In Archegos Aftermath: Questions, Collateral And Bullet Dodgers

Days on from the first position unwinds, there were still (far) more questions than answers around the Archegos blow-up.

Chief among them: What’s next for Credit Suisse?

The shares dropped a third session Wednesday. They were down almost 25% in March (figure below). S&P cut its outlook on the bank Tuesday and Moody’s followed less than 24 hours later.

March was one of the worst months ever for the stock, and not everyone seems convinced it’s a dip worth buying.

Consternation crept into the bank’s CoCos too, as speculation swirled around the size of the eventual Archegos-linked loss, which some media reports pegged as high as $4 billion. “Knowing the extent of the damage is crucial for CoCo bondholders in particular, because coupon payments may be canceled if the bank breaches regulatory capital requirements,” Bloomberg wrote.

Moody’s cited “potential deficiencies in cross-divisional governance and risk control or awareness” in cutting the bank’s outlook. The rationale notes that,

The negative outlooks on the senior unsecured debt, long-term issuer and deposit ratings – where applicable – of CS and CSG reflect Moody’s view on (1) emerging signs of a higher-than-anticipated risk appetite or potential deficiencies in its risk management, audit, compliance or governance control processes and frameworks, as highlighted by a likely material loss from unwinding concentrated leveraged equity and derivatives’ exposures following the failure of a US hedge fund client, in addition to the aggregate risk the group assumed in relation to Greensill’s founder and his companies culminating in the wind-down of CS’s supply chain finance funds; (2) potential strain on the bank’s financial profile and, in particular, its capital position stemming from possible losses in relation to the wind-down of the hedge-fund-related positions and its now suspended supply chain funds either as a result of litigation or regulatory or other efforts to mitigate franchise and reputational impairment; and (3) the potential for client defections and franchise impairment from the possible reputational effects these events might have on the bank’s integrated businesses and, ultimately the bank’s profitability and, thereby, its ability to generate capital internally.

I’ll roll out the same (dark) quip from Tuesday. That’s not positive, which is why the outlook is now Negative.

At the end of 2020, the bank’s CET1 ratio was 12.9% and Credit Suisse aims to keep it above 12.5% in the first half. “In the Greensill context, Credit Suisse says in its annual report that FINMA could add a Pillar 2 buffer; we think potential material hedge fund losses could add to this,” UBS said, in a note dated Tuesday, which posed all manner of questions around both Greensill and Archegos (which some analysts are still quaintly referring to as “the hedge fund”). Here’s UBS:

Outflows? P&L impact? Insurance coverage? Quality of underlying assets? Litigation? Developments around involved partners? Reputational impact? Impact on strategy? How will the incoming chairman look at these matters? Ripple effects into other businesses? Outcome of various investigations? Is the recently proclaimed “Growth phase” (Dec investors’ day 2020) at risk?

Weighing in, JPMorgan’s Kian Abouhossein wrote that on the bank’s calculations, and assuming no RWA growth compared to year-end 2020, Credit Suisse “can absorb a max one-time pre-tax hit of $4.5 billion for Archegos which post-tax is 116bps of CET1 capital offset by 32bps of Retained earnings and still reach 12% by the end of Q1 21.”

That’s “an acceptable level for S/Hs under Basel 3,” Abouhossein went on to say, before noting that “every additional $1 billion pre-tax hit is 26bps of CET1 capital based on year-end 2020 RWAs and hence any hits beyond $5 billion pre-tax from Archegos will call into question the capital position, in our view.”

Apparently, Deutsche Bank did its best Trinity (from The Matrix) impression, defying physics to “dodge” a multi-billion dollar “bullet” (quotes denote Bloomberg’s word choices. “The bank sold some $4 billion of holdings seized in the implosion of Archegos in one large private deal on Friday, helping it emerge unscathed from a scramble that may cost some rivals billions of dollars,” a story out Wednesday afternoon read, citing people familiar with the matter. Although other banks were already selling, Deutsche managed to get a direct deal done during what sounds like an insane dash to liquidate.

Although I will not venture to speculate about re-pledged collateral, what I will do is safely quote from someone who did. “I think something else triggered the decision by Goldman and Morgan Stanley to exercise whatever liquidation provisions they had in their custody and counterparty/credit agreements with Archegos,” Ben Hunt wrote, adding that,

I think this was a “margin call”, not a margin call. What can trigger a “margin call,” by which I mean a forced liquidation of positions held at your prime broker even if you’re not in violation of net capital requirements? I can think of two possibilities: 1) Goldman got wind of Archegos borrowing with other prime brokers by pledging the same collateral they pledged to Goldman.

I’m not going to print the second possibility Ben posits, but he’ll tell you all about it here.

If you ask Hunt, “there are a lot more Bill Hwangs out there.”