Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Executive Summary: The <a href="https://www.smartkarma.com/entities/credit-suisse-group-ag" target="_blank" data-smartkarma-citation="entities:22253:1" rel="noopener">Credit Suisse Group (CSGN VX)</a> requires between CHF4 to 8bn in additional Common Equity Tier 1 (CET1) to remain competitive and bring its capital buffer in-line with peers. We noted several week ago that the firm’s capital buffer was too thin to absorb large losses while its Contingent Capital (CoCo) securities continued to trade rich relative to peers. The thin, and likely declining, buffer may now affect its ability to compete. In our view, the issue is quickly moving from damage control towards a capital raise.We derive our capital estimates by starting with the amount required to bring the CET1 buffer up to peer levels. To this we add various exceptional charges which are increasing every other week. Details within.We were ahead of the market with our Underweight recommendation on CS bonds. When we initiated this call, the CS 4.5% coupon 2030 callable Additional Tier 1 bond was trading close to par. It is now below $95. Our recommendation was based on a fundamental assessment of CS’ business model, risk tolerance and capitalization. Please see: <a href="https://www.smartkarma.com/compose/insight/49775/Credit%20Suisse%20%E2%80%93%20Perfection%20Priced%20into%20Long-Dated%20AT1.%20Read%20more:%20https:/skr.ma/7w5Cm" target="_blank" rel="noopener">Credit Suisse – Perfection Priced into Long-Dated AT1</a> for more details. These negative factors were magnified by the Greensill episode. Please see: <a href="https://www.smartkarma.com/compose/insight/49775/Credit%20Suisse:%20Greensill%20Sows%20Reputation%20Risks,%20Underweight%20CS%20Bonds.%20Read%20more:%20https:/skr.ma/tq31o" target="_blank" rel="noopener">Credit Suisse: Greensill Sows Reputation Risks, Underweight CS Bonds</a> and <a href="https://www.smartkarma.com/compose/insight/49775/Credit%20Suisse:%20Greensill's%20Capital%20Implications%20Outweigh%20Asset%20Management%20Corrective%20Action.%20Read%20more:%20https:/skr.ma/WWiXU" target="_blank" rel="noopener">Credit Suisse: Greensill's Capital Implications Outweigh Asset Management Corrective Action</a>. The Archegos affair adds fuel to this fire.It is too early to consider this a buying opportunity. While we believe in our recapitalization call, we do not anticipate an immediate move towards improving the firms’ competitive position. The flames are rising and more fuel could be added before the capital blanket is applied. As such, we believe CS’ bonds may continue to lag that of its peers.However, the Swiss regulator may be unwilling to wait for the smoke to dampen and the arrival of a new Board Chairman should create the opportunity to clear the air at Credit Suisse. Obviously in addition to raising equity, CS would need to take serious action concerning its risk management and tolerance. Risk tolerance needs to be reduced until risk management is improved as these are the embers which stated this fire. This should be beneficial to AT1 investors over the long-run.

Executive Summary: The Credit Suisse Group (CSGN VX) requires between CHF4 to 8bn in additional Common Equity Tier 1 (CET1) to remain competitive and bring its capital buffer in-line with peers. We noted several week ago that the firm’s capital buffer was too thin to absorb large losses while its Contingent Capital (CoCo) securities continued to trade rich relative to peers. The thin, and likely declining, buffer may now affect its ability to compete. In our view, the issue is quickly moving from damage control towards a capital raise.We derive our capital estimates by starting with the amount required to bring the CET1 buffer up to peer levels. To this we add various exceptional charges which are increasing every other week. Details within.We were ahead of the market with our Underweight recommendation on CS bonds. When we initiated this call, the CS 4.5% coupon 2030 callable Additional Tier 1 bond was trading close to par. It is now below $95. Our recommendation was based on a fundamental assessment of CS’ business model, risk tolerance and capitalization. Please see: Credit Suisse – Perfection Priced into Long-Dated AT1 for more details. These negative factors were magnified by the Greensill episode. Please see: Credit Suisse: Greensill Sows Reputation Risks, Underweight CS Bonds and Credit Suisse: Greensill's Capital Implications Outweigh Asset Management Corrective Action. The Archegos affair adds fuel to this fire.It is too early to consider this a buying opportunity. While we believe in our recapitalization call, we do not anticipate an immediate move towards improving the firms’ competitive position. The flames are rising and more fuel could be added before the capital blanket is applied. As such, we believe CS’ bonds may continue to lag that of its peers.However, the Swiss regulator may be unwilling to wait for the smoke to dampen and the arrival of a new Board Chairman should create the opportunity to clear the air at Credit Suisse. Obviously in addition to raising equity, CS would need to take serious action concerning its risk management and tolerance. Risk tolerance needs to be reduced until risk management is improved as these are the embers which stated this fire. This should be beneficial to AT1 investors over the long-run. 

