UBS and Credit Suisse merge; why it happened and what it means?

It was almost like a weekend plot that was quietly played behind the scenes. The cast included the central bank of Switzerland, Credit Suisse, UBS, and the regulators across the world. The subject was the orderly closure of Credit Suisse, a venerable 167 year old bank and a world leader in financial services. Let us first look at how the deal was structured late on Sunday to avoid any signs of panic on Monday.

Key aspects of the Credit Suisse merger into UBS

Once upon a time, the gnomes of Zurich were represented by 3 large and powerful banks viz. UBS, Credit Suisse, and Swiss Banking Corporation. Swiss Banking Corporation merged into UBS in 1998. Exactly 25 years later, even Credit Suisse has been consumed by UBS. Here is how the deal between UBS and Credit Suisse was structured.

• Under the terms of the deal, the Union Bank of Switzerland will offer SFR3 billion (approximately $3.23 billion) for buying out Credit Suisse. The deal was entirely syndicated by the Swiss government and the Swiss central bank.
   

• The shareholders of Credit Suisse will get 1 share of UBS for every 22.48 shares of Credit Suisse held by them. That is a payout of SFR0.76 per share, against the market price of Credit Suisse at SFR1.86 per share. That sounds unfair, but that was the best that could happen to the shareholders. It is almost thrice the original offer made by UBS.
   

• There will be a sharing of losses between UBS, Credit Suisse capital and the government of Switzerland as part of the rescue package. For the year 2022, Credit Suisse had reported net losses of $7.3 billion.
   

• Not surprisingly, the entire $17 billion of Additional Tier 1 (AT-1) bonds will be repudiated and written down to zero. These bond holders get nothing. Remember that AT1 bonds are perpetual bonds which can be repudiated by the issuer in extreme cases. In India, a similar case happened in the Yes Bank case.
   

• The Swiss central bank (SNB) has offered UBS liquidity assistance of SFR100 billion ($108 billion), in the form of an emergency line of credit for UBS to fall back upon. However, there is an exit clause for UBS too. If the credit default swap (CDS) spread of Credit Suisse rises beyond a limit, then UBS can walk out of the deal.

The many blunders of Credit Suisse

There was nothing new about what happened at Credit Suisse. The problems had been brewing and the condition of the bank had been worsening progressively since the Global Financial Crisis of 2008u and the European crisis of 2010. Things took a turn for the worse in the last few months, but the real trigger for this sell-out came in the last few days as the global banking crisis worsened. Also, the newly appointed chairman of Credit Suisse could not do anything to fetch the bank back from the brink. The problems were just too deep.

It is one thing to blame the foray into investment banking; but even UBS did that but never faced the consequences of Credit Suisse. There were some atrocious funding decisions in the recent few years. For instance, Credit Suisse lost $5.4 billion as the largest financier for Bill Hwang’s Archegos Capital. It lost another $2.5 billion funding the fraudulent supply chain activities of Greensill Capital. But that was not all. Credit Suisse had funded drug dealers in Bulgaria, government corruption in Mozambique and even spied on former employees and leaked customer data. The result was a massive outflow of $147 billion in the December 2022 quarter, which made it impossible for the bank to sustain.

The immediate trigger for the fall of Credit Suisse came from the global banking crisis triggered off by names like SVB Financial and Signature Bank in the US. Both these banks suffered huge bond losses trying to fund a run on their deposits via a fire sale of bonds. As the losses mounted due to rising bond yields both the banks did not have enough capital to bridge the gap. A similar fate was expected for Credit Suisse too. Another trigger was when the 9.90% shareholder of Credit Suisse (Saudi National Bank), refused to infuse any fresh funds into the bank; as did the Qatar Investment Authority. With that window closed, there were limited options left for the Swiss government than to merge Credit Suisse into UBS.

What does this mean for Credit Suisse and for UBS?

One thing is certain. This is the end of Credit Suisse as we know this venerable bank. One can rue the fall of another big banking name, but in this case the bank only has itself to blame. From being a reputed wealth manager, Credit Suisse digressed into investment banking. It was profitable for Credit Suisse, but along came a slew of risks that the bank was just not prepared for. That was like the real tipping point for Credit Suisse.

It is not just Credit Suisse but a host of other European banks have also done the same. Deutsche Bank did the same and has been facing a lot of problems. UBS and Swiss Banking Corporation have also been aggressively buying global investment banks including names like First Boston, Donald, Lufkin & Jenrette, SG Warburg, Brinson Partners and Dillon Read. When the combination of funding and structuring got into trouble, that was when the enthusiasm for investment banking unravelled.

This raises a question at a more regulatory level. The US used to have the Glass Steagall Act in the US, which separated commercial banking from investment banking. It was later diluted in the last 25 years, which eventually created the global financial crisis. What that is hard to say, one outcome could be that banks are likely to stick to their core business rather than diversifying into other areas. That should be a good place to start with and a good outcome of the Credit Suisse story.