Tuesday March 21st, 2023
We have all witnessed, if not been a part player, in the turmoil of the last fortnight as markets have reacted more violently than most have ever seen to a seemingly endless onslaught of upsetting revelations. The mise-en-scene is a familiar one. A character in distress plays into a wider collaboration with other parties leading to a more indiscernible debacle of complex relationships, inter-dependencies and more often than not, a cry for help from better placed third parties playing the difficult part of common sense mentor and saviour.
We can readily relate the above to a number of Acts in the performance playing out before us. In late Act I the collapse of SVB triggered memories of the 2008 GFC and fears of contagion throughout the US banking system. Once these fears were allayed by the action of the authorities it became more obvious that the actions of SVB were more extreme than comparable banks and may be seen somewhat as an outlier. Indeed, the white knights of the Fed, FDIC and Treasury in the USA and HSBC in the UK rode in to save the day.
We did see collateral damage in the short-term as analysts crunched the numbers and unveiled vulnerabilities at other banks, however, confidence was restored through support from the regulators, the government and other members in the peer group. Naturally, we have seen price volatility as bets played out and this may continue for some time, however, the imminent fear of a US banking meltdown has been averted, for now.
In Act II, we witnessed a more substantial threat as one of the banks "too big to fail" took centre stage. Described by Fed Chairman Benanke in 2010 as "A too-big-to-fail firm is one whose size, complexity, interconnectedness, and critical functions are such that, should the firm go unexpectedly into liquidation, the rest of the financial system and the economy would face severe adverse consequences''. Clearly, this may propose a more serious problem to overcome?
Credit Suisse (CS) was founded in 1856 and has been a stalwart of the Swiss banking industry for decades, a first mover with alliances such as CS with First Boston in 1978 and a rollup of the Winterthur Group, Swiss Volksbank, SAS, Bank Leu etc. Admittedly, CS had been cast as a bit of a villain in recent years, but many have strayed away from the straight and narrow once in a while. In living memory we have witnessed some major scandals perpetrated by the likes of Penn Central, The US Savings and Loans, Barings Bank, Long-Term Capital Management, Enron, Refco, Kidder Peabody, Drexel Burnham, Bear Stearns, Lehman Brothers, AIG, RBS, ABN-Amro, Madoff, Wirecard, FTX.... the list is not exhaustive. These scandals mostly eventuated in insolvency, however, for those that failed many survived to fight another day. Many on the list were allowed to fail; they were not accorded coordinated lifelines of financial support to help ensure survival. So be it.
CS was one of the hardiest institutions through the 2008 crisis and had solidified shareholder support through investments from the Saudi National Bank, QIA, Blackrock, Norges Bank and others with deep pockets and reputations as savvy investors. Core CET1 capital ratios were at 14.1% and just a couple of weeks ago and liquidity was said to be "fine". Following a deep dive by many analysts into the ongoing "troubles" at CS, shareholder support seemed plausible, reserves had been taken against ongoing litigation, (Greensill, Archegos etc.) penance had been paid for the embarrassing Bulgarian money-laundering fiasco, and although performance at the investment bank had been dire the hard numbers seemed defensible. Then, late in Act II one of the protagonists delivered a short, fateful monologue when asked if he would increase its stake in CS.
Last Wednesday Ammar Al Khudairy, Chairman of the Saudi National Bank, the largest single shareholder in CS responded " The answer is absolutely not, for many reasons," "I'll cite the simplest reason which is regulatory and statutory. We now own 9.8% of the bank - if we go above 10% all kinds of new rules kick in, whether be it by our regulator or the European regulator or the Swiss regulator. " " We are not inclined to get into a new regulatory regime.". Whether this statement was meant to be an idle remark or not, it beggars belief that an incumbent shareholder would so carelessly hole the good ship CS below the waterline in such a casual fashion.
CS had received all the support expected from the SNB and FINMA, CHF50bn in immediate liquidity had been prepared, nevertheless, one short, pithy statement from their most prominent shareholder helped precipitate a 24% decline in equity value by the end of the same Wednesday session. The crash rolled over into other European banking shares notably at BNP, Societe Generale, Commerzbank, Deutsche Bank and in the UK and Italy. The ECB was alarmed, interdependencies with CS were analysed, and customers began to accelerate the withdrawal of deposits. Liquidity was no longer "fine". The rest is a short history. Failed rhetoric, an inability to "fight the market" and a renewed fear of real contagion eventuate in a reluctant shotgun marriage between CS with its arch-rival across the street.
We might think that confirmation bias should help in situations like these. Shareholders, depositors, investors, regulators and functionaries all benefit from, and should take solace in, the fact that the powers that be are in agreement; that a solution has been supported and that concrete measures to help achieve a successful outcome are readily made available; alongside positive statements of financial and moral support. However, what have we learned from recent history?
Jim Cramer is not the poster child for investment advice, but on March 11th 2008 he stated to the CNBC universe "Bear Stearns is fine. Do not take your money out". The stock was at $62; five days later it was bailed out by JP Morgan at $2. Positive statements of financial stability are myriad in association with all of the failures we have listed above. Unfortunately, in finance we seem to suffer from negative confirmation bias. Positive statements of financial stability in general have provoked anxiety and mistrust. In this case an outright statement undermining support can only exacerbate the willingness for the market to suspect the worst and abandon all hope. After Wednesday's statement did CS stand a chance?
In Act III we see much that will be debated in the near future concerning the minutiae surrounding the ability of the "authorities" to ride roughshod over shareholders and bondholders, and more meaningfully, the corresponding relationship that AT1 bondholders have with other debtors in the credit spectrum. Have we been idly misrepresenting the real risk of AT1 Bonds and misaligning our thoughts on recovery rates? We would suggest 'Yes". More on this to come.
Regardless.... in the prescient words of David Byrne ..."You may find yourself living in a shotgun shack", discerningly... " Well...how did I get here?", worryingly... " My God what have I done" and resignedly.... " This is not my beautiful wife". To be clear this is the " same as it ever was", and, for sure, we can surmise this is not a "Once in a Lifetime" event.
Paul Durrant
The Talking Head
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