Navigating Rates

European banks: steadying the ship?

A week on from the collapse of Silicon Valley Bank in the US, all eyes are on Europe with the merger of UBS following its takeover of Swiss rival Credit Suisse. Has the deal to rescue Credit Suisse – and the wider actions of European regulators – helped to restore confidence?



What has happened?

UBS has agreed to acquire its troubled Swiss rival Credit Suisse in a deal worth CHF 3 billion (USD 3.3 billion). Brokered by the Swiss government, this rescue avoids the disorderly failure of one of the world’s 30 systemically important financial institutions and the second-largest lender in Switzerland.

This follows a week of turmoil in the sector beginning with the collapse of Silicon Valley Bank in the US. Other US banks have faced similar struggles, including Signature Bank (now the third-largest bank failure in US history) and First Republic Bank (subject to continuing rescue efforts).1

Credit Suisse has underperformed the banking sector for several years, following losses related to the collapse of Archegos Capital Management and Greensill.

While in many ways idiosyncratic events – with each bank suffering from specific issues – these incidents can also be viewed as the ramifications of the fastest and largest rise in interest rates for more than 40 years, following years of easy monetary policy.

In effect, money has a cost again. The world economy has ultimately entered a period of re-adjustment and rebalancing. As so often in the past, this process leads to financial stresses and accidents.

Our Views

Simon Outin

Simon Outin

Director of Financials Research, Global

In our opinion, the acquisition of Credit Suisse by UBS is sufficient to provide visibility for the Credit Suisse group. Credit spreads and credit default swaps on the senior debt issued by the Credit Suisse holding company and operating companies should stabilise in the coming days and weeks, avoiding the disorderly failure of one of the 30 globally systemically important financial institutions.

In many respects, the deal looks favourable for UBS, although may not be without risks:

  • Scope – Credit Suisse’s valuable Swiss bank is included in the deal, and antitrust considerations are not considered relevant given financial stability concerns.
  • Liquidity – Includes a liquidity line of up to CHF 100 billion plus the CHF 50 billion provided to Credit Suisse last week.
  • Capital –CHF 16 billion worth of AT1s written down and badwill of more than CHF 30 billion, ie, the common equity tier 1 (CET1) of Credit Suisse minus the CHF 3 billion price.
  • Tail risk – Also includes up to CHF 9 billion second-loss insurance from the federal Swiss government.

The consequences for additional tier 1 (AT1) bond holders are significant.

The deal to rescue Credit Suisse involved the write-down of USD 17 billion of AT1 debt to zero. This represents the largest loss in the AT1 market to date.2

AT1 bonds were created in the wake of the global financial crisis to absorb losses in a going-concern scenario. The goal was to facilitate the rescue of banks while avoiding using too much public money – in contrast to the banks’ hybrids issued before the crisis. Also known as contingent convertibles, AT1s help banks meet their capital requirements, because they can be converted into equity or written down if the issuing bank’s capital strength falls below a pre-determined level.

Concerns about the wider prospects for AT1s led to negative price action varying from 5-20 percentage points across the board for European banks on Monday morning.

But it seems the markets have drawn some limited reassurance from the statement by the European banking regulators, and subsequently the Bank of England, reiterating that – despite what happened in the case of Credit Suisse – AT1 debt holders should suffer losses only after equity investors have been fully wiped out.3

In addition, we believe banks will do the maximum to pay coupons as due and to reimburse on the first call date with a view to bolster much-needed confidence. Banks can also replace AT1s with pure CET1 capital – a decision, we believe, they are likely to take on a unilateral basis, if the supervisor agrees, as the banks estimate their cost of equity versus cost of funding.

In the case of Credit Suisse, senior creditors (preferred or not) have been fully protected.4 We think that, after the initial shock reaction on Monday, this will likely be reflected in positive price actions on AT1s, which are critical for financial stability in Europe.