Credit Suisse: Where There’s Smoke, There’s a Capital Raise

Silver Point

Thomas J. Monaco

Independent Insight Provider

Silver Point is a boutique research firm that focuses on the broader financial services sector, with a particular focus on troubled institutions globally. 

Asia Ex Japan

Equity Bottom-Up

*US Greensill Arm Declares BK: On March 25, 2021, Greensill filed for Chapter 11 bankruptcy protection for its US subsidiary, Greensill Capital Inc. (GCI), in the Southern District of New York. GCI sold Greensill products in the US with revenue passing directly through to the Greensill in London; and*Watch Your Risk: Greensill allegedly has USD 5 bn in risk outstanding to GFG Alliance Group (GFG) – a company owned by Sanjeev Gupta, who appears to be at the center of this entire debacle. Credit Suisse, GAM Holdings (GAM.VX), Tokio Marine Holdings (8766.JP), SoftBank Group (9984.JP) amongst many others are likely to be further impacted given the growing uncertainties of Greensill and GFG Alliance.

*US Greensill Arm Declares BK: On March 25, 2021, Greensill filed for Chapter 11 bankruptcy protection for its US subsidiary, Greensill Capital Inc. (GCI), in the Southern District of New York. GCI sold Greensill products in the US with revenue passing directly through to the Greensill in London; and*Watch Your Risk: Greensill allegedly has USD 5 bn in risk outstanding to GFG Alliance Group (GFG) – a company owned by Sanjeev Gupta, who appears to be at the center of this entire debacle. Credit Suisse, GAM Holdings (GAM.VX), Tokio Marine Holdings (8766.JP), SoftBank Group (9984.JP) amongst many others are likely to be further impacted given the growing uncertainties of Greensill and GFG Alliance. 

*Greensill Tab Begins:Greensill Capital (Greensill) filed for insolvency in the United Kingdom after lawyers for had cited Greensill’s inability to repay a USD 140 mn bridge loan provided by Credit Suisse Group (CSGN.VX) [Credit Suisse]. In particular, the allegations of fraud by Bafin and the British Business Bank removing the British government guarantee on COVID-19 lending highlight the increased likelihood of substantially higher losses and other tail risk; and  *Credit Suisse Taking Steps: The hit parade continues. Credit Suisse has stated that the company’s Board is investigating its own ties with Greensill, replaced its asset management CEO, asset management will be segregated from international wealth management, and employee compensation could be subject to clawback.

*Greensill Tab Begins:Greensill Capital (Greensill) filed for insolvency in the United Kingdom after lawyers for had cited Greensill’s inability to repay a USD 140 mn bridge loan provided by Credit Suisse Group (CSGN.VX) [Credit Suisse]. In particular, the allegations of fraud by Bafin and the British Business Bank removing the British government guarantee on COVID-19 lending highlight the increased likelihood of substantially higher losses and other tail risk; and  *Credit Suisse Taking Steps: The hit parade continues. Credit Suisse has stated that the company’s Board is investigating its own ties with Greensill, replaced its asset management CEO, asset management will be segregated from international wealth management, and employee compensation could be subject to clawback. 

