Credit Suisse –  How Bad and What Next?

Blain’s Morning Porridge – March 16^th 2023: Credit Suisse –  How Bad and What Next?

“Credit Suisse is a bank that’s gone senile.…”

This Morning – Credit Suisse is in the headlines for all the wrong reasons. Confidence in the bank is zero. The Swiss National Bank has provided a backstop, but a sale looks likely of the bank that just can’t get it right.

It’s all about banks this week. Just when we thought it was time to hoover up cheap bank stocks in the wake of Silicon Valley Bank resolution, the whole of Europe’s banking sector was wobbling like a particularly soft jelly as rumours mounted and swirled around the imminent potential fail of Credit Suisse… It is among Europe’s worst performing stocks – down 87% over 2 years. It’s tumbled 36% this month from $3 to $1.93.

Last night, after pleas from Credit Suisse execs, the Swiss National Bank stepped in with a CHF50 bln liquidity backstop which should relieve immediate pressure, but it fixes little in the long-run. It will also offer to repurchase $3 bln of its outstanding debt, which may relieve some of the pressure on its junk-like funding status and soaring credit default swaps, but does nothing for its beleaguered stock holders. Once confidence in a bank is broken – it tends to stay that way.

Officially, investors are worried just how much more banks are going to hurt from losses on the bond portfolios caused by rising rates. Larry Fink of Blackrock is warning banks are so crushed by rising rates, they will restrict lending creating a recession. Frankly, if investors were unaware rising interest rates were going to thump bonds and therefore impact banks – then they should reconsider their career choices. The real reasons for banking weaknesses are multiple – but they certainly included the 8000 kg Sick Gorilla in the Room – Credit Suisse.

“When the ECB started asking questions of Europe’s big banks about the scale of their exposures to Credit Suisse, well that’s when we started carving the tombstone.”

It’s not just the ECB that was asking. Last week the Fed invited CS execs in for a proverbial cup of tea. It’s difficult to imagine just how unlike anything in banking history the long slow lingering demise of Credit Suisse has been. If it was a dog, we’d have cuddled it one final time, kissed it goodbye and shot it. Instead, we’ve got to watch the once towering titan of the global financial stage totter through senility, raging incoherently at the dying of the light.

Banks usually die quick. Most tumble on a liquidity event – confidence collapses, followed by a run on the bank, and inevitably the authorities step in to ensure the unwind isn’t too messy. Occasionally, it’s a solvency event – when a bank is crushed by a credit misstep or no-see-um, and its capital reserves evaporate, forcing it to close the doors. Sometimes it’s a combination of both – where it can’t refinance, and its losses look insurmountable, forcing it into a distressed sale, like Bear Stearns in 2008. Sometimes, no one is willing to take on the risk, as happened to Lehman Brothers.

But, I’ve never watched a bank die slowly of financial dementia before…

The immediate crisis was brought on Tuesday when its largest shareholder, a Saudi Bank, stated it would definitely not be increasing its stake. Oops. That was seen as notification of a collapse in confidence in the bank and its management.

Earlier this week it reported material weaknesses in its financial reporting for the past 2 years…. When Switzerland’s second largest bank lacks the basic competency to count its money – that’s a problem. One rumour said it is long to the eyeballs on long duration debt which will trigger massive losses if its forced to sell if clients exit and demand their money back.

Over the past few years, if there has been a banking scandal or screw up, you can bet Credit Suisse’s name will be all over it. The bank lost the plot when it came to managing and understanding it’s risk, encouraging bankers to chase anything on the basis it might work. It foisted a culture of profit first, prudence last. From funding fraudulent Tuna fishing boats in Mozambique, multiple drug money laundering failures, spying on its own staff, backing financial scam artists like Greensill, losing billions on hedge fund scam Archegos, you name it… Credit Suisse was there.

However, there is nothing anyone can point to today and say definitively as the issue that will mortally wound the bank. Credit Suisse had the wherewithal to withstand depositors demanding their cash back – even before the SNB liquidity injection it could have sold its Available-For-Sale Government bonds at a substantial loss (but covered by its 14% capital ratio). There is no black hole at the core of its credit book set to consume the bank from within – that we know of, yet.

I’ve been “doing” Financial Institutions finance for nearly 40 years as a banker, originator, trader and broker. I’ve seen stuff that would make your hair turn white in a heartbeat… But Credit Suisse is developing into something very dark and different. I’ve watched Deutsche Bank stumble from one crisis to another, but never thought it was doomed. I’ve smiled at the sheer incompetent resilience of the Italian banks but always been sure Monte dei Paschi di Siena would wriggle through (incidentally, it was the first bank I ever did a deal for a very junior banker in 1986, a $40mm CD.)

