The Bank Run Cometh
Equations have two-sides, and solutions involve balance. Perhaps there is no country greater known for keeping a balance than Switzerland. In fact, Switzerland has maintained it's strength through several "world orders" by maintaining balance on the financial equation - not by keeping balanced finances, but by serving both sides. It is common history that Switzerland's Bank for International Settlements (BIS) serviced Nazi Germany's economy, granting them the financial fortitude to carry a war against the world. Switzerland has long stood by an ethos of "a world that banks together, stays together", sheltering it's institutions against countless historical attempts to engrain ethics or be held accountable for the downstream effects of those they help. Tangential to every step of Credit Suisse's story, and this analyst's interpretation, has been the approval and motions of the SNB. Pre-COVID, SNB requested CS to strengthen it's balance sheet. Failing this direction, SNB next pushed CS to merge with an ally to rebuild the international banking arm to preserve Swiss interests. On the back of those proclamations: Greensill, Archegos, Russian Oligarchical financing, #SuisseSecrets, CET1 requirements breach, a recent bank run, and... more?
Credit Suisse revealed their most recent restructuring plan on October 27th, 2022 headlining with Cost and Staff cuts, a $4 billion capital raise via equity dilution, and a nascent restart of the First Boston Investment Bank. All this will bring on a new investor with just under 10% ownership of the Swiss bank - the Saudi National Bank (SaNB). Switzerland has been integral to the history of the world since it's birth in 1291, playing critical roles long before the Americas were discovered by a European power, long before the notion of the Petrodollar and Bretton Woods. Now, as sovereign rivalries reshape the global economy, centered on the United States-Saudi leaders mutual hostility, Switzerland finds itself in a uniquely-Swiss position. There is a historical platitude for making UBS the Western bank, CS the Eastern. Switzerland would maintain their position as the neutral facilitator of global financial matters, eschewing notions of ethics for a platform of stability. While many governments might be quick to take sides for diplomatic favours and intranational positioning, Switzerland alone can service the inelastic needs for all sides to maintain a balance, maintaining the equation for global growth and unity.
But can Credit Suisse maintain a balance without losing more legs? Taking on a Middle Eastern sovereign as a major shareholder is a repeat of CS's GFC restructuring, a plan that saw Qatar taking massive stakes in convertible bonds leading to equity dilutions. However, the GFC-periods rise in oil prices was far from political-endeavors for national profits; a hyperinflationary risk environment led to hyperinflationary asset appreciation across the board, oil as well. The current rise in oil prices is a direct confrontation between US and OPEC leaders - specifically Saudi Arabia (minus the chaos from Putin's moronic war*). The ability for a single organization to maintain bridges between Western and Middle Eastern financial interests might be difficult, but separating them between two arms of the same sovereign state might provide cover. Which makes the First Boston move the oddity of the plan - perhaps even the impossibility. Renaming the investment branch as a new investment bank is one way to obscure losses, but First Boston has a ring to it that assumes Western positioning, positioning that will involve Saudi money. First Boston is to be Headquartered in NYC. With recent moves by the US government to limit and block Chinese investments in specific technological sectors, the question of moves against Saudi interests is not a silent one. Especially with NOPEC, the No Oil Producing and Exporting Cartels Act, a bill making it's way through the US senate that would allow charges to be brought into US courts against OPEC nations. Blurring the lines of whose money goes where is one thing, doing it in an environment of direct financial confrontation is requiring more finesse than an organization that just recently announced it had a bank run might be capable of.
