The primary role of the Public Trust Advisors Credit Team (Credit Team) (California CLASS Investment Advisor and Administrator) is to evaluate the credit profile of investable entities and determine their suitability as counterparties. Lofty words? Yes. But what do these lofty words mean down in the trenches? As with any high-level description, the practical details of what really goes on behind the curtain is buried. Simply put, your Credit Team is in a continual, unending battle to stay one step ahead of potential reactions to rating agencies directly and by other market participants. During times of credit deterioration, for example, your Credit Team aims to ensure that they are not caught running for the exits with the rest of the market. This ‘alert readiness’ requires credit analysts to be well-versed in recent company-specific information; understand the ever-changing macroeconomic and regulatory environments across a multitude of geographies; and form independent opinions that are not always in line with the prevailing market consensus. To provide better insight into your Credit Team’s processes, we’d like to take a look at our most recent downgrade example, Credit Suisse.
Credit Suisse has been one of the most prolific news stories of 2023, as financial analysts and journalists alike spent the first several months of the year expounding on its persistent operational pressures and speculating about its future. Those speculations were put to rest in late March when the bank was formally sold to a competing Swiss bank, and its existence as an independent financial institution came to a close. The iceberg was seemingly averted – the part above the water – but to better understand the Credit Suisse story from a credit perspective, it is necessary to look deeper and back much further in time.
Through much of 2021, concerning reports from Credit Suisse were becoming more frequent as the bank was dealing with looming potential losses and ongoing lawsuits. However, these reports were projections, and the outcome would either be material or immaterial to the rating. The bank was supported by a strong capital position as well as a positive operating performance during this time and, as a result, the Credit Team held steady with limits already in place on the purchase of Credit Suisse’s money market instruments. The Credit Team maintains several tools at its disposal to reflect their opinion about the creditworthiness of an entity. Two powerful tools include (a) the ability to limit either the allowable exposure to a certain company as a percentage of total holdings or (b) to limit the allowable duration of money market instruments purchased from that entity by Public Trust. In the Fall of 2021, the tools were ready when needed.
In October 2021, the Credit Team lowered the allowable duration of Credit Suisse money market instruments from any (permitted instruments) to only those maturing within 180 days. The tighter restrictions were made in response to questions surrounding the bank’s risk management and internal controls. Credit restrictions were not stricter given the bank’s maintenance of strong capital and asset quality.
Over the next several months, the Credit Team imposed further restrictions on Credit Suisse instruments in response to its CEO departing; management turnover; mounting concerns around risk management practices; and in anticipation of a potential negative rating action at one of the credit rating agencies. By February 2022, limitations had been tightened to the strictest levels that still allowed investment and only permitted investment in Credit Suisse instruments maturing within 60 days, and those collective instruments needed to account for less than 5.00% of Public Trust holdings. Just a few months later in May 2022, the credit rating agencies took negative rating actions to reflect the deteriorating Credit Suisse credit profile. S&P lowered the bank’s credit rating by one notch, and the bank was placed on a negative outlook at Moody’s.
The ability to parse through the “noise” in the market to determine what is both relevant and accurate is among the primary skills of a credit research analyst. The Credit Team, toolbox at the ready, saw the difference between thin ice and solid footing, decided there was no longer any level of investment that could be held safely in the bank, and made the decision to remove Credit Suisse from its approved list in July 2022. Just five days later, the bank’s credit rating was downgraded by one notch at Moody’s and placed on negative outlook at S&P, with similar events unfolding until its eventual sale.
Few credit stories are as severe as the credit deterioration that occurred at Credit Suisse, but it serves as the most recent example of what a Credit Team’s purpose is and how proactive decision-making can assist clients like California CLASS. Your Public Trust Credit Team does not work in isolation, but rather in conjunction with its Portfolio Management and Operating teams to prioritize California CLASS protection of client capital. If you would like to meet with your representatives to discuss questions in general or regarding credit in particular, we will gladly arrange!
Taylor Budrow, CFA®
Senior Credit Analyst
Public Trust Advisors, LLC