Idea of the Week: Credit Suisse SGD AT1 bonds look attractive after repricing

• Earnings for Credit Suisse (“CS”) were lackluster as CS reported a loss to net income attributable to shareholders of CHF 273m.

• Ahead of its 2Q22 results, CS issued its 3rd consecutive profit loss warning to its investors.

• CS estimates approximately up to CHF 1.4b could be incurred from additional litigation provisions.

• Nonetheless, the Group still maintains a sound solvency profile based on the latest quarterly results.

• We also believe CS prioritises replacing its AT1 notes prior to its call date, which would reduce non-call risks. 

Credit Suisse Group AG (“CS”) was caught up in yet another scandal involving the failure to prevent money-laundering relating to a Bulgarian drug ring. CS had a turbulent 2021 as the bank continue to recover from the losses incurred from the collapse of Archegos and Greensill Capital.

FY21 financial highlights

CS announced its first quarter 2022 earnings (“1Q22”) for the quarter ended 31 March 2022. Earnings were lackluster as CS suffered a loss to net income attributable to shareholders of CHF 273m. Net revenues amounted to CHF 4,412m while total operating expenses amounted to CHF 4,950m. As such, cost-to-income ratio for the bank was 112.2% in 1Q22. The increase in operating expense was due to higher litigation provisions relating to various legal matters that CS was tangled up in.

Ahead of its 2Q22 results expected to be released on 27 July 2022, CS issued its 3rd consecutive profit loss warning to its investors. CS cited geopolitical tensions in Russia and Ukraine as well as interest rate hikes by major central banks as reasons for the expected profit loss in 2Q22. In its Investment Bank (“IB”) segment, capital markets issuance have slowed down and widening credit spreads have depressed performance of IB in April and May. Earnings in 2Q22 will also be affected by their equity stake in Allfunds Group. CS holds 8.6% stake in Allfunds Group, which its stock price have fallen ~59% year-to-date.

For FY2022, the Group said that it will be a transition year for the bank as they will look to reallocate capital towards core businesses and generate structural cost savings to invest for growth. These initiatives will likely look to materialize from 2023 onwards.

Higher litigation costs

Recently in late June 2022, CS made the headlines again as the Switzerland Federal Criminal Court found Credit Suisse guilty of failing to prevent money-laundering relating to a Bulgarian drug ring. The bank faced a fine of CHF 2m and confiscation of assets worth more than CHF 31m, the amount related to the accounts of the drug gang held at Credit Suisse. The court also imposed a fine and convicted a former Credit Suisse employee suspended 20-month prison sentence.

CS was involved in various litigation matters in connection with the conduct of its businesses. As of 31 December 2021, CS allocated approximately CHF 1.5b of litigation provisions and may continue to incur more each litigation case develops and more legal costs are required. CS estimates approximately up to CHF 1.4b could be incurred from additional litigation provisions which would negatively impact the bank’s earnings.

Table 1: Litigation provisions for CS

Credit and solvency profile

Nonetheless, the Group still maintains a sound solvency profile based on the latest quarterly results. CET1 ratio for 1Q22 is 13.8% (vs 12.2% in 1Q21), which remains well above regulatory requirements while liquidity coverage ratio was 196% in 1Q22, demonstrating a continued conservative liquidity position. Its leverage exposure was also down by CHF 11b due to the ongoing de-risking of its investment banking division, while net stable funding ratio improved slightly to 128% from 127% in 4Q21.

Comparing to CET1 ratio of other EU banks, CS remains within the peer average of 13.8%. Although we do note that with more losses incurring from potential litigation costs, this would put pressure on CS’s CET1 ratio. CS has a buffer of ~3.1% (~CHF 8.5b) above regulatory requirements which we view still adequate and sufficient to take additional hits from litigation losses.

Table 2: CET1 Ratio of EU Banks

Recommendation

Bond price of the CS 5.625% Perpetual Corp (SGD) saw significant repricing following the issuance of the CS 9.750% Perpetual Corp (USD). Bond prices fell from ~99.16 to ~97.98 after the issuance of the new USD AT1s. On top of that, CS bond spreads have also widened compared to other peers due to the weakening earnings outlook for CS as well as increasing operating costs that may affect the bank’s capital position.

We remain positive on CS 5.625% Perpetual Corp (SGD) at an indicative yield to worst of 8.48% with about 1.92 years to its next call date. We think CS still remains well-capitalised with a CET 1 ratio of 13.8% and a buffer of ~310 bps above regulatory requirements. However, we would like to caution investors that due to the many litigation cases that CS is involved in and potentially new cases that may implicate CS, prices of CS bonds may be volatile.

Also, CS prioritises replacing its AT1s with a similar instrument on its call date. CS redeemed the CS 7.125% Perpetual Corp (USD) prior to its call date and replaced it with the CS 9.750% Perpetual Corp (USD). Although the new CS 9.750% Perpetual Corp (USD) will cost more in interest expense, CS still issued the new AT1s at a higher coupon rate. Thus, we believe CS still prioritises calling back its AT1s ahead of its call date.

Table 3: Relative Valuation of CS with other bank AT1s

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in CS 5.625% Perpetual Corp (SGD), SOCGEN 8.250% Perpetual Corp (SGD) and UBS 5.875% Perpetual Corp (SGD) and the analyst who produced this report holds a NIL position in the abovementioned securities.

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