What exactly is wrong with Credit Suisse

It is a long time since we discussed the possibility of the demise of massive financial institutions. That was way back in 2008. It began with Bear Sterns going bust followed by the formidable Lehman Brothers filing for bankruptcy in September 2008. By October 2008, Fannie Mae, Freddie Mac, GE Capital, Morgan Stanley and Goldman Sachs were all on the brink. The drama and action of that period was best captured by Hank Paulson in his famous book “On the Brink”. At that point even the likes of UBS and Barclays were deep in trouble. After nearly 15 years, the problems appears have resurfaced with Credit Suisse.

Just a few days back, the newly appointed CEO of Credit Suisse, Ulrich Koerner, sent a memo to the staff of the bank assuring them that Credit Suisse had a strong capital base and liquidity position even as its stock price continued to fall vertically. In fact, Ulrich had gone so far as to mention that Credit Suisse had a capital buffer of $100 billion and high quality liquid assets of $238 billion. However, when there is fear on the street, not many are willing to believe such feel good stories. Like in the past, such assurances had the exact opposite impact. It just made the investors and the institutions panic all the more.

But to really understand this entire panic and where it started, one has to go back to the now famous (or rather infamous) credit default swaps (CDS). What exactly are these credit default swaps? A CDS is a bet on whether the issuer of the bond (borrower) will survive or not. The 5 year CDS widened to 250 meaning nobody was really willing to take such a long term bet on Credit Suisse. Technically, this level of CDS is not too high in isolation but it is the highest that Credit Suisse has seen since the year 2009 when it was just about recovering from the nasty shock of the global financial crisis of 2008. That is bad enough.

Others like Goldman Sachs and UBS had their CDS trading at well under 150, so definitely Credit Suisse looked like an awful outlier. That is not the only problem for Credit Suisse. At a time when all the wall street investment banks have been posting profit quarter after quarter, Credit Suisse has been the only one to be consistently losing money over the last 3 quarters in succession. One reason could be that it did make some awful investment decisions. Worse still, after making awful decisions, it also persisted with these decisions for too long. We will look at two such cases where Credit Suisse lost a lot of money.

The first big investment blunder was lending aggressively to Bill Hwang, the notorious boss of Archegos Capital Management. Credit Suisse lost close to $5.5 billion in Archegos case, not being able to exit its positions on time. Bill Hwang had built his family office wealth on hype and when the hype collapsed the family office also collapsed with it. Credit Suisse being the biggest financier of Bill Hwang’s positions bore the brunt. The other was the loans given to the Greensill Capital supply chain network. In the case of Archegos, Goldman and Morgan were much quicker to exit. Greensill promises to drag on for more than 5 years.

Proof of the pudding lies in the eating. The market cap of Credit Suisse has fallen from $22.3 billion last year to just $10.2 billion this year and it is yet to find a bottom. That is roughly the value it has lost in Greensill Capital and Archegos put together. For now, things are still in a state of flux. The bank to management is expected to present a strategic plan on 27th October, which will include, among other things, sweeping changes in its business model and demands for more capital. It remains to be seen how this plan is received, but most of the talent at Credit Suisse is already beginning to think with its feel. That is the problem.

To be fair, not every capital infusion or capital demand is akin to bankruptcy. Like Germany want out of the way to save its iconic Deutsche Bank, even Switzerland is likely to go out of the way to save the iconic Credit Suisse. In all likelihood, Credit Suisse may have to hive off its investment banking business. That will not only save the bank, but also be good in the long term.