European financials are in the spotlight again. And once again, it is not because of anything good. The CDS spread on Credit Suisse has spurted up over the past few days. Is this just the tip of the iceberg? Many “investors” and “gurus” are eager to point out possible systemic risk. At least as far as I can see, there is none of that right now.
The chart below shows the Credit Default Swap spread, known as CDS spread, on Credit Suisse, alongside that on fellow Swiss financial UBS, Deutsche Bank (because… you know), BNP Paribas, Europe’s largest “bank”, and a basket of 25 major European financials.
As of Thursday, the time of writing - which can matter quite a bit, the CDS on Credit Suisse stands at 370 basis points, a record. And while spreads on other financials are also up, it is safe to say that Credit Suisse clearly stands out.
Credit Suisse’s CDS spread is:
- 2.5 times higher than the CDS spread on the basket of 25 European financials
- 3.3 times as high as the CDS spread on peer UBS
- 4.4 times as high as the CDS spread on BNP Paribas
Corporate Bond Spread
To determine whether there is systemic risk or risk linked to the financial sector, I compare the CDS spread on the basket of 25 financials with the spread on Euro Corporate Bonds. So including all other sectors besides financials.
The chart shows that the correlation between the two is particularly high. This is not surprising, of course. Both say something about perceived bankruptcy risk. And with an upcoming recession in Europe, it is not surprising that both spreads are going up. In relative terms, the spread on euro Corporate bonds has risen even slightly harder than the CDS spread on the 25 financials.
Non-performing loans
The percentage of bad loans has fallen below 2 per cent in the eurozone. That is not bad.
The ECB has required a total capital buffer of Eurozone financials of 15.1 per cent since the beginning of this year. Of this, core capital - the CET1 ratio - must be at least 10.6 per cent. In the table below on the far right, are the capital buffers of 112 financial institutions monitored by the ECB in Q1 of this year. The capital ratios, outlined by the green dotted line, are significantly higher than required by the ECB.
By the way, note the red oval. Just because financial institutions have good buffers does not mean they are also good investments. Return on equity has fallen hard in recent quarters.
No risk?
Judging from the above, I cannot conclude that there is systemic risk to the European financial sector. Incidentally, that is not the same as saying that there can be no spill-over effects. Credit Suisse is making a loss and thus digging into its equity, pushing down capital buffers. A major issue seems obvious. In addition, Credit Suisse is losing customers and no new ones are coming in. That puts pressure on earnings.
The last point to bear in mind is that Credit Suisse, as its name suggests, is Swiss and thus deals with the Swiss central bank, the SNB. The SNB is much smaller than the ECB and Credit Suisse, on the other hand, is particularly large relative to the Swiss economy. That suggests Credit Suisse would pose a systemic risk for the SNB sooner than for the ECB.
I think it is also, alongside idiosyncratic factors, one of the reasons why investors are after Credit Suisse and not, say, Deutsche Bank.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every Monday on Investment Officer.
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