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Prime example

29 March 2021 By Liam Proud, Jennifer Hughes

How can the collapse of a single prime-broking client wipe out the best part of a bank’s earnings for the year? That’s the question investors in Credit Suisse and Nomura are asking after both lenders warned of significant hits from the collapse of Archegos Capital Management. The glaring control failures raise questions about what other dangers are lurking in banks’ books.

Shares in the Swiss and Japanese lenders both fell by roughly 16% on Monday, wiping out a combined $8.4 billion of equity value. Nomura said it has a roughly $2 billion claim against a client, reported by Reuters to be Archegos, a family office run by former Tiger Asia manager Bill Hwang. The Financial Times reported that Credit Suisse’s losses may be $3 billion to $4 billion after the fund defaulted on margin calls late last week. The aggregate hit could be equivalent to the combined net income the two banks had been expected to generate in the current calendar year, using estimates compiled by Refinitiv.

Neither has been forthcoming about how a single client could cost them so much. True, Hwang’s underlying trades may have been dicey. According to news reports, Archegos used derivatives such as contracts for difference to make bets on richly valued companies like GSX Techedu and Baidu. Those instruments come with leverage built in, magnifying losses when markets turn. Nomura and Credit Suisse also seem to have been caught at the tail end of a domino effect which began when rivals like Goldman Sachs and Morgan Stanley seized collateral from Hwang. Sales of multibillion-dollar tranches of shares by those banks tanked stocks like ViacomCBS, leaving the laggards holding the bag.

Yet the sheer size of the losses implies a broader failure of elementary risk management. The eight stocks most frequently associated with Hwang in media reports fell by an average of 36% last week. That’s steep, but well within the bounds of the worst-case scenarios that banks should be planning for when extending credit for risky trades. It’s also hard to fathom how the banks approved such large exposures.

One likely response is that prime broking desks at Nomura, Credit Suisse and elsewhere tighten their lending standards. That in turn could spark a wave of forced selling at other leveraged hedge funds, potentially exposing other overextended investors. Archegos’ collapse hasn’t yet dragged down wider markets, but it’s far too early to declare it a one-off.

 

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