So frantic was the demand for the derivatives, known as credit-default swaps, that they spiked to levels that signal Credit Suisse is in deep financial distress — something unseen at a major global bank since at least the throes of the financial crisis.

The surge came after the chairman of the lender’s biggest shareholder, Saudi National Bank’s Ammar Al Khudairy, said it doesn’t want to boost its stake in the lender for regulatory reasons.

Banks rushing to buy the CDS to reduce their counterparty risk exacerbated the move, according to people with knowledge of the matter. 

Chaotic Day

In a chaotic day of trading, quotes for one-year credit default swaps were considerably more expensive than the offers for longer durations as lenders tried to give themselves a near-term shield from their exposure to the lender, the people said.

Bid-ask spreads were as much as 10 points apart upfront, they added, asking not to be named because they aren’t authorized to speak publicly. So far, the moves are limited to Credit Suisse and haven’t spread to other lenders. The bank declined to comment. 

Banks buy and sell derivative contracts and other instruments constantly, meaning they assume counterparty risk when they take the other side of a trade. When the default risk of a lender increases, it can lead to mark-to-market losses known as a credit valuation adjustment even if the institution meets its obligations. 

Hedging Risk

“CVA desks need to hedge counterparty risk,” said Jochen Felsenheimer, a portfolio manager at XAIA Investment. “Assuming they have been hedged at the end of 2022, they still have to hedge additionally on recently opened trades and against mark-to-market losses.” 

Even if the trades are limited in size, it has a dramatic impact on derivative prices because of thin volumes, he added. The pricing means it’s almost impossible for people to hedge now, said Baylor Lancaster-Samuel, Chief Investment Officer of Amerant Investments. At some point, it “is so expensive that it does not make sense to put it on.”

While the bank has insisted that its financial position is sound, the spiking CDS prices are causing turmoil in the market. Similar moves were seen in the short-term credit derivatives linked to banks such as Morgan Stanley in the aftermath of the Lehman Brothers collapse in September 2008.

Market Jitters

Jitters in the market following the failure of Silicon Valley Bank have caused CDS trading volumes overall to reach their highest levels in nearly six months this week, data compiled by Bloomberg show.

Credit Suisse’s bonds, meanwhile, dropped by as much as 40 cents on the dollar Wednesday, making it by far the biggest decliner amid a broader credit slump led by bank debt. The lender has €41.8 billion ($44 billion) of bonds maturing by the end of 2024, according to data compiled by Bloomberg.

“Unlike Silicon Valley and Signature Banks, CS is a global systemically important banking institution,” said Scott Kimball, managing director of fixed income at Loop Capital Asset Management, which has a position in the lender’s bonds. 

“We can compartmentalize the former two as one-offs, but the persistent problems at CS carry bigger problems for the credit markets,” he added. “They can’t seem to get the ship right.”

Complex Restructuring

Credit Suisse, which is in the middle of a complex three-year restructuring, has been struggling to contain deposit outflows. The bank appealed to the Swiss National Bank and regular FINMA for a public show of support after Wednesday’s share price rout, the Financial Times reported earlier.

Credit-default swaps on Credit Suisse covered a net notional of $2.06 billion of debt as of Friday, a slight increase from previous weeks, according to the latest available report from the Depository Trust & Clearing Corp. Data for this week isn’t available. 

“The trading levels have become somewhat a crisis in confidence in Credit Suisse,” said Mark Heppenstall, president of Penn Mutual Asset Management. “People are looking for any way possible to get protection.”

–With assistance from Carmen Arroyo, Tasos Vossos, Giulia Morpurgo, Josyana Joshua and Caleb Mutua.