The Credit Suisse Rescue Deal: Impact on Banks’ Cost of Capital and Credit Policy
Credit Suisse is considered to be a “global systemically important bank” (G-SIB) by the Financial Stability Board, the international body set up following the 2009 G20 summit to monitor our global banking system. This is a very exclusive status shared with only 29 other institutions globally. To put it into context, not all of the UK’s big 4 banks make the list of G-SIBs. So when it became clear that Credit Suisse was encountering difficulties last week, it is understandable that the regulatory bodies would be keen to come up with a solution, and quickly. And they did – over the weekend it was announced that UBS would acquire Credit Suisse.
So what caused this? Well, very briefly, as central bank rates rose, Credit Suisse was forced to announce that it would take advantage of a lifeline of $53.7bn offered by the Swiss National Bank to shore up its liquidity. It had been left vulnerable after a series of events in recent years, including a $5.5bn loss from the collapse of Archegos Capital in 2021 and then social media speculation on its stability leading to capital withdrawals by customers in 2022. It is a stark reminder that the global banking system is built on the foundations of confidence and that a lack of confidence can be fatal.
So what was so unusual about the UBS deal, and what does it mean for everyday business? The most unusual feature of the deal has to do with AT1 (Additional Tier 1) bonds. AT1 bonds, also known as contingent convertible (CoCo) bonds, are a type of hybrid security that is designed to provide banks with a buffer against losses in times of stress – they count towards Tier 1 capital without diluting the equity of the bank. In times of trouble, AT1 bonds can be written off or converted into equity, increasing the bank’s capital buffer.
As a bond, many investors assumed that, while riskier than other bonds, they would still rank ahead of shareholders and their value would only be written down in the event that the shares became worthless. This proved to be an inaccurate assumption, with the regulator instead opting to write down $17bn of Credit Suisse’s AT1 bonds while shareholders received value for their shares. This has caused a revaluation of the traditional wisdom that debt ranks ahead of equity in bank capital structures.
The situation is so unusual that the Bank of England issued a statement confirming that, in the UK, “holders of such instruments will be exposed to losses in resolution or insolvency in the order of their positions in the hierarchy” – or to put it another way, the BOE will write down equity before it writes down debt. The fact this needs to be said at all perhaps outlines just how unusual the Credit Suisse situation is.
And despite such statements, the global market has been revaluating AT1 bonds. Many bonds have lost up to 80% of their value on the global secondaries markets and it is not clear that if this is a final position, as there are, understandably, more sellers than buyers right now. It is likely that banks will find it harder to issue AT1 bonds in future, and that it will be more costly for them to do so.
The knock on impact of this is that the cost of capital is suddenly higher across the banking market as a result of the effects of the Credit Suisse deal. And where costs of capital increases, a tightening of credit policy and increase in pricing follows. What does that mean for businesses back home in the UK? A sadly familiar story for 2023: borrowing is going to become more difficult, and more expensive.