At first, March 25 seemed like a typical day in the market. The S&P 500 would post a measly decline and everything looked normal on the surface. However, it was anything but normal. By the close of trading, shares of companies like ViacomCBS, Vipshop Holdings, and Tencent Music would have plunged by 34%, 30%, and 35%, respectively, over just a few days.
Stocks regularly experience volatility, and the ones mentioned had all enjoyed steep rises since the beginning of 2021, so corrections at some point were to be expected. However, when these stocks came back down, Archegos Capital Management lost its entire $20 billion in value due to its highly leveraged bets on those companies and others like them.
The result of this sent shockwaves through the financial world as many of Archegos' prime lenders were left scrambling to find buyers for these stocks. Big banks like Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS) were able to race ahead of the panic and got out of the situation relatively unscathed. Banks like Credit Suisse (NYSE:CS) and Nomura Holdings (NYSE:NMR) weren't so lucky.
To understand what happened, you must first understand how a 30% drop in a few stocks could cause such panic in financial circles.
Archegos was founded as a family office in 2013 by "Tiger Cub" Bill Hwang, one of several successful proteges of billionaire hedge-fund manager Julian Robertson at Tiger Management. Between 2013 and early 2021, Hwang and Archegos Capital made investing moves that turned $200 million into more than $20 billion. To accomplish this feat, Archegos used "equity swaps" -- agreements where a partner bank owns stocks on behalf of its clients and extends leverage on those holdings. Large investment banks provide prime brokerage services to hedge funds, and these services can be capital intensive and potentially risky endeavors -- as this situation has so clearly demonstrated.
Archegos had relationships with several investment firms that provided it with prime brokerage services. The firm was highly levered as a result: JPMorgan Chase analysts estimated that it was levered at anywhere from 5 to 8 times. That extreme leverage turned the firm into a house of cards.
When the share prices of ViacomCBS, Tencent Music, and others declined so rapidly, Archegos Capital was hit with margin calls -- or demands from its prime brokers to put up more capital. Archegos was unable to meet these margin calls, which sent its prime brokerage providers into a frenzy.
How Morgan Stanley and Goldman Sachs weathered the storm
Two of Archegos' prime brokerages were Morgan Stanley and Goldman Sachs. Morgan Stanley looks to have been the first mover on the margin call news, and was able to unload a significant portion of the risky positions before news of Archegos's troubles become public. According to CNBC, Morgan Stanley sold $5 billion in shares related to the blowup on March 25, and was able to escape without any material losses.
CNBC also reported that Morgan Stanley was one of the biggest holders of the top stocks traded by Archegos by the end of 2020, with positions totaling $18 billion. Analysts estimate the bank could have faced over $10 billion in losses had it not acted so swiftly.
Meanwhile, Goldman Sachs began dumping Archegos-related stocks on March 26, selling $10.5 billion worth of shares. In an interview with CNBC, CEO David Solomon said that the bank's risk-management systems performed well. "We identified risk early on," he said. "We took prompt, corrective action to lower our risk according to the contract we had with the client."
While Morgan Stanley and Goldman Sachs acted swiftly, Nomura and Credit Suisse weren't so fortunate.
Facing billions in losses
In a note to investors, Nomura indicated its claim on stocks related to Archegos was estimated to be about $2 billion. It responded by slashing its share buyback program from 75 billion Japanese yen to 10 billion Japanese yen. However, investors are awaiting more details on the extent of Nomura's losses and how they will impact its fiscal fourth quarter, which ended March 31. The company will announce those results on April 27.
Meanwhile, Credit Suisse looks to have taken to brunt of the hit from the sell-off. The bank has warned investors that the fallout will end up costing it 4.4 billion Swiss francs (about $4.7 billion), which will result in the bank posting an estimated pre-tax loss of 900 million Swiss francs (about $960 million).
Credit Suisse has been forced to take a number of measures. After dumping a significant amount of stock at a loss, the executive board has suspended bonuses related to fiscal 2020, slashed the company's proposed dividend from 0.29 Swiss francs per share to 0.10 Swiss francs per share, and suspended its share buyback program.
As a result of the Archegos blowup, Credit Suisse saw its common equity tier 1 (CET1) ratio drop from 12.9% in the fourth quarter to 12% in the first quarter, while its tier 1 leverage ratio went from 6.4% to 5.4% and its CET1 leverage ratio went from 4.4% to 3.7%. The bank has stated that it will not resume share repurchases until it regains its target capital ratio and reinstates its dividend.
The bank had been under pressure already. Just one month ago, it suffered losses from the collapse of Greensill Capital, a British supply chain finance firm. As a result of mounting losses, Credit Suisse Investment Bank CEO Brian Chin and Chief Risk and Compliance Officer Lara Warner have stepped down.
A lesson in leverage
Goldman Sachs and Morgan Stanley were fortunate to have gotten out of the Archegos blowup mostly unscathed, and their stock prices reflect that, staying more or less flat. Meanwhile, Credit Suisse and Nomura continue to feel pain from the blowup, with both companies' shares down by about 19% since March 25.
Investors can learn a lesson from all this about the high risks of trading on margin. While using margin can make good times for your stocks great for your portfolio, in bad times, it magnifies the declines. And in the face of substantial declines, margin calls like the ones that crushed Archegos can bring your entire portfolio down.
Heavy use of margin and leverage is one way to turn $200 million into $20 billion in just eight years -- and to turn $20 billion into $0 in just a few days.