Credit Suisse Group – Greensill Fallout Continues

As the fallout from the Greensill affair continues, <a href="https://www.smartkarma.com/entities/credit-suisse-group-ag-f4b24f0c-c294-40b3-b491-759f0cb277e9" target="_blank" data-smartkarma-citation="entities:27915:1" rel="noopener">Credit Suisse Group (CSGN SW)</a> acknowledged 3 items regarding this situation:First, the Pillar 2 capital buffer requirement may be impacted by the Greensill affair. This may have long lasting negative implications for the valuation of CS contingent capital Tier 1 bonds.Second, certain notes underlying the Supply Chain Finance (SCF) funds will not be repaid when they fall due. The nonpayment creates considerable uncertainty regarding the valuation of a significant part of the remaining US$6.9bn. of assets in the SCF funds.Third, certain investors have already threatened litigation and, CS also stated that it “might also suffer reputational harm associated with these matters that might cause client departures or loss of assets under management.” This is what we warned when the Greensill news broke two weeks ago. Please see <a href="https://www.smartkarma.com/insights/credit-suisse-greensill-sows-reputation-risks-underweight-cs-bonds" target="_blank" data-smartkarma-citation="insights:48839" rel="noopener">Credit Suisse: Greensill Sows Reputation Risks, Underweight CS Bonds</a> for more details. In the intervening time-period, CS equity and credit have materially underperformed their respective indexes.At this point, investors’ main concern should be the amount or level of additional Pillar 2 capital which the firm may need to retain. The is not currently factored into CS’ debt or equity valuations.To its credit, the bank is taking prompt corrective action in restructuring the leadership, transparency, and compensation of the Asset Management division. However, we remain skeptical with whether the worst is past in this affair. Alternative assets require greater oversight as they are harder to manage and value. Combining risk management and compliance functions across CS stills seems like a mistake when it comes to asset management. However, the segmental separation of the Asset Management division may be a first step to unloading the relatively undersized entity. Distancing the unit from the Wealth Management operations may limit client departures.We continue to believe that the pricing of Credit Suisse bonds does not fully reflect the risks, complexity, and low capitalization of the firms’ underlying business model; nor does it capture potential franchise impairment from increasing reputation risk. The recent suspension of redemptions from certain CS funds is at best an embarrassment and at worst a signal that controls remain in need of considerable attention. This is unfortunate, as CS is highly geared to the business cycle and could outperform peers, if it can get its house in order. However, CS’s long-dated Additional Tier 1 bonds already trade tight relative to the challenges facing the firm. Please see: <a href="https://www.smartkarma.com/insights/credit-suisse-perfection-priced-into-long-dated-at1" target="_blank" data-smartkarma-citation="insights:48461" rel="noopener">Credit Suisse – Perfection Priced into Long-Dated AT1</a> for more details.   We suspect that credit may continue to follow equity and underperform over the near term. Longer-term, Pillar 2 considerations suggest that an even lower capital buffer as a cushion for AT1 investors, unless hidden capital is realized, or shareholders receive less in returns. Taken together, we remain comfortable with our recommendation that investors underweight Credit Suisse.