Enter the bank run. Last week Credit Suisse announced investor withdrawals pushing below their minimum CET1 requirement, a simple metric to prevent banks from taking on too much leverage compared to liquid and valuable assets. Credit Suisse has one of the higher minimums at 11.4%, but CET1 is hardly the metric of stability to be called on. The actual requirements of Capital Equity Tier 1 is loose; Capital Equity Tier 1 includes volatile equity holdings and swaps that are not guaranteed or protected by any sovereign. Q3 2021, Credit Suisse sat at 14.4% CET1, Q2 2022 was 13.5%, and Q3 2022 was 12.6%. Which means in early October, as Credit Default Swaps moved to GFC#1 highs and equity to lows, major investors withdrew at least ~$2 billion dollars. Credit Suisse claims that they did not need SNB-aid, but someone in Switzerland activated Federal Reserve dollar swaps to a tune of $10-11 billion through the SNB. UBS released a report saying it could have been an arbitrage opportunity, as the Federal Reserve's interest rate is ~.25%, and SNB is giving .45% interest for dollar liquidity - an arbitrage opportunity specifically designed to exist to give financial institutions deniability and liabilities - or rather assets (banks sure do like to flip the names). Bank runs are considered old, maybe even ancient. Fall of 2021 led to some "bank run" behaviours in China when the collapse of Evergrande reverberated across financial institutions and many citizens attempted withdrawals. The pictures and videos were clear as long lines of customers stood outside of their bank, and more stood outside the offices of their favoured real estate investment vehicle company. One of the biggest arguments against a financial crash and bank run in 2022, is that this couldn't happen in 2022 - banks would be able to give endless amounts of capital to customers to move to other banks and just write them off as liabilities and take a loan from their courterparts - an act that is playing out similarly to Credit Suisse as just about every major bank in the world is filling in their accounts with loans. When the BIS added CET1 requirements post-GFC, the ideaology was that it forced banks to control risk-on behaviour and limit leverage, preventing even the possibility of bank runs. But if there was anything positive from the recent Senate oversight committee on the banks, it was that JP Morgan et al are quite worried about these CET1 requirements. The idea was sound, the regulations too loose, and now the tool to prevent is looking like the tool to affect. Depending on how much investors did withdraw, as Credit Suisse was only ~$1.5 billion from their threshold as of latest quarterly reports, another bank run could happen as investors digest a restructuring plan promising weak profits 3 years in the future against a backdrop of continued legal troubles, major geopolitical contentions, and whatever stupid risky loans Credit Suisse has made that hasn't collapsed yet. Because yet is coming.
And then there was the restructuring plan. Credit Suisse will tap Apollo and friends to handle the Securitized Product arm, rename the Investment Bank arm, and try desperately to hold onto wealth management while reducing "non-core businesses". Apollo and friends will control business operations of the securitized product arm and feed these assets back into the Wealth management and Investment Banking arms of Credit Suisse, the same Securitized product arm that securitized Russian oligarch's yachts, faxed the paperwork to all their rich clientele to woo investors, subpoenaed for information and details on said paperwork, and then asked their clientele to destroy all paperwork. The idea is that this isn't going to end, but Credit Suisse will have maximum plausible deniability as they no longer "know" the details of securitized products, just interest and fees. The Non-Core Unit they are winding down? It is leveraged 132x, makes up Residual Prime lending, European Investment bank lending, Emerging Markets lending, and presence in selected countries**. The billions of dollars Credit Suisse has of CET1 is ubiquitous across the Bank, these are the same billions of dollars needed to maintain Leverage ratios of 168X in Wealth Management, 241x in the core Swiss Bank, 3x in Asset Management, 184x in Investment Bank, 32x in Corporate Center, 85x in Securitized Products, and 132x in the Non-core unit. This means that Credit Suisse has to completely restructure and shed massive capital arms without taking on major losses, again. All of this just to squeeze out sub-10% return on tangible equity (the most intangible returns possible), meanwhile almost every banking competitor is above that now and without as massive losses coming into this quarter.
This analyst's fascination with Credit Suisse is mechanical. How does a bank run happen in modern financial infrastructure with modern financial regulations? How does it start? How does it end? How does it spread? Bank runs are an unhealthy event, but part of a healthy cycle of degradative turnover. In the human body, old and dead cells are continuously removed so that new and healthier cells can take their place. Credit Suisse failed their basic role of creating healthy and stable economic growth, they failed their basic role of making money, and they failed their basic role of assuming safe risk. Archegos and Greensill were multi-billion dollar loans with limited possible profits, but extremely outsized risks. Even if Credit Suisse didn’t know what Archegos was buying (which would be impossible since they were a prime brokerage and thus the point of contact), loaning tens of billions of dollars for Public Equity market portfolios on derivative holdings is… dumb. Greensill's business worked by premonition; Greensill would loan massive amounts of money to specific businesses in their sector on the assumption business would grow and they would make *billions* in interest fees. All of this with Greensill booking and billing companies that it never interacted with, and never formed contracts. It shouldn't take too competent a risk management team to dissect these business plans and point out the stupid, but Credit Suisse's were not up to the task. Similar to investors leaving CS, major employees are too. Part of this is good, some of these high up employees failed their basic roles and responsibilities, so watching them move to their competitors is an oddity. But now CS is expected to restructure while maintaining, continuing to find and invest in profitable wealth and investment vehicles, without any of their staff. Staff who are also being fired to the tune of 9000 bankers this year.
