In just a matter of days, Credit Suisse Group AG went from an “excellent” start to 2021 to facing $5.5 billion of losses on a single investment-banking client—Archegos Capital—and a material hit from the implosion of its asset-management partner, the supply-chain finance firm Greensill Capital.
It was an extraordinary reversal. Efforts to shore up the firm’s balance sheet with a $2 billion capital raise, announced on Thursday, and a broad review of the bank’s risk-management failures should put out the raging fires. But Credit Suisse’s stumbles don’t just reflect a turn of events that caught it unawares. Deep weaknesses in oversight and a seemingly insatiable appetite for risk pervade the organization. Expect the rehabilitation and return to sustainable profitability to be a long and uncertain process.
While details on exactly how Credit Suisse came to lose so much money on Bill Hwang’s family office remain scant, the firm’s Archegos bet was clearly outsized and mismanaged. Chief Executive Officer Thomas Gottstein, speaking to analysts on Thursday, acknowledged that his firm will need to look at its “absolute limits” on exposure, which were greater than at other prime brokers. Of the competitors we know about, Morgan Stanley lost $1 billion on the total-return swaps with Archegos and Nomura Holdings Inc. faces a $2 billion hit, while Goldman Sachs Group Inc. and others were largely unscathed.
Credit Suisse needs to look at how it runs similar derivative positions. It may force clients to post more collateral as volatility increases, for example, and scrutinize its concentration of risk and correlations between long and short positions, Gottstein said. Archegos begs the question of how aggressive Credit Suisse has been to win business elsewhere.
Greensill’s blowup also shouldn’t have been a surprise. Credit Suisse reviewed its $10 billion supply-chain funds (backed by Greensill assets) last year because of red flags, including the fact that one client, Sanjeev Gupta, relied far too heavily on Greensill for its financing. The Swiss bank is trying to recover $2.3 billion in funds to return to clients from three parties and is confident of its legal position, it said. But having marketed these funds to customers as relatively safe, Credit Suisse wouldn’t be able to pass on losses to clients without facing severe blowback.
If you exclude the “unacceptable” mishaps, as Gottstein described them, Credit Suisse’s earnings did look strong in the first quarter, leaving it with only a 252 million Swiss franc ($275 million) loss. Revenue was 31% higher than in the first three months of 2020, driven largely by private-banking clients trading more in Asia and an investment bank that was on a tear—as the Archegos debacle attests. The underwriting of initial public offerings of special-purpose acquisitions companies (another risky area), fixed-income trading and equity trading all contributed to a surge in income.
But as markets normalize and risk-taking is reined in, the investment bank’s rare moment in the sun must be over. For years the unit hasn’t been earning its cost of equity, JPMorgan Chase & Co. analyst Kian Abouhossein notes. The retreat to less perilous waters has only just started and the consequences are unpredictable.
As part of a risk review, undertaken by Gottstein and Chief Financial Officer David Mathers, the bank plans to scale back its so-called leverage exposure in prime broking by at least $35 billion (a third). While the total-return swaps put in place for Archegos didn’t necessarily affect that lending, Mathers told me, the bank wants to focus now on serving hedge funds with the closest connections to the rest of the firm. Citigroup Inc. analysts estimate that it could lose as much as 3% of group revenue and group profit because of the prime-broking cuts.
And the other areas of banking in which Credit Suisse wants to keep competing will have been affected by the reputational damage of the past few weeks. As Deutsche Bank AG experienced a few years back, market share can quickly erode in the “good” parts of the business when you’re trying to shrink elsewhere.
Incoming Chairman Antonio Horta-Osorio will be reassured to see that the company has cleaned out the top ranks after Archegos and Greensill, and taken the capital question off the table. But how big an investment bank Credit Suisse should keep is a question he has to answer. For starters, management should resist the temptation to use the new funds to fuel lending growth to wealthy clients. Until the regulators and the bank are done reviewing what went wrong, the bank’s in no position to chase hasty expansion.
Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.