The Breakdown - Is Credit Suisse the Next Lehman Brothers?

Episode Date: October 4, 2022

This episode is sponsored by Nexo.io, Circle and FTX US.   After a wild weekend of speculation and discussion, NLW breaks down what’s actually happening with beleaguered Credit Suisse, as well as why the FinTwit doom machine seems so focused on it.  - Nexo Pro allows you to trade on the spot and futures markets with a 50% discount on fees. You always get the best possible prices from all the available liquidity sources and can earn interest or borrow funds as you wait for your next trade. Get started today on pro.nexo.io. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “The Now” by Aaron Sprinkle and “The Life We Had” by Moments. Image credit: Dan Kitwood/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Circle, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, October 3rd, and today we are talking about credit suisse. Before we dive into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us in the Breakers Discord. You can find a link in the show notes or go to bit. ly slash breakdown pod. All right, folks, well, listen, this weekend, we were gone at a wedding,

and I was basically completely off Twitter. But even through that, it was impossible not to notice everyone on FinTwit screaming about Credit Suisse. So today we're going to look at what the hell was actually going on and what it means for markets in the broader economy. Early on Saturday morning, ABC Australia, the state news company, published an article about the crisis in the UK bond market and potential systemic weaknesses in the global financial system. This was, to be clear, a fairly standard article, similar to 100 others from last week. What sparked the subsequent panic was the accompanying tweet from the reporter, seemingly based on an anonymous quote and narrative angle that didn't make it into the article itself.

Quote, credible source tells me a major international investment bank is on the brink. By Saturday afternoon, the Finwit Duhmachine was in full swing, pushing the narrative through news aggregators as credible source as a major international investment bank on the brink, ABC Australia. In other words, making it seem that the National News Service had lent credibility to the quote. Although no bank had been named at that point, the online consensus immediately jumped to the conclusion that Credit Suisse was the bank in question. As the story developed, reporting by Reuters, the previous day resurfaced to give additional context and quotes. On Friday, Credit Suisse's CEO Ulrich Corner sent a memo to staff saying, I know it's not easy to remain focused amid the many stories you read in the media, in particular given the many factually inaccurate statements being made.

That said, I trust you are not confusing our day-to-day stock price performance with the strong capital base and liquidity position of the bank. Additional comments in the memo said that the bank was at a, quote, critical moment ahead of a restructuring plan to be announced on October 27th. Team leaders at the bank apparently were working the phones all weekend to reassure clients, counterparts and investors about the bank's capital and liquidity. Back on Twitter, meanwhile, Finuit was totally focused on market signals. The most obvious market signal was around credit default swaps or CDS. These financial instruments function as insurance in case of default on bonds. The higher

the perceived risk of default, the higher the cost of a CDS. On Friday, Credit Suisse's CDS's closed near levels reached at their peak during the 2008 crisis. They've been steadily rising over the course of the year and particularly rapidly over the last three months. The other market signal people were looking at is stock price. Credit Suisse equity has also been taking a beating recently. Their stock had fallen by more than 20% in a day on the Friday before last, from five Swiss francs to below four. The stock is down 55% for the year and has been on a slow march downward since its post-GFC high of 52 francs at the end of 2009. On October 1st, Wall Street Silver tweeted, Credit Suisse is probably going bankrupt. The collapse in Credit Suisse's share price is of great

concern. From 1490 in February 2021 to 390 currently. And with price-to-book ratio at 0.22, markets are saying it's insolvent and probably bust. 2008 moment soon? Systemic bank risk. Ben Woodman at Waterloo Capital Management writes, Credit Suisse's five-year credit default swaps spreads are approaching 2008 levels, the time of the global financial crisis. Markets are sensing a lot of risk in CS and Europe generally. And less capital rights either Credit Suisse or Deutsche Bank or both are on the brink of failing. CS seems more imminent based on CDS blowing out, but that unregulated $30 trillion derivative book at DB could blow the entire financial system up as contagion spreads. Holgerz-Bits writes,

Oops, Credit Suisse CEO seeks to calm as default swaps near 2009 level. Cornytaut's strong capital after shares touched new low. The cost of ensuring banks bonds against default climbed about 15% last week. Markets price default probability at 20%. These are just a few examples of the dominant narrative, but it wasn't the only narrative. Boas Weinstein, the founder of Sabah Capital Management, wrote, Oh my, this feels like like a concerted effort at scaremongering. In 2011, 2012, Morgan Stanley's CDS was twice as wide as Credit Suisse is today. Take a deep breath, guys. So let's try to get a slightly more dispassionate summary. Alex Good wrote a long viral threat about this, saying, Credit Suisse, below, I will summarize what

has happened and what I think the implications are. Credit Suisse options price an explosive equity move over the next three months. Implied volatility of 61 at decade highs imply moves 2x times U.S. financials. Bonds and CDS paint a similar story. CDS are a bit hard to understand, so instead I'll focus on the bonds. The 2025 Credit Suisse bonds trade at 6.4%. Compare this, for example, to Ukraine 2025 debt trading at 67%. Talk about Ukraine debt default makes sense. CS debt default, less so. CS bonds are not pricing a pending credit event because as of the July quarter, CS's CET1 capital adequacy was at 13.5%. Within the bank's own target and well above the 8% international regulatory requirement or the 10% Swiss hurdle. In the pre-08 era, sub 5% CET1s were common. That said,

