Seems nobody on the blogosphere is buying into Ernst & Young’s recent mea culpa admitting to have been wrong on its estimate of China banks’ bad debt holdings.  The general view is that the retraction comes not from any re-calculation of the report’s numbers, but from a re-calculation of what the report will do to Ernst & Young’s own profit numbers.

David Bosco over at The Foreign Policy Blog has this to say, in his post, entitled, “In China’s Debt” [link no longer exists]:

Last week, I blogged briefly about a report by Ernst & Young on China’s looming bad loan problem. It painted a grim picture of China’s banking system, which is lending too much and collecting too little. For its part, the People’s Bank of China trashed the report, calling it “ridiculous and barely understandable.” Now, Ernst & Young has withdrawn it, claiming it was not properly reviewed. It’s a bizarre sequence of events, to say the least, and I can’t help wondering what kind of pressure China brought to bear on Ernst & Young.

The Asia Business Intelligence Blog, [link no longer exists] in its post, entitled, “Ernst and Young Retracts China Bad Loans Report,” had this to say:

Here’s what Jack Rodman, a managing director at E&Y, said when the report was issued, before the retraction:

“I think the numbers will be a big surprise because China has been giving the impression (with its banks listing overseas) that the problem is behind us,” said Jack Rodman, a managing director with E&Y. “China has not really resolved the issue – they have just moved it from one state enterprise to another.”

Wow! It was refreshing to hear so bold a comment uttered by an executive representative of a major western business operating in China. (We have been writing in a similar vain for a number of years.) But then came the muzzling of those who felt it safe to speak in earnest. What happened?

Read the press release carefully, as it appears to have been drafted with great care. Within this work of fine draftsmanship (I heartily commend the writer), one finds an explanation to its global readership. May I paraphrase?

“We, a global leader in professional services committed to restoring the public’s trust in financial accounting, told the world Chinese big four NPLs hit 358, but we were on the receiving end of some serious heat from the central bank the week it was issued, even though they characteristically didn’t announce us by name. And, anyway, we’re auditors for two of those banks, so what could we do? We haven’t any choice but to kow-tow if we want to keep the business — this is China and we’re in it up to our double chins. Ok, here’s the official number: $133 billion. We’re not saying explicitly that we avow the truth of that number, but it is the official version. Can you dig it?”

Sadly, none of the western press seems to have picked up on anything but the exact wording of the press release, making it appear as though E&Y was entirely at fault. At least, in the near term, their bold assertion may work to harm their reputation in the eyes of those who without China business experience. E&Y press relations people outside of China may wish to pitch the rest of the story, off the record, to their media contacts at some point.

The Epic of the Fall Blog posits a similar view in its post, bluntly entitled, “Ernst & Young Bullied To Withdraw NPL Report By Chinese Authorities.” [link no longer exists]

The title of the post on this at Doing Tha’ Deal Blog makes clear this bloggers’ views on the retraction: “We Bend Over For Our Clients.

The China Business Services Blog, in its post, entitled, “Non Performing Accountants (and Loans),” though somewhat subtle, also appears not to believe Ernst & Young’s retraction:

Ernst & Young is quoted as saying: ‘Upon further research, Ernst & Young Global finds that this number cannot be supported, and believes it to be factually erroneous’. They added ”we sincerely regret any misleading views that the report conveyed’.

I bet they do! It does not help one’s domestic business to be picking up black marks from the government, your major clients or, as an accountant, to get your sums wrong’then again, who really does know the true state of China’s NPLs?

There is no way Ernst & Young can or should come out of this without looking bad.  Either its initial report was sloppy and wrong OR they are willing to lie for money.  Though I tend to think it is the later, I have not seen the hard evidence that would allow me to state this unequivocally.

And, as I mentioned in my initial post on the retraction, one of our readers early on posited that the Ernst & Young numbers were wrong because of double counting.

I would love to hear from any accountants who have had an opportunity to review the report.  What do you think?

  • Joseph Wang

    I outlined the problem with the E&Y numbers. Some of the numbers you can argue back and forth, but the major problem is that the report double counted $250 billion. That’s not arguable, it is just wrong.
    E&Y looks really bad, because it’s been one of the auditors for the big four banks. If it really believed that there were off-book NPL’s in the big four banks (and I don’t think there are), then it shouldn’t have signed the accounting certifications.
    Also, the trouble with NPL numbers isn’t government secrecy at all. The problem is that it often isn’t clear what constitues a NPL. If I miss a credit card payment by one day, that isn’t an NPL. If I miss one by one year, that is. Somewhere in between is a fuzzy line. There are a lot of accounting rules and standards that make this determination, but applying them involves pretty much examining line by line every transaction of a multi-billion dollar corporation. That is not easy, but it was done with the big four banks. The status of pre-1998 loans is not a topic for which you can argue very much over.
    Some of the numbers involved are “hard” numbers (i.e. the amount that was transferred from the banks to AMC’s). Some of the numbers are “soft” (i.e. what are the probable losses due to real estate loans made in 2004). Some are in between (what are the NPL’s resulting from SOE’s issued in 1994).
    But you can get a handle on even the soft numbers. For example, I’d argue that it is unlikely that there is much in the way of pre-1998 NPL’s on the books of the banks, because there is no reason for the government not to have transferred those to the AMC’s. I’m also an optimist on the level of NPL’s resulting from the post-2001 credit boom, (and I can go into some detail as to why if anyone is interested). But since those numbers are soft, people can have legitimate disagreements (and I can also go into detail about why my arguments could be broken).
    But the mistake that E&Y did was to add 1 and 1 and get three. It’s unfortunate that E&Y isn’t going to publish a “post-mortem” explaining why the numbers are off. It’s even more unfortunate that E&Y isn’t going to publish a “post-mortem” explaining how a bad mistake like this slipped through.
    I should point out that in arguments like this it is really important to go in and get your fingers dirty with the details. If you don’t dig into the numbers and figure out where they came from and what they mean, it is really hard to figure out what to believe.
    This is bad because in the case of E&Y you are forced to throw out some good stuff. The NPL report had the best summary of Western investments in Chinese banks I’ve ever seen, and they also have a report next to it on Chinese real estate loans which seems really good.

  • Mr. Wang —
    Thank you so much for checking in again on this. I completely agree with you on the importance of getting ones “fingers dirty with the details” on something like this as it is only in the details that the answers will be found.
    I also concur with you in hoping E&Y will issue a full “post-mortem” on this, but I am not expecting it.

  • I would love a chance to review the report in full. It seems to have disappeared from where your reader cited it on the Ernst & Young site.

  • BR —
    I will try to track it down and post it later today. In the meantime, if anyone finds it onlne, I would greatly appreciate them alerting us of its location in a comment.
    Thanks.

  • I wonder if Mr. Wang might share his copy with us.

  • BR —
    Great idea. Mr. Wang, would you be so kind as to e-mail me a copy to firm @ harrismoure.com? Please note that I added a space to the e-mail address to avoid the dreaded spambots. Thanks.

  • Joseph Wang

    I wish I had saved a copy of the document.

  • Mr. Wang —
    Me too, as I am having no luck tracking it down on the internet. Anyone have it?
    Latest word is that E&Y will be re-issuing it in a month or so with the “corrected” numbers.

  • Adventure of Strategy

    A Small Matter of Double-Counting $250 billion?

    So Ernst & Young has retracted a report that it released showing that bad loans in China’s big four state-owned banks had reached a massive $358bn. (See a brief article from the Financial Times and a blog posting from…