Credit Suisse traded down to a record low before recovering this morning on concerns regarding the spreads on the Swiss bank’s credit default swaps.
That selloff was spurred by a weekend report from ABC Australia stating that the CEO of Credit Suisse had been meeting with “major institutional investors” who are worried about the financial stability of the company. “The investment bank is a disaster,” said one large investor. “The CDS’s of the bank have been trading as if a Lehman moment was about to hit.” By CDS’s, that investor was speaking about credit default swaps, which currently price in a 23% likelihood of default within the next 5 years.
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What Are Credit Default Swaps?
While some have called credit default swaps the “herald of doom”, you can think of a credit default swap like insurance. Credit default swaps are derivative contracts that transfer, or swap credit exposure with another investor. That investor collects the premium from the buyer of the contract, and in return, agrees to reimburse the buyer of the credit default swap if the borrower defaults. Just like your monthly insurance payment, CDS contracts are often maintained via ongoing premium payments. Credit default swaps aren’t necessarily a bet that a borrower will default — they’re simply a tool for risk management. However, when the price (or “spread”) starts getting bid-up, it signals growing concern from market participants.
Past Cases of Credit Default Swaps Foreshadowing Trouble
Bear Stearns credit default swaps move from <200 to 772.1.
For 85 years, Bear Stearns was a successful investment bank operating out of New York. The 2008 recession and financial crisis led to their downfall, and they were ultimately sold to JPMorgan. In the weeks before the fall, Bear Stearns credit default swaps more than tripled in price.
AIG CDS’ move from 68.9 in January to 3500.3 in September
Later on in the 2008 credit crisis, AIG got into hot water, as this September 2008 New York Times article explains:
“With Lehman Brothers running out of options this week, investors fear that A.I.G. will face billions in additional losses because it has effectively guaranteed complex financial instruments tied to home loans whose values have plummeted. If so, it too could need to raise capital, which Freddie Mac, Fannie Mae and Lehman have demonstrated can be a vexing problem in the current market environment.”
Lehman Brothers CDS vs. LEH Stock, January 2007 through July 2008
We would be remiss not to mention the Lehman Brothers, who are often seen as the poster-child of the 2008 Global Financial Crisis.
By now, you likely have figured out where we’re going with this.
Credit Suisse: False Flag, or Canary in the Coal Mine?
Credit Suisse has… a lot of problems. (More on that later.) But lately, the problem that everyone has their eye on is the more than 4X rally in the price of credit default swaps from 59.34 in January of 2022, to more than 250 on September 30th.
The rally looks eerily similar to the charts found above. There’s nothing that says these insurance-hungry market participants have to be right, but it certainly doesn’t look good.
Unusual Options Activity in Credit Suisse
The credit market isn’t the only group of market participants who were sniffing out a way to protect themselves from a potential bank bust. On September 26th and September 13th, Market Rebellion’s unusual options activity identified two instances of big bearish put buying in Credit Suisse.
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Credit Suisse CEO Responds
“Credit Suisse has solid capital and liquidity”, said CEO Ulrich Koerner to staff in an internal memo. The memos release precedes a “strategic review” coming later in October. That review may include several divestitures and the sale of certain assets. Despite reports from Reuters that Credit Suisse is in desperate need of fresh cash, the CEO remained upbeat in the memo, stating:
“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 that you are not confusing our day-to-day stock price performance with the strong capital base and liquidity position of the bank,”
But should the CEO of Credit Suisse be taken at his word?
Credit Suisse is no stranger to financial scandals. The second largest Swiss bank — and one of the largest banks in the world — has been used as a tool for everyone from run-of-the-mill criminals to shady world leaders. Following each scandal, spokesmen from Credit Suisse have been quick to get out in front of the headline with PR-friendly sentiment about learning “valuable lessons” and making internal changes… only for the bank to end up in similar predicaments soon after.
