How big is the gap in Credit Suisse’s capital?

Credit Suisse has spent the last few days fighting social media rumors about its financial health, and trying to convince investors and customers that the fall in its share price and the soaring CDS (a contract that works as a kind of insurance against default) a company) do not tell the true story about the bank’s health.

At the heart of the storm is a simple question that analysts and market commentators have been asking since Credit Suisse announced weeks ago that it would scale back its investment bank and cut 1.5 billion Swiss francs in costs: What will it really be? the size of the hole in the bank’s capital?

Last month, analysts at Deutsche Bank estimated that the drastic measures would force the Swiss bank to find an additional 4 billion Swiss francs, due to restructuring costs, the need to expand other lines of business and regulatory pressure to strengthen its capital.

The reduction of investment banking activities and the dismissal of thousands of workers would result in labor costs and the possible need to record losses with the liquidation of high-risk businesses. The bank would also need to invest in other areas of its business – notably wealth management – ​​to increase revenue streams and make up for lost income by the investment bank.

On Friday (30), analysts at investment bank Keefe, Bruyette & Woods estimated the value at 6 billion Swiss francs. They argued that, after the asset sale, this would force Credit Suisse to ask for 4 billion Swiss francs in equity from investors “to accommodate a clear growth plan and/or compensate for any unknown factors, such as litigation or fear of loss of customers”.

For a bank whose market capitalization has dropped to CHF 10 billion in recent weeks as a result of a 25% drop in its share price, the prospect of asking investors for help, who have already had to face losses from scandals such as those of Archegos and Greensill, looks less and less inviting.

Senior executives at the bank – which has announced it will unveil a detailed plan for scaling back its investment arm by the end of the month – insist that raising capital would be a last resort.

An executive who spent the weekend calling the bank’s main clients and peers to try to reassure them about Credit Suisse’s financial health said the bank is not looking for capital.

The bank plans to sell parts of its investment arm – which could include its coveted securitized products division, whose value analysts have estimated at up to 2 billion Swiss francs.

Credit Suisse’s managers were forced to launch a public relations campaign after spreads on the group’s CDS peaked last week, indicating investors are becoming increasingly pessimistic about the group. Over the weekend, social media and web forums were awash with rumors about the bank’s imminent collapse.

On Monday (3), it became clear that the bank’s communication campaign had failed to calm the nervousness of the markets. Traders and investors rushed to sell Credit Suisse stocks and bonds and buy CDS.

Credit Suisse’s five-year CDS rose by more than 100 basis points on Monday, and some traders were quoting them as high as 350 basis points, according to quotes seen by the Financial Times. The bank’s shares fell to all-time lows below CHF 3.60, down 10%, when the market opened.

The two issues that seem to concern investors and social media commentators most are the bank’s capital position, which reflects its ability to absorb losses, and its liquidity levels, which could be put to the test in a short-term period of wear and tear. deadline. The bank insists that neither poses a risk.

In its latest quarterly results in July, Credit Suisse reported a top-tier equity ratio, an indicator of its financial resilience, of 13.5%, well within its target of between 13% and 14% for this year. . This is up from 11.4% in 2015 and 12.9% in 2020, and amounts to CHF 37 billion of capital.

Compared to other European banks, Credit Suisse has a CET1 ratio similar to that of UBS, HSBC, Deutsche Bank and BNP Paribas.

In addition, the bank has 15.7 billion Swiss francs in additional prime capital, raised through the issuance of so-called “contingent convertible” bonds – “coconuts” in market slang – because they can be converted into shares in wear moments.

Credit Suisse has raised $1.5 billion of AT1 capital in recent months with a bond issue with a yield of 9.75%. Although at the time the issue seemed expensive, the bank has since been downgraded by several credit agencies and the paper is currently trading at a yield of 12.5%.

Furthermore, in its most recent financial results, the bank had 44.2 billion Swiss francs of “complementary equity”, which is additional capital required by Swiss regulatory authorities to absorb losses without triggering bankruptcy.

A Credit Suisse executive said the bank would need to burn CHF 97 billion of capital before anything happens to customers or employees, adding CET1, AT1 and complementary equity. He points out that UBS burned billions during the financial crisis and was bailed out — a situation that would be different from that of Credit Suisse.

Over the weekend, comparisons also emerged with Deutsche Bank’s strong bond sales in 2016, when concern that the German bank would default on coupons on some of its equity securities spurred sharp moves in the CDS market.

“We were cautious about the idea of ​​drawing parallels with banks in 2008 or Deutsche Bank in 2016,” said Andrew Coombs, an analyst at Citigroup.

“The market appears to be incorporating highly diluting capital raising into its prices. We do not believe this is an inescapable conclusion and would therefore argue that Credit Suisse can be bought by the brave at current rates.”

As for the bank’s liquidity levels, Credit Suisse has a liquidity coverage ratio of 191%, significantly higher than most of its peers. The ratio is a reflection of the amount of highly liquid financial assets the bank holds that can be used to cover short-term obligations.

“From our perspective, looking at the company’s financials at the end of the second quarter, we view Credit Suisse’s capital position and liquidity as healthy,” said Kian Abouhossein, analyst at JP Morgan.

At the end of Monday, the bank’s shareholders seemed calmer because of the reassuring messages sent by analysts, even if there were also increasingly strong calls for the revelation of the new strategic plan to be presented.

By the close of the market in Zurich, Credit Suisse shares had rallied to roughly where they had started the day at 4 Swiss francs.

Meanwhile, in Australia, a business journalist for the public TV network ABC who had posted a widely publicized tweet on Saturday implying that a major international investment bank was “on the verge of bankruptcy”, withdrew the message and his employer reported that they had reminded the employee about their social media guidelines.

Translation by Paulo Migliacci