Swiss Cheese: UBS/CS

The hills are alive, to the sound of a merger in Switzerland as a hasty shotgun marriage is arranged by regulators to have Union Bank of Switzerland (UBS) acquire Credit Suisse (CS) for CHF 0.76 (CHF 3bln, US$3.24bln) in UBS shares (no capital raise). Gobs of liquidity are on offer, CHF 200bln inclusive of the 50bln provided to Credit Suisse Wednesday past. UBS take “first-loss” of 5bln with a government guarantee for up to 9bln CHF (not likely required, barring further fall-out).

CS equity opened down 60% on Monday Mar 20,2023 as the terms of the “take-under” were announced. The market noise that echoes through the mountains is not for common equity holders, but for CoCo security holders. CS CoCo’s have been zeroed out. With over $3bln paid to CS common shareholders some may think they are living in the “upside down” from a priority of payment perspective, but the contract terms of AT1 bonds, also known as Enhanced Capital Notes (ECN’s) ranks holders behind common equity on a breach of contractual triggers (typically 2/3 capital write-downs, order of magnitude). Over US$17bln of such securities were issued by CS. Current valuation $0.00, a goose egg for all CS AT1 holders.

Contingent convertible securities have been issued in size since the 2007/2008 GFC with in excess of US$250bln now outstanding. Germany hears the echoes of said CoCo losses. Deutsche Bank (DB) 6% US$1.25bln AT1’s which were trading just shy of $90.00 in early March fell 10% to $79.00 and sit at $70.56 this morning at the time of writing. There is scant liquidity in sovereign bonds presently. Last week featured futures trading halts on SOFR and Fed Fund contracts on the CME. The exits for AT1 bonds are narrow, if not sealed. After a ferocious February for IG credit where U$140bln was issued, last week saw zero investment grade bonds brought to market.

DB 6.0% 2049 AT1

Batton to the Fed’s Powell stateside. If we see a 0.25% Fed Funds hike on Wednesday Mar 22nd we will know they are out of touch with the fragility of the market at present. The Fed has raised rates >400bp in a very short period of time, the pace in fact without precedent. The Fed/Treasury is complicit in the regional banking meltdown which remains front burner. The Swiss were not the only busy bees this weekend as numerous jets were seen in Nebraska, assumed to be regional bank CEOs. Buffett is not long CoCo securities, but he loves double digit preferred shares! Forced marriages and an unlimited FDIC limit appear to be next up.

Stay diligent. Keep your wits about you.

Caleb Gibbons, CFA, FRM (the Other Prof G)