Corners Friday comments, quote, no doubt there will be more noise in the markets and in the press between now and the end of October. All I can tell you is to remain disciplined and stay as close as ever to your clients. Did not sound great for equity holders. CS results have four levers. A, a Swiss bank and wealth arm serving rich folk, doing great. B, an investment bank that's losing share with no prime brokerage due to Bill Huang's blowup. C, big legal liability and fines from B. D. D. A flailing fund distribution suite. The drop in CS stock price has coincided with declining earnings expectations. CS price to book is similar to Deutsche Bank or one-sixth of JPMs and one-third of HSBC's. Good goes on then to get deep into the company. He talks about their wealth management business. He

talks about the $5.5 billion blowup based on Bill Huang's archa-ghost from last year, and so on and so forth. In total, he says, that leaves a pretty nasty setup to the Q3 plan announcement later this month. The leveraged finance group probably lost even more money, and other banks won't have risk appetite for a structured products group, given what's happening in mortgages and other credit markets. Am I jumping up and down to fade the CS panic? No. Is it Lehman? No. Lehman was the cause. CS is a casualty. Could the stock go to zero because of bond market liquidity issues compounding its asset sale plan? Yes, which is probably relevant to the financial stability narrative. Want to keep more profits when trading? Get the best possible prices

and trade with 50% lower fees on NXO Pro. The new spot and futures trading platform uses aggregated liquidity of over 3,000 order books collected from multiple sources. Utilizing the complete nexus suite allows you to earn interest and borrow funds as you wait for the next trade setup. Visit pro. That's PRO. That's P-R-O-N-E-X-O-D-I-O and sign up today. The breakdown is sponsored by F-TX-U-S. F-TX-U-S is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors.

There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDX-U-S is also the only leading exchange that supports both a and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. It's worth taking a minute to ask why we actually even care about Credit Suisse. The company is classified as a globally systematic important bank by the Financial Stability Board. It is classified at level one, which is the same as BNY Mellon. There are 12 banks classified at higher levels considered more important to the global financial system. These

classifications require banks that could cause global contagion to hold additional capital buffers, an extra 1% in the case of Credit Suisse. The point of this is that the contagion risk is real. It has been designated as real if there are major problems at Credit Suisse. Another point of concern is that these globally important banks are much larger than they were in 2007, as the banking sector has significantly consolidated since then. When Lehman Brothers collapsed, it had only 600 billion in assets under management. Credit Suisse today has around $1.6 trillion. The last few years have also been rough for Credit Suisse. The main problem has been horrendously bad losses for its investment banking division. Credit Suisse lost $5.5 billion after Archegos Capital blew up in June 2021, defaulting on debts owed to the bank.

It had also funded Greensill, a scandal-ridden logistics financing company which collapsed in April 2021, which caused the loss of $1.7 billion to bank clients. The loss of reputation, though, was the most concerning part of the Green Sale collapse. The bank had sold Green Sills' debt to wealth management clients who now face a multi-year legal battle to claim repayment. The bank has also faced legal troubles and regulatory action. Between 2012 and 2016, the bank sold $1.3 billion worth of tuna bonds for the Republic of Mozambique for critical infrastructure. It was later revealed that the financing involved a $137 million kickback program to bankers and corrupt officials. The bank was fined more than $450 million by U.S. and U.K. regulators

and decided to forgive $200 million worth of debt in exchange for lighter sentencing. Important to note, the legal problems surrounding these things, especially Greensill and Archegos, are ongoing, which means we can expect more repercussions in the years to come. To this end, the bank has increased litigation provisions in its reporting for the last two quarters to over 700 million. In the face of this pile of scandals, both the chairman and CEO have resigned over the last year. This was the second CEO to depart the bank in two years, with the previous executive being implicated in a corporate espionage scandal, where former employees were surveilled as they attempted to move on with their careers at other institutions. The most recent CEO resigned after quarter two

earnings for this year, reported a significant $1.6 billion loss for the quarter. And speaking of, let's turn now to the numbers on their actual books. Crypto-Murleyan did a threat about this writing. Is Credit Suisse insolvent? Taking a look at their Q2 report, the best indicator of short-term liquidity is their LCR. Looks pretty healthy at 203%, but might not tell the whole picture. In the three months since, markets have been pretty volatile, but overall are lower than they were at June ME. The LCR is a weak metric in some regards, the outflows on committed facilities, are much lower than has been seen in reality. On top of this, the Swiss regulator holds its two largest banks to a higher standard. They're not expected to have an LCR of 100%, but more like 140%.

