Credit Suisse: A Falling Knife

The Swiss bank looks cheap, but looks can be deceiving

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Mar 15, 2023
Summary
  • The banking sector came into the spotlight last week with the collapse of SVB Financial Group.
  • Credit Suisse's stock has plunged to a record low amid the scrutiny on the banking sector.
  • Although Credit Suisse might look like a bargain today, investors need to dig deeper.
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The banking sector came into the spotlight last week with the collapse of SVB Financial Group (

SIVB, Financial). Things did not get any better from there, with Signature Bank (SBNY, Financial) caving in amid a run on the bank, with customers withdrawing more than $10 billion in deposits last Friday, marking the third-largest bank failure in U.S. history.

Many leading bank stocks came under pressure due to these adverse developments, presenting an opportunity for value investors to double down on their investments with strong liquidity. Credit Suisse Group AG's (

CS, Financial) stock plunged to a record low on March 15 amid the negativity surrounding the banking sector, and the bank is now valued at less than half of its last 12 months' revenue. Although Credit Suisse might look like a bargain today, investors need to dig deeper to understand whether or not it can make a strong comeback.

Questionable risk management strategy

The recent downfall has renewed investor fears of an industry-wide collapse similar to what was seen during the global financial crisis almost 15 years ago. With investors wanting to avoid value traps in the financial services sector, the focus seems to be on the liquidity profile of banks. Although it is necessary for a bank to be well liquidated, investors should not jump on board just because a bank meets the minimum liquidity criteria set by the Federal Reserve or any other banking regulator around the world. It is imperative for an investor to evaluate the effectiveness of the risk management strategy used by a bank. Credit Suisse, unfortunately, does not have a strong track record on this front.

When Archegos Capital Management defaulted on margin calls from several investment banks, Credit Suisse lost a staggering $5.5 billion in 2021. While many other investment banks were quick to liquidate the collateral kept by Archegos, Credit Suisse took little to no action, leading to such massive losses. The bank’s risk evaluation and mitigation strategies received backlash at that time, prompting it to consider a major reorganization of the business, including a complete overhaul of the company culture.

The Archegos Capital saga was not the only recent instance in which Credit Suisse’s risk management failures were brought to light. Just before the Archegos Capital debacle in 2021, Greensill Capital defaulted on supply chain finance repayments, forcing the bank to book a loss of approximately $1.72 billion.

In addition to these troubling events, Credit Suisse came under pressure last year from billionaire Georgian investor Bidzina Ivanishvili as he claimed his relationship manager at Credit Suisse was involved in criminal activities that cost his portfolio millions of dollars. A Swiss court found the banker guilty of the charges and estimated the client’s losses at an eye-popping $553 million, and the ruling judge announced that Credit Suisse was well and truly aware of the banker’s wrongdoings and that it could have taken action but decided to turn a blind eye.

Amid the noticeable failure to adopt effective risk management practices, Credit Suisse’s revenue declined from $20.96 billion in 2018 to $16.1 billion in 2022. The bank’s profits evaporated as well, with Credit Suisse reporting a loss of close to $8 billion last year. Not so surprisingly, this disappointing financial performance has wiped out nearly 90% of Credit Suisse’s market value in the last five years.

Ownership dilution is on the cards

Credit Suisse is in a turnaround phase and companies that successfully turn things around end up delivering handsome rewards to long-term investors. That being said, not every company that enters a turnaround phase is a bargain as things could still go south if it fails to execute its strategy. For Credit Suisse, there are substantial execution risks, including the risk of facing a liquidity crunch, although the bank has sufficient liquidity today. If this risk materializes, shareholders are likely to be diluted.

Last November, the bank issued new equity worth $4.2 billion, and this fresh capital boosted its liquidity profile. The bank might have to tap capital markets yet again in the coming quarters if its core operations fail to deliver strong results, which is a very likely scenario. On its most recent earnings call, Credit Suisse warned investors of substantial losses in 2023, which paints a bleak outlook from a cash flow perspective.

To make matters worse, Saudi National Bank, the largest shareholder of Credit Suisse, warned on Tuesday that any further investment in Credit Suisse is not on the table because of regulatory challenges since it already holds close to 10% of the company. The bank played a massive role in Credit Suisse’s successful fundraising last November, so the loss of additional support complicates its outlook even further.

Takeaway

At all-time lows, Credit Suisse shares may seem attractive on the surface given the stock is likely to surge if the bank executes its turnaround strategy to perfection. However, there are a lot of ifs in Credit Suisse’s story, and things are likely to get worse before they get better – if at all.

With the entire banking sector being hammered, investors have a lot of options to choose from today, which leads to substantial opportunity costs. Considering the long, bumpy road ahead for recovery, the poor risk management track record and the possibility for significant ownership dilution in the future, I think it may be best to avoid Credit Suisse currently.

Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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