Credit Suisse is different

• Even after the SNB backstop, my gut tells me Credit Suisse is history. A bank just can’t survive this level of crisis and stock price collapse. Confidence has gone.
• My head told me it was likely to be “supported” – rather than outright rescued – by the Swiss Government – which is what is happening. It’s too big as a systemically important financial institution in Europe and globally, and too critical to the Swiss economy.

Despite the SNB “backstop”, Credit Suisse can’t just be left on its deathbed, hoping for recovery. The most likely outcome now is a distressed sale. Realistically, that probably has to be UBS as the only likely buyer. The Swiss will not want one of its “national champion” banks going overseas, and although it will concentrate banking into a single name, UBS is a better managed institution and big enough. It will be a brutal takeout – and Geneva will be the loser.

A trade sale might sound like the currently depressed stock is a screaming buy, but don’t be so sure. UBS (or any other bank) will see a purchase of CS as a rescue – and will look at HSBC’s £1 purchase of SVB UK earlier this week as their pricing point.

Playing in the bank credit default swap market may be a better idea – betting that selling protection on a bank that won’t default but will be “resolved” makes sense. I need to check exactly what the definitions of a credit event would be – and that a rescue that effectively wipes equity and CET1 capital isn’t a credit event that would trigger default.

How did Credit Suisse get to this stage?

There are some basic rules when it comes to investing in banks.

• The first is simple – buy dull, boring, predictable banks doing banking in a dull, boring, predictable way that don’t feature front-page-of-the-FT risk for repeatedly getting it wrong.
• The second is look at the quality of management: Good banks replace good managers with better managers. Bad banks tend to replace bad managers with even worse ones.
• The third is CAMEL-L: understand the bank’s Capital, Assets, Management structure, Earnings, Liquidity and Liabilities.
• The fourth is their business – look for diversity and their degree of inter-connectedness – how reliant on the rest of the banking system are they. Who is their regulator. How systemically vulnerable are they. (Pay close attention to their derivative exposures – which is why French bank stocks are so volatile.)
• Don’t trust anything. Take a slide-rule to their accounts and look at the notes on held-to-maturity assets.
• Who are their clients?
• If these check out, then, and only then, start to think about buying the stock or bonds.

Do the above tests for Credit Suisse. It’s a Fail right down the list.

Back when I was a young banker in the 1980s, Credit Suisse was a legend. Ossie Grubel was the banker’s banker, the trader’s trader who rose to ultimately became CEO. Credit Suisse First Boston made Goldman look second tier in investment banking. Credit Suisse Financial Products was arrogant to the nth degree, but they ran the derivatives business.

What went wrong? A series of poor management choices, a failure to understand the unique risks it faces, a dereliction of clients, a failure to nurture its private banking, a loss of confidence in its investment banking division. The once successful Swiss Bank became an international bank with a Swiss name run by international banking technocrats with little understanding of its unique strength or culture. Everyone raved about CEO Tidjane Thiam except anyone who had to work with him. Even the Swiss Banking authority fined the bank for laundering drug money!

For years its being trying to reinvent itself – multiple plans replaced by new plans, vaguely worded around “cultural transformation”, “risk management” and “control processes” to strengthen its Wealth Management, Private Banking and Swiss Banking division. It was even planning to relaunch the Credit Suisse First Boston (CSFB) brand as a stand-alone investment bank. Frankly when you’ve read a recovery plan in October, and a new one is announced in March, its difficult to find he enthusiasm to open it..

I wonder when the axe will fall, and the takeover announced…. It feels inevitable. If it happens, then there is a chance, a slim one, even the Germans might take notice, and Europe’s overbanked market of lacklustre national champions might be resolved into a unified banking environment. Who Am I Kidding – that will never happen!

Five Things To Read (and listen to) This Morning

BBerg              Credit Suisse Erupts Into Full Blown Crisis as Rivals Back Away

Thunderer       Goldman Sach’s duel role in Silicon Valley Bank crisis under spotlight

FT                    US stocks close lower amid renewed sell-off in bank shares

WSJ                 Bank Failures, Market Turmoil Fuel Bets on a Pause in Fed Interest Rate Increases

Torygraph       More banks could go under, warns Larry Fink

Podcast           What happened with SVB, and what now?

In this week’s Shard Capital Lite-Bite Podcast, Bill Blain, Strategist and Head of Alternative Assets is joined by Ernst Knacke, Head of Research, as they discuss what exactly happened to Silicon Valley Bank and why markets have been affected by it.

What will happen next? Will we see a change in valuations in real assets? How will risk be priced into equities? Will Central Banks continue to normalise rates and fight inflation, or will be they be forced to ease to preserve market stability?

Out of time and back to the day job…

Bill Blain

Strategist – Shard Capital