Credit Suisse: Overblown Lehman Brothers Banking Collapse Fear

I woke up this morning and found that #CreditSuisse was trending on Twitter and over the weekend, I have been hearing rumors about a possible collapse of some European banks. That Credit Suisse (NYSE:CS) and Deutsche Bank (DB) are on that short list of banks that might implode does not come as a surprise to me. However, what I do want to discuss is how rumors of a collapse and how these rumors are being spread could actually contribute to financial instability. So, it is not necessarily a rumor preceding a fact but a rumor contributing to the fact if a collapse were to happen, which is a dangerous phenomenon.

Why the red lights are flashing

So, let’s first discuss why the red lights are flashing in general and in particular for Credit Suisse. Right now recession fears are high and the probability of a recession is no less. We saw inflation numbers from the US at 8.3% which sent stock markets down. In Europe, the situation is not any better. Inflation in Europe is expected to be 10% in September and in The Netherlands where I used to live until a few months ago inflation climbed to 17.1% and in Romania where I live now the most recent harmonized inflation reading was 15.3%. So whether you live in Western Europe or Eastern Europe, double digit inflation rates are a reality. In Germany, considered the engine of the European economy, inflation rates have been 10.9%. What does this have to do with Credit Suisse? A lot.

The inflation rate is now at double digits because of the high gas prices in Europe. Some countries, such as The Netherlands, are prone to that due to their dependence on gas or the liberalization of the energy markets. Additionally, the way electricity prices are calculated also hurt as there is a link to gas prices driving up the prices of electricity. So, the inflation is mostly driven by the higher energy prices and central banks are trying to fight that with raising interest rates. That is what is one of the things that might end up hurting Credit Suisse. Inflation might ultimately lead to people defaulting on their mortgages, but that is not Credit Suisse’s biggest problem. In fact, for banks the higher interest rates make it more attractive for people to store their money in their bank accounts again contrary to investing it in the stock and bond market. That is where the cracks start to propagate for Credit Suisse. With recession fears mounting and storing your money in your bank account gaining some appeal, investors are no longer as interested in buying risky debt leaving underwriting banks of said debt with a costly headache. With money flowing out of the stock market as well as the bond market, Credit Suisse’s investment banking arm which did not perform all too well in recent years is in distress.

Credit Suisse Stock Nose-Dived

Without doubt, there are grave concerns on the economic health of Europe at this moment. What makes Credit Suisse an easy target for speculations of a collapse are a mix of the following items:

1. Stock price
2. Credit Suisse credit default swaps
3. A bunch of bad transactions and involvements

When it comes to stock price, the banks year-to-date as well as its one-year performance show declines around 56% which to some speculators is proof that things are going downhill for Credit Suisse. Separately, the increase in the credit default swap spreads is being used by speculators as a barometer for risk of default with comparisons made with Lehman Brothers back in 2008 while essentially the CDS more closely resembles risk appetite. The higher the spread, the lower the risk appetite and the higher it costs to cover against default of debt. Yet, what speculators are focused on is the fact that the spread is at a 14-year high, last seen when Lehman Brothers collapsed. However, back then Credit Suisse did not collapse and so Credit Suisse reaching those same levels is not a sign that the bank will collapse, but it makes for an easy argument for speculators especially since the credit default swaps are now increasing almost exactly 14 years after the collapse of Lehman Brothers. It makes for some juicy theories. The fact is that if you make comparisons with Lehman Brothers, the spread of Credit Suisse credit default swaps is not nearly as high.

What hunts Credit Suisse is a bunch of scandals it was involved in. A non-exhaustive list includes the Malaysia Development Berhad scandal in 2015, a $10 billion involvement with Greensill Capital which collapsed in 2021 of which the majority was collected and $5.5 billion in losses linked to the collapse of Archegos Capital, also in 2021. It are these involvements that are mostly reflected in the company’s stock prices.

Capital raise prospects make things worse

While I do consider the speculations and comparison to the Lehman Brother collapse somewhat wild and even suggestive at times, there are rumors that Credit Suisse needs a capital raise of at least $4 billion, and with a market cap of $10.64 billion, raising $4 billion is a challenge. Without doubt, Credit Suisse needs to reorganize and possibly establish a bad bank to place non-performing loans and illiquid assets in, and reorganizations cost money. Raising and refinancing debt is going to be a challenge due to the credit default swap spread as well as the rising interest rates. Additionally, with the stock trading near 52-week lows issuing equity is not attractive and is going to significantly dilute existing shareholders. The company could also be looking at selling parts of its business, but with stock prices being low and pressure to reorganize, one can wonder how good the pricing of asset and segment sales will be. So, Credit Suisse seems to be stuck in what will be a pricey trap either way if a capital raise is required and given the need to maintain a strong core capital ratio.

What also does not radiate strength at this point is that the CEO had to send out a memo before the weekend pointing at the strong capital base and liquidity. It shows that within the company there is grave concern about the path forward for the company. Credit Suisse has been denying that it needs to raise capital and that brings back strong memories to Lehman Brothers, which also said it did not need to raise capital: All was good, until it wasn’t, and we all know how things ended.

The recent rumors of a collapse have only made Credit Suisse’s task of restructuring its business harder.

Conclusion: CS Stock Is A Sell Not A Buy

Right now, we are seeing a lot of macro elements that boost fear among investors and is grist to the mill of speculators. I believe that speculators are making comparisons to Lehman Brothers in places while they are not always valid, there even are people pointing out that the Chairman of the Board of Directors is named Lehmann to intensify connections to the Lehman Brothers collapse. What also infuses the speculations are continued denials of a need for a capital raise and the Credit Suisse CDS returning to 14-year highs, 14 years after the collapse of Lehman Brothers.

While I do believe that the situation in Europe is dire and it will get worse before it gets better, the connection with the Lehman Brothers collapse is overblown. Even without the overblown comparison, Credit Suisse is really not placed well to spin off parts of its business, finance with debt or refinance due to increased interest rates and decreased risk appetite or issue equity as a $4 billion raise does not contrast favorably to its market cap. The rumors that come on top of that could even hinder the company in achieving a successful turnaround. So, to me the rumors that are surfacing now on Twitter and among investors are not rumors preceding a possible a collapse but rumors that could eventually contribute to one if it were to happen. All with all, I would not feel comfortable holding shares of Credit Suisse and mark shares of the Swiss bank as a sell. There is simply too much negative attention for the stock now and management is not making a strong impression.