Still, banks can’t just fail. Banks are connected to each other directly and indirectly, through third party counter-risk groups. Credit Suisse makes a loan to company X for $5 billion over 10 years. Credit Suisse goes to counter-risk party A to hedge this loan, i.e. if X fails to pay, A pays out. It doesn't cover everything, but on paper it changes a $5 billion liability into a neutral bet, books are even-weighted and no one is concerned. Counter-risk party A plays counter-risk to several banks on many loans. The recent work by Ellul and Kim on "Counterparty Choice, Bank Interconnectedness, and Bank Risk-Taking" published by the Office of Financial Research using confidential risk agreements by US banks illustrates this perfectly***. In fact, their work illustrates that banks aren't just more likely to use the same counterparties for risk, but they are also selling Credit Default Swaps on these counterparties, almost as if they are sure they will fail. Which means they are completely unhedged. Either Credit Suisse survives, or more will fall.
*Putin's moronic war - this author feels comfortable with this description, as Russia, the sovereign country, is much less so. Sure, Putin drove a massive rise in energy prices that benefitted Russia's energy exports, but led to a destruction in international wealth, value, and respect that will take decades to recover from. Furthermore, Russia has seen so much loss in combat personnel that it will take generations to recover. Yes, he has slaughtered thousands and thousands of Ukrainian citizens and soldiers, raised hell in Western markets and economies, but has brought more pain upon his own nation than any other - making this a stupid and moronic war.
**TBD, likely to grow to… all.
*** financialresearch.gov/working-papers/2022/09/22/counterparty-choice-bank-interconnectedness-and-bank-risk-taking/ READ THIS! Using confidential information given to federal regulators, Ellul and Kim perfectly show how banks have engaged in the riskiest behaviours by selling default debt on their counterparties and by overloading the same counterparties. If bad loans default, the hedging banks do will be negated.
Selected References
credit-suisse.com/media/assets/corporate/docs/about-us/media/media-release/2022/10/strategy-update-press-release-en.pdf
finews.com/news/english-news/54008-credit-suisse-silence-of-the-swiss
congress.gov/bill/117th-congress/senate-bill/977
financialresearch.gov/working-papers/2022/09/22/counterparty-choice-bank-interconnectedness-and-bank-risk-taking/
Credit Suisse revealed their most recent restructuring plan on October 27th, 2022 headlining with Cost and Staff cuts, a $4 billion capital raise via equity dilution, and a nascent restart of the First Boston Investment Bank. All this will bring on a new investor with just under 10% ownership of the Swiss bank - the Saudi National Bank (SaNB). Switzerland has been integral to the history of the world since it's birth in 1291, playing critical roles long before the Americas were discovered by a European power, long before the notion of the Petrodollar and Bretton Woods. Now, as sovereign rivalries reshape the global economy, centered on the United States-Saudi leaders mutual hostility, Switzerland finds itself in a uniquely-Swiss position. There is a historical platitude for making UBS the Western bank, CS the Eastern. Switzerland would maintain their position as the neutral facilitator of global financial matters, eschewing notions of ethics for a platform of stability. While many governments might be quick to take sides for diplomatic favours and intranational positioning, Switzerland alone can service the inelastic needs for all sides to maintain a balance, maintaining the equation for global growth and unity.
