An Update on CREDIT SUISSE
As world investors are worrying about a Credit Suisse default, we have started building a small position in the shares of the Swiss banking giant. We have no privileged information of any nature but we do our analysis in terms or risk/reward, as always, and the case is compelling, even if there is no doubt that this is a risky trade.
Credit Suisse and UBS, Switzerland’s two banking giants represent 450% of the Swiss GDP in terms of total assets and are considered “too big to fail”. This is not the first time one of them is in trouble. in 2008, UBS had to be bailed out through Public funds. Since then, the bank recovered and became private again, and tougher banking rules have been implemented including higher capital ratios and more stringent credit and KYC procedures.
CREDIT SUISSE shares never recovered fully since 2008, and it has been a long, painful and drawn out decline since their peak of CHF 81 in the summer of 2007. Today the shares are trading at CHF 1.8, a 98 % decline.
In 2007, CS generated CHF 44 Bln in Revenues and CHF 7.7 Bln in net profits. The following year it lost CHF 7.2 Bln before recovering a more normal average of CHf 3.5 Bln per annum in the following decade.
Today, CS is going through a rough patch again, with its investment banking division having lost fortunes in major deals going sour, with a loss of CHF 5.8 Billion in 2022 on 14.4 Billion of revenues and an expected return to profitability in 2024.
Looking into the future, the consensus of analysts see CS generating 16 to 17 Billion in revenues by 2026 / 2027 with margins going back to 8 / 10 % and net income reaching CHF 1.7 Billion or roughly CHF 0.5 per share.
In terms of valuation, with a market capitalisation of CHF 7.1 Billion, that put the shares at roughly 3.5x times 2026 earnings. CS currently trades at a historical low of 0.16 Book value, 0.2x sales and 0.4x cash flow.
As always, Sell-side analysts are all negative at the bottom apart from two of them. . Still their average target price in 12 months is CHF 2.88, a + 61 % upside from current levels.
They were almost all positive in March 2022 with a price target of CHF 13 in March
In the past two years, CREDIT SUISSE suffered a succession of setbacks:
. Investment banking : Credit Suisse booked sever losses on ARCHEGOS in February 2021 and on Greenhsill Capital due to a high exposure, weak internal controls and a slow reaction to problems. These risks should have been detected earlier and, more importantly, managed swiftly s was the case with other major institutions exposed the the two issues. It is nit unusual for banks to suffer from bad deals and they are non-recurring by nature.
. Corporate Culture: Credit Suise has been criticised for a culture of lack of accountability, risk taking and weak transparency and regulatory framework. Te back has been plagued with investigations and regulatory scrutiny over money laundering tax evasion and market manipulation. At the core is a management problem which explains the high turnover at the helm of the Swiss group.
. Business Model : CREDOT SUIS has always had a business model with a strong reliance on investment banking model that explains is stealer performances and results in the 2002 – 2006 period. That model usually requires stricter than average risk controls and management, something the bank probably lacked unfortunately. Furthermore, the shift towards sustainable finance and far more volatile markets in 2022 compounded the problems.
The succession of managers at the helm and the disastrous financial results led to a crisis of confidence, with key staff leaving the bank and clients leaving in droves, causing the wealth management unit, usually a steady profit-making division to book losses in 2022 as well.
The new management in place has been implement a strategy of furthering controls, reining in risk taking and making the business model more balanced. Unfortunately, the confidence crisis accelerated in 2023, making CREDIT SUISSE access to the financial markets far more expensive and its liquidity ratios dwindling.
Last week, the cost of insuring CS debt surged to what is usually considered default risks.
In sum, CS is a venerable institution that is paying the price of management mistakes of the past, and, for now, the panic that has set-in did not leave the management the time to implement its strategy plans to restore credibility, confidence and turn profits again.
On Tuesday, the Swiss National Bank granted CS a lifeline of CHF 50 Bln to address its liquidity problem, eliminate the risk of defazûtl and gives it the ability to buy back deeply discounted debt, enhancing its capital ratios, looking large profits and reducing its interest rates costs.
Since 2008, the Swiss Regulator imposed banks to issue a new type of fixed-income instruments, namely “bail-in” ones as opposed to previous “bail-out” (when Governments would inject money into banks in trouble and every layer of the balance sheet except shareholders, would recoup their losses). Bail-In debt provide that in case of bank failure, the financial institution can impose the cancellation of debt owed to creditors & depositors or make them bear the cost of recapitalization.
In the case of CS, the lifeline provided by the Swiss National Bank (SNB) has a direct impact on CS liquidity coverage ratio (“the requirement whereby a bank must hold an amount of high-quality liquid assets big enough to cover cash outflows for a month”).
Analysts estimate the coverage ratio of CS to be at around 200% now which compares to the European banks average of 166% by June 2022, according to the EBA (European Banking Authority).
The other good news is that the bank will tender an equivalent amount of circa CHF 2.8bn of bonds in the secondary market, giving relief to its debt floating in the market and diminishing its cost of financing. Besides being its own bonds in the market, at a deep discount, shoring up its balance sheet, bail-in bonds including senior non-preferred and subordinated debts totalling CHF 49.1 bn as well as 14.7 Bln of Cocos and AT1s could lead to debt being converted into equity, certainly diluting shareholders but further reducing the liability side of the bank’s balance sheet.
When analysing the asset side of the equation, CS retail banking unit and Swiss corporate business, a very stable business, is worth at least CHF 10 Billion, against the current market capitalisation of CHF 7.1 Billion.
Finally, CS is “too Big to fail”, not only for Switzerland but also world wide considering ts size and global reach.
Credit Suisse has CHF 531 Billion in assets ( loans ) – twice the size of SVB, the US 16th largest bank – and a substantial share of the Swiss domestic retail and corporate market.
In yesterday’s official Press Release from the FINMA & SNB, there was a reference to a close monitoring by the Department of Finance. Does that mean the latter could be a shareholder as opposed to both the SNB & FINMA which cannot?
What is sure though, is that it will not be allowed to go bust. Restoring market and client confidence is key and the other key metrics is giving the management the time to restructure its operations.
The ultimate question then becomes whether at current prices and valuation metrics, investors have enough buffer to take the risk of acquiring shares of an institution that has one single division worth 40 % more than the market cap of the whole ensemble that they acquire at 16 % of its book value.
Crisis are opportunities and when Governments start intervening on too big to fail, the worst has probably been seen.
This is not to say that it is without risks, but we see the risk/reward ratio as particularly favourable at this juncture.
Following this week’ selling climax, we have ramped up the long side of our portfolio.
We still expect the market to re-test the 3800 level going into next week’s FED meeting, but we have too many BUY signals to ignore, particularly on the Nasdaq and technology stocks.
Today, we added to our position in China through US listed ADR’s and started a new position on china’s FT50 Index, we took our profits on our short in CATERPILLAR, and went long AMZN, GOOG and NFLX, added to our long positions in NOVOVAX and MATCH and initiated new long positions in SNAP, ZOOM and OCAD of the uK.
We reversed our position on the NASDAQ and went long the RUSSELL 2000.
Our portfolio is now NET LONG exposure where we are increasing China, keeping our European shorts and a marginal net long in US equities.
New Asset Allocation
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