Credit Suisse and the CDS Streisand effect

This weekend we have mostly been looking at Credit Suisse charts that look like a misfiring firework. Here’s another one, via Google Trends.

Need a quick recap of the story? It began on Friday, when Credit Suisse CEO Ulrich Koerner committed a memo.

No doubt there will be more noise in the markets and the press between now and the end of October. All I can tell you is to remain disciplined and stay as close as ever to your clients and colleagues.

I know it’s not easy to remain focused amid the many stories you read in the media – in particular, given the many factually inaccurate statements being made.

That said, 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.

Calming the mood is what it didn’t. In rushed the Reddit degens:

Credit Suisse is probably going bankrupt … $CS

The collapse in Credit Suisse’s share price is of great concern. From $14.90 in Feb 2021, to $3.90 currently.

And with P/B=0.22, markets are saying it’s insolvent and probably bust.

2008 moment soon ?
Systemic risk bank. pic.twitter.com/tbYgdGYOMY

— Wall Street Silver (@WallStreetSilv) October 1, 2022

. . . followed by the messageboard polymaths. 

Credit Suisse CDS pic.twitter.com/lInqptLYcY

— Dominic Cummings (@Dominic2306) October 1, 2022

Then came the shitposters. So many shitposters.

In such circumstances it becomes very tricky to separate the signal from the noise.

A good starting point is with the Credit Suisse share price, which has been in tailspin for months. It’s all a replay of Deutsche Bank in 2017: the company can’t deny it needs to raise capital but has no good options to do so.

Koerner has a plan to move on from years of scandal (Archegos, Greensill Capital, Mozambique tuna bonds, Bulgarian money laundering, corporate espionage, etc) that will start at the cash-haemorrhaging investment bank. Sacking bankers has a big upfront cost, however, and a bank promising to self-fund its turnround rarely wins investor confidence.

Meanwhile, an equity issue is becoming tricky given . . . 

. . . so Credit Suisse has been advertising for partners to suck the marrow from one of its more profitable divisions. Its strategic review plan outlined in July included a promise to “evaluate strategic options for the Securitized Products business, which may include attracting third-party capital” — though its timing here really wasn’t great.

A falling valuation for Securitized Products adds extra pressure to Koerner, whose plan is due to be announced at the end of the month. There’s neither much time nor much margin of error. Credit Suisse has a target capital ratio of 13-14 per cent before 2024 and >14 per cent afterwards; tweak a just couple of numbers in the RBC-supplied forecast tables below and capital suddenly becomes the big issue.

All of which partly explains the elevated CDS price, though not entirely.

(Enlarge)

Credit Suisse is out in front in the IB default sweepstakes, with peers trending higher as a pack. The bunching is because CDS isn’t an objective barometer of default risk. Investors use the contracts for simple directional bets, or to hedge sector exposures, which makes price swings look more extreme.

Exaggeration is easiest to see in the iTraxx Europe Crossover, a junk bond CDS tracker. Having spiked alarmingly in recent months, it’s currently predicting a wave of defaults over the next five years that’s comparable to the one expected in the first days of pandemic lockdowns. Yet, year-to-date, there hasn’t been a single default in the index. Risk-off hedging is a more convincing explanation than macro despair.

(Enlarge)

Alternatively, here’s investment bank 5yr CDS from 2007 to date. Only two defaulted; you probably remember which.

(Enlarge)

As per the above, a CDS with a 2 handle is quite high but nowhere close to “imminent default” high:

The tweet below feels like scaremongering, perhaps unintentionally. Or it’s confusing steeply falling equity with default risk. Is General Motors also on the bring of failing? Their CDS is identical to Credit Suisse. We should be careful not to yell ????. https://t.co/hvbxersfXy

— boaz weinstein (@boazweinstein) October 1, 2022

That’s not to say CDS doesn’t matter. It matters a lot for funding costs. Rising credit spreads are making Credit Suisse’s wall of debt very expensive to refinance.

Over 2020-2021 the average CDS spread for Credit Suisse’s opco debt was about 57 basis points and for the holdco the average over the previous three years was 83 basis points, according to RBC. The relevant CDS contracts closed Friday at 251 and 285 respectively — suggesting an incremental increase in 2023 refinancing costs in the order of SFr300mn.

It’s a powerful extra headwind that Koerner really doesn’t need right now. That alone might explain the CEO’s jitteriness with the reply-all function.

Credit Suisse team leaders are said to have been working the phones all weekend to reassure customers, counterparties and investors on capital and liquidity, as well as to reiterate that restructuring plans are on course. Given the current hysteria, this one-on-one approach is probably preferable to any more memos.

Footnote, for posterity:

Dear Colleagues,

I am conscious that there is lots of uncertainty and speculation both outside and within the company. While you will appreciate that I am unable to share details of our transformation plans before October 27, I also want to make sure that you hear from me directly during this challenging period. I will therefore be sending a regular update to you all until then.

In these notes I will share some of my thoughts on where the bank is heading, my management priorities and observations from speaking with you at your desks and meetings with key stakeholders. I will also use the communication to recognize some of the work we are accomplishing for clients. And, as a recurring feature, I will endeavor to respond to some of your questions.

I begin by thanking all of you for your great dedication and hard work. As Axel and I wrote to you recently, this is a critical moment for the whole organization, and we appreciate your commitment to ensuring Credit Suisse remains a trusted partner for our clients. We also told investors and the media this week that we are “well on track” with our strategic review. We are.

No doubt there will be more noise in the markets and the press between now and the end of October. All I can tell you is to remain disciplined and stay as close as ever to your clients and colleagues. I know it’s not easy to remain focused amid the many stories you read in the media – in particular, given the many factually inaccurate statements being made. That said, 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.

Earlier this week, I had the pleasure to speak at the Wealth Management Global UHNWI Forum, which was themed “Rising like a Phoenix.” It is an apt metaphor for what we want to accomplish. As I told our colleagues, we are in the process of reshaping Credit Suisse for a long-term, sustainable future – with significant potential for value creation. Given the deep franchise we have, with a long-standing focus on serving some of the world’s most successful entrepreneurs, I am confident we have what it takes to succeed.

To that end, I would like to congratulate: the IBCM team in APAC, which secured a suite of awards from Asiamoney, for their work in Indonesia, Malaysia, the Philippines, Vietnam and, for the first time ever, Cambodia.

We should also recognize the team that led the Blue Bond for the Government of Barbados, which allows the country to redirect some of its sovereign debt service into ocean conservation funding.

I wish you a good end of the week.

Ulrich Körner
Chief Executive Officer