Over the March 17th weekend, Swiss banking giant UBS acquired its cross-street rival Credit Suisse (CS) after the first globally systemically important bank (GSIB) failure since the 2008 global financial crisis (GFC). Existing Credit Suisse (CS) shareholders would receive one share in the new UBS in exchange for 22.48 shares of CS, valuing the shares at roughly CHF0.83, 1/10th the price compared to the roughly CHF8 they were trading at a year ago. Additionally, approximately $17 billion of Alternative Tier 1 (AT1) high-risk bonds of the company were also wiped, lessening the debt burden on the acquiring entity.
After years of seemingly one-off losses tied to lax risk controls, numerous attempts at turnarounds, a veritable merry go round of CEOs who each tried a variety of strategies, and outflows from depositors in its wealth management and private banking divisions, the viability of Credit Suisse as a standalone going concern came under question as the banking crisis in the U.S. fueled doubts of a quick improvement. Despite an extraordinary CHF50 billion lending facility extended to the beleaguered bank on March 15th by the Swiss National Bank (SNB), the country’s central bank, outflows continued, and the decision was taken to merge the weaker CS with its much sturdier rival UBS.
Are there any continued Contagion Risks?
While Credit Suisse’s failure on the heels of the implosion of Silicon Valley Bank, Signature Bank and the stress of First Republic have led many to label the current crisis the next global financial crisis, the scope, breadth and causes of the two crises are vastly different. Credit risk, which played a central role in the 2008 crisis, specifically in the form of sub-prime mortgages and counterparty credit defaults, has not played a notable role in this crisis. Secondly, the risk has thus far been contained to regional banks inside the U.S., while Credit Suisse was stressed for quite some time. Third, the 2008 crisis was worsened by derivatives, the scale of which were not well understood by most executives and regulators at the time. Lastly, banks are significantly better capitalized today than they were 15 years ago.
Was the sale rushed and is that a sign of a bigger hidden risk?
While the transaction may have happened swiftly in the eyes of many, it is standard operating procedure for regulators to act promptly in times of crisis. In this case, the “resolution weekend” is the term given to the resolvability workaround that stressed banks undergo. Regulators announce a closure or merger after-bank-hours on Friday with the intention of reopening by bank hours on Monday morning with a firm solution in place for the future of the business. A similar “resolution weekend” was announced with Silicon Valley Bank, with the FDIC stepping in on Friday, and guaranteeing depositors capital by Sunday evening. These steps are taken to ensure smooth operations for the customers of the banks and are actually indicative that the regulators’ contingency plans are working as they should.
How has the Market reacted?
Despite the fact that Credit Suisse is twice the size of Lehman Brothers, the markets reacted positively to the news of the takeover on Monday. The S&P finished the day up almost 1%, while equity exchanges in Europe were also up around a similar level. The U.S. Treasury 10-year note yield climbed by approximately 9 basis points. Even oil prices gained, with Brent finishing the session up by 1.2%, after hitting a 15-month low on Friday. Crypto assets remained steady, with Bitcoin hovering around the $29,000 level.
What are the business implications of the move?
Furthermore, outflows from regional banks in the U.S. have usually landed in the coffers of larger banks, with JP Morgan Chase, Wells Fargo and Bank of America being the biggest benefactors. It is true that the FDIC may increase the deposit insurance from the current $250,000, and the Fed may impose more stringent regulations on small and medium sized banks. These steps could increase the costs faced by banks. However, those costs could be passed on to customers in the form of lower interest paid on deposits.
What should investors do?
In the medium term, we believe any significant pullback in the banking sector would create an attractive buying opportunity. Banks remain well capitalized and have sufficient liquidity in the short-term to handle most scenarios of increased redemptions and withdrawals. Further, the numerous recent rate hikes have increased the net interest margin for banks as the interest income earned on loans has risen a lot faster than the interest income banks pay on money they have borrowed or taken as deposits. On a broader level, a more dovish Fed is always a positive for the stock market. We believe long-term investors should remain committed to their strategies as the current noise in the market will most likely subside in the upcoming quarters.
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