Soured Luckin Coffee bet fails to dissuade Credit Suisse from chasing Chinese billionaires

Luckin’s dramatic fall from grace this month blindsided some of the top names in global finance but few have seen a bigger fallout than Credit Suisse

A man walks into a Luckin Coffee store in Beijing, China July 17, 2018. Picture taken July 17, 2018. REUTERS/Jason Lee

Before the accounting scandal and the stock crash and the defaulted loans, Luckin Coffee's billionaire founder Lu Zhengyao was an ideal customer for Credit Suisse.

“I’ve had I don’t know how many dinners with him in Beijing and he’s absolutely the poster child for what we want to do,” Tidjane Thiam said at a conference last year when he was still head of the bank. He lauded Mr Lu’s relationship with the firm that ranged from private banking to stock sales. “He’s a dream client.”

Luckin’s dramatic fall from grace this month blindsided some of the top names in global finance but few have seen a bigger fallout than Credit Suisse. The lender lost a high-profile Hong Kong initial public offering in the wake of the scandal and reported a five-fold increase in loan losses at its Asia Pacific unit, primarily due to a default by Mr Lu. The bank is conducting an internal review of the case, and scrutiny on loans to Chinese companies has increased, according to sources.

While Mr Lu has not been accused of wrongdoing, Luckin’s revelation that senior executives may have fabricated $310 million (Dh1.1 billion) in sales underscores the risk for investment banks of doing deals in China, following a series of accounting scandals. The world’s second-biggest economy is core to Credit Suisse’s strategy to win business from rich entrepreneurs across Asia.

“Luckin is a microcosm of what can happen when weak underwriting standards are allowed to persist in the pursuit of rapid growth,” said Mark Williams, a professor at Boston University and a former US Federal Reserve bank examiner. “Luckin exhibited many signs of a high-growth, high-risk business.”

A Credit Suisse spokeswoman in Hong Kong declined to comment and did no t elaborate on the remarks by Mr Thiam.

Bank's chief executive Thomas Gottstein, who took over from Mr Thiam in February, declined to comment on Luckin in a Bloomberg Television interview last week. The lender was still at the beginning of investigations involving auditors and lawyers, he said. “Too many parties involved to make an early conclusion.”

Mr Gottstein signaled the Luckin stock collapse would not prompt a strategic shift, and the bank will continue to target wealthy entrepreneurs in China.

“It’s a strategy that our firm believes in because it combines our strength in private banking and investment banking and we have had so many successes all over the world,” he said.

Credit Suisse wasn’t the only firm caught out by the scandal at Luckin, whose offices were raided this week by Chinese regulators. Luckin’s early investors included global giants such as GIC, the Singapore sovereign wealth fund. Morgan Stanley was part of the IPO group and provided some of the margin loans to Mr Lu, as did Barclays, among others. Morgan Stanley, Credit Suisse and the other IPO banks face an investor lawsuit after Luckin’s 91 per cent collapse from its January high.

Morgan Stanley, Barclays, and GIC declined to comment.

Yet, Credit Suisse had the closest ties. It was the lead underwriter for Luckin’s IPO last year in New York and the secondary sale in January, garnering 60 per cent of the banking fees. That amounted to about $30m for two deals that raised more than $1.2bn for the coffee chain and a shareholder, according to data compiled by Bloomberg.

The bank also led a $460m convertible bond sale in January and is on the hook for a portion of the $518m in margin loans to Mr Lu that are now in default. The firm has been working with the founder since taking his car rental company public six years ago.

Aside from the deals, the bank has other connections to the retailer. Luckin chief financial officer Reinout Hendrik Schakel worked for eight years as an analyst and investment banker for Credit Suisse in Hong Kong until 2016. And Mr Lu’s daughter Nancy works for Credit Suisse in Hong Kong in a role unrelated to the Luckin account, according to sources. She didn’t respond to phone calls and text messages, while the bank declined to comment.

"Luckin is a microcosm of what can happen when weak underwriting standards are allowed to persist in the pursuit of rapid growth," said Mark Williams, a professor at Boston University and a former US Federal Reserve bank examiner.

Given those links, Luckin’s downfall has hit Credit Suisse harder than others. Due to the scandal, the firm was dropped from a $500m IPO in Hong Kong for WeDoctor, the healthcare start-up backed by Tencent Holdings, according to sources. The bank has also increased scrutiny on Chinese loans in the wake of the collapse and the pandemic, the sources said. It ended talks on a $1.5bn loan to Melco Resorts and Entertainment, a Macau casino operator, after the financing failed to win internal approval. A spokeswoman at Melco declined to comment.

Mr Thiam identified Asia as a key growth driver when he was appointed chief executive in 2015. The region was carved out from Europe, giving local managers more clout over lending and capital. The move fit the global shift away from investment banking to wealth management, particularly in China, which crowns a new billionaire every three days. While multi-billionaires are well served in the US and Europe, the market in Asia is just getting started.

Mr Thiam couldn’t be reached for comment.

After years of reorganisation and cost reductions, mostly in the markets division, the bank is starting to see the results of its shift. Private banking revenue rose 36 per cent in Asia in the first quarter, while advisory, underwriting and financing revenue tumbled 78 per cent. Pretax income in the region jumped 38 per cent to 252 million Swiss francs (Dh1.05bn), as bank-wide profit beat estimates.

The wealth focus has come at the expense of the investment-banking team. Several senior bankers in Asia have left in recent years, including Mervyn Chow, who was at the bank for two decades, and Isabella Luan, a technology banker.

Credit Suisse has seen more turnover at its China team than some of its biggest competitors, going through four Greater China chief executives in recent years. By contrast, the China heads at UBS Group and Morgan Stanley have spent more than two decades at their firms.

Rivals such as UBS and Goldman Sachs have about twice the staff in China as Credit Suisse, while universal banks like JPMorgan Chase and Citigroup, have broader corporate banking and treasury operations.

Helman Sitohang, who runs the Asia Pacific division at Credit Suisse, said his competitors may have “bigger muscles and balance sheets”, yet the focus on the 1,000 billionaires across Asia is paying off. “We don’t want to be the biggest,” he said at an investor day in December. “We want to be the most profitable.”

Mr Sitohang lauded Mr Lu as one of the bank’s success stories. Mr Lu started Car Inc in 2007 and built it into China’s biggest rental company. Credit Suisse was there from the beginning, taking it public in Hong Kong in 2014, along with Morgan Stanley, and leading three US bond sales totaling almost $1.2 bn.

Mr Lu then set out to take on Starbucks in China, expanding Luckin to 4,500 stores in just two years. For a while it became a darling of US investors, with the stock tripling in its first eight months of trading.

While the Luckin board said it’s focusing its probe on chief operating officer Jian Liu, Mr Lu said the company went too far too fast, going public after just 18 months in business. Mr Liu couldn’t be reached for comment, nor could company officials.

“I’ve been blaming myself,” Mr Lu told the National Business Daily in China, referring to the rapid growth that created “a lot of problems” for the company.

The stock remains halted on the Nasdaq pending the review, with the last trade at $4.39 on April 6, down from a January high of $51.38. The company’s convertible bonds meanwhile trade at just 24 cents on the dollar, a clear signal of distress.

In the end, Credit Suisse will move on from Luckin, even if it results in short-term losses, said Ismail Ertürk, senior lecturer in banking at Alliance Manchester Business School in the UK. The lender will chalk it up as the “cost of doing business”.