UBS agreed to acquire Credit Suisse - Yet the bigger risks remain

Andrew Williams, Investment Director – Value Equities at Schroders

What has happened?

A banking shock that started in California, has reminded the world that banks are businesses that critically depend on the confidence of depositors and investors.

Silicon Valley Bank’s issues were specific to the US technology-focused lender. A combination of weak capital, weak liquidity and depositor concentration caused the bank to unravel in a matter of days. The ramifications of that collapse have yet to fully play out, but the financial world asked (as it always does) who else is vulnerable. Signature bank, another tech focussed bank had similar issues to SVB and has also been taken over by receivers. Regional US bank failure risk remains with all eyes on First Republic today.

Credit Suisse was in a much stronger position from a capital perspective but yet again the recent events serve as a reminder that a bank run is fundamentally about confidence. If you don’t trust the bank to be able to pay your money back in the future, you take your money out now. And if everyone does that simultaneously, it can be fatal for any bank.

Over the weekend, UBS agreed to acquire Credit Suisse at a price of 1 UBS share for every 22.48 shares in Credit Suisse, meaning Credit Suisse shareholders will own just 5% of the combined group (and the deal represents a 60% discount to Friday’s closing price). Credit Suisse’s AT1 securities are to be written down to zero (additional Tier 1 bonds, or AT1s for short, are a key instrument in regulators’ post Global Financial Crisis (bail-in regime). In addition, the Swiss National Bank is providing a CHF100bn liquidity line is being provided (that’s double last week’s CHF50bn line).

We reiterate our view that this is not 2008, and the balance sheets of banks are much better protected, within a regulatory framework designed explicitly to protect against these kind of issues (at least for the major global banks – Donald Trump, perhaps unwisely, relaxed the rules for US regional banks in 2018).

We also take some comfort that no other major European bank is in Credit Suisse’s position. The market was worried about the risk of contagion. The deal over the weekend has removed the risk of a messy collapse of Credit Suisse, which should be positive for the sector. Moreover, the wider banks sector is in a very different (and better) situation than the Global Financial Crisis. Coming into the GFC banks were weakly capitalised, there was no liquidity regulation, no central bank liquidity support playbook, and no concept of bail-in capital. Many banks had also seen very rapid balance sheet growth and many had balance sheets stuffed full with securities and CDOs that they thought were AAA rated but were actually worthless. None of this is the case today.

The bigger risk from the fallout remains; a broader collapse in financial market confidence feeding into a lack of economic confidence, a recession, spiking unemployment, collapsing real estate prices and a sharp downswing in rates. This does not seem probable today, and if it does happen the consequences will be felt far beyond the Banking Sector.