A Brief Timeline of Credit Suisse Scandals
- 1986: Helped Philippine dictator Ferdinand Marcos store $5-$10B of stolen money by opening up accounts under aliases like “William Saunders” and “Jane Ryan”.
- Result: Ordered to return $500M of stolen funds to the Philippines.
- 1999: Credit Suisse bankers in Japan hold a “shredding party” to destroy evidence in an ongoing investigation that alleged CS had assisted 60 Japanese businesses to conceal their losses.
- Result: Credit Suisse loses business license (in Japan) and is barred from signing new customers for a year. CS spokesman says an “important lesson was learned.”
- 2000: Credit Suisse is found to have laundered more than $200M for Nigerian dictator Sani Abacha.
- Result: $505M in fines from the Swiss Banking Association. Credit Suisse pledges to better investigate clients in the future.
- 2004: Credit Suisse launders $5B yen for the Japanese Yakuza.
- Result: None, bank acquitted.
- 2009: Credit Suisse is caught after assisting the governments of two US-sanctioned countries, Iran and Sudan, in moving funds over the course of 12 years between 1995-2007.
- Result: $536M in fines.
- 2011: Credit Suisse is caught assisting more than a thousand German customers in a tax evasion scheme.
- Result: $208M paid in settlement. Spokesperson for Credit Suisse says that the company has learned a “valuable lesson” and actions have been taken.
- 2012: It is discovered that actions from four (former) Credit Suisse bankers directly contributed to the 2007 credit crisis when $3B of sub-prime bonds were knowingly overpriced.
- Result: One managing director is sent to jail.
- 2014–2016: Not long after the bank was caught for tax evasion in Germany, it is uncovered that Credit Suisse was doing the same thing in America and Italy for many years. In the same period, Credit Suisse was fined by the US government for its “deficiency” in preventing money laundering.
- Result: $2.6B in US fines, $121M in Italy fines.
- 2017: Just one year after the US fined Credit Suisse for its laxed anti-money laundering policies, the Swiss bank was yet again caught laundering money. The clients: A Malaysian investment firm.
- Result: $700M in fines.
- 2017: Credit Suisse offices and employees from France to the UK to Australia are investigated for assisting more than 50,000 accounts in evading taxes.
- Result: Credit Suisse cooperates with authorities and publicly advertises its zero-tolerance policy toward tax evasion.
- 2018: Credit Suisse banker admits to forgery, making stock market bets with client money, incurs $150M in bad trades.
- Result: One CS banker is charged with five years in prison.
- 2020: Credit Suisse is accused of failure to perform proper checks on $146M of funds allegedly associated with Bulgarian drug trafficking.
- Result: Trial is ongoing, Credit Suisse rejects all allegations.
- 2021: Credit Suisse loses $5.5B due to its involvement with collapsed fund Archegos Capital Management.
- Result: 9 staff members fired.
- 2021: Credit Suisse investors see 10B of funds “suspended” following the collapse of Greensill Capital, which provided “risky loans” to CS clients.
- Result: Credit Suisse is still in the process of retrieving money for its investors.
- 2021: Credit Suisse punished for its involvement in Mozambique loan bribery scandal.
- Result: Credit Suisse is charged $414M in fines
The Bottom Line: A History of Bad Decisions
Credit Suisse has long been neck deep in problematic choices. Choices that have led them to where they are today, with a depreciating share price and soaring CDS contracts. Still, fellow investment banks aren’t giving up on them just yet. On October 3rd, Citigroup called CS stock a “buy for the brave.” Analysts from Citi stated that though there is “significant execution risk” in any new plan and that the bank is likely to be hit with more pessimistic headlines, Credit Suisse is still unlikely to default in the view of Citi, with analysts saying the situation is “night and day from 2007.” Analysts at JPMorgan corroborated that view on Monday, calling Credit Suisse’s capital position “healthy.” Only time will tell whether Citi and JPMorgan are correct in their read of Credit Suisse’s situation — or if the insurance-hungry CDS-market is predicting something far more dire.