And just like that, when we were finally starting to relax, “Omicron” was added to our Covid-era lexicon and the world worries again, with scientists scrambling and markets quivering. During this latest pandemic scare, we’re watching a multitude of names closely, including Credit Suisse, which looks like a solid contrarian candidate. We bought into this bank in May at US$10.11, through its NYSE ADR listing.
Market observers may recall the collapse of Archegos Capital Management and a supply chain financing company called Greensill Capital this past spring. Unfortunately for Credit Suisse, its investment bank arm had significant exposure to both firms, resulting in impairments of 4.4 billion Swiss francs ($6.6 billion) in the first quarter, and another half a billion in the second.
The third quarter saw some of these impairments clawed back, and the worst is likely over, but there are still material Greensill liabilities to work through. In response to all this commotion, the stock tanked. Then, to add insult to injury, CS paid a settlement of 214 million Swiss francs for its involvement in a debt-financing scandal in Mozambique that operated between 2012 and 2016.
Needless to say, this enterprise needed to turn around its business practices and overhaul its corporate culture. Fortunately, that is exactly what started to happen this spring, which is when we got interested.
Many employees, managers and board members were fired or resigned in the wake of the Archegos collapse, and new executives were aggressive in addressing festering risk-management problems. A convertible note was issued to infuse capital into the business, the board hired an outside firm to conduct an independent investigation into the company’s risk management practices and new directors bought stock to restore faith in the enterprise.
In early November, Credit Suisse held an investor day and presented a corporate road map through 2024. The organization’s plan is to build its wealth management arm and its retail and commercial banking business and expand in the Asia-Pacific region — especially China. During this time, Credit Suisse will continue to overhaul the risk-management culture at its investment bank, reduce the size of this operation and consolidate the unit.
This detailed and time-bound turnaround plan features quantitative targets for many metrics, including returns on equity of greater than 10 percent. At Contra, we look for these kind of turnaround plans because the specificity tends to help executive teams to maintain their focus, and it drives better decision-making when tough issues or tradeoffs arise. From an investor’s point of view, clear targets make tracking progress easier, too.
Some stockholders may be concerned by the Chinese expansion plans, given the unfolding Evergrande saga and cracks appearing in the Chinese real estate market. Though exposure to China could indeed spell trouble, Credit Suisse sold off its position in Evergrande in 2020 because of the company’s leverage and opaque financing practices.
Even if a collapse in Chinese real estate mirrors the one seen in the US subprime crisis of 2007, it is unlikely that Credit Suisse faces any systemic risk. As one of Switzerland’s biggest banks, it falls firmly into the “too big to fail” category, along with UBS.
Indeed, the Swiss bailout of UBS in 2008 shows the country’s capacity and willingness to move if warranted — not that the bailout was painless for UBS, as the Swiss soaked them with a loan carrying a 12.5 percent interest rate (from which Swiss taxpayers eventually pocketed five billion Swiss francs). Nevertheless, Credit Suisse investors will likely benefit from implicit government support for a backstop.
Underneath the turnaround strategy, Credit Suisse also looks like a solid value and contrarian stock. Valuations are low and insiders are looking to capitalize, having been significant net buyers, purchasing 3.6 million worth Swiss francs in stock year-to-date, according to the Swiss regulator.
And while the share count has doubled in the past decade, the enterprise has been profitable in seven of the past 10 years, and it’s reasonable to expect dividend growth over time.
Finally, inflation has many investors spooked, given the market’s valuations and debt loads within the economy. If inflation increases or turns out to be sticky, financials such as Credit Suisse should be able to hold their own as interest rates rise because net interest margins will expand, too. Moreover, value stocks tend to outperform growth stocks during inflationary periods.
Though the stock is currently below our purchase price of US$10.11, we think it could more than double, and have set a sell range between US$22 and US$27. Eight years ago, it traded north of US$31.