The cost of buying insurance against Credit Suisse defaulting on its debt soared to a record high on Monday, as the Swiss bank failed to calm market concerns around the strength of its balance sheet.
Traders and investors rushed to sell Credit Suisse’s shares and bonds while buying credit default swaps (CDS), derivatives that act like insurance contracts that pay out if a company reneges on its debts. Credit Suisse’s five-year CDS soared by more than 100 basis points on Monday, with some traders quoting it as high as 350 basis points, according to quotes seen by the Financial Times.
The bank’s shares tumbled to historic lows of below SFr3.60 (€3.71), down close to 10 per cent when the market opened, before paring losses. They were down 6 per cent at SFr3.74 by mid-afternoon.
The market moves were even more dramatic in the bank’s shorter-term CDS, with one trading desk quoting Credit Suisse’s one-year CDS at 440bp higher than on Friday at 550bp.
These moves mean that Credit Suisse’s CDS curve inverted on Monday, a phenomenon that happens when investors rush to buy protection against a default in the very near term. While these levels are even higher than where the Swiss bank’s CDS traded in the 2008 financial crisis, a change to the contracts means the derivatives now reference a riskier class of debt that is more exposed to losses if the bank collapses.
Senior Credit Suisse executives spent the weekend calling the bank’s biggest clients, counterparties and investors in an effort to reassure them about the group’s liquidity and capital position. The bank was responding to a sharp spike in CDS spreads last week and rumours on social media about the bank’s financial resilience.
In a briefing note prepared for executives speaking to investors on Sunday, the bank wrote: “A point of concern for many stakeholders, including speculation by the media, continues to be our capitalisation and financial strength.
“Our position in this respect is clear. Credit Suisse has a strong capital and liquidity position and balance sheet. Share price developments do not change this fact.”
Several investors said the exaggerated market moves reflected chaotic trading rather than fundamental fears over the bank’s solvency, with one credit hedge fund manager comparing investors buying one-year CDS to people rushing to “buy lottery tickets”.
Many compared the situation to the sharp sell-off in Deutsche Bank’s debt in 2016, when concerns that the German bank would have to skip some coupon payments on its capital bonds drove sharp moves in the CDS market.
The sell-off also fed through to prices on Credit Suisse’s additional tier 1 (AT1) bonds — the riskiest class of bank debt that is most exposed to losses in a crisis — many of which fell by about 10 percentage points on Monday. The price of a $1.5 billion AT1 bond that the Swiss bank can redeem in 2027 fell 12 cent to 58 cent on the dollar, according to Tradeweb.
JPMorgan analyst Kian Abouhossein said that the group’s financial position at the end of the second quarter was “healthy”, with a common equity tier 1 ratio — an indicator of its financial strength — of 13.5 per cent and a liquidity coverage ratio of 191 per cent.
“Credit Suisse has indicated a near-term intention to run with 13-14 per cent CET1 ratio, so the second quarter end ratio is well within that range and the liquidity coverage ratio is well above requirements,” he wrote.
Citigroup analyst Andrew Coombs added that the bank’s capital ratio was high compared with peers and would imply about SFr2.5 billion of excess capital on a 12.5 per cent ratio, which is where he expected the target to move if the bank sold its securitised products business, as it has signalled.
By comparison, UBS’s CET1 ratio at the end of the second quarter was 14.2 per cent, while Deutsche Bank’s was 13 per cent.
Recently installed chief executive Ulrich Körner and chair Axel Lehmann have promised to provide the market with a plan to significantly overhaul the group and strip back the investment bank alongside its third-quarter results on October 27th.
The plan is expected to include up to SFr1.5 billion of cost cuts, which is likely to include thousands of job losses.
Mr Abouhossein said there was a chance an announcement on the bank’s capital position could be brought forward in response to the market sell-off.
Credit Suisse declined to comment. - Copyright The Financial Times Limited 2022