The Swiss bank Credit Suisse Group (CS) has really struggled this year, with the stock now trading down close to 60% and hitting all-time lows.
Credit Suisse has been closely associated with several scandals in recent years and now must put together a transformation plan, which could involve raising capital at a distressed valuation.
Still, one might argue that a lot of the bank's troubles have been priced into the stock, which trades at about 26% of its tangible book value, or net worth. That means you can buy a share of Credit Suisse for 26 cents on the dollar, and if the bank can turn things around, there could be a lot of upside ahead. Given this absurdly cheap valuation, is Credit Suisse stock a buy?
Failure is very unlikely, but there's a lot of work to do
Credit Suisse's name is in the headlines a lot lately, and not in a positive way. With spreads on its credit-default swaps -- basically insurance against the bank defaulting on its debt -- widening recently, there is talk that the bank could be on the brink of failure, which leads some to believe that a Lehman Brothers-like collapse could happen.
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Analyzing the situation, I feel fairly confident in saying this is an extremely unlikely scenario, and not just because Credit Suisse is simply too big to fail. The bank had a Common Equity Tier 1 (CET1) capital ratio (a bank's core capital expressed as a measure of its risk-weighted assets such as loans) of 13.5% at the end of the second quarter. Its regulatory requirement is a minimum of 10.5%, meaning it has a lot of excess capital right now. On the bank's second-quarter earnings call, (now former) chief financial officer David Mathers said the 13.5% CET1 is one of the highest capital ratios the bank has ever reported.
Credit Suisse's U.S. subsidiary is also incredibly well capitalized with a CET1 ratio of more than 27% at the end of 2021. The bank is not without risk, and does have exposure to the oil and gas sector and Russian credit, but not the kind of exposure that would bring the bank down.
That said, Credit Suisse has no shortage of problems, and its investment bank has been involved in many major scandals in recent years that put it in a very bad position. The bank had as much as $20 billion of exposure to Archegos Capital before the fund collapsed, resulting in a loss of $5.5 billion.
It also took a $1.7 billion write-down from its exposure to financial services company Greensill Capital, which failed in 2021, and it has been involved in other scandals as well.
The options aren't great for Credit Suisse
After the multiple scandals, Credit Suisse will now likely need to overhaul its investment bank and fix risk management to prevent further losses that could arise.
The investment bank is a big part of Credit Suisse's business, and restructuring the division could be costly and take several years. On its last earnings call, management laid out strategies being considered: make further investments and prioritize asset and wealth management, restructure the investment bank, and cut costs. There have also been rumors that it might split the investment bank into three separate units, according to the Financial Times.
Some analysts estimate that the bank could face a capital shortfall due to the restructuring costs. This doesn't mean it would not have enough capital to survive, but its capital ratios might dip below its regulatory requirements or not allow it to maintain a reasonable buffer.
Banks can dip below these levels and still operate fine, but they might need to limit capital distributions to shareholders. Credit Suisse already had to cut its dividend and has not been able to buy back shares, either.
Furthermore, this shortfall could require Credit Suisse to raise capital. Not only would this be incredibly dilutive to existing shareholders at the bank's current distressed valuation, but it might also be challenging if prospective new shareholders are not convinced that the bank can turn things around. Another option would be to sell some of its stronger-performing businesses to raise capital in a nondilutive way, but then earnings are going to be challenged further down the line.
Is Credit Suisse stock a buy?
Until there is much more clarity about how Credit Suisse will proceed, I would stay away from the stock, but not because the bank could fail.
A potential capital raise would dilute your position if you buy now. And while banks executing turnarounds can be great opportunities, there needs to be a clearer transformation plan, including what units might be sold and what will happen to the investment bank.
I also see absolutely no need to take an unnecessary risk on Credit Suisse when other European banks like Deutsche Bank and Barclays also trade at distressed valuations but without nearly the same breadth of issues and with much better profitability projections. Look at these names if you are interested in the European banking sector.
