fired underwriter who had exceeded his authority by binding insurers  to contracts insuring Greensill to the tune of about $10 billon. (From the context I read this as 10 billion US dollars rather than Australian dollars). The core quote is:

BCC director Toby Guy wrote to Greensill chief executive Lex Greensill and Greensill Bank director Markus Nunnerich on August 4, telling them that Mr Brereton had exceeded his authority in approving customer limits to Greensill between July 2019 and July 2020 when he signed numerous comprehensive trade credit insurance policies worth about $10 billion. He was dismissed on July 8, 2020.Many insurance policies have terms that require insurance companies to renew and there is complex law around this. I am neither a la

There are several things to observe here.

First BCC is that Sydney based insurance broker I mentioned in the letter to ASIC. It bound insurance policies for both Insurance Australia Group and Tokio Marine. 

Second the 10 billion dollars in policies are substantially larger than the policies disclosed in any  Credit Suisse documents - so I am guessing that they include the policies that purported to protect the assets of Greensill's German  Bank.

Third, and most importantly, the policies were written until July 2020. This is important because most insurance policies cover 12 months, and many credit insurance policies are longer. If BCC was writing  policies until July 2020 some of them are likely still in force.

If that is the case Insurance Australia Group and Tokio Marine are staring down the barrel of some very large losses.

Insurance Australia Group is a minnow. Large losses on this scale could reasonably bankrupt it. Tokio Marine is a relative giant and large losses will hurt but not mortally wound it.

Fortunately for Insurance Australia Group they sold their interest in BCC some time ago to Tokio Marine so their exposure may not be large.

That said  - if they are eventually forced to renew exposures on old policies (as per the argument Greensill put at the late night court case) then IAG may incur some very large losses, especially as they appear not to have renewed their reinsurance (as disclosed in NSW Supreme Court).

You may think I am drawing a long bow here, but Insurance Australia Group recently lost a major case on pandemic caused business interruption insurance and were forced to raise AUD865 million in extra capital to remedy their "mistake". The mistake  was contract wording.

That said it will be up to the courts (and most certainly not me) to work out the extent to which Tokio Marine and AIG are left holding the Greensill bag.

A plea for disclosure

Insurance Australia Group disclosure on Greensill has been appalling. There are exposures potentially large enough to bankrupt them that were undisclosed. Robert Smith, Michael Pooler and Olaf Storbeck in  the Financial Times describe the problem as a "rogue underwriter".  To quote:

One insurer has already laid the blame for the scale of cover it extended to the company at the feet of a rogue underwriter.

“This is similar to what blew up AIG in 2008,” says one person close to the brewing disputes, in reference to the complexity of the contracts involved.

A rogue trader can kill a bank as per Barings, but the situation with insurance is even more stark. Rogue underwriters crashed AIG - previously the largest market cap insurer in the world.

Given the scale of the issue and the fact that key details have been partially disclosed in court I think it is time for a more public airing than this blog post.

I do not know the disclosure rules in Japan (applying to Tokio Marine) but the continuous disclosure rules that apply to ASX rules seem to impose some duties on Insurance Australia Group and potentially its directors.

What if the liabilities for Greensill losses do not fall on insurers?

It is possible that insurers will duck much of the liability to make good Greensill losses. If policies were written as late as July 2020 (as per the above quoted financial review article) it is unlikely insurers will avoid all liability, but depending on what policy was written when, and depending on the wording of those policies they may duck most liability.

So then someone else may be left holding the bag.

I think there is a good chance that someone will be Credit Suisse Financial Group.

Here is the final letter to clients of one of the credit funds

Here is the core client pitch:

The fund seeks to generate stable and uncorrelated returns by investing in notes with a maturity of typically less than one year which are backed by buyer confirmed trade receivables/ buyer payment undertakings, supplier payment undertakings and account receivables (”Receivables”). The underlying credit risk of the notes is insured by highly rated insurance companies. The Fund aims for a target return of 1.50% p.a. above the 3-month USD LIBOR and a short term maturity profile.

The highlighted section is  a doozy. It says that the underlying credit risk of the notes is insured by highly rated insurance companies.

Well it either is or it isn't.

If it is insured Insurance Australia and Tokio are in a world of pain.

If it is not insured then one might expect extensive litigation and potentially large losses at Credit Suisse. 

GAM, who previously had a fund exposed to Greensill and has barely recovered.  Here is a ten year stock chart. The decline from 15 Swiss Franc to under 5 Swiss Franc per share is Greensill related.

