Liquidity and capital count for something, even at Credit Suisse
The Swiss bank is sufficiently capitalised and fears of 2008 are far-flung, though dire market conditions are against its restructuring
Credit Suisse’ CEO Ulrich Körner has a point. The Swiss bank does indeed have the “strong capital base and liquidity position” as he discussed in his fateful memo last Friday which, unintentionally, brought fears of the 2008 financial crisis.
But the bloodshed that ensued from the price action on Monday seems to suggest that many ignored the bank’s relatively strong capital base. Focusing on CS' capital should overturn any comparison to a "Lehman moment".
While current sentiment screams to sell anything related to the beleaguered Swiss bank across asset classes, a deep dive into its balance sheet actually shows reasonably solid capital buffers. CS appears sufficiently prepared to withstand more market shocks, something its bond prices appear to not be factoring in.
The bank has been plagued by its financial market misadventures and scandals, resulting in lawsuits and losses, most notably from the collapse of supply chain finance company Greensill Capital and Archegos, the family office run by Bill Hwang.
However, the moves in its shares and bonds since last Friday — that has seen its credit default swaps spiking to as high as 550bp — are unsubstantiated, at least if regulatory capital is anything to go by.
Following the shock waves from the collapse of Lehman Brothers during the financial crisis in 2008, global banking regulations have significantly tightened. As of its last quarter results in June, CS sported a common equity tier one ratio of 13.5%, versus a requirement of 9.6%. The bank expects to maintain a ratio of 13%-14% for the rest of the year.
Moreover, under the Basel III international regulatory framework, since 2019 global systematically important banks (G-Sibs) have been required to meet a minimum total loss-absorbing capacity on their capital. Initially this was set at 10.5% of their capital ratio, though national regulations often require higher levels.
With a Sfr727bn balance sheet and Sfr274bn of risk-weighted assets (RWAs), CS is technically a G-sib.
In the latest update of G-sibs, as of November 2021, it sat in so-called bucket one along with other global firms such as Credit Agricole, Mizuho, Royal Bank of Canada, Wells Fargo, UniCredit and compatriot UBS. That bucket of banks was required to have an additional 1% capital buffer.
What this means is that, since TLAC was introduced, CS had built €97bn-equivalent of eligible debt for bail-in should that need arise, as of the last quarter, according to ABN Amro calculations. This was equivalent to a 35.2% TLAC ratio, or about 7.3 percentage points higher ratio than the minimum required by the Swiss regulator.
So, that leaves a Sfr20bn buffer in terms of RWAs, pointed out ABN's research, seemingly “sufficient to absorb upcoming losses from divestments/assets sales” from its restructuring of the investment bank.
The investment bank is where the trouble lies. It has created all the negative noise for the rest of the group, including CS’ well-regarded private wealth management business as well as its retail and commercial bank franchises.
The investment bank has been under a well-documented restructuring. Being in the middle of that transformation process is likely what had prompted the CEO to issue his internal memo last Friday. As staff were heading into the weekend, he asked them to "remain disciplined" following a series of reports about the scale of the restructuring plan that he was set to announce at the bank’s third quarter results on October 27.
But the market freaked out and as it reopened on Monday, it sent CS’ CDS spread as high as 550bp at one stage, though by the end of the day it was quoted anywhere between 270bp and 335bp.
As the bank’s equity price tanked, the negative sentiment spilled over into its bonds. Its holding company senior debt, which is TLAC eligible and bail-inable, spiked. The spread of its euro holdco bonds, which are referenced by the CDS, jumping by around 100bp and the equivalent dollar paper was spotted 50bp wider during Monday afternoon European hours.
These kind of spreads appeared overdone, based on CS’ capital position. Its euro 2.125% May 2024 bail-inable holdco debt moved out to a spread as high as mid-swaps plus 230bp, which was three times above comparable bonds trading in the iBoxx index, according to ABN Amro.
Following these worries, CS’ bond curve inverted in “a sign of substantial market worries,” wrote ING, but also highlighting that other lower rated banks’ bond spread too widened. ING spotted widening in the senior bonds of Barclays and Deutsche Bank on Monday, as the rumour mill also focused on their existential problems, although their spreads widened far less than did CS paper.
The argument that CS’ bond spreads have gone too far goes back to its balance sheet. The bank showed a strong liquidity position, ending last quarter with a liquidity ratio of 191%, or Sfr235bn of high quality liquid assets, and a net stable funding ratio of 132%.
Moreover, CS was able to convince investors to lend it money and secure more than $10bn-equivalent of funding from sterling and dollar Yankee issuance in senior preferred and non-preferred formats.
What has changed since then is the turbulence in market conditions.
The bank’s troubles are not new, although its shares, listed in Switzerland, nosedived again and lost nearly 20% between Wednesday and the close of trading on Monday. After the broader market recovery on Tuesday, CS shares also jumped, regaining almost 9% on the day.
But even then, that left the bank with a market capitalisation of just under $12bn.
Some of the capital evaporation it has suffered was likely spurred by the fear that gripped the market over the weekend. But on the other hand, there has been plenty of market chatter that CS has been looking for equity capital fundraising, with some market commentators suggesting a rights issue in the area of Sfr4bn-Sfr5bn.
The forward looking nature of markets means that CS’ share price likely reflects the dilution effect of a potential rights issue.
Bond markets often behave differently from equities. But now that both asset classes are showing similar reaction, amid high global volatility, the CS CEO should take heed.
The bank indeed appears to be well-capitalised to withstand market turmoil but the restructuring may suffer amid adverse market conditions. Both the bond and equities markets are hinting that CS may have to deliver its restructuring plan sooner than the end of October, regardless of its capital base.
One credit strategist neatly summarised the current worries: "If there is smoke in this market, it probably means it's better to be safe than sorry. But overall, these bond moves seem irrational. Then again the tide — in this worsening market since the end of August — is against them."