As the fallout from the Greensill affair continues, Credit Suisse Group (CSGN SW) acknowledged 3 items regarding this situation:First, the Pillar 2 capital buffer requirement may be impacted by the Greensill affair. This may have long lasting negative implications for the valuation of CS contingent capital Tier 1 bonds.Second, certain notes underlying the Supply Chain Finance (SCF) funds will not be repaid when they fall due. The nonpayment creates considerable uncertainty regarding the valuation of a significant part of the remaining US$6.9bn. of assets in the SCF funds.Third, certain investors have already threatened litigation and, CS also stated that it “might also suffer reputational harm associated with these matters that might cause client departures or loss of assets under management.” This is what we warned when the Greensill news broke two weeks ago. Please see Credit Suisse: Greensill Sows Reputation Risks, Underweight CS Bonds for more details. In the intervening time-period, CS equity and credit have materially underperformed their respective indexes.At this point, investors’ main concern should be the amount or level of additional Pillar 2 capital which the firm may need to retain. The is not currently factored into CS’ debt or equity valuations.To its credit, the bank is taking prompt corrective action in restructuring the leadership, transparency, and compensation of the Asset Management division. However, we remain skeptical with whether the worst is past in this affair. Alternative assets require greater oversight as they are harder to manage and value. Combining risk management and compliance functions across CS stills seems like a mistake when it comes to asset management. However, the segmental separation of the Asset Management division may be a first step to unloading the relatively undersized entity. Distancing the unit from the Wealth Management operations may limit client departures.We continue to believe that the pricing of Credit Suisse bonds does not fully reflect the risks, complexity, and low capitalization of the firms’ underlying business model; nor does it capture potential franchise impairment from increasing reputation risk. The recent suspension of redemptions from certain CS funds is at best an embarrassment and at worst a signal that controls remain in need of considerable attention. This is unfortunate, as CS is highly geared to the business cycle and could outperform peers, if it can get its house in order. However, CS’s long-dated Additional Tier 1 bonds already trade tight relative to the challenges facing the firm. Please see: Credit Suisse – Perfection Priced into Long-Dated AT1 for more details.   We suspect that credit may continue to follow equity and underperform over the near term. Longer-term, Pillar 2 considerations suggest that an even lower capital buffer as a cushion for AT1 investors, unless hidden capital is realized, or shareholders receive less in returns. Taken together, we remain comfortable with our recommendation that investors underweight Credit Suisse. 

Credit Suisse: Greensill's Capital Implications Outweigh Asset Management Corrective Action

Stronger than expected US employment data combined with uncertainty surrounding the Fed’s next steps to drive broader credit markets wider by weekend, although financials remained better bid. Taperless tantrums may be repeated over the near term but financials may be less impacted.While US CCC-rated bonds and Asia High Yield sold-off, almost all European contingent capital and Asia High Yield bonds tightened in credit spread terms as investors remained anchored to banks as an economic recovery play. Investors grabbed longer duration Additional Tier 1 (AT1) bonds as the week progressed, on economic strength expectations, while lower duration Senior Unsecured bonds outperformed on rising interest rate expectations. Friday’s non-farm report generated concerns on European growth in a rising rate environment. Queue central bank assurances that they will respond to rising rates over the next few weeks.Despite higher spreads available in more moderate duration AT1 notes, Europe's outperformers were almost exclusively long duration bonds. This outperformance is a very bullish signal. However, we are not convinced that this should apply to each of these institutions.  Please see <a href="https://www.smartkarma.com/insights/credit-suisse-greensill-sows-reputation-risks-underweight-cs-bonds" target="_blank" data-smartkarma-citation="insights:48839" rel="noopener">Credit Suisse: Greensill Sows Reputation Risks, Underweight CS Bonds</a> for further details.Financials remain the sweet spot in Asia credit. Levered to the economy and rising rates, this is the place to be at this point in the market cycle.  Performance attributes varied amongst the various bank credit classes in Asia. Risk-on sentiment drove higher risk AT1 and less subordinated Tier 2 bonds tighter. Meanwhile duration concerns drove investors to target higher spreads per unit of duration in BBB-rated and High Yield Senior Unsecured notes. Taken together, this performance outcome is likely evidence of the melt-up in spreads that we anticipated several weeks ago. Please see <a href="https://www.smartkarma.com/insights/bank-credit-strategy-melt-up-before-meltdown-where-to-position" target="_blank" data-smartkarma-citation="insights:48133" rel="noopener">Bank Credit Strategy: Melt-Up Before Meltdown, Where to Position</a> for more details.Admittedly, however, we are surprised by the credit strength of Asia-headquartered financials during the global rates rout. We attribute this to two items. First, China is further along the Covid-19 curve in recovery and will clearly benefit as the rest of the world catches-up. Second, financials are a leverage play on the global recovery. Taken together, Asia financials overall are well placed to continue outperforming other markets over the near term.Market Outlook: The Fed will likely Twist before it Tapers, but the timing of both remain uncertain as real long term interest rates remain negative. In the interim, global treasury markets may remain unsettled. The US economy may run very hot before we see a change in Fed policy regarding short-term interest rates and the US dollar should remain stronger than analysts forecasted at year-end. Broadly, this is not Emerging Market IEM) friendly; however, a strong US economic rebound should benefit EM and European financials. Short duration in investment grade financials combined with high credit spreads in High Yield financials and more subordinated debt may remain the way forward.

