CWS Market Review – March 21, 2023

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RIP: Credit Suisse

After 167 years, Credit Suisse is no more. The bank has ceased to be. It is bereft of life. This is an ex-bank.

Over the weekend, UBS bought out its long-time rival, Credit Suisse, for $3.24 billion.

This is a major event in global banking. Consider that at the end of last year, Credit Suisse had a balance sheet of half a trillion dollars and 50,000 employees globally. Shares of CS closed Monday at 94 cents.

To say this was a fire sale badly understates the events. The Swiss government essentially forced this deal to happen. They aimed to stop the banking crisis cold. To give you an idea of how far they went, the settled price for Credit Suisse was less than half of Friday’s closing price. It works out to 7% of CS’s tangible book value.

CS shareholders will get one share of UBS for every 22.48 shares of CS they own. That values a share of CS at 0.76 Swiss francs which is 99% below its high.

The Swiss government even sweetened the pot for UBS. The government said it would chip in $9 billion to backstop any losses from the deal. The Swiss National Bank said it would provide $100 billion in liquidity. Investor lesson: When the government—any government—wants a financial outcome badly enough, it’s hard to say “no.”

Mind you, the authorities weren’t crazy. The Swiss government strongly preferred a buyout over a wind-down that would be run by courts, lawyers and regulators. Plus, they wanted a deal done fast. The goal was to have something complete before Asian markets opened on Sunday evening. They made it, but barely.

Frankly, they had to do something. The mess at Credit Suisse was bad and getting worse. The bank was hemorrhaging $10 billion a day. Credit Suisse’s Chairman, Axel Lehmann, said, “The acceleration of the loss of trust and the worsening of the last few days made it clear that Credit Suisse cannot continue to exist in its current form.” That statement was one of the few things they got right.

Banking Is About Confidence

This wasn’t a story of garbage loans. Instead, all the customers headed for the exits. Quite simply, no one believed in them anymore.

That’s the thing about banking. Most people think banking runs on money. It doesn’t. A bank runs on confidence. Once that’s gone, the whole game’s up. It doesn’t matter how much money SNB threw at the problem; without confidence, it wasn’t enough, and it never could be enough.

It’s hard not to have some sympathy for Credit Suisse, but they made just about every mistake they could. They recently got a $4 billion cash injection from the Saudi National Bank on the hopes they could engineer a turnaround. That didn’t happen. Perhaps CS’s biggest mistake was going bust so close behind SVB and Signature.

Last Thursday, the Swiss government extended CS a $54 billion lifeline to make sure they would last until the weekend. Later, they had to double that amount.

Not surprisingly, UBS clearly didn’t want any part of a deal. They realized they were in the strong position, so they asked for a lot, and they got it. During any normal time, the hitching of these two would have been an obvious anti-trust red flag. Not this time. Funny how the government can decide which rules to enforce, when and to whom.

The initial deal that UBS offered was for $1 billion. After shareholders complained, the price tag was lifted to $3 billion, which is still very cheap. As a result of the deal, UBS said it would halt its stock buyback program and pare back its plans for CS First Boston, CS’s investment banking business.

One of the big issues is CS’s investment banking business. CS had been looking to spin it off, and that’s probably not going to happen. They could lose a bundle in scrapping the deal. That’s one of the reasons why UBS was so reticent about taking CS on.

Over the weekend, there was one last-ditch attempt to save CS. A group was planning to inject $5 billion into CS if the government promised to make the bondholders whole. The government turned it down.

I had difficulty keeping up with all of Credit Suisse’s misdeeds. Here are a few.

In 2020, the CEO resigned after it was learned that the COO hired a private investigator to spy on the bank’s former head of wealth management. They wanted to see if he was poaching clients or employees as he had recently transferred to UBS.

Even though the CEO resigned, an investigation found that he had no knowledge of the plan, which raised the question of why was he out of the loop. The scandal later took a tragic turn when the hired private investigator committed suicide.

The following year, Credit Suisse was fined after it was revealed that the bank had bribed government officials in Mozambique and accepted kickbacks. The bank was supposed to be organizing loans to help Mozambique’s tuna industry. The fines would have been higher, but CS agreed to write off some of the loans.

Credit Suisse was also involved in the very strange story of Bill Hwang and his firm, Archegos Capital. Hwang seemed to have no idea what he was doing. Naturally, he was managing several billion dollars.