So who is holding the bag?

Well, genuinely I do not know. It could be Insurance Australia Group or Tokio Marine. It could be German taxpayers (through the subsidiary bank) and Credit Suisse.

I figure I know the winners though. Lawyers. Lots and lots of lawyers.

And maybe a short seller or two if we pick the shorts right. You can presume I have some position in  most of the companies mentioned.


Saturday, December 26, 2020

Job Interview Questions: Plus 500

I gave someone a quick job interview today. It was kind of miserable except the kid was enthusiastic and came with a lot of (what he thought were) good ideas.

Chief amongst his good ideas was to short XRP - the crypto-currency associated with Ripple.

His case was primarily "have you read the SEC complaint?"

Anyway my concern wasn't that. It was how do I actually execute this trade? What broker would I leave my collateral with to do this and why should I trust this broker.

The problem is acute. I am most likely to win in this trade in the event of a collapse in crypto-currencies generally - and that is the time the broker is most likely to default and wind up not paying me.

I can imagine it being a really bad trade whatever the market outcome. If I am wrong and crypto just keeps going up I will lose money. If I crypto collapses I can't collect my winnings - indeed I just lose my collateral.

Okay - his thought - do it at a broker which is not crypto-dominated. He thought Plus 500 which he told me was ASIC regulated. (ASIC is the Australian securities regulator.)

The ASIC regulated status I was amused by. They have never been particularly good at hunting debacles before they happened. And beside Plus 500 is an Israel/Cyprus operation listed in London - and is rather hard for ASIC to regulate properly. I could just imagine the ASIC officer trying get a holiday in Cyprus on the public purse because he wanted to do a site visit...

Whatever - he was convinced.

And so I left him a task. Could he analyse Plus 500. It is a listed company. Could he tell me whether I should own the stock or whether I should trust it with my precious collateral.

The accounts are public after all.

Does anyone think this is a reasonable task for a job applicant?

Asking for a friend.


Thursday, December 17, 2020

Delusion, fraud and the role of the SEC - the General Electric long-term care case

Luckin Coffee just settled with the SEC for a fine which I guess will be paid by shareholders. Given that the whole thing is a massive admitted fraud being paid by "shareholders" is a pretty moot case. There is not much evidence that the shareholders have anything left. Other than any part of the fine that might be distributed to them I doubt the shareholders ever get a penny.

Whatever: this prompted a twitter debate about the fine paid by General Electric after their long-term-care debacle.

This tweet by Francine McKenna is where it started.

I disagree sharply. 

First let's explain what that $24 billion cost at GE was.

a). GE wrote a lot of business in now sold/closed insurers insuring against the need for people to go into nursing homes. It would pay for the nursing home if that unfortunate situation actually arose. This insurance is called "long-term care insurance".

b). Long-term care insurance has been a near universal disaster for the insurance industry. Almost everyone who touched it lost money. The reason is that people lived longer than expected, they lived more of those years in nursing homes than people expected and the cost of nursing homes went up more than expected. Insurers did not deliberately lose money in long-term care - but everyone lost money in the end. That is the nature of insurance - it is full of surprises - and the surprises are mostly negative.

c). GE had a keepwell agreement with (State) Insurance Commissioners that required that they keep the long-term care subsidiaries capitalised at 300 percent of statutory minimums. This meant that negative surprises at the subsidiaries caused a cash call on the parent company of 3x the negative surprise. 

d). The long term care companies were under-reserved by $8 billion - a mistake that was common in the industry - but in this case a pretty nasty mistake.

e). Because of the keepwell agreement the cost to the GE Parent company was $24 billion. If the book of business runs off as GE currently expects much of that $24 billion - will be returned over time. After all the bulk of it is agreed "excess" capital.

By constrast Luckin Coffee was a fraud from when it listed and was purely a device to extract money from shareholders.

The GE long-term care business was not a fraud from when it listed. Indeed they were blithely writing long-term care insurance in the expectation it would be profitable. So were many other insurance companies.

At some point they will pay out far more than they took in (and the business will not have been profitable). I am not even sure that line has been crossed yet - but as of a couple of years ago when GE took the charge it had not been crossed.

But at some point on that path it will become obvious to anyone who takes a dispassionate view that the line will be crossed someday in the near future.

There is a sequence here.

First there is an honest mistake (writing the business).

