The writer is managing partner and head of research at Axiom Alternative Investments
Bank investors are well aware of the risks; they know that banking relies on trust and that sentiment can change quickly. The crisis now faced by Credit Suisse is, however, a previously unseen phenomenon.
Every single bank failure I can remember was caused by hidden losses, be they in loan books, derivatives books or bond books. Even though this latest episode of market panic was triggered by bond losses in midsized American banks, there is no suggestion that the current Credit Suisse crisis stems from this problem. So how did this happen and what are the lessons we can draw from the crisis and the intervention by the Swiss authorities?
In shaky markets following the collapses of Silicon Valley Bank and Signature Bank, an awkward statement by Credit Suisse’s largest shareholder, saying that it would not provide any further assistance, was enough to send the bank’s share price into a tailspin. Financial assistance is the Chekhov’s gun of banking: mention it and it is very likely that it will be used before the end of the play.
It is not a coincidence that Credit Suisse has become the main target of the markets. For years now, it has been embroiled in a series of scandals and management controversies. It sometimes feels like its annual report is nothing but a long list of litigations both old and new along with acknowledgment of poor risk controls.
Consequently, CS has established itself as the weakest link of the European globally systemic banks. It is a bit of an odd weak link, because it had plenty of capital and plenty of liquidity. It is not the only bank with low profitability and is not even the only one that had deposit outflows in the fourth quarter. And it is certainly not the only bank to face scandals over the years. It is, however, the one that had all these weaknesses at the worst possible moment.
What were the options to stop the bleed? The Swiss authorities did not really have a choice. Ultimately, Credit Suisse’s own clients decided its fate, not the investors. They had made up their minds and withdrew funds. Merging with UBS is an obvious solution that was on everyone’s mind. Maybe the Swiss authorities will be criticised because they reportedly did not do more to open the bidding war to non-Swiss players, but can we really blame them? Can anyone remember a bank failure resolved in a weekend with a foreign white knight?
This is why UBS has been in a very strong negotiating position. People will argue about the possibility of litigation losses, further bad loans or the cost of winding down the investment bank of Credit Suisse. But UBS is paying a fraction of the bank’s shareholder equity, estimated at SFr45bn ($49bn) at the end of last year. Even after accounting for the likely sale of some assets in the Swiss retail bank to manage competition issues, this deal is likely to be very value enhancing for UBS shareholders. Restoring client confidence and low funding costs could also be a game-changer for profitability.
It appears bondholders, however, are going to be forced to take a loss. In the longer term, this could raise issues of financial stability given this case was driven by market panic on a bank with high capital and liquidity that was supported by its supervisor.
There are many lessons to be drawn from this crisis, but my hope is that ultimately the one that will prevail is this: a bank’s culture is too important to treat it lightly. A bout of market volatility after internal failings or even a banker gone rogue can jeopardise the work of tens of thousands of hard-working people who will feel both betrayed and frowned upon just because they worked in the wrong company. Regulators and investors have done a lot of work on this, but evidently there is still much to do.
Axiom trades in bonds of Credit Suisse and other banks