Swiss bank Credit Suisse (CGSN) is the latest target of global investors' fears now that the markets have become sanguine about the UK's fiscal strategy, pushing shares plummeting at the open on European stocks the first day of October. The Zurich-based bank, which was established in 1856, slumped by nearly 59% this year amid concern of its ability to withstand financial headwinds.

The bank has addressed external parties and staff to reassure them of their position. Ulrich Koerner told staff last week to disregard recent falls in the share price and concentrate on “its strong capital base and liquidity position.”

The banking analyst Johann Scholtz is not worried about Credit Suisse collapsing and some parts of the market are getting ahead of themselves. A rights issue seems inevitable and that could prompt it to lower its fair value to SFr10 (shares trade at SFr4).

“Some pundits have talked about a Lehman-Brothers type default. As far as we know now, this seems unlikely. Credit Suisse is well funded at least in the worst case, it is in line with its peer group in terms of capital adequacy. Liquidity is an underappreciated strength of Credit Suisse.”

But he believes a capital raising could be required to alleviate concerns from wholesale funders. Granted, it sounds odd to worry about Credit Suisse’s solvency when we are asking the company to add capital. But banks are more sentiment-reliant than most, less leveraged businesses, and Credit Suisse’s multiple recent failures on risk management have hardly inspired much confidence.

“There are clearly wholesale funders who are asking that Credit Suisse has a larger capital cushion and they view it as one of the European banks most at risk to credit ratings downgrades and it is probably a warranted risk,” he said.

Scholtz does believe that Credit Suisse is vulnerable to a downgrade from credit rating agencies, where it is just two notches above junk. All of the agencies have a negative outlook on Credit Suisse.

CDS revisited

It’s the first time since the crisis hit 10 years ago that investors have been this interested in CDOs (credit default swaps). Credit Suisse CDS shot up to record highs on Monday, highlighting investors’ fears about the Swiss bank’s riskiness. Social media swiftly seized on Reddit posts discussing Credit Suisse’s similar precariousness, drawing short-sellers and speculators to the fray (and a lot of jokes about “Debit Suisse”). Followers of European banks will know the almost constant state of anxiety and crisis shares in Germany’s Deutsche Bank have been highly volatile in past years and are down 41% this year. Markets are fragile in 2022, so corporate disasters are quickly telegraphed and magnified on Twitter and message boards.

What is a credit default swap? Basically, they are derivatives that work like insurance contracts on a company or a country defaulting – the higher the CDS, the greater the risk and the more costly it is to buy. They can be purchased as short- or long-term instruments. (Here’s a useful explainer from trader Alex Good on CDS and the technicalities of why the markets may be getting out over their skis on the likelihood of default and the outlook for CS’s investment bank).

The bank is undertaking a strategic review and will disclose more at its Q3 results on the 27th October. What is in this review? Mostly asset sales, also offloading underperforming units, to cut costs through job cuts and a self-styled “company-wide digital transformation”. The investment bank is the focus, and it could be divided and reconfigured as a “capital-light” entity servicing advisory and markets clients.

What makes the collapse of Switzerland’s great banking house so shocking is how few people thought they were doing something this stupid and how many are now furiously backpedaling. Credit Suisse AG was down again on Monday, and a lot of smart people are vehemently insisting that this has nothing to do with Deutsche Bank or its flailing perennial show pony, Italy. But banks are more strongly capitalised than before the GFC, with higher capital ratios, and rising interest rates serve to make lending in the sector more profitable. The firm also makes money in Swiss francs, one of the world’s top performing currencies this year excluding the dollar.

When the Covid crisis struck, dividends were temporarily halted across the European banking industry under regulatory pressure, but Europe’s banks have now resumed payouts across the board. Considering Credit Suisse’s nearest and larger rival, UBS (UBSG), its stock has also declined since September, though the same shares are down just 12% in 2022, and rose 1% Monday during the day. Credit Suisse shares plunged on Monday morning, but were flat by the close of trading — and rose 5% in Tuesday trading.

Yet last week, the European Systemic Risk Board said that the continent is itself threatened with risks to its financial stability as a result of the Russian invasion of Ukraine and an imminent recession. Europe’s financial numbers, like Purchasing Manager Indices and job figures, show the bloc coming under greater stress than the United States. This September, the euro fell below $1, to multi-decade lows.

Internal Turmoil

DBRS, the ratings agency, is of the view that external circumstances ranging from war to inflation to interest rate hikes, are meeting with internal matters such as changes in leadership. Thomas Gottstein stepped down as CEO this summer, with Ulrich Koerner assuming the role on Aug. 1, 2022. The former chair Antonio Horta-Osorio, a former chief executive of Lloyds Banking Group, stepped down at the beginning of 2022 after violating the rules around quarantining. The firm has also been linked to multiple scandals, among them Archegos and Greensill Capital. Credit Suisse which along with its clients has lost money through connections to the Archegos Capital Management, the family office founded by a man who was recently indicted on charges of fraud and racketeering.

“While high market volatility may provide an opportunity for banks and business, for CSG, DBRS believes that these challenges are being compounded by the several management transitions in a short period of time, coupled with challenges to articulate and execute a clear strategy, particularly within its Investment Bank,” its analysts wrote on 28 September.

"Management stability is of critical importance to any organisation's reputation as solid management is enabled to develop and implement a consistent strategy preserving the value of the franchise and rely on the support of shareholders and investors."

Credit Suisse is rated A (low) with a negative trend by DBRS. “The A (low) level is supported by the Group’s strong capital base and its having addressed weaknesses in risk management (including several management changes and de-risking through the exit of some investment banking businesses). But the Negative outlook reflects that reputational and franchise impact of risk management failings may lead to lower business volumes.” DBRS said it is watching developments at the bank which could impact the bank’s credit position moving forward.