Swiss banks generally have a reputation for being solid and predictable. Over the past 18 months, Credit Suisse has provided its clients and investors with just the opposite. Its chairman, Axel Lehmann, can save the day by halving the size of his accident-prone investment bank and cutting costs. To reduce it, you will need more capital. The cleanest and fastest way to do this is to go to the shareholders.
Debt and shares of the Zurich-based bank plummeted on Monday, fueled by unfounded rumors on social media that it could go bankrupt. There is no reason to think that the entity’s bankruptcy is likely, and the massive sale of shares quickly reversed on Tuesday and the following days, a reaction also supported by the entity’s announcement that it is going to repurchase up to 3,000 million euros of its own debt. But the price of its shares and its risky bonuses remain a sign of danger. Credit Suisse shares are valued at about $11 billion after losing more than 50% of their value since the start of the year. One of its Tier 1 securities (a form of debt that can be converted into equity) is yielding almost 15%, up from 10% this summer.
For this reason, Lehmann, which plans to announce its new strategy on October 27, has to take radical measures. One of the priorities is to turn the investment bank into a more stable and “capital-light” business focused on operations and fundraising, rather than trading debt securities. Doing this will be expensive. Suppose Credit Suisse cuts credit trading and half of its other fixed-income businesses, putting them in a “bad bank,” leaving behind a smaller unit focused on safer bonds and currencies. Using RBC’s calculations of the division’s balance sheet, that would mean shedding $24 billion of risk-weighted assets.
The last time Credit Suisse created a bad bank, the unit’s pre-tax losses amounted to a fifth of the risk-weighted assets it divested. A similar result this time would reduce the bank’s own funds by $4.7 billion. However, the move would also free up $3.2 billion of capital, using the bank’s Common Equity Tier 1 ratio of 13.5%. Together, the net hit to capital would be $1.5 billion.
But that would only be the beginning. Lehmann has also promised to cut up to $1.5 billion in costs across the group, in part by simplifying IT processes on its back-office. KBW analysts estimate that investment banks typically incur restructuring costs equivalent to three-quarters of planned cuts. This would cut another $1.1 billion from the bank’s own funds.
Ultimately, putting Credit Suisse in a safer position means building a cushion for future litigation or other charges, including any fines or settlements related to collapsed hedge fund Archegos Capital Management and supply chain lender Greensill Capital. RBC pegs total litigation expenses at $2bn between 2023 and 2025. If we add this to restructuring costs and bad bank costs, the total impact on capital would be $4.7bn.
Lehmann is reluctant to ask shareholders for a cash infusion equal to two-fifths of the company’s market capitalization. That is why he is considering the possibility of selling businesses, according to people close to the entity. The obvious candidate is Credit Suisse’s group of securitized products, one of the few bright spots at its investment bank. A book value sale could raise $2.7 billion, assuming equity is 13.5% of risk-weighted assets. Potential bidders include Apollo Global Management and BNP Paribas. But given the volatility of the credit markets, it would be unwise to bet on a quick sell.
Credit Suisse could follow suit with Deutsche Bank, which raised cash by taking a minority stake in its wealth-management business public in 2018. But Credit Suisse’s unit carries the taint of the Greensill saga, the factoring firm that tainted the bank. in his fall. The sale of shares in its Swiss national unit, valued at $10 billion according to analysts at JP Morgan, could herald a breakup of Credit Suisse. In addition, any public offering for sale would be at the mercy of the volatility of the markets.
Ask for money
So the cleanest way to end Credit Suisse’s problems would be to borrow money from major shareholders, such as Qatar’s sovereign wealth fund. To drop $4.7 billion, they would have to believe that the value of the bank will eventually increase by at least the same amount. This implies a market cap of at least $15.8 billion. Assuming that Credit Suisse’s tangible book value after the call for cash was about the same as today, the bank would have to trade at a third of book value, versus a quarter today.
That would still be a fraction of the value that investors attribute to its perennial Swiss rival, UBS.
The biggest risk is that Lehmann avoids taking bold steps and opts to minimally downsize the investment bank. That would be a mistake. Without a major restructuring, Credit Suisse’s funding costs would remain high and its wealth clients would be nervous. The bank would remain vulnerable to future market shocks. Any change at Credit Suisse will be slow and complicated. But the first step to a successful solution is to win back investor support.
