Is Credit Suisse the Lehman Brothers of 2022?

Credit Suisse is back in the headlines. And once again it’s for all the wrong reasons.

On Monday, the stock plunged to a record low of 3.52 Swiss francs on the back of a sharp spike in the cost of insuring its debt against bankruptcy.

So-called credit default swaps (CDSs) now indicate markets are pricing in an implied 23% chance Credit Suisse will declare bankruptcy in the next five years, sparking inevitable comparisons it may face the same fate as Lehman Brothers in 2008.

The global financial crisis reached its peak in September 2008 when a collapse in the subprime mortgage debt market forced Wall Street investment banking giant Lehman Brothers to file for bankruptcy.

Fortune has reached out to Credit Suisse for comment.

Given the importance of confidence in credit markets, unsubstantiated talk of distress among certain lenders can often lead to very real distress itself if there is a figurative run on the bank, and right now tensions are already running high.

Thanks to a midday rebound that carried into Tuesday’s trading session, shares in CS have now recouped all their losses.

But what underlying reasons caused the selloff? And is there cause to remain concerned?

Credit Suisse, $CS, executives spent the weekend reassuring large clients, counterparties and investors about its liquidity and capital position, the Financial Times reported.

— unusual_whales (@unusual_whales) October 2, 2022

Broader picture

Financing conditions in general have tightened ever since global central banks began hiking rates, with investors particularly concerned that aggressive action by the Federal Reserve will trigger a hard landing. Making matters worse, a looming winter energy crunch in Europe is expected to trigger a severe recession.

With markets reacting extremely sensitively, U.K. Prime Minister Liz Truss’ radical unfunded tax cut plan led to a rout in the U.K. currency and sovereign bond markets. The Bank of England was then forced to commit to a $74 billion intervention amid reports the sudden swing caught the market wrong-footed and nearly risked damaging pension funds holding $1.7 trillion in assets.

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Overall sentiment in capital markets is therefore quite volatile, especially when it comes to the financial sector.

Warning signs

Unfortunately from the perspective of major Credit Suisse shareholders like Harris Associates’ portfolio manager David Herro, the markets are quick to punish the Swiss bank in particular whenever there’s broader trouble. That is because it has replaced Deutsche Bank as the chief source of instability in Europe’s ailing banking industry.

Panned as “Debit Suisse,” the lender has suffered an 18-month-long string of scandals and embarrassing executive departures, including those of ex-chairman Antonio Horta Osorio and former CEO Thomas Gottstein.

The bank has seen its market cap drop to roughly a quarter of the 42.5 billion francs in tangible book equity. That means its stock is valued at a sharp discount to the sum total of Credit Suisse’s hard recoverable assets that can be liquidated to cover debt in the event of collapse—usually a sign of extreme distress.

While its record high CDS prices can be a further signal of trouble, it’s important to remember one key aspect about this asset class: Anyone can buy them. Hedge funds, which often employ excessive amounts of leverage to fund their speculative wagers, can bet on a default whether they own the underlying debt or not.

Experts have therefore often likened it to buying insurance in the event your neighbor’s house burns down: It can create a perverse incentive to commit financial arson.

The catalyst

With markets febrile and its reserve of confidence all but exhausted, Credit Suisse has now proposed its third restructuring plan since February 2020 when Gottstein took over.

The problems began when Reuters reported on Sept. 23 that the bank was sounding out investors over a capital increase to fund the costs of shrinking its investment banking activities. Some analysts have estimated this could require up to 4 billion francs, more than a third of what the bank is currently worth, and shares subsequently sold off that day.

Credit Suisse CDS pic.twitter.com/lInqptLYcY

— Dominic Cummings (@Dominic2306) October 1, 2022

Credit Suisse then unwittingly exacerbated its problems after an internal memo by new CEO Ulrich Körner was leaked on Friday, in which he told staff the bank enjoyed “a strong capital base and liquidity position.”

Resorting to assurances like this can backfire, creating the psychologically opposite effect intended. That proved the case, unnerving markets rather than soothing them, and Credit Suisse promptly fell 12% at the start of the subsequent trading day.

The real risk to global investors

A potential wipeout of Credit Suisse shareholders would certainly be a shock, but manageable in the broader scheme if its fallout is contained. The real risk to global investors is a domino effect, should other lenders be forced to write off large exposures to their Swiss peer that then creates cascading uncertainty across the sector.

Transparency over what kind of risks a bank is exposed to via its trading book is critical for judging contagion. One of the causes for the crash in 2008 was the preponderance of financial assets structured for tailor-made bets that were so illiquid, banks could only value them based on untested theoretical pricing models. When these proved untenable, every counterparty fell under suspicion as no one knew who held what exotic derivative.

Already spooked markets simply don’t know who is sitting on the other side of Credit Suisse trades, and are buying more insurance against a possible default elsewhere. Consequently Deutsche Bank and UBS are seeing the prices of their CDSs rise as well.

What’s next?

Credit Suisse CEO Körner is due to present his restructuring plan on Oct. 27, when the bank reports third-quarter earnings.

“The aim is to create a more focused, agile group with a significantly lower absolute cost base, capable of delivering sustainable returns for all stakeholders and first-class service to clients,” it informed markets last Monday.

More important, one thing has changed since 2008: Credit Suisse is a systemically important bank subject to the most stringent solvency requirements set out in Swiss banking laws.

Under regulations updated to reflect lessons from the global financial crisis, it must maintain a common equity Tier 1 (CET1), equivalent to a tenth of its total risk-weighted assets.

Very roughly speaking, it must hold $10 in the hardest form of shareholder capital on its books to act as a loss-absorbing cushion for every $100 it lends out.

As of the end of June, the most recent reported figure, its CET1 ratio was 13.5%, suggesting it went into the current quarter with a solid solvency ratio. The question is how much it could be diluted by the new CEO’s restructuring plan.

For now the downward spiral of ever declining confidence in Credit Suisse has been broken, but the pressure on Körner to deliver after just two months at the helm is immense.

This story was originally featured on Fortune.com