As you might guess, this came to an unpleasant end. Hwang made a giant and highly-leveraged bet on ViacomCBS (now called Paramount Global). The media company announced a stock sale, and the shares took a big hit. Hwang’s leveraged position started to plunge and he got a margin call. One of my first jobs in finance was making margin calls to clients. When you get a margin call, you have two options: put up more money or sell. If you don’t sell, the firm will do it for you.

According to Bloomberg, Hwang lost $20 billion in two days. He had borrowed tons of money from Wall Street banks, and they were suddenly left exposed. Goldman Sachs and Morgan Stanley moved fast to protect themselves. Credit Suisse did not, and the bank got stung for a loss of $5.5 billion.

Hwang was later arrested and charged with racketeering, securities fraud and wire fraud. Credit Suisse’s reputation never recovered.

What Are CoCo Bonds?

Another odd aspect of this Credit Suisse debacle is that the bonds have been far more volatile than the equity. CS shares are getting shares of UBS. That’s pretty straightforward, but some of the bondholders have been wiped out.

Credit Suisse has what are called additional tier 1 (AT1) bonds. More formally, these are called convertible contingency bonds. Less formally, they’re known as CoCos.

CoCos are bonds that convert into stock if some pre-specified event happens. For example, going bankrupt. CoCos can even be declared worthless, and that’s exactly what happened with Credit Suisse.

On Sunday, the Swiss regulators announced that as part of the deal, Credit Suisse’s AT1 bonds will get a brand-new price of $0. The AT1 investors are furious, and I’m sure this will all be headed to court.

This is one of the hidden aspects of a financial blowup. You never know exactly where it will spread. The AT1 bonds are turning into a major issue. According to the regulators, $17.3 billion of CS’s CoCo bonds have gone up in smoke.

So now folks are wondering why the CoCos got torched when the stockholders didn’t. Traditionally, bondholders outrank equity owners. This has roiled the entire CoCo market. For example, Invesco has an ETF that invests in AT1 bonds. On Monday, it lost close to 6%.

CoCos came about after the financial crisis and became popular with many European banks. Today, there’s more than $250 billion of outstanding AT1 bonds. The bonds were popular with investors. They paid a good deal and the prospect of going bust seemed improbable. Raymond DeVoe famously said, “More money has been lost reaching for yield than at the point of a gun.”

In 2020, Credit Suisse was able to float $1.5 billion in AT1s and they got a rate of 5.25%. They were seen as a safe way of shifting bailout risk to bondholders from taxpayers. That’s why they were afterward called bail-ins instead of bailouts.

But now, the whole CoCo market has gone cuckoo. Everyone had assumed these bonds were safe. Hey, what’s the worst that can happen? Well, now we know. I’ve seen several clips this week of investors furious that their Cocos have been zeroed out. Don’t play the game if you don’t know the risks. In Monday’s trading, Deutsche Bank saw its AT1 bonds drop sharply. So did UBS. Importantly, CoCos are not issued by American banks.

Thanks to this deal they didn’t want, UBS is now one of the largest and most important financial institutions in the world.

Expect the Fed to Hike by 0.25%

I got a good response from last week’s issue when I did a deep dive on what happened at Silicon Valley Bank. That’s why I decided to do the same with Credit Suisse.

But I didn’t want to leave without discussing this week’s Fed meeting. The Fed’s two-day meeting began today and will wrap up tomorrow. The policy statement will be released on Wednesday at 2 p.m. ET.

I expect the Fed will once again hike interest rates by 0.25%. Until recently, I was leaning toward a 0.50% increase, but the events of late have changed that outlook.

At the next meeting in May, I expect another 0.25% hike. After that, however, I think things may change. There’s a good chance that the Fed will take a break for a few months and leave rates unchanged. Of course, this is just a guess and much of what the Fed will do will depend on the behavior of inflation and the economy.

There’s even a decent chance that the Fed will soon shift its bias toward rate cuts, especially if the slowdown in housing spreads to other sectors. The simple fact is that the economy will probably weaken as we get closer to 2024. I hope the Fed will address these issues in tomorrow’s press conference. I’ll have more details in our next premium issue.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

Posted by on March 21st, 2023 at 6:08 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.