Bank shares slide after UBS agrees ‘emergency rescue’ of Credit Suisse – business live

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Some calm has returned to the financial markets, after a choppy start to the morning after the emergency rescue of Credit Suisse last night.

The FTSE 100 index is now flat, having been down almost 2% at one stage in early trading.

Bank stocks have recovered some ground, after European regulators insisted that under their rules common equity would be wiped out before AT1 bonds were triggered (unlike in the Credit Suisse rescue, which alarmed investors).

Bank shares are still weak, though, as investors digest the ramifications of the UBS-CS deal.

Barclays (-3.5%), Standard Chartered (-3.3%), HSBC (-2.6%) and NatWest (-1.9%) are among the big fallers on the FTSE 100 index.

Patrick Ghali, managing partner of Sussex Partners, says it remains to be seen if the latest actions from policymakers are enough to stem what has become a crisis of confidence and whether further contagion can be contained.

Ghali explains:

The worry remains that markets continue to be stretched and fragile and anything could trigger a further sell off. The events over the last few days, including not just credit Suisse, but also other banks, show that things are perhaps not as robust as some have suggested.

The case for an economic contraction is becoming clearer by the day, and the consensus seems to be moving away from the wishful thinking of a soft landing. Investors need to watch liquidity and the knock-on effects of this extremely closely, also as it relates to private assets”.

Eurozone banks borrowed just $5m from the European Central Bank through the new dollar swap facility set up by the major central banks last night, Reuters reports.

The Bank of England has not received any requests for dollars through the new operation announced by the world’s top central banks last night.

According to Reuters, the BoE said it received no bids for dollar liquidity at a first daily seven-day repo operation that was launched on Monday.

That suggests that UK banks were not desperate to get their hands on US dollars this morning – an encouraging sign.

The dollar repo operation was part of the push to enhance liquidity of US dollars in the markets, through new swap lines.

Those swap lines are meant to provide low-risk short-term loans that ensure the world’s major economies have adequate supply of US dollars to meet local demands.

The euro area’s top financial regulators have just issued a statement, in an attempt to reassure markets that the Credit Suisse deal hasn’t changed their position on the hierachy of debt when a bank fails.

The Single Resolution Board, the European Banking Authority and ECB Banking Supervision say they welcome the “comprehensive set of actions taken yesterday by the Swiss authorities”.

They then spell out to investors that they will force losses on equity holders, before investors holding AT1 bonds, despite the Credit Suisse deal inverting this order by wiping out its AT1, or CoCo, bonds (see previous post).

The regulators say:

The resolution framework implementing in the European Union the reforms recommended by the Financial Stability Board after the Great Financial Crisis has established, among others, the order according to which shareholders and creditors of a troubled bank should bear losses.

In particular, common equity instruments are the first ones to absorb losses, and only after their full use would Additional Tier One be required to be written down. This approach has been consistently applied in past cases and will continue to guide the actions of the SRB and ECB banking supervision in crisis interventions.

Additional Tier 1 is and will remain an important component of the capital structure of European banks.

Derivatives that track the value of riskier bank debt – the sort that is being wiped out in the Credit Suisse takeover – are falling sharply today.

Invesco’s AT1 Capital Bond exchange-traded fund , which tracks the value of AT1 debt issued by banks, is down 15% this morning.

Those AT1 bonds, known as “contingent convertible” debt or CoCos, are designed to be triggered at times of market turbulence. They are basically shock absorbers to activate in a crisis – if a bank’s capital levels fall below a certain point in a crisis, AT1s are converted into equity, or written off.

As we’ve been covering this morning, investors are startled that Credit Suisse’s AT1 bonds are being written off, even though the bank’s equity is not totally destroyed (shareholders are taking a 60% haircut). Typically, AT1 bonds is meant to be above equity in the debt heirachy.

Neil Wilson, chief markets analyst at Markets.com, says this ‘blatant’ upending of the debt heirachy will have ramifications.

These are ‘contingent convertible’ bonds that are riskier than other debt instruments and designed to get wiped out in a crisis – or converted to equity. Usually this would be the same thing – like when Banco Popular got gobbled up by its national rival Santander in 2017 – the only precedent for the CS takeout.

However, shareholders in CS are getting something, even if it’s not much. Blatantly upending the hierarchy of debt will have ramifications and I think this is why we are seeing such a negative reaction in bank shares this morning.

Charles-Henry Monchau, chief investment officer at Syz Bank, fears there will be ‘spillover’ damage to global credit markets.

Monchau says:

According to the Swiss bail-in regime, AT1 debt is above equity in the loss absorption waterfall.

This is an arresting development, given that even unsecured bondholders usually rank above equity holders in the capital structure. So for equity holders to get “something” and CoCo bond holders to get “nothing” raises serious questions about the real value of CoCo bonds.

