Is Credit Suisse defaulting?
Another week, another potential insolvency. The highly leveraged European investment bank could be the next victim of the quickly tightening interest rate environment, but not this year.
Dear readers,
Do you recognize this building? It’s the exterior of Lehman Brothers on September 15th, 2008, the day it filed for bankruptcy. As of today, October 5th, 2022, are we on the cusp of more investment bank turmoil?
Headlines are swirling about Credit Suisse potentially facing solvency issues. The market corroborates this, with soaring credit default swap spreads ascribing increasingly fatal market-implied conditions.
After UK pension funds were bailed out last week by the BoE, fragility is rising across the global economy in the face of a Fed determined to tighten. Could the historically overleveraged Credit Suisse be the next victim of the tightest credit conditions we’ve seen in decades? Here’s what you need to know.
Voltage helps you solve the biggest problem with Lightning nodes and scaling. No more headaches with maintenance, reliability, or uptime issues. Voltage makes running Lightning instant and now easier than ever. These radical improvements to Lightning empower startups and enterprise brands to bring incredible applications and services to market. You can also spin up a personal node and pay by the hour. Scale your infrastructure as fast as Lightning itself.
Create a node in less than 2 minutes, just visit voltage.cloud
Today’s Topics
This is not a Lehman Brothers moment, yet.
Credit Suisse has an ugly capital structure.
This is likely a 2023 or 2024 capital generation issue, not imminent default.
Reputation, not default, risk is the biggest concern for Credit Suisse.
Grasping at straws for a Lehman moment?
Lehman Brothers was not at imminent risk for bankruptcy during the beginning of the Great Financial Crisis in 2007. However, as sentiment got progressively worse about the highly leveraged investment bank, bankruptcy became a self-fulfilling prophecy.
The question now: is Credit Suisse on the brink of insolvency and in imminent need of a bailout or buyout? No, but the market is placing dwindling odds on the long-term solvency of the bank.
Credit default swaps are an insurance policy against a company defaulting on its bonds—a proxy for credit risk. If CDS spreads move up, that means there's a higher premium required for that insurance, or a higher market-implied risk of default. This can be influenced by negative headlines, which further fuel the feedback loop of pressure on the company. Check out the CDS of CS since 2007—we are way beyond 2008/2009 levels:
While we won't discount the market entirely, the actual default risk of the company (as implied by its balance sheet and capital structure) is elevated but no cause for immediate concern. Default risk is not the key problem for CS in the near term, market confidence is. Confidence plays an integral role in credit markets.
The main risk for an investment bank like Credit Suisse is that this decrease in creditworthiness will lead to funding issues. Trouble finding buyers for its short-term debt would pose a great threat to the solvency of Credit Suisse. For now, if it can successfully maneuver the headlines and emerge from its abysmal position to successfully raise capital, it will live to fight on.
Reputation is everything, and the likelihood that CS will be able to finance debt at a level it can afford is slim to none. Recent headlines surrounding credit stress at the bank have caused a bond selloff, driving yields for its short-end debt through the roof:
Talks of restructuring are swirling throughout the firm. An exit from its tumultuous tenure in US investment banking and a capital raise (after its borrowing spreads narrow) have been discussed openly by the CEO—a Deutsche Bank alum. Given CS has had a slow, scandal-ridden decade of low growth, it’s unlikely we see a sudden collapse of the bank into insolvency. A highly visible, slower fade into irrelevance, followed by a bailout or buyout, looks more likely.
Very ugly capital structure
Here is a default risk model for Credit Suisse on a Bloomberg Terminal—this is more representative of credit risk than CDS spreads, evaluating the capital structure of the firm, not just its market-implied credit risk: