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Credit Suisse Doesn’t Derail Investment Case For European Financials – GAM

Editorial Staff

22 March 2023

The takeover of and the shock to bond investors hasn’t destroyed the investment case for European financials; it is largely a “one-off” event, Zurich-listed GAM Investments says.

On Sunday, in a deal was backed by Swiss authorities, UBS purchased its embattled rival for SFr3.2 billion. Shareholder approval for the deal was not sought. 

Under the terms of the takeover, there is a complete write-down of SFr16 billion ($17.3 billion) of the bank’s AT1 bonds in order to increase core capital. The write-down has prompted criticism, as holders of some equities appear to have gained more protection than holders of the ATIs. The Additional Tier 1 bonds were created around the time of the eurozone debt crisis more than a decade ago as a way for banks to acquire capital buffers. They are relatively high risk in terms of their seniority. 

The demise of Credit Suisse, which has a history dating back to the mid-19th century, has rattled investors’ nerves at a time when they were already hit by the collapse of US-based Silicon Valley Bank. 

“From a European financials perspective, we do not think what has happened to Credit Suisse should derail the investment case for European financials. It is a painful and historic situation, given the importance of Credit Suisse as an institution in the financial system and to Switzerland. However, it is largely being seen as a one-off,” David Dowsett, global head of investments at GAM Investments, said in a note. 

“There is still ongoing uncertainty in the US banking sector which warrants caution. We think that we are probably only in the early stages of the uncertainty around US regional banks, which are more lightly regulated and probably still have more mark-to-market challenges ahead of them. As a result, single-name risk in that sector from a headline perspective is still apparent and is something we should be prepared for,” he continued. 

“On the banking sector as a whole globally, it is important to stress that this is not a bad asset problem. The Global Financial Crisis was such a problem, where banks had significant assets on their balance sheets that were not worth anything or worth very little; this is not the case this time. We have a mark-to-market situation and level of uncertainty associated with government bonds and the bubble that burst last year that has to work its way through the system. We do not believe that there is a silver bullet to resolve this issue and it has to resolve itself over a period of time. It is worth bearing in mind that government bonds will mature at par. From this perspective, there is less price risk than there has been in previous episodes of banking uncertainty,” Dowsett said. 

“We also have uncertainty about deposit outflows, particularly in the US, where smaller banks are still vulnerable, in our view. There is action authorities can take that are much wider ranging guarantees of deposits in the US. It is, though, very difficult to do and there are concerns over the legal implications and the legislative process associated with that. However, there is a growing sense that wider action for banks in the US to deal with that issue is going to be necessary. The moves last week of major banks to reinvest deposits, back into First Republic for instance, are very much a sticking plaster move that will not decisively resolve the situation,” he said. 

(Dowsett was referring to pressures on First Republic Bank, the shares of which fell by as much as 50 per cent on Monday this week because investors fear that it will need a second rescue to stay afloat. Last week, large US banks pumped $30 billion in deposits into the midsized US lender.)

“We would emphasise that we do not believe overall that this is a credit event for the banking sector in the US, the same as it is not in Europe. Rather, it is a product of the tightening of interest rates that we have seen over the past 12 months and in that respect, is typical of what might be expected at this point in the cycle; liquidity conditions are tightening and businesses that have not been run effectively during the period of low interest rates are now not viable. What we are seeing is what tends to happen before a recession. This is not the precursor to a global banking crisis, but is making the recession that has been on the horizon more inevitable, which is what we are seeing priced in the interest rate curve with the move in the two-year,” Dowsett said. 

Reverting to the Credit Suisse demise and the wipeout of the AT1 bonds, Dowsett concluded: “We would not underestimate the sticker shock of a $16 billion write-down, and anticipated default on assets that were trading at around 85 cents a week ago. We would also not underestimate the contagion effects in the short term to an asset class that is $275 billion in size, ie the total AT1 market. These are meaningful but do not translate into a credit/banking crisis in our view. They do however, translate into further headwinds for developed world growth.”