Everyone is talking about a potential default concerning Credit Suisse (NYSE:CS), eliciting memories of Lehman Brothers’ collapse in 2008.
CEO Ulrich Koerner sought to quench these fears, stating in a memo that Credit Suisse had ample liquidity and capital:
I know it’s not easy to remain focused amid the many stories you read in the media – in particular, given the many factually inaccurate statements being made. That said, I trust that you are not confusing our day-to-day stock price performance with the strong capital base and liquidity position of the bank.
The memo has somewhat calmed investors’ nerves, as shares closed in the green for the day. On Oct. 27, the bank will share new transformation plans that will seek to create sustainable, long-term success.
So, why is everyone worried about Credit Suisse? Front and center are the bank’s credit default swaps (CDS). CDS are basically a derivative hedge against financial risks, such as bankruptcy. As the name suggests, credit risk is swapped with another investor. That investor agrees to reimburse payments if the issuer defaults in exchange for a premium. Today, Credit Suisse’s one-year CDS reached an all-time high, while its CDS curve inverted.
Is Credit Suisse Going to Collapse?
Earlier today, one-year CDS reached 500 basis points (bps), while the five-year hit just over 300 bps. This implies a 23% chance that the bank would default on its bonds during the next five years. In addition, the bank is still reeling from a $5.1 billion loss last year as a result of the awry trades of Archegos Capital Management. To alleviate going concern risks, Credit Suisse will likely sell out of some of its businesses, such as wealth management and asset management.
Meanwhile, Credit Suisse still has over $100 billion in buffer capital. Like Goldman Sachs (NYSE:GS) and JP Morgan (NYSE:JPM), the bank is considered to be a global systemically important bank (G-SIB), which means that a default would likely have global spillover effects. However, as a G-SIB and one of the largest banks in Switzerland, it is also likely to receive government support and funding in the actual event of a default.
Citi Analysts Chime in on Credit Suisse
Investment bank Citi believes that the Swiss bank will probably not carry over spillover effects in the event of a default. While not explicitly named, Citi analysts noted that “a large European bank” would likely not have contagion spillover effects. Citi also explained that today’s macroeconomic situation is very different from the situation in 2007 and 2008, as banks’ balance sheets are “fundamentally different in terms of capital and liquidity.” On top of that, the analysts also stated that CS stock is a buy for those willing to stomach negative headlines and execution risks.
This isn’t the first time that a bank’s CDS have soared. Boaz Weinstein of Saba Capital Management pointed out that Morgan Stanley’s (NYSE:MS) CDS spread was twice as wide between 2011 and 2012. Since 2012, MS stock has returned over 300%.
On the date of publication, Eddie Pan did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.