Credit Suisse on the verge of a collapse?
Latest developments of the trending swiss bank
Our desk has been busy all the morning with flows on Credit Suisse. We began the day with accounts selling bonds (in particular senior bonds), then we had some shy buying flow. Little to none flow on AT1.
It is a good timing to review this case.
Is the bank on the verge of a collapse?
During the last weeks, the market conditions are tough for European banks as indicated in the interbank lending market. The FRA-OIS indicator has risen quite rapidly over the last two weeks. This indicates how expensive (or cheap) it will be for banks to borrow in the future.
The stress on the European banking sector soared further during the weekend as unconfirmed but credible sources rumoured about a major international investment bank on the brink of collapse. Everyone thought it was Credit Suisse.
So this morning we have the stock down 10% and bonds down between 2 and 10 points (both Senior and Subordinated bonds severely hit).
Credit Suisse has today a market cap below US$ 10bn, with the decline accelerating on the 21 September following headlines about the potential capital increase. One year ago, CS market value was US$ 22.3bn. In just one year, its shares fell 60% to US$ 3.67.
The bank investment banking arm has been hit by multiple scandals, putting earnings at risk. This is significant because the investment bank accounts for a third of the bank’s revenue. A lot of the investment bank’s recent revenue also came from Leveraged Finance, M&A and SPAC deal activity, which are all areas that have declined recently.
Basically, Credit Suisse needs to restructure its investment bank and it is being punished for it at worst possible time.
The bank is seeking to take “measures to strengthen the wealth management franchise, transform the investment bank into a capital-light, advisory-led banking business and more focused markets business, evaluate strategic options for the securitized products business, which includes attracting third-party capital, as well as reduce the group’s absolute cost base to below 15.5 billion francs ($15.7 billion) in the medium term.”
Credit Suisse options are now pricing high volatility in equity over the next 3 months. Implied volatility of 61 (decade highs) imply moves at a rate of x2 vs US financials.
Last week, the bank CDSs reached 2008 levels, with markets pricing default probability at 20% (significant but not scary). Today the CDS 5y spread widened 20bps. But compared to 2008, the credit curve is not negative (CSD 5y minus 1y), implying the short term default risk priced by CDS market is lower than 14 years ago.
Bonds and CDS are not pricing a credit event because as of the 3Q, Credit Suisse's CET1 capital adequacy was at 13.5% (within the bank's own target and above the 10% Swiss hurdle). During 2008, 5%< CET1s were common.
Boaz Weinstein, the founder of Saba Capital Management, tweeted the risks of bankruptcy are overstated, pointing that in 2011-2012 Morgan Stanley CDS was twice as wide as Credit Suisse is today.
Analysts at Citi, who say they have fielded inquiries wondering about the contagion impact, said they “understand the nature of the concerns, but the current situation is night and day from 2007 as the balance sheets are fundamentally different in terms of capital and liquidity, and we struggle to see something systemic.”
The CEO failed to reassure
Senior Credit Suisse executives spent the weekend assuring large clients, counter-parties and investors that its liquidity and capital positions are sound Financial Times.
Ulrich Körner has been meeting with major institutional investors that are worried the firm is on shaky financial footing and assuring them the bank has strong capital, liquidity.
The new management of the Swiss bank is working on its new strategic plan and, on Friday CEO Ulrich Körner sent a company-wide memo to try to reassure staff over the bank’s capital position and liquidity.
CEO Ulrich Koerner said the firm is at a ‘critical moment’ and sees strength, as well as noted they have a strong capital base and liquidity in a recent attempt to calm nerves.
Clearly he failed in this effort.
As said, over the weekend there were unsubstantiated rumours on social media (i.e. FinTwit) that a major investment bank was on the brink with many pointing to Credit Suisse. The CEO conceded that there is a fair bit of uncertainty and speculation around the future of the bank ahead of the results of its strategic review on 27 October, and vouched to send regular updates to the staff till that date.
He further requested employees to "remain disciplined and close to clients despite all the media attention the bank is receiving", CNBC reported.
Last but not least, the Bank of England has been liaising with Swiss authorities on the bank's condition, the Telegraph reported.
So, executive comments could be reliable:
“Credit Suisse has a strong capital and liquidity position and balance sheet. Share price developments do not change this fact.”
Conclusion
Arguably, Credit Suisse is a very systemically important European bank with a large asset base so this has wide implications (i.e. financial stability). We will have to watch closely as banking is a game of confidence.
The bank has different issues to solve: a disastrous investment bank with no prime brokerage due to Bill Hwang's blow up and big legal liability and fines coming from it (estimated to be in area $1bn in 1H 2022). AS the FT reported the bank's plan for dealing with the Leveraged Fininance losses is to package them into some kind of "bad bank" separate from other assets in the investment bank and let investors bid on that separately, presumably at a steep discount. We have seen this many times in the past and, together with the perspective capital increase, it is a viable option.
On the other hand the bank has a valuable wealth management platform and it is getting new money from its Asian expansion (i.e. China).
No doubt that these developments are not good for anyone, especially at this moment. After the UK’s pension crisis last week, it’s clear that cracks in the financial system are beginning to appear.
In conclusion, even if the bank remains unprofitable due to its investment banking and needs a big U-turn in strategy management, we have to recognize that we are not in 2008. We do not foresee a bank default, but certainly investors exposed to equity and subordinated bonds (in particular AT1s) could end up suffering more.
We have the feeling we are in the situation where things could get worse before getting better. In fact, further stress on the name and the European banking sector could force the action from authorities and regulators with supportive measures.
At this point, we cannot rule out an opportunity yet as we continue to view this case as a falling knife. From a risk management perspective, investors holding equity and subordinated bonds, should cut risk, not add.