Then there is just error - not noticing the models that you wrote too are wrong by a large enough amount to cause problems.

Then the error - under-reserving - becomes delusion. After all it is very hard to admit a mistake even to yourself. I have held a stock way too long when I am wrong and most people who invest have done this. Error is human. And sometimes that error becomes delusion and that is human too.

But there is a nasty line here. Sometimes that delusion becomes fraud. It is fraud when you start to lie about it and know you are lying about it

Luckin Coffee was a fraud from before the IPO. To even equate it to the GE thing is to downplay how much malice was involved in the Luckin Coffee fraud.

Now GE did pay a fine. 

I have a strong view here. If the SEC could prove that certain GE execs crossed the line between human delusion and fraud they should have criminally prosecuted.

And if they could not prove that then they should have not fined at all (except maybe for insufficient financial controls). 

As far as I know they could not prove it. But hey - GE settled quickly on a civil case. 

I can see how this happens. The SEC has lots of powers and it sort of forces GE to settle. But this is not what should happen. 

Either the SEC has a case - in which case it should have been criminal - or they have no case at all - in which case the fine is inappropriate.

My guess here is that the fine is just inappropriate. It makes me respect the SEC less. 

So was the fine against Luckin' Coffee appropriate?

By my own logic the fine against Luckin' Coffee was not appropriate either - what should have happened is criminal charges.

But the SEC has a real problem. The real problem is that the malefactors are in China. 

And it is awful hard to criminally prosecute them.

They may want to come to the United States (or some country with an extradition treaty one day). So settling for a fine works for them.

Whether it works for America I do not know. Sure some money came back Stateside - and maybe that was all that was ever able to be recovered.

The SEC notes it is really hopeless. To quote the press:

“While there are challenges in our ability to effectively hold foreign issuers and their officers and directors accountable to the same extent as U.S. issuers and persons, we will continue to use all our available resources to protect investors when foreign issuers violate the federal securities laws,” said Stephanie Avakian, director of the SEC’s division of enforcement, in the regulator’s announcement on Luckin.

The SEC is nastier against GE because it can be

The Luckin case was criminal - and all it got was a fine. That was because the malefactors were in China.

GE was probably not even fraud - and they got a fine.

That is because they were American. Nothing more.

Yeah, it is not fair.

But that is the world we are in. 

Francine McKenna pontificating just exaggerates that unfairness. But whatever.


Saturday, October 10, 2020

Charity auction: fishing the Manning river with local professional fisherman (and me)

In March/April I sought to donate money to a few charities hard-hit by COVID-19. My family wound up donating to three women's shelters.

One of these was Great Lakes Women's Shelter hit by the double-whammy of bushfires and then COVID. They are at Forster, about three hours north of Sydney.

2019-20 was rough for them. Needs had gone (way) up and their usual sources of funds had evaporated.

Anyway this developed into a conversation about how we could raise more money. And so comes to you one of the most interesting charity auctions you will ever see.

There is a wonderful documentary (Teach a Man to Fish) about Leigh Saunders (a well known aboriginal documentary maker) learning - as a middle aged man - how to fish from his father. It is poignant and beautiful.

Well Ray Suanders has volunteered to teach me and a lucky reader how to fish too. 

The Women's Shelter is running an auction for a day fishing on the Manning River. It will be on a Friday (professional fisherman are prohibited on the river on weekends). It will be gas fun.

We will also probably meet a few of the local aboriginal elders over the weekend too. Lets make a weekend of it.

You can bid here

I am donating a further 10 thousand dollars to kick it along.

Happy bidding.


Monday, June 22, 2020

Olaf Scholz - the German Finance Minister is delusional

Wirecard - a major German fraud - is unwinding as I write this. They have withdrawn several years of accounts and they wonder whether the business (their main profit generator) was conducted at all.

Over 2 billion euro is missing.

This fraud has been well telegraphed for a long time, with several short cases and some excellent articles by the Financial Times providing a rare glimpse into a major fraud real time.

The financial regulator did no investigation of the fraud. But they investigated short-sellers for market manipulation, threw some in jail and filed criminal charges against the journalists who wrote ultimately correct articles about the company. 

As someone with "anglo" sensibilities I tend to think there is a real problem when bureaucrats throw people in prison and raise criminal charges for telling the truth. I thought that ended in Germany when the Wall came down (but I am clearly wrong).

No apology though.

