How did Credit Suisse end up being bought by UBS?
Credit Suisse has been struggling for several years. It became a focal point of concern again following the collapse of Silicon Valley Bank in California, and Signature Bank in New York. Credit Suisse’s annual report, published just days after regulators announced the closure of Silicon Valley Bank, announced it had found “material weakness” in its financial reporting processes. The report was due to be published a few days earlier but had been delayed following a call with the US Securities and Exchange Commission. The day after the report was published, Saudi National Bank (SNB), Credit Suisse’s top shareholder, said it would not invest more in the lender.
The combined effect of the publication of Credit Suisse’s annual report and SNB’s statement led to a spike in Credit Suisse’s credit default swaps, which in turn prompted further panic and accelerated deposit outflows, ultimately resulting in a liquidity crisis. A US $54 billion loan from the Swiss central bank failed to provide an adequate lifeline, prompting the Swiss authorities to push UBS to agree to the takeover as the best way to achieve an orderly resolution of Credit Suisse’s difficulties.
Does the decision to wipe out Credit Suisse’s AT1 bonds mean that AT1 bonds issued by other banks are at risk?
Under Swiss rules, national regulator Finma already had broad discretion on when it could impose losses on AT1 investors, including the scope to write instruments down to zero before equity is wiped out — and this is exactly what it decided to do with Credit Suisse’s AT1 bonds. To ensure the move was legally watertight, the Swiss government passed an emergency law allowing the merger to go through without shareholder approval. The move was greeted with alarm because bondholders usually rank above shareholders in the capital structure.
Following Finma’s decision, the European Central Bank (ECB) moved quickly to reassure investors that it would not target AT1 bondholders in the same way and would respect the traditional hierarchy between bondholders and shareholders. However, despite the ECB’s reassurances, the write down of Credit Suisse’s AT1 bonds highlights the inherent risks associated with this asset class and the scope for financial authorities to pass emergency laws to protect financial stability. It also indicated that the markets had perhaps become complacent and were pricing AT1 bonds too tightly.
There are concerns about the potential systemic risk of this situation. Do you anticipate further volatility — and possible consolidation in the banking sector?
The crisis of confidence in the banking sector appears to have been contained for now. However, the situation remains fragile. Liquidity is incredibly important for banks — if a bank has a liquidity crisis, it can easily turn into a solvency crisis. And in the age of digital banking, money can be withdrawn much more quickly than in the past. If central banks continue to hike aggressively, the potential for further deposit outflows remains.
The European banking sector is already fairly well consolidated, so further consolidation is only likely to occur on an involuntary basis. However, we may see more banks reduce or sell off their overseas operations and retrench to their core markets — a trend we have already witnessed over the past few years.
What have recent events taught us about the level of support authorities are willing to provide to banks and which sectors may therefore be more attractive?
To some degree, the regulatory framework built up after the global financial crisis has worked. However, the rapid escalation of the risks that led to the collapse of Credit Suisse came as a shock to many. Regulators and governments will likely continue to focus on the stability of the financial system and will use whatever tools at their disposal to achieve that. There also appears to still be a strong preference among regulators for national solutions to these issues.
Will the recent turmoil in the European banking sector influence the ECB’s hiking path?
The ECB’s main statutory objective is stability — in its March press conference, President Lagarde took pains to emphasise that there is no trade-off between price stability and financial stability and pledged that the bank will take a ‘robust’ approach in tackling inflation. The terminal rate is still likely to be around 3.75-4% — however, the possibility that it falls short of that level, or hits it but then falls rapidly back, has probably increased because of recent events.
What would be required for you to become more confident in the financial sector?
Four things:
- Deposit stability
- The strengthening of deposit insurance schemes
- Stronger endorsement by regulators of the health of bank balance sheets, for example by allowing banks to issue generous dividends and undertake share buybacks
- A more attractive risk/return trade-off
Are there any potential winners from recent events?
What ultimately separates winners from losers is the ability to expand margins and to maintain stable deposits — it’s about the perception of safety. Invariably, it is the large national champions that benefit from periods of instability as there is a flight to quality. In Europe, these are likely to be the major national banks in each country that are generally regarded as safe havens. These are the types of institutions that are able to keep their deposits without having to reprice them and damage their margins.
Given recent events, are banks now attractively valued?
There is probably more bad news priced into bank share prices at present than there is in the rest of the market. Banks are currently trading below their price-to-tangible book levels, which suggests there is scope for valuations to rise again once the crisis of confidence is over and there is a perception that stability has returned.
From a fixed income perspective, we believe that the spread premium offered by banks is currently attractive compared to other corporates in the investment grade space. The collapse of Credit Suisse obviously caused a shock, but It also created attractive entry points in the senior debt and subordinated debt of specific banks. In-depth fundamental research can help filter the most attractive opportunities of the sector.
