Crisis/Time Management at Credit Suisse

Time is money, and money is franchise value

Put aside corporate finance theory. Regardless of who legally/usually/technically/ostensibly owns a bank, its fate also lives in the hands of a higher power: the market. Deifying phrasing aside, these aren’t some all-powerful, Adam-Smith-esque invisible hands. Rather, it’s the many hands answering phones and punching keyboards (sometimes literally) across the Street.

Concern over Credit Suisse’s value as a going concern ticked up last week, enough to prompt a second CEO letter to employees—of apparently more memos to come—from new CS chief Ulrich Körner. The memo laid out CS’s financial strength, which of course exacerbated concern over the weekend. New talking points were circulated Sunday to executives speaking with investors, clients, and counterparties. More from the FT:

Senior executives within the bank [. . .] are adamant a capital raise would be a last resort.

“I want to be clear, we have not sounded out investors for capital,” said one banker who spent the weekend calling top clients and counterparties trying to reassure them of the bank’s financial health.

These reassurances backfired early Monday. CS’s stock dropped double digits and CDS spreads shot up. Bagehot famously wrote (emphasis in original): “Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone.”

Perhaps in the spirit of updating Bagehot, we could also add: “Every banker who does not have to prove that they are worthy of credit but does so anyway, in fact will lose their credit.”

Most of this adverse market movement on Credit Suisse was given back later Monday when a few other Street analysts put out notes broadly supportive of Körner’s assessment. (←Coming back to this.) But these concerns are still lingering—and could flare up again. Credit Suisse still is deferring to its late-October earnings release date before saying anything definitive on its restructuring plans. As Körner wrote in his memo,

No doubt there will be more noise in the markets and the press between now and the end of October. All I can tell you is to remain disciplined and stay as close as ever to your clients and colleagues.

[…]

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.

However, this is Körner committing exactly this sin.

Calling investors to assure them you aren’t raising dilutive capital is conflating the importance of the “day-to-day stock price performance” with the bank’s long-term franchise value. Counterparties are getting jumpy, funding costs are going up, CDS spreads are making headlines, employees are defecting. Worrying about shareholders’ dilution is a peacetime privilege. When the market—those very visible hands of your counterparties on the Street—smell blood, diluting it gets them to move along.

Körner has a solid reputation, for now. He should trade on it by calling a meeting of the Five Families. He needs to call the heads of the rest of the Street and tell them to issue the order from on high: no inquiries made, no acts of vengeance. Business as usual.

With that part done, he can stop writing memos. The bank can focus on its October 27 restructuring (or even bringing it forward…). The day-to-day stock price can still bop around, worried about exactly how much capital CS might need to raise, if any. But, with the Street behind the bank, and its CDS spreads out of the headlines, it can kill the scenario where the stock price goes to zero in the short-term.

One idea circulating is that CS might do good-bank/bad-bank structure. The value in this structure isn’t just that passive cash flows of the good assets are protected from the passive potential losses on the bad assets. It also comes from the fact that, freed from worrying about and managing the blowup risk lingering in the bad assets, bank management can focus on the franchise value of the “good bank.” CS can do something analogous before it does an ounce of restructuring: Make sure the Street is on board—thus removing that downside tail risk—and then focus on managing the bank and its franchise value. That’s time better spent.

They should’ve done it last week, and the market punished them for their failure to do so. They can avoid making the same mistake in these crucial few weeks.

Post-crisis risk management and regulations have helped bolster banks’ resilience. Here’s Bloomberg with a bit of “for instance”:

Authorities now mandate that banks hold enough cash and highly liquid assets to cover a month of outflows in severe stress. Credit Suisse said in July that it had almost double that requirement. 

And banks have fewer derivative trades these days that force them to post collateral in the event of a credit downgrade. A decade ago, Credit Suisse said a two-notch cut by all major ratings companies would force it to pony up 3.6 billion francs. Now, the equivalent figure is one-sixth of that.

These changes help prevent a bank with long-term value from getting toppled overnight. They don’t guarantee that long-term value. The longer whispers of a potential CS-less future linger, the more franchise value CS will lose.

As alluded to at the beginning, in an ideal world the shareholders own the bank. For that to be case, however, the market needs to move along.

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