To quote the Financial Times:
...Olaf Scholz, Germany’s finance minister, rebuffed calls for tighter regulation as a consequence from the Wirecard case. “The supervisory institutions worked very hard and did their job, which we see today,” said Mr Scholz in a video interview at the summit.
Mr Scholz is delusional. No rational outside observer thinks this was a good job.

But may I ask some questions:

a) if ignoring the evidence and prosecuting whistle-blowers is a good job what is a bad job? 


b) are German standards really this low - or is it only Mr Scholz's standards?

Just asking

John Hempton

Wednesday, June 17, 2020

Will the market lend USD500 million to a Canadian reverse merger with a collapsed stock, marginally unprofitable gold mines in China, and a non-legally binding State guarantee?

China Gold International (CGG-TSE) is a Canadian listed company with two not particularly good gold mines in China. One of these mines is very large (but is also directly mortgaged to Chinese banks).

The stock was a reverse merger back-in-the-day. But that was almost twenty years ago. The name on the original reverse merger document is Rui Feng. This is the same Rui Feng associated with Silvercorp Metals. Silvercorp had a famous but ultimately inconclusive fight with short-sellers who alleged fraud.

There are a long collection of past directors who merged in companies with names like "Rapid Results" and who have a record of association with collapsed reverse mergers but those people are long gone.

China Gold International has risen far beyond its origins. It has two real (but sharply underperforming) gold mines. And it has a very high quality shareholder.

Top if the register with over 39 percent is China National Gold.

China National Gold is
  • one of only about 100 centrally owned State Owned Enterprises (SOEs) in China,
  • the biggest gold miner in the world by ounces and revenue 
  • able to borrow as a AAA in China, and having recently completed large bond offerings at low spreads obviously fairly liquid.

This is a very high quality shareholder - especially for a company with reverse-merger origins.

The high quality shareholder however can't be particularly pleased with the stock they bought into.

China National Gold bought into what was then Jinshan Gold Mines Inc buy buying out a position held by (Robert Friedland's) Ivanhoe Mines. They paid Canadian $3.18 per share and they also paid out Ivanhoe on some minor debt provisions. You can find the original press release here (and original source here).

The stock had a little bit of a run-up and then a run down - and then in 2011 China National Gold purchased another 412 thousand shares in the open market. You can find the original press release here (and the original source here).

But since then the stock has just gone down and down and become very illiquid. Here is a chart for the stock over the past ten years courtesy of CapitalIQ.

The stock is now Canadian 56c down from a peak around $6. It is a little worse if measured in Yuan or US Dollars because the Canadian currency has also lost some value. Measured in Yuan the stock has lost well over 90 percent of its value.

The market cap is now Canadian 222 million or 163 million USD. The China National Gold stake is worth about USD65 million if they could sell it. They probably could not because the Canadian stock now has low liquidity.

This is consistent with mines that have (fairly sharply) underperformed the engineering and reserve studies laid out for them about a decade ago.

China Gold International traded debts

Being a shareholder is not the only relationship that China National Gold has with China Gold International. They are the (sole) customer for metal concentrates and gold dorĂ© produced and they provided most of the equipment and engineering services needed to actually build the two above-mentioned mines.

By the time you get to the 2013 annual report (copied here) the company has extensive related party transactions where the mines are developed almost entirely by paying China National Gold subsidiaries for detailed engineering services. By the end of 2013 the company owed China National Gold a lot of money (and it still had more money to pay to China National Gold). [The multiple pages detailing related party transactions start on P.16.]

In 2014 China Gold International with the support of China National Gold went to the Hong Kong market to pay for all this. They issued USD500 million in three year debt in 2014. That debt was repaid in 2017 and another three year debt was issued. The 2017 issuance is due for repayment in early July of this year and as of the time of printing China Gold International clearly does not have the money (though may be able to raise it).

This debt is issued through Skyland Mining (BVI) limited - a British Virgin Islands company that was at one stage the owner of the more valuable of the two China Gold International Mines. The debt is guaranteed by Canadian parent company.

I wondered whether it would default. That would of course make China Gold International (the guarantor of the debt) a great short. The combination looked pretty sweet to me. A large amount of short-dated debt and underperforming mines on a stock that is an old reverse merger is is the sort of thing that makes short-sellers salivate.

Alas it is not so simple. Bloomberg says pretty clearly that the debt is guaranteed by China National Gold.

Here are some cut-and-snips from our Bloomberg machine. Here is what Bloomberg says about the bond issue:

This clearly delineates the issuer as Skyland Mining BVI LTD and states unequivocally that there is letter of support by China National Gold Corp.

As China National Gold Corp is amongst the more solvent and liquid Chinese SOEs this debt trades as a quasi-Chinese sovereign debt.

If you go back to the press releases when the debt was issued Bloomberg also clearly states that the debt was issued with a letter of support.

And this is where a short-case ends. I do not feel like shorting the Chinese National Government. This debt trades at par, and if it is really supported by China National Gold it deserves to trade at par.

Trust but verify

I am however an intense fan of Ronald Reagan's approach to dealing with the Russians (or in this day-and-age the Chinese). The Reagan approach was to "trust but verify".

I went looking for the original offer document to find this letter of support.

Bloomberg had no document that verified that a letter of support existed.

So I looked a little harder. Actually a lot harder. And here is what I found.

The 2014 debt issuance

The 2014 debt issuance is explained in the 2014 CGG annual report. To quote:
On July 10, 2014, the Company, its wholly-owned subsidiary, Skyland Mining (BVI) Limited (the “Issuer”), China National Gold and Standard Chartered Bank, Citigroup Global Markets Limited, Merrill Lynch International and CCB International Capital Limited (the “Joint Lead Managers”) have entered into a subscription agreement (the “Subscription Agreement”) pursuant to which the Issuer has agreed to issue to the Joint Lead Managers, and the Joint Lead Managers have agreed, severally and not jointly, to subscribe for bonds in an aggregate principal amount of US$500 million (equivalent to approximately HK$3,900 million) at an issue price of 99.634% (the “Bonds”) bearing interest at the rate of 3.5% with a maturity date of July 17, 2017, rated BBB- by Standard & Poor’s. The bonds were unconditionally and irrevocably guaranteed by the Company. The net proceeds would be used for working capital, capital expenditures and general corporate purposes of the Company. 
On July 17, 2014, all the conditions precedent to the issue of the Bonds as set out in the Subscription Agreement were satisfied and the issue of the Bonds was closed. The Bonds were listed on the Stock Exchange of Hong Kong Limited on July 18, 2014. Details of the Subscription Agreement are stated in the Company’s announcements dated July 11, 2014 and July 18, 2014.
You will note that in this China National Gold was a participant in the subscription agreement.

Also to confuse matters the press releases are not dated 11 July and 18 July. They are in fact dated 10 July and 17 July. I guess this could have been an effect of the International date line between the Hong Kong listing and the Canadian listing.

That said you can find the 10 July press release here (original here) and the 17 July press release here (original here). They detail all the conditions of the bonds.

The 10 July 2014 press release starts as follows:

VANCOUVER, July 10, 2014 – The Board of Directors of China Gold International Resources Corp. Ltd. (TSX: CGG; HKEx: 2099) (the “Company”, the “Guarantor” or “China Gold International Resources”) is pleased to announce that on July 10, 2014, the Company, its wholly-owned subsidiary, Skyland Mining (BVI) Limited (the “Issuer”), China National Gold Group Corporation (the “Keepwell Provider”) and Joint Lead Managers as defined below, have entered into a subscription agreement (the “Subscription Agreement”) pursuant to which the Issuer has agreed to issue to the Joint Lead Managers, and the Joint Lead Managers have agreed, severally and not jointly, to subscribe for bonds (the “Offer”) in an aggregate principal amount of US$500 million (equivalent to approximately HK$3,900 million) at an issue price of 99.634% (the  Bonds”) bearing interest at the rate of 3.5% with a maturity date of July 17, 2017, rated BBB- by Standard & Poor’s.

This press release clearly states that China National Gold Corporation is a "Keepwell provider".

CapitalIQ also has the original offering documents. For those with a CapitalIQ subscription you can find them here - but I have downloaded here. This document confirms China National Gold as a Keepwell provider. [Incidentally the dates on the Capital IQ releases match the annual report again suggesting that it was a dateline issue.]

We can be pretty sure that the credit on the 2014 bond issuance was supported by China National Gold.

You would expect it to be money-good regardless of the performance of the underlying mines.

And it was. The issuance was repaid in 2017 and another USD500 million was borrowed in the Hong Kong market.

