Credit Suisse: recent developments and the path ahead

16th March 2023

The collapse of Silicon Valley Bank (SVB) in the US has understandably resulted in many questioning their faith in other banks. In Europe, investors quickly turned their attention to Credit Suisse given its own recent period of instability towards the end of last year.

Background

Credit Suisse has faced a number of different issues over the last decade, largely driven by decisions in their investment banking division and a lack of risk management controls, resulting in billions of losses. A combination of lawsuits, scandals, and losses led to increasing funding costs for Credit Suisse, prompting a decline in confidence and a significant deposit flight in Q4 2022.

During the quarter, over CHF140bn of deposits were withdrawn, leading management to raise additional equity and issue new debt at an elevated cost. A restructuring plan was also announced to streamline the bank and refocus on its core, less risky activities of wealth management, asset management and consumer banking.

For a while, things at Credit Suisse appeared to have stabilised, but the recent collapse of SVB renewed the concerns of its clients and shareholders. Yesterday, news broke that Saudi National Bank (SNB), one of the key shareholders and recent backers of Credit Suisse, has ruled out any additional support. This decision was made due to the regulatory hurdles presented by shareholders exceeding a 10% stake (SNB currently holds 9.9%), but this nevertheless spooked markets by highlighting the difficulties Credit Suisse faces to raise further funding and drove the share price down by nearly 30%.

Balance sheet

Whilst the flight of deposits echoes the SVB story, the assets side of the balance sheet is very different. Credit Suisse was well-prepared for an adverse event as it had CHF250bn of available liquidity compared to a vastly smaller position at SVB. So far, Credit Suisse has managed to weather the enormous outflows of CHF140bn by utilising its cash as well as the repo facilities available. Both banks have seen around 40% of their deposits leave rapidly; whilst this led to the instant collapse of SVB, Credit Suisse maintains a solid liquidity position and has reported that their current (Q1 2023) Liquidity Coverage Ratio is at 150% - above the 144% recorded in Q4 2022.

Furthermore, Credit Suisse’s remaining assets do not have the same issues as SVB. Firstly, their ‘held-to-maturity’ assets are minimal, meaning that any losses are reported to the market at fair value, and the interest rate risk is “fully hedged”. Secondly, their borrowers are mostly comprised of Swiss consumers and small businesses, as well as corporates and wealthy individuals globally. The credit quality of this book is therefore not in question. Furthermore, total charge-offs (whereby companies write off debts they do not expect to receive) were under CHF200m relative to its loan book of CHF270bn, which represents a lower charge-off ratio than banks such as J.P. Morgan and Bank of America.

Whilst there is a similarity between Credit Suisse’s mortgage book of around $120bn and the mortgage-backed security (MBS) exposure at SVB, Swiss mortgages tend to be five or ten year fixed terms compared to the thirty year terms popular in the US. Variable rate mortgages also comprise around 25% of Credit Suisse’s total. Additionally, the minimum deposit required in Switzerland is 20%, significantly reducing the loan-to-value on each mortgage. These two factors reduce the mortgage book’s sensitivity to interest rates.

Overall, despite incurring a CHF7bn loss in 2022, the book value at Credit Suisse remains at CHF45bn and its capital at CHF35bn, equating to a 14.1% CET1 ratio (the highest quality of regulatory capital). This compares to the negative book value at SVB at the time of collapse (once all investment losses are accounted for).

Liquidity

Whilst liquidity at Credit Suisse remains solid, it has dwindled to around CHF120bn and could be pressured if deposit flight resumes at the pace of Q4 2022. Although the CEO said that Credit Suisse saw material inflows on Monday, Credit Suisse 16th March 2023 following SVB’s collapse, deposit flows overall have not reversed in Q1 2023 and have continued to decline, albeit at a slower pace. Yesterday’s events are unlikely to give further confidence to depositors at the bank.

The potential problem developing for Credit Suisse is that its remaining assets are becoming increasingly illiquid, mostly comprised of loans. Even though the quality of these loans is not in question, these are not MBS instruments which can be sold relatively easily to raise liquidity if needed. The sale of a loan book comprised of individual mortgages could be lengthy and incur unnecessary losses.

Yesterday evening, Swiss National Bank – in a joint statement with Swiss regulator FINMA – announced it would provide CHF50bn additional liquidity covered by Credit Suisse assets. CHF11bn of this comprises a short-term liquidity facility and CHF39bn will be under the official Covered Loan Facility. It is unclear what type of assets will be used as collateral, but loans to Swiss SMEs meet the eligibility criteria for the Covered Loan Facility. We would assume that a significant portion of the CHF39bn would be comprised of the more illiquid assets rather than the more liquid trading securities. Using the Q4 2022 financials as a proxy, Credit Suisse should now have freely available liquidity to cover 70% - 80% of all outstanding deposits, which hopefully should restore some confidence in the market.

