Credit Suisse's management must do one thing above all next week: create trust. Rumored plans for a bad bank could play a decisive role in doing so.
Since July 27, top management at Credit Suisse has been tight-lipped about its new strategy - even though it has had to run the gauntlet of media, and major and meme investors in the process. Next Thursday when the big reveal of the strategy comes, the bank needs to put every foot right. Observers say management still has this one late chance to regain the lost trust of the financial markets.
Two indicators give the current state of play. There is the share price, which briefly sank to an all-time low of 3.67 Swiss francs at the beginning of October. Then there are the prices of credit derivatives, which bondholders use to hedge against default. According to «Bloomberg,» spreads of 5-year credit default swaps (CDS) rose from 55 basis points to more than 290 basis points at the beginning of the month. At times, prices were even higher.
Lehman Memories
As CDS spreads reached their highest level since the financial crisis, social media promptly began to build up momentum and began to chatter about a «Lehman moment» for Switzerland's second-largest bank. Lehman Brothers went bankrupt after the liquidity crisis in September 2008.
It seems that idea caught on, and even more prudent and better-informed observers are talking about an impending Lehman moment. If Credit Suisse can no longer refinance itself in the financial market because of lost investor confidence, even the capital ratio of 13.5 percent will not be of much use to it, a banking observer points out. The race against time has begun.
Three-Way Split
The turnaround of Credit Suisse won't be accomplished overnight, even with such experiences restructurers CEO Ulrich Koerner, chief financial officer Dixit Joshi, and chief operating officer Francesca McDonagh. A foundation needs to be established so markets come to again have trust in the bank. The idea of a «bad bank» within the investment bank would be one way to achieve this.
The idea for such a solution for troubled assets was first floated a month ago when the «Financial Times» speculated about carving up the investment bank into three parts: an advisory business, remaining business areas that are still useful for the group, and a «bad bank» for risky assets to be wound up. The idea has taken hold among local bank analysts as well.
Reactivate SRU?
This is not a new idea for Credit Suisse. After taking office in 2015, then-CEO Tidjane Thiam created a strategic resolution unit (SRU), in which the bank placed its barely saleable securities. While the bad bank was initially a millstone for results, Credit Suisse managed to reduce the positions in a relatively short time, freeing up a great deal of previously tied-up capital.
At the end of 2018, the SRU was entirely wound down, with the bank suffering $12 billion in losses the unit during that time. Still, it managed to nearly halve its risk-weighted assets in trading.
Balm for the Markets
Narrowing down problem areas and limiting damage in the operating business with a relaunch of the SRU, could serve as a calming signal to the markets. Credit Suisse declined to comment on this when asked by finews.com and referred to the update on October 27.
That raises the question of who will provide the necessary capital, and which corner of Credit Suisse will the junk be swept into? There is an estimated capital gap of $4 billion to $9 billion depending on which analyst you talk to. To be sure, an external injection of funds would be welcome, but also high risk given the condition of the bank and collateral in the bad bank.
The Wages of Fear
In the past, the Qatari sovereign wealth fund has shown a willingness to buy Credit Suisse convertible bonds at rates of 9 and 9.5 percent. But for an investment in a new SRU, the rate demanded is likely to be quite a bit higher.
Even if the idea seems heretical, it would still be cheaper than obtaining capital from the government, for which there is also a precedent in Swiss banking. In 2008, the Swiss government and the Swiss National Bank (SNB) invested in the stabilization fund to save UBS, in which illiquid toxic securities could be parked. UBS then repurchased the securities from the «Stabfonds», which turned a profit of nearly 6 billion francs for both the federal government and the SNB. But given the enormous risks taken with taxpayers' money, it can hardly be called a good deal.
Difficult Environment
After the Federal Council granted a loan of 1.9 billion francs to Swiss airlines during the Corona crisis and now looking to help the Swiss Federal Railway (SBB) with a financial injection of 3 billion francs, it is highly questionable whether the state has the appetite to come to the bank's rescue considering many of its problems are self-inflicted.
It is difficult to recall an overall environment in financial markets, the real economy, and geopolitics that has been more difficult than now. Against this backdrop, risking a possible test of «too big to fail» provisions can hardly be in the interest of regulators and the government.
