Credit Suisse case: Western Assets expects Swiss authorities to act if sentiment doesn't improve

Summary

Credit Suisse (CS) stock and bonds are materially weaker given recent US bank failures and specific fears related to CS. Contagion and confidence fears are at the root of the potential liquidity crisis as constructive CS management statements were largely ignored by the market while it waited for Swiss authorities to boost much needed confidence in an effort to preserve deposits and prevent contagion for the Swiss banking system, and to safeguard broader financial stability. The Swiss National Bank (SNB) and Swiss Financial Market Supervisory Authority, FINMA, surprisingly took time to respond. However, it has now affirmed CS’s strength and promised to provide liquidity to CS should it prove necessary. We expect Swiss authorities to monitor the situation closely and respond more forcefully if sentiment does not improve. Prices have moved off the lows since the authorities made their joint statement this afternoon.

Following the recent takeovers of Silicon Valley Bank (SIVB) and Signature Bank (SBNY), the second and third largest US bank failures in history, respectively, after Washington Mutual in 2008, stocks and bonds of European banks and CS in particular have fallen dramatically in recent days. We believe that SIVB and SBNY are idiosyncratic cases with very limited systemic impact to the European banking system. Our investment thesis for European banks favors large institutions with “well-established business models” and “large in-country footprints of retail banking,” which are completely different from the SIVB and SBNY situations in the following ways:

1. European banks have extremely limited exposure to the sectors that have caused issues for SIVB;
2. The bulk of deposits in the European banking system is made up of very sticky retail deposits, and the vast majority is covered by government guarantee programs, which further increases stickiness; and
3. Unlike SIVB, European banks (or banks in general) are positively geared toward rising rates. Typical banks have a loan-to- securities mix that benefits from rising rates. In addition, the majority of securities holdings are rates swapped, which limits interest rate risks. As a result of higher rates, banks have generally seen double-digit increases in net interest income.

Today, CS is again under particular scrutiny following comments from the Chair of its largest shareholder, Saudi National Bank, that it would not increase its investment in CS for various reasons (e.g., regulatory, etc.). In response, CS senior management has tried to calm investor fears, unsuccessfully for now, by highlighting that:

1. SIVB’s failure and deposit run are very different in terms of the extremely tough regulatory environment for CS, which is classified as a global systemically important bank (GSIB). CS’s business is stress-tested to a much higher degree, and it cannot run asset liability mismatches as did SIVB. SIVB tripled its assets in the last three years, versus CS’s meaningful asset shrinkage into a less risky business model. Unlike SIVB, CS is interest rate hedged and it benefits from higher interest rates.
2. SIVB accounted for 1% of US bank assets with only 20 branches and extremely concentrated deposits (95% uninsured). In contrast, CS has a large Swiss domestic retail business with roughly a 20%-25% domestic market share and assets roughly equal to the Swiss GDP. The Swiss funding base has proven to be relatively sticky and CS has a leading domestic franchise in Switzerland.
3. CS’s reported capital and liquidity currently surpass regulatory requirements and compare favorably versus its global peers; Swiss regulatory requirements are considerably tougher than those of most countries.
4. On Tuesday, March 14, the CEO of CS confirmed that its three-year restructuring program is ahead of schedule in terms of costs and asset sales, such as the Structured Products Group. CS’s debt, assets and risk should decline over 2023 and issuance needs are relatively limited given recent issuance and shrinking assets.

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Our long-term fundamental investment thesis for CS is as follows:

1. AAA rated Switzerland offers a unique combination of the lowest risk country profile and toughest banking regulator.
2. CS’s self-help credit story is under extreme regulatory scrutiny; new management has doubled down on a long-term, very bondholder-friendly business transformation strategy;
3. The announced unwind of CS’s high-risk and failed investment banking strategy is aimed at creating a simpler, smaller, and lower risk bank;
4. CS has a clear road map: “Travelling the Road Back to Successful Swiss Heritage.”

Resolving CS’s current confidence crisis requires swift and forceful central bank support. Given the size and importance of CS to the Swiss economy, our expectation was that the SNB would lend support to the institution. The SNB has now confirmed that it will provide liquidity as necessary to CS, as well as affirming CS’s strong standing with regard to stringent regulatory liquidity requirements. We expect Swiss authorities to monitor the situation closely and respond more forcefully if sentiment does not improve. Western Asset is continuing to hold current positions while also keeping a close watch on the latest developments.