Credit Suisse: A crisis of confidence

A crisis of confidence

The New York Stock Exchange (NYSE) bell will toll for Credit Suisse Group AG (CS) for the last time this year when the acquisition of the large Swiss bank by long-time rival, UBS, closes. This will bring an end to Credit Suisse’s chequered 167-year history. 

On Sunday, 19 March, the Swiss authorities announced that UBS had agreed to purchase CS for 3 billion Swiss francs (about US$3.2 billion) after some strong-arming from the Swiss National Bank (SNB) central bank and the financial regulator Swiss Financial Market Supervisory Authority (FINMA). 

How did a large, well-known, and (some might say) illustrious European financial institution’s market capitalisation plunge so drastically? It fell from around 80 billion Swiss francs in 2006 to 23.3 billion Swiss francs in 2021, to 11.06 billion Swiss francs in 2022, and finally to just 3 billion Swiss francs in March 2023. In comparison, UBS had a market cap to the tune of US$57 billion, First Republic Bank’s was at US$4.3 billion, and GameStop had a market value of US$5.1 billion, as of 17 Mar 2023.

Credit Suisse was one of the few “too large to fail” banks that survived the 2008 Global Financial Crisis without having to be bailed out by the authorities. Its rival and now acquirer, UBS, was not as fortunate.

Since then, Credit Suisse has paid multiple fines for a whole host of risk management and governance failures — the largest of which might be its losses associated with the Archegos fund. Notwithstanding a string of scandals and authority censures, Credit Suisse also invested in loans linked to Greensill Capital via investment funds; that led to massive losses, with Credit Suisse closing about US$10 billion in funds in 2021. Credit Suisse admitted in an internal review that it had overlooked earlier red flags when conducting due diligence.

Everything, everywhere, all at once 

And then in March 2023, a little known US regional bank, Silicon Valley Bank (SVB), was subject to a bank run and subsequently taken over by the Federal Deposit Insurance Corporation (FDIC). SVB was shut down by the US authorities on 10 March.  

Meanwhile, on 9 March, Credit Suisse postponed the publication of its annual report after the United States Securities and Exchange Commission (SEC) raised questions about its earlier financial statements. On 14 March, the Swiss lender released its 2022 annual report citing material weakness in its financial reporting. 

This dealt another blow to Credit Suisse shares, as investors’ and clients’ confidence took a further dive. The bank had already been seeing record deposit outflows from earlier incidents. This loss in confidence was exacerbated by comments from Saudi National Bank, its largest shareholder, that it could not provide Credit Suisse with more financial assistance. That triggered a further sell-off, although Credit Suisse shares later surged after Switzerland’s central bank Swiss National Bank tossed it a 50 billion Swiss franc lifeline. Deposit outflows, however,  continued.

Despite reassurance from the central bank, investors and clients remained jittery, and over the 18-19 March weekend, the Swiss authorities persuaded UBS to take over Credit Suisse.

Credit Suisse AT1 bondholders wiped out

With the UBS rescue deal, an equity shareholder of Credit Suisse will get one UBS share for 22.48 CS shares. That translates to about US$0.95 per CS share, a steep discount of over 50% from the stock’s closing price of about US$2.15 on Friday, 17 March, before the deal was announced.

The Swiss authorities will grant Credit Suisse access to additional liquidity, if required. The financial regulator FINMA also announced that Credit Suisse’s Additional Tier 1 (AT1) bonds — worth about US$17 billion in notional terms — will be written off to zero, as part of the takeover by UBS. That essentially means the AT1 bondholders will lose all of their investment in the risky bank debt. Meanwhile, Credit Suisse’s shareholders will not be wiped out completely; instead, they will be compensated with UBS shares, albeit at a big discount.

This decision by the regulator to pay out equity shareholders and bypass the AT1 bondholders in the rescue deal is unprecedented, given that equity investments are usually classified as subordinate to (and therefore may be less protected than) AT1 bonds.

In the past few years, AT1s have been popular with investors from Asia, particularly those in the high-net-worth segment, for these bonds’ high yield and perceived lower risk of principal loss. The latest decision by FINMA rattled investors in this region, triggering a sell-off of Asian financial shares.

On Monday, 20 March, stock prices of large Japanese financial institutions declined by about 2%, and the Hong Kong-listed shares of HSBC Holdings and Standard Chartered lost about 6% and 7%, respectively. Other financial institutions in the region fared slightly better.

What are AT1 bonds, Tier 2 capital, and CoCos?