But can Credit Suisse maintain a balance without losing more legs? Taking on a Middle Eastern sovereign as a major shareholder is a repeat of CS's GFC restructuring, a plan that saw Qatar taking massive stakes in convertible bonds leading to equity dilutions. However, the GFC-periods rise in oil prices was far from political-endeavors for national profits; a hyperinflationary risk environment led to hyperinflationary asset appreciation across the board, oil as well. The current rise in oil prices is a direct confrontation between US and OPEC leaders - specifically Saudi Arabia (minus the chaos from Putin's moronic war*). The ability for a single organization to maintain bridges between Western and Middle Eastern financial interests might be difficult, but separating them between two arms of the same sovereign state might provide cover. Which makes the First Boston move the oddity of the plan - perhaps even the impossibility. Renaming the investment branch as a new investment bank is one way to obscure losses, but First Boston has a ring to it that assumes Western positioning, positioning that will involve Saudi money. First Boston is to be Headquartered in NYC. With recent moves by the US government to limit and block Chinese investments in specific technological sectors, the question of moves against Saudi interests is not a silent one. Especially with NOPEC, the No Oil Producing and Exporting Cartels Act, a bill making it's way through the US senate that would allow charges to be brought into US courts against OPEC nations. Blurring the lines of whose money goes where is one thing, doing it in an environment of direct financial confrontation is requiring more finesse than an organization that just recently announced it had a bank run might be capable of.
Enter the bank run. Last week Credit Suisse announced investor withdrawals pushing below their minimum CET1 requirement, a simple metric to prevent banks from taking on too much leverage compared to liquid and valuable assets. Credit Suisse has one of the higher minimums at 11.4%, but CET1 is hardly the metric of stability to be called on. The actual requirements of Capital Equity Tier 1 is loose; Capital Equity Tier 1 includes volatile equity holdings and swaps that are not guaranteed or protected by any sovereign. Q3 2021, Credit Suisse sat at 14.4% CET1, Q2 2022 was 13.5%, and Q3 2022 was 12.6%. Which means in early October, as Credit Default Swaps moved to GFC#1 highs and equity to lows, major investors withdrew at least ~$2 billion dollars. Credit Suisse claims that they did not need SNB-aid, but someone in Switzerland activated Federal Reserve dollar swaps to a tune of $10-11 billion through the SNB. UBS released a report saying it could have been an arbitrage opportunity, as the Federal Reserve's interest rate is ~.25%, and SNB is giving .45% interest for dollar liquidity - an arbitrage opportunity specifically designed to exist to give financial institutions deniability and liabilities - or rather assets (banks sure do like to flip the names). Bank runs are considered old, maybe even ancient. Fall of 2021 led to some "bank run" behaviours in China when the collapse of Evergrande reverberated across financial institutions and many citizens attempted withdrawals. The pictures and videos were clear as long lines of customers stood outside of their bank, and more stood outside the offices of their favoured real estate investment vehicle company. One of the biggest arguments against a financial crash and bank run in 2022, is that this couldn't happen in 2022 - banks would be able to give endless amounts of capital to customers to move to other banks and just write them off as liabilities and take a loan from their courterparts - an act that is playing out similarly to Credit Suisse as just about every major bank in the world is filling in their accounts with loans. When the BIS added CET1 requirements post-GFC, the ideaology was that it forced banks to control risk-on behaviour and limit leverage, preventing even the possibility of bank runs. But if there was anything positive from the recent Senate oversight committee on the banks, it was that JP Morgan et al are quite worried about these CET1 requirements. The idea was sound, the regulations too loose, and now the tool to prevent is looking like the tool to affect. Depending on how much investors did withdraw, as Credit Suisse was only ~$1.5 billion from their threshold as of latest quarterly reports, another bank run could happen as investors digest a restructuring plan promising weak profits 3 years in the future against a backdrop of continued legal troubles, major geopolitical contentions, and whatever stupid risky loans Credit Suisse has made that hasn't collapsed yet. Because yet is coming.
And then there was the restructuring plan. Credit Suisse will tap Apollo and friends to handle the Securitized Product arm, rename the Investment Bank arm, and try desperately to hold onto wealth management while reducing "non-core businesses". Apollo and friends will control business operations of the securitized product arm and feed these assets back into the Wealth management and Investment Banking arms of Credit Suisse, the same Securitized product arm that securitized Russian oligarch's yachts, faxed the paperwork to all their rich clientele to woo investors, subpoenaed for information and details on said paperwork, and then asked their clientele to destroy all paperwork. The idea is that this isn't going to end, but Credit Suisse will have maximum plausible deniability as they no longer "know" the details of securitized products, just interest and fees. The Non-Core Unit they are winding down? It is leveraged 132x, makes up Residual Prime lending, European Investment bank lending, Emerging Markets lending, and presence in selected countries**. The billions of dollars Credit Suisse has of CET1 is ubiquitous across the Bank, these are the same billions of dollars needed to maintain Leverage ratios of 168X in Wealth Management, 241x in the core Swiss Bank, 3x in Asset Management, 184x in Investment Bank, 32x in Corporate Center, 85x in Securitized Products, and 132x in the Non-core unit. This means that Credit Suisse has to completely restructure and shed massive capital arms without taking on major losses, again. All of this just to squeeze out sub-10% return on tangible equity (the most intangible returns possible), meanwhile almost every banking competitor is above that now and without as massive losses coming into this quarter.
