Chris Kamykowski, CFA, CFP®, Head of Investment Strategy and Research
Mark Webster, CMFC®, Senior Investment Research Analyst
Markets are currently experiencing an unexpected flashback to the 2008 Great Financial Crisis (GFC) as a handful of banks come under pressure from multiple angles. Luckily for now, we are only dealing with a couple weeks of consternation over the soundness of the banking system versus the persistent late summer carnage that took out financial behemoths such as Merrill Lynch (acquired), Washington Mutual (acquired) and Lehman Brothers (bankruptcy).
One can be forgiven for believing that after the GFC, all the new banking regulations, capital requirements and stress testing would negate the risk of systematically important banks facing critical moments of collapse or forced acquisition. Yet, here we sit nearly 15 years later, the day after UBS Group AG was politely forced to purchase its 167 year old, $500 billion balance sheet rival, Credit Suisse Group AG, after multiple failures last week to stem a crisis of confidence in Credit Suisse.
Despite a $54 billion financing backstop by the Swiss National Bank (SNB) last week, a more intrusive intervention was mounted by the Swiss Federal Department of Finance, SNB and the Swiss Financial Market Supervisory Authority FINMA (FINMA) to help push this deal through on Sunday. Key details of the acquisition include1:
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- UBS to purchase Credit Suisse for approximately $3.3B.
- The Swiss government is providing $9 billion to offset potential losses UBS may incur as part of the purchase.
- SNB is providing $100 billion of liquidity to UBS to help move the deal through to completion.
- Importantly, Credit Suisse continues to operate in the ordinary course of business and implement its restructuring measures in collaboration with UBS.
Separately but related, starting today and lasting through April, the Fed — alongside the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank — are expanding the frequency of dollar swap line operations2. This is likely a step to continue to reduce the concern over contagion; it allows foreign central banks to supply dollars locally to serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses.
Market Response
After the news on Sunday, Europe was better bid as the FTSE 100 and DAX indices were up 0.93% and 1.12%, respectively. Importantly, UBS stock closed up just over 3% today and the STOXX Europe 600 Bank index was up 1.5% as well. Other overseas markets finished Monday mixed with the Hang Seng and Shanghai Composite indices down -0.5% to -2.7%, respectively.
In the US, as of market close, equity markets experienced modestly positive relief with the Dow Jones higher by 1.2% and S&P 500 index up 0.89%. US small cap equities, as represented by the Russell 2000 index, were higher by 1.11%. The violent bond market rally seen recently reversed course – at least for the moment – as risk-free asset yields moved higher with the US 2-Year and US 10-Year Treasury bonds up 0.14% and 0.06%, respectively.
Comments
While these extraordinary efforts may calm markets for now, there are clear losers in this deal. Credit Suisse equity holders, while lucky to avoid outright bankruptcy, have seen the market value of their holdings cut substantially versus Friday’s values. The approximately $17B of Additional Tier 1 Capital will be written off to zero1. These perpetual bonds were issued to help meet Tier 1 capital ratio thresholds but were of lower quality given they were subordinated to all other debt. A potential winner is UBS which could be the phoenix from the ashes, as it now takes hold of a valuable wealth management franchise and near monopoly in Swiss banking.
The shift in the recent narrative from banks such as Silicon Valley Bank and Signature Bank to Credit Suisse is stark and sure to lead to continued trepidation by investors over the near term. While it had a storied history and larger balance sheet, Credit Suisse was plagued more recently by leadership turnover, legal issues, risk management and regulatory setbacks which made them vulnerable to a loss of confidence, which had already been eroding. Deliberate and decisive action was needed as the bank was hemorrhaging $10 billion a day in deposits after seeing $120+ billion exit in late 2022. More importantly, action was needed to contain declining confidence in the banking system at large.
On a side note, Credit Suisse’s 2022 annual report was released earlier this month. The CEO and Chairman closed their opening statement stating, “With a new and highly experienced leadership team, which has a proven track record in the delivery of restructurings and executing to plan, we believe we have the right team in place to achieve the strategic, cultural and operational transformation of our bank. Since October 2022, this team has been executing our strategy towards the new Credit Suisse at pace and with full dedication and commitment. Together, we will work hard to restore trust and pride in Credit Suisse, to create value for our clients and to deliver strong returns for our shareholders.”3
Unfortunately, time ran out for this plan to pan out for the new leadership team as the market, customers, their rival and government entities forced their hand.
What Now?
Near term, fear will still dominate as contagion concerns persist. This will likely heighten downside risk as markets assess the extent of more collateral damage relative to actions taken to stem the impact of recent banking troubles. Fear of a 2008-esque repeat will permeate narratives but it is important to note 2008 saw an economy actually in a recession, a complete collapse of the housing market, and widespread deleveraging across consumers and businesses. For now, the issue here is a crisis of confidence in the banking system which sees central banks and governments acting decisively to contain. The economy remains strong, labor tight, and corporate and consumer fundamentals are in a better position than in 2008.
The FOMC will be meeting early this week (3/21 & 3/22) for its regularly scheduled meeting which will likely prove interesting as they debate the next move: continue to hike given inflation or pause to give the market a reprieve from the current volatility. Neither choice is without downside: hike and the market could fall due to what is characterized as a tone-deaf response by the Fed. Pause and the Fed’s credibility is challenged as their data dependent approach reacts to items outside their charge of price stability and full unemployment. The Fed warned markets about the pain that could come from upending years of accommodative monetary policy and we are certainly in the midst of acute pain that will test the Fed’s resolve it just recommitted to a couple weeks ago.
That all said, this is still a very fluid environment with an evolving narrative which we will be monitoring as things transpire.
Sources
Bloomberg
1 – https://www.credit-suisse.com/about-us-news/en/articles/media-releases/credit-suisse-and-ubs-to-merge-202303.html
2 – March 19, 2023 Press Release : https://www.federalreserve.gov/newsevents/pressreleases/monetary20230319a.html
3 – 2022 Annual Report: https://www.credit-suisse.com/about-us/en/reports-research/annual-reports.html
Definitions
The DAX is a stock market index consisting of the 40 major German blue chip companies trading on the Frankfurt Stock Exchange.
The Dow Jones Industrial Average, Dow Jones, is a stock market index of 30 prominent companies listed on stock exchanges in the United States.
The Hang Seng Index is a free float-adjusted market-capitalization-weighted stock-market index in Hong Kong.
The Russell 2000® Index is an index of 2000 issues representative of the U.S. small capitalization securities market.
The Shanghai Composite Index is a stock market index of all stocks (A shares and B shares) that are traded at the Shanghai Stock Exchange.
The S&P 500 Index is a free-float capitalization-weighted index of the prices of approximately 500 large-cap common stocks actively traded in the United States.
The STOXX Supersector indices track supersectors of the relevant benchmark index. There are 20 supersectors according to the Industry Classification Benchmark (ICB). Companies are categorized according to their primary source of revenue.
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