Credit Suisse rescue shockwave spreads

European and UK bank stocks slumped again on Monday morning after the weekend deal by the Swiss National Bank to fold Credit Suisse (US:CS) into UBS (US:UBS). The deal came after Credit Suisse’s market capitalisation cratered to $8bn last week; the all-share deal valued the global banking giant at just $3.25bn. 

“With the takeover of Credit Suisse by UBS, a solution has been found to secure financial stability and protect the Swiss economy in this exceptional situation,” the Swiss National Bank said. 

UK banks dropped on Monday – Barclays (BARC), Standard Chartered (STAN) and HSBC (HSBA) all fell between 3 and 5 per cent, although the FTSE 100 rebounded from initial losses to trade flat by mid-morning. Banking analysts were quick to underline the overall strength of the sector, pointing to strong liquidity levels and well capitalised balance sheets. 

“We continue to view the overall European banking sector as healthy, but the current environment is largely about maintaining confidence in the banking system, including US regional banks, which can be difficult to predict,” said UBS’ own analyst team. 

UBS shares were down 8 per cent in reaction to the deal, taking its month-to-date decline to 22 per cent. 

But the bank’s chair Colm Kelleher struck a bullish tone when announcing the Credit Suisse deal on Sunday. “We have structured a transaction which will preserve the value left in the business while limiting our downside exposure,” he said. “Acquiring Credit Suisse’s capabilities in wealth, asset management and Swiss universal banking will augment UBS’s strategy of growing its capital-light businesses.” 

The acquisition could prove lucrative once the dust settles. To the cut-price fee investors should add the fact that UBS has been permitted to write-off Credit Suisse’s additional tier 1 debt securities, known as contingent convertibles (cocos), a move that will boost the newly combined group’s equity capital by roughly CHF16bn (£14bn).

UBS will also receive several billion francs worth of protection to cover potential losses on Credit Suisse assets. The deal will cement its position in global wealth management, give it a truly dominant position in the Swiss banking market at all levels, and the bank is already talking about material cost savings to be made.

The Financial Times reported that Credit Suisse outflows hit CHF10bn a day last week, up from an already elevated CHF111bn in the whole of the fourth quarter of 2022, but UBS will assume these will now abate.

AT1 drop

The writing off of Credit Suisse’s AT1 debt, while a boon to UBS, has caused ruptures of its own this morning. “These are bonds that are designed to be written off or converted to equity in order to bolster a bank’s capital position prior to it defaulting,” noted Gary Greenwood at Shore Capital. The related selloff in other banks’ AT1 bonds will lead to higher costs of capital, he said. 

While the structure of the bonds allows for them to be written down to zero at owners or regulators’ behest, most holders – however misguidedly – still expected them to rank above equity in the capital structure. With Credit Suisse shareholders receiving some recompense, that is clearly not the case in this deal.

The bond market is repricing accordingly: the Invesco AT1 Capital Bond ETF fell almost 20 per cent, before recovering slightly once European regulators said in a statement that they would seek to wipe out equity holders before AT1 writedowns began in the event of a European bank failure. These are particularly popular funding instruments among UK banks: the treatment of Credit Suisse AT1s suggests that market will be closed, or at least much more expensive, for the foreseeable future.

What next? 

With confidence still shaky, the focus may now shift to unrealised losses on other banks’ balance sheets, as commonplace as these may be at this stage in the cycle. UBS estimates these sit at €50bn (£44bn) across the MSCI Europe Banks index. This is a “reasonable” level, the analysts said, although they added that net interest margins would come under pressure from central banks hitting the brakes on interest rate rises. 

Greenwood said UK banks “could not be in a stronger position to withstand the current economic downturn” because of “strong capital, funding and liquidity, and asset bases that are now much lower risk”. 

Market expectations have already shifted significantly regarding interest rate rises, with the 0.5 percentage point European Central Bank rise last week potentially the last big rise from the bloc. Economists expect a 0.25 percentage point rise from US Federal Reserve this week, but then a freeze afterwards. 

Neil Shearing, chief economist at Capital Economics, said a “reasonable base case” was for further problems to emerge at other banks, but for the world to avoid a “system-wide crisis on the scale of 2007-08”. 

He added that bank lending would likely “contract in most advanced economies” and interest rates could peak below current forecasts. That contraction in lending, in a worst-case scenario, would knock major economies and eventually lead to a rate-cutting cycle to bring back growth. Some indicators point to a Fed rate cut as early as June.