A crisis is (hopefully) averted as UBS bails out Credit Suisse

It is remarkable that the failure of two insignificant banks in the US could topple a 167-year-old institution of globally systemic importance. But the contagion from the US regional bank crisis has driven Credit Suisse into the somewhat reluctant arms of UBS.

The failure of the Silicon Valley and Signature banks in the US last week and the fears those failures ignited among US regional lenders more broadly quickly spread to a Credit Suisse made vulnerable by its recent string of costly mistakes and the massive outflows of client funds it experienced.

What began as a manageable liquidity issue last week as Credit Suisse customers began to withdraw their funds rapidly escalated into a fully-fledged crisis with international dimensions.

Swiss authorities described the outflows Credit Suisse experienced towards the end of the past week as massive.Credit:AP

The Swiss authorities were forced to double the scale of the liquidity support they provided from 50 billion Swiss francs ($80 billion) to 100 billion francs as they quickly realised they were confronted with the failure of a bank that was too big in both the domestic and international contexts to be allowed to fail.

At the press conference in Switzerland on Sunday announcing the deal, the Swiss authorities described the outflows Credit Suisse experienced towards the end of the week as “massive” amid a “huge loss of confidence”.

Despite having the capital and, with the Swiss central bank’s support, access to the liquidity it needed to be viable, they said, ultimately that loss of confidence was just too great to halt the downward spiral.

The obvious solution in the short time available – because if there had been no solution over the weekend, events would have inevitably condemned Credit Suisse – was to convince the other and far bigger Swiss bank UBS to acquire its smaller rival.

That was an option because Credit Suisse’s problem was liquidity – the out-of-control “run” it was experiencing – rather than solvency.

UBS was initially reluctant to take on a bank with a very different and, in the time available, difficult-to-assess risk profile to its own.

It would also have been very aware that acquiring Credit Suisse would make UBS a bank really too big to fail, ensuring far more intrusive regulation and probably tougher capital and liquidity requirements – which is what has now transpired from Swiss regulators acutely conscious that they will soon have one dominant bank with a balance sheet worth multiples the size of its economy. UBS will now probably be the most intensely-supervised bank on the planet.

What the chain of events has demonstrated is that trust in banks is fragile, and that even a well-regulated bank like Credit Suisse can be completely destabilised and forced to the brink of failure by the aftershocks of trust lost elsewhere.

Yet UBS’ own self-interest in avoiding the global financial crisis that would have been triggered by a collapse of Credit Suisse, a crisis whose epicentre would have been its own home base of Switzerland, helped convince it to join the authorities in a rescue of its rival.

As the only obvious saviour of Credit Suisse, and the Swiss economy and financial system, it has driven a hard bargain.

Initially, it offered a meagre 25 francs for shares that last traded at 186 francs, but was convinced to up its offer to an all-share offer equivalent to 76 francs per Credit Suisse share, with the Swiss government and central bank guaranteeing 100 billion francs liquidity support for each of the banks and taking on a “second-tranche” 9 billion franc exposure to any losses UBS incurs from taking on Credit Suisse’s riskier assets.

UBS said its “first loss” exposure was significant, but that the limited nature of the due diligence it had been able to undertake of Credit Suisse’s long-dated derivatives and other complex exposures warranted the insurance from the government.

The offer values Credit Suisse’s equity at about $4.85 billion, but appears to completely wipe out the value of about $25 billion of the bank’s “additional tier one” bonds (the post-financial-crisis unsecured securities known as perpetual contingent convertible bonds, or “Cocos,” designed to converted into equity or completely written off if a bank gets into serious strife).

Given that the bank’s market capitalisation on Friday was close to $12 billion – as recently as the start of last month it was about $22 billion and three years ago closer to $86 billion – shareholders and bondholders have taken a massive hit from a deal they will have no say in.

For UBS, the government’s back-stopping and limiting of any losses it might experience, the wipe out of the Coco bonds and the valuation of Credit Suisse’s equity, largely de-risk the deal. It will emerge with more than $2.2 trillion of assets under management and about $7.5 trillion of total assets and says it expects to generate annual run-rate cost reductions of more than $12 billion by 2027.

The risky part of the process for UBS will be how it manages down and de-risks the “tricky” businesses within Credit Suisse’s investment banking division. UBS has its own investment banking operations, but indicated it will essentially shut down the Credit Suisse counterpart over time. The Swiss government’s guarantee at least caps its potential losses, although it didn’t disclose the level of that cap.

Swiss government ministers and bank regulators speaking at the press conference made it clear that the crisis unfolding in Switzerland was being closely monitored by their counterparts in the rest of the world because of the risk that a Credit Suisse failure could spread contagion throughout the global system.

Whether the intervention and actions by the Swiss authorities, with UBS and its balance sheet’s help, are sufficient to prevent any further contagion won’t be clear for days, if not weeks.

If the failure of a couple of banks in the US with combined assets of less than $450 billion could spark major tremors in bond and equity markets, runs on other smaller banks in the US and a crisis in a bank of global systemic importance, then the failure of that globally significant bank could have created another global financial crisis.

What the chain of events over the past week has demonstrated is that trust in banks is fragile, and that even a well-regulated bank like Credit Suisse, with the onerous capital and liquidity requirements and intrusive supervision that banks of global systemic importance attract, can be completely destabilised and forced to the brink of failure by the aftershocks of trust lost elsewhere.

Whether the dramatic intervention and actions by the Swiss authorities, with UBS and its balance sheet’s help, are sufficient to prevent any further contagion from the events of the past week won’t be clear for days, if not weeks.

The flood of cash out of the regional banks in the US that the Silicon Valley and Signature bank failures kindled appears to have slowed, and now the fate of the most exposed of the international mega banks has been resolved.

The surge in US bond yields that helped exacerbate the fears around banks – by piling up the unrealised losses on securities that the smaller US banks (which don’t mark their assets to market) might need to sell to meet a run on deposits – has also receded.

Absent another failure or near-failure, or a decision or statement that emerges from the US Federal Reserve Board meeting this week that unnerves the markets, the decisive actions taken by the US and Swiss authorities in response to the stresses within their banking systems may be enough to prevent something quite catastrophic from developing.

The alternative, given the experience of the 2008 banking and financial crisis, is more than disturbing.

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