The Breakdown - Was UBS Buying Credit Suisse Just ‘Soft Nationalization’?

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Starting point is 00:00:44 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the Big Picture Power Shifts remaking our world. The breakdown is produced and distributed by CoinDes. What's going on, guys? It is Monday, March 20th, and today we are following up on credits, suites and whether it amounted to a soft nationalization. A quick note before we dive in, there are two ways to listen to The Breakdown. You can hear us on the Coin Desk Podcast Network, which comes out every afternoon and features other great CoinDesk shows, or you can listen on the breakdown-only feed, which comes out a few

Starting point is 00:01:18 hours later in the evening. Wherever you're listening, if you would take the time to leave a five-star rating or a review, I would so appreciate it. It makes a huge difference. All right, guys. Well, another busy weekend. If you were on Twitter, I'm sure you saw the frenzy of debate around Bellaji's $1 million Bitcoin bet.

Starting point is 00:01:36 TLDR, Balaji Shrinivasin, who is the former Coinbase CTO and just generally interesting thinker. He authored that book, The Network State, which is also the name of his new podcast, and has been on this show before as well, has been what he has been ringing the alarm, as he puts it, around impending financial crisis. He is arguing that these bank failures are a direct result of Fed policies, and he thinks it gets worse before it gets better. Now, to put his money where his mouth is, he's taken at least two people up on a million dollar bet that Bitcoin reaches a. million dollars per coin within 90 days. If that seems crazy to you, you are certainly not alone. That has been the standard response from people in the FinTwit space and from traditional finance. But those who are in crypto don't quickly forget just how Presyantpology's predictions around the COVID-19 pandemic were. Anyways, it's something I'm watching, but if you want more in depth on that,

Starting point is 00:02:27 go check out the YouTube channel. I did a whole episode around it on Sunday. To the extent the story continues and it continues to shape debates, I may come back to that later in the week. Outside of that, all eyes were on the fraught negotiations to find a resolution for Credit Suisse. Now, why would this matter and why does it matter enough to be the feature of this show? First of all, in the wake of the Silicon Valley Bank run and signatures shut down and everything that we've seen from the U.S. banking sector, any other banking turmoil, even if it's far away and even if it's caused by totally different reasons, is going to get everyone on alert. But in the case of Credit Suisse, it's not just that. Credit Suisse is what's called a globally

Starting point is 00:03:04 systemically important bank or G-Sib. That's a bank whose systemic risk has been determined to be such that if it were to fail, it would likely trigger a huge array of additional consequences and financial crises. There are different rules for G-Sibs, different prudential regulation, different capital requirements, different surcharges, different stress tests, and so much more. The narrative around Silicon Valley Bank had been that this was an issue of either A, crypto-slash-tech banks and their concentrated deposit base, or B, a problem for smaller and regional banks that weren't backstop by the Fed in the same way that the too big to fail banks were. So understanding what the resolution of this G-Sib failure was going to be was top of mind for

Starting point is 00:03:43 anyone paying attention. On Sunday, a deal did indeed come together, and so today we're going to discuss that, what it says about the banking crisis, and what it suggests about the broader state of markets. At the end of the day, after all was said and done, credit Swiss was sold to its largest Swiss competitor, UBS. But it was done so with a gigantic backstop from the Swiss government. UBS will pay more than $3 billion to close the deal, with the Swiss government kicking in around $9 billion to cover some foreseeable losses, as well as providing $100 billion in liquidity provisioning from the Swiss National Bank. Late last week, the S&B was only willing to provide $50 billion in emergency liquidity, while the UBS offer was reportedly only at $1 billion.

Starting point is 00:04:20 Given how much changed in just a few days, it demonstrated how strategically important closing the deal was to the nation of Switzerland. The deal will see more than half a trillion dollars in Credit Suisse assets rolled into the operations of UBS, which already houses over $1 trillion in assets. This will size up UBS to a similar level to Goldman Sachs or Deutsche Bank. In announcements on Sunday, Credit Suisse called the deal a merger, while UBS characterized it as an acquisition. And regardless of which label was attached, the deal was urgent. Credit Suisse had seen as much as $10 billion in customer outflows per day last week,

Starting point is 00:04:50 adding to the $100 billion withdrawn for the bank in the final quarter of last year. Pressure was on the Swiss government to announce a deal ahead of the opening of Asian markets on Sunday night. Now, I did a little bit of background last week, but for those who didn't listen to that, Credit Suisse was in the midst of a multi-year restructuring effort that had failed to make progress. Time after time over recent years, the bank found itself in the headlines, attached to scandals including the collapse of Archegos Capital, the Greensill Capital Fraud, and a range of other corporate espionage schemes.

