FPXE - European Banks After Credit Suisse
2023-03-24 03:30:00 ET
Summary
- UBS will receive substantial downside protection on acquired CS non-core assets of up to CHF25 billion.
- Credit Suisse remains active and should continue meeting its obligations until the merger closes, likely in the second quarter of 2023.
- Recent events have resulted in dislocations in the bonds of European banks.
By Victor Grigore
Recent events bring into focus the AT1 market and credit fundamentals of European banks.
We have seen significant market movement in bonds issued by European banks given the ongoing uncertainty leading to UBS's (UBS) takeover of Credit Suisse (CS), the write-down of CS Additional Tier 1 (AT1) bonds, and attention to implications for the European financial sector.
While integration risk will likely be an immediate focus for UBS investors, our view is that UBS's business profile will strengthen over the medium term with the addition of CS's strong franchise in Swiss Universal Banking, while CS's Global Wealth and Asset Management should recover under new leadership. As part of the deal structure, UBS will also receive substantial downside protection on acquired CS non-core assets of up to CHF25 billion.
In addition, we expect a limited direct impact on other European financials from these events. CS, as a counterparty, remains active and should continue meeting its obligations until the merger closes, likely in the second quarter of 2023. Large national champion banks in Europe that are focused on retail and commercial banking have customer counts in the millions and granular, largely insured deposit franchises. The few banks with large investment bank businesses could be in focus, however, although they are on a much stronger footing than CS and their divisions reported good results last year. We also expect limited effects on European insurance companies given their conservative fixed-income portfolios and typically minimal (if any) allocations to subordinated financial bonds.
There are implications for the AT1 market. CS was one of the largest AT1 issuers at roughly 6% of the market.* While CS common shareholders will continue to participate in the new, merged entity, the write-down of CS AT1 bonds reflects contractual features specific to Swiss AT1. This outcome would not be expected in other non-Swiss European or U.K. AT1s, given that the latter typically employ equity-style conversions and not permanent write-downs like Swiss AT1s; resolution authorities follow statutory law that requires respecting a specific creditor hierarchy respecting loss allocation to common equity holders.
Recent events have resulted in dislocations in the bonds of European banks, and, in our view, offer relative value opportunities given the diversity of bank business models, with many issuers still likely to present strong financial results this year. Investors in AT1s will likely demand higher risk premiums from issuers, which will need to be thoughtful regarding how to manage their AT1 call profiles, taking into account overall funding costs and the optimal amount of AT1 to include in their capital stack.
*Source: Bloomberg
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European Banks After Credit Suisse