By Alexander Jones, International Banker
In late July, Credit Suisse announced a massive loss of 1.59 billion Swiss francs ($1.65 billion), alongside a 29-percent decline in revenue, for the second quarter. The mediocre performance from the Swiss banking stalwart—one of the most historically important in Europe—surpassed analyst expectations of a more modest $400-million loss and stood in stark contrast with the more upbeat results posted by peers such as fellow Swiss lender UBS and even troubled German banking major Deutsche Bank. And with the results having followed a series of major scandals, strategic blunders and several key litigation events against the bank, significant restructuring and reform have become desperately needed for Credit Suisse to get back on the road to recovery once more.
Of course, none of this comes as much of a surprise given that Credit Suisse’s disastrous performance has followed three profit warnings issued by the ailing bank ahead of its second quarter (Q2) results. On June 8, it issued its third profit warning of the year—specifically that an impending loss would be reported as the war in Ukraine, inflationary and increasingly restrictive macroeconomic environment, and drawdown of pandemic stimulus measures would weigh heavily on its investment-banking business. And indeed, investment banking turned out to be the biggest drag on Q2 earnings, with the division recording a net loss of $1.2 billion, largely caused by sluggish bond issuances and loans for companies, as well as declines in trading revenues. The bank said it had experienced “weak customer flows and ongoing client deleveraging”, most notably in the Asia-Pacific region, as clients ended up withdrawing 7.7 billion francs and de-risking their positions in the face of volatile equity markets.
Given its smaller size versus other Tier 1 lenders in the investment-banking space, moreover, Credit Suisse has found winning business an uphill struggle, meaning that its return on capital has dwindled throughout much of the last decade. It has also excessively focused on businesses that have yielded lacklustre returns across the industry in recent times, such as leveraged finance and securitised products. Indeed, Credit Suisse’s chairman, Axel Lehmann, has acknowledged that the bank has been “badly diversified” in this regard.
Had Credit Suisse’s problems stopped at the mercy of the market, one might have more confidence in the bank reversing its fortunes. But a series of episodes in recent years have demonstrated grave mismanagement and inflicted deep wounds on the bank’s reputation. Most recently, for instance, it was found guilty in late June by the Federal Criminal Court of Switzerland for failing to prevent money laundering in a hugely important case that many believe will set a precedent for banks in the country going forward.
Specifically, the case revolved around whether Credit Suisse and one of its former employees did enough to prevent funds from an alleged Bulgarian cocaine-trafficking group from being laundered through the bank between 2004 and 2008. Ultimately, the court found that Credit Suisse lacked sufficient client-relations management with the group and failed to monitor the appropriate anti-money laundering rules adequately. “These deficiencies enabled the withdrawal of the criminal organization’s assets, which was the basis for the conviction of the bank’s former employee for qualified money laundering,” the court said, having issued a fine of 2 million Swiss francs ($2.1 million) against the bank.
But this case has caused Credit Suisse only a fraction of the damage of the single most damaging incident to the bank of all—the March 2021 default of US hedge fund Archegos Capital Management—has cost the bank. Archegos went under after being over-leveraged on a series of equity-derivative contracts that turned sour, particularly those triggered by ViacomCBS’ $3 billion stock offering falling apart. Archegos’ resulting liquidation inflicted a staggering $4.7-billion loss on Credit Suisse and smaller losses on other major banks.
While the financial penalty of the collapse is certainly high, it is also the nature of Credit Suisse’s relationship with Archegos—and the failures by the bank to detect the early warnings—that have since come under the microscope. According to an independent report on the relationship, the bank failed “to effectively manage risk in the Investment Bank’s Prime Services business by both the first and second lines of defense as well as a lack of risk escalation”; it also found a failure “to control limit excesses across both lines of defense as a result of an insufficient discharge of supervisory responsibilities in the Investment Bank and in Risk, as well as a lack of prioritization of risk mitigation and enhancement measures (such as dynamic margining).”
The other blockbuster litigation case plaguing Credit Suisse to this day—and is set to do so for many years—involves the now-collapsed financial firm Greensill Capital, to which it lent substantial sums of funds through its wealthy clients. Last year, the bank was forced to suspend $10 billion of supply-chain financing to Greensill after it collapsed due to widespread fraud. As such, the decision to invest in Greensill assets using client money proved disastrous, with the pandemic exposing a hugely fragile firm replete with risky lending practices and countless conflicts of interest.
Today, the bank is bracing for five years of court cases and insurance disputes, which it now estimates will cost $291 million, roughly double its initial estimates. This has only further aggravated clients who face billions of dollars in losses from this funding relationship and were told by the bank that they were investing in low-risk products that were fully insured against losses. “It’s devastating that the investors are paying for all these expenses that are based on a mess up by Credit Suisse,” one of the roughly 1,200 investors in the Greensill funds told the Financial Times. What’s more, costs pertaining to legal and restructuring advisory fees, insolvency fees and support for sustaining Greensill’s continued operations with minimal staff (which cost $10 million last year) must also be paid. “Most importantly, a big chunk of these expenses are keeping Greensill alive,” the investor added.
