The chart below demonstrates the multi-year decline in Credit Suisse’s business.
Credit Suisse’s problems revealed today stem from issues the company discussed last June in a profit warning. Below is a chart of Credit Suisse’s assets under management discussed during that profit warning.
According to a January 2023 report from S&P Global, “A string of debacles, including exposure to the collapses of U.S. hedge fund Archegos Capital and financial services firm Greensill Capital (UK) Ltd., have knocked confidence in Credit Suisse franchise. Clients pull roughly CHF 84 billion of assets from the company in recent months, mainly in its core wealth management unit. Assets under management in the unit slumped in the first nine months of 2022 as net new assets turned negative.”
About two years ago, Credit Suisse was wrapped up in a big investment with Archegos Capital Management, a private investment company that basically managed the assets of one person named Bill Hwang. The company had some gains, so they asked Credit Suisse for some cash back on the margin Credit Suisse provided them, and Credit Suisse obliged. Soon after, Archegos went belly up, taking Credit Suisse’s cash with them. This was a major blow to the bank financially, but even more so reputationally. Investors wondered why Credit Suisse essentially levered up their position in Archegos.
This reputational damage caused AUM from the unit to plummet, with new outflows overtaking new inflows in the first three quarters of 2022 while the S&P 500 was down 25% over the same period.
In October, Credit Suisse announced a new strategy to restructure, prioritizing wealth management, a trend among banks after the horrible business environment for IPOs last year and continuing into this year. In keeping with the trend, Credit Suisse planned to allocate 80% of capital to its wealth management division and spin off its investment banking division.
The only problem was nobody wanted to keep their money with Credit Suisse. Looking at financials for 2022, we can see that AUM fell off a cliff, even more than was expected as of Q3 2022. Net assets fell by CHF 95.7 billion.
Here are the same figures from the histogram above, as of year end 2022.
Along with the firm’s strategic pivot came a major capital raise of USD 4.25 billion (CHF 4 billion), all in equity, which was highly dilutive.
Today, the Chairman of Saudi National Bank (which owns a 9.9% stake in Credit Suisse after the last round of equity) said in an interview that they would “absolutely not” provide any more capital to the Swiss bank.
These problems have been in the pipeline for a long time as the bank has become entangled in scandals and has experienced a downward trajectory since 2021. So, what happened this week to start the panic?
Last week, the SEC had questions about previous financial statements specifically with regard to the statement of cash flows. This caused Credit Suisse to delay publication of its annual report this year. This is fairly uncommon. After some review, Credit Suisse came out to say that it found “material weaknesses” in reporting and control procedures for the last two years – the same two years during which Credit Suisse had its worst earnings to date. The firm also had an adverse opinion issued by PwC (accounting) on internal controls. This sparked more investor concerns, especially amidst Silicon Valley Bank’s failure.
Most importantly, the bank said fixing these material weaknesses, “could require us to expend significant resources to correct the material weaknesses or deficiencies.”
Below is a look at net new assets for UBS’s wealth management division, a competitor to Credit Suisse.
This and other banks may be where customers are moving their money. Credit Suisse and SIVB’s issues are fundamentally different. Unlike SIVB, who had a poor liquidity ratio, Credit Suisse reported a liquidity coverage ratio of 144%, a good liquidity position.
Based on this chart, the market predicts a 47% probability of default, under 50%, but still very high. The bank is too big to fail in the most extreme sense. Central banks and governments must step in now to avoid major adverse effects. Other banks recognize Credit Suisse’s precarious position and are already moving to distance themselves from the contamination. The US Treasury also has started reviewing exposure of US banks to Credit Suisse.
The market is now pricing in a pivot from the ECB, moving away from the widely anticipated 50 bps announced last meeting down to 25 bps. We’ll see tomorrow.
As of 12/31/22, none of the securities mentioned were held in the Knowledge Leaders Strategy.
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