Is this the end of Credit Suisse as we know it?

Credit Suisse, established in the middle of the 19^th century, merged into UBS in a stock swap deal. The entire deal would take close to a year to fructify, but the writing was always on the wall. With this deal, only one out of the famous troika of Swiss banks comprising Swiss Banking Corporation, UBS and Credit Suisse remain. It may be recollected that Swiss Banking Corporation was merged into UBS in the year 1998. A full 25 years later, the Swiss troika has been reduced to just one bank.

How has the merger deal been structured?

The merger was rushed through over the weekend so that there is clarity in the markets when it reopens on Monday. Here are some of the highlights of the merger deal between UBS and Credit Suisse.

• UBS will pay SFR 3 billion or $3.23 billion for Credit Suisse as part of this Swiss government sponsored deal. Shareholders of Credit Suisse will receive 1 share of UBS for every 22.48 shares of Credit Suisse held by them. That is a payout of SFR 0.76 per share. This is higher than the original price offered by UBS, but much lower than the current market price of the Credit Suisse stock at SFR 1.86. 

   

• In exchange for the deal, UBS will assume $5.4 billion in losses of Credit Suisse. Between the years 2021 and 2022, Credit Suisse had posted cumulative losses of more than $10 billion. There will be some losses written off against the capital of Credit Suisse, while some will be taken over by the Swiss government as part of the rescue package.

   

• Once again the inherent risk of Additional Tier 1 (AT-1) bonds was underlined. AT1 bonds are perpetual bonds which can be repudiated by the issuer in extreme cases. In the case of Credit Suisse, as part of the deal, AT-1 bonds to the tune of $17 billion have been written down to zero. This is likely to anger bond holders, but there is little choice.

   

• As requested by UBS, the Swiss central bank (SNB) has offered liquidity assistance of SFR 100 billion ($108 billion). This will be an emergency line of credit that UBS can fall back upon in the event of any emergency. Since the deal price is less than half of the market price of Credit Suisse, it will wipe out substantial wealth of share owners.

There is one exit route for UBS, and that is if the credit default swaps surge above a certain point. In that case, UBS would be allowed to walk out of the deal.

What went wrong at Credit Suisse and what exacerbated the crisis?

There are two parts to this story. There are the origins of the current problems at Credit Suisse and then there were a set off factors that exacerbated the crisis. Let us look at the origins of the problems first. The problems for Credit Suisse started when it digressed from its core goal of managing wealth for the rich into investment banking. The investment banking business was extremely profitable, but started unravelling post the Global Financial crisis. However, while UBS recovered from the crisis, Credit Suisse did not.

It was a mix of bad decisions and some reckless lending by the bank. Sample these! At $5.4 billion, it was the largest financier for Bill Hwang’s Archegos Capital as well as for Greensill Capital (a supply chain management firm). Both firms are bankrupt and set back Credit Suisse by nearly $8 billion. But that was just the tip of the iceberg. Credit Suisse laundered funds for drug dealers in Bulgaria, was embroiled in a Mozambique corruption case, spied on former employees and saw massive client data leaks. Year 2022 saw some of the biggest client outflows, especially the fourth quarter seeing outflows of $147 billion.

But, the exacerbation of the crisis in March 2023 happened at two levels. Even as Credit Suisse was planning to raise equity capital to shore up its balance sheet, its largest shareholder (Saudi National Bank) refused to provide fresh capital. Saudi National Bank holds 9.9% stake in Credit Suisse. The deterioration in credit default spreads became steeper after the fall of SVB Financial and Signature Bank in the US. These banks suffered huge bond losses trying to fund a run on their deposits through a fire sale of bonds. The losses were huge amidst rising bond yields. This was expected to happen at Credit Suisse too. When the $54 billion credit line for Credit Suisse did not calm markets; it was bail out or perish.

A deal driven by regulators

Incidentally, this rescue deal was put together by the FINMA and the Swiss National Bank. In order to fast track the takeover, the government is likely to introduce legislation to bypass the 6-week consultation period for UBS shareholders. This will allow the deal to be sealed immediately. The entire framework for the deal was designed by the Swiss regulators and pre-approval has already been sought from the US and EU regulators. The priority was to ensure stability of the banking system and prevent contagion in the markets.

The regulators have also broadly laid out the future trajectory of the deal. For instance, UBS will dramatically shrink the investment banking business of Credit Suisse to less than one-third post-merger. With this deal, the only large Swiss bank left would be UBS, with combined invested assets of $5 trillion. To sweeten the deal, the Swiss government will also assume losses to the tune of SFR 9 billion. This hopefully gives breathing space for Credit Suisse (twice as large as Lehman Brothers) and for the Swiss and European Financial markets.

Where do Credit Suisse and UBS go from here?

These are early days still, but some of the numbers are surely mindboggling. In the December 2022 quarter alone, Credit Suisse lost nearly 38% of its total deposits. In the last 2 years, it had reported net losses in excess of $10 billion and 2023 was supposed to be worse. At the end of the day, the $3.2 billion offer for Credit Suisse shareholders was better than the $1 billion that UBS had originally offered, but is still less than half the depleted market price. Apparently, there were others like Blackrock in the fray, but the Swiss government was prepared to offer special protective terms only to a Swiss institution, so that left UBS as the sole suitor for Credit Suisse.

It is surely the end of the road for Credit Suisse as we know it, but it once again brings to the fore the debate over allowing banking and investment banking to co-exist under one roof. Swiss Banks had been extremely aggressive buying out global investment banks in last 30 years. Credit Suisse bought First Boston and Donald, Lufkin & Jenrette. Swiss Banking Corporation had acquired SG Warburg and Brinson Partners. UBS took over Dillon Read and eventually bought out Swiss Banking Corporation. The idea of structuring and financing deals were great when the going was good. With risks rising, these ideas are backfiring.

The big question is; whether this will again lead to legislation like Glass Steagall, to keep commercial banks and investment banks ring-fenced. One thing is clear that the struggling banks are likely to now stick to their core business; a strategy that has stood them in good stead over the years. UBS has a massive $5 trillion asset base to manage now and their challenges may just be starting.