Credit Suisse is in trouble, but this is not 2008 – investors remain wary of the ‘all is well’ soundbites

• Credit Suisse, one of the largest and oldest banks of the world, is in trouble after the sharp rise in its credit default swaps.
  
• Loss of talent, bad risk management and loss of investor confidence have sent the bank’s stock into a spiral.
  
• Market experts believe a 2008-like situation is possible if the bank sinks like Lehman Brothers did.
  
• Citibank says it would be wary of drawing parallels with 2008 and that CS has multiple options.
  

On 23 September Nassim Nicholas Taleb tweeted about his former employer Credit Suisse, and ever since social media platforms have not stopped buzzing. So much so that analysts have started coming out with reports explaining why the sharp fall in its stock and rise in credit default swaps is not similar to what happened in 2008.

What’s happening at Credit Suisse is uncannily similar to what happened prior to the Global Financial Crisis in 2008, when financial markets saw a complete meltdown once Lehman Brothers went under. Taleb’s Tweet needs to be seen in the context of the GFC, which saw central banks unleashing large scale bond buying programmes and interest rates went to zero. In his Tweet, Taleb said: “15 years of near zero interest rates wiped out the brains at CS & all those with risk & market knowledge were forcibly retired; risk-blind profitable turkeys were promoted. It's the #FooledbyRandomness effect: evolution in reverse. Sadly, I worked there & loved it.”

Credit Suisse, one of the oldest and largest banks, has been in trouble for a while now. While the change of the CEO made some waves in July this year, it has become all the buzz in social media after its credit default swaps – which is nothing but the protection that credit instruments have against default – jumped sharply to levels seen last in 2008. This brought its stock down by 95% from its all-time highs. The buzz soon translated into a flurry of media reports, and statements from Credit Suisse that are eerily similar to what Lehman Brothers was saying prior to its collapse in 2008.

Joining the Credit Suisse discussion in India was Sandeep Parekh, an independent director on HDFC Bank’s board, who said on Twitter that a “real shit show” was ahead, regardless of Credit Suisse going bust or being rescued by the Swiss government.

The Global Financial Crisis that plunged the world into a recession was triggered by the burst of the housing bubble in the US, with Lehman Brothers at the center of it. This caused a spillover effect throughout the world given how interconnected economies are – for instance, the benchmark Nifty50 index fell 40% and took over nine months to recover since the fall of Lehman Brothers in September 2008.

Given how large and systemically important Credit Suisse is – together with Deutsche Bank, Credit Suisse – has $2,800 billion worth assets under management. In comparison, Lehman Brothers’ AUM stood at $600 billion – the current crisis threatens to be another Lehman moment. While Deutsche Bank has lost 31% of its market cap this year, Credit Suisse’ stock has lost over 54% of its value in the same time.

“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,” Credit Suisse CEO Ulrich Koerner said in a memo, assuaging investor concerns. However, people were quick to point out the similarities with statements from Lehman Brothers.

While the 2008 recession was triggered by the housing bubble collapse, CDS could end up being the trigger for a collapse now.

Here’s why Credit Suisse is in trouble

The answer lies in credit default swaps, also known as CDS. Simply put, CDS is an insurance policy that lenders take against the loans they have given to someone.

In this case, Credit Suisse borrows money to do business. Its lenders take insurance against Credit Suisse defaulting on its obligations. For this, they have to pay a premium to the issuer, just like you would pay a premium on your insurance policies.

The problem is, the price of these Credit Suisse CDS’ are off the charts now – higher than they were in 2008 when the banking industry collapse was imminent.

This, combined with Credit Suisse’ inefficient risk management policies – it was involved in two massive debacles, Greensill and Archegos Capital, where its investors lost billions of dollars – has limited the bank’s avenues for obtaining finance, further increasing its borrowing costs.


Essentially, Credit Suisse’ situation right now is of a person with multiple defaults in the past eroding their capital, causing their credit rating to go junk. As a result, that person’s borrowing costs increase since lenders are wary of defaults. This essentially increases the risk of the said person going bankrupt and investors losing their money.

Apart from this, the bank has reported three consecutive quarterly losses, leading to the appointment of a new CEO in August. It also lost over 60 executives in the past 18 months, with the latest high-profile departure being Jens Welter, who defected to Citigroup after a 27-year stint at Credit Suisse.

But analysts suggest this is not 2008 and Credit Suisse has multiple options in front of it to escape the current crisis. “We would be wary of drawing parallels with banks in 2008 or Deutsche Bank in 2016. Credit Suisse has a CET1 (Tier 1 capital) ratio of 13.5%, high vs peers, and would imply Swiss Franc 2.5 billion of excess capital vs a 12.5% ratio,” said a report by Citi Research.

What does this mean? Essentially, Credit Suisse is placed comfortably when it comes to capital adequacy, and a run on the bank is not a certainty as of now.

“The liquidity credit ratio at 191% is among best in class, with a Swiss Franc 235 billion high-quality liquid assets portfolio, so the liquidity position is very healthy. Rather than liquidity concerns, we see the current move in spreads as an inconvenience for funding costs,” the report added further, explaining where Credit Suisse stands currently, and what the impact of the flurry of negative media reports could be on the bank.

The short of it is, Credit Suisse might experience higher financing costs in the interim until the bank’s management plans and executes a restructuring strategy.

Everything hinges on whether Credit Suisse is able to navigate these choppy waters and execute its restructuring strategy efficiently or not. After all, the ‘all is well’ play will only work for so long before the fundamentals trigger a response.

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