Will Credit Suisse be the next big bank to fall?

Following the collapse of Silicon Valley Bank (“SVB”), markets were jittery over further blow-ups from major financial institutions. News outlets reported that Credit Suisse’s (“CS”) largest shareholder, the Saudi National Bank, will not be increasing its stake over 10% should CS require additional capital. Saudi National Bank recently acquired a 9.88% stake in CS for CHF 1.4b. The reasons cited by Saudi National Bank’s chairman, Al Khudairy, was due to regulatory concerns as increasing their stake past 10% will incur additional regulatory requirements.

As markets were still recovering from the fallout of SVB, shares of CS plunged. CS shares fell by almost 28% from the news. In order to shore up confidence in the Swiss Banking sector, the Swiss Financial Market Supervisory Authority (“FINMA”) and Swiss National Bank (“SNB”) put out a statement to assure markets that there are “there are no indications of a direct risk of contagion for Swiss institutions due to the current turmoil in the US banking market.” SNB will also provide CS with liquidity if required. CS exercised its option to draw CHF 50b through a covered loan facility and short-term liquidity facility which will be collateralised by high quality assets.

Will CS be the next big bank to fall?

Decisive and swift actions by CS and SNB were executed during the turmoil in order to shore up market confidence. CS had a total liquidity pool of CHF 118.5b of which CHF 62.3b of cash held at central banks and CHF 56.2b of securities. Liquidity coverage ratio (“LCR”), which measures the liquidity of the bank during a period of liquidity stress, was 144%. The stress test simulates a period of liquidity stress that mimics shocks experienced during 2008 over a period of 30 days. Another liquidity indicator is the Net Stable Funding Ratio (“NSFR”). It ensures that the bank has stable funding relative to their assets and off-balance sheet activities. NSFR for CS for FY22 was 117% which indicates available stable funding was sufficient to fund its assets.

In terms of its investments in debt securities, as of FY22, CS had CHF 921m of debt securities held-to-maturity and CHF 797m of debt securities available-for-sale. Debt securities from Swiss federal government entities and corporate debt securities make up securities available-for-sale and had a gross unrealised loss of CHF 156m. There is no long-term debt held in CS’ bond holdings. CS’ held-to-maturity portfolio consists of a fair value of CHF 981m of debt due from 1 to 5 years at an average yield of 3.94%. Debt securities available-for-sale had a CHF 156m fair value loss which have already been accounted in their FY22 results.

The potential collapse of CS is mitigated for now. The assurance and injection of liquidity to CS from SNB ensures CS have enough liquidity to fund withdrawals. Deposits should be safe as SNB stepped in to assure liquidity will be provided to CS. CS had CHF 118.5b of high quality liquid assets which is enough to pay out ~50% of its deposits. Interest rate risks is hedged by CS and held-to-maturity bond portfolio are medium-term bonds with an average yield of 3.94% and no long-term bond is held-to-maturity.

In addition, CS is making a cash tender offer to 10 USD senior debt securities and 4 EUR senior debt securities for a consideration of USD 2.5b and EUR 500m respectively. The tender offer will free up some liabilities at the Operating Company (“OpCo”) level.

The injection of liquidity by SNB will bolster CS’ LCR and help it to withstand heavy outflows of deposits. As of FY22, LCR was 144% and this means that CS is able to cover heavy outflows over a period of 30 days.

Moving forward, CS would have to tide through yet another period of negative sentiment as markets become less confident on financial institutions. With the current help and liquidity that CS has, we do not think CS will face a collapse. Unlike SVB, which is an isolated incident due to bad risk management and a concentrated client base, CS’ balance sheet is hedged against interest rate movements.

(Related article - Everything you need to know about the collapse of Silicon Valley Bank)

Increased risk in holding subordinated CS bonds

We see higher risks in holding subordinated bank debt such as Additional Tier 1 (“AT1”) and Tier 2 (“T2”) bonds from CS. AT1 bonds have loss absorption features which will trigger when Common Equity Tier 1 (“CET1”) ratio falls below a certain threshold. The first set of AT1s will be written down when CET1 ratio falls below 7%. As of FY22, CS has a CET1 ratio of 14.1% which is 710 basis points above the trigger level. Following the incident, we expect CET1 ratio to fall as the outflow of customer deposits may be negative to its earnings in the next few quarters. However, we do not think the CS’ CET1 ratio will fall close to 7%, triggering a write-down.  Coupon deferral for its AT1 interest payments may be triggered if CET1 ratio reaches close to its Maximum Distributable Amount (“MDA”). The MDA is calculated as the amount of interim or year-end profits not yet incorporated in CET1 capital, multiplied by a factor ranging from 0 to 0.6 depending on the size of the CET1 shortfall. CS’ buffer over regulatory requirements of 374 basis points will help to mitigate CET1 falling close to MDA levels.

Negative sentiment and fear is spreading through financial markets and we expect increasing volatility on the banking sector. This will lead to other similar episodes of another bank being caught in negative news and leading to large withdrawals, testing a bank’s liquidity. While we do not think a write down on CS’ AT1 bonds will be triggered, we see increasing non-call risks for the CS AT1 bonds. Funding for CS is impacted from customer withdrawals and on top of that CS is in the midst of a major restructuring.  Large restructuring costs is to be expected and this may cause CS to rethink their funding plans over the next few years. Bonds of CS have sold off to distressed levels and this may impact their ability to replace existing AT1 perps.

Credit default swaps (“CDS”) have surged from the news, indicating a higher probability of default. We think with the adequate liquidity that CS has and the additional injection of liquidity from SNB, we do not think CS is on a brink of a collapse. Still, the worse is not yet over for CS as it has to navigate a major restructuring during a time of increasing stress on the financial sector. Investors should monitor the CDS and if it increases, the likelihood of a write-down on AT1s will be higher.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds NIL position and the analyst who produced this report holds a NIL position in the abovementioned securities.