Looking at the impact of archegos, for example, this had the double impact of reducing HQLA, but also blowing up contingent outflows on derivatives collateral. So a few smaller versions of this could cause issue. So it may be that they are not actually insolvent, but they are in breach of or close to their regulatory limits and currently in crisis mode trying to resolve that problem. Others on FinTwit noted that Credit Suisse has around $160 billion in cash, $400 billion in at-call liabilities, meaning they can be redeemed at will by clients, $900 billion in leverage exposure to derivatives markets, and $40 billion in equity at book value. That is actually dramatically reduced and is currently worth about $10 billion in markets. But as we heard before, while

these numbers sound alarming, especially with that gigantic amount of outstanding derivatives exposure, bank's capital adequacy remains at 13.5%, which is well above the 8% standard international regulatory requirement. In other words, this is an entirely different situation to the pre-GFC era where capital adequacy below 5% was common, and where Lehman Brothers was at a reported 3.1% when it hit problems. This has led to some saying that the narrative unfint to it is just wrong. Paul J. Davies from Bloomberg Opinion wrote a piece today called No, Credit Suisse isn't on the brink. He writes, Credit Suisse is in a tight spot, but it isn't on the brink, as the fevered typist of social media imagined over the weekend. The Swiss Bank, however, is going through its darkest hours at exactly

the worst time, when markets are volatile and everyone is nervous about what's around the corner. Disappointment is still more likely than disaster. Financial markets aren't getting any friendlier. The quicker that Credit Suisse's board can complete its strategic plan and in the uncertainty, the better. Now, broadening this out a little bit, some on Fin Twit noted that it wasn't just CS. Alistair McLeod wrote, Credit Suisse is not the only major bank whose price to book is flashing warning signals. He then shared a list of globally systematically important banks with priced a book of under 40 percent, and said, a failure of one of them is likely to call the survival of the others into

question. TXMC trades wrote, seeing the chatter in my feet about Credit Suisse feels like one of those moments where FinTwit has sniffed out a big problem long before the broader media catches on. Michael Gade of Leadlag report writes, look at the chart of Credit Suisse and tell me again we aren't in for another financial crisis. Look at the chart of long government bonds and tell me again we aren't in for another financial crisis. We are way past an inflation crisis. This is now a credit crisis. The Happy Hawaiian wrote, The Credit Suisse's CDS explosion to a level above 2008 doesn't mean they're going bankrupt. He means they're going bankrupt if central banks continue to be hawkish. So the Fed and ECB have the choice. Pivot or destroy a global systemically important bank. Still at the end of the day,

many were quick to remind that there are dangers and overly relying on old narratives. Guy Labas writes, everyone on FinTwit seems busy this morning fighting the last battle. So let me point out that 2008 cannot happen again in the same way because one, counterparty risk hedging regulation, two, central banks and governments are more aware of banking interconnectedness. Three, bank capital is way higher, which isn't to say that a bank couldn't fail, just that the risk of systemic failure from counterparty risk is not a significant worry. Joseph Wang said if a major financial institution were in danger, the government would step in and bail it out, thinking Lehman is fighting the last war. Indeed, many ultimately, when all was said and done, think that Fin Twit's excitement about

this was really just about their desperation for the Fed's hand to be forced to a pivot. Terrick Brooker writes a scenario. Major global investment bank goes bust, gets bailed out with highly targeted assistance. No Lehman moment equals no mass QE. Market sees no boost from intervention beyond initial euphoria and disappointment that the liquidity tap remains a trickle. So if things aren't like 2008, what is likely to happen next? Lin Alden tried to take this on in one tweet. Seeing lots of social media chatter about bank contagion, so I'll retweet this here. The bigger economic and financial issues here in 2022 are centered in sovereign bonds, currencies, and energy. They're not centered primarily in banks like 2008, except for some areas.

To be clear, the riskiest banks are indeed vulnerable, as they are in every recession, especially in parts of Europe and especially for common shareholders. I'm talking about the banking system as a whole and about where the core issues are, which are different than 2008. Lightning rarely strikes at the same place twice, especially because protection gets put on what was struck. So where I think we're left is that something is clearly going on with Credit Suisse that the company has to address, and that something isn't just about market volatility, although that's not helping things. But when it comes to what it means for markets more broadly, I think that's a lot less clear. Certainly it's something we're going to be debating all week,

so I look forward to keeping you up to speed. For now, I want to say thanks again to my sponsors, nexo.io, Circle and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event, the investing in digital enterprises and Asset Summit or Ideas. The event facilitates capital flow and market growth by connecting the digital economy with traditional finance. Join CoinDesk October 18th and 19th in New York City for a 360-degree investment experience, where you can source, invest, and secure the next big deal in digital assets. Use code breakdown 20 for 20% off a general pass. You can register today at coin desk.com slash ideas.