Starting point is 00:05:16 To fund their restructuring, Credit Suisse had raised $4 billion from the Saudi National Bank in October, which granted the Saudis a 10% stake in the bank. Reports of behind-the-scenes government dealings over the weekend paint a picture of absolute panic. Swiss authorities were reported to be close to even considering a plan B in the form of nationalizing the bank. Finma, Switzerland's financial regulator, said that Credit Suisse had experienced a crisis of confidence and that there was, quote, a risk of the bank becoming illiquid even if it remains solvent, and it was necessary for the authorities to take action in order to prevent serious damage to the Swiss and international financial markets. The Swiss government, in fact, took the extraordinary step of changing the law

Starting point is 00:05:53 to ensure that the deal could go through in an expedited manner without a vote from shareholders. Those shareholders will take a massive haircut, with the deal marked up at a 60% discount to the closing price for Credit Suisse shares on Friday. Bondholders will also take a massive loss, as $17 billion worth of so-called additional tier one bonds will be marked to zero. This write-down will be the largest in the history of Europe's $275 billion AT1 market. More on that in just a minute. Now, the deal marks the first time a systemically important bank has failed since 2008, and

Starting point is 00:06:24 it will leave a lasting mark on the Swiss banking system. The tone of public statements could not have been more clear. This deal was done in hopes of stopping further panic throughout the global financial system. The UBS chairman said in a press release, quote, this acquisition is attractive for UBS shareholders, but let us be clear, as far as Credit Suisse is concerned, this is an emergency rescue. It is absolutely essential to the financial structure of Switzerland and to global finance. In case that wasn't clear, global banking regulators from the U.S. to the UK had a hand in the weekend negotiations,

Starting point is 00:06:53 and public statements echoed the hope that this deal would calm the bank pan. Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen issued a joint statement saying, quote, we welcome the announcements by the Swiss authorities today to support financial stability. The capital and liquidity positions of the U.S. banking system are strong, and the U.S. financial system is resilient. ECB President Christine Lagarde said, I welcome the swift action and the decisions taken by the Swiss authorities. They're instrumental for restoring orderly market conditions and ensuring financial stability. The BEOE also released a statement, complementing the quick action.

Starting point is 00:07:23 Now, one interesting little denouement in this particular story, the Wall Street Journal reported that the Saudi National Bank had an alternative deal on the table and at higher mark. From WSJ, quote, On Sunday, there was a last-ditch effort by a group including Credit Suisse's largest shareholder Saudi National Bank to keep the lender alive, according to people familiar with the matter. The group made a rival proposal to inject around $5 billion into Credit Suisse. Under the plan, Credit Suisse bondholders would have been fully protected. Swiss ministers rejected the offer outright, according to the people.

Starting point is 00:07:52 The shareholders wanted the same government backstops being offered to UBS, such as the liquidity line, but were turned down. So in this context, you kind of have to ask what the Swiss interest was. Certainly they wanted to prevent larger global ramifications, but it seems pretty clear that they also wanted to keep CS as a nominally Swiss business, rather than allowing the Saudis to take control of a geostrategically relevant asset, even though it might have been a better deal for shareholders. I think it's really important. To give some context, Swiss GDP is around $800 billion per year, while the Swiss National Bank balance sheet is at around $884 billion after marking a $132 billion loss last year, which is the biggest loss in the central bank's 115 year history. In other words, this isn't exactly putting an entire nation's resources into backstopping the financial sector,

Starting point is 00:08:37 but it's not an insignificant portion with that $100 billion guarantee. I think it's really important to keep an eye on this sort of soft nationalization. I think one can make an argument that it has echoes of what's going on in the U.S. as the FDIC steps in to backstop all depositors at these early bankrun banks rather than just up to their $250,000 limits. Obviously, I'm not characterizing that as a nationalization of the U.S. banking system, but it's clear we are in times where these lines between the public and private sector are up for grabs and subject to change very, very rapidly.

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Starting point is 00:09:47 Let's stick a little bit now, though, into this conversation around the bonds. Markets analyst Johannes Borgon says CS confirmed shareholders will get $3 billion and AT1 holders zero. This won't go down very well as it's an obvious breach of the hierarchy of claims. Trinonomics says the wipeout of CS's $17 billion A.1 bonds is brutal and will lead to a tightening of liquidity for the sector. With a headline in Bloomberg saying, J.P. Morgan, decision to write down credits Swiss AT1 could lead to contagion for wholesale funding costs across the sector. Now, a different take comes from Count Dragula, great name by the way, a macro trader on Twitter, who writes that this is perhaps less of a big deal than it seems. They write all of

Starting point is 00:10:26 Credit Suisse's AT1 was in the form of cocoa or contingent convertible bonds. The conditions of general cocos is that they would either get ridden down or converted to equity once a certain trigger is hit, usually an amount of total capital. AT1 should lose only after all equity capital is wiped out, honoring the usual hierarchy of losses. But this didn't happen in the CS merger with UBS. In the process of writing down assets, the bank fell below the key thresholds for tier one capital, and this triggered a write-down in AT1 assets. Since the company was taken over, though, equity holders received a payment in UBS shares in return for relinquishing control to UBS. This was probably to satisfy the Saudis who received a non-trivial recovery on their recent