The 2017 debt issuance

The 2017 debt issuance looks somewhat different. Again we can find a description in the CCG annual report (in this case the 2017 annual). Here is the text:

On June 27, 2017, the Company, Skyland Mining, China International Capital Corporation Hong Kong Securities Limited, Citigroup Global Markets Limited, CCB International Capital Limited, Industrial Bank Co., Ltd. Hong Kong Branch and Standard Chartered Bank (the “Joint Lead Managers”) entered into a subscription agreement (the “Subscription Agreement”) pursuant to which Skyland Mining agreed to issue to the Joint Lead Managers, and the Joint Lead Managers agreed severally and not jointly, to subscribe for bonds in an aggregate principal amount of US$500 million (equivalent to approximately HK$3,880 million) at an issue price of 99.663% (the “Bonds”) bearing interest at the rate of 3.25% with a maturity date of July 6, 2020, rated BBB- by Standard & Poor’s. The Bonds were unconditionally and irrevocably guaranteed by the Company. The net proceeds are used for repaying existing indebtedness, working capital and general corporate purposes of the Company. 
On July 6, 2017, all the conditions to the issue of the Bonds as set out in the Subscription Agreement were satisfied and the issue of the Bonds was closed. The Bonds were listed on the Hong Kong Stock Exchange on July 7, 2017. Details of the Subscription Agreement are stated in the Company’s announcements dated June 27, 2017 and July 6, 2017.
This differs in one key respect from the 2014 disclosure. China National Gold is not a party to the subscription agreement.

The press releases dated June 27, 2017 is here (original here).

The press releases dated July 6, 2017 is here (original here).

Here again is the opening paragraph of the first release.

VANCOUVER, June 27, 2017 – The Board of Directors of China Gold International Resources Corp. Ltd. (TSX: CGG; HKEx: 2099) (the “Company”, the “Guarantor” or “China Gold International Resources”) is pleased to announce that on June 27, 2017, the Company, its wholly-owned subsidiary, Skyland Mining (BVI) Limited (the “Issuer”) and Joint Lead Managers as defined below, have entered into a subscription agreement (the “Subscription Agreement”) pursuant to which the Issuer has agreed to issue to the Joint Lead Managers, and the Joint Lead Managers have agreed, severally and not jointly, to subscribe for bonds (the “Offer”) in an aggregate principal amount of US$500 million (equivalent to approximately HK$3.88 billion) at an issue price of 99.663% (the “Bonds”) bearing interest at the rate of 3.25% with a maturity date of July 6, 2020, rated BBB- by Standard & Poor’s.

You will note that China National Gold appears nowhere in this. The "Keepwell" has disappeared. China National Gold is not mentioned in either release.

Again CapitalIQ has a page on this bond (here) and if you have a subscription you can download a longer-form offering document. I have saved it here.

Again it contains no reference to China National Gold or to a Keepwell agreement.

Bloomberg isn't right here - but it turns out it is not unequivocally wrong

Bloomberg is pretty unequivocal - the 2017 bond expiring in early July this year has a letter of support from China National Gold.

But that letter of support does not exist in China Gold International's own press releases.

Bloomberg however is a pretty reliable source normally and so after much scrounging we actually got a copy of the offering document from one of the original brokers. You can find it here.

This offering document lays out what is meant by the letter of support - because yes - there is a letter of support from China National Gold.

The Letter of Support is neither legally binding nor a guarantee, and the Company is not legally obliged to support the Issuer and the Guarantor in the manner contemplated in the Letter of Support. 
The Letter of Support is not legally binding on the Company [which in this case is the SOE]. See “Summary of Letter of Support”. It is not a guarantee by the Company for the payment obligations of the Issuer under the Bonds or the Guarantor under the Guarantee, and there is no assurance that the Company will provide support to the Guarantor in the manner contemplated in the Letter of Support. The Trustee will not, in any circumstances, be able to bring any action against the Company to enforce the provisions of the Letter of Support. Even if the Company intends to provide direct financial support to the Guarantor to meet its outstanding debt obligations, such financial support may be subject to governmental approvals which may not be obtained.
They go on in the offering documents. All it says is that China Gold International occupies a strategic position in the China National Gold group. And hence it is likely that China National Gold will support the debt. It is a non-guarantee guarantee.

Now those 2017 bonds are about to expire (early July this year) and so China Gold International needs to refinance them.

And it is fair to say that the underlying gold mines have sharply underperformed expectations in those three years with the company producing losses in both 2018 and 2019.

China Gold International are cumulatively unprofitable reverse merger with over a billion USD in debt and a collapsed stock price. They are not repaying the money unless someone lends them another cool half billion.