In addition, to further shore up confidence, Credit Suisse announced a tender offer for USD2.5bn and EUR500m of bonds to signal to markets that it has the financial strength for a bond buyback programme, despite these trading at distressed levels. We also note that the SNB has updated its comments by saying that Credit Suisse “does not need more capital”, adding that there has been no assistance sought by Credit Suisse and that regulatory constraints prevent them from considering an ownership stake above 10%.

Unfortunately, the Swiss regulators have not yet gone so as far as to guarantee all uninsured depositors, which could mean that some of the larger deposits continue to flow out. Around 60% of the total deposit base are corporate deposits, which are likely to be larger as well as uninsured.

Restructuring

In October 2022, management announced a comprehensive restructuring plan which aims to return Credit Suisse to its core businesses of wealth and asset management, reducing the capital requirements of the group. The investment bank is planned to move to a separate Credit Suisse First Boston entity, joined with the boutique advisory firm Michael Klein. Further progress has been made on the sale of its securitisation business, freeing up CHF45bn in risk-weighted assets (RWA) and resulting in a CHF800m gain on sale.

Management is also running a significant client outreach programme to all wealth management clients globally, to reassure them of the bank’s creditworthiness and to stem deposit outflows. Clients are further compensated with some of the highest deposit rates available in the market, although management has confirmed that the group has not bought any deposits from other banks nor it plans to.

Cost-cutting is the final leg of the restructuring plan with substantial headcount reduction planned, appropriate for the new size of the business. Overall, these measures would reduce balance sheet risk, in turn reducing capital requirement and returning Credit Suisse to profitability by 2025.

The plan is sensible and, according to management, progressing ahead of schedule. There is clear scope for Credit Suisse to recover and stabilise the situation, but the bank will undoubtedly be pressured by the market to speed up its restructuring plan. This could result in an accelerated sale process for the investment bank division or one of its other smaller businesses, rather than opportunistically restructuring and waiting for IPO. This would undoubtedly result in a loss, but would raise immediate liquidity and address balance sheet concerns.

‘Waterfall’ structure of potential upcoming events

1. The bank is allowed by market conditions to execute its existing restructuring path. This is becoming increasingly unlikely given SVB’s collapse and the subsequent decline in bank confidence, resulting in a deposit flight and declining liquid assets at Credit Suisse.
2. The accelerated significant asset sale may then steady the ship.
3. Regulator steps in further with the aim of restoring confidence in the bank. This could materialise in the following sequence of events in order of severity and decreasing likelihood of outcome:
   1. Regulator insures larger depositors and/or accepts mortgages or commercial loans as collateral
   2. Equity dividends are cut followed by a coupon suspension on the bank’s AT1 instruments.
      1. - These two measures would save around CHF1.3bn annually, enough to cover the expected restructuring costs over the next three years.
      2. - However, to caveat the above action, there remains a considerable capital cushion above the level where mandatory AT1 coupon suspension is required by regulation, although FINMA can exercise this at their discretion (see chart below).
      3. - Management’s discretionary compensation is suspended (although it is important to note that several members of senior management have already taken significant cuts in base pay and bonuses are largely tied to the bank’s future performance).
   3. Regulators impose a bail-in on the bank’s AT1 instruments (whereby bondholders are forced to write off debt they are owed) and their conversion to equity or a partial write-down if weakness persists. However, this would require further losses of CHF17.8bn, representing double the amount of losses incurred during 2008.
   4. A total bail-in of all unsecured debtholders is executed. This should technically only be considered if losses reach around CHF23bn. The impact of this may be limited for senior unsecured debtholders however, given Credit Suisse’s balance sheet strength (a 20% haircut on the loan book would be required before senior bondholders are subject to losses).
4. The next move from the rating agencies is also important as there are often contractual triggers on collateral linked to credit ratings (credit ratings are also often incorporated into many other clauses). Credit Suisse’s issuer (holdco) rating is Baa2/BBB - so there is very little headroom to remain within investment grade rating and above high yield, an important contractual threshold. A downgrade by both agencies to high yield could add to the complexity of the situation and require Credit Suisse to post additional collateral on its liquidity lines. In its recent annual report, Credit Suisse guides that additional collateral requirements and derivative payments, in the case of a downgrade to high yield, would only be around CHF1bn, so the potential impact appears to be manageable.

Source: Bloomberg Intelligence

Conclusion Credit Suisse is designated as a globally systemically important bank and faces far more stringent regulation compared to SVB. Current capitalisation levels are relatively high and it is not operating under negative equity as SVB did. Whilst we must caution how quickly markets can lose confidence in a bank run, often faster than the regulator or management can respond, following the actions of the regulator and Swiss National Bank yesterday, the share price is up +19% on the day at current time.

For further information, please contact:

Esther Clark: +44 (0)20 3207 8007 / [email protected]