And although more than $7 billion—or 73 percent of the fund’s assets under management (AUM) at the time of suspension—has been successfully recouped from the incident, the bank has confirmed that around $2 billion of the total will be exceptionally difficult to recover. Efforts continue to be made to compensate clients; for instance, Credit Suisse’s asset-management unit has filed 18 insurance claims tied to the frozen supply-chain finance funds linked to Greensill, with aggregate exposure of some $2.2 billion.
A series of other cases have further drained the bank of much-needed funds, perhaps most notably the $22.6 million it was required to pay to investors who purchased billions of dollars of debt to fund a tuna-fishing and maritime-security project in Mozambique. The “tuna bonds” scandal arose from the $1.3 billion worth of loans that Credit Suisse had arranged for the country between 2012 and 2016, which eventually saw the bank pleading guilty to wire fraud, paying $475 million in fines to regulators and forgiving $200 million of debt to Mozambique.
Such cases clearly illustrate some significant internal failures on the part of Credit Suisse, failures that have cost it dearly. Under Lehmann, however, the bank has launched a comprehensive review of its business strategy—the second in two years and the third since 2015—to implement key cost-cutting measures and bolster its risk-management capabilities. The consensus seems intent on trimming its investment-banking business, moreover, and instead shifting focus towards growing the bank’s more lucrative private-banking and wealth-management businesses.
The bank has also acknowledged to investors clear weaknesses in its risk-management framework, in which “outcome sustainability deviated from historical performance”, particularly regarding last year’s Archegos default. It has thus promised to realign its aggregate risk profile to reduce exposure to higher-risk market areas.
“While the bank has already taken a series of decisive actions to strengthen the risk framework, we are determined to learn all the right lessons and further enhance our control functions to ensure that we emerge stronger,” said António Horta-Osório, former Credit Suisse chairman, shortly before he left at the beginning of the year. “We are committed to developing a culture of personal responsibility and accountability, where employees are, at heart, risk managers; know exactly what they must do; escalate any concerns; and are responsible for their actions. Such a culture is of critical importance and, by working relentlessly on this goal, we can create lasting change and value for both clients and shareholders.”
Not surprisingly, heads have rolled at Credit Suisse—none more high-profile than Chief Executive Officer Thomas Gottstein, whose departure was announced at the same time the bank reported its massive second-quarter loss. The asset-management division’s chief executive, Ulrich Körner, has replaced Gottstein at the top, while the outgoing chief executive admitted that the results were “disappointing” and performance was “significantly affected by a number of external factors, including geopolitical, macroeconomic and market headwinds”.
The bank’s investment banking chief executive, Brian Chin, and chief risk and compliance officer, Lara Warner, were also removed from their roles soon after the Archegos debacle. David Wildermuth, from Goldman Sachs, replaced Warner. It was revealed in April that Chin had violated the bank’s code of conduct, including mistreating women in the bank, which led to around $18 million in compensation being withheld from his compensation package. Other notable moves include the appointments of Deutsche Bank’s treasurer, Dixit Joshi, as the new chief financial officer and the head of Europe, Middle East and Africa, Francesca McDonagh, as the new chief operating officer.
Another Goldman alumni, Joanne Hannaford, has joined as Credit Suisse’s new chief technology and operations officer. Hannaford has proposed a cost-cutting plan that leverages technology such as cloud-based systems to save 200 million Swiss francs in each of 2022 and 2023, as well as a further 400 million francs in the medium term. Plans to improve efficiency and develop in-house talent have also been put forward for consideration.
Perhaps this new management shake-up will prove instrumental in the bank’s eventual turnaround. ″[Koerner] knows banking inside out. He was building businesses, he was COO in large organizations, so he has a truly front to back, and I call it, a back to front, approach,” Lehmann told CNBC following his appointment. “He will take over with immediate effect, and he will drive the transformation that we will speed up.”
But with both Europe and the United States increasingly expected to enter recessions before the end of the year, the deteriorating operating environment for banks in both jurisdictions means that Credit Suisse does not have time on its hands to inspire the sort of comeback it so sorely needs. This has not gone unnoticed by ratings agencies: early August saw two of the three major agencies taking negative action on the bank, with S&P Global Ratings cutting its credit outlook from “stable” to “negative” and Moody’s downgrading its senior unsecured debt from Baa1 to Baa2. “We see increasing risks to the stability of the bank’s franchise, uncertainty around the reshuffling of top executives, and a lack of a clear strategy, and we think the group’s risk-adjusted and absolute profitability is likely to remain weak over the medium term,” S&P stated following its downgrade.
As is the case for much of Europe, therefore, it appears as though the weakened Swiss lender is in for a grim winter. As Eoin Mullany, an analyst at Berenberg, recently noted, “With sticky near-term costs and revenues under increasing pressure, it is hard to be positive on Credit Suisse.”