This analyst's fascination with Credit Suisse is mechanical. How does a bank run happen in modern financial infrastructure with modern financial regulations? How does it start? How does it end? How does it spread? Bank runs are an unhealthy event, but part of a healthy cycle of degradative turnover. In the human body, old and dead cells are continuously removed so that new and healthier cells can take their place. Credit Suisse failed their basic role of creating healthy and stable economic growth, they failed their basic role of making money, and they failed their basic role of assuming safe risk. Archegos and Greensill were multi-billion dollar loans with limited possible profits, but extremely outsized risks. Even if Credit Suisse didn’t know what Archegos was buying (which would be impossible since they were a prime brokerage and thus the point of contact), loaning tens of billions of dollars for Public Equity market portfolios on derivative holdings is… dumb. Greensill's business worked by premonition; Greensill would loan massive amounts of money to specific businesses in their sector on the assumption business would grow and they would make *billions* in interest fees. All of this with Greensill booking and billing companies that it never interacted with, and never formed contracts. It shouldn't take too competent a risk management team to dissect these business plans and point out the stupid, but Credit Suisse's were not up to the task. Similar to investors leaving CS, major employees are too. Part of this is good, some of these high up employees failed their basic roles and responsibilities, so watching them move to their competitors is an oddity. But now CS is expected to restructure while maintaining, continuing to find and invest in profitable wealth and investment vehicles, without any of their staff. Staff who are also being fired to the tune of 9000 bankers this year.
Still, banks can’t just fail. Banks are connected to each other directly and indirectly, through third party counter-risk groups. Credit Suisse makes a loan to company X for $5 billion over 10 years. Credit Suisse goes to counter-risk party A to hedge this loan, i.e. if X fails to pay, A pays out. It doesn't cover everything, but on paper it changes a $5 billion liability into a neutral bet, books are even-weighted and no one is concerned. Counter-risk party A plays counter-risk to several banks on many loans. The recent work by Ellul and Kim on "Counterparty Choice, Bank Interconnectedness, and Bank Risk-Taking" published by the Office of Financial Research using confidential risk agreements by US banks illustrates this perfectly***. In fact, their work illustrates that banks aren't just more likely to use the same counterparties for risk, but they are also selling Credit Default Swaps on these counterparties, almost as if they are sure they will fail. Which means they are completely unhedged. Either Credit Suisse survives, or more will fall.
*Putin's moronic war - this author feels comfortable with this description, as Russia, the sovereign country, is much less so. Sure, Putin drove a massive rise in energy prices that benefitted Russia's energy exports, but led to a destruction in international wealth, value, and respect that will take decades to recover from. Furthermore, Russia has seen so much loss in combat personnel that it will take generations to recover. Yes, he has slaughtered thousands and thousands of Ukrainian citizens and soldiers, raised hell in Western markets and economies, but has brought more pain upon his own nation than any other - making this a stupid and moronic war.
**TBD, likely to grow to… all.
*** financialresearch.gov/working-papers/2022/09/22/counterparty-choice-bank-interconnectedness-and-bank-risk-taking/ READ THIS! Using confidential information given to federal regulators, Ellul and Kim perfectly show how banks have engaged in the riskiest behaviours by selling default debt on their counterparties and by overloading the same counterparties. If bad loans default, the hedging banks do will be negated.
Selected References
credit-suisse.com/media/assets/corporate/docs/about-us/media/media-release/2022/10/strategy-update-press-release-en.pdf
finews.com/news/english-news/54008-credit-suisse-silence-of-the-swiss
congress.gov/bill/117th-congress/senate-bill/977
financialresearch.gov/working-papers/2022/09/22/counterparty-choice-bank-interconnectedness-and-bank-risk-taking/
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