Swiss banking deal will help restore confidence

Last night, a deal was announced in Switzerland whereby UBS will take over its long-time competitor Credit Suisse. The deal followed a period of unrest around Credit Suisse and was put together with strong involvement of the Swiss authorities. UBS will pay around CHF 3 billion (more than USD 3 billion) for Credit Suisse, which resembles a significant discount compared to the closing price of shares in Credit Suisse last Friday. The Swiss National Bank will provide additional liquidity and the Swiss government will provide guarantees on potential losses if such losses were to exceed a certain threshold. As part of the government’s rescue package, around CHF 16 billion worth of so-called "additional tier 1 bonds" (AT1 bonds) will be written off completely (additional tier 1 bonds are bonds issued by a bank, whereby the value can be written off if specific capital ratios of a bank fall below a certain threshold).

At first sight, the agreed take-over price seems very low compared to the market value of Credit Suisse in the recent past. At the end of 2022, the market capitalisation of Credit Suisse was exceeding CHF 20 billion. The main reason for this seemingly low take-over price is that it is impossible to foresee how clients of Credit Suisse are going to respond. After all, clients withdrawing their money due to a lack of trust in Credit Suisse lies at the heart of the problem. It is also unclear what kind of future losses and potential lawsuits will have to be dealt with by the new owner UBS.

In our view, the take-over deal is a difficult but necessary step to rebuild confidence in the banking sector. The deal was made under a lot pressure in order to be finished before markets would open on Monday morning. It is good news that this goal has been achieved, even though the deal is a bitter pill to swallow for Credit Suisse shareholders and particularly for investors in Credit Suisse AT1 bonds.

Even though we see this as an important step to rebuild confidence, there is still a lot that needs to be done. First, the question is what will be the impact of the write-down of Credit Suisse’s AT1 bonds. It is currently unclear who were the investors in these bonds and what the impact of the write-off will be on the institutions holding these bonds. Major central banks (including the Federal Reserve and the European Central Bank) have announced to offer additional liquidity to further support the financial industry if needed. Next to the Credit Suisse AT1 bonds, AT1 bonds issued by other parties – traded in the broader markets for subordinated bonds – are likely to be repriced, as the write-off of Credit Suisse’s AT1 bonds could also lead to a change in how other more risky bonds are perceived by investors. For the holders of more senior bonds issued by Credit Suisse, the takeover deal is good news, as there are no write-offs on these bonds expected for now.

As to the situation in the US banking sector, unclarity related to regional US banks remains. Last Friday, regional banks were again under pressure, as investors feared that clients will continue to withdraw deposits, ultimately leading to a situation comparable to Silicon Valley Bank (which collapsed a week earlier). Finally, we expect that banks will be less eager to hand out new loans (tightening of their lending criteria) and that they will try to attract more deposits by offering higher interest rates.

Our view on the financial sector remains unchanged. After a period of significant outperformance of European banks – supported by higher interest rates and stronger economic growth than expected – the recent developments in the banking sector are putting financial stocks under pressure, as banks have to face new challenges. These challenges include the possibility that regulators will impose higher capital and liquidity requirements on banks in coming quarters. Consequently, we remain neutral on the sector financials.

The impact of the turmoil will mainly come via tighter financial conditions. We have seen that financial conditions have tightened significantly over the last week (see figure). Tighter financial conditions put pressure on economic growth. For example, as banks become more conservative, credit growth will decline. For companies, this means it will be more difficult and/or more expensive to obtain loans, resulting in lower investments by these companies. Here, it is important to remember that lower growth is actually something that central banks are currently trying to achieve, as a decline in growth should help to curb high inflation. We still expect a further 25 basis-point rate hike by the Federal Reserve later this week.

Even though we believe that the take-over of Credit Suisse by UBS is a good step to restore confidence, we do expect that volatility will continue over the coming weeks. Equity markets in Asia and Europe have opened lower this morning, as investors are digesting the news. In volatile markets, we recommend investors not to make significant changes to their investment portfolios. Central banks have indicated that they stand ready to act if necessary, which provides support to markets. However, it is too soon to consider the current market developments as an opportunity to increase risk in the portfolio.

Richard de Groot
Global Head Investment Centre