Starting point is 00:11:02 investment. Also, maybe to satisfy employees. The initial reaction to this is shock. Why invest in AT1 if equity gets a payout before you? How will this affect other Euro-AT1 securities? Will investors dump them? The question is complex. Kocos and bail-in regs in total are tough for investors. They introduce trigger risk and are almost impossible to price. There aren't many better solutions to the tail risk of banks failing, though. The terms of the AT-1s weren't a secret. They were all the type that would write down rather than convert to equity. This made them almost guaranteed to be subordinated to equity. So why buy AT1 at all anymore? These were issued at about 8% over the ECB rate, providing a big return in a low-return world. Presumably they'll pay more in the future. For anything to

Starting point is 00:11:43 change based on this contradiction, investors would have had to have thought of AT1 as being anything different to equity. I don't think they did. In the case of a restructuring or failure, the probability that losses are big enough to wipe equity but also small enough only to wipe equity is very, very low. Since the advent of Coco's, everyone knows that these are just equity that pay a big coupon. This coupon still probably made them a better deal than equity over time. So, nothing should change, but the market isn't always that rational. Now, for a little bit of history, these sort of contingent convertibles, these AT-1s, were introduced after the global financial crisis in order to incentivize private recapitalization of European banks.

Starting point is 00:12:21 These aren't a type of asset that exists in the U.S. It gave banks an ability to offer an equity-like raise that is treated like a bond in bankruptcy. The risk is that this resolution to credit Suisse has thrown that idea in the trash can. And the concern is that there is now going to be zero appetite for putting risk capital into failing banks, given that the rug was just pulled on an emergency capital raise avenue for all other GSIbs. In other words, this avenue for private recapitalization without government backing is largely gone. The implicit bet of AT1s and a whole bunch of the pricing structure was premised on the idea that GSIs would not be allowed to fail.

Starting point is 00:12:56 One way to look at Credit Suisse is that we're now seeing that GSIs will be allowed to sort of fail, with the outcome being that AT1 holders are zeroed out. So if, for example, Deutsche Bank needs to raise $3 billion to span the next year, then their access to capital has been pretty significantly cut off by the Swiss National Bank demonstrating that AT-1s are first in line to be zeroed out. Now, ultimately, this might not matter, but I think it is worth keeping an eye on, as we understand, again, the shifting dynamics of where public and private begin and end. Ultimately, this was not an arrangement that really anyone was happy about, and it was pretty

Starting point is 00:13:29 clear that the whole goal was to stop it from spilling over into larger market trouble. Indeed, on Sunday night, shortly before Asian markets opened, global central banks announced coordinated action to, quote, enhance the provision of U.S. dollar liquidity. The move will make dollar swap lines available on a daily basis, where previously they were a weekly offering. Dollar swap lines are provided by the Federal Reserve to five major central banks in Europe, Canada, England, Japan, and Switzerland.

Starting point is 00:13:52 These allow those central banks to swap national currency for dollars on a short-term basis on behalf of the commercial banks within their jurisdiction. The goal is to provide cheaper funding for dollar liquidity throughout the global financial system, which is screaming out for additional liquidity. Structurally, using dollar swap lines is very similar to a foreign central bank showing up to the Federal Reserve's discount window, which is typically a sign of extreme liquidity distress. The rationale for providing this liquidity is that the alternative would be foreign central banks dumping their U.S.

Starting point is 00:14:19 government bonds on the market to access the dollars that they need, causing further dislocation and volatility in the bond market. Swap lines are a permanent arrangement with these five major central banks, but they've been used very little since the first half of 2020. As you might imagine, the financial commentary on Twitter is split between the idea that this is sort of just business as usual. For example, Nick Timrose at the Wall Street Journal, who's often seen as a proxy for what the Fed thinks, writes, these swaps have been around for years. The Fed lends dollars to foreign central banks usually weekly with seven-day loans. But others see it as a more dramatic step. Mike Green says,

Starting point is 00:14:51 fairly big deal in my humble opinion. By creating the same differential between U.S. and foreign banks as it creates between the two big to fail banks and other banks, the U.S. has put the onus onus on other sovereigns to guarantee U.S.D. deposits. Without continuous and unlimited U.S.D. swap lines, this is not possible. Zero hedge, as you would expect, is even more extreme, saying the Fed has capitulated. Opening the swap line spigots is the first of many steps. Trillions in liquidity coming see the COVID playbook. Any half-ass steps now only guarantee much more liquidity will be needed down the road.

Starting point is 00:15:19 Now, on Wednesday, I have an interview with Lubita Welts, Ram Al-Alawalia, where we get much deeper into whether this represents an inflationary force, whether it's predicated on deflationary impulses, so look out for that. For now, like I said, Credit Suisse is nominally resolved, although the burden is now on UBS, and so people are watching Credit Default swap prices on UBS pretty closely. The curse of living through interesting times continues, but I am glad to have you here along for the ride. Until tomorrow, guys, be safe and take care of each other. Peace.

The Breakdown - Was UBS Buying Credit Suisse Just ‘Soft Nationalization’?

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