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Credit Suisse: Greensill Sows Reputation Risks, Underweight CS Bonds

Gravity Works As WeWork Doesn't; Now Plan B

Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

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