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Credit Suisse in debit balance – will this make the US banking crisis worse?

Stocks, US

Written by:

Alex Yeo

The week has been eventful. Since our post at the start of the week analyzing whether you should sell your US banks, much has happened in this short time.

Regulators have taken control of two banks, Silicon Valley Bank (NASDAQ: SIVB) and Signature Bank (NASDAQ: SBNY).

The banking crisis has become worse with credit rating agencies cutting the outlook for the US banking system and for certain individual banks, particularly those with large uninsured deposits and long-term Treasury bonds that have decreased in value significantly.

Credit Suisse’s issues surfaced alongside the troubled US banks as Credit Suisse has seen significant depositors outflow since 2022.

Here we provide an update on the latest situation and analyse the impact of Credit Suisse on the US banking crisis.

What happened to Credit Suisse?

Credit Suisse has been in crisis, running into new controversies again and again.

Recently the bank acknowledged that there were material weaknesses in its financial reporting for its 2022 and 2021, only after being queried by the US SEC.

A little while ago, Credit Suisse was linked with the fallout of the hedge fund. The bank lost $5.5 billion when Archegos defaulted in March 2021.

There were also revelations that its clients were involve in corruption, torture, trafficking and other serious crimes.

A key executive of Credit Suisse even admitted to spying on another key management over concerns of client poaching.

As a result, the bank has continuously faced outflows of funds, exodus of staff and one of its key shareholder, the Saudi National Bank has ruled out further capital injection into the Credit Suisse.

Thankfully, the Swiss National Bank (SNB) came out in support, lending more than 50 billion Swiss Francs (US$54 billion) to Credit Suisse.

Credit Suisse in Charts

1) Share price

As shown in the chart above, the share price has been slaughtered. Although the stock went up 20% after the announcement of the 50 billion swiss franc loan by the SNB, the stock is down nearly 90% in 5 years.

2) Credit default swaps

Credit default swaps are purchased as a form of insurance. The Buyer pays a certain percentage and if the bank defaults, the seller will cover the capital loss.

As shown in the chart above, in less than 4 days, the cost of CDS for Credit Suisse for the various bond tenures increased substantially. The 1 year bond increased from 3.6% on 10 March to 8.4% on 14March and spiked to nearly 10% on 15 March.

This implies that the risk of Credit Suisse defaulting has spiked significantly.

How does this affect the US banking crisis?

A collapse of a small bank poses a severe risk while the collapse of a globally systemically important bank is catastrophic.

As Credit Suisse is a “Global systemically important bank” (GSIB), the bank is deemed as “too big to fail”. There is a risk that if Credit Suisse fails, the effect on the world economy and the global banking system would be catastrophic.

When there is a GSIB that is seemingly tethering on the verge of failure and waiting for bailouts, every single investor sits up and notice.

Many of these investors would act by deleveraging, reducing exposure to risky positions. This could lead to forced sales or fire sales of assets at prices which are lower than usual market conditions.

Will the US banking crisis get worse?

We think it is still unravelling and the US banking crisis will get worse before it gets better. The two reasons are high interest rates and loss of confidence.

1) High interest rates

We are still in a rate hike cycle.

Higher interest rates will lower the value of existing bonds even more.

US interest rates are currently at 4.5% and the Fed seemed poised to hike to as high as 6% to combat inflation. However, this is all uncertain now.

If the Fed does continue on their path of rate hike, this will lead to more unrealized losses for the existing portfolio of many banks and may trigger another loss of confidence.

2) What does loss of confidence imply?

Loss of confidence may lead to panic and another bank run.

The reality is that there are many mini bank runs now.

Many smaller banks have seen significant outflows while larger banks or GSIBs have seen inflows from depositors seeking safety.

JPMorgan (NYSE: JPM) Citigroup (NYSE: C) and Bank of America (NYSE: BAC) have both received substantial inflows of depositors with Bank of America reporting an inflow of at least US$10 billion this week alone.

Closing statements

We are currently in very uncertain times.

Although the way every crisis unfurls is different, there are many similarities.

In 2008 there were special mortgage bonds which were actually subprime but packaged as investment grade investments. Lehman Brothers had a large portion of its balance sheet on these risky subprime assets.

Now the US government bonds are the toxic assets. Silicon Valley Bank(SVB) had a large portion of their assets in the government bonds. This is a really extraordinary situation.

Although the situation is likely to get worse before it gets better, one should not assume the worst case scenario. In fact, the regulators have been swift to act, putting SVB into their control and finding solutions very quickly.

The Fed is also looking at implementing stricter regulations for smaller sized banks, although this may be too little too late.

We earlier opined that the larger financial institutions would benefit and as of now these GSIBs have seen massive influx of funds from depositors seeking safety. Hence, these GSIBs are now even more resilient with the additional cash in their kitty.

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