Credit Suisse: bailouts and waiting for the ECB
All eyes may have been on the Chancellor today, however the real action in financial markets was in the banking sector. Credit Suisse’s share price fell to a record low, and was down 25% at one point, and closed trading on Wednesday at $2.16. A year ago, this stock was trading at $8. CS has been a slow-motion car crash for the best part of 3-years, beset by scandal after scandal from spying on executives to backing the failed Greensill and Archegos, which led to a drip flow of deposits out of the bank, which have recently turned into a current. This week’s decimation of the share price wasn’t due to SVB’s collapse, but instead because the bank announced that they have found irregularities in their financial statements, which then led to their largest shareholder, Saudi National Bank, to publicly declare that they would not buy any more shares in the lender, they own just under 10%.
There was some speculation around why Saudi National Bank did this, as the comments from their chairman caused a massive rout in the share price, which hurt their position. However, Saudi National Bank may have had enough with CS’s turnaround story and the endless skeletons in the closet. It may have been a sign that they were giving up, or had mentally written off their stake, a bit like other big shareholders who have cut their losses in recent weeks and months.
The key developments for CS today:
- It’s share price fell to a record low.
- Its bond price sunk to 40 cents on the dollar.
- 1 year Credit Default Swaps surged above 1000 basis points at one stage, as other lenders rushed to hedge counterparty risk for any positions they are holding with CS. As you can see in the chart below, this did not happen for other lenders, even if CDS’s for other European banks have ticked higher in recent days.
- The Eurostoxx banking index dropped more than 8%, with heavy losses for the euro area’s biggest banks, including Deutche Bank, Soc Gen, and BNP Paribas – its stock was halted from trading earlier because it fell so sharply.
- Credit Suisse is a systemically important bank, and it is in the top ten of the world’s largest investment banks, which is why its problems are causing havoc for the European banking sector, but it is also why it will be saved from going under.
- There is some stress in money market rates, and US repo rates- the rates at which banks lend to each other rose sharply on Wednesday before pulling back.
Chart: Credit Suisse’s CDS swaps are significantly higher than their European peers.
CS: a lifeline from the SNB
Because it is systemically important, it will be saved from going under, in our view. Late on Wednesday, the Swiss National Bank said that it would provide a liquidity backstop to CS, after CS executives asked the SNB for a public show of support. The market likes this move by the SNB, and in pre-market trading, CS shares surged nearly 8% on Wednesday night.
The SNB is a trusted and solid central bank, thus its liquidity backstop will mean: 1, CS can keep trading (although, who would want to do business with it?) and 2, it dramatically reduces counterparty risk, which should see its CDS swaps fall on Thursday. We also think that this could lead to interbank lending rates begin to normalise after Wednesday’s mini bout of volatility.
However, European banks are still likely to trade with a “Credit Suisse” premium for some time so we may not see a full recovery in these stocks, which were some of the star performers in 2022. We still need to find out about the details of the SNB’s liquidity backstop, and how this will impact the bank’s turnaround plans. Will the bank be broken up soon, with a potential sale of its investment banking unit, sooner than what was planned in the turnaround plan? That could be on the cards, but who wants to sell a bank in this market?
The bigger risk to the European banking sector is the ECB, who will announce their latest monetary policy decision tomorrow. Analysts had been expecting the ECB to raise rates by 50 basis points, as they had signalled earlier this month. However, the latest stress in the global banking sector, and the sharp selloff in European banking stocks, mean that they have a tough decision on their hands. If they raise rates then they could tighten financial conditions too much, causing more woes for the banking sector, along with highly indebted sovereigns like Italy. The 1-month Overnight Interest rate swaps market for the Eurozone, which is a good predictor of interest rates, is currently at 2.6% and fell 6 basis points on Wednesday, thus the market is pricing in a less hawkish ECB on Thursday.
Things to look out for at this ECB meeting:
- Will the ECB hike rates by 50 or will it hike rates by 25bps?
- We think they will hike rates, probably 25bps, however, they may signal that they will pause after that due to the stresses in the financial system.
- Will the ECB offer its banks a liquidity boost to ensure that funding markets don’t get gummed up due to the crisis at CS?
- It is worth noting that the market is now pricing in a 52% probability that the Fed will pause rate hikes when it meets next week, and the 2-year Treasury yield fell another 37 basis points on Wednesday, back to its lowest level since September.
We think that European banking stocks may not enjoy the mini recovery trade that CS is expected to have on Thursday, until we have heard from Christine Lagarde and the ECB on Thursday afternoon.
Overall, the outlook remains cloudy, even if CS looks more secure post the SNB financing. All eyes are on the ECB and if they will ease the pressure on the banks by not raising interest rates, or if they will continue to focus on inflation above all else. We think the latter would be a risky move in the current environment.