In order to fully appreciate the magnitude of FINMA’s decision, it is important to understand the capital structure of bank debt.

If a bank struggles financially, the amount and type of debt and equity on its balance sheet will determine who is repaid in what order and proportion. Senior debt sits at the top of the capital structure, which means senior creditors will be repaid first, making such debt lower risk.

The next layer down would be subordinated debt as well as contingent convertible bonds (CoCos) — a hybrid of equity and debt financing. Tier 2 and Additional Tier 1 (AT1) capital are usually found here. 

AT1s have perpetual terms and can be converted into equity when a trigger event occurs, such as if the bank’s capital levels fall below requirements. They have specific conditions that, once breached, will allow the bond issuer to convert the bond into equity or write the debt off.

AT1 debt was created after the Global Financial Crisis to ensure that losses in times of crises would be borne by investors, rather than taxpayers bailing out borrowers.

Equity typically sits at the bottom of the capital structure. That means shareholders tend to be repaid last, if at all, if the company goes bust, making equity investments the highest risk in this context. In Credit Suisse’s case, the AT1 bondholders had expected to rank before the shareholders in order of priority when it came to any recoveries they could receive.

Limited impact from Credit Suisse's situation on your investments

Endowus has reached out to all the fund managers we work with to check on their funds’ exposure to Credit Suisse, in particular the bank’s AT1 bonds.

Due to the diversified nature of Endowus advised portfolios, there is limited direct exposure to Credit Suisse bonds — less than 1%. Moreover, most of this exposure is in the senior part of the capital structure, with only a very small proportion invested in Credit Suisse’s AT1 bonds.

For the funds on the Endowus Fund Smart platform, there is also limited exposure to Credit Suisse bonds. Fixed-income funds focused on Asia or emerging markets generally do not have any exposure to Credit Suisse bonds. 

Where exposures to Credit Suisse might be found are i) some global fixed income funds and ii) funds that specialise in bank capital. In the first category, among some global fixed income funds, the exposure to CS bonds is small — ranging from almost negligible to a maximum of 1.5% on a single fund basis. In the second category, among funds that specialise in bank capital, there are three such funds on the Fund Smart platform, including two that are only available to accredited investors. These three funds have very limited exposure to Credit Suisse — less than 5%.

These levels of exposure are low and should be reassuring to Endowus clients, as it means that there will not be much impact on their investments from direct exposure to Credit Suisse.

As of 22 March, the full extent of what Credit Suisse’s situation will mean for the financial markets is still unclear. However, based on yield curve movements and market sentiment, it is possible that credit conditions will tighten as banks tighten their lending criteria. In the short term, it is also highly likely that we will continue to see volatility in the markets. 

In the long term, spreading your investments across asset classes and geographies will help with diversifying your risk. It is hard to know when and where the next blow to the market will come from. With market volatility comes opportunities. If you have a long-term investing horizon, as many of us do, these developments may offer an opportunity through steady, regular investing in diversified and risk-adjusted portfolios — characteristics of the Endowus Flagship Portfolios.

UBS, a long-term partner of Endowus

UBS is one of the largest global wealth managers in the world and, with the acquisition of CS, has grown stronger in this area. The emergency rescue deal is expected to create a combined business with more than US$5 trillion in total invested assets and sustainable value opportunities, as UBS announced on 19 March. This will further strengthen its position as the leading Swiss-based global wealth manager, and it remains capitalised well above its target of 13%. UBS Chairman Colmn Kelleher said the transaction will preserve the value left in the Credit Suisse business while limiting UBS’ downside exposure.

UBS has been a strategic investor in Endowus since 2021. It has played and will continue to play a critical role in cementing Endowus’ ambition to be the leading fee-only digital wealth manager of choice in Singapore and Asia. As part of our mission to provide a seamless digital platform for effortless and expert investing for everyone, we value UBS as an important investor and strategic partner to Endowus.

Endowus has two funds from UBS Asset Management (as of 22 Mar 2023) on our Fund Smart platform, namely the US Total Yield Sustainable Fund and the Asia Flexible Bond Fund. The Asia Flexible Bond Fund is also featured in the Endowus Low Volatility Fixed Income Portfolio, part of our Satellite offerings.

To explore other funds available on Fund Smart, please refer to the Endowus Investment Funds List.

With digital wealth platform Endowus, you can plan and manage your money — whether held in cash, CPF, or SRS — by investing in globally diversified, intelligent, low-cost portfolios seamlessly. To get started, click here.

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