To The Moon

The Swiss National Bank's US$54 billion loan to Credit Suisse apparently didn't restore the confidence in Credit Suisse. The next move is to change the owner for the bank.

The Swiss authorities were busy over the weekend, brokering a merger between Credit Suisse and UBS.

UBS has reached an agreement to acquire Credit Suisse for US$3.25 billion, or CHF0.76 per share. This price was less than half of the bank's market capitalization at the close of trading last Friday.

In other words, a Credit Suisse shareholder saw the value of his shares decline 59% over the weekend while the market was close.

This offer is particularly disappointing given that Credit Suisse's market capitalization was valued at US$27 billion at the start of 2022 and had peaked at US$79 billion in 2007. This deal can be seen as a significant undervaluation and a major blow to the reputation of Credit Suisse.

The news comes as a shock to many, given that Credit Suisse has always been regarded as a prestigious brand for the world's wealthiest individuals and has a rich history spanning over 167 years. It is both sad and surprising to see how the bank has come to this point.

The initial offer for Credit Suisse was more insulting, as it amounted to a mere US$1 billion. It is hardly surprising that the management and investors of Credit Suisse objected to that offer.

Despite the bank's recent difficulties, it is worth noting that it still holds a substantial amount of assets under management, totaling US$1.4 trillion, half a trillion in assets, and a book value of US$49 billion as of the end of 2022.

While it may seem like UBS has secured a good deal with its acquisition of Credit Suisse, it's important to recognize that this is a forced merger and UBS may not have pursued this opportunity under normal circumstances.

Credit Suisse's assets have dwindled since the start of the crisis, as clients have withdrawn their funds due to concerns about the bank's stability. In fact, withdrawals began in late 2022, with 38% of its deposits being withdrawn in the fourth quarter of that year. It's likely that further withdrawals occurred as the crisis deepened, leading to an even greater decline in the bank's assets.

Moreover, Credit Suisse has struggled financially in recent years, experiencing losses of $860 million and $7.9 billion in 2021 and 2022 respectively. Credit Suisse expected another substantial loss in 2023 too.

UBS will need to absorb these losses and assume some of Credit Suisse's debts, which are over $160 billion. To mitigate some of these losses, the AT1 bonds worth US$17 billion were written down and the Swiss government would provide more than US$9 billion to backstop some losses for UBS.

However, UBS will still have to undertake significant restructuring efforts, which will be a major challenge and a drag to UBS performance in the coming years.

Given these challenges, UBS's share price is likely to take a hit as a result of the merger.

But shareholders of Credit Suisse will likely suffer the most. Consider, for example, an investor who purchased Credit Suisse stock at CHF7.18 just a year ago. The investor would receive only CHF0.76 per share, resulting in a staggering 89% loss.

And it isn't going to be cash, Credit Suisse shareholders will be receiving UBS shares instead. Some of these shareholders may choose to sell the UBS shares, which could weigh down the share prices further.

Not all holders of Credit Suisse bonds are spared. A special class of AT1 bonds that were created during the last financial crisis in 2008 have been rendered worthless while other bonds are still honored.

It may be surprising to some that AT1 bondholders received nothing, while shareholders were able to recover some value, given that bondholders typically have greater priority in the event of a bank's failure. However, it is important to note that AT1 bonds are a special type of bond that can be converted to shares or written down when a bank's capital falls below a certain threshold. Unfortunately, that threshold has been breached in this case. Fair though not pleasant, terms and conditions apply.

The banking crisis in the US remains unresolved too. The US authorities have flew to Omaha over the weekend to seek advice from Warren Buffett. Mergers may be in the cards as well, though shareholders shouldn't expect much in terms of financial gain from these deals. Despite this, it's crucial that these measures be carried out in order to prevent a total collapse of the financial system.

In the bigger scheme of things, merging banks to improve their financial strength is a temporary solution rather than a permanent one. As banks become larger through these mergers, they also become too big to fail, making future rescue packages even larger and more challenging.

In this case, the UBS and Credit Suisse merger is joining two systemically important banks together and the pillars of the Swiss banking system is left with one instead of two. While the move may be a short term solution, this may be a Frankenstein in the making and potentially increasing the risk of a more dangerous failure down the road.

Unfortunately, it seems that we haven't learned enough from past bank failures to prevent them from happening again. The nature of banking involves high levels of leverage, with banks lending out more than the deposits. As a result, banks may experience a negative impact that is multiplied and cause problems to spiral out of control.

The causes of bank failures have been different in the past, such as the deflationary effect during the 1920s, sub-prime lending in the 2007-2008 period, and now it is due to the fast-paced interest rate hike.

There will undoubtedly be future black swan events that will cause banks to struggle again. These events are often difficult to identify before they happen, but glaringly obvious in hindsight. Sadly, it's unlikely that this will be the last banking crisis we will face, and the next one is likely to be bigger too.

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