I was a staunch bear when it came to Credit Suisse Group AG (NYSE:CS) in the wake of theArchegoes Capitaldebacle and when the stock was trading at over $10. I suspected there would be a timeto become more bullish, after all CS had an enviable position and great reputation in wealth management.
I finallyturned bullishwhen the stock was trading around $3 and change and it seemed like most of the bank news including the $4 billion capital raise was factored into the stock price.
The thesis was quite straightforward. CS was de-emphasizing the investment bank and fully retreating to its core strength of wealth management complemented by a strong brand name. Wealth management businesses tend to be valued quite generously by the market. For example, Morgan Stanley (MS) is valued at 2xtangible book, and even UBS (UBS) is valued at a premium to tangible book value. CS was trading at ~0.25x tangible book, and if it were able to stabilize the outflows from clients, the future seemed quite bright. I was very encouraged by comments provided by the Chairman at the time that appear to indicate that outflows had stabilized, and I figured that was a good time to start a position.
At the time, I outlined the rationale in thisarticle:
The newsflow suggesting that material outflows are happening in Q4 was very troubling, if this was to continue, then the WM would potentially become materially impaired. It also appears that the outflows also led to the liquidity at some of its entities dropping below regulatory requirements. The outflows would also hit revenue and the WM business is predominantly a fixed-cost business. The key reason appears to be the relentless social media rumor mill relating to its financial stability. Many HNW investors were spooked and simply did not want to take a chance this is going to manifest in a European Lehman Brothers moment.
Fortunately, in recent days the newsflow improved significantly. On Thursday, Chairman Axel Lehmanntoldthe Financial Times that client outflows have partially reversed and very few clients have left the bank entirely.
This is an important distinction. The fact that clients did not leave the bank suggests this is temporary and client flows can return very quickly. It is important to understand that once a client closes the accounts and leaves the bank - re-onboarding this client is a protracted (potentially several months) and costly exercise. Clients who leave (i.e. close their accounts) are unlikely to return.
It appears that clients may have only temporarily diversified their funds away due to (unjustified) concerns relating to CS's financial stability.
Based on theQ4 earnings call disclosure, it appears that I was possibly misled by the Chairman:
As Ulrich mentioned, more than two-thirds of the flows occurred in October and more than 85% in October and November. And in our disclosures, we were pretty fulsome in October around some temporary breaches that we had.
So it appears that outflows did not stop and reverse in December as communicated by the Chairman on the 9th and 10th of December tothe Financial Times and Bloomberg, respectively.
It appears that I was basing my bullish call on possibly incorrect information and, as per theexclusive Reuters report, it seems that the Swiss financial regulator is reviewing these comments by Chairman Axel Lehmann which will possibly move into an official investigation.
My takeaway
There could be several possibilities that have played out:
- Perhaps the Chairman was not properly briefed when he made these statements about outflows stability
- Outflows may have temporarily stabilized in early December but then outflows intensified later on in the month
- The Chair glossed over the facts or did not reveal the complete picture that became apparent in the earnings call
It is also important to note that these comments were made at the time when the company was raising $4 billion from investors. This is somewhat troubling to me. I assume the Swiss regulator inquiry will determine what really transpired and whether an official investigation will be required. In any case, all of these permutations are bad news for the stock, as clearly the outflows have continued.
Management now has an additional potential credibility and trust issue with the market, and thus I am not surprised the stock is down hard this morning.
The risk is that with the loss of trust by market participants, the business may go into a slow death spiral, funding costs could spike again, and the company may continue to bleed assets under management ("AUM") and lose key rainmakers. There is a possibility that a new management team will be needed as well, as the current team may not survive the turmoil. Banking is all about retaining the trust of market participants and regulators, and that is hard and takes a long time to regain that trust.
Final thoughts
I am selling Credit Suisse Group AG stock as I have completely lost trust in the management team. The bank may also now be under regulatory scrutiny, it is not investible now in my view.
I suspect this will now be a much longer and protracted turnaround story and the odds of success have declined materially.
I do acknowledge that Credit Suisse Group AG stock is trading at distressed valuations (less than 0.2x tangible book), so any good news and the stock will likely melt up. Other outcomes that are possible that may be bullish would be M&A (i.e., someone will buy this bank) or explicit support from Middle Eastern investors (e.g., contributing to AUM).
Having said that, the risk/reward for Credit Suisse Group AG is not compelling to me at this juncture. Absent an M&A transaction or a miracle, I expect Credit Suisse to slowly bleed assets and people and ultimately for the business to shrink.
Thankfully, my disciplined risk management has worked out, as my Credit Suisse Group AG position was a relatively small one. I will take a small loss and move on.
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Source:SeekingAlpha
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