Dirk Becker

Dirk Becker

Senior Portfolio Manager, Global Financials

Credit Suisse has been seen as the weakest link in the global banking sector for several months, after various scandals and poor management decisions.5 We think the merger can therefore help to stabilise the global financial system:

  • In our view, UBS are being paid for running down the risky parts of Credit Suisse, and they get to keep the highly profitable Swiss domestic unit in return. They will have a CHF 54 billion gain on the first consolidation because they are buying the Credit Suisse equity at a huge discount, and they get the AT1 capital on top for “free” – although there will likely be many issues to deal with over the coming years as the Credit Suisse positions are wound down and legal costs have to be paid.
  • The decision of the Swiss regulator to wipe out Credit Suisse’s AT1 bonds while equity holders receive at least a token compensation initially sent shockwaves through the AT1 market (see above).6 If, in contrast to what had been said before, those instruments rank, junior to equity in the capital stack, a repricing of those bonds would be required. Banks who issue new instruments will pay a higher risk premium, so this instrument becomes more expensive. (And if it becomes more expensive than equity, there is no reason to issue it any longer.) But in our view, the statement from EU regulators should calm fears in the European banks' AT1 market.7
  • The takeover of Credit Suisse could be seen as a positive for the wider banking sector and the financial system as a whole. Banks are still expecting a record year in 2023 due to higher interest rates after posting their highest net profit last year since 2007 (see chart below). Q1 results should be helped by fixed-income trading. The economy is still stronger than anticipated, which should keep loan losses under control. The sector is trading on 0.6x price-to-book-value ratio and 6x price-to-earnings ratio for 2023E.

Looking ahead, regulation is potentially the key risk. Regulators tend to take a conservative view on risk and prefer to err on the cautious side. Will the European Central Bank (ECB) prefer the banks to keep equity on the balance sheet – rather than honour their commitments to generous dividends and share buybacks? While it is difficult to call, the Credit Suisse incident may be atypical of a sector that has – so far – seemed relatively robust during this crisis.

Exhibit 1: European banks net profit (EUR billion)
Exhibit 1: European banks net profit (EUR billion)

Source: Bloomberg, as of 20 March 2023

  • Disclaimer
    Diversification does not guarantee a profit or protect against losses.

    Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

    The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

    This material has not been reviewed by any regulatory authorities. In mainland China, it is for Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations and is for information purpose only. This document does not constitute a public offer by virtue of Act Number 26.831 of the Argentine Republic and General Resolution No. 622/2013 of the NSC. This communication's sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of his document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Brazil, Panama, Peru, and Uruguay. In Australia, this material is presented by Allianz Global Investors Asia Pacific Limited (“AllianzGI AP”) and is intended for the use of investment consultants and other institutional/professional investors only, and is not directed to the public or individual retail investors. AllianzGI AP is not licensed to provide financial services to retail clients in Australia. AllianzGI AP is exempt from the requirement to hold an Australian Foreign Financial Service License under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order (CO 03/1103) with respect to the provision of financial services to wholesale clients only. AllianzGI AP is licensed and regulated by Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.

    This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Distributors LLC, distributor registered with FINRA, is affiliated with Allianz Global Investors U.S. LLC; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG; in HK, by Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; in Singapore, by Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; in Japan, by Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424], Member of Japan Investment Advisers Association, the Investment Trust Association, Japan and Type II Financial Instruments Firms Association; in Taiwan, by Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan; and in Indonesia, by PT. Allianz Global Investors Asset Management Indonesia licensed by Indonesia Financial Services Authority (OJK).

    2801946

Recent insights

Embracing Disruption

The “Internet of Things” (IoT) has made strong progress over the past decade, with connected devices now commonplace across both households and industry. However, in terms of the promises of IoT translating into tangible productivity gains, we have seen some bumps in the road to wider adoption, not least among systems providers seeking sustainable models for monetizing this quickly developing technology.

Discover more

Navigating Rates

Many of the major central banks (excluding Japan) are beginning or set to begin interest rate-cutting cycles this year. Here are four fixed income themes we believe could present investors with opportunities during the remainder of 2024.

Discover more

Modi’s victory, and the continuation of the reform agenda his government has embraced, should further strengthen the trajectory towards an ‘Emerging New India.

Discover more

Allianz Global Investors

You are leaving this website and being re-directed to the below website. This does not imply any approval or endorsement of the information by Allianz Global Investors Asia Pacific Limited contained in the redirected website nor does Allianz Global Investors Asia Pacific Limited accept any responsibility or liability in connection with this hyperlink and the information contained herein. Please keep in mind that the redirected website may contain funds and strategies not authorized for offering to the public in your jurisdiction. Besides, please also take note on the redirected website’s terms and conditions, privacy and security policies, or other legal information. By clicking “Continue”, you confirm you acknowledge the details mentioned above and would like to continue accessing the redirected website. Please click “Stay here” if you have any concerns.