How Exposed Are Canadian Investors to Credit Suisse?

Just after the first few dominos fell in the United States, banking woes in Europe emerged with concerns related to Swiss lender Credit Suisse (CS). The two meltdowns aren’t directly related but occur amidst heightened anxiety for the global financial system.

What Happened to Credit Suisse?

After a slump in its shares intensified by the fallout of U.S. regional banks Silicon Valley Bank, Signature Bank, and First Republic, Credit Suisse announced a lifeline injection of CHF 50 billion in liquidity from the Swiss central bank, which equity analyst Johann Scholtz says could buy Credit Suisse some precious time to execute a more radical restructuring than it previously envisaged. “It has become clear that the current restructuring plan does not go far enough to address the concerns of funders, clients, and shareholders,” Scholtz notes. “We believe that the key to restoring confidence and ensuring its viability is for Credit Suisse to run down its loss-making securities-trading business in an orderly fashion. While we believe the liquidity injection is positive, the situation remains highly fluid, and we keep our fair value estimate and moat rating under review.”

Just today, DBRS Morningstar downgraded the Long-Term Issuer Rating for Credit Suisse to BBB from ‘A (low). But the lender has been plagued with problems for a while. “Credit Suisse has long been one of the more troubled banks,” says Brian Moriarty, associate director of fixed-income strategies for Morningstar, and U.S. banking turmoil may have tipped it over the edge: “In the wake of SVB's collapse, the market focused on the most obvious weak link—Credit Suisse—driving down both equity and bond prices.”

What Could Happen to Credit Suisse?

The fall in Credit Suisse’s stock price, however, doesn’t necessarily mean the company has to fail. “Credit Suisse has a profitability problem, not an asset quality problem,” contends Scholtz. “Its current restructuring plan is too complex and does not provide enough detail on the future of the investment banking business.” Moriarty agrees: “The bank is in a reasonably strong position: leverage is down, liquidity ratios are high, and there hasn't been a deluge of deposit outflows… It is extremely unlikely that Credit Suisse will outright fail, given support from the Swiss National Bank and the SNB's desire for two major Swiss banks (Credit Suisse and UBS).”

“The question isn't ‘Will Credit Suisse fail?’ but rather ‘What will it cost to save it?’” says Moriarty. “That's an open question. UBS could acquire it, with plans to quickly spin out Credit Suisse's Swiss banking business to maintain the ‘two bank’ policy. Or management could accelerate the restructuring plan, which would be costly in the short term. Or they could continue as they have this week under the belief that Credit Suisse is able to weather the storm.” 

What Would It Take to Fix Credit Suisse?

In the long term, Scholtz sees fundamental changes needed to restore investor confidence, namely around Credit Suisse’s investment business: “Investment banking has been the source of many of Credit Suisse's past woes,” he notes. “Under the current restructuring plan, Credit Suisse will retain the perennially unprofitable securities trading business… We believe a more radical separation of investment banking activities from Credit Suisse is needed to restore confidence.”

How Are Canadian Banks Different From Credit Suisse (and SVB)?

When assessing whether a poorly performing investment department with Credit Suisse or a risky concentrated deposit base at SVB could affect Canadian banks, consider funding sources and loan books—which are both diversified at Canadian banks, say Tony Genua, senior vice-president and portfolio manager, and Jonathan Lo, vice-president of growth equities at AGF Investments. “Tech lending exposure is quite low,” they say, and the businesses here are different. “Depositors are skewed to retail, which is traditionally very sticky, even with higher rates as customers shift away from low-yielding chequing towards higher-cost but stickier GICs.”

At Credit Suisse, Scholtz says there were concerns about interest-rate risks and potential mark-to-market losses of held-to-maturity bonds. The lender did recently make a welcome announcement that its high-quality liquid assets bond portfolio is fully hedged against interest-rate risk but the issue is still likely less of a concern with the Big Six banks. “Canadian banks have constructed sophisticated and savvy treasury departments, and part of their job is to mitigate interest-rate risk as best they can,” say Genua and Lo. “Treasurers are charged with asset liability management to lessen the duration mismatch that otherwise could occur unchecked.”

“The Canadian banks (like the largest-cap U.S. banks) are subject to much tighter regulatory oversight,” say Genua and Lo. “Annual stress tests on capital levels as well as so-called horizontal stress-testing of bank liquidity are performed annually. No such oversight existed for SVB as its assets were below the required $250 billion asset threshold. Additionally, both regimes require extra buffers on capital. For instance, in Canada, the Big Six are required to hold an amount of regulatory capital and bail-in debt, known as total loss-absorbing capital, of at least equal to 21.5% of their risk-weighted assets. Finally, the Canadian banks (like their largest global peers) are held to a general liquidity standard, or what is known as a liquidity coverage ratio. The banks must have on hand at least 100% of an estimated cash flow draw over a 30-day period. Canadian bank LCRs range from 122% to 151% at 31 Jan 2023 (compared with JPMorgan Chase at 112% at 31 Dec 2022).”

How Exposed Are Canadian Investors to Credit Suisse?

As we did with Silicon Valley Bank stock this week, we found the Canadian funds with the highest Credit Suisse holdings. Thankfully, the direct impact appears minimal: