Credit Suisse: bad times but not bust yet

If a week is a long time in politics then just a few hours – let alone days – can be an eternity in the world of finance. On Friday last week, Credit Suisse was having a relatively boring day despite having one of the roughest years in its 166-year-old history. Yet by Sunday night the Zurich-based bank was rumoured to be the next Lehman Brothers.

Here’s, more or less as far as we know, what happened. Credit Suisse has been having a tough time: its shares have tanked by 50% over the last year after a number of scandals including the collapse of supply chain finance group Greensill Capital and the family office of Archegos. These twin hits led to $10bn – some £8bn – of its clients’ assets being frozen and a $5.5bn trading loss.

While the rest of Wall Street has been posting profits, Credit Suisse has lost money for three straight quarters but the market has taken this on board. If you like, the bad news has already been discounted into the share price. 

Which is why eyes were focused on the next trading update from the new chief executive, Ulrich Koerner, who is due to announce details of the bank’s restructuring later this month. 

Then, sometime over the weekend, news leaked that on Friday Koerner had sent staff a memo assuring them that life was tickety-boo. Within hours, what Koerner wrote was splashed all over Twitter and Reddit:  “I trust that you are not confusing our day-to-day stock price performance with the strong capital base and liquidity position of the bank.”

His memo fed the panic and over the weekend the rumour machine went for the kill. As they say, if it bleeds, it leads. Well, as you can imagine, after the fragile nature of market trading around the world last week Koerner’s comments had the opposite effect to those intended, triggering a sense of deja vu in the markets. Those with long memories will remember that Koerner’s words echoed what Lehman boss, Dick Fuld, said ahead of his firm’s collapse in September 2008. 

Responding to those rumours, Koerner and his top lieutenants spent the weekend talking to clients and colleagues assuring them that the bank was sound and all was good. 

But by Sunday night, social media went over board with one journalist tweeting that Credit Suisse – deemed one of the world’s top 30 systemically important banks – was about to have a Lehman Brothers moment. 

So what started out on the Friday as mild concern with some share selling had reached crisis point by the Sunday night, suggesting Credit was on the edge. That was patently nonsense, although in these febrile times anything is possible and made far worse by the exponential impact of social media which takes the “if it bleeds it leads” mantra to a new level.

On Monday morning, Credit Suisse opened its doors for business. In an another attempt to quash the rumours, Koerner made another statement, claiming again that the bank was sound and that he would be delivering his quarterly update as planned on 27 October.

Koerner made things worse: CS’s shares tanked again, another 11% and the cost of credit defaults swaps or CDSs- in other words buying insurance against Credit Suisse defaulting on its debt – soared to a record high.  At one point they jumped to 355 basis points on Monday, a record measure of its risk of defaulting. The shares have since recovered a bit, to $4.22 against a year’s high of $10,  valuing the once mighty bank at a paltry $11 billion. 

So what’s the real picture? In Koerner’s own words, CS  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.”

Here’s the translation. Koerner means to boost the wealth business – which does well because of juicy fees and slash back the investment bank which is suffering because IPOs and capital raising is thin on the ground and M&A is scaling back. It also lost its key prime brokerage business when Archegos blew up.

Taking a knife to the investment bank is going to be tricky for Koerner to carry out: egos are big and the pay is bigger so there will be resistance and it will be costly.

To date, the market seems to accept that CS’s capital base is relatively strong. Boaz Weinstein, the founder of Saba Capital Management and a former CS trader, has tweeted the risks of bankruptcy are overstated while the Bank of England – which monitors the bank – said it was satisfied and that it meets all its Basel 11 requirements.

According to the Wall Street Journal, Credit Suisse has said it has a capital buffer of nearly $100 billion with high quality liquid assets near the $238 billion reported in June.

For now, the focus has switched away from Credit Suisse although it is not out of the woods. Such is the fear and greed stalking the markets that analysts have already switched their attention to other poorly performing banks which also trade at a discount to net asset value.

What stresses the markets is not only the costs involved in running investment banks but fee income coming down while interest rates – and bad loan provisions – are going up. It’s not a good combination. Paradoxically, banks with credit in their name are among the worst performers and look particularly cheap : France’s Credit Agricole and Italy’s Unicredit are now up for scrutiny, as is BNP Paribas which are all trading at low book values – the proportion of shareholders funds less than its total liabilities.

The truth is that there is a wider problem within the European banking system. It remains – as it has for decades –  highly fragmented, so margins aren’t great while the European pools of capital are relatively small in the equity and bond markets. That means competition between the banks is intense and that they are constantly searching for even the slimmest of pickings at the tiniest of margins.

In contrast, the US is dominated by few big bulge bracket banks – which can charge higher fees – and have massive capital pools to fish in.

Another reason why the European banks are weaker than their US counterparts is that, according to Russ Mould, investment director at AJ Bell, the European Union did not do such a good job of cleaning up the banks’ bad debts after the 2008 Great Financial Crash.

While the EU did little to support the banks, the European Central Bank charged the banks to park their capital with it in contrast to the Federal Reserve which paid interest on bank reserves, thus bolstering those reserves and encouraging them to lend.

As Mould puts it: “EU dumb, US smart”. Europe’s political and corporate leaders have also gone flat out on getting rid of their fossil fuel investment, when Europe became addicted to Russian gas. It’s an incendiary mix, as they have discovered, and it means the banks too are over-exposed to loans to companies expanding into renewables. Not a clever move.

Yet as Mould also points out, each financial crisis is different. Each has a different match to light the powder keg even if the causes of excess credit and poor management are the same. Famous last words, on my part, but it looks unlikely that Credit Suisse – or any of the European banks despite their exposure to fancy derivatives and bad loans – are the ones likely to blow a hole in the financial system.

Look instead at over-exposed sovereigns: this time it is governments which are the most vulnerable as they overloaded themselves with debt through QE and low interest rates and now face higher bond yields and weaker currencies.

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