Credit Suisse’s demise is not a Lehman moment

Recently, foreign media reported that Credit Suisse, a century-old investment bank, is facing a bankruptcy crisis, causing concern in the financial market. Credit Suisse's 5-year credit default swap (CDS) soared to its 2008 financial crisis high, while the stock fell to its closing price of $3.92.

Its Price-to-Book (P/B) was just 0.197. The P/B ratio was used by investors to compare a firm's market capitalization to its book value and locate undervalued companies. It also measures the market's valuation of a company relative to its book value.

Figure 1: External pressure: macroeconomic downturn & bank operating environment deterioration

Source: Bloomberg

Macroeconomic downturn

The global economy is under pressure- the UK pension insurance is "out of position", and the housing market is under obvious pressure. The British government announced a large-scale tax reduction plan, and to pay for the tax cuts, the government needs to sell as much as an extra £72.4bn of bonds. This will likely cause investors to demand lower prices to buy such large volumes, allowing the yield of British government bonds to rise. British pension funds use the interest rate swap (IRS) of derivatives. As interest rate rises, the floating interest paid by pension far exceeds the fixed income of long-term national debt purchased (IRS has incurred losses). When the IRS has incurred losses, the pension party needs to make up the margin and provide cash/bonds to the counterparty's investment bank. Even worse, the soaring yield of national debt means that the price of national debt plummets and the collateral provided by pension and the collateral for supplementary payment will soon be exhausted. Therefore, pension liquidity is impacted and the IRS faces huge pressure of default.

Figure 2: UK Mortgage rates throughout the years

Source: Bloomberg

In terms of the housing market, the UK is dominated by the 30-year fixed interest rate. As 26% of the total outstanding mortgage loans in the UK are floating interest rates, the UK's mortgage loans are more vulnerable to the impact of the Bank of England's benchmark interest rate. The benchmark of mortgage loans rose to as high as that of the 2008 financial crisis and that caused a huge impact on the UK housing market..

The operating environment of banks is deteriorating

In the past months, dollar liquidity in the interbank lending market has been under pressure. The difference between Forward Rate Agreements (FRA) and Overnight Index Swaps (OIS) can be used to measure the liquidity of the US dollar. The greater the difference, the higher the financing cost and the tighter the liquidity of the US dollar. The cost of borrowing has risen sharply in banks, causing interest rates to rise while economic growth depletes. As the overall credit quality of banks deteriorates, the bank borrowers struggle to make their payments.

Uncertainty in restructuring and transformation

The increase in restructuring and transformation risks will lead to low profitability for Credit Suisse in the medium term. Credit Suisse's investment bank is being restructured to achieve a more stable, light capital, and better investment banking business. However, these measures will take several years to be fully implemented, and the bank needs to invest a large sum to produce long-term positive results. Besides, the deterioration of macroeconomic and market conditions may complicate the prospects of the ongoing restructuring, and the expected benefits of the strategic restructuring are questionable. After the deleveraging of capital-intensive businesses and the withdrawal of bulk brokerage businesses, Credit Suisse may lose market share and franchise strength.

On the other hand, huge losses may delay technology investment in business transformation. After losing 1.6 billion Swiss francs in 2021, Credit Suisse lost 1.9 billion Swiss francs in H1 in 2022. The huge losses of investment banks are mainly caused by extraordinary valuation losses, the reduction of revenue beyond expectations, and the rise of costs. It is expected that there will be no significant improvement in the short term. At the same time, the income of wealth management and asset management also declined, partly because of the cyclical pressure of income and the lack of flexibility of the cost base. It is expected that there will be a large loss in 2022, and the profitability will remain weak in 2023.

Lack of prudent risk control

It has been analyzed that Credit Suisse has poor risk management and a prudent corporate culture. Besides that, the major change in the board and executive leadership of Credit Suisse made this situation worse. Since the beginning of 2021, Credit Suisse Group has reappointed new chairman, senior executives, and regional heads. Credit Suisse needs to retain key employees and reduce its turnover rates to maintain the implementation of its long-term strategy. It is essential to have stable leadership to fully implement prudent control.

Conclusion

Despite the high CDS during Lehman Brothers’ bankruptcy, Credit Suisse did not go bankrupt at that time. Swaps linked to Credit Suisse show that the probability of bond default within five years is about 23%, suggesting an increase in credit risk. The stock price continued to fall, and there is a little signal of turnaround. The terrible fundamental problem of Credit Suisse is at the operational level. The company needs outstanding strategic transformation to regain the trust of the market. Although the Company's stable asset structure and sufficient liquidity leave room for the Company's transformation, the benefits of restructuring and transformation are questionable, and the initial costs and time investment are huge. If the worst happens, the impact of Credit Suisse will be far weaker than that of Lehman Brothers.

Reference:

Jinji Morning news (2022,October17). https://eopa.baidu.com/page/liteSwan-iax9Cu23?type=0&appKey=oFx3nbdDN6GWF3Vb0Wh7EDBMBxRTTcfe&path=%2Fzhihu%2Fanswer%3Fid%3D2772187685%26isShared%3D1%26uid_f%3D1242942813300015104&_refluxos=a2

Wallstreetcn（2022，October 5).

https://my.mbd.baidu.com/r/RmIN39Mm2Y?f=cp&u=372abca2cd9ab0d7