Credit Suisse: This is not the next Lehman Brothers

Now that markets are more comfortable with the UK’s fiscal plans, Swiss bank Credit Suisse (CGSN) is the latest concern for global investors, with stocks plunging as European markets open on the first trading day of October. The Zurich-based bank, which dates back to 1856, has lost almost 59% of its value this year as concerns grow over its financial viability.

In the meantime, the bank has taken steps to reassure external stakeholders and staff of its position. Ulrich Koerner told employees last week to ignore recent share price weakness and focus on “its strong capital base and liquidity position.”

Update: The Morningstar View

Banking analyst Johann Scholtz doesn’t think Credit Suisse is in danger of going bankrupt and some segments of the market are booming. A rights issue is likely, and this could lead to a reduction in Morningstar’s fair value of SFr10 (shares are currently at SFr4).

“Some commentators have raised the possibility of a Lehman Brothers-style meltdown. From what we currently know, we think this is unlikely. Credit Suisse is well capitalized – at worst, its capital adequacy is in line with that of its peer group. Liquidity is an underestimated strength of Credit Suisse.”

But he thinks raising capital might be necessary to address fears from big money lenders. “It may seem incongruous that we don’t have concerns about the solvency of Credit Suisse, but we are asking them to raise capital. However, banks remain more exposed to sentiment than other less leveraged companies, and Credit Suisse’s numerous recent risk management failures have inspired very little confidence.

“Wholesale lenders are clearly demanding a greater capital reserve from Credit Suisse, which they rightly consider to be one of the European banks most exposed to credit rating downgrade risk.”

Scholtz thinks Credit Suisse is at risk of being downgraded by rating agencies, with its debt just two notches above junk status. All agencies have Credit Suisse negative outlook.

CDS revisited

Investors haven’t been this excited about credit default swaps (CDOs) since the eurozone debt crisis, which peaked 10 years ago. Credit Suisse CDS hit record highs on Monday, reflecting the Swiss bank’s perceived risk. Social media quickly picked up Reddit posts about Credit Suisse’s precarious position, which naturally attracted short sellers and speculators (and very many references to “Debit Suisse”). Followers of European banks know the near-permanent sense of anxiety and crisis – shares of Germany’s Deutsche Bank have been highly volatile in recent years and are down 41% this year. In 2022, markets are fragile, so corporate disasters are easily anticipated and amplified on Twitter and message boards.

What are credit default swaps? Essentially, they are derivatives that act like insurance contracts against a corporate or sovereign default – the bigger the CDS, the higher the risk and the more expensive it is to buy. They can be purchased as short-term and long-term instruments. (A useful explanation can be found here by trader Alex Good on the technical details of CDS, the outlook for CS’s investment bank and why markets might overstate the case for default).

The bank has launched a strategic review and will provide more details with its third quarter results on October 27. What is this review about? Mainly asset sales, underperforming units, cost cutting through job cuts and what he described as “enterprise-wide digital transformation.” The focus is on investment banking, which could be spun off and restructured into a “capital light” business aimed at advisory and markets clients.

As with the financial crisis of 2008-2009, some investors fear that Credit Suisse’s problems are evidence of a risk of contagion among European banks. But banks are better capitalized than before the GFC, with higher capital ratios, and rising interest rates are increasing the profitability of loans in the sector. The company also earns revenue in Swiss francs, one of the best performing currencies in the world this year, except for the US dollar.

Dividends were briefly suspended in the European banking sector under regulatory pressure during the Covid crisis, but European banks have since restored payments across the board. As for Credit Suisse’s closest and largest rival, UBS (UBSG), its shares have weakened since September but are only down 12% in 2022 and rose 1% on Monday over one day. While Credit Suisse shares fell on Monday morning, they closed relatively flat – and rose 5% in morning trade on Tuesday.

Yet last week, the European Systemic Risk Board said the continent faces risks to its financial stability due to the impact of Russia’s invasion of Ukraine and the impending recession. European financial indicators, such as purchasing managers’ indices and employment data, suggest the bloc is showing more signs of strain than in the United States. The euro broke through the $1 threshold in September to hit multi-decade lows.

Internal restlessness

Rating Agency DBRS Morningstar said that external challenges such as war, inflation and interest rate hikes, collide with internal issues such as leadership changes. Thomas Gottstein stepped down as chief executive (CEO) this summer and Ulrich Koerner took over on August 1, 2022. Former chairman Antonio Horta-Osorio, a former chief executive of Lloyds Banking Group, resigned in early 2022 after having breaking quarantine rules. The company has also been linked to various scandals, including Archegos and Greensill Capital. Credit Suisse and its clients have been hurt financially by their ties to Archegos Capital Management, a family office whose founder has been charged with fraud and racketeering.

“While some banks and corporates could benefit from high market volatility, DBRS Morningstar believes that for CSG the challenges are exacerbated by the various leadership changes in a short period of time, alongside the challenges of defining and executing a strategy. claire, especially in its Investment Bank,” their analysts wrote on Sept. 28.

“Management stability is a key element of any organization’s reputation, as strong management must be able to design and execute a consistent strategy that preserves franchise value and relies on the support of shareholders and investors”.

DBRS Morningstar rates Credit Suisse at A (low) with a negative trend. “Level A (low) is supported by the good capital position of the Group and takes into account that the Group has taken measures to improve risk management, including several management changes and reduces risks thanks to the exit of certain investment banking activities. However, the negative trend reflects the fact that the full reputational and frankness impact of shortcomings in risk management could result in lower business volumes.” DBRS Morningstar said it was monitoring developments at the bank that could affect its credit standing going forward.