Stronger than expected US employment data combined with uncertainty surrounding the Fed’s next steps to drive broader credit markets wider by weekend, although financials remained better bid. Taperless tantrums may be repeated over the near term but financials may be less impacted.While US CCC-rated bonds and Asia High Yield sold-off, almost all European contingent capital and Asia High Yield bonds tightened in credit spread terms as investors remained anchored to banks as an economic recovery play. Investors grabbed longer duration Additional Tier 1 (AT1) bonds as the week progressed, on economic strength expectations, while lower duration Senior Unsecured bonds outperformed on rising interest rate expectations. Friday’s non-farm report generated concerns on European growth in a rising rate environment. Queue central bank assurances that they will respond to rising rates over the next few weeks.Despite higher spreads available in more moderate duration AT1 notes, Europe's outperformers were almost exclusively long duration bonds. This outperformance is a very bullish signal. However, we are not convinced that this should apply to each of these institutions.  Please see Credit Suisse: Greensill Sows Reputation Risks, Underweight CS Bonds for further details.Financials remain the sweet spot in Asia credit. Levered to the economy and rising rates, this is the place to be at this point in the market cycle.  Performance attributes varied amongst the various bank credit classes in Asia. Risk-on sentiment drove higher risk AT1 and less subordinated Tier 2 bonds tighter. Meanwhile duration concerns drove investors to target higher spreads per unit of duration in BBB-rated and High Yield Senior Unsecured notes. Taken together, this performance outcome is likely evidence of the melt-up in spreads that we anticipated several weeks ago. Please see Bank Credit Strategy: Melt-Up Before Meltdown, Where to Position for more details.Admittedly, however, we are surprised by the credit strength of Asia-headquartered financials during the global rates rout. We attribute this to two items. First, China is further along the Covid-19 curve in recovery and will clearly benefit as the rest of the world catches-up. Second, financials are a leverage play on the global recovery. Taken together, Asia financials overall are well placed to continue outperforming other markets over the near term.Market Outlook: The Fed will likely Twist before it Tapers, but the timing of both remain uncertain as real long term interest rates remain negative. In the interim, global treasury markets may remain unsettled. The US economy may run very hot before we see a change in Fed policy regarding short-term interest rates and the US dollar should remain stronger than analysts forecasted at year-end. Broadly, this is not Emerging Market IEM) friendly; however, a strong US economic rebound should benefit EM and European financials. Short duration in investment grade financials combined with high credit spreads in High Yield financials and more subordinated debt may remain the way forward.

Bank Credit Weekly: One Size Does Not Fit All

Switzerland

UBS Group AG provides financial services to private, corporate and institutional clients. The Company offers investment banking, retail banking, corporate and institutional banking, as well as holistic wealth management planning and asset management services. UBS also offers securities services such as fund administration and third-party fund management.

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UBS Group AG (UBSG VX)

Credit Suisse: Where There’s Smoke, There’s a Capital Raise

CS needs as much as CHF8bn in common equity to bring its capital buffer in-line with peers. The Archegos affair adds fuel to risk management and...

Hank Calenti, CFA

Credit Suisse – Another Shoe Drops

CREDIT SUISSE GROUP: Greensill has filed for Chapter 11 bankruptcy protection for its US subsidiary in New York. The subsidiary sold Greensill...

Thomas J. Monaco

Credit Suisse Group – Greensill Fallout Continues

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Thomas J. Monaco

Credit Suisse: Greensill's Capital Implications Outweigh Asset Management Corrective Action

Additional Pillar 2 capital requirements are not currently factored into valuations. CS bonds do not reflect the risks, complexity, and low...

Hank Calenti, CFA

Bank Credit Weekly: One Size Does Not Fit All

Performance attributes varied amongst bank credit classes. Short duration in IG financials combined with high credit spreads in HY and more...

Hank Calenti, CFA

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