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What Happened to Credit Suisse?

by internationalbanker

By Nicholas Larsen, International Banker


On March 20, reports confirmed that UBS had agreed to buy Credit Suisse for CHF3 billion, or 76 cents a share, representing a massive discount to its tangible book value, as the once-mighty Swiss banking stalwart teetered on the edge of failure. But the private and convention-defying nature of the deal has spawned much dismay across Switzerland and seriously risks permanently damaging the reputation of one of the world’s premier financial centres.

Even before the recent wave of US banking collapses, Credit Suisse had seen client funds leave in droves amid a loss of confidence in the lender, which had consistently ranked among Switzerland’s leading financial institutions since the 19th century. Indeed, numerous high-profile scandals contributed towards exposing grave inadequacies at the bank, including its failure to address money-laundering activities among clients, losses in billions of dollars from the liquidation of US hedge fund Archegos Capital Management, the ill-fated decision to use client money to invest in fraudulent financial firm Greenhill Capital and the bank’s failed “tuna bonds” scheme to fund a tuna-fishing and maritime-security project in Mozambique.

But the collapse of US Silicon Valley Bank (SVB) in March exacerbated the already fragile situation for Credit Suisse, despite there being no systemic connection between the two institutions. And when on March 15, Ammar Al Khudairy, the chair of Saudi National Bank (SNB)—Credit Suisse’s biggest shareholder with a 10-percent stake—publicly ruled out the possibility of more financial assistance being made available, the bank’s share price plummeted, prompting a mass exodus of cash deposits from Credit Suisse accounts, the non-renewal of maturing time deposits and the curtailment of credit limits by numerous trading counterparties. That same day also saw the bank request an emergency credit line of CHF50 billion (US$54 billion) from the Swiss National Bank (SNB), but this was not enough to prevent the outflow of funds as clients continued to flee the bank, with $35 billion estimated to have exited in just three days.

The bank’s fate was ultimately decided on March 20 when Swiss regulators arranged a rescue by its larger Swiss banking peer, UBS—a bank that needed saving itself in 2008 by the Swiss government—in a $3.25-billion deal that has seen it absorb $5.4 billion in losses from unwinding Credit Suisse’s risky assets, such as its derivative contracts. The deal creates the world’s fourth-largest bank by assets, managing $5 trillion in assets and employing 120,000 staff in total, while the newly merged entity will also receive more than CHF260 billion ($280 billion) in state and central bank support—approximately one-third of Switzerland’s entire gross domestic product (GDP)—to shore up the Swiss banking system and the wider economy against any potential financial crises.

But the deal has proven decidedly acrimonious for several reasons, not least because of the haste with which it was arranged, the use of taxpayer money to support it, the denial of a shareholder vote on the agreement, the public disclosures that made it appear as if the bank was still healthy despite authorities scurrying behind the scenes to guarantee its rescue as it teetered on the verge of collapse, and the wiping out of top-tier bondholders. Indeed, holders of around $17 billion of Additional Tier 1 (AT1) bonds issued by Credit Suisse have received nothing in compensation, while typically lower-ranking shareholders have received $3.23 billion.

In response, bondholders holding billions of dollars of AT1s have launched legal action against Switzerland’s banking regulator FINMA (Swiss Financial Market Supervisory Authority) on the grounds that the AT1 bonds should not have been written down under the emergency ordinance. “We are working with a significant number of AT1 investors to execute a multi-jurisdictional litigation strategy to secure compensation and redress for our clients. The purported write-down of the AT1s was unlawful, and our clients must be fully compensated,” Natasha Harrison, a partner at law firm Pallas Partners that is representing two groups of Credit Suisse bondholders, confirmed. “Finma didn’t have the authority to issue the order to write down the bonds; this was an abuse of process, and the resolution procedure should not be used by Switzerland to enable UBS to take over Credit Suisse to the detriment of AT1 holders.”

But regulators insist that the deal was necessary from a wider systemic standpoint. “The collapse of Credit Suisse would have sent a shockwave through the global financial system. The consequences for the real economy, both in Switzerland and abroad, would have been dramatic,” the chairman of the governing board of the SNB, Thomas Jordan, recently stated. “This extremely demanding situation required quick and decisive action. The federal government, FINMA and the SNB worked together under high-pressure conditions to find a solution that was viable and as market-based as possible in order to safeguard financial stability and protect the Swiss economy.” The Swiss Bankers Association’s (SBA’s) chairman and former UBS chief executive officer, Marcel Rohner, also defiantly asserted on March 21 that the Swiss financial sector was able to address this major issue of a significant player. “In that sense, I also see a prosperous future for the financial centre because we have hundreds of very well-capitalised banks and very successful wealth management and asset management banks.”

But some regard the reputation of that “financial centre”—managing an estimated $2.6 trillion in global assets—as being irreversibly damaged by Credit Suisse’s fall from grace and the subsequent merger. While many agree that the rescue was necessary to stabilise the Swiss banking system and economy, the undemocratic nature of the deal, the use of taxpayer money and the substantial state and central bank support propping up the deal will ensure that public scrutiny remains intense for some time to come.

Jordan also acknowledged, however, that banking regulation and supervision must be reviewed in light of recent events. “This will require in-depth analysis. Quick fixes must be avoided,” he stated, adding that UBS’s takeover fundamentally changed the structure of the Swiss banking sector. “It is important that Swiss households and businesses continue to benefit from a broad range of efficiently priced banking services. This requires competition and diversity. We are optimistic that our domestically focused banks, but also the foreign banks operating in Switzerland, will adjust their product ranges accordingly. We are also convinced that UBS will carry out its task of providing Swiss households and the wider economy with banking services responsibly.”

The events are also likely to impact the wider European banking system, which should play into the hands of Asia and the United States. “There is a basic principle that common equity takes the hit first. It seems that the treatment of AT1s—even if correct under the current Swiss rules—will raise the cost of capital for Swiss banks and for European banks,” Tidjane Thiam, Credit Suisse’s chief executive from 2016 to 2020, explained in a Financial Times article. “This will have some of their US peers rubbing their hands. AT1s or ‘cocos’ are an important source of capital for European banks, and because of the market appetite, interest rates may not have fully reflected the risks involved. This new layer of uncertainty will have an adverse impact on the competitiveness of the European banking sector. Net net, US and Asian rivals could come out of all this relatively stronger.”

Much depends on what happens next, therefore. Customer deposits are estimated to have declined by CHF67 billion during the first quarter and have since reportedly stabilised at lower absolute levels, but they had not reversed as of late April. The net asset outflow totalled CHF61.2 billion ($68.6 billion) during the first quarter, with its flagship wealth-management unit losing 9 percent of assets, which will force cuts in the fees it generates and “likely lead to a substantial loss in wealth management” during the second quarter. The bank also reported an adjusted CHF1.3-billion pre-tax loss for the quarter.

UBS is already planning to carve up Credit Suisse, keeping some parts of the business and winding down others. Some expect Credit Suisse’s investment bank to be considerably downsized, while UBS is also reportedly seeking assurances from the government that it will not be liable to pay fines from any pending legal cases or regulatory investigations into Credit Suisse. “The magnitude of losses and outflows is alarming,” Thomas Hallett, an analyst at Keefe, Bruyette & Woods, told the Financial Times on April 24. “There is more to come. Simply put, even if UBS is able to take out CHF8 billion of costs by 2027, the revenue trajectory is so damaged that the deal could well remain a drag on UBS operating results unless a deeper restructuring plan is announced.”

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