News Flash - March 2023 - Crédit Suisse
The Swiss authorities stated that the best solution for CSG would have been a solution without third-party involvement, but the merger with UBS was preferred due to adverse market conditions. We consider that investors in European banks should now focus readjusting the write-down of the AT1 (Additional Tier 1) bonds given that the extraordinary
support provided by the government will result in Credit Suisse’s AT1 bonds, with a value of approximately CHF 16 billion, being fully written down. This write-down of the AT1 bonds of a systemically important bank will, in broad terms, have adverse implications for the AT1 bonds of other European banks and for banks’ overall funding profiles and cost of equity. The law firm QUINN EMANUEL URQUHART & SULLIVAN has said that it has held discussions with a “significant percentage” of Credit Suisse’s AT1 bondholders concerning possible legal action following the UBS-CSG agreement. The holders of senior notes are not, however, impacted.
Under the terms of the transaction, Credit Suisse’s shareholders will receive 1 UBS share for every 22,48 Credit Suisse shares they hold, equivalent to CHF 0,76 per share and a total amount of CHF 3 billion. The transaction is scheduled to complete Q2 2023, provided that it receives swift regulatory approval. UBS also stated that it remained committed to paying progressive cash dividends and that it was temporarily suspending share buybacks. UBS expects the transaction to have a positive impact on earnings per share by 2027 and the bank remains capitalised well above its 13% target.
UBS is protected against the losses derived from the CHF 15,8 billion of Credit Suisse AT1 instruments written off by FINMA. In addition, in relation to non-essential assets, while the first CHF 5 billion of losses are to be assumed by UBS, the next CHF 9 billion of losses above that amount are being protected by the Swiss authorities, with the next CHF 2 billion being protected by FINMA.
The two banks have unlimited access to the existing facilities provided by the Swiss National Bank (SNB), under which they are able to obtain liquidity from the SNB in accordance with the guidelines on monetary policy instruments. In addition, under the Federal Council’s Emergency Ordinance, Credit Suisse and UBS may obtain a liquidity assistance loan, with privileged creditor status in the event of bankruptcy, for a total amount of up to CHF 100 billion. Under the Federal Council’s Emergency Ordinance, the SNB may grant Credit Suisse a liquidity assistance loan of up to CHF 100 billion, backed by a federal default guarantee from the Confederation.
UBS expects the merger to result in a company with more than USD 5.000 billion of invested assets, including more than USD 3.400 billion of assets invested in wealth management on a combined basis, operating in the most attractive growth markets. The combined asset management activities will have invested assets of more than USD 1.500 billion. UBS also intends to retain CSG’s Swiss bank.
FINMA has stated that the takeover will result in a larger bank, for which the current regulations require higher capital buffers.. FINMA will grant appropriate transitional periods for these to be built up. UBS has stated that its target CET1 ratio (a key measure of banks’ financial strength) will remain at 13%.
After years of stagnation, shares in European banks are finally enjoying a period of growth as a result of investors betting on them being the main winners from the rise in interest rates. We remain confident that the results of European banking shares will be strong in the first quarter of 2023. However, the sudden crisis, first in the form of the insolvency of Silicon Valley Bank (SVB) in the United States, and then in relation to Credit Suisse, which resulted in it being taken over by UBS, is a warning sign and gives investors, the banks in the region and all equity markets in Europe, on which financial stocks have the greatest weighting, pause for thought.
Many funds had taken positions on European banks and short-term bonds. Despite the recent sharp fall, confidence has been shaken at least temporarily, and the potential for a recovery in banking shares is probably more limited than before, as many investors have become much more cautious. Against this backdrop, we are reducing our overweight positioning in European banks to become neutral.
Our positioning
The central scenario has not changed. We are still in an environment of economic slowdown coupled with monetary tightening, which is having a significant impact on lending conditions. If we add persistent inflation, particularly in the core portfolio, we have all the ingredients for a hard landing. Admittedly, for the time being, the economy continues to hold up, but these unfavourable conditions are likely to ultimately impact business activity and employment.
Despite widespread hopes of a soft landing at the beginning of the year, this view is clearly being challenged by the stress being caused to the banking system. This situation will continue to tighten lending conditions, and will therefore increase the monetary tightening already in place.
Admittedly, we were of the view last month that the recession was becoming more remote. Certain indicators, such as employment, were still too resilient to suggest that a recession was imminent. That said, a recession remained on the horizon as a result of monetary tightening. Today, the stress being caused to the banking sector demonstrates the initial damage caused by such monetary tightening. Of course, incidents of this type are very difficult to predict, but in a “risk management” approach, it must be acknowledged that they are more likely to occur in the current macroeconomic environment.
The recent dynamics on the banking sector are putting pressure on the market. Although European banks are more solid than US banks (due to their CET1, LCR, etc.), the entire sector would be impacted in the event of a crisis of confidence.
We have therefore decided to adjust our call on the European banking sector in view of current concerns and are returning to a neutral positioning.