This is creating contagion risks on CoCos (see market action this morning in Asia – e.g Bank of East Asia 5.825% perpetual slumped 8.6 cents to 79.7 cents). There is also a risk of spillover effect on global credit (although we note that senior secured bonds seem quite resilient including CS senior secured bonds which are jumping in price this morning).

The UBS acquisition of Credit Suisse eliminates immediate tail risks in the banking sector, argues analysts at Jefferies, but it also raises questions.

In a research note this morning, they point to the fact that UBS shareholders were not asked for approval (because emergency powers were activated) and that holders of Credit Suisse’s AT1 bonds (risky debt) are being wiped out while shareholders aren’t entirely (which breaks the usual seniority for creditworthiness).

Jefferies say:

It’s positive news that a deal could be found as there were not many alternatives, and a nationalization or unwinding of CS would likely have increased sector risks.

However, in terms of sector ramifications, while this deal significantly reduces the immediate systemic risk from CS’ weaknesses, we think two key negatives elements will also catch the eye: (1) that CS’ AT1 holders are wiped out whereas shareholders are not entirely, though normally more junior in creditworthiness, and (2) that shareholder approval was not asked on UBS’ side for this deal.

We think the objective of this transaction, while solving CS’ situation & associated risks for the system, is to reach a win/win, where UBS shareholders also get value out of this deal over time.

The low price paid (CHF 3bn) and significant safety net provided to UBS (with government guarantee) are positive, while UBS’ strategy is unchanged. However, UBS embarks significant execution risk, litigation risk, the buyback is temporarily suspended (unclear how long), UBS’ capital requirement is likely to be revised up, and management focus will be captured by this deal for many quarters, maybe years.

The turmoil in the banking sector may deter the Bank of England from raising borrowing cost again this week.

The money markets this morning indicate that the BoE is more likely to not lift interest rates, than to push them higher, when it sets monetary policy on Thursday.

No Change from the Bank is seen as a 57% possibility, while a quarter-point hike from 4% to 4.25% is seen as a 43% chance.

The increases in interest rates by major central banks in the last year or so have already added to tensions in the markets. They pushed down US government bond prices, which was the cause of the losses at Silicon Valley Bank which failed earlier this month.

Bank failures typically precede a US recession, as our economics editor Larry Elliott explains here.

Bank bonds are sliding after Swiss authorities decided to wipe out Credit Suisse’s riskier bonds as part of the rescue package, explains Alvin Tan of RBC Capital Markets.

Tan says:

The biggest one was UBS’ acquisition of Credit Suisse, supported by a CHF9bn guarantee from the Swiss government to cover potential losses from specific business lines.

However, the Swiss regulator’s decision to write-down completely CS’ additional Tier 1 bonds has sparked a selloff in bank bonds globally.

After months of uncertainty, client withdrawals, a sliding share price and existential angst, UBS’ takeover comes as a relief for Credit Suisse, says Victoria Scholar, Head of Investment at interactiveinvestor.

However its shares are still sharply lower and its bondholders face much uncertainty, Scholar explains:

Credit Suisse’s CoCo bonds, high-yield investments which are a cross between a stock and a bond have been written off, landing its AT1 bondholders with hefty losses. This has sparked nervousness about AT1 bonds more broadly with some investors retreating from them altogether.

Credit Suisse is a 167 year old institution that has been instrumental to the growth of the Swiss economy. The end of its history marks a sad day for longstanding employees and loyal customers. There will be hard yards ahead for UBS to successfully implement the takeover. Credit Suisse is likely to be vastly reduced to only its most profitable components.

UBS’ acquisition has done little to allay the market’s unease with banks nursing painful losses across Europe on Monday. Credit Suisse has opened down by more than 60% and UBS is down by over 8%.

Banks including Deutsche Bank, Commerzbank and BNP Paribas are trading sharply lower with German banks understood to have direct financial exposure of at least $11.5 billion to Swiss banks. Banks on the FTSE 100 like StanChart, Barclays and NatWest are languishing at the bottom of the UK index.”

Stephen Innes, managing partner at SPI Asset Management, says the markets risk being pulled into a ‘horrible negative feedback loop’, as authorities take action to (they hope) stem the crisis [such as the new dollar swaps announced last night].

No, if and or buts; price action in oil and safe-havens gold and yen suggests folks are still spooked, hinting we are in the process of devolving from a bank to an economic crisis when growth becomes more concerning than the crisis itself.

And if that proves accurate, a negative equity-bond correlation should see gold push higher and oil continues to tank.

Compounding matters is that the more policymakers do, the more investors expect bad news to come down the pipe, which creates a horrible negative feedback loop, almost as if investors are asking themselves “what do they know we do not know?”

The cost of insuring UBS Group debt against default has risen after it agreed to buy Credit Suisse.

UBS’s five-year credit default swaps, derivatives which are often used to gauge a borrower’s credit risk, widened to 153 basis points from 117bps on Friday, according to S&P Global Market Intelligence data.

Shares in UBS have dropped by 8.7% in early trading, as investors react to its cut-price takeover of Credit Suisse.