Credit Suisse: Too big to… (ignore)

The lifeline thrown by the Swiss National Bank (SNB) wasn’t long enough. After an intense, hectic weekend, the crisis-ridden Credit Suisse group has lost its independence after 167 years in business and has ended up in the hands of UBS. The emergency rescue will likely stabilize the financial markets, but Switzerland’s status as a banking center has been tarnished. For investors, the issue of diversification has taken on a whole new meaning once more.

A horrible end

“Better a horrible end than endless horror” is probably what the crisis managers at the SNB and the Swiss Financial Market Supervisory Authority (FINMA) and in Switzerland’s federal government said to themselves last weekend, because even the CHF 50 billion lifeline guaranteed by the SNB last Thursday didn’t appear to the financial markets to be enough. According to the Financial Times, Credit Suisse (CS) was hemorrhaging CHF 10 billion worth of net asset outflows per day at the end of last week. A number of counterparties were already preparing to curtail their business dealings with CS. A run on the bank possibly would have loomed on Monday of this week. A run on a bank that, despite years of decline, was still deemed a systemically important big bank, with CHF 531 billion of total assets and a prominent presence in global investment banking, might have caused further dislocations and adverse contagion effects on financial markets around the world. So, after hectic, intensive talks, Credit Suisse’s demise was sealed on Sunday after 167 years of independence. CS was rather grudgingly forced into the arms of its archrival UBS. The forced marriage is outlined below in bullet points:

• Acquisition price: UBS is taking over all of Credit Suisse with no cherry-picking for around CHF 3 billion. Shareholders of CS will receive CHF 0.76 per share (the closing price on Friday was CHF 1.86).
• Emergency law: Under the emergency decree by the Swiss Federal Council, the acquisition does not require the approval of UBS’s and CS’s shareholders. Normally, the owners of the banks would have to approve the merger at an extraordinary general shareholders’ meeting. The very strong market position of the combined CS/UBS colossus also isn’t a dealbreaker – to protect creditors, FINMA can overrule Switzerland’s Federal Competition Commission and can override competition law.
• Liquidity assistance: The SNB has granted Credit Suisse and UBS extensive extraordinary liquidity assistance amounting to a total of CHF 200 billion, consisting of a CHF 100 billion senior secured loan with bankruptcy privilege rights and a CHF 100 billion default guarantee from Switzerland’s federal government.
• Guarantee: To reduce the risks to UBS resulting from the transaction, the government of Switzerland has granted a CHF 9 billion guarantee to UBS for the assumption of potential losses arising from certain assets. However, this insurance doesn’t kick in unless a predetermined loss threshold is exceeded.

Banks always die during the weekend | First quickly, then suddenly

Credit Suisse’s stock price

Sources: Bloomberg, Kaiser Partner Privatbank

Many losers, few winners

The time pressure under which the deal was struck evidently was extremely acute. Pressure and expectations were also brought to bear by the financial markets and, last but not least, by countries abroad. So, a workable “Swiss solution” that perforce could only be cobbled together in a hurry had to be presented before the stock market opened. More sophisticatedly thought-out ideas would have taken far too much time to devise. At the press conference on Sunday evening, it therefore was vehemently emphasized that stabilizing international financial markets and Switzerland’s economy took top priority because, in the end, the solution arrived at is a compromise that creates many losers:

• Shareholders: Although CS shareholders won’t go away completely empty-handed, most of them will likely view their investment as a total loss because although Credit Suisse was on the ropes in the end, the bank was neither illiquid nor undercapitalized, nor would a turnaround have been impossible. Shareholders now have to stand by and watch the bank get sold far below market value without having a say at all in the matter.
• Bondholders: Specifically holders of subordinated bonds (Additional Tier 1 capital notes). They get nothing and have to completely write off a total sum amounting to around CHF 16 billion. Putting shareholders ahead of bondholders seemingly turns the normal creditor hierarchy enshrined in law on its head, but whoever reads the fine print on the debt securities will likely come to the realization that this is in compliance with the rules (because government aid was drawn upon and the writedown was ordered by FINMA). Nevertheless, this incident is bound to become a hot topic of discussion in the days ahead and could prompt a reevaluation of the risks associated with contingent convertible (CoCo) bonds and could lead to higher financing costs for European banks.
• Employees: Around 50,000 CS personnel will join UBS’s roughly 70,000 employees in the new megabank. Inevitably, not all of them will be allowed to remain on board in all likelihood. CS’s investment banking operations look set to be further downsized, and there are a lot of overlaps between CS and UBS, particularly in Switzerland. The combined bank reportedly intends to cut its annual operating costs by CHF 7.4 billion by 2027. Personnel expenses are the biggest cost-cutting lever.
• The Swiss financial center: Only time will tell how much lasting reputational damage has been inflicted on Switzerland as a banking center. Credit Suisse per se didn’t develop an image problem just in the last two weeks. Moreover, credit must be given to Swiss institutions for their ability to take action and for the speed with which they did. But now with a single megabank that truly is too big to fail, Switzerland appears destined to lose attractiveness as a safe haven and as a destination for investment capital, at least in the near term and possibly also in the long run.

UBS unquestionably ranks among the winners of the last few turbulent days even if the bank isn’t gloating about it. Over the weekend, UBS was in the best bargaining position and was able to negotiate a dirt-cheap purchase price: for a cost of just CHF 3 billion, UBS acquired a book value of more than CHF 40 billion. Moreover, UBS was able to limit the (legal) risks resulting from the takeover. Although UBS’s focus for the next few years now is no longer on growth as originally planned and is instead more on integration and concentration on itself, the acquisition of CS promises to yield substantial added value and looks set to deliver a positive contribution to earnings from 2027 onward. In the wake of the deal, UBS now more than ever is the undisputed number one in global wealth management. Meanwhile, its gain of additional well-educated and talented personnel is bound to be another benefit for the leader in the Swiss banking sector if UBS is able to motivate them tackle the new challenge. But UBS isn’t the only one that has something to gain; unexpected opportunities will open up for other banks as well in the months ahead, be it in the search for qualified personnel or in the acquisition of new clients. Because for many investors, the word “diversification” has likely taken on a whole new meaning once more in the aftermath of the last several days and weeks. Putting all of one’s eggs in one basket has never been a good idea, but many investors and bank customers will now likely find themselves forced to confront precisely this scenario and will soon have their money housed in just a single institution. It makes sense for them to retake their bearings and to look over the rim of the teacup. But their eyes don’t have to wander all that far because in these stormy times, the Liechtenstein financial center has once again demonstrated resilience and has proven to be the real safe haven that investors are seeking today more than ever.

Two become one | UBS is one of the winners

Market capitalization of UBS and Credit Suisse in CHF billion

Sources: Bloomberg, Kaiser Partner Privatbank