The Lex Newsletter: Credit Suisse bank run brings down an avalanche

Dear reader,

Last Friday, we speculated that Credit Suisse had been struggling to transact in the interbank market and might need to combine with UBS. This happened sooner than we expected. Swiss authorities arranged the shotgun wedding of Credit Suisse to its larger rival on Sunday.

A distant yodel of distress from failed or struggling US regional lenders such as Silicon Valley Bank and First Republic exacerbated deposit flight at Credit Suisse. This has brought down an avalanche on European banking. The consequences have included:

• the obliteration of a 167-year-old Swiss lender

• turmoil in bank bonds

• serious damage to the standing of Switzerland as a financial centre

• a potentially irresolvable dilemma for central bank rate-setters

UBS had its arm twisted to take over Credit Suisse before markets opened on Monday. Lex saw this as a decent deal for UBS nevertheless. It was underwritten with hefty state liquidity and a modest $3bn all-share purchase price.

To comment on this or any aspect of our coverage, please email me at [email protected]. And thanks to the many hundreds of readers that participated in our survey. It will help set our course for the next few years.

On Sunday, we predicted a storm of litigation, given the peremptory character of the UBS/Credit Suisse deal. By Monday, it was clear this would primarily be against Switzerland rather than UBS.

Swiss authorities had wiped out $17bn of Credit Suisse AT1s, bank bonds usually designed to evaporate after equity in a crisis. The unexpected move deepened losses on European AT1s as an entire asset class. We wrote that persistently high yields would make AT1s unviable for new issuance.

Law firms such as Quinn Emanuel and Pallas are vying to represent AT1 owners. We gave the following précis of the nascent legal attack on Switzerland:

• Swiss law requires equity to absorb losses before debt in an insolvency and may do so in rescues too

• special cases where fine print permits hierarchy inversion may not include the UBS takeover

• Switzerland’s emergency ordinance wiping out the bonds may be overridden by overarching property rights

The courtroom battle would simultaneously smack of hedge funds taking on defaulter Argentina in the noughties and the fictional case of Jarndyce vs Jarndyce, which left only lawyers wealthier.

We expect that central bankers will reflexively demand much higher capital buffers from commercial lenders. This would not stop bank runs during financial panics. But central bankers are a bit like those celebrities who say you can never be too rich or too skinny. They believe you should have more buffer capital in all circumstances.

They are more conflicted about interest rates. Inflation is still steep, but unless they moderate the path of rate rises, further panic and more bank collapses may result. As we predicted, the European Central Bank has softened its rhetoric. The Fed raised rates by a quarter point rather than half a percentage point on Wednesday. Slower, lower increases are a reason aside from higher capital buffers why bank profits will falter.

UBS boss Ralph Hamers is left to integrate UBS with its erstwhile deadly rival. One ex-UBS investment banker of our acquaintance expects Hamers to dispense with more than half of Credit Suisse’s workforce. Almost nobody will go from UBS he believes.

Lex predicts that the axe will fall most heavily on Credit Suisse’s Asian units. We think UBS has a decent chance of bolstering its position in global wealth management.

’Fraid in America

The UK government that dealt with the 2007-2008 great financial crisis tended to bracket it with phrases such as “the American financial crisis that was invented by Americans and came over here from the US”.

Clear on that? The GFC had nothing to do with the wild UK lending practices that UK politicians had done nothing to stop. Lex expects European politicians and central bankers to blame the US for the current instability in the same way.

Undeniably, the proximate trigger for current turmoil was the collapse of Silicon Valley Bank in California. The US leg of the crisis went on twitching this week. Fugitive deposits have been swelling money market funds. We see these as relatively safe investments (fingers crossed).

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Regional bank shares plainly are not safe. We had some sympathy with a call from the Mid-Size Bank Coalition of America for an extension of deposit insurance above a cap of $250,000 each. Sheila Bair, former boss of the Federal Deposit Insurance Corporation, pointed out that deposit flight could simply increase the competitive advantage of Wall Street giants. US Treasury secretary Janet Yellen responded with mixed messages during the week.

The Federal Reserve has lent as much as $109bn to First Republic, at present the most precarious US regional bank. It is doing so at an annualised cost of 4.75 per cent. The bank’s asset book, largely of long-dated mortgages, recently yielded 3.5 per cent. This is a bad look and a recapitalisation will be needed.

New York Community Bank agreed to absorb failed crypto-focused lender Signature. The acquirer received a gift of £2.7bn in equity and its shares leapt accordingly.

Non-apocalyptic news

Chatbots continue to obsess tech types. Google launched its Bard chatbot in rivalry with OpenAI’s upgraded ChatGPT, which was unveiled last week. The potential for seamless human/computer interaction is exciting, but the technology is not there yet. Nor is the business model.

Sports cars work pretty well, though Italians apparently joke that the only time you see a Maserati on the street is when it is being towed to the garage. The company is midway through a strategic U-turn: it has realised profits matter more than sales. That revelation should help if it eventually floats. We valued Maserati at about €6bn after surveying its peer group.

John Lewis is another famous brand that could be open to external investment. The employee-owned business comprises department stores and the Waitrose groceries chain. A turnround plan does not appear to be bearing fruit and the business may sell a £2bn minority stake to an external investor.

Spedan Lewis, the architect of employee ownership, must be spinning in his grave.

Stuff I enjoyed this week

I am still reading Edward Gibbon’s The History of the Decline and Fall of the Roman Empire.

I also relished the FT’s account of the decline and fall of the Credit Suisse empire by Stephen Morris, James Fontanella-Khan and Arash Massoudi. This was compellingly written.

I would not say I entirely enjoyed reflections on the same collapse by Tidjane Thiam, who ran the bank until 2020. You might say it provided insights into the capacity that all of us have for post-event rationalisation.

Have a good weekend,

Jonathan Guthrie
Head of Lex