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Finance
Credit Suisse: how the mighty fell
Iconoclast: n. A person who attacks or criticizes cherished beliefs or institutions.
This on-going column is intended to challenge the status quo. Not always giving answers, not always right, but smartly challenging our own assumptions, actions, organizations and institutions.
What was behind the shocking demise of a treasured institution – and how will the proposed rescue package play out?
When they hear the name “Credit Suisse”, my grandchildren will likely have to google (or whichever search engine exists then) these two words. For most of my contemporaries here in Switzerland, Credit Suisse is an inherent part of Swiss history and culture. The past weekend has been historical in many dimensions for Switzerland. The country used to be praised as a successful financial center due to its stability and lack of political uncertainty, but instead recent developments have prompted a combination of curiosity and panic. A too-big-to-fail institution has indeed failed, some of its bonds written off, and its remaining assets purchased by its neighbor and competitor UBS.
Why has this happened? Certainly Credit Suisse’s problems did not start last week. Its fate results from a combination of poor strategic decisions, a rotting culture, and bad luck. The power of its brand had kept the bank afloat despite corporate governance scandals, the choice of wrong partners, and a sequence of CEOs and top executives that were unable to restore confidence and lead a turnaround. And when there was turbulence in financial markets because of the default of Silicon Valley Bank (SVB), the weakest banks sunk first.
While the SVB collapse demonstrates the gaps in US banking regulation, the response of the Swiss National Bank (SNB), FINMA, the Swiss financial regulator, and the Swiss Confederation should be praised as adequate and speedy. SVB’s shareholders and depositors were the victims of a regulatory framework that allows non-systemic banks in the United States to account for fixed income securities as “held to maturity securities”— that is, accounted at cost of acquisition instead of at fair value or market value. When SVB showed financial weakness, depositors started to withdraw their money. Being forced to liquidate such fixed-income securities at depressed values, SVB became undercapitalized and technically bankrupt.
As financial panic spread throughout the world, it reached Switzerland, and Credit Suisse wealth management clients, depositors and shareholders became concerned about the going-concern value of the bank. We heard last night in a historical press conference that survival alternatives for Credit Suisse had been considered from last Wednesday, including splitting the business into parts, nationalization, and an outright sale to UBS. The latter is what ultimately happened after a frantic weekend.
“While the SVB collapse demonstrates the gaps in US banking regulation, the response of the Swiss National Bank (SNB), FINMA the Swiss financial regulator, and the Swiss Confederation should be praised as adequate and speedy”
Together with a group of EMBA students* (we are now in Estonia on a Discovery Expedition) we watched the news conference last night aware of the relevance of such historical event. Switzerland will never be the same.
My early reaction after a sleepless night can be summarized as follows:
- 1. The reaction of Swiss authorities aimed to reduce the risk of a financial panic when the markets opened on Monday. In that sense, the support of US and UK regulators is revealing. But it is not clear that the final solution is the best one for Switzerland. For starters, the future of the 16,000 employees working in the retail network in Switzerland is very uncertain. The Credit Suisse branch in the city where I live is right in front of UBS’s, meaning one of the two will certainly close. Secondly, despite the cost synergies of the UBS acquisition, there will be significant losses in the wealth management arms of both banks. Those customers who were holding accounts in both banks for diversification reasons will now have to diversify elsewhere. Thirdly, the reputation of Swiss banking has now been damaged, and this means that many clients and depositors will leave both banks. I bet Singaporean wealth managers foresee a significant increase in their assets under management. Finally, the outcome of this crisis is a huge bank (one of the largest banks in Europe by assets) having quasi-monopoly power in some segments of the Swiss markets, which is undesirable for Swiss customers.
- 2. The cost of the bailout is entirely borne by Swiss taxpayers. Besides the original CHF50bn liquidity guarantee provided by the SNB, the Confederation is guaranteeing losses to UBS for up to CHF9bn on the transaction. On top of this, the SNB is now offering a 100 billion-franc liquidity assistance to UBS. Add to that the potential costs coming from job losses and restructuring charges and it all comes to a bazooka plan never seen before in Switzerland. By comparison, the IMF reports that the Confederation spent CHF73bn to support the Swiss economy during the first wave of the COVID pandemic in the form of federal-level support packages.
- 3. Irrespective of the potential violations of the Absolute Priority Rule (in default, creditors get paid ahead of shareholders), Credit Suisse shareholders are receiving CHF0.75 per share. This is a massive destruction of wealth over a weekend, and I suspect that the largest shareholders of Credit Suisse Group (Saudi National Bank for starters) will not accept the deal. Neither will Swiss Pension Funds, which hold a large number of shares. Markets will tell whether UBS shareholders themselves see the deal as accretive. While it seems a sweet deal for UBS (around CHF3bn for an institution with very valuable assets and brand name), the costs and risks of the acquisition may scare off UBS clients, depositors and shareholders.
- 4. An interesting feature of the rescue package is that, for the first time in a relevant case, a regulator is writing off Contingent Write-Down bonds. These are technically considered Additional Tier 1 capital (AT1) and were issued by many banks after the 2008 financial crisis as a way to raise additional capital. Unlike Contingent Convertibles (CoCos) that would be converted into equity in case of financial distress, the regulator has the power to write-off Convertible Write-Down bonds, something FINMA has done. Whether or not this is creating potential legal liabilities is being openly discussed in the media today.
- 5. Time will tell whether this was the best course of action. My late colleague Stewart Hamilton told me in 2009 that I would witness several more financial crises in my life and I did not believe him. Experience indeed provides interesting lessons when looking at the past. The Credit Suisse absorption by UBS reminds me of the bargain sale of Swiss to Lufthansa. The financial situation of Swiss was undeniably terrible, but it has proven to be one of the sweetest deals ever for Lufthansa. It also reminds me of the UBS bailout in 2008 by the Swiss Confederation and the Singapore Investment Company—it turned out very well in the long run for UBS. Wouldn’t a solution like that have been more appropriate?
- 6. Finally, will the merger work? I have been discussing bank mergers extensively in my executive programs lately, and one of the most established facts in academic research is that bank mergers hardly ever work, especially when the combination involves two blue chips (banks with low PE ratios). Escaping the value trap (that is, reinventing itself through innovation and technology) is now more difficult for UBS, given it is also facing competition from fintech disruptors and neobanks. It is now a bigger, slower-moving creature.
As I write these lines, I worry about how this will all play out. There is further damage to be inflicted to Credit Suisse’s reputation when UBS disposes of its Investment Banking arm. The popular response in Switzerland, and the subsequent reaction by the Swiss Legislative (let’s not forget that the Federal Assembly has to confirm the bailout within the next six months) are both uncertain. As shown by the initial reaction of stock markets to the news, a global banking crisis does not appear to have been averted, so we need to remain cautious. Finally – and thinking domestically – Switzerland is now in a situation with a single, large retail bank, and a plethora of locally confined cantonal banks which paints a very weird banking market. How will the government foster competition in a key sector for the Swiss economy?
First the pandemic, then the war in Ukraine, and here we have a third unthinkable, unforeseen event. We are moving from an era of uncertainty to an era of total unpredictability.
*This article has been written with contributions by and inspiration from Davide Serrago, and Hanh Nguyen.
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