But as they have to come to market they are trying to come to market.

There is a press release in Chinese that explains that they are coming to market for a debt issue of unspecified size. The press release mentions a letter of support from China National Gold but no mention as to whether this letter is a guarantee (as per the 2014 debt issue) or a prop with no legal power (as per the 2017 debt issue).

I guess if there were legally binding state guarantee as per the 2014 issue then there should be no problems getting this done. I guess this is a test of what is required get a deal done.

But as it stands this is a test if a company which barely trades at all and with a collapsed stock and some sharply underperforming gold mines can raise a half billion dollars supported by what appears to be a fictional quasi-government guarantee.

But in this market even that seems likely. As long as it yields over 100 bps. Long live loose monetary policy.


Disclosure: we have no position in the stock. We have a small position short the bonds.

Friday, May 15, 2020

Open letter to Institutional Investor Magazine

Last night Australian time Institutional Investor published a piece on Bronte Capital's position in Herbalife.

To quote the opening sentence:

Australian hedge fund manager John Hempton, the co-founder of Bronte Capital, has turned out to be a true believer in Herbalife, the controversial multilevel marketing company that has been under investigation by one federal agency or another for several years. Over the past year, Hempton doubled down on Herbalife...

I observed on twitter that contrary to standard journalism ethics the author (Michelle Celarier) did not seek our comment before publishing.

She told me to check my email. So I did. Ms Celarier did in fact send something.

Here it is:

Michelle Celarier
01:15 (12 hours ago)

Hi John 
I am writing a news story for Institutional Investor about your investment in Herbalife, as you disclosed updated filings for the quarter.   
I note that you've been adding to your position over the past year, according to the SEC. 
I also quote from your recent letter about Herbalife-- and note your performance this calendar year. 
Just wanted to let you know about this. I'm on deadline, so if you have further comment please respond asap. 
Thank you 

Michelle Celarier
917 971 0279 
Follow me on twitter @mcelarier
You will notice that this came at 1.15AM Australian time. It came when I was (and could reasonably be expected to be asleep). The story was published before I woke up at approximately 6AM.

This is a clear breach of journalist ethics. But it is also sloppy and demonstrates what happens when you do not check your facts.

There are two reasons our Herbalife position has increased.

a). Our fund was closed and it re-opened. We got considerable flows. We adjusted the Herbalife position to match the flows.

b). We sold a large position in the 50s (when Bill Ackman covered) and we repurchased it (and then some) at lower prices.

The second one is instructive. If you sell a $1000 worth of Herbalife stock at $53 and buy it back at $27 you will wind up with more Herbalife stock. (This trade matches some of what actually happened in our book.)

For these reasons our Herbalife stock position (measured in number of shares) has increased considerably.

But the position measured in the percentage of the fund at cost has actually shrunk. We did not "double-down" as the article suggests - we actually took some off the table.

The article is false and should be withdrawn.

The statement that we doubled-down is contrary to both our risk management policy and what actually happened.

That said: for the record we still think the stock is a good value at this price. We have a full-sized position now (or we would buy more). But that is not a newsworthy story. The only story Michelle Celarier has is that a fund manager is bullish about a stock they own.

John Hempton

Monday, March 30, 2020

Watch what the Chinese do

I don't easily believe Chinese statistics - especially regarding something as awful as COVID-19. Believe your eyes and common sense over Chinese statistics.

When China (officially) had 19 deaths they started building massive field hospitals. Believe what you see (the hospitals) but take the 19 deaths as a rather dubious estimate (as per that time).

By contrast when the Chinese Government say COVID-19 is highly controlled in China you can believe them because there are Westerners and Western companies throughout China and what you can see (Shanghai and Chongqing as functional cities) comports with the statements and the actions of the Chinese Government.

My general view: watch what the Chinese Government does - rather than what they say.

This is a story about journalists returning to their home in Beijing before a Government crackdown on foreigners. 

Watch it.

You can see the Chinese take COVID-19 very seriously indeed.

We can conclude that

a. The Chinese have seen the virus. They think they know what it can do. They are scared. Do not believe the Chinese numbers. The truth is much worse. But believe the Chinese actions. They think fear is appropriate.

b. The Chinese have proven that a super-hard lockdown lasting seven weeks in affected areas 2.5 weeks in Shanghai etc can work. Their major cities have low virus load and major Western cities have not.

c. The Chinese Government are super-scared of reintroducing it.


General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.